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# Case 8-1: Norman Corporation (A)* Note: This case has been updated from the Twelfth Edition.

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This teaching note was prepared Robert N. Anthony. Copyright Robert N. Anthony.

straight-line depreciation, one-fifth of the asset amount (\$7,000) should be charged as depreciation expense in 2010. Note that the depreciation charge is based on useful life, not the lease term or ACRS schedules. If the student has been required to cover the appendix, enough information is given to calculate the interest rate of the lease, which is 8 percent (see below). Thus the \$13,581 first-year payment is divided between \$2,800 interest expense (.08 * \$35,000) and \$10,781 reduction of capital lease obligations. Answer to Optional Question 2 We are told to assume that the \$100,000 (par value) bond with a 5 percent coupon rate in item 4 of Question 1 involves 15 year-end annual interest payments of \$5,000 (\$100,000 * 0.05). (The payments are assumed to be annual, at year-end, rather than the more realistic semiannual, so that students not having PV calculators can use the texts appendix tables.) Tables A and B and a rate of 8 percent results in a present value of \$5,000 * 8.559 = \$42,795 for interest payments plus \$100,000 * 0.315 = \$31,500, or a total of \$74,295; since the investor paid \$80,000, the yield rate is less than 8 percent. Trying 6 percent, we get PV = (\$5,000 * 9.712) + (\$100,000 * 0.417) = \$90,260; so we know the yield is between 6 and 8 percent. Using 7 percent and linear interpolation in Tables A and B. we have PV = (\$5,000 * 9.135) + (\$100,000 * .366) = \$82,275. (The mathematically inclined student will realize that linear interpolation for 7.0 percent will result in the average of the two PVs we found for 6 and 8 percent, except for rounding.) I accept 7 percent as a perfectly adequate answer. Those with calculators will come up with 7.23. As for the correctness of the \$784 first-year bond discount amortization, the calculation is as follows: Since the bond proceeds were \$80,000 and the true yield was 7.23 percent, then Year 1 net interest should be \$80,000 * 0.0723 = \$5,784. But the stated (cash) interest payment is \$5,000; thus the remaining \$784 of interest expense is amortization of bond discount. Ms. Fullers calculation was correct. Answer to Optional Question 3 The interest rate is determined by finding the value in Table B equal to \$35,000 divided by the annual payments of \$13,581 for a period of 3 years (\$35,000 divided by \$13,581 = 2.577). The interest rate is 8 percent. The amortization schedule: Principal Reduction \$10,781 11,643 12,575

Year 1 2 3

## Interest \$2,800 1,938 1,006

I use this schedule to generate journal entries for the lease payment and then show the asset depreciation entries, which are based on the useful life of five years.