similar notes is 12%. Prepare Shlee's January 1 journal entry.

BE14.13 (LO3) On January 1, 2019, Henderson Corporation retired $500,000

of bonds at 99. At the time of retirement, the unamortized premium was
$15,000. Prepare Henderson's journal entry to record the reacquisition of
the bonds.
BE14.14 (LO3) Refer to the note issued by Coldwell AG in BE14.9. During
2019, Coldwell experiences financial difficulties. On January 1, 2020,
Coldwell negotiates a settlement of the note by issuing to Flint Hills Bank
20,000 €1 par Coldwell ordinary shares. The ordinary shares have a market
price of €4.75 per share on the date of the settlement. Prepare Coldwell's
entries to settle this note.
BE14.15 (LO3) Refer to the note issued by Coldwell AG in BE14.9. During
2019, Coldwell experiences financial difficulties. On January 1, 2020,
Coldwell negotiates a modification of the terms of the note. Under the
modification, Flint Hills Bank agrees to reduce the face value of the note to
€90,000 and to extend the maturity date to January 1, 2024. Annual interest
payments on December 31 will be made at a rate of 8%. Coldwell's market
interest rate at the time of the modification is 12%. Prepare Coldwell's
entries for (a) the modification on January 1, 2020, and (b) the first interest
payment date on December 31, 2020.
BE14.16 (LO4) Shonen Knife Ltd. has elected to use the fair value option for
one of its notes payable. The note was issued at an effective rate of 11%
and has a carrying value of HK$16,000. At year-end, Shonen Knife's
borrowing rate has declined; the fair value of the note payable is now
HK$17,500. (a) Determine the unrealized gain or loss on the note. (b)
Prepare the entry to record any unrealized gain or loss, assuming that the
change in value was due to general market conditions.
BE14.17 (LO4) At December 31, 2019, Hyasaki Corporation has the following
account balances:
Bonds payable, due January 1, 2027 $1,912,000
Interest payable 80,000
Show how the above accounts should be presented on the December 31,
2019, statement of financial position, including the proper classifications.

Exercises

E14.1 (LO1) (Classification of Liabilities) Presented below are various

 account balances.
a. Bank loans payable of a winery, due March 10, 2022. (The product
requires aging for 5 years before sale.)
b. Serial bonds payable, €1,000,000, of which €250,000 are due each
July 31.
c. Amounts withheld from employees' wages for income taxes.
d. Notes payable due January 15, 2021.
e. Credit balances in customers' accounts arising from returns and
allowances after collection in full of account.
f. Bonds payable of €2,000,000 maturing June 30, 2022.
g. Overdraft of €1,000 in a bank account. (No other balances are carried
at this bank.)
h. Deposits made by customers who have ordered goods.
Instructions

Indicate whether each of the items above should be classified on December

31, 2019, as a current liability, a non-current liability, or under some other
classification. Consider each one independently from all others; that is, do not
assume that all of them relate to one particular business. If the classification of
some of the items is doubtful, explain why in each case.
E14.2 (LO1) (Classification) The following items are found in the financial
statements.
a. Interest expense (credit balance).
b. Bond issue costs.
c. Gain on repurchase of debt.
d. Mortgage payable (payable in equal amounts over next 3 years).
e. Debenture bonds payable (maturing in 5 years).
f. Notes payable (due in 4 years).
g. Income bonds payable (due in 3 years).
Instructions

Indicate how each of these items should be classified in the financial

statements.
E14.3 (LO1) (Entries for Bond Transactions) Presented below are two
independent situations.
1. On January 1, 2019, Divac SA issued €300,000 of 9%, 10-year bonds
at par. Interest is payable quarterly on April 1, July 1, October 1, and
January 1.
2. On June 1, 2019, Verbitsky AG issued €200,000 of 12%, 10-year
bonds dated January 1 at par plus accrued interest. Interest is payable
semiannually on July 1 and January 1.
Instructions

For each of these two independent situations, prepare journal entries to

record the following.
a. The issuance of the bonds.
b. The payment of interest on July 1.
c. The accrual of interest on December 31.
E14.4 (LO1) (Entries for Bond Transactions) Foreman Cleaners issued
€800,000 of 10%, 20-year bonds on January 1, 2019, at 119.792 to yield
8%. Interest is payable semiannually on July 1 and January 1.
Instructions

Prepare the journal entries to record the following.

a. The issuance of the bonds.
b. The payment of interest and the related amortization on July 1, 2019.
c. The accrual of interest and the related amortization on December 31,
2019.
E14.5 (LO1) (Entries for Bond Transactions) Assume the same information
as in E14.4, except that the bonds were issued at 84.95 to yield 12%.
Instructions

Prepare the journal entries to record the following. (Round to the nearest
euro.)
a. The issuance of the bonds.
b. The payment of interest and related amortization on July 1, 2019.
c. The accrual of interest and the related amortization on December 31,
 2019.
E14.6 (LO1) (Amortization Schedule) Spencer plc sells 10% bonds having a
maturity value of £3,000,000 for £2,783,724. The bonds are dated January
1, 2019, and mature January 1, 2024. Interest is payable annually on
January 1.
Instructions

Set up a schedule of interest expense and discount amortization.

(Hint: The effective-interest rate must be computed.)
E14.7 (LO1) (Determine Proper Amounts in Account Balances)
Presented below are three independent situations.
Instructions

a. McEntire Co. sold $2,500,000 of 11%, 10-year bonds at 106.231 to

yield 10% on January 1, 2019. The bonds were dated January 1, 2019,
and pay interest on July 1 and January 1. Determine the amount of
interest expense to be reported on July 1, 2019, and December 31,
2019.
b. Cheriel Inc. issued $600,000 of 9%, 10-year bonds on June 30, 2019,
for $562,500. This price provided a yield of 10% on the bonds. Interest
is payable semiannually on December 31 and June 30. Determine the
amount of interest expense to record if financial statements are issued
on October 31, 2019.
c. On October 1, 2019, Chinook Company sold 12% bonds having a
maturity value of $800,000 for $853,382 plus accrued interest, which
provides the bondholders with a 10% yield. The bonds are dated
January 1, 2019, and mature January 1, 2024, with interest payable
December 31 of each year. Prepare the journal entries at the date of
the bond issuance and for the first interest payment.
E14.8 (LO1) (Entries and Questions for Bond Transactions) On
June 30, 2018, Macias SA issued R$5,000,000 face value of 13%, 20-year
bonds at R$5,376,150 to yield 12%. The bonds pay semiannual interest on
June 30 and December 31.
Instructions

a. Prepare the journal entries to record the following transactions.

 1. The issuance of the bonds on June 30, 2018.
2. The payment of interest and the amortization of the premium on
December 31, 2018.
3. The payment of interest and the amortization of the premium on
June 30, 2019.
4. The payment of interest and the amortization of the premium on
December 31, 2019.
b. Show the proper statement of financial position presentation for the
liability for bonds payable on the December 31, 2019, statement of
financial position.
c. Provide the answers to the following questions.
1. What amount of interest expense is reported for 2019?
2. Determine the total cost of borrowing over the life of the bond.
E14.9 (LO1) (Entries for Bond Transactions) On January 1, 2019, Osborn
plc sold 12% bonds having a maturity value of £800,000 for £860,651.79,
which provides the bondholders with a 10% yield. The bonds are dated
January 1, 2019, and mature January 1, 2024, with interest payable
December 31 of each year.
Instructions

a. Prepare the journal entry at the date of the bond issuance.

b. Prepare a schedule of interest expense and bond amortization for
2019–2021.
c. Prepare the journal entry to record the interest payment and the
amortization for 2019.
d. Prepare the journal entry to record the interest payment and the
amortization for 2021.
E14.10 (LO1) (Information Related to Various Bond Issues) Pawnee Inc.
has issued three types of debt on January 1, 2019, the start of the
company's fiscal year.
a. $10 million, 10-year, 13% unsecured bonds, interest payable quarterly.
Bonds were priced to yield 12%.
b. $25 million par of 10-year, zero-coupon bonds at a price to yield 12%
per year.
 c. $15 million, 10-year, 10% mortgage bonds, interest payable annually to
yield 12%.
Instructions

Prepare a schedule that identifies the following items for each bond: (1)
maturity value, (2) number of interest periods over life of bond, (3) stated rate
per each interest period, (4) effective-interest rate per each interest period, (5)
payment amount per period, and (6) present value of bonds at date of issue.
E14.11 (LO2) (Entries for Zero-Interest-Bearing Notes) On January 1,
2019, McLean AG makes the two following acquisitions.
1. Purchases land having a fair value of €300,000 by issuing a 5-year,
zero-interest-bearing promissory note in the face amount of €505,518.
2. Purchases equipment by issuing a 6%, 8-year promissory note having
a maturity value of €400,000 (interest payable annually).
The company has to pay 11% interest for funds from its bank.
Instructions

a. Record the two journal entries that should be recorded by McLean AG

for the two purchases on January 1, 2019.
b. Record the interest at the end of the first year on both notes.
E14.12 (LO2) (Imputation of Interest) The following are two independent
situations.
Instructions

a. On January 1, 2019, Spartan Inc. purchased land that had an

assessed value of $390,000 at the time of purchase. A $600,000, zero-
interest-bearing note due January 1, 2022, was given in exchange.
There was no established exchange price for the land, nor a ready
market price for the note. The interest rate charged on a note of this
type is 12%. Determine at what amount the land should be recorded at
January 1, 2019, and the interest expense to be reported in 2019
related to this transaction.
b. On January 1, 2019, Geimer Furniture Co. borrowed $4,000,000 (face
value) from Aurora Co., a major customer, through a zero-interest-
bearing note due in 4 years. Because the note was zero-interest-
bearing, Geimer Furniture agreed to sell furniture to this customer at
lower than market price. A 10% rate of interest is normally charged on
 this type of loan. Prepare the journal entry to record this transaction
and determine the amount of interest expense to report for 2019.
E14.13 (LO2) (Imputation of Interest with Right) On January 1, 2019, Durdil
A.Ş borrowed and received 500,000 from a major customer evidenced by
a zero-interest-bearing note due in 3 years. As consideration for the zero-
interest-bearing feature, Durdil agrees to supply the customer's inventory
needs for the loan period at lower than the market price. The appropriate
rate at which to impute interest is 8%.
Instructions

a. Prepare the journal entry to record the initial transaction on January 1,

2019.
b. Prepare the journal entry to record any adjusting entries needed at
December 31, 2019. Assume that the sales of Durdil's product to this
customer occur evenly over the 3-year period.
E14.14 (LO1, 3) (Entry for Retirement of Bond; Bond Issue Costs) On
January 2, 2016, Prebish Corporation issued $1,500,000 of 10% bonds to
yield 11% due December 31, 2025. Interest on the bonds is payable
annually each December 31. The bonds are callable at 101 (i.e., at 101% of
face amount), and on January 2, 2019, Prebish called $1,000,000 face
amount of the bonds and retired them.
Instructions

a. Determine the price of the Prebish bonds when issued on January 2,

2016.
b. Prepare an amortization schedule for 2016–2020 for the bonds.
c. Ignoring income taxes, compute the amount of loss, if any, to be
recognized by Prebish as a result of retiring the $1,000,000 of bonds
on January 2, 2019, and prepare the journal entry to record the
retirement.
E14.15 (LO1,3) (Entries for Retirement and Issuance of Bonds) On June
30, 2011, Mendenhal plc issued 8% bonds with a par value of £600,000 due
in 20 years. They were issued at 82.8414 to yield 10% and were callable at
104 at any date after June 30, 2019. Because of lower interest rates and a
significant change in the company's credit rating, it was decided to call the
entire issue on June 30, 2020, and to issue new bonds. New 6% bonds
were sold in the amount of £800,000 at 112.5513 to yield 5%; they mature
 in 20 years. Interest payment dates are December 31 and June 30 for both
old and new bonds.
Instructions

a. Prepare journal entries to record the retirement of the old issue and the
sale of the new issue on June 30, 2020. Unamortized discount is
£78,979.
b. Prepare the entry required on December 31, 2020, to record the
payment of the first 6 months' interest and the amortization of premium
on the bonds.
E14.16 (LO1, 3) (Entries for Retirement and Issuance of Bonds) Kobiachi
Group had bonds outstanding with a maturity value of ¥5,000,000. On April
30, 2020, when these bonds had an unamortized discount of ¥100,000,
they were called in at 104. To pay for these bonds, Kobiachi had issued
other bonds a month earlier bearing a lower interest rate. The newly issued
bonds had a life of 10 years. The new bonds were issued at 103 (face value
¥5,000,000).
Instructions

Ignoring interest, compute the gain or loss and record this refunding
transaction.
E14.17 (LO3) (Settlement of Debt) Strickland Company owes $200,000 plus
$18,000 of accrued interest to Moran State Bank. The debt is a 10-year,
10% note. During 2019, Strickland's business deteriorated due to a faltering
regional economy. On December 31, 2019, Moran State Bank agrees to
accept an old machine and cancel the entire debt. The machine has a cost
of $390,000, accumulated depreciation of $221,000, and a fair value of
$180,000.
Instructions

a. Prepare journal entries for Strickland Company to record this debt

settlement.
b. How should Strickland report the gain or loss on the disposition of
machine and on restructuring of debt in its 2019 income statement?
c. Assume that, instead of transferring the machine, Strickland decides to
grant 15,000 of its ordinary shares ($10 par), which have a fair value of
$180,000 in full settlement of the loan obligation. Prepare the entries to
 record the transaction.
E14.18 (LO3) (Loan Modification) On December 31, 2019, Sterling Bank
enters into a debt restructuring agreement with Barkley plc, which is now
experiencing financial trouble. The bank agrees to restructure a 12%,
issued at par, £3,000,000 note receivable by the following modifications:
1. Reducing the principal obligation from £3,000,000 to £2,400,000.
2. Extending the maturity date from December 31, 2019, to January 1,
2023.
3. Reducing the interest rate from 12% to 10%. Barkley's market rate of
interest is 15%.
Barkley pays interest at the end of each year. On January 1, 2023, Barkley
Company pays £2,400,000 in cash to Sterling Bank.
Instructions

a. Can Barkley record a gain under the term modification mentioned

above? Explain.
b. Prepare the amortization schedule of the note for Barkley Company
after the debt modification.
c. Prepare the interest payment entry for Barkley on December 31, 2021.
d. What entry should Barkley make on January 1, 2023?
E14.19 (LO3) (Loan Modification) Use the same information as in E14.18
except that Sterling Bank reduced the principal to £1,900,000 rather than
£2,400,000. On January 1, 2023, Barkley pays £1,900,000 in cash to
Sterling Bank for the principal.
Instructions

a. Prepare the journal entries to record the loan modification for Barkley.
b. Prepare the amortization schedule of the note for Barkley Company
after the debt modification.
c. Prepare the interest payment entries for Barkley on December 31 of
2020, 2021, and 2022.
d. What entry should Barkley make on January 1, 2023?
E14.20 (LO3) (Entries for Settlement of Debt) Consider the following
independent situations.
Instructions

a. Gottlieb Stores owes €199,800 to Ceballos SpA. The debt is a 10-year,

11% note. Because Gottlieb is in financial trouble, Ceballos agrees to
accept some land and cancel the entire debt. The land has a book
value of €90,000 and a fair value of €140,000. Prepare the journal entry
on Gottlieb's books for debt settlement.
b. Vargo Corp. owes $270,000 to First Trust. The debt is a 10-year, 12%
note due December 31, 2019. Because Vargo Corp. is in financial
trouble, First Trust agrees to extend the maturity date to December 31,
2021, reduce the principal to $220,000, and reduce the interest rate to
5%, payable annually on December 31. Vargo's market rate of interest
is 8%. Prepare the journal entries on Vargo's books on December 31,
2019, 2020, and 2021.
E14.21 (LO4) (Fair Value Option) Fallen AG commonly issues long-term
notes payable to its various lenders. Fallen has had a pretty good credit
rating such that its effective borrowing rate is quite low (less than 8% on an
annual basis). Fallen has elected to use the fair value option for the long-
term notes issued to Barclay's Bank and has the following data related to
the carrying and fair value for these notes. (Assume that changes in fair
value are due to general market interest rate changes).

Carrying Value Fair Value

December 31, 2019 €54,000 €54,000
December 31, 2020 44,000 42,500
December 31, 2021 36,000 38,000
Instructions

a. Prepare the journal entry at December 31 (Fallen's year-end) for 2019,

2020, and 2021, to record the fair value option for these notes.
b. At what amount will the note be reported on Fallen's 2020 statement of
financial position?
c. What is the effect of recording the fair value option on these notes on
Fallen's 2021 income?
d. Assuming that general market interest rates have been stable over the
period, does the fair value data for the notes indicate that Fallen's
creditworthiness has improved or declined in 2021? Explain.
 e. Assuming the conditions that exist in (d), what is the effect of recording
the fair value option on these notes in Fallen's income statement in
2019, 2020, and 2021?
E14.22 (LO4) (Long-Term Debt Disclosure) At December 31, 2019,
Redmond Company has outstanding three long-term debt issues. The first
is a $2,000,000 note payable which matures June 30, 2022. The second is
a $6,000,000 bond issue which matures September 30, 2023. The third is a
$12,500,000 sinking fund debenture with annual sinking fund payments of
$2,500,000 in each of the years 2021 through 2025.
Instructions

Prepare the required note disclosure for the long-term debt at December 31,
2019.

Problems

P14.1 (LO1) (Analysis of Amortization Schedule and Interest

Entries) The following amortization and interest schedule reflects the
issuance of 10-year bonds by Capulet SpA on January 1, 2013 and the
subsequent interest payments and charges. The company's year-end
is December 31, and financial statements are prepared once yearly.
Amortization Schedule
Year Cash Interest Amount Unamortized Book Value
1/1/2013 €5,651 € 94,349
2013 €11,000 €11,322 5,329 94,671
2014 11,000 11,361 4,968 95,032
2015 11,000 11,404 4,564 95,436
2016 11,000 11,452 4,112 95,888
2017 11,000 11,507 3,605 96,395
2018 11,000 11,567 3,038 96,962
2019 11,000 11,635 2,403 97,597
2020 11,000 11,712 1,691 98,309
2021 11,000 11,797 894 99,106
2022 11,000 11,894 100,000
Instructions
 a. Indicate whether the bonds were issued at a premium or a
discount and how you can determine this fact from the schedule.
b. Determine the stated interest rate and the effective-interest rate.
c. On the basis of the schedule, prepare the journal entry to record
the issuance of the bonds on January 1, 2013.
d. On the basis of the schedule, prepare the journal entry or entries
to reflect the bond transactions and accruals for 2013. (Interest is
paid January 1.)
e. On the basis of the schedule, prepare the journal entry or entries
to reflect the bond transactions and accruals for 2020. Capulet
does not use reversing entries.
P14.2 (LO1, 3) (Issuance and Retirement of Bonds) Venzuela Co. is
building a new hockey arena at a cost of $2,500,000. It received a
down payment of $500,000 from local businesses to support the project
and now needs to borrow $2,000,000 to complete the project. It
therefore decides to issue $2,000,000 of 10.5%, 10-year bonds. These
bonds were issued on January 1, 2018, and pay interest annually on
each January 1. The bonds yield 10%.
Instructions

a. Prepare the journal entry to record the issuance of the bonds on

January 1, 2018.
b. Prepare a bond amortization schedule up to and including January
1, 2022.
c. Assume that on July 1, 2021, Venzuela Co. retires half of the
bonds at a cost of $1,065,000 plus accrued interest. Prepare the
journal entry to record this retirement.
P14.3 (LO1) (Negative Amortization) Good-Deal Auto developed a new
sales gimmick to help sell its inventory of new automobiles. Because
many new car buyers need financing, Good-Deal offered a low down
payment and low car payments for the first year after purchase. It
believes that this promotion will bring in some new buyers.
On January 1, 2019, a customer purchased a new €33,000 automobile,
making a down payment of €1,000. The customer signed a note
indicating that the annual rate of interest would be 8% and that quarterly
payments would be made over 3 years. For the first year, Good-Deal
required a €400 quarterly payment to be made on April 1, July 1, October
1, and January 1, 2020. After this one-year period, the customer was
required to make regular quarterly payments that would pay off the loan
as of January 1, 2022.
Instructions

a. Prepare a note amortization schedule for the first year.

b. Indicate the amount the customer owes on the contract at the end
of the first year.
c. Compute the amount of the new quarterly payments.
d. Prepare a note amortization schedule for these new payments for
the next 2 years.
e. What do you think of the new sales promotion used by Good-
Deal?
P14.4 (LO1) (Effective-Interest Method) Samantha Cordelia, an
intermediate accounting student, is having difficulty amortizing bond
premiums and discounts using the effective-interest method.
Furthermore, she cannot understand why IFRS requires that this
method be used. She has come to you with the following problem,
looking for help.
On June 30, 2019, Hobart SA issued R$2,000,000 face value of 11%, 20-
year bonds at R$2,171,600, a yield of 10%. Hobart Company uses the
effective-interest method to amortize bond premiums or discounts. The
bonds pay semiannual interest on June 30 and December 31. Compute
the amortization schedule for four periods.
Instructions

Using the data above for illustrative purposes, write a short memo (1–1.5
pages double-spaced) to Samantha, explaining what the effective-interest
method is, why it is preferable, and how it is computed. (Do not forget to
include an amortization schedule, referring to it whenever necessary.)
P14.5 (LO2) (Entries for Zero-Interest-Bearing Note) On December 31,
2019, Faital plc acquired a computer from Plato Group by issuing a
£600,000 zero-interest-bearing note, payable in full on December 31,
2023. Faital Company's credit rating permits it to borrow funds from its
several lines of credit at 10%. The computer is expected to have a 5-
year life and a £70,000 residual value.
Instructions

a. Prepare the journal entry for the purchase on December 31, 2019.
b. Prepare any necessary adjusting entries relative to depreciation
(use straight-line) and amortization on December 31, 2020.
c. Prepare any necessary adjusting entries relative to depreciation
and amortization on December 31, 2021.
P14.6 (LO2) (Entries for Zero-Interest-Bearing Note; Payable in
Installments) Sabonis Cosmetics Co. purchased machinery on
December 31, 2018, paying $50,000 down and agreeing to pay the
balance in four equal installments of $40,000 payable each December
31. An assumed interest of 8% is implicit in the purchase price.
Instructions

Prepare the journal entries that would be recorded for the purchase and
for the payments and interest on the following dates.
a. December 31, 2018.
b. December 31, 2019.
c. December 31, 2020.
d. December 31, 2021.
e. December 31, 2022.
P14.7 (LO1, 3, 4) (Issuance and Retirement of Bonds; Income
Statement Presentation) Chen Ltd. issued its 9%, 25-year mortgage
bonds in the principal amount of ¥30,000,000 on January 2, 2005, at a
discount of ¥2,722,992 (effective rate of 10%). The indenture securing
the issue provided that the bonds could be called for redemption in total
but not in part at any time before maturity at 104% of the principal
amount, but it did not provide for any sinking fund.
On December 18, 2019, the company issued its 11%, 20-year debenture
bonds in the principal amount of ¥40,000,000 at 102, and the proceeds
were used to redeem the 9%, 25-year mortgage bonds on January 2,
2020. The indenture securing the new issue did not provide for any
sinking fund or for retirement before maturity. The unamortized discount
at retirement was ¥1,842,888.
Instructions
 a. Prepare journal entries to record the issuance of the 11% bonds
and the retirement of the 9% bonds.
b. Indicate the income statement treatment of the gain or loss from
retirement and the note disclosure required.
P14.8 (LO1, 3) (Comprehensive Bond Problem) In each of the
following independent cases, the company closes its books on
December 31.
1. Sanford Co. sells $500,000 of 10% bonds on March 1, 2019. The
bonds pay interest on September 1 and March 1. The due date of
the bonds is September 1, 2022. The bonds yield 12%. Give
entries through December 31, 2020.
2. Titania Co. sells $400,000 of 12% bonds on June 1, 2019. The
bonds pay interest on December 1 and June 1. The due date of
the bonds is June 1, 2023. The bonds yield 10%. On October 1,
2020, Titania buys back $120,000 worth of bonds for $126,000
(includes accrued interest). Give entries through December 1,
2021.
Instructions

For the two cases, prepare all of the relevant journal entries from the time
of sale until the date indicated. (Construct amortization tables where
applicable.) Amortize premium or discount on interest dates and at year-
end. (Assume that no reversing entries were made; round to the nearest
dollar.)
P14.9 (LO1, 3) (Issuance of Bonds Between Interest Dates,
Retirement) Presented below are selected transactions on the books
of Simonson Foundry.
July Bonds payable with a par value of €900,000, which are dated
1, January 1, 2019, are sold at 112.290 plus accrued interest to yield
2019 10%. They are coupon bonds, bear interest at 12% (payable
annually at January 1), and mature January 1, 2029. (Use interest
expense account for accrued interest.)
Dec. Adjusting entries are made to record the accrued interest on the
31 bonds, and the amortization of the proper amount of premium.
Jan. Interest on the bonds is paid.
1,
2020
Jan. Bonds of par value of €360,000 are called at 102 and
2 extinguished.
Dec. Adjusting entries are made to record the accrued interest on the
31 bonds, and the proper amount of premium amortized.
Instructions

Prepare journal entries for the transactions above.

P14.10 (LO1, 3) (Entries for Life Cycle of Bonds) On April 1, 2019,
Sarkar Sailboats sold 15,000 of its 11%, 15-year, R$1,000 face value
bonds to yield 12%. Interest payment dates are April 1 and October 1.
On April 2, 2020, Sarkar took advantage of favorable prices of its
shares to extinguish 6,000 of the bonds by issuing 200,000 of its R$10
par value ordinary shares. At this time, the accrued interest was paid in
cash. The company's shares were selling for R$31 per share on April
2, 2020.
Instructions

Prepare the journal entries needed on the books of Sarkar to record the
following.
a. April 1, 2019: issuance of the bonds.
b. October 1, 2019: payment of semiannual interest.
c. December 31, 2019: accrual of interest expense.
d. April 1, 2020: payment of semiannual interest.
e. April 2, 2020: extinguishment of 6,000 bonds. (No reversing
entries made.)
P14.11 (LO3) (Modification of Debt) Daniel Perkins is the sole
shareholder of Perkins Inc., which is currently under protection of the
U.S. bankruptcy court. As a “debtor in possession,” he has negotiated
the following revised loan agreement with United Bank. Perkins Inc.'s
$600,000, 12%, 10-year note was refinanced with a $600,000, 5%, 10-
year note. Perkins has a market rate of interest of 15%.
Instructions

a. What is the accounting nature of this transaction?

b. Prepare the journal entry to record this refinancing on the books of
 Perkins Inc.
P14.12 (LO3) (Modification of Note under Different Circumstances)
Halvor Corporation is having financial difficulty and therefore has asked
Frontenac National Bank to restructure its $5 million note outstanding.
The present note has 3 years remaining and pays a current rate of
interest of 10%. The present market rate for a loan of this nature is
12%. The note was issued at its face value.
Instructions

Presented below are three independent situations. Prepare the journal

entry that Halvor would make for each of these restructurings.
a. Frontenac National Bank agrees to take an equity interest in
Halvor by accepting ordinary shares valued at $3,700,000 in
exchange for relinquishing its claim on this note. The ordinary
shares have a par value of $1,700,000.
b. Frontenac National Bank agrees to accept land in exchange for
relinquishing its claim on this note. The land has a book value of
$3,250,000 and a fair value of $4,000,000.
c. Frontenac National Bank agrees to modify the terms of the note,
indicating that Halvor does not have to pay any interest on the note
over the 3-year period.
P14.13 (LO3) (Debtor/Creditor Entries for Continuation of Debt with
New Effective Interest) Crocker plc owes Yaeger Ltd. a 10-year, 10%
note in the amount of £330,000 plus £33,000 of accrued interest. The
note is due today, December 31, 2019. Because Crocker is in financial
trouble, Yaeger agrees to forgive the accrued interest, £30,000 of the
principal and to extend the maturity date to December 31, 2022.
Interest at 10% of revised principal will continue to be due on 12/31
each year. Given Crocker's financial difficulties, the market rate for its
loans is 12%.
Instructions

a. Prepare the amortization schedule for the years 2019 through

2022.
b. Prepare all the necessary journal entries on the books of Crocker
for the years 2019, 2020, and 2021.
P14.14 (LO1, 3, 4) (Comprehensive Problem: Issuance,
 Classification, Reporting) Presented below are three independent
situations.
Instructions

a. On January 1, 2019, Langley Co. issued 9% bonds with a face

value of $700,000 for $656,992 to yield 10%. The bonds are dated
January 1, 2019, and pay interest annually. What amount is
reported for interest expense in 2019 related to these bonds?
b. Tweedie Building Co. has a number of long-term bonds
outstanding at December 31, 2019. These long-term bonds have
the following sinking fund requirements and maturities for the next
6 years.

Sinking Fund Maturities

2020 $300,000 $100,000
2021 100,000 250,000
2022 100,000 100,000
2023 200,000 —
2024 200,000 150,000
2025 200,000 100,000
Indicate how this information should be reported in the financial
statements at December 31, 2019.
c. In the long-term debt structure of Beckford Inc., the following three
bonds were reported: mortgage bonds payable $10,000,000;
collateral trust bonds $5,000,000; bonds maturing in installments,
secured by plant equipment $4,000,000. Determine the total
amount, if any, of debenture bonds outstanding.

Concepts for Analysis

CA14.1 (LO1, 4) (Bond Theory: Statement of Financial Position

Presentations, Interest Rate, Premium) On January 1, 2020, Nichols
Company issued for $1,085,800 its 20-year, 11% bonds that have a maturity
value of $1,000,000 and pay interest semiannually on January 1 and July 1.
Bond issue costs were not material in amount. Below are three
presentations of the non-current liability section of the statement of financial
position that might be used for these bonds at the issue date.
1. Bonds payable (maturing January 1, 2040) $1,085,800
2. Bonds payable—principal (face value $1,000,000 maturing $
January 1, 2040) 142,050a
Bonds payable—interest (semiannual payment $55,000) 943,750b
Total bond liability $1,085,800
3. Bonds payable—principal (maturing January 1, 2040) $1,000,000
Bonds payable—interest ($55,000 per period for 40 periods) 2,200,000
Total bond liability $3,200,000
a The present value of $1,000,000 due at the end of 40 (6-month) periods at the yield rate of 5% per
period.
b The present value of $55,000 per period for 40 (6-month) periods at the yield rate of 5% per period.

Instructions

a. Discuss the conceptual merit(s) of each of the date-of-issue statement

of financial position presentations shown above for these bonds.
b. Explain why investors would pay $1,085,800 for bonds that have a
maturity value of only $1,000,000.
c. Assuming that a discount rate is needed to compute the carrying value
of the obligations arising from a bond issue at any date during the life of
the bonds, discuss the conceptual merit(s) of using for this purpose:
1. The coupon or nominal rate.
2. The effective or yield rate at date of issue.
d. If the obligations arising from these bonds are to be carried at their
present value computed by means of the current market rate of
interest, how would the bond valuation at dates subsequent to the date
of issue be affected by an increase or a decrease in the market rate of
interest?
CA14.2 (LO1, 4) (Various Non-Current Liability Conceptual Issues)
Schrempf AG has completed a number of transactions during 2019. In
January, the company purchased under contract a machine at a total price
of €1,200,000, payable over 5 years with installments of €240,000 per year.
The seller has considered the transaction as an installment sale with the
title transferring to Schrempf at the time of the final payment.
On March 1, 2019, Schrempf issued €10 million of general revenue bonds
priced at 99 with a coupon of 10% payable July 1 and January 1 of each of
the next 10 years. The July 1 interest was paid and on December 30, the
company transferred €1,000,000 to the trustee, Flagstad SE, for payment of
the January 1, 2020, interest.
As the accountant for Schrempf, you have prepared the statement of financial
position as of December 31, 2019, and have presented it to the president of
the company. You are asked the following questions about it.
1. Why has depreciation been charged on equipment being purchased
under contract? Title has not passed to the company as yet and,
therefore, it is not our asset. Why should the company not show on the
left side of the statement of financial position only the amount paid to
date instead of showing the full contract price on the left side and the
unpaid portion on the right side? After all, the seller considers the
transaction an installment sale.
2. Bond interest is shown as a current liability. Did we not pay our trustee,
Flagstad SE, the full amount of interest due this period?
Instructions

Outline your answers to these questions by writing a brief paragraph that will
justify your treatment.
CA14.3 (LO1, 3, 4) (Bond Theory: Price, Presentation, and Retirement)
On March 1, 2020, Sealy Sundries sold its 5-year, £1,000 face value, 9%
bonds dated March 1, 2020, at an effective annual interest rate (yield) of
11%. Interest is payable semiannually, and the first interest payment date is
September 1, 2020. Sealy uses the effective-interest method of
amortization. The bonds can be called by Sealy at 101 at any time on or
after March 1, 2021.
Instructions

a.
1. How would the selling price of the bond be determined?
2. Specify how all items related to the bonds would be presented in a
statement of financial position prepared immediately after the bond
issue was sold.
b. What items related to the bond issue would be included in Sealy's
2020 income statement, and how would each be determined?
 c. Would the amount of bond discount amortization using the effective-
interest method of amortization be lower in the second or third year of
the life of the bond issue? Why?
d. Assuming that the bonds were called in and extinguished on March 1,
2021, how should Sealy report the retirement of the bonds on the 2021
income statement?
CA14.4 (LO1, 3, 4) (Bond Theory: Amortization and Gain or Loss
Recognition) Part I: The required method of amortizing a premium or
discount on issuance of bonds is the effective-interest method.
Instructions

How is amortization computed using the effective-interest method, and

why and how do amounts obtained using the effective-interest method
provide financial statement readers useful information about the cost of
borrowing?
Part II: Gains or losses from the early extinguishment of debt that is
refunded can theoretically be accounted for in three ways:
1. Amortized over remaining life of old debt.
2. Amortized over the life of the new debt issue.
3. Recognized in the period of extinguishment.
Instructions
a. Develop supporting arguments for each of the three theoretical
methods of accounting for gains and losses from the early
extinguishment of debt.
b. Which of the methods above is generally accepted under IFRS and
how should the appropriate amount of gain or loss be shown in a
company's financial statements?
CA14.5 (LO4) (Off-Balance-Sheet Financing) Matt Ryan Corporation
is interested in building its own soda can manufacturing plant adjacent to its
existing plant in Partyville, Kansas. The objective would be to ensure a
steady supply of cans at a stable price and to minimize transportation costs.
However, the company has been experiencing some financial problems and
has been reluctant to borrow any additional cash to fund the project. The
company is not concerned with the cash flow problems of making payments
but rather with the impact of adding additional long-term debt to its
statement of financial position.
The president of Ryan, Andy Newlin, approached the president of the
Aluminum Can Company (ACC), its major supplier, to see if some agreement
could be reached. ACC was anxious to work out an arrangement since it
seemed inevitable that Ryan would begin its own can production. Aluminum
Can Company could not afford to lose the account.
After some discussion, a two-part plan was worked out. First, ACC was to
construct the plant on Ryan's land adjacent to the existing plant. Second,
Ryan would sign a 20-year purchase agreement. Under the purchase
agreement, Ryan would express its intention to buy all of its cans from ACC,
paying a unit price which at normal capacity would cover labor and material,
an operating management fee, and the debt service requirements on the
plant. The expected unit price, if transportation costs are taken into
consideration, is lower than current market. If Ryan did not take enough
production in any one year and if the excess cans could not be sold at a high
enough price on the open market, Ryan agrees to make up any cash shortfall
so that ACC could make the payments on its debt. The bank will be willing to
make a 20-year loan for the plant, taking the plant and the purchase
agreement as collateral. At the end of 20 years, the plant is to become the
property of Ryan.
Instructions

a. What are project financing arrangements using special purpose

entities?
b. What are take-or-pay contracts?
c. Should Ryan record the plant as an asset together with the related
obligation? If not, should Ryan record an asset relating to the future
commitment?
d. What is meant by off-balance-sheet financing?
CA14.6 (LO1, 4) (Bond Issue) Donald Lennon is the president, founder,
and majority owner of Wichita Medical Group, an emerging medical
technology products company. Wichita is in dire need of additional capital to
keep operating and to bring several promising products to final
development, testing, and production. Donald, as owner of 51% of the
outstanding shares, manages the company's operations. He places heavy
emphasis on research and development and long-term growth. The other
principal shareholder is Nina Friendly who, as a non-employee investor,
owns 40% of the shares. Nina would like to deemphasize the R & D
functions and emphasize the marketing function to maximize short-run
 sales and profits from existing products. She believes this strategy would
raise the market price of Wichita's shares.
All of Donald's personal capital and borrowing power is tied up in his 51%
share ownership. He knows that any offering of additional shares will dilute his
controlling interest because he won't be able to participate in such an
issuance. But, Nina has money and would likely buy enough shares to gain
control of Wichita. She then would dictate the company's future direction,
even if it meant replacing Donald as president.
The company already has considerable debt. Raising additional debt will be
costly, will adversely affect Wichita's credit rating, and will increase the
company's reported losses due to the growth in interest expense. Nina and
the other minority shareholders express opposition to the assumption of
additional debt, fearing the company will be pushed to the brink of bankruptcy.
Wanting to maintain his control and to preserve the direction of “his” company,
Donald is doing everything to avoid a share issuance and is contemplating a
large issuance of bonds, even if it means the bonds are issued with a high
effective-interest rate.
Instructions

a. Who are the stakeholders in this situation?

b. What are the ethical issues in this case?
c. What would you do if you were Donald?

Using Your Judgment

Financial Reporting Problem

Marks and Spencer plc (M&S)

The financial statements of M&S (GBR) are presented in Appendix A. The

company's complete annual report, including the notes to the financial
statements, is available online.
Instructions

Refer to M&S's financial statements and the accompanying notes to answer

the following questions.
a. What cash outflow obligations related to the repayment of long-term
debt does M&S have over the next 5 years?
 b. M&S indicates that it believes that it has the ability to meet business
requirements in the foreseeable future. Prepare an assessment of its
liquidity, solvency, and financial flexibility using ratio analysis.

Comparative Analysis Case

adidas and Puma

The financial statements of adidas (DEU) and Puma (DEU) are presented in
Appendices B and C, respectively. The complete annual reports, including the
notes to the financial statements, are available online.
Instructions

Use the companies' financial information to answer the following questions.

a. Compute the debt to assets ratio and the times interest earned for
these two companies. Comment on the quality of these two ratios for
both adidas and Puma.
b. What is the difference between the fair value and the historical cost
(carrying amount) of each company's borrowings at year-end 2015?
Why might a difference exist in these two amounts?
c. Do these companies have debt issued in foreign countries? Speculate
as to why these companies may use foreign debt to finance their
operations. What risks are involved in this strategy, and how might they
adjust for this risk?

Financial Statement Analysis Cases

Case 1 Commonwealth Edison Co.

The following article about Commonwealth Edison Co. (USA) appeared in

the Wall Street Journal.
Bond Markets
Giant Commonwealth Edison Issue Hits Resale Market With $70 Million
Left Over
NEW YORK—Commonwealth Edison Co.'s slow-selling new 9¼% bonds
were tossed onto the resale market at a reduced price with about $70
million still available from the $200 million offered Thursday, dealers said.
 The Chicago utility's bonds, rated double-A by Moody's and double-A-
minus by Standard & Poor's, originally had been priced at 99.803, to yield
9.3% in 5 years. They were marked down yesterday the equivalent of
about $5.50 for each $1,000 face amount, to about 99.25, where their
yield jumped to 9.45%.
Instructions

a. How will the development above affect the accounting for

Commonwealth Edison's bond issue?
b. Provide several possible explanations for the markdown and the slow
sale of Commonwealth Edison's bonds.
Case 2 Eurotec

Consider the following events relating to Eurotec's long-term debt in a recent

year.
1. The company decided on February 1 to refinance €500 million in short-
term 7.4% debt to make it long-term 6%.
2. €780 million of long-term zero-coupon bonds with an effective-interest
rate of 10.1% matured July 1 and were paid.
3. On October 1, the company issued €250 million in Australian dollars
6.3% bonds at 102 and €95 million in Italian lira 11.4% bonds at 99.
4. The company holds €100 million in perpetual foreign interest payment
bonds that were issued in 1989 and presently have a rate of interest of
5.3%. These bonds are called perpetual because they have no stated
due date. Instead, at the end of every 10-year period after the bond's
issuance, the bondholders and Eurotec have the option of redeeming
the bonds. If either party desires to redeem the bonds, the bonds must
be redeemed. If the bonds are not redeemed, a new interest rate is set,
based on the then-prevailing interest rate for 10-year bonds. The
company does not intend to cause redemption of the bonds but will
reclassify this debt to current next year since the bondholders could
decide to redeem the bonds.
Instructions

a. Consider event 1. What are some of the reasons the company may
have decided to refinance this short-term debt, besides lowering the
interest rate?
 b. What do you think are the benefits to the investor in purchasing zero-
coupon bonds, such as those described in event 2? What journal entry
would be required to record the payment of these bonds? If financial
statements are prepared each December 31, in which year would the
bonds have been included in current liabilities?
c. Make the journal entry to record the bond issues described in event 3.
Note that the bonds were issued on the same day, yet one was issued
at a premium and the other at a discount. What are some of the
reasons that this may have happened?
d. What are the benefits to Eurotec in having perpetual bonds as
described in event 4? Suppose that in the current year, the bonds are
not redeemed and the interest rate is adjusted to 6% from 7.5%. Make
all necessary journal entries to record the renewal of the bonds and the
change in rate.

Accounting, Analysis, and Principles

The following information is taken from the 2019 annual report of Bugant SA.
Bugant's fiscal year ends December 31 of each year.

Bugant, SA
Statement of Financial Position
December 31, 2019

Assets
Plant and equipment (net of accumulated depreciation of €1,840
€160)
Inventory €1,800
Cash 450
Total current assets 2,250
Total assets €4,090
Equity
Share capital €1,500
Retained earnings 1,164
Liabilities
Bonds payable (net of discount) 1,426
Total equity and liabilities €4,090
Note X: Long-Term Debt
On January 1, 2017, Bugant issued bonds with face value of €1,500 and
coupon rate equal to 10%. The bonds were issued to yield 12% and mature
on January 1, 2022.
Additional information concerning 2020 is as follows.
1. Sales were €2,922, all for cash.
2. Purchases were €2,000, all paid in cash.
3. Salaries were €700, all paid in cash.
4. Plant and equipment was originally purchased for €2,000 and is
depreciated on a straight-line basis over a 25-year life with no residual
value.
5. Ending inventory was €1,900.
6. Cash dividends of €100 were declared and paid by Bugant.
7. Ignore taxes.
8. The market rate of interest on bonds of similar risk was 16% during all
of 2020.
9. Interest on the bonds is paid semiannually each June 30 and
December 31.
Accounting

Prepare an income statement for Bugant for the year ending December 31,
2020, and a statement of financial position at December 31, 2020. Assume
semiannual compounding.
Analysis

Use common ratios for analysis of long-term debt to assess Bugant's long-run
solvency. Has Bugant's solvency changed much from 2019 to 2020? Bugant's
net income in 2019 was €550 and interest expense was €169.39.
Principles

Recently, the FASB and the IASB allowed companies the option of
recognizing in their financial statements the fair values of their long-term debt.
That is, companies have the option to change the statement of financial
position value of their long-term debt to the debt's fair (or market) value and
report the change in statement of financial position value as a gain or loss in
income. In terms of the qualitative characteristics of accounting information
(Chapter 2), briefly describe the potential trade-off (s) involved in reporting
long-term debt at its fair value.

Bridge to the Profession

Authoritative Literature References

[1] International Financial Reporting Standard 9, Financial Instruments:
Recognition and Measurement (London, U.K.: IFRS Foundation, 2013), par.
4.2.1.
[2] International Financial Reporting Standard 9, Financial Instruments
(London, U.K.: IFRS Foundation, 2013), par. 5.1.1.
[3] International Financial Reporting Standard 9, Financial Instruments
(London, U.K.: IFRS Foundation, 2013), par. B5.1.2A.
[4] International Financial Reporting Standard 9, Financial Instruments
(London, U.K.: IFRS Foundation, 2013), par. 3.3.
[5] International Financial Reporting Standard 9, Financial Instruments
(London, U.K.: IFRS Foundation, 2013), par. B3.3.6.
[6] International Financial Reporting Standard 9, Financial Instruments
(London, U.K.: IFRS Foundation, 2013), par. 3.3.2.
[7] International Financial Reporting Standard 9, Financial Instruments
(London, U.K.: IFRS Foundation, 2013), par. 4.2.2.
[8] International Financial Reporting Standard 9, Financial Instruments
(London, U.K.: IFRS Foundation, November 2013), paras. 5.7.7–5.7.8.
[9] International Financial Reporting Standard 10, Consolidated Financial
Statements (London, U.K.: International Accounting Standards Committee
Foundation, May 2011), paras. IN8–IN9.
[10] International Accounting Standard 1, Presentation of Financial
Statements (London, U.K.: International Accounting Standards Committee
Foundation, 2003), paras. 69–76.

Research Case
Wie Company has been operating for just 2 years, producing specialty golf
equipment for women golfers. To date, the company has been able to finance
its successful operations with investments from its principal owner, Michelle
Wie, and cash flows from operations. However, current expansion plans will
require some borrowing to expand the company's production line.
As part of the expansion plan, Wie is contemplating a borrowing on a note
payable or issuance of bonds. In the past, the company has had little need for
external borrowing so the management team has a number of questions
concerning the accounting for these new non-current liabilities. They have
asked you to conduct some research on this topic.
Instructions

Access the IFRS authoritative literature at the IASB website

(http://eifrs.iasb.org/) (you may register for free eIFRS access at this site).
When you have accessed the documents, you can use the search tool in your
Internet browser to respond to the following questions. (Provide paragraph
citations.)
a. With respect to a decision of issuing notes or bonds, management is
aware of certain costs (e.g., printing, marketing, and selling) associated
with a bond issue. How will these costs affect Wie's reported earnings
in the year of issue and while the bonds are outstanding?
b. If all goes well with the plant expansion, the financial performance of
Wie Company could dramatically improve. As a result, Wie's market
rate of interest (which is currently around 12%) could decline. This
raises the possibility of retiring or exchanging the debt, in order to get a
lower borrowing rate. How would such a debt extinguishment be
accounted for?

Global Accounting Insights

LEARNING OBJECTIVE 5
U.S. GAAP and IFRS have similar definitions for liabilities. In addition, the
accounting for current liabilities is essentially the same under both IFRS
and U.S. GAAP. However, there are substantial differences in terminology
related to non-current liabilities as well as some differences in the
accounting for various types of long-term debt transactions.
Relevant Facts

Similarities

As indicated above, U.S. GAAP and IFRS have similar liability definitions.
Both also classify liabilities as current and non-current.
Much of the accounting for bonds and long-term notes is the same under
U.S. GAAP and IFRS.
Under U.S. GAAP and IFRS, bond issue costs are netted against the
carrying amount of the bonds.
Both U.S. GAAP and IFRS require the best estimate of a probable loss. In
U.S. GAAP, the minimum amount in a range is used. Under IFRS, if a
range of estimates is predicted and no amount in the range is more likely
than any other amount in the range, the midpoint of the range is used to
measure the liability.
Both U.S. GAAP and IFRS prohibit the recognition of liabilities for future
losses.

Differences

Under U.S. GAAP, companies must classify a refinancing as current only if

it is completed before the financial statements are issued. IFRS requires
that the current portion of long-term debt be classified as current unless an
agreement to refinance on a long-term basis is completed before the
reporting date.
U.S. GAAP uses the term contingency in a different way than IFRS. A
contingency under U.S. GAAP may be reported as a liability under certain
situations. IFRS does not permit a contingency to be recorded as a liability.
U.S. GAAP uses the term estimated liabilities to discuss various liability
items that have some uncertainty related to timing or amount. IFRS
generally uses the term provisions.
U.S. GAAP and IFRS are similar in the treatment of environmental
liabilities. However, the recognition criteria for environmental liabilities are
more stringent under U.S. GAAP: Environmental liabilities are not
recognized unless there is a present legal obligation and the fair value of
the obligation can be reasonably estimated.
 U.S. GAAP uses the term troubled debt restructurings and develops
recognition rules related to this category. IFRS generally assumes that all
restructurings should be considered extinguishments of debt.
Under U.S. GAAP, companies are permitted to use the straight-line
method of amortization for bond discount or premium, provided that the
amount recorded is not materially different than that resulting from
effective-interest amortization. However, the effective-interest method is
preferred and is generally used. Under IFRS, companies must use the
effective-interest method.
Under U.S. GAAP, companies record discounts and premiums in separate
accounts (see the About the Numbers section). Under IFRS, companies
do not use premium or discount accounts but instead show the bond at its
net amount.
Under U.S. GAAP, losses on onerous contracts are generally not
recognized unless addressed by industry- or transaction-specific
requirements. IFRS requires a liability and related expense or cost be
recognized when a contract is onerous.

About the Numbers

Under IFRS, premiums and discounts are netted against the face value of the
bonds for recording purposes. Under U.S. GAAP, discounts and premiums are
recorded in separate accounts. To illustrate, consider the €100,000 of bonds
dated January 1, 2019 (8 percent coupon, paid semiannually), issued by
Evermaster to yield 6 percent on January 1, 2019. Recall from the discussion
earlier in this chapter that the price of these bonds was €108,530. Using U.S.
GAAP procedures, Evermaster makes the following entry to record issuance
of the bonds.

January 1, 2019
Cash 108,530
Bonds Payable 100,000
Premium on Bonds Payable (€108,530 − €100,000) 8,530
As indicated, the bond premium is recorded in a separate account (the
account, “Discount on Bonds Payable,” has a debit balance and is used for
bonds issued at a discount). Evermaster makes the following entry on the first
interest payment date.
 July 1, 2019
Interest Expense (€108,530 × 6% × ½) 3,256
Premium on Bonds Payable (€4,000 − €3,256) 744
Cash (€100,000 × 8% × ½) 4,000
Following this entry, the net carrying value of the bonds is as follows.
Bonds Payable €100,000
Premium on bonds payable (€8,530 − €744) 7,786
Carrying value of bonds payable €107,786
Thus, with a separate account for the premium, entries to record amortization
are made to the premium account, which reduces the carrying value of the
bonds to face value over the life of the bonds.

On the Horizon

As indicated in Chapter 2, the IASB and FASB are working on a conceptual

framework project, part of which will examine the definition of a liability. In
addition, the two Boards are attempting to clarify the accounting related to
provisions and related contingencies. The FASB has a project that will align
the classification of debt to be refinanced in a manner similar to IFRS.

GAAP Self-Test Questions

1. Under U.S. GAAP, bond issuance costs, including the printing costs
and legal fees associated with the issuance, should be:
a. expensed in the period when the debt is issued.
b. recorded as a reduction in the carrying value of bonds payable.
c. accumulated in a deferred charge account and amortized over the
life of the bonds.
d. reported as an expense in the period the bonds mature or are
redeemed.
2. Which of the following is stated correctly?
a. Current liabilities follow non-current liabilities on the statement of
financial position under U.S. GAAP but non-current liabilities follow
current liabilities under IFRS.
 b. IFRS does not treat debt modifications as extinguishments of debt.
c. Bond issuance costs are recorded as a reduction of the carrying
value of the debt under U.S. GAAP but are recorded as an asset
and amortized to expense over the term of the debt under IFRS.
d. Under U.S. GAAP, bonds payable is recorded at the face amount
and any premium or discount is recorded in a separate account.
Under IFRS, bonds payable is recorded at the carrying value so no
separate premium or discount accounts are used.
3. All of the following are differences between IFRS and U.S. GAAP in
accounting for liabilities except:
a. When a bond is issued at a discount, U.S. GAAP records the
discount in a separate contra liability account. IFRS records the
bond net of the discount.
b. Under IFRS and U.S. GAAP, bond issuance costs reduce the
carrying value of the debt.
c. U.S. GAAP, but not IFRS, uses the term “troubled-debt
restructurings.”
d. U.S. GAAP, but not IFRS, uses the term “provisions” for contingent
liabilities that are accrued.
4. All of the following are similarities in the accounting for liabilities under
IFRS and U.S. GAAP except:
a. Bond issue costs are netted against the carrying amount of the
bonds.
b. Both U.S. GAAP and IFRS use the same terms when describing
liabilities.
c. Recognition of liabilities for future losses is prohibited under U.S.
GAAP and IFRS.
d. Both U.S. GAAP and IFRS require the best estimate for a
probable loss with U.S. GAAP selecting the minimum amount in
the range.
5. On January 1, Martinez Inc. issued $3,000,000, 11% bonds for
$3,195,000. The market rate of interest for these bonds is 10%. Interest
is payable annually on December 31. Martinez uses the effective-
interest method of amortizing bond premium. At the end of the first
year, Martinez should report bonds payable of:
 a. $3,185,130.
b. $3,184,500.
c. $3,173,550.
d. $3,165,000.

GAAP Concepts and Application

GAAP14.1 Briefly describe some of the similarities and differences

between U.S. GAAP and IFRS with respect to the accounting for
liabilities.
GAAP14.2 Diaz Company issued $100,000 face value, 9% coupon
bonds on January 1, 2018, for $92,608 to yield 11%. The bonds mature in
5 years and pay interest annually on December 31. Prepare the entries
under U.S. GAAP for Diaz for (a) date of issue, (b) first interest payment
date, and (c) January 1, 2020, when Diaz calls and extinguishes the
bonds at 101.
GAAP14.3 Briefly discuss how accounting convergence efforts
addressing liabilities are related to the IASB/FASB conceptual framework
project.

Notes
1 It is generally the case that the stated rate of interest on bonds is set in
rather precise decimals (such as 10.875 percent). Companies usually
attempt to align the stated rate as closely as possible with the market
effective rate at the time of issue.
2 The carrying value is the face amount minus any unamortized discount or
plus any unamortized premium. The term carrying value is synonymous
with book value .
3 The issuance of bonds involves engraving and printing costs, legal and
accounting fees, commissions, promotion costs, and other similar charges.
These costs should be recorded as a reduction of the issue amount of the
bond payable and then amortized into expense over the life of the bond,
through an adjustment to the effective-interest rate (see Underlying
Concepts). [2 ] For example, if the face value of the bond is €100,000 and
issue costs are €1,000, then the bond payable (net of the bond issue costs)
 is recorded at €99,000. Thus, the effective-interest rate will be higher,
based on the reduced carrying value.
4 Because companies pay interest semiannually, the interest rate used is
. The number of periods is 10 (5 years × 2) .
5 The issuer may call some bonds at a stated price after a certain date. This
call feature gives the issuing company the opportunity to reduce its bonded
indebtedness or take advantage of lower interest rates. Whether callable or
not, a company must amortize any premium or discount over the bond's life
to maturity because early redemption (call of the bond) is not a certainty.
6 Determination of the price of a bond between interest payment dates
generally requires use of a financial calculator because the time value of
money tables shown in this textbook do not have factors for all
compounding periods. For homework purposes, the price of a bond sold
between interest dates will be provided .
7 Although we use the term “note” throughout this discussion, the basic
principles and methodology apply equally to other long-term debt
instruments.
8

9 Points, in mortgage financing, are analogous to the original issue discount of

bonds.
10 Some companies have attempted to extinguish debt through an in-
substance defeasance. In-substance defeasance is an arrangement
whereby a company provides for the future repayment of a long-term debt
issue by placing purchased securities in an irrevocable trust. The company
pledges the principal and interest of the securities in the trust to pay off the
principal and interest of its own debt securities as they mature. However, it
is not legally released from its primary obligation for the debt that is still
outstanding. In some cases, debtholders are not even aware of the
transaction and continue to look to the company for repayment. This
 practice is not considered an extinguishment of debt, and therefore the
company does not record a gain or loss. [4 ]
11 The issuer of callable bonds must generally exercise the call on an interest
date. Therefore, the amortization of any discount or premium will be up to
date, and there will be no accrued interest. However, early extinguishments
through purchases of bonds in the open market are more likely to be on
other than an interest date. If the purchase is not made on an interest date,
the discount or premium must be amortized, and the interest payable must
be accrued from the last interest date to the date of purchase.
12 Likewise, the creditor must determine the excess of the receivable over the
fair value of those same assets or equity interests transferred. The creditor
normally charges the excess (loss) against Allowance for Doubtful
Accounts. Creditor accounting for these transactions is addressed in
Chapter 7.
13 An exception to the general rule is when the modification of terms is not
substantial. A substantial modification is defined as one in which the
discounted cash flows under the terms of the new debt (using the historical
effective-interest rate) differ by at least 10 percent of the carrying value of
the original debt. If a modification is not substantial, the difference (gain) is
deferred and amortized over the remaining life of the debt at the (historical)
effective-interest rate. [5 ] In the case of a non-substantial modification, in
essence, the new loan is a continuation of the old loan. Therefore, the
debtor should record interest at the historical effective-interest rate.
14 Throughout the textbook, we use the label “statement of financial position”
rather than “balance sheet” in referring to the financial statement that
reports assets, liabilities, and equity. We use off-balance-sheet in the
present context because of its common usage in financial markets.
15 The IASB has issued consolidation guidance that looks beyond equity
ownership as the primary criterion for determining whether an off-balance-
sheet entity (and its assets and liabilities) should be on-balance-sheet (i.e.,
consolidated). Specifically, an investor controls an investee when it is
exposed, or has rights, to variable returns from its involvement with the
investee and has the ability to affect those returns through its power over
the investee. Thus, the principle of control sets out the following three
elements of control: (1) power over the investee; (2) exposure, or rights, to
variable returns from involvement with the investee; and (3) the ability to
use power over the investee to affect the amount of the investor's returns.
 In general, the control principle is applied in circumstances when voting
rights are not the dominant factor in deciding who controls the investee,
such as when any voting rights relate to administrative tasks only and the
relevant activities are directed by means of contractual arrangements. [9 ]
The details of consolidation accounting procedures are beyond the scope
of this textbook and are usually addressed in an advanced accounting
course.
16 It is unlikely that the IASB will be able to stop all types of off-balance-sheet
transactions. Financial engineering is the Holy Grail of securities markets.
Developing new financial instruments and arrangements to sell and market
to customers is not only profitable but also adds to the prestige of the
investment firms that create them. Thus, new financial products will
continue to appear that will test the ability of the IASB to develop
appropriate accounting standards for them.