ACCT 210 Lecture, Fall 2004

25 Minutes, Medium BLEM 10.4A QUICK LUBE a. and d. a. d. PROBLEM 10.4A QUICK LUBE (concluded) b. General Journal 2005 Oct 1 Interest Expense 10,800 Mortgage Note Payable 310 Cash 11,110 Nov 1 Interest Expense 10,797 Mortgage Note Payable 313 Cash 11,110 To record monthly mortgage payment. The amount of the monthly payments exceeds the amount of the monthly interest expense. Therefore, a portion of each payment reduces the unpaid balance of the loan. The continuous reduction in the unpaid balance, in turn, causes the monthly interest expense to be less in each successive month, and the amount applied to the unpaid balance to increase. At December 31, 2005, two amounts relating to this mortgage loan will appear as current liabilities in the borrower’s balance sheet. First, as payments are due on the first day of each month, one month’s interest has accrued since the December 1 Next, the portion of the unpaid principal that will be repaid during 2006 represents a current liability. Parts b and c appear on the following page. To record monthly payment on mortgage. c. Amortization Table (12%, 30-Year Mortgage Note Payable for $1,080,000; Payable in 360 Monthly Installments of $11,110) Reduction in Interest Payment Monthly Interest Unpaid Unpaid Period Date Payment Expense Balance Balance Issue date Sept. 1, 2005 $ 1,080,000 1 Oct. 1 $ 11,110 $ 10,800 $ 310 1,079,690 2 Nov. 1 11,110 10,797 313 1,079,377 3 Dec. 1 11,110 10,794 316 1,079,061 4 Jan. 1, 2006 11,110 10,791 319 1,078,742 35 Minutes, Strong BLEM 10.6A LUMBER COMPANY a. General Journal (1) Bonds issued at 98: 2005 Dec 31 Bond Interest Expense ### 26,667 ### four months in 2005: ### 26,667 ### 2006 Mar 1 Bond Interest Payable ### Bond Interest Expense ### 13,334 Cash ### (2) Bonds issued at 101: 2005 Dec 31 Bonds Interest Expense ### Premium on Bonds Payable 13,333 ### ### (13,333) ### 2006 Mar 1 Bond Interest Payable ### Bond Interest Expense ### Premium on Bonds Payable 6,666 Cash ### Discount on Bonds Payable Bond Interest Payable To record accrual of bond interest expense for Contract interest ($80,000,000 x 10% x 4/12) Discount amortization ($1,600,000 ÷ 20 years) x 4/12 Bond interest expense for four months Discount on Bonds Payable To record semiannual bond interest payment and interest expense for two months (1/2 of interest for four months, as computed in preceding entry). * Bond Interest Payable Accrual of interest on bonds for four months: Contract interest ($80,000,000 x 10% x 4/12) Less: Premium amortization ($800,000 ÷ 20 yrs) x 4/12 Bond interest expense for four months Semiannual bond interest payment and interest expense for two months (1/2 of interest for four months, as computed in preceding entry).* * Actual amount differs slightly due to rounding errors. BLEM 10.6A R COMPANY (concluded) b. Net bond liability at Dec. 31, 20 Bonds Bonds Issued Issued at 98 at 101 Bond payable ### ### * Less: Discount on bonds payable ( ### ** Add: Premium on bonds payable 746,667 ### ### * Discount amortized at Dec. 31, 2006: Amount amortized in 2005 ……… $ 26,667 80,000 Discount amortized ### ** Premium amortized at Dec. 31, 2006: Amount amortized in 2005 ………… $ 13,333 40,000 Premium amortized at 12/31 $ 53,333 c. Net bond liability at Dec. 31, 2006: Amount amortized in 2006 ($1,600,000 ¸ 20 years) ………………………………….. Amount amortized in 2006 ($800,000 ¸ 20 years) …………………………………… The effective rate of interest would be higher under assumption 1. The less that investors pay for bonds with a given contract rate of interest, the higher the effective interest rate they will earn. 25 Minutes, Medium BLEM 10.4B WALLA a. and d. a. d. BLEM 10.4B WALLA (concluded) b. General Journal 2005 Nov 1 Interest Expense 1,000 Note Payable 1,633 Cash 2,633 Vicksburg National Bank. Dec 1 Interest Expense 984 Note Payable 1,649 Cash 2,633 Vicksburg National Bank. The amount of the monthly payments exceeds the amount of the monthly interest expense. Therefore, a portion of each payment reduces the unpaid balance of the loan. The continuous reduction in the unpaid balance, in turn, causes the monthly interest At December 31, 2005, two amounts relating to this mortgage loan will appear as current liabilities in the borrower’s balance sheet. First, as payments are due on the first day of each month, one month’s interest has accrued since the December 1 Next, the portion of the unpaid principal that will be repaid during 2006 represents a current liability. Parts b and c appear on the following page. To record monthly payment on note payable to To record monthly payment on note payable to c. Amortization Table (12%, 4-Year Mortgage Note Payable for $100,000; Payable in 48 Monthly Installments of $2,633) Reduction in Interest Payment Monthly Interest Unpaid Unpaid Period Date Payment Expense Balance Balance Issue date Oct. 1, 2005 ### 1 Nov. 1 $ 2,633 $ 1,000 $ 1,633 98,367 2 Dec. 1 2,633 984 1,649 96,718 3 Jan. 1, 2006 2,633 967 1,666 95,052 4 Feb. 1 2,633 951 1,682 93,370 35 Minutes, Strong BLEM 10.6B BELLA COMPANY a. General Journal (1) Bonds issued at 98: 2005 Dec 31 Bond Interest Expense 203,333 3,333 200,000 four months in 2005: ### 3,333 ### 2006 Mar 1 Bond Interest Payable 200,000 Bond Interest Expense 101,667 1,667 Cash 300,000 (2) Bonds issued at 104: 2005 Dec 31 Bonds Interest Expense 193,333 Premium on Bonds Payable 6,667 200,000 ### Less: Premium amortization ($200,000 x 4/120) (6,667) ### 2006 Mar 1 Bond Interest Payable 200,000 Bond Interest Expense 96,667 Premium on Bonds Payable 3,333 Cash 300,000 Discount on Bonds Payable Bond Interest Payable To record accrual of bond interest expense for Contract interest ($5,000,000 x 12% x 4/12) Discount amortization ($100,000 x 4/120) Bond interest expense for four months Discount on Bonds Payable To record semiannual bond interest expense for two months (1/2 of interest for four months, as computed in Bond Interest Payable Accrual of interest on bonds for four months: Contract interest ($5,000,000 x 12% x 4/12) Bond interest expense for four months Semiannual bond interest payment and interest expense for two months (1/2 of interest for four months, as computed in preceding entry).* * Actual amount differs slightly due to rounding errors. BLEM 10.6B BELLA (concluded) b. Net bond liability at Dec. 31, 20 Bonds Bonds Issued Issued at 98 at 104 Bond payable ### ### * Less:Discount on bonds payable ( (86,667) ** Add:Premium on bonds payable Net bond liability 173,333 ### ### * Discount amortized at Dec. 31, 2006: Amount amortized in 2005 ……… $ 3,333 Amount amortized in 2006 ($100,000 x 10,000 Discount amortized $ 13,333 ** Premium amortized at Dec. 31, 2006: Amount amortized in 2005 ……… $ 6,667 Amount amortized in 2006 ($200,000 x 20,000 Premium amortized at 12/31 $ 26,667 c. The effective rate of interest would be higher under assumption 1. The less that investors pay for bonds with a given contract rate of interest, the higher the effective interest rate they will earn. 45 Minutes, Strong BLEM 10.7B UTILITY COMPANY a. DELAWARE UTILITY COMPANY Partial Balance Sheet December 31, 2005 Liabilities: (in thousands) Current liabilities: Accounts payable $ 48,000 Accrued expenses payable (othe 7,200 Accrued interest payable 3,650 Notes payable (short-term) 75,000 Lease payment obligation (current portion 3,000 Unfunded obligation for postretirement ben other than pensions (current portion) 16,000 Income taxes payable 8,000 Total current liabiliti ### Long-term liabilities: 10% Bonds payable, due April 1 ### 8% Bonds payable, due October ### Less: Discount on bonds payab 270 149,730 12% Bonds payable, due April 1 ### Add: Premium on bonds payabl 2,000 302,000 Lease payment obligation (less 15,000 Unfunded obligation for postretirement benefits other than pensions (less current portion 44,000 Deferred income taxes 110,000 Total long-term liabilities ### Total Liabilities ### Part b appears on the following page. c. (1) Computation of debt ratio: Total liabilities (above) ### Total assets (given) ### 40% (2) Computation of interest coverage ratio: Operating income (given) ### Annual interest expense ($57,00 $ 65,000 5.25 times PROBLEM 10.7B Debt ratio ($881,580 ÷ $2,203,950) Interest coverage ratio ($341,250 Part d appears on the following page. (concluded) b. (1) (2) (3) (4) As the pension plan is fully funded, the company has no pension liability. (5) (6) d. DELAWARE UTILITY COMPANY As the 10% bond issue is being refinanced on a long-term basis (that is, paid from the proceeds of a long-term bond issue rather than from current assets), it is classified as a long-term liability rather than a current liability. The 8% bonds will be repaid from a bond sinking fund rather than from current assets. Therefore, this liability continues to be classified as long-term, despite its maturity date in less than one year. The portion of the capitalized lease payment obligation that will be repaid within one year ($3,000) is classified as a current liability, and the remainder of this obligation is classified as long-term. The payments applicable to operating leases will be recognized as rental expense in the periods in which these costs are incurred. The $16,000 portion of the unfunded liability for nonpension postretirement benefits that will be funded within one year is a current liability, and the remaining $44,000 ($60,000 - $16,000) is classified as long-term. Income taxes payable relate to the current year’s income tax return and, therefore, are a current liability. Although deferred income taxes can include a current portion, all of the deferred income taxes are stated to be a long-term liability. Based solely upon its debt ratio and interest coverage ratio, Delaware Utility appears to be a good credit risk. One must consider, however, that Delaware Utility is a utility company, not a business organization that battles numerous competitors on a daily basis. Utility companies enjoy a “captive market” on a long-term basis. Also, their rates are regulated to allow them to recover their costs and to earn a reasonable profit, except in unusual circumstances. In summary, the fact that Delaware Utility is a profitable utility company with a reasonable debt ratio and interest coverage ratio makes this business entity a relatively low long-term credit risk. OBLEM 10.7B (concluded) n liability. TY COMPANY (that is, paid from nt assets), it is than from current -term, despite its l be repaid within ainder of this o operating leases se costs are ostretirement benefits e remaining $44,000 turn and, therefore, ude a current -term liability. ity appears to be a tility company, not a Utility companies ated to allow them to umstances. with a reasonable ly low long-term 45 Minutes, Strong BLEM 10.7A ESOTA SATELLITE NE CORPORATION a. MINNESOTA SATELLITE TELEPHONE CORPORATION Partial Balance Sheet December 31, 2005 Liabilities: (in thousands) Current liabilities: Accounts payable $ 65,600 Accrued expenses payable (othe 11,347 Accrued interest payable 7,333 Notes payable (short-term) 110,000 Lease payment obligation (current portion 4,621 Unfunded obligation for postretirement ben other than pensions (current portion) 18,000 Income taxes payable 17,300 Total current liabiliti ### Long-term liabilities: 6-3/4% Bonds payable, due Febr ### 8-1/2% Bonds payable, due June ### Less: Discount on bonds payab 260 249,740 11% Bonds payable, due June 1 ### Add: Premium on bonds payabl 1,700 301,700 Lease payment obligation (less 18,979 Unfunded obligation for postretirement benefits other than pensions (less current portion 54,000 Deferred income taxes 130,000 Total long-term liabilities ### Total liabilities ### Part b appears on the following page. c. (1) Computation of debt ratio: Total liabilities (above) ### Total assets (given) ### 52% (2) Computation of interest coverage ratio: Operating income (given) ### Annual interest expense ($61,00 $ 78,000 3.6 times Debt ratio ($1,088,620 ÷ $2,093,500) Interest coverage ratio ($280,000 Part d appears on the following page. PROBLEM 10.7A MINNESOTA SATELLITE LEPHONE CORPORATION (concluded) b. (1) (2) (3) (4) As the pension plan is fully funded, the company has no pension liability. (5) (6) d. As the 6 3/4% bond issue is being refinanced on a long-term basis (that is, paid from the proceeds of a long-term bond issue rather than from current assets), it is classified as a long-term liability rather than a current liability. The 8 1/2% bonds will be repaid from a bond sinking fund rather than from current assets. Therefore, this liability continues to be classified as long-term, despite its maturity date in less than one year. The portion of the capitalized lease payment obligation that will be repaid within one year ($4,621) is classified as a current liability, and the remainder of this obligation is classified as long-term. The payments applicable to operating leases will be recognized as rental expense in the periods in which these costs are incurred. The $18,000 portion of the unfunded liability for nonpension postretirement benefits that will be funded within one year is a current liability, and the remaining $54,000 ($72,000 - $18,000) is classified as long-term. Income taxes payable relate to the current year’s income tax return and, therefore, are a current liability. Although deferred income taxes can include a current portion, all of the deferred income taxes are stated to be a long-term liability. Based solely upon its debt ratio and interest coverage ratio, Minnesota Satellite Telephone Corporation appears to be a good credit risk. One must consider, however, that Minnesota Satellite Telephone Corporation is a telephone company, not a business organization that battles hundreds of numerous competitors on a daily basis. Telephone companies enjoy a somewhat of a “captive market” on a long-term basis. Also, their rates are often regulated to allow them to recover their costs and to earn a reasonable profit, except in unusual circumstances. In summary, the fact that Minnesota Satellite Telephone Corporation is a profitable telephone company with a reasonable debt ratio and interest coverage ratio makes this business entity an outstanding long-term credit risk. OBLEM 10.7A A SATELLITE ORPORATION (concluded) n liability. sis (that is, paid from nt assets), it is her than from current -term, despite its l be repaid within ainder of this o operating leases se costs are ostretirement benefits e remaining $54,000 turn and, therefore, ude a current -term liability. tellite Telephone r, that Minnesota ganization that mpanies enjoy a e often regulated to n unusual profitable telephone his business entity an