Chapter 10

Chapter 10
Reporting and Interpreting Bonds
ANSWERS TO QUESTIONS
1. A company might choose to issue bonds instead of stock to avoid diluting
shareholders’ interests, to benefit from the tax deductions associated with paying
interest, and to potentially increase the return to shareholders.
2. A bond is a liability that is issued to the investing public to raise capital. Bonds are
traded on established exchanges, such as the New York Bond Exchange. When a
company issues bonds, it receives money from investors. Investors pay for the
bonds in order to earn interest over the life of the bond. At the end of a bond’s life,
investors receive the bond principle amount back from the company.
3. Unsecured bonds are not backed by any type of asset as a guarantee of repayment
at maturity. Secured bonds are backed by specific assets as a guarantee of
repayment at maturity.
4. A bond indenture is a legal document that specifies all the details of a bond
offering. A prospectus is a regulatory document filed with the Security and
Exchange Commission. It also provides details of the bond offering. A bond
indenture and a bond prospectus provide similar information.
5. Bond covenants are designed to protect bond investors but limiting what a
company can do while the bond is still outstanding.
Financial Accounting, 9/e 10-1

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6. A bond’s coupon rate (also called the stated rate, contract rate, or nominal rate) is
the interest rate specified on a bond and is the rate used to compute the bond’s
periodic cash interest payment. The market rate of interest (also known as the yield
or effective interest rate) is the rate of return investors demand for a company’s
bonds on the date the bonds are issued. Any difference between a bond’s coupon
rate and the market rate of interest on the date of issuance creates a bond discount
or a bond premium depending on whether the coupon rate is lower or higher than
the market rate.
7. The difference between a bond’s coupon rate and the market rate of interest
determines whether a bond is issued at a discount or a premium. When the coupon
rate is lower than the market rate of interest, the bond is issued at a discount.
When the coupon rate is higher than the market rate of interest, the bond is issued
at a premium.
8. The market interest rate reflects the return investor demand to invest in a security
with a given level of risk, so it is the rate used to discount a bond’s future cash
flows when calculating a bond’s present value.
9. The book value of a bond is the bond’s principle amount plus any premium or
minus any discount. A bond’s book value is what a company reports on its balance
sheet.
10. The formula used to calculate the cash payment bond investors receive for interest
each period is: principle amount x coupon rate. The formula used to calculate
interest expense reported each period is: book value of the bond at the beginning
of the period x the market rate of interest on the date of issuance.
11. The debt-to-equity ratio is calculated by dividing total liabilities by total stockholders’
equity. The ratio describes the relationship between the amount of capital provided
by owners and the amount of capital provided by creditors.
12. When market interest rates increase, bond prices decrease. This concept is easily
understood by remembering that the market rate of interest is the discount rate
used to calculate the present value of a bond’s future cash flows. The higher the
discount rate the lower the present value of the bond.
ANSWERS TO MULTIPLE CHOICE
1. c) 2. c) 3. b) 4. d) 5. c)
6. b) 7. c) 8. c) 9. a) 10. c)
10-2 Solutions Manual

Authors’ Recommended Solution Time
(Time in minutes)
Alternate Cases and
Mini-exercises Exercises Problems Problems Projects
No. Time No. Time No. Time No. Time No. Time
1 5 1 5 1 15 1 30 1 25
2 10 2 10 2 30 2 30 2 20
3 5 3 20 3 30 3 30 3 20
4 5 4 20 4 20 4 35 4 30
5 10 5 15 5 25 5 35 5 30
6 15 6 10 6 30 6 30 6 25
7 15 7 15 7 45 7 35 7 *
8 10 8 20 8 45 8 35
9 15 9 20 9 30
10 15 10 20 10 40
11 15 11 15 11 45
12 15 12 10 12 45
13 5 13 20 13 15
14 5 14 20 14 15
15 20 15 45
16 15 16 10
17 15
18 15
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20 20
21 20
22 20
23 20
24 10
* Due to the nature of this project, it is very difficult to estimate the amount of time
students will need to complete the assignment. As with any open-ended project, it is
possible for students to devote a large amount of time to these assignments. While
students often benefit from the extra effort, we find that some become frustrated by the
perceived difficulty of the task. You can reduce student frustration and anxiety by
making your expectations clear. For example, when our goal is to sharpen research
skills, we devote class time to discussing research strategies. When we want the
students to focus on a real accounting issue, we offer suggestions about possible
companies or industries.

MINI-EXERCISES
M10–1. 1. Balance Sheet

2. Footnotes
3. Footnotes
4. Income Statement
5. Footnotes
6. Statement of cash flows
M10–2.
Principal $600,000  0.45639 = $273,834
Interest $ 24,000*  13.59033 = 326,168
Issue Price = $600,002**
* ($600,000 x .08 x ½ year)
**Issue price should be exactly $600,000. The $2 difference is the result of

rounding the present value factors at five digits. If you use Excel or a financial
calculator to do this problem the present value will equal exactly $600,000.
M10–3.
The times interest earned ratio is a better indicator. The debt-to-equity ratio
assesses how much debt relative to equity a company has in its capital structure.
It is considered a broad measure of risk sense a heavy reliance on debt financing
increases the risk that a company may not be able to meet its contractual
financial obligations. A ratio that gets at a company’s ability to meet a very
specific financial obligation is the times interest earned ratio. It attempts to
assess whether a company is generating sufficient resources from its profit-
making activities to meet its current interest obligations.
M10–4.
The formula for the times interest earned ratio is:

Times Interest Earned = Net Income + Interest Expense + Income Tax
Interest Expense
For Oak this results in a times interest earned ratio of:

14.29 = $117,180 + $12,600 + $50,220
$12,600
M10–5.
Principal $900,000  0.43499 = $391,491
Interest $ 27,000*  13.29437 = 358,948
* ($900,000 x .06 x ½ year)
**Using Excel or a financial calculator results in a present value of $750,438

(rounded).
M10–6.
January 1:
Cash (+A) .............................................................................. 940,000
Bond discount (+XL, -L) ........................................................ 60,000
Bonds Payable (+L) .......................................................... 1,000,000
June 30:
Interest Expense (+E, -SE) ($940,000  .11  1/2) .............. 51,700
Bond discount (-XL, +L) .................................................... 1,700
Cash (-A) ($1,000,000  .10  1/2) ................................... 50,000
M10–7.
January 1:
Cash (+A) .............................................................................. 940,000
Bonds Payable (+L) .......................................................... 940,000
June 30:
Interest Expense (+E, -SE) ($940,000  .11  1/2) .............. 51,700
Bonds Payable (+L)........................................................... 1,700
Cash (-A) ($1,000,000  .10  1/2) ................................... 50,000

M10–8.
Principal $500,000  0.45639 = $228,195
Interest $ 25,000*  13.59033 = 339,758
* ($500,000 x .05 x ½ year)
**Using Excel or a financial calculator results in a present value of $567,952

(rounded).
M10–9
January 1:
Cash (+A) .............................................................................. 910,000
Bond premium (+L) ........................................................... 60,000
Bonds Payable (+L) .......................................................... 850,000
December 31:
Interest Expense (+E, -SE) ($910,000  .07) ........................ 63,700
Bond premium (-L) ................................................................ 4,300
Cash (-A) ($850,000  .08) ................................................ 68,000
M10–10
January 1:
Cash (+A) .............................................................................. 910,000
Bonds Payable (+L) .......................................................... 910,000
December 31:
Interest Expense (+E, -SE) ($910,000  .07) ........................ 63,700
Bonds Payable (-L) ............................................................... 4,300
Cash (-A) ($850,000  .08) ................................................ 68,000

M10–11.
January 1:
Cash (+A) .............................................................................. 580,000
Bonds Payable (+L) ........................................................... 600,000
June 30:
Interest Expense (+E, -SE) ($30,000 + $1,000) .................... 31,000
Bond discount (-XL, +L) ($20,000 / 20) ............................. 1,000
Cash (-A) ($600,000 x .10 x ½) ......................................... 30,000
M10–12.
January 1:
Cash (+A) .............................................................................. 580,000
Bonds Payable (+L) ........................................................... 580,000
June 30:
Interest Expense (+E, -SE) ($30,000 + $1,000) .................... 31,000
Bonds Payable (+L) ($20,000 / 20) ................................... 1,000
Cash (-A) ($600,000 x .10 x ½) ......................................... 30,000
M10–13.
If market interest rates fall after the issuance of a bond, the bond’s price will
increase. This is because the market interest rate is used to discount the bond’s
future cash flows to determine its price, and a lower discount rate means a higher
present value (price). The company will report a loss on the debt retirement
because it will have to pay more to investors to retire the bonds than the bond’s
book value. On the balance sheet, cash and bonds payable will decrease. On
the income statement, a loss would be recorded for the difference between the
cash paid and the bond’s book value.
M10–14.
Cash paid for principle when a bond matures would be reported in the financing
section of the Statement of Cash Flows, while cash paid for interest would be
reported in the operating section.

EXERCISES
E10–1.
Investors care about knowing the coupon rate because it determines the cash interest
payment they will receive each period. Investors care about knowing the yield because
it reflects the return they can expect if they invest in the bonds, and is the market
interest rate they would use to discount the bonds to determine its price. A decrease in
the yield after the bonds have initially been issued does not affect Apple’s financial
statements.
E10–2.
If interest rates were to fall, companies might decide to call their bonds and issue
new ones at a lower interest rate. When this is the case, a zero coupon bond offers
an extra margin of protection. A zero coupon bond is sold at a deep discount (say
60% of par). It would be very unusual to see a company call such a bond if it were
callable at par.
E10–3.
CASE A:
$100,000 x 0.58349 ...................................................... $ 58,349
$8,000* x 5.20637 ........................................................ 41,651
Issue price (market and stated rate same) ................... $100,000
*$100,000 x .08
CASE B:
$100,000 x 0.66506 ...................................................... $ 66,506
$8,000* x 5.58238 ........................................................ 44,659
Issue price (market rate less than stated rate).............. $111,165 (at a premium)
*$100,000 x .08
CASE C:
$100,000 x 0.54703 ...................................................... $ 54,703
$8,000* x 5.03295 ........................................................ 40,264
Issue price (market rate more than stated rate) ............ $ 94,967 (at a discount)
*$100,000 x .08

E10–4.
CASE A:
$500,000 x 0.67297 ...................................................... $ 336,485
$15,000* x 16.35143 .................................................... 245,271
Issue price (market rate less than coupon rate)............ $581,756 **(at a premium)
*$500,000 x .06 x ½
**Using Excel or a financial calculator results in a

present value of $581,757 (rounded).
CASE B:
$500,000 x 0.55368 ...................................................... $ 276,840
$15,000* x 14.87747 .................................................... 223,162
Issue price (market rate same as coupon rate) ............ $500,002 (at par)
*$500,000 x .06 x 1/2

present value of $500,000.
CASE C:
$500,000 x 0.43499 ...................................................... $ 217,495
$15,000* x 13.29437 .................................................... 199,416
Issue price (market rate greater than coupon rate)....... $ 416,911 (at a discount)
*$500,000 x .06 x 1/2

E10–5.
Req. 1
At issuance, liabilities go up and equity is not affected so the debt-to-equity ratio

increased.
Req. 2
When Denver recognized interest expense, it decreased net income and decreased
cash. Since the balance in the bond payable account did not change, this means
that liabilities stay the same and equity decreased (as a result of the interest
expense). This will also increase the debt-to-equity ratio.
E10–6.
Applied Engineering’s ratios look better than Innovative Engineering’s ratios.

Applied Engineering has a lower debt-to-equity ratio than Innovative Engineering.
This means that they have less debt relative to equity in their capital structure,
and therefore, are a less leveraged company and have less risk than Innovative
Engineering. Applied Engineering’s times interest earned ratio is higher than the
ratio for Innovative Engineering. This also makes Applied Engineering a less
risky company than Innovative Engineering because Applied Engineering
generates a larger amount of income compared to its interest expense than does
Innovative Engineering.
E10–7.
Present value:
$250,000 x 0.67556 = 168,890
$ 7,500* x 8.11090 = 60,832
Issue price = $229,722**
*$250,000 x .06 x 1/2

E10–8.
Present value:
$600,000 x 0.71679 = 430,074
$ 22,500* x 6.66378 = 149,935
Issue price = $580,009
*$600,000 x .075 x 1/2

Req. 1
January 1:
Cash (+A) .............................................................................. 580,009
Bonds Payable (+L) ........................................................... 600,000

E10–8 (continued).
Req. 2
June 30:
Interest Expense* (+E, -SE) ................................................. 24,650
Cash (-A) ........................................................................... 22,500
*($580,009 x .085 x ½)
Req. 3
June 30:
Balance sheet:
Long-term Liabilities
Bonds payable $582,159*
*This is the book value of the bond payable. It is computed in one of two ways: (1)
By subtracting the unamortized discount ($19,991 - $2,150) from the face value of the
bonds ($600,000), or (2) by adding the amount of the discount amortized on June 30
($2,150) to the book value of the bond at the beginning of the period ($580,009).
E10–9.
Present value:
$600,000 x 0.71679 = 430,074
$ 22,500* x 6.66378 = 149,935
*$600,000 x .075 x 1/2

Req. 1
January 1:
Cash (+A) .............................................................................. 580,009
Bonds Payable (+L) ........................................................... 580,009

Req. 2
June 30:
Interest Expense* (+E, -SE) ................................................. 24,650
Bonds Payable (+L)........................................................... 2,150
Cash (-A) ........................................................................... 22,500
*($580,009 x .085 x ½)
Req. 3
June 30:
Balance sheet:
*This is the book value of the bond payable. It is computed by adding the amount of the
discount amortized on June 30 ($2,150) to the book value of the bond at the beginning
of the period ($580,009).
E10–10.
Req. 1
Cash Discount Book Value
Date Interest Interest Expense Amortization of Bond
Jan. 1, Yr 1 $97,327
Dec. 31, Yr 1 $5,000* $97,327 x .06 = $5,840 $840 98,167
Dec. 31, Yr 2 5,000 98,167 x .06 = $5,890 890 99,057
Dec. 31, Yr 3 5,000 99,057 x .06 = $5,943 943 100,00
*$100,000 x .05
Present value computation:

Principal: $100,000 x .83962 $ 83,962
Interest: 5,000 x 2.67301 13,365
Issue price $97,327
Req. 2
Year 1 Year 2
December 31:
Interest expense................... $5,840 $5,890
Bond liability…………………. $98,167 $99,057
E10–11.
1. The bond issue price was $948. This is given in the amortization table. It can also
be computed by taking the present value of the future cash flows and discounting
them by the market interest rate of 8 percent.
2. The bond sold at a discount. The amount of the discount was $52 ($1,000 – $948)
3. Balance sheet:
Year 1: $ 964 ($948 + $16)
Year 2: $ 981 ($964 + $17)
4. (a) $1,000 x .06 = $60.

(b) $964 x .08 = $77 (rounded).
(c) $77 – $60 = $17.
(d) $964 + $17 = $981.
E10–12.
American specifies the coupon rate for the bonds, which determines the cash
payment made to investors each period for interest. American does not get to
specify the effective (market) interest rate. It is determined by market forces and
not the company. The market rate of interest continually changes as the result of
such factors as inflation expectations and the level of business activity.
E10–13.
Present value:
$2,000,000 x 0.43499 = 869,980
$ 100,000* x 13.29437 = 1,329,437
Issue price = $2,199,417
*$2,000,000 x .01 x 1/2

present value of $2,199,415 (rounded).

Req. 1
January 1:
Cash (+A) .............................................................................. 2,199,417
Bonds premium (+L).......................................................... 199,417
Bonds Payable (+L) .......................................................... 2,000,000
Req. 2
June 30:
Interest Expense (+E, -SE) ($2,199,417 x .0425) ................ 93,475
Bond premium (-L) ................................................................ 6,525
Cash (-A) ($2,000,000 x .10 x ½) ...................................... 100,000
Req. 3
Balance sheet:
Bonds payable $2,192,892*
By adding the unamortized premium ($199,417 - $6,525) to the face value of the bonds
($2,000,000), or (2) by subtracting the amount of the premium amortized on June 30
($6,525) from the book value of the bond at the beginning of the period ($2,199,417).

E10–14.
Present value:
$2,000,000 x 0.43499 = 869,980
$ 100,000* x 13.29437 = 1,329,437
Issue price = $2,199,417
*$2,000,000 x .01 x 1/2

Req. 1
January 1:
Cash (+A) .............................................................................. 2,199,417
Bonds Payable (+L) .......................................................... 2,199,417
Req. 2
June 30:
Interest Expense (+E, -SE) ($2,199,417 x .0425) ................ 93,475
Bonds Payable (-L) ............................................................... 6,525
Cash (-A) ($2,000,000 x .10 x ½) ...................................... 100,000
Req. 3
Balance sheet:
*This is the book value of the bond payable. It is computed by subtracting the amount of
the premium amortized on June 30 ($6,525) from the book value of the bond at the
beginning of the period ($2,199,417).

E10–15.
Req. 1
Cash Premium Book Value
Date Interest Interest Expense Amortization of Bond
Jan. 1, Yr 1 $10,278
Dec. 31, Yr 1 $500* $10,278 x .04 = $411 $89 10,189
Dec. 31, Yr 2 500 10,189 x .04 = $408 92 10,097
Dec. 31, Yr 3 500 10,097 x .04 = $404 96 10,001**
*$10,000 x .05
** $1 rounding error
Present value computation:
Principal: $10,000 x .88900 $ 8,890
Interest: 500 x 2.77509 1,388
Issue price $10,278
Req. 2
Year 1 Year 2
December 31:
Interest expense................... $411 $408
Bond liability…………………. $10,189 $10,097
E10–16.
Req. 1
Present value
$ 1,000,000 x .45639 = 456,390
$ 45,000* x 13.59033 = 611,565
$ 1,067,955**
*$1,000,000 x .09 x 1/2

January 1:
Cash (+A) .............................................................................. 1,067,955
Bonds payable (+L) ........................................................... 1,000,000
Bond premium (+L) ............................................................ 67,955

Req. 2
On January 1, cash flows from financing activities will increase by $1,067,955. On

June 30 and December 31, cash flows from operating activities will decrease by
$45,000, the amount of the cash interest payment.
E10–17.
Bonds payable (-L) ................................................................ 1,000,000

Loss on bond call (+Loss, -SE) ............................................. 50,000
Cash (-A) ........................................................................... 1,050,000*
*$1,000,000 x (1 +.05)
E10–18.
Bonds payable (-L) ................................................................ 1,000,000

Cash (-A) ........................................................................... 1,050,000*
*$1,000,000 x (1 + .05)
E10–19.
Bonds payable (-L) ................................................................ 984,000

Cash (-A) ........................................................................... 1,050,000*
*$1,000,000 x (1 + .05)

E10–20.
Present value:
$750,000 x 0.42241 = 316,808
$ 60,000* x 6.41766 = 385,060
*$750,000 x .08

Req. 1
January 1:
Cash (+A) .............................................................................. 701,868
Bonds Payable (+L) ........................................................... 750,000
Req. 2
December 31:
Interest Expense (+E, -SE) ................................................... 64,813
Bond discount (-XL, +L) ($48,132 / 10) ............................. 4,813
Cash (-A) ........................................................................... 60,000
Req. 3
December:
Balance sheet:
By subtracting the unamortized discount ($48,132 - $4,813) from the face value of the
bonds ($750,000), or (2) by adding the amount of the discount amortized on December
31 ($4,813) to the book value of the bond at the beginning of the period ($701,868).

E10–21.
Present value:
$750,000 x 0.42241 = 316,808
$ 60,000* x 6.41766 = 385,060
*$750,000 x .08

Req. 1
January 1:
Cash (+A) .............................................................................. 701,868
Bonds Payable (+L) ........................................................... 701,868
Req. 2
December 31:
Bonds Payable (+L) (($750,000 - $701,868) / 10) ............. 4,813
Cash (-A) ........................................................................... 60,000
Req. 3
December 31:
Balance sheet:
*This is the book value of the bond payable. It is computed by adding the amount of the
discount amortized on December 31 ($4,813) to the book value of the bond at the
beginning of the period ($701,868).

E10–22.
Present value:
$1,400,000 x 0.78941 = 1,105,174
$ 56,000* x 7.01969 = 393,103
Issue price = $1,498,277**
*$1,400,000 x .08 x 1/2

Req. 1
January 1:
Cash (+A) .............................................................................. 1,498,277
Bond premium (+L) ........................................................... 98,277
Bonds Payable (+L) .......................................................... 1,400,000
Req. 2
June 30:
Bonds premium (-L) ($98,277 / 8) ......................................... 12,285
Cash (-A) ........................................................................... 56,000
Req. 3
June 30
Balance sheet:
By adding the unamortized premium ($98,277 - $12,285) to the face value of the bonds
($1,400,000), or (2) by subtracting the amount of the premium amortized on June 30
($12,285) from the book value of the bond at the beginning of the period ($1,498,277).

E10–23.
Present value:
$1,400,000 x 0.78941 = 1,105,174
$ 56,000* x 7.01969 = 393,103
Issue price = $1,498,277**
*$1,400,000 x .08 x 1/2

Req. 1
January 1:
Cash (+A) .............................................................................. 1,498,277
Bonds Payable (+L) .......................................................... 1,498,277
Req. 2
June 30:
Bonds Payable (-L) (($1,498,277 - $1,400,000 / 8) ............... 12,285
Cash (-A) ........................................................................... 56,000
Req. 3
June 30
Balance sheet:
*This is the book value of the bond payable. It is computed by subtracting the amount of
the premium amortized on June 30 ($12,285) from the book value of the bond at the
beginning of the period ($1,498,277).

E10–24.
1. $960,000 will be reported as a financing cash inflow.
2. Transaction does not involve cash so there is no effect on the Statement of Cash
Flows.
3. $45,000 will be reported as an operating cash outflow.
4. $1,000,000 will be reported as a financing cash outflow.

PROBLEMS
P10–1.
Req. 1
Current debt-to-equity ratio: $500,000 / $300,000 = 1.67
Req. 2
Debt-to-equity ratio assuming issuance of debt: $600,000 / $300,000 = 2.00
Req. 3
Debt-to-equity ratio assuming issuance of stock: $500,000 / $400,000 = 1.25
Req. 4
It is important to note that the above calculations assume that Arbor’s other liability and
equity accounts do not change, and that we are only adding additional debt or equity to
its balance sheet. Since we do not have additional information this is a fair assumption,
but it is not likely to be the case. For example, Arbor may earn a substantial amount of
net income during the year, which would reduce its debt-to-equity ratio in both
calculations above.
Relying just on the ratios computed above, it appears that issuing additional debt to
fund the project would be risky since it will put Arbor right on the edge of violating its
debt covenant. Typically when a company violates its debt covenants, it is required to
expedite the repayment of any debt governed by the covenant. This would be costly to
Arbor. As a result, the safest alternative is likely to be choosing to fund the project by
issuing additional equity.

P10–2.
Req. 1
Present value
$ 100,000 x .67556 = 67,556
$ 4,000* x 8.11090 = 32,444
Issue price $100,000
*$100,000 x .08 x 1/2

Req. 2
June 30 Dec. 31
Interest expense ($100,000 x .08 x 1/2) . $4,000 $4,000
Req. 3
June 30 Dec. 31
Cash owed ($100,000 x .08 x 1/2) ......... $4,000 $4,000
Req. 4
This Year Next Year

Bonds payable book value ..................... $100,000 $100,000
P10–3.
CASE A
a. Cash received at issuance (Case A): Market interest 7%
Present value:
$500,000 x 0.50835 = 254,175
$ 35,000* x 7.02358 = 245,825
*$500,000 x .07

b. Interest expense calculation: $500,000 x .07 = $35,000
c. Cash payment for interest: $500,000 x .07 = $35,000
CASE B
a. Cash received at issuance (Case B): Market interest 8%
Present value:
$500,000 x 0.46319 = 231,595
$ 35,000* x 6.71008 = 234,853
*$500,000 x .07

CASE C
a. Cash received at issuance (Case C): Market interest 6%
Present value:
$500,000 x 0.55839 = 279,195
$ 35,000* x 7.36009 = 257,603
*$500,000 x .07

Case A Case B Case C

a. Cash received at issue .......................................... $500,000 $466,448 $536,798
b. Interest expense recorded in Year 1 ...................... $ 35,000 $ 37,316 $ 32,208
c. Cash paid for interest in Year 1 ............................. $35,000 $35,000 $35,000
d. Cash paid at maturity for bond principle ................ $500,000 $500,000 $500,000
P10–4.
CASE A:
$800,000 x 0.73069 ...................................................... $ 584,552
$32,000* x 6.73274 ...................................................... 215,448
Issue price (market rate same as coupon rate) ............ $800,000 (at par)**
*$800,000 x .08 x ½

CASE B:
$800,000 x 0.78941 ...................................................... $ 631,528
$32,000* x 7.01969 ...................................................... 224,630
Issue price (market rate less than coupon) ................... $856,158 (at a premium)**
*$800,000 x .08 x 1/2


CASE C:
$800,000 x 0.67684 ...................................................... $ 541,472
$32,000* x 6.46321 ...................................................... 206,823
Issue price (market rate greater than coupon rate)....... $ 748,295 (at a discount)**
*$800,000 x .08 x 1/2

P10–5.
1. Issuance price:
Present value:
$200,000 x 0.46319 = 92,638
$ 12,000* x 6.71008 = 80,521
*$200,000 x .06

2. Computation of interest expense recorded on December 31 of this year:

$173,159 x .08 = $13,853
3.
Time Debt-to-Equity Times Interest Earned
(a) Issuance Increase Stays the same
(b) Interest expense recorded Increase Decrease*
The times interest earned ratio decreases because interest expense is tax deductible,
which reduces the numerator, and the increase in interest expense increases the
denominator…both of which decrease the ratio.

P10–6.
Req. 1
Issuance price:
Present value:
$1,000,000 x 0.31180 = 311,800
$ 50,000* x 11.4699 = 573,495
*$1,000,000 x .10 x 1/2

Req. 2
June 30 December 31
Interest expense..................................... $53,118* $53,305**
$885,295 x .12 x ½ = $53,118
**[$885,296 + ($53,118 - $50,000)] x .12 x ½= $53,305
Req. 3
June 30 December 31
Cash paid ($1,000,000 x .10 x ½) .......... $50,000 $50,000
Req. 4
June 30 December
31
Bonds payable ....................................... $888,4134* $891,718**
*$885,295 + $3,118 = $888,413
**$888,413+ $3,305 = $891,718

P10–7.
Present value:
$100,000 x 0.78941 = 78,941
$ 2,000* x 7.01969 = 14,039
*$100,000 x .08 x 1/4

Req. 1
January 1:
Cash (+A) .............................................................................. 92,980
Bonds discount (+XL, -L)....................................................... 7,020
Bonds Payable (+L) ........................................................... 100,000
Req. 2
March 31:
Interest Expense (+E, -SE) ($92,980 x .12 x ¼) ................... 2,789
Bond discount (-XL, +L) .................................................... 789
Cash (-A) ($100,000 x .08 x ¼) ......................................... 2,000
Book value of bond: $93,769 ($100,000 – ($7,020 - $789))
June 30:
Cash (-A) ($100,000 x .08 x ¼) ......................................... 2,000
Book value of bond: $94,582 ($100,000 – ($7,020 - $789 - $813))
September 31:
Cash (-A) ($100,000 x .08 x ¼) ......................................... 2,000
Book value of bond: $95,419 ($100,000 – ($7,020 - $789 – $813 - $837))

P10–7 (continued).
December 31:
Bond discount (-XL, +L) ....................................................... 863
Cash (-A) ($100,000 x .08 x ¼) ......................................... 2,000
Book value of bond: $96,282 ($100,000 – ($7,020 - $789 – $813 - $837 - $863))
Req. 3
December 31:
Balance sheet:
Bonds payable $96,282
P10–8.
Present value:
$100,000 x 0.78941 = 78,941
$ 2,000* x 7.01969 = 14,039
*$100,000 x .08 x 1/4

Req. 1
January 1:
Cash (+A) .............................................................................. 92,980
Bonds Payable (+L) ........................................................... 92,980
Req. 2
March 31:
Bonds Payable (+L)........................................................... 789
Cash (-A) ($100,000 x .08 x ¼) ......................................... 2,000
Book value of bond: $93,769 ($92,980 + $789)

P10–8 (continued).
June 30:
Bonds Payable (+L)........................................................... 813
Cash (-A) ($100,000 x .08 x ¼) ......................................... 2,000
September 31:
Bonds Payable (+L)........................................................... 837
Cash (-A) ($100,000 x .08 x ¼) ......................................... 2,000
December 31:
Bonds Payable (+L)........................................................... 863
Cash (-A) ($100,000 x .08 x ¼) ......................................... 2,000
Req. 3
December 31:
Balance sheet:

P10–9.
Req. 1
Issuance price:
Present value
$700,000 x 0.31180 = 218,260
$ 45,500* x 11.46992 = 521,881
*$700,000 x .13 x 1/2

Req. 2
June 30 December 31
$740,141 x .12 x ½ = $44,408
**[$740,141 - ($45,500- $44,408)] x .12 x ½= $44,343
Req. 3
June 30 December 31
Cash paid ............................................... $45,500 $45,500
Req. 4
June 30 December 31
Bonds payable ....................................... $723,802* $721,730**
*$740,141 – ($45,500 – $44,408) = $739,049
**$739,049 – ($45,500 - $44,343) = $737,892

P10–10.
1. Missing amounts are underlined:

Date Cash Interest Amortization Balance
Jan. 1, Year 1........................... $48,813
End of Year 1 ........................... $3,600 $3,417 $183 48,630
End of Year 2 ........................... 3,600 3,404 196 48,434
End of Year 3 ........................... 3,600 3,390 210 48,224
End of Year 4 ........................... 3,600 3,376 224* 48,000
Calculations:
Annual market interest rate at time of issuance: $3,417  $48,813 = 7%
Coupon rate: $48,000 / $3,600 = 7.5%
Interest: 7% x Previous balance
Cash payment: 7.5% x $48,000
Amortization: Cash payment – Interest
Balance: Previous balance – Amortization
2. Principle amount: $48,000 from last column at end of the last year.
3. Cash received: $48,813 from last column at January 1, Year 1.
4. Bonds were issued at a premium: $48,813 – $48,000 = $813.
5. Cash disbursed for interest each period: $3,600

Total cash distributed over life of bonds: $3,600 x 4 = $14,400.
6. Coupon rate: $3,600  $48,000 = 7.5%.
7. Annual market rate of interest: $3,417  $48,808 = 7%.
8. From amortization table: Year 2: $3,417 ($48,813 x .07)

Year 3: $3,404 ($48,630 x .07)
9. From amortization table: Year 2: $48,630

Year 3: $48,434

P10–11.
Present value:
$300,000 x 0.85349 = 256,047
$ 9,000* x 7.32548 = 65,929
*$300,000 x .12 x 1/4

Req. 1
January 1:
Cash ...................................................................................... 321,976
Bond premium (+L) ........................................................... 21,976
Bond payable (+L) ............................................................. 300,000
Req. 2
March 31:
Interest Expense (+E, -SE) ($321,976 x .02) ....................... 6,440
Bond premium (-L) ................................................................ 2,560
Cash (-A) ($300,000 x .12 x ¼) ......................................... 9,000
Book value of bond: $319,416 ($300,000 + ($21,976 - $2,560))
June 30:
Bond premium (-L) ................................................................ 2,612
Cash (-A) ($300,000 x .12 x ¼) ......................................... 9,000
Book value of bond: $316,804 ($300,000 + ($21,976 - $2,560 - $2,612))
September 31:
Bond premium (-L) ................................................................ 2,664
Cash (-A) ($300,000 x .12 x ¼) ......................................... 9,000
Book value of bond: $314,140 ($300,000 + ($21,976 - $2,560 - $2,612 - $2,664))
December 31:
Bond premium (-L) ................................................................ 2,717
Cash (-A) ($300,000 x .12 x ¼) ......................................... 9,000

Book value of bond: $311,423 ($300,000 + ($21,976 - $2,560 - $2,612 - $2,664 -
$2,717))
Req. 3
December 31:
Balance sheet:
P10–12.
Present value:
$300,000 x 0.85349 = 256,047
$ 9,000* x 7.32548 = 65,929
*$300,000 x .12 x 1/4

Req. 1
January 1:
Cash ...................................................................................... 321,976
Bond payable (+L) ............................................................. 321,976
Req. 2
March 31:
Bonds Payable (-L) ............................................................... 2,560
Cash (-A) ($300,000 x .12 x ¼) ......................................... 9,000
Book value of bond: $319,416 ($321,976 - $2,560)
June 30:
Bonds Payable (-L) ............................................................... 2,612
Cash (-A) ($300,000 x .12 x ¼) ......................................... 9,000

September 31:
Bonds Payable (-L) ............................................................... 2,664
Cash (-A) ($300,000 x .12 x ¼) ......................................... 9,000
December 31:
Bonds Payable (-L) ............................................................... 2,717
Cash (-A) ($300,000 x .12 x ¼) ......................................... 9,000
Req. 3
December 31:
Balance sheet:
P10–13.
Bonds payable (-L) ................................................................ 1,000,000

Bond premium (-L) ................................................................ 10,000
Cash (-A) ........................................................................... 1,050,000*
*$1,000,000 x (1 + .05)
P10–14.
Bonds payable (-L) ................................................................ 1,000,000

Bond Payable (-L) ................................................................. 10,000
Cash (-A) ........................................................................... 1,050,000*
*$1,000,000 x (1 + .05)

P10–15.
Req. 1
Present value:
$800,000 x 0.56743 = 453,944
$ 64,000* x 3.60478 = 230,706
*$800,000 x .08

Req. 2—Straight-line amortization:

Year 1 Year 2 Year 3 Year 4 Year 5
a. Cash interest payment
($800,000 x .08) ................... $64,000 $64,000 $64,000 $64,000 $64,000
b. Amortization of discount
($115,350  5 years) ............ 23,070 23,070 23,070 23,070 23,070
c. Bond interest expense ............. $87,070 $87,070 $87,070 $87,070 $87,070
Req. 3 —Effective-interest amortization:

Bond Amortization Schedule
Cash Amortization of Net
Date Payment Interest Expense Discount Liability
Issuance $684,650
End of Year 1 $64,000 $684,650 x .12 =
$82,158 $18,158 702,808
End of Year 2 64,000 702,808 x .12 = 84,337 20,337 723,145
End of Year 3 64,000 723,145 x .12 = 86,777 22,777 745,922
End of Year 4 64,000 745,922 x .12 = 89,511 25,511 771,433
End of Year 5 64,000 771,433 x .12 = 92,567* * 28,567 800,000
*Calculated interest is $92,572. We use $92,567 in the table to bring the bond payable
balance to exactly $800,000 at the end of Year 5. If we had started our amortization
table with $684,647 and used Excel or a financial calculator to derive interest
expense we would not need to round any of the numbers.

P10–16.
1. Yes. Cash received from issuing bonds is a financing cash inflow.

2. No. Cash payments for interest are an operating cash outflow.
3. Yes. Cash paid for principle at maturity is a financing cash outflow.
4. No effect

ALTERNATE PROBLEMS
AP10–1.
Req. 1
Present value
$ 2,000,000 x .61391 = 1,227,820
$ 100,000* x 7.72173 = 772,173
Issue price $1,999,993**
*$2,000,000 x .10 x 1/2
**If the tables carried the decimal out further the issue price would be $2,000,000.
Using Excel or a financial calculator results in a present value of $2,000,000.
Req. 2
June 30 Dec. 31
Interest expense ($2,000,000 x .10 x ½) $100,000 $100,000
Req. 3
June 30 Dec. 31
Cash paid($2,000,000 x .10 x ½) ........... $100,000 $100,000
Req. 4
This Year Next Year

Bonds payable ....................................... $2,000,000 $2,000,000

AP10–2.
At End At End At End

of Year 1 of Year 2 of Year 3
Case A: Sold at Par (10%)

Interest expense for the year $10,000 $10,000 $10,000
Net liability on balance sheet 100,000 100,000 100,000
Case B: Sold at a discount (12%)

Interest expense for the year 11,150 11,292 11,452
$92,639 x .12 x ½ $93,790 x .12 x ½ $95,082 x .12 x ½
+ $93,198 x .12 x ½ + $94,417 x .12 x ½ + $95,787 x .12 x ½
Case C: Sold at a premium (8%)

Interest expense for the year $8,621 $8,509 $8,388
$108,111 x .08 x ½ $106,732 x .08 x ½ $105,242 x .08 x ½
+$107,435 x .08 x ½ +$106,002 x .08 x ½ +$104,452 x .08 x ½

AP10–3.
Req. 1
Present value
$ 2,000,000 x 0.71299 = 1,425,980
$ 120,000* x 4.10020 = 492,024
Issue Price $1,918,004**
*$2,000,000 x .06

Req. 2
This Year Next Year

$1,918,004 x .07 = $134,260
**[$1,918,004 + ($134,260- $120,000)] x .07 = $135,258
Req. 3
This Year Next Year

Cash paid ............................................... $120,000 $120,000
Req. 4
This Year Next Year

Bonds payable ....................................... $1,932,286* $1,947,546**
*$1,918,004 + $14,260 = $1,932,264
**$1,932,264 + $15,258 = $1,947,522

AP10–6.
Req. 1 Present value

$ 4,000,000 x 0.74726 = 2,989,040
$ 360,000* x 4.21236 = 1,516,450
Issue Price $4,505,490**
*$4,000,000 x .09

Req. 2
This Year Next Year

$4,505,490 x .06 = $270,329
**[$4,505,490 - ($360,000 - $270,329)] x .06 = $264,949
Req. 3
This Year Next Year

Cash paid ............................................... $360,000 $360,000
Req. 4
This Year Next Year

Bonds payable ....................................... $4,415,819 $4,320,768**
*$4,505,490 - $89,671 = $4,415,819
**$4,415,819 - $95,051 = $4,320,768

AP10–7.
Present value:
$200,000 x 0.77901 = 155,802
$ 10,000* x 5.19974 = 51,997
*$200,000 x .10 x 1/2

Req. 1
January 1:
Cash ...................................................................................... 207,799
Bond premium (+L) ........................................................... 7,799
Bond payable (+L) ............................................................. 200,000
Req. 2
June 30:
Interest Expense (+E, -SE) ($207,799 x .085 x 1/2) ............. 8,831
Bond premium (-L) ................................................................ 1,169
Cash (-A) ($200,000 x .10 x 1/2) ....................................... 10,000
Book value of bond: $206,630 ($200,000 + ($7,799 - $1,169))
December 31:
Bond premium (-L) ................................................................ 1,218
Cash (-A) ($200,000 x .10 x 1/2) ....................................... 10,000
Book value of bond: $205,412 ($200,000 + ($7,799 - $1,169 - $1,218))
Req. 3
December 31:
Balance sheet:

AP10–8.
Present value:
$200,000 x 0.77901 = 155,802
$ 10,000* x 5.19974 = 51,997
*$200,000 x .10 x 1/2

Req. 1
January 1:
Cash ...................................................................................... 207,799
Bonds Payable (+L)........................................................... 7,799
Bond payable (+L) ............................................................. 200,000
Req. 2
June 30:
Bonds Payable (-L) ............................................................... 1,169
Cash (-A) ($200,000 x .10 x 1/2) ....................................... 10,000
December 31:
Bonds Payable (-L) ............................................................... 1,218
Cash (-A) ($200,000 x .10 x 1/2) ....................................... 10,000
Req. 3
December 31:
Balance sheet:

CASES AND PROJECTS
CONTINUING CASE
CON10–1.
Req. 1
Present value
$750,000,000 x .67297 = 504,727,500
$ 18,750,000* x 16.35143 = 306,589,313
Issue price $811,316,813**
*$750,000,000 x .05 x 1/2

Req. 2
June 30 Dec. 31
This Year This Year
Interest expense.....................................$16,226,336* $16,175,863**
*$811,316,813 x .04 x 1/2
**$808,793,149 x .04 x 1/2
Req. 3
June 30 Dec. 31
This Year This Year
Cash paid ...............................................$18,750,000* $18,750,000*
*750,000,000 x .05 x 1/2

CON10–1 (continued).
Req. 4
June 30 Dec. 31
This Year This Year
Book value of bonds...............................
$808,793,149* $806,219,012**
*$750,000,000 + ($61,316,813 - $2,523,664)
**$750,000,000 + (($61,316,813 - $2,523,664 - $2,574,137)
FINANCIAL REPORTING AND ANALYSIS CASES
CP10–1.
Req. 1
Near the end of footnote 2, American Eagle reports paying interest of $638,000.
Req. 2
Footnote 9 describes the company’s “Credit Agreement.” Under the agreement, the
company can borrow up to $400 million.
Req. 3 0.49 = ($459,093 + $98,069) / $1,139,746
CP10–2.
Req. 1
The company would report the amount of cash paid for interest in its cash flow
statement or in its footnotes.
Req. 2
Footnote 7 describes the company’s “Line of Credit.” Under the agreement, the
company can currently borrow up to $175 million, though the agreement has an
accordion feature that allows Urban Outfitters to increase this amount in the future.
Req. 3 0.42 = $560,772 / $1,327,969

CP10–3.
Req. 1
The three ratios are quite similar. American Eagle’s debt-to-equity ratio is 0.49. Urban
Outfitters’ debt-to-equity ratio is 0.42. The industry average debt-to-equity ratio is 0.43.
Req. 2
Neither American Eagle or Urban Outfitters have issued bonds, nor does either firm
have much long-term debt. This indicates that the debt-to-equity ratio may be of limited
use when analyzing the firms. At a minimum, analysts should keep this in mind when
analyzing the two firms and comparing them to the industry average.
CP10–4.
Req. 1
A zero coupon bond simply means that no periodic interest payments will be made over
the bond’s life. It does not mean that investors will not earn interest. Investors will simply
adjust the price they are willing to pay for the bond until it reflects a return over the life of
the bond that is equal to the market rate of interest. Thus, with a zero coupon bond,
investors do not get periodic interest payments, but they do earn interest. The just have
to wait until the bond matures, at which time they get all of the interest they have earned
plus the principle they contributed.
Req. 2
Principal: $500,000,000 x 0.94260 = 471,300,000* euros
*Using Excel or a financial calculator results in a present value of 471,297,955 euros

(rounded).
Req. 3
Principal: $500,000,000 x 0.74409 = 372,045,000* euros
*Using Excel or a financial calculator results in a present value of 372,046,957 euros

(rounded).

CRITICAL THINKING CASES
CP10–5.
People invest in different securities for a variety of reasons. Bondholders are

interested in fixed income and low risk. They are willing to give up higher returns
for lower risk. While the president of the company may be confident of a high
return on the investment, in reality there is always risk. It is not unethical to offer
an investor a lower-risk, lower-return investment.
CP10–6.
As with most difficult decisions that people face, this dilemma does not have an
obvious right answer. We have found that some students approach this question
from the perspective that people’s jobs are more important than people’s money.
We try to point out that both the current workers and the retired investors are
dependent on income from the corporation in order to survive. Nevertheless,
some students will not budge from the belief that workers have a higher priority
than suppliers of capital. Once this part of the discussion winds down, we like to
shift to the issues of fiduciary responsibility. Even if students believe that the
needs of the workers should take priority, a question remains concerning the
portfolio manager’s professional obligation. Given that he has been hired to
protect the interests of the investors, how high a priority can be placed on
another group that will be affected by a potential bankruptcy?
FINANCIAL REPORTING AND ANALYSIS PROJECTS
CP10–7.
The response to this case will depend on the companies selected by the
students.


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Reporting and Interpreting Bonds

Financial Accounting, 9/e 10-1

ANSWERS TO MULTIPLE CHOICE

10-2 Solutions Manual

Financial Accounting, 9/e 10-3

M10–1. 1. Balance Sheet

Principal $600,000  0.45639 = $273,834

Interest $ 24,000*  13.59033 = 326,168

Issue Price = $600,002**

* ($600,000 x .08 x ½ year)

**Issue price should be exactly $600,000. The $2 difference is the result of

The formula for the times interest earned ratio is:

For Oak this results in a times interest earned ratio of:

Principal $900,000  0.43499 = $391,491

Interest $ 27,000*  13.29437 = 358,948

Issue Price = $750,439**

* ($900,000 x .06 x ½ year)

**Using Excel or a financial calculator results in a present value of $750,438

Financial Accounting, 9/e 10-5

Principal $500,000  0.45639 = $228,195

Interest $ 25,000*  13.59033 = 339,758

Issue Price = $567,953**

* ($500,000 x .05 x ½ year)

**Using Excel or a financial calculator results in a present value of $567,952

10-6 Solutions Manual

Financial Accounting, 9/e 10-7

10-8 Solutions Manual

**Using Excel or a financial calculator results in a

**Using Excel or a financial calculator results in a

**Using Excel or a financial calculator results in a

At issuance, liabilities go up and equity is not affected so the debt-to-equity ratio

Applied Engineering’s ratios look better than Innovative Engineering’s ratios.

*$250,000 x .06 x 1/2

**Using Excel or a financial calculator results in a

*$600,000 x .075 x 1/2

**Using Excel or a financial calculator results in a

10-10 Solutions Manual

*$600,000 x .075 x 1/2

**Using Excel or a financial calculator results in a

Financial Accounting, 9/e 10-11

Present value computation:

4. (a) $1,000 x .06 = $60.

*$2,000,000 x .01 x 1/2

**Using Excel or a financial calculator results in a

Financial Accounting, 9/e 10-13

10-14 Solutions Manual

*$2,000,000 x .01 x 1/2

**Using Excel or a financial calculator results in a

Financial Accounting, 9/e 10-15

*$1,000,000 x .09 x 1/2

**Using Excel or a financial calculator results in a

10-16 Solutions Manual

On January 1, cash flows from financing activities will increase by $1,067,955. On

Bonds payable (-L) ................................................................ 1,000,000

Bonds payable (-L) ................................................................ 1,000,000

Bonds payable (-L) ................................................................ 984,000

Financial Accounting, 9/e 10-17

**Using Excel or a financial calculator results in a

10-18 Solutions Manual

**Using Excel or a financial calculator results in a

Financial Accounting, 9/e 10-19

*$1,400,000 x .08 x 1/2