Deck 9: Reporting and Analyzing Liabilities

Question 1

Accounts payable is a short-term source of non-interest bearing financing.

Answer 1

True

Question 2

Excessive 'leaning on the trade' by a company can often cause long-term profits.

Answer 2

False

Question 3

Companies typically delay paying accounts payable as it represents an inexpensive form of financing.

Answer 3

True

Question 4

Accrued liabilities are considered long-term operating liabilities.

Question 5

Contingent liabilities that a company considers to be reasonably possible and for which a company is able to reasonably estimate the amount of a loss are recognized on the balance sheet and the income statement.

Question 6

Both cash received and interest accrued on short-term bank loans used to finance seasonal swings in working capital are reported on the balance sheet.

Question 7

Security for debt in the form of mortgages on assets is known as covenants.

Question 8

Companies with current maturities of long-term debt are required to report an amortization schedule in their financial statements.

Question 9

A bond selling for an amount above face value is said to be selling at a discount.

Question 10

Market prices of bonds fluctuate because the company's obligation (in the form of principal and interest payments) remains fixed.

Question 11

The bond issuing company can repurchase its bond at the bonds' issuing price if the bond indenture has a call provision allowing a call of the bonds.

Question 12

Debt ratings specify the amount at which investors can buy bonds from companies.

Question 13

IFRS and U.S. GAAP are the same with reporting contingencies.

Question 14

Which of the following does not affect the current liabilities section of the balance sheet?

A) Purchase of inventory on credit
B) Wages owed to employees but not yet paid
C) Insurance bill to be paid next month
D) Sale of goods on credit
E) A probable legal obligation, due within 12 months

Question 15

Wheat Inc. issued a 120-day note in the amount of $300,000 on October 31, 2016 with an annual rate of 6%. What amount of interest has accrued as of December 31, 2016?

A) $3,000
B) $2,250
C) $9,000
D) $1,500
E) Zero. The interest is accrued at the end of the 120 day period.

Question 16

Which of the following corporate debt ratings are listed in an increasing level of risk?

A) AAA, A, BB, C
B) A, AAA, BB, C
C) BB, C, A, AAA
D) C, BB, A, AAA

Question 17

For what is the coupon rate used to compute?

A) Rate that investors expect to earn on this investment
B) Interest payments paid to bondholders during the life of the bond issue
C) Bond issue price
D) Fee paid to an underwriter for determining the bond price

Question 18

Which of the following transactions that impact current liabilities has a corresponding entry on the income statement?

A) Purchase inventory on credit from Company XYZ on January 1
B) Payment to XYZ on February 1 for a January 1 purchase
C) Interest accrued on a note payable
D) Payment to employees in March for wages earned in February

Question 19

Which one of the following is not correct?

A) For debt issued at par, its interest expense reported on the income statement equals the cash interest payment.
B) For bond repurchases: Net bonds payable = Repurchase payment + Gain (loss) on bond repurchase.
C) For debt issued at a discount, interest expense reported on the income statement consists of the following two components: cash interest paid less the amortization of a discount.
D) None of the above

Question 20

Which one of the following would be considered a contingent liability?

A) A company owes $44,000 on inventories purchased on credit
B) A company has $980,000 worth of bonds outstanding
C) A company estimates that it will probably have to pay $48,000 to the Department of Environment Protection for a chemical spill
D) The company has access to a line of credit with a bank in the amount of $576,000
E) The company believes that it is reasonably possible it will lose a lawsuit but is unable to determine the possible damages

Question 21

How many payment periods are in a 10-year, 8% bond with an effective interest rate of 6%, and paid semiannually?

A) 5
B) 10
C) 20
D) 40

Question 22

What effects would the accrual of $200 of interest on a note payable have on financial statements?
I. Balance sheet: Liabilities are decreased by $200
II. Income statement: Expenses are increased by $200
III. Balance sheet: Retained earnings are decreased by $200
IV. Balance sheet: Cash assets are decreased by $200
V. Balance sheet: Liabilities are increased by $200

A) I, II and III
B) II, III and V
C) II, IV and V
D) II, III and IV

Question 23

The price of a bond is equivalent to:
I. Face value
II. Projected interest payments discounted to the present
III. The amortization amount of a bond
IV. The present value of the principal payment

A) I + III
B) I - III
C) II + IV
D) I + II

Question 24

Flower Mart borrows $240,000 on July 1 with a short-term loan that has an annual interest rate of 5% which is payable on the first day of each subsequent quarter.
What will Flower Mart need to accrue on August 31, assuming that no accrual had been made since the last interest payment?

A) $6,000; Decrease liabilities and decrease cash
B) $2,000; Increase liabilities, increase expenses
C) $1,500; Decrease liabilities, decrease cash
D) $1,000; Increase expenses

Question 25

Which of the following details of a company's long-term liabilities are normally reported in footnote disclosures?

A) Collateral
B) Interest rates
C) Maturity dates
D) All of the above

Question 26

On April 30, 2016, one year before maturity, Periwinkle Products, Inc. retired $600,000 of 8% bonds payable at 103. The book value of the bonds on April 30 was $578,400. Bond interest was last paid on April 30, 2016.
What is the gain or loss on the retirement of the bonds?

A) $19,800 loss
B) $10,800 gain
C) $39,600 loss
D) $239,600 gain

Question 27

If bonds are issued at 102.25, this means that:

A) A $2,000 bond sold for $204.50
B) The bonds sold at a discount
C) The bond rate of interest is 10.22% of the market rate of interest
D) A $2,000 bond sold for $2,045.00

Question 28

Imagination Industries plans to issue 8-year, 8%, $400,000 bonds paying interest on an annual basis, at a $5,760 premium. Which one of the following statements is true?

A) The cash paid to bondholders will be $5,760 each interest period
B) Imagination will receive $394,240 as the issue price
C) Imagination's annual interest expense on the bonds will be greater than the amount of interest payments to bondholders each year
D) Imagination's annual interest expense on the bonds will be less than the amount of interest payments to bondholders each year

Question 29

On January 1, 2016, Lumos Maxima, Inc. issued $800,000, 10-year, 10% bonds for $750,000. The bonds pay interest on June 30 and December 31. The market rate is 12%.
How much is the interest expense on the bonds for the first interest payment on June 30, 2016?

A) $36,000
B) $45,000
C) $86,400
D) $43,200

Question 30

Which of the following is true concerning contingency reporting?

A) IFRS uses the term "provisions" to refer to contingent liabilities that are accrued and reported on the balance sheet while an obligation that is disclosed in the notes is labeled "contingent liability."
B) IFRS allows companies to report contingent gains if a present obligation exists and the sacrifice of resources is probable.
C) A key difference in reporting contingent liabilities under U.S. GAAP compared to IFRS is that only IFRS requires that the obligation is probable and the amount estimable to recognize the obligation.
D) U.S. GAAP requires that a contingent liability be recognized instead of a contingent loss, whereas IFRS requires both.

Question 31

Middle Earth Company gave a creditor a 90-day, 6% note payable for $56,000 on December 1, 2016. What amount of interest will be accrued as of December 31, 2016? Where will this amount be reported in the company's financial statements?

Question 32

For each of the following, indicate the liability, if any, which would be shown on a balance sheet of Sunshine, Inc. as of December 31, 2016.
1. Sunshine, Inc. received an invoice for advertising during December totaling $2,000, but this has yet to be paid.
2. Sunshine, Inc. has accounts payable of $40,000 for products that are included in the 2016 year-end inventory.
3. Sunshine, Inc. has an unused line of credit of $30,000 from E-Z Loan Bank.

Question 33

On June 30, one year before maturity, Tennis Shoes, Inc. retired $720,000 of its 10% bonds payable at 96. The bond's book value on June 30 is $660,000. Bond interest is presently paid up to the date of retirement.
How much is the gain or loss on the retirement of these bonds?

Question 34

Indicate the proper financial classification (balance sheet or income statement) for each of the following accounts:
A. Loss on bond retirement
B. Bonds payable
C. Mortgage interest expense
D. Gift certificates sold to customers
E. Bonds due to be paid within 12 months

Question 35

Calculate the interest accrued for each of the following notes payable owed by Four Square Company as of December 31, 2016:

Question 36

Power 2020 Company issued $1,400,000 of 7%, 20-year bonds at 104 on January 1, 2002. Interest is payable semi-annually on July 1 and January 1. Through January 1, 2016, Power 2020 amortized $39,200 of the bond premium. On January 1, 2016, Power 2020 retires the bond at 101 (after making the interest payment on that date). Using the following table, indicate the effects on the company's financial statements of the bond retirement for January 1, 2016.

Question 37

Flower Company issues $2,000,000 of 8% bonds that pay interest semiannually and mature in 10 years. Compute the bonds' issue price assuming that the bonds' market interest rate is:
A. 6% per year compounded semiannually
B. 10% per year compounded semiannually

Question 38

Determine how each of the following transactions affect liabilities.
A. Payment to employees for wages previously accrued
B. Accrue interest of $200 on a note payable
C. Payment of $200 to bank for interest accrued on a note payable

Question 39

Atlanta Mountain took out a one-year, 6%, $60,000 to be repaid on April 1, 2017. Interest is due when the loan is repaid. How much interest should be accrued at December 31, 2016, and how should it be recorded in the financial statements?

Question 40

Brahtz Fabricators, a manufacturing company, paid $6,500,000 to retire $8,000,000 in 7% bonds due in 5 years. The book value of the bonds was $6,400,000 at the date of retirement.
A. How much is the net gain or loss on the redemption of these bonds?
B. Prepare the journal entry to record the transaction.

Question 41

The following items represent various types of liabilities.
1. A manufacturing company is sued for alleged product liability. The company's attorney does not feel that the suit will result in liability to the company, but a loss is possible. If adversely adjudicated, the liability would be material.
2. Mr. Gold, Inc. has sold products to Twinkle Jewelers, a retailer, which sold the products to customers. The manufacturer's warranty offers replacement of the product if it is found to be defective within 90 days of the sale to the consumer. Historically, 0.06% of the products are returned for replacement.
3. A customer has filed a lawsuit for a minor amount against Twinkle Jewelers. Twinkle 's attorneys have reviewed the case and have found that many similar cases have never been awarded to the plaintiff.
Identify if the following independent situations should be (a) recorded in the financial statements, (b) disclosed in a footnote in the financial statements, or (c) neither.

Question 42

Select the following items with each of the following:

-Short-term loans from a financial institution

A) Current operating liability
B) Current non-operating liability

Question 43

Select the following items with each of the following:

-Rent payable

A) Current operating liability
B) Current non-operating liability

Question 44

Select the following items with each of the following:

-Insurance premiums payable

A) Current operating liability
B) Current non-operating liability

Question 45

Select the following items with each of the following:

-Current maturities of long-term debt

A) Current operating liability
B) Current non-operating liability

Question 46

Select the following items with each of the following:

-Utilities payable

A) Current operating liability
B) Current non-operating liability

Question 47

If Mary's Motor Parts issues $2,300,000 in 6% bonds due in 5 years with semiannual interest payments, how much should it expect to raise if the market return for similar bonds is 8%?

Question 48

The following data relates to Beluga Company and three of its competitors in the mining industry:
Comment on the above industry ratios and address specific concerns about Beluga Company that you might have as a commercial lender.

Question 49

Rural Roads Company has the following values taken from its 2016 annual report:
A. Calculate Rural Roads Company's times interest earned and debt-to-equity ratios.
B. How are these ratios used in credit ratings?
C. According to Standard & Poor's, what are the 2 types of risk factors considered in credit analysis?

Question 50

Cat Chow Corp. recently issued bonds with a face value of $4,000,000 and a coupon rate of 6% for 10 years. The market rate of interest is 4% and the bonds pay interest semi-annually.
A. Compute the market value of the bond using a financial calculator or Excel.
B. How much is the premium at the bond issuance date?
C. Assume the market rate remains the same after one year and Cat Chow Corp decides to retire this bond issuance at a cost of $ 4,480,000. Will there be a gain or loss on the retirement and what amount? How is this transaction recorded?

Question 51

Renegade Corporation issued $60,000,000 in bonds which mature in 5 years. The bonds pay a 10% semiannual coupon. The current market rate for similar bonds is 8%.
A. At what price should this bond offering sell?
B. Create a table showing the amortized premium or discount the first three periods of the bonds.
C. How much is the book value of the bonds at the end of the first year (2 payments)?

Question 52

Following are the liability and equity sections of the consolidated balance sheet and related notes from Delicious Doughnuts, Inc.'s 2016 annual report (in thousands):
A. Identify the current liabilities recorded for Delicious Doughnuts as of December 31, 2016.
B. What types of costs might be included in the accrued liabilities?

Question 53

Following is an excerpt from a footnote from the Soft-Drink Company 2016 annual report:
NOTE10: DEBT AND BORROWING ARRANGEMENTS
Short-Term Borrowings
Loans and notes payable consist primarily of commercial paper issued in the United States. As of December 31, 2016 and 2015, we had $32,408 million and $24,270 million, respectively, in outstanding commercial paper borrowings. Our weighted-average interest rates for commercial paper outstanding were approximately 0.3 percent and 0.2 percent per year as of December 31, 2016 and 2015, respectively.
In addition, we had $15,536 million in lines of credit and other short-term credit facilities as of December 31, 2016, of which $1,708 million was related to the Company's consolidated Philippine bottling operations that were classified as held for sale. The Company's total lines of credit included $186 million that was outstanding and primarily related to our international operations.
Included in the credit facilities discussed above, the Company had $12,628 million in lines of credit for general corporate purposes. These backup lines of credit expire at various times from 2017 through 2021. There were no borrowings under these backup lines of credit during 2016. These credit facilities are subject to normal banking terms and conditions. Some of the financial arrangements require compensating balances, none of which is presently significant to our Company.
Long-Term Debt
During 2016, the Company retired $2,500 million of long-term notes upon maturity and issued $5,500 million of long-term debt. The general terms of the notes issued are as follows:
●$2,000 million total principal amount of notes due March 14, 2018, at a variable interest rate equal to the three-month London Interbank Offered Rate ("LIBOR") minus 0.05 percent;
●$2,000 million total principal amount of notes due March 13, 2019, at a fixed interest rate of 0.75 percent; and
●$1,500 million total principal amount of notes due March 14, 2022, at a fixed interest rate of 1.65 percent.
The Company's long-term debt consisted of the following (in millions, except average rate data):
Maturities of long-term debt for the five years succeeding December 31, 2016, are as follows (in millions):
The cash flows from financing activities section of Soft-Drink Company's 2016 annual report contains the following cash flows provided by (used by) activities (in millions):
A. What amount was issued in the form of debt in 2016? 2015?
B. Does Soft-Drink Company finance its activities primarily through short-term or long-term debt?
C. Based on the info above, what are the details of the long-term debt issuance for 2016?
D. How would the issuance of debt in 2016 be reflected on the financial statements for The Soft-Drink Company?
E. How would the payments of debt affect the financial statements in 2016?

Question 54

Roaring Rapids Adventures is short on cash, and facing a serious problem. The company does not have enough cash to pay the wages of its park employees, and paychecks are due. Several of the employees have indicated that they will quit if they do not receive their paychecks on time. The company has decided to make a public offering on October 31, 2016, of a $200,000, 5-year 10% bond with semiannual payments to cover the immediate problems as well as some long-term investments that the company hopes to make. Similar bonds demand an 8% return.
A. Is this bond being sold at a premium or a discount? Does this have an effect on the risk of the bond?
B. Assuming negligible charges by the company's discount investment banking firm, show effects of these initial offerings using the financial statement equation format.
C. Create a bond amortization table for the first 3 payments showing the effects of amortization on the liability and interest payments.
D. How and by what amount would the amortization differ if Roaring Rapids Adventures issued zero-coupon debt?

Question 55

You are a pension fund manager looking for an investment vehicle that will provide your fund with a reliable stream of income over the next 10 years. You want to find the best yield possible while still conforming to the pension fund covenant of investing in investment grade bonds or better. You are trying to decide between the following investment options for your equity:
A. Diner by the Sea
10 years, 5.5% yield, EBIT Interest coverage ratio = 4.0, EBITDA Interest coverage ratio = 6.0, total debt of $480,000,000 (all of which is long term), total equity of $1,000,000,000, and a return on equity of 8.3
B. Perfect Home Products
10 years, 2.5% yield, EBIT Interest coverage ratio = 22.0, EBITDA Interest coverage ratio = 31.0, total debt of $320,000,000 (all of which is long term), total equity of $10,000,000,000, and a return on equity of 25.0
C. Cell Phone Supplies, Inc.
10 years, 8.5% yield, EBIT Interest coverage ratio = 0.78, EBITDA Interest coverage ratio = 1.3, total debt of $210,000,000, total equity of $320,000,000, and a return on equity of 8.2
Using the table below, discuss each investment option's pros and cons, attempt to determine the grade of each bond, and ultimately make an argument for which bond is the appropriate investment for your pension fund. Note: Bonds rated BB, or lower, are considered to be non-investment grade bonds.

Question 56

What are the requirements for determining the financial reporting of a contingent liability? Why would a company want to keep its contingent liability as low as possible? How could a company manipulate contingent liability to its advantage?

Question 57

The following table lists some bond rankings:
What impact does increased risk have on the credit rating of bonds issued by a company? Why do companies in the same industry have different bond rates?

Question 58

Explain the differences in the components of interest expense for the bonds sold at par, discount, and at a premium.