5.
a.
b.
c.
d.
e.
f.
g.
÷12 =
0.006667
Rounded
6
5
*
** 8%
CHAPTER 10—Solutions
LONG-TERM LIABILITIES
3
2
4
Chapter 10, SE 1.
7
Chapter 10, SE 2.
1
467
* ÷ 12 =
**
2011
Dec. 31 35,000 5,000
30,000
$412,950
104,400 517,350
$30,000 × 13.765
Income Taxes Expense
Deferred Income Taxes
Income Taxes Payable
Present value of a single payment at the end of 30
periods at 6% (from Table 1*)
$600,000 × 0.174
(from Table 2*)
Total present value of Choice A
Choice B
Present value of 30 periodic payments at 6%
$600,000 ×
0.097
Chapter 10, SE 5.
Chapter 10, SE 4.
Interest for 1
9% 0.0075
Rounded
×
=
1 356,000 16,000
=
1 356,000 16,000
340,000
÷(5 ×
=××6/
=
Apr.
discount )
To pay semiannual interest and amortize
Cash
$8,000,000
$8,000,000 0.085
Unamortized Bond Discount
Bond Interest Expense
0.085
2012
$340,000
$16,000 12
2
Chapter 10, SE 7.
$160,000 years
$7,840,000
Unamortized Bond Discount
Bond Interest ExpenseOct.
0.98
$340,000 12
$8,000,000
469
1 10,200,000
200,000
÷(5 ×
=××6/
=
Unamortized Bond Premium
$20,000
$10,000,000 0.080 12
$400,000
$200,000 years
2)
Chapter 10, SE 8.
2011
Apr. Cash
× 1.06 =
31 9,434
66 9,500
( $200,000 × 0.095 × 6 / )
– ( $212,000 × 0.089 × 6 / )
× 1.04 =
a.
b.
Amount paid: $100,000 × 1.03 = $103,000
There is a loss on retirement of $500, computed as follows:
Cash paid – Book value: $103,000 – ($100,000 + $2,500) = $500
$240,000 ×=
$400,000
Chapter 10, SE 11.
$10,500 $6,300
Chapter 10, SE 9.
Unamortized Bond Premium
Recorded accrued semiannual interest and
Bond Interest Payable
Bond Interest ExpenseAug.
amortized premium on 9.5%, 20-year bonds
12
12
471
2011
Mar. 1 1,200,000 24,000
240,000
936,000
×20 =
×=
$2,000,000
$1,200,000 × $40,000 = $24,000
24,000 shares $10 $240,000
Converted $1,200,000 of 6% bonds into
common stock at the rate of 20 shares for
each $1,000 bond
1,200 shares 24,000 shares
Chapter 10, SE 12.
Bonds Payable
Unamortized Bond Discount
Common Stock
Additional Paid-In Capital
4.
Chapter 10, E 1.
to ensure proper matching of all the borrowing costs associated with bonds
payable. Interest payment dates rarely coincide with the end of the accounting
period.
473
$1,650
$2,900
= = 4.1
= = 5.6 Times
Times
The interest coverage ratio declined from 2011 to 2012 from 5.6 to 4.1 times. The
Reduction
in Debt
300,000 300,000
3,000
at End of Period
Unpaid Balance
mortgage
Mortgage Interest Expense
Building
Entries prepared in journal form
Month at 1% on
Month 1
Month
2.
Unpaid Balance
Chapter 10, E 4.
1. Monthly payment schedule prepared
Interest for 1
Monthly
Payment
Mortgage Payable
Purchased building by signing a
38,851
69,931
× 0.15 = 67,521
18,479 86,000
( – ) × 0.15
=
Chapter 10, E 5.
1. Present value calculated
Interest Expense
2.
Journal entry prepared to record the lease agreement
3. Journal entry prepared to record depreciation for the first year
Depreciation Expense—Capital Lease Equipment
Accumulated Depreciation—Capital Lease
4. Journal entries prepared to record lease payments
Year 1
Capital Lease Obligations
Year 2 Interest Expense
$67,521
Cash
Made lease payment for second year
$16,069$466,206
476
2011
×38,800
× $412,950
×69,600 482,550
$1,002,822
*From Appendix B
Issue price (total present value) of both bonds
Issue price (total present value) of Choice B
$30,000
$400,000
0.097
of 30 periods at 6% (from Table 1*):
Chapter 10, E 6.
$400,000 0.174
13.765
Present value of a single payment at the end
477
a.
(from Table 2*): $6,000 × 12.462 $ 74,772
(from Table 1*): $150,000 × 0.377 56,550
$131,322
b. (from Table 2*): $6,000 × 14.878 $ 89,268
(from Table 1*): $150,000 × 0.554 83,100
$172,368
Present value of 20 periodic payments at 5%
Issue price (total present value) of bond issue
Present value of a single payment at the end of 20 periods at 3%
Present value of a single payment at the end of 20 periods at 5%
Chapter 10, E 8.
Present value of 20 periodic payments at 3%
Issue price (total present value) of bond issue
Face value = ÷
Face value = ÷
Face value = ÷
Face value = ÷
0.099
$50,000,000
0.021
Chapter 10, E 9.
0.057
$50,000,000
0.009
$50,000,000
$50,000,000
2. a. × × 6 / 12 =
b. ( $320,000 ÷ 10 ÷ =
b. ( $320,000 ÷ 10 ÷ =
c. –=
2
Amortization of bond premium:
years )
$420,000
$8,000,000 0.105
$420,000
Amortization of bond premium: $16,000
$16,000 $404,000
Interest expense:
1.04
$420,000
$8,000,000
0.105
Chapter 10, E 10.
×=
Sept. 1 186,000 16,000
=+=
2012
Mar. 1 186,000 16,000
=+=
$4,000,000
Chapter 10, E 11.
0.96
$186,000
0.085$4,000,000
$4,000,000
Bond Interest Expense $3,840,000
$170,000
$170,000
Unamortized Bond Discount
$16,000
$170,000
$170,000 $16,000 $186,000
0.085
Bond Interest Expense
481
2011
Mar. 1 5,150,000
150,000
5,000,000
×
=
Sept. 1 160,000
15,000
175,000
Cash
Bond Interest Expense
Unamortized Bond Premium
$5,150,000
Issued 7.0%, 5-year bonds at 103
$5,000,000 1.03
Unamortized Bond Premium
Bonds Payable
Chapter 10, E 12.
Cash
1. a. × 1.06 =
2. a. × 0.095 × 6 / =
b. $250,000 × 0.095 × 6 / )
3. a. × 0.095 × 6 / =
$265,000 – $82 × 6 / 12
–=
c. – $86 =
] =
12
Amortization of bond premium:
$11,875
$11,875 $11,789
$86
Interest expense:
$11,789
[( ) ×
0.089
Chapter 10, E 13.
$250,000
$250,000
$265,000
$11,875
483
(××6/12
–=
2012
[ ( +
×6/12]–( ×
$120,000 $6,646
$126,646
Chapter 10, E 14.
0.10 ) –
0.11
$2,400,000
) =
2. ( ÷ ) × 20 =
3.
$600,000
30,000
$570,000
Bonds payable
2. Gain or loss calculated
Unamortized bond discount*
Unamortized discount attributable to retired bonds:
Total liabilities are reduced by $570,000, as follows:
Decrease in total liabilities
Chapter 10, E 15.
×150,500
$700,000
Current market value of the bonds calculated
Chapter 10, E 17.
1.
2.
Face value
0.215
$700,000
a.
×=
b. 171,864 171,864
×= 14,700
9,300 24,000
0.09
1.
Periodic Payment × Factor (Table 2 in Appendix B: 9%, 12 periods) = Present
Value of Lease $171,8647.161
Recorded the lease contract
$171,864
$15,468
Chapter 10, P 1.
Lease option examined
Present value calculated
$24,000
Journal entry prepared to record the lease agreement
Capital Lease Building
Capital Lease Obligations
Year 2
Interest Expense
Capital Lease Obligations
a.
Reduction
in Debt
$800
806
812
b. 160,000 160,000
Journal entries prepared
Chapter 10, P 1. (Continued)
Interest for 1
Monthly payment schedule prepared
2.
2,000 1,194
$1,200
3158,394
159,200
$160,000
157,582
0$2,000
2
1
1,1882,000
Month at 0.75% on
Unpaid Balance
Monthly
Payment
Purchase option examined
Month Unpaid Balance
at End of Period
3. Options discussed
options result in an increase in assets and in liabilities.
An advantage of the lease is that it has a limited term and the company has no more
responsibility after completing the lease. A disadvantage is that if the company still
needs customer parking after 12 years, it will have to make arrangements for new
parking facilities, which could be accomplished by releasing the current facility if it
Chapter 10, P 1. (Continued)
Based on the calculation, it appears that the purchase is best because the cost of
$160,000 is less than the net present value of the lease, which is $171,864. Both
Chapter 10, P 2.
A decrease in the market interest rate will increase the price of the bond, therefore
issuing it at a premium. The amount of cash received will exceed face value. The in-
2. User Insight: Effect of market interest rates
b.
b.
(3) = + = $532,500
$10,000,000Amount of bonds payable:
1.03 $10,300,000
Chapter 10, P 3.
$10,000,000
$10,000,000
$10,000,000
Amount of bonds payable:
0.97 $9,700,000
a. = × $10,400,000
b.
a.
b. ÷ × 25 = 250,000
c.
Bonds payable and its accompanying unamortized discount will
capital will be increased in stockholders’ equity.
be reduced in the liabilities. Common stock and additional paid-in
No gain or loss occurs in a bond conversion because the issued stock is re-
Gain or loss calculated:
$1,000$10,000,000 sharesbonds
Numbers of shares of common stock computed:
Effects of liabilities and stockholders’ equity shown:
shares
4. Bonds converted to common stock 10 years later
Cash to retire bonds: 1.04
Chapter 10, P 3. (Continued)
Call amount $10,000,000 =
3. Bonds called and retired 10 years later
corded at the carrying value of the bonds that are converted.
Decrease in liabilities
risen, the bondholders will be better off electing to convert the bonds into common
stock (the result in requirement 4) than selling them back to the company at the call
rather than accepting the call price. Since the price of the company’s stock has
The company can improve its debt to equity ratio without using cash by calling the
bonds, thereby inducing the bondholders to convert their bonds in common stock
5. User Insight: Strategy of calling bonds when stock price has risen
Chapter 10, P 3. (Continued)
2011
Aug. 31 94,000
1,000 95,000
=
2012
Feb. 28 94,000
1,000 95,000
Sold 9.5%, 25-year bonds at 102.5
Bond Interest Expense
Unamortized Bond Premium
12
$2,000,000
$95,000
Unamortized Bond Premium
0.095
Chapter 10, P 4.
Bond Interest Expense
Cash
1. Journal entries prepared for bonds issued at more than face value
2011
Aug. 31 96,000 1,000
95,000
÷(25 ×2
=××6/
=
the discount on 9.5%, 25-year bonds
years
Chapter 10, P 4. (Continued)
Cash
Paid semiannual interest and amortized
Bond Interest Expense
Unamortized Bond Discount
Sold 9.5%, 25-year bonds at 97.5
)$50,000
$1,000 12$2,000,000 0.095
3.
Market interest rates play a role in creating the premium and discount in the pre-
2. Journal entries prepared for bonds issued at less than face value
User Insight: Role of market interest rates
31 94,300
( × 0.095 × 6 / 12 )
– ( × 0.092 × 6 / 12 )
= $95,000 – =
( × 0.095 × 6 / 12 )
– ( × 0.092 × 6 / 12 )
$2,049,300 $94,268
$700
2012
$2,050,000 $94,300
Aug. Bond Interest Expense
Sold 9.5%, 25-year bonds at 102.5
1. Journal entries prepared for bonds issued at more than face value
Chapter 10, P 5.
2011
*
31 95,550 550
95,000
(××6/12)
– ( × × 6 / 12 )
= $95,550 – =
Market interest rates play a role in creating the premium and discount in the pre-
3. User Insight: Role of market interest rates
$550
$2,000,000 0.095
$95,000
the discount on 9.5%, 25-year bonds
$1,950,000 0.098
Cash
Paid semiannual interest and amortized
Aug. Bond Interest Expense
Unamortized Bond Discount
Sold 9.5%, 25-year bonds at 97.5
2. Journal entries prepared for bonds issued at less than face value
Chapter 10, P 5. (Continued)
2011
a.
×=
154,062 154,062
×= 11,871
6,129
$154,0628.559
Capital Lease Obligations
Y
ear 2
Chapter 10, P 6.
Present value calculated
Interest Expense
b. Journal entry prepared to record the lease agreement
Capital Lease Equipment
c. Journal entry prepared to record depreciation for the first year
Value of Lease
0.08
$154,062
$18,000
$12,325
1. Lease option examined
Recorded the lease contract
Capital Lease Obligations
Periodic Payment × Factor (Table 2 in Appendix B: 8%, 15 periods) = Present
Reduction
in Debt
$696
701
705
Month at 0.67% on Unpaid Balance
1,500
$804
3
Unpaid Balance
119,304
Payment
2
Monthly
Chapter 10, P 6. (Continued)
a. Monthly payment schedule prepared
Interest for 1
118,603
0$1,500
at End of Period
$120,000
1
Month
2. Purchase option examined
799
7951,500 117,898
3. Options discussed
Chapter 10, P 6. (Continued)
Based on the calculation, it appears that the purchase is best because the cost of
$120,000 is less than the net present value of the lease, which is $154,062. Both op-
tions result in an increase in assets and in liabilities.
An advantage of the lease is that it has a limited term and the company has no more
responsibility after completing the lease. A disadvantage is that if the company still
needs storage space after 15 years, it will have to make arrangements for new stor-
age facilities, which could be accomplished by releasing the current facility if it is
a. ×=
d. (1) × × 6 / 12 $190,000
(3) = + = $192,800
Calculation of cash received:
1. Bonds issued at 103.5 on May 1, 2011
Chapter 10, P 7.
$4,000,000 1.035
$4,140,000
0.965 $3,860,000
2. Bonds issued at 96.5 on May 1, 2011
b.
a.
b. ÷ × = 160,000
×( 84,000)
$3,916,000
Numbers of shares of common stock computed:
$4,000,000
Chapter 10, P 7. (Continued)
Call amount
4. Bonds converted to common stock 10 years later
1.03 =
Gain or loss calculated:
Carrying value:
$140,000
Bond carrying value
corded at the carrying value of the bonds that are converted.
$140,000 discount, or $84,000, remains to be amortized. Increase in stock-
Since the call takes places after 10 years of a 25-year period, 60 percent of the
0.6Unamortized bond discount
No gain or loss occurs in a bond conversion because the issued stock is re-
holders’ equity:
risen, the bondholders will be better off electing to convert the bonds into common
stock (the result in requirement 4) than selling them back to the company at the call
5. User Insight: Strategy of calling bonds when stock price has risen
Chapter 10, P 7. (Continued)
rather than accepting the call price. Since the price of the company’s stock has
The company can improve its debt to equity ratio without using cash by calling the
bonds, thereby inducing the bondholders to convert their bonds in common stock
30 517,500
7,500
=
××6/
=
31 517,500
7,500 525,000
Chapter 10, P 8.
2011
Sold 10.5%, 20-year bonds at 103
Unamortized Bond Premium
Nov. Bond Interest Expense
Unamortized Bond Premium
2012
May Bond Interest Expense
Cash
1. Journal entries prepared for bonds issued at more than face value
$525,000
$10,000,000
0.105 12
30 532,500 7,500
=
31 532,500 7,500
=
Chapter 10, P 8. (Continued)
2011
Sold 10.5%, 20-year bonds at 97
Unamortized Bond Discount
Nov. Bond Interest Expense
2012
$10,000,000
May Bond Interest Expense
Unamortized Bond Discount
User Insight: Role of market interest rates
Market interest rates play a role in creating the premium and discount in the pre-
12
3.
0.105
2. Journal entries prepared for bonds issued at less than face value
$525,000
1 10,300,000 300,000
10,000,000
30 394,000
6,000
400,000
Chapter 10, P 9.
2011
June Cash
Unamortized Bond Premium
Bonds Payable
Sold 8%, 25-year bonds at 103
Unamortized Bond Premium
Cash
Nov. Bond Interest Expense
Paid semiannual interest and amortized
the premium on 8%, 25-year bonds
0.080
$10,000,000
1. Journal entries prepared for bonds issued at more than face value
1 9,700,000
300,000 10,000,000
=
31 406,000 6,000
=
Chapter 10, P 9. (Continued)
2011
June Cash
Unamortized Bond Discount
Bonds Payable
Sold 8%, 25-year bonds at 97
12$10,000,000
May Bond Interest Expense
Unamortized Bond Discount
3. User Insight: Role of market interest rates
Market interest rates play a role in creating the premium and discount in the pre-
0.080
2. Journal entries prepared for bonds issued at less than face value
$400,000
2012
– ( × × 6 / 12 )
=–=
– ( × × 6 / 12 )
=–=
Chapter 10, P 10.
$8,550
0.093
$15,291,450 $711,052$720,000
0.093 $8,948
$711,450$720,000
2012
$15,300,000
2011
Sold 9.6%, 10-year bonds at 102
1. Journal entries prepared for bonds issued at more than face value
*
30 734,400 14,400
– ( × × 6 / 12 )
= $734,400 – =
2012
Chapter 10, P 10. (Continued)
Sold 9.6%, 10-year bonds at 96
2011
Sept.
$720,000 $14,400
Bond Interest Expense
Market interest rates play a role in creating the premium and discount in the pre-
vious example. When market rates are above the face interest rate, a discount
Unamortized Bond Discount
0.096
2. Journal entries prepared for bonds issued at less than face value
3. User Insight: Role of market interest rates
exists. When market rates are below the face interest rate, a premium exists.
509
a corresponding long-term liability. The lease payments are then considered to be
future payments do not appear on the balance sheet as liabilities, any ratio that in-
Chapter 10, C 1.
chase the assets it is leasing. Walgreens’ operating lease commitments are greater
Future commitments for operating leases, such as those described for Walgreens,
asset is leased, under a capital lease, it must be recorded as a long-term asset with
than the liabilities shown on the balance sheet.
as an operating expense on the income statement.
make payments for five years or more in the future. Since these commitments for
it would if the company recognized the future lease payments as liabilities. Further,
cludes debt, such as the debt to equity or interest coverage ratio, looks better than
option to buy the asset at a nominal price at the end of the lease. Even though the
about the same as the useful life of the asset, and stipulates that the lessee has the
do not appear on the balance sheet. The $2.0 billion for the current year will appear
Often these operating leases represent commitments on the part of the company to
partly interest and partly repayment of the debt.
free cash flow is improved because the company is not making expenditures to pur-
A capital lease is a long-term lease that cannot be canceled, has a duration that is
health.
If the lease commitments were shown on the balance sheet, a more realistic picture
of the company’s assets, debt, and interest expense and debt to equity, interest
coverage, and free cash flow ratios would be provided in the company’s financial
Chapter 10, C 2.
ceive the company as being a bigger risk.
and the interest payment were 4.875 percent of the face value of the bond. If the
Leverage is a corporation’s ability to increase earnings by earning more on its as-
bond had originally been issued at a premium or a discount, the interest expense
would be different.
Chapter 10, C 3.
bond. Since the original issue price was face value or 100, both the interest expense
Chapter 10, C 4.
1.08). The current market value of the bond did not affect either the interest expense
or the interest payment. These amounts depend on the original issue price of the
by increasing earnings per share through leverage may not work if investors per-
without an increase in earnings. This strategy for increasing the value of the stock
sets than it is paying in interest on its debt. This plan results in higher leverage
because it involves issuing debt and reducing the amount of stock outstanding by
buying it back. The ratio that reflects leverage and financial risk is the debt to equity
ratio. The higher the debt to equity ratio, the more leverage and the more financial
risk. The stock buyback will reduce the number of shares outstanding, reducing the
denominator in computing earnings per share. Thus, earnings per share increases
512
Chapter 10, C 5.
that the value of the underlying stock will increase and therefore the value of the
bonds will also increase. Second, by issuing convertible notes, the company does
There are several good reasons for issuing convertible notes instead of noncon-
vertible notes or common stock. First, the effective interest rate of 6.875 percent is
much lower than the company would have to pay if the notes were nonconvertible.
The investors are willing to give up some current interest in return for the prospect
not have to give up any current control of the company. Noteholders do not have
1.
2.
3.
that must be paid in the future. (Note: The instructor may want to point out that
underfunded pension plans are a major problem of federal, state, and local gov-
ernments including school districts.)
fund employees’ future pension benefits. CVS’ plan is underfunded by $240 mil-
lion ($612 million – $372 million) which means CVS has a long-term obligation
the life of the lease is shorter than the life of the asset being leased. In contrast,
a capital lease is more like an installment purchase where the life of the lease is
Chapter 10, C 6.
roughly the life of the asset. Companies like CVS find it advantageous to struc-
$525
$509
76.3%
2008: =
$34,574
Chapter 10, C 7.
CVS’s Interest Coverage Ratio:
= 12.3 Times
= 11.9 Times
515
balance-sheet" financing.
184.0%
$4,953
=
Southwest’s Interest Coverage Ratio:
2008:
$186
=
2009 and 11.9 in 2008), whereas Southwest’s interest coverage ratios are lower (1.9
in 2008 to 161.1 percent in 2009. CVS has higher interest coverage ratios (12.3 in
million, respectively, in the case of CVS) were considered in addition to interest ex-
pense, both companies’ interest (and lease) coverage ratios would decline sharply.
lion. If the present value of these leases were to be considered as long-term debt,
the debt to equity ratios of both companies, especially CVS, would increase dra-
matically. Further, if the lease expense for 2008 and 2009 ($1,724 million and $1,899
These examples illustrate why long-term operating leases are considered "off-
total lease commitments were $26,913 million compared to Southwest’s $2,659 mil-
companies leased a substantial portion of their assets on long-term leases. CVS’s
1.9 Times
in 2009 and 3.1 in 2008). However, these figures do not tell the whole story. Both
2009. Southwest’s debt to equity was higher. Its ratio decreased from 184.0 percent
516
Chapter 10, C 8.
Kwak’s proposal is not considered acceptable accounting practice because no