Solution manual financial accounting 4e by wild chapter10

It specifies such items as the par value of the bonds, the contract interest rate, the due dates for interest payments, and the maturity dates of the bonds.. Total bond interest expense

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4 A trustee for bondholders has the responsibility of monitoring the issuer’s actions, financial performance, and financial condition to ensure that the obligations in the bond indenture are met

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 (also known as the coupon rate, stated rate, or nominal 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 bond’s 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. C 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

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11 The issue price of a $2,000 bond sold at 98 ¼ is 98.25% of $2,000, or $1,965 The issue price of a $6,000 bond priced at 101 ½ is 101.5% of $6,000, or $6,090

12 The debt-to-equity ratio is calculated by dividing total liabilities by total equity The higher a company’s debt-to-equity ratio, the higher proportion of a company’s assets that are provided by creditors If a company has a high debt-to-equity ratio, the company may be at risk during poor economic times, because it must still pay off creditors even though it may not be earning as much as it did in the past

13 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

14 Best Buy shows long-term both ―Long-term Liabilities‖ and ―Long-Term Debt‖ on its balance sheet To determine whether the long term debt is comprised of bonds or other obligations we must read footnote 4 disclosing details of the Long-Term Debt of the company The footnote reports that its long-term debt is comprised of Convertible debentures (bonds), Lease Obligations, and Mortgages

15 Per Circuit City’s February 28, 2005, statement of cash flows (financing section), the company repaid $28,008,000 for the fiscal year ended February 28, 2005

16 The financing section of the statement of cash flows of Apple indicates that for the year ended September 25, 2004, the company issued common stock totaling $427,000,000 For that same period, the company repaid debt in the amount of $300,000,000

17. D If a lease qualifies to be recorded as a capital lease, 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.

18. D 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

19. D 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

pre-defined benefit amount to its retirees For example, an employee’s 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 employee’s annual salary to the pension plan every year

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QUICK STUDIES Quick Study 10-1 (10 minutes)

1 Bond’s cash proceeds: $250,000 x 0.875 = $218,750

2 Twenty semiannual interest payments of $10,000* $200,000

Plus bond discount ($250,000 - $218,750) 31,250 Total bond interest expense $231,250

*$250,000 x 0.08 x ½ = $10,000

3 Bond interest expense on first payment date:

$231,250 / 20 semiannual periods = $11,563

Quick Study 10-2 B (10 minutes)

1 Bond’s cash proceeds: $240,000 x 1.1725 = $281,400

2 Thirty semiannual interest payments of $12,000* $360,000

Less premium ($281,400 - $240,000) (41,400) Total bond interest expense $318,600

To record issuing bonds at a premium

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©McGraw-Hill Companies, 2008

Financial Accounting, 4th Edition

518

Quick Study 10-4 (10 minutes)

a Using facts in QS 10-1, the bond’s cash proceeds for the bond selling at

a discount are computed as follows

$250,000 par (maturity) value 0.3769 $ 94,225

$10,000 interest payment 12.4622 124,622

Price of Bond $218,847*

* Agrees with $218,750 as given in QS 10-1, except for rounding difference

(Instructor note: The price in QS 10-1 is rounded to 87.5 from 87.5388, yielding the $97 difference.)

b Using facts in QS 10-2, the bond’s cash proceeds for the bond selling at

a premium are computed as

$240,000 par (maturity) value 0.3083 $ 73,992

$ 12,000 interest payment 17.2920 207,504

Price of Bond $281,496*

* Agrees with $281,400 as given in QS 10-2, except for rounding difference

( Instructor note: The price in QS 10-2 is rounded to 117.5 from 117.29, yielding the $96 difference.)

2008

July 1 Bonds Payable 400,000

Premium on Bonds Payable 16,000

Gain on Retirement of Bonds* 8,000 Cash 408,000

To record retirement of bonds before maturity

Paid-In Capital in Excess of Par Value 1,000,000

To record retirement of bonds by stock

conversion *1,000,000 shares x $1.00

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Amount of annual payment =

a 4%: Payment = $340,000 / 4.4518 = $76,374

b 8%: Payment = $340,000 / 3.9927 = $85,155

c 12%: Payment = $340,000 / 3.6048 = $94,319

1 A Registered bond 5 E Convertible bond

2 C Serial bond 6 D Bond Indenture

3 H Secured bond 7 G Sinking fund bond

4 F Bearer bond 8 B Debenture

Ratio of debt to equity

Atlanta Company Spokane Company Total liabilities $429,000 $ 548,000

Total equity $572,000 $1,827,000

Debt-to-equity ratio 0.75 0.30

Analysis and interpretation: Atlanta Company’s debt-to-equity ratio of 0.75 implies a riskier financing structure than Spokane Company’s 0.30 debt-to- equity ratio

Quick Study 10-10 C (10 minutes)

2008

Mar 1 Cash 405,333

Interest payable* 5,333 Bonds payable 400,000

Sold $400,000 of bonds with two months’

accrued interest *($400,000 x 08 x 2/12)

Initial cash proceeds from note Table B.3 present value for 5 payments

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Cash (or Payable) 250

To record rental expense for car lease

Quick Study 10-12 C (10 minutes)

Leased Asset—Office Equipment 15,499

Lease Liability 15,499

To record capital lease of office equipment

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522

Exercise 10-2 (30 minutes)

1 Discount = Par value - Issue price = $180,000 - $170,862 = $9,138

2 Total bond interest expense over the life of the bonds

Amount repaid

Six payments of $7,200* $ 43,200

Par value at maturity 180,000

Total repaid 223,200

Less amount borrowed (170,862)

Total bond interest expense $ 52,338

*180,000 x 0.08 x ½ = $7,200

or:

Six payments of $7,200 $ 43,200

Plus discount 9,138

3 Straight-line amortization table ($9,138/6 = $1,523)

Semiannual

Period-End

Unamortized Discount

Carrying Value (0) 1/01/2008 $9,138 $170,862

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Exercise 10-3 B (30 minutes)

1 Discount = Par value - Issue price = $500,000 - $463,140 = $36,860

Amount repaid

Six payments of $22,500* $135,000

Total bond interest expense $171,860

*$500,000 x 0.09 x ½ = $22,500

or

Six payments of $22,500 $135,000

3 Effective interest amortization table

Semiannual

Interest

Period-End

(A) Cash Interest Paid [4.5% x $500,000]

(B) Bond Interest Expense [6% x Prior (E)]

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

(D) Unamortized Discount [Prior (D) - (C)]

(E) Carrying Value [$500,000 - (D)]

6/30/2008 $ 22,500 $ 27,788 $ 5,288 31,572 468,428 12/31/2008 22,500 28,106 5,606 25,966 474,034 6/30/2009 22,500 28,442 5,942 20,024 479,976 12/31/2009 22,500 28,799 6,299 13,725 486,275 6/30/2010 22,500 29,176 6,676 7,049 492,951 12/31/2010 22,500 29,549 * 7,049 0 500,000

$135,000 $171,860 $36,860

*Adjusted for rounding

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524

1 Premium = Issue price - Par value = $409,850 - $400,000 = $9,850

Amount repaid

Six payments of $26,000* $156,000

*$400,000 x 0.13 x ½ = $26,000

or

Six payments of $26,000 $156,000

Less premium (9,850)

3 Straight-line amortization table ($9,850/6 = $1,642)

Semiannual

Interest Period-End

Unamortized Premium

Carrying Value

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Exercise 10-5 B (30 minutes)

1 Premium = Issue price - Par value = $409,850 - $400,000 = $9,850

Amount repaid

Six payments of $26,000* $ 156,000

*$400,000 x 0.13 x ½ = $26,000

or

Six payments of $26,000 $ 156,000

3 Effective interest amortization table

Semiannual

Interest

Period-End

(A) Cash Interest Paid [6.5% x $400,000]

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

(D) Unamortized Premium [Prior (D) - (C)]

(E) Carrying Value [400,000 + (D)]

6/30/2008 $ 26,000 $ 24,591 $1,409 8,441 408,441 12/31/2008 26,000 24,506 1,494 6,947 406,947 6/30/2009 26,000 24,417 1,583 5,364 405,364 12/31/2009 26,000 24,322 1,678 3,686 403,686 6/30/2010 26,000 24,221 1,779 1,907 401,907 12/31/2010 26,000 24,093 * 1,907 0 400,000

$156,000 $146,150 $9,850 *Adjusted for rounding

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526

1 Semiannual cash interest payment = $800,000 x 6% x ½ year = $24,000

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 Table Value* Amount Present Value

Par (maturity) value B.1 0.4564 $800,000 $365,120 Interest (annuity) B.3 13.5903 24,000 326,167

* Table values are based on a discount rate of 4% (half the annual market rate) and

20 periods (semiannual payments)

1 Semiannual cash interest payment = $150,000 x 10% x ½ year = $7,500

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* Amount Present Value

Par (maturity) value B.1 0.6756 $150,000 $101,340 Interest (annuity) B.3 8.1109 7,500 60,832

10 periods (semiannual payments)

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3 Total amortization for first 6 years

The first six years (from 1/1/07 to 12/31/12) equals 40% of the bonds’ year life Therefore, the total amortization equals 40% of the total

15-discount (since straight-line amortization is being used), which is

$15,750 x 40%, or $6,300

4 Carrying value of the bonds at 12/31/2012

Discount at issuance (from part 2) $ 15,750

Less amortization (from part 3) (6,300)

Cash paid (from part 5) $146,300

Carrying value (from part 4) (138,110)

Loss on retirement $ 8,190

7 Journal entry at retirement for 20% of bonds

2013

Jan 1 Bonds Payable 140,000

Loss on Retirement of Bonds Payable 8,190

Discount on Bonds Payable 1,890 Cash 146,300

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Sold bonds with 4 months’ accrued interest

June 30 Interest Payable 102,000

Bond Interest Expense 51,000

Cash 153,000

Paid semiannual interest on the bonds

Dec 31 Bond Interest Expense 153,000

Cash 153,000

Paid semiannual interest on the bonds

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Carrying Value 6/01/2007 $4,052 $95,948

**$100,000 x 0.07 x ½ = $3,500

or

Eight payments of $3,500 $ 28,000

Semiannual straight-line interest expense = $32,052 / 8 = $4,006 (rounded)

Semiannual bond discount amortization = $4,052 / 8 = $506 (rounded)

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Nov 30 Bond Interest Expense 4,006

Discount on Bonds Payable 506

Cash 3,500

To record 6 months’ interest and discount amortization

Dec 31 Bond Interest Expense 668

Discount on Bonds Payable 84 Interest Payable 584

To record one month's accrued interest

($4,006 x 1/6) and amortization ($501 x 1/6)

2008

May 31 Interest Payable 584

Bond Interest Expense 3,338

Discount on Bonds Payable 422 Cash 3,500

To record five months’ interest ($4,006 - $668)

and amortization ($506 - $84) and eliminate

the accrued interest liability

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(B) Debit Interest Expense [7% x (A)]

+

(C) Debit Notes Payable [(D) - (B)]

=

(D) Credit

Cash [computed]

(E)

Ending Balance [(A) - (C)]

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by borrowing the funds

To record capital lease of office equipment

2 Depreciation Expense—Office Equipment 8,200

Accum Depreciation—Office Equipment 8,200

To record depreciation ($41,000 / 5 years)

Exercise 10-16 D (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

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

best lease deal

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534

PROBLEM SET A Problem 10-1A (50 minutes)

* Table values are based on a discount rate of 4% (half the annual market rate)

and 20 periods (semiannual payments)

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.)

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Problem 10-1A (Concluded)

* Table values are based on a discount rate of 6% (half the annual market rate)

and 20 periods (semiannual payments)

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[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 = $4,000,000 x 6% x 6/12 year = $120,000

Less amount borrowed (3,456,448)

Total bond interest expense $4,143,552

or:

Thirty payments of $120,000 $ 3,600,000

Total bond interest expense $ 4,143,552

Part 4 (Semiannual amortization: $543,552/30 = $18,118.4)

Semiannual

Period-End

Carrying Value 1/01/2007 $543,552 $3,456,448

6/30/2007 525,434 3,474,566

12/31/2007 507,316 3,492,684

6/30/2008 489,198 3,510,802

12/31/2008 471,080 3,528,920

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Problem 10-2A (Continued)

Part 5

2007

June 30 Bond Interest Expense 138,118

Discount on Bonds Payable 18,118

Cash 120,000

To record six months’ interest and

discount amortization

2007

Dec 31 Bond Interest Expense 138,118

Discount on Bonds Payable 18,118 Cash 120,000

Requirement 3

Thirty payments of $120,000 $3,600,000

Par value at maturity 4,000,000

Total repaid 7,600,000

Less amount borrowed (4,895,980)

Total bond interest expense $2,704,020

or:

Thirty payments of $120,000 $ 3,600,000

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Carrying Value 1/01/2007 $895,980 $4,895,980

June 30 Bond Interest Expense 90,134

Premium on Bonds Payable 29,866

Cash 120,000

premium amortization

2007

Dec 31 Bond Interest Expense 90,134

Premium on Bonds Payable 29,866

Cash 120,000

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Problem 10-3A (45 minutes)

Part 1

Ten payments of $8,125* $ 81,250

Carrying Value

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Premium on Bonds Payable 533

Cash 8,125

2007

Cash 8,125

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Problem 10-4A B (45 minutes)

Part 1

Ten payments of $8,125* $ 81,250

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

(D) Unamortized Premium [Prior (D) - (C)]

(E) Carrying Value [$250,000 + (D)]

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Cash 8,125

2007

* 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

This present value ($252,326) equals the carrying value of the bonds in column (E) of the amortization table ($252,326) This shows a general rule: The bond carrying value 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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Problem 10-5A (60 minutes)

*$325,000 x 0.05 x ½ = $8,125

or:

Eight payments of $8,125 $ 65,000

Part 3 Straight-line amortization table ($32,819/8 =$4,102)

Semiannual

Interest Period-End

Carrying Value

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2007

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

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Problem 10-6A B (60 minutes)

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

(D) Unamortized Discount [Prior (D) - (C)]

(E) Carrying Value [$325,000 - (D)]

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2007

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