Chapter 12

Question 1

Which of the following represents a liability?

a. The obligation to pay interest on a five-year note payable that was issued the last day of the current year.
b. The obligation to provide goods that customers have ordered and paid for during the current year.
c. The obligation to pay for goods that a company expects to order from suppliers next year.
d. The obligation to distribute shares of a company’s own common stock next year as a result of a stock dividend declared

Answer 1

b. The obligation to provide goods that customers have ordered and paid for during the current year.

Question 2

Which of the following does not meet the FASB’s definition of a liability?
Which of the following does not meet the FASB’s definition of a liability?
a. A note payable with no specified maturity date
b. The signing of a three-year employment contract at a fixed annual salary
c. An obligation to provide goods or services in the future
d. An obligation that is estimated in amount

Answer 2

b. The signing of a three-year employment contract at a fixed annual salary

Question 3

Stockton Co. has a $20,000, two-year note payable to Lawton City Bank that matures June 30, 2012. Stockton’s management intends to refinance the note for an additional three years and is negotiating a financing agreement with Lawton City. In order to exclude this note from current liabilities on its December 31, 2011, balance sheet, Stockton Co. must

a. complete the refinancing before the note’s maturity date.
b. pay off the note and complete the refinancing before the 2011 financial statements are issued.
c. demonstrate an ability to refinance the obligation before the 2011 financial statements are issued.
d. complete the refinancing before the balance sheet date.

Answer 3

c. demonstrate an ability to refinance the obligation before the 2011 financial statements are issued.

Question 4

At December 31, 2012, Bennett Corp. owed notes payable of $1,000,000 with a maturity date of April 30, 2013. These notes did not arise from transactions in the normal course of business. On February 1, 2013, Bennett issued $3,000,000 of ten-year bonds with the intention of using part of the bond proceeds to liquidate the $1,000,000 of notes payable. Bennett’s December 31, 2012, financial statements were issued on March 29, 2013. How much of the $1,000,000 notes payable should be classified as current in Bennett’s balance sheet at December 31, 2012?

a. $1,000,000
b. $900,000
c. $0
d. $100,000

Answer 4

c. $0

Question 5

On January 1, 2012, Wooten Company lent $17,800 cash to Singer Company. The promissory note made by Singer for $20,000 did not bear explicit interest and was due on December 31, 2014. No other rights or privileges were exchanged. The prevailing interest rate for a loan of this type was six percent.
Assume that the present value of $1 for two periods at six percent is .89. Singer should recognize interest expense in 2012 of
a. $1,068.
b. $0.
c. $1,200.
d. $1,100.

Answer 5

a. $1,068.

Question 6

A loan backed by an asset that serves as collateral for the loan is known as:

a. a derivative.
b. a purchase commitment.
c. a futures contract.
d. a mortgage.

Answer 6

d. a mortgage.

Question 7

Unamortized debt premium should be reported on the balance sheet of the issuer as a

a. deduction from the issue costs.
b. direct addition to the present value of the debt.
c. direct addition to the face amount of the debt.
d. deferred credit.

Answer 7

c. direct addition to the face amount of the debt.

Question 8

Which one of the following is true when the effective-interest method of amortizing bond discount is used?

a. Interest expense as a percentage of the bonds’ book value varies from period to period.
b. Interest expense remains constant for each period.
c. Interest expense increases each period.
d. The interest rate decreases each period.

Answer 8

c. Interest expense increases each period.

Question 9

An action taken to reduce the risk associated with a related investment or action is known as a:

a. an economic loss.
b. an offsetting loss.
c. a bond.
d. a hedge.

Answer 9

d. a hedge.

Question 10

When must a company designate whether it is using the fair value option with respect to a financial asset or financial liability?

a. when it sees which way the interest rates go.
b. None of these are correct.
c. when the initial transaction to create the item occurs.
d. when top management decides on a specific recording date.

Answer 10

c. when the initial transaction to create the item occurs.

Question 11

An entity would be considered the primary beneficiary of a variable interest entity (VIE) if the entity

a. holds an equity interest equal to 10% of the total assets of the VIE.
b. holds an equity interest equal to 20% of the total assets of the VIE.
c. holds the largest voting interest in the VIE.
d. provides the majority of financial support when other parties are providing financial support to the VIE as well.

Answer 11

d. provides the majority of financial support when other parties are providing financial support to the VIE as well.

Question 12

If the financial risk associated with the research and development is transferred from the Company A to Company B and there is no obligation to them, the journal entry to be made by Company A will include a:

a. None of these because a liability does not need to be recorded by Company A.
b. a debit to Deferred Revenue
c. credit to Accounts Payable
d. credit Research and Development Expense

Answer 12

a. None of these because a liability does not need to be recorded by Company A.

Question 13

Selected financial data of Vamosi Corporation for the year ended December 31, 2012, is presented below:

Common stock dividends were $120,000. The times-interest-earned ratio is

a. 9.0 to 1.
b. 4.8 to 1.
c. 6.0 to 1.
d. 2.8 to 1.

Answer 13

a. 9.0 to 1.

Question 14

On December 31, 2012, Water Corporation’s current liabilities total $60,000 and long-term liabilities total $160,000. Working capital at December 31, 2012, is equal to $90,000. If Water Corporation’s debt-to-equity ratio is .40 to 1, total long-term assets must equal

a. $680,000.
b. $550,000.
c. $620,000.
d. $770,000.

Answer 14

c. $620,000.

Question 15

Common disclosure associated with long-term debt include all of the following except:

a. maturities.
b. the officers involved in securing the debt.
c. interest rates.
d. conversion privileges.

Answer 15

b. the officers involved in securing the debt.

Question 16

All of the following statements are true regarding common disclosure associated with long-term debt except::

a. In disclosing details about long-term debt in the notes to the financial statements, it is not necessary to disclose the portion of long-term debt coming due in the current period because that can be calculated from the balance sheet.
b. In disclosing details about long-term debt in the notes to the financial statements, the assets pledged should be indicated.
c. In disclosing details about long-term debt in the notes to the financial statements, the methods of liquidation should be indicated.
d. In disclosing details about long-term debt in the notes to the financial statements, the nature of the liabilities should be indicated.

Answer 16

a. In disclosing details about long-term debt in the notes to the financial statements, it is not necessary to disclose the portion of long-term debt coming due in the current period because that can be calculated from the balance sheet.

Question 17

Troubled debt restructuring can include concessions for all of the following except:

a. principal payments on installment obligations.
b. interest payments.
c. concessions for all of these are possible.
d. periodic payments to bond retirement funds.

Answer 17

c. concessions for all of these are possible.

Question 18

Which of the following restructuring is considered a significant economic event but does not require a gain or loss to be recognized?

a. Grant of equity interest in full settlement (equity swap)
b. Transfer of assets in full settlement (asset swap)
c. Modification of Terms: Total payment under new structure is less than debt carrying value
d. Modification of Terms: Total payment under new structure exceeds debt carrying value

Answer 18

d. Modification of Terms: Total payment under new structure exceeds debt carrying value

Question 19

MC12-1 (LO1) For a liability to exist,

a. a past transaction or event must have occurred.
b. the exact amount must be known.
c. the identity of the party owed must be known.
d. an obligation to pay cash in the future must exist.

Answer 19

a. a past transaction or event must have occurred.

Question 20

MC12-2 (LO2) Guanajuato Co. has a $50,000, three-year note payable to the Bank of Mexico that matures on May 31, 2013. Guanajuato’s management intends to refinance the note for an additional three years and is negotiating a financing agreement with the Bank of Mexico. In order to exclude this note from current liabilities on its December 31, 2012, balance sheet, Guanajuato Co. must

a. pay off the note and complete the refinancing before the 2012 financial statements are issued.
b. demonstrate an ability to refinance the obligation before the 2012 financial statements are issued.
c. complete the refinancing before the balance sheet date.
d. complete the refinancing before the note’s maturity date.

Answer 20

b. demonstrate an ability to refinance the obligation before the 2012 financial statements are issued.

Question 21

MC12-3 (LO3) On July 1, 2012, Quartz Co. issued a five-year note payable with a face amount of $500,000 and an interest rate of 10 percent. The terms of the note require Quartz to make five annual payments of $100,000 plus accrued interest, with the first payment due on June 30, 2013. With respect to this item, the Current Liabilities section of Quartz’s December 31, 2012, balance sheet should include

a. $25,000.
b. $100,000.
c. $125,000.
d. $150,000.

Answer 21

c. $125,000.

Question 22

MC12-4 (LO4) The effective interest rate on bonds is lower than the stated rate when bonds sell

a. at face value.
b. above face value.
c. below face value.
d. at maturity value.

Answer 22

c. book value of the bonds multiplied by the effective interest rate.

Question 23

MC12-6 (LO6) Which of the following is NOT considered a form of off-balance-sheet financing?

a. VIEs
b. unconsolidated subsidiaries
c. capital leases
d. operating leases

Answer 23

d. operating leases

Question 24

MC12-8 (LO8) Which of the following items is NOT a required disclosure associated with debt financing?

a. the parties holding the debt
b. maturity dates
c. assets pledged
d. interest rates

Answer 24

a. the parties holding the debt

Question 25

MC12-9 (LO9) In which of the following situations will no gain or loss be recognized by the issuer in a troubled debt restructuring?

a. total payment under new structure is less than debt carrying value
b. total payment under new structure exceeds debt carrying value
c. grant of equity interest in full settlement
d. transfer of assets in full settlement

Answer 25

b. total payment under new structure exceeds debt carrying value

Question 26

1. Which of the following does not meet the FASB’s definition of a liability?
   a. The signing of a three‐year employment contract at a fixed annual salary
   b. An obligation to provide goods or services in the future
   c. A note payable with no specified maturity date
   d. An obligation that is estimated in amount

Answer 26

a. The signing of a three‐year employment contract at a fixed annual salary

Question 27

2. The market price of a bond issued at a discount is the present value of its principal amount at the
   market (effective) rate of interest
   a. plus the present value of all future interest payments discounted at the market
   (effective) rate of interest.
   b. plus the present value of all future interest payments discounted at the rate of
   interest stated on the bond.
   c. minus the present value of all future interest payments discounted at the market
   (effective) rate of interest.
   d. minus the present value of all future interest payments discounted at the rate of
   interest stated on the bond.

Answer 27

a. plus the present value of all future interest payments discounted at the market
(effective) rate of interest.

Question 28

3. How would the carrying value of a bond payable be affected by amortization of each of the
following?
Discount Premium
a. No effect No effect
b. Increase No effect
c. Increase Decrease
d. Decrease Increase

Answer 28

c. Increase Decrease

Question 29

4. Callable bonds
   a. can be redeemed by the issuer at some time at a pre‐specified price.
   b. can be converted to stock.
   c. mature in a series of payments.
   d. None of these is correct.

Answer 29

a. can be redeemed by the issuer at some time at a pre‐specified price.

Question 30

5. A contingency must be accrued in the accounts and reported in the financial statements when
   a. the amount of the loss can be reliably estimated and it is probable that an asset is
   impaired or a liability incurred.
   b. it is evident that an asset has been impaired or a liability has been incurred even
   though the amount of the loss cannot be reliably estimated.
   c. it is not certain that funds will be available to settle damages that may arise from a
   pending lawsuit.
   d. a loss is expected and its amount is uncertain.

Answer 30

a. the amount of the loss can be reliably estimated and it is probable that an asset is
impaired or a liability incurred.

Question 31

6. On July 1, 2011, TJR issued 2,000 of its 8 percent, $1,000 bonds. The bonds were issued to yield 10
   percent. The bonds are dated July 1, 2011, and mature on July 1, 2021. Interest is payable
   semiannually on January 1 and July 1. Using the effective‐interest method, how much of the bond
   discount should be amortized for the six months ended December 31, 2011?
   a. $15,076
   b. $12,461
   c. $9,128
   d. $7,538

Answer 31

d. $7,538

Question 32

7. White Sox Corporation issued $200,000 of 10‐year bonds on January 1. The bonds pay interest on
   January 1 and July 1 and have a stated rate of 10 percent. If the market rate of interest at the time
   the bonds are sold is 8 percent, what will be the issuance price of the bonds?
   a. $175,076
   b. $141,091
   c. $226,840
   d. $227,181

Answer 32

d. $227,181

Question 33

8. The effective interest rate of a 10‐year, 8 percent, $1,000 bond issued at 103 would be
approximately
a. 7.6 percent.
b. 3.8 percent.
c. 8.0 percent.
d. 8.2 percent.

Answer 33

D

Question 34

9. On January 1, 2011, Felipe Hospital issued a $250,000, 10 percent, 5‐year bond for $231,601.
   Interest is payable on June 30 and December 31. Felipe uses the effective‐interest method to
   amortize all premiums and discounts. Assuming an effective interest rate of 12 percent, how much
   interest expense should be recorded on June 30, 2011?
   a. $11,580.05
   b. $12,500.00
   c. $13,896.06
   d. $27,792.12

Answer 34

C

Question 35

10. If a $1,000, 9 percent, 10‐year bond was issued at 96 plus accrued interest one month after the
    authorization date, how much cash was received by the issuer?
    a. $967.50
    b. $960.00
    c. $1,007.50
    d. $992.50

Answer 35

A