Bonds Payable and Investments in Bonds: Class Discussion Questions
Bonds Payable and Investments in Bonds: Class Discussion Questions
Bonds Payable and Investments in Bonds: Class Discussion Questions
89
EXERCISES
Ex. 141
a.
Compatriot
Co.
$ 1,000,000
400,000
$ 600,000
240,000
$ 360,000
300,000
$
60,000
0.30
$ 1,500,000
400,000
$ 1,100,000
440,000
$ 660,000
300,000
$ 360,000
1.80
$ 2,500,000
400,000
$ 2,100,000
840,000
$ 1,260,000
300,000
$ 960,000
4.80
Ex. 142
Factors other than earnings per share that should be considered in evaluating
financing plans include: bonds represent a fixed annual interest requirement,
while dividends on stock do not; bonds require the repayment of principal, while
stock does not; and common stock represents a voting interest in the ownership
of the corporation, while bonds do not.
Ex. 143
a. Cisco Systems major source of financing is common stock. Although it has
established a line of credit, it has not borrowed any monies under this
agreement.
b. Cisco Systems has relatively little investment in property and equipment.
Instead, it has chosen to lease its fixed assets.
Ex. 144
a. $10,000 1.06 = $9,434
$ 9,434 1.06 = $8,900
$ 8,900 1.06 = $8,396
b. $10,000 0.83962 = $8,396.20*
*The difference of $0.20 between answers (a) and (b) is due to rounding.
Ex. 145
a. First Year:
$6,000 0.95238 =
Second Year: $6,000 0.90703 =
Third Year:
$6,000 0.86384 =
Fourth Year: $6,000 0.82270 =
Total present value
$ 5,714.28
5,442.18
5,183.04
4,936.20
$ 21,275.70
Ex. 146
$400,000 11.65358 = $4,661,432
Ex. 147
No. The present value of your winnings using an interest rate of 14% is $2,749,172
($400,000 6.87293), which is more than one-half of the present value of your
winnings using an interest rate of 7% ($4,661,432; see Ex. 146). This is because
of the effect of compounding the interest.
Ex. 148
Present value of $1 for 10 (semiannual)
periods at 5% (semiannual rate)...........................
Face amount of bonds................................................
Present value of an annuity of $1
for 10 periods at 5%...............................................
Semiannual interest payment....................................
Total present value (proceeds)..................................
0.61391
$ 8,000,000
$
7.72174
360,000
$ 4,911,280
2,779,826
$ 7,691,106
Ex. 149
Present value of $1 for 10 (semiannual)
periods at 5 1/2% (semiannual rate)....................
Face amount of bonds................................................
Present value of an annuity of $1
for 10 periods at 5 1/2%.........................................
Semiannual interest payment....................................
Total present value (proceeds)..................................
0.58543
$10,000,000
$
7.53763
600,000
$ 5,854,300
4,522,578
$10,376,878
Ex. 1410
The bonds were selling at a premium. This is indicated by the selling price of
102 5/8, which is stated as a percentage of face amount and is more than par
(100%). The market rate of interest for similar quality bonds was lower than
7 1/2% on September 7, 2000, and this is why the bonds are selling at a premium.
Ex. 1411
Apr.
Cash....................................................................... 12,000,000
Bonds Payable......................................................
12,000,000
Oct.
Interest Expense...................................................
Cash.......................................................................
540,000
Interest Expense...................................................
Interest Payable....................................................
270,000
Dec. 31
540,000
270,000
Ex. 1412
a.
1. Cash.............................................................................
Discount on Bonds Payable.....................................
Bonds Payable......................................................
4,434,676
565,324
2. Interest Expense........................................................
Cash.......................................................................
200,000
3. Interest Expense........................................................
Cash.......................................................................
200,000
4. Interest Expense........................................................
Discount on Bonds Payable................................
$565,324 5 years = $113,065
113,065
5,000,000
200,000
200,000
113,065
$ 400,000
113,065
$ 513,065
Note: The following data in support of the proceeds of the bond issue stated
in the exercise are presented for the instructors information. Students are
not required to make the computations.
Present value of $1 for 10 (semiannual)
periods at 5 1/2% (semiannual rate)...................
Face amount..........................................................
Present value of annuity of $1 for 10
periods at 5 1/2%..................................................
Semiannual interest payment..............................
Total present value of bonds payable................
0.58543
$ 5,000,000 $ 2,927,150
7.53763
$200,000
1,507,526
$ 4,434,676
Ex. 1413
a.
Cash.............................................................................
Premium on Bonds Payable................................
Bonds Payable......................................................
10,386,057
386,057
10,000,000
Note: The following data are in support of the determination of the proceeds
of the bond issue stated in the exercise:
Present value of $1 for 10 (semiannual)
periods at 5% (semiannual rate).........................
0.61391
Face amount............................................................... $10,000,000
$ 6,139,100
4,246,957
$10,386,057
b. Interest Expense........................................................
Premium on Bonds Payable.....................................
Cash.......................................................................
7.72174
$550,000
511,394
38,606*
550,000
Ex. 1414
2003
Mar. 1
Sept. 1
2007
Sept. 1
Cash....................................................................... 15,000,000
Bonds Payable..................................................
15,000,000
Interest Expense...................................................
Cash...................................................................
600,000
600,000
Ex. 1415
2003
June 1
Dec.
2008
Dec. 1
Cash....................................................................... 20,000,000
Bonds Payable..................................................
20,000,000
Interest Expense...................................................
Cash...................................................................
900,000
900,000
Ex. 1416
1. The significant loss on redemption of the series A bonds should be reported
in the income statement separately as an extraordinary loss, not as part of
Other Expense.
2. The series B bonds outstanding at the end of the current year should be
reported as a noncurrent liability on the balance sheet because they are to be
paid from funds set aside in a sinking fund.
Ex. 1417
The discount of $811 ($1,000 $189) is amortized as interest revenue over the life
of the bonds, using the straight-line method (illustrated in this chapter) or the
interest method (illustrated in the appendix to this chapter).
Ex. 1418
a.
307,500
6,000
b. Cash..................................................................................
Interest Revenue........................................................
12,000
c.
313,500
12,000
Interest Revenue..............................................................
Investment in Glitz Co. Bonds..................................
250
d. Cash..................................................................................
Loss on Sale of Investments..........................................
Investment in Glitz Co. Bonds..................................
Interest Revenue........................................................
297,500
7,000
250
302,500
2,000
Ex. 1419
a.
172,800
1,500
b. Cash..................................................................................
Interest Revenue........................................................
4,500
c.
1,440
d. Cash..................................................................................
Investment in Sequoyah Co. Bonds.........................
Gain on Sale of Investments.....................................
Interest Revenue........................................................
181,200
174,300
4,500
1,440
176,300
1,900
3,000
Ex. 1420
a.
Current year:
Number of times interest charges earned: 2.0 =
Preceding year:
Number of times interest charges earned: 5.7 =
$135,178,000 $130,598,000
$130,598,0 00
$329,079,0 00 $70,350,00 0
$70,350,00 0
b. The number of times interest charges earned has declined from 5.7 to 2.0 in
the current year. This would potentially cause concern among debtholders.
1. Cash.............................................................................
Discount on Bonds Payable.....................................
Bonds Payable......................................................
4,434,676
565,324
2. Interest Expense........................................................
Cash.......................................................................
200,000
3. Interest Expense........................................................
Cash.......................................................................
200,000
4. Interest Expense........................................................
Discount on Bonds Payable................................
90,229
5,000,000
200,000
200,000
90,229
Computations:
$4,434,676 0.055 = $243,907
$243,907 $200,000 = $43,907 first semiannual amortization
$4,434,676 + $43,907 = $4,478,583
$4,478,583 0.055 = $246,322
$246,322 $200,000 = $46,322 second semiannual amortization
$43,907 + $46,322 = $90,229 amortization for first year
Note: The following data in support of the proceeds of the bond issue stated
in the exercise are presented for the instructors information. Students are
not required to make the computations.
Present value of $1 for 10 (semiannual)
periods at 5 1/2% (semiannual rate)...................
Face amount...............................................................
Present value of annuity of $1 for
10 periods at 5 1/2%.............................................
Semiannual interest payment...................................
Total present value of bonds payable.....................
b. Annual interest paid........................................................
Plus discount amortized.................................................
Interest expense for first year........................................
0.58543
$5,000,000 $ 2,927,150
7.53763
$200,000
1,507,526
$ 4,434,676
$400,000
90,229
$490,229
1. Interest Expense........................................................
Cash.......................................................................
550,000
2. Interest Expense........................................................
Cash.......................................................................
550,000
62,929
550,000
550,000
62,929
Computations:
$10,386,057 5% = $519,303
$550,000 $519,303 = $30,697 first semiannual amortization
$10,386,057 $30,697 = $10,355,360
$10,355,360 5% = $517,768
$550,000 $517,768= $32,232 second semiannual amortization
$30,697 + $32,232 = $62,929 first year amortization
b. Annual interest paid........................................................
Less premium amortized................................................
Interest expense for first year........................................
$1,100,000
62,929
$1,037,071
$14,635,750
11,306,445
$25,942,195
$ 1,500,000
1,426,821
$
73,179
c.
$ 1,500,000
1,422,796
$
77,204
$ 3,000,000
150,383*
$ 2,849,617
$ 7,817,600
5,152,063
$12,969,663
c.
778,180
700,000
78,180
782,871
700,000
82,871
$ 1,400,000
161,051*
$ 1,561,051
PROBLEMS
Prob. 141A
1.
Earnings before interest and income tax......
Deduct interest on bonds................................
Income before income tax...............................
Deduct income tax...........................................
Net income........................................................
Dividends on preferred stock.........................
Available for dividends on common stock....
Shares of common stock outstanding...........
Earnings per share on common stock...........
Plan 1
$ 2,500,000
$ 2,500,000
1,000,000
$ 1,500,000
$ 1,500,000
500,000
$
3.00
Plan 2
$ 2,500,000
$ 2,500,000
1,000,000
$ 1,500,000
600,000
$ 900,000
250,000
$
3.60
Plan 3
$ 2,500,000
750,000
$ 1,750,000
700,000
$ 1,050,000
400,000
$ 650,000
125,000
$
5.20
2.
Earnings before interest and income tax......
Deduct interest on bonds................................
Income before income tax...............................
Deduct income tax...........................................
Net income........................................................
Dividends on preferred stock.........................
Available for dividends on common stock....
Shares of common stock outstanding...........
Earnings per share on common stock...........
Plan 1
$ 1,500,000
$ 1,500,000
600,000
$ 900,000
$ 900,000
500,000
$
1.80
Plan 2
$ 1,500,000
$ 1,500,000
600,000
$ 900,000
600,000
$ 300,000
250,000
$
1.20
Plan 3
$ 1,500,000
750,000
$ 750,000
300,000
$ 450,000
400,000
$
50,000
125,000
$
0.40
Prob. 141A
Concluded
Prob. 142A
1.
Cash.............................................................................
Premium on Bonds Payable................................
Bonds Payable......................................................
8,498,492*
498,492
8,000,000
a. Interest Expense...................................................
Premium on Bonds Payable ($498,492 20).....
Cash..................................................................
415,075
24,925
b. Interest Expense...................................................
Premium on Bonds Payable................................
Cash..................................................................
415,075
24,925
$ 3,015,120
5,483,372
$ 8,498,492
440,000
440,000
3.
$415,075
4.
Yes. Investors will be willing to pay more than the face amount of the bonds
when the interest payments they will receive from the bonds exceed the
amount of interest that they could receive from investing in other bonds.
Prob. 142A
Concluded
$ 9,356,392
228,950
2,681,650
139,650
182,950
$12,589,592
Equipment......................................................... $ 1,390,000
Accum. depreciationequipment.............
109,600 $ 1,280,400
Building............................................................. $ 5,405,000
Accum. depreciationbuilding.................
672,000
Total plant assets.....................................
4,733,000
6,013,400
Total assets.......................................................
Liabilities
Accounts payable.............................................
Bonds payable..................................................
Premium on bonds payable............................
Total long-term liabilities...........................
$18,602,992
$
32,000
$ 8,000,000
448,642
8,448,642
Total liabilities...................................................
$ 8,480,642
Stockholders Equity
Paid-in capital:
Preferred stock............................................ $ 2,100,000
Excess of issue price over parPS.........
172,500
Common stock............................................ 4,500,000
Excess of issue price over parCS......... 1,100,000
From sale of treasury stock.......................
2,000
Total paid-in capital.................................
$ 7,874,500
Retained earnings............................................
2,467,850
Total..............................................................
Deduct treasury stock......................................
Total stockholders equity...............................
Total liabilities and stockholders equity.......
$ 10,342,350
220,000
10,122,350
$18,602,992
Prob. 143A
1.
Cash.............................................................................
Discount on Bonds Payable.....................................
Bonds Payable......................................................
9,376,895*
623,105
10,000,000
a. Interest Expense...................................................
Discount on Bonds Payable
($623,105 20).................................................
Cash..................................................................
481,155
b. Interest Expense...................................................
Discount on Bonds Payable..........................
Cash..................................................................
481,155
$ 3,768,900
5,607,995
$ 9,376,895
31,155
450,000
31,155
450,000
3.
$481,155
4.
Yes. Investors will not be willing to pay the face amount of the bonds when
the interest payments they will receive from the bonds are less than the
amount of interest that they could receive from investing in other bonds.
Prob. 143A
Concluded
$ 8,869,695
602,200
809,300
46,400
85,000
$ 10,412,595
$ 1,132,900
69,000
1,063,900
Total assets....................................................
$ 11,476,495
Liabilities
Accounts payable..........................................
$ 835,100
Bonds payable............................................... $10,000,000
Discount on bonds payable..........................
560,795
Total long-term liabilities..........................
9,439,205
Total liabilities...................................................
$ 10,274,305
Stockholders Equity
Paid-in capital:
Preferred stock......................................... $
600,000
Excess of issue price over parPS.......
75,000
Common stock.........................................
400,000
Excess of issue price over parCS.......
200,000
From sale of treasury stock....................
11,000
Total paid-in capital...............................
$ 1,286,000
Deficit..............................................................
62,810
Total...........................................................
Deduct treasury stock...................................
Total stockholders equity............................
Total liabilities and stockholders equity....
$ 1,223,190
21,000
1,202,190
$ 11,476,495
Prob. 144A
1.
2002
July
Dec.
2003
June
Dec.
2004
July
1 Cash................................................................ 21,472,126
Premium on Bonds Payable....................
1,472,126
Bonds Payable..........................................
20,000,000
31 Interest Expense............................................
Cash...........................................................
1,400,000
147,213
31 Income Summary...........................................
Interest Expense.......................................
1,252,787
30 Interest Expense............................................
Cash...........................................................
1,400,000
31 Interest Expense............................................
Cash...........................................................
1,400,000
294,425
31 Income Summary...........................................
Interest Expense.......................................
2,505,575
1,400,000
147,213
1,252,787
1,400,000
1,400,000
294,425
2,505,575
2.
a.
b.
2002: $1,252,787
2003: $2,505,575
3.
$21,472,126
(147,213)
(294,425)
$21,030,488
Prob. 144A
Concluded
$ 2,110,044
728,950
4,681,650
139,650
182,950
$ 7,843,244
Equipment....................................................
Accum. depreciationequipment.......
$ 2,390,000
109,600
$ 2,280,400
Building........................................................
Accum. depreciationbuilding...........
Total plant assets...............................
$ 7,405,000
772,018
6,632,982
8,913,382
Total assets.................................................
$ 16,756,626
Liabilities
Accounts payable.......................................
32,000
Stockholders Equity
Paid-in capital:
Preferred stock......................................
Excess of issue price over parPS....
Common stock.......................................
Excess of issue price over parCS....
From sale of treasury stock.................
Total paid-in capital............................
Retained earnings.......................................
Total........................................................
Deduct treasury stock................................
Total stockholders equity..........................
Total liabilities and stockholders equity.
$ 4,100,000
672,500
6,500,000
1,600,000
2,000
$12,874,500
4,070,126
$16,944,626
220,000
16,724,626
$ 16,756,626
Prob. 145A
2002
Sept. 1
Dec. 31
31
2007
June 30
Oct. 31
31
Dec. 31
31
482,150
7,500
Cash.......................................................................
Interest Revenue...............................................
22,500
300
Cash.......................................................................
Interest Revenue...............................................
22,500
375
489,650
22,500
300
22,500
375
Cash.......................................................................
248,350*
Loss on Sale of Investments...............................
2,550
Investment in Donner Company Bonds.........
Interest Revenue...............................................
*($250,000 0.965) + ($250,000 9% 4/12) $400
Cash.......................................................................
Interest Revenue...............................................
11,250
450
243,400
7,500
11,250
450
a. Interest Expense........................................................
Premium on Bonds Payable
[$440,000 (5% $8,498,492)]..................................
Cash.......................................................................
424,925
b. Interest Expense........................................................
Premium on Bonds Payable
[$440,000 (5% $8,483,417)]..................................
Cash.......................................................................
424,171
15,075
440,000
15,829
440,000
2. $424,925
a. Interest Expense........................................................
Discount on Bonds Payable
[($9,376,895 5%) $450,000]............................
Cash.......................................................................
468,845
b. Interest Expense........................................................
Discount on Bonds Payable
[($9,395,740 5%) $450,000]............................
Cash.......................................................................
469,787
2. $468,845
18,845
450,000
19,787
450,000
Prob. 141B
1.
Earnings before interest and income tax......
Deduct interest on bonds................................
Income before income tax...............................
Deduct income tax...........................................
Net income........................................................
Dividends on preferred stock.........................
Available for dividends on common stock....
Shares of common stock outstanding...........
Earnings per share on common stock...........
2.
Earnings before interest and income tax......
Deduct interest on bonds................................
Income before income tax...............................
Deduct income tax...........................................
Net income........................................................
Dividends on preferred stock.........................
Available for dividends on common stock....
Shares of common stock outstanding...........
Earnings per share on common stock...........
Plan 1
$ 5,000,000
$ 5,000,000
2,000,000
$ 3,000,000
$ 3,000,000
1,000,000
$
3.00
Plan 1
800,000
$ 800,000
320,000
$ 480,000
$ 480,000
1,000,000
$
0.48
$
Plan 2
$ 5,000,000
$ 5,000,000
2,000,000
$ 3,000,000
250,000
$ 2,750,000
500,000
$
5.50
$
$
$
$
Plan 2
800,000
800,000
320,000
480,000
250,000
230,000
500,000
0.46
Plan 3
$ 5,000,000
500,000
$ 4,500,000
1,800,000
$ 2,700,000
125,000
$ 2,575,000
250,000
$
10.30
$
$
$
$
Plan 3
800,000
500,000
300,000
120,000
180,000
125,000
55,000
250,000
0.22
Prob. 141B
Concluded
Prob. 142B
1.
Cash.............................................................................
Premium on Bonds Payable................................
Bonds Payable......................................................
13,495,471*
1,495,471
12,000,000
a. Interest Expense...................................................
Premium on Bonds Payable ($1,495,471 20). .
Cash..................................................................
645,226
74,774
b. Interest Expense...................................................
Premium on Bonds Payable................................
Cash..................................................................
645,226
74,774
$ 4,522,680
8,972,791
$13,495,471
720,000
720,000
3. $645,226
4. Yes. Investors will be willing to pay more than the face amount of the bonds
when the interest payments they will receive from the bonds exceed the
amount of interest that they could receive from investing in other bonds.
Prob. 142B
Concluded
$12,448,271
602,200
809,300
46,400
85,000
$13,991,171
$ 1,132,900
69,000
1,063,900
Total assets....................................................
$15,055,071
Liabilities
Accounts payable..........................................
$ 835,100
Bonds payable............................................... $ 12,000,000
Premium on bonds payable..........................
1,345,923
Total long-term liabilities.........................
13,345,923
Total liabilities................................................
$14,181,023
Stockholders Equity
Paid-in capital:
Preferred stock......................................... $
600,000
Excess of issue price over parPS.......
75,000
Common stock.........................................
400,000
Excess of issue price over parCS.......
200,000
From sale of treasury stock....................
11,000
Total paid-in capital...............................
$ 1,286,000
Deficit..............................................................
390,952
Total...........................................................
Deduct treasury stock...................................
Total stockholders equity............................
Total liabilities and stockholders equity....
895,048
21,000
874,048
$15,055,071
Prob. 143B
1.
Cash.............................................................................
Discount on Bonds Payable.....................................
Bonds Payable......................................................
6,639,795*
860,205
7,500,000
a. Interest Expense...................................................
Discount on Bonds Payable
($860,205 20).................................................
Cash..................................................................
418,010
b. Interest Expense...................................................
Discount on Bonds Payable..........................
Cash..................................................................
418,010
$ 2,338,575
4,301,220
$ 6,639,795
43,010
375,000
43,010
375,000
3.
$418,010
4.
Yes. Investors will not be willing to pay the face amount of the bonds when
the interest payments they will receive from the bonds are less than the
amount of interest that they could receive from investing in other bonds.
Prob. 143B
Concluded
$ 7,627,695
228,950
2,681,650
139,650
182,950
$10,860,895
Equipment......................................................... $ 1,390,000
Accum. depreciationequipment.............
109,600 $ 1,280,400
Building............................................................. $ 5,405,000
Accum. depreciationbuilding.................
672,000
Total plant assets.....................................
4,733,000
6,013,400
Total assets.......................................................
$16,874,295
Liabilities
Accounts payable.............................................
$
32,000
Bonds payable.................................................. $ 7,500,000
Discount on bonds payable............................
774,185
Total long-term liabilities...........................
6,725,815
Total liabilities...................................................
$ 6,757,815
Stockholders Equity
Paid-in capital:
Preferred stock............................................ $2,100,000
Excess of issue price over parPS.........
172,500
Common stock............................................ 4,500,000
Excess of issue price over parCS......... 1,100,000
From sale of treasury stock.......................
2,000
Total paid-in capital.................................
$ 7,874,500
Retained earnings............................................
2,461,980
Total..............................................................
Deduct treasury stock......................................
Total stockholders equity...............................
Total liabilities and stockholders equity.......
$ 10,336,480
220,000
10,116,480
$16,874,295
Prob. 144B
1.
2002
July
Dec.
2003
June
Dec.
2004
June
1 Cash................................................................
Discount on Bonds Payable.........................
Bonds Payable..........................................
9,227,796
772,204
31 Interest Expense............................................
Cash...........................................................
400,000
31 Interest Expense............................................
Discount on Bonds Payable....................
77,220
31 Income Summary...........................................
Interest Expense.......................................
477,220
30 Interest Expense............................................
Cash...........................................................
400,000
31 Interest Expense............................................
Cash...........................................................
400,000
31 Interest Expense............................................
Discount on Bonds Payable....................
154,440
31 Income Summary...........................................
Interest Expense.......................................
954,440
10,000,000
400,000
77,220
477,220
400,000
400,000
154,440
2.
a.
b.
3.
954,440
463,324
9,850,000
2002: $477,220
2003: $954,440
$9,227,796
77,220
154,440
$9,459,456
Prob. 144B
Concluded
$ 8,820,596
1,352,200
809,300
46,400
85,000
$ 11,113,496
$ 1,882,900
69,000
1,813,900
Total assets.......................................................
$12,927,396
Liabilities
Accounts payable.............................................
835,100
Stockholders Equity
Paid-in capital:
Preferred stock............................................ $ 4,600,000
Excess of par over issue pricePS.........
1,075,000
Common stock............................................
4,400,000
Excess of par over issue priceCS.........
1,200,000
From sale of treasury stock.......................
11,000
Total paid-in capital.................................
$ 11,286,000
Retained earnings............................................
827,296
Total..............................................................
Deduct treasury stock......................................
Total stockholders equity...............................
Total liabilities and stockholders equity.......
$ 12,113,296
21,000
12,092,296
$12,927,396
Prob. 145B
2002
Sept. 1
Dec. 31
31
2008
June 30
Aug. 31
31
247,375
3,200
Cash.......................................................................
Interest Revenue...............................................
9,600
Interest Revenue...................................................
Investment in Joshua Company Bonds.........
250
Cash.......................................................................
Interest Revenue...............................................
9,600
Interest Revenue...................................................
Investment in Joshua Company Bonds.........
250
Cash.......................................................................
Gain on Sale of Investments...........................
Investment in Joshua Company Bonds.........
Interest Revenue...............................................
250,575
9,600
250
9,600
250
123,500*
462
121,438
1,600
Cash.......................................................................
Interest Revenue...............................................
4,800
Interest Revenue...................................................
Investment in Joshua Company Bonds.........
375
4,800
375
a. Interest Expense........................................................
Premium on Bonds Payable
[$720,000 (5% $13,495,471)]................................
Cash.......................................................................
674,774
b. Interest Expense........................................................
Premium on Bonds Payable
[$720,000 (5% $13,450,245)]................................
Cash.......................................................................
672,512
45,226
720,000
47,488
720,000
2. $674,774
a. Interest Expense........................................................
Discount on Bonds Payable
[($6,639,795 6%) $375,000]..................................
Cash.............................................................................
398,388
b. Interest Expense........................................................
Discount on Bonds Payable
[($6,663,183 6%) $375,000]..................................
Cash.............................................................................
399,791
2. $398,388
23,388
375,000
24,791
375,000
COMPREHENSIVE PROBLEM 4
1.
a. Cash.............................................................................
Common Stock.....................................................
Paid-in Capital in Excess of Par
Common Stock.....................................................
540,000
b. Cash.............................................................................
Preferred Stock.....................................................
Paid-in Capital in Excess of Par
Preferred Stock.....................................................
900,000
c. Cash.............................................................................
Bonds Payable......................................................
Premium on Bonds Payable................................
6,373,869
300,000
240,000
750,000
150,000
6,000,000
373,869
Computations:
Present value of face amount: $6,000,000 0.37689
[present ...value of $1 for 20 (semiannual) periods
at 5% (semiannual rate)]............................................
Present value of semiannual interest payments of
$330,000 at 5% compounded semiannually:
$330,000 12.46221 (present value of annuity
of $1 for 20 periods at 5%)........................................
Total present value of bonds.........................................
$2,261,340
4,112,529
$6,373,869
d. Cash Dividends..........................................................
Cash Dividends Payable......................................
55,000
55,000
f. Bonds Payable...........................................................
Premium on Bonds Payable.....................................
Cash.......................................................................
Gain on Redemption of Bonds...........................
500,000
6,150
g. Treasury Stock...........................................................
Cash.......................................................................
210,000
55,000
55,000
505,000
1,150
210,000
Comp. Prob. 4
Continued
h. Stock Dividends.........................................................
Cash Dividends................................................................
Stock Dividends Distributable..................................
Paid-In Capital in Excess of Par
Common Stock...........................................................
Cash Dividends Payable...........................................
77,900*
30,000
47,500
30,400
30,000
47,500
30,000
97,000
3,750
k. Cash.............................................................................
Treasury Stock......................................................
Paid-In Capital from Sale of Treasury Stock.....
144,000
l. Interest Expense........................................................
Premium on Bonds Payable.....................................
Cash.......................................................................
311,307
18,693
47,500
30,000
100,750
126,000
18,000
330,000
Computations:
Semiannual interest payment........................................
Amortization premium [($373,869 120 months)
6 months, rounded] ..................................................
Interest expense..............................................................
m. Interest Receivable....................................................
Interest Revenue...................................................
$330,000
18,693
$311,307
5,000
5,000
100
100
Comp. Prob. 4
2.
Continued
a.
$ 3,150,000
1,890,000
$ 1,260,000
$180,000
98,000
75,000
45,000
17,000
10,000
5,000
$ 430,000
$ 85,000
25,000
13,100
5,300
1,600
130,000
$
$ 311,307
1,350
309,957
$
$
390,043
156,043
234,000
72,000
162,000
1,000
163,000
$ 120,000
48,000
$
560,000
700,000
1,150
150
Comp. Prob. 4
Continued
$1.29*
0.72
$0.57
0.01
$0.58
$ 677,124
$ 163,000
$ 160,000
77,900
237,900
74,900
$ 602,224
Comp. Prob. 4
Continued
c.
Comp. Prob. 4
Concluded
Liabilities
Current liabilities:
Accounts payable.......................................
Income tax payable.....................................
Dividends payable......................................
Deferred income tax payable.....................
Total current liabilities..........................
Long-term liabilities:
Bonds payable, 11%, due 2013..................
Add premium on bonds payable...............
Deferred credits:
Deferred income tax payable.....................
Total liabilities...................................................
149,500
55,900
30,000
4,700
$
$ 6,000,000
355,176
240,100
6,355,176
21,000
$ 6,616,276
Stockholders Equity
Paid-in capital:
Preferred 8% stock, $100 par (30,000
shares authorized; 15,000 shares
issued).................................................... $ 1,500,000
Excess of issue price over par..................
240,000 $ 1,740,000
Common stock, $25 par (400,000 shares
authorized; 101,900 shares issued)..... $ 2,547,500
Excess of issue price over par..................
560,000
3,107,500
From sale of treasury stock.......................
18,000
Total paid-in capital...............................
$ 4,865,500
Retained earnings............................................
602,224
Total..............................................................
$ 5,467,724
Deduct treasury common stock (2,000
shares at cost).............................................
84,000
Total stockholders equity...............................
5,383,724
Total liabilities and stockholders equity.......
$12,000,000
SPECIAL ACTIVITIES
Activity 141
Without the consent of the bondholders, Lee Noels use of the sinking fund cash
to temporarily alleviate the shortage of funds would violate the bond indenture
contract and the trust of the bondholders. It would therefore be unprofessional. In
addition, the use of Noels brother-in-law as trustee of the sinking fund is a
potential conflict of interest that could be considered unprofessional.
Activity 142
Theoretically, accountants would be justified in using present values to value all
liabilities presented in the balance sheet. As a practical matter, however, current
liabilities that will be paid within one year are presented at their face value, since
this value usually approximates the present value of the liability. Other liabilities
such as pensions and lease obligations involve complex assumptions that
include considering the present values.
Finally, generally accepted accounting principles require that long-term liabilities
be amortized using present values (the effective interest rate method). The
straight-line amortization method may be used if the results are not materially
different from those of the effective interest rate method. In this chapter, we have
used the straight-line method to simplify our discussions. The effective interest
rate method is illustrated in an appendix to the chapter.
Activity 143
The primary advantage of issuing preferred stock rather than bonds is that the
preferred stock does not obligate Daffodil to pay dividends, while interest on
bonds must be paid. That is, the issuance of bonds will require annual interest
payments, thus necessitating a periodic (probably semiannual) cash outflow.
Given WaterWaves volatility of operating cash flows, the required interest
payments might strain Daffodils liquidity. In the extreme, this could even lead to
a bankruptcy of Daffodil.
The issuance of bonds has the advantage of providing a tax deduction for
interest expense. This would tend to reduce the net (aftertax) cost of the bonds.
Probably the safest alternative is for Daffodil to issue preferred stock. Of course,
another alternative might be to issue a combination of preferred stock and
bonds.
Activity 144
Note to Instructors: The purpose of this activity is to familiarize students with
bonds as an investment and the sources of information about bonds.
Activity 145
1.
2.
Plan 1
40,000
$ 700,000
400,000
$ 300,000
120,000
$ 180,000
Plan 2
110,000
$ 700,000
260,000
$ 440,000
176,000
$ 264,000
a.
b.
4.50
2.40
Activity 146
Note to Instructors: The purpose of this activity is to familiarize students with
bond ratings and the importance of bond ratings to the issuer as well as to the
investor.