Chapter 10
Liabilities
True/False
1. A liability that is known to exist but the precise dollar amount is not known is called a possible
liability
Answer: False
Learning Objective: 1
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
2. Bonds secured by a pledge of specific assets are called debenture bonds.
Answer: False
Learning Objective: 5
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
3. Junk bonds are attractive to investors because they carry a high rate of interest and are usually
convertible into a specified number of shares of capital stock.
Answer: False
Learning Objective: 5
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
4. Dividends paid by a corporation to its stockholders are tax deductible by the corporation but
interest paid on bonds is not.
Answer: False
Learning Objective: 5
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
5. When bonds are sold by one investor to another, they sell at market price plus accrued interest
since the last payment date.
Answer: True
Learning Objective: 5, 6
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
498
6. When bonds are issued at a discount, the borrower must pay more at maturity than the amount
originally received.
Answer: True
Learning Objective: 6
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
7. The account Discount on Bonds Payable actually represents interest expense and will be
amortized over the life of the bond.
Answer: True
Learning Objective: 6
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
8. A loss contingency is recorded in the accounting records when it is probable that a loss has
been incurred and the amount of the loss is known.
Answer: False
Learning Objective: 8
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
9. A commitment, such as a contract to pay a baseball player $5,000,000 a year for five years,
should be listed as a long-term liability.
Answer: False
Learning Objective: 8
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
10. If a lease transfers ownership of the property to the lessee at the end of the lease term, it
should be regarded as an operating lease.
Answer: False
Learning Objective: 10
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
499
11. When a company has a fully funded pension plan, they only need to record the present value
of pension payments as a current liability.
Answer: False
Learning Objective: 10
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
12. Gross pay minus withholding tax and minus worker’s compensation is considered net pay.
Answer: False
Learning Objective: 3
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
13. Estimated liabilities, contingencies and commitments are usually reported in the long-term
liability section of the financial statements.
Answer: False
Learning Objective: 8
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
14. The amount of FICA tax and Medicare tax withheld from an employee is used to pay the
employer’s percentage of the tax and is mailed to the government quarterly.
Answer: False
Learning Objective: 3
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
15. When a company sells bonds, the bondholders are permitted to vote for the board of
directors.
Answer: False
Learning Objective: 5
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
16. The combination of liabilities and owners' equity used in financing the assets of a business is
called the company's capital structure.
Answer: True
Learning Objective: 1
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
500
17. Prepayments and owners' equity are both sources of financing.
Answer: False
Learning Objective: 1
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
18. The current portion of long-term debt should be reported separately in the current liabilities
section of the balance sheet.
Answer: True
Learning Objective: 1
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
19. When money is borrowed by issuing a note payable, the borrower records a liability equal to
the maturity value of the note.
Answer: False
Learning Objective: 2
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
20. An employer's annual cash outlays for payroll-related expenses normally are more than the
employer's wages and salaries expense.
Answer: False
Learning Objective: 3
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
21. Social security and Medicare taxes have a cap on employees' salaries where the tax is ended.
Answer: False
Learning Objective: 3
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
22. If a long-term debt is to be paid off in monthly installments over a 5-year period, the entire
principal should be classified as a long-term debt.
Answer: False
Learning Objective: 4
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
501
23. There is a tax advantage for a company to issue bonds in lieu of stocks.
Answer: True
Learning Objective: 5
AACSB: Reflective Thinking
AICPA BB: Resource Management
AICPA FN: Decision Making
24. The withholding of taxes from an employee's pay is a liability to the company.
Answer: True
Learning Objective: 3
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
25. Bonds payable are a means of dividing a very large, long-term liability among many creditors
some of whom may participate in the loan only for a short period of time.
Answer: True
Learning Objective: 5
AACSB: Reflective Thinking
AICPA BB: Resource Management
AICPA FN: Decision Making
26. Liabilities that fall due within one year or within the operating cycle are classified as current
liabilities.
Answer: True
Learning Objective: 1
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
27. In the marketplace, bond prices tend to fluctuate directly with changes in interest rates.
Answer: False
Learning Objective: 5
AACSB: Reflective Thinking
AICPA BB: Industry
AICPA FN: Measurement
28. Convertible bonds can be exchanged for common stock at the option of the company.
Answer: False
Learning Objective: 5
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
502
29. In a long-term capital lease, the lessor views a portion of each lease payment as interest
expense.
Answer: False
Learning Objective: 6
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
30. Payments of pensions and other benefits to retired workers are recognized as expense in the
period payment is made.
Answer: False
Learning Objective: 10
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
31. Sinking funds make a bond issue less attractive to the investor.
Answer: False
Learning Objective: 5
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
32. Deferred income taxes eventually come due.
Answer: True
Learning Objective: 10
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
33. If a bond is callable, the call price is usually lower than the face value of the bond.
Answer: False
Learning Objective: 5
AACSB: Reflective Thinking
AICPA BB: Resource Management
AICPA FN: Measurement
34. The quick ratio is a more stringent measure of solvency than the current ratio.
Answer: True
Learning Objective: 9
AACSB: Reflective Thinking
AICPA BB: Resource Management
AICPA FN: Measurement
503
35. A high interest coverage ratio is a sign of creditworthiness.
Answer: True
Learning Objective: 9
AACSB: Reflective Thinking
AICPA BB: Resource Management
AICPA FN: Measurement
36. Loss contingencies stem from past events.
Answer: True
Learning Objective: 8
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
37. Bonds, with the same face value, issued at a premium will have a higher maturity value than
bonds issued at a discount
Answer: False
Learning Objective: 6
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
38. Loss contingencies should be recorded in the accounting records whenever it is probable that
a loss has been incurred and the amount of loss might be material in amount.
Answer: False
Learning Objective: 8
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
39. The account Discount on Bonds Payable has a debit balance and should appear on the
balance sheet as an asset; the account Premium on Bonds Payable has a credit balance and should
be classified as a liability.
Answer: False
Learning Objective:6
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
40. The future value will always be less than the present value.
Answer: False
Learning Objective: 7
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
504
41. The amortization of discount on bonds payable reduces the amount of interest expense
recognized during the period.
Answer: False
Learning Objective: 6
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
42. The amortization of bond discount by the issuing company decreases the carrying value of its
bonds payable.
Answer: False
Learning Objective: 6
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
43. A primary means used by credit rating agencies to evaluate a company’s ability to pay it’s
debts is to compare total assets to total liabilities.
Answer: True
Learning Objective: 9
AACSB: Reflective Thinking
AICPA BB: Resource Management
AICPA FN: Measurement
44. Companies may understate liabilities so as not to be perceived as risky by credit rating
agencies.
Answer: True
Learning Objective: 9
AACSB: Reflective Thinking
AICPA BB: Resource Management
AICPA FN: Risk Analysis
45. Special purpose entities (SPEs) are established by corporations to accomplish specific
purposes such as borrowing money.
Answer: True
Learning Objective: 5
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
505
Multiple Choice
46. U. S. GAAP requires that convertible bonds be classified on the balance sheet as:
A) Part liability, part equity
B) A liability
C) Either a liability or equity
D) As an asset
Answer: B
Learning Objective: 5, 8
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Reporting
47. International accounting standards require that convertible bonds be classified on the balance
sheet as:
A) Part liability, part equity
B) A liability
C) Either a liability or equity
D) As an asset
Answer: A
Learning Objective: 5, 8
AACSB: Reflective Thinking
AICPA BB: Global
AICPA FN: Measurement
48. Off balance sheet financing may involve either:
A) An operating lease
B) A special purpose entity
C) Both of the above
D) Neither of the above
Answer: C
Learning Objective: 8
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
49. Employers are required to pay all of the following on the wages paid to each employee
except:
A) Social security taxes
B) Worker’s compensation insurance
C) Medicare taxes
D) Health insurance benefits.
Answer: D
Learning Objective: 3
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
506
50. In preparing an amortization table, it is necessary to include:
A) The original amount of the liability, the amount of periodic payments and the interest rate.
B) The original amount of the liability, the amount of periodic payments and the amount of past
payments.
C) The monthly payment, the total amount of past payments and the original amount of the
liability.
D) The total amount of past payments, the interest rate and the amount of periodic payments.
Answer: A
Learning Objective: 4
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
51. A company issues $60 million of bonds at par on January 1, 2007. The bonds pay 10%
interest semi-annually on 12/31 and 6/30 and mature in 20 years. The journal entry when the
bonds are sold is:
A) A Above.
B) B Above.
C) C Above.
D) D Above.
Answer: A
Learning Objective: 5
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
507
52. The amount of the present value of a future cash receipt will depend upon
A) The length of time until the money is received.
B) The amount of money to be received.
C) The required rate of return.
D) All of the above.
Answer: D
Learning Objective: 7
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
53. The FICA tax paid by an employer is:
A) Greater than the amount paid by the employee.
B) Less than the amount paid by the employee.
C) Equal to the amount paid by the employee.
D) The employer does not pay FICA tax, only the employee pays the tax.
Answer: C
Learning Objective: 3
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
54. When a company sells bonds between interest dates they will pay which of the following at
the first interest payment date?
A) An amount less than the stated interest.
B) An amount more than the stated interest.
C) An amount equal to the stated interest.
D) The company may skip the first interest payment date since the appropriate time has not
passed.
Answer: C
Learning Objective: 2
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
55. A $1,000 bond that sells for 103 has a cost of:
A) $1,003
B) $1,030
C) $1,300
D) $1,000
Answer: B
Learning Objective: 6
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
508
56. Which of the following is not an accurate statement regarding the distinction between debt
and equity?
A) Only equity is considered a source of financing for operations of the business, since debt
must be repaid at a specified maturity date.
B) If a business ceases operations and liquidates, claims of all creditors have legal priority over
claims of the stockholders.
C) Most debt requires the borrower to pay interest annually; equity financing does not obligate
the company to make a specified annual payment.
D) The providers of equity are owners of the business; the providers of borrowed funds are
creditors.
Answer: A
Learning Objective: 5
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
57. Which of the following is not a characteristic of current liabilities?
A) They are due within one year or within the operating cycle, whichever is longer.
B) They may involve estimated amounts.
C) They may be replaced with a new short-term liability rather than being paid in cash.
D) All three of the above are characteristic of current liabilities.
Answer: D
Learning Objective: 1
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
58. If a bond is selling at 102, it is selling at:
A) Maturity value and yields a 2% interest rate.
B) A discount.
C) A premium.
D) $102 per bond.
Answer: C
Learning Objective: 6
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
59. Which of the following payroll costs are shared equally by the employer and the employee?
A) State unemployment taxes.
B) Workers' compensation.
C) Social security.
D) Federal unemployment taxes.
Answer: C
Learning Objective: 3
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
509
60. Interest payable on a loan becomes a liability:
A) When the note payable is issued.
B) As it accrues.
C) At the maturity date.
D) When the borrowed money is received.
Answer: B
Learning Objective: 2
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
61. An employer's total payroll-related costs always exceed the wages and salaries earned by
employees by:
A) Amounts withheld from employees' pay.
B) Payroll taxes and mandated programs such as workers' compensation insurance.
C) 50%.
D) None of the above. Employers' payroll-related costs actually are less than the gross wages
and salaries earned by employees, because of amounts withheld from employees' checks.
Answer: B
Learning Objective: 3
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
62. Bonds, with the same face value, issued at a premium will:
A) Have a greater maturity value than a bond issued at a discount.
B) Have a lesser maturity value than a bond issued at a discount.
C) Have the same maturity value as a bond issued at a discount.
D) Have a different maturity value than a bond issued at a discount, depending upon the interest
rate and maturity date.
Answer: C
Learning Objective: 6
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
63. The amounts that a business withholds as taxes from an employee's earnings:
A) Represent payroll taxes expense to the employer.
B) Are deposited in an interest-bearing account until the employee is terminated.
C) Represent miscellaneous revenue to the employer.
D) Represent current liabilities to the employer.
Answer: D
Learning Objective: 3
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
510
64. Unearned revenue:
A) Appears on the income statement as income.
B) Appears on the income statement as a reduction to income.
C) Appears on the income statement as a liability.
D) Appears on the balance sheet as a liability.
Answer: D
Learning Objective: 1
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
Use the following to answer questions 65-67.
The average employee of Winthrop Corporation earns gross pay of $60,000 per year. The
following table shows the relative size of various payroll amounts by expressing each as a
percentage of total wages and salaries expense (gross pay):
In addition, Winthrop pays $325 per month per employee for group health insurance.
65. Refer to the above data. Which of the following is the largest payroll-related expense
incurred by Winthrop?
A) Group health insurance premiums.
B) Income taxes expense.
C) The employer's share of social security taxes.
D) Wages and salaries expense.
Answer: D
Learning Objective: 3
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
511
66. Refer to the above data. Which of the following represents the second largest payroll related
expense incurred by Winthrop?
A) Group health insurance premiums.
B) Income taxes expense.
C) The employer's share of social security taxes and Medicare taxes.
D) Wages and salaries expense.
Answer: C
Learning Objective: 3
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
67. Refer to the above data. Which of the following represents the largest amount withheld from
employees' paychecks?
A) Workers' compensation insurance.
B) Social Security and Medicare.
C) Personal income taxes.
D) Group health insurance.
Answer: C
Learning Objective: 3
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
68. When a corporation has a right to redeem bonds in advance of the maturity date, it is known
as:
A) Convertible.
B) Callable.
C) Junk bonds.
D) Debentures.
Answer: B
Learning Objective: 5
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
69. Sinking funds usually appear on the balance sheet as:
A) Current asset.
B) Long-term investment.
C) Current liability.
D) Appropriation of retained earnings.
Answer: B
Learning Objective: 5, 8
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
512
70. A bond that is not secured is also known as:
A) A sinking fund.
B) A mortgage.
C) A debenture.
D) A junk bond.
Answer: C
Learning Objective: 5
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
71. Management has both the intent and the ability to refinance a liability maturing in four
months by taking out a new loan at the due date which would not be due for several years. How
would this situation be reported in financial statements prepared as of today's date?
A) The original liability is classified as current, with a footnote describing management's plan
for refinancing.
B) The original liability is classified as current and the new loan is reported as a long-term
liability.
C) The original liability is classified as long-term; the new loan is not included in liabilities at
this date.
D) The original liability need not be reported at all; only the new loan is reported as a long-term
liability.
Answer: C
Learning Objective: 8
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
72. Nouveau Corporation purchased a piece of real estate, paying $300,000 cash and financing
$600,000 of the purchase price with a 10-year, 15% installment note. The note calls for equal
monthly payments that will result in the debt being completely repaid by the end of the tenth year.
In this situation:
A) The aggregate amount of the monthly payments is $600,000.
B) Each monthly payment is greater than the amount of interest accruing each month.
C) The portion of each payment representing interest expense will increase over the 10-year
period, since principal is being paid off, yet the payment amount does not decrease.
D) The portion of each monthly payment representing repayment of principal remains the same
throughout the 10-year period.
Answer: B
Learning Objective: 2, 4
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
513
73. When an installment note is structured as a "fully amortizing" loan with equal monthly
payments (such as a traditional mortgage):
A) The portion of each payment allocated to interest expense is the same each month.
B) The sum of the monthly payments is equal to the amount of the installment note (mortgage).
C) The difference between the sum of all monthly payments and the principal amount of the
note constitutes interest.
D) The portion of each payment allocated to repayment of principal decreases each month as the
mortgage is paid off.
Answer: C
Learning Objective: 2, 4
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
74. In relation to a bond issue, the role of the underwriter is to:
A) Guarantee payment to bondholders of both the periodic interest payments and the maturity
value.
B) Purchase the entire bond issue from the issuing corporation and then sell the bonds to the
public.
C) Represent the interests of the bondholders and, if necessary, to take legal action on their
behalf.
D) Maintain a subsidiary ledger of individual bondholders and mail out the periodic interest
checks.
Answer: B
Learning Objective: 5
AACSB: Reflective Thinking
AICPA BB: Industry
AICPA FN: Decision Making
75. If a bond is issued at par and between interest dates:
A) The cash received by the corporation will be less than the face value of the bond.
B) The cash received by the corporation will be greater than the face value of the bond.
C) The cash received by the corporation will be the same as the face value of the bond.
D) Interest receivable will be debited.
Answer: B
Learning Objective: 2
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
514
76. The term "junk bonds" describes bonds with:
A) Low interest rates.
B) Indefinite maturity dates.
C) Low maturity values.
D) High risk.
Answer: D
Learning Objective: 2
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
77. One advantage to issuing bonds instead of stock is that:
A) Interest is tax deductible whereas dividends are not.
B) Bonds have a longer maturity date.
C) Interest rates are lower than dividend rates.
D) The issuance of bonds does not affect earnings per share.
Answer: A
Learning Objective: 2
AACSB: Analytic
AICPA BB: Resource Management
AICPA FN: Decision Making
78. Choose the statement that correctly summarizes the tax advantage of raising money by
issuing bonds instead of common stock:
A) The amount paid by the corporation to redeem bonds at maturity date is deductible in
computing income subject to corporate income tax.
B) Interest payments are deductible in determining income subject to corporate income tax;
dividends are not deductible.
C) A corporation must pay tax on the sales price of stock issued, but is not taxed on the amount
received when bonds are issued.
D) Both interest and dividends paid are deductible in computing taxable income, but since
interest must be paid annually, the corporation usually gets a larger tax deduction over the life of
the bonds payable.
Answer: B
Learning Objective: 2
AACSB: Analytic
AICPA BB: Resource Management
AICPA FN: Decision Making
515
79. Hickory Corporation plans to invest $200 million to earn about 15% before income taxes.
The company is considering whether it should raise the $200 million by issuing 10% bonds
payable or capital stock. If the company issues the bonds, it will probably report:
A) Lower net income and lower income taxes expense than if it issues capital stock.
B) Higher net income and higher income taxes expense than if it issues capital stock.
C) Lower net income and higher income taxes expense than if it issues capital stock.
D) Higher net income and lower income taxes expense than if it issues capital stock.
Answer: A
Learning Objective: 5
AACSB: Analytic
AICPA BB: Resource Management
AICPA FN: Measurement
80. The current portion of long-term debt should be reported:
A) Separately in the long-term liabilities section of the balance sheet.
B) In the long-term liabilities section of the balance sheet, along with the other long-term debt.
C) In the current liabilities section of the balance sheet.
D) In a separate section of the balance sheet, between long-term liabilities and shareholders'
equity.
Answer: C
Learning Objective: 8
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
81. An operating lease:
A) Creates an asset and a liability on the balance sheet.
B) Is a form of off-balance sheet financing.
C) Is always preferable to a capital lease.
D) Transfers title to the asset being leased.
Answer: B
Learning Objective: 10
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
82. Suppose investors decide to sell their holdings of capital stock in order to purchase
outstanding bonds payable. As a result, the prices of bonds payable increase. What would be the
likely impact on market interest rates?
A) Market interest rates will be unaffected.
B) Market interest rates will increase.
C) Market interest rates will fall.
D) Although interest rates will change, it is impossible to predict the direction of change.
Answer: C
Learning Objective: 2
AACSB: Analytic
AICPA BB: Resource Management
AICPA FN: Measurement
516
83. Which one of the following is not a condition to capitalize a lease?
A) Bargain purchase.
B) Transfer of title.
C) Term is more than 75% of economic life.
D) Present value of minimum lease payments is less than 90% of the fair market value of the
asset.
Answer: D
Learning Objective: 10
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
84. Which of the following payroll taxes do not stop once an employee reaches a certain level of
income:
A) Medicare taxes.
B) Social security taxes.
C) Unemployment taxes.
D) All three of the above have a cap on salaries where the tax ends.
Answer: A
Learning Objective: 3
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
85. The price at which a bond sells is equal to the:
A) Maturity value of the bonds plus the present value to investors of the future interest
payments.
B) Sum of the future interest payments, minus the maturity value of the bonds.
C) Present value to investors of the future principal and interest payments.
D) Sum of the future interest payments, plus the maturity value of the bonds.
Answer: C
Learning Objective: 7
AACSB: Reflective Thinking
AICPA BB: Resource Management
AICPA FN: Measurement
86. After bonds have been issued, their market value can be expected to:
A) Rise as any premium is amortized
B) Fall if interest rates rise.
C) Fall as any discount is amortized.
D) Rise if interest rates rise.
Answer: B
Learning Objective: 2
AACSB: Reflective Thinking
AICPA BB: Resource Management
AICPA FN: Measurement
517
87. The amortization of a bond discount:
A) Decreases the carrying value of a bond and increases interest expense.
B) Decreases the carrying value of a bond and decreases interest expense.
C) Increases the carrying value of a bond and increases interest expense.
D) Increases the carrying value of a bond and decreases interest expense.
Answer: C
Learning Objective: 4, 6
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
88. Which of the following does not affect the market price of an outstanding bond issue?
A) Fluctuations in the current market rate of interest.
B) The credit rating of the issuing corporation.
C) The price at which the bonds were originally issued.
D) The length of time remaining until the bonds' maturity date.
Answer: C
Learning Objective: 5
AACSB: Reflective Thinking
AICPA BB: Resource Management
AICPA FN: Measurement
89. Each of the following must be disclosed in the financial statements, except:
A) The total amounts of long-term debt maturing in each of the next five years.
B) The company's debt ratio and interest coverage ratio for the current year.
C) Loss contingencies, when a reasonable possibility exists that a material loss has been
incurred.
D) The fair value of long-term liabilities when this value is significantly different from the
amount shown in the balance sheet.
Answer: B
Learning Objective: 8
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Reporting
90. A capital lease is recorded in the accounting records of the lessee by an entry:
A) Debiting Rent Expense and crediting Cash each time a lease payment is made.
B) Debiting Cash and crediting Rental Revenue each time a lease payment is received.
C) Debiting an asset account and crediting a liability account for the present value of the future
lease payments.
D) Debiting an asset account and crediting Sales for the present value of the future lease
payments.
Answer: C
Learning Objective: 10
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
518
91. Which of the following are factors in determining pension expense?
A) Average age, retirement age, and life expectancy of employees.
B) Employee turnover rate.
C) Expected rate of return to be earned by the pension fund.
D) All three of the above.
Answer: D
Learning Objective:10
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
92. The pension expense of the current period is equal to:
A) Amounts paid to retired workers during the current period.
B) The estimated future pension benefits earned by today's workers during the current period.
C) The present value of the estimated future pension benefits earned by today's workers during
the current period.
D) Cash payments made during the period to the trustee of the pension plan.
Answer: C
Learning Objective: 10
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
93. A company with a fully funded pension plan:
A) Recognizes no pension expense.
B) Reports no long-term liability for future pension payments.
C) Does not utilize the services of a trustee to operate the pension plan.
D) Recognizes pension expense equal to the cash payments made to retirees during the current
period.
Answer: B
Learning Objective: 10
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
94. The amortization of a bond premium:
A) Decreases the carrying value of a bond and increases interest expense.
B) Decreases the carrying value of a bond and decreases interest expense.
C) Increases the carrying value of a bond and increases interest expense.
D) Increases the carrying value of a bond and decreases interest expense.
Answer: B
Learning Objective: 6
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
519
95. In estimating annual pension expense, which of the following factors would not be taken into
consideration?
A) Current financial condition of the company.
B) Expected rate of return to be earned on pension fund assets.
C) Employee turnover rates.
D) Compensation levels and estimated rate of pay increases.
Answer: A
Learning Objective: 10
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
96. The present value:
A) Will always be greater than the future value.
B) Will always be less than the future value.
C) Will always be equal to the future value.
D) Can be greater than, less than, or equal to the future value depending upon interest rates and
the time period involved.
Answer: B
Learning Objective: 7
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
97. Pension expense is:
A) The present value of the estimated future pension benefits earned by employees as a result of
their services during the period.
B) The amount funded to the pension in a given year.
C) The future value of rights granted to employees as a result of their services during the period.
D) The amount withdrawn from the pension fund to pay retirees during the period.
Answer: A
Learning Objective: 10
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
98. Which of the following is not true about postretirement benefits?
A) Postretirement costs should be recognized as expense as the workers earn the right to receive
the benefits.
B) Most corporations have fully funded their postretirement benefits.
C) Unfunded postretirement costs are a noncash expense.
D) A corporation's liability for postretirement benefits is equal to the present value of estimated
future payments.
Answer: B
Learning Objective: 10
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
520
99. A liability for deferred income taxes represents:
A) Income taxes on earnings already reported in the income statement, but that will be taxed in
future periods.
B) Income taxes already paid on earnings which have not yet been reported in the company's
income statement.
C) Income tax obligations being disputed with the Internal Revenue Service.
D) Income taxes levied in prior years which are now past due.
Answer: A
Learning Objective: 10
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
100. In a statement of cash flows, most interest payments are classified as:
A) Operating activities.
B) Non-operating activities.
C) Financing activities.
D) Current liabilities.
Answer: A
Learning Objective: 2
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Reporting
101. Using different accounting methods on financial statements and tax returns will create:
A) No effect upon the balance sheet, only the income statement.
B) No effect upon the balance sheet nor the income statement.
C) A deferred tax liability.
D) An illegal situation.
Answer: C
Learning Objective: 10
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
102. The interest coverage ratio is computed by dividing:
A) Net income by interest expense.
B) Operating income by interest expense.
C) Interest expense by net income.
D) Interest expense by operating income.
Answer: B
Learning Objective: 9
AACSB: Reflective Thinking
AICPA BB: Resource Management
AICPA FN: Decision Making
521
103. Losses on the early retirement of bonds are classified as:
A) Extraordinary losses.
B) Operating losses.
C) Unrealized losses.
D) Other losses.
Answer: A
Learning Objective: 8
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Reporting
104. Which of the following statistics is of more significance to a long-term creditor than to a
short-term creditor?
A) Interest coverage ratio.
B) Receivables turnover rate.
C) Working capital.
D) Quick ratio.
Answer: A
Learning Objective: 9
AACSB: Reflective Thinking
AICPA BB: Resource Management
AICPA FN: Decision Making
105. The interest coverage ratio:
A) Is computed by dividing total liabilities by annual interest expense.
B) Is computed by dividing liquid assets by annual required interest payment.
C) Indicates the percentage of total assets that are financed with borrowed money.
D) Measures the number of times the annual interest expense could be covered by annual
income from operations.
Answer: D
Learning Objective: 9
AACSB: Reflective Thinking
AICPA BB: Resource Management
AICPA FN: Decision Making
106. Workers' compensation is:
A) A required minimum compensation level.
B) The rules for paying overtime.
C) A state mandated insurance program.
D) Includes all three above.
Answer: C
Learning Objective: 3
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
522
107. The basic measure of the amount of leverage being applied within the capital structure of an
organization is the:
A) Interest coverage ratio.
B) Debt ratio.
C) Return on assets.
D) Return on equity.
Answer: B
Learning Objective: 9
AACSB: Reflective Thinking
AICPA BB: Resource Management
AICPA FN: Measurement
108. The principal amount of a bond is:
A) The total future interest charges.
B) The unpaid balance exclusive of any interest charges.
C) The unpaid balance plus any future interest charges.
D) The maturity value less any currently unpaid balances.
Answer: B
Learning Objective: 4, 5
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
109. Which of the following is not a characteristic of an estimated liability?
A) The liability is known to exist.
B) The precise dollar amount cannot be determined until a later date.
C) The liability should not be recorded in the accounting records until future events have
determined the exact amount.
D) The liability stems from past transactions.
Answer: C
Learning Objective: 8
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
110. Commitments, such as contracts for future transactions:
A) Are classified as liabilities.
B) Are classified as assets.
C) Are footnoted in financial statements, if material.
D) Are only disclosed if negative due to the principle of conservatism.
Answer: C
Learning Objective: 8
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Reporting
523
111. Which of the following is an example of a contingent liability?
A) A lawsuit pending against a restaurant chain for improper storage of perishable food items.
B) The liability for future warranty repairs on computers sold during the current period.
C) A corporation's long-term employment contract with its chief executive officer.
D) A liability for notes payable with interest included in the face amount.
Answer: A
Learning Objective: 8
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
112. Which of the following ratios and rates that measure debt-paying ability focuses on the
long-term position of a company?
A) Quick ratio.
B) Inventory turnover.
C) Current ratio.
D) Debt ratio.
Answer: D
Learning Objective: 9
AACSB: Reflective Thinking
AICPA BB: Resource Management
AICPA FN: Decision Making
113. Which of the following is an example of a loss contingency that should be disclosed in a
footnote to a company's financial statements?
A) The president of the company has threatened to resign if the board of directors does not vote
to increase executive salaries.
B) A lawsuit has been brought against the company, but the company hopes to prevail in the suit
and thereby avoid any liability.
C) The allowance for uncollectible accounts receivable is estimated at $200,000.
D) The company owns special-purpose machinery which, if sold, would probably bring a price
less than its current book value.
Answer: B
Learning Objective: 8
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
524
114. Dynamic Company is a defendant in a lawsuit alleging damages of $3 billion. The
litigation is expected to continue for several years, and no reasonable estimate can be made at this
time of Dynamic Company's ultimate financial responsibility. This situation is an example of:
A) Off-balance-sheet financing.
B) A loss contingency which should be disclosed in notes to Dynamic Company's financial
statements.
C) An estimated liability which must appear in Dynamic Company's balance sheet.
D) A loss in purchasing power caused by inflation.
Answer: B
Learning Objective: 8
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
115. The Stereo Studio issues a contract to a new recording artist to produce a number of albums
over the next five years at $1 million per album. This situation is an example of:
A) A contingent liability which should be recorded in the accounting records.
B) A contingent liability requiring footnote disclosure.
C) An estimated liability, since the number of albums to be produced is not yet determined.
D) A commitment which, if material, may be disclosed in a footnote.
Answer: D
Learning Objective: 8
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
116. A discount on bonds payable is best described as:
A) An element of future interest expense.
B) A bonus paid by the bondholders to the issuing corporation because of the unusually high
interest rate stated in the bonds.
C) The present value of the future interest payments of bond interest and principal.
D) An amount below par which the bondholders may be called upon to make good.
Answer: A
Learning Objective: 6
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
117. Deferred taxes are classified as:
A) Only a liability.
B) Only an asset.
C) Either an asset or liability, depending upon the situation.
D) A non-operating expense.
Answer: C
Learning Objective: 10
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Reporting
525
118. Amortizing a discount on bonds payable:
A) Increases interest expense.
B) Increases periodic cash payments to bondholders.
C) Decreases interest expense.
D) Decreases periodic cash payments to bondholders.
Answer: A
Learning Objective: 6
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
119. Premium on bonds payable:
A) Is an asset account.
B) Increases the carrying value of the liability.
C) Is a contra-asset account.
D) Is disclosed by a footnote.
Answer: B
Learning Objective: 6
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Reporting
120. Amortizing a premium on bonds payable:
A) Increases interest expense.
B) Increases periodic cash payments to bondholders.
C) Decreases interest expense.
D) Decreases periodic cash payments to bondholders.
Answer: C
Learning Objective: 6
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
121. On December 1, Goldwin Corporation borrowed $45,000 from a bank and signed a 12%,
90-day note payable in the amount of $45,000. The December 31 adjusting entry will be:
A) Debit Interest Expense $450 and credit Notes Payable $450.
B) Debit Interest Expense $450 and credit Interest Payable $450.
C) Debit Discount on Notes Payable $900 and credit Interest Payable $900.
D) Debit Interest Expense $450 and credit Cash $450.
Answer: B
Response
45,000 x .12 x 30/360 = 450
Learning Objective: 2
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
526
Use the following to answer questions 122-125:
On November 1, Year 1, Dover Co. borrowed $70,000 from Village Bank and signed a 12%, sixmonth note payable, all due at maturity. The interest on this loan is stated separately.
122. Refer to the above data. How much must Dover pay Village Bank on May 1, Year 2, when
the note matures?
A) $70,000.
B) $78,400.
C) $74,200.
D) $72,800.
Answer: C
Response
70,000 x .12 x 6/12 = 74,200
Learning Objective: 2
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
123. Refer to the above data. How much interest expense will Dover recognize on this note in
Year 2?
A) $8,400.
B) $4,200.
C) $2,100.
D) $2,800.
Answer: D
Feedback:
70,000 x .12 x 4/12 = 2,800
Learning Objective: 2
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
124. Refer to the above data. At December 31, Year 1, Dover Co.'s overall liability for this loan
amounts to:
A) $70,000.
B) $71,400.
C) $72,800.
D) $74,200.
Answer: B
Feedback:
70,000 + (70,000 x .12 x 2/12) = 71,400
Learning Objective: 2
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
527
125. Refer to the above data. At December 31, Year 1, the adjusting entry with respect to this
note includes a:
A) Credit to Interest Payable for $1,400.
B) Credit to Notes Payable for $1,400.
C) Debit to Interest Expense for $2,800.
D) Credit to Cash for $2,800.
Answer: A
Learning Objective: 2
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Use the following to answer questions 126-129
On September 1, 2007, Eliza Company purchased a building from Henry Corporation by paying
$100,000 cash and issuing a one-year note payable for the balance of the purchase price. Interest
on the note is stated at an annual rate of 9% and is paid at maturity. In its December 31, 2007,
balance sheet, Eliza correctly presented the note and interest payable as follows:
126. Refer to the above data. How much must Eliza pay Henry Corporation on September 1,
2008, when the note matures?
A) $500,000.
B) $530,000.
C) $545,000.
D) Some other amount.
Answer: C
Feedback:
500,000 + (500,000 x .09) = 545,000
Learning Objective: 2
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
528
127. Refer to the above data. What is the amount of the interest expense Eliza will recognize on
this note in 2008?
A) $15,000.
B) $45,000.
C) $30,000.
D) Some other amount.
Answer: C
Feedback:
500,000 x .09 x 8/12 = 30,000
Learning Objective: 2
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
128. Refer to the above data. What is the total cash paid for the building purchased by Eliza?
A) $600,000.
B) $630,000.
C) $645,000.
D) $615,000.
Answer: C
Feedback:
100,000 + 500,000 + 45,000 = 645,000
Learning Objective: 2
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
129. Refer to the above data. The adjusting entry at December 31, 2007, with respect to this note
included:
A) A debit to Interest Expense for $15,000.
B) A credit to Cash for $15,000.
C) A credit to Notes Payable for $15,000.
D) A credit to Interest Expense for $15,000.
Answer: A
Learning Objective: 2
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Use the following to answer questions 130-131.
On September 1, 2007, Willis Company borrowed $600,000 from a bank and signed a 12%, sixmonth note payable, with interest on the note due at maturity.
529
130. Refer to the above data. The total amount of the current liability (including interest payable)
for this loan that appears in Willis Company's balance sheet at December 31, 2007, is:
A) $600,000.
B) $624,000.
C) $636,000.
D) $672,000.
Answer: B
Feedback:
600,000 + (600,000 x .12 x 4/12) = 624,000
Learning Objective: 2
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
131. Refer to the above data. Assume Willis made no adjusting entry with respect to this note
before preparing the financial statements at December 31, 2007. What is the effect of this error
on the financial statements for 2007?
A) Total liabilities are overstated.
B) Net income is overstated.
C) Owners' equity is understated.
D) Interest Payable is overstated.
Answer: B
Learning Objective: 2
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
132. Horizon Corporation borrowed $80,000 by issuing a 12%, six-month note payable, all due
at the maturity date. After one month, the company's total liability for this loan amounts to:
A) $80,000.
B) $80,400.
C) $80,800.
D) $81,600.
Answer: C
Feedback:
80,000 + (80,000 x .12 x 1/12) = 80,800
Learning Objective: 2
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
530
133. On November 1 of the current year, Premier Company borrowed $50,000 by issuing a 12%,
six-month note payable, all due at maturity date. Interest expense on this note to be recognized
during the current year amounts to:
A) $ 500.
B) $1,000.
C) $1,500.
D) $4,000.
Answer: B
Feedback:
50,000 x .12 x 2/12 = 1,000
Learning Objective: 2
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Use the following to answer questions 134-137.
Gem Corporation has 24 employees and incurs total wages and salaries expense of $850,000 per
year. The following table shows various payroll amounts as a percentage of this annual wage and
salaries expense:
In addition, Gem provides group health insurance for its entire workforce. The cost of this
insurance is $225 per month for each employee.
134. Refer to the above data. The company's annual payroll-related expenses amount to
approximately:
A) $ 914,800.
B) $1,081,825.
C) $1,146,850.
D) Some other amount.
Answer: B
Feedback:
850,000 + (.05 x 850,000) + (.0765 x 850,000) + (.05 x 850,000) + (.02 x 850,000) + (225 x 12 x
24) = 1,081,825
Learning Objective: 3
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
531
135. Refer to the above data. Employees' annual "take-home-pay," totals approximately:
A) $765,000.
B) $722,500.
C) $784,975.
D) $699,975.
Answer: D
Feedback:
850,000 – (850,000 x .0765) – (850,000 x .10) = 699,975
Learning Objective: 3
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
136. Refer to the above data. Some of the payroll-related expenses incurred by Gem Corporation
are mandated by law, rather than negotiated with employees. During the current year, these
mandated amounts increased Gem 's payroll-related expenses by approximately:
A) $ 65,025.
B) $172,550.
C) $124,525.
D) $130,050.
Answer: C
Feedback:
(850,000 x .05) + (850,000 x .0765) + (850,000 x .02) = 124,525
Learning Objective: 3
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
137. Refer to the above data. Assume that the federal government implements an 10% payroll tax
upon employers to finance health insurance for all citizens and residents. Gem will pay this tax
instead of purchasing group health insurance. This will cause Gem 's total annual payroll-related
expenses to:
A) Increase by $20,200.
B) Decrease by $20,200.
C) Increase by $19,400.
D) No change, because payroll taxes are withheld from employees' pay.
Answer: A
Feedback:
(850,000 x .10) – (225 x 12 x 24) = 20,200
Learning Objective: 3
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
532
Use the following to answer questions 138-142.
On December 1, Year 1, Capital Corporation incurs a 15-year $200,000 mortgage liability in
conjunction with the acquisition of an office building. This mortgage is payable in monthly
installments of $2,400, which include interest computed at the rate of 12% per year. The first
monthly payment is made on December 31, Year 1.
138. Refer to the above data. Compute the total amount to be paid by Capital over the 15-year
life of the mortgage.
A) $200,000.
B) $562,000.
C) $432,000.
D) $474,000.
Answer: C
Feedback:
2,400 x 12 x 15 = 432,000
Learning Objective: 2, 4
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
139. Refer to the above data. How much of the first payment made on December 31, Year 1,
represents interest expense?
A) $2,400.
B) $ 400.
C) $2,304.
D) $2,000.
Answer: D
Feedback:
1% x 200,000 = 2,000
Learning Objective: 2, 4
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
140. Refer to the above data. The total liability related to this mortgage reported in Capital 's
balance sheet at December 31, Year 1, is:
A) $432,100.
B) $199,600.
C) $194,923.
D) $200,000.
Answer: B
Feedback:
200,000 – 400 = 199,600
Learning Objective: 2, 4
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
533
141. Refer to the above data. Over the 15-year life of the mortgage, the total amount Capital will
pay for interest charges is:
A) $232,000.
B) $360,000.
C) $200,000.
D) $432,060.
Answer: A
Feedback:
432,000 – 200,000 = 232,000
Learning Objective: 2, 4
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
142. Refer to the above data. The portion of the second monthly payment made on January 31,
Year 2, which represents repayment of principle is:
A) $400.
B) $404.
C) $2,400.
D) $1,996.
Answer: B
Feedback:
2,400 – (1% x 199,600) = 404
Learning Objective: 2, 4
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
143. On October 1, 2007, Highway borrows $600,000 from its bank for five years at an annual
interest rate of 10%. According to the terms of the loan, the principal amount will not be due for
five years. Interest is to be paid monthly on the first day of each month, beginning November 1,
2007. With respect to this borrowing, Highway 's December 31, 2007, balance sheet included
only a long-term note payable of $600,000. As a result:
A) The December 31, 2007, financial statements are accurate.
B) Liabilities are understated by $15,000 accrued interest payable ($600,000 x 10% x 3/12).
C) Liabilities are understated by $5,000 accrued interest payable ($600,000 x 10% x 1/12).
D) Liabilities are understated by the amount of interest for the five-year term of the note that has
not yet been paid.
Answer: C
Learning Objective: 1, 2
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
534
144. At the end of 2008 it is discovered that the accountant for Champion Company failed to
record $60,000 of interest payable which had accrued since the last interest payment date. The
current ratio, quick ratio and debt ratio, as well as the financial statements, had already been
computed using the erroneous data. Correction of the accounting records will have which of the
following effects?
A) Net income as formerly computed will not be affected by the correction of the error.
B) The interest coverage ratio as formerly computed will not change as a result of the correction.
C) The debt ratio as formerly computed will decrease as a result of the correction.
D) The quick ratio as formerly computed will decrease as a result of the correction.
Answer: D
Learning Objective: 2, 9
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Use the following to answer questions 145-148.
On April 1, year 1, Quinn Corporation issues $40 million of 12%, 10-year bonds payable at par.
Interest on the bonds is payable semiannually each April 1 and October 1.
145. Refer to the above data. The amount of cash paid to bondholders for interest during Year 1,
is:
A) $6,000,000
B) $4,800,000
C) $2,400,000
D) $1,200,000
Answer: C
Feedback:
40,000,000 x .06 = 2,400,000
Learning Objective: 5
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
146. Refer to the above data. Interest expense on this bond issue reported in Quinn’s year 1,
income statement is:
A) $4,800,000
B) $2,400,000
C) $3,600,000
D) $6,000,000
Answer: C
Feedback:
40,000,000 x .12 x 9/12 = 3,600,000
Learning Objective: 5
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
535
147. Refer to the above data. The adjustment necessary at December 31, Year 1 (if any), related
to this bond issue involves:
A) Recognition of interest expense of $6,000,000.
B) Recognition of interest expense of $1,200,000.
C) Payment of cash of $1,200,000.
D) There is no adjustment necessary.
Answer: B
Feedback:
40,000,000 x .12 x 3/12 = 1,200,000
Learning Objective: 5
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Refer To: 10_07
148. Refer to the above data. With respect to this bond issue, Quinn Corporation's balance sheet
at December 31, Year 1, will include:
A) Bonds payable of $41,200,000.
B) Bonds payable of $46,000,000.
C) Bonds payable of $40 million, as well as interest payable of $1,200,000.
D) Bonds payable of $40 million, as well as interest payable of $6,000,000.
Answer: C
Learning Objective: 5
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Use the following to answer questions 149-153.
On April 1, year 1, Fiesta Corporation issues $20 million of 10%, 20-year bonds payable at par.
Interest on the bonds is payable semiannually each April 1 and October 1.
149. Refer to the above data. The journal entry to record the first cash payment to bondholders
on October 1, year 1, will include:
A) A credit to Cash of $2,000,000.
B) A debit to Bonds Payable of $1,000,000.
C) A debit to Interest Expense of $1,000,000
D) A credit to Interest Payable of $1,000,000.
Answer: C
Feedback:
20,000,000 x .10 x 6/12 = 1,000,000
Learning Objective: 5
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
536
150. Refer to the above data. The adjusting entry (if any) required on December 31, Year 1,
related to this bond issue involves:
A) Recognition of interest expense of $1,000,000.
B) Recognition of interest expense of $500,000.
C) A credit to Interest Payable of $2,000,000.
D) A credit to Cash of $500,000.
Answer: B
Feedback:
20,000,000 x .10 x 3/12 = 500,000
Learning Objective: 5
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
151. Refer to the above data. In Year 2, Fiesta 's income statement will report interest expense
arising from this bond issue of:
A) $1,000,000.
B) $2,000,000.
C) $500,000.
D) $1,500,000.
Answer: B
Feedback:
20,000,000 x .10 = 2,000,000
Learning Objective: 5
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
152. Refer to the above data. On April 1, Year 1, the journal entry to record issuance of the
bonds will include:
A) A credit to Interest Payable of $1,000,000.
B) A debit to Cash of $20,000,000.
C) A credit to Bonds Payable of $2,100,000.
D) A debit to Cash of $21,000,000.
Answer: B
Learning Objective: 5
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
537
153. Refer to the above data. With respect to this bond issue, Fiesta 's balance sheet at December
31, Year 1, will include:
A) Bonds payable of $20,500,000.
B) Bonds payable of $19,500,000.
C) Bonds payable of $20 million, as well as interest payable of $1,500,000.
D) Bonds payable of $20 million, as well as interest payable of $500,000.
Answer: D
Learning Objective: 5
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Use the following to answer questions 154-157.
Dallas Corporation issues $3,000,000 of 12%, 10-year bonds, dated December 31, Year 1. The
bonds are issued on April 30, Year 2, at a price of 100 plus accrued interest. Interest on the bonds
is payable semiannually each June 30 and December 31.
154. Refer to the above data. The total amount of cash received by Dallas Corporation upon
issuance of the bonds on April 30, Year 2, is:
A) $3,000,000.
B) $3,120,000.
C) $3,060,000.
D) $3,180,000.
Answer: B
Learning Objective: 5
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
155. Refer to the above data. The entry to record the issuance of bonds payable on April 30, Year
2, includes:
A) A credit to Premium on Bonds Payable of $120,000.
B) A debit to Cash of $2,000,000.
C) A debit to Bond Interest Expense of $120,000.
D) A credit to Bond Interest Payable of $120,000.
Answer: D
Learning Objective: 5
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
538
156. Refer to the above data. The journal entry made by Dallas Corporation to record the first
semiannual interest payment on the bonds includes:
A) A debit to Bond Interest Expense of $180,000.
B) A debit to Bond Interest Payable of $60,000.
C) A debit to Bond Interest Expense of $60,000.
D) A debit to Bond interest Expense of $120,000.
Answer: C
Learning Objective: 4, 5
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
157. Refer to the above data. The amount of Dallas 's interest expense on this bond issue during
year 2 amounts to:
A) $240,000.
B) $320,000.
C) $180,000.
D) $270,000.
Answer: A
Learning Objective: 5
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Use the following to answer questions 158-160.
Minuteman Co. has outstanding $100 million of 6% bonds, due in 7 years, and callable at 105.
The bonds were issued at par and are selling today at a market price of 93.
158. Refer to the above data. If Minuteman Co. retires $10 million of these bonds by purchasing
them from bondholders at current market price, the company will report:
A) A $700,000 gain.
B) A $500,000 loss.
C) An unrealized gain.
D) None of the above; neither gains nor losses are recognized on early retirements of debt.
Answer: A
Feedback:
10,000,000 – 9,300,000 = 700,000
Learning Objective: 5
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
539
159. Refer to the above data. If Minuteman Co. calls $10 million of these bonds it will report:
A) A $700,000 gain.
B) A $500,000 loss.
C) An unrealized gain.
D) None of the above; neither gains nor losses are recognized on early retirements of debt.
Answer: B
Feedback:
10,000,000 – 10,500,000 = (500,000)
Learning Objective: 5
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
160. Refer to the above data. If Minuteman Co. retires $10 million of these bonds by purchasing
them from bondholders at current market price, the company will report:
A) A $500,000 cash receipt from operating activities.
B) A $9.3 million cash payment for operating activities.
C) A $500,000 cash receipt from financing activities.
D) A $9.3 million cash payment for financing activities.
Answer: D
Learning Objective: 5
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Use the following to answer questions 161-163.
The current balance sheet of Ventura reports total assets of $20 million, total liabilities of $2
million, and owners' equity of $18 million. Ventura is considering several financing possibilities
in order to expand operations. Each question based on this data is independent of any others.
161. Refer to the above data. What will be the effect on Ventura 's debt ratio if Ventura 's owner
invests an additional $2 million to finance its expansion?
A) The debt ratio will decrease from .1 (2/20) before to .0909 (2/22) after the additional
investment.
B) The debt ratio will decrease from 2/9 before to 2/11 after the additional investment.
C) The debt ratio will increase from 20 before to 22 after the additional investment.
D) Additional investment by owner will have no effect on the debt ratio.
Answer: A
Learning Objective: 9
AACSB: Analytic
AICPA BB: Resource Management
AICPA FN: Measurement
540
162. Refer to the above data. Assume Ventura borrows $2 million to finance its expansion.
Ventura’s debt ratio immediately after the borrowing will be:
A) .10.
B) .20.
C) .33 (rounded).
D) .18.
Answer: D
Feedback:
4/22 = .18
Learning Objective: 9
AACSB: Analytic
AICPA BB: Resource Management
AICPA FN: Measurement
163. Refer to the above data. What is the maximum amount Ventura can borrow and not exceed
a debt ratio of .3?
A) $4,000,000.
B) $5,500,000.
C) $5,000,000.
D) Some other amount.
Answer: B
Feedback:
7.5/25.5 = 2.94
Learning Objective: 9
AACSB: Analytic
AICPA BB: Resource Management
AICPA FN: Measurement
164. On February 28, 2007, $2,500,000 of 12%, 10-year bonds payable, dated December 31,
2006, are issued. Interest on the bonds is payable semiannually each June 30 and December 31.
If the total amount received (including accrued interest) by the issuing corporation is $2,560,000,
which of the following is correct?
A) The bonds were issued at a premium.
B) The amount of cash paid to bondholders on the next interest date, June 30, 2006, is $240,000.
C) The amount of cash paid to bondholders on the next interest date, June 30, 2006, is $40,000.
D) The bonds were issued at a discount.
Answer: A
Feedback:
2,560,000 – (2,500,000 – (2,500,000 x .12 x 2/12)) = 10,000 premium
Learning Objective: 6
AACSB: Analytic
AICPA BB: Resource Management
AICPA FN: Measurement
Use the following to answer questions 165-168.
Erasmus Company issues $10,000,000 face value, 12%, 5-year bonds payable on December 31,
2007. Interest is paid semiannually each June 30 and December 31. The bonds sell at a price of
97; Erasmus uses the straight-line method of amortizing bond discount or premium.
541
165. Refer to the information above. The entry made by Erasmus Company to record issuance of
the bonds payable at December 31, 2007, includes:
A) A debit to Cash of $1,000,000.
B) A debit to Discount on Bonds Payable of $300,000.
C) A credit to Bonds Payable of $9,700,000.
D) A credit to Bond Interest Payable of $300,000.
Answer: B
Feedback:
10,000,000 – (10,000,000 x .97) = 300,000
Learning Objective: 5, 6
AACSB: Analytic
AICPA BB: Resource Management
AICPA FN: Measurement
166. Refer to the information above. Erasmus 's entry at June 30, 2008, to record the first
semiannual payment of interest and amortization of discount on the bonds includes a:
A) Debit to Bond Interest Expense of $600,000.
B) Credit to Cash of $630,000.
C) Debit to Discount on Bonds Payable of $30,000.
D) Debit to Bond Interest Expense of $630,000.
Answer: D
Feedback:
10,000,000 x. 06 + 300,000/10 = 630,000
Learning Objective: 5, 6
AACSB: Analytic
AICPA BB: Resource Management
AICPA FN: Measurement
167. Refer to the information above. The amount of bond interest expense recognized by
Erasmus Company in 2008 with respect to these bonds is:
A) $600,000.
B) $630,000.
C) $1,200,000.
D) $1,260,000.
Answer: D
Feedback:
10,000,000 x .12 + 2(300,000/10) = 1,260,000
Learning Objective: 5, 6
AACSB: Analytic
AICPA BB: Resource Management
AICPA FN: Measurement
542
168. Refer to the information above. The carrying value of this liability in Erasmus Company's
December 31, 2008, balance sheet is:
A) $10,000,000.
B) $9,700,000.
C) $9,760,000.
D) Some other amount.
Answer: C
Feedback:
10,000,000 – (300,000-60,000) = 9,760,000
Learning Objective: 5, 6
AACSB: Analytic
AICPA BB: Resource Management
AICPA FN: Measurement
Essay
169. Accounting terminology
Listed below are nine technical accounting terms introduced in this chapter:
Each of the following statements may (or may not) describe one of these technical terms. In the
space provided below each statement, indicate the accounting term described, or answer "None"
if the statement does not correctly describe any of the terms.
____(a). Operating income divided by annual interest expense
____(b) The amount paid during the current period to retired employees.
____(c) A lease agreement that is viewed as equivalent to the lessee purchasing the leased asset.
____(d) Using borrowed money to finance business operations.
____(e) The risk of a loss occurring in a future period.
____(f) A permanent reduction in the amount of income taxes owed which results from the tax
deductions for depreciation.
____(g) The amount that must be paid to settle a liability at the date it becomes due.
Answer: (a)Interest coverage ratio, (b)None (postretirement benefit expense is the present value
of future benefits earned by the workforce, not the amount paid to workers already retired),
(c)Capital lease. (d)Applying leverage, (e) None (a loss contingency is a loss that already may
have occurred, not a loss that may occur in the future), (f) None (deferred income taxes have been
postponed, not eliminated), (g) Maturity value
Learning Objective: 8, 10
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Decision Making
543
170. Notes payable
On September 1, 2006, Rhett Associates borrowed $700,000 from Scarlett Credit Union and
signed a 9%, one-year note payable, all due at maturity.
Answer:
(d)
Learning Objective: 2
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
544
171. Notes payable
On September 1, 2006, Brian Sweeney borrowed $100,000 from The Actors Credit Union and
signed an 8%, one-year note payable, all due at maturity. The interest on this loan is stated
separately.
Answer:
(a)$100,000 + ($100,000 x .08) = $108,000
(b)$100,000 x .08 x 8/12 = $5,333
(c)$100,000 + $2,667 (four months' interest payable ) = $102,667
Learning Objective: 2
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
545
172. Payroll-related expenses
Shown below is a summary of the annual payroll data of Viking Ironworks:
(d) How were the costs of postretirement benefits determined? Which of these amounts results in
a liability to Viking Ironworks, and when will this liability be paid? Will the amount of the
payments be more or less than the amount now shown as a liability? Explain.
Answer:
(d) The costs of postretirement benefits were determined by estimating the present value of the
future costs of retirement benefits earned during the year by today's workforce.
Only the unfunded portion of these costs represents a liability to Viking Ironworks. This liability
will be paid either when it funds the plan or pays for the promised benefits after today's workers
have retired.
The liability reflects only the present value of unfunded benefits to be made in the distant future.
The actual payments will be substantially larger than their present value at this time.
Learning Objective: 3
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
546
173. Fully amortizing installment note payable (mortgage)
On October 31, 2006, Richmond Company incurs a 30-year $800,000 mortgage liability in
conjunction with the purchase of a motel. This mortgage is payable in equal monthly installments
of $8,228, which include interest computed at an annual rate of 12%. The first monthly payment
is made on November 30, 2006. This mortgage is fully amortizing over 360 months.
Complete the amortization table for the first two payments by entering the correct dollar amounts
in the blank spaces provided. In addition, answer the questions which follow.
(a) With respect to this mortgage, Richmond 's 2006 income statement includes interest expense
of $_______________, and Richmond 's balance sheet at December 31, 2006, includes a total
liability for this mortgage of _______________. (Do not separate into current and long-term
portions.)
(b) The aggregate monthly cash payments Richmond will make over the 30-year life of the
mortgage amount to $_______________.
(c) Over the 30-year life of the mortgage, the amount Richmond will pay for interest amounts to
$_______________.
Answer:
1 $800,000 x .12 x 1/123 [$8,228 - $8,000]
2 $799,772 x .12 x 1/124 [$800,000 - $228]
(a)With respect to this mortgage Richmond 's 2006 income statement includes interest expense of
$15,997, and Richmond 's balance sheet at December 31, 2006, includes a total liability for this
mortgage of $799,541.
$8,000 + $7,997 = $15,997 interest expense for 2006.
$800,000 - $228 - $231 = $799,541 remaining principal (per table).
(b)The aggregate monthly cash payments Richmond will make over the 30-year life of the
mortgage amount to $2,962,080.
$8,228 x 30 years x 12 payments per year = $2,962,080.
(c)Over the 30-year life of the mortgage, the amount Richmond will pay for interest amounts to
$2,162,080.
$2,962,080 aggregate payments - $800,000 principal = $2,162,080.
Learning Objective: 2, 4
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
547
174. Fully amortizing installment note payable
On October 31, 2007 Herbert signed a 2-year installment note in the amount of $50,000 in
conjunction with the purchase of equipment. This note is payable in equal monthly installments
of $2,354, which include interest computed at an annual rate of 12%. The first monthly payment
is made on November 30, 2007 This note is fully amortizing over 24 months.
Complete the amortization table for the first two payments by entering the correct dollar amounts
in the blank spaces provided. In addition, answer the questions that follow.
(a) With respect to this note, Herbert 's 2007 income statement includes interest expense of
$_______________, and Herbert 's balance sheet at December 31, 2007, includes a total liability
for this note payable of _______________. (Do not separate into current and long-term portions.)
(b) The aggregate monthly cash payments Herbert will make over the 2-year life of the note
payable amount to $_______________.
(c) Over the 2-year life of the note, the amount Herbert will pay for interest amounts to
$_______________.
Answer:
(a)With respect to this note, Herbert 's 2007 income statement includes interest expense of $981
(per table); and Herbert 's balance sheet at December 31, 2007, includes a total liability for this
note payable of $46,273 (per table).
(b) The aggregate monthly cash payments Herbert will make over the 2-year life of the note
payable amount to $56,496.
$2,354 monthly payment x 24 months = $56,496
(c) Over the 2-year life of the note, the amount Herbert will pay for interest amounts to $6,496.
$56,496 aggregate payments - $50,000 principal = $6,496.
Learning Objective: 2, 4
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
548
175. Bonds issued at par - basic concepts
On April 1, Year 1, Gem Products, Inc. issued at par $15 million of 10%, 10-year bonds payable.
Interest is payable semiannually each April 1 and October 1.
(a) What is the amount of cash paid to bondholders for interest during year 1?
$_______________
(b) Give the adjusting entry necessary at December 31, Year 1 (if any), regarding this
bond issue.
(c) Interest expense on this bond issue reported in Gem Products' Year 1 income statement is:
$_______________
(d) With respect to this bond issue, Gem Products' balance sheet at December 31, Year 1,
includes bonds payable of $__________________ and interest payable of $_______________
(indicate $0 or "none" if the item is not reported.
(e) Give the journal entry made by Gem Products on April 1, Year 2, to record the semiannual
payment of interest to bondholders.
Answer:
(a) $750,000 (Oct. 1 payment: $15,000,000 x .10 x 6/12)
(b) Year 1
(c) $1,125,000 ($15 million x .10 x 9/12)
(d) Bonds payable: $15,000,000
Interest payable $375,000
(e) Year 2
Learning Objective: 5
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
549
176. Bonds issued at par - basic concepts
On March 1, Year 1, Sapparo Co. issued at a price of 100 $20 million of 12%, 25-year bonds
payable. Interest is payable semiannually each March 1 and September 1.
(a) What is the amount of cash paid to bondholders for interest during year 1?
$_______________
(b) Give the adjusting entry necessary at December 31, year 1 (if any), regarding this bond issue.
(c) Interest expense on this bond issue reported in Sapparo 's Year 1 income statement is:
$_______________
(d) With respect to this bond issue, Sapparo 's balance sheet at December 31, Year 1, includes
bonds payable of $_______________ and interest payable of $_______________. (indicate $0
or "none" if the item is not reported.)
(e) Give the journal entry made by Sapparo on March 1, Year 2, to record the semiannual
payment of interest to bondholders.
Answer:
(a) $1,200,000 ($20,000,000 x 12% x ½)
(b)
(c) $2,000,000 ($1,200,000 from part a + $800,000 from part b)
(d) Bonds payable
$20,000,000
Bond interest payable $ 800,000
(e)
Learning Objective: 5
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
550
177. Bonds payable-issued between interest dates
Barney Corporation received authorization on December 31, Year 1, to issue $2,500,000 of 6%,
10-year bonds. The interest payment dates are June 30 and December 31. All the bonds were
issued at a price of 100, plus accrued interest, on February 28, Year 2, two months after the
authorization of the bond issue.
(d) Prepare the journal entry at February 28, Year 2, to record the issuance of the bonds.
(e) Prepare the journal entry at June 30, Year 2 to record the first semiannual interest payment on
the bonds.
Answer:
(a) $2,525,000
(b) $75,000
(c) $125,000 ($2,500,000 x .06 x 10/12)
(d)
Learning Objective: 5
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
551
178. Bonds payable issued between interest dates - early retirement
Connors Imports received authorization on December 31, Year 1, to issue $4,500,000 face value
of 8%, 20-year bonds. The interest payment dates are June 30 and December 31. All the bonds
were issued at par, plus accrued interest on February 1, Year 2. The bonds are callable by
Connors at any time at 105.
(a) Prepare the journal entry to record the issuance of the bonds on February 1, Year 2.
(b) Prepare the journal to record the first interest payment on the bonds at June 30, Year 2
(c) What is the amount of bond interest expense reported in Connors Imports' Year 2 income
statement relating to these bonds? $___________
(d) What is the amount of bond interest payable appearing in Connors Imports' balance sheet at
December 31, Year 2, with respect to these bonds? $____________
(e) Connors exercises the call provision and retires one-third of the bond issue on July 1, Year 3.
Prepare the journal entry to record this transaction on July 1, Year 3.
Answer:
(c) $330,000 interest expense
Since the bonds were issued at par, interest expense is equal to the contractual interest for the
period that the bonds were outstanding.
($4,500,000 x .08 x 11/12 = $330,000)
(d)$-0- accrued bond interest payable
The interest payment date is December 31; therefore, interest for the last six months of a year is
paid and does not appear as a liability in the balance sheet at December 31.
Learning Objective: 5
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
552
179. Effects of transactions upon financial measurements
Five events relating to liabilities are described below:
(a) Recorded a bi-weekly payroll, including the issuance of paychecks to employees. Amounts
withheld from employees' pay and payroll taxes will be forwarded to appropriate agencies in the
near future. (Ignore postretirement costs.)
(b) Made a monthly payment on a 12-month installment note payable, including interest and a
partial repayment of the principal amount.
(c) Shortly before the maturity date of a six-month bank loan, made arrangements with the bank
to refinance the loan on a long-term basis.
(d) Made an adjusting entry to record accrued interest payable on a 2-year bank loan (interest is
paid monthly.)
(e) Made a year-end adjusting entry to amortize a portion of the discount on long-term bonds
payable.
Indicate the immediate effects of each transaction or adjusting entry upon the financial
measurements in the five column headings listed below. Use the code letters, I for increase, D for
decrease, and NE for no effect.
Answer:
Learning Objective: 2, 3, 6
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
553
180. Bonds issued at discount or premium
On March 31, 2007 Helen Company issued $10,000,000 face amount of 9%, 5-year bonds
payable, with interest payable each June 30 and December 31. The company received cash of
$10,100,000, including the accrued interest from December 31, 2006. Helen uses the straight-line
method of amortizing any discount or premium over the remaining life of the bonds - 57 months.
(a) What was the amount of accrued interest received by Helen on March 31, 2007 when the
bonds were issued? (Do not assume the bonds were issued at par.)
$_______________
(b) What was the amount of discount or premium on the bonds at issuance date?
(Indicate discount or premium.) $_______________
(c) What amount of cash is paid to bondholders for interest during year 2007?
$_______________
(d) What is Helen's total interest expense for year 2007 related to this bond issue?
$_______________
(e) What is the carrying value of this bond issue as of December 31, year 2007?
$_______________
Answer:
(a) Accrued interest: $10,000,000 x 9% x 3/12 = $225,000
(b) $125,000 discount
$10,100,000 - $225,000 accrued interest = $9,875,000
$10,000,000 - $9,875,000 for bonds = $125,000 discount
(c) $900,000
$450,000 (June 30) + $450,000 (December 31) = $900,000
$10,000,000 x 10% x 6/12 = $450,000 semiannually
(d) $694,737
Learning Objective: 6
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
554
181. Fully amortizing installment notes
When Sue Meadow purchased a home, she signed a $150,000, 12%, fully amortizing mortgage
note, payable at $1,543 per month. After making the first monthly payment, Meadow received a
notice from the bank stating that $1,500 of the payment had applied to interest, and only $43
reduced the principal amount of the loan. Meadow does not understand how this loan is fully
amortizing over a period of 30 years. She computes that at $43 per month, it will take
approximately 3,488 months (or 290 years) to repay this loan. Evaluate Meadow 's analysis.
Answer:
Meadow 's analysis is incorrect, because the unpaid balance (principal amount) of the mortgage
note will not be repaid at a constant rate of $43 per month. The portion of each payment
representing interest expense is based upon the unpaid balance of the loan. Since this unpaid
balance is reduced each month, the portion of each successive payment representing interest will
decrease, and the portion applied to repayment of the principal amount will increase. Thus, the
unpaid balance of the loan is repaid at an ever-increasing rate.
Learning Objective: 4
AACSB: Communications
AICPA BB: Resource Management
AICPA FN: Decision Making
182. Bond prices after issuance
Several years ago, Clear-Air Systems issued $100 million of 30-year, 8% bonds payable at a
small premium. Since the bonds were issued, Clear-Air 's financial strength and credit rating
have actually improved, but today the bonds are trading among investors at a price of 98.
(a) Explain the most probable reason why the market price of these bonds has declined, even
though Clear-Air‘s credit rating has improved.
(b) How will the drop in the market value of these bonds be reported (if at all) in Clear-Air's
income statements and balance sheets? Explain.
Answer: (a) The interest rates available to investors have probably increased since Clear-Air
issued these bonds. Bonds provide investors with a return which is fixed in dollar amount.
Therefore, as the interest rates available from alternative investment opportunities rise, the price
of a given bond issue tends to fall. In summary, bond prices vary inversely with fluctuations in
market interest rates.
(b) After bonds have been issued, they belong to the bondholders, not to the issuing corporation.
Therefore, changes in the market price of bonds subsequent to their issuance do not affect the
amounts shown in the financial statements of the issuing company. (However, the FASB
presently requires companies to disclose the fair values of financial instruments (including bonds
payable) in footnotes to the financial statements whenever the fair value is (1) reasonably
determinable, and (2) significantly different from the carrying value in the financial statements.)
Learning Objective: 5, 7
AACSB: Communications
AICPA BB: Industry
AICPA FN: Reporting
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183. Operating and capital leases
Berkeley Corporation wants to expand operations and is considering various leasing
arrangements for additional equipment. Berkeley 's management has heard the terms capital lease
and operating lease mentioned by the accounting department and wants clarification of these
terms before signing any lease contracts.
(a) Briefly explain the difference between a capital lease and an operating lease from a lessee's
(Berkeley 's) point of view. Your answer should include the financial statement impact of each
type of lease.
(b) How does a lessee determine whether a specific lease contract is an operating lease or a
capital lease? Include at least two of the criteria specified by the FASB in your answer.
(c) Which of the above two types of leases is sometimes referred to as "off-balance-sheet
financing?" Briefly explain.
Answer: (a) A capital lease transfers most of the risks and rewards of ownership from the lessor
to the lessee. From an accounting point of view, capital leases are regarded as essentially
equivalent to a sale of the property to the lessee, even though title to the leased property has not
been transferred. When equipment is acquired through a capital lease, the lessee includes an asset,
Leased Equipment, and a liability, Lease Payment Obligation, in its balance sheet. Interest
Expense and Depreciation Expense on the leased asset are reported in the lessee's income
statement annually. No rent expense is involved in a capital lease.
In an operating lease, the lessor gives the lessee the right to use leased property for a limited
period of time, but retains the usual risks and rewards of ownership. No asset or liability relating
to the lease appears in the balance sheet of the lessee; lease payments are simply reported as
rental expense.
(b) The FASB requires that a lease which meets any one of the following criteria be accounted for
as a capital lease (students are to give any two of the four):
(1.) The lease transfers ownership of the property to the lessee at the end of the lease term.
(2.) The lease contains a "bargain purchase option."
(3.) The lease term is equal to 75% or more of the estimated economic life of the leased property.
(4.) The present value of the minimum lease payments amounts to 90% or more of the fair value
of the leased property.
Any lease which does not meet any of the above criteria is an operating lease.
(c)Operating leases are sometimes referred to as "off-balance-sheet financing." The lessee's
balance sheet contains no asset or liability related to the lease arrangement other than perhaps a
short-term liability for accrued rent payable. The entire leasing arrangement is not reflected in
the balance sheet.
Learning Objective: 10
AACSB: Communications
AICPA BB: Industry
AICPA FN: Measurement
556
184. Deferred income taxes
At the end of its first year of operations, Salem Construction, Inc., included in its balance sheet a
long-term liability entitled "Deferred Income Taxes."
(a) Briefly explain what deferred income taxes represents, including how this liability came into
existence and whether such an item is generally perceived as favorable or unfavorable from
company management's point of view.
(b) If Salem Construction, Inc., is a successful, growing business, would you expect the liability
for deferred income taxes to increase or decrease over the next few years? Explain.
Answer: (a) For Salem Construction, Inc., deferred income taxes represents a portion of the
current-year income tax expense whose payment is postponed until future periods.
Deferred income taxes arise when items of revenue are included in the income statement in the
current period, but are not taxed until some future period. Deferred income taxes also arise when
expenses recognized in the financial statements are smaller than the expenses deducted in the
current year's tax return. In both of these situations, pretax accounting income is larger than the
taxable income reported in the current-year income tax return. In general, deferred income taxes
arise because the income tax expense recognized for accounting purposes is larger than the
amount of taxes owed for the current period (based upon the current-year tax return).
In most cases, the existence of deferred income taxes would be regarded as a favorable situation,
as it indicates that the cash outlay for income taxes to date is smaller than the amount of income
tax expense reported in the income statement.
(b) Although some of the income taxes deferred in prior years constantly are coming due, the
liability for deferred taxes usually increases as a company grows and prospers.
Learning Objective: 10
AACSB: Communications
AICPA BB: Industry
AICPA FN: Risk Analysis
185. Loss contingencies
East-to-West Airlines could, at any time, incur a large loss if one of its airplanes were to crash. Is
this an example of a loss contingency which should be disclosed in the company's financial
statements? Explain.
Answer: The risk of a future airplane crash is not a loss contingency. Loss contingencies relate to
events which have already occurred, but for which the financial impact is uncertain. The risk of a
future airplane crash is a potential future loss. Potential future losses are not disclosed in
financial statements.
Learning Objective: 10
AACSB: Communications
AICPA BB: Industry
AICPA FN: Measurement
557
186. On March 1, 2008, five-year bonds are sold for $254,013 that have a face value of $250,000
and an interest rate of 10%. Interest is paid semi-annually on March 1 and September 1. Using
the straight-line amortization method, prepare the borrower’s journal entries on
March 1, 2008
September 1, 2008
December 31, 2008
March 1, 2009
Answer:
Learning Objective: 5, 6
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
187. The LBB Company recently took a mortgage on a property for $100,000. The interest is
12% and the monthly payment is $1,020. Prepare the first four months of the amortization table
beginning on January 1, 2007.
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Answer:
Learning Objective: 4
AACSB: Analytic
AICPA BB: Resource Management
AICPA FN: Measurement
559
Chapter 10
Liabilities
CHAPTER 10
NAME
________________# ______
10-MINUTE QUIZ A
SECTION __________________________________________
Indicate the best answer for each question in the space provided.
On November 30, 2005, Majestic Food purchased two trucks for a total of $120,000,
issuing a one-year, 6% note payable, all due at maturity. The interest on this loan is stated
separately.
560
1
Refer to the above data. The December 31, 2005, adjusting entry for this note
includes:
a
A credit to Cash for $1,200.
b
A credit to Interest Payable for $7,200.
c
A credit to Interest Payable for $1,200.
d
A credit to Interest Payable for $600.
2
Refer to the above data. The total liabilities related to this note reported in Majestic
Food’s December 31, 2005, balance sheet is:
a $120,000. b $127,200.
c $120,600.
d $121,200.
3
Refer to the above data. What is the amount of interest expense Majestic Food’s
recognizes on this note in 2006
a $600.
b $7,200.
c $6,600.
d $1,200.
4
Refer to the above data. How much must Majestic Food pay the lender upon
maturity of this note?
a $120,600. b $120,000.
c $126,600.
d $127,200.
5
Refer to the above data. The liability for this loan as of December 31, 2005:
a Is equal to its maturity value.
b Is equal to the book value of the two trucks that were acquired in exchange.
c Is classified as a long-term liability, since it was used to acquire noncurrent
assets.
d Is classified as a long-term liability if Majestic Food has the intent and ability
to refinance by taking out a new loan not due for several years.
CHAPTER 10
NAME
#
10-MINUTE QUIZ B
SECTION
Shown below is a summary of the annual payroll data of Rose Co.:
$2,250,000
Wages and salaries expense (gross
pay)
.....................................................................................
Amounts withheld form employees’ pay:
Income
taxes
.........................................................................................
Social Security and
Medicare
.........................................................................................
Payroll taxes expense:
Social Security and
Medicare
.........................................................................................
Unemployment
taxes
.........................................................................................
Workers’ compensation
premiums
.........................................................................................
Group health insurance premiums (paid by employer)
Contributions to employees’ pension plan (paid by
employer and fully
funded)
.........................................................................................
Cost of other postretirement benefits:
$170,000
$150,000
320,000
$150,000
58,000
208,000
130,000
252,000
140,000
$90,000
Funded
.........................................................................................
120,000
210,000
Unfunded
.........................................................................................
1
Refer to the above data. Rose Company’s total payroll-related expense for the year
is:
a
$2,250,000.
b $3,510,000.
c $2,840,000.
d $3,190,000.
2
Refer to the above data. Compute the company’s cash outlays during the year for
payroll-related costs. Assume short-term obligations such as insurance premiums
and payroll taxes have been paid.
561
a
562
$2,750,000.
b
$3,070,000.
c
$1,930,000.
d
$3,510,000.
3
Refer to the above data. The annual ”take-home-pay” of Rose’ employees is:
a
$2,520,000.
b $2,250,000.
c $1,930,000
d $2,750,000
4
Refer to the above data Amounts paid during the year to retirees for pension and
other postretirement benefits total:
a
$140,000.
b $350,000.
c $230,000
d None of above
5
Refer to the above data. When a company has a fully-funded pension plan:
a
The dollar amounts paid to retirees are greater than the amounts recognized as
pension expense by the employer.
b
Pension expense is equal to the cash payments made to retirees during the
current period.
c
No pension expense is recognized in the income statement.
d
It does not use the services of a trustee to operate the pension plan.
CHAPTER 10
NAME
#
10-MINUTE QUIZ C
SECTION
Regal Industries received authorization on December 31, year 1, to issue $6,000,000 face value of 9%,
10-year bonds. The interest payment dates are June 30 and December 31. All the bonds were issued
at par, plus accrued interest, April 1, Year 2. The bonds are callable by Regal Industries at any time at
102.
1
Prepare the journal entry to record issuance of the bonds on April 1, Year 2.
2
Prepare the journal entry to record the first semiannual interest payment on the bonds at June
30, Year 2.
3
What is the amount of bond interest expense that appears in Regal’s Year 2 income statement
relating to these bonds?
$_________________________
4
What is the amount of accrued bond interest expense that appears in Regal’s balance sheet at
December 31, Year 2, with respect to these bonds?
$_________________________
5
Regal exercises the call provision and retires one-half of the bond issue on July, 1, Year 4.
Prepare the journal entry to record this transaction on July 1, Year 4.
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CHAPTER 10
NAME
#
10-MINUTE QUIZ D
SECTION
On December 1, 2006, Garden Corporation incurs a 30-year, $400,000 mortgage liability upon
purchase of a warehouse. This mortgage is payable in monthly installments of $4,116, which
include interest computed at the rate of 12% per year. The first monthly payment is made on
December 31, 2006.
1
How much of the first payment made on December 31, 2006, is allocated to repayment of
principal?
$________
2
What is the total liability related to this mortgage to be reported in Garden’s balance sheet at
December 31, 2006? (Do not separate into current and long-term portions.)
$________
3
The portion of the second monthly payment made on January 31, 2007, which represents interest
expense is
$________
4
What is the aggregate amount paid by Garden over the 30-year life of the mortgage?
$________
5
Over the 30-year life of the mortgage, the total amount Garden will pay for interest charges is
$________
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CHAPTER 10 SELF-TEST QUESTIONS FROM TEXTBOOK
Choose the best answer for each of the following questions and insert the identifying letter
in the space provided.
1
Which of the following is characteristic of liabilities, rather than of equity? (More
than one answer may be correct.)
a
The obligation matures.
b
Interest paid to the provider of the capital is deductible in the determination of
taxable income.
c
The capital providers’ claims are residual in the event of liquidation of the
business.
d
The capital providers normally have the right to exercise control over business
operations.
2
On October 1, Dalton Corp. borrows $100,000 from National Bank, signing a sixmonth note payable for that amount, plus interest to be computed at a rate of 9% per
annum. Indicate all correct answers.
a
Dalton’s liability at October 1 is only $100,000.
b
The maturity value of this note is $104,500.
c
At December 31, Dalton will have a liability for accrued interest payable in
the amount of $4,500.
d
Dalton’s total liability for this loan at November 30 is $101,500.
3
Identify all correct statements concerning payrolls and related payroll costs:
a
Both employers and employees pay Social Security and Medicare taxes.
b
Workers’ compensation premiums are withheld from employees’ wages.
c
An employer’s total payroll costs usually exceed total wages expense by
about 7 1/2%.
d
Under current law, employers are required to pay Social Security taxes on
employees’ earnings, but are not required to pay for health insurance.
4
Identify those types of information that can readily be determined from an
amortization table for an installment loan. (More than one answer may be correct.)
a
Interest expense on this liability for the current year.
b
The present value of the future payments under current market conditions.
c
The unpaid balance remaining after each payment.
d
The portion of the unpaid balance that is a current liability.
5
Which of the following statements is (are) correct? (More than one statement may
be correct.)
a
A bond issue is a technique for subdividing a very large loan into a great
many small, transferable units.
b
Bond interest payments are contractual obligations, whereas the board of
directors determines whether or not dividends will be paid.
c
As interest rates rise, the market prices of bonds fall; as interest rates fall,
bond prices tend to rise.
d
Bond interest payments are deductible in determining income subject to
income taxes, whereas dividends paid to stockholders are not deductible.
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6
Identify all statements that are consistent with the concept of present value. (More
than one answer may be correct.)
a
The present value of a future amount is always less than that future amount.
b
An amount of money available today is considered more valuable than the
same sum which will not become available until a future date.
c
A bond’s issues price is equal to the present value of its future cash flows.
d
The liability for an installment note payable is recorded at only the principal
amount, rather than the sum of the scheduled payments.
7
Identify those trends that are unfavorable from the viewpoint of a bondholder (More
than one answer may be correct.)
a
Market interest rates are steadily rising.
b
The issuing company’s interest coverage ratio is steadily rising.
c
The issuing company’s net cash flow from operating activities is steadily
declining.
d
The issuing company’s debt ratio is steadily declining.
8
A basic difference between loss contingencies and “real” liabilities is:
a
Liabilities stem from past transactions; loss contingencies stem from future
events.
b
Liabilities always are recorded in the accounting records, whereas loss
contingencies never are.
c
The extent of uncertainty involved.
d
Liabilities can be large in amount, where as loss contingencies are immaterial.
9
Which of the following situations require recording a liability in 2005? (More than
one answer may be correct.)
a
In 2005, a company manufactures and sells stereo equipment which carries a
three-year warranty.
b
In 2005, a theater group receives payments in advance from season ticket
holders for productions to be performed in 2006.
c
A company is a defendant in a legal action. At the end of 2005, the company’s
attorney feels it is possible the company will lose, and that the amount of the
loss might be material.
d
During 2005, a midwest agricultural co-operative is concerned about the risk
of loss if inclement weather destroys the crops.
10
Silverado maintains a fully funded pension plan. During 2005, $1 million was paid
to retired workers currently employed by the company earned a portion of the right
to receive pension payments expected to total $6 million over their lifetimes.
Silverado’s pension expense for 2005 amounts to:
a
$1 million.
b
$6 million.
c
$7 million.
d
Some other amount.
11
Deferred income taxes result from:
a
The fact that bond interest is deductible in the computation of taxable income.
b
Depositing income taxes due in future years in a special fund managed by an
independent trustee.
c
Timing differences between when income is recognized in financial
statements and in income tax returns.
d
The inability of a bankrupt company to pay its income tax liability on
schedule.
567
SOLUTIONS TO CHAPTER 10 10-MINUTE QUIZZES
QUIZ A
1
D
2
C
3
C
4
D
5
D
QUIZ B
1
D
2
B
3
C
4
D
5
A
QUIZ C
1
Cash ..................................................................................................
Bonds Payable .............................................................................
Bond Interest Payable .................................................................
Issued $6,000,000 face value bonds at par,
plus three months’ accrued interest.
($6,000,000 x 9% x 3/12 = $135,000)
2
Bond Interest Payable .......................................................................
Bond Interest Expense.......................................................................
Cash .............................................................................................
To record payment of semiannual interest.
($6,000,000 x 9% x 1/2)
6,135,000
6,000,000
135,000
135,000
135,000
270,000
3
$405,000 interest expense.
Since the bonds were issued at par, interest expense is equal to the contractual interest for the period
that the bonds were outstanding. ($6,000,000 x 9% x 9/12 = $405,000)
4
$0 accrued bond interest payable.
The interest payment date is Dec. 31; therefore, interest for the last six months of a year is paid and
does not appear as a liability in the balance sheet.
5
Bonds Payable ...................................................................................
Loss on Early Retirement of Bonds
(Extraordinary Loss) ...................................................................
Cash .........................................................................................
To record retirement of $3,000,000-face-value
bonds, originally issued at par, at 102.
568
3,000,000
60,000
3,060,000
QUIZ D
1
$116 [$4,116 - $4,000 interest ($400,000 x .12 x 1/12)]
2
$399,884 [$400,000 - $116 repayment of principal]
3
$3,999 [$399,884 x .12 x 1/12 = $3,999]
4
$1,481,760 [$4,116 monthly x 360 months]
5
$1,081,760 [$1,481,760 total payments - $400,000 principal]
SOLUTIONS TO CHAPTER 10 SELF-TEST QUESTIONS FROM TEXTBOOK
1 a ,b 2 a, b, d 3 a, d 4 a, c, d 5 a, b, c, d 6 a, b, c, d 7 a, c
8 c 9 a, b 10 d 11 c
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