Accounting 206 Exam 3

Madison Company issued an interest-bearing note payable with a face value of $25,800 and a stated interest rate of 8% to Metropolitan Bank on August 1, Year 1. The note carried a one-year term. Based on this information alone, what is the amount of cash flow from operating activities reported on Madison's Year 1 statement of cash flows? A) $2,064 B) $860 C) $25,800 D) $0

$0 Exp: The $25,800 borrowed is classified as a financing activity, not an operating activity. No interest was paid in Year 1, so there is no cash flow related to the interest.

On September 1, Year 1, West Company borrowed $56,000 from Valley Bank. West agreed to pay interest annually at the rate of 6% per year. The note issued by West carried an 18-month term. West Company has a calendar year-end. What is the amount of interest expense that will be reported on West's income statement for Year 1? A) $0 B) $840 C) $336 D) $1,120

$1,120 Exp: Interest expense (September 1 through December 31) = $56,000 × 6% × (4 ÷ 12) = $1,120. The fact that it was an 18-month note does not affect the Year 1 interest expense.

Curtain Company paid dividends of $5,000, $6,200, and $8,000 during Year 1, Year 2, and Year 3, respectively. The company had 1,700 shares of 3.5%, $100 par value preferred stock outstanding that paid a cumulative dividend. What is the total amount of dividends paid to common shareholders during Year 3? A) $5,950 B) $1,200 C) $1,350 D) $950

$1,350 Exp: Preferred dividend = 1,700 Outstanding shares × Par value of $100 per share × 3.5% = $5,950 Dividends in arrears at end of Year 1 = Preferred dividend of $5,950 − Dividends paid in Year 1 of $5,000 = $950Dividends in arrears at end of Year 2 = Preferred dividend of $5,950 + Dividend in arrears from Year 1 of $950 − Dividends paid in Year 2 of $6,200 = $700Year 3 Dividends to common shareholders = Dividends paid in Year 3 of $8,000 − (Preferred dividend of $5,950 + Dividend in arrears from Year 2 of $700) = $1,350

On January 1, Year 1, Mahoney Company borrowed $169,000 cash from Sun Bank by issuing a 5-year, 8% term note. The principal and interest are repaid by making annual payments beginning on December 31, Year 1. The annual payment on the loan equals $40,750. What is the amount of principal repayment included in the payment made on December 31, Year 1? A) $13,600 B) $40,775 C) $37,513 D) $27,175

$27,175 Exp: Year 1 Interest expense = Principal balance on January 1 of $170,000 × 8% = $13,600Year 1 Principal repayment = Payment of $40,775 − Interest portion of $13,600 = $27,175

Kier Company issued $660,000 in bonds on January 1, Year 1. The bonds were issued at face value and carried a 5-year term to maturity. The bonds have a 6.00% stated rate of interest and interest is payable in cash on December 31 each year. Based on this information alone, what are the amounts of interest expense and cash flows from operating activities, respectively, that will be reported in the financial statements for the year ending December 31, Year 1? A) $39,600 and Zero B) Zero and $39,600 C) $39,600 and $39,600 D) Zero and Zero

$39,600 and $39,600 Exp: Since the bonds were issued at face value, the cash payment for interest equals the interest expense.Payment of interest = Face value of $660,000 × 0.060 = $39,600The payment of interest on December 31, Year 1, increases interest expense by $39,600 and is reported as a cash outflow from operating activities.

On September 1, Year 1 Western Company borrowed $36,000 cash. The one-year note carried a 5% rate of interest. The amount of interest expense on the income statement and the amount of cash flow from operating activities shown on Western's December 31, Year 1 financial statements would be A) $600 interest expense and $1,800 cash outflow from operating activities. B) $1,200 interest expense and $1,800 cash outflow from operating activities. C) $600 interest expense and zero cash outflow from operating activities. C) $1,200 interest expense and zero cash outflow from operating activities.

$600 interest expense and zero cash outflow from operating activities. Exp: The amount of interest expense is computed as follows: Total annual interest = $36,000 × .05 = $1,800 Monthly interest = $1,800 annual interest ÷ 12 months = $150 Interest expense in Year 1 = $150 per month × 4 months = $600. Since the total amount of interest will be paid on the maturity date in Year 2, the cash flow associated with interest expense in Year 1 is zero.

A company's classified balance sheet shows current assets of $8,650 and current liabilities of $6,000. What is the company's current ratio? A) 0.69 to 1 B) 1.44 to 1 C) 1.16 to 1 D) 3.26 to 1

1.44 to 1 Exp: Current ratio = Current assets ÷ Current liabilitiesCurrent ratio = $8,650 ÷ $6,000 = 1.44 to 1

The following information is taken from the balance sheet of Atlanta Company: Current assets $1,368 Current liabilities $720 Property, Plant & Equipment $1,480 Noncurrent liabilities 730 Total assets $2,848 Total liabilities $1,450 What is Atlanta Company's current ratio? A) 2.01 to 1 B) 1.9 to 1 C) 1.96 to 1 D) 0.53 to 1

1.9 to 1 Exp: Current ratio = Current assets ÷ Current liabilities Current ratio = $1,368 ÷ $720 = 1.9 to 1

Montana Company was authorized to issue 105,000 shares of common stock. The company had issued 42,000 shares of stock when it purchased 6,500 shares of treasury stock. After the purchase of treasury stock, the number of outstanding shares of common stock was which of the following? A) 98,500 B) 48,500 C) 35,500 D) 42,000

35,500 Exp: Outstanding stock (total issued stock minus treasury stock) is stock owned by investors outside the corporation.Outstanding shares = 42,000 Issued shares - 6,500 Treasury shares = 35,500

Which of the following entities would have a "Paid-in Capital in Excess" account in the equity section of the balance sheet? A) A corporation B) A municipality C) A sole proprietorship D) A partnership

A corporation Exp: Any amount received above the par or stated value is recorded in an account called Paid-in Capital in Excess of Par (or Stated) Value. Only a corporation issues stock; thus, only corporations have this type of account.

Which of the following correctly describes an installment note? A) An installment note requires equal interest payments with the entire principal balance paid at maturity. B) An installment note requires equal payments of interest and principal in which the amount of interest decreases over the life of the note. C) An installment note requires equal payments of interest and principal in which the amount of interest increases over the life of the note. D) The installment note requires decreasing payments of interest and principal in which the amount of interest remains constant over the life of the note

An installment note requires equal payments of interest and principal in which the amount of interest decreases over the life of the note. Exp: Loans that require payments of principal and interest at regular intervals (amortizing loans) are typically represented by installment notes. As the principal balance of the note decreases over time the portion of the payment that is applied to interest expense decreases. However, the amount of the payment remains constant.

How is treasury stock reported on a corporation's balance sheet? A) As an addition to total paid-in capital B) As a deduction in determining total stockholders' equity C) As a deduction from total paid-in capital D) As a deduction from retained earnings

As a deduction in determining total stockholders' equity Exp: Treasury stock is a contra equity account. It is deducted from the other equity accounts in determining total stockholders' equity.

On January 1, Year 1 Residence Company issued bonds with a $50,000 face value. The bonds were issued at 104 resulting in a 4% premium. They had a 20 year term and a stated rate of interest of 7%. Which of the following shows how the bond issue will affect Residence's financial statements on January 1, Year 1? A) Balance Sheet Income StatementStatement of Cash FlowsAssets=Carrying Value Bond Liability+Stockholders' EquityRevenue−Expenses=Net Income50,000 48,000 2,000NA NA NA48,000 FABalance SheetIncome StatementStatement of Cash FlowsAssets=Carrying Value Bond Liability+Stockholders' EquityRevenue−Expenses=Net Income48,000 48,000 NANA NA NA48,000 FABalance SheetIncome StatementStatement of Cash FlowsAssets=Carrying Value Bond Liability+Stockholders' EquityRevenue−Expenses=Net Income52,000 52,000 NANA NA NA52,000 FACorrectBalance SheetIncome StatementStatement of Cash FlowsAssets=Carrying Value Bond Lia

Balance Sheet Income Statement Statement of Cash FlowsAssets=Carrying Value Bond Liability+Stockholders' EquityRevenue−Expenses=Net Income52,000 52,000 NANA NA NA52,000 FA

On January 1, Year 1, Burton Corporation recorded the following journal entry: Account Title. Cash 196,000 (D) Discount on Bonds Payable 4,000 (D) Bonds Payable 200,000 (C) Which of the following correctly describes the related transaction? A) Burton issued bonds at 102. B) Burton issued bonds at 98. C) Burton issued bonds at a $4,000 premium. D) Burton signed a note payable for $196,000.

Burton issued bonds at 98. Exp: Proceeds of $196,000 = Face value of $200,000 × Issue price issue price = $196,000 ÷ $200,000 = 98. A $200,000 bond issued at 98 will be recorded as a debit (increase) to cash for $196,000, the issue price, a debit (increase) to discount on bonds payable (a contra liability) for $4,000, and a credit (increase) to bonds payable for $200,000, the bond's face value.

Smith Company sold merchandise for $3,000 cash. Assume the event is subject to a state sales tax of 9%. Which of the following journal entries would be required to record the sales event? (Ignore any effects associated with the recognition of cost of goods sold.) A) Cash 3,270 (D) Sales Revenue 3,270 (R) B) Cash 3,000 (D) Sales Tax Expense 270 (D) Sales Revenue 3,270 (R) C) Cash 3,000 (D) Sales Tax Payable 270 (C) Sales Revenue 2,730 (C) D)Cash 3,270 (D) Sales Tax Payable 270 (C) Sales Revenue 3,000 (C)

Cash 3,270 (D) Sales Tax Payable 270 (C) Sales Revenue 3,000 (C) Exp: Smith would receive $3,270 [$3,000 + ($3,000 × 0.09)] cash. This would cause assets (cash) to increase. Smith would recognize a $270 obligation ($3,000 × 0.09) for the cash that was collected for the taxing authority. This increases liabilities (sales tax payable). Finally, Smith would recognize $3,000 of Sales Revenue. Debit entries increase assets while credit entries increase liabilities and stockholders' equity. In this case, Cash is debited while Sales Tax Payable and Sales Revenue are credited.

Chico Company borrowed $40,000 on a four-year, 8% installment note. How will Chico record the issuance of this note? Multiple Choice A) Cash 36,800 (D) Discount on notes payable 3,200 (D) Notes payable 40,000 (C) B) Cash 40,000 (D) Interest payable 3,200 (C) Notes payable 36,800 (C) C) Cash 43,200 (D) Notes payable 43,200 (C) D) Cash 40,000 (D) Notes payable 40,000 (C)

Cash 40,000 (D) Notes payable 40,000 (C) Exp: Issuing a long-term installment note is recorded by debiting (increasing) cash and crediting (increasing) the liability notes payable for the face value of the note.

Clayton Corporation made the following entry in its general journal: Account Title Interest expense 5,400 (D) Discount on bonds payable 400 (C) Cash 5,000 (C) Which of the following describes the above transaction? A) Clayton records interest expense and amortization of discount on bonds payable. B) Clayton issues bonds with a face value of $5,400 for $5,000 cash. C) Clayton records annual interest and amortization of premium on bonds. D) Clayton redeems callable bonds when the carrying value is $5,400.

Clayton records interest expense and amortization of discount on bonds payable. Exp: The payment of cash and recognition of interest expense (which, in this case, includes the amortization of the discount on bonds payable) decreases assets (by crediting cash), increases liabilities (by crediting discount on bonds payable, a contra-liability account), and increases expenses (by debiting interest expense).

Which form of business organization is established as a separate legal entity?

Corporation Exp: A corporation is a separate legal entity created by the authority of a state government.

What is another term used to describe unsecured bonds? A) Discount bonds B) Coupon bonds C) Debentures D) Par value bonds

Debentures Exp: Unsecured bonds, also called debentures, are issued based on the general strength of the borrower's credit.

Which of the following describes the effect of remitting the sales tax to the tax authority? A) Decreases liabilities. B) A claims exchange transaction. C) Decreases stockholders' equity. D) All of these answer choices are correct.

Decreases liabilities Exp: Remittance of sales tax decreases assets (cash) and decreases liabilities (sales tax payable).

Which of the following is responsible for paying unemployment tax? A) Employee only B) Employer only C) Both employee and employer D) Federal government

Employer only

Which of the following is not an item deducted from salary expense to arrive at net pay? A) FICA tax for Social Security B) FICA tax for Medicare C) Federal unemployment tax D) These answer choices are all deducted from salary expense to arrive at net pay

Federal unemployment tax Exp: Federal unemployment tax is paid entirely by the employer; as such, it is not withheld from an employee's pay.

Ogilvie Corporation issued 15,000 shares of no-par stock for $40 per share. Ogilvie was authorized to issue 38,000 shares. What effect will this event have on the elements of the company's financial statements? A) Increase assets and increase stockholders' equity by $1,520,000 B) Increase assets and increase stockholders' equity by $600,000Correct C) Increase cash inflows from investing activities by $600,000 D) None of these answer choices are correct.

Increase assets and increase stockholders' equity by $600,000 Exp: Assets (cash) and stockholders' equity (common stock) increase by $600,000 (or 15,000 shares × $40 per share). The cash inflow is reported in the financing activities section of the statement of cash flows.

Franklin Company issued a $40,000 note to the Mercantile Bank on August 1, Year 1. The note carried a one-year term and a 12% rate of interest. How will the adjusting entry, dated December 31, Year 1, to record accrued interest expense impact the elements of the financial statements? A) Decrease assets and decrease retained earnings by $2,000 B) Increase liabilities and decrease equity by $2,000 C) Increase liabilities and decrease equity by $1,600 D) Decrease equity and increase liabilities by $4,800

Increase liabilities and decrease equity by $2,000 Exp: Accrued interest expense = $40,000 × 12% × (5 ÷ 12) = $2,000The adjusting entry to accrue interest expense will increase liabilities (interest payable) and decrease stockholders' equity (retained earnings). It increases expenses, which will decrease net income. It does not affect the statement of cash flows.

Which of the following statements is true regarding the straight-line method of amortizing discounts and premiums on bonds? A) It assigns variable amounts of interest over the term of the liability. B) It uses compound interest principles. C) It assigns the same amount of interest to each interest period over the life of the bond. D) It accurately reports the amount of interest expense incurred during each interest period.

It assigns the same amount of interest to each interest period over the life of the bond. Exp: The straight-line method amortizes the discount equally over the life of the bond. While the straight-line method is easy to understand, it is inaccurate because it does not show the correct amount of interest expense incurred during each accounting period. This straight-line recognition pattern is irrational because the amount of interest expense recognized should increase (decrease) as the carrying value of the bond liability increases (decreases). A more accurate recognition pattern can be accomplished by using an approach called the effective interest rate method.

Fixit Corporation issued 36,000 shares of $10 par value common stock at its current market price of $31. How does this event affect total stockholders' equity? A) It increases by $1,116,000. B) It is unaffected. C) It increases by $756,000. D) It increases by $360,000.

It increases by $1,116,000. Exp: The event increases assets and stockholders' equity by $1,116,000 (or $31 per share × 36,000 shares). The increase in stockholders' equity is divided into two parts, $360,000 of par value (or $10 per share × 36,000 shares) and $756,000 ($1,116,000 − $360,000) received in excess of par value.

What is the name used for the type of secured bond that requires a pledge of a designated piece of property in case of default? A) Debenture bond B) Indenture bond C) Mortgage bond D) Registered bond

Mortgage bond Exp: Secured bonds grant their holders a priority legal claim on specified identifiable assets should the issuer default. A common type of secured bond is a mortgage bond, which conditionally transfers the title of designated property to the bondholder until the bond is paid.

Which of the following terms designates the maximum number of shares of stock that a corporation may issue? A) Number of shares issued B) Number of shares authorized C) Par value D) Number of shares outstanding

Number of shares authorized Exp: As part of the regulatory function, states approve the maximum number of shares of stock that corporations are legally permitted to issue. This maximum number is called authorized stock.

Which of the following items would most likely not be classified as a current asset? A) Office equipment B) Merchandise inventory C) Office supplies D) Prepaid rent

Office equipment Exp: A current (short-term) asset is expected to be converted to cash or consumed within one year or an operating cycle, whichever is longer. An operating cycle is defined as the average time it takes a business to convert cash to inventory, inventory to accounts receivable, and accounts receivable back to cash. Merchandise inventory, office supplies, and prepaid rent would be classified as current assets. Office equipment is not a current asset because it would be used for more than one year or one operating cycle.

Which of the following statements about types of business entities is true? A) For accounting purposes, a sole proprietorship is not a separate entity from its owner. B) Ownership in a partnership is represented by having shares of capital stock. C) One advantage of the corporation form is the ability to raise capital. D) Sole proprietorships are subject to double taxation.

One advantage of the corporation form is the ability to raise capital.

Which of the following best describes how each share of par value stock issued is reported in the Common Stock account? A) Current market value B) Average issue price C) Par or stated value D) Lower of cost or market

Par or stated value Exp: The par value of the stock is recorded in the Common Stock account. Any amount received above the par value is recorded in the Paid-in Capital in Excess of Par (or Stated) Value account.

Which of the following statements about par value is true? A) Par value dictates the initial price of the stock. B) Par value may be revised each time a company issues more shares of stock. C) Par value is generally greater than market value. D) Par value has little connection to the market value of the stock

Par value has little connection to the market value of the stock. Exp: Par value is an arbitrary value assigned to stock by the board of directors; like stated value, par value designates legal capital. On the other hand, market value is the price at which securities sell in the secondary market. Thus, par value has little connection to market value.

Which of the following is a disadvantage of a sole proprietorship? A) Entrenched management B) Double taxation C) Personal liability D) Excessive regulation

Personal liability Exp: Unlike corporate stockholders, the owners of proprietorships and partnerships are personally liable for actions they take in the name of their companies. The benefit of limited liability is one of the most significant reasons limited liability companies and corporations are so popular.

How does the amortization of the principal balance on an installment note payable affect the amount of interest expense recorded each succeeding year? A) Reduces the amount of interest expense each year B) Increase the amount of interest expense each year C) Has no effect on interest expense each year D) Cannot be determined from the information provided

Reduces the amount of interest expense each year Exp: As the principal balance declines each year, the interest expense becomes smaller, and the amount of principal repayment becomes larger with each subsequent payment.

Which of the following is one of the main advantages of using long-term debt financing instead of equity financing? A) Not having to pay back the principal B) Ability to raise large amounts of capital C) Tax-deductibility of interest D) Tax-deductibility of dividends

Tax-deductibility of interest Exp: One of the main advantages of debt financing is that interest paid on bonds and notes is tax-deductible, while dividends paid on equity financing is not.

On January 2, Year 1, Torres Corporation issued 21,000 shares of $15 par-value common stock for $20 per share. Which of the following statements is true? A) The Common Stock account will increase by $420,000. B) The Cash account will increase by $315,000. C) Total stockholders' equity will increase by $315,000. D) The Paid-in Capital in Excess of Par Value account will increase by $105,000. Correct

The Paid-in Capital in Excess of Par Value account will increase by $105,000. Exp: The cash account will increase by $420,000 (21,000 × $20), the common stock account will increase by $315,000 (21,000 × $15 par value), and the paid-in capital in excess of par value account will increase by $105,000 (21,000 × $5).

Which of the following describes what happens when bonds are issued when the market interest rate is less than the stated interest rate? A) The bonds are issued at a premium. B) The bonds are issued at less than their face value. C) It raises the effective interest rate above the stated rate of interest. D) The bonds are issued at a premium and the effective interest rate is higher than the stated rate.

The bonds are issued at a premium. Exp: When the market rate of interest is lower than the stated rate of interest, bonds will sell at a premium so as to reduce the effective rate to the market rate. On the other hand, when the market rate of interest is higher than the stated rate of interest, bonds will sell at a discount so as to increase the effective rate of interest to the market rate.

A discount or premium on bonds payable can be defined by which of the following statements? A) The difference between the market price on the issue date and the face value. B) The difference between the call price and the face value of the bond. C) The market rate of interest on the date of the bond issuance. D) The difference between the interest rate and the market price of the bond.

The difference between the market price on the issue date and the face value. Exp: When the market rate of interest is higher than the stated rate of interest, bonds will sell at a discount so as to increase the effective rate of interest to the market rate. When the market rate is lower than the stated rate, bonds will sell at a premium so as to reduce the effective rate to the market rate.

Under what condition should a pending lawsuit be recognized as a liability on a company's balance sheet? A) The amount can be reasonably estimated. B) The outcome is probable. C) The outcome is reasonably possible. D) The outcome is probable and the amount can be reasonably estimated.

The outcome is probable and the amount can be reasonably estimated. Exp: A contingent liability should be recorded in the financial statements as a liability if the outcome is considered probable and the amount owed can be reasonably estimated. If it is considered only reasonably possible, it is only disclosed in the notes to the financial statements.

Which of the following is not normally a preference given to the holders of preferred stock? A) The right to receive a specified amount of dividends prior to any being paid to common stockholders. B) The right to vote before the common stockholders at the corporation's annual meeting. C) The right to receive preference over common stockholders as to the distribution of assets during a liquidation process. D) All of these are preferences given to preferred stock.

The right to vote before the common stockholders at the corporation's annual meeting. Exp: Preferred stockholders do not have voting rights.

On January 1, Year 1, Strang Incorporated issued bonds with a face value of $500,000, a stated rate of interest of 8%, and a 5-year term to maturity. The effective rate of interest was 10%. Interest is payable in cash on June 30 and December 31 of each year. Which of the following statements is true? A) This bond was issued at a premium, and each semiannual cash payment is $25,000. B) This bond was issued at a discount, and each semiannual cash payment is $20,000. C) This bond was issued at a discount, and the annual interest expense is $40,000. D) This bond was issued at a premium, and the annual interest expense is $40,000.

This bond was issued at a discount, and each semiannual cash payment is $20,000. Exp: When the market rate of interest is higher than the stated rate of interest, bonds will sell at a discount so as to increase the effective rate of interest to the market rate.Semiannual interest payment = Face value of $500,000 × 8% × ½ = $20,000

The adjusting entry required to recognize warranty expense will cause A) assets and equity to increase. B) liabilities to increase and equity to decrease. C) assets and liabilities to decrease. D) liabilities to decrease and equity to increase.

liabilities to increase and equity to decrease. Exp: When a company recognizes warranty expense, it acknowledges its obligation to repair or replace defective products that were sold to customers. As a result, liabilities (warranties payable) increase. The recognition of the warranty expense decreases net income and ultimately equity (retained earnings).

Standard Company has a contingent liability that has a likelihood of actual occurrence that is classified probable. Also, the amount of the liability can be reasonably estimated. Under these circumstances, Standard is required to A) recognize a liability only. B) recognize an expense only. disclose but not C) recognize the liability or the expense. D) recognize a liability and an expense in its financial statements.

recognize a liability and an expense in its financial statements. Exp: If a contingent liability is classified as probable and estimable, GAAP requires that the liability and related expense be shown in the financial statements.

Yang Company sold merchandise for $2,000. The event is subject to a state sales tax of 9%. Based on this information, Yang would be required to recognize A) sales revenue of $2,180. B) sales tax expense of $180. C) sales tax liability of $180. Correct D) sales revenue of $1,820.

sales tax liability of $180. Exp: Yang is required by the government to collect the tax from the customer. Yang is then obligated to pay the tax to the government. As a result, Yang incurs a $180 liability ($2,000 × 0.09) when the sales event occurs.