Chapter 10 – Long-Term Liabilities
TRUE/FALSE
1. Financial leverage is also known as trading on the debt.
2. The debt to equity ratio is a measure of financial leverage.
3. The interest coverage ratio is expressed in times.
4. Bondholders share voting rights with stockholders.
5. The debt to equity ratio is expressed as a percent.
6. The higher the debt to equity ratio, the greater the financial risk the company is taking.
7. The practice of off-balance-sheet financing is legal.
8. The interest coverage ratio measures the degree of protection a company has from default on interest
payments.
9. Leases of short-term assets are capital leases, and leases of long-term assets are operating leases.
10. A capital lease is a lease of property, plant, or equipment that is in effect an installment purchase.
11. Accounting for operating leases can be thought of as similar to accounting for mortgage payments.
12. Under a defined contribution pension plan, retirement benefits are based entirely on the annual
contribution to the fund plus earnings thereon.
13. Accounting for a defined benefit pension plan is more complex than accounting for a defined
contribution plan.
14. Costs of postretirement benefits other than pension plans should be expensed when paid to the retired
employee.
15. An operating lease represents both an asset and a liability.
16. Financial leverage refers to the issuance of stock to raise cash.
17. Interest on debt is tax-deductible to the issuing corporation, whereas dividends on stock are not.
18. A corporation’s stockholders are the primary recipients of financial leverage.
19. Entering into a capital lease is an example of off-balance-sheet financing.
20. Failure to make interest payments on debt can force a company into bankruptcy.
21. When earnings from an investment exceed the interest payments on the investment, negative financial
leverage has occurred.
22. Deferred income taxes arise when accounting methods used for financial reporting differ from those
used on the income tax return.
23. Under a capital lease, each monthly payment is debited by the lessee to Rent Expense.
24. When the terms of a lease require that the lessee record an asset and a liability, the two accounts are
recorded at the present value of the total lease payments required.
25. Under a capital lease, the lessee records both an asset and a liability.
26. Under a capital lease, the lessor, not the lessee, should record depreciation.
27. In a monthly mortgage payment, a smaller amount is devoted to interest expense than in the previous
month’s payment.
28. When a monthly mortgage payment is made and recorded, the debit to Mortgage Payable represents
the reduction in the principal balance.
29. As the interest coverage ratio increases, the risk for creditors decreases.
30. The more debt securities a corporation issues, the greater the risk of default.
31. Bondholders are debtors of the issuing corporation.
32. Secured bonds are also known as debentures.
33. Unamortized Bond Premium is subtracted from Bonds Payable on the balance sheet.
34. Face interest rate is another term for market interest rate.
35. The callable feature of a bond can be exercised by the issuer.
36. The convertibility feature of a bond can be exercised by the issuing corporation.
37. Unamortized Bond Discount is a contra-asset account.
38. If the market interest rate at the date of issuance of a bond exceeds the face interest rate, the bond will
probably be sold at a premium.
39. A bond agreement is referred to as the premium.
40. Interest on bonds usually is paid annually.
41. Bond certificates are issued to the issuing corporation by the SEC.
42. Most bonds issued today are coupon bonds rather than registered bonds.
43. The par value of a bond is equal to its market value.
44. When all the bonds of an issue mature at the same time, they are called serial bonds.
45. The market interest rate is also called the face interest rate.
46. Discounts or premiums are contra-accounts that are subtracted from or added to bonds payable on the
balance sheet.
47. If the face interest rate at the date of bond issuance exceeds the market interest rate, the bond will
probably be sold at a discount.
48. The convertible feature of bonds is useful if a company wants to retire a bond issue.
49. The call price of bonds is usually below face value.
50. A corporation probably does not know who owns its coupon bonds.
51. An $160,000 bond issue priced at 97-3/4 is sold for $156,400.
52. The carrying amount always approaches the face value over the life of the bond.
53. Once a corporation issues bonds, it need only pay interest to the bondholders over the life of the bonds,
usually semi-annually, and not repay principal of the bonds at maturity.
54. Bond issue costs have the effect of increasing a premium, or reducing a discount, on bonds issued.
55. If a bond has a face interest rate of 6 percent, a face value of $40,000, and pays interest semi-annually,
each interest payment will amount to $2,400.
56. If a bond with a face value of $1,000 and a face interest rate of 7 percent is issued for $970, the market
interest rate at the date of issuance must have been greater than 7 percent.
57. The present value of a bond is determined by subtracting the discounted value of the payment at
maturity from the discounted value of a series of fixed interest payments.
58. When the present value of a bond issue is calculated, both the present value of a single sum table and
the present value of an annuity table must be used.
59. If the market interest rate at the date of issuance of a bond exceeds the face interest rate, the present
value of the face value plus the present value of all the future interest payments will equal an amount
greater than the face value of the bond.
60. When the present value of a bond issue is calculated, the discount rate used should equal the face
interest rate of the bonds.
61. The present value of a bond can be more or less than the face value of the bond.
62. Whether a bond is sold at a discount or a premium, its carrying value will not equal its face value on
the maturity date.
63. The effective interest method produces a constant dollar amount of bond interest expense to be
reported each interest period.
64. When there are material differences between the results of using the straight-line method and using the
effective interest method of amortization, the straight-line method should be used.
65. Issuing bonds at a discount has the effect of decreasing interest expense below the face amount of
interest.
66. Total interest cost for a bond issued at a premium equals the total of the periodic interest payments
plus the premium.
67. Under the effective interest method of amortizing a bond discount, the bond interest expense recorded
for each period increases over the life of the bond.
68. The carrying value of a bond issued at a premium is calculated at any given point in time by adding the
balance of the unamortized premium from the bond’s face value.
69. When a bond has been issued at a discount, the carrying value at the end of one period is equal to the
carrying value at the beginning of the period plus the amount of discount that was amortized during the
period.
70. When the effective interest method of amortization is used, the amount of bond interest expense for a
given period is calculated by multiplying the market interest rate by the bond’s carrying value at the
beginning of the given period.
71. Regardless of whether the straight-line method or the effective interest method is used, the carrying
value of a term bond issued at a discount will decrease continually over the life of the bond.
72. The calculation of cash for interest to be paid each interest period in connection with a bond payable is
influenced by any premium or discount upon issuance.
73. The amount of unamortized discount at the end of an interest period is equal to the amount of the
unamortized discount at the beginning of the period minus the amount of discount that was amortized
during the period.
74. When a bond issue is converted into common stock, total contributed capital is increased by the face
value of the bonds converted.
75. When bonds are converted to stock, no gain or loss is recognized.
76. When bonds are called for retirement, any excess of the bonds’ call price over the bonds’ carrying
value is reported as a loss on the income statement.
77. If bonds are retired by an issuer by purchase on the open market at a price below the bonds’ carrying
value, a gain will result.
78. When bonds are converted to stock, any excess carrying value of the bonds over the par value of the
stock is to be recorded as Capital Stock.
79. It is the bondholder rather than the issuer who may exercise the call feature of a callable bond.
MULTIPLE CHOICE
1. The debt to equity ratio is expressed in terms of
a.
a percentage.
b.
dollars.
c.
units.
d.
times.
2. The interest coverage ratio equals income before income taxes plus interest expense divided by
a.
income before income taxes.
b.
gross profit.
c.
interest expense.
d.
income taxes.
3. Which of the following is not descriptive of a defined benefit plan?
a.
The pension expense account must be determined by actuarial calculations.
b.
The employer guarantees the employee certain benefits upon retirement.
c.
The accounting for annual pension expense is simple.
d.
The annual contribution is based on estimated future benefits.
4. Under an operating lease, the lessee
a.
debits Capital Lease Equipment.
b.
debits Rent Expense.
c.
records depreciation on the leased asset.
d.
credits Capital Lease Obligations.
5. Under a capital lease, the lessee does not record which of the following?
a.
Rent expense
b.
Capital lease obligations
c.
Depreciation on the leased asset
d.
Capital lease assets
6. Under a defined benefit pension plan,
a.
actuarial computations are unnecessary.
b.
accounting for annual pension expense is simple.
c.
retirement payments are based on the amount accumulated in the pension fund.
d.
the employer guarantees the employees certain benefits upon retirement.
7. Which of the following is not an advantage of issuing long-term debt?
a.
The stockholders do not relinquish any control.
b.
The interest is tax-deductible.
c.
The risk of becoming bankrupt is reduced.
d.
Increased earnings accrue to the stockholders.
8. All of the following are advantages of issuing bonds rather than stock except
a.
financial leverage.
b.
payment of bond interest is not required
c.
bond interest is tax-deductible.
d.
bondholders do not have voting rights.
9. Interest coverage ratio is a measure of
a.
how much debt a company carries.
b.
income after taxes and interest divided by interest expense.
c.
stockholders’ control.
d.
protection from default on interest.
10. A deferred income tax liability arises when
a.
a revenue item is not subject to income taxes.
b.
there is a difference between financial reporting requirements and income tax filing
requirements.
c.
a corporation is able to obtain an extension on its income tax filing.
d.
an expense is not deductible for tax purposes.
11. The advantages of financial leverage accrue primarily to
a.
management.
b.
stockholders.
c.
bondholders.
d.
lenders.
12. Which of the following is an example of off-balance-sheet financing?
a.
Leases
b.
Bonds
c.
Mortgages
d.
Pensions
13. Which of the following qualifies as a capital lease?
a.
Three-year lease on a company vehicle
b.
Five-year lease on equipment with an option to renew for one more year
c.
Seven-year lease on a machine that has a seven-year useful life
d.
Monthly lease on office space that can be canceled with 30 days’ notice
14. Other postretirement benefits should be expensed
a.
on the employee’s retirement date.
b.
as they are received by the employee.
c.
when the employee is hired.
d.
as the employee earns them.
15. Which of the following statements best describes the behavior over time of the components of equal
mortgage payments?
a.
The proportion of interest expense to payment of principal remains the same.
b.
Payment of principal increases and interest expense decreases.
c.
Both payment of principal and interest expense decrease.
d.
Interest expense increases and payment of principal decreases.
16. All of the following are operating leases except a
a.
monthly lease on a building that can be canceled with 60 days’ notice.
b.
Seven-year lease on a new building.
c.
Four-year lease on a truck with an option to renew for two more years.
d.
Ten-year lease of a computer with an option to buy for a small amount at the end of the
lease.
17. Which of the following statements is not true about trading on the equity?
a.
It can become a disadvantage to a corporation.
b.
It is another phrase for financial leverage.
c.
It will increase the number of shares of stock owned.
d.
It will increase the interest a corporation must pay.
18. Adair Corporation purchased a building on January 2 by signing a long-term $1,200,000 mortgage
with monthly payments of $11,000. The mortgage carries an interest rate of 10 percent. The entry to
record the mortgage will include a
a.
debit to the Mortgage Payable account for $1,200,000.
b.
credit to the Cash account for $1,200,000.
c.
debit to the Cash account for $1,200,000.
d.
credit to the Mortgage Payable account for $1,200,000.
19. Adair Corporation purchased a building on January 2 by signing a long-term $1,200,000 mortgage
with monthly payments of $11,000. The mortgage carries an interest rate of 10 percent. The entry to
record the first monthly payment will be:
a.
Mortgage Interest Expense 11,000
Cash 11,000
b.
Mortgage Payable 1,000
Mortgage Interest Expense 10,000
Cash 11,000
c.
Mortgage Interest Expense 1,000
Mortgage Payable 10,000
Cash 11,000
d.
Mortgage Payable 11,000
Cash 11,000
20. Adair Corporation purchased a building on January 2 by signing a long-term $1,200,000 mortgage
with monthly payments of $11,000. The mortgage carries an interest rate of 10 percent. The amount
owed on the mortgage at the end of the first month will be
a.
$1,200,000.
b.
$1,199,000.
c.
$1,190,000.
d.
$1,189,000.
21. A company with income before income taxes of $192,000, and $40,000 in interest expense, has an
interest coverage ratio of
a.
5.8 times.
b.
4.8 times.
c.
3.8 times.
d.
6.8 times.
22. Bonds that mature in installments are called
a.
term bonds.
b.
debenture bonds.
c.
zero coupon bonds.
d.
serial bonds.
23. An unsecured bond is the same as a
a.
serial bond.
b.
zero coupon bond.
c.
debenture bond.
d.
secured bond.
24. A corporation issues bond certificates to
a.
owners.
b.
principals.
c.
creditors.
d.
debtors.
25. A secured bond is
a.
a bond that is secured by specific assets of the issuing corporation.
b.
the agreement between the issuing corporation and the bondholders.
c.
a bond that is unsecured.
d.
a bond that has past due interest payments.
26. Debenture bonds are
a.
bonds that have a single maturity date.
b.
bonds secured by specific assets of the issuing corporation.
c.
issued only by the federal government.
d.
issued on the general credit of the corporation and do not pledge certain assets as
collateral.
27. Term bonds are bonds that
a.
mature on several different dates.
b.
all have the same maturity date.
c.
must be secured.
d.
are also called serial bonds.
28. Term bonds are bonds that
a.
are also called serial bonds.
b.
may be called in and redeemed by the issuing corporation prior to their scheduled maturity
date.
c.
are secured by specific assets of the issuing corporation.
d.
mature in one lump sum at a single maturity date.
29. If the market interest rate is higher than the face interest rate at the date of issuance, bonds will
a.
not sell until the face interest rate is adjusted.
b.
sell at face value.
c.
sell at a discount.
d.
sell at a premium.
30. If bonds are issued at a premium, the face interest rate is
a.
lower than the market rate of interest.
b.
higher than the market rate of interest.
c.
too low to attract investors.
d.
adjusted to a higher effective rate of interest.
31. The responsibility for receiving the proper amount of interest falls on the bondholder most heavily in
the case of
a.
unsecured bonds
b.
secured bonds
c.
coupon bonds.
d.
registered bonds.
32. A bond with a face value of $1,000 has a current price quote of 98.00. This bond is selling for
a.
$1,080.00.
b.
$1,030.00.
c.
$980.00.
d.
$880.00.
33. A bond with a face value of $20,000 has a current price quote of 102.62. The price in dollars and cents
is
a.
$20,005.24.
b.
$20,401.24.
c.
$20,052.40.
d.
$20,524.00.
34. Bond issue costs
a.
must be expensed when incurred.
b.
must be amortized over the life of the bonds.
c.
are recorded in an asset account and not amortized.
d.
appear on the balance sheet as a liability.
35. Any unamortized bond discount should be reported on the balance sheet of the issuing corporation as
a(n)
a.
asset.
b.
direct deduction from retained earnings in the stockholders’ equity section.
c.
addition to the face amount of the bonds in the liability section.
d.
direct deduction from the face amount of the bonds in the liability section.
36. Bonds Payable should be classified as a long-term liability on a balance sheet unless the issue is
a.
not maturing within one year of the balance sheet date.
b.
maturing within one year of the balance sheet date and is to be paid by segregated assets
that are classified as long-term assets.
c.
maturing within one year of the balance sheet date and is to be retired by the use of current
assets.
d.
maturing within one year of the balance sheet date and is to be replaced by another bond
issue.
37. The entry to record the issuance of bonds at a discount on an interest payment date should include a
a.
debit to Cash for the face amount of the bonds.
b.
debit to Cash for the face amount of the bonds plus the amount of discount.
c.
debit to Cash for the face amount of the bonds minus the amount of discount.
d.
credit to Cash for the face amount of the bonds.
38. Bond issue costs have the effect of
a.
decreasing the face value of the bond.
b.
increasing a bond premium.
c.
decreasing the effective interest rate.
d.
increasing a bond discount.
39. If Crittenden Corporation issued Ten bonds of $3,000 at 99.75 on the interest date. The entry to
record this transaction is:
a.
Cash 2,993
Bonds Payable 2,993
b.
Cash 29,925
Bonds Payable 29,925
c.
Cash 30,000
Unamortized Bond Premium 75
Bonds Payable 29,925
d.
Cash 29,925
Unamortized Bond Discount 75
Bonds Payable 30,000
40. Which of the following is not needed in calculating the value of a bond?
a.
Face interest rate
b.
Market interest rate
c.
Present value of periodic interest payments
d.
Future value of face (maturity) amount
41. On January 2, 2013, Barham Corporation issued ten-year bonds payable with a face value of $400,000
and a face interest rate of 9 percent. The bonds were issued to yield a market interest rate of 10
percent. Interest is payable semi-annually on January 2 and July 1. In calculating the present value of
the bond issue on January 2, 2013,
a.
the 9 percent rate will be used to calculate the present value of the face amount and the
present value of the periodic interest payments.
b.
a 5 percent rate will be used to calculate the present value of the face amount and the
present value of the periodic interest payments.
c.
the 10 percent rate will be used to calculate the present value of the face amount and the
present value of the periodic interest payments.
d.
the 10 percent rate will be used to calculate the present value of the face amount and a 5
percent rate will be used to calculate the present value of the periodic interest payments.
42. On January 2, 2013, Owsley Corporation issued 20-year bonds payable with a face value of $600,000
and a face interest rate of 10 percent. The bonds were issued to yield a market interest rate of 12
percent. Interest is payable annually on January 2. In calculating the present value of the bond issue of
January 2, 2013, the
a.
12 percent rate will be used to calculate the present value of the face amount and the 10
percent rate will be used to calculate the present value of the periodic interest payments.
b.
12 percent rate will be used to calculate the present value of the face amount and the
present value of the periodic interest payments.
c.
10 percent rate will be used to calculate the present value of the face amount and the
present value of the periodic interest payments.
d.
10 percent rate will be used to calculate the present value of the face amount and the 12
percent rate will be used to calculate the present value of the periodic interest payments.
43. A $10,000, 8%, 5-year bond pays fixed interest of $400 every 6 months. If the current market rate of
interest is 6%, what is the present value of the bond? (Round to the nearest dollar.)
a.
$10,004
b.
$10,882
c.
$10,852
d.
$10,054
44. A bond premium has the effect of
a.
lowering the carrying value of the bond.
b.
raising the effective interest rate above the face interest rate.
c.
increasing the amount of cash paid for interest each six months.
d.
lowering the effective interest rate below the face interest rate.
45. When bonds are issued at a premium, the total interest cost of the bonds over the life of the bonds is
equal to the amount of
a.
interest payments made over the life of the bonds minus the amount of issuance premium.
b.
issuance premium.
c.
interest payments made over the life of the bonds plus the amount of issuance premium.
d.
interest payments made over the life of the bonds.
46. The effective interest method of amortization of bond premiums and discounts is superior to the
straight-line method because it results in a(n)
a.
more variable interest rate.
b.
uniform rate of interest.
c.
interest rate that increases or decreases slightly over time.
d.
interest rate that is close to the market interest rate.
47. In 2010, Hopkins Corporation issued ten-year, 10 percent bonds when the market interest rate was 12
percent. Interest is payable annually. During 2013, the market rate of interest for similar bonds was 14
percent. Using the effective interest method of amortization, what interest rate will be used to calculate
interest expense for 2013?
a.
14 percent
b.
10 percent
c.
4 percent
d.
12 percent
48. Spencer Corporation issued 30-year term bonds at a premium in 2013. Interest is payable
semi-annually. Which of the following statements is true, assuming that the effective interest method
of amortization is used for the bond premium?
a.
Interest expense decreases each six-month interest period.
b.
Interest expense as a percentage of the bond’s book value changes from period to period.
c.
Interest expense increases each six-month interest period.