Chapter 5 Practice Questions PDF

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Practice Questions for Chapter 5...

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For quick querying, use Crtl + F on Windows or Command + F on Mac Questions are in the same order on EdX – If a question is not, then it is a quizz question. For all questions – Make sure to practice BEFORE looking at the solution!! MODULE 5 PRACTICE QUESTIONS REPORTING AND INTERPRETING LIABILITIES, BONDS AND INSTALLMENT NOTES PAYABLE 1. Which of the following is not a characteristic of a liability? A. It represents a probable, future sacrifice of economic benefits B. It must be payable in cas C. It represents obligations to other entities D. It results from past transactions or events Solution:

2.

Solution:

3.

Solution:

There are a number of liabilities that are paid with services and not with cash. For example, companies often provide (or sell additional) warranties on products which represent liabilities. These are obligations for the seller to provide repair service for the products covered under the warranty period and do not require cash outflows. Another example of a noncash liability would be professional sports teams selling season tickets. These liabilities represent obligations to provide access to future sporting events to the season ticket holders.

Which of the following statements does not describe an essential characteristic of a liability? A. a liability is a present obligation that will be settled by a probable future transfer or use of assets. B. the obligated entity has little discretion to avoid the future sacrifice C. the identity of the recipient must be known to the obligated party D. the transaction or event obligating the enterprise has already occurred A liability may be recorded even though the identity of the recipient is unknown. For example, companies often sell gift cards to customers whose identities are unknown. These are recorded as liabilities, and may be redeemed by whoever has possession of the gift cards.

Unearned or deferred revenue can occur when: A. services are provided prior to receipt of cash B. goods are sold on account C. services are provided after the receipt of cash D. goods are sold for cash Unearned or Deferred revenues are liabilities which are recorded when a company, such as an insurance company receives a cash payments in advance of providing a service. When the service is provided (such as the time period covered by the insurance premium elapses, the insurance company will need to make an adjusting entry to reduce the liability and increase a revenue for the same amount.

4. On August 1, 2018, Bartley Corporation issued a 8%, 9 month, $36,000 note payable. What are the amounts of interest expenses recorded in the years 2018 and 2019? A. $0 in 2018 and $2,160 in 2019. B. $1,350 in 2018 and $1,080 in 2019. C. $1,600 in 2018 and $1,280 in 2019. D. $1,200 in 2018 and $960 in 2019.

Solution: The nine month note will mature on May 1, 2019 (9 months from August 1, 2018) The interest expense for August 1 thru December 31, 2018: $36,000 x 8% X (5/12) = $1,200 Interest expense from January 1, 2019 thru May 1, 2019: $36,000 x 8% x (4/12) = $960

5. Cantor Corporation issued a four month, $40,000, 6.5% note payable on October 1, 2018. Determine the total amount to be paid by the borrower on the date of the note’s maturity? A. $40,867 B. $42,600. C. $40,650. D. $40,000. Solution: The interest expense for 4 months = $40,000 x 6.5% x (4/12) = $867 (rounded) So, total amount to be repaid = Principal $40,000 + Interest expense $867 = $40,867

6. On January 1, 2019, James Company purchased a new equipment with a fair market value of $65,000 in exchange for an installment note requiring seven equal annual payments, starting on December 31, 2019. The implied interest rate is 8% per year. What is the annual payment to be made by made by James Company (requires use of present value tables) A. $37,830.65 B. $37,926.85 C. $12,484.70 D. $10,885.40

Solution: The installment note represents an annuity, which will require an annual payment (based on the present value factor of an ordinary annuity of $1 for 7 periods at 8% = $65,000 ÷ 5.20637 = $12,484.70

7. On January 1, 2019, William purchased an equipment, and signed an instalment note requiring equal annual payments (including principal and interest) of $6,520 at the end of every year for 10 years. The market value of the equipment is $47,988, which is equal to the discounted present value of the instalment payments at 6%. Determine the balance of the instalment note payable (carrying value) after first year’s payment (rounded to the nearest dollar). A. $ 41,468 B.

$ 45,109

C.

$ 44,347

D.

$38,589

Solution: Interest Expense on the instalment loan on year 1 = $47,988 x 6% = $2,879.28 So, decrease in note payable (principal potion of payment) = $6,520 – $2,879.28 = $3640.72 Carrying value of Note Payable after first payment = $47,988 – $3,640.72 = $44,347.28

8. On January 1, 2018, Barry Company purchased an equipment by signing a five-year installment note requiring five equal payments of $40,000 due on December 31 of each year with the first payment due December 31, 2018. Assuming an implied interest rate of 9%, determine the balance of the note payable that Barry Company should report on its December 31, 2008 balance sheet? (requires use of present value tables)

A.

$ 115,586

B.

$ 141,183

C.

$ 115,600

D.

$ 129,589

Solution: First, we need to determine the PV factor for an ordinary annuity for 5 periods at 9% = 3.88965 So, present value of annual payments (equivalent to purchase price of equipment) = $40,000 x 3.88965 = $155,586 Interest Expense on the instalment loan on year 1 = $155,586 x 9% = $14,003 So, decrease in note payable (principal potion of payment) = $40,000 - $14,003 = $25,997 Carrying value of Note Payable after first payment = $155,586 - $25,997 = $129,589 9. Red & Black Corp. signed a 4 year installment note to purchase a machine on January 1, 2019. The terms of the note require quarterly payments of $4,000 payable each year on March 31, June 30, September 30 and December 31. Assume annual interest rate of 8%. Rounded to the nearest dollar, what will be the balance in the note payable account after the first payment on March 31, 2019 (rounded)? A. $10,308 B. $54,311 C. $51,397 D. $12,189 Solution:

This note will require a total of 16 payments (quarterly payments for 4 years) at a quarterly rate of 2% Present value factor for an ordinary annuity in arrears for 16 periods at 2% = 13.57771 So, present value of 16 instalment payments = $4,000 x 13.57771 = $54,310.84 Interest expense for quarter 1 = $54,310.84 x 2% = $1,086.22 Principal portion of payment in quarter 1 = $4,000 - $1,086.22 = $2,913.78 Balance of Note Payable after year 1 = $54,310.84 - $2,913.78 = $51,397.06

10. Ann Company borrowed $200,000 to buy an equipment on January 1, 2018, and signed a 7% instalment note requiring annual equal payments, including principal and interest at the end of every year for 15 years. Rounded to the nearest dollar, determine the balance in the Instalment Note Payable account after making the first two annual payments (requires use of present value tables) A. $ 172,557

Solution:

11.

B.

$ 192,041

C.

$ 178,041

D.

$ 183,525

Present value factor for an ordinary annuity in arrears for 15 periods at 7% = 9.10791 So, annual payment on the instalment note = $200,000 ÷ 9.10791 = $21,958.93 Interest expense for year 1 = $200,000 x 7% = $14,000 Principal portion of payment in year 1 = $21,958.93 - $14,000 - $7,958.93 Balance of Note Payable after year 1 = $200,000 - $7,958.93 = $192,041.07 Interest Expense for year 2 = $192,041.07 x 7% = $13,442.87 Principal portion of payment in year 2 = $21,958.93 – 13,442.87 = $8,516.06 Balance of Note Payable after year 2 = $192,041.07 - $8516.06 = $183,525.01

For a company trying to raise capital, an advantage of issuing bonds over issuing stocks is: A. Bonds do not affect owner control. B. Bonds require payment of par value at maturity. C. Bond payments must be made even when income and cash flows are low. D. Bonds require payment of periodic interest.

Solution: Issuing bonds are often attractive for corporations trying to raise capital because owning bonds does not provide ownership to bondholders, and hence does not dilute the equity ownership of the present stockholders.

12. Bonds usually A. B. C. D. Solution:

sell at a premium when Investors are willing to invest in the bonds at the stated interest rate The market rate of interest is lower than the stated interest rate The market rate of interest is higher than the stated interest rate The bond issuer expects a gain when the bonds are retired

The relationship between the stated (coupon) rate and the market (effective) rate of interest determines whether bonds are issued at premiums or discounts. When the coupon rate is higher than the market rate, potential buyers will be willing to pay a premium (higher than par value) to purchase these bonds.

13. If the market interest rate on bonds is higher than the coupon rate, bonds will sell A. at face value. B.

above face value.

C.

below face value.

D. at maturity value. Solution:

14.

The relationship between the stated (coupon) rate and the market (effective) rate of interest determines whether bonds are issued at premiums of discounts. When the coupon rate is lower than the market rate, potential buyers will only buy these bonds if they are offered at a discount (lower than par value).

Mendez Corporation issues 3,000, 10-year, 8%, $1,000 bonds dated January 1, 2019, at 103. The journal entry to record the issuance will show a A. B. C. D.

Solution:

15.

debit to Cash of $3,000,000. credit to Bonds Payable for $3,015,000. credit to Cash for $3,090,000. credit to Premium on Bonds Payable for $90,000.

The journal entry to record the issuance of these bonds will be to: Debit Cash for 3,000 x $1,000 x 103% = $3,090,000 Credit Bonds Payable (par value) 3,000 x $1,000 = 3,000,000 And Credit Premium on Bonds Payable for the difference ($3,090,000 - $3,000,000) = $90,000

The journal entry to record $200,000 of bonds that were issued at 104 would be to: A. debit Cash, $200,000; credit Bonds payable, $200,000. B. debit Cash, $208,000; credit Bonds payable, $208,000. C.

Solution:

debit Cash, $208,000; credit Bonds payable, $200,000; credit Premium on bonds payable, $8,000. D. debit Cash, $200,000; debit Discount on bonds payable, $8,000; credit Bonds payable, $208,000. The journal entry to record the issuance of these bonds will be to: Debit Cash for $200,000 x 104% = $208,000 Credit Bonds Payable (par value) = $200,000

And Credit Premium on Bonds Payable for the difference ($208,000 - $200,000) = $8,000

16.

Bonds payable should be reported as a long-term liability on the balance sheet of the issuing corporation at: A. Face value less any unamortized discount or plus any unamortized premium. B. Current bond market price. C. Face value less any unamortized premium or plus any unamortized discount. D. Face value less accrued interest since the last interest payment date.

Solution:

Bonds Payable are reported on Balance Sheets at their net value or carrying values. For discount bonds, carrying value = Par Value – Umamortized Discounts For premium bonds, carrying value = Par Value + Unamortized Premiums.

1 7 . The carrying amount of a bond liability that appears on the balance sheet is the A. call price of the bond plus bond discount or minus bond premium.

Solution:

B.

face value of the bond plus related premium or minus related discount.

C.

face value of the bond plus related discount or minus related premium.

D.

maturity value of the bond plus related discount or minus related premium.

Bonds Payable are reported on Balance Sheets at their net value or carrying values. For discount bonds, carrying value = Par Value – Umamortized Discounts For premium bonds, carrying value = Par Value + Unamortized Premiums.

18. Which statement is false? A. The periodic interest payment on a bond is based upon the market rate of interest. B.

The coupon rate of interest and the market rate of interest are usually different on the date the bond is issued.

C.

If a bond is sold at a price that is greater than face value, it is said to be sold at a premium. If a bond is sold at a price that is less than face value, it is said to be sold at a discount.

D.

Solution: The periodic interest payments on bonds are calculated by multiplying the predetermined coupon rate (stated) rate by the par value of bonds. The interest payment remains unchanged through the life of the bonds, and is not affected by the fluctuation in market rate of interest.

19. Bonds payable should be reported as a long-term liability on the balance sheet of the issuing corporation at: A. Current bond market price. B. Face value less accrued interest since the last interest payment date C. D.

Solution:

Face value less any unamortized premium or plus any unamortized discount Face value less any unamortized discount or plus any unamortized premium

Bonds payable are reported on balance sheets at their carrying value or book values.

For discount bonds, carrying value = Par Value – Umamortized Discounts For premium bonds, carrying value = Par Value + Unamortized Premiums.

20. A call provision in a bond contract may specify that the issuing company: A. can issue the bonds at any interest rate it can entice the investors to accept. B. must make periodic interest payments C. must deposit cash in the bank to be available when the bonds mature D. may buy back bonds from the investors

Solution:

Bonds may be issued with a callable feature, which allows the bond issuer to call back and retire the bonds by paying the bondholders a pre-specified “call price”.

21. Amortizing a bond discount will _______the discount balance and _____the carrying value of the bond so that when the bond matures the carrying value will ______the face value. A.

decrease; increase; be greater than

B.

increase; decrease; be greater than

C.

decrease; increase; equal

D.

decrease; decrease; equal

Solution: When bonds are issued at a discount, the discount is amortized over the life of the bond. The process of amortization gradually decreases the discount, so that at maturity the amount of the discount becomes zero. Also, carrying value of a discounted bond = par value – unamortized discount. So, as the unamortized discount decreases, the carrying value increases, such at maturity the carrying value equals the par value.

22. How would the carrying value of a bond payable be affected by amortization of each of the following? Discount

Premium

No effect

No effect

B.

Increase

No effect

C.

Increase

Decrease

D.

Decrease

Increase

A.

Solution:

When bonds are issued at a discount, amortization of the discount lowers the balance of the discount, which helps to increase the carrying value of the Bonds Payable (Par Value – unamortized discount). When bonds are issued at a premium, amortization of the premium lowers the balance of the premium, which helps to decrease the carrying value of the Bonds Payable (Par Value + unamortized premium)

23. A company prepared the following journal entry: Cash Discount on bonds payable Bonds payable

xxx xxx xxx

Which of the following statements incorrectly describes the effect of this journal entry on the financial statements? A. Total liabilities increase by the amount of the credit to bonds payable. B. Discount on bonds payable is reported on the balance sheet as a contra-liability account. C. Assets increase by the amount of the debit to cash. D. The cash debit amount is reported as a cash inflow from financing activities.

Solution:

24.

In this situation, bonds are issued at a discount. This implies that the issuing company collects less cash than the par value of the bonds payable, and would record a net liability (carrying value) equal to the amount of cash received (par value – discount on bonds payable), not the gross amount of the bonds payable. The discount on the bonds payable acts as a contra liability to reduce the liabilities reported on the balance sheet.

Flute Corporation issued $200,000, 10-year 8 percent bonds, which pay interest semiannually. If the market rate of interest was 6% (annual), the issue price of the bonds should be (requires use of present value tables): A. $229,442 B. $172,821 C. $154,119 D. $229,756

Solution:

Semiannual interest payment = $200,000 x 8% x ½ = $8,000 PV factor of ordinary annuity of $1 for 20 periods (10 years) at a semiannual market rate of 3% = 14.87747 Present Value of interest payment (annuity) = $8,000 x 14.87747 = $119,020 (rounded) PV factor of $1 for 20 periods (10 years) at a semiannual rate of 3% = 0.55368 Present value of principal payment = $200,000 x 0.55368 = $110,736 Issue price of bonds = Present value of interest payments + present value of principal = $119,020 + $110,736 = $229,756

25. Green Bay Corporation issued $300,000 of 15-year bonds on January 1. The bonds pay interest on January 1 and July 1 with a stated rate of 8 percent. If the annual market rate of interest at the time the bonds are sold is 10 percent, what will be the issuance price of the bonds (requires use of present value tables): ? A.

Solution:

$278,345

B.

$254,366

C.

$277,248

D.

$253,883

Semiannual interest payment = $300,000 x 8% x ½ = $12,000 PV factor of ordinary annuity of $1 for 30 periods (15 years) at a semiannual market rate of 5% = 15.37245 Present Value of interest payment (annuity) = $12,000 x 15.37245 = $184,469 (rounded) PV factor of $1 for 30 periods (10 years) at a semiannual rate of 5% = 0.2 3138 Present value of principal payment = $300,000 x 0.23138 = $69,414 Issue price of bonds = Present value of interest payments + present value of principal = $184,469 + $69,414 = $253,883

26. On January 1, 2018, Ellison Co. issued eight-year bonds with a face value of $1,000,000 and a stated interest rate of 6%, payable semiannually on June 30 and December 31. The bonds were sold to yield 8% annually. The issue price of the bonds is (requires use of present value tables):

Solution:

A.

$883,479

B.

$884,820

C.

$889,560

D.

$999,600

Semiannual interest payment = $1,000,000 x 6% x ½ = $30,000 PV factor of ordinary annuity of $1 for 16 periods (8 years) at a semiannual market rate of 4% = 11.6523 Present Value of interest payment (annuity) = $30,000 x 11.6523 = $349,569 PV factor of $1 for 16 periods (8 years) at a semiannual rate of 5% = 0.53391 Present value of principal payment = $1,000,000 x 0.53391 = $533,910

Issue price of bonds = Present value of interest payments + present value of principal = $349,569 + $533,910 = $883,479

27. Bishop Company issued 10% bonds on January 1, 2019 w...