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Chapter 14: Q2E (page 754)

E14-2 (L01) (Classification) The following items are found in the financial statements.

(a) Discount on bonds payable.

(b) Interest expense (credit balance).

(c) Unamortized bond issue costs.

(d) Gain on repurchase of debt.

(e) Mortgage payable (payable in equal amounts over next 3 years).

(f) Debenture bonds payable (maturing in 5 years).

(g) Notes payable (due in 4 years).

(h) Premium on bonds payable.

(i) Bonds payable (due in 3 years).

Instructions

Indicate how each of these items should be classified in the financial statements.

Short Answer

Expert verified

Item

Classification in the financial statement

(a) Discount on bonds payable.

Contra-account to bond payable

(b) Interest expense (credit balance).

Interest payable (current liability)

(c) Unamortized bond issue costs.

Part of long-term liabilities

(d) Gain on repurchase of debt.

Other gains and losses in the income statement

(e) Mortgage payable (payable in equal amounts over next 3 years).

1/3 of the total amountas the current portion of long-term debt and 2/3 as long-term debt

(f) Debenture bonds payable (maturing in 5 years).

Long-term liability

(g) Notes payable (due in 4 years).

Long-term liability

(h) Premium on bonds payable.

Adjunct to the bond payable (long-term liability account)

(i) Bonds payable (due in 3 years).

Long-term liability

Step by step solution

01

Definition of Liability

Any event that will create the outflow of economic benefits is known as liability. The liability of the business entity is reported in the financial statement known as the balance sheet, under which it is classified as current and non-current.

02

Classification in the financial statement

(a) Discount on bond payable reduces the carrying value of the bond payable. Therefore, it is reported as a contra-account of bond payable.

(b) Interest expenses (credit balance) refers to the interest expenses that are not paid. These are reported as interest payable in the current liability.

(c) The unamortized cost incurred in the bond issue will be reported as part of the long-term liability, i.e., bonds payable.

(d) Gain on redemption of debt will be reported as other income in the income statement of the business entity.

(e) The portion of the mortgage that will be paid within the operating period will be classified as the current portion of long-term debt, and the remaining will be reported as long-term debt.

(f) Debenture bond payable will mature after the operating period and, therefore, will be reported as a long-term liability.

(g) Note payable that will get due in 4 years will be reported as long-term debt in the balance sheet.

(h) Premium on bond payable will be reported as an adjunct account to the bond payable in the long-term liabilities section. It will be added to the bond payable.

(i) Bond payable due after an operating period will be reported as long-term liability.

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Most popular questions from this chapter

Pierre Company has a 12% note payable with a carrying value of \(20,000. Pierre applies the fair value option to this note. Given an increase in market interest rates, the fair value of the note is \)22,600. Prepare the entry to record the fair value option for this note, assuming

(a) no change in credit risk, and

(b) the change is due to a change in credit risk.

Question: What is the required method of amortizing discount and premium on bonds payable? Explain the procedures.

Part I: The appropriate method of amortizing a premium or discount on issuance of bonds is the effective-interest method.

Instructions

  1. What is the effective-interest method of amortization and how is it different from and similar to the straight-line method of amortization?
  2. How is amortization computed using the effective-interest method, and why and how do amounts obtained using the effective-interest method differ from amounts computed under the straight-line method?

Part II: Gains or losses from the early extinguishment of debt that is refunded can theoretically be accounted for in three ways:

  1. Amortized over remaining life of old debt.
  2. Amortized over the life of the new debt issue.
  3. Recognized in the period of extinguishment

Instructions

  1. Develop supporting arguments for each of the three theoretical methods of accounting for gains and losses from the early extinguishment of debt.
  2. Which of the methods above is generally accepted and how should the appropriate amount of gain or loss be shown in a company鈥檚 financial statements?

Question: (Restructure of Note under Different Circumstances) Halvor Corporation is having financial difficulty and therefore has asked Frontenac National Bank to restructure its \(5 million note outstanding. The present note has 3 years remaining and pays a current rate of interest of 10%. The present market rate for a loan of this nature is 12%. The note was issued at its face value.

Instructions

The following are four independent situations. Prepare the journal entry that Halvor and Frontenac National Bank would make for each of these restructurings.

(a) Frontenac National Bank agrees to take an equity interest in Halvor by accepting common stock valued at \)3,700,000 in exchange for relinquishing its claim on this note. The common stock has a par value of \(1,700,000.

(b) Frontenac National Bank agrees to accept land in exchange for relinquishing its claim on this note. The land has a book value of \)3,250,000 and a fair value of \(4,000,000.

(c) Frontenac National Bank agrees to modify the terms of the note, indicating that Halvor does not have to pay any interest on the note over the 3-year period.

(d) Frontenac National Bank agrees to reduce the principal balance due to \)4,166,667 and require interest only in the second and third year at a rate of 10%.

On April 1, 2017, Seminole Company sold 15,000 of its 11%, 15-year, \(1,000 face value bonds at 97. Interest payment dates are April 1 and October 1, and the company uses the straight-line method of bond discount amortization. On March 1, 2018, Seminole took advantage of favorable prices of its stock to extinguish 6,000 of the bonds by issuing 200,000 shares of its \)10 par value common stock. At this time, the accrued interest was paid in cash. The company鈥檚 stock was selling for $31 per share on March 1, 2018.

Instructions

Prepare the journal entries needed on the books of Seminole Company to record the following.

(a) April 1, 2017: issuance of the bonds.

(b) October 1, 2017: payment of semi-annual interest.

(c) December 31, 2017: accrual of interest expense.

(d) March 1, 2018: extinguishment of 6,000 bonds. (No reversing entries made.)
See all solutions

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