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CPA Exam: FAR · Select Balance Sheet Accounts

CPA Exam: FAR: Payables, Debt, and Equity Concepts

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Overview

This chapter covers what a business owes and what its owners own. Liabilities range from short-term items like accounts payable and accrued wages to long-term bonds and notes. Equity covers stock issued, retained earnings, treasury stock, and dividends.

Bonds are recorded at the cash received, which is the present value of the future payments at the market rate. When the stated rate is below the market rate, the bonds sell at a discount; when above, at a premium. Interest expense each period equals the carrying amount times the market rate at issuance, which is the effective interest method, and debt issuance costs reduce the carrying amount of the debt. When debt is paid off early, the difference between the amount paid and the carrying amount is a gain or loss in income.

In equity, buying back the company's own shares under the cost method records treasury stock at the price paid, which reduces total equity. Cash dividends reduce retained earnings and become a liability on the declaration date. Stock dividends only move amounts within equity: a small stock dividend is recorded at fair value, and a large one at par value, so total equity does not change.

Key concepts

  • Effective interest method

    Interest expense equals the bond's carrying amount at the start of the period times the market rate at issuance. The cash paid is face value times the stated rate. The difference amortizes the discount or premium.

    Memory tipA discount makes interest expense larger than the cash paid; a premium makes it smaller.

    Source: FASB ASC 835-30 · as of 2026

  • Debt issuance costs

    Costs to issue debt, such as underwriting and legal fees, are shown as a direct reduction of the debt's carrying amount and amortized as interest expense.

    Memory tipThey are not shown as a separate asset for term debt.

    Source: FASB ASC 835-30 · as of 2026

  • Extinguishment of debt

    When debt is retired before maturity, the difference between the reacquisition price and the net carrying amount is recognized as a gain or loss in income in the period of extinguishment.

    Memory tipUpdate the carrying amount for amortization up to the retirement date first.

    Source: FASB ASC 470-50 · as of 2026

  • Short-term debt to be refinanced

    Short-term debt can be classified as noncurrent if the company intends to refinance it on a long-term basis and shows the ability to do so, such as by actually refinancing before the statements are issued or by a qualifying financing agreement.

    Memory tipIntent alone is not enough; ability must also be shown.

    Source: FASB ASC 470-10 · as of 2026

  • Treasury stock (cost method)

    Reacquired shares are debited to treasury stock at cost, a contra-equity account. On reissue above cost, the excess goes to additional paid-in capital; below cost, the shortfall reduces paid-in capital from treasury stock and then retained earnings.

    Memory tipGains and losses on treasury stock never go to net income.

    Source: FASB ASC 505-30 · as of 2026

  • Stock dividends and splits

    A small stock dividend (generally under 20 to 25 percent of shares outstanding) is recorded at fair value; a large one is recorded at par. A stock split changes the number of shares and par per share with no entry to equity amounts.

    Memory tipStock dividends do not change total equity.

    Source: FASB ASC 505-20 · as of 2026

Often tested

  • Bond price equals the present value of interest and face value at the market rate.
  • Interest expense = carrying amount x market rate at issuance.
  • Debt issuance costs reduce the carrying amount of the debt.
  • Gain or loss on early retirement = reacquisition price minus net carrying amount.
  • Treasury stock reduces equity and creates no income statement gain or loss.
  • Small stock dividends at fair value, large at par.

Easy to confuse: Cash dividend vs. stock dividend

ItemCash dividendStock dividend
Effect on total equityDecreasesNo change
Liability at declarationDividends payableNone (stock dividend distributable is equity)
Retained earningsDecreases by cash amountDecreases by fair value (small) or par (large)

3 sample questions

Verified practice questions from this unit.

Practice questionReviewedSelect Balance Sheet Accounts › Payables, Debt, and Equity★★★★☆

Question 1. On January 1, a company issues $500,000 face value, 5-year bonds with a 6% stated rate paid annually on December 31. The bonds sell for $460,000 to yield 8%. Using the effective interest method, what is interest expense for the first year?

  1. ① $30,000
  2. ② $40,000
  3. ③ $36,800
  4. ④ $6,800
▼ Show answer and explanation▲ Hide answer and explanation

Answer: ③ $36,800

Key point: Interest expense = carrying amount × market rate

Under the effective interest method, interest expense equals the bond's carrying amount times the market rate at issue. The difference from cash paid amortizes the discount.

  1. Interest expense: $460,000 × 8% = $36,800
  2. Cash paid: $500,000 × 6% = $30,000
  3. Discount amortized: $6,800

Check: new carrying amount $466,800 moves toward $500,000.

Wrong choices

  • $30,000: This is the cash interest paid, not interest expense under the effective interest method.
  • $40,000: Effective interest is applied to the carrying amount ($460,000), not the face value.
  • $6,800: This is the discount amortization, which is only part of the expense.
Practice questionReviewedSelect Balance Sheet Accounts › Payables, Debt, and Equity★★★★☆

Question 2. On January 1, a company issues $200,000 face value bonds with a 10% stated rate paid annually. The bonds sell for $215,000 to yield 8%. Using the effective interest method, what is the carrying amount of the bonds at December 31 of the first year?

  1. ① $215,000
  2. ② $212,200
  3. ③ $217,800
  4. ④ $200,000
▼ Show answer and explanation▲ Hide answer and explanation

Answer: ② $212,200

Key point: Premium amortization lowers carrying amount

With a premium, cash interest is larger than interest expense. The difference reduces the premium and the carrying amount.

  1. Interest expense: $215,000 × 8% = $17,200
  2. Cash paid: $200,000 × 10% = $20,000
  3. Premium amortized: $20,000 − $17,200 = $2,800
  4. Carrying amount: $215,000 − $2,800 = $212,200

Wrong choices

  • $215,000: The premium must be amortized each year, so the carrying amount goes down.
  • $217,800: Premium amortization reduces the carrying amount; it does not increase it.
  • $200,000: Face value is reached only at maturity.
Practice questionReviewedSelect Balance Sheet Accounts › Payables, Debt, and Equity★★★★☆

Question 3. A company pays its employees $10,000 every Friday for a 5-day work week (Monday to Friday). The fiscal year ends on a Wednesday. What amount of accrued salaries should the company report at year-end?

  1. ① $4,000
  2. ② $6,000
  3. ③ $10,000
  4. ④ $2,000
▼ Show answer and explanation▲ Hide answer and explanation

Answer: ② $6,000

Key point: Accrue expenses incurred but not yet paid

Salaries earned by employees but not yet paid at year-end are an accrued liability.

  1. Daily salaries: $10,000 ÷ 5 = $2,000
  2. Days worked but unpaid: Monday, Tuesday, Wednesday = 3
  3. Accrued salaries: 3 × $2,000 = $6,000

Wrong choices

  • $4,000: This counts only 2 days; Monday, Tuesday, and Wednesday are all unpaid at year-end.
  • $10,000: A full week has not been worked by year-end.
  • $2,000: This is only one day of salaries.
Practice 5 questions from this unit →