Bonds Payable and Other Long-term Liabilities
Self Test
Introduction to Accounting
Bonds Payable and Other Long-term Liabilities
Self Test
Click the “Check Your Answer” box below each question to reveal the correct answer and explanation.
1. A bond payable occurs when
a. the company borrows from a bank
b. the company borrows from a financing company
c. the company borrows from investors
d. all of the above
Answer
C. A bond payable is borrowing monies from investors. (a. & b.) is normally called long term debt or notes payable.
2. The maturity value is
a. the amount of cash exchanged when the bond is issued
b. the fair market value of the bonds at the end of the current period
c. the net amount owed at the end of every period
d. the amount that must be repaid on the maturity date
Answer
C. A bond payable is borrowing monies from investors. (a. & b.) is normally called long term debt or notes payable.
3. The maturity date is
a. the date interest is paid
b. the date the maturity value must be repaid
c. the date fair market value must be repaid
d. the date the bond is issued
Answer
B. The maturity date is the date the maturity value must be repaid. The maturity date and maturity amount are set in the bond contract.
4. The stated annual interest rate is
a. the stated rate
b. the rate that determines the amount of cash paid
c. the rate that is stated in the bond contract
d. all of the above
Answer
D. The stated annual interest rate is also referred to as the stated rate. It determines the amount of cash that will be paid periodically, is stated in the bond contract, and will not change.
5. The annual market yield/effective rate is
a. the annual rate the investor earns
b. the annual rate that determines the amount of cash paid
c. a rate that is stated in the bond contract
d. all of the above
Answer
A. The annual market yield/effective rate is the rate the investor earns. The investor will determine this rate by the amount of cash invested on the issue date or on the trade date. The market rate will change as economic or risk factors change. It is not stated in the bond contract. This rate will be different than the stated rate unless the bond is issued at par.
6. The market yield/effective interest rate will
a. never change
b. change when economic or risk factors change
c. determine the amount of cash paid to the investor
d. is determined by the maturity value of the bond
Answer
B. The market rate changes when economic or risk factors change. This rate will change constantly on market exchanges. The amount of cash paid to the investor is determined by the stated rate.
7. An investor who pays $800 for a bond with a maturity value of $1,000 will earn
a. a higher rate of return than the stated rate
b. a lower rate of return than the stated rate
c. a higher rate of return than the market effective rate
d. the same rate of return as the stated rate
Answer
A. The cash received annually from the bond for interested is stated in the contract and will not change. It is the maturity value x stated %. When the investor pays less, the interest rate earned (effective market yield) is higher.
Remember:
Pay less = Earn more
Pay more = Earn less
8. A discount occurs when
a. cash exchanged is less than face value
b. cash exchanged is more than face value
c. cash exchanged is the same as face value
d. the market effective yield is lower than the stated rate of return
Answer
A. A discount occurs when the cash received by the company is lower than the maturity value. This also causes a higher effective interest rate.
9. A premium occurs when
a. cash exchanged is less than face value
b. cash exchanged is more than face value
c. cash exchanged is the same as face value
d. the market effective yield is higher than the stated rate of return
Answer
B. A premium occurs when the cash received by the company is higher than the maturity value. This also causes a lower effective interest rate.
10. A bond that is issued at par will
a. always have cash paid for interest equal to interest expense incurred
b. always have cash paid for interest higher than interest expense incurred
c. always have cash paid for interest lower than interest expense incurred
d. have an effective market yield higher than the stated rate of return
Answer
A. A bond issued at par means the cash exchanged is equal to the maturity value. The stated rate is equal to the effective market rate. When the rates are the same, cash paid for interest will equal interest expense. The stated rate is the decrease to cash and the effective rate is the increase to interest expense.
11. What amount must always be repaid on the maturity date?
a. maturity rate
b. maturity value
c. maturity yield
d. maturity fair market value
Answer
B. The maturity value must be repaid on the maturity date. Both are stated in the bond contract.
12. A bond issued at a price of 96 can be purchased at
a. 96% of fair market value
b. 96% of the maturity value
c. 0.96% of the current market interest rate
d. 0.96% of the current stated interest rate
Answer
B. The price of the bond is stated as a % of maturity value. To determine the amount of cash exchanged when the bond is issued, make the number a % and multiply the % by the maturity value.
13. The market price of a bond on any given date is
a. the present value of future cash flows
b. always the fair market value on the date of issue
c. the present value of past cash flows
d. the original issue price
Answer
14. When recording the issuance of a bond, the amount owed is always recorded
a. as a credit (increase) to bonds payable at the expected fair market value on the maturity date
b. as a credit (increase) to bonds payable at the maturity value
c. as a debit to a premium
d. as a debit to a discount
Answer
B. The bond payable is always recorded for the maturity value amount. A premium (credit) occurs when cash exchanged is higher than maturity value. A discount (debit) occurs when cash exchanged is lower than maturity value.
15. Interest expense will be greater than cash paid for interest when
a. the bond is issued at par
b. the bond is issued at a discount
c. the bond is issued at a premium
d. the bond is issued at maturity value
Answer
B. Interest expense is the effective market rate times the amount of cash exchanged. When the effective market rate is higher than the stated rate, interest expense will be higher than cash paid. The amount of cash exchanged is lower than maturity value when there is a discount.
16. The purpose of the amortization schedule is to
a. determine the price of the bond
b. determine interest expense for each period
c. determine the amount of cash paid for interest
d. determine the maturity value of the bond
Answer
B. The amortization schedule is used to determine interest expense. Interest expense changes each period as the net amount owed changes. The price of the bond is determined by the market rate at the time (a.) The amount of cash paid and the maturity value of the bond is stated in the contract (c. & d.).
17. The difference in cash paid for interest and interest expense when the bond is issued at a premium will always
a. decrease the net amount owed to the investor
b. increase the net amount owed to the investor
c. not affect the net amount owed to the investor
d. change the maturity value by this amount
Answer
A. A premium means that cash exchanged is higher than the maturity value. The difference is reduced as cash paid for interest is higher than interest expense. A bond issued at a premium is issued at a higher price than maturity value and must decrease to get to maturity value by the maturity date.
18. The amount recorded for interest expense is the amount in which column on the amortization schedule?
a. carrying value
b. discount/premium
c. effective interest
d. stated interest
Answer
C. The effective interest column always gives the amount recorded as an increase to interest expense. (a.) is the net amount owed to the investor. (b.) is the difference between cash exchanged and the maturity value. (d) is used to determine the amount of cash that is paid to the investor periodically.
19. The amount paid for interest is the amount in which column on the amortization schedule?
a. carrying value
b. discount/premium
c. effective interest
d. stated interest
Answer
D. The amount paid for interest is the amount in the stated interest column. The amount is computed as maturity value x stated interest % / # payments each year. This amount will be the same for each period.
20. A long term installment note is repaid
a. with equal payments at the end of stated periods of time
b. on the termination date of the loan
c. on demand
d. in principle only, no interest is charged
Answer
A. Installment notes are repaid with equal periodic payments. Each payment is considered an installment. Interest is almost always charged.
21. Periodic payments on a long-term note payable must pay
a. interest incurred on the entire time borrowed before paying any principle
b. interest incurred each period plus partial principle repayment
c. interest incurred each period plus entire principle repayment
d. interest paid for future periods
Answer
B. The payment must pay interest incurred during the period and a portion of the principle owed. Interest is paid as it is incurred on the amount owed. As payments are made, the amount owed decreases and interest expense is lower in future periods.
22. When a payment is made on a long term note payable
a. future interest expense is decreased (credit)
b. future interest expense is increased (debit)
c. long term notes payable is decreased (credit)
d. both a. & c.
Answer
D. The payment covers interest expense incurred during the period and repays a portion of the note payable. Interest incurred is an increase, recorded with a debit. Repayment is a decrease to notes payable.
23. The amortization schedule for a long-term note payable
a. determines the amount paid for interest expense and the amount paid for principle
b. determines the effective borrowing cost on the note payable
c. determines the dollar value of the payment that must be made this period
d. determines the amount that can be borrowed
Answer
A. The amortization schedule determines the interest expense portion of the payment. Interest expense is calculated based on the amount owed, which decreases as payments are made. (b. & c.) are stated in the borrowing agreement.
24. The carrying value of a note payable will always
a. increase when a payment is made
b. decrease when a payment is made
c. not change until the maturity date
d. change when the effective yield changes
Answer
B. Carrying value is the amount owed at the end of the period. The amount owed will decrease when payments are made. (d.) The interest rate is the same for the entire payment period. The balance owed changes with each payment made since part of the payment covers interest expense and part of the payment pays principle owed.
25. The only difference in the journal entry made to record the first payment and the journal entry made for the second payment on a long-term note payable is
a. the interest expense amount will be different
b. the amount the note payable is decreased will be different
c. the journal entries will be exactly the same
d. both a. & b.
Answer
D. The balance owed changes when the first payment is made. Interest is computed based on the amount owed Interest expense will be lower and principle repaid is higher on the second payment.