Welcome back to part three, the final in our three part series about how to get the most out of your multiple choice (MCQ) study time. After discussing the four general ways to get more out of your study time and how to anchor all of your questions in the general accounting cycle in part one, and how to take that foundation-level knowledge to the next level and deep-dive into recommended topics in part two, for part three we are saying enough with the theory, already… let’s look at an example of how to work through a topic.
FAR 2-Q177 F248. A company issued a bond with a stated rate of interest that is less than the effective interest rate on the date of issuance. The bond was issued on one of the interest payment dates. What should the company report on the first interest payment date?
- An interest expense that is less than the cash payment made to bondholders.
- An interest expense that is greater than the cash payment made to bondholders.
- A debit to the unamortized bond discount.
- A debit to the unamortized bond premium.
(in case you wondered, the correct answer is A).
Now that we have our question, let’s work through the topic. The first step is to identify where in the accounting cycle this MCQ is focused. What is your best guess?
After identifying where in the accounting cycle the MCQ is focused, the second step is to focus on any impact to journal entries, financial statements, disclosures, and any exceptions. These would be the questions that we would ask when studying this particular MCQ:
- What are the journal entries for issuing the bonds, amortizing the bonds, and retiring/extinguishing the bonds early? Don't forget the amortization schedule from which you will get the figures for the journal entries!
- Where does interest expense, amortization of bond issue costs, and gain/loss on extinguishment of bonds appear on the multiple-step income statement?
- Where does the discount on bonds payable, premium on bonds payable, bond issue costs, bonds payable (carrying value and face value), and interest payable appear on the balance sheet?
- How is the amortization of bond discount added back to Net Income in the operating section? How is the amortization of bond premium subtracted from Net Income in the operating section? How is the amortization of bond issue costs added back to Net Income in the operating section? How is interest paid disclosed for the indirect method of presentation versus the direct method of presentation?
- What about bond sinking funds and maturing bonds? What are their disclosure boundaries (hint: they require FIVE YEARS of detailed disclosures).
- What is the EXCEPTION for regular accounting for bonds? FYI, it is to elect the fair value option under ASC 825. In that case, there is NO discount and NO premium reported on the balance sheet. You just mark-to-market the liability at each balance sheet date and record a gain or loss on the income statement.
Once you start working through the question, it’s easy to see that something as simple as “what should the company report on the first interest payment date” can turn into a page or more of notes… But that’s the point. When you are struggling with a topic, take the question and use it as a starting point to know it inside and out.
And for those of you who are overachievers, once you have these steps in US GAAP locked down, move on to compare the differences in terminology and treatment for IFRS.
Part One: click here to read
Part Two: click here to read