Long-Term Liabilities

Analyzing, journalizing, and reporting bond transactions

Johnny’s Hamburgers issued 8%, 10-year bonds payable at 85 on December 31, 2018.

At December 31, 2020, Johnny reported the bonds payable as follows:

Long-term Liabilities:

Bonds Payable \( 300,000

Less: Discount on Bonds Payable (36,000) \) 264,000

Johnny pays semiannual interest each June 30 and December 31.

Requirements

1. Answer the following questions about Johnny’s bonds payable:

a. What is the maturity value of the bonds?

b. What is the carrying amount of the bonds at December 31, 2020?

c. What is the semiannual cash interest payment on the bonds?

d. How much interest expense should the company record each year?

2. Record the June 30, 2020, semiannual interest payment and amortization of discount.

Analyzing and journalizing bond transactions

On January 1, 2018, Electricians Credit Union (ECU) issued 8%, 20-year bonds payable with face value of $400,000. The bonds pay interest on June 30 and December 31. The issue price of the bonds is 104.

Journalize the following bond transactions:

a. Issuance of the bonds on January 1, 2018.

b. Payment of interest and amortization on June 30, 2018.

c. Payment of interest and amortization on December 31, 2018.

d. Retirement of the bond at maturity on December 31, 2037, assuming the last interest payment has already been recorded.

Reporting liabilities on the balance sheet and computing debt to equity ratio

The accounting records of Compass Wireless include the following as of December 31, 2018:

Accounts Payable                     \( 74,000       Salaries Payable                          \) 7,500

Mortgages Payable (long-term) 80,000        Bonds Payable (current portion) 25,000

Interest Payable                          21,000         Premium on Bonds Payable         13,000

Bonds Payable (long-term)        63,000         Unearned Revenue (short-term)   2,700

Total Stockholders’ Equity        145,000

Requirements

1. Report these liabilities on the Compass Wireless balance sheet, including headings and totals for current liabilities and long-term liabilities.

2. Compute Compass Wireless’s debt to equity ratio at December 31, 2018.

Determining the present value of bonds payable and journalizing using the effective-interest amortization method

Ari Goldstein issued $300,000 of 11%, five-year bonds payable on January 1, 2018. The market interest rate at the date of issuance was 10%, and the bonds pay interest semiannually.

Requirements

1. How much cash did the company receive upon issuance of the bonds payable? (Round to the nearest dollar.)

2. Prepare an amortization table for the bond using the effective-interest method, through the first two interest payments. (Round to the nearest dollar.)

3. Journalize the issuance of the bonds on January 1, 2018, and the first second payments of the semiannual interest amount and amortization of the bonds on June 30, 2018, and December 31, 2018. Explanations are not required.

Determining the present value of bonds payable and journalizing using the effective-interest amortization method

Sleep Well, Inc. is authorized to issue 9%, 10-year bonds payable. On January 1, 2018, when the market interest rate is 10%, the company issues $500,000 of the bonds. The bonds pay interest semiannually.

Requirements

1. How much cash did the company receive upon issuance of the bonds payable? (Round to the nearest dollar.)

2. Prepare an amortization table for the bond using the effective-interest method, through the first two interest payments. (Round to the nearest dollar.)

3. Journalize the issuance of the bonds on January 1, 2018, and the first and second payment of the semiannual interest amount and amortization of the bonds on June 30, 2018, and December 31, 2018. Explanations are not required.

Describing bonds, journalizing transactions for bonds payable using the straight-line amortization method, and journalizing transactions for a mortgage payable

This problem continues the Canyon Canoe Company situation from Chapter 11. Canyon Canoe Company is considering raising additional capital for further expansion. The company wants to finance a new business venture into guided trips down the Amazon River in South America. Additionally, the company wants to add another building on their land to offer more services for local customers. Canyon Canoe Company plans to raise the capital by issuing \(210,000 of 7.5%, six-year bonds on January 2, 2020. The bonds pay interest semiannually on June 30 and December 31. The company receives \)208,476 when the bonds are issued.

The company also issues a mortgage payable for \(450,000 on January 2, 2020. The proceeds from the mortgage will be used to construct the new building. The mortgage requires annual payments of \)45,000 plus interest for ten years, payable on December 31. The mortgage interest rate is 8%.

Requirements

1. Will the bonds issue at face value, a premium, or a discount?

2. Record the following transactions. Include dates and round to the nearest dollar. Omit explanations.

a. Cash received from the bond issue.

b. Cash received from the mortgage payable.

c. Semiannual bond interest payments for 2020. Amortize the premium or discount using the straight-line amortization method.

d. Payment on the mortgage payable for 2020.

3. Calculate the total interest expense incurred in 2020.

The following questions are not related.

Requirements

1. Duncan Brooks needs to borrow \(500,000 to open new stores. Brooks can borrow \)500,000 by issuing 5%, 10-year bonds at 96. How much will Brooks actually receive in cash under this arrangement? How much must Brooks pay back at maturity? How will Brooks account for the difference between the cash received on the issue date and the amount paid back?

2. Brooks prefers to borrow for longer periods when interest rates are low and for shorter periods when interest rates are high. Why is this a good business strategy?

Raffie’s Kids, a nonprofit organization that provides aid to victims of domestic violence,low-income families, and special-needs children, has a 30-year, 5% mortgageon the existing building. The mortgage requires monthly payments of \(3,000. Raffie’sbookkeeper is preparing financial statements for the board and, in doing so, lists themortgage balance of \)287,000 under current liabilities because the board hopes to beable to pay the mortgage off in full next year. Of the mortgage principal, $20,000 willbe paid next year if Raffie’s pays according to the mortgage agreement. The boardmembers call you, their trusted CPA, to advise them on how Raffie’s Kids shouldreport the mortgage on its balance sheet. What is the ethical issue? Provide and discussthe reason for your recommendation.

Bill and Edna had been married two years and had just reached the point where they

had enough savings to start investing. Bill’s uncle Dave told them that he had recently

inherited some very rare railroad bonds from his grandmother’s estate. He wanted

to help Bill and Edna get a start in the world and would sell them 50 of the bonds at

\(100 each. The bonds were dated 1873, beautifully engraved, showing a face value of

\)1,000 each. Uncle Dave pointed out that “United States of America” was printed

prominently at the top and that the U.S. government had established a sinking fund to

retire the old railroad bonds. A sinking fund is a fund established for the purpose of

repaying the debt. It allows the organization (the U.S. government, in this example)

to set aside money over time to retire the bonds. All Bill and Edna needed to do was

hold on to them until the government contacted them, and they would eventually get

the full \(1,000 for each bond. Bill and Edna were overjoyed—until a year later when

they saw the exact same bonds for sale at a coin and stamp shop priced as “collectors’

items” for \)9.95 each!

Requirements

1. If a company goes bankrupt, what happens to the bonds it issued and the investorswho bought the bonds?

2. When investing in bonds, how can you tell whether the bond issue is a legitimatetransaction?

3. Is there a way to determine the relative risk of corporate bonds?