14–61
*PROBLEM 14-12
(a) It is a troubled debt restructuring.
(b)
1. No entry.
2. Bad Debt Expense ………………………………………….
237,311*
Allowance for Doubtful Accounts ……………..
237,311
*Calculation of loss.
(c) Losses are calculated based upon the discounted present value of
future cash flows. However, the debtor’s gain is calculated using the
Pre-restructure carrying amount
Present value of restructured cash flows:
14–62
*PROBLEM 14-13
(a)
On the books of Halvor Corporation:
Notes payable ……………………………………………………….
5,000,000
Common Stock ……………………………………………….
1,700,000
Paid-in Capital in Excess of Par—
On the books of Frontenac National Bank:
Equity Investments …………………………………………………
3,700,000
Allowance for Doubtful Accounts …………………………..
1,300,000
Notes Receivable …………………………..……………….
5,000,000
(b)
On the books of Halvor:
Notes Payable ……………………………………………………….
5,000,000
Land ……………………………………………………….
3,250,000
Gain on Disposal of Plant Assets …………………….
750,000
Gain on Restructuring of Debt …………………………
1,000,000
Fair value of land …………………………..
Book value of land …………………………..
Gain on disposal of
Note payable (carrying
amount) …………………………..
Gain on restructuring
On the books of Frontenac National Bank:
Land ………………………………………………………………………
4,000,000
Allowance for Doubtful Accounts …………………………..
1,000,000
Notes Receivable …………………………..……………….
5,000,000
Gain on Restructuring of Debt …………………………
1,300,000
Fair value of equity …………………………..
Gain on restructuring
14–63
*PROBLEM 14-13 (Continued)
(c)
On the books of Halvor:
No entry is needed because aggregate cash flows equal
the carrying amount.
Aggregate cash flows—principal ……………………..
$5,000,000
Carrying amount …………………………………………….
$5,000,000
(d)
On the books of Halvor:
No entry is needed because aggregate cash flows equal
the carrying amount.
Principal ……………………………………………………….
Interest ($4,166,667 X 10% X 2) ………………………..
Aggregate cash flows
$5,000,000
Carrying amount
$5,000,000
On the books of Frontenac National Bank:
Allowance for Doubtful Accounts …………………….
On the books of Frontenac National Bank:
Allowance for Doubtful Accounts …………………….
3 years at 10% (Table 6-2);
($5,000,000 X.75132) …………………………………
$1,243,400
14–64
*PROBLEM 14-13 (Continued)
*Calculation of loss:
Pre-restructure carrying amount …………………………..
$5,000,000
Present value of restructured cash flows:
Present value of $4,166,667 due in
3 years at 10%, interest payable
annually (Table 6-2); ($4,166,667 X
.75132) ……………………………………………………….
Present value of $416,667 interest
payable annually for 3 years at 10%,
(Table 6-4); ($416,667 X 2.48685) ……………………
Less first year payment:
Present value of $416,667 interest due
in 1 year at 10% (Table 6-2);
($416,667 X .90909) …………………………..
3,787,900
14–65
*PROBLEM 14-14
Carrying amount of the debt at date of restructure, $330,000 + $33,000 =
$363,000. Total future cash flow, $300,000 + ($300,000 X .10 X 3) = $390,000.
Because the future cash flow exceeds the carrying amount of the debt, no
gain is recognized at the date of restructure.
Therefore, the approximate effective rate is 2 5/8%.
(b) SCHEDULE OF DEBT REDUCTION
AND INTEREST EXPENSE AMORTIZATION
Date
Cash
Paid
Interest
Expense
Premium
Amortized
Carrying
Amount of
Note
14–66
*PROBLEM 14-14 (Continued)
(c)
Calculation of loss:
Pre-restructure carrying amount …………………………..
$363,000
Present value of restructured cash flows:
Creditor’s loss on restructuring of debt ……………………
$ 63,000
*Although the sum of the present value amounts is $300,001, the true
present value of a 10% note discounted at 10% is face value, or
$300,000. The $1 difference is due to rounding.
Date
Cash
Received
Interest
Revenue
Change in
Carrying
Amount
Carrying
Amount of
Note
(d)
Crocker Corp. entries:
December 31, 2012
Interest Payable ………………………………………………………
33,000
Notes Payable ………………………………………………..
33,000
Interest Expense …………………………………………………….
Notes Payable ……………………………………………………….
20,471
Cash …………………………..…………………………..
Present value of $300,000 due in 3 years
at 10% , interest payable annually
(Table 6-2); ($300,000 X .75132) ……………………..
Present value of $30,000 interest payable
annually for 3 years at 10% (Table 6-4);
($30,000 X 2.48685) ………………………………………
(300,000*)
*PROBLEM 14-14 (Continued)
December 31, 2014
Interest Expense …………………………………………………….
8,991
Notes Payable ……………………………………………………….
21,009
Cash ……………………………………………………….
30,000
(e)
Bad Debt Expense ………………………………………………….
Allowance for Doubtful Accounts …………………….
63,000
Cash ………………………………………………………………………
Interest Revenue …………………………………………….
14–68
TIME AND PURPOSE OF CONCEPTS FOR ANALYSIS
CA 14-1 (Time 25–30 minutes)
Purpose—to provide the student with some familiarity with the economic theory which relates to the
accounting for a bond issue. The student is required to discuss the conceptual merits for each of the three
different balance sheet presentations for the same bond issue, and the merits for utilizing the nominal
rate versus the effective rate at date of issue in the computation of the carrying value of the obligations
arising from a bond issue.
CA 14-2 (Time 15–25 minutes)
Purpose—this case includes discussions of the determination of the selling price of bonds, presentation
of items related to bonds on the balance sheet and the income statement, whether discount amor–
tization increases or decreases, and how an early retirement of bonds should be reported on the income
statement.
CA 14-3 (Time 20–25 minutes)
Part I—Purpose—to provide the student with an understanding of the significance of the difference
between the effective-interest method of amortization and the straight-line method of amortization.
Part II—Purpose—to provide the student with some familiarity with the various methods of accounting
for gains and losses from the early extinguishment of debt, and the justifications for each of the different
methods.
CA 14-4 (Time 20–30 minutes)
Purpose—the student is asked to explain project financing arrangements, take–or-pay contracts, off-
balance-sheet financing, and the conditions for which a contractual obligation is to be disclosed as an
unconditional purchase obligation. The case also requires the student to determine accounting treat–
ment for a project financing arrangement.
CA 14-5 (Time 20–30 minutes)
Purpose—to provide the student with an opportunity to examine the ethical issues related to the issue
of bonds.
SOLUTIONS TO CONCEPTS FOR ANALYSIS
CA 14-1
(a) 1. This is a common balance sheet presentation and has the advantage of being familiar to users
of financial statements. The face or maturity value of $1,000,000 is shown in an obvious
(b) When an entity issues interest-bearing bonds, it normally accepts two types of obligations: (1) to
pay interest at regular intervals and (2) to pay the principal at maturity. The investors who
purchase Nichols Company bonds expect to receive $55,000 each January 1 and July 1 through
January 1, 2033 plus $1,000,000 principal on January 1, 2033. Since this ($55,000) is more than
the 10% per annum ($50,000 semiannually) that the investors would be willing to accept on an
investment of $1,000,000 in these bonds, they are willing to bid up the price—to pay a premium for
them. The amount that the investors should be willing to pay for these future cash flows depends
upon the interest rate that they are willing to accept on their investment(s) in this security.
(c) 1. The use of the coupon rate for discounting bond obligations would give the face value of the
bond at January 1, 2013, and at any interest-payment due thereafter. Although the coupon rate
is readily available while the effective rate must be computed, the coupon rate may be set
arbitrarily at the discretion of management so that there would be little or no support for
accepting it as the appropriate discount rate.
CA 14-1 (Continued)
2. The effective-interest rate at January 1, 2013 is the market rate to Nichols Company for long–
term borrowing. This rate gives a discounted value for the bond obligations, which is the
amount that could be invested at January 1, 2013 at the market rate of interest. This
CA 14-2
(a) 1. The selling price of the bonds would be the present value of all of the expected net future cash
outflows discounted at the effective annual interest rate (yield) of 11 percent. The present
value is the sum of the present value of its maturity amount (face value) plus the present value
of the series of future semiannual interest payments.
14–71
CA 14-2 (Continued)
(d) The retirement of the bonds would result in a loss from extinguishment of debt that should be
included in the determination of net income and classified as an ordinary loss.
CA 14-3
Part I.
(a) The effective-interest method of amortization of bond discount or premium applies a constant
interest rate to the carrying value of the debt. The straight-line method applies a constant dollar
amount over the life of the debt resulting in a changing effective-interest rate incurred based on the
carrying value of the debt. Either method, however, computes the total premium or discount to be
amortized as the difference between the par value of the debt and the proceeds from the issuance.
Part II.
(a) 1. Gain or loss to be amortized over the remaining life of old debt. The basic argument
supporting this method is that if refunding is done to obtain debt at a lower cash outlay (interest
cost), then the gain or loss is truly a cost of obtaining the reduction in cash outlay. As such, the
new rate of interest alone does not reflect the cost of the new debt, but a portion of the gain or
loss on the extinguishment of the old instrument must be matched with the nominal interest to
reflect the true cost of obtaining the new debt instrument. This argument states that this
matching must continue for the unexpired life of the old debt in order to reflect the true nature
of the transaction and cost of obtaining the new debt instrument.
14–72
CA 14-3 (Continued)
3. Gain or loss recognized in the period of extinguishment. Proponents of this method state
that the early extinguishment of debt to be refunded actually does not differ from other types of
extinguishment of debt where the consensus is that any gain or loss from the transaction
should be recognized in full in current net earnings. The early extinguishment of the debt is
CA 14-4
(a) Such financing arrangements arise when (1) two or more entities form another entity to construct
an operating plant that will be used by both parties; (2) the new entity borrows funds to construct
the project and repays the debt from the proceeds received from the project; and (3) payment of
the debt is guaranteed by the companies that formed the new entity.
14–73
CA 14-4 (Continued)
According to current practice, Ryan does not record an asset relating to the future purchase
commitment. However, if the dollar amount involved is material, the details of the contract should
be disclosed in a footnote to the balance sheet. In addition, if the contracted price is in excess of
the purchase market price and it is expected that losses will occur when the purchase is effected,
losses should be recognized in the accounts in the period during which such declines in prices
CA 14-5
(a) The stakeholders in the Wichita case are:
Donald Lennon, president, founder, and majority stockholder.
Nina Friendly, minority stockholder.
Other minority stockholders.
14–74
FINANCIAL REPORTING PROBLEM
(a) According to the Short-Term and Long-Term Debt note (Note 4),
(b) (Amounts in $millions)
1. Working capital = Current assets less current liabilities.
($8,996) = $21,905 – $30,901
P&G has a fairly weak liquidity position. The current ratio is below 1.
The acid-test ratio is significantly below 1, possibly due to a slowing
economy.
The other ratio analysis below corroborates P&G’s relatively poor
financial position in 2009.
14–75
FINANCIAL REPORTING PROBLEM (Continued)
Current cash debt
coverage ratio =
Net cash provided by operating activities
Average current liabilities
=
$14,919
$30,901 + $30,958
2
=
0.48 times
=
0.20 times
Debt to total assets =
$71,734
= 0.53
$134,833
Cost of goods sold
$6,880 + $8,416
=
5.09 times
14–76
COMPARATIVE ANALYSIS CASE
(a) Debt to total assets ratio:
Coca-Cola $23,325/$48,671 = 47.9%%
PepsiCo $22,406/$39,848 = 56.2%
(b)
Carrying Value
Fair Value
Coca-Cola
$5,110
$5,371
PepsiCo
7,864
8,600
The fair value will vary from the historical cost carrying value due to
changes in interest rates.
(c) 1. Lower interest rates may be available in foreign countries.