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Revised 05.01.

17

Module 7
Current and Long-Term Liabilities

MINI EXERCISES
M7-9. (15 minutes)

a. Accounts Payable, $220,000 (current liability).

b. Not recorded as a liability; an accounting transaction has not yet occurred because
Bloomington did not receive the drill press before year-end and anticipated transactions are
not recorded.

c. Liability for Product Warranty, $3,100 (current liability).

d. Bonuses Payable, $40,000 (current liability)—computed as $800,000  5%. This liability must
be reported because the bonus relates to executives’ efforts to generate operating results in
2016.

M7-10. (10 minutes)

a. Citigroup is offering bonds (maturing 2028) with a coupon (stated) rate of 6.625% when
the market rate (yield) is lower at 3.725%. To obtain this expected rate of return, the bonds
must sell at a premium price of 129.87 (129.87% of par). The other bonds also sell at a
premium, but the premium is smaller because the market rate and the coupon rate are
closer than that for the bonds maturing in 2028.

b. The first bond matures in 2028 and yields 3.725% while the second matures in 2043 and
yields 4.095%. The market generally demands a higher rate (yield) for a longer maturity
debt instrument.

M7-15. (15 minutes)

(in $000)
Balance Sheet Income Statement

Cash Noncash Liabil- Contrib. Earned Rev Expen Net


Transaction + = + + – =
Asset Assets ities Capital Capital enues -ses Income
©Cambridge Business Publishers, 2018
Solutions Manual, Module 7 7-1
LTD 626
Cash 618
GN 8
626
To retire bonds +8
-626 +8
at 103 and -618 Gain on
= Long-term Retained – = +8
Cash report gain on Cash Bond
Debt Earnings
618 bond retirement* Retirement

GN
8

* Retirement price = $618,000, computed as $600,000 × 103%.


Original net book value of bonds = $636,000, computed as $600,000 × 106%
Net book value of bonds at retirement = $626,000, computed as $636,000 - $10,000.

M7-19. (15 minutes)

a. Selling price for $700,000, 9% bonds discounted at 8% (4% semiannually):

Calculator inputs: N = 20 I/Y = 4 PMT = -31,500 FV = -700,000,


PV = 747,566.14

Excel inputs: = PV(4%,20,-31500,-700000,0) Cell will display: 747,566.14

Present value of principal repayment ($700,000  0.45639a) $319,473


Present value of interest payments ($31,500  13.59033b) 428,095
Selling price of bonds $747,568

a
Table 1, 20 periods at 4%.
b
Table 2, 20 periods at 4%.

b. Selling price for $700,000, 9% bonds discounted at 10% (5% semiannually):

Calculator inputs: N = 20 I/Y = 5 PMT = -31,500 FV = -700,000,


PV = 656,382.26

Excel inputs: = PV(5%,20,-31500,-700000,0) Cell will display: 656,382.26

Present value of principal repayment ($700,000  0.37689a) $263,823


Present value of interest payments ($31,500  12.46221b) 392,560
Selling price of bonds $656,383

a
Table 1, 20 periods at 5%.
b
Table 2, 20 periods at 5%.

©Cambridge Business Publishers, 2018


7-2 Financial Accounting for MBAs, 7th Edition
M7-21. (15 minutes)

Balance Sheet Income Statement

Cash Noncash Liabil- Contrib. Earned Rev- Expen- Net


Transaction + = + + – =
Asset Assets ities Capital Capital enues ses Income
INV 1,260
AP 1,260

INV a. Purchases
+1,260
$1,260 of +1,260
1,260 = Accounts – =
inventory Inventory
Payable
on credit
AP
1,260

AR 1,650
Sales 1,650

AR b. Sells
+1,650 +1,650
inventory +1,650
1,650 Accounts = Retained – = +1,650
for $1,650 Sales
Receivable Earnings
on credit
Sales
1,650

COGS 1,260
INV 1,260

COGS c. Records
–1,260 +1,260
$1,260 –1,260
1,260 = Retained – Cost of = –1,260
cost of Inventory
Earnings Sales
sales
INV
1,260

Cash 1,650
AR 1,650
d. Receives
Cash $1,650 –1,650
+1,650
1,650 cash for Accounts = – =
Cash
accounts Receivable
AR receivable
1,650

AP 1,260
Cash 1,260 e. Pays
$1,260
AP –1,260
cash to –1,260
1,260 = Accounts – =
settle Cash
Payable
accounts
Cash payable
1,260

©Cambridge Business Publishers, 2018


Solutions Manual, Module 7 7-3
M7-22. (30 minutes)

a.
Data inputs into Excel—
=price(settlement,maturity,rate,yld,redemption,frequency,basis)
01/01/17 Settlement date
12/31/26 Maturity date
8.00% Percent annual coupon rate
7.00% Percent annual yield
100 Redemption value
2 Frequency is semiannual (given in problem)
1 actual/actual basis

Percent of par Sale proceeds


Price……… 107.10 $428,400
($400,000 × 1.0710)

b.
Premium Premium Carrying
Period Interest Cash Paid Amortization Balance Amount
0 28,400.00 428,400.00
1 14,994.00 16,000.00 1,006.00 27,394.00 427,394.00
2 14,958.79 16,000.00 1,041.21 26,352.79 426,352.79
3 14,922.35 16,000.00 1,077.65 25,275.14 425,275.14
4 14,884.63 16,000.00 1,115.37 24,159.77 424,159.77
5 14,845.59 16,000.00 1,154.41 23,005.36 423,005.36
6 14,805.19 16,000.00 1,194.81 21,810.55 421,810.55
7 14,763.37 16,000.00 1,236.63 20,573.92 420,573.92
8 14,720.09 16,000.00 1,279.91 19,294.00 419,294.00
9 14,675.29 16,000.00 1,324.71 17,969.29 417,969.29
10 14,628.93 16,000.00 1,371.07 16,598.22 416,598.22
11 14,580.94 16,000.00 1,419.06 15,179.16 415,179.16
12 14,531.27 16,000.00 1,468.73 13,710.43 413,710.43
13 14,479.86 16,000.00 1,520.14 12,190.29 412,190.29
14 14,426.66 16,000.00 1,573.34 10,616.95 410,616.95
15 14,371.59 16,000.00 1,628.41 8,988.55 408,988.55
16 14,314.60 16,000.00 1,685.40 7,303.14 407,303.14
17 14,255.61 16,000.00 1,744.39 5,558.75 405,558.75
18 14,194.56 16,000.00 1,805.44 3,753.31 403,753.31
19 14,131.37 16,000.00 1,868.63 1,884.68 401,884.68
20 14,115.32* 16,000.00 1,884.68 (0.00) 400,000.00
* adjusted to absorb $49.36 cumulative rounding error.

©Cambridge Business Publishers, 2018


7-4 Financial Accounting for MBAs, 7th Edition
EXERCISES

E7-28. (20 minutes)

1. Neither record nor disclose (the loss is not probable, nor reasonably possible).

2. Record a current liability for the note. At the financial statement date, record a liability for any
interest that has been incurred since the note was signed.

3. Disclose in a footnote (the loss is reasonably possible but the amount cannot be estimated).

4. Record warranty liability on the balance sheet and recognize an expense in the income
statement (costs are probable and reasonably estimable).

E7-35. (25 minutes)

a. Selling price of bonds

Calculator inputs: N = 18 I/YR = 5 PMT = -14,000 FV = -350,000,


PV = 309,086.45

Excel inputs: =PV(5%,18,-14000,-350000,0) Cell will display: 309,086.45

Present value of principal repayment ($350,000  0.41552) $145,432


Present value of interest payments ($14,000  11.68959) 163,654
Selling price of bonds $309,086

b.
Balance Sheet Income Statement

Cash Noncash Liabil- Contrib. Earned Rev- Expen- Net


Transaction + = + + – =
Asset Assets ities Capital Capital enues ses Income
Cash 309,086
LTD 309,086 1. Issue
Cash $350,000, +309,086
+309,086
309,086 8% bonds = Long-Term – =
Cash
to yield Debt
LTD 10%(1)
309,086

IE 15,454 2. Pay +1,454 –15,454 +15,454


–14,000
LTD 1,454 interest on = Long-Term Retained – Interest = –15,454
Cash
Cash 14,000 June 30 (2) Debt Earnings Expense

©Cambridge Business Publishers, 2018


Solutions Manual, Module 7 7-5
IE
15,454

LTD
1,454

Cash
14,000
IE 15,527
LTD 1,527
Cash 14,000
IE
3. Pay
15,527 +1,527 –15,527 +15,527
interest on –14,000
= Long-Term Retained – Interest = –15,527
December Cash
Debt Earnings Expense
LTD 31 (3)
1,527

Cash
14,000
(1) The bond is reported at its sale price, which is par value of $350,000 less the discount of $40,914.
(2) $14,000 cash paid = bond face amount × coupon rate ($350,000 × 0.04). The $15,454 interest expense = bond carrying
amount × discount rate ($309,086 × 0.05). The difference between the two is the amortization of the discount, which increases
the bond carrying amount.
(3) $14,000 cash paid = bond face amount × coupon rate ($350,000 × 0.04). The $15,527 interest expense = bond carrying
amount × discount rate [($309,086 + $1,454) × 0.05]. The difference between the two is the amortization of the discount,
which increases the bond carrying amount.

©Cambridge Business Publishers, 2018


7-6 Financial Accounting for MBAs, 7th Edition
PROBLEMS

P7-45. (40 minutes)

a. The current maturities of long-term debt are repayments of long-term debt that must be
made during the next year. Because they represent a current obligation of the company,
they are included among current liabilities on the balance sheet. PepsiCo chose to group
its current maturities of $3,109 million with its other short-term debt rather than report them
as a separate line in the current liabilities section of the balance sheet. Both are common
disclosure methods.

Companies report maturities so that financial statement users can assess future cash
outflows. In particular, the $8,396 million of long-term debt scheduled to mature in 2017-
2018 must be repaid during that time period.

The $8,396 million amount is important to our analysis of the company’s solvency. The
company has two options in settling its debt: 1) refinance the maturing debt with a new
debt issuance, or 2) repay the debt from cash flows in the year the debt matures. PepsiCo
generated $10,580 million of cash from operating activities in 2015, the year that this debt
footnote is reported. A current maturity of $8,396 million would, therefore, require the use
of almost 80% of this operating cash flow if PepsiCo cannot refinance the debt.
Accordingly, the magnitude of this debt and its upcoming due date should be viewed with
some degree of concern unless we are comfortable with the company’s operating cash
flow or other sources of liquidity.

b. There is an inverse relation between bond price and effective bond yield. The information
here reveals that the PepsiCo bond maturing in 2018 is selling at a premium (112.32% of
par). This premium will cause the effective yield to be less than the 5% coupon on this
bond (1.374% in this case). The market rates reflect underlying interest rates and risk
premia as of 2016, whereas PepsiCo established the coupon rates when the bond was
issued in the first quarter of 2010. Thus, assuming that the bonds were originally issued
at par, the premium price that exists at 2016 (112.32% of par) reflects the effect of
decreasing interest rates. Since the problem assumes constant credit ratings, the premium
must have resulted from an overall decrease in market interest rates since PepsiCo issued
the bond.

c. PepsiCo’s schedule of long-term contractual commitments reveals that there are $3,109
million of long-term debt maturing in the next year and $8,396 billion maturing in the next
two years. We might have some concern if a significant portion of PepsiCo’s long-term
debt was scheduled to mature within the near future, but that is not the case. Further,
PepsiCo’s operating cash flow is very strong and this mitigates any concern we might
have about its ability to meet its maturing debt obligations.
Continued next page

©Cambridge Business Publishers, 2018


Solutions Manual, Module 7 7-7
P7-45. concluded

d. Moody’s provided the rating on Pepsi’s new note issuance to provide an opinion about the
company’s ability to repay the $3 billion. Investors can infer that the new notes did not
impair PepsiCo’s creditworthiness because the rating action says, “Other ratings were
unchanged.” The rating action will affect the proceeds that PepsiCo receives on the new
notes. The credit rating of A1 indicates a low risk premium because the rating is fairly high.
A low risk premium keeps PepsiCo’s borrowing costs down and, therefore, the note
proceeds will be higher.

e. To improve its credit ratings, PepsiCo must improve its liquidity and solvency and/or
reduce its debt payments (by reducing its debt level). All of these actions, while serving to
improve its credit ratings, entail certain costs that PepsiCo must seriously consider. For
example, increasing liquidity by reducing inventories or foregoing capital expenditures can
impact PepsiCo’s sales and competitive position. Likewise, reducing debt by issuing equity
is costly because equity capital is usually more expensive (due to the subordinated
position of equity investors vis-à-vis creditors and also the non-deductibility of dividends
for tax purposes). In sum, PepsiCo must carefully weigh the costs and benefits of various
actions it can undertake to increase its credit ratings.

©Cambridge Business Publishers, 2018


7-8 Financial Accounting for MBAs, 7th Edition