Chapter 14: Financing Liabilities: Bonds and Notes Payable
171. On January 1, 2016, Darth Corp. issued 50,000 of five-year, $1,000 bonds payable at 104. These bonds were each
convertible into 100 shares of $10 par common stock. On January 1, 2019, Darth converted all of these bonds when
the stock was selling at $11.50 a share.
Required:
Complete the matrix below to indicate the amounts that would be recorded for the indicated accounts in the journal
entry to record the bond conversion. Then record the journal entry for the bond conversion.
Loss on
Additional
Bond Conversion
Paid-in Capital
(debit)
(credit)
Book value method
________
________
Market value method
________
________
Bond Conversion
Paid-in Capital
(debit)
(credit)
Book value method
Market value method
800
Common Stock
50,000
Additional Paid-in Capital
800
Common Stock
50,000
a
$50,000 (.04) × 2/5 = $800
b
50 × 100 ×$1.50 = $7,500
172. On January 1, 2016, the Porter Corporation issued a five-year, non-interest-bearing, $44,000 note to Longshore
Corporation in exchange for used equipment. Neither the fair market value of the equipment nor that of the note is
determinable. The incremental borrowing rate of Porter is 12% and the incremental borrowing rate of Longshore is
10%. Present value factors for n = 5 years are
Interest Rate
PV of $1
10%
0.620921
12%
0.567427
Required:
a.
Prepare the journal entry to record the issuance of the note by Porter on January 1, 2016.
b.
Prepare the journal entry to record the interest expense on December 31, 2016.
c.
Prepare the journal entry to record the interest expense on December 31, 2017.
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Challenging
ACCT.WHAL.16.14.8 – LO: 14.8
United States – BUSPORG: Analytic
United States – OH – Default City – AICPA: FN-Measurement
Bloom’s: Analyzing
173. Sand Castle Co. borrowed $40,000 by issuing a four-year non-interest-bearing note to a customer. In addition, Sand
Castle agreed to sell inventory to the same customer at reduced prices over the four-year period. Sand Castle’s
incremental borrowing rate was 8%, so the present value of the note was $29,400. The customer agreed to purchase
an equal amount of inventory each year over the four-year period.
Required:
Prepare journal entries to:
a.
Issue the note
b.
Adjust at the end of the first year
c.
Adjust at the end of the second year
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Challenging
ACCT.WHAL.16.14.8 – LO: 14.8
United States – BUSPORG: Analytic
United States – OH – Default City – AICPA: FN-Measurement
Bloom’s: Analyzing
174. Orange Mfg. Co. issued a four-year non-interest-bearing note with a face value of $500,000. Orange received
$329,365, resulting in an effective 11% interest rate.
Required:
Prepare journal entries to:
a.
Issue the note
b.
Record interest at the end of the first year
c.
Record interest at the end of the second year
(Note: round all answers to the nearest dollar.)
1
Challenging
ACCT.WHAL.16.14.8 – LO: 14.8
United States – BUSPORG: Analytic
United States – OH – Default City – AICPA: FN-Measurement
Bloom’s: Analyzing
175. The Bellefonte Company is delinquent on a $100,000, 12% note plus $20,000 accrued interest to the Hollywood
National Bank. The note was due on June 1, 2016. On June 2, 2016, the bank agrees to restructure the debt by
forgiving the accrued interest, reducing the face value of the note to $90,000, reducing the interest rate to 7%, and
extending the maturity date to June 1, 2019. The interest is due each year on June 1.
Required:
Prepare the journal entries for Bellefonte Company to record the restructuring on June 2, 2016, and the payment of
interest on June 1, 2017.
176. Nassau Co. owes Dominion Ltd. $115,000 on a note payable, plus $7,500 interest. Dominion agrees to accept land in
full settlement. The land is recorded on the books of Nassau at $55,600 and is currently worth $85,000.
Required:
Prepare the journal entries to record the debt settlement on the books of Nassau.
177. Cat’s Eye, Inc. owes Brusters, Inc. $45,000 on a note payable, plus $3,250 interest. Bruster’s agrees to accept 1,000
shares of Cat’s Eye common stock in full settlement of the debt. The stock has a par value of $5 per share and a
current market value of $45 a share.
Required:
Record this debt restructuring on the books of Cat’s Eye.
178. On December 31, 2015, Albright Bank restructures an $800,000, 12% note receivable with $192,000 of accrued
interest so that the new principal is $750,000, payable in four years at 10%. Present value factors for n = 4 years are:
Discount rate
PV of $1
PV of an annuity
10%
0.683013
3.169865
12%
0.635518
3.037350
Required:
a.
Prepare the journal entry to record the loss on restructuring.
b.
Prepare the journal entry to record the 2015 interest revenue.
c.
Compute the carrying value of the note on December 31, 2013.
d.
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Challenging
ACCT.WHAL.16.14.1 – LO: 14.1
United States – BUSPORG: Analytic
United States – OH – Default City – AICPA: FN-Measurement
Bloom’s: Analyzing
Compute the carrying value of the note on December 31, 2019 before the payment is
received.
179. What are advantages and disadvantages of issuing long term debt?
180. Define the following characteristics of bonds:
• Debenture bonds
• Mortgage bonds
• Zero-coupon bonds
• Callable bonds
• Convertible bonds
• Serial bonds
181. How is the stated interest rate on the bond different from the effective rate? What can cause the difference between
the two rates?
182. How is the issue price for a bond determined? What are the three alternative states of the bond issue price?
183. What is the difference between the straight line method and the effective interest method of amortization of bond
discount/premium? Which method is more commonly utilized? Why?
184. List three reasons a company might call a bond.
185. How should a company treat the issuance of convertible debt per GAAP? What two methods are available to record
the issuance?
186. How does GAAP require a note payable to be valued? What three categories do notes fall within?
187. How can a company restructure their debt in the event of financial difficulties?
188. What is the primary difference between a debtor’s and creditor’s accounting for a modification of terms in a troubled
debt restructuring?
189. Companies can raise additional capital either by issuing bonds or by selling common stock. And investors can buy
either bonds or common stock as a way to earn additional revenue. Both alternatives have ramifications for both the
issuing company and the investor.
Required:
Discuss the advantages and disadvantages of bonds versus common stock from both the issuing company’s and the
investor’s perspective.
190. When a company issues bonds, the selling price of the bonds is determined by a number of factors. Two factors that
affect bond prices are the bond’s contract (stated) rate and its effective yield (effective rate).
Required:
Explain the effect on a bond’s selling price caused by the stated and effective rates.
Challenging
United States – BUSPROG: Communication
United States – OH – Default City – AICPA: FN-Measurement
191. Two methods of amortization of a discount or premium are used by businesses. These two methods are the effective
interest method and the straight-line method.
Required:
a.
Explain how premiums and discounts are amortized using the straight-line and effective
interest methods.
b.
State which of the two methods is preferred and explain why.
c.
Explain why many companies are able to use the method that is not considered GAAP.
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Challenging
ACCT.WHAL.16.14.4 – LO: 14.4
United States – BUSPROG: Communication
United States – OH – Default City – AICPA: FN-Decision Modeling
Bloom’s: Understanding
192. There are two ways, conceptually, that can be used to account for convertible debt. However, only one of them is
acceptable under GAAP.
Required:
Identify the two methods that could be used to record convertible debt and indicate which one is acceptable under
GAAP.
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ACCT.WHAL.16.14.7 – LO: 14.7
United States – OH – Default City – AICPA: FN-Decision Modeling
Bloom’s: Evaluating
193. How do the classification requirements of IFRS for instruments as financial liabilities versus equity differ from those
of GAAP?
Moderate
United States – BUSPROG: Communication
United States – OH – Default City – AICPA: FN-Decision Modeling