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 Debt issue costs (⁹/₁₀x $1,500) 1,350 Discount on bonds (⁹/₁₀x [$400,000 – $385,000]) 13,500 Cash(given) 395,000

Problem 14-17

Requirement 1

Bonds payable (face amount) 20,000,000 Premium on bonds (²⁰/₄₀x $6,000,000) 3,000,000 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 Premium on bonds (¹⁰/₄₀x $6,000,000) 1,500,000 Gain on early extinguishment (to balance) 1,000,000 Cash(given) 10,500,000

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

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

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

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

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

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)

Decrease in earnings $6,000

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 ¼) 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 decreased by:

Interest expense $ 8,298

Unrealized holding gain (13,298)

Increase in earnings $ 5,000

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

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)

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

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 Interest receivable ($30,000,000 x 12% x⁴/₁₂) 1,200,000 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

Interest receivable ($16,000,000 x 10% x⁶/₁₂) 800,000 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 Interest receivable ($30,000,000 x 12% x¹/₁₂) 300,000 Premium on investment ($10,000 x 1 month)10,000 Interest revenue(to balance)290,000

Problem 14-22 (continued)

2012

Jan. 1

Cash (10% x $16,000,000 x⁶/₁₂) 800,000 Interest receivable (from adjusting entry) 800,000

June 1

Cash(12% x $30,000,000 x⁶/₁₂) 1,800,000 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

Cash (10% x $16,000,000 x⁶/₁₂) 800,000 Discount on bond investment($1,250 x 6 months)7,500 Interest revenue(to balance)807,500

Sept. 1

Interest receivable (12% x $15,000,000 x³/₁₂) 450,000 Premium on investment ($10,000 x 3 months x¹⁵/₃₀)15,000 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 Interest receivable (12% x $15,000,000 x³/₁₂) 450,000

*([$1,160,000 – 20,000 – 10,000 – 50,000 ] x¹⁵/₃₀ ) – $15,000 = $525,000, or [$1,160,000 x¹⁰⁵/₁₁₆ x¹⁵/₃₀] = $525,000

**[$15,000,000 + 525,000] – [101% x $15,000,000]) = $375,000

Problem 14-22 (continued)

Dec. 1

Cash(12% x $15,000,000 x⁶/₁₂) 900,000 Premium on investment*30,000 Interest revenue(to balance)870,000

* ($10,000 x 6 months x¹⁵/₃₀)

Dec. 31 Accrued interest

Bracecourt Interest receivable (10% x $16,000,000 x⁶/₁₂) 800,000 Discount on bond investment($1,250 x 6 months)7,500 Interest revenue(to balance)807,500

Framm Interest receivable ($15,000,000 x 12% x¹/₁₂) 150,000 Premium on investment ($10,000 x 1 month x¹⁵/₃₀)5,000 Interest revenue(to balance)145,000

2013

Jan. 1

Cash (10% x $16,000,000 x⁶/₁₂) 800,000 Interest receivable (from adjusting entry) 800,000

Problem 14-22 (continued)

Feb. 28

Interest receivable (12% x $15,000,000 x²/₁₂) 300,000 Premium on investment ($10,000 x 2 months x¹⁵/₃₀)10,000 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 Interest receivable (12% x $15,000,000 x³/₁₂) 450,000

*$1,160,000 – 20,000 – 10,000 – 50,000 – 15,000 – 525,000 – 30,000 – 5,000 – 10,000 = $495,000, or [$1,160,000 x⁹⁹/₁₁₆ x¹⁵/₃₀] = $495,000

**[$15,000,000 + 495,000] – [102% x $15,000,000]) = $195,000

Dec. 31 Accrued interest

Interest receivable (10% x $16,000,000 x⁶/₁₂) 800,000 Discount on bond investment($1,250 x 6 months)7,500 Interest revenue(to balance)807,500

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 1807,500

Interest revenue–Sept. 1435,000

Loss on sale of investment (375,000) Interest revenue–Dec. 1870,000

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

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 Cash15

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

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

CASES

Communication Case 14-1