DMP3e CH09 Solutions 05.17.10 Revised

Chapter 9
Reporting and Analyzing Liabilities

Learning Objectives coverage by question
Miniexercises LO1 Identify and account for current operating liabilities. LO2 Describe and account for current nonoperating (financial) liabilities. LO3 Explain and illustrate the pricing of long-term nonoperating liabilities. LO4 Analyze and account for financial statement effects of longterm nonoperating liabilities. LO5 Explain how solvency ratios and debt ratings are determined and how they impact the cost of debt. 18, 22, 30 Exercises 36, 37, 38, 49 Problems Cases 61
18
49 40, 43, 44, 45, 46, 47, 48, 50 39, 42, 43, 44, 45, 47, 48, 49, 50 51, 52, 53, 54, 55, 56, 57, 58, 59, 60 51, 52, 53, 54, 55, 56, 57, 58
61
19, 28, 29, 31, 34, 35 17, 20, 21, 23, 24, 25, 26, 31, 33, 34
62, 63
61, 62, 63
20, 27, 32
41
51
62, 63
Cambridge Business Publishers, 2011 Solutions Manual, Chapter 9 9-1
QUESTIONS
Q9-1. Current liabilities are obligations that require payment within the coming year or operating cycle, whichever is longer. Generally, current liabilities are normally settled with use of existing current assets or operating cash flows. Q9-2. An accrual is the recognition of an event in the financial statements even though no actual transaction has occurred. Accruals can involve both liabilities (and expenses) and assets (and revenues). Accruals are vital to the fair presentation of the financial condition of a company as they impact both the recognition of revenue and the matching of expense. Q9-3. The coupon rate is the rate specified on the face of the bond. It is used to compute the amount of cash interest paid to the bond holder. The market rate is the rate of return expected by investors that purchase the bonds. The market rate determines the market price of the bond. It incorporates expectations about the relative riskiness of the borrower and the rate of inflation. In general, there is an inverse relation between the bonds market rate and the bonds market price. Bonds sold at face (par) value earn an effective interest rate equal to the bonds coupon rate. Bonds are sold at a discount when the effective interest rate is higher than the coupon rate. Bonds are sold at a premium when the effective interest rate is lower than the coupon rate. Bonds are reported at historical cost, that is, the face amount plus (minus) unamortized premium (discount). The market price of the bonds varies inversely with the level of interest rates and fluctuates continuously. Differences between the market price of a bond and its carrying amount represent unrealized gains and losses. These unrealized gains (losses) are not reflected in the financial statements (although they are disclosed in the footnotes). They must be recognized upon repurchase of the bonds, the point at which they become realized. If the bonds are refunded (that is, replaced with new bonds reflecting current market values and interest rates), the gain (or loss) that is recognized in the current period will be offset by correspondingly higher (lower) interest payments in the future. The present value of the future interest payments, along with the present value of the difference between the face amount of the new bond and the former face amount, exactly offset the reported gain (loss).
Q9-4.
Q9-5.
Cambridge Business Publishers, 2011 9-2 Financial Accounting, 3rd Edition
Q9-6.
Debt ratings reflect the relative riskiness of the borrowing company. This riskiness relates to the probability of default (e.g., not repaying the principal and interest when due). Higher (greater quality) debt ratings result in higher market prices for the bonds and a correspondingly lower effective interest rate for the issuer. Lower (lesser quality) debt ratings result in lower market prices for the bonds and a correspondingly higher effective interest rate for the issuer. Reported gains or losses on bond redemption result from changes in the market price of the bonds and the use of historical cost accounting. Because bonds are typically reported at historical cost, fluctuations in bond prices are not recognized until they are realized when the bonds are redeemed or refunded. If the bonds are refunded (new bonds are issued), the gain or loss is offset by the present value of lower (higher) future interest payments on the new bond issue. (a) Term loan a loan that matures on a single, pre-specified date (b) Bonds payable the liability account used to record the face value of bonds issued by a company (c) Serial bonds bonds that mature in installments rather than on one date (d) Call provision the right for the bond issuer to repurchase the debt, before it matures, at a predetermined price. (e) Convertible bonds bonds that can be converted into some other asset (typically common stock) at the option of the bondholder (f) Face value the predetermined amount (typically $1,000) that must be repaid when a bond matures (g) Nominal rate the rate specified on the face of the bond that determines the periodic interest (coupon) payment (h) Bond discount the difference between the face value of the bond and the market price when the price is lower than the face value; recorded as a contra-liability (i) Bond premium the difference between the market price of a bond and the face value when the market price is higher than the face value; recorded as an adjunct-liability (j) Amortization of premium or discount the periodic reduction of the balance in the premium or discount account recorded each time interest expense is accrued; equal to the difference between the accrued interest and the coupon payment (or payable)
Q9-7.
Q9-8.
Q9-9.
The advantages of issuing bonds are (1) the interest payments are limited to the predetermined amount specified on the bond; (2) the interest is tax deductible; (3) bondholders do not have a vote when it comes to electing directors and managing the company; (4) the additional financial leverage created when bonds are issued increases profits in good years. The disadvantages of bonds include (1) bonds must be repaid while common stock is issued with an indefinite life; (2) bondholders can impose restrictive covenants in the loan indenture; (3) the additional financial leverage created when bonds are issued decreases profits in lean years.
Q9-10. $3,000,000 x [.98 + (.09 x 3/12)] = $3,007,500 Q9-11. The contract rate (or stated rate or coupon rate) determines the periodic coupon payment. If this rate is not equal to the rate required by the market, the bond price is adjusted to the present value of the cash payments from the bond discounted at the applicable market rate of interest. If the market rate is higher than the coupon rate, then the periodic coupon payments are insufficient and the bond will be priced lower than the face value (a discount). If the market rate is lower than the coupon rate, then the periodic coupon payments will be higher than required by the market, and the bond will sell for a premium. Q9-12. When the bonds mature, the book value of the bonds will be equal to the face value. Over the life of the bonds, the change in the book value of the bonds will be equal to face value less the market value at the time that the bonds are issued. Q9-13. When the effective interest method is used to amortize a bond discount or premium, the effective rate is multiplied by the net balance in bonds payable (bonds payable plus/minus the premium or discount). If the bond is issued at a discount, the balance increases over the life of the bond; the interest expense will increase as the balance increases. If the bond is issued at a premium, the balance decreases over the life of the bond; the interest expense will decrease as the balance decreases. Q9-14. Bonds payable is presented in the balance sheet net of any discount or plus any premium. Q9-15. The loss is the difference between the retirement value and the book value of the bond: 101% x $200,000 $197,600 = $4,400. Q9-16. Each payment includes both interest on the outstanding balance and repayment of the principal. As each payment is made, the principal balance is reduced. As a consequence, the interest component of the payment is smaller each period.
MINI EXERCISES
M9-17 (10 minutes) a. b.
Interest Payable (L) + + Interest Expense (E) -
Interest expense (+E,-SE)... Interest payable (+L)...
24 24
24
a.
a.
24
c.
Balance Sheet
Transaction
Accrued $24 interest on note payable
Income Statement
Net Revenues - Expenses = Income +24 -24 - Interest =
Expense
Cash Asset
LiabilContrib. Earned + Noncash Assets = ities + Capital + capital +24 -24 = Interest Retained
Payable Earnings
M9-18 (15 minutes) a. Accounts Payable, $110,000 (current liability). b. Not recorded as a liability; an accountable transaction has not yet occurred. c. Estimated liability for product warranty, $2,200 (current liability). d. Bonuses Payable, $30,000 (current liability)computed as $600,000 5%. This liability must be reported since its payment is probable and can be estimated.
M9-19 (10 minutes) a. Boston Scientific is offering bonds with a coupon (stated) rate of 4.25% when the market rate (yield) is higher (4.349%). In order to obtain this expected rate of return, the bonds sell at a discount price of 99.476 (99.476% of par). b. The first bond matures in 2011 while the second matures in 2017. There is, generally, a higher rate (yield) expected for a longer maturity.
M9-20 (10 minutes) Amount paid to retire bonds ($200,000 x 101%)......................................... $202,000 Book value of retired bonds, net of $2,400 unamortized discount........... 197,600 Loss on bond retirement.............................................................................. $ 4,400
M9-21 (10 minutes) a. The $45 million indicates that BMY has bonds maturing that will require payment in the amount of $45 million in 2010. b. BMY will need to pay off the bonds when they mature. This will result in a cash outflow that must come from operating activities if the bonds cannot be refinanced prior to maturity. However, most of BMYs long-term debt matures more than 5 years after the financial statement date (December 31, 2008). Thus, BMYs near-term cash needs for covering long-term debt should not place a significant burden on the companys operations.
M9-22 (10 minutes)

a. Gain on Bond Retirement: In the other (nonoperating) revenues and expenses section unless it meets the tests for extraordinary treatment (e.g., unusual and infrequent) b. Discount on Bonds Payable: Deduction from Bonds Payable; thus, a (contra) long-term liability in the balance sheet (e.g., it is netted in the presentation of long-term liabilities). c. Mortgage Notes Payable: Long-term liability in the balance sheet. d. Bonds Payable: Long-term liability in the balance sheet. e. Bond Interest Expense: In other (nonoperating) revenues and expenses section of income statement. f. Bond Interest Payable: Current liability in the balance sheet. g. Premium on Bonds Payable: Addition to Bonds Payable; thus, part of a long-term liability in the balance sheet (e.g., it is included in the presentation of long-term liabilities). h. Loss on Bond Retirement: In the other (nonoperating) revenues and expenses section unless it meets the tests for extraordinary treatment (e.g., unusual and infrequent)
M9-23 (15 minutes)
a. Financial ratios used in bond covenants are typically designed to protect the
bond holders against actions by management that they feel would be detrimental to their interests. These might include restrictions against the impairment of liquidity, restrictions on the amount of financial leverage the company can employ, and restrictions on the payment of dividends. In addition, bond holders usually impose various covenants prohibiting the acquisition of other companies or the divestiture of business segments without their consent. All of these covenants, by design, restrict management in its actions.
b. Management, facing imminent default in one or more of its bond covenants,

may be pressured into taking actions in order to avoid such default. These may include, for example, operational actions, such as reduction of R&D or advertising in order to improve profitability, or leaning on the trade or reduction of receivables (via early payment incentives) and inventories (by marketing promotions or delaying restocking) in order to boost cash balances. Actions may also include fraudulent accounting measures, such as improper recognition of revenues or delayed recognition of expenses.
c. Restricted assets, such as cash or securities, should not be considered as

general assets in an analysis of the firms liquidity or solvency because they are not available to management for general corporate uses.
M9-24 (15 minutes) a. 1/1/2004 Cash (+A) ..... Bonds payable (+L) .. Bond premium (+L) ..
1/1/2009
432,000 400,000 32,000 400,000 27,809 412,000 15,809

Bonds Payable (L) 400,000 400,000 Bond Premium (L) 32,000 27,809 + 1/1/04 + 1/1/04
Bonds payable (-L) .... Bond premium (-L) .... Cash (-A) ..... Gain on retirement of bonds (+R, +SE)
Cash (A) 432,000 412,000 1/1/09 + 1/1/09 1/1/09 1/1/09
b.
+ 1/1/04 -
Gain on Retirement of Bonds (R) 15,809
c.
Balance Sheet
Transaction
1/1/04 Issue bonds at a premium.
Income Statement
Earned Capital Net Revenues - Expenses = Income
Cash Noncash Liabil- + Contrib. + Asset + Assets = ities Capital 432,000 +400,000
Cash Bonds Payable
+32,000
Bonds Payable, net
1/1/09 Retired bonds issued on 1/1/04.
-412,000
Cash
-400,000
Bonds Payable
+15,809
Retained Earnings
+15,809
Gain on Retirement of Bonds
+15,809
-27,809
Bonds Payable, net
M9-25 (15 minutes) a. 7/1/2003 Cash (+A) . Bond discount (+XL, -L) ... Bonds payable (+L) ..
7/1/2009
240,000 10,000 250,000 250,000 9,314 6,814 252,500 Bonds Payable (L) 250,000 250,000 Bond Discount (XL) 10,000 6,814 + 7/1/03 7/1/09
Bonds payable (-L) Loss on retirement of bonds (+E, -SE) Bond discount (-XL, +L) . Cash (-A) . + Cash (A) 240,000 252,500 7/1/09 7/1/09 + 7/1/03
b. 7/1/03
+ Loss on Retirement of Bonds (E) 7/1/09 9,314
c.
Balance Sheet
Transaction
7/1/03 Issue bonds at a discount
Income Statement
Cash Noncash Liabil- + Contrib. + Asset + Assets = ities Capital +240,000 +250,000
Cash Bonds Payable
-10,000
Bonds Payable, net
7/1/09 Retired bonds issued on 7/1/03
-252,500
Cash
-250,000
Bonds Payable
-9,314
Retained Earnings
+9,314
-9,314 =
+6,814
Bonds Payable, net
Loss on retirement of Bonds
M9-26 (10 minutes) Nissim: Klein: Bildersee: $18,000 0.10 40/365 $14,000 0.09 18/365 $16,000 0.12 12/365 = = = $197.26 62.14 63.12 $322.52
M9-27 (10 minutes) a. The Debt-to-Equity ratio (D/E) will likely change, but the direction and amount is difficult to determine from the information given. The increase in outstanding debt by $773.2 million ($946.6+$1,450.0-$1,623.4) along with the net share repurchases of $1,336 million ($2,425.9-$1,089.4) and dividend payments of $529.7 million will increase D/E. (The effect of the share repurchases on reported equity is not provided the $2,425.9 million is the market value of the repurchased shares.) Times interest earned will decrease as additional interest cost on new borrowing is added to the denominator. How much of an effect this will have depends on the size of the change in net income. b. Generally, the higher (lower) the firm's solvency measures, the higher (lower) the firm's debt rating. In financial leverage terms, the higher (lower) the firm's leverage the lower (higher) the firm's debt rating. Increasing the amount of debt while decreasing equity may harm General Mills debt ratings. M9-28 (15 minutes) a. Selling price of 9% bonds discounted at 8% Present value of principal repayment ($500,000 0.45639) ....................$228,195 Present value of interest payments ($22,500 13.59033) .................... 305,782 Selling price of bonds.................................................................................$533,977 b. Selling price of 9% bonds discounted at 10% Present value of principal repayment ($500,000 0.37689) ....................$188,445 Present value of interest payments ($22,500 12.46221) .................... 280,400 Selling price of bonds.................................................................................$468,845 M9-29 (15 minutes) a. Selling price of zero-coupon bonds discounted at 8%: Present value of principal repayment ($500,000 0.45639) $228,195 b. Selling price of zero coupon bonds discounted at 10%: Present value of principal repayment ($500,000 0.37689) $188,445 c. Based on the debt-to-equity ratio, financial leverage would increase from 2.0 [=($3 - $1)/$1] to 2.19 [=($3 - $1 + $0.188)/$1)
M9-30 (15 minutes) a. 1. Inventory (+A) . Accounts payable (+L) 2. 3. 4. 5. b. + 5. + Cash (A) 300 420 5. 3. + Accounts Receivable (A) 2. 420 420 + 1. Inventory (A) 300 300 4. 4. Accounts receivable (+A) Sales revenue (+R, +SE) .... Cost of goods sold (+E, -SE) . Inventory (-A) Accounts payable (-L) . Cash (-A) Cash (+A) Accounts receivable (-A)
300 300 420 420 300 300 300 300 420 300 Accounts Payable (L) 300 300 Sales Revenue (R) 420 + 2. + 1.
Cost of Goods Sold (E) 3. 300
c.
Balance Sheet
Transaction
1. Purchase inventory on account. 2. Sell inventory on credit. 3. Cost of sales from 2. 4. Paid cash for inventory purchased in 1. d. Receive cash on receivable from 2.
Income Statement
Earned Capital Net Revenues - Expenses = Income +420
Retained Earnings
Cash Asset
LiabilContrib. + Noncash Assets = ities + Capital + +300 +300 Inventory = Accounts

Payable
= = +300
Cost of Goods Sold
+420
Accts Rec
= = -300 = Accounts
Payable
+420
Sales
+420 -300
-300
Inventory
-300
Retained Earnings
= = =
-300
Cash
420
Cash
-420
Accts Rec
M9-31 (30 minutes) a. Data Inputs into Excel 1/1/2009 12/31/2018 9.00% 8.00% $100 2 1 Settlement date Maturity date Percent semiannual coupon Percent yield Redemption value Frequency is semiannual (see above) actual/actual basis Percent of Par 106.7951632 Sale Proceeds $533,975.82 Premium Amortization 1,140.97 1,186.61 1,234.07 1,283.43 1,334.77 1,388.16 1,443.69 1,501.44 1,561.49 1,623.95 1,688.91 1,756.47 1,826.73 1,899.79 1,975.79 2,054.82 2,137.01 2,222.49 2,311.39 2,403.85 Premium Balance 33,975.82 32,834.85 31,648.24 30,414.17 29,130.74 27,795.97 26,407.81 24,964.12 23,462.68 21,901.19 20,277.24 18,588.33 16,831.86 15,005.14 13,105.34 11,129.56 9,074.74 6,937.73 4,715.24 2,403.85 0.00 Carrying Amount 533,975.82 532,834.85 531,648.24 530,414.17 529,130.74 527,795.97 526,407.81 524,964.12 523,462.68 521,901.19 520,277.24 518,588.33 516,831.86 515,005.14 513,105.34 511,129.56 509,074.74 506,937.73 504,715.24 502,403.85 500,000.00
Price b. Period 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
Interest 21,359.03 21,313.39 21,265.93 21,216.57 21,165.23 21,111.84 21,056.31 20,998.56 20,938.51 20,876.05 20,811.09 20,743.53 20,673.27 20,600.21 20,524.21 20,445.18 20,362.99 20,277.51 20,188.61 20,096.15
Cash Paid 22,500.00 22,500.00 22,500.00 22,500.00 22,500.00 22,500.00 22,500.00 22,500.00 22,500.00 22,500.00 22,500.00 22,500.00 22,500.00 22,500.00 22,500.00 22,500.00 22,500.00 22,500.00 22,500.00 22,500.00
M9-32 (15 minutes) Verizons leverage as measured by its D/E ratio is higher than either Comcast or Sprint (Quest has negative equity). On the other hand, Verizon is in better shape than any of its competitors in terms of its ability to pay the interest on its debt as indicated by its greater TIE ratio. The comparison includes Sprint/Nextel which has a negative operating income.
M9-33 (15 minutes) a. b. c. d. e. f. g. Gain on bond retirement Discount on bonds payable Mortgage notes payable Bonds payable Bond interest expense Bond interest payable Premium on bonds payable Reported in the income statement under other (nonoperating) income Contra-liability netted against bonds payable under long-term liabilities in the balance sheet Long-term liability in the balance sheet; the amount due within one year would be reported as a current liability Long-term liability in the balance sheet; the amount due within one year would be reported as a current liability Nonoperating expense reported in the income statement A current liability in the balance sheet Adjunct-liability added to bonds payable under long-term liabilities in the balance sheet
M9-34 (15 minutes) a. 12/31/10 Cash (+A) ..... Mortgage note payable (+L) ..
6/30/11
700,000 700,000 42,000 8,854 50,854 41,469 9,385 50,854
Interest expense (+E, -SE) .. Mortgage note payable (-L) . Cash (-A) . Interest expense (+E, -SE) .. Mortgage note payable (-L) . Cash (-A) .
12/31/11
* $41,469 = ($700,000 $8,854) x 12%/2.
b. +
12/31/10
Cash (A) 700,000 50,854 50,854 Interest Expense (E) 42,000 41,469
6/30/11 12/31/11
Mortgage Note Payable (L) + 12/31/10 700,000 6/30/11 8,854 12/31/11 9,385
+
6/30/11 12/31/11
c.
Balance Sheet
Transaction
12/31/10 Borrow Cash $700,000 on a 15year mortgage note payable. 6/30/11 Interest -50,854 Cash payment on note. 12/31/11 Interest payment on note.
Income Statement
Cash Noncash Liabil- + Contrib. + Asset + Assets = ities Capital +700,000 +700,000 =
Mortgage Note Payable
-42,000
Retained Earnings
= +42,000 -42,000 = -41,469 =
-8,854 =
Interest Expense
-50,854
Cash
-9,385 =
-41,469
Retained Earnings
+41,469
Interest Expense
M9-35 (5 minutes) $900,000 x 0.55839 + (900,000 x 10%/2) x 7.36009 = $833,755. $833,755 / $900,000 = 92.6% of par value.
EXERCISES
E9-36 (15 minutes) a. Total expected failures from units sold (69,000 0.02)................ Average cost per failure................................................................. Total expected future warranty costs............................................ Current warranty liability................................................................ Additional warranty cost liability required.................................... 1,380 $50 $69,000 $10,000 $ 59,000
The product warranty liability must be increased by $59,000 to cover the expected repair costs, (because the warranty is for a 60-day period, the $10,000 remaining in the liability account represents unused amounts left from prior years accruals). Warranty expense of $59,000 must be recorded in the income statement when the liability account is increased. b. The warranty liability should be equal, at all times, to the expected dollar cost of repairs. Analysis issues relate to whether the warranty liability exists and, if so, is it at the correct amount. Understating (overstating) the accrual overstates (understates) current period income at the expense (benefit) of future income. c. The debt-to-equity ratio will increase and the operating cash flow to liabilities will decrease. The times-interest earned ratio will not be affected.
E9-37 (10 minutes) Item a. b. c. d. Accounting Treatment Neither record nor disclose (neither probable nor reasonably possible) Record a current liability for the note, no liability for interest until incurred Disclose in a footnote (at least reasonably possible) Record warranty liability on balance sheet and recognize expense in income statement (costs are probable and reasonably estimable).
E9-38 (15 minutes) The company must accrue the $25,000 of wages that have been earned by employees even though these wages will not be paid until the first of next month. The required accounting accrual will: increase wages payable by $25,000 on the balance sheet increase wages expense by $25,000 in the income statement
Failure to make this accounting accrual (called adjusting entry) would understate liabilities, understate expenses, overstate income, and overstate stockholders equity. M9-39 (15 minutes) a. Selling price of bonds: Present value of principal repayment ($300,000 0.30832).............$ 92,496 Present value of interest payments ($16,500 17.29203)................ 285,318 Selling price of bonds $377,814 b.
1/1/10
Cash (+A) .. Bond premium (+L) Bonds payable (+L) ... Interest expense (+E, -SE) Bond premium (-L) ..... Cash (-A) .. Interest expense (+E, -SE) Bond premium (-L) . Cash (-A) ..
377,814 77,814 300,000 15,113 1,387 16,500 15,057 1,443 16,500
6/30/10
12/31/10
* $15,057 = ($377,814 $1,387) x 8%/2.
c. +
1/1/10
6/30/10 12/31/10
Bonds Payable (L) 300,000
+
1/1/10
+
6/30/10 12/31/10
Bond Premium (L) 77,814 6/30/10 1,387 12/31/10 1,443
+
1/1/10
d.
Balance Sheet
Transaction
Income Statement
Cash Bonds Payable
+77,814
Bonds Payable, net
6/30/10 Interest -16,500 Cash payment on bonds. 12/31/10 Interest -16,500 Cash payment on bonds.
-1,387 =
Bonds Payable, net
-15,113
Retained Earnings
+15,113
-15,113 = -15,057 =
Interest Expense
-1,443 =
Bonds Payable, net
-15,057
Retained Earnings
+15,057
Interest Expense
E9-40 (10 minutes) Selling price of bonds Present value of principal repayment ($900,000 0.44230)................$398,070 Present value of interest payments ($49,500 9.29498)...................... 460,102 Selling price of bonds.............................................................................$858,172 E9-41 (15minutes) a. Warranty expense (+E, -SE) . Warranty liability (+L) b.
Accrued Warranty Liability (L) + 60.5 07 bal. 08 cost 125.1 123.0 08 exp. 55.2 08 bal. + Warranty Expense (E) 123.0 -
123.0 123.0
c. 2008: $123.0 / $6,086.1 = 2.0% 2007: $118.8 / $6563.2 = 1.8%. Warranty expense appears to have increased in 2008 as a percentage of sales revenue.
E9-42 (15 minutes) a. 5/1/10 Cash (+A) ... Bonds payable (+L)
10/31/10
500,000 500,000 22,5001 22,500 300,000 3,000 303,0002
Interest expense (+E, -SE) Cash (-A) .. Bonds payable (-L) . Loss on retirement of bonds (+E, -SE) . Cash (-A) ..
11/1/11
$500,000 x 0.09 x 1/2 = $22,500 interest expense. Because the bonds were sold at par, there is no discount or premium amortization. Cash required to retire $300,000 of bonds at 101 = $300,000 x 1.01 = $303,000. The difference between the cash paid and the carrying amount of the bonds is the gain or loss on the redemption. In this case, the loss is $3,000. This calculation assumes that the interest was paid on 10/31/11, so accrued interest is not recorded.
b. +
5/1/010
Cash (A) 500,000 22,500 303,000 Interest Expense (E) 22,500
10/31/10 11/1/11
11/1/11
Bonds Payable (L) 500,000 300,000
+
5/1/10
+
10/31/10
+ Loss on Retirement of Bonds (E) 11/1/11 3,000
c.
Balance Sheet
Transaction
5/1/10 Issue bonds.
Income Statement
Cash Noncash Liabil- + Contrib. + Asset + Assets = ities Capital +500,000 +500,000 = Bonds Cash
Payable
-22,500
Retained Earnings
= +22,500
Interest Expense
10/31/10Interest -22,500 Cash payment on bonds. 11/1/11 Early retirement of bonds.
= -300,000 =
Bonds Payable
= =
-22,500 -3,000
-303,000
Cash
-3,000
Retained Earnings
+3,000
Loss on Retirement of Bonds
E9-43 (25 minutes) a. Selling price of bonds Present value of principal repayment ($250,000 0.41552)................$103,880 Present value of interest payments ($10,000 11.68959).................. 116,896 Selling price of bonds.............................................................................$220,776 b.
1/1/10
Cash (+A) . Bond discount (+XL, -L) Bonds payable (+L) .. Interest expense (+E, -SE) Bond Discount (-XL, +L) .. Cash (-A) .. Interest expense (+E, -SE) . Bond Discount (-XL, +L) .. Cash (-A) ..
220,776 29,224 250,000 11,039 1,039 10,000 11,091 1,091 10,000
6/30/10
$11,039 = $220,776 .05. 12/31/10
$11,091 = [$220,776 + $1,039] .05.
c. +
1/1/10
6/30/10 12/31/10
+
1/1/10
+
6/30/10 12/31/10
Bond Discount (XL) 1/1/10 29,224 1,039 6/30/10 1,091 12/31/10
E9-43continued. d.
Balance Sheet
Transaction
1/1/10 Issue bonds at a discount.
Income Statement
Cash Bonds Payable
-29,224
Bonds Payable, net
+1,039 =
Bonds Payable, net
-11,039
Retained Earnings
+11,039
-11,039 = -11,091 =
Interest Expense
+1,091 =
Bonds Payable, net
-11,091
Retained Earnings
+11,091
Interest Expense
E9-44 (25 minutes) a. Selling price of bonds: Present value of principal repayment ($800,000 0.20829)................$166,632 Present value of interest payments ($36,000 19.79277).................... 712,540 Selling price of bonds.............................................................................$879,172 b.
1/1/10
Cash (+A) ... Bond premium (+L) Bonds payable (+L) Interest expense (+E,-SE) . Bond premium (-L) . Cash (-A) .. Interest expense (+E,-SE) . Bond premium (-L) . Cash (-A) ..
879,172 79,172 800,000 35,167 833 36,000 35,134 866 36,000
6/30/10
$35, 167 = $879,172 x .04. 12/31/10
$35,134 = ($879,171 - $833) x .04.
E9-44continued. c. +
1/1/10
Cash (A) 879,172
36,000 6/30/10 36,000 12/31/10
+
1/1/10
+
6/30/10 12/31/10
Interest Expense (E) 35,167 35,134
Bond Premium (L) 79,172 6/30/10 833 12/31/10 866
+
1/1/10
d.
Balance Sheet
Transaction
Income Statement
Cash Bonds Payable
+79,172
Bonds Payable, net
-833 =
Bonds Payable, net
-35,167
Retained Earnings
+35,167
-35,167 = -35,134 =
Interest Expense
-866 =
Bonds Payable, net
-35,134
Retained Earnings
+35,134
Interest Expense
E9-45 (20 minutes)
a. There is an inverse relation between interest rates and bond prices (examine
the increasing discount rates as the yield increases in present value tables). Since the bonds now trade at a premium and assuming that Deeres credit ratings have not changed, we can conclude that interest rates have fallen since the bonds were issued.
b. No, once the bond is initially recorded, neither the coupon rate nor the yield
used to compute interest expense is changed. Bonds are recorded at historical cost (like most other balance sheet assets and liabilities). As a result, changes in the general level of interest rates have no effect on interest expense (or the interest payment) that is reflected in the financial statements.
c. Because the bonds trade at a premium in the market, Deere would be paying
more to retire the bonds than the amount at which they are carried on its balance sheet. This would result in a loss on the repurchase that would lower current profitability.
d. The face amount of the bonds will be paid at maturity. As a result, the market
price of the bonds must also equal their face amount ($200 million) at that time.
E9-46A (20 minutes) a. 1. $90,000 0.46319 2. $90,000 0.45639 b. $1,000 5.33493 c. $600 17.29203 d. $500,000 0.38554 = = = = $41,687 $41,075 $5,335 $10,375
= $192,770
E9-47 (25 minutes) a. Selling price of bonds Present value of principal repayment ($600,000 0.09722).................$ 58,332 Present value of interest payments ($33,000 15.04630).................... 496,528 Selling price of bonds.............................................................................$554,860
E9-47continued. b.
1/1/10
Cash (+A) .. Bond discount (+XL, -L) .. Bonds payable (+L) .. Interest expense (+E, -SE) Bond discount (-XL, +L) .. Cash (-A) . Interest expense (+E, -SE) Bond discount (-XL, +L) .. Cash (-A) ..
554,860 45,140 600,000 33,292 292 33,000 33,309 309 33,000
6/30/10
$33,292 = $554,860 .06. 12/31/10
$33,309 = ($554,860 + $292) .06.
c. +
1/1/10
6/30/10 12/31/10
+
1/1/10
+
6/30/10 12/31/10
+
1/1/10
Bond Discount (XL) 45,140 292 6/30/10 309 12/31/10
d.
Balance Sheet
Transaction
Income Statement
Cash Bonds payable
-45,140
Bonds Payable, net
6/30/10 Interest -33,000 Cash payment on bonds. 12/31/10Interest -33,000 Cash payment on bonds.
+292
Bonds Payable, net
-33,292
Retained Earnings
+33,292
-33,292
Interest Expense
+309 =
Bonds Payable, net
-33,309
Retained Earnings
+33,309
Interest Expense
-33,309 =
E9-48 (25 minutes) a. Selling price of bonds Present value of principal repayment ($400,000 0.61391)...................... Present value of interest payments ($26,000 7.72173)............................ Selling price of bonds.................................................................................. b.
1/1/10
$245,564 200,765 $446,329
Cash (+A) ... Bond premium (+L) Bonds payable (+L) Interest expense (+E,-SE) . Bond premium (-L) . Cash (-A) .. Interest expense (+E,-SE) . Bond premium (-L) . Cash (-A) ..
446,329 46,329 400,000 22,316 3,684 26,000 22,132 3,868 26,000
6/30/10
$22,316 = $446,329 .05. 12/31/10
$22,132 = ($446,329 - $3,684) .05.
c. +
1/1/10
Cash (A) 446,329 26,000 6/30/10 26,000 12/31/10 Interest Expense (E) 22,316 22,132 -
+
1/1/10
+
6/30/10 12/31/10
Bond Premium (L) 46,329 6/30/10 3,684 12/31/10 3,868
+
1/1/10
E9-48continued. d.
Balance Sheet
Transaction
Income Statement
Cash Bonds Payable
+46,329
Bonds Payable, net
-3,684 =
Bonds Payable, net
-22,316
Retained Earnings
+22,316
-22,316 = -22,132 =
Interest Expense
-3,868 =
Bonds Payable, net
-22,132
Retained Earnings
+22,132
Interest Expense
E9-49 (10 minutes) Current liabilities: Bond interest payable Current maturities of long-term debt: 10% bonds payable due 2011, including $15,000 premium Total current liabilities Long-term debt: 9% bonds payable due 2012, net of $19,000 discount Zero coupon bonds payable due 2013 8% bonds payable due 2015 Total long-term debt $ 25,000 515,000 $540,000
$581,000 170,500 100,000 $851,500
E9-50 (20 minutes) a. 12/31/10 Cash (+A) Mortgage note payable (+L) .
3/31/11
500,000 500,000 10,000 8,278 18,278 9,834 8,444 18,278
Interest expense (+E, -SE) . Mortgage note payable (-L) ... Cash (-A) Interest expense (+E, -SE) . Mortgage note payable (-L) ... Cash (-A)
6/30/11
$9,834 = ($500,000 $8,278) x 8%/4.
b. +
12/31/10
Cash (A) 500,000 18,278 18,278
3/31/11 6/30/11
Mortgage Note Payable (L) + 500,000 12/31/10 3/31/11 8,278 6/30/11 8,444
+
3/31/11 6/30/11
Interest Expense (E) 10,000 9,834
c.
Balance Sheet
Transaction
Income Statement
-10,000
Retained Earnings
= +10,000 -10,000 = -9,834 =
-8,278 =
Interest Expense
-18,278
Cash
-8,444 =
-9,834
Retained Earnings
+9,834
Interest Expense
PROBLEMS
P9-51 (20 minutes)
a.
Hewlett-Packard Accrued Warranty Liability (L) + 2,376 07 bal. 3,244 08 exp. Dell Inc. Accrued Warranty Liability (L) + 929 07 bal. 1,180 08 exp.
3,006
2,614 08 bal.
1,074
1,035 08 bal.
Hewlwtt-Packard incurred $3,006 million in warranty repair costs and settlements in 2008 while Dell, Inc. incurred costs of $1,074 million. b. HPs ratio of warranty expense to sales was 3.5% in 2008 ($3,244/$91,697) up from 3.1% in 2007 ($2,604/$84,229). Dells ratio was 1.9% both years ($1,180/$61,101 in 2008 and $1,176/$61,133 in 2007). Dells warranty expense is lower and more stable relative to sales revenue than that of HP. Possible reasons for this include the following: (1) perhaps Dell products are higherquality and require fewer repairs than HP products or (2) HP may have a more generous warranty policy than Dell, resulting in more warranty repairs, even if the quality is the same. The increase in HPs warranty expense as a percent of sales indicates that either (1) warranty costs have gone up, (2) the company underestimated warranty costs in the past and needed to record larger than normal accruals in 2008 to correct the underestimation; or (3) HP is building up a cookie-jar reserve by increasing its warranty liability this year.
P9-52 (20 minutes) a. Cash (+A) .. Accrued interest payable (+L) Bonds payable (+L) .. 518,750 18,750 500,000
$18,750 = $500,000 x .09 x 5/12
b.
Interest expense (+E, -SE). Accrued interest payable (-L) .. Cash (-A) ..
3,750 18,750 22,500
$22,500 = $500,000 x 9%/2
c.
Interest expense (+E, -SE) Accrued interest payable (+L)
7,500 7,500
$7,500 = $500,000 x 9% x 2/12
d.
Interest expense (+E, -SE) Accrued interest payable (-L) .. Cash (-A) ..
15,000 7,500 22,500
e.
Bonds payable (-L) . Loss on retirement of bonds (+E, -SE) . Cash (-A) ..
300,000 3,000 303,000
+ a.
Cash (A) 518,750 22,500 22,500 303,000
b. d. e. -
Bonds payable (L) 500,000 e. 300,000
+ a.
+ b. c. d.
Interest expense (E) 3,750 7,500 15,000
Accrued Interest Payable (L) + 18,750 a. b. 18,750 7,500 c. d. 7,500 + Loss on Retirement of Bonds (E) e. 3,000
Balance Sheet
Transaction
a. (10/1/10) Issue bonds.
Income Statement
Earned capital Net Revenues - Expenses = Income
Cash
Bonds Payable
+18,750
Interest Payable
b. (11/1/10 Interest -22,500 Cash payment on bonds. c. (12/31/10) Accrued interest on bonds. d. (5/1/11) Interest -22,500 Cash payment on bonds. e. 5/1/15 Early retirement of bonds.
= = =
-18,750
Interest Payable
-3,750
Retained Earnings
+3,750
Interest Expense
= = =
-3,750 -7,500 -15,000 -3,000
+7,500
Interest Payable
-7,500
Retained Earnings
+7,500
Interest Expense
-7,500
Interest Payable
-15,000
Retained Earnings
+15,000
Interest Expense
-303,000
Cash
-300,000 =
Bonds Payable
-3,000
Retained Earnings
+3,000
Loss on Retirement of Bonds
P9-53 (15 minutes) a. CVS reports interest expense of $529.8 million on average long-term debt of $8,203.45 million ([$8,057.2 million + $8,349.7 million]/2) for an average rate of 6.5%. Using interest paid ($573.7 million) instead of interest expense yields 7.0%. See the answer to c below. CVS reports coupon rates of 4.0% to 8.52% so, the average rate seems reasonable given the information disclosed in the long-term debt footnote. Interest paid can differ from interest expense if bonds are sold at a premium or a discount. It can also differ because of capitalized interest. CVS reported capitalized interest of $27.8 million in 2008 (information not provided in the problem).
b. c.
P9-54 (25 minutes) a. 6/1/10 Cash (+A) . Accrued interest payable (+L) . Bonds payable (+L) Interest expense (+E, -SE) .. Accrued interest payable (-L) . Cash (-A) Interest expense (+E, -SE) Accrued interest payable (+L) . Interest expense (+E) Accrued interest payable (-L) . Cash (-A) Bonds payable (-L) Loss on retirement of bonds (+E, -SE) Cash (-A) .. Cash (A) 824,000 36,000 36,000 202,000 Interest Expense (E) 12,000 24,000 12,000 b. d. e. e. 824,000 24,000 800,000 12,000 24,000 36,000 24,000 24,000 12,000 24,000 36,000 200,000 2,000 202,000 + a.
$24,000 = $800,000 x .09 x 4/12
b. 9/1/10
$36,000 = $800,000 x 9%/2
c. 12/31/10
d. 3/1/11
e. 3/1/11
+ a.
Bonds Payable (L) 800,000 200,000
+ b. c. d.
Accrued Interest Payable (L) b. 24,000 24,000 d. 24,000 24,000
+ a. c.
+ Loss on Retirement of Bonds (E) e. 2,000
Balance Sheet
Transaction
a. (7/1/10) Issue bonds.
Income Statement
Cash
Bonds Payable
+24,000
Interest Payable
b. (9/1/10) Interest -36,000 Cash payment on bonds. c. (12/31/10) Accrued interest on bonds. d. (3/1/11) Interest -36,000 Cash payment on bonds. e. 3/1/11 Early retirement of bonds.
= = = =
-24,000
Interest Payable
-12,000
Retained Earnings
+12,000
Interest Expense
= = = =
-12,000 -24,000 -12,000 -2,000
+24,000
Interest Payable
-24,000
Retained Earnings
+24,000
Interest Expense
-24,000
Interest Payable
-12,000
Retained Earnings
+12,000
Interest Expense
-202,000
Cash
-200,000
Bonds Payable
-2,000
Retained Earnings
+2,000
Loss on Retirement of bonds
P9-55 (20 minutes) a. Period 0 1 2 Interest expense $40,722 $40,790 Cash interest paid $39,600 $39,600 Discount amortizatio n $1,122 $1,190 Discount balance $41,292 $40,170 $38,980 Bond payable net $678,708 $679,830 $681,020
$40,722 = $678,708 x 12%/2. $40,790 = $679,830 x 12%/2.
b.
12/31/10
Cash (+A) .. Bond discount (+XL) . Bonds payable (+L) .. Interest expense (+E,-SE) . Bond discount (-XL) .. Cash (-A) .. Interest expense (+E,-SE) . Bond discount (-XL) .. Cash (-A) ..
678,708 41,292 720,000 40,722 1,122 39,600 40,790 1,190 39,600
6/30/11
12/31/11
c. +
12/31/10
6/30/11 12/31/11
Bonds Payable (L) + 12/31/10 720,000
+
6/30/11 12/31/11
+
12/31/10
Bond Discount (XL) 41,292 1,122 6/30/11 1,190 12/31/11
d.
Balance Sheet
Transaction
Income Statement
Net Revenues - Expenses = Income
Cash Noncash Liabil- + Contrib. + Retained Asset + Assets = ities Capital Earnings +678,708 +720,000
Cash Bonds Payable
-41,292
Bonds Payable, net
+1,122 =
Bonds Payable, net
-40,722
Retained Earnings
+40,722
-40,722 = -40,790 =
Interest Expense
+1,190 =
Bonds Payable, net
-40,790
Retained Earnings
+40,790
Interest Expense
P9-56 (20 minutes) a. Period 0 1 2 Interest expense $8,271 $8,302 Cash interest paid $7,500 $7,500 Discount amortizatio n $771 $802 Discount balance $43,230 $42,459 $41,657 Bond payable net $206,770 $207,541 $208,343
$8,271= $206,770 x 8%/2. $8,302 = $207,541 x 8%/2.
b.
4/30/10
Cash (+A) .... Bond discount (+XL, -L) . Bonds payable (+L) . Interest expense (+E, -SE) ..... Bond discount (-XL, +L) . Cash(-A) .. Interest expense (+E, -SE) ..... Bond discount (-XL, +L) . Accrued interest payable (+L) .. Interest expense (+E, -SE) ..... Accrued interest payable (-L) .... Bond discount (-XL, +L) . Cash(-A) ..
206,770 43,230 250,000 8,271 771 7,500 2,767 267 2,500 5,535 2,500 535 7,500
10/31/10
12/31/10
4/30/11
c. +
4/30/10
Cash (A) 206,770 7,500 7,500 Interest Expense (E) 8,271 2,767 5,535
10/31/10 4/30/11
+
4/30/10
+
10/31/10 12/31/10 4/30/11
+
4/30/10
Bond Discount (XL) 43,230 771 10/31/10 267 12/31/10 535 4/30/11
Accrued Interest Payable (L) + 2,500 12/31/10 4/30/11 2,500
d.
Balance Sheet
Cash Noncash Liabil- + Contrib. + Asset + Assets = ities Capital 4/30/10 Issue bonds at +206,770 +250,000
Income Statement
Transaction
a discount.
Cash
Bonds Payable
-43,230
Bonds Payable, net
10/31/10 Interest payment on bonds. 12/31/10 Accrued interest on bonds.
-7,500
Cash
+771 =
Bonds Payable, net
-8,271
Retained Earnings
+8,271
-8,271 = -2,767 =
Interest Expense
+267 =
Bonds Payable, net
-2,767
Retained Earnings
+2,767
Interest Expense
+2,500
Accrued Interest Payable
4/30/11 Interest payment on bonds.
-7,500
Cash
+535 =
Bonds Payable, net
-5,535
Retained Earnings
+5,535
Interest Expense
-5,535 =
-2,500
Accrued Interest Payable
P9-57 (20 minutes) a. Payment x 12.46221 = $500,000; Payment = $500,000/12.46221 = $40,121. b.

12/31/10
Cash (+A) .. Mortgage note payable (+L) Interest expense (+E, -SE) Mortgage note payable (-L) . Cash (-A) ..
500,000 500,000 25,000 15,121 40,121
6/30/11
* $25,000 = $500,000 x 10%/2 12/31/11
Interest expense (+E, -SE) . Mortgage note payable (-L) .. Cash (-A) ..
24,244 15,877 40,121
$24,244 = ($500,000 $15,121) x 10%/2.
c. +
12/31/10
6/30/11 12/31/11
+
6/30/11 12/31/11
d.
Balance Sheet
Transaction
Income Statement
-25,000
Retained Earnings
= +25,000 -25,000 = -24,244 =
-15,121 =
Interest Expense
-40,121
Cash
-15,877 =
-24,244
Retained Earnings
+24,244
Interest Expense
P9-58 (20 minutes) a. Payment x 16.35143 = $950,000; Payment = $950,000/16.35143 = $58,099. b. 12/31/10 Cash (+A) .. 950,000 Mortgage note payable (+L) 950,000
3/31/11
Interest expense (+E, -SE) Mortgage note payable (-L) . Cash (-A) ..
19,000* 39,099 58,099
* $19,000 = $950,000 x 8%/4 6/30/11
Interest expense (+E, -SE) Mortgage note payable (-L) . Cash (-A) ..
18,218* 39,881 58,099
* $18,218 = ($950,000 $39,099) x 8%/4.
c. +
12/31/10
3/31/11 6/30/11
+
3/31/11 6/30/11
d.
Balance Sheet
Transaction
12/31/10 Borrow Cash $950,000 on a 5year mortgage note payable. 3/31/11 Payment on -58,099 Cash note. 6/30/11 Payment on note.
Income Statement
-19,000
Retained Earnings
= +19,000
-39,099 =
Interest Expense
= -19,000
-58,099
Cash
-39,881 =
-18,218
Retained Earnings
+18,218
Interest Expense
= -18,218
P9-59 (20 minutes) a. 1. $90,000 x 0.54703 = $49,233 2. $90,000 x 0.53997* = $48,597 (*0.53997 = 1.045 -14) 3. $90,000 x 0.53632** = $48,269 (**0.5632 = 1.0225 -28) b. $1,000 x 4.21236 = $4,212 c. $2,400 x 15.24696 = $36,593 d. $500,000 x 0.38554 = $192,770 e. $2,500 x 11.46992 + $85,000 x 0.31180 = $55,178
P9-60 (20 minutes) a. $7,000 x 4.17725 = $29,241. b. $7,000 x 4.32194 = $30,254. c. $29,241 x 0.23939 = $7,000. d. $6,000 x 1.69005 = $10,140. e. $500 x 21.24339 = $10,622.
CASES
C9-61 (50 minutes) a. The $1,300 million reported in short-term liabilities means that this face amount will come due in 2009 and needs to be paid or refunded with new debt. The amount of debt needed to be either paid or refunded with a new issue is important because it implies required uses of cash unless refunding is available. The note reveals that, in October 2008, PBG issued $1,300 million of 6.95% senior notes due in 2014 and the proceeds were used to pay off the 7% notes due in February 2009. At the end of 2008, both debt issues appeared on PBGs balance sheet. b. The 98.919 price indicates that each $1,000 bond would sell for $989.19. Each $1,000 bond still returns $70 of interest per year. The result is that the investor's return is increased. The lower bond price reflects an increase in market interest rates. c. The first covenant indicates an upper limit on borrowing. The debt to EBITDA ratio is an additional constraint on the level of debt. The third covenant restricts new borrowing secured by the pledge of specific assets of the firm. All of these covenants restrict the firm's freedom to borrow. d. Bond discount arises when a bond is sold at less than par. Sale below par occurs when the market interest rate exceeds the coupon rate for the issue. The result is that the issuer receives less money but the interest payment remains at the coupon rate. The amortization of the bond discount results in an increase in the firm's interest expense. The initial discount is reported as a debit contra account to the outstanding bond's face value. The discount is amortized over time reflected by a credit to it and a debit to interest expense.
C9-62 (50 minutes) a. From the firm's view, it is useful to know the maturity dates in order to complete the firm's cash budget and to be able to plan for any refunding or additional cash needs if refunding is not an option. This information is also useful to analysts as that they consider the firms solvency and debt capacity as indicators of the firm's health and ability to implement its strategy. b. Several factors can cause a difference between interest expense and interest paid. Some of a firm's accrued interest may have been capitalized to assets under construction. In addition, bonds issued at a discount will result in interest expense that is greater than interest paid, while bonds issued at a premium will lead to interest expense that is less than cash interest paid. c. Several ratios discussed in this chapter may be useful in assessing a firms riskiness include the firm's debt-to-equity ratio and its time interest earned. Credit rating companies look for the amount of indebtedness in relation to the operating cash flow and asset size of the company. This is because cash serves as the primary source of debt repayment and assets serve as a backup source, in the event of default. Other factors such as profitability measures, an examination of the firm's closeness to its debt covenants, the state of the firm's sales and industry health should also be considered. d. $374.57 million. If the notes originally sold at par, the difference between the $385 million issue price and the current $374.57 million value would not be reflected in the firm's current financial statements. (The firm could report the market value in a note if it wished.) Repurchase of the issue at the current market price would eliminate the debt of $385 million for a cash payment of $374.57 million and a gain on redemption equal to the difference. The 97.29 price tells us that market rate of interest for the risk level associated with this debt issue has increased. An alternative explanation would be that Southwest's credit rating has declined since the notes were issued. e. Cash (+A) ....... Bond discount (+XL) ................ 5% Notes payable, due 2016 (+L) .... 297 3 300
C9-63 (20 minutes) a. The gain results from the difference between the book value of the debt ($3,000,000) and the current redemption (market) value ($1,900,000). The gain would be reported in the income statement under other (nonoperating) income. The source of the gain should be adequately disclosed in the notes. b. Currently, Foster is paying 8% interest on the $3,000,000 of long-term debt, or $240,000 per year. Under the proposed refinancing, Foster would pay 16%, or $480,000. The refinancing would generate an additional $1,100,000 in cash. However, because interest costs are increasing by $240,000 per year ($480,000 - $240,000), Foster is effectively borrowing the additional $1,100,000 at a rate of almost 22% ($240,000 / $1,100,000). As such, Foster would be paying in the future (in the form of higher interest costs) for a one-time boost in current earnings. c. The potential ethical conflict exists because Fosters president is concerned that his job might be dependent on producing short-term earnings. Because of this, he might be tempted to accept this proposal and boost current earnings at the cost of lower earnings in future years. This thinking is misguided because, given adequate disclosure, analysts and investors would be able to identify and discount the source of the earnings boost. The most serious unethical act would be to try to hide (or obfuscate) the bond refinancing with inadequate disclosure.

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Chapter 9

Reporting and Analyzing Liabilities

Cambridge Business Publishers, 2011 Solutions Manual, Chapter 9 9-1

Cambridge Business Publishers, 2011 9-2 Financial Accounting, 3rd Edition

Cambridge Business Publishers, 2011 Solutions Manual, Chapter 9 9-3

Cambridge Business Publishers, 2011 9-4 Financial Accounting, 3rd Edition

Interest expense (+E,-SE)... Interest payable (+L)...

M9-22 (10 minutes)

Cambridge Business Publishers, 2011 9-6 Financial Accounting, 3rd Edition

M9-23 (15 minutes)

b. Management, facing imminent default in one or more of its bond covenants,

c. Restricted assets, such as cash or securities, should not be considered as

Cambridge Business Publishers, 2011 Solutions Manual, Chapter 9 9-7

432,000 400,000 32,000 400,000 27,809 412,000 15,809

Gain on Retirement of Bonds (R) 15,809

1/1/09 Retired bonds issued on 1/1/04.

Cambridge Business Publishers, 2011 9-8 Financial Accounting, 3rd Edition

+ Loss on Retirement of Bonds (E) 7/1/09 9,314

7/1/09 Retired bonds issued on 7/1/03

Loss on retirement of Bonds

Cambridge Business Publishers, 2011 Solutions Manual, Chapter 9 9-9

Cambridge Business Publishers, 2011 9-10 Financial Accounting, 3rd Edition

Cost of Goods Sold (E) 3. 300

LiabilContrib. + Noncash Assets = ities + Capital + +300 +300 Inventory = Accounts

Cambridge Business Publishers, 2011 Solutions Manual, Chapter 9 9-11

Cambridge Business Publishers, 2011 9-12 Financial Accounting, 3rd Edition

Cambridge Business Publishers, 2011 Solutions Manual, Chapter 9 9-13

700,000 700,000 42,000 8,854 50,854 41,469 9,385 50,854

* $41,469 = ($700,000 $8,854) x 12%/2.

= +42,000 -42,000 = -41,469 =

Cambridge Business Publishers, 2011 9-14 Financial Accounting, 3rd Edition

Cambridge Business Publishers, 2011 Solutions Manual, Chapter 9 9-15

377,814 77,814 300,000 15,113 1,387 16,500 15,057 1,443 16,500

* $15,057 = ($377,814 $1,387) x 8%/2.

Bonds Payable (L) 300,000

Bond Premium (L) 77,814 6/30/10 1,387 12/31/10 1,443

Cambridge Business Publishers, 2011 9-16 Financial Accounting, 3rd Edition

Cambridge Business Publishers, 2011 Solutions Manual, Chapter 9 9-17

500,000 500,000 22,5001 22,500 300,000 3,000 303,0002

Cash (A) 500,000 22,500 303,000 Interest Expense (E) 22,500

Bonds Payable (L) 500,000 300,000

+ Loss on Retirement of Bonds (E) 11/1/11 3,000

10/31/10Interest -22,500 Cash payment on bonds. 11/1/11 Early retirement of bonds.

Cambridge Business Publishers, 2011 9-18 Financial Accounting, 3rd Edition

220,776 29,224 250,000 11,039 1,039 10,000 11,091 1,091 10,000

$11,039 = $220,776 .05. 12/31/10

$11,091 = [$220,776 + $1,039] .05.

Bonds Payable (L) 250,000

Bond Discount (XL) 1/1/10 29,224 1,039 6/30/10 1,091 12/31/10

Cambridge Business Publishers, 2011 Solutions Manual, Chapter 9 9-19

879,172 79,172 800,000 35,167 833 36,000 35,134 866 36,000

$35, 167 = $879,172 x .04. 12/31/10

$35,134 = ($879,171 - $833) x .04.

Cambridge Business Publishers, 2011 9-20 Financial Accounting, 3rd Edition

Cash (A) 879,172

36,000 6/30/10 36,000 12/31/10

Bonds Payable (L) 800,000

Interest Expense (E) 35,167 35,134

Bond Premium (L) 79,172 6/30/10 833 12/31/10 866

Cambridge Business Publishers, 2011 Solutions Manual, Chapter 9 9-21

E9-45 (20 minutes)

Cambridge Business Publishers, 2011 9-22 Financial Accounting, 3rd Edition

554,860 45,140 600,000 33,292 292 33,000 33,309 309 33,000

$33,292 = $554,860 .06. 12/31/10