ACCOUNTING 3620 FALL 2015

QUIZ # 3 (5 Points)

Name____________________

Problem 1 (2 Points)
Fly-By-Night Credit Card has a special benefit for their customers. Whenever a
customer books an airline ticket using their Fly-By-Night card, Fly-By-Night guarantees
that the consumers baggage will arrive on time. In the event that it doesnt, Fly-ByNight will pay a customer $ 1,000, which covers the cost of the replacement items. The
consumer is allowed to keep the entire $ 1,000, even if the baggage eventually arrives.
On December 31, 2014, consumers had booked a total of 50,000 flights using their
Fly-By-Night cards. Past experience indicates that approximately 1% of consumers lose
their baggage during an airline flight.
A. (1) _______

Given the information provided above, in accordance with US GAAP,

which of the following statements is (are) true?
A. Fly-By-Night should report a liability in the amount of $ 500,000
related to the guarantees that baggage will arrive on time.
B. Fly-By-Night should disclose that their maximum obligation related
to lost baggage is $ 50,000,000.
C. Both A and B
D. None of the above

B. Do you AGREE or DISAGREE with the following statement?

My answer to Part A would have been the same prior to the issuance of
Financial Interpretation 45 (i.e. FIN 45).
Circle either AGREE or DISAGREE, and BRIEFLY support your answer.

Problem 2 (2 Points)
On January 1, 2009, Broke Company issued bonds in order to raise cash. Relevant
information related to the issuance of the bonds is as follows:
Face Value:
$ 40,000,000
Maturity Date: December 31, 2023
Coupon Rate:
9.0% per year
Interest Payments: Annually on December 31
At the time the bonds were issued, the credit rating of Broke Company was BB. At the
time of issuance, for fifteen year bonds, credit ratings translate into the following yield
to maturity:
Interest Rate

AAA AA
4.0% 6.0%

A
BBB
8.0% 10.0%

BB
12.0%

B
14.0%

CCC
18.0%

Please note that there are present value tables for one-time cash flows (PVFn,i%) and for
annuities (PVA n, i%) on page three.
A. (1)

B. (1)

Based on the information provided above, and assuming that the bonds are
not paid off prior to the maturity date, what is the Total Interest Expense that
Broke Company will record over the lifetime of the bonds?

What journal entry will Broke Company prepare to record the Interest
Expense/Payment for the fiscal year ending December 31, 2019?

Problem 3 (1 Point)
The following statement is TRUE / FALSE (circle one):
Under Current U.S. GAAP, firms are NOT allowed to report a Gain/Loss on their
income statement if they retire their bonds prior to the maturity date.

FACTORS
Present Value of 1:

PVF n, i

1/ (1 + i)n

Present Value of 1

1
2
3
4
5
7
10
15
20
30
40

2.0%
0.9804
0.9612
0.9423
0.9238
0.9057
0.8706
0.8203
0.7430
0.6730
0.5521
0.4529

4.0%
0.9615
0.9246
0.8890
0.8548
0.8219
0.7599
0.6756
0.5553
0.4564
0.3083
0.2083

6.0%
0.9434
0.8900
0.8396
0.7921
0.7473
0.6651
0.5584
0.4173
0.3118
0.1741
0.0972

8.0%
0.9259
0.8573
0.7938
0.7350
0.6806
0.5835
0.4632
0.3152
0.2145
0.0994
0.0460

Present Value of an Ordinary Annuity of 1: PVA n,i =

10.0%
0.9091
0.8264
0.7513
0.6830
0.6209
0.5132
0.3855
0.2394
0.1486
0.0573
0.0221

12.0%
0.8929
0.7972
0.7118
0.6355
0.5674
0.4523
0.3220
0.1827
0.1037
0.0334
0.0107

14.0%
0.8772
0.7695
0.6750
0.5921
0.5194
0.3996
0.2697
0.1401
0.0728
0.0196
0.0053

15.0%
0.8696
0.7561
0.6575
0.5718
0.4972
0.3759
0.2472
0.1229
0.0611
0.0151
0.0037

18.0%
0.8475
0.7182
0.6086
0.5158
0.4371
0.3139
0.1911
0.0835
0.0365
0.0070
0.0013

15.0%
0.8696
1.6257
2.2832
2.8550
3.3522
4.1604
5.0188
5.8474
6.2593
6.5660
6.6418

18.0%
0.8475
1.5656
2.1743
2.6901
3.1272
3.8115
4.4941
5.0916
5.3527
5.5168
5.5482

____1___
i ( 1 + i )n

Present Value of an Ordinary Annuity of 1 - No Growth

1
2
3
4
5
7
10
15
20
30
40

2.0%
0.9804
1.9416
2.8839
3.8077
4.7135
6.4720
8.9826
12.8493
16.3514
22.3965
27.3555

4.0%
6.0%
8.0%
0.9615
0.9434 0.9259
1.8861
1.8334 1.7833
2.7751
2.6730 2.5771
3.6299
3.4651 3.3121
4.4518
4.2124 3.9927
6.0021
5.5824 5.2064
8.1109
7.3601 6.7101
11.1184
9.7122 8.5595
13.5903 11.4699 9.8181
17.2920 13.7648 11.2578
19.7928 15.0463 11.9246

10.0%
0.9091
1.7355
2.4869
3.1699
3.7908
4.8684
6.1446
7.6061
8.5136
9.4269
9.7791

12.0%
0.8929
1.6901
2.4018
3.0373
3.6048
4.5638
5.6502
6.8109
7.4694
8.0552
8.2438

14.0%
0.8772
1.6467
2.3216
2.9137
3.4331
4.2883
5.2161
6.1422
6.6231
7.0027
7.1050

Problem 1
A. The correct answer is C. Subsequent to the passage of FIN 45, when a firm
makes a guarantee, they are initially required to report a liability equal to the fair
value of the liability at inception. Further, a firm is required to disclose the
maximum obligation that could be incurred related to the liability.
B. Assuming that you answered Part A as indicate above, you would DISAGREE
with the statement. Prior to the issuance of FIN 45, firms treated guarantees
in a manner consistent with contingencies. That is, a firm was only required to
report a liability if they deemed it probable that the firm would be required to
make a payment related to the guarantee.
Problem 2
A.

Calculate the Total Interest Expense over the lifetime of the bonds as being equal
To the difference between the Total Payments made related to the bonds less the
Proceeds received when the bonds were issued.
With a discount rate of 12%, the total proceeds received from the bonds would be
calculated as:
$ 40,000,000 x PVFn=15,i=12% + ($ 40,000,000 x .09) x PVAn=15,i=12%
= $ 40,000,000 x 0.1827
+ $ 3,600,000 x 6.8109
= $ 7,308,000 + 24,519,240 = $ 31,827,240
Total Payments made on the bonds equal $ 94,000,000, calculated as 15 annual
Interest payments x $ 3,600,000 per year plus $ 40,000,000 at the maturity date.
Thus, Total Interest Expense equals $ 62,172,760 (i.e. $ 94,000,000 - $ 31,827,240)

B.

Calculate the carrying value of the bond on December 31, 2018 as being equal to
$ 35,673,280:
$ 40,000,000 x PVFn=5,i=12% + ($ 40,000,000 x .09) x PVAn=5,i=12%
= $ 40,000,000 x 0.5674
+ $ 3,600,000 x 3.6048
= $ 22,696,000 + 12,977,280 = $ 35,673,280
Thus, 2019 Interest Expense is $ 4,280,794, and the applicable journal entry is:
DB Interest Expense
$ 4,280,794
CR
Cash
$ 3,600,000
CR
Disc. on Bonds Payable
680,794

Problem 3
The statement is FALSE. When a firm retires a bond prior to maturity, the firm reports
a GAIN/LOSS equal to the difference between the carrying value of the bonds and the
amount paid to retire the bond.

ACCT 3620 FALL 2015

QUIZ 3 ANALYSIS
DISTRIBUTION BY TOTAL
Score
5
4-4.5
3.3.5
2-2.5
<2
Mean
Std. Dev.

Number
4
10
14
3
0
3.74
0.84

DISTRIBUTION BY QUESTION
Question
1A
1B
2A
2B
3

Avg.
0.76
0.98
0.53
0.56
0.90

Mean

3.74