FAR · Select balance sheet accounts · 8 practice questions
Bonds and Notes: Carrying Amount and Debt Issuance Costs
For term debt at amortized cost, add unamortized premiums to face and subtract unamortized discounts and issuance costs. Below: a worked balance sheet calculation and free practice, with accrued interest kept separate.
Try one first
Hint
Focus on what current U.S. GAAP nets against a term debt liability at issuance, not just what gets amortized later.
Answer D. Under current U.S. GAAP, a bond issued below face creates a discount that reduces the liability, and debt issuance costs related to that term debt are presented as a direct deduction from the carrying amount of the liability. Because both the discount and the issuance costs exist at issuance and no amortization has occurred yet, both reduce the initial reported carrying amount.
Why not A: Both items exist at issuance and are reflected on the balance sheet from day one; amortization affects subsequent periods but the first interest payment is not the trigger for initial recognition.
Why not B: This reflects an older way some candidates remember (deferred asset treatment). Current guidance requires debt issuance costs related to recognized term debt to be shown as a deduction from the liability, not as a separate asset.
Why not C: A discount arises because the bond was issued for less than face value, so it affects the carrying amount immediately. Amortization spreads the discount over time but does not delay its initial recognition on the balance sheet.
Worked example
At December 31, Vale Co. has term bonds measured at amortized cost with a $750,000 face amount, a $35,000 unamortized discount, and $9,000 of unamortized issuance costs. Accrued interest is $7,000. No principal is due within the next 12 months. What amount is reported as noncurrent bonds payable?
| 1 | Subtract the unamortized discount$750,000 - $35,000 = $715,000 | $715,000 |
| 2 | Subtract unamortized issuance costs$715,000 - $9,000 = $706,000 | $706,000 |
| 3 | Keep accrued interest separate$706,000 + $0 = $706,000 | $706,000 |
Vale reports $706,000 as noncurrent bonds payable and $7,000 separately as interest payable.
Check: The two remaining deductions total $44,000, so bonds payable equals $750,000 - $44,000 = $706,000; accrued interest stays separate.
Key points
- Debt issuance costs for term debt are a contra-liability, not a separate asset.
- At issuance, ordinary term debt's carrying amount equals proceeds less debt issuance costs.
- Use remaining unamortized balances, not original costs or the current year's amortization.
- The same net presentation applies to term notes payable.
How the exam traps you
- Reporting the original issue price as the year-end carrying amount. Start with face and apply the remaining unamortized premium, discount, and issuance costs.
- Subtracting the discount but reporting issuance costs as a separate asset. Deduct both unamortized balances from the term debt liability.
- Adding accrued interest to bonds payable. Keep accrued interest in interest payable, separate from the debt's carrying amount.
Question 2
Hint
First allocate the gross proceeds between debt and equity using the relative standalone fair values, then apportion the directly attributable issuance costs using the same percentages; the debt-side cost reduces the liability.
Answer D. Allocate the $980,000 gross proceeds by relative fair values: debt proportion = $900,000 / ($900,000 + $100,000) = 90%, so debt is allocated $980,000 × 90% = $882,000. Apportion the $20,000 issuance costs using the same 90%: debt's share = $20,000 × 90% = $18,000. Subtract that from the debt allocation: $882,000 − $18,000 = $864,000. This approach is consistent with U.S. GAAP guidance for allocating proceeds and directly attributable costs between liability and equity components (see ASC 470-20).
Why not A: Tempting because it correctly allocates the $980,000 proceeds to debt by relative fair value (90% × $980,000 = $882,000), but it fails to account for the debt's share of directly attributable issuance costs, which reduce the debt carrying amount.
Why not B: This reflects allocating proceeds to debt ($882,000) and then subtracting the full $20,000 issuance cost. That overstates the cost allocated to debt; issuance costs must be apportioned between debt and equity, so only the debt's share ($18,000) reduces the debt.
Why not C: This equals the note's standalone fair value less all issuance costs ($900,000 − $20,000). It's incorrect because initial measurement requires allocating the gross proceeds between debt and equity first, and issuance costs are apportioned rather than charged entirely to the debt.
Question 3
Hint
Ask whether these issuance costs create a separate resource, increase the liability, or adjust the net amount at which the debt is reported.
Answer A. For a term note that is not measured at fair value, unamortized debt issuance costs are presented on the balance sheet as a direct deduction from the carrying amount of the related debt (similar to a discount). These costs are then amortized to interest expense over the life of the note. The stem excludes exceptions (for example, certain revolving credit arrangements).
Why not B: Historically these amounts were sometimes called deferred financing costs and shown as assets, but current U.S. GAAP requires presentation as a reduction of the related debt for term borrowings rather than as a separate noncurrent asset.
Why not C: Issuance costs do not increase the stated liability; they reduce the net carrying amount of the debt and are amortized as interest expense over time, so adding them to the principal would be incorrect.
Why not D: Although the costs ultimately affect interest expense, they are not expensed immediately for a term note without the fair value option; instead they are deferred as a contra-liability and amortized over the note's life.
Question 4
Hint
First decide whether the conversion option requires separate accounting. Then apply the required presentation for debt issuance costs (asset vs. deduction).
Answer B. No embedded feature requires separation, so the instrument is recorded as a single debt liability. Cash proceeds = $5,000,000 × 101% = $5,050,000. Under U.S. GAAP, debt issuance costs related to a recognized debt liability are presented as a direct deduction from that liability (ASC 835-30; see ASC 470), so initial carrying amount = $5,050,000 − $75,000 = $4,975,000.
Why not A: Tempts because it records the full cash proceeds and treats issuance costs as a capitalized deferred charge (an approach used by some historically). It is incorrect under current U.S. GAAP: issuance costs related to recognized debt are shown as a direct reduction of the debt carrying amount, not as a separate asset.
Why not C: Tempts by treating the 101 issue price premium ($50,000) as an equity component for the conversion feature. The stem states no embedded feature requires separate accounting, and issuance costs must also be accounted for, so you cannot both ignore issuance costs and create a separate equity component here.
Why not D: Tempts because it allocates net proceeds between debt (face less issuance costs) and equity so totals match net cash received. However, because no separation of the conversion option is required, the full net proceeds (after issuance costs) belong to the debt, there should be no additional paid-in capital for the conversion.
Question 5
Hint
Work item by item: first determine the bonds' carrying amount, then decide whether the note due next year stays current, and finally ask whether the unused revolver fee belongs in liabilities at all.
Answer B. Report the bonds at carrying amount: $4,000,000 − $90,000 unamortized discount − $30,000 unamortized debt issuance costs = $3,880,000. The $600,000 note can be classified as noncurrent because Reno entered into a noncancelable financing agreement before year-end, intends to refinance, and was in compliance, so include the $600,000 as long-term. The unused revolver commitment fee is not a liability (it is a deferred charge/asset). Total long-term debt and financial liabilities = $3,880,000 + $600,000 = $4,480,000.
Why not A: Tempting if a candidate reclassifies the $600,000 note as long-term but treats the $30,000 issuance costs incorrectly (for example, by adding them or not netting them against the bond). Debt issuance costs reduce the carrying amount of the related debt; the bonds are not $4,000,000 − $90,000 = $3,910,000 plus anything else.
Why not C: Tempting if a candidate incorrectly applies 'net financing costs reduce debt' to the unused revolver. Because no amount was outstanding on the revolver at year-end, the $12,000 commitment fee is a deferred cost (asset), not a reduction of reported debt, so subtracting $12,000 from the long-term total is incorrect.
Why not D: Reflects the common mistake of classifying the $600,000 note as current simply because it is due within one year. Given the qualifying noncancelable financing agreement in place at December 31 and Reno's intent and compliance, the note may be classified as noncurrent and included in long-term liabilities.
Question 6
Hint
Compute two separate remaining balances as of Year 2 end: the unamortized premium and the unamortized debt issuance costs. Then decide how each affects the carrying amount of term debt.
Answer B. The unamortized bond premium at December 31, Year 2 is $24,000 (original premium $40,000 less 2 years of straight-line amortization of $8,000 per year). The unamortized debt issuance costs are $10,800 (original costs $18,000 less 2 years of amortization of $3,600 per year). For term debt, unamortized issuance costs are presented as a direct deduction from the carrying amount, so the carrying amount equals $1,000,000 + $24,000 - $10,800 = $1,013,200.
Why not A: This equals face amount plus the unamortized premium after two years but ignores that debt issuance costs reduce the carrying amount as a direct deduction; therefore it overstates the reported liability.
Why not C: This equals the original cash received ($1,040,000) less the unamortized issuance costs, which neglects that the premium is amortized and affects the liability over time. It therefore overstates the carrying amount.
Why not D: This equals face amount less the unamortized issuance costs and ignores the remaining unamortized premium. A bond issued at a premium is reported above face value before considering issuance costs, so this understates the carrying amount.
Question 7
Hint
Begin with the cash proceeds received and then recall how directly attributable issuance costs are presented when debt is measured at amortized cost.
Answer D. Under U.S. GAAP (ASU 2015-03), debt issuance costs are presented as a direct deduction from the carrying amount of the related liability when measured at amortized cost. The initial carrying amount equals proceeds less directly attributable issuance costs: $980,000 − $15,000 = $965,000.
Why not A: Tempts because it is the bond's face (maturity) amount. Incorrect because the bonds were issued at a discount and issuance costs are deducted from the liability at initial recognition, so carrying amount is less than face.
Why not B: Tempts because it equals the cash proceeds received from investors. Incorrect because it ignores directly attributable issuance costs, which must be deducted from the liability under amortized-cost accounting.
Why not C: Tempts because a candidate might mistakenly add issuance costs to proceeds or misunderstand the presentation of transaction costs. Incorrect because issuance costs reduce the carrying amount rather than increase it; the correct initial carrying amount is $980,000 − $15,000 = $965,000.
Question 8
Hint
Start with the bond's face amount, then think about which items reduce the carrying amount of a term debt liability at issuance.
Answer D. At issuance the carrying amount equals the face amount less the bond discount and less debt issuance costs. The bonds sold at 97 produced proceeds of $1,940,000 (a $60,000 discount), and third-party issuance costs of $40,000 are presented as a direct deduction from the related debt, so the carrying amount is $1,900,000.
Why not A: This is the legal face amount only. Under U.S. GAAP the balance sheet shows the carrying amount, which reflects both any discount (or premium) and related debt issuance costs, not just face value.
Why not B: This equals the cash proceeds (bonds at 97) and correctly reflects the discount, but it ignores the separate deduction for debt issuance costs, which also reduce the carrying amount at issuance.
Why not C: This subtracts the $40,000 issuance costs from face value but fails to account for the $60,000 discount from selling the bonds at 97, so it overstates the carrying amount.
Common questions
How do you calculate the carrying amount of bonds payable?
For term debt at amortized cost, start with face, add any unamortized premium, and subtract any unamortized discount and issuance costs. Use balances remaining at the balance sheet date.
Are unamortized debt issuance costs an asset under GAAP?
For recognized term debt measured at amortized cost, they reduce the related debt liability. Do not report them as a separate deferred financing asset.
Is accrued interest included in a bond's carrying amount?
No. Report accrued interest separately as interest payable, not as part of bonds payable.
Watch it solved
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Bond Interest & Early Extinguishment | CPA FAR Simulation (TBS) on YouTube
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