Liabilities Overview and Management

Questions and Answers

A measure of a company's solvency is the:

Acid-test ratio

Asset turnover ratio

Current ratio

Times interest earned (correct)

The times interest earned is computed by dividing:

Income before interest expense and income taxes by interest expense (correct)

Income before income taxes by interest expense

Income before interest expense by interest expense

Net income by interest expense

Liquidity ratios measure a company's:

Short-term debt paying ability (correct)

Long-range solvency

Operating cycle

Revenue-producing ability

The relationship between current assets and current liabilities is:

Useful in evaluating a company's liquidity Signup and view all the answers

Parker Company issued ten-year, 9%, bonds payable in 2014 at a premium. During 2014, the company's accountant failed to amortize any of the bond premium. The omission of the premium amortization will:

Cause net income for 2014 to be understated Signup and view all the answers

When the straight-line method of amortization is used for a bond premium, the amount of interest expense for an interest period is calculated by:

Subtracting the amount of premium amortized for that period from the amount of cash paid for interest during the period Signup and view all the answers

When the straight-line method of amortization is used for a bond discount, the amount of interest expense for an interest period is calculated by:

Adding the amount of discount amortized for that period to the amount of cash paid for interest during the period Signup and view all the answers

If bonds are originally sold at a discount using the straight-line amortization method:

Unamortized discount is subtracted from the face value of the bond to determine its carrying value Signup and view all the answers

Which of the following statements regarding the effective interest method of accounting for bonds characteristics is false?

The amount of periodic interest expense decreases over the life of a discounted bond issue when the effective interest method is used Signup and view all the answers

When the effective-interest method of amortization is used for a bond premium, the amount of interest expense for an interest period is calculated by multiplying the:

Carrying value of the bonds at the beginning of the period by the effective interest rate Signup and view all the answers

The amortization of a bond premium will result in reporting an amount of interest expense for an interest period that:

Is less than the amount of cash to be paid for interest for the period Signup and view all the answers

The effective-interest method of amortization of bond premiums and discounts is considered superior to the straight-line method because it results in a(n):

Uniform rate of interest Signup and view all the answers

Which of the following statements best describes the behavior over time of the components of equal mortgage payments?

Payment of principal increases and interest expense decreases Signup and view all the answers

Liabilities are classified on the balance sheet as current or:

Long-term Signup and view all the answers

Most companies pay current liabilities:

Out of current assets Signup and view all the answers

A current liability is a debt that can reasonably be expected to be paid:

Within one year, or the operating cycle, whichever is longer Signup and view all the answers

Which of the following most likely would be classified as a current liability?

Dividends payable Signup and view all the answers

Failure to record a liability will probably:

Result in an overstated net income Signup and view all the answers

Very often, failure to record a liability means failure to record a(n):

Expense Signup and view all the answers

Current liabilities are due:

And payable within one year Signup and view all the answers

Liabilities are classified as current or long-term based on their:

Due date Signup and view all the answers

Which of the following is not a current liability on December 31, 2014?

A lawsuit judgment to be decided on January 10, 2015 Signup and view all the answers

With an interest-bearing note, the amount of assets received upon issuance of the note is generally:

Equal to the note's face value Signup and view all the answers

As interest is recorded on an interest-bearing note, the Interest Expense account is:

Increased; the Interest Payable account is increased Signup and view all the answers

The interest charged on a $250,000 note payable, at the rate of 6%, on a 90-day note would be:

$3,750 Signup and view all the answers

The interest charged on a $250,000 note payable, at the rate of 6%, on a 60-day note would be:

$2,500 Signup and view all the answers

The interest charged on a $250,000 note payable, at the rate of 6%, for a year would be:

$15,000 Signup and view all the answers

Interest expense on an interest-bearing note is:

Accrued over the life of the note Signup and view all the answers

Sales taxes collected by a retailer are recorded by:

Crediting Sales Taxes Payable Signup and view all the answers

Unearned Rent Revenue is:

Reported as a current liability Signup and view all the answers

The amount of sales tax collected by a retail store when making sales is:

A current liability Signup and view all the answers

A company receives $176, of which $16 is for sales tax. The journal entry to record the sale would include a:

Credit to Sales Taxes Payable for $16 Signup and view all the answers

A company receives $261, of which $21 is for sales tax. The journal entry to record the sale would include a:

Debit to Cash for $261 Signup and view all the answers

The current portion of long-term debt should:

Be reclassified as a current liability Signup and view all the answers

Sales taxes collected by a retailer from a customer are expenses of the:

Customers Signup and view all the answers

A retailer that collects sales taxes is acting as an agent for the:

Taxing authority Signup and view all the answers

Sales taxes collected by a retailer are reported as:

Current liabilities Signup and view all the answers

Morgan Company does not ring up sales taxes separately on the cash register. Total receipts for February amounted to $25,440. If the sales tax rate is 6%, what amount must be remitted to the state for February's sales taxes?

$1,440 Signup and view all the answers

From the standpoint of the issuing company, a disadvantage of using bonds as a means of long-term financing is that:

Interest must be paid on a periodic basis regardless of earnings Signup and view all the answers

Secured bonds are bonds that:

Have specific assets of the issuer pledged as collateral Signup and view all the answers

A legal document that indicates the name of the issuer, the face value of the bond and such other data is called:

A bond certificate Signup and view all the answers

Stockholders of a company may be reluctant to finance expansion through issuing more equity because:

Their earnings per share may decrease Signup and view all the answers

Which of the following is not an advantage of issuing bonds instead of common stock?

Earnings per share on common stock may be lower Signup and view all the answers

Bonds that are secured by real estate are termed:

Mortgage bonds Signup and view all the answers

Bonds that may be exchanged for common stock at the option of the bondholders are called:

Convertible bonds Signup and view all the answers

Bonds that are subject to retirement at a stated dollar amount prior to maturity at the option of the issuer are called:

Callable bonds Signup and view all the answers

Bonds that are issued against the general credit of the borrower are called:

Debenture bonds Signup and view all the answers

Corporations are granted the power to issue bonds through:

State laws Signup and view all the answers

Bonds are not always categorized as:

Callable or convertible Signup and view all the answers

Which of the following statements concerning bonds is not a true statement?

The bond indenture is prepared after the bonds are printed Signup and view all the answers

The contractual rate of interest is usually stated as a(n):

Annual rate Signup and view all the answers

When authorizing bonds to be issued, the board of directors does not specify the:

Selling price Signup and view all the answers

Bonds with a face value of $300,000 and a quoted price of 102¼ have a selling price of:

$306,750 Signup and view all the answers

The present value of a bond is also known as its:

Market price Signup and view all the answers

All of the following statements regarding convertible bonds are true except:

Convertible bonds can be converted into common stock at the option of the issuing company Signup and view all the answers

The contractual interest rate on a bond is often referred to as the:

Stated rate Signup and view all the answers

If the market interest rate for a bond is higher than the stated interest rate, the bond will sell at:

A discount Signup and view all the answers

If the market rate of interest is greater than the contractual rate of interest, bonds will sell:

At a discount Signup and view all the answers

The interest expense recorded on an interest payment date is increased:

By the amortization of discount on bonds payable Signup and view all the answers

If the market rate of interest is 10%, a $10,000, 12%, 10-year bond that pays interest annually would sell at an amount:

Greater than face value Signup and view all the answers

If the market rate of interest is lower than the contractual interest rate, the bonds will sell at:

A premium Signup and view all the answers

If bonds are issued at a premium, the stated interest rate is:

Higher than the market rate of interest Signup and view all the answers

The present value of a $10,000, 5-year bond will be less than $10,000 if the:

Contractual rate of interest is less than the market rate of interest Signup and view all the answers

The market value (present value) of a bond is a function of all of the following except the:

Type of bonds Signup and view all the answers

The market rate of interest is often called the:

Effective rate Signup and view all the answers

If bonds are issued at a discount, it means that the:

Market interest rate is higher than the contractual interest rate Signup and view all the answers

Selling the bonds at a premium has the effect of:

Causing the total cost of borrowing to be lower than the bond interest paid Signup and view all the answers

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:

Interest paid over the life of the bond minus the amount of premium at sale point Signup and view all the answers

The statement 'Bond prices vary inversely with changes in the market rate of interest' means that if the:

Market rate of interest decreases, then bond prices will go up Signup and view all the answers

The carrying value of bonds will equal the market price:

On the date of issuance Signup and view all the answers

Over the term of the bonds, the balance in the Discount on Bonds Payable account will:

Decrease Signup and view all the answers

The sale of bonds above face value:

Will cause the total cost of borrowing to be less than the bond interest paid Signup and view all the answers

In the balance sheet, the account Premium on Bonds Payable is:

Added to bonds payable Signup and view all the answers

In the balance sheet, the account Discount on Bonds Payable is:

Deducted from bonds payable Signup and view all the answers

Bond discount should be amortized to comply with:

The expense recognition principle Signup and view all the answers

The journal entry to record the issuance of bonds at a discount will include a:

Debit to Cash for the face amount of the bonds minus the amount of the discount Signup and view all the answers

If bonds have been issued at a discount, then over the life of the bonds the:

Carrying value of the bonds will increase Signup and view all the answers

When bonds are retired before maturity:

Either a gain or a loss on redemption can be recorded Signup and view all the answers

Restoration Company issued bonds that had the following data associated with them: interest to be paid is $40,000. Interest expense to be recorded is $45,000. Which of the following characteristics is true?

After recording the interest expense, the amortization will increase the bond carrying value Signup and view all the answers

Study Notes

Liabilities Overview

Liabilities are classified as current or long-term based on their due date.
Current liabilities are debts expected to be settled within one year or the operating cycle.

Current Liabilities

Common examples include accounts payable and dividends payable.
The current portion of long-term debt is reclassified as a current liability when due.
Current liabilities are typically settled using current assets.

Recording Liabilities

Failing to record a liability may result in overstated net income.
Unrecorded liabilities often correlate with unrecorded expenses.
Important journal entries for liabilities include recognizing interest expenses and sales taxes payable.

Interest and Notes

Interest on notes payable is recorded as an increase in Interest Payable.
Calculating interest involves the principal amount, interest rate, and duration.
Interest expense accumulates over the life of the note, impacting financial statements.

Sales Tax Management

Sales taxes collected by retailers are recorded as current liabilities.
Retailers act as agents for the government when collecting taxes.
Proper entry for sales tax includes crediting Sales Taxes Payable.

Bonds Overview

Bonds can be secured by assets or unsecured (debenture bonds).
Bonds may also be callable or convertible based on issuer options.
The contractual interest rate is a fixed percentage, while market rates can affect bond pricing.

Amortization of Discounts and Premiums

Discount bonds require amortization to match interest expense to actual payments.
Premium bonds reduce the total interest cost over their life compared to interest payments.
Carrying values of bonds adjust according to the amortization method used.

Financial Ratios and Analysis

Times interest earned measures solvency by comparing income to interest expenses.
Liquidity ratios assess a company’s short-term debt paying ability using current assets and liabilities.
Solvency ratios indicate a company's long-term financial health.

Importance of Accurate Reporting

Accurate recording of liabilities affects net income and retained earnings.
Any discrepancies between recorded and actual liabilities can mislead investors and stakeholders.
Regular assessments and adjustments are vital for maintaining accurate financial statements.### Amortization Methods for Bonds
Interest expense in the straight-line amortization method equals cash paid for interest plus the amortized discount.
For a bond sold at a discount, the unamortized discount is subtracted from the face value for carrying value.
Interest expenses in the initial years are equal to paid interest when using the straight-line method.

Effective Interest Method

GAAP mandates the effective interest method for bond accounting.
Interest expenses decrease over time for discounted bonds using this method.
Carrying value of discounted bonds increases as they mature when adopting the effective interest method.
This method applies a constant percentage to carrying value for calculating interest expense.

Bond Premium Amortization

For the effective-interest method applied to bond premiums, interest expense is calculated by using the carrying value and effective interest rate.
Amortization of bond premium leads to reported interest expense being less than cash paid for interest.

Comparison of Amortization Methods

The effective-interest method is preferred over the straight-line method as it yields a more uniform interest rate throughout the bond's life.

Behavior of Mortgage Payments

With equal mortgage payments, the share of principal repayment grows while interest expense decreases over time.

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Description

This quiz provides an overview of liabilities, distinguishing between current and long-term classifications. It covers examples of current liabilities, the importance of accurate recording, and the implications of interest expenses. Test your understanding of how liabilities impact financial statements.