Chapter 14
Bonds and Long-Term Notes
Exercise 14-1
1. Price of the bonds at January 1, 2013
Interest Principal
$ 12,000,000 ¥ $240,000,000
x x
11.46992 * 0.31180 **
Present value (price) of the bonds ¥
5% x $240,000,000
*
present value of an ordinary annuity of $1: n=20, i=6%
= =
$137,639,040 74,832,000 $212,471,040
** present value of $1: n=20, i=6%
2. January 1, 2013
Cash (price determined above)....................................... ....................................... 212,471,040 212,471,040 Discount on bonds (difference).......... ............... .......... ............ ............... ........ 27,528,9 27,528,960 60 Bonds payable (face amount).................................. 240,000,000 3. June 30, 2013
Interest expense (6% x $212,471,040)............................... 12,748,262 Discount on bonds payable (difference).................. 748,262 Cash (5% x $240,000,000)........................................ 12,000,000 4. December 31, 2013
Interest expense (6% x [$212,471,040 + 748,262)............ 12,793,158 Discount on bonds payable (difference).................. 793,158 Cash (5% x $240,000,000)........................................ 12,000,000
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Exercise 14-2 Requirement 1 Schmidt (Issuer)
Cash (102% x $60 million)........................................... Convertible bonds payable (face amount)............... Premium on bonds payable (difference)..................
61,200,000 60,000,000 1,200,000
Facial Mapping (Investor)
Investment in convertible bonds (10% x $60 million).. Premium on bond investment (difference)..................... Cash (102% x $6 million).........................................
6,000,000 120,000 6,120,000
Requirement 2 Schmidt (Issuer)
Interest expense ($2,700,000 - $60,000)............................ Premium on bonds payable ($1,200,000 ÷ 20)............. Cash (4.5% x $60,000,000).......................................
2,640,000 60,000 2,700,000
Facial Mapping (Investor)
Cash (4.5% x $6,000,000)............................................. Premium on bond investment ($120,000 ÷ 20)........ Interest revenue ($270,000 - $6,000)............................
270,000 6,000 264,000
[Using the straight-line method, each interest entry is the same.] Requirement 3 Schmidt (Issuer)
Convertible bonds payable (10% of the account balance) Premium on bonds payable (($1,200,000 - [$60,000 x 11]) x 10%)....................... Common stock ([6,000 x 40 shares] x $1 par)............ Paid-in capital – excess of par (to balance).............
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6,000,000 54,000 240,000 5,814,000
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Facial Mapping (Investor)
Investment in common stock (to balance)...................... Investment in convertible bonds (account balance).. Premium on bond investment ($120,000 - [$600 x 11])
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6,054,000 6,000,000 54,000
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Exercise 14-3 Requirement 1 June 30, 2013
Interest expense (5% x $368 million) Discount on bonds paable (di!!erence) #as (4% x $400 million)
18,400,000 ",400,000 16,000,000
Requirement 2 December 31, 2013 Interest expense (5% x $368 million & "'4 million) Discount on bonds paable (di!!erence) #as (4% x $400 million)
18,5"0,000 ",5"0,000 16,000,000
Requirement 3
e interest entries increased te boo* +alue !rom $368,000,000 to $3",-"0,000' o increase te boo* +alue to $36,000,000, .nnatural needed te !ollo/in entr .nreali2ed oldin loss air +alue adustment ($36,000,000 3",-"0,000)
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3,080,000 3,080,000
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PROBLEMS Problem 14-1 Requirement 1
1 2 3 4 5 6 7 8
Cash Interest
Effective Interest
4.5% x Face Amount
5% x Outstanding Balance
9,000 9,000 9,000 9,000 9,000 9,000 9,000 9,000
.05(193,537) = 9,677
72,000
78,463
.05(194,214) = 9,711 .05(194,925) = 9,746 .05(195,671) = 9,784 .05(196,455) = 9,823 .05(197,278) = 9,864 .05(198,142) = 9,907 .05(199,049) = 9,951*
Increase in Balance
Outstanding Balance
677 711 746 784 823 864 907 951
193,537 194,214 194,925 195,671 196,455 197,278 198,142 199,049 200,000
6,463
* rounded.
Requirement 2
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Cash Interest
4.5% x Face Amount
1 2 3 4 5 6 7 8
9,000 9,000 9,000 9,000 9,000 9,000 9,000 9,000
Recorded Interest
Increase in Balance
Cash plus Discount Reduction
$6,463 ÷ 8
(9,000 + 808) (9,000 + 808) (9,000 + 808) (9,000 + 808) (9,000 + 808) (9,000 + 808)
= = = = = =
(9,000 + 808)
=
(9,000 + 808)
=
72,000
9,808 9,808 9,808 9,808 9,808 9,808 9,808 9,808
808 808 808 808 808 808 808 808
78,463
6,463
Outstanding Balance
193,537 194,345 195,153 195,961 196,769 197,577 198,385 199,192* 200,000
* rounded.
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Problem 14-1 (continued)
Requirement 3
(effective interest) Interest expense (5% x $196,455)...................................... Discount on bonds payable (difference).................. Cash (4.5% x $200,000)............................................ (straight-line) Interest expense (9,000 + 808)........................................... Discount on bonds payable (6,463 ÷ 8)................... Cash (4.5% x $200,000)............................................
9,823 823 9,000
9,808 808 9,000
Requirement 4
By the straight-line method, a company determines interest indirectly by allocating a discount or a premium equally to each period over the term to maturity. This is allowed if doing so produces results that are not materially different from the interest method. The decision should be guided by whether the straight-line method would tend to mislead investors and creditors in the particular circumstance. Allocating the discount or premium equally over the life of the bonds by the straight-line method results in an unchanging dollar amount of interest each period. By the straight-line method, the amount of the discount to be reduced periodically is calculated, and the effective interest is the “plug” figure . Unchanging dollar amounts like these are not produced when the effective interest approach is used. By that approach , the dollar amounts of interest vary over the term to maturity because the percentage rate of interest remains constant, but is applied to a changing debt balance. Remember that the “straight-line method,” is not an alternative method of determining interest in a conceptual sense, but is an application of the materiality concept. The appropriate application of GAAP, the effective interest method, is bypassed as a practical expediency in situations when doing so has no “material” effect on the results.
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Problem 14-1 (concluded)
Requirement 5
The amortization schedule in requirement 1 gives us the answer – $19,728. The outstanding debt balance after the June 30, 2015, interest payment (line 5) is the present value at that time ($197,278) of the remaining payments. Since $20,000 face amount of the bonds is 10% of the entire issue, we take 10% of the table amount. This can be confirmed by calculating the present value: Interest Principal
$ 900 ¥ x $20,000 x
2.72325 * 0.86384 **
Present value (price) of the bonds
= =
$2,451 17,276 $19,727 (rounded)
¥
4.5% x $20,000
*
present value of an ordinary annuity of $1: n=3, i=5%
** present value of $1: n=3, i=5%
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Problem 14-2 Requirement 1
Interest $ 25,000 ¥ x Principal $500,000 x
3.16987 * 0.68301 **
= =
Present value (price) of the note
$ 79,247 341,505 $420,752
¥
5% x $500,000
*
present value of an ordinary annuity of $1: n=4, i=10%
** present value of $1: n=4, i=10%
Operational assets (price determined above)..................... Discount on notes payable (difference)........................... Notes payable (face amount).......................................
420,752 79,248 500,000
Requirement 2
Dec.31
Cash Interest
2013 25,000 2014201425,000 2015 25,000 2016 25,000 100,000
Effective Interest
.10(420,753) = 42,075 .10(437,827) = 43,783 .10(456,610) = 45,661 .10(477,271) = 47,729* 179,248
Increase in Balance
17,075 18,783 20,661 22,729
Outstanding Balance
420,752 437,827 456,610 477,271 500,000
79,248
* rounded
Requirement 3
Interest expense (market rate x outstanding balance)........... Discount on notes payable (difference)....................... Cash (stated rate x face amount)....................................
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45,661 20,661 25,000
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Problem 14-2 (concluded)
Requirement 4
$420,753 amount of loan
÷
3.16987 =
$132,735
(from Table 6A-4) n=4, i=10%
installment payment
Requirement 5
Dec.31
Cash Payment
Effective Interest
Decrease in Balance
10% x Outstanding Balance
Balance Reduction
2013 132,735 .10(420,753) 20142014132,735 .10(330,093) 2015 132,735 .10(230,367) 2016 132,735 .10(120,669) 530,940
= = = =
42,075 33,009 23,037 12,066* 110,187
90,660 99,726 109,698 120,669
Outstanding Balance
420,753 330,093 230,367 120,669 0
420,753
* rounded
Requirement 6
Interest expense (market rate x outstanding balance)........... Note payable (difference)................................................ Cash (payment determined above)..................................
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23,037 109,698 132,735
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Problem 14-3 Requirement 1
Bonds payable (face amount).......................................... Premium on bonds (20 / 40 x $30,000,000)........................ Gain on early extinguishment (to balance)................. Cash ($100,000,000 x 102%).......................................
100,000,000 15,000,000 13,000,000 102,000,000
Requirement 2
Bonds payable (face amount).......................................... Premium on bonds (10 / 40 x $30,000,000)........................ Gain on early extinguishment (to balance)................. Cash (given)..............................................................
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50,000,000 7,500,000 5,000,000 52,500,000
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