Deck 11: Financial Instruments As Liabilities

Question 1

A product warranty provided with the sale of an item of merchandise gives rise to a nonmonetary liability.

Answer 1

True

Question 2

A liability that is satisfied through the payment of cash is referred to as a denominational liability.

Answer 2

False

Question 3

When the market rate of interest is above the nominal rate,a bond sells at a premium.

Answer 3

False

Question 4

Annual amortization of discount on bonds payable (bond discount)results in an increase in interest expense and the bond's carrying value.

Question 5

Bonds are required by GAAP to be reported on the balance sheet at market value.

Question 6

During the past year a company reported bond interest expense of $29,875 and a cash interest payment of $27,500;therefore the bond's carrying value must have increased by $2,375 during the past year.

Question 7

As a bond matures,annual amortization of premium on bonds payable (bond premium)increases while annual interest expense decreases.

Question 8

The annual amortization of both discount on bonds payable (bond discount)and premium on bonds payable (bond premium)increases as the bond matures.

Question 9

When the market rate of interest is below the nominal rate,a bond sells at stated value.

Question 10

When the effective yield of a bond is the same as the stated rate on the bond,the bond is sold at par.

Question 11

A rise in the market rate of interest will cause the value of a financial instrument such as a bond to rise.

Question 12

A five-year bond with a maturity value of $900,000 and a stated interest rate of 8% initially sold for $879,000;total interest expense during the five-year life of the bond will be $339,000.

Question 13

Net income for a particular time period will be understated if a bond issuer fails to amortize premium on bonds payable (bond premium)during that time period.

Question 14

The price charged for the privilege of delaying payment on a liability is interest.

Question 15

Annual amortization of discount on bonds payable (bond discount)increases as a bond matures.

Question 16

Discount on bonds payable (bond discount)is a liability valuation account.

Question 17

The precise terms of a bond issue are found in the bond indenture agreement.

Question 18

When bonds were initially sold at a discount,interest expense increases as the bonds reach maturity.

Question 19

A company is considering offering for sale one of two bond issues.The two bond issues are equivalent except that one bond pays semi-annual interest while the other bond pays annual interest.The proceeds from the sale of the bond with annual interest payments will be greater than the proceeds from the sale of the bonds with semi-annual payments.

Question 20

A current monetary liability is shown on the financial statements at the undiscounted amount due.

Question 21

The value of a futures contract entered into to hedge inventory being held for sale increases as the selling price of the inventory increases.

Question 22

A call option contract requires the holder to buy a specific underlying asset at a set price during a specific time period.

Question 23

Floating-rate debt protects investors from losses because the market value of this debt remains constant when the market rate of interest changes.

Question 24

All derivatives must be carried on the balance sheet at historical cost.

Question 25

Current GAAP has eliminated the opportunity for a company to attempt to generate income statement gains and the resulting favorable financial ratio effects associated with many debt-for-debt and debt-for-equity swaps.

Question 26

Changes in the fair value of all derivatives other than hedges must be recognized in income when they occur.

Question 27

A year-by-year transfer of wealth from bondholders to stockholders occurs when the market rate of interest increases and the historical cost accounting model is used to account for bonds.

Question 28

When a debt is retired on the maturity date,the book value is always equal to the market value.

Question 29

The gain or loss on the early retirement of a bond is the difference between the amount paid to retire the bond and the bond's carrying value at the date of retirement.

Question 30

A hedge of the exposure to changes in the fair market value of an existing asset or liability or a firm commitment is a fair value hedge.

Question 31

A lender can effectively convert a fixed-rate debt into a floating-rate debt by using an interest rate swap.

Question 32

An example of a derivative instrument is a forward contract.

Question 33

The gain or loss on the extinguishment of debt is usually categorized on the income statement as part of continuing operations.

Question 34

When a debt is retired on the maturity date,a loss occurs if the market rate of interest increased subsequent to the issue of the bond.

Question 35

The intent of covenants in debt agreements is to discourage lender fraud.

Question 36

The retirement of a bond which has a $250,000 maturity value and a $10,000 balance in premium on bonds payable (bond premium)creates a $15,000 gain if the bond is retired at a cost of $245,000.

Question 37

Floating-rate debt is the most common method for lenders to protect themselves from losses that arise as a result of increases in the market interest rate.

Question 38

When market rates of interest increase,the use of floating-rate debt benefits the issuing company.

Question 39

When interest rates have increased and bonds are retired before maturity,market value is below book value generating an accounting loss.

Question 40

A debt-for-debt swap of debts with equal maturity values that occurs when the market rate of interest is higher than the stated rate of the old debt will give rise to a gain on debt extinguishments.

Question 41

Strauss Company sold $100,000 of long-term bonds in the open market for $100,000.The entry to record the transaction would be

A) DR Cash $\quad$$\quad$ 100,000
CR Bonds payable $\quad$ 100,000
B) DR Bonds payable $\quad$ 100,000
CR Cash $\quad$$\quad$ 100,000
C) DR Accounts payable $\quad$ 100,000
CR Bonds payable $\quad$$\quad$ 100,000
D) DR Cash $\quad$ 100,000
CR Interest payable $\quad$ 100,000

Question 42

Theta Company has prepared to sell bonds with a stated rate of 6% when the market rate is 8%.These bonds will sell in the market at

A)par.
B)a discount.
C)a premium.
D)stated value.

Question 43

Hooker Company sells $200,000 of ten-year,8% bonds to yield 10% on January 1,2014.The bonds pay interest annually on December 31.The bonds were sold at a discount of $24,578.The bond interest expense for 2014 is

A)$16,000.
B)$17,542.
C)$20,000.
D)$21,542.

Question 44

Generally accepted accounting principles require that when bonds are sold at a discount,the discount must be allocated to interest expense using the

A)cash interest method.
B)effective interest method.
C)bond yield method.
D)cumulative interest methoD.

Question 45

Under IFRS,a classified balance sheet may list accounts in the following order: stockholders' equity,long-term liabilities,current liabilities.

Question 46

Hooker Company sells $200,000 of ten-year,8% bonds to yield 10% on January 1,2014.The bonds pay interest annually on December 31.The bonds were sold at a discount of $24,578.The bond carrying value at the end of 2015 is

A)$175,422.
B)$178,660.
C)$200,000.
D)$203,238.

Question 47

Hooker Company sells $200,000 of ten-year,8% bonds to yield 10% on January 1,2014.The bonds pay interest annually on December 31.The bonds were sold at a discount of $24,578.The bond carrying amount at the end of 2014 is

A)$175,422.
B)$176,964.
C)$200,000.
D)$201,542.

Question 48

IFRS allows the fair value option for liabilities only to eliminate or significantly reduce the "mismatch" that arises when different measurement bases are used for related financial instruments.

Question 49

Under IFRS,debt issue costs are treated as an expense of the period when the debt is issued.

Question 50

Amortization of discount on bonds payable (bond discount)results in which of the following?

A)A decrease in bond interest expense
B)An increase in net income
C)An increase in the carrying value of the bond
D)An increase in stockholders' equity due to the decrease in bond interest expense

Question 51

A probable future sacrifice of an economic benefit arising from a present obligation to transfer assets or provide services to other entities in the future as a result of a past transaction is a/an

A)asset.
B)liability.
C)equity.
D)expense.

Question 52

Baker Company issued $200,000 of ten-year bonds to yield 11% when the stated rate of the bonds was 9%.Present value factors are: $\begin{array}{lll}&9\%&11\%\\\text { PVIF of } \$ 1,10 \text { years } & 0.42241 & 0.35218 \\\text { PVIF of Annuity of } \$ 1,10 \text { years } & 6.41766 & 5.88923\end{array}$
The entry to record the sale would be

A) DR Cash $\quad 176,442$
DR Bond premium $\quad$ 23,558
CR Bonds payable $\quad$ 200,000
B) DR Cash $\quad$ 176,442
DR Bond discount $\quad$ 23,558
CR Bonds payable $\quad$ 200,000
C) DR Cash $\quad$ 223,558
CR Bond premium $\quad$ 23,558
CR Bonds payable $\quad$ 200,000
D) DR Cash $\quad$ 223,558
CR Bond discount $\quad$ 23,558
CR Bonds payable $\quad$ 200,000

Question 53

Hooker Company sells $200,000 of ten-year,8% bonds to yield 10% on January 1,2014.The bonds pay interest annually on December 31.The bonds were sold at a discount of $24,578.The amount of bond discount amortization for 2015 is

A)$1,696.
B)$2,458.
C)$3,080.
D)$4,000.

Question 54

When the market rate of interest is below the nominal rate,a bond sells at

A)par.
B)a premium.
C)a discount.
D)stated value.

Question 55

Noncurrent monetary liabilities are initially recorded at their

A)future value.
B)historical value.
C)present value when incurred.
D)undiscounted amount due.

Question 56

When computing the issue price of a bond that has a stated rate of 8% payable semiannually and a market rate of 10%,the discount rate used would be

A)8%.
B)10%.
C)4%.
D)5%.

Question 57

When the effective yield of a bond is the same as the stated rate on the bond,the bond is sold at

A)a discount.
B)a premium.
C)par.
D)a price above par.

Question 58

Hooker Company sells $200,000 of ten-year,8% bonds to yield 10% on January 1,2014.The bonds pay interest annually on December 31.The bonds were sold at a discount of $24,578.The amount of cash interest paid in 2014 on the bonds is

A)$14,458.
B)$16,000.
C)$17,542.
D)$20,000.

Question 59

Hooker Company sells $200,000 of ten-year,8% bonds to yield 10% on January 1,2014.The bonds pay interest annually on December 31.The bonds were sold at a discount of $24,578.The amount of cash interest paid in 2015 is

A)$16,000.
B)$18,000.
C)$19,080.
D)$20,000.

Question 60

Theta Company has prepared to sell bonds with a stated rate of 6% when the market rate is 5%.These bonds will sell in the market at

A)par.
B)a discount.
C)a premium.
D)stated value.

Question 61

The Ness Company sells $5,000,000 of five-year,10% bonds at the start of the year.The bonds have an effective yield of 9%.Present value factors are below: $$\begin{array} { l c c } & \underline { \mathbf { 1 0 } \% } & \underline { \mathbf { 9 \% } } \\\text { PV \$1 factor 1 year } & 0.90909 & 0.91743 \\\text { PV \$1 factor 2 years } & 0.82645 & 0.84168 \\\text { PV \$1 factor 3 years } & 0.75131 & 0.77218 \\\text { PV \$1 factor 4 years } & 0.68301 & 0.70843 \\\text { PV \$1 factor 5 years } & 0.62092 & 0.64993\end{array}$$
The bond carrying value at the end of Year 1 is

A)$4,500,000.
B)$5,000,000.
C)$5,126,556.
D)$5,161,978.

Question 62

The Ness Company sells $5,000,000 of five-year,10% bonds at the start of the year.The bonds have an effective yield of 9%.Present value factors are below: $\begin{array}{lll}&10\%&9\%\\\text { PV \$1 factor 1 year } & 0.90909 & 0.91743 \\\text { PV \$1 factor 2 years } & 0.82645 & 0.84168 \\\text { PV \$1 factor 3 years } & 0.75131 & 0.77218 \\\text { PV \$1 factor 4 years } & 0.68301 & 0.70843 \\\text { PV \$1 factor 5 years } & 0.62092 & 0.64993\end{array}$
The bond carrying value at the end of Year 2 is

A)$4,805,525.
B)$5,000,000.
C)$5,126,556.
D)$5,194,475.

Question 63

The Ness Company sells $5,000,000 of five-year,10% bonds at the start of the year.The bonds have an effective yield of 9%.Present value factors are below: $$\begin{array} { l c c } & \underline { \mathbf { 1 0 } \% } & \underline { \mathbf { 9 \% } } \\\text { PV \$1 factor 1 year } & 0.90909 & 0.91743 \\\text { PV \$1 factor 2 years } & 0.82645 & 0.84168 \\\text { PV \$1 factor 3 years } & 0.75131 & 0.77218 \\\text { PV \$1 factor 4 years } & 0.68301 & 0.70843 \\\text { PV \$1 factor 5 years } & 0.62092 & 0.64993\end{array}$$
The bonds will sell for

A)$4,805,525.
B)$5,000,000.
C)$5,050,000.
D)$5,194,475.

Question 64

When market rates of interest decrease,the use of floating-rate debt benefits

A)investors.
B)issuing companies.
C)all parties.
D)no one.

Question 65

Dot Company issued $200,000 of bonds on January 1,2014 with interest payable each year.The bonds had a stated rate of 8%.The bonds were set up as floating-rate debt with the rated pegged to LIBOR plus 3%.Which of the following will be the interest expense for year 1 if LIBOR is 5%?

A)$6,000
B)$10,000
C)$16,000
D)$18,000

Question 66

Which of the following statements with respect to floating-rate debt is incorrect?

A)If the market rate of interest increases,the market value of the floating-rate debt will remain the same.
B)If the market rate of interest decreases,the cash interest payment required by the issuing company would decrease.
C)If the market rate of interest increases,the investors benefit while the issuing corporation does not benefit.
D)If the market rate of interest decreases,both the issuing company and the investors benefit.

Question 67

The Ness Company sells $5,000,000 of five-year,10% bonds at the start of the year.The bonds have an effective yield of 9%.Present value factors are below: $$\begin{array} { l c c } & \underline { \mathbf { 1 0 } \% } & \underline { \mathbf { 9 \% } } \\\text { PV \$1 factor 1 year } & 0.90909 & 0.91743 \\\text { PV \$1 factor 2 years } & 0.82645 & 0.84168 \\\text { PV \$1 factor 3 years } & 0.75131 & 0.77218 \\\text { PV \$1 factor 4 years } & 0.68301 & 0.70843 \\\text { PV \$1 factor 5 years } & 0.62092 & 0.64993\end{array}$$
The bond interest expense for Year 1 is

A)$467,503.
B)$500,000.
C)$532,497.
D)$538,895.

Question 68

Hooker Company sells $200,000 of ten-year,8% bonds to yield 10% on January 1,2014.The bonds pay interest annually on December 31.The bonds were sold at a discount of $24,578.The amount of bond interest expense for 2015 is

A)$16,000.
B)$17,696.
C)$18,458.
D)$19,280.

Question 69

The market value of floating-rate debt of $200,000 will

A)rise by $2,000 with a 1% rise in interest rates.
B)fall by $2,000 with a 1% fall in interest rates.
C)remain unchanged with a change in interest rates.
D)will rise in the short run and fall in the long run with a change in interest rates.

Question 70

Dot Company issued $200,000 of bonds on January 1,2014 with interest payable each year.The bonds had a stated rate of 8%.The bonds were set up as floating-rate debt with the rated pegged to LIBOR plus 3%.Interest expense for year one if LIBOR is 7% will be which one of the following?

A)$6,000
B)$14,000
C)$16,000
D)$20,000

Question 71

On January 1,2014 when the effective interest rate was 14%,a company issued bonds with a maturity value of $1,000,000.The stated rate of interest is 12%,the bonds pay interest semi-annually and sold for $893,640.The amount of bond discount amortized on July 1,2014 is approximately

A)$1,000.
B)$2,555.
C)$2,000.
D)$5,110.

Question 72

The Ness Company sells $5,000,000 of five-year,10% bonds at the start of the year.The bonds have an effective yield of 9%.Present value factors are below: $\begin{array}{lll}& \underline { \mathbf { 1 0 } \% } & \underline { \mathbf { 9 \% } } \\\text { PV \$1 factor 1 year } & 0.90909 & 0.91743 \\\text { PV \$1 factor 2 years } & 0.82645 & 0.84168 \\\text { PV \$1 factor 3 years } & 0.75131 & 0.77218 \\\text { PV \$1 factor 4 years } & 0.68301 & 0.70843 \\\text { PV \$1 factor 5 years } & 0.62092 & 0.64993\end{array}$
The amount of bond premium amortization for Year 2 is

A)$32,497.
B)$35,422.
C)$38,895.
D)$50,000.

Question 73

Which of the following statements is correct?

A)Amortization of discount on bonds payable (bond discount)results in an increase in a bond's carrying value.
B)Amortization of discount on bonds payable (bond discount)results in a decrease in bond interest expense.
C)Amortization of premium on bonds payable (bond premium)results in an increase in a bond's carrying value.
D)Amortization of premium on bonds payable (bond premium)results in an increase in bond interest expense.

Question 74

The Ness Company sells $5,000,000 of five-year,10% bonds at the start of the year.The bonds have an effective yield of 9%.Present value factors are below: $$\begin{array} { l c c } & \underline { \mathbf { 1 0 } \% } & \underline { \mathbf { 9 \% } } \\\text { PV \$1 factor 1 year } & 0.90909 & 0.91743 \\\text { PV \$1 factor 2 years } & 0.82645 & 0.84168 \\\text { PV \$1 factor 3 years } & 0.75131 & 0.77218 \\\text { PV \$1 factor 4 years } & 0.68301 & 0.70843 \\\text { PV \$1 factor 5 years } & 0.62092 & 0.64993\end{array}$$
The amount of cash interest paid in Year 1 on the bonds is

A)$450,000.
B)$467,503.
C)$500,000.
D)$538,895.

Question 75

Floating-rate debt is the most common method for lenders to protect themselves from losses that arise as a result of

A)increases in the market interest rate.
B)decreases in the market interest rate.
C)increases in the stated interest rate on bonds.
D)decreases in the stated rate on bonds.

Question 76

When a bond is sold at a discount the effective interest rate is

A)equal to the stated rate.
B)above the stated rate.
C)below the stated rate.
D)equal to the stated rate for a period of time and then above the stated rate for a period of time.

Question 77

Which of the following statements is not correct regarding amortization when using the effective interest method (basis)?

A)Amortization of discount on bonds payable (bond discount)increases in later years relative to earlier years of a bond's life.
B)Amortization of premium on bonds payable (bond premium)increases in later years relative to earlier years of a bond's life.
C)Amortization of both premium on bonds payable (bond premium)and discount on bonds payable (bond discount)decreases in later years relative to earlier years of a bonds life.
D)Amortization of discount on bonds payable (bond discount)results in an increase in interest expense and in an increase in the bond's carrying value.

Question 78

When a bond is sold at a premium the

A)effective interest rate is less than the stated rate.
B)effective interest rate is greater than the stated rate.
C)effective interest rate relative to the stated rate is not known.
D)interest expense during the life of the bond exceeds the amount of cash interest payments during the life of the bonD.

Question 79

The Ness Company sells $5,000,000 of five-year,10% bonds at the start of the year.The bonds have an effective yield of 9%.Present value factors are below: $\begin{array}{lll}&10\%&9\%\\\text { PV \$1 factor 1 year } & 0.90909 & 0.91743 \\\text { PV \$1 factor 2 years } & 0.82645 & 0.84168 \\\text { PV \$1 factor 3 years } & 0.75131 & 0.77218 \\\text { PV \$1 factor 4 years } & 0.68301 & 0.70843 \\\text { PV \$1 factor 5 years } & 0.62092 & 0.64993\end{array}$
The amount of bond interest expense for Year 2 is

A)$450,000.
B)$464,578.
C)$500,000.
D)$535,422.

Question 80

A bond with a maturity value of $700,000 was initially issued for $715,000.The bond has a ten-year life and a stated interest rate of 10%.The total interest expense over the life of the bond is

A)$700,000.
B)$715,000.
C)$685,000.
D)not determinable without knowing the bond's effective yielD.