F5 - Liabilities

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On June 30 of the current year Huff Corp. issued at 99, one thousand of its 8%, $1,000 bonds. Huff uses U.S. GAAP. The bonds were issued through an underwriter to whom Huff paid bond issuance costs of $35,000. On June 30 of the current year, Huff should report the bond liability at: A. $ 955,000 B. $ 990,000 C. $1,000,000 D. $1,025,000

*A. $ 955,000* Explanation Choice "A" is correct. *$990,000 bond liability at 6/30 less $35,000 of bond issuance costs* equals $955,000 net bond liability. *Rule*: Discount or premium on the sale of bonds as well as the bond issuance costs are included in the carrying value of the bonds on the balance sheet.

On December 31, of the current year, Wright Corp. placed cash of $875,000 in an irrevocable trust. The trust's assets are to be used solely for satisfying obligations on Wright's 6%, $1,100,000, 30-year bond payable. Wright has not been legally released from its obligations under the bond agreement, but any additional liability is considered remote. This material event is considered unusual and infrequent for Wright. On December 31, of the current year, the bond's carrying amount was $1,050,000, and its market value was $800,000. Disregarding income taxes, what amount of gain (loss) should Wright report in its current year income statement? A. $0 B. $(75,000) C. $175,000 D. $250,000

*A. $0* Explanation Choice "A" is correct. None A debtor is relieved of its obligation to the creditor only by: 1. Paying the creditor. 2. Being released of the debt judicially or by the creditor. Considering debt as "extinguished" (defeasing debt) by placing cash in an irrevocable trust is *not* GAAP for "extinguishment of debt."

On January 2, Vole Co. issued bonds with a face value of $480,000 at a discount to yield 10%. The bonds pay interest semiannually. On June 30, Vole paid bond interest of $14,400. After Vole recorded amortization of the bond discount of $3,600, the bonds had a carrying amount of $363,600. What amount did Vole receive upon issuing the bonds? A. $360,000 B. $367,200 C. $476,400 D. $480,000

*A. $360,000* Explanation Choice "A" is correct. The unamortized discount on bonds payable is a contra to bonds payable. It is presented on the balance sheet as a direct reduction from the face value of the bonds to arrive at the bond's carrying amount. As the discount is amortized, the discount decreases and the carrying value of the bond increases. The carrying amount is $363,600 after recording amortization of $3,600. Therefore, the carrying amount before amortization is $360,000. Choice "B" is incorrect. Amortization of a discount increases, not decreases, the carrying amount of the bond. Amortization of the discount or premium always moves the carrying value closer to the face value. Choice "C" is incorrect. Amortization is calculated on the carrying amount of the bond, not the face value of the bond. Choice "D" is incorrect. The face value of the bond is received if there was no discount or premium.

As of December 15, Year 3, Aviator had dividends in arrears of $200,000 on its cumulative preferred stock. Dividends for Year 3 of $100,000 have not yet been declared. The board of directors plan to declare cash dividends on its preferred and common stock on January 16, Year 4. Aviator paid an annual bonus to its CEO based on the company's annual profits. The bonus for Year 3 was $50,000, and it will be paid on February 10, Year 4. What amount should Aviator report as current liabilities on its balance sheet at December 31, Year 3? A. $50,000 B. $150,000 C. $200,000 D. $350,000

*A. $50,000* Explanation Choice "A" is correct. Under the matching principle, expenses are recognized when an entity's economic benefits are used up. In the case of the CEO bonus of $50,000, that was clearly earned in Year 3 and should be accrued for accordingly. The *dividends were not declared* in Year 3 and as such should *not* be accrued for. *Upon declaration*, dividends become a debt of the corporation (*credit to dividends payable*) and are debited to retained earnings.

On July 31, Year 1, Dome Co. issued $1,000,000 of 10 percent, 15-year bonds at par and (as a typical risk-management strategy to Dome Co.) used a portion of the proceeds to call its 600 outstanding 11 percent, $1,000 face value bonds, due on July 31, Year 11, at 102. On that date, unamortized bond premium relating to the 11 percent bonds was $65,000. In its Year 1 income statement, what amount should Dome report as gain or loss from retirement of bonds? A. $53,000 gain B. $0 C. $(65,000) loss D. $(77,000) loss

*A. $53,000 gain* *Gain on debt restructuring = Carrying amount - Future cash payments = (Face value of old debt + unamortized premium) - (Fave value of new debt x premium%)* Explanation Choice "A" is correct. A gain of $53,000 is recognized because the *$665,000 book value of the debt* ($600,000 face value plus $65,000 unamortized premium) *is settled for $612,000* ($600,000 at 102). There is no accrued interest because the redemption takes place on an interest date. The proceeds from the new bond issuance are not relevant. Note that the gain is reported as part of continuing operations because the transaction is a typical risk-management strategy of the company. Choice "B" is incorrect. The retirement price does not equal the book value, so a gain or loss must be recognized. Choice "C" is incorrect. Gain or loss is not determined solely by the amount of unamortized premium. Choice "D" is incorrect. The combination of the unamortized premium plus the excess of the retirement price over the bond face value is not relevant.

Which of the following is not a criteria for recognizing a liability associated with exit or disposal activities? A. A commitment to an exit plan. B. The existence of a present obligation to transfer assets in the future. C. The occurrence of an obligating event. D. The entity has no discretion to avoid the future transfer of assets.

*A. A commitment to an exit plan.* Explanation Choice "A" is correct. An entity's commitment to an exit or disposal plan, by itself, is *not enough to result in liability recognition*. A liability is only recognized when all of the following criteria are met: 1. An obligating event has occurred. 2. The event results in a present obligation to transfer assets or to provide services in the future. 3. The entity has little or no discretion to avoid the future transfer of assets or providing of services.

When the effective interest method of amortization is used for bonds issued at a premium, the amount of interest payable for an interest period is calculated by multiplying the: A. Face value of the bonds at the beginning of the period by the contractual interest rate. B. Face value of the bonds at the beginning of the period by the effective interest rates. C. Carrying value of the bonds at the beginning of the period by the contractual interest rate. D. Carrying value of the bonds at the beginning of the period by the effective interest rates.

*A. Face value of the bonds at the beginning of the period by the contractual interest rate.* Explanation Choice "A" is correct. The interest payable on a bond is calculated by taking the face value of the bond at the beginning of the period and multiply this amount by the contractual interest rate. Choice "B" is incorrect. This calculation is not used in bond accounting. Choice "C" is incorrect. This calculation is not used in bond accounting. Choice "D" is incorrect. This is the formula used to calculate the interest expense on a bond.

For a troubled debt restructuring involving only a modification of terms, which of the following items specified by the new terms would be compared to the carrying amount of the debt to determine if the debtor should report a gain on restructuring? A. The total future cash payments. B. The present value of the debt at the original interest rate. C. The present value of the debt at the modified interest rate. D. The amount of future cash payments designated as principal repayments.

*A. The total future cash payments.* Explanation Choice "A" is correct. Carrying amount - Total future cash payments = Gain.

On December 31, Key Co. received two $10,000 non-interest-bearing notes from customers in exchange for services rendered. The note from Alpha Co., which is due in nine months, was made under customary trade terms, but the note from Omega Co., which is due in two years, was not. The market interest rate for both notes at the date of issuance is 8%. The present value of $1 due in nine months at 8% is .944. The present value of $1 due in two years at 8% is .857. At what amounts should these two notes receivable be reported in Key's December 31 balance sheet? Alpha Omega A. $9,440 $8,570 B. $10,000 $8,570 C. $9,440 $10,000 D. $10,000 $10,000

*B. $10,000 $8,570* Explanation Choice "B" is correct. Because the term of the Alpha note does not exceed one year, it is recorded at its face amount of $10,000, while the two-year Omega note must be reported at the present value of the obligation calculated using the market interest rate of 8%: $10,000 × 0.857 = $8,570 Choice "A" is incorrect. Because the term of the Alpha note does not exceed one year, it is recorded at its face amount of $10,000. Choice "C" is incorrect. Because the term of the Alpha note does not exceed one year, it is recorded at its face amount of $10,000, while the two-year Omega note must be reported at the present value of the obligation calculated using the market interest rate of 8%. Choice "D" is incorrect. The two-year Omega note must be reported at the present value of the obligation calculated using the market interest rate of 8%.

On January 1, Year 1, Cain Corp. issued 200 of its 9%, $1,000 bonds at 103. The bonds are dated January 1, Year 1 and mature on January 1, Year 11. Interest is payable semiannually on January 1 and July 1. Cain paid bond issue costs of $5,000. Cain Corp. uses IFRS. On January 1, Year 1, the net carrying value of the bond liability is: A. $200,000 B. $201,000 C. $206,000 D. $211,000

*B. $201,000* Explanation Choice "B" is correct. Under IFRS, bond issue costs reduce the cash received from the bond issuance and are deducted from the carrying value of the liability. This bond was issued at a premium for $206,000 ($200,000 x 103%). The net premium on the bond is $1,000 ($6,000 premium on issuance - $5,000 bond issue costs). The bond issuance is recorded as follows: DR: Cash $201,000 CR: Premium $1,000 CR: Bond liability 200,000 The net carrying value of the bond liability on January 1, Year 1, is: $200,000 bond liability + $1,000 net premium = $201,000.

A company issued a bond with a stated rate of interest that is less than the effective interest rate on the date of issuance. The bond was issued on one of the interest payment dates. What should the company report on the first interest payment date? A. An interest expense that is less than the cash payment made to bondholders. B. An interest expense that is greater than the cash payment made to bondholders. C. A debit to the unamortized bond discount. D. A debit to the unamortized bond premium.

*B. An interest expense that is greater than the cash payment made to bondholders.* Explanation Choice "B" is correct. Because the stated rate of interest is less than the effective interest rate when the bond is issued, this bond is issued at a discount. When the first interest payment is made, the discount is amortized. The discount amortization will increase interest expense for the period so that interest expense exceeds the interest payment to bondholders. Choice "A" is incorrect. Interest expense is less than the cash payment made to bondholders when a bond premium is amortized. This bond was issued at a discount, not a premium, because the stated rate was less than the effective interest rate when the bond was issued. Choice "C" is incorrect. When the bond is issued, the bond discount account is debited. When the first interest payment is made, the bond discount will be amortized. Discount amortization is recorded by crediting, not debiting, the bond discount account. Choice "D" is incorrect. This bond was issued at a discount, not a premium, because the bond was issued when the stated rate was less than the effective interest rate.

An investor purchased a bond classified as a long-term investment between interest dates at a discount. At the purchase date, the carrying amount of the bond is more than the: Cash paid to seller/ Face amount of bond A. No/ Yes B. No/ No C. Yes/ No D. Yes/ Yes

*B. No/ No* Explanation Choice "B" is correct. No - No. The carrying value is *less than* the cash paid by the investor because *accrued interest is included in the cash.* The carrying value is *less than* the face amount of the bond because it was purchased at a discount.

Weald Co. took advantage of market conditions to refund debt. This was the fifth refunding operation carried out by Weald within the last four years. The excess of the carrying amount of the old debt over the amount paid to extinguish it should be reported as a (an): A. Deferred credit to be amortized over life of new debt. B. Part of continuing operations. C. Separate item, net of income taxes. D. A reduction of interest expense for the year.

*B. Part of continuing operations.* Explanation Choice "B" is correct. Many companies and agencies extinguish (or refund) long-term debt prior to maturity as a method of managing financial risk. The gain (retirement price less carrying amount of the old debt) will be included as part of continuing operations. Choice "A" is incorrect. Gains or losses on early retirement of debt must be recognized at the time of the transaction. Choice "C" is incorrect. The gain is not reported net of income taxes. Choice "D" is incorrect. The gain is not reported as a reduction of interest expense.

Cali Inc. had a $4,000,000 note payable due on March 15, Year 5. On January 28, Year 5, before the issuance of its Year 4 financial statements, Cali issued long-term bonds in the amount of $4,500,000. Proceeds from the bonds were used to repay the note when it came due. How should Cali classify the note in its December 31, Year 4, financial statements? A. As a current liability, with separate disclosure of the note refinancing. B. As a current liability, with no separate disclosure required. C. As a noncurrent liability, with separate disclosure of the note refinancing. D. As a noncurrent liability, with no separate disclosure required.

*C. As a noncurrent liability, with separate disclosure of the note refinancing.* *Rule*: Bonds or notes due within one year are shown as "noncurrent" if the issuer has the intent and ability to refinance with a new issuance of long-term debt. This intent and ability must usually be demonstrated through refinancing of the debt after the balance sheet date, but before the issuance of the financial statements. Separate disclosure of the refinancing is required. Choice "C" is correct. As a noncurrent liability, with separate disclosure of the note refinancing.

As of December 1, Year 2 a company obtained a $1,000,000 line of credit maturing in one year on which it has drawn $250,000, a $750,000 secured note due in five annual installments, and a $300,000 three-year balloon note. The company has no other liabilities. How should the company's debt be presented in its classified balance sheet on December 31, Year 2 if no debt repayments were made in December? A. Current liabilities of $1,000,000; long-term liabilities of $1,050,000. B. Current liabilities of $500,000; long-term liabilities of $1,550,000. C. Current liabilities of $400,000; long-term liabilities of $900,000. D. Current liabilities of $500,000; long-term liabilities of $800,000.

*C. Current liabilities of $400,000; long-term liabilities of $900,000.* Explanation Choice "C" is correct. The *current* liabilities ($400,000) consist of the *$250,000 draw on the line of credit* due within one year and *$150,000 (1/5 of the $750,000)*, which represents the portion of the secured note due within the next year. The *long-term liabilities* are $900,000, which consist of the four *remaining installments of the secured note, which is $600,000* (4 × $150,000) *plus the $300,000* three-year balloon note. Choice "A" is incorrect. Only the portion which has been drawn off the line of credit will be reported as a liability on the balance sheet. Furthermore, the portion of the secured note due within one year, $150,000 ($750,000 / 5), will be reported as a current liability and not a long-term liability.

When a loan receivable is impaired but foreclosure is not probable, which of the following may the creditor use to measure the impairment? I. The loan's observable market price. II. The fair value of the collateral if the loan is collateral dependent. A. I only. B. II only. C. Either I or II. D. Neither I nor II.

*C. Either I or II.* Explanation Choice "C" is correct. A loan is impaired when it is probable that a creditor will be unable to collect all amounts due (including both principal and interest) according to the contractual terms of the loan agreement. When a loan is impaired and foreclosure is not probable, the creditor should measure impairment based on the present value of expected future cash flows discounted at the loan's effective interest rate. However, as a practical expedient, the creditor may measure impairment based on (1) a loan's observable market price, or (2) the fair value of the collateral if the loan is collateral dependent. If foreclosure of a loan is probable, impairment must be measured based on the fair value of the collateral. Choices "A", "B", and "D" are incorrect. Both the loan's observable market price and the fair value of collateral can be used to measure impairment.

Which of the following is reported as interest expense? A. Pension cost interest. B. Postretirement healthcare benefits interest. C. Imputed interest on non-interest bearing note. D. Interest incurred to finance construction of machinery for own use.

*C. Imputed interest on non-interest bearing note.* Explanation Choice "C" is correct. Imputed interest on non-interest bearing note is reported as interest expense. Choice "A" is incorrect. Pension cost interest is a component of pension plan expense. Choice "B" is incorrect. Post retirement healthcare benefits interest is part of post retirement benefit expense. Choice "D" is incorrect. Interest incurred to finance construction of machinery for own use is capitalized as part of the cost of the machinery.

When debt is issued at a discount, interest expense over the term of debt equals the cash interest paid: A. Minus discount. B. Minus discount minus par value. C. Plus discount. D. Plus discount plus par value.

*C. Plus discount.* Explanation Choice "C" is correct. When debt is issued at a discount, interest expense over the term of the debt equals the cash interest paid plus amortization of the discount. The Journal Entry for the amortization of the discount is as follows: DR: Interest expense XXX CR: Amortization of bond discount XXX CR: Cash (or interest payable) XXX An easy way to remember whether to add or to subtract is that the discount is a reduction (Dr) of the bond's face value or par amount (Cr). Since the discount is a debit, the way to reduce (amortize) it is to credit it. Choice "A" is incorrect. When debt is issued at a discount, interest expense over the term of the debt equals the cash interest paid plus, not minus, amortization of the discount. Choice "B" is incorrect. When debt is issued at a discount, interest expense over the term of the debt equals the cash interest paid plus amortization of the discount. The par value should definitely not be subtracted. Choice "D" is incorrect. When debt is issued at a discount, interest expense over the term of the debt equals the cash interest paid plus amortization of the discount. The par value should definitely not be added.

Pie Co. uses the installment sales method to recognize revenue. Customers pay the installment notes in 24 equal monthly amounts, which include 12% interest. What is an installment note's receivable balance six months after the sale? A. 75% of the original sales price. B. Less than 75% of the original sales price. C. The present value of the remaining monthly payments discounted at 12%. D. Less than the present value of the remaining monthly payments discounted at 12%.

*C. The present value of the remaining monthly payments discounted at 12%.* Explanation Choice "C" is correct. The present value of the remaining monthly payments discounted at 12% equals the installment note receivable balance at any time. Choice "A" is incorrect. Because the early loan payments are mostly interest, with little principal pay down, the balance will be more than 75% of the original price. Choice "B" is incorrect. Because the balance will be more than 75% of the loan balance. Choice "D" is incorrect. Because the balance will always be the present value of the remaining monthly payments discounted at 12%.

The market price of a bond issued at a premium is equal to the present value of its principal amount: A. Only, at the stated interest rate. B. And the present value of all future interest payments, at the stated interest rate. C. Only, at the market (effective) interest rate. D. And the present value of all future interest payments, at the market (effective) interest rate.

*D. And the present value of all future interest payments, at the market (effective) interest rate.* Explanation Choice "D" is correct. To determine the market price of a bond, the present value of the principal is added to the present value of all interest payments, using the market interest rate. Choice "A" is incorrect. The stated interest rate is used to calculate the amount of interest payment, but not the market price of the bond. Choice "B" is incorrect. The stated interest rate is used to calculate the amount of interest payment, but not the market price of the bond. Choice "C" is incorrect. The market interest rate is used in calculating the price of the bond; however, all the interest payments must also be taken into consideration.

An entity, upon initial recognition of an asset retirement obligation, should not take which of the following actions? A. Allocate asset retirement cost to expense over the useful life of the related asset. B. Measure the asset retirement cost at fair value. C. Capitalize the asset retirement cost by increasing the carrying amount of the related asset. D. Capitalize the asset retirement cost at its undiscounted cash flow value.

*D. Capitalize the asset retirement cost at its undiscounted cash flow value. * Explanation Choice "D" is correct. When an asset retirement obligation exists, the entity should record an asset retirement cost (ARC) which increases the carrying value of the long-lived asset as well as an asset retirement obligation (ARO), which is the liability recorded on the balance sheet related to the retirement. The amount recorded to both the asset and liability will be equal to the fair value of the asset retirement obligation (which is determined by discounting the future cash flows required). The ARC will be depreciated over the useful life of the related asset while the ARO will be "accreted" based on the relevant accretion rate.

Which of the following is a cost associated with exit and disposal activities? A. Benefits related to voluntary employee termination. B. Costs to terminate a capital lease. C. Costs to relocate employees. D. Costs associated with the retirement of a fixed asset.

Explanation Choice "C" is correct. Costs to relocate employees are costs associated with exit and disposal activities. Choice "A" is incorrect. Exit and disposal activities include benefits related to involuntary (not voluntary) employee termination. Choice "B" is incorrect. Exit and disposal activities include costs to terminate a contract that is *not* a *capital lease*. Capital lease termination costs are accounted for separately from exit and disposal activities. Choice "D" is incorrect. The cost of retiring a fixed asset is not considered an exit or disposal cost.


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