Week 5 (SU 10 Bonds and 11 Leases) Sp24 to present(2)
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e. Bond date
B. coupon
A. Face (maturity) value
f. Issuance date
G. Maturity date
H. Term
C. Pay dates
I.Proceeds
D. Market Int
J.Bond Issuance
CPA Review – FAR – Spring 2024 - Week 5 Handouts (covers SU 10 and 11)
10.1 and 10.3 Types of Bond Liabilities and Bonds Payable – Initial Measurement
A.
Face (maturity) value
B.
Stated (coupon) interest rate
C.
Interest payment dates
D.
Market (yield, effective) interest rate
E.
Bond date
F.
Issuance date
G.
Maturity date
H.
Bond term
I.
Bond proceeds
J.
Bond issuance costs
On January 1, Year 1 the company issued $700,000 of 12% bonds
, dated January 1. Interest is payable semiannually on June 30 and December 31. The bonds mature in three years on December 31, Year 3. The market yield for bonds of similar risk and maturity is 14%
. $700,000 of the issuance was purchased by ABC. The bonds sold for $666,633 and the company incurred $100,000 in costs to issue the bonds.
10.3 Calculate the PV or Price of the bonds:
PV of Annuity Stream of Cash Interest
12%*700K*1/2 = 42,000
4.76654*$42k cash
=$200,195
n= 6 i=
14%* ½ = 7%
PV of Principle
0.66634*700k = 466,438
N = 6 i=
14%* ½ = 7%
Selling price of the Bond or PV of the Bond
$666,633
1.Prepare the Bond Amortization table for the initial $700,000 bond issuance.
MARKET
Selling price of the Bond or PV of the Bond
$666,633 0.06
0.07
DISCOUNT
Dates
Cash
Inter Exp
Change
Carry Value/OS Balance
inception - 1/1/20
-
-
33,367.00
$666,633
6/30/2020
42,000.00
46,664.31
4,664.31
671,297.31
12/31/2020
42,000.00
46,990.81
4,990.81
676,288.12
6/30/2021
42,000.00
47,340.17
5,340.17
681,628.29
12/31/2021
42,000.00
47,713.98
5,713.98
687,342.27
6/30/2022
42,000.00
48,113.96
6,113.96
693,456.23
12/31/2022
42,000.00
48,543.94
6,543.94
700,000.00
<-- GOAL
*never change
700,000.17
(0.17)
Calculate the ENTIRE amortization schedule using the market interest rate on the date of issuance – do not adjust in the future
1
st
Interest payment date
6/30/20
At Dec. 31, 2021, what entry would be recorded?
Interest expense 46,664
Interest expense 47,714
Discount 4,664
Discount 5,714
CASH 42,000
CASH 42,000
1
PV
Principal
PV - OA
interest = n=
% %
US > Market premium
-----------------------------------------------------
US < Market discount
% %
2.The following information pertains to Camp Corp.'s issuance of bonds on July 1, 20X5:
Face amount
$800,000
Ordinary Annuity = On the Border (
eat, then pay)
*Normal for bonds!!
Annuity due = Dairy Queen (Pay, then eat)
*Normal for LEASES!!!
Term
10 years
Stated interest rate
6
%
cash interest
Interest payment dates
Annually on July 1
Yield
9%
market
Factors
At 6%
At 9%
1,000.00 0.42 422.00 60.00 6.42 385.08 807.08
Present value of 1 for 10 periods
0.558
0.422
Future value of 1 for 10 periods
1.791
2.367
Present value of ordinary annuity of 1 for 10 periods
7.360
6.418
What should be the issue price for each $1,000 bond?
A.
$1,000
B.
$864
C.
$807
D.
$700
3. On July 1, 2019, Noble, Inc. issued 9% bonds in the face amount of $10,000,000, which mature on July 1, 2025
. The
bonds were issued for $
9,560,000 to yield 10%, resulting in a bond discount of $440,000. Noble uses the effective-
interest method of amortizing bond discount. Interest is payable annually on June 30. At June 30, 2021, Noble's
unamortized bond discount should be
A
.
$322,400.
B.
$340,000.
C.
$352,000.
D.
$310,000.
What is considered long-term/noncurrent liability? If does not meet the definition of a current liability, it must be
long-term.
Bonds Sold Between Interest Dates
- Buyer pays the issues the amount of interest that has accrued since the last payment date in addition to the purchase price of the bonds
4.1.2021
(Bond date)
7.1.2021
(Bonds sold)
10.1.2021
(Interest date)
Issued
4.On July 1, 2021, Spear Co. issued 4,000 of its 10%, $1,000 bonds at 99 plus accrued interest
. The bonds are dated April
1, 2021 and mature on April 1, 2031. Interest is payable semiannually on April 1 and October 1. What amount did Spear receive from the bond issuance?
a.
$4,060,000
b.
$4,000,000
c.
$3,960,000
d.
$3,860,000
Pay attention:
Look at dates! Year end dates are not always the same as the interest payment dates. All interest rates are expressed at annual rates, so be sure to adjust for the time period.
2
900,000.00
0.09
0.10
DISCOUNT
Dates
Cash
Inter Exp
Change
Carry Value/OS Balance
inception -7/1/19
-
-
440,000.00
$9,560,000
6/30/2020
900,000.00
956,000.00
56,000.00
9,616,000.00
6/30/2021
900,000.00
961,600.00
61,600.00
9,677,600.00
322,400.00
Bond proceeds PLUS Accrued interest
4,000#*$1000 = 4,000,000 * .99 = 3,960,000 discount
Cash interest = 4m *.10 * ½ year = $200,000 for 6 months
Prepaid for (3/6) = 50%
Preaid interest of 200k * 50% = 100k
Cash received 3,960,000+
100,000 accrued interest = 4060000
Dr. Cash 4,060,000
Dr. Discount 40,000
Cr. Int payable 100,000 (or Interest exp)
Cr. Bonds payable 4,000,000
5.On January 1, 2021, Solis Co. issued its 10% bonds in the face amount of $8,000,000, which mature on January 1, 2031.
The bonds were issued for $
9,080,000 to yield 8%,
resulting in bond premium of $1,080,000
. Solis uses the effective-
interest method of amortizing bond premium. Interest is payable annually on December 31. At December 31, 2021, Solis's adjusted unamortized bond premium should be
a.
$1,080,000.
b.
$1,006,400.
c.
$972,000.
d.
$812,000.
SU 10.5 Debt Issuance Costs
Costs to bring debt to market – printing, legal, accounting, underwriters, promotion costs
Balance Sheet: RECORD as a Contra-liability (so they have a debit balance). Not an asset!!!
When present, net against face amount of the debt.
Income Statement:
AMORTIZE using effective interest method into interest expense (unless state use S/L)
6.Determine Proper Amounts in Account Balances.
Presented below are three independent situations.
a.Snider Corporation incurred the following costs in connection with the issuance of bonds
:
(1) printing and engraving costs $40,000; (2) legal fees $120,000, and (3) commissions paid to underwriter $320,000. What amount should be reported as Unamortized Bond Issue Costs, and where should this amount be reported on the balance sheet
?
40,000 +120,000 + 320,000 = $480,000
Contra-liability nets with the bonds payable on the B/S
b.
Banks Co. sold $5,000,000 of 6%, 10-year bonds at 104 on January 1, 2020.
The bonds were dated January 1, 2020, and pay interest on July 1 and January 1
. If Banks uses the straight-line method to amortize bond premium or discount
,
determine the amount of interest expense to be reported on July 1, 2020, and December 31, 2020.
Issuance
Cash (5m*1.04) 5,200,000
Premium 200,000
Bonds Payable 5,000,000
July 1
**Use S/L for interest expense
Interest expense 140,000
plug
Premium* 10,000
Cash 150,000
*200,000/ 20# n = 10,000 amort
December 31
no cash until 1/1
Interest expense 140,000
plug
Premium* 10,000
Int payable 150,000
January 1 (next day)
Interest payable 150,000
Cash 150,000
c.Cey Inc. issued $1,000,000 of 10%, 10-year bonds on June 30, 2020, for $885,296
. This price provided a yield of 12% on the bonds. Interest is payable semiannually on December 31 and June 30. If Cey uses the effective-interest method, determine the amount of interest expense to record if financial statements are issued on October 31, 2020
.
Issue 6.30.2020
pay interest 12.31.2020
Interest exp for 10.31.20
Carrying value $885,296 * 12% * ½ year = 53,118
PROPRaTE – expense for 4 of the 6 months
over 6.00 months 8,852.96 35,411.84 months
Inter expense 35,412
Discount 2,079
Inter payable (1m*
10%*1/2 yr * 4/6) 33,333
3
Issue 1.1.21
premium at 12.31.21
8,000,000.00
MARKET
Selling price of the Bond or PV of the Bond
800,000.00
0.10
0.08
Premium
Dates
Cash
Inter Exp
Change
Carry Value/OS Balance
Inception 1.1.21
-
-
1,080,000.00
$9,080,000
12/31/21/
800,000.00
726,400.00
(73,600.00)
9,006,400.00
1,006,400.00
Can use effective or S/L amortization of discount/ premium – have
to show that it’s
not a material difference
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7.On December 1, 2021, Lester Company issued at
103, eight hundred of its 9%, $1,000 bonds. Attached to each bond was one detachable stock warrant entitling the holder to purchase 10 shares of Lester's common stock. On December 1, 2021, the market value of the bonds, without the stock warrants, was 95, and the market value of each stock purchase warrant was $50. The amount of the proceeds from the issuance that should be accounted for as the initial carrying value of the bonds payable would be
a.
$774,560.
b.
$782,800.
c.
$800,000.
d.
$824,000.
SU 10.6 Extinguishment of Debt
Debt Retirement Principles - Must Know:
Financial statement presentation
Calculation of bond net carrying value
Calculation of gain or loss on extinguishment
PLUG from everything
When bonds are retired at maturity, the final payment extinguishes the liability
GOAL! No I/s Impact!!!
When bonds are retired before maturity, the final payment is compared to net book value and a gain or loss is
recognized
Net book value = face +/– unamortized premium/discount –unamortized bond issue costs [contra-liability acct]
Gains/Losses are recognized in earnings in the period of extinguishment
Can only derecognize
the liability if it (1) pays and is relieved of obligation OR (2) is legally released
8.On January 1, 2021, Goll Corp. issued 3,000 of its 10%, $1,000 bonds for $3,120,000.
These bonds were to mature on January 1, 2031 but were callable at 101 any time after December 31, 2024
. Interest was payable semiannually on July 1
and January 1. On July 1, 2026
, Goll called all of the bonds and retired them. Bond premium was amortized on a straight-line basis. Before income taxes, Goll's gain or loss in 2026 on this early extinguishment of debt was
a.
$90,000 gain.
b.
$36,000 gain.
c.
$30,000 loss.
d.
$24,000 gain.
JE @ issuance
Cash 3,120,000
Premium 120,000
Bonds payable 3,000,000
Premium Amort 120,000 S/L
N=20#
PREMIUM AMORT PER PERIOD = 120K/20 = 6,000
Amortized premium = 6k * 11n# = 66,000
Unamortized premium = 54,000
JE @ Retirement
Bonds payable 3,000,000
Premium 54,000
GAIN (plug) 24,000
Cash (101) 3,030,000
4
**check coverage on 2024 FAR**
1.1.21
12.31.22
12.31.23
12.31.24
12.31.25
12.31.26
# years
Year 1
# I pays
2
2
2
2
2
1 – 7.1.26
Total n’s = 11#
9.A ten-year bond was issued in 2019 at a discount with a call provision to retire the bonds
. When the bond issuer exercised the call provision on an interest date in 2021, the carrying amount of the bond was less than the call price. The
amount of bond liability removed from the accounts in 2021 should have equaled the
a.
call price.
b.
call price less unamortized discount.
c.
face amount less unamortized discount.
d.
face amount plus unamortized discount
SU10.7 Noncurrent Notes Payable – may require no payments, just interest payments or interest + principle payments over time
10.Entries for Zero-Interest-Bearing Note
On December 31, 2020, Payson Company acquired a press from Sugar Corporation by issuing a $400,000 zero-interest-bearing note, payable in full on December 31, 2023
. Payson’s credit rating permits it to borrow funds from its several lines of credit at 8%. The press is expected to have a 6-year life and a $40,000 salvage value. Prepare the journal entry for the purchase on December 31, 2020.
PVF n=3, I = 8 .79383 * 400,000 = 317,532 PV of my NP
Equipment (PV of the NP) 317,532
NP Discount 82,468
Notes payable (gross) 400,000
Date
Cash Payment
Effective Interest
Change in Balance
Outstanding Balance
12/31/2020
- - 82,468.00 317,532.00 - 25,402.56 25,402.56 342,934.56 - 27,434.76 27,434.76 370,369.32 - 29,631.55 29,631.55 400,000.00 <-- goal 400,000.87 12/31/2021
12/31/2022
12/31/2023
Prepare any necessary adjusting entries relative to depreciation (use straight-line) and amortization (use effective-
interest method) on December 31, 2022.
Depr = (317,532 – 40,000 SV)/ 6 year = 46,255
Depr exp 46,255
Interest expe 27,434.76
Accum dep 46,255
Np Discount 27,434.76
5
Issued in 2019 (made up numbers)
Cash 3,000
Discount 1,000
Bonds payable 4,000
Called in 2021….. CV< Call price CV 3,500, < Call 4,000
Bonds payable 4,000
Discount 1,000 Cash 4,000
11.Entries for Zero-Interest-Bearing Note; Payable in Installments
North Sea Drilling Co. purchased machinery on December 31, 2019, paying $100,000 down and agreeing to pay the balance in f
ou
r equal installments of $125,000
payable each December 31. An assumed interest of 6% is implicit in the purchase price. Prepare the journal entries that would be recorded for the purchase and for the payments and interest.
Equipment (PV of NP + $100k down)
533,139
PVOA n= 4, I = 6% 3.46511
125,000* 3.46511 = Discount on NP
66,861
Notes payable
(500,000)
Cash (
$100,000) Date
Cash Payment
Effective Interest
Discount
Change in Principle Balance
Outstanding Balance
12/31/2019
0.06 Reduce NP
Date Cash paym Inter Diff CV inception -
433,138.75 12/31/2020
125,000.00 25,988.33 99,011.68 334,127.08 12/31/2021
125,000.00 20,047.62 104,952.38 229,174.70 12/31/2022
125,000.00 13,750.48 111,249.52 117,925.18 12/31/2023
125,000.00 7,075.51 117,924.49 - 12/31/2020
12/31/2021
12/31/2022
12/31/2023
JE at 12/31/20
JE at 12/31/21
Interest expense 25,988
Interest expense 20,048
NP 125,000
NP 125,000
Discount 25,988
Discount 20,048
Cash 125,000
Cash 125,000
SU 10.8 Troubled Debt Restructurings In a debt restructuring, the creditor grants concessions to the debtor that would not otherwise
be considered.
PV of the consideration paid under the restructured agreement is LESS than the carrying value of the debt (including unpaid inteerst) at the date of restructure. KNOW: accounting for both the creditor and debtor
Creditor
Debtor
Settlement – settlement in full
Records a LOSS – Difference between assets FV received and BV of the receivable (1)Records a GAIN– Difference between BV of debt and FV of consideration
(2) Gain/Loss on non-monetary asset transferred between BV and FV of asset (no +/- with cash transfer)
Modification Type 1
Modification of terms; New cash flows < =BV of debt
Nominal/Minimum CF <= BV of Debt
Decrease CV Debt
Records a GAIN of the difference Nominal/Minimum
CF <= BV of Debt
Decrease CV Debt
No future I expense – all Principle
Modification Type 2
Modification of terms; New cash flows > =BV of debt
Loan impairment
NO gain/loss
Use new interest rate for interest
Expense
6
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12.In a troubled debt restructuring in which the debt is continued with modified terms and the carrying amount of the debt is less than the total future cash flows, the creditor should
a. compute a new effective-interest rate.
b not recognize a loss.
c. calculate its loss using the historical effective rate of the loan.
d. calculate its loss using the current effective rate of the loan.
13.Eddy Co. is indebted to Cole under a $1,000,000, 12%, three-year note dated December 31, 2019. Because of Eddy's financial difficulties developing in 2021, Eddy owed accrued interest of $120,000 on the note at December 31, 2021. Under a troubled debt restructuring, on December 31, 2021, Cole agreed to settle the note and accrued interest for a tract of land having a fair value of $900,000. Eddy's acquisition cost of the land is $725,000. Ignoring income taxes, on its
2021 income statement Eddy should report as a result of the troubled debt restructuring:
Gain on Disposal
Restructuring Gain
a. $395,000
$0
b. $275,000
$0
c. $175,000
$100,000
d. $175,000
$220,000
What Is a Debt Covenant? A “restriction”
A clause in a debt instrument contract included to protect the creditor. It describes the rights and actions of the two
parties if conditions defined in the covenant occur.
SU 10.9 Asset Retirement Obligations (ARO)
ARO – company must recognize an ARO when it has LEGAL obligation associated with the RETIREMENT of a long-lived asset and when it can reasonably estimate the amount of the liability. Record at present value.
Initiation of Asset
– capitalize expected PV of retirement (
dr. Asset, cr. Long term liability @ PV
)
Over time –
depreciate the capital asset, accrete through interest expense the PV of the liability to face value at maturity Maturity – release the Liability when retire the asset (and incur the costs)
14.To record an asset retirement obligation (ARO), the cost associated with the ARO is
a. expensed.
b. included in the carrying amount of the related long-lived asset.
cap @ start, depr over the life MATCHING
c. included in a separate account.
d. capitalized over the asset's useful life.
15.A company buys an oil rig for $5,000,000 on January 1, 2021. The life of the rig is 10 years and the expected cost to
dismantle the rig at the end of 10 years is $1,000,000 (present value at 10% is $385,550)
. 10% is an appropriate interest
rate for this company. What expense should be recorded for 2021 as a result of these events?
a. Depreciation expense of $600,000
b. Depreciation expense of $500,000 and interest expense of $38,555
c. Depreciation expense of $500,000 and interest expense of $100,000
d. Depreciation expense of $538,555 and interest expense of $38,555
7
ARO = Dep exp AND Interest exp
Depr = 5m+385k ARO = 5385k/ 10 = 538,555
Int exp = End of Year 1
385,550*10% = 38,555
16.Oil products Company purchases an oil tanker depot on January 1, 2020 at a cost of $600,000
. Oil Products expects to operate the depot for 10 years, at which time it is legally required to dismantle the depot and remove the underground storage tanks. It is estimated that it will cost $75,000 to dismantle the depot
and remove the tanks at the end of the depot’s useful life
. $75k = cost to remove in 10 years
Liabilitiy, long-term, @PV
Prepare the JE to record the depot and the ARO for the depot on January 1, 2020. Based on an effective interest rate of 6%, the PV of the ARO on January 1, 2020 is $41, 879. PV$1, n=10,i=6%
Depot – Fixed Asset $600,000
Cash 600,000
Depot – ARO – Fixed Asset 41, 879
ARO – Liability 41, 879
Prepare the JE for the depot and the ARO at December 31, 2020. Oil Products uses straight-line depreciation; the estimated salvage value for the depot is zero
. Depot = 600k/ 10 yr = 60,000 per year… ARO –41,879/10 yr = 4,188
Depr exp 60,000
Depr exp 4,188
Total depr exp = 64,188
Accum depr 60,000
Accum Depr 4,188
Interest expense 2,513
41, 879*6% = 2,513
ARO -Liability 2,513
On December 31, 2029, Oil products pays a demolition firm to dismantle the depot and remove the tanks at a price of $80,000. Prepare the entry for the settlement of the ARO.
ARO -Liability 75,000
Loss on ARO 5,000 <- change in estimate
Cash 80,000
8
ARO – Liability @ inception
41, 879
End Yr 1
2,513
…@ end
75,000
(so we can resolve
SU 11 – Leases, Contingencies and Warranties
SU 11.5 – Contingencies
Accrual of Loss Contingency “cannot accrue for a worry” KEY: Must be a result of a PAST event!
LOSS
CONTINGENCY
LOSS CONTINGENCY
$$ AMOUNT OF POTENTIAL LOSS
Likelihood
Known
Reasonable Estimable
Not Reasonable
Estimable
Probable
Accrue & Disclose
Accrue & Disclose
Disclosure Only
Reasonably Possible
Disclose Only
Disclose Only
Disclose Only
Remote
Nothing
Nothing
Nothing
A loss contingency is accrued only if a loss is ____PROBABLE
_______ AND
the amount can be _____RESONABLY______ ______ESTIMATED________________
If there is a range, accrue the LOW the range. We __
NEVER EVER EVER EVER EVER
___ ever accrue for a gain contingency! TAKE THE BAD NOW, WAIT FOR THE GOOD
Presented below are three independent situations. Prepare the Je needed as of December 31, 2020 and what should be reported in the financial statements and accompanying footnotes.
17. As a result of uninsured accidents during the year, personal injury suits for $261,000 and $697,000 have been filed against the company. It is the judgment of Starfish‘s legal counsel that an unfavorable outcome is unlikely in the $261,000 c
ase but that an unfavorable verdict approximating $410,000 will probably result in the $697,000 case
.
Legal loss $410,000
Nothing for the $261k as it is
Legal liability $410,000
“unlikely”
18. Starfish‘s deep sea exploration division consisting of operations in the Marina Trench is uninsurable because of the
special risk of injury to employees and losses due to high pressure. The year 2020 is considered one of the safest (luckiest) in the division’s history because no loss due to injury or casualty was suffered. Having suffered an average of two casualties a year during the rest of the past decade (ranging from $25,000 to $1,000,000), management is certain that next year the company will probably not be so fortunate. No accrual – it does not result from a PAST transaction or event
19.Starfish Corporation owns a subsidiary in a foreign country that has a book value of $21,600,000 and an estimated fair value of $30,890,000.
The foreign government has communicated to Starfish its intention to expropriate the assets and business of all foreign investors. On the basis of settlements other firms have received from this same country, Starfish expects to receive 60% of the fair value of its properties as final settlement
.
Loss on expropriated assets 3,066,000
PROBABLE
accrue & disclose REASONABLY ESTIMATE
Fv 30,890,000 *60% = 18,534,000
Bv 21,600,000 == DIFF 3,066,000
Accued liability 3,066,000
**All situations – when a loss is KNOWN, we accrue it!
9
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SU 11.6 Warranties – a special type of Contingency **this is the perspective of the ISSUER!!**
Assurance Type Warranty Included – 3 year/ 36k miles warranty
Service –Type Warranty
EXTENDED
**Separate performance obligation for revenue
recognition
Defined
Specified in contract – record a liability when record the sale of the product
Extended Warranty – added service beyond assurance, record separately as unearned revenue and recognize revenue on a systematic basis (S/L) over the time period
How record?
Matching of Rev & Exp – record warranty liability when sold
Dr. Exp/ Cr. Liability
Separately as unearned revenue when sold
Dr Cash/ Cr. Unearned Rev
Impact on I/S?
Expense 100% of the expected expense when sold (in the same period)
Recognize revenue on S/L basis over time
***EXPENSE THE COST TO SERVICE AS INCURRED Dr. Exp/ Cr. Cash
20. Floating Company sells hot tubs at an average price of $2,100
and also offers to each customer a separate 5-year
warranty contract for $215 that requires the company to perform periodic services and to replace defective parts.
During 2020, the company sold 625 hot tubs and 460 warranty contracts for cash
. It estimates the 5-year warranty
costs as $45 for parts and $90 for labor and accounts for warranties separately
. Assume sales occurred on December
31, 2020, and straight-line recognition of warranty revenues occurs. **THIS IS A SERVICE TYPE WARRANTY/EXTENDED
WARRANTY
(a) Record any necessary journal entries in 2020.
Cash 1,411,400
625#*$2100 = 460#*$215 = Sales Revenue 1,312,500
Unearned Rev (Warranty) 98,900
(b) In 2021, Floating incurred actual costs relative to 2020 hot tub warranty sales of $4,100 for parts and $6,800 for
labor
. Record any necessary journal entries in 2021 relative to 2020 hot tub warranties.
Unearned Rev (Warranty) 19,780
625.00 2,100.00 1,312,500.00 460.00 215.00 98,900.00 5.00 years 19,780.00 1,411,400.00 Warranty revenue 19,780
Warranty expense 10,900
Gross Profit in 2021? Related to the Service Type warr
Revneue 19,780
Exp (
10,900)
Gross profit 8,880
Inventory 4,100
Salaries payable 6,800
21.Ivanhoe provides extended service contracts
on electronic equipment sold through major retailers. The standard contract is for four years
. During the current year, Ivanhoe provided 41,900 such warranty contracts at an average price
of $164 each
. The company spent $804,000 servicing the contracts during the current year and expects to spend $4,260,000 more in the future. What is the net profit that the company will recognize in the current year related to these contracts?
a.
$6,067,600
b.
$913,900
c.
$804,000
d.
$1,830,000
10
Separate performance obligation
net profit
Revenue 41,900 # * $164 = 6,871,600
21.00
41,900.00
164.00
6,871,600.00
4.00
years
1,717,900.00
Rev per ye
$804,000
expense
913,900.00
gp
SU 11.1 – Lease Classification **FAR 2024
only responsible for the LESSEE PERSPECTIVE!**
A lease Conveys the use of an asset from one to another WITHOUT transferring of ownership. Substance over form
A lease is a __
legal
____ agreement between a __
lessor
____ and a ___
lessee
_____, that gives the _
lessee
__ the RIGHT OF USE
of specific property (PP&E) owned by the _
lessor
___, for a specified period of _
time
__. Focus is on substance over form.
Finance Lease Criteria (
O
nly B
uy T
he M
inimum A
lways on C
redit when between ages 75 - 90
)
(First 5 apply to LESSEE and LESSOR)
O
wnership transfers to lessee at end of lease term OR
Purchase Option Test (
B
argain)
OR
T
erm >= 75% of expected economic life
OR
PV M
inimum lease payments >= 90% of FV of asset
OR
A
lternative Use Test – specialized that there are no alternative uses after
AND for LESSOR to be able to count as Finance Lease –(Either Sales Type/Direct Financing) NEEDS
C
ollectability of lease payments reasonably predictable
If it is not probable, do not recognize selling profit – recognize as deposit liability!
Lessor only – Direct Financing – lease includes a 3
rd
party guaranteed residual value
11
LESSEE
LESSOR
Lease Term –
noncancelable period
. INCLUDE periods to extend the lease if the
(1)
lessee is reasonable certain to exercise that option OR
(2)
the option is controlled by the lessor
What discount rate to use?
(1)Use the implicit rate
in the lease which is the
r
ate on the lease commence date that causes FV of leased asset to equal PV of payments [if known to lessee]
**or***
(2)Lessee’s incremental borrowing rate
Lease payments include
– rental payments (minus incentives), plus purchase option plus penalties for terminating
FASB ASC 842 mandates that all companies will have to report both assets and related liabilities for practically all lease arrangements.
LESSEE
Defined
Record @ Inception
Ongoing Activity
Finance Lease
Lease transfers control (or ownership) of the underlying asset to a lessee.
@ Inception of lease
Dr. Right of Use Asset
Cr. Lease Liability
*both at PV of Min Lease Pymnts –
cannot be > FV
@ fiscal year end
Dr. Amort Exp (Rof U Asset)
Cr. Right of Use Asset
(Amortize over the shorter of the lease term or the useful life of the asset)
Dr. Interest Exp (on lease liability)
Cr. Lease Liability
When make cash payment
Dr. Lease Liability
Cr. Cash
Operating Lease
Obtains right to use asset, but not ownership
@ Inception of lease
Dr. Right of Use Asset
Cr. Lease Liability
*both at PV of Min Lease Pymnts –
cannot be > FV
@ fiscal year end
Dr. Lease Expense
COMPROMISE!!!!!
Cr. Lease Liability (Int on lease)
Cr. ROU Asset
(only line on I/S, equal to cash lease payments, same amount every period)
When make cash payment
Dr. Lease Liability
Cr.Cash
Short-term
Lease
ENOUGH!
A lease that at commencement date has a lease term of 12 months OR LESS.
@ Inception of lease
Not carried on the Balance Sheet
When make cash payment
Dr. Lease Expense (expense as incurred)
Cr. Cash
Right of Use Asset
=
Lease Liability
+ Initial direct costs incurred by the lessee
Lease Liability
=
PV of Lease Payments
=
PV of Rent Payments OR
PV of Rent Payments
+ PV of probably owned for RV guaranteed by lessee
+ PV of the exercise price of a purchase option
+ PV of nonrenewal penalty
12
Operating Lease Lease Expense
ALWAYS THE
SAME
=
Undiscounted lease payments over term (includes initial direct costs) / years
OR
Interest expense
on lease liability
+ Amortization on ROU Asset [plug]
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Lessee’s amortization of the ROU Asset
Amortization of the ROU Asset is based on how it qualifies as a Finance lease
Amortize over the shorter of its useful life or the lease term
Ownership transfer
Useful life of leased asset
Bargain purchase
Useful life of leased asset
Term > 75
Shorter of ROU asset’s useful life or lease term
Min PV > 90
Shorter of ROU asset’s useful life or lease term
Alternatives NOT
Shorter of ROU asset’s useful life or lease term
Operating Lease
Difference between single periodic lease expense and the interest expense l the lease liability recognized
[plug]
Inception 12.31 12.31 12.31 12.31 12.31 12.31 12.31 12.31 12.31 12.31
22.
Overview Example: Lease requires ten payments of $50,000
at the beginning of each year, implicit discount rate is 6%,
PV of remaining lease payment is $340,000
(after 1
st
payment for 1
st
year)
LESSEE JES
If Operating Lease -L
essee does NOT effectively obtain control of the asset
If Finance Lease - Lessee effectively obtains control of asset Inception
RofU Asset 390,000
RofU Asset 390,000
Lease liability 340,000
Lease liability 340,000
Cash 50,000
Cash 50,000
Expense at @ End of Year 1
Lease expense 50,000
Interest expense* 20,400
Lease liability* 20,400 Amort expense** 39,000 RofU Asset [PLUG!] 29,600 Lease liability* 20,400
*Inter exp 340k*6% = 20,400
Pay it!!
Lease liability 50,000
Cash 50,000 RofU Asset ** 39,000 **390k/10 yr = 39,000 23.In an operating lease, the lessee records
a.
amortization expense.
b.
interest expense.
c.
lease expense.
d.
amortization expense and lease expense.
24.On December 31, 2018, Burton, Inc. leased machinery with a fair value of $
1,575,000 from Cey Rentals Co
. The agreement is a six-year noncancelable lease requiring annual payments of $300,000 beginning December 31, 2018. The lease is appropriately accounted for by Burton as a finance lease. Burton’s incremental borrowing rate is 11%. Burton knows the interest rate implicit in the lease payments is 10%.
The present value of an annuity due of 1 for 6 years at 10% is 4.7908.
The present value of an annuity due of 1 for 6 years at 11% is 4.6959.
In its December 31, 2018 balance sheet, Burton should report a lease liability of
a.
$1,137,240.
b.
$1,275,000.
c.
$1,408,770.
d.
$1,437,240.
13
24.00
6.00
years
300,000.00
annual
FINANCE lease
1.00
@ incepti
interest
0.10
2.00
PVAD
4.79
3.00
includes 1st
1,437,240.00
4.00
300,000.00
5.00
1,137,240.00
6.00
25.On January 1, 2026, Lessor and Lessee sign a three year non-cancelable
lease of equipment.
1.
Equipment has an estimated economic life of three years. 3yr/3 yr = 100% > 75% FINANCE LEASE
2.
The three lease payments are $34,972.07, each payable on January 1, 2026, 2027 and 2028.
3.
The fair value of the asset at the lease commencement is $100,000.
4.
Lease does not contain a renewal or purchase option and asset returns to lessor at end of the lease.
5.
Asset’s residual value is $0 and there is no guaranteed residual value.
6.
Lessee’s incremental borrowing rate is 5% and uses straight line method for depreciation.
7.
Lessor’s implicit interest rate is 5% and is known by the lessee.
8.
Initial direct costs of $800 for legal fees related the execution of the less were paid on January 1, 2026 and the lessor the lessor paid a lease incentive to the lessee of $1,200 on the same date.
1.Determine the proper lease classification on January 1, 2026. (PVAD n=3, i=5%.. 2.85941) from the lessee’s perspective.
O B T75 M90 A C 3yr/3 yr = 100% > 75% FINANCE LEASE
2.Calculate the lease liability and right of use asset.
Lease liability
Right of use asset
3.Preare the lease liability amortization
schedule and Journal entries for years 1, 2 and 3
Lease payment
Interest on liability
Lease Liability
Net Lease Liability
Jan 1, 2026-inception
Jan 1, 2026
Jan 1, 2027
Jan 1, 2028
January 1, 2026
inception @ 1s payment
January 1, 2027
2
nd
payment
Right of Use Asset 99,600
Lease liability 34,972
Cash (1200 in, 800 out) 400
34,972
Lease liability 100,000
Lease liability 34,972
Cash 34,972
December 31, 2026
accrue
December 31, 2027
accrue
Interest expense 3,251
Interest expense 1,665
Amortization exp* 33,200
Amortization exp* 33,200
Lease liability 3,251
Lease liability 1,665
Right of Use Asset 33,200
* 99,600/ 3 years = 33,200
Right of Use Asset 33,200
* 99,600/ 3 years = 33,200
14
25.00
Lease liab
RofU Asset
pay
34,972.07
800.00
Legal fees
# pay
3.00
*1st pay is on inception
1,200.00
Lease incentive TO U
interest
0.05
99,999.49
PV Lease
PVAD
2.859410
800.00
PV of Leas
99,999.49
(1,200.00)
99,599.49
RofU Asset
0.05
Date
Cash
Eff inter
Change
Carry Value
@ inception
100,000.00
@ incepti
34,972.07
-
34,972.07
65,027.93
1.1.24
34,972.07
3,251.40
31,720.67
33,307.26
1.1.25
34,972.07
1,665.36
33,306.71
0.55
<-- goal
26.On January 2, 2018, Hernandez, Inc. signed a ten-year noncancelable lease for a heavy duty drill press. The lease stipulated annual payments of $300,000 starting at the beginning of the first year, with title passing to Hernandez at the expiration of the lease. Hernandez treated this transaction as a finance lease. The drill press has an estimated useful life of 15 years, with no salvage value. Hernandez uses straight-line amortization for all of its plant assets. Aggregate lease payments were determined to have a present value of $1,800,000, based on implicit interest of 10%.
In its 2018 income statement, what amount of amortization expense
should Hernandez report from this lease transaction?
a.
$300,000
b.
$240,000
c.
$180,000
d.
$120,000
On January 1, 2018, Yancey, Inc. signs a 10-year noncancelable lease agreement to lease a storage building from Holt Warehouse Company. Collectability of lease payments is reasonably predictable and no important uncertainties surround the amount of costs yet to be incurred by the lessor. The following information pertains to this lease agreement.
(a)
The agreement requires equal rental payments at the beginning each year.
(b)
The fair value of the building on January 1, 2018 is $6,000,000; however, the book value to Holt is $4,950,000.
(c)
The building has an estimated economic life of 10 years, with no residual value. Yancey depreciates similar buildings using the straight-line method.
(d)
At the termination of the lease, the title to the building will be transferred to the lessee.
(e)
Yancey’s incremental borrowing rate is 11% per year. Holt Warehouse Co. set the annual rental to insure a 10% r
ate of return. The implicit rate of the lessor is known by Yancey, Inc.
(f)
The yearly rental payment includes $15,000 of executory costs related to taxes on the property.
The present value of an annuity due of 1 for 10 years at 10% is 6.75902
The present value of an annuity due of 1 for 10 years at 11% is 6.53705
27.What is the annual lease payment excluding executory costs? (Rounded to the nearest dollar.)
a.
$272,703
b.
$872,703
c.
$887,703
d.
$902,703
28.What is the total annual lease payment?
a.
$272,703
b.
$872,703
c.
$887,703
d.
$902,703
29.From the lessee’s viewpoint, what type of lease in this?
a.
Sales-type lease
b.
Sale-leaseback
c.
Finance lease
d.
Operating lease
15
Finance lease
26.00
10.00
year
300,000.00
payments
15.00
estimated life
1,800,000.00
PV
120,000.00
annual amort
27.00
10.00
years
o
6,000,000.00
FV
b
10.00
est life
t 75
1.00
0.10
INTEREST
m 90
15,000.00
EXECUTORY
a
6.759020
PVAD factor
887,702.66
Annual pays
6,000,000.00
PV MLP = Fvof the asset
902,702.66
w/executory
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30. Crane Inc. leased a new crane to Blue Construction under a 5-year, non-cancelable contract starting January 1, 2025. Terms of the lease require payments of $49,500 each January 1, starting January 1, 2025. The crane has an estimated life
of 7 years, a fair value of $240,000, and a cost to Crane of $240,000. The estimated fair value of the crane is expected to be $40,000 (unguaranteed) at the end of the lease term. No bargain purchase or renewal options are included in the contract, and it is not a specialized asset. Both Crane and Blue adjust and close books annually at December 31. Collectibility of the lease payments is probable. Blue’s incremental borrowing rate is 9%, and Crane’s implicit interest rate of 9% is known to Blue. Factors
At 9%
Present value of 1 for 5 periods
0.64993
Present value of ordinary annuity
of 1 for 5 periods
4.23972
Identify the type of lease involved. __
operating
________ Amort schedule for Rent Payment
InterestLease Liability
Net Lease Liability
Amort schedule for Rent Payment
Interest
Lease Liability Net Lease Liability
1/1/25
1/1/25
12/31/25
12/31/26
12/31/27
12/31/28
Amort schedule for S/L Rent expense
Interest
Amort of RouA Carry Value RouA
1/1/25
12/31/25
12/31/26
12/31/27
12/31/28
12/31/29
Lessee’s Entries --Date
Account
Debit/ (Credit)
1/1/25
Right of Use Asset
209,866
Lease liability
(209,866)
Lease liability
49,500
CASH
(49,500)
12/31/25
Lease expense
49,500
Right of Use Asset
(35,067)
Lease liability
(14,433)
16
Alt Corporation enters into an agreement with Yates Rentals Co. on January 1, 2018 for the purpose of leasing a machine
to be used in its manufacturing operations. The following data pertain to the agreement:
(a)
The term of the noncancelable lease is 3 years with no renewal option. Payments of $574,864 are due on January 1 of each year.
(b)
The fair value of the machine on January 1, 2018, is $1,600,000. The machine has a remaining economic life of 10 years, with no salvage value. The machine reverts to the lessor upon the termination of the lease.
(c)
Alt depreciates all machinery it owns on a straight-line basis.
(d)
Alt’s incremental borrowing rate is 10% per year. Alt does not have knowledge of the 8% implicit rate used by Yates.
The present value of an annuity due of 1 for 3 years at 8% is 2.78326
The present value of an annuity due of 1 for 3 years at 10% is 2.73554
31.What type of lease is this from Alt Corporation’s viewpoint?
a.
Operating lease
b.
Finance lease
c.
Sales-type lease
d.
Direct-financing lease
32.If Alt accounts for the lease as an operating lease,
what expenses will be recorded as a consequence of the lease during the fiscal year ended December 31, 2018?
a.
Amortization Expense
b.
Lease Expense
c.
Interest Expense
d.
Amortization Expense and Interest Expense
33.If the present value of the future lease payments is $1,600,000 at January 1, 2018, what is the amount of the reduction in the lease liability for Alt Corp. in the second full year of the lease if Alt Corp. accounts for the lease as a finance lease? a.
$414,852
b.
$446,852
c.
$472,350
d.
$456,350
17
Lessee
Amortize over the shorter of the lease term or the useful life of the asset
Variable lease payments – payments that change over time of the lease – if we know it then we include PV in the Lease Liability. If it is unknown then expense as incur
ed
Amortize RofUse Asset over the shorter of the lease term or the useful life of the asset
Direct Costs (
incremental costs of a lease that would not have been incurred had the lease not been executed)
18
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- Subject: acountingarrow_forward[The following information applies to the questions displayed below.] Hillside issues $4,000,000 of 6%, 15-year bonds dated January 1, 2021, that pay interest semiannually on June 30 and December 31. The bonds are issued at a price of $3,456,448. Required: 1. Prepare the January 1 journal entry to record the bonds' issuance. 2(a) For each semiannual period, complete the table below to calculate the cash payment. 2(b) For each semiannual period, complete the table below to calculate the straight-line discount amortization. 2(c) For each semiannual period, complete the table below to calculate the bond interest expense. 3. Complete the below table to calculate the total bond interest expense to be recognized over the bonds' life. 4. Prepare the first two years of a straight-line amortization table. 5. Prepare the journal entries to record the first two interest payments. Complete this question by entering your answers in the tabs below. Req 1 Req 2A to 2C Req 3 Req 4 Req 5 For each…arrow_forwardThe redemption of bonds at maturity, assuming interest for the latinterest period has Problem 1 bond discount. Prepare the journal entries to record these events: The issuance of the bonds on January 1, 2021 2. The accrual of interest and the discount amortization on December 31, 2021. 3. The payment of interest on January 1, 2022 4. been paid and recorded.arrow_forward
- (b) Prepare a bond amortization schedule up to and including January 1, 2028, using the effective-interest method. (Round present value factor to 5 decimal places, e.g. 1.24356 and final answers to 0 decimal places, e.g. 38,548.) Date 1/1/24 1/1/25 1/1/26 1/1/27 1/1/28 $ Cash Paid $ Interest Expense $ Premium Amortization GA Carrying Value of Bondsarrow_forwardAssume bonds payable are amortized using the straight-line amortization method unless stated otherwise. Pricing bonds Bond prices depend on the market rate of interest, stated rate of interest and time. Requirements Compute the price of the following 8% bonds of Country Telecom. a. $100,000 issued at 75.25 $100,000 issued at 94.50 b. $100,000 issued at 103 50 c. $100,000 issued at 94.50 d. $100,000 issued at 103.25 2. Which bond will Country Telecom have to pay the most to retire at maturity? Explain your answer.arrow_forwardTerms related to long-term debt. Place the letter of the best matching phrase before each word. 1. Indenture 6. Times Interest Earned Ratio Refunding Bonds Issued at Par 2. 7. Mortgage 3. 8. Premium on Bonds Carrying Value Nominal Rate 4. 9. Reacquisition Price 5. 10. Market Rate Requires that bond discount be reported in the balance sheet as a direct deduction from the face of the bond. b. a. Rate set by party issuing the bonds which appears on the bond instrument. The interest paid each period is the effective interest at date of issuance. d. C. Rate of interest actually earned by the bondholders. Results when bonds are sold below par. f. e. Results when bonds are sold above par. The replacement of an existing bond issuance with a new one. g. h. Price paid by issuing corporation for its own bonds. Book value of bonds at any given date. Ratio of current assets to current liabilities. i. k. The bond contract or agreement. 1. Indicates the company's ability to meet interest payments as…arrow_forward
- 3. Prepare the journal entries to record the issuance of the bonds by Sanyal and Barnwell’s investment on February 1, 2024. 4. Prepare the journal entries by both firms to record all events related to the bonds through January 31, 2026. Note: Use tables, Excel, or a financial calculator. (FV of $1, PV of $1, FVA of $1, PVA of $1, FVAD of $1 and PVAD of $1)arrow_forwardRecording Bond Entries and Preparing an Amortization Schedule—Effective Interest Method, Premium Mitchell Inc. issued 198, 6%, $1,000 bonds on January 1, 2020. The bonds pay cash interest semiannually each June 30, and December 31, and were issued to yield 5%. The bonds mature December 31, 2024, and the company uses the effective interest method to amortize bond discounts or premiums. Required a. Determine the selling price of the bonds. Round amount to the nearest whole dollar. b. Prepare an amortization schedule for the full bond term. c. Prepare journal entries on the following dates. 1. January 1, 2020, bond issuance. 2. June 30, 2020, interest payment. 3. December 31, 2020, interest payment.arrow_forwardDevin Company computes the following bond interest amortization table for bonds issued on January 1, 2021. Use the information on this table to answer the questions below. Interest Cash Payment Payment Interest Decrease in Вook Date Amount Discount Value Expense $441,068 $444,310 $447,683 $451,190 $454,838 $458,631 $462,577 $466,680 $470,947 $475,385 Discount $360,000 $360,000 $360,000 $360,000 $360,000 $360,000 $360,000 $360,000 $360,000 $360,000 $81,068 $84,310 $87,683 $91,190 $94,838 $98,631 $102,577 $106,680 $110,947 $115,385 $892,240 $807,929 $720,247 $629,056 $534,219 $435,587 $333,011 $226,331 $115,385 $0 $11,107,760 $11,192,071 $11,279,753 $11,370,944 $11,465,781 $11,564,413 $11,666,989 $11,773,669 $11,884,615 $12,000,000 June 30, 2021 Dec 31, 2021 June 30, 2022 Dec 31, 2022 June 30, 2023 Dec 31, 2023 June 30, 2024 Dec 31, 2024 June 30, 2025 Dec 31, 2025arrow_forward
- When the interest payment dates of a bond are May 1 and November 1,and a bond issue is sold on June 1, the amount of cash received by theissuer will be: a. increased by accrued interest from June 1 to November 1b. increased by accrued interest from May 1 to June 1c. decreased by accrued interest from June 1 to November 1d. decreased by accrued interest from May 1 to June 1arrow_forwardFollowing information is available for a bond issued on January 1, 2021: Period Beginning Balance Accrued Interest Amortization Payment Amortized cost 31/12/2021 996,843 41,238 248,762 290,000 748,081 31/12/2022 748,081 30,947 249,053 280,000 499,028 31/12/2023 499,028 20,644 249,356 270,000 249,672 31/12/2024 249,672 10,328 249,672 260,000 - It is also known that at time bond was issued, market rate was 5% per annum.1.- Determine commission (as a % of the market price) paid by investor.2.- Determine percentage decrease in investor's rate of return as a result of commission.3.- Perform accounting entries as of December 31, 2023.4.- Make corresponding accounting entries as of 12/1/2024 if issuer indicates that it will be able to pay ONLY 60% of remaining cash flows and there was also an estimated IMPAIRMENT of $12,115. 5.- Make accounting entries at December 31, 2024 if investor receives $156,000.arrow_forwardSheridan Inc. is building a new hockey arena at a cost of $2,150,000. It received a down payment of $430,000 from local businesses to support the project, and now needs to borrow $1,720,000 to complete the project. It therefore decides to issue $1,720,000 of 10- year, 10.5% bonds. These bonds were issued on January 1, 2023, and pay interest annually on each January 1. The bonds yield 10.5% to the investor and have an effective interest rate to the issuer of 10.40530%. (There is an increased effective interest rate due to the capitalization of the bond issue costs.) Any additional funds that are needed to complete the project will be obtained from local businesses. Sheridan paid and capitalized $43,000 in bond issuance costs related to the bond issue. Sheridan prepares financial statements in accordance with IFRS.arrow_forward
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