CHAPTER 16
Long-Term Liabilities
ASSIGNMENT CLASSIFICATION TABLE
Study Objectives
Brief
Exercises
Questions
Exercises
Problems
Set A
Problems
Set B
1. Describe the advantages and
illustrate the impact of issuing
bonds instead of common
shares.
1, 2, 3, 4, 5, 6
1
1
2. Prepare the entries for the issue
of bonds and the recording of
interest expense.
7, 8, 9, 10,
11, 12
2, 3, 4, 5, 6, 7
2, 3, 4, 7, 8
1, 2, 3, 5, 6
1, 2, 3, 5, 6
3. Contrast the effects of the
straight-line and effective
interest methods of amortizing
bond discounts and premiums.
13, 14
7, 8
5, 6
4, 5
4, 5
4. Prepare the entries when bonds
are retired.
15
9
7, 8, 9
6
6
5. Account for long-term notes
payable.
16, 17
10, 11
10
7
7
6. Contrast the accounting for
operating leases and capital
leases.
18, 19
12
11, 12
8
8
7. Explain and illustrate the
methods for the financial
statement presentation and
analysis of long-term liabilities.
20, 21, 22
13, 14
12, 13
1, 2, 5, 7, 9
1, 2, 5, 7, 9
16-1
ASSIGNMENT CHARACTERISTICS TABLE
Problem
Number
Description
Difficulty
Level
Time
Allotted (min.)
1A
Prepare entries for bonds, using straight-line method of
amortization. Show balance sheet presentation.
Simple
25-35
2A
Prepare entries for bonds, using straight-line method of
amortization. Show balance sheet presentation.
Simple
25-35
3A
Prepare entries for bonds using effective interest method of
amortization.
Moderate
20-30
4A
Prepare entries for bonds sold between interest periods.
Simple
10-20
5A
Prepare entries for bonds, using effective interest method of
amortization. Show balance sheet presentation. Answer
analytical questions.
Moderate
25-35
6A
Prepare entries for bonds, using straight-line method of
amortization, and redemption of bonds.
Moderate
25-35
7A
Prepare instalment payments schedule and entries for
mortgage note payable. Show balance sheet presentation.
Moderate
20-30
8A
Analyse various lease situations, prepare entries, and
discuss financial statement presentation.
Moderate
20-30
9A
Calculate and analyse debt ratios.
Moderate
20-30
1B
Prepare entries for bonds, using straight-line method of
amortization. Show balance sheet presentation.
Simple
25-35
2B
Prepare entries for bonds, using straight-line method of
amortization. Show balance sheet presentation.
Simple
25-35
3B
Prepare entries for bonds, using effective interest method of
amortization.
Moderate
20-30
4B
Prepare entries for bonds sold between interest periods,
using straight-line method of amortization.
Complex
25-35
5B
Prepare entries for bonds, using effective interest method of
amortization. Show balance sheet presentation. Answer
analytical questions.
Moderate
25-35
6B
Calculate interest rate on bonds; prepare entries for bonds,
using straight-line method of amortization, and redemption of
bonds.
Complex
25-35
7B
Prepare instalment payments schedule and entries for
mortgage note payable. Show balance sheet presentation.
Moderate
20-30
8B
Analyse various lease situations, prepare entries and discuss
financial statement presentation.
Moderate
20-30
16-2
Problem
Number
9B
Description
Difficulty
Level
Time
Allotted (min.)
Calculate and analyse debt ratios.
Moderate
20-30
16-3
BLOOM’S TAXONOMY TABLE
Correlation Chart between Bloom’s Taxonomy, Study Objectives and End-of-Chapter Material
Study Objectives
1. Describe the
advantages and
illustrate the impact of
issuing bonds instead
of common shares.
Knowledge
Comprehension
Q16-1
Q16-2
Q16-3
Q16-4
Q16-5
Q16-6
Application
BE16-1
Analysis
E16-1
2.
Prepare the entries
for the issue of bonds
and recording of
interest expense.
Q16-10
Q16-7
Q16-8
Q16-9
Q16-11
Q16-12
BE16-2
BE16-3
BE16-4
BE16-5
BE16-6
BE16-7
E16-2
E16-3
E16-4
E16-7
E16-8
P16-1A
P16-2A
P16-3A
P16-6A
P16-1B
P16-2B
P16-3B
P16-6B
P16-5A
P16-5B
3.
Contrast the effects of
the straight-line and
effective interest
methods of amortizing
bond discounts and
premiums.
Q16-14
Q16-13
BE16-7
BE16-8
E16-5
P16-4A
P16-4B
E16-6
P16-5A
P16-5B
4.
Prepare the entries
when bonds are
retired.
Q16-15
BE16-9
E16-7
E16-8
E16-9
P16-6A
P16-6B
5.
Account for long-term
notes payable.
Q16-16
Q16-17
BE16-10
BE16-11
E16-10
P16-7A
P16-7B
6.
Contrast the
accounting for
operating leases and
capital leases.
Q16-18
Q16-19
BE16-12
E16-11
P16-8A
P16-8B
E16-12
7.
Explain and illustrate
the methods for the
financial statement
presentation and
analysis of long-term
liabilities.
Q16-21
Q16-22
BE16-13
BE16-14
E16-13
P16-1A
P16-2A
P16-7A
P16-1B
P16-2B
P16-7B
E16-12
P16-5A
P16-9A
P16-5B
P16-9B
BYP16-4
BYP16-1
BYP16-2
BYP16-5
Broadening Your
Perspective
Q16-20
16-4
BYP16-3
BYP16-6
BYP16-7
Synthesis
Evaluation
BYP16-8
ANSWERS TO QUESTIONS
01. Long-term liabilities are obligations that are expected to be paid after
one year. Examples include bonds, long-term notes payable, and lease
liabilities.
02. (a) The major advantages are:
1. Shareholder control is not affected—bondholders do not have
voting rights, with the result that current shareholders retain
full control over the company.
2. Income tax savings result—bond interest is deductible for tax
purposes; dividends on shares are not.
3. Income to common shareholders may increase—if a company
can earn more on borrowed funds than the interest cost on
these funds, the income to common shareholders will increase.
4. Earnings per share may be higher—although bond interest
expense will reduce net income, earnings per share will often
be higher under bond financing, because no additional
common shares are issued.
(b) The major disadvantages in using bonds are that interest must be
paid on a periodic basis and the principal (face value) of the bonds
must be paid at maturity. They are binding legal obligations.
03. (a) Secured bonds have specific assets of the issuer pledged as
collateral. In contrast, unsecured bonds are issued against the
general credit of the borrower. These bonds are called debenture
bonds.
(b) Term bonds mature at a single specified future date. In contrast,
serial bonds mature in instalments.
(c) Retractable bonds can be redeemed before maturity at the option
of the bondholder. In contrast, redeemable bonds are subject to
call and retirement at a stated dollar amount prior to maturity, at
the option of the issuer.
16-5
Questions Chapter 16 (Continued)
04. (a) Face value is the amount of principal due at the maturity date. Face
value is also called par value.
(b) The contractual interest rate is the rate used to determine the
amount of cash interest the borrower pays and the investor
receives. This rate is also called the stated interest rate, because it
is the rate stated on the bonds.
(c) The market rate of interest is the rate investors demand for lending
their money.
05. The two major obligations incurred by a company when bonds are
issued are the interest payments due on a periodic basis and the
principal that must be paid at maturity.
6. Convertible bonds are bonds that can be converted into shares. The
advantage to a bondholder is that they have the opportunity to convert
their bonds if the market price of the shares increases. While waiting
for the share price to increase, the bondholders still receive interest
payments. For the issuer, bonds with a conversion feature generally
sell at a higher price and pay a lower rate of interest than comparable
debt securities that do not have a conversion option.
07. Investors paid less than the face value; therefore, the market interest
rate must have been greater than the contractual rate.
08. $30,000. $600,000 X 10% X 6/12 months = $30,000. Because there is no
premium or discount the interest expense will be the same regardless
of whether the effective interest method or the straight-line method of
amortization is used.
09. $860,000. 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.
16-6
Questions Chapter 16 (Continued)
10. The straight-line method results in the same amortized amount being
allocated 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.
The effective interest method results in varying amounts of
amortization and interest expense per period but a constant
percentage rate. The amount is determined by multiplying the carrying
value of the bonds at the beginning of the period by the market
(effective) rate of interest.
11. $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 2003. Since the
straight line method is being used interest expense for 2004 will also
be $14,400.
12.
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 by the effective-interest rate.
13. The investor will pay 4 months accrued interest, $27 ($1,000 X 8% X
4/12). The bond discount will be amortized over 56 months (60 – 4).
14.
Julia should tell her staff that the effective-interest method results in a
varying amount of interest expense but a constant rate of interest on
the balance outstanding. Accordingly, it results in a better matching
of expenses with revenues than the straight-line method.
16-7
Questions Chapter 16 (Continued)
15. Bond Payable ..................................................................... XXX
Premium on Bonds ............................................................ XXX
Gain on Redemption ................................................
Cash ..........................................................................
XXX
XXX
16. Instalment notes payable with fixed principal payments are repayable
in equal periodic amounts, plus interest. Instalment notes with blended
principal and interest payments are repayable in equal periodic
amounts, including interest.
17. This is not the case. Each payment by Doug consists of (1) interest on
the unpaid balance of the loan and (2) a reduction of loan principal.
The interest decreases each period (as the principal owing is reduced)
while the portion applied to the loan principal increases each period.
18. (a) A lease agreement is a contract in which the lessor gives the
lessee the right to use an asset for a specified period, in return for
one or more periodic rental payments. The lessor is the owner of
the property and the lessee is the renter or tenant.
(b) The two major types of leases are operating leases and capital
leases.
(c) In an operating lease the property is rented by the lessee and the
lessor retains all ownership risks and responsibilities. A capital
lease transfers substantially all the benefits and risks of ownership
from the lessor to the lessee, so that the lease is in effect a
purchase of the property.
19.
In a capital lease agreement, the lessee records the present value of
the lease payments as an asset and a liability. Therefore, Rasch
Company would debit Leased Equipment for $186,300 and credit
Lease Liability for the same amount.
16-8
Questions Chapter 16 (Continued)
20.
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 financial statements. The notes should also indicate the
interest rates, maturity dates, conversion privileges, any assets
pledged as collateral, and the currency (e.g., Cdn. dollars, US dollars,
Euros, etc.) in which the liabilities are denominated.
21.
EBIT stands for earnings before interest expense and income tax
expense. EBITDA stands for interest before interest expense, income
tax expense, and depreciation and amortization expense. EBITDA is a
basic measure of a company’s ability to generate cash from operating
activities.
22.
The accrual-based interest coverage ratio does not necessarily
indicate whether the company has sufficient cash available to pay
interest. Therefore, investors often consider the cash based interest
coverage ratio to be a better indication of an entity’s ability to meet
debt service requirements.
16-9
SOLUTIONS TO BRIEF EXERCISES
BRIEF EXERCISE 16-1
Issue
Shares
Issue
Bonds
Income before interest and income tax
Interest expense ($2,000,000 X 8%)
Income before income tax
Income tax expense (30%)
Net income (a)
$1,000,000
00, 00,000
01,000,000
0 ,300,000
$ 700,000
$1,000,000
00,160,000
00,840,000
0 ,252,000
$ 588,000
Issued shares (b)
Earnings per share (a)  (b)
00,700,000
00$1.00
00,500,000
00$1.18
Net income is higher if shares are issued. However, earnings per share is
lower because of the additional shares that are issued. Therefore, on the
basis of earnings per share, the bonds alternative is preferable.
BRIEF EXERCISE 16-2
(a) Mar. 01 Cash .......................................................
Bonds Payable (1,000 X $1,000) ...
1,000,000
(b) Sept. 01 Bond Interest Expense .........................
Cash ($1,000,000 X 9% X 6/12) ......
45,000
(c) Dec. 31 Bond Interest Expense .........................
Bond Interest Payable
($1,000,000 X 9% X 4/12) ............
30,000
16-10
1,000,000
45,000
30,000
BRIEF EXERCISE 16-3
(a)
(a) Mar. 01 Cash (98% X $1,000,000) ......................
Discount on Bonds Payable .................
Bonds Payable ...............................
980,000
20,000
(b) Sept. 01 Bond Interest Expense .........................
Discount on Bonds Payable
($20,000  5 X 6/12) ....................
Cash ($1,000,000 X 9% X 6/12) ......
47,000
(c) Dec. 31 Bond Interest Expense .........................
Discount on Bonds Payable
($20,000  5 X 4/12) .....................
Bond Interest Payable
($1,000,000 X 9% X 4/12) ............
31,333
1,000,000
2,000
45,000
1,333
30,000
(b)
(a) Mar. 1
Cash (102% X $1,000,000) ....................
Bonds Payable ...............................
Premium on Bonds Payable .........
1,020,000
Interest Expense ...................................
Premium on Bonds Payable
($20,000  5 X 6/12) ...........................
Cash ($1,000,000 X 9% X 6/12) ......
43,000
(c) Dec. 31 Bond Interest Expense .........................
Premium on Bonds Payable
($20,000  5 X 4/12) ...........................
Bond Interest Payable
($1,000,000 X 9% X 4/12) ...........
28,667
(b) Sept. 1
16-11
1,000,000
20,000
2,000
45,000
1,333
30,000
BRIEF EXERCISE 16-4
(a) Jan. 01 Cash (96% X $2,000,000) ......................
Discount on Bonds Payable .................
Bonds Payable ...............................
1,920,000
80,000
(b) July 01 Bond Interest Expense .........................
Discount on Bonds Payable
($80,000  10 X 6/12) ..................
Cash ($2,000,000 X 9% X 6/12) ......
94,000
2,000,000
4,000
90,000
BRIEF EXERCISE 16-5
(a) Jan. 1 Cash (103% X $3,000,000) ....................
Bonds Payable ...............................
Premium on Bonds Payable .........
3,090,000
(b) July 1 Interest Expense ....................................
Premium on Bonds Payable
($90,000  5 X 6/12) .............................
Cash ($3,000,000 X 10% X 6/12) ....
141,000
16-12
3,000,000
90,000
9,000
150,000
BRIEF EXERCISE 16-6
Discount = $100,000 – $92,639 = $7,361
(a) Straight-Line Amortization
Date
October 1, 2003
1. Bond Interest Payable
$100,000 X 10% X 6/12
= $5,000
April 1, 2004
$100,000 X 10% X
6/12
= $5,000
2. Amortization of Discount $7,361 ÷ 5 x 6/12
= $736.10
$7,361 ÷ 5 X 6/12
= $736.10
3. Interest Expense (1 + 2)
$5,736.10
(b)
$5,736.10
Effective Interest Amortization
Date
October 1, 2003
April 1, 2004
1. Bond Interest Payable
$100,000 X 10% X 6/12
= $5,000
$100,000 X 10% X
6/12
= $5,000
2. Interest Expense
$92,639 X 12% X 6/12
= $5,559
$92,639 + $559 =
$93,198 X 12% X 6/12
= $5,592
3. Amortization of Discount $5,000 - $5,559
(1-2)
= $559
16-13
$5,000 - $5,592
= $592
BRIEF EXERCISE 16-7
(a) Bond Interest Expense ...................................................
Discount on Bonds Payable ...................................
Cash .........................................................................
46,884
1,884
45,000
(b) Contractual interest rate: ($45,000 X 2) ÷ ($62,311 + $937,689) = 9%
Market interest rate: ($46,884 X 2) ÷ $937,689 = 10%
(c) Interest expense is greater than interest paid because the bonds sold
at a discount. The bonds sold at a discount because investors demand
a market (or effective) 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 advantage of the effective rate method is that it uses a constant
rate of interest. The effective-interest method results in a varying
amount of interest expense but a constant rate of interest on the
balance outstanding. Accordingly, it results in a better matching of
expenses with revenues than the straight-line method.
BRIEF EXERCISE 16-8
(a) May 01 Cash .......................................................
Bonds Payable ...............................
Bond Interest Payable
($1,000,000 X 9% X 4/12) ...........
1,030,000
(b) July 01 Bond Interest Payable ..........................
Bond Interest Expense
($1,000,000 X 9% X 2/12) ...................
Cash ($1,000,000 X 9% X 6/12) ......
30,000
16-14
1,000,000
30,000
15,000
45,000
BRIEF EXERCISE 16-9
July 1 Bonds Payable .......................................
Loss on Bond Redemption
($990,000 – $940,000) ........................
Discount on Bonds Payable .........
Cash ($1,000,000 X 99%) ...............
1,000,000
50,000
60,000
990,000
BRIEF EXERCISE 16-10
(a)
Monthly
Interest
Period
Nov. 30, 2003
Dec. 31, 2003
Jan. 31, 2004
2003
Nov. 30
Dec. 31
2004
Jan. 31
(A)
Cash
Payment
$5,000
04,979
(B)
Interest
Expense
(D) X 10%
X 1/12
(C)
Reduction
of Principal
(A) – (B)
$2,500
02,479
$2,500
02,500
Cash .............................................................
Mortgage Note Payable .......................
300,000
Interest Expense .........................................
Mortgage Note Payable ..............................
Cash .....................................................
2,500
2,500
Interest Expense .........................................
Mortgage Note Payable ..............................
Cash .....................................................
2,479
2,500
16-15
(D)
Principal
Balance
(D) – (C)
$300,000
297,500
295,000
2,000
300,000
5,000
4,979
BRIEF EXERCISE 16-10 (Continued)
(b)
Monthly
Interest
Period
Nov. 30, 2003
Dec. 31, 2003
Jan. 31, 2004
2003
Nov. 30
Dec. 31
2004
Jan. 31
(A)
Cash
Payment
$3,964.52
3,964.52
(B)
Interest
Expense
(D) X 10%
X 1/12
$2,500.00
2,487.79
(C)
Reduction
of Principal
(A) – (B)
(D)
Principal
Balance
(D) – (C)
$1,464.52
1,476.73
01476.73
$300,000.00
298,535.48
297,058.75
22,000
Cash ............................................................. 300,000.00
Mortgage Note Payable .......................
300,000.00
Interest Expense .........................................
Mortgage Note Payable ..............................
Cash .....................................................
2,500.00
1,464.52
Interest Expense .........................................
Mortgage Note Payable ..............................
Cash .....................................................
2,487.79
1,476.73
3,964.52
3,964.52
BRIEF EXERCISE 16-11
Monthly
Interest
Period
Issue Date
1
2
3
(A)
Cash
Payment
$132.15
0132.15
132.15
(B)
Interest
Expense
(D) X 10%
X 1/12
$83.33
082.93
82.52
16-16
(C)
Reduction
of Principal
(A) – (B)
(D)
Principal
Balance
(D) – (C)
$48.82
49.22
49.63
01476.73
$10,000.00
9,951.18
9,901.96
9,852.33
22,000
BRIEF EXERCISE 16-12
1.
2.
Rent Expense ........................................................
Cash ...............................................................
70,000
Leased Asset—Building .......................................
Lease Liability ...............................................
600,000
70,000
600,000
BRIEF EXERCISE 16-13
WAUGH COMPANY
Balance Sheet (Partial)
December 31, 2003
Long-term liabilities
Bonds payable, due 2005 ....................................
$900,000
Less: Discount on bonds payable .....................
45,000
Notes payable, due 2007 .........................................................
Lease liability ...........................................................................
Total long-term liabilities .................................................
$855,000
80,000
0 50,000
$985,000
Note that any portion to be paid within the next year should be reported
separately, under current liabilities.
16-17
BRIEF EXERCISE 16-14
($ in millions)
(a) Debt to total assets = Total debt ÷ Total assets
$2,086.1
 67.04%
$3,111.8
(b) Interest coverage= EBIT ÷ Interest expense
($70.8)  ($4.9)  $77.8
 0.03 times
$77.8
(c) Cash interest coverage = EBITDA ÷ Interest expense
($70.8)  ($4.9)  $77.8  $100.3
 1.32 times
$77.8
16-18
SOLUTIONS TO EXERCISES
EXERCISE 16-1
Issue
Shares
Issue
Bonds
Income before interest and income tax
Interest expense ($2,700,000 X 13%)
Income before income tax
Income tax expense (30%)
Net income
Issued shares
Earnings per share
$500,000
0
0500,000
0150,000
$350,000
0150,000
0$2.33
$500,000
0351,000
0149,000
0 44,700
$104,300
0090,000
0$1.16
Net income and earnings per share would be higher if the company
financed the fleet using a share issue versus debt.
EXERCISE 16-2
(a) Jan. 01 Cash ...........................................................
Bonds Payable ...................................
100,000
(b) July 01 Bond Interest Expense .............................
Cash ($100,000 X 10% X 6/12)...........
5,000
(c) Dec. 31 Bond Interest Expense .............................
Bond Interest Payable .......................
5,000
16-19
100,000
5,000
5,000
EXERCISE 16-3
(a) Jan. 01 Cash ...........................................................
Discount on Bonds Payable .....................
Bonds Payable ...................................
(b) July 01 Bond Interest Expense
($609,497 X 10% X 6/12) .........................
Discount on Bonds Payable .............
Cash ($650,000 X 9% X 6/12).............
(c) Dec. 31 Bond Interest Expense
[($609,497 + $1,225) X 10% X 6/12] .......
Discount on Bonds Payable .............
Bond Interest Payable .......................
609,497
40,503
650,000
30,475
1,225
29,250
30,536
1,286
29,250
Detailed Calculations:
Semiannual
Interest
Period
Issue date
1
2
(B)
(A)
Interest Expense
Interest
(Preceding
(C)
(D)
Payment
Bond Carrying
Discount
Unamortized
($650,000 X Value X 10% X Amortization
Discount
9% X 6/12)
6/12)
(B) – (A)
(D) – (C)
29,250
29,250
30,475
30,536
1,225
1,286
16-20
40,503
39,278
37,992
(E)
Bond
Carrying
Value
609,497
610,722
612,008
16-21
EXERCISE 16-4
(a) Jan. 01 Cash ...........................................................
Premium on Bonds Payable .............
Bonds Payable ...................................
637,378
37,378
600,000
(b) July 01 Bond Interest Expense
($637,378 X 10% X 6/12) ..........................
Premium on Bonds Payable .....................
Cash ($600,000 X 11% X 6/12)...........
31,869
1,131
(c) Dec. 31 Bond Interest Expense
[($637,378 – $1,131) X 10% X 6/12] ......
Premium on Bonds Payable .....................
Bond Interest Payable .......................
31,812
1,188
33,000
33,000
Detailed Calculations:
(A)
Interest
Semi - Payment
annual ($600,000
Interest X 11% X
Period
6/12)
Issue date
1
2
33,000
33,000
(B)
Interest
Expense
(Preceding
(C)
Bond Carrying
Premium
Value X 10% X Amortization
6/12)
(A) – (B)
31,869
31,812
1,131
1,188
16-22
(D)
Unamortized
Premium
(D) – (C)
37,378
36,247
35,059
(E)
Bond
Carrying
Value
637,378
636,247
635,059
EXERCISE 16-5
(a) Apr. 01 Cash ...........................................................
Bonds Payable ...................................
Bond Interest Payable
($120,000 X 10% X 3/12) ................
123,000
(b) July 01 Bond Interest Payable ..............................
Bond Interest Expense .............................
Cash ($120,000 X 10% X 6/12)...........
3,000
3,000
(c) Apr. 01 Cash ...........................................................
Bonds Payable ...................................
Premium on Bonds............................
Bond Interest Payable
($120,000 X 10% X 3/12) ................
124,200
July 01 Bond Interest Payable ..............................
Bond Interest Expense .............................
Premium on Bonds ($1,200 ÷ 10 X 6/12) ..
Cash ($120,000 X 10% X 6/12)...........
3,000
2,940
60
16-23
120,000
3,000
6,000
120,000
1,200
3,000
6,000
EXERCISE 16-6
(a) Jan. 1
Cash ........................................................
Discount on Bonds Payable ..................
Bonds Payable ...............................
864,100
135,900
1,000,000
(b) (1) Straight-Line Method
Period 1
Period 20
Bond Interest Expense ..........................
Discount on Bonds Payable
($135,900 ÷ 20) .............................
Cash ($1,000,000 X 6% X 6/12).......
36,795
Bond Interest Expense ..........................
Discount on Bonds Payable
($135,900 ÷ 20) .............................
Cash ($1,000,000 X 6% X 6/12).......
36,795
6,795
30,000
6,795
30,000
(2) Effective Interest Method
Period 1
Period 20
1
Bond Interest Expense
($864,100 X 8% X 6/12) ........................
Discount on Bonds Payable ..........
Cash ($1,000,000 X 6% X 6/12).......
Bond Interest Expense ..........................
Discount on Bonds Payable ..........
Cash ($1,000,000 X 6% X 6/12).......
34,564
4,564
30,000
39,6151
Principal: $1,000,000 X 0.96154 (Table 3, n=1, i=4%) = $961,540
Interest: $30,000 x 0.96154 (Table 4, n=1, i=4%) = $28,846
Carrying (present) value of bond at end of period 19
= $961,540 + $28,846 = $990,386 x 8% x 6/12 = $39,615
16-24
9,615
30,000
EXERCISE 16-6 (Continued)
(c)
(1) Straight-Line Method
Period 1 $36,795 ÷ $864,100 = 4.3%
Period 20 $36,795 ÷ $990,386 = 3.7%
(2) Effective Interest Method
Period 1 $34,564 ÷ $864,100 = 4.0%
Period 20 $39,615 ÷ $990,386 = 4.0%
(d) The effective rate of interest method provides the better measure of
the effective cost of borrowing. Using this method interest expense as
a percentage of the carrying value remains constant over the life of the
bond.
EXERCISE 16-7
2003
(a) Jan. 01 Cash ($400,000 X 103%) ...........................
Premium on Bonds Payable .............
Bonds Payable ...................................
(b) July 01 Bond Interest Expense .............................
Premium on Bonds Payable
($12,000 ÷ 20 X 6/12) .................................
Cash ($400,000 X 9% X 6/12).............
2022
(c) Dec. 31 Bond Interest Expense .............................
Premium on Bonds Payable .....................
Bond Interest Payable .......................
2023
(d) Jan.
1 Bonds Payable ...........................................
Cash ...................................................
16-25
412,000
12,000
400,000
17,700
300
18,000
17,700
300
18,000
400,000
400,000
EXERCISE 16-8
(a)
2003
Dec. 31 Cash ...........................................................
Discount on Bonds Payable .....................
Bonds Payable ...................................
(b) 2004
June 30 Bond Interest Expense .............................
Discount on Bonds Payable
($20,000  10 X 6/12) ......................
Cash ($300,000 X 11% X 6/12)...........
(c)
2004
Dec. 31 Bond Interest Expense .............................
Discount on Bonds Payable .............
Cash ...................................................
(d) 2013
Dec. 31 Bonds Payable ..........................................
Cash ...................................................
280,000
20,000
300,000
17,500
1,000
16,500
17,500
1,000
16,500
300,000
300,000
EXERCISE 16-9
1.
2.
June 30 Bonds Payable ..........................................
Loss on Bond Redemption
($121,200 – $107,500) ............................
Discount on Bonds Payable
($120,000 – $107,500) ....................
Cash ($120,000 X 101%) ....................
120,000
June 30 Bonds Payable ..........................................
Premium on Bonds Payable .....................
Gain on Bond Redemption ...............
Cash ($150,000 X 96%) ......................
150,000
1,000
16-26
13,700
12,500
121,200
7,000
144,000
EXERCISE 16-10
(a)
Semi-annual
Interest
Period
Dec. 31, 2003
June 30, 2004
Dec. 31, 2004
(A)
Cash
Payment
$15,000
14,625
01
(B)
Interest
Expense
(D) X 10%
X 6/12
$7,500
07,125
(C)
Reduction
of Principal
(A) – (B)
(D)
Principal
Balance
(D) – (C)
$7,500
7,500
01476.73
$150,000
142,500
135,000
22,000
Issue of Note
2003
Dec. 31
Cash ....................................................
Mortgage Note Payable ..............
150,000
150,000
First Instalment Payment
2004
June 30
Interest Expense
($150,000 X 10% X 6/12) .................
Mortgage Note Payable......................
Cash ............................................
7,500
7,500
15,000
Second Instalment Payment
Dec. 31
Interest Expense
[($150,000 – $7,500) X 10% X 6/12]
Mortgage Note Payable......................
Cash.............................................
16-27
7,125
7,500
14,625
EXERCISE 16-10 (Continued)
(b)
Semi-annual
Interest
Period
Issue Date
June 30, 2004
Dec. 31, 2004
(A)
Cash
Payment
$12,036.39
12,036.39
01
(B)
Interest
Expense
(D) X 10%
X 6/12
$7,500.00
7,273.18
(C)
Reduction
of Principal
(A) – (B)
(D)
Principal
Balance
(D) – (C)
$4,536.39
4,763.21
01476.73
$150,000.00
145,463.61
140,700.40
22,000
0
Issue of Note
2003
Dec. 31
Cash ....................................................
Mortgage Note Payable ..............
150,000
150,000
First Instalment Payment
2004
June 30
Interest Expense
($150,000 X 10% X 6/12) ................. 7,500.00
Mortgage Note Payable...................... 4,536.39
Cash ............................................
12,036.39
Second Instalment Payment
Dec. 31
Interest Expense [($150,000
– $4,536.39) X 10% X 6/12] .............. 7,273.18
Mortgage Note Payable...................... 4,763.21
Cash.............................................
16-28
12,036.39
EXERCISE 16-11
(a) May 21 Car Rental Expense .................................
Cash ..................................................
500
(b) Jan. 01 Leased Equipment ...................................
Lease Liability...................................
149,211
500
149,211
EXERCISE 16-12
(a) ($ in millions)
1.
Debt to total assets = Total debt ÷ Total assets
$2,199.9
 62.0%
$3,546.2
2.
Interest coverage = EBIT ÷ Interest expense
$199.6  $145.0  $72.3
 5.8 times
$72.3
3.
Cash interest coverage = EBITDA ÷ Interest expense
$199.6  $145.0  $72.3  $113.5
 7.3 times
$72.3
(b) The implication of these unrecorded liabilities is that it reduces the
cash available to meet debt-servicing requirements.
16-29
EXERCISE 16-13
(a)
PRIYA CORPORATION
Balance Sheet (Partial)
July 31, 2004
Long-term liabilities
Bonds payable, due 2010 .......................... $150,000
Add: Premium on bonds payable ............ 0 32,000
Lease liability.....................................................
Total long-term liabilities ..........................
$182,000
48,500
$230,500
(b) Bond Interest Payable should be classified as a current liability.
Similarly, the portion of the lease liability due within one year should
be classified as a current liability
16-30
SOLUTIONS TO PROBLEMS
PROBLEM 16-1A
(a)
1.
2.
3.
Jan. 01 Cash ($2,500,000 X 100%) ....................... 2,500,000
Bonds Payable ..................................
July 01 Bond Interest Expense ............................
Cash ($2,500,000 X 8% X 6/12) .........
100,000
Dec. 31 Bond Interest Expense ............................
Bond Interest Payable ......................
100,000
100,000
100,000
Jan. 01 Cash ($2,500,000 X 103%) ....................... 2,575,000
Premium on Bonds Payable ............
Bonds Payable ..................................
July 01 Bond Interest Expense ............................
Premium on Bonds Payable
($75,000  10 X 6/12) ............................
Cash ($2,500,000 X 8% X 6/12) .........
96,250
Dec. 31 Bond Interest Expense ............................
Premium on Bonds Payable ....................
Bond Interest Payable ......................
96,250
3,750
75,000
2,500,000
3,750
100,000
100,000
Jan. 01 Cash ($2,500,000 X 96%) ......................... 2,400,000
Discount on Bonds Payable .................... 100,000
Bonds Payable ..................................
July 01 Bond Interest Expense ............................
Discount on Bonds Payable
($100,000  10 X 6/12) ....................
Cash ..................................................
105,000
Dec. 31 Bond Interest Expense ............................
Discount on Bonds Payable ............
Bond Interest Payable ......................
105,000
16-31
2,500,000
2,500,000
5,000
100,000
5,000
100,000
PROBLEM 16-1A (Continued)
(b) Par
ECOMDRIVE.COM CORPORATION
Balance Sheet (Partial)
December 31, 2003
Current liabilities
Bond interest payable ....................................................
Long-term liabilities
Bonds payable, due 2013 ..............................................
00,
$ 100,000
2,500,000
Premium
ECOMDRIVE.COM CORPORATION
Balance Sheet (Partial)
December 31, 2003
Current liabilities
Bond interest payable ....................................................
Long-term liabilities
Bonds payable, due 2013 .......................
Add: Premium on bonds payable..........
$2,500,000
67,500
$0,0100,000
2,567,500
Discount
ECOMDRIVE.COM CORPORATION
Balance Sheet (Partial)
December 31, 2003
Current liabilities
Bond interest payable ....................................................
Long-term liabilities
Bonds payable, due 2013 .......................
Less: Discount on bonds payable ........
16-32
$2,500,000
0 ,090,000
$0,0100,000
2,410,000
PROBLEM 16-2A
(a)
2003
Jan. 01 Cash (104% X $4,000,000) ....................
Bonds Payable ...............................
Premium on Bonds Payable .........
4,160,000
4,000,000
160,000
(b) See following page.
(c)
2003
July 01 Bond Interest Expense .........................
Premium on Bonds Payable .................
Cash ...............................................
Dec. 31 Bond Interest Expense .........................
Premium on Bonds Payable .................
Bond Interest Payable ...................
2004
Jan. 01 Bond Interest Payable ..........................
Cash ...............................................
192,000
8,000
200,000
192,000
8,000
200,000
200,000
200,000
July 01 Bond Interest Expense .........................
Premium on Bonds Payable .................
Cash ...............................................
192,000
8,000
Dec. 31 Bond Interest Expense .........................
Premium on Bonds Payable .................
Bond Interest Payable ...................
192,000
8,000
16-33
200,000
200,000
PROBLEM 16-2A (Continued)
(b)
Semiannual
Interest
Period
Jan. 1, 2003
July 1, 2003
Jan. 1, 2004
July 1, 2004
Jan. 1, 2005
(A)
Interest
Payment
($4,000,000 X
10% X 6/12)
$200,000
0200,000
0200,000
0200,000
(B)
Interest
Expense
(A) – (C)
(C)
(E)
Premium
(D)
Bond
Amortization Unamortized Carrying Value
($160,000  10
Premium
[$3,000,000 +
X 6/12)
(D) – (C)
(D)]
$192,000
0192,000
0192,000
0192,000
$160,000
0152,000
0144,000
0136,000
0128,000
$8,000
08,000
08,000
08,000
(d)
EASTER ELECTRIC
Balance Sheet (Partial)
December 31, 2004
Current liabilities
Bond interest payable ......................................................
Long-term liabilities
Bonds payable, due 2013........................... $4,000,000
Add: Premium on bonds payable ............. 0 128,000
16-34
$200,000
4,128,000
$4,160,000
04,152,000
04,144,000
04,136,000
04,128,000
PROBLEM 16-3A
(a)
(b)
2003
July 01 Cash .......................................................
Discount on Bonds Payable .................
Bonds Payable ...............................
2,531,760
168,240
2,700,000
GLOBAL SATELLITES
Bond Discount Amortization
Effective Interest Method—Semi-annual Interest Payments
9% Bonds Issued at 10%
Semiannual
Interest
Period
(A)
(B)
Interest Interest
Payment Expense
July 1, 2003
Jan. 1, 2004 $121,500 $126,588
July 1, 2004 0121,500 0126,842
Jan. 1, 2005 0121,500 0127,110
(C)
Discount
Amortization
(B) – (A)
$5,088
05,342
05,610
(D)
(E)
UnamorBond
tized
Carrying
Discount
Value
(D) – (C) ($2,700,000 – D)
$168,240
0163,152
0157,810
0152,200
(c) 2003
Dec. 31 Bond Interest Expense
($2,531,760 X 10% X 6/12) ..................
Discount on Bonds Payable .........
Bond Interest Payable
($2,700,000 X 9% X 6/12) ............
(d) 2004
July 01 Bond Interest Expense
[($2,531,760 + $5,088) X 10% X 6/12]
Discount on Bonds Payable .........
Cash ...............................................
16-35
$2,531,760
02,536,848
02,542,190
02,547,800
126,588
5,088
121,500
126,842
5,342
121,500
PROBLEM 16-3A (Continued)
(e) Dec. 31 Bond Interest Expense
[($2,536,848 + $5,342) X 10% X 6/12]
Discount on Bonds Payable .........
Bond Interest Payable ...................
16-36
127,110
5,610
121,500
PROBLEM 16-4A
(a) Dec. 01 Cash ($1,000,000 X 100%) ....................... 1,020,000
Bonds Payable ..................................
Bond Interest Payable
($1,000,000 X 12% X 2/12) ............
(b) Dec. 31 Bond Interest Expense ............................
Bond Interest Payable
($1,000,000 X 12% X 1/12) ............
10,000
(c) Mar. 31
30,000
30,000
Bond Interest Expense ............................
Bond Interest Payable .............................
Cash ($1,000,000 X 12% X 6/12) .......
16-37
1,000,000
20,000
10,000
60,000
PROBLEM 16-5A
(a)
1.
2.
3.
4.
2003
July 01
Dec. 31
2004
July 01
Dec.31
Cash ...............................................
Bonds Payable .......................
Premium on Bonds Payable .
5,623,112
5,000,000
623,112
Bond Interest Expense
($5,623,112 X 10% X 6/12) ..........
Premium on Bonds Payable .........
Bond Interest Payable
($5,000,000 X 6% X 6/12) ....
281,156
18,844
300,000
Bond Interest Expense
[($5,623,112 – $18,844) X 5%] ....
Premium on Bonds Payable .........
Cash........................................
280,213
19,787
Bond Interest Expense
[($5,604,268 – $19,787) X 5%] ....
Premium on Bonds Payable .........
Bond Interest Payable ...........
279,224
20,776
300,000
300,000
(b)
WEBHANCER CORP.
Balance Sheet (Partial)
December 31, 2004
Long-term liabilities
Bonds payable...........................................
Add: Premium on bonds payable............
$5,000,000
0 ,563,705*
* $623,112 – $18,844 – $19,787 – $20,776 = $563,705
16-38
$5,563,705
PROBLEM 16-5A (Continued)
(c) Dear Webhancer Corp.
The effective-interest method will result in more interest expense
reported than the straight-line method in 2004 when the bonds are
sold at a premium. Straight-line interest expense for 2004 is $537,688
($300,000 – $31,156 = $268,844 x 2), compared to $559,437 ($280,213 +
$279,224) under the effective-interest method.
The cost of borrowing over the life of the bonds is equal to the cash
payments made less the bond premium received when the bonds were
originally sold.
Semi-annual interest payments
($5,000,000 X 12% X 10 periods).........................
Less: Bond premium ............................................
Total cost of borrowing ..........................................
$6,000,000
00,623,112
$5,376,888
Interest expense will be exactly the same regardless of the method of
amortization used. The choice of amortization methods will determine
the amount of the premium to be amortized each period. While the
different methods will cause the amortization to be different in each
period, the overall amount of amortization will be the same—it will
always equal the amount of the premium.
16-39
PROBLEM 16-6A
(a) Jan. 01 Bond Interest Payable ............................
Cash .................................................
120,000
(b) July 01 Bond Interest Expense ...........................
Discount on Bonds Payable
($90,000  20 periods) .................
Cash ($2,400,000 X 10% X 6/12) ......
124,500
(c) July 01 Bonds Payable ........................................
Loss on Bond Redemption.....................
Discount on Bonds Payable
[($90,000 – $4,500) X ¼] ...............
Cash ($600,000 X 102%) ..................
600,000
33,375
(d) Dec. 31 Bond Interest Expense ...........................
Discount on Bonds Payable
($64,125*  19 periods) ................
Bond Interest Payable
($1,800,000 X 10% X 6/12) ............
93,375
* $90,000 – $4,500 – $21,375 = $64,125
16-40
120,000
4,500
120,000
21,375
612,000
3,375
90,000
PROBLEM 16-7A
(a)
Semi-annual
Interest Period
Dec. 31, 2003
June 30, 2004
Dec. 31, 2004
June 30, 2005
Dec. 31, 2005
Cash
Payment
$64,194
064,194
064,194
064,194
Interest
Expense
$40,000
038,790
037,520
036,186
Reduction of
Principal
Principal
Balance
$024,194
0025,404
0026,674
0028,008
$800,000
0775,806
750,402
723,728
0695,720
(b)
2003
Dec. 31 Cash ...........................................................
Mortgage Notes Payable ...................
800,000
2004
June 30 Interest Expense .......................................
Mortgage Notes Payable ..........................
Cash ...................................................
40,000
24,194
Dec. 31 Interest Expense .......................................
Mortgage Notes Payable ..........................
Cash ...................................................
16-41
800,000
64,194
38,790
25,404
64,194
PROBLEM 16-7A (Continued)
(c)
KINYAE ELECTRONICS
Balance Sheet (Partial)
December 31, 2004
Current liabilities
Current portion of mortgage note payable .....
$ 54,682*
Long-term liabilities
Mortgage notes payable ..................................
695,720**
* $26,674 + $28,008 = $54,682
** $750,402 (Dec. 31, 2004) – $54,682 = $695,720 or see Dec. 31, 2005
balance
16-42
PROBLEM 16-8A
(a) Manitoba Enterprises should record the Potter Co. lease as a capital
lease because the lease term is greater than 75% of the estimated
economic life of the leased property.
Both the Haskins Inc. and Lornegren Associates leases should be
reported as operating leases, because none of the conditions is met to
require treatment as a capital lease. It should be noted that only one
condition need be met to require capitalization.
(b) The Potter Co. lease is a capital lease. The entry to record the capital
lease on January 1, 2003 is as follows:
Leased Asset—Truck ...................................................
Lease Liability .......................................................
50,000
50,000
The Lornegren Associates lease is an operating lease. The entry to
record the lease payment in 2003 therefore is as follows:
Rent Expense ................................................................
Cash .......................................................................
13,000
13,000
This entry would be made on the date the rental payment is due.
The Haskins Inc. lease is an operating lease. The entry to record the
lease payment in 2003 therefore is as follows:
Rent Expense ................................................................
Cash .......................................................................
4,000
This entry would be made on the date the rental payment is due.
16-43
4,000
PROBLEM 16-8A (Continued)
(c)
Since the Lornegren lease and Haskins lease do not qualify as a
capital leases, nothing would appear on Manitoba’s balance sheet
regarding either the bulldozer or the furniture. As well, no amount
payable under the terms of the lease arrangement will appear on
Manitoba’s balance sheet. The annual rental fees would simply be
charged to expense when they are paid each year.
The Potter Co. lease is a capital lease. Therefore, the truck would be
recorded as an asset on Manitoba’s balance sheet. A corresponding
liability for leased assets would also be recorded.
16-44
PROBLEM 16-9A
(a)
($ in millions)
1. Debt to total assets = Total debt ÷ Total assets
2000
1999
$5,075 ÷ $7,979 = 63.6%
$4,510 ÷ $7,105 = 63.4%
2. Interest coverage = EBIT ÷ Interest expense
2000
1999
($376 + $280 + $112) ÷ $112 = 6.9 times
($261 + $199 + $68) ÷ $68 = 7.8 times
3. Cash interest coverage = EBITDA ÷ Interest expense
2000
1999
(b)
($376 + $280 + $112 + $273) ÷ $112 = 9.3 times
($261 + $199 + $68 + $183) ÷ $68 = 10.5 times
Although Loblaw has a significant amount of debt, the company
appears to be generating sufficient income and cash to continue
to operate without any concerns as to solvency.
16-45
PROBLEM 16-1B
(a)
1.
2.
3.
July 01 Cash ($500,000 X 100%) ..........................
Bonds Payable ..................................
500,000
Dec. 31 Bond Interest Expense ............................
Bond Interest Payable
($500,000 X 12% X 6/12) ................
30,000
July 1 Cash ($500,000 X 104%) ..........................
Premium on Bonds Payable ............
Bonds Payable ..................................
520,000
Dec. 31 Bond Interest Expense ............................
Premium on Bonds Payable
($20,000 ÷ 10 X 6/12) ..............................
Bond Interest Payable
($500,000 X 12% X 6/12) ................
29,000
July 01 Cash ($500,000 X 98%) ............................
Discount on Bonds Payable ....................
Bonds Payable ..................................
490,000
10,000
Dec. 31 Bond Interest Expense ............................
Discount on Bonds Payable
($10,000 ÷ 10 X 6/12) ......................
Bond Interest Payable
($500,000 X 12% X 6/12) ................
30,500
16-46
500,000
30,000
20,000
500,000
1,000
30,000
500,000
500
30,000
PROBLEM 16-1B (Continued)
(b) 1. Par
EATSLEEPMUSIC.COM INC.
Balance Sheet (Partial)
December 31, 2003
Current liabilities
Bond interest payable ....................................................
$ 30,000
Long-term liabilities
Bonds payable, due 2013 ..............................................
500,000
2. Premium
EATSLEEPMUSIC.COM INC.
Balance Sheet (Partial)
December 31, 2003
Current liabilities
Bond interest payable ....................................................
Long-term liabilities
Bonds payable, due 2013 .........................
Add: Premium on bonds payable............
$ 30,000
$500,000
0 19,000
519,000
Current liabilities
Bond interest payable ....................................................
$ 30,000
3. Discount
EATSLEEPMUSIC.COM INC.
Balance Sheet (Partial)
December 31, 2003
Long-term liabilities
Bonds payable, due 2013 .........................
Less: Discount on bonds payable ..........
16-47
$500,000
0 ,09,500
490,500
PROBLEM 16-2B
(a)
2003
April 01
Cash (98% X $3,000,000) ..............
Discount on Bonds Payable ........
Bonds Payable .....................
2,940,000
60,000
3,000,000
(b) See following page.
(c)
2003
1. Oct.0 1
2. Dec. 31
2004
3. April0 1
Bond Interest Expense .................
Discount on Bonds Payable
Cash .....................................
Bond Interest Expense
($136,500 X 3/6) ..........................
Discount on Bonds Payable
($1,500 X 3/6).....................
Bond Interest Payable
($135,000 X 3/6) .................
Bond Interest Payable ..................
Bond Interest Expense
($136,500 X 3/6) ..........................
Discount on Bonds Payable
($1,500 X 3/6).....................
Cash .....................................
16-48
136,500
1,500
135,000
68,250
750
67,500
67,500
68,250
750
135,000
PROBLEM 16-2B (Continued
16-49
PROBLEM 16-2B (Continued
(b)
Semi-annual
Interest
Period
Apr. 1, 2003
Oct. 31, 2003
Apr. 1, 2004
(A)
Interest
Payment
($3,000,000 X
9% X 6/12)
$135,000
0135,000
(C)
Discount
(D)
Amortization Unamortized
($60,000  20
Discount
X 6/12)
(D) – (C)
(B)
Interest
Expense
(A) – (C)
$136,500
0136,500
$1,500
01,500
$60,000
058,500
057,000
(d)
KYBERPASS CORP.
Balance Sheet (Partial)
December 31, 2003
Current liabilities
Bond interest payable ...................................................... $ 67,500
Long-term liabilities
Bonds payable, due 2023 .......................... $3,000,000
Less: Discount on bonds payable ...........
57,750* 2,942,250
* $60,000 - $1,500 - $750 = $57,750
16-50
(E)
Bond
Carrying Value
[$3,000,000 (D)]
$2,940,000
02,941,500
02,943,000
PROBLEM 16-3B
(a)
(b)
2002
July 01 Cash .......................................................
Premium on Bonds Payable .........
Bonds Payable ...............................
1,686,934
186,934
1,500,000
CLIO CORPORATION
Bond Premium Amortization
Effective Interest Method—Semi-annual Interest Payments
12% Bonds Issued at 10%
Semiannual
Interest
Period
July 1, 2002
Jan. 1, 2003
July 1, 2003
Jan. 1, 2004
(A)
(B)
Interest Interest
Payment Expense
$90,000
090,000
090,000
$84,347
084,064
083,767
(C)
Premium
Amortization
(A) – (B)
$5,653
05,936
06,233
(D)
(E)
UnamorBond
tized
Carrying
Premium
Value
(D) – (C) ($1,500,000 + D)
$186,934
0181,281
0175,345
0169,112
(c) 2002
Dec. 31 Bond Interest Expense
($1,686,394 X 10% X 6/12) ..................
Premium on Bonds Payable .................
Bond Interest Payable
($1,500,000 X 12% X 6/12) ..........
(d) 2003
July 01 Bond Interest Expense
[($1,686,934 - $5,653) X 10% X 6/12] .
Premium on Bonds Payable .................
Cash ...............................................
16-51
$1,686,934
01,681,281
01,675,345
01,669,112
84,347
5,653
90,000
84,064
5,936
90,000
PROBLEM 16-3B (Continued)
(e) 2003
Dec. 31 Bond Interest Expense
[($1,681,281 - $5,936) X 10% X 6/12] .
Premium on Bonds Payable .................
Bond Interest Payable ...................
16-52
83,767
6,233
90,000
PROBLEM 16-4B
(a) Bond Interest Payable = $1,500,000 X 6% X 2/12 = $15,000
(b) Sept. 01 Cash [($1,500,000 X 102%) + $15,000)] ... 1,545,000
Premium on Bonds...........................
Bonds Payable ..................................
Bond Interest Payable
($1,500,000 X 6% X 2/12) ..............
(c) Jan. 1
Bond Interest Expense ............................
Premium on Bonds Payable
($30,000 X 4/118 months)......................
Bond Interest Payable .............................
Cash ($1,500,000 x 6% X 6/12) .........
16-53
30,000
1,500,000
15,000
28,983
1,017
15,000
45,000
PROBLEM 16-5B
(a)
1.
2.
3.
4.
2003
July 0 1 Cash ...............................................
Discount on Bonds Payable .........
Bonds Payable .......................
Dec. 31 Bond Interest Expense
($1,947,651 X 6%) .......................
Discount on Bonds Payable .
Bond Interest Payable
($2,200,000 X 5%) .................
2004
July 0 1 Bond Interest Expense
[($1,947,651 + $6,859) X 6%] .......
Discount on Bonds Payable .
Cash........................................
Dec. 31 Bond Interest Expense
[($1,954,510 + $7,271) X 6%] ......
Discount on Bonds Payable .
Bond Interest Payable ...........
1,947,651
252,349
2,200,000
116,859
6,859
110,000
117,271
7,271
110,000
117,706
7,706
110,000
(b)
WAUBONSEE COMPANY LTD.
Balance Sheet (Partial)
December 31, 2004
Long-term liabilities
Bonds payable.........................................
Less: Discount on bonds payable ........
$2,200,000
230,513*
* $252,349 – $6,859 – $7,271 – $7,706 = $230,513
16-54
$1,969,487
PROBLEM 16-5B (Continued)
(c)
Dear Waubonsee Company Ltd.
In regards to your questions, interest expense for 2004 under the effective
interest method is $234,977 ($117,271 + $117,706).
The effective-interest method will result in less interest expense reported
than the straight-line method in 2004 when the bonds are sold at a
discount. Straight-line interest expense for 2004 is $245,234 ($110,000 +
$12,617 = $122,617 X 2), compared to $234,977 ($117,271 + $117,706) under
the effective-interest method.
The total cost of borrowing over the life of the bonds will equal the total of
all the interest payments plus the discount on the bonds:
Semi-annual interest payments
($2,200,000 X 10% X 10) ........................................
Add: Bond discount ..............................................
Total cost of borrowing...........................................
$2,200,000
00,252,349
$2,452,349
Interest expense will be exactly the same regardless of the method of
amortization used. The choice of amortization methods will determine the
amount of the discount to be amortized each period. While the different
methods will cause the amortization to be different in each period, the
overall amount of amortization will be the same—it will always equal the
amount of the discount.
The advantage of the effective rate method is that it uses a constant rate of
interest. The effective-interest method results in a varying amount of
interest expense but a constant rate of interest on the balance outstanding.
Accordingly, it results in a better matching of expenses with revenues than
the straight-line method. However, the straight-line method is simpler and
easier to apply.
16-55
PROBLEM 16-6B
(a)
$90,000 X 2
 6%
$3,000,000
(b) July
1 Bond Interest Expense .........................
Premium on Bonds Payable
($200,000 ÷ 5 X 6/12) ..........................
Cash ($3,000,000 X 3%) .........
70,000
20,000
90,000
(c) Percentage of bonds redeemed = $1,200,000 ÷ $3,000,000 = 40%
July 01 Bonds Payable ........................................ 1,200,000
Premium on Bonds Payable
[($200,000 – $20,000) X 40%] ...............
72,000
Gain on Bond Redemption .............
Cash ($1,200,000 X 99%) .................
(d) Dec. 31 Bond Interest Expense ...........................
Premium on Bonds Payable ...................
Bond Interest Payable
($1,800,000 X 3%) .........................
84,000
1,188,000
42,000
12,000**
54,000
**$200,000 – $20,000 – $72,000 = $108,000; $108,000  9 periods =
$12,000
16-56
PROBLEM 16-7B
(a)
Semi-annual
Interest Period
Dec. 31, 2003
June 30, 2004
Dec. 31, 2004
June 30, 2005
Dec. 31, 2005
Cash
Payment
$44,000
042,800
041,600
040,400
Interest
Expense
Reduction of
Principal
$24,000
022,800
021,600
020,400
$400,000
0380,000
0360,000
0340,000
0320,000
$20,000
20,000
20,000
20,000
(b) 2003
Dec. 31 Cash ...........................................................
Mortgage Note Payable .....................
400,000
2004
June 30 Interest Expense .......................................
Mortgage Note Payable ............................
Cash ...................................................
24,000
20,000
Dec. 31 Interest Expense .......................................
Mortgage Note Payable ............................
Cash ...................................................
Principal
Balance
400,000
44,000
22,800
20,000
42,800
(c)
ELITE ELECTRONICS
Balance Sheet (Partial)
December 31, 2004
Current liabilities
Current portion of mortgage note payable .....
Long-term liabilities
Mortgage notes payable ..................................
$ 40,000
320,000*
* $360,000 - $40,000 = $320,000 or see Dec. 31, 2005 balance
16-57
PROBLEM 16-8B
(a) Choi Inc. should record the SameDay Delivery lease as a capital lease
because (1) the lease term is greater than 75% of the estimated
economic life of the leased property and (2) the present value of the
lease payments is 90% or more of the fair market value of the
computer. It should be noted that only one condition need be met to
require capitalization.
Both the Duncan Co. and Riverview Auto leases should be reported as
operating leases, because none of the conditions is met to require
treatment as a capital lease.
(b) The SameDay Delivery lease is a capital lease. The entry to record the
capital lease on January 1, 2003 therefore is as follows:
Leased Asset—Computer ............................................
Lease Liability .......................................................
31,000
31,000
The Duncan Co. lease is an operating lease. The entry to record the
lease payment in 2003 therefore is as follows:
Rent Expense ................................................................
Cash .......................................................................
4,200
4,200
This entry would be made on the date the rental payment is due.
The Riverview Auto lease is an operating lease. The entry to record the
lease payment in 2003 therefore is as follows:
Rent Expense ................................................................
Cash .......................................................................
3,700
This entry would be made on the date the rental payment is due.
16-58
3,700
PROBLEM 16-8B (Continued)
(c)
Since the Duncan Co. lease and Riverview Auto lease do not qualify
as a capital leases, nothing would appear on Choi’s balance sheet
regarding either the delivery equipment or the automobile. As well, no
amount payable under the terms of the lease arrangement will appear
on Choi’s balance sheet. The annual rental fees would simply be
charged to expense when they are paid each year.
The SameDay Delivery lease is a capital lease. Therefore, the
computer would be recorded as an asset on Choi’s balance sheet. A
corresponding liability for leased assets would also be recorded.
16-59
PROBLEM 16-9B
(a)
($ in thousands)
1. Debt to total assets = Total debt ÷ Total assets
2000
1999
$2,073,335 ÷ $2,890,999 = 71.7%
$2,128,828 ÷ $2,878,817 = 73.9%
2. Interest coverage = EBIT ÷ Interest expense
2000
1999
($80,246 + $77,541 + $88,875) ÷ $88,875 = 2.8 times
[($8,074) + ($10,197) + $46,301] ÷ $46,301 = 0.6 times
3. Cash interest coverage = EBITDA ÷ Interest expense
(b)
2000
$80,246+$77,541+$88,875+$98,055
 3.9 times
$88,875
1999
($8,074)+($10,197)+$46,301+$72,415
 2.2 times
$46,301
Sears is financing over 70% of their assets with debt instead of
equity. This is very high. Their solvency has improved over the
past year because they had net income in the current year versus a
loss last year.
16-60
BYP 16-1 FINANCIAL REPORTING PROBLEM
(a) Long-term debt as at June 24, 2000 is $10,250,000. This is a
decrease of $9,050,000 from the 1999 proforma numbers.
(b) Second Cup’s current portion of long-term debt is $3,000,000.
(c) The long-term debt consists of a non-revolving term facility secured
by the Company’s investment in Diedrich Coffee, Inc.
(d) The company has no capital leases but does have commitment
under operating leases. Per Note 12 to the 2000 financial
statements, these commitments total $3,761,000.
16-61
BYP 16-2 INTREPRETING FINANCIAL STATEMENTS
(a)
($ in
thousands)
Reitmans
La Senza
Debt to assets Total debt ÷ Total assets
$59,728
 23.5%
$253,849
Interest
coverage
Cash interest
coverage
$108,588
 48.8%
$222,590
EBIT ÷ Interest expense
$51,707+$20,159+$608
$608
 119.2 times
$6,070+$4,855+$486
$486
 23.5 times
EBITDA ÷ Interest expense
EBITDA ÷ Interest expense
$51,707+$20,159+$608+$12,371 $6,070+$4,855+$486+$15,284
$608
$486
 139.5 times
 54.9 times
Reitmans has much less debt in relation to its assets than does La
Senza. Accordingly, it has much less interest on a percentage basis.
This makes Reitmans more comfortable with regards to the ability to
remain solvent. However, even though La Senza carries more debt, it
appears to be more than able to meet its interest requirements.
Therefore, any additional returns accrue to the shareholders. Using
debt to finance assets can be a benefit to the existing shareholders so
long as the company can afford to pay its interest and principal
payments which it appears is the case with both Reitmans and La
Senza.
(b) If the company has obligations under lease, this reduces the cash
available to repay interest and principal payments on their debt. The
company is therefore at a greater risk of becoming insolvent.
16-62
BYP 16-3 INTREPRETING FINANCIAL STATEMENTS
(a) Coupon is the contractual rate; yield is the market (effective) rate.
(b) The coupon rates have the widest range. They are set by the issuers of
the bonds. The effective rates, on the other hand, are set by market
forces.
(c) The yield rate gets higher as the term to maturity gets longer. This is
logical because it requires more incentive to lend money for the longer
term, since there is greater risk.
(d) Government of Canada bonds have the lowest yield rates because they
involve the least risk.
(e) Most of the bonds listed are selling at a premium, because interest
rates moved to lower levels after they were issued.
16-63
BYP 16-4 ACCOUNTING 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 on-line in the Instructor Resources section of our home page
[www.wiley.com/canada/weygandt2].
16-64
BYP 16-5 ACCOUNTING 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 on-line in the Instructor Resources section of our home page
[www.wiley.com/canada/weygandt2].
16-65
BYP 16-6 COLLABORATIVE LEARNING ACTIVITY
(a)
Discount calculation
= $1,200,000 – ($1,200,000 X 97%)
= $36,000
Amortization $36,000 ÷ 10
= $3,600 per period
Unamortized discount
= $36,000 – $14,400 ($3,600 X 4 periods)
= $21,600
Carrying value of bonds = $1,200,000 – $21,600 = $1,178,400
(b)
Jan. 1
1
Bonds Payable .............................. 1,200,000
Discount on Bonds Payable ...........
Cash ........................................
Gain on Retirement of Bonds
21,600
1,000,000
178,400
Cash ................................................
Bonds Payable .......................
1,000,000
16-66
1,000,000
BYP 16-6 (Continued)
(c)
MEMO
To:
From:
Date:
Re:
Barbara Landry
Student
Bond Retirement
In considering your repurchase proposal there are several
economic factors you should consider.
1.
You should consider what will happen with interest rates in
the future. If interest rates are expected to fall further over the
next several months you may want to consider delaying the
refinancing.
2.
You need to consider the cost of refinancing. There will be
significant costs associated with the refinancing such as the
issue costs related to the new bonds. You will need to ensure
that the cost savings from the refinancing are sufficient to
cover these additional costs.
16-67
BYP 16-7 COMMUNICATION ACTIVITY
To:
Finn Berge
From:
I. M. Student
Subject:
Bond Financing
The advantages of bond financing over common share financing include:
1.
2.
3.
4.
Shareholder control is not affected.
Income tax savings result.
Income to common shareholders may increase.
Earnings per share may be higher.
The types of bonds that may be issued include:
1.
2.
3.
4.
5.
6.
Secured or unsecured bonds.
Term or serial bonds. Term bonds mature at a single specified date,
while serial bonds mature in instalments.
Registered or bearer bonds. Registered bonds are issued in the name
of the owner, while bearer bonds are not.
Convertible bonds, which can be converted by the bondholder into
common shares.
Redeemable or callable bonds, which are subject to early retirement by
the issuer at a stated amount.
Retractable bonds, which can be redeemed prior to maturity at a stated
amount, at the option of the bondholder.
Provincial laws grant corporations the power to issue bonds after formal
approval by the board of directors and shareholders. The terms of the bond
issue are set forth in a legal document called a bond indenture. After the
bond indenture is prepared, bond certificates are printed. Bonds which are
to be sold to the public (rather than through a private placement) usually
require the approval of a securities commission.
16-68
BYP 16-8 ETHICS CASE
(a) The stakeholders in the Custom case are:
Andy Vicks: president, founder, and majority shareholder.
Jill Caterino, minority shareholder.
Other minority shareholders.
Existing creditors (debt holders).
Future bondholders.
Employees, suppliers, and customers.
(b) The ethical issues:
The desires of the majority shareholder (Andy Vicks) versus the
desires of the minority shareholders (Jill Caterino and others).
Doing what is right for the company and others versus doing what
is best for oneself.
Questions:
Is what Andy wants to do legal? Is it unethical? Is Andy's action
brash and irresponsible? Who may benefit/suffer if Andy arranges
a high-risk bond issue? Who may benefit/suffer if Jill Caterino
gains control of Custom?
Note that Andy may genuinely believe that his retaining control of
the company is in the best interests of others—such as
employees—as well as serving his interests.
(c) The rationale provided by the student will be more important than the
specific position, because this is a borderline case with no right
answer.
16-69