(continued) P 9-86B
Req. 3
Journal
DATE
ACCOUNT TITLES AND EXPLANATION
DEBIT
CREDIT
2016
a.
Dec.
31
Cash ………………………………………………….
1,739,841
Discount on Bonds Payable ……………….
260,159
Convertible Bonds Payable ……………
2,000,000
To issue bonds at a discount.
2017
b.
June
30
Interest Expense ………………………………..
78,293
Cash …………………………………………….
70,000
Discount on Bonds Payable ………….
8,293
To pay interest and amortize bond discount.
c.
Dec.
31
Interest Expense ………………………………..
78,666
Cash ……………………………………………..
70,000
Discount on Bonds Payable …………..
8,666
To pay interest and amortize bond discount.
2018
d.
July
1
Convertible Bonds Payable ………………..
800,000
Discount on Bonds Payable
($234,144 × .40) …………………………..
93,658
Common Stock (70,000 × $1) …………
70,000
Paid-in Capital in Excess of
To record conversion of bonds.
Req. 4 (balance sheet presentation of bonds payable at
Dec. 31, 2018)
Convertible bonds payable
($2,000,000 − $800,000) …………………………………
$1,200,000
($224,680 × 3/5)*…………………………….….
$1,065,192
(15-30 min.) P 9-87B
Req. 1
Alternative
Alternative
1
2
Borrow $4.75
Issue 100,000
mil at 3%
shares of stock
Net income 2 years from
now
$1,815,000
$1,815,000
Less income tax expense
363,000
Projected net income 2
years from now
$1,338,000
$1,452,000
$1,452,000/(100,000 +
100,000)
Req. 2
TO: Management of Summit Medical Goods
FROM: Student Name
SUBJECT: Advantages and disadvantages of borrowing
versus issuing stock to raise cash for expansion
(continued) P 9-87B
in the business and to carry out their plans without interference from a new
group of stockholders. Under normal conditions, borrowing results in a higher
earnings per share of common stock, because the interest expense on the
debt is tax-deductible. And higher earnings per share usually lead to higher
stock prices for company owners.
The main advantage of issuing stock is that owners avoid the burden of
making interest and principal payments on the debt. Issuing stock creates no
liability to pay anything to the owners. If the directors consider it necessary,
they can refuse to pay dividends in order to conserve cash. Therefore, it is
safer to issue stock.
(20-30 min.) P 9-88B
Req. 1
Brillhart Foods, Inc.
Partial Balance Sheet
Dec. 31, 2016
Property, plant,
and equipment:
Current liabilities:*
Equipment ……….
$745,000
Bonds payable,
Accumulated
current portion ……………….
$200,000
Depreciation ….
(168,000)
Mortgage note payable,
current portion ………………
Interest payable ……………….
Total current liabilities ………..
Mortgage note
payable …………………………..
$312,000
Bonds payable ….. $300,000
Less: Discount on
bonds payable ….. (21,000)*
279,000
Pension liability ……………….
50,000**
Total long-term liabilities ……
641,000
_____
(continued) P 9-88B
Req. 2
a. Carrying amount of bonds payable:
Current portion …………………………………………………….. $200,000
b. Interest payable is the amount of interest that Brillhart owes at year-
end. Interest expense is the company’s cost of borrowing for the full
year.
Req. 3
Req. 4
Leverage
ratio
=
Total assets ($4,600,000)
Total stockholders’ equity ($3,586,000)*
=
1.28
Debt ratio
=
Total liabilities [$1,014,000 = $373,000 + $641,000]
=
0.22
Total assets ($4,600,000)
(continued) P 9-88B
Req. 5
Leverage
ratio
Total assets ($8,400,000)
Total stockholders’ equity ($3,586,000)
=
2.34
Challenge Exercises and Problem
(10-15 min.) E 9-89
Req. 1
Current ratio
=
Total current assets
=
$324,900 − X
=
2.80
Total current liabilities
$173,700 − X
Let X = amount of current liabilities to pay in order to achieve a current
ratio of 2.80. Parker Marketing Services should pay off $89,700* of
current liabilities. Then the current ratio will be:
Req. 2
Leverage
ratio
=
Total assets ($1,398,900)
Total stockholders’ equity ($979,700)
=
1.43
(20-30 min.) P 9-90
Req. 1
a. Current ratio
2016
2015
b. Debt ratio
2016
2015
Debt
ratio
Total
liabilities
$72,800 – $30,500
=.58
$46,500 – $26,100
=.44
Total
assets
$72,800
$46,500
Req. 2
a. Current ratio
Current
Current assets
$20,900
= 1.04
Current liabilities
= .58
Req. 3
Current
ratio
Current assets
$20,900
= 1.13
Current liabilities
$18,300 + $250
$42,300 + $940
= .59
Decision Cases
(15-20 min.) Decision Case 1
Req. 1
As
Reported
$54,033
Total assets
$65,503
=
Return on
Assets
=
Net income
=
$979
(ROA)
Total assets
$65,503
Total assets
Req.2
Leverage
=
Total assets
=
$65,503
ratio
Total
stockholders’
$11,470
equity
=
Return on
Equity (ROE)
=
=
(continued) Decision Case 1
The ROE is greater than the ROA because the leverage ratio is
extremely high which magnifies the ROA. The debt ratio is also
extremely high and indicates that 82% of the assets were financed
with debt. The high leverage ratio and debt ratio should have made
investors question the soundness of Enron.
Req. 3
After Including the
Special-Purpose Entities
*The SPEs originally reported assets of $7,000 million when those assets were
only worth $500 but actually had liabilities of $6,900.
Return on
*The SPEs’ income was nearly wiped out due to the restatement meaning that the
SPE did not earn a net income but had a loss, of which $300 applies to 2000; they
did have assets with a market value of $500.
(continued) Decision Case 1
As
After Including the
Reported
Special-Purpose Entities
Times-interest-
earned ratio
Req. 4
It appears that Enron excluded the special-purpose-entities (SPEs) from its
financial statements in order to hide their debt from Enron’s investors and
(30-40 min.) Decision Case 2
Req. 1 (Analysis of financing plans)
PLAN A
PLAN B
PLAN C
BORROW
AT 6%
ISSUE
COMMON
STOCK
ISSUE $3.75
NONVOTING
PREFERRED
STOCK
Net income before expansion
$3,500,000
$3,500,000
$3,500,000
Project income before interest
and income tax
$1,500,000
$1,500,000
$1,500,000
Less interest expense
($5,000,000 × .06)
300,000
-0-
Project income before income tax
Less income tax expense (35%)
420,000
525,000
525,000
Project net income
Less preferred dividends
(100,000 × $3.75)
-0-
-0-
375,000
Additional net income available
to common stockholders
780,000
975,000
600,000
Total company net income
$4,280,000
$4,475,000
$4,100,000
Earnings per share including new
project:
Plan A
($4,280,000 / 1,000,000 shares)
$ 4.28
Plan B
($4,475,000 / 1,100,000 shares)
$ 4.07
Plan C
($4,100,000 / 1,000,000 shares)
(continued) Decision Case 2
Req. 2 (Recommendation)
The best choice appears to be Plan A — borrowing at 6% — because:
(1) Borrowing allows the family to maintain control of the
business;
Ethical Issue 1
Req. 1
A company would prefer not to disclose its contingent liabilities because
they cast a shadow on the business and create a negative impression.
Req. 2 and 3
The potential parties and economic consequences of the decision not to
disclose contingent liabilities are:
1. The bank and its shareholders: With misleading information, they
might extend additional funds to the borrower assuming a better ability
to pay back the funds than actually exists. A contingent liability creates
2. The company seeking the loan: Might become overextended in its
borrowing and risk default on debt in the future.
3. Microsoft stockholders.
4. Parties to the lawsuit.