1.

Exercise 13-3 Short-term notes [LO2]

The following selected transactions relate to liabilities of United Insulation Corporation. Uniteds fiscal
year
ends on December 31.
2011
Jan. 13
Feb. 1
May 1
Dec. 1
31
2012
Sept
1
.

Negotiated a revolving credit agreement with Parish Bank that can be renewed annually upon
bank approval. The amount available under the line of credit is $18.8 million at the banks
prime rate.
Arranged a three-month bank loan of $3.76 million with Parish Bank under the line of credit
agreement. Interest at the prime rate of 8% was payable at maturity.
Paid the 8% note at maturity.
Supported by the credit line, issued $9.4 million of commercial paper on a nine-month note.
Interest was discounted at issuance at a 7% discount rate.
Recorded any necessary adjusting entry(s).
Paid the commercial paper at maturity.

Required:
Prepare the appropriate journal entries through the maturity of each liability. (In cases where no entry is
required, please select the option "No journal entry required" for your answer to grade correctly.
Leave no cells blank - be certain to enter "0" wherever required. Do not round intermediate
calculations. Round your final answers to the nearest dollar amount. Omit the "$" sign in your
response.)
Date
2011
Jan. 13

General Journal
No journal entry is required

Debit
0

No journal entry is required

Feb. 1

Cash

3,760,000

Notes payable

May 1

3,760,000

Interest expense

75,200

Notes payable

3,760,00

Cash

Dec. 1

Cash

Credit

8,906,50

Discount on notes payable

493,500

Notes payable

Dec. 31

Interest expense

9,400,000

54,833

Discount on notes payable

54,833

2012
Sept. 1

Interest expense
Discount on notes payable

Notes payable
Cash

438,667

9,400,000
9,400,000

Explanation:

2011
May 1
Interest expense ($3,760,000 8% 3/12) = 75,200
Notes payable (face amount) = 3,760,000
Cash ($3,760,000 + 75,200) = 3,835,200
Dec. 1
Cash (difference) = 8,906,500
Discount on notes payable ($9,400,000 7% 9/12) = 493,500
Notes payable (face amount) = 9,400,000
Dec. 31
The effective interest rate is 7.3879% ($493,500 $8,906,500) 12/9. So, properly, interest should be
recorded at that rate times the outstanding balance times one-twelfth of a year:
Interest expense ($8,906,500 7.3879% 1/12) = 54,833
Discount on notes payable = 54,833
However the same results are achieved if interest is recorded at the discount rate times the maturity
amount times one-twelfth of a year:
Interest expense ($9,400,000 7% 1/12) = 54,833.
Discount on notes payable = 54,833
2012
Sept. 1
Interest expense ($9,400,000 7% 8/12)* = 438,667
Discount on notes payable = 438,667
Notes payable (balance) = 9,400,000

Cash (maturity amount) = 9,400,000

* or, ($8,906,500 7.3879% 8/12) = $438,667

2. Exercise 13-13 Warranties [LO5, 6]

Cupola Awning Corporation introduced a new line of commercial awnings in 2011 that carry a two-year
warranty against manufacturers defects. Based on their experience with previous product introductions,
warranty costs are expected to approximate 3.5% of sales. Sales and actual warranty expenditures for
the first year of selling the product were:
Sales
$4,805,000

Actual Warranty Expenditures

$42,044

Required:
(1-a) Does this situation represent a loss contingency?
Yes
(1-b) How should Cupola account for it?
Estimated warranty liability is credited and warranty expense is debited in 2011.
(2) Prepare journal entries that summarize sales of the awnings (assume all credit sales) and any
aspects of the warranty that should be recorded during 2011. (Omit the "$" sign in your response.)
General Journal

Debit

Credit

2011 Sales
Accounts receivable

4,805,000

Sales

4,805,000

Accrued liability and expense

Warranty expense

168,175

Estimated warranty liability

168,175

Actual expenditures
Estimated warranty liability
Cash, wages payable, parts and supplies, etc.

42,044
42,044

(3) What amount should Cupola report as a liability at December 31, 2011? (Omit the "$" sign in your
response.)

Liability

126,131

Explanation:
(1)

This is a loss contingency. There may be a future sacrifice of economic benefits (cost of satisfying the
warranty) due to an existing circumstance (the warranted awnings have been sold) that depends on an
uncertain future event (customer claims).
The liability is probable because product warranties inevitably entail costs. A reasonably accurate
estimate of the total liability for a period is possible based on prior experience. So, the contingent liability
for the warranty is accrued. The estimated warranty liability is credited and warranty expense is debited
in 2011, the period in which the products under warranty are sold.
(2)

Accrued liability and expense:

Warranty expense (3.5% $4,805,000) = 168,175.
(3)

Warranty Liability
Actual expenditures

168,175

Estimated liability

126,131

Balance

42,044

3. Exercise 14-2 Determine the price of bonds in various situations [LO2]

Determine the price of a $1 million bond issue under each of the following independent assumptions:
(Use Table 2 and Table 4). (Round "PV Factor" to 5 decimal places, intermediate and final answers to
the nearest whole dollar amount. Omit the "$" sign in your response.)
Effective
(Market)
Maturity Interest Paid Stated Rate
Rate
1.

10 years

2.

annually

10%

12%

10 years semiannually

10%

12%

3.

10 years semiannually

12%

10%

4.

20 years semiannually

12%

10%

5.

20 years semiannually

12%

12%

Price
$
886,992 .1%

$
885,296 .1%

$
1,124,623 .01%

$
1,171,595 .01%

$
999,998 .1%

Explanation:
1.

Maturity
10 years

Interest paid Stated rate Effective (market) rate

annually
10%
12%
5.65022*
Interest $ 100,000
$
565,022
=
Princip
1,000,000
$
.32197**
321,970
al
=
Present value (price) of the
bonds

886,992

10% $1,000,000
* present value of an ordinary annuity of $1: n = 10, i = 12% (Table 4)
** present value of $1: n = 10, i = 12% (Table 2)
2.

Maturity
20 years

Interest paid Stated rate Effective (market) rate

semiannually
10%
12%
11.46992*
Interest $ 50,000
$
573,496
=
Princip
1,000,000
$
.31180**
311,800
al
=
Present value (price) of the
bonds

885,296

5% $1,000,000
* present value of an ordinary annuity of $1: n = 20, i = 6% (Table 4)
** present value of $1: n = 20, i = 6% (Table 2)
3.

Maturity
20 years

Interest paid Stated rate Effective (market) rate

semiannually
12%
10%
12.46221*
Interest $ 60,000
$
747,733
=
Princip
1,000,000
$
.37689**
376,890
al
=
Present value (price) of the
bonds

1,124,623

6% $1,000,000
* present value of an ordinary annuity of $1: n = 20, i = 5% (Table 4)
** present value of $1: n = 20, i = 5% (Table 2)

4.

Maturity
40 years

Interest paid Stated rate Effective (market) rate

semiannually
12%
10%
17.15909*
Interest $ 60,000
$
1,029,545
=
Princip
1,000,000
$
.14205**
142,050
al
=
Present value (price) of the
bonds

1,171,595

6% x $1,000,000
* present value of an ordinary annuity of $1: n = 40, i = 5% (Table 4)
** present value of $1: n = 40, i = 5% (Table 2)
5.

Maturity
40 years

Interest paid Stated rate Effective (market) rate

semiannually
12%
12%
15.04630*
Interest $ 60,000
$
902,778
=
Princip
1,000,000
$
.09722**
97,220
al
=
Present value (price) of the
bonds

999,998

actually, $1,000,000 if PV table factors were not rounded

6% $1,000,000
* present value of an ordinary annuity of $1: n = 40, i = 6% (Table 4)
** present value of $1: n = 40, i = 6% (Table 2)

4. Exercise 14-4 Investor; effective interest [LO2]

The Bradford Company sold 8% bonds, dated January 1, with a face amount of $70 million on January 1,
2011 to Saxton-Bose Corporation. The bonds mature in 2020 (10 years). For bonds of similar risk and
maturity, the market yield is 10%. Interest is paid semiannually on June 30 and December 31.
Use (Table 2) and (Table 4)
Required:
(1) Prepare the journal entry to record the purchase of the bonds by Saxton-Bose on January 1, 2011.
(Enter your answers in dollars not in millions. Round "PV Factor" to 5 decimal places andfinal
answers to the nearest whole dollar amount. Omit the "$" sign in your response.)
Date

General Journal

Debit

Credit

Jan 1,
2011

Bond investment

70,000,000 0.01%

Discount on bond investment

8,723,51

Cash

61,276,4

(2) Prepare the journal entry to record interest revenue on June 30, 2011 (at the effective rate). (Enter
your answers in dollars not in millions. Round "PV Factor" to 5 decimal places andfinal
answers to the nearest whole dollar amount. Omit the "$" sign in your response.)
Date
June 30,
2011

General Journal

Debit

Cash

2,800,00

Discount on bond investment

263,824

Interest revenue

Credit

3,063,824 0.01%

(3) Prepare the journal entry to record interest revenue on December 31, 2011 (at the effective rate).
(Enter your answers in dollars not in millions. Round "PV Factor" to 5 decimal places andfinal
answers to the nearest whole dollar amount. Omit the "$" sign in your response.)
Date
Dec. 31,
2011

General Journal
Cash

2,800,00

Discount on bond investment

277,016

Interest revenue

$ 2,800,000
$ 70,000,000

12.46221* =
.37689** =

Present value (price) of the bonds

$ 34,894,188
26,382,300
$ 61,276,488

4% $70,000,000
* present value of an ordinary annuity of $1: n = 20, i = 5% (Table 4)
** present value of $1: n = 20, i = 5% (Table 2)
(2) June 30, 2011

Cash (4% $70,000,000) = 2,800,000

Interest revenue (5% $61,276,488) = 3,063,824

Credit

3,077,016 0.01%

Explanation:
(1) January 1, 2011

Interest
Principal

Debit

(3) December 31, 2011

Cash (4% $70,000,000) = 2,800,000

Interest revenue (5% [$61,276,488 + 263,824]) = 3,077,016

5. Exercise 14-9 Issuance of bonds; effective interest;

amortization schedule; financial statement effects [LO2]
When Patey Pontoons issued 5.00% bonds on January 1, 2011, with a face amount of $700,000, the
market yield for bonds of similar risk and maturity was 6.00%. The bonds mature December 31, 2014 (4
years). Interest is paid semiannually on June 30 and December 31. (Use Table 2 and Table 4)
Required:
(1 Determine the price of the bonds at January 1, 2011. (Do not round PV factors. Round final
) answer to the nearest dollar amount. Omit the "$" sign in your response.)
$

Price of the bonds

675,431

(2 Prepare the journal entry to record their issuance by Patey on January 1, 2011. (Do not round PV
) factors. Round final answer to the nearest dollar amount. Omit the "$" sign in your response.)
Date
Jan. 1

General Journal

Debit

Cash

675,431

Discount on bonds

24,569

Bonds payable

Credit

700,000

(3 Prepare an amortization schedule that determines interest at the effective rate each period. (Do not
) round PV factors. Round final answer to the nearest dollar amount. Omit the "$" sign in your
response.)
Cash
Payment

Effective
Interest

Increase in
Balance

Outstanding
Balance
675,431

17,500

20,263

2,763

678,194

17,500

20,346

2,846

681,040

17,500

20,431

2,931

683,971

17,500

20,519

3,019

686,990

17,500

20,610

3,110

690,100

17,500

20,703

3,203

693,303

17,500

20,799

3,299

696,602

17,500

20,898

3,398

700,000

140,000

164,569

24,569

(4 Prepare the journal entry to record interest on June 30, 2011. (Do not round PV factors. Round
) final answer to the nearest dollar amount. Omit the "$" sign in your response.)
Date
June 30

General Journal

Debit

Interest expense

Credit

20,263

Discount on bonds payable

2,763

Cash

17,500

(5 What is the amount related to the bonds that Patey will report in its balance sheet at December 31,
) 2011? (Do not round PV factors. Round final answer to the nearest dollar amount. Omit the "$"
sign in your response.)
December 31, 2011 net liability

$
681,040

(6 What is the amount related to the bonds that Patey will report in its income statement for the year
) ended December 31, 2011? (Ignore income taxes.) (Do not round PV factors. Round final answer
to the nearest dollar amount. Omit the "$" sign in your response.)
$

Interest expense for 2011

40,609

(7 Prepare the appropriate journal entries at maturity on December 31, 2014. (Do not round PV
) factors. Round final answer to the nearest dollar amount. Omit the "$" sign in your response.)
Date
Dec. 31

General Journal
Interest expense

Debit

Credit

20,898

Discount on bonds payable

3,398

Cash

17,500

Dec. 31

Bonds payable

700,000

Cash

700,000

rev: 12_13_2011

Explanation:
(1)

Price of the bonds at January 1, 2011

$17,500
Interest 7.01969*
=
$700,000
Principa
l
0.78941**
=
Present value
(price) of the bonds

122,845

552,586

675,431

2.500% $700,000
present value of an ordinary annuity of $1: n = 8, i = 3.000% (Table 4)
**
present value of $1: n = 8, i = 3.000% (Table 2)
*

(3)

Cash
Payment
2.500% Face
Amount
1
2
3
4
5
6
7
8

17,500
17,500
17,500
17,500
17,500
17,500
17,500
17,500
140,000

*rounded
(4)

Effective
Interest
3.000% Outstanding Balance
0.030 (675,431) =
0.030 (678,194) =
0.030 (681,040) =
0.030 (683,971) =
0.030 (686,990) =
0.030 (690,100) =
0.030 (693,303) =
0.030 (696,602) =

Increase in
Balance
Discount
Reduction

20,263
20,346
20,431
20,519
20,610
20,703
20,799
20,898*

2,763
2,846
2,931
3,019
3,110
3,203
3,299
3,398

164,569

24,569

Outstanding
Balance
675,431
678,194
681,040
683,971
686,990
690,100
693,303
696,602
700,000

Interest expense (3.000% $675,431) = 20,263

Cash (2.500% $700,000) = 17,500
(5)

Bonds payable
Less: discount
Initial balance, January
1, 2011
June 30, 2011
discount amortization
Dec. 31, 2011
discount amortization

700,000
(24,569)

675,431
2,763
2,846

December 31, 2011 net

liability

681,040

(6)

June 30, 2011

interest expense
Dec. 31, 2011
interest expense
Interest expense for
2011

20,263
20,346

40,609

(7)

Interest expense (3.000% 696,602) = 20,898*

* rounded value from amortization schedule
Cash (2.500% $700,000) = 17,500

6. Exercise 14-10 Issuance of bonds; effective interest;

amortization schedule [LO2]
National Orthopedics Co. issued 8% bonds, dated January 1, with a face amount of $800,000 on
January 1, 2011. The bonds mature in 2014 (4 years). For bonds of similar risk and maturity the market
yield was 9%. Interest is paid semiannually on June 30 and December 31. (Use Table 2 andTable 4)
Required:
(1 Determine the price of the bonds at January 1, 2011. (Round PV factors to 5 decimal places.Round
) your answer to the nearest dollar amount. Omit the "$" sign in your response.)

Price of the bonds

$
773,620 0.1%

(2 Prepare the journal entry to record their issuance by National on January 1, 2011. (Round PV factors
) to 5 decimal places. Round your answers to the nearest dollar amount. Omit the "$" sign in
your response.)
Date
Jan. 1

General Journal

Debit

Cash

773,620

Discount on bonds payable

26,380

Bonds payable

Credit

800,000 0.1%

(3 Prepare an amortization schedule that determines interest at the effective rate each period. (Round
) PV factors to 5 decimal places. Round your answers to the nearest dollar amount. Omit the "$"
sign in your response.)
Cash
Payment

Effective
Interest

Increase in
Balance

Outstanding
Balance
773,620 0.1%

32,000 0.1%

34,813 0.1%

2,813 0.1%

776,433 0.1%

32,000 0.1%

34,939 0.1%

2,939 0.1%

779,372 0.1%

32,000 0.1%

35,072 0.1%

3,072 0.1%

782,444 0.1%

32,000 0.1%

35,210 0.1%

3,210 0.1%

785,654 0.1%

32,000 0.1%

35,354 0.1%

3,354 0.1%

789,008 0.1%

32,000 0.1%

35,505 0.1%

3,505 0.1%

792,513 0.1%

32,000 0.1%

35,663 0.1%

3,663 0.1%

796,176 0.1%

32,000 0.1%

35,824 0.1%

3,824 0.1%

256,000 0.1%

282,380 0.1%

26,380 0.1%

800,000

(4 Prepare the journal entry to record interest on June 30, 2011. (Round PV factors to 5 decimal
) places. Round your answers to the nearest dollar amount. Omit the "$" sign in your response.)
Date

General Journal

Debit

Credit

June 30

Interest expense

34,813 0.1%

Discount on bonds payable

2,813

Cash

32,000

(5 Prepare the appropriate journal entries at maturity on December 31, 2014. (Round PV factors to 5
) decimal places. Round your answers to the nearest dollar amount. Omit the "$" sign in your
response.)
Date
Dec. 31

Dec. 31

General Journal

Debit

Interest expense

Credit

35,824 0.1%

Discount on bonds payable

3,824

Cash

32,000

Bonds payable

800,000

Cash

800,000

Explanation:
(1)

Price of the bonds at January 1, 2011

$32,000
6.59589* =
Principa $800,000
l
0.70319** =
Interest

Present value (price) of

the bonds

211,068
562,552

773,620

4.0% $800,000
present value of an ordinary annuity of $1: n = 8, i = 4.5% (Table 4)
**
present value of $1: n = 8, i = 4.5% (Table 2)
*

(3)

Cash
Payment
4.0% Face
Amount

Effective
Interest
4.5% Outstanding Balance

Increase in
Balance
Discount
Reduction

Outstanding
Balance
773,620

1
2
3
4
5
6
7
8

32,000
32,000
32,000
32,000
32,000
32,000
32,000
32,000

.045 (773,620) =
.045 (776,433) =
.045 (779,372) =
.045 (782,444) =
.045 (785,654) =
.045 (789,008) =
.045 (792,513) =
.045 (796,176) =

256,000

34,813
34,939
35,072
35,210
35,354
35,505
35,663
35,824*

2,813
2,939
3,072
3,210
3,354
3,505
3,663
3,824

282,380

26,380

776,433
779,372
782,444
785,654
789,008
792,513
796,176
800,000

*rounded
(4)

Interest expense (4.5% $773,620) = 34,813

Cash (4.0% $800,000) = 32,000
(5)

Interest expense (4.5% 796,176) = 35,824*

* rounded value from amortization schedule
Cash (4.0% $800,000) = 32,000

7. Exercise 14-12 Bonds; straight-line method;

adjusting entry [LO2]
On March 1, 2011, Stratford Lighting issued 15% bonds, dated March 1, with a face amount of $850,000.
The bonds sold for $833,000 and mature on February 28, 2021 (10 years). Interest is paid semiannually
on August 31 and February 28. Stratford uses the straight-line method and its fiscal year ends December
31.
Required:
(1 Prepare the journal entry to record the issuance of the bonds by Stratford Lighting on March 1, 2011.
) (Omit the "$" sign in your response.)
Date
Mar. 1

General Journal

Debit

Cash

833,000

Discount on bonds payable

17,000

Bonds payable

Credit

850,000 1

(2 Prepare the journal entry to record interest on August 31, 2011. (Omit the "$" sign in your
) response.)
Date

General Journal

Debit

Credit

Aug. 31

Interest expense

64,600 1

Discount on bonds payable

850 1

Cash

63,750

(3 Prepare the journal entry to accrue interest on December 31, 2011. (Do not round intermediate
) calculations. Round your answers to the nearest dollar amount. Omit the "$" sign in your
response.)
Date
Dec. 31

General Journal
Interest expense

Debit

Credit

43,067 1

Discount on bonds payable

567 1

Interest payable

42,500

(4 Prepare the journal entry to record interest on February 28, 2012. (Do not round intermediate
) calculations. Round your answers to the nearest dollar amount. Omit the "$" sign in your
response.)
Date
Feb. 28

General Journal

Debit

Interest expense

21,533

Interest payable

42,500

Credit

Discount on bonds payable

283 1

Cash

63,750

Explanation:

(2
August 31, 2011:
)
Interest expense ($63,750 + 850) = 64,600
Discount on bonds payable ($17,000 20) = 850
Cash (7.5% $850,000) = 63,750
(3
December 31, 2011:
)
Interest expense (4/6 $64,600) = 43,067
Discount on bonds payable (4/6 $850) = 567
Interest payable (4/6 $63,750) = 42,500
(4
February 28, 2012:
)

Interest expense (2/6 $64,600) = 21,533

Interest payable (4/6 $63,750) = 42,500
Discount on bonds payable (2/6 $850) = 283
Cash (7.5% $850,000) = 63,750

8. Exercise 14-19 Installment note [LO3]

LCD Industries purchased a supply of electronic components from Entel Corporation on November 1,
2011. In payment for the $29 million purchase, LCD issued a 1-year installment note to be paid in equal
monthly payments at the end of each month. The payments include interest at the rate of 12%. (Use Table
4.)
Required:
(1) Prepare the journal entry for LCDs purchase of the components on November 1, 2011. (Enter your
answers in dollars not in millions. Omit the "$" sign in your response.)
Date
Nov. 1 2011

General Journal
Component inventory

Debit

Credit

29,000,000

Notes payable

29,000,000

(2) Prepare the journal entry for the first installment payment on November 30, 2011. (Enter your
answers in dollars not in millions. Round "PV Factor" to 5 decimal places and final answers to
the nearest dollar amount. Omit the "$" sign in your response.)
Date
Nov. 30 2011

General Journal

Debit

Interest expense

290,000

Note payable

2,286,61

Cash

Credit

2,576,615 1

(3) What is the amount of interest expense that LCD will report in its income statement for the year ended
December 31, 2011?. (Enter your answers in dollars not in millions. Round your answer to the
nearest dollar amount. Omit the "$" sign in your response.)
Interest expense

$
557,134 1

Explanation:
(2)

November 30, 2011

Interest expense (1% outstanding balance) = 290,000
Note payable (difference) = 2,286,615
Cash (payment determined below) = 2,576,615

Calculation of installment payment:

$29,000,000

11.25508
amount
(from Table 4)
of loan
n = 12, i = 1%

$2,576,615
installment
payment

(3)

November (1%
$29,000,000)
December (1%
[$29,000,000
2,286,615])

290,000
267,134

2011 interest expense

557,134

9. Exercise 14-22 Convertible bonds [LO5]

On January 1, 2011, Gless Textiles issued $20 million of 10.9%, 10-year convertible bonds at 103. The
bonds pay interest on June 30 and December 31. Each $1,000 bond is convertible into 90 shares of
Glesss no par common stock. Bonds that are similar in all respects, except that they are nonconvertible,
currently are selling at 101 (that is, 101% of face amount). Century Services purchased 12% of the issue
as an investment.
Required:
(1) Prepare the journal entries for the issuance of the bonds by Gless and the purchase of the bond
investment by Century. (Enter your answers in dollars not in millions. Do not round intermediate
calculations. Round your answers to the nearest dollar amount. Omit the "$" sign in your
response.)
General Journal

Debit

Credit

Gless (Issuer)
Cash

20,600,000

Convertible bonds payable

20,000,0

Premium on bonds payable

600,000

Century (Investor)
Investment in convertible bonds

2,400,00

Premium on bond investment

72,000

Cash

2,472,000 1

(2) Prepare the journal entries for the June 30, 2015, interest payment by both Gless and Century
assuming both use the straight-line method. (Enter your answers in dollars not in millions. Do not
round intermediate calculations. Round your answers to the nearest dollar amount. Omit the
"$" sign in your response.)
General Journal

Debit

Credit

Gless (Issuer)
Interest expense

1,060,00

Premium on bonds payable

30,000

Cash

1,090,000

Century (Investor)
Cash

130,800 1

Premium on bond investment

3,600

Interest revenue

127,200

(3) On July 1, 2016, when Glesss common stock had a market price of $33 per share, Century converted
the bonds it held. Prepare the journal entries by both Gless and Century for the conversion of the
bonds (book value method). (Enter your answers in dollars not in millions. Do not round
intermediate calculations. Round your answers to the nearest dollar amount. Omit the "$" sign
in your response.)
General Journal

Debit

Credit

Gless (Issuer)
Convertible bonds payable

2,400,00

Premium on bonds payable

32,400

Common stock

2,432,400 1

Century (Investor)
Investment in common stock

2,432,400 1

Investment in convertible bonds

2,400,00

Premium on bond investment

32,400

rev: 04-27-2011
Explanation:
(1)

Gless (Issuer)

Cash (103% $20 million) = 20,600,000

Convertible bonds payable (face amount) = 20,000,000
Premium on bonds payable (difference) = 600,000
Century (Investor)
Investment in convertible bonds (12% $20 million) = 2,400,000
Premium on bond investment (difference) = 72,000
Cash (103% $2,400,000) = 2,472,000
(2)

Gless (Issuer)
Interest expense ($1,090,000 30,000) = 1,060,000
Premium on bonds payable ($600,000 20) = 30,000
Cash (5.45% $20,000,000) = 1,090,000
Century (Investor)
Cash (5.45% $2,400,000) = 130,800
Premium on bond investment ($72,000 20) = 3,600
Interest revenue ($130,800 3,600) = 127,200
[Using the straight-line method, each interest entry is the same.]
(3)

Gless (Issuer)
Convertible bonds payable (12% of the account balance) = 2,400,000
Premium on bonds payable (($600,000 [$30,000 11]) 12%) = 32,400
Common stock (to balance)= 2,432,400
Century (Investor)
Investment in common stock = 2,432,400
Investment in convertible bonds (account balance) = 2,400,000
Premium on bond investment ($72,000 [$3,600 11]) = 32,400

10. Exercise 14-27 Reporting bonds at fair value [LO6]

Federal Semiconductors issued 9% bonds, dated January 1, with a face amount of $849 million on
January 1, 2011. The bonds sold for $776,163,483 and mature in 2030 (20 years). For bonds of similar
risk and maturity the market yield was 10%. Interest is paid semiannually on June 30 and December 31.
Federal determines interest at the effective rate. Federal elected the option to report these bonds at their
fair value. On December 31, 2011, the fair value of the bonds was $724 million as determined by their
market value in the over-the-counter market.
Required:
(1) Prepare the journal entry to adjust the bonds to their fair value for presentation in the December 31,
2011, balance sheet. (Enter your answers in dollars not in millions. Round "PV Factor" to 5
decimal places and final answers to the nearest whole dollar amount. Omit the "$" sign in your
response.)
Date
June 30,
2011

General Journal
Interest expense
Discount on bonds payable

Debit

Credit

38,808,174 0.01%
603,174

Cash
Dec 31,
2011

38,205,0

Interest expense

38,838,333 0.01%

Discount on bonds payable

633,333

Cash

38,205,0

Fair value adjustment

53,399,990 0.01%

Unrealized holding gain

53,399,990 0.01%

(2) Assume the fair value of the bonds on December 31, 2012, had risen to $734 million. Prepare the
journal entry to adjust the bonds to their fair value for presentation in the December 31, 2012, balance
sheet. (Enter your answers in dollars not in millions. Round "PV Factor" to 5 decimal places
and final answers to the nearest whole dollar amount. Omit the "$" sign in your response.)
Date
June 30,
2012

Dec 31,
2012

General Journal
Interest expense

Debit

Credit

38,870,000 0.01%

Discount on bonds payable

665,000

Cash

38,205,0

Interest expense

38,903,250 0.01%

Discount on bonds payable

698,250

Cash

38,205,0

Unrealized holding loss

Fair value adjustment

8,636,750 0.01%
8,636,750 0.01%

Explanation:
(1)

At January 1, 2011, the book value of the bonds was the initial issue price, $776,163,483. The liability,
though, was increased when Federal recorded interest during 2011:
June 30, 2011
Interest expense (5% $776,163,483) = 38,808,174
Cash (4.5% $849,000,000) = 38,205,000

December 31, 2011

Interest expense (5% [$776,163,483 + 603,174]) = 38,838,333
Cash (4.5% $849,000,000) = 38,205,000
Reducing the discount increases the book value of the bonds:
Jan.1, 2011, book value
Increase from discount amortization
($603,174 + 633,333)

776,163,483
1,236,507

December 31, 2011, book value (amortized

initial amount)

777,399,990

Comparing the amortized initial amount at December 31, 2011, with the fair value on that date provides
the Fair value adjustment balance needed:
December 31, 2011, book value
(amortized initial amount)
December 31, 2011, fair value
Fair value adjustment balance
needed: debit/(credit)

777,399,990
724,000,000

53,399,990

Federal would record the $53,399,990 as a gain in the 2011 income statement:
Note: A decrease in the value of an asset is a loss; a decrease in the value of a liability is a gain.
In the balance sheet, the bonds are reported among long-term liabilities at their $724,000,000 fair value:
Bonds payable
Less: Discount on bonds payable
December 31, 2011, book value
(amortized initial amount)
Less: Fair value adjustment
December 31, 2011, fair value

$ 849,000,000
(71,600,010)
$ 777,399,990
(53,399,990)
$ 724,000,000

(2)

If the fair value at December 31, 2012, is $734,000,000 a year later, Federal needs to compare that
amount with the amortized initial measurement on that date. That amount was increased when Federal
recorded interest during 2012:

June 30, 2012

Interest expense (5% [$776,163,483 + 603,174 + 633,333]) = 38,870,000
Cash (4.5% $849,000,000) = 38,205,000
December 31, 2012
Interest expense (5% [$776,163,483 + 603,174 + 633,333 + 665,000]) = 38,903,250
Cash (4.5% $849,000,000) = 38,205,000
Reducing the discount increases the book value of the bonds:
December 31, 2011, book value (amortized
initial amount)
Increase from discount amortization
($665,000 + 698,250)
December 31, 2012, book value (amortized
initial amount)

777,399,990
1,363,250

778,763,240

Comparing the amortized initial amount at December 31, 2012, with the fair value on that date provides
the Fair value adjustment balance needed:
December 31, 2012, book value (amortized
initial amount)
December 31, 2012, fair value
Fair value adjustment balance needed: debit/
(credit)
Less: Fair value adjustment debit/(credit),
balance 1/1/2012
Change in fair value adjustment, 12/31/2012

$ 778,763,240
(734,000,000)
$

44,763,240
53,399,990

(8,636,750)

Federal records the $8,636,750 as a loss in the 2012 income statement:

Note: An increase in the value of an asset is a gain; an increase in the value of a liability is a loss.
In the balance sheet, the bonds are reported among long-term liabilities at their $734,000,000 fair value:
Bonds payable
Less: Discount on bonds payable
December 31, 2012, book value
(amortized initial amount)
Less: Fair value adjustment
December 31, 2012, fair value

$ 849,000,000
(70,236,760)
$ 778,763,240
(44,763,240)
$ 734,000,000