ACCT5001 S1 2010

Self-Study Solutions

Week 10

ACCT5001 S1 2010

Self-Study Solutions

Week 10

Ch.9: Q3, Q8, Q9, E9.3, E9.5, PSA9.1, PSA9.2, PSA9.4*; BBS9.5, BBS9.4*, Additional (TBA)

EXERCISE 9.5

3.

No, Jack is not right. The market price on any note is a function of three factors: (1) the dollar amounts to be received by the investor (interest and principal), (2) the length of time until the amounts are received (interest payment dates and maturity date), and (3) the market interest rate.

(a)

30 June Interest Expense Loan Payable Cash at Bank

861 4,139 5,000

(To record the loan payment for June)

8.

A mortgage loan is a secured liability, repayable in regular instalments over the period of the loan. A mortgage liability should be reported as an interest-bearing liability. The current and non-current components of the mortgage liability should be reported separately. That is, the current portion of the mortgage liability should be included in financial liabilities (also referred to as borrowings) that are classified as current liabilities. The non-current portion of the mortgage liability should be included in the financial liabilities that are classified as non-current liabilities.

(b)

The carrying amount of the mortgage liability after the above entry is $81,994.

(c)

The current portion of the mortgage liability is $53,014 ($81,994 - $28,980).

(d)

The non-current portion is $28,980. This is the loan balance at 30 June 2013.

9.

Many financially healthy companies have current ratios below 2:0. In order to reduce costs, many companies today keep low amounts of inventory on hand. Consequently, liquidity ratios are generally lower than they used to be. Another measure that could be checked is the quick ratio. This ratio is a measure of a companys immediate short-term liquidity and inventory is not included in this calculation. Another measure of liquidity is working capital.

(e)

It is important to classify liabilities as current or non-current because readers of the financial statements use this information to assess a companys liquidity and solvency. A liquidity analysis focuses on current liabilities, often comparing them to current assets, for example. The inability to meet obligations as they become due could lead to bankruptcy. Examples of current liabilities are accounts payable, unearned revenues, wages and salaries, provisions and interest.

EXERCISE 9.3

(a)

Jan.

Cash at Bank ................................................100,000 Unsecured Notes Payable ............................... 100,000

(b)

July

Interest Expense ...........................................

5,000 5,000

Cash at Bank ($100,000 X 10% X 1/2). (c) Dec. 31 Interest Expense ...............................................5,000 Interest Payable ...............................................

5,000

ACCT5001 S1 2010 Week 10 Self-Study Solutions 5.doc10/05/2010

ACCT5001 S1 2010 Week 10 Self-Study Solutions 5.doc10/05/2010

ACCT5001 S1 2010

Self-Study Solutions

Week 10

ACCT5001 S1 2010

Self-Study Solutions

Week 10

PROBLEM SET A 9.1 Cling-on Ltd (a) Sept. 1 Inventory or Purchases .....................................16,000 Notes Payable .................................................... Interest Expense ............................................... 120 ($16,000 X .09 X 1/12) Interest Payable.................................................. Climbing Wall ....................................................10,000 Notes Payable .................................................... Interest Expense ............................................... 220 ($10,000 X .12 X 1/12 + $120) Interest Payable.................................................. Vehicles.............................................................26,000 Notes Payable .................................................... Cash at Bank ...................................................... Interest Expense ............................................... 430 ($18,000 X .14 X 1/12 + $100 + $120) Interest Payable.................................................. Notes Payable ...................................................16,000 Interest Payable ................................................ 360 Cash at Bank ...................................................... Interest Expense ($100 + $210) ........................ 310 Interest Payable..................................................

(b) Notes Payable 1/12 16,000 Closing Balance 28,000 44,000 120 10,000 1/12 Dr $ 16,000 1/9 1/10 1/11 Cr $ 16,000 10,000 18,000 44,000

30

Opening Balance 28,000 Interest Payable Dr $ 360 30/9 31/10 30/11 31/12 Opening Balance Cr $ 120 220 430 310 1,080 720

Oct.

31

Closing Balance 220

720 1,080

Nov.

18,000 8,000 30/9 31/10 30/11 31/12

Interest Expense Cr $ Dr $ 120 Closing entry to P&L 1,080 220 Summary 430 310 1,080 1,080

Nov.

30

430

Dec.

16,360

Note: The general ledger account Interest Expense will be closed to P&L Summary at the end of each accounting period.

31

310

(c)

Current liabilities Notes payable ...................................................................................... 28,000 Interest payable.................................................................................... 720

(d)

Total interest expense is $1,080.

(e)

The advantage of using notes payable for purchasing inventory is that the purchaser will probably have a longer period of time to pay for the inventory than under the normal credit terms for accounts payable. The disadvantage is that interest will have to be paid on the notes whereas accounts payable is usually interest free. In fact, suppliers often offer a discount for early payment. That would not be available in a notes payable scenario.

ACCT5001 S1 2010 Week 10 Self-Study Solutions 5.doc10/05/2010

ACCT5001 S1 2010 Week 10 Self-Study Solutions 5.doc10/05/2010

ACCT5001 S1 2010

Self-Study Solutions

Week 10

ACCT5001 S1 2010

Self-Study Solutions

Week 10

. PROBLEM SET A 9.2 Fair Meadow Ltd Revenue Received in Advance ........................... 5,000 Service Revenue .................................................. PAYG Withheld Tax Payable .............................. 8,500 Cash at Bank ........................................................ Cash at Bank.......................................................18,000 Notes Payable ...................................................... Interest Expense .................................................. 49 Interest Payable.................................................... ($18,000 X 10% X 10/365 = $49) Salaries and Wages Expense .............................40,000 Health Fund Payable ............................................ PAYG Withheld Tax Payable................................ Superannuation Payable ...................................... Salaries and Wages Payable ...............................

PROBLEM SET A 9.4* Carlsbad Electrical Ltd

(a)

Jan

12

(a) 5,000

2010 Jan.

Cash at Bank ............................................. 3,000,000* Debentures Payable................................... Interest Expense ........................................... 150,000* Cash at Bank.............................................. Interest Expense ........................................... 150,000* Interest Payable .........................................

3,000,000

14

8,500

(b)

July

150,000

21

18,000

Dec. 31

150,000

(b)

Jan.

31

49

(c)

2011 Dec. 31

31

Debentures Payable ....................................3,000,000 Loss on Debenture Redemption .....................120,000 Cash at Bank ($3,000,000 X 104%)...................

3,120,000

2,800 3,800 1,100 32,300

(c)

Current liabilities Notes payable ....................................................................................$ 18,000* Accounts payable ............................................................................... 52,000* Revenue in advance ($14,000 $5,000) ........................................... 9,000* Interest payable................................................................................... 49* Health Fund Payable.......................................................................... 2,800* PAYG withheld tax payable ................................................................ 3,800* Superannuation payable .................................................................... 1,100* Salaries and wages payable .............................................................. 32,300* Total current liabilities...............................................................$119,049*

ACCT5001 S1 2010 Week 10 Self-Study Solutions 5.doc10/05/2010

ACCT5001 S1 2010 Week 10 Self-Study Solutions 5.doc10/05/2010

ACCT5001 S1 2010 BUILDING BUSINESS SKILLS 9.5 2011 (a) Jan. 1

Self-Study Solutions GROUP DECISION CASE

Week 10

ACCT5001 S1 2010

Self-Study Solutions

Week 10

ADDITIONAL DEBENTURE (BOND) ISSUE SELF STUDY QUESTIONS

Q. 1

Debentures Payable (net)......................1,144,000 Gain on Debenture Redemption............................ Cash at Bank ......................................................... (To record repurchase of 10% debentures)

a) What is the present value of $10,000 due in 8 periods from now, discounted at 10%? 144,000 1,000,000 $10 000 x 0.467 (see present value of $1 table) = $4 670

Jan.1

Cash at Bank .........................................1,000,000 Debentures Payable .............................................. (To record sale of 10-year, 17.36% debentures at face value)

1,000,000

b) What is the present value of an annuity $10,000 to be paid at the end of each of 6 periods, discounted at 8% ? $10 000 Q.2 Neagle Corporation issued $500,000 9%, 10year Debentures (bonds) on 1 July 2007 for $468 895. This price resulted in an effective interest rate of 10% on the bonds (equivalent to the market rate at the date of issue). Interest is payable semi annually on 1 July and 1 January each year. a) Use present value calculations to show how the issue price was derived [I = 5 n = 20] PV of face value 500 000 22 500 x x .377 12.462 = = 188 500 280 395 468 895 b) Record the issue of the debentures (bonds) 2007 July 1 Dr Cr Cash Debentures payable 468 895 468 895 PV of interest x 4.623 (see present value of an annuity table = $46,230

(b)

Dear Ms Payne, The early redemption of the 10%, 5-year debentures results in recognising an increase in profit of $144,000 that increases current year profit by the after-tax effect of the gain. The amount of the liabilities on the balance sheet will be lowered by the issue of the new debentures and retirement of the 5-year debentures. 1. The annual cash flow of the company as it relates to debentures payable will be adversely affected as follows: Annual interest payments on the new issue ($1,000,000 X 17.36%) Annual interest payments on the 5-year debentures ($1,200,000 X 10%) Additional cash outflows per year 2. $173,600 120,000 $ 53,600

The amount of interest expense shown on the income statement will be higher as a result of the decision to issue new debentures. These comparisons hold for only the 3-year remaining life of the 10%, 5-year debentures. There will of course be a cash saving on the repayment of the principal five years later but the company will be committed to a higher interest rate for five years. The company must contemplate either redemption of the debentures at maturity, 1 January 2014, or refinancing of that issue at that time and consider what interest rates will be in 2014 in evaluating a redemption and issue in 2011.

c) Record the payment of interest on 1 January 2008 1 Jan 2008 Dr Interest expense Cr Bonds payable Cr Cash (interest paid) 23 445 945 22 500

Sincerely, d) Record the accrual of interest on 30 June 2008, (assuming the accounting period ends on June 30) 30 Jun 2008 Dr Interest expense Cr Bonds payable Cr Interest payable Q.3 23 492 992 22 500

ACCT5001 S1 2010 Week 10 Self-Study Solutions 5.doc10/05/2010

ACCT5001 S1 2010 Week 10 Self-Study Solutions 5.doc10/05/2010

ACCT5001 S1 2010

Self-Study Solutions

Week 10

ACCT5001 S1 2010 Q.4

Self-Study Solutions

Week 10

$100 000 9% 20 yr debentures (bonds) were issued on 1 January 2004. Interest is to be paid annually on Dec 31 each year. At the time of issue the market rate on similar securities was 10%. a) Record the issue of the bonds on 01 January 2004 [i=10 n=20] PV of face PV of interest 2004 Jan 1 Dr Cr Cash Debentures (Bonds) payable 91 526 91 526 100 000 x 9 000 x 0.149 8.514 = = 14 900 76 626 91 526

On 1 January 2009 100 000 15 year bonds issued, with a coupon rate of 9% p.a. paid semi-annually. By the time of issue the market rate on similar debt securities had dropped to 8%. a) Record the issue of the bonds 01/01/2009 [i=4 n=30] PV of face PV of interest 2009 Jan 1 Dr Cash Cr Bond payable 108 614 108 614 100 000 4 500 x x .308 17.292 = = 30 800 77 814 108 614

b) Record the interest payment on 31/12/2004 2004 Dec 31 Dr Cr Cr Interest Expense (91 526 x 10%) Debentures (Bonds) Payable Cash (100 000 x 9%) 9 153 153 9 000 Dr c) Record the interest payment on 31/12/2005 2005 Dec 31 Dr Cr Cr Interest expense [(91 526+153) x 10%)] Debentures (Bond) Payable Cash (100 000 x 9%) 9 168 168 9 000 c) Record the interest payment on 31/12/2009 2009 Dec 31 Dr Dr Interest expense (108 614 155) x 4%) d) Show the BS presentation 31/12/2005 Non-Current Liabilities: Debentures (Bonds) payable * (91 526 + 153 + 168) e) Why didn't the bonds sell for $100 000? The market rate on the bonds (MR) > the face rate on the bonds (FR) by the time of issue. The debentures were discounted so that the effective rate of interest was equivalent to the market rate on similar investments and maturity at the date of issue. 91 847* d) Show the BS presentation on 31/12/2009 Non-Current Liabilities: Bonds payable net * (8 614 155 -162) e) Why didn't the bonds sell for $100 000? The market rate on the bonds (MR) < the face rate on the bonds (FR) by the time of issue. The bonds were able to be issued at a premium to make the effective rate of interest equivalent to the market rate on similar investments and maturity at the date of issue. 108 297* Bond Payable Cr Cash (100 000 x 4.5%) 162 4 500 4 338 Cr b) Record the interest payment on 1/07/2009 2009 July 1 Dr Interest expense (108 614 x 4%) Bond payable Cash (100 000 x 4.5%) 155 4 500 4 345

ACCT5001 S1 2010 Week 10 Self-Study Solutions 5.doc10/05/2010

ACCT5001 S1 2010 Week 10 Self-Study Solutions 5.doc10/05/2010

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ACCT5001 S1 2010 BUILDING BUSINESS SKILLS 9.4*

Self-Study Solutions

Week 10

ACCT5001 S1 2010

Self-Study Solutions

Week 10

FINANCIAL ANALYSIS ON THE WEB

(a)

Students should describe any two of the following research services provided by Moodys (source: www.moodys.com):

Moodys Municipal Credit Research Service - providing information for investors in tax exempt securities and for those managing exposures to state and local governments in the U.S. Asia Pacific Weekly - provides market participants with an overview of Moodys activities in the region, each weeks rating activities, regular economic commentary, special publications and upcoming events. Credit Trends - a web based service highlighting the research and analysis of Moody's Economists around the globe who focus specifically on the credit markets and how they are affected by economic changes and global events. Historical Yields Archive - access to Moodys proprietary database of Yield and Spread information on US long-term corporates, US intermediate-term corporates and US Municipal bonds since 1919.

Corporate Finance Research - a global suite of forward-looking research on 4,000 companies, covering 90% of public market debt and 50% of syndicated loans. Financial Institutions Research - debt and deposit ratings, credit opinion, corporate assessments, email alerts and statistics on issuers. Sovereign Credit Research - providing information about the creditworthiness of governments and supranationals. Ratings Interactive - web-based tool that gives the user access to the vast data in Moody's comprehensive ratings database. Market Implied Ratings - allows users to compare Moodys ratings on over 3,000 issuers with ratings implied from market prices. Structured Finance Research - broadcast coverage of ratings and analysis, available by asset class as follows: asset-backed research; mortgage-backed research; and commercial paper research. Performance Data Services - access to the markets richest database of Asset Backed and Residential Mortgage Backed performance data from the 1980s to the present. Default Research - provides a statistical analysis for tracking near- and long-term rating histories, default rates, and recovery rates for corporations, financial institutions, and sovereigns. Company Research - independent insight on over one thousand companies, including assessments of company fundamentals, corporate governance issues, cash flow and industry trends. Commercial Mortgage Metrics - with Torto Wheaton, Moodys provides credit risk metrics with early warning of potential defaulters for commercial mortgage loan portfolios. Moodys Mortgage Metrics - analytic tool to quickly and accurately assess the risks and credit enhancement levels of A and Alt-A residential mortgage loan pools. Enhanced Monitoring Service - is a collection of in-depth reports on individual cash flow CDOs. CDO Research Data Feed - provides information behind the CDO research to facilitate performance monitoring and market comparisons. CDO Edge - a collection of software tools for all levels of CDO analysis. CDOROM - a Monte Carlo simulation model for assessing expected loss on static synthetic CDO tranches. US Public Finance Research - providing ratings coverage and analysis on 90% of public debt issued by state and local governments, hospitals, higher education institutions and other tax-exempt entities.

(b)

Moodys takes the view that most fixed-income market participants are long-term investors and are, therefore, more concerned about the long-terms prospects of a corporation or investment product. Accordingly, Moodys focuses on assessing the ability of an entity to meet its credit obligations over the long term rather than on temporary fluctuations in prices and returns. Moodys long term view is, generally a time horizon of five-to-ten years, set to capture at least one full economic cycle. They focus on the risks specific to each borrowers industry, country and region within the long-term horizon.

ACCT5001 S1 2010 Week 10 Self-Study Solutions 5.doc10/05/2010

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ACCT5001 S1 2010 Week 10 Self-Study Solutions 5.doc10/05/2010

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