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Chapter 14: Q11Q (page 753)

Question: What is the “call” feature of a bond issue? How does the call feature affect the amortization of bond premium or discount?

Short Answer

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Answer

A call feature is a characteristic in the contract of bond that permits the issuer to repay bonds at a stated price within specified future time interval. The call feature has no effect on the amortization of bond premium or discount.

Step by step solution

01

Meaning of bond issue

Bond issue is a method adopted by the firms for raising money. Herein, the investor agrees to give the corporation a specified amount of money for a particular time period. In return, the investor obtains regular payment of interest.

02

“Call” feature of a bond issue

The call feature of a bond issue permits the issuer the advantage of buying, after a specified date at a aforesaid price, outstanding bonds with the motive of diminishing indebtedness or taking benefit of lesser rates of interest.

03

The way by which the call feature affects the amortization of bond premium or discount

The call feature remains unaffected by the amortization of bond discount or premium as untimely redemption is uncertain, the term of bonds is to be used for the cause of amortization.

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Most popular questions from this chapter

(b) What type of concessions might a creditor grant the debtor in a troubled-debt situation?

On January 1, 2017, Nichols Company issued for \(1,085,800 its 20-year, 11% bonds that have a maturity value of \)1,000,000 and pay interest semiannually on January 1 and July 1. The following are three presentations of the long-term liability section of the balance sheet that might be used for these bonds at the issue date.

1

Bonds payable (maturing January 1, 2037)

\(1,000,000

Unamortized premium on bonds payable

85,800

Total bond liability

\)1,085,800

2

Bonds payable—principal (face value \(1,000,000 maturing January 1, 2037)

\) 142,050a

Bonds payable—interest (semiannual payment \(55,000)

943,750b

Total bond liability

\)1,085,800

3

Bonds payable—principal (maturing January 1, 2037)

\(1,000,000

Bonds payable—interest (\)55,000 per period for 40 periods)

2,200,000

Total bond liability

\(3,200,000

aThe present value of \)1,000,000 due at the end of 40 (6-month) periods at the yield rate of 5% per period

bThe present value of \(55,000 per period for 40 (6-month) periods at the yield rate of 5% per period.

Instructions

(a) Discuss the conceptual merit(s) of each of the date-of-issue balance sheet presentations shown above for these bonds.

(b) Explain why investors would pay \)1,085,800 for bonds that have a maturity value of only $1,000,000.

(c)Assuming that a discount rate is needed to compute the carrying value of the obligations arising from a bond issue at any date during the life of the bonds, discuss the conceptual merit(s) of using for this purpose: (1) The coupon or nominal rate. (2) The effective or yield rate at date of issue.

(d)If the obligations arising from these bonds are to be carried at their present value computed by means of the current market rate of interest, how would the bond valuation at dates subsequent to the date of the issue be affected by an increase or a decrease in the market rate of interest?

BE14-2 (L01) The Colson Company issued $300,000 of 10% bonds on January 1, 2017. The bonds are due January 1, 2022, with interest payable each July 1 and January 1. The bonds are issued at face value. Prepare Colson’s journal entries for (a) the January issuance, (b) the July 1 interest payment, and (c) the December 31 adjusting entry.

Distinguish between the following interest rates for bonds payable:

(a)Yield rate

(b) Nominal Rate

(c) Stated rate

(d) Market rate

(e) Effective rate

When is the stated interest rate of a debt instrument presumed to be fair?
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