Chapter 14 Troubled Debt Restructuring

1. In a troubled debt restructuring in which the debt is continued with modified terms and
the carrying amount of the debt is less than the total future cash flows,
a. a loss should be recognized by the debtor.
b. a gain should be recognized by the debtor.
c. a new effective-interest rate must be computed.
d. no interest expense or revenue should be recognized in the future.

2. In a troubled debt restructuring in which the debt is continued with modified terms, a gain
should be recognized at the date of restructure, but no interest expense should be
recognized over the remaining life of the debt, whenever the
a. carrying amount of the pre-restructure debt is less than the total future cash flows.
b. carrying amount of the pre-restructure debt is greater than the total future
cash flows.
c. present value of the pre-restructure debt is less than the present value of the future
cash flows.
d. present value of the pre-restructure debt is greater than the present value of the
future cash flows.

3. In a troubled debt restructuring in which the debt is continued with modified terms and
the carrying amount of the debt is less than the total future cash flows, the creditor
should
a. compute a new effective-interest rate.
b. not recognize a loss.
c. calculate its loss using the historical effective rate of the loan.
d. calculate its loss using the current effective rate of the loan.

Use the following information for questions 4 through 6:

On December 31, 2008, Nolte Co. is in financial difficulty and cannot pay a note due that day. It
is a $600,000 note with $60,000 accrued interest payable to Piper, Inc. Piper agrees to accept
from Nolte equipment that has a fair value of $290,000, an original cost of $480,000, and
accumulated depreciation of $230,000. Piper also forgives the accrued interest, extends the
maturity date to December 31, 2011, reduces the face amount of the note to $250,000, and
reduces the interest rate to 6%, with interest payable at the end of each year.

4. Nolte should recognize a gain or loss on the transfer of the equipment of

a. $0.
b. $40,000 gain.
c. $60,000 gain.
d. $190,000 loss.

$ 480,000-$230,000= $250,000 cost basis. FV of equipment is $ 290,000 thus $ 40,000 gain.

 5. Nolte should recognize a gain on the partial settlement and restructure of the debt of
a. $0.
b. $15,000.
c. $55,000.
d. $75,000.

($ 600,000 debt + $ 60,000 accrued interest) – ($ 290,000 FV of equipment +

$250,000 note +accrued interest of $ 45,000 on new note). Interest on new note
= $ 250,000 x 6% x 3 years.

6. Nolte should record interest expense for 2011 of

a. $0. Effective Interest rate is 0.
b. $15,000.
c. $30,000.
d. $45,000.

7. Eddy Co. is indebted to Cole under a $400,000, 12%, three-year note dated
December 31, 2009. Because of Eddy's financial difficulties developing in 2011, Eddy
owed accrued interest of $48,000 on the note at December 31, 2011. Under a troubled
debt restructuring, on December 31, 2011, Cole agreed to settle the note and accrued
interest for a tract of land having a fair value of $360,000. Eddy's acquisition cost of the
land is $290,000. Ignoring income taxes, on its 2011 income statement Eddy should
report as a result of the troubled debt restructuring
Gain on Disposal Restructuring Gain
a. $158,000 $0
b. $110,000 $0
c. $70,000 $40,000
d. $70,000 $88,000

Gain on disposal: $360,000 FV- $290,000 Cost of Land

Restructuring Gain: $400,000 Debt+ $ 48,000 accrued interest- $ 360,000 FV of Land

8. Accounting for a troubled debt settlement.

Ludwig, Inc., which owes Giffin Co. $800,000 in notes payable, is in financial difficulty. To
eliminate the debt, Giffin agrees to accept from Ludwig land having a fair market value of
$610,000 and a recorded cost of $450,000.

Instructions
(a) Compute the amount of gain or loss to Ludwig, Inc. on the transfer (disposition) of the land.
(b) Compute the amount of gain or loss to Ludwig, Inc. on the settlement of the debt.
(c) Prepare the journal entry on Ludwig 's books to record the settlement of this debt.
(d) Compute the gain or loss to Giffin Co. from settlement of its receivable from Ludwig.
(e) Prepare the journal entry on Giffin's books to record the settlement of this receivable.
Solution
(a) Fair market value of the land $610,000
Cost of the land to Ludwig, Inc. 450,000
Gain on disposition of land $160,000

(b) Carrying amount of debt $800,000

Fair market value of the land given 610,000
Gain on settlement of debt $190,000

(c) Notes Payable ............................................................................. 800,000

Land ................................................................................ 450,000
Gain on Disposition of Land ............................................. 160,000
Gain on Settlement of Debt .............................................. 190,000

(d) Carrying amount of receivable $800,000

Land received in settlement 610,000
Loss on settled debt $190,000

(e) Land ............................................................................................ 610,000

Allowance for Doubtful Accounts ................................................. 190,000
Notes Receivable ............................................................. 800,000
CHAPTER 14 LONG TERM LIABILITIES- TIPS ON BONDS

1. The denomination of a bond is called the face value. Synonymous terms are par value, principal
amount, maturity value and face amount.
2. Bond prices are quoted in terms of percentage of par. Thus bond with a par value of $ 4,000
and a price quote of 102 is currently selling for a price of $ 4,080 (102 x $ 4,000). A bond with a
quote of 100 is selling at par or face value.
3. The bond contract is called an indenture. This term is often confused with the term debenture.
A debenture bond is an unsecured bond.
4. The interest rate written in the bond indenture and ordinarily appearing on the bond certificate
is known as the stated rate. Synonymous terms are: coupon rate, nominal rate and contract
rate.
5. The rate of interest actually earned by bondholders is called the effective, yield or market rate.
6. A bond’s issuance price is determined by the present value of all of the future cash flows
promised by the bond indenture. The future cash flows include the face value and interest
payments. The bond’s present value is determined by using the market rate of interest at the
date of issuance. An excess of the issuance price over par is called a premium; an excess of par
value over issuance price is called a discount.
7. In computing the present value of a bond’s (1) maturity value and (2) interest payments, the
same interest rate is used. That rate is the effective interest rate on a per interest period basis.
Example: If a ten year bond has a state rate of 10%, pays interest semiannually, and is issued to
yield 12%, a 6% rate is used to perform all of the present value calculations.
8. Bond prices vary inversely with changes in the market rate of interest. This means :

As the market rate of interest goes down, bond prices go up.

As the market rate of interest goes up, bond prices go down.

This also means that at the date of issuance:

If the market rate of interest is below the state rate, the price will be above par.

If the market rate of interest is above the stated rate, the price will be below par.

Thus, a premium or a discount is an adjustment to interest via an adjustment to price. The

adjustment to interest is recorded by the process of amortizing the premium or discount over
the periods the bond is outstanding.

9. Interest payments on notes payable are generally made on a monthly or quarterly basis.
Interest payments on bonds payable are usually made semiannually. Despite these practices
interest rates generally are express on an annual basis. Therefore care must be taken that the
annual rate be converted to a ”rate per period” before other computations are performed.
10. The Discount on Bonds Payable is a contra liability account so its balance should be deducted
from Bonds Payable on the balance sheet. The Premium on Bonds Payable account is an
adjunct type of valuation account so that its balance is added to Bonds Payable on the balance
sheet. Unamortized Bond Issuance Costs are to be classified as a deferred charge in the “other
 assets” classification on the balance sheet; they should be amortized over the bond’s life using
the straight line method.
11. The effective interest method of amortization is sometimes called the interest method or the
present value method or the effective method. When the effective interest method is used, the
bond’s carrying value will equal its present value (assuming amortization is up to date). The
effective interest method is the only amortization method that qualifies as GAAP. However,
when the results of applying the straight- line method of amortization are not materially
different than the results of using the effective interest method, the straight-line method may
be used without being considered a departure (a violation) of GAAP.
12. When the accounting period ends on a date other than an interest date, the amortization
schedule for a bond or a note payable is unaffected by this fact. That is, the schedule is
prepared and computations are made according to the bond periods, ignoring the details of the
accounting period. The interest expense amounts shown in the amortization schedule are then
apportioned to the appropriate accounting period.

EXAMPLE: If the interest expense for the six months ending April 30, 2008 is $ 120,000,
then $ 40,000 (2/6) of that amount would appear on the income statement for the 2007
calendar year and $ 80,000 (4/6) should be reflect on the income statement for the 2008
calendar year.
Chapter 14 Bond Prices and Interest Rates:

Facts: Three year bonds are issued at face value of $ 100,000 and a stated rate of interest of 12%.

1. If the bonds are issued to yield 10%, what is the selling price of the bond?

PV of $100,000 (Table 6-2-PV of a $1) x .75132 = $ 75,132

PV of Interest Payments (Table 6-4-PV of Ordinary Annuity)

$ 100,000 x 12% = $ 12,000 annual interest x 2.48685 = $ 29,842

Selling Price of Bonds $104,974

Were the bonds sold at a premium or a discount and what is the journal entry to record the transaction?

Because the stated rate is higher than the effective(also referred to as market or yield rate), bonds are
sold at a premium.

Cash $ 104,974

Bonds Payable $ 100,000

Premium 4,974

2. If the bonds are issued to yield 12%, what is the selling price of the bond?

PV of $ 100,000 (Table 6-2) $ 100,000 x .71178 = $ 71,178

PV of Interest Payments (Table 6-4)

$ 100,000 x 12% = $ 12,000 interest x 2.40183 = $ 28,822

Selling Price of bonds at par = $ 100,000

Were the bonds sold at a premium or discount and what is the journal entry to record the transaction?

Bonds were sold at par since the market(yield or effective) rate equals the stated rate of 12%.

Cash $ 100,000

Bonds Payable $ 100,000

3. If the bonds were issued to yield 15%, what is the selling price of the bond?

PV of $ 100,000 ( Table 6-2) $ 100,000 x .65752 = $ 65,752

PV of Interest Payments ( Table 6-4)

$ 100,000 x 12% = $ 12,000 interest payments x 2.40183 = $ 27,399

Selling price of bonds = $ 93,151

Were the bonds sold at a premium or discount and what is the journal entry to record the transaction?

Bonds were sold at a discount-since market(effective or yield) rate is higher than stated rate, we
must discount the bonds in order to get people wanting to buy them.

Cash $ 93,151

Discount 6,849

Bonds Payable $ 100,000

Chapter 14 Bond Problems including Accrued Interest with Solutions
1. On March 31, 2009, Hanson Corporation sold $7,000,000 of its 8%, 10-year bonds for $6,730,500
including accrued interest. The bonds were dated January 1, 2009. Interest is paid semiannually on
January 1 and July 1. On April 1, 2013, Hanson purchased 1/2 of the bonds on the open market at 99 plus
accrued interest and canceled them. Hanson uses the straight-line method for amortization of bond
premiums and discounts.

(a) What was the amount of the gain or loss on retirement of the bonds?

1. Determine amount of interest included in $ 6,730,500 purchase price.

($7,000,000 × .08 × 3/12) = Accrued interest at Date Bond sold or $140,000

Thus the bond itself sold for $ 6,590,500

2. Determine premium or discount

Face of Bonds $7,000,000
Bond Price $6,590,500
Discount at 3/31/09 409,500

3. Determine amortization

This was a 10 year bond = 10 x 12 = 120 months

3 months have lapsed prior to sale = 3 months
Remaining months to amortize = 117 months

Monthly amortization = $409,500 / 117 = $3,500 per month

How many months have passed until 4/1/2013? 48

Thus the amortization to 4/1/13 = $3,500 x 48 months = $168,000

Original Discount at Date of Sale = $ 409,500

Less amortization taken = $ 168,000
Unamortized discount at 4/1/13 = $ 241,500
Carrying value at 4/1/13 = $ 6,758,500
Carrying value of 1/2 of the bonds $ 3,379,250
Less acquisition price ($7,000,000 ×.99 × 1/2) 3,465,000
Loss on retirement $ 85,750

Journal Entry when bonds are sold on March 31, 2009:

Cash $6,730,500
Discount 409,500

Bonds Payable $7,000,000

Interest Expense (or Interest Payable) 140,000
 (b) Prepare the journal entry needed at April 1, 2013 to record retirement of the bonds. Assume that
interest and premium or discount amortization have been recorded through January 1, 2013. Record
interest and amortization on only the bonds retired.

Interest Expense .................................................................... 75,250

Discount on Bonds Payable ($1,750 × 3) ...................... 5,250
Cash ............................................................................. 70,000
(To accrue interest to 4/1/13:
$7,000,000 × .08 × 3/12 × 1/2 = $70,000)

This entry is to accrue the interest expense for January 1, 2013 to April 1, 2013 and pay the cash owed
to the bondholder-he is entitled to the cash at date bond is retired.

Bonds Payable .................................................................. 3,500,000

Loss on Redemption of Bonds .................................................. 85,750
Discount on Bonds Payable ($241,500 × 1/2) ................ 120,750
Cash ............................................................................. 3,465,000
(To remove carrying value of bonds)

(c) Prepare the journal entry needed at July 1, 2013 to record interest and premium or discount
amortization.

Interest Expense ...................................................................... 150,500

Discount on Bonds Payable .......................................... 10,500
Cash ............................................................................. 140,000
(Discount amortization:
$409,500 ÷ 117 mos. × 6 mos. × 1/2 = $10,500)

Remember this is for the ½ bonds that remain-it is not advised for purposes of this class to redo your schedule.
Just remember only ½ of bond remain.

2. On January 1 of the current year, Feller Corporation issued $3,000,000 of 10% debenture bonds on a basis
to yield 9%, receiving $3,134,580. Interest is payable annually on December 31 and the bonds mature in 6
years. The effective-interest method is used.

(a) What is the interest expense for the first year?

First year interest expense:

$3,134,580 × .09 = $282,112

(b)What is the interest expense for the second year?

Second year interest expense:

$300,000 – $282,112 = $17,888 Premium amortization (First year).

$3,134,580 – $17,888 = $3,116,692 Book value of bonds at the beginning of the second year.

$3,116,692 × .09 = $280,502 Interest expense.

3. On October 1, 2012, Noller Company issued $4,000,000 par value, 10%, 10-year bonds dated July 1,
2012, with interest payable semiannually on January 1 and July 1. The bonds are issued at $4,542,000 (to
yield 8%) plus accrued interest. The effective interest method is used.

(a) Prepare the journal entry at the date the bonds are issued.

Cash .................................................................................. 4,642,000

Bonds Payable ............................................................. 4,000,000
Premium on Bonds Payable ......................................... 542,000
Interest Payable ........................................................... 100,000

(b) Prepare the adjusting entry at December 31, 2012, the end of the fiscal year.

Interest Expense ............................................................................ 90,840

Premium on Bonds Payable ..................................................... 9,160
Interest Payable ........................................................... 100,000
(Interest expense: $4,542,000 × .08 × 3/12 = $90,840)

(c) Prepare the entry for the interest payment on January 1, 2013.

Interest Payable ...................................................................... 200,000

Cash ............................................................................. 200,000

4. Prepare journal entries to record the following transactions related to long-term bonds of Quirk Co.
(a) On April 1, 2011, Quirk issued $1,000,000, 9% bonds for $1,075,736 including accrued interest. Interest is
payable annually on January 1, and the bonds mature on January 1, 2021.

Cash.............................................................................................. 1,075,736
Bonds Payable .................................................................... 1,000,000
Interest Expense ($1,000,000 × 9% × 3/12) ........................ 22,500
Premium on Bonds Payable ................................................ 53,236
(b) On July 1, 2013 Quirk retired $300,000 of the bonds at 102 plus accrued interest. Quirk uses straight-line
amortization.

1. Amortize bond to date of retirement.

Interest Expense ........................................................................... 12,680

Premium on Bonds Payable ($53,236 × .3 × 6/117) ...................... 820
Cash ($300,000 × 9% × 6/12) ............................................. 13,500

This entry amortizes the bond to the date of retirement and pays the bondholder the interest he is owed in
cash. This also brings the Income Statement to the correct amount of interest expense incurred for the period
to the date of retirement.

Note: This was a 10 year bond but it was not sold until the 3 months after the date 9( assumed since it matures
on January 1, 2021. Maturity is on the same date as original bond date but in the future. Thus for amortization
purposes we only have 117 months remaining at date bond is sold until it matures.

2. Retire the portion of the bond and its related accounts to determine gain or loss.

Bonds Payable .............................................................................. 300,000

Premium on Bonds Payable ($53,236 × .3 × 90/117) .................... 12,284
Cash ................................................................................... 306,000
Gain on Redemption of Bonds ............................................ 6,284

Here we determined the number of months remaining to amortize by determining the months that have
lapsed (quick short cut).

2011 9 months
2012 12 months
2013 6 months

Total 27 months

5. A company issues $5,000,000, 7.8%, 20-year bonds to yield 8% on January 1, 2007. Interest is paid
on June 30 and December 31. The proceeds from the bonds are $4,901,036. Using effective-interest
amortization, what will the carrying value of the bonds be on the December 31, 2007 balance sheet?
a. $4,903,160
b. $5,000,000
c. $4,906,281
d. $4,902,077

Cash Interest Effective/Yield Amortization Carrying Value

Interest
4,901,036
195,000 196,041 1,041 4,902,077
195,000 196,083 1,083 4,903,160
6. On January 1, 2001, Gonzalez Corporation issued $4,500,000 of 10% ten-year bonds at 103. The
bonds are callable at the option of Gonzalez at 105. Gonzalez has recorded amortization of the bond
premium on the straight-line method (which was not materially different from the effective-interest
method).
On December 31, 2007, when the fair market value of the bonds was 96, Gonzalez repurchased
$1,000,000 of the bonds in the open market at 96. Gonzalez has recorded interest and amortization for
2007. Ignoring income taxes and assuming that the gain is material, Gonzalez should report this
reacquisition as
a. a loss of $49,000.
b. a gain of $49,000.
c. a loss of $61,000.
d. a gain of $61,000.

Carrying Value at Date of Issue = $ 4,500,000 x 1.03= $ 4,635,000

Thus we have a Premium of $135,000.
Straight Line amortization for 10 years = $1,125 per month

At date bonds are acquired in the open market determine the carrying value of the entire bond issue as
of 12/31/07.

Bond Payable $ 4,500,000

Plus remaining Bond Premium $1,125 x 36 months remaining 40,500
Carrying Value of Entire Bond $4,540,500

What percentage of bonds are being retired? 22.22 % ($1,000,000/ $4,500,000)

Thus the CV is $ 1,009,000 for bonds repurchased as of 12/31/07. ($4,540,500 x.22222) and rounded.

To determine gain or loss:

Bonds Payable 1,000,000

Bond Premium 9,000
Cash 960,000 ($1,000,000 x .96)
Gain on Sale 49,000

7. Goebel Company issues $5,000,000 face value of bonds at 96 on January 1, 2006. The bonds are
dated January 1, 2006, pay interest semiannually at 8% on June 30 and December 31, and mature in
10 years. Straight-line amortization is used for discounts and premiums. On September 1, 2009,
$3,000,000 of the bonds are called at 102 plus accrued interest. What gain or loss would be recognized
on the called bonds on September 1, 2009?
a. $300,000 loss
b. $136,000 loss
c. $180,000 loss
d. $226,667 loss

Bonds issued at $4,800,000 ($5,000,000 face x .96)

Thus there is a $ 200,000 discount
Straight line amortization would be for 120 months or $1,666.67 per month

Amortize bond to date of call:

Carrying Value at date bond is issued: $ 4,800,000
Amortization to 9/1/2009 73,333 ($1,666.67 x 44 months)
Carrying Value at 9/1/09 $ 4,873,333
What percentage of bonds are being called? 60% ($3,000,000/$5,000,000)
Carrying value to be removed: $4,873,333 x 60% = $ 2,923,999.80 or $2,924,000 rounded.
Journal Entry:

Bonds Payable 3,000,000

Loss on Retirement 136,000
Discount on Bonds 76,000
Cash 3,060,000 ($3,000,000 x 1.02)
Chapter 14 Bonds Class Problems

1. On April 1,2006, Holiday Brands issued $ 30 million of 6% , 30 year bonds, dated January 1, 2006
for $ 27.5 million, plus accrued interest. What was the amount of accrued interest that was
included in the proceeds received from the bond issue?

2. A company issued 5% , 20 year bonds with a face amount of $ 80 million. The market yield for
bonds of similar risk and maturity is 6%. Interest is paid semiannually. At what price did the
bonds sell?

3. A company issued 6%, 15 year bonds with a face amount of $ 75 million, The market yield for
bonds of similar risk and maturity is 6%. At what price did the bonds sell, if interest is paid
semiannually?

4. A company issued 5%, 20 year bonds with a face amount of $ 100 million. The market yield for
bonds of similar risk and maturity is 4%. Interest is paid semiannually. At what price did the
bonds sell?

5. On January 1, a company issued 7%, 15 year bonds with a face amount of $ 90 million for
$ 82,218,585 to yield 8%. Interest is paid semiannually. What was the interest expense at the
effective interest rate on the December 31 annual income statement?

1
 6. On January 1, a company issued 3% , 20 year bonds with a face amount of $ 80 million for
$ 69,033,776 to yield 4%. Interest is paid semiannually. What was the interest expense at the
effective interest rate on the December 31 income statement?

7. On January 1, a company issued 3% , 20 year bonds with a face amount of $ 80 million for
$ 69,033,776 to yield 4%. Interest is paid semiannually. What was the interest expense using
the straight line method on the December 31 income statement?

8. On January 1, 2007, Oak Co. issued 400 of its 8%, $ 1,000 bonds at 97 plus accrued interest. The
bonds are dated October 1, 2006, and mature on October 1, 2012. Interest is payable
semiannually on April 1 and October 1. Accrued interest for the period October 1, 2006 to
January 1, 2007 amounted to $ 8,000. On January 1, 2007, what amount should Oak report as
bonds payable net of discount?

a. $ 380,000
b. $ 388,000
c. $ 388,300
d. $ 392,000

9 A bond issued on June 1, 2006 has interest payment dates of April 1 and October 1. Bond
interest expense for the year ended December 31, 2006 is a for a period of:

a. 3 months
b. 4 months
c. 6 months
d. 7 months

2
Chapter 14-Class Problems Solution

1. Holiday Brands Problems

$30,000,000 x 6% x 3/12 = $450,000

face annual fraction of the accrued
amount rate annual period interest

2.

Interest $ 2,000,000 ¥ x 23.11477* = $46,229,540

Principal $80,000,000 x 0.30656** = 24,524,800
Present value (price) of the bonds $70,754,340
¥ [5÷2] % x $80,000,000
* present value of an ordinary annuity of $1: n=40, i=3%
** present value of $1: n=40, i=3%

3.

The price will be the present value of the periodic cash interest payments (face amount x
stated rate) plus the present value of the principal payable at maturity. Both interest and
principal are discounted to present value at the market rate of interest for securities of similar risk
and maturity. When the stated rate and the market rate are the same, the bonds will sell at face
value, $75 million in this instance.

4.

Interest $ 2,500,000 ¥ x 27.35548* = $ 68,388,700

Principal $100,000,000 x 0.45289** = 45,289,000
Present value (price) of the bonds $113,677,700
¥ [5÷2] % x $100,000,000
* present value of an ordinary annuity of $1: n=40, i=2%
** present value of $1: n=40, i=2%

5.

Interest will be the effective rate times the outstanding balance:

3
 Cash Interest Effective Interest Amortization Carrying Value

1/1 $82,218,585

6/30 3,150,000 3,288,743 138,743 $ 82,357,328

12/31 3,150,000 3,294,293 144,293 $ 82,501,621

Interest per Income Statement for year of issuance = $ 6,583,036

Cash Flow Statement Interest = $ 6,300,000

How would your answer change is Interest was not paid until January 1 of the next week? Interest for income
statement would not change but for first year of statement of cash flows, there would only be $ 3,150,000 .

6.

Interest will be the effective rate times the outstanding balance:

June 30
Interest expense (2% x $69,033,776)..................................... 1,380,676
Discount on bonds payable (difference) ............................ 180,676
Cash (1.5% x $80,000,000) ............................................... 1,200,000

December 31
Interest expense (2% x [$69,033,776 + 180,676]) ................. 1,384,289
Discount on bonds payable (difference) ............................ 184,289
Cash (1.5% x $80,000,000) ............................................... 1,200,000

$1,380,676 + 1,384,289 = $2,764,965

7.

Interest will be a plug figure:

$80,000,000 - 69,033,776 = $10,966,224 discount

$10,966,224 / 40 semiannual periods = $274,156 reduction each period

June 30
Interest expense (to balance) .................................................. 1,474,156
Discount on bonds payable (difference) ............................ 274,156
Cash (1.5% x $80,000,000) ............................................... 1,200,000

4
 December 31
Interest expense (to balance) .................................................. 1,474,156
Discount on bonds payable (difference) ............................ 274,156
Cash (1.5% x $80,000,000) ............................................... 1,200,000

$1,474,156 + 1,474,156 = $2,948,312

8. b

9. d

5
CHAPTER 14 BONDS EXTRA QUESTIONS SOLUTIONS

Problem 1 Arnold Howell and Company

a.$ 100, 000 par value x 7% stated rate = $ 7,000 annual cash interest

Factor for PV of single sum, I = 10% ; n= 3 .75132

Factor for PV of an ordinary annuity i=10%, n = 3 2.48685
$ 100,000 x .75132 = $ 75,132.00
$ 7,000 x 2.48685= $ 17,407.95
Issue Price $ 92,539.95

Face Value $ 100,000.00

Issue Price $ 92,539.95
Discount $ 7,460.05

b. Cash ( $ 92,539.95- $ 8,000) $ 84,539.95

Discount on bonds payable $ 7,460.05

Bond Issue Costs $ 8,000.00

Bonds Payable $ 100,000

c. Date 7% Stated 10% Effective Amortization Carrying Value

1/1/07 $ 92,539.95

1/1/08 $ 7,000 $ 9,254.00 $ 2,254.00 $ 94,793.95

1/1/09 $ 7,000 $ 9,479.40 $ 2,479.40 $ 97,273.35

1/1/10 $ 7,000 $ 9,726.65* $ 2,726.65 $ 100,000.00

* includes rounding error of .69

Note: Stated interest is determined by multiplying the par value (face value) of the bonds of $ 100,000 by the contract or stated rate
of interest (7%). Interest expense is computed by multiplying the carrying value at the beginning of the interest period by the
effective rate (10%). The amount of discount amortization for the period is the excess of the interest expense over the stated
interest (cash interest) amount. The carrying value at an interest payment date is the carrying value at the beginning of the interest
period plus the discount amortization for the period.

Helpful Hints:

1. The amount of interest expense of $ 9479.40 appearing on the 1/1/09 payment line is the amount of interest expense for
the interest period ending on that date. Thus, in this case, $ 9,479.40 is the interest expense for the 12 months preceding
the date 1/1/09, which would be the calendar year 2008.

2. Any rounding error should be plugged to(included in) the interest expense amount for the last interest period. Otherwise,
there would forever be a small balance left in the Discount for Bonds Payable account long after the bonds were
extinguished.

1
 3. Notice that the total interest expense ($ 28,460.05) over the 3 year period equals the total cash interest ($21,000) plus the
total issuance discount ( $ 7,460.05) . Thus you can see that the issuance discount represents an additional amount of
interest to be recognized over the life of the bonds.

d. December 31, 2007

Bond Interest Expense $ 9,254.00

Interest Payable $ 7,000

Discount of Bonds Payable $ 2,254.00

Bond Issue Expense $ 2,666.67 ( $ 8,000 / 3 years)

Unamortized Bond Issue Costs $ 2,666.67

January 1, 2008
Interest Payable $ 7,000
Cash $ 7,000

December 31, 2008

Bond Interest Expense $ 9,479.40
Interest Payable $ 7,000.00
Discount on Bonds Payable $ 2,479.40

Bond Issue Expense $2,666.67

Unamortized Bond Issue Costs $2,666.67

e. January 1, 2009
Interest Payable $ 7,000.00
Bonds Payable $ 100,000.00
Loss on Redemption of Bonds $ 7,393.31
Discount on Bonds Payable $ 2,726.55
Unamortized Bond Issue Costs $ 2,666.66
Cash( $ 102,000 + $ 7,000) $ 109,000.00
( $ 7,460.05- $ 2,254.00-$ 2,479.40= $ 2,762.65 unamortized discount)
( $ 8,000.00- $ 2,666.67-$ 2,666.67= $ 2,666.66 unamortized issue costs)
( $ 100,000x 102% = $ 102,000 price to retire)
( $ 100,000- $ 2,726.65= $ 97,273.35 carrying value)
( $ 97,273.36-$ 2,666.66= $ 94,606.69 net carrying value)
($ 102,000- $ 94,606.69= $ 7,393.31 loss)

Hint: There was a call premium ( amount in excess of par required) of $ 2,000.00 in this situation which is included in
the loss computation.

2
Gains or losses on extinguishment of debt were formerly classified as extraordinary items on the income statement
because of the guidelines contained in SFAS No. 4. A few years ago, the FASB eliminated extraordinary treatments for
extinguishments in response to concerns that such gains or losses are neither unusual or infrequent. These gains or
losses are not to be classified as “Other Gains and Losses” on the Income Statement.

The debit to interest payable (for interest accrued last period) assumes that reversing entries are not made.

Straight Line vs Effective Interest Methods

Tip: Regardless of whether the straight-line method or the effective interest method of amortization is used, the
following will occur:
1. The amount of cash interest (stated interest) is a constant amount each period.
2. The bonds’ carrying amount increases over the bond’s life if it is issued at a discount, due to the amortization of
the discount.
3. The bonds’ carrying amount decreases over the bond’s life if it is issued at a premium, due to the amortization
of the premium.

Tip: If the straight-line method of amortization is used, the following relationships exist:
1. The amount of amortization is a constant amount each period.
2. The amount of interest expense is a constant amount each period.

Tip: If the effective interest method is used, the following relationships exist:
1. The effective interest rate is constant each period.
2. The interest expense is an increasing amount each period if the bond is issued at a discount( because a constant
rate is applied to an increasing carrying amount each period).
3. The interest expense is a decreasing amount each period if the bond is issued at a premium( because a constant
rate is applied to an decreasing carrying amount each period).
4. The amount of amortization expense increases each period because the difference between the effective
interest expense and the cash interest widens each period.

14-2 Peter Pan Tools Corporation

a.
Interest paid on July 1, 2007 ( $ 1,400,000 x 9% x 6/12) $ 63,000
Premium amortized on July 1, 2007 ( $ 56,000 x 2/116) $ (966)
Accrued Interest collected on May 1, 2007( $ 1,400,000 x 9% x 4/12) $ (42,000)
Interest accrued on December 31, 2007 ( $ 1,400,000 x 9% x 6/12 $ 63,000
Premium amortized on December 31, 2007 ( $ 56,000 x 6/116) $ ( 2,897)
Total bond interest expense for the year ending 12/31/2007 $ 80,137

Explanation: Prepare the journal entries to record the issuance of the bonds, the payment of interest and amortization
of premium on July 1, 2007 and the year-end adjusting entry. Post the entries to the interest expense account and
determine its balance at 12/31/2007.
3
5/1/2007
Cash $ 1,498,000
Bonds Payable $ 1,400,000
Premium on Bonds Payable $ 56,000
Bond Interest Expense $ 42,000
( 104% x $ 1,400,000 - $ 1,400,000 = $ 56,000 premium)
(9% x $ 1,400,000 x 4/12 = $ 42,000 accrued interest for Jan thru April 2007)
( $ 1,456,000 issue price + $ 42,000 accrued interest = $ 1,498,000 cash proceeds)

7/1/07
Bond Interest Expense( $ 63,000- $ 966) $ 62,034
Premium on Bonds Payable( $ 56,000 x 2/116) $ 966
Cash ( $ 1,400,000 x 9% x 6/12) $ 63,000
( A premium or discount is to be amortized over the period the bonds are outstanding(from the date of issuance to the date of maturity). In this case, May 1, 2007 to
January 1, 2017 is 4 months shy of 10 years , which is 116 months)
12/31/2007
Bond Interest Expense ( $ 63,000- $ 2,897) $ 60,103
Premium on Bond Payable ( $ 56,000x 6/116) $ 2,897
Bond Interest Payable $ 63,000
( $ 1,400,000 x 9% x 6/12) To record accrual of interest since last payment date and amortization of premium for 6 months.

Tip: Bonds are often issued between issued interest payment dates. When this occurs, the issuer requires the investor to pay the market price for
the bonds plus accrued interest since the last interest date. At the next interest payment date, the corporation will return the accrued interest to
the investor by paying the full amount of interest due on outstanding bonds. In the situation at hand, the issuer collects from the investor interest
from the date the bonds are dated to the date of issuance (Jan. 1 to May 1, 2007) which is 4 months. When the next interest date rolls around on
July 1, 2007, a full interest payment is made to the investor. Thus, the investor receives the 2 months interest earned from May 1 to June 30, 2007,
plus the accrued interest for 4 months that the investor paid in at the purchase date. Accrued interest at the date bonds are sold by an issuer is
handled in this manner to expedite the issuer’s payment procedures. At any interest payment date, interest for a full interest period is paid to each
bondholder, there is no need to compute the actual time the bond investment was held by a particular bondholder and to prorate the interest
because the investor has already paid in any portion of the full interest payment not earned by them during that interest period.

The journal entry to record the 2nd interest payment on 1/1/2008 would be as follows ( assuming reversing entries are not used)
Bond Interest Payable $ 63,000
Cash $ 63,000

Bond Interest Expense Bond Interest Payable

12/31/07 $ 63,000
62,034 42,000
60,103
80,137

b. Accrued interest payable at 12/31/2007 $ 1,400,000 x 9% x 6/12 = $ 63,000

c. Interest paid on July 1, 2008 ( $ 1,400,000 x 9% x 6/12) $ 63,000
Premium amortized on July1, 2008 ( $ 56,000 x 6/116) ( 2,897)
4
 Interest accrued on December 31, 2008 ( $ 1,400,000 x 9% x 6/12) $ 63,000
Premium amortized on December 31, 2008 ( $ 56,000 x 6/116) ( 2,897)
Total Bond Interest Expense for 12/31/2008 $ 120,206

14-3 P & J Chase Company

a.
$ 500,000 x .66506= $ 332,530.00 ( PV of single sum, using I = 6%, n = 7)
$ 25,000 x 5.58238= $ 139,559.50 (PV of ordinary annuity using I= 6%, n = 7)
Issue Price $ 472,089.50

b. Date Stated Interest 6% Interest Amortization Carrying Value

11/1/07 $ 472,089.50
5/1/08 $ 25,000 $ 28,325.37 $ 3,325.37 $ 475,414.87
11/1/08 $ 25,000 $ 28,524.89 $ 3,524.89 $ 478,939.76
5/1/09 $ 25,000 $ 28,736.39 $ 3,736.39 $ 482,676.15
11/1/09 $ 25,000 $ 28,960.57 $ 3,960.57 $ 486,636.72
5/1/10 $ 25,000 $ 29,198.20 $ 4,198.20 $ 490,834.92
11/1/10 $ 25,000 $ 29,450.10 $ 4,450.10 $ 495,285.02
5/1/11 $ 25,000 $ 29,714.98 $ 4,714.98 $ 500,000.00
Hint: If you round all your computations to the nearest cent, your rounding error will be small. A small ( less than $ 5.00) rounding error provides
some comfort that the amortization schedule is largely correct. A large rounding error (more than $ 10.00) indicates that one or more mistakes are
likely included in the computation within the schedule or in the determination of the starting point (issue price of the debt).

c.
11/1/07
Cash $ 472,089.50
Discount on Bonds Payable $ 27,910.50
Bonds Payable $ 500,000
12/31/07
Bond Interest Expense $ 9,441.79
Discount on Bonds Payable $ 1,108.46
Interest Payable $ 8,333.33
( $28,325.37 x 2/6 = $ 9,441.79)
( $ 3,325.37 x 2/6 = $ 1,108.46)
( $ 25,000 x 2/6 = $ 8,333.33)

5/1/08 5/1/09
Interest Payable $ 8,333.33 Bond Interest Expense $19,157.59
Bond Interest Expense $ 18,883.58 Interest Payable $ 8,333.33
Discount on Bonds Payable $ 2,216.91 Discount/Bonds Payable $ 2,490.92
Cash $ 25,000.00 Cash $25,000.00
( $28,325.37 - $ 9,441.79 = $ 18,883.58)
( $ 3,325.37- $ 1,108.46= $ 2,216.91)

11/1/08
Bond Interest Expense $ 28,524.89
Discount on Bonds Payable $ 3,524.89
Cash $ 25,000.00

12/31/08

5
Bond Interest Expense $ 9,578.80
Discount on Bonds Payable $ 1,245.47
Interest Payable $ 8,333.33

14-4 Tuna Fishery

a. Stated Interest = Stated rate of interest x par

$ 7,000 = stated rate of interest x $ 100,000
$ 7,000 / $ 100,000 = 7% or stated rate of interest
b.
Effective interst = Market rate x carrying value at beginning of period
$ 6,252.74= Market rate x $ 104,212.37
$ 6,252.74/$ 104,212.37 = 6% market rate
c.
Cash $ 102,212.37
Unamortized Bond Issue Costs $ 2,000.00
Bonds Payable $ 100,000.00
Premium on Bonds Payable $ 4,212.37

d. Bond Interest Expense $ 6,160.38

Premium on Bonds Payable $ 839.62
Interest Payable $ 7,000.00
Bond Issue Expense $ 400.00
Unamortized Bond Issue Costs $ 400.00

e. Bond issue expense $ 400 ( $ 2,000 / 5 years)

Bond Interest Expense $ 6,160.38

f. Other Assets
Unamortized Bond Issue Costs $ 800
Current Liabilities
Interest Payable $ 7,000
Long-term Liabilities
Bonds Payable $ 100,000.00
Unamortized Premium $ 1,833.40
$ 101,833.40
g. $ 101,833.40
Book value is another name for carrying value or carrying amount.

The amount can also be computed by

Carrying amount @ 1/1/09 $ 102,673.02
Amortization for 2009 ( 839.62)
Carrying Value @ 12/31/09 $ 101,833.40

h. Bonds Payable Balance $ 100,000.00

Premium on Bonds Payable $ 1,833.40
Book Value @ 12/31/09 $ 101,833.40
Unamortized issue costs $ (800.00)
Net Book value @ 12/31/09 $ 101,033.40
i. Gain-A gain will result because the retirement price is less than the net carrying value at the date of retirement.
Net Carrying Value @ 1/1/10 $ 101,033.40
6
Retirement price $ 100,500.00
Gain on retirement $ 533.40

This gain from retirement of debt should be classified in the Other Gains and Losses section on the Income Statement.

7
Problem: Issuing Bond with Accrued Interest

On July 1, 2007, ABC issued 1,000 of its 10% $ 1,000 bonds at 99 plus accrued interest. The bonds are
date April 1, 2007 and mature on April 1, 2017. Interest is payable semiannually on April 1 and October
1. What amount did ABC receive from the bond issue?

Step 1: Bond Payable at Face x Issue Price

$ 1,000,000 x .99 = $ 990,000

Thus the bond was issued at a discount.

Step 2: Compute accrued interest.

$ 1,000,000 x 5% interest for 6 months = $ 50,000 interest payable every 6 months

$ 50,000 x 3/6 = $ 25,000 (Interest has accrued for 3 months-April, May, June)

Step 3: Cash received from bond issue: $ 990,000 + $ 25,000 = $ 1,015,000

CHAPTER 14 SAMPLE QUESTIONS AND SOLUTIONS

1. When the interest payment dates of a bond are May 1 and November 1, and a bond issue
is sold on June 1, the amount of cash received by the issuer will be
a. decreased by accrued interest from June 1 to November 1.
b. decreased by accrued interest from May 1 to June 1.
c. increased by accrued interest from June 1 to November 1.
d. increased by accrued interest from May 1 to June 1.

2. If bonds are initially sold at a discount and the straight-line method of amortization is
used, interest expense in the earlier years will
a. exceed what it would have been had the effective-interest method of
amortization been used.
b. be less than what it would have been had the effective-interest method of
amortization been used.
c. be the same as what it would have been had the effective-interest method of
amortiza-tion been used.
d. be less than the stated (nominal) rate of interest.

3. An early extinguishment of bonds payable, which were originally issued at a premium, is

made by purchase of the bonds between interest dates. At the time of reacquisition
a. any costs of issuing the bonds must be amortized up to the purchase date.
b. the premium must be amortized up to the purchase date.
c. interest must be accrued from the last interest date to the purchase date.
d. all of these.

On January 1, 2007, Bleeker Co. issued eight-year bonds with a face value of $1,000,000 and a
stated interest rate of 6%, payable semiannually on June 30 and December 31. The bonds were
sold to yield 8%. Table values are:
Present value of 1 for 8 periods at 6% ............................................ .627
Present value of 1 for 8 periods at 8% ............................................ .540
Present value of 1 for 16 periods at 3% .......................................... .623
Present value of 1 for 16 periods at 4% .......................................... .534
Present value of annuity for 8 periods at 6% .................................. 6.210
Present value of annuity for 8 periods at 8% .................................. 5.747
Present value of annuity for 16 periods at 3% ................................ 12.561
Present value of annuity for 16 periods at 4% ................................ 11.652

4. The present value of the principal is

a. $534,000.
b. $540,000.
c. $623,000.
d. $627,000.

$1,000,000 × .534 = $534,000.

1
 5. The present value of the interest is
a. $344,820.
b. $349,560.
c. $372,600. ($1,000,000 × .03) × 11.652 = $349,560.
d. $376,830.

6. The issue price of the bonds is

a. $883,560.
b. $884,820.
c. $889,560.
d. $999,600

$534,000 + $349,560 = $883,560.

7. Benton Company issues $10,000,000 of 10-year, 9% bonds on March 1, 2007 at 97 plus

accrued interest. The bonds are dated January 1, 2007, and pay interest on June 30 and
December 31. What is the total cash received on the issue date?
a. $9,700,000
b. $10,225,000
c. $9,850,000
d. $9,550,000

($10,000,000 × .97) + ($900,000 × 2/12) = $9,850,000.

8. A company issues $20,000,000, 7.8%, 20-year bonds to yield 8% on January 1, 2007.

Interest is paid on June 30 and December 31. The proceeds from the bonds are
$19,604,145. Using effective-interest amortization, how much interest expense will be
recognized in 2007?
a. $780,000
b. $1,560,000
c. $1,568,498
d. $1,568,332

($19,604,145 × .04) + ($19,608,310 × .04) = $1,568,498.

9. A company issues $5,000,000, 7.8%, 20-year bonds to yield 8% on January 1, 2007.

Interest is paid on June 30 and December 31. The proceeds from the bonds are
$4,901,036. Using effective-interest amortization, what will the carrying value of the
bonds be on the December 31, 2007 balance sheet?
a. $4,903,160
b. $5,000,000
c. $4,906,281
d. $4,902,077

$4,901,036 + [($4,901,036 × .04) – $195,000] + [($4,902,077 × .04) – $195,000]

= $4,903,160.

2
 10. A company issues $5,000,000, 7.8%, 20-year bonds to yield 8% on January 1, 2006.
Interest is paid on June 30 and December 31. The proceeds from the bonds are
$4,901,036. Using straight-line amortization, what is the carrying value of the bonds on
December 31, 2008?
a. $4,917,558
b. $4,985,156
c. $4,908,458
d. $4,915,881

$4,901,036 + ($98,964 × 3/20) = $4,915,881.

11. On January 1, 2001, Gonzalez Corporation issued $4,500,000 of 10% ten-year bonds at
103. The bonds are callable at the option of Gonzalez at 105. Gonzalez has recorded
amortization of the bond premium on the straight-line method (which was not materially
different from the effective-interest method).
On December 31, 2007, when the fair market value of the bonds was 96, Gonzalez
repurchased $1,000,000 of the bonds in the open market at 96. Gonzalez has recorded
interest and amortization for 2007. Ignoring income taxes and assuming that the gain is
material, Gonzalez should report this reacquisition as
a. a loss of $49,000.
b. a gain of $49,000.
c. a loss of $61,000.
d. a gain of $61,000.

$ 4,500,000 x 1.03= $ 4,635,000 CV at date of issue. At December 31, 2007, CV is $

1,009,000 for bonds repurchased . Calculated as 135,000 /10 x 3 for years remaining +
4.500,000 x .2222.

12. Goebel Company issues $5,000,000 face value of bonds at 96 on January 1, 2006. The
bonds are dated January 1, 2006, pay interest semiannually at 8% on June 30 and
December 31, and mature in 10 years. Straight-line amortization is used for discounts and
premiums. On September 1, 2009, $3,000,000 of the bonds are called at 102 plus accrued
interest. What gain or loss would be recognized on the called bonds on September 1,
2009?
a. $300,000 loss
b. $136,000 loss
c. $180,000 loss
d. $226,667 loss

{$4,800,000 + [$200,000 × (3 2/3 ÷ 10)]} × .60 = $2,924,000

$3,060,000 – $2,924,000 = $136,000.

13.—Bond issue price and premium amortization.

On January 1, 2007, Lowry Co. issued ten-year bonds with a face value of $1,000,000 and a
stated interest rate of 10%, payable semiannually on June 30 and December 31. The bonds
were sold to yield 12%. Table values are:
Present value of 1 for 10 periods at 10% .................................... .386
Present value of 1 for 10 periods at 12% .................................... .322
Present value of 1 for 20 periods at 5% ...................................... .377
Present value of 1 for 20 periods at 6% ...................................... .312

3
 Present value of annuity for 10 periods at 10% .......................... 6.145
Present value of annuity for 10 periods at 12% .......................... 5.650
Present value of annuity for 20 periods at 5% ............................ 12.462
Present value of annuity for 20 periods at 6% ............................ 11.470

Instructions
(a) Calculate the issue price of the bonds.
(b) Without prejudice to your solution in part (a), assume that the issue price was $884,000.
Prepare the amortization table for 2007, assuming that amortization is recorded on
interest payment dates.

Solution 13
(a) .312 × $1,000,000 = $312,000
11.470 × $50,000 = 573,500
$885,500
(b) Date Cash Expense Amortization Carrying Amount
1/1/07 $884,000
6/30/07 $50,000 $53,040 3,040 887,040
12/31/07 50,000 53,222 3,222 890,262

14.-—Amortization of discount or premium.

Benson Industries, Inc. issued $6,000,000 of 8% debentures on May 1, 2006 and received cash
totaling $5,323,577. The bonds pay interest semiannually on May 1 and November 1. The
maturity date on these bonds is November 1, 2014. The firm uses the effective-interest method of
amortizing discounts and premiums. The bonds were sold to yield an effective-interest rate of
10%.
Instructions
Calculate the total dollar amount of discount or premium amortization during the first year
(5/1/06 through 4/30/07) these bonds were outstanding. (Show computations and round to the
nearest dollar.)

Solution 14
Interest Cash Discount Carrying
Date Expense Interest Amortized Value of Bonds
5/1/06 $5,323,577
11/1/06 $266,179 $240,000 $26,179 5,349,756
5/1/07 267,488 240,000 27,488 5,377,244
Total $53,667

15.—Entries for bonds payable.

Prepare journal entries to record the following transactions relating to long-term bonds of Grier,
Inc. (Show computations.)

(a) On June 1, 2006, Grier, Inc. issued $600,000, 6% bonds for $587,640, which includes
accrued interest. Interest is payable semiannually on February 1 and August 1 with the
bonds maturing on February 1, 2016. The bonds are callable at 102.

(b) On August 1, 2006, Grier paid interest on the bonds and recorded amortization. Grier uses
straight-line amortization.

4
(c) On February 1, 2008, Grier paid interest and recorded amortization on all of the bonds, and
purchased $360,000 of the bonds at the call price. Assume that a reversing entry was made
on January 1, 2008.

Solution 15
(a) Cash ............................................................................................. 587,640
Discount on Bonds Payable .............................................................. 24,360
Bonds Payable ...................................................................... 600,000
Interest Expense ($600,000 × 6% × 4/12) ............................ 12,000

(b) Interest Expense ($600,000 × 6% × 6/12) + $420............................ 18,420

Cash ...................................................................................... 18,000
Discount on Bonds Payable ($24,360 × 2/116) .................... 420

(c) Interest Expense ($18,000 + $1,260)................................................ 19,260

Cash ...................................................................................... 18,000
Discount on Bonds Payable ($24,360 × 6/116) ................... 1,260

Bonds Payable .................................................................................. 360,000

Loss on Bond Redemption ............................................................... 19,296
Discount on Bonds Payable [.6 × ($24,360 – $4,200)] ....... 12,096
Cash ...................................................................................... 367,200

16 A corporation issues bonds with detachable warrants. The amount to be recorded as paid-
in capital is preferably
a. zero.
b. calculated by the excess of the proceeds over the face amount of the bonds.
c. equal to the market value of the warrants.
d. based on the relative market values of the two securities involved.

17. Jenks Co.has $2,500,000 of 8% convertible bonds outstanding. Each $1,000 bond is
convertible into 30 shares of $30 par value common stock. The bonds pay interest on January 31
and July 31. On July 31, 2007, the holders of $800,000 bonds exercised the conversion
privilege. On that date the market price of the bonds was 105 and the market price of the
common stock was $36. The total unamortized bond premium at the date of conversion was
$175,000. Jenks should record, as a result of this conversion, a
a. credit of $136,000 to Paid-in Capital in Excess of Par.
b. credit of $120,000 to Paid-in Capital in Excess of Par.
c. credit of $56,000 to Premium on Bonds Payable.
d. loss of $8,000.

$800,000 + ($175,000 × .32) – (800 × 30 × $30) = $136,000.

18. In 2006, Berger, Inc., issued for $103 per share, 60,000 shares of $100 par value
convertible preferred stock. One share of preferred stock can be converted into three
shares of Berger's $25 par value common stock at the option of the preferred stockholder.
In August 2007, all of the preferred stock was converted into common stock. The market

5
 value of the common stock at the date of the conversion was $30 per share. What total
amount should be credited to additional paid-in capital from common stock as a result of
the conversion of the preferred stock into common stock?
a. $1,020,000.
b. $780,000.
c. $1,500,000.
d. $1,680,000.

d $6,180,000 – (60,000 × 3 × $25) = $1,680,000.

19. On December 1, 2007, Howell Company issued at 103, two hundred of its 9%, $1,000
bonds. Attached to each bond was one detachable stock warrant entitling the holder to
purchase 10 shares of Howell's common stock. On December 1, 2007, the market value
of the bonds, without the stock warrants, was 95, and the market value of each stock
purchase warrant was $50. The amount of the proceeds from the issuance that should be
accounted for as the initial carrying value of the bonds payable would be
a. $193,640.
b. $195,700.
c. $200,000.
d. $206,000.

b($200,000 × .95) + (200 × $50) = $200,000; $200,000 × 1.03 = $206,000

$190,000
———— × $206,000 = $195,700.
$200,000

20. During 2007, Cartel Company issued at 104 three hundred, $1,000 bonds due in ten
years. One detachable stock warrant entitling the holder to purchase 15 shares of Cartel’s
common stock was attached to each bond. At the date of issuance, the market value of the
bonds, without the stock warrants, was quoted at 96. The market value of each detachable
warrant was quoted at $40. What amount, if any, of the proceeds from the issuance
should be accounted for as part of Cartel’s stockholders' equity?
a. $0
b. $12,000
c. $12,480
d. $11,856

c ($300,000 × .96) + (300 × $40) = $300,000; $300,000 × 1.04 = $312,000

$12,000
———— × $312,000 = $12,480.
$300,000

21—Convertible Bonds.
Dahl Co. issued $5,000,000 of 12%, 5-year convertible bonds on December 1, 2006 for
$5,020,800 plus accrued interest. The bonds were dated April 1, 2006 with interest payable April
1 and October 1. Bond premium is amortized each interest period on a straight-line basis. Dahl
Co. has a fiscal year end of September 30.

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On October 1, 2007, $2,500,000 of these bonds were converted into 35,000 shares of $15 par
common stock. Accrued interest was paid in cash at the time of conversion.

Instructions
(a) Prepare the entry to record the interest expense at April 1, 2007. Assume that interest
payable was credited when the bonds were issued (round to nearest dollar).

(b) Prepare the entry to record the conversion on October 1, 2007. Assume that the entry to
record amortization of the bond premium and interest payment has been made.

Solution 21

When bond was sold, the entry would be:

Cash 5,120,800
Bond Payable 5,000,000
Premium on Bonds Payable 20,800
Interest Payable 100,000

At December 31, 2006, the required journal entry is

Interest Expense 50,000

Interest Payable 50,000

(a) Interest Payable ............................................................................... 150,000

Interest Expense .............................................................................. 148,400
Premium on Bonds Payable ............................................................ 1,600
Cash..................................................................................... 300,000

Calculations:
Issuance price $5,020,800
Par value 5,000,000
Total premium $ 20,800

Months remaining 52
Premium per month $400
Premium amortized (4 × $400) $1,600

(b) Bonds Payable ................................................................................. 2,500,000

Premium on Bonds Payable ............................................................ 8,400
Common Stock (35,000 × $15)........................................... 525,000
Paid-in Capital in Excess of Par.......................................... 1,983,400

Calculations:
Premium related to 1/2 of the bonds $10,400 ($20,800 ÷ 2)
Less premium amortized 2,000 [($10,400 ÷ 52) × 10]
Premium remaining $ 8,400

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