R28 Noncurrent Long Term Liabilities Answers PDF

Question 1
L1R32TB-AC007-1605
LOS: LOS-3320
Lesson Reference: Lesson 3: Pensions and Other Post-Employment Benefits and Evaluating Solvency
Difficulty: medium
If a defined benefit pension is underfunded this will be reported:
as a balance sheet liability.
off-balance sheet in the supplemental section.
on the income statement as an expense specific to the funding shortfall.
Rationale
 as a balance sheet liability.
An underfunded pension is a liability to the company in the amount equal to the underfunded status.
Rationale
 off-balance sheet in the supplemental section.
Rationale
 on the income statement as an expense specific to the funding shortfall.
Question 2
L1FR-PQ3212-1410
LOS: LOS-3230
LOS: LOS-3240
Lesson Reference: Lesson 1: Bonds Payable
Difficulty: medium
Which of the following is most likely as to whether use of the effective interest method to account for
financing liabilities is required under IFRS and U.S. GAAP?
U.S. GAAP IFRS
A. Yes No
B. Yes Yes
C. No Yes
Row A
Row B
Row C
Rationale
 This Answer is Correct
The effective interest method is required under IFRS and preferred under U.S. GAAP.
Question 3
L1R31TB-BW012-1612
LOS: LOS-3290
Lesson Reference: Lesson 2: Leases
Difficulty: medium
Which of the following statements is correct?
Reporting as a finance lease is more preferable for lessees.
If any one of the finance lease criteria is met, the lease is considered a finance lease by the
lessor under U.S. GAAP.
U.S. GAAP prescribes more specific criteria for determining lease type compared to IFRS.
Rationale
 Reporting as a finance lease is more preferable for lessees.
The first choice is incorrect. Lessees prefer reporting leases as operating leases since no liability related
to the lease is recognized.
Rationale
 If any one of the finance lease criteria is met, the lease is considered a finance lease by the
lessor under U.S. GAAP.
The second choice is incorrect. Under U.S. GAAP, if an entity meets one of the criteria, the lease is
already considered as finance provided that the collectibility of lease payments is reasonably certain,
and the lessor has substantially completed performance.
Rationale
 U.S. GAAP prescribes more specific criteria for determining lease type compared to IFRS.
The third choice is correct.
Question 4
L1R32TB-ITEMSET-AC001-1605
LOS: LOS-3330
Difficulty: N/A
Use the following table for questions 7 and 8.
Tryst Industries 2010

Tryer Inc
2010
Short-term borrowing 500 750

Current portion of long-term debt (interest bearing) 20 4,000
Long-term debt (interest bearing) 1,000 25,000
Total shareholder's equity 1,500 15,000
Total assets 4,000 49,700
EBIT 5,000 16,500
Interest payments 150 1,700
i.
The debt to capital ratio for the two companies is closest to:
66.5% (Tryst) and 50.3% (Tryer).
50% (Tryst) and 10% (Tryer).
Rationale
Debt to capital is equal to debt (short term and long term) divided by the sum of debt and
shareholder's equity.
Rationale
Rationale
 This Answer is Incorrect
ii.
The debt to asset ratio for the two companies is:
Rationale
The value is equal to the sum of short-term borrowing, current position of long-term debt and long-
term interest bearing debt divided by total assets.
Rationale
Rationale
Question 5
L1FR-PQ3225-1410
LOS: LOS-3290
LOS: LOS-3300
Difficulty: medium
XYZ Company leases an asset for 4 years. During the term of the lease, XYZ must make a payment of $8,000
each year for using the asset. The rate implicit in the lease is 7%. XYZ has a bargain purchase option on the
asset.
Operating and nonoperating expenses in Year 3 are closest to:
Operating Expenses Nonoperating Expenses

A. $8,000 Zero
B. $6,988 $1,012
C. Zero $6,774
Row A
Row B
Row C
Rationale
In a finance lease, depreciation is classified as an operating expense, while interest expense is classified
as a nonoperating expense.
ANNUAL LEASE INTEREST EXPENSE REDUCTION OF LEASE BALANCE
YEARS
PAYMENTS ($) (7%) ($) OBLIGATION ($) ($)
0 - - - 27,097.69
1 8,000 1,896.84 6,103.16 20,994.53
2 8,000 1,469.62 6,530.38 14,464.15
3 8,000 1,012.49 6,987.51 7,476.64
4 8,000 523.36 7,476.64 -
Question 6
L1FR-PQ3258-1410
LOS: LOS-3310
Difficulty: medium
The following disclosures regarding finance and operating leases are made by Magnus Corp. in its notes to
the financial statements for 2010:
Leased Assets
2010 2009
Acquisition Cost ($ Net Book Value ($ Acquisition Cost ($ Net Book Value ($
Millions) Millions) Millions) Millions)
Land and
58 50 65 54
buildings
Machinery 545 224 560 345
Others 90 52 105 56
Total 693 326 730 455
Liabilities from Finance Leases ($ Millions)
2010 2009
Minimum Lease Interest Leasing Minimum Lease Interest Leasing
Payments Portion Liability Payments Portion Liability
Following
45 10 25 54 12 28
Year 1
Following
55 12 30 58 14 31
Year 2
Following
40 8 20 76 22 38
Year 3
Over 3
60 16 35 72 18 36
years
200 46 110 260 66 133
Commitments Due to Operating Lease Contracts ($ Millions)
Nominal Value of the Future Minimum Payments

December 31, 2010 December 31, 2009
Less than 1 year 395 430
1-3 years 860 775
Over 3 years 790 645
2,045 1,850
The amount of leased assets reported by Magnus Corp. at the end of 2010 is closest to:
$693 million.
$326 million.
$730 million.
Rationale
This is the total of the 2010 column “Net Book Value” in the “Leased Assets” table.
Question 7
L1R32TB-AC004-1605
LOS: LOS-3240
Difficulty: medium
At the time of issue of a 7.5% coupon bond, the effective rate was 5%. The bonds were most likely issued at:
par.
discount.
premium.
Rationale
 par.
The coupon is higher than the prevailing rate; therefore, investors will be willing to pay more than the
face value to the point that the yield on the bond equates to the effective rate.
Rationale
 discount.
Rationale
 premium.
Question 8
L1FR-PQ3223-1410
LOS: LOS-3290
Difficulty: medium
ABC Company leases an asset for 5 years. During the term of the lease, ABC must make a payment of $5,000
each year for using the asset. The rate implicit in the lease is 8%. ABC treats the lease as an operating lease.
The book value of the lease-related liability at the beginning of Year 3 is closest to:
$12,885
Zero
$8,916
Rationale
In an operating lease no liability is recognized on the balance sheet.
Question 9
L1FR-PQ3238-1410
LOS: LOS-3230
LOS: LOS-3240
Difficulty: medium
Star Traders issues an 8% annual coupon bond with a par value of $100,000 which will be redeemed after 4
years. Market interest rates at the time of issuance are 9%.
The increase in liability over Year 2 is closest to:
$708
$772
$842
Rationale
Beginning liability Interest expense Coupon payment Change in liability Closing liability
Year ($) ($) ($) ($) ($)
0 96,760.28
1 96,760.28 8,708.43 8,000.00 708.43 97,468.71
2 97,468.71 8,772.18 8,000.00 772.18 98,240.89
3 98,240.89 8,841.68 8,000.00 841.68 99,082.57
4 99,082.57 8,917.43 8,000.00 917.43 100,000.00
Question 10
L1FR-TBP263-1501
LOS: LOS-3280
Difficulty: easy
Which of the following is the least likely advantage of an operating lease to a lessee?
It is an off-balance-sheet financing.
It leads to a better debt-to-equity ratio.
It helps companies to reduce taxes due to increased depreciation expense.
Rationale
Operating leases do not allow depreciation expense, as the ownership of the asset is not transferred to
the lessee.
Question 11
L1R31TB-BW003-1612
LOS: LOS-3240
Difficulty: medium
On January 1, 2014, Bar Company issued its 10-year, 10% semiannual coupon bond with a face value of
$7,000,000 when the market rate is 12%. What is the carrying amount of the bond at December 31, 2016?
$6,349,351
$6,361,074
$7,000,000
Rationale
 $6,349,351
At December 31, 2016 the bond will have 7 years to go => 14 N (note the bond is semi-annual)
An annual yield of 12% implies 6% every six months => 6 I/Y
The six-monthly coupon is 5%, i.e., 0.05 x 7,000,000 = 350,000 PMT
The par amount is 7,000,000 => 7,000,000 FV
CPT PV 6,349,351
Rationale
 $6,361,074
CPT PV 6,349,351
Rationale
 $7,000,000

CPT PV 6,349,351
Question 12
L1R32TB-AC019-1605
LOS: LOS-3280
Difficulty: medium
Temporary differences in taxes payable and income tax expense are most likely caused by:
expensed items not allowed by tax legislation.
restructuring costs.
tax credits.
Rationale
Restructuring costs are expensed at the time of restructuring but are only tax deductible when paid.
This leads to a deferred tax liability
Question 13
L1FR-PQ3256-1410
LOS: LOS-3310
Difficulty: medium
Leased Assets 2010 2009

Land and
58 50 65 54
buildings
Machinery 545 224 560 345
Others 90 52 105 56
Total 693 326 730 455
Liabilities from Finance
2010 2009
Leases ($ Millions)
Minimum Minimum
Interest Leasing Interest Leasing
Lease Lease
Portion Liability Portion Liability
Payments Payments
Following Year 1 45 10 25 54 12 28
Following Year 2 55 12 30 58 14 31
Following Year 3 40 8 20 76 22 38
Over 3 years 60 16 35 72 18 36
200 46 110 260 66 133
1-3 years 860 775
2,045 1,850
Magnus Corp.’s total commitments under operating leases at the end of 2009 and 2010 are closest to:
2010 ($ Millions) 2009 ($ Millions)

A. 790 645
B. 395 430
C. 2,045 1,850
Row A
Row B
Row C
Rationale
These are the totals of the 2009 and 2010 columns “Nominal Value of the Future Minimum Payments”
in the “Commitments Due to Operating Lease Contracts” table.
Question 14
L1R32TB-AC003-1605
LOS: LOS-3230
Difficulty: medium
A company issues $10 million of bonds at face value. When the bonds are issued, the company will record a:
cash inflow from investing activities.
cash inflow from financing activities.
cash inflow from operating activities.
Rationale
 cash inflow from investing activities.
The inflow will be cash from investors and will be recorded as a financing activity.
Rationale
 cash inflow from financing activities.
Rationale
 cash inflow from operating activities.
Question 15
L1FR-PQ3226-1410
LOS: LOS-3290
LOS: LOS-3300
Difficulty: medium
asset.
The book value of the lease-related liability at the beginning of Year 3 is closest to:
$14,464
Zero
$7,477
Rationale
ANNUAL LEASE INTEREST EXPENSE REDUCTION OF LEASE BALANCE
YEARS
PAYMENTS ($) (7%) ($) OBLIGATION ($) ($)
0 - - - 27,097.69
1 8,000 1,896.84 6,103.16 20,994.53
2 8,000 1,469.62 6,530.38 14,464.15
3 8,000 1,012.49 6,987.51 7,476.64
4 8,000 523.36 7,476.64 -
Question 16
L1R32TB-AC009-1605
LOS: LOS-3240
Difficulty: medium
$10 million of bonds are sold at a discount, resulting in proceeds of $9,578,760. The bonds pay a coupon of
3% annually and have a maturity of five years. Assuming straight-line amortization the annual interest
expense recorded would be closest to:
$300,000
$384,248
$425,000
Rationale
 $300,000
The issuer would pay the coupon of 3% or $300,000 and would also amortize the original discount
annually, making the effective payout equal to $300,000 + ($421,240/5), or $384,248.
Rationale
 $384,248
Rationale
 $425,000
Question 17
L1R32TB-AC014-1605
LOS: LOS-3290
Difficulty: medium
Compared to a lessee leasing a comparable asset under a financing lease scenario, a lessee using an
operating lease plan will have:
lower operating cash flow.
higher operating cash flow.
comparable operating cash flow.
Rationale
 lower operating cash flow.
Financing leases result in higher operating cash flow because the lease payments are split between
operating cash flow and financing cash flow since a portion of the lease payment satisfies the
treatment of the lease as a purchase agreement.
Rationale
 higher operating cash flow.
Rationale
 comparable operating cash flow.
Question 18
L1FR-PQ3260-1410
LOS: LOS-3270
Difficulty: medium
Following are some of the excerpts from disclosures made by Gamma Corp. regarding its long-term debt in
its 2010 financial statements:
Note 11 (excerpt)
The components of long-term debt are as follows:
$ Millions 2010 Effective Rate % 2009 Effective Rate %

4.5% Debentures due 2015 455 450 7.0%
5.35% Debentures due 2022 795 5.35%
4.25% Notes due 2018 1,391 4.95% 1,347 4.95%
Note 23: Debentures Payable (excerpt)
On March 31, 2010, the company issued 2.5%, $100 par convertible bonds with stock warrants due 2022 with
an aggregate principal amount of $24 billion. Each lot of 5 bonds is entitled to warrants to subscribe 40
shares of the company at an initial exercise price of $22.
The carrying amount of 5.35% Debentures due 2022 in 2010 is closest to:
$855 million.
$455 million.
$795 million.
Rationale
The effective interest rate at which the 5.35% Debentures due 2022 were issued is the same as the
coupon rate, which implies that they were issued at par. Therefore, the carrying amount of the
Debentures in 2010 is the same as that in 2009 (i.e., $795 million).
Question 19
L1FR-PQ3241-1410
LOS: LOS-3230
LOS: LOS-3240
Difficulty: medium
Mercury Traders issued a 12% annual coupon bond with a par value of $100,000 and a 4-year term. Market
interest rates at issuance were 10%.
The change in liability over Year 2 is closest to:
−$1,503
$1,366
−$10,634
Rationale
Years ($) ($) ($) ($) ($)
0 106,339.73
1 106,339.73 10,633.97 12,000.00 −1,366.03 104,973.70
2 104,973.70 10,497.37 12,000.00 -1,502.63 103,471.07
3 103,471.07 10,347.11 12,000.00 −1,652.89 101,818.18
4 101,818.18 10,181.82 12,000.00 −1,818.18 100,000.00
Question 20
L1FR-PQ3210-1410
LOS: LOS-3230
LOS: LOS-3240
Difficulty: medium
A company needs to raise $20 million and has a choice between issuing zero-coupon bonds or bonds with a
coupon rate that is 100 basis points lower than the market interest rate at the issuance date. As the bond’s
maturity day approaches, the reported debt-equity ratio will most likely:
Zero-coupon Bond Coupon-bearing Bond
A. Rise Stay the same
B. Fall Fall
C. Rise Rise
Row A
Row B
Row C
Rationale
The book value of the liability rises over the term of the bond for both zero-coupon and coupon-
bearing bonds that are issued at a discount. Therefore, the reported debt-equity ratio rises.
Question 21
L1R31TB-BW006-1612
LOS: LOS-3250
Difficulty: medium
Which of the following statements is false?
Unamortized bond issue costs must be written off and be included in the determination of
gain or loss under IFRS.
At maturity, the issuer does not recognize any gains or losses.
For analysis and forecasting purposes, analysts should eliminate the gain or loss from bond
redemption.
Rationale
 Unamortized bond issue costs must be written off and be included in the determination of
gain or loss under IFRS.
The first choice is correct. U.S. GAAP requires writing off of any remaining unamortized bond issue costs
and including it in the calculation of bond retirement. IFRS requires no write-off since it is reflected in
the amount of bond liability.
Rationale
 At maturity, the issuer does not recognize any gains or losses.
The second choice is incorrect.
Rationale
 For analysis and forecasting purposes, analysts should eliminate the gain or loss from bond
redemption.
The third choice is incorrect.
Question 22
L1FR-PQ3233-1410
LOS: LOS-3290
LOS: LOS-3300
Difficulty: medium
QRS Company leases out an asset for 4 years to TUV Inc. During the term of the lease, TUV must make a
payment of $5,000 each year for using the asset. The rate implicit in the lease is 8%. The lease is classified as
a finance lease and both companies use straight-line depreciation and zero salvage values to depreciate all
fixed assets.
If QRS were to classify the lease as an operating lease, CFO in Year 2 would most likely:
Be higher by $3,969.
Be lower by $171.
Be the same as under a direct-finance lease.
Rationale
CFO in Year 2:
Operating lease: $5,000
Direct-financing lease: $1,030.84 (Interest income)

Question 23
L1FR-PQ3229-1410
LOS: LOS-3290
LOS: LOS-3300
Difficulty: medium
fixed assets.
Interest income for QRS in Year 3 is closest to:
Zero
$713
$370
Rationale
Lease Amortization Schedule:
Annual Lease Payments Interest Income (8%) Reduction of Lease Balance

Years
Received ($) ($) Receivable ($) ($)
0 - - - 16,560.63
1 5,000 1,324.85 3,675.15 12,885.48
2 5,000 1,030.84 3,969.16 8,916.32
3 5,000 713.31 4,286.69 4,629.63
4 5,000 370.37 4,629.63 -
Net Income Schedule:
YEARS ANNUAL LEASE PAYMENTS RECEIVED ($) DEPRECIATION EXPENSE ($) NET INCOME ($)
1 5,000 4,140.16 859.84
2 5,000 4,140.16 859.84
3 5,000 4,140.16 859.84
4 5,000 4,140.16 859.84
Question 24
L1R31TB-BW004-1612
LOS: LOS-3240
Difficulty: medium
A firm incurs issuance costs of $10,000 in issuing its $1 million bonds for 97. How much is the change in firm's
liabilities under (1) U.S. GAAP and (2) IFRS from the issuance of the bond?
$960,000 increase; (2) $960,000 increase
Rationale
 $960,000 increase; (2) $960,000 increase
Previously, U.S. GAAP required issuance costs to be capitalized as an asset and be allocated to profit or
loss over the life of the bond.
However, U.S. GAAP now follows the same approach as IFRS, which requires bond issuance costs to
reduce the amount recognized initially as liability, thus affecting the effective interest rate. Thus, under
U.S. GAAP and IFRS, liabilities increase by 960,000.
Rationale
 $970,000 increase; (2) $970,000 increase
Rationale
 $970,000 increase; (2) $960,000 increase
Question 25
L1FR-PQ3255-1410
LOS: LOS-3310
Difficulty: medium

Land and
58 50 65 54
buildings
Machinery 545 224 560 345
Others 90 52 105 56
Total 693 326 730 455
2010 2009
Leases ($ Millions)
Minimum Minimum
Lease Lease
Payments Payments
Following Year 1 45 10 25 54 12 28
Following Year 2 55 12 30 58 14 31
Following Year 3 40 8 20 76 22 38
Over 3 years 60 16 35 72 18 36
200 46 110 260 66 133
1-3 years 860 775
2,045 1,850
With respect to the finance lease agreements in place at the end of 2010, the amount of interest expense that
Magnus Corp. will report in 2011 is closest to:
$10 million.
$12 million.
$46 million.
Rationale
This is reported in the 2010 column “Interest Portion” row “Following Year 1” in the “Liabilities from
Finance Leases” table.
Question 26
L1FR-PQ3224-1410
LOS: LOS-3290
LOS: LOS-3300
Difficulty: medium
asset.
The increase in liabilities upon inception of the lease is closest to:
Zero
$27,098
$32,000
Rationale
XYZ must classify the lease as a finance lease because it holds a bargain purchase option on the asset.
The present value of lease payments is recognized as a liability at the inception of the lease for a
finance lease.
PMT = −$8,000: N = 4; I/Y = 7; CPT PV; PV = $27,097.69

Question 27
L1FRR32-LIC009-1510
LOS: LOS-3240
Difficulty: medium
When a bond is issued at a discount and the issuer uses the effective interest rate method, rather than the
straight-line method, to amortize the discount it will lead to the issuer reporting:
A lower interest expense in the first year.
A higher interest expense in the first year.
A higher total interest expense over the life of the bond.
Rationale
Under the straight-line method, the interest expense will be spread equally over the life of the bond;
using the effective rate method, it will be lower in the early years when the carrying amount of the bond
is lower. The total interest expense is the same with both methods.
Question 28
L1FR-TBP266-1501
LOS: LOS-3160
LOS: LOS-3290
Difficulty: hard
Blyrie Corp. and Weldine Corp. are similar in all aspects except for the following parameters:
Parameters Blyrie Corp. Weldine Corp.

Lease Finance lease Operating lease
Tax reporting Accelerated depreciation Straight-line depreciation
Financial reporting Straight-line depreciation Accelerated depreciation
If Weldine Corp. creates a valuation allowance, in comparison to Blyrie Corp., Weldine Corp.'s return on
equity (ROE) will most likely be:
the same.
lower.
higher.
Rationale
Impact Blyrie Corp. Weldine Corp.
Impact of lease Lower return on equity Higher return on equity
Impact of depreciation on tax expense Tax expense is higher than Tax expense is lower than tax
and tax payable tax payable payable
Deferred tax liability is Deferred tax asset is created.
created
Impact of valuation allowance Deferred tax liability is not Deferred tax asset is reduced
affected
Tax expense remains the Tax expense increases as DTA
same decreases
Net income will remain the Net income will reduce
same
ROE = Net income / Equity Remains the same ROE will decrease
Question 29
L1R31TB-BW011-1612
LOS: LOS-3240
Difficulty: hard
Five thousand pieces of bonds having a P1,000 face value, stated rate of 6%, paying semi-annual coupons
(June 30 and December 31), and 10-year maturity were issued to yield 7%. Assuming the issue date of all
these bonds were January 1, 2015, what is the recorded interested expense related to the bond for 2017?
P341,867.52
P300,000
P329,339.91
Rationale
 P341,867.52
The first choice is incorrect. [Amortized discount for a certain year] = [Carrying amount as of year-end
(2017)] – [Carrying amount as of prior year-end (2016)] = 4,726,986.99 − 4,697,647.08 = 29,339.91.
Interest expense for the year is increased by the amortization of a bond's discount and decreased by
the amortization of a bond's premium. In the current scenario, a discount is present hence we add the
amortization for year 2017 to the yearly stated interest expense of (5,000,000 × 6%) or 300,000.
[Interest expense for year 2017] = 300,000 + 29,339.91 = 329,339.91
Rationale
 P300,000
The second choice is incorrect. [Amortized discount for a certain year] = [Carrying amount as of year-
end (2017)] – [Carrying amount as of prior year-end (2016)] = 4,726,986.99 – 4,697,647.08 = 29,339.91.
[Interest expense for year 2017] = 300,000 + 29,339.91 = 329,339.91.
Rationale
 P329,339.91
The third choice is correct. [Amortized discount for a certain year] = [Carrying amount as of year-end
(2017)] – [Carrying amount as of prior year-end (2016)] = 4,726,986.99 – 4,697,647.08 = 29,339.91.
[Interest expense for year 2017] = 300,000 + 29,339.91 = 329,339.91

Question 30
L1R32TB-AC013-1605
LOS: LOS-3230
Difficulty: medium
A company raises capital by issuing zero-coupon bonds; the bond will be issued at:
par.
discount.
premium.
Rationale
 par.
Zero-coupon bonds are issued at a discount to par given that the interest rate is implicit by way of the
difference in the price paid and face value relative to the time to maturity.
Rationale
 discount.
Rationale
 premium.
Question 31
L1FRR32-LIC006-1510
LOS: LOS-3230
Difficulty: medium
Market rates are 5% per annum and a 6% semiannual coupon bond is issued at $1,100 with a face value of
$1,000. If an investor buys 1,000 bonds at issue and receives a coupon payment after six months, how much
of this coupon payment will be recorded as principal repayment by the issuer using the effective interest rate
method to amortize the discount or premium?
$2,500.
$5,000.
$30,000.
Rationale
The coupon paid will be 3% multiplied by $1 million, which is $30,000. The interest the investor earns is
2.5% multiplied by $1.1 million, which is $27,500, so the remainder is principal repayment of $2,500.
Question 32
L1FR-PQ3205-1410
LOS: LOS-3290
LOS: LOS-3300
Difficulty: medium
When a lease is classified as a finance lease, a long-lived asset is recognized and depreciated on the:
Lessor’s financial statements.
Lessee’s financial statements.
Both the lessor and the lessee’s financial statements.
Rationale
When a lease is classified as a finance lease, a long-lived asset is recognized and depreciated on the
lessee’s financial statements. The lessor removes the long-lived asset from its books and recognizes a
lease-receivable asset.
Question 33
L1FR-TBP264-1501
LOS: LOS-3240
Difficulty: medium
Which of the following actions of a firm will most likely violate the debt covenant that requires a firm to
maintain a financial leverage of 1.2 times?
It issues convertible debt.
It opts for an operating lease.
It recognizes goodwill impairment.
Rationale
An issue of convertible debt will most likely violate the debt covenant. If the convertible debt option is
exercised, it will lead to an increase in equity and reduce the financial leverage ratio.
Question 34
L1FRR32-LIC007-1510
LOS: LOS-3320
Difficulty: medium
Which of the following would be most likely to increase the reported pension expense for a company with a
defined benefit pension plan? An increase in:
The retirement age for employees.
Compensation rates for employees.
The expected return on plan assets.
Rationale
An increase in the expected return on plan assets would reduce the pension expense, as would an
increase in retirement age.
Question 35
L1FR-PQ3247-1410
LOS: LOS-3320
Difficulty: medium
Under U.S. GAAP, an increase in which of the following least likely increases pension expense under a
defined-benefit plan?
Interest expense
Expected return on plan assets
Service costs
Rationale
Return on plan assets decreases the amount of funding required to meet the expected pension
obligation and thus decreases pension expense for the period.
Question 36
L1FR-PQ3209-1410
LOS: LOS-3230
LOS: LOS-3240
Difficulty: medium
ABC Company receives $10 million for bonds carrying a coupon rate of 9%. XYZ Company receives $10
million for bonds carrying a coupon rate of 11%. Given that market interest rates at issuance for both the
bonds stood at 10.5% and that both have a 10-year term to maturity, which of the following is least likely?
In Year 2, the book value of the bonds is higher on ABC’s financial statements compared to
XYZ’s financial statements.
ABC records a higher outflow from operating activities each year.
The par value of ABC’s bonds is greater than that of XYZ’s bonds.
Rationale
ABC issues bonds at a discount to par (coupon rate is less than the market interest rate) and XYZ issues
bonds at a premium (coupon rate is more than the market interest rate). Therefore:
The par value of ABC’s bonds is higher than that of XYZ’s.

Over the term of the bonds, ABC will recognize an increasing value of the liability each year while
XYZ will record a decreasing value of the liability. In Year 2, the book value of the liability will be
higher on ABC’s financial statements.
No definitive statement can be made about coupon payments. All we know is that the par value
of ABC’s bonds is greater, but XYZ’s bonds carry a higher coupon rate.
Question 37
L1FR-PQ3207-1410
LOS: LOS-3290
Difficulty: medium
Recognition of a finance lease as opposed to an operating lease by the lessee least likely results in:
Higher CFO.
Higher current liabilities.
Lower nonoperating expenses.
Rationale
Recognition of a finance lease as opposed to an operating lease by the lessee results in higher CFO,
higher current liabilities, and higher nonoperating expenses (interest expense).
Question 38
L1R32TB-AC012-1605
LOS: LOS-3320
Difficulty: medium
Defined contribution plans are:
sensitive to discount rate assumptions.
have limited employer liability compared with defined benefit plans.
are represented on the balance sheet of an employer, unlike defined benefit plans.
Rationale
 sensitive to discount rate assumptions.
Defined contribution plans require an employer to make a set (defined) contribution. The value of the
contribution is a pension expense and is recorded as an operating outflow. The contribution may be
treated as a balance sheet item if it is not paid when due and as a result becomes a recorded liability.
Rationale
 have limited employer liability compared with defined benefit plans.
Rationale
 are represented on the balance sheet of an employer, unlike defined benefit plans.
Question 39
L1FR-PQ3244-1410
LOS: LOS-3230
LOS: LOS-3240
Difficulty: medium
Interest expense for Year 2 under the straight-line method is closest to:
$10,415
$12,000
$10,497
Rationale
Under the straight-line method, the bond premium is amortized evenly across the bond’s term. The
amount of premium amortized each year equals $6,339.73 / 4 = $1,584.93.
Therefore, annual interest expense = 12,000 – 1,584.93 = $10,415.07.

Question 40
L1FRR32-LIC001-1510
LOS: LOS-3230
Difficulty: medium
If a company using US generally accepted accounting principles (GAAP) issues a zero-coupon bond, an
analyst should:
Reduce cash flow from operations.
Increase cash flow from investing.
Increase cash flow from operations.
Rationale
Cash flow from operations is overstated since the full repayment of maturity value is treated as a
financing cash flow whereas it represents interest repayments, which should be classified as an
operating cash flow.
Question 41
L1FR-PQ3261-1410
LOS: LOS-3270
Difficulty: medium
Note 11 (excerpt)
$ Millions 2010 Effective Rate % 2009 Effective Rate %

4.5% Debentures due 2015 455 450 7.0%
5.35% Debentures due 2022 795 5.35%
4.25% Notes due 2018 1,391 4.95% 1,347 4.95%
The 4.25% Notes due 2018 were most likely issued at:
A premium.
A discount.
Par.
Rationale
The carrying value of these bonds has risen from 2009 to 2010, and the effective interest rate on them is
greater than their coupon rate. We can therefore conclude that the bonds were issued at a discount to
par.
Question 42
L1FR-PQ3217-1410
LOS: LOS-3260
Difficulty: medium
Which of the following is least likely required by debt covenants?
Mandatory dividend payments
Maximum levels of leverage
Maintenance of pledged collateral
Rationale
Debt covenants typically put restrictions on dividend payments; they do not require the company to
pay out dividends to shareholders.
Question 43
L1FR-PQ3253-1410
LOS: LOS-3310
Difficulty: medium
Leased
2010 2009
Assets
Land and
58 50 65 54
buildings
Machinery 545 224 560 345
Others 90 52 105 56
Total 693 326 730 455
2010 2009
Leases ($ Millions)
Minimum Minimum
Lease Lease
Payments Payments
Following Year 1 45 10 25 54 12 28
Following Year 2 55 12 30 58 14 31
Following Year 3 40 8 20 76 22 38
Over 3 years 60 16 35 72 18 36
200 46 110 260 66 133
1–3 years 860 775
2,045 1,850
The total amounts of finance lease liabilities reported by Magnus Corp. on its balance sheet for 2009 and
2010 are closest to:
2010 ($ Millions) 2009 ($ Millions)

A. 200 260
B. 110 133
C. 356 459
Row A
Row B
Row C
Rationale
The total amounts of finance lease liabilities are the total of the “Lease Liability” column in the
“Liabilities from Finance Leases” table. The amount recognized as a liability equals the present value of
minimum lease payments.
Question 44
L1FR-TB0063-1412
LOS: LOS-3230
Difficulty: easy
When a company issues bonds at a discount, it can be safely assumed that the market interest rate, as
compared to the coupon rate, is:
greater.
lower.
the same.
Rationale
If the market interest rate is greater than the coupon rate, the bond will be issued at a discount. Since
the coupon rate on offer is less than the compensation required by market participants, the bond will
sell for less than its face value.
Question 45
L1FR-PQ3203-1410
LOS: LOS-3230
LOS: LOS-3240
Difficulty: medium
Company A issued bonds with a 10-year maturity 5 years ago when market interest rates stood at 10%.
Company B issues 5-year bonds today when market interest rates stand at 5%. Given that the book value of
these bond-related liabilities is identical on the two companies’ financial statements as of today, which of
the following statements is most likely?
Company A is better off because the economic value of its bonds is higher as interest rates
have decreased.
Company B is better off because the true value of its obligations is lower than that of
Company A’s.
The economic value of Company B’s liabilities is lower than the book value recognized on its
balance sheet.
Rationale
Interest rates have fallen significantly since the time that Company A issued its bonds. Therefore, the
actual value of Company A’s obligations (liabilities) is higher than what is reflected on its financial
statements. The book value of bonds on Company B’s balance sheet is the same as their actual value
since they were issued today.
Question 46
L1FR-PQ3216-1410
LOS: LOS-3230
LOS: LOS-3240
Difficulty: medium
U.S. GAAP allows interest expense to be classified under:
CFO only.
CFF only.
CFO or CFF.
Rationale
Under U.S. GAAP, interest payments on bonds may be classified as CFO only.
Question 47
L1FR-TB0067-1412
LOS: LOS-3330
Difficulty: medium
Dream Dallas Corporation, a U.S.-based real estate company, offers pension plans along with health care
plans, and medical insurance post retirement of their employees. As per the pension plan, the company is
required to contribute an agreed-upon amount of funds into the plan. However, the company makes no
commitment regarding the future value of plan assets. How will the company record its pension plan in its
financial statements?
On the cash flow statement, the associated cash outflow is treated as an investing cash flow.
On the balance sheet, the company records a decrease in cash or an associated liability.
On the income statement, the change in net pension liability or asset is recognized in profit
and loss.
Rationale
Dream Dallas uses a defined-contribution pension plan. For accounting defined-contribution plans:
On the income statement, the company recognizes the amount it is required to contribute into
the plan as pension expense for the period.
On the balance sheet, the company records a decrease in cash. If the agreed-upon amount is not
deposited into the plan during a particular period, the outstanding amount is recognized as a
liability.
On the cash flow statement, the outflow is treated as an operating cash flow.
Question 48
L1FR-TB0065-1412
LOS: LOS-3240
Difficulty: hard
Marvel Land Inc. issued $1 million five-year bonds on January 1, 2012. The market interest rate on the issue
date was 5%. The coupon rate of the bonds was 4% and the sales proceeds amounted to $956,705. As
compared to the straight-line method, if the company uses the effective interest rate method to amortize the
discount, Marvel Land's profitability in 2012 will most likely appear:
greater.
less.
the same.
Rationale
The method of discount amortization can affect the interest expense charge, which can in turn affect
the profitability of a company.
Effective interest rate method
Interest expense = Carrying value × Market rate at issue = $956,705 × 5% = $47,835
Straight-line method
Interest expense = Interest payment* + (Total discount / Time to maturity) = $40,000 + [($1,000,000 –
$956,705) / 5] = $48,659
*Interest payment = Face value × Coupon rate
Since the interest expense under the effective interest rate method is less then the interest expense
under the straight-line method, Marvel Land will appear more profitable under the effective interest
rate method in 2012.
Question 49
L1FR-TB0068-1412
LOS: LOS-3290
LOS: LOS-3335
LOS: LOS-2860
LOS: LOS-2880
Difficulty: hard
Alfarm Corporation enters into a lease agreement for the use of a piece of machinery for four years beginning
October 1, 2012. The lease terms are as follows:
Annual payments (starting October 1, 2012) $ 57,358

Fair value 200,000
Present value of lease payments 200,000
Salvage value 0
The useful life of the machine is four years and the company's discount rate is 10%. The company accounts
for the lease as a finance lease and uses the straight-line depreciation method. Assuming there were no tax
effects, if the company had accounted the lease as an operating lease, on December 31, 2012, it would have
most likely reported:
a higher current ratio than reported using a finance lease.

a lower total asset turnover ratio than reported using a finance lease.
the same cash flow debt coverage ratio as reported using a finance lease.
Rationale
Under the operating lease, the lessee neither records the leased asset nor the lease liability in its
accounts. However, it will record the lease expense on an accrual basis reflecting the usage of the
asset. Here, Alfarm made its first (advance) lease payment of $57,358 on October 1, 2012 and has used
only $14,339 ($57,358 × 3/12) at the year-end. Hence, it will record an asset for prepaid expense of
$43,019 ($57,358 – $14,339) as part of its current asset. Thus, Alfarm will record a higher current ratio
while using the operating lease method than reported using the finance lease.
Under the operating lease method, the total assets reported would be lower by the net of decrease in
leased asset and increase in lease prepayment. A lower total assets value will result in a higher total
asset turnover ratio than reported using finance lease.
Cash flow debt coverage ratio is generally calculated as cash flow from operations divided by total
debt. Under the operating lease method, the lease payment is classified as a cash outflow from
operating activities by the lessee. Here, the cash flow from operating activities and the total debt will
decrease in different amounts which will most likely change the cash flow debt coverage ratio.
Question 50
L1FR-PQ3252-1410
LOS: LOS-3330
Difficulty: medium
Alpha Inc. ($ Millions) Beta Inc. ($ Millions)

2010 2009 2010 2009
Short-term borrowings 2,331 3,524 4,681 1,140
Current portion of long-term interest bearing debt 4,250 3,942 215 775
Long-term interest bearing debt 35,675 31,422 1,464 984
Total shareholders’ equity 160,250 151,250 29,625 30,450
Total assets 310,425 270,495 44,655 42,350
EBIT 17,291 35,467 10,425 14,365
Interest expense 1,919 1,729 695 255
Consider the following statements:
Statement 1: Alpha Inc.’s interest coverage ratio has improved over the 2 years.
Statement 2: Beta Inc. is in a better position to cover its interest payments compared to Alpha Inc.
Which of the following is most likely?
Only Statement 1 is incorrect.

Only Statement 2 is incorrect.
Both statements are correct.
Rationale
Alpha Inc.
Interest coverage ratio for 2009 = EBIT / Interest payments
Interest coverage ratio for 2009 = 35,467 / 1,729 = 20.51
Interest coverage ratio for 2010 = 17,291 / 1,919 = 9.01
Beta Inc.
Interest coverage ratio for 2010 = 10,425 / 695 = 15

Question 51
L1FR-PQ3237-1410
LOS: LOS-3230
LOS: LOS-3240
Difficulty: medium
Interest expense in Year 2 is closest to:
$8,708
$708
$8,772
Rationale
Year ($) ($) ($) ($) ($)
0 96,760.28
1 96,760.28 8,708.43 8,000.00 708.43 97,468.71
2 97,468.71 8,772.18 8,000.00 772.18 98,240.89
3 98,240.89 8,841.68 8,000.00 841.68 99,082.57
4 99,082.57 8,917.43 8,000.00 917.43 100,000.00
Question 52
L1FR-PQ3204-1410
LOS: LOS-3290
Difficulty: medium
When a lease is classified as an operating lease, a noncurrent asset is recognized and depreciated on the:
Lessor’s financial statements.
Lessee’s financial statements.
Both the lessor and the lessee’s financial statements.
Rationale
When a lease is classified as an operating lease, a noncurrent asset is recognized and depreciated on
the lessor’s financial statements. No asset is recognized on the lessee’s financial statements.
Question 53
L1FR-PQ3240-1410
LOS: LOS-3230
LOS: LOS-3240
Difficulty: medium
Mercury Traders most likely issued the bond at:
Par.
Discount.
Premium.
Rationale
The bond’s coupon rate is greater than the market rate at issuance. Therefore, the bond was issued at a
premium.
Question 54
L1FR-PQ3236-1410
LOS: LOS-3230
LOS: LOS-3240
Difficulty: medium
Star Traders most likely issued the bond at:
Par.
Discount.
Premium.
Rationale
The bond’s coupon rate is less than the market rate at issuance. Therefore, the bond is issued at a
discount.
Question 55
L1FR-TB0064-1412
LOS: LOS-3240
Difficulty: medium
Wonder Shore Inc. issued 500 five-year bonds on January 1, 2012. The associated interest rates were as
follows:
Market interest rate (January 1) 4.0%

Nominal interest rate 5.0%
Assuming the sales proceeds are $522,259, the amortization of premium using the effective interest rate
method is closest to:
$4,110.
$5,000.
$4,452.
Rationale
Carrying Interest Interest Premium Carrying value (year-

value expense payment amortization end)
2012 $522,259 $20,890 $25,000 $4,110 $518,149
Interest expense = Carrying value × Market interest rate
Interest payment = Face value × Coupon (nominal) rate
Premium amortization = Interest payment – Interest expense
Year-end carrying value = Carrying value at beginning – Premium amortization

Question 56
L1FR-PQ3215-1410
LOS: LOS-3230
LOS: LOS-3240
Difficulty: medium
IFRS allows interest expense to be classified under:
CFO only.
CFO or CFF.
CFO or CFI.
Rationale
Under IFRS, interest payments on bonds may be classified as CFO or CFF.
Question 57
L1FRR32-LIC002-1510
LOS: LOS-3290
Difficulty: medium
Lessors usually prefer to classify leases as finance leases rather than operating leases because:
They can report larger sales revenue immediately.
They can report a larger net cash flow immediately.
Over the term of the lease the total net income will be higher.
Rationale
The second choice is not correct since operating cash flow is positive but investing cash flow is negative
by the same amount. The third choice is not correct since the total net income would be the same
whichever method is used.
Question 58
L1FR-PQ3220-1410
LOS: LOS-3290
Difficulty: medium
From the lessee’s perspective, which of the following is most likely to be higher under an operating lease
compared to a finance lease?
CFO
CFI
CFF
Rationale
CFF is higher under an operating lease as the entire lease payment is an outflow from operating
activities.
Question 59
L1FR-PQ3201-1410
LOS: LOS-3230
LOS: LOS-3240
Difficulty: medium
Which of the following statements is most likely regarding accounting for discount bonds?
The book value of the liability decreases each year over the term of the bonds.
Interest expense recognized exceeds the coupon payment each year over the term of the
bonds.
The excess of interest expense over the coupon payment serves to reduce the liability balance
each year.
Rationale
For bonds issued at a discount:
Interest expense exceeds the coupon payment due to discount amortization.

The book value of the liability increases each year and the shortfall of the coupon payment
compared to interest expense serves to increase the liability balance each year.
Question 60
L1FRR32-LIC008-1510
LOS: LOS-6910
LOS: LOS-3290
Difficulty: medium
If a company using U.S. GAAP actively uses operating leases, which of the following statements is least
accurate?
Total cash flow is understated.
Off-balance-sheet financing is significant.
Minimum lease payments for the next 5 years must be disclosed in the company's accounts.
Rationale
Total cash flow is not understated but cash flow from operations is lower than if the lease were
capitalized.
Question 61
L1FR-PQ3239-1410
LOS: LOS-3230
LOS: LOS-3240
Difficulty: medium
The value of the liability at the beginning of Year 4 is closest to:
$98,241
$99,083
$100,000
Rationale
Year ($) ($) ($) ($) ($)
0 96,760.28
1 96,760.28 8,708.43 8,000.00 708.43 97,468.71
2 97,468.71 8,772.18 8,000.00 772.18 98,240.89
3 98,240.89 8,841.68 8,000.00 841.68 99,082.57
4 99,082.57 8,917.43 8,000.00 917.43 100,000.00
Question 62
L1FRR32-LIC010-1510
LOS: LOS-3260
Difficulty: medium
A company has just issued a bond with covenants. Which of the following clauses is least likely to be
included in the bond covenants?
A requirement that return on capital should exceed a specified percentage.
A restriction on dividend payments to shareholders if they would reduce stockholders' equity
below a specified level.
A requirement that no future debt can be issued that ranks higher than the original bonds
giving the holders a prior claim on assets.
Rationale
Covenants tend to focus on clauses that restrict leverage, issuance of new debt, or spending (on
dividends or investment) that would limit the funds available to repay bond holders. Therefore, a
return on capital requirement is least likely to be specified.
Question 63
L1FR-PQ3232-1410
LOS: LOS-3290
LOS: LOS-3300
Difficulty: medium
QRS Company purchases an asset and then leases it to TUV, Inc. under a four-year financing lease at 8%,
with the first payment of $5,591 due at inception. The present value of the lease payments and the fair value
of the equipment equals $20,000. The useful life of the asset is four years and it will have no salvage value
after that period. QRS pretax income under the financing lease in period 2 will most likely be:
Lower by 394.
Higher by 562.
The same as under the operating lease.
Rationale
For a financing lease, the lessor reduces assets by the carrying amount of the leased asset and reports a
lease receivable based on the present value of lease payments. The income statement shows interest
revenue from the lease. QRS net income for period 2 under the financing lease arrangement assuming
an 8% implicit rate is 1,153:
Beginning Lease Annual Lease Previous Year Accrued Reduction to Lease Ending Lease
Period Receivable Payment Interest (8%) Receivable Receiveable
1 20,000 5,591 0 5,591 14,409
2 14,409 5,591 1,153 4,438 9,971
3 9,971 5,591 798 4,793.94 5,177
4 5,177 5,591 414 5,177 0
For an operating lease, the lessor continues to report the leased asset on the balance sheet. The lessor
records lease revenue as earned and recognizes an associated depreciation expense as a reduction to
rent income. In this case, depreciation expense equals 5,000 each period (20,000/4).
1 2
Rent received 5,591 5,591
less: depreciated expense 5,000 5,000
Pretax income 591 591
QRS pretax income for period 2 under the operating lease arrangement is 591. Therefore, the financing
lease pretax income is greater than the operating lease pretax income by 1,153 − 591 = 562.
Question 64
L1FR-PQ3221-1410
LOS: LOS-3290
Difficulty: medium
The increase in liabilities upon inception of the lease is closest to:
Zero
$25,000
$19,964
Rationale
There are no effects on the balance sheet of the lessee if the lease is classified as an operating lease.
Question 65
L1FRR32-LIC004-1510
LOS: LOS-3260
Difficulty: medium
Bond covenants are used to:
Protect investors in the bond.
Clarify the relationship between the bond holder and the bond issuer.
Protect equity investors from bond holders exercising a claim on a firm's assets.
Rationale
Covenants are to protest creditors'—in this case, the bond holders'—interests by limiting the debtor's
activities if it could weaken the creditors' position.
Question 66
L1R31TB-BW015-1612
LOS: LOS-3320
Difficulty: medium
Which of the following statements is true?
The plan is overfunded if the fair value of plan assets is greater than the estimated pension
obligation.
In a defined benefit plan, the firm promises to contribute a specific sum each period to the
employee's retirement account.
In a defined contribution plan, the firm contributes variable payments each period to the
Rationale
 The plan is overfunded if the fair value of plan assets is greater than the estimated pension
obligation.
The first choice is correct.
Rationale
 In a defined benefit plan, the firm promises to contribute a specific sum each period to the
The second choice is incorrect. A defined benefit plan is a company pension plan in which an
employee's pension payments are calculated according to length of service and the salary they earned
at the time of retirement.
Rationale
 In a defined contribution plan, the firm contributes variable payments each period to the
The third choice is incorrect. A defined contribution plan is a type of retirement plan in which the
employer, employee, or both make contributions on a regular basis.
Question 67
L1FR-PQ3246-1410
LOS: LOS-3320
Difficulty: medium
Which of the following statements regarding pension plans is most accurate?
Under a defined-benefit plan, a company contributes an agreed-upon amount into the plan in
each period.
Under a defined-contribution plan, the amount of cash paid by the company into the plan is
treated as a financing cash outflow on the cash flow statement.
A defined-contribution plan may give rise to a liability on the balance sheet.
Rationale
Under a defined-contribution plan, a company contributes an agreed-upon amount into the plan. The
amount of cash paid by the company into the plan is treated as an operating cash outflow on the cash
flow statement.
The only impact on the balance sheet is a decrease in cash; however, if the agreed-upon amount is not
deposited into the plan during a particular period, the outstanding amount is recognized as a liability.
Question 68
L1R31TB-BW002-1612
LOS: LOS-3260
Difficulty: easy
The following are examples of affirmative covenant, except:
Maintenance of collateral.
Payment of principal and interest on time.
Refraining from engaging in mergers and acquisitions.
Rationale
 Maintenance of collateral.
The first choice is incorrect.
Rationale
 Payment of principal and interest on time.
Rationale
 Refraining from engaging in mergers and acquisitions.
The third choice is correct. This is an example of a negative covenant.
Question 69
L1FR-PQ3242-1410
LOS: LOS-3230
LOS: LOS-3240
Difficulty: medium
Interest expense for Year 3 under the effective interest method is closest to:
$10,497
$10,347
$1,653
Rationale
Years ($) ($) ($) ($) ($)
0 106,339.73
1 106,339.73 10,633.97 12,000.00 −1,366.03 104,973.70
2 104,973.70 10,497.37 12,000.00 −1,502.63 103,471.07
3 103,471.07 10,347.11 12,000.00 −1,652.89 101,818.18
4 101,818.18 10,181.82 12,000.00 −1,818.18 100,000.00
Question 70
L1FR-PQ3249-1410
LOS: LOS-3330
Difficulty: medium

2010 2009 2010 2009
Total assets 310,425 270,495 44,655 42,350
EBIT 17,291 35,467 10,425 14,365
Alpha Inc.’s debt-to-assets ratio for 2009 is closest to:
13.61%
14.38%
14.24%
Rationale
Debt-to-assets ratio = Total debt / Total assets
Debt-to-assets ratio = (3,524 + 3,942 + 31,422) / 270,495 = 14.38%

Question 71
L1FR-PQ3251-1410
LOS: LOS-3330
Difficulty: medium

2010 2009 2010 2009
Total assets 310,425 270,495 44,655 42,350
EBIT 17,291 35,467 10,425 14,365
Which of the following statements regarding the two companies’ solvency ratios is most accurate?
Beta Inc.’s debt-to-equity ratio has declined over the 2 years.

Alpha Inc. has a higher financial leverage ratio than Beta Inc.
Alpha Inc.’s debt-to-equity ratio has declined over the 2 years.
Rationale
Alpha Inc.
Debt-to-equity ratio = Total debt / Total shareholders’ equity
Debt-to-equity ratio for 2009 = (3,524 + 3,942 + 31,422) / 151,250 = 25.71%
Debt-to-equity ratio for 2010 = (2,331 + 4,250 + 35,675) / 160,250 = 26.37%
Financial leverage ratio = Average total assets / Average shareholders’ equity
Financial leverage ratio = [(310,425 + 270,495)/2] / [(160,250 + 151,250)/2] = 1.8649
Beta Inc.
Debt-to-equity ratio for 2009 = (1,140 + 775 + 984) / 30,450 = 9.52%
Debt-to-equity ratio for 2010 = (4,681 + 215 + 1,464) / 29,625 = 21.47%
Financial leverage ratio = [(44,655 + 42,350) / 2] / [(29,625 + 30,450) / 2] = 1.4483

Question 72
L1R32TB-AC008-1605
LOS: LOS-3280
Difficulty: medium
An advantage of a lease is:
lower upfront cash required.
potential for favorable tax treatment.
both choices.
Rationale
 lower upfront cash required.
A lease may require relatively lower cash outlay than purchase of an asset and may also create less
restriction specific to fiscal management. Additionally, depending on the type of lease, there may be a
Rationale
 potential for favorable tax treatment.
Rationale
 both choices.
Question 73
L1FR-PQ3208-1410
LOS: LOS-3230
LOS: LOS-3240
Difficulty: medium
A company issued bonds when market interest rates stood at 8%. Today, market interest rates are 10%.
Given that these bonds offer a coupon of 9%, the bonds were most likely issued at:
A discount to par.
A premium to par.
Par.
Rationale
Since market interest rates at issuance were lower than the coupon rate offered, the bonds were issued
at a premium.
Question 74
L1FR-PQ3227-1410
LOS: LOS-3290
LOS: LOS-3300
Difficulty: medium
asset.
Lease-related current liabilities at the end of Year 1 are closest to:
$6,530
Zero
$20,995
Rationale
The reduction in lease liability over Year 2 is classified as a current liability at the end of Year 1.
Question 75
L1R32TB-AC006-1605
LOS: LOS-3260
Difficulty: medium
Debt covenants are most likely to:
restrict payments of dividends.
limit the issuer's ability to raise additional debt capital.
limit the issuer's ability to raise equity capital.
Rationale
 restrict payments of dividends.
Debt covenants protect debtholders from excessive risk taking. Issuance of additional debt may reduce
the solvency of a company and increase the potential of default on already outstanding debt
obligations.
Rationale
 limit the issuer's ability to raise additional debt capital.
obligations.
Rationale
 limit the issuer's ability to raise equity capital.
obligations.
Question 76
L1R31TB-BW001-1612
LOS: LOS-3230
Difficulty: easy
Red Inc. issued bonds paying a coupon rate greater than the market rate. The said bonds are issued at:
Par.
A discount.
A premium.
Rationale
 Par.
Rationale
 A discount.
Rationale
 A premium.
Question 77
L1FR-PQ3222-1410
LOS: LOS-3290
Difficulty: medium
Assuming that ABC depreciates all its assets using the straight-line method with zero salvage value,
operating and nonoperating expenses in Year 3 are closest to:
Operating Expenses Nonoperating Expenses

A. $5,000 Zero
B. $3,993 $1,031
C. Zero $1,031
Row A
Row B
Row C
Rationale
In an operating lease, the entire lease payment is classified as an operating expense. There is no
interest (nonoperating) expense.
Question 78
L1R31TB-BW010-1612
LOS: LOS-3240
Difficulty: hard
Five thousand pieces of bonds having a P1,000 face value, stated rate of 7%, paying semiannual coupons
(June 30 and December 31), and 10-year maturity were issued to yield 9%. Assuming the issue date of all
these bonds were January 1, 2015, what carrying amount for the bond will be seen on the face of the
December 31, 2020, financial statements?
P5,000,000.00
P4,670,205.70
P4,649,827.60
Rationale
 P5,000,000.00
The first choice is incorrect. The carrying amount for a certain year may be obtained by solving for the
present value of the remaining cash flows from the bond. The PVCF comprises of the cash flows from all
remaining interest payments and the cash flow from the repayment of principal at maturity.
[Coupon payment] × [PVAF] = PV annuity of interest payments
[5M × 7% × 6/12] × [(1−(1/1.0458))/0.045] = 1,154,280.06
[Principal]/[PV of 1] = [PV of principal]
[5M]/[1.0458] = 3,515,925.64
Carry amount = PV annuity of interest payments + PV of principal = 4,670,205.70
Rationale
 P4,670,205.70
The second choice is correct. The carrying amount for a certain year may be obtained by solving for the
[5M × 7% × 6/12] × [(1−(1/1.0458))/0.045] = 1,154,280.06
[5M]/[1.0458] = 3,515,925.64

Rationale
 P4,649,827.60
The third choice is incorrect. The carrying amount for a certain year may be obtained by solving for the
[5M × 7% × 6/12] × [(1−(1/1.0458))/0.045] = 1,154,280.06
[5M]/[1.0458] = 3,515,925.64

Question 79
L1FR-PQ3250-1410
LOS: LOS-3330
Difficulty: medium

2010 2009 2010 2009
Total assets 310,425 270,495 44,655 42,350
EBIT 17,291 35,467 10,425 14,365
Beta Inc.’s debt-to-capital ratio for 2010 is closest to:
17.67%
20.87%
8.69%
Rationale
Debt-to-capital ratio = Total debt / (Total debt + Total shareholders’ equity)
Debt-to-capital ratio = (4,681 + 215 + 1,464) / (4,681 + 215 + 1,464 + 29,625) = 17.67%
Question 80
L1R32TB-AC020-1605
LOS: LOS-3320
Difficulty: medium
Which of the following represents a difference between IFRS and U.S. GAAP in accounting for defined-benefit
pensions?
U.S. GAAP includes past service cost in pension expense, while IFRS does not.
IFRS includes past service cost in pension expense, while U.S. GAAP does not.
IFRS amortizes actuarial gains and losses onto the income statement over time, while U.S.
GAAP does not.
Rationale
 U.S. GAAP includes past service cost in pension expense, while IFRS does not.
In accounting for pensions, IFRS includes past service cost in the pension expense. U.S. GAAP places
past service cost on the balance sheet and amortizes it onto the income statement over time.
Rationale
 IFRS includes past service cost in pension expense, while U.S. GAAP does not.
Rationale
 IFRS amortizes actuarial gains and losses onto the income statement over time, while U.S.
GAAP does not.
Question 81
L1FR-PQ3245-1410
LOS: LOS-3230
LOS: LOS-3240
Difficulty: medium
Consider the following statements:
Statement 1: Ignoring any effects on taxes, amortization of a bond premium or discount is a non-cash item.
Statement 2: If the cash flow statement is prepared using the indirect method, amortization of a bond
premium is added back to net income.
Which of the following is most likely?
Only Statement 1 is correct.

Only Statement 2 is correct.
Both statements are incorrect.
Rationale
If the cash flow statement is prepared using the indirect method, amortization of a bond premium is
deducted from net income.
Question 82
L1FR-TB0087-1412
LOS: LOS-3240
Difficulty: hard
If a company amortizes its bond premium using the effective interest rate method, as compared to the
straight-line method, its profitability in the later years of the bond's life will most likely be:
higher.
lower.
the same.
Rationale
A company will evenly amortize its bond premium under the straight-line method and as a result will
have the same interest expense in each period over the life of the bond. However, a company using the
effective interest rate method will calculate its interest expense by multiplying the carrying amount of
the bond with the effective interest rate. As the carrying value of a bond issued at a premium is higher
in the initial years, the interest expense under the effective interest rate method will be higher in initial
years and lower in later years. This will result in a lower profitability for the company in the early years
of the bond's life and higher profitability in the later years of the bond's life.
Question 83
L1FR-PQ3254-1410
LOS: LOS-3310
Difficulty: medium

Land and buildings 58 50 65 54
Machinery 545 224 560 345
Others 90 52 105 56
Total 693 326 730 455
2010 2009
Leases ($ Millions)
Minimum Minimum
Lease Lease
Payments Payments
Following Year 1 45 10 25 54 12 28
Following Year 2 55 12 30 58 14 31
Following Year 3 40 8 20 76 22 38
Over 3 years 60 16 35 72 18 36
200 46 110 260 66 133
1-3 years 860 775
2,045 1,850
With respect to the finance lease agreements in place at the end of 2010, the amount of Magnus Corp's.
finance lease commitments in 2011 is closest to:
$80 million.
$25 million.
$45 million.
Rationale
This is reported in the 2010 column “Minimum Lease Payments” row “Following Year 1” in the
“Liabilities from Finance Leases” table.
Question 84
L1FR-PQ3243-1410
LOS: LOS-3230
LOS: LOS-3240
Difficulty: medium
The book value of the liability at the beginning of Year 4 is closest to:
$100,000
$103,471
$101,818
Rationale
Years ($) ($) ($) ($) ($)
0 106,339.73
1 106,339.73 10,633.97 12,000.00 −1,366.03 104,973.70
2 104,973.70 10,497.37 12,000.00 −1,502.63 103,471.07
3 103,471.07 10,347.11 12,000.00 −1,652.89 101,818.18
4 101,818.18 10,181.82 12,000.00 −1,818.18 100,000.00
Question 85
L1FR-PQ3213-1410
LOS: LOS-3230
LOS: LOS-3240
Difficulty: medium
Use of the effective interest method to account for financing liabilities most likely results in:
A constant rate of interest over the bond’s term.
An increasing rate of interest over the bond’s term.
A decreasing rate of interest over the bond’s term.
Rationale
The effective interest method results in a constant rate of interest over the bond’s term.
Question 86
L1R32TB-AC018-1605
LOS: LOS-3330
Difficulty: medium
Leverage ratios focus on the balance sheet and:
provide an indication of debt to equity preference.
the amount of debt financing relative to equity financing.
indicate whether income is sufficient to service debt.
Rationale
 provide an indication of debt to equity preference.
Leverage ratios look at the proportion of debt in the firm's capital structure. The greater the ratios are,
the more leveraged the firm's balance sheet is, and the greater the firm's financial risk.
Rationale
 the amount of debt financing relative to equity financing.
Rationale
 indicate whether income is sufficient to service debt.
Question 87
L1FR-PQ3214-1410
LOS: LOS-3230
LOS: LOS-3240
Difficulty: medium
Printing and legal fees incurred when bonds are issued are most likely to be included in the measurement of
the liability under:
U.S. GAAP only.
IFRS only.
U.S. GAAP and IFRS.
Rationale
Printing and legal fees incurred when bonds are issued are included in the measurement of the liability
under IFRS.
Under U.S. GAAP these costs are typically capitalized and written off over the bond’s term.
Question 88
L1FRR32-LIC003-1510
LOS: LOS-3290
Difficulty: medium
Lessees, when they are expanding companies, generally prefer to classify leases as operating rather than
finance leases since it leads to all of the following except:
Higher reported assets.
Higher return on equity.
Lower reported leverage.
Rationale
The first choice is not correct; with an operating lease both reported assets and liabilities will be lower.
Question 89
L1FR-PQ3259-1410
LOS: LOS-3270
Difficulty: medium
Note 11 (excerpt)
Amount in Millions 2009 Effective Rate

4.5% Debentures due 2015 455 7.00%
4.25% Notes due 2018 1391 4.95%
2.5% Debentures due 2022 795 5.35%
The effective interest rate for 2010 for 4.5% Debentures due 2015 is closest to:
4.5%
7.0%
5.35%
Rationale
The effective interest rate is the market interest rate at the time the bonds are issued and, therefore,
does not vary from year to year.
Question 90
L1R32TB-AC017-1605
LOS: LOS-3230
Difficulty: medium
At the time of issue of a 7.5 percent coupon bond, the effective rate was 10 percent. The bonds were most
likely issued at:
par.
discount.
premium.
Rationale
 par.
The prevailing rate is higher than the coupon rate; therefore, investors will be willing to pay less than
the face value to the point that the yield on the bond equates to the effective rate.
Rationale
 discount.
Rationale
 premium.
Question 91
L1FR-PQ3234-1410
LOS: LOS-3290
LOS: LOS-3300
Difficulty: medium
fixed assets.
If the asset had cost QRS $12,000, its net income in Year 1 would be closest to:
$1,325
$4,561
$5,885
Rationale
Since the cost of the asset is lower than the present value of lease payments, QRS would recognize a
gross profit on the sale ($4,560.63) and interest income in Year 1 ($1,324,85).
Question 92
L1R32TB-AC005-1605
LOS: LOS-3330
Difficulty: medium
A company raises capital by issuing zero-coupon bonds; the effect on its debt to equity ratio will:
increase as the maturity date approaches.
decrease as the maturity date approaches.
remain constant through the life of the bond.
Rationale
 increase as the maturity date approaches.
Over time the discount on the bond is amortized. The amortization of the bond over its life reduces
earnings at an increasing rate, reducing retained earnings. The net effect is higher debt and lower
retained earnings resulting in a higher debt to equity value as the zero-coupon bonds approach
maturity.
Rationale
 decrease as the maturity date approaches.
maturity.
Rationale
 remain constant through the life of the bond.
maturity.
Question 93
L1FR-PQ3206-1410
LOS: LOS-3290
Difficulty: medium
Recognition of a finance lease as opposed to an operating lease by the lessor most likely results in:
Higher total net income over the lease term.
Higher total CFI over the lease term.
Lower taxes in the early years of the lease term.
Rationale
Recognition of a finance lease as opposed to an operating lease by the lessor results in the same total
net income, higher total CFI over the lease term, and higher taxes in the early years of the lease.
Question 94
L1FR-TBP265-1501
LOS: LOS-3290
Difficulty: medium
Fresnas Corp. and Hisson Inc. are similar companies in all aspects except that Fresnas Corp. has opted for a
finance lease and Hisson Inc. has opted for an operating lease. Based solely on the information, which of the
following is least accurate of the cash flows?
Fresnas Corp. Hisson Inc.
A. Cash flow from financing activities Higher Lower
B. Cash flow from operating activities Higher Lower
C. Total cash flow Same Same
Row A
Row B
Row C
Rationale
Fresnas Corp. will have lower cash from financing as a part of lease payment will be deducted from
cash from financing activities.
Question 95
L1FR-PQ3235-1410
LOS: LOS-3290
LOS: LOS-3300
Difficulty: medium
fixed assets.
If the asset had cost QRS $14,000, its net income in Year 3 would be closest to:
$713
$640
$1,353
Rationale
Gross profit on the sale is only recognized in Year 1. Only interest income would be recognized on the
income statement in Year 3.
Question 96
L1FRR32-LIC005-1510
LOS: LOS-3230
Difficulty: medium
When a bond issuer makes a coupon payment for a bond that was issued at a premium it will be reported in
the company's financial statements (under US GAAP) as:
A cash flow from financing.
A cash flow from operations.
Partly as a cash flow from operations and partly as a cash flow from financing.
Rationale
The coupon payment will be counted as a cash flow from operations, although it can be argued that
the interest component should be seen as a cash flow from operations and the reduction in principal as
cash flow from financing.
Question 97
L1FR-TB0066-1412
LOS: LOS-3335
LOS: LOS-2880
Difficulty: hard
Marvel Land Inc. issued $1 million five-year bonds on January 1, 2013. The market interest rate on the issue
date was 5%. However, the average market interest rate was 6%. The coupon rate of the bonds was 4% and
the sales proceeds amounted to $956,705. The company uses the effective interest rate method rather than
the straight-line method for amortizing the discount. Based solely on the given information, as compared to
using the straight-line method, in 2017 Marvel Land most likely will have:
a higher pretax margin.
a lower debt-to-capital ratio.
the same total debt ratio.
Rationale
At the end of 2017, the bonds are due and both the effective interest rate method and straight-line
method will show the same carrying value of $1 million for the bonds. Hence, Marvel Land will show the
same total debt ratio under both the effective interest rate method and straight-line method in 2017.
Question 98
L1FR-PQ3219-1410
LOS: LOS-3290
Difficulty: medium
From the lessee’s perspective, which of the following is least likely to be higher under an operating lease
compared to a finance lease?
Operating expenses
Nonoperating expenses
Net income in the early years
Rationale
No nonoperating expenses are recognized by the lessee under an operating lease. Under a finance
lease interest expense is classified as a nonoperating expense.
Question 99
L1R31TB-ITEMSET-BW007-1612
LOS: LOS-3240
Use the following data to answer questions 84–86.
The following relates to the bond issued by Vow Inc.:
Principal: $100 million

Coupon rate: 8%, semiannual payment
Maturity: 10 years
Market rate: 10%
i.
The above transactions causes financing cash flows to increase by:
$87,537,790
$87,710,866
$113,590,326
Rationale
The first choice is correct. The increase in financing cash flows is equal to the cash proceeds upon
issuance net of issuance costs. The cash proceeds is equal to the present value of cash flows, which is
87,537,790.
Rationale
Rationale
ii.
Interest expense for the second year is
8,000,000
8,848,195
8,851,817
Rationale
Rationale
Rationale
Date Payment Interest Expense Amortization Carrying Value
87,537,789.66
Year 1 4,000,000.00 4,376,889.48 376,889.48 87,914,679.14
Year 1 4,000,000.00 4,395,733.96 395,733.96 88,310,413.10
Year 2 4,000,000.00 4,415,520.66 415,520.66 88,725,933.76
Year 2 4,000,000.00 4,436,296.69 436,296.69 89,162,230.44
iii.
Lily purchases a quarter of Force Inc. bonds at issuance and subsequently sells it three years later when
interest rates are 8%. How much would Lily report as gain on sale related to this?
0
2,474,660
9,898,640
Rationale
Rationale
The second choice is correct.
Proceeds (PV at 8%) 25,000,000
Carrying Amount 22,525,340
Gain on Sale 2,474,660
Rationale
Question 100
L1FR-TBP260-1501
LOS: LOS-3240
Difficulty: medium
Hisson Inc. issues a $5,000 par value bond that matures in three years. The market interest rate is 10% and
the coupon rate is 12%. The most accurate approach to arrive at the ending book value of the bond for the
first year would be to amortize the:
premium and deduct it from the beginning book value of the bond to arrive at the ending
book value of the bond.
discount and add it to the beginning book value of the bond to arrive at the ending book value
of the bond.
premium and add it to the beginning book value of the bond to arrive at the ending book
value of the bond.
Rationale
The market interest rate of the bond is less than the coupon rate of the bond, so the bond is issued at
premium.
For a premium bond, the amortized premium is deducted from the beginning book value of the bond to
arrive at the ending book value of the bond.
Question 101
L1FR-TBP255-1501
LOS: LOS-3300
Difficulty: easy
Which of the following is the least accurate difference between a finance lease and an operating lease?
Finance lease Operating lease
A. Return on equity Lower Higher
B. Current ratio Lower Higher
C. Debt to equity Lower Higher
Row A
Row B
Row C
Rationale
Debt to equity is higher in finance lease and lower in operating lease. Assets and liabilities both
increase by the same amount and the resulting ratio is higher.
Question 102
L1R31TB-BW013-1612
LOS: LOS-3300
Difficulty: hard
Megan Inc. agreed to lease out a 400-square-meter condominium unit to Pao Inc. The deal was agreed upon
on January 1, 2017, wherein part of the terms state that Megan Inc. will retain ownership of the property and
Pao Inc. is not entitled to a bargain purchase option. It will cost Pao $100,000 a year, paid every December
31, to rent the condo. Eleven percent is the incremental borrowing rate of the lessee, and 10% is the implicit
rate known to both parties. Pao also shelled out $20,000 in initial direct costs in order to negotiate and
secure the agreement. With the noncancelable lease agreement lasting 10 years and the estimated useful life
being 12 years, what amount should be capitalized by Pao Inc. as the value of the leased property on the
date the deal was agreed upon?
$614,460
$634,460
$608,920
Rationale
 $614,460
The first choice is incorrect. Check whether the lease term is at least 75% of the estimated useful life. If
it is, then it qualifies to be recognized as a finance lease. To solve for the cost, use the following
equation:
([Annual lease payments] × [PVAF for 10 periods at 10%]) + [Initial direct costs] = Cost of lease
(100,000 × 6.1446) + 20,000 = 634,460
Rationale
 $634,460
The second choice is correct. Check whether the lease term is at least 75% of the estimated useful life.
If it is, then it qualifies to be recognized as a finance lease. To solve for the cost, use the following
equation:
(100,000 × 6.1446) + 20,000 = 634,460
Rationale
 $608,920
The third choice is incorrect. Check whether the lease term is at least 75% of the estimated useful life. If
it is, then it qualifies to be recognized as a finance lease. To solve for the cost, use the following
equation:
(100,000 × 6.1446) + 20,000 = 634,460

Question 103
L1FR-TBP272-1501
LOS: LOS-2640
LOS: LOS-2910
LOS: LOS-3290
Difficulty: hard
The CFO of Belto Corp. decided to position the company's stocks as undervalued stocks based on the PE
ratio. Which of the following actions of the CFO will least likely help in achieving this objective?
To opt for operating lease instead of finance lease.
To opt for straight-line depreciation instead of double declining depreciation.
To issue convertible preference shares instead of nonconvertible debentures.
Rationale
To position the company stocks as undervalued, the CFO can manipulate it by decreasing the PE ratio.
If the CFO decides to opt for operating lease instead of finance lease, then the company will report
increased net income, increased EPS, and decreased PE ratio.
If the CFO decides to opt for straight-line depreciation instead of double declining depreciation, then
the company will report increased net income, increased EPS, and decreased PE ratio.
If the CFO decides to issue convertible preference shares instead of nonconvertible debentures, then
net income available for the equity shareholders will decrease if the conversion option is exercised.
This will in turn reduce the EPS and increase the PE ratio.

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Question 1

Use the following table for questions 7 and 8.

Tryst Industries 2010

Short-term borrowing 500 750

Operating and nonoperating expenses in Year 3 are closest to:

Operating Expenses Nonoperating Expenses

Liabilities from Finance Leases ($ Millions)

Commitments Due to Operating Lease Contracts ($ Millions)

Nominal Value of the Future Minimum Payments

The increase in liability over Year 2 is closest to:

An annual yield of 12% implies 6% every six months => 6 I/Y

The six-monthly coupon is 5%, i.e., 0.05 x 7,000,000 = 350,000 PMT

The par amount is 7,000,000 => 7,000,000 FV

An annual yield of 12% implies 6% every six months => 6 I/Y

The six-monthly coupon is 5%, i.e., 0.05 x 7,000,000 = 350,000 PMT

The par amount is 7,000,000 => 7,000,000 FV

An annual yield of 12% implies 6% every six months => 6 I/Y

The six-monthly coupon is 5%, i.e., 0.05 x 7,000,000 = 350,000 PMT

The par amount is 7,000,000 => 7,000,000 FV

Leased Assets 2010 2009

2010 ($ Millions) 2009 ($ Millions)

The components of long-term debt are as follows:

$ Millions 2010 Effective Rate % 2009 Effective Rate %

Note 23: Debentures Payable (excerpt)

The change in liability over Year 2 is closest to:

Operating lease: $5,000

Direct-financing lease: $1,030.84 (Interest income)

Interest income for QRS in Year 3 is closest to:

Lease Amortization Schedule:

Annual Lease Payments Interest Income (8%) Reduction of Lease Balance

Net Income Schedule:

Leased Assets 2010 2009

The increase in liabilities upon inception of the lease is closest to:

PMT = −$8,000: N = 4; I/Y = 7; CPT PV; PV = $27,097.69

Parameters Blyrie Corp. Weldine Corp.

[Interest expense for year 2017] = 300,000 + 29,339.91 = 329,339.91

[Interest expense for year 2017] = 300,000 + 29,339.91 = 329,339.91.

[Interest expense for year 2017] = 300,000 + 29,339.91 = 329,339.91

The par value of ABC’s bonds is higher than that of XYZ’s.

Therefore, annual interest expense = 12,000 – 1,584.93 = $10,415.07.

The components of long-term debt are as follows:

$ Millions 2010 Effective Rate % 2009 Effective Rate %

Note 23: Debentures Payable (excerpt)

2010 ($ Millions) 2009 ($ Millions)

Effective interest rate method

Interest expense = Carrying value × Market rate at issue = $956,705 × 5% = $47,835

*Interest payment = Face value × Coupon rate

Annual payments (starting October 1, 2012) $ 57,358

a higher current ratio than reported using a finance lease.

Alpha Inc. ($ Millions) Beta Inc. ($ Millions)

Consider the following statements:

Which of the following is most likely?

Only Statement 1 is incorrect.

Interest coverage ratio for 2009 = EBIT / Interest payments

Interest coverage ratio for 2009 = 35,467 / 1,729 = 20.51

Interest coverage ratio for 2010 = 17,291 / 1,919 = 9.01

Interest coverage ratio for 2010 = 10,425 / 695 = 15

Interest expense in Year 2 is closest to:

Mercury Traders most likely issued the bond at:

Star Traders most likely issued the bond at:

Market interest rate (January 1) 4.0%

Carrying Interest Interest Premium Carrying value (year-

Interest expense = Carrying value × Market interest rate