Solutions Manual and Test Bank of Intermediate Accounting Kieso Weygandt Warfield 15th edition
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Chapter 14 Long-Term Liabilities
Chapter 14 Long-Term Liabilities
1. (a) From what sources might a corporation obtain funds through long-term debt? (b) What is a bond indenture? What does it contain? (c) What is a mortgage?
2. Potlatch Corporation has issued various types of bonds such as term bonds, income bonds, and debentures. Differentiate between term bonds, mortgage bonds, collateral trust bonds, debenture bonds, income bonds, callable bonds, registered bonds, bearer or coupon bonds, convertible bonds, commodity-backed bonds, and deep discount bonds.
3. Distinguish between the following interest rates for bonds payable: (a) Yield rate. (d) Market rate. (b) Nominal rate. (e) Effective rate. (c) Stated rate.
4. Distinguish between the following values relative to bonds payable: (a) Maturity value. (c) Market (fair) value. (b) Face value. (d) Par value.
5. Under what conditions of bond issuance does a discount on bonds payable arise? Under what conditions of bond issuance does a premium on bonds payable arise?
6. How should discount on bonds payable be reported on the financial statements? Premium on bonds payable?
7. What are the two methods of amortizing discount and premium on bonds payable? Explain each.
8. Zopf Company sells its bonds at a premium and applies the effective-interest method in amortizing the premium. Will the annual interest expense increase or decrease over the life of the bonds? Explain.
9. Briggs and Stratton recently reported unamortized debt issue costs of $5.1 million. How should the costs of issuing these bonds be accounted for and classified in the financial statements?
10. Will the amortization of Discount on Bonds Payable increase or decrease Bond Interest Expense? Explain.
11. What is the “call” feature of a bond issue? How does the call feature affect the amortization of bond premium or discount?
12. Why would a company wish to reduce its bond indebtedness before its bonds reach maturity? Indicate how this can be done and the correct accounting treatment for such a transaction.
13. How are gains and losses from extinguishment of a debt classified in the income statement? What disclosures are required of such transactions?
14. What is done to record properly a transaction involving the issuance of a non-interest-bearing long-term note in exchange for property?
15. How is the present value of a non-interest-bearing note computed? 16. When is the stated interest rate of a debt instrument presumed to be fair? 17. What are the considerations in imputing an appropriate interest rate? 18. Differentiate between a fixed-rate mortgage and a variablerate mortgage. 19. What is the fair value option? Briefly describe the controversy of applying the fair value option to financial liabilities. 20. Pierre Company has a 12% note payable with a carrying value of $20,000. Pierre applies the fair value option to this note; given an increase in market interest rates, the fair value of the note is $22,600. Prepare the entry to record the fair value option for this note. 21. What disclosures are required relative to long-term debt and sinking fund requirements?
22. What is off-balance-sheet financing? Why might a company be interested in using off-balance- sheet financing?
23. What are some forms of off-balance-sheet financing?
24. Explain how a non-consolidated subsidiary can be a form of off-balance-sheet financing.
*2 5. What are the types of situations that result in troubled debt?
*2 6. What are the general rules for measuring gain or loss by both creditor and debtor in a troubled-debt restructuring involving a settlement?
*2 7. (a) In a troubled-debt situation, why might the creditor grant concessions to the debtor? (b) What type of concessions might a creditor grant the debtor in a troubled-debt situation?
*2 8. What are the general rules for measuring and recognizing gain or loss by both the debtor and the creditor in a troubleddebt restructuring involving a modification of terms?
*2 9. What is meant by “accounting symmetry” between the entries recorded by the debtor and creditor in a troubleddebt restructuring involving a modification of terms? In what ways is the accounting for troubled-debt restructurings non-symmetrical?
*3 0. Under what circumstances would a transaction be recorded as a troubled-debt restructuring by only one of the two parties to the transaction? BRI E F EXERCI S E S
BE14-1 Whiteside Corporation issues $500,000 of 9% bonds, due in 10 years, with interest payable semiannually. At the time of issue, the market rate for such bonds is 10%. Compute the issue price of the bonds.
BE14-2 The Colson Company issued $300,000 of 10% bonds on January 1, 2013. The bonds are due January 1, 2018, with interest payable each July 1 and January 1. The bonds are issued at face value. Prepare Colson’s journal entries for (a) the January issuance, (b) the July 1 interest payment, and (c) the December 31 adjusting entry.
BE14-3 Assume the bonds in
BE14-2 were issued at 98. Prepare the journal entries for (a) January 1, (b) July 1, and (c) December 31. Assume The Colson Company records straight-line amortization semiannually.
BE14-4 Assume the bonds in
BE14-2 were issued at 103. Prepare the journal entries for (a) January 1, (b) July 1, and (c) December 31. Assume The Colson Company records straight-line amortization semiannually.
BE14-5 Devers Corporation issued $400,000 of 6% bonds on May 1, 2013. The bonds were dated January 1, 2013, and mature January 1, 2015, with interest payable July 1 and January 1. The bonds were issued at face value plus accrued interest. Prepare Devers’s journal entries for (a) the May 1 issuance, (b) the July 1 interest payment, and (c) the December 31 adjusting entry.
BE14-6 On January 1, 2013, JWS Corporation issued $600,000 of 7% bonds, due in 10 years. The bonds were issued for $559,224, and pay interest each July 1 and January 1. JWS uses the effective-interest method. Prepare the company’s journal entries for (a) the January 1 issuance, (b) the July 1 interest payment, and (c) the December 31 adjusting entry. Assume an effective-interest rate of 8%.
BE14-7 Assume the bonds in
BE14-6 were issued for $644,636 and the effective-interest rate is 6%. Prepare the company’s journal entries for (a) the January 1 issuance, (b) the July 1 interest payment, and (c) the December 31 adjusting entry.
BE14-8 Teton Corporation issued $600,000 of 7% bonds on November 1, 2013, for $644,636. The bonds were dated November 1, 2013, and mature in 10 years, with interest payable each May 1 and November 1. Teton uses the effective-interest method with an effective rate of 6%. Prepare Teton’s December 31, 2013, adjusting entry.
BE14-9 At December 31, 2013, Hyasaki Corporation has the following account balances: Bonds payable, due January 1, 2021 $2,000,000 Discount on bonds payable 88,000 Interest payable 80,000 Show how the above accounts should be presented on the December 31, 2013, balance sheet, including the proper classifications.
BE14-10 Wasserman Corporation issued 10-year bonds on January 1, 2013. Costs associated with the bond issuance were $160,000. Wasserman uses the straight-line method to amortize bond issue costs. Prepare the December 31, 2013, entry to record 2013 bond issue cost amortization.
BE14-11 On January 1, 2013, Henderson Corporation retired $500,000 of bonds at 99. At the time of retirement, the unamortized premium was $15,000 and unamortized bond issue costs were $5,250. Prepare the corporation’s journal entry to record the reacquisition of the bonds.
BE14-12 Coldwell, Inc. issued a $100,000, 4-year, 10% note at face value to Flint Hills Bank on January 1, 2013, and received $100,000 cash. The note requires annual interest payments each December 31. Prepare Coldwell’s journal entries to record (a) the issuance of the note and (b) the December 31 interest payment.
BE14-13 Samson Corporation issued a 4-year, $75,000, zero-interest-bearing note to Brown Company on January 1, 2013, and received cash of $47,664. The implicit interest rate is 12%. Prepare Samson’s journal entries for (a) the January 1 issuance and (b) the December 31 recognition of interest.
BE14-14 McCormick Corporation issued a 4-year, $40,000, 5% note to Greenbush Company on January 1, 2013, and received a computer that normally sells for $31,495. The note requires annual interest payments each December 31. The market rate of interest for a note of similar risk is 12%. Prepare McCormick’s journal entries for (a) the January 1 issuance and (b) the December 31 interest.
BE14-15 Shlee Corporation issued a 4-year, $60,000, zero-interest-bearing note to Garcia Company on January 1, 2013, and received cash of $60,000. In addition, Shlee agreed to sell merchandise to Garcia at an amount less than regular selling price over the 4-year period. The market rate of interest for similar notes is 12%. Prepare Shlee Corporation’s January 1 journal entry.
BE14-16 Shonen Knife Corporation has elected to use the fair value option for one of its notes payable. The note was issued at an effective rate of 11% and has a carrying value of $16,000. At year-end, Shonen Knife’s borrowing rate has declined; the fair value of the note payable is now $17,500. (a) Determine the unrealized holding gain or loss on the note. (b) Prepare the entry to record any unrealized holding gain or loss. 4 5 6
E14-1 (Classification of Liabilities) Presented below are various account balances. (a) Bank loans payable of a winery, due March 10, 2016. (The product requires aging for 5 years before sale.) (b) Unamortized premium on bonds payable, of which $3,000 will be amortized during the next year. (c) Serial bonds payable, $1,000,000, of which $250,000 are due each July 31. (d) Amounts withheld from employees’ wages for income taxes. (e) Notes payable due January 15, 2015. (f) Credit balances in customers’ accounts arising from returns and allowances after collection in full of account. (g) Bonds payable of $2,000,000 maturing June 30, 2014. (h) Overdraft of $1,000 in a bank account. (No other balances are carried at this bank.) (i) Deposits made by customers who have ordered goods.
Instructions Indicate whether each of the items above should be classified on December 31, 2013, as a current liability, a long-term liability, or under some other classification. Consider each one independently from all others; that is, do not assume that all of them relate to one particular business. If the classification of some of the items is doubtful, explain why in each case.
E14-2 (Classification) The following items are found in the financial statements. (a) Discount on bonds payable (b) Interest expense (credit balance) (c) Unamortized bond issue costs (d) Gain on redemption of bonds (e) Mortgage payable (payable in equal amounts over next 3 years) (f) Debenture bonds payable (maturing in 5 years) (g) Premium on bonds payable 2 2 (h) Notes payable (due in 4 years) (i) Income bonds payable (due in 3 years)
Instructions Indicate how each of these items should be classified in the financial statements.
E14-3 (Entries for Bond Transactions) Presented below are two independent situations. 1. On January 1, 2012, Divac Company issued $300,000 of 9%, 10-year bonds at par. Interest is payable quarterly on April 1, July 1, October 1, and January 1. 2. On June 1, 2012, Verbitsky Company issued $200,000 of 12%, 10-year bonds dated January 1 at par plus accrued interest. Interest is payable semiannually on July 1 and January 1.
Instructions For each of these two independent situations, prepare journal entries to record the following. (a) The issuance of the bonds. (b) The payment of interest on July 1. (c) The accrual of interest on December 31.
E14-4 (Entries for Bond Transactions—Straight-Line) Foreman Company issued $800,000 of 10%, 20-year bonds on January 1, 2013, at 102. Interest is payable semiannually on July 1 and January 1. Foreman Company uses the straight-line method of amortization for bond premium or discount.
Instructions Prepare the journal entries to record the following. (a) The issuance of the bonds. (b) The payment of interest and the related amortization on July 1, 2013. (c) The accrual of interest and the related amortization on December 31, 2013.
E14-5 (Entries for Bond Transactions—Effective-Interest) Assume the same information as in
E14-4, except that Foreman Company uses the effective-interest method of amortization for bond premium or discount. Assume an effective yield of 9.7705%.
Instructions Prepare the journal entries to record the following. (Round to the nearest dollar.) (a) The issuance of the bonds. (b) The payment of interest and related amortization on July 1, 2013. (c) The accrual of interest and the related amortization on December 31, 2013.
E14-6 (Amortization Schedules—Straight-Line) Spencer Company sells 10% bonds having a maturity value of $3,000,000 for $2,783,724. The bonds are dated January 1, 2012, and mature January 1, 2017. Interest is payable annually on January 1.
Instructions Set up a schedule of interest expense and discount amortization under the straight-line method.
E14-7 (Amortization Schedule—Effective-Interest) Assume the same information as
Instructions Set up a schedule of interest expense and discount amortization under the effective-interest method. (Hint: The effective-interest rate must be computed.)
E14-8 (Determine Proper Amounts in Account Balances) Presented below are three independent situations. (a) Chinook Corporation incurred the following costs in connection with the issuance of bonds: (1) printing and engraving costs, $15,000; (2) legal fees, $49,000, and (3) commissions paid to underwriter, $60,000. What amount should be reported as Unamortized Bond Issue Costs, and where should this amount be reported on the balance sheet? (b) McEntire Co. sold $2,500,000 of 10%, 10-year bonds at 104 on January 1, 2012. The bonds were dated January 1, 2012, and pay interest on July 1 and January 1. If McEntire uses the straight-line method to amortize bond premium or discount, determine the amount of interest expense to be reported on July 1, 2012, and December 31, 2012. (c) Cheriel Inc. issued $600,000 of 9%, 10-year bonds on June 30, 2012, for $562,500. This price provided a yield of 10% on the bonds. Interest is payable semiannually on December 31 and June 30. If Cheriel uses the effective-interest method, determine the amount of interest expense to record if financial statements are issued on October 31, 2012.
E14-9 (Entries and Questions for Bond Transactions) On June 30, 2012, Mackes Company issued $5,000,000 face value of 13%, 20-year bonds at $5,376,150, a yield of 12%. Mackes uses the effective-interest method to amortize bond premium or discount. The bonds pay semiannual interest on June 30 and December 31.
Instructions (a) Prepare the journal entries to record the following transactions. (1) The issuance of the bonds on June 30, 2012. (2) The payment of interest and the amortization of the premium on December 31, 2012. (3) The payment of interest and the amortization of the premium on June 30, 2013. (4) The payment of interest and the amortization of the premium on December 31, 2013. (b) Show the proper balance sheet presentation for the liability for bonds payable on the December 31, 2013, balance sheet. (c) Provide the answers to the following questions. (1) What amount of interest expense is reported for 2013? (2) Will the bond interest expense reported in 2013 be the same as, greater than, or less than the amount that would be reported if the straight-line method of amortization were used? (3) Determine the total cost of borrowing over the life of the bond. (4) Will the total bond interest expense for the life of the bond be greater than, the same as, or less than the total interest expense if the straight-line method of amortization were used?
E14-10 (Entries for Bond Transactions) On January 1, 2012, Osborn Company sold 12% bonds having a maturity value of $800,000 for $860,651.79, which provides the bondholders with a 10% yield. The bonds are dated January 1, 2012, and mature January 1, 2017, with interest payable December 31 of each year. Osborn Company allocates interest and unamortized discount or premium on the effective-interest basis.
Instructions (a) Prepare the journal entry at the date of the bond issuance. (b) Prepare a schedule of interest expense and bond amortization for 2012–2014. (c) Prepare the journal entry to record the interest payment and the amortization for 2012. (d) Prepare the journal entry to record the interest payment and the amortization for 2014.
E14-11 (Information Related to Various Bond Issues) Pawnee Inc. has issued three types of debt on January 1, 2012, the start of the company’s fiscal year. (a) $10 million, 10-year, 13% unsecured bonds, interest payable quarterly. Bonds were priced to yield 12%. (b) $25 million par of 10-year, zero-coupon bonds at a price to yield 12% per year. (c) $15 million, 10-year, 10% mortgage bonds, interest payable annually to yield 12%.
Instructions Prepare a schedule that identifies the following items for each bond: (1) maturity value, (2) number of interest periods over life of bond, (3) stated rate per each interest period, (4) effective-interest rate per each interest period, (5) payment amount per period, and (6) present value of bonds at date of issue.
E14-12 (Entry for Retirement of Bond; Bond Issue Costs) On January 2, 2007, Prebish Corporation issued $1,500,000 of 10% bonds at 97 due December 31, 2016. Legal and other costs of $24,000 were incurred in connection with the issue. Interest on the bonds is payable annually each December 31. The $24,000 issue costs are being deferred and amortized on a straight-line basis over the 10-year term of the bonds. The discount on the bonds is also being amortized on a straight-line basis over the 10 years. (Straight-line is not materially different in effect from the preferable “interest method”.) The bonds are callable at 101 (i.e., at 101% of face amount), and on January 2, 2012, Prebish called $1,000,000 face amount of the bonds and retired them.
Instructions Ignoring income taxes, compute the amount of loss, if any, to be recognized by Prebish as a result of retiring the $1,000,000 of bonds in 2012 and prepare the journal entry to record the retirement. (AICPA adapted)
E14-13 (Entries for Retirement and Issuance of Bonds) Robinson, Inc. had outstanding $5,000,000 of 11% bonds (interest payable July 31 and January 31) due in 10 years. On July 1, it issued $7,000,000 of 10%, 15-year bonds (interest payable July 1 and January 1) at 98. A portion of the proceeds was used to call the 11% bonds at 102 on August 1. Unamortized bond discount and issue cost applicable to the 11% bonds were $120,000 and $30,000, respectively.
Instructions Prepare the journal entries necessary to record issue of the new bonds and the refunding of the bonds. 3 4 3 4 3 3 4 5 3 4 5
E14-14 (Entries for Retirement and Issuance of Bonds) On June 30, 2004, Mendenhal Company issued 12% bonds with a par value of $600,000 due in 20 years. They were issued at 98 and were callable at 104 at any date after June 30, 2012. Because of lower interest rates and a significant change in the company’s credit rating, it was decided to call the entire issue on June 30, 2013, and to issue new bonds. New 10% bonds were sold in the amount of $800,000 at 102; they mature in 20 years. Mendenhal Company uses straightline amortization. Interest payment dates are December 31 and June 30.
Instructions (a) Prepare journal entries to record the retirement of the old issue and the sale of the new issue on June 30, 2013. (b) Prepare the entry required on December 31, 2013, to record the payment of the first 6 months’ interest and the amortization of premium on the bonds.
E14-15 (Entries for Retirement and Issuance of Bonds) Friedman Company had bonds outstanding with a maturity value of $500,000. On April 30, 2013, when these bonds had an unamortized discount of $10,000, they were called in at 104. To pay for these bonds, Friedman had issued other bonds a month earlier bearing a lower interest rate. The newly issued bonds had a life of 10 years. The new bonds were issued at 103 (face value $500,000). Issue costs related to the new bonds were $3,000.
Instructions Ignoring interest, compute the gain or loss and record this refunding transaction. (AICPA adapted)
E14-16 (Entries for Zero-Interest-Bearing Notes) On January 1, 2013, McLean Company makes the two following acquisitions. 1. Purchases land having a fair value of $300,000 by issuing a 5-year, zero-interest-bearing promissory note in the face amount of $505,518. 2. Purchases equipment by issuing a 6%, 8-year promissory note having a maturity value of $400,000 (interest payable annually). The company has to pay 11% interest for funds from its bank.
Instructions (a) Record the two journal entries that should be recorded by McLean Company for the two purchases on January 1, 2013. (b) Record the interest at the end of the first year on both notes using the effective-interest method.
E14-17 (Imputation of Interest) Presented below are two independent situations: (a) On January 1, 2013, Spartan Inc. purchased land that had an assessed value of $390,000 at the time of purchase. A $600,000, zero-interest-bearing note due January 1, 2016, was given in exchange. There was no established exchange price for the land, nor a ready fair value for the note. The interest rate charged on a note of this type is 12%. Determine at what amount the land should be recorded at January 1, 2013, and the interest expense to be reported in 2013 related to this transaction. (b) On January 1, 2013, Geimer Furniture Co. borrowed $4,000,000 (face value) from Aurora Co., a major customer, through a zero-interest-bearing note due in 4 years. Because the note was zerointerest- bearing, Geimer Furniture agreed to sell furniture to this customer at lower than market price. A 10% rate of interest is normally charged on this type of loan. Prepare the journal entry to record this transaction and determine the amount of interest expense to report for 2013.
E14-18 (Imputation of Interest with Right) On January 1, 2012, Durdil Co. borrowed and received $500,000 from a major customer evidenced by a zero-interest-bearing note due in 3 years. As consideration for the zero-interest-bearing feature, Durdil agrees to supply the customer’s inventory needs for the loan period at lower than the market price. The appropriate rate at which to impute interest is 8%.
Instructions (a) Prepare the journal entry to record the initial transaction on January 1, 2012. (Round all computations to the nearest dollar.) (b) Prepare the journal entry to record any adjusting entries needed at December 31, 2012. Assume that the sales of Durdil’s product to this customer occur evenly over the 3-year period. 3 4
E14-19 (Fair Value Option) Fallen Company commonly issues long-term notes payable to its various lenders. Fallen has had a pretty good credit rating such that its effective borrowing rate is quite low (less than 8% on an annual basis). Fallen has elected to use the fair value option for the long-term notes issued to Barclay’s Bank and has the following data related to the carrying and fair value for these notes. Carrying Value Fair Value December 31, 2012 $54,000 $54,000 December 31, 2013 44,000 42,500 December 31, 2014 36,000 38,000
Instructions (a) Prepare the journal entry at December 31 (Fallen’s year-end) for 2012, 2013, and 2014, to record the fair value option for these notes. (b) At what amount will the note be reported on Fallen’s 2013 balance sheet? (c) What is the effect of recording the fair value option on these notes on Fallen’s 2014 income? (d) Assuming that general market interest rates have been stable over the period, does the fair value data for the notes indicate that Fallen’s creditworthiness has improved or declined in 2014? Explain.
E14-20 (Long-Term Debt Disclosure) At December 31, 2012, Redmond Company has outstanding three long-term debt issues. The first is a $2,000,000 note payable which matures June 30, 2015. The second is a $6,000,000 bond issue which matures September 30, 2016. The third is a $12,500,000 sinking fund debenture with annual sinking fund payments of $2,500,000 in each of the years 2014 through 2018.
Instructions Prepare the required note disclosure for the long-term debt at December 31, 2012. *E 14-21 (Settlement of Debt) Strickland Company owes $200,000 plus $18,000 of accrued interest to Moran State Bank. The debt is a 10-year, 10% note. During 2012, Strickland’s business deteriorated due to a faltering regional economy. On December 31, 2012, Moran State Bank agrees to accept an old machine and cancel the entire debt. The machine has a cost of $390,000, accumulated depreciation of $221,000, and a fair value of $180,000.
Instructions (a) Prepare journal entries for Strickland Company and Moran State Bank to record this debt settlement. (b) How should Strickland report the gain or loss on the disposition of machine and on restructuring of debt in its 2012 income statement? (c) Assume that, instead of transferring the machine, Strickland decides to grant 15,000 shares of its common stock ($10 par) which has a fair value of $180,000 in full settlement of the loan obligation. If Moran State Bank treats Strickland’s stock as a trading investment, prepare the entries to record the transaction for both parties. *E 14-22 (Term Modification without Gain—Debtor’s Entries) On December 31, 2012, the American Bank enters into a debt restructuring agreement with Barkley Company, which is now experiencing financial trouble. The bank agrees to restructure a 12%, issued at par, $3,000,000 note receivable by the following modifications: 1. Reducing the principal obligation from $3,000,000 to $2,400,000. 2. Extending the maturity date from December 31, 2012, to January 1, 2016. 3. Reducing the interest rate from 12% to 10%. Barkley pays interest at the end of each year. On January 1, 2016, Barkley Company pays $2,400,000 in cash to Firstar Bank.
Instructions (a) Will the gain recorded by Barkley be equal to the loss recorded by American Bank under the debt restructuring? (b) Can Barkley Company record a gain under the term modification mentioned above? Explain. (c) Assuming that the interest rate Barkley should use to compute interest expense in future periods is 1.4276%, prepare the interest payment schedule of the note for Barkley Company after the debt restructuring. (d) Prepare the interest payment entry for Barkley Company on December 31, 2014. (e) What entry should Barkley make on January 1, 2016? 7 9 10 10 *E 14-23 (Term Modification without Gain—Creditor’s Entries) Using the same information as in
E14-22, answer the following questions related to American Bank (creditor).
Instructions (a) What interest rate should American Bank use to calculate the loss on the debt restructuring? (b) Compute the loss that American Bank will suffer from the debt restructuring. Prepare the journal entry to record the loss. (c) Prepare the interest receipt schedule for American Bank after the debt restructuring. (d) Prepare the interest receipt entry for American Bank on December 31, 2014. (e) What entry should American Bank make on January 1, 2016? *E 14-24 (Term Modification with Gain—Debtor’s Entries) Use the same information as in
E14-22 above except that American Bank reduced the principal to $1,900,000 rather than $2,400,000. On January 1, 2016, Barkley pays $1,900,000 in cash to American Bank for the principal.
Instructions (a) Can Barkley Company record a gain under this term modification? If yes, compute the gain for Barkley Company. (b) Prepare the journal entries to record the gain on Barkley’s books. (c) What interest rate should Barkley use to compute its interest expense in future periods? Will your answer be the same as in
E14-22 above? Why or why not? (d) Prepare the interest payment schedule of the note for Barkley Company after the debt restructuring. (e) Prepare the interest payment entries for Barkley Company on December 31, of 2013, 2014, and 2015. (f) What entry should Barkley make on January 1, 2016? *E 14-25 (Term Modification with Gain—Creditor’s Entries) Using the same information as in
E14-24, answer the following questions related to American Bank (creditor).
Instructions (a) Compute the loss American Bank will suffer under this new term modification. Prepare the journal entry to record the loss on American’s books. (b) Prepare the interest receipt schedule for American Bank after the debt restructuring. (c) Prepare the interest receipt entry for American Bank on December 31, 2013, 2014, and 2015. (d) What entry should American Bank make on January 1, 2016? *
E14-26 (Debtor/Creditor Entries for Settlement of Troubled Debt) Gottlieb Co. owes $199,800 to Ceballos Inc. The debt is a 10-year, 11% note. Because Gottlieb Co. is in financial trouble, Ceballos Inc. agrees to accept some property and cancel the entire debt. The property has a book value of $90,000 and a fair value of $140,000.
Instructions (a) Prepare the journal entry on Gottlieb’s books for debt restructure. (b) Prepare the journal entry on Ceballos’s books for debt restructure. *E 14-27 (Debtor/Creditor Entries for Modification of Troubled Debt) Vargo Corp. owes $270,000 to First Trust. The debt is a 10-year, 12% note due December 31, 2012. Because Vargo Corp. is in financial trouble, First Trust agrees to extend the maturity date to December 31, 2014, reduce the principal to $220,000, and reduce the interest rate to 5%, payable annually on December 31.
Instructions (a) Prepare the journal entries on Vargo’s books on December 31, 2012, 2013, 2014. (b) Prepare the journal entries on First Trust’s books on December 31, 2012, 2013, 2014. 10
P14-1 (Analysis of Amortization Schedule and Interest Entries) The following amortization and interest schedule reflects the issuance of 10-year bonds by Capulet Corporation on January 1, 2006, and the subsequent interest payments and charges. The company’s year-end is December 31, and financial statements are prepared once yearly. Amortization Schedule Amount Carrying Year Cash Interest Unamortized Value 1/1/2006 $5,651 $ 94,349 2006 $11,000 $11,322 5,329 94,671 2007 11,000 11,361 4,968 95,032 2008 11,000 11,404 4,564 95,436 2009 11,000 11,452 4,112 95,888 2010 11,000 11,507 3,605 96,395 2011 11,000 11,567 3,038 96,962 2012 11,000 11,635 2,403 97,597 2013 11,000 11,712 1,691 98,309 2014 11,000 11,797 894 99,106 2015 11,000 11,894 100,000
Instructions (a) Indicate whether the bonds were issued at a premium or a discount and how you can determine this fact from the schedule. (b) Indicate whether the amortization schedule is based on the straight-line method or the effectiveinterest method and how you can determine which method is used. (c) Determine the stated interest rate and the effective-interest rate. (d) On the basis of the schedule above, prepare the journal entry to record the issuance of the bonds on January 1, 2006. (e) On the basis of the schedule above, prepare the journal entry or entries to reflect the bond transactions and accruals for 2006. (Interest is paid January 1.) (f) On the basis of the schedule above, prepare the journal entry or entries to reflect the bond transactions and accruals for 2013. Capulet Corporation does not use reversing entries.
P14-2 (Issuance and Retirement of Bonds) Venezuela Co. is building a new hockey arena at a cost of $2,500,000. It received a downpayment of $500,000 from local businesses to support the project, and now needs to borrow $2,000,000 to complete the project. It therefore decides to issue $2,000,000 of 10.5%, 10-year bonds. These bonds were issued on January 1, 2011, and pay interest annually on each January 1. The bonds yield 10%. Venezuela paid $50,000 in bond issue costs related to the bond sale.
Instructions (a) Prepare the journal entry to record the issuance of the bonds and the related bond issue costs incurred on January 1, 2011. (b) Prepare a bond amortization schedule up to and including January 1, 2015, using the effectiveinterest method. (c) Assume that on July 1, 2014, Venezuela Co. retires half of the bonds at a cost of $1,065,000 plus accrued interest. Prepare the journal entry to record this retirement.
P14-3 (Negative Amortization) Good-Deal Inc. developed a new sales gimmick to help sell its inventory of new automobiles. Because many new car buyers need financing, Good-Deal offered a low down payment and low car payments for the first year after purchase. It believes that this promotion will bring in some new buyers. On January 1, 2012, a customer purchased a new $33,000 automobile, making a downpayment of $1,000. The customer signed a note indicating that the annual rate of interest would be 8% and that quarterly payments would be made over 3 years. For the first year, Good-Deal required a $400 quarterly payment to be made on April 1, July 1, October 1, and January 1, 2013. After this one-year period, the customer was required to make regular quarterly payments that would pay off the loan as of January 1, 2015. 3 4 3 4 5 3 4
Instructions (a) Prepare a note amortization schedule for the first year. (b) Indicate the amount the customer owes on the contract at the end of the first year. (c) Compute the amount of the new quarterly payments. (d) Prepare a note amortization schedule for these new payments for the next 2 years. (e) What do you think of the new sales promotion used by Good-Deal?
P14-4 (Issuance and Retirement of Bonds; Income Statement Presentation) Holiday Company issued its 9%, 25-year mortgage bonds in the principal amount of $3,000,000 on January 2, 1998, at a discount of $150,000, which it proceeded to amortize by charges to expense over the life of the issue on a straight-line basis. The indenture securing the issue provided that the bonds could be called for redemption in total but not in part at any time before maturity at 104% of the principal amount, but it did not provide for any sinking fund. On December 18, 2012, the company issued its 11%, 20-year debenture bonds in the principal amount of $4,000,000 at 102, and the proceeds were used to redeem the 9%, 25-year mortgage bonds on January 2, 2013. The indenture securing the new issue did not provide for any sinking fund or for retirement before maturity.
Instructions (a) Prepare journal entries to record the issuance of the 11% bonds and the retirement of the 9% bonds. (b) Indicate the income statement treatment of the gain or loss from retirement and the note disclosure required.
P14-5 (Comprehensive Bond Problem) In each of the following independent cases the company closes its books on December 31. 1. Sanford Co. sells $500,000 of 10% bonds on March 1, 2012. The bonds pay interest on September 1 and March 1. The due date of the bonds is September 1, 2015. The bonds yield 12%. Give entries through December 31, 2013. 2. Titania Co. sells $400,000 of 12% bonds on June 1, 2012. The bonds pay interest on December 1 and June 1. The due date of the bonds is June 1, 2016. The bonds yield 10%. On October 1, 2013, Titania buys back $120,000 worth of bonds for $126,000 (includes accrued interest). Give entries through December 1, 2014.
Instructions (Round to the nearest dollar.) For the two cases prepare all of the relevant journal entries from the time of sale until the date indicated. Use the effective-interest method for discount and premium amortization (construct amortization tables where applicable). Amortize premium or discount on interest dates and at year-end. (Assume that no reversing entries were made.)
P14-6 (Issuance of Bonds between Interest Dates, Straight-Line, Retirement) Presented below are selected transactions on the books of Simonson Corporation. May 1, 2012 Bonds payable with a par value of $900,000, which are dated January 1, 2012, are sold at 106 plus accrued interest. They are coupon bonds, bear interest at 12% (payable annually at January 1), and mature January 1, 2022. (Use interest expense account for accrued interest.) Dec. 31 Adjusting entries are made to record the accrued interest on the bonds, and the amortization of the proper amount of premium. (Use straight-line amortization.) Jan. 1, 2013 Interest on the bonds is paid. April 1 Bonds with par value of $360,000 are called at 102 plus accrued interest, and retired. (Bond premium is to be amortized only at the end of each year.) Dec. 31 Adjusting entries are made to record the accrued interest on the bonds, and the proper amount of premium amortized.
Instructions Prepare journal entries for the transactions above.
P14-7 (Entries for Life Cycle of Bonds) On April 1, 2012, Seminole Company sold 15,000 of its 11%, 15-year, $1,000 face value bonds at 97. Interest payment dates are April 1 and October 1, and the company uses the straight-line method of bond discount amortization. On March 1, 2013, Seminole took advantage of favorable prices of its stock to extinguish 6,000 of the bonds by issuing 200,000 shares of its $10 par value common stock. At this time, the accrued interest was paid in cash. The company’s stock was selling for $31 per share on March 1, 2013. 3 4 5 8 3 4
Instructions Prepare the journal entries needed on the books of Seminole Company to record the following. (a) April 1, 2012: issuance of the bonds. (b) October 1, 2012: payment of semiannual interest. (c) December 31, 2012: accrual of interest expense. (d) March 1, 2013: extinguishment of 6,000 bonds. (No reversing entries made.)
P14-8 (Entries for Zero-Interest-Bearing Note) On December 31, 2012, Faital Company acquired a computer from Plato Corporation by issuing a $600,000 zero-interest-bearing note, payable in full on December 31, 2016. Faital Company’s credit rating permits it to borrow funds from its several lines of credit at 10%. The computer is expected to have a 5-year life and a $70,000 salvage value.
Instructions (a) Prepare the journal entry for the purchase on December 31, 2012. (b) Prepare any necessary adjusting entries relative to depreciation (use straight-line) and amortization (use effective-interest method) on December 31, 2013. (c) Prepare any necessary adjusting entries relative to depreciation and amortization on December 31, 2014.
P14-9 (Entries for Zero-Interest-Bearing Note; Payable in Installments) Sabonis Cosmetics Co. purchased machinery on December 31, 2011, paying $50,000 down and agreeing to pay the balance in four equal installments of $40,000 payable each December 31. An assumed interest of 8% is implicit in the purchase price.
Instructions Prepare the journal entries that would be recorded for the purchase and for the payments and interest on the following dates. (a) December 31, 2011. (d) December 31, 2014. (b) December 31, 2012. (e) December 31, 2015. (c) December 31, 2013.
P14-10 (Comprehensive Problem: Issuance, Classification, Reporting) Presented below are four independent situations. (a) On March 1, 2013, Wilke Co. issued at 103 plus accrued interest $4,000,000, 9% bonds. The bonds are dated January 1, 2013, and pay interest semiannually on July 1 and January 1. In addition, Wilke Co. incurred $27,000 of bond issuance costs. Compute the net amount of cash received by Wilke Co. as a result of the issuance of these bonds. (b) On January 1, 2012, Langley Co. issued 9% bonds with a face value of $700,000 for $656,992 to yield 10%. The bonds are dated January 1, 2012, and pay interest annually. What amount is reported for interest expense in 2012 related to these bonds, assuming that Langley used the effective-interest method for amortizing bond premium and discount? (c) Tweedie Building Co. has a number of long-term bonds outstanding at December 31, 2012. These long-term bonds have the following sinking fund requirements and maturities for the next 6 years. Sinking Fund Maturities 2013 $300,000 $100,000 2014 100,000 250,000 2015 100,000 100,000 2016 200,000 — 2017 200,000 150,000 2018 200,000 100,000 Indicate how this information should be reported in the financial statements at December 31, 2012. (d) In the long-term debt structure of Beckford Inc., the following three bonds were reported: mortgage bonds payable $10,000,000; collateral trust bonds $5,000,000; bonds maturing in installments, secured by plant equipment $4,000,000. Determine the total amount, if any, of debenture bonds outstanding.
P14-11 (Effective-Interest Method) Samantha Cordelia, an intermediate accounting student, is having difficulty amortizing bond premiums and discounts using the effective-interest method. Furthermore, she cannot understand why GAAP requires that this method be used instead of the straight-line method. She has come to you with the following problem, looking for help. On June 30, 2012, Hobart Company issued $2,000,000 face value of 11%, 20-year bonds at $2,171,600, a yield of 10%. Hobart Company uses the effective-interest method to amortize bond premiums or discounts. The bonds pay semiannual interest on June 30 and December 31. Prepare an amortization schedule for four periods. 6 6 3 4 5 9 4
Instructions Using the data on the prior page for illustrative purposes, write a short memo (1–1.5 pages double-spaced) to Samantha, explaining what the effective-interest method is, why it is preferable, and how it is computed. (Do not forget to include an amortization schedule, referring to it whenever necessary.) *
P14-12 (Debtor/Creditor Entries for Continuation of Troubled Debt) Daniel Perkins is the sole shareholder of Perkins Inc., which is currently under protection of the U.S. bankruptcy court. As a “debtor in possession,” he has negotiated the following revised loan agreement with United Bank. Perkins Inc.’s $600,000, 12%, 10-year note was refinanced with a $600,000, 5%, 10-year note.
Instructions (a) What is the accounting nature of this transaction? (b) Prepare the journal entry to record this refinancing: (1) On the books of Perkins Inc. (2) On the books of United Bank. (c) Discuss whether generally accepted accounting principles provide the proper information useful to managers and investors in this situation. *
P14-13 (Restructure of Note under Different Circumstances) Halvor Corporation is having financial difficulty and therefore has asked Frontenac National Bank to restructure its $5 million note outstanding. The present note has 3 years remaining and pays a current rate of interest of 10%. The present market rate for a loan of this nature is 12%. The note was issued at its face value.
Instructions Presented below are four independent situations. Prepare the journal entry that Halvor and Frontenac National Bank would make for each of these restructurings. (a) Frontenac National Bank agrees to take an equity interest in Halvor by accepting common stock valued at $3,700,000 in exchange for relinquishing its claim on this note. The common stock has a par value of $1,700,000. (b) Frontenac National Bank agrees to accept land in exchange for relinquishing its claim on this note. The land has a book value of $3,250,000 and a fair value of $4,000,000. (c) Frontenac National Bank agrees to modify the terms of the note, indicating that Halvor does not have to pay any interest on the note over the 3-year period. (d) Frontenac National Bank agrees to reduce the principal balance due to $4,166,667 and require interest only in the second and third year at a rate of 10%. *P 14-14 (Debtor/Creditor Entries for Continuation of Troubled Debt with New Effective Interest) Crocker Corp. owes D. Yaeger Corp. a 10-year, 10% note in the amount of $330,000 plus $33,000 of accrued interest. The note is due today, December 31, 2012. Because Crocker Corp. is in financial trouble, D. Yaeger Corp. agrees to forgive the accrued interest, $30,000 of the principal, and to extend the maturity date to December 31, 2015. Interest at 10% of revised principal will continue to be due on 12/31 each year. Assume the following present value factors for 3 periods. 21/4% 23/8% 21/2% 25/8% 23/4% 3% Single sum .93543 .93201 .92859 .92521 .92184 .91514 Ordinary annuity of 1 2.86989 2.86295 2.85602 2.84913 2.84226 2.82861
Instructions (a) Compute the new effective-interest rate for Crocker Corp. following restructure. (Hint: Find the interest rate that establishes approximately $363,000 as the present value of the total future cash flows.) (b) Prepare a schedule of debt reduction and interest expense for the years 2012 through 2015. (c) Compute the gain or loss for D. Yaeger Corp. and prepare a schedule of receivable reduction and interest revenue for the years 2012 through 2015. (d) Prepare all the necessary journal entries on the books of Crocker Corp. for the years 2012, 2013, and 2014. (e) Prepare all the necessary journal entries on the books of D. Yaeger Corp. for the years 2012, 2013, and 2014. 10 CONCEPTS FOR ANALYS I S
CA14-1 (Bond Theory: Balance Sheet Presentations, Interest Rate, Premium) On January 1, 2013, Nichols Company issued for $1,085,800 its 20-year, 11% bonds that have a maturity value of $1,000,000 and pay interest semiannually on January 1 and July 1. Bond issue costs were not material in amount. Below are three presentations of the long-term liability section of the balance sheet that might be used for these bonds at the issue date. 1. Bonds payable (maturing January 1, 2033) $1,000,000 Unamortized premium on bonds payable 85,800 Total bond liability $1,085,800 2. Bonds payable—principal (face value $1,000,000 maturing January 1, 2033) $ 142,050a Bonds payable—interest (semiannual payment $55,000) 943,750b Total bond liability $1,085,800 3. Bonds payable—principal (maturing January 1, 2033) $1,000,000 Bonds payable—interest ($55,000 per period for 40 periods) 2,200,000 Total bond liability $3,200,000 aThe present value of $1,000,000 due at the end of 40 (6-month) periods at the yield rate of 5% per period. bThe present value of $55,000 per period for 40 (6-month) periods at the yield rate of 5% per period.
Instructions (a) Discuss the conceptual merit(s) of each of the date-of-issue balance sheet presentations shown above for these bonds. (b) Explain why investors would pay $1,085,800 for bonds that have a maturity value of only $1,000,000. (c) Assuming that a discount rate is needed to compute the carrying value of the obligations arising from a bond issue at any date during the life of the bonds, discuss the conceptual merit(s) of using for this purpose: (1) The coupon or nominal rate. (2) The effective or yield rate at date of issue. (d) If the obligations arising from these bonds are to be carried at their present value computed by means of the current market rate of interest, how would the bond valuation at dates subsequent to the date of issue be affected by an increase or a decrease in the market rate of interest? (AICPA adapted)
CA14-2 (Bond Theory: Price, Presentation, and Retirement) On March 1, 2013, Sealy Company sold its 5-year, $1,000 face value, 9% bonds dated March 1, 2013, at an effective annual interest rate (yield) of 11%. Interest is payable semiannually, and the first interest payment date is September 1, 2013. Sealy uses the effective-interest method of amortization. Bond issue costs were incurred in preparing and selling the bond issue. The bonds can be called by Sealy at 101 at any time on or after March 1, 2014.
Instructions (a) (1) How would the selling price of the bond be determined? (2) Specify how all items related to the bonds would be presented in a balance sheet prepared immediately after the bond issue was sold. (b) What items related to the bond issue would be included in Sealy’s 2013 income statement, and how would each be determined? (c) Would the amount of bond discount amortization using the effective-interest method of amortization be lower in the second or third year of the life of the bond issue? Why? (d) Assuming that the bonds were called in and retired on March 1, 2014, how should Sealy report the retirement of the bonds on the 2014 income statement? (AICPA adapted)
CA14-3 (Bond Theory: Amortization and Gain or Loss Recognition) Part I. The appropriate method of amortizing a premium or discount on issuance of bonds is the effectiveinterest method.
Instructions (a) What is the effective-interest method of amortization and how is it different from and similar to the straight-line method of amortization? (b) How is amortization computed using the effective-interest method, and why and how do amounts obtained using the effective-interest method differ from amounts computed under the straight-line method? Part II. Gains or losses from the early extinguishment of debt that is refunded can theoretically be accounted for in three ways: 1. Amortized over remaining life of old debt. 2. Amortized over the life of the new debt issue. 3. Recognized in the period of extinguishment.
Instructions (a) Develop supporting arguments for each of the three theoretical methods of accounting for gains and losses from the early extinguishment of debt. (b) Which of the methods above is generally accepted and how should the appropriate amount of gain or loss be shown in a company’s financial statements? (AICPA adapted)
CA14-4 (Off-Balance-Sheet Financing) Matt Ryan Corporation is interested in building its own soda can manufacturing plant adjacent to its existing plant in Partyville, Kansas. The objective would be to ensure a steady supply of cans at a stable price and to minimize transportation costs. However, the company has been experiencing some financial problems and has been reluctant to borrow any additional cash to fund the project. The company is not concerned with the cash flow problems of making payments, but rather with the impact of adding additional long-term debt to its balance sheet. The president of Ryan, Andy Newlin, approached the president of the Aluminum Can Company (ACC), their major supplier, to see if some agreement could be reached. ACC was anxious to work out an arrangement, since it seemed inevitable that Ryan would begin their own can production. The Aluminum Can Company could not afford to lose the account. After some discussion a two-part plan was worked out. First, ACC was to construct the plant on Ryan’s land adjacent to the existing plant. Second, Ryan would sign a 20-year purchase agreement. Under the purchase agreement, Ryan would express its intention to buy all of its cans from ACC, paying a unit price which at normal capacity would cover labor and material, an operating management fee, and the debt service requirements on the plant. The expected unit price, if transportation costs are taken into consideration, is lower than current market. If Ryan did not take enough production in any one year and if the excess cans could not be sold at a high enough price on the open market, Ryan agrees to make up any cash shortfall so that ACC could make the payments on its debt. The bank will be willing to make a 20-year loan for the plant, taking the plant and the purchase agreement as collateral. At the end of 20 years, the plant is to become the property of Ryan.
Instructions (a) What are project financing arrangements using special-purpose entities? (b) What are take-or-pay contracts? (c) Should Ryan record the plant as an asset together with the related obligation? (d) If not, should Ryan record an asset relating to the future commitment? (e) What is meant by off-balance-sheet financing?
CA14-5 (Bond Issue) Donald Lennon is the president, founder, and majority owner of Wichita Medical Corporation, an emerging medical technology products company. Wichita is in dire need of additional capital to keep operating and to bring several promising products to final development, testing, and production. Donald, as owner of 51% of the outstanding stock, manages the company’s operations. He places heavy emphasis on research and development and long-term growth. The other principal stockholder is Nina Friendly who, as a nonemployee investor, owns 40% of the stock. Nina would like to deemphasize the R & D functions and emphasize the marketing function to maximize short-run sales and profits from existing products. She believes this strategy would raise the market price of Wichita’s stock. All of Donald’s personal capital and borrowing power is tied up in his 51% stock ownership. He knows that any offering of additional shares of stock will dilute his controlling interest because he won’t be able to participate in such an issuance. But, Nina has money and would likely buy enough shares to gain control of Wichita. She then would dictate the company’s future direction, even if it meant replacing Donald as president and CEO. The company already has considerable debt. Raising additional debt will be costly, will adversely affect Wichita’s credit rating, and will increase the company’s reported losses due to the growth in interest expense. Nina and the other minority stockholders express opposition to the assumption of additional debt, fearing the company will be pushed to the brink of bankruptcy. Wanting to maintain his control and to preserve the direction of “his” company, Donald is doing everything to avoid a stock issuance and is contemplating a large issuance of bonds, even if it means the bonds are issued with a high effective-interest rate.
Instructions (a) Who are the stakeholders in this situation? (b) What are the ethical issues in this case? (c) What would you do if you were Donald?
Financial Reporting Problem The Procter & Gamble Company (P&G) The financial statements of P&G are presented in Appendix 5B or can be accessed at the book’s companion website, www.wiley.com/college/kieso.
Instructions Refer to P&G’s financial statements and the accompanying notes to answer the following questions. (a) What cash outflow obligations related to the repayment of long-term debt does P&G have over the next 5 years? (b) P&G indicates that it believes that it has the ability to meet business requirements in the foreseeable future. Prepare an assessment of its liquidity, solvency, and financial flexibility using ratio analysis.
Comparative Analysis Case
The Coca-Cola Company and PepsiCo, Inc.
Instructions Go to the book’s companion website and use information found there to answer the following questions related to The Coca-Cola Company and PepsiCo, Inc. (a) Compute the debt to total assets ratio and the times interest earned ratio for these two companies. Comment on the quality of these two ratios for both Coca-Cola and PepsiCo. (b) What is the difference between the fair value and the historical cost (carrying amount) of each company’s debt at year-end 2009? Why might a difference exist in these two amounts? (c) Both companies have debt issued in foreign countries. Speculate as to why these companies may use foreign debt to finance their operations. What risks are involved in this strategy, and how might they adjust for this risk?
Financial Statement Analysis Case Commonwealth Edison Co. The following article appeared in the Wall Street Journal. Bond Markets Giant Commonwealth Edison Issue Hits Resale Market With $70 Million Left Over new york—Commonwealth Edison Co.’s slow-selling new 9?% bonds were tossed onto the resale market at a reduced price with about $70 million still available from the $200 million offered Thursday, dealers said. The Chicago utility’s bonds, rated double-A by Moody’s and double-A-minus by Standard & Poor’s, originally had been priced at 99.803, to yield 9.3% in 5 years. They were marked down yesterday the equivalent of about $5.50 for each $1,000 face amount, to about 99.25, where their yield jumped to 9.45%.
Instructions (a) How will the development above affect the accounting for Commonwealth Edison’s bond issue? (b) Provide several possible explanations for the markdown and the slow sale of Commonwealth Edison’s bonds.
Accounting, Analysis, and Principles The following information is taken from the 2012 annual report of Bugant, Inc. Bugant’s fiscal year ends December 31 of each year. Bugant’s December 31, 2012, balance sheet is as follows. USING YOUR JUDGMENT
Using Your Judgment 833 Additional information concerning 2013 is as follows. 1. Sales were $3,500, all for cash. 2. Purchases were $2,000, all paid in cash. 3. Salaries were $700, all paid in cash. 4. Property, plant, and equipment was originally purchased for $2,000 and is depreciated straight-line over a 25-year life with no salvage value. 5. Ending inventory was $1,900. 6. Cash dividends of $100 were declared and paid by Bugant. 7. Ignore taxes. 8. The market rate of interest on bonds of similar risk was 12% during all of 2013. 9. Interest on the bonds is paid semiannually each June 30 and December 31.
Accounting Prepare a balance sheet for Bugant, Inc. at December 31, 2013, and an income statement for the year ending December 31, 2013. Assume semiannual compounding of the bond interest.
Analysis Use common ratios for analysis of long-term debt to assess Bugant’s long-run solvency. Has Bugant’s solvency changed much from 2012 to 2013? Bugant’s net income in 2012 was $550 and interest expense was $169.
Principles Recently, the FASB and the IASB allowed companies the option of recognizing in their financial statements the fair values of their long-term debt. That is, companies have the option to change the balance sheet value of their long-term debt to the debt’s fair value and report the change in balance sheet value as a gain or loss in income. In terms of the qualitative characteristics of accounting information (Chapter 2), briefly describe the potential trade-off(s) involved in reporting long-term debt at its fair value.
BRIDGE TO THE PROFESSION
Professional Research: FASB Codifi cation Wie Company has been operating for just 2 years, producing specialty golf equipment for women golfers. To date, the company has been able to finance its successful operations with investments Bugant, Inc. Balance Sheet December 31, 2012 Assets Cash $ 450 Inventory 1,800 Total current assets 2,250 Plant and equipment 2,000 Accumulated depreciation (160) Total assets $4,090 Liabilities Bonds payable (net of discount) $1,426 Stockholders’ equity Common stock 1,500 Retained earnings 1,164 Total liabilities and stockholders’ equity $4,090 Note X: Long Term Debt: On January 1, 2011, Bugant issued bonds with face value of $1,500 and a coupon rate equal to 10%. The bonds were issued to yield 12% and mature on January 1, 2016. from its principal owner, Michelle Wie, and cash flows from operations. However, current expansion plans will require some borrowing to expand the company’s production line. As part of the expansion plan, Wie will acquire some used equipment by signing a zerointerest- bearing note. The note has a maturity value of $50,000 and matures in 5 years. A reliable fair value measure for the equipment is not available, given the age and specialty nature of the equipment. As a result, Wie’s accounting staff is unable to determine an established exchange price for recording the equipment (nor the interest rate to be used to record interest expense on the long-term note). They have asked you to conduct some accounting research on this topic.
Instructions If your school has a subscription to the FASB Codification, go to http://aaahq.org/ascLogin.cfm to log in and prepare responses to the following. Provide Codification references for your responses. (a) Identify the authoritative literature that provides guidance on the zero-interest-bearing note. Use some of the examples to explain how the standard applies in this setting. (b) How is present value determined when an established exchange price is not determinable and a note has no ready market? What is the resulting interest rate often called? (c) Where should a discount or premium appear in the financial statements? What about issue costs?
Professional Simulation In this simulation, you are asked to address questions related to the accounting for long-term liabilities. Prepare responses to all parts.
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