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Chapter 14: Q19E (page 758)

Fallen Company commonly issues long-term notes payable to its various lenders. Fallen has had a pretty good credit rating such that its effective borrowing rate is quite low (less than 8% on an annual basis). Fallen has elected to use the fair value option for the long-term notes issued to Barclay鈥檚 Bank and has the following data related to the carrying and fair value for these notes. Any changes in fair value are due to changes in market rates, not credit risk.

Carrying Value

Fair Value

December 31, 2017

\(54,000

\)54,000

December 31, 2018

44,000

42,500

December 31, 2019

36,000

38,000

Instructions

(a) Prepare the journal entry at December 31 (Fallen鈥檚 year-end) for 2017, 2018, and 2019, to record the fair value option for these notes.

(b) At what amount will the note be reported on Fallen鈥檚 2018 balance sheet?

(c) What is the effect of recording the fair value option on these notes on Fallen鈥檚 2019 income?

(d) Assuming that general market interest rates have been stable over the period, does the fair value data for the notes indicate that Fallen鈥檚 creditworthiness has improved or declined in 2019? Explain.

Short Answer

Expert verified

(a) No entry needs to be passed for 31/12/2017. At the end of 2018 and 2019, unrealized holding gains/losses were $1,500 and $3,500.

(b) The fair value of $42,500.

(c) Unrealized holding loss of $3,500.

(d) Throughout 2019, Fallen's creditworthiness has increased.

Step by step solution

01

Meaning of Fair value

According to a company's financial statement, the fair value represents the estimated value of its assets and liabilities.Fair market value refers to an item's fair sale value for the buyer and seller.

02

(a) Preparing journal entry

Date

Particulars

Debit ($)

Credit ($)

31/12/2017

No entry

31/12/2018

Notes payable ($44,000鈭�$42,500)

1,500

Unrealized Holdings gain

1,500

31/12/2019

Unrealized Holdings Gain/Loss

3,500

Notes Payable($38,000鈭�$36,000+$1,500)

3,500

Notes: No entry on 31/12/2017 since carrying value = Fair value.

03

(b) Amount to be reported on Fallen’s 2018 balance sheet

The note will be reported at fair value as of Dec 31, 2018, on Fallen's balance sheet.

Hence, the note will report at $42,500

04

(c) Effect of recording the fair value option on these notes on Fallen’s 2019 income

Fallen's net income will decrease by $3,500per the 3rd journal entry since the change in fair value will be deducted from the net income.

05

Explaining whether the fair value data for the notes indicate that Fallen’s creditworthiness has improved or declined in 2019

Fallen's creditworthiness has increased throughout 2019 due to bond investors earning a greater yield than investors in investments with comparable risk. Changes in fallen credit risk should be considered when recording any gains or losses in other comprehensive income.

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Most popular questions from this chapter

(Entries for Redemption and Issuance of Bonds) Matt Perry, Inc. had outstanding \(6,000,000 of 11% bonds (interest payable July 31 and January 31) due in 10 years. On July 1, it issued \)9,000,000 of 10%, 15-year bonds (interest payable July 1 and January 1) at 98. A portion of the proceeds was used to call the 11% bonds (with unamortized discount of $120,000) at 102 on August 1.

Instructions

Prepare the journal entries necessary to record issue of the new bonds and refunding of the bonds.

(Term Modification with Gain鈥擠ebtor鈥檚 Entries) Use the same information as in E14-22 above except that American Bank reduced the principal to \(1,900,000 rather than \)2,400,000. On January 1, 2021, Barkley pays $1,900,000 in cash to American Bank for the principal. Instructions

(a) Can Barkley Company record a gain under this term modification? If yes, compute the gain for Barkley Company.

(b) Prepare the journal entries to record the gain on Barkley鈥檚 books.

(c) What interest rate should Barkley use to compute its interest expense in future periods? Will your answer be the same as in E14-22 above? Why or why not?

(d) Prepare the interest payment schedule of the note for Barkley Company after the debt restructuring.

(e) Prepare the interest payment entries for Barkley Company on December 31, of 2018, 2019, and 2020.

(f) What entry should Barkley make on January 1, 2021?

E14-3 (L01) (Entries for Bond Transactions) Presented below are two independent situations.

1. On January 1, 2017, Simon Company issued \(200,000 of 9%, 10-year bonds at par. Interest is payable quarterly on April 1, July 1, October 1, andJanuary 1.

2. On June 1, 2017, Garfunkel Company issued \)100,000 of 12%, 10-year bonds dated January 1 at par plus accrued interest. Interest is payable semi-annually on July 1 and January 1.

Instructions

For each of these two independent situations, prepare journal entries to record the following.

(a) The issuance of the bonds.

(b) The payment of interest on July 1.

(c) The accrual of interest on December 31.

E14-1 (L01) (Classification of Liabilities) Presented below are various account balances of K.D. Lang Inc.

(a) Unamortized premium on bonds payable, of which \(3,000 will be amortized during the next year.

(b) Bank loans payable of a winery, due March 10, 2021. (The product requires aging for 5 years before sale.)

(c) Serial bonds payable, \)1,000,000, of which \(200,000 are due each July 31.

(d) Amounts withheld from employees鈥� wages for income taxes.

(e) Notes payable due January 15, 2020.

(f) Credit balances in customers鈥� accounts arising from returns and allowances after collection in full of account.

(g) Bonds payable of \)2,000,000 maturing June 30, 2018.

(h) Overdraft of $1,000 in a bank account. (No other balances are carried at this bank.)

(i) Deposits made by customers who have ordered goods.

Instructions

Indicate whether each of the items above should be classified on December 31, 2017, as a current liability, a long-term liability, or under some other classification. Consider each one independently from all others; that is, do not assume that all of them relate to one particular business. If the classification of some of the items is doubtful, explain why in each case.

BE14-1 (L01) Whiteside Corporation issues $500,000 of 9% bonds, due in 10 years, with interest payable semi-annually. At the time of issue, the market rate for such bonds is 10%. Compute the issue price of the bonds.
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