Chapter 14
LONG-TERM LIABILITIES
1. The legal contract between the issuing corporation and the bondholders is called the bond
indenture.
2. Term bonds are scheduled for maturity on one specified date, whereas serial bonds mature
at more than one date.
3. Debentures always have specific assets of the issuing company pledged as collateral.
4. Callable bonds have an option exercisable by the issuer to retire them at a stated dollar
amount prior to maturity.
5. Callable bonds can be exchanged for a fixed number of shares of the issuing corporation’s
common stock.
6. Callable bonds reduce the bondholder’s risk by requiring the issuer to create a sinking fund
of assets set aside at specified amounts and dates to repay the bonds at maturity.
7. Owners of coupon bonds are not required to pay tax on the interest earned.
8. A bond’s par value is not necessarily the same as its market value.
9. An installment note is an obligation of the issuing company that requires a series of
periodic payments to the lender.
10. Payments on an installment note normally include the accrued interest expense plus a
portion of the amount borrowed.
11. Bonds and long-term notes are similar in that they are typically transacted with multiple
lenders.
12. The carrying value of a long-term note is computed as the present value of all remaining
future payments, discounted using the market rate at the time of issuance.
13. Mortgage contracts grant the lender the right to be paid from the cash proceeds of the sale
of a borrower’s assets identified in the mortgage.
14. Mortgage bonds are backed only by the good faith and credit of the issuing company.
15. A basic present value concept is that cash paid or received in the future is worth less than
the same amount of cash today.
16. A basic present value concept is that cash paid or received in the future is worth more than
the same amount of cash received today.
17. Compound interest means that interest in a second period is based on the total amount
borrowed plus the interest accrued in the first period.
18. A company invests $10,000 at 7% compounded annually. At the end of the second year,
the company should have $11,400 in the fund.
19. An annuity is a series of equal payments at equal time intervals.
20. The present value of an annuity can be best or quickly computed as the sum of the
individual future values for each payment.
21. The present value of an annuity factor at 8% for 10 years is 6.7101. This implies that an
annuity of ten $15,000 payments at 8% yields a present value of $2,235.
22. The present value of an annuity factor for 6 years at 10% is 4.3553. This implies that an
annuity of six $2,000 payments at 10% would equal $8,710.60.
23. 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.
24. Operating leases are long-term or noncancelable leases in which the lessor transfers
substantially all the risks and rewards of ownership to the lessee.
25. A pension plan is a contractual agreement between an employer and its employees in
which the employer provides benefits to employees after they retire.
26. A bond is a written promise to pay an amount identified as the par value of the bond along
with interest.
27. An advantage of bond financing is that issuing bonds does not affect owner control.
28. Interest payments on bonds are determined by multiplying the par value of the bond by the
stated contract rate.
29. 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.
30. The use of debt financing insures an increase in return on equity.
31. Bond interest paid by a corporation is an expense, whereas dividends paid are not an
expense of the corporation.
32. Collateral from unsecured loans may be sold to offset the loan obligation if the loan is in
default.
33. A company’s ability to issue unsecured debt depends on its credit standing.
34. A lessee has substantially all of the benefits and risks of ownership in an operating lease.
35. A company with a low level of liabilities in relation to stockholders’ equity is likely to
have a very high debt-to-equity ratio.
36. The debt-to-equity ratio is calculated by dividing total stockholders’ equity by total
liabilities.
37. The debt-to-equity ratio enables financial statement users to assess the risk of a company’s
financing structure.
38. A company has assets of $350,000 and total liabilities of $200,000. Its debt-to-equity ratio
is 0.6.
39. 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.
40. The contract rate on previously issued bonds changes as the market rate of interest
changes.
41. Long-term bonds have relatively higher interest rates because they carry higher risk due to
the longer time period.
42. 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.
43. When the contract rate on a bond issue is less than the market rate, the bonds will
generally sell at a discount.
44. When the contract rate is above the market rate, a bond sells at a discount.
45. A discount on bonds payable occurs when a company issues bonds with an issue price less
than par value.
46. The carrying (book) value of a bond at the time when it is issued is always equal to its par
value.
47. The carrying (book) value of a bond payable is the par value of the bonds plus the
discount.
48. On January 1, a company issued a $500,000, 10%, 8-year bond payable, and received
proceeds of $487,000. Interest is payable each June 30 and December 31. The total interest
expense on the bond over its eight-year life is $400,000.
49. On January 1, a company issued a $500,000, 10%, 8-year bond payable, and received
proceeds of $487,000. 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 $812.50.
50. On January 1, a company issued a $500,000, 10%, 8-year bond payable, and received
proceeds of $487,000. 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.
51. A premium on bonds occurs when bonds carry a contract rate greater than the market rate
at issuance and the premium reduces the interest expense of the bond over its life.
52. The market value or issue price of a bond is equal to the present value of all future cash
payments provided by the bond.
53. Premium on Bonds Payable is an adjunct or accretion liability account.
54. If a bond’s interest period does not coincide with the issuing company’s accounting period,
an adjusting entry is necessary to recognize bond interest expense accruing since the most
recent interest payment.
55. The issue price of bonds is found by computing the future value of the bond’s cash
payments, discounted at the market rate of interest.
56. The effective interest method yields increasing amounts of bond interest expense and
decreasing amounts of premium amortization over the bond’s life for bonds issued at a
premium.
57. Two common ways of retiring bonds before maturity are to (1) exercise a call option or
(2) purchase them on the open market.
58. 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.
59. Payments on installment notes normally include accrued interest plus a portion of the
principal amount borrowed.
60. 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.
61. Sinking fund bonds:
A. Require the issuer to set aside assets to retire 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.
62. Bonds that have an option exercisable by the issuer to retire them at a stated dollar amount
prior to maturity are known as:
A. Convertible bonds.
B. Sinking fund bonds.
C. Callable bonds.
D. Serial bonds.
E. Junk bonds.
63. A bond traded at 102½ means that:
A. The bond pays 2.5% interest.
B. The bond traded at $1,025 per $1,000 bond.
C. The market rate of interest is 2.5%.
D. The bonds were retired at $1,025 each.
E. The market rate of interest is 2 ½ % above the contract rate.
64. Secured bonds:
A. Are called debentures.
B. Have specific assets of the issuing company pledged as collateral.
C. Are backed by the issuer’s bank.
D. Are subordinated to those of other unsecured liabilities.
E. Are the same as sinking fund bonds.
65. Bonds that have interest coupons attached to their certificates, which the bondholders
detach during each interest period and present to a bank for collection, are called:
A. Coupon bonds.
B. Callable bonds.
C. Serial bonds.
D. Convertible bonds.
E. Registered bonds.
66. Bonds owned by investors whose names and addresses are recorded by the issuing
company, and for which interest payments are made with checks or cash transfers to the
bondholders, are called:
A. Callable bonds.
B. Serial bonds.
C. Registered bonds.
D. Coupon bonds.
E. Bearer bonds.