Solution manual accounting 25th editon warren chapter 14

Net income……… Dividends on preferred stock……… Available for dividends on common stock……… Shares of common stock outstanding……… Earnings per share on common stock……… 5 3... Earnings befor

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CHAPTER 14 LONG-TERM LIABILITIES: BONDS AND NOTES

DISCUSSION QUESTIONS

1 (1) To pay the face (maturity) amount of the bonds at a specified date (2) To pay periodic

interest at a specified percentage of the face amount

2 a Bonds that may be exchanged for other securities under specified conditions.

b The issuing corporation reserves the right to redeem the bonds before the maturity date.

c Bonds issued on the basis of the general credit of the corporation

3 More than face amount Because comparable bonds provide a market interest rate (11%) that

is less than the rate on the bond being issued (12%), the bond will sell at a premium as the

market’s means of equalizing the two interest rates

8 A mortgage note is an installment note that is secured by a pledge of the borrower’s assets.

If the borrower fails to pay the note, the lender has the right to take possession of the pledged asset and sell it to pay off the debt

9 A bond is an interest-bearing note that requires periodic interest payments and repayment of

the face amount of the bonds at maturity Bonds consist of two different components:

(1) interest payments made periodically over the life of the bond and (2) the face amount that must be repaid at maturity The periodic payments consist entirely of interest, and the final

payment at maturity consists entirely of principal Installment notes, on the other hand, have periodic payments that consist partially of interest and partially of principal Each payment

reduces the principal on the note so that at maturity the entire amount borrowed will have been repaid

10 a As a current liability on the balance sheet.

b As a long-term liability on the balance sheet.

CHAPTER 14 Long-Term Liabilities: Bonds and Notes

PRACTICE EXERCISES

PE 14–1A

1

Dividends on preferred stock……… 0 300,000

Earnings per share on common stock……… $ 1.68 $ 1.20

1

$6,000,000 × 6%

2

$840,000 × 40%

3

$5,000,000 × 6%

4

$900,000 × 40%

5

($3,000,000 ÷ $30) × $3.00

PE 14–1B

5

1

$4,000,000 × 10%

2

$1,600,000 × 40%

3

$2,500,000 × 10%

4

$1,750,000 × 40%

5

($3,000,000 ÷ $25) × $2.50

14-2

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Net income………

Dividends on preferred stock………

Available for dividends on common stock……… Shares of common stock outstanding………

Earnings per share on common stock………

5 3

Loss on Redemption of Bonds

Discount on Bonds Payable

Cash

PE 14–6B

Bonds Payable

Premium on Bonds Payable

Gain on Redemption of Bonds

b The number of times interest charges are earned has decreased from 13.0 in 2013

to 11.0 in 2014 Although the company has adequate earnings to pay interest, the decline in this ratio may cause concern among debtholders.

Ex 14–1

Rhett Co.

a Earnings before bond interest and income tax………

Bond interest………

Balance………

Income tax………

Net income………

Dividends on preferred stock………

Earnings available for common stock………

Shares of common stock outstanding………

Earnings per share on common stock………

b Earnings before bond interest and income tax………

Bond interest………

Balance………

Income tax………

Net income………

Dividends on preferred stock………

Earnings available for common stock………

Shares of common stock outstanding………

Earnings per share on common stock………

c Earnings before bond interest and income tax………

Bond interest………

Balance………

Income tax………

Net income………

Dividends on preferred stock………

Earnings available for common stock………

Shares of common stock outstanding………

Earnings per share on common stock………

Ex 14–2

Factors other than earnings per share that should be considered in evaluating

financing plans include: bonds represent a fixed annual interest requirement, while

dividends on stock do not; bonds require the repayment of principal, while stock

does not; and common stock represents a voting interest in the ownership of the

corporation, while bonds do not.

Ex 14–3

Nike’s major source of financing is common stock It has relatively little long-term debt

compared to stockholders’ equity.

Ex 14–4

The bonds were selling at a premium This is indicated by the selling price of

115.948, which is stated as a percentage of the face amount and is more than par

(100%) The market rate of interest for similar quality bonds was lower than 7.25%,

and this is why the bonds were selling at a premium.

Cash Interest Expense

Cash Interest Expense

Discount on Bonds Payable

Ex 14–6 (Concluded)

Plus discount amortized………

Interest expense for first year………

c The bonds sell for less than their face amount because the market rate of

interest is greater than the contract rate of interest Investors are not willing to

pay the full face amount for bonds that pay a lower contract rate of interest than

the rate they could earn on similar bonds (market rate).

c The bonds sell for more than their face amount because the market rate of

interest is less than the contract rate of interest Investors are willing to pay

more for bonds that pay a higher rate of interest (contract rate) than the rate

they could earn on similar bonds (market rate).

b Notes payable are reported as liabilities on the balance sheet The portion of the

note payable that is due within one year is reported as a current liability The

remaining portion of the note payable that is not due within one year is reported

as a long-term liability For this company, the current and noncurrent portions

of the note payable would be reported as follows:

Ex 14–10 (Concluded)

Current liabilities :

* The principal repayment portion of the next installment payment See computation below.

Noncurrent liabilitie s

** Original note payable……… $50,000

Less principal repayment from year 1………

Note payable balance at the end of year 1………

Annual payment on note………

Second year interest payment ($42,649 × 0.05)………

Principal repayment portion of next installment………

Note payable balance at the end of year 1………

Current portion of note payable (due within one year)………

Noncurrent portion of note payable………

Ex 14–11

2014

Notes Payable

Notes Payable Cash

2017

Notes Payable* Cash

*$46,813 – $10,665

CHAPTER 14 Long-Term Liabilities: Bonds and Notes

Ex 14–12

a Amortization of Installment Notes

For the

Year Ending

2015

Notes Cash

2016

Notes Cash

2017

Notes Cash

Ex 14–13

1 The significant loss on redemption of the Simmons Industries bonds should be reported in the Other Income and Expense section of the income statement, rather than as an extraordinary loss.

2 The Hunter Corporation bonds outstanding at the end of the current year

should be reported as a current liability on the balance sheet because they

mature within one year.

be welcomed by the debtholders.

b The number of times interest charges are earned has decreased from 28.0 in 2013

to 24.0 in 2014 Although Loomis has adequate earnings to pay interest, the decline in this ratio may cause concern among debtholders.

b The number of times interest charges are earned has decreased from 2.2 in 2013

to 1.7 in 2014 Although the company has enough earnings to pay interest in

2014, the deterioration in this ratio is a cause for concern to debtholders.

Appendix 1 Ex 14–17

$1,000,000 × 0.75131 = $751,310

Cash on hand today can be invested to earn income If $751,315 is invested at

10%, it will be worth $1,000,000 at the end of three years.

c Cash on hand today can be invested to earn income If each of the $200,000

of cash receipts is invested at 7%, it will be worth $677,444 at the end of four years.

Appendix 1 Ex 14–19

$7,500,000 × 7.02358 = $52,676,850

Appendix 1 Ex 14–20

No The present value of your winnings using an interest rate of 12% is $42,376,650 ($7,500,000 × 5.65022), which is less than the present value of your winnings using

an interest rate of 7% ($52,676,865; see Appendix 1 Ex 14–19) This is because

the winnings are affected by the higher interest rate.

Appendix 1 Ex 14–21

Present value of $1 for 10 semiannual

Present value of an annuity of $1

$16,098,250

Semiannual interest payment……… × $ 875,000* 6,923,630

* $25,000,000 × 3.5%

Appendix 1 Ex 14–22

Present value of $1 for 8 semiannual

Face amount of bonds………

Present value of an annuity of $1

× $30,000,000 $21,920,700

for 8 semiannual periods at 4.0% semiannual rate……… 6.73274

Semiannual interest payment……… × $ 1,500,000* 10,099,110

Discount on Bonds Payable Cash**

periods at 4.5% semiannual rate………

Face amount of bonds………

CHAPTER 14 Long-Term Liabilities: Bonds and Notes

Appendix 2 Ex 14–23 (Concluded)

3.

* ($43,495,895 + $207,315) × 4.5%

Note: The following data in support of the proceeds of the bond issue stated in

the exercise are presented for the instructor’s information Students are not

required to make the computations.

Present value of $1 for 20 semiannual

Present value of annuity of $1

for 20 semiannual periods at 4.5% semiannual rate……… 13.00794

$20,732,000

Semiannual interest payment……… × $ 1,750,000 * 22,763,895

* $50,000,000 × 3.5%

b Annual interest paid………

Plus discount amortized*………

Interest expense for first year………

* $207,315 + $216,644

c The bonds sell for less than their face amount because the market rate of

interest is greater than the contract rate of interest Investors are not

willing to pay the full face amount for bonds that pay a lower contract rate

of interest than the rate they could earn on similar bonds (market rate).

Face amount of bonds………

Appendix 2 Ex 14–24 (Concluded)

Less premium amortized*………

Interest expense for first year………

* $155,961 + $161,420

c The bonds sell for more than their face amount because the market rate of

interest is less than the contract rate of interest Investors are willing to pay

more for bonds that pay a higher rate of interest (contract rate) than the rate

they could earn on similar bonds (market rate).

Appendix 1 and 2 Ex 14–25

a Present value of $1 for 10 semiannual

Face amount of bonds………

Present value of an annuity of $1 for 10

× $35,000,000 $21,486,850

semiannual periods at 5% semiannual rate………… 7.72173

Semiannual interest payment……… × $ 2,100,000 16,215,633

Less premium amortized*………

Interest expense for first year………

* $214,876 + $225,620

CHAPTER 14 Long-Term Liabilities: Bonds and Notes

Appendix 1 and 2 Ex 14–26

a Present value of $1 for 10 semiannual

Face amount of bonds……… ×

Present value of an annuity of $1 for 10 semiannual $80,000,000 $44,671,200 periods at 6.0% semiannual rate……… 7.36009 Semiannual interest payment……… × $ 3,600,000 * 26,496,324 Proceeds of bond sale……… $71,167,524 * $80,000,000 × 4.5% b 6.0% of carrying amount of $71,167,524………

First semiannual interest payment………

Discount amortized………

c 6.0% of carrying amount of $71,837,575*………

Second semiannual interest payment………

Discount amortized………

* $71,167,524 + $670,051 d Annual interest paid………

Plus discount amortized*………

Interest expense for first year………

* $670,051 + $710,255

Prob 14–1A

1.

Earnings before interest and income tax……

Deduct interest on bonds………

Income before income tax………

Deduct income tax………

Net income………

Dividends on preferred stock………

Available for dividends on common stock… Shares of common stock outstanding………

Earnings per share on common stock………

2 Earnings before interest and income tax……

Deduct interest on bonds………

Income before income tax………

Deduct income tax………

Net income………

Dividends on preferred stock………

Available for dividends on common stock… Shares of common stock outstanding………

Earnings per share on common stock………

3 The principal advantage of Plan 1 is that it involves only the issuance of common stock, which does not require a periodic interest payment or return of principal,

and a payment of preferred dividends is not required It is also more attractive to

common shareholders than is Plan 2 or 3 if earnings before interest and income tax

is $1,050,000 In this case, it has the largest EPS ($0.35) The principal disadvantage of Plan 1 is that, if earnings before interest and income tax is $2,100,000, it offers the lowest EPS ($0.70) on common stock.

The principal advantage of Plan 3 is that less investment would need to be made by common shareholders Also, it offers the largest EPS ($1.44) if earnings before interest and income tax is $2,100,000 Its principal disadvantage is that the bonds carry a fixed annual interest charge and require the payment of principal It also requires a dividend payment to preferred stockholders before a common dividend can be paid Finally, Plan 3 provides the lowest EPS ($0.04) if earnings before interest and income tax is

$1,050,000.

Plan 2 provides a middle ground in terms of the advantages and disadvantages

described in the preceding paragraphs for Plans 1 and 3.

4 Yes Investors will not be willing to pay the face amount of the bonds when the

interest payments they will receive from the bonds are less than the amount of

interest that they could receive from investing in other bonds.

5 Present value of $1 for 40 semiannual

Face amount of bonds………

Present value of annuity of $1 for 40

× $100,000,000 $14,205,000

semiannual periods at 5.0% semiannual rate………… 17.15909

Semiannual interest payment……… × $ 4,500,000 77,215,905

4 Yes Investors will be willing to pay more than the face amount of the bonds

when the interest payments they will receive from the bonds exceed the amount

of interest that they could receive from investing in other bonds.

5 Present value of $1 for 40 semiannual

Face amount of bonds……… ×

Present value of annuity of $1

$150,000,000 $ 25,789,500

for 40 semiannual periods at 4.5% semiannual rate……… 18.40158

Semiannual interest payment……… × $ 9,000,000 165,614,220

Prob 14–4A (Concluded)

2016

Interest Payable Notes Payable Cash

b.

3 Initial carrying amount of bonds………

Discount amortized on December 31, 2014………

Discount amortized on December 31, 2015………

Carrying amount of bonds, December 31, 2015………

Appendix 1 and 2 Prob 14–5A

Prob 14–1B

1.

Earnings before interest and income tax………

Deduct interest on bonds………

Income before income tax………

Deduct income tax………

Net income………

Dividends on preferred stock………

Available for dividends on common stock……

Shares of common stock outstanding………

Earnings per share on common stock………

2 Earnings before interest and income tax………

Deduct interest on bonds………

Income before income tax………

Deduct income tax………

Net income………

Dividends on preferred stock………

Available for dividends on common stock………

Shares of common stock outstanding…………

Earnings per share on common stock…………

3 The principal advantage of Plan 1 is that it involves only the issuance of common stock, which does not require a periodic interest payment or return of principal, and a payment of preferred dividends is not required It is also more attractive to common shareholders than is Plan 2 or 3 if earnings before interest and income tax is $6,000,000 In this case, it has the largest EPS ($0.90) The principal

disadvantage of Plan 1 is that, if earnings before interest and income tax is

$10,000,000, it offers the lowest EPS ($1.50) on common stock.

The principal advantage of Plan 3 is that less investment would need to be made

by common shareholders Also, it offers the largest EPS ($2.84) if earnings before interest and income tax is $10,000,000 Its principal disadvantage is that the bonds carry a fixed annual interest charge and require the payment of principal It also requires a dividend payment to preferred stockholders before a common dividend can be paid Finally, Plan 3 provides the lowest EPS ($0.44) if earnings before interest and income tax is $6,000,000.

Plan 2 provides a middle ground in terms of the advantages and disadvantages described in the preceding paragraphs for Plans 1 and 3.