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Chapter 14

Long-Term Liabilities
QUESTIONS
1. A bond is a liability of the issuing company. A share of stock represents an ownership
interest in the company.
2. Notes payable generally involve borrowing from a single creditor, whereas bonds
payable are usually sold to many different lenders (bondholders).
3. A trustee for bondholders has the responsibility of monitoring the issuers actions,
financial performance, and financial condition to ensure that the obligations in the bond
indenture are met.
4. Bonds can allow a companys owners to increase their return on equity without
investing additional amounts. This result occurs as long as the rate of return on the
assets acquired from the borrowed cash is greater than the interest rate paid on the
bonds. Bonds also help the current owners remain in control of the company. There is
also a tax advantage with bonds when issued by corporations.
5. A bond indenture is a legal contract between the issuing company and the bondholders
that identifies the obligations and rights of both parties. It specifies such items as the
par value of the bonds, the contract interest rate, the due dates for interest payments,
and the maturity date(s) of the bonds. It also may name a trustee, describe the bond
issue in detail, and provide for a sinking fund.
6. The contract rate is the rate that is identified in the bond indenture. It is applied to the
par value to determine the size of the cash interest payments. The market rate is the
consensus rate that a company is willing to pay and that investors are willing to accept
for a specific bond.
7. In general, the supply of and demand for bonds affect market rates. The market rate for
a particular bond issue is also affected by risks unique to the issuer (e.g., financial
performance and condition) and the length of time until the bonds mature.
8.B The effective interest method creates a constant rate of interest over a bonds life
because the market rate at the time of issuance is multiplied by the beginning balance
for each period. The straight-line method produces either an increasing or decreasing
rate because it allocates the same amount of expense to each period, even if the liability
balance is growing (a discount) or decreasing (a premium).
9. When issuing bonds between interest dates, a company collects accrued interest from
the purchasers to avoid keeping detailed records of bond purchasers and the dates
when bonds are purchased. If the company did not collect accrued interest, individual
checks would be needed to pay the correct amount of interest to each purchaser. By
collecting in advance, the issuer merely distributes the same amount per check to all
bondholders, regardless of when they purchased the bonds.

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10. The price of bonds can be computed by using the market rate to find the present value
of both the par value at maturity and the periodic cash interest payments.
11. The issue price of a $2,000 bond sold at 98 is 98.25% of $2,000, or $1,965. The issue
price of a $6,000 bond priced at 101 is 101.5% of $6,000, or $6,090.
12. Installment notes usually require one of two payment patterns: (1) payments of accrued
interest plus equal amounts of principal, and (2) equal total payments that consist of
changing amounts of interest and principal.
13. An increase in this ratio can indicate that there has been a shrinkage in the pool of
assets available for paying the companys unsecured liabilities. It can also indicate that
the value of the company's assets in liquidation is low. In either case, the unsecured
creditors lower their confidence in the company's ability to meet its obligations from
operations.
14. An entrepreneur (owner) must repay the bondholders the principal (par value) according
to the term of the bonds. He or she must also pay interest on the bonds per the amount
and frequency cited in the bond indenture, and must adhere to any stipulations
(covenants) specified in the bond contract.
15. Krispy Kreme does show long-term debt on the balance sheet. To determine whether
the long term debt is comprised of bonds or other obligations we can read footnote 7
disclosing debt details of the company. The footnote reports that its long-term debt is
comprised of term loans and lines of credit, not bonds.
16. Per Tastykakes December 28, 2002, statement of cash flows (financing section), the
company repaid $2,117,092 for the fiscal year ended December 28, 2002.
17. The financing section of the statement of cash flows of Harley-Davidson indicates that
for the year ended December 31, 2002, the company issued common stock under
employee stock option plans totaling $12,679,000. For that same period, the company
reports proceeds from issuing finance debt of $165,528,000.
18.C If a lease qualifies to be recorded as a capital lease then an asset account for the leased
asset will be debited with an amount equal to the present value of the future lease
payments. The corresponding credit will be to a lease liability account.
19.C An operating lease is a short-term or cancelable lease in which the lessor retains the
risks and rewards of ownership. The lessee expenses operating lease payments when
incurred and the lessee does not report the leased item(s) as an asset nor as a liability.
A capital lease is a long-term or noncancelable lease in which the lessor transfers
substantially all the risks and rewards of ownership to the lessee. The lessee records
the leased item as its own asset along with a lease liability at the start of the lease term
the amount recorded equals the present value of all lease payments.
20.C Pension plans can be designed as defined benefit plans or defined contribution plans. In
a defined benefit plan the employer estimates the contribution necessary to pay a predefined benefit amount to its retirees. For example, an employees monthly pension
benefit may be set at $1,000 per month. The employer must contribute the amount
necessary to the pension plan to fund the $1,000 a month to the employee when the
employee retires. Alternatively, with a defined contribution plan, the pension
contribution is defined and the employer or employee contributes the amount specified
in the pension agreement. For example, a defined contribution plan might specify that
the employer will contribute 2% of an employees annual salary to the pension plan every
year.

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Fundamental Accounting Principles, 17th Edition

QUICK STUDIES
Quick Study 14-1 (10 minutes)
1.
2.
3.
4.

B
D
F
A

Debenture
Bond Indenture
Bearer bond
Registered bond

5.
6.
7.
8.

G
E
H
C

Sinking fund bond


Convertible bond
Secured bond
Serial bond

Quick Study 14-2 (10 minutes)


1.

Bonds cash proceeds: $350,000 x 0.875 = $306,250

2.

Twenty semiannual interest payments of $14,000......


Plus bond discount ($350,000 - $306,250)...................
Total bond interest expense..........................................

3.

Bond interest expense on first payment date:


$323,750 / 20 semiannual periods = $16,188

$280,000
43,750
$323,750

Quick Study 14-3B (10 minutes)


1.

Bonds cash proceeds: $120,000 x 1.1725 = $140,700

2.

Thirty semiannual interest payments of $6,000..........


Less premium ($140,700 - $120,000)............................
Total bond interest expense..........................................

3.

Bond interest expense on first payment date:


$140,700 x 4% = $5,628

Solutions Manual, Chapter 14

$180,000
(20,700)
$159,300

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Quick Study 14-4 (10 minutes)


2005
Jan. 1

Cash.................................................................................
306,250
Discount on Bonds Payable..........................................
43,750
Bonds Payable..........................................................
350,000
To record issuing bonds at a discount.

Jan. 1

Cash.................................................................................
140,700
Bonds Payable..........................................................
120,000
Premium on Bonds Payable....................................
20,700
To record issuing bonds at a premium.

Quick Study 14-5 (10 minutes)


a. Using facts in QS 14-2, the bonds cash proceeds for the bond selling at
a discount are computed as follows
Cash Flow
Table Value
$350,000 par (maturity) value................ 0.3769
$14,000 interest payment....................... 12.4622
Price of Bond.......................................
*

Present Value
$131,915
174,471
$306,386*

Agrees with $306,250 as given in QS 14-2, except for rounding difference.


(Instructor note: The price in QS 14-2 is rounded to 87.5 from 87.5388, yielding the $136 difference).

b. Using facts in QS 14-3, the bonds cash proceeds for the bond selling at
a premium are computed as
Cash Flow
Table Value
$120,000 par (maturity) value................
0.3083
$ 6,000 interest payment...................... 17.2920
Price of Bond.......................................
*

Present Value
$ 36,996
103,752
$140,748*

Agrees with $140,700 as given in QS 14-3, except for rounding difference.

Quick Study 14-6 (10 minutes)


2005
Mar. 1

Cash................................................................................
202,667
Interest payable*.......................................................
2,667
Bonds payable..........................................................
200,000

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Fundamental Accounting Principles, 17th Edition

Sold $200,000 of bonds with two months


accrued interest. *($200,000 x .08 x 2/12)

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Quick Study 14-7 (10 minutes)


2005
July 1

Bonds Payable................................................................
200,000
Premium on Bonds Payable..........................................
8,000
Gain on Retirement of Bonds*................................
Cash...........................................................................

3,000
205,000

To record retirement of bonds before maturity.


*$3,000 = $208,000 - $205,000

Quick Study 14-8 (10 minutes)


2005
Jan. 1

Bonds Payable.................................................................
1,000,000
Common Stock*.........................................................
Contributed Capital in Excess of Par Value................

250,000
750,000

To record retirement of bonds by stock


conversion. *500,000 shares x $0.50

Quick Study 14-9 (10 minutes)


Initial cash proceeds from note
Amount of annual payment = Table B.3 present value for 5 payments
a.

4%: Payment = $170,000 / 4.4518 = $38,187

b.

8%: Payment = $170,000 / 3.9927 = $42,578

c.

12%: Payment = $170,000 / 3.6048 = $47,159

Quick Study 14-10 (10 minutes)


Collins Industries is restricted in several ways by the creditor bank. They are
restricted from incurring certain types of additional indebtedness, from
making certain investments, from selling a substantial portion of their assets,
from making certain capital expenditures, and from granting substantial cash
dividends. In addition, the company must maintain the agreed upon level of
certain financial ratios and other measures of financial condition.

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Fundamental Accounting Principles, 17th Edition

Quick Study 14-11 (10 minutes)


Ratio of pledged assets to secured liabilities
Xiang Co.

Xu Co.

Pledged assets.......................

$387,000

$172,000

Secured liabilities...................

$163,000

$158,000

Ratio........................................

2.37 to 1

1.09 to 1

Analysis and interpretation: Xus secured liabilities appear more risky as it


only has $1.09 in pledged assets for each $1 in secured liabilities. In
comparison, each $1 of Xiangs secured liabilities is covered by $2.37 in
pledged assets.

Quick Study 14-12C (10 minutes)


Rental Expense...............................................................350
Cash (or Payable).....................................................

350

To record rental expense for car lease.

Quick Study 14-13C (10 minutes)


Leased AssetOffice Equipment.................................
20,859
Lease Liability...........................................................

20,859

To record capital lease of office equipment.

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EXERCISES
Exercise 14-1 (15 minutes)
1.

Semiannual cash interest payment = $1,700,000 x 9% x 1/2 = $76,500

2.
Journal entries
2005
(a)
Jan. 1 Cash.................................................................................
1,700,000
Bonds Payable..........................................................

1,700,000

Sold bonds at par.

(b)
June 30

Bond Interest Expense..................................................


76,500
Cash...........................................................................

76,500

Paid semiannual interest on bonds.

(c)
Dec. 31

Bond Interest Expense..................................................


76,500
Cash...........................................................................

76,500

Paid semiannual interest on bonds.

3.
2005
(a)
Jan.

Cash*
1,666,000
Discount on Bonds Payable..........................................
34,000
Bonds Payable..........................................................

1,700,000

Sold bonds at 98. *($1,700,000 x 0.98)

(b)
Jan.

Cash*
1,734,000
Premium on Bonds Payable....................................
Bonds Payable..........................................................

34,000
1,700,000

Sold bonds at 102. *($1,700,000 x 1.02)

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Fundamental Accounting Principles, 17th Edition

Exercise 14-2 (30 minutes)


1. Discount = Par value - Issue price = $90,000 - $85,431 = $4,569
2. Total bond interest expense over the life of the bonds
Amount repaid
Six payments of $3,600.................
Par value at maturity.....................
Total repaid....................................
Less amount borrowed....................
Total bond interest expense............

$ 21,600
90,000
111,600
(85,431)
$ 26,169

or:
Six payments of $3,600....................
Plus discount....................................
Total bond interest expense............

$ 21,600
4,569
$ 26,169

3. Straight-line amortization table


Semiannual
Period-End

Unamortized
Discount

Carrying
Value

(0)

1/01/2005.........................$4,569

$85,431

(1)

6/30/2005......................... 3,807

86,193

(2) 12/31/2005......................... 3,045

86,955

(3)

6/30/2006......................... 2,283

87,717

(4) 12/31/2006......................... 1,521

88,479

(5)

89,241

6/30/2007.........................

(6) 12/31/2007.........................

759*
0

90,000

*Adjusted for rounding

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Exercise 14-3B (30 minutes)


1. Discount = Par value - Issue price = $250,000 - $231,570 = $18,430
2. Total bond interest expense over the life of the bonds
Amount repaid
Six payments of $11,250...............
Par value at maturity.....................
Total repaid....................................
Less amount borrowed....................
Total bond interest expense............
or
Six payments of $11,250..................
Plus discount....................................
Total bond interest expense............

$ 67,500
250,000
317,500
(231,570)
$ 85,930
$ 67,500
18,430
$ 85,930

3. Effective interest amortization table


Semiannual
Interest
Period-End

(A)
(B)
Cash Interest
Bond Interest
Paid
Expense
[4.5% x $250,000] [6% x Prior (E)]

(C)
Discount
Amortization
[(B) - (A)]

1/01/2005

(D)
(E)
Unamortized
Carrying
Discount
Value
[Prior (D) - (C)] [$250,000 - (D)]

$18,430

$231,570

6/30/2005

$11,250

$13,894

$ 2,644

15,786

234,214

12/31/2005

11,250

14,053

2,803

12,983

237,017

6/30/2006

11,250

14,221

2,971

10,012

239,988

12/31/2006

11,250

14,399

3,149

6,863

243,137

6/30/2007

11,250

14,588

3,338

3,525

246,475

12/31/2007

11,250

14,775 *

3,525

250,000

$67,500

$85,930

$18,430

*Adjusted for rounding.

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Fundamental Accounting Principles, 17th Edition

Exercise 14-4 (30 minutes)


1. Premium = Issue price - Par value = $819,700 - $800,000 = $19,700
2. Total bond interest expense over the life of the bonds
Amount repaid
Six payments of $52,000...............
Par value at maturity.....................
Total repaid....................................
Less amount borrowed....................
Total bond interest expense............
or
Six payments of $52,000..................
Less premium...................................
Total bond interest expense............

$ 312,000
800,000
1,112,000
(819,700)
$ 292,300
$ 312,000
(19,700)
$ 292,300

3. Straight-line amortization table: ($19,700/6 = $3,283)


Semiannual
Interest Period-End

Unamortized
Premium

Carrying
Value

1/01/2005

$19,700

$819,700

6/30/2005

16,417

816,417

12/31/2005

13,134

813,134

6/30/2006

9,851

809,851

12/31/2006

6,568

806,568

6/30/2007

3,285

803,285

12/31/2007

800,000

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Exercise 14-5B (30 minutes)


1. Premium = Issue price - Par value = $819,700 - $800,000 = $19,700
2. Total bond interest expense over the life of the bonds
Amount repaid
Six payments of $52,000...............
Par value at maturity.....................
Total repaid....................................
Less amount borrowed....................
Total bond interest expense............
or
Six payments of $52,000..................
Less premium...................................
Total bond interest expense............

$ 312,000
800,000
1,112,000
(819,700)
$ 292,300
$ 312,000
(19,700)
$ 292,300

3. Effective interest amortization table


Semiannual
Interest
Period-End

(A)
(B)
Cash Interest
Bond Interest
Paid
Expense
[6.5% x $800,000] [6% x Prior (E)]

(C)
Premium
Amortization
[(A) - (B)]

1/01/2005

(D)
(E)
Unamortized
Carrying
Premium
Value
[Prior (D) - (C)] [800,000 + (D)]

$19,700

$819,700

6/30/2005

$ 52,000

$ 49,182

$ 2,818

16,882

816,882

12/31/2005

52,000

49,013

2,987

13,895

813,895

6/30/2006

52,000

48,834

3,166

10,729

810,729

12/31/2006

52,000

48,644

3,356

7,373

807,373

6/30/2007

52,000

48,442

3,558

3,815

803,815

12/31/2007

52,000

48,185*

3,815

800,000

$312,000

$292,300

$ 19,700

*Adjusted for rounding.

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Fundamental Accounting Principles, 17th Edition

Exercise 14-6 (25 minutes)


1. Semiannual cash interest payment = $600,000 x 6% x year = $18,000
2. Number of payments = 10 years x 2 per year = 20 semiannual payments
3. The 6% contract rate is less than the 8% market rate; therefore, the
bonds are issued at a discount.
4. Estimation of the market price at the issue date
Cash Flow
Table
Par (maturity) value........B.1
Interest (annuity).............B.3
Price of bonds.................

Table Value*
0.4564
13.5903

Amount
$600,000
18,000

Present Value
$273,840
244,625
$518,465

* Table values are based on a discount rate of 4% (half the annual market rate) and
20 periods (semiannual payments).

5.

Cash.................................................................................
518,465
Discount on Bonds Payable..........................................
81,535
Bonds Payable..........................................................
600,000
Sold bonds at a discount on the stated issue date.

Exercise 14-7 (25 minutes)


1. Semiannual cash interest payment = $75,000 x 10% x year = $3,750
2. Number of payments = 5 years x 2 per year = 10 semiannual payments
3. The 10% contract rate is greater than the 8% market rate; therefore, the
bonds are issued at a premium.
4. Estimation of the market price at the issue date
Cash Flow
Table Table Value*
Par (maturity) value........B.1
0.6756
Interest (annuity).............B.3
8.1109
Price of bonds.................

Amount
$75,000
3,750

Present Value
$50,670
30,416
$81,086

* Table values are based on a discount rate of 4% (half the annual market rate) and
10 periods (semiannual payments).

5.

Cash.................................................................................
81,086

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Premium on Bonds Payable....................................


Bonds Payable..........................................................

6,086
75,000

Sold bonds at a premium on the stated issue date.

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Fundamental Accounting Principles, 17th Edition

Exercise 14-8 (20 minutes)


1. Cash proceeds from sale of bonds at issuance
$350,000 x 97.75% = $342,125
2. Discount at issuance
Par value................................................ $350,000
Cash issue price (from part 1)............. (342,125)
Discount at issuance............................ $ 7,875
3. Total amortization for first 6 years
The first six years (from 1/1/04 to 12/31/09) equals 40% of the bonds 15year life. Therefore, the total amortization equals 40% of the total
discount (since straight-line amortization is being used), which is
$7,875 x 40%, or $3,150.
4. Carrying value of the bonds at 12/31/2009
Discount at issuance (from part 2)......
Less amortization (from part 3)...........
Remaining discount..............................

$ 7,875
(3,150)
$ 4,725

Entire Group
Par value................................................. $350,000
Remaining discount...............................
(4,725)
Carrying value........................................ $345,275

Retired 20%
$70,000
(945)
$69,055

5. Cash purchase price


($350,000 x 20%) x 104.5% = $73,150
6. Loss on retirement
Cash paid (from part 5).......................
Carrying value (from part 4)................
Loss on retirement..............................

$ 73,150
(69,055)
$ 4,095

7. Journal entry at retirement for 20% of bonds


2010
Jan. 1
Bonds Payable................................................................
70,000
Loss on Retirement of Bonds Payable........................
4,095
Discount on Bonds Payable....................................
Cash...........................................................................

945
73,150

To record the retirement of bonds.

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Exercise 14-9 (20 minutes)


1. Semiannual cash interest payment = $1,700,000 x 9% x year = $76,500
Amount accrued for four months = $76,500 x 4/6 = $51,000
2. Journal entries
2005
May

Cash.................................................................................
1,751,000
Interest Payable........................................................
Bonds Payable..........................................................

51,000
1,700,000

Sold bonds with 4 months accrued interest.

June 30

Interest Payable..............................................................
51,000
Bond Interest Expense..................................................
25,500
Cash...........................................................................

76,500

Paid semiannual interest on the bonds.

Dec. 31

Bond Interest Expense..................................................


76,500
Cash...........................................................................

76,500

Paid semiannual interest on the bonds.

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Fundamental Accounting Principles, 17th Edition

Exercise 14-10 (40 minutes)


1.

Straight-line amortization table


Semiannual
Period-End

Unamortized
Discount

Carrying
Value

6/01/2004.....................

$2,026

$47,974

11/30/2004.....................

1,773

48,227

5/31/2005.....................

1,520

48,480

11/30/2005.....................

1,267

48,733

5/31/2006.....................

1,014

48,986

11/30/2006.....................

761

49,239

5/31/2007.....................

508

49,492

11/30/2007.....................

255*

49,745

5/31/2008.....................
*

Rounding difference.

Supporting computations

Eight payments of $1,750........................


Par value at maturity................................
Total repaid...............................................
Less amount borrowed...........................
Total bond interest expense....................
or
Eight payments of $1,750........................
Plus discount...........................................
Total bond interest expense....................

50,000

$ 14,000
50,000
64,000
(47,974)
$ 16,026
$ 14,000
2,026
$ 16,026

Semiannual straight-line interest expense = $16,026 / 8 = $2,003 (rounded)


Semiannual bond discount amortization = $2,026 / 8 = $253 (rounded)

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Exercise 14-10 (Concluded)


2.
2004
Nov. 30

Bond Interest Expense..................................................


2,003
Discount on Bonds Payable....................................
Cash...........................................................................

253
1,750

To record 6 months interest and discount amortization.

Dec. 31

Bond Interest Expense.................................................. 334


Discount on Bonds Payable....................................
Interest Payable........................................................

42
292

To record one month's accrued interest


($2,003 x 1/6) and amortization ($253 x 1/6).

2005
May 31

Interest Payable.............................................................. 292


Bond Interest Expense..................................................
1,669
Discount on Bonds Payable....................................
Cash...........................................................................

211
1,750

To record five months interest ($2,003 - $334)


and amortization ($253 - $42) and eliminate
the accrued interest liability.

Exercise 14-11 (20 minutes)


1. Amount of principal in each payment = $25,000 / 4 years = $6,250
2. Amortization table for the loan
Payments

(A)
Period
Ending
Date

Beginning
Balance

(B)
Debit
Interest
Expense

Cash

Ending
Balance

[Prior (E)]

[7% x (A)]

[$25,000/4]

[(B) + (C)]

[(A) - (C)]

2005.......

$25,000

$1,750

$ 6,250

$ 8,000

$18,750

2006.......

18,750

1,313

6,250

7,563

12,500

2007.......

12,500

875

6,250

7,125

6,250

2008.......

6,250

438

6,250

6,688

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(C)
Debit
Notes
Payable

(D)
Credit
=

(E)

Fundamental Accounting Principles, 17th Edition

$4,376

Solutions Manual, Chapter 14

$25,000

$29,376

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Exercise 14-12 (20 minutes)


2005
Jan. 1

Cash.................................................................................
25,000
Notes Payable...........................................................

25,000

Borrowed $25,000 by signing a 7%


installment note.

2005
Dec. 31

Interest Expense.............................................................
1,750
Notes Payable.................................................................
6,250
Cash...........................................................................

8,000

To record first installment payment.

2006
Dec. 31

Interest Expense.............................................................
1,313
Notes Payable.................................................................
6,250
Cash...........................................................................

7,563

To record second installment payment.

2007
Dec. 31

Interest Expense............................................................. 875


Notes Payable.................................................................
6,250
Cash...........................................................................

7,125

To record third installment payment.

2008
Dec. 31

Interest Expense............................................................. 438


Notes Payable.................................................................
6,250
Cash...........................................................................

6,688

To record fourth installment payment.

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Fundamental Accounting Principles, 17th Edition

Exercise 14-13 (20 minutes)


1. Amount of each payment = Initial note balance / Table B.3 value
= $25,000 / 3.3872 = $7,381
2. Amortization table for the loan
(A)
Period
Ending
Date

Beginning
Balance

(B)
Debit
Interest
Expense

[Prior (E)]

[7% x (A)]

2005....... $25,000

Payments
(C)
Debit
Notes
Payable
=

(D)
Credit

(E)

Cash

Ending
Balance

[(D) - (B)]

[computed]

[(A) - (C)]

$1,750

$ 5,631

$ 7,381

$19,369

2006.......

19,369

1,356

6,025

7,381

13,344

2007.......

13,344

934

6,447

7,381

6,897

2008.......

6,897

484*

6,897

7,381

$25,000

$29,524

$4,524
*Adjusted for rounding.

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Exercise 14-14 (20 minutes)


2005
Jan. 1

Cash.................................................................................
25,000
Notes Payable...........................................................

25,000

Borrowed $25,000 by signing a 7%


installment note.

2005
Dec. 31

Interest Expense.............................................................
1,750
Notes Payable.................................................................
5,631
Cash...........................................................................

7,381

To record first installment payment.

2006
Dec. 31

Interest Expense.............................................................
1,356
Notes Payable.................................................................
6,025
Cash...........................................................................

7,381

To record second installment payment.

2007
Dec. 31

Interest Expense.............................................................934
Notes Payable.................................................................
6,447
Cash...........................................................................

7,381

To record third installment payment.

2008
Dec. 31

Interest Expense.............................................................484
Notes Payable.................................................................
6,897
Cash...........................................................................

7,381

To record fourth installment payment.

Exercise 14-15 (30 minutes)


The ratio of pledged assets to secured liabilities describes the pool of assets
that are committed to being available for paying the secured creditors if the
borrower should experience financial distress and be unable to make payment
on the secured liabilities. The increasing value of the ratio could arise from at
least two sets of activities.
First, the borrower could be significantly decreasing the amount of debt that is
secured by assets, but still keeping the assets pledged as collateral. These
activities would cause the ratios numerator to stay constant while the
denominator decreases.
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Fundamental Accounting Principles, 17th Edition

Exercise 14-15 (concluded)


Second, the borrower might be keeping the amount of debt constant while
greatly increasing the amount of assets that have been pledged as security. A
higher ratio value would result from a larger numerator, while the denominator
stayed constant.
In either case, the increasing ratio could be alarming to the unsecured creditor
because it might reflect a growing concern by the secured creditors that the
values of the borrowers assets are not sufficient for paying the secured
debts. If so, the unsecured creditors are more vulnerable to losing their
balances if the company should be forced into bankruptcy. Of course, the
change could arise from a combination of both activities. In accordance with
a basic concept of financial analysis, the change in a ratio does not fully
explain what happened, but does point out areas where potential problems
might exist and where we might search for more complete answers.

Exercise 14-16C (10 minutes)


1. Operating

2. Capital

3. Capital

Exercise 14-17C (20 minutes)


1.

Leased AssetOffice Equipment.................................


82,000
Lease Liability...........................................................

82,000

To record capital lease of office equipment.

2.

Depreciation ExpenseOffice Equipment..................


16,400
Accum. DepreciationOffice Equipment..............

16,400

To record depreciation ($82,000 / 5 years).

Exercise 14-18C (15 minutes)


[Note: 12% / 12 months = 1% per month as the relevant interest rate.]

Option 1: $1,750 per month for 25 months = $1,750 x 22.0232 = $38,541


Option 2: $1,500 per month for 25 months + $5,000 =
($1,500 x 22.0232) + $5,000 = $38,035
Option 3:

Solutions Manual, Chapter 14

= $38,500

McGraw-Hill Companies, Inc., 2005


75

Analysis: Option 2 has the lowest present value at $38,035 and, thus, is the
best lease deal.

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Fundamental Accounting Principles, 17th Edition

PROBLEM SET A
Problem 14-1A (50 minutes)
Part 1
a.
Cash Flow
Table
Par value...................... B.1
Interest (annuity)......... B.3
Price of bonds.............

Table Value*
0.4564
13.5903

Amount
$20,000
1,000

Bond premium.............

Present Value
$ 9,128
13,590
$22,718
$ 2,718

* Table values are based on a discount rate of 4% (half the annual market rate)
and 20 periods (semiannual payments).

b.
2005
Jan. 1

Cash.................................................................................
22,718
Premium on Bonds Payable....................................
Bonds Payable..........................................................

2,718
20,000

Sold bonds on stated issue date.

Part 2
a.
Cash Flow
Table
Par value...................... B.1
Interest (annuity)......... B.3
Price of bonds.............

Table Value*
0.3769
12.4622

Amount
$20,000
1,000

Present Value
$ 7,538
12,462
$20,000

* Table values are based on a discount rate of 5% (half the annual market rate) and
20 periods (semiannual payments). (Note: When the contract rate and market rate
are the same, the bonds sell at par and there is no discount or premium.)

b.
2005
Jan. 1

Cash.................................................................................
20,000
Bonds Payable..........................................................

20,000

Sold bonds on stated issue date.

Solutions Manual, Chapter 14

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77

Problem 14-1A (Concluded)


Part 3
a.
Cash Flow
Table
Par value..................... B.1
Interest (annuity)........ B.3
Price of bonds............

Table Value*
0.3118
11.4699

Bond discount............

Amount
$20,000
1,000

Present Value
$ 6,236
11,470
$17,706
$ 2,294

* Table values are based on a discount rate of 6% (half the annual market rate) and
20 periods (semiannual payments).

b.
2005
Jan. 1

Cash.................................................................................
17,706
Discount on Bonds Payable..........................................
2,294
Bonds Payable..........................................................

20,000

Sold bonds on stated issue date.

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Fundamental Accounting Principles, 17th Edition

Problem 14-2A (40 minutes)


Part 1
2004
Jan. 1

Cash.................................................................................
1,728,224
Discount on Bonds Payable..........................................
271,776
Bonds Payable..........................................................

2,000,000

Sold bonds on stated issue date.

Part 2
[Note: The semiannual amounts for (a), (b), and (c) below are the same throughout the bonds
life because this company uses straight-line amortization.]

(a) Cash Payment = $2,000,000 x 6% x 6/12 year = $60,000


(b) Discount = $2,000,000 - $1,728,224 = $271,776
Straight-line discount amortization= $271,776 / 30 semiannual periods
= $9,059*
*rounded

(c) Bond interest expense = $60,000 + $9,059 = $69,059


Part 3
Thirty payments of $60,000 ............
Par value at maturity........................
Total repaid.......................................
Less amount borrowed....................
Total bond interest expense............

$1,800,000
2,000,000
3,800,000
(1,728,224)
$2,071,776

or:
Thirty payments of $60,000..................
Plus discount.........................................
Total bond interest expense.................

$1,800,000
271,776
$2,071,776

Part 4
Semiannual
Unamortized
Period-End
Discount
1/01/2004..................... $271,776

Carrying
Value
$1,728,224

6/30/2004.....................

262,717

1,737,283

12/31/2004.....................

253,658

1,746,342

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6/30/2005.....................

244,599

1,755,401

12/31/2005.....................

235,540

1,764,460

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Fundamental Accounting Principles, 17th Edition

Problem 14-2A (Continued)


Part 5
2004

June 30

Bond Interest Expense..................................................


69,059
Discount on Bonds Payable....................................
Cash...........................................................................

9,059
60,000

To record six months interest and


discount amortization.

2004

Dec. 31

Bond Interest Expense..................................................


69,059
Discount on Bonds Payable....................................
Cash...........................................................................

9,059
60,000

To record six months interest and


discount amortization.

Part 6
[Note: Parts 1 through 5 are repeated assuming a bond premium.]

Requirement 1
2004

Jan. 1

Cash.................................................................................
2,447,990
Premium on Bonds Payable....................................
Bonds Payable..........................................................

447,990
2,000,000

Sold bonds on issue date at a premium.

Requirement 2

(a) Cash Payment = $2,000,000 x 6% x 6/12 = $60,000


(b) Premium = $2,447,990 - $2,000,000 = $447,990
Straight-line premium amortization = $447,990 / 30 semiannual periods
= $14,933
(c) Bond interest expense = $60,000 - $14,933 = $45,067
Requirement 3

Thirty payments of $60,000 ............


Par value at maturity........................
Total repaid.......................................
Less amount borrowed....................
Total bond interest expense............
or:

$1,800,000
2,000,000
3,800,000
(2,447,990)
$1,352,010

Thirty payments of $60,000..................

$1,800,000

Solutions Manual, Chapter 14

McGraw-Hill Companies, Inc., 2005


81

Less premium........................................
Total bond interest expense.................

McGraw-Hill Companies, Inc., 2005


82

(447,990)
$1,352,010

Fundamental Accounting Principles, 17th Edition

Problem 14-2A (Concluded)


Requirement 4

Semiannual
Period-End
1/01/2004.....................
6/30/2004.....................

Unamortized
Premium

Carrying
Value

$447,990

$2,447,990

433,057

2,433,057

12/31/2004.....................

418,124

2,418,124

6/30/2005.....................

403,191

2,403,191

12/31/2005.....................

388,258

2,388,258

Requirement 5

2004
June 30

Bond Interest Expense..................................................


45,067
Premium on Bonds Payable..........................................
14,933
Cash...........................................................................

60,000

To record six months interest and


premium amortization.

2004
Dec. 31

Bond Interest Expense..................................................


45,067
Premium on Bonds Payable..........................................
14,933
Cash...........................................................................

60,000

To record six months interest and


premium amortization.

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83

Problem 14-3A (45 minutes)


Part 1
Ten payments of $16,250 ................
Par value at maturity........................
Total repaid.......................................
Less amount borrowed....................
Total bond interest expense............

$ 162,500
500,000
662,500
(510,666)
$151,834

or:
Ten payments of $16,250.................
Less premium...................................
Total bond interest expense............

$162,500
(10,666)
$151,834

Part 2
Straight-line amortization table ($10,666/10 = $1,067*)
Semiannual
Interest Period-End

Unamortized
Premium

Carrying
Value

1/01/2004

$10,666

$510,666

6/30/2004

9,599

509,599

12/31/2004

8,532

508,532

6/30/2005

7,465

507,465

12/31/2005

6,398

506,398

6/30/2006

5,331

505,331

12/31/2006

4,264

504,264

6/30/2007

3,197

503,197

12/31/2007

2,130

502,130

6/30/2008

1,063**

501,063

12/31/2008
* Rounded to nearest dollar.

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84

500,000

** Adjusted for rounding.

Fundamental Accounting Principles, 17th Edition

Problem 14-3A (Concluded)


Part 3
2004
June 30

Bond Interest Expense..................................................


15,183
Premium on Bonds Payable..........................................
1,067
Cash...........................................................................

16,250

To record six months interest and


premium amortization.

2004
Dec. 31

Bond Interest Expense..................................................


15,183
Premium on Bonds Payable..........................................
1,067
Cash...........................................................................

16,250

To record six months interest and


premium amortization.

Solutions Manual, Chapter 14

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85

Problem 14-4AB (45 minutes)


Part 1
Ten payments of $16,250 ................
Par value at maturity........................
Total repaid.......................................
Less amount borrowed....................
Total bond interest expense............

$ 162,500
500,000
662,500
(510,666)
$ 151,834

or:
Ten payments of $16,250.................
Less premium...................................
Total bond interest expense............

$ 162,500
(10,666)
$151,834

Part 2
Semiannual
Interest
Period-End

(A)
(B)
Cash Interest
Bond Interest
Paid
Expense
[3.25% x $500,000] [3% x Prior (E)]

(C)
Premium
Amortization
[(A) - (B)]

1/01/2004

(D)
(E)
Unamortized
Carrying
Premium
Value
[Prior (D) - (C)] [$500,000 + (D)]

$10,666

$510,666

930

9,736

509,736

6/30/2004

$ 16,250

$ 15,320

12/31/2004

16,250

15,292

95
8

8,778

508,778

6/30/2005

16,250

15,263

98
7

7,791

507,791

12/31/2005

16,250

15,234

1,016

6,775

506,775

6/30/2006

16,250

15,203

1,047

5,728

505,728

12/31/2006

16,250

15,172

1,078

4,650

504,650

6/30/2007

16,250

15,140

1,110

3,540

503,540

12/31/2007

16,250

15,106

1,144

2,396

502,396

6/30/2008

16,250

15,072

1,178

1,218

501,218

12/31/2008

16,250

15,032*

1,218

500,000

$162,500

$151,834

$10,666

*Adjusted for rounding.


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Fundamental Accounting Principles, 17th Edition

Problem 14-4AB (Concluded)


Part 3
2004
June 30

Bond Interest Expense..................................................


15,320
Premium on Bonds Payable..........................................
930
Cash...........................................................................

16,250

To record six months interest and


premium amortization.

2004
Dec. 31

Bond Interest Expense..................................................


15,292
Premium on Bonds Payable..........................................
958
Interest Payable........................................................

16,250

To record six months interest and


premium amortization.

Part 4
As of December 31, 2006
Cash Flow
Table
Par value...................... B.1
Interest (annuity)......... B.3
Price of bonds.............

Table Value*
0.8885
3.7171

Amount
$500,000
16,250

Present Value
$444,250
60,403
$504,653

* Table values are based on a discount rate of 3% (half the annual original market
rate) and 4 periods (semiannual payments).

Comparison to Part 2 Table


Except for a small rounding difference, this present value ($504,653) equals
the carrying value of the bonds in column (E) of the amortization table
($504,650). This shows a general rule: The carrying value of bonds at any
point in time equals the present value of the remaining cash flows using
the market rate at the time of issuance.

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87

Problem 14-5A (60 minutes)


Part 1
2004
Jan. 1

Cash.................................................................................
584,361
Discount on Bonds Payable..........................................
65,639
Bonds Payable..........................................................

650,000

Sold bonds on stated issue date.

Part 2
Eight payments of $16,250* .................
Par value at maturity.............................
Total repaid............................................
Less amount borrowed........................
Total bond interest expense................

$ 130,000
650,000
780,000
(584,361)
$ 195,639

or:
Eight payments of $16,250*..................
Plus discount........................................
Total bond interest expense................

$ 130,000
65,639
$ 195,639

Semiannual interest payment, computed as $650,000 x 5% x year.

Part 3 Straight-line amortization table ($65,639/8 =$8,205)


Semiannual
Interest Period-End

Unamortized
Discount

Carrying
Value

1/01/2004

$65,639

$584,361

6/30/2004

57,434

592,566

12/31/2004

49,229

600,771

6/30/2005

41,024

608,976

12/31/2005

32,819

617,181

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Fundamental Accounting Principles, 17th Edition

Problem 14-5A (Concluded)


Part 4
2004
June 30

Bond Interest Expense..................................................


24,455
Discount on Bonds Payable....................................
Cash...........................................................................

8,205
16,250

To record six months interest and


discount amortization.

2004
Dec. 31

Bond Interest Expense..................................................


24,455
Discount on Bonds Payable....................................
Cash...........................................................................

8,205
16,250

To record six months interest and


discount amortization.

Part 5
If the market interest rate on the issue date had been 4% instead of 8%, the
bonds would have sold at a premium because the contract rate of 5% would
have been greater than the market rate.
This change would affect the balance sheet because the bond liability would
be larger (par value plus a premium instead of par value minus a discount).
As the years passed, the bond liability would decrease with amortization of
the premium instead of increasing with amortization of the discount.
The income statement would show smaller amounts of bond interest expense
over the life of the bonds issued at a premium than it would show if the bonds
had been issued at a discount.
The statement of cash flows would show a larger amount of cash received
from borrowing. However, the cash flow statements presented over the life of
the bonds (after issuance) would report that the same amount of cash was
paid for interest. This cash amount is fixed as it is the product of the contract
rate and the par value of the bonds and is unaffected by the change in the
market rate.

Solutions Manual, Chapter 14

McGraw-Hill Companies, Inc., 2005


89

Problem 14-6AB (60 minutes)


Part 1
2004
Jan. 1

Cash.................................................................................
584,361
Discount on Bonds Payable..........................................
65,639
Bonds Payable..........................................................

650,000

Sold bonds on stated issue date.

Part 2
Eight payments of $16,250* .................
Par value at maturity.............................
Total repaid............................................
Less amount borrowed........................
Total bond interest expense................

$ 130,000
650,000
780,000
(584,361)
$ 195,639

or:
Eight payments of $16,250*..................
Plus discount........................................
Total bond interest expense................

$ 130,000
65,639
$ 195,639

Semiannual interest payment, computed as $650,000 x 5% x year.

Part 3
Semiannual
Interest
Period-End

(A)
Cash Interest
Paid
[2.5% x $650,000]

(B)
Bond Interest
Expense
[4% x Prior (E)]

(C)
Discount
Amortization
[(B) - (A)]

1/01/2004

(D)
(E)
Unamortized
Carrying
Discount
Value
[Prior (D) - (C)] [$650,000 - (D)]

$65,639

$584,361

6/30/2004

$16,250

$23,374

$7,124

58,515

591,485

12/31/2004

16,250

23,659

7,409

51,106

598,894

6/30/2005

16,250

23,956

7,706

43,400

606,600

12/31/2005

16,250

24,264

8,014

35,386

614,614

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Fundamental Accounting Principles, 17th Edition

Problem 14-6AB (Concluded)


Part 4
2004
June 30

Bond Interest Expense..................................................


23,374
Discount on Bonds Payable....................................
Cash...........................................................................

7,124
16,250

To record six months interest and


discount amortization.

2004
Dec. 31

Bond Interest Expense..................................................


23,659
Discount on Bonds Payable....................................
Cash...........................................................................

7,409
16,250

To record six months interest and


discount amortization.

Solutions Manual, Chapter 14

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91

Problem 14-7AB (60 minutes)


Part 1
2004
Jan. 1

Cash.................................................................................
92,283
Premium on Bonds Payable....................................
Bonds Payable..........................................................

2,283
90,000

Sold bonds on stated issue date.

Part 2
Six payments of $4,950 ...................
Par value at maturity........................
Total repaid.......................................
Less amount borrowed....................
Total bond interest expense............

$ 29,700
90,000
119,700
(92,283)
$ 27,417

or:
Six payments of $4,950....................
Less premium...................................
Total bond interest expense............

$ 29,700
(2,283)
$ 27,417

Part 3
Semiannual
Interest
Period-End

(A)
Cash Interest
Paid
[5.5% x $90,000]

(B)
Bond Interest
Expense
[5% x Prior (E)]

(C)
Premium
Amortization
[(A) - (B)]

1/01/2004

(D)
(E)
Unamortized
Carrying
Premium
Value
[Prior (D) - (C)] [$90,000 + (D)]

$2,283

$92,283

6/30/2004

$4,950

$4,614

$336

1,947

91,947

12/31/2004

4,950

4,597

353

1,594

91,594

6/30/2005

4,950

4,580

370

1,224

91,224

12/31/2005

4,950

4,561

389

835

90,835

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Fundamental Accounting Principles, 17th Edition

Problem 14-7AB (Concluded)


Part 4
2004
June 30

Bond Interest Expense..................................................


4,614
Premium on Bonds Payable..........................................
336
Cash...........................................................................

4,950

To record six months interest and


premium amortization.

2004
Dec. 31

Bond Interest Expense..................................................


4,597
Premium on Bonds Payable..........................................
353
Cash...........................................................................

4,950

To record six months interest and


premium amortization.

Part 5
2006
Jan. 1

Bonds Payable ...............................................................


90,000
Premium on Bonds Payable..........................................
835
Cash*.........................................................................
Gain on Retirement of Bonds..................................

88,200
2,635

To record the retirement of bonds.


*($90,000 x 98%)

Part 6
If the market rate on the issue date had been 12% instead of 10%, the bonds
would have sold at a discount because the contract rate of 11% would have been
lower than the market rate.
This change would affect the balance sheet because the bond liability would be
smaller (par value minus a discount instead of par value plus a premium). As the
years passed, the bond liability would increase with amortization of the discount
instead of decreasing with amortization of the premium.
The income statement would show larger amounts of bond interest expense over
the life of the bonds issued at a discount than it would show if the bonds had
been issued at a premium.
The statement of cash flows would show a smaller amount of cash received from
borrowing. However, the cash flow statements presented over the life of the
bonds (after issuance) would report the same total amount of cash paid for
interest. This amount is fixed as it is the product of the contract rate and the par
value of the bonds and is unaffected by the change in the market rate.

Solutions Manual, Chapter 14

McGraw-Hill Companies, Inc., 2005


93

Problem 14-8A (45 minutes)


Part 1

Amount of Payment
Note balance...................................................................
$400,000
Number of periods.........................................................
5
Interest rate.....................................................................
8%
Value from Table B.3......................................................
3.9927
Payment ($400,000 / 3.9927)..........................................
$100,183

Part 2
(B)
Debit
Interest
Expense +
[8% x (A)]

Payments
(C)
(D)
Debit
Credit
Notes
Payable =
Cash
[(D) - (B)]
[computed]

Ending
Balance
[(A) - (C)]

10/31/2005.............
$400,000

$ 32,000

$ 68,183

$100,183

$331,817

10/31/2006.............
331,817

26,545

73,638

100,183

258,179

10/31/2007.............
258,179

20,654

79,529

100,183

178,650

10/31/2008.............
178,650

14,292

85,891

100,183

92,759

92,759

100,183

$400,000

$500,915

(A)
Period
Ending
Date

Beginning
Balance
[Prior (E)]

10/31/2009.............
92,759

7,424*
$100,915

(E)

* Adjusted for rounding

Part 3
2004
Dec. 31

Interest Expense.............................................................
5,333
Interest Payable........................................................

5,333

Accrued interest on the installment


note payable ($32,000 x 2/12).

2005
Oct. 31

Interest Expense.............................................................
26,667
Interest Payable..............................................................
5,333
Notes Payable.................................................................
68,183
Cash...........................................................................
100,183
Record first payment on installment note
(interest expense = $32,000 - $5,333).

McGraw-Hill Companies, Inc., 2005


94

Fundamental Accounting Principles, 17th Edition

Problem 14-8A (Concluded)


Part 4
Payments
(A)
Period
Ending
Date

Beginning
Balance
[Prior (E)]

(B)
(C)
Debit
Debit Notes
Interest
Payable
Expense + [$400,000/5] =
[8% x (A)]

(D)
Credit

(E)

Cash
[(B) + (C)]

Ending
Balance
[(A) - (C)]

10/31/2005.............
$400,000

$32,000

$ 80,000

$112,000

$320,000

10/31/2006.............
320,000

25,600

80,000

105,600

240,000

10/31/2007.............
240,000

19,200

80,000

99,200

160,000

10/31/2008.............
160,000

12,800

80,000

92,800

80,000

10/31/2009.............80,000

6,400

80,000

86,400

$96,000

$400,000

$496,000

2004
Dec. 31

Interest Expense.............................................................
5,333
Interest Payable........................................................

5,333

Accrued interest on the installment


note payable ($32,000 x 2/12).

2005
Oct. 31

Interest Expense.............................................................
26,667
Interest Payable..............................................................
5,333
Notes Payable.................................................................
80,000
Cash...........................................................................

112,000

Record first payment on installment note


(interest expense = $32,000 - $5,333).

Solutions Manual, Chapter 14

McGraw-Hill Companies, Inc., 2005


95

Problem 14-9A (30 minutes)


Part 1
Wildcat Company
Pledged assets [($900,000 x 43%) + $225,000]...........................$612,000
Secured liabilities ($210,000 + $135,000)....................................$345,000
Ratio ($612,000 / $345,000)...........................................................1.77 to 1
Athens Company
Pledged assets [($450,000 x 54%) + $150,000]...........................$393,000
Secured liabilities ($75,000 + $60,000)........................................$135,000
Ratio ($393,000 / $135,000)..........................................................2.91 to 1
Part 2
Athens's ratio of pledged assets to secured liabilities is higher than
Wildcat's, so the Athens bonds appear less risky. Before deciding to buy
Athens's bonds, however, it might be helpful to estimate the liquidation
value of both companies assets that are pledged as collateral. It also is
important to evaluate the ability of each company to meet its obligations
from operating cash flows.

McGraw-Hill Companies, Inc., 2005


96

Fundamental Accounting Principles, 17th Edition

Problem 14-10AC (35 minutes)


Part 1
Present Value of the Lease Payments
$20,000 x 3.9927 (from Table B.3) = $79,854
Part 2
Leased AssetOffice Equipment.................................
79,854
Lease Liability...........................................................

79,854

To record capital lease of office equipment.

Part 3
Capital Lease Liability Payment (Amortization) Schedule
Beginning
Period Balance of
Ending
Lease
Date
Liability

Interest on
Lease
Liability
(8%)

Reduction
of Lease
Liability

Year 1

$79,854

$ 6,388*

$13,612

$ 20,000

$66,242

Year 2

66,242

5,299

14,701

20,000

51,541

Year 3

51,541

4,123

15,877

20,000

35,664

Year 4

35,664

2,853

17,147

20,000

18,517

Year 5

18,517

1,483**

18,517

20,000

$79,854

$100,000

$20,146
*
**

Cash
Lease
Payment

Ending
Balance of
Lease
Liability

Rounded to nearest dollar.


Difference due to rounding.

Part 4
Depreciation ExpenseOffice Equipment..................
15,971
Accum. DepreciationOffice Equipment..............

15,971

To record depreciation ($79,854 / 5 years).

Solutions Manual, Chapter 14

McGraw-Hill Companies, Inc., 2005


97

PROBLEM SET B
Problem 14-1B (50 minutes)
Part 1
a.
Cash Flow
Table
Par value.................
B.1
Interest (annuity)....
B.3
Price of bonds........

Table Value*
0.6139
7.7217

Amount
$45,000
2,700

Bond Premium........

Present Value
$27,626
20,849
$48,475
$ 3,475

* Table values are based on a discount rate of 5% (half the annual market rate) and
10 periods (semiannual payments).

b.
2005
Jan. 1

Cash.................................................................................
48,475
Premium on Bonds Payable....................................
Bonds Payable..........................................................

3,475
45,000

Sold bonds on stated issue date.

Part 2
a.
Cash Flow
Table
Par value.................
B.1
Interest (annuity)....
B.3
Price of bonds........

Table Value*
0.5584
7.3601

Amount
$45,000
2,700

Present Value
$25,128
19,872
$45,000**

* Table values are based on a discount rate of 6% (half the annual market rate) and
10 periods (semiannual payments). (Note: When the contract rate and market
rate are the same, the bonds sell at par and there is no discount or premium.)
**Adjusted for rounding.

b.
2005
Jan. 1

Cash.................................................................................
45,000
Bonds Payable..........................................................

45,000

Sold bonds on stated issue date.

McGraw-Hill Companies, Inc., 2005


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Fundamental Accounting Principles, 17th Edition

Problem 14-1B (Concluded)


Part 3
a.
Cash Flow
Table
Par value.................
B.1
Interest (annuity)....
B.3
Price of bonds........

Table Value*
0.5083
7.0236

Amount
$45,000
2,700

Present Value
$22,874
18,964
$41,838

Bond discount........

$ 3,162

* Table values are based on a discount rate of 7% (half the annual market rate) and
10 periods (semiannual payments).

b.
2005
Jan. 1

Cash.................................................................................
41,838
Discount on Bonds Payable..........................................
3,162
Bonds Payable..........................................................

45,000

Sold bonds on stated issue date.

Problem 14-2B (40 minutes)


Part 1
2004
Jan. 1

Cash.................................................................................
1,505,001
Discount on Bonds Payable..........................................
194,999
Bonds Payable..........................................................

1,700,000

Sold bonds on stated issue date.

Part 2
[Note: The semiannual amounts for (a), (b), and (c) below are the same throughout
the bonds life because the company uses straight-line amortization.]

(a) Cash Payment = $1,700,000 x 10% x 6/12 year = $85,000


(b) Discount = $1,700,000 - $1,505,001 = $194,999
Straight-line discount amortization= $194,999 / 20 semiannual periods
= $9,750
(c) Bond interest expense = $85,000 + $9,750 = $94,750

Solutions Manual, Chapter 14

McGraw-Hill Companies, Inc., 2005


99

Problem 14-2B (Continued)


Part 3
Twenty payments of $85,000...........
Par value at maturity........................
Total repaid.......................................
Less amount borrowed....................
Total bond interest expense............

$1,700,000
1,700,000
3,400,000
(1,505,001)
$1,894,999

or:
Twenty payments of $85,000 ..........
Plus discount....................................
Total bond interest expense............

$1,700,000
194,999
$1,894,999

Part 4
Semiannual
Period-End

Unamortized
Discount

Carrying
Value

1/01/2004.....................

$194,999

$1,505,001

6/30/2004.....................

185,249

1,514,751

12/31/2004.....................

175,499

1,524,501

6/30/2005.....................

165,749

1,534,251

12/31/2005.....................

155,999

1,544,001

Part 5
2004
June 30

Bond Interest Expense..................................................


94,750
Discount on Bonds Payable....................................
Cash...........................................................................

9,750
85,000

To record six months interest and


discount amortization.

2004
Dec. 31

Bond Interest Expense..................................................


94,750
Discount on Bonds Payable....................................
Cash...........................................................................

9,750
85,000

To record six months interest and


discount amortization.

McGraw-Hill Companies, Inc., 2005


100

Fundamental Accounting Principles, 17th Edition

Problem 14-2B (Continued)


Part 6. [Requirements 1 through 5 are repeated assuming a bond premium.]
Requirement 1

2004
Jan. 1

Cash.................................................................................
2,096,466
Premium on Bonds Payable....................................
Bonds Payable..........................................................

396,466
1,700,000

Sold bonds on issue date at a premium.

Requirement 2

(a) Cash Payment = $1,700,000 x 10% x 6/12 year = $85,000


(b) Premium = $2,096,466 - $1,700,000 = $396,466
Straight-line premium amortization= $396,466/20 semiannual periods
= $19,823*
*rounded

(c) Bond interest expense = $85,000 - $19,823 = $65,177


Requirement 3

Twenty payments of $85,000 ..........


Par value at maturity........................
Total repaid.......................................
Less amount borrowed....................
Total bond interest expense............

$1,700,000
1,700,000
3,400,000
(2,096,466)
$1,303,534

or:
Twenty payments of $85,000 ..........
Less premium...................................
Total bond interest expense............

$1,700,000
(396,466)
$1,303,534

Solutions Manual, Chapter 14

McGraw-Hill Companies, Inc., 2005


101

Problem 14-2B (Concluded)


Requirement 4

Semiannual
Period-End

Unamortized
Premium

1/01/2004..................... $396,466

Carrying
Value
$2,096,466

6/30/2004.....................

376,643

2,076,643

12/31/2004.....................

356,820

2,056,820

6/30/2005.....................

336,997

2,036,997

12/31/2005.....................

317,174

2,017,174

Requirement 5

2004
June 30

Bond Interest Expense..................................................


65,177
Premium on Bonds Payable..........................................
19,823
Cash...........................................................................

85,000

To record six months interest and


premium amortization.

2004
Dec. 31

Bond Interest Expense..................................................


65,177
Premium on Bonds Payable..........................................
19,823
Cash...........................................................................

85,000

To record six months interest and


premium amortization.

McGraw-Hill Companies, Inc., 2005


102

Fundamental Accounting Principles, 17th Edition

Problem 14-3B (45 minutes)


Part 1
Ten payments of $7,200 ..................
Par value at maturity........................
Total repaid.......................................
Less amount borrowed....................
Total bond interest expense............

$ 72,000
160,000
232,000
(166,494)
$ 65,506

or:
Ten payments of $7,200 ..................
Less premium...................................
Total bond interest expense............

$ 72,000
(6,494)
$ 65,506

Part 2
Straight-line amortization table ($6,494/10 = $649)
Semiannual
Interest Period-End

Unamortized
Premium

Carrying
Value

1/01/2004

$6,494

$166,494

6/30/2004

5,845

165,845

12/31/2004

5,196

165,196

6/30/2005

4,547

164,547

12/31/2005

3,898

163,898

6/30/2006

3,249

163,249

12/31/2006

2,600

162,600

6/30/2007

1,951

161,951

12/31/2007

1,302

161,302

6/30/2008
12/31/2008

653*
0

160,653
160,000

* Adjusted for rounding.

Solutions Manual, Chapter 14

McGraw-Hill Companies, Inc., 2005


103

Problem 14-3B (Concluded)


Part 3
2004
June 30

Bond Interest Expense..................................................


6,551
Premium on Bonds Payable..........................................
649
Cash...........................................................................

7,200

To record six months interest and


premium amortization.

2004
Dec. 31

Bond Interest Expense..................................................


6,551
Premium on Bonds Payable..........................................
649
Interest Payable........................................................

7,200

To record six months interest and


premium amortization.

McGraw-Hill Companies, Inc., 2005


104

Fundamental Accounting Principles, 17th Edition

Problem 14-4BB (45 minutes)


Part 1
Ten payments of $7,200 ..................
Par value at maturity........................
Total repaid.......................................
Less amount borrowed....................
Total bond interest expense............

$ 72,000
160,000
232,000
(166,494)
$ 65,506

or:
Ten payments of $7,200 ..................
Less premium...................................
Total bond interest expense............

$ 72,000
(6,494)
$ 65,506

Part 2
Semiannual
Interest
Period-End

(A)
(B)
Cash Interest
Bond Interest
Paid
Expense
[4.5% x $160,000] [4% x Prior (E)]

(C)
Premium
Amortization
[(A) - (B)]

1/01/2004

(D)
(E)
Unamortized
Carrying
Premium
Value
[Prior (D) - (C)] [$160,000 + (D)]

$6,494

$166,494

6/30/2004

$ 7,200

$ 6,660

$ 540

5,954

165,954

12/31/2004

7,200

6,638

562

5,392

165,392

6/30/2005

7,200

6,616

584

4,808

164,808

12/31/2005

7,200

6,592

608

4,200

164,200

6/30/2006

7,200

6,568

632

3,568

163,568

12/31/2006

7,200

6,543

2,911

162,911

6/30/2007

7,200

6,516

2,227

162,227

12/31/2007

7,200

6,489

711

1,516

161,516

6/30/2008

7,200

6,461

739

777

160,777

12/31/2008

7,200

6,423*

777

160,000

$72,000

$65,506

$6,494

657
684

*Adjusted for rounding.

Solutions Manual, Chapter 14

McGraw-Hill Companies, Inc., 2005


105

Problem 14-4BB (Concluded)


Part 3
2004
June 30

Bond Interest Expense..................................................


6,660
Premium on Bonds Payable..........................................
540
Cash...........................................................................

7,200

To record six months interest and


premium amortization.

2004
Dec. 31

Bond Interest Expense..................................................


6,638
Premium on Bonds Payable..........................................
562
Interest Payable........................................................

7,200

To record six months interest and


premium amortization.

Part 4
As of December 31, 2006
Cash Flow
Table
Par value.................
B.1
Interest (annuity)....
B.3
Price of bonds........

Table Value*
0.8548
3.6299

Amount
$160,000
7,200

Present Value
$136,768
26,135
$162,903

* Table values are based on a discount rate of 4% (half the annual original market
rate) and 4 periods (semiannual payments).

Comparison to Part 2 Table


Except for a small rounding difference, this present value ($162,903) equals
the carrying value of the bonds in column (E) of the amortization table
($162,911). This reveals a general rule: The carrying value of bonds at any
point in time equals the present value of the remaining cash flows using
the market rate at the time of issuance.

McGraw-Hill Companies, Inc., 2005


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Fundamental Accounting Principles, 17th Edition

Problem 14-5B (60 minutes)


Part 1
2004
Jan. 1

Cash.................................................................................
99,247
Discount on Bonds Payable..........................................
20,753
Bonds Payable..........................................................

120,000

Sold bonds on stated issue date.

Part 2
Thirty payments of $3,600* .............
Par value at maturity........................
Total repaid.......................................
Less amount borrowed....................
Total bond interest expense............

$108,000
120,000
228,000
(99,247)
$128,753

or:
Thirty payments of $3,600* .............
Plus discount....................................
Total bond interest expense............

$108,000
20,753
$128,753

Semiannual interest payment, computed as $120,000 x 6% x year.

Part 3 Straight-line amortization table ($20,753/30= $692)


Semiannual
Interest Period-End

Unamortized
Discount

Carrying
Value

1/01/2004

$20,753

$ 99,247

6/30/2004

20,061

99,939

12/31/2004

19,369

100,631

6/30/2005

18,677

101,323

12/31/2005

17,985

102,015

Solutions Manual, Chapter 14

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107

Problem 14-5B (Concluded)


Part 4
2004
June 30

Bond Interest Expense..................................................


4,292
Discount on Bonds Payable....................................
Cash...........................................................................

692
3,600

To record six months interest and


discount amortization.

2004
Dec. 31

Bond Interest Expense..................................................


4,292
Discount on Bonds Payable....................................
Cash...........................................................................

692
3,600

To record six months interest and


discount amortization.

McGraw-Hill Companies, Inc., 2005


108

Fundamental Accounting Principles, 17th Edition

Problem 14-6BB (60 minutes)


Part 1
2004
Jan. 1

Cash.................................................................................
99,247
Discount on Bonds Payable..........................................
20,753
Bonds Payable..........................................................

120,000

Sold bonds on stated issue date.

Part 2
Thirty payments of $3,600* .............
Par value at maturity........................
Total repaid.......................................
Less amount borrowed....................
Total bond interest expense............

$108,000
120,000
228,000
(99,247)
$128,753

or:
Thirty payments of $3,600* .............
Plus discount....................................
Total bond interest expense............

$108,000
20,753
$128,753

Semiannual interest payment, computed as $120,000 x 6% x year.

Part 3
Semiannual
Interest
Period-End

(A)
Cash Interest
Paid
[3% x $120,000]

(B)
Bond Interest
Expense
[4% x Prior (E)]

(C)
(D)
(E)
Discount
Unamortized
Carrying
Amortization
Discount
Value
[(B) - (A)]
[Prior (D) - (C)] [$120,000 - (D)]

1/01/2004

$20,753

$ 99,247

6/30/2004

$3,600

$3,970

$370

20,383

99,617

12/31/2004

3,600

3,985

385

19,998

100,002

6/30/2005

3,600

4,000

400

19,598

100,402

12/31/2005

3,600

4,016

416

19,182

100,818

Solutions Manual, Chapter 14

McGraw-Hill Companies, Inc., 2005


109

Problem 14-6BB (Concluded)


Part 4
2004
June 30

Bond Interest Expense..................................................


3,970
Discount on Bonds Payable....................................
Cash...........................................................................

370
3,600

To record six months interest and


discount amortization.

2004
Dec. 31

Bond Interest Expense..................................................


3,985
Discount on Bonds Payable....................................
Cash...........................................................................

385
3,600

To record six months interest and


discount amortization.

McGraw-Hill Companies, Inc., 2005


110

Fundamental Accounting Principles, 17th Edition

Problem 14-7BB (70 minutes)


Part 1
2004
Jan. 1

Cash.................................................................................
987,217
Premium on Bonds Payable....................................
Bonds Payable..........................................................

87,217
900,000

Sold bonds on stated issue date.

Part 2
Eight payments of $58,500 .............
Par value at maturity........................
Total repaid.......................................
Less amount borrowed....................
Total bond interest expense............

$ 468,000
900,000
1,368,000
(987,217)
$ 380,783

or:
Eight payments of $58,500 .............
Less premium...................................
Total bond interest expense............

$ 468,000
(87,217)
$ 380,783

Part 3
Semiannual
Interest
Period-End

(A)
Cash Interest
Paid
[6.5% x $900,000]

(B)
Bond Interest
Expense
[5% x Prior (E)]

(C)
Premium
Amortization
[(A) - (B)]

1/01/2004

(D)
(E)
Unamortized
Carrying
Premium
Value
[Prior (D) - (C)] [$900,000 + (D)]

$87,217

$987,217

6/30/2004

$58,500

$49,361

$ 9,139

78,078

978,078

12/31/2004

58,500

48,904

9,596

68,482

968,482

6/30/2005

58,500

48,424

10,076

58,406

958,406

12/31/2005

58,500

47,920

10,580

47,826

947,826

Solutions Manual, Chapter 14

McGraw-Hill Companies, Inc., 2005


111

Problem 14-7BB (Concluded)


Part 4
2004
June 30

Bond Interest Expense..................................................


49,361
Premium on Bonds Payable..........................................
9,139
Cash...........................................................................

58,500

To record six months interest and


premium amortization.

2004
Dec. 31

Bond Interest Expense..................................................


48,904
Premium on Bonds Payable..........................................
9,596
Cash...........................................................................

58,500

To record six months interest and


premium amortization.

Part 5
2006
Jan. 1

Bonds Payable ...............................................................


900,000
Premium on Bonds Payable..........................................
47,826
Loss on Retirement of Bonds.......................................
6,174
Cash*.........................................................................

954,000

To record the retirement of bonds.


*($900,000 x 106%)

Part 6
If the market rate on the issue date had been 14% instead of 10%, the bonds
would have sold at a discount because the contract rate of 13% would have been
lower than the market rate.
This change would affect the balance sheet because the bond liability would be
smaller (par value minus a discount instead of par value plus a premium). As the
years passed, the bond liability would increase with amortization of the discount
instead of decreasing with amortization of the premium.
The income statement would show larger amounts of bond interest expense over
the life of the bonds issued at a discount than it would show if the bonds had
been issued at a premium.
The statement of cash flows would show a smaller amount of cash received from
borrowing. However, the cash flow statements presented over the life of the
bonds (after issuance) would report the same total amount of cash paid for
interest. This amount is fixed as it is the product of the contract rate and the par
value of the bonds and is unaffected by the change in the market rate.

McGraw-Hill Companies, Inc., 2005


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Fundamental Accounting Principles, 17th Edition

Problem 14-8B (45 minutes)


Part 1

Amount of Payment
Note balance...................................................................
$300,000
Number of periods.........................................................
3
Interest rate.....................................................................
10%
Value from Table B.3......................................................
2.4869
Payment ($300,000 / 2.4869)..........................................
$120,632

Part 2
(B)
Debit
Interest
Expense +

Payments
(C)
Debit
Notes
Payable =

[10% x (A)]

9/30/2005...............
$300,000

(A)
Period
Ending
Date

Beginning
Balance

(D)
Credit

(E)

Cash

Ending
Balance

[(D) - (B)]

[computed]

[(A) - (C)]

$30,000

$ 90,632

$120,632

$209,368

9/30/2006...............
209,368

20,937

99,695

120,632

109,673

9/30/2007...............
109,673

10,959*

109,673

120,632

$300,000

$361,896

[Prior (E)]

$61,896
*Adjusted for rounding.

Part 3
2004
Dec. 31

Interest Expense.............................................................
7,500
Interest Payable........................................................

7,500

Accrued interest on the installment


note payable ($30,000 x 3/12).

2005
Sept. 30

Interest Expense.............................................................
22,500
Interest Payable..............................................................
7,500
Notes Payable.................................................................
90,632
Cash...........................................................................

120,632

Record first payment on installment note


(interest expense = $30,000 - $7,500).

Solutions Manual, Chapter 14

McGraw-Hill Companies, Inc., 2005


113

Problem 14-8B (Concluded)


Part 4
(A)
Period
Ending
Date

(D)
Credit

(E)

Cash

Ending
Balance

[10% x (A)]

[$300,000/ 3]

[(B) + (C)]

[(A) - (C)]

9/30/2005...............
$300,000

$30,000

$100,000

$130,000

$200,000

9/30/2006...............
200,000

20,000

100,000

120,000

100,000

9/30/2007...............
100,000

10,000

100,000

110,000

$60,000

$300,000

$360,000

2004
Dec. 31

Beginning
Balance

(B)
Debit
Interest
Expense +

Payments
(C)
Debit
Notes
Payable =

[Prior (E)]

Interest Expense.............................................................
7,500
Interest Payable........................................................

7,500

Accrued interest on the installment


note payable ($300,000 x .10 x 3/12).

2005
Sept. 30

Interest Expense.............................................................
22,500
Interest Payable..............................................................
7,500
Notes Payable.................................................................
100,000
Cash...........................................................................
130,000
Record first payment on installment note
(interest expense = $30,000 - $7,500).

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Problem 14-9B (30 minutes)


Part 1
Hunt Company
Pledged assets [($180,000 x 32%) + $120,000]...........................$177,600
Secured liabilities ($39,000 + $45,000)........................................$ 84,000
Ratio ($177,600 / $84,000).............................................................2.11 to 1
Hound Company
Pledged assets [($750,000 x 10%) + $225,000]...........................$300,000
Secured liabilities ($57,000 + $150,000)......................................$207,000
Ratio ($300,000 / $207,000)...........................................................1.45 to 1
Part 2
Hunt's ratio of pledged assets to secured liabilities is higher than Hound's,
so the Hunt bonds appear less risky to bondholders. Before deciding to
buy Hunts bonds, however, it might be helpful to know the liquidation
value of both companies assets that are pledged as collateral. It also is
important to evaluate the ability of each company to meet its obligations
from operating cash flows.

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Problem 14-10BC (35 minutes)


Part 1
Present Value of the Lease Payments
$10,000 x 3.7908 (from Table B.3) = $37,908.
Part 2
Leased AssetOffice Equipment.................................
37,908
Lease Liability...........................................................

37,908

To record capital lease of office equipment.

Part 3
Capital Lease Liability Payment (Amortization) Schedule
Period
Ending
Date

Beginning
Balance of
Lease
Liability

Interest on
Lease
Liability
(10%)

Reduction
of Lease
Liability

Cash
Lease
Payment

Ending
Balance of
Lease
Liability

Year 1

$37,908

$ 3,791*

$ 6,209

$10,000

$31,699

Year 2

31,699

3,170

6,830

10,000

24,869

Year 3

24,869

2,487

7,513

10,000

17,356

Year 4

17,356

1,736

8,264

10,000

9,092

Year 5

9,092

9,092

10,000

$37,908

$50,000

908**
$12,092

*
**

Rounded to nearest dollar.


Difference due to rounding.

Part 4
Depreciation ExpenseOffice Equipment..................7,582
Accum. DepreciationOffice Equipment..............

7,582

To record depreciation ($37,908 / 5 years).

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SERIAL PROBLEM
Serial Problem, Success Systems (75 minutes)
Part 1
Pledged Assets

Balances at 3/31/05

Accounts Receivable...........................................
Merchandise inventory........................................
Net Plant Assets...................................................
Total Pledged Assets...........................................

$22,720
704
24,700
$48,124

Maximum Loan Allowed.......................................

Pledged assets to secured loan ratio.................

Maximum loan allowed $48,124 / [?] = 6

$8,020

Part 2
Assume the secured loan is taken, then the percent of assets financed by:
a. Debt
($875 + $8,020) / ($129,909 + $8,020) = 6.4%
b. Equity
$129,034 / ($129,909 + $8,020)

Solutions Manual, Chapter 14

= 93.6%

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Reporting in Action

BTN 14-1

1. The balance sheet of Krispy Kreme reports long-term debt. However,


there is no evidence of bonds having been issued by Krispy Kreme
from its balance sheet or from its note disclosures. Specifically, Note 7
to its financial statements reports that its long-term debt consists of
lines of credit and term notes.
2. Krispy Kremes statement of cash flows (financing section) for the year
ended February 2, 2003, reports its repayment of long-term debt that
totals $2,170,000 and its repayment of revolving lines of credit that total
$121,000.
3. Krispy Kremes statement of cash flows (financing section) for the year
ended February 2, 2003, reports proceeds from additions to long-term
debt (borrowings) that total $44,234,000.
4. Answer depends on the financial statement information obtained.

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Comparative Analysis

BTN 14-2

[Note: Assignment assumes that both companies have pledged all of their current
receivables, inventory, and property and equipment as collateral for their long-term debt.]

1. Krispy Kremes pledged assets to secured liabilities ratio (in thousands)


Current Year
= (Receivables + Inventory + Property and Equipment) / Long-Term debt
= ($46,319* + $24,365 + $202,558) / $53,201 = $273,242/ $53,201 = 5.14
Prior Year
= (Receivables + Inventory + Property and Equipment) / Long-Term debt
= ($38,682* + $16,159 + $112,577) / $4,643 = $167,418 / $4,643 = 36.06
*Includes receivables from affiliates and other receivables.

Tastykakes pledged assets to secured liabilities ratio (in thousands)


Current Year
= (Receivables + Inventory + Property and Equipment) / Long-Term debt**
= ($20,882 + $6,777 + $58,391) / $13,500 = $86,050 / $13,500 = 6.37
Prior Year
= (Receivables + Inventory + Property and Equipment) / Long-Term debt
= ($22,233 + $8,412 + $59,702) / $14,900** = $90,347 / $14,900 = 6.06
**Does not include current and long-term capital lease obligations.

2. Krispy Kremes ratio implies that it has $5.14 ($36.06) of collateral for
each $1 of secured debt in the current (prior) year. Tastykakes ratio
implies that it has $6.37 ($6.06) of collateral for each $1 of secured debt
in the current (prior) year.
These results suggest that Krispy Kremes secured creditors, in the
current year, are at slightly more risk than Tastykakes secured
creditors. However, in the prior year, Krispy Kreme had a far superior
ratio of 36.06, implying very low risk for long-term secured creditors.

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119

Ethics Challenge

BTN 14-3

1. The ethics of the Brevard County officials are questionable. The


financial impact of the leasing arrangement is the same as bond
financing in that the county has a debt obligation requiring the
repayment of principal and interest over time. Taxes may need to be
raised to repay the lease just as they would have if bonds were issued.
Yet, the voters had no say in the financing arrangement the officials
agreed to.
In reality, the taxpayers of Brevard County, Florida, reacted very
negatively to the actions of the county officials when they learned of the
leasing arrangement. The taxpayers felt that their voice was taken out
of the governing process. Brevard County officials responded to the
outrage of their constituents by floating the idea of holding a
referendum on whether to stop the lease payments on the building. Of
course, such talk angered the municipal bond industry and the
investors.
2. Since the lease requires payments of a non-binding nature, investors
who purchased the tax-exempt securities from the bank are holding an
investment that is more risky than the conventional municipal bonds of
Brevard County.

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Communicating in Practice

BTN 14-4

MEMORANDUM
TO:
FROM:
SUBJECT:
The body of the memorandum should make the following points:
The associate is confused about the concept of a bond premium. Bonds
that sell at a premium provide the issuing company more cash than they
are required to pay the bondholders at their maturity date. When a bond is
issued at a premium, the face amount is less than the amount the associate
will invest to acquire the bond. As a result, the investment will yield the
investor (and cost the issuing corporation) less than the contract rate of
interest. This means that selling/buying at a premium incurs/yields an
effective rate of interest equivalent to the market rate for the risk assessed
for that bond at the time of issuance. In addition, this market rate of
interest is lower than the contract rate of interest for premium bonds. The
bottom line is that the market prices the bonds according to their perceived
risks and returns. What your associate needs to focus on is the level of risk
she is willing to accept and then invest accordingly.
A cordial closing that indicates willingness to discuss the issue further
would be appropriate.

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121

Taking It to the Net

BTN 14-5

1. Per the 2002 Statement of Cash Flows, Coca-Cola Co. issued $1,622
million of debt in 2002.
2. Per the 2002 Statement of Cash Flows, Coca-Cola Co. repaid $2,378
million in debt in 2002.
3. In 2002, Coca-Cola Co. issued $107 million in stock. This amount of
financing from issuing stock is much less than the $1,622 million
obtained from debt financing.
4.
2002
Issuances of debt.......................................
$ 1,622

2001

2000

$ 3,011

$ 3,671

Payments of debt.......................................(2,378)

(3,937)

(4,256)

Net issuance or (net repayment)...............


$ (756)

$ (926)

$ (585)

Analysis: The amount of debt issued in 2002 is less than that issued in
2000 and 2001. For all three years the amount of debt repaid exceeded
the new debt issued.

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Teamwork in Action

BTN 14-6

Parts 1 and 2
Effective Interest Amortization of Bond Premium
Semiannual
Period-end

(A)
Cash
Interest
Paid

(B)
Bond
Interest
Expense

(C)

(D)

(E)

Premium
Amortization

Unamortized
Premium

Carrying
Value

1/01/2005

$ 4,100

$ 104,100

6/30/2005

$ 4,500

$ 4,164

$ 336

3,764

103,764

12/31/2005

4,500

4,151

349

3,415

103,415

6/30/2006

4,500

4,137

363

3,052

103,052

12/31/2006

4,500

4,122

378

2,674

102,674

6/30/2007

4,500

4,107

393

2,281

102,281

Since teams generally have 4 or 5 members, the team solution will likely end about
here. The remainder of the table is shown for help in answering part 3.

12/31/2007
6/30/2008
12/31/2008
6/30/2009
12/31/2009

4,500
4,500
4,500
4,500
4,500
$45,000

4,091
4,075
4,058
4,040
3,955*
$40,900

409
425
442
460
545
$4,100

1,872
1,447
1,005
545
0

101,872
101,447
101,005
100,545
100,000

*Discrepancy due to rounding.

The following computations should be articulated by team members as


each line is explained and prepared:
Column (A) Cash Interest Paid = Bonds' par value ($100,000) x Semiannual
contract rate (4.5%).
Column (B) Bond interest expense = Bonds prior period carrying value x
Semiannual market rate (4%).
Column (C) Premium Amortization = difference between cash interest paid and
bond interest expense, or [(A) - (B)].
Column (D) Unamortized Premium = prior periods unamortized premium less the
current periods premium amortization, or [(D) - (C)].
Column (E) Bonds Carrying Value = Bonds par value plus unamortized premium,
or [$100,000 + (D)] or Previous book value - Periods amortization.

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Teamwork in Action (Concluded)


Part 3
Without completing the table, team members should be able to project the
final number in the first column and for each of the columns (A), (D), and
(E). Specifically:
(Col. 1) Last interest period date is 12/31/2009 because this is a five-year
bond, issued 1/1/2005, with semiannual interest payments made
on 6/30 and 12/31 of each year.
(Col. A) Interest paid of $4,500 (every interest period has the same amount
of interest paid).
(Col. D) Zero unamortized premium (by the last interest period the
premium must be fully amortized).
(Col. E) Ending carrying value is $100,000 (the carrying value always
equals the par value at the maturity date, after all amortization is
completed).
Part 4
Total Bond interest expense = Interest Paid - Premium
= ($4,500 x 10 periods) - $4,100
= $45,000 - $4,100 = $40,900
Part 5.

List likely includes:

Similarities
a. Table column headings
for the period and for
columns (A), (B), and (E).

Differences
a. Column (C) will be Discount Amortization and
Column (D) will be Unamortized Discount.

b. Dates in the period


column and interest paid in
column (A).

b. Bond interest expense is higher (lower) than the


interest paid and will increase (decrease) as we
amortize a discount (premium).

c. Computations in
Columns (A), (B), and (D)
will follow the same format.

c. Carrying value will increase (decrease) as we


amortize a discount (premium).

d. Ending unamortized
premium and discount will
both be zero.

d. Discount (premium) amortization will decrease


(increase) each period.

e. Carrying value at
12/31/2009 will be $100,000
in both cases.

e. Computation of Column (C) will be (B) - (A), not


(A) - (B).
f. Computation of Column (E) will be previous
Column (E) plus discount amortization whereas
with a premium we subtract to find the new
carrying value.

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Business Week Activity

BTN 14-7

1. This article discusses the challenges that emerging countries face in


attracting and retaining foreign investment capital.
2. The capital attracted by emerging countries can be considered hot
money in that investors might not be content to invest long-term in
emerging countries. Instead, investors tend to move money among the
various foreign capital markets in search of a better hot deal (higher
interest rates, returns, etc.).
3. At the time of the article, the available (printed) Polish Treasury bills
were yielding 18%.
4. Emerging countries try to attract foreign capital by paying high interest
rates on their bonds and loans.
5. Emerging economies (countries) can experience difficulties in retaining
foreign investment. This is for several reasons, but one of the main
reasons is that if a country attempts to lower its interest rates the
investors will sell their investments and then reinvest in another
country (or opportunity) where higher rates of interest can be earned.

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Entrepreneurial Decision

BTN 14-8

Part 1
The table below reveals how the five alternative interest-bearing notes
affect Noodles & Companys interest expense, net income, equity, and
return on equity (net income/equity):
Current

Alternative Notes for Expansion


10% Note 15% Note 16% Note 17% Note 20% Note

Income before
interest..............$ 40,000 $ 56,000 $ 56,000 $ 56,000 $ 56,000 $ 56,000
Interest expense....

10,000

20,000

25,000

26,000

27,000

30,000

Net income.............$ 30,000 $ 36,000 $ 31,000 $ 30,000 $ 29,000 $ 26,000


Equity.....................$250,000 $250,000 $250,000 $250,000 $250,000 $250,000
Return on equity. . .

12%

14.4%

12.4%

12%

11.6%

10.4%

Part 2
The analysis in Part 1 illustrates the general rule (called financial leverage or
trading on the equity): When a company earns a higher return with
borrowed funds than it is paying in interest, it increases its return on equity.
In the case of Kennedys franchise, it is predicting a return of 16% on its
investment, computed as its expected $16,000 additional annual income
before interest divided by its $100,000 investment. This means that for it to
pursue the investment, the interest on the borrowed funds must be less than
16%. The table in Part 1 shows this result, where those notes with interest
expense below 16% are profitable (that is, yield a return greater than the
current ROE of 12%) while those above 16% are not (that is, yield a return less
than the current ROE of 12%). Also, Noodles & Company should take into
account any potential variability in its income predictions because any
downturn in income that results in return on equity lower than the interest rate
paid on the notes would be unprofitable.

Hitting the Road

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BTN 14-9

Fundamental Accounting Principles, 17th Edition

Students answers will depend on the municipality and time period chosen
for analysis. Students often find this assignment interesting as it
reinforces the relevance of their accounting studies.

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127

Global Decision

BTN 14-10

1. Grupo Bimbos pledged assets to secured liabilities ratio (in thousands


of pesos)
Current Year
= (Receivables + Inventory + Property and Equipment) / Long-Term debt
= (3,794 + 905 + 15,444) / 11,466
= 20,143 / 11,466 = 1.76
Prior Year
= (Receivables + Inventory + Property and Equipment) / Long-Term debt
= (3,207 + $767 + 14,683) / 5,004
= 18,657 / 5,004 = 3.73
2. Tastykake exhibits the most stable and largest multiple of pledged
assets to secured liabilities. In the most recent year Tastykakes
multiple of 6.37 exceeded Krispy Kremes ratio of 5.14 and Grupo
Bimbos (much weaker) ratio of 1.76. Therefore, according to this ratio
only, we conclude that Tastykakes long-term debt is least risky.
However, we caution that we should consider other measures of
solvency before making a definite conclusion regarding the riskiness of
the long-term debt of these companies.
3. The Statement of Changes in Financial Position (financing activities)
reports that Grupo Bimbo borrowed 6,462 million (pesos) of debt in
2002. In contrast, they repaid only 69.1 million (pesos) to financial
institutions in 2002.

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