Solution manual accounting 21e by warreni ch 15

The issuing corporation reserves the right to redeem the bonds before the maturity date.. Because comparable investments in bonds provide a market interest rate 8% that is greater than t

CHAPTER 15 BONDS PAYABLE AND INVESTMENTS IN BONDSCLASS DISCUSSION QUESTIONS

1 (1) To pay the face (maturity) amount of the

bonds at a specified date (2) To pay

periodic interest at a specified percentage

of the face amount

2 a Bonds that may be exchanged for other

securities under specified conditions.

b The issuing corporation reserves the

right to redeem the bonds before the

maturity date.

c Bonds issued on the basis of the

general credit of the corporation.

3 The phrase “time value of money” means

that an amount of cash to be received

today is worth more than the same amount

of cash to be received in the future This is

because cash on hand today can be

invested to earn income.

4 (b) $5,000 to be received at the end of

each of the next two years has the higher

present value because cash is received

earlier than can be invested to earn

income.

5 Less than face amount Because

comparable investments in bonds provide a

market interest rate (8%) that is greater

than the rate on the bond being purchased

(7%), the bond will sell at a discount as the

market’s means of equalizing the two

c Premium on Bonds Payable

9 a Debit Interest Expense

Credit Discount on Bonds Payable

b Debit Premium on Bonds Payable

Credit Interest Expense

10 No Because zero-coupon bonds do not

provide for interest payments, they will sell

at a discount.

11 The purpose of a bond sinking fund is to

accumulate over the life of a bond issue enough funds to pay the indebtedness at the maturity date.

12 The bond issue that is callable is more

risky for investors, because the company may redeem (call) the bond issue if interest rates fall In addition, since the bonds may

be called at their face amount, they will sell for a lower value than the noncallable bond issue.

13 A loss of $8,500 [($800,000 × 0.97) – ($800,000 – $32,500)]

14 Under the caption “Investments”

15 At their cost less any amortized premium or

plus any amortized discount

169

b Earnings before bond interest and income tax $ 2,400,000 Bond interest 640,000 Balance $ 1,760,000 Income tax 704,000 Net income $ 1,056,000 Dividends on preferred stock 480,000 Earnings available for common stock $ 576,000 Earnings per share on common stock $ 2.88

c Earnings before bond interest and income tax $ 4,000,000 Bond interest 640,000 Balance $ 3,360,000 Income tax 1,344,000 Net income $ 2,016,000 Dividends on preferred stock 480,000 Earnings available for common stock $ 1,536,000 Earnings per share on common stock $ 7.68

Ex 15–2

Factors other than earnings per share that should be considered in evaluating financing plans include: bonds represent a fixed annual interest requirement, while dividends on stock do not; bonds require the repayment of principal, while stock does not; and common stock represents a voting interest in the ownership

of the corporation, while bonds do not.

Ex 15–3

Home Depot’s major source of financing is common stock It has long-term debt, excluding current installments, of $1,321,000,000, compared to stockholders’ equity of $19,802,000,000.

of the effect of compounding the interest That is, compound interest functions are not linear functions, but use exponents.

Ex 15–8

Present value of $1 for 10 (semiannual)

periods at 6% (semiannual rate) 0.55840

Face amount of bonds × $12,000,000 $ 6,700,800 Present value of an annuity of $1

for 10 periods at 6% 7.36009

Semiannual interest payment × $480,000 3,532,843 Total present value (proceeds) $ 10,233,643

Ex 15–9

Present value of $1 for 10 (semiannual)

periods at 5% (semiannual rate) 0.61391

Face amount of bonds × $40,000,000 $24,556,400 Present value of an annuity of $1

Ex 15–11

May 1 Cash 18,000,000

Bonds Payable 18,000,000 Nov 1 Interest Expense 630,000

Cash 630,000 Dec 31 Interest Expense 210,000

Interest Payable 210,000

Note: The following data in support of the proceeds of the bond issue stated

in the exercise are presented for the instructor’s information Students are not required to make the computations.

Present value of $1 for 10 (semiannual)

periods at 5 1/2% (semiannual rate) 0.58543

Face amount × $ 8,000,000 $ 4,683,440 Present value of annuity of $1 for 10

periods at 5 1/2% 7.53763

Semiannual interest payment × $320,000 2,412,042 Total present value of bonds payable $ 7,095,482

Ex 15–13

a Cash 7,789,543

Premium on Bonds Payable 289,543 Bonds Payable 7,500,000

Note: The following data are in support of the determination of the proceeds

of the bond issue stated in the exercise:

Present value of $1 for 10 (semiannual)

periods at 5% (semiannual rate) 0.61391

Face amount × $7,500,000 $ 4,604,325 Present value of an annuity of $1 for 10

Cash 480,000 2010

Oct 1 Bonds Payable 12,000,000

Loss on Redemption of Bonds 240,000

Cash 12,240,000

Ex 15–15

2006

Jan 1 Cash 18,000,000

Bonds Payable 18,000,000 July 1 Interest Expense 810,000

Cash 810,000 2012

July 1 Bonds Payable 18,000,000

Gain on Redemption of Bonds 540,000 Cash 17,460,000

Ex 15–16

1 The significant loss on redemption of the series X bonds should be reported

in the Other Income and Expense section of the income statement, rather than

as an extraordinary loss.

2 The series Y bonds outstanding at the end of the current year should be reported as a noncurrent liability on the balance sheet because they are to be paid from funds set aside in a sinking fund.

Ex 15–17

The discount of $811 ($1,000 – $189) is amortized as interest revenue over the life

of the bonds, using the straight-line method (illustrated in this chapter) or the interest method (illustrated in the appendix to this chapter).

Loss on Sale of Investments 8,250

Investment in Pierce Co Bonds 453,750 Interest Revenue 3,000

$827,659,0 +

b The number of times interest charges earned has declined from 12.6 to 4.7 in the current year Although Southwest Airlines has adequate earnings to pay interest, the decline in this ratio would potentially cause concern among debt- holders.

$394,115 – $320,000 = $74,115 second semiannual amortization

$70,252 + $74,115 = $144,367 amortization for first year

Note: The following data in support of the proceeds of the bond issue stated

in the exercise are presented for the instructor’s information Students are not required to make the computations.

Present value of $1 for 10 (semiannual)

periods at 5 1/2% (semiannual rate) 0.58543

Face amount × $8,000,000 $ 4,683,440 Present value of annuity of $1 for

$7,789,543 × 5% = $389,477

$412,500 – $389,477 = $23,023 first semiannual amortization

$7,789,543 – $23,023 = $7,766,520

$7,766,520 × 5% = $388,326

$412,500 – $388,326 = $24,174 second semiannual amortization

$23,023 + $24,174 = $47,197 first year amortization

b Annual interest paid $825,000 Less premium amortized 47,197 Interest expense for first year $777,803

Appendix Ex 15–23

a Present value of $1 for 10 (semiannual)

periods at 5 1/2% (semiannual rate) 0.58543

Face amount × $32,500,000 $19,026,475 Present value of annuity of $1 for 10

c Second semiannual interest payment $ 1,950,000

5 1/2% of carrying amount of $33,629,720* 1,849,635 Premium amortized $ 100,365

*$33,724,853 – $95,133 = $33,629,720

d Annual interest paid $ 3,900,000 Less premium amortized 195,498* Interest expense for first year $ 3,704,502

*$95,133 + $100,365 = $195,498

Appendix Ex 15–24

a Present value of $1 for 10 (semiannual)

periods at 6% (semiannual rate) 0.55840

Face amount × $17,500,000 $ 9,772,000 Present value of annuity of $1 for 10 periods at 6% 7.36009

Semiannual interest payment × $875,000 6,440,079 Proceeds of bond sale $16,212,079

b 6% of carrying amount of $16,212,079 $ 972,725 First semiannual interest payment 875,000 Discount amortized $ 97,725

c 6% of carrying amount of $16,309,804* $ 978,588 Second semiannual interest payment 875,000 Discount amortized $ 103,588

*$16,212,079 + $97,725 = $16,309,804

d Annual interest paid $ 1,750,000 Plus discount amortized 201,313* Interest expense first year $ 1,951,313

*$97,725 + $103,588 = $201,313

PROBLEMS Prob 15–1A

1 Plan 1 Plan 2 Plan 3 Earnings before interest and income tax $15,000,000 $15,000,000 $15,000,000 Deduct interest on bonds — — 1,000,000 Income before income tax $15,000,000 $15,000,000 $14,000,000 Deduct income tax 6,000,000 6,000,000 5,600,000 Net income $ 9,000,000 $ 9,000,000 $ 8,400,000 Dividends on preferred stock — 600,000 300,000 Available for dividends on common stock $ 9,000,000 $ 8,400,000 $ 8,100,000 Shares of common stock outstanding ÷ 4,000,000 ÷ 2,000,000 ÷ 1,000,000 Earnings per share on common stock $ 2.25 $ 4.20 $ 8.10

2 Plan 1 Plan 2 Plan 3 Earnings before interest and income tax $ 1,600,000 $ 1,600,000 $ 1,600,000 Deduct interest on bonds — — 1,000,000 Income before income tax $ 1,600,000 $ 1,600,000 $ 600,000 Deduct income tax 640,000 640,000 240,000 Net income $ 960,000 $ 960,000 $ 360,000 Dividends on preferred stock — 600,000 300,000 Available for dividends on common stock $ 960,000 $ 360,000 $ 60,000 Shares of common stock outstanding ÷ 4,000,000 ÷ 2,000,000 ÷ 1,000,000 Earnings per share on common stock $ 0.24 $ 0.18 $ 0.06

Prob 15–1A Concluded

3 The principal advantage of Plan 1 is that it involves only the issuance of common stock, which does not require a periodic interest payment or return

of principal, and a payment of preferred dividends is not required It is also more attractive to common shareholders than is Plan 2 or 3 if earnings before interest and income tax is $1,600,000 In this case, it has the largest EPS ($0.24) The principal disadvantage of Plan 1 is that it requires an additional investment by present common shareholders to retain their current interest in the company Also, if earnings before interest and income tax is $15,000,000, this plan offers the lowest EPS ($2.25) on common stock.

The principal advantage of Plan 3 is that little additional investment would need to be made by common shareholders for them to retain their current interest in the company Also, it offers the largest EPS ($8.10) if earnings before interest and income tax is $15,000,000 Its principal disadvantage is that the bonds carry a fixed annual interest charge and require the payment of principal It also requires a dividend payment to preferred stockholders before a common dividend can be paid Finally, Plan 3 provides the lowest EPS ($0.06) if earnings before interest and income tax is $1,600,000.

Plan 2 provides a middle ground in terms of the advantages and disadvantages described in the preceding paragraphs for Plans 1 and 3.

Prob 15–2A

1 Cash 10,121,603*

Premium on Bonds Payable 1,121,603 Bonds Payable 9,000,000

*Present value of $1 for 20 (semiannual)

periods at 5% (semiannual rate) 0.37689

Face amount × $9,000,000 $ 3,392,010 Present value of an annuity of $1 for 20

Prob 15–2A Concluded

This solution is applicable only if the P.A.S.S Software that accompanies the text

is used.

REST-IN-PEACE CORPORATION

Balance Sheet June 30, 2007 Assets Cash $10,434,403

Premium on bonds payable 1,009,443

Total long-term liabilities 10,009,443 Total liabilities $10,844,543

Stockholders’ Equity Paid-in capital:

Preferred stock $ 600,000

Excess of issue price over par—preferred stock 75,000

Common stock 400,000

Excess of issue price over par—common stock 200,000

From sale of treasury stock 11,000

Total paid-in capital $ 1,286,000

Retained earnings 931,660

Total $ 2,217,660

Less treasury stock 21,000

Total stockholders’ equity 2,196,660 Total liabilities and equity $13,041,203

Prob 15–3A

1 Cash 10,623,552*

Discount on Bonds Payable 1,376,448

Bonds Payable 12,000,000

*Present value of $1 for 20 (semiannual)

periods at 6% (semiannual rate) 0.31180

Face amount × $12,000,000 $ 3,741,600 Present value of an annuity of $1 for 20

June 30 Interest Expense 320,000

Cash 320,000 Dec 31 Interest Expense 320,000

June 30 Bonds Payable 8,000,000

Loss on Redemption of Bonds 290,660 Discount on Bonds Payable 370,660 Cash 7,920,000

2 a 2005: $381,776

b 2006: $763,552

3 Initial carrying amount of bonds $7,382,236 Discount amortized on December 31, 2005 61,776 Discount amortized on December 31, 2006 123,552 Carrying amount of bonds, December 31, 2006 $7,567,564

Prob 15–4A Concluded

This solution is applicable only if the P.A.S.S Software that accompanies the text

is used.

PRAIRIE RENAISSANCE INC.

Balance Sheet June 30, 2007 Assets Cash $10,206,812

Stockholders’ Equity Paid-in capital:

Preferred stock $ 4,600,000

Excess of issue price over par—preferred stock 1,075,000

Common stock 4,400,000

Excess of issue price over par—common stock 1,200,000

From sale of treasury stock 11,000

Total paid-in capital $ 11,286,000

Retained earnings 2,213,512

Total $13,499,512

Less treasury stock 21,000

Total stockholders’ equity 13,478,512 Total liabilities and equity $14,313,612

Investment in Sheehan Company Bonds 500

31 Cash 247,600*

Gain on Sale of Investments 1,525 Investment in Sheehan Company Bonds 242,875 Interest Revenue 3,200

Appendix Prob 15–6A

b Interest Expense 639,658

Discount on Bonds Payable

[($10,660,965 × 6%) – $600,000] 39,658 Cash 600,000

2 $637,420

Prob 15–1B

1 Plan 1 Plan 2 Plan 3 Earnings before interest and income tax $ 4,500,000 $ 4,500,000 $ 4,500,000 Deduct interest on bonds — — 1,350,000 Income before income tax $ 4,500,000 $ 4,500,000 $ 3,150,000 Deduct income tax 1,800,000 1,800,000 1,260,000 Net income $ 2,700,000 $ 2,700,000 $ 1,890,000 Dividends on preferred stock — 1,080,000 720,000 Available for dividends on common stock $ 2,700,000 $ 1,620,000 $ 1,170,000 Shares of common stock outstanding ÷ 1,800,000 ÷ 900,000 ÷ 450,000 Earnings per share on common stock $ 1.50 $ 1.80 $ 2.60

2 Plan 1 Plan 2 Plan 3 Earnings before interest and income tax $ 2,700,000 $ 2,700,000 $ 2,700,000 Deduct interest on bonds — — 1,350,000 Income before income tax $ 2,700,000 $ 2,700,000 $ 1,350,000 Deduct income tax 1,080,000 1,080,000 540,000 Net income $ 1,620,000 $ 1,620,000 $ 810,000 Dividends on preferred stock — 1,080,000 720,000 Available for dividends on common stock $ 1,620,000 $ 540,000 $ 90,000 Shares of common stock outstanding ÷ 1,800,000 ÷ 900,000 ÷ 450,000 Earnings per share on common stock $ 0.90 $ 0.60 $ 0.20