Deck 10: Reporting and Analyzing Long-Term Liabilities

Question 1

Bonds and long-term notes are similar in that they are typically transacted with multiple lenders.

Answer 1

False

Question 2

A basic present value concept is that cash paid or received in the future has more value now than the same amount of cash received today.

Answer 2

False

Question 3

The carrying value of a long-term note is computed as the present value of all remaining payments, discounted using the market rate at issuance.

Answer 3

True

Question 4

A basic present value concept is that cash paid or received in the future has less value now than the same amount of cash today.

Question 5

Callable bonds have an option exercisable by the issuer to retire them at a stated dollar amount prior to maturity.

Question 6

Issuers of coupon bonds are not allowed to deduct the interest expense on their tax returns.

Question 7

A bond's par value is not necessarily the same as its market value.

Question 8

Mortgage bonds are backed only by the good faith and credit of the issuing company.

Question 9

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 if the borrower fails to make the required payments.

Question 10

The legal contract between the issuing corporation and the bondholders is called the bond indenture.

Question 11

Payments on an installment note normally include the accrued interest expense plus a portion of the amount borrowed.

Question 12

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.
$10,000 + ($10,000 * 7%) + [($10,000 + ($10,000 * 7%)) * 7%] = $11,449 or
$10,000 * 1.07 * 1.07 = $11,449

Question 13

A disadvantage of bond financing over equity financing is the burden on the cash flows of the company.

Question 14

Callable bonds can be exchanged for a fixed number of shares of the issuing corporation's common stock.

Question 15

Term bonds are scheduled for maturity on one specified date, whereas serial bonds mature at more than one date.

Question 16

An installment note is an obligation of the issuing company that requires a series of periodic payments to the lender.

Question 17

Debentures always have specific assets of the issuing company pledged as collateral.

Question 18

A particular feature of callable bonds is that they 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.

Question 19

Compounded means that interest during a second period is based on the total amount borrowed plus the interest accrued in the first period.

Question 20

One of the similarities of bond and equity financing is that both interest and equity payments are tax deductible.

Question 21

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.

Question 22

A bond is an issuer's written promise to pay an amount identified as the par value of the bond with interest.

Question 23

Bond interest paid by a corporation is an expense, whereas dividends paid are not an expense of the corporation.

Question 24

A lessee has substantially all of the benefits and risks of ownership in an operating lease.

Question 25

A company's ability to issue unsecured debt depends on its credit standing.

Question 26

Collateral from unsecured loans may be sold to offset the loan obligation if the loan is in default.

Question 27

The factor for the present value of an annuity 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.
$15,000 * 6.7101 = $100,651.50

Question 28

Return on equity increases when the expected rate of return from new assets is higher than the rate of interest expense on the debt financing.

Question 29

An annuity is a series of equal payments at equal time intervals.

Question 30

The factor for the present value of an annuity 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.
$2,000 * 4.3553 = $8,710.60

Question 31

An advantage of bond financing is that issuing bonds does not affect owner control.

Question 32

Operating leases are long-term or noncancelable leases in which the lessor transfers substantially all the risks and rewards of ownership to the lessee.

Question 33

The present value of an annuity can be best or quickly computed as the sum of the individual future values for each payment.

Question 34

The use of debt financing ensures an increase in return on equity.

Question 35

A pension plan is a contractual agreement between an employer and its employees to provide benefits to employees after they retire.

Question 36

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.

Question 37

Interest payments on bonds are determined by multiplying the par value of the bond by the stated contract rate.

Question 38

A company with a low level of liabilities in relation to stockholders' equity is likely to have a very high debt-to-equity ratio.

Question 39

An advantage of lease financing is the lack of an immediate large cash payment for the leased asset.

Question 40

A disadvantage of an operating lease is the inability to deduct rental payments in computing taxable income.

Question 41

When the contract rate is above the market rate, a bond sells at a discount.

Question 42

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.

Question 43

The carrying (book) value of a bond payable is the par value of the bonds plus any discount or minus any premium.

Question 44

The debt-to-equity ratio is calculated by dividing total stockholders' equity by total liabilities.

Question 45

The contract rate on previously issued bonds changes as the market rate of interest changes.

Question 46

When the contract rate on a bond issue is less than the market rate, the bonds will generally sell at a discount.

Question 47

A discount on bonds payable occurs when a company issues bonds with an issue price less than par value.

Question 48

A premium on bonds occurs when bonds carry a contract rate greater than the market rate at issuance.

Question 49

A premium reduces the interest expense of a bond over its life.

Question 50

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.

Question 51

A company has assets of $350,000 and total liabilities of $200,000. Its debt-to-equity ratio is 0.6.
If total assets and total liabilities are $350,000 and $200,000, respectively, stockholders' equity must be $150,000. Thus, the debt-to-equity ratio is $200,000/$150,000 or 1.3.

Question 52

A discount reduces the interest expense of a bond over its life.

Question 53

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.
Interest Expense = Cash Paid + Discount Amortization
Interest Expense = ($500,000 * 10% * 6/12) + ($26,155/16) = $26,634.69

Question 54

The carrying (book) value of a bond at the time when it is issued is always equal to its par value.

Question 55

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.
($500,000 - $473,845)/16 = $1,634.69

Question 56

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.
Total interest expense recognized is ($500,000 * 10% * 8 years) + discount ($26,155) = $426,155.

Question 57

The market value (issue price) of a bond is equal to the present value of all future cash payments provided by the bond.

Question 58

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 the interest payment on June 30 is $25,000.
Interest Expense = Cash Paid + Discount Amortization
Interest Expense = ($500,000 * 10% * 6/12) = $25,000

Question 59

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 a longer time period.

Question 60

The debt-to-equity ratio enables financial statement users to assess the risk of a company's financing structure.

Question 61

Premium on Bonds Payable is an adjunct liability account.

Question 62

A contract pledging title to assets as security for a note or bond is known as a(an):

A)Sinking fund.
B)Mortgage.
C)Equity.
D)Lease.
E)Indenture.

Question 63

Bonds that mature at more than one date with the result that the principal amount is repaid over a number of periods are known as:

A)Registered bonds.
B)Bearer bonds.
C)Callable bonds.
D)Sinking fund bonds.
E)Serial bonds.

Question 64

Bonds that have interest coupons attached to their certificates, which the bondholders present to a bank or broker for collection, are called:

A)Coupon bonds.
B)Callable bonds.
C)Serial bonds.
D)Convertible bonds.
E)Registered bonds.

Question 65

Payments on installment notes normally include accrued interest plus a portion of the principal amount borrowed.

Question 66

The carrying value of a long-term note payable is computed as:

A)The future value of all remaining payments, using the market rate of interest.
B)The face value of the long-term note less the total of all future interest payments.
C)The present value of all remaining payments, discounted using the market rate of interest at the time of issuance.
D)The present value of all remaining interest payments, discounted using the note's rate of interest.
E)The face value of the long-term note plus the total of all future interest payments.

Question 67

The effective interest method assigns a bond interest expense amount that increases over the life of a premium bond.

Question 68

Two common ways of retiring bonds before maturity are to (1) exercise a call option or (2) purchase them on the open market.

Question 69

Sinking fund bonds:

A)Require the issuer to set aside assets at specified amounts 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.

Question 70

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.

Question 71

The carrying value of bonds at maturity always equals:

A)the amount of cash originally received in exchange for the bonds.
B)the par value of the bond.
C)the amount of discount or premium.
D)the amount of cash originally received in exchange for the bonds plus any unamortized discount or less any premium.
E)$0.

Question 72

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 accrued since the most recent interest payment.

Question 73

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.

Question 74

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.

Question 75

A bond traded at 102½ means that:

A)The bond pays 2.5% interest.
B)The bond traded at 102.5% of its par value.
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 2½% above the contract rate.

Question 76

The contract between the bond issuer and the bondholders identifying the rights and obligations of the parties, is called a(n):

A)Debenture.
B)Bond indenture.
C)Mortgage.
D)Installment note.
E)Mortgage contract.

Question 77

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.

Question 78

Promissory notes that require the issuer to make a series of payments consisting of both interest and principal are:

A)Debentures.
B)Discounted notes.
C)Installment notes.
D)Indentures.
E)Investment notes.

Question 79

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.

Question 80

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.