Question

When issuing bonds or notes, Papaya Company incurs costs, such as legal and accounting fees, printing costs, and registration and underwriting fees. Papaya records these costs by combining them with any discount (or subtracting them from any premium) on the debt. Which of the following is an accurate statement regarding the company’s policy?

Multiple Choice

• The policy is inappropriate because these costs should be expensed in the period the debt is issued.

• The policy is inappropriate because these costs should be recorded in a Debt Issue Costs account and amortized over the term to maturity of the debt.

• This approach has the appeal of reflecting the effect that debt issue costs have on the effective interest rate because deducting debt issue costs lowers the carrying amount of the debt, which effectively increases the interest rate on that debt.

• This approach is conceptually correct because the net amount borrowed is higher, but interest payments are the same, so the effective rate of borrowing is lower.

Answer 1

Answer is option B. This is an inappropriate approach because these costs need to be deferred over the period of bond life. This is done because of matching principal.

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