Chapter 7

A line of credit ______.

-normally has fluctuating interest rates. -is normally renewable on a one-year term

Assume that a $1,000 face value bond sells at a $100 discount. If the bond has a 7% stated rate of interest and a 5 year term to maturity, the effective rate of interest is approximately ______.

10% Reason: Total annual interest = ($1,000 x 7%) + ($100 ÷ 5) discount = $90. Effective interest rate = $90 annual interest ÷ $900 amount borrowed = 10%.

A potential obligation arising from a past event is called a(n)

Contingent liability.

In practice, bonds normally pay interest ______.

Semiannually

Issuing a note to borrow money affects the ______. balance sheet statement of cash flows income statement

balance sheet statement of cash flows

The seller of a bond is called the _______ , while the buyer of a bond is called the _______

borrower, lender

When bonds are issued at a discount, they sell for ____ face value.

less

A business has a debt that is due in May, Year 2. At December 31, Year 1 the company does not plan to use any of its current assets to repay this debt. This debt should be classified as _____ on the December 31, Year 1 balance sheet.

long term

Bond obligations normally have _____ terms when compared to notes issued to bank.

longer

Bond interest rates are generally _____ than interest rates charged by bank.

lower

When a company recognizes a cash revenue event that is subject to state sales tax, the balance in the Cash account increases by ______ the amount of revenue. more than less than the same amount as

more than

Warranties normally:

represent liabilities. guarantee repair or replacement. cover a specific time period.

Which of the following statements are true? Restrictive covenants are used to require executives to pledge personal assets as collateral for business loans. Creditors may demand executives to pledge personal assets as well as business assets as security for loans. Assets like accounts receivable, inventory, equipment, buildings, land may be pledged as collateral for business loans. Executives of major corporations are more likely to be asked to pledge personal assets as collateral than are owners of small businesses.

Creditors may demand executives to pledge personal assets as well as business assets as security for loans. Assets like accounts receivable, inventory, equipment, buildings, land may be pledged as collateral for business loans.

On January 1, Year 1, Dixon Company issued 10-year, 8% bonds with a $50,000 face value at 96. Interest is payable in cash on December 31 of each year. Assuming straight-line amortization, the annual interest payment decreases assets 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 × 8% = $4,000).

Agreements that restrict additional borrowing, limit dividend payments, or restrict salary increases are examples of _____ covenant

restrictive

Which of the following statements regarding contingent liabilities is true? (Select all that apply.) Contingent liabilities represent losses; the contingency is about the amount. A contingent liability is a potential obligation arising from a past event. For reporting purposes, contingent liabilities are sorted into three categories depending on the likelihood of their becoming actual liabilities. The amount or existence of a contingent liability depends on some future event.

-A contingent liability is a potential obligation arising from a past event. -For reporting purposes, contingent liabilities are sorted into three categories depending on the likelihood of their becoming actual liabilities. -The amount or existence of a contingent liability depends on some future event.

The actual rate of interest a company must pay on a bond is called the _____ interest rate.

Effective

Issuing a bond to borrow money affects the ______.

affects the income statement. affects the balance sheet.

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

borrowing money with a two year term to maturity

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

cash flow from operating activities retained earnings cash

Loans that require payments of principal and interest at regular intervals are called ______. balloon notes accounts payable lines of credit installment notes

installment notes

Current assets include ______.

inventory supplies cash accounts receivable

Recognizing accrued interest expense ______. is a claims exchange transaction has no effect on total liabilities decreases total assets decreases net income

is a claims exchange transaction decreases net income

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

lines of credit

The effective rate of interest investors are willing to accept for a particular bond equals the _____ rate of interest for other investments of similar risk.

market

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

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

The average time it takes a business to convert cash to inventory, inventory to accounts receivable, and accounts receivable back to cash is commonly called the _____ Cycle.

operating

The cash outflow for interest payments on bonds is reported in the , ____ activities section of the statement of cash flows.

operating

The carrying value of a bond issued at a premium is equal to that face value of the bond

plus the premium

The carrying value of a bond issued at a premium is equal to that face value of the bond

plus the premium.

Warranty obligations ______. are reported in financial statements are not considered liabilities only require footnote disclosure have uncertain timing and amounts

are reported in financial statements have uncertain timing and amounts

Simms Accountants charged a client $2,000 cash plus tax for services provided in a state where the service sales tax rate is 6%. As a result of this event, the ______. sales tax liability account increases by $120 cash account increases by $2,120 cash flow from operating activities is not affected revenue account increases by $2,120

sales tax liability account increases by $120 cash account increases by $2,120

What type of interest rate fluctuates up or down during the loan period? variable hybrid fixed

variable

On January 1, Year 1, Dixon Company issued 10-year, 8% bonds with a $50,000 face value at 96. As a result on this, the Bonds Payable account increases by

$50,000.

On January 1, Year 1, Dixon Company issued 10-year, 8% bonds with a $50,000 face value at 104. Recognizing the bond issue, causes total liabilities to increase by

$52,000

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.

Bond premiums reduce the _____ interest rate

effective

True or false: When a bond is issued, the stated interest rate is determined by current market conditions.

false

True or false: When bonds are issued at a premium, GAAP requires the premium to be classified as a cash inflow from operating activities.

false

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

financing Operating

On January 1, Year 1, Dixon Company issued 10-year, 8% bonds with a $50,000 face value at 96. As a result on this, the statement of cash flows shows a cash flow from ______ activities of _______.

financing, $48,000

What type of interest rate remains constant during the term of the loan?

fixed

Payments on installment loans ______.

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

Recognizing accrued interest expense affects the ______.

income statement balance sheet

On January 1, Year 1, Dixon Company issued 10-year, 8% bonds with a $50,000 face value at 96. Interest is payable in cash on December 31 of each year. Assuming straight-line amortization, the carrying value of the bond liability will ______ at each interest payment.

increase by $200 Reason: The amortization of the bond discount ($2,000 ÷ 10 years = $200 per year) decreases the balance in the Discount on Bonds Payable account. Since the carrying value of the bond liability is equal to the face value of the bond minus the Discount on Bonds Payable, the amortization of the discount increases the carrying value.

Which of the following statements are true? Most businesses provide information about their bill-paying ability by classifying their assets and liabilities according to liquidity. The more quickly an asset is converted to cash or consumed, the more liquid it is considered. Long-term assets are usually presented before short-term assets on a classified balance sheet. A current asset is expected to be converted to cash or consumed within one year or an operating cycle, whichever is shorter.

Most businesses provide information about their bill-paying ability by classifying their assets and liabilities according to liquidity. The more quickly an asset is converted to cash or consumed, the more liquid it is considered.

Current liabilities include: interest receivable. 5 year bonds due in 2 years. accounts payable. wages payable. 10 years bonds due in 5 months.

accounts payable. wages payable. 10 years bonds due in 5 months.

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

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

Semiannual interest means that interest is paid ______.

two times per year