Solutions CH 14

SOLUTIONS TO EXERCISES
EXERCISE 14-1 (15-20 minutes)

(a)Valuation account relating to the long-term liability, bonds payable
(sometimes referred to as an adjunct account). The $3,000 would
continue to be reported as long-term.
(b)Current liability if current assets are used to satisfy the debt.
(c)Current liability, $200,000; long-term liability, $800,000.
(d)Current liability.
(e)Probably noncurrent, although if operating cycle is greater than
one year and current assets are used, this item would be
classified as current.
(f) Current liability.
(g)Current liability unless (a) a fund for liquidation has been
accumulated which is not classified as a current asset or (b)
arrangements have been made for refinancing.
(h)Current liability.
(i) Current liability.

(a) Discount on Bonds PayableContra account to bonds payable on
balance sheet.
(b) Interest expense (credit balance)Reclassify to interest payable
on balance sheet.
(c) Unamortized Bond Issue CostsClassified as Other Assets on
balance sheet.
(d) Gain on repurchase of debtClassify as part of other gains and
losses on the income statement.
(e) Mortgage payableClassify one-third as current liability and the
remainder as long-term liability on balance sheet.
(f) Debenture bondsClassify as long-term liability on balance sheet.
(g) Notes payableClassify as long-term liability on balance sheet.
(h) Premium on bonds payableClassify as adjunct account to
Bonds Payable on balance sheet.
(i) Treasury bondsClassify as contra account to bonds payable on
balance sheet.
(j) Income bonds payableClassify as long-term liability on balance
sheet.

1.
Paul Simon Company:

(a)
(b)
(c)
2.
1/1/04
Cash ...................................................
Bonds Payable.............................
200,000
Bond Interest Expense.....................

($200,000 X 9% X 3/12)
Cash..............................................
4,500
12/31/04 Bond Interest Expense.....................

Interest Payable...........................
4,500
7/1/04
200,000
4,500
4,500
Graceland Company:
(a)
(b)
(c)
6/1/04
7/1/04
Cash ...................................................
Bonds Payable.............................
Bond Interest Expense...............
($100,000 X 12% X 5/12)
105,000
Bond Interest Expense.....................

Cash..............................................
($100,000 X 12% X 6/12)
6,000
12/31/04 Bond Interest Expense..................

Interest Payable.......................
100,000
5,000
6,000
6,000
Note to instructor: Some students may credit Interest Payable on

6/1/04. If they do so, the entry on 7/1/04 will have a debit to Interest
Payable for $5,000 and a debit to Bond Interest Expense for
$1,000.
6,000

(a)
(b)
(c)
1/1/05
Cash ($600,000 X 102%)...........................

Bonds Payable....................................
Premium on Bonds
Payable.............................................
612,000
Bond Interest Expense............................

Premium on Bonds Payable....................
($12,000 40)
Cash.....................................................
($600,000 X 10% X 6/12)
29,700
300
12/31/05 Bond Interest Expense............................

Interest Payable..................................
29,700
300
7/1/05
600,000
12,000
30,000
30,000

(a)
(b)
(c)
1/1/05
7/1/05
12/31/05
Cash ($600,000 X 102%)...........................

Bonds Payable....................................
Premium on Bonds Payable..............
612,000
Bond Interest Expense.............................

($612,000 X 9.75% X 1/2)
Cash.....................................................
($600,000 X 10% X 6/12)
29,835
Bond Interest Expense..........................

($611,835 X 9.75% X 1/2)
Premium on Bonds Payable..................
Interest Payable................................
600,000
12,000
165
30,000
29,827
173
Carrying amount of bonds at July 1, 2005:

Carrying amount of bonds at January 1, 2005
Amortization of bond premium
($300,000 $29,835)
Carrying amount of bonds at July 1, 2005
30,000
$612,000
(165)
$611,835

Schedule of Discount Amortization
Straight-Line Method
Year
Credit
Interest
Payable
Credit
Bond
Discount
Debit
Interest
Expense
Carrying
Value of
Bonds
(1)
(2)
(3)=(1)+(2)
(4)=CVBY+(3)
$1,855,816.00
1,884,652.80
1,913,489.60
1,942,326.40
1,971,163.20
2,000,000.00
1/1/04
12/31/04
$200,000
$228,836.80
$28,836.80
12/31/05
200,000
228,836.80
28,836.80
12/31/06
200,000
228,836.80
28,836.80
12/31/07
200,000
228,836.80
28,836.80
12/31/08
200,000
228,836.80
28,836.80
a
$200,000 = $2,000,000 X 10%
b
$28,836.80 = ($2,000,000 $1,855,816) 5
CVBY = carrying value of bond at beginning of year

The effective interest or yield rate is 12%. It is determined through
trial and error using Table 6-2 for the discounted value of the principal
($1,134,860) and Table 6-4 for the discounted value of the interest
($720,956); $1,134,860 plus $720,956 equals the proceeds of
$1,855,816. (A financial calculator may be used to determine the rate
of 12%.)
Schedule of Discount Amortization
Effective Interest Method (12%)
Year
1/1/04
12/31/04
12/31/05
12/31/06
12/31/07
12/31/08
a
Debit
Interest
Expense
Credit
Interest
Payable
Credit
Bond
Discount
Carrying
Value of
Bonds
(1)
(2)
(3)=(1)-(2)
(4)=CVBY+(3)
$1,855,816.00
1,878,513.92
1,903,935.59
1,932,407.86
1,964,296.80
2,000,000.00
$222,697.92a
225,421.67b
228,472.27c
231,888.94d
235,703.20e
$200,000
200,000
200,000
200,000
200,000
$22,697.92
25,421.67
28,472.27
31,888.94
35,703.20
$222,697.92 = $1,855,816.00 X 12%

$225,421.67 = $1,878,513.92 X 12%
c
$228,472.27 = $1,903,935.59 X 12%
d
$231,888.94 = $1,932,407.86 X 12%
e
$235,703.20 = $2,000,000 - 1,964,296.80 + 200,000
b

(a)
Printing and engraving costs of bonds

Legal fees
Commissions paid to underwriter
Amount to be reported as Unamortized Bond Issue
Costs
$12,000
49,000
60,000
$121,000
The Unamortized Bond Issue Costs, $121,000, should be reported as a

deferred charge in the Other Assets section on the balance sheet.
(b)
(c)
Interest paid for the period from January 1

(July 1) to June 30 (December 31), 2004;
$2,000,000 X 10% X 6/12
Less: Premium amortization for the period from
January 1 (July 1) to June 30 (December 31), 2004
[($2,000,000 X 1.04) $2,000,000] 10 X 6/12
Interest expense to be recorded on July 1
(December 31), 2004
Carrying amount of bonds on June 30, 2004

Effective interest rate for the period from June 30
to October 31, 2004 (.10 X 4/12)
Interest expense to be recorded on October 31, 2004
$100,000
4,000
$ 96,000
$562,500
X.033333
$ 18,750

(a)
1.
2.
June 30, 2005

Cash ..................................................
4,300,920.00
Bonds Payable............................
Premium on Bonds Payable......
December 31, 2005
Bond Interest Expense....................
258,055.20
($4,300,920.00 X 12% X 6/12)
Premium on Bonds Payable............
1,944.80
Cash.............................................
($4,000,000 X 13% X 6/12)
3.
4.
4,000,000.00
300,920.00
260,000.00
June 30, 2006

257,938.51
[($4,300,920.00 $1,944.80)
X 12% X 6/12]
2,061.49
Cash.............................................
260,000.00
December 31, 2006

257,814.82
[($4,300,920.00 $1,944.82
$2,061.49) X 12% X 6/12]
2,185.18
Cash.............................................
260,000.00
EXERCISE 14-9 (Continued)

(b)
Long-term Liabilities:
Bonds payable, 13% (due on June 30, 2025)
Premium on Bonds Payable*
Book value of bonds payable
$4,000,000.00
294,728.53
$4,294,728.53
*($4,300,920.00 $4,000,000) ($1,944.80 + $2,061.49 + $2,185.18) = $294,728.53
(c)
1.
Interest expense for the period from

January 1 to June 30, 2006 from (a) 3.
Interest expense for the period from
July 1 to December 31, 2006 from (a) 4.
Amount of bond interest expense
reported for 2006
$257,938.51
257,814.82
$515,753.33
2.
The amount of bond interest expense reported in 2006 will be

greater than the amount that would be reported if the
straight-line method of amortization were used. Under the
straight-line method, the amortization of bond premium is
$15,046 ($300,920/20). Bond interest expense for 2006 is the
difference between the amortized premium, $15,046, and the
actual interest paid, $520,000 ($4,000,000 X 13%). Thus, the
amount of bond interest expense is $504,954, which is
smaller than the bond interest expense under the effective
interest method.
3.
Total interest to be paid for the bond

($4,000,000 X 13% X 20)
Principal due in 2025
Total cash outlays for the bond
Cash received at issuance of the bond
Total cost of borrowing over the life
of the bond
4.
They will be the same.
$10,400,000
4,000,000
14,400,000
(4,300,920)
$10,099,080

(a)
January 1, 2004
Cash ...........................................................
537,907.37
Premium on Bonds Payable..............
Bonds Payable....................................
(b)
37,907.37
500,000.00
Schedule of Interest Expense and Bond Premium Amortization

Effective Interest Method
12% Bonds Sold to Yield 10%
Date
1/1/04
12/31/04
12/31/05
12/31/06
12/31/07
12/31/08
Credit
Cash
(1)
$60,000.00
60,000.00
60,000.00
60,000.00
60,000.00
Debit
Interest
Expense
(2)
$53,790.74 a
53,169.81 b
52,486.79 c
51,735.47 d
50,909.82 e
Debit
Bond
Premium
(3)=(1)-(2)
$6,209.26
6,830.19
7,513,21
8,264.53
9,909.18
Carrying
Value of
Bonds
(4)=CVBY-(3)
$537,907.37
531,698.11
524,867.92
517,354.71
509,090.18
500,000.00
$53,790.74 = $537,907.37 X 10%

$53,169.81 = $531,698.11 X 10%
c
$52,486.79 = $524,867.92 X 10%
d
$51,735.47 = $517,354.71 X 10%
e
$50,909.82 = $500,000 - 509,090.18 + 60,000
b
(c)
(d)
December 31, 2004

53,790.74
6,209.26
Cash.....................................................
60,000.00
December 31, 2006

52,486.79
7,513.21
Cash.....................................................
60,000.00

Unsecured
Bonds
(1)
Maturity value
(2)
Number of interest
periods
(3)
Stated rate per period
(4)
Effective rate per period
(5)
Payment amount per

period
(6)
Present value
Zero Coupon
Bonds
Mortgage
Bonds
$10,000,000
$25,000,000
$20,000,000
40
10
10
15%
4
10%
12%
4
12%
12%
$375,000 (a)
$2,000,000 (b)
$11,733,639 (c)
$8,049,250 (d)
$17,739,840 (e)
3.75% (
3% (
(a)
$10,000,000 X 15% X 1/4 = $375,000

$20,000,000 X 10% = $2,000,000
(c)
Present value of an annuity of $375,000
discounted at 3% per period for 40
periods ($375,000 X 23.11477) =
Present value of $10,000,000 discounted
at 3% per period for 40 periods
($10,000,000 X .30656) =
(b)
(d)
(e)

at 12% for 10 periods
($25,000,000 X .32197) =
Present value of an annuity of $2,000,000 discounted

at 12% for 10 periods
($2,000,000 X 5.65022) =
at 12% for 10 years
($20,000,000 X .32197)
$ 8,668,039
3,065,600
$11,733,639
$ 8,049,250
$11,300,440
6,439,400
$17,739,840

Reacquisition price ($900,000 X 101%)
Less: Net carrying amount of bonds redeemed:
Par value
Unamortized discount
Unamortized bond issue costs
Loss on redemption
Calculation of unamortized discount
Original amount of discount:
$900,000 X 3% = $27,000
$27,000/10 = $2,700 amortization per year
Amount of discount unamortized:
$2,700 X 5 = $13,500
Calculation of unamortized issue costs
Original amount of costs:
$24,000 X $900,000/$1,500,000 = $14,400
$14,400/10 = $1,440 amortization per year
Amount of costs unamortized:
$1,440 X 5 = $7,200
January 2, 2004
Bonds Payable......................................................
Loss on Redemption of Bonds ..........................
Unamortized Bond Issue Cost......................
Discount on Bonds Payable..........................
Cash.................................................................
$909,000
$900,000
(13,500)
(7,200)
879,300
$ 29,700
900,000
29,700
7,200
13,500
909,000

Cash .......................................................................
Discount on Bonds Payable (.02 X $9,000,000).
Bonds Payable................................................
(To record issuance of 10% bonds)
Bonds Payable......................................................
Loss on Redemption of Bonds...........................
Cash ($6,000,000 X 1.02)................................
Discount on Bonds Payable..........................
Unamortized Bond Issue Costs....................
(To record retirement of 11% bonds)
Reacquisition price..............................................
Par value..........................................................
Unamortized bond discount..........................
Unamortized bond issue costs.....................
Loss on redemption.............................................
8,820,000
180,000
9,000,000
6,000,000
270,000
6,120,000
120,000
30,000
$6,120,000
$6,000,000
(120,000)
(30,000)
5,850,000
$ 270,000

(a)
June 30, 2005

Bonds Payable.............................................
Loss on Redemption of Bonds...................
Discount on Bonds Payable.................
Cash........................................................
Reacquisition price ($800,000 X 104%)......
Net carrying amount of bonds redeemed:
Par value.................................................
Unamortized discount...........................
(.02 X $800,000 X 11/20)
Loss on redemption.....................................
Cash ($1,000,000 X 102%)...........................
Premium on Bonds Payable.................
Bonds Payable.......................................
(b)
December 31, 2005

Cash.....................................................
*(1/40 X $20,000 = $500)
**(.05 X $1,000,000 = $50,000)
800,000
40,800
8,800
832,000
$832,000
$800,000
(8,800)
(791,200)
$ 40,800
1,020,000
20,000
1,000,000
49,500
500*
50,000**

Reacquisition price ($300,000 X 104%)................
Par value..........................................................
Unamortized discount....................................
Loss on redemption................................................
$312,000
$300,000
(10,000)
Bonds Payable........................................................
Loss on Redemption of Bonds..............................
Discount on Bonds Payable............................
Cash...................................................................
(To record redemption of bonds
payable)
300,000
22,000
Cash .........................................................................
Unamortized Bond Issue Costs.............................
Premium on Bonds Payable............................
Bonds Payable..................................................
(To record issuance of new bonds)
306,000
3,000
290,000
$ 22,000
10,000
312,000
9,000
300,000

(a)
1.
2.
January 1, 2005
Land ......................................................
200,000.00
Discount on Notes Payable................
137,012.00
Notes Payable................................
(The $200,000 capitalized land
cost represents the present
value of the note discounted
for five years at 11%.)
Equipment.............................................
Discount on Notes Payable................
Notes Payable................................
*Computation of the discount on

notes payable:
Maturity value
Present value of $250,000 due in
8 years at 11%$250,000
X .43393
Present value of $15,000
payable annually for 8 years
at 11% annually$15,000
X 5.14612
Present value of the note
Discount
(b)
1.
2.
337,012.00
185,674.30
64,325.70*
250,000.00
$250,000.00
$108,482.50
77,191.80
(185,674.30)
$ 64,325.70
Interest Expense..................................
Discount on Notes Payable..........
($200,000 X .11)
22,000.00
Interest Expense..................................
($185,674.30 X .11)
Discount on Notes Payable..........
Cash ($250,000 X .06)....................
20,424.17
22,000.00
5,424.17
15,000.00

(a)
(b)
Face value of the noninterest-bearing note

Discounting factor (12% for 3 periods)
Amount to be recorded for the land at January 1, 2005
$550,000
X .71178
$391,479
Carrying value of the note at January 1, 2005

Applicable interest rate (12%)
Interest expense to be reported in 2005
$391,479
X
.12
$ 46,977
January 1, 2005
Cash ...........................................................
Discount on Notes Payable.....................
Notes Payable.....................................
Unearned Revenue*............................
5,000,000
1,584,950
*$5,000,000 ($5,000,000 X .68301) = $1,584,950

Carrying value of the note
at January 1, 2005
Applicable interest rate (10%)
Interest expense to be
reported for 2005
$3,415,050**
X
.10
$ 341,505
**$5,000,000 $1,584,950 = $3,415,050
5,000,000
1,584,950

(a)
Cash ...........................................................
Discount on Notes Payable.....................
Notes Payable.....................................
Unearned Revenue.............................
($400,000 $284,712)
Face value
Present value of 1 at 12%
for 3 years
Present value
(b)
400,000
115,288
400,000
115,288
$400,000
X .
71178
$284,712
Interest Expense ($284,712 X 12%).........

Discount on Notes Payable...............
34,165
Unearned Revenue ($115,288 3)

Sales....................................................
38,429
34,165
38,429

At December 31, 2003, disclosures would be as follows:
Maturities and sinking fund requirements on long-term debt are as
follows:
2004
2005
2006
2007
2008
$
0
3,500,000
5,500,000
9,500,000
3,500,000
($2,000,000 + $3,500,000)
($6,000,000 + $3,500,000)
*EXERCISE 14-20 (15-20 minutes)

(a)
Transfer of property on December 31, 2004:

Larisa Nieland Company (Debtor):
Note Payable...................................................
Interest Payable..............................................
Accumulated DepreciationMachine.........
Machine...................................................
Gain on Disposition of Machine...........
Gain on Debt Restructuring..................
200,000
18,000
221,000
390,000
21,000a
28,000b
$190,000 ($390,000 $221,000) = $21,000.

($200,000 + $18,000) $190,000 = $28,000.
First State Bank (Creditor):

Machine...........................................................
Allowance for Doubtful Accounts................
Note Receivable.....................................
Interest Receivable................................
190,000
28,000
200,000
18,000
(b) Gain on Machine Disposition and the Gain on Debt

Restructuring should be reported as an ordinary gain in the
income statement in accordance with APB Opinion No. 30 and
SFAS No. 145.
(c)
Granting of equity interest on December 31, 2004:

Larisa Nieland Company (Debtor):
Note Payable...................................................
200,000
Interest Payable..............................................
18,000
Common Stock.......................................
Additional Paid-in Capital.....................
Gain on Debt Restructuring..................
First State Bank (Creditor):
Investment (Trading)......................................
190,000
Allowance for Doubtful Accounts................
28,000
Note Receivable.....................................
Interest Receivable................................
150,000
40,000
28,000
200,000
18,000

(a)
No. The gain recorded by Bradtke is not equal to the loss

recorded by Firstar Bank under the debt restructuring agreement.
(You will see why this happens in the following four exercises.) In
response to this accounting unsymmetry treatment, FASB
stated that Statement No. 114 does not address debtor accounting
because the FASB was concerned that expansion of the scope of
the statement would delay its issuance.
(b)
No. There is no gain under the modified terms because the total
future cash flows after restructuring exceed the total prerestructuring carrying amount of the note (principal):
Total future cash flows after restructuring are:
Principal
Interest ($1,600,000 X 10% X 3)
Total pre-restructuring carrying amount of note:
$1,600,000
480,000
$2,080,000
$2,000,000
EXERCISE 14-21 (Continued)

(c)
The interest payment schedule is prepared as follows:

BRADTKE COMPANY
INTEREST PAYMENT SCHEDULE AFTER DEBT RESTRUCTURING
EFFECTIVE INTEREST RATE 1.4276%
Date
Cash
Interest
(10%)
Effective
Interest
(1.4276%)
12/31/04
12/31/05
$160,000a
$28,552b
12/31/06
160,000
26,675
12/31/07
160,000
24,773d
Total
$480,000
$80,000
a
$1,600,000 X 10% = $160,000.
b
$2,000,000 X 1.4276% = $28,552.
c
$160,000 $28,552 = $131,448.
d
Adjusts $1 due to rounding.
(d)
Reduction
of Carrying
Amount
$131,448c
133,325
135,227
$400,000
$2,000,000
1,868,552
1,735,227
1,600,000
Interest payment entry for Bradtke Company is:

December 31, 2006
Note Payable........................................................
Interest Expense.................................................
Cash...............................................................
(e)
Carrying
Amount of
Note
133,325
26,675
160,000
The payment entry at maturity is:

January 1, 2008
Note Payable........................................................
Cash...............................................................
1,600,000
1,600,000

(a) The Firstar Bank should use the historical interest rate of 12% to
calculate the loss.
(b)
The loss is computed as follows:

Pre-restructuring carrying amount of note
Less: Present value of restructured future cash flows:
Present value of principal $1,600,000
due in 3 years at 12%
$1,138,848a
Present value of interest $160,000
paid annually for 3 years at 12%
Loss on debt restructuring
a
$1,600,000 X .71178 = $1,138,848.
b
$160,000 X 2.40183 = $384,293.
December 31, 2004
Bad Debt Expense...............................................
Allowance for Doubtful Accounts...............
384,293b
$2,000,000
1,523,141
$ 476,859
476,859
476,859
(c) The interest receipt schedule is prepared as follows:

FIRSTAR BANK
INTEREST RECEIPT SCHEDULE AFTER DEBT RESTRUCTURING
EFFECTIVE INTEREST RATE 12%
Date
Cash
Interest
(10%)
Effective
Interest
(12%)
12/31/04
12/31/05 $160,000a
$182,777b
12/31/06
160,000
185,510
12/31/07
160,000
188,572
Total
$480,000
$556,859
a
$1,600,000 X 10% = $160,000.
b
$1,523,141 X 12% = $182,777.
c
$182,777 $160,000 = $22,777.
Increase
in Carrying
Amount
$22,777c
25,510
28,572
$76,859
Carrying
Amount of
Note
$1,523,141
1,545,918
1,571,428
1,600,000
*EXERCISE 14-22 (Continued)

(d)
(e)
Interest receipt entry for Firstar Bank is:

December 31, 2006
Cash .....................................................................
Allowance for Doubtful Accounts.....................
Interest Revenue...........................................
The receipt entry at maturity is:
January 1, 2008
Cash .....................................................................
Note Receivable............................................
160,000
25,510
185,510
1,600,000
400,000
2,000,000
Note to Instructor: An entry to clear the allowance account and the

note receivable account of their balance ($400,000) would be
prepared at this time.

(a) Yes. Bradtke Company can record a gain under this term modification. The gain is calculated as follows:
Total future cash flows after restructuring are:
Principal
Interest ($1,300,000 X 10% X 3)
Total pre-restructuring carrying amount of note
(principal):
$1,300,000
390,000
$1,690,000
$2,000,00
0
Therefore, the gain = $2,000,000 $1,690,000 = $310,000.

(b)
(c)
The entry to record the gain on December 31, 2001:

Note Payable..................................................
310,000
Gain on Debt Restructuring.................
310,000
Because the new carrying value of the note ($2,000,000 $310,000 =

$1,690,000) equals the sum of the undiscounted future cash flows
($1,300,000 principal + $390,000 interest = $1,690,000), the imputed
interest rate is 0%. Consequently, all the future cash flows reduce
the principal balance and no interest expense is recognized.

(d) The interest payment schedule is prepared as follows:
BRADTKE COMPANY
INTEREST PAYMENT SCHEDULE AFTER DEBT RESTRUCTURING
Cash
Effective
Reduction
Carrying
Interest
Interest
of Carrying
Amount of
Date
(10%)
(0%)
Amount
Note
12/31/04
$1,690,000
a
12/31/05
$130,000
$0
$130,000
1,560,000b
12/31/06
130,000
0
130,000
1,430,000
12/31/07
130,000
0
130,000
1,300,000
Total
$390,000
$0
$390,000
a
$1,300,000 X 10% = $130,000.

$1,690,000 $130,000 = $1,560,000.
(e)
Cash interest payment entries for Bradtke Company are:

December 31, 2005, 2006, and 2007
Note Payable..............................................
130,000
Cash......................................................
(f)
130,000
The payment entry at maturity is:

January 1, 2008
Note Payable..............................................
Cash......................................................
1,300,000
1,300,000

(a)
The loss can be calculated as follows:

Pre-restructuring carrying amount of note
Less: Present value of restructured future
cash flows:
Present value of principal $1,300,000
Present value of interest $130,000
paid annually for 3 years at 12%
Loss on debt restructuring
a
$1,300,000 X .71178 = $925,314
b
$130,000 X 2.40183 = $312,238
$2,000,000
$925,314a
312,238b
December 31, 2004

Bad Debt Expense...............................................
Allowance for Doubtful Accounts...............
1,237,552
$ 762,448
762,448
762,448
(b) The interest receipt schedule is prepared as follows:

FIRSTAR BANK
INTEREST RECEIPT SCHEDULE AFTER DEBT RESTRUCTURING
Date
Cash
Interest
(10%)
Effective
Interest
(12%)
12/31/04
12/31/05
$130,000a
$148,506b
12/31/06
130,000
150,727
12/31/07
130,000
153,215
Total
$390,000
$452,448
a
$1,300,000 X 10% = $130,000.
b
$1,237,552 X 12% = $148,506.
c
$148,506 $130,000 = $18,506.
Increase
in Carrying
Amount
$18,506c
20,727
23,215
$62,448
Carrying
Amount of
Note
$1,237,552
1,256,058
1,276,785
1,300,000

(c)
(d)
Interest receipt entries for Firstar Bank are:

December 31, 2005
Cash .....................................................................
130,000
18,506
December 31, 2006

Cash .....................................................................
130,000
20,727
December 31, 2007

Cash .....................................................................
130,000
23,215
148,506
150,727
153,215
The receipt entry at maturity is:

January 1, 2008
Cash .....................................................................
Note Receivable............................................
1,300,000
700,000
2,000,000


(a)
Langrova Co.s entry:

Notes Payable......................................................
Property.........................................................
Gain on Property Disposition......................
(Ordinary) ($120,000 $80,000)
Gain on Restructuring..................................
199,800
80,000
40,000
79,800*
*$199,800 $120,000
(b)
Fernandez Inc. entry:

Property................................................................
(or Bad Debt Expense)....................................
Notes Receivable..........................................
120,000
79,800
199,800

Because the carrying amount of the debt, $225,000 exceeds the total
future cash flows $220,000 [$200,000 + ($10,000 X 2)], a gain and a
loss are recognized and no interest is recorded by the debtor.
(a)
(b)
Graf Corp.s entries:

2004 Notes Payable............................................
Gain on Restructuring..........................
(Extraordinary)
5,000
5,000
2005 Notes Payable............................................

Cash (5% X $200,000)...........................
10,000
2006 Notes Payable............................................

Cash.......................................................
[$200,000 + (5% X $200,000)]
210,000
First Trusts entry on December 31, 2004:

Bad Debt Expense.................................................
Allowance for Doubtful Accounts.................
Pre-restructure carrying amount
Present value of restructured cash flows:
Present value of $200,000 due in 2 years
at 12%, interest payable annually
(Table 6-2); (200,000 X .79719)
Present value of $10,000 interest payable
annually for 2 years at 12% (Table 6-4);
($10,000 X 1.69005)
Creditors loss on restructure
10,000
210,000
48,661
48,661
$225,000
$159,438
16,901
176,339
$(48,661)
Date
12/31/04
12/31/05
12/31/06
Cash
Interest
Effective
Interest
Increase
in Carrying
Amount
$10,000a
10,000
$21,161b
22,500
$11,161c
12,500
Carrying
Amount of
Note
$176,339
187,500
200,000
$10,000 = $200,000 X .05

$21,161 = $176,339 X 12%
c
$11,161 = $21,161 $10,000
b
December 31, 2005

Cash .....................................................................
10,000
11,161
December 31, 2006

Cash .....................................................................
10,000
12,500
Cash .....................................................................
Notes Receivable..........................................
21,161
22,500
200,000
25,000
225,000


(a)
Journal entry to record issuance of loan by Paris Bank:

December 31, 2003
Note Receivable..................................................
Discount on Note Receivable......................
Cash...............................................................
100,000
37,908
62,092
$100,000 X Present value of 1 for 5 periods at 10%

$100,000 X .62092 = $62,092
(b)
Note Amortization Schedule
(Before Impairment)
Date
12/31/03
12/31/04
12/31/05
Cash
Received
(0%)
$0
0
Interest
Revenue
(10%)
$6,209
6,830
Discount
Amortized
Carrying
Amount of
Note
$6,209
6,830
$62,092
68,301
75,131
Computation of the impairment loss:

Carrying amount of investment (12/31/05)
Less: Present value of $75,000 due in 3 years at 10%
($75,000 X .75132)
Loss due to impairment
$75,131
56,349
$18,782
The entry to record the loss by Paris Bank is as follows:

Bad Debt Expense.................................................
(c)
18,782
18,782
Iva Majoli Company, the debtor, makes no entry because it still legally
owes $100,000.

(a)
Cash received by Conchita Martinez Company on December 31, 2002:

Present value of principal ($1,000,000 X .56743)
Present value of interest ($100,000 X 3.60478)
Cash received
$567,430
360,478
$927,908
(b)
Date
12/31/02
12/31/03
12/31/04
(c)
Note Amortization Schedule

(Before Impairment)
Cash
Interest
Received
Revenue
Discount
(10%)
(12%)
Amortized
$100,000
100,000
$111,349
112,711
Loss due to impairment:

Carrying amount of loan (12/31/04)
Less: Present value of $600,000 due in
3 years ($600,000 X .71178)
Present value of $100,000 payable
annually for 3 years ($100,000 X
2.40183)
$11,349
12,711
Carrying
Amount of
Note
$927,908
939,257
951,968
$951,968
427,068
240,183
667,251
$284,717
SOLUTIONS TO PROBLEMS
PROBLEM 14-1
(a)
The bonds were sold at a discount of $5,651. Evidence of the

discount is the January 1, 1997 book value of $94,349, which is
less than the maturity value of $100,000 in 2006.
(b)
The interest allocation and bond discount amortization are

based upon the effective interest method; this is evident from the
increasing interest charge. Under the straight-line method the
amount of interest would have been $11,565.10 [$11,000 + ($5,651
10)] for each year of the life of the bonds.
(c) The stated rate is 11% ($11,000 $100,000). The effective rate is
12% ($11,322 $94,349).
(d)
(e)
(f)
January 1, 1997
Cash .....................................................................
Discount on Bonds Payable..............................
Bonds Payable..............................................
December 31, 1997
Bond Interest Expense.......................................
Discount on Bonds Payable........................
Interest Payable............................................
94,349
5,651
100,000
11,322
322
11,000
January 1, 2004 (Interest Payment)

Interest Payable...................................................
11,000
Cash...............................................................
11,000
December 31, 2004

Bond Interest Expense.......................................
Interest Payable............................................
712
11,000
11,712
PROBLEM 14-2
(a)
Present value of the principal

$1,500,000 X .38554 (PV10, 10%)
$ 578,310
Present value of the interest payments

$157,500* X 6.14457 (PVOA10, 10%)
967,770
Present value (selling price of the bonds)

*$1,500,000 X 10.5% = $157,500
$1,546,080
Cash .....................................................................
Unamortized Bond Issue Costs.........................
Bonds Payable..............................................
Premium Bonds Payable..............................
1,496,080
50,000
(b)
Date
1/1/02
1/1/03
1/1/04
1/1/05
1/1/06
(c)
Cash
Price
$157,500
157,500
157,500
157,500
Interest
Expense
$154,608
154,319
154,001
153,651
Carrying amount as of 1/1/05

Less: Amortization of bond premium
(3,849 2)
Reacquisition price
(1,534,583 2)
Loss
1,500,000
46,080
Premium
Amortization
Carrying
Amount of
Bonds
$2,892
3,181
3,499
3,849
$1,546,080
1,543,188
1,540,007
1,536,508
1,532,659
$1,536,508
1,925
$1,534,583
$800,000
(767,292)
$32,708
PROBLEM 14-2 (Continued)

Entry for accrued interest
Interest Expense
Premium on Bonds Payable
($3,849 X 1/2 X 1/2)
Cash
($157,500 X 1/2 X 1/2)
Entry for reacquisition
Bonds Payable
Premium on Bonds Payable
Loss on Redemption of Bonds
Cash
38,413
962
39,375
750,000
17,292*
32,708
*Premium as of 7/1/02 to be written off

($1,534,582 $1,500,000,000) X 1/2 = $17,292
The loss is reported as an ordinary loss under SFAS No. 145.
800,000
PROBLEM 14-3
(a)
Date
1/1/04
4/1/04
7/1/04
10/1/05
1/1/05
Cash
Paid
Interest
Expense
Amortization
$300
300
300
300
$480
484
487
491
$180
184
187
191
Carrying
Amount of
Note
$24,000
24,180
24,364
24,551
24,742
(b) At this point, we see that the customer owes $24,742, or $742
more than at the beginning of the year.
(c) To earn 8% over the next two years the quarterly payments must
be $3,378 computed as follows:
$24,742 7.32548 (PVOA8, 2%) = $3,378
(d)
Carrying
Interest
Amount of
Date
Cash
Expense
Amortization
Note
1/1/05
$24,742
4/1/05
$3,378
$495
$2,883
21,859
7/1/05
3,378
437
2,941
18,918
10/1/05
3,378
378
3,000
15,918
1/1/06
3,378
318
3,060
12,858
4/1/06
3,378
257
3,121
9,737
7/1/06
3,378
195
3,183
6,554
10/1/06
3,378
131
3,247
3,307
1/1/07
3,378
71
3,307
0
(e) The new sales gimmick may bring people into the showroom the
first time but will drive them away once they learn of the amount of
their year 2 and year 3 payments. Many will not have budgeted for
these increases, and will be in a bind because they owe more on
their car than its worth. One should question the ethics of a
dealer using this tactic.
PROBLEM 14-4
(a)
Entry to record the issuance of the 11% bonds on December 18, 2004:
Cash .....................................................................
Bonds Payable..............................................
Premium on Bonds Payable........................
6,120,000
6,000,000
120,000
Entry to record the retirement of the 9% bonds on January 2, 2005:

Bonds Payable....................................................
Loss on Redemption of Bonds..........................
($250,000 X 10/25)
Cash ($5,000,000 x 104%)............................
[The loss represents the excess of the
cash paid ($5,200,000) over the
carrying amount of the bonds
($4,900,000).]
5,000,000
300,000
100,000
5,200,000
(b) The loss is reported as an ordinary loss under SFAS No. 145.
Note 1. Loss on Bond Redemption
The loss represents a loss of $300,000 from the redemption and
retirement of $5,000,000 of the Companys outstanding bond issue
due in 2015. The funds used to purchase the mortgage bonds
represent a portion of the proceeds from the sale of $6,000,000 of 11%
debenture bonds issued December 18, 2004 and due in 2024.
PROBLEM 14-5
1. Danny Ferry Co.
3/1/04
Cash ...............................................................
Discount on Bonds Payable.........................
Bonds Payable........................................
Maturity value of bonds payable

Present value of $250,000 due in 7 periods at 6%
($250,000 X .66506)
Present value of interest payable semiannually
($12,500 X 5.58238)
Proceeds from sale of bonds
Discount on bonds payable
9/1/04
12/31/04
3/1/05
9/1/05
12/31/05
236,045
13,955
250,000
$250,000
$166,265
69,780
(236,045)
$ 13,955
Interest Expense........................................
Discount on Bonds Payable...............
Cash......................................................
14,163
($1,762 X 4/6)
Interest Payable ($12,500 X 4/6).........
9,508
Interest Payable.........................................
($1,762 X 2/6)
Cash......................................................
4,754
8,333
Cash......................................................
14,368
($1,980 X 4/6)
Interest Payable...................................
9,653
1,663
12,500
1,175
8,333
587
12,500
1,868
12,500
1,320
8,333

Schedule of Bond Discount Amortization
Effective Interest Method
10% Bonds Sold to Yield 12%
Date
3/1/04
9/1/04
3/1/05
9/1/05
3/1/06
9/1/06
3/1/07
9/1/07
6/1/04
Credit
Cash
$12,500
12,500
12,500
12,500
12,500
12,500
12,500
Debit
Interest
Expense
$14,163
14,262
14,368
14,480
14,599
14,725
14,858
Credit
Bond
Discount
Carrying
Value of
Bonds
$1,663
1,762
1,868
1,980
2,099
2,225
2,358
$236,045
237,708
239,470
241,338
243,318
245,417
247,642
250,000
2. Dougherty Co.
Cash ...............................................................
Premium on Bonds Payable..................
Bonds Payable........................................
Maturity value of bonds payable

Present value of $600,000 due in 8 periods at 5%
($600,000 X .67684)
Present value of interest payable semiannually
($36,000 X 6.46321)
Proceeds from sale of bonds
Premium on bonds payable
12/1/04
Premium on Bonds Payable.....................
Cash ($600,000 X .12 X 6/12)..............
12/31/04 Interest Expense ($31,736 X 1/6)..............
Premium on Bonds Payable...... Payable
($4,264 X 1/6)
638,780
38,780
600,000
$600,000
$406,104
232,676
638,780
$ 38,780
31,939
4,061
36,000
5,289
711
Interest Payable ($36,000 X 1/6).........
6,000

6/1/05
Interest Expense ($31,736 X 5/6)..............

($4,264 X 5/6)
Cash......................................................
26,447
6,000
3,553
($31,523 X .2* X 4/6)
($4,477 X .2 X 4/6)
Cash......................................................
*$120,000 $600,000 = .2
4,203
Bonds Payable...........................................
Gain on Redemption of Bonds...........
Cash......................................................
Reacquisition price
($126,000 $120,000 X 12% X 4/12)
Net carrying amount of bonds redeemed:
Par value
Unamortized premium
[.2 X ($38,780 $4,061 $4,264) $597]
Gain on redemption
12/1/05
Interest Expense ($31,523 X .8*)...............
($4,477 X .8)
Cash ($36,000 X .8)..............................
*($600,000 $120,000) $600,000 = .8
120,000
5,494
10/1/05
10/1/05
12/31/05
($31,299 X .8 X 1/6)
($4,701 X .8 X 1/6)
Interest Payable...................................
($36,000 X .8 X 1/6)
36,000
597
4,800
4,294
121,200
$121,200
$120,000
5,494
(125,494)
$ (4,294)
25,218
3,582
28,800
4,173
627
4,800

6/1/06
12/1/06
Interest Expense ($31,299 X .8 X 5/6).......

($4,701 X .8 X 5/6)
Cash ($36,000 X .8)..............................
20,866
4,800
3,134
Interest Expense ($31,064 X .8)................

($4,936 X .8)
Cash ($36,000 X .8)..............................
24,851
3,949
Date
6/1/04
12/1/04
6/1/05
12/1/05
6/1/06
12/1/06
6/1/07
12/1/07
6/1/08
Cash
Credit
Debit
Interest
Expense
Debit
Bond
Premium
$36,000
36,000
36,000
36,000
36,000
36,000
36,000
36,000
$31,939
31,736
31,523
31,299
31,064
30,817
30,558
30,284*
$4,061
4,264
4,477
4,701
4,936
5,183
5,442
5,716
*$1.80 adjustment due to rounding.
28,800
28,800
Carrying
Value of
Bonds
$638,780
634,719
630,455
625,978
621,277
616,341
611,158
605,716
600,000
PROBLEM 14-6
May 1, 2004
Cash ............................................................................
($700,000 X 106%) + ($700,000 X 12% X 4/12)
Bonds Payable......................................................
Premium on Bonds Payable................................
Interest Expense ($700,000 X 12% X 4/12).........
December 31, 2004
Interest Expense ($700,000 X 12%)..........................
Interest Payable....................................................
Premium on Bonds Payable......................................
Interest Expense..................................................
($42,000 X 8/116* = $2,896.55)
*(12 X 10) 4 = 116
January 1, 2005
Interest Payable..........................................................
Cash.......................................................................
770,000.00
700,000.00
42,000.00
28,000.00
84,000.00
84,000.00
2,896.55
2,896.55
84,000.00
84,000.00
April 1, 2005
Bonds Payable............................................................ 420,000.00
Premium on Bonds Payable*....................................
22,810.34
Interest Expense ($420,000 X .12 X 3/12).................
12,600.00
Cash ($428,400 + $12,600)...................................
441,000.00
Gain on Retirement of Bonds
14,410.34
[($420,000 + $22,810.34) $420,000 X
102%)]
*[($420,000 $700,000) X $42,000 X 105/116 = $22,810.34]
Reacquisition price (including accrued interest)
($420,000 X 102%) + ($420,000 X 12% X 3/12)
$441,000.00
Net carrying value of bonds redeemed:
Par value
$420,000.00
Unamortized premium
[$42,000 X ($420,000 $700,000) X 105/116]
22,810.34 (442,810.34)
Accrued interest ($420,000 X 12% X 3/12)
(12,600.00)
Gain on redemption
$(14,410.34)

December 31, 2005
Interest Expense ($280,000 X .12).............................
Interest Payable....................................................
Premium on Bonds Payable......................................
Interest Expense..................................................
Amortization per year on $280,000
($42,000 X 12/116 X .40*)
Amortization on $420,000 for 3 months
($42,000 X 3/116 X .60**)
Total premium amortization
*($700,000 $420,000) $700,000 = .4
**$420,000 ) $700,000 = .6
33,600.00
33,600.00
2,389.65
2,389.65
$1,737.93
651.72
$2,389.65
PROBLEM 14-7
(a)
4/1/04
Cash (12,000 X $1,000 X 97%).......... 11,640,000

Discount on Bonds Payable.............
360,000
Bonds Payable.............................
12,000,000
(b)
10/1/04
Bond Interest Expense......................

Cash..............................................
Discount on Bonds Payable.......
*$12,000,000 X .11 X 6/12 =
$660,000
**$360,000 180 months =
$2,000/mo.; $2,000/mo.
X 6 months = $12,000
672,000
12/31/04 Bond Interest Expense......................

Interest Payable...........................
($660,000 X 3/6)
Discount on Bond Payable.........
($2,000 X 3 months)
336,000
(c)
(d)
3/1/05
660,000*
12,000**
Interest Payable.................................
Bond Interest Expense......................
Cash..............................................
Discount on Bonds Payable.......
*Cash paid to retiring
bondholders: $3,000,000
X .11 X 5/12 = $137,500
**$2,000/mo. X 2 months X
1
/4 of the bonds = $1,000
330,000
6,000
82,500
56,000
At March 1, 2005 the carrying amount of the retired

bonds is:
Bonds payable
Less unamortized discount
*$2,000/mo. X 169 months X 1/4 of the bonds = $84,500
137,500*
1,000**
$3,000,000
84,500*
$2,915,500

The reacquisition price: 100,000 shares X $31 = $3,100,000.
The loss on extinguishment of the bonds is:
Reacquisition price
Less carrying amount
Loss
The entry to record extinguishment of the bonds is:
Bonds Payable.............................................
3,000,000
Loss on Redemption of Bonds
184,500
Common Stock....................................
Paid-in Capital in Excess of Par.........
(or Premium on Common Stock)
$3,100,000
2,915,500
$ 184,500
84,500
1,000,000
2,100,000
(a)
(b)
PROBLEM 14-8
December 31, 2004
Computer Equipment.......................................
Discount on Notes Payable.............................
Notes Payable.............................................
(Computer capitalized at the present
value of the note$400,000 X .68301)
December 31, 2005
Depreciation Expense..........................................
Accumulated Depreciation
Computer Equipment..................................
[($273,204 $50,000) 5]
Interest Expense...................................................
Discount on Notes Payable...........................
273,204.00
126,796.00
400,000.00
44,640.80
44,640.80
27,320.40
27,320.40
Schedule of Note Discount Amortization

Date
Debit, Interest Expense Credit,

Discount on Notes Payable
12/31/04
12/31/05
$27,320.40
12/31/06
30,052.44
12/31/07
33,057.68
12/31/08
36,365.48*
*2.03 adjustment due to rounding.
(c)
December 31, 2006

Depreciation Expense.........................................
Accumulated Depreciation
Computer....................................................
Interest Expense.................................................
Discount on Notes Payable.........................
Carrying Value
of Note
$273,204.00
300,524.40
330,576.84
363,634.52
400,000.00
44,640.80
44,640.80
30,052.44
30,052.44
PROBLEM 14-9
(a)
(b)
12/31/03 Machinery.......................................... 131,120.50

Discount on Notes Payable.............
28,879.50
Cash.............................................
Notes Payable.............................
[To record machinery at the
present value of the note plus
the immediate cash payment:
PV of $30,000 annuity @ 12%
for 4 years ($30,000 X
3.03735)
$ 91,120.50
Down payment
40,000.00
Capitalized value of
machinery
$131,120.50
12/31/04 Notes Payable...................................
Cash.............................................
30,000.00
Interest Expense...............................
Discount on Notes Payable.......
10,934.46
40,000.00
120,000.00
30,000.00
10,934.46
Schedule of Note Discount Amortization

Date
Debit, Interest Expense Credit,

Discount on Notes Payable
Credit
Cash
Carrying Value
of Note
12/31/03
12/31/04
12/31/05
12/31/06
12/31/07
$10,934.46
8,646.60
6,084.19
3,214.25**
$30,000.00
30,000.00
30,000.00
30,000.00
*$72,054.96 = $91,120.50 + $10,934.46 $30,000.00.

**$0.04 adjustment due to rounding.
$91,120.50
72,054.96*
50,701.56
26,785.75

(c)
(d)
(e)
12/31/05 Notes Payable...................................

Cash.............................................
30,000.00
8,646.60
12/31/06 Notes Payable...................................

Cash.............................................
30,000.00
6,084.19
12/31/07 Notes Payable...................................

Cash.............................................
30,000.00
3,214.25
30,000.00
8,646.60
30,000.00
6,084.19
30,000.00
3,214.25
PROBLEM 14-10
(a)
(b)
Heide Co.
Selling price of the bonds ($3,000,000 X 103%)
Accrued interest from January 1 to February
28, 2005 ($3,000,000 X 9% X 2/12)
Total cash received from issuance of the bonds
Less: Bond issuance costs
Net amount of cash received
Reymont Co.
Carrying amount of the bonds on 1/1/04
Effective interest rate (10%)
Interest expense to be reported for 2004
$3,090,000
45,000
3,135,000
27,000
$3,108,000
$469,280
X 0.10
$ 46,928
(c)
Czeslaw Building Co.

Maturities and sinking fund requirements on long-term debt for the
next five year are as follows:
2006
$400,000
2009 $200,000
2007
350,000
2010
350,000
2008
200,000
(d)
Marie Curie Inc.

Since three bonds reported by Marie Curie Inc. are secured either real
estate, securities of other corporations, or plant the company.
PROBLEM 14-11
Dear Mathilda,
When a bond is issued at face value, the annual interest expense and
the interest payout equals the face value of the bond times the
interest rate stated on its face. However, if the bond is issued to yield
a higher or lower interest rate than what is stated on its face, the
interest expense and the actual interest payout will differ. Labeled as
a discount or premium respectively, this difference in interest must be
systematically associated with the interest periods which occur over
the bond's life through a process called amortization.
One method of amortization is the straight-line method whereby the
amount of the premium or discount is divided by the number of
interest periods in the bond's life. The result is an even amount of
amortization for every period.
However, a better way of matching interest expense to the period
during which it is incurred is the Effective Interest Method. Assume a
premium: the theory behind this method is that, as time passes, the
difference between the face value of the bond and its carrying amount
becomes smaller, resulting in a lower interest expense every period.
(The carrying amount equals the face value of the bond plus any
unamortized portion of the premium.) Because the carrying amount of
the bond becomes smaller over time, the effective interest expense
also does. Since the stated interest rate remains constant, the
resulting difference between the actual interest payout and the
interest expense recognized must be reflected when interest expense
is recorded for the period.
To amortize the premium applying this method to the data provided,
you must know the bond's face amount, its stated rate of interest, its
effective rate of interest, and its premium.
1. Multiply the stated rate times the face amount. This is the interest
payout.
2. Calculate the carrying amount by adding the premium to the

bond's face amount, Now multiply this carrying amount by the
effective rate which gives you the actual interest expense.
3. Subtract the amount calculated in #2 above from that found in #1.
This is the amount to be amortized for the period.
4. Subtract the difference computed in #3 from the carrying amount.
The process begins all over when you apply the effective rate to
this new carrying amount for the following period.
The schedule below illustrates this calculation. The face value
($3,000,000) is multiplied by the stated rate of 13 percent, while the
carrying amount ($3,225,690) is multiplied by the effective rate of 12
percent. Because this bond pays interest semiannually, you must also
multiply these amounts by 6/12. The result is the stated interest of
$195,000 and effective interest of $193,541. The difference ($1,459) is
amortized, lowering the carrying amount of the bond to $3,224,231.
For the next period, this new carrying amount will be multiplied by the
effective rate times 6/12 and subtracted from the constant $195,000.
Obviously this time the effective interest will be lower than it was last
period, resulting in a greater amount of amortization in the next
period.
Follow these steps and you should have no trouble amortizing
premiums and discounts over the life of a bond.
Sincerely,
Attachment to letter
Date
6-30-03
12-31-03
6-30-04
12-31-04
6-30-05
Joan Elbert Company

Interest and Discount Amortization Schedule
13% Bond Issued to Yield 12%
Cash
Interest
Amortized
Bond
Paid
Expense
Bond
Carrying
13%
12%
Premium
Amount
$3,225,690
$195,000
$193,541
$1,459
3,224,231
195,000
193,454
1,546
3,222,685
195,000
193,361
1,639
3,221,046
195,000
193,263
1,737
3,219,309
*PROBLEM 14-12
(a) The entries for the issuance of the note on January 1, 2004:
The present value of the note is: $1,200,000 X .68058 = $816,700
(Rounded by $4).
Bostan Company (Debtor):
Cash..............................................................
Discount on Note Payable..........................
Note Payable........................................
National Organization Bank (Creditor):
Note Receivable...........................................
Discount on Note Receivable.............
Cash......................................................
(b)
816,700
383,300
1,200,000
1,200,000
383,300
816,700
The amortization schedule for this note is:

SCHEDULE FOR INTEREST AND DISCOUNT AMORTIZATION
EFFECTIVE INTEREST METHOD
$1,200,000 NOTE ISSUED TO YIELD 8%
Date
Cash
Interest
Effective
Interest
1/1/04
12/31/04
$0
$ 65,336*
12/31/05
0
70,563
12/31/05
0
76,208
12/31/06
0
82,305
12/31/06
0
88,888
Total
$0
$383,300
*$816,700 X 8% = $65,336.
**$816,700 + $65,336 = $882,036.
Discount
Amortized
$ 65,336
70,563
76,208
82,305
88,888
$383,300
Carrying
Amount
$ 816,700
882,036**
952,599
1,028,807
1,111,112
1,200,000

(c)
The note can be considered to be impaired only when it is

probable that, based on current information and events, National
Organization Bank will be unable to collect all amounts due (both
principal and interest) according to the contractual terms of the
loan.
(d)
The loss is computed as follows:

Carrying amount of loan (12/31/05)
Less: Present value of $800,000
$952,599a
(635,064)b
$317,535
See amortization schedule from answer (b) above.

$800,000 X .79383 = $635,064.
December 31, 2002

Bostan Company (Debtor):
No entry.
National Organization Bank (Creditor):
Bad Debt Expense.......................................
Allowance for Doubtful Accounts......
317,535
317,535
*PROBLEM 14-13
(a)
It is a troubled debt restructuring.
(b)
1. Hillary Inc.: No entry necessary.

2. Bad Debt Expense.......................................
Allowance for Doubtful Accounts......
158,208*
158,208
*Calculation of loss.
Present value of $400,000 due in 10
years at 12%, interest payable
annually (Table 6-2); ($400,000 X
.32197)
Present value of $20,000 interest
payable annually for 10 years at 12%
(Table 6-4); ($20,000 X 5.65022)
$400,000
$128,788
113,004
(241,792)
$158,208
(c) Statement No. 114 amends Statement No. 15 so losses are now
calculated based upon the discounted present value of future
cash flows; thus, this fairly approximates the economic loss to the
lender. However, Statement No. 114 did not amend debtor
accounting. The debtors gain is still calculated under Statement
No. 15 using the undiscounted cash flows. This does not fairly
state the economic benefits derived by the debtor as a result of
the restructuring.
*PROBLEM 14-14
(a)
On the books of Sandro Corporation:

Notes payable.....................................................
Common Stock.............................................
Additional Paid-in Capital...........................
Gain on Restructuring of Debt...................
Fair value of equity
Carrying amount of debt
Gain on restructuring
of debt
$ 800,000
On the books of Sandro:

Notes Payable....................................................
Land..............................................................
Gain on Disposition of Real Estate............
Gain on Restructuring of Debt...................
Fair value of land
$2,400,000
Book value of land
1,950,000
Gain on disposition of
real estate
$ 450,000
Note payable (carrying amt)
Fair value of land
Gain on restructuring
of debt
1,000,000
1,200,000
800,000
$2,200,000
3,000,000
On the books of Botticelli National Bank:

Investment in Sandro........................................
Allowance for Doubtful Accounts (or Bad
Debt Expense).................................................
Notes Receivable.........................................
(b)
3,000,000
$3,000,000
2,400,000
$ 600,000
2,200,000
800,000
3,000,000
3,000,000
1,950,000
450,000
600,000
*PROBLEM 14-14 (Continued)

Investment in Land............................................
Allowance for Doubtful Accounts (or Bad
Debt Expense).................................................
Notes Receivable.........................................
(c)
2,400,000
600,000
3,000,000

No entry needed because aggregate cash flows equal the
carrying amount.
Aggregate cash flowsprincipal
$3,000,000
Carrying amount
$3,000,000
Bad Debt Expense.............................................
746,040*
Allowance for Doubtful Accounts..............
746,040
*Calculation of loss:
$3,000,000
Less: Present value of restructured cash flows:
Present value of $3,000,000 due in 3 years at 10%
Interest payable annually (Table 6-2);
($3,000,000 X .75132)
2,253,960
$ (746,040)
(d)

No entry needed because aggregate cash flows equal
the carrying amount.
Aggregate cash flows
Principal
Interest ($2,500,000 X 10% X 2)
Carrying amount
Bad Debt Expense.............................................
Allowance for Doubtful Accounts..............
$2,500,000
500,000
$3,000,000
$3,000,000
727,260*
727,260

*Calculation of loss:
Present value of $2,500,000 due in
3 years at 10%, interest payable
annually (Table 6-2); ($2,500,000 X
.75132)
Present value of $250,000 interest
payable annually for 3 years at 10%,
(Table 6-4); ($250,000 X 2.48685)
Less first year payment:
Present value of $250,000 interest due
in 1 year at 10% (Table 6-2);
($250,000 X .90909)
$3,000,000
$1,878,300
621,713
(227,273)
(2,272,740)
$ (727,260)
*PROBLEM 14-15
Carrying amount of the debt at date of restructure, $110,000 + $11,000
= $121,000. Total future cash flow, $100,000 + ($100,000 X .10 X 3) =
$130,000. Because the future cash flow exceeds the carrying amount
of the debt, no gain is recognized at the date of restructure.
(a)
The effective interest rate subsequent to restructure is

computed by trial and error using the assumed partial present
value tables based on the present value of $100,000 (new
principal) plus $10,000 (interest per year) for three years to equal
$121,000.
Try 2 1/2%
($100,000)(.92859)
($10,000)(2.85602)
PV
$ 92,859
28,560
$121,419
Try 2 3/4%
($100,000)(.92184)
($10,000)(2.84226)
PV
$ 92,184
28,423
$120,607
Try 2 5/8%
($100,000)(.92521)
$ 92,521
($10,000)(2.84913)
28,491
PV
$121,012
Therefore, the approximate effective rate is 2 5/8%.
(b)
SCHEDULE OF DEBT REDUCTION AND
INTEREST EXPENSE AMORTIZATION
Date
Cash
Interest
Effective
Interest
12/31/04
12/31/05
$ 10,000
$3,176*
12/31/06
10,000
2,997
12/31/07
10,000
2,827**
12/31/07
100,000
*$3,176 = $121,000 X 2.625%
**Adjusted $14 due to rounding.
Premium
Amortized
$
6,824
7,003
7,173
100,000
Carrying
Amount
$121,000
114,176
107,173
100,000
-0-

(c)
Calculation of loss:
Present value of $100,000 due in 3 years
at 10% , interest payable annually
(Table 6-2); ($100,000 X .75132)
Present value of $10,000 interest payable
annually for 3 years at 10% (Table 6-4);
($10,000 X 2.48685)
$121,000
$75,132
24,869
100,000*
$ (21,000)
*Although the sum of the present value amounts is $100,001, the

true present value of a 10% note discounted at 10% is face value,
or $100,000. The $1 difference is due to rounding.
Date
Cash
Interest
12/31/04
12/31/05
$ 10,000a
12/31/06
10,000
12/31/07
10,000
12/31/07
100,000
a
$10,000 = $100,000 X 10%.
b
$10,000 = $100,000 X 10%.
c
$100,000 = $100,000 $0.
(d)
Effective
Interest
b
$10,000
10,000
10,000
0
Change in
Carrying
Amortized
$
Carrying
Amount of
Note
$100,000
100,000c
100,000
100,000
0
0
0
0
100,000
Mildred Corp. entries:

December 31, 2004
Interest Payable.....................................................
Notes Payable..................................................
December 31, 2005
Interest Expense....................................................
Notes Payable........................................................
Cash..................................................................
11,000
11,000
3,176
6,824
10,000
(e)
December 31, 2006

Interest Expense....................................................
Notes Payable........................................................
Cash..................................................................
2,997
7,003
December 31, 2004

Bad Debt Expense.................................................
21,000
December 31, 2005, 2006

Cash ........................................................................
Interest Revenue.............................................
10,000
10,000
21,000
10,000

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SOLUTIONS TO EXERCISES

EXERCISE 14-1 (15-20 minutes)

EXERCISE 14-2 (15-20 minutes)

EXERCISE 14-3 (15-20 minutes)

Paul Simon Company:

Bond Interest Expense.....................

12/31/04 Bond Interest Expense.....................

Bond Interest Expense.....................

12/31/04 Bond Interest Expense..................

Note to instructor: Some students may credit Interest Payable on

EXERCISE 14-4 (15-20 minutes)

Cash ($600,000 X 102%)...........................

Bond Interest Expense............................

12/31/05 Bond Interest Expense............................

EXERCISE 14-5 (15-20 minutes)

Cash ($600,000 X 102%)...........................

Bond Interest Expense.............................

Bond Interest Expense..........................

Carrying amount of bonds at July 1, 2005:

EXERCISE 14-6 (15-20 minutes)

EXERCISE 14-7 (15-20 minutes)

$222,697.92 = $1,855,816.00 X 12%

EXERCISE 14-8 (15-20 minutes)

Printing and engraving costs of bonds

The Unamortized Bond Issue Costs, $121,000, should be reported as a

Interest paid for the period from January 1

Carrying amount of bonds on June 30, 2004

EXERCISE 14-9 (20-30 minutes)

June 30, 2005

June 30, 2006

December 31, 2006

EXERCISE 14-9 (Continued)

*($4,300,920.00 $4,000,000) ($1,944.80 + $2,061.49 + $2,185.18) = $294,728.53

Interest expense for the period from

The amount of bond interest expense reported in 2006 will be

Total interest to be paid for the bond

They will be the same.

EXERCISE 14-10 (15-20 minutes)

Schedule of Interest Expense and Bond Premium Amortization

$53,790.74 = $537,907.37 X 10%

December 31, 2004

December 31, 2006

EXERCISE 14-11 (20-30 minutes)

Stated rate per period

Effective rate per period

Payment amount per

$10,000,000 X 15% X 1/4 = $375,000

Present value of $25,000,000 discounted

Present value of an annuity of $2,000,000 discounted

EXERCISE 14-12 (15-20 minutes)

EXERCISE 14-13 (15-20 minutes)

EXERCISE 14-14 (12-16 minutes)

June 30, 2005

December 31, 2005

EXERCISE 14-15 (10-15 minutes)

EXERCISE 14-16 (15-20 minutes)

*Computation of the discount on