Module 7
Reporting and Analyzing Nonowner
Financing
Learning Objectives – coverage by question
True/False Multiple Choice Exercises Problems Essays
LO1 – Describe the
accounting for current
1, 2, 4-8, 1, 2,
operating liabilities, including 1-5 1-4 1-3
10-12 5-9
accounts payable and
accrued liabilities.
LO2 – Describe the
accounting for current and 3, 9, 3, 4,
6-11 5-9 4-6
long-term nonoperating 13-18 10-19
liabilities.
LO3 – Explain how credit
ratings are determined and
12-16 19-25 20, 21 8-10 6-9
identify their effect on the cost
of debt.
©Cambridge Business Publishers, 2015
Test Bank, Module 7 7-1
,Module 7: Reporting and Analyzing Nonowner Financing
True/False
Topic: Accounts Payable as a Source of Financing
LO: 1
1. Accounts payable are a short-term source of non-interest-bearing financing.
Answer: True
Rationale: Accounts payable that arise from the purchase of goods and services usually do not carry
any interest charges and can represent a good source of short-term inexpensive financing.
Topic: Deferred Revenue
LO: 1
2. Unearned revenue, a current operating liability, arises when a company receives cash before any
goods are delivered or services are rendered.
Answer: False
Rationale: Deferred revenues can also be long-term liabilities.
Topic: Accrued Liabilities
LO: 1
3. Accrued liabilities are obligations for which there is no external transaction.
Answer: True
Rationale: Companies must estimate accrued liabilities such as rent payable because there has been
no bill received or no transaction.
Topic: Income Shifting
LO: 1
4. If accrued liabilities are overestimated in the current period, the reported income in a following period
will be lower than it should be.
Answer: False
Rationale: If the accrued liabilities in this period are overestimated, then the current income is lower
than it should be. This error will be corrected in a following period, and will artificially inflate income.
Topic: Contingent Liabilities
LO: 1
5. Contingent liabilities that are ‘probable’ and can be reasonably estimated are recorded on the balance
sheet as a liability and as an expense in the income statement.
Answer: True
Rationale: Only ‘probable’ contingent liabilities are estimated and recorded on the balance sheet or
the income statement. Anything less than ‘probable’ liabilities (such as ‘reasonably possible’) are
referenced in footnotes.
©Cambridge Business Publishers, 2015
7-2 Financial & Managerial Accounting for MBAs, 4th Edition
,Topic: Discount Bond
LO: 2
6. A bond selling for an amount above face value is said to be selling at a discount.
Answer: False
Rationale: This bond sells at a premium, not a discount.
Topic: Reporting of Current Portion of Long-Term Debt
LO: 2
7. The principal and interest that will be paid on long-term debt within the next operating cycle are
reported on the balance sheet as “current portion of long-term debt.”
Answer: False
Rationale: Only the principal portion is classified as “current portion of long-term debt.”
Topic: Secondary Market for Bonds
LO: 2
8. Unlike stock, once sold, bonds can only be traded in private transactions between arms’ length
parties.
Answer: False
Rationale: There exists a secondary market for previously issued bonds.
Topic: Bond Prices
LO: 2
9. Market prices of bonds fluctuate because the company’s obligation (in the form of principal and
interest payments) remains fixed.
Answer: True
Rationale: Market prices fluctuate similar to stocks. The reasoning behind this is that bonds compete
with other investments and become more or less attractive based on the interest rates of competing
securities and the financial condition of the borrowing company.
Topic: Reporting Gains (Losses) on Bond Repurchase
LO: 2
10. Most gains and losses on bond repurchases are reported as extraordinary items.
Answer: False
Rationale: GAAP specifies that gains and losses should be included as extraordinary items (below
income from continuing operations) only if they meet the criteria of unusual and infrequent. As
relatively few bond repurchases meet these criteria, they are typically included as part of income from
ongoing operations.
©Cambridge Business Publishers, 2015
Test Bank, Module 7 7-3
, Topic: Secured Debtholders
LO: 2
11. Secured debtholders have a preferred position over other creditors but not over preferred stock
holders.
Answer: False
Rationale: When a company provides collateral, it provides security for the debt in the form of liens on
the company’s assets. Secured debtholders have a priority claim on those secured assets. These
come before all stockholder claims, even those from preferred stockholders.
Topic: Cost of Debt
LO: 3
12. The effective rate of a bond typically equals the yield (market) rate.
Answer: False
Rationale: Bonds are priced to yield the return (market rate) demanded by investors. Consequently,
the effective rate of a bond always equals the yield (market) rate.
Topic: Cost of Debt
LO: 3
13. The market rate of interest is equal to the risk-free rate plus a credit-rating premium.
Answer: False
Rationale: The market rate of interest is usually defined as the yield on U.S. Government borrowings
such as treasury bills, notes, and bonds, called the risk-free rate, plus a spread (also called a risk
premium).
Topic: Debt Ratings
LO: 3
14. Credit ratings are an opinion of a company’s relative default risk.
Answer: True
Rationale: The credit rating agencies provide an assessment of their view of the likelihood that a
company will default on its debt obligations.
Topic: Cost of Debt
LO: 3
15. The market rate of interest is equal to the risk-free rate plus a risk premium.
Answer: True
Rationale: The market rate of interest is usually defined as the yield on U.S. Government borrowings
such as treasury bills, notes, and bonds, called the risk-free rate, plus a spread (also called a risk
premium).
Topic: Bond Interest Rates
LO: 3
16. Higher credit-rated borrowers receive lower interest rates than lower credit-rated borrowers, but the
differences are typically not significant.
Answer: False
Rationale: The difference is significant. Highest credit-rated borrowers receive interest rates
approximately ½ that of lowest credit-rated borrowers.
©Cambridge Business Publishers, 2015
7-4 Financial & Managerial Accounting for MBAs, 4th Edition
Reporting and Analyzing Nonowner
Financing
Learning Objectives – coverage by question
True/False Multiple Choice Exercises Problems Essays
LO1 – Describe the
accounting for current
1, 2, 4-8, 1, 2,
operating liabilities, including 1-5 1-4 1-3
10-12 5-9
accounts payable and
accrued liabilities.
LO2 – Describe the
accounting for current and 3, 9, 3, 4,
6-11 5-9 4-6
long-term nonoperating 13-18 10-19
liabilities.
LO3 – Explain how credit
ratings are determined and
12-16 19-25 20, 21 8-10 6-9
identify their effect on the cost
of debt.
©Cambridge Business Publishers, 2015
Test Bank, Module 7 7-1
,Module 7: Reporting and Analyzing Nonowner Financing
True/False
Topic: Accounts Payable as a Source of Financing
LO: 1
1. Accounts payable are a short-term source of non-interest-bearing financing.
Answer: True
Rationale: Accounts payable that arise from the purchase of goods and services usually do not carry
any interest charges and can represent a good source of short-term inexpensive financing.
Topic: Deferred Revenue
LO: 1
2. Unearned revenue, a current operating liability, arises when a company receives cash before any
goods are delivered or services are rendered.
Answer: False
Rationale: Deferred revenues can also be long-term liabilities.
Topic: Accrued Liabilities
LO: 1
3. Accrued liabilities are obligations for which there is no external transaction.
Answer: True
Rationale: Companies must estimate accrued liabilities such as rent payable because there has been
no bill received or no transaction.
Topic: Income Shifting
LO: 1
4. If accrued liabilities are overestimated in the current period, the reported income in a following period
will be lower than it should be.
Answer: False
Rationale: If the accrued liabilities in this period are overestimated, then the current income is lower
than it should be. This error will be corrected in a following period, and will artificially inflate income.
Topic: Contingent Liabilities
LO: 1
5. Contingent liabilities that are ‘probable’ and can be reasonably estimated are recorded on the balance
sheet as a liability and as an expense in the income statement.
Answer: True
Rationale: Only ‘probable’ contingent liabilities are estimated and recorded on the balance sheet or
the income statement. Anything less than ‘probable’ liabilities (such as ‘reasonably possible’) are
referenced in footnotes.
©Cambridge Business Publishers, 2015
7-2 Financial & Managerial Accounting for MBAs, 4th Edition
,Topic: Discount Bond
LO: 2
6. A bond selling for an amount above face value is said to be selling at a discount.
Answer: False
Rationale: This bond sells at a premium, not a discount.
Topic: Reporting of Current Portion of Long-Term Debt
LO: 2
7. The principal and interest that will be paid on long-term debt within the next operating cycle are
reported on the balance sheet as “current portion of long-term debt.”
Answer: False
Rationale: Only the principal portion is classified as “current portion of long-term debt.”
Topic: Secondary Market for Bonds
LO: 2
8. Unlike stock, once sold, bonds can only be traded in private transactions between arms’ length
parties.
Answer: False
Rationale: There exists a secondary market for previously issued bonds.
Topic: Bond Prices
LO: 2
9. Market prices of bonds fluctuate because the company’s obligation (in the form of principal and
interest payments) remains fixed.
Answer: True
Rationale: Market prices fluctuate similar to stocks. The reasoning behind this is that bonds compete
with other investments and become more or less attractive based on the interest rates of competing
securities and the financial condition of the borrowing company.
Topic: Reporting Gains (Losses) on Bond Repurchase
LO: 2
10. Most gains and losses on bond repurchases are reported as extraordinary items.
Answer: False
Rationale: GAAP specifies that gains and losses should be included as extraordinary items (below
income from continuing operations) only if they meet the criteria of unusual and infrequent. As
relatively few bond repurchases meet these criteria, they are typically included as part of income from
ongoing operations.
©Cambridge Business Publishers, 2015
Test Bank, Module 7 7-3
, Topic: Secured Debtholders
LO: 2
11. Secured debtholders have a preferred position over other creditors but not over preferred stock
holders.
Answer: False
Rationale: When a company provides collateral, it provides security for the debt in the form of liens on
the company’s assets. Secured debtholders have a priority claim on those secured assets. These
come before all stockholder claims, even those from preferred stockholders.
Topic: Cost of Debt
LO: 3
12. The effective rate of a bond typically equals the yield (market) rate.
Answer: False
Rationale: Bonds are priced to yield the return (market rate) demanded by investors. Consequently,
the effective rate of a bond always equals the yield (market) rate.
Topic: Cost of Debt
LO: 3
13. The market rate of interest is equal to the risk-free rate plus a credit-rating premium.
Answer: False
Rationale: The market rate of interest is usually defined as the yield on U.S. Government borrowings
such as treasury bills, notes, and bonds, called the risk-free rate, plus a spread (also called a risk
premium).
Topic: Debt Ratings
LO: 3
14. Credit ratings are an opinion of a company’s relative default risk.
Answer: True
Rationale: The credit rating agencies provide an assessment of their view of the likelihood that a
company will default on its debt obligations.
Topic: Cost of Debt
LO: 3
15. The market rate of interest is equal to the risk-free rate plus a risk premium.
Answer: True
Rationale: The market rate of interest is usually defined as the yield on U.S. Government borrowings
such as treasury bills, notes, and bonds, called the risk-free rate, plus a spread (also called a risk
premium).
Topic: Bond Interest Rates
LO: 3
16. Higher credit-rated borrowers receive lower interest rates than lower credit-rated borrowers, but the
differences are typically not significant.
Answer: False
Rationale: The difference is significant. Highest credit-rated borrowers receive interest rates
approximately ½ that of lowest credit-rated borrowers.
©Cambridge Business Publishers, 2015
7-4 Financial & Managerial Accounting for MBAs, 4th Edition
