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Chapter 14: Q2E (page 754)

E14-2 (L01) (Classification) The following items are found in the financial statements.

(a) Discount on bonds payable.

(b) Interest expense (credit balance).

(c) Unamortized bond issue costs.

(d) Gain on repurchase of debt.

(e) Mortgage payable (payable in equal amounts over next 3 years).

(f) Debenture bonds payable (maturing in 5 years).

(g) Notes payable (due in 4 years).

(h) Premium on bonds payable.

(i) Bonds payable (due in 3 years).

Instructions

Indicate how each of these items should be classified in the financial statements.

Short Answer

Expert verified

Item

Classification in the financial statement

(a) Discount on bonds payable.

Contra-account to bond payable

(b) Interest expense (credit balance).

Interest payable (current liability)

(c) Unamortized bond issue costs.

Part of long-term liabilities

(d) Gain on repurchase of debt.

Other gains and losses in the income statement

(e) Mortgage payable (payable in equal amounts over next 3 years).

1/3 of the total amountas the current portion of long-term debt and 2/3 as long-term debt

(f) Debenture bonds payable (maturing in 5 years).

Long-term liability

(g) Notes payable (due in 4 years).

Long-term liability

(h) Premium on bonds payable.

Adjunct to the bond payable (long-term liability account)

(i) Bonds payable (due in 3 years).

Long-term liability

Step by step solution

01

Definition of Liability

Any event that will create the outflow of economic benefits is known as liability. The liability of the business entity is reported in the financial statement known as the balance sheet, under which it is classified as current and non-current.

02

Classification in the financial statement

(a) Discount on bond payable reduces the carrying value of the bond payable. Therefore, it is reported as a contra-account of bond payable.

(b) Interest expenses (credit balance) refers to the interest expenses that are not paid. These are reported as interest payable in the current liability.

(c) The unamortized cost incurred in the bond issue will be reported as part of the long-term liability, i.e., bonds payable.

(d) Gain on redemption of debt will be reported as other income in the income statement of the business entity.

(e) The portion of the mortgage that will be paid within the operating period will be classified as the current portion of long-term debt, and the remaining will be reported as long-term debt.

(f) Debenture bond payable will mature after the operating period and, therefore, will be reported as a long-term liability.

(g) Note payable that will get due in 4 years will be reported as long-term debt in the balance sheet.

(h) Premium on bond payable will be reported as an adjunct account to the bond payable in the long-term liabilities section. It will be added to the bond payable.

(i) Bond payable due after an operating period will be reported as long-term liability.

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Most popular questions from this chapter

Part I: The appropriate method of amortizing a premium or discount on issuance of bonds is the effective-interest method.

Instructions

  1. What is the effective-interest method of amortization and how is it different from and similar to the straight-line method of amortization?
  2. How is amortization computed using the effective-interest method, and why and how do amounts obtained using the effective-interest method differ from amounts computed under the straight-line method?

Part II: Gains or losses from the early extinguishment of debt that is refunded can theoretically be accounted for in three ways:

  1. Amortized over remaining life of old debt.
  2. Amortized over the life of the new debt issue.
  3. Recognized in the period of extinguishment

Instructions

  1. Develop supporting arguments for each of the three theoretical methods of accounting for gains and losses from the early extinguishment of debt.
  2. Which of the methods above is generally accepted and how should the appropriate amount of gain or loss be shown in a company’s financial statements?

(Entries for Redemption and Issuance of Bonds) Matt Perry, Inc. had outstanding \(6,000,000 of 11% bonds (interest payable July 31 and January 31) due in 10 years. On July 1, it issued \)9,000,000 of 10%, 15-year bonds (interest payable July 1 and January 1) at 98. A portion of the proceeds was used to call the 11% bonds (with unamortized discount of $120,000) at 102 on August 1.

Instructions

Prepare the journal entries necessary to record issue of the new bonds and refunding of the bonds.

The following amortization and interest schedule reflects the issuance of 10-year bonds by Capulet Corporation on January 1, 2011, and the subsequent interest payments and charges. The company’s year-end is December 31, and financial statements are prepared once yearly.

Amortization Schedule

Year

Cash

Interest

Amount unamortized

Carrying value

1/1/2011

\(5,651

\)94,349

2011

\(11,000

\)11,322

5,329

94,671

2012

11,000

11,361

4,968

95,032

2013

11,000

11,404

4,564

95,436

2014

11,000

11,452

4,112

95,888

2015

11,000

11,507

3,605

95,395

2016

11,000

11,567

3,038

96,962

2017

11,000

11,635

2,403

97,597

2018

11,000

11,712

1,691

98,309

2019

11,000

11,797

894

99,106

2020

11,000

11,894

100,000

Instructions

(a) Indicate whether the bonds were issued at a premium or a discount and how you can determine this fact from the schedule.

(b) Indicate whether the amortization schedule is based on the straight-line method or the effective-interest method, and how you can determine which method is used.

(c) Determine the stated interest rate and the effective-interest rate.

(d) On the basis of the schedule above, prepare the journal entry to record the issuance of the bonds on January 1, 2011.

(e) On the basis of the schedule above, prepare the journal entry or entries to reflect the bond transactions and accruals for 2011. (Interest is paid on January 1.)

(f) On the basis of the schedule above, prepare the journal entry or entries to reflect the bond transactions and accruals for 2018. Capulet Corporation does not use reversing entries.

Question: The following information is taken from the 2017 annual report of Bugant, Inc. Bugant’s fiscal year ends December 31 of each year. Bugant’s December 31, 2017, balance sheet is as follows.

Bugant, Inc.

Balance Sheet

December 31, 2017

Assets

Cash \( 450

Inventory 1,800

Total current assets 2,250

Plant and equipment 2,000

Accumulated depreciation (160)

Total assets \)4,090

Liabilities

Bonds payable (net of discount) \(1,426

Stockholders’ equity

Common stock 1,500

Retained earnings 1,164

Total liabilities and stockholders’ equity \)4,090

Note X: Long Term Debt:

On January 1, 2016, Bugant issued bonds with face value of \(1,500 and a coupon rate equal to 10%. The bonds were issued to yield 12% and mature on January 1, 2021.

Additional information concerning 2018 is as follows.

  1. Sales were \)3,500, all for cash.
  2. Purchases were \(2,000, all paid in cash.
  3. Salaries were \)700, all paid in cash.
  4. Property, plant, and equipment was originally purchased for \(2,000 and is depreciated straight-line over a 25-year life with no salvage value.
  5. Ending inventory was \)1,900.
  6. Cash dividends of \(100 were declared and paid by Bugant.
  7. Ignore taxes.
  8. The market rate of interest on bonds of similar risk was 12% during all of 2018.
  9. Interest on the bonds is paid semiannually each June 30 and December 31.

Accounting

Prepare a balance sheet for Bugant, Inc. at December 31, 2018, and an income statement for the year ending December 31, 2018. Assume semiannual compounding of the bond interest.

Analysis

Use common ratios for analysis of long-term debt to assess Bugant’s long-run solvency. Has Bugant’s solvency changed much from 2017 to 2018? Bugant’s net income in 2017 was \)550 and interest expense was $169.

Principles

The FASB and the IASB allow companies the option of recognizing in their financial statements the fair values of their long-term debt. That is, companies have the option to change the balance sheet value of their long-term debt to the debt’s fair value and report the change in balance sheet value as a gain or loss in income. In terms of the qualitative characteristics of accounting information (Chapter 2), briefly describe the potential trade-off(s) involved in reporting long-term debt at its fair value.

Assume the same information as in E14-4, except that Celine Dion Company uses the effective-interest method of amortization for bond premium or discount. Assume an effective yield of 9.7705%

Instructions

Prepare the journal entries to record the following. (Round to the nearest dollar.)

(a) The issuance of the bonds.

(b) The payment of interest and related amortization on July 1, 2017.

(c) The accrual of interest and the related amortization on December 31, 2017.
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