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Financial Reporting and Analysis (7th Ed.)
Chapter 11 Solutions
Financial Instruments and Liabilities
Exercises
Exercises
E11-1. Finding the issue price (LO 11-2)
(AICPA adapted)
We know that the bonds were priced to yield 8% when the contract
interest rate was only 6%. Since the yield is higher than the contract
interest rate, we know the bonds were sold at a discount, and we
must use the yield to maturity to find interest expense and the price
of the bond.
Present value of interest payments
E11-2. Determining market price following a change in interest rate
(LO 11-2)
Now we’ve moved one year closer to the maturity date. So, two
aspects of the calculation in E11-1 will have changed: The yield to
maturity is now 10% (or 5% per period), and there are 18 periods to
maturity.
Present value of principal
E11-3. Finding the discount at Issuance (LO 11-2)
To find the amount of amortization on July 1, 2017 we first need to
know the book value of the bond on that date. Since this is the first
interest payment date, the beginning-of-period book value is the
same as the original issue (selling) price, which is the face value
Semiannual:
E11-4. Determining a bond’s balance sheet value (LO 11-2)
(AICPA adapted)
Even though the bonds pay interest only annually on December 31,
the
June 30 balance sheet would still need to reflect interest accrued
since the issue date:
975
Interest expense is $23,475 = $469,500 x 10% x 1/2 year, interest
payable is $22,500 = $500,000 x 9% x 1/2 year, and the
amortization is the difference between these two amounts.
E11-5. Calculating gain or loss at early retirement (LO 11-4)
(AICPA adapted)
The gain (or loss) on bond extinguishment can be computed as
follows:
The reacquisition price is the cash paid out by Davis to reacquire its
bonds. Since it is less than the book value of the bonds, the
company realizes a gain on the retirement of its debt.
E11-6. Amortizing a premium (LO 11-2)
(AICPA adapted)
To find the amount of unamortized premium on June 30, 2018, we
first need to find the interest expense for 2018 (6% of the June 30,
2017, book value, 6% of $105,000).
Date
Interest
Payment
Interest
Expense
Premium
Amortization Book Value
The carrying (or book) value of the bond on June 30, 2018, is
$104,300. We know that the face value of the bond is $100,000 and
E11-7. Recording loss contingencies (LO 11-9)
(AICPA adapted)
Brower expects to receive $3.2 million as compensation for the
expropriation of its manufacturing plant. The plant has a book value
of $5.0 million, so the estimated loss is $1.8 million ($5.0 book value
- $3.2 million expropriation proceeds). The journal entry to record
the intended expropriation is:
E11-8. Zero coupon bond (LO 11-2)
Requirement 1:
These bonds have a face value of $250 million, a zero coupon
rate, a market yield rate of 12%, and mature in 20 years. The issue
price is:
Present value of principal
If the market interest rate is instead 12% semi-annually (6% each
Requirement 2:
How much interest expense would the company record on the
bonds in 2017? Although the bonds don’t pay interest, an expense
would still be recorded:
Requirement 3:
Interest expense in 2018 would be:
E11-9. Floating-rate debt (LO 11-3)
Requirement 1:
The floating interest rate for 2017, set on January 1 of that year,
was 12% or the LIBOR rate of 6% plus 6% additional interest. The
For 2018, the floating rate will be 14%, or a LIBOR rate of 8% plus
6% additional interest. So the company will pay out $28 million
Requirement 2:
The debentures were issued at par for $200 million, so there is no
E11-10. Identifying incentives for early debt retirement (LO 11-4)
Requirement 1:
We must first determine the book value of the bonds on December
31, 2017—almost two years after issuance. That would seem easy
because the bonds were issued at par, but there is a catch: The
The total book value (including Interest) of the debt on December
31, 2017, is $130 million, the $125 million borrowed plus the $5
Present value of principal
Plus the accrued interest of $5 million gives a total market value of
the bond equal to $97,492,085.
The entry to record the debt extinguishment is:
CR Taxes payable
$11,377,770
Requirement 2:
There are several reasons a company might want to retire debt
early: take advantage of lower interest rates; postpone scheduled
principal repayments; eliminate a conversion feature attached to
the debt; improve the company’s mix of debt and equity capital; or
E11-11. Early extinguishment of debt (LO 11-2, LO 11-4)
Requirement 1 – Issuance price
Because the coupon and market rates are equal, the bonds will sell for par
value, or $250,000,000. We can check this result by using present value
tables as follows.
*$10,000,000 = $250,000,000 par x 8%÷2.
The computed amount does not equal $250,000,000 because the present
Requirement 2 – Bond price at July 1, 2019
Remaining periods 16
Market rate 6%
Payments per year 2
Requirement 3 – Journal entry if 50% of the bonds are retired on July
1, 2019
aPar value of $250,000,000 x 50%.
bBond price of $281,403,500 x 50%.
cBonds payable of $125,000,000 less cash outflow of $140,701,750.
E11-12. Fair value option (LO 11-5)
Requirement 1: Book value on January 1, 2017
Requirement 2: Journal entries during 2017
January 1, 2017
To record interest expense
To record change in bond price
After the second journal entry, the bonds payable net of the adjustment will
reflect fair value. The interest expense and unrealized gain would probably
netted in one financing expense line item on the income statement.
*Price adjustment calculation
Remaining periods
9
Market rate 9%
Payments per year 1
Market value (tables)
246,043,500
Requirement 3 - Increase in interest rate and deteriorating financial condition
If the increase in interest rate were due to worsening financial health, the credit
E11-13. Noninterest-bearing loan (LO 11-3)
Requirement 1:
The present value of this payment stream, discounted at 9%, is:
Total present value of payment stream
$451,822
Requirement 2:
The purchase would be recorded at its implied cash price of
$451,822 as:
Interest expense at 9% per year on the unpaid balance would also be recorded over time.
Requirement 3:
McClelland should purchase from Agri-Products because it has
offered the best price.
E11-14. Understanding GAAP hedges (LO 11-8)
Requirement 1:
A “hedged item” can be (1) an existing asset or liability on the
company’s books, (2) a firm commitment, or (3) an anticipated
1. Manufacturer’s work-in-process inventory is an existing asset.
2. Credit card receivables are an existing asset at JC Penney.
Requirement 2:
The qualifying hedge instrument is most often a derivative security,
although not all derivatives meet the GAAP rules and some
qualifying hedges do not involve derivatives. Insurance contracts,
options to purchase real estate, equity and debt securities, and
Requirement 3:
Eligible risks for hedge accounting are those that arise from overall
changes in the fair value or cash flow of the hedged item, or from
(a) Alliant Energy’s risk that summer demand will exceed its
(b) Ford’s risk of steel price increases is an eligible risk of
(c) American Express’s risk that members won’t pay their bills is
(d) The risk of grain mold is not an eligible risk.
