Chapter 14

Long-Term Liabilities: Bonds and Notes

Study Guide Solutions
Fill-in-the-Blank Equations
1. A discount
2. Face amount
3. A premium
4. Interest expense

Exercises
1. The Garden Supply has two options in financing: issue $3,000,000 of common stock with
a $20 par value and $2,000,000 of 10% bonds or issue $2,500,000 of the same common
stock and $2,500,000 of the same bonds. All bonds and stock are issued at their par or
face amount. If the earnings before interest and income taxes are $750,000 with a 40%
tax rate, what would the effect of the two financing options be on the earnings per
share?
Option 1 Option 2
Common stock, $20 par $3,000,000 $2,500,000
10% bonds 2,000,000 2,500,000
Total $5,000,000 $5,000,000
Earnings before interest & income tax 750,000 750,000
Deduct interest on bonds 200,000 250,000
Income before income tax 550,000 500,000
Deduct income tax 220,000 200,000
Net income 330,000 300,000
Shares of common stock outstanding 150,000 125,000
Earnings per share on common stock $2.20 $2.40

1
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 2 Chapter 14

2. Gifts For All has the financing options below. Assume all bonds and stock are issued at
their par or face amount. The company’s earnings before interest and income taxes are
$1,900,000 with a 35% tax rate. What would the effect of the financing options be on
the earnings per share? Round EPS to two decimal places.

Option 1 Option 2 Option 3

Amount Percent Amount Percent Amount Percent
Issue 15% bonds — $ 5,000,000 50% $ 2,500,000 25%
Issue preferred 6%
stock, $25 par value — 2,500,000 25% 2,500,000 25%
Issue common stock,
$15 par value $10,000,000 100% 2,500,000 25% 5,000,000 50%
$10,000,000 100% $10,000,000 100% $10,000,000 100%

Option 1 Option 2 Option 3

15% bonds — $5,000,000 $2,500,000
Common stock, $15 par $10,000,000 2,500,000 5,000,000
Preferred 6% stock, $25 par — 2,500,000 2,500,000
Total $10,000,000 $10,000,000 $10,000,000
Earnings before interest & income tax 1,900,000 1,900,000 1,900,000
Deduct interest on bonds — 750,000 375,000
Income before income tax 1,900,000 1,150,000 1,525,000
Deduct income tax 665,000 402,500 533,750
Net income 1,235,000 747,500 991,250
Dividends on preferred stock — 150,000 150,000
Available for dividends on common stock 1,235,000 597,500 841,250
Shares of common stock outstanding 666,667 166,667 333,333
Earnings per share on common stock $1.85 $3.58 $2.52

Option 2 would give the company the highest earnings per share. The option gives the
highest tax savings for interest. Although Option 2 generates the lowest net income, less
shares of common stock are outstanding to distribute the earnings.

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 Long-Term Liabilities: Bonds and Notes 3

3. AMC Corporation has the financing options below. Assume all bonds and stock are
issued at their par or face amount. The company’s earnings before interest and income
taxes for the year are $1,500,000 at a 40% tax rate. Which option would generate the
highest earnings per share?

Option 1 Option 2 Option 3

Amount Percent Amount Percent Amount Percent
Issue 18% bonds 1,000,000 20% $3,000,000 60% $2,000,000 40%
Issue preferred 4%
stock, $15 par value 2,500,000 50% 1,000,000 20% 1,500,000 30%
Issue common stock,
$5 par value $1,500,000 30% 1,000,000 20% 1,500,000 30%
$5,000,000 100% $5,000,000 100% $5,000,000 100%

Option 1 Option 2 Option 3

18% bonds $1,000,000 $3,000,000 $2,000,000
Preferred 4% stock, $15 par 2,500,000 1,000,000 1,500,000
Common stock, $5 par 1,500,000 1,000,000 1,500,000
Total $5,000,000 $5,000,000 $5,000,000
Earnings before interest & income tax 1,500,000 1,500,000 1,500,000
Deduct interest on bonds 180,000 540,000 360,000
Income before income tax 1,320,000 960,000 1,140,000
Deduct income tax 528,000 384,000 456,000
Net income 792,000 576,000 684,000
Dividends on preferred stock 100,000 40,000 60,000
Available for dividends on common stock 692,000 536,000 624,000
Shares of common stock outstanding 300,000 200,000 300,000
Earnings per share on common stock $2.31 $2.68 $2.08

Option 2 would give the highest earnings per share.

Strategy: Earnings per share on common stock should be calculated using earnings after
interest and income taxes. First, determine the amount of interest to be paid on any
bonds outstanding and subtract this amount from earnings before interest and taxes.
Subtract income tax from the income before tax to arrive at net income. If any preferred
stock is outstanding, dividends will be first be paid to the preferred shareholders, so
subtract the preferred dividends from net income to calculate net income allocable to
common shareholders. Divide the net income allocable to common shareholders by the
common stock outstanding to arrive at earnings per share on common stock.

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4 Chapter 14

4. Roses Corporation issued a bond with a contract interest rate of 10%. The current
market rate of a bond is 9%. Is the bond being issued at a discount, premium, or face
amount? Would the selling price be higher or lower than the face amount?

The bond is being issued at a premium, and the selling price would be higher than the
face amount.

5. The Garden Supply issued a $1,000,000 bond for $975,000. Would the contract rate be
higher or lower than the market rate? Is the bond being issued at a discount, premium,
or face amount?

The bond is being issued at a discount, and the contract rate would be lower than the
market rate.

6. If The Garden Supply issued a $5,000,000 bond with the same market rate as the
contract rate, how much cash would the company receive for the bond? Is the bond
being issued at a discount, premium, or face amount?

The company would receive $5,000,000 for the bond because it is being issued at face
amount.

Strategy: A bond issued at face amount means that the contract rate is equal to the
market rate, so the amount of cash received is equal to the bond payable. If a premium
exists, the contract rate is higher than the market rate, so investors are willing to pay
more for the bond. However, if the contract rate is lower than the market rate, investors
will only want to invest if they have an incentive, such as a discount.

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 Long-Term Liabilities: Bonds and Notes 5

7. The Howling Moon issued $2,500,000 of 5-year, 10% bonds at par value on January 1,
2015. Interest is payable semiannually, on June 30 and December 31. Prepare the
journal entries related to the following:

a. Issuance of the bonds

Jan. 1 Cash 2,500,000

Bonds Payable 2,500,000
b. Interest expense on June 30, 2015

June 30 Interest Expense 125,000

Cash 125,000
Interest expense: $2,500,000 × 10% × ½ year

c. Retirement of the bonds

Jan. 1 Bonds Payable 2,500,000

Cash 2,500,000

8. Burns’ Alley issued $1,000,000 of 10-year, 8% bonds at par value on June 30, 2015. The
interest is payable annually, beginning on January 1 of the following year. Prepare the
journal entries related to the following:
a. Issuance of the bonds

June 30 Cash 1,000,000

Bonds Payable 1,000,000

b. Interest expense on January 1, 2016

Jan. 1 Interest Expense 80,000

Cash 80,000

Interest expense: $1,000,000 × 8%

c. Retirement of the bonds

June 30 Bonds Payable 1,000,000

Cash 1,000,000

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6 Chapter 14

9. RPC Corporation issued $4,000,000 of 2-year, 12% bonds at par value on September 30,
2015. The interest is payable every quarter, starting on December 31, 2015. Prepare the
journal entries for the following:
a. Issuance of the bonds

Sept. 30 Cash 4,000,000

Bonds Payable 4,000,000

b. Interest expense on January 1, 2016

Jan. 1 Interest Expense 120,000

Cash 120,000

Interest expense: $4,000,000 × 12% × ¼ year

c. Retirement of the bonds

Sept. 30 Bonds Payable 4,000,000

Cash 4,000,000

Strategy: When bonds are issued at par, the cash received is equal to the face amount of
the bond, so a premium or discount will not be recorded and amortized. The interest
expense is equal to the contract rate multiplied by the face amount of the bond.

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 Long-Term Liabilities: Bonds and Notes 7

10. Shem Creek issued $200,000 of 5-year, 9% bonds for $192,298 on January 1, 2015. The
interest is payable semiannually on June 30 and December 31, beginning on June 30,
2015. The market rate at the time of issuance is 10%. Calculate the amount of interest
expense and amortization of the discount recorded for the first fiscal year ending
December 31, 2015 using:

a. Straight-line method for amortization

Discount on bonds payable $7,702

Term of bonds 5 years
Semiannual amortization ($7,702/10 periods) $770.20
Interest expense: ($9,000 + $770.20) × 2 periods = $19,540.40
Amortization of discount: $770.20 × 2 periods = $1,540.40
b. Effective interest method for amortization

Payment Int. Paid (Face Int. Exp. (Carrying Disc. Amortization Unamortized Bond Carrying
Date × 9% × ½) value × 10% ×½) (Int. Exp. – Int. Paid) Disc. Value
$7,702.00 $192,298.00
June 30 $9,000 $9,614.90 $614.90 7,087.10 192,912.90
Dec. 31 9,000 9,645.60 645.60 6,441.50 193,558.50

Interest expense: $9,614.90 + $9,645.60 = $19,260.50

Amortization of discount: $614.90 + $645.60 = $1,260.50

11. Prepare the journal entries for the issuance, interest payments for the first year, and
retirement of the bonds for Shem Creek using the information in Exercise 10. Assume
the company uses the effective interest method to amortize the bond discount.

Issuance Jan. 1 Cash 192,298.00

Discount on Bonds Payable 7,702.00
Bonds Payable 200,000.00
Int. Payment June 30 Interest Expense 9,614.90
Discount on Bonds Payable 614.90
Cash 9,000.00
Int. Payment Dec. 31 Interest Expense 9,645.60
Discount on Bonds Payable 645.60
Cash 9,000.00
Retirement Jan. 1 Bonds Payable 200,000.00
Cash 200,000.00

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8 Chapter 14

12. Cooper River Corporation issued $1,000,000 of 5-year, 8% bonds for $922,780 at the
beginning of its fiscal year on July 1, 2015, when the market rate is 10%. The interest is
payable semiannually, beginning December 31, 2015. Calculate the interest expense and
discount amortization for the first fiscal year using:
a. Straight-line method for amortization
Discount on bonds payable $77,220
Term of bonds 5 years
Semiannual amortization ($77,220 / 10 periods) $7,722
Interest expense: ($7,722 + $40,000) × 2 periods = $95,444
Amortization of discount: $7,722 × 2 periods = $15,444
b. Effective interest method for amortization (round answers to the nearest dollar)

Payment Int. Paid (Face Int. Exp. (Carrying Disc. Amortization Unamortized Bond Carrying
Date × 8% × ½) value × 10% ×½) (Int. Exp. – Int. Paid) Disc. Value
$77,220.00 $922,780.00
Dec. 31 $40,000 $46,139.00 $6,139.00 71,081.00 928,919.00
June 30 40,000 46,445.95 6,445.95 64,635.05 935,364.95

Interest expense: $46,139.00 + $46,445.95 = $92,584.95

Amortization of discount: $6,139.00 + $6,445.95 = $12,584.95

13. Prepare the journal entries required for the issuance, interest payments for the first
year, and retirement of the bonds for Cooper River Corporation using the information in
Exercise 12. Assume the company accounts for the bond discount using the straight-line
method.

Issuance July 1 Cash 922,780

Discount on Bonds Payable 77,220
Bonds Payable 1,000,000
Int. Payment Dec. 31 Interest Expense 47,722
Discount on Bonds Payable 7,722
Cash 40,000
Int. Payment June 30 Interest Expense 47,722
Discount on Bonds Payable 7,722
Cash 40,000
Retirement July 1 Bonds Payable 1,000,000
Cash 1,000,000

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 Long-Term Liabilities: Bonds and Notes 9

14. On January 1, 2015, Terese Corporation issued $2,000,000 of 3-year, 13% bonds for
$1,952,334.20. Interest on the bonds is payable semiannually, on June 30 and December
31. On the date of issuance, the market rate of bonds was 14%. Calculate the interest
expense and bond amortization for the first fiscal year using:

a. Straight-line method for amortization

Discount on bonds payable $47,665.80

Term of bonds 3 years
Semiannual amortization ($47,665.80/6 periods) $7,944.30

Interest expense: ($7,944.30 + $130,000) × 2 periods = $275,888.60

Amortization of discount: $7,944.30 × 2 periods = $15,888.60
b. Effective interest method for amortization

Payment Int. Paid (Face Int. Exp. (Carrying Disc. Amortization Unamortized Bond Carrying
Date × 13% × ½) value × 14% ×½) (Int. Exp. – Int. Paid) Disc. Value
$47,665.80 $1,952,334.20
June 30 $130,000 $136,663.39 $6,663.39 41,002.41 1,958,997.59
Dec. 31 130,000 137,129.83 7,129.83 33,872.58 1,966,127.42

Interest expense: $136,663.39 + $137,129.83 = $273,793.22

Amortization of discount: $6,663.39 + $7,129.83 = $13,793.22
Strategy: If a bond is issued at a discount, the investors are essentially receiving interest
for not paying the full amount of the bond, so the amortization of the discount should be
added to the interest paid by the corporation to calculate the interest expense. The
amount of interest expense and discount amortization depends upon the method used,
with straight line giving the same interest expense every period, and the effective
interest method varying over time.

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10 Chapter 14

15. Using the information in Exercise 14, prepare the journal entries to record the issuance,
interest payments for the first year, and retirement of the bonds for Terese Corporation.
Assume that the company uses the effective interest method to account for the
amortization.

Issuance Jan. 1 Cash 1,952,334.20

Discount on Bonds Payable 47,665.80
Bonds Payable 2,000,000.00
Int. Payment June 30 Interest Expense 136,663.39
Discount on Bonds Payable 6,663.39
Cash 130,000
Int. Payment Dec. 31 Interest Expense 137,129.83
Discount on Bonds Payable 7,129.83
Cash 130,000.00
Retirement Jan. 1 Bonds Payable 2,000,000.00
Cash 2,000,000.00

Strategy: Upon issuance, the discount on the bonds should be debited to show that the
amount of cash received is less than the amount owed to the bondholders. When
recording an interest expense, the discount will be amortized by crediting Discount on
Bonds Payable, which reduces the account. Upon retirement, the bond will be fully
amortized. Debit Bonds Payable for the face amount and credit Cash for the same
amount, which will be paid to the bondholders.

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 Long-Term Liabilities: Bonds and Notes 11

16. Trends Inc. issued $1,000,000 of 5-year, 9% bonds on January 1, 2015, for $1,041,000.
The bonds will pay interest semiannually, beginning on June 30, 2015. The market rate
at the date of issuance was 8%. Calculate the interest expense and bond amortization
for the first fiscal year using:

a. Straight-line method for amortization

Premium on bonds payable $41,000
Term of bonds 5 years
Semiannual amortization ($41,000/10 periods) $4,100

Interest expense: ($45,000 - $4,100) × 2 periods = $81,800

Amortization of premium: $4,100 × 2 periods = $8,200
b. Effective interest method for amortization

Payment Int. Paid (Face Int. Exp. (Carrying Prem. Amortization Unamortized Bond Carrying
Date × 9% × ½) value × 8% ×½) (Int. Paid – Int. Exp.) Prem. Value
$41,000.00 $1,041,000.00
June 30 $45,000 $41,640.00 $3,360.00 37,640.00 1,037,640.00
Dec. 31 45,000 41,505.60 3,494.40 34,145.60 1,034,145.60

Interest expense: $41,640 + $41,505.60 = $83,145.60

Amortization of premium: $3,360 + $3,494.40 = $6,854.40

17. Using the information in Exercise 16, prepare the journal entries to record the issuance,
interest payments for the first year, and retirement of the bonds for Trends Inc. Assume
that the company uses the effective interest method to account for the amortization.

Issuance Jan. 1 Cash 1,041,000.00

Premium on Bonds Payable 41,000.00
Bonds Payable 1,000,000.00
Int. Payment June 30 Interest Expense 41,640.00
Premium on Bonds Payable 3,360.00
Cash 45,000.00
Int. Payment Dec. 31 Interest Expense 41,505.60
Premium on Bonds Payable 3,494.40
Cash 45,000.00
Retirement Jan. 1 Bonds Payable 1,000,000.00
Cash 1,000,000.00

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12 Chapter 14

18. Fast Tires issued $5,000,000 of 5-year, 10% bonds on June 30, 2015, for $5,405,550. The
bonds pay interest quarterly, beginning September 30, 2015. At the date of issuance,
the market rate was 8%. Calculate the interest expense and bond amortization for the
first fiscal year using:

a. Straight-line method for amortization

Premium on bonds payable $405,550
Term of bonds 5 years
Quarterly amortization ($405,550/20 periods) $20,277.50

Interest expense: ($125,000 – $20,277.50) × 4 periods = $418,890

Amortization of premium: $20,277.50 × 4 periods = $81,110
b. Effective interest method for amortization

Payment Int. Paid (Face Int. Exp. (Carrying Prem. Amortization Unamortized Bond Carrying
Date × 10% × ¼) value × 8% ×¼) (Int. Paid – Int. Exp.) Prem. Value
$405,550.00 $5,405,550.00
Sept. 30 $125,000 $108,111.00 $16,889.00 388,661.00 5,388,661.00
Dec. 31 125,000 107,773.22 17,226.78 371,434.22 5,371,434.22
Mar. 31 125,000 107,428.68 17,571.32 353,862.90 5,353,862.90
June 30 125,000 107,077.26 17,922.74 335,940.16 5,335,940.16

Interest expense: $108,111 + $107,773.22 + $107,428.68 + $107,077.26 =

$430,390.16
Amortization of premium: $16,889.00 + $17,226.78 + $17,571.32 + $17,922.74 =
$69,609.84

19. Use the information in Exercise 18 to prepare the journal entries to record the issuance,
first interest payment, and retirement of the bonds for Fast Tires. Assume the company
uses the straight-line method for amortization.

Issuance June 30 Cash 5,405,550

Premium on Bonds Payable 405,550
Bonds Payable 5,000,000
Int. Payment Sept. 30 Interest Expense 104,722.50
Premium on Bonds Payable 20,277.50
Cash 125,000
Retirement June 30 Bonds Payable 5,000,000
Cash 5,000,000

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 Long-Term Liabilities: Bonds and Notes 13

20. Tortoise Cleaning Corp. issued $250,000 of 5-year, 7% bonds payable for $271,880 on
January 1, 2015. The bonds will pay interest semiannually, beginning on June 30, 2015.
At the time of issuance, the market rate was 5%. Calculate the interest expense and
bond amortization for the first year using:

a. Straight-line method for amortization

Premium on bonds payable $21,880
Term of bonds 5 years
Semiannual amortization ($21,880/10 periods) $2,188

Interest expense: ($8,750 – $2,188) × 2 periods = $13,124

Amortization of premium: $2,188 × 2 periods = $4,376

b. Effective interest method for amortization

Payment Int. Paid (Face Int. Exp. (Carrying Prem. Amortization Unamortized Bond Carrying
Date × 7% × ½) value × 5% ×½) (Int. Paid – Int. Exp.) Prem. Value
$21,880.00 $271,880.00
June 30 $8,750 $6,797.00 $1,953.00 19,927.00 269,927.00
Dec. 31 8,750 6,748.18 2,001.82 17,925.18 267,925.18

Strategy: If a bond is issued at a premium, the corporation will have to pay more in
interest than the market rate. The amortization of the premium should be subtracted
from the interest paid to calculate interest expense for the period.

21. Use the information in Exercise 20 to prepare the journal entries to record the issuance,
first interest payment, and retirement of the bonds for Tortoise Cleaning Corp.,
assuming the company uses the straight-line method for amortization.

Issuance Jan. 1 Cash 271,880

Premium on Bonds Payable 21,880
Bonds Payable 250,000
Int. Payment June 30 Interest Expense 6,562
Premium on Bonds Payable 2,188
Cash 8,750
Retirement Jan. 1 Bonds Payable 250,000
Cash 250,000

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14 Chapter 14

Strategy: When recording the issuance of a bond at a premium, credit Premium on

Bonds Payable to show that the corporation received more cash than will be paid back at
retirement. Over time the premium will be amortized, which should be recorded by
debiting Premium on Bonds Payable. At the time of retirement, the premium will be fully
amortized. Debit Bonds payable for the face amount and credit Cash for the same
amount, which is also the amount paid to the investors.

22. On March 31, 2015, RPC Corporation redeems ½ of the outstanding bonds payable for
$62,500. The total bonds outstanding had a face amount of $120,000 and an
unamortized premium of $7,500. Prepare the journal entry to record the redemption.

Mar. 31 Bonds Payable 60,000

Premium on Bonds Payable 3,750
Gain on Redemption of Bonds 1,250
Cash 62,500

23. Apple Tree Corp. redeemed ¼ of the outstanding bonds payable for $90,000 on May 5,
2015. The total bonds outstanding had a face amount of $400,000 and an unamortized
bond discount of $16,000. Prepare the journal entry to record the redemption.

May 5 Bonds Payable 100,000

Gain on Redemption of Bonds 6,000
Discount on Bonds Payable 4,000
Cash 90,000

24. On July 15, 2015, a corporation redeems ½ of its outstanding bonds payable for $24,000.
The total bonds outstanding had a face amount of $50,000 and an unamortized bond
discount of $2,200. Prepare the journal entry to record the redemption.

July 15 Bonds Payable 25,000

Loss on Redemption of Bonds 100
Discount on Bonds Payable 1,100
Cash 24,000

Strategy: When a bond is redeemed prior to retirement, the unamortized discount or

premium related to the bond redeemed also needs to be taken off the books. A discount
will be removed with a credit, while a premium will be removed with a debit. Debit
Bonds Payable to remove the liability from the books using a debit for the face amount.
Credit Cash for the amount paid. Any difference in the cash paid and the bond’s carrying
value creates a loss or gain on the redemption. Record losses using a debit and gains
using a credit.

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 Long-Term Liabilities: Bonds and Notes 15

25. In exchange for $120,000 cash, Blodgett Express issued a 12% note payable that
requires six annual payments of $29,187. Prepare an amortization schedule for the
installment note, which was issued on January 1, 2015, rounding amounts to two
decimal places. The annual payments begin on December 31, 2015.

Jan. 1 Interest Expense Dec. 31

For the year Carrying Note (Carrying Decrease in Carrying
ending Amount Payment amount × 12%) Notes Payable Amount
Dec. 31, 2015 $120,000.00 $29,187.00 $14,400.00 $14,787.00 $105,213.00
Dec. 31, 2016 105,213.00 29,187.00 12,625.56 16,561.44 88,651.56
Dec. 31, 2017 88,651.56 29,187.00 10,638.19 18,548.81 70,102.75
Dec. 31, 2018 70,102.75 29,187.00 8,412.33 20,774.67 49,328.08
Dec. 31, 2019 49,328.08 29,187.00 5,919.37 23,267.63 26,060.45
Dec. 31, 2020 26,060.45 29,187.00 3,127.25 26,059.75 Approx. 0

26. Use the information from Exercise 25 to prepare the journal entries to record the
issuance of the note and payment for the first two years.

Jan. 1, 2015 Cash 120,000.00

Notes Payable 120,000.00
Dec. 31, 2015 Interest Expense 14,400.00
Notes Payable 14,787.00
Cash 29,187.00
Dec. 31, 2016 Interest Expense 12,625.56
Notes Payable 16,561.44
Cash 29,187.00

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16 Chapter 14

27. A corporation issues a 12% installment note for $500,000 cash on the beginning of its
fiscal year, April 1, 2015. The note requires 10 semiannual payments of $67,934 every
September 30 and March 31, which begin the same year. Prepare an amortization
schedule for the installment note. Round amounts to two decimal places.

April 1 Interest Expense Mar. 31

For the Carrying Note (Carrying amount Decrease in Carrying
period ending Amount Payment × 12% × ½) Notes Payable Amount
Sept. 30, 2015 $500,000.00 67,934.00 $30,000.00 $37,934.00 $462,066.00
Mar. 31, 2016 462,066.00 67,934.00 $27,723.96 40,210.04 421,855.96
Sept. 30, 2016 421,855.96 67,934.00 25,311.36 42,622.64 379,233.32
Mar. 31, 2017 379,233.32 67,934.00 22,754.00 45,180.00 334,053.32
Sept. 30, 2017 334,053.32 67,934.00 20,043.20 47,890.80 286,162.52
Mar. 31, 2018 286,162.52 67,934.00 17,169.75 50,764.25 235,398.27
Sept. 30, 2018 235,398.27 67,934.00 14,123.90 53,810.10 181,588.16
Mar. 31, 2019 181,588.16 67,934.00 10,895.29 57,038.71 124,549.45
Sept. 30, 2019 124,549.45 67,934.00 7,472.97 60,461.03 64,088.42
Mar. 31, 2020 64,088.42 67,934.00 3,845.31 64,088.69 Approx. 0

28. Use the information from Exercise 27 to prepare the journal entries required for the
installment note over the first fiscal year.

April 1, 2015 Cash 500,000.00

Notes Payable 500,000.00
Sept. 30, 2015 Interest Expense 30,000.00
Notes Payable 37,934.00
Cash 67,934.00
Mar. 31, 2016 Interest Expense 27,723.96
Notes Payable 40,210.04
Cash 67,934.00

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 Long-Term Liabilities: Bonds and Notes 17

29. On January 1, 2015, Allen Ales issued a 6% installment note for $100,000 in cash. The
note requires five annual payments of $23,739.64, which are due beginning December
31, 2015. Prepare an amortization schedule for the installment note. Round amounts to
two decimal places.

Jan. 1 Interest Expense Decrease in Dec. 31

For the year Carrying (Carrying amount Notes Carrying
ending Amount Note Payment × 6%) Payable Amount
Dec. 31, 2015 $100,000.00 $23,739.64 $6,000.00 $17,739.64 $82,260.36
Dec. 31, 2016 82,260.36 23,739.64 4,935.62 18,804.02 63,456.34
Dec. 31, 2017 63,456.34 23,739.64 3,807.38 19,932.26 43,524.08
Dec. 31, 2018 43,524.08 23,739.64 2,611.44 21,128.20 22,395.89
Dec. 31, 2019 22,395.89 23,739.64 1,343.75 22,395.89 0

Strategy: An amortization schedule shows in detail the amount of interest expense and
decrease in principal of the note that should be recorded each period. The note payment
remains constant over the life of the note, but interest expense changes, which also
changes the amount of principal paid each period. Interest Expense is calculated by
multiplying the contract rate by the carrying amount at the beginning of the period. The
difference between the note payment and payment of interest is the amount of principal
paid.

30. Using the information from Exercise 29, prepare the journal entries required for the
installment note during the 2015 fiscal year.

Jan. 1 Cash 100,000.00

Notes Payable 100,000.00
Dec. 31 Interest Expense 6,000.00
Notes Payable 17,739.64
Cash 23,739.64

Strategy: When issuing an installment note, debit Cash for the amount received, which is
also the same amount of the note payable to record (credit to increase the account). An
annual payment includes payment of the principal and interest, so Interest Expense and
Notes Payable should both be debited to record the payment of interest and reduction in
the liability.

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18 Chapter 14

31. A corporation currently has $1,500,000 of 5% bonds outstanding and $5,000,000 of

installment notes payable. The company makes semiannual payments of $129,000 on
the note ($24,000 of which will be related to interest in the upcoming year). Ignoring
any other liabilities, how much of current and long-term liabilities will the corporation’s
balance sheet present?

Current liabilities:
Interest payable $ 99,000
Notes payable, current portion 105,000
Total current liabilities $ 204,000
Long-term liabilities:
Bonds payable $1,500,000
Notes payable 4,895,000
Total long-term liabilities $6,395,000

Interest payable: $24,000 + (5% × $1,500,000)

Notes payable, current portion: $129,000 – $24,000
Notes payable: $5,000,000 – $105,000

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 Long-Term Liabilities: Bonds and Notes 19

32. In addition to the Accounts Payable of $125,000, RPC Corporation has the following
liabilities as of December 31, 2015: Notes Payable, $750,000 and 10% Bonds Payable,
$2,000,000. The company’s bonds have an unamortized discount of $134,000 and the
notes payable has a payment of $100,000 due in the upcoming January, $21,000 of
which will be for interest in the upcoming year. Ignoring any other liabilities the
company may have, prepare the liabilities portion of the balance sheet.

RPC Corporation
Balance Sheet
As of December 31, 2015
Current liabilities:
Accounts payable $ 125,000
Interest payable 221,000
Notes payable, current portion 79,000
Total current liabilities $425,000
Long-term liabilities:
Bonds payable, 10% $2,000,000
Less unamortized discount 134,000 $1,866,000
Notes payable 671,000
Total long-term liabilities $2,537,000
Total liabilities $2,962,000

Interest payable: $21,000 + (10% × $2,000,000)

Notes payable, current portion: $100,000 – $21,000
Notes payable: $750,000 – $79,000

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20 Chapter 14

33. Shem Creek has the following liabilities outstanding: Notes Payable, $6,700,000; 7.5%
Bonds Payable, $3,100,000; and Accounts Payable, $150,000. The installment note
requires quarterly payments of $41,000 every year, $36,000 of which will be for interest
payments for the upcoming year. The bond also has an unamortized premium of
$400,000. Ignoring any other liabilities Shem Creek may have, prepare the liabilities
portion of the balance sheet for the 2015 calendar year-end.

Shem Creek
Balance Sheet
As of December 31, 2015
Current liabilities:
Accounts payable $ 150,000
Interest payable 268,500
Notes payable, current portion 128,000
Total current liabilities $ 546,500
Long-term liabilities:
Bonds payable, 10% $3,100,000
Plus unamortized premium 400,000 $ 3,500,000
Notes payable 6,572,000
Total long-term liabilities $10,072,000
Total liabilities $10,618,500

Interest payable: $36,000 + (7.5% × $3,100,000)

Notes payable, current portion: ($41,000 × 4 periods) - $36,000
Notes payable: $6,700,000 – $128,000

Strategy: Current liabilities include liabilities that will be paid within the upcoming
business cycle. Any current portion of installment notes, interest on the installment
notes, and interest on bonds payable should be recorded as a current liability. Bonds
should be recorded as long-term liabilities, unless due within the upcoming business
cycle, at their carrying amount.

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 Long-Term Liabilities: Bonds and Notes 21

34. Use the information below to determine a corporation’s number of times interest
charges are earned for 2015 and 2016. Determine if the change is favorable or
unfavorable. Round answers to two decimal places.

2016 2015
Interest expense $38,750 $35,450
Income before income tax expense 326,900 320,875
Number of times interest charges are earned 9.44 10.05

The decrease in number of times interest charges are earned is unfavorable because the
debt holders are less confident they will receive interest payments

35. Assume the interest on the bonds listed below will be Cooper River’s only interest
expense for 2015 and 2016. Calculate the company’s number of times interest charges
are earned ratio for the two years and determine if the change is favorable or
unfavorable. Round answers to two decimal places.

2016 2015
10% Bonds $1,300,000 $1,200,000
Income before income tax expense 1,025,000 920,000
Interest expense (Bonds outstanding × 10%) 130,000 120,000
Number of times interest charges are earned 8.88 8.67

The increase in number of times interest charges are earned is a favorable trend.

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22 Chapter 14

36. Using the information below, calculate the number of times interest charges are earned
in 2015 and 2016 for Tortoise Cleaning Corporation. Assume the interest paid on the
bond will be the only interest expense for both years and the company is subject to a
40% tax rate. How many times in each year will the corporation be able to cover its
interest payments? Round answers to two decimal places.

2016 2015
8% Bonds $5,270,000 $5,000,000
Net income 525,000 450,000
Interest expense (Bonds outstanding × 8%) 421,600 400,000
Income before income tax expense [Net income/(1 – 40%)] 875,000 750,000
Number of times interest charges are earned 3.08 2.88

In 2015, the corporation earned enough income to pay its interest expense 2.88 times.
The number of times it could pay interest increased to 3.08 in 2016.

Strategy: To find the number of times interest charges are earned, first determine the
income before tax expense and interest expense. Add the two and divide the sum by the
interest expense. Investors prefer a higher ratio because it indicates the company has a
higher ability to pay its interest.

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