P14-5 (Comprehensive Bond Problem) In each of the following independent cases the company

closes
its books on December 31.
1. Danny Ferry Co. sells $250,000 of 10% bonds on March 1, 2007. The bonds pay interest on
September
1 and March 1. The due date of the bonds is September 1, 2010. The bonds yield 12%. Give
entries through December 31, 2008.

2. Brad Dougherty Co. sells $600,000 of 12% bonds on June 1, 2007. The bonds pay interest on
December 1 and June 1. The due date of the bonds is June 1, 2011. The bonds yield 10%. On
October 1, 2008, Dougherty buys back $120,000 worth of bonds for $126,000 (includes accrued
interest). Give entries through December 1, 2009.

Instructions
(Round to the nearest dollar.)
For the two cases prepare all of the relevant journal entries from the time of sale until the date
indicated.
Use the effective interest method for discount and premium amortization (construct amortization
tables
where applicable). Amortize premium or discount on interest dates and at year-end. (Assume that no
reversing
entries were made.)

1. Danny Ferry Co.

3/1/01 Cash....................................................................
236,045

Discount on Bonds Payable................................

13,955

Bonds Payable............................................. 250,000

Maturity value of bonds payable $250,00

0

Present value of $250,000 due in 7 periods

at 6%

($250,000 X .66506) $166,26

5

Present value of interest payable

semiannually
 ($12,500 X 5.58238) 69,78
0

Proceeds from sale of bonds (236,04

5)

Discount on bonds payable $

13,955

9/1/01 Interest Expense................................................

14,163

Discount on Bonds Payable........................ 1,663

Cash............................................................ 12,500

12/31/0 Interest Expense................................................

9,508
1

Discount on Bonds Payable........................ 1,175

($1,762 X 4/6)

Interest Payable ($12,500 X 8,333

4/6)

3/1/02 Interest Expense................................................

4,754

Interest Payable..................................................
8,333

Discount on Bonds Payable........................ 587

($1,762 X 2/6)

Cash............................................................ 12,500
9/1/02 Interest Expense................................................
14,368

Discount on Bonds Payable........................ 1,868

Cash............................................................ 12,500

12/31/0 Interest Expense................................................

9,653
2

Discount on Bonds Payable........................ 1,320

($1,980 X 4/6)

Interest Payable.......................................... 8,333

Schedule of Bond Discount Amortization

Effective Interest Method

10% Bonds Sold to Yield 12%

Debit Credit Carrying

Credit Interest Bond Value of
Date Cash Expense Discount Bonds
3/1/01 $236,045
9/1/01 $12,500 $14,163 $1,663 237,708

3/1/02 12,500 14,262 1,762 239,470

9/1/02 12,500 14,368 1,868 241,338

3/1/03 12,500 14,480 1,980 243,318

9/1/03 12,500 14,599 2,099 245,417

3/1/04 12,500 14,725 2,225 247,642

9/1/04 12,500 14,858 2,358 250,000

 2. Dougherty Co.

6/1/01 Cash....................................................................
638,780

Premium on Bonds Payable........................ 38,780

Bonds Payable............................................. 600,000

Maturity value of bonds payable $600,00

0

Present value of $600,000 due in 8 periods

at 5%

($600,000 X .67684) $406,10

4

Present value of interest payable

semiannually

($36,000 X 6.46321) 232,67

6

Proceeds from sale of bonds 638,78

0

Premium on bonds payable $

38,780

12/1/01 Interest Expense................................................

31,939

Premium on Bonds Payable................................

4,061
 Cash ($600,000 X .12 X 6/12)...................... 36,000

12/31/0 Interest Expense ($31,736 X 1/6).......................

5,289
1

Premium on Bonds Payable...............................

711
Payable...............................................................

($4,264 X 1/6)

Interest Payable ($36,000 X 6,000

1/6)

6/1/02 Interest Expense ($31,736 X 5/6).......................

26,447

Interest Payable..................................................
6,000

Premium on Bonds Payable................................

3,553

($4,264 X 5/6)

Cash............................................................ 36,000

10/1/02 Interest Expense................................................

4,203

($31,523 X .2* X 4/6)

Premium on Bonds Payable................................

597

($4,477 X .2 X 4/6)

Cash............................................................ 4,800

*$120,000  $600,000 = .2

10/1/02 Bonds Payable....................................................

120,000
 Premium on Bonds Payable................................
5,494

Gain on Redemption of Bonds.................... 4,294

Cash............................................................ 121,200

Reacquisition price

($126,000 – $120,000 X 12% X 4/12) $121,20

0

Net carrying amount of bonds redeemed:

Par value $120,00

0

Unamortized premium

[.2 X ($38,780 – $4,061 – $4,264) – 5,49 (125,49

$597] 4 4)

Gain on redemption $
(4,294)

12/1/02 Interest Expense ($31,523 X .8*).......................

25,218

Premium on Bonds Payable................................

3,582

($4,477 X .8)

Cash ($36,000 X .8)..................................... 28,800

*($600,000 – $120,000)  $600,000

= .8

12/31/0 Interest Expense................................................

4,173
2

($31,299 X .8 X 1/6)

Premium on Bonds Payable................................

627

($4,701 X .8 X 1/6)

Interest Payable.......................................... 4,800

($36,000 X .8 X 1/6)

6/1/03 Interest Expense ($31,299 X .8 X 20,866

5/6)

Interest Payable..................................................
4,800

Premium on Bonds Payable................................

3,134

($4,701 X .8 X 5/6)

Cash ($36,000 X .8)..................................... 28,800

12/1/03 Interest Expense ($31,064 X .8).........................

24,851

Premium on Bonds Payable................................

3,949

($4,936 X .8)

Cash ($36,000 X .8)..................................... 28,800

Debit Debit Carrying

Cash Interest Bond Value of
Date Credit Expense Premium Bonds
6/1/01 $638,780
12/1/01 $36,000 $31,939 $4,061 634,719
6/1/02 36,000 31,736 4,264 630,455
 12/1/02 36,000 31,523 4,477 625,978
6/1/03 36,000 31,299 4,701 621,277
12/1/03 36,000 31,064 4,936 616,341
6/1/04 36,000 30,817 5,183 611,158
12/1/04 36,000 30,558 5,442 605,716
6/1/05 36,000 30,284 5,716 600,000
*

*$1.80 adjustment due to rounding.

I5-1:

The following information is available concerning The Blue Collar Company’s

payroll for November, 2009:

October Federal State

Year to Income Income
Date Date November Tax Tax
Employee of Hire Earnings Earnings Withheld Withheld

Z. Allen 1/6/2002 $104,000 $10,600 $3,200 $250

G. Burns 9/1/2009 6,000 3,000 600 45
C. Gunn 5/1/2001 100,000 10,000 3,000 225
B. Stark 11/1/2001 0 3,500 700 55
K. Veil 3/1/2003 110,000 11,000 3,500 265

Blue Collar pays wages monthly.

The O.A.S.D.I. rate is 6.2% on the first $106,800 of earnings.

The Hospital Insurance tax is 1.45%.

The federal unemployment tax is 6.2% on the first $7,000 of earnings.

The state unemployment tax is 5.5% on the first $7,000 of earnings.

However, because of Blue Collar’s excellent merit rating, the rate has been
reduced to 2.5%. Employees do not pay state unemployment taxes.

Instructions:
1. Prepare the journal entries necessary to record the November payroll and
all taxes.

The O.A.S.D.I. Tax for each person would be based on when the earnings reach $106,800.
Z. Allen - Earnings already $104,000 and so only balance $2,800 would be subject to tax =
2,800 X 6.2 % = 173.6
G. Burns = 3,000 X 6.2% = 186
C. Gunn - Earnings already $100,000 and tax would be on remaining 6,800 = 6,800 X 6.2%
= 421.60
B. Stark = 3,500 X 6.2% = 217
K. Veil - earnings already over 106,800 and so no tax

Total O.A.S.D.I tax is $998.20

Total Federal income tax withheld is $11,000
Total state income tax withheld is $840
Total earnings for November are $38,100
Hospital tax is 38,100 X 1.45% = $552.45
Total deductions are 998.20 + 11,000+840 + 552.45 = 13,390.65
Gross Pay is 38,100
Net Pay = 38,100-13,390.65 = $24,709.35

The journal entry to record November payroll is

Salaries and Wages Expense 38,100

O.A.S.D.I. Payable 998.20
Federal Income Tax Payable 11,000
State Income Tax Payable 840
Hospital Insurance Tax Payable 552.45
Salaries and Wages Payable 24,709.35

The payroll taxes are

O.A.S.D.I 998.20
Hospital Insurance Tax 552.45

Federal unemployment tax is limited to $7,000 and so would be paid on $1,000 income of G.
Burns and 3,500 of B. Stark
Federal unemployment tax = 4,500 X 6.2% = 279
State unemployment tax is also on first $7,000 and so would be paid on 4,500 X 2.5% =
112.50
Total payroll tax expense = 998.20+552.45 + 279+112.5 = $1,942.15

The journal entry is

Payroll Tax Expense 1,942.15

O.A.S.D.I. Payable 998.20
Hospital Insurance Tax Payable 552.45
Federal Unemployment Tax Payable 279
State Unemployment Tax Payable 112.50

I5-2:

The Hill Valley Company had the following gross sales on Tuesday March 3 rd:

Credit Sales: $45,950.67

Cash Sales: $23,575.45

The sales include the state’s 5.5% sales tax.

Instructions:

1. Prepare the journal entry to properly record the day’s sales.

We first calculate the tax amount on each sale. The tax rate is 5.5%. The sales with sales tax
are

Credit sales = 45,950.67/1.055 = 43,555.14

Tax amount is 45,950.67 – 43,555.14 = 2,395.53

Cash sales = 23,575.45/1.055 = 22,346.40

Tax amount = 23,575.45 – 22,346.40 = 1,229.05

The entry to record the sales is

March 3 Cash 23,575.45

Accounts Receivable 45,950.67

Sales 65,901.54

Sales Tax Payable 3,624.58

I5-3:

Consider the following independent situations of the Back Fire Corporation (BFC):

1. A BFC deliver truck was involved in an accident with a private automobile. BFC
carries an insurance deductible of $25,000 per accident. That is, BFC must pay the
first $25,000 of any costs as a result of a traffic accident. The driver of the
automobile was slightly injured and the damage to the automobile was
approximately $8,000. The insurance adjustor estimated that the total cost to repair
the automobile and for the driver’s injuries will be about $10,000. The accident was
a result of the automobile running a stop sign and the adjustor advises that it is
unlikely that BFC will be required to pay for the automobile repairs or the driver’s
injury.

2. BFC sued the ABC Company for a patent infringement issue. BFC lawyers indicate
that they are 100% sure that BFC will win the suit and collect $200,000 from ABC.

3. A retaining wall at one of BFC’s factories failed and caused a mud slide that
damaged the building next door belonging to the XYZ Company. BFC has admitted
responsibility and has received bids from three contractors to repair the damage.
The estimated were $103,000; $77,500; and $154,000.

4. A leak at an underground storage tank contaminated the adjacent property

belonging to the PDQ Company. The approximate costs to repair the damage is
$45,000 and BFC’s insurance should reimbursement BFC for the costs except for
the deductible of $5,000.

Instructions:

1. For each of the above situations determine the amount that should be recorded as a
contingent liability, if any.
I5-4:

The XYZ Company entered into the following leasing arrangements, as the
lessee, during the current year:

A. XYZ leased a copy machine for 3 years. The fair market value of the
machine at the inception of the lease was $17,500 and XYZ agreed to
pay a quarterly lease payment of $1,475. At the end of the lease the
remaining life is estimated to be 2 years and XYZ has the option to
purchase the copy machine for its then estimated fair market value of
$5,000.

B. XYZ leased a mid-range computer for 4 years. The fair market value
of the computer at the inception of the lease was $139,000 and XYZ
agreed to pay a quarterly lease payment of $9,000. At the end of the
lease the remaining life is estimated to be 2 years. XYZ has no option
to purchase the computer at any time during the lease term.

C. XYZ leased a new car for 2 years for its president’s use. The fair
market value of the car at the inception of the lease was $65,000 and
XYZ agreed to pay a quarterly lease payment of $5,750. At the end of
the lease the remaining life is estimated to be 4 years. XYZ has no
option to purchase the car at any time during the lease term.

D. XYZ leased a delivery truck for 5 years. The fair market value of the
truck at the inception of the lease was $84,000 and XYZ agreed to pay
a quarterly lease payment of $4,500. At the end of the lease the fair
market value of the truck is estimated to be $24,000 and the truck’s
remaining economic life is estimated to be 2 years. XYZ has the
option to purchase the truck at the end of the lease for $10,000.

E. XYZ leased a collation machine for 6 years. The fair market value of
the machine at the inception of the lease was $142,000 and XYZ
agreed to pay a quarterly lease payment of $6,750. At the end of the
lease, the ownership of the machine transfers to XYZ.

F. XYZ leased a widget production machine for 7 years. The fair market
value of the machine at the inception of the lease was $246,000 and
XYZ agreed to pay a quarterly lease payment of $11,000. XYZ has no
option to purchase the machine at any time during the lease term.

XYZ current borrowing rate is 10%.

All lease payments are made in advance at the beginning of each quarter.

Instructions:

1) Determine if each lease is an operating or a capital lease.

2) For each capital lease, identify the factor or factors that qualify the lease
as a capital lease. Include the appropriate calculations to support your
conclusions.

A lease is a capital lease if it meets any one of the following four criteria –

a. There is a bargain purchase option at the end of the lease

b. The lease transfers ownership at the end of the lease

c. The lease term is greater or equal to 75% of the economic life of the asset

d. The present value of lease payments is greater or equal to 90% of fair value of the asset.

Applying these criteria to see if the lease is a capital lease or an operating lease.

A. XYZ leased a copy machine for 3 years. The fair market value of the machine at the inception of the
lease was $17,500 and XYZ agreed to pay a quarterly lease payment of $1,475. At the end of the lease
the remaining life is estimated to be 2 years and XYZ has the option to purchase the copy machine for its
then estimated fair market value of $5,000.

There is no bargain purchase option.

Lease life is 3/5 (at the end of lease there are still 2 years left and so asset life is 5 years)=
60% of asset life which is <75%

The PV of lease payments is 1,475 per quarter, quarter rate is 10%/4 = 2.5% and number
of quarters are 3X4 =12. This is annuity due since the payments are made at the beginning
of the quarter

PV annuity due = 1,475 X PVIFA (2.5%,12) = $15,508.46

This is 15,508.46/17,500 = 88.6% of fair value < 90%

Since no capital lease criteria are met, it is an operating lease

B. XYZ leased a mid-range computer for 4 years. The fair market value of the computer at the inception
of the lease was $139,000 and XYZ agreed to pay a quarterly lease payment of $9,000. At the end of the
lease the remaining life is estimated to be 2 years. XYZ has no option to purchase the computer at any
time during the lease term.

There is no bargain purchase option

The lease life is 4/(4+2) = 67% of asset life < 75%

The PV of lease payments is

PV annuity due = 9,000 X PVIFA (2.5%,16) = 120,432.4

The PV is 120,432.4/139,000 = 86.6% of fair value

Since no capital lease criteria are met, it is an operating lease

C. XYZ leased a new car for 2 years for its president’s use. The fair market value of the car at the
inception of the lease was $65,000 and XYZ agreed to pay a quarterly lease payment of $5,750. At the
end of the lease the remaining life is estimated to be 4 years. XYZ has no option to purchase the car at
any time during the lease term.

There is no bargain purchase option

The lease life is 2/(2+4) = 33% of asset life < 75%

The PV of lease payments is

PV annuity due = 5,750 X PVIFA (2.5%,8) = 42,259

The PV is 42,259/65,000 = 65% of fair value

Since no capital lease criteria are met, it is an operating lease

D. XYZ leased a delivery truck for 5 years. The fair market value of the truck at the inception of the lease
was $84,000 and XYZ agreed to pay a quarterly lease payment of $4,500. At the end of the lease the fair
market value of the truck is estimated to be $24,000 and the truck’s remaining economic life is estimated
to be 2 years. XYZ has the option to purchase the truck at the end of the lease for $10,000.

There is a bargain purchase option since the truck can be purchased for $10,000 against the
fair market value of $24,000 and so this is a capital lease

E. XYZ leased a collation machine for 6 years. The fair market value of the machine at the inception of
the lease was $142,000 and XYZ agreed to pay a quarterly lease payment of $6,750. At the end of the
lease, the ownership of the machine transfers to XYZ.

The lease transfer the ownership at the end of the lease and so it is a capital lease

F. XYZ leased a widget production machine for 7 years. The fair market value of the machine at the
inception of the lease was $246,000 and XYZ agreed to pay a quarterly lease payment of $11,000. XYZ
has no option to purchase the machine at any time during the lease term.

There is no bargain purchase option

The PV of lease payments is

PV annuity due = 11,000 X PVIFA (2.5%,28) = 225,104

The PV is 225,104/246,000 = 92% of fair value

This is a capital lease since the PV of lease payments exceed 90% of the fair market value

XYZ current borrowing rate is 10%.

All lease payments are made in advance at the beginning of each quarter.
Instructions:

1) Determine if each lease is an operating or a capital lease.

A lease will be a capital lease if it meets any one of the following four criteria –

a. There is a bargain purchase option at the end of the lease

b. The lease transfers ownership at the end of the lease

c. The lease term is greater or equal to 75% of the economic life of the asset

d. The present value of lease payments is greater or equal to 90% of fair value of the asset.

We apply these criteria to see if the lease is a capital lease or an operating lease.

2) For each capital lease, identify the factor or factors that qualify the lease as a capital lease. Include
the appropriate calculations to support your conclusions.