Suggestions for Class Activities
1. Real World Scenario
An article in Barron’s, titled “Wall Street’s Latest Illusion,” reported that “Goldman Sachs,
Morgan Stanley and other firms are booking profits from the falling value of their own debt.”
The article asserts that when a company’s credit weakens, it reports a gain.
Suggestions:
Have students consider this assertion and explain how it occurs.
Points to Note:
A company is not required to, but has the option to, value some or all of its financial assets
and liabilities, including bonds and notes, at fair value. If a company chooses the option to report
at fair value, then it reports changes in fair value in its income statement.
When a company’s credit worthiness declines, the yield on its debt rises relative to the market
causing the debt price to decline. The company then reports a gain in its income statement if it
has elected the fair value option.
2. Real World Scenario
Texas Eastern Transmission Corporation is a unit of PanEnergy Corporation. In a press
release, the company announced the retirement of some of its bonds. Excerpts from the press
release follow:
…. $100 million face value of outstanding of 10 1/8% debentures and $150 million
outstanding of the 10% debentures are outstanding. The 10 1/8% debentures are due Sept. 1,
2015, and the 10% debentures are due Oct. 1, 2015. The redemption price for the 10 1/8%
debentures is 105.062% of the principal amount to be redeemed, together with interest
accrued to the Oct. 1 redemption date.
Suggestions:
Have the students consider how they would account for the retirement of the 10 1/8 bonds.
Ask them to assume they were issued at face value.
Points to Note:
Because the maturity date is Sept. 1, it’s likely that that’s also an interest date, so interest was
last paid one month before redemption.
3. Spreadsheet Activity
Have students create a functional debt amortization schedule in Excel. Suggest that the
spreadsheet:
1. Include cells for the number of periods, the stated interest rate, the effective interest rate, the
principal, the present value of cash flows, and the periodic cash payment. The cells should be
“defined” as the respective variables so that formulas in the schedule that refer to the variable
names will pick up the values entered in the cells.
2. The initial balance can be made to calculate the bond price if a principal is provided by the
user in the principal cell or to assume an installment note and calculate the PV of cash
payments if the principal is not provided by the user in the principal cell.
3. In addition, the cash payments cell can be made to calculate installment payments if the PV is
provided by the user in a PV cell. Thus, if “PV” is blank, the calculation will default to a
bond or note with the principal paid at maturity.
Provide students with various variable values to conduct several “what if?” exercises.
4. Spreadsheet Activity
Ask students to use the spreadsheet they created in Activity 2 or the spreadsheet available to
them on the course website to create an amortization schedule for the purchase of a car. You
might suggest they do so for a car of their dreams or one you identify—for example, a Nissan
Maxima costing $40,000. Have them determine the monthly payments on a four-year car loan
with a 9% interest rate.
A variation is to ask them to determine the car price they can afford given a monthly payment
they can manage.
5. Bond Valuation Activity
This is to reinforce students’ understanding of bond valuation concepts:
Have students determine the price of the bonds at January 1, 2018, under each of the following
independent assumptions, one at a time. Have students volunteer solutions out loud. After each
response, ask the class why the chosen number of periods and discount rate were used and why
the price is more or less than $200 million.
Bond offerings:
On January 1, 2018, Ross-Finn Fabrication issued $200 million of 12% bonds, dated January
1.
(a) The bonds mature in 2038 (20 years). The market yield for bonds of similar risk and
maturity is 14%. Interest is paid annually.
(b) The bonds mature in 2038 (20 years). The market yield for bonds of similar risk and
maturity is 14%. Interest is paid semiannually.
(c) The bonds mature in 2038 (20 years). The market yield for bonds of similar risk and
maturity is 11%. Interest is paid semiannually.
(d) The bonds mature in 2048 (30 years). The market yield for bonds of similar risk and
maturity is 11%. Interest is paid semiannually.
(e) The bonds mature in 2048 (30 years). The market yield for bonds of similar risk and
maturity is 12%. Interest is paid semiannually.
Calculations:
(a)
Interest $24,000,000 ¥
× 6.62313 * =$158,955,120
Principal $200,000,000 × 0.07276 ** = 14,552,000
Present value (price) of the bonds $173,507,120
¥ 12% × $200,000,000
*present value of an ordinary annuity of $1: n=20, i=14%
** present value of $1: n=20, i=14%
(b)
Interest $12,000,000 ¥
× 13.33171 * = $159,980,520
Principal $200,000,000 × 0.06678 ** = 13,356,000
Present value (price) of the bonds $173,336,520
¥ 6% × $200,000,000
*present value of an ordinary annuity of $1: n=40, i=7%
** present value of $1: n=40, i=7%
(c)
Interest $12,000,000 ¥
× 16.04612 * = $192,553,440
Principal $200,000,000 × 0.11746 ** = 23,492,000
Present value (price) of the bonds $216,045,440
¥ 6% × $200,000,000
*present value of an ordinary annuity of $1: n=40, i=5.5%
** present value of $1: n=40, i=5.5%
(d)
Interest $12,000,000 ¥
× 17.44985 * = $209,398,200
Principal $200,000,000 × 0.04026 ** = 8,052,000
Present value (price) of the bonds $217,450,200
¥ 6% × $200,000,000
*present value of an ordinary annuity of $1: n=60, i=5.5%
** present value of $1: n=60, i=5.5%
(e)
Interest $12,000,000 ¥
× 16.16143 * = $193,937,160
Principal $200,000,000 × 0.03031 ** = 6,062,000
Present value (price) of the bonds $199,999,160
actually, $200,000,000 if PV table factors were not rounded
¥ 6% × $200,000,000
*present value of an ordinary annuity of $1: n=60, i=6%
** present value of $1: n=60, i=6%
6. Professional Skills Development Activities
The following are suggested assignments from the end-of-chapter material that will help your
students develop their communication, research, analysis, and judgment skills.
Communication Skills. In addition to Communication Cases 14–1, 14–3 and 14–7, Judgment
Case 14–5 can be adapted to ask students to write a memo to Mr. Wilde, and Judgment
Case 14–6 can be adapted to ask students to write a memo to Jaecke’s chief accountant
defending their positions. Judgment Case 14–5 is suitable for student presentation(s).
Communication Case 14–3 requires group interaction. In addition, Ethics Case 14–8 and
Judgment Case 14–9 do well as group assignments. Questions 14–11 and 14–20 and
Exercise 14–22 create good class discussions.
Research Skills. In their careers, our graduates will be required to locate and extract relevant
information from available resource material to determine the correct accounting practice,
perhaps identifying the appropriate authoritative literature to support a decision. Real
World Case 14–2 and Research Case 14–10 provide an excellent opportunity to help
students develop this skill.
Here’s another research activity that may add to your students’ research skills:
Very frequently, the Wall Street Journal lists new security issues in a boxed section
toward the end of the “Money and Investing” section by the “NEW SECURITY ISSUES”
that includes corporate debt issues and stock issues. Ask students to locate that
section of a recent issue of the Journal and list the corporate debt issues described.
For each, ask them to determine:
1. Whether it is secured or unsecured
2. The face amount and the issue price
3. The stated rate and yield
4. The term to maturity
5. Whether it is callable
Analysis Skills. The “Broaden Your Perspective” section includes Analysis Cases that direct
students to gather, assemble, organize, process, or interpret date to provide options for
making business and investment decisions. In addition to Analysis Cases 14–4, 14–11 and
14–19, Exercise 14–6, Problems 14–2 and 14–4, and Real World Case 14–2 also provide
opportunities to develop analysis skills.
Judgment Skills. The “Broaden Your Perspective” section includes Judgment Cases that
require students to critically analyze issues to apply concepts learned to business situations
in order to evaluate options for decision making and provide an appropriate conclusion. In
addition to Judgment Cases 14–5, 14–6, and 14–9, Communication Case 14–7 also requires
students to exercise judgment.
Assignment Chart
Learning Est.
time
Questions Objective(s) Topic
(min.)
14–1 1 Periodic interest 5
14–2 1 Reporting long-term liabilities on a balance
sheet
5
14–3 1 How are bonds and notes the same? 5
14–4 2 Bond indenture 5
14–5 2 Bond pricing 5
14–6 2 Bond pricing 5
14–7 2 Zero-coupon bond 5
14–8 2 Bonds issued at a premium 5
14–9 2 Methods of determining interest on bonds 5
14–10 2 Debt issue costs 5
14–11 3 When a note’s stated rate of interest is
unrealistic relative to the “market rate”
5
14–12 3 Notes 5
14–13 4 Disclosures 5
14–14 5 Early extinguishment of debt 5
14–15 5 Early extinguishment of debt 5
14–16 5 Convertible bonds and bonds issued with
detachable warrants
5
14–17 5 Voluntary conversion 5
14–18 5,7 IFRS; convertible bonds 5
14–19 6 Fair value option 5
14–20 14A Pricing bonds at price plus accrued interest 5
14–21 14B Troubled debt restructuring 5
14–22 14B Troubled debt restructuring 5
14–23 14B Troubled debt restructuring 5
Brief Learning Est.
time
Exercises Objective(s) Topic
(min.)
14–1 1 Bond interest 5
14–2 2 Determining the price of bonds 5
14–3 2 Determining the price of bonds 5
14–4 2 Determining the price of bonds 5
14–5 2 Effective interest on bonds 5
14–6 2 Effective interest on bonds 5
14–7 2 Straight-line interest on bonds 5
14–8 2 Investment in bonds 5
14–9 3 Note issued for cash; borrower and lender 5
14–10 3 Note with unrealistic interest rate 5
14–11 3 Installment note 5
14–12 5 Early extinguishment; effective interest 5
14–13 5 Bonds with detachable warrants 5
14–14 5 Convertible bonds 5
14–15 6 Reporting bonds at fair value 5
Learning Est.
time
Exercises Objective(s) Topic
(min.)
14–1 2 Bond valuation 25
14–2 2 Determine the price of bonds in various
situations
35
14–3 2 Determine the price of bonds; issuance;
effective interest
15
14–4 2 Investor; effective interest 15
14–5 2 Bonds; issuance; effective interest; financial
statement effects
15
14–6 2 Bonds; issuance; effective interest 15
14–7 2 Determine the price of bonds; issuance;
straight-line method
15
14–8 2 Investor; straight-line method 15
14–9 2 Issuance of bonds; effective interest;
amort-ization schedule; financial statement
effects
15
14–10 2 Issuance of bonds; effective interest;
amortization schedule
25
14–11 2 Bonds; effective interest; adjusting entry 15
14–12 2 Bonds; straight-line method; adjusting entry 15
14–13 2 Issuance of bonds; effective interest 15
14–14 2 New debt issues; offerings announcements 15
14–15 2 Error correction; accrued interest on bonds 15
14–16 3 Error in amortization schedule 20
14–17 3 Note with unrealistic interest rate; borrower;
amortization schedule
25
14–18 3 Note with unrealistic interest rate; lender;
amortization schedule
25
14–19 3 Installment note; lender; amortization schedule 20
14–20 3 Installment note; amortization schedule 20
14–21 3 Installment note 20
14–22 2,3,4 FASB codification research 15
14–23 5 Early extinguishment 10
14–24 5 Convertible bonds 20
14–25 5,7 IFRS; convertible bonds 10
14–26 5 Convertible bonds; induced conversion 20
14–27 5,7 IFRS; convertible bonds 20
14–28 5 Bonds with detachable warrants 20
14–29 6 Reporting bonds at fair value 20
14–30 6 Reporting bonds at fair value 25
14–31 6 Reporting bonds at fair value; calculate fair
value
30
14–32 14A Accrued interest 5
14–33 14B Troubled debt restructuring; debt settled 10
14–34 14B Troubled debt restructuring; modification of
terms
15
14–35 14B Troubled debt restructuring; modification of
terms; unknown effective rate
20
14–36 14B FASB codification research; legal fees in a
troubled debt restructuring
15
Learning Est.
time
Problems Objective(s) Topic
(min.)
14–1 2 Determining the price of bonds; discount and
premium; issuer and investor
20
14–2 2 Effective interest; financial statement effects 30
14–3 2 Straight-line and effective interest compared 30
14–4 2 Bond amortization schedule 20
14–5 2 Issuer and investor; effective interest; amortization
schedule; adjusting entries
50
14–6 2,14A Issuer and investor; straight-line method;
adjusting entries
50
14–7 2 Issuer and investor; effective interest 25
14–8 2 Bonds; effective interest; partial period interest;
financial statement effects
60
14–9 2 Zero-coupon bonds 20
14–10 3 Notes exchanged for assets; unknown effective
rate
25
14–11 3 Note with unrealistic interest rate 15
14–12 3 Noninterest-bearing installment note 20
14–13 3 Note and installment note with unrealistic interest
rate
25
14–14 5 Early extinguishment of debt 15
14–15 5 Early extinguishment; effective interest 15
14–16 2,5 Debt issue costs; issuance; expensing; early
extinguishment; straight-line amortization
20
14–17 2,7 IFRS; transaction costs 20
14–18 5 Early extinguishment 15
14–19 5 Convertible bonds; induced conversion; bonds
with detachable warrants
25
14–20 5 Convertible bonds; zero coupon; potentially
convertible into cash; FASB codification research;
MLS
60
14–21 1,2,3,4,5 Concepts; terminology 20
14–22 6 Determine bond price; record interest; report
bonds at fair value
60
14–23 6 Report bonds at fair value; quarterly reporting 60
14–24 2,14A Investments in bonds; accrued interest; sale;
straight-line interest
60
14–25 14A Accrued interest; effective interest; financial
statement effects
60
14–26 14B Troubled debt restructuring 30
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Learning Est.
time
Cases Objective(s) Topic
(min.)
Communication Case 14–1 5 Convertible securities and warrants; concepts 45
Real World Case 14–2 2 Zero-coupon debt; HP Inc. 35
Communication Case 14–3 5 Is convertible debt a liability or is it
shareholders’ equity? Group interaction
30
Analysis Case 14–4 2 Issuance of bonds 20
Judgment Case 14–5 3 Noninterest-bearing debt 15
Judgment Case 14–6 3 Noninterest-bearing note exchanged for cash
and other privileges
15
Communication Case 14–7 3 Note receivable exchanged for cash and other
services
25
Ethics Case 14–8 5 Debt for equity swaps; have your cake and eat it
too
20
Judgment Case 14–9 1,4 Analyzing financial statements; financial
leverage; interest coverage
25
Research Case 14–10 1,2,3,4 FASB codification research; researching the way
long-term debt is reported; Macy’s, Inc.
45
Analysis Case 14–11 5 Bonds; conversion; extinguishment 30
Target Case 4
Air France–KLM Case 7 IFRS; accounting for bonds and long-term
notes; Air France–KLM
30