MACC7003 Advanced Financial Accounting

Assignment 1 – solutions

Topic 1 Financial Liabilities

Question 1
1. Price of the bonds at January 1, 2023
Present value of principal $3,000,000 x 0.7307* = $2,192,100
Present value of interests $150,000 x 6.7327** = $1,009,905
Price of bonds = $3,202,005
* present value of $1: n=8, i=4%
**present value of an ordinary annuity of $1: n=8, i=4%

Bond premium = $3,202,005– $3,000,000 = $202,005

2. Issuance of bonds
January 1, 2023
Dr. Cash 3,202,005
Cr. Bond payable 3,000,000
Cr. Premium on bond payable (bal.fig) 202,005

3. Interest on Jun 30, 2023 & December 31, 2023

June 30, 2023
Dr. Interest expenses ($3,202,005 x 4%) 128,080
Dr. Premium on bond payable (bal.fig) 21,920
Cr. Cash 150,000

December 31, 2023

Dr. Interest expenses ($3,180,085 x 4%) 127,203
Dr. Premium on bond payable (bal.fig) 22,797
Cr. Cash 150,000
Question 2
1. Issuance of convertible bonds
January 1, 2023
$4,341,23
Dr. Cash
2
Dr. Discount on bond payable 308,928
Cr. Bond payable 4,000,000
Cr. Paid in capital from bond conversion feature 650,160

PV (bond with option feature) (n=10, i=3%) = $4m x 0.7441 + $160,000 x 8.5302 =
$4,341,232
PV (bond without option feature) (n=10, i=5%) = $4m x 0.6139 + $160,000 x 7.7217 =
$3,691,072
Option value = $4,341,232-3,691,072=650,160

2. Bonds conversion (Book value approach)

June 30, 2024
Dr. Bond payable 1,000,000
Dr. Paid in capital from bond conversion feature
162,540
($650,160 x 1m/4m)
Cr. Discount on bond payable
57,844
($1,000,000 – $942,156)
Cr. Ordinary share capital (bal.fig) 1,104,696

* *PV of $1 million bonds (bond without option feature) at June 30, 2024 (n=7, i=5%)
= $1m x 0.7107 + $40,000 x 5.7864 = $942,156

3. Early extinguishment of bonds

December 31, 2025
Dr. Bond payable 1,200,000
Dr. Paid in capital from bond conversion feature 195,048
($650,160 x 1.2m/4m)
 Cr. Gain on early extinguishment (bal.fig) 128,496
Cr. Discount on bond payable
42,552
($1,200,000 - $1,157,448)
Cr. Cash ($1.2m x 102%) 1,224,000

PV of $1.2 million bonds (bond without option feature) at Dec 31, 2025 (n= 4, i=5%)
= $1.2m x 0.8227 + $48,000 x 3.5460 =$1,157,448
Question 3
Carry value of the old debt = $8,000,000 + $480,000 = $8,480,000
PV (restructured debt) (n=5,i=6%) = $7m x 0.7473 + $350,000 x 4.2124 = $6,705,440
Difference = $8,480,000 - $6,705,440 = $1,774,560
Difference is 21% ($1,774,560 / $8,480,000), which is larger than the threshold 10%, the
terms are substantially modified.

FV of new debt (n=5, i=8%) = $7m x 0.6806 + $350,000 x 3.9927 = $6,161,645

Decrease in note payable = $8,000,000 - $7,000,000 = $1,000,000

1. January 1, 2020
Dr. Notes payable (old) 8,000,000
Dr. Interest payable ($8m x 6%) 480,000
2,318,35
Cr. Gain on trouble debt restructuring
5
6,161,64
Cr. Notes payable (new)
5
Topic 2 Leases
Question 1
1. Lessee (Solar Company) – to record lease at the beginning of the lease term
Present value of lease payments
= 10,000 + 10,000 x PV annuity (3, 7%) + 25,000 x PV (4, 7%)
= 10,000 + 10,000 x 2.6243 + 25,000 x 0.7629
= 55,316

1/1/2021
Dr. Right-of-use asset 55,316
Cr. Lease liability 55,316

Dr. Lease liability 10,000

Cr. Cash 10,000

2. Lessee (Solar Company) – to record the lease on Dec 31, 2021

31/12/2021
Dr. Interest expense (55,316– 10,000) x 7% 3,172
Cr. Lease liability - current 3,172

Dr. Depreciation expense –Right-of-use asset 9,219

Cr. Accumulated depreciation 9,219
($55,316 / 6 years)

The right-of-use-asset is subsequently depreciated. Depreciation is over the shorter

of the useful life of the asset and the lease term, unless the title to the asset transfers
at the end of the lease term, in which case depreciation is over the useful life.
Question 2

1. Annual rental payment (P)

Present value of lease payments = Fair value of asset
P + P x PV annuity (5, 4%) + $75,000 x PV (6, 4%) = $800,000
P + P x 4.4518 + $75,000 x 0.7903 = $800,000
P x 5.4518 = $740,728
P = $135,868

2. Lessee (A&B Furniture) – to record lease for the year 2021

Expected residual value $25,000 is lower than guaranteed residual value $75,000,
differences $50,000 ($75,000 - $25,000) should be included in lessee’s lease liability.
Lessee’s lease liability = $135,868 + $135,868 x PV annuity (5, 4%) + $50,000 x PV (6, 4%)
= $780,240

1/1/2021
Dr. Right-of-use asset 780,240
Cr. Lease liability 780,240

Dr. Lease liability 135,868

Cr. Cash 135,868

31/12/2021
Dr. Interest expense (780,240–135,868) x 4% 25,775
Cr. Lease liability - current 25,775

The asset reverts to lessor at the end of the lease term, lease assets should be fully
amortized.
Dr. Depreciation expense –Right-of-use asset 130,040
Cr. Accumulated depreciation 130,040
($780,240/ 6 years)
3. Lessor (Silver Leasing) – to record the lease for the year 2021
1/1/2021
Dr. Lease payment receivable 800,000
Cr. Lease equipment 800,000

Dr. Cash 135,868

Cr. Lease payment receivable 135,868

31/12/2021
Dr. Lease receivable 26,565
Cr. Interest revenues (800,000 – 135,868) x 4% 26,565
Question 3
1. Nature of lease
To the lessor, this lease is a finance lease. First of all, the facts that the lease is
noncancelable, the lease term is greater than 75% of the economic life of the lease asset,
and the present value of the lease payments ($304,742) is greater than 90% of the fair
value of the leased asset, classify the lease as a finance lease. Furthermore, reasonably
predictable collectability of minimum lease payments and absence of important
uncertainties surrounding amount of non-reimbursable costs yet to be incurred by lessor
qualify the lease as direct financing or sales-type lease to lessor. It is sales-type lease as it
gives rise to manufacturer’s profit to lessor in addition to having other attributes of direct
financing lease

2. Lessor (Copper Leasing Company)

Dr. Initial direct costs ................. 10,000
Cr. Cash ......... 10,000

Dr. Lease payment receivable ....... 320,000**

Dr. Cost of goods sold (250,000 + 10,000 – 15,258***) 244,742
Cr. Sales revenue 304,742*
Cr. Initial direct costs 10,000
Cr. Inventory of equipment 250,000

* 84,083 + 84,083 x PVA (n=3,i=7%) = 304,742

** 304,742 + 20,000  PV (n=4,i=7%) = 320,000
*** 20,000  PV (n=4,i=7%) = 15,258

Dr. Cash (lease payment) 84,083

Cr. Lease payment receivable 84,083

Gross profit from lease

Sales $304,742
Less: Cost of goods sold (244,742 $60,000
)
Interest revenue [(320,000 – 84,083)  7%] $16,514
Total $76,514
3. Total amount of lease-related income for lessor