BSA 2201- INTERMEDIATE ACCOUNTING 3

PRELIMINARY DEPARTMENTAL EXAM REVIEWER

TOPIC COVERAGE:

 PAS 73 (Current Liabilities, Provisions and Contingencies)

 Accounts and Notes Payable

 Non-current liabilities (Bonds Payable)

THEORIES

1. A constructive obligation is an obligation

I. That is derived from an entity´s action that the entity will accept certain responsibilities

because of past practice, published policy or current statement.

II. The entity has created a valid expectation in other parties that it will discharge those

responsibilities.

a. I only

b. II only

c. Both I and II

d. Either I or II

2. It is a contract in which the unavoidable costs of meeting the obligation under the contract

exceed the economic benefits to be received under the contract.

a. Onerous contract

b. Executory contract

c. Executed contract

d. Sale contract

3. Which of the following is true about accounts payable?

I. Accounts payable should not be reported at their present value.

II. When accounts payable are recorded at the net amount, a Purchase Discounts account

will be used.

III. When accounts payable are recorded at the gross amount, a Purchase Discounts Lost

account will be used.

a. I only
b. II only

c. III only

d. Both II and III are true.

4. An entity borrowed cash from a bank and issued to the bank a short term noninterest bearing

note payable. The bank discounted the note at 10% and remitted the proceeds to the entity.

The effective interest rate paid by the entity in this transaction would be

a. Equal to the stated discount rate of 10%

b. More than the stated discount rate of 10%

c. Less than the stated discount rate of 10%

d. Independent on the stated discount rate of 10%

5. Which of the following statements concerning discount on the notes payable is false?

a. Discount on note payable may be debited when entity discounts its own note with the

bank.

b. The discount on note payable is a contra liability account which is shown as a deduction

from note payable.

c. The discount on note payable represents interest charges applicable to future periods.

d. Amortizing the discount causes the carrying amount of the liability to gradually decrease

over the life of the note.

6. When an entity issued a note solely in exchange for cash, the present value of the note at

issuance is equal to

a. Face amount

b. Face amount discounted at the market interest rate

c. Proceeds received

d. Proceeds received discounted at the market rate

7. At issuance date, the present value of a promissory note will be equal to its face amount if the

note

a. Bears a stated rate of interest which is realistic

b. Bears a stated rate of interest which is less than the prevailing market rate for similar

notes.
c. Is noninterest bearing and the implicit interest rate is less than the prevailing market rate

for similar notes.

d. Is noninterest bearing and the implicit interest rate is equal to the prevailing marker rate

for similar notes.

8. On September 1, 2021, an entity borrowed cash and signed a three-year interest bearing note

win which both the principal and interest are payable on September 1, 2024. On December

31, 2021, accrued interest should

a. Be reported as a current liability

b. Be reported as noncurrent liability

c. Be reported as part of the note payable

d. Not reported.

9. Which of the following is not true about the discount on short-term notes payable?

a. The Discount on Notes Payable account has a debit balance.

b. The Discount on Notes Payable account should be reported as an asset on the balance

sheet.

c. When there is a discount on a note payable, the effective interest rate is higher than the

stated discount rate.

d. All of these are true.

10. Which of the following should not be included in the current liabilities section of the balance

sheet?

a. Trade notes payable

b. Short-term zero-interest-bearing notes payable

c. The discount on short-term notes payable

d. All of these are included

11. The “amortized cost” of bonds payable means

a. Face amount plus premium on bonds payable

b. Face amount minus discount on bonds payable

c. Face amount minus bond issue cost.

d. Face amount plus premium on bonds payable, minus discount on bonds payable and
minus bond issue cost.

12. Bonds that mature on a single date are called

a. Term bonds

b. Serial bonds

c. Debenture bonds

d. Callable bonds

13. Bonds payable not designated at fair value through profit or loss shall be measured initially at

a. Fair value

b. Fair value plus bond issue cost

c. Fair value minus bond issue cost

d. Face amount

14. Bonds payable should be initially recognized at

a. Issue price minus transaction costs incurred by the entity

b. Issue price

c. Issue price plus accrued interest

d. Face value

15. Unamortized debt discount should be reported as

a. Direct deduction from the face amount of the debt.

b. Direct deduction from the present value of the debt.

c. Deferred charge

d. Part of the issue costs.

16. The rate of interest actually earned by bondholders is called the

a. stated rate.

b. yield rate.

c. effective rate.

d. effective, yield, or market rate.

17. When bonds are sold between interest dates, any accrued interest is credited to

a. Interest payable

b. Interest revenue
c. Interest receivable

d. Bonds payable

18. If bonds are issued initially at a premium and the effective-interest method of amortization is

used, interest expense in the earlier years will be

a. greater than if the straight-line method were used.

b. greater than the amount of the interest payments.

c. the same as if the straight-line method were used.

d. less than if the straight-line method were used.

19. The covenants and other terms of the agreement between the issuer of bonds and the lender

are set forth in the

a. bond indenture.

b. bond debenture.

c. registered bond.

d. bond coupon.

20. Which of the following is true of a premium on bonds payable?

a. The premium or bonds payable is a contra shareholder’s equity account

b. The premium on bonds payable is an account that appears only on the books of the

investor

c. The premium or bonds payable increases when amortization entries are made until

maturity date

d. The premium on bonds payable decreases when amortization entries are made until the

balance reaches zero at maturity date.

21. Under the effective-interest method of bond discount or premium amortization, the periodic

interest expense is equal to

a. the stated (nominal) rate of interest multiplied by the face value of the bonds.

b. the market rate of interest multiplied by the face value of the bonds.

c. the stated rate multiplied by the beginning-of-period carrying amount of the bonds.

d. the market rate multiplied by the beginning-of-period carrying amount of the bonds.

22. The proceeds from the issue of the bonds payable

b. Will always be less than the face amount

c. Will always be more than the face amount

d. May be equal, more or less than the face amount depending on market interest rate.

23. If bonds are issued between interest dates, the entry on the books of the issuing corporation

could include a

a. debit to Interest Payable.

b. credit to Interest Receivable.

c. credit to Interest Expense.

d. credit to Unearned Interest.

24. Treasury bonds should be shown on the balance sheet as

a. an asset.

b. a deduction from bonds payable issued to arrive at net bonds payable and outstanding.

c. a reduction of stockholders' equity.

d. both an asset and a liability.

25. An early extinguishment of bonds payable, which were originally issued at a premium, is made

by purchase of the bonds between interest dates. At the time of reacquisition

a. any costs of issuing the bonds must be amortized up to the purchase date.

b. the premium must be amortized up to the purchase date.

c. interest must be accrued from the last interest date to the purchase date.

d. all of these.

26. Edson Corp. signed a three-month, zero-interest-bearing note on November 1, 2021 for the

purchase of 150,000 of inventory. The face value of the note was 152,205. Assuming Edson

used a “Discount on Note Payable” account to initially record the note and that the discount

will be amortized equally over the 3-month period, the adjusting entry made at December 31,

2021 will include a

a. debit to Discount on Note Payable for 735.

b. debit to Interest Expense for 1,470.

c. credit to Discount on Note Payable for 735.

27. On December 31, 2020, Frye Co. has 2,000,000 of short-term notes payable due on February

14, 2021. On January 10, 2021, Frye arranged a line of credit with County Bank which allows

Frye to borrow up to 1,500,000 at one percent above the prime rate for three years. On

February 2, 2021, Frye borrowed 1,200,000 from County Bank and used 500,000 additional

cash to liquidate 1,700,000 of the short-term notes payable. The amount of the short-term

notes payable that should be reported as current liabilities on the December 31, 2020 balance

sheet which is issued on March 5, 2021 is

a. 0.

b. 300,000.

c. 500,000.

d. 800,000.

28. Included in Sauder Corp.'s liability account balances at December 31, 2021, were the

following:

7% note payable issued October 1, 2021, maturing September 30, 2022 250,000

8% note payable issued April 1, 2021, payable in six equal annual

installments of 150,000 beginning April 1, 2022 600,000

Sauder 's December 31, 2021 financial statements were issued on March 31, 2022. On

January 15, 2022, the entire 600,000 balance of the 8% note was refinanced by issuance of

a long-term obligation payable in a lump sum. In addition, on March 10, 2022, Sauder

consummated a no cancelable agreement with the lender to refinance the 7%, 250,000 note

on a long-term basis, on readily determinable terms that have not yet been implemented. On

the December 31, 2021 balance sheet, the amount of the notes payable that Sauder should

classify as short-term obligations is

a. 175,000.

b. 125,000.

c. 50,000.

d. 0.

Use the following information for answering questions 29 and 31:

customers receive a leash. The leashes cost Kent 2.00 each. Kent estimates that 40 percent of

the coupons will be redeemed. Data for 2021 and 2022 are as follows:

2021 2022

Bags of dog food sold 500,000 600,000

Leashes purchased 18,000 22,000

Coupons redeemed 120,000 150,000

29. The premium expense for 2021 is

a. 25,000.

b. 30,000.

c. 35,000.

d. 50,000.

30. The estimated liability for premiums at December 31, 2021 is

a. 7,500.

b. 10,000.

c. 17,500.

d. 20,000.

31. The estimated liability for premiums at December 31, 2022 is

a. 11,250.

b. 21,250.

c. 22,500.

d. 42,500.

32. On January 1, 2019, Las Vegas Company purchased a specialized machinery with a cash

equivalent price of 59,737. Las Vegas signed a deferred payment contract that calls for 10,000

down payment and a 3-year note for 49,737. The note is payable in 3 equal annual payments

of 20,000 beginning December 31, 2019. The annual payment includes 10% interest.

How much is the (1) interest expense for the year ended December 31. 2019 and the (2)

carrying amount of the note payable at December 31, 2019?

(1) (2) (1) (2)

b. 4,974 44,711

c. 5,974 34,711

d. 5,974 44,711

33. A company issues 20,000,000, 7.8%, 20-year bonds to yield 8% on January 1, 2021. Interest

is paid on June 30 and December 31. The proceeds from the bonds are 19,604,145. Using

effective-interest amortization, how much interest expense will be recognized in 2021?

a. 780,000

b. 1,560,000

c. 1,568,498

d. 1,568,332

34. On July 1, 2019, Kitel, Inc. issued 9% bonds in the face amount of 5,000,000, which mature

on July 1, 2015. The bonds were issued for 4,695,000 to yield 10%, resulting in a bond

discount of 305,000. Kitel uses the effective-interest method of amortizing bond discount.

Interest is payable annually on June 30. At June 30, 2021, Kitel's unamortized bond discount

should be

a. 264,050.

b. 255,000.

c. 244,000.

d. 215,000.

35. On January 1, 2002, Pine Corp. issued 1,000 of its 10%, 1,000 bonds for 1,040,000. These

bonds were to mature on January 1, 2012 but were callable at 101 any time after December

31, 2019. Interest was payable semiannually on July 1 and January 1. On July 1, 2021, Pine

called all of the bonds and retired them. Bond premium was amortized on a straight-line basis.

Before income taxes, Pine's gain or loss in 2021 on this early extinguishment of debt was

a. 30,000 gain.

b. 12,000 gain.

c. 10,000 loss.

d. 8,000 gain.
36. On December 31, 2019, the liability section of Texas Company´s financial position included

bonds payable of 10 million and unamortized premium on bonds payable of 180,000. Further

verification revealed that these bonds were issued on December 31, 2017 and will become

due on December 31, 2027. Interest at 12% is payable every June 30 and December 31. On

April 1, 2020, Texas retired 4,000,000 of these bonds at 97 plus accrued interest. How much

was the total amount of cash paid for the retirement of bonds on April 1, 2020?

a. 3,950,000

b. 4,000,000

c. 4,040,000

d. 4,180,000

37. On January 1, 2019, London Company issued its 9% 2 million bonds, which mature on

January 1, 2026. The bonds were issued for 1,878,000 to yield 10% resulting in a bond

discount of 122,000. Interest is payable annually on December 31. What is the carrying

amount of the bonds at December 31, 2019?

a. 1,885,800

b. 1,896,000

c. 1,896,780

d. 1,898,000

38. Nevada, Inc. issued a 5,000,000, 10%, 10-year bonds on July 1, 2019 for 113.6 when the

effective interest rate was 8%. Interest is payable on June 30 and December 31. How much

interest expense should Nevada report in profit or loss for the year ended December 31,

2019?

a. 284,000

b. 250,000

c. 227,200

d. 200,000

Use the following information on answering questions 39 and 40:

Michigan, Inc. issued 1 million, 12%, 20-year bonds at 102 plus accrued interest on February

1, 2019. The bonds are dated January 1, 2019 and pay interest semi-annually every June 30
and December 31. Transaction costs totaled 50,000.

39. How much accrued interest on the bonds shall Michigan collect from the investor on February

1?

a. 10,000

b. 20,000

c. 30,000

d. 50,000

40. What is the initial carrying amount of the bonds on February 1, 2019?

a. 950,000

b. 970,000

c. 1,000,000

d. 1,020,000

ANSWER KEY:

THEORIES

1. C. Both I and II

2. A. Onerous contract

3. A. I only

4. B. More than the stated discount rate of 10%

5. D. Amortizing the discount causes the carrying amount of the liability to gradually

decrease over the life of the note.

6. C. Proceeds received

7. A. Bears a stated rate of interest which is realistic

8. B. Be reported as noncurrent liability

9. B. The Discount on Notes Payable account should be reported as an asset on the balance

sheet.

10. D. All of these are included.

11. D. Face amount plus premium on bonds payable, minus discount on bonds payable and

minus bond issue cost.

12. A. Term bonds

14. A. Issue price minus transaction costs incurred by the entity

15. A. Direct deduction from the face amount of the debt.

16. D. effective, yield, or market rate.

17. A. Interest payable

18. A. greater than if the straight-line method were used.

19. A. bond indenture.

20. D. The premium on bonds payable decreases when amortization entries are made until

the balance reaches zero at maturity date.

21. D. the market rate multiplied by the beginning-of-period carrying amount of the bonds.

22. D. May be equal, more or less than the face amount depending on market interest rate.

23. C. credit to Interest Expense.

24. B. a deduction from bonds payable issued to arrive at net bonds payable and outstanding.

25. D. all of these.

PROBLEMS

26. B. debit to Interest Expense for 1,470.

- Solution:

152,205 – 150,000 = 2,205 × 2/3 = 1,470.

27. D. 800,000

- Solution:

2,000,000 – 1,200,000 = 800,000.

28. D. 0

- Explanation:

Conceptual—both notes have been refinanced by long-term obligations.

29. D. 50,000

- Solution:

[(500,000 × .4) ÷ 8] × 2 = 50,000.

30. D. 20,000

- Solution:
[(200,000 – 120,000) ÷ 8] × 2 = 20,000.

31. D. 42,500

- Solution:

{[(600,000 × .4) – 150,000] ÷ 8} × 2 = 22,500 + 20,000 = 42,500.

32. A. 4,974, 34,711

- Solution:

Interest expense (59,737 – 10,000) x 10% 4,974

Carrying amount of note January 1, 2019 49,737

Reduction in the principal at December 31, 2019

Actual payment 20,000

Interest expense 4,974 15,026

Carrying amount of note, December 31, 2019 34,711

33. C. 1,568,498.

- Solution:

(19,604,145 × .04) + (19,608,310 × .04) = 1,568,498.

34. A. 264,050.

- Solution:

2019-2020: 4,695,000 + [(4,695,000 × .1) – (5,000,000 × .09)]

= 4,714,500.

2020-2021: 4,714,500 + (471,450 – 450,000) = 4,735,950

5,000,000 – 4,735,950 = 264,050.

35. D. 8,000 gain

- Solution:

[1,040,000 – (40000× 11)] – (1,000,000 × 1.01) = 8,000.

20

36. B. 4,000,000

- Solution:

Retirement price (4,000,000 x 0.97) 3,880,000

Accrued interest (4,000,000 x 12% x 3/12) 120,000

37. A. 1,885,800

- Solution:

Carrying amount January 1, 2019 1,878,000

Effective interest (1,878,000 x 10%) 187,800

Nominal interest (2,000,000 x9%) 180,000 7,800

Carrying amount, December 31, 2019 1,885,800

38. C. 227,200

- Solution:

Effective interest (5,000,000 x 1.136 = 5,680,000; 5,680,000 x 4%) 227,200

39. A. 10,000

- Solution:

Accrued interest (1,000,000 x 12% x 1/12) 10,000

40. B. 970,000

- Solution:

Issue price (1,000,00 x 1.02) 1,020,000

Transaction costs (50,000)

Initial carrying amount, February 1, 2019 970,000