Unlock document.
This document is partially blurred.
Unlock all pages and 1 million more documents.
Get Access
93. Harris Corporation
Harris Corporation issued $2,000,000, 10-percent, 10-year bonds on January 2, Year 2. The bonds pay interest
semiannually on January 1 and July 1. The bonds were priced on the market to yield 8 percent.
Refer to the Harris Corporation example. The issue price of the bonds is calculated as follows:
94. A firm classifies liabilities which fall due after the operating cycle, usually greater than one year, as
95. A firm classifies mortgages, notes, bonds, and leases which were used to acquire its long-term assets that
fall due after the operating cycle, (usually greater than one year) as
96. (CMA adapted, Dec 90 #12) Marquette, Inc. issued $6,000,000 of 12% bonds on December 1, Year 1, due
on December 1, Year 6, with interest payable each December 1 and June 1. The bonds sold for $5,194,770 to
yield 16%. If the discount is amortized by the effective interest method, Marquette, Inc.'s interest expense for
the fiscal year ended November 30, Year 2 related to its $6,000,000 bond issue will be
97. When the bond indenture provides that stated amounts of principal will become due during the term of the
bond, the bond is called a _____ bond.
98. A callable bond
99. Bonds whose indentures contain a provision which requires the issuing firm to make a provision for partial
early retirement of the bond issue include serial bonds and _____ bonds.
100. A firm classifies liabilities which fall due within the operating cycle, usually one year, as
101. In return for promising to make future payments, a firm receives cash or other assets with a measurable
cash-equivalent value. The firm records a long-term liability for that amount and the book value of that
borrowing at any time equals the
102. In return for promising to make future payments, a firm receives cash or other assets with a measurable
cash-equivalent value. The firm records a long-term liability for that amount and determines the market interest
rate by finding the
103. The interest rate that discounts a series of future cash flows to its present value is called the
104. Borrowers who retire long-term liabilities debit the liability account for its current book value, credit Cash,
and recognizes any difference on the retirement of the debt as a
105. Bonds whose indentures contain a provision which requires the issuing firm to make a provision for partial
early retirement of the bond issue are sinking fund bonds and _____ bonds.
106. U.S. GAAP requires that all long-term monetary liabilities appear on the balance sheet at the
107. In historical cost accounting, the discounting process uses the original interest rate appropriate for the
particular borrower at the time it incurred the obligation. That rate will have depended on the amount and terms
of the borrowing arrangement as well as the risk that the borrower will default on the obligations. The rate is
known as the
108. A document or agreement giving the terms of the bond and the rights and duties of the borrower and other
parties to the contract that provides some protection to the bondholders and typically limits the borrower's right
to declare dividends, to make other distributions to owners, and to acquire other businesses is known as a
109. The most common type of corporate bond, except in the railroad and public utility industries, that carries
no special collateral and the borrower issues it on the general credit of the business is called a
110. A bond that does not require a periodic cash payment, but instead promises a single payment at maturity, is
called a _____ bond.
111. Debentures that the holder (lender) can exchange, possible after some specific period of time has elapsed,
for a specific number of shares of common stock or, perhaps, preferred stock of the borrower are called _____
bonds.
112. KLM Company, as tenant, acquired for $600,000, paid in a single amount, the right to use an entire office
building for the next ten years. KLM expects to rent out the floors in the building to various commercial
tenants. As tenant, KLM accounts for its lease as a capital lease amortizing the leasehold asset on a straight-line
basis over ten years. KLM, as landlord, signed operating leases with the tenants for all of the rentable space.
The rents total $150,000 received at the end of each year for the next ten years, $1.5 million in total.
Required:
a.
Under current GAAP, can KLM treat the same property as a capital lease and an operating lease?
b.
What is the book value of this property after two years?
Assume, independent of your answer to the preceding question, that the book value of the property after
two years is $400,000. On that date, some of the tenants go bankrupt and KLM believes it will be
unable to rent their now-vacant space, which will remain empty for the remaining eight years. The fair
market value of the remaining leasehold with still-solvent, rent-paying tenants is $300,000.
c.
If the remaining tenants will pay $800,000 in total, with present value $310,000, what entry, if any, will
KLM make?
d.
If the remaining tenants will pay $320,000 in total, with present value $290,000, what entry, if any, will
KLM make?
a.
Yes. Nothing under GAAP prevents KLM from acting as a lessee in a capital lease transaction and as a
lessor in operating lease transactions.
b.
$480,000 = $600,000 ´ (10 - 2)/10
c.
None [An asset impairment loss arises when the carrying values of the assets exceed the sum of the
undiscounted cash flows, in this case the sum of the undiscounted cash flows exceeds the carrying
values of the assets]
d.
Dr. Loss 100,000 [= 400,000 - 300,000]; Cr. NCA [Leasehold] 100,000
113. DeLong Co. leases workout equipment to health clubs. On January 1, Year 1, DeLong Co. leases to
Jimmy's Gym, equipment valued at $150,000, for 2 years. The equipment has a 12-year life with zero salvage
value. The lease payments equal $2,500 per year, payable on the last day of the year.
Required:
a.Identify the type of lease. Give reasons for your conclusion.
b.State the correct entries to be made by the lessor for this lease. You may assume straight-line depreciation is
used by DeLong.
a.
Equipment
21,041
Note Payable
21,041
b.
Interest Expense
3,156
Note Payable
3,156
Depreciation Expense
3,787
Accumulated Depreciation
3,787
c.
Depreciation Expense
3,787
Accumulated Depreciation
3,787
d.
Note Payable
32,000
Cash
32,000
115. Indicate whether each of the following independent transactions is a capital (C) or operating (O) lease.
a.
__________ A firm signs a 5-year lease for equipment with a 7-year life.
b.
__________ A firm signs a lease for property with a fair market value of $20,000. The present value
of the lease payments is $16,000.
c.
__________ A firm signs a lease for equipment which will allow the lessee to purchase the equipment
at the end of the lease for one-half the fair market value.
d.
__________ A firm signs a 16-year lease for equipment with a 20-year life.
e.
__________ A firm signs a lease for property with a fair value of $90,000. The present value of the
lease payments is $85,000.
a.
Operating
b.
Operating
c.
Capital
d.
Capital
e.
Capital
116. Delco Corporation entered into a five-year lease for a computer on January 1, Year 3. The lease requires
Delco to make equal payments of $20,000 on January 1 each year for the five years of the lease, with the first
payment made on January 1, Year 3. Delco's borrowing rate is 10 percent. Delco uses the straight-line
depreciation method for financial reporting. It estimates a zero salvage value. The accounting period is the
calendar year. Round amounts to the nearest dollar.
Required:
a.
Give the journal entries that Delco would make during Year 3 if this lease were considered an operating
lease for financial reporting.
b.
Repeat [a] but assume the lease is a capital lease for financial reporting.
c.
Assume that this lease is considered a capital lease for financial reporting. Calculate depreciation
expense for financial reporting purposes for Year 3 and Year 4.
d.
Compute the total expenses (ignore income taxes) that Delco would recognize over the 5-year term of
the lease, assuming it is an operating lease.
e.
Repeat [d] but assume the lease is a capital lease.
a.
January 1, Year 3
Prepaid Rent
20,000
Cash
20,000
December 31, Year 3
Rent Expense
20,000
Prepaid Rent
20,000
b.
January 1, Year 3
Leased Asset
83,397
Lease Liability
63,397
Cash
20,000
$83,397 = $20,000 + ($20,000 ´ 3.16987).
December 31, Year 3
Interest Expense
6,340
Interest Payable
6,340
$6,340 = .10 ´ $63,397.
Depreciation Expense
16,679
Accumulated Depreciation
16,679
$16,679 = $83,397/5.
c.
December 31, Year 3
Depreciation Expense
16,679
Accumulated Depreciation
16,679
$16,679 = $83,397/5.
December 31, Year 4
Depreciation Expense
$ 16,679
Accumulated Depreciation
$ 16,679
$16,679 = $83,397/5.
d.
Rent expense: $20,000 ´ 5
$100,000
e.
Depreciation Expense
$ 83,397
Interest Expense ($100,000 - $83,397)
16,603
$100,000
117. The following information is available from the comparative balance sheets and related income statement
of the Scanlon Company for the year ended December 31, Year 7.
December 31,
December 31,
Year 6
Year 7
Present value of lease obligation
$2,040,508.60
$1,862,939.10
Leasehold (net of accumulated amortization)
$1,987,224.30
$1,766,421.60
Interest expense on lease obligation for Year 7
$ 122,430.52
The company has only one lease contract outstanding, which it entered into on January 1, Year 6. The contract
called for 10 equal lease payments commencing on December 31, Year 6.
Required:
a.
What was the interest rate used to value the lease?
b.
What is the annual lease payment?
c.
What was the present value of the lease obligation on January 1, Year 6?
d.
What was the amortization expense for Year 6?
a.
6% = $122,430.52/$2,040,508.60.
b.
$300,000 = $122,430.52 + ($2,040,508.60 - $1,862,939.10). (.02 rounding error)
c.
$2,208,027 = $300,000 ´ 7.36009.
d.
$220,802.70 = $2,208,027/10.
118. The annual report of Talk Corporation for Year 1 reports capital leases requiring payments totaling $228
million over future years, including $58 million payable at the end of Year 2. The interest rate on these
obligations is 12 percent and their present value (discounted at 12 percent) at the end of Year 1 was $181
million. The assets financed by capital leases appear on the Year 1 year-end balance sheet at $220 million.
Assume no new leases were entered into during Year 2 and that leasehold assets have a remaining useful life of
10 years at the start of Year 2, but no salvage value. Ignore income taxes.
Required:
a.
What would be the total expense for Year 2 for the leasehold assets and the financing thereof?
b.
What would be the total cash expenditure during Year 2 related to the leasehold assets and the
financing thereof?
c.
What would be the balance sheet amount for leasehold assets at the end of Year 2?
d.
What would be the balance sheet amount for lease obligations at the end of Year 2?
a.
$ 43.7 million [43.7 = 220/10 + .12 ´ 181 = 22 + 21.7]
b.
$ 58 million
c.
$ 198 million [198 = 220 ´ 9/10 = 220 - 22]
d.
$ 144.7 million [144.7 = (181 ´ 1.12) - 58 = 202.7 - 58.0]
119. On January 1, Year 6, Trembley Corporation issued $1,000,000 face value, 20-year bonds. The bonds
carry coupon interest of 6 percent per year, payable semiannually on June 30 and December 31. The bonds were
initially priced on the market to yield 8 percent, compounded semiannually (for an effective annualized yield
greater than 8 percent).
Required:
a.
Compute the issue price of these bonds on January 1, Year 6.
b.
Compute the amount of interest expense on these bonds for Year 6, assuming that the firm uses the
effective-interest method of amortizing bond premium or discount.
c.
Assume for this part that the firm recorded interest expense in Part b. in an amount equal to interest paid
for the year. That is, it failed to record amortization of bond premium or discount. Indicate the effect
(direction and amount) of this omission on the line items in the statement of cash flows using "O/S"
(overstated), "U/S" (understated), or "No" (no effect). Ignore income taxes.
Direction
Amount
1)
Net Income
2)
Adjustments that are added to net income
3)
Adjustments that are subtracted from net income
4)
Cash Flow from Operations
a.
Coupo
n:
$30,000 ´ 19.79277
$593,783
Face:
$1,000,000 ´
0.20829
208,290
Issue
Price:
$802,073
b.
First 6
month
s:
0.04 ´ $802,073
$ 32,083
Secon
d 6
month
s:
.04($802,073 +
$32,083 - $30,000)
32,166
$ 64,249
c.
Direction
Amount
1)
O/S
4,249
2)
U/S
4,249
3)
No
No
4)
No
No
120. Describe the sources of long-term debt financing.
SOURCES OF LONG-TERM DEBT FINANCING
Firms that need cash for long-term purposes, such as acquiring buildings and equipment or financing a business
acquisition, and that wish to use debt as a means of obtaining cash, will do one of two things:
1. Borrow from commercial banks, insurance companies, or other financial institutions.
2. Issue bonds in the capital markets.
Loans from commercial banks and other financial institutions often require firms to pledge assets as collateral.
For example, a firm borrowing to finance the acquisition of equipment would likely pledge the equipment as
collateral. If the firm fails to maintain specified levels of financial health while the loan is outstanding or does
not pay principal and interest on the loan when due, the lender has the right to seize the collateral and sell it to
satisfy the amounts due.
121. Describe what bond provisions exist.
BOND PROVISIONS
Bond issues vary with respect to their specific provisions. For example, particular collateral might back up
bonds (a secured borrowing), or firms might issue bonds based only on their credit worthiness as an entity. Such
unsecured borrowing means that lenders must rely on assets not pledged as collateral for other loans in the event
the firm cannot repay the bonds. Unsecured borrowing might carry senior rights or subordinated rights in the
Some bonds are callable, which means the issuing firm has the right to repurchase the bonds prior to maturity at
a specified price. An issuing firm might exercise this call provision if interest rates decline after the initial
issuance of the bonds. The firm can borrow at the lower interest rate and use the proceeds to finance the
repurchase of the bonds initially issued.
