Chapter 14

Bonds and Long-Term

Notes

Exercise 14-1
1. Price of the bonds at January 1, 2011
Interest
$ 12,000,000
x
Principal
$240,000,000
x
Present value (price) of the bonds

11.46992 *
0.31180 **

5% x $240,000,000

present value of an ordinary annuity of $1: n=20, i=6%

=
=

$137,639,040
74,832,000
$212,471,040

** present value of $1: n=20, i=6%

2. January 1, 2011
Cash (price determined above)...................................... 212,471,040
Discount on bonds (difference)................................... 27,528,960
Bonds payable (face amount)..................................
240,000,000

3. June 30, 2011

Interest expense (6% x $212,471,040).............................. 12,748,262
Discount on bonds payable (difference)..................
748,262
Cash (5% x $240,000,000)........................................
12,000,000

4. December 31, 2011

Alternate Exercise and Problem Solutions

The McGraw-Hill Companies, Inc., 2011

14-1

Interest expense (6% x [$212,471,040 + 748,262)............ 12,793,158

Discount on bonds payable (difference)..................
793,158
Cash (5% x $240,000,000)........................................
12,000,000

The McGraw-Hill Companies, Inc., 2011

14-2

Intermediate Accounting, 6e

Exercise 14-2
Requirement 1
Schmidt (Issuer)
Cash (102% x $60 million)...........................................
Convertible bonds payable (face amount)...............
60,000,000
Premium on bonds payable (difference).................
Facial Mapping (Investor)
Investment in convertible bonds (10% x $60 million)..
Premium on bond investment (difference).....................
Cash (102% x $6 million).........................................

Requirement 2
Schmidt (Issuer)
Interest expense ($2,700,000 - $60,000)...........................
Premium on bonds payable ($1,200,000 20).............
Cash (4.5% x $60,000,000).......................................
Facial Mapping (Investor)
Cash (4.5% x $6,000,000).............................................
Premium on bond investment ($120,000 20)........
Interest revenue ($270,000 - $6,000)............................

61,200,000

1,200,000

6,000,000
120,000
6,120,000

2,640,000
60,000
2,700,000

270,000
6,000
264,000

[Using the straight-line method, each interest entry is the same.]

Requirement 3

Alternate Exercise and Problem Solutions

The McGraw-Hill Companies, Inc., 2011

14-3

Schmidt (Issuer)
Convertible bonds payable (10% of the account balance)
Premium on bonds payable
(($1,200,000 - [$60,000 x 11]) x 10%).......................
Common stock ([6,000 x 40 shares] x $1 par)............
Paid-in capital excess of par (to balance).............
Facial Mapping (Investor)
Investment in common stock (to balance)......................
Investment in convertible bonds (account balance). .
Premium on bond investment ($120,000 - [$600 x 11])

The McGraw-Hill Companies, Inc., 2011

14-4

6,000,000
54,000
240,000
5,814,000

6,054,000
6,000,000
54,000

Intermediate Accounting, 6e

Exercise 14-3
Requirement 1
June 30, 2011
Interest expense (5% x $368 million)
Discount on bonds payable (difference)
Cash (4% x $400 million)

18,400,000
2,400,000
16,000,000

Requirement 2
December 31, 2011
Interest expense (5% x [$368 million + 2.4 million])
Discount on bonds payable (difference)
Cash (4% x $400 million)

18,520,000
2,520,000
16,000,000

Requirement 3
The interest entries increased the book value from $368,000,000 to
$372,920,000. To increase the book value to $376,000,000, Unnatural needed the
following entry:
Unrealized holding loss
Fair value adjustment ($376,000,000 372,920,000)

Alternate Exercise and Problem Solutions

3,080,000
3,080,000

The McGraw-Hill Companies, Inc., 2011

14-5

PROBLEM
S
Increase inOutstanding
Interest
4.5% x Face Amount

1
2
3
4
5
6
7
8

Problem 14-1
Requirement 1

Interest
5% x Outstanding Balance

9,000
9,000
9,000
9,000
9,000
9,000
9,000
9,000

.05(193,537) = 9,677

72,000

78,463

.05(194,214) = 9,711
.05(194,925) = 9,746
.05(195,671) = 9,784
.05(196,455) = 9,823
.05(197,278) = 9,864
.05(198,142) = 9,907
.05(199,049) = 9,951*

Cash

Effective

Balance

Balance

677
711
746
784
823
864
907
951

193,537
194,214
194,925
195,671
196,455
197,278
198,142
199,049
200,000

6,463

* rounded.

Requirement 2

The McGraw-Hill Companies, Inc., 2011

14-6

Intermediate Accounting, 6e

Cash
Interest
4.5% x Face Amount

1
2
3
4
5
6
7
8

9,000
9,000
9,000
9,000
9,000
9,000
9,000
9,000

Recorded
Interest
Cash plus Discount Reduction
(9,000 + 808)

(9,000 + 808)

(9,000 + 808)

(9,000 + 808)

(9,000 + 808)

(9,000 + 808)

(9,000 + 808)

(9,000 + 808)

72,000

Increase in
Balance
$6,463 8

9,808
9,808
9,808
9,808
9,808
9,808
9,808
9,808

808
808
808
808
808
808
808
808

78,463

6,463

Outstanding
Balance

193,537
194,345
195,153
195,961
196,769
197,577
198,385
199,192*
200,000

* rounded.

Alternate Exercise and Problem Solutions

The McGraw-Hill Companies, Inc., 2011

14-7

Problem 14-1 (continued)

Requirement 3
(effective interest)
Interest expense (5% x $196,455).....................................
Discount on bonds payable (difference)..................
Cash (4.5% x $200,000)............................................
(straight-line)
Interest expense (9,000 + 808)...........................................
Discount on bonds payable (6,463 8)...................
Cash (4.5% x $200,000)............................................

9,823
823
9,000

9,808
808
9,000

Requirement 4
By the straight-line method, a company determines interest indirectly by
allocating a discount or a premium equally to each period over the term to maturity.
This is allowed if doing so produces results that are not materially different from the
interest method. The decision should be guided by whether the straight-line method
would tend to mislead investors and creditors in the particular circumstance.
Allocating the discount or premium equally over the life of the bonds by the
straight-line method results in an unchanging dollar amount of interest each period.
By the straight-line method, the amount of the discount to be reduced periodically is
calculated, and the effective interest is the plug figure.
Unchanging dollar amounts like these are not produced when the effective
interest approach is used. By that approach , the dollar amounts of interest vary over
the term to maturity because the percentage rate of interest remains constant, but is
applied to a changing debt balance.
Remember that the straight-line method, is not an alternative method of
determining interest in a conceptual sense, but is an application of the materiality
concept. The appropriate application of GAAP, the effective interest method, is by The McGraw-Hill Companies, Inc., 2011
14-8

Intermediate Accounting, 6e

passed as a practical expediency in situations when doing so has no material effect

on the results.

Alternate Exercise and Problem Solutions

The McGraw-Hill Companies, Inc., 2011

14-9

Problem 14-1 (concluded)

Requirement 5
The amortization schedule in requirement 1 gives us the answer $19,728. The
outstanding debt balance after the June 30, 2013, interest payment (line 5) is the
present value at that time ($197,278) of the remaining payments. Since $20,000 face
amount of the bonds is 10% of the entire issue, we take 10% of the table amount.
This can be confirmed by calculating the present value:
Interest
$ 900 x 2.72325 *
Principal
$20,000 x 0.86384 **
Present value (price) of the bonds

=
=

$2,451
17,276
$19,727 (rounded)

4.5% x $20,000

present value of an ordinary annuity of $1: n=3, i=5%

** present value of $1: n=3, i=5%

The McGraw-Hill Companies, Inc., 2011

14-10

Intermediate Accounting, 6e

Problem 14-2
Requirement 1
Interest $ 25,000 x 3.16987 *
Principal
$500,000 x 0.68301 **
Present value (price) of the note

=
=

$ 79,247
341,505
$420,752

5% x $500,000

present value of an ordinary annuity of $1: n=4, i=10%

** present value of $1: n=4, i=10%

Operational assets (price determined above).....................

Discount on notes payable (difference)...........................
Notes payable (face amount).......................................

420,752
79,248
500,000

Requirement 2

Dec.31

Cash
Interest

Effective
Interest

201125,000
201225,000
201325,000
201425,000

.10(420,753) = 42,075

100,000

179,248

.10(437,827) = 43,783
.10(456,610) = 45,661
.10(477,271) = 47,729*

Increase in
Balance

17,075
18,783
20,661
22,729

Outstanding
Balance

420,752
437,827
456,610
477,271
500,000

79,248

* rounded

Requirement 3

Alternate Exercise and Problem Solutions

The McGraw-Hill Companies, Inc., 2011

14-11

Interest expense (market rate x outstanding balance)...........

Discount on notes payable (difference).......................
Cash (stated rate x face amount)....................................

The McGraw-Hill Companies, Inc., 2011

14-12

45,661
20,661
25,000

Intermediate Accounting, 6e

Problem 14-2 (concluded)

Requirement 4
$420,753 3.16987 =
amount
of loan

$132,735

(from Table 6A-4) installment

n=4, i=10%
payment

Requirement 5
Cash
Dec.31 Payment

2011132,735
2012132,735
2013132,735
2014132,735

Effective
Interest
10% x Outstanding Balance
.10(420,753) =
.10(330,093) =
.10(230,367) =
.10(120,669) =

530,940

42,075
33,009
23,037
12,066*
110,187

Decrease in
Balance
Balance Reduction

90,660
99,726
109,698
120,669

Outstanding
Balance

420,753
330,093
230,367
120,669
0

420,753

* rounded

Requirement 6
Interest expense (market rate x outstanding balance)...........
Note payable (difference)...............................................
Cash (payment determined above)..................................

Alternate Exercise and Problem Solutions

23,037
109,698
132,735

The McGraw-Hill Companies, Inc., 2011

14-13

Problem 14-3
Requirement 1
Bonds payable (face amount)..........................................

100,000,000

Premium on bonds (20/40 x $30,000,000)........................

15,000,000

Gain on early extinguishment (to balance).................

13,000,000
Cash ($100,000,000 x 102%).......................................
102,000,000

Requirement 2
Bonds payable (face amount)..........................................

50,000,000

Premium on bonds (10/40 x $30,000,000)........................

7,500,000

Gain on early extinguishment (to balance).................

Cash (given)..............................................................
52,500,000

The McGraw-Hill Companies, Inc., 2011

14-14

5,000,000

Intermediate Accounting, 6e