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Chapter 14: Q9Q (page 752)

Briggs and Stratton recently issued debt with issue costs of $5.1 million. How should the costs of issuing these bonds be accounted for and classified in the financial statements?

Short Answer

Expert verified

The costs of issuing bonds should be listed as a deduction in the issuance value and are classified as an expense in the financial statements.

Step by step solution

01

Meaning of Financial Statements

Financial statements are the instruments of judging earning potential and managerial efficiency, which provides a comparison and assist in evaluating the company鈥檚 performance. Hence, these provide necessary inputs for predicting and other relevant decision-making purposes.

02

Accounting for bonds issuance costs and their classification in financial statements

The cost borne during the method of debt issuance is termed the unamortized debt issue cost. The costs incurred for issuing bonds should be reported as a decrease in the issuance value and then paid off as an expense over the duration of the bond.

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Most popular questions from this chapter

On December 31, 2017, American Bank enters into a debt restructuring agreement with Barkley Company, which is now experiencing financial trouble. The bank agrees to restructure a 12%, issued at par, \(3,000,000 note receivable by the following modifications:

  1. Reducing the principal obligation from \)3,000,000 to \(2,400,000.
  2. Extending the maturity date from December 31, 2017, to January 1, 2021.
  3. Reducing the interest rate from 12% to 10%.

Barkley pays interest at the end of each year. On January 1, 2021, Barkley Company pays \)2,400,000 in cash to American Bank.

Instructions

  1. Will the gain recorded by Barkley be equal to the loss recorded by American Bank under the debt restructuring?
  2. Can Barkley Company record a gain under the term modification mentioned above? Explain.
  3. Assuming that the interest rate Barkley should use to compute interest expense in future periods is 1.4276%, prepare the interest payment schedule of the note for Barkley Company after the debt restructuring.
  4. Prepare the interest payment entry for Barkley Company on December 31, 2019.
  5. What entry should Barkley make on January 1, 2021?

Shonen Knife Corporation has elected to use the fair value option for one of its notes payable. The note was issued at an effective rate of 11% and has a carrying value of \(16,000. At year-end, Shonen Knife鈥檚 borrowing rate (credit risk) has declined; the fair value of the note payable is now \)17,500. (a) Determine the unrealized holding gain or loss on the note. (b) Prepare the entry to record any unrealized holding gain or loss.

Matt Ryan Corporation is interested in building its own soda can manufacturing plant adjacent to its existing plant in Partyville, Kansas. The objective would be to ensure a steady supply of cans at a stable price and to minimize transportation costs. However, the company has been experiencing some financial problems and has been reluctant to borrow any additional cash to fund the project. The company is not concerned with the cash flow problems of making payments, but rather with the impact of adding additional long-term debt to its balance sheet.

The president of Ryan, Andy Newlin, approached the president of the Aluminum Can Company (ACC), its major supplier, to see if some agreement could be reached. ACC was anxious to work out an arrangement, since it seemed inevitable that Ryan would begin its own can production. The Aluminum Can Company could not afford to lose the account.

After some discussion, a two-part plan was worked out. First, ACC was to construct the plant on Ryan鈥檚 land adjacent to the existing plant. Second, Ryan would sign a 20-year purchase agreement. Under the purchase agreement, Ryan would express its intention to buy all of its cans from ACC, paying a unit price which at normal capacity would cover labor and material, an operating management fee, and the debt service requirements on the plant. The expected unit price, if transportation costs are taken into consideration, is lower than current market. If Ryan did not take enough production in any one year and if the excess cans could not be sold at a high enough price on the open market, Ryan agrees to make up any cash shortfall so that ACC could make the payments on its debt. The bank will be willing to make a 20-year loan for the plant, taking the plant and the purchase agreement as collateral. At the end of 20 years, the plant is to become the property of Ryan.

Instructions

  1. What are project financing arrangements using special-purpose entities?
  2. What are take-or-pay contracts?
  3. Should Ryan record the plant as an asset together with the related obligation?
  4. If not, should Ryan record an asset relating to the future commitment?
  5. What is meant by off-balance-sheet financing?

Gottlieb Co. owes \(199,800 to Ceballos Inc. The debt is a 10-year, 11% note. Because Gottlieb Co. is in financial trouble, Ceballos Inc. agrees to accept some land and cancel the entire debt. The property has a book value of \)90,000 and a fair value of $140,000.

Instructions

  1. Prepare the journal entry on Gottlieb鈥檚 books for debt restructure.
  2. Prepare the journal entry on Ceballos鈥檚 books for debt restructure

The following amortization and interest schedule reflects the issuance of 10-year bonds by Capulet Corporation on January 1, 2011, and the subsequent interest payments and charges. The company鈥檚 year-end is December 31, and financial statements are prepared once yearly.

Amortization Schedule

Year

Cash

Interest

Amount unamortized

Carrying value

1/1/2011

\(5,651

\)94,349

2011

\(11,000

\)11,322

5,329

94,671

2012

11,000

11,361

4,968

95,032

2013

11,000

11,404

4,564

95,436

2014

11,000

11,452

4,112

95,888

2015

11,000

11,507

3,605

95,395

2016

11,000

11,567

3,038

96,962

2017

11,000

11,635

2,403

97,597

2018

11,000

11,712

1,691

98,309

2019

11,000

11,797

894

99,106

2020

11,000

11,894

100,000

Instructions

(a) Indicate whether the bonds were issued at a premium or a discount and how you can determine this fact from the schedule.

(b) Indicate whether the amortization schedule is based on the straight-line method or the effective-interest method, and how you can determine which method is used.

(c) Determine the stated interest rate and the effective-interest rate.

(d) On the basis of the schedule above, prepare the journal entry to record the issuance of the bonds on January 1, 2011.

(e) On the basis of the schedule above, prepare the journal entry or entries to reflect the bond transactions and accruals for 2011. (Interest is paid on January 1.)

(f) On the basis of the schedule above, prepare the journal entry or entries to reflect the bond transactions and accruals for 2018. Capulet Corporation does not use reversing entries.
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