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80 Cards in this Set

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From what sources might a corporation obtain funds through long term debt?
Funds might be obtained through long-term debt from the issuance of bonds, and from the signing of long-term notes and mortgages.
What is bond indenture?
A bond indenture is a contractual agreement (signed by the issuer of bonds) between the bond issuer and the bondholders. The bond indenture contains covenants or restrictions for the protection of the bondholders.
What is a mortgage
A mortgage is a document which describes the security for a loan, indicates the conditions under which the mortgage becomes effective (that is, conditions of default), and describes the rights of the mortgagee under default relative to the security. The mortgage accompanies a formal promissory note and becomes effective only upon default of the note.
what is a term bond
matures on a single date
What is a mortgage bond
secured by real estate
What is a collateral trust bond
secured by the securities of other corporations
What is a Debenture bond?
unsecured bonds
What is an income bond
depends on the existence of operating income in the issuing company
What is a callable bond
may be called and retired by the issuer proior to maturity
Registered bonds
issued in the name of the owner and require surrender of the certificate and issuance of a new certificate to complete the sale
A Bearer or Coupon bond
is not recorded in the name of the owner and may be transferred from one investor to another like cash
Convertible bonds
can be converted into other securities of teh issuing corporation for a specified time after issuance
Commodity backed bonds or asset linked bonds
are redeemable in measures of a commodity
deep discount bonds or zero interest bonds
are sold at a discount which provides the buyers total interest payoff at maturity
what is the yeild rate
the rate of interest actually earned by the bondholders; it is synonymous with the effective and market rates
What is the nominal rate
the rate set by the party issuing the bonds and expressed as a percentage of the par value; it is synonymous with the stated rate.
what is the stated rate
synonymous with nominal rate
what is the market rate
synonymous with yield rate and effective rate
what is the effective rate
synonymous with market rate and yield rate
Maturity value
the face value of the bonds; the amount which is payable upon maturity.
Face Value
synonymous with par value and maturity value.
Market Value
the amount realizable upon sale
Par Value
synonymous with maturity and face value
When does a discount on bonds payable arise
when investors demand a rate of interest higher than the rate stated on the bonds. The investors are not satisfied with the nominal interest rate because they can earn a greater rate on alternative investments of equal risk. They refuse to pay par for the bond and cannot change the nominal rate. However, by lowering the amount paid for the bonds, investors can alter the effective rate of interest.
When does a premium on bonds payable arise
when investors are satisfied with a rate of interest lower than the rate stated on the bonds, they are willing to pay more than the face value of the bonds in order to acquire them, thus reducing their effective rate of interest below the stated rate.
How should a discount (premium) on bonds payable be reported on the financial statement
should be reported in the balance sheet as a direct deduction from (addition to) the face amount of the bond. Both are liability valuation accounts
Bond discount or premium may be ammortized in what ways?
straight-line basis or on an effective interest basis. The profession recommends the effective interest method but permits the straightline method when the results obtained are not materially different from the effective interest
method
what is the straight line method of ammortizing bond discount or premium
The straight-line method results in an even or average allocation of the total interest over the life of the notes or bonds. The straight-line method results in a constant dollar amount of interest and an increasing or decreasing rate of interest over the life of the bonds.
What is the effective interest rate method of ammortizing bond discount or premium
The effective interest method results in an increasing or decreasing amount of interest each period. This is because interest is based on the carrying amount of the bond issuance at the beginning of each period
The effective interest method results in an increasing or decreasing dollar amount of interest and a constant rate of interest over the life of the bonds.
If a company sells its bonds at a premium and applies the effective interest method in amortizing the premium the annual interest expense will ____ over the life of the bonds
decrease,
Under the effective interest method the interest expense each period is equal to the effective or yield interest rate times the book value of the bonds at the beginning of each interest period. When bonds are sold at a premium, their book value declines to face value over their life; therefore, the interest expense declines also.
Where should treasury bonds be shown on the balance sheet
Treasury bonds should be shown on the balance sheet as a deduction from the bonds payable issued in order to arrive at the net figure representing bonds payable outstanding. Treasury bonds should be carried at par.
What is the call feature of a bond issue.
grants the issuer the privilege of purchasing, after a certain date at a stated price, outstanding bonds for the purpose of reducing indebtedness or taking advantage of lower interest rates
How does the call feature affect the amortization of bond premium or discount
The call feature does not affect the amortization of bond discount or premium; because early redemption is not a certainty, life to maturity date should be used for amortization purposes.
Why would a company wish to reduce its bond indebtedness before its bonds reach maturity
It is sometimes desirable to reduce bond indebtedness in order to take advantage of lower prevailing
interest rates. Also the company may not want to make a very large cash outlay all at once
when the bonds mature.
Indicate how a company can reduce its bond indebtedness before its bonds reach maturity
Bond indebtedness may be reduced by either issuing bonds callable after a certain date and then calling some or all of them, or by purchasing bonds on the open market and then retiring them.
When a portion of bonds outstanding is going to be retired, it is necessary for the accountant to make sure any corresponding discount or premium is properly amortized. Gains or losses from these transactions must be shown in the income statement as extraordinary items.
How are gains and losses from the extinguishment of debt classified in the income statement.
Gains or losses from extinguishment of debt should be aggregated and reported in income.
For extinguishment of debt transactions disclosure is required of which items
1. A description of the transactions, including the sources of any funds used to extinguish debt if it is practicable to identify the sources.
2. The income tax effect in the period of extinguishment.
3. The per share amount of the aggregate gain or loss net of related tax effect.
What is done to record properly a transaction ivolving the issuance of a non-interest-bearing long-term note or property
The entire arrangement must be evaluated and an appropriate interest rate imputed. This is done by (1) determining the fair value of the property, goods, or services exchanged or (2) determining the market value of the note, whichever is more clearly determinable.
How is the present value of a non-interest-bearing note computed?
If a note is issued for cash, the present value is assumed to be the cash proceeds. If a note is issued for noncash consideration, the present value of the note should be measured by the fair value of the property, goods, or services or by an amount that reasonably approximates the market value of the note (whichever is more clearly determinable).
When is the stated interest rate of a debt instrument deemed to be fair?
When a debt instrument is exchanged in a bargained transaction entered into at arm’s-length, the stated interest rate is presumed to be fair unless: (1) no interest rate is stated, or (2) the stated interest rate is unreasonable, or (3) the stated face amount of the debt instrument is materially different from the current sales price for the same or similar items or from the current market value of the debt instrument.
What are the considerationsin imputing an appropriate interest rate
In imputing interest, the objective is to approximate the rate which would have resulted if an independent borrower and an independent leader had negotiated a similar transaction under comparable terms and conditions with the option to pay the cash price upon purchase
consideration must be given to (1) the credit standing of the issuer, (2) restrictive covenants, (3) collateral, (4) payment and other items pertaining to the debt, (5) the existing prime interest rate, and (6) the prevailing rates for similar instruments of issuers with similar credit ratings.
What is a fixed rate mortgage
is a note that requires payment of interest by the mortgagor at a rate that does not change during the life of the note.
What is a variable rate mortgage
is a note that features an interest rate that fluctuates with the market rate; the variable rate generally is adjusted periodically as specified in the terms of the note and is usually limited in the amount of each change in the rate up or down and in the total change that can be made in the rate.
What does FASB statement No. 47 require
disclosure at the balance sheet date of future payments for
sinking fund requirements and the maturity amounts of long-term debt during each of the next five
years.
What does APB Opinion No. 21 require?
Bond issuance costs according to APB Opinion No. 21 should be debited to a deferred charge account for Unamortized Bond Issue Costs and amortized over the life of the issue, separately from but in a manner similar to that used for discount on bonds.
WHat does FASB require in SFAC No. 3
The FASB in SFAC No. 3 takes the position that debt issue costs can be treated as either an expense of the period in which the bonds are issued or a reduction of the related debt liability.
What is off balance sheet financing
an attempt to borrow monies in such a way that the obligations are not recorded.
Reasons for off-balance sheet financing are:
1. Many believe removing debt enhances the quality of the balance sheet and permits credit to be obtained more readily and at less cost.
2. Loan covenants are less likely to be violated.
3. The asset side of the balance sheet is understated because fair value is not used for many assets. As a result, not reporting certain debt transactions offsets the nonrecognition of fair values on certain assets.
Forms of off-balance-sheet financing include
(1) investments in non-consolidated subsidiaries for which the parent is liable for the subsidiary debt; (2) use of special purpose entities (SPEs), which are used to borrow money for special projects (resulting in take-or-pay contracts; (3) operating leases, which when structured carefully give the company the benefits of ownership without reporting the liability for the lease payments.
What are take-or-pay contracts
the outside party agrees to make specified minimum payments even if it
does not take possession of the contracted goods or services
What are through put contracts
the outside party agrees to pay specified amounts in return for processing or transportation services rendered by the debtor, which is usually the owner of a manufacturing or transportation facility.
An example of an item which is not a liability is
a. dividends payable in stock.
b. advances from customers on contracts.
c. accrued estimated warranty costs.
d. the portion of long-term debt due within one year.
a
The covenants and other terms of the agreement between the issuer of bonds and the lender are set forth in the
a. bond indenture.
b. bond debenture.
c. registered bond.
d. bond coupon.
a
3. The term used for bonds that are unsecured as to principal is
a. junk bonds.
b. debenture bonds.
c. indebenture bonds.
d. callable bonds.
b
4. The interest rate written in the terms of the bond indenture is known as the
a. coupon rate.
b. nominal rate.
c. stated rate.
d. coupon rate, nominal rate, or stated rate.
d
5. The rate of interest actually earned by bondholders is called the
a. stated rate.
b. yield rate.
c. effective rate.
d. effective, yield, or market rate.
d
6. Stone, Inc. issued bonds with a maturity amount of $200,000 and a maturity ten years from date of issue. If the bonds were issued at a premium, this indicates that
a. the effective yield or market rate of interest exceeded the stated (nominal) rate.
b. the nominal rate of interest exceeded the market rate.
c. the market and nominal rates coincided.
d. no necessary relationship exists between the two rates.
b
7. If bonds are initially sold at a discount and the straight-line method of amortization is used, interest expense in the earlier years will
a. exceed what it would have been had the effective interest method of amortization been used.
b. be less than what it would have been had the effective interest method of amortization been used.
c. be the same as what it would have been had the effective interest method of amortization been used.
d. be less than the stated (nominal) rate of interest.
a
8. Under the effective interest method of bond discount or premium amortization, the periodic interest expense is equal to
a. the stated (nominal) rate of interest multiplied by the face value of the bonds.
b. the market rate of interest multiplied by the face value of the bonds.
c. the stated rate multiplied by the beginning-of-period carrying amount of the bonds.
d. the market rate multiplied by the beginning-of-period carrying amount of the bonds.
d
9. When the effective interest method is used to amortize bond premium or discount, the periodic amortization will
a. increase if the bonds were issued at a discount.
b. decrease if the bonds were issued at a premium.
c. increase if the bonds were issued at a premium.
d. increase if the bonds were issued at either a discount or a premium.
d
10. If bonds are issued between interest dates, the entry on the books of the issuing corporation could include a
a. debit to Interest Payable.
b. credit to Interest Receivable.
c. credit to Interest Expense.
d. credit to Unearned Interest.
c
11. When the interest payment dates of a bond are May 1 and November 1, and a bond issue is sold on June 1, the amount of cash received by the issuer will be
a. decreased by accrued interest from June 1 to November 1.
b. decreased by accrued interest from May 1 to June 1.
c. increased by accrued interest from June 1 to November 1.
d. increased by accrued interest from May 1 to June 1.
d
Theoretically, the costs of issuing bonds could be
a. expensed when incurred.
b. reported as a reduction of the bond liability.
c. debited to a deferred charge account and amortized over the life of the bonds.
d. any of these.
d
The printing costs and legal fees associated with the issuance of bonds should
a. be expensed when incurred.
b. be reported as a deduction from the face amount of bonds payable.
c. be accumulated in a deferred charge account and amortized over the life of the bonds.
d. not be reported as an expense until the period the bonds mature or are retired.
c
Treasury bonds should be shown on the balance sheet as
a. an asset.
b. a deduction from bonds payable issued to arrive at net bonds payable and outstanding.
c. a reduction of stockholders' equity.
d. both an asset and a liability.
b
An early extinguishment of bonds payable, which were originally issued at a premium, is made by purchase of the bonds between interest dates. At the time of reacquisition
a. any costs of issuing the bonds must be amortized up to the purchase date.
b. the premium must be amortized up to the purchase date.
c. interest must be accrued from the last interest date to the purchase date.
d. all of these.
d
The generally accepted method of accounting for gains or losses from the early extinguishment of debt treats any gain or loss as
a. an adjustment to the cost basis of the asset obtained by the debt issue.
b. an amount that should be considered a cash adjustment to the cost of any other debt issued over the remaining life of the old debt instrument.
c. an amount received or paid to obtain a new debt instrument and, as such, should be amortized over the life of the new debt.
d. a difference between the reacquisition price and the net carrying amount of the debt which should be recognized in the period of redemption.
d
When a note payable is issued for property, goods, or services, the present value of the note is measured by
a. the fair value of the property, goods, or services.
b. the market value of the note.
c. using an imputed interest rate to discount all future payments on the note.
d. any of these.
d
When a note payable is exchanged for property, goods, or services, the stated interest rate is presumed to be fair unless
a. no interest rate is stated.
b. the stated interest rate is unreasonable.
c. the stated face amount of the note is materially different from the current cash sales price for similar items or from current market value of the note.
d. any of these.
d
Discount on Notes Payable is charged to interest expense
a. equally over the life of the note.
b. only in the year the note is issued.
c. using the effective interest method.
d. only in the year the note matures.
c
Which of the following is an example of "off-balance-sheet financing"?
1. Non-consolidated subsidiary.
2. Special purpose entity.
3. Operating leases.
a. 1
b. 2
c. 3
d. All of these are examples of "off-balance-sheet financing."
d
Which of the following must be disclosed relative to long-term debt maturities and sinking fund requirements?
a. The present value of future payments for sinking fund requirements and long-term debt maturities during each of the next five years.
b. The present value of scheduled interest payments on long-term debt during each of the next five years.
c. The amount of scheduled interest payments on long-term debt during each of the next five years.
d. The amount of future payments for sinking fund requirements and long-term debt maturities during each of the next five years.
d
Note disclosures for long-term debt generally include all of the following except
a. assets pledged as security.
b. call provisions and conversion privileges.
c. restrictions imposed by the creditor.
d. names of specific creditors.
d
The times interest earned ratio is computed by dividing
a. net income by interest expense.
b. income before taxes by interest expense.
c. income before income taxes and interest expense by interest expense.
d. net income and interest expense by interest expense.
c
The debt to total assets ratio is computed by dividing
a. current liabilities by total assets.
b. long-term liabilities by total assets.
c. total liabilities by total assets.
d. total assets by total liabilities.
c
In a troubled debt restructuring in which the debt is continued with modified terms and the carrying amount of the debt is less than the total future cash flows,
a. a loss should be recognized by the debtor.
b. a gain should be recognized by the debtor.
c. a new effective interest rate must be computed.
d. no interest expense or revenue should be recognized in the future.
c
A troubled debt restructuring will generally result in a
a. loss by the debtor and a gain by the creditor.
b. loss by both the debtor and the creditor.
c. gain by both the debtor and the creditor.
d. gain by the debtor and a loss by the creditor.
d
In a troubled debt restructuring in which the debt is settled by a transfer of assets with a fair market value less than the carrying amount of the debt, the debtor would recognize
a. no gain or loss on the settlement.
b. a gain on the settlement.
c. a loss on the settlement.
d. none of these.
b
In a troubled debt restructuring in which the debt is continued with modified terms, a gain should be recognized at the date of restructure, but no interest expense should be recognized over the remaining life of the debt, whenever the
a. carrying amount of the pre-restructure debt is less than the total future cash flows.
b. carrying amount of the pre-restructure debt is greater than the total future cash flows.
c. present value of the pre-restructure debt is less than the present value of the future cash flows.
d. present value of the pre-restructure debt is greater than the present value of the future cash flows.
b
In a troubled debt restructuring in which the debt is continued with modified terms and the carrying amount of the debt is less than the total future cash flows, the creditor should
a. compute a new effective interest rate.
b. not recognize a loss.
c. calculate its loss using the historical effective rate of the loan.
d. calculate its loss using the current effective rate of the loan.
c