B EXERCISES 2 E1-1B (Classification of Liabilities) Presented below are various account balances of Royale Corp. (a) Bonds payable of $12,000,000 maturing January, 2017. (b) Unamortized discount on bonds payable, of which $8,00 will be amortized during the next year. (c) Serial bonds payable, $6,000,000, of which $00,000 are due each December 1. (d) Bank loans payable, due May, 2018. (The Company s timber products requires years of growth before harvesting.) (e) Notes payable due December 1, 2016. (f) Credit balances in customers accounts arising from returns and allowances after collection in full of account. (g) Deposits made by customers who have ordered goods. (h) Overdraft of $,000 in a bank account. (No other balances are carried at this bank.) (i) Amounts withheld from employees wages for FICA taxes. Indicate whether each of the items above should be classified on December 1, 201, as a current liability, a long-term liability, or under some other classification. Consider each one independently from all others; that is, do not assume that all of them relate to one particular business. If the classification of some of the items is doubtful, explain why in each case. 2 E1-2B (Classification) The following items are found in the financial statements. (a) Debenture bonds payable (maturing in years). (b) Premium on bonds payable. (c) Income bonds payable (due in years). (d) Treasury bonds. (e) Notes payable (due in years). (f) Discount on bonds payable. (g) Unamortized bond issue costs. (h) Mortgage payable (payable in equal amounts over next years). (i) Gain on repurchase of debt. (j) Interest expense (credit balance). Indicate how each of these items should be classified in the financial statements. E1-B (Entries for Bond Transactions) Presented below are two independent situations. 1. On January 1, 201, Delgado Company issued $00,000 of 8%, -year bonds at par. Interest is payable quarterly on April 1, July 1, October 1, and January 1. 2. On June 1, 201, Kumiko Company issued $200,000 of %, -year bonds dated January 1 at par plus accrued interest. Interest is payable semiannually on July 1 and January 1. For each of these two independent situations, prepare journal entries to record the following. (a) The issuance of the bonds. (b) The payment of interest on July 1. (c) The accrual of interest on December 1. E1-B (Entries for Bond Transactions Straight-Line) McGee Company issued $00,000 of 8%, 20-year bonds on January 1, 201, at 2. Interest is payable semiannually on July 1 and January 1. McGee Company uses the straight-line method of amortization for bond premium or discount. Prepare the journal entries to record the following. (a) The issuance of the bonds. (b) The payment of interest and the related amortization on July 1, 201. (c) The accrual of interest and the related amortization on December 1, 201. E1-B (Entries for Bond Transactions Effective Interest) Assume the same information as in E1-B, except that McGee Company uses the effective-interest method of amortization for bond premium or discount. Assume an effective yield of 6% in pricing the bond. 1
2 Chapter 1 Long-Term Liabilities Prepare the journal entries to record the following. (Round to the nearest dollar.) (a) The issuance of the bonds. (b) The payment of interest and related amortization on July 1, 201. (c) The accrual of interest and the related amortization on December 1, 201. E1-6B (Amortization Schedules Straight-Line) Clark Company sells 8% bonds having a maturity value of $,000,000 for $,21,26. The bonds are dated January 1, 201, and mature January 1, 2019. Interest is payable annually on January 1. Set up a schedule of interest expense and premium amortization under the straight-line method. E1-7B (Amortization Schedule Effective-Interest) Assume the same information as E1-6B. Set up a schedule of interest expense and premium amortization under the effective-interest method. (Hint: The effective interest rate must be computed.) E1-8B (Determine Proper Amounts in Account Balances) Presented below are three independent situations. (a) Snider Corporation incurred the following costs in connection with the issuance of bonds: (1) printing and engraving costs $0,000; (2) legal fees $120,000, and () commissions paid to underwriter $20,000. What amount should be reported as Unamortized Bond Issue Costs, and where should this amount be reported on the balance sheet? (b) Banks Co. sold $,000,000 of 6%, -year bonds at on January 1, 201. The bonds were dated January 1, 201, and pay interest on July 1 and January 1. If Banks uses the straight-line method to amortize bond premium or discount, determine the amount of interest expense to be reported on July 1, 201, and December 1, 201. (c) Cey Inc. issued $1,000,000 of %, -year bonds on June 0, 201, for $88,296. This price provided a yield of 12% on the bonds. Interest is payable semiannually on December 1 and June 0. If Cey uses the effective-interest method, determine the amount of interest expense to record if financial statements are issued on October 1, 201. E1-9B (Entries and Questions for Bond Transactions) On July 1, 201, Sugarland Company issued $2,000,000 face value of %, -year bonds at $1,770,602, a yield of 12%. Sugarland uses the effectiveinterest method to amortize bond premium or discount. The bonds pay semiannual interest on June 0 and December 1. (a) Prepare the journal entries to record the following transactions. (1) The issuance of the bonds on July 1, 201. (2) The payment of interest and the amortization of the premium on December 1, 201. () The payment of interest and the amortization of the premium on June 0, 201. () The payment of interest and the amortization of the premium on December 1, 201. (b) Show the proper balance sheet presentation for the liability for bonds payable on the December 1, 201, balance sheet. (c) Provide the answers to the following questions. (1) What amount of interest expense is reported for 201? (2) Will the bond interest expense reported in 201 be the same as, greater than, or less than the amount that would be reported if the straight-line method of amortization were used? () Determine the total cost of borrowing over the life of the bond. () Will the total bond interest expense for the life of the bond be greater than, the same as, or less than the total interest expense if the straight-line method of amortization were used? E1-B (Entries for Bond Transactions) On January 1, 201, Spalding Company sold 12% bonds having a maturity value of $1,000,000 for $1,07,81.7, which provides the bondholders with a % yield. The bonds are dated January 1, 201, and mature January 1, 2019, with interest payable December 1 of each year. Spalding Company allocates interest and unamortized discount or premium on the effectiveinterest basis. (a) Prepare the journal entry at the date of the bond issuance. (b) Prepare a schedule of interest expense and bond amortization for 201 2016.
B Exercises 6 (c) Prepare the journal entry to record the interest payment and the amortization for 201. (d) Prepare the journal entry to record the interest payment and the amortization for 2016. E1-11B (Information Related to Various Bond Issues) Brooks Inc. has issued three types of debt on January 1, 201, the start of the company s fiscal year. (a) $ million, 20-year, 8% secured subordinated bonds, interest payable annually. Bonds were priced to yield %. (b) $8 million par of 20-year, zero-coupon bonds at a price to yield 12% per year. (c) $ million, 20-year, % bonds secured by the factory building interest payable semi-annually to yield 8%. Prepare a schedule that identifies the following items for each bond: (1) maturity value, (2) number of interest periods over life of bond, () stated rate per each interest period, () effective interest rate per each interest period, () payment amount per period, and (6) present value of bonds at date of issue. E1-12B (Entry for Retirement of Bond; Bond Issue Costs) On January 1, 2012, Ladon Corporation issued $,000,000 of % bonds at 2 due December 1, 2021. Legal and other costs of $81,000 were incurred in connection with the issue. Interest on the bonds is payable annually each December 1. The $81,000 issue costs are being deferred and amortized on a straight-line basis over the -year term of the bonds. The premium on the bonds is also being amortized on a straight-line basis over the years. (Straight-line is not materially different in effect from the preferable interest method.) The bonds are callable at (i.e., at % of face amount), and on January 2, 201, London called one-half of the bonds and retired them. Ignoring income taxes, compute the amount of loss, if any, to be recognized by London as a result of retiring the $2,000,000 of bonds in 201 and prepare the journal entry to record the retirement. (AICPA adapted) E1-1B (Entries for Retirement and Issuance of Bonds) Cummings, Inc. had outstanding $8,000,000 of 12% bonds (interest payable July 1 and January 1) due in years. On July 1, it issued $12,000,000 of %, 1-year bonds (interest payable July 1 and January 1) at 98. A portion of the proceeds was used to call the 12% bonds at 6 on August 1. Unamortized bond discount and issue cost applicable to the 12% bonds were $10,000 and $60,000, respectively. Prepare the journal entries necessary to record the issue of the new bonds and the refunding of the bonds. E1-1B (Entries for Retirement and Issuance of Bonds) On June 0, 2008, Einstein Corp. issued % bonds with a par value of $1,000,000 due in 20 years. They were issued at 98 and were callable at 2 at any date after June 0, 201. Because of lower interest rates and a significant change in the company s credit rating, it was decided to call the entire issue on June 0, 201, and to issue new bonds. New 6% bonds were sold in the amount of $1,0,000 at 1; they mature in 20 years. Einstein Corp. uses straightline amortization. Interest payment dates are December 1 and June 0. (a) Prepare journal entries to record the retirement of the old issue and the sale of the new issue on June 0, 201. (b) Prepare the entry required on December 1, 201, to record the payment of the first 6 months interest and the amortization of premium on the bonds. E1-1B (Entries for Retirement and Issuance of Bonds) Alan Company had bonds outstanding with a maturity value of $1,00,000. On June 0, 201, when these bonds had an unamortized premium of $21,000, they were called in at. To pay for these bonds, Alan had issued other bonds a month earlier bearing a lower interest rate. The newly issued bonds had a life of 20 years. The new bonds were issued at 98 (face value $1,800,000). Issue costs related to the new bonds were $26,000. Ignoring interest, compute the gain or loss and record this refunding transaction. (AICPA adapted) E1-16B (Entries for Zero-Interest-Bearing Debt) On January 1, 201, Fisher Company makes the two following acquisitions. 1. Purchases land having a fair market value of $800,000 by issuing a -year, zero-interest-bearing promissory note in the face amount of $1,17,6.
Chapter 1 Long-Term Liabilities 2. Purchases equipment by issuing a %, 8-year promissory note having a maturity value of $0,000 (interest payable annually). The company has to pay 8% interest for funds from its bank. (a) Record the two journal entries that should be recorded by Fisher Company for the two purchases on January 1, 201. (b) Record the interest at the end of the first year on both notes using the effective-interest method. 6 6 E1-17B (Imputation of Interest) Presented below are two independent situations: (a) On January 1, 201, Excess Inc. purchased undeveloped land that had an assessed value of $261,000 at the time of purchase. A $00,000, zero-interest-bearing note due January 1, 2020, was given in exchange. There was no established exchange price for the land, nor a ready market value for the note. The interest rate charged on a note of this type is 1%. Determine at what amount the land should be recorded at January 1, 201, and the interest expense to be reported in 201 related to this transaction. (b) On January 1, 201, DonnAll Diamond borrowed $1,000,000 (face value) from Allstar Co., a major customer, through a zero-interest-bearing note due in years. Because the note was zero-interest-bearing, DonnAll agreed to sell diamonds to this customer at lower than market price. A 12% rate of interest is normally charged on this type of loan. Prepare the journal entry to record this transaction and determine the amount of interest expense to report for 201. E1-18B (Imputation of Interest with Right) On January 1, 201, Devlin Co. borrowed and received $200,000 from a major customer evidenced by a zero-interest-bearing note due in years. As consideration for the zero-interest-bearing feature, Devlin agrees to supply the customer s inventory needs for the loan period at lower than the market price. The appropriate rate at which to impute interest is 8%. (a) Prepare the journal entry to record the initial transaction on January 1, 201. (Round all computations to the nearest dollar.) (b) Prepare the journal entry to record any adjusting entries needed at December 1, 201. Assume that the sales of Devlin s product to this customer occur evenly over the -year period. 7 E1-19B (Fair Value Option) Emily Company commonly issues long-term notes payable to its various lenders. Emily has had a pretty good credit rating such that its effective borrowing rate is quite low (less than 7% on an annual basis). Emily has elected to use the fair value option for the long-term notes issued to Second National Bank and has the following data related to the carrying and fair value for these notes. Carrying Value Fair Value December 1, 201 $0,000 $,000 December 1, 201 0,000 2,00 December 1, 2016 61,000 62,00 (a) Prepare the journal entry at December 1 (Emily s year-end) for 201, 201, and 2016, to record the fair value option for these notes. (b) At what amount will the note be reported on Emily s 201 statement of financial position? (c) What is the effect of recording the fair value option on these notes on Emily s 2016 income? (d) Assuming that general market interest rates have been stable over the period, does the fair value data for the notes indicate that Emily s creditworthiness has improved or declined in 2016? Explain. 9 E1-20B (Long-Term Debt Disclosure) At December 1, 201, Bradley Company has outstanding three long-term debt issues. The first is a $6,000,000 note payable which matures June 0, 2017. The second is an $18,000,000 bond issue which matures September 0, 2018. The third is a $2,00,000 sinking fund debenture with annual sinking fund payments of $,00,000 in each of the years 201 through 2020. Prepare the note disclosure for the long-term debt at December 1, 201. *E1-21B (Settlement of Debt) Nixim Company owes $800,000 plus $121,000 of accrued interest to 2nd State Bank. The debt is a -year, % note. During 2012, Nixim s business deteriorated due to a faltering regional economy. On December 1, 201, 2nd State Bank agrees to accept some undeveloped land and cancel the entire debt. The land has a cost of $1,200,000, and a fair market value of $680,000.
B Exercises (a) Prepare journal entries for Nixim Company and 2nd State Bank to record this debt settlement. (b) How should Nixim report the gain or loss on the disposition of land and on restructuring of debt in its 201 income statement? (c) Assume that, instead of transferring the land, Nixim decides to grant 200,000 shares of its common stock ($1 par) which has a fair value of $680,000 in full settlement of the loan obligation. If 2nd State Bank treats Nixim s stock as a trading investment, prepare the entries to record the transaction for both parties. *E1-22B (Term Modification without Gain Debtor s Entries) On December 1, 201, Zettlein Bank enters into a debt restructuring agreement with Larkin Company, which is now experiencing financial trouble. The bank agrees to restructure a 12%, issued at par, $,000,000 note receivable by the following modifications: 1. Reducing the principal obligation from $,000,000 to $8,000,000. 2. Extending the maturity date from December 1, 201, to December 1, 2017.. Reducing the interest rate from 12% to %. Larkin pays interest at the end of each year. On January 1, 2018, Larkin Company pays $8,000,000 in cash to Zettlein Bank. (a) Will the gain recorded by Larkin be equal to the loss recorded by Zettlein Bank under the debt restructuring? (b) Can Larkin Company record a gain under the term modification mentioned above? Explain. (c) Assuming that the interest rate Larkin should use to compute interest expense in future periods is 1.276%, prepare the interest payment schedule of the note for Larkin Company after the debt restructuring. (d) Prepare the interest payment entry for Larkin Company on December 1, 2016. (e) What entry should Larkin make on January 1, 2018? *E1-2B (Term Modification without Gain Creditor s Entries) Using the same information as in E1-22B above, answer the following questions related to Zettlein Bank (creditor). (a) What interest rate should Zettlein Bank use to calculate the loss on the debt restructuring? (b) Compute the loss that Zettlein Bank will suffer from the debt restructuring. Prepare the journal entry to record the loss. (c) Prepare the interest receipt schedule for Zettlein Bank after the debt restructuring. (d) Prepare the interest receipt entry for Zettlein Bank on December 1, 2016. (e) What entry should Zettlein Bank make on January 1, 2018? *E1-2B (Term Modification with Gain Debtor s Entries) Use the same information as in E1-22B above except that Zettlein Bank reduced the principal to $6,00,000 rather than $8,000,000. On January 1, 2018, Larkin pays $6,00,000 in cash to Zettlein Bank for the principal. (a) Can Larkin Company record a gain under this term modification? If yes, compute the gain for Larkin Company. (b) Prepare the journal entries to record the gain on Larkin s books. (c) What interest rate should Larkin use to compute its interest expense in future periods? Will your answer be the same as in E1-22B above? Why or why not? (d) Prepare the interest payment schedule of the note for Larkin Company after the debt restructuring. (e) Prepare the interest payment entries for Larkin Company on December 1, of 201, 2016, and 2017. (f) What entry should Larkin make on January 1, 2018? *E1-2B (Term Modification with Gain Creditor s Entries) Using the same information as in E1-22B and E1-2B above, answer the following questions related to Zettlein Bank (creditor). (a) Compute the loss Zettlein Bank will suffer under this new term modification. Prepare the journal entry to record the loss on Zettlein s books. (b) Prepare the interest receipt schedule for Zettlein Bank after the debt restructuring. (c) Prepare the interest receipt entry for Zettlein Bank on December 1, 201, 2016, and 2017. (d) What entry should Zettlein Bank make on January 1, 2018?
6 Chapter 1 Long-Term Liabilities *E1-26B (Debtor/Creditor Entries for Settlement of Troubled Debt) Weaver Co. owes $1,98,600 to McBride Inc. The debt is a -year, 11% note. Because Weaver Co. is in financial trouble, McBride Inc. agrees to accept some property and cancel the entire debt. The property has a book value of $60,000 and a fair market value of $80,000. (a) Prepare the journal entry on Weaver s books for debt restructure. (b) Prepare the journal entry on McBride s books for debt restructure. *E1-27B (Debtor/Creditor Entries for Modification of Troubled Debt) Vista Corp. owes $600,000 to First National. The debt is a -year, % note due December 1, 201. Because Vista Corp. is in financial trouble, First National agrees to extend the maturity date to December 1, 2017, reduce the principal to $00,000, and reduce the interest rate to 6%, payable annually on December 1. (a) Prepare the journal entries on Vista s books on December 1, 201, 201, 2016, 2017. (b) Prepare the journal entries on First National s books on December 1, 201, 201, 2016, 2017.