finanical accounting 9th Edition Solutions Ch9.Docx
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Chapter 9 Liabilities Short Exercises (10 min.) S 9-1 Journal DATE
2012 July
2013 Apr.
July
ACCOUNTTITLESANDEXPLANATION
DEBIT
31 Inventory…………………………………………… NotePayable,Short-Term…………………… Purchasedinventoryby issuinga note payable.
11,000
30 InterestExpense($11,000× .12 × 9/12)……….. InterestPayable……………………………….. Accruedinterestexpense.
990
CREDIT
11,000
990
31 NotePayable,Short-Term………………............ InterestPayable…………………………………… InterestExpense($11,000× .12 × 3/12)……….. Cash……………………………………………… Paid notepayableand interestat maturity.
11,000 990 330 12,320
Balance Sheet on April 30, 2013: Notepayable,short-term
$11,000
Interestpayable
990
Chapter 9
Liabilities
9-1
Income Statement, April 30, 2013: InterestExpense
9-2
Financial Accounting 9/e Solutions Manual
$990
(5-10 min.) S 9-2 Req. 1 2012
2011
Accounts payable turnover: COGS Averageaccountspayable
Days payable outstanding: 365 Accountspayableturnover
$2,700,000 = 9 $300,000
$2,500,000 = 10 $250,000
365 = 41 days 9
365 = 37 days 10
Req. 2 Thecompany’sliquiditypositionhas deterioratedduring2012.
Chapter 9
Liabilities
9-3
(10 min.) S 9-3 Req. 1 DATE
Journal ACCOUNTTITLESANDEXPLANATION
DEBIT
Cash($564,000× .40)…………………..….. NotesReceivable($564,000− $255,600).. SalesRevenue…………………………… To recordsaleson account.
225,600 338,400
WarrantyExpense($564,000× .05)……… EstimatedWarrantyPayable……….…. To accruewarrantyexpense.
28,200
EstimatedWarrantyPayable……………... Cash…………………………………….…. To pay warrantyclaims.
18,000
CREDIT
564,000
28,200
18,000
Req. 2 EstimatedWarrantyPayable Bal. 18,000 Bal.
13,000 28,200 23,200 (5-10 min.) S 9-4
Warrantyexpense= $28,200 Theexpense recognition principle addressesthis situation. The warrantyexpensefor the year doesnot necessarilyequal the year’s cashpayments for warranties. Cash paymentsfor warranties do not determinethe amount of warranty expense for that year. Instead, the warranty expense is estimated and deducted from
9-4
Financial Accounting 9/e Solutions Manual
revenueduringthe periodof the sale, regardlessof whenthe companypaysfor warranty claims. Studentresponsesmayvary.
Chapter 9
Liabilities
9-5
(5-10 min.) S 9-5 1. These are contingent liabilities, because, at the time of the note, Tony Chase, Inc., wasnot liablefor any of theseproductlosses. 2. In the United States, the contingencycan becomea real liability if a user of a Tony Chaseproductsuffersa lossfor whichthe companyis responsible. Tony Chase must pay for all individual losses up to $3.8 million and all aggregate losses above $26.3 million. The company is insured against losses between $3.8 millionand$26.3million. 3. Outsidethe UnitedStates,the contingencybecomesa real liability the sameway — if a TonyChaseuser suffersa lossfor whichthe companyis responsible. Outside the United States, Tony Chase must pay only for losses above $26.3 million becausethe companyis insuredagainstlossesup to $26.3million.
9-6
Financial Accounting 9/e Solutions Manual
(5-10 min.) S 9-6 a. $155,500
($200,000× .7775)
b. $207,000
($200,000× 1.0350)
c. $188,500
($200,000× .9425)
d. $205,000
($200,000× 1.0250)
(5 min.) S 9-7 a. Discount b. Premium c. Par (face)value d. Discount
Chapter 9
Liabilities
9-7
(5-10 min.) S 9-8 Journal DATE
ACCOUNTTITLESANDEXPLANATION
2012 a. July 1 Cash…………………………………………….. BondsPayable…………………………….. To issuebondat par. b. Dec. 31 InterestExpense($125,000× .08 × 6/12)……. InterestPayable……………………………. To accrueinterestexpense. 2013 c. Jan. 1 InterestPayable……………………………….. Cash…………………………………………. To pay semiannualintereston bonds. 2019 d. July 1 BondsPayable………………………………… Cash………………………………………..... To pay bondsat maturity.
9-8
Financial Accounting 9/e Solutions Manual
DEBIT
CREDIT
125,000 125,000
5,000 5,000
5,000 5,000
125,000 125,000
(10-15 min.) S 9-9 Req. 1 Amortization table A
Semiannual Interest Date
Interest Payment (3%of Maturity Value)
B
C
Interest Expense (4.5%of Preceding BondCarrying Amount)
Discount Amortization (B - A)
Mar. 31, 2012
D
E
Discount Account Balance (Preceding (D - C)
Bond Carrying Amount ($560,000 - D)
$109,200
$450,800
Sept. 30, 2012
$16,800
$20,286
$3,486
105,714
454,286
Mar. 31, 2013
16,800
20,443
3,643
102,071
457,929
Sept. 30, 2013
16,800
20,607
3,807
98,264
461,736
Req. 2 Journal DATE
2012 Mar. 31
Sept.
30
ACCOUNTTITLESANDEXPLANATION
DEBIT
Cash($560,000× .805)…………… Discounton BondsPayable…….. BondsPayable………………….
450,800 109,200
InterestExpense………………….. Discounton BondsPayable… Cash……………………………..
20,286
CREDIT
560,000
3,486 16,800
(10 min.) S 9-10 Req. 1— Borrowed$450,800. Maturityvalueis $560,000. Req. 2—Cashinterestis $16,800.
Chapter 9
Liabilities
9-9
Req. 3—InterestexpenseSeptember30, 2012is $20,286. InterestexpenseMarch31, 2013is $20,443. (10-15 min.) S 9-11 Req. 1—Borrowed$2,925,000: Journal DATE
2012 July 1
ACCOUNTTITLESANDEXPLANATION
Cash($3,000,000× .975)…………… Discounton BondsPayable………. BondsPayable……………………
DEBIT
CREDIT
2,925,000 75,000 3,000,000
Req. 2—Payback$3,000,000at maturity,July 1, 2022. Req. 3—Cashinterestis $120,000($3,000,000× 8% × 6/12) eachsix months. Req. 4—Interestexpenseis $123,750[$120,000+ ($75,000/ 20)]
Journal DATE
2012 Dec. 31
2013 Jan. 1
9-10
ACCOUNTTITLESANDEXPLANATION
DEBIT
InterestExpense.................................... Discounton BondsPayable............... InterestPayable................................
123,750
InterestPayable..................................... Cash...............................................
120,000
Financial Accounting 9/e Solutions Manual
CREDIT
3,750 120,000
120,000
(10-15 min.) S 9-12 Req. 1 Wal Mart Stores
Best Buy Co. 5
Leverage ratio
6 Total debt 7
Debtratio
8
Times interest earned
$17,849/ $7,292
$17,849- $7,292 $10,557/ $17,849
$2,114/ $87
2.45
$180,663/ $71,247
2.53
$10,557 $180,663- $71,247 .59
24.2 times
$109,416
$109,416/ $180,663
$25,542/ $1,928
.60
13.2 times
Req. 2 Bothcompanies’debt-payingabilitiesare strong. Fromthe standpointof leverage(debt) the companiesare aboutequal. However,Best Buyhas a strongertimes-interest-earned ratio (24.2 vs. 13.2).
Chapter 9
Liabilities
9-11
(10-15 min.) S 9-13 PlanA Issue$1,000,000of 7% BondsPayable Net incomebeforeexpansion...........................
PlanB Issue$1,000,000 of CommonStock
$400,000
$400,000
Projectincomebeforeinterest andincometax..........................................
$ 100,000
$100,000
Less:interestexpense($1,000,000× .07)
(70,000)
-0-
Projectincomebeforeincometax.....................
30,000
100,000
Lessincometax expense(30%)........................
(9,000)
(30,000)
Projectnet income..........................................
21,000
70,000
Total companynet income...............................
$421,000
$470,000
Earningsper shareincludingexpansion: PlanA ($421,000/ 100,000shares)............... PlanB ($470,000/ 200,000shares)...............
$4.21 $2.35
Recommendation: To increase earnings per share, Wavetown Marina should borrow the money.
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Financial Accounting 9/e Solutions Manual
(5-10 min.) S 9-14 Req. 1 Leverage ratio
$100.0/ $40.0 = 2.5
Thismeansthat Evensonhas $2.50of assetsfor everydollar of stockholders’equity.
Debtratio
$60.0/ $100.0 = .60
Thismeansthat Evensonhas $.60 in liabilities(debt)for everydollar of assets.
Timesinterestearned $4.1 / $1.1 = 3.73 times Thismeansthat for everydollar of interestexpenseEvensonhas earned$3.73of operatingincome.
Evenson’sdebt ratio is aboutaverageandcancoverits existinginterest expense. I wouldbe willingto lendEvenson$1 million.
Chapter 9
Liabilities
9-13
(10 min.) S 9-15 LIABILITIES Current: Accountspayable………………………..
$ 33,000
Currentportionof bondspayable…….
56,000
Interestpayable…………………………..
1,700
Total currentliabilities……………….
90,700
Longterm: Notespayable,long-term……………….
125,000
Bondspayable……………………………
$375,000
Less:Discounton bondspayable…….
(11,250)
Total liabilities……………………………….
9-14
Financial Accounting 9/e Solutions Manual
363,750 $579,450
Exercises (5-15 min.) E 9-16A Req. 1 Journal DATE
ACCOUNTTITLESANDEXPLANATION
DEBIT
WarrantyExpense($111,000× .08)………… EstimatedWarrantyPayable……………..
8,880
EstimatedWarrantyPayable………………… Cash…………………………………………..
7,000
CREDIT
8,880
7,000
Req. 2 INCOMESTATEMENT Salesrevenue……………………………………… Warrantyexpense…………………………………
$111,000 8,880
BALANCESHEET Currentliabilities Estimatedwarrantypayable ($5,000+ $8,880− $7,000)…………………
$ 6,880
Req. 3 Estimated warranty payable, a current liability, will cause a company’s current ratio to decrease.
Chapter 9
Liabilities
9-15
(10-15 min.) E 9-17A Journal DATE
2012 Oct.
Nov.
Dec.
ACCOUNTTITLESANDEXPLANATION
DEBIT
1 Cash………………………………………………… UnearnedSubscriptionRevenue…………... SalesTax Payable($2,400× .09)……………
2,616
15 SalesTax Payable………………………………... Cash……………………………………………..
216
31 UnearnedSubscriptionRevenue……………… SubscriptionRevenue($2,400× 3/12)……..
600
CREDIT
2,400 216
216
600
BALANCESHEET Currentliabilities: Unearnedsubscriptionrevenue($2,400− $600)……
$1,800
(10 min.) E 9-18A INCOMESTATEMENT Expenses: Payroll expense……………………………………….
$150,000
Payroll tax expense($150,000× .08)………………
12,000
BALANCESHEET Currentliabilities: Salarypayable………………………………………… Payroll tax payable…………………………………...
9-16
Financial Accounting 9/e Solutions Manual
$7,500 700
(5-10 min.) E 9-19A Req. 1 Accruedinterest, Dec. 31, 2012
=
$85,000× .08 × 9/12
=
$85,000+ ($85,000× .08)
=
$5,100
Req. 2 Final payment on April 1, 2013
= $91,800
Req. 3 Interestexpensefor: 2012 = 2013 =
$85,000× .08 × 9/12 $85,000× .08 × 3/12
= =
Chapter 9
$5,100 $1,700
Liabilities
9-17
(10-15 min.) E 9-20A Olsen’sbalancesheetat December31, 2013, reported: Incometax payable.......................................................
$166,000*
Olsen’s2013incomestatementreported: Incometax expense($900,000× .29)...............................
$261,000
Beginningincometax payable....................…………………….. Incometax expense(andpayable)for the year.............. $900,000× .29)................................................................... Incometax paymentsduringthe year.................................... Endingincometax payable..................................................
$150,000
_____ * + − =
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Financial Accounting 9/e Solutions Manual
261,000 (245,000) $166,000
(10-20 min.) E 9-21A Req. 1 Accounts payable are amounts owed to suppliers for products or services that have beenpurchasedon account. Accrued expenses are expenses that the companyhas incurred but not yet paid. They are liabilitiesfor expensessuchas interestandincometaxes. Employeecompensation and benefits are amounts owed to employeesfor salaries and otherpayroll-relatedexpenses. Current portion of long-term debt is next year’s payment on the company’s long-term debt. Long-term debt is the amount of long-term notes and bonds payable that the company expectsto pay after the comingyear. Postretirement benefits are the company’s liabilities for providing benefits — mainly healthcare— to retirees. The other liabilities are a catch-all group of liabilities that do not fit one of the more specific categories.The other liabilitiesare long-term, as shownby the fact that they are not listedamongthe currentliabilities.
Chapter 9
Liabilities
9-19
(continued) E 9-21A Req. 2 Total assets= $3,714million,the sumof total liabilitiesand stockholders’equity. (in millions)
2012
Leverage = ratio Debtratio
=
Total assets($3,714) Total stockholders’equity($1,951) Total liabilities($3,714− $1,951)* Total assets($3,714)
= 1.90 = 0.47
For 2011,the leverageratio was2.26 andthe debt ratio was.56. Boththe leverageratio and debt ratio improvedin 2012. Therefore,the company improved. ____ *Or, $259+ $1,394+ $102+ $8 = $1,763
Req. 3 2012 Accounts payable turnover
Cost of goodssold AverageAccounts payable
$1,656 $146
= 11.3
*($110+ $182) / 2
Dayspayable outstanding
365 Accts.payable turnover
365 11.3
Current ratio
Currentassets Currentliabilities
$661 $259
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Financial Accounting 9/e Solutions Manual
= 32.3
= 2.55
2011 $1,790 $186 = 9.6 **($182+ $190)/ 2
365 9.6
$600 $394
= 38.0
= 1.52
Thecompany’sability to coveraccountspayableand currentliabilitiesover the year improved.
Chapter 9
Liabilities
9-21
(5-10 min.) E 9-22A Req. 1 SmithSecuritySystemsshouldreport this situationin a note to the financialstatements. Thenoteshouldconveyessentiallythe samemessagegivenin Note14.
Req. 2 Smithwouldreport: INCOMESTATEMENT Estimatedloss (or expense)………………
$3,000,000
BALANCESHEET Estimatedliability……………………………
$3,000,000
Thenotedisclosurewouldbe similarto Requirement1. Journal DATE 2012
ACCOUNTTITLESANDEXPLANATION EstimatedLossfromDamageClaim EstimatedLiabilityfromDamageClaim
9-22
Financial Accounting 9/e Solutions Manual
DEBIT
CREDIT
3,000,000 3,000,000
(15-20 min.) E 9-23A Banff Electronics BalanceSheet(partial) March31, 2012 Currentliabilities: a. Estimatedwarrantypayable [$35,000+ ($2,400,000× .04) − $57,000]...............................
$ 74,000
b. Currentportionof long-termnote payable...............................
16,250
Interestpayable($65,000× .07 × 1/12).....................................
379
c. Unearnedsalesrevenue($100,000− $85,000)..........................
15,000
d. Employeewithheldincometax payable..................................
30,900
FICAtax payable($320,000× .0765)….....................................
24,480
Total currentliabilities......................................................
$161,009
Long-termliabilities: Notepayable($65,000− $16,250)............................................
Chapter 9
$ 48,750
Liabilities
9-23
(10-15 min.) E 9-24A Req. 1 Journal DATE
2012 a. Jan.
b. July
c. Dec.
9-24
ACCOUNTTITLESANDEXPLANATION
DEBIT
31 Cash($8,000,000× 0.96)............................ Discounton BondsPayable....................... BondsPayable..................................... To issuebondsat a discount.
7,680,000 320,000
31 InterestExpense...................................... Cash($8,000,000× .07 × 6/12)................ Discounton BondsPayable ($320,000/ 10).................................. To pay interestand amortizebonds.
312,000
31 InterestExpense...................................... InterestPayable ($8,000,000× .07 × 5/12).................... Discounton BondsPayable ($320,000/ 10 × 5/6).......................... To accrueinterestand amortizebonds.
260,000
Financial Accounting 9/e Solutions Manual
CREDIT
8,000,000
280,000 32,000
233,333 26,667
(10-15 min.) E 9-25A
1. Cashreceived= $100,000× 1.05 =
$105,000
2. Principal……………………………………………………… Interest($100,000× .07 × 20)…………………….............. Total cashpaid………………………………………………
$100,000 140,000 $240,000
3. Total cashpaid……………………………………………… Less: Cashreceived…………………………………….... Difference= Total interestexpense……………………...
$240,000 (105,000) $135,000
4. Annualinterestexpenseby the straight-line amortizationmethod: $100,000× (1.05− 1.00) 20
$100,000× .07
same $7,000
Cashinterestpayment
−
$250
=
$ 6,750
Premiumamortization × 20 years
Total interestexpenseover the life of the bonds
$135,000
Chapter 9
Liabilities
9-25
(15-20 min.) E 9-26A Req. 1 (amortization table) A
SEMIANNUAL INTEREST DATE
INTEREST PAYMENT (2 ½ % OF MATURITY VALUE)
B INTEREST EXPENSE (3%OF PRECEDING BOND CARRYING AMOUNT)
C
D
E
DISCOUNT AMORTIZATION (B – A)
DISCOUNT ACCOUNT BALANCE (PRECEDING D – C)
BONDCARRYING AMOUNT ($4,000,000– D)
$297,550
$3,702,450
Dec. 31, 2012 June30, 2013
$100,000
$111,073
$ 11,073
286,477
3,713,524
Dec. 31, 2013
100,000
111,406
11,406
275,071
3,724,929
June30, 2014
100,000
111,748
11,748
263,323
3,736,677
Dec. 31, 2014
100,000
112,100
12,100
251,223
3,748,777
ACCOUNTTITLESANDEXPLANATION
DEBIT
Req. 2 Journal DATE
2012 Dec. 31 Cash……………………………………… Discounton BondsPayable…………. BondsPayable……………………… To issuebondsat a discount. 2013 June 30 InterestExpense........................................ Cash.................................................... Discounton BondsPayable.................... To pay semiannualinterestand amortizebonds. 2013 Dec. 31 InterestExpense........................................ Cash.................................................... Discounton BondsPayable.................... 9-26
Financial Accounting 9/e Solutions Manual
CREDIT
3,702,450 297,550 4,000,000
111,074 100,000 11,074
111,406 100,000 11,406
To pay semiannualinterestand amortizebonds.
Chapter 9
Liabilities
9-27
(15-20 min.) E 9-27A Req. 1 (amortization table) A
SEMIANNUAL INTEREST DATE
INTEREST PAYMENT (4½%OF MATURITY VALUE)
B INTEREST EXPENSE (4%OF PRECEDING BOND CARRYING AMOUNT)
C
PREMIUM AMORTIZATION (A – B)
D
E
PREMIUM ACCOUNT BONDCARRYING BALANCE AMOUNT (PRECEDING ($4,000,000+ D) D – C)
June30, 2012
$395,800
$4,395,8001 4,391,632
Dec. 31, 2012
$180,000
$175,832
$4,168
391,632
June30, 2013
180,000
175,665
4,335
387,297
4,387,297
Dec. 31, 2013
180,000
175,492
4,508
382,789
4,382,789
June30, 2014
180,000
175,312
4,688
378,101
4,378,101
_____ $4,000,000× 1.09895= $4,395,800
1
Req. 2 (journal entries) Journal DATE
ACCOUNTTITLESANDEXPLANATION
2012 June 30 Cash($4,000,000× 1.09895)…………….. BondsPayable……………………....... Premiumon BondsPayable………… To issuebondsat a premium. Dec.
31 InterestExpense………………………….. Premiumon BondsPayable……………. Cash…………………………………….. To pay semiannualinterestand amortizebonds.
2013 9-28
Financial Accounting 9/e Solutions Manual
DEBIT
CREDIT
4,395,800 4,000,000 395,800
175,832 4,168 180,000
June
30 InterestExpense…………………………. Premiumon BondsPayable.………...... Cash……………………………………. To pay semiannualinterestand amortizebonds.
175,665 4,335 180,000
Chapter 9
Liabilities
9-29
(15-20 min.) E 9-28A
1 2 3 4
A
B
C
D
E
Date
Interest Payment
Interest Expense
Discount Amortization
Discount Balance
F Bond Carrying Amount
$21,071
$278,929
5 Jan. 1, 2012 6 Dec. 31, 2012
$18,000
$19,525
$1,525
19,546
280,454
7 Dec. 31, 2013
18,000
19,632
1,632
17,914
282,086
8 Dec. 31, 2014
18,000
19,746
1,746
16,168
283,832
9 Dec. 31, 2015
18,000
19,868
1,868
14,300
285,700
10 Dec. 31, 2016
18,000
19,999
1,999
11 Dec. 31, 2017
18,000
20,139
2,139
10,162
289,838
12 Dec. 31, 2018
18,000
20,289
2,289
7,873
292,127
13 Dec. 31, 2019
18,000
20,449
2,449
5,424
294,576
14 Dec. 31, 2020
18,000
20,620
2,620
2,804
297,196
15 Dec. 31, 2021
18,000
20,804
2,804
0
300,000
12,301
Note: Computer-generatedsolutionsmaycontainslightroundingdifferences.
9-30
Financial Accounting 9/e Solutions Manual
287,699
(15-20 min.) E 9-29A Req. 1 The company has the right to occupy space and operate out of leased stores for several years to come. In return, the company is obligated to make payments amountingto over $2.6 billiondollarsto variouslandlords(lessors). Req. 2 The rights and obligations discussed in Req. 1 are classified as operating leases and are not reported on the balancesheet. Omitting them from the balance sheet improves (lowers)the company’sdebt and leverageratios.
Req. 3
In the future, the FASB and IASB are proposing to eliminate most operating leases. If this rule change occurs, companies like Abercrombie and Fitch Co. will have to capitalize leased property as assets and also record the related lease obligations as liabilities.
Chapter 9
Liabilities
9-31
(20-25 min.) E 9-30A Amounts in millions or billions Company Company Company B N V
Ratio Current ratio
=
Total currentassets Total currentliabilities
=
B Debt === = ratio
Total liabilities* Total assets**
=
¥5,321 ¥2,217
€144,720 € 72,000
= 1.89
= 2.40
= 2.01
N
V
$227+ $77 $429+ $81
¥2,217+ ¥2,277 ¥5,321+ ¥592
= 0.60
= 0.76
Total assets Leverage = = ratio Tot. stockholders’equity
=
€72,000+ €111,177 €144,720+ €65,828
= 0.87
B
N
$510 $206
¥5,913 ¥1,419
= 2.48
TimesinterestOperatingincome = earned Interestexpense ratio
$429 $227
= 4.17
V €210,548 €27,371
= 7.69
B
N
V
$295 $41
¥230 ¥27
€5,646 €655
= 7.2 times
= 8.5 times
= 8.6 times
_____
Assets Liabilities 9-32
Financial Accounting 9/e Solutions Manual
B
N
V
$510 $304
¥5,913 ¥4,494
€210,548 €183,177
Basedon theseratio values,CompanyN looksthe least risky.
Chapter 9
Liabilities
9-33
(15-20 min.) E 9-31A Req. 1 PLANB PLANA
ISSUE
BORROW
$600,000
$600,000
OF COMMON STOCK
AT 6%
Net incomebeforeexpansion…………………
$300,000
$300,000
Projectincomebeforeinterestand incometax
$500,000
$500,000
Lessinterestexpense($600,000× .06)……….
36,000
-0-
Projectincomebeforeincometax…………….
464,000
500,000
Less:incometax expense(25%)………………
(116,000)
(125,000)
Projectnet income……………………………….
348,000
375,000
Total companynet income…………………
$648,000
$675,000
Earningsper shareincludingnewproject: PlanA ($648,000/ 100,000shares)…….................. PlanB ($675,000/ 225,000shares)........................
9-34
Financial Accounting 9/e Solutions Manual
$6.48 $3.00
(continued) E 9-31A Req. 2 MEMORANDUM TO:
Boardof Directorsof PrimeNationFinancialServices
FROM:
StudentName
SUBJECT:
Financingplanto expandoperations
Plan A (borrowing) results in much higher earnings per share. Plan A also allows the existing stockholdersto retain control of the companybecausethe companyissues no new stock. But Plan A also creates more financial risk becauseborrowingobligates the companyto pay the interest and the principal of the debt. I prefer Plan A, assumingthe company’slevel of debt is not alreadytoo high.
Students can defend either plan based on their preferencesfor control of the business, avoidanceof risk, andhigherearningsper share.
Chapter 9
Liabilities
9-35
(5-15 min.) E 9-32B Req. 1 Journal DATE
ACCOUNTTITLESANDEXPLANATION
DEBIT
WarrantyExpense($176,000× .09)………… EstimatedWarrantyPayable……………..
15,840
EstimatedWarrantyPayable………………… Cash…………………………………………..
9,000
CREDIT
15,840
9,000
Req. 2 INCOMESTATEMENT Salesrevenue………………………………………… Warrantyexpense……………………………………
$176,000 15,840
BALANCESHEET Currentliabilities Estimatedwarrantypayable ($2,000+ $15,840− $9,000)……………….....
$ 8,840
Req. 3 Estimated warranty payable, a current liability, will cause a company’s current ratio to decrease.
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(10-15 min.) E 9-33B Journal DATE
2012 Oct.
Nov.
Dec.
ACCOUNTTITLESANDEXPLANATION
DEBIT
1 Cash………………………………………………… UnearnedSubscriptionRevenue…………... SalesTax Payable($2,100× .07)……………
2,247
15 SalesTax Payable………………………………... Cash……………………………………………..
147
31 UnearnedSubscriptionRevenue……………… SubscriptionRevenue($2,100× 3/12)……..
525
CREDIT
2,100 147
157
525
BALANCESHEET Currentliabilities: Unearnedsubscriptionrevenue($2,100− $525)……
$1,575
(10 min.) E 9-34B INCOMESTATEMENT Expenses: Payroll expense……………………………………….
$190,000
Payroll tax expense($190,000× .08)………………
15,200
BALANCESHEET Currentliabilities: Salarypayable…………………………………………
$ 8,000
Payroll tax payable…………………………………...
750
Chapter 9
Liabilities
9-37
(5-10 min.) E 9-35B Req. 1 Interestto accrueat Dec. 31, 2012
=
Final payment on October1, 2013
=
$84,000× .07 × 3/12
=
$1,470
Req. 2 $84,000+ ($84,000× .07)
=
Req. 3 Interestexpensefor: . = 2013 =
9-38
$84,000× .07 × 3/12 $84,000× .07 × 9/12
Financial Accounting 9/e Solutions Manual
= =
$1,470 $4,410
$89,880
(10-15 min.) E 9-36B McKinley’sbalancesheetat December31, 2013reported: Incometax payable…………………………………...
$436,000*
McKinley’s2013incomestatementreported: Incometax expense($1,600,000× .36)……………
$576,000
_____ *
Beginningincometax payable…………………….. + Incometax expense(andpayable)for the year ($1,600,000× .36)…………………………………… − Incometax paymentsduringthe year……………. = Endingincometax payable…………………………
$210,000 576,000 (350,000) $436,000
Chapter 9
Liabilities
9-39
(10-20 min.) E 9-37B Req. 1 Accounts payable are amounts owed to suppliers for products or services that have beenpurchasedon account. Accrued expenses are expenses that the companyhas incurred but not paid. They are liabilitiesfor expensessuchas interestand incometaxes. Employeecompensation and benefits are amounts owed to employeesfor salaries and otherpayroll-relatedexpenses. Current portion of long-term debt is next year’s payment on the company’s long-term debt. Long-term debt is the amount of long-term notes and bonds payable that the company expectsto pay after the comingyear. Postretirement benefits are the company’s liabilities for providing benefits — mainly healthcare— to retirees. The other liabilities are a catch-all group of liabilities that do not fit one of the more specific categories.The other liabilitiesare long-term, as shownby the fact that they are not listedamongthe currentliabilities.
9-40
Financial Accounting 9/e Solutions Manual
(continued) E 9-37B Req. 2 Total assets= $4,050million,the sumof total liabilitiesand stockholders’equity. (in millions)
2012
Leverage ratio
=
Debtratio
=
Total assets($4,050) Total stockholders’equity($2,027) Total liabilities($4,050− $2,027)* Total assets($4,050)
= 2.0 = 0.50
For 2011,the leverageratio was2.23 andthe debt ratio was.55. Boththe leverageratio and debt ratio improved. Therefore,the companyimproved. ____ *Or, $368+ $1,497+ $138+ $20 = $2,023
Req. 3 2012 Accounts payable turnover
Cost of goodssold Averageaccounts payable
$1,885 $159*
= 11.8
*($137+ $181) / 2
Dayspayable outstanding
365 Accts.payable turnover
365 11.8
Current ratio
Currentassets Currentliabilities
$643 $368
2011 $2,196 $188** = 11.6 **($181+ $195)/ 2
= 30.9
= 1.75
365 11.6
= 31.5
$610 $376
Chapter 9
= 1.62
Liabilities
9-41
Thecompany’sability to coveraccountspayableand currentliabilitiesover the year improved.
9-42
Financial Accounting 9/e Solutions Manual
(5-10 min.) E 9-38B Req. 1 Clark SecuritySystemsshouldreport this situationin a note to the financial statements. Thenoteshouldconveyessentiallythe samemessagegivenin Note14.
Req. 2 Clarkwouldreport: INCOMESTATEMENT Estimatedloss (or expense)………………
$2,000,000
BALANCESHEET Estimatedliability……………………………
$2,000,000
Thenotedisclosurewouldbe similarto Requirement1.
Journal DATE 2012
ACCOUNTTITLESANDEXPLANATION EstimatedLossfromDamageClaim EstimatedLiabilityfromDamageClaim
DEBIT
CREDIT
2,000,000 2,000,000
Chapter 9
Liabilities
9-43
(15-20 min.) E 9-39B JasperElectronics BalanceSheet(partial) June30, 2012 Currentliabilities: a. Estimatedwarrantypayable [$36,000+ ($2,100,000× .06) − $51,000]………
$111,000
b. Currentportionof long-termnote payable……...
11,250
Interestpayable($45,000× .07 × 1/12)……………
263
c. Unearnedsalesrevenue($130,000− $75,000)….
55,000
d. Employeewithheldincometax payable………….
30,300
FICAtax payable($300,000× .0765)………………
22,950
Total currentliabilities…………………………..
$230,763
Long-termliabilities: Notepayable($45,000− $11,250)……………........
9-44
Financial Accounting 9/e Solutions Manual
$ 33,750
(10-15 min.) E 9-40B Req. 1 Journal DATE
ACCOUNTTITLESANDEXPLANATION
a. Jan. 31 Cash($9,000,000× 0.93)……………… Discounton BondsPayable…………. BondsPayable……………………... To issuebondsat a discount.
DEBIT
CREDIT
8,370,000 630,000 9,000,000
b. July 31 InterestExpense....................................... Cash($9,000,000× .09 × 6/12)................. Discounton BondsPayable ($630,000/ 20)................................... To pay interestand amortizebonds.
436,500
c. Dec. 31 InterestExpense....................................... InterestPayable ($9,000,000× .09 × 5/12)..................... Discounton BondsPayable ($31,500× 5/6)................................... To accrueinterestandamortizebonds.
363,750
405,000 31,500
337,500 26,250
Chapter 9
Liabilities
9-45
(10-15 min.) E 9-41B
1. Cashreceived= $300,000× 1.01 =
$303,000
2. Principal………………………………………………………
$300,000
Interest($300,000× .06 × 20)……………………..............
360,000
Total cashpaid………………………………………………
$660,000
3. Total cashpaid………………………………………………
$660,000
Less: Cashreceived……………………………………...
(303,000)
Difference= Total interestexpense……………………...
$357,000
4. Annualinterestexpenseby the straight-line amortizationmethod: $300,000× (1.01− 1.00) 20
$300,000× .06
same $18,000
Cashinterestpayment
−
$150
=
$ 17,850
Premiumamortization × 20 years
Total interestexpenseover the life of the bonds
9-46
Financial Accounting 9/e Solutions Manual
$357,000
(15-20 min.) E 9-42B Req. 1 (amortization table) A
SEMIANNUAL INTEREST DATE
INTEREST PAYMENT (6%OF MATURITY VALUE)
B INTEREST EXPENSE (7%OF PRECEDING BOND CARRYING AMOUNT)
C
DISCOUNT AMORTIZATION (B – A)
D
DISCOUNT ACCOUNT BONDCARRYING BALANCE AMOUNT (PRECEDING ($3,200,000– D) D – C)
Dec. 31, 2012 June30, 2013
$192,000
Dec. 31, 2013
192,000
June30, 2014
192,000
Dec. 31, 2014
192,000
$200,270 200,849 201,468 202,131
E
$339,000
$2,861,000
$8,270
330,730
2,869,270
8,849
321,881
2,878,119
9,468
312,413
2,887,587
302,282
2,897,718
10,131
Req. 2 Journal DATE
ACCOUNTTITLESANDEXPLANATION
2012 Dec. 31 Cash........................................................... Discounton BondsPayable........................... BondsPayable........................................ To issuebondsat a discount. 2013 June 30 InterestExpense.......................................... Cash....................................................... Discounton BondsPayable...................... To pay semiannualinterestand amortizebonds. 2013 Dec. 31 InterestExpense.......................................... Cash....................................................... Discounton BondsPayable......................
DEBIT
CREDIT
2,861,000 339,000 3,200,000
200,270 192,000 8,270
200,849 192,000 8,849 Chapter 9
Liabilities
9-47
To pay semiannualinterestand amortizebonds.
9-48
Financial Accounting 9/e Solutions Manual
(15-20 min.) E 9-43B Req. 1 (amortization table) A
SEMIANNUAL INTEREST DATE
INTEREST PAYMENT (4%OF MATURITY VALUE)
B INTEREST EXPENSE (3-1/2%OF PRECEDING BOND CARRYING AMOUNT)
C
PREMIUM AMORTIZATION (A – B)
D
E
PREMIUM ACCOUNT BONDCARRYING BALANCE AMOUNT (PRECEDING ($1,600,000+ D) D – C)
June30, 2012
$188,000
$1,788,000
Dec. 31, 2012
$64,000
$62,580
$1,420
186,580
1,786,580
June30, 2013
64,000
62,530
1,470
185,110
1,785,110
Dec. 31, 2013
64,000
62,479
1,521
183,589
1,783,589
June30, 2014
64,000
62,426
1,574
182,015
1,782,015
ACCOUNTTITLESANDEXPLANATION
DEBIT
_____ $1,600,000× 1.1175= $1,788,000
1
Req. 2 (journal entries) Journal DATE
2012 June 30 Cash($1,600,000× 1.1175)……….. BondsPayable………………… Premiumon BondsPayable… To issuebondsat a premium. Dec.
31 InterestExpense……………………. Premiumon BondsPayable……… Cash………………………………. To pay semiannualinterestand amortizebonds.
CREDIT
1,788,000
1,600,000 188,000
62,580 1,420 64,000
2013 Chapter 9
Liabilities
9-49
June
9-50
30 InterestExpense……………………. Premiumon BondsPayable.……... Cash……………………………….. To pay semiannualinterestand amortizebonds.
Financial Accounting 9/e Solutions Manual
62,530 1,470 64,000
(15-20 min.) E 9-44B A
B
C
D
E
F
1
Bond
2 3
Date
Interest
Interest
Discount
Discount
Carrying
Payment
Expense
Amortization
Balance
Amount
$33,120
$416,880
4 5 Jan. 1, 2012 6 Dec. 31, 2012
$22,500
$25,013
$2,513
30,607
419,393
7 Dec. 31, 2013
22,500
25,164
2,664
27,943
422,057
8 Dec. 31, 2014
22,500
25,323
2,823
25,120
424,880
9 Dec. 31, 2015
22,500
25,493
2,993
22,127
427,873
10 Dec. 31, 2016
22,500
25,672
3,172
11 Dec. 31, 2017
22,500
25,863
3,363
15,592
434,408
12 Dec. 31, 2018
22,500
26,064
3,564
12,028
437,972
13 Dec. 31, 2019
22,500
26,278
3,778
8,250
441,750
14 Dec. 31, 2020
22,500
26,505
4,005
4,245
445,755
15 Dec. 31, 2021
22,500
26,745
4,245
0*
450,000*
18,955
431,045
*Note: Computer-generatedsolutionsmaycontainslightroundingdifferences.
Chapter 9
Liabilities
9-51
(15-20 min.) E 9-45B Req. 1 The company has the right to occupy space and operate out of leased stores for several years to come. In return, the company is obligated to make payments amountingto over $1 billion dollars to variouslandlords(lessors). A very small portion of thesepaymentsmaybe offsetby receiptsfromsub-leasesto othertenants. Req. 2 The rights and obligations discussed in Req. 1 are classified as operating leases and are not reported on the balancesheet. Omitting them from the balance sheet improves (lowers)the company’sdebt and leverageratios.
Req. 3
In the future, the FASB and IASB are proposing to eliminate most operating leases. If this rule change occurs, companies like Ann Taylor Stores Corporation will have to capitalize leased property as assets and also record the related lease obligations as liabilities.
9-52
Financial Accounting 9/e Solutions Manual
(20-25 min.) E 9-46B Amounts in millions or billions Compan y Company K R
Company Ratio
F
Current Total currentassets = ratio Total currentliabilities
Debt Total liabilities = ratio Total assets
=
=
¥5,383 ¥2,197
€148,526 €72,100
= 2.10
= 2.45
= 2.06
F
K
$207+ $107 $434+ $96
¥2,197+ ¥2,318 ¥5,383+ ¥405
= 0.59
= 0.78
Total assets Leverage = = ratio Tot. stockholders’equity
Timesinterest- Operatingincome = earned Interestexpense ratio
$434 $207
=
R €72,100+ €110,107 €148,526+ €49,525 = 0.92
F
K
$530 $216
¥5,788 ¥1,273
R €198,051 €15,844
= 2.45
= 4.55
= 12.50
F
K
R
$292 $46
¥224 ¥33
€5,592 €736
= 6.4 times
= 6.8 times
= 7.6 times
_____
Assets
F
K
R
$530
¥5,788
€198,051
Chapter 9
Liabilities
9-53
Liabilities
$314
¥4,515
Basedon theseratio values,CompanyK looksthe least risky.
9-54
Financial Accounting 9/e Solutions Manual
€182,207
(15-20 min.) E 9-47B Req. 1
PLANA BORROW $900,000 AT 10%
PLANB ISSUE $900,000 OF COMMON STOCK
Net incomebeforeexpansion……………………..
$600,000
$600,000
Projectincomebeforeinterestand incometax..
$800,000
$800,000
Less:interestexpense($900,000× .10)…………
(90,000)
-0-
Projectincomebeforeincometax……………….
710,000
800,000
Less:incometax expense(40%)…………………
(284,000)
(320,000)
Projectnet income…………………………………..
426,000
480,000
Total companynet income…………………….
$1,026,000
$1,080,000
Earningsper shareincludingnewproject: PlanA ($1,026,000/ 200,000shares)…………
$5.13
PlanB ($1,080,000/ 450,000shares)………...
$2.40
Chapter 9
Liabilities
9-55
(continued) E 9-47B Req. 2
MEMORANDUM TO:
Boardof Directorsof UnitedNationFinancialServices
FROM: SUBJECT:
StudentName Financingplanto expandoperations
Plan A (borrowing) results in much higher earnings per share. Plan A also allows the existing stockholdersto retain control of the companybecausethe companyissues no new stock. But Plan A also creates more financial risk becauseborrowingobligates the companyto pay the interest and the principal of the debt. I prefer Plan A, assumingthe company’slevel of debt is not alreadytoo high.
Students can defend either plan based on their preferencesfor control of the business, avoidanceof risk, andhigherearningsper share.
9-56
Financial Accounting 9/e Solutions Manual
Quiz
Q9-48
d
Q9-49
a
Q9-50
d
Q9-51
c
Q9-52
a
Q9-53
b
Q9-54
d
Q9-55
a
Q9-56
f
Q9-57
b
Q9-58
c
Q9-59
b
Q9-60
Q9-61
[($650,000+ $850,000)× .07] – $5,200− $42,500= $57,300
($400,000× .13) + [($400,000− $388,000)/ 10] = $53,200
InterestExpense………………………………….. Discounton BondsPayable ($12,000/ 10 × 9/12)………………………… InterestPayable($400,000× .13 × 9/12)…...
39,900
InterestPayable……………………….................. InterestExpense………………………………….. Discounton BondsPayable ($12,000/ 10 × 3/12)…………………………. Cash($400,000× .13)…………………...........
39,000 13,300
Q9-62
d
Q9-63
c
Q9-64
c
Q9-65
c
Q9-66
a
900 39,000
300 52,000
($295,000 x .07) = $20,650)
Chapter 9
Liabilities
9-57
9-58
Financial Accounting 9/e Solutions Manual
Problems
(15-20 min.) P 9-67A a. Salestax payable($150,000× .06)..................………………………………
$9,000
b. Notepayable,short-term..................…………………………………………
$81,000
Interestpayable($81,000× .04 × 4/12).................. …………………………
1,080
c. Unearnedservicerevenue($3,000× 4/6)..................………………………
$1, 000
d. Estimatedwarrantypayable ($11,300+ $32,000− $34,500)................. ………………………………...
$8,800
e. Portionof long-termnotepayabledue withinone year.................. ………………………………………………….
$20,000
Interestpayable($100,000× .06).................. ………………………………..
6,000
Chapter 9
Liabilities
9-59
(30-40 min.) P 9-68A Journal DATE
ACCOUNTTITLESANDEXPLANATION
DEBIT
2012 Mar. 3 Inventory............................................................. NotePayable,Short-term...................................
50,000
May
31 Cash................................................................... NotePayable,Short-term................................... NotePayable,Long-term...................................
85,000
3 NotePayable,Short-term....................................... InterestExpense($50,000× .08 × 6/12)…… Cash...............................................................
50,000 2,000
31 WarrantyExpense($196,000× .025)........................ EstimatedWarrantyPayable..............................
4,900
31 InterestExpense($85,000× .08 × 7/12) InterestPayable............................................... 2013 May 31 NotePayable,Short-term....................................... InterestPayable................................................... InterestExpense($85,000× .08 × 5/12)…… Cash...............................................................
3,967
Sept.
Dec.
9-60
Financial Accounting 9/e Solutions Manual
CREDIT
50,000
17,000 68,000
52,000
4,900
3,967 17,000 3,967 2,833 23,800
(20-25 min.) P 9-69A Req. 1 Journal DATE
ACCOUNTTITLESANDEXPLANATION
2012 a. May 31 Cash($7,000,000× 1/2)…………...... BondsPayable……………………. To issuebondsat par. b. Nov. 30 InterestExpense…………………...... Cash($3,500,000× .09 × 6/12)…. To pay intereston bonds. c. Dec. 31 InterestExpense ($3,500,000× .09 × 1/12)…………….. InterestPayable………………...... To accrueinterest. 2013 d. May 31 InterestPayable………………………. InterestExpense ($3,500,000× .09 × 5/12)…………….. Cash($3,500,000× .09 × 6/12)….. To pay intereston bonds.
DEBIT
CREDIT
3,500,000 3,500,000
157,500 157,500
26,250 26,250
26,250 131,250 157,500
Req. 2 (reporting the liabilities on the balance sheet at December 31, 2012) Currentliabilities: Interestpayable.....................................................
$ 26,250
Long-termliabilities: Bondspayable......................................................
$3,500,000
Chapter 9
Liabilities
9-61
9-62
Financial Accounting 9/e Solutions Manual
30-40 min.) P 9-70A Req. 1 The 6% bondsissuedwhenthe market interest rate is 5% will be priced at a premium. They are relativelyattractivein this market, so investorswill pay a price abovepar value to acquirethem.
Req. 2 The 6% bondsissuedwhen the market interest rate is 7% will be priced at a discount. Theyare relativelyunattractivein this market,so investorswill pay less thanpar valueto acquirethem.
Chapter 9
Liabilities
9-63
(continued) P 9-70A Req. 3 Journal DATE
ACCOUNTTITLESANDEXPLANATION
2012 a. Feb. 28 Cash($900,000× .96)...................................... Discounton BondsPayable............................. BondsPayable........................................... To issuebondsat a discount. b. Aug.
c. Dec.
DEBIT
CREDIT
864,000 36,000 900,000
31 InterestExpense............................................. Cash($900,000× .06 × 6/12)......................... Discounton BondsPayable ($36,000/ 20)........................................... To pay interestand amortizebonds.
28,800
31 InterestExpense............................................. InterestPayable($27,000× 4/6).................... Discounton BondsPayable ($1,800× 4/6)........................................... To accrueinterestandamortizebonds.
19,200
2013 d. Feb. 28 InterestPayable(fromDec. 31)…………. InterestExpense............................................. Cash($900,000× .06 × 6/12)......................... Discounton BondsPayable ($1,800× 2/6)........................................... To pay interestand amortizebonds.
27,000 1,800
18,000 1,200
18,000 9,600 27,000 600
Req. 4 (reporting the liabilities on the balance sheet at December 31, 2012) Currentliabilities: Interestpayable……………………………. Long-termliabilities: 9-64
Financial Accounting 9/e Solutions Manual
$ 18,000
Bondspayable……………………………... Less: Discounton bondspayable ($36,000− $1,800- $1,200)……..
$900,000 (33,000)
Chapter 9
867,000
Liabilities
9-65
(30-40 min.) P 9-71A Req. 1 Journal DATE
ACCOUNTTITLESANDEXPLANATION
2012 Jan. 1 Cash($4,000,000× .95)...................................... Discounton BondsPayable............................... BondsPayable…………………………... To issuebondsat a discount. July
DEBIT
3,800,000 200,000 4,000,000
1 InterestExpense.............................................. Cash($4,000,000× .06 × 6/12)........................ Discounton BondsPayable ($200,000/ 20)........................................... To pay interestand amortizebonds.
130,000
Dec. 31 InterestExpense.............................................. InterestPayable ($4,000,000× .06 × 6/12).............................. Discounton BondsPayable………….............. To accrueinterestand amortizebonds. 2013 Jan. 1 InterestPayable............................................... Cash........................................................... To pay interest. 2022 Jan. 1 BondsPayable................................................. Cash........................................................... To pay bondsat maturity.
130,000
9-66
Financial Accounting 9/e Solutions Manual
CREDIT
120,000 10,000
120,000 10,000
120,000 120,000
4,000,000 4,000,000
(continued) P 9-71A Req. 2 Carrying amount at December 31, 2012. Bondspayable,net ($4,000,000− $200,000+ $10,000+ $10,000)………
$3,820,000
Req. 3 a. Interestexpense
= $130,000
b. Cashinterestpaid
= $120,000
Interestexpenseexceedscashinterestpaid becausethe companyissuedthe bondsat a discountand must pay back the full face value of the bondsat maturity. Amortizationof the bond discount causes the interest expense on the bonds to exceed the amount of cashinterestpaid.
Chapter 9
Liabilities
9-67
(30-45 min.) P 9-72A Req. 1 a. Maturityvalueis $5,000,000 b. Annualcashinterestpaymentis $300,000 ($5,000,000× .06) c. Carryingamountis $4,479,360
Req. 2 (amortization table) A
ANNUAL INTEREST DATE
B C INTEREST EXPENSE INTEREST (8% OF PAYMENT PRECEDING (6% OF BOND DISCOUNT MATURITY CARRYING AMORTIZATION VALUE) AMOUNT) (B – A)
Dec. 31, Yr. 1
D
E
DISCOUNT ACCOUNT BOND BALANCE CARRYING (PRECEDIN AMOUNT G ($5,000,000–D) D – C)
$520,640
$4,479,360
Dec. 31, Yr. 2
$300,000
$358,349
$58,349
462,291
4,537,709
Dec. 31, Yr. 3
300,000
363,017
63,017
399,274
4,600,726
Dec. 31, Yr. 4
300,000
368,058
68,058
331,216
4,668,784
Interestexpensefor the year endedDecember31, Year 4, is $368,058.
Req. 3 (reporting the liabilities at December 31, Year 4) Currentliabilities: Currentinstallmentof notespayable…….. Long-termliabilities: 9-68
Financial Accounting 9/e Solutions Manual
$ 55,000
Bondspayable………………………………...
$5,000,000
Less:Discounton bondspayable……….
(331,216)
Notespayable…………………………………
4,668,784 275,000
Chapter 9
Liabilities
9-69
(40-50 min.) P 9-73A Req. 1 (amortization table) A
SEMIANNUAL INTEREST DATE
INTEREST PAYMENT (5.5%OF MATURITY VALUE)
B INTEREST EXPENSE (6%OF PRECEDING BOND CARRYING AMOUNT)
C
DISCOUNT AMORTIZATION (B – A)
12-31-12
E
DISCOUNT ACCOUNT BONDCARRYING BALANCE AMOUNT (PRECEDING ($4,000,000– D) D – C)
$229,400
$3,770,600*
6-30-13
$220,000
$226,236
$6,236
223,164
3,776,836
12-31-13
220,000
226,610
6,610
216,554
3,783,446
6-30-14
220,000
227,007
7,007
209,547
3,790,453
12-31-14
220,000
227,427
7,427
202,120
3,797,880
_____ *$4,000,000× .94265= $3,770,600
9-70
D
Financial Accounting 9/e Solutions Manual
(continued) P 9-73A Req. 2 Journal DATE
ACCOUNTTITLESANDEXPLANATION
DEBIT
2012 a. Dec. 31 Cash($4,000,000× .94265)........................... Discounton BondsPayable......................... ConvertibleBondsPayable...................... To issuebondsat a discount. 2013 b. June 30 InterestExpense......................................... Cash..................................................... Discounton BondsPayable..................... To pay interestand amortizebonds.
CREDIT
3,770,600 229,400 4,000,000
226,236 220,000 6,236
c. Dec. 31 InterestExpense......................................... Cash..................................................... Discounton BondsPayable..................... To pay interestand amortizebonds. 2014 d. July 1 ConvertibleBondsPayable.......................... Discounton BondsPayable ($209,547× 2/5)................................... CommonStock(90,000× $1).................... Paid-in Capital in Excessof Par — Common.................................. To recordconversionof bonds.
226,610 220,000 6,610
1,600,000 83,819 90,000 1,426,181
Req. 3 (balance sheet presentation of bonds payable at December 31, 2014) Convertiblebondspayable ($4,000,000− $1,600,000)..................................... Less:Discounton bondspayable ($202,120× 3/5*).................................................
$2,400,000 (121,272) Chapter 9
2,278,728 Liabilities
9-71
_____ *3/5 of the bondsare outstanding,so 3/5 of the discount remains.
9-72
Financial Accounting 9/e Solutions Manual
(20-30 min.) P 9-74A Req. 1 TO: FROM:
Managementof TonySportingGoods StudentName
SUBJECT: Advantagesanddisadvantagesof borrowing versusissuingstockto raisecashfor expansion Raising money by borrowing has at least two advantages over issuing commonstock. Borrowing does not change the present ownership of the business. It enables the present owners to keep their proportionate interests in the business and to carry out their plans without interference from a new group of stockholders. Under normal conditions, borrowingresults in a higher earningsper share of commonstock, because the interestexpenseon the debt is tax-deductible.Andhigherearningsper shareusually lead to higherstockpricesfor companyowners. The main disadvantage of borrowing is that the debt increases the financial risk of the company. The principal and the related interest expense must be paid whether the company is earning a profit or not. If times get sufficiently bad, the debt burden could threatenthe ability of the businessto continueas a goingconcern. The main advantageof issuingstock is that ownersavoid the burdenof makinginterest and principal paymentson the debt. Issuingstock createsno liability to pay anythingto the owners. If the directors consider it necessary, they can refuse to pay dividends in orderto conservecash.Therefore,it is safer to issuestock.
Chapter 9
Liabilities
9-73
(continued) P 9-74A
One disadvantage of issuing stock is dilution of the ownership interests of existing stockholders if the purchasers of new stock are outsiders. The new stockholders may havedifferentideasabouthowto managethe businessand that mayposedifficultiesfor the original stockholder group. Another disadvantage of issuing stock is that earnings per share are usually lower because of (1) the greater number of shares of stock outstanding,and(2) the non-tax-deductibilityof dividendspaid on the stock. There is insufficient information available upon which to make a decision. Tony’s managementmust preparebudgetswhichindicatethe impactof the newstoresin terms of net incomeand cash flow. Managementmust also estimatethe cost of borrowingthe funds.
Studentresponsesmayvary.
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Financial Accounting 9/e Solutions Manual
(20-30 min.) P 9-75A Req. 1 BrightonFoods,Inc. Partial BalanceSheet December31, 2012 Property,plant, and equipment: Equipment...................
Currentliabilities:* $744,000
Accumulated depreciation..............
Mortgagenote payable,current....................
(166,000) 578,000
$ 92,000
Bondspayable, currentportion.....................
500,000
Interestpayable......................
75,000
Total currentliabilities................
667,000
Long-termliabilities: Mortgagenote payable................................
$ 318,000
Bondspayable….$200,000 Discounton bondspayable…. (25,000)*
175,000
Pensionliability......................
30,000**
Total long-termliabilities............
523,000
Notes: * The orderof listingcurrentliabilitiesand long-termliabilitiesis optional. However, Discount on BondsPayableshouldcomeimmediatelyafter Bonds Payable. Also, it is customaryto report Interest Payable after the related liability accounts, Mortgage Note Payable and Bonds Payable, Current Portion. ** Computationof pensionliability: Accumulatedpensionbenefit obligation…………….……............ Less:Pensionplanassets, at marketvalue………………............ Pensionliability to be reportedon the balancesheet…………...
$450,000 (420,000) $ 30,000 Chapter 9
Liabilities
9-75
(continued) P 9-75A Req. 2 a.
b.
Carryingamountof bondspayable: Currentportion…………………………………. Long-termportion($200,000− $25,000)……. Carryingamount………………………………..
$ 500,000 175,000 $675,000
Interest payableis the amountof interest that Brightonowesat year end. Interest expenseis the company’scost of borrowingfor the full year.
Req. 3 Times-interest-earnedratio
= =
Operatingincome Interestexpense
=
$370,000 $229,000
1.62 times
Req. 4 Leverage ratio Debtratio
= =
Total assets($4,500,000) Total stockholders’equity($3,310,000) Total liabilities[$1,190,000= $667,000+ $523,000] Total assets($4,500,000)
= 1.36 = 0.26
The company’s debt ratio and leverage ratios are low, and operating income covers interest paymentsby 1.62 times. With this limited information, the companyappearsto be low risk from a leverage point of view. Additional information from prior years and competitorswouldalso be helpful.
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Financial Accounting 9/e Solutions Manual
(continued) P 9-75A Req. 5 Leverage ratio Debtratio
= =
Total assets($7,500,000) Total stockholders’equity($3,310,000) Total liabilities($4,190,000) Total assets($7,500,000)
= 2.26 = 0.56
Theleverageratio and debt ratio wouldincrease. The companywouldstill be consideredhealthy(averagerisk) froma leveragepoint of view.
Chapter 9
Liabilities
9-77
(15-20 min.) P 9-76B a. Salestax payable($130,000× .07)...................................................
$9,100
b. Notepayable,short-term...............................................................
$80,000
Interestpayable($80,000× .06 × 4/12).............................................
1,600
c. Unearnedservicerevenue($3,000× 2/6)..........................................
$1,000
d. Estimatedwarrantypayable ($11,800+ $34,000− $34,800)....................................................
$11,000
e. Portionof long-termnotepayabledue withinone year........................................................................
$30,000
Interestpayable($90,000× .06)......................................................
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Financial Accounting 9/e Solutions Manual
5,400
(30-40 min.) P 9-77B Journal DATE
ACCOUNTTITLESANDEXPLANATION
DEBIT
CREDIT
2012 Mar. 3 Inventory…………………………………… NotePayable,Short-term…………….
70,000
May
31 Cash…………………………………………. NotePayable,Short-term……………. NotePayable,Long-term……………..
70,000
3 NotePayable,Short-term………………... InterestExpense($70,000× .06 × 6/12).. Cash……………………………………...
70,000 2,100
31 WarrantyExpense($194,000× .02)……. EstimatedWarrantyPayable………...
3,880
Sept.
Dec.
Dec.
70,000
14,000 56,000
72,100
3,880
31 InterestExpense ($70,000× .05 × 7/12)…………………….. InterestPayable………………………..
2,042
2013 May 31 NotePayable,Short-term……………….. InterestPayable…………………………… InterestExpense($70,000× 0.05 × 5/12) Cash[$14,000+ ($70,000× .05)] …...
14,000 2,042 1,458
2,042
17,500
Chapter 9
Liabilities
9-79
(20-25 min.) P 9-78B Req. 1 Journal DATE
2012 a. May
b. Nov.
c. Dec.
2013 d. May
ACCOUNTTITLESANDEXPLANATION
DEBIT
31 Cash...................................................... BondsPayable.................................... To issuebondsat par.
4,000,000 4,000,000
30 InterestExpense……………….......... Cash($4,000,000× .06 × 6/12)….. To pay intereston bonds.
120,000 120,000
31 InterestExpense ($4,000,000× .06 × 1/12)............................ InterestPayable.................................. To accrueinterest.
20,000 20,000
31 InterestPayable....................................... InterestExpense ($4,000,000× .06 × 5/12)............................ Cash……………………………….. To pay intereston bonds.
20,000 100,000 120,000
Req. 2 (reporting the liabilities on the balance sheet at December 31, 2012) Currentliabilities: Interestpayable…………………………….
$
Long-termliabilities: Bondspayable……………………………...
$4,000,000
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Financial Accounting 9/e Solutions Manual
CREDIT
20,000
(30-40 min.) P 9-79B
Req. 1 The 10%notesissuedwhenthe market interest rate is 9% will be pricedat a premium. They are relativelyattractivein this market, so investorswill pay a price abovepar value to acquirethem.
Req. 2 The 10%notesissuedwhenthe marketinterestrate is 11%will be pricedat a discount. Theyare relativelyunattractivein this market,so investorswill pay less thanpar valueto acquirethem.
Chapter 9
Liabilities
9-81
(continued) P 9-79B Req. 3 Journal DATE
ACCOUNTTITLESANDEXPLANATION
DEBIT
2012 a. Feb. 28 Cash($1,200,000× 0.96)……………………… Discounton BondsPayable…………………. BondsPayable……………………………… To issuebondspayableat a discount.
CREDIT
1,152,000 48,000 1,200,000
b. Aug. 31 InterestExpense……………………………….. Discounton BondsPayable($48,000/ 10) Cash($1,200,000× .05 × 6/12)……………. To pay interestandamortizebondspayable.
64,800
c. Dec. 31 InterestExpense……………………………….. Discounton BondsPayable($4,800× 4/6) InterestPayable($60,000× 4/6)………….. To accrueinterestand amortizebondspayable. 2022 d. Feb. 28 InterestPayable(fromDec. 31)……………… InterestExpense……………………………….. Discounton BondsPayable($4,800× 2/6) Cash($1,200,000× .10 × 6/12)…………… To pay interestandamortizebondspayable.
43,200
Req. 4
4,800 60,000
3,200 40,000
40,000 21,600 1,600 60,000
(reporting the liabilities on the balance sheet at December 31, 2012)
Currentliabilities: Interestpayable...................................................
$ 40,000
Long-termliabilities: Bondspayable..................................................... Less: Discounton bondspayable 9-82
Financial Accounting 9/e Solutions Manual
$1,200,000
($48,000− $4,800− $3,200)..................................
(40,000)
Chapter 9
1,160,000
Liabilities
9-83
(30-40 min.) P 9-80B Req. 1 Journal DATE
ACCOUNTTITLESANDEXPLANATION
2012 Jan. 1 Cash($3,000,000× .94)........................................ Discounton BondsPayable.................................. BondsPayable................................................ To issuebondsat a discount.
DEBIT
2,820,000 180,000 3,000,000
July 1 InterestExpense................................................. Cash($3,000,000× .08 × 6/12)........................... Discounton BondsPayable ($180,000/ 20).............................................. To pay interestand amortizebonds.
129,000
Dec. 31 InterestExpense................................................. InterestPayable($3,000,000× .08 × 6/12) Discounton BondsPayable ($180,000/ 20)…………………………… To accrueinterestandamortizebonds. 2013 Jan. 1 InterestPayable………………………………. Cash………………………………………… To pay interest. 2022 Jan. 1 BondsPayable………………………………… Cash…………………………………………. To pay off bondsat maturity.
129,000
9-84
Financial Accounting 9/e Solutions Manual
CREDIT
120,000 9,000
120,000 9,000
120,000 120,000
3,000,000 3,000,000
(continued) P 9-80B Req. 2 Carrying amount at December 31, 2012: Bondspayable,net ($3,000,000− $180,000+ $9,000+ $9,000)= $2,838,000
Req. 3 a. Interestexpense
= $129,000
b. Cashinterestpaid
= $120,000
Interestexpenseexceedscashinterestpaid becausethe companyissuedthe bondsat a discountand must pay back the full face value of the bondsat maturity. Amortizationof the bonds causes the interest expense on the bonds to exceed the amount of cash interestpaid.
Chapter 9
Liabilities
9-85
(30-45 min.) P 9-81B Req. 1 a.
Maturityvalueis $4,000,000.
b.
Annualcashinterestpaymentis $200,000($4,000,000× .05).
c.
Carryingamountis $3,568,850.
Req. 2 (amortization table) A
ANNUAL INTEREST DATE
INTEREST PAYMENT (5%OF MATURITY VALUE)
B INTEREST EXPENSE (7%OF PRECEDING BOND CARRYING AMOUNT)
C
D
E
DISCOUNT AMORTIZATION (B – A)
DISCOUNT ACCOUNT BALANCE (PRECEDING D – C)
BONDCARRYING AMOUNT ($4,000,000– D)
$431,150
$3,568,850
Dec. 31, Yr. 1 Dec. 31, Yr. 2
$200,000
$249,820
$49,820
381,331
3,618,670
Dec. 31, Yr. 3
200,000
253,307
53,307
328,024
3,671,976
Dec. 31, Yr.4
200,000
257,038
57,038
270,985
3,729,015
Interestexpensefor the year endedDecember31, Year 4 is $257,038.
Req. 3 (reporting the liabilities at December 31, Year 4) Currentliabilities: Currentportionof notespayable............................
$ 40,000
Long-termliabilities: Bondspayable..................................................... Less:Discounton bondspayable……….. 9-86
Financial Accounting 9/e Solutions Manual
$4,000,000 (270,985)
3,729,015
Notespayable ($360,000− $60,000)...........................................
200,000
Chapter 9
Liabilities
9-87
(40-50 min.) P 9-82B Req. 1 (amortization table) A
SEMIANNUAL INTEREST DATE
B INTEREST EXPENSE (3%OF PRECEDING BOND CARRYING AMOUNT)
INTEREST PAYMENT (2-1/2%OF MATURITY VALUE)
C
DISCOUNT AMORTIZATION (B – A)
12-31-12 6-30-13
D
DISCOUNT ACCOUNT BONDCARRYING BALANCE AMOUNT (PRECEDING ($5,000,000- D) D – C)
$372,000 $125,000
$138,840
$13,840
E
$4,628,000*
358,160
4,641,840
12-31-13
125,000
139,255
14,255
343,905
4,656,095
6-30-14
125,000
139,683
14,683
329,222
4,670,778
12-31-14
125,000
140,123
15,123
314,099
4,685,901
_____ *$5,000,000× .9256= $4,628,000
9-88
Financial Accounting 9/e Solutions Manual
(continued) P 9-82B Req. 2 Journal DATE
ACCOUNTTITLESANDEXPLANATION
DEBIT
CREDIT
2012 a. Dec.
31 Cash($5,000,000× .9256)................................. Discounton BondsPayable……………… ConvertibleBondsPayable........................... To issuebondsat a discount.
4,628,000 372,00 5,000,000
2013 b. June 30 InterestExpense............................................. Cash......................................................... Discounton BondsPayable......................... To pay interestand amortizebonds. c. Dec.
2014 d. July
138,840 125,000 13,840
31 InterestExpense............................................. Cash.......................................................... Discounton BondsPayable.......................... To pay interestand amortizebonds.
139,255
1 ConvertibleBondsPayable............................... Discounton BondsPayable ($329,222× 2/5)......................................... CommonStock(90,000× $1)......................... Paid-in Capital in Excessof Par — Common........................................
2,000,000
125,000 14,255
131,689 90,000 1,778,311
To recordconversionof bonds.
Req. 3 (balance sheet presentation of bonds payable at December 31, 2014) Convertiblebondspayable ($5,000,000− $2,000,000)............................................ Less: Discounton bondspayable
$3,000,000
Chapter 9
Liabilities
9-89
($314,099 × 3/5)*……………………………….…. _____ *3/5 of the bondsare outstanding,so 3/5 of the discountremains.
9-90
Financial Accounting 9/e Solutions Manual
(188,459)
$2,811,541
(15-30 min.) P 9-83B TO: FROM:
Managementof Marco’sSportingGoods StudentName
SUBJECT: Advantagesanddisadvantagesof borrowing versusissuingstockto raisecashfor expansion Raising money by borrowing has at least two advantages over issuing commonstock. Borrowing does not change the present ownership of the business. It enables the present owners to keep their proportionate interests in the business and to carry out their plans without interference from a new group of stockholders. Under normal conditions, borrowingresults in a higher earningsper share of commonstock, because the interestexpenseon the debt is tax-deductible.Andhigherearningsper shareusually lead to higherstockpricesfor companyowners. The main disadvantage of borrowing is that the debt increases the financial risk of the company. The principal and the related interest expense must be paid whether the company is earning a profit or not. If times get sufficiently bad, the debt burden could threatenthe ability of the businessto continueas a goingconcern.
The main advantageof issuingstock is that ownersavoid the burdenof makinginterest and principal paymentson the debt. Issuingstock createsno liability to pay anythingto the owners. If the directors consider it necessary, they can refuse to pay dividends in orderto conservecash.Therefore,it is safer to issuestock.
Chapter 9
Liabilities
9-91
(continued) P 9-83B One disadvantage of issuing stock is dilution of the ownership interests of existing stockholders if the purchasers of new stock are outsiders. The new stockholders may havedifferentideasabouthowto managethe businessand that mayposedifficultiesfor the original stockholder group. Another disadvantage of issuing stock is that earnings per share are usually lower because of (1) the greater number of shares of stock outstanding,and(2) the non-tax-deductibilityof dividendspaid on the stock. There is insufficient information available upon which to make a decision. Marco’s managementmust preparebudgetswhichindicatethe impactof the newstoresin terms of net incomeand cash flow. Managementmust also estimatethe cost of borrowingthe funds. Studentresponsesmayvary.
9-92
Financial Accounting 9/e Solutions Manual
(20-30 min.) P 9-84B Req. 1 BraintreeFoods,Inc. Partial BalanceSheet December31, 2012 Property,plant, and equipment: Equipment…….
Currentliabilities:* $745,000
Accumulated depreciation…
Bondspayable, currentportion…………..
(162,000) 583,000
$ 420,000
Mortgagenotepayable, currentportion………….
97,000
Interestpayable……………
74,000
Total currentliabilities……...
591,000
Long-termliabilities: Mortgagenote payable……………………
$ 314,000
Bondspayable…$1,680,000 Less:Discounton bondspayable.. (22,000)*
1,658,000
Pensionliability……………
45,000**
Total long-termliabilities…...
2,017,000
_____ Notes: * Theorderof listinglong-termliabilitiesis optional.However,Discounton Bonds Payable shouldcomeimmediatelyafter BondsPayable.Also,it is customary to report Interest Payableafter the relatedliability accounts. ** Computationof pensionliability: Accumulatedpensionbenefit obligation……………………..
$470,000
Less:Pensionplanassets,at marketvalue………………….
(425,000)
Pensionliability to be reportedon the balancesheet…......
$ 45,000 Chapter 9
Liabilities
9-93
9-94
Financial Accounting 9/e Solutions Manual
(continued) P 9-87B Req. 2 a.
b.
Carryingamountof bondspayable: Currentportion..................................................................... Long-termportion................................................................ Carryingamount...................................................................
$ 420,000 1,658,000 $2,078,000
Interest payable is the amount of interest that Braintree owes at year-end. Interest expenseis the company’scost of borrowingfor the full year.
Req. 3 Times-interest-earnedratio
= =
Operatingincome Interestexpense
=
$390,000 $227,000
1.72 times
Req. 4 Leverage ratio Debtratio
= =
Total assets($4,200,000) Total stockholders’equity($1,592,000) Total liabilities[$2,608,000= $591,000+ $2,017,000] Total assets($4,200,000)
= 2.63 = 0.62
Thecompany’sdebt ratio andleverageratiosare average,and operatingincomecovers interestpaymentsby 1.72 times. Withthis limitedinformation,the companyappearsto be averagerisk froma leveragepoint of view. Additionalinformationfromprior years and competitorswouldalso be helpful.
Chapter 9
Liabilities
9-95
(continued) P 9-84B Req. 5 Leverage ratio Debtratio
=
Total assets($7,200,000) Total stockholders’equity($1,592,000) Total liabilities($5,608,000) Total assets($7,200,000)
= 4.52 = 0.78
Theleverageratio and debt ratio wouldincrease. The companywouldbe considered higherrisk froma leveragepoint of view.
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Financial Accounting 9/e Solutions Manual
ChallengeExercisesandProblem (10-15 min.) E 9-85
Currentratio
=
Total currentassets Total currentliabilities
=
$324,500- X $173,800- X
=
2.00
Let X = amount of current liabilities to pay in order to achieve a current ratio of 2.25. Marquis Marketing Services should pay off $23,100* of current liabilities. Then the currentratio will be: $324,500− $23,100* $173,800− $23,100*
=
$301,400 $150,700
=
2.00
_____ *Computation:
$324,500− X $173,800− X
=
2.00
$324,500− X
=
2.00 ($173,800− X)
−X
=
$347,600− 2.00X− $324,500
X
=
$23,100
Req. 2 Leverage ratio Debtratio
= =
Total assets($1,423,000) Total stockholders’equity($1,001,700) Total liabilities($421,300) Total assets($1,423,000)
= 4.52 = .30
Theleverageratio and debt ratio are low. The debt positionis low. Otherhelpful informationwouldbe the leverageand debt ratiosfromprior yearsand comparative ratiosfromcompetitors. Chapter 9
Liabilities
9-97
(20-25 min.) E 9-86 Req. 1
BondsPayable,5 ¼ %................................................ BondsPayable,13%........................................ Cash .......................................................... Gainon Retirementof BondsPayable................
Millions 160 80 17 63
Req. 2 (Dollar amounts in millions)
Annualinterestexpense…..
Old Bonds
NewBonds
$160× .0525 = $8.40
$80 × .13 = $10.40
Req. 3 Possiblereasonsfor the debt refinancing: 1. To decreaseannual interest expense: NO, becauseannual interest expenseon the old bondsis less ($2,000,000)thaninterestexpenseon the newbonds. 2. To increase net income: YES, because the gain on retirement of bonds payable added$63 millionto net income. 3. To decreasethe leverageratio: YES, as follows: (Dollar amounts in millions) Leverage Total assets = ratio Total stockholders’ equity
Before After Refinancing Refinancing $503 $503− $17 = $144 $144+ $63 = 3.49 = 2.35
4. To decreasethe debt ratio: YES,as follows: (Dollar amounts in millions)
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Financial Accounting 9/e Solutions Manual
BeforeRefinancing
After Refinancing
Debt ratio
=
Total liabilities Total assets
=
$359 $503 = 0.71
$359− $160+ $80 $503− $17 = 0.57
Chapter 9
Liabilities
9-99
(20-30 min.) P 9-87 Req. 1 a.
Currentratio
Current ratio
b.
2010 $21,579 $18,508
Currentassets Currentliabilities
= 1.17
Debtratio 2010
Debt ratio
2009 $17,551 1.28 $13,721
Total liabilities Total assets
2009
$72,921- $31,317 $72,921
=.571
$48,671– $25,346 $48,671
Req. 2 a.
Currentratio
Current ratio
b.
Currentassets Currentliabilities
$21,579 $18,508+ $1,590
= 1.07
Debtratio
Debt ratio
Total liabilities Total assets
$41,604+ $1,590- $1,590
Currentassets Currentliabilities
$21,579 $18,508+ $205
= .571
$72,921
Req. 3 Current ratio
b. 9-100
Debtratio
Financial Accounting 9/e Solutions Manual
= 1.15
=.479
Debt ratio
Total liabilities Total assets
$41,604+ $965 $72,921
= .584
DecisionCases (15-20 min.) DecisionCase1 Req. 1 As Reported
Debtratio
Returnon Assets (ROA)
=
=
Total liabilities = Total assets
Net income Total assets
$54,033 $65,503
=
0.82
=
$979 $65,503
=
1.5%
=
$65,503 $11,470
=
5.71
Req.2 Leverage ratio
Returnon Equity(ROE)
=
=
Total assets Total stockholders’ equity
ROAx Leverageratio
=
1.5%x 5.71 = 8.5%
The ROE is greater than the ROA becausethe leverageratio is extremely high which magnifies the ROA. The debt ratio is also extremely high and indicates that 82% of Chapter 9
Liabilities
9-101
the assets were financed with debt. The high leverage ratio and debt ratio should havemadeinvestorsquestionthe soundnessof Enron.
(continued)DecisionCase1 Req. 3 After Includingthe Special-PurposeEntities
Debtratio
=
Total liabilities = Total assets
$54,033+ $6,900 $65,503 + $500* = 0.92
*The SPEs originally reported assets of $7,000 million when those assets were only worth $500 but actuallyhadliabilitiesof $6,900.
Returnon Assets
=
Net income Total assets
$979+ $0* $100,789+ $500 = .1%
*TheSPEs’incomewasnearlywipedout dueto the restatementmeaningthat the SPEdid not earna net incomebut did haveassetswith a marketvalueof $500.
Times-interestearnedratio
=
Operating Income Interest expense
Req. 4 9-102
Financial Accounting 9/e Solutions Manual
As
After Includingthe
Reported
Special-PurposeEntities
=
$1,953 $838
$1,953+ ($300) $838+ ($6,900× .10)
=
2.3 times
= 1.1 times
It appears that Enron excluded the special-purpose-entities (SPEs) from its financial statementsin order to hide their debt fromEnron’sinvestorsand creditors.The purpose was to understate Enron’s liabilities. We would view Enron as much more risky after including the SPEs in Enron’s financial statements. So did their banks, which is why theystoppedlendingmoneyto them,causingthemto haveto file for bankruptcy. (30-40 min.) DecisionCase2 Req. 1 (Analysis of financing plans)
Net incomebeforeexpansion
PLANA
PLANB
BORROW AT 6%
ISSUE COMMON STOCK
PLANC ISSUE$3.75 NONVOTING PREFERRED STOCK
$3,500,000
$3,500,000
$3,500,000
$1,500,000
$1,500,000
$1,500,000
300,000
-0-
-0-
1,200,000
1,500,000
1,500,000
Lessincometax expense(35%)
420,000
525,000
525,000
Projectnet income
780,000
975,000
975,000
-0-
-0-
375,000
to commonstockholders
780,000
975,000
600,000
Total companynet income
$4,280,000
$4,475,000
$4,100,000
Projectincomebeforeinterest and incometax Lessinterestexpense ($5,000,000× .06) Projectincomebeforeincometax
Lesspreferreddividends (100,000× $3.75) Additionalnet incomeavailable
Earningsper shareincludingnew project: Chapter 9
Liabilities
9-103
PlanA ($4,280,000/ 1,000,000shares) PlanB ($4,475,000/ 1,100,000shares) PlanC ($4,100,000/ 1,000,000shares)
9-104
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$
4.28
$
4.07
$
4.10
(continued) DecisionCase2 Req. 2 (Recommendation) Thebest choiceappearsto be PlanA — borrowingat 6% — because: (1) Borrowingallowsthe familyto maintaincontrolof the
business;
(2) EPSis higherunderborrowingthanunderissuingpreferred stock (which would also maintainfamilycontrol); and (3) EPSunderborrowingis higherthan it wouldbe if commonstockwereissued.Also, cash flow under Plan A (borrowing) may be almost as good as under Plan B (issuingcommonstock)after consideringstockholders’demandsfor dividends.
Chapter 9
Liabilities
9-105
EthicalIssue1 Req. 1 A company would prefer not to disclose its contingent liabilities because they cast a shadowon the businessand createa negativeimpression.
Req. 2 and 3 The potential parties and economic consequences of the decision not to disclose contingentliabilitiesare:
1. The bank and its shareholders: With misleading information, they might extend additional funds to the borrower assuming a better ability to pay back the funds than actually exists. A contingent liability creates risk for a company. If the contingent liability is not reported, the bank may view the companyas low-risk. This may lead the bank to loan moneyat low interest rates and with easy paymentterms. With knowledge of the contingent liability, the bank might not have made the loan at all. Or the bank might have required a higher interest rate or more stringent payment terms. Making loanson too-easytermsrobsthe bank’sownersof their money.
2. The companyseekingthe loan: Mightbecomeoverextendedin its borrowingand risk default on debt in the future.
Req. 3 Legal and ethical consequences
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Banks have legal requirements to keep certain ratios of assets and liabilities on their booksor risk default. Failureof a companyto report (continued)EthicalIssue1 its contingentliabilities to a bank requestingthis disclosurecould subject the company to a lawsuitlater on.
Froman ethical standpoint, reporting a contingent liability requires a delicate balancing act. Ethics require that outsiders’ interests be protected. The company must disclose enoughinformationto give outsidersa reasonablebasis for makinginformeddecisions about the company. At the same time, the company should avoid giving away secrets that could damageits owners’investmentin the business.This dilemmais clear whena defendant fears losing an important lawsuit. Fortunately for accountants, most companies settle out of court those lawsuits that they expect to lose. In such cases, thereare no contingentliabilitiesto disclose. Req. 4
As discussedin the chapter, changesare being discussedbetweenthe FASBand IASB about a new standard for reporting contingencies. It is likely that, in the future, more losses resulting from lawsuits and other contingenciesare likely to be disclosed in the bodyand the footnotesof financialstatements.
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EthicalIssue2 1. The ethical issueis whetherto structurethis leaseto avoid its havingto be disclosed as a capital lease. The companywill do that if it is possible. It appearsthat Gockerand Moranhavesomeflexibility in settingthe life of the lease(4-6 years). If they set the term of the lease at 4 years, it will be only 66 2/3 percent of the economiclife of the asset (6 years). Thus, the leasewill fail all of the mechanicaltests for the leaseto be treatedas a capital lease, and by default, it will be treated as an operating lease, and Gocker can avoidcapitalizingthe assetand includingthe liability on her financialstatements. If they set the term of the lease at 5 or 6 years, it will exceed 75% of the economic life of the asset, and thusthe leasewill haveto be capitalized.
2. The stakeholdersare Gocker, the lessee;Morgan,the lessor; and Last NationalBank, Gocker’spresentcreditor. The potentialconsequencesto the stakeholdersare:
a. economic: If the leaseis structuredas a capital lease, Gockerwill violate
its
long-term loan covenant with Last National Bank. As a result, the bank might demand immediate payment of their loan. This may damage Gocker’s credit rating and create difficultygettingfuturebankloans. Alternatively,Last NationalBankmaywaivethe loan covenantin exchangefor a higherinterest rate or morestringentrepaymentterms. This too could cause Gocker financial difficulties. Morgan is not affected economically, becauseMorganwill receive its paymentson the leasedproperty regardlessof how the transactionis disclosed.
(continued)EthicalIssue2
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b. legal: If we assume that GAAP substitutes for legal requirements, if Gocker is careful to structurethe lease termsso that it avoidsthe requirementsfor a capital lease, thereshouldbe no problemstatingthat the leaseagreementcomplieswith GAAP. c. ethical: The substanceof a capital leaseis one that transfersthe risks and rewards of ownershipto the lessee. If in fact, the substanceof the termsof this leasedo that, the equipmentshouldbe capitalizedby the lesseeregardlessof the formof the lease terms. To use mechanical rules to avoid recognizing assets and liabilities hardly seems like a truthfulwayto do business. Nevertheless,U.S. GAAPpresentlyallowit! 3. Studentresponseswill vary on this question. Somewill say that, if the rules allowit, then why not engineer the transaction in such as way as to benefit Gocker by keeping the asset, and the lease obligation, off the books. After all, this is perfectly legal, and perfectly in accordance with existing U.S. GAAP (FAS 13). In the view of the authors, Gocker should evaluate whether, in fact, she obtains the rights and rewards associated with ownership of the machine. If so, she could so structure the lease that it fits the economic substance of the transaction, which is what should also be disclosed in the financial statements. If it turns out that the equipment and the related lease obligation will have to be addedto assets and liabilities in the balancesheet, thus causingGocker to default on the loan covenant, she should attempt to obtain a waiver of the covenant. This option is going to prove costly for Gocker, so she’s to have to be convinced that she did the right thingin orderto be motivatedto followthis courseof action.
(continued)EthicalIssue2
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4. The FASBand IASBare workingon a proposednew lease standardthat removesthe mechanicalcriteria for lease capitalizationdiscussedin the chapter in favor of the more theoretically and substantively correct, but also more subjective, “risks and rewards” approach. As a result, more companies will be faced with making the judgment as to whether their lease agreementsactually transfer risks and rewardsto lessees. This will not remove the temptation to deliberately twist the facts. Under a “principles” based standard, there will exist the opportunity for “strategic non-compliance”(that is, simply decide that risks and rewards are not transferred and thus achieve the same result as the “financial engineering” allowed by current GAAP. More judgment requires better ethics. Whatdo you thinkwill happen?(Studentresponseswill vary on this question).
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Focuson Financials: Amazon.com,Inc. (20 min.) Req. 1 Amazon.com, Inc.’s accounts payable increased from $5,605 million in 2009 to $8,051 million in 2010, an increase of about 43.6 percent. Accordingly, Account Payable Turnoveris: OperatingExpenses
$32,798
Avg. Accts.Pay.
($8,051+$5,605)/2
=
4.80
It takes Amazon.com,Inc. an average of (365/4.80) 76 days to pay its accounts payable. Thislengthoverall is fairly longgiventhat typical credit termsare closerto 30 days.
Req. 2
Provisionfor incometaxes Incometaxespaid
$352
million
75
million
These amounts differ because tax and accounting rules differ resulting in a different incometax on the incomestatement(provisionfor incometaxes) than on the tax return (incometax paid).
Req. 3 Refer to Note 5—LongTerm Debt. Based on this information, the company’slong term debt (after current maturities) increased from $109 in 2009 to $184 in 2010. From this
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increase, you can tell that Amazon.com. Inc. borrowed more than they paid off during 2010.
(continued)Amazon Req. 4
Referto Note6—CommitmentsandContingencies. The footnotesdisclosecommitmentsof $3,799million. Someof thesecommitmentswill already be reported as liabilities, such as obligations for debt principal and interest, capital leases, and financing leases. However, the commitments for operating leases wouldnot be reportedin liabilities.
The footnotes also include a discussion of various legal proceedings against Amazon. These legal proceedings are of the nature of “disclosed” loss contingencies, as discussed in the chapter, therefore, are not included in the financial statements. The criteria for disclosureof these contingentliabilities is that it is reasonablypossible that the companywill havean obligationfromthe lawsuitcompanyin the future.
Req. 5
Ratio Debtratio
2010
2009
$10,372+ $1,561= 63.5% $18,797
$7,364+ $1,192= 61.9% $13,813
Timesinterest earned
$1,406 $39
Currentratio
$13,747
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= 36.1 times
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$1,129 $34 $9,797
= 33.2 times
$10,372 = 1.33
$7,364 = 1.33
(continued)Amazon
Amazon.com,Inc.’s leverageincreasedslightly during 2010, as reflectedin the increase of its debt to total asset ratios from2009to 2010. Becauseof strongearnings,the times interest earned (operating income/interest expense) ratios improved. The current ratio has remainedrelativelystable.
Cash provided by operating activities on the Consolidated Statements of Cash Flows increasedfrom$3,293millionin 2009to $3,495in 2010. On this basis, Amazon.com,Inc. appears to be experiencinggrowth. They appear to be positionedwell for more growth, profitabilityand improvedliquidityand leveragepositionsin the future.
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Focuson Financials: RadioShack,Corp. (20 min.) Req. 1 • CurrentMaturitiesof Long-TermDebt—theamountof principalthat is payable withinone year. • AccountsPayable—theamountowedfor productsor servicespurchasedon account. • AccruedExpenses—theamountof expensesincurredbut not yet paid. • IncomeTaxesPayable—theamountof incometax incurredbut not yet paid.
Req. 2 • Payroll andBonuses– an accrualfor wagesfor pay earnedby employeesbut not yet paid to employees. • Insurance– an accrualfor insuranceexpenseincurredbut not yet paid. • SalesandPayroll Taxes– liability for amountowedto the governmentfor sales and payroll taxes. • Rent– an accrualfor rent expenseincurredbut not yet paid. • Advertising– an accrualfor advertisingexpenseincurredbut not yet paid. • Gift CardDeferredRevenue– liability for the amountof goodsand servicesowed to customerswhohavegift cardbalances. 9-114
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• Other– all otherliabilitiesthat will be paid with currentassetsthat do not meet the definitionsof the categoriesabove.
(continued)RadioShackCorp. Req. 3
AP Turnover
COGS Avg. Accts.Pay.
$2,462.1 ($272.4+$262.9)/2
Daysin AP
365 AP Turnover
365 9.20
39.7
Current Ratio
Currentassets Currentliabilities
$1,778.7 $908.1
1.96
QuickRatio
Cash+ ST Inv. + Rec. CurrentLiabilities
$569.4+$377.5+$108.1 $908.1
1.16
Daysin AR
365 (Sales/Avg.AR)
365 ($4,472.7/$350)
28.6
Average AR
Beg. AR+End. AR 2
($377.5+$322.5) 2
$350
Inv. Turnover
COGS Avg. Inventory
$2,462.1 (($723.7+$670.6)/2)
3.53
Daysin Inv.
365 InventoryTurnover
365 3.53
103
9.20
• The companyis currently able to pay its accounts within an average of about 40 dayswhichis slightlylongerthanoptimal. • The companyhas a strongCurrent Ratio close to 2 and a QuickRatio still greater than 1 meaning that it has the current assets necessary to pay for its current liabilities. Chapter 9
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• The inventoryturnoverratio is quite disturbingin that RadioShackis only turning over its inventoryevery 103 days on average. This meansthat RadioShackmust wait at least 103 daysafter purchasinginventoryto sell it.
(continued)RadioShackCorp.
• It takesRadioShackalmost92 days(103 +28.6– 39.7) to turn inventorypurchases backinto cashvia salesand collections. A comparisonto previousyearswould indicateif this is trendingfavorableor unfavorable. Overall, it wouldappearthat RadioShack,Corp. has the ability to pay its liabilities.
Req. 4 Five-year 2.5%unsecuredconvertiblenotes($375million) Ten-year 7.375%unsecurednotes($307million) The related interest is recorded in interest expenseon the IncomeStatement. The tenyear notes are classified as current because they are due in 2011. The remaining fiveyear notesare due in 2013.
Req. 5 Refer to Note 13—Commitments and Contingencies. RadioShack leases most of its facilities and disclosesthese commitmentsin Note 13. The leases are operatingleases and thereforeno liability is reportedon the balancesheet. 9-116
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In this same note, RadioShack disclosed facts about litigation. Since RadioShack considers the outcome of this lawsuit to be uncertain, the contingent liability is disclosedin the notesto the financialstatementsratherthanaccrued.
GroupProjects Studentresponseswill vary.
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