Question 3

The difference between debt and equity in an entitys statement of financial position is not easilydistinguishable for preparers of financial statements. Some financial instruments may have both features,which can lead to inconsistency of reporting. The international Accounting Standards Board has agreedthat greater clarity may be required in its definitions of assets and liabilities for debt instruments. It isthought that defining the nature of liabilities would help the IASBs thinking on the difference betweenfinancial instruments classified as equity and liability.

a) Explain why it is important for entities to understand the impact of the classification of a financial instrument as debt or equity in the financial statements

b) Witco Limited patented and successfully tested a new e-cigarette. To expand its ability to produce andmarket this new product, Witco needs to raise $400,000.

On January 1 2010, Witco issued a 12% $400,000, 5 year bond. The bond pays interest semi-annually on June30 and December 31. The bonds effective interest rate is 10%.

1) Calculate the proceeds from the sale of the bond & the discount or premium. Give 2 reasons why you think it is discount/premium. Show workings

2) Prepare a bond amortization schedule for the life of the bond

3) Prepare the journal entries to record the following:

a) The issuance of the bond on Jan 1 2010

b) The first interest payment

c) The retirement of the bond at a $400,000 call price on January 1 2013