Liabilities

Chapter 10 - Liabilities

Chapter 10Liabilities

True / False Questions

1. A liability that is known to exist but the precise dollar amount is not known is called a possible liability True False

2. Bonds secured by a pledge of specific assets are called debenture bonds. True False

3. Junk bonds are attractive to investors because they carry a high rate of interest and are usually convertible into a specified number of shares of capital stock. True False

4. Dividends paid by a corporation to its stockholders are tax deductible by the corporation but interest paid on bonds is not. True False

5. When bonds are sold by one investor to another, they sell at market price plus accrued interest since the last payment date. True False

6. When bonds are issued at a discount, the borrower must pay more at maturity than the amount originally received. True False

7. The account Discount on Bonds Payable actually represents interest expense and will be amortized over the life of the bond. True False

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8. A loss contingency is recorded in the accounting records when it is probable that a loss has been incurred and the amount of the loss is known. True False

9. A commitment, such as a contract to pay a baseball player $5,000,000 a year for five years, should be listed as a long-term liability. True False

10. If a lease transfers ownership of the property to the lessee at the end of the lease term, it should be regarded as an operating lease. True False

11. When a company has a fully funded pension plan, they only need to record the present value of pension payments as a current liability. True False

12. Gross pay less withholding tax and less worker's compensation is considered net pay. True False

13. Estimated liabilities, contingencies and commitments are usually reported in the long-term liability section of the financial statements. True False

14. The amount of FICA tax and Medicare tax withheld from an employee is used to pay the employer's percentage of the tax and is mailed to the government quarterly. True False

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15. When a company sells bonds, the bondholders are permitted to vote for the board of directors. True False

16. The combination of liabilities and owners' equity used in financing the assets of a business is called the company's capital structure. True False

17. Prepayments and owners' equity are both sources of financing. True False

18. The current portion of long-term debt should be reported separately in the current liabilities section of the balance sheet. True False

19. When money is borrowed by issuing a note payable, the borrower records a liability equal to the maturity value of the note. True False

20. The most common types of payroll deductions are taxes, insurance premiums, employee savings, and union dues. True False

21. Social security and Medicare taxes have a cap on employees' salaries where the tax is ended. True False

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22. If a long-term debt is to be paid off in monthly installments over a 5-year period, the entire principal should be classified as a long-term debt. True False

23. There is a tax advantage for a company to issue bonds in lieu of stocks. True False

24. The withholding of taxes from an employee's pay is a liability to the company. True False

25. Bonds payable are a means of dividing a very large, long-term liability among many creditors some of whom may participate in the loan only for a short period of time. True False

26. Liabilities that fall due within one year or within the operating cycle are classified as current liabilities. True False

27. In the marketplace, bond prices tend to fluctuate directly with changes in interest rates. True False

28. Convertible bonds can be exchanged for common stock at the option of the company. True False

29. In a long-term capital lease, the lessor views a portion of each lease payment as interest expense. True False

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30. Payments of pensions and other benefits to retired workers are recognized as expense in the period payment is made. True False

31. Sinking funds make a bond issue less attractive to the investor. True False

32. Deferred income taxes eventually come due. True False

33. If a bond is callable, the call price is usually lower than the face value of the bond. True False

34. The quick ratio is a more stringent measure of solvency than the current ratio. True False

35. A high interest coverage ratio is a sign of creditworthiness. True False

36. Loss contingencies stem from past events. True False

37. Bonds, with the same face value, issued at a premium will have a higher maturity value than bonds issued at a discount True False

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38. Loss contingencies should be recorded in the accounting records whenever it is probable that a loss has been incurred and the amount of loss might be material in amount. True False

39. The account Discount on Bonds Payable has a debit balance and should appear on the balance sheet as an asset; the account Premium on Bonds Payable has a credit balance and should be classified as a liability. True False

40. The future value will always be less than the present value. True False

41. The amortization of discount on bonds payable reduces the amount of interest expense recognized during the period. True False

42. The amortization of bond discount by the issuing company decreases the carrying value of its bonds payable. True False

43. A primary means used by credit rating agencies to evaluate a company's ability to pay its debts is to compare total assets to total liabilities. True False

44. Companies may understate liabilities so as not to be perceived as risky by credit rating agencies. True False

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45. Special purpose entities (SPEs) are established by corporations to accomplish specific purposes such as borrowing money. True False

Multiple Choice Questions

46. U. S. GAAP requires that convertible bonds be classified on the balance sheet as: A. Part liability, part equityB. A liabilityC. Either a liability or equityD. As an asset

47. International accounting standards require that convertible bonds be classified on the balance sheet as: A. Part liability, part equityB. A liabilityC. Either a liability or equityD. As an asset

48. Off balance sheet financing may involve either: A. An operating leaseB. A special purpose entityC. Both of the aboveD. Neither of the above

49. Employers are required to pay all of the following on the wages paid to each employee except: A. Social security taxesB. Worker's compensation insuranceC. Medicare taxesD. Health insurance benefits.

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50. In preparing an amortization table, it is necessary to include: A. The original amount of the liability, the amount of periodic payments and the interest rate.B. The original amount of the liability, the amount of periodic payments and the amount of past payments.C. The monthly payment, the total amount of past payments and the original amount of the liability.D. The total amount of past payments, the interest rate and the amount of periodic payments.

51. A company issues $50 million of bonds at par on January 1, 2009. The bonds pay 10% interest semi-annually on 12/31 and 6/30 and mature in 20 years. The journal entry when the bonds are sold is:A)

B)

C)

D)

A. Option AB. Option BC. Option CD. Option D

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52. The amount of the present value of a future cash receipt will depend upon A. The length of time until the money is received.B. The amount of money to be received.C. The required rate of return.D. All of the above.

53. The FICA tax paid by an employer is: A. Greater than the amount paid by the employee.B. Less than the amount paid by the employee.C. Equal to the amount paid by the employee.D. The employer does not pay FICA tax, only the employee pays the tax.

54. When a company sells bonds between interest dates they will pay which of the following at the first interest payment date? A. An amount less than the stated interest rate times the principal.B. An amount more than the stated interest rate times the principal.C. An amount equal to the stated interest rate times the principal.D. The company may skip the first interest payment date since the appropriate time has not passed.

55. A $1,000 bond that sells for 104 has a selling price of: A. $1,004B. $1,040C. $1,400D. $1,000

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56. Which of the following is not an accurate statement regarding the distinction between debt and equity? A. Only equity is considered a source of financing for operations of the business, since debt must be repaid at a specified maturity date.B. If a business ceases operations and liquidates, claims of all creditors have legal priority over claims of the stockholders.C. Most debt requires the borrower to pay interest; equity financing does not obligate the company to make a specified payment.D. The providers of equity are owners of the business; the providers of borrowed funds are creditors.

57. Which of the following is not a characteristic of current liabilities? A. They are due within one year or within the operating cycle, whichever is longer.B. They may involve estimated amounts.C. They may be replaced with a new short-term liability rather than being paid in cash.D. All three of the above are characteristic of current liabilities.

58. If a bond is selling at 103, it is selling at: A. Maturity value and yields a 2% interest rate.B. A discount.C. A premium.D. $103 per bond.

59. Which of the following payroll costs are shared equally by the employer and the employee? A. State unemployment taxes.B. Workers' compensation.C. Social security.D. Federal unemployment taxes.

60. Interest payable on a loan becomes a liability: A. When the note payable is issued.B. As it accrues.C. At the maturity date.D. When the borrowed money is received.

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61. An employer's total payroll-related costs always exceed the wages and salaries earned by employees by: A. Amounts withheld from employees' pay.B. Payroll taxes and mandated programs such as workers' compensation insurance.C. 50%.D. None of the above. Employers' payroll-related costs actually are less than the gross wages and salaries earned by employees, because of amounts withheld from employees' checks.

62. Bonds, with the same face value, issued at a premium will: A. Have a greater maturity value than a bond issued at a discount.B. Have a lesser maturity value than a bond issued at a discount.C. Have the same maturity value as a bond issued at a discount.D. Have a different maturity value than a bond issued at a discount, depending upon the interest rate and maturity date.

63. The amounts that a business withholds as taxes from an employee's earnings: A. Represent payroll taxes expense to the employer.B. Are deposited in an interest-bearing account until the employee is terminated.C. Represent miscellaneous revenue to the employer.D. Represent current liabilities to the employer.

64. Unearned revenue: A. Appears on the income statement as income.B. Appears on the income statement as a reduction to income.C. Appears on the income statement as a liability.D. Appears on the balance sheet as a liability.

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The average employee of Girard Corporation earns gross pay of $75,000 per year. The following table shows the relative size of various payroll amounts by expressing each as a percentage of total wages and salaries expense (gross pay):

In addition, Girard pays $425 per month per employee for group health insurance.

65. Refer to the above data. Which of the following is the largest payroll-related expense incurred by Girard? A. Group health insurance premiums.B. Income taxes expense.C. The employer's share of social security taxes.D. Wages and salaries expense.

66. Refer to the above data. Which of the following represents the second largest payroll related expense incurred by Girard? A. Group health insurance premiums.B. Income taxes expense.C. The employer's share of social security taxes and Medicare taxes.D. Wages and salaries expense.

67. Refer to the above data. Which of the following represents the largest amount withheld from employees' paychecks? A. Workers' compensation insurance.B. Social Security and Medicare.C. Personal income taxes.D. Group health insurance.

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68. When a corporation has a right to redeem bonds in advance of the maturity date, the bond is considered a: A. Convertible bond.B. Callable bond.C. Junk bond.D. Debenture bond.

69. Sinking funds usually appear on the balance sheet as: A. Current asset.B. Long-term investment.C. Current liability.D. Appropriation of retained earnings.

70. A bond that is not secured is also known as: A. A sinking fund.B. A mortgage.C. A debenture.D. A junk bond.

71. Management has both the intent and the ability to refinance a liability maturing in four months by taking out a new loan at the due date which would not be due for several years. How would this situation be reported in financial statements prepared as of today's date? A. The original liability is classified as current, with a footnote describing management's plan for refinancing.B. The original liability is classified as current and the new loan is reported as a long-term liability.C. The original liability is classified as long-term; the new loan is not included in liabilities at this date.D. The original liability need not be reported at all; only the new loan is reported as a long-term liability.

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72. Temple Corporation purchased a piece of real estate, paying $400,000 cash and financing $700,000 of the purchase price with a 10-year, 15% installment note. The note calls for equal monthly payments that will result in the debt being completely repaid by the end of the tenth year. In this situation: A. The aggregate amount of the monthly payments is $700,000.B. Each monthly payment is greater than the amount of interest accruing each month.C. The portion of each payment representing interest expense will increase over the 10-year period, since principal is being paid off, yet the payment amount does not decrease.D. The portion of each monthly payment representing repayment of principal remains the same throughout the 10-year period.

73. When an installment note is structured as a "fully amortizing" loan with equal monthly payments (such as a traditional mortgage): A. The portion of each payment allocated to interest expense is the same each month.B. The sum of the monthly payments is equal to the amount of the installment note (mortgage).C. The difference between the sum of all monthly payments and the principal amount of the note constitutes interest.D. The portion of each payment allocated to repayment of principal decreases each month as the mortgage is paid off.

74. In relation to a bond issue, the role of the underwriter is to: A. Guarantee payment to bondholders of both the periodic interest payments and the maturity value.B. Purchase the entire bond issue from the issuing corporation and then sell the bonds to the public.C. Represent the interests of the bondholders and, if necessary, to take legal action on their behalf.D. Maintain a subsidiary ledger of individual bondholders and mail out the periodic interest checks.

75. If a bond is issued at par and between interest dates: A. The cash received by the corporation will be less than the face value of the bond.B. The cash received by the corporation will be greater than the face value of the bond.C. The cash received by the corporation will be the same as the face value of the bond.D. Interest receivable will be debited.

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76. The term "junk bonds" describes bonds with: A. Low interest rates.B. Indefinite maturity dates.C. Low maturity values.D. High risk.

77. One advantage of issuing bonds instead of stock is that: A. Interest is tax deductible whereas dividends are not.B. Bonds have a longer maturity date.C. Interest rates are lower than dividend rates.D. The issuance of bonds does not affect earnings per share.

78. Choose the statement that correctly summarizes the tax advantage of raising money by issuing bonds instead of common stock: A. The amount paid by the corporation to redeem bonds at maturity date is deductible in computing income subject to corporate income tax.B. Interest payments are deductible in determining income subject to corporate income tax; dividends are not deductible.C. A corporation must pay tax on the sales price of stock issued, but is not taxed on the amount received when bonds are issued.D. Both interest and dividends paid are deductible in computing taxable income, but since interest must be paid annually, the corporation usually gets a larger tax deduction over the life of the bonds payable.

79. Elm Corporation plans to invest $300 million to earn about 15% before income taxes. The company is considering whether it should raise the $300 million by issuing 10% bonds payable or capital stock. If the company issues the bonds, it will probably report: A. Lower net income and lower income taxes expense than if it issues capital stock.B. Higher net income and higher income taxes expense than if it issues capital stock.C. Lower net income and higher income taxes expense than if it issues capital stock.D. Higher net income and lower income taxes expense than if it issues capital stock.

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80. The current portion of long-term debt should be reported: A. Separately in the long-term liabilities section of the balance sheet.B. In the long-term liabilities section of the balance sheet, along with the other long-term debt.C. In the current liabilities section of the balance sheet.D. In a separate section of the balance sheet, between long-term liabilities and shareholders' equity.

81. An operating lease: A. Creates an asset and a liability on the balance sheet.B. Is a form of off-balance sheet financing.C. Is always preferable to a capital lease.D. Transfers title to the asset being leased.

82. Suppose investors decided to sell their holdings of capital stock in order to purchase outstanding bonds payable and as a result, the prices of bonds payable increased. What would be the likely impact on market interest rates? A. Market interest rates will be unaffected.B. Market interest rates will increase.C. Market interest rates will fall.D. Although interest rates will change, it is impossible to predict the direction of change.

83. Which one of the following is not considered a criteria to capitalize a lease? A. The lease contains a bargain purchase option.B. The lease transfers ownership at the end of the lease term.C. The lease term is more than 75% of economic life of the property.D. The present value of minimum lease payments is less than 90% of the fair market value of the asset.

84. Which of the following payroll taxes do not stop once an employee reaches a certain level of income: A. Medicare taxes.B. Social security taxes.C. Unemployment taxes.D. All three of the above have a cap on salaries where the tax ends.

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85. The price at which a bond sells is equal to the: A. Maturity value of the bonds plus the present value to investors of the future interest payments.B. Sum of the future interest payments, minus the maturity value of the bonds.C. Present value to investors of the future principal and interest payments.D. Sum of the future interest payments, plus the maturity value of the bonds.

86. After bonds have been issued, their market value can be expected to: A. Rise as any premium is amortizedB. Fall if interest rates rise.C. Fall as any discount is amortized.D. Rise if interest rates rise.

87. The amortization of a bond discount: A. Decreases the carrying value of a bond and increases interest expense.B. Decreases the carrying value of a bond and decreases interest expense.C. Increases the carrying value of a bond and increases interest expense.D. Increases the carrying value of a bond and decreases interest expense.

88. Which of the following does not affect the market price of an outstanding bond issue? A. Fluctuations in the current market rate of interest.B. The credit rating of the issuing corporation.C. The price at which the bonds were originally issued.D. The length of time remaining until the bonds' maturity date.

89. Each of the following must be disclosed in the financial statements, except: A. The total amounts of long-term debt maturing in each of the next five years.B. The company's debt ratio and interest coverage ratio for the current year.C. Loss contingencies, when a reasonable possibility exists that a material loss has been incurred.D. The fair value of long-term liabilities when this value is significantly different from the amount shown in the balance sheet.

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90. A capital lease is recorded in the accounting records of the lessee by an entry: A. Debiting Rent Expense and crediting Cash each time a lease payment is made.B. Debiting Cash and crediting Rental Revenue each time a lease payment is received.C. Debiting an asset account and crediting a liability account for the present value of the future lease payments.D. Debiting an asset account and crediting Sales for the present value of the future lease payments.

91. Which of the following are factors in determining pension expense? A. Average age, retirement age, and life expectancy of employees.B. Employee turnover rate.C. Expected rate of return to be earned by the pension fund.D. All three of the above.

92. The pension expense of the current period is equal to: A. Amounts paid to retired workers during the current period.B. The estimated future pension benefits earned by today's workers during the current period.C. The present value of the estimated future pension benefits earned by today's workers during the current period.D. Cash payments made during the period to the trustee of the pension plan.

93. A company with a fully funded pension plan: A. Recognizes no pension expense.B. Reports no long-term liability for future pension payments.C. Does not utilize the services of a trustee to operate the pension plan.D. Recognizes pension expense equal to the cash payments made to retirees during the current period.

94. The amortization of a bond premium: A. Decreases the carrying value of a bond and increases interest expense.B. Decreases the carrying value of a bond and decreases interest expense.C. Increases the carrying value of a bond and increases interest expense.D. Increases the carrying value of a bond and decreases interest expense.

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95. In estimating annual pension expense, which of the following factors would not be taken into consideration? A. Current financial condition of the company.B. Expected rate of return to be earned on pension fund assets.C. Employee turnover rates.D. Compensation levels and estimated rate of pay increases.

96. Is the present value of an amount A. Always greater than the future value.B. Always less than the future value.C. Always equal to the future value.D. Greater than, less than, or equal to the future value depending upon interest rates and the time period involved.

97. Pension expense is: A. The present value of the estimated future pension benefits earned by employees as a result of their services during the period.B. The amount funded to the pension in a given year.C. The future value of rights granted to employees as a result of their services during the period.D. The amount withdrawn from the pension fund to pay retirees during the period.

98. Which of the following is not true about postretirement benefits? A. Postretirement costs should be recognized as expense as the workers earn the right to receive the benefits.B. Most corporations have fully funded their postretirement benefits.C. Unfunded postretirement costs are a non-cash expense.D. A corporation's liability for postretirement benefits is equal to the present value of estimated future payments.

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99. A liability for deferred income taxes represents: A. Income taxes on earnings already reported in the income statement, but that will be taxed in future periods.B. Income taxes already paid on earnings which have not yet been reported in the company's income statement.C. Income tax obligations being disputed with the Internal Revenue Service.D. Income taxes levied in prior years which are now past due.

100. In a statement of cash flows, most interest payments are classified as: A. Operating activities.B. Non-operating activities.C. Financing activities.D. Current liabilities.

101. Using different accounting methods on financial statements and tax returns will create: A. No effect upon the balance sheet, only the income statement.B. No effect upon the balance sheet nor the income statement.C. A deferred tax liability.D. An illegal situation.

102. The interest coverage ratio is computed by dividing: A. Net income by interest expense.B. Operating income by interest expense.C. Interest expense by net income.D. Interest expense by operating income.

103. Does a call provision on a bond A. Permit the corporation to redeem the bonds at a specified price.B. Allow the corporation to revise the stated interest rate.C. Allow the corporation to revise the maturity date.D. Always create the lowest price at which the bond will sell for.

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104. Which of the following statistics is of more significance to a long-term creditor than to a short-term creditor? A. Interest coverage ratio.B. Receivables turnover rate.C. Working capital.D. Quick ratio.

105. The interest coverage ratio: A. Is computed by dividing total liabilities by annual interest expense.B. Is computed by dividing liquid assets by annual required interest payment.C. Indicates the percentage of total assets that are financed with borrowed money.D. Measures the number of times the annual interest expense could be covered by annual income from operations.

106. Workers' compensation is: A. A required minimum compensation level.B. The rules for paying overtime.C. A state mandated insurance program.D. Includes all three above.

107. The basic measure of the amount of leverage being applied within the capital structure of an organization is the: A. Interest coverage ratio.B. Debt ratio.C. Return on assets.D. Return on equity.

108. The principal amount of a bond is: A. The total future interest charges.B. The unpaid balance exclusive of any interest charges.C. The unpaid balance plus any future interest charges.D. The maturity value less any currently unpaid balances.

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109. Which of the following is not a characteristic of an estimated liability? A. The liability is known to exist.B. The precise dollar amount cannot be determined until a later date.C. The liability should not be recorded in the accounting records until future events have determined the exact amount.D. The liability stems from past transactions.

110. Commitments, such as contracts for future transactions: A. Are classified as liabilities.B. Are classified as assets.C. Are footnoted in financial statements, if material.D. Are only disclosed if negative due to the principle of conservatism.

111. Which of the following is an example of a contingent liability? A. A lawsuit pending against a restaurant chain for improper storage of perishable food items.B. The liability for future warranty repairs on computers sold during the current period.C. A corporation's long-term employment contract with its chief executive officer.D. A liability for notes payable with interest included in the face amount.

112. Which of the following ratios and rates that measure debt-paying ability focuses on the long-term position of a company? A. Quick ratio.B. Inventory turnover.C. Current ratio.D. Debt ratio.

113. Which of the following is an example of a loss contingency that should be disclosed in a footnote to a company's financial statements? A. The president of the company has threatened to resign if the board of directors does not vote to increase executive salaries.B. A lawsuit has been brought against the company, but the company hopes to prevail in the suit and thereby avoid any liability.C. The allowance for uncollectible accounts receivable is estimated at $200,000.D. The company owns special-purpose machinery which, if sold, would probably bring a price less than its current book value.

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114. Ultimate Company is a defendant in a lawsuit alleging damages of $3 billion. The litigation is expected to continue for several years, and no reasonable estimate can be made at this time of Ultimate Company's ultimate financial responsibility. This situation is an example of: A. Off-balance-sheet financing.B. A loss contingency which should be disclosed in notes to Ultimate Company's financial statements.C. An estimated liability which must appear in Ultimate Company's balance sheet.D. A loss in purchasing power caused by inflation.

115. The Music House issues a contract to a new recording artist to produce a number of albums over the next five years at $1 million per album. This situation is an example of: A. A contingent liability which should be recorded in the accounting records.B. A contingent liability requiring footnote disclosure.C. An estimated liability, since the number of albums to be produced is not yet determined.D. A commitment which, if material, may be disclosed in a footnote.

116. A discount on bonds payable is best described as: A. An element of future interest expense.B. A bonus paid by the bondholders to the issuing corporation because of the unusually high interest rate stated in the bonds.C. The present value of the future interest payments of bond interest and principal.D. An amount below par which the bondholders may be called upon to make good.

117. Deferred taxes are classified as: A. Only a liability.B. Only an asset.C. Either an asset or liability, depending upon the situation.D. A non-operating expense.

118. Amortizing a discount on bonds payable: A. Increases interest expense.B. Increases periodic cash payments to bondholders.C. Decreases interest expense.D. Decreases periodic cash payments to bondholders.

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119. Premium on bonds payable: A. Is an asset account.B. Increases the carrying value of the liability.C. Is a contra-asset account.D. Is disclosed by a footnote.

120. Amortizing a premium on bonds payable: A. Increases interest expense.B. Increases periodic cash payments to bondholders.C. Decreases interest expense.D. Decreases periodic cash payments to bondholders.

121. On November 1, Metro Corporation borrowed $55,000 from a bank and signed a 12%, 90-day note payable in the amount of $55,000. The November 30 adjusting entry will be: (assume 360 days in year) A. Debit Interest Expense $550 and credit Notes Payable $550.B. Debit Interest Expense $550 and credit Interest Payable $550.C. Debit Discount on Notes Payable $1,100 and credit Interest Payable $1,100.D. Debit Interest Expense $550 and credit Cash $550.

On November 1, Year 1, Noble Co. borrowed $80,000 from South Bank and signed a 12%, six-month note payable, all due at maturity. The interest on this loan is stated separately.

122. Refer to the above data. How much must Noble pay South Bank on May 1, Year 2, when the note matures? A. $80,000.B. $89,600.C. $84,800.D. $82,400.

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123. Refer to the above data. How much interest expense will Noble recognize on this note in Year 2? A. $9,600.B. $4,800.C. $2,400.D. $3,200.

124. Refer to the above data. At December 31, Year 1, Noble Co.'s overall liability for this loan amounts to: A. $80,000.B. $81,600.C. $83,200.D. $84,800.

125. Refer to the above data. At December 31, Year 1, the adjusting entry with respect to this note includes a: A. Credit to Interest Payable for $1,600.B. Credit to Notes Payable for $1,600.C. Debit to Interest Expense for $3,200.D. Credit to Cash for $3,200.

On September 1, 2009, Able Company purchased a building from Regal Corporation by paying $200,000 cash and issuing a one-year note payable for the balance of the purchase price. Interest on the note is stated at an annual rate of 9% and is paid at maturity. In its December 31, 2009, balance sheet, Able correctly presented the note and interest payable as follows:

126. Refer to the above data. How much must Able pay Regal Corporation on September 1, 2010, when the note matures? A. $600,000.B. $618,000.C. $654,000.D. Some other amount.

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127. Refer to the above data. What is the amount of the interest expense Able will recognize on this note in 2010? A. $18,000.B. $31,500.C. $36,000.D. Some other amount.

128. Refer to the above data. What is the total cash (including interest) paid for the building purchased by Able? A. $800,000.B. $836,000.C. $854,000.D. $816,000.

129. Refer to the above data. The adjusting entry at December 31, 2009, with respect to this note included: A. A debit to Interest Expense for $18,000.B. A credit to Cash for $18,000.C. A credit to Notes Payable for $18,000.D. A credit to Interest Expense for $18,000.

On September 1, 2009, Select Company borrowed $600,000 from a bank and signed a 12%, six-month note payable, with interest on the note due at maturity.

130. Refer to the above data. The total amount of the current liability (including interest payable) for this loan that appears in Select Company's balance sheet at December 31, 2009, is: A. $600,000.B. $624,000.C. $636,000.D. $672,000.

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131. Refer to the above data. Assume Select made no adjusting entry with respect to this note before preparing the financial statements at December 31, 2009. What is the effect of this error on the financial statements for 2009? A. Total liabilities are overstated.B. Net income is overstated.C. Owners' equity is understated.D. Interest Payable is overstated.

132. Sanford Corporation borrowed $90,000 by issuing a 12%, six-month note payable, all due at the maturity date. After one month, the company's total liability for this loan amounts to: A. $90,000.B. $90,450.C. $90,900.D. $91,800.

133. On November 1 of the current year, Garcia Company borrowed $50,000 by issuing a 9%, six-month note payable, all due at maturity date. Interest expense on this note to be recognized during the current year amounts to: A. $500.B. $750.C. $1,500.D. $4,500.

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Stone Corporation has 25 employees and incurs total wages and salaries expense of $900,000 per year. The following table shows various payroll amounts as a percentage of this annual wage and salaries expense:

In addition, Stone provides group health insurance for its entire workforce. The cost of this insurance is $350 per month for each employee.

134. Refer to the above data. The company's annual payroll-related expenses amount to approximately: A. $1,085,600.B. $1,181,850.C. $1,250,700.D. Some other amount.

135. Refer to the above data. Employees' annual "take-home-pay," totals approximately: A. $672,300.B. $762,300.C. $675,000.D. $741,150.

136. Refer to the above data. Some of the payroll-related expenses incurred by Stone Corporation are mandated by law, rather than negotiated with employees. During the current year, these mandated amounts increased Stone's payroll-related expenses by approximately: A. $68,850.B. $200,700.C. $131,850.D. $176,850.

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137. Refer to the above data. Assume that the federal government implements an 10% payroll tax upon employers to finance health insurance for all citizens and residents. Stone will pay this tax instead of purchasing group health insurance. This will cause Stone 's total annual payroll-related expenses to: A. Decrease by $15,000.B. Increase by $15,000.C. Decrease by $32,500.D. No change, because payroll taxes are withheld from employees' pay.

On December 1, Year 1, Bradley Corporation incurs a 15-year $200,000 mortgage liability in conjunction with the acquisition of an office building. This mortgage is payable in monthly installments of $2,400, which include interest computed at the rate of 12% per year. The first monthly payment is made on December 31, Year 1.

138. Refer to the above data. Compute the total amount to be paid by Bradley over the 15-year life of the mortgage. A. $200,000.B. $562,000.C. $432,000.D. $474,000.

139. Refer to the above data. How much of the first payment made on December 31, Year 1, represents interest expense? A. $2,400.B. $ 400.C. $2,304.D. $2,000.

140. Refer to the above data. The total liability related to this mortgage reported in Bradley 's balance sheet at December 31, Year 1, is: A. $432,100.B. $199,600.C. $194,923.D. $200,000.

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141. Refer to the above data. Over the 15-year life of the mortgage, the total amount Bradley will pay for interest charges is: A. $232,000.B. $360,000.C. $200,000.D. $432,060.

142. Refer to the above data. The portion of the second monthly payment made on January 31, Year 2, which represents repayment of principle is: A. $400.B. $404.C. $2,400.D. $1,996.

143. On October 1, 2009, Master's Co. borrows $500,000 from its bank for five years at an annual interest rate of 10%. According to the terms of the loan, the principal amount will not be due for five years. Interest is to be paid monthly on the first day of each month, beginning November 1, 2009. With respect to this borrowing, Master's December 31, 2009, balance sheet included only a long-term note payable of $500,000. As a result: A. The December 31, 2009, financial statements are accurate.B. Liabilities are understated by $12,500 accrued interest payable.C. Liabilities are understated by $4,167 accrued interest payable.D. Liabilities are understated by the amount of interest for the five-year term of the note that has not yet been paid.

144. At the end of 2010 it is discovered that the accountant for Gower Company failed to record $60,000 of interest payable which had accrued since the last interest payment date. The current ratio, quick ratio and debt ratio, as well as the financial statements, had already been computed using the erroneous data. Correction of the accounting records will have which of the following effects? A. Net income as formerly computed will not be affected by the correction of the error.B. The interest coverage ratio as formerly computed will not change as a result of the correction.C. The debt ratio as formerly computed will decrease as a result of the correction.D. The quick ratio as formerly computed will decrease as a result of the correction.

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On April 1, year 1, Cricket Corporation issues $60 million of 12%, 10-year bonds payable at par. Interest on the bonds is payable semiannually each April 1 and October 1.

145. Refer to the above data. The amount of cash paid to bondholders for interest during Year 1, is: A. $6,600,000B. $5,400,000C. $3,600,000D. $1,800,000

146. Refer to the above data. Interest expense on this bond issue reported in Cricket's year 1, income statement is: A. $2,400,000B. $4,800,000C. $5,400,000D. $7,200,000

147. Refer to the above data. The adjustment necessary at December 31, Year 1 (if any), related to this bond issue involves: A. Recognition of interest expense of $3,600,000.B. Recognition of interest expense of $1,800,000.C. Payment of cash of $1,800,000.D. There is no adjustment necessary.

148. Refer to the above data. With respect to this bond issue, Cricket Corporation's balance sheet at December 31, Year 1, will include: A. Bonds payable of $61,800,000.B. Bonds payable of $63,600,000.C. Bonds payable of $60 million, as well as interest payable of $1,800,000.D. Bonds payable of $60 million, as well as interest payable of $3,600,000.

On April 1, year 1, Greenway Corporation issues $20 million of 10%, 20-year bonds payable at par. Interest on the bonds is payable semiannually each April 1 and October 1.

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149. Refer to the above data. The journal entry to record the first cash payment to bondholders on October 1, year 1, will include: A. A credit to Cash of $2,000,000.B. A debit to Bonds Payable of $1,000,000.C. A debit to Interest Expense of $1,000,000D. A credit to Interest Payable of $1,000,000.

150. Refer to the above data. The adjusting entry (if any) required on December 31, Year 1, related to this bond issue involves: A. Recognition of interest expense of $1,000,000.B. Recognition of interest expense of $500,000.C. A credit to Interest Payable of $2,000,000.D. A credit to Cash of $500,000.

151. Refer to the above data. In Year 2, Greenway's income statement will report interest expense arising from this bond issue of: A. $1,000,000.B. $2,000,000.C. $500,000.D. $1,500,000.

152. Refer to the above data. On April 1, Year 1, the journal entry to record issuance of the bonds will include: A. A credit to Interest Payable of $1,000,000.B. A debit to Cash of $20,000,000.C. A credit to Bonds Payable of $2,100,000.D. A debit to Cash of $21,000,000.

153. Refer to the above data. With respect to this bond issue, Greenway's balance sheet at December 31, Year 1, will include: A. Bonds payable of $20,500,000.B. Bonds payable of $19,500,000.C. Bonds payable of $20 million, as well as interest payable of $1,500,000.D. Bonds payable of $20 million, as well as interest payable of $500,000.

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Austin Corporation issues $6,000,000 of 10%, 10-year bonds, dated December 31, Year 1. The bonds are issued on April 30, Year 2, at 100 plus accrued interest. Interest on the bonds is payable semiannually each June 30 and December 31.

154. Refer to the above data. The total amount of cash received by Austin Corporation upon issuance of the bonds on April 30, Year 2, is: A. $6,000,000.B. $6,200,000.C. $6,150,000.D. $6,300,000.

155. Refer to the above data. The entry to record the issuance of bonds payable on April 30, Year 2, includes: A. A credit to Premium on Bonds Payable of $200,000.B. A debit to Cash of $150,000.C. A debit to Bond Interest Expense of $200,000.D. A credit to Bond Interest Payable of $200,000.

156. Refer to the above data. The journal entry made by Austin Corporation to record the first semiannual interest payment on the bonds includes: A. A debit to Bond Interest Expense of $300,000.B. A debit to Bond Interest Payable of $100,000.C. A debit to Bond Interest Expense of $100,000.D. A debit to Bond interest Expense of $200,000.

157. Refer to the above data. The amount of Austin's interest expense on this bond issue during year 2 amounts to: A. $400,000.B. $450,000.C. $360,000.D. $600,000.

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Salem Co. has outstanding $100 million of 7% bonds, due in 7 years, and callable at 104. The bonds were issued at par and are selling today at a market price of 94.

158. Refer to the above data. If Salem Co. retires $10 million of these bonds by purchasing them from bondholders at current market price, the company will report: A. A $600,000 gain.B. A $500,000 loss.C. An unrealized gain.D. None of the above; neither gains nor losses are recognized on early retirements of debt.

159. Refer to the above data. If Salem Co. calls $10 million of these bonds it will report: A. A $700,000 gain.B. A $400,000 loss.C. An unrealized gain.D. None of the above; neither gains nor losses are recognized on early retirements of debt.

160. Refer to the above data. If Salem Co. retires $10 million of these bonds by purchasing them from bondholders at current market price, the company will report: A. A $600,000 cash receipt from operating activities.B. A $9.4 million cash payment for operating activities.C. A $600,000 cash receipt from financing activities.D. A $9.4 million cash payment for financing activities.

The current balance sheet of Apex reports total assets of $20 million, total liabilities of $2 million, and owners' equity of $18 million. Apex is considering several financing possibilities in order to expand operations. Each question based on this data is independent of any others.

161. Refer to the above data. What will be the effect on Apex's debt ratio if Apex's owner invests an additional $2 million to finance its expansion? A. The debt ratio will decrease from .1 (2/20) to .0909 (2/22) after the additional investment.B. The debt ratio will decrease from 2/9 before to 2/11 after the additional investment.C. The debt ratio will increase from 20 before to 22 after the additional investment.D. Additional investment by owner will have no effect on the debt ratio.

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162. Refer to the above data. Assume Apex borrows $2 million to finance its expansion. Apex's debt ratio immediately after the borrowing will be: A. .10.B. .20.C. .33 (rounded).D. .18.

163. Refer to the above data. What is the maximum amount Apex can borrow and not exceed a debt ratio of .3? A. $4,000,000.B. $5,500,000.C. $5,000,000.D. Some other amount.

164. On February 28, 2009, $5,000,000 of 6%, 10-year bonds payable, dated December 31, 2008, are issued. Interest on the bonds is payable semiannually each June 30 and December 31. If the total amount received (including accrued interest) by the issuing corporation is $5,060,000, which of the following is correct? A. The bonds were issued at a premium.B. The amount of cash paid to bondholders on the next interest date, June 30, 2009, is $300,000.C. The amount of cash paid to bondholders on the next interest date, June 30, 2009, is $50,000.D. The bonds were issued at a discount.

Webster Company issues $1,000,000 face value, 6%, 5-year bonds payable on December 31, 2009. Interest is paid semiannually each June 30 and December 31. The bonds sell at a price of 97; Webster uses the straight-line method of amortizing bond discount or premium.

165. Refer to the information above. The entry made by Webster Company to record issuance of the bonds payable at December 31, 2009, includes: A. A debit to Cash of $1,000,000.B. A debit to Discount on Bonds Payable of $30,000.C. A credit to Bonds Payable of $970,000.D. A credit to Bond Interest Payable of $30,000.

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166. Refer to the information above. Webster 's entry at June 30, 2010, to record the first semiannual payment of interest and amortization of discount on the bonds includes a: A. Debit to Bond Interest Expense of $30,000.B. Credit to Cash of $33,000.C. Debit to Discount on Bonds Payable of $3,000.D. Debit to Bond Interest Expense of $33,000.

167. Refer to the information above. The amount of bond interest expense recognized by Webster Company in 2009 with respect to these bonds is: A. $60,000.B. $63,000.C. $120,000.D. $66,000.

168. Refer to the information above. The carrying value of this liability in Webster Company's December 31, 2010, balance sheet is: A. $1,000,000.B. $970,000.C. $976,000.D. Some other amount.

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Essay Questions

169. Accounting terminologyListed below are nine technical accounting terms introduced in this chapter:

Each of the following statements may (or may not) describe one of these technical terms. In the space provided below each statement, indicate the accounting term described, or answer "None" if the statement does not correctly describe any of the terms.(a) Operating income divided by annual interest expense(b) The amount paid during the current period to retired employees.(c) A lease agreement that is viewed as equivalent to the lessee purchasing the leased asset.(d) Using borrowed money to finance business operations.(e) The risk of a loss occurring in a future period.(f) A permanent reduction in the amount of income taxes owed which results from the tax deductions for depreciation.(g) The amount that must be paid to settle a liability at the date it becomes due.

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170. Notes payableOn September 1, 2009, Charles Associates borrowed $600,000 from Diana Credit Union and signed a 9%, one-year note payable, all due at maturity.

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171. Notes payableOn September 1, 2009, George Hanby borrowed $100,000 from The Actors Credit Union and signed an 6%, one-year note payable, all due at maturity. The interest on this loan is stated separately.

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172. Payroll-related expensesShown below is a summary of the annual payroll data of Revere Ironworks:

(d) How were the costs of postretirement benefits determined? Which of these amounts results in a liability to Revere Ironworks, and when will this liability be paid? Will the amount of the payments be more or less than the amount now shown as a liability? Explain.

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173. Fully amortizing installment note payable (mortgage)On October 31, 2009, Seldon Company incurs a 30-year $600,000 mortgage liability in conjunction with the purchase of a motel. This mortgage is payable in equal monthly installments of $6,485, which include interest computed at an annual rate of 12%. The first monthly payment is made on November 30, 2009. This mortgage is fully amortizing over 360 months.Complete the amortization table for the first two payments by entering the correct dollar amounts in the blank spaces provided. In addition, answer the questions which follow.

(a) With respect to this mortgage, Seldon's 2009 income statement includes interest expense of $_______________, and Seldon's balance sheet at December 31, 2009, includes a total liability for this mortgage of _______________. (Do not separate into current and long-term portions.)(b) The aggregate monthly cash payments Seldon will make over the 30-year life of the mortgage amount to $_______________.(c) Over the 30-year life of the mortgage, the amount Seldon will pay for interest amounts to $_______________.

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174. Fully amortizing installment note payableOn October 31, 2009 Ronald signed a 2-year installment note in the amount of $50,000 in conjunction with the purchase of equipment. This note is payable in equal monthly installments of $2,354, which include interest computed at an annual rate of 12%. The first monthly payment is made on November 30, 2009. This note is fully amortizing over 24 months.Complete the amortization table for the first two payments by entering the correct dollar amounts in the blank spaces provided. In addition, answer the questions that follow.

(a) With respect to this note, Ronald's 2009 income statement includes interest expense of $_______________, and Ronald's balance sheet at December 31, 2009, includes a total liability for this note payable of _______________. (Do not separate into current and long-term portions.)(b) The aggregate monthly cash payments Ronald will make over the 2-year life of the note payable amount to $_______________.(c) Over the 2-year life of the note, the amount Ronald will pay for interest amounts to $_______________.

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175. Bonds issued at par - basic conceptsOn April 1, Year 1, Olsen Products, Inc. issued at par $25 million of 10%, 10-year bonds payable. Interest is payable semiannually each April 1 and October 1.(a) What is the amount of cash paid to bondholders for interest during year 1?$_______________(b) Give the adjusting entry necessary at December 31, Year 1 (if any), regarding thisbond issue.(c) Interest expense on this bond issue reported in Olsen Products' Year 1 income statement is:$_______________(d) With respect to this bond issue, Olsen Products' balance sheet at December 31, Year 1, includes bonds payable of $__________________ and interest payable of $_______________ (indicate $0 or "none" if the item is not reported.(e) Give the journal entry made by Olsen Products on April 1, Year 2, to record the semiannual payment of interest to bondholders.

176. Bonds issued at par - basic conceptsOn March 1, Year 1, Hubbard Co. issued at a price of 100 $20 million of 8%, 25-year bonds payable. Interest is payable semiannually each March 1 and September 1.(a) What is the amount of cash paid to bondholders for interest during year 1?$_____________(b) Give the adjusting entry necessary at December 31, year 1 (if any), regarding this bond issue.(c) Interest expense on this bond issue reported in Hubbard's Year 1 income statement is:$_______________(d) With respect to this bond issue, Hubbard 's balance sheet at December 31, Year 1, includes bonds payable of $_______________ and interest payable of $_______________. (indicate $0 or "none" if the item is not reported.)(e) Give the journal entry made by Hubbard on March 1, Year 2, to record the semiannual payment of interest to bondholders.

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177. Bonds payable-issued between interest dates Barney Corporation received authorization on December 31, Year 1, to issue $2,500,000 of 6%, 10-year bonds. The interest payment dates are June 30 and December 31. All the bonds were issued at a price of 100, plus accrued interest, on February 28, Year 2, two months after the authorization of the bond issue.

(d) Prepare the journal entry at February 28, Year 2, to record the issuance of the bonds.(e) Prepare the journal entry at June 30, Year 2 to record the first semiannual interest payment on the bonds.

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178. Bonds payable issued between interest dates - early retirementDeegan Imports received authorization on December 31, Year 1, to issue $4,500,000 face value of 8%, 20-year bonds. The interest payment dates are June 30 and December 31. All the bonds were issued at par, plus accrued interest on February 1, Year 2. The bonds are callable by Deegan at any time at 105.(a) Prepare the journal entry to record the issuance of the bonds on February 1, Year 2.(b) Prepare the journal to record the first interest payment on the bonds at June 30, Year 2(c) What is the amount of bond interest expense reported in Deegan Imports' Year 2 income statement relating to these bonds? $___________(d) What is the amount of bond interest payable appearing in Deegan Imports' balance sheet at December 31, Year 2, with respect to these bonds? $____________(e) Deegan exercises the call provision and retires one-third of the bond issue on July 1, Year 3.Prepare the journal entry to record this transaction on July 1, Year 3.

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179. Effects of transactions upon financial measurementsFive events relating to liabilities are described below:(a) Recorded a bi-weekly payroll, including the issuance of paychecks to employees. Amounts withheld from employees' pay and payroll taxes will be forwarded to appropriate agencies in the near future. (Ignore postretirement costs.)(b) Made a monthly payment on a 12-month installment note payable, including interest and a partial repayment of the principal amount.(c) Shortly before the maturity date of a six-month bank loan, made arrangements with the bank to refinance the loan on a long-term basis.(d) Made an adjusting entry to record accrued interest payable on a 2-year bank loan (interest is paid monthly.)(e) Made a year-end adjusting entry to amortize a portion of the discount on long-term bonds payable.Indicate the immediate effects of each transaction or adjusting entry upon the financial measurements in the five column headings listed below. Use the code letters, I for increase, D for decrease, and NE for no effect.

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180. Bonds issued at discount or premiumOn March 31, 2009 Louis Company issued $20,000,000 face amount of 7%, 5-year bonds payable, with interest payable each June 30 and December 31. The company received cash of $20,200,000, including the accrued interest from December 31, 2008. Louis uses the straight-line method of amortizing any discount or premium over the remaining life of the bonds - 57 months.(a) What was the amount of accrued interest received by Louis on March 31, 2009 when the bonds were issued? (Do not assume the bonds were issued at par.)$_______________(b) What was the amount of discount or premium on the bonds at issuance date?(Indicate discount or premium.)$_______________(c) What amount of cash is paid to bondholders for interest during year 2009?$_______________(d) What is Louis ' total interest expense for year 2009 related to this bond issue?$_______________(e) What is the carrying value of this bond issue as of December 31, year 2009?$_______________

181. Fully amortizing installment notes When Sue Meadow purchased a home, she signed a $150,000, 12%, fully amortizing mortgage note, payable at $1,543 per month. After making the first monthly payment, Meadow received a notice from the bank stating that $1,500 of the payment had applied to interest, and only $43 reduced the principal amount of the loan. Meadow does not understand how this loan is fully amortizing over a period of 30 years. She computes that at $43 per month, it will take approximately 3,488 months (or 290 years) to repay this loan. Evaluate Meadow's analysis.

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182. Bond prices after issuanceSeveral years ago, Clear-Air Systems issued $100 million of 30-year, 8% bonds payable at a small premium. Since the bonds were issued, Clear-Air's financial strength and credit rating have actually improved, but today the bonds are trading among investors at a price of 98.(a) Explain the most probable reason why the market price of these bonds has declined, even though Clear-Air‘s credit rating has improved.(b) How will the drop in the market value of these bonds be reported (if at all) in Clear-Air's income statements and balance sheets? Explain.

183. Operating and capital leasesBerkeley Corporation wants to expand operations and is considering various leasing arrangements for additional equipment. Berkeley's management has heard the terms capital lease and operating lease mentioned by the accounting department and wants clarification of these terms before signing any lease contracts.(a) Briefly explain the difference between a capital lease and an operating lease from a lessee's (Berkeley's) point of view. Your answer should include the financial statement impact of each type of lease.(b) How does a lessee determine whether a specific lease contract is an operating lease or a capital lease? Include at least two of the criteria specified by the FASB in your answer.(c) Which of the above two types of leases is sometimes referred to as "off-balance-sheet financing?" Briefly explain.

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184. Deferred income taxes At the end of its first year of operations, Harding Construction, Inc., included in its balance sheet a long-term liability entitled "Deferred Income Taxes."(a) Briefly explain what deferred income taxes represents, including how this liability came into existence and whether such an item is generally perceived as favorable or unfavorable from company management's point of view.(b) If Harding Construction, Inc., is a successful, growing business, would you expect the liability for deferred income taxes to increase or decrease over the next few years? Explain.

185. Loss contingenciesOcean to Coast Airlines could, at any time, incur a large loss if one of its airplanes were to crash. Is this an example of a loss contingency which should be disclosed in the company's financial statements? Explain.

186. On March 1, 2009, five-year bonds are sold for $508,026 that have a face value of $500,000 and an interest rate of 10%. Interest is paid semi-annually on March 1 and September 1. Using the straight-line amortization method, prepare the borrower's journal entries onMarch 1, 2009September 1, 2009December 31, 2009March 1, 2010

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187. The LBB Company recently took a mortgage on a property for $100,000. The interest is 12% and the monthly payment is $1,020. Prepare the first four months of the amortization table beginning on January 1, 2009.

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Chapter 10 Liabilities Answer Key

True / False Questions

1. A liability that is known to exist but the precise dollar amount is not known is called a possible liability FALSE

AACSB: Reflective ThinkingAICPA BB: Critical ThinkingAICPA FN: MeasurementLearning Objective: 1

2. Bonds secured by a pledge of specific assets are called debenture bonds. FALSE


3. Junk bonds are attractive to investors because they carry a high rate of interest and are usually convertible into a specified number of shares of capital stock. FALSE


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4. Dividends paid by a corporation to its stockholders are tax deductible by the corporation but interest paid on bonds is not. FALSE


5. When bonds are sold by one investor to another, they sell at market price plus accrued interest since the last payment date. TRUE


6. When bonds are issued at a discount, the borrower must pay more at maturity than the amount originally received. TRUE


7. The account Discount on Bonds Payable actually represents interest expense and will be amortized over the life of the bond. TRUE


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8. A loss contingency is recorded in the accounting records when it is probable that a loss has been incurred and the amount of the loss is known. FALSE


9. A commitment, such as a contract to pay a baseball player $5,000,000 a year for five years, should be listed as a long-term liability. FALSE


10. If a lease transfers ownership of the property to the lessee at the end of the lease term, it should be regarded as an operating lease. FALSE


11. When a company has a fully funded pension plan, they only need to record the present value of pension payments as a current liability. FALSE


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12. Gross pay less withholding tax and less worker's compensation is considered net pay. FALSE


13. Estimated liabilities, contingencies and commitments are usually reported in the long-term liability section of the financial statements. FALSE


14. The amount of FICA tax and Medicare tax withheld from an employee is used to pay the employer's percentage of the tax and is mailed to the government quarterly. FALSE


15. When a company sells bonds, the bondholders are permitted to vote for the board of directors. FALSE


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16. The combination of liabilities and owners' equity used in financing the assets of a business is called the company's capital structure. TRUE


17. Prepayments and owners' equity are both sources of financing. FALSE


18. The current portion of long-term debt should be reported separately in the current liabilities section of the balance sheet. TRUE


19. When money is borrowed by issuing a note payable, the borrower records a liability equal to the maturity value of the note. FALSE


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20. The most common types of payroll deductions are taxes, insurance premiums, employee savings, and union dues. TRUE


21. Social security and Medicare taxes have a cap on employees' salaries where the tax is ended. FALSE


22. If a long-term debt is to be paid off in monthly installments over a 5-year period, the entire principal should be classified as a long-term debt. FALSE


23. There is a tax advantage for a company to issue bonds in lieu of stocks. TRUE

AACSB: Reflective ThinkingAICPA BB: Resource ManagementAICPA FN: Decision MakingLearning Objective: 5

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24. The withholding of taxes from an employee's pay is a liability to the company. TRUE


25. Bonds payable are a means of dividing a very large, long-term liability among many creditors some of whom may participate in the loan only for a short period of time. TRUE

AACSB: Reflective ThinkingAICPA BB: Resource ManagementAICPA FN: Decision MakingLearning Objective: 5

26. Liabilities that fall due within one year or within the operating cycle are classified as current liabilities. TRUE


27. In the marketplace, bond prices tend to fluctuate directly with changes in interest rates. FALSE

AACSB: Reflective ThinkingAICPA BB: IndustryAICPA FN: MeasurementLearning Objective: 5

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28. Convertible bonds can be exchanged for common stock at the option of the company. FALSE


29. In a long-term capital lease, the lessor views a portion of each lease payment as interest expense. FALSE


30. Payments of pensions and other benefits to retired workers are recognized as expense in the period payment is made. FALSE


31. Sinking funds make a bond issue less attractive to the investor. FALSE


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32. Deferred income taxes eventually come due. TRUE


33. If a bond is callable, the call price is usually lower than the face value of the bond. FALSE

AACSB: Reflective ThinkingAICPA BB: Resource ManagementAICPA FN: MeasurementLearning Objective: 5

34. The quick ratio is a more stringent measure of solvency than the current ratio. TRUE


35. A high interest coverage ratio is a sign of creditworthiness. TRUE


36. Loss contingencies stem from past events. TRUE


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37. Bonds, with the same face value, issued at a premium will have a higher maturity value than bonds issued at a discount FALSE


38. Loss contingencies should be recorded in the accounting records whenever it is probable that a loss has been incurred and the amount of loss might be material in amount. FALSE


39. The account Discount on Bonds Payable has a debit balance and should appear on the balance sheet as an asset; the account Premium on Bonds Payable has a credit balance and should be classified as a liability. FALSE


40. The future value will always be less than the present value. FALSE


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41. The amortization of discount on bonds payable reduces the amount of interest expense recognized during the period. FALSE


42. The amortization of bond discount by the issuing company decreases the carrying value of its bonds payable. FALSE


43. A primary means used by credit rating agencies to evaluate a company's ability to pay its debts is to compare total assets to total liabilities. TRUE


44. Companies may understate liabilities so as not to be perceived as risky by credit rating agencies. TRUE

AACSB: Reflective ThinkingAICPA BB: Resource ManagementAICPA FN: Risk AnalysisLearning Objective: 9

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45. Special purpose entities (SPEs) are established by corporations to accomplish specific purposes such as borrowing money. TRUE


Multiple Choice Questions

46. U. S. GAAP requires that convertible bonds be classified on the balance sheet as: A. Part liability, part equityB. A liabilityC. Either a liability or equityD. As an asset

AACSB: Reflective ThinkingAICPA BB: Critical ThinkingAICPA FN: ReportingLearning Objective: 5Learning Objective: 8

47. International accounting standards require that convertible bonds be classified on the balance sheet as: A. Part liability, part equityB. A liabilityC. Either a liability or equityD. As an asset

AACSB: Reflective ThinkingAICPA BB: GlobalAICPA FN: MeasurementLearning Objective: 5Learning Objective: 8

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48. Off balance sheet financing may involve either: A. An operating leaseB. A special purpose entityC. Both of the aboveD. Neither of the above


49. Employers are required to pay all of the following on the wages paid to each employee except: A. Social security taxesB. Worker's compensation insuranceC. Medicare taxesD. Health insurance benefits.


50. In preparing an amortization table, it is necessary to include: A. The original amount of the liability, the amount of periodic payments and the interest rate.B. The original amount of the liability, the amount of periodic payments and the amount of past payments.C. The monthly payment, the total amount of past payments and the original amount of the liability.D. The total amount of past payments, the interest rate and the amount of periodic payments.


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51. A company issues $50 million of bonds at par on January 1, 2009. The bonds pay 10% interest semi-annually on 12/31 and 6/30 and mature in 20 years. The journal entry when the bonds are sold is:A)

B)

C)

D)

A. Option AB. Option BC. Option CD. Option D

AACSB: AnalyticAICPA BB: Critical ThinkingAICPA FN: MeasurementLearning Objective: 5

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52. The amount of the present value of a future cash receipt will depend upon A. The length of time until the money is received.B. The amount of money to be received.C. The required rate of return.D. All of the above.


53. The FICA tax paid by an employer is: A. Greater than the amount paid by the employee.B. Less than the amount paid by the employee.C. Equal to the amount paid by the employee.D. The employer does not pay FICA tax, only the employee pays the tax.


54. When a company sells bonds between interest dates they will pay which of the following at the first interest payment date? A. An amount less than the stated interest rate times the principal.B. An amount more than the stated interest rate times the principal.C. An amount equal to the stated interest rate times the principal.D. The company may skip the first interest payment date since the appropriate time has not passed.


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55. A $1,000 bond that sells for 104 has a selling price of: A. $1,004B. $1,040C. $1,400D. $1,000


56. Which of the following is not an accurate statement regarding the distinction between debt and equity? A. Only equity is considered a source of financing for operations of the business, since debt must be repaid at a specified maturity date.B. If a business ceases operations and liquidates, claims of all creditors have legal priority over claims of the stockholders.C. Most debt requires the borrower to pay interest; equity financing does not obligate the company to make a specified payment.D. The providers of equity are owners of the business; the providers of borrowed funds are creditors.


57. Which of the following is not a characteristic of current liabilities? A. They are due within one year or within the operating cycle, whichever is longer.B. They may involve estimated amounts.C. They may be replaced with a new short-term liability rather than being paid in cash.D. All three of the above are characteristic of current liabilities.


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58. If a bond is selling at 103, it is selling at: A. Maturity value and yields a 2% interest rate.B. A discount.C. A premium.D. $103 per bond.


59. Which of the following payroll costs are shared equally by the employer and the employee? A. State unemployment taxes.B. Workers' compensation.C. Social security.D. Federal unemployment taxes.


60. Interest payable on a loan becomes a liability: A. When the note payable is issued.B. As it accrues.C. At the maturity date.D. When the borrowed money is received.


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61. An employer's total payroll-related costs always exceed the wages and salaries earned by employees by: A. Amounts withheld from employees' pay.B. Payroll taxes and mandated programs such as workers' compensation insurance.C. 50%.D. None of the above. Employers' payroll-related costs actually are less than the gross wages and salaries earned by employees, because of amounts withheld from employees' checks.


62. Bonds, with the same face value, issued at a premium will: A. Have a greater maturity value than a bond issued at a discount.B. Have a lesser maturity value than a bond issued at a discount.C. Have the same maturity value as a bond issued at a discount.D. Have a different maturity value than a bond issued at a discount, depending upon the interest rate and maturity date.


63. The amounts that a business withholds as taxes from an employee's earnings: A. Represent payroll taxes expense to the employer.B. Are deposited in an interest-bearing account until the employee is terminated.C. Represent miscellaneous revenue to the employer.D. Represent current liabilities to the employer.


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64. Unearned revenue: A. Appears on the income statement as income.B. Appears on the income statement as a reduction to income.C. Appears on the income statement as a liability.D. Appears on the balance sheet as a liability.


The average employee of Girard Corporation earns gross pay of $75,000 per year. The following table shows the relative size of various payroll amounts by expressing each as a percentage of total wages and salaries expense (gross pay):

In addition, Girard pays $425 per month per employee for group health insurance.

65. Refer to the above data. Which of the following is the largest payroll-related expense incurred by Girard? A. Group health insurance premiums.B. Income taxes expense.C. The employer's share of social security taxes.D. Wages and salaries expense.


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66. Refer to the above data. Which of the following represents the second largest payroll related expense incurred by Girard? A. Group health insurance premiums.B. Income taxes expense.C. The employer's share of social security taxes and Medicare taxes.D. Wages and salaries expense.


67. Refer to the above data. Which of the following represents the largest amount withheld from employees' paychecks? A. Workers' compensation insurance.B. Social Security and Medicare.C. Personal income taxes.D. Group health insurance.


68. When a corporation has a right to redeem bonds in advance of the maturity date, the bond is considered a: A. Convertible bond.B. Callable bond.C. Junk bond.D. Debenture bond.


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69. Sinking funds usually appear on the balance sheet as: A. Current asset.B. Long-term investment.C. Current liability.D. Appropriation of retained earnings.

AACSB: Reflective ThinkingAICPA BB: Critical ThinkingAICPA FN: MeasurementLearning Objective: 5Learning Objective: 8

70. A bond that is not secured is also known as: A. A sinking fund.B. A mortgage.C. A debenture.D. A junk bond.


71. Management has both the intent and the ability to refinance a liability maturing in four months by taking out a new loan at the due date which would not be due for several years. How would this situation be reported in financial statements prepared as of today's date? A. The original liability is classified as current, with a footnote describing management's plan for refinancing.B. The original liability is classified as current and the new loan is reported as a long-term liability.C. The original liability is classified as long-term; the new loan is not included in liabilities at this date.D. The original liability need not be reported at all; only the new loan is reported as a long-term liability.


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72. Temple Corporation purchased a piece of real estate, paying $400,000 cash and financing $700,000 of the purchase price with a 10-year, 15% installment note. The note calls for equal monthly payments that will result in the debt being completely repaid by the end of the tenth year. In this situation: A. The aggregate amount of the monthly payments is $700,000.B. Each monthly payment is greater than the amount of interest accruing each month.C. The portion of each payment representing interest expense will increase over the 10-year period, since principal is being paid off, yet the payment amount does not decrease.D. The portion of each monthly payment representing repayment of principal remains the same throughout the 10-year period.

AACSB: AnalyticAICPA BB: Critical ThinkingAICPA FN: MeasurementLearning Objective: 2Learning Objective: 4

73. When an installment note is structured as a "fully amortizing" loan with equal monthly payments (such as a traditional mortgage): A. The portion of each payment allocated to interest expense is the same each month.B. The sum of the monthly payments is equal to the amount of the installment note (mortgage).C. The difference between the sum of all monthly payments and the principal amount of the note constitutes interest.D. The portion of each payment allocated to repayment of principal decreases each month as the mortgage is paid off.


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74. In relation to a bond issue, the role of the underwriter is to: A. Guarantee payment to bondholders of both the periodic interest payments and the maturity value.B. Purchase the entire bond issue from the issuing corporation and then sell the bonds to the public.C. Represent the interests of the bondholders and, if necessary, to take legal action on their behalf.D. Maintain a subsidiary ledger of individual bondholders and mail out the periodic interest checks.

AACSB: Reflective ThinkingAICPA BB: IndustryAICPA FN: Decision MakingLearning Objective: 5

75. If a bond is issued at par and between interest dates: A. The cash received by the corporation will be less than the face value of the bond.B. The cash received by the corporation will be greater than the face value of the bond.C. The cash received by the corporation will be the same as the face value of the bond.D. Interest receivable will be debited.


76. The term "junk bonds" describes bonds with: A. Low interest rates.B. Indefinite maturity dates.C. Low maturity values.D. High risk.


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77. One advantage of issuing bonds instead of stock is that: A. Interest is tax deductible whereas dividends are not.B. Bonds have a longer maturity date.C. Interest rates are lower than dividend rates.D. The issuance of bonds does not affect earnings per share.

AACSB: AnalyticAICPA BB: Resource ManagementAICPA FN: MeasurementLearning Objective: 2

78. Choose the statement that correctly summarizes the tax advantage of raising money by issuing bonds instead of common stock: A. The amount paid by the corporation to redeem bonds at maturity date is deductible in computing income subject to corporate income tax.B. Interest payments are deductible in determining income subject to corporate income tax; dividends are not deductible.C. A corporation must pay tax on the sales price of stock issued, but is not taxed on the amount received when bonds are issued.D. Both interest and dividends paid are deductible in computing taxable income, but since interest must be paid annually, the corporation usually gets a larger tax deduction over the life of the bonds payable.


79. Elm Corporation plans to invest $300 million to earn about 15% before income taxes. The company is considering whether it should raise the $300 million by issuing 10% bonds payable or capital stock. If the company issues the bonds, it will probably report: A. Lower net income and lower income taxes expense than if it issues capital stock.B. Higher net income and higher income taxes expense than if it issues capital stock.C. Lower net income and higher income taxes expense than if it issues capital stock.D. Higher net income and lower income taxes expense than if it issues capital stock.


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80. The current portion of long-term debt should be reported: A. Separately in the long-term liabilities section of the balance sheet.B. In the long-term liabilities section of the balance sheet, along with the other long-term debt.C. In the current liabilities section of the balance sheet.D. In a separate section of the balance sheet, between long-term liabilities and shareholders' equity.


81. An operating lease: A. Creates an asset and a liability on the balance sheet.B. Is a form of off-balance sheet financing.C. Is always preferable to a capital lease.D. Transfers title to the asset being leased.


82. Suppose investors decided to sell their holdings of capital stock in order to purchase outstanding bonds payable and as a result, the prices of bonds payable increased. What would be the likely impact on market interest rates? A. Market interest rates will be unaffected.B. Market interest rates will increase.C. Market interest rates will fall.D. Although interest rates will change, it is impossible to predict the direction of change.


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83. Which one of the following is not considered a criteria to capitalize a lease? A. The lease contains a bargain purchase option.B. The lease transfers ownership at the end of the lease term.C. The lease term is more than 75% of economic life of the property.D. The present value of minimum lease payments is less than 90% of the fair market value of the asset.


84. Which of the following payroll taxes do not stop once an employee reaches a certain level of income: A. Medicare taxes.B. Social security taxes.C. Unemployment taxes.D. All three of the above have a cap on salaries where the tax ends.


85. The price at which a bond sells is equal to the: A. Maturity value of the bonds plus the present value to investors of the future interest payments.B. Sum of the future interest payments, minus the maturity value of the bonds.C. Present value to investors of the future principal and interest payments.D. Sum of the future interest payments, plus the maturity value of the bonds.


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86. After bonds have been issued, their market value can be expected to: A. Rise as any premium is amortizedB. Fall if interest rates rise.C. Fall as any discount is amortized.D. Rise if interest rates rise.


87. The amortization of a bond discount: A. Decreases the carrying value of a bond and increases interest expense.B. Decreases the carrying value of a bond and decreases interest expense.C. Increases the carrying value of a bond and increases interest expense.D. Increases the carrying value of a bond and decreases interest expense.


88. Which of the following does not affect the market price of an outstanding bond issue? A. Fluctuations in the current market rate of interest.B. The credit rating of the issuing corporation.C. The price at which the bonds were originally issued.D. The length of time remaining until the bonds' maturity date.


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89. Each of the following must be disclosed in the financial statements, except: A. The total amounts of long-term debt maturing in each of the next five years.B. The company's debt ratio and interest coverage ratio for the current year.C. Loss contingencies, when a reasonable possibility exists that a material loss has been incurred.D. The fair value of long-term liabilities when this value is significantly different from the amount shown in the balance sheet.

AACSB: Reflective ThinkingAICPA BB: Critical ThinkingAICPA FN: ReportingLearning Objective: 8

90. A capital lease is recorded in the accounting records of the lessee by an entry: A. Debiting Rent Expense and crediting Cash each time a lease payment is made.B. Debiting Cash and crediting Rental Revenue each time a lease payment is received.C. Debiting an asset account and crediting a liability account for the present value of the future lease payments.D. Debiting an asset account and crediting Sales for the present value of the future lease payments.


91. Which of the following are factors in determining pension expense? A. Average age, retirement age, and life expectancy of employees.B. Employee turnover rate.C. Expected rate of return to be earned by the pension fund.D. All three of the above.


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92. The pension expense of the current period is equal to: A. Amounts paid to retired workers during the current period.B. The estimated future pension benefits earned by today's workers during the current period.C. The present value of the estimated future pension benefits earned by today's workers during the current period.D. Cash payments made during the period to the trustee of the pension plan.


93. A company with a fully funded pension plan: A. Recognizes no pension expense.B. Reports no long-term liability for future pension payments.C. Does not utilize the services of a trustee to operate the pension plan.D. Recognizes pension expense equal to the cash payments made to retirees during the current period.


94. The amortization of a bond premium: A. Decreases the carrying value of a bond and increases interest expense.B. Decreases the carrying value of a bond and decreases interest expense.C. Increases the carrying value of a bond and increases interest expense.D. Increases the carrying value of a bond and decreases interest expense.


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95. In estimating annual pension expense, which of the following factors would not be taken into consideration? A. Current financial condition of the company.B. Expected rate of return to be earned on pension fund assets.C. Employee turnover rates.D. Compensation levels and estimated rate of pay increases.


96. Is the present value of an amount A. Always greater than the future value.B. Always less than the future value.C. Always equal to the future value.D. Greater than, less than, or equal to the future value depending upon interest rates and the time period involved.


97. Pension expense is: A. The present value of the estimated future pension benefits earned by employees as a result of their services during the period.B. The amount funded to the pension in a given year.C. The future value of rights granted to employees as a result of their services during the period.D. The amount withdrawn from the pension fund to pay retirees during the period.


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98. Which of the following is not true about postretirement benefits? A. Postretirement costs should be recognized as expense as the workers earn the right to receive the benefits.B. Most corporations have fully funded their postretirement benefits.C. Unfunded postretirement costs are a non-cash expense.D. A corporation's liability for postretirement benefits is equal to the present value of estimated future payments.


99. A liability for deferred income taxes represents: A. Income taxes on earnings already reported in the income statement, but that will be taxed in future periods.B. Income taxes already paid on earnings which have not yet been reported in the company's income statement.C. Income tax obligations being disputed with the Internal Revenue Service.D. Income taxes levied in prior years which are now past due.


100. In a statement of cash flows, most interest payments are classified as: A. Operating activities.B. Non-operating activities.C. Financing activities.D. Current liabilities.


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101. Using different accounting methods on financial statements and tax returns will create: A. No effect upon the balance sheet, only the income statement.B. No effect upon the balance sheet nor the income statement.C. A deferred tax liability.D. An illegal situation.


102. The interest coverage ratio is computed by dividing: A. Net income by interest expense.B. Operating income by interest expense.C. Interest expense by net income.D. Interest expense by operating income.


103. Does a call provision on a bond A. Permit the corporation to redeem the bonds at a specified price.B. Allow the corporation to revise the stated interest rate.C. Allow the corporation to revise the maturity date.D. Always create the lowest price at which the bond will sell for.


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104. Which of the following statistics is of more significance to a long-term creditor than to a short-term creditor? A. Interest coverage ratio.B. Receivables turnover rate.C. Working capital.D. Quick ratio.


105. The interest coverage ratio: A. Is computed by dividing total liabilities by annual interest expense.B. Is computed by dividing liquid assets by annual required interest payment.C. Indicates the percentage of total assets that are financed with borrowed money.D. Measures the number of times the annual interest expense could be covered by annual income from operations.


106. Workers' compensation is: A. A required minimum compensation level.B. The rules for paying overtime.C. A state mandated insurance program.D. Includes all three above.


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107. The basic measure of the amount of leverage being applied within the capital structure of an organization is the: A. Interest coverage ratio.B. Debt ratio.C. Return on assets.D. Return on equity.


108. The principal amount of a bond is: A. The total future interest charges.B. The unpaid balance exclusive of any interest charges.C. The unpaid balance plus any future interest charges.D. The maturity value less any currently unpaid balances.


109. Which of the following is not a characteristic of an estimated liability? A. The liability is known to exist.B. The precise dollar amount cannot be determined until a later date.C. The liability should not be recorded in the accounting records until future events have determined the exact amount.D. The liability stems from past transactions.


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110. Commitments, such as contracts for future transactions: A. Are classified as liabilities.B. Are classified as assets.C. Are footnoted in financial statements, if material.D. Are only disclosed if negative due to the principle of conservatism.


111. Which of the following is an example of a contingent liability? A. A lawsuit pending against a restaurant chain for improper storage of perishable food items.B. The liability for future warranty repairs on computers sold during the current period.C. A corporation's long-term employment contract with its chief executive officer.D. A liability for notes payable with interest included in the face amount.


112. Which of the following ratios and rates that measure debt-paying ability focuses on the long-term position of a company? A. Quick ratio.B. Inventory turnover.C. Current ratio.D. Debt ratio.


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113. Which of the following is an example of a loss contingency that should be disclosed in a footnote to a company's financial statements? A. The president of the company has threatened to resign if the board of directors does not vote to increase executive salaries.B. A lawsuit has been brought against the company, but the company hopes to prevail in the suit and thereby avoid any liability.C. The allowance for uncollectible accounts receivable is estimated at $200,000.D. The company owns special-purpose machinery which, if sold, would probably bring a price less than its current book value.


114. Ultimate Company is a defendant in a lawsuit alleging damages of $3 billion. The litigation is expected to continue for several years, and no reasonable estimate can be made at this time of Ultimate Company's ultimate financial responsibility. This situation is an example of: A. Off-balance-sheet financing.B. A loss contingency which should be disclosed in notes to Ultimate Company's financial statements.C. An estimated liability which must appear in Ultimate Company's balance sheet.D. A loss in purchasing power caused by inflation.


115. The Music House issues a contract to a new recording artist to produce a number of albums over the next five years at $1 million per album. This situation is an example of: A. A contingent liability which should be recorded in the accounting records.B. A contingent liability requiring footnote disclosure.C. An estimated liability, since the number of albums to be produced is not yet determined.D. A commitment which, if material, may be disclosed in a footnote.


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116. A discount on bonds payable is best described as: A. An element of future interest expense.B. A bonus paid by the bondholders to the issuing corporation because of the unusually high interest rate stated in the bonds.C. The present value of the future interest payments of bond interest and principal.D. An amount below par which the bondholders may be called upon to make good.


117. Deferred taxes are classified as: A. Only a liability.B. Only an asset.C. Either an asset or liability, depending upon the situation.D. A non-operating expense.


118. Amortizing a discount on bonds payable: A. Increases interest expense.B. Increases periodic cash payments to bondholders.C. Decreases interest expense.D. Decreases periodic cash payments to bondholders.


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119. Premium on bonds payable: A. Is an asset account.B. Increases the carrying value of the liability.C. Is a contra-asset account.D. Is disclosed by a footnote.


120. Amortizing a premium on bonds payable: A. Increases interest expense.B. Increases periodic cash payments to bondholders.C. Decreases interest expense.D. Decreases periodic cash payments to bondholders.


121. On November 1, Metro Corporation borrowed $55,000 from a bank and signed a 12%, 90-day note payable in the amount of $55,000. The November 30 adjusting entry will be: (assume 360 days in year) A. Debit Interest Expense $550 and credit Notes Payable $550.B. Debit Interest Expense $550 and credit Interest Payable $550.C. Debit Discount on Notes Payable $1,100 and credit Interest Payable $1,100.D. Debit Interest Expense $550 and credit Cash $550.

$55,000 12% 30/360 = $550


On November 1, Year 1, Noble Co. borrowed $80,000 from South Bank and signed a 12%, six-month note payable, all due at maturity. The interest on this loan is stated separately.

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122. Refer to the above data. How much must Noble pay South Bank on May 1, Year 2, when the note matures? A. $80,000.B. $89,600.C. $84,800.D. $82,400.

$80,000 12% 6/12 = $4,800 + $80,000 = $84,800


123. Refer to the above data. How much interest expense will Noble recognize on this note in Year 2? A. $9,600.B. $4,800.C. $2,400.D. $3,200.

$80,000 12% 4/12 = $3,200


124. Refer to the above data. At December 31, Year 1, Noble Co.'s overall liability for this loan amounts to: A. $80,000.B. $81,600.C. $83,200.D. $84,800.

$80,000 + ($80,000 12% 2/12) = $81,600


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125. Refer to the above data. At December 31, Year 1, the adjusting entry with respect to this note includes a: A. Credit to Interest Payable for $1,600.B. Credit to Notes Payable for $1,600.C. Debit to Interest Expense for $3,200.D. Credit to Cash for $3,200.


On September 1, 2009, Able Company purchased a building from Regal Corporation by paying $200,000 cash and issuing a one-year note payable for the balance of the purchase price. Interest on the note is stated at an annual rate of 9% and is paid at maturity. In its December 31, 2009, balance sheet, Able correctly presented the note and interest payable as follows:

126. Refer to the above data. How much must Able pay Regal Corporation on September 1, 2010, when the note matures? A. $600,000.B. $618,000.C. $654,000.D. Some other amount.

$600,000 + ($600,000 .09) = $654,000


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127. Refer to the above data. What is the amount of the interest expense Able will recognize on this note in 2010? A. $18,000.B. $31,500.C. $36,000.D. Some other amount.

$600,000 .09 8/12 = $36,000


128. Refer to the above data. What is the total cash (including interest) paid for the building purchased by Able? A. $800,000.B. $836,000.C. $854,000.D. $816,000.

$200,000 + $600,000 + $54,000 = $854,000


129. Refer to the above data. The adjusting entry at December 31, 2009, with respect to this note included: A. A debit to Interest Expense for $18,000.B. A credit to Cash for $18,000.C. A credit to Notes Payable for $18,000.D. A credit to Interest Expense for $18,000.


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On September 1, 2009, Select Company borrowed $600,000 from a bank and signed a 12%, six-month note payable, with interest on the note due at maturity.

130. Refer to the above data. The total amount of the current liability (including interest payable) for this loan that appears in Select Company's balance sheet at December 31, 2009, is: A. $600,000.B. $624,000.C. $636,000.D. $672,000.

$600,000 + ($600,000 12% 4/12) = $624,000


131. Refer to the above data. Assume Select made no adjusting entry with respect to this note before preparing the financial statements at December 31, 2009. What is the effect of this error on the financial statements for 2009? A. Total liabilities are overstated.B. Net income is overstated.C. Owners' equity is understated.D. Interest Payable is overstated.


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132. Sanford Corporation borrowed $90,000 by issuing a 12%, six-month note payable, all due at the maturity date. After one month, the company's total liability for this loan amounts to: A. $90,000.B. $90,450.C. $90,900.D. $91,800.

$90,000 + ($90,000 12% 1/12) = $90,900


133. On November 1 of the current year, Garcia Company borrowed $50,000 by issuing a 9%, six-month note payable, all due at maturity date. Interest expense on this note to be recognized during the current year amounts to: A. $500.B. $750.C. $1,500.D. $4,500.

$50,000 .09 2/12 = $750


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Stone Corporation has 25 employees and incurs total wages and salaries expense of $900,000 per year. The following table shows various payroll amounts as a percentage of this annual wage and salaries expense:

In addition, Stone provides group health insurance for its entire workforce. The cost of this insurance is $350 per month for each employee.

134. Refer to the above data. The company's annual payroll-related expenses amount to approximately: A. $1,085,600.B. $1,181,850.C. $1,250,700.D. Some other amount.

$900,000 + (.05 $900,000) + (.0765 $900,000) + (.05 $900,000) + (.02 $900,000) + ($350 12 25) = $1,181,850


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135. Refer to the above data. Employees' annual "take-home-pay," totals approximately: A. $672,300.B. $762,300.C. $675,000.D. $741,150.

$900,000 - ($900,000 .0765) - ($900,000 .10) = $741,150


136. Refer to the above data. Some of the payroll-related expenses incurred by Stone Corporation are mandated by law, rather than negotiated with employees. During the current year, these mandated amounts increased Stone's payroll-related expenses by approximately: A. $68,850.B. $200,700.C. $131,850.D. $176,850.

($900,000 .05) + ($900,000 .0765) + ($900,000 .02) = $131,850


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137. Refer to the above data. Assume that the federal government implements an 10% payroll tax upon employers to finance health insurance for all citizens and residents. Stone will pay this tax instead of purchasing group health insurance. This will cause Stone 's total annual payroll-related expenses to: A. Decrease by $15,000.B. Increase by $15,000.C. Decrease by $32,500.D. No change, because payroll taxes are withheld from employees' pay.

($900,000 .10) - ($350 12 25) = $15,000


On December 1, Year 1, Bradley Corporation incurs a 15-year $200,000 mortgage liability in conjunction with the acquisition of an office building. This mortgage is payable in monthly installments of $2,400, which include interest computed at the rate of 12% per year. The first monthly payment is made on December 31, Year 1.

138. Refer to the above data. Compute the total amount to be paid by Bradley over the 15-year life of the mortgage. A. $200,000.B. $562,000.C. $432,000.D. $474,000.

$2,400 12 15 = $432,000


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139. Refer to the above data. How much of the first payment made on December 31, Year 1, represents interest expense? A. $2,400.B. $ 400.C. $2,304.D. $2,000.

1% $200,000 = $2,000


140. Refer to the above data. The total liability related to this mortgage reported in Bradley 's balance sheet at December 31, Year 1, is: A. $432,100.B. $199,600.C. $194,923.D. $200,000.

200,000 - 400 = 199,600


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141. Refer to the above data. Over the 15-year life of the mortgage, the total amount Bradley will pay for interest charges is: A. $232,000.B. $360,000.C. $200,000.D. $432,060.

$432,000 - $200,000 = $232,000


142. Refer to the above data. The portion of the second monthly payment made on January 31, Year 2, which represents repayment of principle is: A. $400.B. $404.C. $2,400.D. $1,996.

$2,400 - (1% $199,600) = $404


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143. On October 1, 2009, Master's Co. borrows $500,000 from its bank for five years at an annual interest rate of 10%. According to the terms of the loan, the principal amount will not be due for five years. Interest is to be paid monthly on the first day of each month, beginning November 1, 2009. With respect to this borrowing, Master's December 31, 2009, balance sheet included only a long-term note payable of $500,000. As a result: A. The December 31, 2009, financial statements are accurate.B. Liabilities are understated by $12,500 accrued interest payable.C. Liabilities are understated by $4,167 accrued interest payable.D. Liabilities are understated by the amount of interest for the five-year term of the note that has not yet been paid.

$500,000 10% 1/12 = $4,167


144. At the end of 2010 it is discovered that the accountant for Gower Company failed to record $60,000 of interest payable which had accrued since the last interest payment date. The current ratio, quick ratio and debt ratio, as well as the financial statements, had already been computed using the erroneous data. Correction of the accounting records will have which of the following effects? A. Net income as formerly computed will not be affected by the correction of the error.B. The interest coverage ratio as formerly computed will not change as a result of the correction.C. The debt ratio as formerly computed will decrease as a result of the correction.D. The quick ratio as formerly computed will decrease as a result of the correction.


On April 1, year 1, Cricket Corporation issues $60 million of 12%, 10-year bonds payable at par. Interest on the bonds is payable semiannually each April 1 and October 1.

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145. Refer to the above data. The amount of cash paid to bondholders for interest during Year 1, is: A. $6,600,000B. $5,400,000C. $3,600,000D. $1,800,000

$60,000,000 .06 = $3,600,000


146. Refer to the above data. Interest expense on this bond issue reported in Cricket's year 1, income statement is: A. $2,400,000B. $4,800,000C. $5,400,000D. $7,200,000

$60,000,000 12% 9/12 = $5,400,000


147. Refer to the above data. The adjustment necessary at December 31, Year 1 (if any), related to this bond issue involves: A. Recognition of interest expense of $3,600,000.B. Recognition of interest expense of $1,800,000.C. Payment of cash of $1,800,000.D. There is no adjustment necessary.

$60,000,000 12% 3/12 = $1,800,000


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148. Refer to the above data. With respect to this bond issue, Cricket Corporation's balance sheet at December 31, Year 1, will include: A. Bonds payable of $61,800,000.B. Bonds payable of $63,600,000.C. Bonds payable of $60 million, as well as interest payable of $1,800,000.D. Bonds payable of $60 million, as well as interest payable of $3,600,000.


On April 1, year 1, Greenway Corporation issues $20 million of 10%, 20-year bonds payable at par. Interest on the bonds is payable semiannually each April 1 and October 1.

149. Refer to the above data. The journal entry to record the first cash payment to bondholders on October 1, year 1, will include: A. A credit to Cash of $2,000,000.B. A debit to Bonds Payable of $1,000,000.C. A debit to Interest Expense of $1,000,000D. A credit to Interest Payable of $1,000,000.

$20,000,000 10% 6/12 = $1,000,000


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150. Refer to the above data. The adjusting entry (if any) required on December 31, Year 1, related to this bond issue involves: A. Recognition of interest expense of $1,000,000.B. Recognition of interest expense of $500,000.C. A credit to Interest Payable of $2,000,000.D. A credit to Cash of $500,000.

$20,000,000 10% 3/12 = $500,000


151. Refer to the above data. In Year 2, Greenway's income statement will report interest expense arising from this bond issue of: A. $1,000,000.B. $2,000,000.C. $500,000.D. $1,500,000.

$20,000,000 10% = $2,000,000


152. Refer to the above data. On April 1, Year 1, the journal entry to record issuance of the bonds will include: A. A credit to Interest Payable of $1,000,000.B. A debit to Cash of $20,000,000.C. A credit to Bonds Payable of $2,100,000.D. A debit to Cash of $21,000,000.


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153. Refer to the above data. With respect to this bond issue, Greenway's balance sheet at December 31, Year 1, will include: A. Bonds payable of $20,500,000.B. Bonds payable of $19,500,000.C. Bonds payable of $20 million, as well as interest payable of $1,500,000.D. Bonds payable of $20 million, as well as interest payable of $500,000.


Austin Corporation issues $6,000,000 of 10%, 10-year bonds, dated December 31, Year 1. The bonds are issued on April 30, Year 2, at 100 plus accrued interest. Interest on the bonds is payable semiannually each June 30 and December 31.

154. Refer to the above data. The total amount of cash received by Austin Corporation upon issuance of the bonds on April 30, Year 2, is: A. $6,000,000.B. $6,200,000.C. $6,150,000.D. $6,300,000.

$6,000,000 + ($6,000,000 10% 4/12) = $6,200,000


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155. Refer to the above data. The entry to record the issuance of bonds payable on April 30, Year 2, includes: A. A credit to Premium on Bonds Payable of $200,000.B. A debit to Cash of $150,000.C. A debit to Bond Interest Expense of $200,000.D. A credit to Bond Interest Payable of $200,000.


156. Refer to the above data. The journal entry made by Austin Corporation to record the first semiannual interest payment on the bonds includes: A. A debit to Bond Interest Expense of $300,000.B. A debit to Bond Interest Payable of $100,000.C. A debit to Bond Interest Expense of $100,000.D. A debit to Bond interest Expense of $200,000.


157. Refer to the above data. The amount of Austin's interest expense on this bond issue during year 2 amounts to: A. $400,000.B. $450,000.C. $360,000.D. $600,000.

$6,000,000 10% 8/12 = $400,000


Salem Co. has outstanding $100 million of 7% bonds, due in 7 years, and callable at 104. The bonds were issued at par and are selling today at a market price of 94.

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158. Refer to the above data. If Salem Co. retires $10 million of these bonds by purchasing them from bondholders at current market price, the company will report: A. A $600,000 gain.B. A $500,000 loss.C. An unrealized gain.D. None of the above; neither gains nor losses are recognized on early retirements of debt.

$10,000,000 - $9,400,000 = $600,000


159. Refer to the above data. If Salem Co. calls $10 million of these bonds it will report: A. A $700,000 gain.B. A $400,000 loss.C. An unrealized gain.D. None of the above; neither gains nor losses are recognized on early retirements of debt.

$10,000,000 - $10,400,000 = ($400,000)


160. Refer to the above data. If Salem Co. retires $10 million of these bonds by purchasing them from bondholders at current market price, the company will report: A. A $600,000 cash receipt from operating activities.B. A $9.4 million cash payment for operating activities.C. A $600,000 cash receipt from financing activities.D. A $9.4 million cash payment for financing activities.


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The current balance sheet of Apex reports total assets of $20 million, total liabilities of $2 million, and owners' equity of $18 million. Apex is considering several financing possibilities in order to expand operations. Each question based on this data is independent of any others.

161. Refer to the above data. What will be the effect on Apex's debt ratio if Apex's owner invests an additional $2 million to finance its expansion? A. The debt ratio will decrease from .1 (2/20) to .0909 (2/22) after the additional investment.B. The debt ratio will decrease from 2/9 before to 2/11 after the additional investment.C. The debt ratio will increase from 20 before to 22 after the additional investment.D. Additional investment by owner will have no effect on the debt ratio.


162. Refer to the above data. Assume Apex borrows $2 million to finance its expansion. Apex's debt ratio immediately after the borrowing will be: A. .10.B. .20.C. .33 (rounded).D. .18.

$4/$22 = .18


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163. Refer to the above data. What is the maximum amount Apex can borrow and not exceed a debt ratio of .3? A. $4,000,000.B. $5,500,000.C. $5,000,000.D. Some other amount.

$7.5/$25.5 = 2.94


164. On February 28, 2009, $5,000,000 of 6%, 10-year bonds payable, dated December 31, 2008, are issued. Interest on the bonds is payable semiannually each June 30 and December 31. If the total amount received (including accrued interest) by the issuing corporation is $5,060,000, which of the following is correct? A. The bonds were issued at a premium.B. The amount of cash paid to bondholders on the next interest date, June 30, 2009, is $300,000.C. The amount of cash paid to bondholders on the next interest date, June 30, 2009, is $50,000.D. The bonds were issued at a discount.

$5,060,000 - ($5,000,000 6% 2/12) = $10,000 premium


Webster Company issues $1,000,000 face value, 6%, 5-year bonds payable on December 31, 2009. Interest is paid semiannually each June 30 and December 31. The bonds sell at a price of 97; Webster uses the straight-line method of amortizing bond discount or premium.

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165. Refer to the information above. The entry made by Webster Company to record issuance of the bonds payable at December 31, 2009, includes: A. A debit to Cash of $1,000,000.B. A debit to Discount on Bonds Payable of $30,000.C. A credit to Bonds Payable of $970,000.D. A credit to Bond Interest Payable of $30,000.

$1,000,000 - ($1,000,000 .97) = $30,000


166. Refer to the information above. Webster 's entry at June 30, 2010, to record the first semiannual payment of interest and amortization of discount on the bonds includes a: A. Debit to Bond Interest Expense of $30,000.B. Credit to Cash of $33,000.C. Debit to Discount on Bonds Payable of $3,000.D. Debit to Bond Interest Expense of $33,000.

$1,000,000 3% + $30,000/10 = $33,000


167. Refer to the information above. The amount of bond interest expense recognized by Webster Company in 2009 with respect to these bonds is: A. $60,000.B. $63,000.C. $120,000.D. $66,000.

$1,000,000 .06 + 2($30,000/10) = $66,000


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168. Refer to the information above. The carrying value of this liability in Webster Company's December 31, 2010, balance sheet is: A. $1,000,000.B. $970,000.C. $976,000.D. Some other amount.

$970,000 + $6,000 = $976,000


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Essay Questions

169. Accounting terminologyListed below are nine technical accounting terms introduced in this chapter:

Each of the following statements may (or may not) describe one of these technical terms. In the space provided below each statement, indicate the accounting term described, or answer "None" if the statement does not correctly describe any of the terms.(a) Operating income divided by annual interest expense(b) The amount paid during the current period to retired employees.(c) A lease agreement that is viewed as equivalent to the lessee purchasing the leased asset.(d) Using borrowed money to finance business operations.(e) The risk of a loss occurring in a future period.(f) A permanent reduction in the amount of income taxes owed which results from the tax deductions for depreciation.(g) The amount that must be paid to settle a liability at the date it becomes due.

(a) Interest coverage ratio, (b) None (postretirement benefit expense is the present value of future benefits earned by the workforce, not the amount paid to workers already retired), (c) Capital lease, (d) Applying leverage, (e) None (a loss contingency is a loss that already may have occurred, not a loss that may occur in the future), (f) None (deferred income taxes have been postponed, not eliminated), (g) Maturity value

AACSB: Reflective ThinkingAICPA BB: Critical ThinkingAICPA FN: Decision MakingLearning Objective: 10Learning Objective: 8

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170. Notes payableOn September 1, 2009, Charles Associates borrowed $600,000 from Diana Credit Union and signed a 9%, one-year note payable, all due at maturity.

(a)$654,000[$600,000 + ($600,000 9%)](b)$36,000($600,000 9% 8/12)(c)$618,000[$600,000 + ($600,000 9% 4/12)](d)


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171. Notes payableOn September 1, 2009, George Hanby borrowed $100,000 from The Actors Credit Union and signed an 6%, one-year note payable, all due at maturity. The interest on this loan is stated separately.

(a)$100,000 + ($100,000 .06) = $106,000(b)$100,000 .06 8/12 = $4,000(c)$100,000 + $2,000 (four months' interest payable) = $102,000


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172. Payroll-related expensesShown below is a summary of the annual payroll data of Revere Ironworks:

(d) How were the costs of postretirement benefits determined? Which of these amounts results in a liability to Revere Ironworks, and when will this liability be paid? Will the amount of the payments be more or less than the amount now shown as a liability? Explain.

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(d) The costs of postretirement benefits were determined by estimating the present value of the future costs of retirement benefits earned during the year by today's workforce.Only the unfunded portion of these costs represents a liability to Revere Ironworks. This liability will be paid either when it funds the plan or pays for the promised benefits after today's workers have retired.The liability reflects only the present value of unfunded benefits to be made in the distant future. The actual payments will be substantially larger than their present value at this time.


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173. Fully amortizing installment note payable (mortgage)On October 31, 2009, Seldon Company incurs a 30-year $600,000 mortgage liability in conjunction with the purchase of a motel. This mortgage is payable in equal monthly installments of $6,485, which include interest computed at an annual rate of 12%. The first monthly payment is made on November 30, 2009. This mortgage is fully amortizing over 360 months.Complete the amortization table for the first two payments by entering the correct dollar amounts in the blank spaces provided. In addition, answer the questions which follow.

(a) With respect to this mortgage, Seldon's 2009 income statement includes interest expense of $_______________, and Seldon's balance sheet at December 31, 2009, includes a total liability for this mortgage of _______________. (Do not separate into current and long-term portions.)(b) The aggregate monthly cash payments Seldon will make over the 30-year life of the mortgage amount to $_______________.(c) Over the 30-year life of the mortgage, the amount Seldon will pay for interest amounts to $_______________.

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(a) With respect to this mortgage Seldon's 2009 income statement includes interest expense of $11,995, and Seldon's balance sheet at December 31, 2009, includes a total liability for this mortgage of $599,025.$6,000 + $5,995 = $11,995 interest expense for 2009$600,000 - $485 - $490 = $599,025 remaining principal (per table) .(b) The aggregate monthly cash payments Seldon will make over the 30-year life of the mortgage amount to $2,334,600.$6,485 30 years 12 payments per year = $2,334,600.(c) Over the 30-year life of the mortgage, the amount Seldon will pay for interest amounts to $2,334,600.$2,334,600 aggregate payments - $600,000 principal = $1,734,600.


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174. Fully amortizing installment note payableOn October 31, 2009 Ronald signed a 2-year installment note in the amount of $50,000 in conjunction with the purchase of equipment. This note is payable in equal monthly installments of $2,354, which include interest computed at an annual rate of 12%. The first monthly payment is made on November 30, 2009. This note is fully amortizing over 24 months.Complete the amortization table for the first two payments by entering the correct dollar amounts in the blank spaces provided. In addition, answer the questions that follow.

(a) With respect to this note, Ronald's 2009 income statement includes interest expense of $_______________, and Ronald's balance sheet at December 31, 2009, includes a total liability for this note payable of _______________. (Do not separate into current and long-term portions.)(b) The aggregate monthly cash payments Ronald will make over the 2-year life of the note payable amount to $_______________.(c) Over the 2-year life of the note, the amount Ronald will pay for interest amounts to $_______________.

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(a) With respect to this note, Ronald's 2009 income statement includes interest expense of $981 (per table); and Ronald's balance sheet at December 31, 2009, includes a total liability for this note payable of $46,273 (per table).(b) The aggregate monthly cash payments Ronald will make over the 2-year life of the note payable amount to $56,496.$2,354 monthly payment 24 months = $56,496(c) Over the 2-year life of the note, the amount Ronald will pay for interest amounts to $6,496.$56,496 aggregate payments - $50,000 principal = $6,496.


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175. Bonds issued at par - basic conceptsOn April 1, Year 1, Olsen Products, Inc. issued at par $25 million of 10%, 10-year bonds payable. Interest is payable semiannually each April 1 and October 1.(a) What is the amount of cash paid to bondholders for interest during year 1?$_______________(b) Give the adjusting entry necessary at December 31, Year 1 (if any), regarding thisbond issue.(c) Interest expense on this bond issue reported in Olsen Products' Year 1 income statement is:$_______________(d) With respect to this bond issue, Olsen Products' balance sheet at December 31, Year 1, includes bonds payable of $__________________ and interest payable of $_______________ (indicate $0 or "none" if the item is not reported.(e) Give the journal entry made by Olsen Products on April 1, Year 2, to record the semiannual payment of interest to bondholders.

(a) $1,250,000 (Oct. 1 payment: $25,000,000 .10 6/12)(b) Year 1

(c) $1,875,000 ($25 million .10 9/12)(d) Bonds payable: $25,000,000Interest payable $625,000(e) Year 2

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176. Bonds issued at par - basic conceptsOn March 1, Year 1, Hubbard Co. issued at a price of 100 $20 million of 8%, 25-year bonds payable. Interest is payable semiannually each March 1 and September 1.(a) What is the amount of cash paid to bondholders for interest during year 1?$_____________(b) Give the adjusting entry necessary at December 31, year 1 (if any), regarding this bond issue.(c) Interest expense on this bond issue reported in Hubbard's Year 1 income statement is:$_______________(d) With respect to this bond issue, Hubbard 's balance sheet at December 31, Year 1, includes bonds payable of $_______________ and interest payable of $_______________. (indicate $0 or "none" if the item is not reported.)(e) Give the journal entry made by Hubbard on March 1, Year 2, to record the semiannual payment of interest to bondholders.

(a) $800,000 ($20,000,000 8% ½)(b)

(c) $1,333,333 ($800,000 from part a + $533,333 from part b)(d) Bonds payable $20,000,000Bond interest payable $ 533,333(e)


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177. Bonds payable-issued between interest dates Barney Corporation received authorization on December 31, Year 1, to issue $2,500,000 of 6%, 10-year bonds. The interest payment dates are June 30 and December 31. All the bonds were issued at a price of 100, plus accrued interest, on February 28, Year 2, two months after the authorization of the bond issue.

(d) Prepare the journal entry at February 28, Year 2, to record the issuance of the bonds.(e) Prepare the journal entry at June 30, Year 2 to record the first semiannual interest payment on the bonds.

(a) $2,525,000(b) $75,000(c) $125,000 ($2,500,000 .06 10/12)(d)


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178. Bonds payable issued between interest dates - early retirementDeegan Imports received authorization on December 31, Year 1, to issue $4,500,000 face value of 8%, 20-year bonds. The interest payment dates are June 30 and December 31. All the bonds were issued at par, plus accrued interest on February 1, Year 2. The bonds are callable by Deegan at any time at 105.(a) Prepare the journal entry to record the issuance of the bonds on February 1, Year 2.(b) Prepare the journal to record the first interest payment on the bonds at June 30, Year 2(c) What is the amount of bond interest expense reported in Deegan Imports' Year 2 income statement relating to these bonds? $___________(d) What is the amount of bond interest payable appearing in Deegan Imports' balance sheet at December 31, Year 2, with respect to these bonds? $____________(e) Deegan exercises the call provision and retires one-third of the bond issue on July 1, Year 3.Prepare the journal entry to record this transaction on July 1, Year 3.

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(c) $330,000 interest expenseSince the bonds were issued at par, interest expense is equal to the contractual interest for the period that the bonds were outstanding.($4,500,000 .08 11/12 = $330,000)(d) $-0- accrued bond interest payableThe interest payment date is December 31; therefore, interest for the last six months of a year is paid and does not appear as a liability in the balance sheet at December 31.


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179. Effects of transactions upon financial measurementsFive events relating to liabilities are described below:(a) Recorded a bi-weekly payroll, including the issuance of paychecks to employees. Amounts withheld from employees' pay and payroll taxes will be forwarded to appropriate agencies in the near future. (Ignore postretirement costs.)(b) Made a monthly payment on a 12-month installment note payable, including interest and a partial repayment of the principal amount.(c) Shortly before the maturity date of a six-month bank loan, made arrangements with the bank to refinance the loan on a long-term basis.(d) Made an adjusting entry to record accrued interest payable on a 2-year bank loan (interest is paid monthly.)(e) Made a year-end adjusting entry to amortize a portion of the discount on long-term bonds payable.Indicate the immediate effects of each transaction or adjusting entry upon the financial measurements in the five column headings listed below. Use the code letters, I for increase, D for decrease, and NE for no effect.

AACSB: AnalyticAICPA BB: Critical ThinkingAICPA FN: MeasurementLearning Objective: 2Learning Objective: 3Learning Objective: 6

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180. Bonds issued at discount or premiumOn March 31, 2009 Louis Company issued $20,000,000 face amount of 7%, 5-year bonds payable, with interest payable each June 30 and December 31. The company received cash of $20,200,000, including the accrued interest from December 31, 2008. Louis uses the straight-line method of amortizing any discount or premium over the remaining life of the bonds - 57 months.(a) What was the amount of accrued interest received by Louis on March 31, 2009 when the bonds were issued? (Do not assume the bonds were issued at par.)$_______________(b) What was the amount of discount or premium on the bonds at issuance date?(Indicate discount or premium.)$_______________(c) What amount of cash is paid to bondholders for interest during year 2009?$_______________(d) What is Louis ' total interest expense for year 2009 related to this bond issue?$_______________(e) What is the carrying value of this bond issue as of December 31, year 2009?$_______________

(a) Accrued interest: $20,000,000 7% 3/12 = $350,000(b) $150,000 discount$20,200,000 - $350,000 accrued interest = $19,850,000$20,000,000 - $19,850,000 for bonds = $150,000 discount(c) $1,400,000$700,000 (June 30) + $700,000 (December 31) = $1,400,000$20,000,000 .07 6/12 = $700,000 semiannually(d) $1,026313


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181. Fully amortizing installment notes When Sue Meadow purchased a home, she signed a $150,000, 12%, fully amortizing mortgage note, payable at $1,543 per month. After making the first monthly payment, Meadow received a notice from the bank stating that $1,500 of the payment had applied to interest, and only $43 reduced the principal amount of the loan. Meadow does not understand how this loan is fully amortizing over a period of 30 years. She computes that at $43 per month, it will take approximately 3,488 months (or 290 years) to repay this loan. Evaluate Meadow's analysis.

Meadow's analysis is incorrect, because the unpaid balance (principal amount) of the mortgage note will not be repaid at a constant rate of $43 per month. The portion of each payment representing interest expense is based upon the unpaid balance of the loan. Since this unpaid balance is reduced each month, the portion of each successive payment representing interest will decrease, and the portion applied to repayment of the principal amount will increase. Thus, the unpaid balance of the loan is repaid at an ever-increasing rate.


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182. Bond prices after issuanceSeveral years ago, Clear-Air Systems issued $100 million of 30-year, 8% bonds payable at a small premium. Since the bonds were issued, Clear-Air's financial strength and credit rating have actually improved, but today the bonds are trading among investors at a price of 98.(a) Explain the most probable reason why the market price of these bonds has declined, even though Clear-Air‘s credit rating has improved.(b) How will the drop in the market value of these bonds be reported (if at all) in Clear-Air's income statements and balance sheets? Explain.

(a) The interest rates available to investors have probably increased since Clear-Air issued these bonds. Bonds provide investors with a return which is fixed in dollar amount. Therefore, as the interest rates available from alternative investment opportunities rise, the price of a given bond issue tends to fall. In summary, bond prices vary inversely with fluctuations in market interest rates.(b) After bonds have been issued, they belong to the bondholders, not to the issuing corporation. Therefore, changes in the market price of bonds subsequent to their issuance do not affect the amounts shown in the financial statements of the issuing company. (However, the FASB presently requires companies to disclose the fair values of financial instruments (including bonds payable) in footnotes to the financial statements whenever the fair value is (1) reasonably determinable, and (2)significantly different from the carrying value in the financial statements.)

AACSB: Reflective ThinkingAICPA BB: Critical ThinkingAICPA FN: ReportingLearning Objective: 5Learning Objective: 7

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183. Operating and capital leasesBerkeley Corporation wants to expand operations and is considering various leasing arrangements for additional equipment. Berkeley's management has heard the terms capital lease and operating lease mentioned by the accounting department and wants clarification of these terms before signing any lease contracts.(a) Briefly explain the difference between a capital lease and an operating lease from a lessee's (Berkeley's) point of view. Your answer should include the financial statement impact of each type of lease.(b) How does a lessee determine whether a specific lease contract is an operating lease or a capital lease? Include at least two of the criteria specified by the FASB in your answer.(c) Which of the above two types of leases is sometimes referred to as "off-balance-sheet financing?" Briefly explain.

(a) A capital lease transfers most of the risks and rewards of ownership from the lessor to the lessee. From an accounting point of view, capital leases are regarded as essentially equivalent to a sale of the property to the lessee, even though title to the leased property has not been transferred. When equipment is acquired through a capital lease, the lessee includes an asset, Leased Equipment, and a liability, Lease Payment Obligation, in its balance sheet. Interest Expense and Depreciation Expense on the leased asset are reported in the lessee's income statement annually. No rent expense is involved in a capital lease.In an operating lease, the lessor gives the lessee the right to use leased property for a limited period of time, but retains the usual risks and rewards of ownership. No asset or liability relating to the lease appears in the balance sheet of the lessee; lease payments are simply reported as rental expense.(b) The FASB requires that a lease which meets any one of the following criteria be accounted for as a capital lease (students are to give any two of the four) :(1.) The lease transfers ownership of the property to the lessee at the end of the lease term.(2.) The lease contains a "bargain purchase option."(3.) The lease term is equal to 75% or more of the estimated economic life of the leased property.(4.) The present value of the minimum lease payments amounts to 90% or more of the fair value of the leased property.Any lease which does not meet any of the above criteria is an operating lease.(c)Operating leases are sometimes referred to as "off-balance-sheet financing." The lessee's balance sheet contains no asset or liability related to the lease arrangement other than perhaps a short-term liability for accrued rent payable. The entire leasing arrangement is not reflected in the balance sheet.


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184. Deferred income taxes At the end of its first year of operations, Harding Construction, Inc., included in its balance sheet a long-term liability entitled "Deferred Income Taxes."(a) Briefly explain what deferred income taxes represents, including how this liability came into existence and whether such an item is generally perceived as favorable or unfavorable from company management's point of view.(b) If Harding Construction, Inc., is a successful, growing business, would you expect the liability for deferred income taxes to increase or decrease over the next few years? Explain.

(a) For Harding Construction, Inc., deferred income taxes represents a portion of the current-year income tax expense whose payment is postponed until future periods.Deferred income taxes arise when items of revenue are included in the income statement in the current period, but are not taxed until some future period. Deferred income taxes also arise when expenses recognized in the financial statements are smaller than the expenses deducted in the current year's tax return. In both of these situations, pretax accounting income is larger than the taxable income reported in the current-year income tax return. In general, deferred income taxes arise because the income tax expense recognized for accounting purposes is larger than the amount of taxes owed for the current period (based upon the current-year tax return).In most cases, the existence of deferred income taxes would be regarded as a favorable situation, as it indicates that the cash outlay for income taxes to date is smaller than the amount of income tax expense reported in the income statement.(b) Although some of the income taxes deferred in prior years constantly are coming due, the liability for deferred taxes usually increases as a company grows and prospers.


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185. Loss contingenciesOcean to Coast Airlines could, at any time, incur a large loss if one of its airplanes were to crash. Is this an example of a loss contingency which should be disclosed in the company's financial statements? Explain.

The risk of a future airplane crash is not a loss contingency. Loss contingencies relate to events which have already occurred, but for which the financial impact is uncertain. The risk of a future airplane crash is a potential future loss. Potential future losses are not disclosed in financial statements.


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186. On March 1, 2009, five-year bonds are sold for $508,026 that have a face value of $500,000 and an interest rate of 10%. Interest is paid semi-annually on March 1 and September 1. Using the straight-line amortization method, prepare the borrower's journal entries onMarch 1, 2009September 1, 2009December 31, 2009March 1, 2010


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187. The LBB Company recently took a mortgage on a property for $100,000. The interest is 12% and the monthly payment is $1,020. Prepare the first four months of the amortization table beginning on January 1, 2009.


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CHAPTER 10 NAME ________________ # ______

10-MINUTE QUIZ A SECTION __________________________________________

Indicate the best answer for each question in the space provided.

On November 30, 2010, Central Food purchased two trucks for a total of $140,000, issuing a one-year, 6% note payable, all due at maturity. The interest on this loan is stated separately.

1 Refer to the above data. The December 31, 2010, adjusting entry for this note includes:a A credit to Cash for $1,400.b A credit to Interest Payable for $8,400.c A credit to Interest Payable for $1,400.d A credit to Interest Payable for $700.

2 Refer to the above data. The total liabilities related to this note reported in Central Food’s December 31, 2010, balance sheet is:a $140,000. b $148,400. c $140,700. d $141,400.

3 Refer to the above data. What is the amount of interest expense Central Food’s recognizes on this note in 2011a $700. b $8,400. c $7,700. d $1,400.

4 Refer to the above data. How much must Central Food pay the lender upon maturity of this note?a $140,700. b $140,000. c $147,700. d $148,400.

5 Refer to the above data. The liability for this loan as of December 31, 2010a Is equal to its maturity value.b Is equal to the book value of the two trucks that were acquired in exchange.c Is classified as a long-term liability, since it was used to acquire non-current

assets.d Is classified as a long-term liability if Central Food has the intent and ability to

refinance by taking out a new loan not due for several years.

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CHAPTER 10 NAME #

10-MINUTE QUIZ B SECTION

Shown below is a summary of the annual payroll data of Rose Co.:

Wages and salaries expense (gross pay).......................$2,250,000

Amounts withheld form employees’ pay: Income taxes.......................................................... $170,000 Social Security and Medicare................................. $150,000 320,000Payroll taxes expense: Social Security and Medicare................................. $150,000 Unemployment taxes............................................. 58,000 208,000Workers’ compensation premiums................................. 130,000Group health insurance premiums (paid by employer) 252,000Contributions to employees’ pension plan (paid by employer and fully funded).................................... 140,000Cost of other postretirement benefits: Funded................................................................... $90,000 Unfunded............................................................... 120,000 210,000

1 Refer to the above data. Rose Company’s total payroll-related expense for the year is:a $2,250,000. b $3,510,000. c $2,840,000. d $3,190,000.

2 Refer to the above data. Compute the company’s cash outlays during the year for payroll-related costs. Assume short-term obligations such as insurance premiums and payroll taxes have been paid.a $2,750,000. b $3,070,000. c $1,930,000. d $3,510,000.

3 Refer to the above data. The annual ”take-home-pay” of Rose’ employees is:a $2,520,000. b $2,250,000. c $1,930,000 d $2,750,000

4 Refer to the above data Amounts paid during the year to retirees for pension and other postretirement benefits total:a $140,000. b $350,000. c $230,000 d None of above

5 Refer to the above data. When a company has a fully-funded pension plan:a The dollar amounts paid to retirees are greater than the amounts recognized as

pension expense by the employer.b Pension expense is equal to the cash payments made to retirees during the current

period.c No pension expense is recognized in the income statement.d It does not use the services of a trustee to operate the pension plan.

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CHAPTER 10 NAME #

10-MINUTE QUIZ C SECTION

Seaview Industries received authorization on December 31, year 1, to issue $7,000,000 face value of 6%, 10-year bonds. The interest payment dates are June 30 and December 31. All the bonds were issued at par, plus accrued interest, April 1, Year 2. The bonds are callable by Seaview Industries at any time at 102.

1 Prepare the journal entry to record issuance of the bonds on April 1, Year 2.

2 Prepare the journal entry to record the first semiannual interest payment on the bonds at June 30, Year 2.

3 What is the amount of bond interest expense that appears in Seaview’s Year 2 income statement relating to these bonds?

$_________________________

4 What is the amount of accrued bond interest expense that appears in Seaview’s balance sheet at December 31, Year 2, with respect to these bonds?

$_________________________

5 Seaview exercises the call provision and retires one-half of the bond issue on July, 1, Year 4. Prepare the journal entry to record this transaction on July 1, Year 4.

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CHAPTER 10 NAME #

10-MINUTE QUIZ D SECTION

On December 1, 2009, Fisher Corporation incurs a 30-year, $400,000 mortgage liability upon purchase of a warehouse. This mortgage is payable in monthly installments of $4,116, which include interest computed at the rate of 12% per year. The first monthly payment is made on December 31, 2009.

1 How much of the first payment made on December 31, 2009, is allocated to repayment of principal? $________

2 What is the total liability related to this mortgage to be reported in Fisher’s balance sheet at December 31, 2009? (Do not separate into current and long-term portions.)

$________

3 The portion of the second monthly payment made on January 31, 2010, which represents interest expense is $________

4 What is the aggregate amount paid by Fisher over the 30-year life of the mortgage?$________

5 Over the 30-year life of the mortgage, the total amount Fisher will pay for interest charges is$________

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CHAPTER 10 SELF-TEST QUESTIONS FROM TEXTBOOK

Choose the best answer for each of the following questions and insert the identifying letter in the space provided.

1 Which of the following is characteristic of liabilities, rather than of equity? (More than one answer may be correct.)a The obligation matures.b Interest paid to the provider of the capital is deductible in the determination of

taxable income.c The capital providers’ claims are residual in the event of liquidation of the

business.d The capital providers normally have the right to exercise control over business

operations.

2 On October 1, Dalton Corp. borrows $100,000 from National Bank, signing a six-month note payable for that amount, plus interest to be computed at a rate of 9% per annum. Indicate all correct answers.a Dalton’s liability at October 1 is only $100,000.b The maturity value of this note is $104,500.c At December 31, Dalton will have a liability for accrued interest payable in the

amount of $4,500.d Dalton’s total liability for this loan at November 30 is $101,500.

3 Identify all correct statements concerning payrolls and related payroll costs:a Both employers and employees pay Social Security and Medicare taxes.b Workers’ compensation premiums are withheld from employees’ wages.c An employer’s total payroll costs usually exceed total wages expense by

about 7 1/2%.d Under current law, employers are required to pay Social Security taxes on

employees’ earnings, but are not required to pay for health insurance.

4 Identify those types of information that can readily be determined from an amortization table for an installment loan. (More than one answer may be correct.)a Interest expense on this liability for the current year.b The present value of the future payments under current market conditions.c The unpaid balance remaining after each payment.d The portion of the unpaid balance that is a current liability.

5 Which of the following statements is (are) correct? (More than one statement may be correct.)a A bond issue is a technique for subdividing a very large loan into a great many

small, transferable units.b Bond interest payments are contractual obligations, whereas the board of

directors determines whether or not dividends will be paid.c As interest rates rise, the market prices of bonds fall; as interest rates fall, bond

prices tend to rise.d Bond interest payments are deductible in determining income subject to income

taxes, whereas dividends paid to stockholders are not deductible.

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6 Identify all statements that are consistent with the concept of present value. (More than one answer may be correct.)a The present value of a future amount is always less than that future amount.b An amount of money available today is considered more valuable than the same

sum which will not become available until a future date.c A bond’s issues price is equal to the present value of its future cash flows.d The liability for an installment note payable is recorded at only the principal

amount, rather than the sum of the scheduled payments.

7 Identify those trends that are unfavorable from the viewpoint of a bondholder (More than one answer may be correct.)a Market interest rates are steadily rising.b The issuing company’s interest coverage ratio is steadily rising.c The issuing company’s net cash flow from operating activities is steadily

declining.d The issuing company’s debt ratio is steadily declining.

8 A basic difference between loss contingencies and “real” liabilities is:a Liabilities stem from past transactions; loss contingencies stem from future

events.b Liabilities always are recorded in the accounting records, whereas loss

contingencies never are.c The extent of uncertainty involved.d Liabilities can be large in amount, whereas loss contingencies are immaterial.

9 Which of the following situations require recording a liability in 2005? (More than one answer may be correct.)a In 2005, a company manufactures and sells stereo equipment which carries a

three-year warranty.b In 2005, a theater group receives payments in advance from season ticket holders

for productions to be performed in 2006.c A company is a defendant in a legal action. At the end of 2005, the company’s

attorney feels it is possible the company will lose, and that the amount of the loss might be material.

d During 2005, a midwest agricultural co-operative is concerned about the risk of loss if inclement weather destroys the crops.

10 Silverado maintains a fully funded pension plan. During 2005, $1 million was paid to retired workers currently employed by the company earned a portion of the right to receive pension payments expected to total $6 million over their lifetimes. Silverado’s pension expense for 2005 amounts to:a $1 million.b $6 million.c $7 million.d Some other amount.

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11 Deferred income taxes result from:a The fact that bond interest is deductible in the computation of taxable income.b Depositing income taxes due in future years in a special fund managed by an

independent trustee.c Timing differences between when income is recognized in financial statements

and in income tax returns.d The inability of a bankrupt company to pay its income tax liability on schedule.

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SOLUTIONS TO CHAPTER 10 10-MINUTE QUIZZES

QUIZ A QUIZ B1 D 1 D2 C 2 B3 C 3 C 4 D 4 D5 D 5 A

QUIZ C1Cash ............................................................................................... 7,105,000

Bonds Payable.......................................................................... 7,000,000Bond Interest Payable............................................................... 105,000

Issued $7,000,000 face value bonds at par,plus three months’ accrued interest.($7,000,000 x 6% x 3/12 = $105,000) 2Bond Interest Payable..................................................................... 105,000Bond Interest Expense.................................................................... 105,000

Cash.......................................................................................... 210,000To record payment of semiannual interest.($7,000,000 x 6% x 1/2) 3$315,000 interest expense. Since the bonds were issued at par, interest expense is equal to the contractual interest for the period that the bonds were outstanding. ($7,000,000 x 6% x 9/12 = $315,000) 4 $0 accrued bond interest payable. The interest payment date is Dec. 31; therefore, interest for the last six months of a year is paid and does not appear as a liability in the balance sheet. 5Bonds Payable................................................................................ 3,500,000Loss on Early Retirement of Bonds

(Extraordinary Loss)................................................................. 70,000 Cash...................................................................................... 3,570,000

To record retirement of $3,500,000-face-valuebonds, originally issued at par, at 102.

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QUIZ D1$116 [$4,116 - $4,000 interest ($400,000 x .12 x 1/12)] 2$399,884 [$400,000 - $116 repayment of principal] 3$3,999 [$399,884 x .12 x 1/12 = $3,999]

4$1,481,760 [$4,116 monthly x 360 months] 5 $1,081,760 [$1,481,760 total payments - $400,000 principal]

SOLUTIONS TO CHAPTER 10 SELF-TEST QUESTIONS FROM TEXTBOOK

1 a , b 2 a, b, d 3 a, d 4 a, c, d 5 a, b, c, d 6 a, b, c, d 7 a, c 8 c 9 a, b 10 d 11 c

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Liabilities

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