Accounting Ch10

CHAPTER 10
Reporting and Analyzing Liabilities

ANSWERS TO QUESTIONS
1.
While this is generally true, more precisely a current liability is a debt that can reasonably be
expected to be paid: (a) from existing current assets or through the creation of other current
liabilities and (2) within one year or the operating cycle, whichever is longer.
2.
In the balance sheet, Notes Payable of $20,000 and Interest Payable of $450 ($20,000 X 9% X
3/12) should be reported as current liabilities. In the income statement, Interest Expense of $450
should be reported under other expenses and losses.
3.
(a) Disagree. The company only serves as a collection agent for the taxing authority. It does not
report sales taxes as an expense; it merely forwards the amount paid by the customer to the
government.
(b) The entry to record the proceeds is:
Cash ........................................................................................
Sales ................................................................................
Sales Taxes Payable........................................................
4.
8,550
8,000
550
(a) The entry when the tickets are sold is:

Cash .........................................................................................
Unearned Football Ticket Revenue ...................................
810,000
(b) The entry after each game is:

Unearned Football Ticket Revenue ...........................................
Football Ticket Revenue....................................................
162,000
810,000
162,000
5.
Three taxes commonly withheld by employers from employees gross pay are (1) federal income
taxes, (2) state income taxes, and (3) social security (FICA) taxes.
6.
(a) Three taxes commonly paid by employers on employees salaries and wages are (1) social
security (FICA) taxes, (2) state unemployment taxes, and (3) federal unemployment taxes.
(b) Taxes withheld from employees gross pay and not yet remitted to the appropriate
government agency are reported in the balance sheet as current liabilities.
7.
The liabilities that Tootsie Roll identified as current are: Accounts payable, Dividends payable,
Accrued liabilities, and Income taxes payable.
8.
(a) Long-term liabilities are obligations that are expected to be paid after one year. Examples
include bonds and long-term notes.
(b) Bonds are a form of interest-bearing notes payable used by corporations, universities, and
governmental agencies.
Copyright 2010 John Wiley & Sons, Inc.
Kimmel, Financial Accounting, 5/e, Solutions Manual
(For Instructor Use Only)
10-1
Questions Chapter 10 (Continued)

9.
(a) Secured bonds have specific assets of the issuer pledged as collateral. In contrast, unsecured
bonds are issued against the general credit of the borrower.
(b) Convertible bonds permit bondholders to convert them into common stock at their option. In
contrast, callable bonds are subject to call and retirement at a stated dollar amount prior to
maturity at the option of the issuer.
10.
(a) Face value is the amount of principal due at the maturity date.
(b) The contractual interest rate is the rate used to determine the amount of cash interest the
borrower pays and the investor receives. This rate is also called the stated interest rate
because it is the rate stated on the bonds.
(c)
11.
A bond certificate is a legal document that indicates the name of the issuer, the face value of
the bonds, and such other data as the contractual interest rate and maturity date of the bonds.
(a) A convertible bond permits bondholders to convert it into common stock at the option of the
bondholders.
(b) For bondholders, the conversion option gives an opportunity to benefit if the market price
of the common stock increases substantially. For the issuer, convertible bonds usually have:
(1) a lower rate of interest than other debt securities, (2) a higher selling price.
12.
The two major obligations incurred by a company when bonds are issued are the interest
payments due on a periodic basis and the principal which must be paid at maturity.
13.
Less than. Investors were required to pay more than the face value; therefore, the market interest
rate is less than the contractual rate.
14.
No, Oprah is not right. The market price on any bond is a function of three factors: (1) the dollar
amounts to be received by the investor (interest and principal), (2) the length of time until the
amounts are received (interest payment dates and maturity date), and (3) the market interest rate.
15.
$48,000. $800,000 X 6% X 1 year = $48,000.
16.
$664,000. The balance of the Bonds Payable account minus the balance of the Discount on
Bonds Payable account (or plus the balance of the Premium on Bonds Payable account) equals
the carrying value of the bonds.
17.
Debits:
Credits:
18.
10-2
Bonds Payable (for the face value) and Premium on Bonds Payable (for the
unamortized balance).
Cash (for 97% of the face value) and Gain on Bond Redemption (to balance entry).
Two issues need to be considered. First, by financing a major purchase such as this with shortterm financing the company will reduce its liquidity. In the case of Hangers Inc., its current ratio
will decrease from 2.2:1 to a less acceptable level of 1.5:1. However, of equal concern is that by
financing a long-term project with short-term financing the company is exposing itself to interest
rate risk. The company has the choice of locking in a long-term rate of 8%, or continually refinancing at whatever the short-term rate is when its short-term debt matures. If short-term rates
increase substantially the increase in interest expense could significantly reduce the companys
profitability.

19. (a) The nature and the amount of each long-term liability should be presented in the balance
sheet or in schedules in the accompanying notes to the financial statements. The notes
should also indicate the interest rates, maturity dates, conversion privileges, and assets
pledged as collateral.
(b) To evaluate liquidity a company may compute working capital and the current ratio. To
evaluate long-run solvency a company may compute a debt to total assets ratio, and a times
interest earned ratio.
20. No, William is not correct. Liquidity involves measuring the short-term ability of a company to pay
its maturing obligations and to meet unexpected needs for cash. Solvency involves measuring
the ability of a company to survive over a long period of time.
21. When companies are trying to overcome customer skepticism about the quality of their product
they often consider providing a more generous warranty. While this may be effective in increasing
sales, it is not without costs. Clearly a longer warranty will usually result in more warranty claims.
Warranties are a contingent liability that must be accrued for each year. If the warranty period is
extended, the size of this accrual could increase significantly. If the quality of the companys
product is not improved at the same time that the warranty is extended, it is quite possible that
the increase in the estimated warranty accrual could exceed the increase in net income from
expanded sales from the more generous warranty.
22. One alternative to purchasing the assets is to lease them through an operating lease agreement.
In an operating lease, the lease payments are recorded as an expense. This allows the lessee to
keep the leased assets and, more importantly, lease liabilities off the balance sheet (referred to as
off-balance-sheet financing). Keeping lease liabilities off the balance sheet will have a favorable
impact on the lessees liquidity and solvency ratios.
Another option is to lease the assets through a capital lease agreement. However, in a capital
lease the lessee must record the asset and a related liability for the lease payments. This treatment would impact liquidity and solvency ratios the same way the purchase of assets would.
23. Sam is not correct. In order to reduce costs, many companies today keep low amounts of inventory
on hand. Consequently, liquidity ratios are generally lower than they used to be. Companies that
keep fewer liquid assets on hand frequently rely on a bank line of credit. A line of credit allows a
company to borrow money on a short-term basis to meet any cash shortfalls caused by a low
amount of liquid assets.
24. If a company has significant operating leases, most analysts would argue that its recorded
assets and liabilities understate its true values. These analysts will increase the companys
liabilities and assets for the unrecorded operating leases.
25. Two criteria must be met: (1) the contingency must be probable and (2) the company must be
able to arrive at a reasonable estimate. If these criteria are not met, the company should disclose
the major facts concerning the contingency in the notes to its financial statements.
10-3

*26.
The straight-line method of amortization results in the same amortized amount being assigned to
Interest Expense each interest period. This amount is determined by dividing the total bond
discount or premium by the number of interest periods the bonds will be outstanding.
*27.
The total amount of interest expense is $10,800. Interest expense is the interest to be paid in cash
less the premium amortization for the year. Cash to be paid equals 6% X $200,000 or $12,000.
Total premium equals 3% of $200,000 or $6,000. Since this is to be amortized over 5 years (the
life of the bonds) in equal amounts, the amortization amount is $6,000 5 = $1,200. Thus,
$12,000 $1,200 or $10,800 is the interest expense for 2010.
*28.
Lucia is probably indicating that since the borrower has the use of the bond proceeds over the
term of the bonds, the borrowing rate in each period should be the same. The effective-interest
method results in a varying amount of interest expense but a constant rate of interest on the
balance outstanding. Accordingly, it results in a better matching of expenses with revenues than
the straight-line method.
*29.
Decrease. Under the effective-interest method the interest expense per period is determined
by multiplying the carrying value of the bonds by the effective-interest rate. When bonds are
issued at a premium, the carrying value decreases over the life of the bonds. As a result, the interest
expense will also decrease over the life of the bonds because it is determined by multiplying the
decreasing carrying value of the bonds at the beginning of the period by the effective-interest rate.
10-4
SOLUTIONS TO BRIEF EXERCISES

BRIEF EXERCISE 10-1
(a) A note payable due in two years is a long-term liability, not a current
liability.
(b) $20,000 of the mortgage payable is a current maturity of long-term
debt. This amount should be reported as a current liability.
(c) Interest payable is a current liability because it will be paid out of
current assets in the near future.
(d) Accounts payable is a current liability because it will be paid out of
current assets in the near future.
BRIEF EXERCISE 10-2

(a) July 1
(b) Dec. 31
Cash ..........................................................
Notes Payable ...................................
90,000
Interest Expense.......................................
Interest Payable
($90,000 X 8% X 6/12)....................
3,600
90,000
3,600
BRIEF EXERCISE 10-3

Sales tax payable
(1) Sales = ($11,395 1.06) = $10,750
(2) Sales taxes payable = ($10,750 X 6%) = $645
or $11,395 $10,750 = $645
Mar. 16
Cash ..................................................................
Sales ..........................................................
Sales Taxes Payable.................................
11,395
10,750
645
10-5
BRIEF EXERCISE 10-4

(a) Cash (3,800 X $80) .................................................
Unearned Basketball Ticket Revenue ...........
(To record sale of 3,800 season tickets)
304,000
(b) Unearned Basketball Ticket Revenue...................

Basketball Ticket Revenue ($304,000 10) ...
(To record basketball ticket revenue
earned)
30,400
304,000
30,400
BRIEF EXERCISE 10-5

Income before interest and taxes
Interest ($2,000,000 X 6%)
Income before income taxes
Income tax expense (30%)
Net income (a)
Outstanding shares (b)
Earnings per share (a) (b)
Issue Stock
Issue Bond
$1,500,000
0
1,500,000
450,000
$1,050,000
$1,500,000
120,000
1,380,000
414,000
$ 966,000
900,000
$1.17
700,000
$1.38
Net income is higher if stock is used. However, earnings per share is lower
than earnings per share if bonds are used because of the additional shares
of stock that are outstanding.
BRIEF EXERCISE 10-6

(a) Jan. 1
(b) Dec. 31
(c) Jan. 1
10-6
Cash.................................................
Bonds Payable
(2,000 X $1,000) ...................
2,000,000
Bond Interest Expense ...................

Bond Interest Payable
($2,000,000 X 7%) ................
140,000
Bond Interest Payable ....................

Cash .........................................
140,000
2,000,000
140,000
140,000
BRIEF EXERCISE 10-7

Bonds Payable .........................................................
Loss on Bond Redemption
($2,040,000 $1,970,000) .....................................
Cash ($2,000,000 X 1.02) ..................................
Discount on Bonds Payable ............................
2,000,000
70,000
2,040,000
30,000
BRIEF EXERCISE 10-8

Long-term liabilities
Bonds payable, due 2014 .................................
Less: Discount on bonds payable ..................
Notes payable, due 2012 ..................................
Total long-term liabilities..........................
$700,000
21,000
$679,000
80,000
$759,000
BRIEF EXERCISE 10-9

SHEELY INC.
Balance Sheet (Partial)
December 31, 2010
Current liabilities
Bank note payable.....................................
Accounts payable......................................
Current portion of long-term debt ............
Interest payable .........................................
Employee benefits payable.......................
Property tax payable .................................
Sales taxes payable...................................
Total current liabilities..........................
Bonds payable, due 2014..........................
Less: Discount on bonds payable...........
Notes payable, due 2012 ...........................
Total long-term liabilities.....................
Total liabilities...................................................
$ 20,000
155,000
240,000
40,000
7,800
3,500
1,400
$ 467,700
$900,000
45,000
855,000
80,000
935,000
$1,402,700
10-7
BRIEF EXERCISE 10-10

(a)
(b)
(c)
(d)
Working capital = $3,925 $2,192 = $1,733

Current ratio = $3,925 $2,192 = 1.79
Debt to total assets = $5,543 $8,379 = 66%
Times interest earned = ($496 + $227 + $197) $197 = 4.67 times
Working capital and the current ratio measure a companys ability to pay
obligations and meet cash needs. Adidass current assets are 79% larger
than the amount of its current liabilities which indicates a relatively high
degree of liquidity.
Debt to total assets and times interest earned measure a companys ability
to survive over a long period of time. Adidass debt to total assets ratio
indicates that approximately $.66 of every dollar invested in assets was
provided by creditors. Adidass times interest earned ratio of 4.67 indicates
that its earnings are adequate to make interest payments as they come due.
BRIEF EXERCISE 10-11
(a) Debt to total assets:
Without operating leases
With operating leases
$14,180
= 59%
$24,004
$14,180 + $740
= 60%
$24,004 + $740
(b) CN does not have significant operating leases, therefore its assets and
liabilities reflect its true financial position. By increasing its assets and
liabilities for these operating leases we see that its debt to total assets
ratio increases only slightly from 59% to 60%.
10-8
*BRIEF EXERCISE 10-12

(a) Jan. 1
(b) Dec. 31
Cash (.99 X $3,000,000) ...................

Discount on Bonds Payable............
Bonds Payable .........................
2,970,000
30,000
Bond Interest Expense ....................

Discount on Bonds
Payable ($30,000 10)..........
Cash ($3,000,000 X 6%)............
183,000
3,000,000
3,000
180,000

(a) Cash (1.03 X $4,000,000) ..................................
Bonds Payable ..........................................
Premium on Bonds Payable .....................
4,120,000
(b) Interest Expense ...............................................

Premium on Bonds Payable
($120,000 5) ................................................
Bond Interest Payable ($4,000,000 X 8%) ...
296,000
4,000,000
120,000
24,000
320,000

(a) Interest Expense ...............................................
Discount on Bonds Payable .....................
Cash ...........................................................
46,884
1,884
45,000
(b) Interest expense is greater than interest paid because the bonds sold
at a discount. The bonds sold at a discount because investors demand
a market interest rate higher than the contractual interest rate. Interest
expense is calculated using the effective interest rate which is higher
than the stated rate used to compute the cash payment.
(c) Interest expense increases each period because the bond carrying
value increases each period. As the market interest rate is applied to
this bond carrying value, interest expense will increase.
10-9
SOLUTIONS TO DO IT! REVIEW EXERCISES

DO IT! 10-1
1.
2.
3.
$70,000 X 12% X 5/12 = $3,500

$42,000/1.05 = $40,000; $40,000 X 5% = $2,000
$42,000 X 2/6 = $14,000
DO IT! 10-2
(a) To determine wages payable, reduce wages expense by the withholdings
for FICA, federal income tax, and state income tax.
Feb. 28 Wages Expense .............................................
FICA Taxes Payable ..................................
Federal Income Taxes Payable.................
State Income Taxes Payable.....................
Wages Payable ..........................................
74,000
4,200
7,300
1,800
60,700
(b) Payroll taxes would be for the companys share of FICA, as well as for
federal and state unemployment tax.
Feb. 28 Payroll Tax Expense......................................
FICA Taxes Payable ..................................
Federal Unemployment Taxes Payable....
State Unemployment Taxes Payable .......
4,470
4,200
110
160
DO IT! 10-3
1.
2.
3.
4.
5.
10-10
False. Mortgage bonds and sinking fund bonds are both examples of
secured bonds.
False. Convertible bonds can be converted into common stock at the
bondholders option; callable bonds can be retired by the issuer at a
set amount prior to maturity.
True.
True.
True.
DO IT! 10-4
(a)
(b)
Cash ......................................................................
Bonds Payable................................................
Premium on Bonds Payable ..........................
(To record sale of bonds at a premium)
312,000
300,000
12,000
Bonds payable ................................................
Plus: Premium on bonds payable ................
$300,000
12,000
$312,000
DO IT! 10-5
Bonds Payable .....................................................
Loss on Bond Redemption..................................
Cash ($400,000 X .99) .....................................
Discount on Bonds Payable ..........................
(To record redemption of bonds at 99)
400,000
6,000
396,000
10,000
10-11
SOLUTIONS TO EXERCISES
EXERCISE 10-1
(a) June 1
Cash ..........................................................
Notes Payable...................................
16,000
16,000
(b) June 30 Interest Expense

($16,000 X .09 X 1/12) ...........................
Interest Payable................................
(c) Interest payable accrued each month ......................
Number of months from borrowing
to year end..............................................................
Balance in interest payable account ........................
(d) Jan. 1
Notes Payable...........................................
Interest Payable........................................
Cash ..................................................
120
120
$120
X 7
$840
16,000
840
16,840
EXERCISE 10-2
(a) Principal X .08 X 4/12 = $400
Principal = $400 (.08 X 4/12)
Principal = $15,000
(b) $18,500 X Interest Rate X 4/12 = $555
Interest Rate = $555 ($18,500 X 4/12)
Interest Rate = 9 percent
(c) Initial Borrowing:
May 15
Cash ........................................................
Notes Payable .................................
15,000
15,000
Repayment:
Sept. 15
10-12
Notes Payable.........................................
Interest Expense.....................................
Cash.................................................
15,000
400
15,400
EXERCISE 10-3
(a) June 1
(b) June 30
(c) Dec.
Cash ............................................................ 40,000

Notes Payable .....................................
Interest Expense ($40,000 X .09 X 1/12) ....
Interest Payable ..................................
40,000
300
Notes Payable............................................. 40,000

Interest Payable
($40,000 X .09 X 6/12) .............................. 1,800
Cash.....................................................
300
41,800
(d) Interest expense accrued each month ........................ $ 300

Number of months of loan ........................................... X
6
Total interest expense .................................................. $1,800
EXERCISE 10-4
Apr. 10
15
GRAINGER COMPANY
Cash ..................................................................... 26,750
Sales .............................................................
Sales Taxes Payable....................................
DARBY COMPANY
Cash ..................................................................... 13,780
Sales ($13,780 1.06) ..................................
Sales Taxes Payable
($13,780 $13,000)...................................
25,000
1,750
13,000
780
10-13
EXERCISE 10-5
(a) Mar. 31
(b) Mar. 31
Salaries and Wages Expense ..............

FICA Taxes Payable......................
Federal Income Taxes Payable ....
State Income Taxes Payable ........
Union Dues Payable .....................
Salaries and Wages Payable ........
60,000
Payroll Tax Expense.............................

FICA Taxes Payable......................
State Unemployment Taxes
Payable ......................................
5,290
4,590
7,500
3,100
400
44,410
4,590
700
EXERCISE 10-6
(a) $1,265,000 $230 = 5,500 season tickets sold.
(b) $1,265,000 20 home games = $63,250 revenue recognized per home
game.
$759,000 $63,250 = 12 home games already played.
(c) Cash......................................................................... 1,265,000
Unearned Season Ticket Revenue .................
1,265,000
(d) Unearned Season Ticket Revenue.........................
Season Ticket Revenue ..................................
63,250
63,250
EXERCISE 10-7
(a) Nov.
(b) Dec. 31
10-14
Cash (6,000 X $26) ................................

Unearned Subscription Revenue ..
156,000
Unearned Subscription Revenue ........

Subscription Revenue
($156,000 X 1/12) ........................
13,000
156,000
13,000
EXERCISE 10-7 (Continued)

(c) Mar. 31
Unearned Subscription Revenue .........

Subscription Revenue
($156,000 X 3/12) ..........................
39,000
39,000
EXERCISE 10-8
2010
(a) Sept. 1
(b) Dec. 31
2011
(c) Sept. 1
Cash .......................................................
Bonds Payable ...............................
600,000
Bond Interest Expense..........................

($600,000 X 8% X 4/12)................
16,000
Bond Interest Expense

($600,000 X 8% X 8/12) .......................
Bond Interest Payable...........................
Cash ($600,000 X 8% X 12/12) .......
600,000
16,000
32,000
16,000
48,000
EXERCISE 10-9
(a) Jan. 1
(b) Dec. 31
(c) Jan. 1
Cash .......................................................
Bonds Payable ...............................
300,000
Bond Interest Expense..........................

($300,000 X 7% X 12/12)..............
21,000
Bond Interest Payable ...........................

Cash................................................
21,000
300,000
21,000
21,000
10-15
EXERCISE 10-10
(a) The General Electric bonds were issued at a premium and the Boeing
bonds were issued at a discount.
(b) The prices of the two bonds differed because bond price is based on the
market rate of interest not the stated rate of interest. Market interest
rates must have been different when the two bonds were issued causing
the selling prices to differ.
(c) Cash (1.1112 X $800,000).......................................
Bonds Payable .................................................
Premium on Bonds Payable............................
888,960
Cash (0.9908 X $800,000).......................................

Discount on Bonds Payable..................................
Bonds Payable .................................................
792,640
7,360
800,000
88,960
800,000
EXERCISE 10-11
2010
(a) Jan. 1
(b) Dec. 31
2011
(c) Jan. 1
2030
(d) Jan. 1
10-16
Cash.......................................................
Bonds Payable ..............................
400,000
Bond Interest Expense .........................

($400,000 X 8% X 12/12) .............
32,000
Bond Interest Payable ..........................

Cash ...............................................
32,000
Bonds Payable ......................................

Cash ...............................................
400,000
400,000
32,000
32,000
400,000
EXERCISE 10-12
(a) June 30
(b) June 30
Bonds Payable......................................
Loss on Bond Redemption ..................
Cash ($140,000 X 102%) ...............
Discount on Bonds Payable*
($140,000 $122,500)................
140,000
20,300*
Bonds Payable.....................................
Premium on Bonds Payable ...............
Cash ($170,000 X 98%) ................
Gain on Bond Redemption..........
170,000
14,000
142,800
17,500
166,600
17,400**
**$122,500 (102% X $140,000)

**$184,000 (98% X $170,000)
EXERCISE 10-13
(a)
Account
Classification
Accounts payable
Accrued pension liability
Accrued liabilities
Bonds payable
Current portion of longterm debt
Income taxes payable
Notes payablelong-term
Operating leases
Loans payablelong-term
Payroll-related liabilities
Short-term borrowings
Unused operating line of
credit
Warranty liabilitycurrent
Reason
Current liability
Due within one year
Long-term liability Likely relates to pensions. Not
due within one year
Current liability
Due within one year
Long-term liability Not due within one year
Current liability
Due within one year
Current liability
Due within one year
N/A
Not a balance sheet itemmay
be disclosed in notes
Current liability
Due within one year
Current liability
Due within one year
N/A
Not a balance sheet item as
unusedmay be disclosed
in notes
Current liability
Can be current and/or long-term
depending on the length of the
warranty. This is current
10-17

(b)
EDMONDS INC.
(Partial) Balance Sheet
January 31, 2010
(in thousands)
Current liabilities
Accounts payable ......................................
Short-term borrowings ..............................
Current portion of long-term debt ............
Warranty liability........................................
Accrued liabilities ......................................
Payroll-related liabilities............................
Income taxes payable................................
Total current liabilities ..........................
Notes payable, long-term ..........................
Bonds payable ...........................................
Accrued pension liability ..........................
Loans payablelong-term........................
Total long-term liabilities.....................
Total liabilities ...................................................
$4,263.9
2,563.6
1,992.2
1,417.3
1,258.1
558.1
235.2
$12,288.4
$6,746.7
1,961.2
1,215.2
335.6
10,258.7
$22,547.1
EXERCISE 10-14
(a) 1.
2.
3.
4.
Working capital = $3,625.3 $3,008.1 = $617.2

Current ratio = $3,625.3 $3,008.1 = 1.21:1
Debt to total assets ratio = $13,565.5 $29,023.8 = 47%
Times interest earned ratio = ($3,544.2 + $1,293.4 + $402.0)
$402.0 = 13.03 times
A current ratio that is less than 1.30 indicates lower liquidity. The debt to
total assets ratio indicates that $.47 of each dollar of asset have been
financed by creditors. The times interest earned ratio of over 13 times
indicates that McDonalds income is large enough to make required
interest payments as they come due.
10-18

(b) Debt to total assets ratio, adjusted for off-balance-sheet lease obligations.
$13,565.5 + $9,900 = 60%
$29,023.8 + $9,900
By including these off-balance-sheet obligations the debt to total assets
ratio increases from 47% to 60%, suggesting that McDonalds is not as
solvent as it first appears.
EXERCISE 10-15
(a) Current ratio
2006
2005
$8,946 $7,323 = 1.22:1

$7,115 $5,238 = 1.36:1
(b) Current ratio

$8,646 $7,023 = 1.23
It would make its current ratio increase from 1.22 to 1.23.
EXERCISE 10-16
(a) Current ratio
2010
2009
$6,444 $4,803 = 1.34:1

$3,798 $3,508 = 1.08:1
(b) Current ratio

($6,444 $1,500) ($4,803 $1,500) = 1.50:1
It would make its current ratio increase (from 1.34:1 to 1.50:1).
(c) The liquidity ratios would not change but having access to a line of
credit means that cash is available on a short-term basis and therefore
the assessment of the companys short-term liquidity would improve.
10-19
EXERCISE 10-17
(a)
Wal-Mart does not have to record these contingent liabilities because

they have determined that they are not likely to occur and the impact
would be immaterial in any event.
(b) For financial statement users it is important to understand the possible

implications that the contingent liabilities could have on the financial
results of the company. If the contingent liabilities result in material
losses for the company it will negatively impact the companys financial results and affect the decisions made by the users of the financial
statements.
*EXERCISE 10-18
2010
(a) Jan. 1
(b) Dec. 31
2011
(c) Jan. 1
2030
(d) Jan. 1
10-20
Cash ($500,000 X 103%) ......................

Bonds Payable .............................
Premium on Bonds Payable ........
515,000
Bond Interest Expense ........................

($15,000 X 1/20) .................................
($500,000 X 7%) .........................
34,250
Bond Interest Payable .........................

Cash ..............................................
35,000
Bonds Payable .....................................

Cash ..............................................
500,000
500,000
15,000
750
35,000
35,000
500,000
*EXERCISE 10-19
2009
(a) Dec. 31
2010
(b) Dec. 31
2019
(c) Dec. 31
Cash ......................................................
Discount on Bonds Payable ................
Bonds Payable ..............................
290,000
10,000
Bond Interest Expense.........................

Discount on Bonds Payable
($10,000 X 1/10) ..........................
Cash ($300,000 X 8%) ...................
25,000
Bonds Payable......................................
Cash...............................................
300,000
300,000
1,000
24,000
300,000
*EXERCISE 10-20
2010
(a) Jan. 1
(b) Dec. 31
2011
(c) Jan. 1
Cash........................................................
Discount on Bonds Payable..................
Bonds Payable ...............................
(559,740 X 8%).....................................
Discount on Bonds Payable..........
($600,000 X 7%) ...........................
Bond Interest Payable ...........................

Cash ................................................
559,740
40,260
600,000
44,779
2,779
42,000
42,000
42,000
For explanation of calculations, see the following table.
10-21
(A)
Interest
Periods
Issue date
1
2
(B)
Interest Expense
to Be Recorded
Interest to
(8% X Preceding
Be Paid
Bond Carrying Value)
(7% X $600,000)
[(E) X .08]
42,000
42,000
44,779
45,002
(C)
(D)
(E)
Discount
Amortization
(B) (A)
Unamortized
Discount
(D) (C)
Bond
Carrying Value
[$600,000 (D)]
2,779
3,002
40,260
37,481
34,479
559,740
562,519
565,521
*EXERCISE 10-20 (Continued)
10-22
(b), (c)
*EXERCISE 10-21
2010
(a) Jan. 1
(b) Dec. 31
2011
(c) Jan. 1
Cash .......................................................
Bonds Payable...............................
Premium on Bonds Payable .........
($483,120 X 6%) ..................................
Premium on Bonds Payable.................
($450,000 X 7%)...........................
Bond Interest Payable ..........................

Cash ...............................................
483,120
450,000
33,120
28,987
2,513
31,500
31,500
31,500
For explanation of calculations, see the following table.
10-23
*EXERCISE 10-21 (Continued)
10-24
(b), (c)
(A)
Interest
Periods
Issue date
1
2
(B)
Interest Expense
to Be Recorded
Interest to
(6% X Preceding
Be Paid
Bond Carrying Value)
(7% X $450,000)
[(E) X .06]
31,500
31,500
28,987
28,836
(C)
(D)
(E)
Premium
Amortization
(A) (B)
Unamortized
Premium
(D) (C)
Bond
Carrying Value
[$450,000 (D)]
2,513
2,664
33,120
30,607
27,943
483,120
480,607
477,943
*EXERCISE 10-22
2010
2011
Dec. 31
June 30
Dec. 31
Issuance of Note
Cash .................................................
Mortgage Notes Payable .........
330,000
330,000
First Installment Payment

Interest Expense
($330,000 X 8% X 6/12) ................
Mortgage Notes Payable.................
Cash..........................................
13,200
7,923
21,123
Second Installment Payment

Interest Expense
12,883
8,240
[($330,000 $7,923) X 8% X 6/12] ...
Mortgage Notes Payable.................

Cash..........................................
(A)
Semiannual
Interest
Period
Issue date
6/30/11
12/31/11
21,123
Cash
Payment
(B)
Interest
Expense
(D X 4%)
(C)
Reduction
of Principal
(A) (B)
$21,123
21,123
$13,200
12,883
$7,923
8,240
(D)
Principal
Balance
(D) (C)
$330,000
322,077
313,837
10-25
SOLUTIONS TO PROBLEMS
PROBLEM 10-1A
(a) Jan. 1
5
12
14
20
(b) Jan. 31
31
31
10-26
Cash..........................................................
Notes Payable...................................
15,000
Cash..........................................................
Sales ($6,510 1.05).........................
Sales Taxes Payable
($6,510 $6,200) ...........................
6,510
Unearned Service Revenue .....................

Service Revenue...............................
10,000
Sales Taxes Payable ................................

Cash ..................................................
6,600
Accounts Receivable ...............................

Sales..................................................
Sales Taxes Payable
(500 X $48 X 5%) ...........................
25,200
Interest Expense ......................................

Interest Payable
($15,000 X 8% X 1/12) ...................
100
Salaries and Wages Expense..................

FICA Taxes Payable .........................
Federal Income Taxes Payable........
State Income Taxes Payable............
Salaries and Wages Payable ...........
70,000
Payroll Tax Expense ................................

5,355
15,000
6,200
310
10,000
6,600
24,000
1,200
100
5,355
5,000
1,500
58,145
5,355
PROBLEM 10-1A (Continued)

(c) Current liabilities
Notes payable.................................................................
Accounts payable ..........................................................
Salaries and wages payable ..........................................
FICA taxes payable ($5,355 X 2)....................................
Unearned service revenue ($19,000 $10,000)............
Federal income taxes payable.......................................
Sales taxes payable .......................................................
State income taxes payable ..........................................
Interest payable..............................................................
Total current liabilities ...........................................
$ 15,000*
42,500*
58,145*
10,710*
9,000*
5,000*
1,510*
1,500*
100
$143,465*
*($6,600 + $310 $6,600 + $1,200)
10-27
PROBLEM 10-2A
(a) Sept. 1
30
Oct.
1
31
Nov.
30
Merchandise Inventory or
Purchases ...........................................
Notes Payable .................................
12,000
Interest Expense
($12,000 X .08 X 1/12)..........................
Interest Payable ..............................
80
Climbing Wall..........................................
Notes Payable .................................
12,000
80
16,000
16,000
Interest Expense
[($16,000 X .09 X 1/12) + $80] .............
Vehicles...................................................
Notes Payable .................................
Cash.................................................
200
200
33,000
25,000
8,000
Interest Expense
[($25,000 X .06 X 1/12) + $120 + $80] .......
325

Dec.
31
325
Notes Payable.........................................
Interest Payable ......................................
Cash.................................................
12,000
240
Interest Expense ($120 + $125)..............

245
12,240
245
(b)
12/1
Notes Payable
12,000 9/1
10/1
11/1
12,000
16,000
25,000
12/31 Bal. 41,000
10-28
12/1
Interest Payable
240 9/30
10/31
11/30
12/31
12/31 Bal.
80
200
325
245
610
PROBLEM 10-2A (Continued)

Interest Expense
9/30
80
10/31
200
11/30
325
12/31
245
12/31 Bal.
850
Notes payable.....................................................................
Interest payable..................................................................
41,000
610
(d) Total interest expense is $850. See (b) above.
10-29
PROBLEM 10-3A
(a) Jan. 1
(b) Jan. 1
(c) Dec. 31
10-30
Bond Interest Payable ......................

Cash ...........................................
40,000
Bonds Payable ..................................

Loss on Bond Redemption ..............
Cash ($100,000 X 104%)........
100,000
4,000
Bond Interest Expense .....................

($400,000 X 8%) ......................
32,000
40,000**
104,000
32,000
PROBLEM 10-4A
2009
(a) Oct. 1
(b) Dec. 31
Cash ..................................................
Bonds Payable ..........................
700,000
Bond Interest Expense.....................

($700,000 X 7% X 3/12)...........
12,250
(c) Current Liabilities

Bond Interest Payable ..................................
Long-term Liabilities
Bonds Payable ..............................................
2010
(d) Oct. 1
(e) Dec. 31
(f)
2011
Jan. 1

($700,000 X 7% X 9/12) ..................
Cash ($700,000 X 7%) ...............
700,000
12,250
12,250
700,000
36,750
12,250
49,000
Bond Interest Expense.....................

Bond Interest Payable ..............
12,250

Cash...........................................
12,250
Bonds Payable..................................
Cash ($700,000 X 102%) ...........
700,000
14,000
12,250
12,250
714,000
10-31
PROBLEM 10-5A
2010
(a) Jan. 1
Cash ($6,000,000 X 98%) ...............

Discount on Bonds Payable .........
Bonds Payable .......................
(b) Long-term Liabilities

Bonds Payable, due 2030 .......................
Less: Discount on bonds payable ........
2011
(c) Dec. 31
Bonds Payable ...............................

($6,120,000 $5,892,000)...........
Cash ($6,000,000 X 102%)......
Discount on Bonds
Payable ...............................
5,880,000
120,000
6,000,000*
$6,000,000
114,000 $5,886,000*
6,000,000
228,000
6,120,000*
108,000*
*$6,000,000 $5,892,000
10-32
PROBLEM 10-6A
(a)
1. Current ratio
2. Free cash flow
2006
2005
$2,601 $2,887
$3,620 $3,848
= .90:1
= .94:1
$1,406 $1,399 $14 = ($7) $2,118 $1,146 $14 = $958
3. Debt to total assets

ratio
4. Times interest
earned ratio
$7,011 $13,460
= 52%
$9181 $128
= 7.17 times
$7,328 $14,003
= 52%
$9012 $122
= 7.39 times
$499 + $291 + $128 = $918

$484 + $295 + $122 = $901
(b) The companys liquidity position as measured through the current

ratio and free cash flow has deteriorated. The debt to total assets ratio
remained constant, but the times interest earned ratio declined slightly
in 2006. Southwest appears to be less liquid and solvent when comparing 2006 to 2005.
(c) Southwests use of operating leases (vs. capital leases) would reduce its
solvency. If the leases were capital rather than operating, the balance sheet
would include higher total assets and higher liabilities. Using the $1,500
as an estimate of the increase in liabilities and assets that would result
if the operating leases were capital leases, the revised debt to total
assets ratio would be [($7,011 + $1,500) ($13,460 + $1,500)] = 57%.
10-33
*PROBLEM 10-7A
(a) Jan. 1
(b) Dec. 31
(c) Jan. 1

Cash ...........................................
168,000

Discount on Bonds Payable
($42,000 10).........................
Cash ($2,400,000 X 7%).............
172,200
Bonds Payable ..................................

Cash ($400,000 X 103%)............
Discount on Bonds Payable .....
400,000
18,300
168,000**
4,200**
168,000**
412,000**
6,300**
*($42,000 $4,200) X 400,000/

* 2,400,000 = $6,300
(d) Dec. 31

Discount on Bonds Payable .....
Bond Interest Payable...............
143,500
3,500**
140,000**
**$42,000 $4,200 $6,300 = $31,500;

**$31,500 9 = $3,500 or
**$4,200 X 2,000,000/2,400,000 = $3,500
**($2,400,000 $400,000 = $2,000,000;
**($2,000,000 X 7% = $140,000)
10-34
*PROBLEM 10-8A
(a) Jan. 1
Dec. 31
(b) Jan. 1
Dec. 31
Cash ($2,000,000 X 103%) ...............

Bonds Payable .........................
Premium on Bonds Payable....
2,060,000
Bond Interest Expense....................

($60,000 10) ..............................
($2,000,000 X 6%) .................
114,000
Cash ($2,000,000 X 98%) .................

Discount on Bonds Payable ...........
Bonds Payable .........................
1,960,000
40,000

Discount on Bonds
Payable ($40,000 10) .........
Bond Interest Payable .............
124,000
2,000,000
60,000
6,000
120,000
2,000,000
4,000
120,000
(c) Premium
Current Liabilities
Bond interest payable..............................
Bonds payable, due 2020 ........................
Add: Premium on bonds payable ..........
$ 120,000
$2,000,000
54,000
2,054,000
Discount
Current Liabilities
Less: Discount on bonds payable .........
$ 120,000
$2,000,000
36,000
1,964,000
10-35
*PROBLEM 10-9A
(a) 1.
2.
1/1/10
1/1/10
Cash ($3,000,000 X 101%) .......

Bonds Payable .................
Premium on Bonds
Payable .........................
3,030,000
Cash ($3,000,000 X 97%) .........

Discount on Bonds
Payable.................................
Bonds Payable .................
2,910,000
3,000,000
30,000
90,000
3,000,000
(b) See amortization tables on following page.

(c) 1.
2.
(d) 1.
2.
10-36
12/31/10
12/31/10
Bond Interest Expense............

Premium on Bonds
Payable.................................
Bond Interest
Payable .........................
264,000
Bond Interest Expense............

Discount on Bonds
Payable .........................
Bond Interest
Payable .........................
288,000
Long-term Liabilities:
Bonds Payable ....................................
Plus: Unamortized Bond
Premium ...................................
Bonds Payable ....................................
Less: Unamortized Bond
Discount...................................
6,000
270,000
18,000
270,000
$3,000,000
24,000 $3,024,000
$3,000,000
72,000 $2,928,000
Annual
Interest
Periods
Issue date
1
2
3
(A)
Interest to
Be Paid
(9% X $3,000,000)
$270,000
270,000
270,000
(B)
Interest Expense
to Be Recorded
(A) (C)
(C)
Premium
Amortization
($30,000 5)
$264,000
264,000
264,000
$6,000
6,000
6,000
(B)
Interest Expense
to Be Recorded
(A) + (C)
(C)
Discount
Amortization
($90,000 5)
(D)
(E)
Unamortized
Bond
Premium
Carrying Value
(D) (C)
[$3,000,000 + (D)]
$30,000
24,000
18,000
12,000
$3,030,000
3,024,000
3,018,000
3,012,000
(2)
Annual
Interest
Periods
Issue date
1
2
3
(A)
Interest to
Be Paid
(9% X $3,000,000)
$270,000
270,000
270,000
$288,000
288,000
288,000
$18,000
18,000
18,000
(D)
(E)
Unamortized
Bond
Discount
Carrying Value
(D) (C)
[$3,000,000 (D)]
$90,000
72,000
54,000
36,000
$2,910,000
2,928,000
2,946,000
2,964,000
*PROBLEM 10-9A (Continued)
(b), (1)
10-37
*PROBLEM 10-10A
2010
(a) Jan. 1
(b)
Cash.................................................
Discount on Bonds Payable ..........
Bonds Payable ........................
1,679,219
120,781
1,800,000
IRIK CORP.
Bond Discount Amortization
Effective-Interest MethodAnnual Interest Payments
7% Bonds Issued at 8%
(A)
Annual
Interest
Periods
(B)
(C)
(D)
(E)
Interest Discount UnamorBond
Interest Expense
Amortized
Carrying
to Be
to Be
tization Discount
Value
Paid
Recorded (B) (A) (D) (C) ($1,800,000 D)
Issue date
1
$126,000 $134,338
2
126,000 135,005
3
126,000 135,725
(c) Dec. 31
2011
(d) Jan. 1
(e) Dec. 31
10-38
$8,338
9,005
9,725
$120,781
112,443
103,438
93,713

($1,679,219 X 8%) .................................
Discount on Bonds Payable ............
($1,800,000 X 7%) .........................
Bond Interest Payable .............................
Cash ..................................................
[($1,679,219 + $8,338) X 8%]................
Discount on Bonds Payable ............
Bond Interest Payable......................
$1,679,219
1,687,557
1,696,562
1,706,287
134,338
8,338
126,000
126,000
126,000
135,005
9,005
126,000
*PROBLEM 10-11A
(a) 1.
2.
3.
4.
Jan. 1
Dec. 31
Jan. 1
Dec. 31
2010
Cash............................................ 3,441,605
Bonds Payable ...................
Premium on Bonds
Payable ...........................
($3,441,605 X 6%) ...................
Premium on Bonds
Payable ...................................
($3,000,000 X 8%) ...........
2011
Bond Interest Payable ...............
Cash ....................................
Bond Interest Expense ..............
[($3,441,605 $33,504) X 6%]
Premium on Bonds
Payable ...................................
Bond Interest Payable........
3,000,000
441,605
206,496
33,504
240,000
240,000
240,000
204,486
35,514
240,000
(b) Bonds payable .................................................... 3,000,000

Add: Premium on bonds payable .....................
372,587*
3,372,587
*($441,605 $33,504 $35,514)

(c) 1.
2.
Total bond interest expense2011, $204,486.

The effective-interest method will result in more interest expense
reported than the straight-line method in 2011 when the bonds
are sold at a premium. Straight-line interest expense for 2011 is
$195,840 [$240,000 ($441,605 10)].
10-39
*PROBLEM 10-12A
(a)
(A)
Quarterly
Interest Period
Issue Date
1
2
3
4
5
(b) Dec. 31
Cash
Payment
$22,095
22,095
22,095
22,095
22,095
(B)
Interest
Expense
(D) X 2%
$6,000
5,678
5,350
5,015
4,673
(C)
Reduction
of Principal
(A) (B)
(D)
Principal
Balance
(D) (C)
$16,095
16,417
16,745
17,080
17,422
$300,000
283,905
267,488
250,743
233,663
216,241
Interest Expense ..................................

Mortgage Notes Payable......................
Cash...............................................
6,000
16,095

Current portion of 8% mortgage notes
payable.........................................................
Mortgage notes payable, 8%, due
in 2014 and secured by plant assets..........
Total liabilities ..................................
22,095
$ 67,664*
216,241***
$283,905*
**($16,417 + $16,745 + $17,080 + $17,422)

**($283,905 $67,664)
10-40
*PROBLEM 10-13A
(a)
Period
July 1, 2009
June 30, 2010
June 30, 2011
June 30, 2012
June 30, 2013
June 30, 2014
Total
Cash
Payment
(A)
$29,267
29,267
29,267
29,267
29,267
146,335
Interest
Principal
Expense
Reduction
Balance
(B) = (D) X 7% (C) = (A) (B) (D) = (D) (C)
$120,000
$8,400
$20,867
99,133
6,939
22,328
76,805
5,376
23,891
52,914
3,704
25,563
27,351
1,916*
27,351
0
26,335
120,000
*Rounded to make principal element equal to balance.

(b) July
1/09 Cash...................................................
Notes Payable ..............................
120,000
June 30/10 Notes Payable ...................................

Interest Expense ...............................
Cash..............................................
20,867
8,400
June 30/11 Notes Payable ...................................

Interest Expense ...............................
Cash..............................................
22,328
6,939
(c) 2011
Current liabilities
Current portion of 7% notes payable ................
Note payable, 7%, due in 2014
($76,805 $23,891)..........................................
120,000
29,267
29,267
$23,891
$52,914
10-41
PROBLEM 10-1B
(a) Jan. 1
5
12
14
20
(b) Jan. 31
31
31
10-42
Cash..........................................................
Notes Payable...................................
18,000
Cash..........................................................
Sales ($18,550 106%).....................
Sales Taxes Payable
($18,550 $17,500) .......................
18,550
Unearned Service Revenue .....................

Service Revenue...............................
8,000
Sales Taxes Payable ................................

Cash ..................................................
8,500
Accounts Receivable ...............................

Sales..................................................
Sales Taxes Payable
(500 X $50 X 6%) ...........................
26,500
Interest Expense ......................................

Interest Payable
($18,000 X 7% X 1/12 = $105) .......
105
Salaries and Wages Expense..................

Federal Income Taxes Payable........
State Income Taxes Payable............
Salaries and Wages Payable ...........
50,000
Payroll Tax Expense ................................

3,825
18,000
17,500
1,050
8,000
8,500
25,000
1,500
105
3,825
3,800
1,100
41,275
3,825
PROBLEM 10-1B (Continued)

Notes payable.................................................................
Accounts payable ..........................................................
Salaries and wages payable ..........................................
FICA taxes payable ($3,825 X 2)....................................
Federal income taxes payable.......................................
Unearned service revenue ($11,000 $8,000)..............
Sales taxes payable .......................................................
State income taxes payable ..........................................
Interest payable..............................................................
Total current liabilities
$ 18,000*
52,000*
41,275*
7,650*
3,800*
3,000*
2,550*
1,100*
105
$129,480*
*$8,500 + $1,050 $8,500 + $1,500
10-43
PROBLEM 10-2B
(a) Mar.
1
31
Apr.
1
30
May
1
31
Bicycles.....................................................
Notes Payable ...................................
10,000
10,000
Interest Expense
($10,000 X .06 X 1/12)............................
Interest Payable ................................
Land...........................................................
Notes Payable ...................................
50
50
30,000
30,000
Interest Expense
[($30,000 X .08 X 1/12) + $50] ...............
Cash ..........................................................
Notes Payable ...................................
250
250
15,000
15,000
Interest Expense
[($15,000 X .06 X 1/12) + $50 + $200] .........
325

June 1
30
325
Notes Payable...........................................
Interest Payable ($10,000 X .06 X 3/12) ...
Cash...................................................
10,000
150
Interest Expense ($200 + $75)..................

275
10,150
275
(b)
6/1
Notes Payable
10,000 3/1
4/1
5/1
10,000
30,000
15,000
6/30 Bal. 45,000
10-44
6/1
Interest Payable
150 3/31
4/30
5/31
6/30
6/30 Bal.
50
250
325
275
750
PROBLEM 10-2B (Continued)

Interest Expense
3/31
50
4/30
250
5/31
325
6/30
275
6/30 Bal.
900
Notes payable.....................................................................
Interest payable..................................................................
45,000
750
(d) $900. See (b) above.
10-45
PROBLEM 10-3B
(a) Jan.
(b) Jan.
1
1
(c) Dec. 31
10-46
Bond Interest Payable............................

Cash.................................................
96,000
Bonds Payable........................................
Loss on Bond Redemption ....................
Cash ($300,000 X 105%) .................
300,000
15,000
Bond Interest Expense...........................

($900,000 X 8%) ............................
72,000
96,000
315,000
72,000
PROBLEM 10-4B
(a) 2009
April 1
Cash .........................................................
Bonds Payable .................................
600,000
(b) Dec. 31
Bond Interest Expense............................

($600,000 X 7% X 9/12)..................
31,500
(c) Current Liabilities

Bond Interest Payable ..........................................
Bonds Payable ......................................................
(d) 2010
April 1
(e) Dec. 31
(f)
2011
Jan.

($600,000 X 7% X 3/12) .........................
Bond Interest Payable.............................
Cash ($600,000 X 7%) ......................
600,000
31,500
31,500
600,000
10,500
31,500
42,000
Bond Interest Expense............................

Bond Interest Payable .....................
31,500
Bond Interest Payable.............................

Cash..................................................
31,500
Bonds Payable ........................................

Loss on Bond Redemption.....................
Cash ($600,000 X 102%) ..................
600,000
12,000
31,500
31,500
612,000
10-47
PROBLEM 10-5B
(a)
Jan. 1
2010
Cash ($5,000,000 X 103%) ................
Bonds Payable ..........................
Premium on Bonds
Payable ..................................
(b) Long-term Liabilities

Bonds payable, due 2030..........................
Add: Premium on bonds payable...........
(c)
Dec. 31
2011
Bonds Payable ..................................
Premium on Bonds Payable ............
($5,135,000 $5,200,000)..............
Cash ($5,000,000 X 104%).........
5,150,000*
5,000,000
150,000
$5,000,000
142,500 $5,142,500
5,000,000*
135,000*
65,000*
5,200,000
*$5,135,000 $5,000,000
10-48
PROBLEM 10-6B
(a)
1. Current ratio
2. Free cash flow
3. Debt to total assets
ratio
2007
$131,818 $134,870
= .98:1
$22,108 $4,005
= $18,103
$270,530 $349,492
= 77%
2006
$147,025 $153,919
= .96:1
$1,865 $10,381
= ($8,516)
$302,184 $410,855
= 74%
(b) In terms of liquidity, Krispy Creme is not in good health. Its current
ratio improved slightly in 2007 over 2006, but is still below 1. Its free cash
flow did improve from a negative $8,516 to positive $18,103. Krispy
Creme may have difficulty meeting its current obligations with existing
current assets. Solvency also appears unhealthy since its debt to total
assets ratio for 2007 and 2006 is 77% and 74% respectively.
(c) Debt to total assets ratioadjusting for $270,530,000 + $135,000,000 = 84%
operating leases
$349,492,000 + $135,000,000
Krispy Cremes use of operating leases (vs. capital leases) causes the
company to appear less solvent. Accounting for the operating leases as
if they were capital leases increases assets and liabilities by $135 million.
The debt to total assets ratio increases from 77% to 84%.
10-49
*PROBLEM 10-7B
(a) Jan. 1
(b) Dec. 31
(c) Jan. 1
2010
Bond Interest Payable ...................
Cash ........................................
324,000**
324,000
Bond Interest Expense ..................

($400,000 10) ...........................
Bond Interest Payable............
284,000**
Bonds Payable ...............................

Cash ($1,800,000 X 1.02)........
Gain on Bond Redemption
($1,980,000 $1,836,000) ...
1,800,000**
180,000**
40,000**
324,000
1,836,000
144,000
*($400,000 $40,000) X 1/2 = $180,000
(d) Dec. 31
Bond Interest Expense ..................

($1,800,000 X 9%) ...............
**$400,000 $40,000 $180,000 = $180,000;
10-50
142,000**
20,000**
162,000
$180, 000
= $20,000 or $40,000 X 1/2.
9
*PROBLEM 10-8B
(a) Jan. 1
Dec. 31
(b) Jan. 1
Dec. 31
2010
Cash ($2,500,000 X 1.02) .................
Bonds Payable .........................
2,550,000
2,500,000
50,000

($50,000 10) ...............................
($2,500,000 X 10%) ...............
245,000
5,000
250,000
2010
Cash ($2,500,000 X .96) ...................
Discount on Bonds Payable ...........
Bonds Payable .........................
2,400,000
100,000
2,500,000

Discount on Bonds
Payable ($100,000 10) .......
($2,500,000 X 10%) ...............
260,000
10,000
250,000
(c) Premium
Current Liabilities
Add: Premium on bonds payable .........
$ 250,000
$2,500,000
45,000
2,545,000
Discount
Current Liabilities
Less: Discount on bonds payable .........
$ 250,000
$2,500,000
90,000
2,410,000
10-51
*PROBLEM 10-9B
(a) 1.
2.
12/31/09 Cash ($2,500,000 X 98%) ......

Discount on Bonds
Payable..............................
Bonds Payable ..............
2,450,000
12/31/09 Cash ($2,500,000 X 104%) ....

Premium on Bonds
Payable ......................
Bonds Payable ..............
2,600,000
50,000
2,500,000
100,000
2,500,000
(b) See page 10-58.

(c) 1.
12/31/10
12/31/11
2.
12/31/10
12/31/11
10-52
Bond Interest Expense.........

Discount on Bonds
Payable ......................
Cash ...............................
177,500

Discount on Bonds
Payable ......................
Cash ...............................
177,500

Premium on Bonds
Payable..............................
Cash ...............................
170,000

Premium on Bonds
Payable..............................
Cash ...............................
170,000
2,500
175,000
2,500
175,000
5,000
175,000
5,000
175,000
*PROBLEM 10-9B (Continued)

(d) 1.
2.
Bonds Payable.............................
Less: Unamortized Bond
Discount ...........................
Bonds Payable.............................
Plus: Unamortized Bond
Premium .......................................
$2,500,000
47,500
$2,452,500
$2,500,000
95,000
$2,595,000
10-53
Annual
Interest
Periods
Issue date
1
2
3
(A)
Interest to
Be Paid
(7% X $2,500,000)
(B)
Interest Expense
to Be Recorded
(A) + (C)
$175,000
175,000
175,000
$177,500
177,500
177,500
(A)
Interest to
Be Paid
(7% X $2,500,000)
(B)
Interest Expense
to Be Recorded
(A) (C)
(C)
Discount
Amortization
($50,000 20)
$2,500
2,500
2,500
(D)
(E)
Unamortized
Bond
Discount
Carrying Value
(D) (C)
[$2,500,000 (D)]
$50,000
47,500
45,000
42,500
$2,450,000
2,452,500
2,455,000
2,457,500
(2)
Annual
Interest
Periods
Issue date
1
2
3
$175,000
175,000
175,000
$170,000
170,000
170,000
(C)
Premium
Amortization
($100,000 20)
$5,000
5,000
5,000
(D)
(E)
Unamortized
Bond
Premium
Carrying Value
(D) (C)
[$2,500,000 + (D)]
$100,000
95,000
90,000
85,000
$2,600,000
2,595,000
2,590,000
2,585,000
10-54
(b), (1)
*PROBLEM 10-10B
2010
Cash .................................................
Bonds Payable .........................
(a) Jan. 1
(b)
2,245,783
2,000,000
245,783
VINEYARD CORPORATION
Bond Premium Amortization
Effective-Interest MethodAnnual Interest Payments
12% Bonds Issued at 10%
Annual
Interest
Periods
(A)
(B)
Interest
to Be
Paid
Interest
Expense
Issue date
1
$240,000 $224,578
2
240,000 223,036
3
240,000 221,340
(c) Dec. 31
(d)
Jan. 1
(e) Dec. 31
(C)
(D)
(E)
Premium UnamorBond
Amortized
Carrying
tization Premium
Value
(A) (B) (D) (C) ($2,000,000 + D)
$15,422
16,964
18,660
$245,783
230,361
213,397
194,737

($2,245,783 X 10%)................................
Premium on Bonds Payable ....................
($2,000,000 X 12%) ........................
$2,245,783
2,230,361
2,213,397
2,194,737
224,578
15,422
240,000
2011
Bond Interest Payable ..............................
Cash...................................................
240,000

[($2,245,783 $15,422) X 10%].............
Premium on Bonds Payable ....................
223,036
16,964
240,000
240,000
10-55
*PROBLEM 10-11B
(a) 1.
Jan. 1
2.
Dec. 31
3.
Jan. 1
4.
Dec. 31
2010
Cash.........................................
Discount on Bonds
Payable .................................
Bonds Payable.................
3,455,131
544,869
4,000,000

($3,455,131 X 12%) ...............
Discount on Bonds
Payable.........................
($4,000,000 X 10%) ......
414,616
14,616
400,000
2011
Bond Interest Payable ............
Cash .................................
400,000
Bond Interest Expense ...........
416,370
400,000
[($3,455,131 + $14,616) X 12%]
Discount on Bonds
Payable.........................
Bond Interest Payable.....
(b) Bonds Payable .................................................
Less: Discount on bonds payable .................
16,370
400,000
$4,000,000*
513,883*
3,486,117
*($544,869 $14,616 $16,370)

(c) 1.
2.
10-56
Total bond interest expense2011, $416,370.

The effective-interest method will result in less interest expense
reported than the straight-line method in 2011 when the bonds
are sold at a discount. Straight-line interest expense for 2011 is
$436,325 [$400,000 + ($544,869 15)].

3.
4.
Annual interest payments

($4,000,000 X 10%) = $400,000; $400,000 X 15 ......
Add: Bond discount ($4,000,000 $3,455,131) .......
Total cost of borrowing.......................................
$6,000,000
544,869
$6,544,869
Total bond interest expense would be the same under both the
straight-line method and the effective-interest method.
10-57
*PROBLEM 10-12B
(a)
(A)
Quarterly
Interest Period
Issue Date
1
2
3
4
5
(b) Dec. 31
Cash
Payment
$29,460
29,460
29,460
29,460
29,460
(B)
Interest
Expense
(D) X 2%
$8,000
7,571
7,133
6,686
6,231
(C)
Reduction
of Principal
(A) (B)
(D)
Principal
Balance
(D) (C)
$21,460
21,889
22,327
22,774
23,229
$400,000
378,540
356,651
334,324
311,550
288,321
Interest Expense ..................................

Mortgage Notes Payable......................
Cash...............................................
8,000
21,460

Current portion of 8% mortgage notes
payable.........................................................
Mortgage notes payable, 8%, due
in 2014 and secured by plant assets..........
Total liabilities ..................................
29,460
$ 90,219*
288,321**
$378,540*
**($21,889 + $22,327 + $22,774 + $23,229)

**($378,540 $90,219)
10-58
*PROBLEM 10-13B
(a)
Period
May 1, 2010
May 31, 2010
June 30, 2010
July 31, 2010
Aug. 31, 2010
(b) May
May 31
June 30
July 31
Cash
Payment
(A)
Interest
Expense
(B) = (D) X 2%
Principal
Reduction
(C) = (A) (B)
$3,531
3,531
3,531
3,531
$1,800
1,765
1,730
1,694
$1,731
1,766
1,801
1,837
Balance
(D) = (D) (C)
$90,000
88,269
86,503
84,702
82,865
Cash .......................................................
Notes Payable................................
90,000
Notes Payable .......................................

Interest Expense ...................................
Cash ...............................................
1,731
1,800
Notes Payable .......................................

Cash ...............................................
1,766
1,765
Notes Payable .......................................

Cash ...............................................
1,801
1,730
90,000
3,531
3,531
3,531
10-59
COMPREHENSIVE PROBLEM SOLUTION
(a)
1. Bond Interest Payable ....................................

Cash .........................................................
3,000
2. Merchandise Inventory...................................
Accounts Payable ...................................
241,100
3. Cash.................................................................
Sales.........................................................
Sales Taxes Payable ...............................
477,000
Cost of Goods Sold ........................................

Merchandise Inventory ...........................
250,000
4. Account Payable .............................................

Cash .........................................................
230,000
5. Bond Interest Expense ...................................

Cash .........................................................
3,000
6. Insurance Expense .........................................

Prepaid Insurance ...................................
5,600
7. Prepaid Insurance...........................................
Cash .........................................................
10,200
8. Sales Taxes Payable.......................................

Cash .........................................................
17,000
9. Other Operating Expenses.............................

Cash .........................................................
91,000
10. Bond Interest Expense ...................................

Cash .........................................................
3,000
Bonds Payable ................................................

Cash .........................................................
Gain on Bond Redemption .....................
50,000
10-60
3,000
241,100
450,000
27,000
250,000
230,000
3,000
5,600
10,200
17,000
91,000
3,000
48,000
2,000
COMPREHENSIVE PROBLEM SOLUTION (Continued)

11. Cash (90,000 X 104%) .....................................
Bonds Payable ........................................
Premium on Bonds Payable...................
93,600
90,000
3,600
Adjusting Entries
12. Insurance Expense ($10,200 X 5/12)..............
Prepaid Insurance ...................................
4,250
13. Depreciation Expense ($38,000 $3,000) 5....

Accumulated Depreciation .....................
7,000
14. Income Tax Expense ......................................

Income Tax Payable................................
26,445
(b)
4,250
7,000
26,445
ABER CORPORATION
Trial Balance
12/31/2010
Account
Cash............................................................
Merchandise Inventory..............................
Prepaid Insurance......................................
Equipment ..................................................
Accumulated Depreciation........................
Accounts Payable ......................................
Sales Tax Payable......................................
Income Tax Payable...................................
Bonds Payable ...........................................
Premium on Bonds Payable......................
Common Stock ..........................................
Retained Earnings .....................................
Sales ...........................................................
Cost of Goods Sold ...................................
Depreciation Expense ...............................
Insurance Expense ....................................
Other Operating Expenses........................
Bond Interest Expense ..............................
Gain on Bond Redemption........................
Income Tax Expense .................................
Debit
$195,900
16,850
5,950
38,000
Credit
7,000
24,850
10,000
26,445
90,000
3,600
20,000
13,100
450,000
250,000
7,000
9,850
91,000
6,000
2,000
26,445
$646,995
$646,995
10-61

(a) and (b) Optional T accounts
Bal.
Bal.
Cash
30,500
477,000
93,600
3,000
230,000
3,000
10,200
17,000
91,000
3,000
48,000
195,900
Merchandise Inventory
Bal.
25,750
250,000
241,100
Bal.
16,850
Bond Interest Payble

3,000 Bal.
3,000
Bal.
0
Sales Tax Payable
17,000
27,000
Bal.
10,000
Income Tax Payable
26,445
Bonds Payable
50,000 Bal.
Bal.
Bal.
Bal.
Bal.
Prepaid Insurance
5,600
10,200
5,950
5,600
4,250
Accumulated Depreciation
7,000
Accounts Payable
230,000 Bal.
13,750
241,100
Bal.
24,850
10-62

3,600
Common Stock
Bal.
Equipment
38,000
50,000
90,000
90,000
20,000
Retained Earnings
Bal.
13,100
Sales
450,000

(a) and (b) (Continued)
Cost of Goods Sold
250,000

3,000
3,000
Bal.
6,000
Depreciation Expense
7,000
Bal.
Insurance Expense
5,600
4,250
9,850
Income Tax Expense

26,445

2,000
Other Operating Expenses

91,000
(c)
ABER CORPORATION
Income Statement
For the Year Ending 12/31/10
Sales ...........................................................
Cost of goods sold ....................................
Gross profit ................................................
Operating expenses
Insurance expense .............................
Depreciation expense ........................
Other operating expenses .................
Total operating expenses..........................
Income from operations ............................
Other revenues and gains
Bond interest expense .......................
Gain on bond redemption..................
Income before taxes ..................................
Income tax expense ...........................
Net income .................................................
$450,000
250,000
200,000
$9,850
7,000
91,000
107,850
92,150
6,000
2,000
4,000
88,150
26,445
$ 61,705
10-63

ABER CORPORATION
Retained Earnings Statement
For the Year Ending 12/31/10
Retained earnings, 1/1/10
Add: Net income
$13,100
61,705
74,805
$74,805
Less: Dividends
Retained earnings, 12/31/10
ABER CORPORATION
Balance Sheet
12/31/2010
Current Assets
Cash.....................................................
Merchandise inventory.......................
Prepaid insurance...............................
Total current assets ......................
Property, Plant, and Equipment
Equipment ...........................................
Accumulated depreciation .................
Total plant assets..........................
Total assets
Current Liabilities
Accounts payable ...............................
Income taxes payable.........................
Sales tax payable................................
Total current liabilities..................
Bonds payable ....................................
Premium on bonds payable ...............
Total long-term liabilities..............
Total liabilities ...............................
Stockholders Equity
Common stock....................................
Retained earnings...............................
Total stockholders equity............
Total liabilities and stockholders
equity .......................................................
10-64
$195,900
16,850
5,950
$218,700
38,000
7,000
31,000
$249,700
$24,850
26,445
10,000
$ 61,295
90,000
3,600
93,600
154,895
20,000
74,805
94,805
$249,700
BYP 10-1
FINANCIAL REPORTING PROBLEM
(a) Total current liabilities at December 31, 2007, $57,972,000. Tootsie

Rolls total current liabilities decreased by $4,239,000 ($62,211,000
$57,972,000) relative to the prior year.
(b) Tootsie Rolls accounts payable at December 31, 2007, $11,572,000.
(c) The other components of current liabilities are:
Dividends payable .............................................................. $ 4,344,000
Accrued liabilities ...............................................................
42,056,000
10-65
BYP 10-2
COMPARATIVE ANALYSIS PROBLEM
(a)
(1) Current ratio
Hershey
Tootsie Roll
$1,426,574
= .88:1
$1,618,770
$199,726
= 3.45:1
$57,972
Based on the current ratio, Tootsie Roll is more liquid than Hershey.
Tootsie Rolls current ratio is 392% larger than Hersheys. A review of
Hersheys balance sheet indicates that almost half of its liabilities is
made up of debt payments due in 2008. Tootsie Roll appears much
more able to meet its current obligations.
(b)
Hershey
(1) Debt to total
assets
(2) Times interest
earned
**$57,972 + $116,523
10-66
$3,623,593
$4,247,113
= 85.3%
Tootsie Roll
$174,495 **
$812,725
= 21.5%
$214,154 + $126,088 + $121,066
$51,625 + $25,542 + $535 ***
$121,066
= 3.8 times
$535
= 145.2 times
***See note 6
BYP 10-2 (Continued)

The higher the percentage of debt to total assets, the greater the risk
that a company may be unable to meet its maturing obligations. Tootsie
Rolls 2007 debt to total assets ratio was considerably less than
Hersheys; thus, Tootsie Roll would be considered significantly better
able to meet its obligations. The times interest earned ratio provides
an indication of a companys ability to meet interest payments. Since
Tootsie Rolls times interest earned ratio is approximately 38 times as
large as Hersheys, Tootsie Roll had a much greater ability to meet its
interest payments in 2007 than Hershey. Tootsie Roll appears to be
significantly more solvent.
10-67
BYP 10-3
RESEARCH CASE
(a) The promise to pay in the future creates a contingent liability for the
companies. It is contingent on the communities incurring costs in the
future to remove MTBE from their water. If the communities dont incur
future costs, the companies will not owe money.
(b) The criteria that are applied to contingent liabilities are: can a reasonable
estimate be made of the future costs and is it probable that the event
(in this case future costs) will occur. If both criteria are met, then the
company must accrue a liability. If only one of the criteria is met, then
the company simply discloses the situation in its notes.
(c) The question is, is it probable that the companies will incur future costs,
and if so, can a reasonable estimate be made. If so the companies should
accrue a liability for this amount. If not, they should disclose. Based
upon the experience of the communities in the past, it seems likely that
they will incur future costs. The difficulty will be in arriving at a reasonable estimate of the amount. The article suggests that estimates have
ranged as high as $30 billion. The companies are not obligated to accrue
for the highest estimate. But if they can arrive at what they consider a
reasonable estimate, they do need to accrue for that. Adjustments can
be made to the estimate in the future as more information becomes
available.
From an investors perspective this is a difficult situation because they
have to evaluate whether the companies have made a reasonable
estimate of the cost. If companies under-accrue, then investors might
think the company is worth more than it actually is. Because the
amounts could be very large, the accuracy of the estimate is very
important to investors.
(d) Exxons situation is different because it has the added complexity of
not knowing whether they will lose the lawsuit. The other companies
already know, because of the settlement, that they have a potential
obligation. Exxon will not have an obligation unless they lose the lawsuit.
Therefore, in this case the question is, is it probable that Exxon will
lose the lawsuit, and, if it is probable, can a reasonable estimate be made
regarding what its potential cost will be. Most companies involved in
lawsuits do not accrue for amounts until they lose. Instead they simply
disclose information about the pending lawsuit in the notes to their
financial statements.
10-68
BYP 10-4
INTERPRETING FINANCIAL STATEMENTS
(a)
Hechinger
Home Depot
Working capital
$1,153 $938 = $215
$4,933 $2,857 = $2,076
Current ratio
$1,153 $938 = 1.23:1
$4,933 $2,857 = 1.73:1
On both dimensions Hechingers liquidity is low and Home Depots is

strong.
(b) Debt to total
$1, 339
assets ratio
$1, 577
Times interest
earned
$93 + $67 + $3
$67
$4, 716
= 85%
$13, 465
= .34 times
= 35%
$1,614 + $37 + $1,040

$37
= 72.7 times
Hechinger relied heavily on debt financing85% of every dollar of

assets was financed with debt versus only 35% by Home Depot.
Hechingers interest coverage ratio was negative, suggesting it did not
have the ability to service its debt. In contrast, Home Depots interest
coverage ratio is exceptionally high, suggesting it could handle even
more debt.
$93
(c) Return on
assets ratio
($1, 577 + $1, 668) 2
Profit
margin ratio
$93
$3, 444
= 5.7%
$1, 614
($13, 465 + $11, 229) 2
= 2.7%
$1, 614
$30, 219
= 13.1%
= 5.3%
Hechinger reported negative profitability ratios because it reported a

loss for the year. If you combine its low liquidity and low solvency with
its inability to generate a profit, it was clearly headed for trouble.
10-69

(d)
Debt to total assets
Original
Restated
$4, 716
= 35%
$13, 465
$4, 716 + $2, 347

= 45%
$13, 465 + $2, 347
After treating Home Depots operating leases as purchases, its debt to

total assets ratio increases from 35% to 45%. While this suggests that
its reliance on debt is actually higher than the balance sheet indicates,
its reliance on debt is still quite reasonable and not cause for concern.
10-70
BYP 10-5
INTERPRETING FINANCIAL STATEMENTS
(a) In the 1870s, a securities system was introduced in Japan and public
bond negotiation began. This resulted in the request for a public
trading institution and the Stock Exchange Ordinance was enacted
in May of 1878. Based on this ordinance, the Tokyo Stock Exchange
Co., Ltd. was established on May 15, 1878 and trading began on June
1st. Japan now has five stock exchanges.
(b) In March of 1943, the Japan Securities Exchange Law was enacted to
reorganize the Stock Exchange as a wartime-controlled institution. With
worsening war conditions and air raids on the main island of Japan, the
securities market was forced to suspend trading sessions on all securities markets on August 10, 1945. Trading was restarted by unofficial
group transactions in December of 1945.
(c) The following are major items with respect to decisions by the company that need to be disclosed to the public:
Issuance of stocks, convertible bonds, and bonds with warrants

Reduction of capital
Stock split or stock consolidation
Merger
Dissolution
Purchase or sale of stocks or equity interest in a subsidiary
Change of representative
Change of the trade name
(d) The following are major items with respect to occurrence of material
fact that need to be disclosed to the public:
Damage incurred by natural disaster or business operations

Change in major shareholders
Commencement of litigation or rendering of a court judgment
Commencement of bankruptcy or reorganization proceedings
10-71

Dishonor of notes
Change of laws and the like in the home country that have a material
effect on the company or its shareholders, such as restriction on
transfer of stocks, nationalization of the company
Tender offer for the companys stocks
Occurrence of facts causing the delisting from the foreign stock
exchange or the like
10-72
BYP 10-6
FINANCIAL ANALYSIS ON THE WEB
(a) In 1909, Moodys introduced the first bond ratings as part of Moodys
Analyses of Railroad Investments.
(b) Moodys tracks more than $35 trillion worth of debt securities.
(c) The ultimate value of a rating agencys contribution to that market efficiency depends on its ability to provide ratings that are clear, credible,
accurate risk opinions based on a fundamental understanding of credit
risk. To provide a reliable frame of reference for investment decisions,
the agencys ratings should offer broad coverage and also be based
on a globally consistent rating process, supported by rating committees
with a multi-national perspective.
10-73
BYP 10-7
FINANCIAL ANALYSIS ON THE WEB
Answers will vary depending on the financial decision chosen by the student.
10-74
BYP 10-8
(a) 1.
DECISION MAKING ACROSS THE ORGANIZATION
Bonds Payable ...........................................

Cash ....................................................
Discount on Bonds Payable ..............
($2,946,000 $2,500,000) ...............
(To record redemption of 8%
bonds)
3,000,000
2,500,000
54,000*
446,000
*($3,000,000 $2,946,000)
2.
Cash............................................................
Bonds Payable....................................
(To record sale of 10-year, 12%
bonds at par)
2,500,000
2,500,000
(b) Dear President Heyman:

The early redemption of the 8%, 5-year bonds results in recognizing a
gain of $446,000 that increases current year net income by the after-tax
effect of the gain. The amount of the liabilities on the balance sheet will
be lowered by the issuance of the new bonds and retirement of the
5-year bonds.
1.
The cash flow of the company as it relates to bonds payable will be

adversely affected as follows:
Annual interest payments on the new issue
($2,500,000 X .12) .......................................................
Annual interest payments on the 5-year bonds
($3,000,000 X .08) .......................................................
Additional cash outflows per year ................................
$300,000
240,000
$ 60,000
10-75

2.
The amount of interest expense shown on the income statement

will be higher as a result of the decision to issue new bonds:
Annual interest expense on new bonds ..........
Annual interest expense on 8% bonds:
Interest payment.........................................
Discount amortization ($54,000 3 yrs.)....
Additional interest expense per year...............
$300,000
$240,000
18,000
258,000
$ 42,000
These comparisons hold for only the 3-year remaining life of the 8%,
5-year bonds. The company must acknowledge either redemption of the
8% bonds at maturity, January 1, 2013, or refinancing of that issue at
that time and consider what interest rates will be in 2013 in evaluating a
redemption and issuance in 2010.
Sincerely,
10-76
BYP 10-9
COMMUNICATION ACTIVITY
To:
Leon Housten
From:
I. M. Student
Subject:
Bond Financing
The advantages of bond financing over common stock financing include:

1.
Stockholder control is not affected.
2.
Tax savings result.
3.
Income to common stockholders may increase.
4.
Earnings per share of common stock may be higher.
The types of bonds that may be issued are:

1.
Secured or unsecured bonds. Secured bonds have specific assets of

the issuer pledged as collateral while unsecured bonds do not.
2.
Convertible bonds, which can be converted by the bondholder into

common stock.
3.
Callable bonds, which are subject to early retirement by the issuer at a

stated amount.
State laws grant corporations the power to issue bonds after formal approval
by the board of directors and stockholders. The terms of the bond issue are
set forth in a legal document called a bond indenture. After the bond indenture is prepared, bond certificates are printed.
10-77
BYP 10-10
ETHICS CASE
(a) The stakeholders in this situation include:

Stockholders
Creditors
Employees
Government inspectors
Customers flying in airplanes
(b) The possible courses of action and their consequences include:
1.
The CEO could inform the auditors. The auditors would then require that this information be disclosed in the annual report. When
the lenders learn about this potential problem, they may decide to
call their loans, and the companys suppliers may decide to quit
sending it goods. This could result in the bankruptcy of the company, even if the company was not at fault for the engine failures.
However, this would be in compliance with the accounting requirement to disclose all material facts. By not disclosing, the CEO is
misinforming a large number of important stakeholders.
2.
The CEO could conceal the information from the auditors. If the
company is not ultimately found at fault, then the company will not
have sustained any financial hardship. However, if the company is
found to be at fault for the engine failures, then not only is it likely
the company will go bankrupt, but the CEO could face prosecution
for failing to disclose the existence of this problem to auditors.
(c) Answer will vary according to student.

(d) If the CEO conceals the information, and the company is subsequently
found to be at fault, a number of stakeholders will suffer. First, the companys creditors will lose money because it is likely the company wont
be able to repay its loans in full. The stockholders will lose because the
value of their shares will plummet. The employees may well lose their
jobs because the company is likely to go bankrupt. Also, it is possible
that other engines might fail in the interim, possibly resulting in a crash.
Answers as to whether the CEO should be punished for concealing this
information will vary by student.
10-78
BYP 10-11
ETHICS CASE
(a) The stakeholders include:

1. Enron management
2. Citigroup management
3. Enron investors
4. Enron creditors
(b) Yes. Although the primary responsibility for proper accounting rests
with company management, other knowledgable parties have secondary responsibilities. Auditors are expected to attest to full disclosure.
Lenders, with access to information that is generally unavailable to
others, are expected to provide full and accurate disclosure of transactions with borrowers.
(c) The auditor may have been unable to detect the inappropriate accounting treatment because secret agreements between Enron and Citigroup
were not made available for review.
(d) A company may wish to conceal financing arrangements in order to
appear more solvent to investors and creditors. GAAP requires full
disclosure of all information that would make a difference to financial
statement users. Intentionally understating liabilities is a violation of
GAAP and thus inappropriate. It is unethical for lenders to market
deals that circumvent GAAP.
(e) The Citigroup deal was more harmful than other off-balance-sheet transactions because it was not fully explained in the financial statement
notes. (The auditors didnt even know the details.) This lack of explanation made it impossible for users of Enron's financial statements to
incorporate such off-balance-sheet information into their evaluation of
Enrons performance.
10-79
BYP 10-12
ALL ABOUT YOU ACTIVITY
The answer to these questions depends on the state in which the student
resides. It also will be depend on the year chosen, although we expect that
the results will be much the same whether they pick any rates between
2005 and 2008. We provide a solution for this problem using the state of
Wisconsin as an example. It should be pointed out that certain taxes can
be deducted for computing federal income tax but are ignored in our
computation.
(a) Wisconsin state income taxes for a single person with a taxable income
of $60,000 is $3,710.80. The tax rate between $17,680 and $132,580 is
$950.30 plus 6.5 percent over $17,680. Therefore the computation is as
follows:
($60,000 $17,680) X 6.5% = $2,751
Base rate
950
Total state income tax
$3,701
(b) The property tax on a $200,000 home at 2.1% is $4,200.
(c) The state gasoline tax in Wisconsin is 32.9 cents per gallon and the federal
gasoline tax is 18.4 cents per gallon. Your total taxes on gasoline are
computed as follows:
400 gallons X ($0.329 + $0.184) = $205
(d) In Wisconsin the state sales tax rate is 5% and excludes food and
prescription drug purchases. Therefore the sales tax is $200 ($4,000 X 5%).
(e) The social security rate is 7.65% on income of $60,000 or $4,590.
(f) Federal income taxes for a single person with a taxable income of $60,000
is $11,538. The tax rate between $30,650 and $74,200 is $4,220 plus
25% over $30,650. Therefore the computation is as follows:
($60,000 $30,650) X 25% = $ 7,338
Base rate
4,220
Total tax
$11,558
10-80

The total taxes paid therefore are computed as follows, based on a $60,000
income amount:
State income tax..................................................................
Property tax on home .........................................................
Gasoline tax.........................................................................
Sales tax ..............................................................................
Social security tax...............................................................
Federal income tax..............................................................
Total tax ...............................................................................
$ 3,701
4,200
205
200
4,590
11,558
$24,454
The percentage of total taxes to income is therefore 41% ($24,454/$60,000),

given the information above.
10-81

Accounting Ch10

Загружено:

Сведения о документе

Авторское право

Доступные форматы

Поделиться этим документом

Поделиться или встроить документ

Параметры публикации

Этот документ был вам полезен?

Это неприемлемый материал?

Авторское право:

Доступные форматы

Accounting Ch10

Загружено:

Авторское право:

Доступные форматы

CHAPTER 10

Reporting and Analyzing Liabilities

(a) The entry when the tickets are sold is:

(b) The entry after each game is:

Copyright 2010 John Wiley & Sons, Inc.

Kimmel, Financial Accounting, 5/e, Solutions Manual

(For Instructor Use Only)

Questions Chapter 10 (Continued)

$48,000. $800,000 X 6% X 1 year = $48,000.

Kimmel, Financial Accounting, 5/e, Solutions Manual

(For Instructor Use Only)

Questions Chapter 10 (Continued)

Copyright 2010 John Wiley & Sons, Inc.

Kimmel, Financial Accounting, 5/e, Solutions Manual

(For Instructor Use Only)

Questions Chapter 10 (Continued)

Copyright 2010 John Wiley & Sons, Inc.

Kimmel, Financial Accounting, 5/e, Solutions Manual

(For Instructor Use Only)

SOLUTIONS TO BRIEF EXERCISES

BRIEF EXERCISE 10-2

BRIEF EXERCISE 10-3

Copyright 2010 John Wiley & Sons, Inc.

Kimmel, Financial Accounting, 5/e, Solutions Manual

(For Instructor Use Only)

BRIEF EXERCISE 10-4

(b) Unearned Basketball Ticket Revenue...................

BRIEF EXERCISE 10-5

BRIEF EXERCISE 10-6

Bond Interest Expense ...................

Bond Interest Payable ....................

Copyright 2010 John Wiley & Sons, Inc.

Kimmel, Financial Accounting, 5/e, Solutions Manual

(For Instructor Use Only)

BRIEF EXERCISE 10-7

BRIEF EXERCISE 10-8

BRIEF EXERCISE 10-9

Copyright 2010 John Wiley & Sons, Inc.

Kimmel, Financial Accounting, 5/e, Solutions Manual

(For Instructor Use Only)

BRIEF EXERCISE 10-10

Working capital = $3,925 $2,192 = $1,733

With operating leases

Copyright 2010 John Wiley & Sons, Inc.

Kimmel, Financial Accounting, 5/e, Solutions Manual

(For Instructor Use Only)

*BRIEF EXERCISE 10-12

Cash (.99 X $3,000,000) ...................

Bond Interest Expense ....................

*BRIEF EXERCISE 10-13

(b) Interest Expense ...............................................

*BRIEF EXERCISE 10-14

Copyright 2010 John Wiley & Sons, Inc.

Kimmel, Financial Accounting, 5/e, Solutions Manual

(For Instructor Use Only)

SOLUTIONS TO DO IT! REVIEW EXERCISES

$70,000 X 12% X 5/12 = $3,500

Copyright 2010 John Wiley & Sons, Inc.

Kimmel, Financial Accounting, 5/e, Solutions Manual

(For Instructor Use Only)

Copyright 2010 John Wiley & Sons, Inc.

Kimmel, Financial Accounting, 5/e, Solutions Manual

(For Instructor Use Only)

(b) June 30 Interest Expense