Financial and Managerial Accounting, 8e (Wild)
Chapter 10 Accounting for Long-Term Liabilities
1) The legal contract between the issuing corporation and the bondholders is called the bond
indenture.
2) One of the similarities of bond and equity financing is that both dividends and equity
distribution payments are tax deductible.
3) Interest on bonds is tax deductible.
4) The relationship between the market rate of a bond and the rate of return on the borrowed
funds affects the company’s return on equity.
5) A disadvantage of bond financing over equity financing is the burden on the cash flows of the
company.
6) Term bonds mature on one specified date, whereas serial bonds mature at more than one date.
7) Debentures always have specific assets of the issuing company pledged as collateral.
8) Indenture refers to a bond’s legal contract; debenture refers to an unsecured bond.
9) Bond market values are expressed as a percent of their par (face) value.
10) A bond with a par value of $1,000 trading at 101 ½ sells for a premium.
11) A bond with a par value of $1,000 trading at 97 ½ sells for a premium.
12) Callable bonds give the issuer the option to retire them at a stated dollar amount before
maturity.
13) Callable bonds can be exchanged for a fixed number of shares of the issuing corporation’s
common stock.
14) A particular feature of callable bonds is that they reduce the bondholder’s risk by requiring
the issuer to set assets aside to repay the bonds at maturity.
15) Convertible bonds can be exchange for a fixed number of shares of the issuing corporation’s
stock.
16) A bond’s par value is not necessarily the same as its market value.
17) An installment note is a liability of the issuing company that requires a series of payments to
the lender.
18) Payments on an installment note include the accrued interest expense plus a portion of the
amount borrowed.
19) Long-term notes are typically transacted with multiple lenders.
20) The carrying value of a bond is computed as the face value minus any unamortized discount
or plus any unamortized premium.
21) Mortgage contracts give the lender the right to be paid from the cash proceeds of the sale of a
borrower’s assets identified in the mortgage if the borrower fails to make the required payments.
22) Mortgage bonds are backed only by the good faith and credit of the issuing company.
23) When calculating the issuance price of a bond, use the market rate to compute the present
value of the bond’s future cash flows.
24) An annual rate of 4% is applied as a semiannual rate of 1%.
25) The bonds’ future cash flows include the par value paid at maturity and the interest payments.
26) A company borrows $10,000 and issues a 5-year, 6% installment note with interest payable
annually. The factor for the present value of an annuity at 6% for 5 years is 4.2124. The factor
for the present value of a single sum at 6% for 5 years is 0.7473. The present value of the interest
payments is $2,527.44.
27) A company borrows $40,000 and issues a 3-year, 10% installment note with interest payable
annually. The factor for the present value of an annuity at 10% for 3 years is 2.4869. The factor
for the present value of a single sum at 10% for 3 years is 0.7513. The amount of the
annual interest payment is $16,084.28.
28) An annuity is a series of equal payments at equal time intervals.
29) Present values can be found using Excel, a calculator or present value tables.
30) The factor for the present value of an annuity at 8% for 10 years is 6.7101. This means that
an annuity of ten $15,000 payments at 8% has a present value of $2,235.
31) The factor for the present value of an annuity for 6 years at 10% is 4.3553. This means that
an annuity of six $2,000 payments at 10% is the equivalent of $8,710.60 today.
32) A lease is a contractual agreement between a lessor and a lessee that grants the lessee the
right to use the asset for a period of time in return for cash payment(s) to the lessor.
33) Operating leases are long-term or noncancelable leases in which the lessor transfers
substantially all the risks and rewards of ownership to the lessee.
34) An advantage of lease financing is the lack of an immediate large cash payment for the
leased asset.
35) A disadvantage of lease financing is the potential to deduct rental payments from taxable
income.
36) A pension plan is a contractual agreement between an employer and its employees to provide
benefits to employees after they retire.
37) A bond is an issuer’s written promise to pay an amount identified as the par value of the bond
along with periodic interest payments.
38) An advantage of bond financing is that issuing bonds does not affect owner control.
39) Periodic interest payments on bonds are determined by multiplying the par value of the bond
by the bond’s contract rate.
40) The contract rate of interest is the rate that borrowers are willing to pay and lenders are
willing to accept for a particular bond and its risk level.
41) Return on equity increases when the expected rate of return from the acquired assets is
higher than the interest rate on the debt issued to finance the acquired assets.
42) The use of debt financing always yields an increase in return on equity.
43) Bond interest paid by a corporation is an expense, whereas dividends paid are not an expense
of the corporation.
44) Collateral from unsecured loans may be sold to offset the loan obligation if the loan is in
default.
45) A company’s ability to issue unsecured debt depends on its credit standing.
46) A lessee has substantially all of the benefits and risks of ownership in an operating lease.
47) A company with a low level of liabilities in relation to stockholders’ equity is likely to have a
very high debt-to-equity ratio.
48) The debt-to-equity ratio is calculated by dividing stockholders’ equity attributable to
common shareholders by total liabilities.
49) The debt-to-equity ratio enables financial statement users to assess the risk of a company’s
financing structure.
50) A company has total assets of $350,000 and total liabilities of $200,000. Its debt-to-equity
ratio is 0.6.
51) A company’s debt-to-equity ratio was 1.0 at the end of Year 1. By the end of Year 2, it had
increased to 1.7. Since the ratio increased from Year 1 to Year 2, the degree of risk in the firm’s
financing structure decreased during Year 2.
52) The contract rate on previously issued bonds changes as the market rate of interest changes.
53) The market rate for bonds is generally higher when the time period to maturity is longer due
to the risk of adverse events occurring over the time period.
54) A 10-year bond issue with a $100,000 par value, 8% annual contract rate, with interest
payable semiannually means that the issuer must repay $100,000 at the end of 10 years and make
20 semiannual interest payments of $4,000 each.
55) When the contract rate on a bond issue is less than the market rate, the bonds sell at a
discount.
56) When the contract rate is above the market rate, a bond sells at a discount.
57) A discount on bonds payable occurs when a company issues bonds with an issue price less
than par value.
58) The carrying (book) value of a bond at the time it is issued is always equal to its par value.
59) The carrying (book) value of a bond payable is the par value of the bonds plus any discount
or minus any premium.
60) On January 1, a company issued a $500,000, 10%, 8-year bond payable, and received
proceeds of $473,845. Interest is payable each June 30 and December 31. The total interest
expense on the bond over its eight-year life is $400,000.
61) On January 1, a company issued a $500,000, 10%, 8-year bond payable, and received
proceeds of $473,845. Interest is payable each June 30 and December 31. The company uses the
straight-line method to amortize the discount. The amount of discount amortized each period is
$1,634.69.
62) On January 1, a company issued a $500,000, 10%, 8-year bond payable, and received
proceeds of $473,845. Interest is payable each June 30 and December 31. The company uses the
straight-line method to amortize the discount. The amount of interest expense to be recorded on
June 30 is $25,000.
63) A premium on bonds occurs when bonds carry a contract rate greater than the market rate at
issuance.
64) A premium reduces the interest expense of a bond over its life.
65) A discount reduces the interest expense of a bond over its life.
66) The issue price of a bond is equal to the present value of all future cash payments discounted
at the bond’s market rate.
67) Premium on Bonds Payable is an adjunct liability account, as it increases the carrying value
of the bond.
68) When the contract rate of a bond is greater than the market rate on the date of issuance, the
bond sells at a discount.
69) The issue price of bonds is found by computing the future value of the bond’s cash payments,
discounted at the contract rate of interest.
70) The effective interest method assigns a bond interest expense amount that increases over the
life of a premium bond.
71) Two common ways of retiring bonds before maturity are to (1) exercise a call option or (2)
purchase them on the open market.
72) When convertible bonds are converted to a company’s stock, the carrying value of the bonds
is transferred to equity accounts and no gain or loss is recorded.
73) Payments on installment notes include accrued interest plus a portion of the amount
borrowed (principal).
74) The equal total payments pattern for installment notes consists of changing amounts of
interest but constant amounts of principal over the life of the note.
75) Sinking fund bonds:
A) Require the issuer to set aside assets to pay the bonds at maturity.
B) Require equal payments of both principal and interest over the life of the bond issue.
C) Decline in value over time.
D) Are registered bonds.
E) Are bearer bonds.