Tb10 - Test Bank Chapter 10 Tb10 - Test Bank Chapter 10

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Tb10 - Test bank chapter 10
Financial Accounting (University of Ottawa)
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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
Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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10 - 2 Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition
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

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10 - 3 Reporting and Analyzing Liabilities
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
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
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
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

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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

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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.

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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.

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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.

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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.

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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.

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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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ANSWERS TO TRUE-FALSE STATEMENTS

Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans.
1. T 10. T 19. F 28. F 37. T 46. T 55. F
2. F 11. T 20. T 29. T 38. T 47. T 56. F
3. T 12. F 21. T 30. F 39. F 48. F 57. T
4. T 13. F 22. F 31. T 40. T 49. F 58. F
5. T 14. T 23. T 32. T 41. F 50. T 59. F
6. T 15. F 24. F 33. F 42. F 51. T 60. F
7. F 16. T 25. F 34. T 43. T 52. F 61. T
8. T 17. F 26. T 35. F 44. F 53. F 62. F
9. F 18. T 27. F 36. F 45. F 54. T 63. T

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MULTIPLE CHOICE QUESTIONS
64. Under IFRS, which of the following would most likely be classified as a current liability?
(a) mortgage payable
(b) bonds payable
(c) bank indebtedness
(d) contingent liability
65. Failure to record a liability will probably

(a) result in overstated profit.
(b) result in overstated total liabilities and shareholders’ equity.
(c) have no effect on profit.
(d) result in overstated total assets.
66. Killarney Exhibits Inc. received its annual property tax bill for $21,500 in January. It was paid
when due on March 31. Killarney Exhibits year end is Dec 31. The Dec 31 balances should be
(a) $5,375 for Prepaid Property Tax; $16,125 for Property Tax Expense.
(b) $5,375 for Prepaid Property Tax; $5,375 for Property Tax Payable.
(c) $0 for Prepaid Property Tax; $0 for Property Tax Payable.
(d) $1,792 for Prepaid Property Tax; $19,708 for Property Tax Expense.
67. Roofer’s Inc. had an operating line of credit of $100,000 and overdrew its bank balance to
result in a negative cash balance of $33,000 at year-end. This would be reported in the
statement of financial position as
(a) a current liability of $33,000.
(b) a non-current liability of $67,000.
(c) a current asset of $67,000.
(d) a current asset of $(33,000).
68. Interest expense on a note payable, with interest due at maturity, is

(a) always equal to zero.
(b) accrued over the life of the note.
(c) only recorded at the time the note is issued.
(d) only recorded at maturity when the note is paid.
Use the following information for questions 69–70.
On January 1 of this year, Gertoni Lenders agrees to lend Ester Corp. $150,000. Ester Corp.
signs a $150,000, 6%, 9-month loan. Interest is due at maturity.
69. The entry made by Ester Corp. on January 1 to record the receipt of the loan is
(a) Interest Expense............................................................................ 6,750
Cash.............................................................................................. 145,500

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Bank Loan Payable................................................................. 150,000

(b) Cash.............................................................................................. 150,000
(c) Cash.............................................................................................. 150,000
Interest Expense............................................................................ 6,750
(d) Cash.............................................................................................. 150,000
Interest Payable...................................................................... 6,750
70. What entry will Ester Corp. make to repay the loan on September 30, assuming no further
adjusting entries have been made since June 30?
(a) Bank Loan Payable........................................................................ 156,750
Cash....................................................................................... 156,750
(b) Bank Loan Payable........................................................................ 150,000
Interest Payable............................................................................. 6,750
Cash....................................................................................... 156,750
(c) Interest Expense............................................................................ 3,375
Bank Loan Payable........................................................................ 150,000
Cash....................................................................................... 153,375
(d) Interest Payable............................................................................. 4,500
Bank Loan Payable ....................................................................... 150,000
Cash....................................................................................... 156,750
Use the following information for questions 71–72.
On October 1, 2015, Mekhi’s Golf Service Limited borrows $80,000 from Rigor Bank by signing
a 3-month, $80,000, 4% bank loan. Interest is due the first of each month.
71. What adjusting entry is required at December 31, 2015?

(a) Interest Payable............................................................................. 800
Interest Expense..................................................................... 800
(b) Interest Expense............................................................................ 800
Interest Payable...................................................................... 800
(c) Interest Expense............................................................................ 267
Interest Payable...................................................................... 267
(d) Interest Expense............................................................................ 267
Bank Loan Payable................................................................. 267
72. The entry by Mekhi’s Golf Service to record payment of the loan and accrued interest on
January 1, 2016 is
(a) Bank Loan Payable........................................................................ 83,200
Cash....................................................................................... 83,200
(b) Bank Loan Payable........................................................................ 80,000
Interest Payable............................................................................. 267

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Cash....................................................................................... 80,267
(c) Bank Loan Payable........................................................................ 80,000
Interest Payable............................................................................. 800
Cash....................................................................................... 80,800
(d) Bank Loan Payable........................................................................ 80,000
Interest Expense............................................................................ 800
Cash....................................................................................... 80,800
73. A customer paid a total of $8,960 for a purchase, including 13% HST (Harmonized Sales
Tax). How much was the HST?
(a) $8,960
(b) $8,000
(c) $1,075
(d) $1,031
74. On January 1, 2015, Junction Limited, a calendar-year company, issued $160,000 of notes
payable, of which $65,000 is due on January 1 for each of the next four years. The proper
statement of financial position presentation on December 31, 2015, is
(a) Current Liabilities, $160,000.
(b) Non-current Liabilities, $160,000.
(c) Current Liabilities, $65,000; Non-current Liabilities, $95,000.
(d) Current Liabilities, $95,000; Non-current Liabilities, $65,000.
75. Harmonized Sales Tax (HST) collected by a retailer are expenses

(a) of the retailer.
(b) of the customers.
(c) of the government.
(d) that are not recognized by the retailer until they are submitted to the government.
Use the following information to answer questions 76–77.
The following totals for the month of April were taken from the payroll register of Yandeau Corp.:
Gross salaries.................................. $19,500
CPP withheld................................... 965
Income taxes withheld...................... 4,200
Medical insurance deductions.......... 675
EI withheld....................................... 347
Union dues withheld......................... 324
76. The journal entry to record payment of the net payroll would include a
(a) debit to Salaries Payable for $12,989.
(b) debit to Salaries Payable for $15,300.
(c) debit to Salaries Payable for $19,500.
(d) credit to Cash for $19,500.

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77. The journal entry to record the accrual of the employee’s portion of Canada Pension Plan
(CPP) would include a
(a) credit to CPP Payable of $965.
(b) debit to CPP Expense of $965.
(c) credit to Employee Benefits Expense of $965.
(d) debit to CPP Payable of $965.
78. When a long-term note payable with a fixed interest rate has fixed principal payments, it
means that
(a) the periodic payment amount is fixed.
(b) the periodic payment increases over time.
(c) the periodic payment decreases over time.
(d) no conclusion can be made on the periodic payment.
79. A financial liability is a

(a) contractual obligation to receive cash in the future.
(b) contractual obligation to pay cash in the future.
(c) contractual obligation to issue common shares in the future.
(d) contractual obligation to issue a mortgage payable.
80. Interest rates on notes and loans are usually stated as a(n)
(a) monthly rate.
(b) daily rate.
(c) semi-annual rate.
(d) annual rate.
81. A long-term note may be secured by a document called a

(a) premium.
(b) debenture.
(c) bond.
(d) mortgage.
82. As blended principal and interest payments are made on a long-term loan,
(a) the interest portion increases and the principal portion decreases.
(b) the interest and principal portions remain the same.
(c) the interest portion decreases and the principal portion increases.
(d) both the interest portion and the principal portion decrease.
83. A five-year, 6%, $47,000 note payable is issued on January 1. Terms include fixed annual
principal payments of $9,400, plus interest on the outstanding balance. The entry to record the
first instalment payment will include a
(a) debit to Notes Payable of $9,400.
(b) credit to Interest Expense of $2,820.
(c) credit to Notes Payable of $12,220.
(d) debit to Cash of $9,400.

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84. On March 1, Brutto Corp. issues a 3 year 5%, $60,000 note payable. The terms of the note
include monthly blended principal and interest payments of $1,799. The entry to record the
second instalment payment will include a
(b) debit to Cash of $1,799.
(c) debit to Interest Expense of $250.
(d) credit to Interest Expense of $244.
85. On March 2, Conroy and Conrad Inc. obtained a loan for $120,000 for 5 years at 7%.
Payments are $2,000. What type of loan is this considered to be?
a) fixed principal payments
b) blended principal payments
c) floating principal payments
d) prime principal payments
86. One example of a liability that is not a financial liability is

a) notes payable.
b) unearned revenue.
c) bonds payable.
d) financial lease.
87. Long term notes may have

a) fixed rates of interest only.
b) floating interest rates only.
c) no interest rates.
d) fixed or floating interest rates.
88. With fixed principal payments, the interest ___ each period as the principal ___.
a) decreases, decreases
b) increases, increases
c) increases, decreases
d) decreases, increases
89. Instalments can be paid

a) monthly.
b) quarterly.
c) semi annually.
d) all of the above.
90. Fixed principal payments and interest are repayable in

a) equal periodic amounts plus interest.
b) varying periodic amounts plus interest.
c) equal periodic amounts including interest.

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d) varying periodic amounts including interest.
91. Blended principal and interest payments are repayable in

a) equal periodic amounts plus interest.
b) varying periodic amounts plus interest.
c) equal periodic amounts including interest.
d) varying periodic amounts including interest.
92. The relationship between current assets and current liabilities is

(a) useful in determining profitability.
(b) useful in evaluating a company’s liquidity.
(c) useful in evaluating a company’s solvency.
(d) useful in determining the amount of a company’s non-current debt.
93. Liquidity ratios measure a company's

(a) operating cycle.
(b) revenue-producing ability.
(c) short-term debt-paying ability.
(d) long-range solvency.
94. A measure of a company's solvency is the

(a) inventory turnover ratio.
(b) current ratio.
(c) times interest earned ratio.
(d) asset turnover ratio.
95. The times interest earned ratio is calculated by dividing

(a) profit by interest expense.
(b) profit plus income tax expense by interest expense.
(c) profit plus interest expense by interest expense.
(d) profit plus interest expense plus income tax expense by interest expense.
96. Last year, Mocha’s Coffee Shop Inc.’s income statement reported the following: profit,
$227,500; interest expense, $45,000; and income tax expense, $78,475. The company’s times
interest earned ratio is
(a) 7.8 times.
(b) 6.2 times.
(c) 5.8 times.
(d) 4.5 times.
97. Under IFRS, if a company can determine a reasonable estimate of an expected loss from a
lawsuit and it is probable it will lose the suit, it should
(a) disclose the basic facts regarding the suit in the notes to its financial statements.
(b) accrue the loss.

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(c) neither disclose in the notes nor accrue the loss.

(d) pay the amount estimated.
98. Under ASPE, a contingent liability is recorded in the accounting records

(a) if it is likely that a future event will confirm that a liability has been incurred and the amount of
the related loss can be estimated.
(b) if the contingency has not already been disclosed in the notes to the financial statements.
(c) if the amount can be estimated, but the possibility of occurrence is remote.
(d) under no circumstances.
99. Off-balance sheet financing usually is found in connection with

(a) finance leases.
(b) operating leases.
(c) both finance and operating leases.
(d) neither finance nor operating leases.
100. On March 1, Brutto Corp. issues a 3 year, 5%, $60,000 note payable. The terms of the
note include monthly blended principal and interest payments of $1,799. The entry to record the
first instalment payment will include a
(b) debit to Cash of $1,799.
(c) credit to Interest Expense of $3,000.
(d) debit to Interest Expense of $250.
101. Bonds that are subject to retirement at a stated dollar amount prior to maturity at the option
of the issuer are called
(a) early retirement bonds.
(b) redeemable bonds.
(c) options.
(d) debentures.
102. A bond with a face value of $100,000 and a quoted price of 102.25 would have a selling
price of
(a) $ 97,800.
(b) $100,000.
(c) $102,250.
(d) $122,250.
103. If the market interest rate is 4.5%, a $100,000, 5.6%, 10-year bond that pays interest semi-
annually would sell at an amount
(a) less than face value.
(b) equal to the face value.
(c) greater than face value.
(d) that cannot be determined.

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104. $8 million, 6%, 10-year bonds are issued at less than face value. Interest will be paid semi-
annually. When calculating the market price of the bond, the present value of
(a) $480,000 received for 10 periods must be calculated.
(b) $240,000 received for 10 periods must be calculated.
(c) $240,000 received for 20 periods must be calculated.
(d) $480,000 received for 20 periods must be calculated.
105. $5 million, 8%, 10-year bonds are issued when the market rate is 6%. Interest will be paid
semi-annually. When calculating the issue price of the bond, the interest rate to be used to
calculate the present value of the face amount and the present value of the periodic interest
payments is
(a) 8%.
(b) 6%.
(c) 4%.
(d) 3%.
106. The market interest rate is often called the

(a) stated interest rate.
(b) effective interest rate.
(c) contractual interest rate.
(d) coupon interest rate.
107. When bonds are issued at a premium, the total interest cost of the bonds over the life of
the bonds is equal to the amount of the
(a) interest paid over the life of the bond.
(b) interest paid over the life of the bond plus the amount of premium amortized.
(c) interest paid over the life of the bond minus the amount of premium amortized.
(d) premium.
108. The carrying amount of a bond not issued at face value will always move
(a) towards the face value.
(b) away from the face value.
(c) upwards.
(d) downwards.
109. For bond amortization, private companies reporting under ASPE

(a) must use the effective-interest method.
(b) are not allowed to use the effective-interest method.
(c) may use any amortization method they wish, as long as the results do not differ materially
from the effective-interest method.
(d) may use any amortization method they wish, regardless of the results.
110. The journal entry to record the issue of bonds at a discount will include a
(a) debit to Cash for the face amount of the bonds.

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(b) debit to Cash for the face amount of the bonds plus the amount of the discount.
(c) debit to Cash for the face amount of the bonds minus the amount of the discount.
(d) credit to Cash for the face amount of the bonds.
Use the information below to answer questions 111–113.
Sail and Sink Inc. issues $425,000 of 6%, 5-year bonds for cash proceeds of $390,529. The
market interest rate is 8%. Interest is paid semi-annually.
111. To the nearest dollar, how much bond interest expense is recorded on the first interest
date?
(a) $12,750
(b) $15,621
(c) $17,000
(d) $2,871
112. To the nearest dollar, what is the carrying amount of the bonds after the first interest
payment?
(a) $395,600
(b) $ 387,658
(c) $ 393,400
(d) $ 425,000
113. What is the total interest cost over the life of the bonds?
(a) $127,500
(b) $34,471
(c) $ 255,000
(d) $161,971
114. When a bond is issued at a discount, the amount of interest expense for an interest period
is calculated by
(a) multiplying the carrying amount times the market interest rate.
(b) multiplying the carrying amount times the coupon interest rate.
(c) multiplying the face amount of the bonds by the coupon interest rate.
(d) multiplying the face amount of the bonds by the market interest rate.

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ANSWERS TO MULTIPLE CHOICE QUESTIONS
Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans.
64. c 72. b 80. d 88. a 96. a 104. c 112. c
65. a 73. d 81. d 89. d 97. a 105. d 113. d
66. c 74. c 82. c 90. a 98. a 106. b 114. a
67. a 75. b 83. a 91. c 99. b 107. c
68. b 76. a 84. a 92. b 100. d 108. a
69. b 77. a 85. b 93. c 101. b 109. c
70. d 78. c 86. b 94. c 102. c 110. c
71. c 79. b 87. d 95. d 103. c 111. b

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EXERCISES
Ex. 115
Your friend, Malaya Claire, recently opened a retail shoe store. She knows she needs to pay
sales tax but isn't sure how much. The GST and PST are calculated by the cash register. The
GST rate is 5% and the PST rate is 8%. Sales, before taxes, for the first month of operations
based on the cash register reports were $125,000. All sales are for cash, debit card, or bank
credit card. Cost of goods sold is 50% of sales and a perpetual inventory system is used.
Instructions
(a) Calculate the amount of GST and PST.
(b) Prepare the journal entry to record the sales and sales taxes, and cost of goods sold.
Solution 115 (10–15 min.)

(a) GST: $125,000 × 5% = $ 6,250
PST: $125,000 × 8% = $10,000
(b) Cash.............................................................................................. 141,250

Sales Tax Payable ($6,250 + $10,000)................................... 16,250
Sales Revenue....................................................................... 125,000
Cost of Goods Sold ($125,000 × 50%).......................................... 62,500

Inventory................................................................................. 62,500
Ex. 116
On April 1, Aces Corporation borrows $160,000 from Rigor Bank by signing an 8-month, 3%,
bank loan. Interest is due at maturity.
Instructions
Prepare the entries listed below associated with the bank loan on the books of Aces
Corporation. Its year end is June 30.
(a) The entry on April 1 when the loan was received.
(b) Any adjusting entries necessary on June 30. Assume no other interest accrual entries have
been made.
(c) The entry to record repayment of the loan at maturity.
Solution 116 (10 min.)

(a) Apr 1 Cash............................................................................ 160,000
Bank Loan Payable.............................................. 160,000
(b) Jun 30 Interest Expense ($160,000  3%  3/12).................. 1,200

Interest Payable.................................................... 1,200
(c) Dec 1 Bank Loan Payable..................................................... 160,000

Interest Payable.......................................................... 1,200
Interest Expense ($160,000 x 3% x 5/12).................... 2,000
Cash..................................................................... 163,200

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Ex. 117
On June 1, Babar Corporation borrows $40,000 from the bank by signing a 2-month, 4.5%,
bank loan. Interest is due at the beginning of each month, commencing July 1.
Instructions
Prepare the entries listed associated with the bank loan on the books of Babar Corporation.
(a) Prepare the entry on June 1 when the loan was received.
(b) Prepare any adjusting entries necessary on June 30 in order to prepare the monthly
financial statements. Assume no other interest accrual entries have been made.
(c) Prepare the entry to record the payment of the interest on July 1.
(c) Prepare the entry to record repayment of the loan at maturity on August 1.

(a) Jun 1 Cash............................................................................ 40,000
Bank Loan Payable.............................................. 40,000
(b) Jun 30 Interest Expense ($40,000  4.5% x 1/12).................. 150

Interest Payable.................................................... 150
(c) Jul 1 Interest Payable.......................................................... 150

Cash..................................................................... 150
(d) Aug 1 Bank Loan Payable..................................................... 40,000

Interest Expense ($40,000  4.5% x 1/12).................. 150
Cash..................................................................... 40,150
Ex. 118
Marlboro Corporation had cash sales of $90,000 for the month of June. Sales are subject to
13% harmonized sales tax (HST). Prepare the entry to record the sales.

Cash.............................................................................................. 101,700
Sales Revenue....................................................................... 90,000
Sales Tax Payable ($90,000 x 13%)....................................... 11,700
Ex. 119
Fantastic Fashions has just completed its first quarter of operations. Below are transactions that
have not yet been recorded. Prepare the journal entries listed below.
Jan 1 Pre-tax cash sales amounted to $75,000. HST is collected on all sales at a rate of
13%.
Jan 15 Signed a three month note for $12,000 to extend amounts owing on account to
Trendy Taste Inc. Interest is 6% annually and due at maturity.
Mar 1 Received the annual property tax bill for $7,500 payable on June 1.
Apr 1 Paid salaries of $10,000; of this amount $495 is CPP, $178 is EI and $3,465 is for
income taxes (record the employer portion as well).
Apr 15 Paid the note due.

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Apr 29 A customer sued Fantastic Fashions for $200,000. Legal counsel has advised that
it is unlikely damages will be awarded.
Jun 1 Paid the property taxes bill in full.
Solution 119
Jan 1 Cash ($75,000 + $9,750)........................................................ 84,750

Sales................................................................................ 75,000
Sales Tax Payable ( $75,000 x 13%)............................... 9,750
Jan 15 Accounts Payable—Trendy Taste Inc..................................... 12,000

Notes Payable—Trendy Taste Inc................................... 12,000
Mar 1 Property Tax Expense ($7,500 x 2/12).................................... 1,250

Property Tax Payable....................................................... 1,250
Apr 1 Salaries expense.................................................................... 10,000

CPP Payable.................................................................... 495
EI Payable........................................................................ 178
Income Tax Payable........................................................ 3,465
Cash................................................................................ 5,862
Apr 1 Employee benefit expense...................................................... 744

CPP Payable.................................................................... 495
EI Payable........................................................................ 249
Apr 15 Notes Payable........................................................................ 12,000

Interest Expense (12,000 x 6% x 3/12)................................... 180
Cash................................................................................ 12,180
Apr 29 No provision should be recorded or contingent liability disclosed because the

probability of a loss is not probable or possible.
Jun 1 Property Tax Payable............................................................. 1,250

Property Tax Expense ($7,500 x 3/12).................................... 1,875
Prepaid Property Tax ($7,500 x 7/12)..................................... 4,375
Cash................................................................................ 7,500
Ex. 120
On December 31, 2015, Industrial Exporters issues a $365,000, 6%, 20-year mortgage. The
terms require monthly payments of $2,615 (principal and interest – blended payment).
Instructions
Prepare the journal entry for Jan 31, 2016 to record the first monthly payment. Include your
calculations.

Jan 31 Interest Expense............................................................... 1,825
Mortgage Payable............................................................ 790
Cash.......................................................................... 2,615

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To record mortgage payment
Calculations:
$365,000  6% x 1/12 = $1,825 interest
$2,615 – $1,825 = $790 principal repayment
Ex. 121
On January 1, 2015, Pardeep Inc. issues a $240,000, 5%, 10-year note payable. The terms
require semi-annual fixed principal payments of $12,000 plus applicable interest.
Instructions:
Prepare the journal entry at Dec 31, 2015 to record the second semi-annual payment. Include
your calculations.
Solution 121
Dec. 31 Interest Expense [($240,000 – $12,000)  5% x 6/12]..... 5,700
Notes Payable.................................................................. 12,000
Cash.......................................................................... 17,700
To record note payment
Ex. 122
On December 31, 2015, Rabin Realty Limited issues a 10-year, 6%, $200,000 mortgage
payable to finance the construction of a building. The terms provide for monthly instalment
payments at the end of each month, commencing January 31, 2016.
Instructions
(a) Record the issue of the mortgage payable on December 31, 2015.
(b) Record the first two instalment payments on January 31, 2016 and February 28, 2016,
assuming the payment is (1) a fixed principal payment of $1,667, and (2) a blended
principal and interest payment of $2,220. Round your answers to the nearest dollar.
Solution 122
(a)
Dec 31, 2015 Cash............................................................................ 200,000
Mortgage Payable................................................ 200,000
(b) (1)
Jan 31, 2016 Mortgage Payable....................................................... 1,667
Cash ($1,667 + $1,000)........................................ 2,667
Feb 28, 2016 Mortgage Payable....................................................... 1,667

Interest Expense [($200,000 – $1,667) x 6% x 1/12]... 992
Cash ($1,667 + $992)........................................... 2,659
(b) (2)
Jan 31, 2016 Mortgage Payable ($2,220 – $1,000).......................... 1,220

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Cash..................................................................... 2,220
Feb 28, 2016 Mortgage Payable ($2,220 – $994)............................. 1,226

Interest Expense [($200,000 – $1,220) x 6% x 1/12]... 994
Cash..................................................................... 2,220
Ex. 123
The following instalment payment schedule is for a long-term instalment mortgage payable:
Interest Period Cash Payment Interest Expense Reduction of Principal Principal Balance
Issue date $120,000.00
1 $28,487.57 $7,200.00 $21,287.57 98,712.43
2 28,487.57 $5,922.75 22,564.82 76,147.61
3 28,487.57 $4,568.86 23,918.71 52,228.89
4 28,487.57 $3,133.73 25,353.84 26,875.06
5 28,487.57 $1,612.50 26,875.06 0.00
Instructions
(a) Is this a fixed principal or blended principal and interest payment schedule?
(b) Assuming payments are made annually, what is the interest rate on the mortgage?
(c) Prepare the journal entry to record the first instalment payment.
(d) What are the current and non-current portions of the mortgage at the end of period 1?
Solution 123
(a) This is a blended interest and payment schedule. Note that the cash payment is constant
each period while the interest and principal amounts change.
(b) The annual interest rate is 6% ($7,200 ÷ $120,000).
(c) Mortgage Payable.......................................................................... 21,287.57

Interest Expense............................................................................ 7,200.00
Cash....................................................................................... 28,487.57
(d) Current portion = $22,564.82

Non-current portion = $76,147.61
Total liability = $22,564.82 + $76,147.61 = $98,712.43
Ex. 124
On January 1, Wonder Water borrowed $300,000 for 5 years at 4.5% to finance expansion.
Fixed Principal Payments are to be made quarterly beginning Mar 1. Below is an instalment
schedule for Wonder Water.

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WONDER WATER
INSTALMENT PAYMENT SCHEDULE- FIXED PRINCIPAL PAYMENTS
Interest Period Cash Pmt Interest Expense Reduction of Principal Principal

Jan 1 300,000
Mar 1 ? 3,375 5,000 295,000
Jun 1 8,320 ? 5,000 ?
Sep 1 ? 3,263 ? 285,000
Dec 1 ? ? 5,000 ?
Instructions
(a) Determine the missing values (round to the nearest dollar).
(b) Prepare the journal entries for the payments made on March 1 and Sept 1.
Solution 124
(a)
Interest Period Cash Pmt Interest Expense Reduction of Principal Principal
Jan 1 300,000
Mar 1 8,375 (1) 3,375 5,000 295,000
Jun 1 8,319 3,319 (2) 5,000 290,000 (3)
Sep 1 8,263 (4) 3,263 5,000 285,000
Dec 1 8,206 (6) 3,206 (5) 5,000 280,000 (7)
(1) $300,000 x 4.5% x 3/12 = $3,375; $3,375 + $5,000 = $8,375

(2) $295,000 x 4.5% x 3/12 = $3,319
(3) $295,000 – $5,000 = $290,000
(4) $5,000+ $3,263 = $8,263
(5) $285,000 x 4.5% x 3/12 = $3,206
(6) $3,206 +$5,000 = $8,206
(7) $285,000 – $5,000 = $280,000
(b)
Mar 1 Interest Expense..................................................................... 3,375
Loan Payable.......................................................................... 5,000
Cash................................................................................ 8,375
Sep 1 Interest Expense..................................................................... 3,263

Loan Payable.......................................................................... 5,000
Cash................................................................................ 8,263
Ex. 125
On January 1, Marvelous Metals borrowed $1,200,000 at 7% for 15 years to begin the
development of a new mine. Blended Principal Payments must be made on the first day of each
month.
Instructions

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(a) Complete the instalment schedule listed below (round to the nearest dollar).
(b) Assuming the year end is March 31, prepare the necessary adjusting entry.
(c) Prepare the journal entries for the payments made on May 1 and June 1.
MARVELOUS METALS
INSTALMENT PAYMENT SCHEDULE- BLENDED PRINCIPAL PAYMENTS
Interest Expense
Interest Period Cash Pmt Reduction of Principal Principal
(D x 7% x 1/12)
Jan 1 1,200,000
Feb 1 10,785 ? 3,785 1,196,215
Mar 1 ? ? 3,807 ?
Apr 1 10,785 6,956 ? ?
May 1 10,785 ? ? 1,184,727
Jun 1 ? ? ? ?
Solution 125
(a)
Interest Expense
(D x 7% x 1/12)
Jan 1 1,200,000
Feb 1 10,785 7,000 (1) 3,785 1,196,215
Mar 1 10,785 6,978 (2) 3,807 1,192,408 (3)
Apr 1 10,785 6,956 3,829 (4) 1,188,579 (5)
May 1 10,785 6,933 (6) 3,852 (7) 1,184,727
Jun 1 10,785 6,911 (8) 3,874 (9) 1,180,853 (10)
(1) $1,200,000 x 7% x 1/12 = $7,000

(2) $1,196,215 x 7% x 1/12 = $6,978
(3) $1,196,215 – $3,807 = $1,192,408
(4) $10,785 – $6,956 = $3,829
(5) $1,192,408 – $3,829 = $1,188,579
(6) $1,188,579 x 7% x1/12 = $6,933
(7) $10,785 – $ 6,933 = $3,852
(8) $1,184,727 x 7% x 1/12 = $6,911
(9) $10,785 – $6,911 = $3,874
(10) $1,184,727 – $3,874 = $1,180,853
(b)
Mar 31 Interest Expense..................................................................... 6,956
Interest Payable............................................................... 6,956
(c)
May 1 Interest Expense..................................................................... 6,933
Cash................................................................................ 10,785
Jun 1 Interest Expense..................................................................... 6,911

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Cash................................................................................ 10,785
Ex. 126
On January 1, 2015 Calcium Inc. has the following two alternatives in regards to financing:
Loan A – $210,000, 4.5% for 5 years. Fixed Principal Payments of $21,000 due semi-annually
on June 30 and December 31.
Loan B – $210,000, 4.5% for 5 years. Blended Principal Payments of $23,685 due semi-
annually on June 30 and December 31.
Instructions
(a) Prepare an instalment schedule for each alternative for June 30, and Dec 31.
(b) Which alternative will reduce the principal on the loan quicker in year 1?
(c) Which alternative will report the least interest expense on the income statement in year 1?
(d) If Calcium wanted to increase net income which alternative would you recommend?
Solution 126
(a)
CALCIUM INC.
INSTALMENT PAYMENT SCHEDULE- FIXED PRINCIPAL PAYMENTS (LOAN A)
Interest Expense
(D x 4.5% x 6/12)
Jan 1 210,000
Jun 30 25,725 4,725 21,000 189,000
Dec 31 25,253 4,253 21,000 168,000
Totals 50,978 8,978 42,000
CALCIUM INC.
INSTALMENT PAYMENT SCHEDULE- BLENDED PRINCIPAL PAYMENTS (LOAN B)
Interest Expense
(D x 4.5% x 6/12)
Jan 1 210,000
Jun 30 23,685 4,725 18,960 191,040
Dec 31 23,685 4,298 19,387 171,653
Totals 47,370 9,023 38,347
(b) Loan A will reduce principal balance to $168,000 which is lower than the balance
outstanding under Loan B of $171,653.
(c) Loan A will report the least interest of $8,978. Loan B will report a higher interest expense of
$9,023.
(d) To increase net income, Calcium would want to report fewer expenses; therefore Loan A will
report a lower amount of expense in regards to financing.

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Ex. 127
Spring Water Corporation has the following selected accounts at December 31, 2015 after
posting adjusting entries:
Accounts Payable........................................................ $ 67,500
Bank Loan Payable, 3-month...................................... 135,000
Accumulated Depreciation—Equipment...................... 14,000
Notes Payable, 5-year, 4%.......................................... 55,000
Employee Benefits Expense........................................ 6,000
Interest Payable.......................................................... 7,550
Mortgage Payable....................................................... 135,000
Sales Tax Payable....................................................... 14,000
Instructions
(a) Prepare the current liability section of Spring Water Corporation's statement of financial
position, assuming $19,500 of the mortgage is payable next year.
(b) Comment on Spring Water’s liquidity, assuming total current assets are $575,000.

(a) SPRING WATER CORPORATION
Statement of Financial Position (partial)
December 31, 2015
Current Liabilities
Current portion of long-term debt................................................... $ 19,500
Bank loan payable, 3-month.......................................................... 135,000
Accounts payable.......................................................................... 67,500
Sales tax payable.......................................................................... 14,000
Interest payable............................................................................. 7,550
Total current liabilities............................................................. $243,550
(b) The liquidity position looks favourable. If all current liabilities are paid out of current assets,
there would still be $331,450 of current assets (working capital). The current ratio is 2.4:1
and it appears as though Spring Water Corporation has sufficient current resources to meet
current obligations when due.
Ex. 128
The following information is available from the 2015 financial statements of Alpha Inc. and
Omega Ltd.:
(in millions)
Alpha Inc. Omega Ltd.
Income tax expense........................................... $ 361 $ 766
Interest expense................................................. 480 1,423
Profit................................................................... 654 948
Total assets........................................................ 24,750 37,525
Total current liabilities......................................... 5,970 14,109
Total liabilities..................................................... 16,485 31,816
Instructions

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(a) Based on the information given, calculate the following ratios for each company:
1. Debt to total assets
2. Times interest earned
(b) What conclusion concerning each company’s long-run solvency can be drawn from these
ratios?

(a) Alpha Inc. Omega Ltd.
1. Debt to total assets: $16,485 ÷ $24,750 $31,816 ÷ $37,525
= 66.7% = 84.8%
2. Times interest earned: $654 + $361 + $480 $948 + $766 + $1,423

$480 $1,423
= $1,495 ÷ 480 = $3,137 ÷ $1,423
= 3.1 times = 2.2 times
(b) Generally, businesses prefer to maintain a lower debt to total assets ratio and a higher
times interest earned ratio. Since Alpha’s debt ratio is 27% [(84.8% – 66.7%) ÷ 66.7%]
lower than Omega’s ratio and Alpha’s times interest earned ratio is 41% [(3.1 – 2.2) ÷ 2.2]
higher than Omega’s, it can be concluded that Alpha is in a better position regarding long-
run solvency than Omega. Omega’s debt load is extremely high, and should be a cause for
alarm.
Ex. 129
Village Home Products Ltd. sells furniture and appliances. It has been in business for many
years and until now has not had any short-term loans. It has approached Friendly Bank for an
operating line of credit. Its current ratio, receivable turnover, and inventory turnover for the past
2 years are presented below. You are the credit manager dealing with the application.
Instructions
Comment on the ratios presented in terms of the application for the line of credit and also
indicate what additional information you would like to receive from the company.
2016 2015
Current ratio 1.6:1 1.2:1
Receivable turnover 5.2 7.5
Inventory turnover 6.8 9.4
Solution 129 (10–15 min.)

1. The fact that the current ratio increased initially seems positive.
2. However, the fact that the receivable and inventory turnovers have declined may indicate
problems.
3. Current assets may include an increasing amount of inventory that may be subject to
obsolescence. This is supported by the decrease in the inventory turnover ratio.
4. The decrease in the receivable turnover may indicate an issue with receivable collections.

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5. Other information that would be useful includes:

(a) industry averages for the ratios
(b) information on what makes up current assets and liabilities
(c) reasons for the change in ratios
(d) profitability information
Ex. 130
Below is a list of Accounts for Crib Inc. Beside each account determine if it is a Current Liability
(C) or a Non- current Liabilities (NC).
1. Accounts Payable
2. Notes Payable (due 9 months)
3. Bank Loan payable (due 16 months)
4. Unearned Revenue
5. Mortgage Payable (due in 20 years)
6. Salaries Payable
7. Sales Tax Payable
8. Current portion of Mortgage Payable
9. Notes payable (due in 12 months)
10. Operating Line of Credit
Solution 130
1. C
2. C
3. NC
4. C
5. NC
6. C
7. C
8. C
9. C
10. C
Ex. 131
Kahluha Manufacturers Inc. reported the following information in its financial statements:
KAHLUHA MANFACTURERS INC.

Statement of Financial Position
June 30

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Assets......................................................................................... 2015 2014

Cash..................................................................................... $32,000 $29,000
Accounts receivable............................................................. 7,500 5,500
Prepaid Insurance................................................................ 1,100 1,450
Inventory............................................................................... 220,000 175,000
Building................................................................................. 145,000 155,000
Equipment............................................................................ 36,000 40,000
Total Assets................................................................................. $441,600 $405,950
Liabilities and shareholders’ equity

Accounts Payable................................................................. $ 12,500 $14,500
Notes Payable...................................................................... 10,000 0
Bonds Payable..................................................................... 145,000 95,000
Long Term Debt.................................................................... 116,000 175,000
Common shares................................................................... 25,000 25,000
Retained earnings................................................................ 133,100 96,450
Total liabilities and shareholders’ equity...................................... $441,600 $405,950
Revenue...................................................................................... $450,000 $300,000

Operating expenses.................................................................... 300,000 210,000
Profit from operations.................................................................. 150,000 90,000
Interest expense.......................................................................... 6,000 9,000
Income tax expense.................................................................... 36,000 20,250
Profit............................................................................................ $108,000 $60,750
Instructions
(a) Calculate the company’s debt to total assets and times interest earned ratios for each year.
(b) Determine if the change from 2014- 2015 is an improvement or deterioration.
(c) If industry averages for debt to total assets is 57% and times interest earned is 6 times, are
Kahluha ratios comparable?
Solution 131
(a) 2015 2014
Debt to total assets =12,500+10,000+145,000+116,000 =14,500+95,000+175,000
441,600 405,950
= 64.2% = 70.1%
Times Interest Earned =108,000+6,000+36,000 =60,750+9,000+20,250

6,000 9,000
= 25 times = 10 times
(b) Debt to total assets ratio is improving.

Times interest earned ratio is also improving.
(c) Kahluha’s debt to total assets ratio is higher than the industry which means they may have
more debt or less assets than the industry averages. Overall debt to total assets varies across
industries because different financing options are appropriate for different industries.

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Kahluha’s times interest earned ratio is better than industry average which means Kahluha has
a greater ability to meet interest payments as they come due than industry average.
Ex. 132
On January 1, 2016, Yawney Inc. issued bonds with a face value of $500,000. The bonds have
a coupon interest rate of 4%, payable each July 1 and January 1.
Instructions
(a) Prepare the journal entry for the issue, assuming the bonds are issued at 97.5.
(b) Prepare the journal entry for the issue, assuming the bonds are issued at 102.5.

(a) Cash ($500,000 x 0.975)............................................................... 487,500
Bonds Payable........................................................................ 487,500
(b) Cash ($500,000 x 1.025)............................................................... 512,500

Bonds Payable........................................................................ 512,500
Ex. 133
On January 1, 2016, Ainsle Corp. issued $600,000, 7%, 10-year bonds. The bonds pay semi-
annual interest on July 1 and January 1. The market interest rate at the time of issue was 6%.
Instructions
(a) Calculate the issue price (round to nearest dollar).
(b) Record the issue of the bonds on Jan. 1.
(c) Record the first interest payment on July 1.

(a) Periodic interest payments $600,000 x 7% x 6/12 = $21,000
n = 10 x 2 = 20 periods i = 6% x 6/12 = 3%
Present value factor for the principal is 0.55368
Present value factor for the interest is 14.87747
$600,000 x 0.55368 = $332,208

$21,000 x 14.877478 = 312,427
Issue price $644,635
OR (using calculator) N 20 I 3 (6%/2) PMT -21000 FV -600000 CPT PV  644,632

(note that rounding discrepancies can sometimes arise between calculations using present
value tables and financial calculators)
(b) January 1, 2016

Cash............................................................................................... 644,635
Bonds Payable........................................................................ 644,635
To record sale of bonds
(c) July 1, 2016


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Bonds Payable............................................................................... 1,661

Cash....................................................................................... 21,000
To record semi-annual payment of interest
$644,635 x 3% = $19,339
Ex. 134
On January 1, 2016, Pinehill Ltd. issued $200,000, 8%, 10-year bonds, when the market
interest rate was 10%. Interest is payable semi-annually on July 1 and January 1. The company
has a calendar year end.
Instructions
(a) Using a calculator, calculate the issue price. Round to nearest dollar.
(b) Record the issue of the bonds.
(c) Record the first interest payment on July 1, 2016. Round to nearest dollar.

(a) (using calculator) N 20 I 5 (10%/2) PMT -8000 FV -200000 CPT PV  175,076
OR Periodic interest payments $200,000 x 8% x 6/12 = $8,000

n = 10 x 2 = 20, i = 10% x 6/12 = 5%
Present value factor for the principal = 0.37689
Present value factor for the interest = 12.46221
$200,000 x 0.37689 = $ 75,378

$8,000 x 12.46221 = 99,698
Issue price $175,076
(b) Jan 1 Cash................................................................................... 175,076

Bonds Payable............................................................ 175,076
(c) Jul 1 Interest Expense ($175,076 x 5%)..................................... 8,754

Bonds Payable............................................................ 754
Cash ($200,000 x 8% x ½).......................................... 8,000
Ex. 135
On January 1, 2016, North West Suppliers Ltd. issues $500,000, 6%, five-year bonds, with
interest payable on July 1 and January 1. Since the market interest rate is 5%, the bonds sell for
$521,880.
Instructions
For the issue date and first semi-annual period, complete (A) through (E) in the table below and
show your calculations.
(A) (B) (C) (D) (E)

Interest Interest Expense Premium Unamortized Bond
Period to be Paid to be Recorded Amortization Premium Carrying amount

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(A) (B) (C) (D) (E)
Interest Interest Expense Premium Unamortized Bond
Period to be Paid to be Recorded Amortization Premium Carrying amount
$21,880 $521,880
1 $15,000 $13,047 $1,953 19,927 519,927
(A) $500,000 × 6% x 6/12 = $15,000
(B) Market interest rate 5% x 6/12 = 2.5% semi-annual

2.5% × $521,880 (bond carrying amount) = $13,047
(C) Premium amortization = $15,000 – $13,047 = $1,953
(D) Unamortized premium = $21,880 – $1,953 = $19,927
(E) Bond carrying amount = $500,000 + $19,927 = $519,927

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MATCHING
136. Match the items below by entering the appropriate code letter in the space provided.
A. Operating line of credit F. Payroll deductions
B. Unsecured debt G. Times interest earned ratio
C. Mortgage H. Redeemable bonds
D. Market interest rate I. Contingent liabilities
E. Discount (on bonds payable) J. Financial liability
_____ 1. Bonds subject to retirement at a stated dollar amount prior to maturity at the option
of the issuer
_____ 2. A long-term secured loan that pledges property as collateral
_____ 3. Pre-authorization by the bank to borrow money, up to a pre-set limit
_____ 4. Existing or possible obligations arising from past events
_____ 5. A measure of a company’s solvency
_____ 6. A form of financial instrument, represented by a contractual obligation to pay cash

in the future
_____ 7. The rate investors demand for loaning funds to a corporation
_____ 8. Debt, such as notes or bonds, that has been issued against the general credit of
the borrower
_____ 9. Occurs when the coupon interest rate is less than the market interest rate
_____10. Deductions from gross pay to determine the amount of a paycheque

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ANSWERS TO MATCHING
1. H
2. C
3. A
4. I
5. G
6. J
7. D
8. B
9. E
10. F

lOMoARcPSD|4061633
SHORT-ANSWER ESSAY QUESTIONS
S-A E 137
Lucious Corporation maintains two separate accounts payable computer systems. One is
known to all the users, and is used to process payments to vendors. Employees enter the
vendor code, or the name and address of new vendors, the amount, the account, and so on.
The other system is a secret one. It is used to cross-check the vendors against an approved
vendor list. If a vendor is not listed as approved, the payment process is halted. Internal audit
employees seek to verify the existence of a bona fide claim by the vendor. All inquiries are
made at the top management level, and very discreetly. No one but top management, the
internal audit staff, and the Board of Directors of the company is even aware of the second
system.
Instructions
Is it ethical for a company to have a secret system like the one described? Explain.
Solution 137
Secret systems that seek to verify the integrity of the non-secret primary system are certainly
ethical. In fact, nearly all fraud and theft detection systems are secret. It is only the misuse of
these systems, such as to obtain unauthorized information, or to commit some other crime, that
is unethical.
S-A E 138
Under what circumstances is a contingent liability recorded in the accounting records as though
an actual liability exists?
Solution 138
If the company can determine a reasonable estimate of the expected cost or loss and it is
probable that it will incur the loss, then the company should accrue the contingent loss and
liability. Note that if the company is reporting under IFRS, “probable” means “more likely than
not,” usually interpreted to mean a more than 50% probability of occurrence. But under ASPE,
“probable” is defined as “likely,” a higher level of probability.
S-A E 139
Your cousin Gerald runs a successful business, and now wants to borrow money to buy a new
delivery van for the business. He has never borrowed money from the bank before (always had
interest-free loans from his parents), and is confused after speaking to his loans officer, Mr Rich.
He said he would be glad to lend Gerald the money, but he needed to know if he wanted to pay
the money back by paying monthly fixed principal payments plus interest, or by paying monthly
blended payments of principal and interest.
So he is asking you to explain this. “Does it make a difference how I repay the loan? I know I
have to pay interest, so what difference does the type of payment make? Will I pay more
interest with one type, rather than the other?”
Instructions
Explain to your cousin the difference between repaying a loan by fixed principal payments plus

lOMoARcPSD|4061633
interest versus blended payments.
Solution 139
First of all, it really doesn’t matter which way you go with this: you will pay approximately the
same amount of interest over the life of the loan. However, consumer loans such as this are
generally repaid by making blended payments. With blended payments, you pay the same
amount each month, which makes it easier for budgeting. Part of the payment goes to interest,
and the rest goes to principal. As you go along, you will pay less and less interest as the
principal is reduced, thus more and more goes to pay off the principal.
With a fixed principal payments plus interest loan, this is exactly what it says. You will pay the
same amount of principal off each month. For instance, if you borrowed $27,000 for a three year
term, you would pay $27,000/36 = $750 on the principal each month, plus applicable interest.
Again, as you go along and pay more off the principal each month, the interest will reduce. This
means that your payments will reduce as you go along. You will start out paying larger
payments than if it were a blended payment, but as time goes by, the payments will become
smaller.
S-A E 140
When determining the issue price of a bond using present value, what are the two components
used in the calculation?
Solution 140
One component is the periodic interest payments over the life of the bonds, discounted using
the market interest rate to calculate the present value. The other component is the present
value of the face value to be paid at maturity, also based on the market interest rate.
S-A E 141
When a bond sells at a discount, what is probably true about the value of the market interest
rate versus the coupon interest rate? Discuss.
Solution 141
For someone to purchase a bond at a discount, the coupon interest rate normally must be below
the market interest rate for similar bonds. Investors will make up the difference by paying less
than the face value of the bonds.
S-A E 142
Bonds are frequently issued at amounts higher or lower than face value. Describe how the
market interest rate, relative to the coupon interest rate, affects the selling price of bonds.
Solution 142
The market interest rate is often different from the coupon interest rate, and therefore bonds are
frequently issued at amounts higher or lower than face value. When the market interest rate is
higher than the coupon interest rate, investors can find better investments elsewhere, and
consequently there is less demand for the bonds. So to make the bonds more attractive, the
issue price will be lowered and the bonds will be issued at a discount. Conversely, if the market
interest rate is lower than the coupon interest rate, there will be greater demand for the bonds
because of the higher interest rate. Thus, the issue price will be higher than face value and the

lOMoARcPSD|4061633
bonds will be issued at a premium.
S-A E 143
Sally Smith works for Peterson Press, a fairly large book publishing firm. Her best friend and
rival, Molly Murray, works for Lifeline Books, a smaller publisher. Both companies issued
$100,000 in bonds on July 1. Peterson's bonds were issued at a discount, while Lifeline's were
issued at a premium. Molly sent Sally an email the next day. She told Sally that it was obvious
who the better publisher was—the market had shown its preference! She reminded Sally again
of her recent increase in salary as further proof of the superiority of Lifeline Books.
Instructions
Draft a short note for Sally to send to Molly. Explain how such a result could occur.
Solution 143
Many answers are possible. The format should be fairly informal, and the point that a discount
or premium is not necessarily a judgement on the strength or weakness of a company should be
addressed. A suggested note follows:
Molly—
I can't believe that Lifeline can survive with people like you handling their money!
I also can't believe their lack of judgement in giving you a raise! Just kidding!
Seriously, though, you can't prove that Peterson is a bad company just by the
bond price.
Our bonds were issued at a discount, not because of the market's evaluation of
our company, but because we underestimated interest rates. Lifeline got a
premium because it overestimated interest rates. You'll have to find some other
evidence to prove your company is better (which you can't, because it isn't.)
Seriously (again), congratulations on your raise. Shall we still meet for lunch on
Wednesday? How about trying our luck with chopsticks at the Chinese Panda?
Let me know if your plans change.
(signed)

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LEGAL NOTICE
Copyright © 2014 by John Wiley & Sons Canada, Ltd. or related companies. All rights
reserved.
The data contained in these files are protected by copyright. This manual is furnished
under licence and may be used only in accordance with the terms of such licence.
The material provided herein may not be downloaded, reproduced, stored in a retrieval
system, modified, made available on a network, used to create derivative works, or
transmitted in any form or by any means, electronic, mechanical, photocopying,
recording, scanning, or otherwise without the prior written permission of John Wiley &
Sons Canada, Ltd.

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Financial Accounting (University of Ottawa)

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REPORTING AND ANALYZING LIABILITIES

Note: E = Easy M = Medium H = Hard

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SUMMARY OF QUESTION TYPES BY STUDY OBJECTIVE AND LEVEL

Note: E = Easy M = Medium H = Hard

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10 - 3 Reporting and Analyzing Liabilities

SUMMARY OF STUDY OBJECTIVES BY QUESTION TYPE

Note: TF = True-False Ma = Matching

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CHAPTER STUDY OBJECTIVES

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10 - 5 Reporting and Analyzing Liabilities

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

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

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

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

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

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10 - 7 Reporting and Analyzing Liabilities

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

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

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28. Unearned revenue is a financial liability.

31. Secured notes are also known as mortgages.

33. Instalments are always paid monthly.

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10 - 9 Reporting and Analyzing Liabilities

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

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

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

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10 - 11 Reporting and Analyzing Liabilities

ANSWERS TO TRUE-FALSE STATEMENTS

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MULTIPLE CHOICE QUESTIONS

65. Failure to record a liability will probably

68. Interest expense on a note payable, with interest due at maturity, is

Use the following information for questions 69–70.

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10 - 13 Reporting and Analyzing Liabilities

Bank Loan Payable................................................................. 150,000

Use the following information for questions 71–72.

71. What adjusting entry is required at December 31, 2015?

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75. Harmonized Sales Tax (HST) collected by a retailer are expenses

Use the following information to answer questions 76–77.

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10 - 15 Reporting and Analyzing Liabilities

79. A financial liability is a

81. A long-term note may be secured by a document called a

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86. One example of a liability that is not a financial liability is

87. Long term notes may have

89. Instalments can be paid

90. Fixed principal payments and interest are repayable in

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