Deck 10: Accounting for Long-Term Liabilities

Question 1

Mortgage contracts grant the lender the right to be paid from the cash proceeds of the sale of a borrower's assets identified in the mortgage if the borrower fails to make the required payments.

Answer 1

True

Question 2

The legal contract between the issuing corporation and the bondholders is called the bond indenture.

Answer 2

True

Question 3

A disadvantage of bond financing over equity financing is the burden on the cash flows of the company.

Answer 3

True

Question 4

An installment note is an obligation of the issuing company that requires a series of periodic payments to the lender.

Question 5

Payments on an installment note normally include the accrued interest expense plus a portion of the amount borrowed.

Question 6

Issuers of coupon bonds are not allowed to deduct the interest expense on their tax returns.

Question 7

Mortgage bonds are backed only by the good faith and credit of the issuing company.

Question 8

A basic present value concept is that cash paid or received in the future has more value now than the same amount of cash received today.

Question 9

A bond's par value is not necessarily the same as its market value.

Question 10

Callable bonds can be exchanged for a fixed number of shares of the issuing corporation's common stock.

Question 11

A company invests $10,000 at 7% compounded annually. At the end of the second year, the company should have $11,400 in the fund.

Question 12

A basic present value concept is that cash paid or received in the future has less value now than the same amount of cash today.

Question 13

One of the similarities of bond and equity financing is that both dividends and equity distribution payments are tax deductible.

Question 14

Term bonds are scheduled for maturity on one specified date, whereas serial bonds mature at more than one date.

Question 15

Compounded means that interest during a second period is based on the total amount borrowed plus the interest accrued in the first period.

Question 16

Callable bonds have an option exercisable by the issuer to retire them at a stated dollar amount prior to maturity.

Question 17

Debentures always have specific assets of the issuing company pledged as collateral.

Question 18

The carrying value of a long-term note is computed as the present value of all remaining future payments, discounted using the market rate at the time of issuance.

Question 19

A particular feature of callable bonds is that they reduce the bondholder's risk by requiring the issuer to create a sinking fund of assets set aside at specified amounts and dates to repay the bonds at maturity.

Question 20

Bonds and long-term notes are similar in that they are typically transacted with multiple lenders.

Question 21

Operating leases are long-term or noncancelable leases in which the lessor transfers substantially all the risks and rewards of ownership to the lessee.

Question 22

The present value of an annuity can be best or quickly computed as the sum of the individual future values for each payment.

Question 23

The factor for the present value of an annuity at 8% for 10 years is 6.7101. This implies that an annuity of ten $15,000 payments at 8% yields a present value of $2,235.

Question 24

Interest payments on bonds are determined by multiplying the par value of the bond by the stated contract rate.

Question 25

Collateral from unsecured loans may be sold to offset the loan obligation if the loan is in default.

Question 26

An advantage of bond financing is that issuing bonds does not affect owner control.

Question 27

An annuity is a series of equal payments at equal time intervals.

Question 28

An advantage of lease financing is the lack of an immediate large cash payment for the leased asset.

Question 29

Return on equity increases when the expected rate of return from the acquired assets is higher than the interest rate on the debt issued to finance the acquired assets.

Question 30

A company with a low level of liabilities in relation to stockholders' equity is likely to have a very high debt-to-equity ratio.

Question 31

A lessee has substantially all of the benefits and risks of ownership in an operating lease.

Question 32

The use of debt financing ensures an increase in return on equity.

Question 33

A bond is an issuer's written promise to pay an amount identified as the par value of the bond along with interest.

Question 34

A company's ability to issue unsecured debt depends on its credit standing.

Question 35

A disadvantage of an operating lease is the inability to deduct rental payments in computing taxable income.

Question 36

A lease is a contractual agreement between a lessor and a lessee that grants the lessee the right to use the asset for a period of time in return for cash payment(s) to the lessor.

Question 37

A pension plan is a contractual agreement between an employer and its employees to provide benefits to employees after they retire.

Question 38

The factor for the present value of an annuity for 6 years at 10% is 4.3553. This implies that an annuity of six $2,000 payments at 10% would equal $8,710.60.

Question 39

The contract rate of interest is the rate that borrowers are willing to pay and lenders are willing to accept for a particular bond and its risk level.

Question 40

Bond interest paid by a corporation is an expense, whereas dividends paid are not an expense of the corporation.

Question 41

A company's debt-to-equity ratio was 1.0 at the end of Year 1. By the end of Year 2, it had increased to 1.7. Since the ratio increased from Year 1 to Year 2, the degree of risk in the firm's financing structure decreased during Year 2.

Question 42

When the contract rate on a bond issue is less than the market rate, the bonds will generally sell at a discount.

Question 43

The debt-to-equity ratio enables financial statement users to assess the risk of a company's financing structure.

Question 44

The debt-to-equity ratio is calculated by dividing total stockholders' equity by total liabilities.

Question 45

If a bond's interest period does not coincide with the issuing company's accounting period, an adjusting entry is necessary to recognize bond interest expense accruing since the most recent interest payment.

Question 46

The market value (issue price) of a bond is equal to the present value of all future cash payments provided by the bond.

Question 47

Two common ways of retiring bonds before maturity are to (1) exercise a call option or (2) purchase them on the open market.

Question 48

On January 1, a company issued a $500,000, 10%, 8-year bond payable, and received proceeds of $473,845. Interest is payable each June 30 and December 31. The total interest expense on the bond over its eight-year life is $400,000.

Question 49

A discount on bonds payable occurs when a company issues bonds with an issue price less than par value.

Question 50

A company has assets of $350,000 and total liabilities of $200,000. Its debt-to-equity ratio is 0.6.

Question 51

The market rate for bonds is generally higher when the time period to maturity is longer due to the risk of adverse events occurring over the time period.

Question 52

The carrying (book) value of a bond payable is the par value of the bonds plus any discount or minus any premium.

Question 53

A 10-year bond issue with a $100,000 par value, 8% annual contract rate, with interest payable semiannually means that the issuer must repay $100,000 at the end of 10 years and make 20 semiannual interest payments of $4,000 each.

Question 54

The carrying (book) value of a bond at the time when it is issued is always equal to its par value.

Question 55

When the contract rate is above the market rate, a bond sells at a discount.

Question 56

A discount reduces the interest expense of a bond over its life.

Question 57

The contract rate on previously issued bonds changes as the market rate of interest changes.

Question 58

The effective interest method assigns a bond interest expense amount that increases over the life of a premium bond.

Question 59

The issue price of bonds is found by computing the future value of the bond's cash payments, discounted at the market rate of interest.

Question 60

Premium on Bonds Payable is an adjunct or accretion liability account.

Question 61

Secured bonds:

A)Are called debentures.
B)Have specific assets of the issuing company pledged as collateral.
C)Are backed by the issuer's bank.
D)Are subordinated to those of other unsecured liabilities.
E)Are the same as sinking fund bonds.

Question 62

The equal total payments pattern for installment notes consists of changing amounts of interest but constant amounts of principal over the life of the note.

Question 63

Promissory notes that require the issuer to make a series of payments consisting of both interest and principal are:

A)Debentures.
B)Discounted notes.
C)Installment notes.
D)Indentures.
E)Investment notes.

Question 64

A company borrowed $40,000 cash from the bank and signed a 6-year note at 7% annual interest. The present value of an annuity factor for 6 years at 7% is 4.7665. The annual annuity payments equal:

A)$10,489.88.
B)$8,391.91.
C)$40,000.00.
D)$52,450.00.
E)$190,660.00.

Question 65

When convertible bonds are converted to a company's stock, the carrying value of the bonds is transferred to equity accounts and no gain or loss is recorded.

Question 66

A company purchased equipment and signed a 7-year installment loan at 9% annual interest. The annual payments equal $9,000. The present value of an annuity factor for 7 years at 9% is 5.0330. The present value of the loan is:

A)$9,000.
B)$5,033.
C)$63,000.
D)$57,330.
E)$45,297.

Question 67

Bonds that have an option exercisable by the issuer to retire them at a stated dollar amount prior to maturity are known as:

A)Convertible bonds.
B)Sinking fund bonds.
C)Callable bonds.
D)Serial bonds.
E)Junk bonds.

Question 68

The carrying value of bonds at maturity always equals:

A)the amount of cash originally received in exchange for the bonds.
B)the par value of the bond.
C)the amount of discount or premium.
D)the amount of cash originally received in exchange for the bonds plus any unamortized discount or less any premium.
E)$0.

Question 69

The party that has the right to exercise a call option on callable bonds is:

A)The bondholder.
B)The bond issuer.
C)The bond indenture.
D)The bond trustee.
E)The bond underwriter.

Question 70

The contract between the bond issuer and the bondholders identifying the rights and obligations of the parties, is called a(n):

A)Debenture.
B)Bond indenture.
C)Mortgage.
D)Installment note.
E)Mortgage contract.

Question 71

Bonds owned by investors whose names and addresses are recorded by the issuing company, and for which interest payments are made with checks or cash transfers to the bondholders, are called:

A)Callable bonds.
B)Serial bonds.
C)Registered bonds.
D)Coupon bonds.
E)Bearer bonds.

Question 72

A bondholder that owns a $1,000, 10%, 10-year bond has:

A)Ownership rights in the issuing company.
B)The right to receive $10 per year until maturity.
C)The right to receive $1,000 at maturity.
D)The right to receive $10,000 at maturity.
E)The right to receive dividends of $1,000 per year.

Question 73

A company borrowed cash from the bank by signing a 5-year, 8% installment note. The present value of an annuity factor at 8% for 5 years is 3.9927. Each annual payment equals $75,000. The present value of the note is:

A)$56,352.84.
B)$93,921.41.
C)$375,000.
D)$299,452.50.
E)$187,842.81.

Question 74

A disadvantage of bond financing is:

A)Bonds do not affect owners' control.
B)Interest on bonds is tax deductible.
C)Bonds can increase return on equity.
D)It allows firms to trade on the equity.
E)Bonds pay periodic interest and the repayment of par value at maturity.

Question 75

A contract pledging title to assets as security for a note or bond is known as a(an):

A)Sinking fund.
B)Mortgage.
C)Equity.
D)Lease.
E)Indenture.

Question 76

A bond traded at 102½ means that:

A)The bond pays 2.5% interest.
B)The bond traded at 102.5% of its par value.
C)The market rate of interest is 2.5%.
D)The bonds were retired at $1,025 each.
E)The market rate of interest is 2 ½ % above the contract rate.

Question 77

Bonds that mature at more than one date with the result that the principal amount is repaid over a number of periods are known as:

A)Registered bonds.
B)Bearer bonds.
C)Callable bonds.
D)Sinking fund bonds.
E)Serial bonds.

Question 78

The carrying value of a long-term note payable is computed as:

A)The future value of all remaining payments, using the market rate of interest.
B)The face value of the long-term note less the total of all future interest payments.
C)The present value of all remaining payments, discounted using the market rate of interest at the time of issuance.
D)The present value of all remaining interest payments, discounted using the note's rate of interest.
E)The face value of the long-term note plus the total of all future interest payments.

Question 79

Payments on installment notes normally include accrued interest plus a portion of the principal amount borrowed.

Question 80

All of the following statements regarding leases are true except:

A)For a capital lease the lessee records the leased item as its own asset.
B)For a capital lease the lessee depreciates the asset acquired under the lease, but for an operating lease the lessee does not.
C)Capital leases create a long-term liability on the balance sheet, but operating leases do not.
D)Capital leases do not transfer ownership of the asset under the lease, but operating leases often do.
E)For an operating lease the lessee reports the lease payments as rental expense.