Accounting Test 4 Study Guide

Which of the following is deductible for tax purposes?

Interest expense only

On January 1, Year 1, Dixon Company issued bonds with a $50,000 face value at 104. The bonds had a 10 year term and a 8% stated rate of interest. As a result of the bond issue, the ______ would not be affected.

Statement of Stockholders' Equity Income Statement

When the market rate of interest is higher than the stated rate of interest, bonds will sell at ______, thereby increasing the effective rate of interest.

a discount

A creditor that holds a subordinated debenture has ______ level of security as a general creditor.

a lower

A payment on an installment loan will ______.

affect the Balance Sheet affect the Statement of Stockholder's Equity

Discount on Bonds Payable is a(n) ______ account.

contra liability

The journal entry to record a cash payment for interest on a bond that was issued at a discount will includes a __________ to the cash account, a ___________ to discount on bonds payable, and a _____________ to interest expense.

credit, credit, debit

The journal entry to record issuing bonds payable at face value would includes a ________ to bonds payable and a ______ to cash.

credit, debit

The journal entry to record a cash payment for interest on a bond that was issued at a premium will include a __________ to the cash account, a ___________ to the premium on bonds payable account, and a _________ to the interest expense account.

credit, debit, debit

The journal entry to record the issue of bonds payable at a discount will include a ______.

debit to cash credit to bonds payable debit to discount on bonds payable

The journal entry to recognize a cash payment for interest on a line of credit includes a ______.

debit to interest expense credit to cash

When a company makes a cash payment for interest on a bond that was issued at face value, the ______ affected.

income statement is stockholder equity is ???

A company experienced an event that caused assets, liabilities and cash flow from financing activities to decrease, but had no affect on net income. This could be due to ______.

paying the principal balance of a bond at maturity

When bonds are sold for more than their face value, the difference between the amount received and the face value is called a bond ________

premium

Given sales of $17,500,000, net income of $1,475,000, earnings before interest and taxes of $2,300,000, income tax expense of $695,000, and interest expense of $130,000, the number of times interest is earned is ______.

17.69

All other things being equal, using debt financing instead of financing with equity will ______ level of retained earnings.

Produce a higher level. (Reason: Since interest is tax deductible, tax expense will be lower if a company pays interest instead of paying dividends which are not tax deductible. The tax savings associated with interest, will result a higher level retained earnings.)

Issuing a bond to borrow money affects the ______,

Statement of cash flows Balance sheet

Which of the following statements are true?

The principal amount of a bond is called the face value of the bond. A bond certificate acknowledges the issuer's obligation to repay the principal amount on the maturity date.

True or false: To encourage investors to buy callable bonds, the call price normally exceeds the face value of the bond.

True

True or false: Bonds that do not pay high enough interest to attract buyers may be discounted in order to make them more attractive.

True (Reason: A discount means that the bond holder will receive more cash back on the maturity date than was paid to acquire the bond. This benefit makes the bond more attractive to potential buyers.)

True or false: Bond prices are normally expressed as a percentage of the face value.

True Reason: A bond that sells at 95 means that it sells for 95% of the face value.

The issuing company is allowed to to redeem (pay off) the bond debt before the maturity date when bonds are _______.

callable

The journal entry to recognize a cash payment to repay amounts borrowed on a line of credit includes a ______.

credit to cash debit to notes payable

The journal entry to record a cash payment for interest on a bond that was issued at a discount will includes a ________ to the cash account, a ________ to discount on bonds payable, and a ________ to interest expense.

credit, credit, debit

When the market rate of interest is higher than the stated rate of interest, bonds will sell at a(n) ______, thereby increasing the effective rate of interest.

discount

The letters in the acronym EBIT stand for ________ ________ _______ and _______.

earnings before interests and taxes

When a company repays the face value of a bond, cash flows from ______ activities decrease.

financing

A payment on an installment loan will be shown in the ______ activities section of the statement of cash flows.

financing operating

A company experienced an event that caused assets, liabilities and cash flow from financing activities to increase, but had no affect on net income. This could be due to ______.

issuing a bond with a 20 year term

When bonds sell at a discount, it means that the selling price is ______ the face value.

less than

Premium on Bonds Payable is a(n) ______ account.

liability

Loans that provide flexible borrowing and repayment options are called ______.

lines of credit

When a company issues a bond at a premium, the amount of cash collected from the issue is ______ the face value of the bond.

more than

When a company recognizes a cash payment for interest expense on a bond that was issued at a discount ______.

net income decreases total assets decrease

Bond obligations ______.

normally carry lower interest rates than banks charge (Reason: Bonds carry a lower rate of interest because the issuer is borrowing directly from the lender thereby avoiding the cost charged by a bank that would otherwise serve as a middle man.)

A line of credit ______.

normally has a fluctuating interest rate usually limits the amount that can be borrowed

Paying the bond liability of bonds issued at a discount will ______.

not affect stockholders' equity decrease assets

When a company makes a cash payment for interest on a bond that was issued at face value, cash flows from ______ activities decrease.

operating

In practice, bonds normally pay interest ______.

semiannually

Bonds that mature at specified intervals throughout the life of the total issue are called _______ bonds

serial

On January 1, Year 1, Zoe Company issued a $200,000, 9%, 5 year term installment loan. The loan required a $51,419 annual cash payment on December 31 of each year. Based on this information, the principal balance of the loan on January 1, Year 2 is ______.

$166,581. (Reason: $200,000 January 1, Year 1 principal balance - $33,419 Year 1 principal repayment = $166,581 January 2, Year 2 principal balance.)

On January 1, Year 1, Zoe Company issued a $200,000, 9%, 5 year term installment loan. The loan required a $51,419 annual cash payment on December 31 of each year. Based on this information, the amount of interest expense incurred during Year 1 was ______,

$18,000 (Reason: $200,000 principal balance x 9% = $18,000.)

On January 1, Year 1, Zoe Company issued a $200,000, 9%, 5 year term installment loan. The loan required a $51,419 annual cash payment on December 31 of each year. Based on this information, the portion of the principal balance repaid during Year 1 was ______.

$33,419 (Reason: $51,419 annual payment - $18,000 interest expense ($200,000 x .09) = $33,419 principal payment.)

Semiannual interest means that interest is paid ______.

two times per year

On January 1, Year 1, Dixon Company issued bonds with a $50,000 face value at 104. The bonds had a 10 year term and a 8% stated rate of interest. Interest is payable in cash on December 31 of each year. Assuming straight-line amortization, when interest expense is recognized on December 31, total assets will decrease by ______.

$4,000 (Reason: The cash outflow for interest is determined by multiplying the face value of the bonds times the stated rate of interest ($50,000 x 8% = $4,000).

On January 1, Year 1, Dixon Company issued bonds with a $50,000 face value at 96. The bonds had a 10 year term and an 8% stated rate of interest. On December 31, Year 10, after the last cash payment for interest has been made, the entry to retire the bonds will cause assets to decrease by ______.

$50,000 (Reason: On the maturity date, the discount will be fully amortized and the Bond Payable account will have a $50,000 balance. Paying off the liability will reduce assets (cash) and liabilities (bonds payable) by $50,000.)

A $10,000 face value bond that sells for 95 1/4 will yield cash proceeds of ______.

$9,525 (Reason: $10,000 × 0.9525 = $9,525.)

A $1,000 face value bond issued at 95 will have a carrying value of ______ immediately after it is issued.

$950

Walt Company issued $100,000 of bonds at face value. The bonds carried an 8 percent annual interest rate. Assuming Walt has an effective income tax rate of 30 percent, the company's after tax cost of debt is ______,

5.6% (Reason: 8% stated rate × (1 - 30% tax rate) = 5.6%)

Given earnings before interest and taxes of $780,000, interest expense of $105,000, income tax expense of $230,000, and net income of $445,000, the number of times interest is earned is ______.

7.43

To avoid the effects of the financing strategy in ROA calculations, companies should use ______ when computing the ratio.

EBIT

The times interest earned ratio is equal to Blank______.

EBIT divided by interest payments

Assume three companies in the same industry have the following number of times interest is earned ratios: Collins Co. = 7.2 times Dean Co. = 9.4 times Edgar Co. = 13.9 times Based on this information alone, which company appears to have the lowest financial risk?

Edgar (Reason: Obviously, interest is only paid once but the more times it could be paid, the bigger the company's safety net. Companies with higher times interest earned have lower financial risk.)

True or false: When bonds are issued at a discount, the balance sheet affect on liabilities is greater than the balance sheet affect on assets.

False (Reason: The cash received equals the carrying value of the bonds.)

Assume three companies in the same industry have the following number of times interest is earned ratios: Fern Co. = 8.2 times Gardenia Co. = 6.4 times Hibiscus Co. = 3.9 times Based on this information alone, which company appears to have the highest financial risk?

Hibiscus

Which of the following is an example of the secured bond?

Mortgage bond

When a company borrows money by issuing a bond, the balance in the Bonds Payable account ______.

and the balance in the Cash account increases

Payments of interest expense on a line of credit is a(n) ______ transaction.

asset use

Bond obligations normally ______.

have longer terms to maturity than bank notes

Other things being equal, a company will appear to have the least financial risk if its number of times interest is earned ratio is ______.

high

Payments on installment notes ______.

include a payment for interest include a repayment of a portion of the principal balance

When a company increases the amount borrowed on a line of credit, net income ______.

is not affected and net cash flow from financing activities increases

When a company repays the face value of a bond, the ______ is affected.

statement of cash flows balance sheet

Bonds that mature on a specified date in the future are called _____ bonds

term