Chapter 11 WWW Cases
Case 11-11 Bond Balance Sheet Presentations, Interest Rate and Premium
On January 1, 2014, Weiss Company issued for $1,085,800 its 20-year, 11% bonds that
have a maturity value of $1,000,000 and pay interest semiannually on January 1 and July
1. Bond issue costs were not material in amount. Below are three presentations of the
long–term liability section of the balance sheet that might be used for these bonds at the
issue date.
1. Bonds payable (maturing January 1, 2034)
$1,000,000
Unamortized premium on bonds payable
85,800
Total bond liability
$1,085,800
2. Bonds payable—principal (Discounted face value $1,000,000)
142,050
Bonds payable—interest (Discounted semiannual payment $55,000)
943,750
Total bond liability
$1,085,800
3. Bonds payable—principal (maturing January 1, 2034)
$1,000,000
Bonds payable—interest ($55,000 per period for 40 periods)
2,200,000
Total bond liability
$3,200,000
Required:
a. Discuss the conceptual merit(s) of each of the date–of–issue balance sheet
presentations shown above for these bonds.
b. Explain why investors would pay $1,085,800 for bonds that have a maturity value of
only $1,000,000.
c. Assuming that a discount rate is needed to compute the carrying value of the
obligations arising from a bond issue at any date during the life of the bonds, discuss
the conceptual merit(s) of using for this purpose:
1. The coupon or nominal rate.
2. The effective or yield rate at date of issue.
d. If the obligations arising from these bonds are to be carried at their present value
computed by means of the current market rate of interest, how would the bond
valuation at dates subsequent to the date of issue be affected by an increase or a
decrease in the market rate of interest?
Case 11-12 Bond Prices, Disclosure, and Retirement
On March 1, 2014, Morgan Company sold its 5-year, $1,000 face value, 9% bonds dated
March 1, 2014, at an effective annual interest rate (yield) of 11%. Interest is payable
semiannually, and the first interest payment date is September 1, 2014. Morgan uses the
effective-interest method of amortization. Bond issue costs were incurred in preparing
and selling the bond issue. The bonds can be called by Morgan at 101 at any time on or
after March 1, 2015.
Required:
a. 1. How would the selling price of the bond be determined?
2. Specify how all items related to the bonds would be presented in a balance
sheet prepared immediately after the bond issue was sold.
b. What items related to the bond issue would be included in Morgan's 2014 income
statement, and how would each be determined?
c. Would the amount of bond discount amortization using the effective-interest
method of amortization be lower in the second or third year of the life of the bond
issue? Why?
d. Assuming that the bonds were called in and retired on March 1, 2015, how
should Morgan report the retirement of the bonds on the 2015 income statement?
Case 11-13 Bond Amortization and Gain or Loss Recognition
Part I.
The appropriate method of amortizing a premium or discount on issuance of bonds is the
effective–interest method.
Required:
a. What is the effective-interest method of amortization and how is it different from and
similar to the straight–line method of amortization?
b. How is amortization computed using the effective–interest method, and why and how
do amounts obtained using the differ from amounts computed under the straight-line
method?
Part II.
Gains or losses from the early extinguishment of debt that is refunded can theoretically be
accounted for in three ways:
1. Amortized over remaining life of old debt.
2. Amortized over the life of the new debt issue.
3. Recognized in the period of extinguishment.
Required:
a. Discuss the arguments for each of the three theoretical methods of accounting for
gains and losses from the early extinguishment of debt.
b. Which of the methods above is generally accepted and how should the appropriate
amount of gain or loss be shown in a company's financial statements
Case 11-14 Financial Analysis
Log onto the World Wide Web and search for the annual reports of three domestic
Fortune 1000 companies and three international companies. (Consult the Preface for
websites of companies or search for different companies.)
Required:
a. For the domestic companies answer the following questions for the last reporting
year:
i. What is the amount of long-term debt disclosed by each of the companies?
ii. Do any of the companies’ debt instruments contain conversion provisions?
iii. Do any of the companies disclose short-term obligations expected to be
refinanced?
iv. Do any of the companies disclose contingent liabilities? If so, have any been
reported as current expenses?
v. Have any of the companies engaged in derivative transactions? If so, what
types?
b. For the international companies answer the following questions for the last
reporting year:
i. Are the companies disclosing the information about their financial liabilities
that is required under the provisions of IAS No. 32?
ii. What is the amount of long-term debt disclosed by each of the companies?
iii. Do any of the company's debt instruments contain conversion provisions?
iv. Do any of the companies disclose contingent liabilities? If so, have any been
reported as current expenses?
v. Have any of the companies engaged in derivative transactions? If so, what
types?.
Financial Analysis Case
Evaluate the use of debt.
Required:
a. Calculate the following ratios:
i. Long-term debt-to-assets ratio
ii. Interest coverage ratio
iii. Debt service coverage ratio
b. Calculate the same ratios for your competitor companies and comment on your
company’s relative solvency and use of leverage
c. Review Item 7a in your company’s and its two competitors’ 10-K reports and
summarize the companies’ disclosure of information on market risk.
d. Comment on your company’s comparative use of derivatives.