Exercise 3
Assignment 1
On 1 January 1999 Kiertzner’s Karaoke Company Ltd. obtained an annuity loan with a face amount
of DKK 500,000 with an annual nominal rate of interest of 6 per cent. The company received a loan
proceed of DKK 486,685. The annual instalment (interest and repayment) to be paid to the lender
on December 31 every year during the 5-year term (the first time being December 30, 1999)
amounts to DKK 118,698. The company wishes to apply the effective interest method in the
financial statements. The company calculated the effective interest rate to be 7 per cent per annum
(and there is no need to check this!)
How are the interest expenses on the loan in 1999 in the income statement?
What is the debt December 31 1999 (after payment has been made on the loan)?
Assignment 2
On January 1st 1999 the modelling agency “3S ltd.” (Stylish Slim Scandinavians) borrows DKK 1
million from the mortgage bank Kreditforeningen Danmark. The loan carries an annual interest of 5
per cent (i.e. the coupon/the nominal rate of interest). The loan has a 30-year maturity. Interests are
compounded annually on 31st December. It is an annuity loan with an annual payment of DKK
65,051.00, which becomes due and are paid 31st December – the first time 31st December 1999. On
1st January 1999 the proceeds are DKK 895.422. The effective rate of interest is 6 per cent.
2.1
Over the 30-year maturity, how much will totally be charged to the income statement (profit and
loss account) for amortisation of discount on the loan using the following methods?
(a) That amortized cost price method by which the nominal interest rate method is combined with a
separate deduction for the discount on loan – a deduction which is regulated by a the linear
depreciation of the original discount on the loan over the lifetime of loan
(b) The effective interest method
2.2.
Assume the financial statements of 3S ltd follow the calendar year. State the amount with which the
loan will influence the Income Statement (the profit and loss account) for 1999 if the company
uses the following methods:
(a) That amortized cost price method by which the nominal interest rate method is combined with a
separately calculated deduction for the discount on the loan (and this deduction is amortized by a
the linear depreciation of the original discount on the loan over the lifetime of loan)
(c) The effective interest method
2.3
(a) State for the balance sheet on 31st December 1999 the amounts that 3S ltd. must report as
short-term and long-term debt respectively by using.
 The effective interest method
 That amortized cost price method by which the nominal interest rate method is
combined with a separately calculated deduction for the discount on the loan (and this
deduction is amortized by a the linear depreciation of the original discount on the loan
over the lifetime of loan)
State also the short-term and long-term part of the debt on 31st December 1999 by use of
 the effective interest method
Assignment 3
(Recommended time to spend on your answer: 30 minutes (only intended as a guide))
As of July 1, a company obtained a 5-year loan with a principal sum (i.e. nominal value) of DKK 1
million. The loan has semi-annual payments, the nominal rate of interest is 3 per cent semi-annually
and the payments are stated in the outline of the loan payments below. Since the effective interest
rate on the loan was 4 per cent semi-annually at the point when the loan was obtained the proceeds
of the loan (i.e. the loan amount paid out) were DKK 935,831,72. (You need not check the
correctness of the amount at this interest rate!).
Assume that the company applies the effective interest method in its annual accounts, and state the
company’s
a) Total debts outstanding on the loan
if the company ends its accounting year on
1. December 31 year 1 (right after having made the first payment)
2. March 31 year 2
b) The short-term part of debts outstanding on the loan if the company ends its
accounting year on
1. December 31 year 1.
2. March 31 year 2
Outline of the loan payments
Date
1.7 year 1
31.12 year 1
30.6 year 2
31.12 year 2
30.6 year 3
31.12 year 3
30.6 year 4
31.12 year 4
30.6 year 5
31.12 year 5
30.6 year 6
Repayments of debts Interest expenses
50,000
50,000
50,000
50,000
50,000
50,000
50,000
50,000
50,000
550,000
30,000
28,500
27,000
25,500
24,000
22,500
21,000
19,500
18,000
16,500
Total payments
80,000
78,500
77,000
75,500
74,000
72,500
71,000
69,500
68,000
566,500
Loan balance
1,000,000
950,000
900,000
850,000
800,000
750,000
700,000
650,000
600,000
550,000
0
Assignment 4 (Recommended time to spend on your answer: 35 minutes (only intended as a guide))
A company has entered into a financial leasing contract which gives the company right of use to a
machine. The company wants to recognize the right of use as an asset and to recognize the payment
obligations in accordance with leasing conditions as a liability applying the effective interest rate
method. The company acquires the right of use over the machine on January 1st year one and pays
the first leasing instalment of DKK 200,000 on the same day. All subsequent 9 leasing payments are
identical, DKK 96,043.56, and they are paid on January 1st the following years. On the basis of an
annual interest rate of 8 per cent, the present value of these subsequent payments is calculated at
DKK 600,000 on January 1st year one. The company wants to depreciate the machines applying the
straight-line method during the term of the contract, which is 10 years.
Question 1
State
a. The amount at which the leased asset should be recorded in the balance sheet of the annual
accounts on December 31st year one.
b. The amount at which the remaining debts of the leasing contract should be recorded in the
balance sheet of the annual accounts on December 31st year one.
c. The amount of total costs (before taxes), which is the result of the leasing contract of the annual
accounts for year one.
Question 2
If instead the company had considered the contract an operational leasing contract, the contract
terms would probably have given the company some problems with a proper allocation of the
leasing costs over the contract period.
What are the problems and how can they be solved?