(20-30 min.) P 9-72A
Alternative
Alternative
1
2
Borrow $6.75
Issue 100,000
mil at 6%
shares of stock
Net income 2 years from
now
$2,880,000
$2,880,000
Less interest expense
405,000
-0-
Projected net income
before tax
2,475,000
2,880,000
Less income tax expense
(35%)
866,250
1,008,000
Projected net income 2
years from now
$1,608,750
$1,872,000
Earnings per share:
$1,608,750/100,000
$16.09
$1,872,000/(100,000 +
100,000)
$9.36
Req. 2
TO: Management of Hillside Medical Goods
FROM: Student Name
SUBJECT: Advantages and disadvantages of borrowing
versus issuing stock to raise cash for expansion
Raising money by borrowing has at least two advantages over issuing
common stock. Borrowing does not change the present ownership of the
(continued) P 9-72A
earnings per share of common stock, because the interest expense on the
debt is tax-deductible. And higher earnings per share usually lead to higher
stock prices for company owners.
(20-30 min.) P 9-73A
Req. 1
Arroya Foods, Inc.
Partial Balance Sheet
Dec. 31, 2014
Current liabilities:*
$784,000
Mortgage note
payable, current ………….
$ 86,000
(167,000)
Bonds payable,
617,000
current portion…………….
515,000
Interest payable ……………..
43,000
Total current liabilities ………
644,000
Long-term liabilities:
Mortgage note
payable ……………………….
$ 386,000
Bonds payable…. $200,000
Discount on
bonds payable... (25,000)*
175,000
Pension liability ……………..
41,000**
Total long-term liabilities …..
602,000
Notes:
* The order of listing current liabilities and long-term liabilities is optional. However,
Discount on Bonds Payable should come immediately after Bonds Payable. Also, it
is customary to report Interest Payable after the related liability accounts, Mortgage
Note Payable and Bonds Payable, Current Portion.
(continued) P 9-73A
Req. 2
a.
Carrying amount of bonds payable:
Current portion ……………………………………………..
$ 515,000
Long-term portion ($200,000 − $25,000) …………..
175,000
Carrying amount ……………………………………………
$690,000
b.
Interest payable is the amount of interest that Arroya owes at year
end. Interest expense is the company’s cost of borrowing for the
full year.
Req. 3
(continued) P 9-73A
Req. 5
Leverage
ratio
=
Total assets ($7,574,000)
Total stockholders’ equity ($3,328,000)
=
2.28
Debt ratio
=
Total liabilities ($4,246,000)
=
0.56
Total assets ($7,574,000)
The leverage ratio and debt ratio would increase. The company would
still be considered healthy (average risk) from a leverage point of view.
(15-20 min.) P 9-74B
a. Sales tax payable ($145,000 × .07) ………………………………..
$10,150
b. Note payable, short-term ……………………………………………..
$76,000
Interest payable ($76,000 × .06 × 4/12) …………………………..
1,520
c. Unearned service revenue ($3,600 × 2/6) ………………………
$1,200
d. Estimated warranty payable
($9,700 + $34,000 − $31,100) …………………………..……….
$12,600
e. Portion of long-term note payable due
within one year …………………………..…………………………..
$30,000
Interest payable ($90,000 × .04)…………………………………….
3,600
(30-40 min.) P 9-75B
Journal
DATE
ACCOUNT TITLES AND EXPLANATION
DEBIT
CREDIT
2014
Mar.
3
Inventory ……………………………………………..
72,000
Note Payable, Short-term ………………….
72,000
May
31
Cash ……………………………………………………
85,000
Note Payable, Short-term ………………….
17,000
Note Payable, Long-term ………………….
68,000
Sept.
3
Note Payable, Short-term ………………………
72,000
Interest Expense ($72,000 × .04 × 6/12) …..
1,440
Cash ……………………………………………….
73,440
Dec.
31
Warranty Expense ($214,000 × .02) ………..
4,280
Estimated Warranty Payable ……………..
4,280
Dec.
31
Interest Expense ($85,000 × .05 × 7/12) …..
2,479
Interest Payable ……………………………….
2,479
2015
May
31
Note Payable, Short-term ………………………
17,000
Interest Payable ……………………………………
2,479
Interest Expense ($85,000 × 0.05 × 5/12) …
1,771
Cash ………………………………………………..
21,250
(20-25 min.) P 9-76B
Req. 1
Journal
DATE
ACCOUNT TITLES AND EXPLANATION
DEBIT
CREDIT
2014
a.
May
31
Cash ………………………………………….
3,500,000
Bonds Payable……………………….
3,500,000
To issue bonds at par.
b.
Nov.
30
Interest Expense ………………………..
105,000
Cash ($3,500,000 × .06 × 6/12) …
105,000
To pay interest on bonds.
c.
Dec.
31
Interest Expense
($3,500,000 × .06 × 1/12) ………………
17,500
Interest Payable ……………………..
17,500
To accrue interest.
2015
d.
May
31
Interest Payable ………………………….
17,500
Interest Expense
($3,500,000 × .06 × 5/12) ………………
87,500
Cash ……………………………………..
105,000
To pay interest on bonds.
Req. 2 (reporting the liabilities on the balance sheet at
Dec. 31, 2014)
Current liabilities:
Interest payable ………………………………………..
$ 17,500
Long-term liabilities:
Bonds payable ………………………………………….
$3,500,000
(30-40 min.) P 9-77B
Req. 1
The 4% bonds issued when the market interest rate is 3% will be priced
Req. 2
(continued) P 9-77B
Req. 3
Journal
DATE
ACCOUNT TITLES AND EXPLANATION
DEBIT
CREDIT
2014
a.
Feb.
28
Cash ($1,200,000 × 0.94) …………………………...
1,128,000
Discount on Bonds Payable ……………………..
72,000
Bonds Payable …………………………………….
1,200,000
To issue bonds payable at a discount.
b.
Aug.
31
Interest Expense ………………………………………
31,200
Discount on Bonds Payable ($72,000 / 10)
7,200
Cash ($1,200,000 × .04 × 6/12) ………………
24,000
To pay interest and amortize bond
discount.
c.
Dec.
31
Interest Expense ………………………………………
20,800
Discount on Bonds Payable ($7,200 × 4/6)
4,800
Interest Payable ($24,000 4/6) …………….
16,000
To accrue interest and amortize bond discount.
2015
d.
Feb.
28
Interest Payable (from Dec. 31) …………………
16,000
Interest Expense ………………………………………
10,400
Discount on Bonds Payable ($7,200 × 2/6)
2,400
Cash ($1,200,000 × .04 × 6/12) ………………
24,000
To pay interest and amortize bond discount.
Req. 4 (reporting the liabilities on the balance sheet at
Dec. 31, 2014)
Current liabilities:
Interest payable ……………………………………….
$ 16,000
Long-term liabilities:
Bonds payable …………………………………………
$1,200,000
Less: Discount on bonds payable
($72,000 − $7,200 − $4,800) ……………………
(60,000)
1,140,000
(30-40 min.) P 9-78B
Req. 1
Journal
DATE
ACCOUNT TITLES AND EXPLANATION
DEBIT
CREDIT
2014
Jan.
1
Cash ($4,000,000 × .94) ………………………….
3,760,000
Discount on Bonds Payable ………………….
240,000
Bonds Payable …………………………………
4,000,000
To issue bonds at a discount.
July
1
Interest Expense …………………………………..
112,000
Cash ($4,000,000 × .05 × 6/12) ……………
100,000
Discount on Bonds Payable
($240,000 / 20) …………………………………..
12,000
To pay interest and amortize bond
discount.
Dec.
31
Interest Expense …………………………………..
112,000
Interest Payable ($4,000,000 × .05 × 6/12) ..
100,000
Discount on Bonds Payable
($240,000 / 20) ………………………………
12,000
To accrue interest and amortize bond
discount.
2015
Jan.
1
Interest Payable ……………………………………
100,000
Cash ………………………………………………..
100,000
To pay interest.
2024
Jan.
1
Bonds Payable ……………………………………..
4,000,000
Cash ………………………………………………..
4,000,000
To pay off bonds at maturity.
(continued) P 9-78B
Req. 2
Carrying amount at Dec. 31, 2014:
Req. 3
(30-45 min.) P 9-79B
Req. 1
a. Using the PV function in EXCEL, the issue price of the bonds is
$3,939,189.
Req. 2 (amortization table)
A
B
C
D
E
Semiannual
Interest Date
Interest
Payment
(5% of
Maturity
Value)
Interest
Expense
(6% of
Preceding
Bond
Carrying
Amount)
Discount
Amortization
(B – A)
Discount
Account
Balance
(Preceding
D – C)
Bond
Carrying
Amount
($4,200,000
– D)
Jan. 1, Yr. 1
260,811
3,939,189
Dec. 31, Yr. 1
210,000
236,351
26,351
234,460
3,965,540
Dec. 31, Yr. 2
210,000
237,932
27,932
206,527
3,993,473
Dec. 31, Yr. 3
210,000
239,608
29,608
176,919
4,023,081
Dec. 31, Yr. 4
210,000
241,385
31,385
145,534
4,054,466
Dec. 31, Yr. 5
210,000
243,268
33,268
112,266
4,087,734
Dec. 31, Yr. 6
210,000
245,264
35,264
77,002
4,122,998
Dec. 31, Yr. 7
210,000
247,380
37,380
39,622
4,160,378
Dec. 31, Yr. 8
210,000
249,623
39,622
4,200,000
(continued) P 9-79B
Req. 3 (reporting the liabilities at Dec. 31, Year 4)
Current liabilities:
Current portion of notes payable …………….
$ 40,000
Long-term liabilities:
Bonds payable ………………………………………
$4,200,000
Less: Discount on bonds payable………..
(145,534)
4,054,466
Notes payable($200,000 – $40,000) ………….
160,000
(40-50 min.) P 9-80B
Req. 1 Using the PV function in EXCEL, the issue price of the bonds is
$4,610,271.
Req. 2 (amortization table)
A
B
C
D
E
Semiannual
Interest Date
Interest
Payment
(2% of
Maturity
Value)
Interest
Expense
(2.5% of
Preceding
Bond
Carrying
Amount)
Discount
Amortization
(B – A)
Discount
Account
Balance
(Preceding
D – C)
Bond
Carrying
Amount
($5,000,000
– D)
Dec. 31, 2014
389,729
4,610,271
June 30, 2015
100,000
115,257
15,257
374,472
4,625,528
Dec. 31, 2015
100,000
115,638
15,638
358,834
4,641,166
June 30, 2016
100,000
116,029
16,029
342,805
4,657,195
Dec. 31, 2016
100,000
116,430
16,430
326,375
4,673,625
June 30, 2017
100,000
116,841
16,841
309,534
4,690,466
Dec. 31, 2017
100,000
117,262
17,262
292,273
4,707,727
June 30, 2018
100,000
117,693
17,693
274,580
4,725,420
Dec. 31, 2018
100,000
118,136
18,136
256,444
4,743,556
June 30, 2019
100,000
118,589
18,589
237,855
4,762,145
Dec. 31, 2019
100,000
119,054
19,054
218,802
4,781,198
June 30, 2020
100,000
119,530
19,530
199,272
4,800,728
Dec. 31, 2020
100,000
120,018
20,018
179,253
4,820,747
June 30, 2021
100,000
120,519
20,519
158,735
4,841,265
Dec. 31, 2021
100,000
121,032
21,032
137,703
4,862,297
June 30, 2022
100,000
121,557
21,557
116,146
4,883,854
Dec. 31, 2022
100,000
122,096
22,096
94,049
4,905,951
June 30, 2023
100,000
122,649
22,649
71,401
4,928,599
Dec. 31, 2023
100,000
123,215
23,215
48,186
4,951,814
June 30, 2024
100,000
123,795
23,795
24,390
4,975,610
Dec. 31, 2024
100,000
124,390
24,390
(0)
5,000,000
(continued) P 9-80B
Req. 3
Journal
DATE
ACCOUNT TITLES AND EXPLANATION
DEBIT
CREDIT
2014
a.
Dec.
31
Cash …………………………..……………………..
4,610,271
Discount on Bonds Payable ……………….
389,729
Convertible Bonds Payable ……………
5,000,000
To issue bonds at a discount.
2015
b.
June
30
Interest Expense ………………………………..
115,257
Cash …………………………………………….
100,000
Discount on Bonds Payable ………….
15,257
To pay interest and amortize bond discount.
c.
Dec.
31
Interest Expense ………………………………..
115,638
Cash ……………………………………………..
100,000
Discount on Bonds Payable …………..
15,638
To pay interest and amortize bond discount.
2016
d.
July
1
Convertible Bonds Payable ………………..
2,000,000
Discount on Bonds Payable
($342,805 × 2/5) …………………………..
137,122
Common Stock (110,000 × $1) ……….
110,000
Paid-in Capital in Excess of
Par — Common ………………………….
1,752,878
To record conversion of bonds.
Req. 4 (balance sheet presentation of bonds payable at
Dec. 31, 2016)
Convertible bonds payable
($5,000,000 − $2,000,000) ………………………………
$3,000,000
Less: Discount on bonds payable
($326,375 × 3/5)*…………………………….….
(195,825)
$2,804,175
_____
*3/5 of the bonds are outstanding, so 3/5 of the discount remains.
(15-30 min.) P 9-81B
Req. 1
Alternative
Alternative
1
2
Borrow $7.75
Issue 100,000
mil at 5%
shares of stock
Net income 2 years from
now
$3,630,000
$3,630,000
Less interest expense
387,500
-0-
Projected net income
before tax
3,242,500
3,630,000
Less income tax expense
(35%)
1,134,875
1,270,500
Projected net income 2
years from now
$2,107,625
$2,359,500
Earnings per share:
$2,107,625/100,000
$21.08
$2,359,500/(100,000 +
100,000)
$11.80
Req. 2
TO: Management of Marcell Medical Goods
FROM: Student Name
SUBJECT: Advantages and disadvantages of borrowing
versus issuing stock to raise cash for expansion
Raising money by borrowing has at least two advantages over issuing
(continued) P 9-81B
in the business and to carry out their plans without interference from a new
group of stockholders. Under normal conditions, borrowing results in a higher
that may pose difficulties for the original stockholder group. Another
disadvantage of issuing stock is that earnings per share are usually lower
because of (1) the greater number of shares of stock outstanding, and (2) the
non-tax-deductibility of dividends paid on the stock.
(20-30 min.) P 9-82B
Req. 1
Gilbert Foods, Inc.
Partial Balance Sheet
Dec. 31, 2014
Property, plant,
and equipment:
Current liabilities:*
Equipment ……….
$731,000
Bonds payable,
Accumulated
current portion ……………….
$ 401,000
Depreciation ….
(165,000)
Mortgage note payable,
566,000
current portion ………………
83,000
Interest payable ……………….
34,000
Total current liabilities ………..
518,000
Long-term liabilities:
Mortgage note
payable …………………………..
$ 314,000
Bonds payable ….. $1,080,000
Less: Discount on
bonds payable ….. (322,000)*
758,000
Pension liability ……………….
42,000**
Total long-term liabilities ……
1,114,000
_____
Notes:
* The order of listing long-term liabilities is optional. However, Discount on
Bonds Payable should come immediately after Bonds Payable. Also, it is
customary to report Interest Payable after the related liability accounts.
Less: Pension plan assets, at market value …………………..
Pension liability to be reported on the balance sheet …….
(continued) P 9-82B
Req. 2
a. Carrying amount of bonds payable:
Current portion ……………………………………………………. $ 401,000
Req. 3
Times-interest-earned ratio
=
Operating income
=
$590,000
Interest expense
$227,000
=
2.60 times
Req. 4