Chapter 14: Long-term financial liabilities

Question 1

Oliveira Industries issued $500,000 in 10% bonds with a 10-year term. If it pays interest to bondholders on a typical schedule, it would pay interest on

A.) each six-month anniversary of the issue date.

B.) the last day of each month.

C.) December 31.

D.) March 31, June 30, September 30, and December 31.

Answer 1

A

Question 2

A debenture bond issued by a corporation

A.) is unsecured.

B.) matures in installments.

C.) may be converted into other securities of the corporation for a specified time after issuance.

D.) is secured by shares and bonds of other corporations.

Answer 2

A

Question 3

What is the term used for bonds that pay no interest unless the issuing company is profitable?

A.) Revenue bonds

B.) Collateral trust bonds

C.) Debenture bonds

D.) Income bonds

Answer 3

D

Question 4

On August 31, Jackson Enterprises issued bonds with a par value of $750,000 and a stated interest rate of 8%. Interest is payable semi-annually on June 30 and December 31. If the proceeds from the issue amounted to $760,000, the bonds were likely

A.) issued at par plus accrued interest.

B.) sold at a higher effective interest rate.

C.) sold at a discount.

D.) sold at a premium.

Answer 4

A

Question 5

Bowser Clothing sold $350,000 in 10-year bonds at an interest rate of 8%. The market rate for similar bonds is 9%. Bowser decides to pay interest annually. Assume that PVF-OA10, 8% = 6.71008, PVF-OA10, 9% = 6.41766, PVF10, 8% = 0.46319, and PVF10, 9% = 0.42241. Based on this, Bowser sold the bonds for ________ of par.

A.) 95.9%

B.) 100%

C.) 102.6%

D.) 93.6%

Answer 5

D

Question 6

Hinds Enterprises issued bonds at a premium. They traditionally use the effective interest method of amortization. Therefore, you would expect the earlier years of the bonds to have an interest expense that is

A.) greater than if the straight-line method were used.

B.) less than if the straight-line method were used.

C.) greater than the amount of interest payments.

D.) the same as if the straight-line method were used.

Answer 6

A

Question 7

How should a bond premium be reported on a statement of financial position?

A.) Along with other premium accounts such as those resulting from share transactions.

B.) As a direct addition to the face amount of the bond.

C.) As a deferred credit.

D.) At the present value of the future reduction in bond interest expense due to the premium.

Answer 7

B

Question 8

When considering discounts or premiums applied to a bond issue, which of the following statements is correct?

A.) The terms “discount” and “premium” are the same as loss and gain, respectively, to both buyer and seller.

B.) The interest expense to the seller of bonds issued at a premium will be less than the total interest payments.

C.) The difference between the effective rate of interest and the market rate of interest is the reason discounts and premiums arise.

D.) When bonds are issued at a discount, the seller has an advantage in that interest payments are based upon an amount less than face value.

Answer 8

B

Question 9

How are commissions, legal fees, and printing fees associated with a bond issue accounted for?

A.) By charging them to an expense account in the year the bonds are actually sold.

B.) By adjusting the bonds’ initial carrying value.

C.) By charging them to an expense account in the year the bonds are originally dated, whether or not they are sold in that year.

D.) By adding them to any discount on bonds or subtracting them from any premium on bonds when the bonds are sold.

Answer 9

B

Question 10

Bond issue costs, premiums, and discounts associated with bonds that are held to maturity

A.) should be written off directly to a bond retirement account as the bond will be redeemed.

B.) will be fully amortized as their amortization period is designed to coincide with the life of the bond issue.

C.) are carried forward and written off in the same manner as that used prior to the maturity date.

D.) should be used to calculate the gain or loss resulting from the maturity of the bonds.

Answer 10

B

Question 11

The present value of a zero-interest-bearing note given for property, goods, or services should be measured by

A.) using a negotiated interest rate between the issuer of the note and the owner of the property, goods, or services to discount the note.

B.) the book value of the property on the seller’s books.

C.) the fair value of the property, goods, or services or by an amount that reasonably approximates the fair value of the note.

D.) using the prime interest rate to discount the note.

Answer 11

C

Question 12

When property with an indeterminable fair market value is exchanged for a debt instrument with no ready market,

A.) the directors of both entities involved in the transaction should negotiate a value to be assigned to the property.

B.) the present value of the debt instrument must be approximated using an imputed interest rate.

C.) the board of directors of the entity receiving the property should estimate a value for the property that will serve as a basis for the transaction.

D.) it should not be recorded on the books of either party until the fair market value of the property becomes evident.

Answer 12

B

Question 13

Marion Company issued a $350,000, zero-interest-bearing, 5-year note in exchange for land with a fair market value of $287,000 from Palma Real Estate. If the present value of the note at an appropriate rate of interest is $287,000, Palma Real Estate should record a

A.) note receivable in the amount of $350,000.

B.) gain on the sale of land.

C.) note receivable in the amount of $287,000.

D.) note payable in the amount of $287,000.

Answer 13

C

Question 14

Brownlee Enterprises calculates the value of their bonds outstanding based on the fair value option. If the market interest rate declines, the value of Brownlee’s bonds is likely to

A.) be the same as the bond’s face value.

B.) increase.

C.) stay the same.

D.) decrease.

Answer 14

B

Question 15

The difference between the reacquisition price and the net carrying amount on the books should be __________ when debt is extinguished before its maturity date through a refunding transaction.

A.) recognized currently in income as a loss or gain

B.) treated as a prior period adjustment

C.) amortized over the remaining original life of the extinguished issue

D.) amortized over the life of the new issue

Answer 15

A

Question 16

On January 1, 2015, Morley Electronics issued bonds with a par value of $1,350,000 at 95, due in 10 years. The bond discount was amortized using the straight-line method. On January 1, 2020, Morley called the entire issue at 102. Calculate Morley’s loss or gain on redemption.

A.) $60,750 loss

B.) $67,500 loss

C.) $44,750 gain

D.) $89,500 gain

Answer 16

A

Question 17

All of the following are valid reasons to form a special-purpose entity except

A.) the special-purpose entity is formed to remove risk from the company’s own financial statements.

B.) two or more entities form a new entity to construct an operating plant that will be used by both parties.

C.) the special purpose entity segregates certain specific company assets from others.

D.) the new entity borrows money to finance a project and repays the debt from the proceeds received from the project.

Answer 17

A

Question 18

A company that enters into off-balance-sheet financing (select all that apply)

A.) can enhance the quality of its financial position and perhaps permit credit to be obtained more readily and at less cost.

B.) wishes to confine all information related to the debt to the income statement and the statement of cash flow.

C.) may be attempting to conceal the debt from shareholders by having no information about the debt included in the balance sheet.

D.) is in violation of generally accepted accounting principles.

Answer 18

A + C

Question 19

Which of the following conditions must be present for a debt refinancing to be treated as a settlement?

A.) The discounted present value of the cash flows under the new terms must be at least 5% greater or less than those under the old terms.

B.) The discounted present value of the cash flows under the new terms must be at least 10% greater or less than those under the old terms.

C.) The discounted present value of the cash flows under the new terms must be at least 10% less than those under the old terms.

D.) The discounted present value of the cash flows under the new terms must be at least 5% less than those under the old terms.

Answer 19

B

Question 20

Farrar Cakes disclosed total liabilities of $5,400,000, total assets of $8,000,000, interest expense of $400,000, income taxes of $600,000, and net income of $1,000,000 in their 2019 financial statements. Based on this, Farrar Cakes’ times interest earned ratio is

A.) 2.5.

B.) 8.

C.) 10.

D.) 5.

Answer 20

D

Question 21

How should long-term debt be reported if it matures within one year and the company has arranged, before its current year-end, to convert the debt into shares?

A.) In a special section between liabilities and shareholders’ equity.

B.) As noncurrent.

C.) As a current liability.

D.) As non-current and accompanied with a note explaining the method to be used in its liquidation.

Answer 21

D

Question 22

Complex financial instruments make the distinction between debt and equity

A.) easier to define.

B.) harder to define.

C.) irrelevant.

D.) less important.

Answer 22

B

Question 23

Which of the following is a required disclosure with respect to liabilities?

A.) payment terms for trade accounts payable

B.) who the creditors are and how much is owed to each

C.) future payments and maturity amounts for each of the next ten years

D.) details of assets pledged as collateral

Answer 23

D

Question 24

Which of the following is not a required disclosure with respect to liabilities?

A.) maturity dates and interest rates for each outstanding bond issue

B.) details of assets pledged as collateral

C.) payment terms for trade accounts payable

D.) future payments and maturity amounts for each of the next five years

Answer 24

C

Question 25

What problem might the existence of a debt covenant pose to accountants and analysts?

A.) The debtor might use overly aggressive accounting in order to meet the condition imposed by the covenant.

B.) The creditor might use overly conservative accounting in order to meet the condition imposed by the covenant.

C.) The creditor might use overly aggressive accounting in order to meet the condition imposed by the covenant.

D.) The debtor might use overly conservative accounting in order to meet the condition imposed by the covenant.

Answer 25

A

Question 26

The numerator of the times interest earned ratio is

A.) net income before interest.

B.) net income before interest and income tax.

C.) net income before interest, income tax, and depreciation (EBITDA).

D.) net income before income tax.

Answer 26

B

Question 27

Which of the following would be considered positive indicators of a company’s financial health?

A.) a high debt to total assets ratio and a low interest coverage ratio

B.) a high debt to total assets ratio and a high interest coverage ratio

C.) a low debt to total assets ratio and a low interest coverage ratio

D.) a low debt to total assets ratio and a high interest coverage ratio

Answer 27

D

Question 28

Which of the following statements is true?

A.) Refinanced long-term debt may be reported as long-term rather than current if the refinancing has been completed before the date of the financial statements, according to ASPE; and before the date of the issue of the financial statements, according to IFRS.

B.) Refinanced long-term debt may be reported as long-term rather than current if the refinancing has been completed before the issue of the financial statements, according to IFRS and ASPE.

C.) Refinanced long-term debt may be reported as long-term rather than current if the refinancing has been completed before the date of the financial statements, according to IFRS; and before the date of the issue of the financial statements, according to ASPE.

D.) Refinanced long-term debt may be reported as long-term rather than current if the refinancing has been completed before the date of the financial statements, according to IFRS and ASPE.

Answer 28

C

Question 29

Which of the following statements is correct?

A.) Both IFRS and ASPE permit either the effective interest method or the straight-line method to be used to amortize bond premiums and discounts.

B.) ASPE requires the effective interest method to be used to amortize bond premiums and discounts; IFRS permits either the effective interest method or the straight-line method.

C.) IFRS requires the effective interest method to be used to amortize bond premiums and discounts; ASPE permits either the effective interest method or the straight-line method.

D.) Both IFRS and ASPE require the effective interest method to be used to amortize bond premiums and discounts.

Answer 29

C