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Chapter14: Bonds and Long-Term Notes

Exercises

An alternate exercise and problem set is available on the text website: www.mhhe.com/spiceland6e

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E 14-1

 

Bond valuation

 

 LO2

Your investment department has researched possible investments in corporate debt securities. Among the available investments are the following $100 million bond issues, each dated January 1, 2011. Prices were determined by underwriters at different times during the last few weeks.

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Each of the bond issues matures on December 31, 2030, and pays interest semiannually on June 30 and December 31. For bonds of similar risk and maturity, the market yield at January 1, 2011, is 10%.

Required:

Other things being equal, which of the bond issues offers the most attractive investment opportunity at the prices stated? the least attractive? Why?

E 14-2

 

Determine the price of bonds in various situations

 

 LO2

Determine the price of a $1 million bond issue under each of the following independent assumptions:

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E 14-3

 

Determine the price of bonds; issuance; effective interest

 

 LO2

The Bradford Company issued 10% bonds, dated January 1, with a face amount of $80 million on January 1, 2011. The bonds mature in 2020 (10 years). For bonds of similar risk and maturity, the market yield is 12%. Interest is paid semiannually on June 30 and December 31.

Required:

1.

 

Determine the price of the bonds at January 1, 2011.

2.

 

Prepare the journal entry to record their issuance by The Bradford Company on January 1, 2011.

p. 787

3.

 

Prepare the journal entry to record interest on June 30, 2011 (at the effective rate).

4.

 

Prepare the journal entry to record interest on December 31, 2011 (at the effective rate).

E 14-4

 

Investor; effective interest

 

 LO2

(Note: This is a variation of the previous exercise modified to consider the investor's perspective.) The Bradford Company sold the entire bond issue described in the previous exercise to Saxton-Bose Corporation.

Required:

1.

 

Prepare the journal entry to record the purchase of the bonds by Saxton-Bose on January 1, 2011.

2.

 

Prepare the journal entry to record interest revenue on June 30, 2011 (at the effective rate).

3.

 

Prepare the journal entry to record interest revenue on December 31, 2011 (at the effective rate).

E 14-5

 

Bonds; issuance; effective interest; financial statement effects

 

 LO2

Myriad Solutions, Inc., issued 10% bonds, dated January 1, with a face amount of $320 million on January 1, 2011 for $283,294,720. The bonds mature in 2021 (10 years). For bonds of similar risk and maturity the market yield is 12%. Interest is paid semiannually on June 30 and December 31.

Required:

1.

 

What would be the net amount of the liability Myriad would report in its balance sheet at December 31, 2011?

2.

 

What would be the amount related to the bonds that Myriad would report in its income statement for the year ended December 31, 2011?

3.

 

What would be the amount(s) related to the bonds that Myriad would report in its statement of cash flows for the year ended December 31, 2011?

E 14-6

 

Bonds; issuance; effective interest

 

 LO2

The Gorman Group issued $900,000 of 13% bonds on June 30, 2011, for $967,707. The bonds were dated on June 30 and mature on June 30, 2031 (20 years). The market yield for bonds of similar risk and maturity is 12%. Interest is paid semiannually on December 31 and June 30.

Required:

1.

 

Prepare the journal entry to record their issuance by The Gorman Group on June 30, 2011.

2.

 

Prepare the journal entry to record interest on December 31, 2011 (at the effective rate).

3.

 

Prepare the journal entry to record interest on June 30, 2012 (at the effective rate).

E 14-7

 

Determine the price of bonds; issuance; straight-line method

 

 LO2

Universal Foods issued 10% bonds, dated January 1, with a face amount of $150 million on January 1, 2011. The bonds mature on December 31, 2025 (15 years). The market rate of interest for similar issues was 12%. Interest is paid semiannually on June 30 and December 31. Universal uses the straight-line method.

Required:

1.

 

Determine the price of the bonds at January 1, 2011.

2.

 

Prepare the journal entry to record their issuance by Universal Foods on January 1, 2011.

3.

 

Prepare the journal entry to record interest on June 30, 2011.

4.

 

Prepare the journal entry to record interest on December 31, 2018.

E 14-8

 

Investor; straight-line method

 

 LO2

(Note: This is a variation of the previous exercise modified to consider the investor's perspective.) Universal Foods sold the entire bond issue described in the previous exercise to Wang Communications.

Required:

1.

 

Prepare the journal entry to record the purchase of the bonds by Wang Communications on January 1, 2011.

2.

 

Prepare the journal entry to record interest revenue on June 30, 2011.

3.

 

Prepare the journal entry to record interest revenue on December 31, 2018.

E 14-9

 

Issuance of bonds; effective interest; amortization schedule; financial statement effects

 

 LO2

When Patey Pontoons issued 6% bonds on January 1, 2011, with a face amount of $600,000, the market yield for bonds of similar risk and maturity was 7%. The bonds mature December 31, 2014 (4 years). Interest is paid semiannually on June 30 and December 31.

Required:

1.

 

Determine the price of the bonds at January 1, 2011.

2.

 

Prepare the journal entry to record their issuance by Patey on January 1, 2011.

3.

 

Prepare an amortization schedule that determines interest at the effective rate each period.

4.

 

Prepare the journal entry to record interest on June 30, 2011.

5.

 

What is the amount(s) related to the bonds that Patey will report in its balance sheet at December 31, 2011?

6.

 

What is the amount(s) related to the bonds that Patey will report in its income statement for the year ended December 31, 2011? (Ignore income taxes.)

7.

 

Prepare the appropriate journal entries at maturity on December 31, 2014.

p. 788

E 14-10

 

Issuance of bonds; effective interest; amortization schedule

 

 LO2

National Orthopedics Co. issued 9% bonds, dated January 1, with a face amount of $500,000 on January 1, 2011. The bonds mature in 2014 (4 years). For bonds of similar risk and maturity the market yield was 10%. Interest is paid semiannually on June 30 and December 31.

Required:

1.

 

Determine the price of the bonds at January 1, 2011.

2.

 

Prepare the journal entry to record their issuance by National on January 1, 2011.

3.

 

Prepare an amortization schedule that determines interest at the effective rate each period.

4.

 

Prepare the journal entry to record interest on June 30, 2011.

5.

 

Prepare the appropriate journal entries at maturity on December 31, 2014.

E 14-11

 

Bonds; effective interest; adjusting entry

 

 LO2

On February 1, 2011, Strauss-Lombardi issued 9% bonds, dated February 1, with a face amount of $800,000. The bonds sold for $731,364 and mature on January 31, 2031 (20 years). The market yield for bonds of similar risk and maturity was 10%. Interest is paid semiannually on July 31 and January 31. Strauss-Lombardi's fiscal year ends December 31.

Required:

1.

 

Prepare the journal entry to record their issuance by Strauss-Lombardi on February 1, 2011.

2.

 

Prepare the journal entry to record interest on July 31, 2011 (at the effective rate).

3.

 

Prepare the adjusting entry to accrue interest on December 31, 2011.

4.

 

Prepare the journal entry to record interest on January 31, 2012.

E 14-12

 

Bonds; straight-line method; adjusting entry

 

 LO2

On March 1, 2011, Stratford Lighting issued 14% bonds, dated March 1, with a face amount of $300,000. The bonds sold for $294,000 and mature on February 28, 2031 (20 years). Interest is paid semiannually on August 31 and February 28. Stratford uses the straight-line method and its fiscal year ends December 31.

Required:

1.

 

Prepare the journal entry to record the issuance of the bonds by Stratford Lighting on March 1, 2011.

2.

 

Prepare the journal entry to record interest on August 31, 2011.

3.

 

Prepare the journal entry to accrue interest on December 31, 2011.

4.

 

Prepare the journal entry to record interest on February 28, 2012.

E 14-13

 

Issuance of bonds; effective interest

 

 LO2

Federal Semiconductors issued 11% bonds, dated January 1, with a face amount of $800 million on January 1, 2011. The bonds sold for $739,814,813 and mature in 2030 (20 years). For bonds of similar risk and maturity the market yield was 12%. Interest is paid semiannually on June 30 and December 31.

Required:

1.

 

Prepare the journal entry to record their issuance by Federal on January 1, 2011.

2.

 

Prepare the journal entry to record interest on June 30, 2011 (at the effective rate).

3.

 

Prepare the journal entry to record interest on December 31, 2011 (at the effective rate).

4.

 

At what amount will Federal report the bonds among its liabilities in the December 31, 2011, balance sheet?

E 14-14

 

New debt issues; offerings announcements

 

 LO2

When companies offer new debt security issues, they publicize the offerings in the financial press and on Internet sites. Assume the following were among the debt offerings reported in December 2011:

New Securities Issues

Corporate

National Equipment Transfer Corporation—$200 million bonds via lead managers Second Tennessee Bank N.A. and Morgan, Dunavant & Co., according to a syndicate official. Terms: maturity, Dec. 15, 2017; coupon 7.46%; issue price, par; yield, 7.46%; noncallable, debt ratings: Ba-1 (Moody's Investors Service, Inc.), BBB + (Standard & Poor's).

IgWig Inc.—$350 million of notes via lead manager Stanley Brothers, Inc., according to a syndicate official. Terms: maturity, Dec. 1, 2019; coupon, 6.46%; Issue price, 99; yield, 6.56%; call date, NC; debt ratings: Baa-1 (Moody's Investors Service, Inc.), A (Standard & Poor's).

Required:

1.

 

Prepare the appropriate journal entries to record the sale of both issues to underwriters. Ignore share issue costs and assume no accrued interest.

2.

 

Prepare the appropriate journal entries to record the first semiannual interest payment for both issues.

p. 789

E 14-15

 

Error correction; accrued interest on bonds

 

 LO2

At the end of 2010, Majors Furniture Company failed to accrue $61,000 of interest expense that accrued during the last five months of 2010 on bonds payable. The bonds mature in 2024. The discount on the bonds is amortized by the straight-line method. The following entry was recorded on February 1, 2011, when the semiannual interest was paid:

Interest expense...........................................

73,200

 Discount on bonds payable...........................................

1,200

 Cash...........................................

72,000

Required:

Prepare any journal entry necessary to correct the error as of January 1, 2011, so that prior years' financial statements can be restated. Also, prepare any adjusting entry at February 28, 2011, related to the situation described. (Ignore income taxes.)

E 14-16

 

Error in amortization schedule

 

 LO3

Wilkins Food Products, Inc., acquired a packaging machine from Lawrence Specialists Corporation. Lawrence completed construction of the machine on January 1, 2009. In payment for the machine Wilkins issued a three-year installment note to be paid in three equal payments at the end of each year. The payments include interest at the rate of 10%.

   Lawrence made a conceptual error in preparing the amortization schedule, which Wilkins failed to discover until 2011. The error had caused Wilkins to understate interest expense by $45,000 in 2009 and $40,000 in 2010.

Required:

1.

 

Determine which accounts are incorrect as a result of these errors at January 1, 2011, before any adjustments. Explain your answer. (Ignore income taxes.)

2.

 

Prepare a journal entry to correct the error.

3.

 

What other step(s) would be taken in connection with the error?

E 14-17

 

Note with unrealistic interest rate; amortization schedule

 

 LO3

Amber Mining and Milling, Inc., contracted with Truax Corporation to have constructed a custom-made lathe. The machine was completed and ready for use on January 1, 2011. Amber paid for the lathe by issuing a $600,000, three-year note that specified 4% interest, payable annually on December 31 of each year. The cash market price of the lathe was unknown. It was determined by comparison with similar transactions that 12% was a reasonable rate of interest.

Required:

1.

 

Prepare the journal entry on January 1, 2011, for Amber Mining and Milling's purchase of the lathe.

2.

 

Prepare an amortization schedule for the three-year term of the note.

3.

 

Prepare the journal entries to record (a) interest for each of the three years and (b) payment of the note at maturity.

E 14-18

 

Installment note; amortization schedule

 

 LO3

American Food Services, Inc., acquired a packaging machine from Barton and Barton Corporation. Barton and Barton completed construction of the machine on January 1, 2011. In payment for the $4 million machine, American Food Services issued a four-year installment note to be paid in four equal payments at the end of each year. The payments include interest at the rate of 10%.

Required:

1.

 

Prepare the journal entry for American Food Services' purchase of the machine on January 1, 2011.

2.

 

Prepare an amortization schedule for the four-year term of the installment note.

3.

 

Prepare the journal entry for the first installment payment on December 31, 2011.

4.

 

Prepare the journal entry for the third installment payment on December 31, 2013.

E 14-19

 

Installment note

 

 LO3

LCD Industries purchased a supply of electronic components from Entel Corporation on November 1, 2011. In payment for the $24 million purchase, LCD issued a 1-year installment note to be paid in equal monthly payments at the end of each month. The payments include interest at the rate of 12%.

Required:

1.

 

Prepare the journal entry for LCD's purchase of the components on November 1, 2011.

2.

 

Prepare the journal entry for the first installment payment on November 30, 2011.

3.

 

What is the amount of interest expense that LCD will report in its income statement for the year ended December 31, 2011?

E 14-20

 

FASB codification research

 

 LO2 LO3 LO4

Access the FASB's Codification Research System at the FASB website (www.fasb.org). Determine the specific citation for accounting for each of the following items:

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1.

 

Disclosure requirements for maturities of long-term debt.

2.

 

How to estimate the value of a note when a note having no ready market and no interest rate is exchanged for a noncash asset without a readily available fair value.

3.

 

When the straight-line method can be used as an alternative to the interest method of determining interest.

E 14-21

 

Early extinguishment

 

 LO5

The balance sheet of Indian River Electronics Corporation as of December 31, 2010, included 12.25% bonds having a face amount of $90 million. The bonds had been issued in 2003 and had a remaining discount of $3 million at December 31, 2010. On January 1, 2011, Indian River Electronics called the bonds before their scheduled maturity at the call price of 102.

Required:

Prepare the journal entry by Indian River Electronics to record the redemption of the bonds at January 1, 2011.

E 14-22

 

Convertible bonds

 

 LO5

On January 1, 2011, Gless Textiles issued $12 million of 9%, 10-year convertible bonds at 101. The bonds pay interest on June 30 and December 31. Each $1,000 bond is convertible into 40 shares of Gless's no par common stock. Bonds that are similar in all respects, except that they are nonconvertible, currently are selling at 99 (that is, 99% of face amount). Century Services purchased 10% of the issue as an investment.

Required:

1.

 

Prepare the journal entries for the issuance of the bonds by Gless and the purchase of the bond investment by Century.

2.

 

Prepare the journal entries for the June 30, 2015, interest payment by both Gless and Century assuming both use the straight-line method.

3.

 

On July 1, 2016, when Gless's common stock had a market price of $33 per share, Century converted the bonds it held. Prepare the journal entries by both Gless and Century for the conversion of the bonds (book value method).

E 14-23

 

IFRS; convertible bonds

 

 LO5 LO7

Refer to the situation described in the previous exercise.

Required:

How might your solution to requirement 1 for the issuer of the bonds differ if Gless Textiles prepares its financial statements according to International Financial Reporting Standards? Include any appropriate journal entry in your response.

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E 14-24

 

Convertible bonds; induced conversion

 

 LO5

On January 1, 2011, Madison Products issued $40 million of 6%, 10-year convertible bonds at a net price of $40.8 million. Madison recently issued similar, but nonconvertible, bonds at 99 (that is, 99% of face amount). The bonds pay interest on June 30 and December 31. Each $1,000 bond is convertible into 30 shares of Madison's no par common stock. Madison records interest by the straight-line method.

   On June 1, 2013, Madison notified bondholders of its intent to call the bonds at face value plus a 1% call premium on July 1, 2013. By June 30 all bondholders had chosen to convert their bonds into shares as of the interest payment date. On June 30, Madison paid the semiannual interest and issued the requisite number of shares for the bonds being converted.

Required:

1.

 

Prepare the journal entry for the issuance of the bonds by Madison.

2.

 

Prepare the journal entry for the June 30, 2011, interest payment.

3.

 

Prepare the journal entries for the June 30, 2013, interest payment by Madison and the conversion of the bonds (book value method).

E 14-25

 

IFRS; convertible bonds

 

 LO5 LO7

Refer to the situation described in the previous exercise.

Required:

How might your solution for the issuer of the bonds differ if Madison Products prepares its financial statements according to International Financial Reporting Standards? Include any appropriate journal entries in your response.

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p. 791

E 14-26

 

Bonds with detachable warrants

 

 LO5

On August 1, 2011, Limbaugh Communications issued $30 million of 10% nonconvertible bonds at 104. The bonds are due on July 31, 2031. Each $1,000 bond was issued with 20 detachable stock warrants, each of which entitled the bondholder to purchase, for $60, one share of Limbaugh Communications' no par common stock. Interstate Containers purchased 20% of the bond issue. On August 1, 2011, the market value of the common stock was $58 per share and the market value of each warrant was $8.

   In February 2022, when Limbaugh's common stock had a market price of $72 per share and the unamortized discount balance was $1 million, Interstate Containers exercised the warrants it held.

Required:

1.

 

Prepare the journal entries on August 1, 2011, to record (a) the issuance of the bonds by Limbaugh and (b) the investment by Interstate.

2.

 

Prepare the journal entries for both Limbaugh and Interstate in February 2022, to record the exercise of the warrants.

E 14-27

 

Reporting bonds at fair value

 

 LO6

(Note: This is a variation of E 14-13 modified to consider the fair value option for reporting liabilities.) Federal Semiconductors issued 11% bonds, dated January 1, with a face amount of $800 million on January 1, 2011. The bonds sold for $739,814,813 and mature in 2030 (20 years). For bonds of similar risk and maturity the market yield was 12%. Interest is paid semiannually on June 30 and December 31. Federal determines interest at the effective rate. Federal elected the option to report these bonds at their fair value. On December 31, 2011, the fair value of the bonds was $730 million as determined by their market value in the over-the-counter market.

Required:

1.

 

Prepare the journal entry to adjust the bonds to their fair value for presentation in the December 31, 2011, balance sheet.

2.

 

Assume the fair value of the bonds on December 31, 2012, had risen to $736 million. Prepare the journal entry to adjust the bonds to their fair value for presentation in the December 31, 2012, balance sheet.

E 14-28

 

Reporting bonds at fair value

 

 LO6

On January 1, 2011, Rapid Airlines issued $200 million of its 8% bonds for $184 million. The bonds were priced to yield 10%. Interest is payable semiannually on June 30 and December 31. Rapid Airlines records interest at the effective rate and elected the option to report these bonds at their fair value. On December 31, 2011, the fair value of the bonds was $188 million as determined by their market value in the over-the-counter market.

Required:

1.

 

Prepare the journal entry to record interest on June 30, 2011 (the first interest payment).

2.

 

Prepare the journal entry to record interest on December 31, 2011 (the second interest payment).

3.

 

Prepare the journal entry to adjust the bonds to their fair value for presentation in the December 31, 2011, balance sheet.

E 14-29

 

Reporting bonds at fair value; calculate fair value

 

 LO6

On January 1, 2011, Essence Communications issued $800,000 of its 10-year, 8% bonds for $700,302. The bonds were priced to yield 10%. Interest is payable semiannually on June 30 and December 31. Essence Communications records interest at the effective rate and elected the option to report these bonds at their fair value. On December 31, 2011, the market interest rate for bonds of similar risk and maturity was 9%. The bonds are not traded on an active exchange.

Required:

1.

 

Using the information provided, estimate the fair value of the bonds at December 31, 2011.

2.

 

Prepare the journal entry to record interest on June 30, 2011 (the first interest payment).

3.

 

Prepare the journal entry to record interest on December 31, 2011 (the second interest payment).

4.

 

Prepare the journal entry to adjust the bonds to their fair value for presentation in the December 31, 2011, balance sheet.

E 14-30

 

Accrued interest

 

On March 1, 2011, Brown-Ferring Corporation issued $100 million of 12% bonds, dated January 1, 2011, for $99 million (plus accrued interest). The bonds mature on December 31, 2030, and pay interest semiannually on June 30 and December 31. Brown-Ferring's fiscal period is the calendar year.

Required:

1.

 

Determine the amount of accrued interest that was included in the proceeds received from the bond sale.

2.

 

Prepare the journal entry for the issuance of the bonds by Brown-Ferring.

E 14-31

 

Troubled debt restructuring; debt settled

 

At January 1, 2011, Transit Developments owed First City Bank Group $600,000, under an 11% note with three years remaining to maturity. Due to financial difficulties, Transit was unable to pay the previous year's interest.

   First City Bank Group agreed to settle Transit's debt in exchange for land having a fair value of $450,000. Transit purchased the land in 2007 for $325,000.

Required:

Prepare the journal entry(s) to record the restructuring of the debt by Transit Developments.

p. 792

E 14-32

 

Troubled debt restructuring; modification of terms

 

At January 1, 2011, Brainard Industries, Inc., owed Second BancCorp $12 million under a 10% note due December 31, 2013. Interest was paid last on December 31, 2009. Brainard was experiencing severe financial difficulties and asked Second BancCorp to modify the terms of the debt agreement. After negotiation Second BancCorp agreed to:

a.

 

Forgive the interest accrued for the year just ended.

b.

 

Reduce the remaining two years' interest payments to $1 million each and delay the first payment until December 31, 2012.

c.

 

Reduce the unpaid principal amount to $11 million.

Required:

Prepare the journal entries by Brainard Industries, Inc., necessitated by the restructuring of the debt at (1) January 1, 2011; (2) December 31, 2012; and (3) December 31, 2013.

E 14-33

 

Troubled debt restructuring; modification of terms; unknown effective rate

 

At January 1, 2011, NCI Industries, Inc., was indebted to First Federal Bank under a $240,000, 10% unsecured note. The note was signed January 1, 2007, and was due December 31, 2012. Annual interest was last paid on December 31, 2009. NCI was experiencing severe financial difficulties and negotiated a restructuring of the terms of the debt agreement. First Federal agreed to reduce last year's interest and the remaining two years' interest payments to $11,555 each and delay all payments until December 31, 2012, the maturity date.

Required:

Prepare the journal entries by NCI Industries, Inc., necessitated by the restructuring of the debt at: (1) January 1, 2011; (2) December 31, 2011; and (3) December 31, 2012.

E 14-34

 

FASB codification research; legal fees in a troubled debt restructuring

 

In negotiating and effecting a troubled debt restructuring, the creditor usually incurs various legal costs. The FASB Accounting Standards Codification represents the single source of authoritative U.S. generally accepted accounting principles.

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Required:

1.

 

Obtain the relevant authoritative literature on the accounting treatment of legal fees incurred by a creditor to effect a troubled debt restructuring using the FASB's Codification Research System at the FASB website (www.fasb.org).

2.

 

What is the specific citation that describes the guidelines for reporting legal costs?

3.

 

What is the appropriate accounting treatment?

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