Chap 014

Chapter 14
Long-Term Liabilities
QUESTIONS
1. A bond is a liability of the issuing company. A share of stock represents an ownership
interest in the company.
2. Notes payable generally involve borrowing from a single creditor, whereas bonds
payable are usually sold to many different lenders (bondholders).
3. A trustee for bondholders has the responsibility of monitoring the issuers actions,
financial performance, and financial condition to ensure that the obligations in the bond
indenture are met.
4. Bonds can allow a companys owners to increase their return on equity without
investing additional amounts. This result occurs as long as the rate of return on the
assets acquired from the borrowed cash is greater than the interest rate paid on the
bonds. Bonds also help the current owners remain in control of the company. There is
also a tax advantage with bonds when issued by corporations.
5. A bond indenture is a legal contract between the issuing company and the bondholders
that identifies the obligations and rights of both parties. It specifies such items as the
par value of the bonds, the contract interest rate, the due dates for interest payments,
and the maturity date(s) of the bonds. It also may name a trustee, describe the bond
issue in detail, and provide for a sinking fund.
6. The contract rate is the rate that is identified in the bond indenture. It is applied to the
par value to determine the size of the cash interest payments. The market rate is the
consensus rate that a company is willing to pay and that investors are willing to accept
for a specific bond.
7. In general, the supply of and demand for bonds affect market rates. The market rate for
a particular bond issue is also affected by risks unique to the issuer (e.g., financial
performance and condition) and the length of time until the bonds mature.
8.B The effective interest method creates a constant rate of interest over a bonds life
because the market rate at the time of issuance is multiplied by the beginning balance
for each period. The straight-line method produces either an increasing or decreasing
rate because it allocates the same amount of expense to each period, even if the liability
balance is growing (a discount) or decreasing (a premium).
9. When issuing bonds between interest dates, a company collects accrued interest from
the purchasers to avoid keeping detailed records of bond purchasers and the dates
when bonds are purchased. If the company did not collect accrued interest, individual
checks would be needed to pay the correct amount of interest to each purchaser. By
collecting in advance, the issuer merely distributes the same amount per check to all
bondholders, regardless of when they purchased the bonds.
Solutions Manual, Chapter 14
McGraw-Hill Companies, Inc., 2005

53
10. The price of bonds can be computed by using the market rate to find the present value
of both the par value at maturity and the periodic cash interest payments.
11. The issue price of a $2,000 bond sold at 98 is 98.25% of $2,000, or $1,965. The issue
price of a $6,000 bond priced at 101 is 101.5% of $6,000, or $6,090.
12. Installment notes usually require one of two payment patterns: (1) payments of accrued
interest plus equal amounts of principal, and (2) equal total payments that consist of
changing amounts of interest and principal.
13. An increase in this ratio can indicate that there has been a shrinkage in the pool of
assets available for paying the companys unsecured liabilities. It can also indicate that
the value of the company's assets in liquidation is low. In either case, the unsecured
creditors lower their confidence in the company's ability to meet its obligations from
operations.
14. An entrepreneur (owner) must repay the bondholders the principal (par value) according
to the term of the bonds. He or she must also pay interest on the bonds per the amount
and frequency cited in the bond indenture, and must adhere to any stipulations
(covenants) specified in the bond contract.
15. Krispy Kreme does show long-term debt on the balance sheet. To determine whether
the long term debt is comprised of bonds or other obligations we can read footnote 7
disclosing debt details of the company. The footnote reports that its long-term debt is
comprised of term loans and lines of credit, not bonds.
16. Per Tastykakes December 28, 2002, statement of cash flows (financing section), the
company repaid $2,117,092 for the fiscal year ended December 28, 2002.
17. The financing section of the statement of cash flows of Harley-Davidson indicates that
for the year ended December 31, 2002, the company issued common stock under
employee stock option plans totaling $12,679,000. For that same period, the company
reports proceeds from issuing finance debt of $165,528,000.
18.C If a lease qualifies to be recorded as a capital lease then an asset account for the leased
asset will be debited with an amount equal to the present value of the future lease
payments. The corresponding credit will be to a lease liability account.
19.C An operating lease is a short-term or cancelable lease in which the lessor retains the
risks and rewards of ownership. The lessee expenses operating lease payments when
incurred and the lessee does not report the leased item(s) as an asset nor as a liability.
A capital lease is a long-term or noncancelable lease in which the lessor transfers
substantially all the risks and rewards of ownership to the lessee. The lessee records
the leased item as its own asset along with a lease liability at the start of the lease term
the amount recorded equals the present value of all lease payments.
20.C Pension plans can be designed as defined benefit plans or defined contribution plans. In
a defined benefit plan the employer estimates the contribution necessary to pay a predefined benefit amount to its retirees. For example, an employees monthly pension
benefit may be set at $1,000 per month. The employer must contribute the amount
necessary to the pension plan to fund the $1,000 a month to the employee when the
employee retires. Alternatively, with a defined contribution plan, the pension
contribution is defined and the employer or employee contributes the amount specified
in the pension agreement. For example, a defined contribution plan might specify that
the employer will contribute 2% of an employees annual salary to the pension plan every
year.

54
Fundamental Accounting Principles, 17th Edition
QUICK STUDIES
Quick Study 14-1 (10 minutes)
1.
2.
3.
4.
B
D
F
A
Debenture
Bond Indenture
Bearer bond
Registered bond
5.
6.
7.
8.
G
E
H
C
Sinking fund bond

Convertible bond
Secured bond
Serial bond

1.
Bonds cash proceeds: $350,000 x 0.875 = $306,250
2.
Twenty semiannual interest payments of $14,000......

Plus bond discount ($350,000 - $306,250)...................
Total bond interest expense..........................................
3.
Bond interest expense on first payment date:

$323,750 / 20 semiannual periods = $16,188
$280,000
43,750
$323,750
Quick Study 14-3B (10 minutes)

1.
Bonds cash proceeds: $120,000 x 1.1725 = $140,700
2.
Thirty semiannual interest payments of $6,000..........

Less premium ($140,700 - $120,000)............................
Total bond interest expense..........................................
3.
Bond interest expense on first payment date:

$140,700 x 4% = $5,628
$180,000
(20,700)
$159,300

55

2005
Jan. 1
Cash.................................................................................
306,250
Discount on Bonds Payable..........................................
43,750
Bonds Payable..........................................................
350,000
To record issuing bonds at a discount.
Jan. 1
Cash.................................................................................
140,700
Bonds Payable..........................................................
120,000
Premium on Bonds Payable....................................
20,700
To record issuing bonds at a premium.

a. Using facts in QS 14-2, the bonds cash proceeds for the bond selling at
a discount are computed as follows
Cash Flow
Table Value
$350,000 par (maturity) value................ 0.3769
$14,000 interest payment....................... 12.4622
Price of Bond.......................................
*
Present Value
$131,915
174,471
$306,386*
Agrees with $306,250 as given in QS 14-2, except for rounding difference.

(Instructor note: The price in QS 14-2 is rounded to 87.5 from 87.5388, yielding the $136 difference).
b. Using facts in QS 14-3, the bonds cash proceeds for the bond selling at
a premium are computed as
Cash Flow
Table Value
$120,000 par (maturity) value................
0.3083
$ 6,000 interest payment...................... 17.2920
Price of Bond.......................................
*
Present Value
$ 36,996
103,752
$140,748*
Agrees with $140,700 as given in QS 14-3, except for rounding difference.

2005
Mar. 1
Cash................................................................................
202,667
Interest payable*.......................................................
2,667
Bonds payable..........................................................
200,000

56
Sold $200,000 of bonds with two months

accrued interest. *($200,000 x .08 x 2/12)

57

2005
July 1
Bonds Payable................................................................
200,000
Premium on Bonds Payable..........................................
8,000
Gain on Retirement of Bonds*................................
Cash...........................................................................
3,000
205,000
To record retirement of bonds before maturity.

*$3,000 = $208,000 - $205,000

2005
Jan. 1
Bonds Payable.................................................................
1,000,000
Common Stock*.........................................................
Contributed Capital in Excess of Par Value................
250,000
750,000
To record retirement of bonds by stock

conversion. *500,000 shares x $0.50

Initial cash proceeds from note
Amount of annual payment = Table B.3 present value for 5 payments
a.
4%: Payment = $170,000 / 4.4518 = $38,187
b.
8%: Payment = $170,000 / 3.9927 = $42,578
c.
12%: Payment = $170,000 / 3.6048 = $47,159

Collins Industries is restricted in several ways by the creditor bank. They are
restricted from incurring certain types of additional indebtedness, from
making certain investments, from selling a substantial portion of their assets,
from making certain capital expenditures, and from granting substantial cash
dividends. In addition, the company must maintain the agreed upon level of
certain financial ratios and other measures of financial condition.

58

Ratio of pledged assets to secured liabilities
Xiang Co.
Xu Co.
Pledged assets.......................
$387,000
$172,000
Secured liabilities...................
$163,000
$158,000
Ratio........................................
2.37 to 1
1.09 to 1
Analysis and interpretation: Xus secured liabilities appear more risky as it

only has $1.09 in pledged assets for each $1 in secured liabilities. In
comparison, each $1 of Xiangs secured liabilities is covered by $2.37 in
pledged assets.
Quick Study 14-12C (10 minutes)

Rental Expense...............................................................350
Cash (or Payable).....................................................
350
To record rental expense for car lease.
Quick Study 14-13C (10 minutes)

Leased AssetOffice Equipment.................................
20,859
Lease Liability...........................................................
20,859
To record capital lease of office equipment.

59
EXERCISES
Exercise 14-1 (15 minutes)
1.
Semiannual cash interest payment = $1,700,000 x 9% x 1/2 = $76,500
2.
Journal entries
2005
(a)
Jan. 1 Cash.................................................................................
1,700,000
Bonds Payable..........................................................
1,700,000
Sold bonds at par.
(b)
June 30
Bond Interest Expense..................................................

76,500
Cash...........................................................................
76,500
Paid semiannual interest on bonds.
(c)
Dec. 31

76,500
Cash...........................................................................
76,500
Paid semiannual interest on bonds.
3.
2005
(a)
Jan.
Cash*
1,666,000
34,000
Bonds Payable..........................................................
1,700,000
Sold bonds at 98. *($1,700,000 x 0.98)
(b)
Jan.
Cash*
1,734,000
Bonds Payable..........................................................
34,000
1,700,000
Sold bonds at 102. *($1,700,000 x 1.02)

60

1. Discount = Par value - Issue price = $90,000 - $85,431 = $4,569
2. Total bond interest expense over the life of the bonds
Amount repaid
Six payments of $3,600.................
Par value at maturity.....................
Total repaid....................................
Less amount borrowed....................
Total bond interest expense............
$ 21,600
90,000
111,600
(85,431)
$ 26,169
or:
Six payments of $3,600....................
Plus discount....................................
$ 21,600
4,569
$ 26,169
3. Straight-line amortization table

Semiannual
Period-End
Unamortized
Discount
Carrying
Value
(0)
1/01/2005.........................$4,569
$85,431
(1)
6/30/2005......................... 3,807
86,193
(2) 12/31/2005......................... 3,045
86,955
(3)
6/30/2006......................... 2,283
87,717
(4) 12/31/2006......................... 1,521
88,479
(5)
89,241
6/30/2007.........................
(6) 12/31/2007.........................
759*
0
90,000
*Adjusted for rounding

61
Exercise 14-3B (30 minutes)

1. Discount = Par value - Issue price = $250,000 - $231,570 = $18,430
Amount repaid
Six payments of $11,250...............
Total repaid....................................
or
Six payments of $11,250..................
Plus discount....................................
$ 67,500
250,000
317,500
(231,570)
$ 85,930
$ 67,500
18,430
$ 85,930
3. Effective interest amortization table

Semiannual
Interest
Period-End
(A)
(B)
Cash Interest
Bond Interest
Paid
Expense
[4.5% x $250,000] [6% x Prior (E)]
(C)
Discount
Amortization
[(B) - (A)]
1/01/2005
(D)
(E)
Unamortized
Carrying
Discount
Value
[Prior (D) - (C)] [$250,000 - (D)]
$18,430
$231,570
6/30/2005
$11,250
$13,894
$ 2,644
15,786
234,214
12/31/2005
11,250
14,053
2,803
12,983
237,017
6/30/2006
11,250
14,221
2,971
10,012
239,988
12/31/2006
11,250
14,399
3,149
6,863
243,137
6/30/2007
11,250
14,588
3,338
3,525
246,475
12/31/2007
11,250
14,775 *
3,525
250,000
$67,500
$85,930
$18,430
*Adjusted for rounding.

62

1. Premium = Issue price - Par value = $819,700 - $800,000 = $19,700
Amount repaid
Six payments of $52,000...............
Total repaid....................................
or
Six payments of $52,000..................
Less premium...................................
$ 312,000
800,000
1,112,000
(819,700)
$ 292,300
$ 312,000
(19,700)
$ 292,300
3. Straight-line amortization table: ($19,700/6 = $3,283)

Semiannual
Interest Period-End
Unamortized
Premium
Carrying
Value
1/01/2005
$19,700
$819,700
6/30/2005
16,417
816,417
12/31/2005
13,134
813,134
6/30/2006
9,851
809,851
12/31/2006
6,568
806,568
6/30/2007
3,285
803,285
12/31/2007
800,000

63
Exercise 14-5B (30 minutes)

1. Premium = Issue price - Par value = $819,700 - $800,000 = $19,700
Amount repaid
Six payments of $52,000...............
Total repaid....................................
or
Six payments of $52,000..................
Less premium...................................
$ 312,000
800,000
1,112,000
(819,700)
$ 292,300
$ 312,000
(19,700)
$ 292,300
3. Effective interest amortization table

Semiannual
Interest
Period-End
(A)
(B)
Cash Interest
Bond Interest
Paid
Expense
[6.5% x $800,000] [6% x Prior (E)]
(C)
Premium
Amortization
[(A) - (B)]
1/01/2005
(D)
(E)
Unamortized
Carrying
Premium
Value
[Prior (D) - (C)] [800,000 + (D)]
$19,700
$819,700
6/30/2005
$ 52,000
$ 49,182
$ 2,818
16,882
816,882
12/31/2005
52,000
49,013
2,987
13,895
813,895
6/30/2006
52,000
48,834
3,166
10,729
810,729
12/31/2006
52,000
48,644
3,356
7,373
807,373
6/30/2007
52,000
48,442
3,558
3,815
803,815
12/31/2007
52,000
48,185*
3,815
800,000
$312,000
$292,300
$ 19,700

64

1. Semiannual cash interest payment = $600,000 x 6% x year = $18,000
2. Number of payments = 10 years x 2 per year = 20 semiannual payments
3. The 6% contract rate is less than the 8% market rate; therefore, the
bonds are issued at a discount.
4. Estimation of the market price at the issue date
Cash Flow
Table
Par (maturity) value........B.1
Interest (annuity).............B.3
Price of bonds.................
Table Value*
0.4564
13.5903
Amount
$600,000
18,000
Present Value
$273,840
244,625
$518,465
* Table values are based on a discount rate of 4% (half the annual market rate) and
20 periods (semiannual payments).
5.
Cash.................................................................................
518,465
81,535
Bonds Payable..........................................................
600,000
Sold bonds at a discount on the stated issue date.

1. Semiannual cash interest payment = $75,000 x 10% x year = $3,750
2. Number of payments = 5 years x 2 per year = 10 semiannual payments
3. The 10% contract rate is greater than the 8% market rate; therefore, the
bonds are issued at a premium.
4. Estimation of the market price at the issue date
Cash Flow
Table Table Value*
Par (maturity) value........B.1
0.6756
Interest (annuity).............B.3
8.1109
Price of bonds.................
Amount
$75,000
3,750
Present Value
$50,670
30,416
$81,086
5.
Cash.................................................................................
81,086

65

Bonds Payable..........................................................
6,086
75,000
Sold bonds at a premium on the stated issue date.

66

1. Cash proceeds from sale of bonds at issuance
$350,000 x 97.75% = $342,125
2. Discount at issuance
Par value................................................ $350,000
Cash issue price (from part 1)............. (342,125)
Discount at issuance............................ $ 7,875
3. Total amortization for first 6 years
The first six years (from 1/1/04 to 12/31/09) equals 40% of the bonds 15year life. Therefore, the total amortization equals 40% of the total
discount (since straight-line amortization is being used), which is
$7,875 x 40%, or $3,150.
4. Carrying value of the bonds at 12/31/2009
Discount at issuance (from part 2)......
Less amortization (from part 3)...........
Remaining discount..............................
$ 7,875
(3,150)
$ 4,725
Entire Group
Par value................................................. $350,000
Remaining discount...............................
(4,725)
Carrying value........................................ $345,275
Retired 20%
$70,000
(945)
$69,055
5. Cash purchase price

($350,000 x 20%) x 104.5% = $73,150
6. Loss on retirement
Cash paid (from part 5).......................
Carrying value (from part 4)................
Loss on retirement..............................
$ 73,150
(69,055)
$ 4,095
7. Journal entry at retirement for 20% of bonds

2010
Jan. 1
Bonds Payable................................................................
70,000
Loss on Retirement of Bonds Payable........................
4,095
Discount on Bonds Payable....................................
Cash...........................................................................
945
73,150
To record the retirement of bonds.

67

1. Semiannual cash interest payment = $1,700,000 x 9% x year = $76,500
Amount accrued for four months = $76,500 x 4/6 = $51,000
2. Journal entries
2005
May
Cash.................................................................................
1,751,000
Interest Payable........................................................
Bonds Payable..........................................................
51,000
1,700,000
Sold bonds with 4 months accrued interest.
June 30
Interest Payable..............................................................
51,000
25,500
Cash...........................................................................
76,500
Paid semiannual interest on the bonds.
Dec. 31

76,500
Cash...........................................................................
76,500
Paid semiannual interest on the bonds.

68

1.
Straight-line amortization table

Semiannual
Period-End
Unamortized
Discount
Carrying
Value
6/01/2004.....................
$2,026
$47,974
11/30/2004.....................
1,773
48,227
5/31/2005.....................
1,520
48,480
11/30/2005.....................
1,267
48,733
5/31/2006.....................
1,014
48,986
11/30/2006.....................
761
49,239
5/31/2007.....................
508
49,492
11/30/2007.....................
255*
49,745
5/31/2008.....................
*
Rounding difference.
Supporting computations
Eight payments of $1,750........................

Par value at maturity................................
Total repaid...............................................
Less amount borrowed...........................
Total bond interest expense....................
or
Eight payments of $1,750........................
Plus discount...........................................
Total bond interest expense....................
50,000
$ 14,000
50,000
64,000
(47,974)
$ 16,026
$ 14,000
2,026
$ 16,026
Semiannual straight-line interest expense = $16,026 / 8 = $2,003 (rounded)

Semiannual bond discount amortization = $2,026 / 8 = $253 (rounded)

69
Exercise 14-10 (Concluded)

2.
2004
Nov. 30

2,003
Cash...........................................................................
253
1,750
To record 6 months interest and discount amortization.
Dec. 31
Bond Interest Expense.................................................. 334

42
292
To record one month's accrued interest

($2,003 x 1/6) and amortization ($253 x 1/6).
2005
May 31
Interest Payable.............................................................. 292

1,669
Cash...........................................................................
211
1,750
To record five months interest ($2,003 - $334)

and amortization ($253 - $42) and eliminate
the accrued interest liability.

1. Amount of principal in each payment = $25,000 / 4 years = $6,250
2. Amortization table for the loan
Payments
(A)
Period
Ending
Date
Beginning
Balance
(B)
Debit
Interest
Expense
Cash
Ending
Balance
[Prior (E)]
[7% x (A)]
[$25,000/4]
[(B) + (C)]
[(A) - (C)]
2005.......
$25,000
$1,750
$ 6,250
$ 8,000
$18,750
2006.......
18,750
1,313
6,250
7,563
12,500
2007.......
12,500
875
6,250
7,125
6,250
2008.......
6,250
438
6,250
6,688

70
(C)
Debit
Notes
Payable
(D)
Credit
=
(E)
$4,376
$25,000
$29,376

71

2005
Jan. 1
Cash.................................................................................
25,000
Notes Payable...........................................................
25,000
Borrowed $25,000 by signing a 7%

installment note.
2005
Dec. 31
Interest Expense.............................................................
1,750
Notes Payable.................................................................
6,250
Cash...........................................................................
8,000
To record first installment payment.
2006
Dec. 31
1,313
Notes Payable.................................................................
6,250
Cash...........................................................................
7,563
To record second installment payment.
2007
Dec. 31
Interest Expense............................................................. 875

Notes Payable.................................................................
6,250
Cash...........................................................................
7,125
To record third installment payment.
2008
Dec. 31
Interest Expense............................................................. 438

Notes Payable.................................................................
6,250
Cash...........................................................................
6,688
To record fourth installment payment.

72

1. Amount of each payment = Initial note balance / Table B.3 value
= $25,000 / 3.3872 = $7,381
2. Amortization table for the loan
(A)
Period
Ending
Date
Beginning
Balance
(B)
Debit
Interest
Expense
[Prior (E)]
[7% x (A)]
2005....... $25,000
Payments
(C)
Debit
Notes
Payable
=
(D)
Credit
(E)
Cash
Ending
Balance
[(D) - (B)]
[computed]
[(A) - (C)]
$1,750
$ 5,631
$ 7,381
$19,369
2006.......
19,369
1,356
6,025
7,381
13,344
2007.......
13,344
934
6,447
7,381
6,897
2008.......
6,897
484*
6,897
7,381
$25,000
$29,524
$4,524

73

2005
Jan. 1
Cash.................................................................................
25,000
Notes Payable...........................................................
25,000
Borrowed $25,000 by signing a 7%

installment note.
2005
Dec. 31
1,750
Notes Payable.................................................................
5,631
Cash...........................................................................
7,381
To record first installment payment.
2006
Dec. 31
1,356
Notes Payable.................................................................
6,025
Cash...........................................................................
7,381
To record second installment payment.
2007
Dec. 31
Interest Expense.............................................................934
Notes Payable.................................................................
6,447
Cash...........................................................................
7,381
To record third installment payment.
2008
Dec. 31
Interest Expense.............................................................484
Notes Payable.................................................................
6,897
Cash...........................................................................
7,381
To record fourth installment payment.

The ratio of pledged assets to secured liabilities describes the pool of assets
that are committed to being available for paying the secured creditors if the
borrower should experience financial distress and be unable to make payment
on the secured liabilities. The increasing value of the ratio could arise from at
least two sets of activities.
First, the borrower could be significantly decreasing the amount of debt that is
secured by assets, but still keeping the assets pledged as collateral. These
activities would cause the ratios numerator to stay constant while the
denominator decreases.
74
Exercise 14-15 (concluded)

Second, the borrower might be keeping the amount of debt constant while
greatly increasing the amount of assets that have been pledged as security. A
higher ratio value would result from a larger numerator, while the denominator
stayed constant.
In either case, the increasing ratio could be alarming to the unsecured creditor
because it might reflect a growing concern by the secured creditors that the
values of the borrowers assets are not sufficient for paying the secured
debts. If so, the unsecured creditors are more vulnerable to losing their
balances if the company should be forced into bankruptcy. Of course, the
change could arise from a combination of both activities. In accordance with
a basic concept of financial analysis, the change in a ratio does not fully
explain what happened, but does point out areas where potential problems
might exist and where we might search for more complete answers.
Exercise 14-16C (10 minutes)

1. Operating
2. Capital
3. Capital

1.

82,000
Lease Liability...........................................................
82,000
2.
Depreciation ExpenseOffice Equipment..................

16,400
Accum. DepreciationOffice Equipment..............
16,400
To record depreciation ($82,000 / 5 years).

[Note: 12% / 12 months = 1% per month as the relevant interest rate.]
Option 1: $1,750 per month for 25 months = $1,750 x 22.0232 = $38,541

Option 2: $1,500 per month for 25 months + $5,000 =
($1,500 x 22.0232) + $5,000 = $38,035
Option 3:
= $38,500

75
Analysis: Option 2 has the lowest present value at $38,035 and, thus, is the
best lease deal.

76
PROBLEM SET A
Problem 14-1A (50 minutes)
Part 1
a.
Cash Flow
Table
Par value...................... B.1
Interest (annuity)......... B.3
Price of bonds.............
Table Value*
0.4564
13.5903
Amount
$20,000
1,000
Bond premium.............
Present Value
$ 9,128
13,590
$22,718
$ 2,718
* Table values are based on a discount rate of 4% (half the annual market rate)
and 20 periods (semiannual payments).
b.
2005
Jan. 1
Cash.................................................................................
22,718
Bonds Payable..........................................................
2,718
20,000
Sold bonds on stated issue date.
Part 2
a.
Cash Flow
Table
Par value...................... B.1
Table Value*
0.3769
12.4622
Amount
$20,000
1,000
Present Value
$ 7,538
12,462
$20,000
20 periods (semiannual payments). (Note: When the contract rate and market rate
are the same, the bonds sell at par and there is no discount or premium.)
b.
2005
Jan. 1
Cash.................................................................................
20,000
Bonds Payable..........................................................
20,000

77
Problem 14-1A (Concluded)

Part 3
a.
Cash Flow
Table
Par value..................... B.1
Interest (annuity)........ B.3
Price of bonds............
Table Value*
0.3118
11.4699
Bond discount............
Amount
$20,000
1,000
Present Value
$ 6,236
11,470
$17,706
$ 2,294
b.
2005
Jan. 1
Cash.................................................................................
17,706
2,294
Bonds Payable..........................................................
20,000

78

Part 1
2004
Jan. 1
Cash.................................................................................
1,728,224
271,776
Bonds Payable..........................................................
2,000,000
Part 2
[Note: The semiannual amounts for (a), (b), and (c) below are the same throughout the bonds
life because this company uses straight-line amortization.]
(a) Cash Payment = $2,000,000 x 6% x 6/12 year = $60,000

(b) Discount = $2,000,000 - $1,728,224 = $271,776
Straight-line discount amortization= $271,776 / 30 semiannual periods
= $9,059*
*rounded
(c) Bond interest expense = $60,000 + $9,059 = $69,059

Part 3
Thirty payments of $60,000 ............
Par value at maturity........................
Total repaid.......................................
$1,800,000
2,000,000
3,800,000
(1,728,224)
$2,071,776
or:
Thirty payments of $60,000..................
Plus discount.........................................
Total bond interest expense.................
$1,800,000
271,776
$2,071,776
Part 4
Semiannual
Unamortized
Period-End
Discount
1/01/2004..................... $271,776
Carrying
Value
$1,728,224
6/30/2004.....................
262,717
1,737,283
12/31/2004.....................
253,658
1,746,342

79
6/30/2005.....................
244,599
1,755,401
12/31/2005.....................
235,540
1,764,460

80
Problem 14-2A (Continued)

Part 5
2004
June 30

69,059
Cash...........................................................................
9,059
60,000
To record six months interest and

discount amortization.
2004
Dec. 31

69,059
Cash...........................................................................
9,059
60,000

Part 6
[Note: Parts 1 through 5 are repeated assuming a bond premium.]
Requirement 1
2004
Jan. 1
Cash.................................................................................
2,447,990
Bonds Payable..........................................................
447,990
2,000,000
Sold bonds on issue date at a premium.
Requirement 2
(a) Cash Payment = $2,000,000 x 6% x 6/12 = $60,000

(b) Premium = $2,447,990 - $2,000,000 = $447,990
Straight-line premium amortization = $447,990 / 30 semiannual periods
= $14,933
(c) Bond interest expense = $60,000 - $14,933 = $45,067
Requirement 3
Thirty payments of $60,000 ............

Total repaid.......................................
or:
$1,800,000
2,000,000
3,800,000
(2,447,990)
$1,352,010
Thirty payments of $60,000..................
$1,800,000

81
Less premium........................................
Total bond interest expense.................

82
(447,990)
$1,352,010

Requirement 4
Semiannual
Period-End
1/01/2004.....................
6/30/2004.....................
Unamortized
Premium
Carrying
Value
$447,990
$2,447,990
433,057
2,433,057
12/31/2004.....................
418,124
2,418,124
6/30/2005.....................
403,191
2,403,191
12/31/2005.....................
388,258
2,388,258
Requirement 5
2004
June 30

45,067
14,933
Cash...........................................................................
60,000

premium amortization.
2004
Dec. 31

45,067
14,933
Cash...........................................................................
60,000


83

Part 1
Ten payments of $16,250 ................
Total repaid.......................................
$ 162,500
500,000
662,500
(510,666)
$151,834
or:
Ten payments of $16,250.................
Less premium...................................
$162,500
(10,666)
$151,834
Part 2
Straight-line amortization table ($10,666/10 = $1,067*)
Semiannual
Interest Period-End
Unamortized
Premium
Carrying
Value
1/01/2004
$10,666
$510,666
6/30/2004
9,599
509,599
12/31/2004
8,532
508,532
6/30/2005
7,465
507,465
12/31/2005
6,398
506,398
6/30/2006
5,331
505,331
12/31/2006
4,264
504,264
6/30/2007
3,197
503,197
12/31/2007
2,130
502,130
6/30/2008
1,063**
501,063
12/31/2008
* Rounded to nearest dollar.

84
500,000
** Adjusted for rounding.

Part 3
2004
June 30

15,183
1,067
Cash...........................................................................
16,250

2004
Dec. 31

15,183
1,067
Cash...........................................................................
16,250


85
Problem 14-4AB (45 minutes)

Part 1
Ten payments of $16,250 ................
Total repaid.......................................
$ 162,500
500,000
662,500
(510,666)
$ 151,834
or:
Ten payments of $16,250.................
Less premium...................................
$ 162,500
(10,666)
$151,834
Part 2
Semiannual
Interest
Period-End
(A)
(B)
Cash Interest
Bond Interest
Paid
Expense
[3.25% x $500,000] [3% x Prior (E)]
(C)
Premium
Amortization
[(A) - (B)]
1/01/2004
(D)
(E)
Unamortized
Carrying
Premium
Value
[Prior (D) - (C)] [$500,000 + (D)]
$10,666
$510,666
930
9,736
509,736
6/30/2004
$ 16,250
$ 15,320
12/31/2004
16,250
15,292
95
8
8,778
508,778
6/30/2005
16,250
15,263
98
7
7,791
507,791
12/31/2005
16,250
15,234
1,016
6,775
506,775
6/30/2006
16,250
15,203
1,047
5,728
505,728
12/31/2006
16,250
15,172
1,078
4,650
504,650
6/30/2007
16,250
15,140
1,110
3,540
503,540
12/31/2007
16,250
15,106
1,144
2,396
502,396
6/30/2008
16,250
15,072
1,178
1,218
501,218
12/31/2008
16,250
15,032*
1,218
500,000
$162,500
$151,834
$10,666

86
Problem 14-4AB (Concluded)

Part 3
2004
June 30

15,320
930
Cash...........................................................................
16,250

2004
Dec. 31

15,292
958
16,250

Part 4
As of December 31, 2006
Cash Flow
Table
Par value...................... B.1
Table Value*
0.8885
3.7171
Amount
$500,000
16,250
Present Value
$444,250
60,403
$504,653
* Table values are based on a discount rate of 3% (half the annual original market
rate) and 4 periods (semiannual payments).
Comparison to Part 2 Table

Except for a small rounding difference, this present value ($504,653) equals
the carrying value of the bonds in column (E) of the amortization table
($504,650). This shows a general rule: The carrying value of bonds at any
point in time equals the present value of the remaining cash flows using
the market rate at the time of issuance.

87

Part 1
2004
Jan. 1
Cash.................................................................................
584,361
65,639
Bonds Payable..........................................................
650,000
Part 2
Eight payments of $16,250* .................
Par value at maturity.............................
Total repaid............................................
Less amount borrowed........................
Total bond interest expense................
$ 130,000
650,000
780,000
(584,361)
$ 195,639
or:
Eight payments of $16,250*..................
Plus discount........................................
$ 130,000
65,639
$ 195,639
Semiannual interest payment, computed as $650,000 x 5% x year.
Part 3 Straight-line amortization table ($65,639/8 =$8,205)

Semiannual
Interest Period-End
Unamortized
Discount
Carrying
Value
1/01/2004
$65,639
$584,361
6/30/2004
57,434
592,566
12/31/2004
49,229
600,771
6/30/2005
41,024
608,976
12/31/2005
32,819
617,181

88

Part 4
2004
June 30

24,455
Cash...........................................................................
8,205
16,250

2004
Dec. 31

24,455
Cash...........................................................................
8,205
16,250

Part 5
If the market interest rate on the issue date had been 4% instead of 8%, the
bonds would have sold at a premium because the contract rate of 5% would
have been greater than the market rate.
This change would affect the balance sheet because the bond liability would
be larger (par value plus a premium instead of par value minus a discount).
As the years passed, the bond liability would decrease with amortization of
the premium instead of increasing with amortization of the discount.
The income statement would show smaller amounts of bond interest expense
over the life of the bonds issued at a premium than it would show if the bonds
had been issued at a discount.
The statement of cash flows would show a larger amount of cash received
from borrowing. However, the cash flow statements presented over the life of
the bonds (after issuance) would report that the same amount of cash was
paid for interest. This cash amount is fixed as it is the product of the contract
rate and the par value of the bonds and is unaffected by the change in the
market rate.

89

Part 1
2004
Jan. 1
Cash.................................................................................
584,361
65,639
Bonds Payable..........................................................
650,000
Part 2
Eight payments of $16,250* .................
Par value at maturity.............................
Total repaid............................................
Less amount borrowed........................
$ 130,000
650,000
780,000
(584,361)
$ 195,639
or:
Eight payments of $16,250*..................
Plus discount........................................
$ 130,000
65,639
$ 195,639
Part 3
Semiannual
Interest
Period-End
(A)
Cash Interest
Paid
[2.5% x $650,000]
(B)
Bond Interest
Expense
[4% x Prior (E)]
(C)
Discount
Amortization
[(B) - (A)]
1/01/2004
(D)
(E)
Unamortized
Carrying
Discount
Value
[Prior (D) - (C)] [$650,000 - (D)]
$65,639
$584,361
6/30/2004
$16,250
$23,374
$7,124
58,515
591,485
12/31/2004
16,250
23,659
7,409
51,106
598,894
6/30/2005
16,250
23,956
7,706
43,400
606,600
12/31/2005
16,250
24,264
8,014
35,386
614,614

90

Part 4
2004
June 30

23,374
Cash...........................................................................
7,124
16,250

2004
Dec. 31

23,659
Cash...........................................................................
7,409
16,250


91

Part 1
2004
Jan. 1
Cash.................................................................................
92,283
Bonds Payable..........................................................
2,283
90,000
Part 2
Six payments of $4,950 ...................
Total repaid.......................................
$ 29,700
90,000
119,700
(92,283)
$ 27,417
or:
Six payments of $4,950....................
Less premium...................................
$ 29,700
(2,283)
$ 27,417
Part 3
Semiannual
Interest
Period-End
(A)
Cash Interest
Paid
[5.5% x $90,000]
(B)
Bond Interest
Expense
[5% x Prior (E)]
(C)
Premium
Amortization
[(A) - (B)]
1/01/2004
(D)
(E)
Unamortized
Carrying
Premium
Value
[Prior (D) - (C)] [$90,000 + (D)]
$2,283
$92,283
6/30/2004
$4,950
$4,614
$336
1,947
91,947
12/31/2004
4,950
4,597
353
1,594
91,594
6/30/2005
4,950
4,580
370
1,224
91,224
12/31/2005
4,950
4,561
389
835
90,835

92

Part 4
2004
June 30

4,614
336
Cash...........................................................................
4,950

2004
Dec. 31

4,597
353
Cash...........................................................................
4,950

Part 5
2006
Jan. 1
Bonds Payable ...............................................................

90,000
835
Cash*.........................................................................
Gain on Retirement of Bonds..................................
88,200
2,635

*($90,000 x 98%)
Part 6
If the market rate on the issue date had been 12% instead of 10%, the bonds
would have sold at a discount because the contract rate of 11% would have been
lower than the market rate.
This change would affect the balance sheet because the bond liability would be
smaller (par value minus a discount instead of par value plus a premium). As the
years passed, the bond liability would increase with amortization of the discount
instead of decreasing with amortization of the premium.
The income statement would show larger amounts of bond interest expense over
the life of the bonds issued at a discount than it would show if the bonds had
been issued at a premium.
The statement of cash flows would show a smaller amount of cash received from
borrowing. However, the cash flow statements presented over the life of the
bonds (after issuance) would report the same total amount of cash paid for
interest. This amount is fixed as it is the product of the contract rate and the par
value of the bonds and is unaffected by the change in the market rate.

93

Part 1
Amount of Payment
Note balance...................................................................
$400,000
Number of periods.........................................................
5
Interest rate.....................................................................
8%
Value from Table B.3......................................................
3.9927
Payment ($400,000 / 3.9927)..........................................
$100,183
Part 2
(B)
Debit
Interest
Expense +
[8% x (A)]
Payments
(C)
(D)
Debit
Credit
Notes
Payable =
Cash
[(D) - (B)]
[computed]
Ending
Balance
[(A) - (C)]
10/31/2005.............
$400,000
$ 32,000
$ 68,183
$100,183
$331,817
10/31/2006.............
331,817
26,545
73,638
100,183
258,179
10/31/2007.............
258,179
20,654
79,529
100,183
178,650
10/31/2008.............
178,650
14,292
85,891
100,183
92,759
92,759
100,183
$400,000
$500,915
(A)
Period
Ending
Date
Beginning
Balance
[Prior (E)]
10/31/2009.............
92,759
7,424*
$100,915
(E)
* Adjusted for rounding
Part 3
2004
Dec. 31
5,333
5,333
Accrued interest on the installment

note payable ($32,000 x 2/12).
2005
Oct. 31
26,667
5,333
Notes Payable.................................................................
68,183
Cash...........................................................................
100,183
Record first payment on installment note
(interest expense = $32,000 - $5,333).

94

Part 4
Payments
(A)
Period
Ending
Date
Beginning
Balance
[Prior (E)]
(B)
(C)
Debit
Debit Notes
Interest
Payable
Expense + [$400,000/5] =
[8% x (A)]
(D)
Credit
(E)
Cash
[(B) + (C)]
Ending
Balance
[(A) - (C)]
10/31/2005.............
$400,000
$32,000
$ 80,000
$112,000
$320,000
10/31/2006.............
320,000
25,600
80,000
105,600
240,000
10/31/2007.............
240,000
19,200
80,000
99,200
160,000
10/31/2008.............
160,000
12,800
80,000
92,800
80,000
10/31/2009.............80,000
6,400
80,000
86,400
$96,000
$400,000
$496,000
2004
Dec. 31
5,333
5,333

2005
Oct. 31
26,667
5,333
Notes Payable.................................................................
80,000
Cash...........................................................................
112,000


95

Part 1
Wildcat Company
Pledged assets [($900,000 x 43%) + $225,000]...........................$612,000
Secured liabilities ($210,000 + $135,000)....................................$345,000
Ratio ($612,000 / $345,000)...........................................................1.77 to 1
Athens Company
Pledged assets [($450,000 x 54%) + $150,000]...........................$393,000
Secured liabilities ($75,000 + $60,000)........................................$135,000
Ratio ($393,000 / $135,000)..........................................................2.91 to 1
Part 2
Athens's ratio of pledged assets to secured liabilities is higher than
Wildcat's, so the Athens bonds appear less risky. Before deciding to buy
Athens's bonds, however, it might be helpful to estimate the liquidation
value of both companies assets that are pledged as collateral. It also is
important to evaluate the ability of each company to meet its obligations
from operating cash flows.

96
Problem 14-10AC (35 minutes)

Part 1
Present Value of the Lease Payments
$20,000 x 3.9927 (from Table B.3) = $79,854
Part 2
79,854
Lease Liability...........................................................
79,854
Part 3
Capital Lease Liability Payment (Amortization) Schedule
Beginning
Period Balance of
Ending
Lease
Date
Liability
Interest on
Lease
Liability
(8%)
Reduction
of Lease
Liability
Year 1
$79,854
$ 6,388*
$13,612
$ 20,000
$66,242
Year 2
66,242
5,299
14,701
20,000
51,541
Year 3
51,541
4,123
15,877
20,000
35,664
Year 4
35,664
2,853
17,147
20,000
18,517
Year 5
18,517
1,483**
18,517
20,000
$79,854
$100,000
$20,146
*
**
Cash
Lease
Payment
Ending
Balance of
Lease
Liability
Rounded to nearest dollar.

Difference due to rounding.
Part 4
Depreciation ExpenseOffice Equipment..................
15,971
15,971

97
PROBLEM SET B
Problem 14-1B (50 minutes)
Part 1
a.
Cash Flow
Table
Par value.................
B.1
Interest (annuity)....
B.3
Price of bonds........
Table Value*
0.6139
7.7217
Amount
$45,000
2,700
Bond Premium........
Present Value
$27,626
20,849
$48,475
$ 3,475
b.
2005
Jan. 1
Cash.................................................................................
48,475
Bonds Payable..........................................................
3,475
45,000
Part 2
a.
Cash Flow
Table
Par value.................
B.1
B.3
Table Value*
0.5584
7.3601
Amount
$45,000
2,700
Present Value
$25,128
19,872
$45,000**
10 periods (semiannual payments). (Note: When the contract rate and market
rate are the same, the bonds sell at par and there is no discount or premium.)
**Adjusted for rounding.
b.
2005
Jan. 1
Cash.................................................................................
45,000
Bonds Payable..........................................................
45,000

98
Problem 14-1B (Concluded)

Part 3
a.
Cash Flow
Table
Par value.................
B.1
B.3
Table Value*
0.5083
7.0236
Amount
$45,000
2,700
Present Value
$22,874
18,964
$41,838
Bond discount........
$ 3,162
b.
2005
Jan. 1
Cash.................................................................................
41,838
3,162
Bonds Payable..........................................................
45,000

Part 1
2004
Jan. 1
Cash.................................................................................
1,505,001
194,999
Bonds Payable..........................................................
1,700,000
Part 2
[Note: The semiannual amounts for (a), (b), and (c) below are the same throughout
the bonds life because the company uses straight-line amortization.]

(b) Discount = $1,700,000 - $1,505,001 = $194,999
Straight-line discount amortization= $194,999 / 20 semiannual periods
= $9,750
(c) Bond interest expense = $85,000 + $9,750 = $94,750

99
Problem 14-2B (Continued)

Part 3
Twenty payments of $85,000...........
Total repaid.......................................
$1,700,000
1,700,000
3,400,000
(1,505,001)
$1,894,999
or:
Twenty payments of $85,000 ..........
Plus discount....................................
$1,700,000
194,999
$1,894,999
Part 4
Semiannual
Period-End
Unamortized
Discount
Carrying
Value
1/01/2004.....................
$194,999
$1,505,001
6/30/2004.....................
185,249
1,514,751
12/31/2004.....................
175,499
1,524,501
6/30/2005.....................
165,749
1,534,251
12/31/2005.....................
155,999
1,544,001
Part 5
2004
June 30

94,750
Cash...........................................................................
9,750
85,000

2004
Dec. 31

94,750
Cash...........................................................................
9,750
85,000


100
Problem 14-2B (Continued)

Part 6. [Requirements 1 through 5 are repeated assuming a bond premium.]
Requirement 1
2004
Jan. 1
Cash.................................................................................
2,096,466
Bonds Payable..........................................................
396,466
1,700,000
Sold bonds on issue date at a premium.
Requirement 2

(b) Premium = $2,096,466 - $1,700,000 = $396,466
Straight-line premium amortization= $396,466/20 semiannual periods
= $19,823*
*rounded
(c) Bond interest expense = $85,000 - $19,823 = $65,177

Requirement 3

Total repaid.......................................
$1,700,000
1,700,000
3,400,000
(2,096,466)
$1,303,534
or:
Less premium...................................
$1,700,000
(396,466)
$1,303,534

101

Requirement 4
Semiannual
Period-End
Unamortized
Premium
1/01/2004..................... $396,466
Carrying
Value
$2,096,466
6/30/2004.....................
376,643
2,076,643
12/31/2004.....................
356,820
2,056,820
6/30/2005.....................
336,997
2,036,997
12/31/2005.....................
317,174
2,017,174
Requirement 5
2004
June 30

65,177
19,823
Cash...........................................................................
85,000

2004
Dec. 31

65,177
19,823
Cash...........................................................................
85,000


102

Part 1
Ten payments of $7,200 ..................
Total repaid.......................................
$ 72,000
160,000
232,000
(166,494)
$ 65,506
or:
Ten payments of $7,200 ..................
Less premium...................................
$ 72,000
(6,494)
$ 65,506
Part 2
Straight-line amortization table ($6,494/10 = $649)
Semiannual
Interest Period-End
Unamortized
Premium
Carrying
Value
1/01/2004
$6,494
$166,494
6/30/2004
5,845
165,845
12/31/2004
5,196
165,196
6/30/2005
4,547
164,547
12/31/2005
3,898
163,898
6/30/2006
3,249
163,249
12/31/2006
2,600
162,600
6/30/2007
1,951
161,951
12/31/2007
1,302
161,302
6/30/2008
12/31/2008
653*
0
160,653
160,000
* Adjusted for rounding.

103

Part 3
2004
June 30

6,551
649
Cash...........................................................................
7,200

2004
Dec. 31

6,551
649
7,200


104
Problem 14-4BB (45 minutes)

Part 1
Ten payments of $7,200 ..................
Total repaid.......................................
$ 72,000
160,000
232,000
(166,494)
$ 65,506
or:
Ten payments of $7,200 ..................
Less premium...................................
$ 72,000
(6,494)
$ 65,506
Part 2
Semiannual
Interest
Period-End
(A)
(B)
Cash Interest
Bond Interest
Paid
Expense
[4.5% x $160,000] [4% x Prior (E)]
(C)
Premium
Amortization
[(A) - (B)]
1/01/2004
(D)
(E)
Unamortized
Carrying
Premium
Value
[Prior (D) - (C)] [$160,000 + (D)]
$6,494
$166,494
6/30/2004
$ 7,200
$ 6,660
$ 540
5,954
165,954
12/31/2004
7,200
6,638
562
5,392
165,392
6/30/2005
7,200
6,616
584
4,808
164,808
12/31/2005
7,200
6,592
608
4,200
164,200
6/30/2006
7,200
6,568
632
3,568
163,568
12/31/2006
7,200
6,543
2,911
162,911
6/30/2007
7,200
6,516
2,227
162,227
12/31/2007
7,200
6,489
711
1,516
161,516
6/30/2008
7,200
6,461
739
777
160,777
12/31/2008
7,200
6,423*
777
160,000
$72,000
$65,506
$6,494
657
684

105
Problem 14-4BB (Concluded)

Part 3
2004
June 30

6,660
540
Cash...........................................................................
7,200

2004
Dec. 31

6,638
562
7,200

Part 4
As of December 31, 2006
Cash Flow
Table
Par value.................
B.1
B.3
Table Value*
0.8548
3.6299
Amount
$160,000
7,200
Present Value
$136,768
26,135
$162,903
* Table values are based on a discount rate of 4% (half the annual original market
rate) and 4 periods (semiannual payments).
Comparison to Part 2 Table

Except for a small rounding difference, this present value ($162,903) equals
the carrying value of the bonds in column (E) of the amortization table
($162,911). This reveals a general rule: The carrying value of bonds at any
point in time equals the present value of the remaining cash flows using
the market rate at the time of issuance.

106

Part 1
2004
Jan. 1
Cash.................................................................................
99,247
20,753
Bonds Payable..........................................................
120,000
Part 2
Thirty payments of $3,600* .............
Total repaid.......................................
$108,000
120,000
228,000
(99,247)
$128,753
or:
Plus discount....................................
$108,000
20,753
$128,753
Part 3 Straight-line amortization table ($20,753/30= $692)

Semiannual
Interest Period-End
Unamortized
Discount
Carrying
Value
1/01/2004
$20,753
$ 99,247
6/30/2004
20,061
99,939
12/31/2004
19,369
100,631
6/30/2005
18,677
101,323
12/31/2005
17,985
102,015

107

Part 4
2004
June 30

4,292
Cash...........................................................................
692
3,600

2004
Dec. 31

4,292
Cash...........................................................................
692
3,600


108

Part 1
2004
Jan. 1
Cash.................................................................................
99,247
20,753
Bonds Payable..........................................................
120,000
Part 2
Total repaid.......................................
$108,000
120,000
228,000
(99,247)
$128,753
or:
Plus discount....................................
$108,000
20,753
$128,753
Part 3
Semiannual
Interest
Period-End
(A)
Cash Interest
Paid
[3% x $120,000]
(B)
Bond Interest
Expense
[4% x Prior (E)]
(C)
(D)
(E)
Discount
Unamortized
Carrying
Amortization
Discount
Value
[(B) - (A)]
[Prior (D) - (C)] [$120,000 - (D)]
1/01/2004
$20,753
$ 99,247
6/30/2004
$3,600
$3,970
$370
20,383
99,617
12/31/2004
3,600
3,985
385
19,998
100,002
6/30/2005
3,600
4,000
400
19,598
100,402
12/31/2005
3,600
4,016
416
19,182
100,818

109

Part 4
2004
June 30

3,970
Cash...........................................................................
370
3,600

2004
Dec. 31

3,985
Cash...........................................................................
385
3,600


110

Part 1
2004
Jan. 1
Cash.................................................................................
987,217
Bonds Payable..........................................................
87,217
900,000
Part 2
Eight payments of $58,500 .............
Total repaid.......................................
$ 468,000
900,000
1,368,000
(987,217)
$ 380,783
or:
Eight payments of $58,500 .............
Less premium...................................
$ 468,000
(87,217)
$ 380,783
Part 3
Semiannual
Interest
Period-End
(A)
Cash Interest
Paid
[6.5% x $900,000]
(B)
Bond Interest
Expense
[5% x Prior (E)]
(C)
Premium
Amortization
[(A) - (B)]
1/01/2004
(D)
(E)
Unamortized
Carrying
Premium
Value
[Prior (D) - (C)] [$900,000 + (D)]
$87,217
$987,217
6/30/2004
$58,500
$49,361
$ 9,139
78,078
978,078
12/31/2004
58,500
48,904
9,596
68,482
968,482
6/30/2005
58,500
48,424
10,076
58,406
958,406
12/31/2005
58,500
47,920
10,580
47,826
947,826

111

Part 4
2004
June 30

49,361
9,139
Cash...........................................................................
58,500

2004
Dec. 31

48,904
9,596
Cash...........................................................................
58,500

Part 5
2006
Jan. 1
Bonds Payable ...............................................................

900,000
47,826
Loss on Retirement of Bonds.......................................
6,174
Cash*.........................................................................
954,000

*($900,000 x 106%)
Part 6
If the market rate on the issue date had been 14% instead of 10%, the bonds
would have sold at a discount because the contract rate of 13% would have been
lower than the market rate.
This change would affect the balance sheet because the bond liability would be
smaller (par value minus a discount instead of par value plus a premium). As the
years passed, the bond liability would increase with amortization of the discount
instead of decreasing with amortization of the premium.
The income statement would show larger amounts of bond interest expense over
the life of the bonds issued at a discount than it would show if the bonds had
been issued at a premium.
The statement of cash flows would show a smaller amount of cash received from
borrowing. However, the cash flow statements presented over the life of the
bonds (after issuance) would report the same total amount of cash paid for
interest. This amount is fixed as it is the product of the contract rate and the par
value of the bonds and is unaffected by the change in the market rate.

112

Part 1
Amount of Payment
Note balance...................................................................
$300,000
Number of periods.........................................................
3
Interest rate.....................................................................
10%
Value from Table B.3......................................................
2.4869
Payment ($300,000 / 2.4869)..........................................
$120,632
Part 2
(B)
Debit
Interest
Expense +
Payments
(C)
Debit
Notes
Payable =
[10% x (A)]
9/30/2005...............
$300,000
(A)
Period
Ending
Date
Beginning
Balance
(D)
Credit
(E)
Cash
Ending
Balance
[(D) - (B)]
[computed]
[(A) - (C)]
$30,000
$ 90,632
$120,632
$209,368
9/30/2006...............
209,368
20,937
99,695
120,632
109,673
9/30/2007...............
109,673
10,959*
109,673
120,632
$300,000
$361,896
[Prior (E)]
$61,896
Part 3
2004
Dec. 31
7,500
7,500

2005
Sept. 30
22,500
7,500
Notes Payable.................................................................
90,632
Cash...........................................................................
120,632


113

Part 4
(A)
Period
Ending
Date
(D)
Credit
(E)
Cash
Ending
Balance
[10% x (A)]
[$300,000/ 3]
[(B) + (C)]
[(A) - (C)]
9/30/2005...............
$300,000
$30,000
$100,000
$130,000
$200,000
9/30/2006...............
200,000
20,000
100,000
120,000
100,000
9/30/2007...............
100,000
10,000
100,000
110,000
$60,000
$300,000
$360,000
2004
Dec. 31
Beginning
Balance
(B)
Debit
Interest
Expense +
Payments
(C)
Debit
Notes
Payable =
[Prior (E)]
7,500
7,500

note payable ($300,000 x .10 x 3/12).
2005
Sept. 30
22,500
7,500
Notes Payable.................................................................
100,000
Cash...........................................................................
130,000

114

Part 1
Hunt Company
Pledged assets [($180,000 x 32%) + $120,000]...........................$177,600
Secured liabilities ($39,000 + $45,000)........................................$ 84,000
Ratio ($177,600 / $84,000).............................................................2.11 to 1
Hound Company
Pledged assets [($750,000 x 10%) + $225,000]...........................$300,000
Secured liabilities ($57,000 + $150,000)......................................$207,000
Ratio ($300,000 / $207,000)...........................................................1.45 to 1
Part 2
Hunt's ratio of pledged assets to secured liabilities is higher than Hound's,
so the Hunt bonds appear less risky to bondholders. Before deciding to
buy Hunts bonds, however, it might be helpful to know the liquidation
value of both companies assets that are pledged as collateral. It also is
important to evaluate the ability of each company to meet its obligations
from operating cash flows.

115
Problem 14-10BC (35 minutes)

Part 1
Present Value of the Lease Payments
$10,000 x 3.7908 (from Table B.3) = $37,908.
Part 2
37,908
Lease Liability...........................................................
37,908
Part 3
Capital Lease Liability Payment (Amortization) Schedule
Period
Ending
Date
Beginning
Balance of
Lease
Liability
Interest on
Lease
Liability
(10%)
Reduction
of Lease
Liability
Cash
Lease
Payment
Ending
Balance of
Lease
Liability
Year 1
$37,908
$ 3,791*
$ 6,209
$10,000
$31,699
Year 2
31,699
3,170
6,830
10,000
24,869
Year 3
24,869
2,487
7,513
10,000
17,356
Year 4
17,356
1,736
8,264
10,000
9,092
Year 5
9,092
9,092
10,000
$37,908
$50,000
908**
$12,092
*
**
Rounded to nearest dollar.

Difference due to rounding.
Part 4
Depreciation ExpenseOffice Equipment..................7,582
7,582

116
SERIAL PROBLEM
Serial Problem, Success Systems (75 minutes)
Part 1
Pledged Assets
Balances at 3/31/05
Accounts Receivable...........................................
Merchandise inventory........................................
Net Plant Assets...................................................
Total Pledged Assets...........................................
$22,720
704
24,700
$48,124
Maximum Loan Allowed.......................................
Pledged assets to secured loan ratio.................
Maximum loan allowed $48,124 / [?] = 6
$8,020
Part 2
Assume the secured loan is taken, then the percent of assets financed by:
a. Debt
($875 + $8,020) / ($129,909 + $8,020) = 6.4%
b. Equity
$129,034 / ($129,909 + $8,020)
= 93.6%

117
Reporting in Action
BTN 14-1
1. The balance sheet of Krispy Kreme reports long-term debt. However,

there is no evidence of bonds having been issued by Krispy Kreme
from its balance sheet or from its note disclosures. Specifically, Note 7
to its financial statements reports that its long-term debt consists of
lines of credit and term notes.
2. Krispy Kremes statement of cash flows (financing section) for the year
ended February 2, 2003, reports its repayment of long-term debt that
totals $2,170,000 and its repayment of revolving lines of credit that total
$121,000.
3. Krispy Kremes statement of cash flows (financing section) for the year
ended February 2, 2003, reports proceeds from additions to long-term
debt (borrowings) that total $44,234,000.
4. Answer depends on the financial statement information obtained.

118
Comparative Analysis
BTN 14-2
[Note: Assignment assumes that both companies have pledged all of their current
receivables, inventory, and property and equipment as collateral for their long-term debt.]
1. Krispy Kremes pledged assets to secured liabilities ratio (in thousands)

Current Year
= (Receivables + Inventory + Property and Equipment) / Long-Term debt
= ($46,319* + $24,365 + $202,558) / $53,201 = $273,242/ $53,201 = 5.14
Prior Year
= ($38,682* + $16,159 + $112,577) / $4,643 = $167,418 / $4,643 = 36.06
*Includes receivables from affiliates and other receivables.
Tastykakes pledged assets to secured liabilities ratio (in thousands)

Current Year
= (Receivables + Inventory + Property and Equipment) / Long-Term debt**
= ($20,882 + $6,777 + $58,391) / $13,500 = $86,050 / $13,500 = 6.37
Prior Year
= ($22,233 + $8,412 + $59,702) / $14,900** = $90,347 / $14,900 = 6.06
**Does not include current and long-term capital lease obligations.
2. Krispy Kremes ratio implies that it has $5.14 ($36.06) of collateral for
each $1 of secured debt in the current (prior) year. Tastykakes ratio
implies that it has $6.37 ($6.06) of collateral for each $1 of secured debt
in the current (prior) year.
These results suggest that Krispy Kremes secured creditors, in the
current year, are at slightly more risk than Tastykakes secured
creditors. However, in the prior year, Krispy Kreme had a far superior
ratio of 36.06, implying very low risk for long-term secured creditors.

119
Ethics Challenge
BTN 14-3
1. The ethics of the Brevard County officials are questionable. The

financial impact of the leasing arrangement is the same as bond
financing in that the county has a debt obligation requiring the
repayment of principal and interest over time. Taxes may need to be
raised to repay the lease just as they would have if bonds were issued.
Yet, the voters had no say in the financing arrangement the officials
agreed to.
In reality, the taxpayers of Brevard County, Florida, reacted very
negatively to the actions of the county officials when they learned of the
leasing arrangement. The taxpayers felt that their voice was taken out
of the governing process. Brevard County officials responded to the
outrage of their constituents by floating the idea of holding a
referendum on whether to stop the lease payments on the building. Of
course, such talk angered the municipal bond industry and the
investors.
2. Since the lease requires payments of a non-binding nature, investors
who purchased the tax-exempt securities from the bank are holding an
investment that is more risky than the conventional municipal bonds of
Brevard County.

120
Communicating in Practice
BTN 14-4
MEMORANDUM
TO:
FROM:
SUBJECT:
The body of the memorandum should make the following points:
The associate is confused about the concept of a bond premium. Bonds
that sell at a premium provide the issuing company more cash than they
are required to pay the bondholders at their maturity date. When a bond is
issued at a premium, the face amount is less than the amount the associate
will invest to acquire the bond. As a result, the investment will yield the
investor (and cost the issuing corporation) less than the contract rate of
interest. This means that selling/buying at a premium incurs/yields an
effective rate of interest equivalent to the market rate for the risk assessed
for that bond at the time of issuance. In addition, this market rate of
interest is lower than the contract rate of interest for premium bonds. The
bottom line is that the market prices the bonds according to their perceived
risks and returns. What your associate needs to focus on is the level of risk
she is willing to accept and then invest accordingly.
A cordial closing that indicates willingness to discuss the issue further
would be appropriate.

121
Taking It to the Net
BTN 14-5
1. Per the 2002 Statement of Cash Flows, Coca-Cola Co. issued $1,622
million of debt in 2002.
2. Per the 2002 Statement of Cash Flows, Coca-Cola Co. repaid $2,378
million in debt in 2002.
3. In 2002, Coca-Cola Co. issued $107 million in stock. This amount of
financing from issuing stock is much less than the $1,622 million
obtained from debt financing.
4.
2002
Issuances of debt.......................................
$ 1,622
2001
2000
$ 3,011
$ 3,671
Payments of debt.......................................(2,378)
(3,937)
(4,256)
Net issuance or (net repayment)...............

$ (756)
$ (926)
$ (585)
Analysis: The amount of debt issued in 2002 is less than that issued in
2000 and 2001. For all three years the amount of debt repaid exceeded
the new debt issued.

122
Teamwork in Action
BTN 14-6
Parts 1 and 2
Effective Interest Amortization of Bond Premium
Semiannual
Period-end
(A)
Cash
Interest
Paid
(B)
Bond
Interest
Expense
(C)
(D)
(E)
Premium
Amortization
Unamortized
Premium
Carrying
Value
1/01/2005
$ 4,100
$ 104,100
6/30/2005
$ 4,500
$ 4,164
$ 336
3,764
103,764
12/31/2005
4,500
4,151
349
3,415
103,415
6/30/2006
4,500
4,137
363
3,052
103,052
12/31/2006
4,500
4,122
378
2,674
102,674
6/30/2007
4,500
4,107
393
2,281
102,281
Since teams generally have 4 or 5 members, the team solution will likely end about
here. The remainder of the table is shown for help in answering part 3.
12/31/2007
6/30/2008
12/31/2008
6/30/2009
12/31/2009
4,500
4,500
4,500
4,500
4,500
$45,000
4,091
4,075
4,058
4,040
3,955*
$40,900
409
425
442
460
545
$4,100
1,872
1,447
1,005
545
0
101,872
101,447
101,005
100,545
100,000
*Discrepancy due to rounding.
The following computations should be articulated by team members as

each line is explained and prepared:
Column (A) Cash Interest Paid = Bonds' par value ($100,000) x Semiannual
contract rate (4.5%).
Column (B) Bond interest expense = Bonds prior period carrying value x
Semiannual market rate (4%).
Column (C) Premium Amortization = difference between cash interest paid and
bond interest expense, or [(A) - (B)].
Column (D) Unamortized Premium = prior periods unamortized premium less the
current periods premium amortization, or [(D) - (C)].
Column (E) Bonds Carrying Value = Bonds par value plus unamortized premium,
or [$100,000 + (D)] or Previous book value - Periods amortization.

123
Teamwork in Action (Concluded)

Part 3
Without completing the table, team members should be able to project the
final number in the first column and for each of the columns (A), (D), and
(E). Specifically:
(Col. 1) Last interest period date is 12/31/2009 because this is a five-year
bond, issued 1/1/2005, with semiannual interest payments made
on 6/30 and 12/31 of each year.
(Col. A) Interest paid of $4,500 (every interest period has the same amount
of interest paid).
(Col. D) Zero unamortized premium (by the last interest period the
premium must be fully amortized).
(Col. E) Ending carrying value is $100,000 (the carrying value always
equals the par value at the maturity date, after all amortization is
completed).
Part 4
Total Bond interest expense = Interest Paid - Premium
= ($4,500 x 10 periods) - $4,100
= $45,000 - $4,100 = $40,900
Part 5.
List likely includes:
Similarities
a. Table column headings
for the period and for
columns (A), (B), and (E).
Differences
a. Column (C) will be Discount Amortization and
Column (D) will be Unamortized Discount.
b. Dates in the period

column and interest paid in
column (A).
b. Bond interest expense is higher (lower) than the

interest paid and will increase (decrease) as we
amortize a discount (premium).
c. Computations in
Columns (A), (B), and (D)
will follow the same format.
c. Carrying value will increase (decrease) as we

amortize a discount (premium).
d. Ending unamortized
premium and discount will
both be zero.
d. Discount (premium) amortization will decrease

(increase) each period.
e. Carrying value at
12/31/2009 will be $100,000
in both cases.
e. Computation of Column (C) will be (B) - (A), not

(A) - (B).
f. Computation of Column (E) will be previous
Column (E) plus discount amortization whereas
with a premium we subtract to find the new
carrying value.

124
Business Week Activity
BTN 14-7
1. This article discusses the challenges that emerging countries face in

attracting and retaining foreign investment capital.
2. The capital attracted by emerging countries can be considered hot
money in that investors might not be content to invest long-term in
emerging countries. Instead, investors tend to move money among the
various foreign capital markets in search of a better hot deal (higher
interest rates, returns, etc.).
3. At the time of the article, the available (printed) Polish Treasury bills
were yielding 18%.
4. Emerging countries try to attract foreign capital by paying high interest
rates on their bonds and loans.
5. Emerging economies (countries) can experience difficulties in retaining
foreign investment. This is for several reasons, but one of the main
reasons is that if a country attempts to lower its interest rates the
investors will sell their investments and then reinvest in another
country (or opportunity) where higher rates of interest can be earned.

125
Entrepreneurial Decision
BTN 14-8
Part 1
The table below reveals how the five alternative interest-bearing notes
affect Noodles & Companys interest expense, net income, equity, and
return on equity (net income/equity):
Current
Alternative Notes for Expansion

10% Note 15% Note 16% Note 17% Note 20% Note
Income before
interest..............$ 40,000 $ 56,000 $ 56,000 $ 56,000 $ 56,000 $ 56,000
Interest expense....
10,000
20,000
25,000
26,000
27,000
30,000
Net income.............$ 30,000 $ 36,000 $ 31,000 $ 30,000 $ 29,000 $ 26,000

Equity.....................$250,000 $250,000 $250,000 $250,000 $250,000 $250,000
Return on equity. . .
12%
14.4%
12.4%
12%
11.6%
10.4%
Part 2
The analysis in Part 1 illustrates the general rule (called financial leverage or
trading on the equity): When a company earns a higher return with
borrowed funds than it is paying in interest, it increases its return on equity.
In the case of Kennedys franchise, it is predicting a return of 16% on its
investment, computed as its expected $16,000 additional annual income
before interest divided by its $100,000 investment. This means that for it to
pursue the investment, the interest on the borrowed funds must be less than
16%. The table in Part 1 shows this result, where those notes with interest
expense below 16% are profitable (that is, yield a return greater than the
current ROE of 12%) while those above 16% are not (that is, yield a return less
than the current ROE of 12%). Also, Noodles & Company should take into
account any potential variability in its income predictions because any
downturn in income that results in return on equity lower than the interest rate
paid on the notes would be unprofitable.
Hitting the Road

126
BTN 14-9
Students answers will depend on the municipality and time period chosen
for analysis. Students often find this assignment interesting as it
reinforces the relevance of their accounting studies.

127
Global Decision
BTN 14-10
1. Grupo Bimbos pledged assets to secured liabilities ratio (in thousands

of pesos)
Current Year
= (3,794 + 905 + 15,444) / 11,466
= 20,143 / 11,466 = 1.76
Prior Year
= (3,207 + $767 + 14,683) / 5,004
= 18,657 / 5,004 = 3.73
2. Tastykake exhibits the most stable and largest multiple of pledged
assets to secured liabilities. In the most recent year Tastykakes
multiple of 6.37 exceeded Krispy Kremes ratio of 5.14 and Grupo
Bimbos (much weaker) ratio of 1.76. Therefore, according to this ratio
only, we conclude that Tastykakes long-term debt is least risky.
However, we caution that we should consider other measures of
solvency before making a definite conclusion regarding the riskiness of
the long-term debt of these companies.
3. The Statement of Changes in Financial Position (financing activities)
reports that Grupo Bimbo borrowed 6,462 million (pesos) of debt in
2002. In contrast, they repaid only 69.1 million (pesos) to financial
institutions in 2002.

128

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Chapter 14

Solutions Manual, Chapter 14

McGraw-Hill Companies, Inc., 2005

McGraw-Hill Companies, Inc., 2005

Fundamental Accounting Principles, 17th Edition

Sinking fund bond

Quick Study 14-2 (10 minutes)

Bonds cash proceeds: $350,000 x 0.875 = $306,250

Twenty semiannual interest payments of $14,000......

Bond interest expense on first payment date:

Quick Study 14-3B (10 minutes)

Bonds cash proceeds: $120,000 x 1.1725 = $140,700

Thirty semiannual interest payments of $6,000..........

Bond interest expense on first payment date:

Solutions Manual, Chapter 14

McGraw-Hill Companies, Inc., 2005

Quick Study 14-4 (10 minutes)

Quick Study 14-5 (10 minutes)

Agrees with $306,250 as given in QS 14-2, except for rounding difference.

Agrees with $140,700 as given in QS 14-3, except for rounding difference.

Quick Study 14-6 (10 minutes)

McGraw-Hill Companies, Inc., 2005

Fundamental Accounting Principles, 17th Edition

Sold $200,000 of bonds with two months

Solutions Manual, Chapter 14

McGraw-Hill Companies, Inc., 2005

Quick Study 14-7 (10 minutes)

To record retirement of bonds before maturity.

Quick Study 14-8 (10 minutes)

To record retirement of bonds by stock

Quick Study 14-9 (10 minutes)

4%: Payment = $170,000 / 4.4518 = $38,187

8%: Payment = $170,000 / 3.9927 = $42,578

12%: Payment = $170,000 / 3.6048 = $47,159

Quick Study 14-10 (10 minutes)

McGraw-Hill Companies, Inc., 2005

Fundamental Accounting Principles, 17th Edition

Quick Study 14-11 (10 minutes)

Analysis and interpretation: Xus secured liabilities appear more risky as it

Quick Study 14-12C (10 minutes)

To record rental expense for car lease.

Quick Study 14-13C (10 minutes)

To record capital lease of office equipment.

Solutions Manual, Chapter 14

McGraw-Hill Companies, Inc., 2005

Semiannual cash interest payment = $1,700,000 x 9% x 1/2 = $76,500

Sold bonds at par.

Bond Interest Expense..................................................

Paid semiannual interest on bonds.

Bond Interest Expense..................................................

Paid semiannual interest on bonds.

Sold bonds at 98. *($1,700,000 x 0.98)

Sold bonds at 102. *($1,700,000 x 1.02)

McGraw-Hill Companies, Inc., 2005

Fundamental Accounting Principles, 17th Edition

Exercise 14-2 (30 minutes)

3. Straight-line amortization table

(2) 12/31/2005......................... 3,045

(4) 12/31/2006......................... 1,521

*Adjusted for rounding