Mini - Exam II

Question 1

Answer 1

Choice “D” is correct. Under accrual accounting, the entire warranty liability must be accrued in the year of the sale to match the warranty cost to the related revenue. The Year 2 warranty expense is $6,000, calculated as follows:

Year 2 sales × 2% = $300,000 × 2% = $6,000

Choices “A”, “B”, and “C” are incorrect, per the above.

Question 2

On December 31, Year 1, an entity awaiting judgment on a lawsuit determined that a loss from the suit ranging between $1,000,000 and $2,000,000 was reasonably possible. On March 15, Year 2, after the entity issued its financial statements, the suit was settled. The settlement required the entity to pay damages of $1,400,000. What amount of contingent liability should the entity have reported on its December 31, Year 1 balance sheet?

A.	$0

B.	$2,000,000

C.	$1,000,000

D.	$1,400,000

Answer 2

Choice “A” is correct. A contingent liability is not accrued for reasonably possible loss contingencies. If the suit had been settled before the financial statements were issued, then a liability would have been recorded on the December 31, Year 1 balance sheet.

Question 3

Which of the following choices is least likely to represent an actual debt covenant?

A.	The debt-to-equity ratio must stay below a specific level.

B.	Collateral cannot fall below a specific amount.

C.	Times interest earned must stay below a specific level.

D.	Working capital levels cannot fall below a specific amount.

Answer 3

Choice “C” is correct. The higher the times interest earned (EBIT/interest expense), the better it is for the company paying interest on the debt. A more appropriate debt covenant would be for the times interest earned to stay above (rather than below) a specific level.

Choice “A” is incorrect. The lower the debt/equity ratio is for a company, the better (from a risk- management and debt-holder perspective). So a maximum threshold for the debt-to-equity ratio is an appropriate debt covenant.

Choice “B” is incorrect. A minimum level for collateral is an appropriate debt covenant.

Choice “D” is incorrect. A minimum level for working capital is an appropriate debt covenant.

Question 4

Answer 4

Question 5

Emma Construction Company started building a new administrative headquarters on January 1, Year 1. Emma intends to occupy the building at the project completion date of January 1, Year 3. At December 31, Year 1, Emma had incurred $2,000,000 of construction costs, evenly spread during that first year. Projected remaining costs are $2,500,000. During Year 1, Emma incurred interest cost on specific construction debt in the amount of $40,000 and interest on other unrelated loans in the amount of $30,000. All loans carry 5% interest. How much interest should Emma capitalize for Year 1?

A.	$70,000

B.	$0

C.	$50,000

D.	$40,000

Answer 5

Question 6

On July 1, Year 1, Black & Associates issued 2,000 of its 8%, $1,000 bonds for $1,752,000. The bonds were issued to yield 10%. The bonds are dated July 1, Year 1 and mature on July 1, Year 11. Interest is payable semiannually on January 1st and July 1st. Using the effective interest method, how much of the bond discount should be amortized for the six months ended December 31, Year 1?

A.	$9,920

B.	$15,200

C.	$7,600

D.	$12,400

Answer 6

Question 7

Answer 7

Question 8

On January 1, Year 1, David Corp. issued 1000 of its $1,000 bonds at 94. David Corp. uses U.S. GAAP. The bonds mature in 10 years but are callable at 102 any time after issuance. On January 1, Year 1, David incurred bond issue costs of $50,000. On July 1, Year 8, David called all of the bonds and retired them. Assuming that bond discount and issue costs were amortized using the straight-line method, what amount of pretax loss would David report from this extinguishment of debt?

A.	$85,000

B.	$47,500

C.	$20,000

D.	$58,500

Answer 8