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Chapter 9 - Long-Term Liabilities
Chapter 9
Long-Term Liabilities
REVIEW QUESTIONS
Question 9-1 (LO 9-1)
Capital structure is the mixture of liabilities and stockholders’ equity a business uses. Companies
in the auto industry, like Ford, typically lean more toward liabilities for their financing, while
companies in the computer industry, like Microsoft, use stockholders’ equity to a greater extent in
financing their asset growth.
Question 9-2 (LO 9-1)
One of the primary reasons a company chooses to borrow money rather than issue additional
stock relates to taxes. Interest expense incurred when borrowing money is tax deductible, while
dividends paid to stockholders is not tax deductible. Therefore, debt can be a less costly form of
financing.
A second reason relates to control. If a company issues additional shares to investors, control in
the company is shared with the new shareholders. If a company borrows funds, voting control in the
company is retained.
Question 9-3 (LO 9-1)
Bond issue costs include underwriting services, legal, accounting, registration, and printing fees
incurred to complete the bond issue. An underwriter is the investment house through which the
bonds are sold like JPMorganChase, Citigroup, and Bank of America.
Question 9-4 (LO 9-1)
A company that borrows by issuing bonds is effectively by-passing the bank and borrowing
directly from the investing public, usually at a lower interest rate than in a bank loan. However,
issuing bonds entails significant bond issue costs that often exceed 5% of the amount borrowed. For
smaller loans, the additional bond issue costs exceed the savings from a lower interest rate, making it
more economical to borrow from a bank. For loans of $20 million or more, the interest rate savings
often exceed the additional bond issuance costs, making a bond issue more attractive.
Question 9-5 (LO 9-2)
(a) Secured bonds are supported by assets pledged as collateral. Unsecured bonds, also referred
to as debentures, are not backed by a specific asset. (b) Term bonds require payment of the full
principal amount of the bond at a single maturity date. Serial bonds require payments in installments
over a series of years. (c) Callable bonds allow the issuer to repay the bonds before their scheduled
maturity date at a specified call price. Convertible bonds allow the investor to convert each bond into
a specified number of shares of common stock.
Solutions Manual, Chapter 9
© The McGraw-Hill Companies, Inc., 2014
9-1
Chapter 9 - Long-Term Liabilities
Answers to Review Questions (continued)
Question 9-6 (LO 9-2)
Convertible bonds allow the investor to convert each bond into a specified number of shares of
common stock. The investor benefits from the conversion feature if share prices rise above the fixed
conversion rate. For instance, assume a $1,000 bond is convertible into 40 shares of common stock,
when the stock is trading at $23 per share. If the stock rises above $25 ($1,000/40), the shareholder
will benefit by converting the bond into 40 common shares of stock. The borrower also benefits.
Convertible bonds sell at a higher price and require a lower interest rate than bonds without a
conversion feature.
Question 9-7 (LO 9-3)
We calculate the issue price of a bond as the present value of the principal (the face amount on
the bond due at maturity) plus the present value of the periodic interest payments. It is not solely the
present value of the principal; rather it is the present value of the principal plus the present value of
the interest payments.
Question 9-8 (LO 9-3)
(a) The face amount is the amount that will be repaid at maturity. The carrying value is the
balance in the bonds payable account at any point in time. For example a $100,000 bond that issues
for $93,205 has a face value of $100,000 and a carrying value of $93,205 on the date of issue. The
carrying value will increase from $93,205 to $100,000 over the life of the bond issue. (b) The stated
interest rate is the rate used to determine the periodic interest payments paid by the borrower. The
market interest rate represents the true interest rate used by investors to value the bond issue.
Question 9-9 (LO 9-3)
The bonds issue at a discount when the stated interest rate is less than the market interest rate.
The bonds are paying less than the going rate and, therefore, issue at a discount.
Question 9-10 (LO 9-3)
The bonds issue at a premium when the stated interest rate is more than the market interest rate.
The bonds are paying more than the going rate and, therefore, issue at a premium.
Question 9-11 (LO 9-3)
The cash payment every six months is $15,000 ($500,000 x .06 x 6/12). There will be 40 interest
payments over the 20 years – one every six months.
Question 9-12 (LO 9-3)
(a) $562,757
(b) $500,000
(c) $446,612
(Note: These answers are based on a calculator/excel. Answers using the present value tables may
differ just a little due to rounding.)
© The McGraw-Hill Companies, Inc., 2014
9-2
Financial Accounting
Chapter 9 - Long-Term Liabilities
Answers to Review Questions (continued)
Question 9-13 (LO 9-4)
If bonds issue at a discount, the carrying value of the bonds and interest expense will increase
over time. Recall that interest expense is calculated as the carrying value of the bond times the
market interest rate. As carrying value increases, interest expense also increases.
Question 9-14 (LO 9-4)
If bonds issue at a premium, the carrying value of the bonds and interest expense will decrease
over time. Recall that interest expense is calculated as the carrying value of the bond times the
market interest rate. As carrying value decreases, interest expense also decreases.
Question 9-15 (LO 9-4)
Cash paid is calculated as the face amount of the bonds times the stated interest rate. Interest
expense is the carrying value times the market rate. The difference between interest expense and the
cash paid increases the carrying value of the bonds. At the maturity date, the carrying value will
equal the face amount.
The amortization schedule is similar when bonds are issued at a premium, except that the
difference between interest expense and the cash paid decreases, rather than increases, the carrying
value of the bonds over time.
Question 9-16 (LO 9-5)
If interest rates decrease, a company may choose to buy back high interest rate bonds and reissue
bonds at a lower interest rate. A company can help protect itself from decreases in interest rates by
including a call feature allowing the company to repurchase bonds at a fixed price (like 2% over face
amount). When interest rates decrease, companies with a call provision are more likely to repurchase
higher-cost debt and then reissue debt at new lower interest rates.
Another incentive to repay debt early is to improve the company's debt and profitability ratios.
Repurchasing debt can improve debt ratios. It can also improve profitability. If interest rates increase,
bond prices go down and a company repurchasing the lower priced debt can report a gain on the
income statement.
Question 9-17 (LO 9-5)
A loss of $50,000 is recorded by the issuer retiring the bonds as follows:
Bonds Payable
Loss
Cash
(Retire bonds before maturity)
Solutions Manual, Chapter 9
280,000
50,000
330,000
© The McGraw-Hill Companies, Inc., 2014
9-3
Chapter 9 - Long-Term Liabilities
Answers to Review Questions (continued)
Question 9-18 (LO 9-6)
Both interest expense and the carrying value of the note decrease over time. Interest expense
decreases with each installment payment. In each of the following periods, the amount that goes to
interest expense becomes less and the amount that goes to decreasing the carrying value becomes
more. Interest expense decreases over time because the carrying value decreases over time, and
interest is a constant percentage of carrying value.
Question 9-19 (LO 9-6)
Operating leases are like rentals. Short-term car rentals and most apartment leases are operating
leases. Capital leases occur when the person or firm making the payments essentially buys an asset
and borrows the money through a lease to pay for the asset.
Question 9-20 (LO 9-7)
Additional debt increases risk. Failure to repay debt or the interest associated with the debt on a
timely basis may result in default and perhaps even bankruptcy. Other things being equal, the higher
the debt, the higher the risk of bankruptcy. Additional debt also offers potential rewards. If a
company earns a return in excess of the cost of borrowing the funds, shareholders are provided with
a total return greater than what could have been earned with equity funds alone. Unfortunately,
borrowing is not always favorable. Sometimes the cost of borrowing the funds exceeds the returns
they generate.
© The McGraw-Hill Companies, Inc., 2014
9-4
Financial Accounting
Chapter 9 - Long-Term Liabilities
BRIEF EXERCISES
Brief Exercise 9-1 (LO 9-2)
1. Convertible bonds sell at a higher price and require a lower interest rate than
bonds without a conversion feature.
2. Investors in convertible bonds benefit if the market price of the common stock
goes above $50 per share ($1,000/20 shares = $50 per share) assuming the current
share, the convertible bondholder can trade his $1,000 bond for 20 shares of stock
worth $60 per share (or $1,200). Prior to conversion the bondholder still receives
interest on the convertible bond.
Brief Exercise 9-2 (LO 9-3)
If the market rate is 7%, the bonds will issue at $60,000 (face amount).
Calculator Input
Bond
Characteristics
1. Face amount
2. Interest payment
3. Market interest rate
4. Periods to maturity
Key
FV
PMT
I
N
Amount
$60,000
$2,100 = $60,000 x 7% x ½ year
3.5% = 7% / 2 semi-annual periods
20 = 10 years x 2 periods each year
Calculator Output
Issue price
Solutions Manual, Chapter 9
PV
$60,000
© The McGraw-Hill Companies, Inc., 2014
9-5
Chapter 9 - Long-Term Liabilities
Brief Exercise 9-3 (LO 9-3)
If the market rate is 8%, the bonds will issue at $54,812 (a discount).
Calculator Input
Bond
Characteristics
1. Face amount
2. Interest payment
3. Market interest rate
4. Periods to maturity
Key
FV
PMT
I
N
Amount
$60,000
$2,100 = $60,000 x 7% x ½ year
4% = 8% / 2 semi-annual periods
30 = 15 years x 2 periods each year
Calculator Output
Issue price
PV
$54,812
Brief Exercise 9-4 (LO 9-3)
If the market rate is 6%, the bonds will issue at $66,934 (a premium).
Calculator Input
Bond
Characteristics
1. Face amount
2. Interest payment
3. Market interest rate
4. Periods to maturity
Key
FV
PMT
I
N
Amount
$60,000
$2,100 = $60,000 x 7% x ½ year
3% = 6% / 2 semi-annual periods
40 = 20 years x 2 periods each year
Calculator Output
Issue price
© The McGraw-Hill Companies, Inc., 2014
9-6
PV
$66,934
Financial Accounting
Chapter 9 - Long-Term Liabilities
Brief Exercise 9-5 (LO 9-4)
1.
January 1, 2015
Cash
Bonds Payable
(Issue bonds at face amount)
2.
June 30, 2015
Interest Expense
Cash ($70,000 x 7% x ½)
(Pay semiannual interest)
70,000
70,000
2,450
2,450
Brief Exercise 9-6 (LO 9-4)
1.
January 1, 2015
Cash
Bonds Payable
(Issue bonds at a discount)
2.
June 30, 2015
Interest Expense ($63,948 x 8% x ½)
Bonds Payable (difference)
Cash ($70,000 x 7% x ½)
(Pay semiannual interest)
Solutions Manual, Chapter 9
63,948
63,948
2,558
108
2,450
© The McGraw-Hill Companies, Inc., 2014
9-7
Chapter 9 - Long-Term Liabilities
Brief Exercise 9-7 (LO 9-4)
1.
January 1, 2015
Cash
Bonds Payable
(Issue bonds at a premium)
2.
June 30, 2015
Interest Expense ($76,860 x 6% x ½)
Bonds Payable (difference)
Cash ($70,000 x 7% x ½)
(Pay semiannual interest)
76,860
76,860
2,306
144
2,450
Brief Exercise 9-8 (LO 9-4)
1.
January 1, 2015
Cash
Bonds Payable
(Issue bonds at face amount)
2.
December 31, 2015
Interest Expense
Cash ($70,000 x 7%)
(Pay annual interest)
© The McGraw-Hill Companies, Inc., 2014
9-8
70,000
70,000
4,900
4,900
Financial Accounting
Chapter 9 - Long-Term Liabilities
Brief Exercise 9-9 (LO 9-4)
1.
January 1, 2015
Cash
Bonds Payable
(Issue bonds at a discount)
2.
December 31, 2015
Interest Expense ($64,008 x 8%)
Bonds Payable (difference)
Cash ($70,000 x7% )
(Pay annual interest)
64,008
64,008
5,121
221
4,900
Brief Exercise 9-10 (LO 9-4)
1.
January 1, 2015
Cash
Bonds Payable
(Issue bonds at a premium)
76,860
2.
December 31, 2015
Interest Expense ($76,860 x 6%)
Bonds Payable (difference)
Cash ($70,000 x 7%)
(Pay annual interest)
4,612
288
76,860
4,900
Brief Exercise 9-11 (LO 9-4)
$2,653 ($88,443 x 6% x ½).
Solutions Manual, Chapter 9
© The McGraw-Hill Companies, Inc., 2014
9-9
Chapter 9 - Long-Term Liabilities
Brief Exercise 9-12 (LO 9-4)
Interest expense for the year ended December 31, 2015 would be $2,765. Interest
expense for the first six months ended June 30, 2015 is $2,075 ($82,985 x 5% x ½).
Interest expense for the next six months ended December 31, 2015 is $2,082
([$82,985 +2,075 – 1,800] x 5% x ½). Thus, the total interest expense for the year is
$2,075 + $2,082 = $4,157.
Brief Exercise 9-13 (LO 9-4)
1.
Cash
63,948
Bonds Payable
(Issue bonds at a discount)
2.
Interest Expense
Bonds Payable
Cash
(Pay semiannual interest)
63,948
2,558
108
2,450
3. Interest expense increases each period because the carrying value of the debt
issued at a discount increases over time.
© The McGraw-Hill Companies, Inc., 2014
9-10
Financial Accounting
Chapter 9 - Long-Term Liabilities
Brief Exercise 9-14 (LO 9-4)
1.
Cash
76,860
Bonds Payable
(Issue bonds at a premium)
2.
Interest Expense
Bonds Payable
Cash
(Pay semi-annual interest)
76,860
2,306
144
2,450
3. Interest expense decreases each period because the carrying value of the debt
issued at a premium decreases over time.
Brief Exercise 9-15 (LO 9-5)
Bonds Payable
Loss
Cash
(Retire bonds before maturity)
64,168
3,832
68,000
Brief Exercise 9-16 (LO 9-5)
Bonds Payable
Gain
Cash
(Retire bonds before maturity)
Solutions Manual, Chapter 9
76,567
4,567
72,000
© The McGraw-Hill Companies, Inc., 2014
9-11
Chapter 9 - Long-Term Liabilities
Brief Exercise 9-17 (LO 9-6)
January 1, 2015
Equipment
Notes Payable
(Issue a note payable)
January 31, 2015
Interest Expense ($30,000 x 5% x 1/12)
Notes Payable (difference)
Cash (monthly payment)
(Pay monthly installment on note)
© The McGraw-Hill Companies, Inc., 2014
9-12
30,000
30,000
125.00
441.14
566.14
Financial Accounting
Chapter 9 - Long-Term Liabilities
Brief Exercise 9-18 (LO 9-7)
1.
Total
Liabilities
$628
÷
÷
Equity
$99
=
=
Debt to Equity
Ratio
6.34
Average Total
Assets
$722.5*
=
=
Return on Assets
Ratio
9.1%
2.
Net
Income
÷
$66
÷
*($718 + $727) / 2
3.
Net
Income
$66
*($99 + $188) / 2
÷
÷
Average
Stock
Equity
$143.5*
=
=
Return on Equity
Ratio
46.0%
=
=
Times Interest
Earned Ratio
8.3
4.
Net Income +
Interest + Taxes ÷
$125
÷
Interest
$15
The return on equity is higher than the return on assets, because the return on equity
Solutions Manual, Chapter 9
© The McGraw-Hill Companies, Inc., 2014
9-13
Chapter 9 - Long-Term Liabilities
EXERCISES
Exercise 9-1 (LO 9-1)
Requirement 1
Operating income
Interest expense (bonds only)
Income before tax
Income tax expense (35%)
Net income
# of shares
Earnings per share (Net income / # of shares)
Issue Bonds
$11,000,000
2,450,000
8,550,000
2,992,500
$ 5,557,500
Issue Stock
$11,000,000
4,000,000
5,000,000
$1.39
$1.43
11,000,000
3,850,000
$ 7,150,000
Requirement 2
Issuing stock results in higher earnings per share. Issuing bonds results in earnings
per share of $1.39 compared with $1.43 for issuing stock.
© The McGraw-Hill Companies, Inc., 2014
9-14
Financial Accounting
Chapter 9 - Long-Term Liabilities
Exercise 9-2 (LO 9-2)
Terms
__e___ 1. Sinking fund.
__g___ 2. Secured bond.
__c___ 3. Unsecured bond.
__f___ 4. Term bond.
__b___ 5. Serial bond.
__a___ 6. Callable bond.
__d___ 7. Convertible bond.
__h___ 8. Bond issue costs.
Definitions
a. Allows the issuer to pay off the bonds early at a fixed price.
b. Matures in installments.
c. Secure
d. Allows the investor to transfer each bond into shares of common stock.
e. Money set aside to pay debts as they come due.
f. Matures on a single date.
g. Supported by specific assets pledged as collateral by the issuer.
h. Includes underwriting, legal, accounting, registration, and printing fees.
Solutions Manual, Chapter 9
© The McGraw-Hill Companies, Inc., 2014
9-15
Chapter 9 - Long-Term Liabilities
Exercise 9-3 (LO 9-3)
Requirement 1
Premium. The issue price is $45,057,519
Calculator Input
Bond
Characteristics
1. Face amount
2. Interest payment
3. Market interest rate
4. Periods to maturity
Key
FV
PMT
I
N
Amount
$41,000,000
$1,845,000 = $41,000,000 x 9% x ½ year
4% = 8% / 2 semi-annual periods
40 = 20 years x 2 periods each year
Calculator Output
Issue price
PV
$45,057,519
Requirement 2
Face amount. The issue price is $41,000,000.
Calculator Input
Bond
Characteristics
1. Face amount
2. Interest payment
3. Market interest rate
4. Periods to maturity
Key
FV
PMT
I
N
Amount
$41,000,000
$1,845,000 = $41,000,000 x 9% x ½ year
4.5% = 9% / 2 semi-annual periods
40 = 20 years x 2 periods each year
Calculator Output
Issue price
© The McGraw-Hill Companies, Inc., 2014
9-16
PV
$41,000,000
Financial Accounting
Chapter 9 - Long-Term Liabilities
Requirement 3
Discount. The issue price is $37,482,387
Calculator Input
Bond
Characteristics
1. Face amount
2. Interest payment
3. Market interest rate
4. Periods to maturity
Key
FV
PMT
I
N
Amount
$41,000,000
$1,845,000 = $41,000,000 x 9% x ½ year
5% = 10% / 2 semi-annual periods
40 = 20 years x 2 periods each year
Calculator Output
Issue price
Solutions Manual, Chapter 9
PV
$37,482,387
© The McGraw-Hill Companies, Inc., 2014
9-17
Chapter 9 - Long-Term Liabilities
Exercise 9-4 (LO 9-3)
Requirement 1
Premium. The issue price is $27,934,072.
Calculator Input
Bond
Characteristics
1. Face amount
2. Interest payment
3. Market interest rate
4. Periods to maturity
Key
FV
PMT
I
N
Amount
$26,000,000
$910,000 = $26,000,000 x7% x ½ year
3% = 6% / 2 semi-annual periods
20 = 10 years x 2 periods each year
Calculator Output
Issue price
PV
$27,934,072
Requirement 2
Face amount. The issue price is $26,000,000.
Calculator Input
Bond
Characteristics
1. Face amount
2. Interest payment
3. Market interest rate
4. Periods to maturity
Key
FV
PMT
I
N
Amount
$26,000,000
$910,000 = $26,000,000 x 7% x ½ year
3.5% = 7% / 2 semi-annual periods
20 = 10 years x 2 periods each year
Calculator Output
Issue price
© The McGraw-Hill Companies, Inc., 2014
9-18
PV
$26,000,000
Financial Accounting
Chapter 9 - Long-Term Liabilities
Requirement 3
Discount. The issue price is $24,233,258.
Calculator Input
Bond
Characteristics
1. Face amount
2. Interest payment
3. Market interest rate
4. Periods to maturity
Key
FV
PMT
I
N
Amount
$26,000,000
$910,000 = $26,000,000 x 7% x ½ year
4% = 8% / 2 semi-annual periods
20 = 10 years x 2 periods each year
Calculator Output
Issue price
PV
$24,233,258
Exercise 9-5 (LO 9-4)
January 1, 2015
Cash
Bonds Payable
(Issue bonds at face amount)
June 30, 2015
Interest Expense
Cash ($500,000 x 9% x ½)
(Pay semiannual interest)
December 31, 2015
Interest Expense
Cash ($500,000 x 9% x ½)
(Pay semiannual interest)
Solutions Manual, Chapter 9
500,000
500,000
22,500
22,500
22,500
22,500
© The McGraw-Hill Companies, Inc., 2014
9-19
Chapter 9 - Long-Term Liabilities
Exercise 9-6 (LO 9-4)
Requirement 1
(1)
Date
1/ 1 /15
6/30/15
12/31/15
(2)
(3)
Cash
Paid
Face Amount
x 4.5% Stated
Rate
Interest
Expense
Carrying Value
x 5% Market
Rate
$ 22,500
22,500
Requirement 2
January 1, 2015
Cash
Bonds Payable
(Issue bonds at a discount)
June 30, 2015
Interest Expense
Bonds Payable (difference)
Cash ($500,000 x 9% x ½)
(Pay semiannual interest)
December 31, 2015
Interest Expense
Bonds Payable (difference)
Cash ($500,000 x 9% x ½)
(Pay semiannual interest)
© The McGraw-Hill Companies, Inc., 2014
9-20
(4)
Increase in
Carrying
Value
(3)
$ 22,855
22,873
(2)
$ 355
373
(5)
Carrying
Value
Prior Carrying
Value + (4)
$ 457,102
457,457
457,830
457,102
457,102
22,855
355
22,500
22,873
373
22,500
Financial Accounting
Chapter 9 - Long-Term Liabilities
Exercise 9-7 (LO 9-4)
Requirement 1
(1)
Date
(2)
(3)
Cash
Paid
Face Amount
x 4.5% Stated
Rate
Interest
Expense
Carrying Value
x 4% Market
Rate
1/ 1 /15
6/30/15
12/31/15
$ 22,500
22,500
Requirement 2
January 1, 2015
Cash
Bonds Payable
(Issue bonds at a premium)
June 30, 2015
Interest Expense
Bonds Payable (difference)
Cash ($500,000 x 9% x ½)
(Pay semiannual interest)
December 31, 2015
Interest Expense
Bonds Payable (difference)
Cash ($500,000 x 9% x ½)
(Pay semiannual interest)
Solutions Manual, Chapter 9
(4)
Decrease in
Carrying
Value
(2)
$ 21,979
21,958
(3)
(5)
Carrying
Value
Prior Carrying
Value (4)
$ 521
542
$ 549,482
548,961
548,419
549,482
549,482
21,979
521
22,500
21,958
542
22,500
© The McGraw-Hill Companies, Inc., 2014
9-21
Chapter 9 - Long-Term Liabilities
Exercise 9-8 (LO 9-4)
January 1, 2015
Cash
Bonds Payable
(Issue bonds at face amount)
June 30, 2015
Interest Expense
Cash ($600,000 x 7% x ½)
(Pay semiannual interest)
December 31, 2015
Interest Expense
Cash ($600,000 x 7% x ½)
(Pay semiannual interest)
© The McGraw-Hill Companies, Inc., 2014
9-22
600,000
600,000
21,000
21,000
21,000
21,000
Financial Accounting
Chapter 9 - Long-Term Liabilities
Exercise 9-9 (LO 9-4)
Requirement 1
(1)
Date
(2)
(3)
Cash
Paid
Face Amount
x 3.5% Stated
Rate
Interest
Expense
Carrying Value
x 4% Market
Rate
1/ 1 /15
6/30/15
12/31/15
$ 21,000
21,000
Requirement 2
January 1, 2015
Cash
Bonds Payable
(Issue bonds at a discount)
June 30, 2015
Interest Expense
Bonds Payable (difference)
Cash ($600,000 x7% x ½)
(Pay semiannual interest)
December 31, 2015
Interest Expense
Bonds Payable (difference)
Cash ($600,000 x 7% x ½)
(Pay semiannual interest)
Solutions Manual, Chapter 9
(4)
Increase in
Carrying
Value
(3)
$ 22,369
22,424
(2)
(5)
Carrying
Value
Prior Carrying
Value + (4)
$ 1,369
1,424
$ 559,229
560,598
562,022
559,229
559,229
22,369
1,369
21,000
22,424
1,424
21,000
© The McGraw-Hill Companies, Inc., 2014
9-23
Chapter 9 - Long-Term Liabilities
Exercise 9-10 (LO 9-4)
Requirement 1
(1)
Date
1/ 1 /15
6/30/15
12/31/15
(2)
(3)
Cash
Paid
Face Amount
x 3.5% Stated
Rate
Interest
Expense
Carrying Value
x 3% Market
Rate
$ 21,000
21,000
Requirement 2
January 1, 2015
Cash
Bonds Payable
(Issue bonds at a premium)
June 30, 2015
Interest Expense
Bonds Payable (difference)
Cash ($600,000 x 7% x ½)
(Pay semi-annual interest)
December 31, 2015
Interest Expense
Bonds Payable (difference)
Cash ($600,000 x 7% x ½)
(Pay semi-annual interest)
© The McGraw-Hill Companies, Inc., 2014
9-24
(4)
Decrease in
Carrying
Value
(2)
$ 19,339
19,289
(3)
(5)
Carrying
Value
Prior Carrying
Value (4)
$ 1,661
1,711
$ 644,632
642,971
641,260
644,632
644,632
19,339
1,661
21,000
19,289
1,711
21,000
Financial Accounting
Chapter 9 - Long-Term Liabilities
Exercise 9-11 (LO 9-4)
January 1, 2015
Cash
Bonds Payable
(Issue bonds at face amount)
December 31, 2015
Interest Expense
Cash ($600,000 x 7%)
(Pay annual interest)
December 31, 2016
Interest Expense
Cash ($600,000 x 7%)
(Pay annual interest)
Solutions Manual, Chapter 9
600,000
600,000
42,000
42,000
42,000
42,000
© The McGraw-Hill Companies, Inc., 2014
9-25
Chapter 9 - Long-Term Liabilities
Exercise 9-12 (LO 9-4)
Requirement 1
(1)
Date
1/ 1 /15
12/31/15
12/31/16
(2)
(3)
Cash
Paid
Face Amount
x 7% Stated
Rate
Interest
Expense
Carrying Value
x 8% Market
Rate
$ 42,000
42,000
Requirement 2
January 1, 2015
Cash
Bonds Payable
(Issue bonds at a discount)
December 31, 2015
Interest Expense
Bonds Payable (difference)
Cash ($600,000 x 7%)
(Pay annual interest)
December 31, 2016
Interest Expense
Bonds Payable (difference)
Cash ($600,000 x 7%)
(Pay annual interest)
© The McGraw-Hill Companies, Inc., 2014
9-26
(4)
Increase in
Carrying
Value
(3)
$ 44,779
45,002
(2)
(5)
Carrying
Value
Prior Carrying
Value + (4)
$ 2,779
3,002
$ 559,740
562,519
565,521
559,740
559,740
44,779
2,779
42,000
45,002
3,002
42,000
Financial Accounting
Chapter 9 - Long-Term Liabilities
Exercise 9-13 (LO 9-4)
Requirement 1
(1)
Date
(2)
(3)
Cash
Paid
Face Amount
x 7% Stated
Rate
Interest
Expense
Carrying Value
x 6% Market
Rate
1/ 1 /15
12/31/15
12/31/16
$ 42,000
42,000
Requirement 2
January 1, 2015
Cash
Bonds Payable
(Issue bonds at a premium)
December 31, 2015
Interest Expense
Bonds Payable (difference)
Cash ($600,000 x 7%)
(Pay annual interest)
December 31, 2016
Interest Expense
Bonds Payable (difference)
Cash ($600,000 x 7%)
(Pay annual interest)
Solutions Manual, Chapter 9
(4)
Decrease in
Carrying
Value
(2)
$ 38,650
38,449
(3)
(5)
Carrying
Value
Prior Carrying
Value (4)
$ 3,350
3,551
$ 644,161
640,811
637,260
644,161
644,161
38,650
3,350
42,000
38,449
3,551
42,000
© The McGraw-Hill Companies, Inc., 2014
9-27
Chapter 9 - Long-Term Liabilities
Exercise 9-14 (LO 9-5)
Requirement 1
(1)
Date
(2)
(3)
Cash
Paid
Face Amount
x 4.5% Stated
Rate
Interest
Expense
Carrying Value
x 5% Market
Rate
1/ 1 /15
6/30/15
12/31/15
6/30/16
12/31/16
$ 22,500
22,500
22,500
22,500
(4)
Increase in
Carrying
Value
(3)
$ 22,855
22,873
22,892
22,911
(2)
(5)
Carrying
Value
Prior Carrying
Value + (4)
$ 355
373
392
411
$ 457,102
457,457
457,830
458,222
458,633
Requirement 2
If the market rate drops to 7%, it will cost $601,452 to retire the bonds.
Calculator Input
Bond
characteristics
Key
1. Face amount
2. Interest payment each period
3. Market interest rate each period
4. Periods to maturity
Amount
FV
PMT
I
N
$500,000
$22,500 = $500,000 x 9% x ½ year
3.5% = 7% / 2 semi-annual periods
36 = 18 years x 2 periods each year
Calculator Output
Issue price
PV
$601,452
December 31, 2016
Bonds Payable
Loss
Cash
(Retire bonds before maturity)
© The McGraw-Hill Companies, Inc., 2014
9-28
458,633
142,819
601,452
Financial Accounting
Chapter 9 - Long-Term Liabilities
Exercise 9-15 (LO 9-5)
Requirement 1
(1)
Date
(2)
(3)
Cash
Paid
Face Amount
x 3.5% Stated
Rate
Interest
Expense
Carrying Value
x 3% Market
Rate
1/ 1 /15
6/30/15
12/31/15
6/30/16
12/31/16
6/30/17
12/31/17
$ 21,000
21,000
21,000
21,000
21,000
21,000
(4)
Decrease in
Carrying
Value
(2)
$ 19,339
19,289
19,238
19,185
19,130
19,074
(3)
(5)
Carrying
Value
Prior Carrying
Value (4)
$ 1,661
1,711
1,762
1,815
1,870
1,926
$ 644,632
642,971
641,260
639,498
637,683
635,813
633,887
Requirement 2
If the market rate increases to 8%, it will cost $568,311 to retire the bonds.
Calculator Input
Bond
Characteristics
Key
1. Face amount
2. Interest payment each period
3. Market interest rate each period
4. Periods to maturity
Amount
FV
PMT
I
N
$600,000
$21,000 = $600,000 x 7% x ½ year
4% = 8% / 2 semi-annual periods
14 = 7 years x 2 periods each year
Calculator Output
Issue price
PV
$568,311
December 31, 2017
Bonds Payable
Gain
Cash
(Retire bonds before maturity)
Solutions Manual, Chapter 9
633,887
65,576
568,311
© The McGraw-Hill Companies, Inc., 2014
9-29
Chapter 9 - Long-Term Liabilities
Exercise 9-16 (LO 9-6)
January 1, 2015
Cash
Notes Payable
(Issue a note payable)
January 31, 2015
Interest Expense ($50,000 x 6% x 1/12)
Notes Payable (difference)
Cash (monthly payment)
(Pay monthly installment on note)
February 28, 2015
Interest Expense ([$50,000-578.64] x 6% x 1/12)
Notes Payable (difference)
Cash (monthly payment)
(Pay monthly installment on note)
© The McGraw-Hill Companies, Inc., 2014
9-30
50,000
50,000
250.00
578.64
828.64
247.11
581.53
828.64
Financial Accounting
Chapter 9 - Long-Term Liabilities
Exercise 9-17 (LO 9-6)
Requirement 1
Assets
$25 million
=
Liabilities
$15 million
+
Equity
?
- $15 million).
Requirement 2
Total
Liabilities
$15 million
Requirement 3
Total
Liabilities
$15 + $2 =
$17 million
÷
÷
÷
÷
Equity
$10 million
Stockho
Equity
$10 million
=
=
Debt to Equity
Ratio
1.50
=
Debt to Equity
Ratio
=
1.70
Requirement 4
Under an operating lease, Coney Island reports a more favorable (lower) debt to
equity ratio.
Solutions Manual, Chapter 9
© The McGraw-Hill Companies, Inc., 2014
9-31
Chapter 9 - Long-Term Liabilities
Exercise 9-18 (LO 9-7)
Requirement 1
($ in thousands)
Total
Liabilities
÷
Equity
=
Debt to Equity
Ratio
E-Travel
Pricecheck
$4,254,475
$486,610
÷
÷
$3,182,681
$1,607,614
=
=
1.34
0.30
E-Travel has a higher debt to equity ratio than Pricecheck. The soft drink industry
represented by Coca-Cola and Pepsi has a higher average debt to equity ratio than the
travel industry represented by E-Travel and Pricecheck.
Requirement 2
Net Income +
($ in thousands) Interest + Taxes ÷
Interest
=
Times Interest
Earned Ratio
E-Travel
Pricecheck
$94,233
$34,084
=
=
6.2
17.6
$588,159
$600,724
÷
÷
Pricecheck, with a times interest earned ratio of 17.6, is better able to meet interest
payments as they become due than E-Travel with a ratio of only 6.2. The soft drink
industry represented by Coca-Cola and Pepsi has a higher average times interest
earned ratio.
© The McGraw-Hill Companies, Inc., 2014
9-32
Financial Accounting
Chapter 9 - Long-Term Liabilities
PROBLEMS: SET A
Problem 9-1A (LO 9-3, 9-4)
Requirement 1
Face amount. The issue price is $1,300,000.
Calculator Input
Bond
Characteristics
1. Face amount
2. Interest payment
3. Market interest rate
4. Periods to maturity
Key
FV
PMT
I
N
Amount
$1,300,000
$45,500 = $1,300,000 x 7% x ½ year
3.5% = 7% / 2 semi-annual periods
30 = 15 years x 2 periods each year
Calculator Output
Issue price
PV
(1)
Date
$1,300,000
(2)
(3)
Cash
Paid
Face Amount
x 3.5% Stated
Rate
Interest
Expense
Carrying Value
x 3.5% Market
Rate
1/ 1 /15
6/30/15
12/31/15
Solutions Manual, Chapter 9
$ 45,500
45,500
$ 45,500
45,500
(4)
Increase in
Carrying
Value
(3)
(2)
$0
0
(5)
Carrying
Value
Prior Carrying
Value + (4)
$ 1,300,000
1,300,000
1,300,000
© The McGraw-Hill Companies, Inc., 2014
9-33
Chapter 9 - Long-Term Liabilities
Requirement 2
Discount. The issue price is $1,187,602.
Calculator Input
Bond
Characteristics
1. Face amount
2. Interest payment
3. Market interest rate
4. Periods to maturity
Key
FV
PMT
I
N
Amount
$1,300,000
$45,500 = $1,300,000 x 7% x ½ year
4% = 8% / 2 semi-annual periods
30 = 15 years x 2 periods each year
Calculator Output
Issue price
(1)
Date
1/ 1 /15
6/30/15
12/31/15
PV
$1,187,602
(2)
(3)
Cash
Paid
Face Amount
x 3.5% Stated
Rate
Interest
Expense
Carrying Value
x 4% Market
Rate
$ 45,500
45,500
© The McGraw-Hill Companies, Inc., 2014
9-34
$ 47,504
47,584
(4)
Increase in
Carrying
Value
(3)
(2)
$ 2,004
2,084
(5)
Carrying
Value
Prior Carrying
Value + (4)
$ 1,187,602
1,189,606
1,191,690
Financial Accounting
Chapter 9 - Long-Term Liabilities
Requirement 3
Premium. The issue price is $1,427,403.
Calculator Input
Bond
Characteristics
1. Face amount
2. Interest payment
3. Market interest rate
4. Periods to maturity
Key
FV
PMT
I
N
Amount
$1,300,000
$45,500 = $1,300,000 x 7% x ½ year
3% = 6% / 2 semi-annual periods
30 = 15 years x 2 periods each year
Calculator Output
Issue price
PV
(1)
Date
$1,427,403
(2)
(3)
Cash
Paid
Face Amount
x 3.5% Stated
Rate
Interest
Expense
Carrying Value
x 3% Market
Rate
1/ 1 /15
6/30/15
12/31/15
Solutions Manual, Chapter 9
$ 45,500
45,500
$ 42,822
42,742
(4)
Decrease in
Carrying
Value
(2)
(3)
$ 2,678
2,758
(5)
Carrying
Value
Prior Carrying
Value (4)
$ 1,427,403
1,424,725
1,421,967
© The McGraw-Hill Companies, Inc., 2014
9-35
Chapter 9 - Long-Term Liabilities
Problem 9-2A (LO 9-4)
Requirement 1
January 1, 2015
Cash
Bonds Payable
(Issue bonds at face amount)
June 30, 2015
Interest Expense
Cash ($600,000 x 8% x ½)
(Pay semiannual interest)
December 31, 2015
Interest Expense
Cash ($600,000 x 8% x ½)
(Pay semiannual interest)
Requirement 2
January 1, 2015
Cash
Bonds Payable
(Issue bonds at a discount)
June 30, 2015
Interest Expense ($544,795 x 9% x ½)
Bonds Payable (difference)
Cash ($600,000 x 8% x ½)
(Pay semiannual interest)
December 31, 2015
Interest Expense ([$544,795+$516] x 9% x ½)
Bonds Payable (difference)
Cash ($600,000 x 8% x ½)
(Pay semiannual interest)
© The McGraw-Hill Companies, Inc., 2014
9-36
600,000
600,000
24,000
24,000
24,000
24,000
544,795
544,795
24,516
516
24,000
24,539
539
24,000
Financial Accounting
Chapter 9 - Long-Term Liabilities
Requirement 3
January 1, 2015
Cash
Bonds Payable
(Issue bonds at a premium)
June 30, 2015
Interest Expense (664,065 x 7% x ½)
Bonds Payable (difference)
Cash ($600,000 x 8% x ½)
(Pay semiannual interest)
December 31, 2015
Interest Expense ([$664,065 $758] x 7% x ½)
Bonds Payable (difference)
Cash ($600,000 x 8% x ½)
(Pay semiannual interest)
Solutions Manual, Chapter 9
664,065
664,065
23,242
758
24,000
23,216
784
24,000
© The McGraw-Hill Companies, Inc., 2014
9-37
Chapter 9 - Long-Term Liabilities
Problem 9-3A (LO 9-4)
1.
2.
3.
4.
5.
6.
Discount
$37,281,935
$40,000,000
7% ($1,400,000 cash paid ÷ $40,000,000 face value) x 2
8% ($1,491,277 interest expense ÷ $37,281,935 carrying value) x 2
$28,000,000 ($1,400,000 x 20 payments)
© The McGraw-Hill Companies, Inc., 2014
9-38
Financial Accounting
Chapter 9 - Long-Term Liabilities
Problem 9-4A (LO 9-4)
Requirement 1
(1)
Date
(2)
(3)
Cash
Paid
Face Amount
x 4% Stated
Rate
Interest
Expense
Carrying Value
x 4.5% Market
Rate
1/ 1 /15
6/30/15
12/31/15
$ 36,000
36,000
Requirement 2
January 1, 2015
Cash
Bonds Payable
(Issue bonds at a discount)
Requirement 3
June 30, 2015
Interest Expense ($841,464 x 9% x ½)
Bonds Payable (difference)
Cash ($900,000 x 8% x ½)
(Pay semiannual interest)
December 31, 2015
Interest Expense ($843,330 x 9% x ½)
Bonds Payable (difference)
Cash ($900,000 x 8% x ½)
(Pay semiannual interest)
Solutions Manual, Chapter 9
$ 37,866
37,950
(4)
Increase in
Carrying
Value
(3)
(2)
(5)
Carrying
Value
Prior Carrying
Value + (4)
$ 1,866
1,950
$ 841,464
843,330
845,280
841,464
841,464
37,866
1,866
36,000
37,950
1,950
36,000
© The McGraw-Hill Companies, Inc., 2014
9-39
Chapter 9 - Long-Term Liabilities
Problem 9-5A (LO 9-6)
Requirement 1
January 1, 2015
Building
Cash
Notes Payable
(Issue a mortgage note payable)
Requirement 2
(1)
(2)
Date
1/1/15
1/31/15
2/28/15
360,000
60,000
300,000
(3)
(4)
(5)
Cash
Paid
Interest
Expense
Decrease in
Carrying
Value
Carrying
Value
Monthly
Payment
Carrying Value
x 0.07 x 1/12
$3,483.25
3,483.25
$ 1,750.00
1,739.89
Requirement 3
January 31, 2015
Interest Expense ($300,000 x 7% x 1/12)
Notes Payable (difference)
Cash (monthly payment)
(Pay monthly installment on note )
(2)
(3)
$ 1,733.25
1,743.36
Prior Carrying
Value (4)
$ 300,000.00
298,266.75
296,523.39
1,750.00
1,733.25
3,483.25
In the first monthly payment, $1,750.00 goes to interest expense and $1,733.25 goes
to reducing the carrying value of the loan.
Requirement 4
Total payments on the loan are $417,990. Since actual payments on the loan are
$300,000, the remainder of $117,990 is the amount paid for interest expense.
Problem 9-6A (LO 9-6, 9-7)
Requirement 1
© The McGraw-Hill Companies, Inc., 2014
9-40
Financial Accounting
Chapter 9 - Long-Term Liabilities
Assets
$81 million
=
Liabilities
$11 + $41 = $52 million
+
Equity
?
29 million ($81 million - $52 million).
Requirement 2
Total
Liabilities
$52 million
÷
÷
Equity
$29 million
=
=
Debt to Equity
Ratio
1.79
Requirement 3
An operating lease is like a rental. Over the lease term, the company making the lease
payments records rent expense and the company receiving the rent payments records
rent revenue. A capital lease is different. In a capital lease, the company making lease
payments (called the lessee) essentially buys the asset and borrows the money
through a lease to pay for the asset. The lease is recorded as an asset and a liability on
Requirement 4
Yes. The debt to equity ratio will not be affected under an operating lease. However,
under a capital lease, assets and liabilities will both increase $16 million while
the debt to equity ratio.
Solutions Manual, Chapter 9
© The McGraw-Hill Companies, Inc., 2014
9-41
Chapter 9 - Long-Term Liabilities
Requirement 5
The debt to equity ratio will not be in violation (exceed 2.0) under an operating lease,
but will be in violation (exceed 2.0) under a capital lease. Therefore, Thrillville has a
strong incentive to structure the lease agreement as an operating lease.
Operating lease:
Total
Liabilities
$52 million
÷
÷
Equity
$29 million
=
=
Debt to Equity
Ratio
1.79
=
=
Debt to Equity
Ratio
2.34
Capital lease:
Total
Liabilities
$68 million
÷
÷
Equity
$29 million
© The McGraw-Hill Companies, Inc., 2014
9-42
Financial Accounting
Chapter 9 - Long-Term Liabilities
Problem 9-7A (LO 9-7)
Requirement 1
($ in millions)
Starwood
Hyatt
Total
Liabilities
÷
Equity
=
Debt to Equity
Ratio
$5,724
$2,819
÷
÷
$3,137
$4,821
=
=
1.82
0.58
Starwood Hotels and Resorts has a higher debt to equity ratio than Hyatt. The hotel
industry represented by Starwood and Hyatt maintains a lower debt to equity ratio
than the soft drink industry represented by Coca-Cola and Pepsi.
Requirement 2
($ in millions)
Net
Income
Starwood
$562
Hyatt
$88
*($8,861 + $9,560) / 2
**($7,640 + $7,507) / 2
Average
÷ Total Assets
÷
÷
=
$9,210.5*
=
$7,573.5** =
Return on
Assets Ratio
6.1%
1.2%
Average
($ in millions)
Net
Income
Starwood
$562
Hyatt
$88
*($3,137 + $2,954) / 2
**($4,821 + $4,818) / 2
÷
=
Return on
Equity Ratio
=
=
18.5%
1.8%
Equity
÷
÷
$3,045.5*
$4,819.5**
Starwood has better profitability ratios than Hyatt. However, Coca-Cola and Pepsi are
both more profitable than Starwood .
Solutions Manual, Chapter 9
© The McGraw-Hill Companies, Inc., 2014
9-43
Chapter 9 - Long-Term Liabilities
Requirement 3
($ in millions)
Starwood
Hyatt
Net Income +
Interest + Taxes
÷
Interest
=
Times Interest
Earned Ratio
$880
$166
÷
÷
$170
$70
=
=
5.2
2.4
Starwood, with a times interest earned ratio of 5.2, is better able to meet interest
payments as they become due than Hyatt with a ratio of only 2.4. The soft drink
industry represented by Coca-Cola and Pepsi has a better times interest earned ratio
than the Starwood and Hyatt hotel chains.
© The McGraw-Hill Companies, Inc., 2014
9-44
Financial Accounting
Chapter 9 - Long-Term Liabilities
PROBLEMS: SET B
Problem 9-1B (LO 9-3, 9-4)
Requirement 1
Face amount. The issue price is $850,000.
Calculator Input
Bond
Characteristics
1. Face amount
2. Interest payment
3. Market interest rate
4. Periods to maturity
Key
FV
PMT
I
N
Amount
$850,000
$25,500 = $850,000 x 6% x ½ year
3% = 6% / 2 semi-annual periods
20 = 10 years x 2 periods each year
Calculator Output
Issue price
PV
(1)
Date
$850,000
(2)
(3)
Cash
Paid
Face Amount
x 3% Stated
Rate
Interest
Expense
Carrying Value
x 3% Market
Rate
1/ 1 /15
6/30/15
12/31/15
Solutions Manual, Chapter 9
$ 25,500
25,500
$ 25,500
25,500
(4)
Increase in
Carrying
Value
(3)
(2)
$0
0
(5)
Carrying
Value
Prior Carrying
Value + (4)
$ 850,000
850,000
850,000
© The McGraw-Hill Companies, Inc., 2014
9-45
Chapter 9 - Long-Term Liabilities
Requirement 2
Discount. The issue price is $789,597.
Calculator Input
Bond
Characteristics
1. Face amount
2. Interest payment
3. Market interest rate
4. Periods to maturity
Key
FV
PMT
I
N
Amount
$850,000
$25,500 = $850,000 x 6% x ½ year
3.5% = 7% / 2 semi-annual periods
20 = 10 years x 2 periods each year
Calculator Output
Issue price
(1)
Date
1/ 1 /15
6/30/15
12/31/15
PV
$789,597
(2)
(3)
Cash
Paid
Face Amount
x 3% Stated
Rate
Interest
Expense
Carrying Value
x 3.5% Market
Rate
$ 25,500
25,500
© The McGraw-Hill Companies, Inc., 2014
9-46
$ 27,636
27,711
(4)
Increase in
Carrying
Value
(3)
(2)
$ 2,136
2,211
(5)
Carrying
Value
Prior Carrying
Value + (4)
$ 789,597
791,733
793,944
Financial Accounting
Chapter 9 - Long-Term Liabilities
Requirement 3
Premium. The issue price is $916,254.
Calculator Input
Bond
Characteristics
1. Face amount
2. Interest payment
3. Market interest rate
4. Periods to maturity
Key
FV
PMT
I
N
Amount
$850,000
$25,500 = $850,000 x 6% x ½ year
2.5% = 5% / 2 semi-annual periods
20 = 10 years x 2 periods each year
Calculator Output
Issue price
PV
(1)
Date
$916,254
(2)
(3)
Cash
Paid
Face Amount
x 3% Stated
Rate
Interest
Expense
Carrying Value
x 2.5% Market
Rate
1/ 1 /15
6/30/15
12/31/15
Solutions Manual, Chapter 9
$ 25,500
25,500
$ 22,906
22,842
(4)
Decrease in
Carrying
Value
(2)
(3)
$ 2,594
2,658
(5)
Carrying
Value
Prior Carrying
Value (4)
$ 916,254
913,660
911,002
© The McGraw-Hill Companies, Inc., 2014
9-47
Chapter 9 - Long-Term Liabilities
Problem 9-2B (LO 9-4)
Requirement 1
January 1, 2015
Cash
Bonds Payable
(Issue bonds at face amount)
June 30, 2015
Interest Expense
Cash ($3,000,000 x 9% x ½)
(Pay semiannual interest)
December 31, 2015
Interest Expense
Cash ($3,000,000 x 9% x ½)
(Pay semiannual interest)
Requirement 2
January 1, 2015
Cash
Bonds Payable
(Issue bonds at a discount)
June 30, 2015
Interest Expense ($2,813,067 x 10% x ½)
Bonds Payable (difference)
Cash ($3,000,000 x 9% x ½)
(Pay semiannual interest)
December 31, 2015
Interest Expense ([$2,813,067+$5,653] x10% x ½)
Bonds Payable (difference)
Cash ($3,000,000 x 9% x ½)
(Pay semiannual interest)
© The McGraw-Hill Companies, Inc., 2014
9-48
3,000,000
3,000,000
135,000
135,000
135,000
135,000
2,813,067
2,813,067
140,653
5,653
135,000
140,936
5,936
135,000
Financial Accounting
Chapter 9 - Long-Term Liabilities
Requirement 3
January 1, 2015
Cash
Bonds Payable
(Issue bonds at a premium)
June 30, 2015
Interest Expense ($3,203,855 x 8% x ½)
Bonds Payable (difference)
Cash ($3,000,000 x 9% x ½)
(Pay semiannual interest)
December 31, 2015
Interest Expense ([$3,203,855 $6,846] x 8% x ½)
Bonds Payable (difference)
Cash ($3,000,000 x 9% x ½)
(Pay semiannual interest)
3,203,855
3,203,855
128,154
6,846
135,000
127,880
7,120
135,000
Problem 9-3B (LO 9-4)
1. Premium
2. $66,934,432
3. $60,000,000
4. 7% ($2,100,000 cash paid ÷ $60,000,000 face value) x 2
5. 6% ($2,008,033 interest expense ÷ $66,934,432 carrying value) x 2
6. $84,000,000 ($2,100,000 x 40 payments)
Problem 9-4B (LO 9-4)
Requirement 1
Solutions Manual, Chapter 9
© The McGraw-Hill Companies, Inc., 2014
9-49
Chapter 9 - Long-Term Liabilities
(1)
Date
1/ 1 /15
6/30/15
12/31/15
(2)
(3)
Cash
Paid
Face Amount
x 3.5% Stated
Rate
Interest
Expense
Carrying Value
x 3% Market
Rate
$ 35,000
35,000
$ 32,940
32,878
Requirement 2
January 1, 2015
Cash
Bonds Payable
(Issue bonds at a premium)
Requirement 3
June 30, 2015
Interest Expense ($1,098,002 x 6% x ½)
Bonds Payable (difference)
Cash ($1,000,000 x 7% x ½)
(Pay semiannual interest)
December 31, 2015
Interest Expense ($1,095,942 x 6% x ½)
Bonds Payable (difference)
Cash ($1,000,000 x 7% x ½)
(Pay semiannual interest)
© The McGraw-Hill Companies, Inc., 2014
9-50
(4)
Decrease in
Carrying
Value
(2)
(3)
(5)
Carrying
Value
Prior Carrying
Value (4)
$ 2,060
2,122
$ 1,098,002
1,095,942
1,093,820
1,098,002
1,098,002
32,940
2,060
35,000
32,878
2,122
35,000
Financial Accounting
Chapter 9 - Long-Term Liabilities
Problem 9-5B (LO 9-6)
Requirement 1
January 1, 2015
Building
Cash
Notes Payable
(Issue a mortgage note payable)
Requirement 2
(1)
(2)
Date
1/1/15
1/31/15
2/28/15
610,000
110,000
500,000
(3)
(4)
(5)
Cash
Paid
Interest
Expense
Decrease in
Carrying
Value
Carrying
Value
Monthly
Payment
Carrying Value
x 0.09 x 1/12
$5,071.33
5,071.33
$ 3,750.00
3,740.09
Requirement 3
January 31, 2015
Interest Expense ($500,000 x 9% x 1/12)
Notes Payable (difference)
Cash (monthly payment)
(Pay monthly installment on note )
(2)
(3)
$ 1,321.33
1,331.24
Prior Carrying
Value (4)
$ 500,000.00
498,678.67
497,347.43
3,750.00
1,321.33
5,071.33
In the first monthly payment, $3,750.00 goes to interest expense and only $1,321.33
goes to reducing the carrying value of the loan.
Requirement 4
Over the 15 year mortgage, $412,839 is interest expense and $500,000 goes to
reducing the carrying value of the loan. Interest expense over the 15 year mortgage is
calculated as the total payments of $912,839 minus the $500,000 carrying value of
the loan.
Solutions Manual, Chapter 9
© The McGraw-Hill Companies, Inc., 2014
9-51
Chapter 9 - Long-Term Liabilities
Problem 9-6B (LO 9-6, 9-7)
Requirement 1
Assets
$201 million
=
Liabilities
+
$91 + $61 = $152 million
Equity
?
49 million ($201 million - $152 million).
Requirement 2
Total
Liabilities
$152 million
÷
÷
Equity
$49 million
=
=
Debt to Equity
Ratio
3.10
Requirement 3
An operating lease is like a rental. Over the lease term, the company making the lease
payments records rent expense and the company receiving the rent payments records
rent revenue. A capital lease is different. In a capital lease, the company making lease
payments (called the lessee) essentially buys the asset and borrows the money
through a lease to pay for the asset. The lease is recorded as an asset and a liability on
ecords calculated as the present value of the lease payments.
Requirement 4
Yes. The debt to equity ratio will not be affected under an operating lease. However,
under a capital lease, assets and liabilities will both increase $26 million while
stockholde
the debt to equity ratio.
© The McGraw-Hill Companies, Inc., 2014
9-52
Financial Accounting
Chapter 9 - Long-Term Liabilities
Requirement 5
The debt to equity ratio will not be in violation under an operating lease, but will be
in violation under a capital lease. Therefore, Chunky Cheese Pizza has a strong
incentive to structure the lease agreement as an operating lease.
Operating lease:
Total
Liabilities
$152 million
÷
÷
Equity
$49 million
=
=
Debt to Equity
Ratio
3.10
=
=
Debt to Equity
Ratio
3.63
Capital lease:
Total
Liabilities
$178 million
Solutions Manual, Chapter 9
÷
÷
Equity
$49 million
© The McGraw-Hill Companies, Inc., 2014
9-53
Chapter 9 - Long-Term Liabilities
Problem 9-7B (LO 9-7)
Requirement 1
($ in millions)
Royal Caribbean
Carnival
Total
Liabilities
÷
Equity
=
Debt to Equity
Ratio
$11,519
$14,302
÷
÷
$8,309
$19,098
=
=
1.39
0.75
Royal Caribbean has a higher debt to equity ratio than Carnival. Royal Caribbean and
Carnival have a lower debt to equity ratio in comparison to the soft drink industry
represented by Coca-Cola and Pepsi.
Requirement 2
($ in millions)
Net
Income
Royal Caribbean
$18
Carnival
$1,298
*($19,828 + $19,804) / 2
**($39,161 + $38,637) / 2
Average
÷ Total Assets
=
Return on
Assets Ratio
$19,816*
$38,899**
=
=
0.1%
3.3%
=
Return on
Equity Ratio
÷
÷
Average
Net
Income
÷
Royal Caribbean
$18
Carnival
$1,298
*($8,309 + $8,408) / 2
**($23,929 + $23,832) / 2
÷
÷
($ in millions)
Equity
$8,358.5*
=
$23,880.5** =
0.2%
5.4%
Carnival has better profitability ratios than Royal Caribbean. However, Coca-Cola
and Pepsi are both more profitable than Carnival.
Requirement 3
© The McGraw-Hill Companies, Inc., 2014
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Financial Accounting
Chapter 9 - Long-Term Liabilities
($ in millions)
Royal Caribbean
Carnival
Net Income +
Interest + Taxes ÷
$374
$1,638
÷
÷
Interest
=
Times Interest
Earned Ratio
$356
$336
=
=
1.1
4.9
Carnival, with a times interest earned ratio of 4.9, is better able to meet interest
payments as they become due than Royal Caribbean with a ratio of only 1.1. The soft
drink industry represented by Coca-Cola and Pepsi has a better times interest earned
ratio than the Royal Caribbean and Carnival cruise lines.
Solutions Manual, Chapter 9
© The McGraw-Hill Companies, Inc., 2014
9-55
Chapter 9 - Long-Term Liabilities
ADDITIONAL PERSPECTIVES
Continuing Problem: Great Adventures
AP9-1
Requirement 1
(1)
Date
1/ 1 /17
1/31/17
2/28/17
(2)
(3)
Cash
Paid
Monthly
Payment
Interest
Expense
Carrying Value
x 6% x 1/12
$ 5,551
5,551
$ 2,500
2,485
Requirement 2
January 1, 2017
Cash
Notes Payable
(Issue a note payable)
January 31, 2017
Interest Expense ($500,000 x 6% x 1/12)
Notes Payable (difference)
Cash (monthly payment)
(Pay monthly installment on note )
February 28, 2017
Interest Expense ($496,949 x 6% x 1/12)
Notes Payable (difference)
Cash (monthly payment)
(Pay monthly installment on note )
© The McGraw-Hill Companies, Inc., 2014
9-56
(4)
Decrease in
Carrying
Value
(2)
(3)
$ 3,051
3,066
(5)
Carrying
Value
Prior Carrying
Value (4)
$ 500,000
496,949
493,883
500,000
500,000
2,500
3,051
5,551
2,485
3,066
5,551
Financial Accounting
Chapter 9 - Long-Term Liabilities
Financial Analysis: American Eagle
AP9-2
Requirement 1
($ in thousands)
Total
Liabilities
÷
Equity
2013
$534,866
÷ $1,221,187
2012
$533,951
÷ $1,416,851
The ratio weakened in the more recent year.
=
Debt to Equity
Ratio
=
=
0.44
0.38
=
Return on
Equity
=
17.6%
Requirement 2
Average
($ in thousands)
Net
Income
2013
$232,108
*($1,416,851 + $1,221,187) / 2
÷
Equity
÷
$1,319,019*
Investors would obtain a higher return on equity if American Eagle borrowed more
money since their return on equity (17.6%) exceeds their interest cost of borrowing
(less than 10%).
Requirement 3
The bankruptcy risk of American Eagle is very low. The company carries very little
debt and has several large lines of credit that it could use to borrow in the future if
necessary.
Solutions Manual, Chapter 9
© The McGraw-Hill Companies, Inc., 2014
9-57
Chapter 9 - Long-Term Liabilities
Financial Analysis: Buckle
AP9-3
Requirement 1
($ in thousands)
Total
Liabilities
÷
Equity
2013
$188,325
$289,649
÷
2012
$168,392
$363,147
÷
The ratio weakened in the more recent year.
=
Debt to Equity
Ratio
=
=
0.65
0.46
=
Return on
Equity
=
50.3%
Requirement 2
Average
($ in thousands)
Net
Income
2013
$164,305
*($363,147 + $289,649) / 2
÷
Equity
÷
$326,398*
Investors would obtain a higher return on equity if Buckle borrowed more money
since their return on equity (50.3%) exceeds their interest cost of borrowing (less than
10%).
Requirement 3
The bankruptcy risk of The Buckle is very low. The company carries no bank
borrowings and has an unsecured line of credit of $25 million that it could use to
borrow in the future if necessary.
© The McGraw-Hill Companies, Inc., 2014
9-58
Financial Accounting
Chapter 9 - Long-Term Liabilities
Comparative Analysis: American Eagle vs. Buckle
AP9-4
Requirement 1
($ in thousands)
Total
Liabilities
÷
Equity
=
Debt to Equity
Ratio
American Eagle
Buckle
$534,866
$188,325
÷
÷
$1,221,187
$289,649
=
=
0.44
0.65
American Eagle has a better (lower) debt to equity ratio. The ratios are both lower
than those for Coca-Cola and Pepsi reported in the chapter. The soft-drink industry
maintains a higher debt to equity ratio than the retail clothing industry.
Requirement 2
($ in thousands)
Net
Income
American Eagle
$232,108
Buckle
$164,305
*($1,950,802 + $1,756,053) / 2
**($531,539 + $477,974) / 2
÷
Average
Total
Assets
=
Return on
Assets Ratio
÷
÷
$1,853,428*
$504,757**
=
=
12.5%
32.6%
=
Return on
Equity Ratio
=
=
17.6%
50.3%
Average
($ in thousands)
Net
Income
American Eagle
$232,108
Buckle
$164,305
*($1,416,851 + $1,221,187) / 2
**($363,147 + $289,649) / 2
÷
Equity
÷
÷
$1,319,019*
$326,398**
Buckle has a better return on assets and return on equity ratio than American Eagle.
Solutions Manual, Chapter 9
© The McGraw-Hill Companies, Inc., 2014
9-59
Chapter 9 - Long-Term Liabilities
Ethics
AP9-5
Requirement 1
Calculator Input
Bond
Characteristics
1. Face amount
2. Interest payment
3. Market interest rate
4. Periods to maturity
Key
FV
PMT
I
N
Amount
$10,000,000
$250,000 = $10,000,000 x 5% x ½ year
4.5% = 9% / 2 semi-annual periods
14 = 7 years x 2 periods each year
Calculator Output
Issue price
PV
Requirement 2
December 31, 2015
Bonds Payable
Gain
Cash
(Retire bonds before maturity)
$7,955,435
10,000,000
2,044,565
7,955,435
Requirement 3
It is not ethical to deceive investors into thinking the $2 million gain is part of ongoing operating income. However, the repurchase of bonds itself is ethical assuming
the company properly discloses the early retirement of 6% bonds and the reissue of
9% bonds.
Requirement 4
In order to report the $2 million gain, the company will give up bonds with interest
costing only $500,000 ($10 million times 5%) each year and reissue new bonds
requiring interest payments of $900,000 ($10 million times 9%) each year. Not a
good idea.
© The McGraw-Hill Companies, Inc., 2014
9-60
Financial Accounting
Chapter 9 - Long-Term Liabilities
Internet Research
AP9-6
This case provides an opportunity for students to learn more about credit ratings at
business press. Answers to the assignment will vary depending on the news items
chosen.
Solutions Manual, Chapter 9
© The McGraw-Hill Companies, Inc., 2014
9-61
Chapter 9 - Long-Term Liabilities
Written Communication
AP9-7
Requirement 1
A company that borrows by issuing bonds is effectively by-passing the bank and
borrowing directly from the investing public, usually at a lower interest rate than it
would in a bank loan. However, issuing bonds entails significant bond issue costs for
the underwriter, legal fees, and accounting costs. For smaller loans, the additional
bond issuance costs exceed the savings from a lower interest rate, making it more
economical to borrow from a bank. For loans of $20 million or more, the interest rate
savings often exceed the additional bond issuance costs, making a bond issue more
attractive.
Requirement 2
One of the primary reasons for issuing bonds over issuing common stock relates to
taxes. Interest expense incurred when borrowing money is tax deductible, while
dividends paid to stockholders are not tax deductible. Therefore, debt can be a less
costly form of financing.
Requirement 3
The price of a bond is calculated as the present value of the principal (the face amount
on the bond due at maturity) plus the present value of the periodic interest payments.
The stated rate is used to calculate the periodic interest payment each period. The
market rate is used to calculate the present value of the principal and periodic interest
payments.
© The McGraw-Hill Companies, Inc., 2014
9-62
Financial Accounting
Chapter 9 - Long-Term Liabilities
Earnings Management
AP9-8
Requirement 1
Calculator Input
Bond
Characteristics
1. Face amount
2. Interest payment
3. Market interest rate
4. Periods to maturity
Key
FV
PMT
I
N
Amount
$100,000,000
$3,000,000 = $100,000,000 x 6% x ½ year
2.5% = 5% / 2 semi-annual periods
30 = 15 years x 2 periods each year
Calculator Output
Issue price
PV
$110,465,146
Requirement 2
Calculator Input
Bond
Characteristics
1. Face amount
2. Interest payment
3. Market interest rate
4. Periods to maturity
Key
FV
PMT
I
N
Amount
$100,000,000
$3,000,000 = $100,000,000 x 6% x ½ year
2.5% = 5% / 2 semi-annual periods
20 = 10 years x 2 periods each year
Calculator Output
Issue price
Solutions Manual, Chapter 9
PV
$107,794,581
© The McGraw-Hill Companies, Inc., 2014
9-63
Chapter 9 - Long-Term Liabilities
Requirement 3
Calculator Input
Bond
Characteristics
1. Face amount
2. Interest payment
3. Market interest rate
4. Periods to maturity
Key
FV
PMT
I
N
Amount
$100,000,000
$3,000,000 = $100,000,000 x 6% x ½ year
4.5% = 9% / 2 semi-annual periods
20 = 10 years x 2 periods each year
Calculator Output
Issue price
PV
$80,488,095
Requirement 4
December 31, 2017
Bonds Payable
107,794,581
Gain
27,306,486
Cash
80,488,095
(Retire bonds before maturity)
The transaction increases net income by the amount of the gain, $27,306,486.
Requirement 5
David Plesko’s plan is ethical as long as he properly discloses the early retirement of
6% bonds and the reissue of 9% bonds. However, investors would probably disagree
with David Plesko’s plan. In order to report the $27 million gain on repurchase, the
company will give up bonds costing only $6 million ($100 million times 6%) in
interest each year and reissue new bonds requiring the payment of $9 million ($100
million times 9%) in interest each year.
© The McGraw-Hill Companies, Inc., 2014
9-64
Financial Accounting