chapter 10 concepts

Question 1

Current liability

Answer 1

A debt that a company reasonably expects to pay (1) from existing current assets or through the creation of other current liabilities, and (2) within one year or the operating cycle, whichever is longer.

Question 2

The different types of current liabilities include:

Answer 2

notes payable, accounts payable, unearned revenues, and accrued liabilities such as taxes, salaries and wages, and interest.

Question 3

Bonds

Answer 3

A form of interest-bearing notes payable issued by corporations, universities, and governmental entities.

Question 4

Secured bonds

Answer 4

Bonds that have specific assets of the issuer pledged as collateral.

Question 5

Unsecured bonds

Answer 5

Bonds issued against the general credit of the borrower.

Question 6

Convertible bonds

Answer 6

Bonds that can be converted into common stock at the bondholder’s option.

Question 7

Callable bonds

Answer 7

Bonds that the issuing company can redeem (buy back) at a stated dollar amount prior to maturity.

Question 8

Bond certificate

Answer 8

A legal document that indicates the name of the issuer, the face value of the bonds, and other data such as the contractual interest rate and the maturity date of the bonds.

Question 9

Face value (par value)

Answer 9

Amount of principal due at the maturity date of the bond.

Question 10

Maturity date

Answer 10

The date on which the final payment on a bond is due from the bond issuer to the investor.

Question 11

Contractual (stated) interest rate

Answer 11

Rate used to determine the amount of interest the borrower pays and the investor receives. Usually an annual rate.

Question 12

Time value of money

Answer 12

The relationship between time and money. A dollar received today is worth more than a dollar promised at some time in the future.

Question 13

Present value

Answer 13

The value today of an amount to be received at some date in the future after taking into account current interest rates.

Question 14

The current market price (present value) of a bond is therefore a function of three factors:

Answer 14

(1) the dollar amounts to be received, (2) the length of time until the amounts are received, and (3) the market interest rate.

Question 15

Market interest rate

Answer 15

The rate investors demand for loaning funds to the corporation.

Question 16

when does a company record bond transactions?

Answer 16

when it issues (sells) or redeems (buys back) bonds and when bondholders convert bonds into common stock.

Question 17

Discount (on a bond)

Answer 17

The difference between the face value of a bond and its selling price when a bond is sold for less than its face value. As a result of the decline in the bonds’ selling price, the actual interest rate incurred by the company increases to the level of the current market interest rate.

Question 18

Premium (on a bond)

Answer 18

The difference between the selling price and the face value of a bond when a bond is sold for more than its face value.

Question 19

True or False Bond prices vary inversely with changes in the market interest rate. As market interest rates decline, bond prices increase. When a bond is issued, if the market interest rate is below the contractual rate, the bond price is higher than the face value.

Answer 19

True

Question 20

what kind of bonds are sold at a discount by design?

Answer 20

“Zero-coupon” bonds, which pay no interest, sell at a deep discount to face value.

Question 21

What is an additional cost of borrowing?

Answer 21

Therefore, the difference between the issuance price and the face value of the bonds—the discount. The company records this cost as interest expense over the life of the bonds.

Question 22

What is amortizing the discount.

Answer 22

To follow the expense recognition principle, companies allocate bond discount to expense in each period in which the bonds are outstanding. Amortization of the discount increases the amount of interest expense reported each period.

Question 23

What is amortizing the premium?

Answer 23

companies allocate bond premium to expense in each period in which the bonds are outstanding. Amortization of the premium decreases the amount of interest expense reported each period.

Question 24

what is a valuation account?

Answer 24

one that is needed to value properly the item to which it relates. Both a discount and a premium account are valuation accounts.

Question 25

True or false. Regardless of the issue price of bonds, the book value of the bonds at maturity will equal their face value.

Answer 25

true

Question 26

The carrying value of the bonds is

Answer 26

the face value of the bonds less unamortized bond discount or plus unamortized bond premium at the redemption date.

Question 27

Liquidity ratios measure

Answer 27

the short-term ability of a company to pay its maturing obligations and to meet unexpected needs for cash.

Question 28

Solvency ratios measure

Answer 28

the ability of a company to survive over a long period of time.

Question 29

Times interest earned

Answer 29

A measure of a company’s solvency, calculated by dividing the sum of net income, interest expense, and income tax expense by interest expense.

Question 30

Contingencies

Answer 30

Events with uncertain outcomes that may represent potential liabilities.

Question 31

Off-balance-sheet financing

Answer 31

The intentional effort by a company to structure its financing arrangements so as to avoid showing liabilities on its balance sheet.

Question 32

Operating lease

Answer 32

A contractual agreement allowing one party (the lessee) to use the asset of another party (the lessor); accounted for as a rental.

Question 33

Capital lease

Answer 33

A contractual agreement allowing one party (the lessee) to use the assets of another party (the lessor); accounted for like a debt-financed purchase by the lessee.

Question 34

debt covenants.

Answer 34

These covenants typically are specific financial measures, such as minimum levels of retained earnings, cash flows, times interest earned, or other measures that a company must maintain during the life of the loan.

Question 35

*Straight-line method of amortization

Answer 35

A method of amortizing bond discount or bond premium that allocates the same amount to interest expense in each interest period.

Question 36

Mortgage note payable

Answer 36

A long-term note secured by a mortgage that pledges title to specific assets as security for the loan.