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.