Bond problems by Alfredo Garcia December 13, 2004
a40.When bonds are sold between interest dates, any accrued interest is credited to a. Interest Payable. b. Interest Revenue. c. Interest Receivable. d. Bonds Payable. d41.Which of the following is true of accrued interest on bonds that are sold between interest dates? a. It is computed at the effective effective market market rate. b. It will be paid to the seller when the bonds mature. c. It is extra income to the buyer. d. None of the above. c42.On July 1, 2002, Riviera Manufacturing Co. issued a five-year note payable with a face amount of $250,000 and an interest rate of 10 percent. The terms of the note require Riviera to make five annual payments of $50,000 plus accrued interest, with the first payment due June 30, 2003. 2003 . With respect to the note, the current liabilities section of Riviera's December 31, 2002, balance sheet should include a.$12,500. b.$50,000. c.$62,500. d.$75,000. b43.In an effort to increase sales, Blue Razor Blade Company inaugurated a sales promotion campaign on June 30, 2002, whereby Blue placed a coupon in each package of razor blades sold, the coupons being redeemable for a premium. Each premium costs Blue $.50, and five coupons must be presented by a customer to receive a premium. Blue estimated that only 60 percent of the coupons issued will be redeemed. For the six months ended December 31, 2002, the following information is available: Packages of razor blades sold 400,000 Premiums purchased 30,000 Coupons redeemed 100,000 What is the estimated liability for premium claims outstanding at December 31, 2002? a.$10,000 b.$14,000 c.$18,000 d.$24,000 d44.Included in Kaiser Corporation's liability account balances at December 31, 2002, were the following: 14 percent note payable issued October 1, 2002, maturing September 30, 2003 $250,000
16 percent note payable issued April 1, 2000, payable in six annual installments of $100,000
beginning April 1, 2001
400,000
Kaiser's December 31, 2002, financial statements were issued on March 31, 2003. On January 15, 2003, the entire $400,000 balance of the 16 percent note was refinanced by issuance of a long-term obligation payable in a lump sum. In addition, on March 10, 2003, Kaiser consummated a noncancelable agree-ment with the lender to refinance the 14 percent, $250,000 note no te on a long-term basis, on readily determinable de terminable terms that have not yet been implemented. Both parties are financially capable of honoring the agreement, and there have been no violations of the agreement's provisions. On the December 31, 2002, balance sheet, the amount of the notes payable that Kaiser should classify as noncurrent obligations is a.$100,000. b.$250,000. c.$350,000. d.$650,000. a45.At December 31, 2002, Reed Corp. owed notes payable of $1,000,000 with a maturity date of April 30, 2003. These notes no tes did not arise from transactions in the normal course o f business. On February 1, 2003, Reed issued $3,000,000 of ten-year bonds with the intention of using part of the bond proceeds to liquidate the $1,000,000 of notes payable. Reed's December 31, 2002, financial statements were issued on March 29, 2003. How much of the $1,000,000 notes payable should be classified as current in Reed's balance sheet at December 31, 2002? a.$0 b.$100,000 c.$900,000 d.$1,000,000 c46.Dean, Inc. has $2,000,000 of notes payable due June 15, 2003. At the financial statement date of December 31, 2002, Dean signed an agreement to borrow up to $2,000,000 to refinance the notes payable on a long-term basis. The financing agreement called for borrowings not to exceed 80 percent of the value of the collateral Dean was providing. At the date of issue of the December 31, 2002, financial statements, the value of the collateral was $2,400,000 and was not expected to fall below this amount during 2003. In its December 31, 2002, balance sheet, Dean should classify notes payable as
Short-Term Long-Term Obligations Obligations a. $2,000,000 $0 b. $400,000 $1,600,000 c. $80,000 $1,920,000 d. $0 $2,000,000
b47.Swanson Inc. purchased $400,000 of Malone Corp. ten-year ten-year bonds with a stated interest interest rate rate of 8 percent payable quarterly. At the time the bonds bon ds were purchased, the market interest rate was 12 percent. Determine the amount of premium or discount on the purchase of the bonds. a.$92,442 premium
b.$92,442 discount c.$81,143 premium d.$81,143 discount b48.Madison Corporation had two issues of securities outstanding-- common stock and a 5 percent convertible bond issue in the face amount of $10,000,000. Interest payment dates of the bond issue are June 30 and December 31. The conversion clause in the bond indenture entitles the bondholders to receive 40 shares of $20 par value common stock in exchange for each $1,000 bond. On June 30, 2002, the holders of $1,800,000 face value bonds exercised the conversion privilege. The market price of the bonds on that date was $1,100 per bond and the market price of the common stock was $35. The total unamortized bond discount at the date of conversion was $500,000. What amount should Madison credit to the account "Paid-In Capital in Excess of Par" as a result of this conversion assuming Madison d oes not want to recognize any gain (or loss) on theconversion? a.$0 b.$270,000 c.$360,000 d.$920,000 d49.Selected financial data of Alexander Corporation for the year ended December presented below: Operating income $900,000 Interest expense (100,000) Income before income tax $800,000 Income tax expense (320,000) Net income $480,000 Preferred stock dividends (200,000) Net income available to common stockholders $280,000 Common stock dividends were $120,000. The times-interest-earned ratio is a.2.8 to 1. b.4.8 to 1. c.6.0 to 1. d.9.0 to 1. b50.Littleton Corp. had the following long-term debt at December 31: Collateral trust bonds, having securities of unrelated corporations as security $250,000 Bonds unsecured as to principal 150,000 The debenture bonds amounted to a. $0. b. $150,000. c. $250,000. d. $400,000. c51.Miller Enterprises had the following long-term debt: Sinking fund bonds, maturing in installments $1,100,000 Industrial revenue bonds, maturing in installments 900,000
31, 2002, is
Subordinated bonds, maturing on a single date
1,500,000
The total of the serial bonds amounted to a.$900,000. b.$1,500,000. c.$2,000,000. d.$2,400,000. d52.On January 1, MAX issued ten-year bonds with a face amount of $1,000,000 and a stated interest rate of 8 percent payable annually each January 1. The bonds were priced to yield 10 percent. The total issue price (rounded) of the bonds was a.$1,000,000. b.$980,000. c.$920,000. d.$880,000. d53.During the year, Hancock Corporation incurred the following costs in connection with the issuance of bonds: Printing and engraving $ 30,000 Legal fees 160,000 Fees paid to independent accountants for registration information 20,000 Commissions paid to underwriter 300,000 The amount recorded as a deferred charge to be amortized over the term of the bonds is a.$0. b.$30,000. c.$300,000. d.$510,000. d54.On January 1, 2002, Lisbon Corp. issued 2,000 of its 9 percent, $1,000 bonds at 95. Interest is payable semiannually on July 1 and January 1. The bonds mature on January 1, 2012. Lisbon paid bond issue costs of $80,000, which are appropriately recorded as a deferred charge. Lisbon uses the straight-line method of amortizing bond discount and bond issue costs. On Lisbon's December 31, 2002, balance sheet, how much would be shown as the carrying amount of the bonds payable? a.$2,110,000 b.$2,090,000 c.$1,982,000 d.$1,910,000
d55.On October 1, 2002, Westridge Inc. issued, at 101 plus accrued interest, 800 of its 10 percent, $1,000 bonds. The bonds are dated July 1, 2002, and mature on July 1, 2012. Interest is payable semiannually on January 1 and July 1. At the time of issuance, Westridge would receive cash of a.$800,000.
b.$808,000. c.$820,000. d.$828,000. b56.On January 1, 2002, Matlock Inc. issued its 10 percent bonds in the face amount of $1,500,000. They mature on January 1, 2012. The bonds were issued for $1,329,000 to yield 12 percent, resulting in bond discount of $171,000. Matlock uses the effective-interest method of amortizing bond discount. Interest is payable July 1 and January 1. For the six months ended June 30, 2002, Matlock should report bond interest expense of a.$75,000. b.$79,740. c.$83,550. d.$85,260. d57.On July 1, 2002, TJR issued 2,000 of its 8 percent, $1,000 bonds for $1,752,000. The bonds were issued to yield 10 percent. The bonds are dated July 1, 2002, and mature on July 1, 2012. Interest is payable semiannually on January 1 and July 1. Using the effective-interest method, how much of the bond discount should be amortized for the six months ended December 31, 2002? a.$15,200 b.$12,400 c.$9,920 d.$7,600 c58.On July 1, 2001, Houston Company purchased as a long-term investment Essex Co mpany's ten-year, 9 percent bonds, with a face value of $100,000 for $95,200. Interest is payable semiannually on January 1 and July 1. The bonds mature on July 1, 2005. Houston uses the straight-line method of amortization. What is the amount of interest revenue that Houston should report in its income statement for the year ended December 31, 2001? a.$3,900 b.$4,500 c.$5,100 d.$5,700 a59.On February 1, 2000, Lantern Corp. issued 12 percent, $2,000,000 face value,ten-year bonds for $2,234,000 plus accrued interest. The bonds are dated November 1, 1999, and interest is payable on May 1 and November 1 Lantern reacquired all of these bonds at 102 on May 1, 2003, and retired them. Unamortized bond premium on that date was $156,000. Ignoring the income tax effect, what was Lantern's gain on the bond retirement? a.$116,000 b.$194,000 c.$234,000 d.$236,000 d60.Laker, Inc. had outstanding 10 percent, $1,000,000 face value, convertible bonds maturing on December 31, 2005. Interest is paid December 31 and June 30. After amortization through June 30, 2002, the unamortized balance in the bond premium account was $30,000. On that date, bonds with a face amount of $500,000 were converted into 20,000 shares of $20 par common stock. Recording the
conversion by using the carrying value of the bonds, Laker should credit Additional Paid-In Capital for a.$0. b.$85,000. c.$100,000. d.$115,000. c61.On July 1, 1999, Cooper Corporation issued for $960,000 one thousand of its 9 percent, $1,000 callable bonds. The bonds are dated July 1, 1999, and mature on July 1, 2009. Interest is payable semiannually on January 1 and July 1. Cooper uses the straight-line method of amortizing bond discount. The bonds can be called by the issuer at 101 at any time after June 30, 2004. On July 1, 2005, Cooper called in all of the bonds and retired them. Ignoring income taxes, how much loss should Cooper report on this early extinguishment of debt for the year ended December 31, 2005? a.$50,000 b.$34,000 c.$26,000 d.$10,000 b62.On June 30, 2002, Country Inc. had outstanding 10 percent, $1,000,000 face amount, 15-year bonds maturing on June 30, 2007. Interest is paid on June 30 and December 31, and bond discount and bond issue costs are amortized on these dates. The unamortized balances on June 30, 2002, of bond discount and bond issue costs were $55,000 and $20,000, respectively. Country reacquired all of these bonds at 96 on June 30, 2002, and retired them. Ignoring income taxes, how much gain or loss should Country record on the bond retirement? a.Loss of $15,000 b.Loss of $35,000 c.Gain of $5,000 d.Gain of $40,000 b63.Woods, Inc. holds an overdue note receivable of $1,600,000 plus recorded accrued interest of $128,000. As a result of a court-imposed settlement on December 31, 2002, Woods agreed to the following restructuring arrangement: Reduce the principal obligation to $1,200,000. Forgive the $128,000 accrued interest. Extend the maturity date to December 31, 2004. Annual interest of $120,000 is to be paid to Woods on December 31, 2002 and 2003. On December 31, 2002, Woods must recognize a loss from structuring of a.$0. b.$288,000. c.$408,000. d.$528,000.
a64.During 2002, Daly Company experienced financial difficulties and is likely to default on a $500 ,000, 15 percent, three-year note dated January 1, 2001, and made payable to Summit Bank. On December 31, 2002, the bank agreed to settle the note and unpaid interest of $75,000 for 2002. The settlement amount is $410,000 cash payable on January 31, 2003. Ignoring income taxes, what amount should Daly report as a gain from the debt restructuring in its 2002 income statement? a.$165,000 b.$90,000 c.$75,000 d.$0 c65.Hull Company is indebted to Apex under a $500,000, 12 percent, three-year note dated December 3, 2000. Because of Hull's financial difficulties developing in 2002, Hull owed accrued interest of $60,000 on the note at December 31, 2002. Under a troubled debt restructuring, on December 31, 2002, Apex agreed to settle the note and accrued interest for a tract of land having a fair value of $450,000. Hull's acquisition cost of the land was $360,000. Ignoring income taxes, on its 2002 income statement Hull should report as a result of the troubled debt restructuring Other Income Extraordinary Gain a. $200,000 $0 b. $140,000 $0 c. $90,000 $110,000 d. $0 $200,000 d66.White Sox Corporation issued $200,000 of 10-year bonds on January 1. The bonds pay interest on January 1 and July 1 and have a stated rate of 10 percent. If the market rate of interest at the time the bonds are sold is 8 percent, what will be the issuance price of the bonds? a.$175,078 b.$211,283 c.$215,902 d.$227,183 b67.White Sox Corporation issued $200,000 of 10-year bonds on January 1. The bonds pay interest on January 1 and July 1 and have a stated rate of 10 percent. If the market rate of interest at the time the bonds are sold is 12 percent, what will be the issuance price of the bonds? a.$114,699 b.$177,059 c.$190,079 d.$224,926 b68.On January 1, 2003, $50,000 of 20-year, 6 percent debentures were issued for $56,275.20. Interest payment dates on the bonds are January 1 and July 1. The amount of premium to be amortized on July 1, 2003, when using the straight-line method is a.$313.76. b.$156.88. c.$776.50. d.$93.11.
d69.The total interest expense on a $200,000, 10 percent, 10-year bond issued at 95 would be a.$190,000. b.$195,000. c.$200,000. d.$210,000. b70.The effective interest rate of a 10-year, 8 percent, $1,000 bond issued at 103 would be approximately a.7.5 percent. b.7.8 percent. c.8.0 percent. d.8.2 percent. b71.On January 1, 2003, Deily Corporation issued $500,000 of 10 percent, 10-year bonds at 88.5. Interest is payable on December 31. If the market rate of interest was 12 percent at the time the bonds were issued, how much cash was paid for interest in 2003? a.$44,250 b.$50,000 c.$53,100 d.$60,000 c72.Assuming the straight-line method of amortization is used, the average yearly interest expense on a $250,000, 11 percent, 20-year bond issued at 94 would be a. $26,750. b.$27,500. c.$28,250. d.$29,500. d73.The annual interest expense on a $50,000, 15-year, 10 percent bond issued for $45,650 plus accrued interest 6 months after authorization, assuming straight-line amortization, would be a.$4,975. b.$5,000. c.$5,025. d.$5,300. c74.On January 1, 2003, Felipe Hospital issued a $250,000, 10 percent, 5-year bond for $231,601. Interest is payable on June 30 and December 31. Felipe uses the effective-interest method to amortize all premiums and discounts. Assuming an effective interest rate of 12 percent, how much interest expense should be recorded on June 30, 2003? a.$11,935.14 b.$12,500.00 c.$13,896.06 d.$14,729.82
d75.A $50,000 bond with a carrying value of $52,000 was called at 103 and retired. In recording the retirement, the issuing company should a.record no gain or loss. b.record a $1,500 loss. c.record a $2,000 gain. d.record a $500 gain. b76.On January 1, 2003, Felipe Hospital issued a $250,000, 10 percent, 5-year bond for $231,601. Interest is payable on June 30 and December 31. Felipe uses the effective-interest method to amortize all premiums and discounts. Assuming an effective interest rate of 12 percent, approximately how much discount will be amortized on December 31, 2003? a.$2,230 b.$1,480 c.$1,396 d.$987 b77.Kiyabu County issued a $500,000, 10 percent, 10-year bond on January 1,2003, for 113.6 when the effective interest rate was 8 percent. Interest is payable on June 30 and December 31. Kiyabu uses the effective-interest method to amortize all premiums and discounts. How much premium or discount should be amortized on June 30, 2003? a.$2,790 b.$2,280 c.$2,000 d.$1,970 c78.Kiyabu County issued a $500,000, 10 percent, 10-year bond on January 1,2003, for 113.6 when the effective interest rate was 8 percent. Interest is payable on June 30 and December 31. Kiyabu uses the effective-interest method to amortize all premiums and discounts. How much interest expense should Kiyabu record on December 31, 2003? a.$25,000.00 b.$23,810.15 c.$22,628.80 d.$19,920.10 c79.Foster Corporation issued a $100,000, 10-year, 10 percent bond on January 1, 2001, for $112,000. Foster uses the straight-line method of amortization. On April 1, 20 04, Foster reacquired the bonds for retirement when they were selling at 102 on the open market. How much gain or loss should Foster recognize on the retirement of the bonds? a.$2,000 loss b.$3,900 gain c.$6,100 gain d.$8,200 loss
a80.If a $1,000, 9 percent, 10-year bond was issued at 96 plus accrued interestone month after the authorization date, how much cash was received by the issuer? a.$967.50 b.$960.00 c.$1,007.50 d.$992.50 a81.Bonds that were authorized on January 1, 2003, and that pay interest on January 1 and July 1 of each year were issued on October 1, 2003. If the issuer's accounting year ends on December 31, how many months would any discount or premium be amortized in 2003? a.3 months b.6 months c.9 months d.12 months a82.If a $1,000, 9 percent, 10-year bond was issued at 103 plus accrued interest one month after the authorization date, how much cash did the issuer receive? a.$1,037.50 b.$1,030.00 c.$1,007.50 d.$992.50 c83.RCM Corporation, a calendar-year firm, is authorized to issue $200,000 of 10 percent, 20-year bonds dated January 1, 2003, with interest payable on January 1 and July 1 of each year. If the bonds were issued on April 1, 2003, the amount of accrued interest on the date of sale is a.$20,000. b.$10,000. c.$5,000. d.$2,500. c84.RCM Corporation, a calendar-year firm, is authorized to issue $200,000 of 10 percent, 20-year bonds dated January 1, 2003, with interest payable on January 1 and July 1 of each year. If the bonds were issued at 97 onApril 1, 2003, plus accrued interest, the amount of cash received by RCM Corporation would be a.$200,000. b.$194,000. c.$199,000. d.None of the above. b85.RCM Corporation, a calendar-year firm, is authorized to issue $ 200,000 of 10 percent, 20-year bonds dated January 1, 2003, with interest payable on January 1 and July 1 of each year. If the bonds were issued at 97 on April 1, 2003, the amount of the discount amortized on July 1 (using the straight-line method) would be approximately a.$25. b.$76. c.$67. d.$152.
c86.If a $6,000, 10 percent, 10-year bond was issued at 104 plus accrued interest two months after the authorization date, how much cash was received by the issuer? a.$6,000 b.$6,240 c.$6,340 d.$6,600 b87.ABC Corporation is authorized to issue $500,000 of 6 percent, 10-year bonds dated July 1, 2003, with interest payments on December 31 and June 30. When the bonds are issued on November 1, 2003, ABC Corporation receives cash of $515,000, including accrued interest. The journal entry to record the issuance of the bonds would include a.$15,000 bond premium. b.$5,000 bond premium. c.$15,000 bond discount. d.no bond premium or discount. b88.On January 1, 2002, Williams Company lent $17,800 cash to Stone Company. The promissory note made by Stone for $20,000 did not bear explicit interest and was due on December 31, 2004. No other rights or privileges were exchanged. The prevailing interest rate for a loan of this type was six pe rcent. Assume that the present value of $1 for two periods at six percent is .89. Stone should recognize interest expense in 2002 of a.$0. b.$1,068. c.$1,100. d.$1,200. b89.Johnson Corporation bought a new machine and agreed to pay for it in equal annual installments of $6,000 at the end of each of the next five years. Assume the prevailing interest rate for this type of transaction is 12%. Assume the present value of an ordinary annuity of $1 at 12% for five periods is 3.60. The future amount of an ordinary annuity of $1 at 12% for five periods is 6.35. The present value of $1 at 12% is 0.567. How much should Johnson record as the note payable on the balance sheet if financial statements were prepared today? a.$17,010 b.$21,600 c.$30,000 d.$38,100 d90.On December 31, 2002, Carlton Corporation's current liabilities total $50,000 and long-term liabilities total $150,000. Working capital at December 31, 2002, is equal to $80,000. If Carlton Corporation's debtto-equity ratio is .32 to 1, total long-term assets must equal a.$625,000. b.$745,000. c.$825,000. d.$695,000.
a91.On December 31, 2002, Roberts Corporation's current liabilities total $60,000 and long-term liabilities total $160,000. Working capital at December 31, 2002, is equal to $90,000. If Roberts Corporation's debtto-equity ratio is .40 to 1, total long-term assets must equal a.$620,000. b.$770,000. c.$550,000. d.$680,000. b92.On December 31, 2002, Anderson Company's current liabilities total $55,000 and long-term liabilities total $155,000. Working capital at December 31, 2002, is equal to $85,000. If Anderson Company's debtto-equity ratio is .30 to 1, total long-term assets must equal a.$910,000. b.$770,000. c.$700,000. d.$825,000. PROBLEMS Problem 1 In an effort to increase sales, Rofix Company began a sales promotion campaign on June 30, 2002. Part of this promotion included placing a special coupon in each package of candy bars sold. Customers were able to redeem ten coupons for a Frisbee. Each premium costs Rofix $1.50. Rofix estimated that 60 percent of the coupons issued will be redeemed. For the six months ended December 31, 2002, the following information is available: Packages of candy bars sold 3,200,000 Premiums purchased 172,000 Coupons redeemed 1,425,000 What is the estimated liability for premium claims outstanding at December 31, 2002? Solution 1 LO2 Number of coupons issued 3,200,000 Expected participation rate x 60% Expected coupon redemptions 1,920,000 x 10% Estimated total premiums 192,000 Number redeemed to date (1,425,000 coupons x 10%) Expected remaining premiums 49,500 49,500 premiums @ $1.50 each = $ 74,250
- 142,500
Problem 2 Monumental Studios, in an effort to promote the release of their new movie "Ninjas from Space," began a national sales promotion campaign. Two coupons from specially marked boxes (one coupon in each box) of "Sugar Charms" cereal are redeemable for one ticket to the show. Tickets cost Monumental $1.50 each. Monumental estimates that 40 percent of the coupons will be redeemed. At the end of 2002, the following information is available:
Boxes of cereal sold 640,000 Movie tickets purchased by Monumental Coupons redeemed 250,000
140,000
What is the estimated liability for premium claims outstanding at December 31, 2002? Solution 2 LO2 Number of coupons available 640,000 Expected redemption rate x 40% 256,000 (two coupons per ticket) x 50% Estimated premiums................................................... 128,000 Premiums redeemed to date (250,000/ 2 coupons per ticket)......... Expected remaining premiums 3,000 3,000 tickets x $1.50 each = $ 4,500
125,000
Problem 3 On March 1, 2002, Pyne Furniture Co. issued $700,000 of 10 percent bonds to yield 8 percent. Interest is payable semiannually on February 28 and August 31. The bonds mature in ten years. Pyne Furniture Co. is a calendar-year corporation. (1) Determine the issue price of the bonds. Show your computations. (2) Prepare an amortization table through the first two interest periods using the effective-interest method. (3) Prepare the journal entries to record bond-related transactions as of the following dates: (a) March 1, 2002 (b) August 31, 2002 (c) December 31, 2002 (d) February 28, 2003 Solution 3 LO4 (1) Calculation of bond sale price: i = 4% n = 20 Present value of the face amount ($700,000 x .4564) $319,480 Present value of the interest ($35,000 x 13.5903) 475,661 $795,141 (2) Amortization table: InterestInterest Amortization Carrying Date Payment Expense of Premium Value 3/1/2002 $795,141 8/31/2002 $35,000 $31,806 * $3,194 791,947 2/28/2003 35,000 31,678 ** 3,322 788,625
Computations: * $795,141 x 4% = $31,806 ** $791,947 x 4% = $31,678 (3) Journal entries: (a)3/1/2002 Cash 795,141 Premium on Bonds Payable 95,741 Bonds Payable 700,000 (b)8/31/2002 Interest Expense 31,806 Premium on Bonds Payable 3,194 Cash 35,000 (c)12/31/2002Interest Expense ($31,678 x 4/6) 21,119 Premium on Bonds Payable ($3,322 x 4/6)2,215 Interest Payable ($35,000 x 4/6) 23,334 (d)Assuming no reversing entries: 2/28/2003Interest Payable 23,334 Premium on Bonds Payable 1,107 Interest Expense 10,559 Cash 35,000 Problem 4 On June 1, 2002, Jefferson Controls, Inc. issued $12,000,000 of 10 percent bonds to yield 12 percent. Interest is payable semiannually on May 31 and November 30. The bonds mature in 15 years. Jefferson Controls, Inc. is a calendar-year corporation. (1) Determine the issue price of the bonds. Show computations. (2) Prepare an amortization table through the first two interest periods using the effective-interest method. (3) Prepare the journal entries to record bond-related transactions as of the following dates: (a) June 1, 2002 (b) November 30, 2002 (c) December 31, 2002 (d) May 31, 2003 Solution 4 LO4 (1) Calculation of bond sale price: i = 6% n = 30 Present value of face amount ($12,000,000 x .1741)$ 2,089,200 Present value of interest ($600,000 x 13.7648) 8,258,880 $10,348,080
(2) Amortization table: Interest Interest Amortization Carrying Date Payment Expense of Discount Value 6/1/2002 $10,348,080 11/30/2002$600,000 $620,885* $20,885 10,368,965 5/31/2003 600,000 622,138** 22,138 10,391,103 Computations: * $10,348,080 x 6% = $620,885 ** $10,368,965 x 6% = $622,138 (3) Journal entries: (a)6/1/2002 Cash 10,348,080 Discount on Bonds Payable 1,651,920 Bonds Payable 12,000,000 (b)11/30/2002Interest Expense Cash 600,000 Discount on Bonds Payable
620,885 20,885
(c)12/31/2002Interest Expense($622,138 x1/6=$103,690)103,690 Discount on Bonds Payable($22,138 x 1/6 = 3,690)3,690 Interest Payable ($600,000 x 1/6) 100,000 (d)Assuming no reversing entries: 5/31/2003Interest Expense 518,448 Interest Payable 100,000 Discount on Bonds Payable 18,448 Cash 600,000 Problem 5 The December 31, 2002, balance sheet of Far Imports includes the following items: 9% bonds payable due 12/31/2011 $800,000 Discount on bonds payable 21,600 The bonds were issued on December 31, 2001, at 97, with interest payable on June 30 and December 31 of each year. The straight-line method is used for discount amortization. On March 1, 2003, Far Imports retired $400,000 of these bonds at 98 plus accrued interest. Prepare the journal entries to record retirement of the bonds, including accrual of interest since the last payment and amortization of the discount. Solution 5 LO4 3/1/2003Interest Expense 6,000 Interest Payable 6,000 ($400,000 x 9% x 2/12)
Interest Expense 200 Discount on Bonds Payable 200 $24,000/10 years = $2,400 per year $2,400 x ½ x 2/12 = $200 Interest Payable 6,000 Bonds Payable 400,000 Loss on Early Retirement of Bonds** 2,600 Discount on Bond Payable* 10,600 Cash ($392,000 + $6,000) 398,000 *$10,800 - $200 = $10,600 **Reacquisition Price ($400,000 x 98%)$ 392,000 Carrying Value ($400,000 - $10,600) 389,400 Loss on Early Retirement of Bonds $ 2,600 Problem 6 On May 1, 2001, J. Cumming acquired $300,000 of Belred Enterprises 12 percent bonds due in five years with interest payable semiannually on May 1 and November 1. The bonds were purchased at $325,268--a price to return 10 percent on the investment. On November 1, 2001, and May 1, 2002, Cumming collected the interest on the bonds. On August 1, 2002, Cumming sold the bonds at 107 plus accrued interest. Rounding figures to the nearest dollar, provide the entries required to record the: (1) Interest collections in 2001 and 2002, assuming that the entries for the premium amortization are made at the time interest is collected. (Use the effective-interest method.) (2) Sale of bonds. Solution 6 LO4 (1)2001 Nov. 1 Cash ($300,000 x 12% x 6/12) 18,000 Interest Revenue* 16,263 Investment in Carpenter Bonds 1,737 2002 May 1 Cash 18,000 Interest Revenue** 16,177 Investment in Carpenter Bonds
1,823
(2)Aug. 1Cash*** 330,000 Interest Revenue**** 8,043 Investment in Carpenter Bonds 321,708 Gain on Sale of Investment 249 * ($325,268 x 10% x 6/12) = $16,263 ** [($325,268 - $1,737) x 10% x 6/12] = $16,177 *** [$321,000 + ($300,000 x 12% x 3/12)] = $330,000 **** [($325,268 - $1,737 - $1,823) x 10% x 3/12] = $8,043
Problem 7 On February 1, 2001, AmeriGas sold $300,000, 12 percent, ten-year bonds at 96 plus accrued interest. Interest is payable semiannually on June 1 and December 1. The bond issue was dated December 1, 2000. On July 31, 2002, $150,000 of the issue was reacquired at 95 plus accrued interest. Make the entries on the issuer's books for the sale of the bonds, the payment of interest, amortization of premium or discount, and accrual of interest, and reacquisition as needed for 2001 and 2002. Straight-line amortization is recorded at the end of the calendar year and accruals are reversed. (Round all calculations.) Solution 7 LO4 2001 Feb. 1 Cash 294,000 Discount on Bonds Payable 12,000 Interest Expense 6,000 Bonds Payable 300,000 June 1 Interest Expense Cash 18,000
18,000
Dec. 1 Interest Expense Cash 18,000
18,000
Dec. 31 Interest Expense 4,119 Discount on Bonds Payable (11/118 x $12,000) Interest Payable 3,000 2002 Jan. 1 Interest Payable Interest Expense June 1 Interest Expense Cash 18,000
3,000 3,000 18,000
July 31 Interest Expense (7/118 x $6,000) Discount on Bonds Payable 356
356
July 31 Bonds Payable 150,000 Interest Expense 6,000 Discount on Bonds Payable 5,085 Cash 148,500 Gain on Bond Reacquisition 2,415 Note: $150,000 of bonds remain outstanding.
1,119
Problem 8 Whitmore Industries is late on interest payments of $100,000 on 10 -year bonds outstanding of $1,000,000. The bonds were originally sold at 97 on the issue date and have 7-1/3 years remaining life. Whitmore uses the straight-line method of amortization. To settle the debt, Whitmore transfers inventory with a book value of $700,000 and a market value of $800,000 (perpetual inventory system). Diane Inc. holds $100,000 face value of the Whitmore bonds. The carrying value and interest receivable on Diane's books are proportionate to the total issue. Give the entries to record the transfer on the books of Whitmore and Diane. Solution 8 LO8 Whitmore Industries Interest Payable 100,000 Bonds Payable 1,000,000 Cost of Goods Sold 700,000 Sales 800,000 Inventory 700,000 Discount on Bonds Payable 22,000 Gain on Restructuring of Debt* 278,000 * Bond issue price $ 970,000 Discount amortized ($30,000 x 32/120) Bond carry value $ 978,000 Interest payable 100,000 Debt carrying value $1,078,000 Market value of inventory 800,000 Gain on restructuring $ 278,000
8,000
Diane Inc. Inventory 80,000 Loss on Restructuring of Debt 27,800 Investment in Whitmore Bonds 97,800 Interest Receivable 10,000 * Investment in bonds $ 97,800 Interest receivable 10,000 Carrying value of debt $107,800 Less market value of inventory 80,000 Loss on restructuring $ 27,800 Problem 9 Evanston Manufacturing is faced with possible bankruptcy. Evanston has $2,000,000 bonds outstanding with an unamortized premium of $68,500. Furthermore, Evanston is behind $125,000 in interest payments. To satisfy the debt, Evanston transfers 60,000 shares of $10 par value stock with a current market value of $33.75.
Blue Ash Corporation holds $125,000 face value of the Evanston bonds. The carrying value and interest receivable on Blue Ash's bond holdings are proportionate to the total issued. Give the entries to record the equity transfer on the books of Evanston and Blue Ash. Solution 9 LO8 Evanston Manufacturing Interest Payable 125,000 Bonds Payable 2,000,000 Premium on Bonds Payable 68,500 Common Stock (60,000 x $10) 600,000 Paid-In Capital in Excess of Par (60,000 x $23.75)1,425,000 Gain on Restructuring of Debt 168,500
Blue Ash Corporation Investment in Evanston Common Stock (125/2,000 x $2,025,000) 126,563 Loss on Restructuring of Debt 10,531 Investment in Evanston Bonds (125/2,000 x $2,068,500)129,281 Interest Receivable (125/2,000 x $125,000)7,813 Problem 10 On January 1, 2001, Kate Products issued ten-year convertible bonds of $1,800,000 at 105. Interest is payable semiannually on June 30 and December 31 at a rate of 12 percent. On June 30, 2003, the company retired bonds of $150,000 at 102 plus accrued interest. Straight-line amortization is recorded at the end of the calendar year. (1) Provide the entries required to record the issuance and retirement of the bonds. (2) Assuming that each $1,000 bond is convertible into eight shares of Kate Products' $120 par common stock (with market value of $130), provide the entries on June 30, 2000, for the two methods that may be used to record a conversion rather than a retirement of $150,000 of bonds. Solution 10 LO4 (1) 2001 Jan. 1 Cash ($1,800,000 x 1.05) 1,890 000 Bonds Payable 1,800,000 Premium on Bonds Payable 90,000 2003 June 30 Premium on Bonds Payable (6/120 x $150,000/$1,800,000 x $90,000) 375 Interest Expense 375
June 30 Bonds Payable 150,000 Premium on Bonds Payable (78/120 x $150,000 / $1,800,000 x $90,000) 4,875 Interest Expense 9,000 Gain on Bond Retirement 1,875 Cash 162,000 (2)Stock recorded at book value of bonds: 2003 June 30 Premium on Bonds Payable 375 Interest Expense 375 Bonds Payable 150,000 Premium on Bonds Payable 4,875 Interest Expense 9,000 Cash 9,000 Common Stock (1,200 shares x $120)144,000 Paid-In Capital in Excess of Par 10,875 Stock recorded at market value of stock: 2003 June 30 Premium on Bonds Payable 375 Interest Expense 375 Bonds Payable 150,000 Premium on Bonds Payable 4,875 Interest Expense 9,000 Loss on Conversion of Bonds 1,125 Cash 9,000 Common Stock (1,200 shares x $120)144,000 Paid-In Capital in Excess of Par 12,000 Problem 11 On January 2, 1997, Picard Enterprises issued $2,400,000 of 8 percent, 15-year semiannual coupon bonds to yield 7.5 percent. Each bond is convertible into 40 shares of $15 par common stock, which was trading at $20 per share on the date of the bond issue. The bonds were issued at 106. Without the conversion feature, the bonds would have been issued for 104.5. On January 3, 2002, all of the bonds were converted into common stock. The market price of the stock was $28 per share on the date of conversion. The issue premium is amortized using the straight-line method. (1)Provide the journal entry to record issuance of the bonds. (2)Provide the journal entry to record the conversion of the bonds assuming Picard considers the conversion (a)not to be a significant culminating transaction. (b)to be a significant culminating transaction.
(3)Explain the theoretical justification for either the book value or market value method of recording conversion. Solution 11 LO4 (1)Issuance of Bonds: Cash ($2,400,000 x 106%) 2,544,000 Bonds Payable 2,400,000 Premium on Bonds Payable 144,000 (2)Conversion: (a) Book value method: Bonds Payable 2,400,000 Premium on Bonds Payable 96,000 Common Stock (2,400 x 40 x $15 par) 1,440,000 Paid-In Capital in Excess of Par 1,056,000 Note: The bonds were converted after five years, so 1/3 of the $144,000 issue premium would have been amortized and 2/3 would be unamortized at the date of conversion. (b) Bonds Payable 2,400,000 Premium on Bonds Payable 96,000 Loss on Conversion 192,000 Common Stock (2,400 x 40 x $15 par) 1,440,000 Paid-In Capital in Excess of Par (2,400 x 40 x $13) 1,248,000 Note: Paid-In Capital in Excess of Par would be credited for $13 per share ($28 fair market value - $15 par). A loss is recorded for the difference between the fair market value of the stock and the carrying value of the bonds. (3)Theoretical justification: Book value method: Most companies record the conversion using the book value method because they do not want to record a loss on the conversion, which generally arises because an increase in the market value of the stock triggers the conversion. Use of the book value method is theoretically justified if the conversion is viewed as the second step of a two-step transaction to issue common stock, the first step being the issuance of the convertible bonds. Since the issuer's intent was ultimately to issue stock, and the issue price received in cash is the issue price of the bonds, the book value method accurately reflects the amount of capital provided by the financing. Market value method: If the issuance of convertible debt is viewed as a separate and independent transaction from the conversion of the debt, the market value method would be used. Proponents of this view argue that the issuance of the bonds is a debt transaction and that the loss that generally results upon conversion should be recorded to disclose the amount of capital foregone by issuing stock through a convertible debt security. The major advantage to the market value method is that contributed capital is stated at a higher amount than under the book value method, which may be interpreted positively in the consideration of capital structure. However, the higher con tributed capital is achieved by a corresponding reduction in retained earnings, so total stockholders' equity is the same using both methods. Since the
increase in contributed capital also necessitates a ch arge against earnings, most companies prefer to record the conversion using the book value method. Problem 12 Debt securities frequently are issued with a convertible feature that permits the ho lder to convert the bond certificates into a determinable number of shares of common stock at any time before the conversion privilege expires. The conversion feature offers many advantages and some disadvantages both to the issuer and the investor,however. Identify the advantages of convertible debt both to the issuer and the investor. Solution 12 LO4 Convertible bonds offer a number of advantages to the issuer. The bonds typically sell at a price considerably above that which could be obtained for nonconvertible bonds with the same contractual interest rate due to the conversion feature. The conversion feature also reduces the number of restrictions on the debt than would be found with nonconvertible debt, again as a result of the perceived value of the conversion feature. The convertibility feature enhances an enterprise's prospects for raising debt capital. The cost of equity capital also is lowered through the use of convertible debt. The issuer can set the conversion price above the prevailing stock price and thus issue fewer shares to obtain the same amount of capital. If the bonds actually are converted, the issuer is not required to pay the maturity value of the bonds. Disadvantages associated with convertible debt for the issuer include the possiblity that the conversion feature will not be exercised by investors. If stock prices remain stable or fall, then investors have little desire to own the stock and will hold the debt to receive the interest payments. The fact that investors choose not to convert means that the issuer must then continue to service the debt. The servicing of the debt may become burdensome since the failure of the stock price to rise to a level to make conversion attractive to investors may be indicative of financial difficulties of the issuer. The issuer is then left with the burden of servicing the debt under more difficult circumstances. Alternatively, if the stock price rises, the issuer still incurs a cost, namely, the opportunity cost of foregoing the sale of the shares converted at a higher price. Major advantages to the investor in convertible debt include the security provided by fixed interest payments and payment of the maturity value should the issuer not prove to be successful to the degree that conversion is desirable. Additionally, the investor has the option of becoming an equity holder should the enterprise prove to be extremely successful thus enhancing the potential for increased wealth in terms of both price appreciation of the shares and/or larger cash flows from dividends. Problem 13 The Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 133, "Accounting for Derivatives and Hedging Activities," as part of its project on financial instruments and its effort to deal with off-balance-sheet financing. Explain what is meant by the term "off-balance-sheet financing" and give two reasons why " off-balancesheet financing" is attractive to the management of an enterprise.
Solution 13 LO5 Off-balance-sheet financing is an attempt to borrow money such that the obligation is not recorded. Longterm liability measurement and disclosure are important in measuring the risk and financial strength of an enterprise. The criteria for recognizing liabilities are imprecise and, as a result, creative individuals have devised financial instruments that avoid the criteria for recognition of a liability. Such financial instruments allow enterprises to raise debt capital without reporting liabilities. Off-balance-sheet financing is attractive to managers because it allows an enterprise to raise debt capital without reporting the associated liability. The debt-equity ratio of the enterprise thus is not increased. An increase in the debt-equity ratio can be a major problem if the debt-equity ratio already is considered high. A high debt-equity ratio suggests that the enterprise has greater risk, particularly if business conditions deteriorate since interest payments must be made even though profits have declined. Shareholders who wish to avoid such risk may sell their shares in the stock of the enterprise thus causing the price of the shares to decline. Additionally, creditors may view the enterprise as "loaded-up" with debt and may refuse to grant additional credit due to the risk associated with an enterprise with high levels of existing debt. Off-balance-sheet financing also is attractive to management because of restrictions related to debt covenants. Existing debt covenants with current bond-holders may include restrictions designed to protect the investments of the bond-holders. A very common covenant in this regard is to prevent an enterprise from issuing additional debt without the consent of the existing bondholders. A similar restriction frequently is used by banks in making loans. Off-balance-sheet financing is a means of issuing additional debt without reporting the debt and thus without technically violating existing debt covenants. F ailure to disclose information about these off-balance-sheet financing activities hinders investors and creditors in assessing the risk associated with an enterprise. Problem 14 On December 31, 2001, International Refining Company purchased machinery having a cash selling price of $85,933.75. The company paid $10,000 down and agreed to finance the remainder by making four equal payments each December 31 at the implicit interest rate of 12%. (1)Determine the amount of the annual payments to be made under the financing agreement. (2)Prepare the journal entry to record the acquisition of the machinery on December 31, 2001. (3)Prepare the journal entry at December 31, 2002. Solution 14 LO3 (1) The total cash price of the machinery is $85,933.75. The company paid $10,000 down, leaving a balance of $75,933.75 to finance. This amount represents the present value of four payments of unknown amounts discounted at 12%. The problem can be solved by dividing the amount to be financed, $75,933.75, by the factor for the present value of an annuity for 4 years at 12%: 3.03735 = $25,000÷
$75,933.75
(2) The journal entry to record the acquisition of the machinery at December 31, 2001, would be: Machinery.............................. ...................
85,933.75
Discount on Notes Payable........................... 24,066.25 Cash. 10,000 Notes Payable 100,000
(3) The journal entry at December 31, 2002, would be: Notes Payable 25,000.00 Interest Expense 9,112.05 Cash 25,000.00 Discount on Notes Payable 9,112.05 Problem 15 The globalization of business has caused many changes in how enterprises are managed. One such change is illustrated by U.S. enterprises obtaining loans denominated in foreign currencies. Identify reasons why such borrowings may occur. Solution 15 LO7 U.S. companies may obtain loans denominated in foreign currencies for any or all of the following reasons: (1)Some countries are reluctant to allow large multinational corporations to do business in their countries without using local financing. (2)Use of local sources of financing helps to establish and maintain good local relations. (3)Subsidiaries of large multinational corporations may be relatively self contained, resulting in virtually all operating, investing, and financing activities being handled locally. (4)Interest rates in foreign markets may be low relative to those in d omestic markets. (5)Loans denominated in foreign currencies may serve as a hedge of assets held by the company which are denominated in foreign currency. Problem 16 Footnote disclosures for long-term liabilities provide information the is not conveniently presented in the balance sheet. Although detailed disclosure requirements exist for certain specialized obligations, a set of general disclosure requirements is applicable to most enterprises. Identify the general disclosure requirements for long-term liabilities.
Solution 16 LO7 The following represent general disclosure requirements related to long-term liabilities: (1) Interest rates, maturity dates, debt restrictions, call provisions, and conversion privileges. (2) Any assets pledged as collateral for debt. (3)Aggregate maturity amounts and sinking fund requirements for all long-term liabilities for each of the five years following the balance sheet date. (4)Long-term debt maturing within one year should be reported as a current liability,unless retirement is to be completed through the use of assets other than current assets. (5)For unconditional purchase obligations actually recorded on the balance sheet,disclosure must be made of payments to be made under the obligation for each of the next five years. (6)For unconditional purchase obligations not shown on the face of the balance sheet, the following disclosures are required: a.The nature and term of the obligations. b.The total amount of the fixed and determinable portion of the obligations at the balance sheet date and for each of the next five years. c.The nature of any variable portions of the obligations. d.The amounts purchased under the obligations for each period for which an income statement is presented.
CHAPTER 10 -- QUIZ A Name _________________________ Section ________________________ T F 1. As defined by the FASB, a liability is recorded as a result of past events or transactions. T F 2. The currently maturing portion of long-term debt should be included in current liabilities if payment will require the use of current assets. T F 3. According to FASB Statement No. 6, one of the following conditions must be met before a short-term obligation may be properly excluded from the current liability classification: (1) management must intend to refinance on a long-term basis or (2) management must demonstrate an ability to refinance the obligation. T F 4. The ability to refinance, according to FASB Statement No. 6, can be demonstrated only by actually refinancing the obligation between the balance sheet date and the date the statements are issued. T F 5. Zero-interest bonds sell at a significant discount that provides an investor with a total interest payoff at maturity. T F 6. Bonds with a variable or floating interest rate reduce the risk to the investor if interest rates rise and reduce the risk to the issuer if interest rates decline. T F 7.
The term "junk bonds" is frequently applied to low-yield bonds.
T F 8. If the stated interest rate for a bond issue exceeds the market interest rate, the bonds will sell at a discount. T F 9. Bond issuance costs must be reported separately as deferred charges and charged to expense over the life of the bond issue. T F 10. Convertible bonds can be exchanged for another form of security, such as common stock, at the option of the issuer. CHAPTER 10 -- QUIZ B Name _________________________ Section ________________________ T F 1. Callable bonds may be redeemed prior to maturity at the option of the issuer. T F 2. The amortization of bond discount reduces interest expense to an amount less than the interest actually paid to bondholders. T F 3. The amortization of bond premium increases the carrying value of the bonds on the books of the issuer. T F 4. The effective-interest method provides for an increasing premium or discount amortization each period.
T F 5. Although the effective-interest method is the recommended method of bond premium or discount amortization, the straight-line method is acceptable in some circumstances. T F 6. Over the life of a bond issue, total premium or discount amortization computed using the effective-interest method exceeds the amount that would have been computed under the straight-line method. T F 7. There is no recognition of any gain or loss on the retirement of bonds at maturity, since the carrying value is equal to the maturity value. T F 8. When debt is retired prior to its maturity date, a gain or loss must be recognized for the difference between the carrying value of the debt security and the amount paid. T F 9. Under generally accepted accounting principles, gain or loss must be recognized on the conversion of bonds into equity securities. T F 10. In-substance defeasance is a process of transferring assets to an irrevocable trust, using the assets and earnings therefrom to satisfy the long-term debt as it comes due.
