Financial Accounting

Module 6 Cases

Oktay Urcan
QUESTION ONE

Refer to the table in Johnson & Johnson’s 2010

annual report for long-term liabilities. Recall that
the company’s fiscal year end is 2 January 2011.
Using the information provided, answer the
following questions.
NOTE: Always use Semi-Annual Calculations.

Johnson & Johnson - Long -Term Debt

QUESTION ONE
a. Refer to the 5.55% debentures due 2017 (3rd
instrument on the table). Calculate the interest
expense on this note for fiscal 2011 (year ended 2
January 2012).
Since the value of the instrument does not change
between year 2009 and 2010, this is a par bond. For par
bonds, interest expense is equal to coupon payment.
Therefore, interest expense is 5.55% * $1,000 = $55.5 in
year 2011.

Johnson & Johnson - Long -Term Debt

QUESTION ONE

Johnson & Johnson: Long -Term Debt

QUESTION ONE
b. Refer to the same note as in part (a). Provide
the entry that the company will record at maturity.
Semi-annual payments
$55.5 / 2 = $27.75

ASSETS LIABILITIES SHE

Cash Bond Payable Income Statement

Coupon Payment (27.75) (27.75)

Bond Payment (1,000.00) (1,000.00)

Johnson & Johnson - Long -Term Debt

QUESTION ONE

Johnson & Johnson: Long -Term Debt

QUESTION ONE

c. Refer to the 3% zero coupon convertible

subordinated debentures due 2020 (6th instrument
on the table). Calculate the interest expense on
this note for fiscal year 2011 (year ended 2
January 2012).
Since this is a zero coupon note there will be no coupon
payment. Interest expense for the year should be $5.86
million calculated as follows:

Johnson & Johnson - Long -Term Debt

QUESTION ONE
c. Refer to the 3% zero coupon convertible
subordinated debentures due 2020 (6th instrument
on the table). Calculate the interest expense on
this note for fiscal year 2011 (year ended 2
January 2012).
ASSETS LIABILITIES SHE

Cash Bond Payable Income Statement

Beginning
194 194 * 1.5% = 2.91
Balance
1st Coupon
0 2.91 (2.91)
Payment
2 Coupon
nd
0 2.95 (2.95)
Payment
(194 + 2.91) * 1.5% = 2.95

Johnson & Johnson - Long -Term Debt

QUESTION ONE

Johnson & Johnson: Long -Term Debt

QUESTION TWO

The following pages contain the balance sheet and

part of the footnote 10C. (long-term debt) for Pfizer
Inc. from their 2007 annual report. Using this
information, please answer the following
questions.
1. What is the net book value of Pfizer’s long-term
debt at December 31, 2007?
$7,314 million

Pfizer, Inc. – Bond Accounting

QUESTION TWO

Pfizer, Inc. – Bond Accounting

QUESTION TWO
2. The following questions relate to the 6.50% senior
unsecured notes due December 2018 (7th item on the
table). Assume that the face value of these bonds is
$700 (in millions) and that interest is recorded annually.

a. What is your estimate of the total amount of interest

expense that Pfizer recognized in fiscal year 2007 on
these 6.50% notes?
Amortization of discount = $527 − $506 = $21

Interest expense = (6.5% * $700) + $21 = $66.5

Pfizer, Inc. – Bond Accounting

QUESTION TWO

a. What is your estimate of the total amount of

interest expense that Pfizer recognized in fiscal
year 2007 on these 6.50% notes?
$ ASSETS LIABILITIES SHE
Cash Bond Payable Income Statement
Beginning
506
Balance
Coupon
$1,141 - (45.5)
$1,099 = $42 21 (66.5)
Payment
Ending
527
Balance 700 * 6.5% = $45.5 45.5 + 21 = $66.5

527-506 = $21

Pfizer, Inc. – Bond Accounting

QUESTION TWO

Pfizer, Inc. – Bond Accounting

QUESTION TWO

b. What is the amount of unamortized discount

or premium related to the 6.50% notes at
December 31, 2007?
$700 − $527 = $173

Pfizer, Inc. – Bond Accounting

QUESTION TWO

Pfizer, Inc. – Bond Accounting

QUESTION TWO

c. What is your best estimate of the historical

interest rate on the 6.50% note?

Interest expense = Interest rate * Beginning NBV

$66.5 = r * $506
r = 13%

Pfizer, Inc. – Bond Accounting

QUESTION TWO

Pfizer, Inc. – Bond Accounting

QUESTION TWO

d. What is your best estimate of the total amount

of interest expense that Pfizer will record next
year (i.e., fiscal year 2008) on these 6.50%
notes?
Interest expense = beginning bond payable * Interest rate
Interest expense = $527 * 13% = $68.51 million

Pfizer, Inc. – Bond Accounting

QUESTION TWO

Pfizer, Inc. – Bond Accounting

QUESTION TWO

e. What is your best estimate of the fair value of

the 6.50% notes at December, 2018, when they
are due?
$700 million

Pfizer, Inc. – Bond Accounting

QUESTION THREE

Refer to the table below from Southwest Airline’s

2017 rnnual report for capital leases (note 7 of
the notes to the financial statements). Using the
information provided, answer the following
questions.
1. What is the present value of future minimum
capital lease payments for Southwest Airlines?
$780 million

Southwest Airlines - Leases

QUESTION THREE

Southwest Airlines - Leases

QUESTION THREE

2. Suppose that the lease payments after 2022

will be equally paid over the next 5 years.
Calculate the lease discount rate for Southwest
Airlines.

Southwest Airlines - Leases

QUESTION THREE

2. Suppose that the lease payments after 2022

will be equally paid over the next 5 years.
Calculate the lease discount rate for Southwest
Airlines.
3.5% (Using Excel and IRR formula)

Year 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027
Amount (780) 107 106 105 100 96 83 83 83 83 83
IRR 3.5%

Southwest Airlines - Leases

QUESTION THREE

3. What is the journal entry for capital lease

payment in fiscal year 2018?

ASSETS LIABILITIES SHE

Cash Lease Payable Income Statement
Beginning
780
Balance
$1,141 - $1,099 = $42
2018 (107) (79.7) (27.3)

107 – 27.3 = $79.7 780 * 3.5% = $27.3

Southwest Airlines - Leases

QUESTION THREE

Southwest Airlines - Leases

QUESTION FOUR

Refer to the table in Amgen’s 2006 annual report

for long-term liabilities. Recall that the company’s
fiscal year end is 31 December, 2006. Using the
information provided, answer the following
questions.
NOTE: Always use semi-annual calculations.

Amgen - Long -Term Debt

QUESTION FOUR
a. Refer to the 4.85% notes due 2014 (4th
instrument on the table). Calculate the interest
expense on this note for fiscal 2007 (year ended
31 December 2007).
Since the value of the instrument does not change
between year 2005 and 2006, this is a par bond. For par
bonds, interest expense is equal to coupon payment.
Therefore, interest expense is 4.85% * $1,000 = $48.5 in
year 2007.

Amgen - Long -Term Debt

QUESTION ONE
QUESTION FOUR
b. Refer to the same note as in part (a). Provide
the entry that the company will record at maturity.
Semi-annual payments
$48.5 / 2 = $24.25

ASSETS LIABILITIES SHE

Cash Bond Payable Income Statement

Coupon Payment (24.25) (24.25)

Bond Payment (1,000.00) (1,000.00)

Amgen - Long -Term Debt

QUESTION ONE
QUESTION FOUR
c. Refer to the zero coupon notes due 2032 (3rd
instrument on the table). Assume these zero
coupon notes have an annual yield of 1.125%.
Calculate the interest expense on this note for
fiscal year 2007 (year ended 31 December 2007).
Since this is a zero coupon note there will be no coupon
payment. Interest expense for the year should be $20.1
million calculated as follows:

Amgen - Long -Term Debt

QUESTION FOUR
c. Refer to the zero coupon notes due 2032 (3rd
instrument on the table). Assume these zero
coupon notes have an annual yield of 1.125%.
Calculate the interest expense on this note for
fiscal year 2007 (year ended 31 December 2007).
ASSETS LIABILITIES SHE

Cash Bond Payable Income Statement

Beginning 1,778 * 1.125% / 2

1,778
Balance = 10.0

1st Coupon
0 10.0 (10.0)
Payment
2 Coupon
nd
0 10.1 (10.1)
Payment (1,778 + 10.0) * 1.125% / 2
= 10.1

Amgen - Long -Term Debt

QUESTION ONE
QUESTION FIVE

The following pages contain the balance sheet and

part of the footnote 18 (debt) for Tyco from the
2002 annual report. Using this information, please
answer the following questions.
1. What is the net book value of Tyco’s long-term
Debt at September 30, 2002?
$16,486.8 million

Tyco International Ltd.– Bond Accounting

QUESTION FIVE

Tyco International Ltd.– Bond Accounting

QUESTION FIVE

2. The following questions relate to the zero

coupon convertible senior debentures with 2003
put options (12th instrument on the table). Assume
that the face value of these bonds is $4,000 (in
millions) and that interest is recorded annually.
(a) What is your estimate of the total amount of
interest expense that Tyco recognized in fiscal
2002 on their zero coupon debentures?

Tyco International Ltd.– Bond Accounting

QUESTION FIVE
(a) What is your estimate of the total amount of
interest expense that Tyco recognized in fiscal
2002 on their zero coupon debentures?

ASSETS LIABILITIES SHE

Cash Bond Payable Income Statement
Beginning
3,499.4
Balance
Coupon
0 19.7 (19.7)
Payment
Ending
3,519.1
Balance

$3,519.1 − $3,499.4 = $19.7 million

Tyco International Ltd.– Bond Accounting
QUESTION FIVE

Tyco International Ltd.– Bond Accounting

QUESTION FIVE

b. What is your best estimate of the historical

interest rate on these zero coupon debentures?

According to Coursera lecture notes:

Interest expense = Interest rate * Beginning bond payable

$19.7 = Interest rate * $3,499.4

Interest rate = 0.6%

Tyco International Ltd.– Bond Accounting

QUESTION FIVE

Tyco International Ltd.– Bond Accounting

QUESTION FIVE

(c) What is your best estimate of the total amount

of interest expense that Tyco will record next year
(i.e., fiscal year 2003) on these zero coupon
notes? Be specific.
Interest expense = Beginning bond payable * Interest rate
Interest expense = $3,519.1 * 0.6% = $21.1 million

Tyco International Ltd.– Bond Accounting

QUESTION FIVE

Tyco International Ltd.– Bond Accounting

QUESTION FIVE

(d) What is your best estimate of the fair value of

these zero coupon debentures at November 2020
when they are due?
$4,000 million

Tyco International Ltd.– Bond Accounting

QUESTION FIVE

3. Assume that the 4.95% notes due 2003 (10th

instrument on the table) were originally issued at
par. What must have happened during 2002?
Since NBV went down, Tyco must have paid off a portion
of these notes.

Tyco International Ltd.– Bond Accounting

QUESTION FIVE

Tyco International Ltd.– Bond Accounting

QUESTION SIX

Refer to the table below from Marriott International,

Inc.’s 2018 annual report for capital leases (note 8
of the notes to the financial statements). Using the
information provided, answer the following
questions.
1. What is the present value of future minimum
capital lease payments for Marriott?
$163 million

Marriott International - Leases

QUESTION SIX

Marriott International - Leases

QUESTION SIX

2. Suppose that the lease payments after 2023

will be equally paid over the next 5 years.
Calculate the lease discount rate for Marriott.

Marriott International - Leases

QUESTION SIX

2. Suppose that the lease payments after 2023

will be equally paid over the next 5 years.
Calculate the lease discount rate for Marriott.
5.54% (Using Excel and IRR formula)

Year 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028
Amount (163) 13 13 13 13 13 33 33 33 33 33
IRR 5.54%

Marriott International - Leases

QUESTION SIX

3. What is the journal entry for capital lease

payment in fiscal year 2019?

ASSETS LIABILITIES SHE

Cash Lease Payable Income Statement
Beginning
163
Balance
$1,141 - $1,099 = $42
2018 (13) (4) (9)

13 - 9 = $4 163 * 5.54% = $9

Marriott International - Leases

QUESTION SIX

Marriott International - Leases