Deck 11: Long-Term Liabilities

Question 1

When it is necessary to impute an interest rate in connection with a note payable, the rate should be

A) Two-thirds of the prime rate effective at the time the obligation is incurred
B) The same as that used in the GNP Implicit Price Deflator
C) At least equal to the rate at which the debtor can obtain financing of a similar nature from other sources at the date of the transaction
D) As near zero as can be justified

Answer 1

C

Question 2

Unamortized bond discount should be reported on the balance sheet of the issuer as

A) A direct deduction from the face amount of the debt
B) A direct deduction from the present value of the debt
C) A deferred charge
D) Part of the issue costs

Answer 2

A

Question 3

The rate of interest actually earned by bondholders is called the

A) Effective rate
B) Stated rate
C) Coupon rate
D) Nominal rate

Answer 3

A

Question 4

A threat of expropriation of assets that is reasonably possible, and for which the amount of loss can be reasonably estimated, is an example of a (an)

A) Loss contingency that should be disclosed, but not accrued
B) Loss contingency that should be accrued and disclosed
C) Appropriation of retained earnings against which losses should be charged
D) General business risk which should not be accrued and need not be disclosed

Question 5

Theoretically, a bond payable should be reported at the present value of the interest discounted at

A) Stated interest rate for both principal and interest
B) Effective interest rate for both principal and interest
C) Stated interest rate for principal and effective interest rate for interest
D) Effective interest rate for principal and stated interest rate for interest

Question 6

Cole Manufacturing Corporation issued bonds with a maturity amount of $200,000 and a maturity 10 years from date of issue. If the bonds were issued at a premium, this indicates that

A) The yield (effective or market) rate of interest exceeded the stated (coupon) rate
B) The stated rate of interest exceeded the yield rate
C) The yield and stated rates coincided
D) No necessary relationship exists between the two rates

Question 7

The term used for bonds that are secured only by the general credit of a company is

A) Indebenture bonds
B) Callable bonds
C) Debenture bonds
D) Mortgage bonds

Question 8

When a note payable is exchanged for property, goods, or services, the stated interest rate is presumed to be appropriate unless

A) No interest rate is stated
B) The stated interest rate is inappropriate.
C) The stated face amount of the note is materially different from the current cash sales price for similar items or from current fair value of the note
D) All of these answers are correct

Question 9

Financial leverage is likely to be a good financial strategy for stockholders of companies having

A) Cyclical high and low amounts of reported earnings
B) Steady amounts of reported earnings
C) Volatile fluctuation in reported earnings over short periods of time
D) Steadily declining amounts of reported earnings

Question 10

If a debt instrument with no ready market is exchanged for property whose fair value is currently indeterminable.

A) The board of directors of the entity receiving the property should estimate a value for the property that will serve as a basis for the transaction
B) The present value of the debt instrument must be approximated using an imputed interest rate
C) The directors of both entities involved in the transaction should negotiate a value to be assigned to the property
D) It should not be recorded on the books of either party until the fair value of the property becomes evident

Question 11

If bonds are issued initially at a discount and the straight-line method of amortization is used for the discount, interest expense in the earlier years will be

A) Greater than if the compound interest method were used
B) The same as if the compound interest method were used
C) Less than if the compound interest method were used
D) Less than the amount of the interest payments

Question 12

If a bond was sold at 97, the market rate of interest was:

A) Equal to the coupon rate
B) Greater than the stated rate
C) Equal to the stated rate
D) Less than the stated rate

Question 13

A loss from early extinguishment of debt, if material, should be reported as a component of income

A) After cumulative effect of accounting changes and after discontinued operations of a segment of a business
B) After cumulative effect of accounting changes and before discontinued operations of a segment of a business
C) Income from continuing operations
D) Before cumulative effect of accounting changes and before discontinued operation s of a segment of a business

Question 14

Financial leverage refers to the

A) Amount of working capital
B) Amount of capital provided by owners
C) Use of borrowed money to increase the return to owners
D) Number of times interest is earned

Question 15

How would the amortization of premium on bonds payable affect each of the following? Carrying value of
Bond Net Income

A) Increase Decrease
B) Increase Increase
C) Decrease Decrease
D) Decrease Increase

Question 16

The covenants and other terms of the agreement between the issuer of bonds and the lender are set forth in the

A) Registered bond
B) Bond coupon
C) Bond indenture
D) Bond debenture

Question 17

Taft Company sells Lee Company a machine, the usual cash price of which is $10,000, in exchange for an $11,800 non-interest-bearing note due three years from date. If Taft initially records the note at $10,000, the overall effect will be

A) A correct sales price and correct interest revenue
B) A correct sales price and understated interest revenue
C) An understated sales price and understated interest revenue
D) An overstated interest price and understated interest revenue

Question 18

When bonds are issued at a discount, interest expense over the term of debt equals the cash interest paid

A) Minus the discount
B) Minus the discount minus the par value
C) Plus the discount
D) Plus the discount plus the par value

Question 19

An example of an item that is not a liability is

A) Dividends payable in stock
B) Advances from customers on contracts
C) Accrued estimated warranty costs
D) The portion of long-term debt due within one year

Question 20

In the situation described in problem 15, if Lee records the asset and note at $11,800, the overall effect will be

A) A correct acquisition cost and correct interest expense
B) A correct acquisition cost and understated interest expense
C) An understated acquisition cost and understated interest expense
D) An overstated acquisition cost and understated interest expense

Question 21

An estimated loss from a loss contingency should be accrued when

A) It is probable at the date of the financial statements that a loss has been incurred and the amount of the loss can be reasonably estimated
B) The loss has been incurred by the date of the financial statements and the amount of the loss may be material
C) It is probable at the date of the financial statements that a loss has been incurred and the amount of the loss may be material
D) It is probable that a loss will be incurred in a future period and the amount of the loss can be reasonably estimated

Question 22

In general, derivative instruments are

A) Not reported in a company's balance sheet because their impact on the company is not yet known.
B) Reported in the balance sheet at fair value and changes in their fair value are reported in earnings.
C) Reported in the balance sheet at historical cost and changes in their fair value are reported in earnings.
D) Reported in the balance sheet at fair value and changes in their fair value are reported in other comprehensive income.

Question 23

A debtor and a creditor have negotiated new terms on a note. How can you determine whether the restructuring is a troubled debt restructure?

A) If the interest rate as stated in the restructuring agreement has been reduced relative to the original loan agreement
B) If the present value of the restructured flows using the original interest rate is less than the market value of the original debt at the date of the restructure
C) If the present value of the restructured flows using the original interest rate is less than the book value of the debt at the date of the restructure
D) If the interest rate that equates (1) the book value of the debt at the date of the restructure and (2) the present value of restructured cash flows, exceeds the original interest rate

Question 24

The following data pertain to Mahler Company's operations for the year ended December 31, 2017:
Operating income : $800,000
Interest expense : 100,000
Income before income tax : 700,000
Income tax expense : 210,000
Net income : $490,000
The times interest earned ratio is

A) 4.9 to 1
B) 5.6 to 1
C) 7.0 to 1
D) 8.0 to 1

Question 25

For the issuer of a 10-year term bond, the amount of amortization using the interest method would increase each year if the bond was sold at a Discount Premium

A) No No
B) Yes Yes
C) No Yes
D) Yes No

Question 26

The times interest earned ratio is computed by dividing

A) Income before income taxes and interest expense by interest expense
B) Income before taxes by interest expense
C) Net income by interest expense.
D) Net income and interest expense by interest expense

Question 27

A two-year note was issued in an arm's-length transaction at face value solely for cash at the beginning of the year. There were no other rights or privileges exchanged. The interest rate is specified at 10 percent per year. Principal and interest are payable at maturity. The prevailing rate of interest for a loan of this type is 15 percent per year. What annual interest rate should be used to record interest expense for this year and next year? This year Next Year

A) 10 percent 15 percent
B) 10 percent 10 percent
C) 15 percent 10 percent
D) 15 percent 15 percent

Question 28

Gain contingencies are usually recognized in the income statement when

A) Realized
B) Occurrence is reasonably possible, and the amount can be reasonably estimated
C) Occurrence is probable and the amount can be reasonably estimated
D) The amount can be reasonably estimated

Question 29

ABC Company has a note payable that is due six months after its year end. Under which of the following conditions will ABC be able to classify the note as a long-term debt.

A) ABC cannot classify the note as long term because it is due within the current operating cycle or one year, whichever is longer.
B) ABC can classify the note as long term because it is due next year.
C) ABC can classify the note as long term because management intends to refinance it with long term debt and has an agreement to do so with a qualified creditor.
D) ABC can classify the note as long term because it is a 10 year note and management intends to pay the maturity value at the end of the 10-year period.

Question 30

The interest rate used to calculate the cash interest payments by the issuer of bonds is

A) The market rate of interest
B) The effective interest rate
C) The stated interest rate
D) Equal to the actual interest expense rate

Question 31

Ace Corporation has a debt to total assets ratio of 65%. This tells the user of Ace's financial statements

A) Ace is getting a 35% return on its assets
B) There is a risk Ace cannot pay its debts as they come due
C) 65% of the assets are financed by the stockholders
D) Ace should issue more debt to reduce its risk

Question 32

How should the value of warrants attached to a debt security be account for?

A) No value assigned
B) A separate portion of paid-in capital
C) An appropriation of retained earnings
D) A liability

Question 33

A zero-coupon bond is different from a typical bond issue because

A) The investor can clip the coupons and get paid for the periodic interest on the bond while a typical bond does not have coupons.
B) It is reported in the balance sheet net of the discount on the bond.
C) The zero-coupon bond's deep discount is reported as an asset and a typical bond that is issued at a discount is reported net of the discount.
D) It does not pay any periodic interest while the typical bond does.

Question 34

A deferred credit meets the definition of a liability because

A) It is a probable future sacrifice of assets as the result of a past transaction or event.
B) It is a present obligation to transfer assets to another entity.
C) It is an accrual representing an obligation to pay money in the future.
D) It is a present obligation to provide services to another entity.

Question 35

The current accounting treatment for convertible debt is to treat it as straight debt. This treatment can be defended on what basis?

A) Convertible debt is a complex financial instrument.
B) Convertible debt comprises two financial instruments - a debt instrument and the option to convert.
C) The debt instrument and the option to convert are not separable.
D) The option to convert is equity.

Question 36

Under a troubled debt restructuring that results in a modification of terms the debtor will report interest expense when

A) The debtor reports a gain on restructuring.
B) The future cash flows under the restructuring agreement are less than the company's obligation at the date the restructuring takes place.
C) Always because the troubled debtor has a new agreement that obligates the company to make payments in the future.
D) The debtor reports no gain on restructuring.

Question 37

In a troubled debt restructuring in which the debt is continued with modified terms and the carrying amount of the debt is less than the total future cash flows,

A) A gain should be recognized by the debtor
B) No interest expense or revenue should be recognized in the future
C) A loss should be recognized by the debtor
D) A new effective-interest rate must be computed

Question 38

For a trouble debt restructuring involving only modification of terms, it is appropriate for a debtor to recognize a gain when the carrying amount of the debt

A) Exceeds the total future cash payments specified by the new terms
B) Is less than the total future cash payments specified by the new terms
C) Exceeds the present value specified by the new terms
D) Is less than the present value specified by the new terms

Question 39

An unearned revenue is an example of a(an)

A) Deferred credit.
B) Accrued liability.
C) Customer billing that takes place before a job is finished.
D) Accounts receivable.

Question 40

Current accounting treatment for gain contingencies is different from the accounting treatment for loss contingencies. Which accounting concept is this differential concept consistent with?

A) Conservatism
B) Materiality
C) Full disclosure
D) Revenue recognition

Question 41

What is off-balance sheet financing and why do companies engage in off-balance sheet financing?

Question 42

The long-term debt to assets ratio is computed by dividing

A) Long-term debt by total assets
B) Total assets by total liabilities
C) Total liabilities by total assets
D) Current liabilities by total assets

Question 43

List the three methods of accounting for bonds refunding. Under current GAAP, how are bond refundings recorded?

Question 44

Discuss accounting for long-term notes payable as originally described in APB Opinion No. 21.

Question 45

Discuss the two methods of accounting for bond discounts or premiums. Include in you answer the preferable treatment under GAAP.

Question 46

How are compound financial instruments accounted for under IAS No. 32?

Question 47

How are bond issue costs recorded and reported on corporate financial statements?

Question 48

Obtain the financial statements of a company and ask the students to compute the:
a. Long-term debt to assets ratio
b. Interest coverage ratio
c. Debt service coverage ratio

Question 49

Explain how the selling price of a bond is determined.

Question 50

What is a derivative? Describe the accounting treatment for fair value and cash flow hedges required by SFAS No. 133.

Question 51

Discuss the difference between the straight-line and the effective interest methods of bond premium or discount amortizations.

Question 52

What is a zero-coupon bond? Discuss accounting for zero-coupon bonds.

Question 53

List and discuss five factors that may be employed to determine if a particular financial instrument is a debt or equity security.

Question 54

Define the following terms:
a. Mortgage bonds
Bonds that are secured by a lien against specific assets of the corporation are known as mortgage bonds.
b. Debenture bonds
Debenture bonds are not secured by any property or assets, and their marketability is based on the corporation's general credit.

Question 55

Define the following terms:
a. Forward
b. Future
c. Option
d. Swap
e. Hybrid

Question 56

Discuss the definition and the proper accounting for mandatorily redeemable preferred stock.

Question 57

What are the general rules for the initial and subsequent measurement of financial liabilities under IFRS No. 9?

Question 58

Discuss the four basic reasons why a corporation may wish to issue debt rather than equity securities.

Question 59

Discuss the factors that might motivate corporate management to decide to issue convertible debt.

Question 60

What is a troubled debt restructuring? How is a troubled debt restructuring accomplished?