Chapter Ten
Challenge Exercise 1
Jake Anderson Company had the following transactions involving notes payable.
June 1, 2014 Borrows $70,000 from First National Bank by signing a 9-month, 12% note.
Dec. 1, 2014 Borrows $90,000 from Sycamore State Bank by signing a 3-month, 10% note.
Dec. 31, 2014 Prepares adjusting entries.
Mar. 1, 2015 Pays principal and interest to Sycamore State Bank.
Mar. 1, 2015 Pays principal and interest to First National Bank.
Instructions:
(a) Prepare journal entries for each of the transactions shown above.
(b) What effect do the 12/31/14 entries have on assets, liabilities, and stockholders’ equity.
(c) What amount of interest expense is reported in the 2014 income statement and in the 2015 income
statement?
Challenge Exercise 1 – Solution
(a)
July 1, 2014
Cash …………………………………………………………………………………. 70,000
Notes Payable …………………………………………………………….. 70,000
Interest Expense …………………………………………………………………. 750
($90,000 X 10% X 1/12)
Interest Payable ……………………………………………………….…. 750
Challenge Exercise 1 – Solution (Continued)
March 1, 2015
Notes Payable ……………………………………………………………………………… 70,000
Challenge Exercise 2
Princess Company publishes a monthly fashion magazine, Tiara. Subscriptions to the magazine cost $30 per
year. During October 2014, Princess sells 12,000 subscriptions beginning with the November issue. Princess
prepares financial statements quarterly and recognizes subscription revenue earned at the end of the quarter.
The company uses the accounts Unearned Subscription Revenue and Subscription Revenue.
Instructions:
(a) Prepare the entry in October for the receipt of the subscriptions.
(b) Prepare the adjusting entry at December 31, 2014, to record sales revenue recognized in December 2014.
(c) Indicate the effect that the transactions in (a) and (b) have on assets, liabilities, and stockholders’ equity.
(d) Prepare the adjusting entry at March 31, 2015, to record sales revenue recognized in the first quarter of
2015.
(e) Indicate how the unearned subscription revenue is reported in the 3/31/15 financial statements, including
the
amount.
Challenge Exercise 2 – Solution
(a) Oct. 31 Cash …………………………………………………………………… 360,000
(b) Dec. 31 Unearned Subscription Revenue …………………………….. 60,000
(c) Transaction (a) increases assets and increases liabilities. Transaction (b) decreases liabilities and
increases stockholders’ equity (due to the revenue).
Challenge Exercise 3
The following financial data were reported by XYZ Company for 2013and 2014 (dollars in millions).
XYZ Company
Balance Sheets (partial)
2014 2013
Current assets
Cash and cash equivalents $2,000 $1,100
Accounts receivable, net 3,900 3,000
Inventories 2,700 2,300
Other current assets 700 1,150
Total current assets $9,300 $7,550
Current liabilities $7,700 $5,500
Instructions:
(a) Calculate the current ratio and working capital for XYZ for 2014 and 2013.
(b) Suppose at the end of 2014, XYZ management used $400 million cash to pay off $400 million of
accounts
payable. How would the current ratio and working capital have changed?
(c) Suppose at the end of 2014, XYZ management collected $300 million cash on accounts receivable.
How
would the current ratio and working capital have changed?
(d) Suppose at the end of 2014, XYZ management sold $250 million of inventory for $400 million on
account.
How would the current ratio and working capital have changed?
Challenge Exercise 3 – Solution
(a) 2014:
Working capital = Current assets – Current liabilities
Working capital = $9,300 – $7,700 = $1,600
(b) Working capital = ($9,300 – $400) – ($7,700 – $400)
Challenge Exercise 3 – Solution (Continued)
(c) Working capital = ($9,300 + $300 – $300) – $7,700
(d) Working capital = ($9,300 + $400 – $250) – $7,700
Challenge Exercise 4
On January 1, Oldur Company issued $700,000, 12%, 10-year bonds at par. Interest is payable semiannually
on July 1 and January 1.
Instructions:
(a) Present journal entries to record the following.
(1) The issuance of the bonds.
(2) The payment of interest on July 1, assuming that interest was not accrued on June 30.
(3) The accrual of interest on December 31.
(b) What effect does each of these transactions have on assets, liabilities, and stockholders’ equity?
Challenge Exercise 4 – Solution
(a)(1) Jan. 1 Cash ………………………………………………………………. 700,000
Bonds Payable …………………………………………. 700,000
(b) The effect of these transactions is:
Assets Liabilities Stockholders’ Equity
(1) I I NE
Challenge Exercise 5
Tea Co. receives $240,000 when it issues a $300,000, 10%, mortgage note payable to finance the
construction of a building at December 31, 2014. The terms provide for semiannual installment payments of
$25,000 on June 30 and December 31.
Instructions:
(a) Prepare the journal entries to record the mortgage loan and the first two installment payments.
(b) Indicate how the remaining balance of the mortgage note payable is reported in the balance sheet.
Challenge Exercise 5 – Solution
(a) 2014 – Issuance of Note
Dec. 31 Cash ……………………………………………………………………… 300,000
2015 – Second Installment Payment
Dec. 31 Interest Expense ………………………………………………………. 14,500
[($300,000 – $10,000) X 10% X 6/12]
Challenge Exercise 6
Dave Ramsey Corporation issued $900,000, 9%, 10-year bonds on January 1, 2014, for $843,920.This price
resulted in an effective-interest rate of 10% on the bonds. Interest is payable semiannually on July 1 and
January 1. Dave Ramsey uses the effective-interest method to amortize bond premium or discount.
Instructions:
Prepare the journal entries to record the following. (Round to the nearest dollar.)
(a) The issuance of the bonds.
(b) The payment of interest and the discount amortization on July 1, 2014, assuming that interest was
not
accrued on June 30.
(c) The accrual of interest and the discount amortization on December 31, 2014.
(d) What will the total interest expense be over the 10 years the bonds are outstanding?
(e) What would the total interest expense be over the 10 years the bonds are outstanding, if the
straight-line
method was used?
Challenge Exercise 6 – Solution
(a) Jan. 1 Cash ……………………………………………………………… 843,920
Discount on Bonds Payable ……………………………….. 56,080
Bonds Payable ………………………………………… 900,000
Challenge Exercise 6 – Solution (Continued)
(d) Principal at maturity ……………………………………………………………… $ 900,000
Semiannual interest payments ($40,500 X 20) …………………………. 810,000
Cash to be paid to bondholders ……………………………………………… 1,710,000