CPA Financial Accounting and Reporting (FAR) : Debt and Equity Financing
Study concepts, example questions & explanations for CPA Financial Accounting and Reporting (FAR)
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Example Questions
Example Question #1 : Equity Transactions
The Mohawk Company borrows $5 million and is required to sign a debt covenant as a condition of taking out the loan. Which of the following is least likely to be required by the debt covenant?
The debt covenant may restrict Mohawk from operating certain business segments if they don't meet minimum profitability requirements
The debt covenant may require Mohawk to uphold certain minimum or maximum ratios
The debt covenant may require Mohawk to maintain a certain amount of working capital
The debt covenant may restrict Mohawk from doing whatever it wants with the loan proceeds
The debt covenant may restrict Mohawk from operating certain business segments if they don't meet minimum profitability requirements
Debt covenants typically place restrictions and requirements on working capital, not company operations.
Example Question #2 : Equity Transactions
The Barry Company borrows on a note payable and is subject to a debt covenant that requires it to maintain a certain level of working capital. In July of Year 1, Barry's working capital requirements fall below the level acceptable by its lender. Which of the following actions could the lender most likely take in response to this?
Immediately sue Barry for violation of the terms of the loan
Hold company officers personally liable for the outstanding balance
Immediately call the entire loan balance due
Seize the remainder of of Barry's working capital in settlement of the balance
Immediately call the entire loan balance due
If debt covenants are met, lenders have many options, but the most likely action they would take is to immediately call the entire balance due.
Example Question #3 : Equity Transactions
First Lender Bank requires all corporate borrowers to maintain a current ratio of .9, or they will be considered out of compliance with the terms of their loan and the full outstanding balance could be called immediately. One of its borrowers, the Stone Company, has current assets of $150,000 and current liabilities of $200,000. Another borrower, the Concrete Company, has current assets of $75,000 and current liabilities of $90,000. Which of these companies is in compliance with First Lender's debt covenant?
Neither Stone Company nor Concrete Company
Concrete Company only
Both Stone Company and Concrete Company
Stone Company only
Neither Stone Company nor Concrete Company
The current ratio is calculated as current assets divided by current liabilities. For Stone Company, the current ratio is $150K/$200K = .75. For Concrete Company, the current ratio is $75K/$90K = .833. Neither company is in compliance because both have ratios below .9.
Example Question #4 : Equity Transactions
A property dividend should be recorded in retained earnings at the property's:
Market value at date of declaration
Book value at date of issuance
Market value at date of issuance
Book value at date of declaration
Market value at date of declaration
A property dividend should be recorded in retained earnings at the property's market value at date of declaration.
Example Question #5 : Equity Transactions
How would a stock dividend affect assets, equity, and retained earnings?
Decrease assets
Decrease retained earnings
Decrease equity
Decrease retained earnings, assets, and equity
Decrease retained earnings
There is no net effect to equity as all transfers take place within equity. There is no effect to assets and only a decrease to retained earnings.
Example Question #6 : Equity Transactions
Additional paid in capital would be utilized in recording gains from _______ transactions.
Neither
Investments in another company
Treasury stock
Both
Treasury stock
APIC is an account used to track the gains and decrease in gains from purchasing and reselling treasury stock.
Example Question #1 : Bonds Payable & Long Term Debt
On January 1, Year 1, a $100,000 bond with a 5% annual stated rate is issued at 94 to yield an effective rate of 7%. Interest payments are made each December 31. If the effective interest method is applied, how much interest expense is recognized in Year 1?
$7,000
$6,580
$4,700
$5,000
$6,580
Interest expense is calculated by taking the beginning period carrying value by the yield rate. A $100K bond issued at 94 has a beginning carrying value of $94K. Thus, the interest expense for Year 1 is $94K x 7%.
Example Question #2 : Bonds Payable & Long Term Debt
On January 2, Year 1, Beanstock Corporation offers to sell a $100,000 bond coming due in 10 years. The bond pays interest of 4% at the end of each year. Beanstock finds a buyer who wants to earn 7% each year, and agrees to the 7% rate at a sales price of $80,000. On the December 31, Year 1 balance sheet, what amount is reported for the liability of this bond?
$96,000
$93,000
$83,200
$85,600
$85,600
The beginning carrying value of the bond is its purchase price of $80K. Interest expense for Year 1 is the carrying value of $80K x the yield rate of 7% = $5,600. The carrying value of the bond increases by the amount of the interest expense to $85,600.
Example Question #3 : Bonds Payable & Long Term Debt
A $100,000 bond payable is issued on July 1, Year 2, at 106. The bond comes due in exactly 5 years. The bond pays interest of 10% per year with payments every January 1st and July 1st. If the straight-line method is used, what amount should be reported for the liability as of December 31, Year 2?
$105,400
$100,000
$104,800
$104,000
$105,400
Under the straight line method, the difference between the carrying value and the face value is amortized evenly over the life of the bond. Here, the premium of $6K is amortized evenly over 5 years, at $1,200 per year. 6 months have gone by since the sale of the bond, so the carrying value of $106K is reduced by $600 ($1,200 x 6/12 months).
Example Question #4 : Bonds Payable & Long Term Debt
Of the following which is a cost associated with exit and disposal activities?
Benefits related to voluntary employee termination
Costs to relocate employees
Costs associated with the retirement of a fixed asset
Costs to terminate a capital lease
Costs to relocate employees
Costs to relocate employees are costs associated with exit and disposal activities.
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