Tutorials Amsterdam Business School Accounting P 6011P0148 / PE 6011P0150 Tutorials Amsterdam Business School

Contents CH7: E7.23, P7.26, C7.34 CH8: P8.28, P8.32 Accounting week 46

E7.23   Transaction/ Current Noncurrent Current Noncurrent Stockholders' Net Adjustment Assets Assets Liabilities Liabilities Equity Income a. Income Taxes Deferred Tax Income Tax Payable Liabilities Expense +500 +200 -700 b. Cash Bonds Payable +4,950 +5,000 Discount on Bonds Payable -50 c. Cash Land -3,000 +3,000 d. Inventory Estimated Warranty -64 Liability -64 e. Cash Notes Payable +19,400 +20,000 Notes Payable -600 f. Current Serial Bonds Maturities Payable of Long-term -35,000 Debt + 35,000 Accounting week 46

E7.23 Accounting week 46

E7.23 Accounting week 46

P7.26 a. Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses 1. To record the cash collection of subscription fees received in advance: Cash Unearned +15,000 Subscription Revenue +15,000   2. To record subscription revenue earned from delivering magazines: Unearned Subscription Subscription Revenue Revenue +750 -750 1. Dr. Cash ($75 * 200 subscriptions) ……… 15,000 Cr. Unearned Subscription Revenue ………. 15,000 To record the cash collection of subscription fees received in advance. 2. Dr. Unearned Subscription Revenue 750 Cr. Subscription Revenue ($75 * 120 subscribers * 1/12)… 750 To record subscription revenue earned from delivering magazines. Accounting week 46

P7.26 b. Revenue earned during September ($75 * 120 subscribers * 1/12) $ 750 Revenue earned from October-December ($75 * 200 subscribers * 3/12) 3,750 Total subscription revenue earned during 2014 $4,500 Solution approach: Assuming that the “profile” of lifetime subscribers for Evans Ltd. will be similar to that of current subscribers, an average lifetime membership will last for 40 years. The present value of a lifetime subscription, discounted at 12% for 40 years = ($75 per year revenues foregone * 8.2438) = $618.29   Accounting week 46

C7.34 a. The average-for-the-year interest rate = (7% + 8%) / 2 = 7.5% The average liability balance = ($190,000 + $250,000) / 2 = $220,000   Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses Interest Interest Payable Expense +16,500 -16,500 Dr. Interest Expense ($220,000 * 7.5%) ……… 16,500 Cr. Interest Payable ……… 16,500 To accrue interest on working capital loans for the year. Accounting week 46

C7.34 b. No. The “current maturities of long-term debt” is related to the “serial bonds due in equal annual installments.” The current maturities owed at the end of 2013 would have been paid at some point during 2014 (at the date specified in the serial bond indenture). At the end of 2014, an entry would have been made to reclassify the 2015 installment of the long-term serial bond as a current liability. Thus, the “current maturities” account would have decreased and then increased by equal amounts during the year. Accounting week 46

C7.34 c. The bonds pay a higher than market-rate of interest, so their price will increase. That is, investors are willing to pay more for bonds offering a higher than market interest rate because such an investment will increase their ROI. Since the bonds are a liability to Corless Co. (the issuer), it is likely that the call feature will be exercised so that bonds with a lower interest rate can be issued in the near future. It would not be to the bondholders’ advantage to exercise the conversion feature at this point. Other factors to consider before deciding to call the bonds? 1) cost of the call premium, and 2) cost of registration and issuance of a new bond issue; both factors should be considered relative to the remaining term of the outstanding bonds. Note that interest rate expectations are not terribly relevant because the new bond issue will have a fixed interest rate (at or near 7%), and if interest rates continue to drop, the call feature can be exercised on the new bonds as well. Accounting week 46

C7.34 d. The market value would be more than the book value of $400,000 because the price of the bonds would increase, as described in item c. This is bad news to Corless Co. because it is paying a higher than market interest rate. Why doesn’t the firm adjust the book value of its liability for the change in market value caused by interest rate movements? That is, why not record the unrealized gain or loss each year as a year-end adjusting entry so that the Bonds Payable account will be marked to market? 1) This would violate the historical cost principle--bonds are initially recorded at their market value at the time of issuance, and the initial amount of discount or premium is amortized over the life of the bond issue (much like the depreciation of the historical cost of long-term assets). Accounting for liabilities should be consistent with the accounting for long-term assets. 2) The going concern concept suggests that, in the end, the bonds will be appropriately valued--the book value will be equal to the face amount at the maturity date, and this is the amount of cash the issuer must ultimately pay to satisfy its obligation. So why keep adjusting the “value” of the Bonds Payable liability up and down if the market adjustments are not going to be realized by the firm. This provides a good opportunity to discuss/reinforce alternative valuation approaches for liabilities (and assets) with emphasis on the historical cost/market value debate. Accounting week 46

C7.34 The following adjusting entry was made at year-end to reclassify the 2015 installment of the serial bond as a current liability:   Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses Serial Bonds Payable -80,000 Current Maturities of Long-Term Debt +80,000 Dr. Serial Bonds Payable ……… 80,000 Cr. Current Maturities of Long-Term Debt 80,000 To reclassify the 2015 installment of the serial bond as a current liability. Accounting week 46

P8.28 P8.28. Other Paid-in Retained Treasury Net   Other Paid-in Retained Treasury Net Cash Assets Liabilities Capital Earnings Stock * Income a. +89,250 +89,250 b. +38,130 -38,130 c. +135,000 +135,000 d. -39,200 +39,200 e. +14,250 +250 -14,000 f. +50,220 -50,220 * Note that an increase in treasury stock (for a purchase transaction such as item d) decreases total stockholders’ equity, and a decrease in treasury stock (for a sale transaction such as item e) increases total stockholders’ equity. The effects shown are with respect to the Treasury Stock account, which is a contra stockholders’ equity account. Accounting week 46

a. Dr. Cash ($52.50 * 1,700 shares) 89,250 Cr. Preferred Stock ($50 par * 1,700 shares) 85,000 Cr. Additional Paid-In Capital ($2.50 excess * 1,700 shares) 4,250   b. Dr. Retained Earnings ($4.10 per share * 9,300 shares) 38,130 Cr. Dividends Payable 38,130 c. Dr. Building ($54 per share * 2,500 shares) 135,000 Cr. Preferred Stock ($50 per share * 2,500 shares) 125,000 Cr. Additional Paid-In Capital ($4 excess * 2,500 shares) 10,000 d. Dr. Treasury Stock ($56 per share * 700 shares) 39,200 Cr. Cash 39,200 e. Dr. Cash ($57 per share * 250 shares) 14,250 Cr. Treasury Stock ($56 per share * 250 shares) 14,000 Cr. Additional Paid-In Capital ($1 excess * 250 shares) 250 f. Dr. Retained Earnings ($36 per share * 9,300 issued * 15%) 50,220 Cr. Common Stock ($1 par * 1,395 dividend shares) 1,395 Cr. Additional Paid-In Capital ($35 excess * 1,395 shares) 48,825 Accounting week 46

P8.32 a. Common stock = ($5 par value * 300,000 shares issued) = $1,500,000   b. Price per share = Increase in paid‑in capital / Number of shares issued. Increase in common stock ($1,500,000 - $1,350,000) $ 150,000 Increase in additional paid‑in capital ($12,990,000 - $11,610,000) 1,380,000 Total increase in paid‑in capital $1,530,000 / Number of shares issued in May 30,000 = Price per share of shares sold in May $51 c. Increase in cost of treasury stock ($2,202,000 - $2,074,000) $128,000 / Increase in number of shares of treasury stock (36,000 – 34,000) 2,000 = Cost per share $64 Accounting week 46

Retained earnings, April 30, 2013 $17,320,000 Add: Net income ? Less: Preferred stock dividend (1/2 year * 9% * $120 par * 70,000 share) ……… (378,000) Retained earnings, May 31, 2013 $18,100,000   Solving for the unknown amount, net income = $1,158,000 e. 1. Shares outstanding = (300,000 shares issued - 36,000 treasury shares) = 264,000 Total cash dividend = ($0.30 dividend per share * 264,000 outstanding) = $79,200 2. The June 30, 2013, balance sheet will reflect a reduction in retained earnings and an increase in dividends payable (a current liability) for the same amount. Dividends declared have no effect on the income statement. Accounting week 46

Balance Sheet Income Statement . Retained Earnings - 990,000 f. Number of dividend shares = (5% dividend rate * 300,000 shares issued) = 15,000   Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses Retained Earnings - 990,000 Common Stock + 75,000 Additional Paid-In Capital + 915,000 Dr. Retained Earnings (15,000 shares @ $66 per share) 990,000 Cr. Common Stock (15,000 shares @ $5 per share) 75,000 Cr. Additional Paid‑In Capital (15,000 shares @ $61 per share) 915,000 Accounting week 46

g. 1. New par value will be 1/2 of prior par value = ($5 / 2) = $2.50. The number of authorized shares will double (500,000 * 2 = 1,000,000) to accommodate the new total number of shares issued.   2. The market price will drop to about 1/2 of the pre‑split market price = (1/2 * $66) = $33 3. The number of treasury shares will double = (36,000 * 2) = 72,000 shares h. Total stockholders’ equity will not change from either a stock dividend or a stock split. Accounting week 46