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P11-11. Discount and premium amortization (LO 11-2)
Requirement 1:
The carrying values of both bonds in each of the two years
presented is simply equal to the present value of the principal and
interest payments discounted over the remaining life of the bond.
Present value of the interest payments:
= $500,000 x Present value of an ordinary annuity of $1 to be
received in
4 periods at 6%
In a similar fashion, the December 31, 2017, value of $10,362,950
for the 10% bonds due in 2019 can be derived as follows. Note
Present value of the principal repayment:
Present value of the interest payments:
The December 31, 2017 carrying value of the 10% bonds due in
2018 is equal to the present value of the principal repayment to be
Present value of the principal repayment:
Present value of the interest payments:
Carrying value of the bonds at December 31, 2017:
The December 31, 2016, carrying value of the 10% bonds due in
2019 is equal to the present value of the principal repayment to be
Present value of the principal repayment:
Carrying value of the bonds at December 31, 2016:
Requirement 2:
The amount of interest expense recognized in 2017 on the bonds
due in 2018 is equal to the cash interest payment of $1 million
($500,000 on both June 30 and December 31) plus the
Total interest expense:
Requirement 3:
The amount of interest expense recognized in 2017 on the bonds
due in 2019 is equal to the cash interest payment of $1 million
($500,000 on both June 30 and December 31) minus the
Total interest expense:
P11-12. Sears: Reading the Financials (LO 11-1, LO 11-6)
Requirement 1:
There are two correct solutions to this requirement, depending
upon how you interpret the company’s “14.6% effective rate”
Notice that interest expense is different from the cash interest
payment, which can be found by multiplying the debt face value by
the stated interest rate:
The discount amortization is the difference between the expense
and cash payment shown above, or $5,674,200 = $26,674,200
minus $21,000,000. The book value change shown on the balance
An alternative solution is based on the notion that the disclosed
“14.6% effective rate” is meant to be interpreted as meaning a
Ending book value of debt (including amortized discount) is now
$185,537,100.
2. Second semi-annual period
These semi-annual calculations show total interest expense to be
$26,881,308 and the total discount amortization to be $5,881,308.
Requirement 2:
There are two ways to compute interest expense on the zero
coupon bonds:
Or, since the entire expense is amortized (there’s no cash
payment), it is all added to the debt book value. Consequently,
interest expense will equal the increase in carrying value of the
bonds, or:
Requirement 3:
The following entry would have been made on December 31, Year
2, for the participating mortgages:
Requirement 4:
The zero coupon bonds do not pay cash interest. $21 million was
P11-13. Hedging (LO 11-7, LO 11-8)
Requirement 1:
The company eliminated its exposure to the cash flow
consequences of changing foreign currency exchange rates
interest and principal U.S. dollar payments with fixed Canadian
dollar payments.
Requirement 2:
The risk being hedged involves fluctuations in the number of
Canadian dollars required to meet the company’s U.S. dollar
Requirement 3:
Consistent with GAAP guidelines (see Figure 11.7), changes in the
Requirement 4:
The financial commodity swap allows the company to “lock in” the
future price of natural gas, an important component to the
Requirement 5:
The hedged item is a forecasted transaction (future purchases of
Requirement 6:
The purposes of these commodity swaps and futures contracts
also is to mitigate the company’s exposure to the risk of fluctuating
prices for future purchases of aluminum, natural gas, electricity,
and diesel fuel.
Requirement 7:
Some contracts have been designated as cash flow hedges, and
the fair value change associated with these contracts bypasses
P11-14. Contingent liabilities and debt covenants (LO 11-9,
LO 11-10)
Requirement 1:
U.S. GAAP guidance state that a loss contingency shall be
recorded when both of the following conditions exist:
Requirement 2:
IFRS guidance on accounting for contingencies is quite similar to
the U.S. GAAP approach except that IFRS focus on the
recognition of contingent liabilities and assets rather than gains
Requirement 3:
It does not appear as though Checkpoint Systems has already
recognized a loss contingency reserve related to this law suit
because there is no mention of a recorded loss accrual or
Requirement 4:
The U.S. District Court assessed damages of $26 million against
Checkpoint in an antitrust lawsuit. The District Court decision
Requirement 5:
As mentioned in the news clip, Checkpoint has loan covenants
that restrict it from putting new debt on the books and that require
the company to maintain a $200 million minimum net worth. The
Requirement 6:
Students will have differing views regarding the bank’s action, but
it is unlikely that a lender will simply waive covenant violations in
such situations. The reason is that the District Court decision
P11-15. Working backward from an amortization table (LO 11-2)
Requirement 1:
Compute:
Discount or premium on the sale
Requirement 2:
At the time of issuance, the bondholders exchanged today’s cash
flow for tomorrow’s, but with the same present value on a
risk-adjusted basis. Consequently, neither the borrower nor the
the stated interest rate is not equal to the market yield (effective)
Requirement 3:
It is the present value of an annuity of $25,000 for the next 5
Requirement 4:
New price of the bonds on January 1, 2020, is:
The economic gain that results from the interest rate increase is:
Considering just the debt, the company and its shareholders are
better off because of the interest rate increase. The economic gain
Of course, things get a bit more complicated when the interest rate
increase has a negative impact on the company’s other activities.
For example, if the company sells products to customers on an
P11-16. Recording floating-rate debt (LO 11-3)
Requirement 1:
Journal entry to record the issuance on January 1, 2017:
If the bonds were issued at par, the effective (or market) interest
Requirement 2:
Interest expense for 2017:
$30,000,000
Interest expense for 2018:
Interest expense for 2019:
CR Cash
$27,500,000
Requirement 3:
If the only factor influencing the market value of these bonds is the
LIBOR, the bonds will have a market value of $250 million on
