QUESTIONS: Chapter 10: Accounting for Long-Term Debt

Accounting for Long-Term Debt

QUESTIONS: Chapter 10: Accounting for Long-Term Debt

1. What is the difference between classification of a note as short term or long term?

2. At the beginning of Year 1, B Co. has a note payable of $72,000 that calls for an annual payment of $16,246, which includes both principal and interest. If the interest rate is 8 percent, what is the amount of interest expense in Year 1 and in Year 2? What is the balance of the note at the end of Year 2?

3. What is the purpose of a line of credit for a business? Why would a company choose to obtain a line of credit instead of issuing bonds?

4. What are the primary sources of debt financing for most large companies?

5. What are some advantages of issuing bonds versus borrowing from a bank?

6. What are some disadvantages of issuing bonds?

7. Why can a company usually issue bonds at a lower interest rate than the company would pay if the funds were borrowed from a bank?

8. What effect does income tax have on the cost of borrowing funds for a business?

9. What is the concept of financial leverage?

10. Which type of bond, secured or unsecured, is likely to have a lower interest rate? Explain.

11. What is the function of restrictive covenants attached to bond issues?

12. What is the difference between term bonds and serial bonds?

13. What is the purpose of establishing a sinking fund?

14. What is the call price of a bond? Is it usually higher or lower than the face amount of the bond? Explain.

15. If Roc Co. issued $100,000 of 5 percent, 10-year bonds at the face amount, what is the effect of the issuance of the bonds on the financial statements? What amount of interest expense will Roc Co. recognize each year?

16. What mechanism is used to adjust the stated interest rate to the market rate of interest?

17. When the effective interest rate is higher than the stated interest rate on a bond issue, will the bond sell at a discount or premium? Why?

18. What type of transaction is the issuance of bonds by a company?

19. What factors may cause the effective interest rate and the stated interest rate to be different?

20. If a bond is selling at 97½, how much cash will the company receive from the sale of a $1,000 bond?

21. How is the carrying value of a bond computed?

22. Gay Co. has a balance in the Bonds Payable account of $25,000 and a balance in the Discount on Bonds Payable account of $5,200. What is the carrying value of the bonds? What is the total amount of the liability?

23. When the effective interest rate is higher than the stated interest rate, will interest expense be higher or lower than the amount of interest paid?

24. Assuming that the selling price of the bond and the face value are the same, would the issuer of a bond prefer to make annual or semiannual interest payments? Why?

25. Rato Co. called some bonds and had a loss on the redemption of the bonds of $2,850. How is this amount reported on the income statement?

26. Which method of financing, debt or equity, is generally more advantageous from a tax standpoint? Why?

27. If a company has a tax rate of 30 percent, and interest expense was $10,000, what is the after-tax cost of the debt?

28. Which type of financing, debt or equity, increases the risk factor of a business? Why?

29. What information does the times-interest-earned ratio provide?