ACCT 3120 Exam 1
Interest
"rent" paid for the use of money for some period of time.
Gruenwald Corp. issues 10,000, $1,000 face amount bonds. Each bond can be converted into 25 shares of common stock. At the bond issue date, the company's common shares trade for $44 per share. At the date of issue, Gruenwald should recognize an addition to equity of
$1,000,000. $1000/25 shares = $40 per share conversion price (44 - 40) x 10,000 x 25 shares
Evergreen Corp. issues 10,000, $1,000 face amount bonds. Each bond can be converted into 20 shares of common stock. At the bond issue date, the company's common shares trade for $55 per share. At the date of issue, Evergreen should recognize an addition to equity of
$1,000,000. (55 - 50) x 10,000 x 20 shares
Milky Company's 5%, $100,000 face amount bonds have a carrying value of $98,000. When the bonds were issued two years ago, the effective interest rate was 6%. The bonds pay interest semi-annually on April 1 and October 1. In the December 31 adjusting entry, Milky Company should recognize interest expense of
$1,470 (98,000 x.06)/3/12
Mitchell's investment in convertible bonds has a net book value of $1.4 million when Mitchell converts the bonds to common stock. The fair value of the common stock is $1.5 million. Mitchell should recognize its investment in common stock at
$1.4 million
On January 1, Arnold Corp issues $100,000 of 7% bonds. Interest of $3,500 is payable semi-annually on June 30 and December 31. The bonds mature in 10 years. The market yield for bonds of similar risk and maturity is 5%. Calculate the issue price of the bonds (round the result to whole dollars).
$115,589 (100,000 x 0.61027) + (3,500 x 15.58916)
Jackie Company's new bond issue with face amount of $6 million sells for $6.4 million. Which of the following facts may explain why the bonds sell at a premium?
The company's stated interest rate must be higher than that of other competing companies.
Which of the following is necessary for a loss contingency to exist?
The potential loss must arise from an event that occurred prior to the financial statement date.
Which of the following is correct regarding the recognition of the value of a conversion feature associated with a convertible bond?
The value of the conversion feature is not recognized separately.
Which of the following is correct regarding the recognition of the value of a conversion feature associated with a convertible bond consistent with IFRS?
The value of the conversion feature is recognized as equity.
Which of the following represents an important difference between bonds with detachable warrants and convertible bonds?
The warrants can be separated from the bonds.
Which of the following statements is correct regarding short-term obligations?
They may be classified as long-term liabilities if they meet certain criteria.
Which of the following statements is correct regarding payment priority to holders of subordinated debentures in the case of a bankruptcy?
They receive payment only after other specific debt has been satisfied.
True or false: The implied interest rate may be different from the stated interest rate of a loan.
True
True or false: The interest rate stated in a note is typically equal to the market rate.
True The rate is typically negotiated at the time of the loan so the two are equal.
Debt that is callable by the creditor in the upcoming year, but is not expected to be called, is reported as
a current liability
Norbert Company's recently signed a 20-year mortgage that requires monthly payments of principal and interest. Norbert should report the mortgage principal payments due during the following accounting period as
a current liability
Christenson Corp. signs a short-term notes payable and pledges a portion of its accounts receivables as collateral. This type of loan is referred to as
a secured loan.
Because interest is paid semiannually, the present value calculations use
a) one-half the stated rate (6%), b) one-half the market rate (5%), and c) 6 (3 × 2) semiannual periods.
Obligations to suppliers of merchandise and obligations for services purchased on open account are referred to as
accounts payable
most common obligations reported as current liabilities
accounts payable, notes payable, commercial paper, income tax liability, dividends payable, and accrued liabilities
Nattel Corp. issues 10,000, $1,000 face amount bonds at 104. Each bond can be converted into 25 shares of no-par common stock. Margarita, Inc., purchased 2,500 of the bonds and converts them after 2 years. At that time, the balance in the premium on bond investment is $75,000. Margarita should recognize this conversion by debiting investment in common stock for
$2,575,000 (2,500 x 1,000) + 75,000
On January 1, 2018, Meister Company issues $200,000 of 6% bonds. Interest of $6,000 is payable semiannually on June 30 and December 31. The bonds mature in 5 years. The bonds were issued at face amount. On the date of issue, Meister should recognize a liability of
$200,000.
Margot wants to calculate the installment payment amount for a new installment notes payable of $200,000, which is due in ten years. Based on the interest rate, Margot determined that the applicable present value factor is 8.1109. Rounding to whole dollars, the installment payment amount is:
$24,658 $200,000/8.1109
Spencer Corp.'s attorney estimates that the company will ultimately have to pay between $250,000 and $500,000 relating to current litigation. Spencer should accrue a contingent liability and loss of
$250,000.
On January 2, 20X1, Schneider Company issues $100,000 of 6% bonds. Interest of $3,000 is payable semi-annually on June 30 and December 31. The bonds mature in 5 years. The bonds issued for $95,842 with an effective interest rate of 7%. Effective interest recognized on June 30, 20X1, will be equal to (round to the nearest full dollar)
$3,354. 95,842 x 0.035
On January 1, 20X1, Smite Corp. borrows $300,000 cash from First Rate Bank and issues a 3-year, $300,000 promissory note. Interest of $12,000 is payable semi-annually on June 30 and December 31. On the date of issuance, First Rate Bank should debit "notes receivable" for
$300,000.
On January 2, 20X1, Schneider Company issues $100,000 of 6% bonds. The market interest rate is 7%. Interest of $3,000 is payable semi-annually on June 30 and December 31. The bonds mature in 5 years. The bond issues for $95,842. On June 30, the company should recognize a discount amortization of
$354. (95,842 x 0.035) - 3,000
January 15, 2018, Munter Company learned of a judgment against the company in a lawsuit brought by a client relating to services provided by Munter during the 2017 fiscal period. The 2017 financial statements have not yet been issued. Munter should
accrue an estimated liability if a loss is probable and estimable.
Line of credit
allows a company to borrow cash without having to follow formal loan procedures and paperwork.
Callable
allows the issuing company to buy back, or call, outstanding bonds from the bondholders before their scheduled maturity date.
The difference between the effective interest and the interest paid represents
amortization of a discount or premium.
An interest rate, unless otherwise specified, is typically a(n) ______ rate. (Enter one word per blank)
annual
Annual bonuses
annual bonuses are one-time payments in addition to normal salary, typically tied to performance of the individual or company during a period.
Discount
arises when bonds are sold for less than face amount.
Premium
arises when bonds are sold for more than face amount.
Mortgage bond
backed by a lien on specified real estate owned by the issuer.
Debenture bond
backed only by the "full faith and credit" of the issuing corporation.
On January 2, 20X1, Schneider Company issues $100,000 of 7% bonds. Interest of $3,500 is payable semi-annually on June 30 and December 31. The bonds mature in 5 years. The market yield for bonds of similar risk and maturity is 8%. Utilizing the time value of money tables in your book, calculate the issue price of the bonds (round the result to whole dollars).
$95,944 (100,000 x 0.67556) + (3,500 x 8.11090)
Short-term obligations can be reported as noncurrent liabilities if the company
(a) intends to refinance on a long-term basis and (b) demonstrates the ability to do so by a refinancing agreement or by actual financing.
Whether a contingency is accrued and reported as a liability depends on
(a) the likelihood that the confirming event will occur and (b) what can be determined about the amount of loss.
Any additional consideration provided to induce conversion of convertible debt is recorded as an expense of the period
.
Any difference between the outstanding debt and the amount paid to retire that debt represents either a gain or a loss.
.
Any interest that has accrued since the last interest date must be recorded by an adjusting entry prior to preparing financial statements
.
Because of the inseparability of their debt and equity features, the entire issue price of convertible bonds is recorded as debt, as if they are nonconvertible bonds.
.
Bonuses sometimes take the place of permanent annual raises.
.
By the straight-line method, the amount of the discount to be reduced periodically is calculated, and the recorded interest is the plug figure.
.
Classifying liabilities as either current or long term helps investors and creditors assess the relative risk of a business's liabilities
.
Convertible bonds can be exchanged for shares of stock at the option of the investor.
.
Convertible bonds have features of both debt and equity.
.
Corporations issuing bonds are obligated to repay a stated amount at a specified maturity date and to pay periodic interest between the issue date and maturity.
.
Current liabilities ordinarily are reported at their maturity amounts.
.
Customary practice should be considered when deciding whether an obligation exists.
.
Determining interest by allocating the discount (or premium) on a straight-line basis is a practical expediency permitted in some situations by the materiality concept.
.
If an event giving rise to a contingency occurs after the year-end, a liability should not be accrued.
.
It must be probable that an unasserted claim or assessment will be asserted before considering whether and how to report the possible loss.
.
Large, highly rated firms sometimes sell commercial paper to borrow funds at a lower rate than through a bank loan.
.
Liabilities accrue for expenses that are incurred but not yet paid
.
Liabilities and owners' equity accounts represent specific sources of a company's assets.
.
Liabilities signify borrowers' interests in a company's assets.
.
Mandatory sinking fund redemptions retire a bond issue gradually over its term to maturity.
.
Most consumer products are accompanied by a guarantee.
.
Most liabilities obligate the debtor to pay cash at specified times and result from legally enforceable agreements.
.
Other things being equal, the lower the perceived riskiness of the corporation issuing bonds, the higher the price those bonds will command.
.
Periodic interest is the effective interest rate times the amount of the debt outstanding during the interest period.
.
SFAC No. 7 provides a framework for using future cash flows in accounting measurements.
.
Sales taxes collected from customers represent liabilities until remitted.
.
Since more cash is paid each period than the effective interest, the debt outstanding is reduced by the overpayment.
.
Some liabilities are not contractual obligations and may not be payable in cash
.
The balance continually increases, eventually becoming the face amount at maturity.
.
The components of compound financial instruments such as convertible bonds are valued and reported separately under IFRS
.
The contingent liability for quality-assurance warranties almost always is accrued.
.
The costs of satisfying guarantees should be recorded as expenses in the same accounting period the products are sold.
.
The currently maturing portion of a long-term debt must be reported as a current liability.
.
The difference between the effective interest and the interest paid increases the existing liability.
.
The effective interest is calculated each period as the market rate times the outstanding balance of the debt during the interest period.
.
The effective interest on debt is the market rate of interest multiplied by the outstanding balance of the debt.
.
The issue price of bonds with detachable warrants is allocated between the two different securities on the basis of their fair values.
.
The value of the conversion feature is not separately recorded.
.
When interest is discounted from the face amount of a note, the effective interest rate is higher than the stated discount rate.
.
When no amount within the range appears more likely than others, we record the minimum amount.
.
When the cause of a loss contingency occurs before the year-end, a clarifying event before financial statements are issued can be used to determine how the contingency is reported.
.
When the necessary conditions are met, compensated future absences are accrued in the year the compensation is earned.
.
Whether bonds are issued at a premium or a discount, the outstanding balance becomes the face amount at maturity.
.
Wagner Company's financial records show that it has a mortgage that requires monthly principal payments of $3,000. The mortgage loan matures in 15 years. What should Wagner show on its balance sheet at the end of the current year? (Select all that apply.)
1. A noncurrent liability of $504,000 2. A current liability of $36,000
Which of the following represent the correct accounting treatment for loss contingencies that do not meet the criteria for accrual but are at least reasonably possible? (Select all that apply.)
1. An estimate of the potential loss should be made (if possible) and disclosed. 2. A disclosure must describe the contingency.
a liability has three essential characteristics
1. Are probable, future sacrifices of economic benefits. 2. Arise from present obligations (to transfer assets or provide services) to other entities. 3. Result from past transactions or events
Which of the following are classified as current liabilities? (Select all that apply.)
1. Debt callable in the upcoming year, even when not expected to be called 2. Current portion of long-term debt 3. Long-term loans with violated debt covenants
Which of the following must employers by law withhold from their employees' pay? (Select all that apply.)
1. Federal taxes 2. FICA contributions
Convertible bonds
bonds for which bondholders have the option to convert the bonds into shares of stock
Convertible bonds
bonds for which bondholders have the option to convert the bonds into shares of stock.
Nattel Corp. issues 10,000, $1,000 face amount bonds at 104. Each bond can be converted into 25 shares of no-par common stock. Two years after issuance, 25% of the bondholders convert their bonds. The balance in the premium on bonds payable account is $300,000. Nattel should debit (Select all that apply.)
1. bonds payable for $2,500,000. 2. premium on bonds payable for $75,000.
On December 31, 20X1, Werner Inc. has $1 million face amount, 6% bonds outstanding. The bonds were issued at a discount and pay interest semi-annually on March 31 and September 30. On 12/31/X1, Werner Inc. should (Select all that apply.)
1. credit interest payable 2. credit discount on bonds payable 3. debit interest expense
Bond issue costs
1. increase the effective interest rate of borrowing. 2. reduce the cash proceeds from the issuance of debt.
For a loss contingency to be accrued, (Select all that apply.)
1. it is not necessary that the lawsuit was filed before the end of the accounting period. 2. the cause of the lawsuit must have occurred before the end of the accounting period.
In practice, accrual of loss contingencies related to litigation claims are uncommon because (select all that apply)
1. it may adversely affect the outcome of the litigation. 2. the outcome related to litigation is highly uncertain.
Installment notes typically involve the purchase of assets and (Select all that apply.)
1. periodic payments include principal and interest. 2. require installment payments over time.
Which of the following are used to categorize the likelihood of the occurrence of a future loss? (Select all that apply.)
1. probable 2. reasonably possible 3. remote
Unredeemed cash rebates related to current year sales should be estimated and the amount treated as a(n): (Select all that apply.)
1. reduction in revenue 2. liability
Lester Corp. sells merchandise to a customer for $1,000. The company also collects state and local sales taxes of 6% and 4%, respectively. At the time of sale, Lester should recognize the following credits in its ledger (Select all that apply.)
1. sales revenue of $1,000. 2. sales taxes payable of $100.
Information relative to a loss contingency that becomes available after the fiscal year ends, but before the financial statement date (select all that apply)
1. should be considered in determining the probability of a loss contingency. 2. should be considered in estimating the amount of the loss.
The following selected information pertains to Wilson Company. Current liabilities: $100; long-term liabilities: $150; contributed capital: $120; retained earnings: $50; accumulated other comprehensive income: $20. The company's debt to equity ratio (rounded to two digits after the decimal point) is
1.32. ($100 + $150)/($120 + $50 + $20)
Otto Company purchases $200,000 face amount, 8% semi-annual 10-year bonds when the market rate is 7%. The number of interest periods utilized to determine interest revenue earned on the investment is
20 periods.
The following selected information pertains to Wilson Company. Total assets: $400; total liabilities: $220; operating income: $60; income from continuing operations: $55; net income: $50. The company's return on shareholders' equity expressed as a percentage is
27.78%. 50/(400 - 220)
The following selected information pertains to Wilson Company. Net income: $50; taxes: $20; interest: $10. The company's times interest earned ratio is
8. ($50 + $20 + $10)/$10
Bonds
A form of debt consisting of separable units (bonds) that obligates the issuing corporation to repay a stated amount at a specified maturity date and to pay interest to bondholders between the issue date and maturity.
Which of the following statements regarding convertible bonds subsequent to issuance is correct?
Accounting is the same as for nonconvertible bonds.
What practical reason may motivate companies to rarely accrue losses for ongoing litigation?
Accrual of a contingent loss may adversely affect the outcome of the company's legal case.
Which of the following is correct regarding accrued interest payable?
Accrued interest payable relates to interest already incurred but not yet paid.
Accrue
Amount of future loss can be reasonably estimated
Disclose only
Amount of future loss cannot be reasonably estimated
Sally Company owes its employees $5,250 for the last 4 days of the year ended December 31. The company will pay this amount on January 7 as part of its regular payroll disbursements of $11,800. What, if anything, should Sally recognize on December 31?
An accrued liability of $5,250.
basic accounting equation
Assets = Liabilities + Owners' Equity
On January 2, 20X1, Hauser Company issues $2 million face amount, 10-year bonds. Issue costs associated with these bonds are $100,000. How are the issue costs accounted for?
Reduce the cash proceeds and increase the discount and debt issue costs account
Which of the following represents the formal credit instrument for an accounts payable?
Supplier's invoice
Reasonably possible
The chance the confirming event will occur is more than remote but less than likely.
Remote
The chance the confirming event will occur is slight.
Werner Inc. sells its products with a 2-year warranty. On December 31, 2017, Werner recognized estimated warranty-related costs of $54,000 for its 2017 sales. During 2018, Werner incurs repair costs of $21,000 related to products sold during 2017. The journal entry to record the cost of repairs would include a debit to:
estimated warranty liability
Loss contingency
existing, uncertain situation involving potential loss which will be resolved when some future event occurs.
Current liabilities
expected to require the use of current assets for payment, and usually are payable within one year from the balance sheet date (or operating cycle, if longer).
Accrued liabilities
expenses already incurred but not yet paid (accrued expenses)
Interest on notes is calculated
face amount x annual rate x time to maturity
The amount of interest paid on bonds is calculated by multiplying ______ of the bonds with the ____ rate.
face amount; stated
Glen Inc. elected to report its bonds at fair value. If the unadjusted carrying value of the bonds is $500,000 and the fair value rises to $515,000, Glen should credit ________
fair value adjustment for $15,000
Trade notes payable
formally recognized by a written promissory note.
All liabilities involve a probable ____ sacrifice of economic benefits and arise as a result of _____ transactions or events.
future; past
The costs incurred to satisfy customer claims under an extended warranty period are recorded
in the same period as the warranty revenue
By law, employers must withhold security taxes and ____ from their employees' paychecks.
income taxes
Emil Company has $4 million in bonds outstanding. During the current year, the applicable market interest rate decreases. The fair value of Emil Company's bonds likely will:
increase
Wasser Company issues $500,000, 8% convertible bonds for $510,000. Without the conversion feature, the bonds would issue at par. Consistent with IFRS, on the date of issuance Wasser should
credit equity-conversion option for $10,000.
Wasser Company issues $500,000, 8% convertible bonds for $510,000. Without the conversion feature, the bonds would issue at par. On the date of issuance, Wasser should
credit premium on bonds payable for $10,000.
The risk that bond investors will not receive interest and principal payments when they are due is referred to as:
credit risk
A bond that is secured only by the faith and credit of the issuing corporation is referred to as a(n)
debenture bond
Early extinguishment of debt
debt is retired prior to its scheduled maturity date
Glocken Company is trying to increase its share of the consumer electronics market. To stimulate sales, the company offers cash rebates ranging from $25-$50 on all of its products. At December 31, 2017, the company estimates that, during 2018, customers will redeem $2,550 in rebates relating to 2017 sales. On December 31, 2017, Glocken should
decrease revenue and recognize a liability for $2,550.
During December, Martin Department Stores sells $240,000 in gift cards. When it sells the gift cards, Martin should recognize
deferred revenue.
A bond that sells for less than its face amount is sold at a _____
discount
Bond indenture
document that describes specific promises made to bondholders.
Munster Company's bonds have increased in fair value and Munster records a gain. This indicates that Munster
elected the fair value option
The decision of whether the straight-line method of allocating bond discount or premium is acceptable should be guided by whether or not the straight-line method would tend to
mislead investors.
committed line of credit
more formal agreement that usually requires the company to pay a commitment fee to the bank to keep a credit line amount available to the company
Serial bonds
more structured (and less popular) way to retire bonds on a piecemeal basis.
Bonds that are backed by a lien on specific real estate owned by the issuer are referred to as ____ bonds.
mortgage
Material events giving rise to a contingency that occur after the end of the fiscal period but before the financial statements are issued
must be disclosed in a subsequent events disclosure note.
Coupons bonds
name of the owner was not registered; the holder actually clipped an attached coupon and redeemed it in accordance with instructions on the indenture.
The return on assets is calculated by dividing __________ __________ by total assets. (Enter only one word per blank.)
net income
For bonds reported under the fair value option, changes in fair value due to interest rate changes are reported in
net income.
Jones Company signs a $15,000, 12-month note and receives $14,250 from the bank. Jones probably signed a(n) ______.
noninterest-bearing note
Noninterest-bearing note
notes for which the interest is deducted from the face amount of the note to determine the cash proceeds made available to the borrower at the outset.
Schulz Company borrows cash from a bank and signs a promissory note. Schulz should credit
notes payable
Accounts payable
obligations to suppliers of merchandise or of services purchased on account.
Current liabilities are those obligations that are payable within ______ or the operating cycle whichever is ____.
one year; longer
In the statement of cash flows, interest paid on long term notes should be reported as outflows from a(n)
operating activity.
Revenue related to extended warranty contracts typically is recognized
over time.
Zero-coupon bonds typically issue at a deep discount because they
pay no interest
zero-coupon bond
pays no interest. Instead, it offers a return in the form of a "deep discount" from the face amount.
Amortization of bond discounts results in the bond being valued on the balance sheet at the
present value of the associated future cash flows.
The issue price of a bond is always equal to the
present value of the future cash flows
If bonds are not traded on an open-market exchange, their fair value can be estimated as the
present value of the remaining future cash flows discounted at the current interest rate.
Generally, liabilities are valued at their
present value.
Conceptually, liabilities should be recorded at their
present values
If a company sells its entire bond issue to a a single investor, the sale is referred to as a
private placement.
Liabilities
probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events.
Superior Printer Company sells a new model with a $30.00 mail-in rebate. At the end of the accounting period, the company estimates that 25% of the 2,000 rebates associated with sales during December will still be returned by customers. On December 31, Superior Printer should
recognize an expense and estimated liability of $15,000.
Straight-line method
recording interest each period at the same dollar amount
Neumann Company issues 20-year bonds. Related to these bonds, Neumann is obligated to
repay a certain amount at a specific date.
If a company elects to report bonds under the fair value option, changes in fair value result in
reported gain or loss
Bonds that retire in installments during all or part of the life of the bond issue are called __________ bonds.
serial
secured
specified asset of the borrower is pledged as collateral or security for the loan
Bond holders who are not entitled to receive any liquidation payments until claims of other specified debt issues are satisfied must have purchased indentures that are referred to as
subordinate
Effective interest expense is calculated as
the effective rate times the carrying value of the debt outstanding during the period
Subordinated debenture
the holder is not entitled to receive any liquidation payments until the claims of other specified debt issues are satisfied.
Detachable stock purchase warrants
the investor has the option to purchase a stated number of shares of common stock at a specified option price, within a given period of time.
Revenue related to extended warranty contracts typically is recognized over time because
the warranty provides coverage over time.
The feature that distinguishes loss contingencies from other liabilities is the
uncertainty that a loss will occur.
Glen Inc. elected to report its bonds at fair value. If the unadjusted carrying value of the bonds is $500,000 and the fair value rises to $515,000 due to the credit risk associated with the bonds, Glen should debit ________
unrealized holding loss - OCI for $15,000
Alabaster Corp. issues $10 million in bonds at a discount. One year later, the unamortized discount associated with the bonds is $325,000. The market value of the bonds is $10.2 million. If the company elected to use the fair value option, Alabaster should recognize an
unrealized holding loss of $525,000.
Commercial paper
unsecured notes sold in minimum denominations of $25,000 with maturities ranging from 30 to 270 days.
If an asset is exchanged for notes payable and the stated interest rate does not closely reflect the market rate at time of negotiation, the market rate should be established with reference to the:
value of the asset or service exchanged
Extended warranty contracts provide
warranty protection beyond the manufacturer's original warranty.
typical annual commitment fee
¼% of the total committed funds
Supreme Inc. sells its products with a 3-year warranty. The company estimates warranty costs relating to sales during 2017 are as follows: 2017: $10,000; 2018: $25,000; 2019: $15,000. Assume that actual warranty costs during 2017 were as estimated. What is the amount of the estimated warranty liability that Supreme should recognize on its 2017 balance sheet?
$40,000 $25,000 + $15,000 = $40,000. The warranty liability is reduced by the warranty costs paid during 2017.
During the current period, Roberts recognized interest expense of $9,400 and paid interest of $9,000 related to its discounted bonds. The amortization recognized during the current period was:
$400
At the beginning of the current year, Wagner Company purchases equipment and signs an installment note requiring 6 annual equal payments at the end of each year. The equipment would sell for $200,000 if the company paid cash. The company's effective borrowing rate is 7%. Wagner must make annual installment payments of (use the tables in your textbook and round to the nearest dollar)
$41,959. 200,000/4.76654
Supreme Inc. sells its products with a 3-year warranty. The company estimates warranty costs relating to sales during 2017 as follows: 2017: $10,000; 2018: $25,000; 2019: $15,000. Assume that actual warranty costs during 2017 were as estimated. What is the amount of warranty expense that Supreme should recognize in its 2017 income statement?
$50,000 $10,000 + $25,000 + $15,000
On January 2, 20X1, Meister Company issues $200,000 of 6% bonds. Interest of $6,000 is payable semi-annually on June 30 and December 31. The bonds mature in 5 years. The market interest rate is 7%. The bond issues for $191,684. On June 30, the company should recognize a discount amortization of
$709. (191,684 x 0.035) - 6,000 7% x 6/12 = .035
Smith Company purchases new machinery by signing an $80,000 face amount, 2-year note. The market interest rate is 6%, but no interest payment is due during the life of the note. Smith should record the machinery at
$71,200. 2 years, 6% factor is .89000 80,000 x 0.89
Small Company purchases new machinery by signing a $100,000 face amount 2-year note. The market interest rate is 8%, but no interest is due over the life of the note. Small should recognize a net note payable of
$85,734. 100,000 x 0.85734
A bond issue divides a large liability into many smaller liabilities.
.
A bond issue will be priced by the marketplace to yield the market rate of interest for securities of similar risk and maturity.
.
A customer advance produces an obligation that is satisfied when the product or service is provided. (deferred revenue or unearned revenue)
.
A loss contingency arises when there is uncertainty about whether a past event will result in a future loss. The uncertainty will be resolved only when some future event occurs.
.
A loss contingency is disclosed in notes to the financial statements if there is at least a reasonable possibility that the loss will occur.
.
A note payable and a note receivable are two sides of the same coin.
.
Accrual of sick pay is not required, but may be appropriate in some circumstances.
.
Amounts collected from employees in connection with payroll represent liabilities until remitted
.
two-step process is involved in deciding how the unasserted claim should be reported:
1. Is it probable that a claim will be asserted? If the answer to that question is "no," stop. No accrual or disclosure is necessary. If the answer is "yes," go on to step 2. 2. Treat the claim as if the claim has been asserted. That requires evaluating (a) the likelihood of an unfavorable outcome and (b) whether the dollar amount of loss can be estimated, just as we already have discussed for other loss contingencies for which a claim has already been asserted.
Which of the following are common strategies for debtors to retire bonds prior to the maturity date? (Select all that apply.)
1. Purchasing bonds on an open market. 2. Including a call feature when the bonds are issued.
The dollar amount of a potential loss from a contingent liability can be classified as (Select all that apply.)
1. Reasonably estimable 2. Known
A contingent liability is accrued if which conditions are met? (Select all that apply.)
1. The amount of the loss can be reasonably estimated. 2. It is probable that a future loss will occur.
Conditions for Accrual of Paid Future Absences
1. The obligation is attributable to employees' services already performed. 2. The paid absence can be taken in a later year—the benefit vests (will be compensated even if employment is terminated) or the benefit can be accumulated over time. 3. Payment is probable. 4. The amount can be reasonably estimated.
Which of the following are correct regarding bonds? (Select all that apply.)
1. They obligate the issuing company to repay the bonds at a specific date. 2. They obligate the issuing company to pay a specific amount.
Which of the following are among the most important reasons why companies issue convertible instead of nonconvertible bonds? (Select all that apply.)
1. To enable smaller or debt-heavy companies to gain access to the bond market. 2. To sell the bonds at a higher price. 3. To use a medium of exchange in mergers and acquisitions.
Periodic payments on installment notes typically include
1. a portion that reduces the outstanding loan balance. 2. a portion that reflects interest at the effective interest rate.
Which of the following are valid valuation methods for reporting bonds payable? (Select all that apply.)
1. amortized cost 2. current fair value on each reporting date
Accounts payable typically (Select all that apply.)
1. are noninterest-bearing. 2. are offered on open account.
Which of the following purchases frequently involve installment notes payable? (Select all that apply.)
1. automobiles 2.land 3. buildings
Probable
Confirming event is likely to occur.
Which of the following concepts or principles is the primary reason why gain contingencies are not accrued, even if they are probable?
Conservatism
Higher risk
Current liabilities already reported on balance sheet
Supreme Inc. offers a 3-year extended warranty for all its products. On January 1, 2018, the company collects $45,000 relating to extended warranty contracts. What entry should Supreme make on January 1, 2018?
Debit cash and credit deferred revenue for $45,000.
Supreme Inc. offers a 3-year extended warranty for all its products. On January 1, 2018, the company collects $45,000 relating to extended warranty contracts. What entry should Supreme make on December 31, 2018?
Debit deferred revenue for $15,000 and credit revenue—extended warranty for $15,000.
Otto Company purchases bonds with a face amount of $80,000 for $74,000. Which of the following journal entries would be correct?
Debit investment in bonds $80,000; credit discount on bond investment for $6,000; credit cash for $74,000.
This ratio may provide information about a company's default risk.
Debt to equity
Taylor Company's attorney informs its client that it is possible, but not probable, that the company will lose a currently litigated lawsuit. No reliable estimate of the potential loss is currently available. How should Taylor accrue and/or disclose this potential loss?
Disclose the contingency and state that an estimate cannot be made.
True or false: If a company elects the fair value option, it must report all of its financial instruments at fair value.
False
Hatter Company's new bond issue with face amount of $7 million sells for $6.8 million. Which of the following facts may explain why the bonds sell at a discount?
Hatter Company's stated interest rate must be lower than that of competing companies in the bond market.
Which of the following is correct regarding the effective interest method?
Interest expense is equal to the effective interest rate multiplied by the outstanding balance of the debt.
Choose the statement that best reflects the nature of interest.
Interest is the "rent" paid by the borrower for using the lender's money.
Which of the following statements regarding the fair value option is correct?
It can be applied on an "instrument-by-instrument" basis.
Which of the following statements regarding the times interest earned ratio is correct?
It indicates the margin of safety provided to creditors.
Gregory Company issues $5 million face amount bonds. The bond indenture is held by a large national bank. Which of the following explains why a bank is holding the indenture?
It is impractical for the issuer to enter into an agreement with each bondholder.
What type of costs relating to ongoing litigation are commonly recognized by companies?
Lawyer fees and other legal costs
Lower risk
Noncurrent liabilities already reported on the balance sheet
Peter Company issues 10-year bonds on October 1, 20X1. The bonds pay 6% interest semi-annually. Peter Company has a calendar year year-end. Which of the following statements is correct regarding interest recognized in its 12/31/X1 income statement relating to this bond issue?
Peter should recognize 3 months of interest.
Which ratio indicates profitability without regard to how resources are financed?
Rate of return on assets
This ratio provides information about a company's effectiveness of employing resources provided by owners.
Rate of return on shareholders' equity
Which of the following transactions will increase a company's working capital?
Receipt of cash on a long-term note
Sinking fund debentures
bonds that must be redeemed on a prespecified year-by-year basis; administered by a trustee who repurchases bonds in the open market.
Long-term obligations
bonds, notes, lease liabilities, deferred tax liabilities
Effective interest method
calculates interest revenue by multiplying the outstanding balance of the investment by the relevant interest rate.
Bonds that can be bought back by the issuer at a specified price prior to the bonds' maturity date are referred to as ____ bonds
callable
Warranties that assure the customer that the products are delivered free from major defects typically result in the accrual of
contingent liabilities
When some doubt exists about whether or not a loss will occur in the future we refer to it as a(n)
contingent liability
The dollar amount of a potential loss when reporting a ______ ______can be classified as either known, reasonably estimable, or not reasonably estimable.
contingent loss
When it is uncertain whether an obligation really exists, we may recognize what is referred to as a
contingent loss.
A bond feature that aims at making the bonds more attractive to investors is the ____ feature.
conversion
On January 1, 20X1, Wormer Company issues $200,000 of 6% bonds. Interest of $6,000 is payable semi-annually on June 30 and December 31. The bonds mature in 5 years and sell for $191,684. On June 30, 20X1, the company recognizes interest expense of $6,709. The company should also
credit discount on bonds payable for $709.
On January 1, 20X1, Wormer Company issues $200,000 of 6% bonds. Interest of $6,000 is payable semi-annually on June 30 and December 31. The bonds mature in 5 years and sell for $191,684. On June 30, 20X1, the company recognizes interest expense of $6,709. As a result of recognizing this transaction, the bond carrying value will
increase by $709. The difference between the cash interest paid of $6,000 and the effective interest of $6709 decreases the bond discount, which increases the carrying value of the bond.
Jackson Company has $1 million bonds outstanding that were issued to yield 5%. During the year, the market interest rate decreases. The fair value of Jackson's bonds likely will
increase.
The specific promises made to bondholders are described in a document referred to as a bond
indenture.
noncommitted line of credit
informal agreement that permits a company to borrow up to a prearranged limit without having to follow formal loan procedures and paperwork
Taxes collected for taxing authorities are recognized as
liabilities
Cash collected from customers as refundable deposits or as advance payments for products or services are recognized as
liabilities.
A company's cash position, its overall ability to obtain cash in the normal course of business, and to satisfy its current obligations reflects the company's
liquidity.
Changes in the current ______ often represent a major contributor to changes in the fair value of bonds.
market interest rate
Under both US GAAP and IFRS, if the fair value of bonds is not readily determinable, the fair value may be calculated as the present value of the future cash flows using the __________ __________ of interest.
market rate
Recognition of costs related to manufacturers' quality assurance warranty during the same period that the related revenue is recognized is consistent with the
matching principle
