a) After completing all of the entries in Exercise 6, what is the correct debit balance recorded to the Interest Expense account? See circle on the printed exercise. (5 points for correct answer. No partial credit). b) After completing all of the entries for the Straight-Line portion in Exercise 8, what is the cash proceeds upon issuance of the bond? See circle on the printed exercise. (5 points for correct answer. No partial credit). c) After completing all of the entries for the Effective Interest Rate portion in Exercise 8, what is the correct Premium Amortization amount for the first interest period (from table)? See circle on the printed exercise. (5 points for correct answer. No partial credit). d) After completing all of the entries in Exercise 10, what is the correct amount recorded to the Loss on Retirement of Bonds account? See circle on the printed exercise. (5 points for correct answer. No partial credit). ACG 2021 - CHAP 9 \& 10 EXERCISE Exercise 1: Short-Term Notes Payable: Use the t-accts below to record the following entries. If you get stuck, carefully review the online and text examples. On September 1st, Geo Inc. borrows $2,400 from State Bank and signs a 10 month short-term note payable. The interest rate on the note is 7%. Even though the note is only for 10 months, the interest rate is an annual rate (see interest calculations below). a) Record the entry to borrow the money from the bank. b) Next, record the accrual of interest at December 31st.2,4007%4/12=$56 (Sept- Dec) c) Finally, record the accrual of interest on June 30th.2,4000.076/12=$84 d) Record the entry to pay the interest on June 30th. e) Record the entry to re-pay the principal balance of the loan. Exercise 2: Sales Tax Payable: Use the t-accts below to record the following entries. If you get stuck, carefully review the online and text examples. Beacon Company had $40,000 in taxable sales for the month of June. The sales tax rate is 6%. b) Record the entry to pay the sales tax. Exercise 3: Estimated Payables: Use the t-accts below to record the following entries. Warranty situations such as this would constitute a "probable" contingent liability. Jet Clean sells washing machines totaling \$1 million. Each washing machine carries a 3 year warranty. Jet Clean estimates that warranty repairs on the washing machines cost 1% of the sales price. a) Record the contingent liability. (1,000,0001%=$10,000) b) Jet Clean pays $750 for repairs under the warranty. Record the entry. Bonds (Straight-Line Method): When a company needs to raise significant amounts of cash, one option may be to issue (sell) bonds. From the company's standpoint, this is a lot like going to the bank and getting a loan. These are the steps a company takes to borrow money by issuing bonds. 1) The company informs the necessary governmental regulatory agencies of its plans to issue bonds. 2) The company partners with an investment banker and begins to prepare an Offering Circular. Among other things, the Offering Circular acts as a marketing document for the sale of the bonds. 3) At the time the initial filings are made, a Stated rate (Coupon rate) of interest is assigned to the bond issue and recorded in the Offering Circular. This rate essentially reflects the current interest rate at the time. This is also the rate that is used to pay interest either semi-annually or annually. 4) In the months (usually 3-6 months) that it takes to finish the filing process and the Offering Circular, the current interest rate often fluctuates in the market place. When the date comes to finally issue (sell) the bonds to potential bondholders, the Effective rate (Market rate) of interest is often different than the Stated rate of interest. 5) A bond pricing model is then used to price the bonds reflecting the difference in the Stated and Effective rates of interest at the time of issue. Prices are essentially reflected as a percentage. A bond price of 100 would indicate that there is no difference between the Stated and Effective rates of interest and the bond issues at Par Value. If the bond pricing model results in a price above 100, the bond will be issued at a Premium. If the price is below 100 , the bond will be issued at a Discount. Exercise 4: Review the following completed example for a bond issued at a price of 100. A $50,000,10 year, 9% (Stated rate) bond is issued on January 1 . The bond pays interest semi-annually, each January 1 and July 1 . The bond's Stated rate is equal to the Effective rate at the time of issue so the bond price is 100 . Review the following entries. 1. Entry required upon issuance of the bond. $50,0001.00=$50,000 2. Entry on first interest payment date $50,0009%6/12=$2,250 (Jan-June) Exercise 5: Review the following completed example for a bond issued at a price of 95. The same bond from Exercise 4 is issued at a price of 95 . This price indicates that the Effective rate of interest is greater than the Stated rate of interest. As a result, the bond issues at a discount. Review the following entries. 1. Entry required upon issuance of the bond. Cash proceeds: $50,0000.95=$47,500. Note: A discount of $2,500($50,00047,500) is recorded as the company must repay the full $50,000 at the end of the bond term. 2. Entry on first interest payment date ( 2 entries that can be combined into one-see journal entry): a. Actual Interest payment $50,0009%6/12=$2,250 b. Amortization of the Discount $2,500/20 interest periods =$125 NOTE: In this example, the discount is amortized to interest expense using a straight-line method (Discount / Interest periods) at the same time each interest payment is made (semiannually). A total of 20 interest periods exist in this bond (Bond term =10 years 2 per yr ). The discount amortization increases Interest Expense. Why? Since the bond was issued at a discount the company received cash proceeds less than the principal amount ($50,000). However, the company still has to pay back the full principal at the end of the bond term. So, the discount effectively represents additional interest expense to the company. Another way to think about it is that the interest paid plus the discount amortization raises the Interest Expense recognized to the full Effective rate of interest (remember in this case the Effective rate was greater than the Stated rate). In the end, the company will really pay the Effective (market) rate of interest over the life of the bond. Exercise 6: Complete the following example for a bond issued at a price of 106 . T-accts below. The same bond from Exercise 4 is issued at a price of 106 . This price indicates that the Effective rate of interest is less than the Stated rate of interest. As a result, the bond issues at a Premium. 1. Entry required upon issuance of the bond. Note: Even though a Premium is recorded, the company must still repay just $50,000 at the end of the bond term. 2. Entry on first interest payment date: a. Actual Interest payment b. Amortization of the Premium %6/12=$ nterest periods =$ NOTE: Much like amortizing a discount, use the total number of interest periods to amortize the premium using the straight-line method. In this case the premium amortization effectively decreases Interest Expense. Why? Once again, since the bond was issued at a premium the company received cash proceeds greater than the principal amount ($50,000). However, the company only has to pay back the principal at the end of the bond term. So, the premium received up front effectively reduces the overall interest expense to the company over the life of the bond. Another way to think about it is that the interest paid combined with the premium amortization lowers the Interest Expense recognized to the full Effective rate of interest (remember in this case the Effective rate was less than the Stated rate). In the end, the company will really pay the Effective (market) rate of interest over the life of the bond. Bonds: Effective Interest Rate Method In the previous examples, you learned how to amortize bond premiums and discounts using a straight-line method. However, per GAAP, the straight-line method can only be used if the results are not materially different than the Effective Interest Rate Method. The Effective Interest Rate Method calculates a different amortization amount each interest period based on the Effective (market) rate of interest. Exercise 7: Review the completed example below. Pay close attention to the table below used to calculate the discount amortization each period. A $100,000,2 year, 11% (Stated rate) bond is sold when the Effective (market) rate is 13%. Interest is paid semi-annually. Since the Effective rate is greater than the Stated rate, the bond pricing model results in a discounted issue price of 96.643. Note: Don't try to calculate how this price is calculated at this point. You'd need to know how the bond pricing model works which we are not covering in this chapter. Assuming a price of 96.643 at issuance, calculate the cash proceeds at bond issuance: 1) Entry upon issuance of bond. Cash proceeds: $100,000.96643=$96,643 2) Entry on first interest payment date. a. Actual Interest payment $100,00011%6/12=$5,500 b. Amortization of the discount. See table. 3) Next, record the entries for the remaining 3 interest payments and discount amortizations. Exercise 8: Complete the following problem. A $20,000,2 year, 10% (Stated rate) bond is sold when the Effective (Market) rate is 8%. The bond pays interest semi-annually. Assuming a price of 104 at issuance record the following. 1. Entry required upon issuance of the bond. Cash proceeds: $ 2. Entry on the first interest payment date. Use STRAIGHT-LINE method for amortization. a. Actual Interest payment %6/12=$ b. Amortization of the Premium using the STRAIGHT-LINE method. $ periods =$ 3. Entry on the second interest payment date. Use STRAIGHT-LINE method for amortization. a. Actual Interest payment b. Amortization of the Premium using the STRAIGHT-LINE method. Next, use the t-accounts below the table to repeat the same three steps (from above) but this time use the EFFECTIVE INTEREST RATE METHOD. Round any calculations to the nearest dollar. Bond Retirements: If a bond has a "callable" feature attached, the company may elect to pay off (retire) the bond early (i.e. before the bond term expires). Example 9: Review the completed example below. A company has a $500,000 callable bond with a $7,000 premium on the books. These balances are reflected in the t-accts below. The bond is retired at a price of 102 . Review these steps to record the retirement entry. 1) Determine how much cash must be paid and record in the T-acct. $500,0001.02=$510,000 2) Record entry to zero out the Bonds Payable account. 3) Record entry to zero out the Premium account. 4) Add up your debits and credits to this point. If you need a debit to balance out the entry, record it to a "Loss on Retirement of Bonds" account. If you need a credit to balance out the entry, record it to a "Gain on Retirement of Bonds account. In this example, a loss is recorded. What if the bonds were called at a price of 101?$500,0001.01=505,000 Example 10: Use the t-accounts below to record the following bond retirement. A $200,000 callable bond with a $5,000 discount is called at a price of 104 . a) After completing all of the entries in Exercise 6, what is the correct debit balance recorded to the Interest Expense account? See circle on the printed exercise. (5 points for correct answer. No partial credit). b) After completing all of the entries for the Straight-Line portion in Exercise 8, what is the cash proceeds upon issuance of the bond? See circle on the printed exercise. (5 points for correct answer. No partial credit). c) After completing all of the entries for the Effective Interest Rate portion in Exercise 8, what is the correct Premium Amortization amount for the first interest period (from table)? See circle on the printed exercise. (5 points for correct answer. No partial credit). d) After completing all of the entries in Exercise 10, what is the correct amount recorded to the Loss on Retirement of Bonds account? See circle on the printed exercise. (5 points for correct answer. No partial credit). ACG 2021 - CHAP 9 \& 10 EXERCISE Exercise 1: Short-Term Notes Payable: Use the t-accts below to record the following entries. If you get stuck, carefully review the online and text examples. On September 1st, Geo Inc. borrows $2,400 from State Bank and signs a 10 month short-term note payable. The interest rate on the note is 7%. Even though the note is only for 10 months, the interest rate is an annual rate (see interest calculations below). a) Record the entry to borrow the money from the bank. b) Next, record the accrual of interest at December 31st.2,4007%4/12=$56 (Sept- Dec) c) Finally, record the accrual of interest on June 30th.2,4000.076/12=$84 d) Record the entry to pay the interest on June 30th. e) Record the entry to re-pay the principal balance of the loan. Exercise 2: Sales Tax Payable: Use the t-accts below to record the following entries. If you get stuck, carefully review the online and text examples. Beacon Company had $40,000 in taxable sales for the month of June. The sales tax rate is 6%. b) Record the entry to pay the sales tax. Exercise 3: Estimated Payables: Use the t-accts below to record the following entries. Warranty situations such as this would constitute a "probable" contingent liability. Jet Clean sells washing machines totaling \$1 million. Each washing machine carries a 3 year warranty. Jet Clean estimates that warranty repairs on the washing machines cost 1% of the sales price. a) Record the contingent liability. (1,000,0001%=$10,000) b) Jet Clean pays $750 for repairs under the warranty. Record the entry. Bonds (Straight-Line Method): When a company needs to raise significant amounts of cash, one option may be to issue (sell) bonds. From the company's standpoint, this is a lot like going to the bank and getting a loan. These are the steps a company takes to borrow money by issuing bonds. 1) The company informs the necessary governmental regulatory agencies of its plans to issue bonds. 2) The company partners with an investment banker and begins to prepare an Offering Circular. Among other things, the Offering Circular acts as a marketing document for the sale of the bonds. 3) At the time the initial filings are made, a Stated rate (Coupon rate) of interest is assigned to the bond issue and recorded in the Offering Circular. This rate essentially reflects the current interest rate at the time. This is also the rate that is used to pay interest either semi-annually or annually. 4) In the months (usually 3-6 months) that it takes to finish the filing process and the Offering Circular, the current interest rate often fluctuates in the market place. When the date comes to finally issue (sell) the bonds to potential bondholders, the Effective rate (Market rate) of interest is often different than the Stated rate of interest. 5) A bond pricing model is then used to price the bonds reflecting the difference in the Stated and Effective rates of interest at the time of issue. Prices are essentially reflected as a percentage. A bond price of 100 would indicate that there is no difference between the Stated and Effective rates of interest and the bond issues at Par Value. If the bond pricing model results in a price above 100, the bond will be issued at a Premium. If the price is below 100 , the bond will be issued at a Discount. Exercise 4: Review the following completed example for a bond issued at a price of 100. A $50,000,10 year, 9% (Stated rate) bond is issued on January 1 . The bond pays interest semi-annually, each January 1 and July 1 . The bond's Stated rate is equal to the Effective rate at the time of issue so the bond price is 100 . Review the following entries. 1. Entry required upon issuance of the bond. $50,0001.00=$50,000 2. Entry on first interest payment date $50,0009%6/12=$2,250 (Jan-June) Exercise 5: Review the following completed example for a bond issued at a price of 95. The same bond from Exercise 4 is issued at a price of 95 . This price indicates that the Effective rate of interest is greater than the Stated rate of interest. As a result, the bond issues at a discount. Review the following entries. 1. Entry required upon issuance of the bond. Cash proceeds: $50,0000.95=$47,500. Note: A discount of $2,500($50,00047,500) is recorded as the company must repay the full $50,000 at the end of the bond term. 2. Entry on first interest payment date ( 2 entries that can be combined into one-see journal entry): a. Actual Interest payment $50,0009%6/12=$2,250 b. Amortization of the Discount $2,500/20 interest periods =$125 NOTE: In this example, the discount is amortized to interest expense using a straight-line method (Discount / Interest periods) at the same time each interest payment is made (semiannually). A total of 20 interest periods exist in this bond (Bond term =10 years 2 per yr ). The discount amortization increases Interest Expense. Why? Since the bond was issued at a discount the company received cash proceeds less than the principal amount ($50,000). However, the company still has to pay back the full principal at the end of the bond term. So, the discount effectively represents additional interest expense to the company. Another way to think about it is that the interest paid plus the discount amortization raises the Interest Expense recognized to the full Effective rate of interest (remember in this case the Effective rate was greater than the Stated rate). In the end, the company will really pay the Effective (market) rate of interest over the life of the bond. Exercise 6: Complete the following example for a bond issued at a price of 106 . T-accts below. The same bond from Exercise 4 is issued at a price of 106 . This price indicates that the Effective rate of interest is less than the Stated rate of interest. As a result, the bond issues at a Premium. 1. Entry required upon issuance of the bond. Note: Even though a Premium is recorded, the company must still repay just $50,000 at the end of the bond term. 2. Entry on first interest payment date: a. Actual Interest payment b. Amortization of the Premium %6/12=$ nterest periods =$ NOTE: Much like amortizing a discount, use the total number of interest periods to amortize the premium using the straight-line method. In this case the premium amortization effectively decreases Interest Expense. Why? Once again, since the bond was issued at a premium the company received cash proceeds greater than the principal amount ($50,000). However, the company only has to pay back the principal at the end of the bond term. So, the premium received up front effectively reduces the overall interest expense to the company over the life of the bond. Another way to think about it is that the interest paid combined with the premium amortization lowers the Interest Expense recognized to the full Effective rate of interest (remember in this case the Effective rate was less than the Stated rate). In the end, the company will really pay the Effective (market) rate of interest over the life of the bond. Bonds: Effective Interest Rate Method In the previous examples, you learned how to amortize bond premiums and discounts using a straight-line method. However, per GAAP, the straight-line method can only be used if the results are not materially different than the Effective Interest Rate Method. The Effective Interest Rate Method calculates a different amortization amount each interest period based on the Effective (market) rate of interest. Exercise 7: Review the completed example below. Pay close attention to the table below used to calculate the discount amortization each period. A $100,000,2 year, 11% (Stated rate) bond is sold when the Effective (market) rate is 13%. Interest is paid semi-annually. Since the Effective rate is greater than the Stated rate, the bond pricing model results in a discounted issue price of 96.643. Note: Don't try to calculate how this price is calculated at this point. You'd need to know how the bond pricing model works which we are not covering in this chapter. Assuming a price of 96.643 at issuance, calculate the cash proceeds at bond issuance: 1) Entry upon issuance of bond. Cash proceeds: $100,000.96643=$96,643 2) Entry on first interest payment date. a. Actual Interest payment $100,00011%6/12=$5,500 b. Amortization of the discount. See table. 3) Next, record the entries for the remaining 3 interest payments and discount amortizations. Exercise 8: Complete the following problem. A $20,000,2 year, 10% (Stated rate) bond is sold when the Effective (Market) rate is 8%. The bond pays interest semi-annually. Assuming a price of 104 at issuance record the following. 1. Entry required upon issuance of the bond. Cash proceeds: $ 2. Entry on the first interest payment date. Use STRAIGHT-LINE method for amortization. a. Actual Interest payment %6/12=$ b. Amortization of the Premium using the STRAIGHT-LINE method. $ periods =$ 3. Entry on the second interest payment date. Use STRAIGHT-LINE method for amortization. a. Actual Interest payment b. Amortization of the Premium using the STRAIGHT-LINE method. Next, use the t-accounts below the table to repeat the same three steps (from above) but this time use the EFFECTIVE INTEREST RATE METHOD. Round any calculations to the nearest dollar. Bond Retirements: If a bond has a "callable" feature attached, the company may elect to pay off (retire) the bond early (i.e. before the bond term expires). Example 9: Review the completed example below. A company has a $500,000 callable bond with a $7,000 premium on the books. These balances are reflected in the t-accts below. The bond is retired at a price of 102 . Review these steps to record the retirement entry. 1) Determine how much cash must be paid and record in the T-acct. $500,0001.02=$510,000 2) Record entry to zero out the Bonds Payable account. 3) Record entry to zero out the Premium account. 4) Add up your debits and credits to this point. If you need a debit to balance out the entry, record it to a "Loss on Retirement of Bonds" account. If you need a credit to balance out the entry, record it to a "Gain on Retirement of Bonds account. In this example, a loss is recorded. What if the bonds were called at a price of 101?$500,0001.01=505,000 Example 10: Use the t-accounts below to record the following bond retirement. A $200,000 callable bond with a $5,000 discount is called at a price of 104