Summary Business Accounting

CHAPTER 14
LONG-TERM LIABILITIES: BONDS AND NOTES

DISCUSSION QUESTIONS

1. (1) To pay the face (maturity) amount of the bonds at a specified date. (2) To pay periodic
interest at a specified percentage of the face amount.
2. a. Bonds that may be exchanged for other securities under specified conditions.
b. The issuing corporation reserves the right to redeem the bonds before the maturity date.
c. Bonds issued on the basis of the general credit of the corporation.
3. More than face amount. Because comparable bonds provide a market interest rate (11%) that
is less than the rate on the bond being issued (12%), the bond will sell at a premium as the
market’s means of equalizing the two interest rates.
4. a. Greater than $26,000,000
b. 1. $26,000,000
2. 7%
3. 9%
4. $26,000,000
5. Less than the contract rate
6. a. Premium
b. $593,454
c. Premium on Bonds Payable
7. A loss of $50,000 [($5,000,000 × 0.98) – ($5,000,000 – $150,000)]
8. A mortgage note is an installment note that is secured by a pledge of the borrower’s assets.
If the borrower fails to pay the note, the lender has the right to take possession of the pledged
asset and sell it to pay off the debt.
9. A bond is an interest-bearing note that requires periodic interest payments and repayment of
the face amount of the bonds at maturity. Bonds consist of two different components:
(1) interest payments made periodically over the life of the bond and (2) the face amount that
must be repaid at maturity. The periodic payments consist entirely of interest, and the final
payment at maturity consists entirely of principal. Installment notes, on the other hand, have
periodic payments that consist partially of interest and partially of principal. Each payment
reduces the principal on the note so that at maturity the entire amount borrowed will have been
repaid.
10. a. As a current liability on the balance sheet.
b. As a long-term liability on the balance sheet.




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, CHAPTER Long-Term Liabilities: Bonds and

PRACTICE EXERCISES
PE 14–1A
Plan 1 Plan 2
Earnings before bond interest and income tax…………… $1,200,000 $1,200,000
1
Deduct interest on bonds........................................................... 360,000 300,0003
Income before income tax…………………………………… $ 840,000 $ 900,000
2
Deduct income tax....................................................................... 336,000 360,000 4
Net income……………………………………………………… $ 504,000 $ 540,000
5
Dividends on preferred stock………………………………… 0 300,000
Available for dividends on common stock………………… $ 504,000 $ 240,000
Shares of common stock outstanding……………………… ÷ 300,000 ÷ 200,000
Earnings per share on common stock……………………… $ 1.68 $ 1.20
1
$6,000,000 × 6%
2
$840,000 × 40%
3
$5,000,000 × 6%
4
$900,000 × 40%
5
($3,000,000 ÷ $30) × $3.00



PE 14–1B
Plan 1 Plan 2
Earnings before bond interest and income tax…………… $2,000,000 $2,000,000
1
Deduct interest on bonds........................................................... 400,000 250,000 3
Income before income tax..........................................................$1,600,000 $1,750,000
2
Deduct income tax....................................................................... 640,000 700,0004
Net income………………………………………………………… $ 960,000 $1,050,000
Dividends on preferred stock………………………………… 0 300,000 5
Available for dividends on common stock………………… $ 960,000 $ 750,000
Shares of common stock outstanding……………………… ÷ 400,000 ÷ 250,000
Earnings per share on common stock……………………… $ 2.40 $ 3.00
1
$4,000,000 × 10%
2
$1,600,000 × 40%
3
$2,500,000 × 10%
4
$1,750,000 × 40%
5
($3,000,000 ÷ $25) × $2.50




14-2

, CHAPTER Long-Term Liabilities: Bonds and


PE 14–2A
Cash 1,920,873
Discount on Bonds Payable 79,127
Bonds Payable 2,000,000


PE 14–2B
Cash 2,889,599
Discount on Bonds Payable 110,401
Bonds Payable 3,000,000


PE 14–3A
Interest Expense 87,913
Discount on Bonds Payable* 7,913
Cash 80,000
* $79,127 ÷ 10 semiannual payments



PE 14–3B
Interest Expense 176,040
Discount on Bonds Payable* 11,040
Cash 165,000
* $110,401 ÷ 10 semiannual payments



PE 14–4A
Cash 4,175,041
Premium on Bonds Payable 175,041
Bonds Payable 4,000,000


PE 14–4B
Cash 8,308,869
Premium on Bonds Payable 308,869
Bonds Payable 8,000,000




14-3

, CHAPTER Long-Term Liabilities: Bonds and


PE 14–5A
Interest Expense 102,496
Premium on Bonds Payable* 17,504
Cash 120,000
* $175,041 ÷ 10 semiannual payments



PE 14–5B
Interest Expense 409,113
Premium on Bonds Payable* 30,887
Cash 440,000
* $308,869 ÷ 10 semiannual payments



PE 14–6A
Bonds Payable 900,000
Loss on Redemption of Bonds 42,000
Discount on Bonds Payable 87,000
Cash 855,000


PE 14–6B
Bonds Payable 500,000
Premium on Bonds Payable 67,000
Gain on Redemption of Bonds 77,000
Cash 490,000


PE 14–7A
a. Cash 80,000
Notes Payable 80,000
Issued installment notes for cash.

b. Interest Expense 5,600
Notes Payable 9,244
Cash 14,844
Paid principal and interest on installment notes.




14-4