CHAPTER 6

PROBLEMS
PROBLEM NO. 1
CURRENT LIABILITIES

The data below are from the records of Arizona Company on December 31, 2009:

Accounts payable $ 340.000

Cash balance, ANZ Bank 620.000
Cash overdraft with BPI Bank 40.000
Customers' accounts with credit balances 12.500
Dividends in arrears on preferred stock 200.000
Employees' income tax payable 50.000
Estimated warranty payable 25.000
Estimated premium claims outstanding 45.000
Income tax payable 200.000
Note payable (issued in 2009 maturing in 20 semiannual installments
beginning on April 1, 2010) 2.000.000
Salaries payable 650.000

REQUIRED: Determine the total current liabilities on December 31, 2009.

Solution:
Cash overdraft with BPI Bank 40.000
Notes payable 200.000
Accounts payable 340.000
Salaries payable 650.000
Employees' income tax payable 50.000
Income tax payable 200.000
Estimated warranty payable 25.000
Estimated premium claims outstanding 45.000
Customers' accounts with credit balances 12.500
1.562.500

PROBLEM NO. 2
NOTES PAYABLE

On October 1, 2009, Longaria Company issued a $500,000, 12-month, 12% note to Angelic Corp. in
payment of account. On the same date, the company borrowed $1,000,000 from the Asean Bank
by signing a 12-month, non-interest bearing $1,120,000 note.

REQUIRED:
1. Prepare adjusting journal entries at December 31, 2009.
Solution: Adjusting Journal Entries
15.000
a. Interest expense 15.000
Interest payable (500,000 x 12% x 3/12)

b. Interest expense 30.000

Discount on notes payable 30.000
(120,000 x 3/12)
2. What is the total/net liability to be reported on December 31 balance sheet for:
a. The interest-bearing note?

Notes payable 500.000

Interest payable 15.000
515.000

b. The no-interest-bearing note?

Notes payable 1.120.000

Less: Discount (120,000-30,000) 90.000
1.030.000

PROBLEM NO. 3
ADJUSTMENTS FOR INTEREST

Described below are certain transactions of Fieldman Company:

1. On April 1, the company bought a truck for $400,000 from General Motors Company, paying
$40,000 in cash and signing a one-year, 12% note for the balance of the purchase price.

2. On May 1, the company borrowed $800,000 from Prudencial Bank by signing $920,000
non-interest bearing note due one year from May 1.

REQUIRED: Prepare any adjusting journal entries to present fair financial statements at
December 31. Assume straight-line amortization of discounts.
Solution: Adjusting Journal Entries
December 31

a. Interest expense 32.400

Interest payable (360,000 x 12% x 9/12) 32.400

b. Interest expense 80.000

Discount on notes payable 80.000
(120,000 x 8/12)

PROBLEM NO. 4
ADJUSTMENTS FOR LOSS CONTINGENCIES

The following items have not been reflected in the financial statements of ConAir Company for the
year ended December 31, 2009:

1. ConAir Company owns a small warehouse located on the banks of a river in which it stores
inventory worth approximately $250,000. ConAir is not insured against flood losses. The
river last overflowed its banks 20 years ago.
No adjustment or disclosure is required. There has been no impairment of an asset or
incurrence of a liability.

2. ConAir offers an unconditional warranty on its toys. Based on past experience, ConAir
estimates its warranty expense to be 1% of sales. Sales during 2009 were $5,000,000.
The warranty liability is probable and reasonably estimable. The amount to be accrued is
$50,000 (5,000,000 x 1%). No additional disclosure required.

3. On October 30, 2009, a safety hazard related to one of ConAir Company's toy products
was discovered. It is considered probable that ConAir will be liable for an amount in the
range of $50,000 to $250,000.
The loss is both probable and reasonably estimable. The amount at the low end of the range
(50,000) must be accrued and the amount at the high range (250,000) must be disclosed.
However, when the amount within the range is a better estimate than any other amount, the
amount is accrued.
4. On November 29, 2009, ConAir initiated a lawsuit seeking $125,000 in damages from a
patent infringement.
Because the situation involves gain con contingency, no adjustment is required.

5. On December 15, 2009, a former employee filed a lawsuit seeking $50,000 for unlawful
dismissal. ConAir attorneys believe the suit is without merit. No court date has been set.
No adjustment or disclosure required. The possibility of loss is remote.

6. On December 12, 2009, ConAir guaranteed a bank loan of $500,000 for its president's
personal use.
No adjustment is required but disclosure of the guarantee of indebtedness must be disclosed.

7. On January 5, 2010, a warehouse containing a substantial portion of ConAir's inventory

was destroyed by fire. Conair expects to recover the entire loss, except for a $125,000
deductible from insurance.
Since the fire loss was not a condition that existed at the balance sheet date, the subsequent
event only requires disclosure.

8. On January 5, 2010, inventory purchased FOB shipping point from a foreign county was
detained at the country's border because of political unrest. The shipment is valued at
$75,000. ConAir's attorneys have stated that its probable that ConAir will be able to
obtain the shipment.
No adjustment or disclosure required. The possibility of loss is remote.

9. On January 30, 2010, ConAir issued $5,000,000 bonds at a premium of $250,000.

The subsequent event only requires disclosure.

10. On February 14, 2010, ConAir was assessed by customs an additional $200,000 for the
2007 tax year. ConAir attorneys and tax accountants have stated that it is likely the
customs will agree to a $150,000 settlement.
The $150,000 should be accrued since this condition already existed at the balance sheet
date.

REQUIRED: For each of the items described above, determine if an adjustment or

disclosure is required.

PROBLEM NO. 5
ACCRUED EXPENSES

Carolina Company must determine the December 31, 2009 year-end accruals for advertising and
rent expenses. A $50,000 advertising bill was received January 10, 2010, comprising costs of
$37,500 for advertisements in December, 2009 issues and $12,500 for advertisements in January
2004 issues of the newspaper.

A store lease, effective December 16, 2008, calls for fixed rent of $120,000 per month, payable one
month from the effective date and monthly thereafter. In addition, rent equal to 5% of net sales
over $30,000,000 per calendar year is payable on January 31 of the following year. Net sales
for 2009 were $55,000,000.

REQUIRED: Determine the total accrued liabilities that Carolina Company should report in
its December 31, 2009 balance sheet.
Solution:
Advertising 37.500
Fixed rent, Dec 16-31 (1/2 x 120,000) 60.000
Variable rent (55,000000-30,000000) x 5% 1.250.000
1.347.500
PROBLEM NO. 6
BONUS COMPUTATION

Peter Miller, president of the Miler Company, has a bonus arrangement with the company under
which he receives 10% of the net income (after deducting taxes and bonuses) each year. For the
current year, the net income before deducting either the provision for income taxes or the bonus
is $4,650,000. The bonus is deductible for tax purposes, and the tax rate is 32%.

REQUIRED:
1. Determine that amount of Peter Miler bonus.
Solution:
B = 10%(4,650,000-B-T)
T = 32%(4,650,000-B)
B = 10%[4,650,000-B-(32%{4,650,000-B})]
B = 10%[4,650,000-B-(1,488,000-32%B)]
B = 10%[4,650,000-B-1,488,000+32%B]
B = 465,000-10%B-148,000+3.2%B
B = 316,200-6.8B
106.8%B = 316,200
B = 316,200/106,8%
B = 296.067

2. Compute the appropriate provision for income tax for the year.

T = 32% (4,650,000- B)
T = 32% (4,650,000 - 296,067)
T = 32% x 4,353,933
T = 1.393.259

3. Prepare the entry to record the bonus (which will be paid in the following year).

Bonus expense 296.067

Bonus payable 296.067

PROBLEM NO. 7
PREMIUMS

In packages of its products, Lenard Company includes coupons that may be presented at retail
stores to obtain discounts on other Lenard products. Retailers reimbursed for the face amount
of coupons redeemed plus 10% of that amount for handling costs. Lenard honors requests for
coupon redemption by retailers up to 3 months after the consumer expiration date.
Lenard estimates that 60%of all coupons issued by Lenard will ultimately be redeemed.
Information relating to coupons issued by Lenard during 2009 is as follows:

Consumer expiration date 12/31/09

Total payments to retailers as of 12/31/09 $165.000
Liability for unredeemed coupons as of 12/31/09 99.000

REQUIRED: Determine the total face amount of coupons issued in 2009.

Solution:
Liability for unredeemed coupons, 12/31 99.000
Add: Total payments to retailers 165.000
Total cost 264.000
Less: Handling charges [264,000-(264,000/110%)] 24.000
To be redeemed 240.000
Redemption rate 60%
Total face amount of coupons issued 400.000
PROBLEM NO. 8
DEBT RESTRUCTURING: ASSET SWAP, EQUITY SWAP AND
MODIFICATION OF TERMS

Delaware Company is having financial difficulty and therefore has asked National Bank to
restructure its $3 million note outstanding. The present note has 3 years remaining and pays
a current rate of interest of 10%. The present market rate for a loan of this nature is 12%. The
note was issued at its face value.

REQUIRED: Presented below are four independent situations. Prepare the journal entry
that Delaware Company would make for each of the following types of
debt restructuring.

a. National Bank agrees to take an equity interest in Delaware Company by accepting

common stock valued at $2,400,000 in exchange for relinquishing its claim on this note.
The common stock has a par value of $1,200,000.

Notes payable 3.000.000

Common shares 1.200.000
Additional paid in capita 1.800.000

b. National Bank agrees to accept land in exchange for relinquishing its claim on this note.
the land has a book value of $2,000,000 and a fair value of $2,500,000.

Notes payable 3.000.000

Land 2.000.000
Gain on exchange 500.000
Gain on debt restructuring 500.000

c. National Bank agrees to modify the terms of the note, indicating that Delaware does not
have to pay any interest on the note over the 3-year period.

No entry because the restructured liability is equal to the book value of the old liability
(3,000,000)

d. National Bank agrees to reduce the principal balance due to $2,000,000 and require interest
only in the second and third year at a rate of 10%

Notes payable-old 3.000.000

Notes payable-restructured 2.400.000
Gain on debt restructuring 600.000

Notes payable 2.000.000

Future interest payment
(2,000,000 x 10% x 2yrs) 400.000
2.400.000
BV of old NP 3.000.000
Gain 600.000
PROBLEM NO. 9
BONDS PAYABLE

In your initial audit of Emerald Company, you find the following ledger account balances:

12% Bonds Payable-Maturity Date, 1/1/2011

1/2/0 CR $5.000.000

Treasury Bonds

10/1/03 CD $1.000.000

Bond Discount

1/2/01 CD $500.000

Bond Interest Expense

1/1'03 CD $300.000
7/1/03 CD 300.000

The bonds were redeemed for permanent cancelation on October 1, 2003 at 107 plus accrued
interest.

REQUIRED:
Determine the following:
1. Adjusted balance of bonds payable on December 31, 2003.

Balance 1/1 5.000.000

Less: Redemption (1,100,000/110%) 1.000.000
Balance 4.000.000
Redemption price 107%
Accrued interest (12% x 3/12) 3%
110%

2. Adjusted balance of bonds discount on December 31, 2003.

Balance, 1/2 500.000

Amortization:
1/2/01-9/30/03 (500,000/10yrs x 2-9/12) (137.500)
10/1/03 - 12/31/03 (500,000 x 4/5 x 3/12) (10.000)
Unamortized discount of bonds redeemed (72.500)
Balance, 12/31/03 (500,000/10 x 1/5 x 7-3/12) 280.000

3. Bond interest expense for 2003.

Jan. 1 - Sept. 30 (5,000,000 x 12% x 9/12) 450.000

Oct. 1 - Dec. 31 (4,000,000 x 12% x 3/12) 120.000
Discount amortization:
Jan. 1 - Sept. 30 (500,000/10 x 9/12) 37.500
Oct. 1- Dec. 31 (400,000/10 x 3/12) 10.000
617.500
4. Gain or loss on bond redemption.

Redemption price (1,000,000 x 107%) 1.070.000

Carrying value of bonds (1,000,000-72,500) 927.500
Loss on bond redemption 142.500

PROBLEM NO. 10
RETIREMENT OF BONDS BEFORE MATURITY

The December 31, 2008, balance sheet of Zurich Company includes the following items:

9% bonds payable due December 31, 2017 $4.000.000

Premium on bonds payable 108.000

The bonds were issued on December 31, 2007 at 103, with interest payable on June 30 and
December 31 of each year. The straight-line method is used for premium amortization.

On March 1, 2009, Zurich Company retired $1,000,000 of these bonds at 97, plus accrued interest.

REQUIRED: Compute the gain or loss on retirement of bonds.

Solution:
Retirement price (1,000,000 x 97%) 970.000
Carrying value of bonds:
FV 1.000.000
Add: Unamortized premium
(106,000 x 1/4) 26.500 1.026.500
Gain 56.500
Balance 108.000
Amortization (1/1-31/1
(12,000 x 2/12) 2.000
106.000