CPA Exam: FAR Payables, Debt, and Equity Summary

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.

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.

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.

Investors are willing to pay more than face value when the bond pays more interest than they could earn elsewhere at the market rate. That extra price is the premium, which is amortized over the bond's life.

Wrong choices

• When the bonds' stated interest rate is lower than the market interest rate: In that case, investors pay less than face value, so the bonds sell at a discount.
• When the stated rate equals the market rate: Equal rates mean the bonds sell at face value (par).
• When the bonds have a longer maturity than usual: Maturity length alone does not create a premium; the rate difference does.

When stock is issued, the common stock account gets the par value of the shares. Any amount received above par goes to additional paid-in capital.

1. Common stock: 1,000 × $1 = $1,000
2. APIC: $25,000 − $1,000 = $24,000

Wrong choices

• Common stock $25,000: Only the par value goes to the common stock account; the rest is additional paid-in capital.
• Common stock $24,000 and additional paid-in capital $1,000: The amounts are reversed; common stock is shares × par value.
• Common stock $1,000 and retained earnings $24,000: Money received from owners is paid-in capital, not retained earnings.

Once the board of directors declares a cash dividend, the company has a legal obligation to pay it. It debits retained earnings and credits dividends payable on the declaration date.

Wrong choices

• The date of record: No entry is made on the record date; it only decides who receives the dividend.
• The payment date: On the payment date, the existing liability is paid off; it was created earlier.
• The end of the fiscal year: The liability arises when the board declares the dividend, whatever the time of year.

Under the cost method, the company debits treasury stock for the price paid and credits cash. Treasury stock is subtracted from total equity.

1. Cost: 500 × $30 = $15,000
2. Effect: cash −$15,000 and equity −$15,000

Wrong choices

• Total assets increase by $15,000: Treasury stock is not an asset; cash goes down and equity goes down.
• Common stock decreases by $15,000: Under the cost method, the common stock account is not changed; a separate contra-equity account is used.
• A $15,000 loss is reported in net income: Transactions in a company's own shares never create income or loss.

When debt is retired early, the gain or loss is the difference between the amount paid and the debt's net carrying amount. It is reported in income.

1. Carrying amount: $1,000,000 − $30,000 = $970,000
2. Price paid: $1,000,000 × 1.01 = $1,010,000
3. Loss: $1,010,000 − $970,000 = $40,000

Wrong choices

• A $10,000 loss: This compares the price with face value and ignores the unamortized discount.
• A $30,000 loss: This only counts the unamortized discount and ignores the call premium paid.
• A $30,000 gain: The company pays more than the carrying amount, so it is a loss, not a gain.

A small stock dividend (less than about 20–25% of shares) is recorded at the shares' fair value. Retained earnings goes down and paid-in capital goes up by the same amount, so total equity does not change.

1. New shares: 100,000 × 10% = 10,000
2. Amount: 10,000 × $15 = $150,000
3. Split: common stock $10,000, APIC $140,000

Wrong choices

• $10,000: Par value is used for large stock dividends; a small stock dividend (under about 20–25%) uses fair value.
• $0: A small stock dividend moves an amount from retained earnings to paid-in capital.
• $1,500,000: Only the 10,000 new shares are recorded, not all 100,000 shares.

Current liabilities are obligations expected to be paid within one year or the operating cycle, whichever is longer. The current portion of long-term debt is split out and shown as current. Deferred taxes are always shown as noncurrent.

Wrong choices

• A deferred tax liability expected to reverse next year: Under current GAAP, all deferred tax liabilities are classified as noncurrent.
• Bonds payable that mature in 3 years: They are not due within one year, so they are noncurrent.
• A note payable due in 18 months: It is due after more than one year (or operating cycle), so it is noncurrent.