Chapter 10 – Long-Term Liabilities
TRUE/FALSE
1. Financial leverage is also known as trading on the equity.
2. Dividends on stock are tax-deductible to the issuing corporation, whereas interest on debt is not.
3. The debt to equity ratio is a measure of financial leverage.
4. The interest coverage ratio is expressed as a percentage.
5. Bondholders share voting rights with stockholders.
6. A corporation’s stockholders are the primary recipients of financial leverage.
7. The debt to equity ratio is expressed in terms of dollars.
8. The higher the debt to equity ratio, the greater the financial risk the company is taking.
9. Entering into a lease is an example of off-balance-sheet financing.
10. The practice of off-balance-sheet financing is illegal.
11. The interest coverage ratio measures the degree of protection a company has from default on interest
payments.
12. Failure to make interest payments on debt can force a company into bankruptcy.
13. When interest payments on an investment exceed the earnings from the investment, negative financial
leverage has occurred.
14. It is illegal for a company to use depreciation methods for financial reporting that differ from those
used for income tax return purposes.
15. Deferred income taxes arise when accounting methods used for financial reporting differ from those
used on the income tax return.
16. Under an operating lease, each monthly payment is debited by the lessee to Rent Expense.
17. Under an operating lease, the lessee records both an asset and a liability.
18. 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.
19. Under a capital lease, the lessor, not the lessee, should record depreciation.
20. In a monthly mortgage payment, the same amount is devoted to interest expense as in the previous
month’s payment.
21. Leases of short-term assets are operating leases, and leases of long-term assets are capital leases.
22. A capital lease is a lease of property, plant, or equipment that is in effect an installment purchase.
23. Accounting for capital leases can be thought of as similar to accounting for mortgage payments.
24. When a monthly mortgage payment is made and recorded, the debit to Mortgage Payable represents
the reduction in the principal balance.
25. Under a defined contribution pension plan, retirement benefits are based entirely on the annual
contribution to the fund plus earnings thereon.
26. Accounting for a defined benefit pension plan is simpler than accounting for a defined contribution
plan.
27. Costs of postretirement benefits other than pension plans should be expensed when paid to the retired
employee.
28. A capital lease represents both an asset and a liability.
29. As the interest coverage ratio declines, the risk for creditors also declines.
30. Financial leverage refers to the issuance of stock to raise cash.
31. The more debt securities a corporation issues, the greater the risk of default.
32. Bondholders are creditors of the issuing corporation.
33. Secured bonds are also known as debentures.
34. Unamortized Bond Premium is added to Bonds Payable on the balance sheet.
35. Face interest rate is another term for market interest rate.
36. 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.
37. The call feature of bonds is useful if a company wants to retire a bond issue.
38. The call price of bonds is usually below face value.
39. The callable feature of a bond can be exercised by the bondholder.
40. The convertibility feature of a bond can be exercised by the issuing corporation.
41. Unamortized Bond Discount is a contra-liability account.
42. 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.
43. A bond agreement is referred to as the debenture.
44. An $80,000 bond issue priced at 97-3/4 is sold for $78,200.
45. Term bonds are of shorter duration than serial bonds.
46. A corporation probably does not know who owns its coupon bonds.
47. Interest on bonds usually is paid annually.
48. Bond certificates are issued to creditors of the issuing corporation.
49. Most bonds issued today are coupon bonds rather than registered bonds.
50. The par value of a bond is equal to its face value.
51. When all the bonds of an issue mature at the same time, they are called serial bonds.
52. The market interest rate is also called the effective interest rate.
53. The carrying amount always approaches the face value over the life of the bond.
54. Once a corporation issues bonds, it must pay interest to the bondholders over the life of the bonds,
usually semi-annually, and the principal of the bonds at maturity.
55. If a bond has a face interest rate of 6 percent, a face value of $20,000, and pays interest semi-annually,
each interest payment will amount to $1,200.
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. Bond issue costs have the effect of increasing a premium, or reducing a discount, on bonds issued.
58. 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
less than the face value of the bond.
59. The present value of a bond is determined by adding the discounted value of the payment at maturity
to the discounted value of a series of fixed interest payments.
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. 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.
62. If a 20-year bond pays interest of 8 percent semi-annually, the present value of the bond is calculated
based upon 4 percent and 40 periods.
63. The present value of a bond is always less than the face value of the bond.
64. The carrying value of a bond is also referred to as its present value.
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
minus the premium.
67. Discounts or premiums are contra-accounts that are subtracted from or added to bonds payable on the
balance sheet.
68. 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.
69. Whether a bond is sold at a discount or a premium, its carrying value will equal its face value on the
maturity date.
70. The carrying value of a bond issued at a premium is calculated at any given point in time by deducting
the balance of the unamortized premium from the bond’s face value.
71. 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.
72. When the effective interest method of amortization is used, the amount of bond interest expense for a
given period is calculated by multiplying the face interest rate by the bond’s carrying value at the
beginning of the given period.
73. 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.
74. The effective interest method produces a constant dollar amount of bond interest expense to be
reported each interest period.
75. The calculation of cash for interest to be paid each interest period in connection with a bond payable is
not influenced by any premium or discount upon issuance.
76. 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.
77. When there are material differences between the results of using the straight-line method and using the
effective interest method of amortization, the effective interest method should be used.
78. When a bond issue is converted into common stock, total contributed capital is increased by the
carrying value of the bonds converted.
79. When bonds are called for retirement, any excess of the bonds’ call price over the bonds’ carrying
value is reported as a gain on the income statement.
80. When bonds are converted to stock, no gain or loss is recognized.
81. 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.
82. 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 Additional Paid-in Capital.
83. It is the bondholder rather than the issuer who may exercise the call feature of a callable bond.
84. The cash received on bonds issued at face value and between interest dates is less than the bonds’ face
value.
85. Issuing bonds between interest payment dates will have the effect of decreasing a bond issuance
discount or increasing a bond issuance premium.
86. The entry to record the issuance of bonds between interest payment dates will include a debit to Bond
Interest Expense.
87. An adjustment must be made at the end of an accounting period to accrue the interest expense on
bonds payable and to amortize any related premium or discount from the last interest payment date to
the end of the fiscal year.
MULTIPLE CHOICE
1. A company with income before income taxes of $96,000, and $20,000 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.
2. The advantages of financial leverage accrue primarily to
a.
management.
b.
stockholders.
c.
the government.
d.
creditors.
3. The debt to equity ratio is expressed in terms of
a.
a percentage.
b.
dollars.
c.
units.
d.
times.
4. Which of the following is an example of off-balance-sheet financing?
a.
Leases
b.
Bonds
c.
Dividends
d.
Notes
5. The interest coverage ratio equals income before income taxes plus interest expense divided by
a.
income before income taxes.
b.
net income.
c.
interest expense.
d.
total assets.
6. Which of the following qualifies as a capital lease?
a.
Four-year lease on a company vehicle
b.
Three-year lease on a computer with an option to renew for one more year
c.
Five-year lease on a machine that has a five-year useful life
d.
Monthly lease on office space that can be canceled with 30 days’ notice
7. 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.
8. Deferred income taxes arise when
a.
a revenue item is not subject to income taxes.
b.
there is a discrepancy 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.
9. 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.
10. All of the following are operating leases except a
a.
monthly lease on a building that can be canceled with 90 days’ notice.
b.
ten-year lease on a new building.
c.
two-year lease on a truck with an option to renew for one more year.
d.
five-year lease of a computer with an option to buy for a small amount at the end of the
lease.
11. Under a defined contribution pension plan,
a.
the pension expense account must be determined by actuarial calculations.
b.
the employer guarantees the employee certain benefits upon retirement.
c.
accounting for annual pension expense is simple.
d.
the annual contribution is based on estimated future benefits.
12. 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.
13. 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
14. Crowley Corporation purchased a building on January 2 by signing a long-term $600,000 mortgage
with monthly payments of $5,500. 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 $600,000.
b.
credit to the Cash account for $600,000.
c.
debit to the Cash account for $600,000.
d.
credit to the Mortgage Payable account for $600,000.
15. Crowley Corporation purchased a building on January 2 by signing a long-term $600,000 mortgage
with monthly payments of $5,500. The mortgage carries an interest rate of 10 percent. The entry to
record the first monthly payment will be:
a.
Mortgage Interest Expense 5,000
Cash 5,000
b.
Mortgage Payable 500
Mortgage Interest Expense 5,000
Cash 5,500
c.
Cash 5,500
Mortgage Interest Expense 5,500
d.
Cash 5,500
Mortgage Payable 5,500
16. Crowley Corporation purchased a building on January 2 by signing a long-term $600,000 mortgage
with monthly payments of $5,500. 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.
$600,000.
b.
$599,500.
c.
$595,000.
d.
$594,500.
17. 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.
18. 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.
19. 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.
20. 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.
21. Interest coverage ratio is a measure of
a.
financial leverage.
b.
income after taxes and interest divided by interest expense.
c.
stockholders’ control.
d.
protection from default on interest.
22. Bonds that mature in installments are called
a.
term bonds.
b.
debenture bonds.
c.
zero coupon bonds.
d.
serial bonds.
23. 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.
24. 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.
25. An unsecured bond is the same as a
a.
term bond.
b.
zero coupon bond.
c.
debenture bond.
d.
bond indenture.
26. A corporation issues bond certificates to
a.
owners.
b.
principals.
c.
creditors.
d.
debtors.
27. The responsibility for receiving the proper amount of interest falls on the bondholder most heavily in
the case of
a.
term bonds.
b.
serial bonds.
c.
coupon bonds.
d.
registered bonds.
28. A bond with a face value of $1,000 has a current price quote of 98.00. This bond is selling for
a.
$1080.00.
b.
$1030.00.
c.
$980.00.
d.
$880.00.
29. A bond indenture 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.
30. 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.
31. A bond with a face value of $10,000 has a current price quote of 102.62. The price in dollars and cents
is
a.
$10,002.62.
b.
$10,200.62.
c.
$10,026.20.
d.
$10,262.00.
32. Serial 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 term bonds.
33. 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.
34. If Rex Corporation issued Ten bonds of $1,000 at 99.75 on the interest date. The entry to record this
transaction is:
a.
Cash 990.75
Bonds Payable 990.75
b.
Cash 9,907.50
Bonds Payable 9,907.50
c.
Cash 997.50
Bonds Payable 997.50
d.
Cash 9,975
Unamortized bond Discount 25
Bonds Payable 10,000
35. 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.
36. 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.
37. 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.
38. 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.
39. Bond issue costs have the effect of
a.
decreasing a bond discount.
b.
increasing a bond premium.
c.
decreasing the effective interest rate.
d.
decreasing a bond premium.
40. On January 2, 2010, 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, 2010,
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.
41. On January 2, 2010, McGowan Corporation issued 20-year bonds payable with a face value of
$300,000 and a face interest rate of 8 percent. The bonds were issued to yield a market interest rate of
9 percent. Interest is payable annually on January 2. In calculating the present value of the bond issue
of January 2, 2010, the
a.
9 percent rate will be used to calculate the present value of the face amount and the 8
percent rate will be used to calculate the present value of the periodic interest payments.
b.
9 percent rate will be used to calculate the present value of the face amount and the present
value of the periodic interest payments.
c.
8 percent rate will be used to calculate the present value of the face amount and the present
value of the periodic interest payments.
d.
8 percent rate will be used to calculate the present value of the face amount and the 9
percent rate will be used to calculate the present value of the periodic interest payments.
42. Which of the following is not needed in calculating the value of a bond?
a.
Face interest rate
b.
Market interest rate
c.
Future value of periodic interest payments
d.
Present value of face (maturity) amount
43. 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.
44. The total interest cost on thirty-nine, ten-year, 6 percent, $1,000 bonds that are issued at 98 is
a.
$24,180.
b.
$22,620.
c.
$23,790.
d.
$23,400.
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. Suffolk Corporation issued $100,000 of 20-year, 6 percent bonds at 98 on one of its semi-annual
interest dates. The straight-line method of amortization is to be used. The entry to record the bond
interest expense on the next interest payment date is:
a.
Bond Interest Expense 3,050
Unamortized Bond Discount 50
Cash 3,000
b.
Bond Interest Expense 6,000
Unamortized Bond Discount 500
Cash 5500
c.
Cash 6,050
Unamortized Bond Discount 6,050
d.
Bond Interest Expense 3,000