14-36 Intermediate Accounting, 8/e
DEBT CONTINUED, WITH MODIFIED TERMS
WHEN TOTAL CASH PAYMENTS
EXCEED THE BOOK VALUE OF THE DEBT
If the payments exceed the amount owed, the restructured debt
agreement still provides interest on the debt – but less than before
the agreement was revised. No longer is the effective rate 10%.
The accounting objective now is to determine what the new
effective rate is and record interest for the remaining term of the
loan at that new, lower rate.
Illustration – Brillard Properties owes First Prudent Bank $30
million, under a 10% note with 2 years remaining to maturity.
Due to Brillard’s financial difficulties, the previous year’s
interest ($3 million) was not paid. First Prudent Bank agrees to:
(1) delay the due date for all cash payments until maturity, and
(2) accept $34,333,200 at that time in full settlement of the debt.
Analysis:
T14-22 (continued)
WHEN TOTAL CASH PAYMENTS
EXCEED THE BOOK VALUE OF THE DEBT
(continued)
The discount rate that “equates” the present value of the debt
($33 million) and its future value ($34,333,200) is the effective
rate of interest.
CALCULATION OF THE NEW EFFECTIVE INTEREST RATE:
• $33,000,000÷ $34,333,200= .9612 – the Table 2 value for n = 2, i = ?
• In row 2 of Table 2, the number .9612 is in the 2% column. So, this is the
T14-22 (continued)
14-38 Intermediate Accounting, 8/e
WHEN TOTAL CASH PAYMENTS
EXCEED THE BOOK VALUE OF THE DEBT
(continued)
At the End of the First Year
Interest expense (2% x [$30,000,000+3,000,000]) 660,000
Suggestions for Class Activities
1. Real World Scenario
An article in BARRON’S, entitled “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 the 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
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:
14-40 Intermediate Accounting, 8/e
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 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
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, 2016, 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, 2016, Ross-Finn Fabrication issued $200 million of 12% bonds, dated January 1.
(a) The bonds mature in 2036 (20 years). The market yield for bonds of similar risk and maturity
Calculations:
(a)
Interest $24,000,000 ¥ x 6.62313 * = $158,955,120
(b)
Interest $12,000,000 ¥ x 13.33171 * = $159,980,520
(c)
Interest $12,000,000 ¥ x 16.04612 * = $192,553,440
(d)
Interest $12,000,000 ¥ x 17.44985 * = $209,398,200
(e)
Interest $12,000,000 ¥ x 16.16143 * = $193,937,160
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
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 and 14-11, 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
14-44 Intermediate Accounting, 8/e
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
A
Pricing bonds at price plus accrued interest
5
14-21
B
Troubled debt restructuring
5
14-22
B
Troubled debt restructuring
5
14-23
B
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 with unrealistic interest rate
5
14-10
3
Installment note
5
14-11
5
Early extinguishment
5
14-12
5
Bonds with detachable warrants
5
14-13
5
Convertible bonds
5
14-14
6
Reporting bonds at fair value
5
14-46 Intermediate Accounting, 8/e
Learning Est. time
Exercises Objective(s) Topic (min.)
14-1
2
Bond valuation
25
14-2
2
Determining the price of bonds
35
14-3
2
Determine the price of bonds; issuance;
effective interest
15
14-4
2
Investor; effective interest
15
14-5
2
Determine the price of bonds; issuance;
effective interest; financial statement effects
15
14-6
2
Determine the price of 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
25
14-18
3
Installment note
20
14-19
3
Installment note
20
14-20
2, 3, 4
FASB codification research
25
14-21
5
Early extinguishment
10
14-22
5
Convertible bonds
20
14-23
5
IFRS; convertible bonds
10
14-24
5
Convertible bonds; induced conversion
20
14-25
5, 7
IFRS; convertible bonds
20
14-26
5
Bonds with detachable warrants
20
14-27
6
Reporting bonds at fair value
20
14-28
6
Reporting bonds at fair value
25
14-29
6
Reporting bonds at fair value
30
14-30
A
Accrued interest
5
14-31
B
Troubled debt restructuring; debt settled
10
14-32
B
Troubled debt restructuring; modification of
terms
15
14-33
B
Troubled debt restructuring; modification of
terms; unknown effective rate
20
14-34
B
FASB codification research; legal fees in a
troubled debt restructuring
20
CPA/CMA Learning Est. time
Exam Questions Objective(s) Topic (min.)
CPA-1
1
Bond pricing
3
CPA-2
2
Bond interest
3
CPA-3
2
Bond interest
3
CPA-4
2
Bond interest
3
CPA-5
2
Bond interest
3
CPA-6
2
Bond interest
3
CPA-7
5
Bond redemption
3
CPA-8
5
Bond conversion
3
CPA-9
5
Bond redemption
3
CPA-10
5
Bonds with warrants
3
CPA-11
5
IFRS
3
CPA-12
5
IFRS
3
CMA-1
1
Bond pricing
3
CMA-2
2
Bond interest
3
CMA-3
4
Bond reporting
3
14-48 Intermediate Accounting, 8/e
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
Accrued interest; 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, A
Issuer and investor; straight-line method;
adjusting entries
50
14-7
2
Issuer and investor; effective interest; no
amortization schedule
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
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
20
14-17
5
IFRS; transaction costs
15
14-18
5
Early extinguishment
15
14-19
5
Convertible bonds; induced conversion; bonds
with detachable warrants
35
14-20
5
Convertible bonds; zero coupon; potentially
convertible into cash; FASB codification research;
Microsoft
45
14-21
1, 2, 3, 4, 5
Concepts; terminology
20
14-22
6
Determine bond price; record interest; reporting
bonds at fair value
60
14-23
6
Reporting bonds at fair value; quarterly reporting
60
14-24
2, A
Investments in bonds; accrued interest; sale
60
14-25
2, A
Accrued interest; effective interest; financial
statement effects
60
14-26
B
Troubled debt restructuring
30
Star Problems
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; Hewlett-Packard Company
35
Communication Case 14-3
5
Is convertible debt a liability or is it
shareholders’ equity?
30
Analysis Case 14-4
2
Issuance of notes
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 14-7
3
Note receivable exchanged for cash and other
services
25
Ethics Case14-8
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 – 4
Researching the way long-term debt is reported;
retrieving information from the Internet: Macy’s
45
Analysis Case 14-11
5
Bonds; conversion; extinguishment
30
Analysis Case 14-12
5
Analyzing financial statements; debt-to-equity;
interest coverage; PetSmart
30
Air France/KLM Case
7
IFRS; accounting for bonds and long-term
notes; Air France
30
CPA Simulation 14-1 Early extinguishment