Question 1

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

Accepted Answer

A product warranty creates a nonmonetary liability for the seller because it obligates them to provide repair or replacement of the item if it becomes defective within a certain period of time. This obligation does not involve the exchange of money, but rather the provision of goods or services.

Question 2

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

Accepted Answer

A denominational liability refers to a liability that is payable in a specific currency or denomination, such as USD or EUR, rather than being satisfied through the payment of cash. Cash payments can be used to settle denominational liabilities, but they are not the only means of settlement.

Question 3

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

Accepted Answer

When the market rate of interest is above the nominal rate, a bond sells at a discount, not a premium. This is because investors demand a higher return on their investment to compensate for the lower interest rate offered by the bond compared to the market rate.

Question 4

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

Accepted Answer

This statement is correct. The discount on bonds payable represents the difference between the face value of the bond and the amount paid for the bond. The discount is amortized (spread out) over the life of the bond, which results in an increase in interest expense and a higher carrying value (or book value) of the bond. As the discount is gradually reduced, the carrying value of the bond will increase until it reaches its face value at maturity.

Question 5

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

Accepted Answer

Bonds are required by GAAP to be reported on the balance sheet at their book value, not market value. Only certain types of investments, such as trading securities, are 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.

Accepted Answer

The difference between the bond interest expense and the cash interest payment ($29,875 - $27,500 = $2,375) represents the amortization of the bond discount, which increases the carrying value of the bond.

Question 7

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

Accepted Answer

As a bond matures, the bond premium is amortized over the remaining life of the bond, which results in an increase in the annual amortization of the premium. At the same time, the annual interest expense decreases as the principal amount of the bond is paid off.

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.

Accepted Answer

The annual amortization of both bond discount and bond premium increases as the bond matures. This is because as the bond gets closer to its maturity date, the difference between the bond's par value and its carrying value decreases, resulting in a smaller amount to be amortized each year. Additionally, as time goes on, the bondholder receives fewer interest payments, which means that a greater portion of the payments received goes towards repaying the principal amount, thereby increasing the amortization of the bond discount or premium.

Question 9

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

Accepted Answer

When the market rate of interest is below the nominal rate, the bond will sell at a premium (above stated value) because investors are willing to pay more for a bond with a higher interest rate.

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.

Accepted Answer

When the effective yield of a bond is the same as the stated rate on the bond, it means the bond is priced at its face value or par value. Therefore, the bond will be 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.

Accepted Answer

When the market rate of interest rises, the value of existing bonds decreases. This is because new bonds are issued at a higher rate of interest, making existing bonds with lower rates of interest less attractive to investors. Therefore, the value of a bond will fall, not rise, when market interest rates increase.

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.

Accepted Answer

We can use the formula for calculating interest expense on a bond:
Interest expense = Maturity value x Stated interest rate x Time

Plugging in the given values, we get:
Interest expense = $900,000 x 8% x 5 years = $360,000

This is different from the given total interest expense of $339,000. Therefore, the statement is false.

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.

Accepted Answer

The unamortized bond premium increases the face amount of the bonds payable, which inflates the interest expense and reduces net income. Therefore, failing to amortize the bond premium will result in an understatement of net income.

Question 14

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

Accepted Answer

This statement accurately describes the definition of interest. Interest is the cost of borrowing money or the price charged for delaying payment on a liability.

Question 15

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

Accepted Answer

As a bond matures, the bond discount decreases and as a result, the annual amortization of the bond discount increases. This is because the discount must be gradually reduced over the life of the bond until it reaches zero at the bond's maturity date.

Question 16

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

Accepted Answer

A discount on bonds payable represents the difference between the face value of a bond and the amount received from investors. It is recorded as a liability on the balance sheet and represents a reduction in the amount owed to bondholders. Therefore, it is a liability valuation account.

Question 17

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

Accepted Answer

The bond indenture agreement outlines the specific details of a bond issue, including the terms and conditions, interest rate, maturity date, and any other pertinent information. It is a legally binding contract between the issuing company and the bondholders.

Question 18

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

Accepted Answer

When bonds are sold at a discount, interest expense is recognized over the life of the bonds, which means that it increases as the bonds reach maturity. This is because as the bonds near maturity, the discount must be gradually amortized, which reduces the amount of interest expense that is recognized each period.

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.

Accepted Answer

This statement is false. All else being equal, the proceeds from the sale of a bond with semi-annual interest payments are typically higher than the proceeds from the sale of a bond with annual interest payments, because investors prefer to receive more frequent interest payments.

Question 20

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

Accepted Answer

Current monetary liabilities are shown at their undiscounted amount due on the financial statements. This means that any interest or other costs associated with the liability are not factored into the recorded amount.

Quiz 11: Financial Instruments As Liabilities