Connect

Close
Skip to eBook contentSkip to Chapter linksSkip to Content links for this ChapterSkip to eBook links

Chapter14: Bonds and Long-Term Notes

Problems

<a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=jpg::::/sites/dl/premium/0077328787/student/820130/Connect_Accounting_CMYK.jpg','popWin', 'width=NaN,height=NaN,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (38.0K)</a>

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

P 14-1

 

Determining the price of bonds; discount and premium; issuer and investor

 

 LO2

On January 1, 2011, Instaform, Inc., issued 10% bonds with a face amount of $50 million, dated January 1. The bonds mature in 2030 (20 years). The market yield for bonds of similar risk and maturity is 12%. Interest is paid semiannually.

Required:

1.

 

Determine the price of the bonds at January 1, 2011, and prepare the journal entry to record their issuance by Instaform.

2.

 

Assume the market rate was 9%. Determine the price of the bonds at January 1, 2011, and prepare the journal entry to record their issuance by Instaform.

3.

 

Assume Broadcourt Electronics purchased the entire issue in a private placement of the bonds. Using the data in requirement 2, prepare the journal entry to record the purchase by Broadcourt.

P 14-2

 

Effective interest; financial statement effects

 

 LO2

On January 1, 2011, Baddour, Inc., issued 10% bonds with a face amount of $160 million. The bonds were priced at $140 million to yield 12%. Interest is paid semiannually on June 30 and December 31. Baddour's fiscal year ends September 30.

Required:

1.

 

What amount(s) related to the bonds would Baddour report in its balance sheet at September 30, 2011?

2.

 

What amount(s) related to the bonds would Baddour report in its income statement for the year ended September 30, 2011?

3.

 

What amount(s) related to the bonds would Baddour report in its statement of cash flows for the year ended September 30, 2011? In which section(s) should the amount(s) appear?

P 14-3

 

Straight-line and effective interest compared

 

 LO2

On January 1, 2011, Bradley Recreational Products issued $100,000, 9%, four-year bonds. Interest is paid semiannually on June 30 and December 31. The bonds were issued at $96,768 to yield an annual return of 10%.

<a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=jpg::::/sites/dl/premium/0077328787/student/820130/excel_icon.jpg','popWin', 'width=NaN,height=NaN,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (14.0K)</a>

Required:

1.

 

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

2.

 

Prepare an amortization schedule by the straight-line method.

3.

 

Prepare the journal entries to record interest expense on June 30, 2013, by each of the two approaches.

4.

 

Explain why the pattern of interest differs between the two methods.

5.

 

Assuming the market rate is still 10%, what price would a second investor pay the first investor on June 30, 2013, for $10,000 of the bonds?

P 14-4

 

Bond amortization schedule

 

 LO2

On January 1, 2011, Tennessee Harvester Corporation issued debenture bonds that pay interest semiannually on June 30 and December 31. Portions of the bond amortization schedule appear below:

<a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=jpg::::/sites/dl/premium/0077328787/student/pg795_1.jpg','popWin', 'width=NaN,height=NaN,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (K)</a>

Required:

1.

 

What is the face amount of the bonds?

2.

 

What is the initial selling price of the bonds?

3.

 

What is the term to maturity in years?

4.

 

Interest is determined by what approach?

5.

 

What is the stated annual interest rate?

6.

 

What is the effective annual interest rate?

7.

 

What is the total cash interest paid over the term to maturity?

8.

 

What is the total effective interest expense recorded over the term to maturity?

P 14-5

 

Issuer and investor; effective interest; amortization schedule; adjusting entries

 

 LO2

On February 1, 2011, Cromley Motor Products issued 9% bonds, dated February 1, with a face amount of $80 million. The bonds mature on January 31, 2015 (4 years). The market yield for bonds of similar risk and maturity was 10%. Interest is paid semiannually on July 31 and January 31. Barnwell Industries acquired $80,000 of the bonds as a long-term investment. The fiscal years of both firms end December 31.

<a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=jpg::::/sites/dl/premium/0077328787/student/820130/excel_icon.jpg','popWin', 'width=NaN,height=NaN,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (14.0K)</a>
<a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=jpg::::/sites/dl/premium/0077328787/student/star_icon.jpg','popWin', 'width=NaN,height=NaN,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (K)</a>

Required:

1.

 

Determine the price of the bonds issued on February 1, 2011.

2.

 

Prepare amortization schedules that indicate (a) Cromley's effective interest expense and (b) Barnwell's effective interest revenue for each interest period during the term to maturity.

3.

 

Prepare the journal entries to record (a) the issuance of the bonds by Cromley and (b) Barnwell's investment on February 1, 2011.

4.

 

Prepare the journal entries by both firms to record all subsequent events related to the bonds through January 31, 2013.

P 14-6

 

Issuer and investor; straight-line method; adjusting entries

 

On April 1, 2011, Western Communications, Inc., issued 12% bonds, dated March 1, 2011, with face amount of $30 million. The bonds sold for $29.3 million and mature on February 28, 2014. Interest is paid semiannually on August 31 and February 28. Stillworth Corporation acquired $30,000 of the bonds as a long-term investment. The fiscal years of both firms end December 31, and both firms use the straight-line method.

Required:

1.

 

Prepare the journal entries to record (a) issuance of the bonds by Western and (b) Stillworth's investment on April 1, 2011.

2.

 

Prepare the journal entries by both firms to record all subsequent events related to the bonds through maturity.

P 14-7

 

Issuer and investor; effective interest

 

 LO2

McWherter Instruments sold $400 million of 8% bonds, dated January 1, on January 1, 2011. The bonds mature on December 31, 2030 (20 years). For bonds of similar risk and maturity, the market yield was 10%. Interest is paid semiannually on June 30 and December 31. Blanton Technologies, Inc., purchased $400,000 of the bonds as a long-term investment.

<a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=jpg::::/sites/dl/premium/0077328787/student/820130/excel_icon.jpg','popWin', 'width=NaN,height=NaN,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (14.0K)</a>

Required:

1.

 

Determine the price of the bonds issued on January 1, 2011.

2.

 

Prepare the journal entries to record (a) their issuance by McWherter and (b) Blanton's investment on January 1, 2011.

3.

 

Prepare the journal entries by (a) McWherter and (b) Blanton to record interest on June 30, 2011 (at the effective rate).

4.

 

Prepare the journal entries by (a) McWherter and (b) Blanton to record interest on December 31, 2011 (at the effective rate).

P 14-8

 

Bonds; effective interest; partial period interest; financial statement effects

 

 LO2

The fiscal year ends December 31 for Lake Hamilton Development. To provide funding for its Moonlight Bay project, LHD issued 5% bonds with a face amount of $500,000 on November 1, 2011. The bonds sold for $442,215, a price to yield the market rate of 6%. The bonds mature October 31, 2030 (20 years). Interest is paid semiannually on April 30 and October 31.

<a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=jpg::::/sites/dl/premium/0077328787/student/star_icon.jpg','popWin', 'width=NaN,height=NaN,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (K)</a>

Required:

1.

 

What amount of interest expense related to the bonds will LHD report in its income statement for the year ending December 31, 2011?

2.

 

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

3.

 

What amount of interest expense related to the bonds will LHD report in its income statement for the year ending December 31, 2012?

4.

 

What amount(s) related to the bonds will LHD report in its balance sheet at December 31, 2012?

P 14-9

 

Zero-coupon bonds

 

 LO2

On January 1, 2011, Darnell Window and Pane issued $18 million of 10-year, zero-coupon bonds for $5,795,518.

Required:

1.

 

Prepare the journal entry to record the bond issue.

2.

 

Determine the effective rate of interest.

3.

 

Prepare the journal entry to record annual interest expense at December 31, 2011.

4.

 

Prepare the journal entry to record annual interest expense at December 31, 2012.

5.

 

Prepare the journal entry to record the extinguishment at maturity.

P 14-10

 

Notes exchanged for assets; unknown effective rate

 

 LO3

At the beginning of the year, Lambert Motors issued the three notes described below. Interest is paid at year-end.

1.

 

The company issued a two-year, 12%, $600,000 note in exchange for a tract of land. The current market rate of interest is 12%.

2.

 

Lambert acquired some office equipment with a fair value of $94,643 by issuing a one-year, $100,000 note. The stated interest on the note is 6%.

3.

 

The company purchased a building by issuing a three-year installment note. The note is to be repaid in equal installments of $1 million per year beginning one year hence. The current market rate of interest is 12%.

Required:

Prepare the journal entries to record each of the three transactions and the interest expense at the end of the first year for each.

P 14-11

 

Note with unrealistic interest rate

 

 LO3

At January 1, 2011, Brant Cargo acquired equipment by issuing a five-year, $150,000 (payable at maturity), 4% note. The market rate of interest for notes of similar risk is 10%.

Required:

1.

 

Prepare the journal entry for Brant Cargo to record the purchase of the equipment.

2.

 

Prepare the journal entry for Brant Cargo to record the interest at December 31, 2011.

3.

 

Prepare the journal entry for Brant Cargo to record the interest at December 31, 2012.

P 14-12

 

Noninterest-bearing installment note

 

 LO3

At the beginning of 2011, VHF Industries acquired a machine with a fair market value of $6,074,700 by issuing a four-year, noninterest-bearing note in the face amount of $8 million. The note is payable in four annual installments of $2 million at the end of each year.

Required:

1.

 

What is the effective rate of interest implicit in the agreement?

2.

 

Prepare the journal entry to record the purchase of the machine.

3.

 

Prepare the journal entry to record the first installment payment at December 31, 2011.

4.

 

Prepare the journal entry to record the second installment payment at December 31, 2012.

5.

 

Suppose the market value of the machine was unknown at the time of purchase, but the market rate of interest for notes of similar risk was 11%. Prepare the journal entry to record the purchase of the machine.

P 14-13

 

Note and installment note with unrealistic interest rate

 

 LO3

Braxton Technologies, Inc., constructed a conveyor for A&G Warehousers that was completed and ready for use on January 1, 2011. A&G paid for the conveyor by issuing a $100,000, four-year note that specified 5% interest to be paid on December 31 of each year, and the note is to be repaid at the end of four years. The conveyor was custom-built for A&G, so its cash price was unknown. By comparison with similar transactions it was determined that a reasonable interest rate was 10%.

<a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=jpg::::/sites/dl/premium/0077328787/student/820130/excel_icon.jpg','popWin', 'width=NaN,height=NaN,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (14.0K)</a>

Required:

1.

 

Prepare the journal entry for A&G's purchase of the conveyor on January 1, 2011.

2.

 

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

3.

 

Prepare the journal entry for A&G's third interest payment on December 31, 2013.

4.

 

If A&G's note had been an installment note to be paid in four equal payments at the end of each year beginning December 31, 2011, what would be the amount of each installment?

5.

 

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

6.

 

Prepare the journal entry for A&G's third installment payment on December 31, 2013.

P 14-14

 

Early extinguishment of debt

 

 LO5

Three years ago American Insulation Corporation issued 10 percent, $800,000, 10-year bonds for $770,000. Debt issue costs were $3,000. American Insulation exercised its call privilege and retired the bonds for $790,000. The corporation uses the straight-line method both to determine interest and to amortize debt issue costs.

Required:

Prepare the journal entry to record the call of the bonds.

P 14-15

 

Early extinguishment; effective interest

 

 LO5

The long-term liability section of Twin Digital Corporation's balance sheet as of December 31, 2010, included 12% bonds having a face amount of $20 million and a remaining discount of $1 million. Disclosure notes indicate the bonds were issued to yield 14%.

   Interest expense is recorded at the effective interest rate and paid on January 1 and July 1 of each year. On July 1, 2011, Twin Digital retired the bonds at 102 ($20.4 million) before their scheduled maturity.

Required:

1.

 

Prepare the journal entry by Twin Digital to record the semiannual interest on July 1, 2011.

2.

 

Prepare the journal entry by Twin Digital to record the redemption of the bonds on July 1, 2011.

P 14-16

 

Debt issue costs; issuance; expensing; early extinguishment; straight-line interest

 

 LO2 LO5

Cupola Fan Corporation issued 10%, $400,000, 10-year bonds for $385,000 on June 30, 2011. Debt issue costs were $1,500. Interest is paid semiannually on December 31 and June 30. One year from the issue date (July 1, 2012), the corporation exercised its call privilege and retired the bonds for $395,000. The corporation uses the straight-line method both to determine interest expense and to amortize debt issue costs.

Required:

1.

 

Prepare the journal entry to record the issuance of the bonds.

2.

 

Prepare the journal entries to record the payment of interest and amortization of debt issue costs on December 31, 2011.

3.

 

Prepare the journal entries to record the payment of interest and amortization of debt issue costs on June 30, 2012.

4.

 

Prepare the journal entry to record the call of the bonds.

P 14-17

 

Early extinguishment

 

 LO5

The long-term liability section of Eastern Post Corporation's balance sheet as of December 31, 2010, included 10% bonds having a face amount of $40 million and a remaining premium of $6 million. On January 1, 2011, Eastern Post retired some of the bonds before their scheduled maturity.

Required:

Prepare the journal entry by Eastern Post to record the redemption of the bonds under each of the independent circumstances below:

1.

 

Eastern Post called half the bonds at the call price of 102 (102% of face amount).

2.

 

Eastern Post repurchased $10 million of the bonds on the open market at their market price of $10.5 million.

P 14-18

 

Convertible bonds; induced conversion; bonds with detachable warrants

 

 LO5

Bradley-Link's December 31, 2011, balance sheet included the following items:

<a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=jpg::::/sites/dl/premium/0077328787/student/pg798_2.jpg','popWin', 'width=NaN,height=NaN,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (K)</a>

<a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=jpg::::/sites/dl/premium/0077328787/student/star_icon.jpg','popWin', 'width=NaN,height=NaN,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (K)</a>

Note 8: Bonds (in part)

The 9.6% bonds were issued in 1998 at 97.5 to yield 10%. Interest is paid semiannually on June 30 and December 31. Each $1,000 bond is convertible into 40 shares of the Company's no par common stock.

 The 10.4% bonds were issued in 2002 at 102 to yield 10%. Interest is paid semiannually on June 30 and December 31. Each $1,000 bond was issued with 40 detachable stock warrants, each of which entitles the holder to purchase one share of the Company's no par common stock for $25, beginning 2012.

   On January 3, 2012, when Bradley-Link's common stock had a market price of $32 per share, Bradley-Link called the convertible bonds to force conversion. 90% were converted; the remainder were acquired at the call price. When the common stock price reached an all-time high of $37 in December of 2012, 40% of the warrants were exercised.

Required:

1.

 

Prepare the journal entries that were recorded when each of the two bond issues was originally sold in 1998 and 2002.

2.

 

Prepare the journal entry to record (book value method) the conversion of 90% of the convertible bonds in January 2012 and the retirement of the remainder.

3.

 

Assume Bradley-Link induced conversion by offering $150 cash for each bond converted. Prepare the journal entry to record (book value method) the conversion of 90% of the convertible bonds in January 2012.

4.

 

Assume Bradley-Link induced conversion by modifying the conversion ratio to exchange 45 shares for each bond rather than the 40 shares provided in the contract. Prepare the journal entry to record (book value method) the conversion of 90% of the convertible bonds in January 2012.

5.

 

Prepare the journal entry to record the exercise of the warrants in December 2012.

P 14-19

 

Concepts; terminology

 

 LO1 through LO5

Listed below are several terms and phrases associated with long-term debt. Pair each item from List A with the item from List B (by letter) that is most appropriately associated with it.

<a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=jpg::::/sites/dl/premium/0077328787/student/pg798_1.jpg','popWin', 'width=NaN,height=NaN,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (K)</a>

P 14-20

 

Determine bond price; record interest; report bonds at fair value

 

 LO6

On January 1, 2011, NFB Visual Aids issued $800,000 of its 20-year, 8% bonds. The bonds were priced to yield 10%. Interest is payable semiannually on June 30 and December 31. NFB Visual Aids records interest expense 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 $668,000 as determined by their market value in the over-the-counter market.

Required:

1.

 

Determine the price of the bonds at January 1, 2011, and prepare the journal entry to record their issuance.

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.

P 14-21

 

Report bonds at fair value; quarterly reporting

 

 LO6

Appling Enterprises issued 8% bonds with a face amount of $400,000 on January 1, 2011. The bonds sold for $331,364 and mature in 2030 (20 years). For bonds of similar risk and maturity the market yield was 10%. Interest is paid semiannually on June 30 and December 31. Appling determines interest expense at the effective rate. Appling elected the option to report these bonds at their fair value. The fair values of the bonds at the end of each quarter during 2011 as determined by their market values in the over-the-counter market were the following:

<a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=jpg::::/sites/dl/premium/0077328787/student/star_icon.jpg','popWin', 'width=NaN,height=NaN,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (K)</a>

   March 31

$350,000

   June 30

340,000

   September 30

335,000

   December 31

342,000

Required:

1.

 

By how much will Appling's earnings be increased or decreased by the bonds (ignoring taxes) in the March 31 quarterly financial statements?

2.

 

By how much will Appling's earnings be increased or decreased by the bonds (ignoring taxes) in the June 30 quarterly financial statements?

3.

 

By how much will Appling's earnings be increased or decreased by the bonds (ignoring taxes) in the September 30 quarterly financial statements?

4.

 

By how much will Appling's earnings be increased or decreased by the bonds (ignoring taxes) in the December 31 annual financial statements?

P 14-22

 

Investments in bonds; accrued interest; sale; straight-line interest

 

 LO2
 Appendix A

The following transactions relate to bond investments of Livermore Laboratories. The company's fiscal year ends on December 31. Livermore uses the straight-line method to determine interest.

<a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=jpg::::/sites/dl/premium/0077328787/student/star_icon.jpg','popWin', 'width=NaN,height=NaN,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (K)</a>

2011

July 1

Purchased $16 million of Bracecourt Corporation 10% debentures, due in 20 years (June 30, 2031), for $15.7 million. Interest is payable on January 1 and July 1 of each year.

Oct. 1

Purchased $30 million of 12% Framm Pharmaceuticals debentures, due May 31, 2021, for $31,160,000 plus accrued interest. Interest is payable on June 1 and December 1 of each year.

Dec. 1

Received interest on the Framm bonds.

31

Accrued interest.

2012

Jan. 1

Received interest on the Bracecourt bonds.

June 1

Received interest on the Framm bonds.

July 1

Received interest on the Bracecourt bonds.

Sept. 1

Sold $15 million of the Framm bonds at 101 plus accrued interest.

Dec. 1

Received interest on the remaining Framm bonds.

31

Accrued interest.

2013

Jan. 1

Received interest on the Bracecourt bonds.

Feb.28

Sold the remainder of the Framm bonds at 102 plus accrued interest.

Dec.31

Accrued interest.

Required:

1.

 

Prepare the appropriate journal entries for these long-term bond investments.

2.

 

By how much will Livermore Labs' earnings increase in each of the three years as a result of these investments? (Ignore income taxes.)

P 14-23

 

Troubled debt restructuring

 

At January 1, 2011, Rothschild Chair Company, Inc., was indebted to First Lincoln Bank under a $20 million, 10% unsecured note. The note was signed January 1, 2008, and was due December 31, 2014. Annual interest was last paid on December 31, 2009. Rothschild Chair Company was experiencing severe financial difficulties and negotiated a restructuring of the terms of the debt agreement.

Required:

Prepare all journal entries by Rothschild Chair Company, Inc., to record the restructuring and any remaining transactions relating to the debt under each of the independent circumstances below:

1.

 

First Lincoln Bank agreed to settle the debt in exchange for land having a fair value of $16 million but carried on Rothschild Chair Company's books at $13 million.

2.

 

First Lincoln Bank agreed to (a) forgive the interest accrued from last year, (b) reduce the remaining four interest payments to $1 million each, and (c) reduce the principal to $15 million.

3.

 

First Lincoln Bank agreed to defer all payments (including accrued interest) until the maturity date and accept $27,775,000 at that time in settlement of the debt.

2011 McGraw-Hill Higher Education
Any use is subject to the Terms of Use and Privacy Notice.
McGraw-Hill Higher Education is one of the many fine businesses of The McGraw-Hill Companies.