## Test Bank for Financial Accounting Tools for Business Decision-Making, 6th Canadian Edition by Paul D. Kimmel

CHAPTER 10

REPORTING AND ANALYZING LIABILITIES

SUMMARY OF QUESTION TYPES BY STUDY OBJECTIVE AND LEVEL OF DIFFICULTY

Item SO LOD Item SO LOD Item SO LOD Item SO LOD Item SO LOD

True-False Statements

1. 1 M 14. 1 M 27. 2 E 40. 3 E 53. 4 M

2. 1 E 15. 1 M 28. 2 M 41. 3 M 54. 4 E

3. 1 M 16. 1 E 29. 2 E 42. 3 E 55. 4 M

4. 1 E 17. 1 M 30. 2 M 43. 3 M 56. 4 M

5. 1 E 18. 2 E 31. 2 M 44. 3 E 57. 4 M

6. 1 M 19. 2 E 32. 2 M 45. 3 M 58. 4 M

7. 1 E 20. 2 E 33. 2 E 46. 3 E 59. 4 M

8. 1 E 21. 2 E 34. 2 M 47. 3 M 60. 4 M

9. 1 M 22. 2 M 35. 2 M 48. 3 E 61. 4 H

10. 1 M 23. 2 M 36. 2 M 49. 3 M 62. 4 H

11. 1 M 24. 2 M 37. 3 M 50. 3 M 63. 4 E

12. 1 M 25. 2 M 38. 3 M 51. 4 E

13. 1 M 26. 2 M 39. 3 E 52. 4 M

Multiple Choice Questions

64. 1 M 75. 1 M 86. 2 H 97. 3 H 108. 4 E

65. 1 H 76. 1 M 87. 2 M 98. 3 H 109. 4 M

66. 1 H 77. 1 E 88. 2 H 99. 3 E 110. 4 M

67. 1 M 78. 2 M 89. 2 E 100. 4 M 111. 4 M

68. 1 M 79. 2 E 90. 2 M 101. 4 E 112. 4 H

69. 1 E 80. 2 E 91. 2 M 102. 4 M 113. 4 H

70. 1 M 81. 2 M 92. 3 E 103. 4 M 114. 4 M

71. 1 H 82. 2 M 93. 3 E 104. 4 M

72. 1 M 83. 2 M 94. 3 M 105. 4 M

73. 1 M 84. 2 H 95. 3 H 106. 4 M

74. 1 M 85. 2 M 96. 3 H 107. 4 M

Note: E = Easy M = Medium H = Hard

SUMMARY OF QUESTION TYPES BY STUDY OBJECTIVE AND LEVEL OF DIFFICULTY (CONTINUED)

Item SO LOD Item SO LOD Item SO LOD Item SO LOD Item SO LOD

Exercises

115. 1 E 120. 2 M 125. 2 M 130. 3 E 135. 4 M

116. 1 M 121. 2 E 126. 2 H 131. 3 M

117. 1 M 122. 2 M 127. 3 E 132. 4 E

118. 1 E 123. 2 M 128. 3 M 133. 4 M

119. 1 H 124. 2 M 129. 3 M 134. 4 M

Matching

136. 1–4 E,M

Short-Answer Essay

137. 1 M 139. 2 E 141. 4 M 143. 4 M

138. 1 E 140. 4 E 142. 4 M

Note: E = Easy M = Medium H = Hard

SUMMARY OF STUDY OBJECTIVES BY QUESTION TYPE

Item Type Item Type Item Type Item Type Item Type Item Type Item Type

Study Objective 1

1. TF 7. TF 13. TF 65. MC 71. MC 77. MC 136. Ma

2. TF 8. TF 14. TF 66. MC 72. MC 115. Ex 137. SAE

3. TF 9. TF 15. TF 67. MC 73. MC 116. Ex 138. SAE

4. TF 10. TF 16. TF 68. MC 74. MC 117. Ex

5. TF 11. TF 17. TF 69. MC 75. MC 118. Ex

6. TF 12. TF 64. MC 70. MC 76. MC 119. Ex

Study Objective 2

18. TF 24. TF 30. TF 36. TF 83. MC 89. MC 123. Ex

19. TF 25. TF 31. TF 78. MC 84. MC 90. MC 124. Ex

20. TF 26. TF 32. TF 79. MC 85. MC 91. MC 125. Ex

21. TF 27. TF 33. TF 80. MC 86. MC 120. Ex 126. Ex

22. TF 28. TF 34. TF 81. MC 87. MC 121. Ex 136. Ma

23. TF 29. TF 35. TF 82. MC 88. MC 122. Ex 139. SAE

Study Objective 3

37. TF 41. TF 45. TF 49. TF 94. MC 98. MC 129. Ex

38. TF 42. TF 46. TF 50. TF 95. MC 99. MC 130. Ex

39. TF 43. TF 47. TF 92. MC 96. MC 127. Ex 131. Ex

40. TF 44. TF 48. TF 93. MC 97. MC 128. Ex 136. Ma

Study Objective 4

51. TF 57. TF 63. TF 105. MC 111. MC 134. Ex 143. SAE

52. TF 58. TF 100. MC 106. MC 112. MC 135. Ex

53. TF 59. TF 101. MC 107. MC 113. MC 136. Ma

54. TF 60. TF 102. MC 108. MC 114. MC 140. SAE

55. TF 61. TF 103. MC 109. MC 132. Ex 141. SAE

56. TF 62. TF 104. MC 110. MC 133. Ex 142. SAE

Note: TF = True-False Ma = Matching

MC = Multiple Choice Ex = Exercise SAE = Short-answer Essay

CHAPTER STUDY OBJECTIVES

1. Account for current liabilities. A current liability is a debt that will be paid (1) from existing current assets or through the creation of other current liabilities, and (2) within one year. An example of a current liability is an operating line of credit that results in bank indebtedness. Current liabilities also include sales taxes, payroll deductions, and employee benefits, all of which the company collects on behalf of third parties. Other examples include property taxes and interest on notes or loans payable, which must be accrued until paid. The portion of non-current debt that is due within the next year must be deducted from the total non-current debt and reported as a current liability.

All of the above are “certain” or determinable liabilities. Contingent liabilities are “uncertain” liabilities awaiting confirmation by a future event that are not recorded unless probable. When recorded, these liabilities are called provisions. The terms and nature of each recorded provision and contingent liability should be described in the notes accompanying the financial statements.

2. Account for instalment notes payable. Long-term notes payable are usually repayable in a series of instalment payments. Each payment consists of (1) interest on the unpaid balance of the note, and (2) a reduction of the principal balance. These payments can be either (1) fixed principal payments plus interest or (2) blended principal and interest payments. With fixed principal payments plus interest, the reduction in principal is constant but the cash payment and interest expense decrease each period as the principal decreases. With blended principal and interest payments, the reduction of principal increases while the interest expense decreases each period. In total, the cash payment (principal and interest) remains constant each period.

3. Identify the requirements for the financial statement presentation and analysis of liabilities. In the income statement, interest expense (finance cost) is reported as “other revenues and expenses.” In the statement of financial position, current liabilities are usually reported first, followed by non-current liabilities.

The liquidity of a company may be analyzed by calculating the current ratio, in addition to the receivables and inventory turnover ratios. The solvency of a company may be analyzed by calculating the debt to total assets and times interest earned ratios. Another factor to consider is unrecorded debt, such as operating lease obligations.

4. Account for bonds payable (Appendix 10A). Bonds are issued at their present (market) value. When they are issued, the Cash account is debited and the Bonds Payable account is credited for the issue price of the bonds.

Bond discounts and bond premiums represent the difference between a bond’s face value and present value. They are amortized to interest expense over the life of the bond using the effective-interest method of amortization. Amortization is calculated as the difference between the interest paid and the interest expense. Interest paid is calculated by multiplying the bonds’ face value by the coupon interest rate. Interest expense is calculated by multiplying the bonds’ carrying amount (which is equal to their present value at that time) at the beginning of the interest period by the market interest rate. The amount of the discount or premium that is amortized is equal to the change in the present value of the bond during that period. The amortization of a bond discount increases interest expense and the bond’s carrying amount. The amortization of a bond premium decreases interest expense and the bond’s carrying amount.

When bonds are retired at maturity, Bonds Payable is debited and Cash is credited. There is no gain or loss at retirement.

TRUE-FALSE STATEMENTS

1. Amounts available to be drawn in the future from an operating line of credit improve a company’s liquidity.

2. Property tax payable is classified as a non-current liability because it is related to property, which is a non-current asset.

3. If a company’s fiscal year is the same as the calendar year used for property tax purposes, there should be no prepaid property tax on its year-end financial statements but there may be a property tax liability.

4. Notes payable usually require the borrower to pay interest.

5. Notes payable are sometimes used instead of accounts payable.

6. If interest is due at maturity, a $50,000, 4%, 9-month note payable requires an interest payment of $1,500.

7. Most notes and bank loans are not interest bearing.

8. If drawing on an operating line of credit results in a negative cash balance, a current liability known as bank indebtedness results.

9. Interest expense on a bank loan payable is only recorded at maturity.

10. When a business sells an item and collects Harmonized Sales Tax (HST) on it, a current liability arises.

11. Payroll liabilities include the employer’s share of CPP contributions and EI premiums.

12. If any portion of a non-current liability is to be paid in the next year, the entire debt should be classified as a current liability.

13. “Current maturities of non-current debt” refers to the amount of interest on notes payable that must be paid in the current year.

14. Even though current and non-current debt must be shown separately on the statement of financial position, it is not necessary to prepare a journal entry to recognize this.

15. Provisions are liabilities of uncertain timing or amount, along with some uncertainty as to whether the liability will have to be paid.

16. A contingent liability may materialize in the future because of something that happened in the past.

17. Under IFRS, contingent liabilities should be recorded in the accounts if there is a remote possibility that the contingency will actually occur.

18. A mortgage payable is often secured by collateral such as a building.

19. All long-term notes payable must be secured.

20. A financial liability means there is a contractual obligation to pay cash in the future.

21. While short-term notes are generally repayable in full at maturity, most long-term notes are repayable in a series of periodic payments called instalments.

22. With fixed principal payments on a long-term note payable, the principal portion increases each period.

23. With fixed principal payments on a long-term note payable, the interest portion decreases each period.

24. With fixed principal payments on a long-term note payable, the interest portion does not change each period.

25. With blended principal and interest payments, the equal periodic payments result in the interest portion increasing each period.

26. With blended principal and interest payments, the equal periodic payments result in the principal portion increasing each period.

27. A non- current liability is an obligation that is expected to be paid within one year.

28. Unearned revenue is a financial liability.

29. Long term notes payable are a common form of debt financing.

30. Long term notes payable can only have floating interest rates.

31. Secured notes are also known as mortgages.

32. Unsecured notes are issued against the general credit of the borrower.

33. Instalments are always paid monthly.

34. Instalment payments consist of a mix of interest on the unpaid balance of the loan and a reduction of the loan principal.

35. Instalment notes with fixed principal payment are repayable in equal periodic amounts which include interest.

36. Since a portion of the principal is repaid each month, the outstanding balance will increase each month.

37. The classification of a liability as current or non-current is important because it may affect the evaluation of a company’s liquidity.

38. The debt to total assets ratio measures the percentage of the total assets provided by creditors.

39. The times interest earned ratio is calculated by dividing net profit by interest expense.

40. Current liabilities are generally presented on the statement of financial position in order or liquidity, but IFRS allows presentation in reverse order of liquidity as well.

41. “Off-balance-sheet financing” refers to a situation where liabilities are recorded in the income statement instead of the statement of financial position.

42. Interest (finance) expenses are separately reported in the “other gain and revenues” section of the income statement.

43. The terms of an operating line of credit and a notes (loans) payable are disclosed in the notes to the financial statements.

44. Current liabilities are listed in order of descending dollar value.

45. All companies are prohibited to report current liabilities in reverse order of liquidity.

46. Full disclosure of non- current debt is very important.

47. Detailed information such as a list showing the amounts of non current debt that is scheduled to be paid off in each of the next five years should be disclosed in the notes to the financial statements.

48. Liquidity ratios measure a company’s long term ability to pay debt.

49. Solvency ratios measure a company’s ability to repay current debt.

50. A high liquidity ratio generally indicates that a company has a greater ability to meet its current obligations.

51. Bonds are often traded on an organized exchange, such as the Toronto Stock Exchange (TSX).

52. The face value of a bond is the amount of principal and interest due at the maturity date.

53. If a bond has a face value of $10,000 and a 6% coupon interest rate, then the semi-annual interest payment will be $600.

54. If bonds are redeemable, they can be retired by the issuer before they mature.

55. All transactions between bondholders and other investors must be recorded by the issuing corporation.

56. The carrying amount of bonds issued at a discount will initially be higher than the face value.

57. The calculation of interest to be paid each interest period for a bond payable is not influenced by any premium or discount upon issue.

58. If $150,000 face value bonds are issued at 102.5, the proceeds received will be $102,500.

59. If the market interest rate at the date of a bond issue is greater than the coupon interest rate, the bond will be issued at a premium.

60. If bonds are issued at a discount, the issuing corporation will pay a principal amount that is less than the face amount of the bonds on the maturity date.

61. Amortization of a bond premium decreases interest expense recorded by the issuer.

62. The carrying amount of a bond is its face value less any unamortized premium or plus any unamortized discount.

63. The effective-interest method is required for companies reporting under IFRS, but optional for companies using ASPE if other methods do not result in material differences.

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