Chapter 14

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Yorkville University *

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Jan 9, 2024

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Chapter 14 Question 1 A company issues 10-year bonds with a par value of $800,000 on Jan 1, 2020. Interest is at 10% payable semi-annually on Jan 1 and Jul 1. Bonds are issued at par. Instructions Record the journal entries for 2020 Stated rate = market rate Jan 1, Issuance of bonds Dr. Cash $800,000 Cr. Bonds payable $800,000 July 1, First Interest payment Dr. Interest Expense $40,000 Cr. Cash $40,000 $800,000 * 10% *(6/12) = 40,000 Dec 31, year end adjustment Dr. Interest Expense 40,000 Cr. Interest Payable 40,000 Question 2 $100,000 in bonds due in 5 years with an interest rate (stated rate) of 9%. Interest is paid at the year-end. Market rate is 11% at date of issuance. Calculate the issuance price Market/effective rate > stated rate 12% > 10% Issue bonds to discount, Issuance price < Maturity Value Funds Received < Payment Issuance price = Present value of Note (I (interest) = market rate) Dr. Cash X Cr. Bonds Payable X Issuance Price Discount = Market Value - Issuance price Added gradually to bonds payable.

Amortize discount 1 – Straight live method  ASPE equally over the life of bond Dr. Interest expense XX Cr. Bonds Payable XX 2 – Effective interest method  IFRS and option for ASPE Amount & discount amortized is different every year. It is based on carrying value of bond. Stated rate 9% < Market rate 11% Bond is issued at discount Issuance price < 100,000 maturity value FV= 100,000 N = 5 I = 11% PMT = [ 100,000 * 9%] Type = 0 PV = 92,608 If interest is paid semi-annually, n = double and i = Halved 3 – Stated rate > Market Rate 10% > 8%  Bond is issued at premium.  Issuance price is higher than the maturity/ face value PV (I = market) Dr. Cash XX (issuance price is more than maturity value) Cr. Bonds payable XX Amortization Premium Dec – bond payable gradually over the life of the bond to be equal to maturity. 1 – Straight line method - ASPE 2- Effective interest method – IFRS

Question 3 Company issues 10-year bonds with a par value of $800,000 on Jan 1, 2020. Interest is at 10% payable annually on Dec 31. Bonds are issued at 97 (97% of par) Instructions Prepare the journal entries to record the issuance and amortization of the bond discount using the straight-line method If par < 100, issue at discount If par > 100, issue at premium Issuance price = 97% * 880,000 = $776,000 To record the issuance Dr. Cash $776,000 Cr. Bonds Payable $776,000 Amortize the discount using straight line Discount = $800,000 – $776,000 = $24,000 Amortize discount over its useful life= 24,000 / 10 = 2,400 Dr. Interest Expense 2400 Cr. Bonds Payable 2400 Record payment of interest Dr. Interest Expense $80,000 Cr. Cash $80,000 $800,000 * 10% = $80,000

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Question 4 Company issues 10-year bonds with a par value of $800,000 on Jan 1, 2020. Interest is at 10% payable annually on Dec 31. Bonds are issued at 103. Instructions Prepare the journal entries to record the issuance and amortization of the bond premium using the straight-line method Dr. Cash 824,000 (103% * 800,000) Cr. Bonds Payable 824,000 Premium price = 103 * 800,000 = 824,000 Premium = 824000 – 800,000 = 24,000 Amortization = 24,000 / 10 = 2400 Dr. Bonds payable 2,400 Cr. Interest Expense 2,400 Dr. Interest Expense 80,000 Cr. Cash 80,000 800,000 * 10 % = 80,000

Question 5 Company issues 10-year bonds with a par value of $800,000 on Jan 1, 2020. Interest is at 10% payable semi-annually on Jan 1 and Jul 1. Bonds are issued on March 1 at 102. Instructions What are the journal entries upon issuance and for the first interest payment? March 1 Dr. Cash 829,333 [102% * 800,000 + (800,000 * 10% * (2/12))] Cr. Bonds payable 816,000 (800,000 * 102%) Cr. Interest Expense 13,333 July 1 Dr. Interest Expense 40,000 Cr. Cash 40,000 800,000 * 10% * (6/12) Question 6 On June 1, 2020, Verbitsky Inc. issued at par, plus accrued interest, $200,000 of 10-year, 12% bonds dated January 1. Interest is payable semi-annually on July 1 and January 1. Instructions Prepare journal entries to record: 1. The issuance of the bonds 2. The payment of interest on July 1

3. The accrual of interest on December 31 Question 7 On August 31, Jackson Enterprises issued bonds with a par value of $750,000 and a stated interest rate of 8%. Interest is payable semi-annually on June 30 and December 31. If the proceeds from the issue amounted to $760,000, the bonds were likely a) sold at a discount. b) issued at par plus accrued interest. c) sold at a premium. d) sold at a higher effective interest rate Question 8 Assume that Master Corporation issued $100,000 of 8% term bonds on January 1, 2020, that are due on January 1, 2025, with interest payable each July 1 and January 1. • Because the investors required an effective interest rate of 10%, they paid $92,278 for the $100,000 of bonds. • Assume that the company uses the effective interest method to calculate the amortization of the bond discount. Stated rate 8% < Market Rate 10%  Discount Issuance price < Face Value $92,278 < $100,000

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Instructions Record issuance of bonds, first interest payment on July 1,2020 and interest expense accrued on Dec.31,2020 Issuance of Bonds Dr. Cash 92,278 Cr. Bonds payable 92,278  Issuance price July 1, 20XX Dr. Interest Exp. 4,614 (92,278 * 10% * (6/12)) = 4,614 Cr. Cash 4,000 (100,000 * 8% * (6/12)) = 4,000 Cr. Bonds Payable 614 (in case of discount) Dec 31, 20XX Dr. Interest Ex. 4,645 ((92,278 + 614) * 10% * (6/12)) Cr. Bonds Payable 645 Cr. Interest payable 4,000

Question 9 On June 30, 2020, Mosca Limited issued $4 million of 20-year, 13% bonds for $4,300,920, which provides a yield of 12%. The bonds are issued at a premium as they are paying higher interest than the market. • The company uses the effective interest method to amortize any bond premium or discount. • The bonds pay semi-annual interest on June 30 and December 31. Instructions a. Prepare the journal entries to record the following transactions (round amounts to the nearest dollar): 1. The issuance of the bonds on June 30, 2020 Dr. Cash 4,300,920 Cr. Bonds Payable 4,300,920 2. The payment of interest and the amortization of the premium on December 31, 2020 Date Cash (4,000,000*13% * (6/12)) Interest Exp. (CV *12% * (6/12)) Amortized Premium CV June 30, 2020 4,300,920 Dec 30, 2020 260,000 258,055 1945 (cash – Interest exp.) 4,298,975 (P.Y - Amortized Premium) June 30, 2021 260,000 257,938 2062 4,296,913 Dec 30, 2021 260,000 257,815 2185 4,294,728 3. The payment of interest and the amortization of the premium on June 30, 2021 4. The payment of interest and the amortization of the premium on December 31, 2021 Question in the textbook, BE1 4.16

Question 10 Louise Inc. borrowed $60,000 on Nov.1,2020 by signing $61,350, three month, zero-interest bearing note. Prepare journal entries on Nov.1,2020, adjusting entry on Dec.31,2020 and Feb.1,2021 Question 11 Brestovacki Corporation issued a $50,000, five-year, 5% note to Jernigan Corp. on January 1, 2020, and received a piece of equipment that normally sells for $38,912. The note requires annual interest payments each December 31. The market interest rate for a note of similar risk is 11%. Face value = 50,000 Stated rate = 5% Market rate = 11% Since we are offering a low rate than the market, the note is issued at a discount. Required a) Prepare Brestovacki's journal entry for the January 1, 2020 Dr. Equipment 38,912 Cr. Notes Payable 38,912 b) Prepare the entry for the December 31, 2020, interest payment using the effective interest method. Dr. Interest Expense 4280 (38,912 *11%) Cr. Notes Payable 1780 Cr. Cash 2500 (50,000*5%)

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Question 12 On Jan 1, 2020 a company issued bonds with a par value of $800,000 at 97 (which is net of issue costs) due in 20 years. Eight years later the entire issue is called at 101 and cancelled. The straight-line method is used. Instructions Prepare the journal entry to reflect the reacquisition of the bond Dr. Bonds payable 785,600 Dr. Loss on redemption 22,400 Cr. Cash $808,000 [101% * 800,000] We need to calculate the current year carrying value (8 th year) Method 1: CV (800,000 * 97%) = 776,000 + Unamortized Discount = (800,000 – 776000 / 20) * 8 = 9600 CV = 785,600 Method 2: Face Value 800,000 - Unamortized Discount (800,000 – 776,000/20) * 12 = (14,400) 785,600

Question 13 Halifax City Bank has lent $20 million to Union Trust. Union Trust in turn has invested this amount in residential apartment buildings, but because of low occupancy rates it cannot meet its loan obligations. Halifax City Bank agrees to accept from Union Trust a building with a fair value of $16 million in full settlement of the $20-million loan obligation. The building has a recorded carrying value of $21 million on the books of Union Trust, that is net of accumulated depreciation of $5 million. For simplicity, assume that no prior allowance for doubtful accounts has been set up on the note and no impairment has been recognized on the building. Instructions Prepare the journal entries to record the settlement and asset transfer for both the creditor and debtor Situation A: City Bank accepts a fair value $16 million building in settlement of 20,000,0000 loan .Building recorded at $21 million net of accumulated depreciation of $5 million. Halifax ( Creditor) Dr. building 16 million  FV Dr. Loss on settlement 4 million Cr. N/R 20 million Union Trust ( Debtor) Dr. N/P 20 Million Dr. Acc. Dep 5 million Dr. Loss on disposal of building 5 million Cr. Building 26 million Cr. Gain on settlement of debt 4 million Building Net value 21 M Face Value 16 M 5 million loss Valuation of debt N/P 20 M Building 16 M 4 million

Situation B: City Bank accepts 320,000 common shares of Union Trust, with a market value of $16 million in full settlement of the $20 million loan. HalifaxCreditor Dr. Investment in Union Trust 16 M Dr. Loss on settlement 4M Cr. N/R 20 M Union Trust ( debtor) Dr. N/P 20 M Cr. Gain on Settlement 4 M Cr. Common Shares 16 M Gain for debtor since they settled their debt for lower amount/cost

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Question 14 On December 31, 2020, Manitoba National Bank enters into a debt restructuring agreement with Resorts Development Corp., which is experiencing financial difficulties. • The bank restructures a $10.5-million loan receivable issued at par (interest paid up to date) by doing all of the following: • It reduces the principal obligation from $10.5 million to $9 million. • It extends the maturity date from December 31, 2020, to December 31, 2024. • It reduces the interest rate from 12% to 8%. (The market rate is currently 9%.) • The PV of loan and interest are as follow Old terms New Term Principal 10.5 Million 9 Million N 4 Stated i 12% Same 8% Market 12% 9% 10.5 M – [ n =4, FV = 9 M, PMT [9 M * 8%], i = 12 % old market rate = 24% 10.5 M Since the value is more than 10% , substantial modification Old Debt New debt Principal 10.5 M 9 M N 4 yrs Stated i 12% 8% Market i 12% 9% Substantial test: Face value of old debt ( 10.5)– PV of new debt ( $7,906,554) Face value of old debt (10.5) Instructions A) Is this a settlement or a modification? Has a substantial modification in the debt occurred? Support your conclusion with an analysis and prepare any related journal entries for the creditor and debtor. Aspe & IFRS agree on recording the settlement of debt with modification Creditor Dr. Notes Receivable (new) xx (PV of new debt) (old market i) Dr. Loss on settlement xx Cr. Notes receivable (old) xx (face value)

Debtor Dr. Notes payable (old) XX ( face value) Cr. Gain on settlement Cr. Notes payable (new) XX (pv of new debt, new market i) Creditors Debtor Dr. N/R ( new) 7,906,554 Dr. Loss on restructure 2,593,428 Cr. N/R (old) 10.5M Dr. N/P (old) 10.5 M Cr. N/P ( new) 8,708,425 Cr. Gain on restructure of debt 1,791,575 N = 4 FV = 9M PMT = -9m * 8% i = 12% (old) N = 4 FV = 9M PMT = -9m * 8% i = 9% (current i) ASPE IFRS - Don’t change the amount of debt - Change interest to equate the new debt. Therefore, no entry to record the restructure - Changes the amount of debt - Require an entry - Both creditor and debtor use the old market i, to record the new debt. b) Assume the same situation as except that the restructuring involves the following: • It reduces the principal obligation to $10 million. • It extends the maturity date from December 31, 2020, to December 31, 2024. • It reduces the interest rate from 12% to 11%. (The market rate is currently 9%.) Old Debt New debt Principal 10.5 M 10 M N 4 yrs Stated i 12% 11% Market i 12% 9% 10.5m – [n=4, i=12%, fv= 10m, -(pmt = 10m * 11%)] = 7.6% 10.5M Since < 10%, not substantial modification

ASPE : No entry required to record the restructure of debt. IFRS : Creditor Dr. Notes receivable 9,696,265 Dr. Loss on restructure of debt 803,735 Cr. Notes receivable ( old) 10.5M Debtor Dr. Notes payable (old) 10.5m Cr. Gain on restructure of debt 803,735 Cr. Notes payable (new) 9.696,265 (using PV 12%)

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Chapter 14

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