Chapter 10 Testbank

1. In accordance with AASB 137 Provisions, Contingent Liabilities and Contingent Assets some present obligations are allowed to be
disclosed in the notes to the financial statements.

TRUE

AACSB: Reflective thinking

Difficulty: Easy
Learning Objective: 10-01 Know the definition of a liability and understand how to apply the recognition criteria provided in the Conceptual Framework for Financial
Reporting.
Learning Objective: 10-02 Understand what a contingent liability represents and understand how it should be disclosed within the notes to a reporting entity's financial
statements.
Section: Contingent liabilities
Topic: Disclosure of liabilities in the notes

2. In a constructive obligation where the entity retains discretion to avoid any future sacrifice of economic benefits, no liability should
be recognised in the financial statements.

TRUE

AACSB: Reflective thinking

Difficulty: Easy
Learning Objective: 10-01 Know the definition of a liability and understand how to apply the recognition criteria provided in the Conceptual Framework for Financial
Reporting.
Section: Liabilities defined
Topic: Recognition of liabilities

3. In accordance with AASB 137 Provisions, Contingent Liabilities and Contingent Assets, a contingent liability must be disclosed in
the financial statement even when the likelihood of a present obligation occurring in future is remote.

FALSE

AACSB: Reflective thinking

Difficulty: Easy
Learning Objective: 10-02 Understand what a contingent liability represents and understand how it should be disclosed within the notes to a reporting entity's financial
statements.
Section: Contingent liabilities
Topic: Recognition of contingent liabilities

10-1
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4. A necessary condition to recognise a present obligation in the financial statements is that the identity of the party to whom the
present obligation is owed must be known.

FALSE

AACSB: Reflective thinking

Difficulty: Easy
Learning Objective: 10-01 Know the definition of a liability and understand how to apply the recognition criteria provided in the Conceptual Framework for Financial
Reporting.
Section: Liability provisions
Topic: Recognition of present obligations

5. Executory contracts are within the scope of AASB 137 Provisions, Contingent Liabilities and Contingent Assets.

FALSE

AACSB: Reflective thinking

Difficulty: Easy
Learning Objective: 10-01 Know the definition of a liability and understand how to apply the recognition criteria provided in the Conceptual Framework for Financial
Reporting.
Section: Contingent liabilities
Topic: Liabilities definition and recognition criteria

6. In AASB 137 Provisions, Contingent Liabilities and Contingent Assets, there is symmetry in the treatment of contingent liabilities
and contingent assets where both are required to be disclosed when the contingent event is probable to occur.

FALSE

AACSB: Reflective thinking

Difficulty: Medium
Learning Objective: 10-11 Understand what a 'contingent asset' is and understand how they shall be disclosed.
Section: Liability provisions
Topic: Recognition of contingent assets and contingent liabilities

7. Entities are only required to record a liability if there has been a past transaction that has created a present obligation to another
entity that is expected to result in an outflow of future economic benefits.

TRUE

AACSB: Reflective thinking

Difficulty: Easy
Learning Objective: 10-01 Know the definition of a liability and understand how to apply the recognition criteria provided in the Conceptual Framework for Financial
Reporting.
Section: Liabilities defined
Topic: Recognition and disclosure of liabilities

10-2
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8. A guarantee provided to a financier for a loan taken out by another entity, where default on that loan is uncertain as at the reporting
date, is an example of a contingent liability.

TRUE

AACSB: Reflective thinking

Difficulty: Easy
Learning Objective: 10-02 Understand what a contingent liability represents and understand how it should be disclosed within the notes to a reporting entity's financial
statements.
Section: Contingent liabilities
Topic: Recognition and disclosure of contingent liabilities

9. Under AASB 101 something may be classified as a current liability even when it is not expected to be settled for a period in excess
of 12 months.

TRUE

AACSB: Reflective thinking

Difficulty: Medium
Learning Objective: 10-03 Understand that liabilities can be disclosed on a current/non-current basis or in order of liquidity.
Section: Classification of liabilities as current or non-current
Topic: Current liabilities

10. Provisions are established to allow for future sacrifices such as repairs and maintenance of machinery and may be recognised as
liabilities.

FALSE

AACSB: Reflective thinking

Difficulty: Medium
Learning Objective: 10-01 Know the definition of a liability and understand how to apply the recognition criteria provided in the Conceptual Framework for Financial
Reporting.
Section: Liability provisions
Topic: Liability provisions

11. A necessary condition for a provision to be recognised is that there is a legal obligation to make a future sacrifice of economic benefits.

FALSE

AACSB: Reflective thinking

Difficulty: Easy
Learning Objective: 10-01 Know the definition of a liability and understand how to apply the recognition criteria provided in the Conceptual Framework for Financial
Reporting.
Section: Liability provisions
Topic: Provisions recognition and disclosure

10-3
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12. Some researchers have found that firms can benefit from being in financial distress.

TRUE

AACSB: Analytic
Difficulty: Medium
Learning Objective: 10-01 Know the definition of a liability and understand how to apply the recognition criteria provided in the Conceptual Framework for Financial
Reporting.
Section: Some implications of reporting liabilities
Topic: Financial distress

13. In terms of accounting treatment debentures and bonds are the same thing.

TRUE

AACSB: Analytic
Difficulty: Easy
Learning Objective: 10-01 Know the definition of a liability and understand how to apply the recognition criteria provided in the Conceptual Framework for Financial
Reporting.
Section: Accounting for debentures
Topic: Liability types

14. A discount on debentures issued arises when the market required rate of return is less than the coupon rate.

FALSE

AACSB: Reflective thinking

Difficulty: Easy
Learning Objective: 10-08 Know how to apply the effective-interest method when accounting for liabilities.
Learning Objective: 10-09 Know how to account for any premium or discount that arises on the issue of debentures.
Section: Accounting for debentures
Topic: Estimation of discount under effective-interest method

15. The market will only pay a premium for debentures if the par value of those debentures is lower than the market interest rate.

FALSE

AACSB: Reflective thinking

Difficulty: Easy
Learning Objective: 10-08 Know how to apply the effective-interest method when accounting for liabilities.
Learning Objective: 10-09 Know how to account for any premium or discount that arises on the issue of debentures.
Section: Accounting for debentures
Topic: Estimation of premium, under effective-interest method

10-4
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16. Convertible notes may be best described as having characteristics of both liabilities and bonds.

FALSE

AACSB: Reflective thinking

Difficulty: Medium
Learning Objective: 10-10 Understand what a 'hybrid' security is and understand how they shall be disclosed.
Section: Hybrid securities
Topic: Characteristics of convertible notes

17. When determining whether a liability exists, the intentions or actions of management need to be taken into account.

TRUE

AACSB: Reflective thinking

Difficulty: Easy
Learning Objective: 10-01 Know the definition of a liability and understand how to apply the recognition criteria provided in the Conceptual Framework for Financial
Reporting.
Section: Liabilities defined
Topic: Recognition of liabilities

18. The defining characteristic of a 'provision' as opposed to other liabilities is that the existence of an obligation is uncertain.

FALSE

AACSB: Reflective thinking

Difficulty: Easy
Learning Objective: 10-01 Know the definition of a liability and understand how to apply the recognition criteria provided in the Conceptual Framework for Financial
Reporting.
Section: Liability provisions
Topic: Characteristics of provisions

19. A provision shall be recognised when an entity may have a future obligation as a result of a past event.

FALSE

AACSB: Reflective thinking

Difficulty: Easy
Learning Objective: 10-01 Know the definition of a liability and understand how to apply the recognition criteria provided in the Conceptual Framework for Financial
Reporting.
Learning Objective: 10-04 Understand which 'provisions' should be treated as liabilities.
Section: Liability provisions
Topic: Recognition criteria of provision

10-5
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20. An entity shall classify a liability as current when it holds the liability primarily for the purpose of trading.

TRUE

AACSB: Reflective thinking

Difficulty: Easy
Learning Objective: 10-03 Understand that liabilities can be disclosed on a current/non-current basis or in order of liquidity.
Section: Classification of liabilities as current or non-current
Topic: Classification of current and non-current liabilities

21. The present obligation component of a liability must be based on:

A. a legal obligation only.

B. a social obligation.
C. a contractual obligation.
D. none of the given answers.

AACSB: Reflective thinking

Difficulty: Easy
Learning Objective: 10-01 Know the definition of a liability and understand how to apply the recognition criteria provided in the Conceptual Framework for Financial
Reporting.
Section: Liabilities defined
Topic: Present obligation

22. What is the treatment of contingent liabilities in the financial statements?

A. Contingent liabilities are to be recognised as a separate category in the statement of financial position, with a clear note disclosure
of the factors that constitute the contingent event for each material contingent liability.
B. Contingent liabilities are required to be disclosed in the notes to the financial statement when the amount of the obligation cannot
be measured with sufficient reliability.
C. Material contingent liabilities only are required to be recognised in the financial statements under AASB 137.
D. Contingent liabilities are to be disclosed in the notes to the accounts in categories that reflect their nature and possible timing.

AACSB: Reflective thinking

Difficulty: Easy
Learning Objective: 10-11 Understand what a 'contingent asset' is and understand how they shall be disclosed.
Section: Contingent liabilities
Topic: Disclosure of contingent liabilities

23. Examples of contingent liabilities include:

A. future payments arising under employee entitlements for long service leave.
B. past tax deductions claimed that are under review by the Australian Taxation Office, but which the entity intends to dispute if
disallowed.
C. out of court settlements in the case of liability for damage to health due to products manufactured by the entity.
D. past tax deductions claimed that are under review by the Australian Taxation Office, but which the entity intends to dispute if
disallowed and out of court settlements in the case of liability for damage to health due to products manufactured by the entity

AACSB: Reflective thinking

Difficulty: Easy
Learning Objective: 10-11 Understand what a 'contingent asset' is and understand how they shall be disclosed.
Section: Contingent liabilities
Topic: Contingent liabilities

10-6
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24. Some provisions traditionally recorded by entities may not be considered liabilities under the AASB framework because:

A. their amounts are not considered probable.

B. they do not involve a future sacrifice of economic benefits.
C. the identity of the external party to whom the present obligation is owed is unknown.
D. there is no entity other than the reporting entity involved in the present obligation as a result of past transactions or other past
events.

AACSB: Reflective thinking

Difficulty: Easy
Learning Objective: 10-04 Understand which 'provisions' should be treated as liabilities.
Section: Liabilities defined
Topic: Recognition of provisions

25. Which of the following provisions satisfy the requirements to be recognised as a liability under AASB 137?

A. Provisions for repairs and overhauls.

B. Provisions for warranties.
C. Provisions for maintenance.
D. Provisions for refurbishment costs.

AACSB: Reflective thinking

Difficulty: Medium
Learning Objective: 10-01 Know the definition of a liability and understand how to apply the recognition criteria provided in the Conceptual Framework for Financial
Reporting.
Learning Objective: 10-04 Understand which 'provisions' should be treated as liabilities.
Section: Liability provisions
Section: Liabilities defined
Topic: Recognition of provisions

26. Outside the situation where specific types of provisions are covered in standards, a provision exists when and only when:

A. the entity has a present legal, equitable or constructive obligation to make a future sacrifice of economic benefits to other entities as
a result of past transactions or other past events; and the amount or timing of the future sacrifice of economic benefits that will be
made to satisfy the present obligation is uncertain.
B. there is a legal or constructive obligation to make a future sacrifice of economic benefits within the entity as a result of past
transactions or other past events, the amount or timing of which is uncertain.
C. the entity has a present legal obligation to make a future sacrifice of economic benefits to other entities as a result of past
transactions or other past events; and the amount or timing of the future sacrifice of economic benefits that will be made to satisfy the
present obligation is uncertain.
D. the amount, timing and entity to whom the obligation to sacrifice future economic benefits as a result of a past legal or constructive
obligation are unknown.

AACSB: Analytic
Difficulty: Medium
Learning Objective: 10-01 Know the definition of a liability and understand how to apply the recognition criteria provided in the Conceptual Framework for Financial
Reporting.
Learning Objective: 10-04 Understand which 'provisions' should be treated as liabilities.
Section: Liabilities defined
Section: Liability provisions
Topic: Recognition of provisions

27. An equitable or constructive obligation arises when:

A. social or moral sanctions or custom leaves the entity no realistic alternative other than to make a sacrifice of future benefits.
B. management makes a discretionary decision to make a future sacrifice of economic benefits.
C. management communicates its decision to commit to the future sacrifice of economic benefits to the parties concerned.
D. social or moral sanctions or custom leaves the entity no realistic alternative other than to make a sacrifice of future benefits and
management communicates its decision to commit to the future sacrifice of economic benefits to the parties concerned.

AACSB: Reflective thinking

Difficulty: Medium
Learning Objective: 10-01 Know the definition of a liability and understand how to apply the recognition criteria provided in the Conceptual Framework for Financial
Reporting.
Section: Liabilities defined
Topic: Obligations

10-7
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28. Examples of equitable or constructive obligations include:

A. a state government promises economic support to householders and businesses affected by recent bushfires. It has in the past
provided at least this level of support.
B. management of a retail store decides to offer compensation to customers as a result of faulty scooters purchased from the store and
causing injury. The manufacturers are normally considered liable for this type of fault.
C. a company that has published policies regarding support for the environment and has in the past rehabilitated polluted sites has
identified contamination it has caused in land surrounding one of its production sites. Not correcting the problem with the site will
lead to serious difficulties with the local community.
D. a state government promises economic support to householders and businesses affected by recent bushfires. A company that has
published policies regarding support for the environment and has in the past rehabilitated polluted sites has identified contamination it
has caused in land surrounding one of its production sites. Not correcting the problem with the site will lead to serious difficulties with
the local community.

AACSB: Reflective thinking

Difficulty: Medium
Learning Objective: 10-01 Know the definition of a liability and understand how to apply the recognition criteria provided in the Conceptual Framework for Financial
Reporting.
Section: Liabilities defined
Topic: Obligations

29. Which of the following is not listed in AASB 101 to determine if a liability should be classified as current?

A. If the liability is guaranteed to be settled within 12 months.

B. If the liability is held primarily for the purpose of being traded.
C. If the entity does not have an unconditional right to defer settlement of the liability for at least 12 months.
D. If the liability is expected to be settled in the entity's normal operating cycle.

AACSB: Reflective thinking

Difficulty: Easy
Learning Objective: 10-03 Understand that liabilities can be disclosed on a current/non-current basis or in order of liquidity.
Section: Classification of liabilities as current or non-current
Topic: Classification as current or non-current

30. If future cash flows are not discounted the effect in the financial statements is to:

A. report amounts of cash outflows that are the same but occur over different time periods as the same amount.
B. report net cash flows at their future value rather than their present value.
C. understate the amount of the present obligation.
D. report net cash flows at their future value rather than their present value and understate the amount of the present obligation.

AACSB: Reflective thinking

Difficulty: Medium
Learning Objective: 10-01 Know the definition of a liability and understand how to apply the recognition criteria provided in the Conceptual Framework for Financial
Reporting.
Section: Liability provisions
Topic: Estimation of a future cash flow

31. Some research has shown that being in financial distress may not be all bad news for an entity because:

A. investors will see this as an opportunity to buy into a company that can really only improve.
B. existing managers will want to be released from their contracts allowing new ideas to be employed.
C. there will be no requirement to consider the social costs of retrenching employees because the accounting numbers show it is
necessary.
D. it will provide the stimulus to rethink activities that may in turn lead to improved future performance.

AACSB: Reflective thinking

Difficulty: Medium
Learning Objective: 10-01 Know the definition of a liability and understand how to apply the recognition criteria provided in the Conceptual Framework for Financial
Reporting.
Section: Some implications of reporting liabilities
Topic: Financial distress

10-8
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32. All things being equal, firms would typically prefer to disclose low levels of debt because:

A. any debt is a bad thing in the capital structure of a business.

B. additional debt may lead to a technical breach of a firm's contractual agreements with existing debt-holders and lead to the possible
wind-up of the business or the need to renegotiate the contract.
C. the level of recognised debt will affect the profitability of the business.
D. recognising debt in the income statement may lead to a decrease in management bonuses that are based on the times-interest-earned
and debt-to-assets ratios.

AACSB: Reflective thinking

Difficulty: Medium
Learning Objective: 10-06 Understand some of the reasons why firms would typically prefer to disclose a transaction as part of equity, rather than as a liability.
Section: Debt equity debate
Topic: Preferences of managers for disclosure

33. One recognised approach to reducing the level of debt that has been adopted in the past was to:

A. attempt to report the debt as equity, often in the form of preference shares.
B. create reserves and draw on them later as a source of funding.
C. treat as many liabilities as possible as provisions.
D. record liabilities as an increase in cash and a decrease in revenues.

AACSB: Reflective thinking

Difficulty: Easy
Learning Objective: 10-06 Understand some of the reasons why firms would typically prefer to disclose a transaction as part of equity, rather than as a liability.
Section: Debt equity debate
Topic: Debt equity debate

34. Preference shares, as noted in AASB 132:

A. should be regarded as debt when redemption is at the option of the holder or on a specified date.
B. will be classified as debt or equity based on their legal form rather than the substance of the financial instrument.
C. exhibit the characteristics of equity when they are non-redeemable.
D. will have their classification as debt or equity affected by the intention to make distributions in the future.

AACSB: Reflective thinking

Difficulty: Medium
Learning Objective: 10-05 Understand why, with certain transactions, professional judgement is required to determine whether the transaction gives rise to a liability,
or should be recognised as part of equity.
Section: Debt equity debate
Topic: Debt equity debate

35. Grindle Ltd has total assets of $1.5 million and liabilities of $0.9 million before it issues $300 000 in preference shares. What is
the debt-to-asset ratio assuming that the preference shares have no voting rights and offer a fixed dividend rate of 10% and (a) are
redeemable at the discretion of the issuer and (b) have a scheduled date for mandatory redemption?

A. (a) 60%; (b) 80%

B. (a) 50%; (b) 67%
C. (a) 80%; (b) 60%
D. (a) 67%; (b) 50%

AACSB: Reflective thinking

Difficulty: Medium
Learning Objective: 10-07 Understand how to calculate the issue price of securities such as bonds (debentures).
Section: Debt equity debate
Topic: Debt equity debate

10-9
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36. Tissues and Co has elected to issue preference shares to the value of $220 000. Prior to the share issue the company has assets of
$780 000, liabilities of $370 000 and equity recorded at $410 000. The terms of the share issue state that these shares are
non-redeemable but a guaranteed cumulative dividend of 8% of share value is payable. Calculate the debt-to-asset ratio immediately
before and after the share issue.

A. before—47.4%; after – 47.4%

B. before—47.4%; after – 37%
C. before—52.6%; after – 63%
D. before—47.4%; after – 59%

AACSB: Reflective thinking

Difficulty: Hard
Learning Objective: 10-07 Understand how to calculate the issue price of securities such as bonds (debentures).
Section: Debt equity debate
Topic: Debt equity debate

37. The par or face value of a debenture is:

A. the amount that debenture holders will receive on maturity of the debenture.
B. the amount that a debenture holder would be prepared to pay for a debenture when the coupon rate is below the interest rate the
debenture holder considers appropriate.
C. the amount debenture holders will receive annually until the debenture matures.
D. the amount that a debenture holder would be prepared to pay for a debenture when the coupon rate is above the interest rate the
debenture holder considers appropriate.

AACSB: Reflective thinking

Difficulty: Easy
Learning Objective: 10-08 Know how to apply the effective-interest method when accounting for liabilities.
Section: Accounting for debentures
Topic: Accounting for debentures

38. If the entity is offering a higher interest rate on debentures than the market believes is appropriate, the market will:

A. be prepared to pay more than the par value of the debentures, offering a discount.
B. be prepared to pay less than the par value of the debentures, offering a discount.
C. be prepared to pay more than the par value of the debentures, offering a premium.
D. be prepared to pay less than the par value of the debentures, offering a premium.

AACSB: Reflective thinking

Difficulty: Medium
Learning Objective: 10-08 Know how to apply the effective-interest method when accounting for liabilities.
Learning Objective: 10-09 Know how to account for any premium or discount that arises on the issue of debentures.
Section: Accounting for debentures
Topic: Accounting for debentures

39. A debenture will be issued at par value:

A. because that is the offer price; if the rate offered is too low the offer will be under-subscribed, so those who take it up will receive
more interest.
B. on most occasions, because management is careful to issue the debentures at an amount close to the market rate.
C. on those rare occasions when the coupon rate is the same as the market rate.
D. on those occasions when the offer rate is equal to the coupon rate.

AACSB: Reflective thinking

Difficulty: Easy
Learning Objective: 10-08 Know how to apply the effective-interest method when accounting for liabilities.
Learning Objective: 10-09 Know how to account for any premium or discount that arises on the issue of debentures.
Section: Accounting for debentures
Topic: Accounting for debentures

10-10
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40. The interest that a debenture holder receives at the time of each payment made by the issuer is:

A. the coupon rate multiplied by the face value of the net debenture liability.
B. the market rate of interest multiplied by the present value of the opening balance of the net debenture liability.
C. the market rate of interest multiplied by the present value of the closing balance of the net debenture liability.
D. the coupon rate of interest multiplied by the present value of the opening balance of the net debenture liability.

AACSB: Reflective thinking

Difficulty: Medium
Learning Objective: 10-08 Know how to apply the effective-interest method when accounting for liabilities.
Section: Accounting for debentures
Topic: Accounting for debentures

41. When debentures are issued at a discount:

A. the discount represents the cost of attracting the funds and should be recognised as an expense.
B. no further entries are required because the discount is calculated prior to receipt of the funds and therefore will not be recorded.
C. the effect interest method is used to calculate the amortised cost of the financial liability.
D. the discount amount can be used to offset any gains shown when debentures have been issued at a premium.

AACSB: Reflective thinking

Difficulty: Easy
Learning Objective: 10-09 Know how to account for any premium or discount that arises on the issue of debentures.
Section: Accounting for debentures
Topic: Accounting for debentures

42. Pearl Ltd issues $8 million in 5-year debentures that pay interest every 6 months at a coupon rate of 12% per annum. The required
market rate of return is 16% per annum. What is the issue price of the debentures (rounded to the nearest dollar)?

A. $6 926 387
B. $8 000 000
C. $9 177 614
D. $8 673 978

AACSB: Reflective thinking

Difficulty: Easy
Learning Objective: 10-08 Know how to apply the effective-interest method when accounting for liabilities.
Section: Accounting for debentures
Topic: Accounting for debentures

10-11
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43. Spoton Co Ltd issues $5 million in 2-year, 8%, semi-annual coupon debentures to the public. The market required rate of return is
also 8%. The money is received on application and the debentures are allotted on the same day: 30 June 2013. What are the journal
entries to record (a) the receipt of funds and allotment of debentures on 30 June 2013, (b) the payment of interest on 31 December
2013 and (c) the redemption of the debentures on 30 June 2015?

A.

B.

C.

10-12
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D.

AACSB: Reflective thinking

Difficulty: Easy
Learning Objective: 10-07 Understand how to calculate the issue price of securities such as bonds (debentures).
Section: Accounting for debentures
Topic: Accounting for debentures

44. Risky Ltd issues $8 million in 5-year, 6%, semi-annual coupon debentures in a private placement. The rate of return required by
the debenture holder is 8%. What is the journal entry to record the issue of the debentures (round to the nearest dollar)?

A.

B.

C.

D.

AACSB: Reflective thinking

Difficulty: Medium
Learning Objective: 10-07 Understand how to calculate the issue price of securities such as bonds (debentures).
Section: Accounting for debentures
Topic: Accounting for debentures

10-13
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45. Banshee Ltd issues $12 million in 8-year, 8%, semi-annual coupon debentures. The rate of return required by the market is 12%.
What is the journal entry to record the first payment of interest assuming that Banshee uses the effective-interest method to amortise
any discount or premium (round to the nearest dollar)?

A.

B.

C.

D.

AACSB: Reflective thinking

Difficulty: Hard
Learning Objective: 10-08 Know how to apply the effective-interest method when accounting for liabilities.
Learning Objective: 10-09 Know how to account for any premium or discount that arises on the issue of debentures.
Section: Accounting for debentures
Topic: Accounting for debentures

46. Buderup Ltd issues $9 million in 12-year, 6%, semi-annual coupon debentures. The rate of return required by the market is 10%
per annum. What are the journal entries to record the first and second payments of interest assuming that Buderup uses the
effective-interest method to amortise any discount or premium (rounded to the nearest dollar)?

A.

B.

10-14
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C.

D.

AACSB: Reflective thinking

Difficulty: Hard
Learning Objective: 10-08 Know how to apply the effective-interest method when accounting for liabilities.
Learning Objective: 10-09 Know how to account for any premium or discount that arises on the issue of debentures.
Section: Accounting for debentures
Topic: Accounting for debentures

47. Dubbin Ltd issues $3 million in 5-year, 8%, semi-annual coupon debentures. The rate of return required by the market is 6% per
annum. What is the journal entry to record the issue of the debentures (rounded to the nearest dollar)?

A.

B.

C.

D.

AACSB: Reflective thinking

Difficulty: Easy
Learning Objective: 10-07 Understand how to calculate the issue price of securities such as bonds (debentures).
Section: Accounting for debentures
Topic: Accounting for debentures

10-15
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McGraw-Hill Education.
48. Edgar Ltd issues $7 million in 6-year, 10%, semi-annual coupon debentures. The rate of return required by the market is 8% per
annum. What is the journal entry to record the first payment of interest assuming using the effective-interest method to amortise any
discount or premium (rounded to the nearest dollar)?

A.

B.

C.

D.

AACSB: Reflective thinking

Difficulty: Medium
Learning Objective: 10-08 Know how to apply the effective-interest method when accounting for liabilities.
Section: Accounting for debentures
Topic: Accounting for debentures

49. Convertible notes are:

A. essentially the same as debentures and need to be recorded as liabilities.

B. a form of asset.
C. are often referred to as hybrid securities and should be recorded as equity as they will eventually be converted into shares.
D. part debt and part equity and should be disclosed as such according to AAB 132.

AACSB: Reflective thinking

Difficulty: Easy
Learning Objective: 10-10 Understand what a 'hybrid' security is and understand how they shall be disclosed.
Section: Hybrid securities
Topic: Hybrid securities

10-16
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50. When an entity's management resolves that the entity will offer to repair a defect it has recently discovered in one of its products,
even though the nature of the defect is such that purchasers of the product would not expect the entity to do so:

A. it must immediately recognise a liability.

B. it must immediately recognise a liability, if it can be measured reliably.
C. it will never recognise a liability as the offer to repair was not part of the contract of sale.
D. it will only need to recognise a liability when the entity makes the offer public, or commits itself in some other way to make the
repairs.

AACSB: Analytic
Difficulty: Medium
Learning Objective: 10-01 Know the definition of a liability and understand how to apply the recognition criteria provided in the Conceptual Framework for Financial
Reporting.
Section: Liabilities defined
Topic: Liabilities defined

51. In disclosing liabilities, a reporting entity:

A. discloses on the basis of the current/non-current liability dichotomy.

B. has a choice, based on the notions of relevance and reliability to disclose liabilities either on the basis of the current/non-current
liability dichotomy or on the basis of order of liquidity.
C. has a choice, based on the principle of conservatism to disclose liabilities either on the basis of the current/non-current liability
dichotomy or on the basis of order of liquidity.
D. discloses on the basis of order of liquidity.

AACSB: Reflective thinking

Difficulty: Easy
Learning Objective: 10-03 Understand that liabilities can be disclosed on a current/non-current basis or in order of liquidity.
Section: Classification of liabilities as current or non-current
Topic: Classification of liabilities as current or non-current

52. A present obligation, as one of the criteria for recognising a liability, implies:

A. there must be a legal obligation.

B. a legally binding contractual arrangement between two parties: the entity and another party.
C. the involvement of two separate parties-the entity and another party-of which the identity of the latter needs not necessarily to be
known.
D. the involvement of two separate parties-the entity and another party-of which the identity of the latter must be known.

AACSB: Reflective thinking

Difficulty: Medium
Learning Objective: 10-01 Know the definition of a liability and understand how to apply the recognition criteria provided in the Conceptual Framework for Financial
Reporting.
Section: Liability provisions
Topic: Liability provisions

53. In accordance with AASB 137 Provisions, Contingent Liabilities and Contingent Assets, which of the following is considered a
contingent liability?

A. Guarantee provided by the parent entity on behalf of a solvent subsidiary.

B. Settlement of a legal case where the company is likely to be held liable for damages in court.
C. Best estimate of likely claims for warranty by customers.
D. Guarantee of an associate's bank overdraft where the associate has declared bankruptcy.

AACSB: Reflective thinking

Difficulty: Medium
Learning Objective: 10-02 Understand what a contingent liability represents and understand how it should be disclosed within the notes to a reporting entity's financial
statements.
Section: Contingent liabilities
Topic: Contingent liabilities

10-17
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54. In accordance with AASB 137 Provisions, Contingent Liabilities and Contingent Assets, which of the following statements is
correct?

A. Contingent liabilities and provisions are required by AASB 137 to be disclosed in the financial statements.
B. Contingent assets where realisation of economic benefits is probable should be recognised in the financial statements.
C. Constructive obligations are recognised when entities have no realistic alternative to making future sacrifice of economic benefits.
D. Provisions for future necessary repairs and maintenance should be recognised in the financial statements.

AACSB: Analytic
Difficulty: Medium
Learning Objective: 10-02 Understand what a contingent liability represents and understand how it should be disclosed within the notes to a reporting entity's financial
statements.
Section: Liabilities defined
Topic: Liabilities defined

55. Evaluate whether the following situations will give rise to a present obligation:

I: Bona Bay Ltd is a large manufacturer of surfboards and provides a two year warranty for all its products from the time of purchase by offering to
repair or replace the item.

II: Sea Eagle Ltd operates its offshore oil rigs near Curlew Beach. During the reporting period, there was a major oil spill and the company had
publicly announced to undertake clean-up of all the contamination that it caused. There is no environmental legislation on oil spills.

III: A customer sued Neck Bay Ltd for damages from a faulty product. The company hired a legal team to dispute this claim.

IV: Whitehaven Ltd had guaranteed a bank loan to an associated company.

In compliance with AASB 137 Provisions, Contingent Liabilities and Contingent Assets, which of the above situations requires recognition in the
financial statements?

A. I, II and III
B. I and II
C. II and III
D. III and IV

AACSB: Reflective thinking

Difficulty: Medium
Learning Objective: 10-01 Know the definition of a liability and understand how to apply the recognition criteria provided in the Conceptual Framework for Financial
Reporting.
Section: Liabilities defined
Topic: Liabilities defined

56. Which of the following statements is consistent with the positive accounting theory paradigm?

A. Managers avoid future sacrifice of economic benefits debt covenants when the company is close to violation of debt covenants.
B. Managers avoid constructive obligations in the presence of accounting based debt covenants even though there is no realistic
alternative to making future sacrifice of economic benefits.
C. Managers choose accounting methods that will decrease income to reduce the probability of debt covenant violation.
D. Managers avoid income increasing accounting methods to reduce the probability of debt covenant violation.

AACSB: Reflective thinking

Difficulty: Medium
Learning Objective: 10-01 Know the definition of a liability and understand how to apply the recognition criteria provided in the Conceptual Framework for Financial
Reporting.
Learning Objective: 10-06 Understand some of the reasons why firms would typically prefer to disclose a transaction as part of equity, rather than as a liability.
Section: Some implications of reporting liabilities
Topic: Some implications of reporting liabilities

10-18
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57. Melville Ltd received a material claim for damages from a customer for not delivering ordered goods on time. The customer
insists that Melville Ltd's late delivery resulted in significant losses to the customer. Melville Ltd admits to the delay but disputes the
material damages being claimed. What is the appropriate accounting treatment for the claim that is in accordance with AASB 137?

A. Ignore the claim.

B. Recognise the minimum amount of the liability.
C. Recognise the maximum amount of the liability.
D. Recognise the best estimate of the liability.

AACSB: Reflective thinking

Difficulty: Easy
Learning Objective: 10-01 Know the definition of a liability and understand how to apply the recognition criteria provided in the Conceptual Framework for Financial
Reporting.
Section: Contingent liabilities
Topic: Contingent liabilities

58. What is the appropriate treatment for convertible notes in accordance with AASB 132 Financial Instruments: Presentation?

A. As a financial liability.
B. As equity.
C. As part debt and part equity.
D. As a financial liability and disclosure of conversion option.

AACSB: Reflective thinking

Difficulty: Medium
Learning Objective: 10-10 Understand what a 'hybrid' security is and understand how they shall be disclosed.
Section: Hybrid securities
Topic: Hybrid securities

59. When measuring a liability at present values, the discount rate to be used, according to paragraph 47 of AASB 137, is:

A. the pre-tax rate that reflects the current market assessments of the time value of money and the risks specific to the liability.
B. the after-tax rate that reflects the current market assessments of the time value of money and the risks specific to the liability.
C. the pre-tax rate that reflects the current market assessments of the time value of money and the risks specific to the liability, and
shall also reflect risks for which future cash flows have already been adjusted.
D. the pre-tax risk free rate.

AACSB: Reflective thinking

Difficulty: Medium
Learning Objective: 10-01 Know the definition of a liability and understand how to apply the recognition criteria provided in the Conceptual Framework for Financial
Reporting.
Section: Liability provisions
Topic: Liability provisions

60. Where the change in the carrying amount of a liability is due to the impacts of using present values, the change shall be recognised
as a(n):

A. gain on sale of liability.

B. revaluation reserve adjustment.
C. adjustment to opening retained earnings.
D. borrowing cost.

AACSB: Reflective thinking

Difficulty: Easy
Learning Objective: 10-01 Know the definition of a liability and understand how to apply the recognition criteria provided in the Conceptual Framework for Financial
Reporting.
Section: Liability provisions
Topic: Liability provisions

10-19
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61. The fact that a preference share is redeemable:

A. makes it a financial liability.

B. makes it an equity instrument.
C. makes it a compound financial instrument.
D. does not automatically mean that it is a financial liability. Conditions and rights attaching to the share need to be considered before
it can be classified as either a financial liability or equity instrument.

AACSB: Reflective thinking

Difficulty: Easy
Learning Objective: 10-05 Understand why, with certain transactions, professional judgement is required to determine whether the transaction gives rise to a liability,
or should be recognised as part of equity.
Section: Debt equity debate
Topic: Debt equity debate

62. A compound instrument, such as a convertible note, comprises two components. They are:

A. a financial liability (contractual arrangement to deliver cash or another financial liability) and an equity instrument (a call option
granting the holder the right, for a specified period of time, to convert it into a fixed number of ordinary shares of the entity).
B. a financial liability (contractual arrangement to deliver cash or another financial asset) and an equity instrument (a call option
granting the holder the right, for a specified period of time, to convert it into a fixed number of ordinary shares of the entity).
C. a financial liability (contractual arrangement to deliver cash or another financial asset) and an equity instrument (a call option
granting the holder the right, for a specified period of time, to convert it into a variable number of ordinary shares of the entity).
D. a financial liability (contractual arrangement to deliver cash or another financial asset) and an equity instrument (a put option
granting the holder the right, for a specified period of time, to convert it into a fixed number of ordinary shares of the entity).

AACSB: Reflective thinking

Difficulty: Hard
Learning Objective: 10-10 Understand what a 'hybrid' security is and understand how they shall be disclosed.
Section: Hybrid securities
Topic: Hybrid securities

63. In determining the amount to be assigned to the equity component of a compound financial instrument, you must:

A. add the face value of the financial liability to the fair value of the compound financial instrument as a whole.
B. deduct the face value of the financial liability from the fair value of the compound financial instrument as a whole.
C. deduct the face value of the financial liability from the face value of the compound financial instrument as a whole.
D. deduct the fair value of the financial liability from the fair value of the compound financial instrument as a whole.

AACSB: Reflective thinking

Difficulty: Hard
Learning Objective: 10-10 Understand what a 'hybrid' security is and understand how they shall be disclosed.
Section: Hybrid securities
Topic: Hybrid securities

10-20
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64. From the following extract of an amortisation schedule pertaining to a compound financial instrument, what is the effective-interest rate
embodied in the instrument?

A. 6%
B. 5%
C. variable, as shown in the table it has increased from 5.5837% in Period 1 to 6.2738% in Period 3
D. 4%.

AACSB: Reflective thinking

Difficulty: Easy
Learning Objective: 10-08 Know how to apply the effective-interest method when accounting for liabilities.
Section: Accounting for debentures
Topic: Accounting for debentures

65. From the following extract of an amortisation schedule pertaining to a compound financial instrument, what is the net liability (assuming the
debenture has not yet been repaid), at the end of Period 10?

A. Nil
B. 9 500 000
C. 9 905 582
D. 10 000 000

AACSB: Reflective thinking

Difficulty: Easy
Learning Objective: 10-08 Know how to apply the effective-interest method when accounting for liabilities.
Section: Accounting for debentures
Topic: Accounting for debentures

66. Unless the probability of any outflow in a settlement is remote, an entity needs to disclose for each class of contingent liability:

A. the possibility of any reimbursement.

B. an indication of the timing and amount uncertainties.
C. an estimate of its financial effect.
D. All of the given answers must be disclosed.

AACSB: Reflective thinking

Difficulty: Medium
Learning Objective: 10-02 Understand what a contingent liability represents and understand how it should be disclosed within the notes to a reporting entity's financial
statements.
Section: Contingent liabilities
Topic: Contingent liabilities

10-21
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McGraw-Hill Education.
67. If liabilities are disclosed as current on the basis of the entity's operating cycle, and this cycle is greater than 12 months it should:

A. adjust the statement of financial position for a 12 month period.

B. disclose the length of the operating cycle.
C. apply the 12-month test.
D. None of the given answers are correct.

AACSB: Reflective thinking

Difficulty: Medium
Learning Objective: 10-03 Understand that liabilities can be disclosed on a current/non-current basis or in order of liquidity.
Section: Classification of liabilities as current or non-current
Topic: Classification of liabilities as current or non-current

68. AASB 13 defines fair value measurement as:

A. the price that would be received to buy an asset or received to transfer a liability in an orderly transaction between market
participants at the due date.
B. the price that would be paid to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the
due date.
C. the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants
at the measurement date.
D. the price that would be estimated to sell an asset or to transfer a liability in an orderly transaction between market participants at the
measurement date.

AACSB: Reflective thinking

Difficulty: Easy
Learning Objective: 10-01 Know the definition of a liability and understand how to apply the recognition criteria provided in the Conceptual Framework for Financial
Reporting.
Section: Accounting for debentures
Topic: Accounting for debentures

69. Adopting the effective-interest method means that the balance of the debenture liability represents:

A. the par value of the debenture.

B. the present value of the liability throughout the debenture term.
C. the adjustment to the debenture par value.
D. the borrowing cost.

AACSB: Reflective thinking

Difficulty: Easy
Learning Objective: 10-08 Know how to apply the effective-interest method when accounting for liabilities.
Section: Accounting for debentures
Topic: Accounting for debentures

70. Thompson Ltd must pay damages in relation to a drilling project environmental disaster. What would be included in the journal
entry, assuming that the company created a provision for $15 000 two months ago but the actual damages were $16 550?

A. DR Provision for environmental disaster 16 550

B. DR Loss on environmental disaster 16 550
C. DR Provision for environmental disaster 15 000
D. CR Cash 15 000

AACSB: Reflective thinking

Difficulty: Easy
Learning Objective: 10-04 Understand which 'provisions' should be treated as liabilities.
Section: Liabilities defined
Topic: Recognition of provisions

10-22
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McGraw-Hill Education.
71. Which of the following is correct about contingent liabilities and provisions?

A. The terms are interchangeable.

B. A provision is based on an estimate while a contingent liability can be estimated reliably.
C. A provision is disclosed in the statement of financial position while a contingent liability is disclosed in the notes.
D. A contingent liability does not need to be disclosed in an entity's annual report.

AACSB: Reflective thinking

Difficulty: Medium
Learning Objective: 10-04 Understand which 'provisions' should be treated as liabilities.
Learning Objective: 10-11 Understand what a 'contingent asset' is and understand how they shall be disclosed.
Section: Contingent liabilities
Section: Liabilities defined
Topic: Recognition of provisions

72. Which of the following is correct about contingent assets?

A. When the realisation income is virtually certain, the asset is a contingent asset and disclosed in the notes.
B. Contingent assets are recognised in the balance sheet and are current or non-current based on when the revenue is expected to flow
to the entity.
C. An example of a contingent asset is a possible receipt of damages that is associated with a legal claim made against another entity.
D. The financial effect of a contingent asset is not disclosed even when it is practicable.

AACSB: Reflective thinking

Difficulty: Medium
Learning Objective: 10-11 Understand what a 'contingent asset' is and understand how they shall be disclosed.
Section: Contingent assets
Topic: Contingent assets

73. Contingent assets are not recognised in financial statements because:

A. As income that may not be realised, they should not be recognised.

B. As they are the result of contingent liabilities not eventuating, there is not enough evidence.
C. The amount of asset cannot be measured reliably at the end of the financial year.
D. The item fails the test of it being 'probable' that future economic benefits will flow.

AACSB: Reflective thinking

Difficulty: Medium
Learning Objective: 10-11 Understand what a 'contingent asset' is and understand how they shall be disclosed.
Section: Contingent assets
Topic: Contingent assets disclosure

74. Which of the following is not a disclosure requirement for contingent assets?

A. Brief description of the nature of the contingent assets.

B. Where practicable, their financial effect.
C. Where practicable, the matched contingent liability.
D. Where an inflow of economic benefits is probable.

AACSB: Reflective thinking

Difficulty: Easy
Learning Objective: 10-11 Understand what a 'contingent asset' is and understand how they shall be disclosed.
Section: Contingent assets
Topic: Contingent assets disclosure

10-23
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McGraw-Hill Education.
75. Which of the following is not an example of an item that would be a contingent asset?

A. A possible receipt of damages that is associated with a legal claim made against another entity.
B. A claim by a company against the State government about some land expropriated in 1997 for which the directors are of the
opinion based on previous negotiations with the government that there is a strong indication of the claim being probable in the next
period.
C. A company has started negotiations with a potential new customer and the directors are of the opinion that it is probable that there
will be a sale in future periods from these negotiations.
D. None of the other options; all are contingent assets.

AACSB: Reflective thinking

Difficulty: Hard
Learning Objective: 10-11 Understand what a 'contingent asset' is and understand how they shall be disclosed.
Section: Contingent assets
Topic: Contingent assets disclosure

76. Which of the following in respect of the inflow of future economic benefits would mean that an asset is not contingent?

A. Virtually certain.
B. Probable, but not virtually certain.
C. Not probable.
D. Can be estimated with reliability.

AACSB: Reflective thinking

Difficulty: Medium
Learning Objective: 10-11 Understand what a 'contingent asset' is and understand how they shall be disclosed.
Section: Contingent assets
Topic: Contingent assets

10-24
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McGraw-Hill Education.
 Chapter 10 Testbank Summary

Category # of Ques
tions
AACSB: Analytic 5
AACSB: Reflective thinking 71
Difficulty: Easy 38
Difficulty: Hard 6
Difficulty: Medium 32
Learning Objective: 10-01 Know the definition of a liability and understand how to apply the recognition criteria provided in the Con 27
ceptual Framework for Financial Reporting.
Learning Objective: 10-02 Understand what a contingent liability represents and understand how it should be disclosed within the not 6
es to a reporting entity's financial statements.
Learning Objective: 10-03 Understand that liabilities can be disclosed on a current/non-current basis or in order of liquidity. 5
Learning Objective: 10-04 Understand which 'provisions' should be treated as liabilities. 6
Learning Objective: 10-05 Understand why, with certain transactions, professional judgement is required to determine whether the tra 2
nsaction gives rise to a liability, or should be recognised as part of equity.
Learning Objective: 10-06 Understand some of the reasons why firms would typically prefer to disclose a transaction as part of equity 3
, rather than as a liability.
Learning Objective: 10-07 Understand how to calculate the issue price of securities such as bonds (debentures). 5
Learning Objective: 10-08 Know how to apply the effective-interest method when accounting for liabilities. 13
Learning Objective: 10-09 Know how to account for any premium or discount that arises on the issue of debentures. 7
Learning Objective: 10-10 Understand what a 'hybrid' security is and understand how they shall be disclosed. 5
Learning Objective: 10-11 Understand what a 'contingent asset' is and understand how they shall be disclosed. 9
Section: Accounting for debentures 19
Section: Classification of liabilities as current or non-current 5
Section: Contingent assets 4
Section: Debt equity debate 5
Section: Hybrid securities 4
Section: Liability provisions 10
Section: Some implications of reporting liabilities 3
Section: Contingent assets 1
Section: Contingent liabilities 10
Section: Debt equity debate 1
Section: Hybrid securities 1
Section: Liabilities defined 14
Section: Liability provisions 2
Topic: Accounting for debentures 16
Topic: Characteristics of convertible notes 1
Topic: Characteristics of provisions 1
Topic: Classification as current or non-current 1
Topic: Classification of current and non-current liabilities 1
Topic: Classification of liabilities as current or non-current 2
Topic: Contingent assets 2
Topic: Contingent assets disclosure 3

10-25
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McGraw-Hill Education.
Topic: Contingent liabilities 4
Topic: Current liabilities 1
Topic: Debt equity debate 5
Topic: Disclosure of contingent liabilities 1
Topic: Disclosure of liabilities in the notes 1
Topic: Estimation of a future cash flow 1
Topic: Estimation of discount under effective-interest method 1
Topic: Estimation of premium, under effective-interest method 1
Topic: Financial distress 2
Topic: Hybrid securities 4
Topic: Liabilities defined 3
Topic: Liabilities definition and recognition criteria 1
Topic: Liability provisions 4
Topic: Liability types 1
Topic: Obligations 2
Topic: Preferences of managers for disclosure 1
Topic: Present obligation 1
Topic: Provisions recognition and disclosure 1
Topic: Recognition and disclosure of contingent liabilities 1
Topic: Recognition and disclosure of liabilities 1
Topic: Recognition criteria of provision 1
Topic: Recognition of contingent assets and contingent liabilities 1
Topic: Recognition of contingent liabilities 1
Topic: Recognition of liabilities 2
Topic: Recognition of present obligations 1
Topic: Recognition of provisions 5
Topic: Some implications of reporting liabilities 1

10-26
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McGraw-Hill Education.