Week 4-Exercises and Problems

Resource: Ch. 10 of Financial Accounting

Complete Exercises E10-6, E10-8, & E10-18.

Complete Problems 10-3A &10-6A.

Submit as a Microsoft® Excel® or Word document.

SEE Attached

Chapter

Liabilities

After studying this chapter, you should be
able to:
1 Explain a current liability, and identify

the major types of current liabilities.
2 Describe the accounting for notes

payable.
3 Explain the accounting for other current

liabilities.
4 Explain why bonds are issued, and

identify the types of bonds.
5 Prepare the entries for the issuance of

bonds and interest expense.
6 Describe the entries when bonds are

redeemed or converted.
7 Describe the accounting for long-term

notes payable.
8 Identify the methods for the presentation

and analysis of long-term liabilities.

S T U D Y O B J E C T I V E S

Feature Story

The Navigator✓

FINANCING HIS DREAMS

What would you do if you had a great idea for a new product, but couldn’t
come up with the cash to get the business off the ground? Small businesses
often cannot attract investors. Nor can they obtain traditional debt financing
through bank loans or bond issuances. Instead, they often resort to unusual,
and costly, forms of nontraditional financing.

Such was the case for Wilbert Murdock. Murdock grew up in a New York
housing project, and always had great ambitions. This ambitious spirit led him
into some business ventures that failed: a medical diagnostic tool, a device to
eliminate carpal-tunnel syndrome, custom-designed sneakers, and a device to
keep people from falling asleep while driving.

Scan Study Objectives ■

Read Feature Story ■

Read Preview ■

Read text and answer
p. 453 ■ p. 458 ■ p. 461 ■ p. 463 ■
p. 465 ■

Work Comprehensive p. 469 ■

Review Summary of Study Objectives ■

Answer Self-Study Questions ■

Complete Assignments ■

The Navigator✓

Do it!

JWCL165_c10_444-505.qxd 8/12/09 7:24 AM Page 444

Another idea was computer-
ized golf clubs that analyze a
golfer’s swing and provide
immediate feedback. Murdock
saw great potential in the
idea: Many golfers are willing
to shell out considerable sums
of money for devices that
might improve their game.
But Murdock had no cash to
develop his product, and
banks and other lenders had
shied away. Rather than give
up, Murdock resorted to credit cards—in a big way. He quickly owed $2

5,000

to credit card companies.

While funding a business with credit cards might sound unusual, it isn’t. A
recent study found that one-third of businesses with fewer than 20 employ-
ees financed at least part of their operations with credit cards. As Murdock
explained, credit cards are an appealing way to finance a start-up because
“credit-card companies don’t care how the money is spent.” However, they
do care how they are paid. And so Murdock faced high interest charges and
a barrage of credit card collection letters.

Murdock’s debt forced him to sacrifice nearly everything in order to keep
his business afloat. His car stopped running, he barely had enough money
to buy food, and he lived and worked out of a dimly lit apartment in his
mother’s basement. Through it all he tried to maintain a positive spirit, joking
that, if he becomes successful, he might some day get to appear in an
American Express commercial.

Source: Rodney Ho, “Banking on Plastic: To Finance a Dream, Many Entrepreneurs Binge
on Credit Cards,” Wall Street Journal, March 9, 1998, p. A

The Navigator✓

Inside Chapter 10…

• Taxes Are the Largest Slice of the Pie (p. 450)

• When to Go Long-Term (p. 457)

• Search for Your Best Rate (p. 465)

• “Covenant-Lite” Debt (p. 467)

• All About You: Your Boss Wants to Know
If You Ran Today (p. 468)

JWCL165_c10_444-505.qxd 7/20/09 4:09 PM Page 445

WHAT IS A CURRENT LIABILITY?

Preview of Chapter

Inventor-entrepreneur Wilbert Murdock, as you can tell from the Feature Story, had to use multiple credit
cards to finance his business ventures. Murdock’s credit card debts would be classified as current liabilities
because they are due every month. Yet by making minimal payments and paying high interest each month,
Murdock used this credit source long-term. Some credit card balances remain outstanding for years as they
accumulate interest.

In Chapter 1, we defined liabilities as creditors’ claims on total assets and as existing debts and obligations.
These claims, debts, and obligations must be settled or paid at some time in the future by the transfer of
assets or services. The future date on which they are due or payable (maturity date) is a significant feature
of liabilities. This “future date” feature gives rise to two basic classifications of liabilities: (1) current liabilities
and (2) long-term liabilities. Our discussion in this chapter is divided into these two classifications.

The content and organization of Chapter 10 are as follows.

The Navigator✓

Liabilities

As explained in Chapter 4, a current liability is a debt with two key fea-
tures: (1) The company reasonably expects to pay the debt from existing
current assets or through the creation of other current liabilities. (2) The
company will pay the debt within one year or the operating cycle,
whichever is longer. Debts that do not meet both criteria are classified as

long-term liabilities. Most companies pay current liabilities within one year out of
current assets, rather than by creating other liabilities.

Companies must carefully monitor the relationship of current liabilities to cur-
rent assets. This relationship is critical in evaluating a company’s short-term debt-
paying ability. A company that has more current liabilities than current assets may
not be able to meet its current obligations when they become due.

Current liabilities include notes payable, accounts payable, and unearned
revenues.They also include accrued liabilities such as taxes, salaries and wages, and
interest payable. In previous chapters we explained the entries for accounts
payable and adjusting entries for some current liabilities. In the following sections,
we discuss other types of current liabilities.

Explain a current liability, and
identify the major types of
current liabilities.

S T U D Y O B J E C T I V E

SECTION 1

Current Liabilities

• Notes payable
• Sales taxes payable
• Payroll and payroll taxes
• Unearned revenues
• Current maturities of long-term

debt
• Statement presentation and

analysis

Long-Term Liabilities

• Bond basics
• Accounting for bond issues
• Accounting for bond

retirements
• Accounting for long-term notes

payable
• Statement presentation and

analysis

JWCL165_c10_444-505.qxd 7/20/09 4:09 PM Page 446

Notes Payable
Companies record obligations in the form of written promissory notes,
called notes payable. Notes payable are often used instead of accounts
payable because they give the lender formal proof of the obligation in case
legal remedies are needed to collect the debt. Notes payable usually
require the borrower to pay interest. Companies frequently issue them to meet
short-term financing needs.

Notes are issued for varying periods. Those due for payment within one year of
the balance sheet date are usually classified as current liabilities.

To illustrate the accounting for notes payable, assume that First National Bank
agrees to lend $100,000 on March 1, 2011, if Cole Williams Co. signs a $100,000,
12%, four-month note. With an interest-bearing promissory note, the amount of
assets received upon issuance of the note generally equals the note’s face value.
Cole Williams Co. therefore will receive $100,000 cash and will make the following
journal entry.

What Is a Current Liability? 44

Describe the accounting for
notes payable.

S T U D Y O B J E C T I V E

Mar. 1 Cash

100,000

Notes Payable 100,000

(To record issuance of 12%, 4-month
note to First National Bank)

Interest accrues over the life of the note, and the company must periodically
record that accrual. If Cole Williams Co. prepares financial statements on June 30,
it makes an adjusting entry at June 30 to recognize interest expense and interest
payable of $4,000 ($100,000 � 12% � 4/12). Illustration 10-1 shows the formula for
computing interest, and its application to Cole Williams Co.’s note.

Cole Williams makes an adjusting entry as follows:

June 30 Interest Expense 4,000
Interest Payable 4,000

(To accrue interest for 4 months on
First National Bank note)

In the June 30 financial statements, the current liabilities section of the balance
sheet will show notes payable $100,000 and interest payable $4,000. In addition,
the company will report interest expense of $4,000 under “Other expenses and
losses”in the income statement. If Cole Williams Co. prepared financial statements
monthly, the adjusting entry at the end of each month would have been

$1,000

($100,000 � 12% � 1/12).

At maturity (July 1, 2011), Cole Williams Co. must pay the face value of the
note ($100,000) plus $4,000 interest ($100,000 � 12% � 4/12). It records payment
of the note and accrued interest, as shown on the next page.

Cash Flows

�100,000

A SEL

� �

�100,000
�100,000

Cash Flows
no effect

A SEL� �

�4,000 Exp
�4,000

Annual Time in

Face Value

� Interest � Terms of � Interest
of Note

Rate One Year

$100,000 � 12% � 4/12 � $4,000

Illustration 10-1
Formula for computing
interest

JWCL165_c10_444-505.qxd 7/20/09 4:09 PM Page 447

Mar. 25 Cash 10,600
Sales 10,000
Sales Taxes Payable 600

(To record daily sales and sales taxes)

448 Chapter 10 Liabilities

July 1 Notes Payable 100,000
Interest Payable 4,000

Cash 104,000
(To record payment of First National
Bank interest-bearing note and accrued
interest at maturity)

Sales Taxes Payable
As a consumer, you know that many of the products you purchase at retail
stores are subject to sales taxes. Many states also are now collecting sales
taxes on purchases made on the Internet. Sales taxes are expressed as a
stated percentage of the sales price. The retailer collects the tax from the

customer when the sale occurs. Periodically (usually monthly), the retailer remits
the collections to the state’s department of revenue.

Under most state sales tax laws, the selling company must ring up separately on
the cash register the amount of the sale and the amount of the sales tax collected.
(Gasoline sales are a major exception.) The company then uses the cash register
readings to credit Sales and Sales Taxes Payable. For example, if the March 25 cash
register reading for Cooley Grocery shows sales of $10,000 and sales taxes of $600
(sales tax rate of 6%), the journal entry is:

When the company remits the taxes to the taxing agency, it debits Sales Taxes
Payable and credits Cash. The company does not report sales taxes as an expense.
It simply forwards to the government the amount paid by the customers. Thus,
Cooley Grocery serves only as a collection agent for the taxing authority.

Sometimes companies do not ring up sales taxes separately on the cash regis-
ter. To determine the amount of sales in such cases, divide total receipts by 100%
plus the sales tax percentage. To illustrate, assume that in the above example
Cooley Grocery rings up total receipts of $10,600. The receipts from the sales are
equal to the sales price (100%) plus the tax percentage (6% of sales), or 1.06 times
the sales total. We can compute the sales amount as follows.

$10,600 � 1.06 � $10,000

Thus, Cooley Grocery could find the sales tax amount it must remit to the state
($600) by subtracting sales from total receipts ($10,600 � $10,000).

Payroll and Payroll Taxes Payable
Every employer incurs liabilities relating to employees’ salaries and wages. One is
the amount of wages and salaries owed to employees—wages and salaries payable.
Another is the amount required by law to be withheld from employees’ gross pay.
Until a company remits these withholding taxes (federal and state income taxes,
and Social Security taxes) to the governmental taxing authorities, they are credited
to appropriate liability accounts. For example, if a corporation withholds taxes
from its employees’ wages and salaries, it would record accrual and payment of a
$100,000 payroll, as shown on the next page.

Explain the accounting for other
current liabilities.

S T U D Y O B J E C T I V E

H E L P F U L H I N T
Alternatively, Cooley
could find the tax by
multiplying sales by
the sales tax rate
($10,000 � .06).

Cash Flows

�104,000

A SEL� �

�100,000
�4,000

�104,000

Cash Flows
�10,600

A SEL� �

�10,600
�10,000 Rev

�600

JWCL165_c10_444-505.qxd 7/20/09 4:09 PM Page 448

Mar. 7 Salaries and Wages Expense 100,000
FICA Taxes Payable1 7,650
Federal Income Taxes Payable 21,864
State Income Taxes Payable 2,9

Salaries and Wages Payable 67,564

(To record payroll and withholding
taxes for the week ending March 7)

What Is a Current Liability? 44

1In 2009 FICA includes 6.2% of the first $106,800 for Old-Age, Survivors, and Disability Insurance
(OASDI) and 1.45% of all wages for Hospital Insurance (HI).

Mar. 11 Salaries and Wages Payable 67,564
Cash 67,564

(To record payment of the March 7
payroll)

Illustration 10-2 summarizes the types of payroll deductions.

Also, with every payroll, the employer incurs liabilities to pay various payroll
taxes levied upon the employer. These payroll taxes include the employer’s share
of Social Security taxes and the state and federal unemployment taxes. Based on
the $100,000 payroll in the previous example, the company would make the follow-
ing entry to record the employer’s expense and liability for these payroll taxes.

Mar. 7 Payroll Tax Expense 13,850
FICA Taxes Payable 7,650
Federal Unemployment Taxes Payable 800
State Unemployment Taxes Payable 5,400

(To record employer’s payroll taxes on
March 7 payroll)

Gross Pay Net Pay

Federal Income Tax

FICA Taxes State and City Income Taxes

Insurance and Pensions Charity Union Dues

Mandatory
Deductions

Voluntary Deductions

Illustration 10-2
Payroll deductions

Cash Flows
no effect
A SEL� �

�100,000
�7,650

�21,864
�2,922

�67,564

Cash Flows
�67,564

A SEL� �

�67,564
�67,564

Cash Flows
no effect
A SEL� �

�13,850
�7,650

�800
�5,400

JWCL165_c10_444-505.qxd 8/7/09 3:15 PM Page 449

Illustration 10-3 shows the types of taxes levied on employers.

450 Chapter 10 Liabilities

Federal Unemployment Taxes

FICA Taxes

State Unemployment Taxes

Computation
Based

on Wages

Illustration 10-3
Employer payroll taxes

Companies classify the payroll and payroll tax liability accounts as current
liabilities because these amounts must be paid to employees or remitted to taxing
authorities in the near term. Taxing authorities impose substantial fines and penal-
ties on employers if the withholding and payroll taxes are not computed correctly
and paid on time.

ACCOUNTING ACROSS THE ORGANIZATION

Taxes Are the Largest Slice of the Pie

In 2008, Americans worked 74 days to afford their federal taxes and 39 more
days to afford state and local taxes, according to the Tax Foundation. Each year

this foundation calculates the mathematical average of tax collections in the United States,
using a formula that divides the year’s total tax collections (federal, state, and local taxes) by
all income earned (the “national income”). The resulting national “tax burden”varies each
year, and the tax burden also varies by state.

National taxation in 2008 was a bigger burden than average expenditures on housing and
household operation (60 days), health and medical care (50 days), food (35 days), transporta-
tion (29 days), recreation (21 days), or clothing and accessories (13 days).

Source: www.taxfoundation.org/taxfreedomday (accessed June 2008). For a map of tax burden by states, see Figure 6
at that site.

If the information on 2008 taxation depicted your spending patterns, on what date
(starting on January 1) will you have earned enough to pay all of your taxes? This date

is often referred to as Tax Freedom Day.

Unearned Revenues
A magazine publisher, such as Sports Illustrated, receives customers’ checks when
they order magazines. An airline company, such as American Airlines, receives cash
when it sells tickets for future flights.Through these transactions, both companies have
incurred unearned revenues—revenues that are received before the company delivers
goods or provides services. How do companies account for unearned revenues?

JWCL165_c10_444-505.qxd 7/20/09 8:58 PM Page 450

1. When a company receives the advance payment, it debits Cash, and credits a
current liability account identifying the source of the unearned revenue.

2. When the company earns the revenue, it debits the Unearned Revenue
account, and credits an earned revenue account.

To illustrate, assume that Superior University sells 10,000 season football
tickets at $50 each for its five-game home schedule. The university makes the
following entry for the sale of season tickets:

What Is a Current Liability? 451

Aug. 6 Cash 500,000
Unearned Football Ticket Revenue 500,000

(To record sale of 10,000 season tickets)

As the school completes each of the five home games, it earns one-fifth of the
revenue. The following entry records the revenue earned.

Sept. 7 Unearned Football Ticket Revenue 100,000
Football Ticket Revenue 100,000

(To record football ticket revenue
earned)

Organizations report any balance in an unearned revenue account (in
Unearned Football Ticket Revenue, for example) as a current liability in the bal-
ance sheet. As they earn the revenue, a transfer from unearned revenue to earned
revenue occurs. Unearned revenue is material for some companies. In the airline
industry, for example, tickets sold for future flights represent almost 30% of total
current liabilities. At United Air Lines, unearned ticket revenue is the largest cur-
rent liability, recently amounting to over $1.6 billion.

Illustration 10-4 shows specific unearned and earned revenue accounts used in
selected types of businesses.

Current Maturities of Long-Term Debt
Companies often have a portion of long-term debt that comes due in the current
year.That amount is considered a current liability. For example, assume that Wendy
Construction issues a five-year interest-bearing $25,000 note on January 1, 2011.
Each January 1, starting January 1, 2012, $5,000 of the note is due to be paid. When
Wendy Construction prepares financial statements on December 31, 2011, it should
report $5,000 as a current liability. It would report the remaining $20,000 on the
note as a long-term liability. Current maturities of long-term debt are often termed
long-term debt due within one year.

It is not necessary to prepare an adjusting entry to recognize the current matu-
rity of long-term debt.The company will recognize the proper statement classifica-
tion of each balance sheet account when it prepares the balance sheet.

Account Title
Type of
Business Unearned Revenue Earned Revenue

Airline Unearned Passenger Ticket Revenue Passenger Revenue
Magazine publisher Unearned Subscription Revenue Subscription Revenue
Hotel Unearned Rental Revenue Rental Revenue
Insurance company Unearned Premium Revenue Premium Revenue

Illustration 10-4
Unearned and earned
revenue accounts

Cash Flows
�500,000

A SEL� �

�500,000
�500,000

Cash Flows
no effect
A SEL� �

�100,000
�100,000 Rev

JWCL165_c10_444-505.qxd 7/20/09 4:09 PM Page 451

452 Chapter 10 Liabilities

STATEMENT PRESENTATION AND ANALYSIS

Presentation
As indicated in Chapter 4, current liabilities are the first category under liabilities
on the balance sheet. Each of the principal types of current liabilities is listed sep-
arately. In addition, companies disclose the terms of notes payable and other key
information about the individual items in the notes to the financial statements.

Companies seldom list current liabilities in the order of liquidity. The reason is
that varying maturity dates may exist for specific obligations such as notes payable.
A more common method of presenting current liabilities is to list them by order of
magnitude, with the largest ones first. Or, as a matter of custom, many companies
show notes payable first, and then accounts payable, regardless of amount. Then
the remaining current liabilities are listed by magnitude. (Use this approach in your
homework.) The following adapted excerpt from the balance sheet of Caterpillar
Inc. illustrates its order of presentation.

CATERPILLAR INC.
Balance Sheet

(partial)
(in millions)

Assets

Current assets $20,856
Property, plant and equipment (net) 7,682
Other long-term assets 14,553

Total assets $43,091

Liabilities and Stockholders’ Equity

Current liabilities
Short-term borrowings (notes payable) $ 4,157
Accounts payable 3,990
Accrued expenses 1,847
Accrued wages, salaries, and employee benefits 1,7

Customer advances 555
Dividends payable 141
Deferred and current income taxes payable 259
Long-term debt due within one year 3,531

Total current liabilities 16,210

Noncurrent liabilities 19,4

Total liabilities 35,6

Stockholders’ equity 7,467

Total liabilities and stockholders’ equity $43,091

H E L P F U L H I N T
For other examples of
current liabilities sections,
refer to the PepsiCo and
Coca-Cola balance sheets
in Appendices A and B.

Illustration 10-5
Balance sheet presentation
of current liabilities

Analysis
Use of current and noncurrent classifications makes it possible to analyze a com-
pany’s liquidity. Liquidity refers to the ability to pay maturing obligations and meet
unexpected needs for cash.The relationship of current assets to current liabilities is
critical in analyzing liquidity. We can express this relationship as a dollar amount
(working capital) and as a ratio (the current ratio).

The excess of current assets over current liabilities is working capital.
Illustration 10-6 shows the formula for the computation of Caterpillar’s working
capital (dollar amounts in millions).

JWCL165_c10_444-505.qxd 7/20/09 4:09 PM Page 452

before you go on…

Bond Basics 453

Current Current Current
� �

Assets Liabilities Ratio

$20,856 � $16,210 � 1.29:1

Current Current Working
� �

Assets Liabilities Capital

$20,856 � $16,210 � $4,646

As an absolute dollar amount, working capital offers limited informational
value. For example, $1 million of working capital may be far more than needed for a
small company but be inadequate for a large corporation.Also, $1 million of working
capital may be adequate for a company at one time but inadequate at another time.

The current ratio permits us to compare the liquidity of different-sized compa-
nies and of a single company at different times. The current ratio is calculated as
current assets divided by current liabilities. The formula for this ratio is illustrated
below, along with its computation using Caterpillar’s current asset and current lia-
bility data (dollar amounts in millions).

Historically, companies and analysts considered a current ratio of 2:1 to be the
standard for a good credit rating. In recent years, however, many healthy compa-
nies have maintained ratios well below 2:1 by improving management of their
current assets and liabilities. Caterpillar’s ratio of 1.29:1 is adequate but certainly
below the standard of 2:1.

Illustration 10-6
Working capital formula and
computation

Illustration 10-7
Current ratio formula and
computation

Related exercise material: BE10-1, BE10-2, BE10-3, BE10-4, BE10-5, BE10-6, E10-1, E10-2, E10-3, E10-4,
E10-5, E10-6, E10-7, and 10-1.Do it!

Action Plan

• Divide total receipts by 100%
plus the tax rate to determine
sales; then subtract sales from
the total receipts.

• Multiply the FICA tax rate times
the salary and wage expense
amount.

1. First, divide the total proceeds by 100% plus the sales tax percentage to find the sales amount.
Second, subtract the sales amount from the total proceeds to determine the sales taxes.

2. Social Security taxes (FICA) � $10,000 � 7.65% � $765.

The Navigator✓

Do it!
You and several classmates are studying for the next accounting examination.

They ask you to answer the following questions: (1) How is the sales tax amount determined
when the cash register total includes sales taxes? (2) What is payroll tax expense related to Social
Security taxes if salaries and wages for the week are $10,000?

Solution

Current Liabilities

SECTION 2 Long-Term Liabilities

Long-term liabilities are obligations that are expected to be paid after one year. In
this section we will explain the accounting for the principal types of obligations
reported in the long-term liability section of the balance sheet. These obligations
often are in the form of bonds or long-term notes.

BOND BASICS

Bonds are a form of interest-bearing notes payable.To obtain large amounts
of long-term capital, corporate management usually must decide whether to
issue common stock (equity financing) or bonds. Bonds offer three advan-
tages over common stock, as shown in Illustration 10-8 (page 454).

Explain why bonds are issued,
and identify the types of bonds.

S T U D Y O B J E C T I V E 4

JWCL165_c10_444-505.qxd 8/11/09 3:35 PM Page 453

As the illustration shows, one reason to issue bonds is that they do not affect
stockholder control. Because bondholders do not have voting rights, owners can
raise capital with bonds and still maintain corporate control. In addition, bonds are
attractive to corporations because the cost of bond interest is tax-deductible. As a
result of this tax treatment, which stock dividends do not offer, bonds may result in
lower cost of capital than equity financing.

To illustrate the third advantage, on earnings per share, assume that
Microsystems, Inc. is considering two plans for financing the construction of a new
$5 million plant. Plan A involves issuance of 200,000 shares of common stock at the
current market price of $25 per share. Plan B involves issuance of $5 million,

bonds at face value. Income before interest and taxes on the new plant will be $1.5
million. Income taxes are expected to be 30%. Microsystems currently has 100,000
shares of common stock outstanding. Illustration 10-9 shows the alternative effects
on earnings per share.

454 Chapter 10 Liabilities

Illustration 10-9
Effects on earnings per
share—stocks vs. bonds

Stockholder control is not affected.
Bondholders do not have voting rights, so current owners
(stockholders) retain full control of the company.

Tax savings result.
Bond interest is deductible for tax purposes; dividends on
stock are not.

Earnings per share may be higher.
Although bond interest expense reduces net income, earnings
per share on common stock often is higher under bond financing
because no additional shares of common stock are issued.

Bond Financing Advantages

Illustration 10-

Advantages of bond
financing over common
stock

Plan A Plan B
Issue Stock Issue Bonds

Income before interest and taxes $1,500,000 $1,500,000
Interest (8% � $5,000,000) — 400,000

Income before income taxes 1,500,000 1,100,000
Income tax expense (30%) 450,000 330,000

Net income $1,050,000 $ 770,000

Outstanding shares 300,000 100,000
Earnings per share $3.50 $7.70

Note that net income is $280,000 less ($1,050,000 � $770,000) with long-term debt
financing (bonds). However, earnings per share is higher because there are 200,000
fewer shares of common stock outstanding.

One disadvantage in using bonds is that the company must pay interest on a
periodic basis. In addition, the company must also repay the principal at the due
date.A company with fluctuating earnings and a relatively weak cash position may
have great difficulty making interest payments when earnings are low.

A corporation may also obtain long-term financing from notes payable and
leasing. However, notes payable and leasing are seldom sufficient to furnish the
amount of funds needed for plant expansion and major projects like new buildings.

Bonds are sold in relatively small denominations (usually $1,000 multiples).As
a result of their size, and the variety of their features, bonds attract many investors.

H E L P F U L H I N T
Besides corporations,
governmental agencies
and universities also
issue bonds to raise
capital.

JWCL165_c10_444-505.qxd 7/20/09 8:58 PM Page 454

Types of Bonds
Bonds may have many different features. In the following sections, we describe the
types of bonds commonly issued.

SECURED AND UNSECURED BONDS
Secured bonds have specific assets of the issuer pledged as collateral for

the bonds.

A bond secured by real estate, for example, is called a mortgage bond. A bond
secured by specific assets set aside to retire the bonds is called a sinking fund bond.

Unsecured bonds, also called debenture bonds, are issued against the general
credit of the borrower. Companies with good credit ratings use these bonds exten-
sively. For example, in a recent annual report, DuPont reported over $2 billion of
debenture bonds outstanding.

TERM AND SERIAL BONDS
Bonds that mature—are due for payment—at a single specified future date are
term bonds. In contrast, bonds that mature in installments are serial bonds.

REGISTERED AND BEARER BONDS
Bonds issued in the name of the owner are registered bonds. Interest payments on
registered bonds are made by check to bondholders of record. Bonds not regis-
tered are bearer (or coupon) bonds. Holders of bearer bonds must send in coupons
to receive interest payments. Most bonds issued today are registered bonds.

CONVERTIBLE AND CALLABLE BONDS
Bonds that can be converted into common stock at the bondholder’s option are
convertible bonds. The conversion feature generally is attractive to bond buyers.
Bonds that the issuing company can retire at a stated dollar amount prior to matu-
rity are callable bonds.A call feature is included in nearly all corporate bond issues.

Issuing Procedures
State laws grant corporations the power to issue bonds. Both the board of directors
and stockholders usually must approve bond issues. In authorizing the bond issue,
the board of directors must stipulate the number of bonds to be authorized, total
face value, and contractual interest rate. The total bond authorization often ex-
ceeds the number of bonds the company originally issues. This gives the corpora-
tion the flexibility to issue more bonds, if needed, to meet future cash requirements.

The face value is the amount of principal the issuing company must pay at the
maturity date. The contractual interest rate, often referred to as the stated rate, is
the rate used to determine the amount of cash interest the borrower pays and the
investor receives. Usually the contractual rate is stated as an annual rate. Interest is
generally paid semiannually.

The terms of the bond issue are set forth in a legal document called a bond
indenture. The indenture shows the terms and summarizes the rights of the
bondholders and their trustees, and the obligations of the issuing company. The
trustee (usually a financial institution) keeps records of each bond-
holder, maintains custody of unissued bonds, and holds conditional title
to pledged property.

In addition, the issuing company arranges for the printing of bond
certificates. The indenture and the certificate are separate documents. As
shown in Illustration 10-10 (page 456), a bond certificate provides the fol-
lowing information: name of the issuer, face value, contractual interest
rate, and maturity date. An investment company that specializes in selling
securities generally sells the bonds for the issuing company.

Bond Basics 455

Convert

Convertible Bonds

Callable Bonds

Bond

Stock

Bond
Bond
Bond

“Hey Harv,
Call in those

bonds”

Bond

E T H I C S N O T E

Some companies try to
minimize the amount of debt
reported on their balance sheet
by not reporting certain types of
commitments as liabilities. This
subject is of intense interest in
the financial community.

Secured Bonds

Unsecured Bonds

No
Asset as

Collateral

JWCL165_c10_444-505.qxd 8/11/09 3:36 PM Page 455

456 Chapter 10 Liabilities

Contractual
interest rate

Face or par
value

Maturity
date

Issuer of
bonds

Bond Trading
Bondholders have the opportunity to convert their holdings into cash at any time
by selling the bonds at the current market price on national securities exchanges.
Bond prices are quoted as a percentage of the face value of the bond, which is
usually $1,000. A $1,000 bond with a quoted price of 97 means that the selling price
of the bond is 97% of face value, or $970. Newspapers and the financial press publish
bond prices and trading activity daily as illustrated by the following.

Illustration 10-

Market information for
bonds

Est. Volume
Bonds Maturity Close Yield (000)

Boeing Co. 5.125 Feb. 15, 2014 96.595 5.747 33,965

This bond listing indicates that Boeing Co. has outstanding 5.125%, $1,000 bonds
that mature in 2014. They currently yield a 5.747% return. On this day, $33,965,000
of these bonds were traded. At the close of trading, the price was 96.595% of face
value, or $965.95.

Illustration 10-10
Bond certificate

JWCL165_c10_444-505.qxd 7/20/09 9:34 PM Page 456

A corporation makes journal entries only when it issues or buys back bonds, or
when bondholders convert bonds into common stock. For example, DuPont does
not journalize transactions between its bondholders and other investors. If Tom
Smith sells his DuPont bonds to Faith Jones, DuPont does not journalize the trans-
action. (DuPont or its trustee does, however, keep records of the names of bond-
holders in the case of registered bonds.)

Determining the Market Value of Bonds
If you were an investor wanting to purchase a bond, how would you determine how
much to pay? To be more specific, assume that Coronet, Inc. issues a zero-interest
bond (pays no interest) with a face value of $1,000,000 due in 20 years. For this
bond, the only cash you receive is a million dollars at the end of 20 years. Would
you pay a million dollars for this bond? We hope not! A million dollars received
20 years from now is not the same as a million dollars received today.

The reason you should not pay a million dollars for Coronet’s bond relates to
what is called the time value of money. If you had a million dollars today, you would
invest it. From that investment, you would earn interest such that at the end of
20 years, you would have much more than a million dollars. If someone is going to
pay you a million dollars 20 years from now, you would want to find its equivalent
today. In other words, you would want to determine how much you must invest today
at current interest rates to have a million dollars in 20 years.The amount that must be
invested today at a given rate of interest over a specified time is called present value.

The present value of a bond is the value at which it should sell in the market-
place. Market value therefore is a function of the three factors that determine
present value: (1) the dollar amounts to be received, (2) the length of time until
the amounts are received, and (3) the market rate of interest. The market interest
rate is the rate investors demand for loaning funds. Appendix 10A discusses the
process of finding the present value for bonds. Appendix C (near the end of the
book) also provides additional material for time value of money computations.

Bond Basics 457

H E L P F U L H I N T
(1) What is the price of a

$1,000 bond trading
at 951⁄4?

(2) What is the price of a
$1,000 bond trading
at 1017⁄8?

Answers: (1) $952.50.
(2) $1,018.75.

2011

$1 million

Same dollars at different
times are not equal.

2031
≠

$1 million

ACCOUNTING ACROSS THE ORGANIZATION
When to Go Long-Term

A decision that all companies must make is to what extent to rely on short-term
versus long-term financing. The critical nature of this decision was highlighted in

the fall of 2001, after the World Trade Center disaster. Prior to September 11, short-term in-
terest rates had been extremely low relative to long-term rates. In order to minimize interest
costs, many companies were relying very heavily on short-term financing to purchase things
they normally would have used long-term debt for. The problem with short-term financing is
that it requires companies to continually find new financing as each loan comes due. This
makes them vulnerable to sudden changes in the economy.

After September 11, lenders and short-term investors became very reluctant to loan
money. This put the squeeze on many companies: As short-term loans came due, they were
unable to refinance. Some were able to get other financing, but at extremely high rates (for
example, 12% as compared to 3%). Others were unable to get loans and instead had to sell
assets to generate cash for their immediate needs.

Source: Henny Sender, “Firms Feel Consequences of Short-Term Borrowing,”Wall Street Journal Online, October 12, 2001.

Based on this story, what is a good general rule to use in choosing between short-term
and long-term financing?

JWCL165_c10_444-505.qxd 7/20/09 8:58 PM Page 457

Jan. 1 Cash 100,000
Bonds Payable 100,000

(To record sale of bonds at face value)

458 Chapter 10 Liabilities

Do it!
State whether each of the following statements is true or false.

_____ 1. Mortgage bonds and sinking fund bonds are both examples of secured bonds.

_____ 2. Unsecured bonds are also known as debenture bonds.

_____ 3. The stated rate is the rate investors demand for loaning funds.

_____ 4. The face value is the amount of principal the issuing company must pay at the maturity
date.

_____ 5. The bond issuer must make journal entries to record transfers of its bonds among
investors.

Solution

Bond Terminology

before you go on…
Action Plan

• Review the types of bonds and
the basic terms associated with
bonds.

Related exercise material: BE10-7, E10-8, E10-9, and 10-2.Do it!

1. True.

2. True.

3. False. The stated rate is the contractual interest rate used to determine the amount of cash
interest the borrower pays.

4. True.

5. False. The bond issuer makes journal entries only when it issues or buys back bonds, when it
records interest, and when bonds are converted.

ACCOUNTING FOR BOND ISSUES

Bonds may be issued at face value, below face value (at a discount), or
above face value (at a premium).

Issuing Bonds at Face Value
To illustrate the accounting for bonds, assume that on January 1, 2011, Candlestick
Corporation issues $100,000, five-year, 10% bonds at 100 (100% of face value).The
entry to record the sale is:

Prepare the entries for the
issuance of bonds and interest
expense.

S T U D Y O B J E C T I V E 5

Candlestick reports bonds payable in the long-term liabilities section of the bal-
ance sheet because the maturity date is more than one year away.

Over the term (life) of the bonds, companies make entries to record bond in-
terest. Interest on bonds payable is computed in the same manner as interest on
notes payable, as explained on page 447.Assume that interest is payable semiannu-
ally on January 1 and July 1 on the bonds described above. In that case, Candlestick
must pay interest of $5,000 ($100,000 � 10% � 6/12) on July 1, 2011. The entry for
the payment, assuming no previous accrual of interest, is:

July 1 Bond Interest Expense 5,000
Cash 5,000

(To record payment of bond interest)

Cash Flows
�100,000

A SEL� �
�100,000
�100,000

Cash Flows

�5,000

A SEL� �

�5,000 Exp
�5,000

The Navigator✓

JWCL165_c10_444-505.qxd 7/20/09 4:09 PM Page 458

At December 31, Candlestick recognizes the $5,000 of interest expense incurred
since July 1 with the following adjusting entry:

Accounting for Bond Issues 459

Dec. 31 Bond Interest Expense 5,000
Bond Interest Payable 5,000

(To accrue bond interest)

Companies classify bond interest payable as a current liability, because it is
scheduled for payment within the next year.When Candlestick pays the interest on
January 1, 2012, it debits (decreases) Bond Interest Payable and credits (decreases)
Cash for $5,000.

Discount or Premium on Bonds
In the Candlestick illustrations above, we assumed that the contractual (stated)
interest rate paid on the bonds and the market (effective) interest rate were the
same. Recall that the contractual interest rate is the rate applied to the face (par)
value to arrive at the interest paid in a year. The market interest rate is the rate in-
vestors demand for loaning funds to the corporation.When the contractual interest
rate and the market interest rate are the same, bonds sell at face value.

However, market interest rates change daily. The type of bond issued, the state
of the economy, current industry conditions, and the company’s performance all
affect market interest rates. Contractual and market interest rates often differ. As
a result, bonds often sell below or above face value.

To illustrate, suppose that a company issues 10% bonds at a time when other
bonds of similar risk are paying 12%. Investors will not be interested in buying the
10% bonds, so their value will fall below their face value. In this case, we say the
10% bonds are selling at a discount. As a result of the decline in the bonds’ selling
price, the actual interest rate incurred by the company increases to the level of the
current market interest rate.

Conversely, if the market rate of interest is lower than the contractual interest
rate, investors will have to pay more than face value for the bonds. That is, if the
market rate of interest is 8% but the contractual interest rate on the bonds is 10%,
the issuer will require more funds from the investor. In these cases, bonds sell at a
premium. Illustration 10-12 shows these relationships graphically.

Bond
Contractual

Interest
Rate

10%

8%
10%

12%

Market
Interest Rate

Bonds Sell
at

Issued when

Premium

Face Value

Discount

Illustration 10-

Interest rates and bond
prices

Issuing bonds at an amount different from face value is quite common. By the
time a company prints the bond certificates and markets the bonds, it will be a co-
incidence if the market rate and the contractual rate are the same. Thus, the sale of
bonds at a discount does not mean that the issuer’s financial strength is suspect.
Nor does the sale of bonds at a premium indicate exceptional financial strength.

Cash Flows
no effect
A SEL� �
�5,000 Exp
�5,000

H E L P F U L H I N T
Discount on

Bonds Payable

Increase Decrease
Debit Credit

Normal
Balance

←

JWCL165_c10_444-505.qxd 7/20/09 4:09 PM Page 459

Issuing Bonds at a Discount
To illustrate issuance of bonds at a discount, assume that on January 1, 2011,
Candlestick, Inc. sells $100,000, five-year, 10% bonds for $92,639 (92.639% of face
value). Interest is payable on July 1 and January 1.The entry to record the issuance is:

460 Chapter 10 Liabilities

Jan. 1 Cash 92,639
Discount on Bonds Payable 7,361

Bonds Payable 100,000
(To record sale of bonds at a discount)

Although Discount on Bonds Payable has a debit balance, it is not an asset. Rather,
it is a contra account. This account is deducted from bonds payable on the balance
sheet, as shown in Illustration 10-13.

CANDLESTICK, INC.
Balance Sheet (partial)

Long-term liabilities
Bonds payable $100,000
Less: Discount on bonds payable 7,361

$92,639

The $92,639 represents the carrying (or book) value of the bonds. On the date of
issue this amount equals the market price

of the bonds.

The issuance of bonds below face value—at a discount—causes the total cost of
borrowing to differ from the bond interest paid. That is, the issuing corporation
must pay not only the contractual interest rate over the term of the bonds, but also
the face value (rather than the issuance price) at maturity.Therefore, the difference
between the issuance price and face value of the bonds—the discount—is an
additional cost of borrowing. The company records this additional cost as bond
interest expense over the life of the bonds.Appendices 10B and 10C show the proce-
dures for recording this additional cost.

The total cost of borrowing $92,639 for Candlestick, Inc. is $57,361, computed
as follows.

H E L P F U L H I N T
Carrying value (book
value) of bonds issued at
a discount is determined
by subtracting the balance
of the discount account
from the balance of the
Bonds Payable account.

Bonds Issued at a Discount

Semiannual interest payments
($100,000 � 10% � 1⁄2 � $5,000; $5,000 � 10)

$50,000

Add: Bond discount ($100,000 � $92,639) 7,361

Total cost of borrowing

$57,361

Bond Issued at a Discount

Principal at maturity $100,000
Semiannual interest payments ($5,000 � 10) 50,000

Cash to be paid to bondholders 150,000
Cash received from bondholders 92,639

Total cost of borrowing $ 57,361

Alternatively, we can compute the total cost of borrowing as follows.

Illustration 10-

Statement presentation of
discount on bonds payable

Illustration 10-14
Total cost of borrowing—
bonds issued at a discount

Illustration 10-

Alternative computation of
total cost of borrowing—
bonds issued at a discount

Cash Flows
�92,639

A SEL� �

�92,639
�7,361

�100,000

JWCL165_c10_444-505.qxd 7/20/09 4:09 PM Page 460

Issuing Bonds at a Premium
To illustrate the issuance of bonds at a premium, we now assume the Candlestick,
Inc. bonds described above sell for $108,111 (108.111% of face value) rather than
for $92,639. The entry to record the sale is:

Accounting for Bond Issues 461

CANDLESTICK, INC.
Balance Sheet (partial)

Long-term liabilities
Bonds payable $100,000
Add: Premium on bonds payable 8,111

$108,111

Bonds Issued at a Premium

Semiannual interest payments
($100,000 � 10% � 1⁄2 � $5,000; $5,000 � 10) $50,000

Less: Bond premium ($108,111 � $100,000) 8,111

Total cost of borrowing

$41,889

Bonds Issued at a Premium
Principal at maturity $100,000
Semiannual interest payments ($5,000 � 10) 50,000

Cash to be paid to bondholders 150,000
Cash received from bondholders 108,111

Total cost of borrowing $ 41,889

Jan. 1 Cash 108,111
Bonds Payable 100,000
Premium on Bonds Payable 8,111

(To record sale of bonds at a premium)

Candlestick adds the premium on bonds payable to the bonds payable amount on
the balance sheet, as shown in Illustration 10-16 below.

H E L P F U L H I N T
Premium on

Bonds Payable

Decrease Increase
Debit Credit

Normal
Balance
←

The sale of bonds above face value causes the total cost of borrowing to be less
than the bond interest paid. The bond premium is considered to be a reduction in
the cost of borrowing. The company credits the bond premium to Bond Interest
Expense over the life of the bonds. Appendices 10B and 10C show the procedures
for recording this reduction in the cost of borrowing. The total cost of borrowing
$108,111 for Candlestick, Inc. is computed as follows.

Alternatively, we can compute the cost of borrowing as follows.

Illustration 10-

Statement presentation of
bond premium

Illustration 10-

Total cost of borrowing—
bonds issued at a premium

Illustration 10-

Alternative computation of
total cost of borrowing—
bonds issued at a premium

Do it!
Giant Corporation issues $200,000 of bonds for $189,000. (a) Prepare the jour-

nal entry to record the issuance of the bonds, and (b) show how the bonds would be reported on
the balance sheet at the date of issuance.

Bond Issuance

before you go on…

Cash Flows
�108,111

A SEL� �

�108,111
�100,000

�8,111

JWCL165_c10_444-505.qxd 7/20/09 4:09 PM Page 461

Bonds Payable 100,000
Cash 100,000

(To record redemption of bonds at maturity)

462 Chapter 10 Liabilities

(a)
Cash 189,000
Discount on Bonds Payable 11,000

Bonds Payable 200,000
(To record sale of bonds at a discount)

(b)
Long-term liabilities

Bonds payable $200,000
Less: Discount on bonds payable 11,000 $189,000

The Navigator✓
Solution

Related exercise material: BE10-8, BE10-9, BE10-10, E10-10, E10-11, E10-12, and 10-2.Do it!

Action Plan

• Record cash received, bonds
payable at face value, and the
difference as a discount or
premium.

• Report discount as a deduction
from bonds payable and
premium as an addition to
bonds payable.

ACCOUNTING FOR BOND RETIREMENTS

An issuing corporation retires bonds either when it redeems the bonds
or when bondholders convert them into common stock. We explain the
entries for these transactions in the following sections.

Redeeming Bonds at Maturity
Regardless of the issue price of bonds, the book value of the bonds at maturity will
equal their face value.Assuming that the company pays and records separately the
interest for the last interest period, Candlestick records the redemption of its bonds
at maturity as follows:

Describe the entries when bonds
are redeemed or converted.

S T U D Y O B J E C T I V E 6

Redeeming Bonds before Maturity
Bonds also may be redeemed before maturity. A company may decide to retire
bonds before maturity to reduce interest cost and to remove debt from its balance
sheet. A company should retire debt early only if it has sufficient cash resources.

When a company retires bonds before maturity, it is necessary to: (1) eliminate
the carrying value of the bonds at the redemption date; (2) record the cash paid;
and (3) recognize the gain or loss on redemption. The carrying value of the bonds
is the face value of the bonds less unamortized bond discount or plus unamortized
bond premium at the redemption date.

To illustrate, assume that Candlestick, Inc. has sold its bonds at a premium. At
the end of the eighth period, Candlestick retires these bonds at 103 after paying
the semiannual interest. Assume also that the carrying value of the bonds at the
redemption date is $101,623. Candlestick makes the following entry to record
the redemption at the end of the eighth interest period (January 1, 2015):

H E L P F U L H I N T
A bond is redeemed
prior to its maturity
date. Its carrying value
exceeds its redemption
price. Will the retirement
result in a gain or a
loss on redemption?
Answer: Gain.

Jan. 1 Bonds Payable 100,000
Premium on Bonds Payable 1,6

Loss on Bond Redemption 1,377

Cash 103,000
(To record redemption of bonds at 103)

Cash Flows
�100,000
A SEL� �
�100,000
�100,000

Cash Flows
�103,000

A SEL� �

�100,000
�1,623

�1,377 Exp
�103,000

JWCL165_c10_444-505.qxd 8/7/09 3:34 PM Page 462

Note that the loss of $1,377 is the difference between the cash paid of $103,000 and
the carrying value of the bonds of $101,623.

Converting Bonds into Common Stock
Convertible bonds have features that are attractive both to bondholders and to the
issuer. The conversion often gives bondholders an opportunity to benefit if the
market price of the common stock increases substantially. Until conversion, though,
the bondholder receives interest on the bond. For the issuer of convertible bonds,
the bonds sell at a higher price and pay a lower rate of interest than comparable debt
securities without the conversion option. Many corporations, such as USAir, USX
Corp., and Chrysler Corporation, have convertible bonds outstanding.

When the issuing company records a conversion, the company ignores the
current market prices of the bonds and stock. Instead, the company transfers the
carrying value of the bonds to paid-in capital accounts. No gain or loss is recognized.

To illustrate, assume that on July 1 Saunders Associates converts $100,000
bonds sold at face value into 2,000 shares of $10 par value common stock. Both the
bonds and the common stock have a market value of $130,000. Saunders makes the
following entry to record the conversion:

Accounting for Long-Term Notes Payable 463

July 1 Bonds Payable 100,000
Common Stock 20,000
Paid-in Capital in Excess of Par Value 80,000

(To record bond conversion)

Note that the company does not consider the current market price of the bonds
and stock ($130,000) in making the entry. This method of recording the bond con-
version is often referred to as the carrying (or book) value method.

Related exercise material: BE10-11, E10-13, E10-14, and 10-3.Do it!

Action Plan

• Determine and eliminate the
carrying value of the bonds.

• Record the cash paid.
• Compute and record the gain or

loss (the difference between
the first two items).

There is a loss on redemption: The cash paid, $510,000 ($500,000 � 102%), is greater than the
carrying value of $508,000. The entry is:

Bonds Payable 500,000
Premium on Bonds Payable 8,000
Loss on Bond Redemption 2,000

Cash 510,000
(To record redemption of bonds at 102)

The Navigator✓

Do it!
R & B Inc. issued $500,000, 10-year bonds at a premium. Prior to maturity,

when the carrying value of the bonds is $508,000, the company retires the bonds at 102. Prepare
the entry to record the redemption of the bonds.

Solution

Bond Redemption

before you go on…

ACCOUNTING FOR LONG-TERM NOTES PAYABLE

The use of notes payable in long-term debt financing is quite common.
Long-term notes payable are similar to short-term interest-bearing notes
payable except that the term of the notes exceeds one year.

Describe the accounting for
long-term notes payable.

S T U D Y O B J E C T I V E 7

Cash Flows
no effect
A SEL� �

�100,000
�20,000 CS
�80,000 CS

JWCL165_c10_444-505.qxd 8/11/09 3:38 PM Page 463

Porter records the mortgage loan and first installment payment as follows.

464 Chapter 10 Liabilities

Dec. 31 Cash 500,000
Mortgage Notes Payable 500,000

(To record mortgage loan)

A long-term note may be secured by a mortgage that pledges title to specific
assets as security for a loan. Individuals widely use mortgage notes payable to pur-
chase homes, and many small and some large companies use them to acquire plant
assets. At one time, approximately 18% of McDonald’s long-term debt related to
mortgage notes on land, buildings, and improvements.

Mortgage loan terms may stipulate either a fixed or an adjustable interest rate.
The interest rate on a fixed-rate mortgage remains the same over the life of the
mortgage.The interest rate on an adjustable-rate mortgage is adjusted periodically
to reflect changes in the market rate of interest. Typically, the terms require the
borrower to make installment payments over the term of the loan. Each payment
consists of (1) interest on the unpaid balance of the loan and (2) a reduction of loan
principal. The interest decreases each period, while the portion applied to the loan
principal increases.

Companies initially record mortgage notes payable at face value. They sub-
sequently make entries for each installment payment. To illustrate, assume
that Porter Technology Inc. issues a $500,000, 12%, 20-year mortgage note on
December 31, 2011, to obtain needed financing for a new research laboratory. The
terms provide for semiannual installment payments of $33,231 (not including real
estate taxes and insurance). The installment payment schedule for the first two
years is as follows.

(B) (C) (D)
Semiannual (A) Interest Reduction Principal

Interest Cash Expense of Principal Balance
Period Payment (D) � 6% (A) � (B) (D) � (C)

12/31/11 $500,000
06/30/12 $33,231 $30,000 $3,231 496,769
12/31/12 33,231 29,806 3,425 493,344
06/30/13 33,231 29,601 3,630 489,714
12/31/13 33,231 29,383 3,848 485,866

June 30 Interest Expense 30,000
Mortgage Notes Payable 3,231

Cash 33,231
(To record semiannual payment on
mortgage)

In the balance sheet, the company reports the reduction in principal for the next
year as a current liability, and it classifies the remaining unpaid principal balance as
a long-term liability. At December 31, 2012, the total liability is $493,344. Of that
amount, $7,478 ($3,630 � $3,848) is current, and $485,866 ($493,344 � $7,478) is
long-term.

Cash Flows
�500,000
A SEL� �
�500,000
�500,000

Cash Flows

�33,231

A SEL� �

�30,000 Exp
�3,231

�33,231

Illustration 10-

Mortgage installment
payment schedule

JWCL165_c10_444-505.qxd 8/7/09 3:37 PM Page 464

before you go on…

Statement Presentation and Analysis 465

STATEMENT PRESENTATION AND ANALYSIS

Presentation
Companies report long-term liabilities in a separate section of the balance
sheet immediately following current liabilities, as shown in Illustration 10-

on the next page.Alternatively, companies may present summary data in the

Identify the methods for the
presentation and analysis of
long-term liabilities.

S T U D Y O B J E C T I V E 8

Related exercise material: BE10-12, E10-15, and 10-4.Do it!

Cash 250,000
Mortgage Notes Payable 250,000

(To record mortgage loan)

Interest Expense 10,000

Mortgage Notes Payable 2,361

Cash 12,361
(To record semiannual payment on mortgage)

*Interest expense � $250,000 � 8% � 6/12.

The Navigator✓

Search for Your Best Rate

Companies spend a great deal of time shopping for the best loan terms. You
should do the same. Suppose that you have a used car that you are planning

to trade in on the purchase of a new car. Experts suggest that you view this deal as three
separate transactions: (1) the purchase of a new car, (2) the trade in or sale of an old car, and
(3) shopping for an interest rate.

Studies suggest that too many people neglect transaction number 3. One survey found
that 63% of people planned on shopping for the best car-loan interest rate online the next
time they bought a car. But a separate study found that only 15% of people who bought a car
actually shopped around for the best online rate. Too many people simply take the interest
rate offered at the car dealership. Many lenders will pre-approve you for a loan up to a
specific dollar amount, and many will then give you a blank check (negotiable for up to that
amount) that you can take to the car dealer.

Source: Ron Lieber, “How to Haggle the Best Car Loan,”Wall Street Journal, March 25, 2006, p. B1.

What should you do if the dealer “trash-talks” your lender, or refuses to sell you the car
for the agreed-upon price unless you get your car loan through the dealer?

Do it!
Cole Research issues a $250,000, 8%, 20-year mortgage note to obtain needed

financing for a new lab. The terms call for semiannual payments of $12,631 each. Prepare the
entries to record the mortgage loan and the first installment payment.

Solution

Long-Term Note

Action Plan

• Record the issuance of the note
as a cash receipt and a liability.

• Record each installment
payment that consists of
interest and payment of
principal.

ACCOUNTING ACROSS THE ORGANIZATION

JWCL165_c10_444-505.qxd 8/11/09 3:38 PM Page 465

Analysis
Long-term creditors and stockholders are interested in a company’s long-run sol-
vency. Of particular interest is the company’s ability to pay interest as it comes due
and to repay the face value of the debt at maturity. Debt to total assets and times
interest earned are two ratios that provide information about debt-paying ability
and long-run solvency.

The debt to total assets ratio measures the percentage of the total assets pro-
vided by creditors. As shown in the formula in Illustration 10-21, it is computed by
dividing total debt (both current and long-term liabilities) by total assets. The
higher the percentage of debt to total assets, the greater the risk that the company
may be unable to meet its maturing obligations.

The times interest earned ratio indicates the company’s ability to meet interest
payments as they come due. It is computed by dividing income before income taxes
and interest expense by interest expense.

To illustrate these ratios, we will use data from Kellogg Company’s recent
annual report. The company had total liabilities of $8,871 million, total assets of
$11,397 million, interest expense of $319 million, income taxes of $444 million, and
net income of $1,103 million. Kellogg’s debt to total assets ratio and times interest
earned ratio are shown below.

466 Chapter 10 Liabilities

LAX CORPORATION
Balance Sheet (partial)

Long-term liabilities
Bonds payable 10% due in 2018 $1,000,000
Less: Discount on bonds payable 80,000 $ 920,000
Mortgage notes payable, 11%, due

in 2024 and secured by plant assets 500,000
Lease liability 440,000

Total long-term liabilities $1,860,000

Illustration 10-20
Balance sheet presentation
of long-term liabilities

Illustration 10-

Debt to total assets and
times interest earned ratios,
with computations

Total Debt � Total Assets � Debt to Total Assets

$8,871 � $11,397 � 77.8%

Income before
Income Taxes and � Interest � Times Interest

Interest Expense Expense Earned

$1,103 � $444 � $319 � $319 � 5.85 times

Kellogg has a relatively high debt to total assets percentage of 77.8%. Its interest cov-
erage of 5.85 times is considered safe.

balance sheet, with detailed data (interest rates, maturity dates, conversion privileges,
and assets pledged as collateral) shown in a supporting schedule. Companies report
the current maturities of long-term debt under current liabilities if they are to be paid
from current assets.

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How can financial ratios such as those covered in this chapter provide protection for
creditors?

I N V E S T O R I N S I G H T
”Covenant-Lite” Debt

In many corporate loans and bond issuances the lending agreement specifies debt
covenants. These covenants typically are specific financial measures, such as minimum levels
of retained earnings, cash flows, times interest earned ratios, or other measures that a com-
pany must maintain during the life of the loan. If the company violates a covenant, it is consid-
ered to have violated the loan agreement; the creditors can demand immediate repayment,
or they can renegotiate the loan’s terms. Covenants protect lenders because they enable
lenders to step in and try to get their money back before the borrower gets too deep into
trouble.

During the 1990s most traditional loans specified between three to six covenants or
“triggers.” In more recent years, when lots of cash was available, lenders began reducing or
completely eliminating covenants from loan agreements in order to be more competitive with
other lenders. In a slower economy these lenders will be more likely to lose big money when
companies default.

Source: Cynthia Koons, “Risky Business: Growth of ‘Covenant-Lite’ Debt,” Wall Street Journal, June 18, 2007, p. C2.

Statement Presentation and Analysis 467

Your Boss Wants to
Know If You Ran Today

on page 468 for infor-
mation on how topics in

this chapter apply to you.

all about Y U*
Be sure to read

JWCL165_c10_444-505.qxd 7/20/09 4:10 PM Page 467

Some Facts*

*all about Y U*

AAs you saw in this chapter, compensation packagesoften include fringe benefits in addition to basic
salary. Health insurance is one benefit that many
employers offer. In recent years, as the cost of health
insurance has sky-rocketed, many employers either
have shifted some of the cost of health insurance
onto employees, or have discontinued health
insurance coverage altogether.

In addition, some employees are encouraging and
setting up preventive healthcare programs. Here are
the percentages for five unhealthy behaviors for
individuals with some college education: current
cigarette smoker (22.9%), five or more alcoholic
drinks at one sitting during at least once in the
past year (30%), physically inactive (30%), obese
(25.2%), or sleep less than 6 hours per day (30.3%).

What Do You Think?*
Suppose you own a business. About a quarter of your employees smoke,
and an even higher percentage are overweight. You decide to implement a
mandatory health program that requires employees to quit smoking and to
exercise regularly, with regular monitoring. If employees do not participate in
the program, they will have to pay their own insurance premiums. Is this fair?

YES: It is the responsibility of management to try to maximize a company’s
profit. Employees with unhealthy habits drive up the cost of health insurance
because they require more frequent and more costly medical attention.

NO: What people do on their own time is their own business. This
represents an invasion of privacy, and is a form of discrimination.

*
The authors’ comments on this situation appear on page 504.

Sources: Dee Gill, “Get Healthy . . . Or Else,” Inc. Magazine, April 2006; “Health Insurance Cost,” The
National Coalition on Health Care, www.nchc.org/facts/cost.shtml (accessed May 2006); Henry J. Reske,
“Hot Docs: Healthcare Costs Put U.S. Workers and Companies at Global Disadvantage,” U.S. News &
World Report, posted March 13, 2009.

Your Boss Wants to Know If You Ran Today

468

About the Numbers*

* For employers, the average cost of healthcare benefits per
employee is about $6,700 per year.

* The rate of increase of employer healthcare costs has slowed
somewhat as employers raised the employee share of premiums
and raised deductibles (the amount of a bill that the employee
pays before insurance coverage begins).

* In 2008, it is estimated that the percentage of persons that did
not have health insurance was 14.5% (43.3 million) for persons
of all ages. Approximately 19.4% of persons under 65 years of
age were covered by public health plans, and 65.5% were
covered by private insurance.

* Government is expected to become the largest source of funding
for health care by 2016 and is projected to pay more than half of
all national health spending by 2018.

* As a percentage of payroll, the employer cost of health benefits
has exploded over the past few decades. In addition, employer
health costs for manufacturing firms in the U.S., $2.38 per worker
per hour, were much higher than the foreign trade-weighted
average of $0.96 per worker per hour in 2005. Employer health
costs make the U.S. less competitive than it could otherwise be.

* The costs and performance of America’s healthcare system are
putting workers and companies at a “significant disadvantage”
in the global marketplace. The Business Roundtable, whose
member companies provide healthcare plans for more than 35
million Americans, finds that compared with people in Canada,
Japan, Germany, the United Kingdom, and France, Americans
receive 23% less value from their healthcare system. When
compared with emerging competitors like Brazil, India, and
China, the U.S. receives 46% less value. This study finds that
for every $1 the U.S. spends on health care, its five leading
competitors spend $0.63, and the emerging competitors just
$0.15. The study also notes that “on the whole, our workforce is
not as healthy” as that of either group of competitors.

As the graph below shows, private health insurance, such as that provided by
employers, pays for less than half of healthcare costs in the U.S. If employers
continue to cut their healthcare benefits, more of the burden will shift to the
government or to individuals as out-of-pocket costs.

Source: Data for 2007, from Centers for Medicare and Medicaid Services, Office of the Actuary,
National Health Statistics Group.

Other
private
4.2%

The Nation’s Healthcare Dollar:
Where It Comes From*

Out-of-pocket
payments

14.3%

Medicaid
16.2%

* Does not add to 100% due to rounding.

Private health
insurance

36.2%

Other government
programs

7.3%

Medicare
21.8%

JWCL165_c10_444-505.qxd 7/20/09 4:10 PM Page 468

Comprehensive Do it! 469

Comprehensive

Snyder Software Inc. has successfully developed a new spreadsheet program. To produce and
market the program, the company needed $2 million of additional financing. On January 1, 2012,
Snyder borrowed money as follows.

1. Snyder issued $500,000, 11%, 10-year convertible bonds.The bonds sold at face value and pay
semiannual interest on January 1 and July 1. Each $1,000 bond is convertible into 30 shares of
Snyder’s $20 par value common stock.

2. Snyder issued $1 million, 10%, 10-year bonds at face value. Interest is payable semiannually
on January 1 and July 1.

3. Snyder also issued a $500,000, 12%, 15-year mortgage note payable. The terms provide for
semiannual installment payments of $36,324 on

June 30 and December 31.

Instructions
1. For the convertible bonds, prepare journal entries for:

(a) The issuance of the bonds on January 1,

2012.

(b) Interest expense on July 1 and

December 31, 2012.

(c) The payment of interest on January 1, 2013.
(d) The conversion of all bonds into common stock on January 1, 2013, when the market

value of the common stock was $67 per share.

2. For the 10-year, 10% bonds:
(a) Journalize the issuance of the bonds on January 1, 2012.
(b) Prepare the journal entries for interest expense in 2012. Assume no accrual of interest on

July 1.
(c) Prepare the entry for the redemption of the bonds at 101 on January 1, 2015, after paying

the interest due on this date.

3. For the mortgage note payable:
(a) Prepare the entry for the issuance of the note on January 1, 2012.
(b) Prepare a payment schedule for the first four installment payments.
(c) Indicate the current and noncurrent amounts for the mortgage note payable at

December 31, 2012.

Solution to Comprehensive Do it!

Do it!

1. (a) 2012
Jan. 1 Cash 500,000

Bonds Payable 500,000
(To record issue of 11%, 10-year
convertible bonds at face value)

(b) 2012
July 1 Bond Interest Expense 27,500

Cash ($500,000 � 0.055) 27,500
(To record payment of semiannual
interest)

Dec. 31 Bond Interest Expense 27,500
Bond Interest Payable 27,500

(To record accrual of semiannual
interest)

Cash 27,500
(To record payment of accrued
interest)

Action plan

• Compute interest semiannually
(six months).

• Record the accrual and payment
of interest on appropriate dates.

• Record the conversion of the
bonds into common stock by
removing the book (carrying)
value of the bonds from the
liability account.

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470 Chapter 10 Liabilities

(d) Jan. 1 Bonds Payable 500,000
Common Stock 300,000*
Paid-in Capital in Excess of Par Value 200,000

(To record conversion of bonds into
common stock)
*($500,000 � $1,000 � 500 bonds;
500 � 30 � 15,000 shares;
15,000 � $20 � $300,000)

2. (a) 2012
Jan. 1 Cash 1,000,000

Bonds Payable 1,000,000
(To record issuance of bonds)

(b) 2012
July 1 Bond Interest Expense 50,000

Cash 50,000
(To record payment of semiannual
interest)

Dec. 31 Bond Interest Expense 50,000
Bond Interest Payable 50,000

(To record accrual of semiannual
interest)

Loss on Bond Redemption 10,000*
Cash 1,010,000

(To record redemption of bonds
at 101)
*($1,010,000 � $1,000,000)

3. (a) 2012
Jan. 1 Cash 500,000

Mortgage Notes Payable 500,000
(To record issuance of mortgage note
payable)

(b) Semiannual (A) (B) (C) (D)
Interest Cash Interest Reduction Principal
Period Payment Expense of Principal Balance

Issue date $500,000
1 $36,324 $30,000 $6,324 493,676
2 36,324 29,621 6,703 486,973
3 36,324 29,218 7,106 479,867
4 36,324 28,792 7,532 472,335

Action Plan

• Record the issuance of the
bonds.

• Compute interest expense for
each period.

• Compute the loss on bond
redemption as the excess of the
cash paid over the carrying
value of the redeemed bonds.

Action Plan

• Compute periodic interest
expense on a mortgage note,
recognizing that as the principal
amount decreases, so does the
interest expense.

• Record mortgage payments,
recognizing that each payment
consists of (1) interest on the
unpaid loan balance and (2) a
reduction of the loan principal.

The Navigator✓

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Glossary 471

1 Explain a current liability, and identify the major types
of current liabilities. A current liability is a debt that can
reasonably be expected to be paid (1) from existing current
assets or through the creation of other current liabilities,
and (2) within one year or the operating cycle, whichever is
longer. The major types of current liabilities are notes
payable, accounts payable, sales taxes payable, unearned
revenues, and accrued liabilities such as taxes, salaries and
wages, and interest payable.

2 Describe the accounting for notes payable. When a
promissory note is interest-bearing, the amount of assets
received upon the issuance of the note is generally equal to
the face value of the note. Interest expense is accrued over
the life of the note.At maturity, the amount paid is equal to
the face value of the note plus accrued interest.

3 Explain the accounting for other current liabilities.
Sales taxes payable are recorded at the time the related
sales occur.The company serves as a collection agent for the
taxing authority. Sales taxes are not an expense to the
company. Until employee withholding taxes are remitted to
governmental taxing authorities, they are credited to appro-
priate liability accounts. Unearned revenues are initially
recorded in an unearned revenue account.As the revenue is
earned, a transfer from unearned revenue to earned revenue
occurs. The current maturities of long-term debt should be
reported as a current liability in the balance sheet.

4 Explain why bonds are issued, and identify the types
of bonds. Bonds may be sold to many investors, and they
offer the following advantages over common stock:
(a) stockholder control is not affected, (b) tax savings
result, and (c) earnings per share of common stock may be
higher. The following different types of bonds may be
issued: secured and unsecured bonds, term and serial

bonds, registered and bearer bonds, convertible and
callable bonds.

5 Prepare the entries for the issuance of bonds and in-
terest expense. When bonds are issued, Cash is debited
for the cash proceeds, and Bonds Payable is credited for the
face value of the bonds. The account Premium on Bonds
Payable is used to show a bond premium; Discount on
Bonds Payable is used to show a bond discount.

6 Describe the entries when bonds are redeemed or
converted. When bonds are redeemed at maturity, Cash
is credited and Bonds Payable is debited for the face value
of the bonds. When bonds are redeemed before maturity,
it is necessary to (a) eliminate the carrying value of the
bonds at the redemption date, (b) record the cash paid, and
(c) recognize the gain or loss on redemption. When bonds
are converted to common stock, the carrying (or book)
value of the bonds is transferred to appropriate paid-in
capital accounts; no gain or loss is recognized.

7 Describe the accounting for long-term notes payable.
Each payment consists of (1) interest on the unpaid bal-
ance of the loan and (2) a reduction of loan principal. The
interest decreases each period, while the portion applied to
the loan principal increases.

8 Identify the methods for the presentation and analysis
of long-term liabilities. The nature and amount of each
long-term debt should be reported in the balance sheet or
in the notes accompanying the financial statements.
Stockholders and long-term creditors are interested in a
company’s long-run solvency. Debt to total assets and times
interest earned are two ratios that provide information
about debt-paying ability and long-run solvency.

SUMMARY OF STUDY OBJECTIVES

The Navigator✓

Bearer (coupon) bonds Bonds not registered. (p. 455).

Bond certificate A legal document that indicates the name
of the issuer, the face value of the bonds, and such other
data as the contractual interest rate and maturity date of
the bonds. (p. 455).

Bond discount The amount by which a bond sells at less
than its face value. (p. 459).

Bond indenture A legal document that sets forth the terms
of the bond issue. (p. 455).

Bond premium The amount by which a bond sells above its
face value. (p. 459).

Bonds A form of interest-bearing notes payable issued
by corporations, universities, and governmental entities.
(p. 453).

Callable bonds Bonds that are subject to retirement at a
stated dollar amount prior to maturity at the option of the
issuer. (p. 455).

Contractual interest rate Rate used to determine the
amount of interest the borrower pays and the investor
receives. (p. 455).

Convertible bonds Bonds that permit bondholders to con-
vert them into common stock at their option. (p. 455).

Current liabilities Debts that a company reasonably ex-
pects to pay from existing current assets within the next
year or operating cycle. (p. 446).

Current ratio A measure of a company’s liquidity; computed
as current assets divided by current liabilities. (p. 453).

Debenture bonds Bonds issued against the general credit
of the borrower. Also called unsecured bonds. (p. 455).

Debt to total assets ratio A solvency measure that indi-
cates the percentage of total assets provided by creditors;
computed as total debt divided by total assets. (p. 466).

Face value Amount of principal the issuer must pay at the
maturity date of the bond. (p. 455).

GLOSSARY

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Long-term liabilities Obligations expected to be paid after
one year. (p. 453).

Market interest rate The rate investors demand for loan-
ing funds to the corporation. (p. 457).

Mortgage bond A bond secured by real estate. (p. 455).

Mortgage note payable A long-term note secured by a
mortgage that pledges title to specific assets as security for
a loan. (p. 464).

Notes payable Obligations in the form of written promis-
sory notes. (p. 447).

Registered bonds Bonds issued in the name of the owner.
(p. 455).

Secured bonds Bonds that have specific assets of the issuer
pledged as collateral. (p. 455).

472 Chapter 10 Liabilities

Serial bonds Bonds that mature in installments. (p. 455).

Sinking fund bonds Bonds secured by specific assets set
aside to retire them. (p. 455).

Term bonds Bonds that mature at a single specified future
date. (p. 455).

Times interest earned ratio A solvency measure that indi-
cates a company’s ability to meet interest payments; com-
puted by dividing income before income taxes and interest
expense by interest expense. (p. 466).

Unsecured bonds Bonds issued against the general credit
of the borrower. Also called debenture bonds. (p. 455).

Working capital A measure of a company’s liquidity; com-
puted as current assets minus current liabilities. (p. 452).

Congratulations! You have a winning lottery ticket and the state has provided you
with three possible options for payment. They are:

1. Receive $10,000,000 in three years.
2. Receive $7,000,000 immediately.
3. Receive $3,500,000 at the end of each year for three years.

Which of these options would you select? The answer is not easy to determine at a
glance. To make a dollar-maximizing choice, you must perform present value com-
putations. A present value computation is based on the concept of time value of
money. Time value of money concepts are useful for the lottery situation and for
pricing other amounts to be received in the future. This appendix discusses how to
use present value concepts to price bonds. It also will tell you how to determine
what option you should take as a lottery winner.

Present Value of Face Value
To illustrate present value concepts, assume that you are willing to invest a
sum of money that will yield $1,000 at the end of one year. In other words,
what amount would you need to invest today to have $1,000 one year from
now? If you want to earn 10%, the investment (or present value) is

$909.09

($1,000 � 1.10). Illustration 10A-1 shows the computation.

APPENDIX 10A Present Value Concepts Related
to Bond Pricing

Compute the market price of a
bond.

S T U D Y O B J E C T I V E 9

Present Value � (1 � Interest Rate) � Future Amount
Present value � (1 � 10%) � $1,000
Present value � $1,000 � 1.10
Present value � $909.09

The future amount ($1,000), the interest rate (10%), and the number of periods
(1) are known. We can depict the variables in this situation as shown in the time
diagram in Illustration 10A-2.

Illustration 10A-1
Present value computation—
$1,000 discounted at 10%
for one year

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If you are to receive the single future amount of $1,000 in two years, discounted at
10%, its present value is $826.45 [($1,000 � 1.10) � 1.10], depicted as follows.

Appendix 10A Present Value Concepts Related to Bond Pricing 473

We also can determine the present value of 1 through tables that show the
present value of 1 for n periods. In Table 10A-1 below, n is the number of discount-
ing periods involved. The percentages are the periodic interest rates, and the five-
digit decimal numbers in the respective columns are the factors for the present
value of 1.

When using Table 10A-1, we multiply the future amount by the present value
factor specified at the intersection of the number of periods and the interest rate.
For example, the present value factor for 1 period at an interest rate of 10% is .90909,
which equals the $909.09 ($1,000 � .90909) computed in Illustration 10A-1.

i = 10%

n = 1 year

Present
Value (?)

$909.09

Future
Amount

$1,000
i = 10%
1
Present
Value (?)
0
Future
Amount

2
n = 2 years$826.45 $1,000

TABLE 10A-1
Present Value of 1

(n)
Periods 4% 5% 6% 8% 9% 10% 11% 12% 15%

1 .96154 .95238 .94340 .92593 .91743 .90909 .90090 .89286 .86957
2 .92456 .90703 .89000 .85734 .84168 .82645 .81162 .79719 .75614
3 .88900 .86384 .83962 .79383 .77218 .75132 .73119 .71178 .65752
4 .85480 .82270 .79209 .73503 .70843 .68301 .65873 .63552 .57175
5 .82193 .78353 .74726 .68058 .64993 .62092 .59345 .56743 .49718

6 .79031 .74622 .70496 .63017 .59627 .56447 .53464 .50663 .43233
7 .75992 .71068 .66506 .58349 .54703 .51316 .48166 .45235 .37594
8 .73069 .67684 .62741 .54027 .50187 .46651 .43393 .40388 .32690
9 .70259 .64461 .59190 .50025 .46043 .42410 .39092 .36061 .284

10 .67556 .61391 .55839 .46319 .42241 .38554 .35218 .32197 .24719

Illustration 10A-3
Finding present value if
discounted for two periods

Illustration 10A-2
Finding present value if
discounted for one period

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The present value in this situation may be computed as follows.

474 Chapter 10 Liabilities

$10,000,000 � PV of 1 due in 3 years at 9% �
$10,000,000 � .77218 (Table 10A-1) $7,721,800

Amount to be received from state immediately 7,000,000

Difference $ 721,800

What this computation shows you is that you would be $721,800 better off receiv-
ing the $10,000,000 at the end of three years rather than taking $7,000,000 imme-
diately.

Present Value of Interest Payments (Annuities)
In addition to receiving the face value of a bond at maturity, an investor also receives
periodic interest payments over the life of the bonds. These periodic payments are
called annuities.

In order to compute the present value of an annuity, we need to know: (1) the
interest rate, (2) the number of interest periods, and (3) the amount of the periodic
receipts or payments.To illustrate the computation of the present value of an annu-
ity, assume that you will receive $1,000 cash annually for three years and the inter-
est rate is 10%. The time diagram in Illustration 10A-5 depicts this situation.

Present Value of 1
Future Amount � Factor at 10% � Present Value

$1,000 (1 year away) .90909 $ 909.09
1,000 (2 years away) .82645 826.45
1,000 (3 years away) .75132 751.32

2.48686 $2,486.86

i = 10%

2Now 3 years

PV = ? $1,000 $1,000$1,000

1
n = 3

We also can use annuity tables to value annuities. As illustrated in Table 10A-2,
these tables show the present value of 1 to be received periodically for a given
number of periods.

For two periods at an interest rate of 10%, the present value factor is .82645, which
equals the $826.45 ($1,000 � .82645) computed previously.

Let’s now go back to our lottery example. Given the present value concepts
just learned, we can determine whether receiving $10,000,000 in three years is
better than receiving $7,000,000 today, assuming the appropriate discount rate is
9%. The computation is as follows.

Illustration 10A-4
Present value of $10,000,000
to be received in three years

Illustration 10A-5
Time diagram for a
three-year annuity

Illustration 10A-6
Present value of a series of
future amounts computation

JWCL165_c10_444-505.qxd 7/20/09 4:10 PM Page 474

From Table 10A-2 you can see that the present value factor of an annuity of
1 for three periods at 10% is 2.48685.2 This present value factor is the total of the
three individual present value factors as shown in Illustration 10A-6.Applying this
amount to the annual cash flow of $1,000 produces a present value of $2,486.85.

Let’s now go back to our lottery example. We determined that you would get
more money if you wait and take the $10,000,000 in three years rather than take
$7,000,000 immediately. But there is still another option—to receive $3,500,000 at
the end of each year for three years (an annuity). The computation to evaluate this
option (again assuming a 9% discount rate) is as follows.

Appendix 10A Present Value Concepts Related to Bond Pricing 475

2The difference of .00001 between 2.48686 and 2.48685 is due to rounding.

TABLE 10A-2
Present Value of an Annuity of 1

(n)
Periods 4% 5% 6% 8% 9% 10% 11% 12% 15%

1 .96154 .95238 .94340 .92593 .91743 .90909 .90090 .89286 .86957
2 1.88609 1.85941 1.83339 1.78326 1.75911 1.73554 1.71252 1.69005 1.62571
3 2.77509 2.72325 2.67301 2.57710 2.53130 2.48685 2.44371 2.40183 2.28323
4 3.62990 3.54595 3.46511 3.31213 3.23972 3.16986 3.10245 3.03735 2.85498
5 4.45182 4.32948 4.21236 3.99271 3.88965 3.79079 3.69590 3.60478 3.35216

6 5.24214 5.07569 4.91732 4.62288 4.48592 4.35526 4.23054 4.11141 3.78448
7 6.00205 5.78637 5.58238 5.20637 5.03295 4.86842 4.71220 4.56376 4.16042
8 6.73274 6.46321 6.20979 5.74664 5.53482 5.33493 5.14612 4.96764 4.48732
9 7.43533 7.10782 6.80169 6.24689 5.99525 5.75902 5.53705 5.32825 4.77158

10 8.11090 7.72173 7.36009 6.71008 6.41766 6.14457 5.88923 5.65022 5.01877

$3,500,000 � PV of 1 due yearly for 3 years at 9% �
$3,500,000 � 2.53130 (Table 10A-2) $8,859,550

Present value of $10,000,000 to be received in 3 years 7,721,800

Difference $1,137,750

If you take the annuity of $3,500,000 for each of three years, you will be $1,137,750
richer as a result.

Time Periods and Discounting
We have used an annual interest rate to determine present value. Present value com-
putations may also be done over shorter periods of time, such as monthly, quarterly,
or semiannually.When the time frame is less than one year, it is necessary to convert
the annual interest rate to the shorter time frame.

Assume, for example, that the investor in Illustration 10A-6 received $500
semiannually for three years instead of $1,000 annually. In this case, the number of
periods becomes six (3 � 2), the interest rate is 5% (10% � 2), the present value
factor from Table 10A-2 is 5.07569, and the present value of the future cash flows is
$2,537.85 (5.07569 � $500). This amount is slightly higher than the $2,486.86 com-
puted in Illustration 10A-6 because interest is computed twice during the same
year. That is, interest is earned on the first half year’s interest.

Illustration 10A-7
Present value of lottery
payments to be received
over three years

JWCL165_c10_444-505.qxd 7/20/09 4:10 PM Page 475

Computing the Present Value of a Bond
The present value (or market price) of a bond is a function of three variables: (1) the
payment amounts, (2) the length of time until the amounts are paid, and (3) the in-
terest (discount) rate.

The first variable (dollars to be paid) is made up of two elements: (1) a series
of interest payments (an annuity), and (2) the principal amount (a single sum). To
compute the present value of the bond, we must discount both the interest pay-
ments and the principal amount.

When the investor’s interest (discount) rate is equal to the bond’s contractual
interest rate, the present value of the bonds will equal the face value of the bonds.
To illustrate, assume a bond issue of 10%, five-year bonds with a face value of
$100,000 with interest payable semiannually on January 1 and July 1. If the discount
rate is the same as the contractual rate, the bonds will sell at face value. In this case,
the investor will receive: (1) $100,000 at maturity and (2) a series of ten $5,000 in-
terest payments [$100,000 � (10% � 2)] over the term of the bonds. The length of
time is expressed in terms of interest periods (in this case, 10) and the discount rate
per interest period (5%). The time diagram in Illustration 10A-8 below depicts the
variables involved in this discounting situation.

476 Chapter 10 Liabilities

i = 5%

Present
Value
(?)

Now

Principal
Amount
$100,000

Diagram
for

Principal
5 6

1
Present
Value
(?)

Now 10

Diagram
for

Interest
5 6

i = 5%

$5,000

2
2
3
3
4
4
7
7
8
8
9
9

$5,000 $5,000 $5,000 $5,000$5,000 $5,000 $5,000 $5,000

n = 10

n = 10
$5,000

Interest
Payments

The computation of the present value of Candlestick’s bonds, assuming they were
issued at face value (page 458), is shown below.

10% Contractual Rate—10% Discount Rate

Present value of principal to be received at maturity
$100,000 � PV of 1 due in 10 periods at 5%
$100,000 � .61391 (Table 10A-1) $ 61,391

Present value of interest to be received periodically
over the term of the bonds

$5,000 � PV of 1 due periodically for 10 periods at 5%
$5,000 � 7.72173 (Table 10A-2) 38,609*

Present value of bonds $100,000

*Rounded.

Illustration 10A-8
Time diagram for the
present value of a 10%,
five-year bond paying
interest semiannually

Illustration 10A-9
Present value of principal
and interest (face value)

JWCL165_c10_444-505.qxd 7/20/09 4:10 PM Page 476

Now assume that the investor’s required rate of return is 12%, not 10%. The
future amounts are again $100,000 and $5,000, respectively. But now we must use a
discount rate of 6% (12% � 2). The present value of Candlestick’s bonds issued at
a discount (page 460) is $92,639 as computed below.

Appendix 10B Effective-Interest Method of Bond Amortization 477

If the discount rate is 8% and the contractual rate is 10%, the present value of
Candlestick’s bonds issued at a premium (page 461) is $108,111 as computed below.

10% Contractual Rate—12% Discount Rate

Present value of principal to be received at maturity
$100,000 � .55839 (Table 10A-1) $55,839

Present value of interest to be received periodically
over the term of the bonds

$5,000 � 7.36009 (Table 10A-2) 36,800

Present value of bonds $92,639

10% Contractual Rate—8% Discount Rate

Present value of principal to be received at maturity
$100,000 � .67556 (Table 10A-1) $ 67,556

Present value of interest to be received periodically
over the term of the bonds

$5,000 � 8.11090 (Table 10A-2) 40,555

Present value of bonds $108,111

Illustration 10A-10
Present value of principal
and interest (discount)

Illustration 10A-11
Present value of principal
and interest (premium)

9 Compute the market price of a bond. Time value of
money concepts are useful for pricing bonds. The present
value (or market price) of a bond is a function of three

variables: (1) the payment amounts, (2) the length of time
until the amounts are paid, and (3) the interest rate.

SUMMARY OF STUDY OBJECTIVE FOR APPENDIX 10A

APPENDIX 10B Effective-Interest Method
of Bond Amortization
Under the effective-interest method, the amortization of bond discount
or bond premium results in periodic interest expense equal to a constant
percentage of the carrying value of the bonds. The effective-interest
method results in varying amounts of amortization and interest expense
per period but a constant percentage rate.

The following steps are required under the effective-interest method.

1. Compute the bond interest expense.To do so, multiply the carrying value of the
bonds at the beginning of the interest period by the effective-interest rate.

2. Compute the bond interest paid (or accrued). To do so, multiply the face value
of the bonds by the contractual interest rate.

3. Compute the amortization amount.To do so, determine the difference between
the amounts computed in steps (1) and (2).

Apply the effective-interest
method of bond discount and
bond premium.

S T U D Y O B J E C T I V E 1 0

JWCL165_c10_444-505.qxd 8/7/09 4:06 PM Page 477

(1) (2) (3)
Bond Interest Expense Bond Interest Paid

Carrying Value
of Bonds Effective-

�
Face Contractual

� Amortizationat Beginning Interest Amount Interest Amount
of Period Rate of Bonds Rate

� �

��

Illustration 10B-1 depicts these steps.

478 Chapter 10 Liabilities

When the difference between the straight-line method of amortization
(Appendix 10C) and the effective-interest method is material, GAAP requires the
use of the effective-interest method.

Amortizing Bond Discount
To illustrate the effective-interest method of bond discount amortization, assume
that Candlestick, Inc. issues $100,000 of 10%, five-year bonds on January 1, 2011,
with interest payable each July 1 and January 1 (page 460). The bonds sell for
$92,639 (92.639% of face value). This sales price results in bond discount of

$7,361

($100,000 � $92,639) and an effective-interest rate of 12%. A bond discount
amortization schedule, as shown in Illustration 10B-2, facilitates the recording of

Illustration 10B-1
Computation of
amortization—effective-
interest method

Illustration 10B-2
Bond discount amortization
schedule

Semiannual
Interest
Periods

A B C D E F

Column (A) remains constant because the face value of the bonds ($100,000) is multiplied by the semiannual contractual interest rate

(5%) each period.

Column (B) is computed as the preceding bond carrying value times the semiannual effective-interest rate (6%).

Column (C) indicates the discount amortization each period.

Column (D) decreases each period until it reaches zero at maturity.

Column (E) increases each period until it equals face value at maturity.

*$2 difference due to rounding.

1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24

CANDLESTICK, INC.
Bond Discount Amortization

Effective-Interest Method—Semiannual Interest Payments
10% Bonds Issued at 12%

(D)
Unamortized

Discount
(D) � (C)

(E)
Bond

Carrying Value
($100,000 � D)

Issue date

1
2
3
4
5
6
7
8
9
10
$7,361

6,803

6,211

5,584

4,919

4,214

3,467

2,675

1,835

945

–0–

$92,639

93,197

93,789

94,416

95,081

95,786

96,533

97,325

98,165

99,055

100,000

(A)
Interest to

Be Paid
(5% � $100,000)

(B)
Interest Expense
to Be Recorded

(6% � Preceding Bond
Carrying Value)

Amortization
(B) � (A)

$ 558

592

627

665

705

747

792

840

890

945

$7,361

$ 5,000

5,000
5,000
5,000
5,000
5,000
5,000
5,000
5,000
5,000
$50,000

(6% � $92,639)

(6% � $93,197)

(6% � $93,789)

(6% � $94,416)

(6% � $95,081)

(6% � $95,786)

(6% � $96,533)

(6% � $97,325)

(6% � $98,165)

(6% � $99,055)

$ 5,558

5,592

5,627

5,665

5,705

5,747

5,792

5,840

5,890

5,945

$57,361
*

File Edit View Insert Format Tools Data Window Help

Candlestick Inc.xls

JWCL165_c10_444-505.qxd 8/11/09 4:29 PM Page 478

interest expense and the discount amortization. Note that interest expense as a per-
centage of carrying value remains constant at 6%.

We have highlighted columns (A), (B), and (C) in the amortization schedule
to emphasize their importance. These three columns provide the numbers for
each period’s journal entries. They are the primary reason for preparing the
schedule.

For the first interest period, the computations of bond interest expense and the
bond discount amortization are:

Appendix 10B Effective-Interest Method of Bond Amortization 479

Bond interest expense ($92,639 � 6%) $5,558
Contractual interest ($100,000 � 5%) 5,000

Bond discount amortization $ 558

Illustration 10B-3
Computation of bond
discount amortization

Candlestick records the payment of interest and amortization of bond discount
on July 1, 2011, as follows.

July 1 Bond Interest Expense 5,558
Discount on Bonds Payable 558
Cash 5,000

(To record payment of bond interest
and amortization of bond discount)

For the second interest period, bond interest expense will be $5,592 ($93,197 �
6%), and the discount amortization will be $592. At December 31, Candlestick
makes the following adjusting entry.

Dec. 31 Bond Interest Expense 5,592
Discount on Bonds Payable 592
Bond Interest Payable 5,000

(To record accrued bond interest
and amortization of bond discount)

Total bond interest expense for 2011 is $11,150 ($5,558 � $5,592). On January 1,
Candlestick records payment of the interest by a debit to Bond Interest Payable
and a credit to Cash.

Amortizing Bond Premium
The amortization of bond premium by the effective-interest method is similar
to the procedures described for bond discount. For example, assume that
Candlestick, Inc. issues $100,000, 10%, five-year bonds on January 1, 2011, with
interest payable on July 1 and January 1 (page 461). In this case, the bonds sell for
$108,111. This sales price results in bond premium of $8,111 and an effective-
interest rate of 8%. Illustration 10B-4 on the next page shows the bond premium
amortization schedule.

H E L P F U L H I N T
When a bond sells for
$108,111, it is quoted as
108.111% of face value.
Note that $108,111 can
be proven as shown in
Appendix 10A.

Cash Flows
�5,000

A SEL� �

�5,558 Exp
�558

�5,000
Cash Flows
no effect
A SEL� �

�5,592 Exp
�592

�5,000

JWCL165_c10_444-505.qxd 7/20/09 4:10 PM Page 479

Candlestick records payments on the first interest date as follows.

480 Chapter 10 Liabilities

Semiannual
Interest
Periods
A B C D E F
Column (A) remains constant because the face value of the bonds ($100,000) is multiplied by the semiannual contractual interest rate
(5%) each period.

Column (B) is computed as the carrying value of the bonds times the semiannual effective-interest rate (4%).

Column (C) indicates the premium amortization each period.

Column (D) decreases each period until it reaches zero at maturity.

Column (E) decreases each period until it equals face value at maturity.

*$2 difference due to rounding.
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30

CANDLESTICK, INC.
Bond Premium Amortization

Effective-Interest Method—Semiannual Interest Payments
10% Bonds Issued at 8%

(E)
Bond
Carrying Value
($100,000 � D)
$108,111

107,435

6,732

6,001

105,241

4,451

3,629

2,774

1,885

100,

960

100,000

(4% � $108,111)

(4% � $107,435)

(4% � $106,732)

(4% � $106,001)

(4% � $105,241)

(4% � $104,451)

(4% � $103,629)

(4% � $102,774)

(4% � $101,885)

(4% � $100,960)

(A)
Interest to Be Paid
(5% � $100,000)
(B)
Interest Expense
to Be Recorded

(4% � Preceding Bond
Carrying Value)

Amortization
(A) � (B)

$ 676

703

731

760

790

822

855

889

925

960

$8,111

$ 5,000
5,000
5,000
5,000
5,000
5,000
5,000
5,000
5,000
5,000
$50,000

$ 4,324

4,297

4,269

4,240

4,210

4,178

4,145

4,111

4,075

4,040

$41,889
*
(D)
Unamortized

Premium
(D) � (C)

$8,111

7,435

6,732
6,001

5,241

4,451
3,629
2,774
1,885
960
–0–
Issue date
1
2
3
4
5
6
7
8
9
10

File Edit View Insert Format Tools Data Window Help

Candlestick Inc.xls

July 1 Bond Interest Expense 4,324
Premium on Bonds Payable 676

Cash 5,000
(To record payment of bond interest
and amortization of bond premium)

For the second interest period, interest expense will be $4,297, and the premium
amortization will be $703. Total bond interest expense for 2011 is $8,621 ($4,324 �
$4,297).

For the first interest period, the computations of bond interest expense and the
bond premium amortization are:

Bond interest expense ($108,111 � 4%) $4,324
Contractual interest ($100,000 � 5%) 5,000

Bond premium amortization $ 676

Illustration 10B-4
Bond premium amortization
schedule

Illustration 10B-5
Computation of bond
premium amortization

Cash Flows
�5,000
A SEL� �

�4,324 Exp
�676

�5,000

JWCL165_c10_444-505.qxd 8/11/09 4:59 PM Page 480

Appendix 10C Straight-Line Amortization 481

Gardner Corporation issues $1,750,000, 10-year, 12% bonds on January 1, 2011, at $1,820,000, to
yield 10%. The bonds pay semiannual interest July 1 and January 1. Gardner uses the effective-
interest method of amortization.

Instructions
(a) Prepare the journal entry to record the issuance of the bonds.
(b) Prepare the journal entry to record the payment of interest on July 1, 2011.

Solution

Do it!Comprehensive for Appendix 10B

Action Plan

• Compute interest expense by
multiplying bond carrying value
at the beginning of the period
by the effective-interest rate.

• Compute credit to cash (or bond
interest payable) by multiplying
the face value of the bonds by
the contractual interest rate.

• Compute bond premium or
discount amortization, which is
the difference between interest
expense and cash paid.

• Understand that interest
expense decreases when the
effective-interest method is
used for bonds issued at a
premium. The reason is that a
constant percentage is applied
to a decreasing book value to
compute interest expense.

(a) 2011
Jan. 1 Cash 1,820,000

Bonds Payable 1,750,000
Premium on Bonds Payable 70,000

(To record issuance of bonds at
a premium)

(b) 2011
July 1 Bond Interest Expense 91,000*

Premium on Bonds Payable 14,000**
Cash 105,000

(To record payment of semiannual
interest and amortization of bond
premium)
*($1,820,000 � 5%)
**($105,000 � $91,000)

The Navigator✓

10 Apply the effective-interest method bond discount
and bond premium. The effective-interest method
results in varying amounts of amortization and interest
expense per period but a constant percentage rate of interest.

When the difference between the straight-line and
effective-interest method is material, GAAP requires the
use of the effective-interest method.

SUMMARY OF STUDY OBJECTIVE FOR APPENDIX 10B

Effective-interest method of amortization A method of
amortizing bond discount or bond premium that results in

periodic interest expense equal to a constant percentage of
the carrying value of the bonds. (p. 477).

GLOSSARY FOR APPENDIX 10B

APPENDIX 10C Straight-Line Amortization
Amortizing Bond Discount
To follow the matching principle, companies should allocate bond dis-
count systematically to each period in which the bonds are outstanding.
The straight-line method of amortization allocates the same amount to

Apply the straight-line method of
amortizing bond discount and
bond premium.

S T U D Y O B J E C T I V E 1 1

JWCL165_c10_444-505.qxd 8/7/09 5:31 PM Page 481

In the Candlestick, Inc. example (page 460), the company sold $100,000, five-
year, 10% bonds on January 1, 2011, for $92,639. This price resulted in a $7,361
bond discount ($100,000 � $92,639). Interest is payable on July 1 and January 1.
The bond discount amortization for each interest period is $736 ($7,361 � 10).
Candlestick records the payment of bond interest and the amortization of bond
discount on the first interest date (July 1, 2011) as follows.

482 Chapter 10 Liabilities

July 1 Bond Interest Expense 5,736
Discount on Bonds Payable 736
Cash 5,000

(To record payment of bond interest and
amortization of bond discount)

At December 31, Candlestick makes the following adjusting entry.

Dec. 31 Bond Interest Expense 5,736
Discount on Bonds Payable 736
Bond Interest Payable 5,000

(To record accrued bond interest and
amortization of bond discount)

Over the term of the bonds, the balance in Discount on Bonds Payable will de-
crease annually by the same amount until it has a zero balance at the maturity date
of the bonds. Thus, the carrying value of the bonds at maturity will be equal to the
face value.

It is useful to prepare a bond discount amortization schedule as shown in
Illustration 10C-2 (page 483).The schedule shows interest expense, discount amor-
tization, and the carrying value of the bond for each interest period. As indicated,
the interest expense recorded each period for the Candlestick bond is $5,736. Also
note that the carrying value of the bond increases $736 each period until it reaches
its face value $100,000 at the end of period 10.

Bond Number Bond

Discount � of Interest � Discount
Periods Amortization

Illustration 10C-1
Formula for straight-line
method of bond discount
amortization

interest expense in each interest period. The amount is determined using the for-
mula in Illustration 10C-1.

Cash Flows
�5,000
A SEL� �

�5,736 Exp
�736

�5,000
Cash Flows
no effect
A SEL� �
�5,736 Exp
�736
�5,000

JWCL165_c10_444-505.qxd 7/20/09 4:10 PM Page 482

Amortizing Bond Premium
The amortization of bond premium parallels that of bond discount. Illustration
10C-3 presents the formula for determining bond premium amortization under the
straight-line method.

Appendix 10C Straight-Line Amortization 483

Semiannual
Interest
Periods
A B C D E F

Column (A) remains constant because the face value of the bonds ($100,000) is multiplied by the
semiannual contractual interest rate (5%) each period.
Column (B) is computed as the interest paid (Column A) plus the discount amortization (Column C).
Column (C) indicates the discount amortization each period.
Column (D) decreases each period by the same amount until it reaches zero at maturity.
Column (E) increases each period by the same amount of discount amortization until it equals the
face value at maturity.
*One dollar difference due to rounding.

1
2
3
4
5
6
7
8
9

10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29

CANDLESTICK, INC.
Bond Discount Amortization

Straight-Line Method—Semiannual Interest Payments

Issue date

(A)
Interest to

Be Paid
(5% � $100,000)

$ 5,000
5,000
5,000
5,000
5,000
5,000
5,000
5,000
5,000
5,000

$50,000
(B)
Interest Expense
to Be Recorded

(A) � (C)

$ 5,736
5,736
5,736
5,736
5,736
5,736
5,736
5,736
5,736
5,737

$57,361
*
(C)
Discount

Amortization
($7,361 � 10)

$ 736
736
736
736
736
736
736
736
736
737

$7,361
*
(D)
Unamortized
Discount
(D) � (C)

$7,361
6,625
5,889
5,153
4,417
3,681
2,945
2,209
1,473

737
–0–

(E)
Bond
Carrying Value
($100,000 � D)

$ 92,639
93,375
94,111
94,847
95,583
96,319
97,055
97,791
98,527
99,263

100,000
1
2
3
4
5
6
7
8
9
10
File Edit View Insert Format Tools Data Window Help

Candlestick Inc.xls
Illustration 10C-2
Bond discount amortization
schedule

Bond Number Bond

Premium � of Interest � Premium
Periods Amortization

Illustration 10C-3
Formula for straight-line
method of bond premium
amortization

Continuing our example, assume that Candlestick sells the bonds for $108,111
(page 461), rather than $92,639.This sale price results in a bond premium of $8,111
($108,111 � $100,000). The bond premium amortization for each interest period is
$811 ($8,111 � 10). Candlestick records the first payment of interest on July 1 as
follows.

Cash Flows
�5,000
A SEL� �

�4,189 Exp
�811

�5,000

July 1 Bond Interest Expense 4,189
Premium on Bonds Payable 811

Cash 5,000
(To record payment of bond interest and
amortization of bond premium)

JWCL165_c10_444-505.qxd 8/11/09 5:00 PM Page 483

At December 31, the company makes the following adjusting entry.

Dec. 31 Bond Interest Expense 4,189
Premium on Bonds Payable 811

Bond Interest Payable 5,000
(To record accrued bond interest
and amortization of bond premium)

Over the term of the bonds, the balance in Premium on Bonds Payable will de-
crease annually by the same amount until it has a zero balance at maturity.

Illustration 10C-4 shows interest expense, premium amortization, and the car-
rying value of the bond. The interest expense recorded each period for the
Candlestick bond is $4,189.Also note that the carrying value of the bond decreases
$811 each period until it reaches its face value $100,000 at the end of period 10.

484 Chapter 10 Liabilities

Illustration 10C-4
Bond premium amortization
schedule

Semiannual
Interest
Periods
A B C D E F

Column (A) remains constant because the face value of the bonds ($100,000) is multiplied by the
semiannual contractual interest rate (5%) each period.
Column (B) is computed as the interest paid (Column A) less the premium amortization (Column C).
Column (C) indicates the premium amortization each period.
Column (D) decreases each period by the same amount until it reaches zero at maturity.
Column (E) decreases each period by the amount of premium amortization until it equals the face value at
maturity.
*One dollar difference due to rounding.

1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29

CANDLESTICK, INC.
Bond Premium Amortization
Straight-Line Method—Semiannual Interest Payments
(D)
Unamortized
Premium
(D) � (C)
(E)
Bond
Carrying Value
($100,000 � D)

Issue date $8,111
7,300
6,489
5,678
4,867
4,056
3,245
2,434
1,623

812
–0–

$108,111
107,300
106,489
105,678
104,867
104,056
103,245
102,434
101,623
100,812
100,000

(A)
Interest to
Be Paid
(5% � $100,000)
$ 5,000
5,000
5,000
5,000
5,000
5,000
5,000
5,000
5,000
5,000
$50,000
1
2
3
4
5
6
7
8
9
10
(B)
Interest Expense
to Be Recorded
(A) � (C)

$ 4,189
4,189
4,189
4,189
4,189
4,189
4,189
4,189
4,189
4,188

$41,889
*

Amortization
($8,111 � 10)

$ 811
811
811
811
811
811
811
811
811
812

$8,111
*

Candlestick Inc.xls
File Edit View Insert Format Tools Data Window Help

Comprehensive 10 for Appendix 10C

Glenda Corporation issues $1,750,000, 10-year, 12% bonds on January 1, 2011, for $1,820,000 to
yield 10%.The bonds pay semiannual interest July 1 and January 1. Glenda uses the straight-line
method of amortization.

Instructions
(a) Prepare the journal entry to record the issuance of the bonds.
(b) Prepare the journal entry to record the payment of interest on July 1, 2011.
Do it!
Action Plan

• Compute credit to Cash (or Bond
Interest Payable) by multiplying
the face value of the bonds by
the contractual interest rate.

Cash Flows
no effect
A SEL� �
�4,189 Exp
�811
�5,000

JWCL165_c10_444-505.qxd 8/11/09 5:01 PM Page 484

Self-Study Questions 485

11 Apply the straight-line method of amortizing bond
discount and bond premium. The straight-line method

of amortization results in a constant amount of amortiza-
tion and interest expense per period.

SUMMARY OF STUDY OBJECTIVE FOR APPENDIX 10C

Answers are at the end of the chapter.

1. The time period for classifying a liability as current is one
year or the operating cycle, whichever is:
a. longer. c. probable.
b. shorter. d. possible.

2. To be classified as a current liability, a debt must be ex-
pected to be paid:
a. out of existing current assets.
b. by creating other current liabilities.
c. within 2 years.
d. both (a) and (b).

3. Maggie Sharrer Company borrows $88,500 on September 1,
2011, from Sandwich State Bank by signing an $88,500,
12%, one-year note. What is the accrued interest at
December 31, 2011?
a. $2,655. c. $4,425.
b. $3,540. d. $10,620.

4. Becky Sherrick Company has total proceeds from sales
of $4,515. If the proceeds include sales taxes of 5%, the
amount to be credited to Sales is:
a. $4,000.
b. $4,300.
c. $4,289.25.
d. No correct answer given.

5. Employer payroll taxes do not include:
a. federal unemployment taxes.
b. state unemployment taxes.
c. federal income taxes.
d. FICA taxes.

6. Sensible Insurance Company collected a premium of
$18,000 for a 1-year insurance policy on April 1. What
amount should Sensible report as a current liability for
Unearned Insurance Premiums at December 31?
a. $0. c. $13,500.
b. $4,500. d. $18,000.

7. The term used for bonds that are unsecured is:
a. callable bonds.
b. indenture bonds.
c. debenture bonds.
d. bearer bonds.

8. Karson Inc. issues 10-year bonds with a maturity value
of $200,000. If the bonds are issued at a premium, this
indicates that:
a. the contractual interest rate exceeds the market interest rate.
b. the market interest rate exceeds the contractual interest rate.
c. the contractual interest rate and the market interest

rate are the same.
d. no relationship exists between the two rates.

SELF-STUDY

QUESTIONS

(SO 1)

(SO 2)

(SO 3)

(SO 3)
(SO 3)

(SO 4)

(SO 5)

Solution
(a) 2011
Jan. 1 Cash 1,820,000
Bonds Payable 1,750,000
Premium on Bonds Payable 70,000

(b) 2011
July 1 Bond Interest Expense 101,500**

Premium on Bonds Payable 3,500*
Cash 105,000

*$70,000 � 20
**$105,000 � $3,500

Action Plan (cont.)

• Compute bond premium or dis-
count amortization by dividing
bond premium or discount by
the total number of periods.

• Understand that interest ex-
pense decreases when bonds
are issued at a premium. The
reason is that the amortization
of a premium reduces the total
cost of borrowing.

The Navigator✓

Straight-line method of amortization A method of amor-
tizing bond discount or bond premium that results in allo-

cating the same amount to interest expense in each interest
period. (p. 481)

GLOSSARY FOR APPENDIX 10C

*Note: All asterisked Questions, Exercises, and Problems relate to material in the appendices to the chapter.

JWCL165_c10_444-505.qxd 8/7/09 4:14 PM Page 485

486 Chapter 10 Liabilities

9. Gester Corporation retires its $100,000 face value bonds
at 105 on January 1, following the payment of semiannual
interest. The carrying value of the bonds at the redemp-
tion date is $103,745. The entry to record the redemption
will include a:
a. credit of $3,745 to Loss on Bond Redemption.
b. debit of $3,745 to Premium on Bonds Payable.
c. credit of $1,255 to Gain on Bond Redemption.
d. debit of $5,000 to Premium on Bonds Payable.

10. Colson Inc. converts $600,000 of bonds sold at face value
into 10,000 shares of common stock, par value $1. Both the
bonds and the stock have a market value of $760,000.
What amount should be credited to Paid-in Capital in
Excess of Par as a result of the conversion?
a. $10,000.
b. $160,000.
c. $600,000.
d. $590,000.

11. Andrews Inc. issues a $497,000, 10% 3-year mortgage note
on January 1. The note will be paid in three annual install-
ments of $200,000, each payable at the end of the year.
What is the amount of interest expense that should be rec-
ognized by Andrews Inc. in the second year?
a. $16,567.
b. $49,700.
c. $34,670.
d. $346,700.

12. Howard Corporation issued a 20-year mortgage note
payable on January 1, 2011. At December 31, 2011, the
unpaid principal balance will be reported as:
a. a current liability.
b. a long-term liability.
c. part current and part long-term liability.
d. interest payable.

13. For 2011, Corn Flake Corporation reported net income of
$300,000. Interest expense was $40,000 and income taxes
were $100,000. The times interest earned ratio was:
a. 3 times.
b. 4.4 times.
c. 7.5 times.
d. 11 times.

*14. The market price of a bond is dependent on:
a. the payment amounts.
b. the length of time until the amounts are paid.

c. the interest rate.
d. All of the above.

*15. On January 1, Besalius Inc. issued $1,000,000, 9% bonds
for $939,000.The market rate of interest for these bonds is
10%. Interest is payable annually on December 31.
Besalius uses the effective-interest method of amortizing
bond discount.At the end of the first year, Besalius should
report unamortized bond discount of:
a. $54,900.
b. $57,100.
c. $51,610.
d. $51,000.

*16. On January 1, Dias Corporation issued $1,000,000, 14%,
5-year bonds with interest payable on July 1 and January 1.
The bonds sold for $1,098,540. The market rate of interest
for these bonds was 12%. On the first interest date, using
the effective-interest method, the debit entry to Bond
Interest Expense is for:
a. $60,000.
b. $76,898.
c. $65,912.
d. $131,825.

*17. On January 1, Hurley Corporation issues $500,000, 5-year,
12% bonds at 96 with interest payable on July 1 and
January 1. The entry on July 1 to record payment of bond
interest and the amortization of bond discount using the
straight-line method will include a:
a. debit to Interest Expense $30,000.
b. debit to Interest Expense $60,000.
c. credit to Discount on Bonds Payable $4,000.
d. credit to Discount on Bonds Payable $2,000.

*18. For the bonds issued in question 17 above, what is the
carrying value of the bonds at the end of the third interest
period?
a. $486,000.
b. $488,000.
c. $472,000.
d. $464,000.

Go to the book’s companion website,
www.wiley.com/college/weygandt,
for Additional Self-Study Questions.

(SO 6)

(SO 6)
The Navigator✓

(SO 7)

(SO 8)

(SO 9)

(SO 10)

(SO 11)

1. Jill Loomis believes a current liability is a debt that can be
expected to be paid in one year. Is Jill correct? Explain.

2. Frederickson Company obtains $40,000 in cash by signing
a 9%, 6-month, $40,000 note payable to First Bank on July 1.
Frederickson’s fiscal year ends on September 30. What in-
formation should be reported for the note payable in the
annual financial statements?

3. (a) Your roommate says, “Sales taxes are reported as an
expense in the income statement.” Do you agree?
Explain.

(b) Planet Hollywood has cash proceeds from sales of
$7,400. This amount includes $400 of sales taxes. Give
the entry to record the proceeds.

4. Baylor University sold 10,000 season football tickets at
$80 each for its five-game home schedule. What entries
should be made (a) when the tickets were sold, and (b) after
each game?

5. What is liquidity? What are two measures of liquidity?
6. Identify three taxes commonly withheld by the employer

from an employee’s gross pay.

QUESTIONS

JWCL165_c10_444-505.qxd 8/7/09 4:15 PM Page 486

7. (a) What are long-term liabilities? Give three examples.
(b) What is a bond?

8. (a) As a source of long-term financing, what are the major
advantages of bonds over common stock? (b) What are
the major disadvantages in using bonds for long-term
financing?

9. Contrast the following types of bonds: (a) secured and
unsecured, (b) term and serial, (c) registered and bearer,
and (d) convertible and callable.

10. The following terms are important in issuing bonds:
(a) face value, (b) contractual interest rate, (c) bond inden-
ture, and (d) bond certificate. Explain each of these terms.

11. Describe the two major obligations incurred by a com-
pany when bonds are issued.

12. Assume that Koslowski Inc. sold bonds with a par value of
$100,000 for $104,000. Was the market interest rate equal
to, less than, or greater than the bonds’ contractual interest
rate? Explain.

13. If a 7%, 10-year, $800,000 bond is issued at par and inter-
est is paid semiannually, what is the amount of the interest
payment at the end of the first semiannual period?

14. If the Bonds Payable account has a balance of $900,000
and the Discount on Bonds Payable account has a balance
of $40,000, what is the carrying value of the bonds?

15. Which accounts are debited and which are credited if a
bond issue originally sold at a premium is redeemed be-
fore maturity at 97 immediately following the payment of
interest?

16. Henricks Corporation is considering issuing a convertible
bond.What is a convertible bond? Discuss the advantages

of a convertible bond from the standpoint of (a) the bond-
holders and (b) the issuing corporation.

17. Tim Brown, a friend of yours, has recently purchased a
home for $125,000, paying $25,000 down and the remain-
der financed by a 10.5%, 20-year mortgage, payable at
$998.38 per month. At the end of the first month, Tim
receives a statement from the bank indicating that only
$123.38 of principal was paid during the month. At this
rate, he calculates that it will take over 67 years to pay off
the mortgage. Is he right? Discuss.

18. In general, what are the requirements for the financial
statement presentation of long-term liabilities?

*19. Laura Hiatt is discussing the advantages of the effective-
interest method of bond amortization with her accounting
staff. What do you think Laura is saying?

*20. Markham Corporation issues $500,000 of 9%, 5-year
bonds on January 1, 2011, at 104. If Markham uses the
effective-interest method in amortizing the premium, will
the annual interest expense increase or decrease over the
life of the bonds? Explain.

*21. Tina Cruz and Dale Commons are discussing how the
market price of a bond is determined. Tina believes that
the market price of a bond is solely a function of the
amount of the principal payment at the end of the term of
a bond. Is she right? Discuss.

*22. Explain the straight-line method of amortizing discount
and premium on bonds payable.

*23. DeWeese Corporation issues $400,000 of 8%, 5-year
bonds on January 1, 2011, at 105. Assuming that the
straight-line method is used to amortize the premium,
what is the total amount of interest expense for 2011?

BE10-1 Buffaloe Company has the following obligations at December 31: (a) a note payable
for $100,000 due in 2 years, (b) a 10-year mortgage payable of $300,000 payable in ten $30,000
annual payments, (c) interest payable of $15,000 on the mortgage, and (d) accounts payable of
$60,000. For each obligation, indicate whether it should be classified as a current liability.
(Assume an operating cycle of less than one year.)

BE10-2 Hanna Company borrows $80,000 on July 1 from the bank by signing a $80,000, 10%,
one-year note payable.

(a) Prepare the journal entry to record the proceeds of the note.
(b) Prepare the journal entry to record accrued interest at December 31, assuming adjusting en-

tries are made only at the end of the year.

BE10-3 Leister Auto Supply does not segregate sales and sales taxes at the time of sale. The
register total for March 16 is $15,540.All sales are subject to a 5% sales tax. Compute sales taxes
payable, and make the entry to record sales taxes payable and sales.

BE10-4 Emporia State University sells 4,000 season basketball tickets at $180 each for its
12-game home schedule. Give the entry to record (a) the sale of the season tickets and (b) the
revenue earned by playing the first home game.

BE10-5 Cindy Neuer’s regular hourly wage rate is $16, and she receives an hourly rate of $24
for work in excess of 40 hours. During a January pay period, Cindy works 47 hours. Cindy’s fed-
eral income tax withholding is $95, and she has no voluntary deductions. Compute Cindy Neuer’s
gross earnings and net pay for the pay period. Assume that the FICA tax rate is 8%.

BRIEF

EXERCISES

Identify whether obligations
are current liabilities.

(SO 1)

Prepare entries for an interest-
bearing note payable.

(SO 2)

Compute and record sales taxes
payable.

(SO 3)

Prepare entries for unearned
revenues.

(SO 3)

Compute gross earnings
and net pay.

(SO 3)

Brief Exercises 487

JWCL165_c10_444-505.qxd 7/20/09 4:10 PM Page 487

BE10-6 Data for Cindy Neuer are presented in BE10-5. Prepare the journal entries to record
(a) Cindy’s pay for the period and (b) the payment of Cindy’s wages. Use January 15 for the end
of the pay period and the payment date.

BE10-7 Mareska Inc. is considering two alternatives to finance its construction of a new
$2 million plant.

(a) Issuance of 200,000 shares of common stock at the market price of $10 per share.
(b) Issuance of $2 million, 8% bonds at par.

Complete the following table, and indicate which alternative is preferable.

488 Chapter 10 Liabilities

Issue Stock Issue Bond

Income before interest and taxes $700,000 $700,000
Interest expense from bonds
Income before income taxes $ $
Income tax expense (30%)
Net income $ $

Outstanding shares 500,000

Earnings per share

BE10-8 Pruitt Corporation issued 3,000, 8%, 5-year, $1,000 bonds dated January 1, 2011, at 100.

(a) Prepare the journal entry to record the

sale of these bonds on January 1, 2011.

(b) Prepare the journal entry to record the first interest payment on July 1, 2011 (interest

payable semiannually), assuming no previous accrual of interest.
(c) Prepare the adjusting journal entry on December 31, 2011, to record interest expense.

BE10-9 Ratzlaff Company issues $2 million, 10-year, 8% bonds at 97, with interest payable on
July 1 and January 1.

(a) Prepare the journal entry to record the sale of these bonds on January 1, 2011.
(b) Assuming instead that the above bonds sold for 104, prepare the journal entry to record the

sale of these bonds on January 1, 2011.

BE10-10 Halloway Company has issued three different bonds during 2011. Interest is payable
semiannually on each of these bonds.

1. On January 1, 2011, 1,000, 8%, 5-year, $1,000 bonds dated January 1, 2011, were issued at face
value.

2. On July 1, $800,000, 9%, 5-year bonds dated July 1, 2011, were issued at 102.
3. On September 1, $200,000, 7%, 5-year bonds dated September 1, 2011, were issued at 98.

Prepare the journal entry to record each bond transaction at the date of issuance.

BE10-11 The balance sheet for Lemay Company reports the following information on July 1,2011.

Long-term liabilities
Bonds payable $1,000,000
Less: Discount on bonds payable 60,000 $940,000

Lemay decides to redeem these bonds at 101 after paying semiannual interest. Prepare the jour-
nal entry to record the redemption on July 1, 2011.

BE10-12 Pickeril Inc. issues a $600,000, 10%, 10-year mortgage note on December 31, 2011,
to obtain financing for a new building. The terms provide for semiannual installment payments
of $48,145. Prepare the entry to record the mortgage loan on December 31, 2011, and the first
installment payment.

BE10-13 Presented below are long-term liability items for Molini Company at December 31,
2011. Prepare the long-term liabilities section of the balance sheet for Molini Company.

Bonds payable, due 2013 $500,000
Lease liability 70,000
Notes payable, due 2016 80,000
Discount on bonds payable 45,000

Record a payroll and the
payment of wages.

(SO 3)

Compare bond versus stock
financing.

(SO 4)

Prepare entries for bonds
issued at face value.

(SO 5)

Prepare entries for bonds sold
at a discount and a premium.

(SO 5)

Prepare entries for bonds
issued.

(SO 5)

Prepare entry for redemption
of bonds.

(SO 6)

Prepare entries for long-term
notes payable.

(SO 7)

Prepare statement presentation
of long-term liabilities.

(SO 8)

JWCL165_c10_444-505.qxd 8/11/09 3:42 PM Page 488

*BE10-14 (a) What is the present value of $10,000 due 8 periods from now, discounted at 10%?
(b) What is the present value of $20,000 to be received at the end of each of 6 periods,

discounted at 8%?

*BE10-15 Presented below is the partial bond discount amortization schedule for Morales
Corp. Morales uses the effective-interest method of amortization.

Do it! Review 489

Semiannual Interest Bond
Interest Interest to Expense to Discount Unamortized Carrying
Periods Be Paid Be Recorded Amortization Discount Value

Issue date $62,311 $937,689
1 $45,000 $46,884 $1,884 60,427 939,573
2 45,000 46,979 1,979 58,448 941,552

Instructions
(a) Prepare the journal entry to record the payment of interest and the discount amortization at

the end of period 1.
(b) Explain why interest expense is greater than interest paid.
(c) Explain why interest expense will increase each period.

*BE10-16 Deane Company issues $5 million, 10-year, 9% bonds at 96, with interest payable on
July 1 and January 1. The straight-line method is used to amortize bond discount.

(a) Prepare the journal entry to record the sale of these bonds on January 1, 2011.
(b) Prepare the journal entry to record interest expense and bond discount amortization on July 1,

2011, assuming no previous accrual of interest.

*BE10-17 Coates Inc. issues $3 million, 5-year, 10% bonds at 102, with interest payable on July
1 and January 1. The straight-line method is used to amortize bond premium.

(a) Prepare the journal entry to record the sale of these bonds on January 1, 2011.
(b) Prepare the journal entry to record interest expense and bond premium amortization on July 1,

2011, assuming no previous accrual of interest.

Determine present value.

(SO 9)

10-1 You and several classmates are studying for the next accounting examination.
They ask you to answer the following questions:

1. The cash register total including sales taxes is $42,000, and the sales tax rate is 5%.What is the
sales taxes payable?

2. What is payroll tax expense related to Social Security taxes if salaries and wages for the week
are $16,000?

10-2 State whether each of the following statements is true or false.

____ 1. Mortgage bonds and sinking fund bonds are both examples of debenture bonds.
____ 2. Convertible bonds are also known as callable bonds.
____ 3. The market rate is the rate investors demand for loaning funds.
____ 4. Semiannual interest on bonds is equal to the face value times the stated rate times 6/12.
____ 5. The present value of a bond is the value at which it should sell in the market.

10-3 Goliath Corporation issues $300,000 of bonds for $312,000. (a) Prepare the
journal entry to record the issuance of the bonds, and (b) show how the bonds would be reported
on the balance sheet at the date of issuance.

10-4 Hucklebuckers Corporation issued $400,000 of 10-year bonds at a discount.
Prior to maturity, when the carrying value of the bonds was $390,000, the company retired the
bonds at 99. Prepare the entry to record the redemption of the bonds.

10-5 Nitro-Sort Corporation issues a $350,000, 6%, 15-year mortgage note to obtain
needed financing for a new lab.The terms call for semiannual payments of $17,857 each. Prepare
the entries to record the mortgage loan and the first installment payment.

Do it!
Do it!
Do it!
Do it!
Do it!

ReviewDo it!
Answer questions about
current liabilities.

(SO 3)

Evaluate statements about
bonds.

(SO 4)

Prepare journal entry for bond
issuance and show balance
sheet presentation.

(SO 5)

Prepare entry for bond
redemption.

(SO 6)
Prepare entries for mortgage note
and installment payment on note.

(SO 7)

Use effective-interest method
of bond amortization.

(SO 10)

Prepare entries for bonds
issued at a discount.

(SO 11)

Prepare entries for bonds
issued at a premium.

(SO 11)

JWCL165_c10_444-505.qxd 8/7/09 4:16 PM Page 489

490 Chapter 10 Liabilities

E10-1 Rob Judson Company had the following transactions involving notes payable.

July 1, 2011 Borrows $50,000 from Third National Bank by signing a 9-month, 12% note.
Nov. 1, 2011 Borrows $60,000 from DeKalb State Bank by signing a 3-month, 10% note.
Dec. 31, 2011 Prepares adjusting entries.
Feb. 1, 2012 Pays principal and interest to DeKalb State Bank.
Apr. 1, 2012 Pays principal and interest to Third National Bank.

Instructions
Prepare journal entries for each of the transactions shown above.

E10-2 On June 1, Melendez Company borrows $90,000 from First Bank on a 6-month,
$90,000, 12% note.

Instructions
(a) Prepare the entry on June 1.
(b) Prepare the adjusting entry on June 30.
(c) Prepare the entry at maturity (December 1), assuming monthly adjusting entries have been

made through November 30.
(d) What was the total financing cost (interest expense)?

E10-3 In providing accounting services to small businesses, you encounter the following situ-
ations pertaining to cash sales.

1. Warkentinne Company rings up sales and sales taxes separately on its cash register. On April 10,
the register totals are sales $30,000 and sales taxes $1,500.

2. Rivera Company does not segregate sales and sales taxes. Its register total for April 15 is
$23,540, which includes a 7% sales tax.

Instructions
Prepare the entry to record the sales transactions and related taxes for each client.

E10-4 Guyer Company publishes a monthly sports magazine, Fishing Preview. Subscriptions
to the magazine cost $20 per year. During November 2011, Guyer sells 12,000 subscriptions
beginning with the December issue. Guyer prepares financial statements quarterly and recog-
nizes subscription revenue earned at the end of the quarter. The company uses the accounts
Unearned Subscriptions and Subscription Revenue.

Instructions
(a) Prepare the entry in November for the receipt of the subscriptions.
(b) Prepare the adjusting entry at December 31, 2011, to record subscription revenue earned in

December 2011.
(c) Prepare the adjusting entry at March 31, 2012, to record subscription revenue earned in the

first quarter of 2012.

E10-5 Don Walls’s gross earnings for the week were $1,780, his federal income tax withhold-
ing was $301.63, and his FICA total was $135.73.

Instructions
(a) What was Walls’s net pay for the week?
(b) Journalize the entry for the recording of his pay in the general journal. (Note: Use Salaries

Payable; not Cash.)
(c) Record the issuing of the check for Walls’s pay in the general journal.

E10-6 According to the accountant of Ulner Inc., its payroll taxes for the week were as fol-
lows: $198.40 for FICA taxes, $19.84 for federal unemployment taxes, and $133.92 for state
unemployment taxes.

Instructions
Journalize the entry to record the accrual of the payroll taxes.

EXERCISES

Prepare entries for interest-
bearing notes.

(SO 2)

Prepare entries for
interest-bearing notes.

(SO 2)

Journalize sales and related
taxes.

(SO 3)

Journalize unearned
subscription revenue.

(SO 3)

Calculate and record net pay.

(SO 3)

Record accrual of payroll taxes.

(SO 3)

JWCL165_c10_444-505.qxd 7/20/09 4:10 PM Page 490

Calculate and analyze current
ratio and working capital.

(SO 3)

3M COMPANY
Balance Sheets (partial)

2008 2007
Current assets

Cash and cash equivalents $1,849 $1,896
Accounts receivable, net 3,195 3,362
Inventories 3,013 2,852
Other current assets 1,541 1,728

Total current assets $9,598 $9,838
Current liabilities $5,839 $5,362

Instructions
(a) Calculate the current ratio and working capital for 3M for 2007 and 2008.
(b) Suppose at the end of 2008, 3M management used $300 million cash to pay off $300 million

of accounts payable. How would the current ratio and working capital have changed?

E10-8 Jim Thome has prepared the following list of statements about bonds.

1. Bonds are a form of interest-bearing notes payable.
2. When seeking long-term financing, an advantage of issuing bonds over issuing common

stock is that stockholder control is not affected.
3. When seeking long-term financing, an advantage of issuing common stock over issuing

bonds is that tax savings result.
4. Secured bonds have specific assets of the issuer pledged as collateral for the bonds.
5. Secured bonds are also known as debenture bonds.
6. Bonds that mature in installments are called term bonds.
7. A conversion feature may be added to bonds to make them more attractive to bond buyers.
8. The rate used to determine the amount of cash interest the borrower pays is called the stated rate.
9. Bond prices are usually quoted as a percentage of the face value of the bond.

10. The present value of a bond is the value at which it should sell in the marketplace.

Instructions
Identify each statement above as true or false. If false, indicate how to correct the statement.

E10-9 Northeast Airlines is considering two alternatives for the financing of a purchase of a
fleet of airplanes. These two alternatives are:

1. Issue 60,000 shares of common stock at $45 per share. (Cash dividends have not been paid nor
is the payment of any contemplated.)

2. Issue 10%, 10-year bonds at par for $2,700,000.

It is estimated that the company will earn $800,000 before interest and taxes as a result of this
purchase.The company has an estimated tax rate of 30% and has 90,000 shares of common stock
outstanding prior to the new financing.

Instructions
Determine the effect on net income and earnings per share for these two methods of financing.

E10-10 On January 1, Neuer Company issued $500,000, 10%, 10-year bonds at par. Interest is
payable semiannually on July 1 and January 1.

Instructions
Present journal entries to record the following.

(a) The issuance of the bonds.
(b) The payment of interest on July 1, assuming that interest was not accrued on June 30.
(c) The accrual of interest on December 31.

Evaluate statements about
bonds.
(SO 4)

Compare two alternatives of
financing—issuance of
common stock vs. issuance
of bonds.

(SO 4)

Prepare entries for issuance of
bonds, and payment and
accrual of bond interest.

(SO 5)

E10-7 The following financial data were reported by 3M Company for 2007 and 2008 (dollars
in millions).

Exercises 491

JWCL165_c10_444-505.qxd 8/7/09 4:17 PM Page 491

E10-11 On January 1, Flory Company issued $300,000, 8%, 5-year bonds at face value.
Interest is payable semiannually on July 1 and January 1.

Instructions
Prepare journal entries to record the following events.

(a) The issuance of the bonds.
(b) The payment of interest on July 1, assuming no previous accrual of interest.
(c) The accrual of interest on December 31.

E10-12 Deng Company issued $500,000 of 5-year, 8% bonds at 97 on January 1, 2011. The
bonds pay interest twice a year.

Instructions
(a) (1) Prepare the journal entry to record the issuance of the bonds.

(2) Compute the total cost of borrowing for these bonds.
(b) Repeat the requirements from part (a), assuming the bonds were issued at 105.

E10-13 The following section is taken from Budke Corp.’s balance sheet at December 31, 2010.

492 Chapter 10 Liabilities

Current liabilities
Bond interest payable $ 72,000

Long-term liabilities
Bonds payable, 9%, due January 1, 2015 1,600,000

Interest is payable semiannually on January 1 and July 1. The bonds are callable on any interest
date.

Instructions
(a) Journalize the payment of the bond interest on January 1, 2011.
(b) Assume that on January 1, 2011, after paying interest, Budke calls bonds having a face value

of $600,000. The call price is 104. Record the redemption of the bonds.
(c) Prepare the entry to record the payment of interest on July 1, 2011, assuming no previous

accrual of

interest on the remaining bonds.

E10-14 Presented below are three independent situations.

1. Sigel Corporation retired $130,000 face value, 12% bonds on June 30, 2011, at 102.The carrying
value of the bonds at the redemption date was $117,500. The bonds pay semiannual interest,
and the interest payment due on June 30, 2011, has been made and recorded.

2. Diaz Inc. retired $150,000 face value, 12.5% bonds on June 30, 2011, at 98. The carrying value
of the bonds at the redemption date was $151,000.The bonds pay semiannual interest, and the
interest payment due on June 30, 2011, has been made and recorded.

3. Haas Company has $80,000, 8%, 12-year convertible bonds outstanding. These bonds were
sold at face value and pay semiannual interest on June 30 and December 31 of each year. The
bonds are convertible into 30 shares of Haas $5 par value common stock for each $1,000
worth of bonds. On December 31, 2011, after the bond interest has been paid, $20,000 face
value bonds were converted. The market value of Haas common stock was $44 per share on
December

31, 2011.

Instructions
For each independent situation above, prepare the appropriate journal entry for the redemption
or conversion of the bonds.

E10-15 Leoni Co. receives $240,000 when it issues a $240,000, 10%, mortgage note payable to
finance the construction of a building at December 31, 2011. The terms provide for semiannual
installment payments of $20,000 on June 30 and December 31.

Instructions
Prepare the journal entries to record the mortgage loan and the first two installment payments.

E10-16 The adjusted trial balance for Gilligan Corporation at the end of the current year con-
tained the following accounts.

Prepare entries to record
issuance of bonds at discount
and premium.

(SO 5)
Prepare entries for bonds
issued at face value.
(SO 5)

Prepare entries for bond
interest and redemption.

(SO 5, 6)

Prepare entries for redemption
of bonds and conversion of
bonds into common stock.

(SO 6)

Prepare entries to record
mortgage note and installment
payments.

(SO 7)

Prepare long-term liabilities
section.

(SO 8)

JWCL165_c10_444-505.qxd 7/20/09 4:10 PM Page 492

Bond Interest Payable $ 9,000
Lease Liability 89,500
Bonds Payable, due 2016 180,000
Premium on Bonds Payable 32,000

Instructions
Prepare the long-term liabilities section of the balance sheet.

*E10-17 Banzai Corporation is issuing $200,000 of 8%, 5-year bonds when potential bond
investors want a return of 10%. Interest is payable semiannually.

Instructions
Compute the market price (present value) of the bonds.

*E10-18 Hrabik Corporation issued $600,000, 9%, 10-year bonds on January 1, 2011, for
$562,613.This price resulted in an effective-interest rate of 10% on the bonds. Interest is payable
semiannually on July 1 and January 1. Hrabik uses the effective-interest method to amortize
bond premium or discount.

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 the discount amortization on July 1, 2011, assuming that interest

was not accrued on June 30.
(c) The accrual of interest and the discount amortization on December 31, 2011.

*E10-19 Siburo Company issued $300,000, 11%, 10-year bonds on January 1, 2011, for $318,694.
This price resulted in an effective-interest rate of 10% on the bonds. Interest is payable semi-
annually on July 1 and January 1. Siburo uses the effective-interest method to amortize bond pre-
mium or discount.

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 the premium amortization on July 1, 2011, assuming that interest

was not accrued on June 30.
(c) The accrual of interest and the premium amortization on December 31, 2011.

*E10-20 Patino Company issued $400,000, 9%, 20-year bonds on January 1, 2011, at 103.
Interest is payable semiannually on July 1 and January 1. Patino uses straight-line amortization
for bond premium or discount.

Instructions
Prepare the journal entries to record the following.

(a) The issuance of the bonds.
(b) The payment of interest and the premium amortization on July 1, 2011, assuming that interest

was not accrued on June 30.
(c) The accrual of interest and the premium amortization on December 31, 2011.
(d) The redemption of the bonds at maturity, assuming interest for the last interest period has

been paid and recorded.

*E10-21 Joseph Company issued $800,000, 11%, 10-year bonds on December 31, 2010, for
$730,000. Interest is payable semiannually on June 30 and December 31. Joseph Company uses
the straight-line method to amortize bond premium or discount.

Instructions
Prepare the journal entries to record the following.

(a) The issuance of the bonds.
(b) The payment of interest and the discount amortization on June 30, 2011.
(c) The payment of interest and the discount amortization on December 31, 2011.
(d) The redemption of the bonds at maturity, assuming interest for the last interest period has

been paid and recorded.

Exercises 493

Compute market price of
bonds.

(SO 9)

Prepare entries for issuance of
bonds, payment of interest, and
amortization of discount using
effective-interest method.

(SO 5, 10)

Prepare entries for issuance of
bonds, payment of interest, and
amortization of premium using
effective-interest method.

(SO 5, 10)

Prepare entries to record
issuance of bonds, payment
of interest, amortization of
premium, and redemption at
maturity.

(SO 5, 11)

Prepare entries to record
issuance of bonds, payment
of interest, amortization of
discount, and redemption at
maturity.

(SO 5, 11)

JWCL165_c10_444-505.qxd 8/7/09 4:18 PM Page 493

494 Chapter 10 Liabilities

Visit the book’s companion website at www.wiley.com/college/weygandt, and choose the Student
Companion site, to access Exercise Set B and a set of Challenge Exercises.

EXERCISES: SET B AND CHALLENGE EXERCISES www

.wiley.com

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PROBLEMS: SET A

P10-1A On January 1, 2011, the ledger of Mane Company contains the following liability
accounts.

Accounts Payable $52,000
Sales Taxes Payable 7,700
Unearned Service Revenue 16,000

During January the following selected transactions occurred.

Jan. 5 Sold merchandise for cash totaling $22,680, which includes 8% sales taxes.
12 Provided services for customers who had made advance payments of $10,000. (Credit

Service Revenue.)
14 Paid state revenue department for sales taxes collected in December 2010 ($7,700).
20 Sold 800 units of a new product on credit at $50 per unit, plus 8% sales tax.
21 Borrowed $18,000 from UCLA Bank on a 3-month, 8%, $18,000 note.
25 Sold merchandise for cash totaling $12,420, which includes 8% sales taxes.

Instructions
(a) Journalize the January transactions.
(b) Journalize the adjusting entries at January 31 for the outstanding notes payable. (Hint: Use

one-third of a month for the UCLA Bank note.)
(c) Prepare the current liabilities section of the balance sheet at January 31, 2011. Assume no

change in accounts payable.

P10-2A The following are selected transactions of Winsky Company. Winsky prepares finan-
cial statements quarterly.

Jan. 2 Purchased merchandise on account from Yokum Company, $30,000, terms 2/10, n/30.
Feb. 1 Issued a 9%, 2-month, $30,000 note to Yokum in payment of account.
Mar. 31 Accrued interest for 2 months on Yokum note.
Apr. 1 Paid face value and interest on Yokum note.
July 1 Purchased equipment from Korsak Equipment paying $11,000 in cash and signing a

10%, 3-month, $40,000 note.
Sept. 30 Accrued interest for 3 months on Korsak note.
Oct. 1 Paid face value and interest on Korsak note.
Dec. 1 Borrowed $15,000 from the Otago Bank by issuing a 3-month, 8% interest-bearing

note with a face value of $15,000.
Dec. 31 Recognized interest expense for 1 month on Otago Bank note.

Instructions
(a) Prepare journal entries for the above transactions and events.
(b) Post to the accounts Notes Payable, Interest Payable, and Interest Expense.
(c) Show the balance sheet presentation of notes and interest payable at December 31.
(d) What is total interest expense for the year?

P10-3A On May 1, 2011, Newby Corp. issued $600,000, 9%, 5-year bonds at face value. The
bonds were dated May 1, 2011, and pay interest semiannually on May 1 and November 1.
Financial statements are prepared annually on December 31.

Instructions
(a) Prepare the journal entry to record the issuance of the bonds.
(b) Prepare the adjusting entry to record the accrual of interest on December 31, 2011.
(c) Show the balance sheet presentation on December 31, 2011.
(d) Prepare the journal entry to record payment of interest on May 1, 2012, assuming no accrual

of interest from January 1, 2012, to May 1, 2012.

Prepare current liability entries,
adjusting entries, and current
liabilities section.

(SO 1, 2, 3)

Journalize and post note
transactions; show balance
sheet presentation.

(SO 2)

Prepare entries to record
issuance of bonds, interest
accrual, and bond redemption.

(SO 5, 6, 8)

(d) $1,550

(d) Int. exp. $18,000

JWCL165_c10_444-505.qxd 7/20/09 4:10 PM Page 494

(f) Loss $12,000

(d) Amortization $9,493

(e) Amortization $9,872

(b) June 30 Mortgage Notes
Payable $13,433

Prepare entries to record
issuance of bonds, interest
accrual, and bond redemption.
(SO 5, 6, 8)

Prepare installment payments
schedule and journal entries
for a mortgage note payable.

(SO 7, 8)

(a) (4) Amortization $16,621
(b) Bond carrying value

$3,549,041

(a) (3) Amortization $15,830

Prepare entries to record
issuance of bonds, payment of
interest, and amortization of
discount using effective-interest
method. In addition, answer
questions.

(SO 5, 10)

Prepare entries to record
issuance of bonds, payment
of interest, and amortization
of bond premium using
effective-interest method.

(SO 5, 10)

(e) Prepare the journal entry to record payment of interest on November 1, 2012.
(f) Assume that on November 1, 2012, Newby calls the bonds at 102. Record the redemption of

the bonds.

P10-4A Kusmaul Electric sold $500,000, 10%, 10-year bonds on January 1, 2011. The bonds
were dated January 1 and paid interest on January 1 and July 1. The bonds were sold at 104.

Instructions
(a) Prepare the journal entry to record the issuance of the bonds on January 1, 2011.
(b) At December 31, 2011, the balance in the Premium on Bonds Payable account is $18,000.

Show the balance sheet presentation of accrued interest and the bond liability at December
31, 2011.

redeemed the bonds at 105. Record the redemption of the bonds assuming that interest for
the period has already been paid.

P10-5A Fordyce Electronics issues a $400,000, 8%, 10-year mortgage note on December 31,
2010. The proceeds from the note are to be used in financing a new research laboratory. The
terms of the note provide for semiannual installment payments, exclusive of real estate taxes and
insurance, of $29,433. Payments are due June 30 and December 31.

Instructions
(a) Prepare an installment payments schedule for the first 2 years.
(b) Prepare the entries for (1) the loan and (2) the first two installment payments.
(c) Show how the total mortgage liability should be reported on the balance sheet at December

31, 2011.

*P10-6A On July 1, 2011, Atwater Corporation issued $2,000,000 face value, 10%, 10-year
bonds at $2,271,813. This price resulted in an effective-interest rate of 8% on the bonds. Atwater
uses the effective-interest method to amortize bond premium or discount. The bonds pay semi-
annual interest July 1 and January 1.

Instructions
(Round all computations to the nearest dollar.)
(a) Prepare the journal entry to record the issuance of the bonds on July 1, 2011.
(b) Prepare an amortization table through December 31, 2012 (3 interest periods) for this bond

issue.
(c) Prepare the journal entry to record the accrual of interest and the amortization of the premium

on December 31, 2011.
(d) Prepare the journal entry to record the payment of interest and the amortization of the

premium on July 1, 2012, assuming no accrual of interest on June 30.
(e) Prepare the journal entry to record the accrual of interest and the amortization of the

premium on December 31, 2012.

*P10-7A On July 1, 2011, Rossillon Company issued $4,000,000 face value, 8%, 10-year bonds
at $3,501,514.This price resulted in an effective-interest rate of 10% on the bonds. Rossillon uses
the effective-interest method to amortize bond premium or discount. The bonds pay semiannual
interest July 1 and January 1.

Instructions
(Round all computations to the nearest dollar.)
(a) Prepare the journal entries to record the following transactions.

(1) The issuance of the bonds on July 1, 2011.
(2) The accrual of interest and the amortization of the discount on December 31, 2011.
(3) The payment of interest and the amortization of the discount on July 1, 2012, assuming

no accrual of interest on June 30.
(4) The accrual of interest and the amortization of the

discount on December 31, 2012.

(b) Show the proper balance sheet presentation for the liability for bonds payable on the
December 31, 2012, balance sheet.

(c) Provide the answers to the following questions in letter form.
(1) What amount of interest expense is reported for 2012?
(2) Would the bond interest expense reported in 2012 be the same as, greater than, or less

than the amount that would be reported if the straight-line method of amortization were
used?

Problems: Set A 495

JWCL165_c10_444-505.qxd 7/20/09 4:10 PM Page 495

(3) Determine the total cost of borrowing over the life of the bond.
(4) Would the total bond interest expense be greater than, the same as, or less than the total

interest expense that would be reported if the straight-line method of amortization were used?

*P10-8A Soprano Electric sold $3,000,000, 10%, 10-year bonds on January 1, 2011. The bonds
were dated January 1 and pay interest July 1 and January 1. Soprano Electric uses the straight-
line method to amortize bond premium or discount. The bonds were sold at 104. Assume no
interest is accrued on June 30.

Instructions
(a) Prepare the journal entry to record the issuance of the bonds on January 1, 2011.
(b) Prepare a bond premium amortization schedule for the first 4 interest periods.
(c) Prepare the journal entries for interest and the amortization of the premium in 2011 and

2012.
(d) Show the balance sheet presentation of the bond liability at December 31, 2012.

*P10-9A Elkins Company sold $2,500,000, 8%, 10-year bonds on July 1, 2011. The bonds were
dated July 1, 2011, and pay interest July 1 and January 1. Elkins Company uses the straight-line
method to amortize bond premium or discount. Assume no interest is accrued on June 30.

Instructions
(a) Prepare all the necessary journal entries to record the issuance of the bonds and bond interest

expense for 2011, assuming that the bonds sold at 104.
(b) Prepare journal entries as in part (a) assuming that the bonds sold at 98.
(c) Show balance sheet presentation for each bond issue at December 31, 2011.

*P10-10A The following is taken from the Pinkston Company balance sheet.

496 Chapter 10 Liabilities

(b) Amortization $6,000

(d) Premium on bonds
payable $96,000

(a) Amortization $5,000
(b) Amortization $2,500
(c) Premium on bonds

payable $95,000
Discount on bonds
payable $47,500

(b) Amortization $10,000

(d) Amortization $6,000

Prepare entries to record
issuance of bonds, interest, and
straight-line amortization of
bond premium and discount.

(SO 5, 11)

Prepare entries to record
interest payments, straight-line
premium amortization, and
redemption of bonds.

(SO 6, 11)

Prepare entries to record
issuance of bonds, interest
accrual, and straight-line
amortization for 2 years.

(SO 5, 11)

PINKSTON COMPANY
Balance Sheet (partial)
December 31, 2011

Current liabilities
Bond interest payable (for 6 months

from July 1 to December 31) $ 105,000
Long-term liabilities

Bonds payable, 7% due January 1, 2022 $3,000,000
Add: Premium on bonds payable 200,000 $3,200,000

Interest is payable semiannually on January 1 and July 1. The bonds are callable on any semi-
annual interest date. Pinkston uses straight-line amortization for any bond premium or discount.
From December 31, 2011, the bonds will be outstanding for an additional 10 years (120 months).

Instructions
(a) Journalize the payment of bond interest on January 1, 2012.
(b) Prepare the entry to amortize bond premium and to pay the interest due on July 1, 2012,

assuming no accrual of interest on June 30.
(c) Assume that on July 1, 2012, after paying interest, Pinkston Company calls bonds having a

face value of $1,200,000. The call price is 101. Record the redemption of the bonds.
(d) Prepare the adjusting entry at December 31, 2012, to amortize bond premium and to accrue

interest on the remaining bonds.

P10-1B On January 1, 2011, the ledger of Payless Software Company contains the following
liability accounts.

Accounts Payable $42,500
Sales Taxes Payable 5,800
Unearned Service Revenue 15,000

During January the following selected transactions occurred.

PROBLEMS: SET B

Prepare current liability entries,
adjusting entries, and current
liabilities section.
(SO 1, 2, 3)

JWCL165_c10_444-505.qxd 7/20/09 4:10 PM Page 496

Jan. 1 Borrowed $30,000 in cash from Amsterdam Bank on a 4-month, 8%, $30,000 note.
5 Sold merchandise for cash totaling $10,400, which includes 4% sales taxes.

12 Provided services for customers who had made advance payments of $9,000. (Credit
Service Revenue.)

14 Paid state treasurer’s department for sales taxes collected in December 2010, $5,800.
20 Sold 900 units of a new product on credit at $52 per unit, plus 4% sales tax.
25 Sold merchandise for cash totaling $18,720, which includes 4% sales taxes.

Instructions
(a) Journalize the January transactions.
(b) Journalize the adjusting entries at January 31 for the outstanding notes payable.
(c) Prepare the current liabilities section of the balance sheet at January 31, 2011. Assume no

change in accounts payable.

P10-2B On June 1, 2011, Logsdon Corp. issued $1,500,000, 8%, 5-year bonds at face value.The
bonds were dated June 1, 2011, and pay interest semiannually on June 1 and December 1.
Financial statements are prepared annually on December 31.

of interest from January 1, 2012, to June 1, 2012.
(e) Prepare the journal entry to record payment of interest on December 1, 2012.
(f) Assume that on December 1, 2012, Logsdon calls the bonds at 102. Record the redemption

of the bonds.

P10-3B Merendo Co. sold $600,000, 9%, 10-year bonds on January 1, 2011. The bonds were
dated January 1, and interest is paid on January 1 and July 1. The bonds were sold at 105.

Instructions
(a) Prepare the journal entry to record the issuance of the bonds on January 1, 2011.
(b) At December 31, 2011, the balance in the Premium on Bonds Payable account is $27,000. Show

the balance sheet presentation of accrued interest and the bond liability at December 31, 2011.
(c) On January 1, 2013, when the carrying value of the bonds was $624,000, the company

redeemed the bonds at 105. Record the redemption of the bonds assuming that interest for
the period has already been paid.

P10-4B Egan Electronics issues a $500,000, 8%, 10-year mortgage note on December 31,
2011, to help finance a plant expansion program. The terms provide for semiannual installment
payments, not including real estate taxes and insurance, of $36,791. Payments are due June 30 and
December 31.

Instructions
(a) Prepare an installment payments schedule for the first 2 years.
(b) Prepare the entries for (1) the mortgage loan and (2) the first two installment payments.
(c) Show how the total mortgage liability should be reported on the balance sheet at December 31,

2012.

*P10-5B On July 1, 2011, Matlock Satellites issued $2,700,000 face value, 9%, 10-year bonds at
$2,531,760.This price resulted in an effective-interest rate of 10% on the bonds. Matlock uses the
effective-interest method to amortize bond premium or discount. The bonds pay semiannual in-
terest July 1 and January 1.

discount on December 31, 2011.
(d) Prepare the journal entry to record the payment of interest and the amortization of the

discount on July 1, 2012, assuming that interest was not accrued on June 30.
(e) Prepare the journal entry to record the accrual of interest and the amortization of the

discount on December 31, 2012.

Problems: Set B 497

(d) Int. exp. $50,000

(f) Loss $30,000

(b) June 30 Mortgage Notes
Payable $16,791

Prepare entries to record
issuance of bonds, interest ac-
crual, and bond redemption.

(SO 5, 6, 8)
Prepare entries to record
issuance of bonds, interest
accrual, and bond redemption.
(SO 5, 6, 8)
Prepare installment payments
schedule and journal entries
for a mortgage note payable.
(SO 7, 8)

Prepare entries to record
issuance of bonds, payment of
interest, and amortization of
bond discount using effective-
interest method.

(SO 5, 10)

(d) Amortization $5,342

(e) Amortization $5,610

JWCL165_c10_444-505.qxd 7/20/09 4:10 PM Page 497

*P10-6B On July 1, 2011, S. Posadas Chemical Company issued $3,000,000 face value, 10%,
10-year bonds at $3,407,720. This price resulted in an 8% effective-interest rate on the bonds.
Posadas uses the effective-interest method to amortize bond premium or discount. The bonds
pay semiannual interest on each July 1 and January 1.

Instructions
(Round all computations to the nearest dollar.)
(a) Prepare the journal entries to record the following transactions.

(1) The issuance of the bonds on July 1, 2011.
(2) The accrual of interest and the amortization of the premium on December 31, 2011.
(3) The payment of interest and the amortization of the premium on July 1, 2012, assuming

no accrual of interest on June 30.
(4) The accrual of interest and the amortization of the premium on December 31, 2012.

(b) Show the proper balance sheet presentation for the liability for bonds payable on the
December 31, 2012, balance sheet.
(c) Provide the answers to the following questions in letter form.
(1) What amount of interest expense is reported for 2012?
(2) Would the bond interest expense reported in 2012 be the same as, greater than, or less
than the amount that would be reported if the straight-line method of amortization were
used?

(3) Determine the total cost of borrowing over the life of the bond.
(4) Would the total bond interest expense be greater than, the same as, or less than the total in-

terest expense if the straight-line method of amortization were used?

*P10-7B Roeder Company sold $4,000,000, 9%, 20-year bonds on January 1, 2011. The bonds
were dated January 1, 2011, and pay interest on January 1 and July 1. Roeder Company uses the
straight-line method to amortize bond premium or discount. The bonds were sold at 96. Assume
no interest is accrued on June 30.

Instructions
(a) Prepare the journal entry to record the issuance of the bonds on January 1, 2011.
(b) Prepare a bond discount amortization schedule for the first 4 interest periods.
(c) Prepare the journal entries for interest and the amortization of the discount in 2011 and 2012.
(d) Show the balance sheet presentation of the bond liability at December 31, 2012.

*P10-8B Karjala Corporation sold $5,000,000, 8%, 10-year bonds on January 1, 2011.The bonds
were dated January 1, 2011, and pay interest on July 1 and January 1. Karjala Corporation uses
the straight-line method to amortize bond premium or discount. Assume no interest is accrued
on June 30.

Instructions
(a) Prepare all the necessary journal entries to record the issuance of the bonds and bond interest

expense for 2011, assuming that the bonds sold at 103.
(b) Prepare journal entries as in part (a) assuming that the bonds sold at 96.
(c) Show balance sheet presentation for each bond issue at December 31, 2011.

*P10-9B The following is taken from the Magana Corp. balance sheet.

498 Chapter 10 Liabilities

(a) (2) Amortization $13,691
(a) (3) Amortization $14,239

(a) (4) Amortization $14,808
(b) Bond carrying value

$3,364,982

(b) Amortization $4,000

(a) Amortization $7,500
(b) Amortization $10,000
(c) Premium on bonds

payable $135,000
Discount on bonds
payable $180,000

(d) Discount on bonds
payable $144,000

Prepare entries to record
issuance of bonds, payment of
interest, and amortization of
premium using effective-
interest method. In addition,
answer questions.

(SO 5, 10)
Prepare entries to record
issuance of bonds, interest
accrual, and straight-line
amortization for 2 years.
(SO 5, 11)
Prepare entries to record
issuance of bonds, interest, and
straight-line amortization of
bond premium and discount.
(SO 5, 11)

MAGANA CORPORATION
Balance Sheet (partial)
December 31, 2011

Current liabilities
Bond interest payable (for 6 months

from July 1 to December 31) $ 84,000
Long-term liabilities

Bonds payable, 7%, due
January 1, 2022 $2,400,000

Less: Discount on bonds payable 90,000 $2,310,000

Interest is payable semiannually on January 1 and July 1.The bonds are callable on any semiannual
interest date. Magana uses straight-line amortization for any bond premium or discount. From
December 31, 2011, the bonds will be outstanding for an additional 10 years (120 months).

Prepare entries to record interest
payments, straight-line discount
amortization, and redemption
of bonds.

(SO 5, 6, 11)

JWCL165_c10_444-505.qxd 8/7/09 4:19 PM Page 498

Instructions
(Round all computations to the nearest dollar).
(a) Journalize the payment of bond interest on January 1, 2012.
(b) Prepare the entry to amortize bond discount and to pay the interest due on July 1, 2012,

assuming that interest was not accrued on June 30.
(c) Assume that on July 1, 2012, after paying interest, Magana Corp. calls bonds having a face

value of $800,000. The call price is 101. Record the redemption of the bonds.
(d) Prepare the adjusting entry at December 31, 2012, to amortize bond discount and to accrue

interest on the remaining bonds.

Comprehensive Problems 499

(b) Amortization $4,500

(d) Amortization $3,000

Visit the book’s companion website at www.wiley.com/college/weygandt, and choose the Student
Companion site, to access Problem Set C.

PROBLEMS: SET C w

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CP10-1 Aber Corporation’s balance sheet at December 31, 2010, is presented below.

COMPREHENSIVE PROBLEMS

ABER CORPORATION
Balance Sheet

December 31, 2010

Cash $30,500 Accounts payable $13,750
Inventory 25,750 Bond interest payable 3,000
Prepaid insurance 5,600 Bonds payable 50,000
Equipment 38,000 Common stock 20,000

$99,850 Retained earnings $13,100
$99,850

During 2011, the following transactions occurred.
1. Aber paid $3,000 interest on the bonds on January 1, 2011.
2. Aber purchased $241,100 of inventory on account.
3. Aber sold for $450,000 cash inventory which cost $250,000.Aber also collected $27,000 sales taxes.
4. Aber paid $230,000 on accounts payable.
5. Aber paid $3,000 interest on the bonds on July 1, 2011.
6. The prepaid insurance ($5,600) expired on July 31.
7. On August 1, Aber paid $10,200 for insurance coverage from August 1,2011,through July 31,2012.
8. Aber paid $17,000 sales taxes to the state.
9. Paid other operating expenses, $91,000.

10. Retired the bonds on December 31, 2011, by paying $48,000 plus $3,000 interest.
11. Issued $90,000 of 8% bonds on December 31, 2011, at 104. The bonds pay interest every

June 30 and December 31.

Adjustment data:
1. Recorded the insurance expired from item 7.
2. The equipment was acquired on December 31, 2010, and will be depreciated on a straight-line

basis over 5 years with a $3,000 salvage value.
3. The income tax rate is 30%. (Hint: Prepare the income statement up to income before taxes

and multiply by 30% to compute the amount.)

Instructions
(You may want to set up T accounts to determine ending balances.)
(a) Prepare journal entries for the transactions listed above and adjusting entries.
(b) Prepare an adjusted trial balance at December 31, 2011.
(c) Prepare an income statement and a retained earnings statement for the year ending

December 31, 2011, and a classified balance sheet as of December 31, 2011.

(b) Totals $646,995
(c) N.I. $61,705

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CP10-2 Paris Company and Troyer Company are competing businesses. Both began opera-
tions 6 years ago and are quite similar in most respects. The current balance sheet data for the
two companies are shown below.

500 Chapter 10 Liabilities

Paris Troyer
Company Company

Cash $ 70,300 $ 48,400
Accounts receivable 309,700 312,500
Allowance for doubtful accounts (13,600) –0–
Merchandise inventory 463,900 520,200
Plant and equipment 255,300 257,300
Accumulated depreciation, plant and equipment (112,650) (189,850)

Total assets 972,950 $948,550

Current liabilities $440,200 $436,500
Long-term liabilities 78,000 80,000

Total liabilities 518,200 516,500
Stockholders’ equity 454,750 432,050

Total liabilities and stockholders’ equity $972,950 $948,550

You have been engaged as a consultant to conduct a review of the two companies.Your goal is to
determine which of them is in the stronger financial position.

Your review of their financial statements quickly reveals that the two companies have not
followed the same accounting practices.The differences and your conclusions regarding them are
summarized below.

1. Paris Company has used the allowance method of accounting for bad debts. A review shows
that the amount of its write-offs each year has been quite close to the allowances that have
been provided. It therefore seems reasonable to have confidence in its current estimate of bad
debts.

Troyer Company has used the direct write-off method for bad debts, and it has been
somewhat slow to write off its uncollectible accounts. Based upon an aging analysis and re-
view of its accounts receivable, it is estimated that $20,000 of its existing accounts will prob
ably prove to be uncollectible.

2. Paris Company has determined the cost of its merchandise inventory on a LIFO basis. The
result is that its inventory appears on the balance sheet at an amount that is below its current
replacement cost. Based upon a detailed physical examination of its merchandise on hand, the
current replacement cost of its inventory is estimated at $517,000.

Troyer Company has used the FIFO method of valuing its merchandise inventory. Its
ending inventory appears on the balance sheet at an amount that quite closely approximates
its current replacement cost.

3. Paris Company estimated a useful life of 12 years and a salvage value of $30,000 for its plant
and equipment. It has been depreciating them on a straight-line basis.

Troyer Company has the same type of plant and equipment. However, it estimated a use-
ful life of 10 years and a salvage value of $10,000. It has been depreciating its plant and equip-
ment using the double-declining-balance method.

Based upon engineering studies of these types of plant and equipment, you conclude that
Troyer’s estimates and method for calculating depreciation are the more appropriate.

4. Among its current liabilities, Paris has included the portions of long-term liabilities that be-
come due within the next year. Troyer has not done so.

You find that $16,000 of Troyer’s $80,000 of long-term liabilities are due to be repaid in
the current year.

Instructions
(a) Revise the balance sheets presented above so that the data are comparable and reflect the

current financial position for each of the two companies.
(b) Prepare a brief report to your client stating your conclusions.

(a) Total assets:
Paris $950,325
Troyer $928,550

JWCL165_c10_444-505.qxd 7/20/09 4:10 PM Page 500

Financial Reporting Problem: PepsiCo
BYP10-1 The financial statements of PepsiCo and the Notes to Consolidated Financial
Statements appear in Appendix A.

Instructions
Refer to PepsiCo’s financial statements and answer the following questions about current and
long-term liabilities.

(a) What were PepsiCo’s total current liabilities at December 27, 2008? What was the
increase/decrease in PepsiCo’s total current liabilities from the prior year?

(b) In PepsiCo’s Note 2 (“Our Significant Accounting Policies”), the company explains the
nature of its contingencies. Under what conditions does PepsiCo recognize (record and
report) liabilities for contingencies?

(c) What were the components of total current liabilities on December 27, 2008?
(d) What was PepsiCo’s total long-term debt (excluding deferred income taxes) at December 27,

2008? What was the increase/decrease in total long-term debt (excluding deferred income
taxes) from the prior year? What does Note 9 to the financial statements indicate about the
composition of PepsiCo’s long-term debt obligation?

(e) What are the total long-term contractual commitments that PepsiCo reports as of December
27, 2008? (See Note 9.)

Comparative Analysis Problem: PepsiCo vs.
Coca-Cola
BYP10-2 PepsiCo’s financial statements are presented in Appendix A. Coca-Cola’s financial
statements are presented in Appendix B.

Instructions
(a) At December 27, 2008, what was PepsiCo’s largest current liability account? What were its

total current liabilities? At December 31, 2008, what was Coca-Cola’s largest current liability
account? What were its total current liabilities?

(b) Based on information contained in those financial statements, compute the following 2008
values for each company.
(1) Working capital.
(2) Current ratio.

FINANCIAL REPORTING AND ANALYSIS

B R O A D E N I N G Y O U R P E R S P E C T I V E

Go to the book’s companion website,
www.wiley.com/college/weygandt,
to see the completion of this problem.

Broadening Your Perspective 501

(Note: This is a continuation of the Cookie Chronicle from Chapters 1 through 9.)

CCC10 Natalie is thinking of repaying all amounts outstanding to her grandmother. Recall
that Cookie Creations borrowed $2,000 on November 16, 2010, from Natalie’s grandmother.
Interest on the note is 6% per year, and the note plus interest was to be repaid in 24 months.
Recall that a monthly adjusting journal entry was prepared for the months of November 2010
(1/2 month), December 2010, and January 2011.

Natalie needs to know the interest expense and interest payable, and she needs to record the
loan repayment.

CONTINUING COOKIE CHRONICLE

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(d) Based on the information contained in these financial statements, compute the following
2008 ratios for each company.
(1) Debt (excluding “deferred income taxes”) to total assets.
(2) Times interest earned.

(e) What conclusions concerning the companies’ long-run solvency can be drawn from these
ratios?

Exploring the Web
BYP10-3 Bond or debt securities pay a stated rate of interest. This rate of interest is depend-
ent on the risk associated with the investment. Moody’s Investment Service provides ratings for
companies that issue debt securities.

Address: www.moodys.com, or go to www.wiley.com/college/weygandt

Steps: From Moody’s homepage, choose About Moody’s.

Instructions
(a) What year did Moody’s introduce the first bond rating? (See Moody’s History.)
(b) What is the total amount of debt securities that Moody’s analysts “track”? (See An

Introduction.)
(c) What characteristics must debt ratings have in order to be useful to the capital markets? (See

Understand Risk: The Truth About Credit Ratings.)

502 Chapter 10 Liabilities

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Decision Making Across the Organization
BYP10-4 On January 1, 2009, Bailey Corporation issued $6,000,000 of 5-year, 8% bonds at 96.
The bonds pay interest semiannually on July 1 and January 1. By January 1, 2011, the market
rate of interest for bonds of similar risk had risen. As a result, the market value of the Bailey
Corporation bonds was $5,000,000 on January 1, 2011—below their carrying value.

Debbie Bailey, president of the company, suggests repurchasing all of these bonds in the
open market at the $5,000,000 price. To do so, the company would have to issue $5,000,000 (face
value) of new 10-year, 11% bonds at par. The president asks you, as controller, “What is the
feasibility of my proposed repurchase plan?”

Instructions
With the class divided into groups, answer the following.

*(a) What is the carrying value of the outstanding Bailey Corporation 5-year bonds on January 1,
2011? (Assume straight-line amortization.)

(b) Prepare the journal entry to retire the 5-year bonds on January 1, 2011. Prepare the journal
entry to issue the new 10-year bonds.

(c) Prepare a list of talking points for your use in meeting with the president in response to her
request for advice. List the economic factors that you believe should be considered for her re-
purchase proposal.

Communication Activity
BYP10-5 Ken Robson, president of the Robson Corporation, is considering the issuance of
bonds to finance an expansion of his business. He has asked you to (a) discuss the advantages
of bonds over common stock financing, (b) indicate the types of bonds he might issue, and
(c) explain the issuing procedures used in bond transactions.

Instructions
Write a memo to the president, answering his request.

CRITICAL THINKING

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Ethics Case
BYP10-6 Sam Farr is the president, founder, and majority owner of Galena Medical Corpo-
ration, an emerging medical technology products company. Galena is in dire need of additional
capital to keep operating and to bring several promising products to final development, testing,
and production. Sam, as owner of 51% of the outstanding stock, manages the company’s oper-
ations. He places heavy emphasis on research and development and on long-term growth. The
other principal stockholder is Jill Hutton who, as a nonemployee investor, owns 40% of the
stock. Jill would like to deemphasize the R&D functions and emphasize the marketing func-
tion, to maximize short-run sales and profits from existing products. She believes this strategy
would raise the market price of Galena’s stock.

All of Sam’s personal capital and borrowing power is tied up in his 51% stock ownership.
He knows that any offering of additional shares of stock will dilute his controlling interest
because he won’t be able to participate in such an issuance. But, Jill has money and would likely
buy enough shares to gain control of Galena. She then would dictate the company’s future di-
rection, even if it meant replacing Sam as president and CEO.

The company already has considerable debt. Raising additional debt will be costly, will ad-
versely affect Galena’s credit rating, and will increase the company’s reported losses due to the
growth in interest expense. Jill and the other minority stockholders express opposition to the
assumption of additional debt, fearing the company will be pushed to the brink of bankruptcy.
Wanting to maintain his control and to preserve the direction of “his”company, Sam is doing
everything to avoid a stock issuance. He is contemplating a large issuance of bonds, even if it
means the bonds are issued with a high effective-interest rate.

Instructions
(a) Who are the stakeholders in this situation?
(b) What are the ethical issues in this case?
(c) What would you do if you were Sam?

”All About You” Activity
BYP10-7 As indicated in the “All About You” feature in this chapter (page 468), medical costs
are substantial and rising. But will medical costs be your most substantial expense over your life-
time? Not likely. Will it be housing or food? Again, not likely. The answer is in the Accounting
Across the Organization box on page 450. On average, Americans work 74 days to afford their
federal taxes. Companies, too, have large tax burdens. They look very hard at tax issues in decid-
ing where to build their plants and where to locate their administrative headquarters.

Instructions
(a) Determine what your state income taxes are if your taxable income is $60,000 and you file as

a single taxpayer in the state in which you live.
(b) Assume that you own a home worth $200,000 in your community and the tax rate is 2.1%.

Compute the property taxes you would pay.
(c) Assume that the total gasoline bill for your automobile is $1,200 a year (400 gallons at $3 per

gallon). What are the amounts of state and federal taxes that you pay on the $1,200?
(d) Assume that your purchases for the year total $9,000. Of this amount, $5,000 was for food and

prescription drugs. What is the amount of sales tax you would pay on these purchases? (Note
that many states do not have a sales tax for food or prescription drug purchases. Does yours?).

(e) Determine what your Social Security taxes are if your income is $60,000.
(f) Determine what your federal income taxes are if your taxable income is $60,000 and you file

as a single taxpayer.
(g) Determine your total taxes paid based on the above calculations, and determine the percent-

age of income that you would pay in taxes based on the following formula:Total taxes paid �
Total income.

FASB Codification Activity
BYP10-8 Access the FASB Codification at http://asc.fasb.org to prepare responses to the
following.
(a) What is the definition of current liabilities?
(b) What is a long-term obligation?
(c) What guidance does the Codification provide for the disclosure of long-term obligations?

Broadening Your Perspective 503

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Answers to Insight and Accounting Across
the Organization Questions
p. 450 Taxes Are the Largest Slice of the Pie
Q: If the information on 2008 taxation depicted your spending patterns, on what date (starting

on January 1) will you have earned enough to pay all of your taxes?
A: As indicated in the story, it takes 113 (74 � 39) days to pay your taxes. Thus, April 23 is Tax

Freedom Day.Tax Freedom Day for the past 26 years has occurred in April, except for the year
2000 when it occurred in May.

p. 457 When to Go Long-Term
Q: Based on this story, what is a good general rule to use in choosing between short-term and

long-term financing?
A: In general, it is best to finance short-term assets with short-term liabilities and long-term

assets with long-term liabilities, in order to reduce the likelihood of a liquidity crunch such
as this.

p. 465 Search for Your Best Rate
Q: What should you do if the dealer “trash-talks” your lender, or refuses to sell you the car for

the agreed-upon price unless you get your car loan through the dealer?
A: Experts suggest that if the dealer “trash-talks” your lender or refuses to sell you the car at the

agreed-upon price unless you get your financing through the dealer, get up and leave, and buy
your car somewhere else.

p. 467 “Covenant-Lite” Debt
Q: How can financial ratios such as those covered in this chapter provide protection for creditors?
A: Financial ratios such as the current ratio, debt to total assets ratio, and the times interest earned

ratio provide indications of a company’s liquidity and solvency. By specifying minimum levels
of liquidity and solvency, as measured by these ratios, a creditor creates triggers that enable it to
step in before a company’s financial situation becomes too dire.

Authors’ Comments on All About You:
Your Boss Wants to Know If You Ran Today, p. 468
On the one hand, a company’s insurance premiums would be substantially lower if its employees
did not smoke and if they were in better shape. Some argue that employees with unhealthy habits
place a burden on healthy employees because they increase the share of insurance premiums
that all employees have to pay, and because unhealthy employees miss more days of work. On
the other hand, some argue that this approach discriminates in favor of “healthy” people.Also, it
is not illegal to smoke or to be overweight. Should an employer really be able to dictate against
non-illegal behavior that employees do on their own time? The cost of health care is a huge prob-
lem in the U.S., with no easy answers.

Answers to Self-Study Questions
1. a 2. d 3. b 4. b 5. c 6. b 7. c 8. a 9. b 10. d 11. c 12. c
13. d *14. d *15. b *16. c *17. d *18. a

504 Chapter 10 Liabilities

Remember to go back to the Navigator box on the chapter-opening page and check off your completed work.✓

JWCL165_c10_444-505.qxd 7/20/09 4:10 PM Page 504

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