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P7.32.
(continued)
b.
The semiannual premium amortization, straight-line basis = $2,400,000 / 40 periods =
$60,000
Balance Sheet Income Statement .
Assets = Liabilities + Owners’ Equity Net income = Revenues - Expenses
Cash Premium on Interest
-4,900,000 Bonds Payable Expense
-60,000 -4,840,000
c.
Premium on bonds payable is amortized with a debit, and thus decreases interest expense.
Under the straight-line basis, the amount of premium amortization is the same each
period. Under the compound (or effective) interest method, the amount of premium
amortization increases each period. Thus, interest expense under the compound method
will be higher in the early years of the bond’s life and lower in the later years, as
compared to interest expense under the straight-line method of amortization.
d.
There is usually a time lag of several weeks from the point that the stated rate of interest
has been established (as part of the bond indenture) and the date that the bonds are sold
C7.34.
a.
The average-for-the-year interest rate = (7% + 8%) / 2 = 7.5%
The average liability balance = ($380,000 + $500,000) / 2 = $440,000
Balance Sheet Income Statement .
Assets = Liabilities + Stockholders’ Equity Net income = Revenues - Expenses
Interest Interest
Payable Expense
+33,000 -33,000
b.
No. The “current maturities of long-term debt” is related to the “serial bonds due in equal
annual installments.” The current maturities owed at the end of 2016 would have been
paid at some point during 2017 (at the date specified in the serial bond indenture). At the
c.
Solution approach: What happens to the market value of the firm’s bonds outstanding
when there is a decline in interest rates for bonds of similar risk? The bonds pay a higher
than market-rate of interest, so their price will increase. That is, investors are willing to
Points for discussion: What other factors should Corless Co. consider before deciding
to call the bonds? 1) cost of the call premium, and 2) cost of registration and issuance of
C7.34.
(continued)
d.
The market value would be more than the book value of $800,000 because the price of
the bonds would increase, as described in item c (since the market rate of interest has
fallen to 7%). This is bad news to Corless Co. because it is paying a higher than market
interest rate.
Points for discussion: Why doesn’t the firm adjust the book value of its liability for the
change in market value caused by interest rate movements? That is, why not record the
unrealized gain or loss each year as a year-end adjusting entry so that the Bonds Payable
e.
The following adjusting entry would have been made (dated December 31, 2017) to
reclassify the 2018 installment of the serial bond as a current liability:
Balance Sheet Income Statement .
Assets = Liabilities + Stockholders’ Equity Net income = Revenues - Expenses
Serial Bonds Payable
-160,000
Current Maturities
of Long-Term Debt
C7.35.
b.
Note to Instructors: This case was originally based on the 1999 annual report of Home
Depot, Inc. The long-term debt note disclosures in more recent years have become less
1. Below face: No, this is not possible.
3. Equal to face: Yes, this is possible.
Discussion: The bonds are redeemable at “a redemption price… equal to the greater of
(1) 100% of the principal amount of the Senior Notes to be redeemed, or (2)…” This
statement indicates that the minimum amount to be paid by Home and Office City is equal
to the principal amount of the notes (i.e., face value). Thus, the notes cannot be redeemed
at a discount—no matter what the “present value” of the remaining principal and interest
C7.35.
(continued)
c.
This statement means that Home and Office City has arranged to have “ready access” to
$800 million of additional borrowings. As of December 31, 2017, no commercial paper
debt was outstanding, which means that the company has not drawn down on this line of
credit. Should the company need to do so, the terms and conditions of the debt (i.e.,
d.
You might want to know, for instance:
1. What amounts are scheduled to mature in which years;
2. What the implicit interest rate (or a range of implicit interest rates) is on the capital
e.
Most installment notes are non-interest bearing on their face. Yet, if you were to add up
the total of the amounts to be repaid in future years, this undiscounted sum would greatly
exceed the amount initially borrowed. Thus, the interest rate charged on the loan is
implicit (rather than explicit, as when it’s stated in the lending documents). The implicit
f.
Any of a number of explanations are possible, including:
2. Unsecured loans are more expensive to borrowers (in the form of higher interest rates).
4. Unsecured loans tend to be of relatively short duration (usually 2-4 years), which may
C7.35.
(continued)
g.
Most of Home and Office City’s long-term debt has near-term maturities. The $500
Instructor’s Manual / Solutions Manual
TAKE-HOME QUIZ--CHAPTER 7 Name___________________________
1. This question relates to the following presentation in the balance sheets of Asriel, Inc. at
December 31, 2017 and 2016:
Current liabilities: 12/31/17 12/31/16
Accounts payable .......................................................................... $ 18,400 $ 16,750
Accrued wages payable ................................................................. 3,800 4,430
Accrued property taxes payable .................................................... 2,200 2,000
Accrued interest payable ............................................................... 1,800 0
a. If wages expense during 2017 totaled $137,600, how much cash was paid for wages?
b. If property taxes paid during 2016 totaled $27,350, how much property tax expense was
accrued during 2017 ?
c. If the interest payable at 12/31/17 had not been accrued at that date, by how much and in what
direction (too high or too low) would net income for 2017 have been misstated?
d. Why are expenses accrued?
Chapter 7 Accounting for and Presentation of Liabilities
TAKE-HOME QUIZ--CHAPTER 7 (continued)
2. On January 1, 2017, Simon, Inc. issued $500,000 of 9%, 10-year bonds at 101. Interest is
payable every June 30 and December 31. Premium is amortized on a straight-line basis.
a. Was the market interest rate on January 1, 2017 equal to, more than, or less than the stated
interest rate of the bonds? Explain your answer.
b. How much interest will be paid on these bonds during 2017?
3. a. The deferred income tax liability arises because book income is greater than taxable income.
What is the principal item that causes book and taxable income to be different for most
companies?
b. What concept is being applied when income taxes that won't be payable for several years are
recognized in the current period's financial statements?
Instructor’s Manual / Solutions Manual
TAKE-HOME QUIZ KEY—CHAPTER 7
1. a. Analyze the wages payable account:
Beginning balance of wages payable ................................................................ $ 4,430
Add: Accrual of wages expense for period ........................................................ 137,600
b. Analyze the property taxes payable account:
Beginning balance of property taxes payable .................................................... $ 2,000
Less: Property taxes paid during period............................................................. (27,350)
c. Net income would have been $1,800 too high.
d. To match revenues and expenses, thus making the financial statements more accurate.
2. a. Less than, because the bonds were issued at a premium.
b. $500,000 * 9% = $45,000
3. a. Depreciation expense. Accelerated depreciation is claimed for income tax purposes
