finanical accounting 9th edition solutions ch9.docx

8/13/2019 finanical accounting 9th Edition Solutions Ch9.Docx

http://slidepdf.com/reader/full/finanical-accounting-9th-edition-solutions-ch9docx 1/117

Chapter 9

Liabilities

Short Exercises

(10 min.) S 9-1

Journal

DATE ACCOUNTTITLESANDEXPLANATION DEBIT CREDIT

2012

July 31 Inventory…………………………………………… 11,000

Note Payable, Short-Term…………………… 11,000

Purchasedinventoryby issuinga

note payable.

2013

Apr. 30 Interest Expense($11,000× .12 × 9/12)……….. 990

Interest Payable……………………………….. 990Accruedinterest expense.

July 31 Note Payable, Short-Term………………............ 11,000

Interest Payable…………………………………… 990

Interest Expense($11,000× .12 × 3/12)……….. 330

Cash……………………………………………… 12,320

Paid note payableand interest at

maturity.

Balance Sheet on April 30, 2013:

Note payable, short-term $11,000

Interest payable 990

Chapter 9 Liabilities 9-1



Income Statement, April 30, 2013:

Interest Expense $990

Financial Accounting 9/e Solutions Manual9-2



(5-10 min.) S 9-2

Req. 1

2012 2011

Accounts payable turnover:

COGS

Averageaccountspayable

$2,700,000 = 9

$300,000

$2,500,000 = 10

$250,000

Days payable outstanding:

365

Accountspayableturnover

365 = 41 days

9

365 = 37 days

10

Req. 2

The company’sliquidity positionhas deterioratedduring2012.




(10 min.) S 9-3

Req. 1

Journal


Cash($564,000× .40)…………………..….. 225,600

Notes Receivable($564,000 $255,600)..− 338,400

Sales Revenue…………………………… 564,000

To recordsales on account.

WarrantyExpense($564,000× .05)……… 28,200

EstimatedWarrantyPayable……….…. 28,200

To accruewarrantyexpense.

EstimatedWarrantyPayable……………... 18,000

Cash…………………………………….…. 18,000

To pay warrantyclaims.

Req. 2

EstimatedWarrantyPayable

Bal. 13,00018,000 28,200

Bal. 23,200

(5-10 min.) S 9-4

Warrantyexpense= $28,200

Theexpense recognition principle addressesthis situation.

The warrantyexpensefor the year does not necessarily equal the year’s cash payments

for warranties. Cash paymentsfor warranties do not determinethe amount of warranty

expense for that year. Instead, the warranty expense is estimated and deducted from




revenueduringthe periodof the sale, regardlessof whenthe companypays for warranty

claims.

Studentresponsesmayvary.




(5-10 min.) S 9-5

1. These are contingent liabilities, because, at the time of the note, Tony Chase, Inc.,

was not liable for any of these productlosses.

2. In the United States, the contingencycan becomea real liability if a user of a Tony

Chaseproductsuffers a loss for whichthe companyis responsible.

Tony Chase must pay for all individual losses up to $3.8 million and all aggregate

losses above $26.3 million. The company is insured against losses between $3.8

million and $26.3 million.

3. Outsidethe United States, the contingencybecomesa real liability the sameway — if

a Tony Chaseuser suffers a loss for whichthe companyis responsible.

Outside the United States, Tony Chase must pay only for losses above $26.3 million

becausethe companyis insuredagainst lossesup to $26.3 million.




(5-10 min.) S 9-6

a. $155,500 ($200,000× .7775)

b. $207,000 ($200,000× 1.0350)

c. $188,500 ($200,000× .9425)

d. $205,000 ($200,000× 1.0250)

(5 min.) S 9-7

a. Discount

b. Premium

c. Par (face) value

d. Discount




(5-10 min.) S 9-8

Journal


2012

a. July 1 Cash…………………………………………….. 125,000BondsPayable…………………………….. 125,000

To issue bondat par.

b. Dec. 31 Interest Expense($125,000× .08 × 6/12)……. 5,000

Interest Payable……………………………. 5,000

To accrueinterest expense.

2013

c. Jan. 1 Interest Payable……………………………….. 5,000

Cash…………………………………………. 5,000

To pay semiannualinterest on bonds.

2019

d. July 1 BondsPayable………………………………… 125,000

Cash………………………………………..... 125,000

To pay bondsat maturity.




(10-15 min.) S 9-9

Req. 1 Amortization table

A B C D E

Semiannual

Interest

Date

Interest

Payment

(3% of

Maturity

Value)

InterestExpense

(4.5%of

Preceding

BondCarrying

Amount)

Discount

Amortization

(B - A)

Discount

Account

Balance

(Preceding

(D - C)

Bond

Carrying

Amount

($560,000

- D)

Mar. 31, 2012 $109,200 $450,800

Sept. 30, 2012 $16,800 $20,286 $3,486 105,714 454,286

Mar. 31, 2013 16,800 20,443 3,643 102,071 457,929

Sept. 30, 2013 16,800 20,607 3,807 98,264 461,736

Req. 2

Journal


2012

Mar. 31 Cash($560,000× .805)…………… 450,800Discounton BondsPayable…….. 109,200

BondsPayable…………………. 560,000

Sept. 30 Interest Expense………………….. 20,286

Discounton BondsPayable… 3,486

Cash…………………………….. 16,800

(10 min.) S 9-10

Req. 1— Borrowed$450,800. Maturity value is $560,000.

Req. 2— Cashinterest is $16,800.




Req. 3— Interest expenseSeptember30, 2012 is $20,286.

Interest expenseMarch31, 2013 is $20,443.

(10-15 min.) S 9-11

Req. 1— Borrowed$2,925,000:

Journal


2012

July 1 Cash($3,000,000× .975)…………… 2,925,000

Discounton BondsPayable………. 75,000

BondsPayable…………………… 3,000,000

Req. 2— Pay back $3,000,000at maturity, July 1, 2022.

Req. 3— Cashinterest is $120,000($3,000,000× 8% × 6/12) each six months.

Req. 4— Interest expenseis $123,750[$120,000+ ($75,000/ 20)]

Journal


2012

Dec. 31 Interest Expense.................................... 123,750

Discounton BondsPayable............... 3,750

Interest Payable................................ 120,000

2013

Jan. 1 Interest Payable..................................... 120,000

Cash............................................... 120,000




(10-15 min.) S 9-12

Req. 1

Best Buy

Co.

Wal Mart

Stores

5 Leverage

ratio

$17,849/ $7,292 2.45 $180,663/ $71,247 2.53

6 Total debt $17,849- $7,292 $10,557 $180,663- $71,247 $109,416

7 Debt ratio $10,557/ $17,849 .59 $109,416/ $180,663 .60

8 Times

interestearned

$2,114/ $87 24.2 times $25,542/ $1,928 13.2 times

Req. 2

Both companies’debt-payingabilities are strong. Fromthe standpointof leverage(debt)

the companiesare about equal. However, Best Buy has a strongertimes-interest-earned

ratio (24.2 vs. 13.2).




(5-10 min.) S 9-14

Req. 1

Leverage

ratio

$100.0 / $40.0 = 2.5

This meansthat Evensonhas $2.50 of assetsfor every dollar of

stockholders’equity.

Debt ratio $60.0 / $100.0 = .60

This meansthat Evensonhas $.60 in liabilities (debt) for every dollar of

assets.

Timesinterest earned

$4.1 / $1.1 = 3.73 times

This meansthat for every dollar of interest expenseEvensonhas

earned$3.73 of operatingincome.

Evenson’sdebt ratio is about averageand can cover its existinginterest

expense. I wouldbe willing to lend Evenson$1 million.




(10 min.) S 9-15

LIABILITIES

Current:

Accountspayable……………………….. $ 33,000

Current portionof bondspayable……. 56,000

Interest payable………………………….. 1,700

Total current liabilities………………. 90,700

Longterm:

Notes payable, long-term………………. 125,000Bondspayable…………………………… $375,000

Less: Discounton bondspayable……. (11,250) 363,750

Total liabilities………………………………. $579,450




Exercises

(5-15 min.) E 9-16A

Req. 1

Journal


WarrantyExpense($111,000× .08)………… 8,880

EstimatedWarrantyPayable…………….. 8,880

EstimatedWarrantyPayable………………… 7,000

Cash………………………………………….. 7,000

Req. 2

INCOMESTATEMENT

Sales revenue……………………………………… $111,000

Warrantyexpense………………………………… 8,880

BALANCESHEETCurrent liabilities

Estimatedwarrantypayable

($5,000+ $8,880 $7,000)…………………− $ 6,880

Req. 3

Estimated warranty payable, a current liability, will cause a company’s current ratio to

decrease .




(10-15 min.) E 9-17A

Journal


2012

Oct. 1 Cash………………………………………………… 2,616UnearnedSubscriptionRevenue…………... 2,400

Sales Tax Payable($2,400× .09)…………… 216

Nov. 15 Sales Tax Payable………………………………... 216

Cash…………………………………………….. 216

Dec. 31 UnearnedSubscriptionRevenue……………… 600

SubscriptionRevenue($2,400× 3/12)…….. 600

BALANCESHEET

Current liabilities:

Unearnedsubscriptionrevenue($2,400 $600)……− $1,800

(10 min.) E 9-18A

INCOMESTATEMENT

Expenses:

Payroll expense………………………………………. $150,000

Payroll tax expense($150,000× .08)……………… 12,000

BALANCESHEET


Salary payable………………………………………… $7,500

Payroll tax payable…………………………………... 700




(5-10 min.) E 9-19A

Req. 1

Accruedinterest,

Dec. 31, 2012 = $85,000× .08 × 9/12 = $5,100

Req. 2

Final payment = $85,000+ ($85,000× .08) = $91,800

on April 1, 2013

Req. 3

Interest expensefor:

2012 = $85,000× .08 × 9/12 = $5,100

2013 = $85,000× .08 × 3/12 = $1,700




(10-15 min.) E 9-20A

Olsen’sbalancesheet at December31, 2013, reported:

Incometax payable....................................................... $166,000*

Olsen’s2013 incomestatementreported:

Incometax expense($900,000× .29)............................... $261,000

_____ * Beginningincometax payable....................…………………….. $150,000

+ Incometax expense(and payable) for the year..............

$900,000× .29)................................................................... 261,000

−

Incometax paymentsduringthe year.................................... (245,000) = Endingincometax payable.................................................. $166,000




(10-20 min.) E 9-21A

Req. 1

Accounts payable are amounts owed to suppliers for products or services that have

been purchasedon account.

Accrued expensesare expenses that the companyhas incurred but not yet paid. They

are liabilities for expensessuch as interest and incometaxes.

Employeecompensationand benefits are amounts owed to employeesfor salaries and

other payroll-relatedexpenses.

Current portion of long-term debt is next year’s payment on the company’s long-term

debt.

Long-term debt is the amount of long-term notes and bonds payable that the company

expectsto pay after the comingyear.

Postretirement benefits are the company’s liabilities for providing benefits — mainly

health care — to retirees.

The other liabilities are a catch-all group of liabilities that do not fit one of the more

specific categories. The other liabilities are long-term, as shownby the fact that they are

not listed amongthe current liabilities.




(continued) E 9-21A

Req. 2

Total assets = $3,714million, the sumof total liabilities and


(in millions) 2012

Leverage

ratio=

Total assets ($3,714)

Total stockholders’ equity ($1,951)= 1.90

Debt ratio =Total liabilities ($3,714 $1,951)*−

= 0.47Total assets ($3,714)

For 2011, the leverageratio was 2.26 and the debt ratio was .56.

Both the leverageratio and debt ratio improvedin 2012. Therefore, the company

improved. ____

*Or, $259 + $1,394+ $102 + $8 = $1,763

Req. 3

2012 2011

Accounts

payable

turnover

Cost of goodssold $1,656

= 11.3

$1,790

= 9.6AverageAccounts

payable

$146 $186

*($110+ $182) / 2 **($182+ $190) / 2

Days payable

outstanding

365 365

= 32.3

365

= 38.0Accts. payable

turnover

11.3 9.6

Current

ratio

Current assets $661= 2.55

$600= 1.52

Current liabilities $259 $394




The company’sability to cover accountspayableand current liabilities over the year

improved.




(5-10 min.) E 9-22A

Req. 1

Smith Security Systemsshouldreport this situationin a note to the financial statements.

The note shouldconveyessentially the samemessagegiven in Note 14.

Req. 2

Smith wouldreport:

INCOMESTATEMENT

Estimatedloss (or expense)……………… $3,000,000

BALANCESHEET

Estimatedliability…………………………… $3,000,000

The note disclosurewould be similar to Requirement1.

JournalDATE ACCOUNTTITLESANDEXPLANATION DEBIT CREDIT

2012

EstimatedLoss fromDamageClaim 3,000,000

EstimatedLiability fromDamageClaim 3,000,000




(15-20 min.) E 9-23A

Banff Electronics

BalanceSheet (partial)

March31, 2012

Current liabilities:a. Estimatedwarrantypayable

[$35,000+ ($2,400,000× .04) $57,000]− ............................... $ 74,000

b. Current portionof long-term note payable............................... 16,250

Interest payable($65,000× .07 × 1/12)..................................... 379

c. Unearnedsales revenue($100,000 $85,000)− .......................... 15,000

d. Employeewithheldincometax payable.................................. 30,900

FICAtax payable($320,000× .0765)…..................................... 24,480

Total current liabilities...................................................... $161,009

Long-term liabilities:

Note payable($65,000 $16,250)− ............................................ $ 48,750




(10-15 min.) E 9-24A

Req. 1

Journal

DATE ACCOUNTTITLESANDEXPLANATION DEBIT CREDIT2012

a. Jan. 31 Cash($8,000,000× 0.96)............................ 7,680,000

Discounton BondsPayable....................... 320,000

BondsPayable..................................... 8,000,000

To issue bondsat a discount.

b. July 31 Interest Expense...................................... 312,000

Cash($8,000,000× .07 × 6/12)................ 280,000

Discounton BondsPayable

($320,000/ 10).................................. 32,000

To pay interest and amortize bonds.

c. Dec. 31 Interest Expense...................................... 260,000

Interest Payable

($8,000,000× .07 × 5/12).................... 233,333


($320,000/ 10 × 5/6).......................... 26,667To accrueinterest and amortizebonds.




(10-15 min.) E 9-25A

1. Cashreceived= $100,000× 1.05 = $105,000

2. Principal……………………………………………………… $100,000Interest ($100,000× .07 × 20)…………………….............. 140,000

Total cash paid……………………………………………… $240,000

3. Total cash paid……………………………………………… $240,000

Less: Cashreceived…………………………………….... (105,000)

Difference= Total interest expense……………………... $135,000

4. Annualinterest expenseby the straight-line amortizationmethod:

$100,000× .07 $100,000× (1.05 1.00)−

20

$7,000 − $250 = $ 6,750

Cashinterest payment Premiumamortization

× 20 years

Total interest expenseover the life of the bonds $135,000


same



(15-20 min.) E 9-26A

Req. 1 (amortization table)

SEMIANNUAL

INTEREST

DATE

A

INTEREST

PAYMENT

(2 ½ % OF

MATURITY

VALUE)

B

INTEREST

EXPENSE

(3% OF

PRECEDING

BOND

CARRYING

AMOUNT)

C

DISCOUNT

AMORTIZATION

(B – A)

D

DISCOUNT

ACCOUNT

BALANCE

(PRECEDING

D – C)

E

BONDCARRYING

AMOUNT

($4,000,000– D)

Dec. 31, 2012 $297,550 $3,702,450

June 30, 2013 $100,000 $111,073 $ 11,073 286,477 3,713,524

Dec. 31, 2013 100,000 111,406 11,406 275,071 3,724,929June 30, 2014 100,000 111,748 11,748 263,323 3,736,677

Dec. 31, 2014 100,000 112,100 12,100 251,223 3,748,777

Req. 2

Journal


2012

Dec. 31 Cash……………………………………… 3,702,450

Discounton BondsPayable…………. 297,550

BondsPayable……………………… 4,000,000


2013

June 30 Interest Expense........................................ 111,074

Cash.................................................... 100,000

Discounton BondsPayable.................... 11,074To pay semiannualinterest and

amortizebonds.

2013

Dec. 31 Interest Expense........................................ 111,406

Cash.................................................... 100,000

Discounton BondsPayable.................... 11,406




To pay semiannualinterest and

amortizebonds.




(15-20 min.) E 9-27A


SEMIANNUAL

INTEREST

DATE

A

INTEREST

PAYMENT

(4½%OF

MATURITY

VALUE)

B

INTEREST

EXPENSE

(4% OF

PRECEDING

BOND

CARRYING

AMOUNT)

C

PREMIUM

AMORTIZATION

(A – B)

D

PREMIUM

ACCOUNT

BALANCE

(PRECEDING

D – C)

E

BONDCARRYING

AMOUNT

($4,000,000+ D)

June 30, 2012 $395,800 $4,395,8001

Dec. 31, 2012 $180,000 $175,832 $4,168 391,632 4,391,632

June 30, 2013 180,000 175,665 4,335 387,297 4,387,297Dec. 31, 2013 180,000 175,492 4,508 382,789 4,382,789

June 30, 2014 180,000 175,312 4,688 378,101 4,378,101

_____ 1$4,000,000× 1.09895= $4,395,800

Req. 2 (journal entries)

Journal


2012

June 30 Cash($4,000,000× 1.09895)…………….. 4,395,800

BondsPayable……………………....... 4,000,000

Premiumon BondsPayable………… 395,800

To issue bondsat a premium.

Dec. 31 Interest Expense………………………….. 175,832

Premiumon BondsPayable……………. 4,168

Cash…………………………………….. 180,000

To pay semiannualinterest and amortizebonds.

2013




June 30 Interest Expense…………………………. 175,665

Premiumon BondsPayable.………...... 4,335

Cash……………………………………. 180,000





(15-20 min.) E 9-28A

A B C D E F

1 Bond

2 Interest Interest Discount Discount Carrying

3 Date Payment Expense Amortization Balance Amount4

5 Jan. 1, 2012 $21,071 $278,929

6 Dec. 31, 2012 $18,000 $19,525 $1,525 19,546 280,454

7 Dec. 31, 2013 18,000 19,632 1,632 17,914 282,086

8 Dec. 31, 2014 18,000 19,746 1,746 16,168 283,832

9 Dec. 31, 2015 18,000 19,868 1,868 14,300 285,700

10 Dec. 31, 2016 18,000 19,999 1,999 12,301 287,699

11 Dec. 31, 2017 18,000 20,139 2,139 10,162 289,838

12 Dec. 31, 2018 18,000 20,289 2,289 7,873 292,127

13 Dec. 31, 2019 18,000 20,449 2,449 5,424 294,576

14 Dec. 31, 2020 18,000 20,620 2,620 2,804 297,196

15 Dec. 31, 2021 18,000 20,804 2,804 0 300,000

Note : Computer-generatedsolutionsmay containslight roundingdifferences.




(15-20 min.) E 9-29A

Req. 1

The company has the right to occupy space and operate out of leased stores for

several years to come. In return, the company is obligated to make payments

amountingto over $2.6 billion dollars to variouslandlords(lessors).

Req. 2

The rights and obligations discussedin Req. 1 are classified as operating leases and

are not reported on the balance sheet. Omitting them from the balance sheet improves

(lowers) the company’sdebt and leverageratios.

Req. 3

In the future, the FASB and IASB are proposing to eliminate most operating leases. If

this rule change occurs, companies like Abercrombie and Fitch Co. will have to

capitalize leased property as assets and also record the related lease obligations as

liabilities.




(20-25 min.) E 9-30A

Amounts in millions or billions

Company Company Company

Ratio B N V

Current =

Total current assets =

$429 ¥5,321 €144,720

ratio Total current liabilities $227 ¥2,217 € 72,000

= 1.89 = 2.40 = 2.01

B N V

Debt=== = Total liabilities* = $227 + $77 ¥2,217+ ¥2,277 €72,000+ €111,177ratio Total assets** $429 + $81 ¥5,321+ ¥592 €144,720+ €65,828

= 0.60 = 0.76 = 0.87

B N V

Leverage

ratio =

Total assets =

$510 ¥5,913 €210,548

Tot. stockholders’equity $206 ¥1,419 €27,371

= 2.48 = 4.17 = 7.69

B N V

Times-

interest- =

Operatingincome =

$295 ¥230 €5,646

earned Interest expense $41 ¥27 €655

ratio

= 7.2 times = 8.5 times = 8.6 times

_____

B N V

Assets $510 ¥5,913 €210,548

Liabilities $304 ¥4,494 €183,177




Basedon these ratio values, CompanyN looks the least risky.




(15-20 min.) E 9-31A

Req. 1

PLANA

BORROW

$600,000

AT 6%

PLANB

ISSUE

$600,000

OF COMMON

STOCK

Net incomebefore expansion………………… $300,000 $300,000

Project incomebefore interest and incometax $500,000 $500,000

Less interest expense($600,000× .06)………. 36,000 -0-

Project incomebefore incometax……………. 464,000 500,000

Less: incometax expense(25%)……………… (116,000) (125,000)

Project net income………………………………. 348,000 375,000

Total companynet income………………… $648,000 $675,000

Earningsper share includingnew project:

Plan A ($648,000/ 100,000shares)…….................. $6.48

Plan B ($675,000/ 225,000shares)........................ $3.00




(continued) E 9-31A

Req. 2

MEMORANDUM

TO: Boardof Directorsof PrimeNationFinancial Services

FROM: StudentName

SUBJECT: Financingplan to expandoperations

Plan A (borrowing) results in much higher earnings per share. Plan A also allows the

existing stockholdersto retain control of the companybecausethe companyissues no

new stock. But Plan A also creates more financial risk becauseborrowingobligates the

companyto pay the interest and the principal of the debt. I prefer Plan A, assumingthe

company’slevel of debt is not alreadytoo high.

Students can defend either plan based on their preferencesfor control of the business,

avoidanceof risk, and higher earningsper share.




(5-15 min.) E 9-32B

Req. 1


WarrantyExpense($176,000× .09)………… 15,840

EstimatedWarrantyPayable…………….. 15,840

EstimatedWarrantyPayable………………… 9,000

Cash………………………………………….. 9,000

Req. 2

INCOMESTATEMENT

Sales revenue………………………………………… $176,000

Warrantyexpense…………………………………… 15,840

BALANCESHEETCurrent liabilities

Estimatedwarrantypayable

($2,000+ $15,840 $9,000)……………….....− $ 8,840

Req. 3

Estimated warranty payable, a current liability, will cause a company’s current ratio to

decrease .




(10-15 min.) E 9-33B

Journal


2012

Oct. 1 Cash………………………………………………… 2,247UnearnedSubscriptionRevenue…………... 2,100

Sales Tax Payable($2,100× .07)…………… 147

Nov. 15 Sales Tax Payable………………………………... 147

Cash…………………………………………….. 157

Dec. 31 UnearnedSubscriptionRevenue……………… 525

SubscriptionRevenue($2,100× 3/12)…….. 525

BALANCESHEET


Unearnedsubscriptionrevenue($2,100 $525)……− $1,575

(10 min.) E 9-34B

INCOMESTATEMENT

Expenses:

Payroll expense………………………………………. $190,000

Payroll tax expense($190,000× .08)……………… 15,200

BALANCESHEET


Salary payable………………………………………… $ 8,000

Payroll tax payable…………………………………... 750




(5-10 min.) E 9-35B

Req. 1

Interest to

accrueat = $84,000× .07 × 3/12 = $1,470Dec. 31, 2012

Req. 2

Final payment= $84,000+ ($84,000× .07) = $89,880

on October1, 2013

Req. 3

Interest expensefor:

. = $84,000× .07 × 3/12 = $1,470

2013 = $84,000× .07 × 9/12 = $4,410




(10-15 min.) E 9-36B

McKinley’sbalancesheet at December31, 2013 reported:

Incometax payable…………………………………... $436,000*

McKinley’s2013 incomestatementreported:

Incometax expense($1,600,000× .36)…………… $576,000

_____ * Beginningincometax payable…………………….. $210,000

+ Incometax expense(and payable) for the year

($1,600,000× .36)…………………………………… 576,000

−

Incometax paymentsduringthe year……………. (350,000) = Endingincometax payable………………………… $436,000




(10-20 min.) E 9-37B

Req. 1

Accounts payable are amounts owed to suppliers for products or services that have

been purchasedon account.

Accrued expenses are expensesthat the companyhas incurred but not paid. They are

liabilities for expensessuch as interest and incometaxes.

Employeecompensationand benefits are amounts owed to employeesfor salaries and

other payroll-relatedexpenses.

Current portion of long-term debt is next year’s payment on the company’s long-term

debt.

Long-term debt is the amount of long-term notes and bonds payable that the company

expectsto pay after the comingyear.

Postretirement benefits are the company’s liabilities for providing benefits — mainly

health care — to retirees.

The other liabilities are a catch-all group of liabilities that do not fit one of the more

specific categories. The other liabilities are long-term, as shownby the fact that they are

not listed amongthe current liabilities.




(continued) E 9-37B

Req. 2

Total assets = $4,050million, the sumof total liabilities and


(in millions) 2012

Leverage

ratio =

Total assets ($4,050)

Total stockholders’ equity ($2,027)= 2.0

Debt ratio =Total liabilities ($4,050 $2,027)*−

= 0.50Total assets ($4,050)

For 2011, the leverageratio was 2.23 and the debt ratio was .55.

Both the leverageratio and debt ratio improved. Therefore, the companyimproved.

____ *Or, $368 + $1,497+ $138 + $20 = $2,023

Req. 3

2012 2011

Accounts

payable

turnover

Cost of goodssold $1,885

= 11.8

$2,196

= 11.6Averageaccounts

payable

$159* $188**

*($137+ $181) / 2 **($181+ $195) / 2

Days payable

outstanding

365 365

= 30.9

365

= 31.5Accts. payable

turnover

11.8 11.6

Current

ratio

Current assets $643= 1.75

$610= 1.62

Current liabilities $368 $376




The company’sability to cover accountspayableand current liabilities over the year

improved.




(5-10 min.) E 9-38B

Req. 1

Clark Security Systemsshould report this situationin a note to the financial statements.

The note shouldconveyessentially the samemessagegiven in Note 14.

Req. 2

Clark wouldreport:

INCOMESTATEMENT

Estimatedloss (or expense)……………… $2,000,000

BALANCESHEET

Estimatedliability…………………………… $2,000,000

The note disclosurewould be similar to Requirement1.


2012

EstimatedLoss fromDamageClaim 2,000,000

EstimatedLiability fromDamageClaim 2,000,000




(15-20 min.) E 9-39B

Jasper Electronics

BalanceSheet (partial)

June 30, 2012


a. Estimatedwarrantypayable

[$36,000+ ($2,100,000× .06) $51,000]………− $111,000

b. Current portionof long-term note payable……... 11,250

Interest payable($45,000× .07 × 1/12)…………… 263

c. Unearnedsales revenue($130,000 $75,000)….− 55,000

d. Employeewithheldincometax payable…………. 30,300

FICAtax payable($300,000× .0765)……………… 22,950

Total current liabilities………………………….. $230,763


Note payable($45,000 $11,250)……………........− $ 33,750




(10-15 min.) E 9-40B

Req. 1

Journal


a. Jan. 31 Cash($9,000,000× 0.93)……………… 8,370,000

Discounton BondsPayable…………. 630,000

BondsPayable……………………... 9,000,000


b. July 31 Interest Expense....................................... 436,500

Cash($9,000,000× .09 × 6/12)................. 405,000


($630,000/ 20)................................... 31,500

To pay interest and amortizebonds.

c. Dec. 31 Interest Expense....................................... 363,750

Interest Payable

($9,000,000× .09 × 5/12)..................... 337,500


($31,500× 5/6)................................... 26,250To accrueinterest and amortize bonds.




(10-15 min.) E 9-41B

1. Cashreceived= $300,000× 1.01 = $303,000

2. Principal……………………………………………………… $300,000

Interest ($300,000× .06 × 20)…………………….............. 360,000

Total cash paid……………………………………………… $660,000

3. Total cash paid……………………………………………… $660,000

Less: Cashreceived……………………………………... (303,000)

Difference= Total interest expense……………………... $357,000

4. Annualinterest expenseby the straight-line amortizationmethod:

$300,000× .06 $300,000× (1.01 1.00)−

20

$18,000 − $150 = $ 17,850

Cashinterest payment Premiumamortization × 20 years

Total interest expenseover the life of the bonds $357,000


same



(15-20 min.) E 9-42B


SEMIANNUAL

INTEREST

DATE

A

INTEREST

PAYMENT

(6% OF

MATURITY

VALUE)

B

INTEREST

EXPENSE

(7% OF

PRECEDING

BOND

CARRYING

AMOUNT)

C

DISCOUNT

AMORTIZATION

(B – A)

D

DISCOUNT

ACCOUNT

BALANCE

(PRECEDING

D – C)

E

BONDCARRYING

AMOUNT

($3,200,000– D)

Dec. 31, 2012 $339,000 $2,861,000

June 30, 2013 $192,000 $200,270 $8,270 330,730 2,869,270

Dec. 31, 2013 192,000 200,849 8,849 321,881 2,878,119June 30, 2014 192,000 201,468 9,468 312,413 2,887,587

Dec. 31, 2014 192,000 202,131 10,131 302,282 2,897,718

Req. 2

Journal


2012

Dec. 31 Cash........................................................... 2,861,000

Discounton BondsPayable........................... 339,000

BondsPayable........................................ 3,200,000


2013

June 30 Interest Expense.......................................... 200,270

Cash....................................................... 192,000

Discounton BondsPayable...................... 8,270To pay semiannualinterest and

amortizebonds.

2013

Dec. 31 Interest Expense.......................................... 200,849

Cash....................................................... 192,000

Discounton BondsPayable...................... 8,849




To pay semiannualinterest and

amortizebonds.




(15-20 min.) E 9-43B


SEMIANNUAL

INTEREST

DATE

A

INTEREST

PAYMENT

(4% OF

MATURITY

VALUE)

B

INTEREST

EXPENSE

(3-1/2%OF

PRECEDING

BOND

CARRYING

AMOUNT)

C

PREMIUM

AMORTIZATION

(A – B)

D

PREMIUM

ACCOUNT

BALANCE

(PRECEDING

D – C)

E

BONDCARRYING

AMOUNT

($1,600,000+ D)

June 30, 2012 $188,000 $1,788,000

Dec. 31, 2012 $64,000 $62,580 $1,420 186,580 1,786,580

June 30, 2013 64,000 62,530 1,470 185,110 1,785,110Dec. 31, 2013 64,000 62,479 1,521 183,589 1,783,589

June 30, 2014 64,000 62,426 1,574 182,015 1,782,015

_____ 1$1,600,000× 1.1175= $1,788,000

Req. 2 (journal entries)

Journal


2012

June 30 Cash($1,600,000× 1.1175)……….. 1,788,000

BondsPayable………………… 1,600,000

Premiumon BondsPayable… 188,000

To issue bondsat a premium.

Dec. 31 Interest Expense……………………. 62,580

Premiumon BondsPayable……… 1,420

Cash………………………………. 64,000


2013




June 30 Interest Expense……………………. 62,530

Premiumon BondsPayable.……... 1,470

Cash……………………………….. 64,000





(15-20 min.) E 9-44B

A B C D E F

1 Bond

2 Interest Interest Discount Discount Carrying

3 Date Payment Expense Amortization Balance Amount

4

5 Jan. 1, 2012 $33,120 $416,880

6 Dec. 31, 2012 $22,500 $25,013 $2,513 30,607 419,393

7 Dec. 31, 2013 22,500 25,164 2,664 27,943 422,057

8 Dec. 31, 2014 22,500 25,323 2,823 25,120 424,880

9 Dec. 31, 2015 22,500 25,493 2,993 22,127 427,87310 Dec. 31, 2016 22,500 25,672 3,172 18,955 431,045

11 Dec. 31, 2017 22,500 25,863 3,363 15,592 434,408

12 Dec. 31, 2018 22,500 26,064 3,564 12,028 437,972

13 Dec. 31, 2019 22,500 26,278 3,778 8,250 441,750

14 Dec. 31, 2020 22,500 26,505 4,005 4,245 445,755

15 Dec. 31, 2021 22,500 26,745 4,245 0* 450,000*

*Note : Computer-generatedsolutionsmay containslight roundingdifferences.




(15-20 min.) E 9-45B

Req. 1

The company has the right to occupy space and operate out of leased stores for

several years to come. In return, the company is obligated to make payments

amountingto over $1 billion dollars to various landlords(lessors). A very small portion

of these paymentsmay be offset by receipts fromsub-leasesto other tenants.

Req. 2

The rights and obligations discussedin Req. 1 are classified as operating leases and

are not reported on the balance sheet. Omitting them from the balance sheet improves

(lowers) the company’sdebt and leverageratios.

Req. 3

In the future, the FASB and IASB are proposing to eliminate most operating leases. If

this rule change occurs, companies like Ann Taylor Stores Corporation will have to

capitalize leased property as assets and also record the related lease obligations as

liabilities.




(20-25 min.) E 9-46B

Amounts in millions or billions

Company Compan

y Company

Ratio F K R

Current =

Total current assets =

$434 ¥5,383 €148,526

ratio Total current liabilities $207 ¥2,197 €72,100

= 2.10 = 2.45 = 2.06

F K R

Debt=

Total liabilities=

$207 + $107 ¥2,197+ ¥2,318 €72,100+ €110,107

ratio Total assets $434 + $96 ¥5,383+ ¥405 €148,526+ €49,525

= 0.59 = 0.78 = 0.92

F K R

Leverageratio

= Total assets = $530 ¥5,788 €198,051Tot. stockholders’equity $216 ¥1,273 €15,844

= 2.45 = 4.55 = 12.50

F K R

Times-

interest-

=

Operatingincome

=

$292 ¥224 €5,592

earned Interest expense $46 ¥33 €736ratio

= 6.4 times = 6.8 times = 7.6 times

_____

F K R

Assets $530 ¥5,788 €198,051




Liabilities $314 ¥4,515 €182,207

Basedon these ratio values, CompanyK looks the least risky.




(15-20 min.) E 9-47B

Req. 1

PLANABORROW

$900,000

AT 10%

PLANB

ISSUE$900,000

OF COMMON

STOCK

Net incomebefore expansion…………………….. $600,000 $600,000

Project incomebefore interest and incometax.. $800,000 $800,000

Less: interest expense($900,000× .10)………… (90,000) -0-

Project incomebefore incometax………………. 710,000 800,000

Less: incometax expense(40%)………………… (284,000) (320,000)

Project net income………………………………….. 426,000 480,000

Total companynet income……………………. $1,026,000 $1,080,000

Earningsper share includingnew project:

Plan A ($1,026,000/ 200,000shares)………… $5.13

Plan B ($1,080,000/ 450,000shares)………... $2.40




(continued) E 9-47B

Req. 2

MEMORANDUM

TO: Boardof Directorsof UnitedNationFinancial Services

FROM: StudentName

SUBJECT: Financingplan to expandoperations

Plan A (borrowing) results in much higher earnings per share. Plan A also allows the

existing stockholdersto retain control of the companybecausethe companyissues no

new stock. But Plan A also creates more financial risk becauseborrowingobligates the

companyto pay the interest and the principal of the debt. I prefer Plan A, assumingthe

company’slevel of debt is not alreadytoo high.

Students can defend either plan based on their preferencesfor control of the business,

avoidanceof risk, and higher earningsper share.




Quiz

Q9-48 d

Q9-49 aQ9-50 d

Q9-51 c

Q9-52 a

Q9-53 b [($650,000+ $850,000)× .07] – $5,200 $42,500= $57,300−

Q9-54 d

Q9-55 a

Q9-56 f

Q9-57 b

Q9-58 c

Q9-59 b ($400,000× .13) + [($400,000 $388,000)/ 10] = $53,200−

Q9-60 Interest Expense………………………………….. 39,900


($12,000/ 10 × 9/12)………………………… 900Interest Payable($400,000× .13 × 9/12)…... 39,000

Q9-61 Interest Payable……………………….................. 39,000

Interest Expense………………………………….. 13,300


($12,000/ 10 × 3/12)…………………………. 300

Cash($400,000× .13)…………………........... 52,000

Q9-62 d ($295,000 x .07) = $20,650)

Q9-63 c

Q9-64 c

Q9-65 c

Q9-66 a




Problems

(15-20 min.) P 9-67A

a. Sales tax payable($150,000× .06)..................……………………………… $9,000

b. Note payable, short-term..................………………………………………… $81,000

Interest payable($81,000× .04 × 4/12)..................………………………… 1,080

c. Unearnedservice revenue($3,000× 4/6)..................……………………… $1, 000

d. Estimatedwarrantypayable

($11,300+ $32,000 $34,500)−

.................………………………………... $8,800

e. Portionof long-term note payabledue

within one year.................. …………………………………………………. $20,000

Interest payable($100,000× .06).................. ……………………………….. 6,000




(30-40 min.) P 9-68A

Journal


2012

Mar. 3 Inventory............................................................. 50,000 Note Payable, Short-term................................... 50,000

May 31 Cash................................................................... 85,000

Note Payable, Short-term................................... 17,000

Note Payable, Long-term................................... 68,000

Sept. 3 Note Payable, Short-term....................................... 50,000

Interest Expense($50,000× .08 × 6/12)…… 2,000

Cash............................................................... 52,000

Dec. 31 WarrantyExpense($196,000× .025)........................ 4,900

EstimatedWarrantyPayable.............................. 4,900

31 Interest Expense($85,000× .08 × 7/12) 3,967

Interest Payable............................................... 3,967

2013

May 31 Note Payable, Short-term....................................... 17,000Interest Payable................................................... 3,967

Interest Expense($85,000× .08 × 5/12)…… 2,833

Cash............................................................... 23,800




(20-25 min.) P 9-69A

Req. 1

Journal


a. May 31 Cash($7,000,000× 1/2)…………...... 3,500,000

BondsPayable……………………. 3,500,000

To issue bondsat par.

b. Nov. 30 Interest Expense…………………...... 157,500

Cash($3,500,000× .09 × 6/12)…. 157,500

To pay interest on bonds.

c. Dec. 31 Interest Expense

($3,500,000× .09 × 1/12)…………….. 26,250

Interest Payable………………...... 26,250

To accrueinterest.

2013

d. May 31 Interest Payable………………………. 26,250

Interest Expense($3,500,000× .09 × 5/12)…………….. 131,250

Cash($3,500,000× .09 × 6/12)….. 157,500


Req. 2 (reporting the liabilities on the balance sheet at

December 31, 2012)


Interest payable..................................................... $ 26,250


Bondspayable...................................................... $3,500,000




30-40 min.) P 9-70A

Req. 1

The 6% bondsissuedwhen the market interest rate is 5% will be priced at a premium .

They are relatively attractive in this market, so investorswill pay a price above par value

to acquire them.

Req. 2

The 6% bonds issuedwhen the market interest rate is 7% will be priced at a discount .

They are relatively unattractivein this market, so investorswill pay less than par value to

acquire them.




(continued) P 9-70A

Req. 3

Journal


2012

a. Feb. 28 Cash($900,000× .96)...................................... 864,000

Discounton BondsPayable............................. 36,000

BondsPayable........................................... 900,000


b. Aug. 31 Interest Expense............................................. 28,800

Cash($900,000× .06 × 6/12)......................... 27,000


($36,000/ 20)........................................... 1,800To pay interest and amortizebonds.

c. Dec. 31 Interest Expense............................................. 19,200

Interest Payable($27,000× 4/6).................... 18,000


($1,800× 4/6)........................................... 1,200

To accrueinterest and amortize bonds.

2013

d. Feb. 28 Interest Payable(fromDec. 31)…………. 18,000

Interest Expense............................................. 9,600

Cash($900,000× .06 × 6/12)......................... 27,000


($1,800× 2/6)........................................... 600


Req. 4 (reporting the liabilities on the balance sheet at December 31, 2012)


Interest payable……………………………. $ 18,000





Bondspayable……………………………... $900,000

Less: Discounton bondspayable

($36,000 $1,800- $1,200)……..− (33,000) 867,000




(30-40 min.) P 9-71A

Req. 1

Journal


Jan. 1 Cash($4,000,000× .95)...................................... 3,800,000

Discounton BondsPayable............................... 200,000

BondsPayable…………………………... 4,000,000


July 1 Interest Expense.............................................. 130,000

Cash($4,000,000× .06 × 6/12)........................ 120,000


($200,000/ 20)........................................... 10,000

To pay interest and amortize bonds.

Dec. 31 Interest Expense.............................................. 130,000

Interest Payable

($4,000,000× .06 × 6/12).............................. 120,000

Discounton BondsPayable………….............. 10,000

To accrueinterest and amortizebonds.2013

Jan. 1 Interest Payable............................................... 120,000

Cash........................................................... 120,000

To pay interest.

2022

Jan. 1 BondsPayable................................................. 4,000,000

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

To pay bondsat maturity.




(continued) P 9-71A

Req. 2

Carrying amount at December 31, 2012.

Bondspayable, net

($4,000,000 $200,000+ $10,000+ $10,000)………− $3,820,000

Req. 3

a. Interest expense = $130,000

b. Cashinterest paid = $120,000

Interest expenseexceedscash interest paid becausethe companyissuedthe bondsat a

discountand must pay back the full face value of the bondsat maturity. Amortizationof

the bond discount causes the interest expense on the bonds to exceed the amount of

cash interest paid.




(30-45 min.) P 9-72A

Req. 1

a. Maturity value is $5,000,000

b. Annualcash interest paymentis $300,000

($5,000,000× .06)

c. Carryingamountis $4,479,360


ANNUAL

INTEREST

DATE

A

INTEREST

PAYMENT

(6% OF

MATURITY

VALUE)

B INTEREST

EXPENSE

(8% OF

PRECEDING

BOND

CARRYING

AMOUNT)

C

DISCOUNT

AMORTIZATION

(B – A)

D

DISCOUNT

ACCOUNT

BALANCE

(PRECEDIN

G

D – C)

E

BOND

CARRYING

AMOUNT

($5,000,000–D)

Dec. 31, Yr. 1 $520,640 $4,479,360

Dec. 31, Yr. 2 $300,000 $358,349 $58,349 462,291 4,537,709

Dec. 31, Yr. 3 300,000 363,017 63,017 399,274 4,600,726

Dec. 31, Yr. 4 300,000 368,058 68,058 331,216 4,668,784

Interest expensefor the year endedDecember31, Year 4, is $368,058.

Req. 3 (reporting the liabilities at December 31, Year 4)


Current installmentof notes payable…….. $ 55,000





Bondspayable………………………………... $5,000,000

Less: Discounton bondspayable………. (331,216) 4,668,784

Notes payable………………………………… 275,000




(40-50 min.) P 9-73A


SEMIANNUAL

INTEREST

DATE

A

INTEREST

PAYMENT

(5.5%OF

MATURITY

VALUE)

B

INTERESTEXPENSE

(6% OF

PRECEDING

BOND

CARRYING

AMOUNT)

C

DISCOUNT

AMORTIZATION

(B – A)

D

DISCOUNT

ACCOUNT

BALANCE

(PRECEDING

D – C)

E

BONDCARRYING

AMOUNT

($4,000,000– D)

12-31-12 $229,400 $3,770,600*

6-30-13 $220,000 $226,236 $6,236 223,164 3,776,836

12-31-13 220,000 226,610 6,610 216,554 3,783,4466-30-14 220,000 227,007 7,007 209,547 3,790,453

12-31-14 220,000 227,427 7,427 202,120 3,797,880

_____ *$4,000,000× .94265= $3,770,600




(continued) P 9-73A

Req. 2

Journal


a. Dec. 31 Cash($4,000,000× .94265)........................... 3,770,600

Discounton BondsPayable......................... 229,400

ConvertibleBondsPayable...................... 4,000,000


2013

b. June 30 Interest Expense......................................... 226,236

Cash..................................................... 220,000

Discounton BondsPayable..................... 6,236


c. Dec. 31 Interest Expense......................................... 226,610

Cash..................................................... 220,000

Discounton BondsPayable..................... 6,610


2014

d. July 1 ConvertibleBondsPayable.......................... 1,600,000 Discounton BondsPayable

($209,547× 2/5)................................... 83,819

CommonStock (90,000× $1).................... 90,000

Paid-in Capital in Excessof

Par — Common.................................. 1,426,181

To recordconversionof bonds.

Req. 3 (balance sheet presentation of bonds payable at

December 31, 2014)

Convertiblebondspayable

($4,000,000 $1,600,000)− ..................................... $2,400,000


($202,120× 3/5*)................................................. (121,272) 2,278,728




_____

*3/5 of the bondsare outstanding,so 3/5 of the discount

remains.




(20-30 min.) P 9-74A

Req. 1

TO: Managementof Tony SportingGoods

FROM: StudentName

SUBJECT:Advantagesand disadvantagesof borrowing

versusissuingstock to raise cash for expansion

Raising money by borrowinghas at least two advantagesover issuing commonstock.

Borrowing does not change the present ownership of the business. It enables the

present owners to keep their proportionate interests in the business and to carry out

their plans without interference from a new group of stockholders. Under normal

conditions, borrowingresults in a higher earningsper share of commonstock, because

the interest expenseon the debt is tax-deductible. And higher earningsper share usually

lead to higher stock prices for companyowners.

The main disadvantageof borrowingis that the debt increases the financial risk of the

company. The principal and the related interest expense must be paid whether the

companyis earning a profit or not. If times get sufficiently bad, the debt burden could

threatenthe ability of the businessto continueas a goingconcern.

The main advantageof issuingstock is that ownersavoid the burdenof makinginterest

and principal paymentson the debt. Issuing stock creates no liability to pay anythingto

the owners. If the directors consider it necessary, they can refuse to pay dividends in

order to conservecash. Therefore, it is safer to issue stock.




(continued) P 9-74A

One disadvantage of issuing stock is dilution of the ownership interests of existing

stockholders if the purchasers of new stock are outsiders. The new stockholders may

have different ideas about how to managethe businessand that may pose difficulties for

the original stockholder group. Another disadvantageof issuing stock is that earnings

per share are usually lower because of (1) the greater number of shares of stock

outstanding,and (2) the non-tax-deductibility of dividendspaid on the stock.

There is insufficient information available upon which to make a decision. Tony’s

managementmust preparebudgetswhich indicate the impact of the new stores in terms

of net incomeand cash flow. Managementmust also estimatethe cost of borrowingthe

funds.

Studentresponsesmay vary.




(20-30 min.) P 9-75A

Req. 1

BrightonFoods, Inc.

Partial BalanceSheetDecember31, 2012

Property, plant, and

equipment: Current liabilities:*

Equipment................... $744,000 Mortgagenote

Accumulated payable, current.................... $ 92,000

depreciation.............. (166,000) Bondspayable,

578,000 current portion..................... 500,000

Interest payable...................... 75,000

Total current liabilities................ 667,000

Long-termliabilities:

Mortgagenote

payable................................ $ 318,000

Bondspayable….$200,000

Discounton

bondspayable…. (25,000)* 175,000

Pensionliability...................... 30,000 **

Total long-termliabilities............ 523,000

Notes:

* The order of listing current liabilities and long-termliabilities is optional. However, Discount onBondsPayableshouldcomeimmediatelyafter Bonds Payable. Also, it is customaryto report Interest

Payable after the related liability accounts, Mortgage Note Payable and Bonds Payable, Current

Portion.

** Computationof pensionliability:

Accumulatedpensionbenefit obligation…………….……............ $450,000

Less: Pensionplan assets, at marketvalue………………............ (420,000)

Pensionliability to be reportedon the balancesheet…………... $ 30,000




(continued) P 9-75A

Req. 2

a. Carryingamountof bondspayable:

Current portion…………………………………. $ 500,000

Long-term portion($200,000 $25,000)…….−

175,000Carryingamount……………………………….. $675,000

b. Interest payable is the amountof interest that Brightonowes at year end. Interest

expenseis the company’scost of borrowingfor the full year.

Req. 3

Times-interest-earnedratio = Operatingincome = $370,000Interest expense $229,000

= 1.62 times

Req. 4

Leverage

ratio=

Total assets ($4,500,000)

Total stockholders’ equity ($3,310,000)= 1.36

Debt ratio = Total liabilities [$1,190,000= $667,000+ $523,000] = 0.26Total assets ($4,500,000)

The company’s debt ratio and leverage ratios are low, and operating income covers

interest paymentsby 1.62 times. With this limited information, the companyappears to

be low risk from a leverage point of view. Additional information from prior years and

competitorswouldalso be helpful.




(continued) P 9-75A

Req. 5

Leverage

ratio=



Debt ratio = Total liabilities ($4,190,000) = 0.56


The leverageratio and debt ratio wouldincrease. The companywouldstill be

consideredhealthy(averagerisk) froma leveragepoint of view.




(15-20 min.) P 9-76B

a. Sales tax payable($130,000× .07)................................................... $9,100

b. Note payable, short-term............................................................... $80,000

Interest payable($80,000× .06 × 4/12)............................................. 1,600

c. Unearnedservice revenue($3,000× 2/6).......................................... $1,000

d. Estimatedwarrantypayable

($11,800+ $34,000 $34,800)− .................................................... $11,000

e. Portionof long-term note payabledue

within one year........................................................................ $30,000

Interest payable($90,000× .06)...................................................... 5,400




(30-40 min.) P 9-77B

Journal


2012

Mar. 3 Inventory…………………………………… 70,000 Note Payable, Short-term……………. 70,000

May 31 Cash…………………………………………. 70,000

Note Payable, Short-term……………. 14,000

Note Payable, Long-term…………….. 56,000

Sept. 3 Note Payable, Short-term………………... 70,000

Interest Expense($70,000× .06 × 6/12).. 2,100

Cash……………………………………... 72,100

Dec. 31 WarrantyExpense($194,000× .02)……. 3,880

EstimatedWarrantyPayable………... 3,880

Dec. 31 Interest Expense

($70,000× .05 × 7/12)…………………….. 2,042

Interest Payable……………………….. 2,042

2013

May 31 Note Payable, Short-term……………….. 14,000

Interest Payable…………………………… 2,042

Interest Expense($70,000× 0.05 × 5/12) 1,458

Cash[$14,000+ ($70,000× .05)] …... 17,500




(20-25 min.) P 9-78B

Req. 1

Journal


a. May 31 Cash...................................................... 4,000,000

BondsPayable.................................... 4,000,000

To issue bondsat par.

b. Nov. 30 Interest Expense……………….......... 120,000

Cash($4,000,000× .06 × 6/12)….. 120,000


c. Dec. 31 Interest Expense

($4,000,000× .06 × 1/12)............................ 20,000

Interest Payable.................................. 20,000

To accrueinterest.

2013

d. May 31 Interest Payable....................................... 20,000

Interest Expense($4,000,000× .06 × 5/12)............................ 100,000

Cash……………………………….. 120,000



December 31, 2012)


Interest payable……………………………. $ 20,000


Bondspayable……………………………... $4,000,000




(30-40 min.) P 9-79B

Req. 1

The 10% notes issuedwhen the market interest rate is 9% will be priced at a premium .

They are relatively attractive in this market, so investorswill pay a price above par value

to acquire them.

Req. 2

The 10%notes issuedwhenthe market interest rate is 11%will be pricedat a discount .

They are relatively unattractivein this market, so investorswill pay less than par value to

acquire them.




(continued) P 9-79B

Req. 3

Journal


a. Feb. 28 Cash($1,200,000× 0.96)……………………… 1,152,000

Discounton BondsPayable…………………. 48,000

BondsPayable……………………………… 1,200,000

To issue bondspayableat a discount.

b. Aug. 31 Interest Expense……………………………….. 64,800

Discounton BondsPayable($48,000/ 10) 4,800

Cash($1,200,000× .05 × 6/12)……………. 60,000To pay interest and amortizebondspayable.

c. Dec. 31 Interest Expense……………………………….. 43,200

Discounton BondsPayable($4,800× 4/6) 3,200

Interest Payable($60,000 4/6)………….. 40,000

To accrueinterest and amortizebondspayable.

2022

d. Feb. 28 Interest Payable(fromDec. 31)……………… 40,000

Interest Expense……………………………….. 21,600

Discounton BondsPayable($4,800× 2/6) 1,600

Cash($1,200,000× .10 × 6/12)…………… 60,000

To pay interest and amortizebondspayable.


December 31, 2012)


Interest payable................................................... $ 40,000


Bondspayable..................................................... $1,200,000





($48,000 $4,800 $3,200)− − .................................. (40,000) 1,160,000




(30-40 min.) P 9-80B

Req. 1

Journal


2012

Jan. 1 Cash($3,000,000× .94)........................................ 2,820,000

Discounton BondsPayable.................................. 180,000

BondsPayable................................................ 3,000,000


July 1 Interest Expense................................................. 129,000

Cash($3,000,000× .08 × 6/12)........................... 120,000 Discounton BondsPayable

($180,000/ 20).............................................. 9,000


Dec. 31 Interest Expense................................................. 129,000

Interest Payable($3,000,000× .08 × 6/12) 120,000


($180,000/ 20)…………………………… 9,000

To accrueinterest and amortize bonds.2013

Jan. 1 Interest Payable………………………………. 120,000

Cash………………………………………… 120,000

To pay interest.

2022

Jan. 1 BondsPayable………………………………… 3,000,000

Cash…………………………………………. 3,000,000

To pay off bondsat maturity.




(continued) P 9-80B

Req. 2

Carrying amount at December 31, 2012:

Bondspayable, net

($3,000,000 $180,000+ $9,000+ $9,000) = $2,838,000−

Req. 3

a. Interest expense = $129,000

b. Cashinterest paid = $120,000

Interest expenseexceedscash interest paid becausethe companyissuedthe bondsat a

discountand must pay back the full face value of the bondsat maturity. Amortizationof

the bonds causes the interest expense on the bonds to exceed the amount of cash

interest paid.




(30-45 min.) P 9-81B

Req. 1

a. Maturity value is $4,000,000.

b. Annualcash interest paymentis $200,000($4,000,000× .05).

c. Carryingamountis $3,568,850.


ANNUAL

INTEREST

DATE

A

INTEREST

PAYMENT

(5% OF

MATURITY

VALUE)

B

INTEREST

EXPENSE

(7% OF

PRECEDING

BOND

CARRYING

AMOUNT)

C

DISCOUNT

AMORTIZATION

(B – A)

D

DISCOUNT

ACCOUNT

BALANCE

(PRECEDING

D – C)

E

BONDCARRYING

AMOUNT

($4,000,000– D)

Dec. 31, Yr. 1 $431,150 $3,568,850

Dec. 31, Yr. 2 $200,000 $249,820 $49,820 381,331 3,618,670

Dec. 31, Yr. 3 200,000 253,307 53,307 328,024 3,671,976

Dec. 31, Yr.4 200,000 257,038 57,038 270,985 3,729,015

Interest expensefor the year endedDecember31, Year 4 is $257,038.

Req. 3 (reporting the liabilities at December 31, Year 4)


Current portionof notes payable............................ $ 40,000


Bondspayable..................................................... $4,000,000

Less: Discounton bondspayable……….. (270,985) 3,729,015




Notes payable

($360,000 $60,000)− ........................................... 200,000




(40-50 min.) P 9-82B


SEMIANNUAL

INTEREST

DATE

A

INTEREST

PAYMENT

(2-1/2%OF

MATURITY

VALUE)

B

INTEREST

EXPENSE

(3% OF

PRECEDING

BOND

CARRYING

AMOUNT)

C

DISCOUNT

AMORTIZATION

(B – A)

D

DISCOUNT

ACCOUNT

BALANCE

(PRECEDING

D – C)

E

BONDCARRYING

AMOUNT

($5,000,000- D)

12-31-12 $372,000 $4,628,000*

6-30-13 $125,000 $138,840 $13,840 358,160 4,641,840

12-31-13 125,000 139,255 14,255 343,905 4,656,095 6-30-14 125,000 139,683 14,683 329,222 4,670,778

12-31-14 125,000 140,123 15,123 314,099 4,685,901

_____ *$5,000,000× .9256 = $4,628,000




(continued) P 9-82B

Req. 2

Journal


a. Dec. 31 Cash($5,000,000× .9256)................................. 4,628,000

Discounton BondsPayable……………… 372,00

ConvertibleBondsPayable........................... 5,000,000


2013

b. June 30 Interest Expense............................................. 138,840

Cash......................................................... 125,000 Discounton BondsPayable......................... 13,840


c. Dec. 31 Interest Expense............................................. 139,255

Cash.......................................................... 125,000

Discounton BondsPayable.......................... 14,255


2014d. July 1 Convertible BondsPayable............................... 2,000,000


($329,222× 2/5)......................................... 131,689

CommonStock(90,000× $1)......................... 90,000

Paid-in Capital in Excessof

Par — Common........................................ 1,778,311

To recordconversionof bonds.

Req. 3 (balance sheet presentation of bonds payable at

December 31, 2014)

Convertiblebondspayable

($5,000,000 $2,000,000)− ............................................ $3,000,000





($314,099 × 3/5)*……………………………….…. (188,459) $2,811,541

_____

*3/5 of the bondsare outstanding,so 3/5 of the discountremains.




(15-30 min.) P 9-83B

TO: Managementof Marco’sSportingGoods

FROM: StudentName

SUBJECT:Advantagesand disadvantagesof borrowing

versusissuingstock to raise cash for expansion

Raising money by borrowinghas at least two advantagesover issuing commonstock.

Borrowing does not change the present ownership of the business. It enables the

present owners to keep their proportionate interests in the business and to carry out

their plans without interference from a new group of stockholders. Under normal

conditions, borrowingresults in a higher earningsper share of commonstock, because

the interest expenseon the debt is tax-deductible. And higher earningsper share usually

lead to higher stock prices for companyowners.

The main disadvantageof borrowingis that the debt increases the financial risk of the

company. The principal and the related interest expense must be paid whether the

companyis earning a profit or not. If times get sufficiently bad, the debt burden could

threatenthe ability of the businessto continueas a goingconcern.

The main advantageof issuingstock is that ownersavoid the burdenof makinginterest

and principal paymentson the debt. Issuing stock creates no liability to pay anythingto

the owners. If the directors consider it necessary, they can refuse to pay dividends in

order to conservecash. Therefore, it is safer to issue stock.




(continued) P 9-83B

One disadvantage of issuing stock is dilution of the ownership interests of existing

stockholders if the purchasers of new stock are outsiders. The new stockholders may

have different ideas about how to managethe businessand that may pose difficulties for

the original stockholder group. Another disadvantageof issuing stock is that earnings

per share are usually lower because of (1) the greater number of shares of stock

outstanding,and (2) the non-tax-deductibility of dividendspaid on the stock.

There is insufficient information available upon which to make a decision. Marco’s

managementmust preparebudgetswhich indicate the impact of the new stores in terms

of net incomeand cash flow. Managementmust also estimatethe cost of borrowingthe

funds.

Studentresponsesmay vary.




(20-30 min.) P 9-84B

Req. 1

BraintreeFoods, Inc.

Partial BalanceSheet

December31, 2012

Property, plant, and

equipment: Current liabilities:*

Equipment……. $745,000 Bondspayable,

Accumulated current portion………….. $ 420,000

depreciation… (162,000) Mortgagenote payable,

583,000 current portion…………. 97,000 Interest payable…………… 74,000

Total current liabilities……... 591,000

Long-termliabilities:

Mortgagenote

payable…………………… $ 314,000

Bondspayable…$1,680,000

Less: Discounton

bondspayable.. (22,000)* 1,658,000

Pensionliability…………… 45,000 **

Total long-termliabilities…... 2,017,000

_____ Notes :

* The order of listing long-termliabilities is optional. However, Discounton Bonds Payable

shouldcomeimmediatelyafter BondsPayable. Also, it is customary to report InterestPayableafter the relatedliability accounts.

** Computationof pensionliability:

Accumulatedpensionbenefit obligation…………………….. $470,000

Less: Pensionplan assets, at market value…………………. (425,000)

Pensionliability to be reportedon the balancesheet…...... $ 45,000




(continued) P 9-87B

Req. 2

a. Carryingamountof bondspayable:

Current portion..................................................................... $ 420,000Long-term portion................................................................ 1,658,000

Carryingamount................................................................... $2,078,000

b. Interest payable is the amount of interest that Braintree owes at year-end. Interest

expenseis the company’scost of borrowingfor the full year.

Req. 3

Times-interest-earnedratio =Operatingincome

= $390,000

Interest expense $227,000

= 1.72 times

Req. 4

Leverage

ratio =



Debt ratio = Total liabilities [$2,608,000= $591,000+ $2,017,000] = 0.62


The company’sdebt ratio and leverageratios are average, and operatingincomecovers

interest paymentsby 1.72 times. With this limited information,the companyappearsto

be averagerisk froma leveragepoint of view. Additional informationfromprior years

and competitorswouldalso be helpful.




(continued) P 9-84B

Req. 5

Leverage

ratio



Debt ratio = Total liabilities ($5,608,000) = 0.78


The leverageratio and debt ratio wouldincrease. The companywouldbe considered

higher risk froma leveragepoint of view.




ChallengeExercisesand Problem

(10-15 min.) E 9-85

Current ratio = Total current assets

=$324,500- X

= 2.00Total current liabilities $173,800- X

Let X = amount of current liabilities to pay in order to achieve a current ratio of 2.25.

Marquis Marketing Services should pay off $23,100* of current liabilities. Then the

current ratio will be:

$324,500 $23,100*− = $301,400 = 2.00

$173,800 $23,100*− $150,700

_____

*Computation: $324,500 X− = 2.00

$173,800 X−

$324,500 X− = 2.00 ($173,800 X)−

−

X = $347,600 2.00X $324,500− −

X = $23,100

Req. 2

Leverage

ratio=



Debt ratio = Total liabilities ($421,300) = .30 Total assets ($1,423,000)

The leverageratio and debt ratio are low. The debt positionis low. Other helpful

informationwouldbe the leverageand debt ratios fromprior years and comparative

ratios fromcompetitors.




(20-25 min.) E 9-86

Req. 1

Millions

BondsPayable, 5 ¼ %................................................ 160

BondsPayable, 13%........................................ 80Cash .......................................................... 17

Gain on Retirementof BondsPayable................ 63

Req. 2 (Dollar amounts in millions)

Old Bonds New Bonds

Annual interest expense…..$160 × .0525 $80 × .13

= $8.40 = $10.40

Req. 3

Possible reasonsfor the debt refinancing:

1. To decreaseannual interest expense: NO, becauseannual interest expenseon the

old bondsis less ($2,000,000)than interest expenseon the new bonds.2. To increase net income: YES, because the gain on retirement of bonds payable

added$63 million to net income.

3. To decreasethe leverageratio: YES, as follows:

Before After

(Dollar amounts in millions) Refinancing Refinancing

Leverage=

Total assets=

$503 $503 $17−

ratio Total stockholders’ $144 $144 + $63

equity = 3.49 = 2.35

4. To decreasethe debt ratio: YES, as follows:

(Dollar amounts in millions) BeforeRefinancing After Refinancing




Debt=

Total liabilities=

$359 $359 $160 + $80−

ratio Total assets $503 $503 $17−

= 0.71 = 0.57




(20-30 min.) P 9-87

Req. 1

a. Current ratio

2010 2009

Currentratio

Current assets $21,579 = 1.17 $17,551 1.28Current liabilities $18,508 $13,721

b. Debt ratio

2010 2009

Debt

ratio

Total

liabilities $72,921- $31,317 =.571 $48,671– $25,346 =.479

Total assets $72,921 $48,671

Req. 2

a. Current ratio

Current

ratio

Current assets $21,579 = 1.07

Current liabilities $18,508+ $1,590

b. Debt ratio

Debt

ratio

Total liabilities $41,604+ $1,590- $1,590 = .571

Total assets $72,921

Req. 3

Current

ratio

Current assets $21,579 = 1.15

Current liabilities $18,508+ $205

b. Debt ratio




Debt

ratio

Total liabilities $41,604+ $965 = .584


DecisionCases

(15-20 min.) DecisionCase 1

Req. 1

As

Reported

Debt ratio =Total liabilities

=$54,033


= 0.82

Returnon

Assets=

Net income=

$979

(ROA) Total assets $65,503

= 1.5%

Req.2

Leverage

=

Total assets

=

$65,503

ratio Total

stockholders’

$11,470

equity

= 5.71

Returnon

ROAx LeverageratioEquity (ROE) = = 1.5%x 5.71 = 8.5%

The ROE is greater than the ROA becausethe leverageratio is extremely high which

magnifies the ROA. The debt ratio is also extremely high and indicates that 82% of




the assets were financed with debt. The high leverage ratio and debt ratio should

have madeinvestorsquestionthe soundnessof Enron.

(continued)DecisionCase 1

Req. 3 After Includingthe

Special-PurposeEntities

Debt ratio =Total liabilities

=$54,033+ $6,900

Total assets $65,503 + $500*

= 0.92*The SPEs originally reportedassets of $7,000 million when those assets were only worth $500 but

actually had liabilitiesof $6,900.

Returnon

Assets=

Net income $979 + $0*

Total assets $100,789+ $500

= .1%

*The SPEs’ incomewas nearly wipedout due to the restatementmeaningthat the SPEdid not earn a

net incomebut did have assetswith a market value of $500.

As After IncludingtheReported Special-PurposeEntities

Operating

Times-interest- = Income = $1,953 $1,953+ ($300)earnedratio Interest $838 $838 + ($6,900× .10)

expense

= 2.3 times = 1.1 times

Req. 4




It appears that Enron excluded the special-purpose-entities (SPEs) from its financial

statementsin order to hide their debt fromEnron’s investorsand creditors. The purpose

was to understate Enron’s liabilities. We would view Enron as much more risky after

including the SPEs in Enron’s financial statements. So did their banks, which is why

they stoppedlendingmoneyto them, causingthemto have to file for bankruptcy.

(30-40 min.) DecisionCase 2

Req. 1 (Analysis of financing plans)

PLANA PLANB PLANC

BORROW

AT 6%

ISSUE

COMMON

STOCK

ISSUE$3.75NONVOTING

PREFERRED

STOCK

Net incomebefore expansion $3,500,000 $3,500,000 $3,500,000

Project incomebefore interest

and incometax $1,500,000 $1,500,000 $1,500,000

Less interest expense ($5,000,000× .06) 300,000 -0- -0-

Project incomebefore incometax 1,200,000 1,500,000 1,500,000

Less incometax expense(35%) 420,000 525,000 525,000

Project net income 780,000 975,000 975,000

Less preferreddividends

(100,000× $3.75) -0- -0- 375,000

Additional net incomeavailable

to commonstockholders 780,000 975,000 600,000

Total companynet income $4,280,000 $4,475,000 $4,100,000

Earningsper share includingnew

project:




Plan A

($4,280,000/ 1,000,000shares) $ 4.28

Plan B

($4,475,000/ 1,100,000shares) $ 4.07

Plan C

($4,100,000/ 1,000,000shares) $ 4.10




(continued) DecisionCase 2

Req. 2 (Recommendation)

The best choiceappearsto be Plan A — borrowingat 6% — because:

(1) Borrowingallowsthe family to maintaincontrol of the business;

(2) EPS is higher under borrowingthan under issuingpreferred stock (which would

also maintainfamily control); and

(3) EPS under borrowingis higher than it wouldbe if commonstock were issued. Also,

cash flow under Plan A (borrowing) may be almost as good as under Plan B

(issuingcommonstock) after consideringstockholders’demandsfor dividends.




Ethical Issue 1

Req. 1

A company would prefer not to disclose its contingent liabilities because they cast a

shadowon the businessand create a negativeimpression.

Req. 2 and 3

The potential parties and economic consequences of the decision not to disclose

contingentliabilities are:

1. The bank and its shareholders: With misleading information, they might extend

additional funds to the borrower assuming a better ability to pay back the funds than

actually exists. A contingent liability creates risk for a company. If the contingent

liability is not reported, the bank may view the companyas low-risk. This may lead the

bank to loan moneyat low interest rates and with easy paymentterms. With knowledge

of the contingent liability, the bank might not have made the loan at all. Or the bank

might have required a higher interest rate or more stringent payment terms. Making

loans on too-easy termsrobs the bank’s ownersof their money.

2. The companyseekingthe loan: Might becomeoverextendedin its borrowingand risk

default on debt in the future.

Req. 3 Legal and ethical consequences




Banks have legal requirements to keep certain ratios of assets and liabilities on their

booksor risk default. Failure of a companyto report

(continued)Ethical Issue 1

its contingent liabilities to a bank requestingthis disclosurecould subject the company

to a lawsuit later on.

Froman ethical standpoint, reporting a contingent liability requires a delicate balancing

act. Ethics require that outsiders’ interests be protected. The company must disclose

enoughinformationto give outsiders a reasonablebasis for makinginformeddecisions

about the company. At the same time, the companyshould avoid giving away secrets

that could damageits owners’ investmentin the business. This dilemmais clear whena

defendant fears losing an important lawsuit. Fortunately for accountants, most

companies settle out of court those lawsuits that they expect to lose. In such cases,

there are no contingentliabilities to disclose.

Req. 4

As discussedin the chapter, changesare being discussedbetweenthe FASBand IASB

about a new standard for reporting contingencies. It is likely that, in the future, more

losses resulting from lawsuits and other contingenciesare likely to be disclosedin the

body and the footnotesof financial statements.




Ethical Issue 2

1. The ethical issue is whetherto structurethis lease to avoid its havingto be disclosed

as a capital lease. The companywill do that if it is possible. It appearsthat Gocker and

Moranhave someflexibility in setting the life of the lease (4-6 years). If they set the term

of the lease at 4 years, it will be only 66 2/3 percent of the economiclife of the asset (6

years). Thus, the lease will fail all of the mechanical tests for the lease to be treatedas a

capital lease, and by default, it will be treated as an operating lease, and Gocker can

avoid capitalizingthe asset and includingthe liability on her financial statements. If they

set the term of the lease at 5 or 6 years, it will exceed 75% of the economic life of the

asset, and thus the lease will have to be capitalized.

2. The stakeholdersare Gocker, the lessee; Morgan, the lessor; and Last National Bank,

Gocker’spresentcreditor. The potential consequencesto the stakeholdersare:

a. economic: If the lease is structuredas a capital lease, Gockerwill violate its

long-term loan covenant with Last National Bank. As a result, the bank might demand

immediate payment of their loan. This may damage Gocker’s credit rating and create

difficulty getting future bank loans. Alternatively, Last National Bank may waive the loan

covenantin exchangefor a higher interest rate or more stringentrepaymentterms. This

too could cause Gocker financial difficulties. Morgan is not affected economically,

becauseMorganwill receive its paymentson the leased property regardlessof how the

transactionis disclosed.





b. legal: If we assume that GAAP substitutes for legal requirements, if Gocker is

careful to structurethe lease termsso that it avoids the requirementsfor a capital lease,

there shouldbe no problemstatingthat the lease agreementcomplieswith GAAP.

c. ethical: The substanceof a capital lease is one that transfersthe risks and rewards

of ownershipto the lessee. If in fact, the substanceof the termsof this lease do that, the

equipmentshould be capitalizedby the lessee regardlessof the form of the lease terms.

To use mechanical rules to avoid recognizing assets and liabilities hardly seems like a

truthful way to do business. Nevertheless,U.S. GAAPpresentlyallowit!

3. Studentresponseswill vary on this question. Somewill say that, if the rules allow it,

then why not engineer the transaction in such as way as to benefit Gocker by keeping

the asset, and the lease obligation, off the books. After all, this is perfectly legal, and

perfectly in accordancewith existing U.S. GAAP(FAS 13). In the view of the authors,

Gocker should evaluate whether, in fact, she obtains the rights and rewards associated

with ownership of the machine. If so, she could so structure the lease that it fits the

economic substance of the transaction, which is what should also be disclosed in the

financial statements. If it turns out that the equipmentand the related lease obligation

will have to be addedto assets and liabilities in the balancesheet, thus causingGocker

to default on the loan covenant, she should attempt to obtain a waiver of the covenant.

This option is going to prove costly for Gocker, so she’s to have to be convincedthat

she did the right thing in order to be motivatedto followthis courseof action.





4. The FASBand IASB are workingon a proposednew lease standardthat removesthe

mechanical criteria for lease capitalizationdiscussedin the chapter in favor of the more

theoretically and substantively correct, but also more subjective, “risks and rewards”

approach. As a result, more companies will be faced with making the judgment as to

whether their lease agreementsactually transfer risks and rewardsto lessees. This will

not remove the temptation to deliberately twist the facts. Under a “principles” based

standard, there will exist the opportunity for “strategic non-compliance”(that is, simply

decide that risks and rewards are not transferred and thus achieve the same result as

the “financial engineering” allowed by current GAAP. More judgment requires better

ethics. What do you think will happen?(Studentresponseswill vary on this question).




Focuson Financials: Amazon.com,Inc.

(20 min.)

Req. 1

Amazon.com, Inc.’s accounts payable increased from $5,605 million in 2009 to $8,051million in 2010, an increase of about 43.6 percent. Accordingly, Account Payable

Turnoveris:

OperatingExpenses

Avg. Accts. Pay.

$32,798

($8,051+$5,605)/2 = 4.80

It takes Amazon.com,Inc. an average of (365/4.80) 76 days to pay its accounts payable.

This length overall is fairly long given that typical credit termsare closer to 30 days.

Req. 2

Provisionfor incometaxes $352 million

Incometaxes paid 75 million

These amounts differ because tax and accounting rules differ resulting in a different

incometax on the incomestatement(provisionfor incometaxes) than on the tax return

(incometax paid).

Req. 3

Refer to Note 5—LongTerm Debt. Based on this information, the company’slong term

debt (after current maturities) increased from $109 in 2009 to $184 in 2010. From this




increase, you can tell that Amazon.com. Inc. borrowedmore than they paid off during

2010.

(continued)Amazon

Req. 4

Refer to Note 6—Commitmentsand Contingencies.

The footnotesdisclosecommitmentsof $3,799 million. Someof these commitmentswill

already be reported as liabilities, such as obligations for debt principal and interest,

capital leases, and financing leases. However, the commitments for operating leases

wouldnot be reportedin liabilities.

The footnotes also include a discussion of various legal proceedings against Amazon.

These legal proceedings are of the nature of “disclosed” loss contingencies, as

discussed in the chapter, therefore, are not included in the financial statements. The

criteria for disclosure of these contingent liabilities is that it is reasonablypossible that

the companywill have an obligationfromthe lawsuit companyin the future.

Req. 5

Ratio 2010 2009Debt ratio $10,372+ $1,561= 63.5%

$18,797

$7,364+ $1,192= 61.9%

$13,813

Timesinterest

earned

$1,406

$39 = 36.1 times

$1,129

$34 = 33.2 times

Current ratio $13,747 $9,797




$10,372 = 1.33 $7,364 = 1.33

(continued)Amazon

Amazon.com,Inc.’s leverageincreasedslightly during 2010, as reflectedin the increase

of its debt to total asset ratios from2009 to 2010. Becauseof strongearnings, the times

interest earned (operating income/interest expense) ratios improved. The current ratio

has remainedrelatively stable.

Cash provided by operating activities on the Consolidated Statements of Cash Flows

increasedfrom$3,293 million in 2009 to $3,495 in 2010. On this basis, Amazon.com,Inc.

appears to be experiencinggrowth. They appear to be positionedwell for more growth,

profitability and improvedliquidity and leveragepositionsin the future.




Focuson Financials: RadioShack,Corp.

(20 min.)

Req. 1

• Current Maturities of Long-TermDebt—theamountof principal that is payable

within one year.

• AccountsPayable—theamountowedfor productsor servicespurchasedon

account.

• AccruedExpenses—theamountof expensesincurredbut not yet paid.

• IncomeTaxesPayable—theamountof incometax incurredbut not yet paid.

Req. 2

• Payroll and Bonuses– an accrual for wagesfor pay earnedby employeesbut not

yet paid to employees.

• Insurance– an accrual for insuranceexpenseincurredbut not yet paid.

• Sales and Payroll Taxes– liability for amountowedto the governmentfor sales

and payroll taxes.

• Rent – an accrual for rent expenseincurredbut not yet paid.

• Advertising– an accrual for advertisingexpenseincurredbut not yet paid.

• Gift Card DeferredRevenue– liability for the amountof goodsand servicesowed

to customerswho have gift card balances.




• Other – all other liabilities that will be paid with current assets that do not meet

the definitionsof the categoriesabove.

(continued)RadioShackCorp.

Req. 3

AP

Turnover

COGS

Avg. Accts.Pay.

$2,462.1

($272.4+$262.9)/2 9.20

Days in AP 365

AP Turnover

365

9.20

39.7

Current

Ratio

Current assets

Current liabilities

$1,778.7

$908.1

1.96

Quick Ratio Cash+ ST Inv. + Rec.

Current Liabilities

$569.4+$377.5+$108.1

$908.1

1.16

Days in AR 365

(Sales/Avg.AR)

365

($4,472.7/ $350)

28.6

Average

AR

Beg. AR+ End. AR

2

($377.5+$322.5)

2

$350

Inv.

Turnover

COGS

Avg. Inventory

$2,462.1

(($723.7+$670.6)/2)

3.53

Days in Inv. 365

InventoryTurnover

365

3.53

103

• The companyis currently able to pay its accounts within an average of about 40

days whichis slightly longer than optimal.

• The companyhas a strongCurrent Ratio close to 2 and a Quick Ratio still greater

than 1 meaning that it has the current assets necessary to pay for its current

liabilities.




• The inventoryturnoverratio is quite disturbingin that RadioShackis only turning

over its inventory every 103 days on average. This meansthat RadioShackmust

wait at least 103 days after purchasinginventoryto sell it.

(continued)RadioShackCorp.

• It takes RadioShackalmost92 days (103 +28.6 – 39.7) to turn inventorypurchases

back into cash via sales and collections. A comparisonto previousyears would

indicateif this is trendingfavorableor unfavorable.

Overall, it wouldappearthat RadioShack,Corp. has the ability to pay its liabilities.

Req. 4

Five-year 2.5%unsecuredconvertiblenotes ($375 million)

Ten-year 7.375%unsecurednotes ($307 million)

The related interest is recordedin interest expenseon the IncomeStatement. The ten-

year notes are classified as current because they are due in 2011. The remaining five-

year notes are due in 2013.

Req. 5

Refer to Note 13—Commitments and Contingencies. RadioShack leases most of its

facilities and disclosesthese commitmentsin Note 13. The leases are operating leases

and thereforeno liability is reportedon the balancesheet.




In this same note, RadioShack disclosed facts about litigation. Since RadioShack

considers the outcome of this lawsuit to be uncertain, the contingent liability is

disclosedin the notes to the financial statementsrather than accrued.

GroupProjects

Studentresponseswill vary.

finanical accounting 9th edition solutions ch9.docx

Documents