P11-17. Unconditional purchase obligations (LO 11-6, LO
11-9)
Requirement 1:
The following schedule shows the present value computation
using an 8% discount rate:
Year
Purchase
commitment Present
value factor
Present value
amount
Requirement 2:
Using the amounts now shown on the balance sheet, the
3.33
If the unconditional purchase obligation contracts were included on
the balance sheet with the company’s other long-term debt, total
4.69
Requirement 3:
Under current GAAP, contracts of this sort are not booked because
neither party is viewed as having taken any action—no cash or
property has yet been exchanged, there is just a promise to do so
in the future. Some companies prefer this approach because it
P11-18. Loss contingencies (LO 11-9)
Requirement 1:
A loss contingency is an event that results in the possibility of
future loss. A primary example of a loss contingency is litigation.
Loss contingencies can be disclosed either by recognizing a
Loss contingencies are included in the financial statements
because the event will possibly cause future loss. That is, the
The Exxon and Borden illustrations are examples of loss
contingencies. A loss contingency meets GAAP guidelines for
Requirement 2:
GAAP states that a loss contingency shall be accrued if it is (1)
probable and (2) the amount of the loss can be reasonably
Requirement 3:
There are several reasons why Exxon does not report a dollar
amount for the loss contingency. First, while a liability clearly
exists, a reasonable estimate of the amount of the liability may not
be possible. Second, even if Exxon could reasonably estimate the
liability, it may be hesitant to disclose the estimate because doing
Stock analysts are unlikely to ignore the loss contingency when
valuing Exxon. Analysts realize that a significant loss has occurred
even if the company does not place a specific dollar amount on the
Requirement 4:
Exxon first reported a balance sheet liability for the Exxon Valdez
spill in 1996, once the court entered the $5.058 billion judgment
Requirement 5:
The Court’s willingness to hear the Exxon appeal will have no
impact on the company’s recorded contingent liability. If and when
Requirement 6:
As the company states in its financial statement note, Visa
recognizes a litigation loss contingency provision when it deems
the loss to be probable and the amount can be reasonably
estimated. When the litigation process is itself quite lengthy, Visa
Requirement 7:
As explained in the company’s financial statement footnote, a $4.1
billion increase to the accrued litigation liability was recorded in
P11-19. Debt-for-debt swaps (LO 11-4, LO 11-10)
Requirement 1:
Since the bonds were originally sold at par, the carrying amount on
December 31, 2017 is equal to $5,000,000. If this bond issued
were retired in exchange for a bond issue valued at $3,200,000
there would be a pre-tax gain of $1,800,000. The journal entry to
record the exchange would be:
Requirement 3:
Requirement 4:
Other ways to avoid the covenant’s violation include: issue
additional common stock, reissue any treasury stock that is being
Requirement 5:
IFRS guidance stipulates that an exchange of financial instruments
qualifies as an extinguishment of debt only if the terms—stated
interest rate, duration, payment schedule, etc.—of the instruments
are “substantially” different. Absent substantial differences in
P11-20. Zero coupon bonds (LO 11-2)
Requirement 1:
ALZA issued $1.0 billion maturity value zero coupon debentures at
Requirement 2:
To record interest expense for the year at a 3% effective
interest rate.
Requirement 4:
Interest rates throughout the economy have declined, making
ALZA’s 3% zero coupon debentures even more attractive to
investors who then bid up the price of the company’s debt.
P11-21. Comprehensive problem on premium bond (LO 11-2)
The following schedule shows the details for most parts of this
question.
Amortization table for 20-year bond with semi-annual interest
payments
Bond Principal $20,000,000
Coupon Interest Rate 6.0%
Market Interest Rate 4.0%
Month and Year Issued July-17
Amortization Table
Month/Year Period
Bond Carrying
Amount at
Start of Period
Interest
Expense
Bond
(Premium)
Discount
Amortization
Premium
(Discount)
Balance
Bond Carrying
Amount at
End of Period
Cost
Interest
Payment
Principal
Payment
Issue date: $27,917,110 $7,917,110
Requirement 1:
Requirement 2:
Requirement 3:
The entry for December 31, 2018 is:
Requirement 4:
Points to be made include: the company received $27.9 million
cash in exchange for a promise to repay on $20 million in principal
and $2.4 million in interest each year; because more than $20
million was received, the true interest rate is less than 6% each
Requirement 5:
Deere will not record the guarantee as a liability on its financial
Requirement 6:
From the amortization schedule in Requirement 1, we can see that
the book value of the entire debt issue is $26,793,486 on July 1,
Requirement 7:
If the market yield on the debt is 10%, its market price would be
$23,074,490 and 40% of the debt would have a market value of
P11-22. Hedging a Purchase
Commitment (LO 11-7, LO 11-8)
Requirement 1:
Silverado must give the supplier a six-month advance commitment
for titanium purchases at a fixed price, but the company does not
want to forego the possibility that titanium prices will decline over
the period. So, the company enters into a forward contract to sell
Was it a good idea? Yes, in this case, because titanium prices fell
to $285 per pound by June 30.
Requirement 2:
Requirement 3:
The following entries are made on March 31:
Notice that the gain on the forward contract is offset by the loss on
Requirement 4:
The following entries are made on June 30:
(To record the change in fair value of the firm commitment)
DR Cash $250,000
(To record the purchase of titanium at the contracted price.)
(To unwind the firm commitment and adjust the carrying amount
of the titanium purchase.)
Notice that titanium inventory is now on the books at June 30
market price of $285 per pound ($3,100,000 minus $250,000 =