<<

. 22
( 29)



>>

08
.9143 .8368 .7664 .7026 .6446 .5919 .5439 .5002 .4604 .4241 .3606 .3075 .2843 .2630 .2255 .1938
09
.9053 .8203 .7441 .6756 .6139 .5584 .5083 .4632 .4224 .3855 .3220 .2697 .2472 .2267 .1911 .1615
10


.8963 .8043 .7224 .6496 .5847 .5268 .4751 .4289 .3875 .3503 .2875 .2366 .2149 .1954 .1619 .1346
11
.8874 .7885 .7014 .6246 .5568 .4970 .4440 .3971 .3555 .3186 .2567 .2076 .1869 .1685 .1372 .1122
12
.8787 .7730 .6810 .6006 .5303 .4688 .4150 .3677 .3262 .2897 .2292 .1821 .1625 .1452 .1163 .0935
13
.8700 .7579 .6611 .5775 .5051 .4423 .3878 .3405 .2992 .2633 .2046 .1597 .1413 .1252 .0985 .0779
14
.8613 .7430 .6419 .5553 .4810 .4173 .3624 .3152 .2745 .2394 .1827 .1401 .1229 .1079 .0835 .0649
15


.8528 .7284 .6232 .5339 .4581 .3936 .3387 .2919 .2519 .2176 .1631 .1229 .1069 .0930 .0708 .0541
16
.8444 .7142 .6050 .5134 .4363 .3714 .3166 .2703 .2311 .1978 .1456 .1078 .0929 .0802 .0600 .0451
17
.8360 .7002 .5874 .4936 .4155 .3503 .2959 .2502 .2120 .1799 .1300 .0946 .0808 .0691 .0508 .0376
18
.8277 .6864 .5703 .4746 .3957 .3305 .2765 .2317 .1945 .1635 .1161 .0829 .0703 .0596 .0431 .0313
19
.8195 .6730 .5537 .4564 .3769 .3118 .2584 .2145 .1784 .1486 .1037 .0728 .0611 .0514 .0365 .0261
20


.7798 .6095 .4476 .3751 .2953 .2330 .1842 .1460 .1160 .0923 .0588 .0378 .0304 .0245 .0160 .0105
25
.7419 .5521 .4120 .3083 .2314 .1741 .1314 .0994 .0754 .0573 .0334 .0196 .0151 .0116 .0070 .0042
30
Long-Term Debt Financing




.6717 .4529 .3066 .2083 .1420 .0972 .0668 .0460 .0318 .0221 .0107 .0053 .0037 .0026 .0013 .0007
40
.6080 .3715 .2281 .1407 .0872 .0543 .0339 .0213 .0134 .0085 .0035 .0014 .0009 .0006 .0003 .0001
50
.5504 .3048 .1697 .0951 .0535 .0303 .0173 .0099 .0057 .0033 .0011 .0004 .0002 .0001
60

1
*The formula used to derive the values in this table was PV F where PV present value, F number of periods.
future amount to be discounted, i interest rate, and n
(1 i )n
The value of 0 to four decimal places.
Chapter 10
f483
table II The Present Value of an Annuity of $1 per Number of Payments*
f484 Part 3




Number of
Payments 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% 12% 14% 15% 16% 18% 20%

0.9901 0.9804 0.9709 0.9615 0.9524 0.9434 0.9346 0.9259 0.9174 0.9091 0.8929 0.8772 0.8596 0.8621 0.8475 0.8333
01
1.9704 1.9416 1.9135 1.8861 1.8594 1.8334 1.8080 1.7833 1.7591 1.7355 1.6901 1.6467 1.6257 1.6052 1.5656 1.5278
02
2.9410 2.8839 2.8286 2.7751 2.7232 2.6730 2.6243 2.5771 2.5313 2.4869 2.4018 2.3216 2.2832 2.2459 2.1743 2.1065
03
3.9820 3.8077 3.7171 3.6299 3.5460 3.4651 3.3872 3.3121 3.2397 3.1699 3.0373 2.9137 2.8550 2.7982 2.6901 2.5887
04
4.8884 4.7135 4.5797 4.4518 4.3295 4.2124 4.1002 3.9927 3.8897 3.7908 3.6048 3.4331 3.3522 3.2743 3.1272 2.9906
05


5.7985 5.6014 5.4172 5.2421 5.0757 4.9173 4.7665 4.6229 4.4859 4.3553 4.1114 3.8887 3.7845 3.6847 3.4976 3.3255
06
6.7282 6.4720 6.2303 6.0021 5.7864 5.5824 5.3893 5.2064 5.0330 4.8684 4.5638 4.2883 4.1604 4.0386 3.8115 3.6046
07
Investing and Financing Activities




7.6517 7.3255 7.0197 6.7327 6.4632 6.2098 5.9713 5.7466 5.5348 5.3349 4.9676 4.6389 4.4873 4.3436 4.0776 3.8372
08
8.5660 8.1622 7.7861 7.4353 7.1078 6.8017 6.5152 6.2469 5.9952 5.7590 5.3282 4.9464 4.7716 4.6065 4.3030 4.0310
09
9.4713 8.9826 8.5302 8.1109 7.7217 7.3601 7.0236 6.7101 6.4177 6.1446 5.6502 5.2161 5.0188 4.8332 4.4941 4.1925
10


10.3676 9.7868 9.2526 8.7605 8.3064 7.8869 7.4987 7.1390 6.8052 6.4951 5.9377 5.4527 5.2337 5.0286 4.6560 4.3271
11
11.2551 10.5733 9.9540 9.3851 8.8633 8.3838 7.9427 7.5361 7.1607 6.8137 6.1944 5.6603 5.4206 5.1971 4.7932 4.4392
12
12.1337 11.3484 10.6350 9.9856 9.3936 8.8527 8.3577 7.9038 7.4869 7.1034 6.4235 5.8424 5.5831 5.3423 4.9095 4.5327
13
13.0037 12.1062 11.2961 10.5631 9.8986 9.2950 8.7455 8.2442 7.7862 7.3667 6.6282 6.0021 5.7245 5.4675 5.0081 4.6106
14
13.8651 12.8493 11.9379 11.1184 10.3797 9.7122 9.1079 8.5595 8.0607 7.6061 6.8109 6.1422 5.8474 5.5755 5.0916 4.6755
15


14.7179 13.5777 12.5611 11.6523 10.8378 10.1059 9.4466 8.8514 8.3126 7.8237 6.9740 6.2651 5.9542 5.6685 5.1624 4.7296
16
15.5623 14.2919 13.1661 12.1657 11.2741 10.4773 9.7632 9.1216 8.5436 8.0216 7.1196 6.3729 6.0472 5.7487 5.2223 4.7746
17
16.3983 14.9920 13.7535 12.6593 11.6896 10.8276 10.0591 9.3719 8.7556 8.2014 7.2497 6.4674 6.1280 5.8178 5.2732 4.8122
18
17.2260 15.6785 14.3238 13.1339 12.0853 11.1581 10.3356 9.6036 8.9501 8.3649 7.3658 6.5504 6.1982 5.8775 5.3162 4.8435
19
18.0456 16.3514 14.8775 13.5903 12.4622 11.4699 10.5940 9.8181 9.1285 8.5136 7.4694 6.6231 6.2593 5.9288 5.3527 4.8696
20


22.0232 19.5235 17.4131 15.6221 14.0939 12.7834 11.6536 10.6748 9.8226 9.0770 7.8431 6.8729 6.4641 6.0971 5.4669 4.9476
25
25.8077 22.3965 19.6004 17.2920 15.3725 13.7648 12.4090 11.2578 10.2737 9.4269 8.0552 7.0027 6.5660 6.1772 5.5168 4.9789
30
32.8347 27.3555 23.1148 19.7928 17.1591 15.0463 13.3317 11.9246 10.7574 9.7791 8.2438 7.1050 6.6418 6.2335 5.5482 4.9966
40
39.1961 31.4236 25.7298 21.4822 18.2559 15.7619 13.8007 12.2335 10.9617 9.9148 8.3045 7.1327 6.6605 6.2463 5.5641 4.9995
50
44.9550 34.7609 27.6756 22.6235 18.9293 16.1614 14.0392 12.3766 11.0480 9.9672 8.3240 7.1401 6.6651 6.2482 5.5553 4.9999
60
1
1
(1 i )n
*The formula used to derive the values in this table was PV F where PV present value, F number of
periodic payment to be discounted, i interest rate, and n
Long-Term Debt Financing




i
payments.
483
484




table III Amount of $1 Due in n Periods


Period 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% 12% 14% 15% 16% 18% 20%

1.0100 1.0200 1.0300 1.0400 1.0500 1.0600 1.0700 1.0800 1.0900 1.1000 1.1200 1.1400 1.1500 1.1600 1.1800 1.2000
01
1.0201 1.0404 1.0609 1.0816 1.1025 1.1236 1.1449 1.1664 1.1881 1.2100 1.2544 1.2996 1.3225 1.3456 1.3924 1.4400
02
1.0303 1.0612 1.0927 1.1249 1.1576 1.1910 1.2250 1.2597 1.2950 1.3310 1.4049 1.4815 1.5209 1.5609 1.6430 1.7280
03
1.0406 1.0824 1.1255 1.1699 1.2155 1.2625 1.3108 1.3605 1.4116 1.4641 1.5735 1.6890 1.7490 1.8106 1.9388 2.0736
04
Long-Term Debt Financing




1.0510 1.1041 1.1593 1.2167 1.2763 1.3382 1.4026 1.4693 1.5386 1.6105 1.7623 1.9254 2.0114 2.1003 2.2878 2.4883
05


1.0615 1.1262 1.1941 1.2653 1.3401 1.4185 1.5007 1.5869 1.6771 1.7716 1.9738 2.1950 2.3131 2.4364 2.6996 2.9860
06
1.0721 1.1487 1.2299 1.3159 1.4071 1.5036 1.6058 1.7138 1.8280 1.9487 2.2107 2.5023 2.6600 2.8262 3.1855 3.5832
07
1.0829 1.1717 1.2668 1.3686 1.4775 1.5938 1.7182 1.8509 1.9926 2.1436 2.4760 2.8526 3.0590 3.2784 3.7589 4.2998
08
1.0937 1.1951 1.3048 1.4233 1.5513 1.6895 1.8385 1.9990 2.1719 2.3579 2.7731 3.2519 3.5179 3.8030 4.4355 5.1598
09
1.1046 1.2190 1.3439 1.4802 1.6289 1.7908 1.9672 2.1589 2.3674 2.5937 3.1058 3.7072 4.0456 4.4114 5.2338 6.1917
10


1.1157 1.2434 1.3842 1.5395 1.7103 1.8983 2.1049 2.3316 2.5804 2.8531 3.4785 4.2262 4.6524 5.1173 6.1759 7.4031
11
1.1268 1.2682 1.4258 1.6010 1.7959 2.0122 2.2522 2.5182 2.8127 3.1384 3.8960 4.8179 5.3502 5.9360 7.2876 8.9161
12
1.1381 1.2936 1.4685 1.6651 1.8856 2.1329 2.4098 2.7196 3.0658 3.4523 4.3635 5.4924 6.1528 6.8858 8.5994 10.699
13
1.1495 1.3195 1.5126 1.7317 1.9799 2.2609 2.5785 2.9372 3.3417 3.7975 4.8871 6.2613 7.0757 7.9875 10.147 12.839
14
1.1610 1.3459 1.5580 1.8009 2.0789 2.3966 2.7590 3.1722 3.6425 4.1772 5.4736 7.1379 8.1371 9.2655 11.973 15.407
15


1.1726 1.3728 1.6047 1.8730 2.1829 2.5404 2.9522 3.4259 3.9703 4.5950 6.1304 8.1372 9.3576 10.748 14.129 18.488
16
1.1843 1.4002 1.6528 1.9479 2.2920 2.6928 3.1588 3.7000 4.3276 5.0545 6.8660 9.2765 10.761 12.467 16.672 22.186
17
1.1961 1.4282 1.7024 2.0258 2.4066 2.8543 3.3799 3.9960 4.7171 5.5599 7.6900 10.575 12.375 14.462 19.673 26.623
18
1.2081 1.4568 1.7535 2.1068 2.5270 3.0256 3.6165 4.3157 5.1417 6.1159 8.6128 12.055 14.231 16.776 23.214 31.948
19
1.2202 1.4859 1.8061 2.1911 2.6533 3.2071 3.8697 4.6610 5.6044 6.7275 9.6463 13.743 16.366 19.460 27.393 38.337
20


1.3478 1.8114 2.4273 3.2434 4.3219 5.7435 7.6123 10.062 13.267 17.449 29.959 50.950 66.211 85.849 143.37 237.37
30
Long-Term Debt Financing




1.4889 2.2080 3.2620 4.8010 7.0400 10.285 14.974 21.724 31.409 45.259 93.050 188.88 267.86 378.72 750.37 1469.7
40
1.6446 2.6916 4.3839 7.1067 11.467 18.420 29.457 46.901 74.357 117.39 289.00 700.23 1083.6 1670.7 3927.3 9100.4
50
1.8167 3.2810 5.8916 10.519 18.679 32.987 57.946 101.25 176.03 304.48 897.59 2595.9 4383.9 7370.1 20555. 56347.
60
Chapter 10
f485
f486 Part 3




table IV Amount of an Annuity of $1 per Number of Payments


Number of
Payments 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% 12% 14% 15% 16% 18% 20%

01 1.0000 1.0000 1.0000 1.0000 1.0000 1.0000 1.0000 1.0000 1.0000 1.0000 1.0000 1.0000 1.0000 1.0000 1.0000 1.0000
02 2.0100 2.0200 2.0300 2.0400 2.0500 2.0600 2.0700 2.0800 2.0900 2.1000 2.1200 2.1400 2.1500 2.1600 2.1800 2.2000
03 3.0301 3.0604 3.0909 3.1216 3.1525 3.1836 3.2149 3.2464 3.2781 3.3100 3.3744 3.4396 3.4725 3.5056 3.5724 3.6400
04 4.0604 4.1216 4.1836 4.2465 4.3101 4.3746 4.4399 4.5061 4.5731 4.6410 4.7793 4.9211 4.9934 5.0665 5.2154 5.3680
Investing and Financing Activities




05 5.1010 5.2040 5.3091 5.4163 5.5256 5.6371 5.7507 5.8666 5.9847 6.1051 6.3528 6.6101 6.7424 6.8771 7.1542 7.4416


06 6.1520 6.3081 6.4684 6.6330 6.8019 6.9753 7.1533 7.3359 7.5233 7.7156 8.1152 8.5355 8.7537 8.9775 9.4420 9.9299
07 7.2135 7.4343 7.6625 7.8983 8.1420 8.3938 8.6540 8.9228 9.2004 9.4872 10.8090 10.7305 11.0668 11.4139 12.1415 12.9159
08 8.2857 8.5830 8.8923 9.2142 9.5491 9.8975 10.2598 10.6366 11.0285 11.4359 12.2997 13.2328 13.7268 14.2401 15.3270 16.4991
09 9.3685 9.7546 10.1591 10.5828 11.0266 11.4913 11.9780 12.4876 13.0210 13.5795 14.7757 16.0853 16.7858 17.5185 19.0859 20.7989
10 10.4622 10.9497 11.4639 12.0061 12.5779 13.1808 13.8164 14.4866 15.1929 15.9374 17.5487 19.3373 20.3037 21.3215 23.5213 25.9587


11 11.5668 12.1687 12.8078 13.4864 14.2068 14.9716 15.7836 16.6455 17.5603 18.5312 20.6546 23.0445 24.3493 25.7329 28.7551 32.1504
12 12.6825 13.4121 14.1920 15.0258 15.9171 16.8699 17.8885 18.9771 20.1407 21.2843 24.1331 27.2707 29.0017 30.8502 34.9311 39.5805
13 13.8093 14.6803 15.6178 16.6268 17.7130 18.8821 20.1406 21.4953 22.9534 24.5227 28.0291 32.0887 34.3519 36.7862 42.2187 48.4966
14 14.9474 15.9739 17.0863 18.2919 19.5986 21.0151 22.5505 24.2149 26.0192 27.9750 32.3926 37.5811 40.5047 43.6720 50.8180 59.1959
15 16.0969 17.2934 18.5989 20.0236 21.5786 23.2760 25.1290 27.1521 29.3609 31.7725 37.2797 43.8424 47.5804 51.6595 60.9653 72.0351


16 17.2579 18.6393 20.1569 21.8248 23.6575 25.6725 27.8881 30.3243 33.0034 35.9497 42.7535 50.9804 55.7178 60.9250 72.9390 87.4421
17 18.4304 20.0121 21.7616 23.6975 25.8404 28.2129 30.8402 33.7502 36.9737 40.5447 48.8837 59.1176 65.0751 71.6730 87.0680 105.9306
18 19.6147 21.4123 23.4144 25.6454 28.1324 30.9057 33.9990 37.4502 41.3013 45.5992 55.7497 68.3941 75.8364 84.1407 103.7403 128.1167
19 20.8190 22.8406 25.1169 27.6712 30.5390 33.7600 37.3790 41.4463 46.0185 51.1591 63.4397 78.9692 88.2118 98.6032 123.4135 154.7400
20 22.0190 24.2974 26.8704 29.7781 33.0660 36.7856 40.9955 45.7620 51.1601 57.2750 72.0524 91.0249 102.4436 115.3797 146.6280 186.6880


30 34.7849 40.5681 47.5754 56.0849 66.4388 79.0582 94.4608 113.2832 136.3075 164.4940 241.3327 356.7868 434.7451 530.3117 790.9480 1181.8816
40 48.8864 60.4020 75.4013 95.0255 120.7998 154.7620 199.6351 259.0565 337.8824 442.5926 767.0914 1342.0251 1779.0903 2360.7572 4163.2130 7343.8578
50 64.4632 84.5794 112.7969 152.6671 209.3480 290.3359 406.5289 573.7702 815.0836 1163.9085 2400.0182 4994.5213 7217.7163 10435.6488 21813.0937 45497.1908
60 81.6697 114.0515 163.0534 237.9907 353.5837 533.1282 813.5204 1253.2133 1944.7921 3034.8164 7471.6411 18535.1333 29219.9916 46057.5085 114189.6665 281732.5718
Long-Term Debt Financing
485
486 f487
Long-Term Debt Financing EOC Chapter 10
Long-Term Debt Financing




review of learning objectives

Use present value concepts to measure long-term li- includes three elements: accounting for their issuance, for in-
1 abilities. Obligations that will not be paid or otherwise terest payments, and for their retirement. If bonds are sold at
satisfied within one year are classified on the balance sheet as face value, Cash is debited and Bonds Payable is credited. More
long-term liabilities. Some common types of long-term liabil- often, however, bonds are sold at a premium or a discount.
ities are notes payable, mortgages payable, lease obligations, The bond liability is recorded at face value in the bonds payable
and pension obligations. The present value of a long-term li- account, and the premium or discount is recorded in a sepa-
ability is the current value, which is computed by discounting rate account and added to (in the case of a premium) or sub-
the known future amount using the current interest rate. If tracted from (in the case of a discount) Bonds Payable on the
the present value amounts of assets or liabilities are known and balance sheet. When interest is paid, Bond Interest Expense is
a future amount is desired, then the present value must be debited and Cash is credited. An adjustment is made to bond
compounded to arrive at a future amount that includes both interest expense if the bond is sold at a premium or discount.
principal and interest. At the date a bond matures, the borrowing company pays the
face value to the investors, and the bonds are canceled. If the
Account for long-term liabilities, including notes bonds are retired before maturity, a gain or loss will be rec-
2 payable and mortgages payable. Interest-bearing notes ognized when the carrying value of the bonds differs from the
are recorded on the books of the issuer at face value. Interest amount paid to retire the bonds.
expense is incurred based on the rate of interest, the carrying
value of the note, and the passage of time. Interest Expense is Use debt-related financial ratios to determine the de-
5
debited for the amount of interest incurred and Cash or In- gree of a company s financial leverage and its ability
terest Payable is credited. to repay loans. Higher leverage allows a company to expand
Mortgage liabilities are paid by a series of regular pay- without requiring additional stockholder investment. How-
ments that include interest expense and a reduction of the prin- ever, higher leverage also makes repayment of debt less cer-
cipal of the mortgage note. The balance sheet liability at any tain. Both the debt ratio (total liabilities divided by total as-
given time is the present value of the remaining mortgage pay- sets) and the debt-to-equity ratio (total liabilities divided by
ments. total stockholders equity) measure the level of a company s
leverage. These ratios are also sometimes computed using only
Account for capital lease obligations and understand interest-bearing debt instead of total liabilities. The times in-
3 the significance of operating leases being excluded terest earned ratio (operating income divided by interest ex-
from the balance sheet. A firm can acquire new assets by ei- pense) measures how much cushion a company has in terms
ther purchasing or leasing them. Leasing involves periodic pay- of being able to make its periodic interest payments.
ments over the life of the lease. The lease is classified as an op-
erating lease if it is short term and does not meet any of the
criteria of a capital lease. If the lease meets one of the specified
capital lease criteria, it is treated as a purchase and referred to
as a capital lease. As such, it is recorded as both an asset and a Amortize bond discounts and bond premiums using
6
long-term liability. The asset is depreciated and the liability is either the straight-line method or the effective-interest
reduced as lease payments are made. Operating leases are a form method. If bonds are issued at a discount, the bond interest
of off-balance-sheet financing because the obligation to make expense for the year is the amount of interest paid plus the
the future operating lease payments is not recognized on the bond discount amortized during that year. If the bonds are
balance sheet. However, the amount of future operating lease sold at a premium, the bond interest expense for the year is
payments is disclosed in the notes to the financial statements. the interest paid minus the bond premium amortized that
year. Bond premiums and discounts generally should be amor-
Account for bonds, including the original issuance, tized using the effective-interest method. The straight-line
4 the payment of interest, and the retirement of bonds. method is allowed provided that the two methods produce
Accounting for bonds by the borrowing company (the issuer) similar results.
487
f488 Long-Term Debt Financing
Part 3 EOC Investing and Financing Activities




key terms

annuity 460 debt-to-equity ratio 476 secured bonds 469
junk bonds 469 serial bonds 469
bond 469
long-term liabilities 456 stated rate of interest 471
bond discount 471
market rate (effective rate or yield term bonds 469
bond indenture 470
rate) of interest 471 times interest earned 477
bond maturity date 470
mortgage amortization schedule zero-coupon bonds 469
bond premium 471
464
callable bonds 469
mortgage payable 463
compounding period 458
present value of $1 456
convertible bonds 469
present value of an annuity 460
coupon bonds 469 bond carrying value 481
principal (face value or maturity
debentures (unsecured bonds) 469 value) 470 effective-interest amortization 478
debt ratio 476 registered bonds 469 straight-line amortization 478




review problems

Energy Corporation had the following transactions relating to its long-term liabilities for the year:
Accounting for Long-
Term Liabilities
a. Issued a $30,000, three-year, 8% note payable to White Corporation for a truck purchased
on January 2. Interest is payable annually on December 31 of each year.
b. Issued $300,000 of 12%, 10-year bonds on July 1. The market rate on the date of issuance
was 12%. Interest payments are made on June 30 and December 31 of each year.
c. Purchased a warehouse on December 1 by borrowing $250,000. The terms of the mort-
gage call for monthly payments of $2,194 for 30 years to be made at the end of each month.
The interest rate on the mortgage is 10%.
Required: Make all journal entries required during the year to account for the above liabilities. Energy Cor-
poration reports on a calendar-year basis.
Solution Jan. 2 Truck . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30,000
Note Payable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30,000
Purchased a truck by issuing a note.
July 1 Cash. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 300,000
Bonds Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 300,000
Issued 12%, 10-year bonds with a face value of $300,000.
Dec. 1 Warehouse . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 250,000
Mortgage Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 250,000
Purchased a warehouse by issuing a 10%, 30-year mortgage.
Dec.31 Interest Expense . . . . . . . . . . . . . . . . . . . . . . . . ............. 2,400
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ............. 2,400
Paid yearly interest on the 3-year, 8% note
($30,000 8% $2,400).
Bond Interest Expense . . . . . . . . . . . . . . . . . . . ............. 18,000
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ............. 18,000
Paid semiannual interest payment on 12%, 10-year bonds
($300,000 0.12 6/12 $18,000).
(continued)
488 f489
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Interest Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,083
Mortgage Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 111
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,194
Paid first monthly payment on 30-year mortgage
(interest: $250,000 0.10 1/12 $2,083;
reduction in principal: $2,194 $2,083 $111).




Bonds Payable Scientific Engineering Company received authorization on July 1, 2003, to issue $300,000 of
12% bonds. The maturity date of the bonds is July 1, 2023. Interest is payable on January 1
and July 1 of each year. The bonds were sold for $289,200 on July 1, 2003 (the same day as
authorized). Scientific Engineering uses straight-line amortization.
Required: 1. Compute the approximate effective interest rate for the bonds.
2. Record the journal entries on:
a. July 1, 2003.
b. December 31, 2003.
c. January 1, 2004.
d. July 1, 2004.
e. December 31, 2004.
3. Record the journal entries on July 1, 2023, for the final interest payment and the retire-
ment of the bonds.
1. Effective Interest Rate
Solution
Because the bonds sold at a discount, the actual or effective rate of interest is higher than the
stated interest rate of 12%. The effective interest rate can be approximated as follows:
Bond discount amortized per year $10,800/20 periods $540
Annual interest expense ($300,000 12%) $540 $36,540
Effective interest rate $36,540/$289,200 12.63%

2. Journal Entries
a. 2003
July 1 Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 289,200
Discount on Bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,800
Bonds Payable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 300,000
To record the sale of $300,000 of 12% bonds
due on July 1, 2023.
b. 2003
Dec. 31 Bond Interest Expense . . . . . . . . . . . . . . . . . . . . . . . . . . 18,270
Discount on Bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . 270
Bond Interest Payable . . . . . . . . . . . . . . . . . . . . . . . . . 18,000
To record semiannual bond interest expense
on $300,000, 12%, 20-year bonds
($300,000 0.12 1/2 year) and amortize bond
discount ($10,800 20 years 1/2 year).
c. 2004
Jan. 1 Bond Interest Payable. . . . . . . . . . . . . . . . . . . . . . . . . . . 18,000
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18,000
Paid semiannual interest on $300,000 bonds.
d. 2004
July 1 Bond Interest Expense . . . . . . . . . . . . . . . . . . . . . . . . . . 18,270
Discount on Bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . 270
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18,000
Paid semiannual interest on $300,000 bonds
and amortized bond discount.
(continued)
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e. 2004
Dec. 31 Bond Interest Expense . . . . . . . . . . . . . . . . . . . . . . . . . . 18,270
Discount on Bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . 270
Bond Interest Payable . . . . . . . . . . . . . . . . . . . . . . . . . 18,000
To record semiannual bond interest expense on
$300,000 bonds and amortize bond discount.

3. Retirement of the Bonds
2023
July 1 Bond Interest Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18,270
Discount on Bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 270
Bond Interest Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18,000
To record the bond interest expense and discount
amortization up to the date of maturity.
Bonds Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 300,000
Bond Interest Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18,000
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 318,000
To record the payment of interest for six months
and retire the bonds at maturity.

The first entry on July 1, 2023, updates the amortization of the bond discount to the retire-
ment date and reflects the cash owed for interest for the period January 1 July 1, 2023. The sec-
ond entry reflects payment for retiring the bonds plus payment of the interest owed. Alternatively,
Cash could have been credited for $18,000 in the first entry. If Cash had been credited, the sec-
ond entry would have included only a debit to Bonds Payable and a credit to Cash for $300,000.




discussion questions

13. When do you think bonds will sell at or near face value?
1. The higher the interest rate, the lower the present value
14. Explain why bonds retired before maturity may result
of a future amount. Why?
in a gain or loss to the issuing company.
2. What is an annuity?
15. What does the debt ratio measure?
3. When does the stated amount of a liability equal its
16. From the standpoint of a lender, which is more attrac-
present value?
tive: a high times interest earned ratio or a low times
4. What is the difference between a note payable and a
interest earned ratio? Explain.
mortgage payable?
5. When a mortgage payment is made, a portion of it is
applied to interest, and the balance is applied to reduce
the principal. How is the amount applied to reduce the
principal computed?
17. What type of account is Discount on Bonds?
6. If a lease is recorded as a capital lease, what is the rela-
18. Why does the amortization of a bond discount increase
tionship of the lease payments and the lease liability?
the book value of bonds?
7. Why do companies prefer to classify leases as operating
19. Why is the effective-interest amortization method more
leases rather than as capital leases?
theoretically appropriate than the straight-line amortiza-
8. To whom do companies usually sell bonds?
tion method?
9. What are two important characteristics that determine
20. What is the carrying value of a bond?
the issuance price of a bond?
21. How does the carrying value of a bond affect the ac-
10. Identify four different ways in which bonds can mature
counting for bonds payable under the effective-interest
or be eliminated as liabilities.
method?
11. If a bond s stated interest rate is below the market inter-
22. If the effective rate of interest for a bond is greater than
est rate, will the bond sell at a premium or at a dis-
its stated rate of interest, explain why the annual bond
count? Why?
interest expense will be different from the periodic cash
12. If you think the market interest rate is going to drop in
interest payments to the bondholders.
the near future, should you invest in bonds?
490 f491
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discussion cases


PRESENT VALUE CONCEPTS
CASE 10-1
Hamburg Company recently began business and purchased a large facility to make beach cloth-
ing. Hamburg Company managed to make a small profit in its initial year of operations, al-
though it used all its cash to purchase inventory and equipment. After preparing its tax return
for the year, Hamburg s managers realized that they could pay less taxes than they thought. Be-
cause IRS accelerated depreciation methods allow for higher depreciation expense than the
straight-line method the company is using for financial reporting purposes, Hamburg can claim
more depreciation expense than it thought it could and can reduce taxable income by $30,000.
However, Hamburg s managers know that the two depreciation methods will eventually even
out because the difference is only temporary and will create a deferred income tax liability, which
must be recorded on the books. The managers are very conservative, though, and would rather
pay the additional taxes now than record a liability that must be paid in the future, even if they
must borrow the money from a bank to pay the extra taxes. They have come to you for advice.
What would you tell them?

CASE 10-2 DEBT AND EQUITY FINANCING
Berlin Company is in a world of hurt. For the past 15 years, the company has been the exclu-
sive toy supplier to Infants-R-Us toy stores. Unfortunately for Berlin Company, Infants-R-Us
just declared bankruptcy and went out of business. Berlin is the supplier for a few local toy
stores, but Infants-R-Us was by far its largest customer. Berlin s managers believe that they can
save the company if they can raise enough money to develop a new product line of a popular
toy, Nano Babies. Developing the new product line will require a considerable investment,
however. Berlin is trying to decide the best way to finance the investment. It has found a bank
that will loan it the money at 18%, a very high rate but the only one it can get because of its
precarious financial position. Berlin can also issue bonds to raise the money, but because of in-
vestors concerns about the future viability of the company, the only kind of bonds investors
will buy are high-interest junk bonds at an interest rate of 17%. Even then, there is concern
that the bonds will be discounted when they are marketed. Which financing alternative would
you recommend to the company? If you were an investor, would you buy Berlin Company s
bonds?




exercises


EXERCISE 10-1 COMPUTING THE PRESENT VALUE OF A SINGLE SUM
Find the present value (rounded to the nearest dollar) of:
1. $15,000 due in 5 years at 8% compounded annually.
2. $25,000 due in 81/2 years at 10% compounded semiannually.
3. $9,500 due in 4 years at 12% compounded quarterly.
4. $20,000 due in 20 years at 8% compounded semiannually.

EXERCISE 10-2 COMPUTING THE FUTURE VALUE OF A SINGLE SUM
Compute the future value (rounded to the nearest dollar) of the following investments:
1. $10,209 invested to earn interest at 8% compounded annually for 5 years.
2. $10,908 invested to earn interest at 10% compounded semiannually for 81/2 years.
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3. $5,920 invested to earn interest at 12% compounded quarterly for 4 years.
4. $4,166 invested to earn interest at 8% compounded semiannually for 20 years.

EXERCISE 10-3 COMPUTING THE PRESENT VALUE OF AN ANNUITY
What is the present value (rounded to the nearest dollar) of an annuity of $8,000 per year for
five years if the interest rate is:
1. 8% compounded annually.
2. 10% compounded annually.

EXERCISE 10-4 COMPUTING THE AMOUNT OF PERIODIC PAYMENTS
U-Crane Company has just borrowed $100,000. The loan is to be repaid in regular annual
payments made at the end of each year. What is the amount of each annual payment under
the following sets of terms:
1. Interest rate of 10% compounded annually; repayment in five annual payments.
2. Interest rate of 12% compounded annually; repayment in 10 annual payments.

EXERCISE 10-5 ACCOUNTING FOR LONG-TERM NOTE PAYABLE
Karl Company borrowed $25,000 on a two-year, 12% note dated October 1, 2002. Interest
is payable annually on October 1, 2003, and October 1, 2004, the maturity date of the note.
The company prepares its financial statements on a calendar-year basis. Prepare all journal en-
tries relating to the note for 2002, 2003, and 2004.

EXERCISE 10-6 ACCOUNTING FOR LONG-TERM NOTE PAYABLE
Silmaril, Inc., borrowed $25,000 from First National Bank by issuing a three-year, 10% note
dated July 1, 2002. Interest is payable semiannually on December 31 and June 30. The
principal amount is to be repaid in full on June 30, 2005. Silmaril, Inc., reports on a calen-
dar-year basis. Prepare all journal entries relating to the note during 2002, 2003, 2004, and
2005.



EXERCISE 10-7 ACCOUNTING FOR A MORTGAGE
Johnson Enterprises borrowed $100,000 on July 1, 2003, to finance the purchase of a building.
The mortgage requires payments of $1,075 to be made at the end of every month for 15 years
with the first payment being due on July 31, 2003. The interest rate on the mortgage is 10%.
1. Prepare a mortgage amortization schedule for 2003.
2. How much interest will be paid in 2003?
3. By how much will the principal amount of the mortgage be reduced by the end of 2003?

EXERCISE 10-8 ACCOUNTING FOR A MORTGAGE
On January 1, 2003, Gandalf, Inc., borrowed $50,000 to finance the purchase of machinery.
The terms of the mortgage require payments to be made at the end of every month with the
first payment being due on January 31, 2003. The length of the mortgage is five years, and
the mortgage carries an interest rate of 12%.
1. Compute the amount of the monthly payment.
2. Prepare a mortgage amortization schedule for 2003.
3. Prepare the journal entry to be made on January 31, 2003, when the first payment is made.
4. For the remainder of the year, how will the journal entries relating to the mortgage differ
from the one made on January 31?

EXERCISE 10-9 LEASE ACCOUNTING
Temple Corporation signed a lease to use a machine for four years. The annual lease payment
is $10,500 payable at the end of each year.
1. Record the lease, assuming that the lease should be accounted for as a capital lease and
the applicable interest rate is 10%. (Round to the nearest dollar.)
2. For the initial year, record the annual lease payment.
492 f493
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EXERCISE 10-10 LEASE ACCOUNTING
Digital, Inc., leased computer equipment from Young Leasing Company on January 2, 2003.
The terms of the lease required annual payments of $4,141 for five years beginning on De-
cember 31, 2003. The interest rate on the lease is 14%.
1. Assuming the lease qualifies as an operating lease, what journal entry would be made on
January 2 to record the leased asset?
2. If the lease qualifies as an operating lease, what journal entry would be made when the
first payment is made on December 31, 2003?
3. Provide the journal entry made on January 2, 2003, assuming the lease qualifies as a cap-
ital lease.
4. Provide the journal entry made on December 31, 2003, to record the first lease payment,
assuming a capital lease.

EXERCISE 10-11 ISSUANCE PRICE OF BONDS
Hanover Company issued five-year bonds on January 1. The face value of the bonds is
$56,000. The stated interest rate on the bonds is 10%. The market rate of interest at the time
of issuance was 8%. The bonds pay interest semiannually. Calculate the issuance price of the
bonds.

EXERCISE 10-12 ISSUANCE PRICE OF BONDS
Bremen Company issued five-year bonds on January 1. The face value of the bonds is $56,000.
The stated interest rate on the bonds is 8%. The market rate of interest at the time of issuance
was 10%. The bonds pay interest semiannually. Calculate the issuance price of the bonds.

EXERCISE 10-13 ACCOUNTING FOR BONDS ISSUED AT FACE VALUE
Romulus, Inc., issued $500,000 of 10%, five-year bonds at face value on July 1, 2003. Inter-
est on the bonds is payable semiannually on December 31 and June 30.
1. Provide the journal entry to record the issuance of the bonds on July 1, 2003.
2. Provide the journal entry made on December 31, 2003, to account for these bonds.
3. On September 29, 2004, Romulus elected to retire the bonds early. The market price of
the bonds on this date was $486,000. Provide the journal entries to record the early re-
tirement.
4. Why do you think Romulus elected to retire the bonds early?

EXERCISE 10-14 ACCOUNTING FOR BONDS ISSUED AT FACE VALUE
Rikker Company issued $600,000 of 12%, 10-year bonds at face value on October 1, 2003.
The bonds pay interest on April 1 and October 1. Rikker uses the calendar year for financial
reporting purposes.
1. Provide the journal entry to record the bond issuance on October 1, 2003.
2. Provide the journal entry to record interest expense on December 31, 2003.
3. Provide the journal entries made during 2004 relating to the bond.
4. On February 14, 2004, Rikker elected to retire the bond issue early. The market price on
the day of retirement was $605,000. Provide the journal entries to record the bond re-
tirement.
5. Why do you think Rikker elected to retire the bonds early?

EXERCISE 10-15 COMPUTATION OF DEBT-RELATED FINANCIAL RATIOS
The following information comes from the financial statements of Willard Hammond Com-
pany:
Long-term debt . . ...... . . . . . . . . $30,000
Total liabilities . . . ...... . . . . . . . . 48,000
Total stockholders equity. . . . . . . . . 25,000
Operating income. ...... . . . . . . . . 7,000
Interest expense . . ...... . . . . . . . . 3,000
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Compute the following ratio values:
1. Debt ratio.
2. Debt-to-equity ratio.
3. Times interest earned.

EXERCISE 10-16 IMPACT OF CAPITALIZING THE VALUE OF OPERATING
LEASES
The following information comes from the financial statements of Karlla Peterson Company:
Total liabilities . . . . . . . . . . . . . . . . . . . . $100,000
Total stockholders equity . . . . . . . . . . . . 80,000

In addition, Karlla Peterson has a large number of operating leases. The payments on these
operating leases total $20,000 per year for the next 15 years. The present value of the eco-
nomic obligation associated with these operating leases is $150,000. Of course, because these
are operating leases, this economic obligation is off the balance sheet.
Compute the following ratio values:
1. Debt ratio. HINT: Remember the accounting equation.
2. Debt-to-equity ratio.
3. Debt-to-equity ratio assuming that Karlla Peterson s operating leases are accounted for as
capital leases.
4. Debt ratio assuming that Karlla Peterson s operating leases are accounted for as capital leases.




EXERCISE 10-17 ACCOUNTING FOR BONDS ISSUED AT A DISCOUNT
Hawaii Equipment Company issued $300,000 of 8%, five-year bonds at 97 on June 30,
2003. Interest is payable on June 30 and December 31. The company uses the straight-line
method to amortize bond premiums and discounts. The company s fiscal year is from Febru-
ary 1 through January 31.
Prepare all necessary journal entries to account for the bonds from the date of issuance
through June 30, 2004. Also record the retirement of the bonds on June 30, 2008, assuming
that all interest has been paid and that the discount has been fully amortized.

EXERCISE 10-18 ACCOUNTING FOR BONDS ISSUED AT A PREMIUM
Sealon Corporation issued $100,000 of 10%, 10-year bonds at 102 on April 1, 2003. Interest
is payable semiannually on April 1 and October 1. Sealon Corporation uses the calendar year
for financial reporting.
1. Record the necessary entries to account for these bonds on the following three dates.
(Use the straight-line method to amortize the bond premium.)
a. April 1, 2003.
b. October 1, 2003.
c. December 31, 2003.
2. Show how the bonds would be reported on the balance sheet of Sealon Corporation on
December 31, 2003.

EXERCISE 10-19 EFFECTIVE-INTEREST CALCULATION
Determine the approximate effective rate of interest for $300,000, 8%, five-year bonds issued
at 95. (Assume straight-line amortization.)

EXERCISE 10-20 BOND AMORTIZATION SCHEDULE
The following is a partially completed amortization schedule prepared for the Liggett Com-
pany to account for its three-year bond issue with a face value of $50,000. The schedule cov-
494 f495
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Long-Term Debt Financing


ers the first three semiannual interest payment dates. Amounts are rounded to the nearest dol-
lar. Compute the missing numbers.

Interest Bond Premium Bonds Payable
Year Paid Expense Amortized Carrying Value
0 $52,537
/2 (1) $2,627 (2) 52,164
1

1 $3,000 (3) $392 (4)
11/2 (5) (6) (7) (8)


EXERCISE 10-21 ACCOUNTING FOR BONDS
Tanner Corporation, a calendar-year firm, is authorized to issue $400,000 of 12%, 10-year
bonds dated May 1, 2003, with interest payable semiannually on May 1 and November 1.
Amortization of bond premiums or discounts is recorded using the straight-line amortiza-
tion method. Prepare journal entries to record the following events, assuming that the bonds
are sold at 96 on May 1, 2003.
1. The bond issuance on May 1, 2003.
2. Payment of interest on November 1, 2003.
3. Adjusting entry on December 31, 2003.
4. Payment of the interest on May 1, 2004.




problems


PROBLEM 10-1 PRESENT AND FUTURE VALUE COMPUTATIONS
1. Determine the present value in each of the following situations:
Required:
a. A $5,000 loan to be repaid in full at the end of three years. Interest on the loan is
payable quarterly. The interest rate is 12% compounded quarterly.
b. A two-year note for $8,000 bearing interest at an annual rate of 10%, compounded
semiannually. Interest is payable semiannually.
c. A five-year mortgage to be paid in monthly installments of $1,000. The interest rate
is 12% compounded monthly.
2. Determine the future value in each of the following situations:
a. An investment of $10,000 today to earn interest at 6% compounded semiannually
to provide for a down payment on a house five years from now.
b. An investment of $25,000 today to earn interest at 8% compounded quarterly that
is designated for a charitable contribution 10 years from now when the donor retires.

PROBLEM 10-2 PRESENT AND FUTURE VALUE COMPUTATIONS
Required: 1. Compute the present value for each of the following situations, assuming an interest rate
of 10% compounded annually. (Round amounts to the nearest dollar.)
a. A single payment of $30,000 due on a mortgage five years from now.
b. A series of payments of $5,000 each, due at the end of each year for five years.
c. A five-year, 10% loan of $25,000, with interest payable annually, and the principal
due in five years.
2. Compute the future value amounts (rounded to the nearest dollar) in each of the follow-
ing situations:
a. A $20,000 lump-sum investment today that will earn interest at 10% compounded
annually over five years.
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b. A $5,000 lump-sum investment today that will earn interest at 8%, compounded
quarterly to provide money for a child s college education 15 years from now.


PROBLEM 10-3 COMPUTING THE AMOUNT OF PERIODIC PAYMENTS
Kenneth J. Nelson has just purchased a new car for $35,000. He paid $5,000 down and signed
a note for the remaining $30,000. The interest rate on the note is 12% compounded monthly,
or 1% per month.
1. Compute the amount of Mr. Nelson s monthly payment if he plans to pay off the
Required:
$30,000 note in 30 monthly payments. Remember: The interest rate is 1% per month.
2. Repeat (1) assuming that Mr. Nelson wishes to repay the note in 60 monthly payments.
3. Assume that Mr. Nelson decides to repay the note in 60 monthly payments. What is the
balance remaining on the note immediately after he makes the 30th payment? HINT:
Compute the present value of the remaining 30 payments.


PROBLEM 10-4 ACCOUNTING FOR NOTES PAYABLE
Sweet s Candy Company needed cash for its current business operations. On January 1, 2002,
the company borrowed $8,000 on a two-year, interest-bearing note from Peterson Bank at an
annual interest rate of 10%. Interest is payable annually on January 1, and the note matures
January 1, 2004. Sweet s Candy Company also borrowed $4,500 from Laurence National Bank
on January 1, 2002, signing a three-year, 11% note due on January 1, 2005, with interest payable
annually on January 1.
Required: Prepare all journal entries relating to the two notes for 2002, 2003, 2004, and 2005. Assume
that Sweet s Candy Company uses the calendar year for financial reporting. (Round all amounts
to the nearest dollar.)


PROBLEM 10-5 ACCOUNTING FOR NOTES PAYABLE
During 2002, Kenan Corporation had the following transactions relating to long-term liabilities:
Apr. 1 Purchased a machine costing $200,000 from Perry Corporation. Issued a two-year,
interest-bearing note with interest payable on April 1 of each year. The note matures
on April 1, 2004, and carries an interest rate of 9%.
July 1 Borrowed $30,000 from Northern National Bank. The terms of the note require semi-
annual payments of interest on December 31 and June 30. The note matures in two
years and carries an interest rate of 8%.
1. Prepare the journal entries made on April 1 and July 1 to record the issuance of these
Required:
two notes.
2. Prepare all journal entries made on December 31, 2002.
3. Prepare all journal entries made during 2003.


ACCOUNTING FOR A MORTGAGE
PROBLEM 10-6
On November 1, 2003, Hill Company arranges with an insurance company to borrow $200,000
on a 20-year mortgage to purchase land and a building to be used in its operations. The land
and the building are pledged as collateral for the loan, which has an annual interest rate of 12%,
compounded monthly. The monthly payments of $2,200 are made at the end of each month,
beginning on November 30, 2003.
1. Prepare the journal entry to record the purchase of the land and building, assuming that
Required:
$40,000 of the purchase price is assignable to the land.
2. Prepare the journal entries on November 30 and December 31 for the monthly payments
on the mortgage.
3. Interpretive Question: Explain generally how the remaining liability at December 31,
2003, will be reported on the company s balance sheet dated December 31, 2003.
496 f497
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PROBLEM 10-7 LEASE ACCOUNTING
On January 1, 2002, Linda Lou Foods, Inc., leased a tractor. The lease agreement qualifies as a
capital lease and calls for payments of $7,000 per year (payable each year on January 1, starting
in 2003) for eight years. The annual interest rate on the lease is 8%. Linda Lou Foods uses a
calendar-year reporting period.
1. Prepare the journal entries for the following dates:
Required:
a. January 1, 2002, to record the leasing of the tractor.
b. December 31, 2002, to recognize the interest expense for the year 2002.
c. January 1, 2003, to record the first lease payment.
2. Prepare the appropriate journal entries at December 31, 2003, and January 1, 2004.
3. Interpretive Question: Explain briefly how the leased asset is accounted for annually.




PROBLEM 10-8 LEASE ACCOUNTING
Exploration, Inc., leased a starship on January 2, 2003. Terms of the lease require annual pay-
ments of $41,208 per year for five years. The interest rate on the lease is 12%, and the first pay-
ment is due on December 31, 2003.
Required: 1. Compute the present value of the lease payments.
2. Assuming the lease qualifies as a capital lease, prepare the journal entry to record the lease.
3. Prepare the journal entry to record the first lease payment on December 31, 2003, and
to depreciate the leased asset. Exploration, Inc., uses the straight-line method for depreci-
ating all long-term assets.
4. Interpretive Question: How would the leased asset, and its associated liability, be dis-
closed on the balance sheet prepared on December 31, 2003?


PROBLEM 10-9 ISSUANCE PRICE OF BONDS
Patterson Company issued 30-year bonds on June 30. The face value of the bonds is $750,000.
The stated interest rate on the bonds is 6%. The market rate of interest at the time of issuance
was 4%. Patterson also issued another set of bonds on August 31. These bonds were 20-year
bonds and had a face value of $556,000. The stated rate of interest on these bonds was 5%.
The market rate of interest at the time these bonds were issued was 8%. Both sets of bonds pay
interest semiannually.
Required: Calculate the issuance price of these bonds.


PROBLEM 10-10 ACCOUNTING FOR BONDS
On July 1, 2003, Paramount, Inc. issued $500,000, 8%, 30-year bonds with interest paid semi-
annually on January 1 and July 1. The bonds were sold when the market rate of interest was
8%. On October 1, 2006, the bonds were retired when their fair market value was $495,000.
1. Demonstrate, using the present value tables, that the bonds were sold for $500,000.
Required:
2. Provide the journal entry made on July 1 to record the issuance of the bonds.
3. Provide the journal entry made on December 31, 2003, relating to interest.
4. Provide the journal entries to record the retirement of the bonds.


PROBLEM 10-11 ACCOUNTING FOR BONDS
Columbia Enterprises issued $1 million, 10%, 20-year bonds on October 1, 2002. Interest pay-
ment dates are April 1 and October 1. The bonds were sold at face value.
Required: 1. Provide the journal entry to record the initial issuance of the bonds.
2. Provide the required journal entry on December 31, 2002.
3. Provide all journal entries relating to the bonds made during 2003.
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PROBLEM 10-12 REPORTING LIABILITIES ON THE BALANCE SHEET
The following list of accounts is taken from the adjusted trial balance of Goforth Company.
Accounts Payable . . . . . . . . . . . . . . . . . . . . . $45,000
Notes Payable (due in 6 months) . . . . . . . . . . 24,000
Income Taxes Payable . . . . . . . . . . . . . . . . . . 18,000
Unearned Sales Revenue . . . . . . . . . . . . . . . . 27,500
Notes Payable (due in 2 years) . . . . . . . . . . . 40,000
Prepaid Insurance . . . . . . . . . . . . . . . . . . . . . 6,200
Accounts Receivable . . . . . . . . . . . . . . . . . . . 53,000
Current Portion of Mortgage Payable . . . . . . . 12,300
Mortgage Payable (due beyond 1 year) . . . . . 93,000
Retained Earnings . . . . . . . . . . . . . . . . . . . . . 91,400
Property Taxes Payable . . . . . . . . . . . . . . . . . 8,700
Salaries & Wages Payable . . . . . . . . . . . . . . . 15,200
Sales Tax Payable . . . . . . . . . . . . . . . . . . . . . 3,100

Prepare the liabilities section of the company s balance sheet.
Required:

PROBLEM 10-13 REPORTING LIABILITIES ON THE BALANCE SHEET
The following amounts are shown on the Plymouth Company s adjusted trial balance for the
year 2003:
Accounts Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 36,000
Property Taxes Payable . . . . . . . . . . . . . . . . . . . . . . 6,300
Short-Term Notes Payable . . . . . . . . . . . . . . . . . . . . 44,000
Mortgage Payable (due within 1 year) . . . . . . . . . . . 28,000
Mortgage Payable (due after 1 year). . . . . . . . . . . . . 300,000
Accrued Interest on Mortgage Payable . . . . . . . . . . . 3,000
Lease Liability (Current Portion) . . . . . . . . . . . . . . . . 58,000
Lease Liability (Long Term) . . . . . . . . . . . . . . . . . . . 414,000
Rent Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70,000
Income Taxes Payable . . . . . . . . . . . . . . . . . . . . . . . 50,000
Federal & State Unemployment Taxes Payable. . . . . 16,000

Required: Prepare the liabilities section of Plymouth Company s balance sheet at December 31, 2003.

PROBLEM 10-14 COMPUTATION OF DEBT-RELATED FINANCIAL RATIOS
The following information comes from the financial statements of Ron Winmill Company:
Long-term debt . . . . . . . . . . . . . . . . $180,000
Total liabilities . . . . . . . . . . . . . . . . . 230,000
Total stockholders equity . . . . . . . . 150,000
Current assets . . . . . . . . . . . . . . . . . 80,000
Earnings before income taxes . . . . . 11,000
Interest expense . . . . . . . . . . . . . . . 23,000

Required: Compute the following ratio values. State any assumptions that you make.
1. Current ratio.
2. Debt ratio.
3. Debt-to-equity ratio.
4. Times interest earned.
5. Interpretive Question: You are a bank manager considering making a new $20,000
loan to Ron Winmill that would replace part of the existing long-term debt. You expect
Ron Winmill to repay your loan in two years. Which of the ratios computed in (1)
through (4) would be most useful to you in evaluating whether to make the loan to
Ron Winmill?
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PROBLEM 10-15 IMPACT OF CAPITALIZING THE VALUE OF OPERATING
LEASES
The following information comes from the financial statements of Travis Campbell Company:
Total liabilities . . . . . . . . . . . . . . . . . . $100,000
Total stockholders equity . . . . . . . . . 80,000
Property, plant, and equipment . . . . . 110,000
Sales . . . . . . . . . . . . . . . . . . . . . . . . . 500,000
Earnings before income taxes . . . . . . 11,000
Interest expense . . . . . . . . . . . . . . . . 23,000

In addition, Travis Campbell has a large number of operating leases. The payments on these
operating leases total $30,000 per year for the next 10 years. The present value of the economic
obligation associated with these operating leases is $180,000. Of course, because these are op-
erating leases, this economic obligation is off the balance sheet.
Required: Compute the following ratio values:
1. Debt ratio. HINT: Remember the accounting equation.
2. Debt ratio assuming that Travis Campbell s operating leases are accounted for as capital
leases.
3. Asset turnover (sales/total assets).
4. Asset turnover assuming that Travis Campbell s operating leases are accounted for as cap-
ital leases.
5. Interpretive Question: You are Travis Campbell s banker. You are concerned that the
times interest earned ratio is not accurately reflecting the risk that Travis Campbell will
not meet its fixed annual payments because most of those fixed payments are operating
lease payments, not interest payments. Design an alternative ratio that will reflect the fact
that, like interest payments, operating lease payments are fixed obligations that must be
covered through operating profits each year. Compute the value for the ratio that you
have designed.




PROBLEM 10-16 ACCOUNTING FOR BONDS
Nemo Company authorized and sold $90,000 of 10%, 15-year bonds on April 1, 2003. The
bonds pay interest each April 1, and Nemo s year-end is December 31.
Required: 1. Prepare journal entries to record the issuance of Nemo Company s bonds under each of
the following three assumptions:
a. Sold at 97.
b. Sold at face value.
c. Sold at 105.
2. Prepare adjusting entries for the bonds on December 31, 2003, under all three assump-
tions. (Use the straight-line amortization method.)
3. Show how the bond liabilities would appear on the December 31, 2003, balance sheet
under each of the three assumptions.
4. Interpretive Question: What condition would cause the bonds to sell at 97? At 105?

PROBLEM 10-17 ACCOUNTING FOR BONDS ISSUED AT A PREMIUM
On March 1, 2003, Devone Corporation issued $50,000 of 10%, five-year bonds at 118. The
bonds were dated March 1, 2003, and interest is payable on March 1 and September 1. Devone
records amortization using the straight-line method. Devone s financial reporting year ends on
December 31.
499
f500 Long-Term Debt Financing
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Provide all necessary journal entries on each of the following dates:
Required:
1. March 1, 2003.
2. September 1, 2003.
3. December 31, 2003.
4. March 1, 2008.

PROBLEM 10-18 BONDS RETIRED AT MATURITY
Stottard Company issued $450,000 of 10%, 10-year bonds on June 1, 2002, at 103. The bonds
were dated June 1, and interest is payable on June 1 and December 1 of each year.
Required: 1. Record the issuance of the bonds on June 1, 2002. (Round to the nearest dollar.)
2. Record the interest payment on December 1, 2002. Stottard uses the straight-line
method of amortization.
3. Record the interest accrual on December 31, 2002, including amortization.
4. Record the journal entries required on June 1, 2012, when the bonds mature.

PROBLEM 10-19 STRAIGHT-LINE VERSUS EFFECTIVE-INTEREST AMORTIZATION
Cyprus Corporation issued $150,000 of bonds on January 1, 2003, to raise funds to buy some
special machinery. The maturity date of the bonds is January 1, 2008, with interest payable each
January 1 and July 1. The stated rate of interest is 10%. When the bonds were sold, the effec-
tive rate of interest was 12%. The company s financial reporting year ends December 31.
Required: 1. Determine the price at which the bonds would be sold.
2. Prepare the amortization schedule using the effective-interest method.
3. Prepare a comparative schedule of interest expense for each year (2003 2008) for the
effective-interest and straight-line methods of amortization.
4. Record the journal entry for the last payment using the amortization schedule in (2).
5. Record the journal entry for the retirement of the bonds.
6. Interpretive Question: Is the difference between the interest expense each year between
the straight-line and effective-interest methods sufficient to require the use of the effective-
interest method? How do you think this question would be answered in practice?

PROBLEM 10-20 EFFECTIVE-INTEREST AMORTIZATION
Lancell Corporation issued $100,000 of three-year, 10% bonds on January 1, 2002. The bonds
pay interest on January 1 and July 1 each year. The bonds were sold to yield an 8% return,
compounded semiannually.
Required: 1. At what price were the bonds issued?
2. Prepare a schedule to amortize the premium or discount on the bonds using the effective-
interest amortization method.
3. Use the information in the amortization schedule prepared for (2) to record the interest
payment on July 1, 2004, including the appropriate amortization of the premium or dis-
count.
4. Interpretive Question: Explain why these bonds sold for more or less than face value.

PROBLEM 10-21 ACCOUNTING FOR BONDS
Bell Company sold $200,000 of 10-year bonds on January 1, 2002, to Brown Corporation. The
bond indenture included the following information:
Face value $200,000
Date of bonds January 1, 2002
Maturity date January 1, 2012
Stated rate of interest 14%*
Effective (market) rate of interest 12%*
*Compounded semiannually
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1. Prepare the journal entry to record the issuance of the bonds.
Required:
2. What is the interest expense on the Bell Company books for the years ending December
31, 2002, and December 31, 2003, using straight-line amortization?
3. Explain how the bonds would be presented on Bell s balance sheet at December 31, 2003.

PROBLEM 10-22 STRAIGHT-LINE VERSUS EFFECTIVE-INTEREST AMORTIZATION
Foster Corporation issued three-year bonds with a $180,000 face value on March 1, 2002, in
order to pay for a new computer system. The bonds mature on March 1, 2005, with interest
payable on March 1 and September 1. The contract rate of interest is 10%. (Interest is com-
pounded semiannually.) When the bonds were sold, the effective rate of interest was 12%. The
company s fiscal year ends on February 28.
Required: 1. At what price were the bonds issued based on the information presented?
2. Prepare an amortization schedule using the effective-interest method.
3. Prepare a schedule of interest expense for each year (2002 2005), comparing the annual
interest expense for straight-line and effective-interest amortization.
4. Using the amortization schedule prepared in (2), prepare the journal entry to record the
interest payment on September 1, 2002.
5. Prepare the adjusting journal entry to record accrued interest on February 28, 2003.
6. Prepare the journal entry to retire the bonds on March 1, 2005, assuming all interest has
been paid prior to retirement.

PROBLEM 10-23 BONDS RETIRED BEFORE MATURITY
Amity Construction Company issued $100,000 of 10% bonds on January 1, 2003. The matu-
rity date of the bonds is January 1, 2013. Interest is payable January 1 and July 1. The bonds
were sold at 111.4 on July 1, 2003. The company uses the straight-line method of amortizing
bond premiums and discounts.
1. Make the required journal entries for each of the following dates:
Required:
a. July 1, 2003.
b. December 31, 2003.
c. January 1, 2004.
d. July 1, 2004.
2. Because of a substantial decline in the market rate of interest, Amity Construction Com-
pany purchased all the bonds on the open market at face value (100) on July 1, 2006.
The following entry had just been made on that day:
Bond Interest Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,400
Premium on Bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 600
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,000
Made semiannual interest payment on the bonds
and amortized bond premium for six months.

Prepare the journal entry to record the retirement of the bonds on July 1, 2006.

PROBLEM 10-24 UNIFYING CONCEPTS: ACCOUNTING FOR BONDS PAYABLE
Durham Corporation was authorized to issue $500,000 of 8%, four-year bonds, dated May 1,
2003. All the bonds were sold on that date when the effective interest rate was 10%. Interest is
payable on May 1 and November 1 each year. The company follows a policy of amortizing pre-
mium or discount using the effective-interest method. The company closes its books on De-
cember 31 of each year.
1. Calculate the issuance price of the bonds.
Required:
2. Prepare an amortization schedule that covers the life of the bond.
3. Prepare journal entries at the following dates based on the information shown in the
amortization schedule prepared for requirement (2).
a. December 31, 2003.
b. May 1, 2004.
501
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c. November 1, 2004.
d. December 31, 2004.
4. Based on the journal entries prepared for requirement (3), how much interest expense re-
lated to this bond issue did the company report on its income statement for the year
2004?
5. What was the carrying value of this bond issue on the balance sheet of the company at
December 31, 2004?
6. Interpretive Question: Explain why another company in the same industry, which issued
bonds with the same amount of face value, the same date of issuance, and the same
stated rate of interest, might have had an issuance price of more or less than the price
you computed for the issuance of the Durham Corporation bonds.

PROBLEM 10-25 ANALYSIS OF BONDS
Bonds with a face value of $200,000 and a stated interest rate of 12% were issued on March 1,
2003. The bonds pay interest each February 28 and August 31 and mature on March 1, 2013.
The issuing company uses the calendar year for financial reporting.
Required: Using these data, complete the following tables for each of the conditions listed. (Show com-
putations and assume straight-line amortization.)
1. The bonds sold at face value.
2. The bonds sold at 97.
3. The bonds sold at 103.


Case 1 Case 2 Case 3

Cash received at issuance date . . . . . . . . . . . . . . . . . . . . . . ______ ______ ______
Total cash paid to bondholders through maturity . . . . . . . . ______ ______ ______
Income Statement for 2003:
Bond interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . ______ ______ ______
Balance Sheet at December 31, 2003:
Long-term liabilities:
Bonds payable, 12% . . . . . . . . . . . . . . . . . . . . . . . . . . . . ______ ______ ______
Unamortized discount . . . . . . . . . . . . . . . . . . . . . . . . . . . ______ ______ ______
Unamortized premium. . . . . . . . . . . . . . . . . . . . . . . . . . . ______ ______ ______
Bond carrying value . . . . . . . . . . . . . . . . . . . . . . . . . . . . ______ ______ ______
Approximate effective interest rate* . . . . . . . . . . . . . . . . ______ ______ ______
*Round to the nearest tenth of a percent.
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competency enhancement opportunities




LLL
LLLL




Analyzing Real Company Information The Debate
International Case Cumulative Spreadsheet Project
Ethics Case Internet Search
Writing Assignment




The following additional assignments provide opportunities for students to de-
velop critical thinking, ethical perspectives, oral and written communication
skills, experience with electronic research, and teamwork through group and
business activities.
L




ANALYZING REAL COMPANY INFORMATION
Analyzing 10-1 (Microsoft)
The 1999 annual report for MICROSOFT is included in Appendix A. Locate that
annual report and consider the following questions:
1. Examine Microsoft s balance sheet as of June 30, 1999. Do you notice any-
thing unusual in connection with Microsoft s reported long-term debt?
2. During fiscal 1997, Microsoft issued $980 million in convertible preferred
stock. The terms of this preferred stock are that the investors agreed to give
Microsoft $980 million, and Microsoft agreed to pay them a fixed amount
of $27 million per year in dividends. Starting in 1999, these preferred stock-
holders can exchange their shares for Microsoft common stock, which will
entitle them to all the rights of Microsoft owners. In what ways is this $980
million investment in Microsoft similar to a loan? In what ways is it differ-
ent from a loan?


Analyzing 10-2 (IBM)
INTERNATIONAL BUSINESS MACHINES (IBM) included the following infor-
mation in Note J to its 1999 financial statements:



Long-Term Debt
At December 31, 1999
(dollars in millions)
Maturity Dates Amount

Items denominated in U.S. dollars:
DEBENTURES:
6.22% debentures . . . . . . . . . . . . ................. 2027 $ 500
61/2% debentures . . . . . . . . . . . . . ................. 2028 700
7% debentures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2025 600
7% debentures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2045 150
71/8% debentures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2096 850
71/2% debentures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2013 550
83/8% debentures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2019 750

(continued)
503
f504 Long-Term Debt Financing
Part 3 CEO Investing and Financing Activities




NOTES:
6.3% average . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2000 2014 $ 4,191
Medium-term note
Program: 5.8% average . . . . . . . . . . . . . . . . . . . . . . . . 2000 2014 6,230
Other: 6.5% average . . . . . . . . . . . . . . . . . . . . . . . . . . . 2000 2012 1,227
$15,748
Items denominated in other currencies:
Japanese yen (3.0% average rate) . . . . .............. 2000 through 2014 $ 3,141
Canadian dollars (5.7% average rate) . . .............. 2000 through 2005 707
German marks (4.9% average rate). . . . . . . . . . . . . . . . . . 2002 103
Swiss francs (2.5% average rate) . . . . . . . . . . . . . . . . . . . 2001 78
U.K. pounds (7.0% average rate) . . . . . . . . . . . . . . . . . . . 2000 through 2003 33
Other currencies (13.6% average rate) . .............. 2000 through 2014 159
$19,969




1. IBM lists seven different issues of debentures. What is a debenture?
2. What is unusual about the 71/8% debentures?
3. IBM has borrowed the equivalent of $4.221 billion in the form of foreign
currency loans. Why would IBM get loans denominated in foreign curren-
cies rather than get all of its loans in U.S. dollars?
4. The average interest rates on the foreign currency loans range from a low
of 2.5% for loans of Swiss francs to 7.0% for loans of U.K. pounds. What
factors would cause IBM to pay a higher interest rate when it borrows U.K.
pounds than when it borrows Swiss francs?
Analyzing 10-3 (Citicorp)
The CITY BANK OF NEW YORK was chartered on June 16, 1812, just two days
before the start of the War of 1812 between the United States and Great Britain.
To get around twentieth-century bank holding laws, a holding company was
organized to own the bank. This holding company took the name of CITICORP
in 1974, and the bank itself is now called CITIBANK. Citibank is one of the largest
banks in the United States.
Below are a simplified balance sheet for Citicorp as of December 31, 1999,
and a schedule outlining the interest rate on Citicorp s outstanding long-term debt:


Citicorp
Balance Sheet
December 31, 1999
(millions of dollars)

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 10,648
Investment securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90,310
Loans receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 203,288
Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23,653
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $327,899
Deposit liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $234,832
Other liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59,753
Long-term debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11,752
Stockholders equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21,562
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $327,899
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Interest Rates Prevailing on Parent and Subsidiary Loans
for Loans Outstanding on December 31, 1999
Average
Interest
Type of Loan Rate

PARENT COMPANY
Senior notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 05.94%
Subordinated notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 07.07%
SUBSIDIARIES
Senior notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 08.22%
Subordinated notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 07.78%




1. Citicorp s simplified balance sheet is representative of most banks balance
sheets. Using the information about relative sizes of assets and liabilities
given in that balance sheet, write a brief description of the primary oper-
ating activity of a bank.
2. Compute Citicorp s debt ratio (total liabilities divided by total assets). Com-
ment on whether the value seems high or low to you.
3. In its long-term debt of $11.752 billion, Citicorp has both fixed-rate loans
and floating-rate (or variable-rate) loans. What is the advantage of bor-
rowing with a fixed-rate loan? What is the advantage of borrowing with a
variable-rate loan?
4. Citicorp includes the following information in its 1999 financial statement
note on long-term debt: Approximately 59% . . . of subsidiary long-term
debt was guaranteed by Citicorp, and of the debt not guaranteed by Citi-
corp, approximately 23% . . . was secured by the assets of the subsidiary.
When Citicorp guarantees the long-term debt of one of its subsidiaries,
does that raise or lower the interest rate that the subsidiary must pay on
the debt? Explain. Is the interest rate on a loan higher when it is secured
by assets or when it is unsecured? Explain.
L




INTERNATIONAL CASE
British Petroleum
In May 1901, William Knox D Arcy convinced the Shah of Persia (present-day
Iran) to allow him to hunt for oil. The oil discovered in Persia in 1908 was the
first commercially significant amount of oil found in the Middle East. The com-
pany making the discovery called itself the ANGLO-PERSIAN OIL COMPANY,
later named BRITISH PETROLEUM, or BP. Today, BP Amoco is one of the largest
oil and gas exploration and refining companies in the world.
The information on the next page comes from Note 23 (Finance debt) of
British Petroleum s 1999 financial statements. All amounts are in millions of
British pounds.
505
f506 Long-Term Debt Financing
Part 3 CEO Investing and Financing Activities




Finance
Loans Leases

Payments due within:
1 year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . £ 4,812 £ 103
2 to 5 years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,646 725
after 5 years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,261 3,569
£12,719 £4,397
Less finance charge . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0 2,572
Net obligation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . £12,719 £1,825




1. In Great Britain, a finance lease is what we in the United States would call
a capital lease. According to Note 23, British Petroleum expects to make
total lease payments of £4.397 billion under finance leases. However, a li-
ability of only £1.825 billion is reported on the balance sheet. Why is there
a difference between the two amounts?
2. The £4.397 billion payment amount for the finance leases reflects the total
of all lease payments that will be made under the agreements. Does the
£12.719 billion amount reported for loans reflect the amount of all pay-
ments that will be made under the loan agreements? Explain.
3. The future loan and finance lease payments are separated into amounts to
be repaid within one year, within two to five years, and after five years.
How would a financial statement user find this payment timing informa-
tion to be useful?
L




ETHICS CASE
Hiding an Obligation By Calling It a Lease
You and your partner own Miss Karma s Preschool, which provides preschool
and day care services for about 100 children per day. Business is booming, and
you are right in the middle of expanding your operation. Three months ago
you took your financial statements to the local bank and applied for a five-year,
$145,000 loan. The bank approved the loan, but it included as part of the loan
agreement a condition that you would incur no other long-term liabilities dur-
ing the five-year loan period. You cheerfully agreed to this condition because
you didn t anticipate any further financing needs.
Two weeks ago a state government inspector came to your facility and said
that your square footage was not enough for the number of children enrolled
in your programs. The inspector gave you one month to find another facility,
or else you would have to shut down. Luckily, you were able to find another
building to use. However, the owner of the building insists on having you sign
a 20-year lease. Alternatively, you can buy the building for $220,000. To buy
the building, you would have to get a mortgage, which would, of course, vio-
late the agreement on your five-year bank loan.
Your partner suggests that the lease is the way to solve all of your prob-
lems. Your partner has studied some accounting and reports that you can sign
the lease but carefully construct the lease contract so that the lease will be ac-
counted for as an operating lease. In this way, the lease obligation will not be
reported as an accounting liability, the loan agreement will not be violated, and
you can move to the new facility without any problem.
506 f507
Long-Term Debt Financing CEO Chapter 10
Long-Term Debt Financing




Is your partner right? Is it possible to avoid reporting the 20-year lease con-
tract as an accounting liability? By signing the lease, are you violating the bank
loan agreement? What do you think is the best course of action?

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