Kimmel, Weygandt, Kieso, Trenholm
Financial Accounting, Second Canadian Edition
CHAPTER 10
Reporting and Analysing Liabilities
ASSIGNMENT CLASSIFICATION TABLE
Study Objectives
Questions
Brief
Exercises
A
Problems
B
Problems
Exercises
1
9
1A
1B
2B, 3B
*1.
Distinguish between
current and long-term
liabilities.
1
*2.
Explain the accounting
for current liabilities.
2, 3, 4, 5, 6 2, 3, 4
1, 2, 3, 4
2A, 3A
*3.
Prepares the entries for
the issue of bonds.
7, 8, 9, 10
5, 6, *13,
*14, *15
5, 6, *13,
*14
4A, 5A, 6A, 4B, 5B, 6B,
*10A, *11A, *10B, *11B,
*12A, *13A *12B, *13B
*4.
Prepare the entries for
11
the retirement of bonds.
7
7, *13, *14 4A, 5A, *11A 4B, 5B,
*11B
*5.
Explain the accounting
for long-term notes
payable.
12, 13
8, 9
8
6A, 7A
6B, 7B
*6.
Identify the requirements for the financial
statement presentation
and analysis of liabilities.
14, 15, 16,
17, 18, 19
10, 11, 12
9, 10, 11,
12
2A, 3A, 5A,
6A, 7A, 8A,
9A, *10A,
*13A
2B, 3B, 5B,
6B, 7B, 8B,
9B, *10B,
*13B
**7. Apply the straight-line
method of amortizing
bond discounts and
premiums.
*20, *21
*13, *14
*13, *14
*10A, *11A
*10B, *11B
**8. Apply the effectiveinterest method of
amortizing bond discounts and premiums.
*20, *22
*15
*15
*12A, 13A
*12B, *13B
*Note: All asterisked Questions, Exercises, and Problems relate to material contained in the Appendices to this
chapter.
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Kimmel, Weygandt, Kieso, Trenholm
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ASSIGNMENT CHARACTERISTICS TABLE
Problem
Number
Description
Difficulty
Level
Time
Allotted (min.)
*1A
Identify liabilities.
Moderate
15-20
*2A
Prepare current liability entries and section of balance Moderate
sheet.
30-40
*3A
Prepare entries for note payable; show balance sheet
presentation.
Moderate
30-40
*4A
Prepare entries for bonds.
Moderate
30-40
*5A
Prepare entries for bonds; show balance sheet
presentation.
Moderate
30-40
*6A
Prepare entries for bonds and mortgage note payable. Show balance sheet presentation.
Moderate
30-40
*7A
Prepare entries for note payable. Show balance
sheet presentation.
Moderate
30-40
*8A
Analyse liquidity and solvency.
Complex
20-30
9A
Analyse liquidity and solvency.
Moderate
30-40
*10A
Prepare entries for bonds, using straight-line amortization. Show balance sheet presentation.
Moderate
30-40
*11A
Prepare entries for bonds, using straight-line amortization.
Moderate
20-30
*12A
Prepares entries for bonds, using effective-interest
amortization.
Moderate
30-40
*13A
Prepares entries for bonds, using effective-interest
amortization. Show balance sheet presentation and
answer questions.
Moderate
30-40
*1B
Identify liabilities.
Moderate
15-20
*2B
Prepare current liability entries and section of balance Moderate
sheet.
30-40
*3B
Prepare entries for notes payable; show balance
30-40
Moderate
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Kimmel, Weygandt, Kieso, Trenholm
Problem
Number
Financial Accounting, Second Canadian Edition
Description
Difficulty
Level
Time
Allotted (min.)
sheet presentation.
*4B
Prepare entries for bonds.
Moderate
30-40
*5B
Prepare entries for bonds; show balance sheet
presentation.
Moderate
30-40
6B
Prepare entries for bonds, and mortgage note payable. Show balance sheet presentation.
Moderate
30-40
7B
Prepare entries for note payable. Show balance
sheet presentation.
Moderate
30-40
8B
Analyse liquidity and solvency.
Complex
20-30
9B
Analyse liquidity and solvency.
Moderate
30-40
*10B
Prepare entries for bonds, using straight-line amortization. Show balance sheet presentation.
Moderate
30-40
*11B
Prepare entries for bonds, using straight-line amortization.
Moderate
20-30
*12B
Prepares entries for bonds, using effective interest
amortization.
Moderate
30-40
*13B
Prepares entries for bonds, using effective-interest
amortization. Show balance sheet presentation and
answer questions.
Moderate
30-40
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Kimmel, Weygandt, Kieso, Trenholm
Financial Accounting, Second Canadian Edition
ANSWERS TO QUESTIONS
1.
While this is generally true, more precisely, a current liability is a debt that can reasonably
be expected to be paid: (a) from existing current assets or through the creation of other
current liabilities and (2) within one year.
2.
Notes payable provide the lender with written documentation of the obligation and usually
require the borrower to pay interest. Accounts payable do not involve documentation other
than the suppliers invoice and do not generally provide for interest until they are past due.
Accounts payable are normally for 30 days; notes payable may be for 30 days to a multiple
of years.
Whereas a note payable is usually provided for a set amount to cover some purchase
made by the borrower, an operating line of credit allows the lender to borrow up to some
preset amount, when it is needed.
3.
In the balance sheet, Notes Payable of $25,000 and Interest Payable of $562.50 ($25,000
X 9% x 3/12) should be reported as current liabilities. In the statement of earnings, Interest
Expense of $562 should be reported under other expenses. In addition, the interest rate
and term of the note are normally reported in the notes to the statements.
4.
Disagree. The company only serves as a collection agent for the taxing authority. It does
not report sales taxes as an expense; it merely forwards the amount paid by the customer
to the government.
5.
Because property tax bills are often not received until spring, companies preparing monthly
financial statements must estimate and accrue property taxes until the bill arrives. This
gives rise to a property tax payable. Once the bill arrives and is set up in the accounts, the
company records a prepaid property tax for the period of time that has not already expired.
At this point, the company has both a prepaid asset and a current liability for the property
tax.
6.
Costs withheld from employees’ gross pay and not yet remitted to the appropriate government agency are reported in the balance sheet as current liabilities.
Costs paid by the employer are recorded in the balance sheet as a current liability until
they are paid. They are also reported as an expense in the statement of earnings, usually
as part of salaries and benefits expense.
7.
The two major obligations incurred by a company when bonds are issued are the interest
payments due on a periodic basis and the principal, which must be paid at maturity.
8.
Less than the contractual interest rate. Investors are required to pay more than the face
value; therefore, the market interest rate is less than the contractual rate.
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Financial Accounting, Second Canadian Edition
Questions (Continued)
9.
No, La is not right. The market price on any bond is a function of three factors: (1) the dollar
amounts to be received by the investor (interest and principal), (2) the length of time until
the amounts are received (interest payment dates and maturity date), and (3) the market
interest rate.
10.
$860,000 ($900,000 - $40,000). The balance of the Bonds Payable account minus the balance of the Discount on Bonds Payable account (or plus the balance of the Premium on
Bonds Payable account) equals the carrying value of the bonds.
11.
Debits:
Credits:
12.
Bonds Payable (for the face value) and Premium on Bonds Payable (for the
unamortized balance).
Cash (for 97% of the face value) and Gain on Bond Redemption (to balance entry).
Instalment notes with fixed principal payments are repayable in equal periodic amounts
plus interest. Each time a payment is made a constant amount of principal is applied to the
note. The total amount of the payment will decline over time as the interest expense portion decreases due to reductions in the principal amount of the note.
An instalment note with a blended principal and interest payment is repayable in equal periodic amounts and result in changing amounts of interest and principal being applied to
the note. The total payment remains the same over the life of the note but the portion applied to the principal increases over time as the interest portion decreases due to reductions in the principal amount of the note.
13.
This is not the case because the amount of interest paid each month will decrease as
payments are made and the principal decreases. This is because the amount of interest is
calculated as a percentage of the remaining principal amount. Because the payment remains constant, over time, greater portions of the payment will be applied to the principal
thereby more quickly reducing the balance of the mortgage.
14.
(a) Current liabilities should be presented in the balance sheet with each principal type
shown separately. They are normally listed in order of magnitude. The notes should
also indicate the terms, including interest rates, maturity dates, and other pertinent information such as assets pledged as collateral.
(b) The nature and the amount of each long-term liability should be presented in the balance sheet or in schedules in the accompanying notes to the statements. The notes
should also indicate the interest rates, maturity dates, conversion privileges, and assets pledged as collateral.
(c) Liquidity: working capital, current ratio, acid-test ratio, receivables turnover, inventory
turnover.
Solvency: debt to total assets ratio, times interest earned ratio.
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Financial Accounting, Second Canadian Edition
Questions (Continued)
15.
Joe Investor is not correct. In order to reduce costs, many companies today keep low
amounts of inventory on hand. Consequently, liquidity ratios are generally lower than they
used to be. Companies that keep fewer liquid assets on hand frequently rely on a bank line
of credit. A line of credit allows a company to borrow money on a short-term basis to meet
any cash shortfalls caused by a low amount of liquid assets. Another measure that could
be checked is the acid-test ratio. This ratio is a measure of a company’s immediate shortterm liquidity. Finally, Joe might check the company’s inventory turnover ratio to see if it
supports the assertions the company is making about its inventory levels.
16.
Off-balance sheet financing refers to situations where a company has liabilities that are not
recorded on the balance sheet. Off-balance sheet transactions arise with a company is
able to structure the acquisition of assets or the financing of its operations with arrangements that in substance are considered liabilities but do not meet the criteria under GAAP
which would require the transaction to be recorded as debt in the financial statements.
Two common types of off-the balance sheet financing are operating leases and special
purpose partnerships.
17.
The primary difference between operating leases and capital leases is that operating leases have the economic characteristics of a rental agreement, while capital leases are like
purchases. For capital leases, an asset and liability are recorded on the balance sheet. For
operating leases, rent expense is recorded on the statement of earnings.
18.
Two criteria must be met: (1) the contingency must be likely to occur and (2) the company
must be able to arrive at a reasonable estimate. If the contingency is likely to occur but not
estimable, the company should disclose the major facts concerning the contingency in its
notes.
19.
Depending on how the lease arrangements are structured, Air Canada could have significantly decreased the obligations being recorded on its balance sheet. If the leases are operating leases, the company will show fewer assets on the balance sheet and less debt, as
financing through the use of operating leases does not have to be recorded on the balance
sheet. Therefore, when preparing a trend analysis, the company will appear to have improved its solvency when in fact all it has done is moved its financing off the balance sheet.
*20. The straight-line method results in the same amortized amount being assigned to Interest
Expense each interest period. This amount is determined by dividing the total bond discount or premium by the number of interest periods the bonds will be outstanding. In contrast, the interest amount using the effective interest method is calculated as a percentage
of the outstanding principal and varies from period to period. In total the interest charged
over the term of the bond is the same – the allocation to accounting periods differs.
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Questions (Continued)
*21. $14,400. Interest expense is the interest to be paid in cash less the premium amortization
for the year. Cash to be paid equals 8% X $200,000 or $16,000. Total premium equals 4%
of $200,000 or $8,000. Since this is to be amortized over 5 years (the life of the bonds) in
equal amounts, the amortization amount is $8,000 ÷ 5 = $1,600. Thus, $16,000 – $1,600 or
$14,400 equals interest expense for 2004.
*22.
Decrease. Under the effective-interest method the interest charge per period is determined by multiplying the carrying value of the bonds by the effective-interest rate. When
bonds are issued at a premium, the carrying value decreases over the life of the bonds. As
a result, the interest expense will also decrease over the life of the bonds because it is determined by multiplying the decreasing carrying value of the bonds at the beginning of the
period by the effective-interest rate.
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Financial Accounting, Second Canadian Edition
SOLUTIONS TO BRIEF EXERCISES
BRIEF EXERCISE 10-1
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
Current liability
Current liability
Current liability
Current liability
Current liability
Current liability
Current asset
Not recorded
Current liability
Current liability
BRIEF EXERCISE 10-2
(a)
(b)
July
1
Dec. 31
Cash ......................................................................
Note Payable.................................................
60,000
Interest Expense ....................................................
Interest Payable ............................................
($60,000 X 5% X 6/12)
1,500
60,000
1,500
BRIEF EXERCISE 10-3
Sales = $8,750.00 ($9,975 ÷ 1.14)
GST payable = $612.50 ($8,750 X 7%)
PST payable = $612.50 ($8,750 X 7%)
Mar. 16
Cash ...............................................................................
Sales ......................................................................
GST Payable ..........................................................
PST Payable ..........................................................
9,975.00
8,750.00
612.50
612.50
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BRIEF EXERCISE 10-4
Property tax expense June 30 statement of earnings:
$25,200 X 6/12 months = $12,600
Prepaid property tax June 30 balance sheet:
$2,100 x 6 months = $12,600
Property tax payable June 30 balance sheet
$2,100 x 12 months = $25,200
BRIEF EXERCISE 10-5
Issue Shares
Earnings before interest and taxes
Interest ($2,000,000 X 8%)
Earnings before income taxes
Income tax expense (30%)
Net earnings (a)
Number of shares (b)
Earnings per share (a) ÷ (b)
Issue Bonds
$1,000,000
0
1,000,000
300,000
$ 700,000
$1,000,000
. 160,000
840,000
252,000
$ 588,000
900,000
700,000
$0.78
$0.84
Net earnings is higher if shares are issued. However, earnings per share are lower than if bonds
are used because of the additional shares. Issuing shares is usually the preferable alternative,
since repayment of funds raised is not required.
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BRIEF EXERCISE 10-6
(a)
(b)
(c)
(d)
March 1
March 1
March 1
(1)
(2)
(3)
(e)
Cash ...........................................................
Bonds Payable ...................................
(1,000 X $1,000)
1,000,000
Cash ($1,000,000 X 0.98) ...........................
Discount on Bonds Payable ........................
Bonds Payable (1,000 X $1,000) .......
980,000
20,000
Cash ($1,000,000 X 1.02) ...........................
Premium on Bonds Payable ...............
Bonds Payable (1,000 X $1,000) .......
1,020,000
1,000,000
1,000,000
20,000
1,000,000
Long-term liabilities
Bonds payable, due 2009 .......................................
$1,000,000
Long-term liabilities
Bonds payable, due 2009 .......................................
Less: Discount on bonds payable ..........................
$1,000,000
20,000
$980,000
Long-term liabilities
Bonds payable, due 2003 .......................................
Add: Premium on bonds payable ..........................
$1,000,000
20,000
$1,020,000
Regardless of whether the bonds were sold at face value, at a discount, or at a premium,
at maturity on March 1, 2009, the carrying value of the bonds will be $1,000,000.
BRIEF EXERCISE 10-7
November 30
Bonds Payable ............................................
Loss on Bond Redemption ..........................
($980,000 – $940,000)
Discount on Bonds Payable ................
Cash ($1,000,000 X .98) .....................
1,000,000
40,000
60,000
980,000
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BRIEF EXERCISE 10-8
Monthly
Interest
Period
(A)
Cash
Payment
(B)
Interest
Expense
(D) X 7% ÷ 12 mos.
(C)
Reduction of
Principal
(A)- (B)
(D)
Principal
Balance
(D) - (C)
Issue date
$10,000.00
1
$116.11
$58.33
$57.78
9,942.22
2
116.11
58.00
58.11
9,884.11
3
116.11
57.66
58.45
9,825.66
BRIEF EXERCISE 10-9
(a)
Monthly
Interest
Period
Nov. 30, 2004
Dec. 31, 2004
Jan. 31, 2005
2004
Nov. 30
Dec.
31
2005
Jan. 31
(A)
Cash
Payment
$4,500
04,483
(B)
Interest
Expense
(D) X 8% X
1/12
(C)
Reduction
of Principal
(A) – (B)
(D)
Principal
Balance
(D) – (C)
$2,000
01,983
$2,500
02,500
$300,000
297,500
295,000
2,000
Cash .........................................................................
Mortgage Note Payable ...................................
300,000
Interest Expense .......................................................
Mortgage Note Payable ............................................
Cash ................................................................
2,000
2,500
Interest Expense .......................................................
Mortgage Note Payable ............................................
Cash ................................................................
1,983
2,500
300,000
4,500
4,483
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Financial Accounting, Second Canadian Edition
BRIEF EXERCISE 10-9 (Continued)
(b)
Monthly
Interest
Period
(A)
Cash
Payment
Nov. 30, 2004
Dec. 31, 2004
Jan. 31, 2005
2004
Nov. 30
Dec.
31
2005
Jan. 31
$3,639.83
3,639.83
(B)
Interest
Expense
(D) X 8% X
1/12
$2,000.00
1,989.07
(C)
Reduction
of Principal
(A) – (B)
$1,639.83
1,650.76
01476.73
(D)
Principal
Balance
(D) – (C)
$300,000.00
298,360.17
296,709.41
22,000
Cash .........................................................................
Mortgage Note Payable ...................................
300,000.00
Interest Expense .......................................................
Mortgage Note Payable ............................................
Cash ................................................................
2,000.00
1,639.83
Interest Expense .......................................................
Mortgage Note Payable ............................................
Cash ................................................................
1,989.07
1,650.76
300,000.00
3,639.83
3,639.83
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BRIEF EXERCISE 10-10
WARNER LTD.
Balance Sheet (Partial)
December 31, 2004
Current liabilities
Bank indebtedness .........................................................
Accounts payable............................................................
Interest payable ..............................................................
Employee benefits payable .............................................
Property tax payable .......................................................
Sales taxes payable ........................................................
Current portion of long-term debt ....................................
Total current liabilities .............................................
Long-term liabilities
Bonds payable, due 2008 ................................................
Less: Discount on bonds payable ...................................
Notes payable, due 2006.................................................
Total long-term liabilities .........................................
Total liabilities ...........................................................................
$ 20,000
135,000
40,000
7,800
3,500
1,400
240,000
$ 447,700
$900,000
45,000
855,000
80,000
935,000
$1,382,700
BRIEF EXERCISE 10-11
[dollar figures in millions]
(a)
Working capital = $516.3  $458.2  $58.1
(b)
Current ratio =
(c)
Acid-test ratio =
(d)
Debt to total assets =
(e)
Times interest earned =
$516.3
 1.13 : 1
$458.2
($4.9  $90.3)
 0.21: 1
$458.2
$1,261.3
 57.8%
$2,178.9
($246.7  $52.1  $0.5)
 5.7 times
$52.1
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Financial Accounting, Second Canadian Edition
BRIEF EXERCISE 10-12
(a)
(b)
Debt to total assets:
Without operating leases
$12,297
= 65%
$18,924
With operating leases
$12,297  $1,154
= 67%
$18,924  $1,154
CN does not have significant operating leases therefore its assets and liabilities reflect its
true financial position. By increasing its assets and liabilities for these operating leases we
see that its debt to total assets ratio increases only marginally from 65% to 67%.
*BRIEF EXERCISE 10-13
(a)
(b)
Jan.
July
1
1
Cash (0.96 X $2,000,000) ...........................
Discount on Bonds Payable ........................
Bonds Payable ...................................
1,920,000
80,000
Bond Interest Expense ................................
Discount on Bonds Payable
($80,000 ÷ 20) .................................
Cash ($2,000,000 X 9% X 6/12) .........
94,000
2,000,000
4,000
90,000
*BRIEF EXERCISE 10-14
(a)
(b)
Jan. 1
July 1
Cash (1.03 X $5,000,000) ...........................
Bonds Payable ....................................
Premium on Bonds Payable ...............
5,150,000
Interest Expense .........................................
Premium on Bonds Payable
($150,000 ÷ 10)...........................................
Cash ($5,000,000 X 8% X 6/12) .........
185,000
5,000,000
150,000
15,000
200,000
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Financial Accounting, Second Canadian Edition
*BRIEF EXERCISE 10-15
(a)
(b)
Cash ..........................................................................................
Discount on Bonds Payable .......................................................
Bonds Payable ..................................................................
937,689
62,311
Interest Expense ........................................................................
Discount on Bonds Payable ..............................................
Cash ..................................................................................
46,884
1,000,000
1,884
45,000
(c)
Interest expense is greater than interest paid because the bonds sold at a discount. The
discount is an additional cost of borrowing that should be recorded as bond interest expense over the life of the bonds. The bonds sold at a discount because investors demand a
market interest rate higher than the contractual interest rate.
(d)
Interest expense increases each period because the bond carrying value increases each
period. As the market interest rate is applied to this bond carrying amount, interest expense
will increase.
(e)
The carrying value of the bond on its maturity date will be $1,000,000.
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SOLUTIONS TO EXERCISES
EXERCISE 10-1
(a)
(b)
(c)
June
June 30
Cash ......................................................................
Note Payable .................................................
50,000
Interest Expense .....................................................
($50,000 X 8% X 1/12)
Interest Payable.............................................
333
Interest payable accrued each month ........................
Number of months from borrowing to year end ..........
Balance in interest payable account ...........................
Dec.
(d)
1
1
50,000
333
$ 333
x
6
$2,000
Note Payable ..........................................................
Interest Payable ......................................................
Cash ..............................................................
50,000
2,000
52,000
The total financing cost (interest expense) was $2,000.
EXERCISE 10-2
(a)
Valerio Construction
Oct. 1
Nov. 1
(b)
Cash .........................................................................
Note Payable..................................................
250,000
Interest Expense .......................................................
Cash ...............................................................
($250,000 X 5% X 1/12)
1,042
Note Receivable .......................................................
Cash ...............................................................
250,000
Cash .........................................................................
Interest Revenue ............................................
($250,000 X 5% X 1/12)
1,042
250,000
1,042
TD Bank
Oct. 1
Nov. 1
250,000
1,042
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Chapter 10
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Financial Accounting, Second Canadian Edition
EXERCISE 10-3
(a)
Jintao Ltd.
Apr. 10
(b)
Cash ...........................................................................
Sales ..................................................................
GST Payable ......................................................
PST Payable ......................................................
28,750
25,000
1,750
2,000
Gan Ltd.
Apr. 15
Cash ...........................................................................
Sales ($11,700 ÷ 1.17) .......................................
GST Payable ($10,000 x 7%) .............................
PST Payable ($10,000 x 10%) ...........................
11,700
10,000
700
1,000
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Chapter 10
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EXERCISE 10-4
(a)
Last calendar year
Oct. 31
- Dec. 31
Property Tax Expense ($24,000 X 1/12) ........................
Prepaid Property Tax ............................................
2,000
2,000
This entry would be made monthly Oct. to Dec. ($2,000 X 3 mos. = $6,000).
Current calendar year
Jan. 31
- Apr. 30
Property Tax Expense ($24,000 X 1/12) ........................
Property Tax Payable............................................
2,000
2,000
This entry would be made monthly Jan. to April ($2,000 X 4 mos. = $8,000).
(b)
May 1
Prepaid Property Tax
($26,400 x 8/12 mos. May-Dec.) ....................................
Property Tax Expense ...................................................
Property Tax Payable ($26,400 - $8,000) .............
17,600
800*
18,400
*[($2,200 - $2,000) x 4 mos. (Jan. to April) under-expensed]
May 31
- June 30
Property Tax Expense ($26,400 X 1/12) ........................
Prepaid Property Tax ............................................
2,200
2,200
This entry would be made monthly May and June ($2,200 X 2 mos. = $4,400).
(c)
(d)
July 1
July 31
- Sept. 30
Property Tax Payable ($8,000 + $18,400) .....................
Cash......................................................................
26,400
Property Tax Expense ($26,400 X 1/12) ........................
Prepaid Property Tax ............................................
2,200
26,400
2,200
This entry would be made monthly July, August, and September.
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Chapter 10
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EXERCISE 10-5
(a)
The Bank of Montreal bonds were issued at a premium and the Bell Canada bonds were
issued at a discount.
(b)
The prices of the two bonds differed because bond price is based on the market rate of interest not the stated rate of interest. Market interest rates must have been different when
the two bonds were issued causing the selling prices to differ.
(c)
Cash (1.1112 X $500,000) ..........................
Premium on Bonds Payable ...............
Bonds Payable ...................................
555,600
Cash (0.9908 X $500,000) ..........................
Discount on Bonds Payable ........................
Bonds Payable ...................................
495,400
4,600
55,600
500,000
500,000
EXERCISE 10-6
(a)
(b)
(c)
Sept.
Dec.
Feb.
1
1
1
Cash ...........................................................
Bonds Payable ...................................
400,000
Interest Expense ($400,000 X 9% X 4/12) ..
Interest Payable .................................
12,000
Interest Expense .........................................
Interest Payable ..........................................
Cash ($400,000 X 9% X 6/12) ............
6,000
12,000
400,000
12,000
18,000
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Chapter 10
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Financial Accounting, Second Canadian Edition
EXERCISE 10-7
(a)
(b)
June
June
30
Bonds Payable ..................................................
Loss on Bond Redemption ................................
Discount on Bonds Payable .....................
($120,000 – $107,500)
Cash ($120,000 X 102%) .........................
30
120,000
14,900*
12,500*
122,400*
Bonds Payable. ................................................. 0000 120,000
Loss on Bond Redemption ................................
10,100**
Discount on Bonds Payable. .................... 000000
12,500
Cash ($120,000 X 98%) ...........................
117,600
*$107,500 – (102% X $120,000) = $14,900
**$107,500 – (98% X $120,000) = $10,100
EXERCISE 10-8
(a)
Semi-annual
Interest
Period
(A)
Cash
Payment
Dec. 31, 2004
June 30, 2005
Dec. 31, 2005
$9,750
9,600
01
(B)
Interest
Expense
(D) X 8% X
6/12
(C)
Reduction
of Principal
(A) – (B)
$6,000
05,850
(D)
Principal
Balance
(D) – (C)
$150,000
146,250
142,500
22,000
$3,750
3,750
01476.73
Issue of Note
2004
Dec.
31
Cash ...............................................................
Mortgage Note Payable .........................
150,000
150,000
First Instalment Payment
2005
June
30
Interest Expense ($150,000 X 8% X 6/12) .....
Mortgage Note Payable ..................................
Cash ......................................................
6,000
3,750
9,750
Second Instalment Payment
Dec.
31
Interest Expense
[($150,000 – $3,750) X 8% X 6/12] .............
Mortgage Note Payable ..................................
Cash.......................................................
5,850
3,750
9,600
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EXERCISE 10-8 (Continued)
(b)
Semi-annual
Interest
Period
(B)
Interest
Expense
(D) X 8% X
6/12
(A)
Cash
Payment
Issue Date
June 30, 2005
Dec. 31, 2005
$7,578.52
7,578.52
01
$6,000.00
5,936.86
(C)
Reduction
of Principal
(A) – (B)
(D)
Principal
Balance
(D) – (C)
$1,578.52
1,641.66
01476.73
$150,000.00
148,421.48
146,779.82
22,000
0
Issue of Note
2004
Dec.
31
Cash ...............................................................
Mortgage Note Payable .........................
150,000
150,000
First Instalment Payment
2005
June
30
Interest Expense
($150,000 X 8% X 6/12) ..............................
Mortgage Note Payable ..................................
Cash ......................................................
6,000.00
1,578.52
7,578.52
Second Instalment Payment
Dec.
31
Interest Expense [($150,000
– $1,578.52) X 8% X 6/12] ...........................
Mortgage Note Payable ..................................
Cash.......................................................
5,936.86
1,641.66
7,578.52
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EXERCISE 10-9
(a) Account
Classification
Reason
Accounts payable
Current liability
Due within one year
Accrued benefit liability
Long-term liability
Accrued liabilities
Current liability
Likely relates to pensions. Not
due within one year
Due within one year
Bonds payable
Long-term liability
Not due within one year
Current portion of long-term
debt
Current liability
Due within one year
Deferred income taxes
Long-term liability
Income taxes payable
Current liability
Income taxes payable in the future
Due within one year
Notes payable - long-term
Long-term liability
Not due within one year
Operating leases
N/A
Other liabilities
Long-term liability
Not a balance sheet item – may
be disclosed in notes
Not due within one year
Other loans payable
Long-term liability
Not due within one year
Payroll related liabilities
Current liability
Due within one year
Short-term borrowings
Current liability
Due within one year
Unused operating line of credit
NA
Warranty provision
Both
Not a balance sheet item as unused – may be disclosed in
notes
Can be current and/or long-term
depending on the length of the
warranty
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EXERCISE 10-9 (Continued)
(b)
BOMBARDIER INC.
(Partial) Balance Sheet
January 31, 2003
(in millions)
Current liabilities
Short-term borrowings ....................................................
Accounts payable ...........................................................
Accrued liabilities............................................................
Current portion of long-term debt ...................................
Payroll related liabilities ..................................................
Income taxes payable ....................................................
Total current liabilities.............................................
Long-term liabilities
Bonds payable ...............................................................
Notes payable, long-term ...............................................
Other liabilities ................................................................
Accrued benefit liability...................................................
Other loans payable .......................................................
Warranty provision .........................................................
Deferred income taxes ...................................................
Total long-term liabilities.........................................
Total liabilities .........................................................................
$2,563.6
3,263.9
1,258.1
1,992.2
558.1
28.8
$ 9,664.7
$1,961.2
5,746.7
1,498.7
1,215.2
335.6
1,417.3
206.4
12,381.1
$22,045.8
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EXERCISE 10-10
($ in thousands)
(a)
Current ratio
2002:
$ 9,034
 0.57 : 1
$15,944
2001:
$12,636
 0.70 : 1
$18,162
Acid-test ratio
(b)
2002:
($ 1,834  $ 4,616  $ 448)
 0.43 : 1
$15,944
2001:
($ 2,247  $ 7,545  $ 612)
 0.57 : 1
$18,162
Current ratio
$ 9,034 - $1,000
 0.54 : 1
$15,944 - $1,000
Acid-test ratio
($ 1,834  $ 4,616  $ 448 - $1,000)
 0.39 : 1
($15,944 - $ 1,000)
Paying off the $1 million would make the Stampede’s current ratio decrease from 0.57:1 to
0.54:1. Its acid-test ratio would decrease from 0.43:1 to 0.39:1.
(c)
The liquidity ratios would not change but having access to a line of credit means that cash
is available on a short-term basis and therefore the assessment of the company’s shortterm liquidity would improve. However, if the company borrows money on their line of credit, their liquidity would be reduced.
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Chapter 10
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EXERCISE 10-11
($ in thousands)
(a)
(1) Working capital = $156,866  $243,121  $266,889  $14,806 - $597,003  $ 84,679
(2) Current ratio =
($156,866  $243,121  $266,889  $14,806)
 1.14 : 1
$597,003
(3) Acid-test ratio =
($156,866  $ 243,121)
 0.67 : 1
$ 597,003
(4) Debt to total assets =
$1,457,346
 66.6%
$2,189,247
(5) Times interest earned =
(b)
($84,686  $56,289  $54,947)
 3.5 times
$56,289
Since operating leases are accounted for as rent expense, Maple Leaf Foods can avoid reporting the lease obligations on its balance sheet. By not reporting the lease obligations as
liabilities, Maple Leaf’s working capital, current ratio, and acid-test ratio are all higher than
they would have been if the leases had been accounted for as a capital lease. The debt to
total assets ratio is lower because of the off-balance sheet financing (keeping liabilities off
the balance sheet).
EXERCISE 10-12
(a)
Wal-Mart does not have to record these contingent liabilities because they have determined that they are not likely to occur and the impact would be immaterial in any event.
(b)
For financial statement users it is important to understand the possible implications that the
contingent liabilities could have on the financial results of the company. If the contingent
liabilities result in material losses for the company it will negatively impact the companies
financial results and affect the decisions made by the users of the financial statements.
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Chapter 10
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*EXERCISE 10-13
(a)
(b)
(c)
(d)
Jan.
July
1/04
1/04
Dec. 31/04
Jan.
1/24
Cash ($300,000 X 103%) ................................
Premium on Bonds Payable ....................
Bonds Payable ........................................
309,000
Bond Interest Expense ....................................
Premium on Bonds Payable ............................
($9,000 X 1/40)
Cash ($300,000 X 9% X 6/12).................
13,275
225
Bond Interest Expense ....................................
Premium on Bonds Payable ............................
Bond Interest Payable .............................
13,275
225
Bonds Payable ................................................
Cash ........................................................
300,000
9,000
300,000
13,500
13,500
300,000
*EXERCISE 10-14
(a)
(b)
(c)
(d)
Dec. 31/04
Jun. 30/04
Dec. 31/04
Dec. 31/14
Cash ...............................................................
Discount on Bonds Payable ............................
Bonds Payable .........................................
172,000
8,000
Bond Interest Expense ....................................
Discount on Bonds Payable .....................
($8,000 ÷ 20)
Cash ($180,000 X 6% X 6/12) .................
5,800
Bond Interest Expense ....................................
Discount on Bonds Payable .....................
Cash ($180,000 X 6% X 6/12) .................
5,800
Bonds Payable ................................................
Cash.........................................................
180,000
180,000
400
5,400
400
5,400
180,000
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Chapter 10
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Financial Accounting, Second Canadian Edition
*EXERCISE 10-15
(a)
(b)
(c)
Jan. 1
Cash ............................................................................
Discount on Bonds Payable ........................................
Bonds Payable ........................................................
559,231
40,769
Interest Expense ($559,231 X 8% X 6/12) ..................
Discount on Bonds Payable ($22,369 – $21,000) ...
Cash ($600,000 X 7% X 6/12).................................
22,369
Dec. 31 Interest Expense [($559,231 + $1,369) X 8% X 6/12] .
Discount on Bonds Payable ($22,424 – $21,000) ...
Interest Payable ($600,000 X 7% X 6/12) ...............
22,424
July 1
600,000
1,369
21,000
1,424
21,000
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SOLUTIONS TO PROBLEMS
PROBLEM 10-1A
(a) 1. Not on balance sheet
FOB destination and arrived after
year-end
2. Current liabilities section
Bonus payable
3. Current liabilities section
Salaries payable
CPP payable
EI payable
Income tax payable
4. Current liabilities section
Unearned revenue
5. Current liabilities section
Environmental liability
6. Current liabilities section
Interest payable
7. Current Liabilities
$36,000
$5,0361
7922
4033
2,4004
$25,000
$250,0005
$1676
Note payable
$25,000
Income Taxes Payable
$10,0007
Calculations:
1
($10,000 X 4/5) – (4.95% X $8,000) – (2.10% X $8,000) – ($3,000 x
4/5) = $5,036
2
(4.95% X $8,000) X 2 = $792
3
(2.10% X $8,000) X 2.4 = $403
4
$3,000 x 4/5 = $2,400
5
Note: Because this contingent liability is likely and estimable, it
should be recorded in the accounts
6
$25,000 X 8% X 1/12 = $167
7
$240,000 - $250,000
(b)
The notes should disclose information on the Note Payable including the interest rate and repayment term.
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PROBLEM 10-2A
(a) Jan. 5
5
12
14
20
20
21
25
25
Cash ...........................................................
Sales ($26,632 ÷ 1.15) ........................
GST Payable ($23,158 X 7%) .............
PST Payable ($23,158 X 8%)..............
26,632
Cost of Goods Sold .....................................
Inventory .............................................
15,000
Unearned Service Revenue ........................
Service Revenue .................................
16,000
GST Payable ..............................................
PST Payable ...............................................
Cash ...................................................
7,500
8,570
Accounts Receivable ..................................
Sales (500 X $150) .............................
GST Payable ($75,000 X 7%) .............
PST Payable ($75,000 X 8%)..............
86,250
Cost of Goods Sold .....................................
Inventory .............................................
45,000
Cash ...........................................................
Note Payable—HSBC Bank ................
18,000
Cash ...........................................................
Sales ($31,340 ÷ 1.15) ........................
GST Payable ($27,252 X 7%) .............
PST Payable ($27,252 X 8%)..............
31,340
Cost of Goods Sold .....................................
Inventory .............................................
12,500
23,158
1,621
1,853
15,000
16,000
16,070
75,000
5,250
6,000
45,000
18,000
27,252
1,908
2,180
12,500
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PROBLEM 10-2A (Continued)
(a)
(Continued)
31
(b) Jan. 31
(c)
Wages Expense..........................................
CPP Payable .......................................
EI Payable ...........................................
Income Tax Payable ...........................
Cash ...................................................
75,000
Employee Benefits Expense .......................
CPP Payable .......................................
EI Payable ...........................................
Workers’ Compensation Payable ........
6,668
Interest Expense .........................................
Interest Payable ..................................
($18,000 X 6% X 1/12 X 1/3 = $30)
30
3,713
1,575
15,000
54,712
3,713
2,205
750
30
BURLINGTON INC.
(Partial) Balance Sheet
January 31, 2004
Liabilities
Current liabilities
Accounts payable...................................................................
Notes payable ........................................................................
GST payable ($7,500 + $1,621- $7,500 + $5,250 + $1,908) ..
PST payable ($8,570 + $1,853 - $8,570 + $6,000 + $2,180)..
CPP Payable ($3,713 X 2) .....................................................
EI payable ($1,575 + $2,205) .................................................
Income tax payable ................................................................
Workers’ compensation payable ............................................
Interest payable .....................................................................
Total current liabilities ........................................................
$ 52,000
18,000
8,779
10,033
7,426
3,780
15,000
750
30
$115,798
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PROBLEM 10-3A
(a) Mar.
2
31
Apr.
1
30
May
1
2
31
June
1
2
30
Equipment .................................................
Note Payable .....................................
8,000
Interest Expense ($8,000 X 9% X 1/12) ....
Interest Payable .................................
60
Land ..........................................................
Note Payable .....................................
21,000
Interest Expense .......................................
[($8,000 X 9% X 1/12)
Interest Payable .................................
60
Interest Expense ($21,000 X 9% X1/12) ...
Cash ..................................................
158
Cash..........................................................
Note Payable .....................................
20,000
Interest Expense .......................................
[($20,000 X 6% X 1/12) + $60]
Interest Payable .................................
160
Interest Expense (21,000 X 9% X1/12) .....
Cash ..................................................
158
Note Payable.............................................
Interest Payable ........................................
Cash ..................................................
8,000
180
Interest Expense ($158 + $100) ................
Interest Payable .................................
258
8,000
60
21,000
60
158
20,000
160
158
8,180
258
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Financial Accounting, Second Canadian Edition
PROBLEM 10-3A (Continued)
(b) Current liabilities
Notes payable ......................................................................
Interest payable ...................................................................
(c)
41,000
358
Total interest expense is $854.
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PROBLEM 10-4A
(a) Jan
(b) Jan
(c) July
1
1
1
(d) Dec. 1
Bond Interest Payable .....................
Cash .......................................
72,000
Bonds Payable ................................
Loss on Bond Redemption ..............
Cash ($400,000 X 1.04) ...........
400,000
16,000
72,000
416,000
Bond Interest Expense ....................
Cash ........................................
[($1,600,000 –$400,000) X 9% X 6/12]
54,000
Bond Interest Expense ....................
Bond Interest Payable ..............
[($1,600,000 –$400,000) X 9% X 6/12]
54,000
54,000
54,000
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PROBLEM 10-5A
2003
(a) May 1
(b) Dec. 31
Cash ...............................................
Bond Payable ..........................
800,000**
Bond Interest Expense ....................
Bond Interest Payable ..............
($800,000 X 9% X 8/12)
48,000**
800,000
48,000
(c) Current liabilities
Bond interest payable .......................................
$48,000
Long-term debt
Bond payable....................................................
$800,000
2004
(d) May 1
(e) Dec. 31
2005
(f) Jan
1
Interest Expense
($800,000 X 8% X 4/12) ............
Interest Payable ..............................
Cash ($800,000 X 9%) .............
24,000
48,000
72,000
Bond Interest Expense ....................
Bond Interest Payable ..............
($800,000 X 9% X 8/12)
48,000**
Bond Interest Payable .....................
Cash .......................................
48,000
Bonds Payable ................................
Loss on Bond Redemption ..............
Cash ($800,000 X 1.01) ...........
800,000
8,000
48,000
48,000
808,000
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PROBLEM 10-6A
(a)
Sept. 1
Dec. 31
2004
Cash ..........................................
Bonds Payable ....................
Bond Interest Expense* ..............
Bond Interest Payable .........
12,000,000
12,000,000**
240,000
240,000
**($12,000,000 X 6% X 4/12) = $240,000
(b)
(A)
Quarterly
Interest Period
Issue Date
Dec. 31/04
March 31/05
June 30/05
Sept. 30/05
Dec. 31/05
Oct.
1
Dec. 31
Cash
Payment
$49,536
049,536
049,536
049,536
049,536
(B)
Interest
Expense
(D) X 6%
X 3/12
$10,500
009,914
009,320
008,717
008,105
(C)
Reduction
of Principal
(A) – (B)
(D)
Principal
Balance
(D) – (C)
$39,036
039,622
040,216
040,819
041,431
$700,000
0660,964
0621,342
0581,126
0540,307
0498,876
Cash ..........................................
Mortgage Note Payable .......
Interest Expense .....................................
Mortgage Notes Payable .........................
Cash ................................................
700,000
700,000
10,500
39,036
49,536
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Chapter 10
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Financial Accounting, Second Canadian Edition
PROBLEM 10-6A (Continued)
(c)
MYRON CORPORATION
Balance Sheet (Partial)
December 31, 2004
Current liabilities
Bond interest payable........................................
$240,000
Current portion of long-term debt.......................
162,088
Total current liabilities .................................
$ 402,088
Long-term liabilities
Bonds payable, due 2014 ................................... $12,000,000
Mortgage note payable, due 2008
($660,964 – $162,088) .......................................
498,876
Total long-term liabilities..............................
12,498,876
Total liabilities............................................................
$12,900,964
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Chapter 10
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Financial Accounting, Second Canadian Edition
PROBLEM 10-7A
(a)
(A)
Cash
Payment
Period
April 1, 2004
March 31, 2005
March 31, 2006
March 31, 2007
March 31, 2008
March 31, 2009
Total
1
(B)
Interest
Expense
(D) X 10%
$ 26,380
26,380
26,380
26,380
26,380
$131,900
$10,000
8,362
6,560
4,578
2,4001
$31,900
(C)
Principal
Reduction
(A) - (B)
$ 16,380
18,018
19,820
21,802
23,980
$100,000
(D)
Balance
(D) - (C)
$100,000
83,620
65,602
45,782
23,980
0
difference of $2 due to rounding.
April 1/04
March 31/05
March 31/06
Cash ..........................................
Note Payable .......................
100,000
Note Payable ..............................
Interest Expense .........................
Cash ....................................
16,380
10,000
Note Payable ..............................
Interest Expense .........................
Cash ....................................
18,018
8,362
100,000
26,380
26,380
(b)
SKI HILL
Balance Sheet (Partial)
December 31, 2006
Current liabilities
Current portion of 10% notes payable
Long-term liabilities
Note payable, 10%, due in 2009
($65,602 - $19,820)
$19,820
45,782
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Chapter 10
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Financial Accounting, Second Canadian Edition
PROBLEM 10-8A
(a)
2002
2001
1. Current ratio
$143,015
 0.82 : 1
$175,064
$85,730
 0.90 : 1
$95,095
2. Acid-test ratio
($100,410  $20,532)
 0.69 : 1
$175,064
($58,942  $12,211  779)
 0.76 : 1
$95,095
3. Cash current debt
coverage
$161,624
($175,064  $95,095)  2
 1.2 times
$67,361
($95,095  $90,780)  2
 0.7 times
$428,449
 54.6%
$784,205
$171,733
 43.6%
$393,903
5. Times interest
earned ratio
$51,780  $3,960  $31,064
$3,960
 21.9 times
$36,710  $2,249  $21,079
$2,249
 26.7 times
6. Cash total debt
coverage
$161,624
($428,449  $171,733)  2
 0.5 times
$67,361
($171,733  $156,080)  2
 0.4 times
4. Debt to total
assets ratio
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Chapter 10
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PROBLEM 10-8A (Continued)
(b) In recent years all airline companies have struggled, this is reflected in the low
liquidity ratios and high debt to total asset ratios in the industry as a whole. In
terms of short-term liquidity WestJet, is as good as or slightly better than other
companies in the industry. The company’s short-term liquidity has fallen in the
past year but is still above the industry average of 0.8:1. WestJet’s acid test ratio of 0.69:1 is well above the industry average of 0.50:1. The increase in the
cash current debt coverage ratio from 0.7 to 1.2 is also a positive indicator that
the company has a good liquidity position.
WestJet’s long-run solvency of the company declined in 2002. However, even
though the company’s debt to total assets ratio has increased over the past
year, at 54.6% it is still well below the industry average of 82.9%. Times interest earned has declined slightly but is still very high indicating the company
has more than enough earnings to repay current interest obligations. The improvement in the cash to total debt coverage ratio is also a positive indicator
when assessing the company’s solvency.
(c) WestJet’s use of operating leases (vs. capital leases) would impact the long
term solvency. If the leases were capital rather than operating, the balance
sheet would include higher property, plant and equipment and total assets and
higher long-term liabilities. Using the total lease obligations as an estimate of
the increase in liabilities and capital assets the revised debt to total assets ratio would be higher:
$428,449 $632,466
 74.9%
$784,205  $632,466
The revised cash total debt coverage ratio would be lower:
$161,624
[($428,449 $ 171,733) 2]  $632,466
 0.17 times
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Chapter 10
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PROBLEM 10-9A
(a)
When reviewing the liquidity ratios for the two companies we can see that the
acid test and current ratios for both companies are better than the industry
average. The receivable turnover ratio shows that Chick’N’ Lick is turning its
receivables over faster than Grab’N Gab, which indicates that the company is
able to convert sales to cash more quickly. However, Chick’N Lick does
seem to be having some problems with its inventory. As indicated by its
higher inventory turnover ratio Grab’N Gab appears to be moving its inventory faster which may also be why the Grab’N Gab’s current ratio is slightly
higher than Chick’N Lick’s even though its acid-test ratio is lower.
Grab’N Gab is performing well when compared to the industry except for the
receivables turnover. The company is taking significantly longer to collect its
accounts receivable than Chick’N Lick and the average firm in the industry.
As a bank manager considering lending money to Grab’N Gab we would
want to ensure that the receivables are not outdated or uncollectible.
Given this information Chick’N Lick appears to be the more liquid company
and is probably a better candidate for a loan.
(b)
In reviewing the solvency of these two companies we see that Chick’N Lick’s
debt to total assets ratio is the better of the two companies. However, both
companies are below the industry average of 66.5%, which indicates that
both companies have a much lower percent of its assets financed by debt.
Both companies appear to have more earnings per dollar of interest expense
than the average company in the industry as evidenced by the times interest
earned ratio of 7.1 times for Grab’N Gab and 8.2 times for Chick’N Lick compared to the industry average of 6.1 times. Based on this analysis, I would
not be concerned about the solvency of either business.
Solutions Manual
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Chapter 10
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Financial Accounting, Second Canadian Edition
*PROBLEM 10-10A
2004
(a) July
1
Dec. 31
Cash ($1,500,000 X 102%) ...............
Premium on Bonds Payable .......
Bonds Payable ...........................
1,530,000
Bond Interest Expense ......................
Premium on Bonds Payable ..............
($30,000 ÷ 20)
Bond Interest Payable ................
($1,500,000 X 7% X 6/12)
51,000
1,500
Cash ($1,500,000 X 94%) .................
Discount on Bonds Payable ...............
Bonds Payable ...........................
1,410,000
90,000
Bond Interest Expense ......................
Discount on Bonds
Payable ($90,000 ÷ 20) ..........
Bond Interest Payable ................
($1,500,000 X 7% X 6/12)
57,000
30,000
1,500,000
52,500
(b)
July
1
Dec. 31
1,500,000
4,500
52,500
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Chapter 10
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Kimmel, Weygandt, Kieso, Trenholm
Financial Accounting, Second Canadian Edition
PROBLEM 10-10A (Continued)
(c)
December 31, 2004
Premium
Long-term liabilities
Bonds payable, due 2014
Add: Premium on bonds payable
$1,500,000
28,5001
$1,528,500
$1,500,000
85,5002
$1,414,500
Discount
Long-term liabilities
Bonds payable, due 2014
Less: Discount on bonds payable
1
2
$30,000 - $1,500 = $28,500
$90,000 - $4,500 = $85,500
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Chapter 10
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Financial Accounting, Second Canadian Edition
*PROBLEM 10-11A
2005
(a) Jan. 1
(b) July
(c) July
1
1
Bond Interest Payable .....................
Cash ........................................
108,000**
Bond Interest Expense ....................
Premium on Bonds Payable ............
($300,000 ÷ 20)
Cash ........................................
93,000**
15,000**
Bonds Payable ................................
Premium on Bonds Payable ............
Gain on Bond Redemption .......
($1,942,500 – $1,818,000)
Cash ($1,800,000 X 1.01) ........
1,800,000**
142,500**
108,000
108,000
124,500
1,818,000
*($300,000 – $15,000) X 1/2 = $142,500
(d) Dec. 31
Bond Interest Expense ....................
Premium on Bonds Payable ............
Bond Interest Payable ..............
($1,800,000 X 6% X 6/12)
46,500**
7,500**
54,000
**$300,000 – $15,000 – $142,500 ÷ 19 periods = $7,500
or $15,000 X 1/2 = $7,500
Text Errata:
Please remind students to check the text errata published on the
Kimmel website www.wiley.com/canada/kimmel. Additional information is available noting that the bonds were originally issued
January 1, 2003 at a premium of $360,000.
Solutions Manual
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Chapter 10
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Financial Accounting, Second Canadian Edition
*PROBLEM 10-12A
(a)
July
(b)
1
2004
Cash ..................................................
Bonds Payable ...........................
Premium on Bonds Payable .......
1,616,917
1,500,000
116,917
PONASIS CORPORATION
Bond Premium Amortization
Effective Interest Method—Semi-annual Interest Payments
6% Bonds Issued at 5%
Semiannual
Interest
Periods
(A)
Interest to Be
Paid
(6% x 6/12 =
3%)
Issue date
Jan.1/05
July 1/05
Jan.1/06
$45,000
045,000
045,000
(c) Dec. 31
(d)
July
1
(e) Dec. 31
(B)
(C)
Interest
Premium
Expense
Amortiza(5% x
tion
6/12 =
(A) – (B)
2.5%)
$40,423
040,309
040,192
$4,577
04,691
04,808
(D)
Unamortized
Premium
(D) – (C)
(E)
Bond
Carrying
Value
($1,500,000 +
D)
$116,917
0112,340
0107,649
0102,841
$1,616,917
01,612,340
01,607,649
01,602,841
Bond Interest Expense ...............................
Premium on Bonds Payable .......................
Bond Interest Payable .........................
2005
Bond Interest Expense ...............................
Premium on Bonds Payable .......................
Cash ...................................................
Bond Interest Expense ...............................
Premium on Bonds Payable .......................
Bond Interest Payable .........................
40,423
4,577
45,000
40,309
4,691
45,000
40,192
4,808
45,000
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Chapter 10
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Financial Accounting, Second Canadian Edition
*PROBLEM 10-13A
(a) 1.
July
2.
1
Dec. 31
3.
July
4.
1
Dec. 31
2004
Cash ..........................................
Discount on Bonds Payable .......
Bonds Payable ...................
Bond Interest Expense ..............
($2,036,357 X 6% X 6/12)
Discount on Bonds Payable
Bond Interest Payable ........
($2,200,000 X 5% X 6/12)
2,036,357
163,643
2,200,000
61,091
6,091
55,000
2005
Bond Interest Expense ..............
61,273
[($2,036,357 + $6,091) X 6% X 6/12]
Discount on Bonds Payable
Cash ..................................
6,273
55,000
Bond Interest Expense ..............
61,462
[($2,042,448 + $6,273) X 6% X 6/12]
Discount on Bonds Payable
Bond Interest Payable ........
6,462
55,000
(b) Long-term liabilities
Bonds payable ....................................... 0000$2,200,000*
Less: Discount on bonds payable.......... 0000 144,817* $2,055,183
*$163,643 – $6,091 – $6,273 – $6,462 = $144,817
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Chapter 10
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Financial Accounting, Second Canadian Edition
*PROBLEM 10-13A (Continued)
(c)
1.
Total bond interest expense, 2005:
$61,273 + $61,462 = $122,735
2.
The effective-interest method will result in less interest expense
reported than the straight-line method in 2005 when the bonds
are sold at a discount. Straight-line interest expense for 2005 would be
$126,364 [($55,000 + $55,000) + ($8,182* + $8,182)].
*$163,643 ÷ 20 periods = $8,182 discount amortization per period
3.
4.
Semi-annual interest payments
$2,200,000 X 2.5% = $55,000; $55,000 X 20 ............
Add: Bond discount ($2,200,000 – $2,036,357) ..........
Total cost of borrowing ..................................................
$1,100,000
163,643
$1,263,643
The same.
Solutions Manual
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Chapter 10
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Financial Accounting, Second Canadian Edition
PROBLEM 10-1B
(a) 1. Current liabilities section
2. Current liabilities section
Bonus payable
3. Current liabilities section
Salaries payable
CPP payable
EI payable
Income tax payable
3
4
5
$35,000
$1,7091
2972
1513
1,0804
Property tax payable
0
5. Contingent liability
Not on balance sheet
0
6. Current liabilities section
Interest payable
Current maturity
Note payable
7. No liability
—company overpaid
2
$150,000
4. No current liability
—relates to next period
Long-term liabilities section
1
Accounts payable
$2,0835
100,000
400,000
No payable
0
Calculations:
($5,000 X 3/5) – (4.95% X $3,000) – (2.10% X $3,000) – ($1,800 x
3/5) = $1,709
(4.95% X $3,000) X 2 = $297
(2.10% X $3,000) X 2.4 = $151
$1,800 x 3/5 = $1,080
$500,000 X 5% X 1/12 = $2,083
(b) The notes should disclose information on the contingent liability– the
lawsuit, including the estimated loss and the fact that the likelihood of
the loss cannot be determined. Information on the note payable should
also be disclosed–including the interest rate and repayment terms and
payments required in each of the next five years.
Solutions Manual
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Chapter 10
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Financial Accounting, Second Canadian Edition
PROBLEM 10-2B
(a)
Jan. 1
5
5
12
14
25
25
31
31
Cash.........................................................
Note Payable .....................................
15,000
Cash.........................................................
Sales ($47,752 ÷ 1.14) ......................
PST Payable ($41,888 x 7%) ............
GST Payable ($41,888 x 7%) ............
47,752
Cost of Goods Sold ..................................
Merchandise Inventory ......................
28,600
Unearned Service Revenue .....................
Service Revenue ...............................
15,000
PST Payable ............................................
GST Payable ............................................
Cash ..................................................
5,800
5,800
Cash.........................................................
Sales ($54,820 1.14) .......................
PST Payable ($48,088 x 7%) ............
GST Payable ($48,088 x 7%) ............
54,820
Cost of Goods Sold .................................
Merchandise Inventory ......................
39,000
Wages Expense........................................
CPP Payable .....................................
EI Payable .........................................
Income Tax Payable ..........................
Union Dues Payable ..........................
Cash ..................................................
62,000
Employee Benefits Expense.....................
CPP Payable .....................................
EI Payable .........................................
4,892
15,000
41,888
2,932
2,932
28,600
15,000
11,600
48,088
3,366
3,366
39,000
3,069
1,302
12,400
800
44,429
3,069
1,823
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Financial Accounting, Second Canadian Edition
PROBLEM 10-2B (Continued)
(b)
Jan. 31
Interest Expense ..................................... 63*
Interest Payable ..................................
63
($15,000 X 5% X 1/12)
* Rounded
(c)
MOLEGA SOFTWARE LTD.
(Partial) Balance Sheet
January 31, 2004
Current liabilities
Accounts payable .........................................................
Note payable ................................................................
PST payable ($5,800 + $2,932 – $5,800 + $3,366) .....
GST payable ($5,800 + $2,932 - $5,800 + $3,366).......
CPP payable ($3,069 X 2) ............................................
EI payable ($1,302 + $1,823) .......................................
Income tax payable ......................................................
Union dues payable ......................................................
Interest payable ............................................................
Total current liabilities ............................................
$42,500
15,000
6,298
6,298
6,138
3,125
12,400
800
63
$92,622
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Financial Accounting, Second Canadian Edition
PROBLEM 10-3B
(a) Sept. 1
Oct.
1
2
Nov.
1
2
30
Dec.
1
1
31
Merchandise Inventory (or Purchases) ......
Note Payable .....................................
15,000
Interest Expense .......................................
($15,000 X 0.08 X 1/12)
Cash ..................................................
100
Climbing Wall ............................................
Note Payable .....................................
10,000
Interest Expense .......................................
[($10,000 X 0.8 X 1/12) + $100]
Cash ..................................................
167
Vehicles ....................................................
Note Payable .....................................
Cash ..................................................
26,000
Interest Expense .......................................
($18,000 X 0.09 X 1/12) .......................
Interest Payable .................................
135
Note Payable.............................................
Interest Expense .......................................
Cash ..................................................
15,000
100
Interest Expense ($10,000 X 0.8 X 1/12) ...
Cash ..................................................
67
Interest Expense .......................................
[($10,000 X 0.8 X 1/12) + $135]
Interest Payable .................................
202
15,000
100
10,000
167
18,000
8,000
135
15,100
67
202
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Financial Accounting, Second Canadian Edition
PROBLEM 10-3B (Continued)
(b)
Current liabilities
Notes payable ......................................................................
Interest payable ...................................................................
28,000
337
(c) Total interest expense is $771.
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Financial Accounting, Second Canadian Edition
PROBLEM 10-4B
(a) Jan
(b) Jan
(c) July
1
1
1
(d) Dec. 1
Bond Interest Payable .....................
Cash .......................................
8,000
Bonds Payable ................................
Loss on Bond Redemption ..............
Cash ($50,000 X 1.02) .............
50,000
1,000
Bond Interest Expense ....................
Cash ........................................
[$200,000 –$50,000) X 8% X 6/12]
6,000
Bond Interest Expense ....................
Bond Interest Payable ..............
[($200,000 –$50,000) X 8% X 6/12]
6,000
8,000
51,000
6,000
6,000
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Financial Accounting, Second Canadian Edition
PROBLEM 10-5B
2003
(a) Oct.
1
(b) Dec. 31
Cash ...............................................
Bond Payable ..........................
600,000
Bond Interest Expense ....................
Bond Interest Payable ..............
($600,000 X 6% X 3/12)
9,000
600,000
9,000
(c) Current liabilities
Bond interest payable .......................................
$9,000
Long-term debt
Bond payable ................................................
$600,000
2004
(d) Oct.
1
(e) Dec. 31
2005
(f) Jan. 1
Interest Expense ($600,000 X 6% X 9/12)
Bond Interest Payable .....................
Cash ($600,000 X 6%) .............
27,000
9,000
36,000
Bond Interest Expense ....................
Bond Interest Payable ..............
($600,000 X 6% X 3/12)
9,000
Bond Interest Payable .....................
Cash .......................................
9,000
Bonds Payable ................................
Loss on Bond Redemption ..............
Cash ($600,000 X 1.03) ...........
600,000
18,000
9,000
9,000
618,000
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Financial Accounting, Second Canadian Edition
PROBLEM 10-6B
(a)
2004
Aug. 1
Dec. 31
Cash .............................................
Bonds Payable .......................
10,000,000*
Bond Interest Expense ...................
Bond Interest Payable ............
($10,000,000 X 8% X 5/12)
333,333*
(b)
(A)
Quarterly
Interest Period
Oct. 1, 2004
Dec. 31, 2004
Mar. 31, 2005
June 20, 2005
Sept. 30, 2005
Dec. 31, 2005
Oct.
1
Dec. 31
Cash
Payment
$47,280
047,280
047,280
047,280
047,280
(B)
Interest
Expense
(D) X
8/% X
3/12
$10,000
009,254
008,494
007,718
006,927
10,000,000**
333,333
(C)
Reduction
of Principal
(A) – (B)
(D)
Principal
Balance
(D) – (C)
$37,280
038,026
038,786
039,562
040,353
$500,000
0462,720
0424,694
0385,908
0346,346
0305,993
Cash .....................................................
Mortgage Note Payable ..................
500,000*
Interest Expense ....................................
Mortgage Note Payable .........................
Cash ...............................................
10,000
37,280
500,000**
47,280
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Financial Accounting, Second Canadian Edition
PROBLEM 10-6B (Continued)
(c)
ATWATER CORPORATION
Balance Sheet (Partial)
December 31, 2004
Current liabilities
Bond interest payable ........................................
Current portion of 8% mortgage note payable ....
Total current liabilities .................................
Long-term liabilities
Bonds payable, 8% due in 2009 .........................
Mortgage note payable, 8%, due in 2007 ...........
Total long-term liabilities .............................
Total liabilities ............................................................
$
333,333
156,727*
490,060
10,000,000*
305,993**
10,305,993
$10,796,053
*$38,026 + $38,786 + $39,562 + $40,353 = $156,727
** $500,000 - $37,280 - $156,727 = $305,993
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Financial Accounting, Second Canadian Edition
PROBLEM 10-7B
(a)
(A)
Cash
Payment
Period
May 1, 2004
June 30, 2004
August 31, 2004
October 31, 2004
December 31, 2004
February 28, 2005
April 30, 2005
June 30, 2005
August 31, 2005
October 31, 2005
May
1
June 30
Aug. 31
Oct. 31
$3,635
3,635
3,635
3,635
3,635
3,635
3,635
3,635
3,635
(B)
Interest
Expense
(D) X 18% X
2/12
$1,500
1,436
1,370
1,302
1,232
1,160
1,086
1,009
930
(C)
Principal
Reduction
(A) – (B)
$2,135
2,199
2,265
2,333
2,403
2,475
2,549
2,626
2,705
Cash ...........................................
Note Payable .......................
50,000
Note Payable ..............................
Interest Expense .........................
Cash ....................................
2,135
1,500
Note Payable ..............................
Interest Expense .........................
Cash ....................................
2,199
1,436
Note Payable ..............................
Interest Expense .........................
Cash ....................................
2,265
1,370
(D)
Balance
(D) - (C)
$50,000
47,865
45,666
43,401
41,068
38,665
36,190
33,641
31,015
28,310
50,000
3,635
3,635
3,635
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Financial Accounting, Second Canadian Edition
PROBLEM 10-7B (Continued)
(b)
SAILING SCHOOL
Balance Sheet (Partial)
October 31, 2004
Current liabilities
Current portion of 18% note payable
Long-term liabilities
Note payable, 18%, due in 2006
($43,401 - $15,091)
Total liabilities
$15,091*
28,310
$43,401
*$2,333 + $2,403 + $2,475 + $2,549 + $2,626 + $2,705 = $15,091
or $43,401 - $28,310 = $15,091
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Financial Accounting, Second Canadian Edition
PROBLEM 10-8B
(a)
2002
2001
1. Current ratio
$1,771
 0.68 : 1
$2,592
$2,235
 0.78 : 1
$2,869
2. Acid-test ratio
($558  $760)
 0.51 : 1
$2,592
($1,067  $764)
 0.64 : 1
$2,869
3. Cash current debt
coverage
$(95)
($2,592  $2,869)  2
$(1,072)
($2,869  $3,560)  2
 - 0.03 times
  0.33 times
4. Debt to total
assets
$9,704
 130.9%
$7,416
$10,204
 116.7%
$8,744
5. Times interest
earned
$(828)  $221  $(384)
$221
 - 4.48 times
$(1,315)  $275  $(330)
$275
 - 4.98 times
6. Cash total debt
coverage
$(95)
($9,704  $10,204)  2
 - 0.01 times
$(1,702)
($10,204  $9,416)  2
 - 0.17 times
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PROBLEM 10-8B (Continued)
(b) In recent years all airline companies have struggled, this is reflected in the low
liquidity ratios and high debt to total asset ratios in the industry as a whole. In
terms of short-term liquidity Air Canada, is obviously in trouble. The company’s current ratio has fallen during the current year and is even below the already low ratio being experienced by other airline companies in the industry.
As well, as evidenced by the cash current debt coverage ratio, the company is
not generating enough cash from operations to repay its current liabilities.
Air Canada’s long-run solvency declined in 2002. The company’s debt to total
asset ratio has skyrocketed to a point where the company’s debt actually exceeds their assets. As indicated by the times interest earned ratio, the company does not have sufficient earnings to cover their interest payments. As
well, the company is not generating a positive cash flow from operations and
therefore does not have cash on hand to repay its debt obligations. Given all
these factors it is clear that Air Canada is in serious financial difficultly.
(c) Air Canada’s use of operating leases (vs. capital leases) would impact the
long-term solvency. If the leases were capital rather than operating, the balance sheet would include higher property, plant and equipment and total assets and higher long-term liabilities. Using the total lease obligations as an estimate of the increase in liabilities and assets, the revised debt to total assets
ratio would be higher:
$9,704  $7,697
 115.1%
$7,416  $7,697
The revised cash total debt coverage ratio would also be lower:
$(95)
 - 0.005 times
[($9,704  $10,204) 2]  $7,697
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PROBLEM 10-9B
(a)
When reviewing the liquidity ratios for the two companies we can see that
Sun-Oil is more liquid than Petro-Zoom. Sun-Oil has both a higher acid test
and current ratio than Petro- Zoom. The receivables turnover ratio shows that
Sun-Oil is turning its receivables over faster than Petro-Zoom, which indicates
that the company is able to convert sales to cash more quickly. Sun-Oil also
seems to be able to move its inventory more quickly than Petro- Zoom as indicated by its higher inventory turnover ratio. In terms of cash available to repay current liabilities, Sun-Oil, with a cash current debt coverage ratio of 1.7
times, is better able to generate cash form operations to repay current debt
than Petro-Zoom whose ratio is only 1.5 times. Finally, all of Sun Oil’s liquidity ratios are better than other companies in the industry whereas most of Petro-Zooms are slightly below the industry averages. Given this information
Sun Oil appears to be the more liquid company.
(a)
In reviewing the solvency of these two companies we see that Petro-Zooms
solvency ratios are the better of the two companies. Petro-Zoom has a much
lower percent of its assets financed by debt as indicated by the lower debt to
total assets ratio. The company appears to have more earnings per dollar of
interest expense as evidenced by the times interest earned ratio of 3.3 times
for Petro-Zoom versus 2.1 for Sun-Oil. However, Sun-Oil is generating more
cash from operations per dollar of debt. While Petro-Zooms solvency ratios
appear to be inline with the industry as a whole, at 62.1% Sun Oil’s debt to
total assets is much higher than the average oil and gas company. While
Petro-Zoom seems to be the more solvent of the two, both companies appear to be generating sufficient earnings and cash to cover debt and interest
payments so I would not be concerned about the solvency of either business.
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Financial Accounting, Second Canadian Edition
*PROBLEM 10-10B
(a) Apr.
Oct.
1
1
Dec. 31
(b) Apr.
Oct.
1
1
Dec. 31
Cash ($1,500,000 X 102%) ...............
Premium on Bonds Payable .......
Bonds Payable ...........................
1,530,000
Bond Interest Expense ......................
Premium on Bonds Payable ..............
($30,000 ÷ 10 years X 6/12)
Cash ..........................................
($1,500,000 X 8% X 6/12)
58,500
1,500
Bond Interest Expense ......................
Premium on Bonds Payable ..............
($30,000 ÷ 10 years X 3/12)
Bond Interest Payable ................
($1,500,000 X 8% X 3/12)
29,250
750
Cash ($1,500,000 X 97%) .................
Discount on Bonds Payable...............
Bonds Payable ...........................
1,455,000
45,000
Bond Interest Expense .....................
Discount on Bonds Payable
($45,000 ÷ 10 X 6/12) ................
Cash ($1,500,000 X 8% X 6/12).
62,250
Bond Interest Expense ......................
Discount on Bonds Payable
($45,000 ÷ 10 X 3/12) ................
Bond Interest Payable ................
($1,500,000 X 8% X 3/12)
31,125
30,000
1,500,000
60,000
30,000
1,500,000
2,250
60,000
1,125
30,000
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Financial Accounting, Second Canadian Edition
*PROBLEM 10-10B (Continued)
(c) Premium: Assumption (a) Bonds are sold at 102
Current liabilities
Bond interest payable
Long-term liabilities
Bonds payable, due 2014
Add: Premium on bonds payable
1
$
$1,500,000
27,7501
30,000
1,527,750
$30,000 - $1,500 - $750 = $27,750
Discount: Assumption (b) Bonds are sold at 97
Current liabilities
Bond interest payable
Long-term liabilities
Bonds payable, due 2014
Less: Discount on bonds payable
2
$
$1,500,000
41,6252
30,000
1,458,375
$45,000 - $2,250 - $1,125 = $41,625
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Financial Accounting, Second Canadian Edition
*PROBLEM 10-11B
(a) Jan. 1
(b) July
(c) July
1
1
Bond Interest Payable ........................
Cash ...........................................
96,000
Bond Interest Expense .......................
Discount on Bonds Payable ........
($84,000 ÷ 20)
Cash ($2,400,000 X 8% x 6/12) ..
100,200
Bonds Payable ...................................
Loss on Bond Redemption .................
Discount on Bonds Payable ........
Cash ($800,000 X 102%) ............
800,000
42,600
96,000
4,200
96,000
26,600
816,000
*($84,000 – $4,200) X ($800,000 ÷ $2,400,000) = $26,600
(d) Dec. 31
Bond Interest Expense .......................
Discount on Bonds Payable ........
Bond Interest Payable .................
66,800
2,800**
64,000**
**($84,000 – $4,200) X 2/3 = $53,200; $53,200 ÷ 19 = $2,800
or $4,200 X 2/3 = $2,800
** $2,400,000 – $800,000 = $1,600,000; $1,600,000 X 8% x 6/12
= $64,000
Text Errata:
Please remind students to check the text errata published on the
Kimmel website www.wiley.com/canada/kimmel. Additional information is available noting that the bonds were originally issued
January 1, 2003 at a discount of $100,800.
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*PROBLEM 10-12B
(a)
July
2004
Cash ..................................................
Discount on Bonds Payable ...............
Bonds Payable ...........................
1
(b)
1,118,462
81,538
1,200,000
GLOBAL SATELLITES CORPORATION
Bond Discount Amortization
Effective Interest Method—Semi-annual Interest Payments
7% Bonds Issued at 8%
Semiannual
Interest
Periods
(A)
Interest
to Be
Paid
Issue date
Jan. 1/05 $42,000
July 1/05 042,000
Jan. 1/06 042,000
(c) Dec. 31
(d)
July
1
(e) Dec. 31
(B)
Interest
Expense
to Be
Recorded
$44,738
044,848
044,962
(C)
Discount
Amortization
(B) – (A)
(D)
Unamortized
Discount
(D) – (C)
(E)
Bond
Carrying
Value
($1,200,000 – D)
$2,738
02,848
02,962
$81,538
078,800
075,952
072,990
$1,118,462
01,121,200
01,124,048
01,127,010
Bond Interest Expense ...............................
($1,118,462 X 8% x 6/12)
Discount on Bonds Payable ................
Bond Interest Payable .........................
($1,200,000 X 7% X 6/12)
2005
Bond Interest Expense ...............................
[($1,118,462 + $2,738) X 8% x 6/12]
Discount on Bonds Payable ................
Cash ...................................................
Bond Interest Expense ...............................
[($1,121,200 + $2,848) X 8% x 6/12]
Discount on Bonds Payable ................
Bond Interest Payable .........................
44,738
2,738
42,000
44,848
2,848
42,000
44,962
2,962
42,000
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Financial Accounting, Second Canadian Edition
*PROBLEM 10-13B
(a)
1.
2.
3.
4.
2004
July 1
Dec. 31
2005
July 1
Dec. 31
Cash ..........................................
Bonds Payable ...................
Premium on Bonds Payable
2,155,890
Bond Interest Expense ..............
($2,155,890 X 5% X 6/12)
Premium on Bonds Payable ......
Bond Interest Payable ........
($2,000,000 X 6% x 6/12)
53,897
Bond Interest Expense ..............
[($2,155,890– $6,103)
X 5% x 6/12]
Premium on Bonds Payable ......
Cash ..................................
53,745
Bond Interest Expense ..............
[($2,155,890 - $6,103 - $6,255)
X 5% x 6/12]
Premium on Bonds Payable ......
Bond Interest Payable ........
53,588
(b) Bonds payable ...............................................
Add: Premium on bonds payable ..................
2,000,000
155,890
6,103
60,000
6,255
60,000
6,412
0$2,000,000*
137,120*
60,000
$2,137,120
*$155,890 – $6,103 – $6,255 – $6,412 = $137,120
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Financial Accounting, Second Canadian Edition
*PROBLEM 10-13B (Continued)
(c) 1.
2.
Total bond interest expense—2005: $107,333 ($53,745 + $53,588).
The effective-interest method will result in more interest expense reported than the straight-line method in 2005 when the bonds are sold at a
premium. Straight-line interest expense for 2005 would be $104,411
[$60,000 + $60,000 – ($7,794.50** + $7,794.50)].
**$155,890 ÷ 20 = $7,794.50
3.
4.
Semi-annual interest payments
$2,000,000 X 3% = $60,000; $60,000 X 20 ...............
Less: Bond premium ..................................................
Total cost of borrowing ..................................................
$1,200,000
155,890
$1,044,110
The same.
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Kimmel, Weygandt, Kieso, Trenholm
Financial Accounting, Second Canadian Edition
BYP 10-1 FINANCIAL REPORTING PROBLEM
(a)
Loblaw’s total current liabilities at December 28, 2002 were $3,154 million.
(b)
Loblaw’s total long-term liabilities at December 28, 2002 were $3,832 million ($3,420+ $68
+ $344).
(c)
Loblaw had the following financing activities related to liabilities in 2002:
repaid bank indebtedness of $95 million
issued $342 million in commercial paper
issued $200 million in long-term debt
retired $88 million in long-term debt
(d)
Loblaw’s has contingent liabilities but management does not expect that they will have a
material impact on the company’s financial position (see note 15 to the financial statements).
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Financial Accounting, Second Canadian Edition
BYP 10-2 COMPARATIVE ANALYSIS PROBLEM
(a)
Loblaw
Sobeys
1. Current ratio
$3,526
 1.12 : 1
$3,154
$1,094.4
 0.93 : 1
$1,180.5
2. Acid-test ratio
($823  $304  $605)
 0.55 : 1
$3,154
($123.1  $191.4  $285.4)
 0.51 : 1
$1,180.5
3. Cash current debt
coverage
4. Debt to total
assets
5. Cash total debt
coverage
6. Times interest
earned
$981
($3,154  $2,796)  2
$348.1
($1,180.5  $990.4)  2
 0.33 times
 0.32 times
$6,986
 62.9%
$11,110
$1,755.7
 55.0%
$3,192.5
$981
($6,986  $6,456)  2
$348.1
($1,755.7  $1,591.9)  2
 0.15 times
 0.21 times
$728  $161  $414
$161
 8.09 times
$179  $41.7  $105.4
$41.7
 7.82 times
(b) Comparing the ratios related to liquidity, Loblaw and Sobeys are very similar. Loblaw’s current ratio and its acid-test ratio is slightly better than Sobeys’ and Sobeys’ cash current
debt coverage ratio is slightly lower than Loblaw’s. Both companies are performing close to
or better than the industry average, which would indicate that neither company appears to
be having any liquidity problems.
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BYP 10-2 (CONTINUED)
(c)
The higher the percentage of debt to total assets, the greater the risk that a company may
be unable to meet its maturing obligations. Loblaw’s 2002 debt to total assets ratio was approximately 62.9%, compared to 55.0% for Sobeys. Thus, Sobeys would be considered better able to meet its obligations. The times interest earned ratio provides an indication of a
company’s ability to meet interest payments. Since Loblaw’s times interest earned ratio is
larger than Sobeys’, Loblaw had a greater ability to meet its interest payments in 2002 than
Sobeys. However, at 0.21 times, Sobeys’ cash total debt coverage is better than Loblaw’s,
this would indicate that Sobeys is better able to generate cash to meet its obligations. Both
companies are close to the industry average for debt to total assets and both are much
higher than the industry average for the times interest earned ratio which would indicate
that neither company is having solvency problems.
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BYP 10-3 RESEARCH CASE
(a)
Examples of off-balance sheet financing include the use of special purpose entities, commitments not being booked and structuring leases such that they are considered to be
operating rather than capital.
This is a very risky practice because a company can be required to repay amounts that
were never recorded in the financial statements. If the company does not have sufficient
funds to repay these unrecorded liabilities it could be forced in to bankruptcy.
(b)
Operating leases are popular with airlines because these companies require significant
investments in expensive assets such as airplanes. If these assets do not have to be
recorded on the balance sheet, because they are leased through an operating lease, neither does the corresponding liability. The fact that the liabilities are not recorded, improves
the companies reported solvency and liquidity position.
(c)
In many cases, off-balance sheet financing is in accordance with GAAP. Standard setters
are trying to improve accounting standards to ensure that financial reporting is more accurate and transparent.
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Financial Accounting, Second Canadian Edition
BYP 10-4 INTERPRETING FINANCIAL STATEMENTS
(a)
Reitmans
La Senza
$134,185  $79,915  $54,270
$109,562  $61,171  $48,391
Current ratio
$134,185
 1.68 : 1
$79,915
$109,562
 1.79 : 1
$61,171
Acid-test ratio
($30,885  $5,089)
 0.45 : 1
$79,915
($20,361  $5,743  $32,615)
 0.96 : 1
$61,171
$32,235
($50,258  $79,915)  2
 0.50 times
$33,690
($61,171  $53,777)  2
 0.59 times
Working capital
Cash current
debt coverage
La Senza’s liquidity is stronger as evidenced by its higher current ratio. As well, La Senza’s acidtest ratio approximately twice as high as Reitmans and La Senza appears to have more cash
available to meet currently maturing obligations as evidenced by its higher cash current debt
coverage ratio. Overall La Senza has the better liquidity position.
(b)
Reitmans
La Senza
$176,049
 42.0%
$419,570
$90,253
 38.5%
$234,609
Times interest
earned
($24,535  $2,656  $12,548)
$2,656
= 15.0 times
($(3,775)  $2,094  $5,945)
=
$2,094
2.03 times
Cash total debt
coverage
$32,235
($176,049  $53,757)  2
= 0.28 times
$33,690
($90,253  $97,133)  2
= 0.36 times
Debt to total assets
La Senza relied more heavily on debt financing; 38.5% of every dollar of assets was financed
with debt versus only 19.3% by Reitmans. Reitmans has much higher times interest earned and
cash interest coverage ratios indicating it is the more solvent of the two companies.
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BYP 10-4 (CONTINUED)
(c)
Operating leases reduce a company’s solvency. Even though they are not shown on the
balance sheet or used in the standard ratio calculations, they are a commitment the company must meet. La Senza’s commitments under operating leases are lower than that of
Reitmans, which improves its relative solvency.
(d)
Reitmans
Return on assets
Profit margin
$24,535
($419,570  $279,336)  2
= 7.0%
$24,535 ÷ $752,494
= 3.2%
La Senza
$15,445
($234,609  $245,258)  2
= 6.4%
$15,445÷ $289,100
= 5.3%
Reitmans’ and La Senza’s return on assets are very similar at 7.0% and 6.4% respectively. However, La Senza’s profit margin is higher than that of Reitmans. This would indicate that La Senza
has more profit per dollar of sales.
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Financial Accounting, Second Canadian Edition
BYP 10-5 A GLOBAL FOCUS
(a)
Swedish Match would disclose the information relating to the contingency rather than accrue it in the financial statements if they cannot reasonably estimate the amount of the
probable loss.
(b)
The legal costs would be expensed in the current period.
(c)
Swedish Match AB becomes less solvent if the user considers the contingent liabilities.
The company would have more debt which would increase the debt to total asset ratio and
the times interest earned ratio would further decrease because earnings would be reduced
by the amount of any loss.
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Kimmel, Weygandt, Kieso, Trenholm
Financial Accounting, Second Canadian Edition
BYP 10-6 FINANCIAL ANALYSIS ON THE WEB
Due to the frequency of change with regard to information available on the world wide web, the
Accounting on the Web cases are updated as required. Their suggested solutions are also updated whenever necessary, and can be found online in the Instructor Resources section of our
home page <www.wiley.com/canada/kimmel>.
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Kimmel, Weygandt, Kieso, Trenholm
Financial Accounting, Second Canadian Edition
BYP 10-7 COLLABORATIVE LEARNING ACTIVITY
(a)
Face value of bonds
Proceeds from sale of bonds ($1,200,000 X 97%)
Discount on bonds payable
$1,200,000
1,164,000
$ 36,000
Bond discount amortization per year:
$36,000 ÷ 5 = $7,200
Face value of bonds
Amount of original discount
Less: Amortization through January 1, 2005 (2 years)
Carrying value of bonds, January 1, 2005
1.
2.
$1,200,000
$36,000
14,400
Bonds Payable ........................................................
Discount on Bonds Payable ...........................
Gain on Bond Redemption .............................
($1,178,400 – $1,000,000)
Cash ...............................................................
(To record redemption of 8% bonds)
1,200,000
Cash .......................................................................
Bonds Payable ...............................................
(To record sale of 10-year, 6% bonds at par)
1,000,000
21,600
$1,178,400
21,600
178,400
1,000,000
1,000,000
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Kimmel, Weygandt, Kieso, Trenholm
Financial Accounting, Second Canadian Edition
BYP 10-7 (CONTINUED)
(b)
Dear President:
The early redemption of the 8%, 5-year bonds results in recognizing a gain of $178,400
that increases current year net earnings by the after-tax effect of the gain. The amount of
the liabilities on the balance sheet will be lowered by the issuance of the new bonds and retirement of the 5-year bonds.
In addition, the cash flow of the company as it relates to bonds payable will be positively affected as follows:
Annual interest payments on the new 10-year bonds
($1,000,000 X 0.06)
Annual interest payments on the old 5-year bonds
($1,200,000 X 0.08)
$60,000
Additional cash inflows per year
$36,000
96,000
The amount of interest expense shown on the statement of earnings
will be lower as a result of the decision to issue new bonds:
Annual interest expense on new bonds
Annual interest expense on old bonds:
Interest payment
Discount amortization
Reduced interest expense per year
$ 60,000
$96,000
7,200
103,200
$ 43,200
These comparisons hold for only the 3-year remaining life of the 8%, 5-year bonds. The
company must acknowledge either redemption of the 8% bonds at maturity, January 1,
2008, or refinancing of that issue at that time and consider what interest rates will be in
2008 in evaluating a redemption and issuance in 2005.
However, before proceeding with the bond refinancing you may want to review where interest rates are expected to move over the next few months. If rates are expected to decrease further you may want to wait before proceeding with the refinancing.
Sincerely,
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Kimmel, Weygandt, Kieso, Trenholm
Financial Accounting, Second Canadian Edition
BYP 10-8 COMMUNICATION ACTIVITY
Memorandum
Re: Unredeemed loyalty points
The loyalty programs offered by many companies today are an incentive to increase revenues in
the period the loyalty points are earned. Therefore, for there to be proper matching of revenues
and expenses, the cost of such programs should be accrued in the financial statements and
matched to the related revenues.
However, the determination of such amounts is often difficult because of uncertainties over the
amount of rewards that will actually be redeemed. If a reasonable estimate can be made of the
amount of the loyalty program rewards that will actually be redeemed and of the cost of providing
such redemptions, then an accrual should be made on the balance sheet for this liability and a
corresponding expense recorded in the statement of earnings.
If the amount cannot be reasonably estimated then there should be note disclosure of this possible future expense so that the users of the financial statements can factor this potential liability
into their analysis of the company.
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Kimmel, Weygandt, Kieso, Trenholm
Financial Accounting, Second Canadian Edition
BYP 10-9 ETHICS CASE
(a)
The stakeholders in this situation include:
Shareholders
Creditors
Employees
(b)
Shifting debt off the balance sheet might make investors believe the company is more solvent than it actually is. This would cause users to make incorrect investment decisions
such as deciding to hold or buy the stock of a company in financial difficulty. It was incorrect information concerning the debt of Enron, which caused employees and other investors to lose millions of dollars when the company declared bankruptcy.
(c)
Answer will vary according to student.
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Financial Accounting, Second Canadian Edition
Legal Notice
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