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Kieso, Weygandt, Warfield, Wiecek, McConomy
Intermediate Accounting, Twelfth Canadian Edition
CHAPTER 14
LONG-TERM FINANCIAL LIABILITIES
Learning Objectives
1. Understand the nature of long-term debt financing
arrangements.
2. Understand how long-term debt is measured and accounted
for.
3. Understand when long-term debt is recognized and
derecognized, including how to account for troubled debt
restructurings.
4. Explain how long-term debt is presented, disclosed, and
analyzed.
5. Identify differences in accounting between IFRS and ASPE,
and what changes are expected in the near future.
Solutions Manual
14.1
Chapter14
Copyright ยฉ 2019John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.
Kieso, Weygandt, Warfield, Wiecek, McConomy
Intermediate Accounting, Twelfth Canadian Edition
Summary of Questions by Learning Objectives and Bloomโs Taxonomy
Item LO
BT Item LO
1.
2.
3.
4.
5.
1
1
2
2
2
C
C
AP
AP
AP
1.
2.
3.
4.
5.
6.
7.
1
1,2
2
2
2
2
2
K
AP
AP
AP
AP
AP
AP
1. 1,2
2. 1,2,4
3. 2
4. 2,3
AP
AP
AP
AP
1.
1,4
AN
1.
1,4
AN
1.
2.
1,4
1,4
AP
AP
BT Item LO
BT Item LO BT Item LO
Brief Exercises
6. 2 AP 11.
2
AP 16.
7. 2 AP 12.
2
AP 17.
8. 2 AP 13.
2
AP 18.
9. 2 AP 14.
2
AP 19.
10. 2 AP 15.
2
AP 20.
Exercises
8. 2 AP 15.
2
AP 22.
9. 2 AP 16. 2,4 AP 23.
10. 2 AP 17.
3
AP 24.
11. 2 AP 18. 2,4 AP 25.
12. 2 AP 19.
3
AP 26.
13. 2 AP 20.
3
AP 27.
14. 2 AP 21.
3
AP 28.
Problems
5. 2,3 AP 9. 2,4 AP 13.
6. 2,3,5 AP 10. 2,4 AP 14.
7. 2,4 AP 11. 2,3 AP 15.
8. 2 AP 12. 2,3 AP 16.
Cases
2.
3.
Integrated Cases
2. 1,3 AN
Research and Analysis
3.
4 AN 4.
1,4 AP 5.
BT
2
2
2
3
3
AP
AP
AP
AP
C
21.
22.
23.
24.
25.
3
3
4
4
4
AP
AN
K
AP
AN
3
3
3,5
3
3
3
3
AP 29.
AP 30.
AP 31.
AP
AP
AP
AP
4
4
4
K
K
AP
2,3
2,3
2,3
2,3
AP
AP
AP
AP
2,3
2,3
2,3
2,3
AP
AP
AP
C
17.
18.
19.
20.
6.
Solutions Manual
14.2
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Copyright ยฉ 2019John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.
Kieso, Weygandt, Warfield, Wiecek, McConomy
Intermediate Accounting, Twelfth Canadian Edition
Summary of Legend: The following abbreviations will appear throughout
the solutions manual file.
LO
BT
Difficulty:
Time:
AACSB
CPA CM
Learning objective
Bloom’s
Taxonomy
K
Knowledge
C
Comprehension
AP Application
AN Analysis
S
Synthesis
E
Evaluation
Level of difficulty
S
Simple
M
Moderate
C
Complex
Estimated time to complete in minutes
Association to Advance Collegiate Schools of Business
Communication
Communication
Ethics
Ethics
Analytic
Analytic
Tech.
Technology
Diversity
Diversity
Reflec. Thinking
Reflective Thinking
CPA Canada Competency Map
Ethics
Professional and Ethical Behaviour
PS and DM
Problem-Solving and Decision-Making
Comm.
Communication
Self-Mgt.
Self-Management
Team & Lead
Teamwork and Leadership
Reporting
Financial Reporting
Stat. & Gov.
Strategy and Governance
Mgt. Accounting
Management Accounting
Audit
Audit and Assurance
Finance
Finance
Tax
Taxation
Solutions Manual
14.3
Chapter14
Copyright ยฉ 2019John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.
Kieso, Weygandt, Warfield, Wiecek, McConomy
Intermediate Accounting, Twelfth Canadian Edition
ASSIGNMENT CLASSIFICATION TABLE
Brief
Exercises
Exercises
Problems
1. Understand the nature of
long-term debt.
1, 2
1, 2
1, 2
2. Understand how long-term
debt ismeasured and
accounted for.
3, 4, 5, 6, 7, 8,
9, 10, 11, 12,
13, 14, 15, 16,
17, 18
3, 4, 5, 6, 7, 8,
9, 10, 11, 12,
13, 14, 15, 16,
17, 18
1, 2, 3, 4, 5,
6, 7, 8, 9, 10,
13
3. Recognition and
derecognition of debt and
debt restructurings.
19, 20, 21
17, 19, 20, 21,
22, 23, 24, 25,
26, 27, 28
6, 11, 12, 13,
14, 15, 16,
17, 18, 19, 20
4. Presentation of long-term
debt.
24
16, 18, 29, 30
2, 8, 10
31
9, 10
Topics
5. Disclosure requirements.
6. Long-term debt analysis.
25
7
7. Differences between IFRS
and ASPE.
NOTE: If your students are solving the end-of-chapter material using
a financial calculator or Excel functionsas opposed to the PV tables,
please note that there will be a difference in amounts. Excel and
financial calculators yield a more precise result as opposed to PV
tables. The amounts used for the preparation of journal entries in
solutions have been prepared from the results of calculations arrived
at using the PV tables unless otherwise indicated in the question.
Solutions Manual
14.4
Chapter14
Copyright ยฉ 2019John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.
Kieso, Weygandt, Warfield, Wiecek, McConomy
Intermediate Accounting, Twelfth Canadian Edition
ASSIGNMENT CHARACTERISTICS TABLE
Item
Description
E14.1
E14.2
E14.3
E14.4
Features of long-term debt
Information related to various bond issues
Entries for bond transactions
Entries for bond transactionsโeffective
interest
Entries for bond transactionsโstraightline
Entries for nonโinterest-bearing debt
Imputation of interest
Purchase of land with instalment note
Purchase of equipment with nonโinterestbearing debt
Purchase of computer with nonโinterestbearing debt
Entries for bond transactions
Amortization scheduleโstraight-line
Amortization scheduleโeffective interest
Determination of proper amounts in
account balances
Interest-free government loan
Entries and questions for bond
transactions
Entries for retirement and issuance of
bonds
Entries for retirement and issuance of
bonds โ straight line
Entries for retirement and issuance of
bonds โ effective interest
Entry for retirement of bond; costs for
bond issuance
Entries for retirement and issuance of
bonds
Impairments
Settlement of debt
Term modificationโdebtorโs entries
Term modificationโcreditorโs entries
Settlementโdebtorโs entries
Settlementโcreditorโs entries
Debtor entries for settlement of troubled
debt
E14.5
E14.6
E14.7
E14.8
E14.9
E14.10
E14.11
E14.12
E14.13
E14.14
E14.15
E14.16
E14.17
E14.18
E14.19
E14.20
E14.21
E14.22
E14.23
E14.24
E14.25
E14.26
E14.27
E14.28
Level of
Difficulty
Time
(minutes)
Simple
Simple
Simple
Simple
10-15
35-45
15-20
15-20
Simple
15-20
Simple
Simple
Moderate
Moderate
15-20
15-20
15-20
15-20
Moderate
15-20
Moderate
Simple
Simple
Moderate
15-20
10-15
15-20
15-20
Moderate
Moderate
15-20
20-30
Simple
10-15
Simple
15-20
Complex
30-35
Moderate
20-25
Simple
10-15
Moderate
Moderate
Complex
Moderate
Moderate
Moderate
Moderate
15-25
15-20
45-50
25-30
25-30
20-30
20-25
Solutions Manual
14.5
Chapter14
Copyright ยฉ 2019John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.
Kieso, Weygandt, Warfield, Wiecek, McConomy
Intermediate Accounting, Twelfth Canadian Edition
ASSIGNMENT CHARACTERISTICS TABLE (CONTINUED)
Item
Description
Level of
Difficulty
Time
(minutes)
E14.29
E14.30
E14.31
Classification of liabilities
Classification.
Long-term debt disclosure.
Simple
Simple
Simple
15-20
15-20
10-15
P14.1
Entries for noninterest-bearing debt;
payable in instalments
Contrasting note terms
Analysis of amortization schedule and
interest entries
Issuance and retirement of bonds
Comprehensive bond problem
Issuance of bonds between interest
dates, straight-line, retirement
Entries for noninterest-bearing debt
Classification of accounts used in bond
issuance
Issuance and retirement of bonds;
income statement presentation
Comprehensive problem; issuance,
classification, reporting
Issuance of bonds,straight-line interest,
retirement
Issuance of bonds effective interest,
retirement
Bonds at discount and premium
including partial redemption
Loan impairment entries
Moderate
30-35
Complex
Simple
50-60
15-20
Moderate
Complex
Complex
25-30
50-65
30-35
Simple
Moderate
15-25
55-65
Simple
15-20
Moderate
20-25
Moderate
20-25
Moderate
30-35
Complex
45-50
Moderate
30-40
Debtor/creditor entries for continuation
of troubled debt
Restructure of note under different
circumstances
Debtor/creditor entries for continuation
of troubled debt
Entries for troubled debt restructuring
Debtor/creditor entries for continuation
of troubled debt with new effective
interest
Legal versus in-substance defeasance
Moderate
15-25
Complex
50-60
Complex
40-50
Moderate
Moderate
30-35
30-35
Moderate
15-20
P14.2
P14.3
P14.4
P14.5
P14.6
P14.7
P14.8
P14.9
P14.10
P14.11
P14.12
P14.13
P14.14
P14.15
P14.16
P14.17
P14.18
P14.19
P14.20
Solutions Manual
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Copyright ยฉ 2019John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.
Kieso, Weygandt, Warfield, Wiecek, McConomy
Intermediate Accounting, Twelfth Canadian Edition
SOLUTIONS TO BRIEF EXERCISES
BRIEF EXERCISE 14.1
(a)
A bondโs credit rating is a reflection of credit quality. The
BBB credit rating of the bond at the time of issuance
reflected an assessment of the companyโs ability to pay
the amounts that will be due on that specific bond. With
four consecutive quarters of increasing losses and
deteriorating financial position in 2020, and new
competition in the industry, credit analysts may downgrade
the bondโs credit rating to below investment grade.
(b)
The market closely monitors a bondโs credit rating when
determining the required yield and pricing of bonds at
issuance and in periods after issuance. If the bondโs credit
rating is downgraded, the yield required by investors will
likely increase,and the price of the bonds will likely
decrease, to compensate the bondholder for the additional
risk associated with that specific bond.
LO 1 BT: C Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 cpa-t005
CM: Reporting and Finance
Solutions Manual
14.7
Chapter14
Copyright ยฉ 2019John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.
Kieso, Weygandt, Warfield, Wiecek, McConomy
Intermediate Accounting, Twelfth Canadian Edition
BRIEF EXERCISE 14.2
(a)
Financing is generally obtained through three sources:
borrowing, issuing shares, and/or using internally
generated funds. Leverage (or using borrowed money to
increase returns to shareholders) can maximize returns to
shareholders, and the related interest paid is tax
deductible. However, borrowed funds must be repaid and
can increase liquidity and solvency risk. Issuing shares
does not increase liquidity and solvency risk; however, it
may result in dilution of ownership. Using internally
generated funds may be appropriate if the companyโs
business model is generating excess funds.
(b)
Based on the information provided, borrowing is the most
suitable source of financing for Jensen & Jensen. With a
debt to total assets ratio of 55%, Jensen& Jensen is
underleveraged compared to similar size competitors
operating in the same industry. This means that Jensen &
Jensen may not be maximizing returns to shareholders,
and that the company may be able to finance the
expansion by borrowing and still maintain an acceptable
level
of
liquidity
and
solvency
risk.
As
a
telecommunications equipment manufacturer, Jensen &
Jensen operates in a capital-intensive industry, and a
lender may be able to structure the lending agreement in
such a way as to secure the loan with the companyโs
underlying tangible assets. Further, issuing shares is not
ideal given the ownersโ desire to keep the company closely
held.
LO 1 BT: C Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 cpa-t005
CM: Reporting and Finance
Solutions Manual
14.8
Chapter14
Copyright ยฉ 2019John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.
Kieso, Weygandt, Warfield, Wiecek, McConomy
Intermediate Accounting, Twelfth Canadian Edition
BRIEF EXERCISE 14.3
1. Using tables:
Present value of the principal
$500,000 X .37689
Present value of the interest payments
$27,500 X 12.46221
Issue price
$188,445
342,711
$531,156
2.Using a financial calculator:
PV
I
N
PMT
FV
Type
? Yields $ 531,155.53
5%
20
$ (27,500)
$ (500,000)
0
3. Using Excel: = PV(rate,nper,pmt,fv,type)
Result: $531,155.53 rounded to $531,156
LO 2 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual
14.9
Chapter14
Copyright ยฉ 2019John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.
Kieso, Weygandt, Warfield, Wiecek, McConomy
Intermediate Accounting, Twelfth Canadian Edition
BRIEF EXERCISE 14.4
(a)
Cash ………………………………………………………………………
300,000
Notes Payable ………………………………………………..
300,000
(b)
Interest Expense($300,000 X 8%) ……………………………..
24,000
Cash ………………………………………………………………24,000
LO 2 BT: AP Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 14.5
(a)1. Using tables:
Present value of the principal
$200,000 X .74409
Present value of the interest payments
$8,000 X 8.53020
Issue price
$148,818
68,242
$217,060
2. Using a financial calculator:
PV
I
N
PMT
FV
Type
?
3%
10
$ (8,000)
$ (200,000)
0
Yields $ 217,060.41
Solutions Manual
14.10
Chapter14
Copyright ยฉ 2019John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.
Kieso, Weygandt, Warfield, Wiecek, McConomy
Intermediate Accounting, Twelfth Canadian Edition
BRIEF EXERCISE 14.5
(a) (continued)
3. Using Excel: =PV(rate,nper,pmt,fv,type)
Result: $217,060.41 rounded to $217,060
(b)
Cash ………………………………………………………………………
217,060
Bonds Payable ……………………………………………….
217,060
(c)
Interest Expense ($217,060 X 6% X
6/12)
6,512
Bonds Payable ($8,000 โ $6,512) ……………………………..
1,488
Cash ($200,000 X 8% X 6/12) …………………………… 8,000
Interest Expense
[($217,060 โ $1,488) X 6% X 6/12] ……………………………
6,467
Bonds Payable ($8,000 โ $6,467) ……………………………..
1,533
Cash ($200,000 X 8% X 6/12) …………………………… 8,000
LO 2 BT: AP Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual
14.11
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Kieso, Weygandt, Warfield, Wiecek, McConomy
Intermediate Accounting, Twelfth Canadian Edition
BRIEF EXERCISE 14.6
(a) 1. Using a financial calculator:
PV
I
N
PMT
FV
Type
$52,000
Yields 15.09%
?
5
$ 0
$ (105,000)
0
2. Using Excel: =RATE(nper,pmt,pv, fv,type)
Result: 15.0898943 Rounded to two decimal places 15.09 %
(b)
Cash ………………………………………………………………………
52,000.00
Notes Payable ……………………………………………….. 52,000.00
(c)
Interest Expense ($52,000X 15.09%) …………………………
7,846.80
Notes Payable ………………………………………………..
7,846.80
Solutions Manual
14.12
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Copyright ยฉ 2019John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.
Kieso, Weygandt, Warfield, Wiecek, McConomy
Intermediate Accounting, Twelfth Canadian Edition
BRIEF EXERCISE 14.6
(d)
Date
Jan. 1
Dec. 31
Dec. 31
Dec. 31
Dec. 31
Dec. 31
1
Schedule of Discount Amortization
Effective Interest Method (15.09%)
15.09%
Effective
Discount
Interest
Amort.
2020
2020
2021
2022
2023
2024
$7,846.80
9,030.88
10,393.64
11,962.04
13,767.641
$53,000.00
$7,846.80
9,030.88
10,393.64
11,962.04
13,766.64
$53,000.00
Carrying
Value
$52,000.00
59,846.80
68,877.68
79,271.32
91,233.36
105,000.00
rounded
LO 2 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual
14.13
Chapter14
Copyright ยฉ 2019John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.
Kieso, Weygandt, Warfield, Wiecek, McConomy
Intermediate Accounting, Twelfth Canadian Edition
BRIEF EXERCISE 14.7
(a)
1. Using a financial calculator:
PV
$ 38,912
Yields 11.00% (rounded to
I
? 2 decimal places)
N
5
PMT
$(2,500)
FV
$ (50,000)
Type
0
2. Using Excel: =RATE(nper,pmt,pv, fv,type)
Result: 11% rounded
(b)
Equipment ……………………………………………………………..
38,912
Notes Payable ………………………………………………..38,912
Solutions Manual
14.14
Chapter14
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Kieso, Weygandt, Warfield, Wiecek, McConomy
Intermediate Accounting, Twelfth Canadian Edition
BRIEF EXERCISE 14.7 (Continued)
(c)
Interest Expense1 ………………………………………………….
4,280
2
Cash …………………………………………………………….. 2,500
Notes Payable………………………………………………… 1,780
1
($38,912 X 11.00% = $4,280)
2
($50,000 X 5% = $2,500)
LO 2 BT: AP Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual
14.15
Chapter14
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Kieso, Weygandt, Warfield, Wiecek, McConomy
Intermediate Accounting, Twelfth Canadian Edition
BRIEF EXERCISE 14.8
Cash ………………………………………………………………………
200,000
Notes Payable…………………………………………………
Unearned Revenue …………………………………………
176,448
23,552
The difference between the present value (using an 8% discount
rate) and proceeds is recorded as unearned revenue, since Big
Country agreed to provide cattle at a reduced price over the term
of the note. The amount will be brought into revenue over the
term of the note, as the cattle are provided to Little Town.
1. Using a financial calculator:
PV
?
Yields $ 176,447.50
I
8%
N
6
PMT
0
FV
$ (280,000)
Type
0
2. Excel formula: =PV(rate,nper,pmt,fv,type)
Result; $176,447.50rounded to $176,448
LO 2 BT: AP Difficulty: C Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual
14.16
Chapter14
Copyright ยฉ 2019John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.
Kieso, Weygandt, Warfield, Wiecek, McConomy
Intermediate Accounting, Twelfth Canadian Edition
BRIEF EXERCISE 14.9
The relevant interest rate to be imputed on the instalment note is
the rate Pflugwould pay at its bank of 11%
1. Using tables:
Using ordinary annuity tables for 11% for two periods, the factor
of 1.71252 is used and divided into the present value amount of
$40,000 to arrive at the amount of the equal instalment payment
of $23,357.39.
2. Using a financial calculator:
PV
I
N
PMT
FV
Type
$ (40,000)
11%
2
? Yields $ (23,357.35)
$ 0
0
3. Using Excel: = PMT(rate,nper,pv,fv,type)
Result: $23,357.35
LO 2 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual
14.17
Chapter14
Copyright ยฉ 2019John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.
Kieso, Weygandt, Warfield, Wiecek, McConomy
Intermediate Accounting, Twelfth Canadian Edition
BRIEF EXERCISE 14.10
(a)
Cash ($500,000 โ $25,000) ……………………………………….
475,000
Bonds Payable ……………………………………………….
475,000
(b)
Interest Expense ($40,0001 + $2,5002) ……………………….
42,500
Bonds Payable ………………………………………………. 2,500
Cash1 ……………………………………………………………..40,000
1
$500,000 X 8% = $40,000
2
$25,000 issue cost X 1/10 = $2,500
(c)
When a note or bond is issued, it should be recognized at
fair value adjusted by any directly attributable issue costs.
However, note that where the liability will subsequently be
measured at fair value (e.g., under the fair value option or
because it is a derivative), the transaction costs should not
be included in the initial measurement (i.e., the costs
should be expensed) [CPA Canada Handbook, Part II,
Section 3856.07 and IFRS 9.5.1.1].
(d)
If the bonds were trading on the market for over their face
value, this would imply that the bonds were not actually
issued at face value, but rather that the interest rate paid
on the bonds exceeds market rate, and thus, the bonds are
trading at a premium. This reflects the fair value hierarchy,
whereby observable market prices for identical assets and
liabilities is first on the hierarchy, and thus, if fair value
was being used to record these bonds, their value would
be higher than what is currently recorded.
LO 2 BT: AP Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual
14.18
Chapter14
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Kieso, Weygandt, Warfield, Wiecek, McConomy
Intermediate Accounting, Twelfth Canadian Edition
BRIEF EXERCISE 14.11
(a)
Cash ………………………………………………………………………
300,000
Bonds Payable ……………………………………………….
300,000
(b)
Interest Expense …………………………………………………….
15,000
Cash ($300,000 X 10% X 6/12) ………………………….15,000
(c)
Interest Expense …………………………………………………….
15,000
Interest Payable ……………………………………………..15,000
LO 2 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 14.12
(a)
Cash ($300,000 X .98) ………………………………………………
294,000
Bonds Payable ……………………………………………….
294,000
(b)
Interest Expense …………………………………………………….
15,600
Cash ($300,000 X 10% X 6/12) ………………………….15,000
Bonds Payable1 ……………………………………………… 600
1
($6,000 X 1/5 X .5 = $600)
(c)
Interest Expense …………………………………………………….
15,600
Interest Payable ……………………………………………..15,000
Bonds Payable ………………………………………………. 600
LO 2 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual
14.19
Chapter14
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Intermediate Accounting, Twelfth Canadian Edition
BRIEF EXERCISE 14.13
(a)
Cash ($300,000 X 1.03 = $309,000) ……………………………
309,000
Bonds Payable ……………………………………………….
309,000
(b)
Interest Expense …………………………………………………….
14,100
Bonds Payable ($9,000 X 1/5 X .5)…………………………….
900
Cash ($300,000 X 10% X 6/12) ………………………….15,000
(c)
Interest Expense …………………………………………………….
14,100
Bonds Payable ……………………………………………………….
900
Interest Payable ……………………………………………..15,000
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BRIEF EXERCISE 14.14
(a)
Cash ………………………………………………………………………
615,000
Bonds Payable ……………………………………………….
600,000
1
Interest Expense ……………………………………………15,000
1
($600,000 X 6% X 5/12 = $15,000)
(b)
Interest Expense2 ……………………………………………………
18,000
Cash ……………………………………………………………..18,000
2
($600,000 X 6% X 6/12 = $18,000)
(c)
Interest Expense …………………………………………………….
18,000
Interest Payable ……………………………………………..18,000
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Solutions Manual
14.20
Chapter14
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Intermediate Accounting, Twelfth Canadian Edition
BRIEF EXERCISE 14.15
(a)
Cash ………………………………………………………………………
559,229
Bonds Payable ……………………………………………….
559,229
(b)
Interest Expense …………………………………………………….
22,369
Cash ………………………………………………………………21,000
Bonds Payable ………………………………………………. 1,369
(c)
Interest Expense …………………………………………………….
22,424
Interest Payable ……………………………………………..21,000
Bonds Payable ………………………………………………. 1,424
(d)
1. Using a financial calculator:
FV =
n=
PMT =
i=
PV =
(600,000)
20
(21,000)
4.0%
559,229
Given
10 years X 2
Face X 7% X 6/12
Calculate
Given
2. Using Excel: =RATE(nper,pmt,pv, fv,type)
Result: 4%
Solutions Manual
14.21
Chapter14
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Intermediate Accounting, Twelfth Canadian Edition
BRIEF EXERCISE 14.15 (Continued)
e.
Schedule of Discount Amortization
Effective Interest Method (4%)
Date
Jan. 1
July 1
Jan. 1
July 1
3.5%
Cash
Paid
2020
2020
2021
2021
4.0%
Interest Discount
Expense Amortized
$21,000.00
21,000.00
21,000.00
$22,369.16
22,423.93
22,480.88
Carrying
Amount
$559,229.00
$1,369.16 560,598.16
1,423.93 562,022.09
1,480.88 563,502.97
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BRIEF EXERCISE 14.16
(a)
Cash ………………………………………………………………………
644,632
Bonds Payable ……………………………………………….
644,632
(b)
Interest Expense …………………………………………………….
19,339
Bonds Payable ……………………………………………………….
1,661
Cash ………………………………………………………………
21,000
(c)
Interest Expense …………………………………………………….
19,289
Bonds Payable ……………………………………………………….
1,711
Interest Payable ……………………………………………..
21,000
(d)1. Using a financial calculator:
FV =
n=
PMT =
i=
PV =
(600,000)
20
(21,000)
3.0%
644,632
Given
10 years X 2
Face X 7% X 6/12
Calculate
Given
Solutions Manual
14.22
Chapter14
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Intermediate Accounting, Twelfth Canadian Edition
BRIEF EXERCISE 14.16 (Continued)
(d) (continued)
2. Using Excel: =RATE(nper,pmt,pv, fv,type)
Result: 3 %
(e)
Schedule of Premium Amortization
Effective Interest Method (3%)
Date
Jan. 1
July 1
Jan. 1
July 1
3.5%
Cash
Paid
3.0%
Interest Premium
Expense Amortized
2020
2020 $21,000.00 $19,338.96
2021 21,000.00 19,289.13
2021 21,000.00 19,237.80
Carrying
Amount
$644,632.00
$1,661.04 642,970.96
1,710.87 641,260.09
1,762.20 639,497.89
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14.23
Chapter14
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Intermediate Accounting, Twelfth Canadian Edition
BRIEF EXERCISE 14.17
(a)
Cash ………………………………………………………………………
1,058,671
Bonds Payable ……………………………………………….
1,058,671
(b)
Interest Expense1 ……………………………………………………
21,173
Bonds Payable ……………………………………………………….
1,327
2
Cash ……………………………………………………………..22,500
1
($1,058,671 x 8% x 3/12 = $21,173)
2
($1,000,000 x 9% x 3/12 = $22,500)
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BRIEF EXERCISE 14.18
(a)
Interest Expense ($1,000,000 X 7%) ………………………….
70,000
Cash ………………………………………………………………70,000
To record payment of interest
Bonds Payable ($1,000,000 – $900,000) …………………….
100,000
Unrealized Gain or Loss ………………………………….
100,000
To record fair value adjustment
The unrealized gain or loss is recorded in net income.
(b)
Interest Expense ($1,000,000 X 7%) ………………………….
70,000
Cash ………………………………………………………………70,000
To record payment of interest
Bonds Payable ($1,000,000 – $900,000) …………………….
100,000
Unrealized Gain or Loss- OCI…………………………..
100,000
To record fair value adjustment
The unrealized gain or loss is recorded in other
comprehensive income.
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Chapter14
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Intermediate Accounting, Twelfth Canadian Edition
BRIEF EXERCISE 14.19
Bonds Payable ($800,000 + $6,500)…………………………..
806,500
Cash ($800,000 X .97) ……………………………………… 776,000
Gain on Redemption of Bonds …………………………
30,500
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BRIEF EXERCISE 14.20
This is a situation where a currently maturing liability (a current
liability) at year end is expected to be refinanced on a long-term
basis.
Under IFRS, this loan liability is required to be reported as a
current liability on the December 31 financial statements
because it was not refinanced by the reporting date. The only
exception permitted would be if the refinancing that extends the
repayment terms was done under an agreement that existed at
December 31 and the decision about the refinancing is solely up
to the discretion of the entityโs management.
The ASPE standard, however, allows more flexibility. The
maturing debt is required to be reported as a current liability
unless it has been refinanced on a long-term basis or there is a
non-cancellable agreement to do so before the financial
statements are completed, and there is nothing that prevents
completion of the refinancing. Because the entityโs financial
statements would not have been completed as soon as two days
after the reporting date (December 31) when the new agreement
was finalized, ASPE would permit the debt to be included with
long-term liabilities.
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Chapter14
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Intermediate Accounting, Twelfth Canadian Edition
BRIEF EXERCISE 14.21
Since the present value of the future cash flows of the new debt
differs by an amount larger than 10% of the present value of the
old debt, the renegotiated debt is considered a settlement. A
gain/loss is recorded by Lawrence (debtor) and no interest is
recorded by the debtor. This is not considered a modification of
terms. The old debt is removed from the books of Lawrence with
a gain/loss being recognized, and the new debt is recorded.
2020 Notes Payable ……………………………………………….
100,000
Gain on Restructuring of Debt …………………
Notes Payable ………………………………………..
27,603
72,397
2021 Interest Expense ($72,397 X .10) …………………….
7,240
Notes Payable …………………………………………
Cash (8% X $75,000) ………………………………..
1,240
6,000
2022 Interest Expense1 ………………………………………….
7,364
Notes Payable …………………………………………
Cash ………………………………………………………
1
($72,397 + $1,240) X .10 = $7,364
To record payment of interest
1,364
6,000
2022 Notes Payable ……………………………………………….
75,000
Cash …………………………………………………….. .
To record maturity of note
75,000
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Chapter14
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Intermediate Accounting, Twelfth Canadian Edition
BRIEF EXERCISE 14.22
(a)
Steinemโs liquidity has improved. As a result of this
transaction, the companyโs SFPwill show $1 million more
cash, and $1 million less accounts receivable (a less liquid
asset than cash).
(b)
Steinemโs SFP will not show increased debt or equity as a
result of this transaction. The cash was generated by the
special purpose entity, which sold shares to its investors.
(c)
This transaction is an example of offโbalancesheet
financing.
(d)
From the perspective of an investor, there is a risk that the
special purpose entity is being used primarily to make
Steinemโs SFP and liquidity positionappear better. As a
general rule, special purpose entities should be
consolidated with the main company when the main
company is the primary beneficiary.
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BRIEF EXERCISE 14.23
Current liabilities
Bond interest payable ……………………………………..
$ 25,000
Bonds payable, due September 1, 2021 ……………$1,200,000
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Solutions Manual
14.27
Chapter14
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Intermediate Accounting, Twelfth Canadian Edition
BRIEF EXERCISE 14.24
(a)
Ambrosia Limited
Partial Statement of Financial Position
As at December 31, 2020
Liabilities
Accounts payable and accrued liabilities
Wages payable
Bonuspayable
Bonds payable
Total liabilities
$ 20,000
15,000
15,000
140,000
$190,000
(b)
Ambrosia Limited
Partial Statement of Financial Position
As at December 31, 2020
Liabilities
Current
Accounts payable and accrued liabilities
Wages payable
Current portion of bonds payable
Total current liabilities
$20,000
15,000
30,000
65,000
Long-term
Bonuspayable
Bonds payable
Total long-term liabilities
Total liabilities
15,000
110,000
125,000
$190,000
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14.28
Chapter14
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Intermediate Accounting, Twelfth Canadian Edition
BRIEF EXERCISE 14.25
Debt-paying ability may be evaluated by calculating the debt to
total assets ratio:
2020 – $500,000 / $900,000= 56%
2019 – $750,000/$700,000 = 107%
Sports Internationalโs debt to assets ratio improved significantly
from 2019 to 2020, so their debt-paying ability and long-term
solvency has improved.
Debt-paying ability may also be evaluated by calculating the
current ratio:
2020 – $120,000 / $100,000 = 1.20
2019 – $140,000 / $150,000 = 0.93
Based on Sports Internationalโs current ratio, their ability to
meet short-term payment requirements in 2020 improved from
2019.
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14.29
Chapter14
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Intermediate Accounting, Twelfth Canadian Edition
SOLUTIONS TO EXERCISES
EXERCISE 14.1
a.
1. 2
2. 3
3. 2
4. 2
5. 1
6. 2
7. 2
8. 1
b.
A feature or characteristic that increases the riskiness of
the long-term debt will cause investors to require a higher
yield on the long-term debt. A higher yield on the long-term
debt will give investors an acceptable return that matches
the issuerโs risk characteristics.
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14.30
Chapter14
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Intermediate Accounting, Twelfth Canadian Edition
EXERCISE 14.2
Unsecured
Bonds
a.
Maturity value
b.
Number of
interest periods
$10,000,000
ZeroCoupon
Bonds
$2,500,000
Mortgage
Bonds
$15,000,000
40
10
10
c.
Stated rate per
period
3.25% (
13%
4
)
0
10%
d.
Effective rate
per period
3% (
12%
4
)
12%
12%
e.
Payment amount
per period
$325,000 (1)
0
$1,500,000 (2)
f.
Present value
$10,577,900 (3)
$804,925 (4)
$13,304,880 (5)
(1)
(2)
$10,000,000 X 13% X 1/4 = $325,000
$15,000,000 X 10% = $1,500,000
1. Using factor tables
(3)
Present value of an annuity of $325,000
discounted at 3% per period for 40
periods ($325,000 X 23.11477) =
Present value of $10,000,000 discounted
at 3% per period for 40 periods
($10,000,000 X .30656) =
$ 7,512,300
3,065,600
$10,577,900
2. Using a financial calculator:
PV
I
N
PMT
FV
Type
$ ?
3%
40
$ (325,000)
$ (10,000,000)
0
Yields $10,577,869
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EXERCISE 14.2 (CONTINUED)
3. Using Excel: = PV(rate,nper,pmt,fv,type)
Result: $10,577,869.30rounded to $10,577,869
1. Using factor tables
(4)
Present value of $2,500,000 discounted at 12% for 10 periods
($2,500,000 X .32197) =
$804,925
2) Using a financial calculator:
PV
I
N
PMT
FV
Type
$ ?
12%
10
0
$ (2,500,000)
0
Yields $804,933
Solutions Manual
14.32
Chapter14
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Intermediate Accounting, Twelfth Canadian Edition
EXERCISE 14.2 (CONTINUED)
3. Using Excel: = PV(rate,nper,pmt,fv,type)
Result: $804,933.09rounded to $804,933
1. Using factor tables
(5)
Present value of an annuity of $1,500,000 discounted
at 12% for 10 periods
($1,500,000 X 5.65022) =
$8,475,330
Present value of $15,000,000 discounted
at 12% for 10 years
($15,000,000 X .32197)
4,829,550
$13,304,880
2. Using a financial calculator:
PV
I
N
PMT
FV
Type
$ ? Yields $13,304,933
12%
10
$ (1,500,000)
$ (15,000,000)
0
Solutions Manual
14.33
Chapter14
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Intermediate Accounting, Twelfth Canadian Edition
EXERCISE 14.2 (CONTINUED)
3. Using Excel:= PV(rate,nper,pmt,fv,type)
Result: $13,304,933.09rounded to $13,304,933
A more accurate result is obtained using Excel and a financial
calculator compared to using factors from tables as there are a
limited number of decimal places in the tables.
Solutions Manual
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Chapter14
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Intermediate Accounting, Twelfth Canadian Edition
EXERCISE 14.2 (CONTINUED)
g. Similarities and differences among the bond features and
their impact on risk are as follows:
โ bond maturity (duration) โ The bonds all have the same
maturity date (duration), thus this risk factor is equalized
among the bonds.
โ bond stated rate and effective interest rate โ The bonds
all have a different stated interest rate (ranging from a deep
discount, zero-coupon bond of 0% to 13%). A discount on
bonds payable results when investors demand a rate of
interest higher than the rate stated on the bonds. This
occurs when the investors are not satisfied with the stated
nominal interest rate because they can earn a greater rate
on alternative investments of equal risk. They refuse to pay
par for the bonds and cannot change the stated nominal
rate. However, by lowering the amount paid for the bonds,
investors can alter the effective rate of interest. A premium
on bonds payable results from the opposite conditions.
That is, when investors are satisfied with a rate of interest
lower than the rate stated on the bonds, they are willing to
pay more than the face value of the bonds in order to
acquire them, thus reducing their effective rate of interest
below the stated rate. In this case, all the bonds are set to
yield an effective interest rate of 12%, which adjusts the
pricing of each individual bond so that they are all equally
attractive to investors (purely on interest rates).
โ timing of cash flows โ The bonds all have differing timing
of cash flow to the investors. This can affect their risk, as
cash flows further in the future have a higher risk factor
than cash flows in the present.
โ bond security โ Bonds security affects the risk of the
bond. In the event of default, a secured bond will rank
higher than an unsecured bond. Thus, unsecured bonds
are generally riskier than secured bonds. Presumably the
mortgage bonds have security.
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Intermediate Accounting, Twelfth Canadian Edition
EXERCISE 14.2 (CONTINUED)
g. (continued)
All the above factors have to be assessed together to
determine the riskiness of each bond. The zero-coupon
bonds have no cash flows over the entire 10-year term,
making them riskier in that the company may not be able to
pay back the $2.5 million at that time. On the other hand, the
zero-coupon bonds may have more security underlying them
than the 13% bonds that are listed as unsecured. The
mortgage bonds are the least risky with the interest cash
flows spread over the life of the bonds, and with physical
property pledged as collateral in the case of inability of
Anaconda to pay the principal or interest. Further
information is required, however, about the fair value of the
underlying collateral.
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14.36
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EXERCISE 14.3
1.
a.
Divac Limited:
1/1/20
Cash ……………………………………………………………………..
300,000
Bonds Payable ……………………………………………….
300,000
b.
7/1/20
c.
12/31/20 Interest Expense …………………………………………………….
6,750
Interest Payable ……………………………………………..
6,750
2.
a.
VerbitskyInc.:
6/1/20
Cash ……………………………………………………………………..
210,000
Bonds Payable ……………………………………………….
200,000
2
Interest Expense ……………………………………………
10,000
2
($200,000 X 12% X 5/12)
b.
7/1/20
c.
12/31/20 Interest Expense …………………………………………………….
12,000
Interest Payable ……………………………………………..
12,000
Interest Expense1 ……………………………………………………
6,750
Cash ………………………………………………………………
6,750
1
($300,000 X 9% X 3/12)
Interest Expense3 ……………………………………………………
12,000
Cash ………………………………………………………………
12,000
3
($200,000 X 12% X 6/12)
Note to instructor: Some students may credit Interest Payable
on 6/1/20. If they do so, the entry on 7/1/20will have a debit to
Interest Payable for $10,000 and a debit to Interest Expense for
$2,000.
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Solutions Manual
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EXERCISE 14.4
a.
1/1/20
b.
7/1/20
Cash ($800,000 X 102%) …………………………………………..
816,000
Bonds Payable …………………………………………………..
816,000
Interest Expense1 ……………………………………………………
39,780
Bonds Payable………………………………………………………..
220
2
Cash ………………………………………………………………..
40,000
1
($816,000 X 9.75% X 1/2)
2
($800,000 X 10% X 6/12)
c.
12/31/20 Interest Expense3 ……………………………………………………
39,769
Bonds Payable………………………………………………………..
231
Interest Payable …………………………………………………
40,000
3
4
($815,780 X 9.75% X 1/2)
4
Carrying amount of bonds at July 1, 2020:
Carrying amount of bonds at January 1, 2020
Amortization of bond premium
($40,000 โ $39,780)
Carrying amount of bonds at July 1, 2020
$816,000
(220)
$815,780
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Intermediate Accounting, Twelfth Canadian Edition
EXERCISE 14.5
a.
(1) 1/1/20
(2) 7/1/20
Cash ($800,000 X 102%) …………………………………………..
816,000
Bonds Payable …………………………………………………..
816,000
Interest Expense……………………………………………………..
39,600
1
Bonds Payable ………………………………………………………
400
2
Cash ………………………………………………………………..
40,000
1
($16,000 ๏ธ 40)
2
($800,000 X 10% X 6/12)
(3) 12/31/20 Interest Expense……………………………………………………..
39,600
Bonds Payable………………………………………………………..
400
Interest Payable …………………………………………………
40,000
b.
Although the effective interest method is required under
IFRS per IFRS 9.5.4.1, accounting standards for private
enterprises do not specify that this method must be used
and therefore, the straight-line method is also an option.
The straight-line method is valued for its simplicity and
might be used by companies whose financial statements
are not constrained by this specific element of GAAP.
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Kieso, Weygandt, Warfield, Wiecek, McConomy
Intermediate Accounting, Twelfth Canadian Edition
EXERCISE 14.6
a.
1.
January 1, 2020
Investment Property ………………………………………………..
1,500,000
Notes Payable …………………………………………………
1,500,000
(The $1,500,000 capitalized cost
represents the present value of the
note with maturity amount of $2,307,941
discounted for five years at 9%)
2.
Land……………………………………………………………………….
1,743,292
Mortgage Payable ……………………………………………
1,743,292
1. Using tables:
Present value of $2,000,000 due in
10 years at 9%โ$2,000,000
X .42241
Present value of $140,000
($2,000,000 X 7%)
payable annually for 10 years
at 9% annuallyโ$140,000
X 6.41766
Present value of the note
Discount to be amortized
$844,820
898,472
$1,743,292
$
256,708
2. Using a financial calculator: – for the principal
PV
I
N
PMT
FV
Type
$ ? Yields $1,743,293.69
9%
10
$(140,000)
$ (2,000,000)
0
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Intermediate Accounting, Twelfth Canadian Edition
EXERCISE 14.6(CONTINUED)
a. (continued)
3. Using Excel: = PV(rate,nper,pmt,fv,type)
Result: $1,743,293.69
A more accurate result is obtained using Excel and a
financial calculator compared to using factors from tables
as there are a limited number of decimal places in the
tables. This difference is in most cases immaterial.
b.
1.
2.
Interest Expense($1,500,000 X .09) …………………………..
135,000
Notes Payable …………………………………………………135,000
Interest Expense($1,743,292 X .09) …………………………..
156,896
Mortgage Payable …………………………………………… 16,896
Cash ($2,000,000 X .07) ……………………………………140,000
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Intermediate Accounting, Twelfth Canadian Edition
EXERCISE 14.7
a.1. Using tables
Face value of the non-interest-bearing note
$600,000
Discounting factor (12% for 3 periods)
X .71178
Amount to be recorded for the land at January 1, 2020 $427,068
2. Using a financial calculator:
PV
I
N
PMT
FV
Type
$ ? Yields
12%
3
0
$ (600,000)
0
$427,068.15
3. Using Excel: = PV(rate,nper,pmt,fv,type)
Result: $427,068.15
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Intermediate Accounting, Twelfth Canadian Edition
EXERCISE 14.7 (CONTINUED)
a. (continued)
Carrying amount of the note at January 1, 2020
Applicable interest rate (12%)
Interest expense to be reported in 2020
$427,068
X
.12
$ 51,248
The assessed value for the land is not as clear a measure of
the value of the land compared to the present value of the
future cash flows on the note. The present value represents
the agreed cash flows, discounted at the market rate of
interest, whereas the assessed value has been computed
(generally) only for the purpose of municipal taxation. It can
be used as a reasonableness check on the amount arrived
for the carrying amount of the nonโinterest-bearing note.
b.1. Using tables
$4,000,000 X .68301 = $2,732,040
2. Using a financial calculator:
PV
I
N
PMT
FV
Type
$ ? Yields $2,732,054
10%
4
0
$ (4,000,000)
0
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Intermediate Accounting, Twelfth Canadian Edition
EXERCISE 14.7 (CONTINUED)
3. Using Excel: = PV(rate,nper,pmt,fv,type)
Result: $2,732,053.82
A more accurate result is obtained using Excel and a
financial calculator compared to using factors from tables as
there are a limited number of decimal places in the tables.
This difference is in most cases immaterial.
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Intermediate Accounting, Twelfth Canadian Edition
EXERCISE 14.8
a.
The purchase price of the land should be recorded at the
present value of the future cash flows of the instalment note
at the imputed interest rate of 9%. This is the fairest
measure of the value of the asset obtained as it represents
the present value of an agreed series of future cash flows.
The listing price represents a tentative amount โaskedโ for
the property and could be above or below the eventual
agreed
value.
b.
Land will be recorded at $110,000 based on the calculations
below:
1. Using tables
*PV of $43,456 ordinary annuity @ 9% for 3
years: ($43,456 X 2.53130) = $110,000
2. Using a financial calculator:
PV
? Yields $ 109,999.94
I
9%
N
3
PMT
$ (43,456)
FV
$0
Type
0
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Intermediate Accounting, Twelfth Canadian Edition
EXERCISE 14.8 (CONTINUED)
3. Using Excel: = PV(rate,nper,pmt,fv,type)
Result: $109,999.94 rounded to $110,000
Effective Interest Amortization Table
Effective Interest Method โ 9%
Year
1/1/20
12/31/20
12/31/21
12/31/22
Note
Payment
9%
Interest
Reduction
of Principal
$43,456
43,456
43,456
$9,900
6,880
3,588
$ 33,556
36,576
39,868
Carrying
Amount
$110,000
76,444
39,868
0
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EXERCISE 14.8(CONTINUED)
c.
Land ……………………………………………………………………….
110,000
Notes Payable …………………………………………………
110,000
d.
Interest Expense …………………………………………………….
9,900
Notes Payable …………………………………………………………
33,556
Cash ………………………………………………………………
43,456
(a)
From the perspective of Safayeni Ltd., an instalment note
provides for a reduced risk of collection when compared to
a regular interest-bearing note. In the case of the interestbearing note, the principal amount is due at the maturity of
the note. Further, the instalment note provides a regular
reduction of the principal balance in every payment
received annually and therefore reduces Safayeniโs
investment in the receivable, freeing up the cash for other
purposes. This is demonstrated in the effective interest
amortization table provided above for the instalment note.
e.
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Intermediate Accounting, Twelfth Canadian Edition
EXERCISE 14.9
a.
Equipment ……………………………………………………………..
316,987
Notes Payable ………………………………………………..
316,987
1. Using tables
PV of $100,000 annuity @ 10% for 4
years: ($100,000 X 3.16987) = $316,987
2. Using a financial calculator:
PV
I
N
PMT
FV
Type
$ ? Yields $316,986.54
10%
4
$ (100,000)
$ 0
0
3. Using Excel: = PV(rate,nper,pmt,fv,type)
Result: $316,986.54 rounded to $316,987
Solutions Manual
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EXERCISE 14.9 (Continued)
b.
Interest Expense1 ……………………………………………………
31,699
Notes Payable ………………………………………………………..
68,301
Cash ………………………………………………………………
100,000
1
(10% X $316,987)
Year
1/2/20
12/31/20
12/31/21
c.
Note
Payment
10%
Interest
Reduction
of Principal
$100,000
100,000
$31,699
24,869
$68,301
75,131
Carrying
Amount
$316,987
248,686
173,555
Interest Expense …………………………………………………….
24,869
Notes Payable ………………………………………………………..
75,131
Cash ………………………………………………………………
100,000
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Intermediate Accounting, Twelfth Canadian Edition
EXERCISE 14.10
a.
Equipment ……………………………………………………………..
86,349
Cash ………………………………………………………………
30,000
Notes Payable ………………………………………………..
56,349
1. Using tables
PV of $75,000 @ 10% for 3 years
($75,000 X 0.75132)
Down payment
Capitalized value of equipment
$56,349
30,000
$86,349
2. Using a financial calculator:
PV
I
N
PMT
FV
Type
$?
10%
3
$0
($ 75,000)
0
Yields $56,348.61
3. Using Excel: = PV(rate,nper,pmt,fv,type)
Result: $56,348.61 rounded to $56,349
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EXERCISE 14.10(Continued)
b.
December 31, 2021:
Interest Expense (see schedule) ………………………………
5,634.90
Notes Payable ………………………………………………..
5,634.90
Year
10% Interest
12/31/20
12/31/21
$5,634.90
12/31/22
6,198.39
12/31/23
6,817.711
1
rounded by $0.52
Balance
$56,349.00
61,983.90
68,182.29
75,000.00
December 31, 2022:
Interest Expense …………………………………………………….
6,198.39
Notes Payable ………………………………………………..
6,198.39
To record interest expense
December 31, 2023:
Interest Expense …………………………………………………….
6,817.71
Notes Payable ………………………………………………..
6,817.71
To record interest expense
Notes Payable ………………………………………………………..
75,000.00
Cash ………………………………………………………………
75,000.00
To record repayment of note
c.
Accounting standards for private enterprises do not
specify that the effective interest method must be used and
therefore the straight-line method is also an option. Collins
may prefer to use the straight-line method due to its
simplicity. However, the effective interest method is
required under IFRS per IFRS 9.5.4.1.
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Intermediate Accounting, Twelfth Canadian Edition
EXERCISE 14.11
a.
January 1, 2020
Cash ………………………………………………………………………
860,652
Bonds Payable ……………………………………………….
860,652
b.
Schedule of Interest Expense and Bond Premium Amortization
Effective Interest Method
12% Bonds Sold to Yield 10%
Debit
Debit
Carrying
Credit
Interest
Bond
Amount of
Date
Cash
Expense
Payable
Bonds
1/1/20
โ
โ
โ
$860,652
1/1/21
$96,000
$86,065
$9,935
850,717
1/1/22
96,000
85,072
10,928
839,789
1/1/23
96,000
83,979
12,021
827,768
c.
December 31, 2020
Interest Expense …………………………………………………….
86,065
Bonds Payable ……………………………………………………….
9,935
Interest Payable ……………………………………………..96,000
January 1, 2021
Interest Payable ……………………………………………………..
96,000
Cash ………………………………………………………………96,000
d.
December 31, 2022
Interest Expense …………………………………………………….
83,979
Bonds Payable ……………………………………………………….
12,021
Interest Payable ……………………………………………..96,000
January 1, 2023
Interest Payable ……………………………………………………..
96,000
Cash ………………………………………………………………96,000
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EXERCISE 14.11 (CONTINUED)
e.
Accounting standards for private enterprises do not
specify that the effective interest method must be used and
therefore the straight-line method is also an option. Osborn
may prefer to use the straight-line method due to its
simplicity. However, the effective interest method is
required under IFRS per IFRS 9.5.4.1.
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EXERCISE 14.12
Year
Jan. 1, 2020
July 1, 2020
Dec. 31, 2020
July 1, 2021
Dec. 31, 2021
1
Schedule of Discount Amortization
Straight-Line Method
Credit
Debit
Credit
Interest
Interest
Bond
Payable
Expense
Payable
$40,000
40,000
40,000
40,000
$90,000
90,000
90,000
90,000
$50,000
50,000
50,000
50,000
1
Carrying
Amount of
Bonds
$800,000
850,000
900,000
950,000
1,000,000
$50,000 = ($1,000,000 โ $800,000) / 4 semi-annual periods
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Intermediate Accounting, Twelfth Canadian Edition
EXERCISE 14.13
a.1. Using a financial calculator:
PV
I
N
PMT
FV
Type
$ 2,783,713
?%
5
$ (300,000)
$ (3,000,000)
0
Yield 12%
2. Using Excel formula: = RATE(nper,pmt,pv,fv,type)
Result: 12%
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Intermediate Accounting, Twelfth Canadian Edition
EXERCISE 14.13 (Continued)
a. (continued)
Year
(1)
Jan. 1, 2020
Dec. 31, 2020
Dec. 31, 2021
Dec. 31, 2022
Dec. 31, 2023
Dec. 31, 2024
1
Schedule of Discount Amortization
Effective Interest Method (12%)
Credit
Debit
Credit
Interest
Interest
Bond
Payable
Expense
Payable
(2)
(3)
(4)
$300,000
300,000
300,000
300,000
300,000
$334,046
338,131
342,707
347,832
353,571
1
$34,046
38,131
42,707
47,832
53,571
Carrying
Amount of
Bonds
$2,783,713
2,817,759
2,855,890
2,898,597
2,946,429
3,000,000
$334,046 = $2,783,713 X .12
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EXERCISE 14.13 (CONTINUED)
b.
The straight-line method results in higher interest expense
for the year ended December 31, 2020, and the effective
interest method results in higher interest expense for the
year ended December 31, 2024. Under the straight-line
method, the amount that is amortized each year is constant.
Under the effective interest method, the amount amortized
each year is based on a constant percentage of the bondsโ
increasing carrying amount. A user who would like the
companyโs income statement to reflect the most faithfully
representative measure of net income would prefer that the
company use the effective interest method, under which
interest expense correlates more closely with the actual
carrying amount of the bond.
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Intermediate Accounting, Twelfth Canadian Edition
EXERCISE 14.14
a.
Printing and engraving costs of bonds
Legal fees
Commissions paid to underwriter
Amount to be reported
$25,000
69,000
70,000
$164,000
When a note or bond is issued, it should be recognized at
the fair value adjusted by any directly attributable issue
costs.The costs would affect the amount of bond premium
or discount amortization recorded and effectively increase
the interest expense over the term of the bond. However,
note that where the liabilities will subsequently be measured
at fair value (e.g., under the fair value option or because they
are derivatives), the transaction costs should not be
included in the initial measurement (i.e., the costs should be
expensed at the time of issuance) [CPA Canada Handbook,
Part II, Section 3856.07 and IFRS 9.5.1.1].
b.
Interest paid for each period, from January 1
to June 30, 2020and July 1 to Dec. 31, 2020
$3,000,000 X 10% X 6/12
Less: Premium amortization for each period from
January 1 to June 30, and July 1 to Dec. 31,
[($3,000,000 X 1.04) โ $3,000,000] ๏ธ 10 X 6/12
Interest expense to be recorded on each of July 1
and December 31, 2020
c.
Carrying amount of bonds on June 30, 2020
Effective interest rate for the period from June 30
to October 31, 2020(.10 X 4/12)
Interest expense to be recorded on October 31, 2020
$150,000
6,000
$ 144,000
$562,613
X.033333
$ 18,754
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EXERCISE 14.14 (CONTINUED)
d.
Carrying amount of bonds on Dec. 31, 2020
Less: fair value of bonds on Dec. 31, 2020
Gain on bondsdue to change in credit risk
$850,716.97
838,000.00
$12,716.97
Under IFRS 9 gains/losses related to changes in credit risk
are booked through Other Comprehensive Income.
(Note that under ASPE, where the fair value option is used,
credit risk is incorporated into the measurement and
resulting gains/losses are booked through net income.)
e.
1. IFRS
Bonds Payable ……………………………………………………….
12,717
Unrealized Gain or LossโOCI …………………………12,717
2. ASPE
Bonds Payable ……………………………………………………….
12,717
Unrealized Gain or Loss ………………………………….12,717
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EXERCISE 14.15
a.
Through the interest-free forgivable loan for Sunshine to
build additional solar panels, the government is reducing
the cost of the panels in addition to providing the
financing.The company is avoiding the interest it would
ordinarily have been charged. Sunshine is getting a
double benefit. First it is getting the loan and second the
company does not have to incur interest payments on the
note. Since the company believes that the loan will be
forgiven, the benefit should be accounted for as a
government grant. The measurement of the interest at 12%
is the fair rate of interest to impute on this loan.
b.
1. Using tables:
PV of $500,000 @ 12% discounted 5 years
(500,000 x 0.56743 = 283,715)
2. Using a financial calculator:
PV
I
N
PMT
FV
Type
$
$ ?
12%
5
$ 0
(500,000)
0
Yields $ 283,713.43
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EXERCISE 14.15 (CONTINUED)
3.Using Excel: =PV(rate,nper,pmt,fv,type)
Result: $283,713.43 rounded to $283,713
Date
12/31/20
12/31/21
12/31/22
12/31/23
Schedule of Note Discount Amortization
Debit, Interest Expense
Carrying Amount
Credit Notes Payable
of Note
$ 283,715
$34,046
317,761
38,131
355,892
42,707
398,599
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Intermediate Accounting, Twelfth Canadian Edition
EXERCISE 14.15 (CONTINUED)
c.
Cash ………………………………………………………………………
500,000
Notes Payable ……………………………………………….. 283,715
Equipment1 ……………………………………………………. 216,285
1
($500,000 โ $283,715 = $216,285)
d.
December 31, 2021
Interest Expense …………………………………………………….
34,046
Notes Payable ………………………………………………..
34,046
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Intermediate Accounting, Twelfth Canadian Edition
EXERCISE 14.16
a.
1.
2.
June 30, 2020
Cash ………………………………………………………………………
4,300,920
Bonds Payable ……………………………………………….
4,300,920
December 31, 2020
Interest Expense ……………………………………………………
258,055
Bonds Payable ……………………………………………………….
1,945
2
Cash …………………………………………………………….. 260,000
1
($4,300,920 X 12% X 6/12)
2
($4,000,000 X 13% X 6/12)
1
3.
June 30, 2021
Interest Expense ……………………………………………………
257,939
Bonds Payable ……………………………………………………….
2,061
Cash ……………………………………………………………… 260,000
3
[($4,300,920 โ $1,945) X 12% X 6/12]
3
4.
December 31, 2021
Interest Expense ……………………………………………………
257,815
Bonds Payable ……………………………………………………….
2,185
Cash ……………………………………………………………… 260,000
4
[($4,300,920 โ $1,945 โ$2,061) X 12% X 6/12]
4
b. Long-term Liabilities:
Bonds payable, 13% (due on June 30, 2040)
$4,298,975
($4,300,920 โ $1,945) = $4,298,975
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Intermediate Accounting, Twelfth Canadian Edition
EXERCISE 14.16 (CONTINUED)
c.
1.
2.
Interest expense for the period from
July 1 to December 31,2020from (a) 2.
Amount of bond interest expense
reported for 2020
$258,055
$258,055
The amount of bond interest expense reported in 2020will
be greater than the amount that would be reported if the
straight-line method of amortization were used. Under the
straight-line method, the amortization of bond premium is
$7,523 ($300,920/20 X 6/12). Bond interest expense for
2020would be the difference between the actual interest
paid, $260,000 ($4,000,000 X 13% X 6/12) and the
amortized premium, $7,523. Thus, the amount of bond
interest expense would be $252,477, which is smaller than
the bond interest expense under the effective interest
method.
Note: Although the effective interest method is required
under IFRS per IFRS 9.5.4.1, accounting standards for
private enterprises do not specify that this method must
be used and therefore the straight-line method is also an
option. The straight-line method is valued for its simplicity
and might be used by companies whose financial
statements are not constrained by this specific element of
GAAP.
3.
4.
Total interest to be paid for the bond
($4,000,000 X 13% X 20)
Principal due in 2040
Total cash outlays for the bond
Cash received at issuance of the bond
Total cost of borrowing over the life
of the bond
$10,400,000
4,000,000
14,400,000
(4,300,920)
$10,099,080
They will be the same, although the pattern of recognition
will be different.
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EXERCISE 14.17
Reacquisition price ($500,000 X 104%) …………………….. $520,000
Less: Net carrying amount of bonds
redeemed:
Face value ……………………………………………………
$500,000
Unamortized discount …………………………………..
(10,000) 490,000
Loss on redemption ……………………………………………….. $ 30,000
April 30, 2020
Bonds Payable ……………………………………………………….
490,000
Loss on Redemption of Bonds ………………………………..
30,000
Cash ………………………………………………………………
To record redemption of bonds payable
March 31, 2020
Cash ………………………………………………………………………
512,000
Bonds Payable
($500,000 + $15,000 โ $3,000) ………………………….
To record issuance of new bonds
520,000
512,000
Note: When a note or bond is issued, it should be recognized at
the fair value adjusted by any directly attributable issue costs.
These costs would affect the amount of bond premium or
discount amortization recorded and effectively increase the
interest expense over the term of the bond through the
allocation of the issuance cost to periods. However, note that
where the liabilities will subsequently be measured at fair value
(e.g., under the fair value option or because they are
derivatives), the transaction costs should not be included in the
initial measurement (i.e., the costs should be expensed at the
time of issuance) [CPACanada Handbook, Part II, Section
3856.07 and IFRS 9.5.1.1].
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EXERCISE 14.18
a.
June 30, 2020
Bonds Payable ……………………………………………………….
789,600
Loss on Redemption of Bonds ………………………………..
42,400
Cash ………………………………………………………………
To record redemption of bonds payable
832,000
Reacquisition price ($800,000 X 104%) …………………….. $832,000
Carrying amount of bonds redeemed:
Par value ………………………………………………………..
$800,000
1
Unamortized discount ……………………………………
(10,400) (789,600)
1
(.02 X $800,000 X 13/20)
Loss on redemption ……………………………………………….. $ 42,400
Cash ($1,000,000 X 102%) ………………………………………..
1,020,000
Bonds Payable ………………………………………………. 1,020,000
To record issuance of new bonds
b.
December 31, 2020
Interest Expense …………………………………………………….
49,500
1
Bonds Payable ………………………………………………………
500
2
Cash …………………………………………………………….50,000
1
(1/40 X $20,000 = $500)
2
(.05 X $1,000,000 = $50,000)
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EXERCISE 14.19
1. Using a financial calculator:
PV
I
N
PMT
FV
Type
$ 784,000
?%
40
$ (48,000)
$ (800,000)
0
Yields 6.135%
2. Using Excel: =RATE(nper,pmt,pv,fv,type)
Result: 6.1351945% rounded to three decimal places 6.135%
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EXERCISE 14.19 (CONTINUED)
a. (continued)
Schedule of Bond Discount Amortization
Effective Interest Method
12% Semi-annual Bonds Sold to Yield 12.27%
6.0%
6.135%
Cash
Interest
Discount
Carrying
Date
Paid
Expense Amortized Amount
June 30 2013
$784,000.00
Dec. 31 2013 $48,000.00 $48,098.40
$98.40
784,098.40
June 30 2014
48,000.00
48,104.44
104.44
784,202.84
Dec. 31 2014
48,000.00
48,110.84
110.84
784,313.68
June 30 2015
48,000.00
48,117.64
117.64
784,431.32
Dec. 31 2015
48,000.00
48,124.86
124.86
784,556.18
June 30 2016
48,000.00
48,132.52
132.52
784,688.70
Dec. 31 2016
48,000.00
48,140.65
140.65
784,829.35
June 30 2017
48,000.00
48,149.28
149.28
784,978.63
Dec. 31 2017
48,000.00
48,158.44
158.44
785,137.07
June 30 2018
48,000.00
48,168.16
168.16
785,305.23
Dec. 31 2018
48,000.00
48,178.48
178.48
785,483.71
June 30 2019
48,000.00
48,189.43
189.43
785,673.14
Dec. 31 2019
48,000.00
48,201.05
201.05
785,874.19
June 30 2020
48,000.00
48,213.38
213.38
786,087.57
$2,087.57
Although not required, the entry at the issuance of the
bonds is:
6/30/13 Cash ($800,000 X 98%)…………………………………………….
784,000
Bonds Payable …………………………………………………..
784,000
At June 30, 2020,the carrying amount of the bonds is as
indicated in the effective interest table: $786,087.57
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EXERCISE 14.19 (CONTINUED)
a. (continued)
June 30, 2020
Bonds Payable ……………………………………………………….
786,087.57
Loss on Redemption of Bonds ………………………………..
45,912.43
Cash ……………………………………………………………… 832,000.00
To record reacquisition of bonds
payable
Reacquisition price ($800,000 X 104%) …………………….. $832,000.00
Net carrying amount of bonds redeemed:
786,087.57
Loss on redemption ……………………………………………….. $45,912.43
Cash ($1,000,000 X 102%) ………………………………………..
1,020,000
Bonds Payable ……………………………………………….
To record issuance of new bonds
1,020,000
1. Using a financial calculator:
PV
I
N
PMT
FV
Type
$ 1,020,000
?%
40
$ (50,000)
$ (1,000,000)
0
Yields 4.885 %
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EXERCISE 14.19 (CONTINUED)
a. (continued)
2.Using Excel: =RATE(nper,pmt,pv,fv,type)
Result: 0.048852691 Rounded to three decimal places 4.885%
b.
December 31, 2020
Interest Expense ……………………………………………………
49,827
Bonds Payable ……………………………………………………….
173
Cash ………………………………………………………………
50,000
1
($1,020,000 X 4.885% = $49,827)
1
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EXERCISE 14.20
a.
Reacquisition price ($850,000 X 102%)
Less: Net carrying amount of bonds redeemed:
Par value
Unamortized discount1
Loss on redemption
Calculation of unamortized discountโ
Original amount of discount:
$850,000 X 3% = $25,500
Bond issuance costs ($110,000 X
$850,000/$1,500,000 =
Amount to be amortized over 10 years
Amount of discount unamortized:
1
($87,833 X 5) รท 10 = $43,917
$867,000
850,000
(43,917)
806,083
$ 60,917
$25,500
62,333
$87,833
January 2, 2020
Bonds Payable ……………………………………………………….
806,083
Loss on Redemption of Bonds ……………………………….
60,917
Cash ……………………………………………………………… 867,000
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EXERCISE 14.20 (CONTINUED)
b.
Had the costs of issuing the bond of $110,000 been
expensed on the date of issue (which is the required
accounting treatment for transactions costs when the debt
is subsequently measured at fair value rather than
amortized cost), the issue costs would have been charged
to expense in 2015.
Reacquisition price ($850,000 X 102%)
Less: Carrying amount of bonds on the
reacquisition date = fair value at that date (see
assumption)
Gain/Loss on redemption
$867,000
867,000
$
-0-
Note to instructor: Since the bonds are carried at fair value,
there would be no separate gain or loss on retirement. All
changes in the fair value of the bonds would have already been
recognized in net income in prior years. If the company had
adopted IFRS 9 early in prior years, all changes in the fair value
of the bonds (which relate to changes in credit risk) would have
already been recognized in Other Comprehensive Income.
January 2, 2020
Bonds Payable ……………………………………………………….
867,000
Cash ……………………………………………………………… 867,000
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EXERCISE 14.20 (CONTINUED)
c.
If Kowalchuk were to follow IFRS, then the effective
interest method must be used to amortize any discounts or
premiums. Although the effective interest method is
required under IFRS per IFRS 9.5.4.1, accounting standards
for private enterprises do not specify that this method
must be used and therefore, the straight-line method is
also an option. The straight-line method is valued for its
simplicity and might be used by companies whose
financial statements are not constrained by this specific
element of GAAP.
Under IAS 39, where the fair value option is selected, credit
risk is incorporated into the measurement and resulting
gains/losses are booked through net income. However,
under IFRS 9, gains/losses related to changes in credit risk
are booked through Other Comprehensive Income.
(Note that under ASPE, where the fair value option is used,
credit risk is incorporated into the measurement and
resulting gains/losses are booked through net income.)
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EXERCISE 14.21
Cash($5,000,000 X .97) …………………………………………….
4,850,000
Bonds Payable ……………………………………………….
To record issuance of 6% bonds
4,850,000
Bonds Payable ……………………………………………………….
8,900,000
Loss on Redemption of Bonds ………………………………..
1,600,000
Cash ($10,000,000 X 1.05) ……………………………….. 10,500,000
To record retirement of 8% bonds
Reacquisition price …………………………………………………$10,500,000
Less: Net carrying amount of bonds redeemed:
Par value ………………………………………………………..
$10,000,000
Unamortized bond discount …………………………….
( 1,100,000)
8,900,000
Loss on redemption ……………………………………………….. $ 1,600,000
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EXERCISE 14.22
a.
Journal entry to record issuance of loan by Par Bank:
December 31, 2019
Notes Receivable ……………………………………………………
81,241
Cash ………………………………………………………………81,241
b.
Date
12/31/19
12/31/20
Note Amortization Schedule
(Before Impairment)
Cash
Interest
Received
Income
Discount
(0%)
(9%)
Amortized
$0
$7,312
$7,312
Computation of the impairment loss:
Carrying amount of investment (12/31/20)
Carrying
Amount of
Note
$81,241
88,553
$88,553
1. Using tables:
Less: Present value of $93,750 due in 4 years
at 9% ($93,750 X .70843)
Loss due to impairment
66,415
$22,138
2. Using a financial calculator:
PV
I
N
PMT
FV
Type
$ ?
9%
4
0
$ (93,750)
0
Yields $66,415
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EXERCISE 14.22 (CONTINUED)
b. (continued)
3. Using Excel: = PV(rate,nper,pmt,fv,type)
Result: $66,414.86354 rounded to $66,415
The entry to record the loss by Par Bank is as follows:
Bad Debt Expense…………………………………………………..
22,138
Allowance for Doubtful Accounts …………………….
c.
22,138
Mohr Inc., the debtor, makes no entry because it still
legally owes $125,000.
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EXERCISE 14.23
a. Transfer of property on December 31, 2020:
Strickland Inc. (Debtor):
Notes Payable ……………………………………………………
200,000
Interest Payable …………………………………………………
18,000
Accumulated DepreciationโMachinery ………………
221,000
Machinery……………………………………………………
Gain on Disposal of Machinery1 ……………………
Gain on Restructuring of Debt2 …………………….
1
2
390,000
11,000
38,000
$180,000 โ ($390,000 โ $221,000) = $11,000
($200,000 + $18,000) โ $180,000 = $38,000
Heartland Bank (Creditor):
Machinery …………………………………………………………..
180,000
3
Allowance for Doubtful Accounts ………………………..
38,000
Notes Receivable …………………………………………
Interest Receivable ………………………………………
200,000
18,000
3
As given in the problem, this assumes Heartland had
previously recognized a loss when they determined the
loan was impaired and set up an allowance for doubtful
accounts or had otherwise included this category of notes
in allowance calculations.
b.
If โGain on Disposalof Machineryโ and โGain on
Restructuring of Debtโ do not occur frequently, they are
still presented as part of income from continuing
operations. If they are not material in amount, they are
combined with the other items in the income statement. If
they are material, they are disclosed separately. However,
if the same types of gains/losses recur each year, then
they are not really unusual and care must be taken to
classify them with other gains and losses as normal
transactions.
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EXERCISE 14.23 (CONTINUED)
c.
Granting of equity interest on December 31, 2020:
Strickland Inc. (Debtor):
Notes Payable ………………………………………………..
200,000
Interest Payable ……………………………………………..
18,000
Common Shares………………………………………
Gain on Restructuring of Debt ………………….
190,000
28,000
Heartland Bank (Creditor):
FV-NI Investments …………………………………………..
190,000
4
Allowance for Doubtful Accounts …………………..
28,000
Notes Receivable …………………………………….
Interest Receivable ………………………………….
200,000
18,000
4
Assumes Heartland had previously recognized a loss
when they determined the loan was impaired and set up
an allowance for doubtful accounts or had otherwise
included this category of notes in allowance calculations.
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EXERCISE 14.24
a.
The first step is to determine the economic substance of
the debt renegotiation and determine if it should be
accounted for as a settlement or a modification/exchange
regarding the old debt. In this case, the creditor is the
same and so is the currency and therefore the test to
establish whether there is a settlement or not revolves
around the cash flows. The present value of the cash flow
streams of the new debt are calculated using the historical
interest rate of 12% for consistency and comparability.
Present value of old debt is $2,000,000.
Present value of new debt is calculated as follows:
1.Using tables:
Single amount
Interest annuity
$1,900,000
190,000
12%
Factor
0.71178
2.40183
Present
Value
$1,352,382
456,348
$1,808,730
2.Using a financial calculator:
PV
I
N
PMT
FV
Type
$?
12%
3
$ (190,000)
$ (1,900,000)
0
Yields $1,808,730
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EXERCISE 14.24 (CONTINUED)
a. (continued)
3. Using Excel: =PV(rate,nper,pmt,fv,type)
Result: $1,808,730.41 rounded to $1,808,730
Since the present value of the future cash flows of the new
debt does not differ by an amount greater than 10%1 of the
present value of the old debt, the renegotiated debt is not
considered a substantial modification. This is considered a
modification of terms. The old debt remains on the books
of Troubled but a gain is recognized to reflect the new cash
flows.Note disclosure is required.
1
Old debt
New debt
Difference
As a %
$2,000,000
1,808,730
$ 191,270
9.56%
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EXERCISE 14.24 (CONTINUED)
b.
Under IFRS, the note would be remeasured to reflect the
new cash flows discounted at the original effective interest
rate of 12% as follows.
December 31, 2020
Notes Payable ………………………………………………………..
191,270
1
Gain on Restructuring of Debt ………………………..
1
($2,000,000 – $1,808,730)
191,270
c.
TROUBLED INC.
INTEREST PAYMENT SCHEDULE AFTER DEBT
RESTRUCTURING
EFFECTIVE INTEREST RATE 12%
Cash
Effective
Increase
Carrying
Interest
Interest
of Carrying
Amount of
Date
(10%)
(12%)
Amount
Note
12/31/20
$1,808,730
a
b
c
12/31/21
$190,000
$217,048
$27,048
1,835,778
12/31/22
190,000
220,293
30,293
1,866,071
12/31/23
190,000
223,929
33,929
1,900,000
Total
$570,000
$661,270
$91,270
a
$1,900,000 X 10% = $190,000
$1,808,730 X 12% = $217,048
c
$190,000 โ $217,048 = $27,048
b
d.
Interest payment entry for Troubled Inc. is:
December 31, 2022
Interest Expense …………………………………………………….
220,293
Notes Payable …………………………………………………30,293
Cash ………………………………………………………………
190,000
January 1, 2024
Notes Payable ………………………………………………………..
1,900,000
Cash ………………………………………………………………
1,900,000
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EXERCISE 14.24 (CONTINUED)
e.
The new effective rate of 7.9592% was computed by
Troubled in order to record the interest expense based on
the future cash flows specified by the new terms with the
pre-restructuring carrying amount of the debt of
$2,000,000. The rate would have been calculated as
follows:
1. Using a financial calculator:
PV
I
N
PMT
FV
Type
$ 2,000,000
?%
3
$ (190,000)
$ (1,900,000)
0
Yields 7.9592 %
2) Using Excel: =RATE(nper,pmt,pv,fv,type)
Result: 0.079592209 rounded to 7.9592%
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EXERCISE 14.24(CONTINUED)
f. The interest payment schedule is prepared as follows:
TROUBLED INC.
INTEREST PAYMENT SCHEDULE AFTER DEBT
RESTRUCTURING
EFFECTIVE INTEREST RATE 7.9592%
Cash
Effective
Reduction
Carrying
Interest
Interest
of Carrying
Amount of
Date
(10%)
(7.9592%)
Amount
Note
12/31/20
$2,000,000
a
b
c
12/31/21
$190,000
$159,184
$30,816
1,969,184
12/31/22
190,000
156,731
33,269
1,935,915
d
12/31/23
190,000
154,085
35,915
1,900,000
Total
$570,000
$470,000
$100,000
a
$1,900,000 X 10% = $190,000
$2,000,000 X 7.9592% = $159,184
c
$190,000 โ $159,184 = $30,816
d
Rounded
b
g.
Interest payment entry for Troubled Inc. is:
December 31, 2022
Notes Payable ………………………………………………………..
33,269
Interest Expense …………………………………………………….
156,731
Cash ………………………………………………………………
190,000
January 1, 2024
Notes Payable ………………………………………………………..
1,900,000
Cash ………………………………………………………………
1,900,000
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Kieso, Weygandt, Warfield, Wiecek, McConomy
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EXERCISE 14.25
a.
Green Bank should use the historical interest rate of 12%
to calculate the loss.
b.
Pre-restructuring carrying amount of note
Present value of restructured cash flows (below)
Loss on restructuring of debt
$2,000,000
1,808,730
$ 191,270
1.Using tables:
Single amount
Interest annuity
$1,900,000
190,000
12%
Factor
0.71178
2.40183
Present
Value
$1,352,382
456,348
$1,808,730
2.Using a financial calculator:
PV
I
N
PMT
FV
Type
$?
12%
3
$ (190,000)
$ (1,900,000)
0
Yields $1,808,730
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EXERCISE 14.25 (CONTINUED)
b. (continued)
3. Using Excel: =PV(rate,nper,pmt,fv,type)
Result: $1,808,730.41 rounded to $1,808,730
December 31, 2020
Modification Gain or Loss ……………………………………….
191,270
Notes Receivable ……………………………………………
191,270
Note: Any gains or losses on modification of contractual
cash flows must be shown in the income statement as a
modification gain or loss (IFRS 9.5.4.3). If Green Bank had
previously recognized an Allowance for Doubtful Accounts
related to this account, the debit account would have been
the Allowance account instead of the expense account.
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EXERCISE 14.25(CONTINUED)
c.
The interest receipt schedule is prepared as follows:
GREEN BANK
INTEREST RECEIPT SCHEDULE AFTER DEBT RESTRUCTURING
EFFECTIVE INTEREST RATE 12%
Cash
Effective
Increase
Carrying
Interest
Interest
in Carrying Amount of
Date
(10%)
(12%)
Amount
Note
12/31/20
12/31/21
$190,000a
$217,048b
12/31/22
190,000
220,293
12/31/23
190,000
223,929
Total
$570,000
$661,270
a
$1,900,000 X 10% = $190,000
b
$1,808,730 X 12% = $217,048
c
$217,048 โ $190,000 = $27,048
d.
c
$27,048
30,293
33,929
$91,270
$1,808,730
1,835,778
1,866,071
1,900,000
Interest receipt entry for Green Bank is:
December 31, 2022
Cash ………………………………………………………………………
190,000
Notes Receivable …………………………………………………….
30,293
Interest Income ……………………………………………….
220,293
e.
The receipt entry at maturity is:
January 1, 2024
Cash ………………………………………………………………………
1,900,000
Notes Receivable …………………………………………….
1,900,000
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EXERCISE 14.26
a.
The first step is to determine the economic substance of
the debt renegotiation and determine if it should be
accounted for as a settlement or a modification/exchange
regarding the old debt. In this case, the creditor is the
same and so is the currency and therefore the test to
establish whether there is a settlement or notrevolves
around the cash flows. The present value of the cash flow
streams of the new debt are calculated using the historical
interest rate of 12% for consistency and comparability.
Present value of old debt is $2,000,000.
Present value of new debt is calculated as follows:
1.Using tables:
Single amount
Interest annuity
$1,600,000
160,000
12%
Present
Factor
0.71178
2.40183
Value
$1,138,848
384,293
$1,523,141
2.Using a financial calculator:
PV
I
N
PMT
FV
Type
$?
12%
3
$ (160,000)
$ (1,600,000)
0
Yields $1,523,141
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EXERCISE 14.26 (CONTINUED)
a. (continued)
3. Using Excel: =PV(rate,nper,pmt,fv,type)
Result: $1,523,141.399 rounded to $1,523,141
Since the present value of the future cash flows of the new
debt of $1,523,141 differs by an amount larger than 10% of
the present value of the future cash flows of the old debt
in the amount of $2,000,000, the renegotiated debt is
considered a settlement and Troubled records a gain.
b.
Notes Payable ………………………………………………………..
2,000,000
Gain on Restructuring of Debt …………………………
400,000
Notes Payable ………………………………………………..
1,600,000
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EXERCISE 14.26 (CONTINUED)
c.
The new debt would be recorded at the present value of the
new cash flows at the current market rate of 10%.
Therefore, Troubled should use the current market rate of
10% to calculate its interest expense in future periods. In
E14.24, the renegotiated debt was not considered a
settlement, and a new effective interest rate was imputed
by equating the carrying amount of the original debt with
the present value of the revised cash flows.
d.
The interest payment schedule is prepared as follows:
TROUBLED INC.
INTEREST PAYMENT SCHEDULE AFTER DEBT
RESTRUCTURING
EFFECTIVE INTEREST RATE 10%
Cash
Effective
Reduction
Carrying
Interest
Interest
of Carrying
Amount of
Date
(10%)
(10%)
Amount
Note
12/31/20
$1,600,000
a
12/31/21
$160,000
$160,000
1,600,000
12/31/22
160,000
160,000
1,600,000
12/31/23
160,000
160,000
1,600,000
Total
$480,000
$480,000
a
$1,600,000 X 10% = $160,000
e.
Interest payment entries for Troubled Inc. are:
December 31, 2021through 2023
Interest Expense …………………………………………………….
160,000
Cash ………………………………………………………………
160,000
f.
The payment entry at maturity is:
January 1, 2024
Notes Payable ………………………………………………………..
1,600,000
Cash ………………………………………………………………
1,600,000
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EXERCISE 14.27
a.
Green Bank needs to calculate the present value of the
expected cash flows discounted at the historical effective
interest rate, which in this case is 12%.
b.
Pre-restructuring carrying amount of note
Present value of restructured cash flows (below)
Loss on debt restructuring
$2,000,000
1,523,141
$ 476,859
1.Using tables:
Single amount
Interest annuity
$1,600,000
160,000
12%
Factor
0.71178
2.40183
Present
Value
$1,138,848
384,293
$1,523,141
2.Using a financial calculator:
PV
I
N
PMT
FV
Type
$?
12%
3
$ (160,000)
$ (1,600,000)
0
Yields $1,523,141
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EXERCISE 14.27 (Continued)
b. (continued)
3. Using Excel: =PV(rate,nper,pmt,fv,type)
Result: $1,523,141.399 rounded to $1,523,141
b.
December 31, 2023
Modification Gain or Loss ……………………………………….
476,859
Notes Receivable ……………………………………………
476,859
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EXERCISE 14.28
The first step is to determine the economic substance of the
debt renegotiation and determine if it should be accounted for
as a settlement or a modification/exchange regarding the old
debt. In this case, the creditor is the same and so is the
currency and therefore the test to establish whether there is a
settlement or not revolves around the cash flows. The present
value of the cash flow streams of the new debt are calculated
using the historical interest rate of 12% for consistency and
comparability.
Present value of old debt is $270,000.
Present value of new debt is calculated as follows:
1.Using tables:
Single amount
Interest annuity
$220,000
11,000
12%
Factor
0.79719
1.69005
Present
Value
$175,382
18,591
$193,973
2.Using a financial calculator:
PV
I
N
PMT
FV
Type
$?
12%
2
$ (11,000)
$ (220,000)
0
Yields $193,973
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EXERCISE 14.28 (CONTINUED)
3. Using Excel: =PV(rate,nper,pmt,fv,type)
Result: $193,973.2143 rounded to $193,973
Since the present value of the future cash flows of the new debt
differs by an amount larger than 10% of the present value of the
old debt, the renegotiated debt is considered a settlement.
A gain/loss is recorded by Vargo (debtor) and no interest is
recorded by the debtor. This is not considered a modification of
terms. The old debt is removed from the books of Vargo with a
gain/loss being recognized, and the new debt is recorded.
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EXERCISE 14.28 (CONTINUED)
Vargo Corp.โs entries:
2020 Notes Payable ………………………………………………..
270,000
Gain on Restructuring of Debt ………………….
Notes Payable ………………………………………….
50,000
220,000
2021 Interest Expense …………………………………………….
11,000
Cash (5% X $220,000)……………………………….
11,000
2022 Interest Expenseโฆโฆโฆโฆโฆโฆโฆโฆโฆโฆ.
Cashโฆโฆโฆโฆโฆโฆโฆโฆโฆโฆโฆโฆโฆ..
11,000
11,000
2022 Notes Payableโฆโฆโฆโฆโฆโฆโฆโฆโฆโฆโฆ
Cashโฆโฆโฆโฆโฆโฆโฆโฆโฆโฆโฆโฆโฆ..
220,000
220,000
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EXERCISE 14.29
a.
IFRS
1.
6.
7.
8.
9.
10.
Current liability since the operating cycle of the winery is 5
years.
Current liability, $2,000,000; long-term liability, $8,000,000.
Current liability (amount actually held in trust).
Noncurrent liability
Interest payable is a current liability and the note payable
is noncurrent liability.
Current liability.
Noncurrent liability.
Current liability.
Current asset โ netted against other cash balances.
Current liability.
b.
ASPE
2.
3.
4.
5.
No differences. All the above IFRS classifications would be
the same under ASPE.
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EXERCISE 14.30
a.
IFRS
1.
Interest expense (debit balance)โโInterest expenseโ on the
income statement.
Loss on restructuring of debtโ If โLoss on restructuring of
debtโ does not occur frequently, it is still presented as part
of โIncome from continuing operations.โ If it is not material
in amount, it is combined with the other items in the
income statement. If it is material, it is disclosed
separately.
Mortgage payableโClassify full amount as long-term
liability on the statement of financial position (SFP).
Debenture bondsโClassify as current liability on the SFP
since the covenant was breached, making the amount
immediately owing. Since the waiver was received after
year end, must still be current.
Promissory notes payableโClassify 1/10 of the balance as
current portion of promissory notes payable, and
remaining balance as long-term liability on theSFP.
Income bonds payableโClassify full amount as current
liability on the SFP.
2.
3.
4.
5.
6.
b.
ASPE
Except for number 4, no differences. All the above IFRS
classifications would be the same under ASPE.
Under number 4, since the waiver was received after year
end but before the financial statements were issued, ASPE
would allow the debentures to still be presented as long
term on the balance sheet.
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EXERCISE 14.31
At December 31, 2020, disclosures would be as follows:
Long-term debt consists of the following:
Notes payable, due June 30, 2023
Bonds, due September 30, 2024
Debenture
$2,200,000
4,000,000
17,500,000
$23,700,000
The debenture has annual sinking fund payments of $3,500,000
in each of the years 2022 to 2026.
Maturities and sinking fund requirements on long-term debt are
as follows:
2021
2022
2023
2024
2025
Thereafter
$
0
3,500,000
5,700,000
7,500,000
3,500,000
3,500,000
($2,200,000 + $3,500,000)
($4,000,000 + $3,500,000)
Note:The company would also need to disclose interest rates
for each liability, collateral if any, covenants, and any other
significant details in the debt agreements.
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TIME AND PURPOSE OF PROBLEMS
Problem 14.1
Purposeโto provide the student with an opportunity to become familiar with the
exchange of an instalment note, which is payable in equal instalments, for raw
materials to construct equipment. This problem requires the preparation of the
necessary journal entries concerning the exchange and the annual payments
and interest. A schedule of note discount amortization should be constructed to
support the respective entries.
Problem 14.2
Purposeโto provide the student with the opportunity to contrast the terms of a
long-term note given in exchange for the purchase of land. The discussion of
risk and financial statement disclosure is included as part of the required for this
question. The preparation of effective interest tables for both alternatives is
intended to draw the studentโs attention to the differences in the treatment of
principal and interest between a regular note and an instalment note payable.
Journal entries and adjusting entries and the SFP disclosure must also be
prepared under both alternatives. This is a comprehensive question.
Problem 14.3
Purposeโto provide the student with the opportunity to interpret a bond
amortization schedule. This problem requires both an understanding of the
function of such a schedule and the relevance of each of the individual numbers.
The student is to prepare journal entries to reflect the information given in the
bond amortization schedule.
Problem 14.4
Purposeโto provide the student with an understanding of how to make the
journal entry to record the issuance of bonds. In addition, a portion of the bonds
are retired and therefore a bond amortization schedule has to be prepared.
Student must also deal with accounting for the costs of issuing a bond and the
fair value method.
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TIME AND PURPOSE OF PROBLEMS (CONTINUED)
Problem 14.5
Purposeโto provide the student with an understanding of the relevant journal
entries that are necessitated for a bond issuance. This problem involves two
independent bond issuances with the assumption that one is sold at a discount
and the other at a premium, both utilizing the effective interest method. This
comprehensive problem requires preparing journal entries for the issuance of
bonds, related interest payments and amortization (with the construction of
amortization tables where applicable), and the retirement of part of the bonds.
Problem 14.6
Purposeโto provide the student with an understanding of the relevant journal
entries for a bond issuance and partial bond retirement. This problem requires
preparing journal entries, assuming the straight-line method, for the issuance of
bonds, related interest payments and amortization, and the retirement of part of
the bonds. The student must also comment on any differences that would be
addressed under IFRS.
Problem 14.7
Purposeโto provide the student with an opportunity to become familiar with the
exchange of notes for cash or property, goods, or services. This problem
requires the preparation of the necessary journal entries concerning the
exchange of a nonโinterest-bearing long-term note for a machine, and the
necessary adjusting entries relative to amortization. The student should
construct the relevant schedule of note discount amortization to support the
respective entries. Finally, the effect of issuing debt on the debt to total assets
ratio is calculated.
Problem 14.8
Purposeโto provide the student with an understanding of the various accounts
that are generated in a non-market rate bond issue, the financing of the
purchase of machinery with an instalment loan, a government loan with a near
zero interest rate, and the treatment of the repurchase of bonds issued earlier in
the year. Justification must be provided for the treatment accorded to accounts
in relation to the specifics of this case.
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TIME AND PURPOSE OF PROBLEMS (CONTINUED)
Problem 14.9
Purposeโto provide the student with an understanding of the relevant journal
entries that are necessitated when there is a bond issuance and bond
retirement. This problem also provides an opportunity for the student to learn the
income statement treatment of the loss from retirement and the footnote
disclosure required.
Problem 14.10
Purposeโto provide the student with an understanding of a number of areas
related to bonds. Specifically, the classification of bonds, determination of cash
received with bond issue costs and accrued interest, and disclosure
requirements.
Problem 14.11
Purposeโto provide the student with a series of transactions from bond
issuance, payment of bond interest, accrual of bond interest, amortization of
bond discount, and bond retirement. Journal entries are required for each of
these transactions.
Problem 14.12
Purposeโto provide the student the same opportunity as those given in
Problem 14.11 except that the effective interest method will be used. The
student will be required to calculate the effective interest rate on the bond using
either a financial calculator or Excel function. The preparation of a partial
effective interest table is also required.
Problem 14.13
Purposeโto provide the student with an understanding of the relevant journal
entries that are necessitated for a bond issuance. This problem involves two
independent bond issuances with the assumption that one is sold at a discount
and the other at a premium, both utilizing the effective interest method. This
comprehensive problem requires preparing journal entries for the issuance of
bonds, related interest payments and amortization (with the construction of
amortization tables where applicable), and the retirement of part of the bonds.
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TIME AND PURPOSE OF PROBLEMS (CONTINUED)
Problem 14.14
Purposeโto provide the student with a loan impairment situation that requires
entries by both the debtor and the creditor and an analysis of the loss on
impairment.
Problem 14.15
Purposeโto provide the student with a troubled debt situation that requires
calculation of the creditorโs loss on restructure, entries to recognize the loss, and
discussion of GAAP relating to this situation.
Problem 14.16
Purposeโto provide the student with four independent and different
restructured debt situations where losses or gains must be computed and
journal entries recorded on the books of the creditor and the debtor.
Problem 14.17
Purposeโto provide the student with a restructuring of a troubled debt situation
requiring computation of the creditorโs loss and entries by both the debtor and
creditor before and after restructuring along with an amortization schedule.
Problem 14.18
Purposeโto provide the student with a situation where troubled debt is sold to
another creditor. The student must prepare entries on the books of both
creditors and debtors after computing any gains or losses.
Problem 14.19
Purposeโto provide the student with a complex troubled debt situation that
requires two amortization schedules, computation of loss on restructure, and
entries at different times on both the creditorโs and debtorโs books.
Problem 14.20
Purposeโto provide the student with an opportunity to advise management on
the legal, accounting, and reporting issues concerning derecognition of debt on
the SFP. Legal defeasance and in-substance defeasance are contrasted in this
case.
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SOLUTIONS TO PROBLEMS
PROBLEM 14.1
a.
1. Using tables:
PV of $200,000 annuity @ 9%
for 5 years ($200,000 X 3.88965)
Down payment
Capitalized value of metals
$ 777,930
500,000
$1,277,930
2.Using a financial calculator:
PV
I
N
PMT
FV
Type
$ ? Yields $777,930
9%
5
$ (200,000)
$0
0
3. Using Excel: =PV(rate,nper,pmt,fv,type)
Result $777,930.2527 rounded to $777,930
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PROBLEM 14.1 (CONTINUED)
b.
Instalment Note Repayment Schedule
Date
Dec. 31
Dec. 31
Dec. 31
Dec. 31
Dec. 31
Dec. 31
2020
2021
2022
2023
2024
2025
Cash
Paid
Interest
Expense
Principal
Paid
$200,000
200,000
200,000
200,000
200,000
$70,014
58,315
45,563
31,664
16,514
$222,070
$129,986
141,685
154,437
168,336
183,486
$777,930
Note
Carrying
Amount
$777,930
647,944
506,259
351,822
183,486
0
c.
12/31/20 Equipment ……………………………………………………………….
1,277,930
Cash ……………………………………………………………………….
500,000
Notes Payable ………………………………………………………….
777,930
12/31/21 Notes Payable………………………………………………………….
129,986
Interest Expense ………………………………………………………
70,014
Cash …………………………………………………………………
200,000
12/31/22 Notes Payable………………………………………………………….
141,685
Interest Expense ………………………………………………………
58,315
Cash ………………………………………………………………
200,000
12/31/23 Notes Payable………………………………………………………….
154,437
Interest Expense ………………………………………………………
45,563
Cash ………………………………………………………………
200,000
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PROBLEM 14.1 (CONTINUED)
c. (continued)
12/31/24 Notes Payable………………………………………………………….
168,336
Interest Expense ………………………………………………………
31,664
Cash ………………………………………………………………
200,000
12/31/25 Notes Payable………………………………………………………….
183,486
Interest Expense ………………………………………………………
16,514
Cash ………………………………………………………………
200,000
d.
From the perspective of the lender, an instalment note
provides for a reduced risk of collection when compared to an
interest-bearing note. In the case of the interest-bearing note,
the principal amount is due at the maturity of the note. Further,
the instalment note provides a regular reduction of the principal
balance in every payment received annually and therefore
reduces the lenderโs investment in the receivable, freeing up
the cash for other purposes. This is demonstrated in the
instalment note repayment schedule provided above.
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PROBLEM 14.2
a.
The value of the land should be recorded at the present value
of the future cash flows of the note given in exchange for the
land. The asking price for the land is higher than the real
purchase price. There is some flexibility to negotiate a
reduction in the asking price for the land for sale by Silverman
Corporation. The relevant interest rate to impute on the note is
the interest rate to MacDougall who is the borrower in this
case. The relevant interest rate is therefore 10%. The interest
rate called for in the note of 4% is very low in relation to a fair
market rate of interest.
b.
A mortgage note involves the registering of a charge against
the property, in this case land, whereas a promissory note
alone offers no reduction of risk to Silverman Corporation.
Should MacDougall fail to pay the note within the terms,
Silverman Corporation can obtain recourse through the court
and obtain the asset, or the proceeds from the resale of the
asset, as satisfaction for the outstanding principal and interest
owing on the mortgage note. A promissory note alone does not
offer this potential relief to the creditor and is therefore a higher
credit risk to Silverman Corporation.
c.
The land is capitalized at the present value of a single payment
at the end of five years of $300,000 plus the annuity interest
payments of $12,000 per year for 5 years, imputed at 10%
interest.
1.Using tables:
$300,000 X .62092 =
$12,000 X 3.79079 =
Present value
*rounded up
$186,276
45,490*
$231,766
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PROBLEM 14.2 (CONTINUED)
c. (continued)
2.Using a financial calculator:
PV
I
N
PMT
FV
Type
$ ? Yields $231,766
10%
5
$ (12,000)
$ (300,000)
0
3. Using Excel: =PV(rate,nper,pmt,fv,type)
Result: $231,765.8382 rounded to $231,766
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PROBLEM 14.2 (CONTINUED)
c. (continued)
Mortgage Note Payable โ interest paid at 4%
Date
June 1 2020
June 1 2021
June 1 2022
June 1 2023
June 1 2024
June 1 2025
1
4%
Cash
Paid
10%
Interest
Expense
$12,000
12,000
12,000
12,000
12,000
$23,177
24,294
25,524
26,876
28,3631
$128,234
Discount
Amortized
$11,177
12,294
13,524
14,876
16,363
$68,234
Note
Carrying
Amount
$231,766
242,943
255,237
268,761
283,637
300,000
$1 rounding
d.
June 1, 2020
Land……………………………………………………………………….
231,766
Notes Payable …………………………………………………
231,766
e.
December 31, 2020
Interest Expense ……………………………………………..
13,520
3
Notes Payable ……………………………………….
Interest Payable ………………………………………
2
($23,177 X 7/12 = $13,520)
3
($11,177 X 7/12 =$6,520)
2
June 1, 2021
Interest Expense ……………………………………………..
9,657
Interest Payable ……………………………………………….
7,000
5
Notes Payable ……………………………………….
Cash ……………………………………………………..
4
($23,177 X 5/12 = $9,657)
5
($11,177 X 5/12 =$4,657)
6,520
7,000
4
4,657
12,000
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PROBLEM 14.2 (CONTINUED)
f. 1. Using the alternative of the instalment note, the land is
capitalized at the present value of the annuity payment at the
end of each of the next five years that will correspond to the
same value as that arrived at for the mortgage note, imputed at
10% interest. The present value is $231,766.
1.Using tables:
$231,766 ๏ธ 3.79079 (PVOA5, 10%) = $61,139.23
2.Using a financial calculator:
PV
I
N
PMT
FV
Type
$ 231,766
10%
5
$ ?
$0
0
Yields $(61,139)
3.Using Excel: =PMT(rate,nper,pv,fv,type)
Result: $61,139.28693 rounded to $61,139
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PROBLEM 14.2 (CONTINUED)
f. (continued)
2.
Date
June 1
June 1
June 1
June 1
June 1
June 1
2
Instalment Note Payable
10%
Cash
Interest
Discount
Paid
Expense
Amortized
2020
2021
2022
2023
2024
2025
$61,139
61,139
61,139
61,139
61,139
$23,177
19,380
15,205
10,611
5,5562
$73,929
$37,962
41,759
45,934
50,528
55,583
$231,766
Note
Carrying
Amount
$231,766
193,804
152,045
106,111
55,583
0.00
$2 Rounding
3.
June 1, 2020
Land……………………………………………………………………….
231,766
Notes Payable …………………………………………………
231,766
4.
December 31, 2020
Interest Expense ……………………………………………..
13,520
Interest Payable ………………………………………
3
($23,177X 7/12 = $13,520)
3
June 1, 2021
Interest Expense ………………………………………………
9,657
Interest Payable ……………………………………………….
13,520
Notes Payable ………………………………………………….
37,962
Cash ……………………………………………………..
13,520
61,139
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PROBLEM 14.2 (CONTINUED)
f. (continued)
5.
The classification of the Mortgage Note on the December 31,
2020 statement of financial position is:
Currentliabilities:
Interest payable
$7,000
Non-currentliabilities:
Mortgage note payable, due June 1, 2025
($231,766 + $6,520)
238,286
The classification of the Instalment Note on the December 31,
2020 statement of financial position is:
6.
Currentliabilities:
Interest payable
Instalment note payable, current portion
$13,520
37,962
Non-current liabilities:
Instalment note payable, (due in annual
payments of $61,139 ending June 1, 2025)
($231,766 โ $37,962)
193,804
Silverman Corporation would insist on the instalment note in
order to secure larger cash inflows during the term of the
note and to reduce the risk of having to collect the note
principal in the case of a default by MacDougall.
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PROBLEM 14.3
a.
The bonds were sold at a discount of $5,651. Evidence of the
discount is the January 1, 2020carrying amount of $94,349,
which is less than the maturity value of $100,000 in 2029.
b.
The interest allocation and bond discount amortization are
based upon the effective interest method; this is evident from
the increasing interest charge. Under the straight-line method
the amount of interest would have been $11,565.10 [$11,000 +
($5,651 ๏ ๏ธ 10)] for each year of the term of the bonds.
Although the effective interest method is required under IFRS
per IFRS 9.5.4.1, accounting standards for private enterprises
do not specify that this method must be used and therefore the
straight-line method is also an option. The straight-line method
is valued for its simplicity and might be used by companies
whose financial statements are not constrained by this specific
element of GAAP.
c.
The stated rate is 11% ($11,000 ๏ธ $100,000). The effective
rate is 12% ($11,322 ๏ธ $94,349).
d.
January 1, 2020
Cash ……………………………………………………………………..
94,349
Bonds Payable…………………………………………………94,349
e.
December 31, 2020
Interest Expense ………………………………………………………
11,322
Bonds Payable………………………………………………… 322
Interest Payable ……………………………………………….11,000
f.
January 1, 2028 (Interest Payment)
Interest Payable ……………………………………………………….
11,000
Cash ………………………………………………………………11,000
December 31, 2028
Interest Expense ………………………………………………………
11,797
Bonds Payable………………………………………………… 797
Interest Payable ……………………………………………….11,000
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PROBLEM 14.4
a.
The present value of the future cash flows totals $2,061,440.
1.Using tables:
Present value of the principal
$2,000,000 X .38554 (PV10, 10%)
$771,080
Present value of the interest payments
$210,000* X 6.14457 (PVOA10, 10%)
1,290,360
Present value (selling price of the bonds)
$2,061,440
*$2,000,000 X 10.5% = $210,000
2. Using a financial calculator:
PV
I
N
PMT
FV
Type
$ ?
10%
10
$ (210,000)
$ (2,000,000)
0
Yields $2,061,446
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PROBLEM 14.4 (CONTINUED)
a. (continued)
3. Using Excel: =PV(rate,nper,pmt,fv,type)
Result: $2,061,445.671 rounded to $2,061,446
=PV(.10,10,-210,000,-2,000,000,0) where .10 designates the
interest rate (Rate), the 10 is for the term (Nper), the outflow of
$210,000 is the annuity payment (Pmt) based on the 10.5%
interest rate, the outflow of $2,000,000 is future value (Fv), and
the zero designates that the annuity is a regular annuity
(Type).
Cash 1 …………………………………………………………………….
2,011,440
Bonds Payable ………………………………………………… 2,011,440
1
($2,000,000 + $61,440 โ $50,000)
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PROBLEM 14.4 (CONTINUED)
b.
Date
1/1/20
1/1/21
1/1/22
1/1/23
1/1/24
1/1/25
c.
Cash
Payment
10.5%
Interest
Expense
10.4053%
Discount
Amortization
$210,000
210,000
210,000
210,000
210,000
$209,296
209,223
209,142
209,053
208,954
$704
777
858
947
1,046
Carrying
Amount of
Bonds
$2,011,440
2,010,736
2,009,959
2,009,101
2,008,154
2,007,108
Carrying amount as of 1/1/23
Less: Amortization of bond premium
($947๏ธ 2)
Carrying amount as of 7/1/23
$2,009,101
Reacquisition price
Carrying amount as of 7/1/23of bond
($2,008,627๏ธ 2)
Loss on Redemption
$1,065,000
474
$2,008,627
(1,004,314)
$ 60,686
Interest Expense ……………………………………………………..
52,263
Bonds Payable($947 X 1/2 X 1/2) ……………………………….
237
Cash ($210,000 X 1/2 X 1/2) ………………………………
To record the payment of interest
52,500
Bonds Payable …………………………………………………………
1,000,000
Loss on Redemption of Bonds ……………………………………
60,686
2
Bonds Payable ………………………………………………………..
4,314
Cash …………………………………………………………….. 1,065,000
To record retirement of the bonds
2
Premium as of 7/1/23to be written off
($2,008,627 โ $2,000,000) X 1/2 = $4,314
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PROBLEM 14.4 (CONTINUED)
d.
By choosing to carry the bonds at fair value and expensingthe
costs of issuing the bond in the amount of $50,000, the
premium on bonds payable would increase at the date of
issuance by the $50,000 expensed at issue. Correspondingly,
the interest expense recorded each year would be lower by the
amount charged to expense using the effective interest method
for the amortization of the additional $50,000 (the effective
interest rate would be 10% instead of the 10.4053% required
due to the capitalization of the bond issue costs). In total, the
periodic expense would be lower over the 10-year term of the
bond by $50,000, equal to the expense recognized at
issuance. The total costs would be ultimately charged to
income. The only difference would be that the charge would be
completely expensed in the year the bond was issued as
opposed to spread over the ten-year term of the bond.
Note: When a note or bond is issued, it should be recognized
at the fair value adjusted by any directly attributable issue
costs. However, note that where the liabilities will subsequently
be measured at fair value (e.g., under the fair value option or
because they are derivatives), the transaction costs should not
be included in the initial measurement (i.e., the costs should be
expensed) [CPA Canada Handbook, Part II, Section 3856.07
and IFRS 9.5.1.1].
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PROBLEM 14.5
1. Armstrong Inc.
3/1/20
Cash ………………………………………………………………………
1,888,352
Bonds Payable …………………………………………………
1,888,352
Maturity value of bonds payable
$2,000,000
1. Using tables:
Present value of $2,000,000 due in 7
periods at 6% ($2,000,000 X .66506)
Present value of interest payable
semi-annually at 6% ($100,000 X 5.58238)
Proceeds from sale of bonds
Discount on bonds payable
$1,330,120
558,238
(1,888,358)
$111,642
2.Using a financial calculator:
PV
I
N
PMT
FV
Type
$
?
6%
7
$ (100,000)
$ (2,000,000)
0
Yields $1,888,352
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PROBLEM 14.5 (CONTINUED)
3. Using Excel: = PV(rate,nper,pmt,fv,type)
Result: $1,888,352.371 rounded to $1,888,352
A more accurate result is obtained using Excel and a financial
calculator compared to using factors from tables as there are a
limited number of decimal places in the tables.
9/1/20
1. Armstrong Inc.
Interest Expense ………………………………………………………
113,301
Bonds Payable…………………………………………………….
13,301
Cash ………………………………………………………………….
100,000
12/31/20 Interest Expense ……………………………………………………….
76,066
Bonds Payable($14,099 X 4/6) ……………………………….
9,399
Interest Payable ($100,000 X 4/6) …………………………..
66,667
3/1/21
Interest Expense ……………………………………………………….
38,033
Interest Payable ………………………………………………………..
66,667
Bonds Payable($14,099 X 2/6) ……………………………
4,700
Cash ……………………………………………………………….
100,000
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PROBLEM 14.5 (CONTINUED)
1. Armstrong Inc. (continued)
9/1/21
Interest Expense ……………………………………………………….
114,945
Bonds Payable …………………………………………………
14,495
Cash ……………………………………………………………….
100,000
12/31/21
Interest Expense ……………………………………………………….
77,228
Bonds Payable($15,842 X 4/6) ……………………………
10,561
Interest Payable………………………………………………..
66,667
Schedule of Bond Discount Amortization
Effective Interest Method
10% Bonds Sold to Yield 12%
Date
3/1/20
9/1/20
3/1/21
9/1/21
3/1/22
9/1/22
3/1/23
9/1/23
Cash
Paid
Interest
Expense
Discount
Amortized
$100,000
100,000
100,000
100,000
100,000
100,000
100,000
$113,301
114,099
114,945
115,842
116,792
117,800
118,869
$13,301
14,099
14,945
15,842
16,792
17,800
18,869
Carrying
Amount of
Bonds
$1,888,352
1,901,653
1,915,752
1,930,697
1,946,539
1,963,331
1,981,131
2,000,000
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PROBLEM 14.5 (CONTINUED)
2. OueletteLtd.
6/1/20
Cash ………………………………………………………………………
6,193,896
Bonds Payable ……………………………………………………
6,193,896
1.Using tables:
Maturity value of bonds payable
Present value of $6,000,000 due in 8
periods at 5% ($6,000,000 X .67684)
Present value of interest payable
semi-annually ($330,000 X 6.46321)
Proceeds from sale of bonds
Premium on bonds payable
$6,000,000
$4,061,040
2,132,859
6,193,899
$193,899
2.Using a financial calculator:
PV
I
N
PMT
FV
Type
$
?
5%
8
$ (330,000)
$ (6,000,000)
0
Yields $6,193,896
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PROBLEM 14.5 (CONTINUED)
3. Using Excel: =PV (rate, nper, pmt, fv, type)
Result: $6,193,896.383 rounded to $6,193,896
=PV(.05,8,-330,000,-6,000,000,0) where .05 designates the interest
rate (Rate), the 8 is for the term (Nper), the outflow of $330,000 is
the annuity payment (Pmt), the outflow of $6,000,000 is future value
(Fv), and the zero designates that the annuity is a regular annuity
(Type).
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PROBLEM 14.5 (CONTINUED)
2. Ouelette Ltd. (continued)
12/1/20
Interest Expense ………………………………………………………
309,695
Bonds Payable …………………………………………………………
20,305
Cash ($6,000,000 X .11 X 6/12)……………………………… 330,000
12/31/20 Interest Expense ($308,680 X 1/6) ………………………………
51,447
Bond Payable($21,320 X 1/6) …………………………………….
3,553
Interest Payable ($330,000 X 1/6) ………………………………. 55,000
6/1/21
Interest Expense ($308,680 X 5/6) ………………………………
257,233
Interest Payable ……………………………………………………….
55,000
Bonds Payable($21,320 X 5/6)……………………………………
17,767
Cash ………………………………………………………………… 330,000
10/1/21
Interest Expense1 ……………………………………………………..
41,015
Bonds Payable($22,386 X .2 X 4/6) …………………………….
2,985
Cash($330,000 X .2* X 4/6) ………………………………….. 44,000
1
($307,614 X .22 X 4/6)
2
$1,200,000 ๏ธ $6,000,000 = .2
To record payment of interest
10/1/21
Bonds Payable …………………………………………………………
1,200,000
Bonds Payable …………………………………………………………
27,469
Loss on Redemption of Bonds ……………………………………
128,531
Cash ………………………………………………………………….
1,356,000
To record reacquisition of bonds
Reacquisition price
($1,400,000 โ $44,000)
Net carrying amount of bonds redeemed:
Par value
Unamortized premium
[.2 X ($193,896โ$20,305โ$21,320)] โ $2,985
Loss on redemption
$1,356,000
$1,200,000
27,469
(1,227,469)
$ 128,531
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PROBLEM 14.5 (CONTINUED)
2. Ouelette Ltd. (continued)
12/1/21
Interest Expense ($307,614 X .83) ………………………………
246,091
Bonds Payable ($22,386 X .8) ……………………………………
17,909
Cash ($330,000 X .8) ………………………………………..
264,000
3
($6,000,000 โ $1,200,000) ๏ธ $6,000,000 = .8
12/31/21 Interest Expense4 ……………………………………………………..
40,866
Bonds Payable($23,506 X .8 X 1/6) …………………………….
3,134
5
Interest Payable ………………………………………………
44,000
4
($306,494 X .8 X 1/6)
5
($330,000 X .8 X 1/6)
6/1/22
Interest Expense ($306,494 X .8 X 5/6) ……………………….
204,329
Interest Payable ……………………………………………………….
44,000
Bonds Payable($23,506 X .8 X 5/6) …………………………….
15,671
Cash ($330,000 X .8) ………………………………………..
264,000
12/1/22
Interest Expense ($305,319 X .8)………………………………..
244,255
Bonds Payable ($24,681 X .8) ……………………………………
19,745
Cash ($330,000 X .8) ………………………………………..
264,000
Date
6/1/20
12/1/20
6/1/21
12/1/21
6/1/22
12/1/22
6/1/23
12/1/23
6/1/24
Cash
Paid
Interest
Expense
Premium
Amortized
$330,000
330,000
330,000
330,000
330,000
330,000
330,000
330,000
$309,695
308,680
307,614
306,494
305,319
304,085
302,789
301,428
$20,305
21,320
22,386
23,506
24,681
25,915
27,211
28,572
Carrying
Amount of
Bonds
$6,193,896
6,173,591
6,152,271
6,129,885
6,106,379
6,081,698
6,055,783
6,028,572
6,000,000
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PROBLEM 14.6
a.
May 1, 2020
Cash ………………………………………………………………………
763,000
($700,000 X 105%) + ($700,000 X 12% X 4/12)
Bonds Payable ($700,000 X 105%) ……………………..
Interest Expense ($700,000 X 12% X 4/12) …………..
December 31, 2020
Interest Expense ($700,000 X 12%)…………………………….
84,000
Interest Payable ……………………………………………….
To accrue interest expense
Bonds Payable …………………………………………………………
2,414
1
Interest Expense ……………………………………………..
1
($35,000 X 8/1162 = $2,414)
2
(12 X 10) โ 4 = 116
To amortize bond premium
January 1, 2021
Interest Payable ……………………………………………………….
84,000
Cash ………………………………………………………………
April 1, 2021
Bonds Payable …………………………………………………………
543
3
Interest Expense ……………………………………………..
3
($35,000 X 3/116 X .604)
4
$420,000 / $700,000 = .60
To amortize bond premium
Bonds Payable5………………………………………………………..
439,009
Interest Expense ($420,000 X .12 X 3/12)…………………….
12,600
Cash ($432,600 + $12,600) ……………………………….
Gain on Redemption of Bonds 6 ………………………….
To record bond redemption
5
below
6
[($420,000 + $19,009) โ $420,000 X 103%)] โ below
735,000
28,000
84,000
2,414
84,000
543
445,200
6,409
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PROBLEM 14.6 (CONTINUED)
a. (continued)
Reacquisition price (including accrued interest)
($420,000 X 103%) + ($420,000 X 12% X 3/12) ………… $445,200
Net carrying amount of bonds redeemed:
Par value ………………………………………………………………… 420,000
Unamortized premium
[$35,000 X ($420,000 ๏ธ $700,000) X 105/116] …………… 19,009
Net carrying amount of bonds redeemed5 ……………………. 439,009
Accrued interest ($420,000 X 12% X 3/12) ………………….. 12,600
451,609
Gain on redemption………………………………………………….. $6,409
December 31, 2021
Interest Expense ($280,000 X .12) ………………………………
33,600
Interest Payable ……………………………………………….
To accrue interest expense
33,600
Bonds Payable …………………………………………………………
1,448
7
Interest Expense ……………………………………………..
To amortize bond premium
1,448
Amortization per year on $280,000
7
($35,000 X 12/116 X .408)
8
($700,000 โ $420,000) ๏ธ $700,000 = .40
$1,448
b.
If Pfaff were to follow IFRS, then the effective interest method
must be used to amortize any discounts or premiums. Although
the effective interest method is required under IFRS per IFRS
9.5.4.1, accounting standards for private enterprises do not
specify that this method must be used and therefore, the
straight-line method is also an option. The straight-line method
is valued for its simplicity and might be used by companies
whose financial statements are not constrained by this specific
element of GAAP.
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PROBLEM 14.7
December 31, 2020
a.
Machinery ………………………………………………………………..
409,806
Notes Payable ………………………………………………….
409,806
Machine capitalized at the present
value of the note
1. Using tables:$600,000 X .68301
2. Using a financial calculator:
PV
I
N
PMT
FV
Type
$ ?
10%
4
$ 0
$ (600,000)
0
Yields $409,808
3. Using Excel: =PV(rate,nper,pmt,fv,type)
Result: $409,808.0732 rounded to $409,808
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PROBLEM 14.7 (CONTINUED)
b.
December 31, 2021
Depreciation Expense1………………………………………………
67,961
Accumulated Depreciationโ
Machinery ……………………………………………………….67,961
1
[($409,806 โ $70,000) ๏ธ 5]
To record depreciation expense
Interest Expense ………………………………………………………
40,981
Notes Payable …………………………………………………40,981
To record interest expense
Date
12/31/20
12/31/21
12/31/22
12/31/23
12/31/24
2
Schedule of Note Discount Amortization
Debit Interest Expense
Carrying Amount
Credit Notes Payable
of Note
$409,806.00
$40,980.60
450,786.60
45,078.66
495,865.26
49,586.53
545,451.79
2
54,548.21
600,000.00
$3.03 adjustment due to rounding
c.
December 31, 2022
Depreciation Expense ……………………………………………….
67,961
Accumulated Depreciationโ
Machinery ……………………………………………………….67,961
To record depreciation expense
Interest Expense ………………………………………………………
45,079
Notes Payable …………………………………………………45,079
To record interest expense
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PROBLEM 14.7 (CONTINUED)
d.
Debt to total assets is a measure of debt-paying ability and
long-run solvency. Prior to purchasing the machine, the
companyโs debt to total assets ratio was 48.2% ($432,000 รท
$896,000). As a result of the purchase, the debt to total assets
ratio increased to 64.5% [($432,000 + $409,806) รท ($896,000 +
$409,806)]. The percentage of total assets provided by
creditors increased, which a creditor would view as
unfavourable. The creditor may also consider that while the
nonโinterest-bearing note payable is included in debt in the
debt to total assets ratio, it will not result in cash outflow until it
is due in four years.
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PROBLEM 14.8
a.
The machine is purchased as an instalment sale. In this case,
this is a debt instrument exchanged for the machine. The fair
value of the debt must be determined discounting the cash
flows required on the debt at the appropriate rate to reflect the
credit risk of Thompson. Because this is a private company,
with no credit rating, we would not be able to observe market
risk assessment rates for this company. We have used
unobservable data that is particular to this company only,
which would be level 3 in the fair value hierarchy. We are told
that the company could have borrowed funds at 7% from the
bank for this same purchase. If we use 7% rate to discount the
cash flows on the debt, the present value can be determined
as follows:
Payment Jan. 1, 2020
$ 240,000
Present value of 4 annual payments of $240,000
at 7% $240,000 X 3.3872
812,928
Total
$1,052,928
1.Using tables:
Present value of 4 annual payments of $240,000at 7%
$240,000 X 3.3872 = 812,928
2.Using a financial calculator:
PV
I
N
PMT
FV
Type
$ ?
7%
4
($ 240,000)
$ 0
0
Yields $812,931
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PROBLEM 14.8 (CONTINUED)
a. (continued)
3.Using Excel: =PV(rate,nper,pmt,fv,type)
Result: $812,930.7016 rounded to $812,931
This fair value determination would be a โsoftโ value since the
7% interest rate is a proposed (versus actual) lending rate.
However, we are also told that the fair value of the machine is
$1,050,000. This is an observable market value for similar
assets. As such, this input is a level 2 fair value hierarchy.
And again, this fair value would be considered a โsoftโ value.
The question becomes, what fair value should be used โ the
fair value of what is given up (the debt) or the fair value of what
has been received (the machine). ASPE and IFRS recommend
that the fair value of the consideration given up should be used
to determine the value of the transaction unless the fair value
of the item received is more reliable and more clearly evident.
In this case, both of the fair values are estimates, and one is
not more reliable than the other.
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PROBLEM 14.8 (CONTINUED)
a. (continued)
As such, the value of the debt that has been given up is
determined to be reliably determinable and is used to value the
transaction. The treatment under ASPE and IFRS would be
the same.
January 1, 2020 – Record purchase of the machine as follows:
Machinery …………………………………………… 1,052,928
Cash ……………………………………………
240,000
Notes Payable ……………………………….
812,928
Government loan โ The government loan has been given at an
interest rate substantially below market. The company would
normally have had to pay 6% given its credit risk, but the
government is charging 1%. To record the loan, we must
determine the loan discounted at 6% and compare to the loan
discounted at 1%.
PV of 500,000 in 5 years
PV of 5,000 annual
payments for 5 years
1%
$475,733
6%
$373,629
24,267
$500,000
21,062
$394,691
Difference
$105,309
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PROBLEM 14.8 (CONTINUED)
a. (continued)
Journal entry to record the government funding December 31, 2020
Cash …………………………………………………..
Notes Payable ……………………………….
Equipment …………………………………….
500,000
394,691
105,309
The grant of $105,309 will be amortized to net income on the
same basis as the plant technology in order to offset the
depreciation. Or alternatively, the grant can be directly netted
against the plant technology equipment purchased and a
smaller amount of depreciation will be recorded each year.
The note payable to the government will be amortized to
interest expense over the five years, so that at the end of 5
years, the balance will be $500,000. Under IFRS, the effective
interest rate of 6% will be used. Again, this rate is likely not
observable in the market place since the company has no
credit rating for comparison purposes. Consequently, this
value is a level 3 in the fair value hierarchy.
b. 1. Use of the asset requires a depreciation charge in each year of
use. This in turn requires carrying the equipment as an asset
as the risk and rewards of ownership have passed, although
the company does not have legal title to the asset. The
company has contracted to purchase the machine and, thus,
has a real liability that affects its financial condition and must
be shown on the statement. As such, the fair value of the
liability that the company owes must be recorded along with
the fair value of the asset that has been received in return for
the liability.
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PROBLEM 14.8 (CONTINUED)
b. (continued)
There is an imputed interest rate built into the payments over
the 5 years that must be recorded. Since the fair value of the
machine is only $1,050,000, then we cannot show a higher
than fair value amount (although in this case the entry was
made for $1,052,928). Effectively, the difference between the
total payments being made and the fair value of the machine is
the interest to be paid over the 5-year period, in the amount of
$147,072[($240,000 x 4) – $812,928].
2. The obligation of a company is to its bondholders, not to the
trustee. Until the bondholders have received payment, the
company still has a liability.
Note to instructor: The student may have difficulty with this
statement because this type of situation was not discussed in the
chapter. It therefore provides an opportunity to emphasize that
payment to an agent or trustee does not constitute payment of the
liability for bond interest. When the trustee dispenses the funds to
bondholders, the liability should be reduced. A separate Bond
Interest Fund account, similar to a โSinkingโ fund is established at
the time payment is made to the trustee. This fund is shown as a
long-term investment in the asset section of the SFP.
3. Repurchased bonds are not an asset. A company cannot
owe or own itself. Thus, these bonds are different from
investments in bonds of other companies. Repurchased
bonds should be reported as a deduction from bonds
payable.
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PROBLEM 14.8 (CONTINUED)
b. (continued)
4. There are two points here. First of all, we obtained very
favourable financing from the government, since we only
must pay 1% on the loan and not 6% that we would have
paid on borrowed funds. Consequently, this concession must
be given separate treatment in our books. It is as though the
government is forgiving 5% interest each year. The loan is
recorded as though it was charging 6%, and therefore the
payments we will make of $5,000 each year for the next 5
years and then the $500,000 repayment are part principal
and part interest payments. An amount of $105,309 will be
charged as interest over the 5-year period.
The second point is what to do about this concession. The
benefit of this will be treated as a government grant (i.e.,
forgiven amount of interest). As a grant, the amount is
recorded either in a separate account or as a reduction
against the technology purchased. In either case, the โgrantโ
is amortized into income over the life of the asset.
Consequently, we will also have a lower depreciation charged
to net income as a result. Over the five years, this reduction in
the depreciation will be offset by the additional interest
expense charged on the loan.
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PROBLEM 14.9
a.
To record the issuance of the 8% mortgage on January 1, 2020:
Cash 1 …………………………………………………………………….
3,030,000
Mortgage Payable …………………………………………….
3,030,000
1
($3 million x 101 = $3,030,000)
To record retirement of the 7% debenture bonds on Jan.1, 2020:
Bonds Payable …………………………………………………………
1,910,000
Loss on Redemption of Bonds ……………………………………
190,000
Cash ($2,000,000 x 105%)…………………………………
2,100,000
At January 1, 2020 the carrying amount of the retired bonds is:
b.
Bonds payable
Less unamortized discount ($300,000 X 3/10)
Bond carrying amount
$2,000,000
90,000
$1,910,000
Income from operations
Loss on redemption of bonds(Note 1)
Income before taxes
Income taxexpense
Net income
$1,700,000
190,000
1,510,000
286,900
$1,223,100
Earnings per share:
Net income
$1.02
Note 1. Debenture Bonds Redemption:
A loss of $190,000 occurred from the redemption and
retirement of $2,000,000 of the corporationโs outstanding
debenturebonds issue due in 2023. The debentures were
redeemed at 105% as provided for in the indenture. The funds
used to repurchase the debentures represent a portion of the
proceeds from the sale of $3,000,000 of 8% mortgage issued
January 1, 2020 and due in 2045.
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PROBLEM 14.10
a.
Wilkie Inc.
Selling price of the bonds ($4,000,000 X 103%)
Accrued interest from January 1 to February
29, 2020 ($4,000,000 X 9% X 2/12)
Total cash received from issuance of the bonds
Less: Bond issuance costs1
Net amount of cash received
$4,120,000
60,000
4,180,000
27,000
$4,153,000
1
When a note or bond is issued, it should be recognized at the
fair value adjusted by any directly attributable issue costs.
However, note that where the liabilities will subsequently be
measured at fair value (e.g., under the fair value option or
because they are derivatives), the transaction costs should not
be included in the initial measurement (i.e., the costs should be
expensed at the time of issuance) [CPA CanadaHandbook,
Part II, Section 3856.07 and IFRS 9.5.1.1].
b.
Langley Ltd.
Carrying amount of the bonds on 1/1/20
Effective interest rate (10%)
Interest expense to be reported for 2020
$469,280
X 0.10
$ 46,928
Although the effective interest method is required under IFRS
per IFRS 9.5.4.1, accounting standards for private enterprises
do not specify that this method must be used and therefore the
straight-line method is also an option. The straight-line method
is valued for its simplicity and might be used by companies
whose financial statements are not constrained by this specific
element of GAAP.
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PROBLEM 14.10 (CONTINUED)
c.
Chico Building Inc.
Maturities and sinking fund requirements on long-term
debt are as follows:
2021
2022
2023
d.
$400,000
350,000
200,000
2024
2025
Thereafter
$200,000
350,000
300,000
Czeslaw Inc.
Since three bonds reported by Czeslaw Inc. are secured
byeither real estate, securities of other corporations, or
plantequipment, there are no debenture bonds outstanding
forthe company.
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PROBLEM 14.11
a.
4/1/20
Cash (12,000 X $1,000 X 97%) …………………………………..
11,640,000
Bonds Payable…………………………………………………….
11,640,000
b.
10/1/20 Interest Expense ………………………………………………………
672,000
1
Cash …………………………………………………………………
660,000
2
Bonds Payable …………………………………………………..
12,000
1
$12,000,000 X .11 X 6/12 = $660,000
2
$360,000 ๏ธ 180 months X 6 months = $12,000
c.
12/31/20 Interest Expense ………………………………………………………
336,000
3
Interest Payable …………………………………………………
330,000
4
Bonds Payable …………………………………………………..
6,000
3
($660,000 X 3/6)
4
($2,000 X 3 months)
d.
3/1/21
Interest Payable ($330,000 X ยผ) …………………………………
82,500
Interest Expense ………………………………………………………
56,000
5
Cash …………………………………………………………………
137,500
6
Bonds Payable …………………………………………………..
1,000
5
$3,000,000X .11 X 5/12 = $137,500
6
$2,000/mo. X 2 months X
ยผ of the bonds = $1,000
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PROBLEM 14.11 (CONTINUED)
d. (continued)
At March 1, 2021the carrying amount of the retired bonds is:
Bonds payable
Less: unamortized discount7
Bond carrying amount
7
$3,000,000
84,500
$2,915,500
$2,000/mo. X 169 months X ยผ of the bonds = $84,500
The reacquisition price: 100,000 shares X $31 = $3,100,000.
The loss on extinguishment of the bonds is:
Reacquisition price
Less: carrying amount
Loss
$3,100,000
2,915,500
$ 184,500
The entry to record extinguishment of the bonds is:
Bonds Payable……………………………………………………….
2,915,500
Loss on Redemption of Bonds …………………………………
184,500
Common Shares …………………………………………….. 3,100,000
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PROBLEM 14.12
1. Using a financial calculator:
PV
I
N
PMT
FV
Type
$ 11,640,000
?%
30
$ (660,000)
$ (12,000,000)
0
Yields 5.7113 %
2. Using Excel: =RATE(nper,pmt,pv,fv,type)
Result: 0.05711256 rounded to four decimal places 5.7113%
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PROBLEM 14.12(CONTINUED)
Schedule of Bond Discount Amortization
Effective Interest Method
5.5% Semi-annual Bonds Sold to Yield 5.7113%
Date
April 1 โ20
Oct. 1 โ20
April 1 โ21
a.
4/1/20
5.5%
Cash
Paid
5.7113%
Interest
Expense
660,000.00
660,000.00
664,795.32
665,069.20
Discount
Amortized
Carrying
Amount
$11,640,000.00
4,795.32 11,644,795.32
5,069.20 11,649,864.52
Cash (12,000 X $1,000 X 97%) …………………………………..
11,640,000
Bonds Payable…………………………………………………….
11,640,000
b.
10/1/20 Interest Expense ………………………………………………………
664,795.32
Cash ………………………………………………………………….
660,000.00
Bonds Payable…………………………………………………….
4,795.32
c.
12/31/20 Interest Expense1 ……………………………………………………..
332,534.60
2
Interest Payable …………………………………………………
330,000.00
3
Bonds Payable …………………………………………………..
2,534.60
1
($665,069.20 X 3/6) = $332,534.60
2
($660,000 X 3/6)
3
($5,069.20 X 3/6 = $2,534.60)
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PROBLEM 14.12 (CONTINUED)
d.
3/1/21
Interest Payable ($330,000 X ยผ) …………………………………
82,500.00
4
Interest Expense ……………………………………………………..
55,422.43
5
Cash …………………………………………………………………
137,500.00
6
Bonds Payable …………………………………………………..
422.43
4
($665,069.20 X 2/6 X ยผ) = $55,422.43
5
$3,000,000X .11 X 5/12 = $137,500.00
6
($5,069.20 X 2/6 X ยผ) = $422.43
At March 1, 2021the carrying amount of the retired bonds is:
Bonds payable
Less: unamortized discount7
Bonds carrying amount
7
Balance of Discount
Balance at issuance
Amortization Oct. 1, 2020
Accrual December 31, 2020
Balance December 31, 2020
March 1, 2021for 25%
Balance March 1, 2021
$3,000,000.00
87,745.09
$2,912,254.91
100%
25%
$360,000.00
(4,795.32)
(2,534.60)
$352,670.08 X ยผ = $88,167.52
(422.43)
$87,745.09
The reacquisition price: 100,000 shares X $31 = $3,100,000.
The loss on extinguishment of the bonds is:
Reacquisition price
Less: carrying amount of bonds
Loss
$3,100,000.00
2,912,254.91
$ 187,745.09
The entry to record extinguishment of the bonds is:
Bonds Payable……………………………………………………….
2,912,254.91
Loss on Redemption of Bonds …………………………………
187,745.09
Common Shares ……………………………………………..
3,100,000.00
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PROBLEM 14.13
1. Sanford Co.
Calculate cash proceeds on issuance:
1.Using tables:
Present value of annuity: $25,000 x 5.58238 =
Present value of principal:$500,000 x 0.66506 =
Total
$139,560
332,530
$472,090
2.Using a financial calculator:
PV
I
N
PMT
FV
Type
$ ?
12%/2 = 6%
7
$(25,000)
$(500,000)
0
Yields $472,088
3.Using Excel: =PV(rate,nper,pmt,fv,type)
Result $472,088.0928 rounded to $472,088
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PROBLEM 14.13 (CONTINUED)
1. Sanford Co. (continued)
Schedule of Bond Discount Amortization
Effective-Interest Method
10% Bonds Sold to Yield 12%
Cash Paid
Date
3/1/20
9/1/20
3/1/21
9/1/21
3/1/22
9/1/22
3/1/23
9/1/23
Interest
Expense
$25,0001
$28,325
25,000
28,525
25,000
28,736
25,000
28,960
25,000
29,198
25,000
29,450
25,000
29,7182
1
($500,000 X 10% X 1/2)
2
Rounded $1
Discount
Amortized
$3,325
3,525
3,736
3,960
4,198
4,450
4,718
Carrying
Amount of
Bonds
$472,088
475,413
478,938
482,674
486,634
490,832
495,282
500,000
3/1/20
Cash ………………………………………………………………………
472,088
Bonds Payable …………………………………………………
472,088
9/1/20
Interest Expense ……………………………………………………….
28,325
Bonds Payable …………………………………………………
3,325
Cash ……………………………………………………………….
25,000
12/31/20
Interest Expense ……………………………………………………….
19,017
Bonds Payable
($3,525 X 4/6) ………………………………………………..
2,350
Interest Payable ($25,000 X 4/6) …………………………
16,667
3/1/21
Interest Expense ……………………………………………………….
9,508
Interest Payable ………………………………………………………..
16,667
Bonds Payable ($3,525 X 2/6) …………………………….
1,175
Cash ……………………………………………………………….
25,000
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PROBLEM 14.13 (CONTINUED)
1. Sandford Co. (continued)
9/1/21
Interest Expense ……………………………………………………….
28,736
Bonds Payable …………………………………………………
3,736
Cash ……………………………………………………………….
25,000
12/31/21
Interest Expense ……………………………………………………….
19,307
Bonds Payable $3,960 X 4/6)
2,640
Interest Payable………………………………………………..
16,667
2. Titania Co.
Calculate cash proceeds on issuance:
1.Using tables:
Present value of annuity: $24,000 x 6.46321=
$155,117
Present value of principal: $400,000 x 0.67684 = 270,736
Total
$425,853
2.Using a financial calculator:
PV
I
N
PMT
FV
Type
$ ?
10%/2 = 5%
8
$(24,000)
$(400,000)
0
Yields $425,853
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PROBLEM 14.13 (CONTINUED)
2. Titania Co. (continued)
3.Using Excel: =PV(rate,nper,pmt,fv,type)
Result: $425,852.851 rounded to $425,853
Schedule of Bond Premium Amortization
Effective-Interest Method
12% Bonds Sold to Yield 10%
Date
6/1/20
12/1/20
6/1/21
12/1/21
6/1/22
12/1/22
6/1/23
12/1/23
6/1/24
Cash
Paid
Interest
Expense
$24,0003
$21,293
24,000
21,157
24,000
21,015
24,000
20,866
24,000
20,709
24,000
20,545
24,000
20,372
24,000
20,190
3
($400,000 X 12% X 1/2)
Premium
Amortized
$2,707
2,843
2,985
3,134
3,291
3,455
3,628
3,810
Carrying
Amount of
Bonds
$425,853
423,146
420,303
417,318
414,184
410,893
407,438
403,810
400,000
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PROBLEM 14.13 (CONTINUED)
2. Titania Co. (continued)
6/1/20
Cash……………………………………………………………………..
425,853
Bonds Payable …………………………………………………
425,853
12/1/20
Interest Expense ……………………………………………………….
21,293
Bonds Payable………………………………………………………….
2,707
Cash ($400,000 X .12 X 6/12) …………………………….
24,000
12/31/20
Interest Expense ($21,157 X 1/6) ………………………………..
3,526
Bonds Payable ($2,843 X 1/6)
474
Interest Payable ($24,000 X 1/6)
4,000
6/1/21
Interest Expense ($21,157 X 5/6) ………………………………..
17,631
Interest Payable ……………………………………………………….
4,000
Bonds Payable ($2,843 X 5/6) …………………………………….
2,369
Cash……………………………………………………………….
24,000
10/1/21
Interest Expense($21,015 X .34 X 4/6) …………………………
4,203
Bonds Payable ($2,985 X .3 X 4/6)………………………………
597
Cash……………………………………………………………….4,800
4
$120,000 รท $400,000 = .3
To record payment of interest
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PROBLEM 14.13 (CONTINUED)
2. Titania Co. (continued)
10/1/21
6
Bonds Payable …………………………………………………………
125,494
5
Gain on Redemption of Bonds
4,294
6
Cash ……………………………………………………………..
121,200
To record redemption of bonds
$126,000 โ ($120,000 X 12% X 4/12)
Net carrying amount of bonds redeemed:
Carrying amount of all bonds June 1, 2021
x 30 % redeemed
Less amortization Oct. 1, 2021
5
Gain on redemption
$121,200
$420,303
126,091
597 (125,494)
$ (4,294)
12/1/21
Interest Expense ($21,015 X .77) …………………………………
14,711
Bonds Payable ($2,985 X .7) ………………………………………
2,089
Cash ($24,000 X .7)…………………………………………..
16,800
7
($400,000 โ $120,000) รท $400,000 = .7
12/31/21
Interest Expense ($20,866 X .7 X 1/6) ………………………….
2,434
Bonds Payable ($3,134 X .7 X 1/6) ………………………………
366
8
Interest Payable ………………………………………………….
2,800
8
($24,000 X .7 X 1/6)
6/1/22
Interest Expense ($20,866 X .7 X 5/6) ………………………….
12,172
Interest Payable ………………………………………………………..
2,800
Bonds Payable ($3,134 X .7 X 5/6) ………………………………
1,828
Cash ($24,000 X .7)…………………………………………..
16,800
12/1/22
Interest Expense ($20,709 X .7) ………………………………….
14,496
Bonds Payable ($3,291 X .7) ………………………………………
2,304
Cash ($24,000 X .7)…………………………………………..
16,800
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PROBLEM 14.14
a.
The entries for the issuance of the note on January 1, 2020:
The present value of the note is:
1. Using tables:
$1,200,000 X .68058 = $816,696
2.Using a financial calculator:
PV
I
N
PMT
FV
Type
$?
8%
5
$ 0
$ (1,200,000)
0
Yields $816,700
3. Using Excel: =PV(rate,nper,pmt,fv,type)
Result: $816,699.8364 rounded to $816,700
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PROBLEM 14.14 (CONTINUED)
a. (continued)
January 1, 2020
b.
BatonicaLimited (Debtor):
Cash ………………………………………………………………
816,700
Notes Payable…………………………………………..
816,700
Northern Savings Bank (Creditor):
Notes Receivable ……………………………………………..
816,700
Cash ……………………………………………………….
816,700
The amortization schedule for this note is:
SCHEDULE FOR INTEREST AND DISCOUNT AMORTIZATIONโ
EFFECTIVE INTEREST METHOD
$1,200,000 NOTE ISSUED TO YIELD 8%
Cash
Effective
Discount
Carrying
Date
Interest
Interest
Amortized
Amount
1/1/20
$ 816,700
12/31/20
$0
$ 65,336
$ 65,336
882,036
12/31/21
0
70,563
70,563
952,599
12/31/22
0
76,208
76,208
1,028,807
12/31/23
0
82,305
82,305
1,111,112
12/31/24
0
88,888
88,888
1,200,000
Total
$0
$383,300
$383,300
c.
In accordance with IFRS 9.5.5.3, Northern Savings Bank would
measure the loss allowance on the receivable for an amount
equal to the lifetime expected credit losses if credit risk has
significantly increased since initial recognition.
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PROBLEM 14.14 (CONTINUED)
d.
The loss is computed as follows:
Carrying amount of loan (12/31/20)
Less: Present value of $800,000
due in 4 years at 8%
Loss due to impairment
a
b
$882,036a
(588,024)b
$294,012
See amortization schedule from answer (b)
1. Using tables:
$800,000 X .73503 = $588,024
2.Using a financial calculator:
PV
I
N
PMT
FV
Type
$ ? Yields $588,024
8%
4
$0
$ (800,000)
0
3. Using Excel: =PV(rate,nper,pmt,fv,type)
Result: $588,023.8822 rounded to $588,824
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PROBLEM 14.14 (CONTINUED)
d. (continued)
Batonica Limited (Debtor):
No entry.
Northern Savings Bank (Creditor):
Bad Debt Expense ……………………………………………….
294,012
Allowance for Doubtful Accounts ……………………..294,012
Note to Instructor: Since this note is not yet restructured, the loss is
treated as an increase in the allowance.
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PROBLEM 14.15
a.
The first step is to determine the economic substance of the
debt renegotiation and determine if it should be accounted for
as a settlement or a modification/exchange regarding the old
debt. In this case, the creditor is the same and so is the
currency, and therefore the test to establish whether there is a
settlement or not revolves around the cash flows. The present
value of both of the cash flow streams of the new debt are
calculated using the historical interest rate of 12% for
consistency and comparability.
Pre-restructure carrying amount
Present value of restructured cash flows:
Present value of $600,000 due in 10
years at 12%, interest payable
annually; ($600,000 X .32197)
Present value of $30,000 interest
payable annually for 10 years at 12%
($30,000 X 5.65022)
Difference
$600,000
$193,182
169,507
(362,689)
$237,311
1. Using tables:
Present value of $600,000 due in 10 years at 12%, interest
payable annually; $600,000 x .32197 = $193,182
Present value of $30,000 interest payable annually for 10 years
at 12%; $30,000 x 5.65022 = $169,507
2.Using a financial calculator:
PV
I
N
PMT
FV
Type
$ ?
12%
10
$ (30,000)
$ (600,000)
0
Yields $362,691
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PROBLEM 14.15 (CONTINUED)
a. (continued)
3. Using Excel: =PV(rate,nper,pmt,fv,type)
Result: $362,690.6328 roundedto $362,691
As the present value of the new debt is more than 10% different
from the present value of the old debt (using the original rate),
this is a substantial change and the transaction is accounted for
as a settlement by Perkins and new debt is recorded.
The new debt is recorded at the present value of the new cash
flows using the current market rate of interest.
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PROBLEM 14.15 (CONTINUED)
b.
1. Perkins Inc.
Notes Payableโฆโฆโฆโฆโฆโฆโฆโฆโฆโฆโฆโฆโฆ.
Gain on Restructuring of Debtโฆโฆ
Notes Payableโฆโฆโฆโฆโฆโฆโฆโฆโฆ.
600,000
237,311
362,689
2. United Bank
Modification Gain or Loss1………………………………………….
237,311
Notes Receivable ………………………………………………..
1
Calculation of loss:
Pre-restructure carrying amount
Present value of restructured cash flows:
Present value of $600,000 due in 10
years at 12%, interest payable
annually; ($600,000 X .32197)
Present value of $30,000 interest
payable annually for 10 years at 12%
($30,000 X 5.65022)
Creditorโs loss on restructure
c.
237,311
$600,000
$193,182
169,507
(362,689)
$237,311
Losses are now calculated based upon the discounted present
value of future cash flows; thus, this fairly approximates the
economic loss to the lender.
The debtor recognizes a gain, which reflects the fact that they
are now paying lower interest. Care should be taken to ensure
the reason for the gain is clearly noted in the statements as
this is material information and the gain has been generated
solely because the entity is in financial distress.
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PROBLEM 14.16
a.
On the books of Rocky Mountain
Corporation:
Notes Payable ………………………………………………………….
2,000,000
Common Shares ……………………………………………… 1,500,000
Gain on Restructuring of Debt …………………………….
500,000
Fair value of equity
Carrying amount of debt
Gain on restructuring of debt
$1,500,000
2,000,000
$ 500,000
On the books of Abbra Bank:
FV-NI Investments ……………………………………………………
1,500,000
Allowance for Doubtful Accounts …………………………………
500,000
Notes Receivable …………………………………………….. 2,000,000
b.
On the books of Rocky Mountain:
Notes Payable ………………………………………………………….
2,000,000
Accumulated Depreciation-Buildings ……………………………
1,400,000
Buildings ………………………………………………………… 1,900,000
Gain on Disposal of Buildings ……………………………. 1,000,000
Gain on Restructuring of Debt …………………………….
500,000
Fair value of building
Carrying amount of building
Gain on disposalof building
$1,500,000
500,000
$1,000,000
Note payable (carrying amount)
Fair value of building
Gain on restructuring of debt
$2,000,000
1,500,000
$ 500,000
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PROBLEM 14.16 (CONTINUED)
b. (continued)
On the books of Abbra Bank:
Investment in Property ………………………………………………
1,500,000
Allowance for Doubtful Accounts …………………………………
500,000
Notes Receivable …………………………………………….. 2,000,000
c.
The first step is to determine the economic substance of the
debt renegotiation and determine if it should be accounted for
as a settlement or a modification/exchange regarding the old
debt. In this case, the creditor is the same and so is the
currency and therefore the test to establish whether there is a
settlement or not revolves around the cash flows. The present
value of the cash flow streams of the new debt are calculated
using the historical interest rate of 7% for consistency and
comparability.
Present value of old debt is $2,000,000.
Present value of new debt is calculated as follows:
Using present value tables:
Single amount
$ 2,000,000
7%
Factor
0.816296
Present
Value
$ 1,632,592
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PROBLEM 14.16 (CONTINUED)
c. (continued)
Using Excel: =PV(rate,nper,pmt,fv,type)
Result $1,632,595.754 roundedto $1,632,596
Since the present value of the future cash flows of the new debt
differs by an amount larger than 10% of the present value of the
future cash flows of the old debt (2,000,000 x 10% = 200,000),
the renegotiated debt is considered a settlement and a gain is
recorded by Rocky Mountain as calculated below:
The amount of the new debt is recorded at the new cash flows
at the current market rate of interest, which is 9%.
Using present value tables:
2,000,000 x 0.772183 = $1,544,367 (rounded by $1)
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PROBLEM 14.16 (CONTINUED)
c. (continued)
Using Excel: =PV(rate,nper,pmt,fv,type)
Result: $1,544,366.96 rounded to $1,544,367
On the books of Rocky Mountain:
Notes Payable………………………………………………………….
2,000,000
Gain on Restructuring of Debt …………………………….
455,633
Notes Payable …………………………………………………
1,544,367
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PROBLEM 14.16(CONTINUED)
c. (continued)
On the books of Abbra Bank:
Modification Gain or Loss1 …………………………………………
367,408
Notes Receivable ……………………………………………..
367,408
1
Calculation of loss:
Pre-restructure carrying amount
Less: Present value of restructured cash flows:
Present value of $2,000,000 due in 3 years
at 7% ($2,000,000 X .816296)
Creditorโs loss on restructure
d.
$2,000,000
1,632,592
$ (367,408)
The first step is to determine the economic substance of the
debt renegotiation and determine if it should be accounted for
as a settlement or a modification/exchange regarding the old
debt. In this case, the creditor is the same and so is the
currency and therefore the test to establish whether there is a
settlement or not revolves around the cash flows. The present
value of the cash flow streams of the new debt are calculated
using the historical interest rate of 7% for consistency and
comparability.
Present value of old debt is $2,000,000.
Present value of new debt is calculated as follows:
Using present value tables:
Single amount
Interest payments for third
year
$1,700,000
7%
Factor
0.816296
Present
Value
$1,387,703
68,000
0.816296
55,508
$1,443,211
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PROBLEM 14.16 (CONTINUED)
d. (continued)
Since the present value of the future cash flows of the new debt
differs by an amount larger than 10% of the present value of the
future cash flows of the old debt (2,000,000 x 10% = 200,000),
the renegotiated debt is considered a settlement and a gain is
recorded by Rocky Mountain as set out below:
The amount of the new debt is recorded at the new cash flows
at the current market rate of interest, which is 9%.
Using present value tables:
Single amount
Interest payments for
third year
$1,700,000
9%
Factor
0.77218
Present
Value
$1,312,706
68,000
0.77218
52,508
$1,365,214
Notes Payable ………………………………………………………….
2,000,000
Gain on Restructuring of Debt …………………………….
634,786
Notes Payable ………………………………………………….
1,365,214
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PROBLEM 14.16 (CONTINUED)
d. (continued)
On the books of Abbra Bank:
Modification Gain or Loss2………………………………………….
556,789
Notes Receivable ……………………………………………..
2
Calculation of loss:
Pre-restructure carrying amount
Present value of restructured cash flows:
Present value of $1,700,000 due in
3 years at 7%,
($1,700,000 X .816296)
Present value of $68,000 interest
payable in third year
7%, ($68,000 X .816296)
Creditorโs loss on restructure
556,789
$2,000,000
$1,387,703
55,508
1,443,211
$ (556,789)
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PROBLEM 14.17
The first step is to determine the economic substance of the debt
renegotiation and determine if it should be accounted for as a
settlement or a modification/exchange regarding the old debt. In this
case, the creditor is the same and so is the currency and therefore
the test to establish whether there is a settlement or not revolves
around the cash flows. The present value of the cash flow streams of
the new debt are calculated using the historical interest rate of 10%
for consistency and comparability.
Present value of old debt is $500,000 + accrued interest of
$50,000($500,000 x 10%) for a total of $550,000.
Present value of new debt is calculated as follows:
Using present value tables:
Single amount, 5 years
Interest annuity, 5 years
($300,000 X 10%)
Shares given 20,000 X $5
$ 300,000
10%
Factor
0.62092
Present
Value
$ 186,276
30,000
3.79079
113,724
300,000
100,000
$400,000
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PROBLEM 14.17 (CONTINUED)
Since the difference between the present value of the future cash
flows of the new debt and the present value of the future cash flows
of the old debt differs by an amount larger than 10% of the present
value of the future cash flows of the old debt (10% x $550,000 =
$55,000),the renegotiated debt is considered a settlement and a gain
is recorded by Gaming as follows:
2020
Entries by Gaming Inc.:
Interest Payable ……………………………………………………….
50,000
Notes Payable ………………………………………………………….
500,000
Notes Payable …………………………………………………. 278,372
Common Shares ……………………………………………… 100,000
Gain on Restructuring of Debt ……………………………. 171,628
The note payable now has a balance of $278,372, which equals the
present value of the future cash flows to be paid.
1. Using tables:
Single amount, 5 years
Interest annuity, 5 years
($300,000 X 10%)
$300,000
12%
Factor
0.56743
Present
Value
$170,229
30,000
3.60478
108,143
$278,372
2. Using a financial calculator:
PV
I
N
PMT
FV
Type
$?
12%
5
$ (30,000)
$ (300,000)
0
Yields $278,371
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PROBLEM 14.17 (CONTINUED)
3. Using Excel: =PV(rate,nper,pmt,fv,type)
Result: $278,371.3428 rounded to $278,371
Date
12/31/20
12/31/21
12/31/22
12/31/23
12/31/24
12/31/25
10%
Cash
Interest
$30,000a
30,000
30,000
30,000
30,000
12%
Effective
Interest
$33,405
33,813
34,271
34,783
35,356d
Increase in
Carrying
Amount
$ 3,405c
3,813
4,271
4,783
5,356
Carrying
Amount of
Note
$ 278,372
281,777
285,590
289,861
294,644
300,000
a
$30,000 = $300,000 x 0.10
$33,405 = $278,372 X 12%
c
$3,405 = $33,405 โ $30,000
d
Adjusted due to rounding
b
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PROBLEM 14.17 (CONTINUED)
Dec. 31, 2021:
Interest Expense ………………………………………………………
33,405
Notes Payable………………………………………………….
Cash ………………………………………………………………
3,405
30,000
Dec. 31, 2022:
Interest Expense ………………………………………………………
33,813
Notes Payable………………………………………………….
Cash ………………………………………………………………
3,813
30,000
Dec. 31, 2023
Interest Expense ………………………………………………………
34,271
Notes Payable………………………………………………….
Cash ………………………………………………………………
4,271
30,000
Dec. 31, 2024
Interest Expense ………………………………………………………
34,783
Notes Payable………………………………………………….
Cash ………………………………………………………………
4,783
30,000
Dec. 31, 2025
Interest Expense ……………………………………………………….
35,356
34,783
Notes Payable ………………………………………………….
5,356
4,783
Cash ………………………………………………………………. 30,000
30,000
To record payment of interest
300,000
Notes Payable ………………………………………………………….
Cash ……………………………………………………………… 300,000
To record repayment of note
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PROBLEM 14.18
a.
September 30, 2020
Thornton:
Interest Receivable …………………………………………………..
27,000
1
Interest Income ……………………………………………….
To accrue interest income
1
($300,000 X .12 X 9/12)
27,000
Losson Investments ………………………………………………….
47,000
Cash ………………………………………………………………………
280,000
Interest Receivable …………………………………………..
Notes Receivable ……………………………………………..
To record sale of note
This would not be a troubled debt restructuring.
27,000
300,000
Shutdown: No entry. Shutdown does not have a troubled debt
restructuring.
Orsini:
Interest Income2 ……………………………………………………….
27,000
Notes Receivable ……………………………………………………..
253,000
Cash ………………………………………………………………
280,000
2
A debit to Interest Receivable is also appropriate. This would not be
a troubled debt restructuring.
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PROBLEM 14.18 (CONTINUED)
b.
December 31, 2020
Shutdown:
Interest Expense ($300,000 X .12) ………………………………
36,000
Interest Payable ……………………………………………….
To record accrued interest expense
Notes Payable ………………………………………………………….
300,000
Interest Payable ……………………………………………………….
36,000
Cost of Goods Sold …………………………………………………..
240,000
Inventory …………………………………………………………
Gain on Restructuring of Debt …………………………….
Sales Revenue …………………………………………………
36,000
240,000
21,000
315,000
This would be a troubled debt restructuring for Shutdown,
since the settlement, $315,000, is less than the carrying
amount of the debt, $336,000.
Orsini:
Interest Receivable3 ………………………………………………….
36,000
Interest Income($300,000 X .12) …………………………
To accrue interest income
36,000
3
Only net of $9,000 reported as interest income because
$27,000 of accrued interest was purchased in September.
Inventory …………………………………………………………………
315,000
Notes Receivable ……………………………………………..
Interest Receivable …………………………………………..
Investment Income or Loss ………………………………..
253,000
36,000
26,000
This would not be a troubled debt restructuring.
(Note to instructor: This problem indicates that symmetry may not
always be achieved between the debtor and creditor and that the
debtor may have a restructuring but the creditor, if changed, may
not.)
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PROBLEM 14.19
a.
The first step is to determine the economic substance of the
debt renegotiation and determine if it should be accounted for
as a settlement or a modification/exchange regarding the old
debt. In this case, the creditor is the same and so is the
currency and therefore the test to establish whether there is a
settlement or not revolves around the cash flows. The present
value of the cash flow streams of the new debt are calculated
using the historical interest rate of 10% for consistency and
comparability.
Present value of old debt is $110,000 + $11,000 = $121,000.
Present value of new debt is calculated as follows:
1.Using tables:
Single amount, 3 years
Interest annuity, 3 years
$100,000
10,000
10%
Factor
0.75132
2.48685
Present
Value
$ 75,132
24,868
$100,000
2.Using a financial calculator:
PV
I
N
PMT
FV
Type
$?
10%
3
$ (10,000)
$ (100,000)
0
Yields $100,000
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PROBLEM 14.19 (CONTINUED)
a. (continued)
3. Using Excel: =PV(rate,nper,pmt,fv,type)
Result: $100,000
Since the present value of the future cash flows of the new debt
differs by an amount larger than 10% of the present value of the
future cash flows of the old debt in the amount of $121,000, the
renegotiated debt is considered a settlement. The old debt
would be removed from the books, the new debt recognized,
and the difference would be recorded as a gain for Mazza.
The effective interest rate subsequent to restructure is the
current market rate of interest.
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PROBLEM 14.19 (CONTINUED)
b.
Date
Mazza Corp.
SCHEDULE OF DEBT REDUCTION AND
INTEREST EXPENSE AMORTIZATION
Cash
Effective
Change in
Interest
Interest
Carrying
(Market)
Amortized
12/31/20
12/31/21
$10,000a
$10,000b
12/31/22
10,000
10,000
12/31/23
10,000
10,000
12/31/23
100,000
a
$10,000 = $100,000 X 10%
b
$10,000 = $100,000 X 10%
$
0
0
0
100,000
c.
Calculation of loss:
Pre-restructure carrying amount
Present value of restructured cash flows:
Tsang Corp.โs loss on restructure
Date
12/31/20
12/31/21
12/31/22
12/31/23
12/31/23
a
b
Cash
Interest
Tsang Corp.
Effective
Interest
(Market)
$10,000a
10,000
10,000
100,000
$10,000b
10,000
10,000
0
Carrying
Amount
$100,000
100,000
100,000
100,000
-0-
$121,000
100,000
$ (21,000)
Change in
Carrying
Amortized
$
0
0
0
100,000
Carrying
Amount of
Note
$100,000
100,000
100,000
100,000
0
$10,000 = $100,000 X 10%
$10,000 = $100,000 X 10%
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PROBLEM 14.19 (CONTINUED)
d.
Mazza Corp. entries:
December 31, 2020
Interest Payable ………………………………………………………..
11,000
Notes Payable ………………………………………………………….
110,000
Notes Payable …………………………………………………..
100,000
Gain on Restructuring of Debt ……………………………..
21,000
December 31, 2021, 2022
Interest Expense ……………………………………………………….
10,000
Cash ……………………………………………………………….
10,000
e.
Tsang Corp. entries:
December 31, 2020
Modification Gain or Loss …………………………………………..
21,000
Notes Receivable………………………………………………
21,000
Note that the dr. could be booked to the
Allowance account instead if the loss had
already been provided for.
December 31, 2021, 2022
Cash ………………………………………………………………………
10,000
Interest Income …………………………………………………
10,000
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PROBLEM 14.20
a.
Legal defeasance requires that the creditor agrees to collect
principal and interest payments from the trust rather than from
LL. A legal agreement on behalf of the creditor, the trust, and
the debtor would be needed to achieve legal defeasance.
Under IFRS, LL would be able to derecognize the liability if they
obtain legal defeasance and extinguish the debt. In-substance
defeasance results when a company sets up a trust to repay
the principal and interest payments for the debt without
obtaining the creditorโs agreement. Without obtaining a legal
agreement from the creditor, the primary obligation to repay the
loan resides with LL. As a result, in-substance defeasance does
not result in derecognition of the liability according to IFRS.
b.
For both legal and in-substance defeasance there is an
argument for derecognition of debt on the financial statements
since LL has set up a trust with low-risk investments that will be
able to cover all future interest and principal payments.
Effectively, by setting up the trust, LL has prepaid the debt with
low risk of default based on their investment strategy.
c.
Regardless of the intent of the company, IFRS looks at whether
there is a legal obligation.. Therefore, if the agreement from the
creditor has not been obtained, in-substance defeasance
occurs andthe debt must remain on the SFP. In order to
extinguish the debt, LL needs to obtain a legal agreement from
the creditor releasing them from the debt obligation and
transferring that obligation to the trust. The ethical accountant
must communicate this to the VP Finance and explain that,
without a formal agreement with the creditor, the debt cannot
be extinguished from the LL financial statements.
LO 2,3 BT: C Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 cpa-t005
CM: Reporting and Finance
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CASE
Note: See the Case Primer on the Student website, as well as the
Summary of the Case Primer in the front of the text. Note that the
first few chapters in volume 1 lay the foundation for financial
reporting decision making.
CA 14.1 Kitchener Mechanical Incorporated
Overview
๏ท Company is a manufacturer and is looking to expand its facility.
The Company has had cash flow issues, and there are
substantial amounts outstanding from a major customer.
๏ท Company has a debt to equity covenant with Nexis Bank that it
is close to breaching.
๏ท Company looking into alternative methods of financing the
expansion where it will not impose more cash flow difficulties.
๏ท MagmumProduction will be a user to assess the financial
position of the Company to ensure that the lease payments
can be made and that a portion of the lease payment based on
revenues is properly remitted.
๏ท Nexis Bank is also a user and will use statements to predict
cash flows to ensure debts are repaid. The bank will also use
the statements to assess whether the covenant is met.
๏ท President is concerned about adding additional debt to the
statement of financial position, specifically in terms of debt to
equity ratio.
๏ท GAAP is a constraint since Magmum would likely want to
assess Kitchenerโs ability to pay as would the bankโGAAP
would provide more useful information. The controller would
like to know where any differences exist between IFRS and
ASPE.
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CA 14.1 Kitchener Mechanical Incorporated (CONTINUED)
Analysis and recommendations
Issue: How to account for the project financing arrangement
Lease
Project financing arrangement
– First would need to assess
– Is this really a project financing
whether the commitment is a
whereby Magmum is providing
capital or operating lease
construction services for the
obligation under ASPE. It
buildingโwhich is really
would appear that it is an
Kitchenerโs building. This is the
operating lease since the
economic substance of the
purchase at the end of the
arrangement.
contract is at 1.2 x market,
– These services are being paid for
which does not constitute a
over time (debt service
bargain purchase option and
component of the lease
the lease term is short
payments) instead of upfront.
compared to the likely life of
– Since the plant ownership reverts
the facility. The amount of
to Kitchener at the end and is on
lease payments is not given in
their land, it could be considered
the case but this would need
their asset. However, given that
to be determined to see how it
Kitchener needs to pay 1.2 x
compares to the fair value of
market value at the end of the
the facility.
term, until that time, the asset
– The purchase of the facility at
does not belong to Kitchener.
1.2 X market value may be a
– Regardless of the above,
binding non-cancellable part of
Kitchener has an obligation to
the arrangement and
pay the lease payments, which
constitute transfer of
are comprised of a flat fee plus a
ownership.
percentage of the revenue
– If this is an operating lease, it
earned.
is considered an executory
– Recognition of an obligation
contract, and no amount would
would worsen the debt to equity
be recorded on the balance
ratio.
sheet.
– Would not record any amount
since the lease payments
become payable as each
month passes.
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CA 14.1 Kitchener Mechanical Incorporated (CONTINUED)
Lease
– Either way, note disclosure
is required of the
commitment to pay lease
payments and the payment
at the end of the term.
– The buildingโeven though
on Kitchenerโs property โ is
owned by Magmum for the
first 20 yearsโKitchener
does not have control over
it.
– Does not affect debt on the
statement of financial
position if treated as
operating lease.
– Under IFRS 16, if the
contract met the definition of
a lease, the company would
have to estimate and
recognize a liability for any
amounts that were probable
as well as a contractual right
to use the facility. This
would impact the debt to
equity ratio (likely worsening
it).
Project financing arrangement
If the lease is classified as an operating lease under ASPE, it would
only be recognized as an expense over the lease term. Under IFRS
a lease liability and contractual right to use the facility would be
recorded. Since the company is planning to go public, likely they
should apply IFRS 16 and recognize the arrangement as a lease.
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INTEGRATED CASES
IC 14.1 Big Bath Emporium (BBE)
Overview
– Bank would like audited statements and debt covenant
requires a debt/equity ratio of no more than 1:1. Therefore, the
statements must follow GAAP (may use ASPE or IFRS) and
debt and equity are sensitive numbers โ may be a bias to
ensure that the debt covenant is not broken since they need
the bank loan in order to finance their expansion to
Quebec.Bob will use the statements to assess financial
position and performance.
– Formerly income tax minimization may have been the
objective, since BBE is a private company. As such, BBE was
not legally bound by GAAP. However, an audit is now required
and there will be a bias to ensure that the debt covenants are
met.
– As auditors, we must ensure that the statements are
transparent. Differences between IFRS and ASPE will be
noted.
Analysis and recommendations – MEMO
To:
Manager, Brayden LLP
From: Senior Accountant, Brayden LLP
Re:
Accounting issues noted for Big Bath Emporium
Introduction
The following report has been prepared to analyze the current
policies in place and the transactions that took place during the year,
in order to determine the issues that will be encountered during the
audit. BBE may choose IFRS or ASPE. We will apply ASPE given
that there is no need to use IFRS as no indication of an intention to
go public. Differences between ASPE and IFRS will be noted for
discussion with our client.
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IC 14.1 BBE (CONTINUED)
Warranty Expense
Issue Analysis: The cash method of accounting for warranty costs
is acceptable when the costs are not material or when the warranty
period is relatively short. It may also be acceptable when the amount
of the liability cannot be reasonably estimated or if future costs are
not likely to be incurred. However, the current warranty expense is
material and can be estimated, and therefore the cash method is not
acceptable.
Given that the warranty is sold as a separate product, the revenue
from the warranty should be recognized (unearned revenues). The
company has sold 100 warranties at $5,000 each, for total revenue
of $500,000. However, given that the performance on the warranty
takes place over five years, the revenue should be recognized over
time. Given that the warranty costs are incurred relatively evenly
over five years, the revenue should also be recognized evenly over
five years, $100,000 per year.
Since no warranty costs were incurred in 2020, the company may
want to examine the basis under which revenues are recognized
over the warranty period. Historically, expenses averaged $500 per
year per warranty over the term of the warranty. If the costs are not
expected to be incurred in a straight-line pattern, then it may be
preferable to recognize revenues in the same pattern as the costs
are expected to be incurred.
Since the company previously recognized revenue on the cash
basis, it needs to reverse the revenue amount pertaining to future
yearsโ service and recognize as unearned revenues ($400,000).
Implication on debt to equity ratio: This increases liabilities by
$400,000 in deferred revenue. Since BBE uses the cash basis to
record the warranty and revenue, the revenue will decrease by
$400,000, decreasing retained earnings and equity.
The treatment of the warranties would be the same under both
ASPE and IFRS.
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IC 14.1 BBE (CONTINUED)
Decommissioning costs
Issue Analysis: The loss should be accrued since the costs meet
the definition of a liability: result of a past transaction (since the
facility has already been built), probable outflow of resources
(government required, thus, probable), and costs are measurable
(management is able to estimate the costs).Given that the amount is
due in ten years, the cost needs to be discounted. We can use the
recent borrowing rate from the bank at 9% for discounting. Using
present value tables: $500,000 x 0.42241 = $211,205. Since the
amount is a decommissioning cost, the $211,205 increases the cost
of the asset, and is also recorded as a liability.
Buildings …………………………………………………………………
211,205
Asset Retirement Obligation …………………………………
211,205
Each year, the liability will be increased, the increase being recorded
as interest expense. The asset will be depreciated with the increased
amount.
Each year, the company would recognize the increase in the ARO
due to accretion as follows:
Year
0
1
2
3
4
5
6
7
8
9
10
1
Balance
$211,205
211,205 + 19,008 = 230,213
230,213 + 20,719 = 250,932
250,932 + 22,584 = 273,516
273,516 + 24,616 = 298,132
298,132 + 26,832 = 324,964
324,964 + 29,247 = 354,211
354,211 + 31,879 = 386,090
386,090 + 34,748 = 420,838
420,838 + 37,875 = 458,713
458,713 + 41,287 = 500,000
Accretion (9%)
$19,008
20,719
22,584
24,616
26,832
29,247
31,879
34,748
37,875
41,2871
0
Rounded
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IC 14.1 BBE (CONTINUED)
Decommissioning costs (continued)
Implication on debt to equity ratio:This negatively impacts the ratio
as debt will increase by $211,205, but it is required for GAAP
compliance.
The treatment of the cleanup costs may be different under IFRS
depending on how the cleanup costs arise. If the costs relate to the
use of the facilities and increase over time, the costs would be
included as product costs. The measurement of the asset retirement
obligation would remain the same.
Interest-Free Loan
Issue Analysis: Long-term debt is recorded at the present value
(fair value) of the stream of payments. Currently, BBE recorded the
liability at the face value of $200,000, however, this represents the
undiscounted amount, and therefore both assets and liabilities are
overstated. The present value of the payments is calculated using
the 9% interest rate on the current bank loan over two years. Present
value using tables is $200,000 x 0.84168 = $168,336. Thus, the
inventory and the liability should be recorded at $168,336. However,
since the net realizable value of the inventory is only $100,000, and
the inventory must be recorded at the lower of cost and net
realizable value, the inventory needs to be written down further to
$100,000, representing a loss of $68,336. The adjusting entries
would be:
Liability ……………………………………………………………………
31,664
Inventory …………………………………………………………..
31,664
Loss on Inventory (or COGS) ……………………………………..
68,336
Inventory (or allowance) ………………………………………
68,336
Interest Expense ………………………………………………………
15,150
Liability ……………………………………………………………..
15,150
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IC 14.1 BBE (CONTINUED)
Interest-Free Loan (continued)
Implication on debt to equity ratio:Liabilities decrease by $16,514,
which reflects positively on the debt to equity ratio, but income
decreases by $83,486 due to the write down and interest expense,
which decreases retained earnings and decreases equity.
The treatment of the interest-free loan would be the same under both
ASPE and IFRS.
Contingent liability
Issue Analysis: The liability should be recognized because the
criteria of likely and measurable are met. The liability is likely given
that the lawyers predict a settlement. The liability is also measurable
because the lawyers anticipate a settlement between $100,000 and
$120,000. Under ASPE, the contingent liability should be recorded at
the lower end of the range, $100,000. Under IFRS, this would need
to be recognized at the mid-point of the range, $110,000. IFRS
would also recognize the liability if it is โprobable,โ rather than likely,
which is a lower threshold. Although Thomas believes that there will
be no outflow, the lawyers anticipate a settlement, and thus the
adjusting journal entry is as follows:
Litigation Expense …………………………………………………….
100,000
Contingent Liability ………………………………………………
100,000
Implication on debt to equity ratio:The ratio is negatively impacted by
the $100,000 expense, decreasing retained earnings and equity, and
increasing liabilities by $100,000.
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IC 14.1 BBE (CONTINUED)
Redeemable and Retractable Shares
Issue Analysis: BBE issued 10,000 redeemable and retractable
preferred shares at $50 each. BBE has classified the shares as
equity, however ASPE/IFRS requires the substance of the
instruments to be assessed, as opposed to the legal form.
Elements of Equity
๏ท Dividends are to be declared on a discretionary period after
the expiry of the retraction period
๏ท Dividends after the retraction period are not cumulative
Elements of Debt
๏ท Mandatory dividend payment of $10 per share requires the
delivery of cash for the first five years
๏ท The shares are retractable at the discretion of the holder,
therefore requiring BBE to deliver cash. The likelihood of
the holders retracting the shares is high given that after 5
years, the retraction period expires and dividends are no
longer mandatory or cumulative.
Based on the substance of the transaction, ASPE/IFRS provides
guidance on when preferred shares establish a contractual obligation
to deliver cash indirectly through the terms and conditions, such as
these preferred shares. These shares should be classified as a
financial liability. ASPE has an exemption for redeemable and
retractable shares issued in a tax planning arrangement. Under the
exemption, the shares may be recognized as equity, and the
dividends accounted for as ordinary dividends through retained
earnings. As such, under ASPE, no revision would be needed.
However, under IFRS, the shares would need to be reclassified as a
liability, and the dividend of $100,000 that went through the retained
earnings should go through the income statement as interest
expense.
Implication on debt to equity ratio:Under ASPE, there would be no
change. Under IFRS, the debt is understated by the $500,000 and
the income is overstated by the $100,000 dividend.
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IC 14.1 BBE (CONTINUED)
Payment of Dividend on Common Shares
Issue Analysis: Prior to paying the dividend, Bob should look at the
revised covenant to determine if it is met after all the adjustments.
Summary: I have prepared Exhibit I to summarize the GAAP
adjustments and the impact on the debt to equity ratio. After making
all of the GAAP adjustments, the debttoequity ratio will be 1.10:1,
definitely in violation of compliance with the covenants. Once the
dividend is paid, equity will decrease by $800,000, and the ratio will
increase to 1.96:1.
Exhibit 1 – Recalculation of Debt to Equity Ratio
Debt
Preliminary
1,300,000
Debttoequity ratio
0.54 :1
GAAP Adjustments
1) Warranty expense
400,000
2) Decommissioning costs
211,205
3) Interest-free loan
(16,514)
4) Contingent liability
100,000
5) Redeemable shares
0
Pre-dividend balances
1,994,691
Debttoequity ratio
1.10 :1
Dividend
Adjusted balance
1,994,691
Adjusted D/E ratio
1.96 : 1
Equity
2,400,000
(400,000)
0
(83,486)
(100,000)
0
1,816,514
(800,000)
1,016,514
It is recommended that Bob does not pay the dividend, and that the
Company seeks an alternative to avoid the covenant violation and
classification of the long-term debt as current. Additional equity is
required. Alternatively, the company should renegotiate the covenant
with the bank, since, even without the dividend, the covenant is still
breached.
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IC 14.2 RTL
Overview:
๏ท RTL is a private family-run business so ASPE is an option.
There are no future plans of going public, so IFRS is not
required.
๏ท The bank will use the financial statements to assess RTLโs
going concern and ability to pay interest and principal.
๏ท Management will use the financial statements to assess RTLโs
transition to digital printing and achievement of revenue
targets.
๏ท The auditors will be auditing the financial statements with a
transparent reporting objective.
๏ท There is a potential for management bias and aggressive
accounting policies.
o RTLโs profits have been declining for the past 2 years
and it has recently lost 50% of its revenue.
o RTL also entered into an agreement with the bank for a
restructuring of its loan.
๏ท Our reporting objective as the controller is to fairly present the
statements.
Issue: Recognition of the restructuring of debt.
A modification of debt can be treated as a settlement if the following
condition is met.
If the discounted PV under the new terms (discounted at the original
effective rate) is at least 10% different from the discounted PV of the
remaining cash flows under the old debt, the old debt is treated as a
settlement and removed from the books.
Old debt: $2,000,000 (debt is due end of 2020)
New debt: $1,500,000 (0.75132) + $120,000 (2.48685) = $1,425,402
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IC 14.2 RTL(CONTINUED)
10% of the value of the old debt is $200,000. The difference
between the old and new debt is greater than $200,000. Therefore,
this restructuring qualifies as a settlement of the old debt.
The discount rates are calculated using the following:
Discount rate of 0.75132 is the PV discount factor for a single sum
(10%, 3 years)
Discount rate of 2.48685 is the PV discount factor for an ordinary
annuity (10%, 3 years)
Using a financial calculator:
PV
$ ?
Yields $1,425,394
I
10%
N
3
PMT
$ (120,000)
FV
$ (1,500,000)
Type
0
Excel formula =PV(rate,nper,pmt,fv,type)
On the books, the new debt is calculated using the current market
discount rates using the following:
Discount rate of 0.77218 is the PV discount factor for a single sum
(9%, 3 years)
Discount rate of 2.53130 is the PV discount factor for an ordinary
annuity (9%, 3 years)
Resulting present value is $1,462,026
Using a financial calculator:
PV
$ ?
I
9%
N
3
PMT
$ (120,000)
FV
$ (1,500,000)
Type
0
Yields $1,462,031
Excel formula =PV(rate,nper,pmt,fv,type)
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IC 14.2 RTL(CONTINUED)
The following journal entry is required (using the PV tables):
Debt (old) ………………………………………………………………..
2,000,000
Debt (new) ………………………………………………………..
1,462,026
Gain on Restructuring of Debt ……………………………..537,974
Issue: Revenue recognition of the digital contract sales.
Immediate recognition
Defer recognition
– Nonrefundable fee โ no
– Nonrefundable fee โ the
additional service is
earnings process for the sales
required to be performed
transaction is the entire duration
by RTL. The upfront fee is
of the contract. RTL must be
paid upfront ensuring
available to perform printing
collectibility and
services on-demand โ the
measurability.
earnings process is not
completed upon signing of the
– Minimum contract fee โ
contract.
RTL earns a minimal
– Minimal contract fee โ same as
contract fee at the end of
the contract term (2-3
above.
years) even if no printing
– Risk still remains with RTL for
services are performed.
the duration of the contract โ for
– Customers pay a per-unit
the on-demand printing services.
fee for each digital print
– Collectibility โ may be an issue โ
and this would be
2 of RTLโs digital customers have
recognized as earned
gone bankrupt. RTL does not
(covering costs).
have any history with digital
– Another option is to
customers โ an appropriate
recognize the
estimate for an allowance for
nonrefundable fee and the
doubtful accounts may not be
minimal contract fee over
possible.
the duration of the contract.
Conclusion:
Depending on the significance of the 2 digital
customers that have filed for bankruptcy and RTLโs limited digital
sales history – Collectibility may be a concern and RTL should
recognize the nonrefundable fee and minimal contract fee at the end
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of the contract. Assuming collectibility โ may recognize overtime as
earned.
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IC 14.2 RTL(CONTINUED)
Minor Issue: Recognition of an asset retirement obligation.
The $100,000 represents a constructive obligation. RTL is planning
to sell the equipment to a vendor who will only purchase the digital
printing equipment if RTL makes the necessary modifications to
update the equipment and prepare it for sale.
The liability should have been recorded at PV (using the discount
rate in effect at that time), not at $100,000. The printing equipment
asset should have increased by the PV of the obligation. Accretion
expense should have been recorded for 2019 and 2020. As the
accounting ledger for 2019 is now closed the correction must be
recorded in the 2020 ledger. An adjustment to opening equity will be
required. For 2020, the appropriate accretion expense must be
recorded in the operating statement.
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RESEARCH AND ANALYSIS
RA 14.1 BROOKFIELD ASSET MANAGEMENT INC.
a.
Debt to total assets ratio = (Total debt) / (Total assets)
Times interest earned = (Income before income taxes + interest expense) /
(Interest expense)
December 31, 2016:
Debt to total assets ratio = $90,138 / $159,826 = 56.4%
Times interest earned = $6,2261 / $3,233 = 1.93
December 31, 2017:
Debt to total assets ratio = $112,848 / $192,720 = 58.6%
Times interest earned = $8,7722 / $3,608 = 2.43
During 2017, BAMโs solvency deteriorated slightly as its ratio of debt to total
assets increased, indicating that the companyโs creditors financed an
increased proportion of its investment in assets. Its times interest earned
improved during 2017, indicating an increase in BAMโs ability to cover the
interest charges associated with its debt. It should be noted that BAMโs
business requires heavy investment in stable long-term assets, so the debt
ratio is likely not out-of-line in its industry. The times interest earned ratio is
reasonable, but there may be a concern regarding meeting its interest
obligations should interest rates rise. Note 27 indicates that the company is
in compliance with all covenants associated with its debt.
1
$3,338 + $3,233 – $345
$4,551 + $3,608 + $613
2
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RA 14.1 BROOKFIELD (CONTINUED)
b.
BAM has borrowed long-term through the following types of interest-bearing
debt: long-term notes payable, commercial paper, bank loans, and
mortgages. Details are not provided about the make-up of the subsidiary
borrowings.
Due dates of debt reported, December 31, 2017:
Corporate
Property-specific
borrowings
mortgages
Current (2018)
$
-0$
8,800
and commercial
paper and bank
borrowings
103
2 to 5 years
(2019 to 2022)
756
29,403
6 to 10 years
(2023 to 2027)
3,707
25,518
After 10 years
(2028 on)
1,131
Deferred financing
costs
(38)
-0$ 5,659
$63,721
Subsidiary
borrowings
$
1,956
5,056
1,997
-0$ 9,009
Note 17 (Corporate Borrowings) gives no indication of security by anything
other than the reputation of the company. However, Note 6 (Fair Value of
Financial Instruments) and Note 8 (Inventory) indicate that $4.1billion of
financial assets and $2.9billion of inventory, respectively, are pledged as
collateral/security. This is likely for any bank borrowings and notes payable.
In addition, all the property-specific mortgages (non-recourse borrowings)
are secured by the underlying property the funds were borrowed for, as
indicated in Note 18. Note 11 (Investment Properties) indicates that the
investment properties are pledged as collateral for the non-recourse
borrowings at their respective properties, and Note 12 (Property, plant and
equipment) indicated that $38.3 billion of property, plant and equipment, at
cost, were pledged as collateral for the property debt at their respective
properties.
The subsidiary borrowings (under non-recourse borrowings) are not
described as secured, but it is likely they are also secured by a mix of
current and financial assets as well as underlying property held by the
subsidiaries.
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RA 14.1 BROOKFIELD (CONTINUED)
c.
Currency
Corporate
Borrowings
US$
Canadian $
Deferred finance costs
Australian $
British ยฃ (pounds)
Brazilian reals
Korean won
Chilean unidades de
fomento
European Union โฌ
(euros)
Indian rupees
Columbian pesos
Peruvian nuevo soles
South African rand
New Zealand dollars
$
Total
2,540
3,157
(38)
PropertySpecific
Mortgages
$ 39,164
5,272
Subsidiary
Borrowings
3,518
6,117
2,677
1,682
976
156
1
$ 5,305
3,547
766
1,346
1,556
450
154
43
$ 5,659
$ 63,721
$ 9,009
Note 2(e) – Foreign Currency Translation indicates that the โU.S. dollar is
the functional and presentation currency of the company.โ This means that
all amounts presented on the December 31, 2017 balance sheet, including
the corporate borrowings, property-specific mortgages, and the subsidiary
borrowings are reported at or are restated into their U.S. dollar equivalent at
this reporting date.
d.
The subsidiary borrowings are included in BAMโs liabilities because BAM
presents consolidated financial statements. As indicated in Note 2(d), such
statements include the accounts (which means all the assets and liabilities)
of the company and entities that BAM exercises control over โ its
subsidiaries. It is BAMโs ability to control the โrelevant activities, exposure or
rights to variable returns from involvement with the investee, and the ability
to use its power over the investee to affect the amount of its returnsโ that is
the reason to include all the controlled companiesโ assets, liabilities,
revenues, and expenses in with BAMโs own corporate items. In this way,
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BAMโs existing and potential shareholders can more fully appreciate the
companyโs financial position and financial performance.
RA14.2 LOBLAW COMPANIES LIMITED AND EMPIRE
COMPANY LIMITED
a.
The following are the debt to total assets and times interest earned ratios for
the companies:
In millions
Loblaw
Empire
December 30, 2017
May 6, 2017
Total liabilities
$22,054
$4,992.8
Total assets
35,106
8,695.5
Debt to asset ratio
0.63
0.57
Earnings before interest and taxes
2,494
333.0
Interest expense*
525
118.0
Times interest earned
4.75
2.82
* Due to the difficulty in separating out the appropriate net direct interest
cost associated with each companyโs total liabilities, the net finance
charges used on the statement of income of each company were used.
From the above analysis, it appears that Loblaw has relatively more debt
than Empire in its capital structure. The two companies have relatively
similar debt to asset ratios when comparing their level of debt to total
assets. Because Loblaw generates substantially higher earnings, it can
achieve a better times interest earned ratio than Empire. This shows that
even with a higher level of debt, Loblaw is better able to service the debt
and has more financial flexibility.
b.
The following key financial condition ratios are highlighted in either or both
of each companyโs Management Discussion and Analysis and its note to the
financial statements on Capital Management, with all terms defined in the
discussion:
Loblaw
Empire
(Note 24)
(Note 29)
Funded debt to total capital ratio
33.9%
Net funded debt to net capital ratio
31.3%
Funded debt to EBITDA
2.4X
EBITDA to interest expense
7.5X
Adjusted retail debt to adjusted EBITDA
1.6:1
Return on equity
14.1%
4.9%
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Return on capital
Intermediate Accounting, Twelfth Canadian Edition
9.7%
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RA 14.2 LOBLAW AND EMPIRE (CONTINUED)
b. (continued)
As can be seen from the above table, the companies use different ratios to
monitor and present their debt financial condition, and the ratios are
calculated differently. Since these are non-GAAP measures, there is detail
provided as to how these ratios have been calculated in the โNon-GAAP
Financial Measuresโ section of the MD&A, although Empire provides this
information in its Capital Management note as well. Financial analysts may
calculate their own ratios so that the two companies could be compared on
the same basis.
In addition, because Loblawโs operations include PC Bank, it is subject to
regulatory requirements of the Superintendent of Financial Institutions
(OSFI), particularly for equity capital ratios.
c.
Reviewing the long-term debt (Note 15) of Empire, the company has a
relatively small amount of first mortgage loans repayable 2021 to 2033,
medium term notes coming due between 2018 to 2040, credit facilities due
in 2020, finance lease obligations payable over the 2017 to 2040 period,
and miscellaneous other debt. According to Empireโs MD&A, the Dominion
Bond Rating Service (DBRS) assessed the credit rating of Sobeys (Empireโs
major food retailer and operating company) as BB (high) with a negative
trend, and Standard and Poors (S&P) rated it at a BB+ rating with a stable
trend.
Loblaw, in note 21, outlines that its debt is primarily made up of debentures
and medium-term notes that mature on various dates from 2018 to 2040. It
also has borrowings under a term loan facility due in 2019, mortgage
secured debt, guaranteed investment certificates (GICs), and independent
securitization and funding trust borrowings. In addition, the company has
finance lease obligations. In Section 7.5 of Loblawโs MD&A, the company
reports that both DBRS and S&P assigned the company a credit rating of
BBB with a stable trend.
Although Empire has a better debt to assets ratio than Loblaw, the lower
rating for Empire could be expected since its times interest earned ratio is
lower than Loblawโs. This is likely due to the extent of Empireโs off-balance
sheet operating lease obligations: a gross lease obligation of $5,330.5
million (see Note 24), more than its total of on-balance sheet long-term debt
of $2,502.1. Loblaw, on the other hand, reports only $4,425 million gross
lease obligations, less than half its reported long-term debt of $13,360.
Credit analysts would consider all obligations both on and off the statement
of financial position in order to assess financial risk.
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RA 14.2 LOBLAW AND EMPIRE (CONTINUED)
d.
Note 29 provides Empireโs capital management disclosures. The companyโs
objectives in managing its capital are: to ensure ongoing liquidity, to minimize
its cost of capital, to maintain an optimal capital structure to ensure financial
flexibility and that financial covenants are met, and to maintain an investment
grade credit rating. The company defines โcapital under managementโ as
including all interest-bearing debt (funded debt) net of cash and cash
equivalents, plus shareholdersโ equity net of non-controlling interests. The
total capital measure at May 6, 2017 was $5,307.7 million. The key ratios
monitored are: funded debt to total capital, funded debt to EBITDA, and
EBITDA to interest expense. Empire had three financial covenants to
maintain for which they were in compliance: (1) adjusted total debt to
EBITDA, (2) lease adjusted debt to EBITDAR (note: the โRโ refers to rent)
and (3) debt service coverage ratio: EBITDA to the total of interest expense
and repayments of long-term debt over the previous 52 weeks.
In Note 24, Loblaw outlines its capital disclosures. It has six objectives in
managing its capital: to ensure sufficient liquidity to pay its obligations and
to carry out its operating and strategic plans; to maintain financial capacity
and the ability to access capital as needs arise; to minimize its cost of
capital; to use short term funding to manage working capital needs and long
term funding to finance long term capital investments; return appropriate
capital to shareholders; and target appropriate leverage and capital
structure for each reportable operating segments.
Management defines capital as the total of its bank indebtedness, current
debt, current and long-term portions of long-term debt, certain other
liabilities, capital securities and Loblaw shareholdersโ equity. At December
30, 2017 capital under management amounted to $24,980 million.
Loblaw monitors certain interest coverage and leverage ratios as defined by
loan facility agreements. Its major subsidiary, Choice Properties, also has
defined debt service and leverage financial ratios it must meet under
creditor agreements. Loblawโs regulated PC Bank subsidiary is required to
meet a common equity Tier 1 capital ratio of 4.5%, a Tier 1 capital ratio of
6.0%, a total capital ratio of 8.0%, as well as liquidity adequacy
requirements such as a liquidity coverage ratio. Loblaw does not provide the
results of its ratios except to state that it has been in compliance with all
requirements throughout the year.
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RA 14.2 LOBLAW AND EMPIRE (CONTINUED)
e.
Empire explains clearly in Note 3 that structured entities are entities
controlled by the company through means other than share ownership and
voting control. Instead, the company has rights through existing
agreements that give it the ability to direct the other entitiesโ activities that
significantly affect the returns to Empire. Such entities are fully
consolidated with their assets and liabilities being combined with those of
Empire and its subsidiaries. While these structured entities are not
specifically identified, the company has franchise affiliates where control is
attained through franchise agreements, guarantees, and standby letters of
credit.
Loblaw, in Note 2, explains its consolidated structured entities. These
include independent franchisees of the company who obtained funding from
a structured independent funding trust associated with Loblaw to help with
their purchase of inventory and fixed assets. Also, through its banking
subsidiary, PC Bank, Loblaw is party to securitization programs that provide
funds to operate its credit card operations (Eagle Credit Card Trust). This
involves selling some of its interests in credit card receivables to Eagle.
PC Bank continues to service the credit cards and retains the rights to
future cash flows after its obligations to Eagle have been met. Loblaw also
has set up trusts to acquire company shares that will be needed under its
executive compensation restricted share unit (RSU) and its performance
share unit (PSU) stock option plans. The company provides the funds to the
trust to acquire its shares and it earns a management fee from the trust. All
the consolidated structured entities are fully consolidated with their assets
and liabilities reported with those of Loblaw itself.
Loblaw also has unconsolidated structured entities. These are made up of
securitization trusts managed by major Canadian banks, and which Loblaw
cannot control through share ownership or management and asset
agreements.
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RA 14.3 DBRS
Note: the solution to this question will necessarily differ in some respects,
depending on the industry chosen by the student. What follows is derived from
โRating Companies in the Merchandising Industry.โ
a.
DBRS explains that there are three steps in assigning a rating to a
particular security: first there is a general industry assessment and risk
rating assigned; then, through a combination of a more detailed business
risk assessment for a specific issuer, and a financial risk assessment and
rating, the specific issuer is given a rating; and lastly, a specific
instrument rating is determined based on the issuer rating, fine-tuned with
detailed input about the conditions associated with the specific security.
In summary, the financial risk assessment is one part of a two-step
process to convert the risk rating for a particular industry into one for a
specific company in that industry.
b.
The following discussion relates to the merchandising industry,
defined by DBRS as companies โprincipally involved in the selling
of any number and type of consumer products and services.โ
Restaurant chains, wholesalers, and distributors in these
consumer segments are also included.
Industry factors considered in assigning a BBB rating to the industry:
๏ท General characteristics include average stability, low barriers to
entry (high competition), sensitivity to changing real estate
conditions, and minimal regulation
๏ท Some segments of the industry are very sensitive to changes in
economic cycles and some are fairly insensitive to economic
conditions
๏ท Large volume retailers have a distinct advantage related to
purchasing power, distribution efficiencies, and negotiating power
and general influence
๏ท Key success factors for long-term success include effective
working capital management, growth and adaptability,
maximization of inventory turnover, and minimization of pricecutting
๏ท New market accessibility and growth are possible with product and
geographic diversification
๏ท Both leasing and ownership of property have decided advantages
and disadvantages
๏ท Offering credit cards and other financial services can help
operations but come with increased risk
๏ท Online sales increase competition for traditional brick-and-mortar
retailers because of same or similar products with a different cost
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structure but they also offer opportunities to reach more
customers.
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RA 14.3 DBRS (CONTINUED)
b. (continued)
The industry risk rating is determined for the average firm in the industry,
and then the specific company whose business risk is being assessed is
rated relative to this โaverage company.โ
Primary general business risk assessment factors of an issuer:
๏ท The nature of the product offering
๏ท The extent to which the company has a brand name
๏ท The companyโs market position as an indication of sales stability
and pricing power.
๏ท The companyโs operational efficiency related to inventory
management, and sales and pricing issues
๏ท The relative scale of its size, and therefore influence in the market
place
๏ท The extent of its geographic diversification and extent of market
saturation
๏ท Location and flexibility of its property, lease attributes
๏ท For all industries: sovereign risk associated with country of
operation, and corporate governance-related matters
๏ท For some issuers: Product positioning, physical size, location and
level of service; discounter vs. high-end retailer characteristics; ecommerce and online opportunities
๏ท Consumer changing demands and company adaptability
๏ท Management and labour relationships
๏ท Existence of loyalty programs, credit cards, and associated
financial businesses
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RA 14.3 DBRS (CONTINUED)
b. (continued)
General financial risk assessment factors of an issuer:
๏ท A thorough assessment of liquidity in addition to a current and/or
quick ratio โ such as cash on hand, operating cash inflows, and
availability of bank financing, all compared with short and medium
uses of liquidity such as operations, capital expenditures, debt
repayments, share buy-backs, and dividends
๏ท Medium-term profitability, assessed through a variety of measures
such as return on capital
๏ท Free cash flow and other metrics to assess a companyโs capacity
to generate cash for debt repayment
๏ท The companyโs internal financial policies such as targeted
leverage, and dividend and other policies that might indicate a
preference for owners over creditors
๏ท Whether the company has had any difficulties in raising capital
๏ท Depending on the company, measures that involve its capital
structure, pension liabilities, and off-balance sheet liabilities such
as operating lease obligations where various metrics such as
determining the amount of debt, equity, EBITDA, and cash flows
have to be adjusted for the related effects
๏ท Calculating primary metrics such as cash-flow-to-debt, debt-toEBITDA, EBITDA-to-interest, and debt-to-capital
In assessing these financial risks, DBRS points out that their ratings are
based on future expectations for the metrics, and that this is subjective
after analyzing the historic measures. In addition, a companyโs ratios tend
to move from the averages calculated, particularly in cyclical businesses,
but also in others from time to time, so a single simple metric cannot be
used on its own. The rating agency also cautions that adjustments may
be needed for inter-company comparisons due to the use of different
accounting principles; and for consistency of the ratio variables with the
financial terms according to DBRS definitions.
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RA 14.3 DBRS (CONTINUED)
c.
DBRS defines the following terms used in part (b) above in its publication
DBRS Criteria: Financial Ratio Definitions and Accounting Adjustments โ
Non-Financial Companies:
Cash flow from operations: core net income + depreciation +
amortization + deferred taxes + other non-cash items from income
statement (before changes in non-cash working capital items)
Debt, total: short-term debt + long-term debt + hybrid debt portion +
capital leases
Debt, net: total debt โ cash
EBITDA: revenue โ cost of goods sold โ selling, general and
administrative expenses
Interest expense, gross: all interest expense + debt hybrid interest
expense + capitalized interest (excludes any IFRS adjustments)
Interest expense, net: gross interest expense โ interest income from
cash and short-term investments
Capital, total: total debt + total preferred equity + total common equity +
minority interest + capital leases
Capital, adjusted: total capital + capitalized operating leases
Ratio analysis is much closer to an art than to a science. An art requires
the significant use of judgement in determining an outcome, whereas a
science has a more prescribed outcome. Science is more โfactโ and art is
more โopinion.โ
DBRS shows 47 ratio definitions, 54 ratio term definitions, 7 particular
areas where further adjustments might be needed, as well as guidance
on off-balance-sheet items that might need to be considered in order to
standardize the input involved in determining ratio values to a reasonable
extent. Even with this extent of guidance, judgement is still required in
developing the appropriate metrics.
Once the metrics based on historic numbers are determined, judgement
needs to be applied in assessing future results and positions because
this is the key in rating companies and preparing inter-company
comparisons. Using the ratios also involves taking into account a
multitude of variables related to economic conditions and industry
outlooks. It is definitely an area that requires significant professional
judgement gained from experience.
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RA 14.4 AIR CANADA& WESTJET
a.
Debt to equity ratio = (Total debt) / (Total equity)
Times interest earned = (Income before income taxes + interest expense) /
(Interest expense)
Air Canada: (in $ millions)
Debt to equity ratio = $14,319 / $3,379 = 4.24 : 1
Times interest earned = ($2,038 – 759 + $311)/ $311 = 5.11 times
WestJet: (in $ thousands)
Debt to equity ratio = $4,287,316 / $2,212,524 = 1.94 : 1
Times interest earned = ($283,578 + $120,557 + $53,710) / $53,710 = 8.52
times
The ratios indicate that Air Canada is very highly leveraged and very risky.
Its liabilities equal 4.24 times its shareholder equity. This means that
amounts owed to creditors amount to almost as must as the companyโs total
assets. However, its income before taxes and interest this year were
sufficient to cover its interest cost.
WestJetโs debt to equity ratio appears more reasonable with liabilities equal
to 1.94 times its shareholdersโ equity. While still a very high ratio, it is
considerably better than Air Canadaโs. Its operations also appear less risky
with income before interest and taxes being a little over 8.5 times its
required interest cost. Here there is a far better safety net in case of
difficulties.
b.
Air Canada: adjusted debt to equity ratio
Adjusted debt to equity ratio (See Note 17)
= $9,920 / $3,379 = 2.94 : 1
WestJet: adjusted debt to equity (See Note 3)
= $3,293,312 / $2,212,524 = 1.49 : 1
The results of the revised calculations underscore the necessity of always
understanding what is included in the terms used in any given ratio. It is
reasonable for the companies to zero in on their long-term interest-bearing
debt, including the addition of the capitalized amount of operating leases, as
being an important part of the capital they manage as both Air Canada and
WestJet have done. The leverage ratios used internally for management
purposes — for both companies โ appear better than using the general ratio
often used.
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RA 14.4 AIR CANADA& WESTJET (CONTINUED)
b. (continued)
Both determined โadjusted debtโ using the same approach: they added
capitalized operating lease obligations to their long-term debt (including its
current portion) and both excluded current liabilities from the definition of
debt. However, Air Canadaโs adjustments were done on a more liberal basis
than WestJetโs more conservative approach. For example, WestJet
calculated the capitalized operating lease obligations using a multiplier of
7.5 times annual lease/rent expense, while Air Canada used a factor of 7.0
times โ both companies indicating this was the industry norm.
For the debt to equity measures used internally by the companies, both
made adjustments to the shareholdersโ equity numbers on the statement of
financial position. Air Canada, in fact, measures โequityโ as the price of its
common shares in the market at year end, thus providing a more positive
number to use in its adjusted debt-to-equity ratio. The internal measure
used for Air Canada was $9,920 / $7,067 = 1.40 : 1using market
capitalization as a substitute for shareholderโs equity. The company does
not provide any information on what guidelines it aims for and judges
acceptable.
WestJet makes only a small adjustment to its reported shareholdersโ equity
by adding back the hedging reserves portion of shareholdersโ equity. Its
internal adjusted debt-to-equity measure, therefore, is $3,293,312 /
$2,214,426 = 1.49 : 1. WestJet discloses that it has a guideline for adjusted
debt-to-equity of less than 2.5. It is well within this guideline.
c.
Air Canada indicates that it can adjust its capital structure through varying
the following decisions:
๏ท Lease versus purchase decisions
๏ท Deferring or cancelling aircraft expenditures by not exercising or
by selling options it has for aircraft
๏ท Issuing debt, redeeming debt, or issuing equity securities
๏ท Repurchasing shares
WestJet indicates that it has choices of the following in order to maintain its
capital structure:
๏ท Purchase shares for cancellation
๏ท Issue new shares
๏ท Pay dividends
๏ท Adjust current and projected debt levels
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