Chapter 9 Flashcards
What is a mixture of liabilities and stockholders’ equity that a business uses?
Capital structure
What occurs when a company is borrowing money?
Debt financing
What occurs when a company is obtaining investment from stockholders?
Equity financing
How do companies obtain external funding?
Debt and equity financing
Which of the following statements is true?
a. Profits generated by a company are a source of external financing.
b. Dividends paid are a tax-deductible expense.
c. Interest paid on debt is a tax-deductible expense.
d. All of the above are true.
c. Interest paid on debt is a tax-deductible expense.
What is one advantage to debt financing?
Interest on borrowed funds is tax-deductible
What is the formula to find interest expense?
Carrying value x market interest rate x fraction of the year
What is the layout for an amortization schedule?
Date, Cash Paid, Interest Expense, Decrease in Carrying Value, Carrying Value
When you borrow money what is your initial carrying value?
The amount of money that you borrow
What is the formula to find the carrying value of the first month?
Initial carrying value - decrease in carry value
Does the cash paid value change?
No
What do you debit and credit when you establish a notes payable?
You debit cash and credit notes payable
When you initially borrow money or take out a loan what do you debit and credit?
You debit cash and credit notes payable
Make the initial journal entry:
Assume a $25,000, 6%, four-year loan for a new delivery truck on January 1, 2018. Payments of $587.13 are required at the end of each month for 48 months.
Cash 25,000
Notes Payable 25,000
When you borrow money or take out a loan what do you debit and credit for the monthly payments?
You debit interest expense and notes payable and credit cash
Make a journal entry for the first 2 monthly payments:
Assume a $25,000, 6%, four-year loan for a new delivery truck on January 1, 2018. Payments of $587.13 are required at the end of each month for 48 months.
25,000 x 6% x (1/12) = 125
587.13 - 125 = 462.13
(D) Interest Expense 125
(D) Notes Payable 462.13
(C) Cash 587.13
25,000 - 462.13 = 24,537.87
24,537.87 x 6% x (1/12) = 122.69
(D) Interest Expense 122.69
(D) Notes Payable 464.44
(C) Cash 587.13
Tropical Paradise borrows $24,000 and agrees to a 5%, five-year installment loan with the bank. Payments of $452.91 are due at the end of each month. How much interest should be recorded for the first month?
a. All $452.91 is attributable to interest.
b. $100.00
c. $352.91
d. $0
b. $100.00
24,000 x 5% x (1/12) = 100
What is a contractual arrangement by which the lessor provides the lessee the right to use an asset for a specified period of time?
A lease
What type of lease is it when the lessor owns the asset, and the lessee simply uses the asset temporarily?
Operating Lease
What type of lease is it when the lessee buys an asset and borrows the money through a lease to pay for the asset?
Capital Lease
Assume a company has assets of $100 million, liabilities of $60 million, and stockholders’ equity of $40 million. The company then signs a new lease to purchase long-term assets valued at $10 million.
What does total assets equal under a operating lease?
100
Assume a company has assets of $100 million, liabilities of $60 million, and stockholders’ equity of $40 million. The company then signs a new lease to purchase long-term assets valued at $10 million.
What does total assets equals under a capital lease?
110
100 + 10
What is the formula to find a capital lease’s ratio of liabilities to stockholders equity?
(liabilities + purchase of long-term assets) / stockholders’ equity
What is the formula to find an operating lease’s ratio of liabilities to stockholders equity?
Liabilities / stockholders’ equity
Fill in the Blank: Lower or Higher
The ratio of liabilities to stockholders equity is _____ under a capital lease
Higher
Which of the following leases is essentially the purchase of an asset with debt financing?
a. A capital lease
b. An operating lease
c. Both a capital and operating lease
d. Neither a capital lease nor an operating lease
a. A capital lease
What is a formal debt instrument that obligates the borrower to repay a stated amount at a specified maturity date?
A bond
What is the money set aside to pay debts as they come due called?
The sinking fund
What type of bond is supported by specific assets pledged as collateral by the issuer?
Secured bond
What type of bond is secured only by the “full faith and credit” of the issuing corporation?
Unsecured bond
What type of bond matures on a single date?
Term bond
What type of bond matures in installments?
Serial bond
What type of bond allows the issuer to pay off the bonds early at a fixed price?
Callable bond
What type of bond allows the investor to transfer each bond into shares of common stock?
Convertible bond
What includes underwriting, legal, accounting, registration, and printing fees?
Bond issue costs
Which of the following bonds always matures on a single date?
a. A serial bond
b. A term bond
c. A secured bond
d. A convertible bond
b. A term bond
On January 1, 2018, California Coasters raises money for development of its new roller coaster by issuing $100,000 of bonds paying a stated interest rate of 7%. The bonds are due in 10 years, with interest payable semiannually on June 30 and December 31 each year.
What is the face amount?
100,000
What is the formula to find the periods to maturity?
The years until bonds are due x 2
What is the formula to find the interest payment?
Face amount x stated interest rate x # of payments per year
Fill in the Blank:
When the market and stated interest rate is the same, the issue price equals the _________
Face amount
What is the formula to find the issue price?
Present value of face amount + present value of interest payment
When finding the issue price do you use the market or stated interest rate?
You use the market interest rate
When finding the issue price what is the formula to find the market interest rate amount?
Market interest rate / 2
If stated interest rate > market interest rate the bond is issues at:
a. Face amount
b. A premium
c. A discount
b. A premium
If stated interest rate < market interest rate the bond is issues at:
a. Face amount
b. A premium
c. A discount
c. A discount
If stated interest rate = market interest rate the bond is issues at:
a. Face amount
b. A premium
c. A discount
a. Face amount
If a 10-year bond is issued with a stated rate of 9% when the market rate is 8%, the bonds will be issued at ______?
a. A premium
b. A discount
c. Face amount
d. Cannot determine with information given
a. A premium
What do you debit and credit when you issue bonds at face value?
You debit cash and credit bonds payable
What do you debit and credit when you issue bonds at face value and pay the first interest payment?
You debit interest expense and credit cash
Make a journal entry:
Issue $100,000 of bonds paying 7% interest for $100,000, assuming a 7% market interest rate
Face Amount
Cash 100,000
Bonds Payable 100,000
Make a journal entry for the first semiannual interest payment:
Issue $100,000 of bonds paying 7% interest for $100,000, assuming a 7% market interest rate
Face Amount
100,000 x 7% x (1/2) = 3,500
Interest Expense 3,500
Cash 3,500
What do you debit and credit when you issue bonds at a discount?
You debit cash and discount on bonds payable and credit bonds payable
What do you debit and credit when you issue bonds at a discount and pay the interest payments?
You debit interest expense and credit cash and discount on bonds payable
Make a journal entry:
Issue $100,000 of bonds paying 7% interest for $93,205, assuming an 8% market interest rate
(D) Cash 93,205
(D) Discount of Bonds Payable 6,795
(C) Bonds Payable 100,000
Make a journal entry for the first and second semiannual interest payment:
Issue $100,000 of bonds paying 7% interest for $93,205, assuming an 8% market interest rate
1st Payment:
93,205 x 8% x (1/2) = 3,728
100,000 x 7% x (1/2) = 3,500
(D) Interest Expense 3,728
(C) Discount of Bonds Payable 228
(C) Cash 3,500
2nd Payment:
(93,205 + 228) x 8% x (1/2) = 3,737
(D) Interest Expense 3,737
(C) Discount of Bonds Payable 237
(C) Cash 3,500
When you issue bonds at a discount what is your initial carrying value amount?
The amount of your discount
What do you debit and credit when you issue bonds at a premium?
You debit cash and credit bonds payable and premium on bonds payable
What do you debit and credit when you issue bonds at a premium and pay the interest payments?
You debit interest expense and premium on bonds payable and credit cash
Make a journal entry:
Issue $100,000 of bonds paying 7% interest for $107,439, assuming a 6% market interest rate
(D) Cash 107,439
(C) Premium on Bonds Payable 7,439
(C) Bonds Payable 100,000
Make a journal entry for the first and second semiannual interest payment:
Issue $100,000 of bonds paying 7% interest for $107,439, assuming a 6% market interest rate
1st Payment:
107,439 x 6% x (1/2) = 3,223
100,000 x 7% x (1/2) = 3,500
(D) Interest Expense 3,223
(D) Premium on Bonds Payable 277
(C) Cash 3,500
2nd Payment:
(107,439 - 277) x 6% x (1/2) = 3,215
(D) Interest Expense 3,215
(D) Premium on Bonds Payable 285
(C) Cash 3,500
When finding the interest expense do you use the market interest rate or stated interest rate?
The market interest rate
When finding the cash (cash paid) do you use the market interest rate or stated interest rate?
The stated interest rate
When you issue a discount do you add or subtract the 1st payment’s discount on bonds payable from the 2nd payment’s interest expense?
You add
Discount on Bonds Payable = 228
Interest Expense = (107,439 + 228) x 6% x (1/2) = 3,737
When you issue a premium do you add or subtract the 1st payment’s premium on bonds payable from the 2nd payment’s interest expense?
You subtract
Premium on Bonds Payable = 277
Interest Expense = (107,439 - 277) x 6% x (1/2) = 3,215
When you issue a premium what is your initial carrying value amount?
The amount of your premium
Fill in the Blank: Increase or Decrease
For a bond issued at a premium, carrying value ______ overtime
Decreases
Fill in the Blank: Increase or Decrease
For a bond issued at a discount, carrying value ______ overtime
Increases
When bonds are issued at face amount do the carrying value and the corresponding interest expense remain constant over time?
Yes
Which of the following statements is true for bonds issued at a discount?
a. The stated interest rate > market rate
b. The stated interest rate < market rate
c. The stated interest rate = market rate
d. The stated interest rate is unrelated to the market rate
b. The stated interest rate < market rate
Which of the following statements is true for bonds issued at a premium?
a. The stated interest rate > market rate
b. The stated interest rate < market rate
c. The stated interest rate = market rate
d. The stated interest rate is unrelated to the market rate
a. The stated interest rate > market rate
Which of the following statements is true for bonds issued at face amount?
a. The stated interest rate > market rate
b. The stated interest rate < market rate
c. The stated interest rate = market rate
d. The stated interest rate is unrelated to the market rate
c. The stated interest rate = market rate
What occurs when the issuing corporation buys back its bonds from the investors?
Bond retirements
What do you debit and credit when bonds retire on maturity?
You debit bonds payable and credit cash
Is there a gain or loss recorded on bonds retired on maturity?
No
Make a journal entry:
Assume $100,000 in bonds are retired at maturity (December 31, 2027)
Bonds Payable 100,000
Cash 100,000
Is there a gain or loss recorded on bonds retired before maturity?
Yes
What do you debit and credit when bonds retire before maturity with a loss?
You debit bonds payable, premium on bonds payable, and loss and credit cash
When bonds retire before maturity what is the bonds payable amount equal to?
The face amount
When bonds retire before maturity how do you find the premium on bonds payable amount?
You take the carrying value of the bonds one year later - the bonds payable amount
When bonds retire before maturity what is the cash amount equal to?
The amount paid before maturity
Make a journal entry:
California Coasters issued bonds on January 1, 2018, above face amount (at a premium) at $107,439. The carrying value of the bonds one year later on December 31, 2018, is $106,877. Record the bond retirement before maturity on December 31, 2018 for $114,353.
(D) Bonds Payable 100,000
(D) Premium on Bonds Payable 6,877
(D) Loss 7,476
(C) Cash 114,353
PoBP = 106,877 - 100,000 Loss = 114,353 - 6,877
When bonds retire before maturity how do you find the loss amount?
You take cash - premium on bonds payable
A company retires a $50 million bond issue before maturity when the carrying value is $48 million, but the market value is $54 million. The company will record:
a. A loss of $6 million
b. A gain of $6 million
c. Neither a gain nor a loss
d. A debit to Cash of $54 million
a. A loss of $6 million
carrying value < market value = loss
54 - 48 = 6
What do you debit and credit when bonds retire before maturity with a gain?
You debit bonds payable and premium on bonds payable and credit gain and cash
What is one of the first places decision makers look when trying to get a handle on risk ?
Long-term debt
What are the two ratios used to measure financial risk related to long-term liabilities?
- Debt to equity ratio
2. Times interest earned ratio
What is a measure of financial leverage?
The debt to equity ratio
What enables a company to earn a higher return using debt than without debt?
Leverage
What is the formula to find the debt to equity ratio?
Total liabilities/stockholders’ equity
When finding the debt to equity ratio do you use the numbers from the current year or the ones from the previous year?
You use the numbers from the current year
Is a higher or lower debt to equity ratio better?
Higher is better
What is the formula to find the times interest earned ratio?
(Net income + interest expense + tax expense) / interest expense
When finding the debt to equity ratio do you add all the total liabilities up or do you just use the total liability from the current year?
You use the total liability from the current year
What measures a company’s ability to meet interest payments as they become due?
The times interest earned ratio
Which of the following ratios best measures financial leverage?
a. Return on assets
b. Inventory turnover
c. Times interest earned
d. Debt to equity ratio
d. Debt to equity ratio
