CH 7 SmartBook
Calculate the amount of interest (discount basis) on a 2-year loan of $2,000 at a 15 percent interest rate.
$2,000 x 0.15 x 2 = $600
Calculate the amount of interest (straight basis) on a 2-year loan of $2,000 at a 15 percent interest rate.
$2,000 x 0.15 x 2 = $600
Calculate the amount of interest (discount basis) on a 6-month loan of $2,000 at a 15 percent interest rate.
$2,000 x 0.15 x 6/12 = $150
Calculate the amount of interest (straight basis) on a 6-month loan of $2,000 at a 15 percent interest rate.
$2,000 x 0.15 x 6/12 = $150
Calculate the effective interest rate (APR) on a 1-year loan of $2,000 at a 15 percent interest rate (discount basis).
$300 / (($2,000 - $300) x 1) = 17.6%
Calculate the effective interest rate (APR) on a 6-month loan of $6,000 at a 10 percent interest rate (discount basis).
10.53% Reason: = ($6,000 × 10% × (6 / 12)) / (($6,000 - 300) × (6 / 12)) = 10.53%
Calculate the annual percentage rate on a 1-year loan of $7,000 at a 12 percent interest rate (straight basis).
12%
Calculate the annual percentage rate on a 6-month loan of $5,000 at a 15 percent interest rate (straight basis).
15%
Suppose a firm has an average income tax rate of 25 percent and issues a 6 percent, long-term debt, then the after-tax cost of debt is _____.
4.5% Reason: 6% × (1 - 25%) = 4.5%
If a firm has an average income tax rate of 25 percent and issues long-term debt with an interest rate of 8 percent, then the after-tax cost of debt is:
8% x (1 - 25%) = 6%
Which of the following statements are true regarding how bond prices are quoted?
A $1,000 face amount bond that has a market value of $980 is priced at 98. A bond is trading at a discount when its face amount is more than its market value. Corporate bonds are usually issued in denominations of $1,000.
Identify the bond that is secured by a pledge of securities or other intangible property.
A collateral trust bond
Which of the following financial statement effects occur when a bond interest payment is made? Assume that the bond interest payment amount had been previously accrued in full. (Check all that apply).
Current assets are decreased. Current liabilities are decreased.
The entry to record accrued interest in the borrower's books has which of the following effects on the financial statements?
Current liabilities are increased. Expenses are increased. Net income is decreased.
Which of the following are impacts of short-term borrowing on financial statements?
Current liabilities increase Current assets increase Cash increases
The entry to record a short-term borrowing is:
DR Cash CR Short-Term Debt
Which of the following statements regarding financial leverage are true?
If a firm's ROI exceeds the interest rate of the borrowed funds, then ROE will be greater than ROI. Financial leverage adds risk to the firm because the interest cost of debt is usually a fixed percentage.
With respect to convertible bonds, which of the following statements are true?
If the common stock price has risen substantially since the bonds were issued, it is more likely that the conversion option will be exercised. The bondholders have the option of converting the bonds into common stock before the scheduled maturity date of the bonds. The conversion feature may not become effective for several years after the bonds are issued.
Which of the following effects would occur when the accrual of income taxes requires an increase in the Deferred Income Tax Liability account?
Income Tax Expense will be debited.Deferred Tax Liabilities will be credited.
Which of the following conditions must be met before a contingent liability is recorded on a firm's balance sheet?
It must be probable that the loss will be confirmed by a future transaction or event.
Identify the impact of recording the cash received in advance from customers.
Net income is not affected. Current liabilities increase. Cash increases.
Which are correct statements about the prime rate?
Prime rate is in reality a benchmark rate. Prime rate is impacted by credit market forces.
Identify an item that is commonly included with noncurrent liabilities.
Product warranties
Identify the impact of allocation of unearned revenue to the fiscal year in which the product is delivered and the revenue is earned.
Revenues increase. Working capital increases. Liabilities decrease.
Which is a correct mode of repayment of term bonds and serial bonds at the time of maturity?
Term bonds require a lump-sum repayment of the face amount, but serial bonds are repaid in installments.
Assume that 8 percent bonds with a 10-year maturity are issued to investors who desire a 10 percent return on investment. The face value of the bonds is $1,000. When pricing the bonds using the present value of the bond payments, which of the following statements are true?
The bonds' maturity amount of $1,000 will be discounted back to present value at the market interest rate of 10 percent. The bonds' annual interest annuity is equal to $80 ($1,000 x 8%).
Assume that 8 percent bonds with a 10-year maturity are issued to investors who desire a 7 percent return on investment. The face value of the bonds is $1,000. In pricing the bonds using the present value of the bond issuance, which of the following statements are true?
The bonds' maturity amount of $1,000 will be discounted back to present value at the market interest rate of 7 percent. The bonds will be issued at a premium. The bonds' annual interest annuity will be discounted back to present value at the market rate of 7 percent.
With respect to callable bonds, which of the following statements are true?
The issuer usually is required to pay a call premium to the bondholders if the bonds are called. The issuer has the option of calling the bonds before the scheduled maturity date, but is not obligated to do so.
Which of the following financial statement effects occur when a bond discount is amortized?
The net carrying value of Bonds Payable is increased. Expenses are increased and net income is decreased.
Deferred tax liabilities arise because of the _____.
accounting process of matching revenues and expenses difference between a company's book income and taxable income
Other accrued liabilities commonly reported on the balance sheet include:
advertising obligations estimated warranty liabilities property taxes payable
The borrower's entry to record the proceeds of a short-term discounted note at the time of borrowing would include: (Check all that apply).
an increase to Cash for the amount of proceeds (the principal amount of the note less the amount of interest on the note). an increase to Short-Term Debt for the principal amount of the note.
The financial statement effects of recording a firm's accrued property taxes for the year include:
an increase to current liabilities and no effect on cash. an increase to expenses and a decrease to net income.
The financial statement effects of the accrual of estimated warranty liability in the year in which products are sold include:
an increase to current liabilities and no effect on cash. an increase to expenses and a decrease to net income.
Deferred tax liabilities:
are provided for temporary differences between income tax and financial statement recognition of revenues and expenses. are normally long term in nature. are one of the most significant liabilities shown on the balance sheet for many firms.
Deferred tax assets _____.
are recorded to recognize temporary differences that will cause taxable income to be lower in future years
Deferred tax assets: (Check all that apply)
are recorded when warranty expense is recorded in the year of sale but the tax deduction is not allowed until warranty expenditure is actually made. result when an expense is recognized for financial accounting purposes before it is deductible for tax purposes. are recorded to recognize temporary differences that will cause taxable income to be higher in future years.
Gain contingencies:
are sometimes disclosed in the notes to the financial statements, but only when the gain is highly likely to occur. are not recognized in the financial statements because of accounting conservatism.
Callable bonds will be called when the market interest rate is sufficiently (above/below) the stated rate being paid on the bonds.
below
Convertible bonds can be converted into common stock of the issuer corporation at the option of the _____.
bondholder
Potential claims on a company's resources arising from such things as pending litigation, environmental hazards, casualty losses to property, and product warranties are referred to as (callable/contingent/convertible) liabilities.
contingent
The financial statement effects of an employer's entry to record payroll obligations for a payroll period include:
credits to withholding liabilities. a credit to Wages Payable (or Accrued Payroll) for the net pay. a debit to Wages Expense for the gross pay.
As unearned revenue involves the receipt of cash in a period prior to the period in which the related revenue is recognized, unearned revenue is considered the opposite of _____.
deferred charge transaction
When a contingent gain is highly likely to occur, it can be _____.
disclosed in the notes to the financial statements along with estimated amounts
For the (straight/discount) basis of interest calculation, the loan is based on the principal amount of the loan but the interest is subtracted from the principal at the beginning of the loan and the difference is made available to the borrower.
discount
The amount of discount or premium amortization on bonds is the smallest in the first year and increases in each subsequent year under the (straight-line/effective) interest method.
effective
Payroll taxes assessed directly against an employer include:
employer's share of FICA tax federal and state unemployment taxes
As market interest rates rise, bond prices (rise/fall).
fall
True or false: The liability and expense amounts reported in the previous year are not retroactively restated because the estimates would be considered errors and errors should not lead to the retroactive restating of financial statements.
false
The largest deductions made from employees' gross wages are for _____.
federal and state income tax withholdings and FICA tax withholdings
The difference between the rate of return earned on assets (ROI) and the rate of return earned on stockholders' equity (ROE) is referred to as (operating/financial) leverage.
financial
The employer's Wages Expense for a payroll period represents the employees' (gross/net) pay.
gross
Withholdings commonly made from gross pay to arrive at an employee's net pay include:
hospitalization insurance employee's share of FICA tax pension plan payments federal and state income tax
Current maturities of long-term debt are reported _____.
in the current liability section but separately from short-term debt
One of the key advantages of issuing debt as opposed to common stock to raise additional funds is that:
interest expense is deductible in calculating taxable income, whereas dividends are not tax deductible.
An unearned revenue or deferred credit:
is a current liability for cash collected from customers prior to delivering the agreed goods.
bond discount
is a deferred charge that is amortized to interest expense over the life of the bond. represents additional interest expense to be recognized over the life of the bond.
Bond premium:
is a deferred credit that is amortized to interest expense over the life of a bond. amortization reduces interest expense below the amount actually paid to bondholders.
Bond discount:
is classified in the balance sheet as a contra account to the Bonds Payable account. amortization increases interest expense over the amount actually paid to bondholders.
When bonds are called, the (bondholder/issuer) usually has to pay a call (discount/premium).
issuer, premium
The (stated/market) interest rate, adjusted for compounding frequency, is the discount rate used in the present value calculations for bond pricing.
market
There is usually a time lag between the establishment of the interest rate to be printed on the face of the bond and the actual issue date. During this time, (stated/market) interest rates fluctuate, causing the proceeds of the bond to be more than the face amount.
market
Bonds are often issued at a premium or discount largely because of:
market interest rate fluctuations that occur from the time the stated interest rate is established until the bonds are issued.
As accrued liabilities represent expenses that have been incurred but not yet paid, accountants report other accrued liabilities on financial statements to adhere to the _____.
matching principle
The employer's Wages Payable or Accrued Payroll for a payroll period represents employees' (gross/net) pay.
net
Accounts payable are normally shown:
on the balance sheet as a current liability, but not reduced by anticipated cash discounts.
A debenture is secured _____.
only by the general credit of the issuer
An unearned revenue or deferred credit is a current liability that is normally settled by:
performing the agreed services (or delivering the agreed goods), which the customer had paid for in advance.
All bonds issued nowadays are in the form of (registered/coupon) bonds.
registered
Bond premium:
represents a reduction in interest expense to be recognized over the life of a bond. has the opposite effect on a bond's carrying value than does a bond discount.
The financial statement effects of an early retirement of bonds usually include:
retirement of any unamortized premium or discount associated with the retired bonds.a decrease to assets.
As market interest rates fall, bond prices (rise/fall).
rise
Prime rate is used to express the interest on _____.
short-term loans
The (stated/market) interest rate, adjusted for compounding frequency, is used to calculate the amount of interest paid for each payment period of a bond's life.
stated
The (straight/discount) basis of interest calculation involves charging interest on the money available to the borrower for the length of time it was borrowed.
straight
The amount of discount or premium amortization on bonds is the same each year under the (straight-line/effective) interest method.
straight-line
At the maturity date, a lump-sum repayment of the face amount of a (term/serial) bond is made, whereas the face amount of a (term/serial) bond is repaid in installments over time.
term, serial
At the maturity date, a lump-sum repayment of the face amount of a (term/serial) bond is made, whereas the face amount of a (term/serial) bond is repaid in installments over time. Listen to the complete question
term, serial
A company should record a contingent liability on its balance sheet only when _____.
the amount of the loss is reasonably estimable
Unearned revenues and prepaid expenses are similar concepts because:
the period of receipt/payment of cash is different from the period of recognition of revenue/expense.
The difference between the gross and net methods of recording the accounts payable relates to:
the timing of the recognition of cash discounts.
True or false: The determination of a contingent liability depends on one or more future events.
true
Liability and expense amounts reported in prior years are not generally restated because the estimates used in prior years:
were based on the best information available at the time and thus were not recorded in "error"
Current maturities of long-term debt are a current liability representing that portion of long-term debt that:
will be maturing within a year of the balance sheet date.
Identify the correct statements about a registered bond.
For a registered bond, interest payments are mailed to the bondholder on the basis as called for in the indenture. For a registered bond, the name and address of the owner of the bond are known to the issuer.
The entry to record the accrual of property taxes for the year includes:
a credit to Property Taxes Payable. a debit to Property Tax Expense.
The entry to record an employer's payroll obligation for a payroll period includes:
a credit to Wages Payable (or Accrued Payroll) for the net pay.
The entry to record a firm's payroll tax obligation for a payroll period includes:
a debit to Payroll Tax Expense. a credit to Payroll Taxes Payable (or Accrued Payroll Taxes).
The financial statement effects of the retirement of discount bonds or premium bonds at maturity include:
a decrease in assets. a decrease in noncurrent liabilities.
The borrower's entry to record the amortization of discount on short-term debt to interest expense would lead to:
a decrease in the Discount on Short-Term Debt account. an increase in the net carrying value Short-Term Debt for the amount of the discount amortized. an increase in Interest Expense account for the amount of the discount amortized.
The entry to record actual warranty costs in the year in which the warranty is honored includes:
a decrease to current liabilities.
The financial statement effects of an early retirement of bonds usually include:
a decrease to noncurrent liabilities. the recognition of a loss (or possibly a gain) on the retirement of bonds.
Debt financing usually has _____.
a lower cost to a firm as compared to equity financing
The entry to record the pay-off of bonds at maturity is:
Dr. Bonds Payable Cr. Cash
The borrower's entry to record the proceeds of a short-term discounted note at the time of borrowing is:
Dr. Cash Dr. Discount on Short-Term Debt Cr. Short-Term Debt
The entry to record the accrual of income taxes when an increase in the Deferred Income Tax Liability account is required is: Multiple choice question.
Dr. Income Tax Expense Cr. Income Taxes Payable Cr. Deferred Tax Liabilities
The borrower's entry to record the amortization of discount on short-term debt is: Multiple choice question.
Dr. Interest Expense Cr. Discount on Short-Term Debt
The entry to record accrued interest in the borrower's book is:
Dr. Interest Expense Cr. Interest Payable
Which of the following are frequently listed as other noncurrent liabilities?
Estimated liabilities under lawsuits Obligations to pension plans
Which of the following financial statement effects occur when a bond premium is amortized?
Expenses are decreased and net income is increased. The net carrying value of Bonds Payable is decreased.
Which of the following financial statement effects occur when bond interest is accrued? (Check all that apply).
Expenses are increased and net income is decreased.Current liabilities are increased.
Firm A (with no financial leverage) earns an ROI of 10 percent. Firm B also earns an ROI of 10 percent, but its assets are partially financed by debt bearing an interest rate of 15 percent. Which of the following statements about the two firms are correct?
Firm B will have negative financial leverage. Firm B's ROE will be less than Firm A's ROE.
Firm A (with no financial leverage) earns an ROI of 10 percent. Firm B also earns an ROI of 10 percent, but its assets are partially financed by debt bearing an interest rate of 8 percent. Which of the following statements about Firm A and Firm B are correct?
Firm B will have positive financial leverage. Firm B's ROE will be greater than Firm A's ROE. Firm B's stockholders will be rewarded for taking the risk of borrowing money at a fixed cost.
Which of the following statements are true regarding how bond prices are quoted?
When a bond has a market price that is greater than its face amount, it is trading at a premium. A bond discount is the excess of the face amount over the market value of the bond. Bond prices are often expressed as a percentage of the bond's face amount.
