Abel Corporation has $10,000,000 of 10.5 percent, 20-year bonds dated June 1, 20x7, with interest payment dates of May 31 and November 30.

After ten years the bonds are callable at 104, and each $1,000 bond is convertible into 25 shares of $20 par value common stock. The company’s fiscal year ends on December 31. It uses the straight-line method to amortize bond premiums or discounts.

Required 1. Assume the bonds are issued at 103 on June 1, 20x7.

a. How much cash is received?

b. How much is Bonds Payable?

c. What is the difference between a and b called and how much is it?

d. With regard to the bond interest payment on November 30, 20x7:

(1) How much cash is paid in interest?

(2) How much is the amortization?

(3) How much is interest expense?

2. Assume the bonds are issued at 97 on June 1, 20x7.

a. How much cash is received?

b. How much is Bonds Payable?

c. What is the difference between a and b called and how much is it?

d. With regard to the bond interest payment on November 30, 20x7:

(1) How much cash is paid in interest?

(2) How much is the amortization?

(3) How much is interest expense?

3. Assume the issue price in requirement 1 and that the bonds are called and retired ten years later.

a. How much cash will have to be paid to retire the bonds?

b. Is there a gain or loss on the retirement, and if so, how much is it?

4. Assume the issue price in requirement 2 and that the bonds are converted to common stock ten years later.

a. Is there a gain or loss on the conversion, and if so, how much is it?

b. How many shares of common stock are issued in exchange for the bonds?

c. In dollar amounts, how does this transaction affect the total liabilities and the total stockholders’ equity of the company? In your answer, show the effects on four accounts.

5. User Insight: Assume that after ten years, market interest rates have dropped significantly and that the price on the company’s common stock has risen significantly. Also assume that management wants to improve its credit rating by reducing its debt to equity ratio and that it needs what cash it has for expansion. Which approach would management prefer—the approach and result in requirement 3 or 4? Explain your answer. What would be a disadvantage of the approach you chose?

Effective Interest Method