Chap 010

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CHAPTER 10
LIABILITIES
OVERVIEW OF EXERCISES, PROBLEMS, CASES,
AND INTERNET ASSIGNMENT
Exercises Toic
Le!r"i"#
O$%ec&i'es C(!r!c&eris&ics
10–1 You as a student 4 Personal, mechanical
10–2 Accounting equation 1–6 Conceptual
10–3 Eects o transactions upon
inancial statements
1, 2, 4, !,
6, "
Conceptual
10–4 #alance sheet presentation 1, !, 6, " Conceptual
10–! Pa$roll%related costs 3 &echanical
10–6 Pa$roll%related costs 3 &echanical, conceptual
10–' (se o an amorti)ation ta*le 4 &echanical, conceptual
10–" +a, *eneit o de*t inancing ! &echanical, conceptual, real-
DuPont
10–. #onds pa$a*le and interest ! &echanical, conceptual
10–10 Accounting or *ond premiums !, 6 &echanical, conceptual
10–11 Accounting or *ond discounts !, 6 &echanical, conceptual
10–12 Anal$)ing sol/enc$ . &echanical, anal$tical, real-Tyco
Toys and Hasbro
010–13 Accounting or leases 10 &echanical, conceptual, ethics
010–14 Accounting or pensions 10 Conceptual, mechanical, ethics
010–1! 1eerred income ta,es 10 Conceptual, mechanical
10–16 2denti$ing de*t . Conceptual, real-Tootsie Roll
Pro$)e*s
10–1 Eects o transactions upon the
accounting equation
1, 2, 3, 4, !,
6, "
Conceptual
10–2 #alance sheet presentation 1, 2, 4, " Conceptual
10–3 3otes pa$a*le 2 &echanical, conceptual
10–4 Preparation and use o an
amorti)ation ta*le
4 &echanical, conceptual
10–! #onds issued at par ! &echanical, conceptual
10–6 #ond discount and premium !, 6 &echanical, conceptual
010–' #alance sheet presentation 1, !, 6, 10 Conceptual, mechanical
____________
*Supplemental Topic: “Special Types of Liabilities.”
+, 4 +he &c5ra6%7ill Companies, 2nc8, 200!
C!ses Toic
Le!r"i"#
O$%ec&i'es C(!r!c&eris&ics
010–1 3ature o lia*ilities 1, 10 Conceptual, can *e group
assignment, real-8 companies
10–2 9actors aecting *ond prices !, 6, ' Conceptual, anal$tical, group, real
-Abbott Labs
10–3 :oss contingencies " Conceptual, group
Business Week
Assi#"*e"&
010–4 Business Week assignment !, 6, ' Conceptual, anal$tical
I"&er"e&
Assi#"*e"&
10–1 Credit ratings or *onds !, 6, . 2nternet, research
____________
*Supplemental Topic: “Special Types of Liabilities.”
+- 4 +he &c5ra6%7ill Companies, 2nc8, 200!
DESCRIPTIONS OF PROBLEMS, CASES,
AND INTERNET ASSIGNMENT
#elo6 are *rie descriptions o each pro*lem, case, and the 2nternet assignment8 +hese descriptions are
accompanied *$ the estimated time ;in minutes< required or completion and *$ a diicult$ rating8 +he time
estimates assume use o the partiall$ illed%in 6or=ing papers8
Pro$)e*s
10–1 Computer Specialists, Inc.
>ho6 the eects o /arious transactions upon the accounting equation8 Also
calls or distinction *et6een current and long%term lia*ilities8 ?uic= and eas$,
*ut quite comprehensi/e8
25 Easy
10–2 Seattle Chocolates
9rom an unclassiied listing o account *alances and other inormation,
prepare current and long%term lia*ilit$ sections o a *alance sheet8 E,plain
treatment o /arious items8
30 Medium
10–3 Swanson Corporation
Accounting or notes pa$a*le, 6ith interest stated separatel$8
25 Medium
10– !uic" #u$e
2n/ol/es conceptual discussion o an amorti)ation ta*le, use o the ta*le, and
e,tension o a partiall$ completed ta*le or t6o more pa$ments8
25 Medium
10–5 %lue Mountain &ower Company
@ournal entries to record issuance o *onds *et6een interest pa$ment dates,
pa$ment o interest, and accrual o interest at $ear%end8 Aequires student to
=no6 that *onds are issued at par 6hen the pre/ailing mar=et rate o interest
equals the contract rate o interest8
15 Easy
10–' &ar" (apids #um$er Company
Year%end adBusting entries or *ond interest 6hen *onds are issued at a
discount and 6hen *onds are issued at a premium8 #ond discount and
premium amorti)ed *$ the straight%line method8
35 Stron)
*10–+ Minnesota Satellite ,elephone Corporation
9rom an unclassiied list o account *alances and other inormation, student is
as=ed to prepare and discuss the current and long%term lia*ilit$ sections o a
*alance sheet8
5 Stron)
____________
*Supplemental Topic: “Special Types of Liabilities.”
C!ses
*10–1 #ia$ilities in &u$lished -inancial Statements
1iscuss the nature o /arious lia*ilities appearing in the *alance sheets o
30 Medium
>olutions &anual Col8 2, Financial and Managerial Accounting 13De, Eilliams et al ,0
6ell%=no6n companies8
0 10–2 .$$ott #a$s
Aequires student to understand the relationship *et6een a *ondFs issue price
and the eecti/e rate o interest, and to dierentiate *et6een cash lo6 and
interest e,pense8 Also requires that students understand that the time
remaining until a *ond matures is a actor in determining the *ondFs current
/alue8
20 Stron)
10–3 #oss Contin)encies/
>tudents are as=ed to e/aluate our situations, indicating 6hether the situation
descri*es a loss contingenc$ and e,plaining the proper inancial statement
treatment o the matter8
25 Medium
Business Week Assi#"*e"&
*10– Business Week .ssi)nment
>tudents are as=ed to e,plain the relationship *et6een changing interest rates
and *ond /alues8
15 Medium
I"&er"e& Assi#"*e"&
10–1 Credit (atin)s
>tudents are introduced to *ond ratings and ho6 the$ correspond to *ond
$ields8
0o time
estimate
____________
*Supplemental Topic: “Special Types of Liabilities.”
,1 4 +he &c5ra6%7ill Companies, 2nc8, 200!
S.GGESTED ANSWERS TO DISC.SSION /.ESTIONS
18 :ia*ilities are de*ts or o*ligations arising rom past transactions or e/ents, and 6hich require
settlement at a uture date8 :ia*ilities and o6nersF equit$ are the t6o primar$ means *$ 6hich a
*usiness inances o6nership o its assets and its *usiness operations8
+he eature 6hich most distinguishes lia*ilities rom equit$ is that lia*ilities mature 6hereas o6nersF
equit$ does not8 2n the e/ent o liquidation o the *usiness, the claims o creditors ;lia*ilities< ha/e
priorit$ o/er the claims o o6ners ;equit$<8 Also, interest paid to creditors is deducti*le in the
determination o ta,a*le income, 6hereas di/idends paid to stoc=holders are not deducti*le8
28 2n the e/ent o liquidation o a *usiness, the claims o creditors ;lia*ilities< ha/e priorit$ o/er the
claims o o6ners ;equit$<8 +he relati/e priorities o indi/idual creditors, ho6e/er, /ar$ greatl$8
>ecured creditors ha/e top priorit$ 6ith respect to proceeds stemming rom the sale o the speciic
assets that ha/e *een pledged as collateral securing their loans8 +he priorit$ o unsecured creditors is
determined *$ legal statutes and indenture contracts8
38 Current lia*ilities are those maturing 6ithin one $ear or the compan$Fs operating c$cle ;6hiche/er is
longer< and e,pected to *e paid rom current assets8 :ia*ilities classiied as long%term include
o*ligations maturing more than one $ear in the uture, and also shorter term o*ligations that 6ill *e
reinanced or paid rom noncurrent assets8
A 10%$ear *ond issue 6ould *e classiied as a current lia*ilit$ once it comes 6ithin 12 months o the
maturit$ date, assuming that the issue 6ill *e paid rom current assets8
A note pa$a*le maturing in 30 da$s 6ould *e classiied as a long%term lia*ilit$ i ;a< management had
*oth the intent and the a*ilit$ to reinance this o*ligation on a long%term *asis, or ;*< the lia*ilit$ 6ill
*e paid rom noncurrent assets8
48 Accounts Pa$a*le ;>mith >uppl$ Compan$<888888888888888888888888888888888888888888888888888 ",000
3otes Pa$a*le8888888888888888888888888888888888888888888888888888888888888888888888888888888888888 ",000
2ssued a 12G, .0%da$ note pa$a*le to replace an account pa$a*le to >mith
>uppl$ Compan$8
3otes Pa$a*le8888888888888888888888888888888888888888888888888888888888888888888888888888888888888888888888888
2nterest E,pense8888888888888888888888888888888888888888888888888888888888888888888888888888888888888888888888
",000
240
Cash8888888888888888888888888888888888888888888888888888888888888888888888888888888888888888888888888888 ",240
Paid 12G, .0%da$ note to >mith >uppl$ Compan$8
!8 All emplo$ers are required *$ la6 to pa$ the ollo6ing pa$roll ta,es and insurance premiumsH >ocial
>ecurit$ and &edicare ta,es, unemplo$ment ta,es, and 6or=ersF compensation insurance premiums8
2n addition, man$ emplo$ers include the ollo6ing as part o the Icompensation pac=ageJ pro/ided to
emplo$eesH group health insurance premiums, contri*utions to emplo$ee pension plans, and
postretirement *eneits ;such as health insurance<8 #oth mandated and discretionar$ costs are
included as part o total pa$roll cost in addition to the 6ages and salaries earned *$ emplo$ees8
68 Eor=ersF compensation premiums are a mandated pa$roll cost-the cost o pro/iding insurance
co/erage to emplo$ees in case o Bo*%related inBur$8 +he dollar amount o the premiums /aries *$
state and *$ emplo$eesF occupation8 +he emplo$er pa$s 6or=ersF compensation premiums8 >ocial
>ecurit$ and &edicare ta,es are paid hal *$ the emplo$er and hal *$ the emplo$ee8
'8 K62,!3' LK63,210 *alance at the *eginning o the period, less K6'3 o the pa$ment that applies to
principal ;K1,200 − K!2' representing interest<M8
>olutions &anual Col8 2, Financial and Managerial Accounting 13De, Eilliams et al ,0
"8 +he anal$sis is incorrect, *ecause the principal amount o the mortgage note 6ill not *e paid o at a
constant rate o K1'8"4 per month8 +he portion o each pa$ment representing an interest charge is
*ased upon the unpaid *alance o the loan8 >ince the principal amount is *eing reduced each month,
the portion o each successi/e pa$ment representing interest 6ill decrease, and the portion applied to
reducing the unpaid *alance 6ill increase8 9or e,ample, let us loo= into the uture to the time 6hen
the loan has *een paid do6n to K10,0008 At this point, a K4'681' monthl$ pa$ment 6ould *e
allocated as ollo6sH interest, K.186' ;K10,000 principal × 11G ×
1
⁄12<, and reduction in principal,
K3"48!0 ;K4'681' − K.186' interest<8 +hus, the unpaid *alance o the loan 6ill *e paid o at an e/er%
increasing rate8
!ote to instructor" +his mortgage 6ill *e paid in ull in 30 $ears8
.8 +he income ta, ad/antage o raising capital *$ issuing *onds rather than stoc= is that interest
pa$ments on *onds are deducti*le in determining income su*Bect to income ta,es8 +his reduces the
Iater%ta,J cost o *orro6ing8 1i/idend pa$ments to stoc=holders, on the other hand, are not
deducti*le in the determination o ta,a*le income8
108
Annual interest pa$ments ;K! million × 10G<888888888888888888888888888888888888888888888888888888888888888888888
K!00,000
:essH Annual ta, sa/ings ;K!00,000 × 30G<8888888888888888888888888888888888888888888888888888888888888888888888
1!0,000
Annual ater%ta, cost o *orro6ing8888888888888888888888888888888888888888888888888888888888888888888888888888888888888 K3!0,000
Ater%ta, cost o *orro6ing as a percentage o amount *orro6edH
K3!0,000 ÷ K!,000,000 N 'G
118 +he present #alue o a uture amount is the amount that a =no6ledgea*le in/estor 6ould pa$ toda$
or the right to recei/e the uture amount8 +his present /alue al6a$s 6ill *e less than the uture
amount, *ecause the in/estor 6ill e,pect to earn some return 6hile 6aiting to recei/e the uture
amount8
128 9rom an in/estorFs perspecti/e, a *ond represents a series o uture cash receipts that are $i%ed in
amount *$ the contract rate o interest printed on the *onds and *$ the *ondsF maturit$ /alue8 As
mar=et interest rates rise, a series o uture receipts that are i,ed in dollar amount loo= less
attracti#e in relation to other in/estment opportunities, and the price o the *ond alls8 As interest
rates all, an$ series o i,ed cash receipts *egins to loo= *etter in relation to other opportunities, and
*ond prices rise8
138 #onds 6ith contract rates o interest a*o/e current mar=et interest rates should *e trading at prices
a*o/e their ace /alues8 #ond prices /ar$ in#ersely 6ith mar=et interest rates8
148
+he mar=et /alue o K2!,000 in *onds trading at 102 6ould *e K2!,!00 ;K2!,000 par /alue × 102G<8
+he mar=et rate o interest or *onds o this qualit$ must *e lo&er than the "G contract rate, there*$
causing in/estors to *e 6illing to pa$ a premium or these *onds8
1!8 A superior credit rating is one reason 6h$ one compan$Fs *onds might trade at a higher price than
those o another compan$8 7o6e/er, the higher mar=et price or the 2nterstate Po6er *onds does not,
in itsel, pro/e that 2nterstate has the *etter credit rating8 As current mar=et interest rates are 6ell
a*o/e the 6G le/el, it is logical that *oth *onds should *e selling at a discount8 +he act that the
2nterstate Po6er *onds are selling at a mar=et price /er$ close to their par /alue pro*a*l$ indicates
that these *onds 6ill mature in the /er$ near uture8 +hus, the dierence in the mar=et price o the
t6o *ond issues ma$ 6ell *e e,plained *$ a dierence in maturit$ dates, rather than *$ a dierence in
the companiesF credit ratings8
,1 4 +he &c5ra6%7ill Companies, 2nc8, 200!
168 2ssuing *onds at a discount increases the cost o *orro6ing8 3ot onl$ does the issuing compan$ ha/e
the use o less *orro6ed mone$ in e,change or its regular interest pa$ments, *ut it also must repa$
more than the original amount *orro6ed8 +hus, an additional interest charge is *uilt into the maturit$
/alue o the *onds8
1'8 #ecause the maturing *onds 6ere paid rom a sin=ing und, the *onds 6ere ne/er classiied as a
current lia*ilit$8 As the sin=ing und 6as ne/er classiied as a current asset, the maturit$ o the *onds
had no e$$ect upon the compan$Fs current ratio8
+he de*t ratio is equal to total lia*ilities di/ided *$ total assets8 31P is a sol/ent *usinessO thereore,
the total lia*ilities are less than total assets, and the de*t ratio is less than 100G8 (nder these
circumstances, reducing the numerator and denominator o the ratio *$ an equal amount causes the
de*t ratio to decrease8 Pne also should arri/e at this conclusion through common sense-repa$ing
de*t reduces the percentage o total assets inanced 6ith capital pro/ided *$ creditors8
1"8 :o6%CalFs /er$ lo6 interest co/erage ratio should *e o greater concern to stoc=holders than to short%
term creditors8 +he act that operating income amounts to onl$ '!G o annual interest implies that
:o6%Cal ma$ ha/e great diicult$ in remaining sol/ent in the long run' 2t does not impl$, ho6e/er,
that the compan$ is not currentl$ sol/ent8 >hort%term creditors, *ecause o their shorter in/estment
hori)on, should *e concerned a*out the current relationships *et6een the compan$Fs liquid resources
and its short%term o*ligations8
1.8 +he return on assets represents the a/erage return that a *usiness earns rom all o the capital8 2 this
a/erage rate is (ig(er than the cost o *orro6ing, the *usiness can *eneit rom using *orro6ed
capital-that is, appl$ing le#erage' 2n essence, i $ou can *orro6 mone$ at a relati/el$ lo6 rate and
in/est it at a signiicantl$ higher one, $ou 6ill *eneit rom doing so8
#ut some *usinesses ha/e *orro6ed such large amounts-and at such high interest rates-that the$
ha/e *een unable to earn enough to pa$ the interest8 2n these cases, the o6ners must come up 6ith
additional mone$ to co/er the interest charges, or the *usiness e/entuall$ 6ill Igo under8J
208 Estimated lia*ilities ha/e t6o *asic characteristicsH ;1< the lia*ilit$ is =no6n to e,ist and ;2< the
precise dollar amount cannot *e determined until a later date8 E,amples include the lia*ilit$ to honor
6arranties on products sold, lia*ilities or income ta,es pa$a*le, and an accrual o lia*ilit$ relating to
a loss contingenc$8
218 A loss contingenc$ is a possi*le loss ;or e,pense< stemming rom past e/ents that 6ill *e resol/ed as
to e,istence and amount *$ some uture e/ent8 E,amples include pending litigation, all estimated
lia*ilities, the allo6ance or uncollecti*le accounts, and the ris= that the political climate in oreign
countries has impaired the /alue o assets in those locations8
:oss contingencies are accrued ;recorded< i it is *oth ;1< probable that a loss has *een incurred, and
;2< the amount o loss can *e estimated reasona*l$8 E/en i these conditions are not met, loss
contingencies should *e disclosed in inancial statements i it is reasonably possible that a material
loss has *een incurred8
>olutions &anual Col8 2, Financial and Managerial Accounting 13De, Eilliams et al ,2
228 A commitment is a contractual o*ligation to conduct $uture transactions on agreed%upon terms8
E,amples include emplo$ment contracts, contracts 6ith suppliers o ser/ices, and contracts to ma=e
uture purchases or sales o in/entor$ or o other assets8
2 the$ are material in dollar amount, the terms o commitments should *e disclosed in inancial
statements8 3o lia*ilit$ normall$ is recorded, *ecause the commitment relates to uture transactions,
rather than to past transactions8
0238 +he lessee accounts or an operating lease as a rental arrangementO the lease pa$ments are recorded
as rental e,pense and no asset or lia*ilit$ ;other than a short%term lia*ilit$ or accrued rent pa$a*le< is
recorded8 A capital lease on the other hand, should *e /ie6ed *$ the lessee as essentiall$ a purchase
o the related asset8 +he lessee accounts or a capital lease *$ de*iting an asset account ;such as
:eased Equipment< and crediting a lia*ilit$ account ;:ease Pa$ment P*ligation< or the present /alue
o the uture lease pa$ments8 :ease pa$ments made *$ the lessee must *e allocated *et6een interest
e,pense and a reduction in the lia*ilit$, :ease Pa$ment P*ligation8 +he asset account is depreciated
o/er the lie o the leased asset8
An operating lease is sometimes called o$$)balance)s(eet $inancing *ecause the o*ligation or uture
lease pa$ments does not appear as a lia*ilit$ in the lesseeFs *alance sheet8
0248 As the pension plan is $ully $unded Prtega 2ndustries has paid its pension o*ligations to the pension
und trustee as these o*ligations ha/e accrued8 +hereore, no lia*ilit$ need appear in PrtegaFs *alance
sheet relating to the pension plans8 Aetired emplo$ees 6ill collect their postretirement *eneits directl$
rom the trustee o the pension plan8
02!8 &ost pension plans are $ully $unded-that is, the corporation deposits cash in the pension und each
period in an amount equal to the current%period lia*ilit$8 +hus, no liability or pension pa$ments
appears in the corporationFs *alance sheet8
&ost corporations, ho6e/er, do not ull$ und their o*ligations or nonpension postretirement
*eneits8 +he dierence *et6een the amount unded and the present /alue o promised uture *eneits
-the ununded amount-is reported as a lia*ilit$8 +his lia*ilit$ gets larger each $ear as the unded
portion lags urther and urther *ehind the present /alue o promised *eneits8
0268 Postretirement costs are recogni)ed as e,pense currently as 6or=ers earn the right to recei/e these
*eneits8 2 these costs are ull$ unded, the compan$ ma=es cash pa$ments 6ithin the current period
equal to the e,pense recogni)ed8 2 the *eneits are not unded, the cash pa$ments are not made until
ater the emplo$ees retire8
02'8 1eerred income ta,es are the portion o this $earFs income ta,es e,pense ;as sho6n in the income
statement< 6hich 6ill appear in the income ta, returns o $uture $ears8 +hereore, due to dierences
*et6een income ta, regulations and accounting principles, the ta,pa$er is a*le to postpone the
pa$ment o some income ta,es so long that these o*ligations *ecome a long)term lia*ilit$8
!ote to instructor" >ituations in 6hich certain e,penses are deducti*le or inancial reporting
purposes *ut not or income ta, purposes ma$ cause deerred ta,es to *e classiied as an asset
instead o a lia*ilit$8
____________
*Supplemental Topic: “Special Types of Liabilities.”
,3 4 +he &c5ra6%7ill Companies, 2nc8, 200!
SOL.TIONS TO EXERCISES
E1. 10–1 2ou would need to sa3e 4+,+'0, as shown in the 5ollowin) loan amorti6ation ta$le7
I"&eres&
Perio4
A""5!)
P!6*e"&
A""5!)
I"&eres&
Exe"se 7 ,8
Re45c&io"
i" ."!i4
B!)!"ce
."!i4
B!)!"ce
8ate o5 9raduation 410,000
2ear 1 41,:0 4;00 4':0 :,310  
2ear 2 1,:0 +5 +5 ;,5'5  
2ear 3 1,:0 ';5 ;05 +,+'0  
E1. 10–2
I"co*e S&!&e*e"& B!)!"ce S(ee&
Tr!"s9
!c&io" Re'e"5e − Exe"ses :
Ne&
I"co*e Asse&s :
C5rre"&
Li!$; <
Lo"#9Ter*
Li!$; <
O="ers>
E?5i&6
a.
$.
c.
d.
e.
5.
).
h.
0E
0E
0E
0E
0E
0E
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I
I
I
0E
0E
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8
8
0E
0E
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8
8
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8
8
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8
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8
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8
I
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8
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0E
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8
0E
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8
8
0E
0E
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8
8
E1. 10–3
Tr!"s!c&io"
C5rre"&
Li!$i)i&ies
Lo"#9Ter*
Li!$i)i&ies
Ne&
I"co*e
Ne& C!s( F)o=
Fro* Oer!&i"#
Ac&i'i&ies
Ne& C!s( F)o=
Fro* A))
So5rces
a.
$.
c.
d.
e.
5.
8
8
0E
0E
0E
I
0E
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I
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8
8
8
8
8
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8
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8
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8
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>olutions &anual Col8 2, Financial and Managerial Accounting 13De, Eilliams et al ,@
E1. 10– a. Current lia$ilities7
<nearned re3enue......................................................................................... 4300,000
0otes paya$le =current portion>................................................................... 10,000
.ccrued $ond interest paya$le..................................................................... 3',000
,otal current lia$ilities..................................................................................... 43',000
$. #on)?term lia$ilities7
0otes paya$le =4;0,000 − 410,000>..............................................................
4 +0,000
%onds paya$le............................................................................................... :00,000
0otes paya$le to $e re5inanced on a lon)?term $asis.................................. +5,000
,otal lon)?term lia$ilities................................................................................. 41,05,000
• ,he interest e1pense that will arise 5rom e1istin) o$li)ations is not yet a lia$ility.
• ,he lawsuit pendin) a)ainst the company is a loss contin)ency. It should $e disclosed,
$ut no lia$ility is recorded as no reasona$le estimate can $e made o5 the dollar amount.
• ,he 3?year salary commitment relates to 5uture transactions and, there5ore, is not yet
a lia$ility o5 the company.
E1. 10–5 a. ,otal payroll related costs7
@a)es and salaries e1pense.......................................................................... 4 +,200,000
&ayroll ta1es.................................................................................................. 5;0,000
@or"ersA compensation premiums.............................................................. 250,000
9roup health insurance premiums............................................................... +25,000
Contri$utions to employeesA pension plan................................................... 50,000
,otal payroll related costs............................................................................ 4 :,205,000
$. EmployeesA Bta"e?home payC7
@a)es and salaries earned........................................................................... 4+,200,000
.mounts withheld 5rom employeesA pay...................................................... 2,200,000
B,a"e?home payC.......................................................................................... 45,000,000
c. =1>
12;D =4:,205,000 ÷ 4+,200,000>
=2>
1;D =4:,205,000 ÷ 45,000,000>
,+ 4 +he &c5ra6%7ill Companies, 2nc8, 200!
E1. 10–' a. @a)es E1pense................................................................................. 250,000
State Income ,a1 &aya$le.................................................... 5,;+5
-ederal Income ,a1 &aya$le................................................ 5',000
Social Security and Medicare ,a1es &aya$le...................... 1:,125
Cash =or @a)es &aya$le>..................................................... 1':,000
,o record )ross wa)es, employee withholdin)s, and employee
ta"e?home pay in -e$ruary.
$. &ayroll ,a1 E1pense......................................................................... 3,125
Social Security and Medicare ,a1es &aya$le...................... 1:,125
-ederal and State <nemployment ,a1es &aya$le............... 15,500
&repaid @or"ersA Compensation Insurance....................... ;,500
,o record employer payroll ta1 e1pense in -e$ruary, 4;,500 o5
which is the e1piration o5 prepaid wor"ersA compensation
insurance premiums.
c. Employee Eealth and #i5e Insurance E1pense............................... 10,000
&ension -und E1pense...................................................................... 22,;+5
&repaid Employee Eealth and #i5e Insurance.................... 10,000
Cash =or &ension %ene5its &aya$le>..................................... 22,;+5
,o record employee $ene5it e1penses in -e$ruary, 410,000 o5
which is the e1piration o5 prepaid employee health and li5e
insurance premium.
d. ,he 4;1,000 amount withheld 5rom the employeesA )ross wa)es does not represent a ta1
le3ied on the employer. ,he 4;1,000 is simply a portion o5 the )ross wa)e e1pense that
must $e sent directly to the proper ta1 authorities, rather than paid to the employees. In
the companyAs $alance sheet, these withholdin)s represent current lia$ilities until the
actual payment to 3arious ta1 authorities is made.
>olutions &anual Col8 2, Financial and Managerial Accounting 13De, Eilliams et al ,,
E1. 10–+ a. A*or&iA!&io" T!$)e
B108 No&e P!6!$)e Cor D130,000E P!6!$)e
i" Mo"&()6 I"s&!))*e"&s oC D1,321F
Mo"&()6
I"&eres&
Perio4
BAF
Mo"&()6
P!6*e"&
BBF
I"&eres& Exe"se
B18 oC &(e L!s&
."!i4 B!)!"ceF
Re45c&io" i"
."!i4 B!)!"ce
BAF − BBF
."!i4
B!)!"ce
Fri)inal $alance
1
2
G
41,53
1,53
G
41,500
1,500
G
43
3
4150,000
1:,:5+
1:,:1
$. Interest E1pense............................................................................... 1,500
Mort)a)e &aya$le............................................................................ 3
Cash....................................................................................... 1,53
,o record second monthly installment on mort)a)e paya$le.
c. 8ecrease. Interest e1pense is $ased on the unpaid principal $alance at the end o5 each
month. .s the unpaid principal $alance decreases each period, interest e1pense will
decrease also.
E1. 10–; a.
.nnual interest e1pense =430 million × '.2D>.........................................
421.0;0 million
#ess7 Income ta1 sa3in)s =421.0;0 million × 0D>...................................
;.32 million
.nnual a5ter?ta1 cost o5 $orrowin)............................................................ 412.'; million
$.
3.+2D =412.'; million ÷ 30 million>
c. ,he o$3ious ad3anta)e o5 de$t 5inancin) is that interest e1pense is ta1 deducti$le,
whereas di3idends are not.
,- 4 +he &c5ra6%7ill Companies, 2nc8, 200!
E1. 10–: a. .pr. 30 Cash................................................................................. 50,3+5
%onds &aya$le.....................................................
%ond Interest &aya$le.........................................
50,000
3+5
Issued 450,000 5ace 3alue o5 :D, 30?year $onds at 100
plus accrued interest 5or one month.
$. Sept. 30 %ond Interest &aya$le..................................................... 3+5
%ond Interest E1pense.................................................... 1,;+5
Cash..................................................................... 2,250
&aid semiannual interest on 450,000 5ace 3alue
o5 :D $onds.
c. 8ec. 31 %ond Interest E1pense.................................................... 1,125
%ond Interest &aya$le......................................... 1,125
.dHustin) entry to reco)ni6e three monthsA interest
accrued on 450,000 5ace 3alue :D $onds since
Septem$er 30.
d. ,his practice ena$les the corporation to pay a 5ull si1 monthsA interest on all $onds
outstandin) at the semiannual interest payment date, re)ardless o5 when the $onds were
purchased. ,he accrued interest collected 5rom in3estors who purchase
$onds $etween interest payment dates is, in e55ect, returned to them at the ne1t interest
payment date. In this e1ercise, 9ardner collected one monthAs interest at issuance and
then paid si1 monthsA interest on Septem$er 30 a5ter the $onds were outstandin) 5or
only 5i3e months.
>olutions &anual Col8 2, Financial and Managerial Accounting 13De, Eilliams et al -0
E1. 10–10 a. 2005
.pr. 1 Cash................................................................................. ;,1'0,000
&remium on %onds &aya$le................................
%ond &aya$le.......................................................
1'0,000
;,000,000
,o record issuance o5 $onds at 102.
$. 2005
Sept. 30 %ond Interest E1pense.................................................... 31',000
&remium on %onds &aya$le............................................ ,000
Cash..................................................................... 320,000
,o pay interest and amorti6e $ond premium7
Semiannual interest payment7
4;,000,000 1 ;D 1 I ................... 4320,000
#ess premium amorti6ed7
J41'0,000 ÷ 20yrs.K 1 I ...............
=,000>
Interest e1pense 431',000
c. 2025
Mar. 31 %ond Interest &aya$le..................................................... 1'0,000
%ond Interest E1pense.................................................... 15;,000
&remium on %onds &aya$le............................................ 2,000
Cash..................................................................... 320,000
,o record 5inal interest payment and amorti6e $ond
premium7
=1> Interest e1pense 5or 3 months in 2025 L 431',000 1 3M' L 415;,000
=2> &remium amorti6ed in 2025 L 4,000 1 3M' L 42,000
=3> Interest paya$le 5rom 12M31M2 L 4320,000 1 3M' L 41'0,000
Mar. 31 %onds paya$le................................................................. ;,000,000
Cash..................................................................... ;,000,000
,o retire $onds at maturity.
d. =1> .morti6ation o5 a $ond premium decreases annual interest e1pense and,
conseNuently, increases annual net income.
=2> .morti6ation o5 a $ond premium is a noncash component o5 the annual interest
e1pense computation. ,hus, it has no e55ect upon annual net cash 5low 5rom
operatin) acti3ities.
=(eceipt o5 cash upon issuance o5 $onds and payment o5 cash to retire $onds at
maturity are $oth classi5ied as 5inancin) acti3ities.>
-1 4 +he &c5ra6%7ill Companies, 2nc8, 200!
E1. 10–11 a. 2005
Ouly 1 Cash............................................................................. ,:00,000
8iscount on %onds &aya$le........................................ 100,000
%onds &aya$le................................................. 5,000,000
,o record issuance o5 $onds at :;.
$. 2005
8ec. 31 %ond Interest E1pense................................................ 20,000
8iscount on %onds &aya$le............................. 2,500
Cash................................................................. 23+,500
,o pay interest and amorti6e $ond discount7
Semiannual interest payment7
45,000,000 1 : ID 1 I ................. 423+,500
.dd discount amorti6ed7
J4100,000 ÷ 20 yrs.K 1 I 8888888888888888
2,500
Interest e1pense......................... 420,000
c. 2025
Oune 30 %ond Interest E1pense................................................ 20,000
8iscount on %onds &aya$le............................. 2,500
Cash................................................................. 23+,500
,o ma"e 5inal interest payment and amorti6e $ond
discount.
=same calculation as in part $. a$o3e>
Oune 30 %ond &aya$le.............................................................. 5,000,000
Cash................................................................. 5,000,000
,o retire $onds at maturity.
d. =1> .morti6ation o5 $ond discount increases annual interest e1pense and,
conseNuently, reduces annual net income.
=2> .morti6ation o5 $ond discount is a noncash component o5 annual interest e1pense
and has no e55ect upon annual net cash 5low 5rom operatin) acti3ities. =(eceipt o5
cash upon issuance o5 $onds and payment o5 cash to retire $onds at maturity are
$oth classi5ied as 5inancin) acti3ities.>
>olutions &anual Col8 2, Financial and Managerial Accounting 13De, Eilliams et al -0
E1. 10–12 a. =1> 8e$t ratio7
Tyco:
43:,+:2

L 5+D
4'15,132
Hasbro:
41,0:0,++'
L 2D
42,'1',3;;
=2> Interest co3era)e ratio7
Tyco:
413,02;
L 0.' times
42;,02'
Hasbro:
430,'+2
L ;.11 times
43+,5;;
$. #on)?term creditors pro$a$ly would re)ard Hasbro as the sa5er in3estment. Eas$ro has
a smaller percenta)e o5 its assets 5inanced $y creditorsA capital, and there$y pro3ides its
creditors with a $i))er B$u55erC o5 eNuity capital. .lso, Eas$ro earns o3er ; times the
amount o5 its interest e1pense, whereas ,yco ,oys earns only ' cents 5or e3ery dollar
o5 interest e1pense it incurs. ,hus, interest payments pose a )reat $urden on ,yco ,oys.
Note to instructor: -or the year in Nuestion, ,ycoAs interest e1pense actually resulted in reportin) an
o3erall net loss 5or the period.
-1 4 +he &c5ra6%7ill Companies, 2nc8, 200!
*E1. 10–13 a. (ent E1pense.................................................................................... 2,500
Cash....................................................................................... 2,500
,o record monthly rental e1pense on eNuipment under an
operatin) lease a)reement.
$. #eased ENuipment............................................................................ +',021
#ease &ayment F$li)ation................................................... +3,521
Cash....................................................................................... 2,500
,o record the acNuisition o5 eNuipment throu)h a capital lease
a)reement.
c. <nder an operatin) lease, no asset or lia$ility =other than perhaps a short?term lia$ility 5or
accrued rent paya$le> relatin) to the lease appears in the lesseeAs $alance sheet.
d. I5 the lease is unNuestiona$ly a capital lease, it would $e unacceptable, unethical and
possi$ly illegal 5or a pu$licly owned company to account 5or it as an operatin) lease.
Such presentation would understate the companyAs total lia$ilities.
*E1. 10–1 a. &ension E1pense............................................................................... 2,500,000
Cash....................................................................................... 2,500,000
,o summari6e payments to a 5ully 5unded pension plan.
$. 0onpension &ostretirement %ene5its E1pense................................. +50,000
Cash....................................................................................... 50,000
<n5unded #ia$ility 5or 0onpension
&ostretirement %ene5its...................................................... +00,000
,o summari6e partial 5undin) o5 nonpension postretirement
$ene5its e1pense 5or the year and an increase in the related
un5unded lia$ility.
c. %ecause the pension plan is 5ully 5unded each year, and $ecause the plan is an entity
separate 5rom @estern Electric, this plan should contain assets appro1imately eNual to
the pension $ene5its earned $y employees in prior years. ,hus, e3en i5 @estern Electric
$ecomes insol3ent, the plan will continue to in3est these assets and should $e a$le to pay
these earned $ene5its in 5uture years.
d. . company does not ha3e an ethical =or le)al> responsi$ility to 5und its nonpension
postretirement $ene5its as they accrue. It does, howe3er, ha3e an ethical responsi$ility to
pro3ide to employees all o5 the $ene5its they ha3e earned durin) their wor"in) careers.
____________
*Supplemental Topic: “Special Types of Liabilities.”
>olutions &anual Col8 2, Financial and Managerial Accounting 13De, Eilliams et al -2
*E1. 10–15 a. 8e5erred ta1es are the income ta1es that will $ecome due in future years upon earnin)s
that already ha3e $een reported in a companyAs income statement. 8e5erred ta1es arise
$ecause o5 timing differences $etween the reco)nition o5 certain re3enue and e1penses in
income ta1 returns and in 5inancial statements.
$. $1,3, =4:'0,000 already paid, plus 430,000 currently paya$le>
c. Current lia$ilities7
Income ta1es paya$le..................................................................................... 4 30,000
8e5erred ta1es paya$le =current portion>..................................................... 30,000
,otal current ta1 lia$ilities........................................................................ 4 3+0,000
#on)?term lia$ilities7
8e5erred ta1es paya$le =4200,000, less current portion o5 430,000>........... 4 1+0,000
E1. 10–1'
a. Current (atio7
=1> Current assets 12M31M02 422,:;
=2> Current lia$ilities 12M31M02 '3,0:'
Current ratio =1> ÷ =2>
3.5+71
!uic" (atio7
=1> -inancial assets 12M31M02 41+3,003
=2> Current lia$ilities 12M31M02 '3,0:'
!uic" ratio =1> ÷ =2>
2.+71
9i3en these stron) ratios, and the 5act that the company has o3er 41' million in cash, cash
eNui3alents, and mar"eta$le securities, it appears that it will ha3e no pro$lem repayin) its current
lia$ilities as they come due.
$. 8e$t (atio7
=1> ,otal lia$ilities 12M31M02 411:,30
=2> ,otal assets 12M31M02 '',0;0
8e$t ratio =1> ÷ =2>
1;.5D
,he company has a 3ery low de$t load. Fnly 1;.5D o5 each asset dollar is de$t 5inanced. F5 this
amount, most is short?term.
c. ,he company reports current lia$ilities o5 appro1imately 4'3.1 million at the end o5 2002. Cash
5lows 5rom operatin) acti3ities 5or the year amount to 4+1.2 million. I5 similar cash 5lows are
)enerated in 2003, no pro$lems should $e encountered in payin) these lia$ilities.
____________
*Supplemental Topic: “Special Types of Liabilities.”
-3 4 +he &c5ra6%7ill Companies, 2nc8, 200!
25 Minutes, Easy
SOL.TIONS TO PROBLEMS
PROBLEM 10G1
COMP.TER SPECIALISTS, INC;
Income Statement Balance Sheet
Current Long-Term Owners’
Transaction Revenue

Expenses
=
Net Income Assets
=
Liabilities
+
Liabilities
+
Equity
a NE I D NE I NE D
b NE NE NE NE I D NE
c NE I D D I NE D
d I NE I NE D NE I
e NE NE NE NE D I NE
f NE I D D D NE D
g NE I D D NE D D
h NE NE NE I NE I NE
i NE I D D NE I D
j NE I D NE I I D
k NE NE NE I NE I NE
l NE I D NE I D D
*m NE I D NE I NE D
*n NE NE NE NE NE NE NE
*o NE NE NE NE NE NE NE
4 +he &c5ra6%7ill Companies, 2nc8, 200!
30 Minutes, Medium
PROBLEM 10G0
SEATTLE CHOCOLATES
a. SEATTLE CHOCOLATES
Partial Balance Sheet
December 31, 2005
Liabilities:
Current liabilities:
Income taxes payable $ 4 0 0 0 0
Accrued expenses and payroll taxes 6 0 0 0 0
Mortgage note payable—current portion ($750,000 - $739,000) 1 1 0 0 0
Accrued interest on mortgage note payable 5 0 0 0
Trade accounts payable 2 5 0 0 0 0
Unearned revenue 1 5 0 0 0
Total current liabilities $ 3 8 1 0 0 0
Long-term liabilities:
Note payable to Northwest Bank $ 5 0 0 0 0 0
Mortgage note payable ($750,000 - $11,000 current portion) 7 3 9 0 0 0
Total long-term liabilities $1 2 3 9 0 0 0
Total liabilities $1 6 2 0 0 0 0
$. Comments on in5ormation in the num$ered para)raphs7
=1> .lthou)h the note paya$le to 0orthwest %an" is due in '0 days, it is classi5ied as a lon)?term
lia$ility $ecause it is to $e re5inanced on a lon)?term $asis.
=2> ,he 411,000 principal amount o5 the mort)a)e note paya$le scheduled 5or repayment in 200'
=4+50,000 − 4+3:,000> is classi5ied as a current lia$ility. &rincipal to $e repaid a5ter 8ecem$er
31, 200', is classi5ied as a lon)?term lia$ility.
=3> .s the accrued interest is paya$le within one month, it is a current lia$ility.
=> ,he pendin) lawsuit is a loss contin)ency. .s no reasona$le estimate can $e made o5 the loss
incurred =i5 any>, this loss contin)ency does not meet the criteria 5or accrual. It will $e disclosed
in the notes accompanyin) the 5inancial statements, $ut it should not $e shown as a lia$ility.
25 Minutes, Medium
PROBLEM 10G1
SWANSON CORPORATION
>olutions &anual Col8 2, Financial and Managerial Accounting 13De, Eilliams et al -+
a.
General Journal

20__
Aug 6 Cash 1 2 0 0 0
Notes Payable 1 2 0 0 0
Borrowed $12,000 @ 12% per annum from Maple Grove Bank.
issued a 45-day promissory note.
Sept 16 Office Equipment 1 8 0 0 0
Notes Payable 1 8 0 0 0
Issued 3-month, 10% note to Seawald Equipment as payment
for office equipment.
Sept 20 Notes Payable 1 2 0 0 0
Interest Expense 1 8 0
Cash 1 2 1 8 0
Paid note and interest to Maple Grove Bank ($12,000 x 12%
x 45/360 = $180).
Nov 1 Cash 2 5 0 0 0 0
Notes Payable 2 5 0 0 0 0
Obtained 90-day loan from Mike Swanson; interest @ 15%
per annum.
Dec 1 Inventory 5 0 0 0
Notes Payable 5 0 0 0
To record purchase of merchandise, and issuance of 90-day,
14% note payable to Gathman Corporation.
Dec 16 Notes Payable 1 8 0 0 0
Interest Expense 4 5 0
Cash 4 5 0
Notes Payable 1 8 0 0 0
Paid interest on note to Seawald Equipment which matured
today and issued a 30-day, 16% renewal note.
Interest: $18,000 x 10% x

3/12 = $450.

b. Adjusting Entry
Dec 31 Interest Expense 6 4 2 8
Interest Payable 6 4 2 8
To record interest accrued on notes payable:
Mike Swanson ($250,000 x 15% x 2/12 = $6,250);
Gathman Corporation ($5,000 x 14% x 1/12 = $58); and
Seawald Equipment ($18,000 x

16% x

1/12 x 1/2 = $120).

c. ,he Seawald ENuipment note dated Septem$er 1' was due in 5ull on 8ecem$er 1'. ,he hi)her rate
o5 interest on the new note may $e associated with the increased risk o5 collectin) in 30 days the
41;,000 principal, plus accrued interest due.
25 Minutes, Medium
PROBLEM 10G2
/.ICH L.BE
-, 4 +he &c5ra6%7ill Companies, 2nc8, 200!
a. and d.
a. ,he amount o5 the monthly payments e1ceeds the amount o5 the monthly interest e1pense. ,here5ore,
a portion o5 each payment reduces the unpaid $alance o5 the loan. ,he continuous reduction in the
unpaid $alance, in turn, causes the monthly interest e1pense to $e less in each successi3e month, and
the amount applied to the unpaid $alance to increase. ,hus, the loan principal is repaid at an e3er?
increasin) rate.
d. .t 8ecem$er 31, 2005, two amounts relatin) to this mort)a)e loan will appear as current lia$ilities
in the $orrowerAs $alance sheet. -irst, as payments are due on the 5irst day o5 each month, one
monthAs interest has accrued since the 8ecem$er 1 payment. ,his accrued interest will $e paid on
Oanuary 1, 200', and there5ore, is a current lia$ility.
0e1t, the portion o5 the unpaid principal that will $e repaid durin) 200' represents a current
lia$ility.
&arts b and c appear on the 5ollowin) pa)e.
PROBLEM 10G2
/.ICH L.BE Bco"c)54e4F
b.
General Journal

2005
Oct 1 Interest Expense 1 0 8 0 0
Mortgage Note Payable 3 1 0
Cash 1 1 1 1 0
To record monthly payment on mortgage.
Nov 1 Interest Expense 1 0 7 9 7
Mortgage Note Payable 3 1 3
Cash 1 1 1 1 0
To record monthly mortgage payment.



>olutions &anual Col8 2, Financial and Managerial Accounting 13De, Eilliams et al --
c. Amortization Table
(12%, 30-Year Mortgage Note Payable for $1,080,000;
Payable in 360 Monthly Installments of $11,110)
Reduction in
Interest Payment Monthly Interest Unpaid Unpaid
Period Date Payment Expense Balance Balance
Issue date Sept. 1, 2005 — — — $1 0 8 0 0 0 0
1 Oct. 1 $ 1 1 1 1 0 $ 1 0 8 0 0 $ 3 1 0 1 0 7 9 6 9 0
2 Nov. 1 1 1 1 1 0 1 0 7 9 7 3 1 3 1 0 7 9 3 7 7
3 Dec. 1 1 1 1 1 0 1 0 7 9 4 3 1 6 1 0 7 9 0 6 1
4 Jan. 1, 2006 1 1 1 1 0 1 0 7 9 1 3 1 9 1 0 7 8 7 4 2
15 Minutes, Easy
PROBLEM 10G3
BL.E MO.NTAIN POWER COMPANI
100 4 +he &c5ra6%7ill Companies, 2nc8, 200!
General Journal

a.
2005
Aug 1 Cash 10 2 5 0 0 0 0
Bonds Payable 10 0 0 0 0 0 0
Bond Interest Payable 2 5 0 0 0 0
Issued $10,000,000 face value of 10%, 20-year bonds at 100
plus accrued interest for three months ($10,000,000 x .10
x 3/12 =

$250,000).
b.
Nov 1 Bond Interest Payable 2 5 0 0 0 0
Bond Interest Expense 2 5 0 0 0 0
Cash 5 0 0 0 0 0
Paid semiannual interest ($10,000,000 x .10 x 1/2 = $500,000).
c.
Dec 31 Bond Interest Expense 1 6 6 6 6 7
Bond Interest Payable 1 6 6 6 6 7
To accrue two months’ interest expense ($10,000,000 x .10 x
2/12 = $166,667).
d.
2006
May 1 Bond Interest Payable 1 6 6 6 6 7
Bond Interest Expense 3 3 3 3 3 3
Cash 5 0 0 0 0 0
To record semiannual bond interest payment and interest
expense for four months since Dec. 31
($10,000,000 x .10 x 4/12 = $333,333).
e. ,he mar"et rate o5 interest on the date o5 issuance was 10D. %ecause the $onds were issued at par
=100>, the mar"et rate had to ha3e eNualed the contract interest rate printed on the $onds.
35 Minutes, Stron)
PROBLEM 10G@
PARH RAPIDS L.MBER COMPANI
>olutions &anual Col8 2, Financial and Managerial Accounting 13De, Eilliams et al 101
a.
General Journal

(1) Bonds issued at 98:
2005
Dec 31 Bond Interest Expense 2 6 9 3 3 3 4
Discount on Bonds Payable 2 6 6 6 7
Bond Interest Payable 2 6 6 6 6 6 7
To record accrual of bond interest expense for four
months in 2002:
Contract interest ($80,000,000 x 10% x 4/12) $2,666,667
Discount amortization ($1,600,000
÷
20 years) x
4/12 26,667
Bond interest expense for four months $2,693,334
2006
Mar 1 Bond Interest Payable 2 6 6 6 6 6 7
Bond Interest Expense 1 3 4 6 6 6 7
Discount on Bonds Payable 1 3 3 3 4
Cash 4 0 0 0 0 0 0
To record semiannual bond interest payment and
interest expense for two months (1/2 of interest for
four months, as computed in preceding entry).*
(2) Bonds issued at 101:
2005
Dec 31 Bond Interest Expense 2 6 5 3 3 3 4
Premium on Bonds Payable 1 3 3 3 3
Bond Interest Payable 2 6 6 6 6 6 7
Accrual of interest on bonds for four months:
Contract interest ($80,000,000 x 10% x 4/12) $2,666,667
Less: Premium amortization
($800,000
÷
20 years) x 4/12 (13,333)
Bond interest expense for four months $2,653,334
2006
Mar 1 Bond Interest Payable 2 6 6 6 6 6 7
Bond Interest Expense 1 3 2 6 6 6 7
Premium on Bonds Payable 6 6 6 6
Cash 4 0 0 0 0 0 0
Semiannual bond interest payment and interest
expense for two months (1/2 of interest for four
months, as computed in preceding entry).*
*Actual amount differs slightly due to rounding errors.
PROBLEM 10G@
PARH RAPIDS L.MBER COMPANI Bco"c)54e4F
100 4 +he &c5ra6%7ill Companies, 2nc8, 200!
b. Net bond liability at Dec. 31, 2006: Bonds Bonds
Issued Issued
at 98 at 101

Bonds payable $ 80 0 0 0 0 0 0 $ 80 0 0 0 0 0 0
* Less: Discount on bonds payable ($1,600,000 - $106,667) (1 4 9 3 3 3 3 )
** Add: Premium on bonds payable ($800,000 - $53,333) 7 4 6 6 6 7
Net bond liability $ 78 5 0 6 6 6 7 $ 80 7 4 6 6 6 7
* 8iscount amorti6ed at 8ec. 31, 200'7
.mount amorti6ed in 2005....................................................... 42',''+
.mount amorti6ed in 200' =41,'00,000 ÷ 20 years>................
;0,000
8iscount amorti6ed at 12M31M0'.....................................
.......................................................................................................
410',''+
** &remium amorti6ed at 8ec. 31, 200'7
.mount amorti6ed in 2005....................................................... 413,333
.mount amorti6ed in 200' =4;00,000 ÷ 20 years>...................
0,000
&remium amorti6ed at 12M31M0'..................................... 453,333
c. ,he e55ecti3e rate o5 interest would $e hi)her under assumption 1. ,he less that in3estors pay 5or
$onds with a )i3en contract rate o5 interest, the hi)her the e55ecti3e interest rate they will earn.
5 Minutes, Stron)
PROBLEM 10G+
MINNESOTA SATELLITE TELEPHONE
CORPORATION
>olutions &anual Col8 2, Financial and Managerial Accounting 13De, Eilliams et al 101
a. MINNESOTA SATELLITE TELEPHONE CORPORATION
Partial Balance Sheet
December 31, 2005
(in thousands)
Liabilities:
Current liabilities:
Accounts payable $ 6 5 6 0 0
Accrued expenses payable (other than interest) 1 1 3 4 7
Accrued interest payable 7 3 3 3
Notes payable (short-term) 1 1 0 0 0 0
Lease payment obligation (current portion) 4 6 2 1
Unfunded obligation for postretirement benefits other than
pensions (current portion) 1 8 0 0 0
Income taxes payable 1 7 3 0 0
Total current liabilities $ 2 3 4 2 0 1
Long-term liabilities:
6-3/4% Bonds payable, due February 1, 2006 $ 1 0 0 0 0 0
8-1/2% Bonds payable, due June 1, 2006 $ 2 5 0 0 0 0
Less: Discount on bonds payable 2 6 0 2 4 9 7 4 0
11% Bonds payable, due June 1, 2015 $ 3 0 0 0 0 0
Add: Premium on bonds payable 1 7 0 0 3 0 1 7 0 0
Lease payment obligation (less current portion) 1 8 9 7 9
Unfunded obligation for postretirement benefits other than
pensions (less current portion) 5 4 0 0 0
Deferred income taxes 1 3 0 0 0 0
Total long-term liabilities $ 8 5 4 4 1 9
Total liabilities $ 1 0 8 8 6 2 0
Part b appears on the following page.
c. (1) Computation of debt ratio:
Total liabilities (above) $ 1 0 8 8 6 2 0
Total assets (given) $ 2 0 9 3 5 0 0
Debt ratio ($1,088,620
÷
$2,093,500) 5 2 %
(2) Computation of interest coverage ratio:
Operating income (given) $ 2 8 0 8 0 0
Annual interest expense ($61,000 + $17,000) $ 7 8 0 0 0
Interest coverage ratio ($280,800
÷
$78,000) 3.6 times
Part d appears on the following page.
PROBLEM 10G+
MINNESOTA SATELLITE TELEPHONE CORPORATION
Bco"c)54e4F
102 4 +he &c5ra6%7ill Companies, 2nc8, 200!
$. =1> .s the '
3
⁄D $ond issue is $ein) re5inanced on a lon)?term $asis =that is, paid 5rom the proceeds
o5 a lon)?term $ond issue rather than 5rom current assets>, it is classi5ied as a lon)?term lia$ility
rather than a current lia$ility.
=2> ,he ;
1
⁄2D $onds will $e repaid 5rom a $ond sin"in) 5und rather than 5rom current assets.
,here5ore, this lia$ility continues to $e classi5ied as lon)?term, despite its maturity date in less
than one year.
=3> ,he portion o5 the capitali6ed lease payment o$li)ation that will $e repaid within one year
=4,'21> is classi5ied as a current lia$ility, and the remainder o5 this o$li)ation is classi5ied as
lon)?term. ,he payments applica$le to operatin) leases will $e reco)ni6ed as rental e1pense in
the periods in which these costs are incurred.
=> .s the pension plan is 5ully 5unded, the company has no pension lia$ility.
=5> ,he 41;,000 portion o5 the un5unded lia$ility 5or nonpension postretirement $ene5its that will $e
5unded within one year is a current lia$ility, and the remainin) 45,000 =4+2,000 − 41;,000> is
classi5ied as lon)?term.
='> Income ta1es paya$le relate to the current yearAs income ta1 return and, there5ore, are a current
lia$ility. .lthou)h de5erred income ta1es can include a current portion, all o5 the de5erred
income ta1es are stated to $e a lon)?term lia$ility.
d. %ased solely upon its de$t ratio and interest co3era)e ratio, Minnesota Satellite ,elephone
Corporation appears to $e at least a )ood credit ris". Fne must consider, howe3er, that Minnesota
Satellite ,elephone Corporation is a telephone company, not a $usiness or)ani6ation that $attles
numerous competitors on a daily $asis. ,elephone companies enHoy a Bcapti3e mar"etC on a lon)?
term $asis. .lso, their rates are re)ulated to allow them to reco3er their costs and to earn a
reasona$le pro5it, e1cept in unusual circumstances.
In summary, the 5act that Minnesota Satellite ,elephone Corporation is a pro5ita$le telephone
company with a reasona$le de$t ratio and interest co3era)e ratio ma"es this $usiness entity an
outstanding lon)?term credit ris".
Note to instructor: @e do not e1pect students to ha3e ad3ance "nowled)e o5 the monopoly position o5
telephone companies. Eowe3er, we $elie3e this situation ena$les us to ma"e a most important point7 To
properly interpret financial information about a business organi!ation, one must understand the nature
of the company"s operations and its business en#ironment$
>olutions &anual Col8 2, Financial and Managerial Accounting 13De, Eilliams et al 103

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