2011 Adjusting entry:

Interest expense(⁵/₆x $73,200) 61,000 Discount on bonds payable(⁵/₆x $1,200) 1,000 Interest payable(⁵/₆x $72,000) 60,000

Entries that should have been recorded:

December, 31, 2010 adjusting entry:

Interest expense (⁵/₆x $73,200) 61,000 Discount on bonds payable (⁵/₆x $1,200) 1,000 Interest payable (⁵/₆x $72,000) 60,000

February 1, 2011:

Interest expense (¹/₆x $73,200) 12,200 Interest payable (⁵/₆x $72,000) 60,000 Discount on bonds payable (¹/₆x $1,200) 200

Cash (given) 72,000

Exercise 14-16

Requirement 1

The error caused both 2009 net income and 2010 net income to be overstated, so retained earnings is overstated by a total of $85,000. Also, the note payable would be understated by the same amount. Remember, the entry to record interest is:

Interest expense xxx Note payable (difference) xxx Cash xxx

So, if interest expense is understated, the reduction in the note will be too much, causing the balance in that account to be understated.

Requirement 2

Retained earnings (overstatement of 2009-2010 income) 85,000 Note payable (understatement determined above) 85,000

Requirement 3

The financial statements that were incorrect as a result of the error would be retrospectively restated to report the correct interest amounts, income, and retained earnings when those statements are reported again for comparative purposes in the current annual report. A “prior period adjustment” to retained earnings would be reported, and a disclosure note should describe the nature of the error and the impact of its correction on each year’s net income, income before extraordinary items, and earnings per share.

Exercise 14-17

Requirement 1

Interest $24,000^¥ x 2.40183 ^* = $ 57,644 Principal $600,000 x 0.71178 ^** = 427,068 Present value (price) of the notes $484,712

^¥ 4% x $600,000

^* present value of an ordinary annuity of $1: n=3, i=12% (Table 4)

^** present value of $1: n=3, i=12% (Table 2)

Machinery(price determined above) 484,712 Discount on notes payable (difference) 115,288 Notes payable (face amount) 600,000

Requirement 2

Cash Effective Increase in Outstanding Payment Interest Balance Balance 4% x Face Amount 12% x Outstanding Balance Discount Reduction

484,712 1 24,000 .12 (484,712) = 58,165 34,165 518,877 2 24,000 .12 (518,877) = 62,265 38,265 557,142

3 24,000 .12 (557,142) = 66,858^* 42,858 600,000

72,000 187,288 115,288

^* rounded.

Requirement 3

Interest expense(market rate x outstanding balance) 58,165 Discount on notes payable (difference) 34,165 Cash(stated rate x face amount) 24,000

Interest expense(market rate x outstanding balance) 62,265 Discount on notes payable (difference) 38,265 Cash(stated rate x face amount) 24,000

Interest expense(market rate x outstanding balance) 66,858 Discount on notes payable (difference) 42,858 Cash(stated rate x face amount) 24,000

Notes payable 600,000 Cash(stated rate x face amount) 600,000

Exercise 14-18