Financial Accounting, 9e (Harrison/Horngren/Thomas)

Chapter 9 Liabilities

9.1 Learning Objective 9-1

1) Current liabilities are expected to be paid within one year or the operating cycle, whichever is longer.
Answer: TRUE
Diff: 1
LO: 9-1
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

2) A current liability must be paid out of current profits.

Answer: FALSE
Diff: 1
LO: 9-1
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

3) Purchasing merchandise inventory on account results in a liability.

Answer: TRUE
Diff: 1
LO: 9-1
AASCB: Analytical Skills
AICPA Bus Persp: Strategic/Critical Thinking
AICPA Functional: Reporting

4) Notes payable usually require the borrower to accrue interest expense and interest payable at the end
of the accounting period.
Answer: TRUE
Diff: 1
LO: 9-1
AASCB: Analytical Skills
AICPA Bus Persp: Strategic/Critical Thinking
AICPA Functional: Measurement

5) Unearned revenues should be classified as Other Revenues on the Income Statement.

Answer: FALSE
Diff: 1
LO: 9-1
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

1
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
6) When accruing interest expense on a short-term note, the Interest Payable account will decrease.
Answer: FALSE
Diff: 2
LO: 9-1
AASCB: Analytical Skills
AICPA Bus Persp: Strategic/Critical Thinking
AICPA Functional: Measurement

7) Interest expense on a note payable is only recorded at maturity.

Answer: FALSE
Diff: 2
LO: 9-1
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

8) Sales tax payable is the tax collected from the customer by the retailer.
Answer: TRUE
Diff: 1
LO: 9-1
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

9) The current ratio is affected by the long-term debt that must be paid in the current period.
Answer: TRUE
Diff: 1
LO: 9-1
AICPA Bus Persp: Strategic/Critical Thinking
AICPA Functional: Measurement

10) The lower the sales tax rate, the more income a retailer can earn.
Answer: FALSE
Diff: 2
LO: 9-1
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

11) Employee compensation is a major expense for most service companies.

Answer: TRUE
Diff: 1
LO: 9-1
AICPA Bus Persp: Strategic/Critical Thinking
AICPA Functional: Measurement

2
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
12) Unearned revenue will be zero when a company has earned all of the revenue it had collected in
advance.
Answer: TRUE
Diff: 1
LO: 9-1
AASCB: Analytical Skills
AICPA Bus Persp: Strategic/Critical Thinking
AICPA Functional: Measurement

13) The exact amount of warranty expense cannot be determined, so businesses must rely on estimates.
Answer: TRUE
Diff: 1
LO: 9-1
AASCB: Analytical Skills
AICPA Bus Persp: Strategic/Critical Thinking
AICPA Functional: Measurement

14) The current portion of a long-term debt refers to the amount of interest on a note payable that must be
paid in the current year.
Answer: FALSE
Diff: 1
LO: 9-1
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

15) It is possible for the warranty expense payable account to never zero out.
Answer: TRUE
Diff: 1
LO: 9-1
AASCB: Analytical Skills
AICPA Bus Persp: Strategic/Critical Thinking
AICPA Functional: Measurement

16) A future obligation that may arise due to past transactions is a contingent liability.
Answer: TRUE
Diff: 1
LO: 9-1
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

17) A contingent liability should be disclosed to the financial statement notes if there is a reasonably
possibility that a loss (or expense) will occur.
Answer: TRUE
Diff: 1
LO: 9-1
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

3
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
18) All contingent liabilities should be reported on the financial statements, even those that are unlikely to
occur.
Answer: FALSE
Diff: 1
LO: 9-1
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

19) Contingent liabilities are reported on the balance sheet.

Answer: TRUE
Diff: 1
LO: 9-1
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

20) The estimating of warranty expense when a product is sold with a warranty is an example of a
contingent liability.
Answer: TRUE
Diff: 1
LO: 9-1
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

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

A) within one year or the company's normal operating cycle (if it is longer than one year).
B) between 6 months and 18 months.
C) out of cash on hand.
D) out of current revenues.
Answer: A
Diff: 1
LO: 9-1
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

22) Liabilities are classified on the balance sheet as current or:

A) unearned.
B) deferred.
C) long-term.
D) accrued
Answer: C
Diff: 1
LO: 9-1
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

4
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
23) At the end of the year, a company makes a journal entry to accrue the interest expense on a short-term
note payable. As a result of this transaction:
A) current liabilities increase and current assets increase.
B) current liabilities increase and equity increases.
C) current liabilities decrease and equity decreases.
D) current liabilities increase and equity decreases.
Answer: D
Diff: 2
LO: 9-1
AASCB: Analytical Skills
AICPA Bus Persp: Strategic/Critical Thinking
AICPA Functional: Measurement

24) If at the end of the year, a company has a short-term note payable outstanding that was entered into
earlier in the current year:
A) short-term notes payable will appear on the balance sheet and interest payable will appear on the
income statement.
B) short-term notes payable will be included in the notes to the financial statements.
C) short-term notes payable and interest payable will appear on the balance sheet.
D) short-term notes payable, interest payable and interest expense will appear on the balance sheet.
Answer: C
Diff: 2
LO: 9-1
AASCB: Analytical Skills
AICPA Bus Persp: Strategic/Critical Thinking
AICPA Functional: Measurement

25) The journal entry to record payroll:

A) debits salary expense and credits salary payable for the net pay.
B) debits salary expense and credits salary payable for the gross pay.
C) debits salary expense for the gross pay and credits salary payable for the net pay.
D) debits salary expense for the net pay and credits salary payable for the gross pay.
Answer: C
Diff: 2
LO: 9-1
AASCB: Analytical Skills
AICPA Bus Persp: Strategic/Critical Thinking
AICPA Functional: Measurement

5
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
26) When a business receives cash from a customer before earning the revenue, they have a(n):
A) bonds payable.
B) notes payable.
C) accounts payable.
D) unearned revenue.
Answer: D
Diff: 1
LO: 9-1
AASCB: Analytical Skills
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

27) All of the following are reported as current liabilities EXCEPT:

A) bonds payable.
B) sales tax payable.
C) accounts payable.
D) unearned revenues.
Answer: A
Diff: 1
LO: 9-1
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

28) Failure to record an accrued liability causes a company to:

A) overstate income.
B) overstate assets.
C) understate liabilities.
D) understate owners' equity.
Answer: C
Diff: 2
LO: 9-1
AASCB: Analytical Skills
AICPA Bus Persp: Strategic/Critical Thinking
AICPA Functional: Measurement

29) Which of the liability accounts below is usually NOT an accrued liability:
A) interest payable.
B) wages payable.
C) taxes payable.
D) notes payable.
Answer: D
Diff: 1
LO: 9-1
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

6
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
30) The current ratio is current assets:
A) minus current liabilities.
B) divided by current liabilities.
C) plus current liabilities.
D) multiplied by current liabilities.
Answer: B
Diff: 1
LO: 9-1
AASCB: Analytical Skills
AICPA Bus Persp: Strategic/Critical Thinking
AICPA Functional: Measurement

31) Estimated warranty payable are reported on the balance sheet as:
A) administrative expenses.
B) a long-term liability.
C) a current liability.
D) part of cost of goods sold.
Answer: C
Diff: 1
LO: 9-1
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

32) The accounting principle requiring that a company record the warranty expense in the same period
that it records sales revenue is the:
A) going concern principle.
B) matching principle.
C) conservatism principle.
D) consistency principle.
Answer: B
Diff: 1
LO: 9-1
AASCB: Analytical Skills
AICPA Bus Persp: Strategic/Critical Thinking
AICPA Functional: Measurement

7
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
33) Omaha Bank lends Nebraska Paper Company $100,000 on January 1. Nebraska Paper Company signs
a $100,000, 8%, 6-month note. The entry made by Nebraska Paper Company on January 1 to record the
proceeds and issuance of the note would include:
A) a debit to cash of $92,000.
B) a debit to interest expense of $8,000.
C) a credit to Notes Payable of $100,000
D) a credit to Interest Payable of $8,000.
Answer: C
Diff: 1
LO: 9-1
AASCB: Analytical Skills
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

34) Monthly sales were $200,000. Warranty costs are estimated at 4% of monthly sales. In the month of
sale, the company should record a credit to:
A) Warranty Payable for $8,000.
B) Warranty Expense for $8,000.
C) Sales for $8,000.
D) Inventory for $8,000.
Answer: A
Diff: 1
LO: 9-1
AASCB: Analytical Skills
AICPA Bus Persp: Strategic/Critical Thinking
AICPA Functional: Measurement

35) Tyler Company paid $1,500 cash to replace a wheel on equipment sold under warranty. The entry to
record the payment would be to:
A) debit warranty expense and credit cash.
B) debit equipment expense and credit cash.
C) debit warranty payable and credit cash.
D) debit parts expense and credit cash.
Answer: C
Diff: 2
LO: 9-1
AASCB: Analytical Skills
AICPA Bus Persp: Strategic/Critical Thinking
AICPA Functional: Measurement

8
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
36) Mitchell Corporation sells 4,000 units of inventory during the year for $500 each. The selling price
includes a one-year warranty on parts. It is estimated that 3% of the units will be defective and that repair
costs are estimated to be $50 per unit. In the year of sale, warranty contracts are honored on 80 units for a
total cost of $4,000. What amount will be reported as Estimated Warranty Liability at the end of the year?
A) $4,000.
B) $2,000.
C) $6,000.
D) $0.
Answer: B
Diff: 2
LO: 9-1
AASCB: Analytical Skills
AICPA Bus Persp: Strategic/Critical Thinking
AICPA Functional: Measurement

37) Michigan Bank lends Canton Furniture Company $100,000 on December 1. Canton Furniture
Company signs a $100,000, 8%, 4-month note. The entry made by Canton Furniture Company on
December 31 to record the accrued interest on the note would be:
A) a debit to interest expense and a credit to interest payable of $2,000.
B) a debit to interest payable and a credit to interest expense of $2,000.
C) a debit to interest expense and a credit to cash of $2,000.
D) a debit to interest payable and a credit to cash of $2,000.
Answer: A
Diff: 2
LO: 9-1
AASCB: Analytical Skills
AICPA Bus Persp: Strategic/Critical Thinking
AICPA Functional: Measurement

38) Michigan Bank lends Canton Furniture Company $100,000 on December 1. Canton Furniture
Company signs a $100,000, 8%, 4-month note. The total cash paid for interest (only) at maturity of the
note is:
A) $6,000.
B) $8,000.
C) $4,000.
D) $32,000
Answer: B
Diff: 2
LO: 9-1
AASCB: Analytical Skills
AICPA Bus Persp: Strategic/Critical Thinking
AICPA Functional: Measurement

9
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
39) Michigan Bank lends Canton Furniture Company $100,000 on December 1. Canton Furniture
Company signs a $100,000, 8%, 4-month note. The total cash paid at maturity of the note is:
A) $108,000.
B) $106,000.
C) $100,000.
D) $104,000.
Answer: A
Diff: 2
LO: 9-1
AASCB: Analytical Skills
AICPA Bus Persp: Strategic/Critical Thinking
AICPA Functional: Measurement

40) The journal entry to record accrued interest on a short-term note payable must include a debit to:
A) interest payable and a credit to cash.
B) interest expense and a credit to cash.
C) interest expense and a credit to interest payable.
D) interest payable and a credit to notes payable.
Answer: C
Diff: 2
LO: 9-1
AASCB: Analytical Skills
AICPA Bus Persp: Strategic/Critical Thinking
AICPA Functional: Measurement

41) Current liabilities fall into two categories which are referred to as:
A) contingent liabilities and contra-liabilities.
B) contingent liabilities and noncontingent liabilities.
C) unearned liabilities and contra-liabilities.
D) liabilities of a known amount and estimated liabilities.
Answer: D
Diff: 2
LO: 9-1
AASCB: Analytical Skills
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

42) The current portion of long-term debt should:

A) be reclassified as a current liability.
B) be paid immediately.
C) be classified as a long-term liability.
D) not be separated from the long-term debt.
Answer: A
Diff: 1
LO: 9-1
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

10
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
43) Kathy's Corner Store has total receipts for the month of $36,750 including sales taxes. If the sales tax
rate is 5%, what are Kathy's sales for the month?
A) $36,750
B) $35,000
C) $34,012.50
D) $1,837.50
Answer: B
Diff: 2
LO: 9-1
AASCB: Analytical Skills
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

44) Short-term notes payable are:

A) shown as a reduction to notes receivable on the balance sheet.
B) generally due within six to eight months.
C) shown on the balance sheet with current liabilities.
D) shown on the balance sheet after long-term liabilities.
Answer: C
Diff: 1
LO: 9-1
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

45) Sales taxes collected by a retailer are reported as:

A) contingent liabilities.
B) revenues.
C) current assets.
D) current liabilities.
Answer: D
Diff: 1
LO: 9-1
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

46) Ironwood Company's sales for May 24 were $29,000. Ironwood is required to collect 6% state sales tax.
The total cash received from customers was:
A) $1,740.
B) $27,260.
C) $29,000.
D) $30,740.
Answer: D
Diff: 2
LO: 9-1
AASCB: Analytical Skills
AICPA Bus Persp: Strategic/Critical Thinking
AICPA Functional: Measurement

11
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
47) Bertha's Pharmacy shows cash sales of $2,500 and sales taxes of $150 for the day. The journal entry to
record this information would include a:
A) debit to cash of $2,650.
B) debit to sales tax expense $150.
C) credit to sales $2,650.
D) credit to sales tax payable $2,650.
Answer: A
Diff: 2
LO: 9-1
AASCB: Analytical Skills
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

48) The total earnings of an employee for the payroll period is the:
A) withholdings.
B) net pay.
C) gross pay.
D) take home pay.
Answer: C
Diff: 1
LO: 9-1
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

49) Unearned revenue is reported on the balance sheet as:

A) a revenue account.
B) a current liability.
C) an unearned liability.
D) a long-term debt.
Answer: B
Diff: 1
LO: 9-1
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

50) Nationwide Magazine sells 60,000 subscriptions in March at $15 each. The entry is made in March to
record the sale of the subscriptions would include a:
A) debit to subscriptions receivable for $900,000.
B) debit to prepaid subscriptions for $900,000
C) credit to cash for $900,000.
D) credit to unearned subscription revenue for $900,000.
Answer: D
Diff: 2
LO: 9-1
AASCB: Analytical Skills
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

12
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
51) Hoover Company has a long-term note payable for $300,000 on January 1, 2012. Each month the
company is required to pay $75,000 on the note. How will this note be reported on January 31, 2012?
A) Long-term liability, $300,000
B) Long-term liability, $225,000
C) Current liability, $75,000; long-term liability, $225,000
D) Current liability, $225,000; long-term liability, $75,000
Answer: C
Diff: 2
LO: 9-1
AASCB: Analytical Skills
AICPA Bus Persp: Strategic/Critical Thinking
AICPA Functional: Reporting

52) Potential liabilities that depend on future events arising out of past events are called:
A) long-term liabilities.
B) estimated liabilities.
C) contingent liabilities.
D) current liabilities.
Answer: C
Diff: 2
LO: 9-1
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

53) A company has a contingent loss that can be estimated and has a probable chance of occurrence. What
reporting does FASB require regarding this contingency?
A) It should be reported in the notes to the financial statements.
B) It should be ignored until the actual loss occurs.
C) It should be accrued, reported on the financial statements and disclosed in the notes to the financial
statements.
D) Nothing is required since there is only a probable chance of occurrence.
Answer: C
Diff: 1
LO: 9-1
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

54) A contingency that is remote:

A) should be disclosed in the financial statements.
B) does not need to be disclosed.
C) must be accrued as a loss.
D) is recorded as a contingent liability.
Answer: B
Diff: 1
LO: 9-1
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

13
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
55) Which of the following items would not be included if a contingent liability were disclosed in the
financial statements?
A) The nature of the item
B) Management's expected outcome
C) The amount of the contingency, if known
D) A numerical probability of the expected loss
Answer: D
Diff: 2
LO: 9-1
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

56) A company has a probable contingent gain that can be reasonably estimated. What reporting does the
FASB require regarding this contingency?
A) It should be reported in the notes to the financial statements.
B) It should be ignored until the actual gain materializes.
C) It should either be reported in the notes to the financial statements or recorded on the financial
statements.
D) It should be accrued and reported in the financial statements.
Answer: B
Diff: 2
LO: 9-1
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

57) On December 1, Goliath Corporation borrowed $10,000 on a 90-day, 6% note. Goliath Corporation's
year end is December 31. Prepare the journal entries to record the issuance of the note, the accrual of
interest at year end, and the payment of the note.
Answer:
December 1:
Cash 10,000
Notes Payable 10,000

December 31:
Interest Expense 50
Interest Payable 50

March 1:
Interest Expense 100
Interest Payable 50
Notes Payable 10,000
Cash 10,150
Diff: 2
LO: 9-1
AASCB: Analytical Skills
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

14
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
58) On December 1, Goliath Corporation borrowed $10,000 on a 90-day, 6% note. Goliath Corporation's
year end is December 31. Determine the balance in any current liabilities associated with the note as of
December 31.
Answer:
Note Payable $10,000
Interest Payable $ 50
Diff: 2
LO: 9-1
AASCB: Analytical Skills
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

59) Davies Accessories Company entered into the following transactions relating to notes payable:

August 1 Purchased inventory costing $42,000 by signing an 8-month, 5% note payable.

October 1 Purchased inventory costing $15,000 by signing a 1-year, 6% note payable.

a. Prepare journal entries to record the above transactions.

b. Assuming Davies Accessories Company has a December 31 year-end, prepare any adjusting entries
needed for the accrual of interest.
Answer:
a. August 1
Inventory 42,000
Note Payable 42,000

October 1
Inventory 15,000
Note Payable 15,000

b. December 31
Interest Expense 1,100
Interest Payable 1,100

Computations: 42,000 × .05 × 5/12 = 875

15,000 × .06 × 3/12 = 225
1,100
Diff: 2
LO: 9-1
AASCB: Analytical Skills
AICPA Bus Persp: Strategic/Critical Thinking
AICPA Functional: Measurement

15
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
60) Raleigh Company billed its customers a total of $1,155,000 for the month of November. The total
includes a 5% state sales tax.

Required:
a. Prepare the journal entry to record the revenue and related liabilities for the month.
b. Prepare the journal entry to record the sales tax remittance to the state.
Answer:
a. Cash 1,155,000
Sales 1,100,000
Sales Tax Payable 55,000

(1,155,000 / 1.05 = 1,100,000)

b. Sales Tax Payable 55,000

Cash 55,000
Diff: 2
LO: 9-1
AASCB: Analytical Skills
AICPA Bus Persp: Strategic/Critical Thinking
AICPA Functional: Measurement

61) In the most recent year of operations, Bradley's Video Games sold merchandise costing $25,000 for $
75,000. All merchandise was sold under a one-year warranty. At the time of sale, Bradley estimated that
warranty claims would amount to 3% of sales. During the year, Bradley replaced defective merchandise
for $1,290. All transactions were cash transactions.

Required:
a. Prepare journal entries to record all transactions related to the warranty.
b. Based solely on the above information, determine Bradley's operating income for the year.
Answer:
a. Warranty Expense 2,250
Estimated Warranty Payable 2,250
(75,000 × .03)

Estimated Warranty Payable 1,290

Cash 1,290

b. $75,000 - $25,000 - $2,250 = $47,750

Diff: 2
LO: 9-1
AASCB: Analytical Skills
AICPA Bus Persp: Strategic/Critical Thinking
AICPA Functional: Measurement

16
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
62) Lansing Company's general ledger shows the following balances for the selected accounts after
posting adjusting entries:

Accounts Payable $155,000

Notes Payable, 3-month 180,000
Accumulated Depreciation-Equipment 114,000
Salaries Payable 127,000
Notes Payable, 5-year, 8% 130,000
Estimated Warranty Liability 134,000
Payroll Tax Expense 16,000
Interest Payable 13,000
Sales Tax Payable 22,000

Required:
Prepare the current liability section of Lansing Company's balance sheet, assuming that the current
portion of the 5-year note is $30,000.
Answer: Lansing Company
Partial Balance Sheet

Current Liabilities
Notes Payable, 3-month $180,000
Accounts Payable 155,000
Estimated Warranty Liability 134,000
Salaries Payable 127,000
Notes Payable, 5-year, 8% (current portion) 30,000
Sales Tax Payable 22,000
Interest Payable 13,000
Total Current Liabilities $661,000
Diff: 2
LO: 9-1
AASCB: Analytical Skills
AICPA Bus Persp: Strategic/Critical Thinking
AICPA Functional: Measurement

17
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
63) Devin's Animal Shop has the following information for the pay period of March 15 to March 31:

Gross payroll $20,000

FICA tax rate 7%
Federal income tax withheld $3,000

Required: Prepare the journal entry to record the accrued payroll on March 31 and the journal entry to
remit the payroll taxes to the government on April 15.
Answer:
Date Account Debit Credit
March 31 Salary Expense 20,000
FICA payable (20,000 × .07) 1,400
Federal income tax payable 3,000
Salary Payable 15,600

April 15 FICA payable 1,400

Federal income tax payable 3,000
Cash 4,400

Diff: 2
LO: 9-1
AASCB: Analytical Skills
AICPA Bus Persp: Strategic/Critical Thinking
AICPA Functional: Measurement

64) All Sports Company publishes a monthly magazine. Subscriptions to the magazine cost $20 per year.
During November 2012, All Sports sells 15,000 subscriptions beginning with the December issue.
Required:
a. Prepare the entry in November to record the receipt of the subscriptions.
b. Prepare the adjusting entry at December 31, 2012.
Answer:
Date Account Debit Credit
a. November 30 Cash 300,000
Unearned Subscriptions 300,000
(15,000 × $20)

b. December 31 Unearned Subscriptions 25,000

Subscriptions Revenue 25,000
(300,000 × 1/12)

Diff: 2
LO: 9-1
AASCB: Analytical Skills
AICPA Bus Persp: Strategic/Critical Thinking
AICPA Functional: Measurement

18
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
65) Wildcat Computers sells all of its computers for $2,500 each. During the month of February Wildcat
sold 20 computers. It is estimated that the warranty expense is 2% of gross sales. Wildcat spent $100 in
cash and $150 in parts repairing computers for this month.
Required: Prepare the journal entries to record the sale, record the estimated warranty expense, and
record the warranty repairs.
Answer:
Date Account Debit Credit
1. Cash 50,000
Sales Revenue 50,000
($2,500 × 20)

2. Warranty Expense 1,000

Estimated warranty payable 1,000
($50,000 × .02)

3. Estimated warranty payable 250

Cash 100
Inventory — parts 150

Diff: 2
LO: 9-1
AASCB: Analytical Skills
AICPA Bus Persp: Strategic/Critical Thinking
AICPA Functional: Measurement

19
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
66) French's Fine Foods experienced the following transactions during the year:

1. A customer fell in one of French's stores and is seeking $150,000 in damages. French's attorneys
believe that it is remote that the customer will win the lawsuit.
2. Another customer became seriously ill after eating some bad snails purchased from French's. The
customer is seeking $200,000 in damages. French's attorneys believe that it is probable that the customer
will win the lawsuit and receive the $200,000.
3. A competitor is suing French's for a trademark violation and is seeking $1,500,000 in damages.
French's attorneys believe that it is reasonably possible that the competitor may win the lawsuit.

Required: For each of the situations, determine the accounting treatment required. If a journal entry is
needed prepare the journal entry.
Answer:
1. Since it is remote, nothing needs to be recorded or disclosed in the footnotes to the financial
statements.
2. Since it is probable, the liability and expense must be recorded.

Lawsuit expense 150,000

Estimated liability from lawsuit 150,000

3. Since it is reasonably possible, the contingency needs to be reported in the footnotes to the financial
statements.
Diff: 2
LO: 9-1
AASCB: Analytical Skills
AICPA Bus Persp: Strategic/Critical Thinking
AICPA Functional: Measurement

9.2 Learning Objective 9-2

1) Corporations borrow large amounts of money by issuing (selling) bonds to the public.
Answer: TRUE
Diff: 1
LO: 9-2
AICPA Functional: Measurement

2) If bonds are issued at a premium, the carrying value of the bonds will be greater than the face value of
the bonds for all periods prior to the bond maturity date.
Answer: TRUE
Diff: 1
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

20
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
3) If bonds are issued at a discount, the issuing corporation will pay a principal amount less than the face
amount of the bonds on the maturity date.
Answer: FALSE
Diff: 1
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

4) The account Discount on Bonds Payable increases a company's liabilities.

Answer: FALSE
Diff: 2
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

5) If the market interest rate is greater than the stated interest rate, the bonds will sell at a discount.
Answer: TRUE
Diff: 2
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

6) If bonds sell at a premium, the interest expense recognized each year will be greater than the stated
interest rate.
Answer: FALSE
Diff: 2
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

7) If $500,000, 6% bonds are issued on January 1 and pay interest semiannually, the amount of interest
paid on July 1 will be $15,000.
Answer: TRUE
Diff: 2
LO: 9-2
AASCB: Analytical Skills
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

8) If $120,000 face value bonds are issued at 104, the proceeds received will be $104,000.
Answer: FALSE
Diff: 1
LO: 9-2
AASCB: Analytical Skills
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

21
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
9) The carrying amount of bonds is calculated by adding the balance of the Discount on Bonds Payable
account to the balance in the Bonds Payable account.
Answer: FALSE
Diff: 1
LO: 9-2
AASCB: Analytical Skills
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

10) The carrying amount of bonds at maturity should be equal to the face value of the bonds.
Answer: TRUE
Diff: 1
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

11) If the interest rate on a bond is 8% and the market interest rate is 7%, the bond will be issued at a price
above the par value of the bond.
Answer: TRUE
Diff: 1
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

12) The future value is always more than the present value.
Answer: TRUE
Diff: 1
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

13) The straight-line amortization method keeps interest expense at the same dollar amount of the bond's
carrying value for every interest payment over the bond's life.
Answer: TRUE
Diff: 1
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

14) The effective-interest method of amortization results in changing amounts of amortization and
interest expense per period but at a constant interest rate.
Answer: TRUE
Diff: 1
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

22
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
15) According to GAAP, the interest paid semiannually on a bond payable can be computed using the
straight-line method only when its amounts differ insignificantly from the effective-interest method.
Answer: TRUE
Diff: 1
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

16) The stated interest rate is always equal to the market interest rate on the date the bonds are issued.
Answer: FALSE
Diff: 1
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

17) Gains and losses are recognized when convertible bonds are converted into common stock.
Answer: FALSE
Diff: 1
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

18) If $500,000 par value bonds with a carrying value of $477,000 are retired when the market price is 97, a
loss on retirement will be recorded.
Answer: TRUE
Diff: 1
LO: 9-2
AASCB: Analytical Skills
AICPA Bus Persp: Strategic/Critical Thinking
AICPA Functional: Measurement

19) The carrying value of bonds decreases each interest period if the bonds were issued at a discount.
Answer: FALSE
Diff: 1
LO: 9-2
AASCB: Analytical Skills
AICPA Bus Persp: Strategic/Critical Thinking
AICPA Functional: Measurement

20) Premium on bonds payable is a contra account to bonds payable.

Answer: FALSE
Diff: 1
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

23
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
21) When bonds are converted into common stock, the carrying value of the bonds is transferred to paid-
in capital.
Answer: TRUE
Diff: 1
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

22) At maturity, the premium on bonds payable will have been amortized to zero, and the bonds'
carrying value will be the face value of the bond.
Answer: TRUE
Diff: 1
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

23) The allocation process of writing off the bond premium or bond discount to interest expense over the
life of the bond is called reducing the market rate.
Answer: FALSE
Diff: 1
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

24) Callable bonds allow the issuer to pay off the bonds whenever the issuer chooses.
Answer: TRUE
Diff: 1
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

25) If a bond is redeemed before maturity, the journal entry to record the redemption will debit the bond
payable and debit any unamortized discount.
Answer: FALSE
Diff: 1
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

26) Convertible bonds allow the investor to exchange a bond receivable for the issuing company's
common stock.
Answer: FALSE
Diff: 1
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

24
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
27) Secured bonds are bonds that:
A) are registered in the name of the owner.
B) give the bondholder the right to take specified assets.
C) are in the possession of a bank.
D) have detachable interest coupons.
Answer: B
Diff: 1
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

28) Bonds that mature at a single specified future date are called:
A) term bonds.
B) coupon bonds.
C) serial bonds.
D) debentures.
Answer: A
Diff: 1
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

29) Bonds that are secured by real estate are called:

A) term bonds.
B) serial bonds.
C) mortgage bonds.
D) debentures.
Answer: C
Diff: 1
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

30) The bond obligates the issuing company to pay the par value of the bond at a specific future time. The
future time is called the:
A) due date.
B) maturity date.
C) issuing date.
D) payment date.
Answer: B
Diff: 1
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

25
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
31) The stated interest rate is always declared as a(n):
A) monthly rate.
B) daily rate.
C) semiannual rate.
D) annual rate.
Answer: D
Diff: 1
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

32) The organization that purchases the bonds from an issuing corporation and resells them to its clients
or sells the bonds for a commission is the:
A) underwriter.
B) bank.
C) stockholders.
D) bondholders.
Answer: A
Diff: 1
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

33) Bonds in a particular issue which mature in installments over a period of time are called:
A) convertible bonds.
B) term bonds.
C) callable bonds.
D) serial bonds.
Answer: A
Diff: 1
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

34) Bonds which are backed only by the good faith of the borrower are referred to as:
A) junk bonds.
B) unregistered bonds.
C) debenture bonds.
D) callable bonds.
Answer: C
Diff: 1
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

26
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
35) If the market interest rate is greater than the stated interest rate, bonds will sell:
A) at face value.
B) at a discount.
C) at a premium.
D) at market value.
Answer: B
Diff: 1
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

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

A) market interest rate is higher than the stated interest rate.
B) market interest rate is lower than the stated interest rate.
C) financial strength of the issuer is weak.
D) bond is convertible.
Answer: A
Diff: 1
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

37) The market interest rate is also referred to as the:

A) contractual rate.
B) coupon rate.
C) effective rate.
D) stated rate.
Answer: C
Diff: 1
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

38) The carrying amount of bonds issued at a discount is calculated by:

A) subtracting Discount on Bonds Payable from Bonds Payable.
B) subtracting the sum of Discount on Bonds Payable and Interest Payable from Bonds Payable.
C) subtracting Interest Payable from Bonds Payable.
D) subtracting Interest Expense from Bonds Payable.
Answer: A
Diff: 1
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

27
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
39) The carrying amount of bonds will equal the market price:
A) at the end of the fiscal period.
B) at the close of every business day.
C) on the date the bond is issued.
D) only when the bonds are converted to common stock.
Answer: C
Diff: 1
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

40) On the bond's maturity date, its face value will equal the:
A) maturity value plus all interest payments.
B) maturity value less all interest payments.
C) present value of the bonds on its issuance date.
D) maturity value.
Answer: D
Diff: 1
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

41) Bond interest paid is:

A) higher when bonds sell at a discount and lower when bonds sell at a premium.
B) the same whether bonds sell at a discount or a premium.
C) lower when bonds sell at a premium.
D) higher when bonds sell at a discount.
Answer: B
Diff: 1
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

42) The interest rate that investors require for loaning their money is referred to as:
A) the contract rate of interest.
B) the market rate of interest.
C) the stated rate of interest.
D) the discount rate of interest.
Answer: B
Diff: 1
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

28
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
43) Bonds with a 7% interest rate were issued when the market rate of interest was 6%. This bond was
issued at:
A) par value.
B) a premium.
C) a discount.
D) face value.
Answer: B
Diff: 1
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

44) If the market interest rate is 6%, a $10,000, 7%, 5-year bond, that pays interest semiannually would sell
at an amount:
A) less than face value.
B) equal to face value.
C) greater than face value.
D) the stated value.
Answer: C
Diff: 2
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

45) The present value of a $10,000, 5-year bond, will be less than $10,000 if the:
A) stated interest rate is less than the market interest rate.
B) stated interest rate is greater than the market interest rate.
C) bond is convertible.
D) stated interest rate is equal to the market interest rate.
Answer: A
Diff: 2
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

46) A bond will sell at a premium when:

A) the coupon rate is equal to the effective rate.
B) the coupon rate is greater than the effective rate.
C) the coupon rate is less than the effective rate.
D) the bond is sold at the end of the fiscal period.
Answer: B
Diff: 2
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

29
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
47) Bonds with a 6% interest rate were issued when the market rate of interest was 7%. The quoted bond
price will be:
A) greater than 100.
B) less than 100.
C) 100.
D) equal to the face value.
Answer: B
Diff: 2
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

48) A bond with a face value of $100,000 and a quoted price of 102 has a selling price of:
A) $102,000.
B) $98,000.
C) $100,000.
D) $120,000.
Answer: A
Diff: 2
LO: 9-2
AASCB: Analytical Skills
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

49) A $5,000, 7% bond is quoted at 95. When the bond is issued, the Bonds Payable account will be
increased by:
A) $4,750.
B) $4,650.
C) $5,000.
D) $5,100.
Answer: C
Diff: 2
LO: 9-2
AASCB: Analytical Skills
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

30
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
50) On January 1, Multichip Corporation issued $2,000,000, 10-year, 8% bonds at 102. The journal entry to
record this transaction would include a:
A) credit to bonds payable $2,040,000.
B) debit to discount on bonds payable $40,000.
C) debit to cash $2,000,000.
D) credit to premium on bonds payable $40,000.
Answer: D
Diff: 2
LO: 9-2
AASCB: Analytical Skills
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

51) The normal balance of the discount on the bonds payable account and the premium on the bonds
payable account are respectively:
A) debit, credit.
B) credit, credit.
C) debit, debit.
D) credit, debit.
Answer: A
Diff: 2
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

52) In the balance sheet, the account, Discount on Bonds Payable, is:
A) added to bonds payable.
B) deducted from bonds payable.
C) classified as a stockholders' equity account.
D) classified as a revenue account.
Answer: B
Diff: 1
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

53) Mercury Corporation issues a $3,000,000, 10-year, 8% bond dated January 1 at 103. The journal entry
to record the issuance will include a:
A) credit to cash for $3,090,000.
B) debit to cash for $3,000,000.
C) credit to premium on bonds payable for $90,000.
D) credit to bonds payable for $3,090,000.
Answer: C
Diff: 2
LO: 9-2
AASCB: Analytical Skills
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

31
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
54) Bonds with a face value of $200,000 were sold at an effective interest rate of 8% to yield cash proceeds
in excess of $200,000. It is apparent that the bonds had a:
A) stated rate less than 8%.
B) stated rate greater than 8%.
C) market rate less than 8%.
D) market rate greater than 8%.
Answer: B
Diff: 2
LO: 9-2
AASCB: Analytical Skills
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

55) Gardner Corporation issues $2,000,000, 10-year, 8% bonds payable at a price of 98. The journal entry
to record the issuance will include a:
A) debit to cash of $2,000,000
B) credit to discount on bonds payable for $40,000.
C) credit to bonds payable for $1,960,000.
D) debit to cash for $1,960,000.
Answer: D
Diff: 2
LO: 9-2
AASCB: Analytical Skills
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

56) The carrying value of a bond immediately after the bond was issued was $245,000. The bond price
was 98. The face value of the bond was:
A) $245,000.
B) $121,250.
C) $250,000.
D) $249,900.
Answer: C
Explanation: C) 245,000/.98 = 250,000
Diff: 2
LO: 9-2
AASCB: Analytical Skills
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

32
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
57) Premium on Bonds Payable:
A) has a debit balance
B) is a contra account.
C) decreases towards maturity value.
D) is deducted from bonds payable on the balance sheet.
Answer: C
Diff: 2
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

58) Which of the following statements regarding the time value of money is not true?
A) The amount to invest now to receive more in the future is the future value.
B) Present value is always less than the future value.
C) The exact present value depends on the interest rate, the length of time and the principal amount.
D) Money earns interest over time.
Answer: A
Diff: 2
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

59) If bonds have been issued at a premium, over the life of the bonds, the:
A) carrying value of the bonds will decrease.
B) carrying value of the bonds will increase.
C) interest expense will decrease, if the premium is being amortized on a straight-line basis.
D) premium amortization will decrease.
Answer: A
Diff: 2
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

60) The journal entry to record a semiannual interest payment on a bond payable:
A) debits interest expense and credits bonds payable.
B) debits interest expense and credits cash.
C) debits cash and credits interest payable.
D) debits cash and credits interest expense.
Answer: B
Diff: 1
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

33
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
61) Sage Company issued $600,000, 8%, 5-year bonds for 106, with interest paid annually. Assuming
straight-line amortization, what is the carrying value of the bonds after one year?
A) $636,000
B) $600,000
C) $628,800
D) $648,000
Answer: C
Diff: 1
LO: 9-2
AASCB: Analytical Skills
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

62) The journal entry to record payment of bond payable at maturity will include a:
A) debit to bonds payable, credit to premium on bonds payable and a credit to cash.
B) debit to cash and a credit to bonds payable.
C) debit to bonds payable and a credit to cash.
D) debit to bonds payable, debit to discount on bonds payable and a credit to cash.
Answer: C
Diff: 1
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

63) Over the term of the bonds, the balance in the Premium on Bonds Payable account will:
A) increase or decrease if the market is unstable.
B) increase.
C) decrease.
D) not change until the bonds mature.
Answer: B
Diff: 1
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

64) The discount on bonds payable:

A) decreases interest expense on the income statement.
B) increases interest expense on the income statement.
C) decreases the amount of cash paid to bondholders over the stated rate of interest.
D) increases the amount of cash paid to bondholders over the stated rate of interest.
Answer: B
Diff: 1
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

34
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
65) The premium on bonds payable:
A) increases the amount of cash paid to bondholders over the stated rate of interest.
B) decreases the amount of cash paid to bondholders over the stated rate of interest.
C) increases interest expense on the income statement.
D) decreases interest expense on the income statement.
Answer: D
Diff: 1
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

66) Either the effective-interest method or the straight-line method of amortization will always result in:
A) the same amount of interest expense being recognized each year.
B) the same amount of interest expense being recognized over the term of the bonds.
C) an increase in interest expense if premium or discounts were not amortized.
D) the same carrying value each year.
Answer: A
Diff: 1
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

67) When the effective-interest method of bond premium amortization is used, the:
A) carrying value of the bonds will increase with each amortization.
B) amount of premium amortized increases with each amortization.
C) interest payment to bondholders will increase after each interest payment.
D) interest payment to bondholders will decrease after each interest payment.
Answer: B
Diff: 1
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

68) Under the effective-interest method of amortizing bond discount, the interest expense recorded for
each semiannual interest payment:
A) will decrease over the life of the bond.
B) will equal the amount of cash paid for each semiannual interest payment.
C) is equal to the carrying value of the bond times the stated rate of interest for each semiannual interest
period.
D) is at the same percentage of the bond's carrying value for every interest payment.
Answer: D
Diff: 1
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

35
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
69) Sisco Company issued $500,000, 6%, 10-year bonds for $425,000 with a market rate of 8%. The
effective-interest method of amortization is to be used and interest is paid annually. The journal entry on
the first interest payment date would include a:
A) debit to Interest Expense of $30,000.
B) credit to Cash of $34,000.
C) credit to Discount on Bonds Payable of $4,000.
D) debit to Interest Expense of $4,000.
Answer: C
Diff: 2
LO: 9-2
AASCB: Analytical Skills
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

70) Under the effective-interest method of amortization, the amount of discount amortized each interest
period is equal to the:
A) amount of interest expense less the cash paid.
B) amount of interest expense plus the cash paid.
C) face value of the bond times the stated interest rate.
D) face value of the bond times the market interest rate at the date of issue.
Answer: A
Diff: 2
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

71) ABC Corporation issued $600,000, 10%, 5-year bonds on January 1, 2012 for $612,000 when the market
interest rate was 8%. Interest is paid semiannually on January 1 and July 1. The corporation uses the
effective-interest method to amortize bond premium. The amount of bond interest expense recognized on
July 1, 2012 is:
A) $30,000.
B) $24,000.
C) $24,480.
D) $30,600.
Answer: C
Diff: 2
LO: 9-2
AASCB: Analytical Skills
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

36
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
72) Under the effective-interest method of amortization, the cash payment on each interest payment is
calculated by multiplying the:
A) face value of the bonds times the effective-interest rate for the appropriate time period.
B) face value of the bonds times the stated interest rate for the appropriate time period.
C) carrying value of the bonds times the stated interest rate for the appropriate time period.
D) carrying value of the bonds times the effective-interest rate for the appropriate time period.
Answer: B
Diff: 2
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

73) On January 1, Charlie Corporation issued $3,000,000, 14%, 5-year bonds with interest payable on
January 1 and July 1. The bonds sold for $3,216,288. The market rate of interest for these bonds was 12%.
Under the effective-interest method, the debit entry to interest expense on July 1 is for (rounded to the
nearest dollar):
A) $180,000.
B) $188,237.
C) $192,978.
D) $210,000.
Answer: C
Diff: 2
LO: 9-2
AASCB: Analytical Skills
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

74) Under the effective-interest method, if bonds are issued at a discount the amount of interest expense:
A) increases each period as the bonds move towards maturity.
B) decreases each period as the bonds move towards maturity.
C) remains the same for each interest period.
D) equals the amount of cash paid for each interest period.
Answer: A
Diff: 2
LO: 9-2
AASCB: Analytical Skills
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

37
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
75) Using the straight-line amortization method, if bonds are sold at a discount:
A) interest expense in the beginning of the bond's life will be less than interest expense at the end of the
bond's life.
B) interest expense in the beginning of the bond's life will be more than interest expense at the end of the
bond's life.
C) unamortized discount is subtracted from the face value of the face value of the bond to determine its
carrying value.
D) unamortized discount is added to the face value of the bond to determine its carrying value.
Answer: C
Diff: 1
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

76) The total interest expense over the life of a bond is:
A) the sum of the interest payments plus the total discount.
B) the sum of the interest payments plus the total premium.
C) the sum of the interest payments less the total discount.
D) the sum of the interest payments.
Answer: A
Diff: 1
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

77) On January 1, Hudson Corporation issues $500,000, 8%, 5-year bonds at 106. Assuming the straight-
line amortization method is used and interest is paid annually, how much bond interest expense is
recorded on the next interest date?
A) $6,000
B) $34,000
C) $46,000
D) $40,000
Answer: A
Diff: 2
LO: 9-2
AASCB: Analytical Skills
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

38
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
78) Ferndale Corporation issued a $20,000, 10-year, 10% bond dated January 1, at 102. The journal entry to
record the issuance of the bond will include a:
A) debit to cash for $20,000.
B) debit to cash for $20,400.
C) credit to bonds payable for $20,400.
D) debit to discount on bonds payable for $400.
Answer: B
Diff: 2
LO: 9-2
AASCB: Analytical Skills
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

79) On January 1, 2012, ACT Corporation issued $800,000 of 6%, 5-year bonds at 98, with interest paid
annually. Using the straight-line amortization method, what is the carrying value of the bonds on January
1, 2012?
A) $784,000
B) $785,600
C) $787,200
D) $790,400
Answer: A
Diff: 2
LO: 9-2
AASCB: Analytical Skills
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

80) On January 1, 2012, ACT Corporation issued $800,000 of 6%, 5-year bonds at 98, with interest paid
annually. Using the straight-line amortization method, what is the carrying value of the bonds one year
later on January 1, 2013?
A) $784,000
B) $785,600
C) $787,200
D) $790,400
Answer: C
Diff: 2
LO: 9-2
AASCB: Analytical Skills
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

39
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
81) A bond was issued at a discount. The journal entry to record the semiannual interest payment would
include a:
A) debit to interest expense and a credit to discount on bonds payable and a credit to cash.
B) debit to interest expense and a debit to discount on bonds payable and a credit to cash.
C) debit to interest expense and a debit to cash and a credit to discount on bonds payable.
D) debit to discount on bonds payable and a credit to cash.
Answer: A
Diff: 2
LO: 9-2
AASCB: Analytical Skills
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

82) Which is the preferred method to use when amortizing a bond discount or premium?
A) Market-interest rate method of amortization
B) Straight-line method of amortization
C) Effective-interest method of amortization
D) Both straight-line and market-interest rate methods of amortization are equally preferred.
Answer: C
Diff: 2
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

83) Acme Corporation issues $500,000, 10%, 5-year bonds on January 1, for $479,000. Interest is paid
annually on January 1. If Acme uses the straight-line method of amortization of bond discount, the
amount of interest expense recorded at year-end would be:
A) $4,200.
B) $45,800.
C) $50,000.
D) $54,200.
Answer: D
Diff: 2
LO: 9-2
AASCB: Analytical Skills
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

40
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
84) Under the effective-interest method of amortization, interest expense each period can be calculated by
multiplying the:
A) face value of the bonds times the effective-interest rate for the appropriate time period.
B) carrying value of the bonds times the effective-interest rate for the appropriate time period.
C) face value of the bonds times the stated interest rate for the appropriate time period.
D) carrying value of the bonds times the stated interest rate for the appropriate time period.
Answer: B
Diff: 1
LO: 9-2
AASCB: Analytical Skills
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

85) On January 1, Woodbridge Corporation issued $2,000,000, 14%, 5-year bonds with interest payable on
January 1 and July 1. The bonds sold for $2,197,080. The market rate of interest was 12%. Using the
effective-interest method, the debit entry to interest expense on July 1 is (round to the nearest dollar):
A) $153,796.
B) $120,000.
C) $140,000.
D) $131,825.
Answer: D
Diff: 1
LO: 9-2
AASCB: Analytical Skills
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

86) Curtis Corporation issued $200,000 of 10% bonds on January 1. The bonds pay interest semiannually
on January 1 and July 1. The company has a fiscal year end of May 31. On May 31, the Curtis Corporation
will:
A) make a journal entry to accrue interest expense from July 1 through December 31.
B) make a journal entry to accrue interest expense from January 1 through July 1
C) make a journal entry to accrue interest expense from January 1 through May 31.
D) make a journal entry to record interest expense on May 31.
Answer: C
Diff: 1
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

41
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
87) Wildcat Corporation issues $500,000, 10%, 5-year bonds on January 1, 2012 for $479,000. Interest is
paid semiannually on January 1 and July 1. If Wildcat uses the straight-line method of amortization of
bond discount, the amount of bond interest expense on July 1, 2012 is:
A) $22,900.
B) $25,000.
C) $27,100.
D) $52,100.
Answer: C
Diff: 1
LO: 9-2
AASCB: Analytical Skills
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

88) On July 1, Browning Corporation issues $1,500,000 of 10-year, 7% bonds dated July 1 at 90 when the
market rate of interest is 9%. Browning uses the straight-line method of amortization. Interest is paid each
June 30 and December 31. The interest expense recognized for the first semiannual interest payment on
December 31 is:
A) $7,500.
B) $52,500.
C) $60,000.
D) $150,000.
Answer: C
Explanation: C) 1,500,000 × .9 = 1,350,000 selling price of bonds
1,500,000 - 1,350,000 = 150,000 discount
150,000/10 year × 6/12 = 7,500 discount amortization per period
150,000 × .07 × 6/12 = 52,500 cash paid
Interest Expense = Cash Paid + Discount Amortized = 52,500 + 7,500 = 60,000
Diff: 2
LO: 9-2
AASCB: Analytical Skills
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

42
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
89) On January 1, Right Way Corporation issues $3,000,000, 5-year, 10% bonds for $2,910,000. Interest is
paid semiannually on January 1 and July 1. Right Way uses the straight-line method of amortization. The
amortization amount for the discount on bonds payable on July 1 is:
A) $9,000.
B) $90,000.
C) $30,000.
D) $29,100.
Answer: A
Explanation: A) 3,000,000 - 2,910,000 = 90,000 discount
90,000/5 year × 6/12 = 9,000 discount amortization per period
Diff: 2
LO: 9-2
AASCB: Analytical Skills
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

90) The primary reason a company will retire bonds early is to:
A) increase the amount of debt on the books.
B) help the bondholders.
C) relieve the pressure of making high interest payments, since they may be able to borrow at a lower
interest rate.
D) be able to issue more bonds.
Answer: C
Diff: 1
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

91) When a company retires bonds early, the gain or loss on the retirement is the difference between the
cash paid and the:
A) face value of the bonds.
B) original selling price of the bonds.
C) maturity value of the bonds.
D) carrying value of the bonds.
Answer: D
Diff: 1
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

43
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
92) Hudson Corporation retires its bonds at 106 on January 1. The face value of the bonds is $600,000. The
carrying value of the bonds at retirement is $619,500. The entry to record the retirement will include a:
A) debit of $36,000 to Premium on Bonds Payable.
B) debit of $19,500 to Premium on Bonds Payable.
C) credit of $19,500 to Gain on Retirement of Bonds.
D) credit of $19,500 to Loss on Retirement of Bonds.
Answer: B
Diff: 2
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

93) Bonds that the issuer may pay off at a prearranged price whenever the issuer chooses before the
maturity date are:
A) serial bonds.
B) callable bonds.
C) convertible bonds.
D) debenture bonds.
Answer: B
Diff: 1
LO: 9-2
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

94) Milton Corporation has $2,000,000 of bonds outstanding. The unamortized premium is $151,000. If the
company retired the bonds at 101, what would be the gain or loss on the retirement?
A) $131,000 gain
B) $131,000 loss
C) $151,000 gain
D) $151,000 loss
Answer: A
Explanation: A) Par Value of bonds retired + unamortized premium = Carrying Value of bonds
2,000,000 + 151,000 = 2,151,000
Carrying value - market price = gain
2,151,000 - (2,000,000 × 1.01) = 2,151,000 - 2,020,000 = 131,000 gain
Diff: 2
LO: 9-2
AASCB: Analytical Skills
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

44
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
95) Conversion of bonds payable into common stock will include a:
A) debit to bonds payable and a credit to common stock
B) debit to bonds payable and a credit to paid-in capital in excess of par
C) debit to cash and a credit to common stock.
D) debit to cash and a credit to paid-in capital in excess of par.
Answer: A
Diff: 1
LO: 9-2
AASCB: Analytical Skills
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

96) If bonds with a face value of $200,000 are converted into common stock when the carrying value of
the bonds is $155,000, the entry to record the conversion would include a debit to:
A) Bonds Payable for $155,000.
B) Bonds Payable for $200,000.
C) Discount on Bonds Payable for $45,000.
D) Cash for $45,000.
Answer: B
Diff: 2
LO: 9-2
AASCB: Analytical Skills
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

97) Immediately after the last interest payment, Henderson Company converted $3,000,000 of its bonds
into 300,000 shares of $10 par value common stock. The unamortized premium on the bonds at the date of
the conversion was $870,000. As a result of this conversion:
A) liabilities decreased by $3,870,000 and stockholders' equity increased by $3,000,000.
B) liabilities decreased by $3,000,000 and stockholders' equity increased by $3,000,000.
C) liabilities decreased by $3,870,000 and stockholders' equity increased by $3,870,000.
D) liabilities decreased by $870,000 and stockholders' equity increased by $870,000.
Answer: B
Diff: 2
LO: 9-2
AASCB: Analytical Skills
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

45
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
98) XYZ Corporation has $30,000 of bonds outstanding with a carrying value of $38,400. The bonds are
converted into 15,000 shares of $1 par value common stock. The common stock had a market value of $5
per share on the date of conversion. The entry to record the conversion would include a debit to bonds
payable of:
A) $38,400.
B) $15,000.
C) $30,000.
D) $23,400.
Answer: C
Diff: 2
LO: 9-2
AASCB: Analytical Skills
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

99) Gardner Corporation has $2,400,000 of bonds outstanding with an unamortized discount of $120,000
immediately following the last interest payment. At that time, the bonds were converted into 250,000
shares of $10 par value common stock. As a result of this conversion:
A) liabilities decreased by $2,280,000 and stockholders' equity increased by $2,280,000.
B) liabilities decreased by $2,400,000 and stockholders' equity increased by $2,400,000.
C) liabilities decreased by $2,500,000 and stockholders' equity increased by $2,500,000.
D) liabilities decreased by $2,280,000 and stockholders' equity increased by $2,500,000.
Answer: A
Diff: 2
LO: 9-2
AASCB: Analytical Skills
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

46
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
100) On January 1, 2012, Kensington Valley Company issued bonds with a face value of $800,000. The
bonds have a stated interest of 7% payable on January 1 and July 1.
Required:
1. Prepare the journal entry for the issuance of the bonds if issued at 97.
2. Prepare the journal entry for the issuance of the bonds if issued at 102.
Answer:
Account Debit Credit
1. Cash 776,000
Discount on Bonds Payable 24,000
Bonds Payable 800,000

2. Cash 816,000
Premium on Bonds Payable 16,000
Bonds Payable 800,000

Diff: 2
LO: 9-2
AASCB: Analytical Skills
AICPA Bus Persp: Strategic/Critical Thinking
AICPA Functional: Measurement

101) Darla's Cookie Emporium borrowed money by issuing $200,000 of bonds at 96 on January 1. The
bonds pay interest on January 1 and July 1. The stated rate of interest is 5% and the bonds mature in 10
years. Any discount or premium is amortized using the straight-line method. Journalize the entries to
record the:
1. issuance of the bonds
2. interest paid on the bonds every six months.
3. payment of the bond at maturity.
Answer:
Date Account Debit Credit
1. Cash 192,000
Discount on Bonds Payable 8,000
Bonds Payable 200,000

2. Interest Expense 5,400

Discount on Bonds Payable 400
Cash 5,000

3. Bonds Payable 200,000

Cash 200,000

Diff: 2
LO: 9-2
AASCB: Analytical Skills
AICPA Bus Persp: Strategic/Critical Thinking
AICPA Functional: Measurement

47
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
102) On January 1, Potter Company issued $600,000, 6%, 5-year bonds at face value. Interest is payable
semiannually on July 1 and January 1. Journalize the entries to record:
1. the issuance of the bonds.
2. payment of interest on July 1.
3. accrual of interest on December 31.
Answer:
Account Debit Credit
1. Cash 600,000
Bonds Payable 600,000

2. Interest Expense 18,000

Cash 18,000

3 Interest Expense 18,000

Interest Payable 18,000

Diff: 2
LO: 9-2
AASCB: Analytical Skills
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

103) On January 1, 2012, Fisher Corporation issued 9%, 10-year bonds with a face value of $900,000 at 96.
Interest is payable semiannually on January 1 and July 1. The effective-interest rate when the bonds were
issued was 10%. Prepare the journal entries to record the issuance of the bonds and the first semiannual
interest payment. Fisher Corporation uses the effective-interest method of amortization.
Answer:
Date Account Debit Credit
Jan 1 Cash 864,000
Discount on Bonds Payable 36,000
Bonds Payable 900,000
(900,000 × .96 = 864,000)

July 1 Interest Expense 43,200

Discount on Bonds Payable 2,700
Cash 40,500
(864,000 × .1 × 6/12 = 43,200)
(900,000 × .09 × 6/12 = 40,500)

Diff: 2
LO: 9-2
AASCB: Analytical Skills
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

48
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
104) On April 1, 2012, Edward Company issues $2,500,000 of 6%, 5-year bonds, with interest payments
made each October 1 and April 1. The bonds are issued at 98. Edward Company amortizes any premium
or discount using the straight-line method.
1. Prepare the journal entry on April 1 to issue the bonds.
2. Prepare the journal entry on October 1 to record the payment of interest and the amortization of any
discount or premium.
3. Prepare the journal entry on December 31 to record accrued interest and the amortization of any
discount or premium.

Answer:
Date Account Debit Credit
April 1 Cash 2,450,000
Discount on Bonds Payable 50,000
Bonds Payable 2,500,000
(2,500,000 × .98 = 2,450,000)

Oct 1 Interest Expense 80,000

Discount on Bonds Payable 5,000
Cash 75,000
2,500,000 × .06 × 6/12 = 75,000
50,000 / 5 × 6/12 = 5,000

Dec 31 Interest Expense 40,000

Discount on Bonds Payable 2,500
Interest Payable 37,500
2,500,000 × .06 × 3/12 = 37,500
50,000 / 5 × 3/12 = 2,500

Diff: 2
LO: 9-2
AASCB: Analytical Skills
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

49
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
105) On January 1, 2012, Henderson Company issued 8%, 20-year bonds with a face amount of $3,000,000
at 101. Interest is payable semiannually on June 30 and December 31. Prepare the journal entries to record
the issuance of the bonds and the first semiannual interest payment. Henderson uses the straight-line
method to amortize bond premium or discount.
Answer:
Date Account Debit Credit
Jan 1 Cash 3,030,000
Premium on Bonds Payable 30,000
Bonds Payable 3,000,000
3,000,000 ×1.01 = 3,030,000

June 30 Interest Expense 119,250

Premium on Bonds Payable 750
Cash 120,000
3,000,000 × .08 × 6/12 = 120,000
30,000 / 20 × 6/12 = 750

Diff: 2
LO: 9-2
AASCB: Analytical Skills
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

50
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
106) Wolverines, Inc. issued $1,000,000 of 7.5%, 10-year bonds dated June 1, 2012, with semiannual
interest payments on June 1 and December 1. The bonds were issued on June 1, 2012, at 103 3/4.
Wolverines' year end is December 31.
1. If the company uses the straight-line method of amortization, what is the amount of interest expense
for the year ended December 31, 2012?
2. What is the carrying value of the bonds on December 31, 2012?
Answer: Calculations:

1. $41,562.50 interest expense

1,000,000 × .075 × 7/12 = 43,750 interest expense prior to premium amortization

1,000,000 × 1.0375 = 1,037,500 issuance price of bonds
1,037,500 - 1,000,000 = 37,500 premium on bonds payable
37,500 / 10 = 3,750 annual amortization of premium
3,750 × 7/12 = 2,187.50 current year's amortization of premium
43,750 - 2,187.50 = 41,562.50 interest expense

2. $1,035,312.50
Unamortized premium (37,500 - 2,187.5) + 1,000,000 bond payable
Diff: 2
LO: 9-2
AASCB: Analytical Skills
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

51
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
107) On January 1, 2012, Peterson Corporation issued $100,000, 9%, 5-year bonds with semiannual
interest payments on June 30 and December 31. The bonds were issued at $93,529 yielding an effective-
interest rate of 10%. Peterson uses the effective-interest method of amortization. Prepare the journal
entries that Peterson would make on January 1, June 30 and December 31, 2012. Round all amounts to the
nearest dollar.
Answer:
Date Account Debit Credit
Jan 1 Cash 93,529
Discount on Bonds Payable 6,471
Bonds Payable 100,000

June 30 Interest Expense 4,677

Discount on Bonds Payable 177
Cash 4,500
100,000 × .09 × 6/12 = 4,500
93,529 × .1 × 6/12 = 4,677

Dec 31 Interest Expense 4,685

Discount on Bonds Payable 185
Cash 4,500
100,000 × .09 × 6/12 = 4,500
(93,529 + 177) × .1 × 6/12 = 4,685

Diff: 2
LO: 9-2
AASCB: Analytical Skills
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

52
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
108) On January 1, 2012, Tata Corporation issued $4,000,000, 9%, 5-year bonds at 96. The bonds pay
semiannual interest on January 1 and July 1. Tata uses the straight-line method of amortization and has a
calendar year end. Prepare all the journal entries that Tata Corporation would make related to this bond
issue through January 1, 2013.
Answer:
Date Account Debit Credit
Jan 1,2012 Cash 3,840,000
Discount on Bonds Payable 160,000
Bonds Payable 4,000,000
(4,000,000 × .96 = 3,840,000)

Jul 1, 2012 Bond Interest Expense 196,000

Discount on Bonds Payable 16,000
Cash 180,000
(4,000,000 × .09 × 6/12 = 180,000)
(160,000 / 5 × 6/12 = 16,000)

Dec 31, 2012 Bond Interest Expense 196,000

Discount on Bonds Payable 16,000
Interest Payable 180,000

Jan 1, 2013 Interest Payable 180,000

Cash 180,000

Diff: 2
LO: 9-2
AASCB: Analytical Skills
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

53
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
109) On July 1, 2012, Bobby's Building Corp. issued $1,000,000 of 10% bonds dated July 1, 2012 for
$937,229. The bonds were sold to yield 11% and pay interest semiannually on June 31 and December 31.
Bobby's Building Corp. uses the effective interest method of amortization.
Required (Round all amounts to the nearest dollar):
1. Prepare the journal entry to record the issuance of the bonds on July 1, 2012.
2. Complete the amortization table below for the first two interest periods.

Interest Discount Bond Carrying

Date Payment Interest Expense Amortization Discount Balance Amount

3. Prepare the journal entry to record the interest payment on December 31, 2012.
4. Suppose Bobby's Building Corp. has a fiscal year end of February 28. Prepare any adjusting entry
needed on February 28, 2012.
Answer: Calculations:
1.
Date Account Debit Credit
July 1, 2012 Cash 937,229
Discount on Bonds Payable 62,771
Bonds Payable 1,000,000

2.
Interest Interest Discount Discount Bond Carrying
Date Payment Expense Amortization Balance Amount
July 1, 2012 62,771 937,229
December 31, 2012 50,000 51,548 1,548 61,223 938,777
July 1, 2012 50,000 51,633 1,633 59,590 940,410

3.
Date Account Debit Credit
Dec 31, 2012 Interest Expense 51,548
Discount on Bonds Payable 1,548
Cash 50,000

.4.
Date Account Debit Credit
Feb 28, 2012 Interest Expense (51,633 × 2/6) 17,211
Discount on Bonds Payable 544
Interest Payable (50,000 × 2/6) 16,667

Diff: 2
LO: 9-2
AASCB: Analytical Skills
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

54
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
110) Fairways West, Inc. has $500,000 of bonds payable outstanding. The bonds have an unamortized
discount of $30,000. Management of Fairways West, Inc. would like to pay off the bonds. The bonds have
a call price of 102 and Fairways West calls the bonds. Determine the gain or loss on the retirement of the
bonds and prepare the journal entry required for the calling of the bonds.
Answer: Calculations:
Call price $500,000 × 1.02 = $510,000
Carrying value = bonds payable - unamortized discount = 500,000 - 30,000 = 470,000
Loss = call price — market price = 510,000 - 470,000 = 40,000

Journal Entry:
Bonds Payable 500,000
Loss on calling of bonds 40,000
Discount on Bonds Payable 30,000
Cash 510,000
Diff: 2
LO: 9-2
AASCB: Analytical Skills
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

111) Bandana Corp. has convertible bonds with a par value of $200,000 and an unamortized discount of
$7,000. The bonds can be converted into 2,000 shares of Bandana's common stock that has a $50 par value.
Prepare the journal entry to record the conversion.
Answer:
Account Debit Credit
Bonds Payable 200,000
Common Stock 100,000
Discount on Bonds Payable 7,000
Paid in capital in excess of par 93,000

Diff: 2
LO: 9-2
AASCB: Analytical Skills
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Measurement

9.3 Learning Objective 9-3

1) Earnings per share is the amount of a company's net income divided by the par value of its stock.
Answer: FALSE
Diff: 1
LO: 9-3
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

55
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
2) Earnings per share is a standard measure of operating performance that applies to companies of
different sizes and from different industries.
Answer: TRUE
Diff: 1
LO: 9-3
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

3) The times-interest-earned ratio is calculated by dividing operating income by operating expenses.

Answer: FALSE
Diff: 1
LO: 9-3
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

4) The times-interest-earned ratio indicates the company's ability to pay interest expense.
Answer: TRUE
Diff: 1
LO: 9-3
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

5) A lower times-interest-earned ratio indicates the ease in a company's ability to pay interest expense
Answer: FALSE
Diff: 1
LO: 9-3
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

6) A disadvantage of using bonds as a method of long-term financing is that:

A) interest must be paid regardless of earnings.
B) interest expense is tax deductible.
C) bond holders do not have voting rights.
D) issuing bonds results in higher earnings per share.
Answer: A
Diff: 2
LO: 9-3
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

56
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
7) Which of the following is NOT an advantage of issuing bonds instead of common stock?
A) Taxable net income is reduced
B) Earnings per share of common stock may be lower
C) Stockholder control is not affected
D) Income to common stockholders may increase
Answer: B
Diff: 2
LO: 9-3
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

8) All of the following are advantages of issuing stock EXCEPT that it:
A) creates no interest expense which must be paid.
B) is less risky to the issuing corporation.
C) creates no liabilities for the corporation.
D) generally results in a higher earnings per share.
Answer: D
Diff: 2
LO: 9-3
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

9) The financing option that has the lowest risk to a company is financing by:
A) retained earnings.
B) issuing stock.
C) issuing bonds payable.
D) issuing notes payable.
Answer: A
Diff: 2
LO: 9-3
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

10) The financing option that creates no liabilities or interest expense is financing by:
A) issuing notes payable.
B) debt.
C) issuing stock.
D) issuing bonds payable.
Answer: C
Diff: 2
LO: 9-3
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

57
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
11) The debt to total assets ratio is computed by dividing:
A) total assets by long-term liabilities.
B) total assets by total debt.
C) total debt by total assets.
D) long-term liabilities by total assets.
Answer: C
Diff: 1
LO: 9-3
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

12) If a company wants to maximize earnings per share it would issue:

A) stock or bonds, depending on the tax rate.
B) stock or bonds, depending on the interest rate.
C) bonds.
D) stock.
Answer: C
Diff: 1
LO: 9-3
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

13) The times-interest-earned ratio is also called:

A) coupon coverage ratio.
B) interest coverage ratio.
C) income-to-expense ratio.
D) expense ratio.
Answer: B
Diff: 1
LO: 9-3
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

14) Earnings per share is only computed for:

A) preferred stock.
B) treasury stock.
C) common stock.
D) preferred and common stock.
Answer: C
Diff: 1
LO: 9-3
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

58
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
15) Diagnostic Corporation is considering two plans for raising $2,000,000. The first plan involves the sale
of 7%, 10-year bonds at the face value of $2,000,000. The second plan involves selling 100,000 shares of
$20 par value common stock. Diagnostic Corporation currently has 150,000 shares of stock outstanding
and net income of $1,500,000. Both plans are expected to generate additional income of $500,000 before
interest and taxes. The income tax rate is 30%.

Calculate earnings per share for both plans.

Answer: Sale of bonds:

Net income before expansion 1,500,000

Additional income before interest and taxes 500,000
Less interest expense (2,000,000 × .07) 140,000
Additional income before taxes 360,000
Less income tax expense 108,000
Additional net income 252,000
Total company net income 1,752,000
Earnings per share (1,752,000/150,000) 11.68

Sale of stock:

Net income before expansion 1,500,000

Additional income before interest and taxes 500,000
Less interest expense 0
Additional income before taxes 500,000
Less income tax expense 150,000
Additional net income 350,000
Total company net income 1,850,000
Earnings per share (1,850,000/250,000) 7.40
Diff: 2
LO: 9-3
AASCB: Analytical Skills
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

59
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
16) Shown below is a partial income statement from Bill's Boat Shop, Inc.:

Bill's Boat Shop, Inc.

Income Statement (partial)
For the Year Ended December 31, 2012

Gross profit 160,000

Expenses
Operating expenses $52,000
Interest expense 18,000
Total expenses 70,000
Income before income taxes 90,000
Income tax expense 27,000
Net income $63,000

The weighted-average number of shares of common stock outstanding during 2012 was 30,000 shares.
Using the information above calculate the earnings per share and the times-interest-earned ratio.
Answer: Earnings per share = $63,000/30,000 = $2.10

Times-interest-earned ratio = ($63,000 + $27,000 + 18,000)/$18,000 = 6 times.

Diff: 2
LO: 9-3
AASCB: Analytical Skills
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

17) Borrowing money is an option to corporations that do not generate enough cash from daily
operations to meet all of its financing needs. If a corporation were to sell bonds as a form of borrowing
money, what disadvantages could arise?
Answer: Borrowing has its disadvantages. Interest expense may be high enough to eliminate net income
and lead to losses. Also, borrowing creates liabilities that must be paid during bad years as well as good
years.
Diff: 2
LO: 9-3
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

9.4 Learning Objective 9-4

1) A capital lease requires the lessee to record the lease as a purchase.

Answer: TRUE
Diff: 1
LO: 9-4
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

60
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
2) The lessee in an operating lease capitalizes the asset if it meets only one of the four criteria.
Answer: FALSE
Diff: 1
LO: 9-4
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

3) An operating lease transfers title of the leased asset to the lessee at the end of the lease term.
Answer: FALSE
Diff: 1
LO: 9-4
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

4) Lease payments are paid by the lessor.

Answer: FALSE
Diff: 1
LO: 9-4
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

5) Operating leases are preferred over capital leases because capital leases increase a company's debt
ratio.
Answer: TRUE
Diff: 1
LO: 9-4
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

6) A lease where the plan is temporary use of an asset by the lessee with continued ownership of the asset
by the lessor is called a(n):
A) capital lease.
B) preferred lease.
C) operating lease.
D) purchased lease.
Answer: C
Diff: 1
LO: 9-4
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

61
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
7) Which of the following statements about capital leases is INCORRECT?
A) Under a capital lease, the lessee's books do not report the leased asset.
B) A capital lease can transfer title of the leased asset to the lessee at the end of the lease term.
C) A capital lease contains a bargain purchase option.
D) Under a capital lease, the lessee records a lease liability at the beginning of the lease term.
Answer: A
Diff: 1
LO: 9-4
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

8) In a lease agreement:
A) the owner of the property is called the lessee.
B) the renter of the property is called the lessor.
C) the presence of a bargain purchase option indicates that it is a capital lease.
D) there is always a transfer of ownership of the leased asset at the end of the lease.
Answer: C
Diff: 1
LO: 9-4
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

9) If, as part of the accounting for a lease, the company debits an asset and credits a liability, then the
lease must be a(n):
A) purchased lease.
B) operating lease.
C) cancelable lease.
D) capital lease.
Answer: D
Diff: 1
LO: 9-4
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

10) Which of the following criteria would allow a lease to be recorded as an operating lease?
A) The lease transfers ownership of the property to the lessee.
B) The lease contains a bargain purchase option.
C) The lease term is less than 75% of the economic life of the leased property.
D) The present value of the lease payments equals or exceeds 90% of the fair market value of the leased
property.
Answer: C
Diff: 1
LO: 9-4
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

62
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
11) Which of the following statements regarding leases is correct?
A) Capital leases are favored over operating leases.
B) A debit balance in the Leased Asset account on the balance sheet indicates an operating lease.
C) Title is transferred to the lessee at the end of an operating lease term.
D) Operating leases require the lessee to make rent payments.
Answer: D
Diff: 1
LO: 9-4
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

12) Wayne Technical Corporation signed a lease for $150,000 for equipment. The equipment has an
estimated useful life of 7 years. This lease would be considered to be a capital lease if:
A) the equipment is leased for 4 years.
B) the present value of the lease payments equals $40,000.
C) title to the equipment transfers to Wayne at the end of the lease term.
D) the lease agreement allows Wayne to purchase the truck for $75,000 at the end of the lease.
Answer: C
Diff: 1
LO: 9-4
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

13) Which type of lease will NOT increase a company's assets or long-term liabilities?
A) An operating lease.
B) A capital lease.
C) A lease that contains a bargain purchase option.
D) A lease that transfers title of the leased asset to the lessee at the end of the lease term.
Answer: A
Diff: 1
LO: 9-4
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

14) If the present value of the lease payments is 90% or more of the market value of the leased asset, the:
A) lease is not cost-effective and should be cancelled.
B) lease may be classified as an operating lease.
C) one of the criteria is met for the lease to be considered a capital lease.
D) lease may be recorded off-balance sheet.
Answer: C
Diff: 2
LO: 9-4
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

63
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
15) To determine whether a pension plan is over-funded or under-funded, a company must compare the:
A) fair market value of the pension plan assets to the accumulated benefit obligation.
B) cost of the pension plan assets to the accumulated benefit obligation.
C) accumulated benefit obligation to the plan's anticipated obligations.
D) fair market value of the pension plan assets to the net income on the Income Statement.
Answer: A
Diff: 2
LO: 9-4
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

16) East-West Airlines is planning on leasing an aircraft. East-West does not receive title to the aircraft
during or at the end of the lease period. Also, the lease does not contain a bargain purchase option. Using
the lease information shown below indicate whether the lease is a capital lease or an operating lease and
explain why.

Type of property — Aircraft

Yearly rental — $9,500,000
Lease term — 15 years
Estimated economic life — 25 years
Fair market value of the leased asset — $85,000,000
Present value of lease rental payments — $77,000,000
Answer: This lease is a capital lease, since it meets one of the four criteria (i.e. the present value of the
lease payments is 90% or more of the market value of the leased asset).
Diff: 2
LO: 9-4
AASCB: Analytical Skills
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

17) East-West Airlines is planning on leasing an aircraft. East-West does not receive title to the aircraft
during or at the end of the lease period. Also, the lease does not contain a bargain purchase option. Using
the lease information shown below indicate whether the lease is a capital lease or an operating lease and
explain why.

Type of property — Aircraft

Yearly rental — $9,500,000
Lease term — 20 years
Estimated economic life — 25 years
Fair market value of the leased asset — $85,000,000
Present value of lease rental payments — $75,000,000
Answer: This lease is a capital lease, since it meets one of the four criteria (i.e. the lease term is 75% or
more of the estimated useful life of the leased asset).
Diff: 2
LO: 9-4
AASCB: Analytical Skills
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

64
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
18) East-West Airlines is planning on leasing an aircraft. East-West does not receive title to the aircraft
during or at the end of the lease period. Also, the lease does not contain a bargain purchase option. Using
the lease information shown below indicate whether the lease is a capital lease or an operating lease and
explain why.

Type of property — Aircraft

Yearly rental - $9,500,000
Lease term — 15 years
Estimated economic life — 25 years
Fair market value of the leased asset - $85,000,000
Present value of lease rental payments - $75,000,000
Answer: This lease is an operating lease, since it does not meet one of the four criteria that would classify
it as a capital lease.
Diff: 2
LO: 9-4
AASCB: Analytical Skills
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

9.5 Learning Objective 9-5

1) Current maturities of long-term debt are reported separately from long-term liabilities.
Answer: TRUE
Diff: 1
LO: 9-5
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

2) Long-term liabilities are reported in the same section as current liabilities on the balance sheet.
Answer: FALSE
Diff: 1
LO: 9-5
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

3) Details about a company's liabilities should be included in the notes to the financial statements.
Answer: TRUE
Diff: 1
LO: 9-5
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

65
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
4) A company must include all of the following about its liabilities in the notes to the financial statements
EXCEPT the:
A) maturity dates of the debt.
B) interest rates on the debt.
C) interest expense paid for the year.
D) current maturities of the long-term debt as a current liability.
Answer: C
Diff: 1
LO: 9-5
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

5) The retirement of callable bonds at an amount below face value would appear on a statement of cash
flows as an:
A) outflow in the financing activities section.
B) inflow in the financing activities section.
C) outflow in the operating activities section.
D) inflow in the operating activities section.
Answer: B
Diff: 1
LO: 9-5
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

6) Bonds with a face value of $300,000 are issued at 101. The statement of cash flows would report a cash
inflow of:
A) $300,000 in the financing activities section.
B) $303,000 in the financing activities section.
C) $3,000 in the financing activities section.
D) $300,000 in the investing activities section.
Answer: B
Diff: 1
LO: 9-5
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

7) David Corporation issued $100,000, 5-year bonds at 97 on January 1, 2008. On December 31, 2012 the
bonds matured. The payment of the bonds at maturity would be reported on the statement of cash flows
as a cash outflow of:
A) $97,000 in the financing activities section.
B) $97,000 in the investing activities section.
C) $100,000 in the financing activities section
D) $100,000 in the investing activities section.
Answer: C
Diff: 2
LO: 9-5
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

66
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall
8) After posting the adjusting entries, Binger Corporation has the following account balances (partial
listing) in their general ledger.

Account General Ledger Balance

Accounts Payable $ 29,000
Notes Payable, 5-month 58,000
Equipment 85,000
Accumulated Depreciation — Equipment 16,000
Notes Payable, 7-year, 7% 120,000
Interest Expense 7,000
Interest Payable 3,000
Sales Tax Payable 24,000

Prepare the current liability section of Binger Corporation's balance sheet. Assume that the current
portion of the long-term debt is $15,000.
Answer: Binger Corporation

Current Liabilities:

Notes Payable, 5-month $ 58,000

Accounts Payable 29,000
Sales Tax Payable 24,000
Current portion of long-term debt 15,000
Interest Payable 3,000
Total Current Liabilities $129,000

Diff: 2
LO: 9-5
AICPA Bus Persp: Legal/Regulatory
AICPA Functional: Reporting

67
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall