Harrison Fa Ifrs 11e Ch09 SM

Chapter 9
Liabilities
Short Exercises
(10 min.) S 9-1
Journal
DATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT
20X0
Sept. 30 Inventory…………………………………….. 4,000
Note Payable, Short-Term…………….. 4,000
Purchased inventory by issuing a note
payable
20X1
June 30 Interest Expense ($4,000 × .08 × 9/12)…. 240
Interest Payable………………………… 240
Accrued interest expense.
Sept. 30 Note Payable, Short-Term………………... 4,000

Interest Payable……………………………. 240
Interest Expense ($4,000 × .08 × 3/12)…. 80
Cash………………………………………. 4,320
Paid note payable and interest at
maturity.
605 Chapter 8 Liabilities

(5-10 min.) S 9-2
Req. 1
Balance Sheet
June 30, 20X1
ASSETS LIABILITIES
Current liabilities:
Note payable, short-term… $4,000
Interest payable
($4,000 × .08 × 9/12)….. 240
Income Statement
Year Ended June 30, 20X1
Revenues:
Expenses:
Interest expense ($4,000 × .08 × 9/12)…………….. $ 240
Req. 2
The 20X2 income statement will report:
Interest expense ($4,000 × .08 × 3/12)………. $80
606 Financial Accounting 9/e Solutions Manual

(10 min.) S 9-3
Req. 1
Journal
Cash ($485,000 × .30)…………………..….. 145,500

Notes Receivable ($485,000 − $145,500).. 339,500
Sales Revenue…………………………… 485,000
To record cash sales and sales on
account.
Warranty Expense ($485,000 × .06)……… 29,100
Provision for Warranty Repairs………. 29,100
To accrue warranty expense.
Provision for Warranty Repairs………..... 18,000

Cash…………………………………….…. 18,000
To pay warranty claims.
Req. 2
Provision for Warranty Repairs

Bal. 11,000
18,000 29,100
Bal. 22,100

(5-10 min.) S 9-4
Warranty expense = $29,100
The matching principle addresses this situation.
The warranty expense for the year does not necessarily equal
the year’s cash payments for warranties. Cash payments for
warranties do not determine the amount of warranty expense
for that year. Instead, the warranty expense is estimated and
matched against revenue during the period of the sale,
regardless of when the company pays for warranty claims.
Note that the relevance qualitative characteristic also applies. If

warranty costs are not expensed at the same period as revenue
generated, it reduces the predictive value of the financial
information produced.
Student responses may vary.

(5-10 min.) S 9-5
1. When it is probable that OC Petroleum Inc. will be liable to

pay for the damage caused by the rig incident, and the
damage can be estimated reliably, it will have to recognize a
provision instead of a contingent liability.
2. The company would have to recognize an expense in

accordance with the provision. This has the effect of
increasing the amount of liabilities on its balance sheet, and
decreasing the net income for the year.

(5-10 min.) S 9-6
a. $303,000 ($ 400,000 × .7575)
b. $411,000 ($ 400,000 × 1.0275)
c. $378,000 ($ 400,000 × .9450)
d. $418,000 ($ 400,000 × 1.0450)
(5 min.) S 9-7
a. Discount
b. Par (face) value
c. Discount
d. Premium

(5-10 min.) S 9-8
Journal
20X0
a. July 1 Cash…………………………………………… 70,000
Bond Payable…………………………….. 70,000
To issue bond payable at par.
b. Dec. 31 Interest Expense ($70,000 × .065 × 6/12) 2,275
Interest Payable………………………….. 2,275
To accrue interest expense.
20X1
c. Jan. 1 Interest Payable…………………………….. 2,275
Cash……………………………………….. 2,275
To pay semiannual interest on bond
payable.
20Z5
d. July 1 Bond Payable………………………………... 70,000
Interest Expense…………………………….. 2,275
Cash………………………………………... 72,275
To pay final interest payment and to
redeem bond at maturity.

(10-15 min.) S 9-9
(PV of $1 = $0.390; PV Annuity of $1 = $15.247)
1. Amortization table
A B C D E
Period Interest Interest Discount Discount Bond
Payment Expense Amortization Account Carrying
Balance Amount
(c% x
(i% x E) (B - A) (D-C) (Maturity - D)
Maturity)
0 0 13,730 46,271
1 1,500 1,851 351 13,379 46,621
2 1,500 1,865 365 13,014 46,986
3 1,500 1,879 379 12,634 47,366
2.
Journal
20X0
Mar. 31 Cash …………… 46,271
Discount on Bonds Payable…… 13,730
Bonds Payable………………… 60,000
Sept. 30 Interest Expense…………………. 1,851

Discount on Bonds Payable… 351
Cash…………………………….. 1,500

(10 min.) S 9-10
1. Borrowed $46,271
Pay back $60,000 at maturity
2. Pay cash interest of $1,500 each six months.
3. Interest expense:
Sept. 31, 20X0…………….. $1,851

Mar. 31, 20X1………………. $1,865
Interest expense increases because the bond carrying amount

increases as the bonds move toward maturity. An increasing
bond carrying amount produces an increasing amount of
interest expense each period.

(10 min.) S 9-11
Journal
20X0
a. July 1 Cash ($520,000 × 0.377 + 0.04 x 520,000 455,250
x 12.462)………………………
Discount on Bonds Payable……………... 64,750
Bonds Payable…………………………... 520,000
To issue bonds at a discount.
b. Dec. 31 Interest Expense ($455,250 x 0.10 x 6/12) 22,763
……………………………
Discount on Bonds Payable 1,963
Interest Payable ($520,000 × .08 × 6/12) 20,800
To accrue interest and amortize bonds.
20X1
c. Jan. 1 Interest Payable…………………………….. 20,800
Cash……………………………………….. 20,800
To pay semiannual interest.

(10 min.) S 9-12
Lease 1 – Operating Lease
Journal
20X0
a. Jan 1 -
b. Dec. 31 Interest Expense 15,000
Cash 15,000
To record first operating lease payment.
Lease 2 – Capital Lease

Journal
20X0
a. Jan 1 Lease Asset (15,000 x 4.329) 64,935
Lease Liability 64,935
To record Capital Lease.
b. Dec. 31 Lease Liability 11,753
Interest Expense (64,935 x 5%) 3,247
Cash 15,000
To record first capital lease payment.

(10-15 min.) S 9-13
Plan A Plan B
Borrow $3,500,000 Issue $3,500,000
at 8% of Common Shares
Net income before expansion……………….. $300,000 $300,000
Project income before interest
and income tax……………………………... $500,000 $500,000
Less interest expense ($3,500,000 × .08)….. (280,000 -0-
Project income before income tax………….. 220,000 500,000
Less incremental income tax expense (35%) (77,000 (175,000
Project net income…………………………….. 143,000 325,000
Total company net income…………………… $443,000 $625,000
Earnings per share including expansion:

Plan A ($443,000 / 100,000 shares)……… $4.43
Plan B ($625,000 / 200,000 shares)……… $3.13
Recommendation: To increase earnings per share,

Speedtown Marina should borrow the
money.

(5-10 min.) S 9-14
Times-interest- Operating income $5.2
= = = 3.3 times
earned ratio Interest expense $1.6
This means that for every dollar of interest expense, Kermit

Plumbing earned $3.30 of operating income.
Based on this ratio, the authors would be willing to lend $1

billion to Kermit Plumbing. In 20X0, Kermit Plumbing was able
to cover its existing interest expense 3.3 times with operating
income.
Students’ conclusions may vary.

(10 min.) S 9-15
LIABILITIES
Current:
Accounts payable……………………….. $ 35,000
Current portion of bonds payable……. 50,000
Interest payable………………………….. 2,000
Total current liabilities………………. $ 87,000
Non-current:
Notes payable, long-term………………. 320,000
Bonds payable…………………………… $402,000
Less: Discount on bonds payable……. (11,000 391,000
Total liabilities………………………………. $798,000

Exercises
Group A
(5-15 min.) E 9-16A
Errata: During 20X0, the business paid $5,000 to satisfy the
warranty claims, not $54,000. Please note we have used the
correct value for the computation of the solution and will
update the print book.
Req. 1
Journal
Warranty Expense (12,000 + 3,000 – 10,000

5,000)
Provision for Warranty Repairs….. 10,000
Provision for Warranty Repairs…..….. 5,000
Cash…………………………………… 5,000
Req. 2
INCOME STATEMENT
Warranty Expense……………………………… 10,000
BALANCE SHEET
Current liabilities
Provision for Warranty Repairs $12,000
Req. 3
Provision for Warranty Repair, a current liability, will cause a

company’s current ratio to decrease.

(10-15 min.) E 9-17A
Journal
20X0
Oct. 1 Cash…………………………………………. 1,620
Unearned Subscription Revenue……. 1,500
Sales Tax Payable ($1,500 × .08)…….. 120
Nov. 15 Sales Tax Payable………………………… 120
Cash………………………………………. 120
Dec. 31 Unearned Subscription Revenue………. 375
Subscription Revenue ($1,500 × 3/12) 375
BALANCE SHEET
Unearned subscription revenue ($1,500 − $375). $1,125

(10 min.) E 9-18A
INCOME STATEMENT
Expenses:
Payroll expense………………………………………. $220,000
Payroll tax expense ($220,000 × .08)…………… 17,600
BALANCE SHEET
Salary payable……………………………………… $ 8,200
Payroll tax payable…………………………………... 700

(5-10 min.) E 9-19A
Req. 1
Interest to
accrue at = $85,000 × .06 × 8/12 = $3,400
Dec. 31,
20X0
Req. 2
Final payment
= $85,000 + ($85,000 × .06) = $90,100
on May 1, 20X1
Req. 3
Interest expense for:

20X0 = $85,000 × .06 × 8/12 = $3,400
20X1 = $85,000 × .06 × 4/12 = $1,700

(10-15 min.) E 9-20A
Sandara’s balance sheet
at December 31, 20X1, reported:
Income tax payable…………………………………... $298,000*
Sandara’s 20X1 income statement reported:
Income tax expense ($1,300,000 × .36)…………… $468,000
_____
* Beginning income tax payable………………… $190,000
+ Income tax expense (and payable) for the year
($1,300,000 × .36)……………………………… 468,000
− Income tax payments during the year………… (360,000)
= Ending income tax payable……………………… $298,000

(10-20 min.) E 9-21A
Req. 1
Accounts payable are amounts owed to suppliers for products or

services that have been purchased on account.
Accrued expenses are expenses that the company has incurred but
not paid. They are liabilities for expenses such as interest and
income taxes.
Employee compensation and benefits are amounts owed to

employees for salaries and other payroll-related expenses.
Current portion of long-term debt is the portion of the long-term

debt that is due within next year.
Long-term debt is the amount of long-term notes and bonds

payable that the company expects to pay after the coming year.
Postretirement benefits are the company’s liabilities for providing

benefits — mainly health care — to retirees.
The other liabilities are a catch-all group of liabilities that do not fit
one of the more specific categories and are not significant enough
to have a category of their own. The other liabilities are long-term,
as shown by the fact that they are not listed among the current
liabilities.

(continued) E 9-21A
Req. 2
Total assets = $3,995 million, the sum of total liabilities and

shareholders’ equity
Total liabilities ($3,995 million − $2,027 million)*

Debt ratio = = 0.49
Total assets ($3,995 million)
A debt ratio of 49% is satisfactory.

____
*Or, $340 + $1,494 + $122 + $12 = $1,968

(5-10 min.) E 9-22A
Req. 1
Rupert Security Systems should report this situation in a note

to the financial statements. The note should convey essentially
the same message given in Note 14.
Req. 2
Rupert would report:
INCOME STATEMENT
Estimated loss (or expense)……………… $1,800,000
BALANCE SHEET
Estimated liability…………………………… $1,800,000
Note 14 -
Same as above.
Journal
20X0
Estimated Loss (or Expense)…... 1,800,000
Estimated Liability……………. 1,800,000

(15-20 min.) E 9-23A
Boni Electronics
Balance Sheet (partial)
June 30, 20X0
a. Estimated warranty payable
[$35,000 + $168,000 − $52,000]……… $151,000
b. Current portion of long-term note payable……... 14,000
Interest payable ($56,000 × .06 × 1/12)…………… 280
c. Unearned sales revenue ($135,000 − $75,000)…. 60,000
d. Employee withheld income tax payable………… 33,000
FICA tax payable ($270,000 × .0765)……………… 20,655
Total current liabilities………………………….. $278,935
Non-current liabilities:
Note payable ($56,000 − $14,000)……………... $42,000

(10-15 min.) E 9-24A
(PV of $1 = 0.610; PV Annuity of $1 = 15.589)
A B C D E
Perio
Interest Interest Premium Premium Bond
d
Balance Amount
(c% x
(i% x E) (A - B) (D-C) (Maturity + D)
Maturity)
0 0 1,165,050 16,165,050
1 450,000 404,126 45,874 1,119,176 16,119,176
2 450,000 402,979 47,021 1,072,155 16,072,155
3 450,000 401,804 48,196 1,023,959 16,023,959
4 450,000 400,599 49,401 974,558 15,974,558
Req 1, 2, and 3
Journal
20X0
Jan. 31 Cash …………… 16,165,050
Premium on Bonds Payable 1,165,050
Bonds Payable…………… 15,000,000
July. 31 Interest Expense…………………. 404,126

Premium on Bonds Payable… 45,874
Cash…………………………….. 450,000
Dec. 31 Interest Expense…………………. 335,816*

Premium on Bonds Payable….. 39,184
Interest Payable…………….. 375,000*
*5/6 x 402,979 = 335,816

** 5/6 x 40,659 = 39,184

***5/6 x 0.03 x 15,000,000 = 375,000

(10-15 min.) E 9-25A
1. Cash received = $600,000 × 1.03 = $618,000
2. Principal……………………………………………………… $600,000
Interest ($600,000 × .07 × 20)…………………….............. 840,000
Total cash paid……………………………………………… $1,440,000
3. Total cash paid……………………………………………… $1,440,000

Less: Cash received……………………………………... (618,000
Difference = Total interest expense……………………... $822,000
4. If straight-line amortization is used, the interest rate will be equal for

each period and a multiplication of the interest expense by 20 will equal
to the amount calculated in requirement 3.
Interest expense (822,000 / 20) = $ 41,100

(15-20 min.) E 9-26A
Req. 1 (amortization table)
A B C D E
INTEREST
EXPENSE
INTEREST (6% OF DISCOUNT
PAYMENT PRECEDING ACCOUNT BOND
SEMIANNUAL (5% OF BOND DISCOUNT BALANCE CARRYING
INTEREST MATURITY CARRYING AMORTIZATION (PRECEDING AMOUNT
DATE VALUE) AMOUNT) (B – A) D – C) ($2,500,000 – D)
Dec. 31, 20X0 $286,250 $2,213,750
June 30, 20X1 $125,000 $132,825 $ 7,825 278,425 2,221,575
Dec. 31, 20X1 125,000 133,295 8,295 270,130 2,229,870
June 30, 20X2 125,000 133,792 8,792 261,338 2,238,662
Dec. 31, 20X2 125,000 134,320 9,320 252,018 2,247,982

(continued) E 9-26A
Req. 2
Journal
DATE ACCOUNT TITLES AND DEBIT CREDIT
EXPLANATION
20X0
Dec. 31 Cash……………………………….. 2,213,750
Discount on Bonds Payable…… 286,250
Bonds Payable……………….. 2,500,000
20X1
June 30 Interest Expense 132,825
Cash 125,000
To pay semiannual interest and
amortize discount on bond payable.
20X1
Dec. 31 Interest Expense 133,295
Cash 125,000
amortize bonds.

(15-20 min.) E 9-27A
A B C D E
Period Interest Interest Premium Premium Bond
Amortizatio
Payment Expense Account Carrying
n
Balance Amount
(c% x
Maturity)
0 0 147,921 997,921
1 21,250 19,958 1,292 146,629 996,629
2 21,250 19,933 1,317 145,312 995,312
3 21,250 19,906 1,344 143,968 993,968
4 21,250 19,879 1,371 142,597 992,597
Journal
20X0
Jun. 30 Cash …………… 997,921
Premium on Bonds Payable 147,921
Bonds Payable…………… 850,000
Dec. 31 Interest Expense…………. 19,958

Cash……………………………. 21,250
20X1
Jun. 30 Interest Expense…………. 19,933

21,250
Cash……………………………..

(15-20 min.) E 9-28A
A B C D E F
Bond
Interest Interest Discount Discount Carrying
Date Payment Expense Amortization Balance Amount
Jan. 1, 20X0 $13,464 $96,536

Dec. 31, 20X0 $8,800 $9,654 $ 854 12,610 97,390
Dec. 31, 20X1 8,800 9,739 939 11,671 98,329
Dec. 31, 20X2 8,800 9,833 1,033 10,638 99,362
Dec. 31, 20X3 8,800 9,936 1,136 9,502 100,498
Dec. 31, 20X4 8,800 10,050 1,250 8,252 101,748
Dec. 31, 20X5 8,800 10,175 1,375 6,877 103,123
Dec. 31, 20X6 8,800 10,312 1,512 5,365 104,635
Dec. 31, 20X7 8,800 10,464 1,664 3,701 106,299
Dec. 31, 20X8 8,800 10,630 1,830 1,871 108,129
Dec. 31, 20X9 8,800 10,671 1,871 0 110,000
Note: Computer-generated solutions may contain slight

rounding differences.

(15-20 min.) E 9-29A
Req. 1
Period Begin LL Payment Interest Principal End LL

A B C D E
(0.1*A) (B-C) (A-D)
1 79,250* 25,000 7,925 17,075 62,175
2 62,175 25,000 6,218 18,782 43,393
3 43,393 25,000 4,339 20,661 22,732
4 22,732 25,000 2,268** 22,732 0
25,000 x 3.170 = 79,250

** Slight rounding difference
Journal
Dec. 31 Lease Liability………………………. 17,075

Interest Expense............................... 7,925
Cash 25,000
Req. 2
Journal
Dec. 31 Lease Expense……………………. 25,000

Cash 25,000
Req 3
An Operating Lease is treated like rental agreements between the
lessor and lesse, while a Capital Lease is treated like a sale.
Therefore, the treatment for both types of leases is different.

(20-25 min.) E 9-30A
Amounts in millions or billions
Company Company Company
Ratio A N S
Current Total current assets $430 ¥5,943 €170,150
= =
ratio Total current liabilities $196 ¥2,198 € 72,420
= 2.19 = 2.70 = 2.35
A N S
Debt Total liabilities $196 + $139 ¥2,198 + ¥2,350 €72,420 + €110,757
= =
ratio Total assets $430 + $138 ¥5,943 + ¥48 €170,150 + €45,324
= 0.59 = 0.76 = 0.85
A N S
Times-
interest- Operating income $291 ¥222 €5,581
= =
earned Interest expense $42 ¥31 €671
ratio
= 6.92 times = 7.16 times = 8.32 times
Based on these ratio values, Company N looks the least risky.
*N has the best current ratio and middle of the range debt and times
interest earned ratios; whereas both A and S have at least one ratio
where they are the worst of the pack.
(15-20 min.) E 9-31A

Req. 1
PLAN B
PLAN A ISSUE
BORROW $900,000
$900,000 OF COMMON
AT 10% SHARES
Net income before expansion…………………….. $600,000 $600,000
Project income before interest and income tax.. $800,000 $800,000
Less interest expense ($900,000 × .10)…………. 90,000 -0-
Project income before income tax………………. 710,000 800,000
Less income tax expense (25%)…………………. 177,500 200,000
Project net income………………………………….. 532,500 600,000
Total company net income……………………. $1,132,500 $1,200,000
Earnings per share including new project:
Plan A ($1,132,500 / 200,000 shares)………. $5.66
Plan B ($1,200,000 / 425,000 shares)………… $2.82

(continued) E 9-31A
Req. 2
MEMORANDUM
TO: Board of Directors of First Bank Financial Services
FROM: [Student Name]
SUBJECT: Financing plan to expand operations
Plan A (borrowing) results in much higher earnings per share.

Plan A also allows the existing shareholders to retain control of
the company because the company issues no new shares. But
Plan A also creates more financial risk because borrowing
obligates the company to pay the interest and the principal of
the debt. On balance, I prefer Plan A, assuming the company’s
level of debt is not already too high.
Students can defend either plan based on their preferences for

control of the business, avoidance of risk, and higher earnings
per share.

Exercises
Group B
(5-15 min.) E 9-32B
Req. 1
Journal
Warranty Expense ….. 13,000

Provision for Warranty Repairs….. 13,000
Provision for Warranty Repairs…..….. 5,000
Cash…………………………………… 5,000
Req. 2
INCOME STATEMENT
Warranty expense………………………………… 13,000
BALANCE SHEET
Current liabilities
Provision for Warranty Repairs………….… 12,000
Req. 3
Provision for Warranty Repairs, a current liability, will cause a

company’s current ratio to decrease.

(10-15 min.) E 9-33B
Journal
20X0
Oct. 1 Cash…………………………………………. 1,526
Unearned Subscription Revenue……. 1,400
Sales Tax Payable (1,400 × .09)…….. 126
Nov. 15 Sales Tax Payable………………………… 126
Cash………………………………………. 126
31 Unearned Subscription Revenue………. 350
Subscription Revenue (1,400 × 3/12) 350
BALANCE SHEET
Unearned subscription revenue (1,400 − 350)…… 1,050

(10 min.) E 9-34B
INCOME STATEMENT
Expenses:
Payroll expense………………………………………. 180,000
Payroll tax expense (180,000 × .09)……………… 16,200
BALANCE SHEET
Salary 7,800
payable…………………………………………
Payroll tax payable…………………………………... 750

(5-10 min.) E 9-35B
Req. 1
Interest to
accrue at = 80,000 × .05 × 10/12 = 3,333
Dec. 31, 20X0
Req. 2
Final payment
= 80,000 + (80,000 × .05) = 84,000
on March 1, 20X1
Req. 3

20X0 = 80,000 × .05 × 10/12 = 3,333
20X1 = 80,000 × .05 × 2/12 = 667

(10-15 min.) E 9-36B
Sybil’s balance sheet
at December 31, 20X1, reported:
Income tax payable…………………………………... 250,000*
Sybil’s 20X0 income statement reported:
Income tax expense (1,600,000 × .25)…………… 400,000
_____
* Beginning income tax payable………………… 160,000
+ Income tax expense (and payable) for the year
(1,600,000 × .25)……………………………… 400,000
− Income tax payments during the year………… (310,000)
= Ending income tax payable……………………… €250,000

(10-20 min.) E 9-37B
Req. 1
Accounts payable are amounts owed to suppliers for products or

services that have been purchased on account.
Accrued expenses are expenses that the company has incurred but
not paid. They are liabilities for expenses such as interest and
income taxes.
Employee compensation and benefits are amounts owed to

employees for salaries and other payroll-related expenses.
Current portion of long-term debt is the portion of the long-term

debt that is due within next year.
Long-term debt is the amount of long-term notes and bonds

payable that the company expects to pay after the coming year.
Postretirement benefits are the company’s liabilities for providing

benefits — mainly health care — to retirees.
The other liabilities are a catch-all group of liabilities that do not fit
one of the more specific categories and are not significant enough
to have a category of their own. The other liabilities are long-term,
as shown by the fact that they are not listed among the current
liabilities.

(continued) E 9-37B
Req. 2
Total assets = €3,998 million, the sum of total liabilities and

shareholders’ equity
Total liabilities (€3,998 million − 2,030 Million)*

Debt ratio = = 0.49
Total assets (€3,998 million)
A debt ratio of 49% is satisfactory

____
*Or, €340 + 1,488 + 129 + 11 = 1,968

(5-10 min.) E 9-38B
Req. 1
Edward Security Systems should report this situation in a note

to the financial statements. The note should convey essentially
the same message given in Note 14.
Req. 2
Edward would report:
INCOME STATEMENT
Estimated loss (or expense)……………… €2,300,000
BALANCE SHEET
Estimated liability…………………………… €2,300,000
Note 14 -
Same as above.
Journal
20X0
Estimated Loss (or Expense)…... 2,300,000
Estimated Liability……………. 2,300,000

(15-20 min.) E 9-39B
Hi-Tech Electronics
Balance Sheet (partial)
September 30, 20X0
a. Estimated warranty payable
[34,000 + 112,500 − 57,000]……… 89,500
b. Current portion of long-term note payable……... 11,000
Interest payable (44,000 × .04 × 1/12)…………… 147
c. Unearned sales revenue (100,000 − 85,000)…. 15,000
d. Employee withheld income tax payable………… 30,000
FICA tax payable (250,000 × .0765)……………… 19,125
Total current liabilities………………………….. 164,772
Note payable (44,000 − 11,000)……………... 33,000

(10-15 min.) E 9-40B
A B C D E
Balance Amount
(c% x
Maturity)
0 0 513,000 11,487,000
1 300,000 344,610 44,610 468,390 11,531,610
2 300,000 345,948 45,948 422,442 11,577,558
3 300,000 347,327 47,327 375,115 11,624,885
4 300,000 348,747 48,747 326,368 11,673,632
Req. 1
Journal
a. Jan. 31 Cash …………… 11,487,000

Discount on Bonds Payable………… 513,000
Bonds Payable…………………… 12,000,000
b. July 31 Interest Expense 344,610

Cash ($11,000,000 × .05 × 6/12) 300,000
To pay interest and amortize discount
on bond payable.
c. Dec 31 Interest Expense 287,175*

Interest Payable…………………....... 250,000**
Discount on Bonds Payable
37,175***
To accrue interest and amortize
bonds.
*344,610 x 5/6 = 287,175

**300,000 x 5/6 = 250,000
***287,175 – 250,000 = 37,175

(10-15 min.) E 9-41B
1. Cash received = 400,000 × 1.04 = €416,000
2. Principal……………………………………………………… 400,000
Interest (400,000 × .09 × 20)…………………….............. 720,000
Total cash paid……………………………………………… €1,120,000
3. Total cash paid……………………………………………… €1,120,000

Less: Cash received……………………………………... (416,000
Difference = Total interest expense……………………... $704,000
4. Market interest rate = 8.58%

20X0 = 416,000 × .0858 = 35,672
20X1 = 415,672 × .0858 = 35,644
*Note: Market interest rate needs to be computed to attempt this

question. Interest expense will gradually decrease over the life of the
bond. The sum of the total interest expense will equal to the amount
calculated in requirement 3.
If straight-line amortization is used, the interest rate will be equal for

each period and a multiplication of the interest expense by 20 will
equal to the amount calculated in requirement 3.

(15-20 min.) E 9-42B
A B C D E
Amortizatio
n
Balance Amount
(c% x
Maturity)
0 0 52,256 787,744
1 37,800 39,387 1,587 50,669 789,331
2 37,800 39,467 1,667 49,002 790,998
3 37,800 39,550 1,750 47,252 792,748
4 37,800 39,637 1,837 45,415 794,585

(continued) E 9-42B
Req. 2
Journal
20X0
Dec. 31 Cash 787,744
Bonds Payable 840,000
20X1
June 30 Interest Expense 39,387
Cash 37,800
amortize discount on bond payable.
20X1
Cash 37,800
amortize bonds.

(15-20 min.) E 9-43B
A B C D E
Period Interest Interest Premium Discount Bond
Balance Amount
(c% x (i% x E) (A - B) (D-C) (Maturity +
Maturity) D)
0 0 222,360 3,622,360
1 170,000 163,006 6,994 215,366 3,615,366
2 170,000 162,691 7,309 208,057 3,608,057
3 170,000 162,363 7,637 200,420 3,600,420
4 170,000 162,019 7,981 192,439 3,592,439

(continued) E 9-43B
Req. 2 (journal entries)
Journal
DATE ACCOUNT TITLES AND DEBIT CREDIT
EXPLANATION
20X0
June 30 Cash ……….. 3,622,360
Bonds Payable………………… 3,400,000
To issue bonds at a premium.
Dec. 31 Interest Expense……………………. 163,006

Premium on Bonds Payable……… 6,994
Cash ………………………………. 170,000
To pay semiannual interest and amortize bond
premium.
20X1
June 30 Interest Expense……………………. 162,691
Premium on Bonds Payable.……... 7,309
Cash……………………………….. 170,000
To pay semiannual interest and amortize bonds.

(15-20 min.) E 9-44B
A B C D E F
Bond
Interest Interest Discount Discount Carrying
Date Payment Expense Amortization Balance Amount
Jan. 1, 20X0 42,375 707,625

Dec. 31, 20X0 82,500 84,915 2,415 39,960 710,040
Dec. 31, 20X1 82,500 85,205 2,705 37,255 712,745
Dec. 31, 20X2 82,500 85,529 3,029 34,226 715,774
Dec. 31, 20X3 82,500 85,893 3,393 30,833 719,167
Dec. 31, 20X4 82,500 86,300 3,800 27,033 722,967
Dec. 31, 20X5 82,500 86,756 4,256 22,777 727,223
Dec. 31, 20X6 82,500 87,267 4,767 18,010 731,990
Dec. 31, 20X7 82,500 87,839 5,339 12,671 737,329
Dec. 31, 20X8 82,500 88,479 5,979 6,692 743,308
Dec. 31, 20X9 82,500 89,192 6,692 0 750,000
*Note: Computer-generated solutions may contain slight

rounding differences.

(15-20 min.) E 9-45B
Req. 1
Period Begin LL Payment Interest Principal End LL

A B C D E
(0.08*A) (B-C) (A-D)
1 59,616* 18,000 4,796 13,231 46,385
2 46,385 18,000 3,711 14,289 32,096
3 32,096 18,000 2,568 15,432 16,664
4 16,664 18,000 1,336** 16,664 0
18,000 x 3.312 = 59,616

** Slight rounding difference
Journal
Dec. 31 Lease Liability………………………. 13,231

Interest Expense............................... 4,769
Cash 18,000
Req. 2
Journal
Dec. 31 Lease Expense……………………. 18,000

Cash 18,000
Req 3
An Operating Lease is treated like rental agreements between the
lessor and lesse, while a Capital Lease is treated like a sale.
Therefore, the treatment for both types of leases is different.
(20-25 min.) E 9-46B

Amounts in millions or billions
Company Company Company
Ratio F L V
Current Total current assets $435 ¥5,422 €147,398
= =
ratio Total current liabilities $227 ¥2,248 €72,620
= 1.92 = 2.41 = 2.03
F L V
Debt Total liabilities $227 + $109 ¥2,248 + ¥2,320 €72,620 + €110,927
= =
ratio Total assets $435 + $135 ¥5,422 + ¥740 €147,398 + €61,173
= 0.59 = 0.74 = 0.88
F L V
Times-
interest- Operating income $294 ¥229 €5,627
= =
earned Interest expense $43 ¥29 €687
ratio
= 6.84 times = 7.90 times = 8.19 times
Based on these ratio values, Company L looks the least risky.
*L has the best current ratio and middle of the range debt and times
interest earned ratios; whereas both F and V have at least one ratio
where they are the worst of the three.

(15-20 min.) E 9-47B
Req. 1
PLAN B
PLAN A ISSUE
BORROW €650,000
€650,000 OF COMMON
AT 5% SHARES
Net income before expansion…………………….. €400,000 €400,000
Project income before interest and income tax.. 550,000 550,000
Less interest expense (650,000 × .05)…………. 32,500 -0-
Project income before income tax………………. 517,500 550,000
Less income tax expense (40%)…………………. 207,000 220,000
Project net income………………………………….. 310,500 330,000
Total company net income……………………. 710,500 730,000
Earnings per share including new project:
Plan A (710,500 / 100,000 shares)…………... 7.11
Plan B (730,000 / 200,000 shares)…………... 3.65

(continued) E 9-47B
Req. 2
MEMORANDUM
TO: Board of Directors of First Federal Financial

Services
SUBJECT: Financing plan to expand operations
Plan A (borrowing) results in much higher earnings per share.

Plan A also allows the existing shareholders to retain control of
the company because the company issues no new shares. But
Plan A also creates more financial risk because borrowing
obligates the company to pay the interest and the principal of
the debt. On balance, I prefer Plan A, assuming the company’s
level of debt is not already too high.
Students can defend either plan based on their preferences for

control of the business, avoidance of risk, and higher earnings
per share.

Challenge Exercises
(10-15 min.) E 9-48
Total current assets $324,700

Current ratio = = = 1.68
Total current liabilities $193,400
Pratt Marketing Services should pay off $88,360* of current

liabilities. Then the current ratio will be:
$324,700 − $105,867 $218,833

= 2.5
$193,400 − $105,867 $87,533 =
_____
*Computation:
Let X = amount of current liabilities to pay in order to achieve

a current ratio of 2.5.
$324,700 − X
= 2.5
$193,400 − X
$324,700 − X = 2.5 ($193,400 − X)
−X = $483,500 − 2.5X −
$324,700
1.5X = $158,800
X = $105,867

(20-25 min.) E 9-49
Req. 1
Millions
Bonds Payable, 5 3/4%…………………………… 150
Bonds Payable, 11%……………………….. 85
Cash…………………………………………... 10
Gain on Retirement of Bonds Payable….. 55
Req. 2 (Dollar amounts in millions)
Old Bonds New Bonds
$150 × .0575 $85 × .11

Annual interest expense…..
= $8.63 = $9.35
Req. 3
Possible reasons for the debt refinancing:

1. To decrease annual interest expense: No, because annual
interest expense on the old bonds is a less ($720,000) than
interest expense on the new bonds.
2. To increase net income: Yes, because the gain on
retirement of bonds payable added $55 million to net
income (less the $720,000 incremental interest expense).
3. To decrease the debt ratio: Yes, as follows:
(Dollar amounts in millions) Before Refinancing After Refinancing
Debt Total liabilities $357 $357 − $150 + $85

= =
ratio Total assets $497 $497 − $10
= 0.72 = 0.60

(20-30 min.) E 9-50
Req. 1
20X0
Mar. 15 Cash ($800,000 × .945)……………… 756,000
Discount on Bonds Payable……….. 44,000
Bonds Payable……………………. 800,000
Holiday Corporation issued the bonds payable to bondholders
in order to borrow $756,000 ($800,000 × 0.945) from the
bondholders. Holiday Corporation received the cash that the
bondholders paid.
Req. 2
$48,000 ($800,000 × 0.12 × 6/12)

(continued) E 9-50
Req. 3
Initial carrying amount of notes ($800,000 × $756,000

0.945)
x Semiannual market interest rate 6.5%
Semiannual interest expense $49,140
*Note: Market interest rate needs to be computed to attempt

this question.
Req. 4
Effective-interest amortization method (amounts in thousands):
A B C D E
BOND
INTEREST INTEREST DISCOUNT CARRYING
PAYMENT EXPENSE BALANCE AMOUNT
SEMIANNUAL ($700,000
(0.06 × (0.065 × DISCOUNT
INTEREST − D)
$700,000) E) AMORTIZATION D − C)
DATE
Mar. 15, 20X0 $44,000 $756,000
Sept. 15 $48,000 $49,140 $1,140 42,860 757,140
Mar. 15, 20X1 48,000 49,214 1,214 41,646 758,354
Sept. 15 48,000 49,293 1,293 40,353 759,647
Mar. 15, 20X2 48,000 49,377 1,377 38,976 761,024
Interest exp. for yr. 1: $98,354 ($49,140 + $49,214)

yr. 2: $98,670 ($49,293 + $49,377)
Interest expense is greater in the second year because the

bond carrying amount increases as the bonds are amortized
toward their maturity value.

Quiz
Q9-51 d
Q9-52 d
Q9-53 d
Q9-54 a
Q9-55 d
Q9-56 c [($450,000 + $750,000) × .06] − $3,150 − $30,000
= $38,850
Q9-57 a
Q9-58 b
Q9-59 e
Q9-60 c
Q9-61 b
Q9-62 e Under effective interest amortization method, the
interest expense is different every year
Q9-63 Interest Expense (192,000 x 0.125 x

9/12)………………………. 18,000
Interest Payable ($200,000 × .12 × 9/12) 18,000
*Note: Implied market interest rate for a price of 96 is
12.73%. Using a market rate of 12.5% will yield an
interest expense similar to cash interest payable, which
result in zero amortization.
Q9-64 Interest Payable………………………........ 18,000
Interest Expense…………………………… 6,000
Cash ($200,000 × .12)…………………... 24,000
Q9-65 e [($275,695 x .07) = $19,299]

Q9-66 a
Q9-67 b
Q9-68 a
Q9-69 c

Problems
Group A
(15-20 min.) P 9-70A

a. Sales tax payable ($140,000 × .05)............................. $7,000
b. Note payable, short-term............................................ $85,000
Interest payable ($87,000 × .04 × 4/12)...................... 1,160
c. Unearned service revenue ($2,700 × 4/6).................. $1,800
d. Estimated warranty payable
($11,800 + $34,400 − $34,800) $11,400
e. Portion of long-term note payable due
within one year....................................................... $30,000
Interest payable ($60,000 × .12)................................. 7,200

(30-40 min.) P 9-71A
Journal
20X0
Mar. 3 Inventory 72,000
Note Payable, Short-term 72,000
May 31 Cash 75,000
Note Payable, Short-term 15,000
Note Payable, Long-term 60,000
Sept. 3 Note Payable, Short-term 72,000
Interest Expense ($72,000 × .04 × 6/12) 1,440
Cash 73,440
Dec. 31 Warranty Expense ($192,000 × .03) 5,760
Provision for Warranty Repairs 5,760
31 Interest Expense ($75,000 × .05 × 7/12) 2,188*
Interest Payable 2,188
20X1
May 31 Note Payable, Short-term 15,000
Interest Expense ($75,000 × .05 × 5/12)….. 1,562*
Cash 18,750
*Rounded off to the nearest whole number.

(20-25 min.) P 9-72A
Req. 1
Journal
20X0
a. May 31 Cash ($8,000,000 × 1/2)…………... 4,000,000
Bonds Payable…………………. 4,000,000
To issue bonds at par.
b. Nov. 30 Interest Expense…………………... 200,000
Cash ($4,000,000 × .10 × 6/12). 200,000
To pay interest on bonds.
c. Dec. 31 Interest Expense
($4,000,000 × .10 × 1/12)………….. 33,333*
Interest Payable………………... 33,333
To accrue interest.
20X1
d. May 31 Interest Payable…………………… 33,333
Interest Expense
($4,000,000 × .10 × 5/12)………….. 166,667*
Cash ($4,000,000 × .10 × 6/12). 200,000
*Rounded off to the nearest whole number.

(continued) P 9-72A
Req. 2 (reporting the liabilities on the balance sheet at
December 31, 20X0)
Interest payable $ 33,333
Bonds payable $4,000,000
(30-40 min.) P 9-73A

Req. 1
The 8% bonds issued when the market interest rate is 7% will

be priced at a premium. They are relatively attractive in this
market, so investors will pay a price above par value to acquire
them.
Req. 2
The 8% bonds issued when the market interest rate is 9% will

be priced at a discount. They are relatively unattractive in this
market, so investors will pay less than par value to acquire
them.

(continued) P 9-73A
Req. 3
A B C D E
Amortizatio
n
Balance Amount
(c% x
Maturity)
0 0 57,184 857,184
1 32,000 30,001 1,999 55,185 855,185
2 32,000 29,931 2,069 53,116 853,116
3 32,000 29,859 2,141 50,975 850,975
4 32,000 29,784 2,216 48,759 848,759
Journal
20X0
a. Feb. 28 Cash 857,184
Bonds Payable 800,000
b. Aug. 31 Interest Expense 30,001

Cash 32,000
To pay interest and amortize bonds.
c. Dec. 31 Interest Expense……………………….. 19,954

Interest Payable………….……….. 21,333

20X1
d. Feb. 28 Interest Payable (from Dec. 31)………. 21,333
Interest Expense 9,977
Premium on Bond Discount 690
Cash 32,000

(continued) P 9-73A
December 31, 20X0)
Interest payable………………………… $ 21,333
Bonds payable…………………………. $800,000
Add: Premium on bonds payable….. 53,806*
853,806
*57,184 – 1,999 – 1,379 = 53,806

(30-40 min.) P 9-74A
A B C D E
Amortizatio
n
Balance Amount
(c% x
Maturity)
0 0 405,300 6,405,300
1 270,000 256,212 13,788 391,512 6,391,512
2 270,000 255,660 14,340 377,172 6,377,172
3 270,000 255,087 14,913 362,259 6,362,259
4 270,000 254,490 15,510 346,749 6,346,749
Req. 1
Journal
20X0
Jan. 1 Cash 6,405,300
Premium on Bond Payable 405,300
Bonds Payable……………………. 6,000,000
July 1 Interest Expense 256,212

Cash 270,000
Dec 31 Interest Expense 255,660
20X1
Jan. 1 Interest Payable 270,000
Cash 270,000
To pay interest.
2020
Jan. 1 Bonds Payable 6,000,000
Cash 6,000,000
To pay bonds at maturity.

(continued) P 9-74A
Req. 2
Carrying amount at December 31, 20X0 = 6,377,172
Req. 3
a. Interest expense = $256,212
b. Cash interest paid = $270,000
The interest expense is lower than the cash interest paid

because the bond was issued at a premium and the company
must pay back the full face value of the bonds at maturity.
Amortization of the bond premium over the life of the bond
causes the amount of cash interest paid to exceed the interest
expense on the bonds.

(30-45 min.) P 9-75A
Req. 1
a. Maturity value is $3,500,000
b. Annual cash interest payment is $245,000

($3,500,000 × .07)
c. Carrying amount is $3,337,635

A B C D E
INTEREST
EXPENSE
ANNUAL (7% OF DISCOUNT CARRYING
BOND BALANCE
DATE VALUE) (B – A) ($3,500,000–D)
AMOUNT) D – C)
Dec. 31, Yr. 1 $162,365 $3,337,635
Dec. 31, Yr. 2 $245,000 $267,011 $22,011 140,354 3,359,646
Dec. 31, Yr. 3 $245,000 268,772 23,772 116,582 2,283,418
Dec. 31, Yr. 4 $245,000 270,673 25,673 90,909 3,409,091
Dec. 31, Yr. 5 $245,000 272,727 27,727 63,182 3,436,818
Interest expense for the year ended December 31, Year 4, is

$270,673.

(continued) P 9-75A
Req. 3 (reporting the liabilities at December 31, Year 4)
Current installment of notes payable…….. $ 55,000
Bonds payable………………………………... $3,500,000
Less: Discount on bonds payable………. ( 90,909) 3,409,091
Notes payable………………………………… 275,000

(40-50 min.) P 9-76A
Req. 1
IAS 17 states that if the terms of the lease meet any of the following
conditions, it will be recognized as a capital lease*:
1. The lease transforms substantially all risks and rewards of the

asset to the lessee.
2. The lease transfers ownership of the asset to the lessee at the

end of the lease.
3. The lease term represents a substantial part of the asset’s useful

life.
4. The present value of the lease payments represents a substantial

part of the fair value of the asset.
Based on the lease terms, fair value for the lease is 55,000 x 3.170
= 174,350. Since this is very close to the fair market value of the
asset at $180,000, this will be classified as a finance lease.
*Note that the U.S. GAAP recognizes a different set of criteria from
IAS 17 when it comes to classifying the lease. For instance, under
the U.S. GAAP, if the term of the lease exceeds 75% of the asset’s
useful life, and the present value of the lease payments exceeds
90% of the asset’s fair value, it will be classified as a capital lease.
Req 2
Journal
Dec. 31 Lease Asset………………………. 174,350

20X0 Lease Liability............................. 174,350
To record capital lease.
Dec. 31 Lease Expense…………………… 17,435

20X1 Lease Liability……………………. 37,565
Cash………………………... 55,000

(20-30 min.) P 9-77A
Req. 1
TO: Management of Viola Sporting Goods
SUBJECT: Advantages and disadvantages of borrowing

versus issuing shares to raise cash for
expansion
Raising money by borrowing has at least two advantages over

issuing common shares. Borrowing does not change the
present ownership of the business. It enables the present
owners to keep their proportionate interests in the business
and to carry out their plans without interference from a new
group of shareholders. Under normal conditions, borrowing
results in a higher earnings per share of common shares
because the interest expense on the debt is tax-deductible. And
higher earnings per share usually lead to higher share prices
for company owners.
The main disadvantage of borrowing is that the debt increases

the financial risk of the company. The principal and the related
interest expense must be paid whether the company is earning
a profit or not. If times get sufficiently bad, the debt burden
could threaten the ability of the business to continue as a going
concern.
(continued) P 9-77A
The main advantage of issuing shares is that owners avoid the
burden of making interest and principal payments on the debt.
Issuing shares creates no liability to pay anything to the
owners. If the directors consider it necessary, they can refuse
to pay dividends in order to conserve cash. Therefore, it is
safer to issue shares.
One disadvantage of issuing shares is dilution of the

ownership interests of existing shareholders if the purchasers
of new shares are outsiders. The new shareholders may have
different ideas about how to manage the business and that may
pose difficulties for the original shareholder group. Another
disadvantage of issuing shares is that earnings per share are
usually lower because of (1) the greater number of shares of
shares outstanding, and (2) the non-tax-deductibility of
dividends paid on the shares.
There is insufficient information available upon which to make

a decision. Viola Sporting Goods’ management must prepare
budgets which indicate the impact of the new stores in terms of
net income and cash flow. Management must also estimate the
cost of borrowing the funds.

(20-30 min.) P 9-78A
Req. 1
Quinzel Foods, Inc.

Partial Balance Sheet
December 31, 20X0
PPE: Current liabilities:
Equipment $745,000 Mortgage note
Accumulated payable, current $ 94,000
depreciation (164,000) Bonds payable,
current portion 400,000
Interest payable 72,000*
Total current liabilities $566,000
Mortgage note payable
Long-term… $ 319,000
Bonds payable. $1,200,000
Discount on bonds
payable……. (27,000)* 1,173,000
Net Pension liability 60,000**
Total non-current liabilities $1,552,000
Notes:
* The order of listing current liabilities and non-current liabilities is optional.
However, Discount on Bonds Payable should come immediately after Bonds
Payable. Also, it is customary to report Interest Payable after the related
liability accounts, Mortgage Note Payable and Bonds Payable, Current
Portion.
** Computation of pension liability:

Accumulated pension benefit obligation…………….……............ $465,000
Less: Pension plan assets, at market value………………............ (405,000)
Net Pension liability to be reported on the balance sheet……… $ 60,000

(continued) P 9-78A
Req. 2
a. Carrying amount of bonds payable:

Current portion……………………………… $ 400,000
Long-term portion ($1,200,000 − $27,000)… 1,173,000
Carrying amount……………………………….. $1,573,000
b. Interest payable is the amount of interest that Quinzel
owes at year end. Interest expense is the company’s
cost of borrowing for the full year.
Req. 3
Operating income $ 400,000

Times-interest-earned ratio = =
Interest expense $ 222,000
= 1.80 times

Problems
Group B
(15-20 min.) P 9-79B

a. Sales tax payable (€120,000 × .08) €9,600
b. Note payable, short-term €81,000
Interest payable (€81,000 × .04 × 4/12) 1,080
c. Unearned service revenue (€1,500 × 4/6) €1,000
d. Estimated warranty payable
(€11,400 + €31,200 − €34,600) €8,000
e. Portion of long-term note payable due
within one year €24,000
Interest payable (€88,000 × .10) 8,800

(30-40 min.) P 9-80B
Journal
20X0
Mar. 3 Inventory…………………………………… 35,000
Note Payable, Short-term……………. 35,000
May 31 Cash…………………………………………. 75,000
Note Payable, Short-term……………. 15,000
Note Payable, Long-term…………….. 60,000
Sept. 3 Note Payable, Short-term……………….. 35,000
Interest Expense (35,000 × .10 × 6/12). 1,750
Cash……………………………………... 36,750
Dec. 31 Warranty Expense (198,000 × .015)….. 2,970
Provision for Warranty Repairs 2,970
Dec. 31 Interest Expense
(75,000 × .08 × 7/12)…………………….. 3,500
Interest Payable……………………….. 3,500
20X1
May 31 Note Payable, Short-term……………….. 15,000
Interest Payable…………………………… 3,500
Interest Expense (75,000 × 0.08 × 5/12).. 2,500
Cash [15,000 + (75,000 × .08)]..…... 21,000

(20-25 min.) P 9-81B
Req. 1
Journal
20X0
a. May 31 Cash 2,000,000
Bonds Payable 2,000,000
To issue bonds at par.
b. Nov. 30 Interest Expense………………... 80,000
Cash (2,000,000 × .08 × 6/12)… 80,000
c. Dec. 31 Interest Expense
(2,000,000 × .08 × 1/12) 13,333
To accrue interest.
20X1
d. May 31 Interest Payable 13,333
Interest Expense
(2,000,000 × .08 × 5/12) 66,667
Cash ………………………….. 80,000

(continued) P 9-81B
December 31, 20X0)
Interest payable……………………………. € 13,333
Bonds payable……………………………... €2,000,000
(30-40 min.) P 9-82B

Req. 1
The 6% notes issued when the market interest rate is 5% will be

priced at a premium. They are relatively attractive in this
market, so investors will pay a price above par value to acquire
them.
Req. 2
The 6% notes issued when the market interest rate is 7%will be

priced at a discount. They are relatively unattractive in this
market, so investors will pay less than par value to acquire
them.

(continued) P 9-82B
Req. 3
A B C D E
Amortizatio
n
Balance Amount
(c% x
Maturity)
0 0 187,635 1,687,635
1 45,000 42,191 2,809 184,826 1,684,826
2 45,000 42,121 2,879 181,947 1,681,947
3 45,000 42,049 2,951 178,996 1,678,996
4 45,000 41,975 3,025 175,971 1,675,971
Journal
20X0
a. Feb. 28 Cash………………………… 1,687,635
Preimum on Bonds Payable…………… 187,635
Bonds Payable……………………………….. 1,500,000
To issue bonds payable at a premium.
b. Aug. 31 Interest Expense…………………………………. 42,191

Premium on Bonds Payable………………. 2,809
Cash……………… 45,000
To pay interest and amortize bonds payable.
c. Dec. 31 Interest Expense (42,121 x 4/6)……………. 28,081

Premium on Bonds Payable (2,879 x 4/6).... 1,919
Interest Payable ($45,000  4/6)……………. 30,000
To accrue interest and amortize bonds payable.
20X1
d. Feb. 28 Interest Payable (from Dec. 31)………………… 30,000

Interest Expense(42,121-28,081)…………….. 14,040
Premium on Bonds Payable(2,879-1,919).... 960
Cash ($1,800,000 × .06 × 6/12)………………. 45,000
To pay interest and amortize bonds payable.

(continued) P 9-82B
December 31, 20X0)
Interest payable € 30,000
Notes payable €1,500,000
Add: Premium on notes payable 182,907*
1,682,907
*187,635 – 2,809 – 1,919 = 182,907

(30-40 min.) P 9-83B
Req. 1
Journal
20X0
Jan. 1 Cash 2,149,390
Bonds Payable 2,000,000
July 1 Interest Expense 64,482

Cash 70,000

Premium on Discount Bond………. 5,684
Interest Payable…… 70,000

20X1
Jan. 1 Interest Payable……………………… 70,000
Cash………………………………… 70,000
To pay interest.
2020
Jan. 1 Bonds Payable……………………… 2,000,000
Cash……………………………… 2,000,000
To pay off bonds at maturity.

(continued) P 9-83B
Req. 2
Carrying amount at December 31, 20X0 = 2,138,188*
*2,149,390 − 5,518 − 5,684
Req. 3
a. Interest expense = $64,482
b. Cash interest paid = $70,000
The interest expense is lower than the cash interest paid

because the bond was issued at a premium and the company
must pay back the full face value of the bonds at maturity.
Amortization of the bond premium over the life of the bond
causes the amount of cash interest paid to exceed the interest
expense on the bonds.

(30-45 min.) P 9-84B
Req. 1
a. Maturity value is €6,500,000.
b. Annual cash interest payment is 260,000 (6,500,000 × .04).
c. Carrying amount is €6,168,760.

A B C D E
INTEREST
EXPENSE
ANNUAL (4% OF BOND DISCOUNT BALANCE CARRYING
DATE VALUE) AMOUNT) (B – A) D – C) ($6,500,000 – D)
Dec. 31, Yr. 1 €331,240 €6,168,760
Dec. 31, Yr. 2 260,000 308,438 €48,438 282,802 6,217,198
Dec. 31, Yr. 3 260,000 310,860 50,860 231,942 6,268,058
Dec. 31, Yr.4 260,000 313,403 53,403 178,539 6,321,461
Dec. 31, Yr.5 260,000 316,073 56,073 122,466 6,377,534
Interest expense for the year ended December 31, Year 4 is

€313,403.

(continued) P 9-84B
Req. 3 (reporting the liabilities at December 31, Year 4)
Current portion of notes payable € 60,000
Bonds payable €6,000,000
Less: Discount on bonds payable € (178,539) €6,321,461
Notes payable
(360,000 − 60,000) €300,000

(40-50 min.) P 9-85B
Req. 1
IAS 17 states that if the terms of the lease meet any of the following
conditions, it will be recognized as a capital lease:
1. The lease transforms substantially all risks and rewards of the

asset to the lessee.
2. The lease transfers ownership of the asset to the lessee at the

end of the lease.
3. The lease term represents a substantial part of the asset’s useful

life.
4. The present value of the lease payments represents a substantial

part of the fair value of the asset.
Based on the lease terms, fair value for the lease is €34,000 x 4.623
= €157,182. Since this is very close to the fair market value of the
asset at €160,000, this will be classified as a finance lease.
*Note that the U.S. GAAP recognizes a different set of criteria from
IAS 17 when it comes to classifying the lease. For instance, under
the U.S. GAAP, if the term of the lease exceeds 75% of the asset’s
useful life, and the present value of the lease payments exceeds
90% of the asset’s fair value, it will be classified as a capital lease.
Req 2
Journal
Dec. 31 Lease Asset………………………. 157,182

20X0 Lease Liability............................. 157,182
To record capital lease.
Dec. 31 Lease Expense…………………… 12,575

20X1 Lease Liability……………………. 21,425
Cash………………………... 34,000

(15-30 min.) P 9-86B
TO: Management of Veronica Sporting Goods
SUBJECT: Advantages and disadvantages of borrowing

versus issuing shares to raise cash for
expansion
Raising money by borrowing has at least two advantages over

issuing common shares. Borrowing does not change the
present ownership of the business. It enables the present
owners to keep their proportionate interests in the business
and to carry out their plans without interference from a new
group of shareholders. Under normal conditions, borrowing
results in a higher earnings per share of common shares
because the interest expense on the debt is tax-deductible. And
higher earnings per share usually lead to higher share prices
for company owners.
The main disadvantage of borrowing is that the debt increases

the financial risk of the company. The principal and the related
interest expense must be paid whether the company is earning
a profit or not. If times get sufficiently bad, the debt burden
could threaten the ability of the business to continue as a going
concern.

The main advantage of issuing shares is that owners avoid the
burden of making interest and principal payments on the debt.
Issuing shares creates no liability to pay anything to the
owners. If the directors consider it necessary, they can refuse
to pay dividends in order to conserve cash. Therefore, it is
safer to issue shares.
One disadvantage of issuing shares is dilution of the

ownership interests of existing shareholders if the purchasers
of new shares are outsiders. The new shareholders may have
different ideas about how to manage the business and that may
pose difficulties for the original shareholder group. Another
disadvantage of issuing shares is that earnings per share are
usually lower because of (1) the greater number of shares of
shares outstanding, and (2) the non-tax-deductibility of
dividends paid on the shares.
There is insufficient information available upon which to make

a decision. Veronica’s management must prepare budgets
which indicate the impact of the new stores in terms of net
income and cash flow. Management must also estimate the
cost of borrowing the funds.

(20-30 min.) P 9-87B
Req. 1
Isley Foods, Inc.

Partial Balance Sheet
December 31, 20X0
PPE: Current liabilities:
Equipment….. €746,000 Bonds payable
Accumulated current portion………… € 500,000
depreciation. (165,000) Mortgage note payable
581,000 current portion……….. 95,000
Interest payable…………. 72,000*
Total current liabilities…… 667,000
Mortgage note payable… 313,000
Bonds payable. 200,000
Discount on bonds
payable……. 23,000* 177,000
Net Pension liability…… 50,000**
Total non-current liabilities 540,000
_____
Notes:
* The order of listing non-current liabilities is optional. However, Discount on
Bonds Payable should come immediately after Bonds Payable. Also, it is
customary to report Interest Payable after the related liability accounts.
** Computation of pension liability:

Accumulated pension benefit obligation…………………….. €460,000
Less: Pension plan assets, at market value…………………. (410,000)
Net Pension liability to be reported on the balance sheet… 50,000

(continued) P 9-87B
Req. 2
a. Carrying amount of bonds payable:

Current portion..................................................... € 500,000
Long-term portion (200,000 - 23,000)................. 177,000
Carrying amount.................................................. €677,000
b. Interest payable is the amount of interest that Isley owes at

year-end. Interest expense is the company’s cost of
borrowing for the full year.
Req. 3
Operating income 360,000

Times-interest-earned ratio = =
Interest expense 224,000
= 1.6 times

Decision Cases
(15-20 min.) Decision Case 1
Req. 1
As After Including the

Reported Special-Purpose Entities
Total liabilities $54,033 $54,033 + $7,300

Debt ratio = =
Total assets $65,503 $65,503 − $800 + $500
= 0.82 = 0.94
Operating
Times-interest- Income $1,953 $1,953
= =
earned ratio Interest $ 838 $838 + ($7,300 × .10)
expense
= 2.3 times = 1.2 times
Req. 2
It appears that Enron excluded the special-purpose-entities

(SPEs) from its financial statements in order to hide their debt
from Enron’s investors and creditors. The purpose was to
understate Enron’s liabilities. We would view Enron as much
more risky after including the SPEs in Enron’s financial
statements. So did their banks, which is why they stopped
lending money to them, causing them to have to file for
bankruptcy.

(30-40 min.) Decision Case 2
Req. 1 (Analysis of financing plans)
PLAN A PLAN B PLAN C

ISSUE $3.75
ISSUE NONVOTING
BORROW COMMON PREFERRED
AT 6% SHARES SHARES
Net income before expansion $3,500,000 $3,500,000 $3,500,000
Project income before interest
and income tax $1,500,000 $1,500,000 $1,500,000
Less interest expense
($6,000,000 × .06) 360,000 -0- -0-
Project income before income tax 1,140,000 1,500,000 1,500,000
Less income tax expense (35%) 399,000 525,000 525,000
Project net income 741,000 975,000 975,000
Less preferred dividends
(100,000 × $3.75) -0- -0- 375,000
Additional net income available
to common shareholders 741,000 975,000 600,000
Total company net income $4,241,000 $4,475,000 $4,100,000
Earnings per share including new

project:
Plan A
($4,241,000 / 1,000,000 shares) $ 4.24
Plan B
($4,475,000 / 1,100,000 shares) $ 4.07
Plan C
($4,100,000 / 1,000,000 shares) $ 4.10

(continued) Decision Case 2
Req. 2 (Recommendation)
The best choice appears to be Plan A — borrowing at 6% —

because:
(1) Borrowing allows the family to maintain control of the

business;
(2) EPS is higher under borrowing than under issuing preferred

shares (which would also maintain family control); and
(3) EPS under borrowing is higher than it would be if common

shares were issued. Also, cash flow under Plan A
(borrowing) may be almost as good as under Plan B
(issuing common shares) after considering shareholders’
demands for dividends.

Ethical Issue 1
Req. 1
A company would prefer not to disclose its contingent

liabilities because they cast a shadow on the business and
create a negative impression. Contingent liabilities relating to
defending legal suits may be taken as admission of legal
responsibility when disclosed.
Req. 2 and 3
The potential parties and economic consequences of the

decision not to disclose contingent liabilities are:
1. The bank and its shareholders: With misleading

information, they might extend additional funds to the borrower
assuming a better ability to pay back the funds than actually
exists. A contingent liability creates risk for a company. If the
contingent liability is not reported, the bank may view the
company as low-risk. This may lead the bank to loan money at
low interest rates and with easy payment terms. With
knowledge of the contingent liability, the bank might not have
made the loan at all. Or the bank might have required a higher
interest rate or more stringent payment terms. Making loans on
too-easy terms expropriate the bank’s owners of their money.

(continued) Ethical Issue 1
2. The company seeking the loan: Might become overextended

in its borrowing and risk default on debt in the future.
Req. 3 Economic, legal, and ethical consequences
Banks have legal requirements to keep certain ratios of assets

and liabilities on their books or risk default. Failure of a
company to report its contingent liabilities to a bank requesting
this disclosure could subject the company to a lawsuit later on.
From an ethical standpoint, reporting a contingent liability
requires a delicate balancing act. Ethics require that outsiders’
interests be protected. The company must disclose enough
information to give outsiders a reasonable basis for making
informed decisions about the company. At the same time, the
company should avoid giving away secrets that could damage
its owners’ investment in the business. This dilemma is clear
when a defendant fears losing an important lawsuit. Fortunately
for accountants, most companies settle out of court those
lawsuits that they expect to lose. In such cases, there are no
contingent liabilities to disclose.

Ethical Issue 2
1. The ethical issue is whether to structure this lease to avoid
its having to be disclosed as a capital lease. The company will
do that if it is possible. It appears that Gocker and Moran have
some flexibility in setting the life of the lease (4-6 years). If they
set the term of the lease at 4 years, it will be only 66 2/3 percent
of the economic life of the asset (6 years). Thus, the lease will
fail all of the mechanical tests for the lease to be treated as a
capital lease, and by default, it will be treated as an operating
lease, and Gocker can avoid capitalizing the asset and
including the liability on her financial statements. If they set
the term of the lease at 5 or 6 years, it will exceed 75% of the
economic life of the asset, and thus the lease will have to be
capitalized.
2. The stakeholders are Gocker, the lessee; Morgan, the lessor;

and Last National Bank, Gocker’s present creditor. The
potential consequences to the stakeholders are:
a. economic: If the lease is structured as a capital lease,

Gocker
will violate its long-term loan covenant with Last National Bank.
As a result, the bank might demand immediate payment of their

loan. This may damage Gocker’s credit rating and create
difficulty getting future bank loans. Alternatively, Last National
Bank may waive the loan covenant in exchange for a higher
interest rate or more stringent repayment terms. This too could
cause Gocker financial difficulties. Morgan is not affected
economically, because Morgan will receive its payments on the
leased property regardless of how the transaction is disclosed.
b. legal: If we assume that GAAP substitutes for legal

requirements, if Gocker is careful to structure the lease terms
so that it avoids the requirements for a capital lease, there
should be no problem stating that the lease agreement
complies with GAAP.
c. ethical: The substance of a capital lease is one that

transfers the risks and rewards of ownership to the lessee. If in
fact, the substance of the terms of this lease do that, the
equipment should be capitalized by the lessee regardless of the
form of the lease terms. To use mechanical rules to avoid
recognizing assets and liabilities hardly seems like a truthful
way to do business. Nevertheless, U.S. GAAP presently allow
it!

3. Student responses will vary on this question. Some will say
that, if the rules allow it, then why not engineer the transaction
in such as way as to benefit Gocker by keeping the asset, and
the lease obligation, off the books. After all, this is perfectly
legal, and perfectly in accordance with existing U.S. GAAP
(FAS 13). In the view of the authors, Gocker should evaluate
whether, in fact, she obtains the rights and rewards associated
with ownership of the machine. If so, she could so structure
the lease that it fits the economic substance of the transaction,
which is what should also be disclosed in the financial
statements. If it turns out that the equipment and the related
lease obligation will have to be added to assets and liabilities in
the balance sheet, thus causing Gocker to default on the loan
covenant, she should attempt to obtain a waiver of the
covenant. This option is going to prove costly for Gocker, so
she’s going to have to be convinced that she did the right thing
in order to be motivated to follow this course of action.

Focus on Financials: Nestlé
(30-40 min.)
1. Trade payables for Nestlé increased in 2016, to CHF 18,629
million from CHF 17,038 million the year before. This
represented an increase of 9.34%. From note 12, it is clear that
the largest contributor to this increase was Nestlé’s taking up
off more commercial paper.
2. Nestlé’s income tax expense in 2016 was CHF 4,413 million.
3. Nestlé borrowed more, as total financial debt increased by

CHF 1,979 million from 2015 to 2016.
4. As of December 31, 2016, Nestlé is exposed to contingent

liabilities from potential litigations amounting to CHF 1,893
million.
5. The debt ratio of Nestlé is defined as Total Liabilities / Total

Assets. Nestlé’s debt ratio stood at 49.98% in the year 2016, up
from 48.40% in the year 2015. This figure is relatively risky, as
is the fact that leverage is going up without a corresponding
increase in net incomes. Some qualitative factors could include
Nestlé’s relationships with banks and the capital markets, its
credit ratings, and the stability of its income streams.
6. Nestlé has Restructuring, Environmental and Legal

provisions. A provision is recognized only when a past event
has created a legal or constructive obligation, an outflow of
resources is probable, and the amount of the obligation can be
estimated reliably.
Nestlé needs provisions for restructuring to recognize the cost
of exiting and ceasing the use of its sites and assets - it must
recognize an expense to match against the revenues that these
sites and assets bring.

A provision is a present liability but a contingent liability is a
possible future liability.
Group Projects
Student responses will vary.

Harrison Fa Ifrs 11e Ch09 SM

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Chapter 9

(10 min.) S 9-1

Sept. 30 Note Payable, Short-Term………………... 4,000

605 Chapter 8 Liabilities

The 20X2 income statement will report:

Interest expense ($4,000 × .08 × 3/12)………. $80

606 Financial Accounting 9/e Solutions Manual

Cash ($485,000 × .30)…………………..….. 145,500

Provision for Warranty Repairs………..... 18,000

Provision for Warranty Repairs

607 Chapter 8 Liabilities

The matching principle addresses this situation.

Note that the relevance qualitative characteristic also applies. If

Student responses may vary.

608 Financial Accounting 9/e Solutions Manual

1. When it is probable that OC Petroleum Inc. will be liable to

2. The company would have to recognize an expense in

609 Chapter 8 Liabilities

b. $411,000 ($ 400,000 × 1.0275)

c. $378,000 ($ 400,000 × .9450)

d. $418,000 ($ 400,000 × 1.0450)

b. Par (face) value

610 Financial Accounting 9/e Solutions Manual

611 Chapter 8 Liabilities

Sept. 30 Interest Expense…………………. 1,851

612 Financial Accounting 9/e Solutions Manual

2. Pay cash interest of $1,500 each six months.

Sept. 31, 20X0…………….. $1,851

Interest expense increases because the bond carrying amount

613 Chapter 8 Liabilities

614 Financial Accounting 9/e Solutions Manual

Lease 2 – Capital Lease

615 Chapter 8 Liabilities

Earnings per share including expansion:

Recommendation: To increase earnings per share,

616 Financial Accounting 9/e Solutions Manual

This means that for every dollar of interest expense, Kermit

Based on this ratio, the authors would be willing to lend $1

Students’ conclusions may vary.

617 Chapter 8 Liabilities

618 Financial Accounting 9/e Solutions Manual

Warranty Expense (12,000 + 3,000 – 10,000

Provision for Warranty Repair, a current liability, will cause a

619 Chapter 8 Liabilities

620 Financial Accounting 9/e Solutions Manual

621 Chapter 8 Liabilities

622 Financial Accounting 9/e Solutions Manual

Interest expense for:

623 Chapter 8 Liabilities

624 Financial Accounting 9/e Solutions Manual

Accounts payable are amounts owed to suppliers for products or

Employee compensation and benefits are amounts owed to

Current portion of long-term debt is the portion of the long-term

Long-term debt is the amount of long-term notes and bonds

Postretirement benefits are the company’s liabilities for providing

625 Chapter 8 Liabilities

Total assets = $3,995 million, the sum of total liabilities and

Total liabilities ($3,995 million − $2,027 million)*

A debt ratio of 49% is satisfactory.

626 Financial Accounting 9/e Solutions Manual

Rupert Security Systems should report this situation in a note

Rupert would report: