Hardest Banking Exam Quiz: MCQ!

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Learning2swerve

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Quizzes Created: 1 | Total Attempts: 294

Questions: 111 | Attempts: 294 | Updated: Mar 20, 2023

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Questions and Answers

1.

An example of an item which is not a liability is
- A.
  
  Dividends payable in stock.
- B.
  
  Advances from customers on contracts.
- C.
  
  Accrued estimated warranty costs.
- D.
  
  The portion of long-term debt due within one year.
Correct Answer
A. Dividends payable in stock.

Explanation
Dividends payable in stock are not considered a liability because they represent a distribution of profits to shareholders rather than an obligation to pay a debt or fulfill a contractual obligation. Dividends payable in stock are typically recorded as a reduction in retained earnings and an increase in common stock or additional paid-in capital accounts. This means that they do not create a future financial obligation for the company and therefore are not classified as a liability.

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2.

The covenants and other terms of the agreement between the issuer of bonds and the lender are set forth in the
- A.
  
  Bond indenture
- B.
  
  Bond debenture
- C.
  
  Registered bond
- D.
  
  Bond coupon
Correct Answer
A. Bond indenture

Explanation
A bond indenture is a legal document that outlines the terms and conditions of a bond agreement between the issuer of the bonds and the lender. It includes details such as the interest rate, maturity date, repayment terms, and any covenants or restrictions placed on the issuer. This document serves as a binding contract between the two parties and provides clarity and protection for both the issuer and the lender.

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3.

The term used for bonds that are unsecured as to principal is
- A.
  
  Mortgage bonds
- B.
  
  Debenture bonds
- C.
  
  Indebenture bonds
- D.
  
  Registered bond
Correct Answer
B. Debenture bonds

Explanation
Debenture bonds are a type of bond that is unsecured as to principal. This means that there is no specific asset or property pledged as collateral for the bond. Instead, debenture bonds rely on the general creditworthiness and reputation of the issuer to repay the principal amount. Unlike mortgage bonds, which are secured by specific properties, debenture bonds do not have any specific assets backing them. Indebenture bonds and registered bonds are not commonly used terms in finance and do not accurately describe the concept of unsecured bonds.

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4.

Bonds for which the owners' names are not registered with the issuing corporation are called
- A.
  
  Bearer bonds
- B.
  
  Term bonds
- C.
  
  Debenture bonds
- D.
  
  Callable bonds
Correct Answer
A. Bearer bonds

Explanation
Bearer bonds are bonds for which the owners' names are not registered with the issuing corporation. This means that the physical bond certificate itself is the proof of ownership, and whoever possesses the bond certificate is considered the owner. Bearer bonds are typically unsecured and can be easily transferred from one person to another, making them more anonymous and potentially more susceptible to theft or fraud.

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5.

Bonds that pay no interest unless the issuing company is profitable are called
- A.
  
  Collateral trust bonds
- B.
  
  Debenture bonds
- C.
  
  Revenue bonds
- D.
  
  Income bonds
Correct Answer
D. Income bonds

Explanation
Income bonds are a type of bond that pay no interest unless the issuing company is profitable. This means that if the company is not making a profit, the bondholders will not receive any interest payments. However, if the company is profitable, the bondholders will receive interest payments based on the company's earnings. This type of bond is often used by companies that have a higher risk of not being profitable, as it provides some protection to bondholders in case of financial difficulties.

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6.

If bonds are issued initially at a premium and the effective-interest method of amortization is used, interest expense in the earlier years will be
- A.
  
  Greater than if the straight-line method were used.
- B.
  
  Greater than the amount of the interest payments
- C.
  
  The same as if the straight-line method were used.
- D.
  
  Less than if the straight-line method were used.
Correct Answer
A. Greater than if the straight-line method were used.

Explanation
If bonds are issued initially at a premium and the effective-interest method of amortization is used, interest expense in the earlier years will be greater than if the straight-line method were used. This is because the effective-interest method allocates the total bond premium over the life of the bond based on the effective interest rate, which is higher in the earlier years. As a result, a larger portion of the premium is amortized in the earlier years, leading to higher interest expense compared to the straight-line method, where the same amount of premium is amortized each year.

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7.

The interest rate written in the terms of the bond indenture is known as the
- A.
  
  Coupon rate
- B.
  
  Nominal rate
- C.
  
  Stated rate
- D.
  
  Coupon rate, nominal rate, or stated rate.
Correct Answer
D. Coupon rate, nominal rate, or stated rate.

Explanation
The interest rate written in the terms of the bond indenture is referred to as the coupon rate, nominal rate, or stated rate. These terms are used interchangeably to describe the fixed interest rate that the bond issuer promises to pay to bondholders over the life of the bond. The coupon rate is typically expressed as a percentage of the bond's face value and is used to calculate the periodic interest payments that bondholders will receive.

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8.

Fox Co. issued $100,000 of ten-year, 10% bonds that pay interest semiannually. The bonds are sold to yield 8%.One step in calculating the issue price of the bonds is to multiply the principal by the table value for
- A.
  
  10 periods and 10% from the present value of 1 table.
- B.
  
  20 periods and 5% from the present value of 1 table.
- C.
  
  10 periods and 8% from the present value of 1 table.
- D.
  
  20 periods and 4% from the present value of 1 table.
Correct Answer
D. 20 periods and 4% from the present value of 1 table.

Explanation
To calculate the issue price of the bonds, the present value of the future cash flows needs to be determined. Since the bonds pay interest semiannually, there will be 20 periods (10 years * 2 periods per year). The yield is 8%, so the interest rate to be used in the present value calculation is 4% (8% / 2). Therefore, the correct answer is 20 periods and 4% from the present value of 1 table.

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9.

Fox Co. issued $100,000 of ten-year, 10% bonds that pay interest semiannually. The bonds are sold to yield 8%.Another step in calculating the issue price of the bonds is to
- A.
  
  Multiply $10,000 by the table value for 10 periods and 10% from the present value of an annuity table.
- B.
  
  Multiply $10,000 by the table value for 20 periods and 5% from the present value of an annuity table.
- C.
  
  Multiply $10,000 by the table value for 20 periods and 4% from the present value of an annuity table.
- D.
  
  None of these answers is correct.
Correct Answer
D. None of these answers is correct.
10.

Reich, Inc. issued bonds with a maturity amount of $200,000 and a maturity ten years from date of issue. If the bonds were issued at a premium, this indicates that
- A.
  
  The effective yield or market rate of interest exceeded the stated (nominal) rate.
- B.
  
  The nominal rate of interest exceeded the market rate.
- C.
  
  The market and nominal rates coincided.
- D.
  
  No necessary relationship exists between the two rates.
Correct Answer
B. The nominal rate of interest exceeded the market rate.

Explanation
If the bonds were issued at a premium, it indicates that the nominal rate of interest exceeded the market rate. This means that the bonds were sold at a price higher than their face value, indicating that investors were willing to pay more for the bonds due to the higher interest rate offered. The premium reflects the difference between the higher nominal rate and the lower market rate, showing that the nominal rate of interest exceeded the market rate.

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11.

If bonds are initially sold at a discount and the straight-line method of amortization is used, interest expense in the earlier years will
- A.
  
  Exceed what it would have been had the effective-interest method of amortization been used.
- B.
  
  Be less than what it would have been had the effective-interest method of amortization been used.
- C.
  
  Be the same as what it would have been had the effective-interest method of amortiza-tion been used.
- D.
  
  Be less than the stated (nominal) rate of interest.
Correct Answer
A. Exceed what it would have been had the effective-interest method of amortization been used.

Explanation
If bonds are initially sold at a discount and the straight-line method of amortization is used, interest expense in the earlier years will exceed what it would have been had the effective-interest method of amortization been used. This is because the straight-line method of amortization allocates the same amount of bond discount to each period, resulting in higher interest expense in the earlier years. On the other hand, the effective-interest method of amortization allocates a higher amount of bond discount to the earlier periods, resulting in lower interest expense in those years. Therefore, interest expense will be higher with the straight-line method compared to the effective-interest method in the earlier years.

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12.

Under the effective-interest method of bond discount or premium amortization, the periodic interest expense is equal to
- A.
  
  The stated (nominal) rate of interest multiplied by the face value of the bonds.
- B.
  
  The market rate of interest multiplied by the face value of the bonds.
- C.
  
  The stated rate multiplied by the beginning-of-period carrying amount of the bonds.
- D.
  
  The market rate multiplied by the beginning-of-period carrying amount of the bonds.
Correct Answer
D. The market rate multiplied by the beginning-of-period carrying amount of the bonds.

Explanation
The correct answer is "the market rate multiplied by the beginning-of-period carrying amount of the bonds." Under the effective-interest method of bond discount or premium amortization, the periodic interest expense is calculated based on the market rate of interest and the carrying amount of the bonds at the beginning of the period. This method ensures that the interest expense recognized over the life of the bond reflects the effective interest rate rather than the nominal rate.

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13.

When the effective-interest method is used to amortize bond premium or discount, the periodic amortization will
- A.
  
  Increase only if the bonds were issued at a discount.
- B.
  
  Decrease only if the bonds were issued at a premium.
- C.
  
  Increase only if the bonds were issued at a premium.
- D.
  
  Increase if the bonds were issued at either a discount or a premium.
Correct Answer
D. Increase if the bonds were issued at either a discount or a premium.

Explanation
The effective-interest method is used to allocate bond premium or discount over the life of the bond. When bonds are issued at a discount, the periodic amortization will increase because the discount is being allocated over a longer period. Similarly, when bonds are issued at a premium, the periodic amortization will also increase because the premium is being allocated over a longer period. Therefore, the periodic amortization will increase if the bonds were issued at either a discount or a premium.

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14.

If bonds are issued between interest dates, the entry on the books of the issuing corporation could include a
- A.
  
  Debit to Interest Payable.
- B.
  
  Credit to Interest Receivable.
- C.
  
  Credit to Interest Expense.
- D.
  
  Credit to Unearned Interest.
Correct Answer
C. Credit to Interest Expense.

Explanation
When bonds are issued between interest dates, the issuing corporation needs to account for the interest expense that will accrue between the date of issuance and the next interest payment date. This is done by crediting the Interest Expense account. The corporation will later debit the Interest Expense account and credit the Interest Payable account when the interest payment is made. Therefore, the correct answer is credit to Interest Expense.

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15.

When the interest payment dates of a bond are May 1 and November 1, and a bond issue is sold on June 1, the amount of cash received by the issuer will be
- A.
  
  Decreased by accrued interest from June 1 to November 1.
- B.
  
  Decreased by accrued interest from May 1 to June 1.
- C.
  
  Increased by accrued interest from June 1 to November 1.
- D.
  
  Increased by accrued interest from May 1 to June 1.
Correct Answer
D. Increased by accrued interest from May 1 to June 1.

Explanation
When a bond issue is sold on June 1 with interest payment dates of May 1 and November 1, the issuer will receive cash that includes the accrued interest from the last interest payment date (May 1) to the date of sale (June 1). Therefore, the amount of cash received by the issuer will be increased by accrued interest from May 1 to June 1.

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16.

Theoretically, the costs of issuing bonds could be
- A.
  
  Expensed when incurred.
- B.
  
  Reported as a reduction of the bond liability.
- C.
  
  Debited to a deferred charge account and amortized over the life of the bonds.
- D.
  
  Any of these answers are correct.
Correct Answer
D. Any of these answers are correct.

Explanation
The costs of issuing bonds can be expensed when incurred, reported as a reduction of the bond liability, or debited to a deferred charge account and amortized over the life of the bonds. All of these options are valid methods for accounting for the costs of issuing bonds, depending on the company's accounting policies and preferences.

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17.

The printing costs and legal fees associated with the issuance of bonds should
- A.
  
  Be expensed when incurred
- B.
  
  Be reported as a deduction from the face amount of bonds payable.
- C.
  
  Be accumulated in a deferred charge account and amortized over the life of the bonds.
- D.
  
  Not be reported as an expense until the period the bonds mature or are retired.
Correct Answer
C. Be accumulated in a deferred charge account and amortized over the life of the bonds.

Explanation
The correct answer is to accumulate the printing costs and legal fees in a deferred charge account and amortize them over the life of the bonds. This is because these costs are directly related to the issuance of the bonds and should be allocated over the period in which the bonds are outstanding. By doing so, the expenses are matched with the revenue generated from the bonds, providing a more accurate representation of the financial performance.

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18.

Treasury bonds should be shown on the balance sheet as
- A.
  
  An asset.
- B.
  
  A deduction from bonds payable issued to arrive at net bonds payable and outstanding.
- C.
  
  A reduction of stockholders' equity.
- D.
  
  Both an asset and a liability.
Correct Answer
B. A deduction from bonds payable issued to arrive at net bonds payable and outstanding.

Explanation
Treasury bonds should be shown on the balance sheet as a deduction from bonds payable issued to arrive at net bonds payable and outstanding because treasury bonds are bonds that have been repurchased by the issuing company. By deducting the treasury bonds from the bonds payable, it reflects the reduction in the company's outstanding debt. This allows for a more accurate representation of the company's net bonds payable and outstanding on the balance sheet.

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19.

Early extinguishment of bonds payable, which were originally issued at a premium, is made by purchase of the bonds between interest dates. At the time of reacquisition
- A.
  
  Any costs of issuing the bonds must be amortized up to the purchase date.
- B.
  
  The premium must be amortized up to the purchase date.
- C.
  
  Interest must be accrued from the last interest date to the purchase date.
- D.
  
  All of these answers are correct.
Correct Answer
D. All of these answers are correct.

Explanation
The given answer is correct because when a company extinguishes bonds payable before their maturity date, any costs of issuing the bonds must be amortized up to the purchase date. Additionally, the premium, which was originally paid to purchase the bonds at a higher price than their face value, must also be amortized up to the purchase date. Lastly, interest must be accrued from the last interest date to the purchase date. Therefore, all of the given answers are correct.

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20.

The generally accepted method of accounting for gains or losses from the early extinguishment of debt treats any gain or loss as
- A.
  
  An adjustment to the cost basis of the asset obtained by the debt issue.
- B.
  
  An amount that should be considered a cash adjustment to the cost of any other debt issued over the remaining life of the old debt instrument.
- C.
  
  An amount received or paid to obtain a new debt instrument and, as such, should be amortized over the life of the new debt.
- D.
  
  A difference between the reacquisition price and the net carrying amount of the debt which should be recognized in the period of redemption.
Correct Answer
D. A difference between the reacquisition price and the net carrying amount of the debt which should be recognized in the period of redemption.

Explanation
When debt is extinguished early, any gain or loss is treated as a difference between the reacquisition price and the net carrying amount of the debt. This difference should be recognized in the period of redemption. In other words, if the debt is repurchased at a price higher or lower than its carrying amount, the resulting gain or loss should be recognized at the time of redemption. This method ensures that the financial statements accurately reflect the impact of the early extinguishment of debt on the company's financial position.

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21.

"In-substance defeasance" is a term used to refer to an arrangement whereby
- A.
  
  A company gets another company to cover its payments due on long-term debt.
- B.
  
  A governmental unit issues debt instruments to corporations.
- C.
  
  A company provides for the future repayment of a long-term debt by placing purchased securities in an irrevocable trust.
- D.
  
  A company legally extinguishes debt before its due date.
Correct Answer
C. A company provides for the future repayment of a long-term debt by placing purchased securities in an irrevocable trust.

Explanation
"In-substance defeasance" refers to a situation where a company ensures the future repayment of its long-term debt by placing purchased securities in an irrevocable trust. This arrangement allows the company to set aside funds to fulfill its debt obligations, providing a sense of security to the lender. By placing the securities in a trust, the company legally commits to using those assets for debt repayment, effectively removing the debt from its balance sheet. This method allows the company to extinguish the debt before its due date and reduces the risk associated with defaulting on the debt.

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22.

A corporation borrowed money from a bank to build a building. The long-term note signed by the corporation is secured by a mortgage that pledges title to the building as security for the loan. The corporation is to pay the bank $80,000 each year for 10 years to repay the loan. Which of the following relationships can you expect to apply to the situation?
- A.
  
  The balance of mortgage payable at a given balance sheet date will be reported as a long-term liability.
- B.
  
  The balance of mortgage payable will remain a constant amount over the 10-year period.
- C.
  
  The amount of interest expense will decrease each period the loan is outstanding, while the portion of the annual payment applied to the loan principal will increase each period
- D.
  
  The amount of interest expense will remain constant over the 10-year period
Correct Answer
C. The amount of interest expense will decrease each period the loan is outstanding, while the portion of the annual payment applied to the loan principal will increase each period

Explanation
This relationship can be expected because as the loan is outstanding, the corporation will be paying off the principal amount of the loan through the annual payments. As the principal amount decreases, the interest expense will also decrease over time. This is because interest is calculated based on the outstanding balance of the loan. Therefore, the portion of the annual payment applied to the loan principal will increase each period, while the amount of interest expense will decrease.

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23.

A debt instrument with no ready market is exchanged for property whose fair value is currently indeterminable. When such a transaction takes place
- A.
  
  The present value of the debt instrument must be approximated using an imputed interest rate.
- B.
  
  It should not be recorded on the books of either party until the fair value of the property becomes evident
- C.
  
  The board of directors of the entity receiving the property should estimate a value for the property that will serve as a basis for the transaction
- D.
  
  The directors of both entities involved in the transaction should negotiate a value to be assigned to the property
Correct Answer
A. The present value of the debt instrument must be approximated using an imputed interest rate.

Explanation
When a debt instrument with no ready market is exchanged for property whose fair value is currently indeterminable, the present value of the debt instrument must be approximated using an imputed interest rate. This is because the fair value of the property is not known, so the value of the debt instrument needs to be estimated based on an assumed interest rate. This approximation allows for the recording of the transaction on the books of the parties involved, even though the fair value of the property is not yet evident.

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24.

When a note payable is exchanged for property, goods, or services, the stated interest rate is presumed to be fair unless
- A.
  
  No interest rate is stated.
- B.
  
  The stated interest rate is unreasonable.
- C.
  
  The stated face amount of the note is materially different from the current cash sales price for similar items or from current fair value of the note.
- D.
  
  Any of these answers are correct
Correct Answer
D. Any of these answers are correct

Explanation
When a note payable is exchanged for property, goods, or services, the stated interest rate is presumed to be fair unless any of the following conditions are met: no interest rate is stated, the stated interest rate is unreasonable, or the stated face amount of the note is materially different from the current cash sales price for similar items or from the current fair value of the note. In other words, if any of these conditions are present, it suggests that the stated interest rate may not be fair or reasonable. Therefore, any of these answers could be correct in determining whether the stated interest rate is presumed to be fair or not.

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25.

Which of the following arguments is presented by FASB to explain why a gain is recorded by a company when its creditworthiness is becoming worse?
- A.
  
  The shareholders' loss is the debtholders' gain.
- B.
  
  The income of the company will increase as the amount of interest payment will reduce
- C.
  
  The decrease in market rate will increase the value of equity shares.
- D.
  
  The debtholders' loss is the shareholders' gain.
Correct Answer
D. The debtholders' loss is the shareholders' gain.

Explanation
When a company's creditworthiness is becoming worse, it is likely that the company will default on its debt obligations. This means that the debtholders will suffer a loss as they may not receive the full amount of their investment back. On the other hand, the shareholders of the company may benefit from this situation as the company's financial distress may result in a decrease in the value of its debt, which in turn increases the value of the equity shares held by the shareholders. Therefore, the debtholders' loss becomes the shareholders' gain.

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26.

If a company chooses the fair value option, a decrease in the fair value of the liability is recorded by crediting
- A.
  
  Bonds Payable.
- B.
  
  Gain on Restructuring of Debt.
- C.
  
  Unrealized Holding Gain/Loss-Income
- D.
  
  None of these answers are correct
Correct Answer
C. Unrealized Holding Gain/Loss-Income

Explanation
When a company chooses the fair value option, any decrease in the fair value of the liability is recorded by crediting Unrealized Holding Gain/Loss-Income. This is because the fair value option allows companies to report certain financial instruments at their fair value, with changes in fair value being recognized in the income statement. Therefore, when the fair value of a liability decreases, it is recorded as an unrealized holding loss in the income statement.

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27.

A project financing arrangement refers to:
- A.
  
  An arrangement where a company creates a special-purpose entity to perform a special project.
- B.
  
  An arrangement where a company borrows from its subsidiary to finance a project.
- C.
  
  An arrangement where a company promises future repayment by placing purchased assets in an irrevocable trust.
- D.
  
  An arrangement where a company finances a project from a sinking fund established for bond repayments.
Correct Answer
A. An arrangement where a company creates a special-purpose entity to perform a special project.

Explanation
A project financing arrangement refers to an arrangement where a company creates a special-purpose entity to perform a special project. This means that the company sets up a separate entity specifically for the purpose of carrying out a particular project. This arrangement allows the company to isolate the risks and liabilities associated with the project, ensuring that the project's success or failure does not impact the overall financial health of the company. It also allows for more efficient management and allocation of resources for the project.

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28.

When a business enterprise enters into what is referred to as off-balance-sheet financing, the company
- A.
  
  Is attempting to conceal the debt from shareholders by having no information about the debt included in the balance sheet
- B.
  
  Wishes to confine all information related to the debt to the income statement and the statement of cash flow.
- C.
  
  Can enhance the quality of its financial position and perhaps permit credit to be obtained more readily and at less cost.
- D.
  
  Is in violation of generally accepted accounting principles
Correct Answer
C. Can enhance the quality of its financial position and perhaps permit credit to be obtained more readily and at less cost.

Explanation
When a business enterprise enters into off-balance-sheet financing, it aims to enhance the quality of its financial position and potentially make it easier to obtain credit at a lower cost. By keeping the debt off the balance sheet, the company can present a stronger financial picture to shareholders and potential creditors. This strategy allows the company to improve its financial ratios and make it appear more attractive to lenders. It is not an attempt to conceal the debt from shareholders, but rather a way to optimize the company's financial position and access credit more easily.

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29.

Long-term debt that matures within one year and is to be converted into stock should be reported
- A.
  
  As a current liability.
- B.
  
  In a special section between liabilities and stockholdersâ�� equity
- C.
  
  As noncurrent.
- D.
  
  As noncurrent and accompanied with a note explaining the method to be used in its liquidation.
Correct Answer
D. As noncurrent and accompanied with a note explaining the method to be used in its liquidation.
30.

Which of the following must be disclosed relative to long-term debt maturities and sinking fund requirements?
- A.
  
  The present value of future payments for sinking fund requirements and long-term debt maturities during each of the next five years.
- B.
  
  The present value of scheduled interest payments on long-term debt during each of the next five years.
- C.
  
  The amount of scheduled interest payments on long-term debt during each of the next five years.
- D.
  
  The amount of future payments for sinking fund requirements and long-term debt maturities during each of the next five years.
Correct Answer
D. The amount of future payments for sinking fund requirements and long-term debt maturities during each of the next five years.

Explanation
The amount of future payments for sinking fund requirements and long-term debt maturities during each of the next five years must be disclosed because it provides information about the cash outflows that the company will need to make in the future to satisfy its debt obligations. This information is important for investors and creditors to assess the company's ability to meet its financial obligations and manage its debt. The present value of future payments and scheduled interest payments are also relevant, but they do not encompass the full extent of the company's debt obligations like the amount of future payments does.

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31.

Note disclosures for long-term debt generally include all of the following except
- A.
  
  Assets pledged as security.
- B.
  
  Call provisions and conversion privileges
- C.
  
  Restrictions imposed by the creditor.
- D.
  
  Names of specific creditors.
Correct Answer
D. Names of specific creditors.

Explanation
The correct answer is "names of specific creditors." In the note disclosures for long-term debt, information about assets pledged as security, call provisions and conversion privileges, and restrictions imposed by the creditor are typically provided. However, the names of specific creditors are usually not disclosed in these note disclosures.

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32.

The times interest earned ratio is computed by dividing
- A.
  
  Net income by interest expense
- B.
  
  Income before taxes by interest expense.
- C.
  
  Income before income taxes and interest expense by interest expense.
- D.
  
  Net income and interest expense by interest expense.
Correct Answer
C. Income before income taxes and interest expense by interest expense.

Explanation
The correct answer is income before income taxes and interest expense by interest expense. This ratio helps determine a company's ability to cover its interest obligations with its earnings. By dividing income before income taxes and interest expense by interest expense, we can assess how many times a company's earnings can cover its interest payments. A higher ratio indicates a greater ability to meet interest obligations, while a lower ratio may suggest financial difficulties.

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33.

The debt to assets ratio is computed by dividing
- A.
  
  Current liabilities by total assets.
- B.
  
  Long-term liabilities by total assets
- C.
  
  Total liabilities by total assets.
- D.
  
  Total assets by total liabilities
Correct Answer
C. Total liabilities by total assets.

Explanation
The debt to assets ratio is a financial metric that measures the proportion of a company's total liabilities to its total assets. It indicates the percentage of a company's assets that are funded by debt. By dividing total liabilities by total assets, we can determine the extent to which a company relies on borrowed funds to finance its operations and investments. A higher debt to assets ratio suggests a higher level of financial risk, as it indicates a larger proportion of debt relative to assets. Conversely, a lower ratio indicates a stronger financial position with a higher proportion of assets funded by equity.

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34.

The residual interest in a corporation belongs to the
- A.
  
  Management
- B.
  
  Creditors
- C.
  
  Common stockholders
- D.
  
  Preferred stockholders
Correct Answer
C. Common stockholders

Explanation
The residual interest in a corporation refers to the remaining assets after all debts and obligations have been paid off. Common stockholders are the owners of a corporation and have a claim on these residual assets. Therefore, the correct answer is common stockholders.

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35.

The pre-emptive right of a common stockholder is the right to
- A.
  
  Share proportionately in corporate assets upon liquidation.
- B.
  
  Share proportionately in any new issues of stock of the same class.
- C.
  
  Receive cash dividends before they are distributed to preferred stockholders.
- D.
  
  Exclude preferred stockholders from voting rights.
Correct Answer
B. Share proportionately in any new issues of stock of the same class.

Explanation
The pre-emptive right of a common stockholder refers to their right to purchase additional shares of stock in the company before it is offered to other investors. This allows common stockholders to maintain their proportional ownership in the company and prevents dilution of their ownership stake. Therefore, the correct answer is that common stockholders have the right to share proportionately in any new issues of stock of the same class.

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36.

The pre-emptive right enables a stockholder to
- A.
  
  Receive the same amount of dividends on a percentage basis as the preferred stockholders.
- B.
  
  Receive cash dividends before other classes of stock without the pre-emptive right.
- C.
  
  Sell capital stock back to the corporation at the option of the stockholder
- D.
  
  None of these answers are correct.
Correct Answer
D. None of these answers are correct.
37.

In a corporate form of business organization, legal capital is best defined as
- A.
  
  The amount of capital the state of incorporation allows the company to accumulate over its existence.
- B.
  
  The par value of all capital stock issued.
- C.
  
  The amount of capital the federal government allows a corporation to generate.
- D.
  
  The total capital raised by a corporation within the limits set by the Securities and Exchange Commission.
Correct Answer
B. The par value of all capital stock issued.

Explanation
Legal capital in a corporate form of business organization refers to the minimum amount of capital that a company must maintain in order to protect creditors. It is typically set by the state of incorporation and represents the par value of all capital stock issued by the company. This value is important because it ensures that there is a certain level of financial stability and assets available to cover any debts or liabilities. It is not related to the amount of capital allowed by the federal government or the total capital raised by the corporation within SEC limits.

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38.

Common stockholders of a business enterprise are said to be the residual owners. The term residual owner means that shareholders
- A.
  
  Are entitled to a dividend every year in which the business earns a profit.
- B.
  
  Have the rights to specific assets of the business.
- C.
  
  Bear the ultimate risks and uncertainties and receive the benefits of enterprise ownership.
- D.
  
  Can negotiate individual contracts on behalf of the enterprise.
Correct Answer
C. Bear the ultimate risks and uncertainties and receive the benefits of enterprise ownership.

Explanation
Common stockholders of a business enterprise are considered the residual owners because they bear the ultimate risks and uncertainties associated with the business. This means that they are the ones who are responsible for any losses or liabilities the business may incur. However, they also have the potential to receive the benefits of enterprise ownership, such as dividends and capital appreciation, if the business performs well. This makes them the true owners of the enterprise, with the ability to reap the rewards or suffer the consequences of its operations.

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39.

Total stockholders' equity represents
- A.
  
  A claim to specific assets contributed by the owners
- B.
  
  The maximum amount that can be borrowed by a company
- C.
  
  A claim against a portion of the total assets of a company
- D.
  
  Only the amount of earnings that have been retained in the business.
Correct Answer
C. A claim against a portion of the total assets of a company

Explanation
Total stockholders' equity represents a claim against a portion of the total assets of a company. This means that the owners or stockholders have a right to a portion of the company's assets after all liabilities have been settled. It is the residual interest in the assets of the company after deducting liabilities. Stockholders' equity includes contributions made by the owners as well as retained earnings. It does not represent the maximum amount that can be borrowed by a company or only the amount of earnings retained in the business.

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40.

A primary source of stockholders' equity is
- A.
  
  Income retained by the corporation
- B.
  
  Appropriated retained earnings
- C.
  
  Contributions by stockholders
- D.
  
  Both income retained by the corporation and contributions by stockholders
Correct Answer
D. Both income retained by the corporation and contributions by stockholders

Explanation
Both income retained by the corporation and contributions by stockholders are primary sources of stockholders' equity. Income retained by the corporation refers to the profits that the company has earned but not distributed to the shareholders as dividends. These retained earnings increase the stockholders' equity. On the other hand, contributions by stockholders refer to the additional capital invested by shareholders into the company, such as purchasing additional shares or making direct investments. These contributions also increase the stockholders' equity. Therefore, both retained earnings and contributions by stockholders contribute to the overall stockholders' equity of a corporation.

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41.

Stockholders' equity is generally classified into two major categories:
- A.
  
  Contributed capital and appropriated capital
- B.
  
  Appropriated capital and retained earnings.
- C.
  
  Retained earnings and unappropriated capital
- D.
  
  Earned capital and contributed capital
Correct Answer
D. Earned capital and contributed capital

Explanation
Stockholders' equity represents the ownership interest in a company. It is divided into two major categories: earned capital and contributed capital. Earned capital refers to the portion of equity that is generated through the company's operations and profits. This includes retained earnings, which are the accumulated profits that have not been distributed to shareholders as dividends. Contributed capital, on the other hand, represents the equity that is contributed by the shareholders through investments in the company, such as through the purchase of common stock. Therefore, the correct answer is earned capital and contributed capital.

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42.

The accounting problem in a lump sum issuance is the allocation of proceeds between the classes of securities. An acceptable method of allocation is
- A.
  
  The pro forma method.
- B.
  
  The proportional method.
- C.
  
  The incremental method.
- D.
  
  Either the proportional method or the incremental method.
Correct Answer
D. Either the proportional method or the incremental method.

Explanation
In a lump sum issuance, the accounting problem arises when determining how to allocate the proceeds between the different classes of securities. The pro forma method, which involves estimating the fair value of each class of securities, is one acceptable approach. The proportional method, on the other hand, allocates the proceeds based on the relative fair values of each class of securities. The incremental method, another acceptable approach, allocates the proceeds based on the incremental fair value of each class of securities compared to the total fair value of all classes combined. Therefore, either the proportional method or the incremental method can be used to address the allocation issue in a lump sum issuance.

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43.

When a corporation issues its capital stock in payment for services, the least appropriate basis for recording the transaction is the
- A.
  
  Market value of the services received.
- B.
  
  Par value of the shares issued
- C.
  
  Market value of the shares issued
- D.
  
  Any of these provides an appropriate basis for recording the transaction.
Correct Answer
B. Par value of the shares issued

Explanation
When a corporation issues its capital stock in payment for services, the least appropriate basis for recording the transaction is the par value of the shares issued. Par value represents the minimum legal value assigned to each share of stock, and it does not reflect the actual value of the services received. The market value of the services received or the market value of the shares issued would be more appropriate measures for recording the transaction, as they reflect the fair value of the exchange. Therefore, the par value of the shares issued is the least suitable basis for recording the transaction.

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44.

Direct costs incurred to sell stock such as underwriting costs should be accounted for as:1. a reduction of additional paid-in capital.2. an expense of the period in which the stock is issued.3. an intangible asset.
- A.
  
  1
- B.
  
  2
- C.
  
  3
- D.
  
  1 or 3
Correct Answer
A. 1

Explanation
Direct costs incurred to sell stock such as underwriting costs should be accounted for as a reduction of additional paid-in capital. This is because underwriting costs are considered as a cost of issuing stock and are directly related to the sale of stock. Therefore, they should be deducted from the additional paid-in capital, which represents the amount received from investors in excess of the stock's par value. This treatment ensures that the costs are properly allocated and do not inflate the reported additional paid-in capital.

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45.

A "secret reserve" will be created if
- A.
  
  Inadequate depreciation is charged to income.
- B.
  
  A capital expenditure is charged to expense
- C.
  
  Liabilities are understated.
- D.
  
  Stockholders' equity is overstated.
Correct Answer
B. A capital expenditure is charged to expense
46.

Which of the following represents the total number of shares that a corporation may issue under the terms of its charter?
- A.
  
  Authorized shares
- B.
  
  Issued shares
- C.
  
  Unissued shares
- D.
  
  Outstanding shares
Correct Answer
A. Authorized shares

Explanation
Authorized shares refer to the maximum number of shares that a corporation is legally allowed to issue according to its charter. This number is specified in the company's articles of incorporation and represents the total pool of shares that can be issued to shareholders. Issued shares are the shares that have already been issued to shareholders, while unissued shares are the authorized shares that have not yet been issued. Outstanding shares are the total number of shares that are currently held by shareholders, including both issued and unissued shares.

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47.

Stock that has a fixed per-share amount printed on each stock certificate is called
- A.
  
  Stated value stock.
- B.
  
  Fixed value stock
- C.
  
  Uniform value stock.
- D.
  
  Par value stock.
Correct Answer
D. Par value stock.

Explanation
Par value stock is a type of stock that has a fixed per-share amount printed on each stock certificate. This value is determined by the company and represents the minimum price at which the stock can be issued. It is used for accounting and legal purposes, but it does not necessarily reflect the actual market value of the stock. Par value stock allows investors to know the minimum value of their shares and provides a basis for calculating dividends and voting rights.

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48.

Which of the following is not a legal restriction related to profit distributions by a corporation?
- A.
  
  The amount distributed to owners must be in compliance with the state laws governing corporations
- B.
  
  The amount distributed in any one year can never exceed the net income reported for that year
- C.
  
  Profit distributions must be formally approved by the board of directors.
- D.
  
  Dividends must be in full agreement with the capital stock contracts as to preferences and participation.
Correct Answer
B. The amount distributed in any one year can never exceed the net income reported for that year

Explanation
The statement "The amount distributed in any one year can never exceed the net income reported for that year" is incorrect because a corporation can distribute dividends even if the net income reported for that year is lower than the amount distributed. Corporations have the flexibility to distribute dividends from retained earnings or accumulated profits from previous years, even if the current year's net income is lower. Therefore, this statement does not represent a legal restriction related to profit distributions by a corporation.

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49.

In January 2014, Finley Corporation, a newly formed company, issued 10,000 shares of its $10 par common stock for $15 per share. On July 1, 2014, Finley Corporation reacquired 1,000 shares of its outstanding stock for $12 per share. The acquisition of these treasury shares
- A.
  
  Decreased total stockholders' equity.
- B.
  
  Increased total stockholders' equity.
- C.
  
  Did not change total stockholders' equity
- D.
  
  Decreased the number of issued shares
Correct Answer
A. Decreased total stockholders' equity.

Explanation
The acquisition of treasury shares by a company decreases total stockholders' equity. This is because treasury shares are considered to be issued shares that have been repurchased by the company. As a result, the company's ownership of its own stock increases, but the ownership of other shareholders decreases. This reduction in ownership leads to a decrease in total stockholders' equity.

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50.

Treasury shares are shares
- A.
  
  Held as an investment by the treasurer of the corporation
- B.
  
  Held as an investment of the corporation
- C.
  
  Issued and outstanding
- D.
  
  Issued but not outstanding.
Correct Answer
D. Issued but not outstanding.

Explanation
Treasury shares refer to shares that have been issued by a corporation but are not currently held by any shareholders. These shares are typically repurchased by the corporation and held as an investment. Therefore, the correct answer is "issued but not outstanding."

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