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CHAPTER 14

Long-Term Liabilities

SOLUTIONS TO EXERCISES

EXERCISE 14-2

(a) Discount on Bonds Payable—Contra account to bonds


payable on balance sheet.

(b) Interest expense (credit balance)—Reclassify to interest


payable on balance sheet.

(c) Unamortized Bond Issue Costs—Classified as “Other Assets”


on balance sheet.

(d) Gain on repurchase of debt—Classify as part of other gains


and losses on the income statement.

(e) Mortgage payable—Classify one-third as current liability and


the remainder as long-term liability on balance sheet.

(f) Debenture bonds—Classify as long-term liability on balance


sheet.

(g) Premium on bonds payable—Classify as adjunct account to


Bonds Payable on balance sheet.

(h) Notes payable—Classify as long-term liability on balance


sheet.

(i) Income bonds payable—Classify as long-term liability on


balance sheet.
EXERCISE 14-5
E14­5 (Entries for Bond Transactions—Effective­Interest) Assume the same information as 
in E14­4, except that Foreman Company uses the effective­interest method of amortization for 
bond premium or discount. Assume an effective yield of 9.7705%.

Instructions

Prepare the journal entries to record the following. (Round to the nearest dollar.)

(a) The issuance of the bonds.(b) The payment of interest and related amortization on July 1, 
2013.(c) The accrual of interest and the related amortization on December 31, 2013.

(a) 1/1/13 Cash ($800,000 X 102%).....................................


816,00
0
Bonds Payable.............................................
800,000
Premium on Bonds Payable........................ 16,000

(b) 7/1/13 Interest Expense


($816,000 X 9.7705% X 1/2).............................
39,864
Premium on Bonds Payable................................
136
Cash
($800,000 X 10% X 6/12)..........................
40,000

(c) 12/31/1 Interest Expense


3
($815,864 X 9.7705% X 1/2).............................
39,857
Premium on Bonds Payable................................
143
Interest Payable..........................................
40,000

Carrying amount of bonds at July 1, 2013:


Carrying amount of bonds at January 1, $816,000
2013
Amortization of bond premium
($40,000 – $39,864) (136)
Carrying amount of bonds at July 1, $815,864
2013
E14­7 (Amortization Schedule—Effective­Interest) Assume the same information as E14­6.

Instructions

Set up a schedule of interest expense and discount amortization under the effective­interest method. 
(Hint: The effective­interest rate must be computed.)

The effective-interest or yield rate is 12%. It is determined


through trial and error using Table 6-2 for the discounted value of
the principal ($1,702,290) and Table 6-4 for the discounted value of
the interest ($1,081,434); $1,702,290 plus $1,081,434 equals the
proceeds of $2,783,724. (A financial calculator may be used to
determine the rate of 12%.)
EXERCISE 14-7 (Continued)

Schedule of Discount Amortization


Effective-Interest Method (12%)
Carrying
Cash Interest Discount Amount of
Year Paid Expense Amortized Bonds
(1) (2) (3) (4)
Jan. 1, 2012 $2,783,724.
00
Dec. 31, $300,00 $334,046. * $34,046.8 2,817,770.88
2012 0 88 8
Dec. 31, 300,000 338,132.5 38,132.51 2,855,903.39
2013 1
Dec. 31, 300,000 342,708.4 42,708.41 2,898,611.80
2014 1
Dec. 31, 300,000 347,833.42 47,833.42 2,946,445.22
2015
Dec. 31, 300,000 353,554.7 ** 53,554.78 3,000,000.0
2016 8 0

*$334,046.88 = $2,783,724 X .12.


**Rounded.
EXERCISE 14-9

E14­9 (Entries and Questions for Bond Transactions) On June 30, 2012, Mackes Company issued 
$5,000,000 face value of 13%, 20­year bonds at $5,376,150, a yield of 12%. Mackes uses the effective­
interest method to amortize bond premium or discount. The bonds pay semiannual interest on June 30 
and December 31.

Instructions

. (a)  Prepare the journal entries to record the following transactions.(1) The issuance of the bonds on 
June 30, 2012.(2) The payment of interest and the amortization of the premium on December 31,
2012. (3) The payment of interest and the amortization of the premium on June 30, 2013.(4) The 
payment of interest and the amortization of the premium on December 31, 2013. 

. (b)  Show the proper balance sheet presentation for the liability for bonds payable on the December 
31, 2013, balance sheet. 

. (c)  Provide the answers to the following questions. 

. (1)  What amount of interest expense is reported for 2013? 

. (2)  Will the bond interest expense reported in 2013 be the same as, greater than, or less than the 
amount that would be reported if the straight­line method of amortization were used? 

. (3)  Determine the total cost of borrowing over the life of the bond. 

. (4)  Will the total bond interest expense for the life of the bond be greater than, the same as, or 
less than the total interest expense if the straight­line method of amortization were used? 

(a) 1. June 30, 2012


Cash....................................................................
5,376,150.0
0
Bonds Payable............................................. 5,000,000.0
0
Premium on Bonds 376,150.00
Payable...............................................................

2. December 31, 2012


Interest Expense
($5,376,150.00 X 12% X 322,569.00
6/12)....................................................................
Premium on Bonds Payable................................
2,431.00
Cash
($5,000,000 X 13% X 325,000.00
6/12)

3. June 30, 2013


Interest Expense
[($5,376,150.00 – $2,431.00)
X 12% X 6/12] 322,423.14
Premium on Bonds Payable 2,576.86
Cash 325,000.00

4. December 31, 2013


Interest Expense
[($5,376,150.00 – $2,431.00

$2,576.86) X 12% X 6/12] 322,268.53
Premium on Bonds Payable 2,731.47
Cash 325,000.00

EXERCISE 14-9 (Continued)

(b) Long-term Liabilities:


Bonds payable, 13% (due on June 30, $5,000,000.00
2032)...................................................................
Premium on Bonds Payable*.............................. 368,410.67
Book value of bonds payable..............................$5,368,410.67

*($376,150) – ($2,431.00 + $2,576.86 + $2,731.47) =


$368,410.67

(c) 1. Interest expense for the period from


January 1 to June 30, 2013 from $322,423.14
(a) 3.....................................................................
Interest expense for the period from
July 1 to December 31, 2013 from 322,268.5
(a) 4..................................................................... 3
Amount of bond interest expense
reported for 2013............................................. $644,691.6
7

2. The amount of bond interest expense reported in 2013


will be greater than the amount that would be reported if
the straight-line method of amortization were used. Under
the straight-line method, the amortization of bond
premium is $18,808 ($376,150/20). Bond interest expense
for 2013 is the difference between the amortized
premium, $18,808, and the actual interest paid, $650,000
($5,000,000 X 13%). Thus, the amount of bond interest
expense is $631,192, which is smaller than the bond
interest expense under the effective-interest method.

3. Total interest to be paid for the bond


($5,000,000 X 13% X 20)................................. $13,000,00
0
Less: Premium................................................... 376,150
Total cost of borrowing over the life
of the bond.......................................................
$12,623,850

4. They will be the same.

E14­12 (Entry for Retirement of Bond; Bond Issue Costs) On January 2, 2007, Prebish Corporation 
issued $1,500,000 of 10% bonds at 97 due December 31, 2016. Legal and other costs of $24,000 were 
incurred in connection with the issue. Interest on the bonds is payable annually each December 31. The 
$24,000 issue costs are being deferred and amortized on a straight­line basis over the 10­year term of the
bonds. The discount on the bonds is also being amortized on a straight­line basis over the 10 years. 
(Straight­line is not materially different in effect from the preferable “interest method”.)

The bonds are callable at 101 (i.e., at 101% of face amount), and on January 2, 2012, Prebish called 
$1,000,000 face amount of the bonds and retired them.

Reacquisition price ($1,000,000 X 101%).......... $1,010,000


Less: Net carrying amount of bonds
redeemed:
Par value...................................................
$1,000,00
0
Unamortized discount...............................(15,000)
Unamortized bond issue costs................. (8,00 977,000
0)
Loss on redemption $ 33,000
Calculation of unamortized discount—
Original amount of discount:
$1,000,000 X 3% = $30,000
$30,000/10 = $3,000 amortization
per year
Amount of discount unamortized:
$3,000 X 5 = $15,000
Calculation of unamortized issue costs—
Original amount of costs:
$24,000 X $1,000,000/$1,500,000 =
$16,000
$16,000/10 = $1,600 amortization
per year
Amount of costs unamortized:
$1,600 X 5 = $8,000

January 2, 2012
Bonds Payable 1,000,000
Loss on Redemption of Bonds 33,000
Unamortized Bond Issue Costs......... 8,000
Discount on Bonds Payable 15,000
Cash 1,010,00
0
EXERCISE 14-21
E14­21 (Settlement of Debt) Strickland Company owes $200,000 plus $18,000 of accrued interest to 
Moran State Bank. The debt is a 10­year, 10% note. During 2012, Strickland’s business deteriorated due
to a falter­ ing regional economy. On December 31, 2012, Moran State Bank agrees to accept an old 
machine and cancel the entire debt. The machine has a cost of $390,000, accumulated depreciation of 
$221,000, and a fair value of $180,000.

Instructions

. (a)  Prepare journal entries for Strickland Company and Moran State Bank to record this debt 
settlement. 

. (b)  How should Strickland report the gain or loss on the disposition of machine and on restructuring 
of debt in its 2012 income statement? 

. (c)  Assume that, instead of transferring the machine, Strickland decides to grant 15,000 shares of its 
common stock ($10 par) which has a fair value of $180,000 in full settlement of the loan 
obligation. If Moran State Bank treats Strickland’s stock as a trading investment, prepare the 
entries to record the transaction for both parties. 

(a) Transfer of property on December 31,


2012:

Strickland Company (Debtor):


Notes Payable.............................................
200,000
Interest Payable.......................................... 18,000
Accumulated Depreciation— 221,000
Machinery...........................................................
Machinery............................................ 390,000
Gain on Disposal of Machinery........... 11,000a
Gain on Restructuring of Debt............ 38,000b
a
$180,000 – ($390,000 – $221,000) =
$11,000.
b
($200,000 + $18,000) – $180,000 =
$38,000.

Moran State Bank (Creditor):


Machinery....................................................
180,000
Allowance for Doubtful Accounts............... 38,000
Notes Receivable................................ 200,000
Interest Receivable............................. 18,000
(b) “Gain on Disposal of Machinery” and the “Gain on
Restructuring of Debt” should be reported as an ordinary gain
in the income statement.

(c) Granting of equity interest on December 31, 2012:

Strickland Company (Debtor):


Notes Payable.............................................
200,000
Interest Payable..........................................
18,000
Common Stock.................................... 150,000
Paid-in Capital in Excess of
Par- 30,000
Common Stock...............................
Gain on Restructuring of Debt............ 38,000

Moran State Bank (Creditor):


Equity Investments.....................................
180,000
Allowance for Doubtful Accounts............... 38,000
Notes Receivable................................ 200,000
Interest Receivable............................. 18,000
PROBLEM 14-9

(Entries for Zero­Interest­Bearing Note; Payable in Installments) Sabonis Cosmetics Co. purchased 
machinery on December 31, 2011, paying $50,000 down and agreeing to pay the balance in four equal 
install­ ments of $40,000 payable each December 31. An assumed interest of 8% is implicit in the 
purchase price.

Instructions

Prepare the journal entries that would be recorded for the purchase and for the payments and interest on 
the following dates.

(a) December 31, 2011. (d) December 31, 2014. (b) December 31, 2012. (e) December 31, 2015. (c) 
December 31, 2013.

(a) 12/31/1 Machinery...........................................................


182,485.2
1 0
Discount on Notes Payable.................................
27,514.80
Cash............................................................
50,000.0
0
Notes Payable............................................. 160,000.
00
[To record machinery
at the
present value of the note
plus
the immediate cash
payment:
PV of $40,000 annuity @
8%
for 4 years ($40,000 X
3.31213)]...................................................
$132,485.
20
Down payment............................................ 50,000.
00
Capitalized value of
Machinery.................................................
$182,485.
20

(b) 12/31/1 Notes Payable.....................................................


40,000.00
2
Cash............................................................
40,000.0
(b) 12/31/1 Notes Payable.....................................................
40,000.00
2
0

Interest Expense................................................
10,598.82
Discount on Notes 10,598.8
Payable............................................................... 2

Schedule of Note Discount Amortization


Interest Carrying
Date Cash Paid Expense Amortizati Amount of
on Note
12/31/1 $132,485.20
1
12/31/1 $40,000.0 $10,598.82 $29,401.18 103,084.02
2 0 *
12/31/1 40,000.0 8,246.72 31,753.28 71,330.74
3 0
12/31/1 40,000.0 5,706.46 34,293.54 37,037.20
4 0
12/31/1 40,000.0 2,962.80 37,037.20 —
5 0 **

*$103,084.02 = $132,485.20 – $29,401.18.


**$0.18 adjustment due to rounding.

PROBLEM 14-9 (Continued)

(c) 12/31/1 Notes Payable.....................................................


40,000.00
3
Cash............................................................
40,000.00

Interest Expense................................................
8,246.72
Discount on Notes 8,246.72
Payable...............................................................

(d) 12/31/1 Notes Payable.....................................................


40,000.00
4
Cash............................................................
40,000.00

Interest Expense................................................
5,706.46
(c) 12/31/1 Notes Payable.....................................................
40,000.00
3
Discount on Notes 5,706.46
Payable...............................................................

(e) 12/31/1 Notes Payable.....................................................


40,000.00
5
Cash............................................................
40,000.00

Interest Expense................................................
2,962.80
Discount on Notes 2,962.80
Payable...............................................................
*PROBLEM 14-12

14­12 (Debtor/Creditor Entries for Continuation of Troubled Debt) Daniel Perkins is the sole share­
holder of Perkins Inc., which is currently under protection of the U.S. bankruptcy court. As a “debtor in 
possession,” he has negotiated the following revised loan agreement with United Bank. Perkins Inc.’s 
$600,000, 12%, 10­year note was refinanced with a $600,000, 5%, 10­year note.

Instructions

(a) What is the accounting nature of this transaction? (b) Prepare the journal entry to record this 
refinancing:

(1) On the books of Perkins Inc.

(2) On the books of United Bank.(c) Discuss whether generally accepted accounting principles provide 
the proper information useful to

managers and investors in this situation.

(a) It is a troubled debt restructuring.

(b) 1. No entry.

2. Bad Debt Expense....................................... 237,311*


Allowance for Doubtful 237,311
Accounts.............................................................

*Calculation of loss.

Pre-restructure carrying amount $600,000


Present value of restructured cash
flows:
Present value of $600,000 due in 10
years at
12%, interest payable annually (Table $193,18
6-2); 2
($600,000 X .32197)..........................................
Present value of $30,000 interest
payable
annually for 10 years at 12% (Table 6- 169,50 (362,689)
4); 7
($30,000 X 5.65022)..........................................
(b) 1. No entry.
Creditor’s loss on restructuring of debt............. $237,311

(c) Losses are calculated based upon the discounted present


value of future cash flows. However, the debtor’s gain is
calculated using the undiscounted cash flows. This does not
fairly state the economic benefits derived by the debtor as a
result of the restructuring.
*PROBLEM 14-13

(Restructure of Note under Different Circumstances) Halvor Corporation is having financial dif­ 
ficulty and therefore has asked Frontenac National Bank to restructure its $5 million note outstanding. 
The present note has 3 years remaining and pays a current rate of interest of 10%. The present market 
rate for a loan of this nature is 12%. The note was issued at its face value.

Instructions

Presented below are four independent situations. Prepare the journal entry that Halvor and Frontenac 
National Bank would make for each of these restructurings.

. (a)  Frontenac National Bank agrees to take an equity interest in Halvor by accepting common stock 
valued at $3,700,000 in exchange for relinquishing its claim on this note. The common stock has 
a par value of $1,700,000. 

. (b)  Frontenac National Bank agrees to accept land in exchange for relinquishing its claim on this 
note. The land has a book value of $3,250,000 and a fair value of $4,000,000. 

. (c)  Frontenac National Bank agrees to modify the terms of the note, indicating that Halvor does not 
have to pay any interest on the note over the 3­year period. 

. (d)  Frontenac National Bank agrees to reduce the principal balance due to $4,166,667 and require 
inter­ est only in the second and third year at a rate of 10%. 

(a) On the books of Halvor Corporation:


Notes payable.....................................................
5,000,00
0
Common Stock............................................ 1,700,000
Paid-in Capital in Excess of Par—
Common Stock....................................... 2,000,000
Gain on Restructuring of Debt.................... 1,300,000

Fair value of equity $3,700,00


0
Carrying amount of (5,000,0
debt 00)
Gain on restructuring
of debt ($1,300,0
00)
On the books of Frontenac National
Bank:
Equity Investments.............................................
3,700,00
0
On the books of Frontenac National
Bank:
Allowance for Doubtful Accounts.......................
1,300,00
0
Notes Receivable........................................ 5,000,000

(b) On the books of Halvor:


Notes Payable.....................................................
5,000,00
0
Land............................................................ 3,250,000
Gain on Disposal of Plant Assets................ 750,000
Gain on Restructuring of Debt.................... 1,000,000

Fair value of land $4,000,00


0
Book value of land (3,250,00
0)
Gain on disposal of
plant assets $
750,000

Note payable
(carrying
amount) $5,000,00
0
Fair value of land (4,000,00
0)
Gain on restructuring
of debt $1,000,00
0

On the books of Frontenac National


Bank:
Land....................................................................
4,000,0
00
Allowance for Doubtful Accounts....................... 1,000,0
00
Notes Receivable........................................ 5,000,00
0
*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................ $5,000,0
00
Carrying amount......................................... $5,000,0
00

On the books of Frontenac National


Bank:
Bad Debt Expense..............................................
1,243,40
0*
Allowance for Doubtful Accounts............... 1,243,40
0

*Calculation of loss:
Pre-restructure carrying amount $5,000,0
00
Less: Present value of restructured cash
flows:
Present value of $5,000,000 due in
3 years at 10% (Table 6-2);
($5,000,000 X.75132)........................... 3,756,60
0
Creditor’s loss on restructuring of debt............. $1,243,40
0

(d) On the books of Halvor:


No entry is needed because aggregate cash
flows equal
the carrying amount.
Principal...................................................... $4,166,66
7
Interest ($4,166,667 X 10% X 2)................. 833,33
3
Aggregate cash flows $5,000,0
00

Carrying amount $5,000,0


00
On the books of Frontenac National
Bank:
Bad Debt Expense..............................................
1,212,10
0*
Allowance for Doubtful Accounts............... 1,212,100
*PROBLEM 14-13 (Continued)

*Calculation of loss:
Pre-restructure carrying amount..................... $5,000,00
0
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)......................................................
$3,130,5
00
Present value of $416,667
interest
payable annually for 3 years at
10%,
(Table 6-4); ($416,667 X 1,036,18
2.48685).............................................................. 8
Less first year payment:
Present value of $416,667
interest due
in 1 year at 10% (Table 6-2);
($416,667 X .90909)................................. 378,7
88 3,787,900
Creditor’s loss on restructuring of $1,212,10
debt 0