Bonds and Other Liabilities - Weebly

Bonds and Other Liabilities

PE

Bonds & Other Liabilities

1

BOND OVERVIEW

For the CPA exam, assume bonds are issued in denominations of $1,000 (face amount) unless otherwise stated.

Rate is the interest rate printed on the face of the bond certificate. Also called coupon or nominal rate of interest.

The price of a bond is quoted in the 100’s.

Carrying value (CV): How the bond is reported on the balance sheet

1. + or

2. –

Make the same entry every year using straight-line amortization (both sides)

The account Bonds Payable always is credited for the face amount of the debt at issue

Interest payment = x 　　　　　　　 amount

Amortization of a discount always carrying value on both sides

When a bond sells at a ; there is effectively more interest for both sides.

1. Issuer: Effectively more interest

2. Investor: Effectively more interest

For the CPA exam, assume that bonds are held-to-maturity investment for the investor, unless otherwise stated.

A.

B.

C.

D.

E.

F.

G.

H.

I.

J.

Record amortization of discount on December 31, Year 1:

$ $ $ $ 　　　　 $ $

Issuer: Investor: $ $ $ 　 $ 　　　 $

STRAIGHT–LINE DISCOUNT AMORTIZATION

2


CV on December 31, Year 1 using shortcut: $ 　 + $ = $

CV at end of: Year 2 $ Year 3 $ Same CV for issuer and investor Year 4 $ Year 5 $

Example 1: Discount

• January 1st company issued one bond, $1,000 face value, stated rate 6% • Matures in 5 years, interest paid annually on December 31 • Sold @ 98, effective yield 61/2%

Record sale/purchase of bond @ 98 on January 1, Year 1:

CV on January 1, Year 1:

$ － $ = $ Same CV for issuer and investor

Record bond retirement on December 31, year 5

$ $ $ $

EFFECTIVE INTEREST DISCOUNT AMORTIZATION


3

Issuer: Investor: $ $ $ (plug) $ 　　　 $ $

Example 2: Discount

• January 1st company issued one bond, $1,000 face value, stated rate 6% • Matures in 5 years, interest paid annually on December 31 • Sold @ 98, effective yield 61/2%

Record interest expense/income on December 31, Year 1 ( % x $ ):

(plug)

(plug)

Record interest expense/income on December 31, Year 2 (6.5% x $983.70):

$ $ $ (plug) $ 　　　 $ $

4


Notes

• The entries on January 1, Year 1 are identical; all that is affected are the interest calculations

• Effective interest method formula: ×

• Amortization of a discount always carrying value

• FASB 115 requires the use of the effective interest method for held-to-maturity invest- ments; held-to-maturity securities must be accounted for at amortized cost

• Semiannual Adjustments

• Suppose the coupon rate is 12% and the effective yield is 13% First entry made on June 30, Year 1 (13% × 1/2 year = 6.5%) Second entry made on December 31, Year 1 (6.5%) Amortization for the year is $3.70 + $3.94 = $7.64

Record bond retirement on December 31, Year 5:

$ $ $ $

Record amortization of premium on December 31, Year 1:

$ $ $ $ 　　　 $ $

STRAIGHT–LINE PREMIUM AMORTIZATION


5

Issuer: Investor: $ $ $ 　　　 $ $

Example 3: Premium

• January 1st, company issued one bond, $1,000 face value, stated rate 6% • Matures in 5 years, interest paid annually on December 31 • Sold @ 102, effective yield 51/2%

Record sale/purchase of bond @ 102 on January 1, Year 1:

(plug)

CV on December 31, Year 1 using shortcut: $ 　 – $ = $

CV at end of: Year 2 $ Year 3 $ Same CV for issuer and investor Year 4 $ Year 5 $

CV on January 1, Year 1:

$ – $ = $ Same CV for issuer and investor

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Notes

• When a bond sells at a premium, there is effectively less interest for both sides:

Issuer –– effectively less interest

Investor –– effectively less interest

• Carrying value (CV) of the bond is +

• On the balance sheet of the issuer, the premium is presented with the debt

• Amortization of premium is the same entry every year using straight-line amortization (both sides)

• Amortization of a premium always carrying value on both sides

EFFECTIVE INTEREST PREMIUM AMORTIZATION


7

Example 4

• January 1st, company issued one bond, $1,000 face value, stated rate 6% • Matures in 5 Years, interest paid annually on December 31 • Sold @ 102, effective yield 51/2%

The entries on January 1, Year 1 are identical; all that is affected are the interest calculations.

Effective interest method formula: 　　　　 ×

Record interest expense/income on December 31, Year 1 ( 　　×$ 　　 ):

Amortization of a premium always 　　　　carrying value

Recorded interest expense/income on December 31, Year 2 (5.5% × $1,016.10)

Interest Expense $ Cash $ Premium (plug) $ Interest Income $ Cash $ Inv. In Bonds $

Semiannual adjustments:

• Suppose the coupon rate is 12% and the effective yield is 11%

• First made on June 30, Year 1 (11% × 1/2 = 5.5%)

• Second entry made on December 31, Year 1 (5.5%)

• Amortization for the year is $3.90 + $4.12 = $8.02

Issuer Investor $ $ $ $ 　　　 $ $

(plug)

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METHOD SELECTION

If a company’s interest expense (issuer) or interest revenue(investor) is a material item on the income statement (I/S), the company is required to use themethod of amortization.

The effective interest method of amortization is theoretically preferred because:

1.

2. The problem with the straight-line method of amortization is:

3. May companies use the straight-line method? Yes No

A.

B.

Independently answer questions 1 - 3.


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1. On May 1, 2002, Bolt Corp. issued 11% bonds in the face amount of $1,000,000 that mature on May 1, 2012 The bonds were issued to yield 10%, resulting in bond premium of $62,000. Bolt uses the effective interest method of amortizing bond premium. Interest is payable semiannually on November 1 and May 1. In its October 31, 2002 balance sheet, what amount should Bolt report as unamortized bond premium?a. $62,000b. $60,100c. $58,900d. $58,590 (3271)

2. Webb Co. has outstanding a 7%, 10-year $100,000 face-value bond. The bond was originally sold to yield 6% annual interest. Webb uses the effective interest rate method to amortize bond premium. On June 30, 2002, the carrying amount of the outstanding bond was $105,000. What amount of unamortized premium on bond should Webb report in its June 30, 2003 balance sheet?a. $1,050b. $3,950c. $4,300d. $4,500 (4405)

3. On January 2, 2004, West Co. issued 9% bonds in the amount of $500,000, which mature on January 2, 2014. The bonds were issued for $469,500 to yield 10%. Interest is payable annually on December 31. West uses the interest method of amortizing bond discount. In its June 30, 2004 balance sheet, what amount should West report as bonds payable?a. $469,500b. $470,475c. $471,025d. $500,000 (5288)

Candidate work area

B. Question 2 Notes

Face amount of the debt: $ Coupon rate: % Carrying value of bond: $ Effective yield: %

Webb Co. uses the ____________ method to amortize bond ____________

Interest expense $_____________ = Effective yield _______% × CV $______________

10


Record sale of bonds on May 1, 2002:

Dr: $

Cr: $

Cr: $


CV on May 1, 2002: face plus unamortized premium

Record semi-annual interest expense on October 31, 2002 ( % x 1/2 = % x $1,062,000):

Dr: $

Dr: $

Cr: $

Calculation of interest payable: % × $ = $

Balance in unamortized premium on October 31, 2002:

May 1, 2002 balance $62,000 Less: 6 months amortization (1,900) October 31, 2002 balance $60,100

A. Question 1 Notes


West Co. uses the ____________ method to amortize bond discount

Bonds payable is reported in the B/S at face –– unamortized

Even though interest is payable annually, on June 30 we make

Record semiannual accrual of interest expense on June 30, 2004 (5% × $469,500):

Dr: $

Cr: $

Cr: $

Calculation of interest payable: % × $ = $

Amortization of a discount always CV

CV of bonds payable on June 30, 2004:

CV on January 2, 2004 $469,500 Add: 6 months amortization 975 CV on June 30, 2004 $470,475


11

Record annual interest payment on June 30, 2003:

Dr: $

Dr: $

Cr: $

Calculation of check amount: % × $ = $

Balance in unamortized premium on June 30, 2003:

June 30, 2002 balance $5,000 Less: 12 months amortization (700) June 30, 2003 balance $4,300

C. Question 3 Notes

BOND MARKET PRICE

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A. How is the market price of a bond determined?

1. Use present value (PV) of $1 (table) for:

2. Use present value (PV) of annuity (table) for:

Answer question 4 with Bob.

4. On January 1, 2000, Dean Company issued ten-year bonds with a face value of $1,000,000 and a stated interest rate of 8% per year payable semiannually on July 1 and January 1. The bonds were sold to yield 10%. Present value factors are as follows:

Present value of 1 for 10 periods at 10% 0.386 Present value of 1 for 20 periods at 5% 0.377 Present value of an annuity of 1 for 10 periods at 10% 6.145 Present value of an annuity of 1 for 20 periods at 5% 12.462

The total issue price of the bonds is:

a. $ 875,480b. $ 877,600c. $ 980,000d. $1,000,000

B. Question 4 Notes

Interest is paid 　　　= 　　　periods of 　　　% each

Calculate issue (discount) price of the bonds:

Principal ($　　　　 × 　　　　) $377,000 Interest ($　　　　 ×　　　　) 498,480 20 semiannual interest checks Issue (discount) price of the bonds $875,480



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5. The following information pertains to Camp Corp.'s issuance of bonds on July 1, 2001.

Face amount $800,000Term 10 years Stated interest rate 6%Interest payment dates Annually on July 1Yield 9%

At 6% At 9%Present value of 1 for 10 periods 0.558 0.422Future value of 1 for 10 periods 1.791 2.367Present value of ordinary annuity of 1 for 10 periods 7.360 6.418

The market price of each bond is:a. $1,000b. $ 864c. $ 807d. $ 700

6. The market price of a bond issued at a premium is equal to the present value of its principal amounta. Only, at the stated interest rate.b. And the present value of all future interest payments, at the stated interest rate.c. Only, at the market (effective) interest rate.d. And the present value of all future interest payments, at the market (effective) interest rate.

(6489)

7. How would the amortization of a discount on bonds payable affect each of the following?

Carrying Amount of Bonds Net Income a. Increase Decrease b. Increase Increase c. Decrease Decrease d. Decrease Increase (1890)

8. How would the amortization of a premium on bonds payable affect each of the following?

Carrying Amount of Bond Net Income a. Increase Decreaseb. Increase Increasec. Decrease Decreased. Decrease Increase (9020)

A. Question 5 Notes

periods @ %

Calculate issue (discount) price of each $1,000 bond:

Principal ($ × ) $422 Interest ($ × ) 385 Issue (discount) price of the bonds $807

B. Question 7 Notes

Which side are we on? Issuer, investor, or no way to tell?

Why?

Amortization of a discount always the CV of a bond

When a bond sells at a discount, there is effectively

• for the issuer

• for the investor

Answer: Issuer side Investor side

Which side are we on: issuer, investor, or no way to tell?

Amortization of a premium always the CV of a bond

When a bond sells at a premium, there is effectively

• for the issuer

• for the investor

Answer: Issuer side Investor side

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15


MID-PERIOD ISSUES

A. Bonds Issued Between Interest Dates: Assume the seller will charge the purchaser up to the date of sale.

Example 5

September 1, A Company issues $10,000 of 6% bonds that pay interest semi-annually on June 30 and December 31.

Purchasers are charged accrued interest for and August.

Issuer Investor

9. On July 1, 2006, Howe Corp. issued 300 of its 10%, $1,000 bonds at 99 plus accruedinterest. The bonds are dated April 1, 2006, and mature on April 1, 2016. Interest is payablesemiannually on April 1 and October 1. What amount did Howe receive from thebond issuance?a. $304,500b. $300,000c. $297,000d. $289,500

10. On March 1, 2000, Cain Corp. issued at 103 plus accrued interest, two hundred of its 9%,$1,000 bonds. The bonds are dated January 1, 2000 and mature on January 1, 2010. Interest ispayable semiannually on January 1 and July 1. Cain paid bond issue costs of $10,000. Cain shouldrealize net cash receipts from the bond issuance ofa. $216,000b. $209,000c. $206,000d. $199,000

D. Question 9 Notes

Howe sold $____________ in bonds x ________% = $ ____________

Investors are charged accrued interest for months of:

Coupon Rate x Face Amount = Annual Quarterly Interest Interest

% x $ = $ x /12 = $

Calculation of proceeds from bond issuance:

Principal sold @ 99 $297,000Accrued interest received 7,500Total proceeds from issuance $304,500

Record sale of bonds @ 99 between interest dates:

Dr: $

Dr: $

Cr: $

Cr: $

$3,000 discount = $300,000 bonds (face value) x 1% discount rate

16


Cain sold$________ in bonds x _______% = $__________

Investors are charged accrued interest for the months of: ____________________

Coupon Rate x Face Amount = Annual Interest x Time = Two Months Interest

_________% x $__________ = $_________ x /12 = $

Calculation of proceeds from bond issuance:Principal sold @ 103 $206,000Accrued interest received 3,000Total proceeds from issuance $209,000

Record sale of bonds @ 103 between interest dates:

Dr: $

Cr: $

Cr: $

Cr: $

On exam, it is safe to assume that bond issuance costs are paid in cash, up front:

Dr: $

Cr: $

Net cash proceeds at issuance: $

Examples of bond issue costs:

The account, bond issue costs, is shown in other assets on the B/S; the costs are

and to expense over the life of the bonds


17

Answer question 11.

E. Question 10 Notes

18


EARLY DEBT RETIREMENT

11. On January 1, 1997, Fox Corp. issued 1,000 of its 10%, $1,000 bonds for $1,040,000. These bonds were to mature on January 1, 2007 but were callable at 101 any time after December 31, 2000. Interest was payable semiannually on July 1 and January 1. On July 1, 2002, Fox called all of the bonds and retired them. Bond premium was amortized on a straight-line basis. Before income taxes, Fox's gain or loss in 2002 on this early extinguishment of debt wasa. $30,000 gainb. $12,000 gainc. $10,000 lossd. $8,000 gain (9022)

Record gain or loss from early retirement of bonds on July 1, 2002:

Dr: $

Dr: $

Cr: $

Cr: $

Cash paid out: % x $ = $

Calculation of unamortized premium:

Premium at issuance of bonds $40,000 Less: straight-line-amortization 　　　years x $ 22,000

Unamortized premium on July 1, 2002 $18,000

B. When you retire debt from your B/S, you must also retire any related to that debt

C. Rarely an extraordinary item

Independently answer question 12.

A. Question 11 Notes


19

Retire bonds at 102% of face value on January 1, 2000:

Dr: $

Dr: $

Cr: 　 $

Cr: 　 $ Cr: 　 $

Original discount (15 years) $

Less: amortization (12 years) straight-line method

Unamortized discount $

Original issue costs (15 years) $

Less: amortization (12 years) straight-line method

Unamortized issue costs $

12. On January 1, 2000, Hart Inc., redeemed its 15-year bonds of $500,000 face amount for 102. They were originally issued on January 1,1988 at 98 with a maturity date of January 1, 2003. The bond issue costs relating to this transaction were $20,000. Hart amortizes discounts, premiums, and bond issue costs using the straight-line method. What amount of extraordinary loss should Hart recognize on the redemption of these bonds?a. $16,000b. $12,000c. $10,000d. $0 (1040)

B. Question 12 Notes

20


SERIAL BONDS

13. On December 31, 2002, Arnold, Inc. issued $200,000, 8% serial bonds, to be repaid in the amount of $40,000 each year. Interest is payable annually on December 31. The bonds were issued to yield 10% a year. The bond proceeds were $190,280 based on the present values at December 31, 2002, of the five annual payments as follows:

Arnold amortizes the bond discount by the interest method. In its December 31, 2003, balance sheet, at what amount should Arnold report the carrying value of the bonds?a. $139,380b. $149,100c. $150,280d. $153,308

Due Amounts due Present value date Principal Interest At 12/31/02 12/31/03 $40,000 $16,000 $ 50,900 12/31/04 40,000 12,800 43,610 12/31/05 40,000 9,600 37,250 12/31/06 40,000 6,400 31,690 12/31/07 40,000 3,200 26,830 $190,280


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A. Defined: A type of bond where the 　 is paid back in a series of payments


Remember: None of the basic accounting principles change

Record the issuance of bonds on December 31, 2002:

Dr: $

Dr: $

Cr: 　 $ 　　Record interest expense on December 31, 2003:

Dr: $

Cr: 　 $

Cr: 　 $

Interest exp. $ 　　　 = Effective yield 　　　 % × CV $

Record repayment of principal on December 31, 2003:

Dr: $

Cr: 　 $

Beginning CV on 12/31/02　　　 $

Add: amortization of discount increases CV Less: principal repaid decreases CV CV on 12/31/03 $

22


STOCK PURCHASE WARRANTS

Definition: Just like a that allows the holder to purchase shares of stock within a certain period of time at a certain fixed price (option price or exercise price)

Purpose

1. Makes bonds more

2. Tends to hold down

Treatment

1. Detachable: warrants can be from the bond and traded in the marketplace as a separate security; the warrants have their own market price or value

2. Non-detachable: warrants and the bond are ; if the bond is sold, the warrants go with it, if the warrants are exercised, the bond is retired legally

A.

B.

C.

Answer question 14


23

14. On April 1,1999, Ward Corp. issued $750,000 of 10% nonconvertible bonds at 102 that are due on March 31, 2009. Each $1,000 bond was issued with 40 detachable stock warrants, each of which entitled the bondholder to purchase one share of Ward $10 par common stock for $25. On April 1,1999, the market value of Wards common stock was $20 per share, and the market value of each warrant was $4. What amount of the proceeds from the bond issue should Ward record as an increase in stockholders’ equity?a. $ 15,000b. $120,000c. $300,000d. $750,000 (1033)

Shortcut; Number of $1,000 bonds sold

# of detachable warrants per bond

Total number of warrants

Market value of each warrant $

APIC from sale of warrants $ increase in S/E

Record issuance of bonds @ 102 on April 1, 1999:

Dr: $

Dr: $

Cr: $

Cr: $

When the cash received for the warrants is deducted, these bonds were really sold at a

The theory of this entry–when the warrants are detachable, the issuing company treats theproblem as if they issued two separate securities:

• Bonds, a(n) security

• Warrants, a(n) security

D. Question 14 Notes

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Record exercising of all 30,000 warrants:

Dr: $

Dr: $

Cr: $

Cr: $ 30,000 shares of $10 par common stock issued at $25 per share

As the warrants are exercised, the money is transferred from APIC from Sale of Warrants toregular APIC

Record issuance of bonds @ 102 on April 1, 1999 (non-detachable warrants):

Dr: $

Cr: $

Cr: $ Treated as if company issued only debt; warrants are ignored

Investor side, record purchase of bonds with 30,000 detachable stock warrants:

Dr: $

Dr: $

Cr: $ Treated as an investment in two separate securities (debt & equity)

Record purchase of bonds with non-detachable stock warrants:

Dr: $

Cr: $


25

15. On December 31, 2003, Moss Co. issued $1,000,000 of 11 % bonds at 109. Each $1,000 bond was issued with 50 detachable stock warrants, each of which entitled the bondholder to purchase one share of $5 par common stock for $25. Immediately after issuance, the market value of each warrant was $4. On December 31, 2003, what amount should Moss record as discount or premium on issuance of bonds?a. $ 40,000 premiumb. $ 90,000 premiumc. $110,000 discountd. $200,000 discount (4849)

16. Main Co. issued bonds with detachable common stock warrants. Only the warrants had a known market value. The sum of the fair value of the warrants and the face amount of the bonds exceeds the cash proceeds. This excess is reported as:a. Discount on bonds payable.b. Premium on bonds payable.c. Common stock subscribed.d. Contributed capital in excess of par-stock warrants.

(1800)


Record issuance of bonds @ 109 on December 31, 2003:

Dr: $

Dr: $

Cr: $

Cr: $

When warrants are detachable, the issuing company 　　　　　　　 some of theproceeds coming in to the warrant feature

Shortcut:

Number of $1,000 bonds sold # of detachable warrants per bonds Total number warrants Market value of each warrant $ APIC from sale of warrants $ increase in S/E

F. Question 16 Notes: Excess is reported as:

Answer question 17

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FMV of bonds $1,080,000FMV on warrants 120,000 10% of total FMVTotal FMV $1,200,000

Record issuance of bonds @ par on December 30, 2002:

Dr: $

Dr: $

Cr: $

Cr: $

Carrying value (CV) of the bond is: face amount + unamortized premium

– unamortized discount

Bonds payable is reported on the B/S as: $ liability

17. On December 30, 2002, Fort Inc. issued 1,000 of its 8%, 10-year, $1,000 face value bonds with detachable stock warrants at par. Each bond carried a detachable warrant for one share of Fort's common stock at a specified option price of $25 per share. Immediately after issuance, the market value of the bonds without the warrants was $1,080,000 and the market value of the warrants was $120,000. In its December 31 2002 balance sheet, what amount should Fort report as bonds payable?a. $1,000,000b. $ 975,000c. $ 900,000d. $ 880,000 (4402)

G. Question 17 Notes


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CONVERTIBLE BONDS–BOOK VALUE

A. Definition: A type of bond that can be converted into of stock; when you turn in the bonds, they are retired legally, and you receive shares of stock in place of the bonds

18. Clay Corp. had $600,000 convertible 8% bonds outstanding at June 30, 2000. Each $1,000 bond was convertible into 10 shares of Clay’s $50 par value common stock. On July 1, 2000, the interest was paid to bondholders, and the bonds were converted into common stock, which had a fair market value of $75 per share. The unamortized premium on these bonds was $12,000 at the date of conversion. Under the book value method, this conversion increased the following elements of the stockholders’ equity section by: Additional Common stock paid-in capital a. $300,000 $312,000b. $306,000 $306,000c. $450,000 $162,000d. $600,000 $ 12,000 (2425)


Record conversion (retirement) of bonds for common stock on July 1, 2000:

Dr: $

Dr: $

Cr: $

Cr: $

C. Book Value Method Synopsis

1 When you retire debt from your B/S, you must also retire any

　　　　　　　related to that debt

2. With the book value method, we are recording the stock at the

of the bonds turned in; there is never a 　　　　　 on conversion

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CONVERTIBLE BONDS – FMV

A. Record conversion (retirement) of bonds for common stock on July 1, 2000: (6,000 shares x $75 FMV = $450,000 credit to capital accounts)

Dr: $

Dr: $

Cr: $

Cr: $

Cr: $ 　　Bonds converted into stock at a ratio of 10 to 1

B. In the FMV approach, you credit capital for: and there

is almost always a on conversion

C. The book value method is theoretically preferred


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DEBENTURE AND COLLATERAL BONDS

A. Debenture: Not secured by any collateral

• Represents debt (i.e., junk bonds)

B. Collateral: Secured by specific collateral

• Represents debt

19. Hancock Co.’s December 31, 2000 balance sheet contained the following items in the long-term liabilities section:

Unsecured 9.375% registered bonds ($25,000 maturing annually beginning in 2004) $275,00011.5% convertible bonds, callable beginning in 2009, due 2020 125,000

Secured9.875% guaranty security bonds, due 2020 $250,00010.0% commodity backed bonds ($50,000 maturing annually beginning in 2005 200,000

What are the total amounts of serial bonds and debenture bonds?

Serial bonds Debenture bonds a. $475,000 $400,000b. $475,000 $125,000c. $450,000 $400,000d. $200,000 $650,000 (9024)

C. Question 19 Notes

1. Serial bonds: $ 　　　　　+ $ 　　　　　　= $

2. Debenture bonds: $

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TROUBLED DEBT RESTRUCTURING

20. Hull Company is indebted to Apex under a $500,000, 12%, three-year note dated December 31, 2004. Because of Hull’s financial difficulties developing in 2006, Hull owed accrued interest of $60,000 on the note at December 31, 2006. Under a troubled debt restructuring, on December 31, 2006, Apex agreed to settle the note and accrued interest for a tract of land having a fair value of $450,000. Hull's acquisition cost of the land is $360,000. Ignoring income taxes, on its 2006 income statement, Hull should report as a result of the troubled debt restructuring:

Dr: $

Dr: $

Cr: $

Cr: $

Cr: $

2. Creditor Perspective: Bank records debt retirement (full settlement)

Dr: $

Dr: $

Dr: $

Cr: $

Cr: $

Cr: $

This is an loan loss for the bank

Gain on Other income Restructuring of debta. $200,000 $ 0b. $140,000 $ 0c. $ 90,000 $ 50,000d. $ 90,000 $110,000 (4605)

1. Question 20 Notes: Record full settlement on December 31, 2006:

A. Full Settlement: Creditor takes assets in full settlement of debt


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The following information pertains to the transfer of real estate pursuant to a troubled debt restructuring by Knob Co. in full liquidation of Knob’s liability:

21. What amount should Knob report as a pretax gain (loss) on restructuring of payables?a. $ (10,000)b. $0c. $ 50,000d. $ 60,000 (4426)

22. What amount should Knob report as ordinary gain (loss) on transfer of real estate?a. $ (10,000)b. $0c. $ 50,000d. $ 60,000 (4427)

3. Question 21 & 22 Notes: Record full settlement:

Dr: $

Dr: $

Cr: $

Cr: $

a. Gain (loss) on debt restructuring $

b. Gain (loss) on transfer of real estate $

Carrying amount of liability liquidated $150,000Carrying amount of real estate transferred 100,000Fair value of real estate transferred 90,000

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B. Modification of Payment Terms

Example 6: Modification of Payment Terms

Debtor has $200,000 note payable and $30,000 interest payable.Monthly note payment is $17,500.Bank agrees to modify the monthly payment to $10,000 for the next 15 months as full payment of the debt.PV of payments (annuity) at a fair rate of interest, $100,000

1. Creditor (bank) uses PV

Debtor owed bank $

Bank agreed to settle for $　　　　　　 discounted PV of annuity

Impairment of debt $

Bank records loan impairment:

Dr: $

Cr: $

2. Debtor does not use PV (looks only at total cash payments due the bank)

Will now pay bank $ $10,000×15 months

Total debt owed to bank $

Immediate gain to debtor $

Debtor records modification of note:

Dr: $

Dr: $

Cr: $

3. Balance in notes payable:

Notes payable, old balance $

Reduction from modification $

Notes payable, new balance $

4. Debtor will pay off this new $150,000 balance at $10,000 over 15 months and ignore interest in these payments

A. Definition: A liability that could happen depending on the outcome of certain events

• Example: Lawsuit, any loss is _________________ on the outcome

B. Categories

1. highly likely

2. reasonably could happen

3. 　　　　　　　　　　　 highly unlikely

C. Criteria: Must accrue contingent loss if it meets two tests

1. Loss must be

2. Can reasonably estimate amount of or settlement

D. Footnote

1. Probable:

2. Reasonably Possible:

3. Remote:

a. Off-Balance-Sheet Risk: b. Answer for the Debt of another:


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CONTINGENT LOSSES

34


Scenario ContingentLosses

A Company is being sued in six unrelated cases for $1 million each.

Scenario ContingentLosses

Determine the amount of any accrual and the content of any footnote based on the counsel’s opinion and estimated amount of any settlement.

Case Opinion of Estimated # Counsel Settlement Accrual Footnote

1 probable loss $800,000

2 probable loss no reasonable way to estimate

3 probable loss from $200,000 to $700,000

4 probable loss from $200,000 to $700,000;

$425,000 best estimate

5

reasonably $400,000

possible loss

6 remote loss $0


35

B. Simulation Notes: In practice, the lower limit of a range generally is the amount of compensatory damages and the upper limit is the amount of punitive damages.

1. Case #1

Dr: $

Cr: $

2. Case #2

3. Case #3

Dr: $

Cr: $

4. Case #4:

Dr: $

Cr: $

5. Case #5:

6. Case #6:



1. If you are given a range, accrue and footnote that it could go higher

2. Had Haft Co. known about the IRS settlement offer before the financial

statements were issued, they would have accrued $ as the best estimate

F. Question 24 Notes

Accrual? Why?

Footnote? Amount: $

23. During 2004, Haft Co. became involved in a tax dispute with the IRS. At December31, 2004, Haft’s tax advisor believed that an unfavorable outcome was probable. A reasonable estimate of additional taxes was $200,000, but could be as much as $300,000.After the 2004 financial statements were issued, Haft received and accepted an IRS settlement offer or $275,000. What amount of accrued liability should Haft have reported in its December 31, 2004, balance sheet?a. $200,000b. $250,000c. $275,000d. $300,000 (5558)

24. On January 17,2001, an explosion occurred at a Sims Co. plant causing extensive property damage to area buildings. Although no claims had yet been asserted against Sims by March 10, 2001, Sims’ management and counsel concluded that it is likely that claims will be asserted and that it is reasonably possible Sims will be responsible for damages. Sims’ management believed that $1,250,000 would be a reasonable estimate of its liability. Sims’ $5,000,000 comprehensive public liability policy has a $250,000deductible clause. In Sims’ December 31, 2000, financial statements, which were issued on March 25, 2001, how should this item be reported?a. As an accrued liability of $250,000b. As a footnote disclosure indicating the possible loss of $250,000c. As a footnote disclosure indicating the possible loss of $1,250,000d. No footnote disclosure or accrual is necessary (2607)

36



37

SUBSEQUENT EVENTS

25. At December 31, 2002, Date Co. awaits judgement on a lawsuit for a competitor’s infringement of Date’s patent. Legal counsel believes it is probable that Date will win the suit and indicated the most likely award together with a range of possible awards. How should the lawsuit be reported in Date’s 2002 financial statements?a. In note disclosure onlyb. By accrual for the most likely awardc. By accrual for the lowest amount of the range of possible awardsd. Neither in note disclosure nor by accrual (4526)

C. Question 25 Notes

A. Types

1. Type 1: Conditions that do exist on B/S date

2. Type 2: Conditions that do not exist on B/S date

B. Footnote Required Even When Conditions Do Not Exist at B/S Date

1. Casualty Losses

2. Purchase Business or Sell Component

3. Issue Stock

4. Issue Debt

Answer question 26

Actual warranty Sales expenditures2000 $150,000 $ 2,2502001 250,000 7,500 $400,000 $9,750

What amount should Gum report as estimated warranty liability in its December 31, 2001 balance sheet?a. $ 2,500b. $ 4,250c. $11,250d. $14,250 (2606)

38


WARRANTY LIABILITY

26. During 2000, Gum Co. introduced a new product carrying a two-year warranty againstdefects. The estimated warranty costs related to dollar sales are 2% within 12 months following the sale and 4% in the second 12 months following the sale. Sales and actual warranty expenditures for the years ended December 31, 2000 and 2001, are as follows:


Estimated warranty on December 31, 2000: % of $

Dr: $

Cr: $

If it is probable and reasonably estimated, accrue all of it

Record warranty claims as they come in:

Dr: $

Cr: $

Estimated warranty on December 31, 2001: % of $

Dr: $

Cr: $


39

27. Oak Co. offers a three-year warranty on its products. Oak previously estimated warranty costs to be 2% of sales. Due to a technological advance in production at the beginning of 2004, Oak now believes 1% of sales to be a better estimate of warranty costs. Warranty costs of $80,000 and $96,000 were reported in 2002 and 2003, respectively. Sales for 2004 were $5,000,000. What amount should be disclosed in Oak’s 2004 financial statements as warranty expense?

Record warranty claims as they come in:

Dr: $

Cr: $

What is the balance in the liability account?Shortcut: or $ $24,000

Less: claims paid in 2000 & 2001 $ 9,750

Estimated liability on 12/31/01 $14,250


Answer question 28

a. $ 50,000b. $ 88,000c. $100,000d. $138,000 (6126)


Estimated warranty expense for 2004: % of $

Dr: $

Cr: 　　$


Estimated liability on 12/31/04

Number of coupons outstanding:

Estimated redemption rate: %

Estimated number of coupons redeemed:

Number of coupons needed to exchange:

Number of toys Mill Co. must buy:

Mill’s net cost per toy: –

Record estimated cost of toys

Dr: $

Cr: $

Record purchase of a toys

Dr: $

Dr: $

Cr: $

40


COUPON LIABILITY

28. In December 2004, Mill Co. began including one coupon in each package of candy that it sells and offering a toy in exchange for 50 cents and five coupons. The toys cost Mill 80 cents each. Eventually 60% of the coupons will be redeemed. During December, Mill sold 110,000 packages of candy and no coupons were redeemed. In its December 31, 2004, balance sheet, what amount should Mill report as estimated liability for coupons?a. $ 3,960b. $10,560c. $19,800d. $52,800 (5557)



Estimated liability on 12/31/01

Number of coupons outstanding

Estimated # of coupons to be redeemed

Case’s cost per coupon

Record Case’s estimated coupon expense for 2001

Dr: $

Cr: $

Record coupon claims as they come in

Dr: $

Cr: $

What is the balance in the liability for coupons account on December 31, 2001?

Estimated coupon expense for 2001 $60,000 Less: Claims paid to retailers 25,000 Estimated liability on 12/31/01 $35,000

It takes days for Case Cereal Co. to receive coupons from retailers, so we will honoradditional coupons until the end of January, 2002.


41

29. Case Cereal Co. frequently distributes coupons to promote new products. On October1, 2001, Case mailed 1,000,000 coupons for $.45 off each box of cereal purchased. Case expects 120,000 of these coupons to be redeemed before the December 31, 2001, expiration date. It takes 30 days from the redemption date for Case to receive the coupons from the retailers. Case reimburses the retailers an additional $.05 for each coupon redeemed. As of December 31, 2001, Case had paid retailers $25,000 related to these coupons and had 50,000 coupons on hand that not been processed for payment. What amount should Case report as a liability for coupons in its December 31, 2001 balance sheet?a. $35,000b. $29,000c. $25,000d. $22,500 (3257)

A. Type

1.

2.

3.

B. Accrual Criteria (FASB 43)

P

R

O Never future services

V Rights are

C. Definitions

1. Vested: Entitled to the money whether you continue employment or not

2. Accumulated: Rights carried forward (i.e., vacation leave)

D. Sick Pay: Must be ;

E. Holiday & Vacation Pay: May be either: or

42


COMPENSATED ABSENCES


43

A. Definition: Benefits owed to former employees, not retired employees (usually health or dental care)

B. Guidance: Must accrue if it meets all four criteria (same as compensated absences)

P

R

O Never future services

V Rights are

POST-EMPLOYMENT BENEFITS

Documents

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