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CHAPTER 10 • LONG-TERM LIABILITIES 10-19
LO 10 PROBLEM 10-7 DEFERRED TAX CALCULATIONS (Appendix)
1. 2014 Income before taxes ......................................................... $210,000
Excess of tax depreciation over
book depreciation ($50,000 – $26,667*) ...................... (23,333)
Taxable income ................................................................ $186,667
2. 2014 Income before taxes ......................................................... $210,000
Income tax expense (35%) ............................................... $ 73,500
3. Col. 1 Col. 2 Col. 3 Col. 4
Income Tax Income Tax Col. 1 – Deferred Tax
Year Expense Payable Col. 2 Account
2014 $73,500 $ 65,333 $ 8,167 $8,167 credit
10-20 FINANCIAL ACCOUNTING SOLUTIONS MANUAL
MULTI-CONCEPT PROBLEMS
LO 4,5 PROBLEM 10-8 BOND TRANSACTIONS
1.
Journal 2016
Entry Apr. 1 Cash ................................................................... 1,000,000
2.
Journal 2016
Entry Oct. 1 Interest Expense ................................................. 60,000
3. Additional interest must be recorded on December 31 to accrue interest for the time
period of October 1–December 31. The interest should be recorded as an expense
when it is incurred under the accrual accounting process. The accrual does not affect
the amount of interest paid on April 1, 2017. A full semiannual payment of $60,000
should occur on that date.
4. Total cash inflow to Brand ....................................... $1,000,000
Total cash outflow:
CHAPTER 10 • LONG-TERM LIABILITIES 10-21
LO 1,8,10 PROBLEM 10-9 PARTIAL CLASSIFIED BALANCE SHEET FOR WALGREENS
1. The following is the Liabilities section of the consolidated balance sheet of
Walgreens at August 31, 2014. (All amounts are in millions.)
Current Trade accounts payable .................................... $4,315
2. Computation of debt-to-equity ratios:
2014: $16,621/$20,561 = 0.81
2013: $16,027/$19,454 = 0.82
3. Walgreens’ lenders want to be sure that the company can repay the principal and
pay the interest on the loan. They would be interested in Walgreens’ times interest
earned and debt service coverage ratios. Both ratios measure the degree to which a
company can make its debt payments out of current cash flows.
10-22 FINANCIAL ACCOUNTING SOLUTIONS MANUAL
ALTERNATE PROBLEMS
LO 3 PROBLEM 10-1A FACTORS THAT AFFECT THE BOND ISSUE PRICE
1. a. The bonds would be issued at par, since the face or coupon rate is equal to the
market rate of interest.
2. a. $500,000 × 0.37689 (n = 20, i = 5%) = $188,445
$ 25,000* × 12.46221 (n = 20, i = 5%) = 311,555
Total $500,000
LO 5 PROBLEM 10-2A AMORTIZATION OF DISCOUNT
1. Discount Amortization
Effective Interest Method of Amortization
Col. 1 Col. 2 Col. 3 Col. 4
Cash Interest Discount
Interest Expense Amortized Carrying
Date 5% 8% Col. 2 – Col. 1 Value
1/01/16 $44,011
12/31/16 $ 2,500 $ 3,521** $1,021 45,032
2. Interest expense $18,489
Cash interest payments 12,500
Discount amortized $ 5,989
PROBLEM 10-2A (Concluded)
3.
Journal 2018
Entry Dec. 31 Interest Expense ................................................. 3,691
Analysis Discount on Bonds Payable .......................... 1,191
Cash ............................................................. 2,500
To record interest and amortization of discount.
Bonds payable ........................................................................................ $50,000
Discount on bonds payable ..................................................................... 2,674*
$47,326
*Total Discount – Amortization of Discount for Year 1, Year 2, and Year 3
= $5,989 – $1,021 – $1,103 – $1,191 = $2,674*
LO 5 PROBLEM 10-3A AMORTIZATION OF PREMIUM
1. Premium Amortization
Effective Interest Method of Amortization
Col. 1 Col. 2 Col. 3 Col. 4
Cash Interest Premium
Interest Expense Amortized Carrying
Date 5% 4% Col. 1 – Col. 2 Value
1/01/16 $52,227
12/31/16 $ 2,500 $ 2,089** $ 411 51,816
2. Interest expense $10,273
Cash interest payment 12,500
Premium amortized $ 2,227
10-24 FINANCIAL ACCOUNTING SOLUTIONS MANUAL
PROBLEM 10-3A (Concluded)
3.
Journal 2018
Entry Dec. 31 Interest Expense ................................................. 2,056
Analysis Premium on Bonds Payable ............................... 444
Cash ............................................................. 2,500
To record interest and amortization of premium.
*Total Premium – Amortization for Premium for Year 1, Year 2, and Year 3
= $2,227– $411 – $427 – $444 = $945
LO 6 PROBLEM 10-4A REDEMPTION OF BONDS
1. Redemption price ($100,000 × 1.01) ........................................... $101,000
Carrying value [$100,000 + ($5,500 – $2,000)] ............................ 103,500
Gain on redemption ..................................................................... $ 2,500
2. Redemption price ($100,000 × 1.04) ........................................... $104,000
3. The gain or loss on bond redemption should be presented on the income statement.
4. Bonds are redeemed early only if it is advantageous to the issuing firm. However,
early redemption is usually not favorable to the investor because it usually means
CHAPTER 10 • LONG-TERM LIABILITIES 10-25
LO 7 PROBLEM 10-5A FINANCIAL STATEMENT IMPACT OF A LEASE
1. Col. 1 Col. 2 Col. 3 Col. 4
Interest Reduction of
Lease Expense Obligation Lease
Date Payment 9% Col. 1 – Col. 2 Obligation
1/01/16 $98,600
12/31/16 $21,980 $8,874** $13,106 85,494
2.
Journal 2016
Entry Jan. 1 Leased Machine ................................................. 98,600
Analysis Lease Liability ............................................... 98,600
To record acquisition by lease.
3.
Journal 2017
Entry Dec. 31 Lease Liability ..................................................... 14,286
Analysis Interest Expense ................................................. 7,694
Cash ............................................................. 21,980
To record payment of lease liability and interest.
10-26 FINANCIAL ACCOUNTING SOLUTIONS MANUAL
PROBLEM 10-5A (Concluded)
Journal Dec. 31 Depreciation Expense—Leased Machine ........... 16,433
Entry Accumulated Depreciation—Leased
Analysis Machine ..................................................... 16,433
To record depreciation of leased asset.
Balance Sheet Income Statement
4. Long-term assets:
Leased machine ................................................................................ $98,600
Accumulated depreciation ................................................................. 32,866*
LO 10 PROBLEM 10-6A DEFERRED TAX (Appendix)
1. The effect on the accounting equation of the December 31, 2016, income tax ex-
pense, deferred tax, and income tax payable is as follows:
ASSETS = LIABILITIES +
STOCKHOLDERS’
EQUITY REVENUES – EXPENSES =
NET
INCOME
Income Tax Payable 120
Deferred Tax (20)
(100)
Income Tax Expense
100
(100)
2. The Deferred Tax account exists to reconcile the difference between the accounting
done for tax purposes and that done for reporting to stockholders, also referred to as
book purposes. The balance of the Deferred Tax account represents all temporary
CHAPTER 10 • LONG-TERM LIABILITIES 10-27
LO 10 PROBLEM 10-7A DEFERRED TAX CALCULATIONS (Appendix)
1. Year 1 Income before taxes .................................................... $120,000
Tax-exempt income ..................................................... (5,000)
Excess of tax depreciation over book
depreciation ($30,000 – $20,000) ........................... (10,000)
2. The Deferred Tax account for Years 1–3 would contain the following information:
Year 1 entry: Tax expense greater than
tax payable ($10,000 × 40%) = $4,000 credit
10-28 FINANCIAL ACCOUNTING SOLUTIONS MANUAL
ALTERNATE MULTI-CONCEPT PROBLEMS
LO 4,6 PROBLEM 10-8A FINANCIAL STATEMENT IMPACT OF A BOND
1.
Journal 2016
Entry July 1 Cash ................................................................... 916,162
Analysis Discount on Bonds Payable................................ 83,838
Bonds Payable .............................................. 1,000,000
$ 50,000* × 8.38384 (Table 9-4, n = 12, i = 6%) = $419,192
$1,000,000 × 0.49697 (Table 9-2, n = 12, i = 6%) = 496,970
$916,162
*$1,000,000 × 10% × 6/12 = $50,000
Journal 2016
Entry Dec. 31 Interest Expense ($916,162 × 6%) ..................... 54,970
Analysis Discount on Bonds Payable .......................... 4,970*
Interest Payable ............................................ 50,000
To record interest and amortization of discount.
CHAPTER 10 • LONG-TERM LIABILITIES 10-29
PROBLEM 10-8A (Concluded)
3.
Journal 2017
Entry Jan. 1 Interest Payable .................................................. 50,000
4. On the maturity date, July 1, 2022, the balance in Discount on Bonds Payable will
have been reduced to $0. The only remaining amount to be paid is the principal on
the bond as shown in the Bonds Payable account, $1,000,000.
LO 1,8,10 PROBLEM 10-9A PARTIAL CLASSIFIED BALANCE SHEET FOR BOEING
1. The following is the Liabilities section of the consolidated balance sheet of Boeing,
Inc., at December 31, 2013. (All amounts are in millions.)
Liabilities
Current liabilities:
10-30 FINANCIAL ACCOUNTING SOLUTIONS MANUAL
2. Computation of debt-to-equity ratios:
2013
$77,666/$14,997= 5.18
2012
3. Boeing’s lenders want to be sure that the company can repay the principal and pay
the interest on the loan. They would be interested in Boeing’s times interest earned
and debt service coverage ratios. Both ratios measure the degree to which a com-
pany can make its debt payments out of current cash flows.
DECISION CASES
READING AND INTERPRETING FINANCIAL STATEMENTS
LO 1,8 DECISION CASE 10-1 EVALUATING THE LIABILITIES OF PANERA BREAD CO.
1. Panera Bread has the following long-term liabilities:
Long-term debt increased from 2013 to 2014.
2. Debt-to-equity ratio for 2014: $654,718/$736,184 = 0.89
Debt-to-equity ratio for 2013: $480,970/$699,892 = 0.69
Times interest earned for 2014: $279,118/$1,824 = 153.03
CHAPTER 10 • LONG-TERM LIABILITIES 10-31
LO 9,10 DECISION CASE 10-2 MAKING BUSINESS DECISIONS: COMPARING TWO
COMPANIES IN THE SAME INDUSTRY: PANERA BREAD AND CHIPOTLE
Part A. The Ratio Analysis Model
1. Formulate the Question:
The use of debt is a good management strategy, but sometimes a company may
have too much debt. The important questions to ask are:
What is the amount of debt in relation to the total equity of the company?
Will the company be able to meet its obligations related to the debt? That is, when
2. Gather the Information from the Financial Statements:
For those questions to be addressed, information from the balance sheet and the in-
3. Calculate the Ratio:
Debt-to-equity ratio for Panera Bread:
4. Compare the Ratio with Other Ratios:
The debt-to-equity ratio for the two companies is quite different. Chipotle carries a very
10-32 FINANCIAL ACCOUNTING SOLUTIONS MANUAL
DECISION CASE 10-2 (Concluded)
Part B. The Business Decision Model
1. Formulate the Question:
If you were a lender, would you be willing to lend money to either or both companies
based on their use of debt?
2. Gather Information from the Financial Statements and Other Sources:
This information will come from a variety of sources, not limited to but including:
● The balance sheet provides information about the amount of debt and equity.
The income statement and statement of cash flows provide information about
3. Analyze the Information Gathered:
Whether a company is using leverage effectively is always a matter of judgment. For
4. Make the Decision:
Taking into account all of the various sources of information, decide either to
● Lend money to either company or
● Find an alternative use for the money
5. Monitor Your Decision:
If you decide to lend money, you will need to monitor your investment periodically.
CHAPTER 10 • LONG-TERM LIABILITIES 10-33
LO 9,10 DECISION CASE 10-3 READING PEPSICO’S STATEMENT OF CASH FLOWS
1. Proceeds from debt is a positive amount on the cash flows statement because it in-
2. When interest rates are at low levels, companies often pay off loans that carry inter-
3. A company may repurchase stock for several reasons. The company may want to
eliminate a certain class of stock or reduce the need to pay dividends. The company
may also want to have more control of its stock by having the stock in the hands of
fewer stockholders. Finally, when a company repurchases stock, this does have a
positive impact on its earnings per share.
MAKING FINANCIAL DECISIONS
LO 1,7 DECISION CASE 10-4 MAKING A LOAN DECISION
1. The bank’s policy is that a 2-to-1 ratio of assets to debt must be maintained. The
note in Molitor’s annual report indicates that generally accepted accounting princi-
2. The bank should adopt a more flexible policy to consider those financing techniques
that are off-balance-sheet. However, it is very difficult to develop a policy that ac-
10-34 FINANCIAL ACCOUNTING SOLUTIONS MANUAL
LO 6 DECISION CASE 10-5 BOND REDEMPTION DECISION
DATE:
TO: Controller
FROM: Student Name
RE: Retirement of Outstanding Bonds
The outstanding bonds require the company to continue to pay 10% in a market that
requires only a 4% return. If the company issues new bonds at 4%, the new issuance
will yield the company $100,000 and the interest cash payment will be much lower at
ETHICAL DECISION MAKING
LO 7 DECISION CASE 10-6 DETERMINATION OF ASSET LIFE
1. Recognize an ethical dilemma:
2. Analyze the key elements in the situation:
Even though criteria exist that govern lease accounting, significant judgment is
3. List alternatives and evaluate the impact of each on those affected:
Whether to record an asset as an operating lease or capital lease can have a potential
CHAPTER 10 • LONG-TERM LIABILITIES 10-35
DECISION CASE 10-6 (Concluded)
4. Select the best alternative:
If Jen believes that the first source of information is valid, she should record the
lease as a capital lease. If the trade publication is more valid, she should record the
lease as an operating lease. Jen should gather additional information and consult
