中级财务会计英文版第九章课后题答案

中级财务会计英文版第九章课后 Chapter 14 - Bonds and Long-Term Notes Chapter 14 Bonds and Long-Term Notes QUESTIONS FOR REVIEW OF KEY TOPICS Question 14-1 Periodic interest is calculated as the effective interest rate times the amount of the debt outstanding during the period. This same principle applies to the flip side of the transaction, i.e., the creditor’s receivable or investment. The approach also is the same regardless of the specific form of the debt – that is, whether in the form of notes, bonds, leases, pensions, or other debt instruments. Question 14-2 Long-term liabilities are appropriately reported at their present values. The present value of a liability is the present value of its related cash flows – specifically the present value of the face amount of the debt instrument, if any, plus the present value of stated interest payments, if any. Both should be discounted to present value at the effective (market) rate of interest at issuance. Question 14-3 Bonds and notes are very similar. Both typically obligate the issuing corporation to repay a stated amount (e.g., the principal, par value, face amount, or maturity value) at a specified maturity date. In return for the use of the money borrowed, the company also agrees to pay interest to the lender between the issue date and maturity. The periodic interest is a stated percentage of face amount. In concept, bonds and notes are accounted for in precisely the same way. Normally a company will borrow cash from a bank or other financial institution by signing a promissory note. Corporations, especially medium- and large- sized firms, often choose to borrow cash by issuing bonds and instead of borrowing from a lending institution, it borrows from the public. A bond issue, in effect, breaks down a large debt into manageable parts ($1,000 units) which makes it more attractive to individual and corporate investors. Also, bonds typically have longer maturities than notes. The most common form of corporate debt is bonds. Question 14-4 All of the specific promises made to bondholders are described in a bond indenture. This formal agreement will specify the bond issue’s face amount, the stated interest rate, the method of paying interest (whether the bonds are registered bonds or coupon bonds), whether the bonds are backed by a lien on specified assets, and whether they are subordinated to other debt. The bond indenture also might provide for redemption through a call feature, by serial payments, through sinking fund provisions, or by conversion. It also will specify the trustee (usually a commercial bank or other financial institution) appointed by the issuing firm to represent the rights of the bondholders. The bond indenture serves as a contract between the company and the bondholder(s). If the company fails to live up to the terms of the bond indenture, the trustee may bring legal action against the company on behalf of the bondholders. 14-1 Chapter 14 - Bonds and Long-Term Notes Answers to Questions (continued) Question 14-5 In order for Brandon to sell its bonds that pay only 11.5% stated interest in a 12.25% market the bonds would have to be priced at a discount from face amount. The discount would be the amount that causes the bond issue to be priced to yield the market rate. In other words, an investor paying that price would earn an effective rate of return on the investment equal to the 12.25% market rate. Question 14-6 The price will be the present value of the periodic cash interest payments (face amount x stated rate) plus the present value of the principal payable at maturity. Both interest and principal are discounted to present value at the market rate of interest for securities of similar risk and maturity. Question 14-7 In a strict sense, it’s true that zero-coupon bonds pay no interest. ―Zeros‖ offer a return in the form of a ―deep discount‖ from the face amount. Still, interest accrues at the effective rate times the outstanding balance, but no interest is paid periodically. So, interest on zero-coupon bonds is determined and reported in precisely the same manner as on interest-paying bonds. Under the concept of accrual accounting, the periodic effective interest is unaffected by when the cash actually is paid. Corporations can deduct for tax purposes the annual interest expense, but without cash outflow until the bonds mature. Question 14-8 When bonds are issued at a premium the debt declines each period because the effective interest each period is less than the cash interest paid. The ―overpayments‖ each period reduce the balance owed. This is precisely the opposite of when debt is sold at a discount. In that case, the effective interest each period is more than the cash paid, and the ―underpayment‖ of interest adds to the amount owed. 14-2 Chapter 14 - Bonds and Long-Term Notes Answers to Questions (continued) Question 14-9 By the effective interest method, interest expense is recorded each period as the effective market rate of interest multiplied by the outstanding balance of the debt (during the interest period). This simply is an application of the accrual concept, consistent with accruing all expenses as they are incurred. The difference between the interest expense and the interest paid increases (or decreases) the existing bond liability and is reflected as ―amortization‖ of the discount (or premium). An exception to the conceptually appropriate method of determining interest for bond issues is the straight-line method. Companies are allowed to determine interest indirectly by allocating a discount or a premium equally to each period over the term to maturity if doing so produces results that are not materially different from the effective interest method. The firm’s decision should be guided by whether the straight-line method would tend to mislead investors and creditors in the particular circumstance. The straight-line method results in a constant dollar amount of interest expense each period. By the straight-line method, the amount of the discount to be reduced periodically is calculated, and the effective interest is the ―plug‖ figure. By the effective interest method, the dollar amounts of interest vary over the term to maturity because the percentage rate of interest remains constant, but is applied to a changing debt balance. The ―straight-line method,‖ is not an alternative method of determining interest in a conceptual sense, but is an application of the materiality concept. Question 14-10 The prescribed treatment requires a debit to an asset account – "debt issue costs‖ which is then allocated to expense, usually on a straight-line basis. An appealing alternative would be to reduce the recorded amount of the debt by the debt issue costs. This approach has the appeal of reflecting the effect debt issue costs have on the effective interest rate. Debt issue costs reduce the net cash the company receives from the sale of the financial instrument. A lower net amount is borrowed at the same cost, increasing the effective interest rate. The actual increase in the effective interest rate is reflected in the interest expense if the issue cost is allowed to reduce the premium (or increase the discount) on the debt. This approach also is consistent with the treatment of issue costs when shares of stock are sold. Share issue costs are recorded as a reduction in the amount credited to stock accounts (Chapter 18). 14-3 Chapter 14 - Bonds and Long-Term Notes Answers to Questions (continued) Question 14-11 When the stated interest rate is not indicative of the market rate at the time a note is negotiated, the value of the asset (cash or noncash) or service exchanged for the note establishes the market rate. This rate is the implicit rate of interest. If the value of the asset (or service) is not readily determinable, the implicit rate may not be apparent. In that case an appropriate rate should be ―imputed‖ as the rate that would be expected in a similar transaction, under similar circumstances. The economic essence of a transaction should prevail over its outward appearance. The accountant should look beyond the form of this transaction and record its substance. The amount actually paid for the asset is the present value of the cash flows called for by the loan agreement, discounted at the ―imputed‖ market rate. Both the asset acquired and the liability used to purchase it should be recorded at the real cost. Question 14-12 Mandatorily redeemable shares, which the issuing company is obligated to buy back in exchange for cash or other assets, must be reported as liabilities. Question 14-13 When notes are paid in installments, rather than a single amount at maturity, installment payments typically are equal amounts each period. Each payment will include both an amount representing interest and an amount representing a reduction of principal. At maturity, the principal is completely paid. The installment amount is calculated by dividing the amount of the loan by the appropriate discount factor for the present value of an annuity. Determining periodic interest is the same as for a note whose principal is paid at maturity – effective interest rate times the outstanding principal. But the periodic cash payments are larger and there is no lump-sum payment at maturity. Question 14-14 For all long-term borrowings, disclosure should include (a) the fair values, (b) the aggregate amounts maturing, and (c) sinking fund requirements (if any) for each of the next five years. Question 14-15 Regardless of the method used to retire debt prior to its scheduled maturity date, the gain or loss on the transaction is simply the difference between the carrying amount of the debt at that time and the cash paid to retire it. To record the extinguishment the account balances pertinent to the debt are removed from the books. Cash is credited for the amount paid (the call price or market price). The difference between the carrying amount and the reacquisition price is the gain or loss. Question 14-16 Gains and losses are reported as extraordinary items when they are considered to be material and both unusual and infrequent. In that case they are reported separate from ordinary operations and net of their tax effects. 14-4 Chapter 14 - Bonds and Long-Term Notes Answers to Questions (continued) Question 14-17 GAAP requires that the entire issue price of convertible bonds be recorded as debt, precisely the same way, in fact, as for nonconvertible bonds. On the other hand, the issue price of bonds with detachable warrants is allocated between the two different securities on the basis of their market values. The difference is based on the relative separability of the debt and equity features of the two securities. In the case of convertible bonds, the two features of the security, the debt and the conversion option, are physically inseparable — the option cannot be exercised without surrendering the debt. But the debt and equity features of bonds with detachable warrants can be separated. Unlike a conversion feature, warrants can be separated from the bonds and can be exercised independently or traded in the market separately from bonds. In substance, two different securities – the bonds and the warrants – are sold as a "package" for a single issue price. Question 14-18 Additional consideration a company provides to induce conversion of convertible debt should be recorded as an expense of the period. It is measured at the fair value of that consideration. This might be cash paid, the market price of stock warrants given, or the market value of additional shares issued due to modifying the conversion ratio. Question 14-19 Rising interest rates, other factors remaining the same, cause prices of fixed-rate securities to fall. For the investor in these securities, the price decline represents a loss; but for Cordova Tools, the debtor, the decline in the value of the liability is a gain. If Cordova has elected the fair value option for the bonds, it will report the gain on change in the fair value of the bonds in its income statement. Question 14-20 Under International Financial Reporting Standards, unlike U.S. GAAP, convertible debt is divided into its liability and equity elements. If a company prepares its financial statements according to IFRS it accounts for convertible bonds it issues for $12.5 million by separating the $12.5 million into two parts. Effectively, the company is selling two securities – (1) bonds and (2) an option to convert to stock – for one package price. The bonds represent a liability; the option is shareholders’ equity. It would record the fair value of the bonds as the liability and the remaining difference between the fair value of the convertible bonds, $12.5 million, and the fair value of the bonds as equity. If the fair value of the bonds cannot be determined from an active trading market, that value can be calculated as the present value of the bonds’ cash flows, using the market rate of interest Question 14-21 All bonds sell at their price plus any interest that has accrued since the last interest date to simplify the process of paying and recording interest. The buyer is asked to pay the seller accrued interest for any time that has elapsed since the last interest date in addition to the price of the bonds so that when a full six months’ interest is paid at the next interest date, the net interest paid/received will be correct for the time the bonds have been held by the investor. 14-5 Chapter 14 - Bonds and Long-Term Notes Answers to Questions (concluded) Question 14-22 By definition, a troubled debt restructuring involves some concessions on the part of the creditor (lender). A creditor may feel it can minimize losses by restructuring a debt agreement, rather than forcing liquidation. A troubled debt restructuring takes one of two forms, with the second further categorized for accounting purposes: 1. The debt may be settled at the time of the restructuring, or 2. The debt may be continued, but with modified terms. a. Under the modified terms, total cash to be paid is less than the carrying amount of the debt. b. Under the modified terms, total cash to be paid exceeds the carrying amount of the debt. Question 14-23 Pratt has a gain of $2 million (the difference between the carrying amount of the debt and the fair value of the property transferred). Pratt also must adjust the carrying amount of the land to its fair value prior to recording its exchange for the debt. Pratt would need to change the recorded amount for the property specified in the exchange agreement from $2 million to the $3 million fair value. This produces a ―gain on disposition of assets‖ of $1 million. So, Pratt would report two items on its income statement in connection with the troubled debt restructuring: (1) a $2 million gain on troubled debt restructuring and (2) a ―gain on disposition of assets‖ of $1 million. Question 14-24 (a) When the total future cash payments are less than the carrying amount of the debt, the difference is recorded as a gain to the debtor at the date of restructure. No interest is recorded thereafter. All subsequent cash payments produce reductions of principal. (b) When the total future cash payments exceed the carrying amount of the debt, no reduction of the existing debt is necessary and no entry is required at the time of the debt restructuring. The accounting objective is to determine the new (lower) effective interest and to record interest expense for the remaining term of the loan at that new, lower rate. 14-6 Chapter 14 - Bonds and Long-Term Notes BRIEF EXERCISES Brief Exercise 14-1 6 $30,000,000 x 6% x / = $900,000 12 face annual fraction of the cash amount rate annual period interest Brief Exercise 14-2 ?* Interest $ 2,000,000 x 23.11477= $46,229,540 ** Principal $80,000,000 x 0.30656= 24,524,800 Present value (price) of the bonds $70,754,340 ? [5?2] % x $80,000,000 * present value of an ordinary annuity of $1: n=40, i=3%. (Table 4) ** present value of $1: n=40, i=3%. (Table 2) Brief Exercise 14-3 The price will be the present value of the periodic cash interest payments (face amount x stated rate) plus the present value of the principal payable at maturity. Both interest and principal are discounted to present value at the market rate of interest for securities of similar risk and maturity. When the stated rate and the market rate are the same, the bonds will sell at face value, $75 million in this instance. Brief Exercise 14-4 ?* Interest $ 2,500,000 x 27.35548= $ 68,388,700 ** Principal $100,000,000 x 0.45289= 45,289,000 Present value (price) of the bonds $113,677,700 ? [5?2] % x $100,000,000 * present value of an ordinary annuity of $1: n=40, i=2%. (Table 4) ** present value of $1: n=40, i=2%. (Table 2) 14-7 Chapter 14 - Bonds and Long-Term Notes Brief Exercise 14-5 Interest will be the effective rate times the outstanding balance: 4% x $82,218,585 = $3,288,743 Brief Exercise 14-6 Interest will be the effective rate times the outstanding balance: June 30 Interest expense (2% x $69,033,776) ................................. 1,380,676 Discount on bonds payable (difference) ................. 180,676 Cash (1.5% x $80,000,000)..................................... 1,200,000 December 31 Interest expense (2% x [$69,033,776 + 180,676]) .......... 1,384,289 Discount on bonds payable (difference) ................. 184,289 Cash (1.5% x $80,000,000) .................................... 1,200,000 Interest expense for the year: $1,380,676 + 1,384,289 = $2,764,965 Brief Exercise 14-7 Interest will be a plug figure: $80,000,000 – 69,033,776 = $10,966,224 discount $10,966,224 / 40 semiannual periods = $274,156 reduction each period June 30 Interest expense (to balance)............................................... 1,474,156 Discount on bonds payable (difference) ................. 274,156 Cash (1.5% x $80,000,000)..................................... 1,200,000 December 31 Interest expense (to balance)............................................... 1,474,156 Discount on bonds payable (difference) ................. 274,156 Cash (1.5% x $80,000,000)..................................... 1,200,000 Interest expense for the year: $1,474,156 + 1,474,156 = $2,948,312 14-8 Chapter 14 - Bonds and Long-Term Notes Brief Exercise 14-8 Interest will be the effective rate times the outstanding balance: June 30 Cash (1.5% x $80,000,000) ........................................ 1,200,000 Discount on investment in bonds (difference) ............ 180,676 Interest revenue (2% x $69,033,776).............................. 1,380,676 December 31 Cash (1.5% x $80,000,000) ........................................ 1,200,000 Discount on investment in bonds (difference) ............ 184,289 Interest revenue (2% x [$69,033,776 + 180,676]) ....... 1,384,289 Brief Exercise 14-9 ? Interest $6,000 x 2.72325 * =$ 16,340 Principal $300,000 x 0.86384 **= 259,152 Present value (price) of the note $275,492 ? 2% x $300,000 * present value of an ordinary annuity of $1: n=3, i=5%. (Table 4) ** present value of $1: n=3, i=5%. (Table 2) Equipment (price determined above)................................. 275,492 Discount on notes payable (difference) ......................... 24,508 Notes payable (face amount) ..................................... 300,000 14-9 Chapter 14 - Bonds and Long-Term Notes Brief Exercise 14-10 $300,000 ? 2.72325 = $110,162 amount (from Table 4) installment of loan n=3, i=5% payment Helpful, but not required: Cash Effective Decrease in Outstanding Payment Interest Balance Balance 5% x Outstanding Balance Balance Reduction 300,000 1 110,162 .05 (300,000) = 15,000 95,162 204,838 2 110,162 .05 (204,838) = 10,242 99,920 104,918 3 110,162 .05(104,918) = 5,246 104,918* 0 * rounded 10,242 Interest expense (5% x ($300,000 – [$110,162 – 5% x $300,000])) Note payable (difference) ............................................. 99,920 Cash (payment determined above) ................................. 110,162 Brief Exercise 14-11 ($ in millions) Bonds payable (face amount) .................................... 60.0 Loss on early extinguishment (to balance) ................. 3.2 Discount on bonds (given) ................................... 2.0 Cash ($60,000,000 x 102%).................................... 61.2 14-10 Chapter 14 - Bonds and Long-Term Notes Brief Exercise 14-12 The issue price of bonds with detachable warrants is allocated between the two different securities on the basis of their market values. ($ in millions) Cash (102% x $60 million) .................................................... 61.2 Discount on bonds payable (difference) .............................. 1.8 Bonds payable (face amount) ........................................... 60.0 Equity – stock warrants outstanding ($5 x 10 warrants x 60,000 bonds) .................................. 3.0 Brief Exercise 14-13 GAAP requires that the entire issue price of convertible bonds be recorded as debt, precisely the same way, in fact, as for nonconvertible bonds. ($ in millions) Cash (102% x $60 million) .................................................... 61.2 Premium on bonds payable (difference) ........................... 1.2 Bonds payable (face amount) ........................................... 60.0 Brief Exercise 14-14 AI will report a gain when adjusting the bonds to fair value. A decrease in the fair value of a liability is a gain, just the opposite of a decrease in the value of an asset. If the change in fair value is attributable to a change in the interest rate, the rate increased. This is because as interest rates rise, the value of a fixed rate instrument – like bonds – falls as occurred with AI’s bonds. 14-11 Chapter 14 - Bonds and Long-Term Notes EXERCISES Exercise 14-1 The DD Corp. bonds are appropriately priced to yield the market rate of interest. The GG Corp. bonds are slightly underpriced at the stated price and therefore are the most attractive. The BB Corp. bonds are slightly overpriced and are the least attractive. Bonds are priced to yield the market rate, 10% in this case. When this rate is used to price the bonds, we get the prices shown below. Presumably, the market rate changed since the underwriters priced two of the bond issues. BB Corp. bonds: ?* Interest $ 5,500,000 x 17.15909 = $ 94,374,995 ** Principal $100,000,000 x 0.14205 = 14,205,000 Present value (price) of the bonds $108,579,995 ? [11?2] % x $100,000,000 * present value of an ordinary annuity of $1: n=40, i=5% (Table 4) ** present value of $1: n=40, i=5% (Table 2) DD Corp. bonds: ?* Interest $ 5,000,000 x 17.15909 = $ 85,795,450 ** Principal $100,000,000 x 0.14205 = 14,205,000 Present value (price) of the bonds $100,000,450 Note: The result differs from $100,000,000 only because the present value factors in any present value table are rounded. Because the stated rate and the market rate are the same, the true present value is $100,000,000. ? [10?2] % x $100,000,000 * present value of an ordinary annuity of $1: n=40, i=5% (Table 4) ** present value of $1: n=40, i=5% (Table 2) GG Corp. bonds: ?* Interest $ 4,500,000 x 17.15909 = $77,215,905 ** Principal $100,000,000 x 0.14205 = 14,205,000 Present value (price) of the bonds $91,420,905 14-12 Chapter 14 - Bonds and Long-Term Notes ? [9?2] % x $100,000,000 * present value of an ordinary annuity of $1: n=40, i=5% (Table 4) ** present value of $1: n=40, i=5% (Table 2) 14-13 Chapter 14 - Bonds and Long-Term Notes Exercise 14-2 1. Maturity Interest paid Stated rate Effective (market) rate 10 years annually 10% 12% ?* Interest $100,000 x 5.65022 = $565,022 ** Principal $1,000,000 x 0.32197 = 321,970 Present value (price) of the bonds $886,992 ? 10% x $1,000,000 * present value of an ordinary annuity of $1: n=10, i=12% (Table 4) ** present value of $1: n=10, i=12% (Table 2) 2. Maturity Interest paid Stated rate Effective (market) rate 10 years semiannually 10% 12% ?* Interest $50,000 x 11.46992 = $573,496 ** Principal $1,000,000 x 0.31180 = 311,800 Present value (price) of the bonds $885,296 ? 5% x $1,000,000 * present value of an ordinary annuity of $1: n=20, i=6% (Table 4) ** present value of $1: n=20, i=6% (Table 2) 14-14 Chapter 14 - Bonds and Long-Term Notes 3. Maturity Interest paid Stated rate Effective (market) rate 10 years semiannually 12% 10% ?* Interest $60,000 x 12.46221 = $ 747,733 ** Principal $1,000,000 x 0.37689 = 376,890 Present value (price) of the bonds $1,124,623 ? 6% x $1,000,000 * present value of an ordinary annuity of $1: n=20, i=5% (Table 4) ** present value of $1: n=20, i=5% (Table 2) 4. Maturity Interest paid Stated rate Effective (market) rate 20 years semiannually 12% 10% ?* Interest $60,000 x 17.15909 = $1,029,545 ** Principal $1,000,000 x 0.14205 = 142,050 Present value (price) of the bonds $1,171,595 ? 6% x $1,000,000 * present value of an ordinary annuity of $1: n=40, i=5% (Table 4) ** present value of $1: n=40, i=5% (Table 2) 14-15 Chapter 14 - Bonds and Long-Term Notes Exercise 14-2 (concluded) 5. Maturity Interest paid Stated rate Effective (market) rate 20 years semiannually 12% 12% ?* Interest $60,000 x 15.04630 = $902,778 ** Principal $1,000,000 x 0.09722 = 97,220 Present value (price) of the bonds $999,998 actually, $1,000,000 if PV table factors were not rounded ? 6% x $1,000,000 * present value of an ordinary annuity of $1: n=40, i=6% (Table 4) ** present value of $1: n=40, i=6% (Table 2) 14-16 Chapter 14 - Bonds and Long-Term Notes Exercise 14-3 1. Price of the bonds at January 1, 2011 ?* Interest $4,000,000 x 11.46992 = $45,879,680 ** Principal $80,000,000 x 0.31180 = 24,944,000 Present value (price) of the bonds $70,823,680 ? 5% x $80,000,000 * present value of an ordinary annuity of $1: n=20, i=6% (Table 4) ** present value of $1: n=20, i=6% (Table 2) 2. January 1, 2011 Cash (price determined above) ..................................... 70,823,680 Discount on bonds (difference)................................. 9,176,320 Bonds payable (face amount) ................................. 80,000,000 3. June 30, 2011 Interest expense (6% x $70,823,680) ................................. 4,249,421 Discount on bonds payable (difference) ................. 249,421 Cash (5% x $80,000,000) ....................................... 4,000,000 Partial amortization schedule (not required) Cash Effective Increase in Outstanding Payment Interest Balance Balance 5% x Face Amount 6% x Outstanding Balance Discount Reduction 70,823,680 1 4,000,000 .06 (70,823,680) = 4,249,421 249,421 71,073,101 2 4,000,000 .06 (71,073,101) = 4,264,386 264,386 71,337,487 , , , , , , , , 4. December 31, 2011 14-17 Chapter 14 - Bonds and Long-Term Notes Interest expense (6% x [$70,823,680 + 249,421]) ............. 4,264,386 Discount on bonds payable (difference) ................. 264,386 Cash (5% x $80,000,000) ....................................... 4,000,000 14-18 Chapter 14 - Bonds and Long-Term Notes Exercise 14-4 1. January 1, 2011 ?* Interest $4,000,000 x 11.46992 = $45,879,680 ** Principal $80,000,000 x 0.31180 = 24,944,000 Present value (price) of the bonds $70,823,680 ? 5% x $80,000,000 * present value of an ordinary annuity of $1: n=20, i=6% (Table 4) ** present value of $1: n=20, i=6% (Table 2) Bond investment (face amount) ................................. 80,000,000 Discount on bond investment (difference) .............. 9,176,320 Cash (price determined above) .................................. 70,823,680 2. June 30, 2011 Cash (5% x $80,000,000) .......................................... 4,000,000 Discount on bond investment (difference) ...................... 249,421 Interest revenue (6% x $70,823,680).............................. 4,249,421 3. December 31, 2011 Cash (5% x $80,000,000) .......................................... 4,000,000 Discount on bond investment (difference) ................. 264,386 Interest revenue (6% x [$70,823,680 + 249,421]) .......... 4,264,386 14-19 Chapter 14 - Bonds and Long-Term Notes Exercise 14-5 1. Liability at December 31, 2011 Bonds payable (face amount) .................................... $320,000,000 Less: discount ...................................................... 36,705,280 Initial balance, January 1, 2011............................... $283,294,720 June 30, 2011 discount amortization....................... 997,683* Dec. 31, 2011 discount amortization ...................... 1,057,544** December 31, 2011 net liability .............................. $285,349,947 2. Interest expense for year ended December 31, 2011 June 30, 2011 interest expense ............................... $16,997,683* Dec. 31, 2011 interest expense............................... 17,057,544** Interest expense for 2011 ...................................... $34,055,227 3. Statement of cash flows for year ended December 31, 2011 Myriad would report the cash inflow of $283,294,720*** from the sale of the bonds as a cash inflow from financing activities in its statement of cash flows. The $32,000,000 ($16,000,000* + 16,000,000**) cash interest paid is cash outflow from operating activities because interest is an income statement (operating) item. 14-20 Chapter 14 - Bonds and Long-Term Notes Exercise 14-5 (concluded) Calculations: January 1, 2011*** Cash (price given)..................................................... 283,294,720 Discount on bonds (difference)................................. 36,705,280 Bonds payable (face amount) ................................. 320,000,000 June 30, 2011* Interest expense (6% x $283,294,720) ............................... 16,997,683 Discount on bonds payable (difference) ................. 997,683 Cash (5% x $320,000,000) ..................................... 16,000,000 December 31, 2011** Interest expense (6% x [$283,294,720 + 997,683]) ........... 17,057,544 Discount on bonds payable (difference) ................. 1,057,544 Cash (5% x $320,000,000) ..................................... 16,000,000 14-21 Chapter 14 - Bonds and Long-Term Notes Exercise 14-6 1. June 30, 2011 Cash (price given)..................................................... 967,707 Bonds payable (face amount) ................................. 900,000 Premium on bonds payable (difference) ................. 67,707 2. December 31, 2011 Interest expense (6% x $967,707) ...................................... 58,062 Premium on bonds payable (difference) .................... 438 Cash (6.5% x $900,000)......................................... 58,500 3. June 30, 2012 Interest expense (6% x [$967,707 – 438]).......................... 58,036 Premium on bonds payable (difference) .................... 464 Cash (6.5% x $900,000)......................................... 58,500 14-22 Chapter 14 - Bonds and Long-Term Notes Exercise 14-7 1. Price of the bonds at January 1, 2011 ?* Interest $7,500,000 x 13.76483 = $103,236,225 ** Principal $150,000,000 x 0.17411 = 26,116,500 Present value (price) of the bonds $129,352,725 ? 5% x $150,000,000 * present value of an ordinary annuity of $1: n=30, i=6% (Table 4) ** present value of $1: n=30, i=6% (Table 2) 2. January 1, 2011 Cash (price determined above) ............................... 129,352,725 Discount on bonds payable (difference) .............. 20,647,275 Bonds payable (face amount) ........................... 150,000,000 3. June 30, 2011 Interest expense ($7,500,000 + $688,243) ......................... 8,188,243 Discount on bonds payable ($20,647,275 ? 30) ........ 688,243 Cash (5% x $150,000,000) ..................................... 7,500,000 4. December 31, 2018 Interest expense ($7,500,000 + $688,243) ......................... 8,188,243 Discount on bonds payable ($20,647,275 ? 30) ........ 688,243 Cash (5% x $150,000,000) ..................................... 7,500,000 [Using the straight-line method, each interest entry is the same.] 14-23 Chapter 14 - Bonds and Long-Term Notes Exercise 14-8 1. January 1, 2011 ?* Interest $7,500,000 x 13.76483 = $103,236,225 ** Principal $150,000,000 x 0.17411 = 26,116,500 Present value (price) of the bonds $129,352,725 ? 5% x $150,000,000 * present value of an ordinary annuity of $1: n=30, i=6% (Table 4) ** present value of $1: n=30, i=6% (Table 2) Bond investment (face amount) ............................. 150,000,000 Discount on bond investment (difference) .......... 20,647,275 Cash (price determined above) .............................. 129,352,725 2. June 30, 2011 Cash (5% x $150,000,000) ......................................... 7,500,000 Discount on bond investment ($20,647,275 ? 30) ......... 688,243 Interest revenue ($7,500,000 + $688,243) ..................... 8,188,243 3. December 31, 2018 Cash (5% x $150,000,000) ......................................... 7,500,000 Discount on bond investment ($20,647,275 ? 30) ......... 688,243 Interest revenue ($7,500,000 + $688,243) ..................... 8,188,243 [Using the straight-line method, each interest entry is the same.] 14-24 Chapter 14 - Bonds and Long-Term Notes Exercise 14-9 1. Price of the bonds at January 1, 2011 ?* Interest $18,000 x 6.87396 = $123,731 ** Principal $600,000 x 0.75941 = 455,646 Present value (price) of the bonds $579,377 ? 3% x $600,000 * present value of an ordinary annuity of $1: n=8, i=3.5% (Table 4) ** present value of $1: n=8, i=3.5% (Table 2) 2. January 1, 2011 Cash (price determined above) .......................... 579,377 Discount on bonds (difference)...................... 20,623 Bonds payable (face amount) ...................... 600,000 3. Amortization schedule Cash Effective Increase in Outstanding Payment Interest Balance Balance 3% x Face Amount 3.5% x Outstanding Balance Discount Reduction 579,377 1 18,000 .035 (579,377) = 20,278 2,278 581,655 2 18,000 .035 (581,655) = 20,358 2,358 584,013 3 18,000 .035 (584,013) = 20,440 2,440 586,453 4 18,000 .035 (586,453) = 20,526 2,526 588,979 5 18,000 .035 (588,979) = 20,614 2,614 591,593 6 18,000 .035 (591,593) = 20,706 2,706 594,299 7 18,000 .035 (594,299) = 20,800 2,800 597,099 8 18,000 .035 (597,099) = 20,901* 2,901 600,000 144,000 164,623 20,623 *rounded 14-25 Chapter 14 - Bonds and Long-Term Notes Exercise 14-9 (concluded) 4. June 30, 2011 Interest expense (3.5% x $579,377) ..................... 20,278 Discount on bonds payable (difference) ...... 2,278 Cash (3% x $600,000) ................................ 18,000 December 31, 2011** Interest expense (3.5% x [$579,377 + 2,278]) ..... 20,358 Discount on bonds payable (difference) ...... 2,358 Cash (3% x $600,000) ................................ 18,000 5. Liability at December 31, 2011 Bonds payable (face amount) .................................... $600,000 Less: discount ...................................................... (20,623) Initial balance, January 1, 2011............................... $579,377 June 30, 2011 discount amortization................. 2,278 Dec. 31, 2011 discount amortization ................ 2,358 December 31, 2011 net liability .............................. $584,013 6. Interest expense for year ended December 31, 2011 June 30, 2011 interest expense ............................... $20,278 Dec. 31, 2011 interest expense............................... 20,358 Interest expense for 2011 ...................................... $40,636 7. December 31, 2014 Interest expense (3.5% x 597,099) ....................... 20,901* Discount on bonds payable (difference) ...... 2,901 Cash (3% x $600,000) ................................ 18,000 * rounded value from amortization schedule Bonds payable .................................................... 600,000 Cash .................................................... 600,000 14-26 Chapter 14 - Bonds and Long-Term Notes Exercise 14-10 1. Price of the bonds at January 1, 2011 ?* Interest $22,500 x 6.46321 = $145,422 ** Principal $500,000 x 0.67684 = 338,420 Present value (price) of the bonds $483,842 ? 4.5% x $500,000 * present value of an ordinary annuity of $1: n=8, i=5% (Table 4) ** present value of $1: n=8, i=5% (Table 2) 2. January 1, 2011 Cash (price determined above) .......................... 483,842 Discount on bonds payable (difference) ......... 16,158 Bonds payable (face amount) ...................... 500,000 3. Amortization schedule Cash Effective Increase in Outstanding Payment Interest Balance Balance 4.5% x Face Amount 5% x Outstanding Balance Discount Reduction 483,842 1 22,500 .05 (483,842) = 24,192 1,692 485,534 2 22,500 .05 (485,534) = 24,277 1,777 487,311 3 22,500 .05 (487,311) = 24,366 1,866 489,177 4 22,500 .05 (489,177) = 24,459 1,959 491,136 5 22,500 .05 (491,136) = 24,557 2,057 493,193 6 22,500 .05 (493,193) = 24,660 2,160 495,353 7 22,500 .05 (495,353) = 24,768 2,268 497,621 8 22,500 .05 (497,621) = 24,879* 2,379 500,000 180,000 196,158 16,158 * rounded. 14-27 Chapter 14 - Bonds and Long-Term Notes Exercise 14-10 (concluded) 4. June 30, 2011 Interest expense (5% x $483,842) ........................ 24,192 Discount on bonds payable (difference) ...... 1,692 Cash (4.5% x $500,000).............................. 22,500 5. December 31, 2014 Interest expense (5% x $497,621) ........................ 24,879* Discount on bonds payable (difference) ...... 2,379 Cash (4.5% x $500,000).............................. 22,500 * rounded value from amortization schedule Bonds payable .................................................... 500,000 Cash .................................................... 500,000 14-28 Chapter 14 - Bonds and Long-Term Notes Exercise 14-11 1. February 1, 2011 Cash (price given).......................................... 731,364 Discount on bonds payable (difference) ......... 68,636 Bonds payable (face amount) ...................... 800,000 2. July 31, 2011 Interest expense (5% x $731,364) ........................ 36,568 Discount on bonds payable (difference) ...... 568 Cash (4.5% x $800,000).............................. 36,000 3. December 31, 2011 5Interest expense (/ x 5% x [$731,364 + 568]) .. 30,497 6 Discount on bonds payable (difference) ...... 497 5 Interest payable (/ x 4.5% x $800,000) ....... 30,000 6 4. January 31, 2012 1Interest expense (/ x 5% x [$731,364 + 568]).. 6,100* 6 Interest payable (from adjusting entry) ............... 30,000 Discount on bonds payable (difference) ...... 100 Cash (4.5% x $800,000) ............................. 36,000 * rounded 14-29 Chapter 14 - Bonds and Long-Term Notes Exercise 14-12 1. March 1, 2011 Cash (price given).......................................... 294,000 Discount on bonds payable (difference) ......... 6,000 Bonds payable (face amount) ...................... 300,000 2. August 31, 2011 Interest expense ($21,000 + 150) ......................... 21,150 Discount on bonds payable ($6,000 ? 40) .. 150 Cash (7% x $300,000) ................................ 21,000 3. December 31, 2011 4Interest expense (/ x $21,150) .......................... 14,100 6 4 Discount on bonds payable (/ x $150) .... 100 6 4 Interest payable (/ x $21,000) .................. 14,000 6 4. February 28, 2012 2Interest expense (/ x $21,150) .......................... 7,050 6 4Interest payable (/ x $21,000) ..................... 14,000 6 2 Discount on bonds payable (/ x $150) .... 50 6 Cash (7% x $300,000) ................................ 21,000 14-30 Chapter 14 - Bonds and Long-Term Notes Exercise 14-13 1. January 1, 2011 Cash (price given)................................................ 739,814,813 Discount on bonds (difference)............................ 60,185,187 Bonds payable (face amount) ............................ 800,000,000 2. June 30, 2011 Interest expense (6% x $739,814,813) ......................... 44,388,889 Discount on bonds payable (difference) ............ 388,889 Cash (5.5% x $800,000,000) .............................. 44,000,000 3. December 31, 2011 Interest expense (6% x [$739,814,813 + 388,889]) ..... 44,412,222 Discount on bonds payable (difference) ............ 412,222 .............................. 44,000,000 Cash (5.5% x $800,000,000) 4. December 31, 2011 Federal will report the bonds among its liabilities in the December 31, 2011, balance sheet at $740,615,924: Balance Jan. 1 $739,814,813 June 30 increase 388,889 Dec. 31 increase 412,222 $740,615,924 14-31 Chapter 14 - Bonds and Long-Term Notes Exercise 14-14 1. National Equipment Transfer Corporation Cash (priced at par) ....................................... 200,000,000 Bonds payable (face amount) ...................... 200,000,000 IgWig Cash (99% x $350 million) ............................... 346,500,000 Discount on notes (difference) ....................... 3,500,000 Notes payable (face amount) ....................... 350,000,000 2. National Equipment Transfer Corporation Interest expense .................................................. 7,460,000 Cash ([7.46% ? 2] x $200 million) .................. 7,460,000 IgWig Interest expense ([6.56% ? 2] x $346,500,000) ... 11,365,200 Discount on notes payable (difference) ....... 60,200 Cash ([6.46% ? 2] x $350 million) ................ 11,305,000 14-32 Chapter 14 - Bonds and Long-Term Notes Exercise 14-15 The 2011 interest expense is overstated by the extra interest recorded in February. Similarly, retained earnings is overstated the same amount because 2010 interest expense was understated when the accrued interest was not recorded. To correct the error: Retained earnings ......................................................... 61,000 Interest expense ($73,200 – 12,200*)......................... 61,000 1*$73,200 x / 6 2011 adjusting entry: 5Interest expense (/ x $73,200) ................................ 61,000 6 5 Discount on bonds payable (/ x $1,200) ............. 1,000 6 5 Interest payable (/ x $72,000) ............................. 60,000 6 ENTRIES THAT SHOULD HAVE BEEN RECORDED: December, 31, 2010 adjusting entry: 5Interest expense (/ x $73,200) ............................................... 61,000 6 5 Discount on bonds payable (/ x $1,200) ............................ 1,000 6 5 Interest payable (/ x $72,000) ........................................... 60,000 6 February 1, 2011: 1Interest expense (/ x $73,200) ............................................... 12,200 6 5Interest payable (/ x $72,000) ............................................... 60,000 6 1 Discount on bonds payable (/ x $1,200) ............................ 200 6 Cash (given) ........................................................................ 72,000 14-33 Chapter 14 - Bonds and Long-Term Notes Exercise 14-16 Requirement 1 The error caused both 2009 net income and 2010 net income to be overstated, so retained earnings is overstated by a total of $85,000. Also, the note payable would be understated by the same amount. Remember, the entry to record interest is: Interest expense ................................................................................ xxx Note payable (difference) ....................................................... xxx Cash .............................................................................. xxx So, if interest expense is understated, the reduction in the note will be too much, causing the balance in that account to be understated. Requirement 2 Retained earnings (overstatement of 2009-2010 income) ................ 85,000 Note payable (understatement determined above) ....................... 85,000 Requirement 3 The financial statements that were incorrect as a result of the error would be retrospectively restated to report the correct interest amounts, income, and retained earnings when those statements are reported again for comparative purposes in the current annual report. A “prior period adjustment” to retained earnings would be reported, and a disclosure note should describe the nature of the error and the impact of its correction on each year’s net income, income before extraordinary items, and earnings per share. 14-34 Chapter 14 - Bonds and Long-Term Notes Exercise 14-17 Requirement 1 ?* Interest $24,000 x 2.40183 =$ 57,644 ** Principal $600,000 x 0.71178 = 427,068 Present value (price) of the notes $484,712 ? 4% x $600,000 * present value of an ordinary annuity of $1: n=3, i=12% (Table 4) ** present value of $1: n=3, i=12% (Table 2) Machinery (price determined above) ....................................... 484,712 Discount on notes payable (difference)................................ 115,288 Notes payable (face amount) ............................................ 600,000 Requirement 2 Cash Effective Increase in Outstanding Payment Interest Balance Balance 4% x Face Amount 12% x Outstanding Balance Discount Reduction 484,712 1 24,000 .12 (484,712) = 58,165 34,165 518,877 2 24,000 .12 (518,877) = 62,265 38,265 557,142 *3 24,000 .12 (557,142) = 66,858 42,858 600,000 72,000 187,288 115,288 * rounded. Requirement 3 Interest expense (market rate x outstanding balance) ................... 58,165 Discount on notes payable (difference) ............................ 34,165 Cash (stated rate x face amount) .......................................... 24,000 Interest expense (market rate x outstanding balance) ................... 62,265 Discount on notes payable (difference) ............................ 38,265 Cash (stated rate x face amount) .......................................... 24,000 Interest expense (market rate x outstanding balance)........................ 66,858 Discount on notes payable (difference) ............................ 42,858 Cash (stated rate x face amount) .......................................... 24,000 14-35 Chapter 14 - Bonds and Long-Term Notes Notes payable ................................................................. 600,000 Cash (stated rate x face amount) .......................................... 600,000 14-36 Chapter 14 - Bonds and Long-Term Notes Exercise 14-18 1. January 1, 2011 Machinery ..................................................................... 4,000,000 Notes payable ............................................................. 4,000,000 2. Amortization schedule $4,000,000 ? 3.16987 = $1,261,881 amount (from Table 4) installment of loan n=4, i=10% payment Cash Effective Decrease in Outstanding Dec.31 Payment Interest Balance Balance 10% x Outstanding Balance Balance Reduction 4,000,000 2011 1,261,881 .10 (4,000,000) = 400,000 861,881 3,138,119 2012 1,261,881 .10 (3,138,119) = 313,812 948,069 2,190,050 2013 1,261,881 .10 (2,190,050) = 219,005 1,042,876 1,147,174 2014 1,261,881 .10 (1,147,174) = 114,707* 1,147,174 0 5,047,524 1,047,524 4,000,000 * rounded. 3. December 31, 2011 Interest expense (10% x outstanding balance).................................. 400,000 Note payable (difference).................................................... 861,881 Cash (payment determined above)........................................ 1,261,881 4. December 31, 2013 Interest expense (10% x outstanding balance).................................. 219,005 Note payable (difference).................................................... 1,042,876 Cash (payment determined above)........................................ 1,261,881 14-37 Chapter 14 - Bonds and Long-Term Notes Exercise 14-19 1. November 1, 2011 Component inventory .............................................. 24,000,000 Notes payable ....................................................... 24,000,000 2. November 30, 2011 Interest expense (1% x outstanding balance).................................... 240,000 Note payable (difference).................................................... 1,892,370 Cash (payment determined below)........................................ 2,132,370 Calculation of installment payment: $24,000,000 ? 11.25508 = $2,132,370 amount (from Table 4) installment of loan n=12, i=1% payment 3. December 31, 2011 November (1% x $24,000,000) $240,000 December (1% x [$24,000,000 – 1,892,370]) 221,076 2011 interest expense $461,076 Journal entry (not required): Interest expense (1% x [$24,000,000 – 1,892,370])....................... 221,076 Note payable (difference).................................................... 1,911,294 Cash (payment determined above)........................................ 2,132,370 14-38 Chapter 14 - Bonds and Long-Term Notes Exercise 14-20 The FASB Accounting Standards Codification represents the single source of authoritative U.S. generally accepted accounting principles. The specific citation for each of the following items is: 1. Disclosure requirements for maturities of long-term debt: FASB ASC 470–10–50–1: ―Debt–Overall–Disclosure–Disclosure of Long-Term Obligations‖ 2. How to estimate the value of a note when a note having no ready market and no interest rate is exchanged for a noncash asset without a readily available fair value: FASB ASC 835–30–25–11: ―Interest–Imputation of Interest–Recognition– General‖ 3. When the straight-line method can be used as an alternative to the interest method of determining interest: FASB ASC 835–30–55–2: ―Interest–Imputation of Interest–Implementation Guidance and Illustrations–Application of the Interest Method‖ 14-39 Chapter 14 - Bonds and Long-Term Notes Exercise 14-21 Bonds payable (face amount) .................................... 90,000,000 Loss on early extinguishment (to balance) ................. 4,800,000 Discount on bonds (given) ................................... 3,000,000 Cash ($90,000,000 x 102%).................................... 91,800,000 14-40 Chapter 14 - Bonds and Long-Term Notes Exercise 14-22 Requirement 1 Gless (Issuer) Cash (101% x $12 million) .......................................... 12,120,000 Convertible bonds payable (face amount) ............... 12,000,000 Premium on bonds payable (difference) ................. 120,000 Century (Investor) Investment in convertible bonds (10% x $12 million) ... 1,200,000 Premium on bond investment (difference)....................... 12,000 Cash (101% x $1.2 million) ...................................... 1,212,000 Requirement 2 Gless (Issuer) Interest expense ($540,000 – 6,000) .................................. 534,000 Premium on bonds payable ($120,000 ? 20).............. 6,000 Cash (4.5% x $12,000,000)..................................... 540,000 Century (Investor) Cash (4.5% x $1,200,000).......................................... 54,000 Premium on bond investment ($12,000 ? 20) ......... 600 Interest revenue ($54,000 – 600).................................... 53,400 [Using the straight-line method, each interest entry is the same.] Requirement 3 Gless (Issuer) Convertible bonds payable (10% of the account balance) 1,200,000 Premium on bonds payable (($120,000 – [$6,000 x 11]) x 10%) ................... 5,400 Common stock (to balance) .................................. 1,205,400 Century (Investor) Investment in common stock ....................................... 1,205,400 Investment in convertible bonds (account balance) .... 1,200,000 Premium on bond investment ($12,000 – [$600 x 11]) 5,400 14-41 Chapter 14 - Bonds and Long-Term Notes Exercise 14-23 Under US GAAP, the entire issue price of convertible debt is recorded as debt: Cash (101% x $12 million) ............................................... 12,120,000 Convertible bonds payable (face amount) .................. 12,000,000 Premium on bonds payable (difference) .................... 120,000 Under IFRS, convertible debt is divided into its liability and equity elements. We achieve separation by measuring the fair value of a similar liability that does not have an associated equity component. In the exercise, we know that bonds similar in all respects, except that they are nonconvertible, currently are selling at 99 (99% of face amount), so the liability-first separation gives us the following entry: Cash (101% x $12 million)............................................... 12,120,000 Bonds payable (99% x $12 million) ............................. 11,880,000* Equity – conversion option (to balance) ........................ 240,000 * Note that the discount on the bonds ($12 million – [99% x $12 million] = $120,000) is combined with the face amount, and the net amount is recorded as Bonds payable. This is the ―net method‖ which is the preferred approach under IFRS. By the gross method, typically used in U.S. GAAP, the entry would be: Cash (101% x $12 million)............................................... 12,120,000 Discount on bonds payable ($12 million – [99% x $12 million]) 120,000 Bonds payable (face amount) .................................... 12,000,000 Equity – conversion option (to balance) ........................ 240,000 14-42 Chapter 14 - Bonds and Long-Term Notes Exercise 14-24 Requirement 1 Cash (given) ........................................................... 40,800,000 Convertible bonds payable (face amount) ............... 40,000,000 Premium on bonds payable (to balance) ................ 800,000 Requirement 2 Interest expense ($1,200,000 – 40,000) ............................. 1,160,000 Premium on bonds payable ($800,000 ? 20).............. 40,000 Cash (3% x $40,000,000) ....................................... 1,200,000 Requirement 3 1,160,000 Interest expense ($1,200,000 – 40,000) ............................. Premium on bonds payable ($800,000 ? 20).............. 40,000 Cash (3% x $40,000,000) ....................................... 1,200,000 Convertible bonds payable (account balance).............. 40,000,000 Premium on bonds payable ($800,000 – [$40,000 x 5]) 600,000 Common stock (to balance) .................................. 40,600,000 14-43 Chapter 14 - Bonds and Long-Term Notes Exercise 14-25 Requirement 1 Under U.S. GAAP, the entire issue price of convertible debt is recorded as debt: Cash (given)................................................................... 40,800,000 Convertible bonds payable (face amount) ..................... 40,000,000 Premium on bonds payable (to balance) ...................... 800,000 Under IFRS, convertible debt is divided into its liability and equity elements. We achieve separation by measuring the fair value of a similar liability that does not have an associated equity component. In the exercise, we know that bonds similar in all respects, except that they are nonconvertible, currently are selling at 99 (99% of face amount), so the liability-first separation gives us the following entry: Cash (given)................................................................... 40,800,000 Convertible bonds payable (99% x $40 million) ............. 39,600,000* Equity – conversion option (to balance) .......................... 1,200,000 * Note that the discount on the bonds ($40 million – [99% x $40 million] = $400,000) is combined with the face amount, and the net amount is recorded as Bonds payable. This is the ―net method‖ which is the preferred approach under IFRS. By the gross method, typically used in U.S. GAAP, the entry would be: Cash (given) ..................................................................................... 40,800,000 Discount on bonds payable ($40 million – [99% x $40 million])........ 400,000 Convertible bonds payable (face amount) ...................................... 40,000,000 Equity – conversion option (to balance) .................................. 1,200,000 Requirement 2 Interest expense ($1,200,000 + 20,000) ............................. 1,220,000 Convertible bonds payable* ($400,000 ? 20) ........ 20,000 Cash (3% x $40,000,000)...................................... 1,200,000 * When the net method is used, the discount (or premium) is amortized directly to the bonds account. 14-44 Chapter 14 - Bonds and Long-Term Notes Exercise 14-25 (concluded) Requirement 3 Interest expense ($1,200,000 + 20,000) ............................. 1,220,000 Convertible bonds payable* ($400,000 ? 20) ........ 20,000 Cash (3% x $40,000,000)...................................... 1,200,000 Convertible bonds payable (account balance*) ............ 39,700,000 Equity – conversion option (account balance) ...................... 1,200,000 Common stock (to balance) .................................. 40,900,000 *$39,600,000 Initial balance + 100,000 ($20,000 x 5) Amortization for 5 periods (2 ? years) $39,700,000 Balance at conversion 14-45 Chapter 14 - Bonds and Long-Term Notes Exercise 14-26 Requirement 1 ($ in millions) Limbaugh (Issuer) Cash (104% x $30 million) .................................................... 31.2 Discount on bonds payable (difference) .............................. 3.6 Bonds payable (face amount) ........................................... 30.0 Equity – stock warrants ($8 x 20 warrants x [$30,000,000 ? $1,000] bonds)............. 4.8 Interstate (Investor) Investment in stock warrants ($4.8 million x 20%).................. 0.96 Investment in bonds (20% x $30 million) ............................... 6.00 Discount on bonds (difference) ....................................... 0.72 Cash (104% x $30 million x 20%) ........................................ 6.24 Requirement 2 ($ in millions) Limbaugh (Issuer) Cash (20% x 30,000 bonds x 20 warrants x $60)......................... 7.20 Equity – stock warrants ($4.8 million x 20%) ......................... 0.96 Common stock (to balance) ............................................ 8.16 Interstate (Investor) Investment in common stock (to balance) ........................... 8.16 Investment in stock warrants ($4.8 million x 20%) .............. .96 Cash (20% x 30,000 x 20 warrants x $60) ............................. 7.20 14-46 Chapter 14 - Bonds and Long-Term Notes Exercise 14-27 Requirement 1 At January 1, 2011, the book value of the bonds was the initial issue price, $739,814,813. The liability, though, was increased when Federal recorded interest during 2011: June 30, 2011 Interest expense (6% x $739,814,813) ......................... 44,388,889 Discount on bonds payable (difference) ............ 388,889 Cash (5.5% x $800,000,000) .............................. 44,000,000 December 31, 2011 Interest expense (6% x [$739,814,813 + 388,889]) ..... 44,412,222 Discount on bonds payable (difference) ............ 412,222 Cash (5.5% x $800,000,000) .............................. 44,000,000 Reducing the discount increases the book value of the bonds: Jan.1, 2011, book value $739,814,813 Increase from discount amortization ($388,889 + 412,222) 801,111 December 31, 2011, book value (amortized initial amount) $740,615,924 Comparing the amortized initial amount at December 31, 2011, with the fair value on that date provides the Fair value adjustment balance needed: December 31, 2011, book value (amortized initial amount) $740,615,924 December 31, 2011, fair value 730,000,000 Fair value adjustment balance needed: debit/(credit) $ 10,615,924 Federal would record the $10,615,924 as a gain in the 2011 income statement: December 31, 2011 Fair value adjustment 10,615,924 Unrealized holding gain 10,615,924 Note: A decrease in the value of an asset is a loss; a decrease in the value of a liability is a gain. 14-47 Chapter 14 - Bonds and Long-Term Notes Exercise 14-27 (continued) In the balance sheet, the bonds are reported among long-term liabilities at their $730,000,000 fair value: Bonds payable $800,000,000 Less: Discount on bonds payable (59,384,076) December 31, 2011, book value (amortized initial amount) $740,615,924 Less: Fair value adjustment (10,615,924) December 31, 2011, fair value $730,000,000 Requirement 2 If the fair value at December 31, 2012, is $736,000,000 a year later, Federal needs to compare that amount with the amortized initial measurement on that date. That amount was increased when Federal recorded interest during 2012: June 30, 2012 Interest expense (6% x [$739,814,813 + 388,889 + 412,222]) 44,436,955 Discount on bonds payable (difference) ................... 436,955 Cash (5.5% x $800,000,000) ..................................... 44,000,000 December 31, 2012 Interest expense (6% x [$739,814,813 + 388,889 + 412,222 + 436,955]) 44,463,173 Discount on bonds payable (difference) ................... 463,173 Cash (5.5% x $800,000,000) ..................................... 44,000,000 Reducing the discount increases the book value of the bonds: December 31, 2011, book value (amortized initial amount) $740,615,924 Increase from discount amortization ($436,955 + 463,173) 900,128 December 31, 2012, book value (amortized initial amount) $741,516,052 14-48 Chapter 14 - Bonds and Long-Term Notes Exercise 14-27 (concluded) Comparing the amortized initial amount at December 31, 2012, with the fair value on that date provides the Fair value adjustment balance needed: December 31, 2012, book value (amortized initial amount) $741,516,052 December 31, 2012, fair value (736,000,000) Fair value adjustment balance needed: debit/(credit) $ 5,516,052 Less: Fair value adjustment debit/(credit), balance 1/1/2012 10,615,924 Change in fair value adjustment, 12/31/2012 $ (5,099,872) Federal records the $5,099,872 as a loss in the 2012 income statement: December 31, 2012 Unrealized holding loss 5,099,872 Fair value adjustment 5,099,872 Note: An increase in the value of an asset is a gain; an increase in the value of a liability is a loss. In the balance sheet, the bonds are reported among long-term liabilities at their $736,000,000 fair value: Bonds payable $800,000,000 Less: Discount on bonds payable (58,483,948) December 31, 2012, book value (amortized initial amount) $741,516,052 Less: Fair value adjustment (5,516,052) December 31, 2012, fair value $736,000,000 14-49 Chapter 14 - Bonds and Long-Term Notes Exercise 14-28 Requirement 1 June 30, 2011 Interest expense (5% x $184 million) 9,200,000 Discount on bonds payable (difference) 1,200,000 Cash (4% x $200 million) 8,000,000 Requirement 2 December 31, 2011 Interest expense (5% x [$184 million + 1.2 million]) 9,260,000 Discount on bonds payable (difference) 1,260,000 Cash (4% x $200 million) 8,000,000 Requirement 3 The interest entries increased the book value from $184,000,000 to $186,460,000. To increase the book value to $188,000,000, Rapid needed the following entry: Unrealized holding loss 1,540,000 Fair value adjustment ($188,000,000 – 186,460,000) 1,540,000 14-50 Chapter 14 - Bonds and Long-Term Notes Exercise 14-29 Requirement 1 If the bonds are not traded on a market exchange, their fair market value is not readily observable. As a result, the next most preferable way to determine fair value is to calculate the fair value as the present value of the remaining cash flows discounted at the current interest rate. At December 31, 18 of the original 20 payments remain. If the current interest rate is 9% (4.5% semi-annually), as we’re assuming now, that present value would be $751,360: Present Values *? Interest $ 32,000 x 12.15999 = $389,120 † Principal $800,000 x 0.45280 = 362,240 Present value of the bonds $751,360 ? (8% / 2) x $800,000 * Present value of an ordinary annuity of $1: n = 18, i = 4.5%. (Table 4) † Present value of $1: n = 18, i = 4.5%. (Table 2) Requirement 2 June 30, 2011 Interest expense (5% x $751,360) 37,568 Discount on bonds payable (difference) 5,568 Cash (4% x $800,000) 32,000 Requirement 3 December 31, 2011 Interest expense (5% x [$751,360 + 5,568]) 37,846 Discount on bonds payable (difference) 5,846 Cash (4% x $800,000) 32,000 14-51 Chapter 14 - Bonds and Long-Term Notes Exercise 14-29 (concluded Requirement 4 The interest entries increased the book value from $700,302 to $706,483: $700,302 January 1 book value 5,568 June 30 increase 5,846 December 31 increase $711,716 December 31 book value To increase the book value to $751,360, Essence needs the following entry: Unrealized holding loss 39,644 Fair value adjustment ($751,360 – 711,716) 39,644 Balances: Bonds payable, Dec. 31 $711,716 Fair value adjustment 39,644 Book value for balance sheet $751,360 14-52 Chapter 14 - Bonds and Long-Term Notes Exercise 14-30 Requirement 1 2 $100 million x 12% x / = $2 million 12 face annual fraction of the accrued amount rate annual period interest Requirement 2 ($ in millions) Cash ($99 million plus accrued interest) ..................................... 101 Discount on bonds ($100 million – 99 million) ......................... 1 Bonds payable (face amount) ........................................... 100 Interest payable (accrued interest determined above) ............... 2 Exercise 14-31 Land ($450,000 – 325,000) ........................................ 125,000 Gain on disposition of assets ............................. 125,000 Note payable (face amount)....................................... 600,000 Accrued interest payable (11% x $600,000) ............... 66,000 Gain on troubled debt restructuring (difference)...... 216,000 Land (fair value) ................................................... 450,000 14-53 Chapter 14 - Bonds and Long-Term Notes Exercise 14-32 Analysis: Carrying amount: $12 million + $1.2 million = $13,200,000 Future payments: ($1 million x 2) + $11 million = 13,000,000 Gain to debtor $ 200,000 1. January 1, 2011 Accrued interest payable (10% x $12,000,000) ........... 1,200,000 Note payable ($13 million – 12 million)* .................... 1,000,000 Gain on troubled debt restructuring .................... 200,000 * Establishes a balance in the note account equal to the total cash payments under the new agreement. 2. December 31, 2012 Note payable ........................................................ 1,000,000 Cash (revised ―interest‖ amount) ................................ 1,000,000 Note: No interest should be recorded after the restructuring. All subsequent cash payments result in reductions of principal. 3. December 31, 2013 Note payable ........................................................ 1,000,000 Cash (revised ―interest‖ amount) ................................ 1,000,000 Note payable ........................................................ 11,000,000 Cash (revised principal amount) ................................. 11,000,000 14-54 Chapter 14 - Bonds and Long-Term Notes Exercise 14-33 Analysis: Carrying amount: $240,000 + (10% x $240,000) = $264,000 Future payments: ($11,555 x 3) + $240,000 = (274,665) Interest $ 10,665 The discount rate that ―equates‖ the present value of the debt ($264,000) and its future value ($274,665) is the effective rate of interest: $264,000 ? $274,665 = .961 – the Table 2 value for n = 2, i = ? In row 2 of Table 2, the value .961 is in the 2% column. So, this is the new effective interest rate. A financial calculator will produce the same rate. 1. January 1, 2011 no entry needed 2. December 31, 2011 Interest expense (2% x $264,000) .............................. 5,280 Accrued interest payable .................................... 5,280 [Unpaid interest is accrued at the effective rate times the carrying amount of the debt.] 3. December 31, 2012 Interest expense (2% x [$264,000 + 5,280]) ................. 5,385* Accrued interest payable .................................... 5,385 *rounded Note payable (balance) ............................................ 240,000 Accrued interest payable ($24,000 + 5,280 + 5,385)..... 34,665 Cash ([$11,555 x 3] + $240,000) .............................. 274,665 14-55 Chapter 14 - Bonds and Long-Term Notes Exercise 14-34 Requirement 2 The specific citation that specifies the accounting treatment of legal fees and other direct costs incurred by a creditor to effect a troubled debt restructuring is FASB ASC 310–40–25–1: ―Receivables–Troubled Debt Restructurings by Creditors – Recognition–Legal Fees.‖ Requirement 3 Legal fees and other direct costs incurred by a creditor to effect a troubled debt restructuring should be recorded as an expense when incurred. 14-56 Chapter 14 - Bonds and Long-Term Notes CPA / CMA REVIEW QUESTIONS CPA Exam Questions 1. c. At issuance, a bond is valued at the present value of the principal and interest payments, discounted at the prevailing market rate of interest at the date of issuance of the bond. 2. d. The interest expense is for the time the bonds were outstanding during the reporting period – 7 months in this case. 3. d. Six months interest revenue at stated rate. Since no yield rate was given, the $1,800 amortization must be accepted. Note that the amortization is added to the stated revenue amount since the bonds were acquired at a discount. 4. b. Present value of payments:. 5. a. A bond issued at a discount reflects that the market rate is greater than the contract rate. 14-57 Chapter 14 - Bonds and Long-Term Notes CPA Exam Questions (continued) 6. a. The interest payable at September 30, 2011, will be for the three month's interest that has accrued since the last interest was paid on June 30, 2011 ($300,000 × 12% × 3/12 = $9,000). 7. a. Must determine carrying value at time of extinguishment: Bond premium at issue $ 40,000 Amortization of premium 1/1/2006 through 7/1/2011: $40,000/20 = $2,000 per period $2,000 x 11 periods 22,000 Unamortized premium 7/1/2011 $ 18,000 Face Value 1,000,000 Carrying value 7/1/2011 $1,018,000 Call (redemption) price 1,010,000 $1,000,000 x 1.01 Gain on extinguishment $ 8,000 8. a. Using the book value method, no gain or loss is recognized. The journal entry for the conversion would be: Bonds payable 1,000,000 Discount on bonds payable 30,000 Common stock (par) 800,000 Paid-in capital – excess of par 170,000 9. b. Carrying value of bonds at 6/30/2011 is $4,980,000 ($5,000,000 + $30,000 – $50,000). 14-58 Chapter 14 - Bonds and Long-Term Notes CPA Exam Questions (concluded) 10. b. The discount on the bonds is $678: Amount allocated to bonds: .83 x $240,000= $199,200 Face amount 200,000 Discount on bonds $ 800 14-59 Chapter 14 - Bonds and Long-Term Notes CMA Exam Questions 1, a. Because the bonds sold for more than their face value, they were sold at a premium. The premium adjusted the yield of the bonds to the effective rate (presumably, the market rate). 2. d. The annual interest cash outlay is $70,000 (7% nominal rate x $1,000,000), or $35,000 each semiannual period. Interest expense is less than $35,000, however, because the bonds were originally issued at a premium. That premium should be amortized over the life of the bond. Thus, interest expense for the first 6 months is $31,884 [$1,062,809 x 6% x (6 months / 12 months)], and premium amortization is $3,116 ($35,000 – $31,884). 3. b. A bond liability is shown at its face value (maturity value), minus any related discount, or plus any related premium. Thus, a bond issued at a premium is shown at its maturity value plus the unamortized portion of the premium. 14-60 Chapter 14 - Bonds and Long-Term Notes PROBLEMS Problem 14-1 Requirement 1 ?* Interest $2,500,000 x 15.04630 = $37,615,750 ** Principal $50,000,000 x 0.09722 = 4,861,000 Present value (price) of the bond s $42,476,750 ? 5% x $50,000,000 * present value of an ordinary annuity of $1: n=40, i=6% (Table 4) ** present value of $1: n=40, i=6% (Table 2) Cash (price determined above) ..................................... 42,476,750 Discount on bonds (difference)................................. 7,523,250 Bonds payable (face amount) ................................. 50,000,000 Requirement 2 * Interest $ 2,500,000 x 18.40158 = $46,003,950 ** Principal $50,000,000 x 0.17193 = 8,596,500 Present value (price) of the bonds $54,600,450 * present value of an ordinary annuity of $1: n=40, i=4.5% (Table 4) ** present value of $1: n=40, i=4.5% (Table 2) Cash (price determined above) ..................................... 54,600,450 Premium on bonds (difference) ............................. 4,600,450 Bonds payable (face amount) ................................. 50,000,000 Requirement 3 Investment in bonds (face amount) .................................... 50,000,000 Premium on bond investment .............................. 4,600,450 Cash (price calculated above) ................................... 54,600,450 14-61 Chapter 14 - Bonds and Long-Term Notes Problem 14-2 1. Liabilities at September 30, 2011 Bonds payable (face amount) .................................... $160,000,000 Less: discount ...................................................... 20,000,000 Initial balance, January 1, 2011............................... $140,000,000 June 30, 2011 discount amortization....................... 400,000* Sept. 30, 2011 discount amortization ..................... 212,000** Sept. 30, 2011 net bonds payable .......................... $140,612,000 Interest payable ** ................................................ $4,000,000 2. Interest expense for year ended September 30, 2011 June 30, 2011 interest expense ............................... $ 8,400,000* September 30, 2011 interest expense...................... 4,212,000** Interest expense for fiscal 2011.............................. $12,612,000 3. Statement of cash flows for year ended September 30, 2011 Baddour would report the cash inflow of $140,000,000*** from the sale of the bonds as a cash flow from financing activities in its statement of cash flows. The $8,000,000* cash interest paid is a cash outflow from operating activities because interest is an income statement (operating) item. 14-62 Chapter 14 - Bonds and Long-Term Notes Problem 14-2 (concluded) Calculations: January 1, 2011*** Cash (price: given) .................................................... 140,000,000 Discount on bonds (difference)................................. 20,000,000 Bonds payable (face amount) ................................. 160,000,000 June 30, 2011* Interest expense (6% x $140,000,000) ............................... 8,400,000 Discount on bonds payable (difference) ................. 400,000 Cash (5% x $160,000,000) ..................................... 8,000,000 September 30, 2011** Interest expense (6% x [$140,000,000 + 400,000] x 3/6)... 4,212,000 Discount on bonds payable (difference) ................. 212,000 Interest payable (5% x $160,000,000 x 3/6) .............. 4,000,000 14-63 Chapter 14 - Bonds and Long-Term Notes Problem 14-3 Requirement 1 Cash Effective Increase in Outstanding Payment Interest Balance Balance 4.5% x Face Amount 5% x Outstanding Balance 96,768 1 4,500 .05 (96,768) = 4,838 338 97,106 2 4,500 .05 (97,106) = 4,855 355 97,461 3 4,500 .05 (97,461) = 4,873 373 97,834 4 4,500 .05 (97,834) = 4,892 392 98,226 5 4,500 .05 (98,226) = 4,911 411 98,637 6 4,500 .05 (98,637) = 4,932 432 99,069 7 4,500 .05 (99,069) = 4,953 453 99,522 8 4,500 .05 (99,522) = 4,978* 478 100,000 36,000 39,232 3,232 * rounded. Requirement 2 Cash Recorded Increase in Outstanding Payment Interest Balance Balance 4.5% x Face Amount Cash plus Discount Reduction $3,232 ? 8 96,768 1 4,500 (4,500 + 404) = 4,904 404 97,172 2 4,500 (4,500 + 404) = 4,904 404 97,576 3 4,500 (4,500 + 404) = 4,904 404 97,980 4 4,500 (4,500 + 404) = 4,904 404 98,384 5 4,500 (4,500 + 404) = 4,904 404 98,788 6 4,500 (4,500 + 404) = 4,904 404 99,192 7 4,500 (4,500 + 404) = 4,904 404 99,596 8 4,500 (4,500 + 404) = 4,904 404 100,000 36,000 39,232 3,232 14-64 Chapter 14 - Bonds and Long-Term Notes Problem 14-3 (continued) Requirement 3 (effective interest) Interest expense (5% x $98,226) ........................................ 4,911 Discount on bonds payable (difference) ................. 411 Cash (4.5% x $100,000)......................................... 4,500 (straight-line) Interest expense ($4,500 + 404) ......................................... 4,904 Discount on bonds payable ($3,232 ? 8) ............... 404 Cash (4.5% x $100,000)......................................... 4,500 Requirement 4 By the straight-line method, a company determines interest indirectly by allocating a discount or a premium equally to each period over the term to maturity. This is allowed if doing so produces results that are not materially different from the interest method. The decision should be guided by whether the straight-line method would tend to mislead investors and creditors in the particular circumstance. Allocating the discount or premium equally over the life of the bonds by the straight-line method results in an unchanging dollar amount of interest each period. By the straight-line method, the amount of the discount to be reduced periodically is calculated, and the effective interest is the ―plug‖ figure. Unchanging dollar amounts like these are not produced when the effective interest approach is used. By that approach, the dollar amounts of interest vary over the term to maturity because the percentage rate of interest remains constant, but is applied to a changing debt balance. Remember that the ―straight-line method,‖ is not an alternative method of determining interest in a conceptual sense, but is an application of the materiality concept. The appropriate application of GAAP, the effective interest method, is by-passed as a practical expediency in situations when doing so has no ―material‖ effect on the results. 14-65 Chapter 14 - Bonds and Long-Term Notes Problem 14-3 (concluded) Requirement 5 The amortization schedule in requirement 1 gives us the answer: $9,864. The outstanding debt balance after the June 30, 2013, interest payment (line 5) is the present value at that time ($98,637) of the remaining payments. Since $10,000 face amount of the bonds is 10% of the entire issue, we take 10% of the table amount. This can be confirmed by calculating the present value: ?* Interest $450 x 2.72325 = $1,225 ** Principal $10,000 x 0.86384 = 8,638 Present value (price) of the bonds $9,864 (rounded) ? 4.5% x $10,000 * present value of an ordinary annuity of $1: n=3, i=5% (Table 4) ** present value of $1: n=3, i=5% (Table 2) 14-66 Chapter 14 - Bonds and Long-Term Notes Problem 14-4 Requirement 1 $8,000,000 (outstanding balance at maturity) Requirement 2 $6,627,273 (outstanding balance at sale date) Requirement 3 20 years (40 semiannual periods) Requirement 4 At the effective interest rate (By the alternative straight-line approach, interest would be the same amount each period) Requirement 5 8% [($320,000 ? $8,000,000) x 2] Requirement 6 10% [($331,364 ? $6,627,273) x 2] Requirement 7 $12,800,000 ($320,000 x 40) Requirement 8 $14,172,727 ($12,800,000* + [$8,000,000 – 6,627,273]) (Total cash interest plus the discount) *$320,000 x 40 14-67 Chapter 14 - Bonds and Long-Term Notes Problem 14-5 Requirement 1 ?* Interest $3,600,000 x 6.46321 =$23,267,556 ** Principal $80,000,000 x 0.67684 = 54,147,200 Present value (price) of the bonds $77,414,756 ? 4.5% x $80,000,000 * present value of an ordinary annuity of $1: n=8, i=5% (Table 4) ** present value of $1: n=8, i=5% (Table 2) Requirement 2 (a) Cromley Cash Effective Increase in Outstanding Payment Interest Balance Balance 4.5% x Face Amount 5% x Outstanding Balance Discount Reduction 77,414,756 1 3,600,000 .05 (77,414,756) = 3,870,738 270,738 77,685,494 2 3,600,000 .05 (77,685,494) = 3,884,275 284,275 77,969,769 3 3,600,000 .05 (77,969,769) = 3,898,488 298,488 78,268,257 4 3,600,000 .05 (78,268,257) = 3,913,413 313,413 78,581,670 5 3,600,000 .05 (78,581,670) = 3,929,084 329,084 78,910,754 6 3,600,000 .05 (78,910,754) = 3,945,538 345,538 79,256,292 7 3,600,000 .05 (79,256,292) = 3,962,815 362,815 79,619,107 8 3,600,000 .05 (79,619,107) = 3,980,893* 380,893 80,000,000 28,800,000 31,385,244 2,585,244 * rounded. 14-68 Chapter 14 - Bonds and Long-Term Notes Problem 14-5 (continued) (b) Barnwell Cash Effective Increase in Outstanding Payment Interest Balance Balance 4.5% x Face Amount 5% x Outstanding Balance Discount Reduction 77,415 1 3,600 .05 (77,415) = 3,871 271 77,686 2 3,600 .05 (77,686) = 3,884 284 77,970 3 3,600 .05 (77,970) = 3,899 299 78,269 4 3,600 .05 (78,269) = 3,913 313 78,582 5 3,600 .05 (78,582) = 3,929 329 78,911 6 3,600 .05 (78,911) = 3,946 346 79,257 7 3,600 .05 (79,257) = 3,963 363 79,620 8 3,600 .05 (79,620) = 3,980 * 380 80,000 28,800 31,385 2,585 *rounded Requirement 3 February 1, 2011 (Cromley) Cash (price determined above) ................................ 77,414,756 Discount on bonds payable (difference) ............... 2,585,244 Bonds payable (face amount) ............................ 80,000,000 February 1, 2011 (Barnwell) Bond investment (face amount) ............................ 80,000 Discount on bond investment (difference) ......... 2,585 Cash (price paid) ............................................. 77,415 14-69 Chapter 14 - Bonds and Long-Term Notes Problem 14-5 (continued) Requirement 4 July 31, 2011 (Cromley) Interest expense (from schedule) ................................. 3,870,738 Discount on bonds payable (from schedule) ..... 270,738 Cash (from schedule) ....................................... 3,600,000 July 31, 2011 (Barnwell) Cash (from schedule) ............................................ 3,600 Discount on bond investment (from schedule) .......... 271 Interest revenue (from schedule)................................ 3,871 December 31, 2011 (Cromley) 5Interest expense (/ x $3,884,275) ............................. 3,236,896 6 5 Discount on bonds payable (/ x $284,275)..... 236,896 6 5 Interest payable (/ x $3,600,000) .................... 3,000,000 6 December 31, 2011 (Barnwell) 5Interest receivable (/ x $3,600).......................... 3,000 6 5Discount on bond investment (/ x $284) ........... 237 6 5 Interest revenue (/ x $3,884) ................................. 3,237 6 January 31, 2012 (Cromley) 1Interest expense (/ x $3,884,275) ............................. 647,379 6 Interest payable (from adjusting entry above) ................. 3,000,000 1 Discount on bonds payable (/ x $284,275)..... 47,379 6 Cash (stated rate x face amount) ........................... 3,600,000 January 31, 2012 (Barnwell) Cash (stated rate x face amount) .............................. 3,600 1Discount on bond investment (/ x $284) ........... 47 6 Interest receivable (from adjusting entry above) ...... 3,000 1 Interest revenue (/ x $3,884) ................................. 647 6 14-70 Chapter 14 - Bonds and Long-Term Notes Problem 14-5 (concluded) July 31, 2012 (Cromley) Interest expense (from schedule) ................................. 3,898,488 Discount on bonds payable (from schedule) ..... 298,488 Cash (from schedule) ....................................... 3,600,000 July 31, 2012 (Barnwell) Cash (from schedule) ............................................ 3,600 Discount on bond investment (from schedule) .......... 299 Interest revenue (from schedule)................................ 3,899 December 31, 2012 (Cromley) 5Interest expense (/ x $3,913,413) ............................. 3,261,177 6 5 Discount on bonds payable (/ x $313,413)..... 261,177 6 5 Interest payable (/ x $3,600,000) .................... 3,000,000 6 December 31, 2012 (Barnwell) 5Interest receivable (/ x $3,600).......................... 3,000 6 5Discount on bond investment (/ x $313) ........... 261 6 5 Interest revenue (/ x $3,913) ................................. 3,261 6 January 31, 2013 (Cromley) 1Interest expense (/ x $3,913,413) ............................. 652,236* 6 Interest payable (from adjusting entry above) ................. 3,000,000 1 Discount on bonds payable (/ x $313,413)..... 52,236* 6 Cash (stated rate x face amount) ........................... 3,600,000 January 31, 2013 (Barnwell) Cash (stated rate x face amount) .............................. 3,600 1Discount on bond investment (/ x $313) ........... 52 6 Interest receivable (from adjusting entry above) ...... 3,000 1 Interest revenue (/ x $3,913) ................................. 652 6 *rounded 14-71 Chapter 14 - Bonds and Long-Term Notes Problem 14-6 Requirement 1 April 1, 2011 (Western) 1Cash ($29,300,000 + [/ x 12% x $30,000,000]) ........ 29,600,000 12 Discount on bonds payable ($30 million – $29.3 million) 700,000 Bonds payable (face amount) ............................ 30,000,000 1 Interest payable (/ x 12% x $30,000,000)........ 300,000 12 April 1, 2011 (Stillworth) Bond investment (face amount) ............................ 30,000 1Interest receivable (/ x 12% x $30,000).............. 300 12 Discount on bond investment ($30,000 – $29,300) 700 1 Cash ($29,300 + [/ x 12% x $30,000]).............. 29,600 12 Alternative: Some accountants prefer to credit (debit) interest expense (revenue), rather than interest payable (receivable), when bonds are sold (purchased). April 1, 2011 (Western) 1Cash ($29,300,000 + [/ x 12% x $30,000,000]) ...... 29,600,000 12 Discount on bonds payable ($30 million – $29.3 million) 700,000 Bonds payable (face amount) ............................ 30,000,000 1 Interest expense (/ x 12% x $30,000,000) ....... 300,000 12 April 1, 2011 (Stillworth) Bond investment (face amount) ............................ 30,000 1Interest revenue (/ x 12% x $30,000) ...................... 300 12 Discount on bond investment ($30,000 – $29,300) 700 1 Cash ($29,300 + [/ x 12% x $30,000]).............. 29,600 12 If the alternate entries are used, entries at the next interest date would require simply a debit (credit) to interest expense (revenue) for the full interest. The interest accounts would then reflect the same net debit of five months' interest. 14-72 Chapter 14 - Bonds and Long-Term Notes Problem 14-6 (continued) Requirement 2 The original maturity of the bonds was 3 years, or 36 months. But since the bonds weren’t sold until one month after they were dated, they are outstanding for only 35 months. Straight-line amortization, then, is $700,000 ? 35 months = $20,000 per month for Western (and $700 ? 35 months = $20 per month for Stillworth’s investment). August 31, 2011 (Western) Interest expense ($1,800,000 + 100,000 – 300,000) .. 1,600,000 Interest payable (accrued interest from above) .............. 300,000 Discount on bonds payable ($20,000 x 5 months) 100,000 6 Cash ($30,000,000 x 12% x /) ...................... 1,800,000 12 August 31, 2011 (Stillworth) 6 ............................... 1,800 Cash ($30,000 x 12% x /) 12 Discount on bond investment ($20 x 5 months) ..... 100 Interest receivable (accrued interest from above) .... 300 Interest revenue ($1,800 + 100 – 300) ..................... 1,600 If alternate method of recording accrued interest is used: August 31, 2011 (Western) Interest expense ($1,800,000 + $100,000) ................. 1,900,000 Discount on bonds payable ($20,000 x 5 months) 100,000 6 Cash ($30,000,000 x 12% x /) ...................... 1,800,000 12 August 31, 2011 (Stillworth) 6Cash ($30,000 x 12% x /) ............................... 1,800 12 Discount on bond investment ($20 x 5 months) ..... 100 Interest revenue ($1,800 + $100) ............................. 1,900 14-73 Chapter 14 - Bonds and Long-Term Notes Problem 14-6 (continued) December 31, 2011 (Western) Interest expense ($1,200,000 + $80,000) ..................... 1,280,000 Discount on bonds payable ($20,000 x 4 months) 80,000 4 Interest payable ($30,000,000 x 12% x /) ........ 1,200,000 12 December 31, 2011 (Stillworth) 4Interest receivable ($30,000 x 12% x /).............. 1,200 12 Discount on bond investment ($20 x 4 months) ..... 80 Interest revenue ($1,200 + $80) ............................... 1,280 February 28, 2012 (Western) Interest expense ($1,800,000 + 40,000 – 1,200,000) . 640,000 Interest payable (from adjusting entry)..................... 1,200,000 Discount on bonds payable ($20,000 x 2 months) 40,000 6 Cash ($30,000,000 x 12% x /) ...................... 1,800,000 12 February 28, 2012 (Stillworth) 6Cash ($30,000 x 12% x /) ................................. 1,800 12 Discount on bond investment ($20 x 2 months) ..... 40 Interest receivable (from adjusting entry) .............. 1,200 Interest revenue ($1,800 + 40 – 1,200) .................. 640 August 31, 2012 (Western) Interest expense ($1,800,000 + $120,000) ................. 1,920,000 Discount on bonds payable ($20,000 x 6 months) 120,000 6 Cash ($30,000,000 x 12% x /) ...................... 1,800,000 12 August 31, 2012 (Stillworth) 6Cash ($30,000 x 12% x /) ............................... 1,800 12 Discount on bond investment ($20 x 6 months) ..... 120 Interest revenue ($1,800 + $120) ............................. 1,920 December 31, 2012 (Western) Interest expense ($1,200,000 + $80,000) ..................... 1,280,000 Discount on bonds payable ($20,000 x 4 months) 80,000 4 Interest payable ($30,000,000 x 12% x /) ........ 1,200,000 12 14-74 Chapter 14 - Bonds and Long-Term Notes Problem 14-6 (continued) December 31, 2012 (Stillworth) 4Interest receivable ($30,000 x 12% x /).............. 1,200 12 Discount on bond investment ($20 x 4 months) ..... 80 Interest revenue ($1,200 + $80) ............................... 1,280 February 28, 2013 (Western) Interest expense ($1,800,000 + 40,000 – 1,200,000) . 640,000 Interest payable (from adjusting entry)..................... 1,200,000 Discount on bonds payable ($20,000 x 2 months) 40,000 6 Cash ($30,000,000 x 12% x /) ...................... 1,800,000 12 February 28, 2013 (Stillworth) 6Cash ($30,000 x 12% x /) ................................. 1,800 12 Discount on bond investment ($20 x 2 months) ..... 40 Interest receivable (from adjusting entry) .............. 1,200 640 Interest revenue ($1,800 + 40 – 1,200) .................. August 31, 2013 (Western) Interest expense ($1,800,000 + $120,000) ................. 1,920,000 Discount on bonds payable ($20,000 x 6 months) 120,000 6 Cash ($30,000,000 x 12% x /) ...................... 1,800,000 12 August 31, 2013 (Stillworth) 6Cash ($30,000 x 12% x /) ............................... 1,800 12 Discount on bond investment ($20 x 6 months) ..... 120 Interest revenue ($1,800 + $120) ............................. 1,920 December 31, 2013 (Western) Interest expense ($1,200,000 + $80,000) ..................... 1,280,000 Discount on bonds payable ($20,000 x 4 months) 80,000 4 Interest payable ($30,000,000 x 12% x /) ........ 1,200,000 12 14-75 Chapter 14 - Bonds and Long-Term Notes December 31, 2013 (Stillworth) 4Interest receivable ($30,000 x 12% x /).............. 1,200 12 Discount on bond investment ($20 x 4 months) ..... 80 Interest revenue ($1,200 + $80) ............................... 1,280 14-76 Chapter 14 - Bonds and Long-Term Notes Problem 14-6 (concluded) February 28, 2014 (Western) Interest expense ($1,800,000 + 40,000 – 1,200,000) . 640,000 Interest payable (from adjusting entry)..................... 1,200,000 Discount on bonds payable ($20,000 x 2 months) 40,000 6 Cash ($30,000,000 x 12% x /) ...................... 1,800,000 12 Bonds payable ............................................... 30,000,000 Cash .......................................................... 30,000,000 February 28, 2014 (Stillworth) 6Cash ($30,000 x 12% x /) ................................. 1,800 12 Discount on bond investment ($20 x 2 months)........ 40 Interest receivable (from adjusting entry) .............. 1,200 Interest revenue ($1,800 + 40 – 1,200) .................. 640 Cash .............................................................. 30,000 Investment in bonds ................................... 30,000 14-77 Chapter 14 - Bonds and Long-Term Notes Problem 14-7 Requirement 1 ?* Interest $16,000,000 x 17.15909 = $274,545,440 ** Principal $400,000,000 x 0.14205 = 56,820,000 Present value (price) of the bonds $331,365,440 ? 4% x $400,000,000 * present value of an ordinary annuity of $1: n=40, i=5% (Table 4) ** present value of $1: n=40, i=5% (Table 2) Requirement 2 (a) Cash (price determined above) ................................ 331,365,440 Discount on bonds (difference)............................ 68,634,560 Bonds payable (face amount) ............................ 400,000,000 (b) Bond investment (face amount) ............................ 400,000 Discount on bond investment (difference) ......... 68,635 Cash (0.1% x $331,365,440) .............................. 331,365 Requirement 3 (a) Interest expense (5% x $331,365,440) ......................... 16,568,272 Discount on bonds payable (difference) ............ 568,272 Cash (4% x $400,000,000) ................................ 16,000,000 (b) Cash (4% x $400,000) ......................................... 16,000 Discount on bond investment (difference) ............ 568 Interest revenue (5% x $331,365)............................. 16,568 Requirement 4 (a) Interest expense (5% x [$331,365,440 + $568,272]) ... 16,596,686 Discount on bonds payable (difference) ............ 596,686 Cash (4% x $400,000,000) ................................ 16,000,000 (b) 14-78 Chapter 14 - Bonds and Long-Term Notes Cash (4% x $400,000) ......................................... 16,000 Discount on bond investment (difference) ............ 597 Interest revenue (5% x [$331,365 + $568]) .............. 16,597 14-79 Chapter 14 - Bonds and Long-Term Notes Problem 14-8 1. Interest expense for year ended December 31, 2011 1 Dec. 31, 2011, interest expense (calculated below ) $4,422 2. Liabilities at December 31, 2011 Bonds payable (face amount) .................................... $500,000 2Less: discount .................................................... (57,785) Initial balance, November 1, 2011 .......................... $442,215 3Dec. 31, 2011 discount amortization .................... 255 Balance, December 31, 2011 ......................... $442,470 4Interest payable .................................................. $4,167 3. Interest expense for year ended December 31, 2012 5April 30, 2012 interest expense ............................ $ 8,844 6Oct. 31, 2012 interest expense .......................... 13,289 7Dec. 31, 2012 interest expense ............................ 4,438 Interest expense for 2012 .............................. $26,571 Or, using the amortization schedule below: 42$13,266 x / + 13,289 + 13,313 x /= $26,571 66 4. Liabilities at December 31, 2012 Balance, December 31, 2011 (from req. 2 above) ... $442,470 8April 30, 2012 discount amortization ................... 511 9Oct. 31, 2012 discount amortization .................... 789 10Dec. 31, 2012 discount amortization .................. 271 Balance, December 31, 2012 ......................... $444,041 11Interest payable ................................................. $4,167 14-80 Chapter 14 - Bonds and Long-Term Notes Problem 14-8 (concluded) Calculations: November 1, 2011 Cash (price: given) ......................................... 442,215 2Discount on bonds (difference)...................... 57,785 Bonds payable (face amount) ...................... 500,000 Partial amortization schedule (not required) Cash Increase in Outstanding Payment Effective Interest Balance Balance 442,215 1 12,500 .03 (442,215) = 13,266 766 442,981 2 12,500 .03 (442,981) = 13,289 789 443,770 3 12,500 .03 (443,770) = 13,313 813 444,583 December 31, 2011 124,422 Interest expense (3% x $442,215 x /) ............... 63 Discount on bonds payable (difference) ...... 255 42 Interest payable (2.5% x $500,000 x /) ....... 4,167 6 April 30, 2012 54Interest expense (3% x $442,215 x /) ............... 8,844 6 Interest payable (from adjusting entry above) ....... 4,167 8 Discount on bonds payable (difference) ...... 511 Cash (stated rate x face amount) ..................... 12,500 October 31, 2012 6Interest expense (3% x [$442,215 + 255 + 511]) . 13,289 9 Discount on bonds payable (difference) ........ 789 Cash (stated rate x face amount) ..................... 12,500 December 31, 2012 72Interest expense (3% x [$442,215 + 255 + 511 + 789] x /) 4,438 610 Discount on bonds payable (difference) ...... 271 11 Interest payable (2.5% x $500,000 x 2/6) ....... 4,167 14-81 Chapter 14 - Bonds and Long-Term Notes Problem 14-9 Requirement 1 Cash (price given)................................................ 5,795,518 Discount on bonds payable (difference) ............... 12,204,482 Bonds payable (face amount) ............................ 18,000,000 Requirement 2 The discount rate that ―equates‖ the present value of the debt ($5,795,518) and its future value ($18,000,000) is the effective rate of interest: $5,795,518 ? $18,000,000 = .32197 – the Table 2 value for n = 10, i = ? In row 10 of Table 2, the value .32197 is in the 12% column. So, this is the effective interest rate. A financial calculator will produce the same rate. Requirement 3 Interest expense (12% x $5,795,518) ........................... 695,462 Discount on bonds payable ......................... 695,462 Requirement 4 Interest expense (12% x [$5,795,518 + $695,462]) ..... 778,918 Discount on bonds payable ......................... 778,918 Requirement 5 Bonds payable ................................................. 18,000,000 Cash .......................................................... 18,000,000 14-82 Chapter 14 - Bonds and Long-Term Notes Problem 14-10 Requirement 1 Land ....................................................................... 600,000 Notes payable (face amount) ..................................... 600,000 Interest expense (12% x $600,000) ................................ 72,000 Cash (12% x $600,000) ............................................. 72,000 Requirement 2 Office equipment (price given) ...................................... 94,643 Discount on notes payable (difference) ......................... 5,357 Notes payable (face amount) ..................................... 100,000 The discount rate that ―equates‖ the present value of the debt ($94,643) and its future value ($100,000 + $6,000) is the effective rate of interest: $94,643 ? $106,000 = .8929 – the Table 2 value for n = 1, i = ? In row 1 of Table 2, the value .8929 is in the 12% column. So, this is the effective interest rate. A financial calculator will produce the same rate. PROOF: ?* Interest $6,000 x 0.89286 = $ 5,357 ** Principal $100,000 x 0.89286 = 89,286 Present value (price) of the note $94,643 ? 6% x $100,000 * present value of an ordinary annuity of $1: n=1, i=12% (Table 4) ** present value of $1: n=1, i=12% (Table 2) Interest expense (12% x $94,643) .................................. 11,357 Discount on note payable (determined above) ............. 5,357 Cash (6% x $100,000) .............................................. 6,000 14-83 Chapter 14 - Bonds and Long-Term Notes Problem 14-10 (concluded) Not required, but recorded at the same date (may be combined with interest entry): Note payable (face amount)........................................... 100,000 Cash .................................................................... 100,000 Requirement 3 $1,000,000 x 2.40183 = $2,401,830 installment (from Table 4) present payments n=3, i=12% value Building (implicit price).................................................. 2,401,830 Note payable (present value determined above) ............... 2,401,830 Interest expense (12% x $2,401,830) .............................. 288,220 Note payable (difference) ............................................. 711,780 Cash (given) ........................................................... 1,000,000 14-84 Chapter 14 - Bonds and Long-Term Notes Problem 14-11 Requirement 1 * Interest $ 6,000 x 3.79079 =$ 22,745 ** Principal $150,000 x 0.62092 = 93,138 Present value (price) of the note $115,883 * present value of an ordinary annuity of $1: n=5, i=10% (Table 4) ** present value of $1: n=5, i=10% (Table 2) Equipment (fair value ) ................................................. 115,883 Discount on notes payable (difference) ......................... 34,117 Note payable (face amount) ....................................... 150,000 Requirement 2 December 31, 2011 Interest expense (10% x $115,883) ......................................... 11,588 Discount on notes payable (difference)...................... 5,588 Cash (given) ........................................................... 6,000 Requirement 3 December 31, 2012 Interest expense (10% x [$115,883 + 5,588]) ......................... 12,147 Discount on notes payable (difference)...................... 6,147 Cash (given) ........................................................... 6,000 14-85 Chapter 14 - Bonds and Long-Term Notes Problem 14-12 Requirement 1 $6,074,700 ? $2,000,000 = 3.03735 present installment present value value payment table amount This is the Table 4 value for n = 4, i = ? In row 4 of Table 4, the number 3.03735 is in the 12% column. So, 12% is the implicit interest rate. Requirement 2 Machine (fair value) ..................................................... 6,074,700 Notes payable (present value) .................................... 6,074,700 Requirement 3 Interest expense (12% x outstanding balance) .......................... 728,964 Notes payable (difference) ............................................ 1,271,036 Cash (given) ........................................................... 2,000,000 Requirement 4 Interest expense (12% x [$6,074,700 – 1,271,036]) ............... 576,440 Note payable (difference) ............................................. 1,423,560 Cash (given) ........................................................... 2,000,000 Requirement 5 $2,000,000 x 3.10245 = $6,204,900 installment (from Table 4) present payment n=4, i=11% value Machine ................................................................... 6,204,900 Notes payable ....................................................... 6,204,900 14-86 Chapter 14 - Bonds and Long-Term Notes Problem 14-13 Requirement 1 ?* Interest $5,000 x 3.16987 = $15,849 ** Principal $100,000 x 0.68301 = 68,301 Present value (price) of the note $84,150 ? 5% x $100,000 * present value of an ordinary annuity of $1: n=4, i=10% (Table 4) ** present value of $1: n=4, i=10% (Table 2) Equipment (price determined above)................................. 84,150 Discount on notes payable (difference) ......................... 15,850 Notes payable (face amount) ..................................... 100,000 Requirement 2 Cash Effective Increase in Outstanding Dec.31 Payment Interest Balance Balance 84,150 2011 5,000 .10 (84,150) = 8,415 3,415 87,565 2012 5,000 .10 (87,565) = 8,757 3,757 91,322 2013 5,000 .10 (91,322) = 9,132 4,132 95,454 2014 5,000 .10 (95,454) = 9,546* 4,546 100,000 20,000 35,850 15,850 * rounded Requirement 3 Interest expense (market rate x outstanding balance)............. 9,132 Discount on notes payable (difference)...................... 4,132 Cash (stated rate x face amount) ................................... 5,000 14-87 Chapter 14 - Bonds and Long-Term Notes Problem 14-13 (concluded) Requirement 4 $84,150 ? 3.16987 = $26,547 amount (from Table 4) installment of loan n=4, i=10% payment Requirement 5 Cash Effective Decrease in Outstanding Dec.31 Payment Interest Balance Balance 10% x Outstanding Balance Balance Reduction 84,150 2011 26,547 .10 (84,150) = 8,415 18,132 66,018 2012 26,547 .10 (66,018) = 6,602 19,945 46,073 2013 26,547 .10 (46,073) = 4,607 21,940 24,133 2014 26,547 .10 (24,133) = 2,414* 24,133 0 106,188 22,038 84,150 * rounded Requirement 6 Interest expense (market rate x outstanding balance)............. 4,607 Note payable (difference) ............................................. 21,940 Cash (payment determined above) ................................. 26,547 14-88 Chapter 14 - Bonds and Long-Term Notes Problem 14-14 Bonds payable (face amount) ........................................ 800,000 Loss on early extinguishment (to balance) ..................... 13,100 7 Debt issue costs (/ x $3,000) ............................... 2,100 10 7 Discount on bonds (/ x [$800,000 – $770,000])....... 21,000 10 Cash (given) ........................................................... 790,000 14-89 Chapter 14 - Bonds and Long-Term Notes Problem 14-15 Requirement 1 Interest expense (7% x $19,000,000) ...................................... 1,330,000 Discount on bonds payable (difference) .................... 130,000 Cash (6% x $20,000,000) .......................................... 1,200,000 Requirement 2 Bonds payable (face amount) ........................................ 20,000,000 Loss on early extinguishment (to balance) ..................... 1,270,000 Discount on bonds payable ($1,000,000 – 130,000) .... 870,000 Cash (redemption price) ............................................. 20,400,000 14-90 Chapter 14 - Bonds and Long-Term Notes Problem 14-16 1. Issuance of the bonds. Cash ($385,000 – 1,500) ............................................... 383,500 Debt issue costs (given) .............................................. 1,500 Discount on bonds payable ($400,000 – 385,000) ............. 15,000 Bonds payable (face amount) .................................... 400,000 2. December 31, 2011 Interest expense ($20,000 + 750)............................................ 20,750 Discount on bonds payable ($15,000 ? 20) ............... 750 Cash (5% x $400,000) .............................................. 20,000 Debt issue expense ($1,500 ? 20) ................................. 75 Debt issue costs ................................................. 75 3. June 30, 2012 Interest expense ($20,000 + 750)............................................ 20,750 Discount on bonds payable ($15,000 ? 20) ............... 750 Cash (5% x $400,000) .............................................. 20,000 Debt issue expense ($1,500 ? 20) ................................. 75 Debt issue costs ................................................. 75 4. Call of the bonds Bonds payable (face amount) ........................................ 400,000 Loss on early extinguishment (to balance) ..................... 9,850 9 Debt issue costs (/ x $1,500) ............................... 1,350 10 9 Discount on bonds (/ x [$400,000 – $385,000])....... 13,500 10 Cash (given) ........................................................... 395,000 14-91 Chapter 14 - Bonds and Long-Term Notes Problem 14-17 Requirement 1 Bonds payable (face amount) ........................................ 20,000,000 20Premium on bonds (/ x $6,000,000) ........................ 3,000,000 40 Gain on early extinguishment (to balance) .................. 2,600,000 Cash ($20,000,000 x 102%) ....................................... 20,400,000 Requirement 2 Bonds payable (face amount) ........................................ 10,000,000 10Premium on bonds (/ x $6,000,000) ........................ 1,500,000 40 Gain on early extinguishment (to balance) .................. 1,000,000 Cash (given) ........................................................... 10,500,000 14-92 Chapter 14 - Bonds and Long-Term Notes Problem 14-18 Requirement 1 ($ in millions) Convertible Bonds – 1998 issue Cash (97.5% x $200 million)...................................................... 195 Discount on bonds (difference)............................................... 5 Convertible bonds payable (face amount) ............................. 200 Bonds With Warrants – 2002 issue Cash (102% x $50 million) ........................................................ 51 Discount on bonds payable (difference) .................................. 3 Bonds payable (face amount) ............................................... 50 Equity – stock warrants (given) .......................................... 4 Requirement 2 ($ in millions) Convertible bonds payable (90% x $200 million) ..................... 180 Discount on bonds payable (90%x $2 million) ....................... 1.8 Common stock (to balance) ................................................ 178.2 Convertible bonds payable (10% x $200 million) ....................... 20.0 Loss on early extinguishment (to balance) ............................... .4 Discount on bonds payable (10% x $2 million) .................... .2 Cash (101% x 10% x $200 million) .......................................... 20.2 Requirement 3 ($ in millions) Convertible bonds payable (90% x $200 million) ....................... 180 Conversion expense (90% x 200,000 bonds x $150) .................... 27 Discount on bonds payable (90% x $2 million) .................... 1.8 Common stock (to balance) ................................................ 178.2 Cash (90% x 200,000 bonds x $150) ....................................... 27.0 14-93 Chapter 14 - Bonds and Long-Term Notes Problem 14-18 (concluded) Requirement 4 ($ in millions) Convertible bonds payable (90% x $200 million) ....................... 180.0 Conversion expense (90% x [200,000 x (45 – 40) shares] x $32) .......................... 28.8 Discount on bonds payable (90% x $2 million) ...................... 1.8 Common stock (to balance) ................................................ 207.0 Requirement 5 ($ in millions) Cash (40% x 50,000 x 40 warrants x $25) ..................................... 20.0 Equity – stock warrants (40% x $4 million) ............................... 1.6 Common stock (to balance) ................................................ 21.6 14-94 Chapter 14 - Bonds and Long-Term Notes Problem 14-19 List A List B j_ 1. Effective rate times balance a. Straight-line method h_2. Promises made to bondholders b. Discount o_3. Present value of interest plus c. Liquidation payments after other present value of principal claims satisfied m_4. Call feature d. Name of owner not registered l_ 5. Debt issue costs e. Premium b_6. Market rate higher than stated rate f. Checks are mailed directly d_7. Coupon bonds g. No specific assets pledged k_8. Convertible bonds h. Bond indenture e_ 9. Market rate less than stated rate i. Backed by a lien n_10. Stated rate times face amount j. Interest expense f_11. Registered bonds k. May become stock g_12. Debenture bond l. Legal, accounting, printing i_13. Mortgage bond m. Protection against falling rates a_14. Materiality concept n. Periodic cash payments c_15. Subordinated debenture o. Bond price 14-95 Chapter 14 - Bonds and Long-Term Notes Problem 14-20 Requirement 1 Interest $ 32,000 x 17.15909* = $549,091 Principal $800,000 x 0.14205 ** = 113,640 $662,731 4% x $800,000 = $32,000 * present value of an ordinary annuity of $1: n=40, i=5% (Table 4) ** present value of $1: n=40, i=5% (Table 2) January 1 Cash 662,731 Discount on bonds payable 137,269 Bonds payable 800,000 Requirement 2 June 30 Interest expense (5% x $662,731) 33,137 Discount on bonds payable (difference) 1,137 Cash (4% x $800,000) 32,000 Requirement 3 December 31 Interest expense (5% x [$662,731 + 1,137]) 33,193 Discount on bonds payable (difference) 1,193 Cash (4% x $800,000) 32,000 Requirement 4 The interest entries increased the book value from $662,731 to $665,061. To increase the book value to $668,000, NFB needed the following entry: Unrealized holding loss 2,939 Fair value adjustment ($668,000 – 665,061) 2,939 14-96 Chapter 14 - Bonds and Long-Term Notes Problem 14-21 Requirement 1 At January 1, the book value of the bonds was the initial issue price, $331,364. The liability, though, was increased by 3 months’ interest that has accrued for the quarter but has not been paid. This is recorded in an adjusting entry in preparation for the quarterly financials: Interest expense (5% x $331,364 x 3/6) 8,284 Discount on bonds payable (difference) 284 Accrued interest payable (4% x $400,000 x 3/6) 8,000 Note: None of the interest will be paid until June 30. Reducing the discount increases the book value of the bonds: January 1 book value and fair value $331,364 Increase from discount amortization 284 Increase from accrued interest payable* 8,000 March 31 book value (amortized initial amount) $339,648 *Interest payable is considered part of the book value of the bonds. Comparing the amortized initial amount at March 31, 2011, with the fair value on that date provides the Fair value adjustment balance needed: March 31 book value (amortized initial amount) $339,648 March 31 fair value 350,000 Fair value adjustment balance needed: debit/(credit) $ (10,352) Appling would record the $10,352 as a loss in the 2011 first quarter income statement: Unrealized holding loss 10,352 Fair value adjustment 10,352 Note: An increase in the value of an asset is a gain; an increase in the value of a liability is a loss. Appling’s first quarter earnings will be decreased by: Interest expense $ 8,284 Unrealized holding loss 10,352 Decrease in earnings $18,636 14-97 Chapter 14 - Bonds and Long-Term Notes Problem 14-21 (continued) Requirement 2 If the fair value on March 31 is $350,000, Appling needs to compare that amount with the amortized initial measurement on that date. That amount was increased when Appling recorded interest on June 30: Interest expense (5% x $331,364* x 3/6 ) 8,284 Accrued interest payable (balance) 8,000 Discount on bonds payable (difference) 284 Cash (4% x $400,000) 16,000 * Because interest is compounded semi-annually on bonds, this amount is not increased by the discount amortization until June 30. March 31 book value (amortized initial amount) $339,648 Increase from discount amortization 284 Decrease from payment of accrued interest payable* (8,000) June 30 book value (amortized initial amount) $331,932 *Interest payable is considered part of the book value of the bonds. Comparing the amortized initial amount at June 30 with the fair value on that date provides the Fair value adjustment balance needed: June 30 book value (amortized initial amount) $331,932 June 30 fair value 340,000 Fair value adjustment balance needed: debit/(credit) $ (8,068) Less: Current fair value adjustment balance debit/(credit) (10,352) Change in fair value adjustment $ 2,284 Appling would record the $2,284 as a gain in the 2011 second quarter income statement: Fair value adjustment 2,284 Unrealized holding gain 2,284 Appling’s second quarter earnings will be decreased by: Interest expense $8,284 Unrealized holding gain (2,284) 14-98 Chapter 14 - Bonds and Long-Term Notes Decrease in earnings $6,000 14-99 Chapter 14 - Bonds and Long-Term Notes Problem 14-21 (continued) Requirement 3 If the fair value on June 30 is $340,000, Appling needs to compare that amount with the amortized initial measurement on that date. That amount, though, has increased by 3 months’ interest that has accrued for the quarter but has not been paid. This is recorded in an adjusting entry in preparation for the quarterly financials: Interest expense (5% x [$331,364 + 284 + 284] x 3/6) 8,298 Discount on bonds payable (difference) 298 Accrued interest payable (8% x $400,000 x ?) 8,000 June 30 book value (amortized initial amount) $331,932 Increase from discount amortization 298 Increase from accrued interest payable* 8,000 September 30 book value (amortized initial amount) $340,230 *Interest payable is considered part of the book value of the bonds. September 30 book value (amortized initial amount) $340,230 September 30 fair value 335,000 Fair value adjustment balance needed: debit/(credit) $ 5,230 Less: Current fair value adjustment balance debit/(credit) (8,068) Change in fair value adjustment $(13,298) Appling would record the $13,298 as a gain in the 2011 third quarter income statement: Fair value adjustment 13,298 Unrealized holding gain 13,298 Appling’s third quarter earnings will be increased by: Interest expense $ 8,298 Unrealized holding gain (13,298) Increase in earnings $ 5,000 14-100 Chapter 14 - Bonds and Long-Term Notes Problem 14-21 (continued) Requirement 4 If the fair value on December 31 is $342,000, Appling needs to compare that amount with the amortized initial measurement on that date. That amount was increased when Appling recorded interest on December 31: Interest expense (5% x [$331,364 + 284 + 284] x 3/6) 8,298 Accrued interest payable (balance) 8,000 Discount on bonds payable (difference) 298 Cash (4% x $400,000) 16,000 September 30 book value (amortized initial amount) $340,230 Increase from discount amortization 298 Decrease from payment of accrued interest payable* (8,000) December 31 book value (amortized initial amount) $332,528 *Interest payable is considered part of the book value of the bonds. December 31 book value (amortized initial amount) $332,528 December 31 fair value 342,000 Fair value adjustment balance needed: debit/(credit) $ (9,472) Less: Current fair value adjustment debit/(credit) 5,230 Change in fair value adjustment $(14,702) Appling would record the $14,702 as a loss in the 2011 income statement: Unrealized holding loss 14,702 Fair value adjustment 14,702 14-101 Chapter 14 - Bonds and Long-Term Notes Problem 14-21 (continued) Appling’s 2011 income statement will include the interest expense for all four quarters as well as the gains and losses from adjusting to fair value: Interest expense, 1st quarter $ 8,284 Interest expense, 2nd quarter 8,284 Interest expense, 3rd quarter 8,298 Interest expense, 4th quarter 8,298 Loss, 1st quarter 10,352 Gain, 2nd quarter (2,284) Gain, 3rd quarter (13,298) Loss, 4th quarter 14,702 Decrease in 2011 earnings $42,636 The same result can be reached by comparing fair values at the beginning and end of the year and including semi-annual interest amounts rather than quarter-by-quarter: If the fair value on December 31 is $342,000, Appling needs to compare that amount with the amortized initial measurement on that date. The liability, though, was increased when Appling recorded interest on June 30 and December 31: Interest expense (5% x $331,364) 16,568 Discount on bonds payable (difference) 568 Cash (4% x $400,000) 16,000 Interest expense (5% x [$331,364 + 568]) 16,597 Discount on bonds payable (difference) 597 Cash (4% x $400,000) 16,000 January 1 book value $331,364 Increase from discount amortization ($568 + 597) 1,165 December 31 book value (amortized initial amount) $332,529 December 31 fair value 342,000 Fair value adjustment balance needed: debit/(credit) $ (9,471) 14-102 Chapter 14 - Bonds and Long-Term Notes Problem 14-21 (concluded) Appling would record the $9,471as a loss in the 2011 income statement: Unrealized holding loss 9,471 Fair value adjustment 9,471 Appling’s 2011 income statement will include the interest expense for June 30 and December 31 as well as the loss from adjusting to fair value: Interest expense, June 30 $16,568 Interest expense, December 31 16,597 Unrealized holding loss 9,471 Decrease in 2011 earnings $42,636 14-103 Chapter 14 - Bonds and Long-Term Notes Problem 14-22 Requirement 1 2011 July 1 Bond investment (face amount) ..................................... 16,000,000 Discount on bond investment (difference) ................. 300,000 Cash (price paid)...................................................... 15,700,000 Oct. 1 Bond investment (face amount) ..................................... 30,000,000 Premium on bond investment .................................. 1,160,000 4Interest receivable ($30,000,000 x 12% x /)................. 1,200,000 12 Cash ($31,160,000 + $1,200,000) ................................ 32,360,000 Dec. 1 Cash (6% x $30,000,000) .............................................. 1,800,000 Premium on investment*.................................................. 20,000 Interest receivable (from October entry) ............................. 1,200,000 Interest revenue (to balance) ............................................... 580,000 * 10 years – (June-September) = 116 months $1,160,000 ? 116 months = $10,000 / month $10,000 x 2 months = $20,000 Dec. 31 Accrued interest Bracecourt 6Interest receivable ($16,000,000 x 10% x /)................. 800,000 12 Discount on bond investment * ................................. 7,500 Interest revenue (to balance) ............................................... 807,500 * 20 years = 240 months $300,000 ? 240 months = $1,250 / month $1,250 x 6 months = $7,500 Framm 1Interest receivable ($30,000,000 x 12% x /)................. 300,000 12 Premium on investment ($10,000 x 1 month) ................... 10,000 Interest revenue (to balance) ............................................... 290,000 14-104 Chapter 14 - Bonds and Long-Term Notes Problem 14-22 (continued) 2012 Jan. 1 6Cash (10% x $16,000,000 x /) ..................................... 800,000 12 Interest receivable (from adjusting entry) ...................... 800,000 June 1 6Cash (12% x $30,000,000 x /) ..................................... 1,800,000 12 Premium on investment ($10,000 x 5 months) .................. 50,000 Interest receivable (from adjusting entry)............................. 300,000 Interest revenue (to balance) ............................................... 1,450,000 July 1 6Cash (10% x $16,000,000 x /)..................................... 800,000 12 7,500 Discount on bond investment ($1,250 x 6 months).............. Interest revenue (to balance) ............................................... 807,500 Sept. 1 3Interest receivable (12% x $15,000,000 x /)................. 450,000 12 15 Premium on investment ($10,000 x 3 months x /) ..... 15,000 30 Interest revenue (difference) ................................................ 435,000 Cash ([101% x $15,000,000] + $450,000).......................... 15,600,000 Loss on sale of investment ** ................................. 375,000 Bond investment (face amount) ................................. 15,000,000 Premium on bond investment * ............................ 525,000 3 Interest receivable (12% x $15,000,000 x /) ............. 450,000 12 15* ([$1,160,000 – 20,000 – 10,000 – 50,000 ] x /) – $15,000 = $525,000, or 30 10515[$1,160,000 x /x /] = $525,000 116 30 ** [$15,000,000 + 525,000] – [101% x $15,000,000]) = $375,000 14-105 Chapter 14 - Bonds and Long-Term Notes Problem 14-22 (continued) Dec. 1 6Cash (12% x $15,000,000 x /)..................................... 900,000 12 Premium on investment* .................................................. 30,000 Interest revenue (to balance) ............................................... 870,000 15* ($10,000 x 6 months x /) 30 Dec. 31 Accrued interest Bracecourt 6Interest receivable (10% x $16,000,000 x /) ................. 800,000 12 Discount on bond investment ($1,250 x 6 months).............. 7,500 Interest revenue (to balance) ............................................... 807,500 Framm 1Interest receivable ($15,000,000 x 12% x /)................. 150,000 12 15 Premium on investment ($10,000 x 1 month x /)....... 5,000 30 Interest revenue (to balance) ............................................... 145,000 2013 Jan. 1 6Cash (10% x $16,000,000 x /) .................................... 800,000 12 Interest receivable (from adjusting entry) ...................... 800,000 14-106 Chapter 14 - Bonds and Long-Term Notes Problem 14-22 (continued) Feb. 28 2Interest receivable (12% x $15,000,000 x /)................. 300,000 12 15 Premium on investment ($10,000 x 2 months x /) ..... 10,000 30 Interest revenue (difference) ................................................ 290,000 Cash ([102% x $15,000,000] + $150,000 + $300,000) .......... 15,750,000 Loss on sale of investment ** ................................. 195,000 Bond investment (face amount) ................................. 15,000,000 Premium on bond investment * ............................ 495,000 3 Interest receivable (12% x $15,000,000 x /) ............. 450,000 12 * $1,160,000 – 20,000 – 10,000 – 50,000 – 15,000 – 525,000 – 30,000 – 5,000 – 991510,000 = $495,000, or [$1,160,000 x /x /] = $495,000 116 30 ** [$15,000,000 + 495,000] – [102% x $15,000,000]) = $195,000 Dec. 31 Accrued interest 6Interest receivable (10% x $16,000,000 x /) ................. 800,000 12 Discount on bond investment ($1,250 x 6 months).............. 7,500 Interest revenue (to balance) ............................................... 807,500 14-107 Chapter 14 - Bonds and Long-Term Notes Problem 14-22 (concluded) Requirement 2 2011 Interest revenue – Dec. 1 $ 580,000 Interest revenue – Dec. 31 807,500 Interest revenue – Dec. 31 290,000 Increase in pretax earnings $1,677,500 2012 Interest revenue – June 1 $1,450,000 Interest revenue – July 1 807,500 Interest revenue – Sept. 1 435,000 Loss on sale of investment (375,000) Interest revenue – Dec. 1 870,000 Interest revenue – Dec. 31 807,500 Interest revenue – Dec. 31 145,000 Increase in pretax earnings $4,140,000 2013 Interest revenue – Feb. 28 $ 290,000 Loss on sale of investment (195,000) Interest revenue – Dec. 31 807,500 Increase in pretax earnings $902,500 14-108 Chapter 14 - Bonds and Long-Term Notes Problem 14-23 Requirement 1 ($ in millions) Land ........................................................................ 3 Gain on disposal ................................................. 3 Note payable ............................................................ 20 Accrued interest payable ........................................... 2 Land .................................................................. 16 Gain on debt restructuring ..................................... 6 Requirement 2 Analysis: Carrying amount: $20 million + $2 million = $22,000,000 Future payments: ($1 million x 4) + $15 million = 19,000,000 Gain to debtor $ 3,000,000 ($ in millions) (a) January 1, 2011 Accrued interest payable ......................................... 2 Note payable * ......................................................... 1 Gain on debt restructuring ..................................... 3 * establishes a balance in the note account equal to the total cash payments under the new agreement ($20 million – 1 million = $19 million) (b) December 31, 2011, 2012, 2013, and 2014 revised “interest” payments Note payable ............................................................ 1 Cash ................................................................... 1 Note: No interest expense should be recorded after the restructuring. All subsequent cash payments result in reductions of principal. (c) December 31, 2014 revised principal payment Note payable ............................................................ 15 Cash .................................................................................... 15 14-109 Chapter 14 - Bonds and Long-Term Notes Problem 14-23 (continued) Requirement 3 Analysis: Carrying amount: $20,000,000 + $2,000,000 = $22,000,000 Future payments: 27,775,000 Interest $ 5,775,000 Calculation of the new effective interest rate: • $22,000,000 ? $27,775,000 = .79208 – the Table 2 value for n = 4, i = ? • In row 4 of Table 2, the number .79209 is in the 6% column. So, this is the new effective interest rate. (a) January 1, 2011 [Since the total future cash payments are not less than the carrying amount of the debt, no reduction of the existing debt is necessary and no entry is required at the time of the debt restructuring.] Amortization Schedule (not required) Cash Effective Increase in Outstanding Dec.31 Payment Interest Balance Balance 6% x Outstanding Balance 22,000,000 2011 0 .06 (22,000,000) = 1,320,000 1,320,000 23,320,000 2012 0 .06 (23,320,000) = 1,399,200 1,399,200 24,719,200 2013 0 .06 (24,719,200) = 1,483,152 1,483,152 26,202,352 2014 0 .06 (26,202,352) = 1,572,648* 1,572,648 27,775,000 0 5,775,000 5,775,000 * rounded 14-110 Chapter 14 - Bonds and Long-Term Notes Problem 14-23 (concluded) (b) December 31, 2011 Interest expense ............................................... 1,320,000 Interest payable............................................ 1,320,000 December 31, 2012 Interest expense ............................................... 1,399,200 Interest payable............................................ 1,399,200 December 31, 2013 Interest expense ............................................... 1,483,152 Interest payable............................................ 1,483,152 December 31, 2014 Interest expense ............................................... 1,572,648 Interest payable............................................ 1,572,648 (c) December 31, 2014 revised payment Interest payable ($2,000,000 + 4 years’ interest above)7,775,000 Note payable ................................................... 20,000,000 Cash ........................................................... 27,775,000 14-111 Chapter 14 - Bonds and Long-Term Notes CASES Communication Case 14-1 Suggested Grading Concepts and Grading Scheme: Content (80% ) 20 Convertible bonds Entire proceeds of the bond issue should be allocated to the debt and the related premium or discount accounts. 20 Bonds with detachable warrants Proceeds of their sale should be allocated between the debt and the warrants. Basis of allocation is their relative fair values. Relative values are usually determined by the price at which the respective instruments are traded in the open market. Portion of the proceeds assigned to the warrants should be accounted for as equity. 20 Reasons why all the proceeds of convertible bonds should be allocated to the debt The option is inseparable from the debt: no way to retain one right while selling the other. The valuation presents practical problems: would be subjective. 20 Arguments that accounting for convertible debt should be the same as for debt issued with detachable stock purchase warrants Convertible debt has features of both debt and shareholders’ equity, and separate recognition should be given to the fundamental elements at the time of issuance. Difficulties in separating the relative values of the features are not insurmountable. Bonus (5) Other relevant arguments not mentioned above 80-85 points Writing (20%) 5 Terminology and tone appropriate to the audience (CFO). 6 Organization permits ease of understanding. Introduction that states purpose. Paragraphs separate main points. 9 English. Word selection. Spelling. Grammar. 20 points 14-112 Chapter 14 - Bonds and Long-Term Notes Real World Case 14-2 Requirement 1 ($ in millions) Cash (price given)..................................................... 968 Discount on notes (difference) .................................. 832 Notes payable (face amount) .................................. 1,800 Requirement 2 Fiscal Increase Outstanding Year-end Cash Interest Expense in Balance Balance 1997 968 1998 0 0.03149 (968) = 30 30 998 1999 0 0.03149 (998) = 31 31 1,030 2000 0 0.03149 (1,030) = 32 32 1,062 2001 0 0.03149 (1,062) = 33 33 1,096 2002 0 0.03149 (1,096) = 35 35 1,130 2003 0 0.03149 (1,130) = 36 36 1,166 2004 0 0.03149 (1,166) = 37 37 1,203 2005 0 0.03149 (1,203) = 38 38 1,240 2006 0 0.03149 (1,240) = 39 39 1,280 2007 0 0.03149 (1,280) = 40 40 1,320 2008 0 0.03149 (1,320) = 42 42 1,361 2009 0 0.03149 (1,361) = 43 43 1,404 2010 0 0.03149 (1,404) = 44 44 1,449 2011 0 0.03149 (1,449) = 46 46 1,494 2012 0 0.03149 (1,494) = 47 47 1,541 2013 0 0.03149 (1,541) = 49 49 1,590 2014 0 0.03149 (1,590) = 50 50 1,640 2015 0 0.03149 (1,640) = 52 52 1,691 2016 0 0.03149 (1,691) = 53 53 1,745 2017 0 0.03149 (1,745) = 55 55 1,800 14-113 Chapter 14 - Bonds and Long-Term Notes Case 14-2 (concluded) Requirement 3 In a strict sense, zero-coupon debt pays no interest. ―Zeros‖ offer a return in the form of a ―deep discount‖ from the face amount. In fact, though, interest accrues at the effective rate (3.149% in this case) times the outstanding balance ($968 million during 1998), even though no interest is paid periodically. Interest on zero-coupon debt is determined and reported in precisely the same manner as on interest-paying debt. Under the concept of accrual accounting, the periodic effective interest is unaffected by when the cash actually is paid. Corporations can even deduct for tax purposes the annual interest expense. So, for 1998, HP’s earnings were reduced by $30 million (.03149 x $968) and increased by the tax savings from being able to deduct the $30 million. If the tax rate was 35%, that savings would have been 35% x $30, or $10.5 million, and the net decrease in earnings would have been $19.5 million ($30 – 10.5). Requirement 4 From the amortization schedule, we can see that the book value of the debt at the end of 2002 was $1,130 million. Requirement 5 The journal entry Hewlett-Packard used to record the early extinguishment of debt in 2002, assuming the purchase was made at the end of the year was: Notes payable (given)......................................... 257 Discount (calculated below) ............................... 96 Gain on the early extinguishment of debt (to balance) 34 Cash (given) ................................................... 127 Calculations: $257 / $1,800 = 14.28% of notes were repurchased 14.28% x $1,130 = $161 million book value of notes repurchased $257 – 161 = $96 million discount on notes repurchased 14-114 Chapter 14 - Bonds and Long-Term Notes Communication Case 14-3 You may wish to suggest to your students that they consult the FASB 1990 Discussion Memorandum, ―Distinguishing between Liability and Equity Instruments and Accounting for Instruments with Characteristics of Both,‖ which sets forth the most common arguments on the issues in this case. Or, you may prefer that they think for themselves and approach the issue from scratch. There is no right or wrong answer. Both views can and often are convincingly defended. The process of developing and synthesizing the arguments likely will be more beneficial than any single solution. Each student should benefit from participating in the process, interacting first with his or her partner, then with the class as a whole. It is important that each student actively participate in the process. Domination by one or two individuals should be discouraged. Arguments brought out in the FASB DM include the following: 14-115 Chapter 14 - Bonds and Long-Term Notes Case 14-3 (continued) Arguments Supporting View 1: 1. Those who favor accounting for convertible debt as entirely a liability until it is either converted or repaid argue that a convertible bond offers the holder two mutually exclusive choices. The holder cannot both redeem the bond for cash at maturity and convert it into common stock. They contend that the accounting before conversion or other settlement should reflect only the issuer's current position as a borrower and the holder's current position as a creditor. Until the conversion option is exercised, the bondholder is entitled to receive, and the enterprise is obligated to pay, only the periodic interest payments. If the option has not been exercised at the date the bonds mature, the issuer is obligated to pay the face amount, not to issue stock to the holder. Advocates of accounting for convertible debt according to its governing characteristics argue that a convertible bond is a single instrument, not two. To account for it as two instruments would not be representationally faithful. (par. 295) 2. Supporters of the first alternative generally also are concerned about the ability to measure reliably the components of convertible debt because neither is separately traded. They conclude that because the market does not determine a separate value for the conversion option, any value attributed to it would be subjective. Opinion 14 cited "the uncertain duration of the right to obtain the stock and the uncertainty as to the future value of the stock obtainable upon conversion" as factors further complicating valuation of the conversion option. (par. 296) 3. Supporters of that view argue that factors other than the conversion feature typically affect the pricing of convertible debt and therefore may complicate an attempt to allocate the proceeds from issuance between the straight debt and the conversion feature. For example, convertible bonds generally have covenants that are less restrictive than those for nonconvertible bonds on matters such as issuing more debt, maintaining specified financial ratios, paying large dividends on common stock, and establishing sinking funds.Less restrictive covenants may result in some reduction in market value and a corresponding increase in yield, which would complicate valuing the debt component of a convertible bond by comparing it with nonconvertible bonds with similar terms issued by enterprises with comparable credit ratings (par. 297). 14-116 Chapter 14 - Bonds and Long-Term Notes Case 14-3 (continued) 4. Moreover, no cash payment from holder to issuer is required when a convertible bond is converted; the bond itself represents the consideration received by the issuing enterprise for the stock into which the bond is converted. Thus, the price paid by the holder upon conversion effectively depends on the market price of the bond at the time of conversion. Those who would account for convertible debt as entirely a liability argue that the absence of a fixed cash price for which a bondholder obtains an equity interest complicates an attempt to value the straight debt and conversion feature components (par. 298). Arguments Supporting View 2: 1. Those who favor separate recognition of the liability and equity components of convertible debt argue that to ignore the existence of the conversion feature in recognizing the issuance of the bond results in overstating the liability and understating the interest expense. The effect of the conversion feature is to lower the rate for otherwise comparable straight debt (par. 333). 2. The higher interest expense recognized if the components are separately recognized than if all of the proceeds of issuance are recorded as a liability reflects the fact that an enterprise that issues debt at less than its face amount pays an effective interest rate that is higher than the coupon rate. The lower reported interest expense that results if the convertible debt is accounted for as entirely a liability leads those who support separate accounting to argue that failure to attribute a portion of the proceeds to the conversion option, thereby overstating the amount of the enterprise's liability, does not faithfully represent the economics of the transaction between the enterprise and the bondholder (par. 334). 3. Supporters of separate accounting contend that accounting for convertible debt as entirely a liability impairs comparability between enterprises. If convertible debt is reported as entirely a liability, an enterprise with a relatively high credit rating that issues nonconvertible debt appears to have a higher cost of borrowing than a company with a lower credit rating that issues convertible debt because inclusion of the conversion feature lowers the nominal interest rate significantly (par. 335). 14-117 Chapter 14 - Bonds and Long-Term Notes Case 14-3 (concluded) 4. Those who support separate recognition of the liability and equity components of convertible debt point to the different values assigned by the market to convertible and nonconvertible debt with like terms as evidence of the inherent value of the conversion feature. They argue that accounting for a convertible bond as if it were entirely a debt instrument fails to recognize and display appropriately the obligation to issue stock, that is, the option embedded in convertible debt. The conversion feature has essentially the same economic value as the call on stock represented by a separately traded call option or warrant. The fact that the conversion feature cannot be sold separately does not justify ignoring its existence (par. 336). 5. In the 21 years since Opinion 14 was issued (to the date of this literature), the idea that many financial instruments may be broken down into more fundamental components, which then may be traded separately, has been embraced by the Wall Street community. The cash flows from instruments that have generally not been thought of as containing different components, such as government bonds, have been unbundled and recombined. Those who support separate accounting for the fundamental components of convertible debt argue that separate accounting would be consistent with the current economic environment. They contend that it is neither necessary nor appropriate to wait until the components of a financial instrument like convertible debt, which so obviously has both liability and equity characteristics, are physically separated to give accounting recognition to the existence of the separate components (par. 337). 14-118 Chapter 14 - Bonds and Long-Term Notes Analysis Case 14-4 Requirement 1 The notice is being placed by the four underwriters listed at the bottom of the notice. The purpose is to announce the sale of the bonds described. Actually, the sale by Craft Foods already has occurred at this point. The underwriters resell the securities to the investing public. These are ten-year bonds. The stated rate of interest is 7.75%, but the bonds are priced to yield a higher rate, which accounts for the fact they are offered at a discount, 99.57% of face value. Requirement 2 In practice, debt securities rarely are priced at a premium in their initial offering. The reason is primarily a marketing consideration. It’s psychologically more palatable for a security salesperson to approach a customer with an issue that is offered at a discount off its face value and that provides a return greater than its stated rate than one which is priced above its face value and provides a return less than its stated rate. Requirement 3 The accounting considerations for Craft Foods are to recognize the liability and related debt issue costs, as well as to record interest expense semiannually over the ten-year term to maturity at the effective rate of interest. The bonds were recorded at their selling price: $750,000,000 x 99.57 = $746,775,000 (Bonds payable at face, discount of $3,225,000). Craft Foods also recorded debt issue costs in a separate account to be amortized over the term to maturity (probably straight-line). We do not know the amount of those costs. It also is not apparent exactly when the sale by Craft Foods was made to the underwriters and therefore the amount of any accrued interest. Any accrued interest would be recorded as interest payable to be paid at the first interest date as part of the first semiannual interest payment. 14-119 Chapter 14 - Bonds and Long-Term Notes Judgment Case 14-5 Obviously, no rational lender will lend money without interest. The zero interest loan described actually does implicitly bear interest. The amount and rate of interest can be inferred from either the market rate of interest at the time for this type of transaction or from the fair value of the asset being sold. The case information provides no information about either, other than that the stated price of the asset is higher than prices for this model Mr. Wilde had seen elsewhere. If we knew, for instance, that the market rate of interest at the time for this type of transaction is 8%, we would assume that’s the effective interest rate and could calculate the price of the equipment as follows: $17,000 x 10.57534 = $179,781 installment (from Table 4) actual payment n=12, i=2.0% price Both the asset acquired and the liability used to purchase it should be recorded at the real cost, $179,781. Similarly, if we knew the cash price of the equipment is $185,430, then we could calculate the effective rate of interest as follows: The discount rate that ―equates‖ the present value of the debt ($185,430) and the installment payments ($17,000) is the effective rate of interest: $185,430 ? $17,000 = 10.9076: the Table 4 value for n = 12, i = ? In row 12 of Table 4, the value 10.90751 is in the 1.5% column. Since payments are quarterly, this equates to a 1.5 x 4 = 6% annual rate. So, 6% is the effective interest rate. A financial calculator will produce the same rate. In any case, Mr. Wilde will not avoid interest charges with this offer. Interest expense must be recorded at the effective rate, 8% in our first scenario, and 6% in the second. 14-120 Chapter 14 - Bonds and Long-Term Notes Judgment Case 14-6 Although not specifically discussed in the chapter, concepts studied in this and other chapters provide the logic for addressing the situation described. The company's accountant is incorrect in valuing the note at $200,000. The note should be valued at the present value of the receivable using the prevailing market rate and the difference between the present value and the cash given is regarded as an addition to the cost of products purchased during the contract term. In this case, the note would be valued at $136,602, computed as follows: PV = $200,000 x .68301 PV of $1: n=4, i=10% (from Table 2) PV = $136,602 The journal entry to record the initial transaction is as follows Note receivable (above) ................................ 136,602 Prepaid inventory (difference) ....................... 63,398 Cash ........................................................ 200,000 Interest revenue is recognized over the 4-year life of the note using the effective interest rate of 10%. Accrued interest will increase the receivable valuation to $200,000. Prepaid inventory is credited and inventory is debited as inventory is purchased, thus increasing the cost of inventory from the prices paid to market value. 14-121 Chapter 14 - Bonds and Long-Term Notes Communication Case 14-7 The critical question that student groups should address is the valuation of the note receivable. In this case, there is a correct answer. The note should be valued at the present value of $300,000 using the appropriate market rate of interest. The difference between present value and the $300,000 should be accounted for by Pastel as prepaid advertising. Interest revenue over the life of the note will be recognized using the effective rate. As advertising services are provided by the radio station, advertising expense is debited and prepaid advertising credited. It is important that each student actively participate in the process of arriving at a solution. Domination by one or two individuals should be discouraged. Students should be encouraged to contribute to the group discussion by (a) offering information on relevant issues, and (b) clarifying or modifying ideas already expressed, or (c) suggesting alternative direction. 14-122 Chapter 14 - Bonds and Long-Term Notes Ethics Case 14-8 Discussion should include these elements. Facts: Inducing a bond conversion is a common method of indirectly issuing stock, though typically not for the purpose of enhancing profits. Reported performance will increase. Company managers stand to benefit from the change. Ethical Dilemma: Should Hunt Manufacturing enter into these transactions primarily for ―window dressing‖ rather than for economic reasons? Who is affected? Meyer Barr Other managers Bondholders Hunt’s auditors Shareholders Potential shareholders The employees Other creditors 14-123 Chapter 14 - Bonds and Long-Term Notes Judgment Case 14-9 Requirement 1 The debt to equity ratio is computed by dividing total liabilities by total shareholders' equity. The ratio summarizes the capital structure of the company as a mix between the resources provided by creditors and those provided by owners. For example, a ratio of 2.0 means that twice as many resources (assets) have been provided by creditors as those provided by owners. Debt to equity ratio Total liabilities = Shareholders' equity $2,414 = $2,931 = 0.82 Industry average = 1.0 In general, debt increases risk. Debt places owners in a subordinate position relative to creditors because the claims of creditors must be satisfied first in case of liquidation. In addition, debt requires payment, usually on specific dates. Failure to pay debt interest and principal on a timely basis may result in default and perhaps even bankruptcy. Other things being equal, the higher the debt to equity ratio, the higher the risk. The type of risk this ratio measures is called default risk because it presumably indicates the likelihood a company will default on its obligations. AGF’s debt to equity ratio is not particularly high – in fact it’s less than the industry average. Requirement 2 Debt also can be used to enhance the return to shareholders. This concept is known as leverage. If a company earns a return on borrowed funds in excess of the cost of borrowing the funds, shareholders are provided with a total return greater than what could have been earned with equity funds alone. This desirable situation is called ―favorable financial leverage.‖ Unfortunately, leverage is not always favorable. Sometimes the cost of borrowing the funds exceeds the returns they generate. This illustrates the typical risk-return tradeoff faced by shareholders. 14-124 Chapter 14 - Bonds and Long-Term Notes Case 14-9 (continued) AGF has experienced favorable leverage, as demonstrated by calculating and comparing the return on assets and the return on shareholders’ equity for 2011: Rate of return on Net income = assets Average total assets $487 = [$5,345 + 4,684] / 2 = 9.7% Rate of return on Net income = shareholders' equity Average shareholders' equity $487 = [$2,931 + 2,671] / 2 = 17.4% The debt to equity ratio is not particularly high, but the debt the company does have has been used to shareholders’ advantage. The return on equity is greater than the return on assets. In fact, it may be that debt is being under-utilized by AGF. More debt might increase the potential for return, but the price would be higher risk. This is a fundamental tradeoff faced by virtually all firms when trying to settle on the optimal capital structure. Requirement 3 Creditors generally demand interest payments as compensation for the use of their capital. Failure to pay interest as scheduled may cause several adverse consequences including bankruptcy. Therefore, another way to measure a company's ability to pay its obligations is by comparing interest payments with cash flow generated from operations. The times interest earned ratio does this by dividing income before subtracting interest expense or income tax expense by interest expense. 14-125 Chapter 14 - Bonds and Long-Term Notes Case 14-9 (concluded) Times interest earned Net income + interest + taxes = Interest $487 + 54 + 316 = $54 = 15.9 times Industry average = 5.1 times Two points about this ratio are important. First, because interest is deductible for income tax purposes, income before interest and taxes is a better indication of a company's ability to pay interest than is income after interest and taxes (i.e., net income). Second, income before interest and taxes is a rough approximation for cash flow generated from operations. The primary concern of decision-makers is, of course, the cash available to make interest payments. In fact, this ratio often is computed by dividing cash flow generated from operations by interest payments. AGF’s fixed charges are covered over 15 times, far exceeding the industry norm. The interest coverage ratio seems to indicate an ample safety cushion for creditors, particularly when considered in conjunction with their debt-equity ratio. There seems also to be considerable room for additional borrowing in the event the firm wanted to increase its leverage in an attempt to further enhance the return to shareholders. 14-126 Chapter 14 - Bonds and Long-Term Notes Real World Case 14-10 The following is from Macy’s annual report: January 31, 2009 2008 Requirement 3 ($ in millions) Total Current Liabilities $5,126 $5,360 Long-term Debt 8,733 9,087 Deferred Income Taxes 1,119 1,446 Other Noncurrent Liabilities 2,521 1,989 Total $17,499 $17,882 Total debt has decreased by less than 1%. Requirement 4 Total debt $17,499 $17,882 Shareholders’ Equity $4,646 $9,907 Total debt 17,499 17,882 Shareholders’ Equity 4,646 9,907 Ratio 3.77 1.80 The debt to equity ratio more than doubled since last year. 14-127 Chapter 14 - Bonds and Long-Term Notes Case 14-10 (concluded) Requirement 5 The vast majority is in the form of notes. Aggregate required payments of maturities of long-term debt for the next five fiscal years are as follows: Dollars in Millions 2010 2011 2012 2013 2014 Required payments $238 $662 $1,663 $138 $508 There is no obvious pattern in the amount of payments due over the next five years. No short-term debt is classified as long-term at January 31, 2009. It would be classified as long-term if the company intended to refinance any currently maturing debt on a long-term basis and could demonstrate the ability to do so. Requirement 6 FASB ASC 470–10–45–14: ―Debt–Overall–Other Presentation Matters–Intent and Ability to Refinance on a Long-Term Basis‖ Macys could report the debt as noncurrent if the company had the intent and ability to refinance on a long-term basis: Intent and Ability to Refinance on a Long-Term Basis 45-14 A short-term obligation shall be excluded from current liabilities if the entity intends to refinance the obligation on a long-term basis and the intent to refinance the short-term obligation on a long-term basis is supported by an ability to consummate the refinancing demonstrated in either of the following ways: a. Post-balance-sheet-date issuance of a long-term obligation or equity securities. After the date of an entity's balance sheet but before that balance sheet is issued or is available to be issued (as discussed in Section 855-10-25), a long-term obligation or equity securities have been issued for the purpose of refinancing the short-term obligation on a long-term basis. If equity securities have been issued, the short-term obligation, although excluded from current liabilities, shall not be included in owners' equity. 14-128 Chapter 14 - Bonds and Long-Term Notes Case 14-10 (concluded) b. Financing agreement. Before the balance sheet is issued or is available to be issued (as discussed in Section 855-10-25), the entity has entered into a financing agreement that clearly permits the entity to refinance the short-term obligation on a long-term basis on terms that are readily determinable. 1. The agreement does not expire within one year (or operating cycle from the date of the entity's balance sheet and during that period the agreement is not cancelable by the lender or the prospective lender or investor (and obligations incurred under the agreement are not callable during that period) except for violation of a provision with which compliance is objectively determinable or measurable. For purposes of this Subtopic, violation of a provision means failure to meet a condition set forth in the agreement or breach or violation of a provision such as a restrictive covenant, representation, or warranty, whether or not a grace period is allowed or the lender is required to give notice. Financing agreements cancelable for violation of a provision that can be evaluated differently by the parties to the agreement (such as a material adverse change or failure to maintain satisfactory operations) do not comply with this condition. 2. No violation of any provision in the financing agreement exists at the balance sheet date and no available information indicates that a violation has occurred thereafter but before the balance sheet is issued or is available to be issued or, if one exists at the balance sheet date has occurred thereafter, a waiver has been obtained. or 3. The lender or the prospective lender or investor with which the entity has entered into the financing agreement is expected to be financially capable of honoring the agreement. 14-129 Chapter 14 - Bonds and Long-Term Notes Analysis Case 14-11 Requirement 1 Earnings are not affected by conversion under the book value method. On the other hand, a gain or loss is recorded and thus earnings are affected by conversion if the market value method is used and the market value differs from the book value of the convertible bonds. In this case, the $6 million fair value of the common stock is higher than the book value of the bonds because the book value would be some amount less than the face amount of 20% x $25 million. A loss would be recorded for the difference, reducing earnings. Requirement 2 The 7% bonds were issued at a discount (less than face amount). We know this because the stated rate was less than the prevailing or market rate for bonds of similar risk and maturity at the time the bonds were issued. Thus, the bonds would have to be sold at a discount for them to yield 8%. Requirement 3 The amount of interest expense would be less in the first year of the term to maturity than in the second year of the life of the bond issue. That’s because the 8% effective interest rate is applied to an increasing bond carrying amount, and results in higher interest expense in each successive year. Requirement 4 We determine gain or loss on early extinguishment of debt by comparing the book value of the bonds at the date of extinguishment with the purchase price. If more is paid than the book value, a loss results. If less is paid than the book value, a gain results. In this case, a loss results. The bonds were issued at a discount so the book value of the bonds at the date of extinguishment must be less than the face amount. Thus, the reacquisition price is more than the book value. 14-130 Chapter 14 - Bonds and Long-Term Notes British Airways Case Requirement 1 Using IFRS, as British Airways does, companies use the ―net method‖ to record notes and other borrowings. A discount on notes would be recorded only using the ―gross method,‖ in which a borrowing sold for less than face value is recorded with a contra-liability account – Discount. The discount is then amortized over the life of the debt. Under IFRS, the discount also is amortized over the life of the debt, but credited directly to the note account rather than to a separate discount account. Thus, ―Amortization of discount‖ in Sealy’s statement of cash flows does not and would not appear in the corresponding note of British Airways. Under U.S. GAAP, debt issue costs are recorded separately as an asset and then amortized as reported by Sealy. A conceptually more appealing treatment, and the one prescribed by IFRS, is to reduce the recorded amount of the debt by the debt issue costs (called transaction costs under IFRS). 14-131 Chapter 14 - Bonds and Long-Term Notes British Airways Case (continued) Requirement 2 Under IFRS, convertible debt is divided into its liability and equity elements. We achieve separation by measuring the fair value of a similar liability that does not have an associated equity component. In the exercise, we know that bonds similar in all respects, except that they are nonconvertible, currently are selling at 99 (99% of face amount), so the liability-first separation gives us the following entry: Cash (101% x $300M) 303 Convertible bonds payable (99% x ?300 million)* 297 Equity – conversion option (to balance) 6 * Note that the discount on the bonds (?300 million – [99% x $300 million] = ?3 million) is combined with the face amount, and the net amount is recorded as Convertible bonds payable. This is the ―net method‖ which is the preferred approach under IFRS. Under U.S. GAAP, the entire issue price of convertible debt is recorded as debt: Cash (given) 303 Convertible bonds payable (face amount) 300 Premium on bonds payable (to balance) 3 Requirement 3 If the BA had elected the FVO for all of its fixed rate borrowings, the Fair value adjustment account would have a March 31, 2009 debit balance of ?56 million, the difference between the ?442 million carrying value and the ?386 million fair value. 14-132 Chapter 14 - Bonds and Long-Term Notes British Airways Case (concluded) Requirement 4 International accounting standards are more restrictive than U.S. standards for determining when firms are allowed to elect the fair value option for financial assets and liabilities. Under IFRS No. 39, companies can elect the fair value option only in specific circumstances. To avoid misuse, the fair value option is limited to only those financial instruments falling into one of the following categories. a group of financial assets, financial liabilities, or both is managed and its , performance is evaluated on a fair value basis, in accordance with a documented risk management or investment strategy, or the fair value option designation eliminates or significantly reduces an ―accounting , mismatch‖ that would otherwise arise if we measured the assets or liabilities or recognized gains and losses on them on different measurement bases. Although U.S. GAAP guidance indicates that the intent of the fair value option under U.S. GAAP is to address these sorts of circumstances, it does not require that those circumstances exist. 14-133 Chapter 14 - Bonds and Long-Term Notes 下面是三个励志小故事，不需要的朋友可以 下载后编辑删除!!!谢谢～～～ 你可以哭泣，但不要忘了奔跑 2012年，我背着大包小包踏上了去往北京的火车，开启了北漂生涯。彼时，天气阴沉，不知何时会掉下雨滴，就像我未知的前方一样，让人担忧。 14-134 Chapter 14 - Bonds and Long-Term Notes 去北京的决定是突然而果决的，我在宿舍纠结了一天，然后在太阳逃离窗口的时候打电话告诉父母，我要到首都闯一闯。消息发出去之后，并没有预料之中的强烈反对，父亲只给我回了一个字:好。 就这样看似毫无忧虑的我，欣喜地踏上了北上的路。有些事情只有真正迈出第一步的时候，才会迎来恐惧。当我踏上北上的列车时，才惊觉对于北京，除了天安门、央视大楼这些着名建筑，我知之甚少。俗话说无知者无畏，可于我而言，这句话并不适用，因为在坐上火车那一刻，我就开始对未来胆战心惊，毫无底气。 火车开动之后，我的心情变得更加复杂而紧张，甚至一度心生退意。人类果然是一个无解的方程式，看似无畏的勇气背后不知藏下了多少怯懦和犹豫。 旁座的姐姐见我一人，开始和我有一搭没一搭地聊起了天。几分钟后，我们竟如同许久未见的好友一般，开始聊起了各自的生活。 我说出了自己的恐惧与未见，期冀从她那里得到些许安慰和鼓励。出乎意料地，她并没有说一些心灵鸡汤般的哲理语句，反而给我讲了一个故事，一个让我在很长一段时间都印象深刻，每次想起便会荷尔蒙再度升高的故事，一个她自己的故事。 那是一段并不愉快的经历，整段经历是蜿蜒前行的。 高考中，她因为做错了三道大题，成为家里的罪人。朋友极尽嘲笑，亲戚们也开始暴露自己毒舌的属性，父母当时并没有过多指责，因为他们正在跟自己的兄弟姐妹们为了祖母的遗产争得死去活来。那被人类歌颂的血缘、亲情，在所有的利益面前瞬间分崩离析。那时的她，像极了一个被遗弃的孩子。或是为了远离当时一片狼藉的场面，家境拮据的她，怀着可能被众叛亲离的勇气，报考了一个三本院校。 当她怀揣着自己暑假赚的6000块钱踏进学校的时候，她以为一切喧闹终将与自己隔绝。但是事实上，天真的想法只维系了几天，便不攻自破。专业老师并不看好这个寡言少语的孩子，因为在她看来，法律专业除了要掌握专业知识之外，利索的嘴皮子也是一名律师出人头地不可缺少的法宝，而这个孩子，显然并没有这方面的天赋。 糟糕的情况在不断地蔓延，那段时期，她如同造物者手中的失败品，什么都做不好，注意力像手中的沙子一般怎么握都握不住。课文理解不了，丧失阅读能力，法律条款、单词统 14-135 Chapter 14 - Bonds and Long-Term Notes 统在跟她作对，连最简单的问题都会堵住她的嘴。考试更不用提了，考前总是睡不好觉，刚迈进考场全身就开始发抖，像个从来没有上过战场的士兵一样。 她一直溺在泪水中，从未上岸，深度抑郁，一度心生退学的想法。她深夜给母亲打去电话，想要获取安慰，家人说当初你自己做的决定，于是她只好自己硬撑着。为了防止自己再胡思乱想，她报了八门选修课，把自己的时间填得满满的。为了应付每科超过6000字的，她总是第一个跑到食堂去打饭，背日语，背法语，做英语听力，背法律常识虽不至于像匡衡一样凿壁偷光，但是只要有光的地方，她都待过。 一个追着阳光跑的人，是永远不会输在路上的。 在不停歇的灌输之下，大脑勉强接受了来自外界的压迫。虽不能到达天才的地步，但是起码恢复了正常的记忆功能。四年的大学生涯也在马不停蹄中准备落下帷幕，为了能够拿到好的工作机会，她到处参加比赛，只是为了让自己在与聘用单位较量时能够多一点筹码。与此同时，她还要忙毕业论文。在有限的时间内打一场不能失败的战争，是那时她的唯一目标。上天果然不会亏待努力的人，她的毕业论文很惊艳，老师甚至生出了让她留校任教的打算，不过还是被她拒绝了，因为她已经进入了当地最着名的一家律师事务所。 在刚进入事务所的时候，她过去光鲜的外衣再次黯然失色。为了能够追赶同事的步伐，她过上了每天哒哒哒飞速敲打键盘的生活。为了跟进一个案子，她常常整夜都在做准备，等到一切就绪时，晨光也恰好如期而至。如今，她已经成为北京最着名的律师事务所的招牌律师之一。这次她本可坐飞机回京，只是因为贪恋沿途的风景才会与我相遇。 14-136 Chapter 14 - Bonds and Long-Term Notes 在最难熬的时光要学会一路狂奔，不要多想，也不要把希望寄托在别人身上，人生来便是要努力的，你可以哭泣，但是不要忘了奔跑。她拍着我的肩膀，身上散发着莲花的香味，清新而让人愉悦。 终点站很快到达，天空依然阴沉着，不知下一秒云上染墨，雨滴降落，还是阳光冲破云雾，普照大地。 当我与她告别，重新背着沉重的行李，阔步向前，我知道等待我的不一定是美好的未来，但是只有拼一拼，才足够对得起自己。 每个人都有一个蜕变的过程，这个过程只能自己咬着牙度过，熬过了便化茧成蝶，熬不过，便像蒲公英一样，被生活的风吹着走。 一辈子走好一条路 有两个西班牙人，一个叫布兰科，一个叫奥特加。虽然他们同龄，又是邻居，但家境却相差很远。布兰科的父亲是一个富商，住别墅，开豪车。而奥特加的父亲却是一个摆地摊的，住棚屋，靠步行。 从小，布兰科的父亲就这样对儿子说:“孩子，长大后你想干什么都行，如果你想当律师，我就让我的私人律师教你当一名好律师，他可是出名的大律师;你如果想当医生，我就让我的私人医生教你医术，他可是我们这里医术最高的医生;如果你想当演员，我就将你送去最好的艺术学校学习，找最好的编剧和导演来给你量身定做角色，永远让你当主角;如果你想当商人，那么我就教你怎样做生意，要知道，你老爸可不是一个小商人，而是一个大商人，只要你肯学，我会将我的经商经验全都传授给你!” 奥特加的父亲则总是这样对儿子说:“孩子，由于爸爸的能力有限，家境不好，给不了你太多的帮助，所以我除了能教你怎样摆地摊外，再也教不了你任何东西了。你除了跟我去学摆地摊，其他的就是想也是白想啊!” 两个孩子都牢牢地记住了自己父亲的话。布兰科首先报考了律师，还没学几天，他就觉得律师的工作太单调，根本就不适合他的性格。他想，反正还有其他事情可以干，于是，他又转去学习医术。因为每天都要跟那些病人打交道，最需要的就是耐心，还没干多久，他又觉得医生这个职业似乎也不太适合他。于是，他想，当演员肯定最好玩，可是不久后，他才 14-137 Chapter 14 - Bonds and Long-Term Notes 知道，当演员真的是太辛苦了。最后，他只得跟父亲学习经商，可是，这时，他父亲的公司因为遭遇金融危机而破产了。 最终，布兰科一事无成。 奥特加跟父亲摆了几天地摊后，就哭着不肯去了，因为摆地摊日晒雨淋不说，还常遭人白眼。可是，一想到除了摆地摊，再也没别的事可干，他又硬着头皮跟父亲出发了。可是，还没干几天，他又受不了了，又吵着闹着不肯去了。因为没事可干，不久，他又跟着父亲出发了。 慢慢地，他竟然从摆地摊中发现，要想永远摆脱摆地摊的工作，就得认真地将地摊摆好。结果，几年后，他终于拥有了自己的专卖店。30年后，他拥有了属于自己的服装集团。如今天，该集团在世界68个国家中总计拥有3691家品牌店，一跃成为世界第二大成衣零售商。奥特加(AmancioOrtega)以250亿美元个人资产，位列《福布斯》2010年世界富豪榜第9位。 人并不是选择越多越好，因为多了反而拿不定主意，无法坚持到底。反而是那些没有选择的人，最终获得了成功。 14-138 Chapter 14 - Bonds and Long-Term Notes 把理想推远一点 比尔?拉福是美国当代的著名企业家。 比尔从商的志向来自他的父亲，他的父亲在商界滚打多年却始终没有取得什么骄人的成绩。受父亲影响，比尔从小就立志要做一位成功的商人，更何况他的父亲也认为他做事机敏果断，敢于创新，非常具有商业天赋，所以一直鼓励比尔去读经济或者商贸类大学。 让父亲没有想到的是，比尔在高中毕业后，却来到麻省理工学院学习工科中最基础最普通的机械制造专业。比尔的父亲生气地指责比尔说:“你一定是忘记了自己的理想，要知道，你并不是要做一位出色的工人，而是做一位成功的商人，你为什么不读商业贸易，反而要来学机械制造呢?你这不是拉近理想，分明是把理想推得更远了!” 比尔不赞同父亲的观点，他觉得适当把理想推远一点是正确的，因为工业商品在商贸中占了绝对的大多数，如果不具备工科知识，就不能了解产品的性能、生产制造等各方面的情况，将来很难保证能在经商中占到优势，更何况工科学习不仅是增强工业技能，还能帮助一个人建立严谨求实的思维能力，培养一种脚踏实地的工作态度，这些素质都是经商所不能缺少的。 听了比尔的解释，他的父亲终于明白了比尔的想法，比尔也得以留在麻省理工学院继续读书，四年的大学，比尔没有拘泥于本专业，他同时还学习了许多化工、建筑、电子等方面的基本知识，毕业后，立志从商的比尔并没有立刻带着这些知识投身商海，而是考入了芝加哥大学继续攻读经济学的硕士学位，这期间，比尔掌握了大量的经济学基本知识，掌握到了决定商业活动正确性的众多因素。 取得学位后，按理说比尔应该可以向理想进发了，可是他不仅没有立刻下海经商，反而还进一步把理想推远了:他又花了三年时间进入别的私人学校学习法律知识，之后又进入了一所法学院旁听法律课程，同时他还学习了一些微观经济活动的专业经济学以及企业管理知识!完成这一切之后，比尔又考进了政府部门工作，直到这时，他的父亲终于忍不住了，他指 14-139 Chapter 14 - Bonds and Long-Term Notes 责比尔已经彻底忘记了自己的理想，他提醒比尔说他应该努力让自己成为一名成功的商人，而不是去从事政治。 比尔有自己的想法，因为经商必须要具备很强的交往能力，要想在商业上获得成功，必须要深知处世规则，善于人际交往，然而这种能力是在任何学校都学不到的，只有在实践中才能磨炼出来，而磨炼这种能力的最佳去处就是政府部门。比尔在政府部门一干就是5年，他也在工作中培养起了深思稳重、沉着冷静的个性。 5年的政府工作结束后，比尔开始慢慢向商业靠近，他应聘到一家公司去熟练商情与商务技巧，因为现突出，两年后，公司打算出高薪让他担任副总经理，但比尔却辞职了，他意识到自己是时候正式向自己的理想迈开脚步了，随后，他开办了自己的拉福商贸公司，这时，比尔已经是一位35岁的中年人。 因为比尔的准备工作实在充分，在接下来的商务操作中，他几乎能考虑到每个细节，能应对一个合格的商人应该能应对的一切，并且能够嗅到各种商机，避免各种法律纠纷，他之前所学的每一点知识和所做的每一步准备，都在他之后的商业活动中发挥出了不可忽略的作用，生意进展异常顺利。 也正因如此，在此后短短的25年时间里，比尔的公司从最初20万美元的资产发展成了现在200亿美元，比尔本人也成为美国商业圈的一个神话人物。 对于比尔的成功，2011年诺贝尔经济学奖得主托马斯?萨金特就曾在一本书中这样评论:“急于求成在很多时候往往是欲速则不达，而适当推远理想反而是一种备战人生的最佳方式，比尔所拥有和依赖的，就是这种独特的智慧!” 14-140