Chapter 10: Long-Term Liabilities
191. Stanton Heights Corporation issued $95,000 face value bonds at a discount of $5,000. The bonds contain a call price
of 102. Stanton Heights decides to redeem the bonds early when the unamortized discount is $2,750.
Required:
1. Calculate Stanton Heights Corporation’s gain or loss on the early redemption of the bonds.
2. Describe how the gain or loss would be reported on the income statement and in the notes to the financial statements.
ANSWER:
1.
Redemption price:
$95,000 × 1.02
=
$96,900
Carrying value:
$95,000 – $2,750
=
92,250
$(4,650)
loss
2. The gain or loss on bond redemption should be presented on the income statement. In most
cases, the gain or loss on bond redemption should not be considered unusual or infrequent
and therefore should not be presented in the section of the statement where extraordinary
items are presented.
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.10-06 – LO:10-06
KEYWORDS:
Bloom’s: Analyzing
Moderate
192. Burger Barn Company issued $150,000 face value bonds at a premium of $6,000. The bonds contain a call provision
of 102. Burger Barn decides to redeem the bonds due to a significant decline in interest rates. On that date, Burger Barn
had amortized only $1,500 of the premium.
Required:
1. Calculate the gain or loss on early redemption of the bonds.
2. What journal entry should be recorded at the time of bond redemption?
3. Where should the gain or loss should be presented on the financial statements?
4. Why is the call price is normally higher than 100?
ANSWER:
1.
Redemption price $150,000 × 1.02 =
$153,000
Carrying value $150,000 + ($6,000 – $1,500) =
154,500
Gain on redemption
$ 1,500
2.
Bond redemption Entry:
Bonds Payable
150,000
Premium on Bonds
4,500
Cash
153,000
Gain on Bond Redemption
1,500
Balance Sheet
Income Statement
Chapter 10: Long-Term Liabilities
Antietam Corporation
Use the note on Disclosure of Leases for the Antietam Corporation to answer the questions that follow.
The Corporation leases office, warehouse and showroom space, retail stores and office equipment under operating leases,
which expire no later than 2030. The Corporation normalizes fixed escalations in rental expense under its operating leases.
Minimum annual rentals under non-cancelable operating leases, excluding operating cost escalations and contingent rental
amounts based upon retail sales, are payable as follows:
Fiscal year ending March 31,
2016
$10,051,000
2017
11,121,000
2018
10,161,000
2019
9,063,000
2020
8,814,000
Thereafter
46,681,000
Rent expense was $12,551,000; $8,911,000; and $5,768,000 for the years ended March 31, 2015, 2014, and 2013
respectively.
193. Review the information for Antietam Corporation.
Required:
(1) What are the two types of leases that a company can have? Describe each briefly.
(2) Does the note disclosure show evidence of the two types of leases?
ANSWER:
(1) The two types of leases that a company can have are operating leases and capital leases.
Operating leases are in substance a rental. The user/lessee makes periodic payments to the
owner/lessor and at the end of the lease term, the property reverts back to the owner. The
lessee does not record the property as an asset, nor does it record depreciation. On the other
hand, a capital lease is in substance a purchase of an asset. The entry to record the acquisition
requires that a liability be established reflecting future payments to the seller.
(2) The note discloses operating leases. The capital leases are included on the balance sheet
as debt while the operating leases are only shown as an expense. The future lease payments
are shown so that creditors and investors will be aware of the cash amounts that Banner is
required to pay.
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.10-07 – LO: 10-07
KEYWORDS:
Bloom’s: Analyzing
$xx
($xx)
$xx
194. Review the information for Antietam Corporation.
Required:
Determine the effect on the accounting equation when recording each type of lease described in the previous question.
ANSWER:
The entry for an operating lease merely records cash payments made and rental expense.
Balance Sheet
Income Statement
Lease Obligation
($367,250 / 10 years = $36,725)
FACC.PONO.13.10-07 – LO: 10-07
Bloom’s: Analyzing
196. Wet Paint Company signed a ten-year lease agreement on January 1, 2016. The lease requires payments of $65,000
per year every December 31. Wet Paint estimates that the leased property has a life of 11 years. The interest rate that
applies to the lease is 12%.
Required:
1. Should Wet Paint Company treat the lease as an operating lease or a capital lease?
2. If a balance sheet is presented on January 1, 2016, what amounts related to the lease will appear on the balance sheet?
3. Assume that the leased asset is depreciated using the straight-line method and the lease is amortized using the effective
interest method. What journal entries should Wet Paint make on December 31, 2016?
ANSWER:
1. This lease is a capital lease because the length of the lease exceeds 75% of the life of the
asset.
2.
Leased asset $65,000 × 5.650 =
$367,250
Table 9-4, n =10, i = 12%
Lease obligation
$367,250
3.
Interest Expense (12% × $367,250)
44,070
Chapter 10: Long-Term Liabilities
Padagonian Company
Use the deferred tax account that appears in the financial statements of Padagonian Company to answer the related
questions.
December 31,
(in millions)
2017
2016
Deferred income taxes
$ 442
$ 358
Total assets
22,417
20,834
Total current liabilities
8,429
9,321
Total stockholders’ equity
11,366
9,316
197. [Appendix] Review the information for Padagonian Company.
Required:
(1) Where will the Deferred Income Taxes account most likely appear on a classified balance sheet?
(2) What percent is deferred income taxes of long-term liabilities for the two years?
2017 __________ 2016 ___________
(3) What percent is deferred income taxes of total liabilities for the two years?
2017 __________ 2016 ___________
ANSWER:
(1) The Deferred Income Taxes account usually appears in the liability section of the balance
sheet. It is classified as a long-term (noncurrent) liability.
(2) The percent of long-term liabilities that is deferred income taxes for the two years is as
follows:
2017: 16.9%; $442/($22,417 – $8,429 – $11,366) = .169
2016: 16.3%; $358/($20,834 – $9,321 – $9,316) = .163
(3) The percent of total liabilities that is deferred income taxes for the two years is as follows:
2017: 4.0%; $442/($22,417 – $11,366) = .0399
2016: 3.1%; $358/($20,834 – $9,316) = .0310
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
FACC.PONO.13.10-08 – LO: 10-08
FACC.PONO.13.10-09 – LO: 10-09
KEYWORDS:
Bloom’s: Analyzing
liabilities is a positive amount or an addition to operating cash flows while a decrease is a
DIFFICULTY:
Moderate
FACC.PONO.13.10-10 – LO: 10-10
KEYWORDS:
Bloom’s: Analyzing
198. [Appendix] Review the information for Padagonian Company.
Required:
(1) In your opinion, are deferred income taxes an appreciable portion of both long-term liabilities and total liabilities?
Why?
(2) What difference between accounting income and taxable income produces the Deferred Income Taxes account?
(3) Will Padagonian eventually pay the deferred tax liability? When?
ANSWER:
(1) Deferred income taxes do not appear to be an appreciable portion of total liabilities. The
percentage did increase slightly from 3.1% to 4.0% of total liabilities; however, this is still an
insignificant part of the total. In 2016, it could be said that deferred income taxes were an
appreciable portion of total long-term liabilities. Deferred income taxes now represent 16.9%
of total long-term liabilities and usually anything greater than 10% is considered to be
material.
(2) The difference between accounting income and taxable income that produces the
Deferred Income Taxes account is a timing one. The IRS and the FASB may recognize
certain items as revenue in different periods. Likewise, expenses may be recognized in
different periods. Companies attempt to increase income for accounting purposes but reduce
it for income tax purposes thereby giving rise to the Deferred Income Taxes liability account.
The use of an accelerated depreciation method (MACRS) is the most common item creating a
Deferred Income Taxes liability.
(3) In the future, presumably all additional taxes which have been deferred, will be payable.
However, the amounts which are payable will probably be reduced by future timing
differences. In fact, in many companies the Deferred Income Taxes account grows year after
year as the business expands and its assets and liabilities increase.
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.10-09 – LO: 10-09
FACC.PONO.13.10-10 – LO: 10-10
KEYWORDS:
Bloom’s: Analyzing
199. [APPENDIX] How do most changes in long-term liabilities on the balance sheet appear on the cash flow statement?
ANSWER:
Most long-term liabilities are related to a company’s financing activities. Accordingly, a
change in the balance of these long-term liabilities will be reflected in the financing activities
category of the cash flow statement. An increase in long-term debt will be shown as a cash
inflow. Similarly, the reduction of long-term debt represents a cash outflow.
200. [APPENDIX] Describe briefly how each of the following long-term liabilities arises; i.e., what kind of transaction
produces the resulting long-term liability? You may want to include the appropriate accounts to increase or decrease
(ignore amounts) in your description.
a) Long-Term Debt
b) Deferred Income Taxes
ANSWER:
Long-term debt arises from the issue of bonds which in fact is a long-term loan. If the debt is
interest bearing, periodic interest payments are required. Cash would be increased (an
increase in assets) and Bonds Payable would be increased (an increase in liabilities).
Deferred income taxes arise from timing differences in the calculation of accounting income
versus taxable income. These differences must be temporary ones. Income Tax Expense
would increase (a decrease in Net Income), Deferred Income Tax would increase (and
increase in a liability), and Income Taxes Payable would increase (an increase in a liability).
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.10-10 – LO: 10-10
KEYWORDS:
Bloom’s: Analyzing
201. [APPENDIX] On January 1, 2016, Hart Company purchased an asset for $137,500. For financial accounting
purposes, the asset will be depreciated on a straight-line basis over five years with no residual value at the end of that
time. For tax purposes, the asset will be depreciated as follows: 2016, $45,000; 2017, $35,000; 2018, $25,000; 2019,
$20,000; and 2020, $12,500. Assume that the company is subject to a 35% tax rate.
Required:
1. What is the amount of deferred tax at December 31, 2016?
2. Does the deferred tax represent an asset or a liability?
3. What is the amount of deferred tax at December 31, 2020?
ANSWER:
1. Deferred Tax = $6,125 ($45,000 – $27,500*) × 0.35
2. The amount will be a deferred tax liability.
3. At December 31, 2020, the amount of deferred tax will be $0.
*Depreciation for Financial Accounting = ($137,500 – $0) /5 years = $27,500
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.10-10 – LO: 10-10
KEYWORDS:
Bloom’s: Analyzing
DIFFICULTY:
Moderate
FACC.PONO.13.10-06 – LO:10-06
KEYWORDS:
Bloom’s: Analyzing
202. A bond with a face value of $10,000 is issued at a discount of $800 on January 1, 2016. The face rate of interest on
the bond is 7%.
Required:
1. Was the market rate at the time of issuance greater than 7% or less than 7%?
2. If a balance sheet is presented on January 1, 2016, how will the bonds appear on the balance sheet?
3. If a balance sheet is presented on December 31, 2016, will the amount for the bonds be higher or lower than on January
1, 2016?
ANSWER:
1. If the bond was issued at a discount, then the market rate of interest exceeded the face rate
of 7%.
2.
Bonds payable
$10,000
Less: Discount on bonds
(800)
$ 9,200
3. Since the discount will be amortized, the amount will be higher than $9,200.
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.10-04 – LO: 10-04
KEYWORDS:
Bloom’s: Analyzing
203. Stanton Heights Corporation decides to redeem its $100,000 face value bonds when the carrying value is
$107,019.48. The bonds are redeemed on December 31, 2016, at 102.
Required:
1. Calculate Stanton Heights Corporation’s gain or loss on the early redemption of the bonds.
2. What journal entry should be recorded at the time of bond redemption?
ANSWER:
1. Gain = Carrying Value – Call Price
Gain = $107,019.48 – $102,000.00
Gain = $5,019.48
2. Bonds Payable……………………………………………. 100,000.00
Premium on Bonds……………………..……………….. 7,019.48
Cash……………………………………..…………….. 102,000.00*
Gain on Bond Redemption………………………… 5,019.48
To record redemption of bonds.
*$100,000 × 102% = $102,000
Chapter 10: Long-Term Liabilities
Essay
204. One of your friends is majoring in Aeronautics. In this industry, leases are very important and he is interested in
knowing a little bit about how international accounting standards will affect the industry as compared to current U.S.
GAAP treatments for leasing. How would you explain the differences in their applications?
ANSWER:
Under U.S. GAAP, the criteria to determine whether a lease contract should be considered a
capital lease are applied in a rather rigid way. If a lease meets any of the criteria, it must be
accounted for as a capital lease. If it does not meet the criteria, even by a small margin, then
it is considered an operating lease.
Under international accounting standards, however, the lease criteria are similar to U.S.
standards, but are used as “guidelines” rather than rigid rules. Therefore, there is much more
flexibility in applying the lease standards when using the international standards. This may be
a benefit or a disadvantage, depending on how you look at it. While the benefits are more
transparency in financial statements, the disadvantages are that IFRS will require more
judgment by accountants in applying those standards.
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.10-07 – LO: 10-07
KEYWORDS:
Bloom’s: Applying
205. A friend of yours has asked you whether off-balance-sheet financing means that the amounts are immaterial and
therefore are not reported. In a short paragraph, tell him what off-balance-sheet financing is and why firms engage in off-
balance-sheet transactions?
ANSWER:
Off-balance-sheet financing refers to transactions whereby a party obtains the use of an asset
but is not required to record the related liability on the balance sheet. These transactions can
be very material. Firms may favor off-balance-sheet arrangements because they believe there
are benefits in not recording an obligation as a liability. Benefits may include the
maintenance of borrowing capacity and flexibility in meeting debt/equity or similar
requirements in existing loan contracts. An example of off-balance-sheet financing is an
operating lease. The lessee is not required to record the right to use the property as an asset or
to record the obligation for payments as a liability.
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.10-07 – LO: 10-07
KEYWORDS:
Bloom’s: Applying