CFA Practice Question

There are 520 practice questions for this study session.

CFA Practice Question

All of the following statements about accounting practices are true EXCEPT:
A. violation of a long-term debt covenant will cause the debt to be classified as short-term debt if the condition is not reversed before the end of the accounting period.
B. debt is considered to be extinguished if the firm places risk-free assets in an irrevocable trust solely for extinguishing that debt.
C. commitments under unconditional purchase obligations that provide financing to suppliers need not be recognized on the purchaser's balance sheet.

User Contributed Comments 12

User Comment
cbb1 Can someone explain why it is false? If covenant violation, then LT debt is reclassified to ST per GAAP?
tengo I do not believe you wait until the end of the acounting period to reclassify it. It should be done immediately perhaps with a press release if it is material
patsy If violation is not reversed before the financial reporting date. I think
danrow There is another question in this section that asks something similar. It elaborates a possible scenario where a convenant was violated, and asks how should be that long term classified in that case. The response says that as long as the violation is curated before the end of accounting period, the long term can be classified as long term debt. What is the difference between that question and this one????
jackwez I don't understand your comment danrow.... regardless, in this question it is a strict violation of GAAP to classify a long term liability as a short term liability.. there is no covenant that can cause you to violate GAAP.
krisc On the balance sheet, I believe it should be current liability
ilgibe If you violate the covenant, you're technically defaulted: youre liabilities are immediately redeemable, which means are current.
najat If debt covenant violation is cured after balance sheet date but before issuance of financial statements, debt can still be classified as long term.
PeterL See MGM's 1Q09 10-Q. All of their debt was classified as ST because the company was in violation of a covenant, the debt accelerated, and everything had cross defaults. Wild times.
yenweic Do you not get a grace period before its considered a technical default? Hence, the statement does not always hold true
mjhuff According to the The Ultimate Accountants' Reference, debt is immediately (key word) reclassified as short term debt.
cfastudypl The amount that becomes payable of a long-term liability automatically becomes a short-term liability. But if at the due date for payment, payment is not made and no talks with the financial institution for reclassification of the debt by way of a new debt covenant before year end, the amount remains available for immediate liquidation (payment) which is short-term, with a very negative impact on liquidity ratios.
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