15. On 1 January 2010, Elegant Fragrances Company issues £1,000,000 face value,

Question

15. On 1 January 2010, Elegant Fragrances Company issues £1,000,000 face value, five-year bonds with annual interest payments of E55,000 to be paid each 31 December. The market interest rate ib. percent. Using the effective interest rate method of amortization. Elegant Fragrances is most like record: A) an interest expense of £S5,000 on its 2010 income statement B) a liability of £982,674 on the 31 December 2010 balance sheet C) a £58,73 6 cash outflow from operating activity on the 2010 statement of cash flows Using the effective interest rate method, the reported interest expense of a bond issued at a premium will A) decrease over the term of the bond. B) increase over the term of the bond. C) remain unchanged over the term of the bond. be 17. A firm has revenues of $8,000 for each of three years. The firm estimates the warranty expense to 12.5% of revenues each year. An actual expenditure of $2,500 to meet warranty claims was not made until the third year. Warranty expenses cannot be recognized for tax purposes until they are a paid. The tax rate is 30%, which of the following is most accurate? ctually A) At the end of year 2 the company would show a deferred tax asset of $300 B) At the end of year 2 the company would show a deferred tax liability of $300 At the end of year 2 the company would show a deferred tax asset of $600 D) At the end of year 2 the company would show a deferred tax liability of $600 financial reporting purposes but they are not recognized for tax purposes. The firm is most likely t record: A) a deferred tax asset B) a deferred tax liability C) no deferred tax asset or liability 18. A firm incurred fines and expenses because of violation of a law. These expenses are recognized fo rtav nurnoces and straight-line depreciation fo

Explanation / Answer

15.

Issue pric of bond:

Option b. is correct as per the above workings.

16.

option .A is correct

When bonds are issued at premium, premium amortisation will reduce interest expense.

But in effective interest method model, higher amount of premium amortised at later periods which in turns result in lesser interest expense at later period.

17.

In case of warranty expenses it is not deducted until actually incurred for tax purposed.

So book income is less than tax income when recognised, results in deferred tax asset.

Option C. is correct

Because warranty claims are not made until 3rd year, means there is deferred tax asset having balance related first two years.

Amount of deferred tax asset at year 1= revenue * expected warranty loss * tax rate= 8000 *12.5% * 30%= 300

Amount of deferred tax benefit for year 2= 300

At the year end of year 2 deferred tax asset will still carry balances for 2 years = 300+300= 600

18.

Option c. is correct

Deferred taxes comes when there is a timing diferrence, in case of fines it is permanent diferrence and no deferred taxes recorded.

Interest amount: Face value 10,00,000 Coupon/stated Rate of interest 5.50% Frequency of payment(in months) 12 Interest amount 1000000*0.055*12/12= 55000 Present value calculation: yield to maturity/Effective rate 6.00% Effective interest per period(i) 0.06*12/12= 0.06 Number of interest payments (n): Years to redemption 5 Interest payments per year 1 Total interest payments(n) 5 Cash flow Discount factor Discounted cash flow Interest payments-Annuity (6%,5 periods) 55,000 4.2124 2,31,680.01 Principle payments -Present value (6%,5 periods) 10,00,000 0.7473 7,47,258.17 Bond price 9,78,938.18 Face value 10,00,000 Premium/(Discount) -21,062

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