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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 issuer’s actions,
financial performance, and financial condition to ensure that the obligations in the bond
indenture are met.
4. Bonds can allow a company’s 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 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. 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.

Solutions Manual, Chapter 14

©McGraw-Hill Companies, Inc., 2005
53

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 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. 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 company’s 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 Tastykake’s 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 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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54

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.

Bond’s 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.

Bond’s 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

©McGraw-Hill Companies, Inc., 2005
55

....... the bond’s cash proceeds for the bond selling at a premium are computed as Cash Flow Table Value $120...............748* Agrees with $140... 0.............000 ©McGraw-Hill Companies...............3769 $14............Quick Study 14-4 (10 minutes) 2005 Jan.......... 140........... yielding the $136 difference)..750 Bonds Payable..............................471 $306..........667 Interest payable*. 2.............................................................700 as given in QS 14-3........667 Bonds payable............250 Discount on Bonds Payable........ * Present Value $ 36........... except for rounding difference........................... 200..... 1 Cash..................... Using facts in QS 14-3.... 120....................................996 103................000 par (maturity) value. 17th Edition ......................5388.................. 1 Cash......000 Premium on Bonds Payable...................... 43..... except for rounding difference.............250 as given in QS 14-2................. 202..... Quick Study 14-6 (10 minutes) 2005 Mar.....000 To record issuing bonds at a discount.......... 20........................................3083 $ 6......2920 Price of Bond......................... 2005 56 Fundamental Accounting Principles.............. 17...... 1 Cash.................................................................................. 350.... the bond’s cash proceeds for the bond selling at a discount are computed as follows Cash Flow Table Value $350......700 To record issuing bonds at a premium......000 interest payment...915 174.....4622 Price of Bond........... Inc.. b... (Instructor note: The price in QS 14-2 is rounded to 87..........5 from 87........ 12....000 interest payment. Quick Study 14-5 (10 minutes) a.700 Bonds Payable......... 0......386* Agrees with $306... Using facts in QS 14-2....000 par (maturity) value..752 $140............ * Present Value $131... Jan. 306............

000 of bonds with two months’ accrued interest.. *($200. Inc.08 x 2/12) Solutions Manual.Sold $200. Chapter 14 ©McGraw-Hill Companies.000 x . 2005 57 .

................000.....$205.187 b............ from selling a substantial portion of their assets.578 c................. 8%: Payment = $170................000 / 4.... Contributed Capital in Excess of Par Value. from making certain investments............000 Premium on Bonds Payable...9927 = $42...................... *$3.........000 Common Stock*..............000 To record retirement of bonds by stock conversion. 3.159 Quick Study 14-10 (10 minutes) Collins Industries is restricted in several ways by the creditor bank....................................Quick Study 14-7 (10 minutes) 2005 July 1 Bonds Payable..3 present value for 5 payments a....000 ...4518 = $38..000 = $208.. 250................000 To record retirement of bonds before maturity.......000 750...000 Gain on Retirement of Bonds*............. Cash.... ©McGraw-Hill Companies....................... In addition.................. Inc... the company must maintain the agreed upon level of certain financial ratios and other measures of financial condition......... *500.. 1..... 200.............000 205..6048 = $47...... 8.. 12%: Payment = $170...... 17th Edition .000 Quick Study 14-8 (10 minutes) 2005 Jan.000 / 3... 2005 58 Fundamental Accounting Principles..........000 / 3....50 Quick Study 14-9 (10 minutes) Initial cash proceeds from note Amount of annual payment = Table B..000 shares x $0................ from making certain capital expenditures..... They are restricted from incurring certain types of additional indebtedness... 4%: Payment = $170... and from granting substantial cash dividends............................. 1 Bonds Payable.

..... Xu Co..... Quick Study 14-13C (10 minutes) Leased Asset—Office Equipment...... 20... $163................ Quick Study 14-12C (10 minutes) Rental Expense.....................................859 To record capital lease of office equipment................Quick Study 14-11 (10 minutes) Ratio of pledged assets to secured liabilities Xiang Co..... 20.............................37 in pledged assets... In comparison................000 Ratio... 2005 59 ..... Solutions Manual......000 $172............................... Pledged assets............................09 to 1 Analysis and interpretation: Xu’s secured liabilities appear more risky as it only has $1. each $1 of Xiang’s secured liabilities is covered by $2........ Inc......... $387......000 Secured liabilities.......37 to 1 1...000 $158.. 350 To record rental expense for car lease................09 in pledged assets for each $1 in secured liabilities..... 2......859 Lease Liability........ Chapter 14 ©McGraw-Hill Companies.......350 Cash (or Payable)....................

............... 1 Cash..........................500 Cash. Journal entries 2005 (a) Jan................. (c) Dec................ 1...............700.....700......................................000 Bonds Payable.. 76...................000 Premium on Bonds Payable............. (b) June 30 Bond Interest Expense.. Semiannual cash interest payment = $1. Inc............ 1 Cash* 1............... 17th Edition ...........................500 Paid semiannual interest on bonds.....666.......000 x 1........... 76...... 76...EXERCISES Exercise 14-1 (15 minutes) 1.....500 Cash... *($1..........000 Sold bonds at 102.....000 x 0........................734..................... 34................................. 1.02) ©McGraw-Hill Companies.......... 34.......................................... 3..............98) (b) Jan....000 x 9% x 1/2 = $76.........000 Discount on Bonds Payable.................000 1..700............. 76............... 2005 60 Fundamental Accounting Principles.000 Bonds Payable...... 1 Cash* 1............... 31 Bond Interest Expense..700......... *($1.... 2005 (a) Jan.....000 Sold bonds at par............................. 1.......700.500 Paid semiannual interest on bonds.... Bonds Payable...................000 Sold bonds at 98...........700......700.............500 2...........

............... 1.................000 111....... 2...................... Straight-line amortization table Semiannual Period-End Unamortized Discount Carrying Value (0) 1/01/2005........569 2...........569 $ 26...................... Total bond interest expense over the life of the bonds Amount repaid Six payments of $3.431) $ 26..... $ 21............431 (1) 6/30/2005.... Plus discount.283 87..600... $ 21..Issue price = $90....169 or: Six payments of $3............ 3...........955 (3) 6/30/2006.....479 (5) 89.........600 (85...000 *Adjusted for rounding Solutions Manual..807 86... Chapter 14 ©McGraw-Hill Companies........521 88.241 6/30/2007......... Discount = Par value ................................. Less amount borrowed.........431 = $4.......717 (4) 12/31/2006.....................193 (2) 12/31/2005.045 86...... Inc.....$85...000 .. Total bond interest expense..600 4....... 759* 0 90...... Total repaid.......... (6) 12/31/2007..Exercise 14-2 (30 minutes) 1.. Par value at maturity....... Total bond interest expense........600............169 3.............$4....... 2005 61 ... 3.......569 $85...........600 90.

.053 2..338 3..971 10....250 14....525 0 250....Issue price = $250. 17th Edition ..803 12...500 $85...........000 . Total bond interest expense.....250..430 2.Exercise 14-3B (30 minutes) 1.983 237..214 12/31/2005 11.000 . Par value at maturity....570 = $18....250 14.221 2.570) $ 85.930 $18.500 18..(C)] [$250.000 $67.....430 $231...786 234.. $ 67..... ©McGraw-Hill Companies........012 239.....000] [6% x Prior (E)] (C) Discount Amortization [(B) ....250 14.399 3...775 * 3...570 6/30/2005 $11... Total bond interest expense over the life of the bonds Amount repaid Six payments of $11.430 $ 85. Discount = Par value ..........137 6/30/2007 11.........5% x $250.(A)] 1/01/2005 (D) (E) Unamortized Carrying Discount Value [Prior (D) ....(D)] $18.430 *Adjusted for rounding.250....863 243.988 12/31/2006 11.017 6/30/2006 11.644 15...894 $ 2...250 $13...250 14. Less amount borrowed....500 250...........$231.. Total repaid... 2005 62 Fundamental Accounting Principles.. Total bond interest expense. Effective interest amortization table Semiannual Interest Period-End (A) (B) Cash Interest Bond Interest Paid Expense [4.... Inc..930 3..............500 (231.588 3.475 12/31/2007 11....525 246..........930 $ 67..... Plus discount....149 6..250 14......... or Six payments of $11..000 317...

..700 .. Less premium..700 $819..000 800..568 806.......417 12/31/2005 13..........300 $ 312..... Total bond interest expense..........000 Solutions Manual.700 6/30/2005 16.... Chapter 14 ©McGraw-Hill Companies....851 12/31/2006 6.851 809.....283) Semiannual Interest Period-End Unamortized Premium Carrying Value 1/01/2005 $19....700/6 = $3.. Less amount borrowed...000. Inc.Exercise 14-4 (30 minutes) 1....700) $ 292.000 1...000 (19...000..285 803.......Par value = $819.... Straight-line amortization table: ($19....300 3............285 12/31/2007 0 800....................568 6/30/2007 3............134 813.134 6/30/2006 9..... Premium = Issue price .. Total bond interest expense over the life of the bonds Amount repaid Six payments of $52..000 (819....700) $ 292...........700 2.112......... Par value at maturity.......000 = $19... or Six payments of $52. Total bond interest expense..$800......... $ 312..... 2005 63 ...417 816.. Total repaid.

... Total repaid.000 800...000] [6% x Prior (E)] (C) Premium Amortization [(A) ..(B)] 1/01/2005 (D) (E) Unamortized Carrying Premium Value [Prior (D) ..700 *Adjusted for rounding... or Six payments of $52...729 810.185* 3...........442 3...000 48.300 $ 19....700) $ 292.815 803.182 $ 2....000 + (D)] $19....000 (19..... Less amount borrowed.. 2005 64 Fundamental Accounting Principles..... 17th Edition ..$800..373 6/30/2007 52....356 7..000 = $19..5% x $800.000 $312.834 3.........000 1.....700 2.644 3.....Exercise 14-5B (30 minutes) 1...700) $ 292.987 13.000 (819....000....000.....000 48.....818 16.Par value = $819....... Premium = Issue price ..882 12/31/2005 52.112..729 12/31/2006 52. ©McGraw-Hill Companies.300 3..815 12/31/2007 52... $ 312..000 $292................700 6/30/2005 $ 52.....815 0 800..... Total bond interest expense....373 807..558 3.895 813......000 48... Total bond interest expense......000 49.....700 .000 $ 49.(C)] [800..........700 $819..882 816...300 $ 312...895 6/30/2006 52...000 48. Less premium. Total bond interest expense over the life of the bonds Amount repaid Six payments of $52.....013 2.. Effective interest amortization table Semiannual Interest Period-End (A) (B) Cash Interest Bond Interest Paid Expense [6....166 10. Par value at maturity... Inc..

B...000 3..086 * Table values are based on a discount rate of 4% (half the annual market rate) and 10 periods (semiannual payments).......840 244.. Table Value* 0.........625 $518.086 Solutions Manual.... Semiannual cash interest payment = $600.......000 x 6% x ½ year = $18.535 Bonds Payable.............B................. 518.............1109 Price of bonds..3 8.......465 Discount on Bonds Payable....5903 Amount $600....1 Interest (annuity)..........000 Present Value $273..Exercise 14-6 (25 minutes) 1.............. Number of payments = 5 years x 2 per year = 10 semiannual payments 3.....000 Sold bonds at a discount on the stated issue date. 5........1 0.416 $81..... therefore....3 Price of bonds........... 5..670 30... Number of payments = 10 years x 2 per year = 20 semiannual payments 3........... 81.... Estimation of the market price at the issue date Cash Flow Table Par (maturity) value.............. 4..... 2005 65 ... Amount $75........ The 6% contract rate is less than the 8% market rate...... Estimation of the market price at the issue date Cash Flow Table Table Value* Par (maturity) value...........6756 Interest (annuity)......... Cash.. 600............ the bonds are issued at a discount....000 2. the bonds are issued at a premium....B.... Semiannual cash interest payment = $75.............750 Present Value $50..............000 x 10% x ½ year = $3.. Chapter 14 ©McGraw-Hill Companies.... Exercise 14-7 (25 minutes) 1...750 2.....B..............4564 13............000 18.. therefore.465 * Table values are based on a discount rate of 4% (half the annual market rate) and 20 periods (semiannual payments)...... 4.......... 81.... The 10% contract rate is greater than the 8% market rate....... Inc........................... Cash....

.Premium on Bonds Payable......000 Sold bonds at a premium on the stated issue date.............. Inc..........................086 75.............. 17th Edition ...... ©McGraw-Hill Companies........ Bonds Payable...... 2005 66 Fundamental Accounting Principles............... 6......

.......................150 6.........75% = $342......275 Retired 20% $70....055 5........ Therefore.......... Inc........................... Journal entry at retirement for 20% of bonds 2010 Jan.......... Carrying value of the bonds at 12/31/2009 Discount at issuance (from part 2).................. Loss on retirement. $350.....725 Entire Group Par value........ 2005 67 .. Cash purchase price ($350...... Remaining discount.......... which is $7.... or $3.............Exercise 14-8 (20 minutes) 1.000 x 20%) x 104................... 4...000 x 97................150) $ 4.............. (342....095 Discount on Bonds Payable........095 7.875 (3.. 70.....150 To record the retirement of bonds.............125 2............. the total amortization equals 40% of the total discount (since straight-line amortization is being used).............875 3..........000 Cash issue price (from part 1).......725) Carrying value..... Cash.........150.................. 4.................. 945 73............... 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. $350.... Chapter 14 ©McGraw-Hill Companies........ $ 7....... Loss on retirement Cash paid (from part 5)............... $ 7.. Cash proceeds from sale of bonds at issuance $350............................875 x 40%.. Less amortization (from part 3)..000 (945) $69.......... Discount at issuance Par value...... Carrying value (from part 4).. (4............. $ 73.................5% = $73............000 Loss on Retirement of Bonds Payable............................... Solutions Manual....125) Discount at issuance..... $345..........055) $ 4..000 Remaining discount................150 (69...... 1 Bonds Payable.......

.... 1......................................................................................000 Sold bonds with 4 months’ accrued interest...... ©McGraw-Hill Companies.....................500 Paid semiannual interest on the bonds............. 2005 68 Fundamental Accounting Principles...............................................................500 Cash.... Dec......... 76........500 Amount accrued for four months = $76. 31 Bond Interest Expense.Exercise 14-9 (20 minutes) 1..700............... June 30 Interest Payable.700.............................000 x 9% x ½ year = $76.. 51......... 76..... 51.............................................................. 25...... Journal entries 2005 May 1 Cash......000 Interest Payable.....500 Cash.............................. 17th Edition ........751.............000 2........................000 Bond Interest Expense...............500 Paid semiannual interest on the bonds............... 76......500 x 4/6 = $51.......... Semiannual cash interest payment = $1.....000 1................... Bonds Payable......................... Inc.....

..........773 48.............................................. Par value at maturity.014 48.........520 48............... 255* 49... or Eight payments of $1.....750... Total repaid........... † Supporting computations 0 Eight payments of $1.. Total bond interest expense...026 $ 16.....000 $ 14. 508 49...... 1.......267 48..492 11/30/2007... Straight-line amortization table Semiannual Period-End Unamortized Discount † Carrying Value 6/01/2004....... 1...........................750................026 / 8 = $2...... Plus discount............. * Rounding difference........ 761 49.986 11/30/2006......733 5/31/2006.....745 5/31/2008.974 11/30/2004.................000 50................... Less amount borrowed....026 $47................000 2.239 5/31/2007.............026 / 8 = $253 (rounded) Solutions Manual......... Inc.....974) $ 16......... $2........000 64................................. 1. 50........................000 (47....Exercise 14-10 (40 minutes) 1.....227 5/31/2005.026 $ 14........... Total bond interest expense...........003 (rounded) Semiannual bond discount amortization = $2.. 1...480 11/30/2005.... Chapter 14 ©McGraw-Hill Companies................026 Semiannual straight-line interest expense = $16..... 2005 69 .................

.250 7....(C)] 2005...... 31 Bond Interest Expense...... 30 Bond Interest Expense...........Exercise 14-10 (Concluded) 2... Exercise 14-11 (20 minutes) 1....... 2.............. 2005 70 + (C) Debit Notes Payable (D) Credit = (E) Fundamental Accounting Principles. 6............. $25.. Amount of principal in each payment = $25... 12....................003 .750 To record 6 months’ interest and discount amortization.... Cash...000 $18..250 7.750 2006............003 x 1/6) and amortization ($253 x 1/6)..... 42 292 To record one month's accrued interest ($2......... 253 1...........000 / 4 years = $6...........750 1........ 211 1............250 6....................................................$42) and eliminate the accrued interest liability............$334) and amortization ($253 . 2004 Nov.250 2008.500 875 6.................... Inc...... 18.............563 12.....688 0 ©McGraw-Hill Companies.003 Discount on Bonds Payable............. 334 Discount on Bonds Payable.000 $1. Dec......250 438 6.................669 Discount on Bonds Payable...... 17th Edition ..........................750 To record five months’ interest ($2.......................................................... Interest Payable..............313 6.....250 2..........000/4] [(B) + (C)] [(A) .................... 292 Bond Interest Expense................................125 6.... 2005 May 31 Interest Payable.. Cash...............750 $ 6.......250 $ 8............................... 1............ 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.................500 2007.................

376 ©McGraw-Hill Companies.. Inc.000 $29.$4. 2005 71 .376 Solutions Manual. Chapter 14 $25.

... 875 Notes Payable.......................... 31 Interest Expense. 2005 72 Fundamental Accounting Principles.............................................. 2006 Dec..... 6...688 To record fourth installment payment... 17th Edition ............. 6.. 25........................ 25. 2005 Dec..... 2007 Dec.............. 2008 Dec.......................... 6............. 1....................................................................... 8...................................... 31 Interest Expense..................................... 1.......563 To record second installment payment.......................250 Cash........... 31 Interest Expense............................................... Inc...............................000 Borrowed $25.......................... 7....................................................................000 by signing a 7% installment note.................. 7..... 31 Interest Expense.......................... 438 Notes Payable...................313 Notes Payable.......125 To record third installment payment............ 6................000 Notes Payable......... 1 Cash...........000 To record first installment payment............................................................................................................ 6.......Exercise 14-12 (20 minutes) 2005 Jan........250 Cash..................................250 Cash.......750 Notes Payable.. ©McGraw-Hill Companies......................................................250 Cash.....................................................................................

(B)] [computed] [(A) .369 + 2006.Exercise 14-13 (20 minutes) 1.524 *Adjusted for rounding. 19.524 $4. 13. Amount of each payment = Initial note balance / Table B.000 / 3... 6.447 7..381 2.369 1.... $25..897 7..381 13....025 7. Amortization table for the loan (A) Period Ending Date Beginning Balance (B) Debit Interest Expense [Prior (E)] [7% x (A)] 2005.750 $ 5... Solutions Manual.381 $19.897 484* 6.344 2007...381 0 $25..356 6.897 2008. Chapter 14 ©McGraw-Hill Companies.. Inc..3 value = $25.631 $ 7....344 934 6.000 Payments (C) Debit Notes Payable = (D) Credit (E) Cash Ending Balance [(D) .381 6.3872 = $7.000 $29...(C)] $1. 2005 73 ...

........................ 7.. Inc.......... ©McGraw-Hill Companies................. 2006 Dec................... 31 Interest Expense.............................381 To record second installment payment......................................................... 1..............................................750 Notes Payable..............................................................................447 Cash......... the borrower could be significantly decreasing the amount of debt that is secured by assets............................. but still keeping the assets pledged as collateral............... 7.....025 Cash...........................897 Cash..................................... 31 Interest Expense........ 2007 Dec..000 by signing a 7% installment note........ 7........ 2008 Dec..................... 7......................................381 To record third installment payment.............................000 Borrowed $25......... 5.......381 To record first installment payment.........Exercise 14-14 (20 minutes) 2005 Jan.. 2005 74 Fundamental Accounting Principles.......... 6............... 1................................ 1 Cash......................... 31 Interest Expense....381 To record fourth installment payment......................................... 2005 Dec................ 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....484 Notes Payable.......................... 25................. These activities would cause the ratio’s numerator to stay constant while the denominator decreases............................................................... The increasing value of the ratio could arise from at least two sets of activities.. 6.......................................... 25....... 6......................... 17th Edition ......................... First.000 Notes Payable....631 Cash..934 Notes Payable....................356 Notes Payable............................................. 31 Interest Expense.......

.. Exercise 14-18C (15 minutes) [Note: 12% / 12 months = 1% per month as the relevant interest rate..541 Option 2: $1.0232 = $38...... If so.. 82.. 82...750 x 22.. 2. Inc....................500 ©McGraw-Hill Companies......400 To record depreciation ($82. Depreciation—Office Equipment........ the change in a ratio does not fully explain what happened... Depreciation Expense—Office Equipment.. Capital 3.. 2005 75 ...000 = ($1. while the denominator stayed constant....... Leased Asset—Office Equipment..000 = $38....500 x 22..0232) + $5. Chapter 14 = $38... In accordance with a basic concept of financial analysis.750 per month for 25 months = $1.... In either case.. 16. Exercise 14-16C (10 minutes) 1..... the borrower might be keeping the amount of debt constant while greatly increasing the amount of assets that have been pledged as security....500 per month for 25 months + $5........000 Lease Liability........Exercise 14-15 (concluded) Second..000 / 5 years).... 16...... Capital Exercise 14-17C (20 minutes) 1.......... the change could arise from a combination of both activities... Operating 2. A higher ratio value would result from a larger numerator.... but does point out areas where potential problems might exist and where we might search for more complete answers... Of course. the unsecured creditors are more vulnerable to losing their balances if the company should be forced into bankruptcy....400 Accum...000 To record capital lease of office equipment.035 Option 3: Solutions Manual.. 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 borrower’s assets are not sufficient for paying the secured debts.] Option 1: $1...

035 and. thus. is the best lease deal.Analysis: Option 2 has the lowest present value at $38. Inc. 2005 76 Fundamental Accounting Principles. ©McGraw-Hill Companies. 17th Edition ..

.............718 * Table values are based on a discount rate of 4% (half the annual market rate) and 20 periods (semiannual payments).........538 12........128 13.......590 $22....3769 12.. Solutions Manual.......1 Interest (annuity)....... 20.......000 Present Value $ 7...........4564 13......... B....000 Bonds Payable........ Table Value* 0.462 $20..000 Sold bonds on stated issue date..........5903 Amount $20...000 1..................................1 Interest (annuity).000 Sold bonds on stated issue date... 2005 77 . (Note: When the contract rate and market rate are the same... Chapter 14 ©McGraw-Hill Companies.... 2........................000 Bond premium.. Bonds Payable...... 2005 Jan... 22... b.... Cash Flow Table Par value.........718 Premium on Bonds Payable... 1 Cash.. Cash Flow Table Par value...... 20.......................) b......................718 $ 2..PROBLEM SET A Problem 14-1A (50 minutes) Part 1 a............000 * Table values are based on a discount rate of 5% (half the annual market rate) and 20 periods (semiannual payments).......4622 Amount $20..............3 Price of bonds...........3 Price of bonds. Table Value* 0.......................... Present Value $ 9........................ 1 Cash................ B..000 1....718 20.... B...... 2005 Jan.................. B............ Part 2 a...................... Inc...... the bonds sell at par and there is no discount or premium....

Cash Flow Table Par value..........470 $17............294 Bonds Payable..... Inc.... 20............... ©McGraw-Hill Companies...... Amount $20..4699 Bond discount........... B.....................3118 11........ 17th Edition .......................706 Discount on Bonds Payable................. 2............. Table Value* 0..... 1 Cash.... 2005 Jan........000 1. 2005 78 Fundamental Accounting Principles..000 Sold bonds on stated issue date......................Problem 14-1A (Concluded) Part 3 a.000 Present Value $ 6...294 * Table values are based on a discount rate of 6% (half the annual market rate) and 20 periods (semiannual payments)...236 11.................... B...706 $ 2................ 17....3 Price of bonds...... b........1 Interest (annuity)....

776 Straight-line discount amortization= $271. and (c) below are the same throughout the bonds’ life because this company uses straight-line amortization..............800..$1.... 2.........................776 / 30 semiannual periods = $9.. (b)...059 Part 3 Thirty payments of $60.....776 Part 4 Semiannual Unamortized Period-End Discount 1/01/2004...............658 1...............000 x 6% x 6/12 year = $60...776 Bonds Payable....000 ....................224 6/30/2004..........] (a) Cash Payment = $2..000... Part 2 [Note: The semiannual amounts for (a).......737.... Par value at maturity..059* *rounded (c) Bond interest expense = $60..224 Discount on Bonds Payable............728.... 2005 79 ... Chapter 14 ©McGraw-Hill Companies........ $1............... $271........................000 Sold bonds on stated issue date...000 3.....224) $2............717 1........000. 1 Cash.......000 (1................. 262.................283 12/31/2004...............800...........728.....000 ............. Plus discount......776 Carrying Value $1.......776 or: Thirty payments of $60..........728...Problem 14-2A (40 minutes) Part 1 2004 Jan...800............000.... 253......000 (b) Discount = $2. 1.776 $2........ $1..000 2. Total bond interest expense.746.... 271...728... Total repaid.000...000 + $9............342 Solutions Manual...... Less amount borrowed.....071..................... Inc....... Total bond interest expense........000 271....224 = $271.000...059 = $69...071..........

.....401 12/31/2005....540 1.... 235..6/30/2005.. 244.......... 2005 80 Fundamental Accounting Principles.....764.... 17th Edition .599 1.460 ©McGraw-Hill Companies.755. Inc.............

....] Requirement 1 2004 Jan...... Inc.... 9...................000 Solutions Manual.000 To record six months’ interest and discount amortization................$14.....000....................... 9. $1.990 ..990 Premium on Bonds Payable......................... 2004 Dec..........Problem 14-2A (Continued) Part 5 2004 June 30 Bond Interest Expense.352.059 60....000 Sold bonds on issue date at a premium.................. 447.000 To record six months’ interest and discount amortization...000 = $447........447....................990) $1..........000............059 60.....059 Discount on Bonds Payable............. Chapter 14 ©McGraw-Hill Companies.........000 3....................................933 (c) Bond interest expense = $60.......................................... or: $1...........933 = $45..........010 Thirty payments of $60.........447.. Bonds Payable............... 1 Cash......... Total bond interest expense........... Cash.....$2...........990 2..059 Discount on Bonds Payable........ 2005 81 ..............000 ................000................... Less amount borrowed.......800....... 31 Bond Interest Expense... 69............067 Requirement 3 Thirty payments of $60.........000 2.. 2.....800...........000 (b) Premium = $2........ Requirement 2 (a) Cash Payment = $2....................990 / 30 semiannual periods = $14.......... Part 6 [Note: Parts 1 through 5 are repeated assuming a bond premium.......990 Straight-line premium amortization = $447...000........ 69........................000 (2........000 x 6% x 6/12 = $60........................447....000..........800......... Total repaid..... Par value at maturity.................. Cash......000 ...........

990) $1..... 2005 82 (447..010 Fundamental Accounting Principles......................352...... 17th Edition . ©McGraw-Hill Companies...Less premium. Inc.......... Total bond interest expense...............

.......258 2........... 45......... Chapter 14 ©McGraw-Hill Companies....933 Cash....403...........933 Cash................418..... 2004 Dec........... 31 Bond Interest Expense....067 Premium on Bonds Payable.... 60................ Unamortized Premium Carrying Value $447....................... Inc.... 418..........124 6/30/2005.....258 Requirement 5 2004 June 30 Bond Interest Expense................................................................... 388..... 45.............. 6/30/2004...... Solutions Manual.. 403.....447....................057 12/31/2004................Problem 14-2A (Concluded) Requirement 4 Semiannual Period-End 1/01/2004.............990 433...............067 Premium on Bonds Payable................057 2.............. 60.. 14..............191 2....000 To record six months’ interest and premium amortization...191 12/31/2005.................124 2........388....000 To record six months’ interest and premium amortization.................................. 14.......990 $2................ 2005 83 ..........433............

... Inc..465 507.331 12/31/2006 4........398 506...264 504...... Fundamental Accounting Principles...... $162..666) $151..... ©McGraw-Hill Companies.....264 6/30/2007 3...532 6/30/2005 7..398 6/30/2006 5...............834 Part 2 Straight-line amortization table ($10.500 (10.. Total repaid......465 12/31/2005 6.. Less amount borrowed.....500 500.666 6/30/2004 9........250....... Total bond interest expense....... $ 162.......666) $151.197 503.... Less premium..500 (510.....250 .666/10 = $1.. 17th Edition .599 509..130 6/30/2008 1..........666 $510.......067*) Semiannual Interest Period-End Unamortized Premium Carrying Value 1/01/2004 $10............599 12/31/2004 8..063 12/31/2008 * Rounded to nearest dollar... Total bond interest expense.......000 ** Adjusted for rounding.130 502.......532 508..........331 505..197 12/31/2007 2...834 or: Ten payments of $16.... Par value at maturity..063** 501. 2005 84 0 500...........Problem 14-3A (45 minutes) Part 1 Ten payments of $16....000 662....

.067 Cash....250 To record six months’ interest and premium amortization.................183 Premium on Bonds Payable............... 1................... 2004 Dec.....Problem 14-3A (Concluded) Part 3 2004 June 30 Bond Interest Expense.............................................. 1................................... 15...........250 To record six months’ interest and premium amortization.................067 Cash... Chapter 14 ©McGraw-Hill Companies........................................... Inc.... 2005 85 . 16...........183 Premium on Bonds Payable....... 15...... 16................................ Solutions Manual....................... 31 Bond Interest Expense................................................

....234 1.000] [3% x Prior (E)] (C) Premium Amortization [(A) ..25% x $500....(B)] 1/01/2004 $ (D) (E) Unamortized Carrying Premium Value [Prior (D) ...... Total bond interest expense....500 $151..834 $10........775 6/30/2006 16....778 508. 2005 86 Fundamental Accounting Principles..396 6/30/2008 16..047 5..791 12/31/2005 16.000 $162.032* 1....666 930 9.....250 15..250 15.. Total bond interest expense.. Less amount borrowed.....250 $ 15.... Inc..650 6/30/2007 16..144 2....Problem 14-4AB (45 minutes) Part 1 Ten payments of $16.. $ 162.....263 98 7 7..203 1.(C)] [$500... Total repaid..218 0 500..078 4.....172 1...500 500.218 12/31/2008 16.......000 + (D)] $10.........778 6/30/2005 16.250 15..728 505.....250 15.736 6/30/2004 $ 16.........736 509.000 662..178 1.....666) $151....016 6.666) $ 151.540 12/31/2007 16......666 $510...... Par value at maturity.....106 1..110 3.250......292 95 8 8.......500 (510....728 12/31/2006 16. Less premium..072 1.140 1...250 15... 17th Edition .540 503...250 15......666 *Adjusted for rounding..791 507..250 15.396 502.218 501..500 (10.....250 15.320 12/31/2004 16...650 504..250 15......775 506. $ 162.... ©McGraw-Hill Companies..834 or: Ten payments of $16.....834 Part 2 Semiannual Interest Period-End (A) (B) Cash Interest Bond Interest Paid Expense [3.250 ..

. B....................... 15...250 To record six months’ interest and premium amortization.......................653 * Table values are based on a discount rate of 3% (half the annual original market rate) and 4 periods (semiannual payments)..........................1 Interest (annuity)..653) equals the carrying value of the bonds in column (E) of the amortization table ($504... Comparison to Part 2 Table Except for a small rounding difference.......8885 3............. Chapter 14 ©McGraw-Hill Companies................ 16....... 31 Bond Interest Expense....... 2004 Dec....... 930 Cash.... Solutions Manual...........................000 16................. Part 4 As of December 31................ B........320 Premium on Bonds Payable......... Table Value* 0....... 2006 Cash Flow Table Par value.....................250 To record six months’ interest and premium amortization... this present value ($504........250 60................. 16. 15.......650)...403 $504..Problem 14-4AB (Concluded) Part 3 2004 June 30 Bond Interest Expense... 2005 87 .......... 958 Interest Payable........7171 Amount $500.................................. Inc....... 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..292 Premium on Bonds Payable..250 Present Value $444............................3 Price of bonds.....

........................... Less amount borrowed......000 Sold bonds on stated issue date..........771 6/30/2005 41...........566 12/31/2004 49.... Total repaid............. 650....000 (584......... 1 Cash............639 $584........361) $ 195........ Total bond interest expense.. 65.....205) Semiannual Interest Period-End Unamortized Discount Carrying Value 1/01/2004 $65..639 * Semiannual interest payment. Plus discount....000 650.............. Part 2 Eight payments of $16. Par value at maturity.639 Bonds Payable.........024 608........ 17th Edition ............. computed as $650...... $ 130....639 or: Eight payments of $16....639/8 =$8............... 584.......... 2005 88 Fundamental Accounting Principles.........229 600.....000 780........250* ......................361 Discount on Bonds Payable. $ 130.................................250*.. Total bond interest expense.361 6/30/2004 57........434 592....Problem 14-5A (60 minutes) Part 1 2004 Jan............... Part 3 Straight-line amortization table ($65.819 617.............000 x 5% x ½ year................000 65...................... Inc...................639 $ 195.........181 ©McGraw-Hill Companies.................976 12/31/2005 32....

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 ½ 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

©McGraw-Hill Companies, Inc., 2005
90

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

©McGraw-Hill Companies, Inc., 2005
91

$ 29....... Inc.. 1 Cash..283 90....597 353 1......000] (B) Bond Interest Expense [5% x Prior (E)] (C) Premium Amortization [(A) .... $ 29....283 6/30/2004 $4............224 12/31/2005 4.700 (92..... Total bond interest expense...950.......... Total bond interest expense... 2005 92 Fundamental Accounting Principles..... Less amount borrowed.700 90...... Par value at maturity..947 91............950 4............5% x $90......950 $4........000 + (D)] $2..000 Sold bonds on stated issue date.. Total repaid. 92...283 $92..561 389 835 90..............594 91.. 2....(C)] [$90..................................................... Bonds Payable.Problem 14-7AB (60 minutes) Part 1 2004 Jan............. Part 2 Six payments of $4.......417 Part 3 Semiannual Interest Period-End (A) Cash Interest Paid [5....283 Premium on Bonds Payable..........417 or: Six payments of $4....283) $ 27...........594 6/30/2005 4.950 4..580 370 1.614 $336 1......................000 119..283) $ 27..700 (2....835 ©McGraw-Hill Companies.......................................950 4...........947 12/31/2004 4................224 91....................(B)] 1/01/2004 (D) (E) Unamortized Carrying Premium Value [Prior (D) .......950 ........ 17th Edition ............ Less premium...

353 Cash........... *($90....................... 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..................950 To record six months’ interest and premium amortization................Problem 14-7AB (Concluded) Part 4 2004 June 30 Bond Interest Expense........................................ As the years passed................................. Gain on Retirement of Bonds................ 4... 4... 336 Cash..... Inc..........................635 To record the retirement of bonds............ 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)........ The statement of cash flows would show a smaller amount of cash received from borrowing..... However...................................614 Premium on Bonds Payable...................950 To record six months’ interest and premium amortization........... 31 Bond Interest Expense.............................................................. Part 5 2006 Jan.................000 x 98%) Part 6 If the market rate on the issue date had been 12% instead of 10%............................. 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............ 835 Cash*..........000 Premium on Bonds Payable...............200 2.... 88....... 2004 Dec..... the bond liability would increase with amortization of the discount instead of decreasing with amortization of the premium................ the bonds would have sold at a discount because the contract rate of 11% would have been lower than the market rate.597 Premium on Bonds Payable......... 2005 93 .............................. 4...... Chapter 14 ©McGraw-Hill Companies.. 4............. Solutions Manual................. 90. the cash flow statements presented over the life of the bonds (after issuance) would report the same total amount of cash paid for interest................................. 1 Bonds Payable .

.915 (A) Period Ending Date Beginning Balance [Prior (E)] 10/31/2009.....183 0 $400.667 Interest Payable..........333). 2005 Oct........ 258..529 100.. 5....... 68..... 17th Edition ....654 79.. 331.................................3.................................183 Record first payment on installment note (interest expense = $32..................183 Cash...759 100..........................333 Interest Payable..... Inc............ 92........ 178.. $400...... 8% Value from Table B.........................650 14....... $100...........000 x 2/12).................000 ... ©McGraw-Hill Companies......................545 73.........000 $ 68........817 10/31/2006...............................(B)] [computed] Ending Balance [(A) ..............9927)................................................ 31 Interest Expense....333 Notes Payable............179 20.........................183 92........................183 $100.. 31 Interest Expense.........................$5..... 5......183 178.... 5 Interest rate...........179 10/31/2007.....759 92... 26........915 (E) * Adjusted for rounding Part 3 2004 Dec........... 5.......Problem 14-8A (45 minutes) Part 1 Amount of Payment Note balance................424* $100.........9927 Payment ($400...817 26...........292 85........183 Part 2 (B) Debit Interest Expense + [8% x (A)] Payments (C) (D) Debit Credit Notes Payable = Cash [(D) .............000 $500...... $400.000 / 3.....650 10/31/2008.............. 2005 94 Fundamental Accounting Principles.........333 Accrued interest on the installment note payable ($32......759 7....000 Number of periods............... 100..............................183 $331...(C)] 10/31/2005............891 100.................................638 100....... 3......183 258.........................000 $ 32...........

....000 Cash....................... Chapter 14 ©McGraw-Hill Companies.... Solutions Manual......800 80.000 2004 Dec...................... 2005 Oct.................................... 31 Interest Expense. 26.....400 0 $96........................... 2005 95 .. 112.........333 Interest Payable..... Inc...000 25..000 $496.200 80.........80..000 92.... 5............200 160.................... 5..............333 Accrued interest on the installment note payable ($32....000 86......333 Notes Payable.....000 10/31/2009........000 $32..... $400............$5.. 240.000 $112..........................000 6............... 160.... 5.............600 240............000 10/31/2006.000 .............000 12..Problem 14-8A (Concluded) Part 4 Payments (A) Period Ending Date Beginning Balance [Prior (E)] (B) (C) Debit Debit Notes Interest Payable Expense + [$400.(C)] 10/31/2005.....000/5] = [8% x (A)] (D) Credit (E) Cash [(B) + (C)] Ending Balance [(A) ...333)................ 80....667 Interest Payable...800 80..000 $400...............................................000 x 2/12)...000 $ 80. 320.. 31 Interest Expense......400 80.000 10/31/2008.................000 105........000 $320.............000 10/31/2007.000 19..........600 80..000 Record first payment on installment note (interest expense = $32......000 99.

.................000 Secured liabilities ($210.........................000 x 43%) + $225.........1.... it might be helpful to estimate the liquidation value of both companies’ assets that are pledged as collateral.......2... It also is important to evaluate the ability of each company to meet its obligations from operating cash flows..........91 to 1 Part 2 Athens's ratio of pledged assets to secured liabilities is higher than Wildcat's.. Before deciding to buy Athens's bonds. so the Athens bonds appear less risky......000)....000 + $135.........................000 x 54%) + $150.............. however....... 2005 96 Fundamental Accounting Principles..000 Ratio ($393.....000 Secured liabilities ($75..$135........ ©McGraw-Hill Companies..000].....000 + $60.....000)....000 / $135..... Inc...............000].....$393.....$612...000)....... 17th Edition ..........Problem 14-9A (30 minutes) Part 1 Wildcat Company Pledged assets [($900........$345..............000 Ratio ($612.........000)........000 / $345..................77 to 1 Athens Company Pledged assets [($450..

.854 / 5 years)..... Chapter 14 ©McGraw-Hill Companies...... Inc. 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 $100. 79..971 Accum..971 To record depreciation ($79.........000 51....000 $66.....146 * ** Cash Lease Payment Ending Balance of Lease Liability Rounded to nearest dollar.517 Year 5 18.242 5.000 18.000 $20.......123 15....517 20.Problem 14-10AC (35 minutes) Part 1 Present Value of the Lease Payments $20.... 2005 97 ...854 $ 6......242 Year 2 66.854 Lease Liability..517 1...541 Year 3 51...... Solutions Manual...664 2..........854 Part 2 Leased Asset—Office Equipment...877 20.854 To record capital lease of office equipment. Difference due to rounding.... Part 4 Depreciation Expense—Office Equipment.000 x 3. 15......853 17...000 35... 15.388* $13.........147 20... 79.701 20....000 0 $79.9927 (from Table B......3) = $79.......299 14........664 Year 4 35... Depreciation—Office Equipment...541 4..483** 18..612 $ 20......

........ 2005 98 Fundamental Accounting Principles.............872 $45...6139 7............5584 7...............3 Price of bonds.......... b..........849 $48........000** * Table values are based on a discount rate of 6% (half the annual market rate) and 10 periods (semiannual payments).........) **Adjusted for rounding....................... 2005 Jan....... B.....3 Price of bonds....... 45....... 3........ Present Value $27... 2005 Jan...700 Bond Premium.. B........ Bonds Payable...........1 Interest (annuity)....... (Note: When the contract rate and market rate are the same.....700 Present Value $25............... the bonds sell at par and there is no discount or premium................000 Sold bonds on stated issue date......000 2... 45.... 17th Edition ...... b....... B........PROBLEM SET B Problem 14-1B (50 minutes) Part 1 a....... 1 Cash..475 * Table values are based on a discount rate of 5% (half the annual market rate) and 10 periods (semiannual payments).........................1 Interest (annuity)............... Part 2 a..000 Sold bonds on stated issue date..... 1 Cash.......................7217 Amount $45. Table Value* 0......... Inc.......475 45...........475 $ 3....000 Bonds Payable..626 20.........475 Premium on Bonds Payable... ©McGraw-Hill Companies......000 2.... Cash Flow Table Par value......3601 Amount $45. B.. Cash Flow Table Par value...128 19............ 48........ Table Value* 0......

.......999 Straight-line discount amortization= $194....... 1........... b........700 Present Value $22...................162 Bonds Payable. 2005 Jan... 3.................... Chapter 14 ©McGraw-Hill Companies......700.... Table Value* 0..........000 x 10% x 6/12 year = $85.....162 * Table values are based on a discount rate of 7% (half the annual market rate) and 10 periods (semiannual payments)......... 45......0236 Amount $45........ and (c) below are the same throughout the bonds’ life because the company uses straight-line amortization....................... Part 2 [Note: The semiannual amounts for (a)..... 1 Cash....................................] (a) Cash Payment = $1.999 / 20 semiannual periods = $9..999 Bonds Payable..838 Discount on Bonds Payable....... Problem 14-2B (40 minutes) Part 1 2004 Jan..... Inc....... Cash Flow Table Par value....................5083 7.......3 Price of bonds...964 $41.000 Sold bonds on stated issue date..................505.... B....001 = $194..............874 18...750 (c) Bond interest expense = $85........ 2005 99 . (b)..000 + $9.......750 = $94.001 Discount on Bonds Payable.............. 194....... 41..000 Sold bonds on stated issue date.505........... 1...$1..000 (b) Discount = $1..................700. $ 3.. B.1 Interest (annuity).. 1 Cash..838 Bond discount........000 .........700..............750 Solutions Manual..000 2..............................Problem 14-1B (Concluded) Part 3 a............

..... 2005 100 Fundamental Accounting Principles...................000 1........ 9... 165... 155............249 1........................ Plus discount..... ©McGraw-Hill Companies..........000 To record six months’ interest and discount amortization....505...................000 To record six months’ interest and discount amortization.999 or: Twenty payments of $85...750 85.................. 31 Bond Interest Expense........... 94.700.........894.... Less amount borrowed........ Par value at maturity.......501 6/30/2005...544..000 (1...............................000 194....999 Part 4 Semiannual Period-End Unamortized Discount Carrying Value 1/01/2004......... $194..499 1... 94....749 1......700.. Inc.......... 175........................514................ Cash.......001 6/30/2004..534.... Total bond interest expense......894...........400.. 17th Edition ...............751 12/31/2004.....750 85..........505......000 .. $1..................251 12/31/2005............................ Cash.........999 $1.......001) $1.......... $1...............Problem 14-2B (Continued) Part 3 Twenty payments of $85......................001 Part 5 2004 June 30 Bond Interest Expense.....999 1....................................... Total bond interest expense.750 Discount on Bonds Payable................... 185...000 3.............700......000....... Total repaid. 2004 Dec........750 Discount on Bonds Payable............................999 $1........ 9..524............................

.............. Chapter 14 ©McGraw-Hill Companies.........................000 (b) Premium = $2..177 Requirement 3 Twenty payments of $85.700........700........466) $1.......466) $1.....700..823 = $65. $1...466 Premium on Bonds Payable.] Requirement 1 2004 Jan.........400..534 Solutions Manual......000 (396...000 Sold bonds on issue date at a premium..303........000 = $396...........Problem 14-2B (Continued) Part 6............466 Straight-line premium amortization= $396.. 2005 101 ..... Less premium....... $1....096........$1........ Inc........096........ Requirement 2 (a) Cash Payment = $1..700.......$19.....000 3.000 (2... Par value at maturity....000 ................466/20 semiannual periods = $19...096.........000 .......... 1 Cash. Less amount borrowed.......000 1................... [Requirements 1 through 5 are repeated assuming a bond premium.. 2... Total bond interest expense..............466 1...000 ......700.. Total bond interest expense......303............ Total repaid.466 ........000 x 10% x 6/12 year = $85..534 or: Twenty payments of $85..... 396................................. Bonds Payable............700....823* *rounded (c) Bond interest expense = $85...

............................ 31 Bond Interest Expense..174 2................ ©McGraw-Hill Companies............... 19...036..643 12/31/2004...096.. 2004 Dec..................... 317..................... 17th Edition .........000 To record six months’ interest and premium amortization........... 376.............823 Cash....... Inc. 65.................................................................174 Requirement 5 2004 June 30 Bond Interest Expense............... 85..............823 Cash.......Problem 14-2B (Concluded) Requirement 4 Semiannual Period-End Unamortized Premium 1/01/2004.......017........................076...........466 Carrying Value $2......... 19.........................056.....997 12/31/2005............... 336.....000 To record six months’ interest and premium amortization....... $396..997 2.466 6/30/2004... 85.......643 2..............820 2...... 2005 102 Fundamental Accounting Principles.177 Premium on Bonds Payable.................................. 356.............820 6/30/2005.... 65........177 Premium on Bonds Payable............

.....506 or: Ten payments of $7.000 232...000 * Adjusted for rounding.196 6/30/2005 4.....494) $ 65. Total repaid.200 . Par value at maturity. Total bond interest expense.302 161......898 163...............600 162.494 6/30/2004 5....249 12/31/2006 2.........000 160....951 161........Problem 14-3B (45 minutes) Part 1 Ten payments of $7..494 $166..... $ 72.302 6/30/2008 12/31/2008 653* 0 160... 2005 103 ..........494/10 = $649) Semiannual Interest Period-End Unamortized Premium Carrying Value 1/01/2004 $6....506 Part 2 Straight-line amortization table ($6....249 163. Less premium........... Solutions Manual.600 6/30/2007 1.653 160.......................845 12/31/2004 5............. Less amount borrowed....494) $ 65..547 164....... Total bond interest expense......196 165......547 12/31/2005 3....... Chapter 14 ©McGraw-Hill Companies..898 6/30/2006 3....... Inc.200 ....000 (166... $ 72.........951 12/31/2007 1...000 (6.....845 165...

..................... 6...... 649 Cash..........200 To record six months’ interest and premium amortization........................ 649 Interest Payable.. Inc................ 6................................. 17th Edition ............................Problem 14-3B (Concluded) Part 3 2004 June 30 Bond Interest Expense........ 2004 Dec.............. 7......... 7... ©McGraw-Hill Companies... 31 Bond Interest Expense.............................551 Premium on Bonds Payable........................ 2005 104 Fundamental Accounting Principles.551 Premium on Bonds Payable.............................................................200 To record six months’ interest and premium amortization...................................

...200 ....494 $166..200 6..000 + (D)] $6.777 12/31/2008 7......660 $ 540 5.....461 739 777 160.200 6......000 $72. Par value at maturity...489 711 1...516 2....543 2.494 657 684 *Adjusted for rounding.... Total bond interest expense.....638 562 5.516 6/30/2008 7...........808 164.494) $ 65....000 $65.....808 12/31/2005 7.000 (6.... Inc.Problem 14-4BB (45 minutes) Part 1 Ten payments of $7..200 6/30/2006 7..494) $ 65........ Chapter 14 ©McGraw-Hill Companies...506 Part 2 Semiannual Interest Period-End (A) (B) Cash Interest Bond Interest Paid Expense [4...954 165.000 (166...(B)] 1/01/2004 (D) (E) Unamortized Carrying Premium Value [Prior (D) .200 $ 6......000 160..516 161..911 6/30/2007 7. Total repaid.568 12/31/2006 7.....(C)] [$160...200 6..392 165...000] [4% x Prior (E)] (C) Premium Amortization [(A) .....423* 777 0 160....200 164......200 6.200 6.911 162...494 6/30/2004 $ 7.000 232...392 6/30/2005 7..227 12/31/2007 7.......568 632 3.. Solutions Manual.568 163...........200 6.... $ 72..5% x $160.... Total bond interest expense.......200 6.. 2005 105 ....200 ......592 608 4.......... Less amount borrowed....227 162.506 $6.....200 6.200 6.. $ 72.954 12/31/2004 7.... Less premium.....506 or: Ten payments of $7....616 584 4..

B................... 2005 106 Fundamental Accounting Principles...........911).. ©McGraw-Hill Companies. Comparison to Part 2 Table Except for a small rounding difference. Table Value* 0.. 562 Interest Payable......... Inc.....8548 3.....200 To record six months’ interest and premium amortization............... this present value ($162....... 6..1 Interest (annuity)..........903 * Table values are based on a discount rate of 4% (half the annual original market rate) and 4 periods (semiannual payments)... 2004 Dec................ 2006 Cash Flow Table Par value.....638 Premium on Bonds Payable..... 17th Edition .6299 Amount $160..........................3 Price of bonds.........135 $162........ 540 Cash.......... 7.......... 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............660 Premium on Bonds Payable............ B........................200 Present Value $136......000 7.200 To record six months’ interest and premium amortization...................................... 6.......... 31 Bond Interest Expense.....768 26.................903) equals the carrying value of the bonds in column (E) of the amortization table ($162................Problem 14-4BB (Concluded) Part 3 2004 June 30 Bond Interest Expense................................... 7.... Part 4 As of December 31..........

... Chapter 14 ©McGraw-Hill Companies....939 12/31/2004 19........... computed as $120...631 6/30/2005 18.. $108..........323 12/31/2005 17.. Part 2 Thirty payments of $3..........000 x 6% x ½ year.. 2005 107 .................985 102............753 $128...000 (99...247 Discount on Bonds Payable............ Inc...............753 or: Thirty payments of $3. Less amount borrowed.....753 $ 99...........................015 Solutions Manual....... Total bond interest expense...753 Bonds Payable.... Part 3 Straight-line amortization table ($20......000 120. $108.600* .........000 228........247) $128....753 * Semiannual interest payment..000 20...............................................247 6/30/2004 20......................753/30= $692) Semiannual Interest Period-End Unamortized Discount Carrying Value 1/01/2004 $20........Problem 14-5B (60 minutes) Part 1 2004 Jan......... 1 Cash.... 120......677 101......000 Sold bonds on stated issue date........ Total repaid....061 99.........369 100.. 99....... Total bond interest expense.. Par value at maturity.............. 20. Plus discount.................................600* ...............

. 4.............. 692 3. 692 3..........................600 To record six months’ interest and discount amortization......................... Cash........................ 2005 108 Fundamental Accounting Principles.......... Cash.................. 31 Bond Interest Expense........ 17th Edition ........................ ©McGraw-Hill Companies............................................. 4........................... 2004 Dec...................... Inc................600 To record six months’ interest and discount amortization.........292 Discount on Bonds Payable.................................292 Discount on Bonds Payable..............Problem 14-5B (Concluded) Part 4 2004 June 30 Bond Interest Expense.................

..002 6/30/2005 3.000] (B) Bond Interest Expense [4% x Prior (E)] (C) (D) (E) Discount Unamortized Carrying Amortization Discount Value [(B) ...000 400 19... Total bond interest expense.. 1 Cash........................ Total repaid........................................ Total bond interest expense.................600 $3.753 $128. $108.............818 Solutions Manual.......... Inc......................000 ...............000 (99.....998 100.........000 20...247 6/30/2004 $3.. 120....000 120....600* ......(C)] [$120.(A)] [Prior (D) .......383 99.247 Discount on Bonds Payable.........753 * Semiannual interest payment............ Part 3 Semiannual Interest Period-End (A) Cash Interest Paid [3% x $120......(D)] 1/01/2004 $20.........617 12/31/2004 3.753 Bonds Payable..600 4...600* .......598 100.985 385 19. Part 2 Thirty payments of $3..000 x 6% x ½ year.247) $128... 2005 109 ..753 $ 99...... $108.182 100.Problem 14-6BB (60 minutes) Part 1 2004 Jan.. computed as $120.....402 12/31/2005 3.....016 416 19..........................753 or: Thirty payments of $3............ Less amount borrowed.... Chapter 14 ©McGraw-Hill Companies..970 $370 20..000 Sold bonds on stated issue date................600 4...... 20...... 99..600 3...........000 228.. Plus discount........... Par value at maturity.....................

.. 31 Bond Interest Expense.985 Discount on Bonds Payable....................... 370 3... Inc. Cash............................................ 17th Edition .600 To record six months’ interest and discount amortization.............. Cash........................................ ©McGraw-Hill Companies.. 2004 Dec.................. 3............... 3............Problem 14-6BB (Concluded) Part 4 2004 June 30 Bond Interest Expense......................................................................................... 2005 110 Fundamental Accounting Principles.................... 385 3...600 To record six months’ interest and discount amortization.....................................970 Discount on Bonds Payable.........

217 6/30/2004 $58.........000 + (D)] $87.........217 900...............406 958............000 (987...000] (B) Bond Interest Expense [5% x Prior (E)] (C) Premium Amortization [(A) ..904 9.. Less amount borrowed..500 $49.500 ......... Total bond interest expense.......500 47........406 12/31/2005 58....... 1 Cash...217) $ 380....................000 1....217 $987..139 78.......783 Part 3 Semiannual Interest Period-End (A) Cash Interest Paid [6.000 Sold bonds on stated issue date.............920 10......078 12/31/2004 58...............783 or: Eight payments of $58...826 947...........217 Premium on Bonds Payable.5% x $900..500 .... Total repaid.. Par value at maturity......000 (87.................000 900.368.........................Problem 14-7BB (70 minutes) Part 1 2004 Jan.. Total bond interest expense.......500 48..... Less premium.................. $ 468. 87.. Chapter 14 ©McGraw-Hill Companies.......596 68..................482 6/30/2005 58.. $ 468.........217) $ 380.........482 968.076 58. Bonds Payable....580 47.... 2005 111 .(B)] 1/01/2004 (D) (E) Unamortized Carrying Premium Value [Prior (D) ...424 10.826 Solutions Manual....... 987.............500 48..........361 $ 9.........078 978...........(C)] [$900........... Part 2 Eight payments of $58..... Inc.

........ 48...139 Cash.. 6.................. 1 Bonds Payable ..................904 Premium on Bonds Payable............................................................ the bonds would have sold at a discount because the contract rate of 13% would have been lower than the market rate.............. 49.. *($900...000 Premium on Bonds Payable....826 Loss on Retirement of Bonds.... 2004 Dec. 2005 112 Fundamental Accounting Principles............ 9............... As the years passed..596 Cash...........................174 Cash*.................. 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............. 47.................................................500 To record six months’ interest and premium amortization..... Inc.............000 To record the retirement of bonds........ 58....... However. 17th Edition .................. the bond liability would increase with amortization of the discount instead of decreasing with amortization of the premium.......................... 900.................................... The statement of cash flows would show a smaller amount of cash received from borrowing..... 31 Bond Interest Expense... 58..................................... 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......Problem 14-7BB (Concluded) Part 4 2004 June 30 Bond Interest Expense..................361 Premium on Bonds Payable.............000 x 106%) Part 6 If the market rate on the issue date had been 14% instead of 10%..................... 954.. 9...........................500 To record six months’ interest and premium amortization...... 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)........ the cash flow statements presented over the life of the bonds (after issuance) would report the same total amount of cash paid for interest.............................. Part 5 2006 Jan........... ©McGraw-Hill Companies........

.....632 109..........500).........................000 x 3/12).......673 9/30/2007............695 120........632 $120....... 2005 Sept............632 $209.......................000 $361.....673 10...... 209.................632 Part 2 (B) Debit Interest Expense + Payments (C) Debit Notes Payable = [10% x (A)] 9/30/2005..3...................... $300. 7............................... 109..........................896 [Prior (E)] $61...000 (A) Period Ending Date Beginning Balance (D) Credit (E) Cash Ending Balance [(D) . 2005 113 . 3 Interest rate................... 7...368 9/30/2006.......4869)...........Problem 14-8B (45 minutes) Part 1 Amount of Payment Note balance......368 20...................................000 / 2.........................000 $ 90...................... 7.. Inc............... 31 Interest Expense...500 Interest Payable...................... 120......4869 Payment ($300.......... $120...........896 *Adjusted for rounding............................ $300.. 2................959* 109........$7...............632 0 $300...... Solutions Manual..000 ..........................(B)] [computed] [(A) .........500 Interest Payable.... Part 3 2004 Dec.000 Number of periods................500 Notes Payable............937 99..........(C)] $30.500 Accrued interest on the installment note payable ($30............. 90.................... 22..............................632 Cash....632 Record first payment on installment note (interest expense = $30...................................... 30 Interest Expense................................................... 10% Value from Table B...... Chapter 14 ©McGraw-Hill Companies........673 120............

...000 2004 Dec..... Inc..... 2005 Sept...............500 Interest Payable...000 0 $60.000 $30......... $300.... 30 Interest Expense.000 10. 130... 31 Beginning Balance (B) Debit Interest Expense + Payments (C) Debit Notes Payable = [Prior (E)] Interest Expense.....000 x ...........................000 100.500 Notes Payable...000 $200....... 17th Edition ..........000 $360...................000 110.. 22.....000 Cash..................000 $100.500 Interest Payable... 2005 114 Fundamental Accounting Principles.. 100......................................... 200.............. 7......................000 100................. ©McGraw-Hill Companies..10 x 3/12).......$7.....................Problem 14-8B (Concluded) Part 4 (A) Period Ending Date (D) Credit (E) Cash Ending Balance [10% x (A)] [$300...........................000 9/30/2007...000 $300.................000 Record first payment on installment note (interest expense = $30.....500 Accrued interest on the installment note payable ($300.....(C)] 9/30/2005..........000 .....................000 $130.... 7. 7..............................000 20..... 100.000/ 3] [(B) + (C)] [(A) .000 100...................................000 120..000 9/30/2006..........500)..........

...000)..............600 / $84...11 to 1 Hound Company Pledged assets [($750...000 x 10%) + $225.000).......000 Ratio ($177......000)........45 to 1 Part 2 Hunt's ratio of pledged assets to secured liabilities is higher than Hound's......................000].... so the Hunt bonds appear less risky to bondholders.........000]... Before deciding to buy Hunt’s bonds.......................$177..... Inc.000 Secured liabilities ($57... Chapter 14 ©McGraw-Hill Companies.$300.. it might be helpful to know the liquidation value of both companies’ assets that are pledged as collateral...000 + $150........000 + $45.000 x 32%) + $120... however............ It also is important to evaluate the ability of each company to meet its obligations from operating cash flows.......000 / $207...........2...........$ 84.................$207....................Problem 14-9B (30 minutes) Part 1 Hunt Company Pledged assets [($180...............000 Ratio ($300.000)...... Solutions Manual....................1.600 Secured liabilities ($39.................. 2005 115 .........

.... ©McGraw-Hill Companies...356 1...830 10..............000 24.487 7...3) = $37.869 Year 3 24....092 Year 5 9........092 9. Depreciation—Office Equipment.356 Year 4 17..791* $ 6.908...7. Part 2 Leased Asset—Office Equipment...000 $31.092 * ** Rounded to nearest dollar.. Difference due to rounding.000 17.209 $10......908 $ 3.513 10.. 17th Edition ..... Inc..... Part 4 Depreciation Expense—Office Equipment...000 908** $12.......000 x 3...699 Year 2 31.000 0 $37...908 To record capital lease of office equipment...170 6.582 To record depreciation ($37.....908 / 5 years)......264 10..... 7. 37..869 2.908 Lease Liability.582 Accum. 2005 116 Fundamental Accounting Principles......908 $50.....699 3.7908 (from Table B.......736 8........ 37.000 9.....Problem 14-10BC (35 minutes) Part 1 Present Value of the Lease Payments $10........092 10...... 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...

...... Inc..........4% b........034 / ($129....... Total Pledged Assets...020) / ($129..720 704 24....................909 + $8.......909 + $8.......................SERIAL PROBLEM Serial Problem...................... Success Systems (75 minutes) Part 1 Pledged Assets Balances at 3/31/05 Accounts Receivable.. 2005 117 .................. Chapter 14 = 93... Merchandise inventory....... $22......... 6 Maximum loan allowed  $48.... Debt ($875 + $8.....020) Solutions Manual.............124 / [?] = 6  $8.......020) = 6... then the percent of assets financed by: a.... Equity $129.....124 Maximum Loan Allowed.. ? Pledged assets to secured loan ratio....................700 $48...6% ©McGraw-Hill Companies................ Net Plant Assets.............020 Part 2 Assume the secured loan is taken.............

Inc. 17th Edition . Krispy Kreme’s statement of cash flows (financing section) for the year ended February 2. 2005 118 Fundamental Accounting Principles. ©McGraw-Hill Companies. Krispy Kreme’s statement of cash flows (financing section) for the year ended February 2.170. reports its repayment of long-term debt that totals $2.000. 2.000 and its repayment of revolving lines of credit that total $121. 3. reports proceeds from additions to long-term debt (borrowings) that total $44. Note 7 to its financial statements reports that its long-term debt consists of lines of credit and term notes. 2003. there is no evidence of bonds having been issued by Krispy Kreme from its balance sheet or from its note disclosures.234.Reporting in Action — BTN 14-1 1. Specifically. However. Answer depends on the financial statement information obtained.000. 4. The balance sheet of Krispy Kreme reports long-term debt. 2003..

643 = $167. However. Solutions Manual.500 = 6. Tastykake’s pledged assets to secured liabilities ratio (in thousands) Current Year = (Receivables + Inventory + Property and Equipment) / Long-Term debt** = ($20.14 ($36. in the prior year. Chapter 14 ©McGraw-Hill Companies.347 / $14.643 = 36.050 / $13.365 + $202.06 *Includes receivables from affiliates and other receivables. 2005 119 .242/ $53.06 **Does not include current and long-term capital lease obligations.900** = $90. are at slightly more risk than Tastykake’s secured creditors.37 ($6. inventory. Krispy Kreme’s pledged assets to secured liabilities ratio (in thousands) Current Year = (Receivables + Inventory + Property and Equipment) / Long-Term debt = ($46. and property and equipment as collateral for their long-term debt. Inc. Tastykake’s ratio implies that it has $6.777 + $58.14 Prior Year = (Receivables + Inventory + Property and Equipment) / Long-Term debt = ($38. Krispy Kreme’s ratio implies that it has $5.702) / $14.Comparative Analysis — BTN 14-2 [Note: Assignment assumes that both companies have pledged all of their current receivables.] 1.201 = 5. in the current year.391) / $13.201 = $273.882 + $6.577) / $4. Krispy Kreme had a far superior ratio of 36.06) of collateral for each $1 of secured debt in the current (prior) year.558) / $53.682* + $16.500 = $86.159 + $112..06.233 + $8.412 + $59.900 = 6. implying very low risk for long-term secured creditors. 2.37 Prior Year = (Receivables + Inventory + Property and Equipment) / Long-Term debt = ($22. These results suggest that Krispy Kreme’s secured creditors.418 / $4.06) of collateral for each $1 of secured debt in the current (prior) year.319* + $24.

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. ©McGraw-Hill Companies. Florida. 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.Ethics Challenge — BTN 14-3 1. 2. The taxpayers felt that their voice was taken out of the governing process.. such talk angered the municipal bond industry and the investors. Yet. 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. reacted very negatively to the actions of the county officials when they learned of the leasing arrangement. Inc. 17th Edition . Since the lease requires payments of a non-binding nature. the taxpayers of Brevard County. Of course. In reality. 2005 120 Fundamental Accounting Principles. Taxes may need to be raised to repay the lease just as they would have if bonds were issued. The ethics of the Brevard County officials are questionable. the voters had no say in the financing arrangement the officials agreed to.

Solutions Manual.. The bottom line is that the market prices the bonds according to their perceived risks and returns. Chapter 14 ©McGraw-Hill Companies. 2005 121 . 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. 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. As a result. Inc. In addition.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. A cordial closing that indicates willingness to discuss the issue further would be appropriate. this market rate of interest is lower than the contract rate of interest for premium bonds. the face amount is less than the amount the associate will invest to acquire the bond. the investment will yield the investor (and cost the issuing corporation) less than the contract rate of interest. What your associate needs to focus on is the level of risk she is willing to accept and then invest accordingly.

.... For all three years the amount of debt repaid exceeded the new debt issued.... ©McGraw-Hill Companies. $ (756) $ (926) $ (585) Analysis: The amount of debt issued in 2002 is less than that issued in 2000 and 2001. In 2002....622 million obtained from debt financing... repaid $2....Taking It to the Net — BTN 14-5 1.. 3... 4.. $ 1......(2.....937) (4......378) (3..671 Payments of debt.. 2.... 2005 122 Fundamental Accounting Principles.. 17th Edition .. 2002 Issuances of debt.....378 million in debt in 2002............ issued $107 million in stock. Per the 2002 Statement of Cash Flows... Coca-Cola Co............. This amount of financing from issuing stock is much less than the $1. issued $1. Inc..622 2001 2000 $ 3.......... Coca-Cola Co..622 million of debt in 2002...256) Net issuance or (net repayment).. Coca-Cola Co.... Per the 2002 Statement of Cash Flows.....011 $ 3..

the team solution will likely end about here.100 1. or [(A) .955* $40.058 4. Column (E) Bonds’ Carrying Value = Bonds’ par value plus unamortized premium.137 363 3..415 103.075 4. or [$100.Period’s amortization.764 103.674 6/30/2007 4.500 $ 4.(C)].005 545 0 101.000 4.052 12/31/2006 4. Inc.000 *Discrepancy due to rounding. Solutions Manual.000) x Semiannual contract rate (4.872 101.500 4.500 4.500 4.500 4. Chapter 14 ©McGraw-Hill Companies.281 102. The remainder of the table is shown for help in answering part 3. Column (D) Unamortized Premium = prior period’s unamortized premium less the current period’s premium amortization.164 $ 336 3.872 1.415 6/30/2006 4.091 4. 2005 123 .447 1. or [(D) .500 4.5%). Column (B) Bond interest expense = Bonds’ prior period carrying value x Semiannual market rate (4%).500 4.107 393 2.500 4.122 378 2.000 + (D)] or Previous book value .545 100.281 Since teams generally have 4 or 5 members.900 409 425 442 460 545 $4.764 12/31/2005 4. The following computations should be articulated by team members as each line is explained and prepared: Column (A) Cash Interest Paid = Bonds' par value ($100.100 6/30/2005 $ 4.052 103. 12/31/2007 6/30/2008 12/31/2008 6/30/2009 12/31/2009 4.151 349 3.500 $45.100 $ 104.040 3. Column (C) Premium Amortization = difference between cash interest paid and bond interest expense.500 4.674 102.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.(B)].005 100.447 101.

2005 124 Fundamental Accounting Principles. 1) Last interest period date is 12/31/2009 because this is a five-year bond. Carrying value at 12/31/2009 will be $100.(A).000 in both cases. c. after all amortization is completed). ©McGraw-Hill Companies. and (E). (B). (D). Column (C) will be Discount Amortization and Column (D) will be Unamortized Discount. d.900 Part 5. Table column headings for the period and for columns (A). team members should be able to project the final number in the first column and for each of the columns (A). with semiannual interest payments made on 6/30 and 12/31 of each year. Computation of Column (C) will be (B) .Premium = ($4.000 (the carrying value always equals the par value at the maturity date. Bond interest expense is higher (lower) than the interest paid and will increase (decrease) as we amortize a discount (premium). (Col. (Col. not (A) . e.100 = $45.$4. Computation of Column (E) will be previous Column (E) plus discount amortization whereas with a premium we subtract to find the new carrying value. A) Interest paid of $4. (B). b. Ending unamortized premium and discount will both be zero.000 .500 (every interest period has the same amount of interest paid). c.. b. 17th Edition . Carrying value will increase (decrease) as we amortize a discount (premium). e. D) Zero unamortized premium (by the last interest period the premium must be fully amortized). Part 4 Total Bond interest expense = Interest Paid .100 = $40. Computations in Columns (A). f. List likely includes: Similarities a.(B). d. Inc. and (E).$4. (Col. and (D) will follow the same format. Specifically: (Col. Differences a.500 x 10 periods) .Teamwork in Action (Concluded) Part 3 Without completing the table. E) Ending carrying value is $100. issued 1/1/2005. Dates in the period column and interest paid in column (A). Discount (premium) amortization will decrease (increase) each period.

). 2005 125 . At the time of the article. Solutions Manual. 5. 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. Emerging countries try to attract foreign capital by paying high interest rates on their bonds and loans.. Emerging economies (countries) can experience difficulties in retaining foreign investment. returns. 3.Business Week Activity — BTN 14-7 1. 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. 4. etc. This article discusses the challenges that emerging countries face in attracting and retaining foreign investment capital. Chapter 14 ©McGraw-Hill Companies. investors tend to move money among the various foreign capital markets in search of a better “hot” deal (higher interest rates. 2. This is for several reasons. Inc. Instead. the available (printed) Polish Treasury bills were yielding 18%.

..Entrepreneurial Decision — BTN 14-8 Part 1 The table below reveals how the five alternative interest-bearing notes affect Noodles & Company’s interest expense.. The table in Part 1 shows this result. net income.000 Net income.000 $ 30...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.. 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..000 $ 31... In the case of Kennedy’s franchise. it increases its return on equity.4% 12% 11..000 $250..000 $ 56.000 30..000 Return on equity.000 $ 29.. 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.000 Interest expense. 10...$ 40. it is predicting a return of 16% on its investment.000 $ 26... equity...4% 12..000 $250.000 $ 56..$250...000 $ 56. where those notes with interest expense below 16% are profitable (that is. yield a return less than the current ROE of 12%)..000 $250.000 $ 56.6% 10.... Hitting the Road ©McGraw-Hill Companies.000 $ 56. computed as its expected $16. 2005 126 — BTN 14-9 Fundamental Accounting Principles..000 26.000 additional annual income before interest divided by its $100. . Inc.. 12% 14..000 20.000 Equity.000 27. This means that for it to pursue the investment..000 $ 36...000 investment... ...000 25.... Also...... the interest on the borrowed funds must be less than 16%..000 $250.. yield a return greater than the current ROE of 12%) while those above 16% are not (that is.000 $250..$ 30. 17th Edition ..

Students’ answers will depend on the municipality and time period chosen for analysis. Solutions Manual.. 2005 127 . Inc. Students often find this assignment interesting as it reinforces the relevance of their accounting studies. Chapter 14 ©McGraw-Hill Companies.

Tastykake exhibits the most stable and largest multiple of pledged assets to secured liabilities. Grupo Bimbo’s pledged assets to secured liabilities ratio (in thousands of pesos) Current Year = (Receivables + Inventory + Property and Equipment) / Long-Term debt = (3. In contrast. 3.Global Decision — BTN 14-10 1. The Statement of Changes in Financial Position (financing activities) reports that Grupo Bimbo borrowed 6.76.207 + $767 + 14.73 2.004 = 18. we conclude that Tastykake’s long-term debt is least risky. 17th Edition .462 million (pesos) of debt in 2002.37 exceeded Krispy Kreme’s ratio of 5.004 = 3. they repaid only 69.14 and Grupo Bimbo’s (much weaker) ratio of 1.466 = 20.143 / 11.657 / 5. Therefore. However. 2005 128 Fundamental Accounting Principles. 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. ©McGraw-Hill Companies. Inc.466 = 1.794 + 905 + 15. In the most recent year Tastykake’s multiple of 6.444) / 11.683) / 5. according to this ratio only..76 Prior Year = (Receivables + Inventory + Property and Equipment) / Long-Term debt = (3.1 million (pesos) to financial institutions in 2002.