- CFA Exams
- CFA Level I Exam
- Topic 3. Financial Statement Analysis
- Learning Module 25. Non-Current (Long-term) Liabilities
- Subject 1. Accounting for Bond Issuance, Bond Amortization, Interest Expense, and Interest Payments

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**CFA Practice Question**

Laker Corporation issued $250,000 in 20-year bonds payable, with 6% interest payable annually. At the time of the bond issuance, the market rate for similar quality investments was 5%. Present value factors are:

PVIF of $1, 20 periods, 6%, .31180

PVIF of Annuity of $1, 20 periods, 5%, 12.46221

PVIF of Annuity of $1, 20 periods, 6%, 11.46992

Bond discount (debit): 31,156

Bonds payable (credit): 250,000

Bond premium (credit): 31,156

Bonds payable (credit): 250,000

Bond premium (debit): 31,156

Bonds payable (credit): 281,156

Bond discount (credit): 31,156

Bonds payable (credit): 250,000

PVIF of $1, 20 periods, 5%, .37689

PVIF of $1, 20 periods, 6%, .31180

PVIF of Annuity of $1, 20 periods, 5%, 12.46221

PVIF of Annuity of $1, 20 periods, 6%, 11.46992

Laker's entry to record the sale is:

A. Cash (debit): 218,844

Bond discount (debit): 31,156

Bonds payable (credit): 250,000

B. Cash (debit): 281,156

Bond premium (credit): 31,156

Bonds payable (credit): 250,000

C. Cash (debit): 250,000

Bond premium (debit): 31,156

Bonds payable (credit): 281,156

D. Cash (debit): 281,156

Bond discount (credit): 31,156

Bonds payable (credit): 250,000

Correct Answer: B

Cash received is ($ 250,000 x .37689) + ($ 15,000 x 12.46221), or $281,156, which is greater than the bonds' face amount. The premium is $31,156 ($281,156 - $250,000). The 5% effective rate is used to compute cash received; the 6% coupon rate is used to compute the annual interest payment.

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**User Contributed Comments**
17

User |
Comment |
---|---|

intj |
The key answer says 6% rate is used to compute the annual interest payment, but the computation uses the 5% figure for annuity. So which one is correct? |

fuller |
6% is used to compute the actual interest payment, which includes both annuity (interest expense) and premium. The answer is correct. |

kalps |
NB. 250,000 20-yr bonds payable means 20 years maturity with payment of 250,000 in 20 years time. Assuming that they are redeemed at PAR |

tinku |
Fuller: In your explanation you said you are computing the interest payment based on 6%coupon rate. But your computation shows you are using annuity factor corresponding to 5%. Which one is correct? |

jwp2 |
Tinku: Interest is paid annually at the stated coupn rate--6%. The market price, and thus the proceeds, are determined by the prevailing rate at the time of issuance--5% |

Will1868 |
Think of it from an imvestment/fixed income perspective. The cash flows yearly are the I-PMT (6% coupon) - these are discounted at the prevailing market rate (5%). There is also the final cash flow of $250K (par) to retire the bonds. So if you sum the NPV of all future cash flows (using 5% as the discount) you get 281,156 (very easy with an HP by the way. |

haarlemmer |
In the exam, I will just look at the rates. As in this case, market rate is lower than the company rate, therefore, it must be sold at higher than face value and at a premium. Under this, answer could only be B. |

yanpz |
Based on Notes, should the answer be D? Credit to Bond Discount Payable? |

wollogo |
Answer is not D, the bond is issued at a premium not a discount. 281,156 > 250,000 |

uberstyle |
did we truly need the PVIF information? When I value a bond with 6% coupons at 5%, I get the same PV. Anything wrong with this approach in general? |

StanleyMo |
hello uber, is that your PMT stick to "market rate" amount? |

arkot90 |
in fact we dont have to compute sth as B is the only correct answer in terms of accounting for premium bonds. |

kutta2102 |
No calculations are required in this one - method of elimination works well. Here's how: the bond has to sell for a premium since the interest rate offered is better than the market rate. That leaves B&D as the only options. Then, one has to decide how the bond premium should be recorded in the ledger - the bond is sold at a premium and D uses an account called bond discount, which doesn't make sense. Therefore, B is the only choice left. |

YOUCANDOIT |
Thx kutta2102 |

thekobe |
you dont need to make calculations, just take a look at the cash, it should be more than 250,000 since the mkt rate is less than the interest rate. So you only have B or D, but again mkt rate is less than the interest rate, so its a bond sold at a premium |

Freddie33 |
Does nobody else not get what any of the numbers mean for the PV factors? |

walterli |
Entry must have a balance,so ... |