Chapter 10 Solution of Fundamental of Financial Accouting by EDMONDS (4th Edition)

ANSWERS TO QUESTIONS - CHAPTER 10
1. Short-term notes mature within one year or one

operating cycle, whichever is longer. Long-term notes
payable are used to satisfy financing periods that range
from two to five years; i.e., notes that do not mature
within one year or one operating cycle, whichever is
longer, are classified as long-term.
2.
Principal Payment Interest Reducti
on
Period Bal. 1/1 12/31 Exp. 8% of Prin.
1 $ 72,000 $16,246 $5,760 $10,486
2 61,514 16,246 4,921 11,325
3 50,189
Interest expense in year 1 and 2 is $5,760 and $4,921,

respectively. The principal balance at the end of year 2 is
$50,189.
3. A line of credit is a preapproved amount of credit that is

available to a business to use as needed. It eliminates
the need to get loan approval each time the company
needs some additional cash. When using a line of credit,
money can be borrowed one day and paid back the next
or used for some prespecified period. A line of credit is
generally used for short-term financing where it is not
practical to issue bonds.
4. A business may need to borrow funds for a short period

of time or a longer period. Most short-term financing is
in the form of loans from financial institutions. However,
when a business needs large sums of money, one
financial institution may not be able to meet the needs of
the business. A company can obtain long-term
permanent financing through the issuance of bonds.
5. One of the primary advantages of bond financing is that

the company can usually obtain larger amounts of money
over a longer term. By going directly to the public, the
10-1
company may also be able to obtain lower financing
costs.
6. One of the primary disadvantages of a bond issue is the

restrictions that may be placed on management. These
restrictions are called debt covenants and may restrict
some actions of management, e.g., there may be a
restriction on the amount of dividends that can be paid.
7. One reason that a company may be able to borrow money

more cheaply if bonds are issued rather than borrowing
the money from a financial institution is the way financial
institutions make their money. Banks receive money
from customers through investments in checking or
savings accounts for which the bank must pay these
customers interest. The bank then uses these funds to
make loans to other customers. The difference in the
amount paid to depositors and the amount received from
loan customers is called a spread. The spread is the
amount the bank uses to pay operating expenses and
then to make a profit. Bonds are sold directly to the
public, thereby avoiding the spread. However, the risk to
the bondholder is greater, so the interest rate that must
be paid is generally higher than for savings accounts.
8. Tax rules seem to encourage borrowing (debt financing)

over stockholder financing (equity financing) because
interest paid on debt is deductible for tax purposes.
Dividends paid to stockholders are not tax deductible.
The fact that interest is deductible reduces the cost of
borrowing by reducing the amount of tax that will be
paid. However, this scenario is only applicable if the
business is a for-profit business and has taxable income.
9. Financial leverage is the concept of acquiring additional

funds through debt, then using these funds to invest in
projects that yield a rate of return higher than the cost of
the debt. Financial leverage is using debt to increase the
earnings of a business.
10-2
10. The secured bond will usually have the lower interest
rate because the bondholder has less risk when the debt
is backed by some real asset. The unsecured bond is
issued based on the general credit of the company and is
not secured by any particular company asset.
11. Restrictive covenants are limitations placed on a

company that will help to reduce a bondholder's risk of
default. Common covenants include restrictions on
additional borrowing, payment of dividends to owners,
and salaries of key employees.
12. Bearer bonds are unregistered bonds and payment is
made to any individual who redeems the coupons or
bond. No record is kept of the purchaser; this makes
these bonds more susceptible to theft.
13. Term bonds mature on a specific date in the future. For

example, a $1,000,000, 10-year term bond issued on Jan.
1, 1996 would mature Jan. 1, 2006.
Serial bonds mature at specified intervals over the life of

the entire issue. For example, a $1,000,000 serial bond
issued may mature at $100,000 each year over 10 years.
14. A sinking fund is a fund into which a company makes

annual or periodic payments to assure the availability of
cash for the payment of the principal amount at the
maturity date of the bond.
15. Callable bonds allow the company to pay off the debt prior
to the maturity date at a specified amount called the call
price. The call price is usually higher than the face value of
the bond. This call premium provides some protection to
bondholders when the interest rate falls and the company
pays off the bond earlier than the maturity date.
16. The issuance of $100,000, 5%, 10-year bonds at face will

result in an increase to assets (cash + $100,000) and
liabilities on the balance sheet. The income statement is
not affected by the issuance of the bonds. The cash
10-3
flows statement will show $100,000 cash inflows from
financing activities.
Annual interest expense and interest payments will be

$5,000 ($100,000 x 5%). Interest expense will reduce net
income on the income statement. The interest payment
is a cash outflow from operating activities on the
statement of cash flows.
17. Bonds can be issued at a premium or discount (an

amount above or below the face amount of the bond) to
equate the stated interest rate with the market interest
rate. The difference in cash proceeds from face value
causes the “effective” interest rate to approximately
equal the market rate.
18. When the effective interest rate is higher than the stated
interest rate the bond will sell at a discount. The amount
of the discount combined with the stated rate of interest
will equal the effective interest rate or market interest
rate.
19. The issuance of bonds by a company is an asset source

transaction. Assets increase and liabilities increase.
20. The passage of time is usually the cause of the effective

interest rate and the stated interest rate being different.
When bonds are issued, the interest rate is set, usually at
the market rate at that time. However, as time passes,
the market rate of interest will continue to change.
Bonds will sell at a discount or premium to equate the
two interest rates and attract buyers for the bonds.
21. The cash received for the bond will be $975 (1,000 x
.975).
22. The carrying value of a bond is the face value of the bond
less any unamortized discount or plus any unamortized
premium.
10-4
23. The carrying value of the bonds is $19,800 ($25,000 face
minus $5,200 discount).
The total liability to be paid at maturity is $25,000. That

amount represents the $19,800 cash received plus
$5,200 of discount (interest) subtracted at issue.
24. When the effective interest rate is higher than the stated
interest rate, interest expense will be larger than the
amount of interest paid. Interest paid is equal to the
face value of the note times the stated interest rate.
Interest expense is the amount of the interest paid plus
the amortization of bond discount.
25. The issuer of a bond would prefer to pay interest annually

rather than semiannually because of the timing of the cash
outflow. Interest paid annually is paid only once a year, at
the end of the year. Semiannual interest payments require
part of the cash outflow to occur every six months. While
the amount of interest paid is the same, paying interest
semiannually transfers control of the funds (i.e., use of the
funds) to the bondholder earlier in the period. This
precludes the bond issuer from using that cash in
operations.
26. The $2,850 loss, if material, is shown as an extraordinary

item, below operating income on the income statement.
27. Debt financing has a tax advantage over equity financing

because interest payments are tax deductible while
dividend payments are not.
28. The after-tax cost of the debt is $7,000, computed as

follows:
Interest Expense $10,000

Reduction in Taxes ($10,000 x 30%) (3,000)
After-Tax Cost $ 7,000
Note: A $10,000 dividend paid to stockholders is not

deductible in calculating taxable income and, therefore,
10-5
would not reduce the income tax liability as interest
does.
29. Debt financing increases the risk factor of a business.

This risk arises due to the definite liability to pay interest
on the debt and repay the principal at maturity. There is
no legal obligation to pay dividends to stockholders or to
return their investment at a specific future date. A
business should use a balance of debt and equity
financing to effectively increase earnings while managing
financial risk.
30. The times-interest-earned ratio (EBIT/Interest Expense)

assesses the ability of a company to pay its interest
expense and is a measure of financial risk from the use of
leverage. Higher times-interest-earned ratios suggest
lower levels of risk.
APPENDIX
31. Simple Interest is interest on the principal only and is

calculated as: Principal x Rate x Time.
Compound interest means that interest earned is

reinvested and interest in future periods is computed on
both principal and prior interest earned. This
compounding allows the investor to earn more over the
same time period than simple interest.
32. The future value of an investment is the amount that an

investment made today will grow to at some specific
future date and specific rate of compound interest.
The future value of an investment can be calculated by

multiplying the investment by a future value conversion
factor. Conversion factors are available in mathematical
tables for most common interest rates and time periods
(Table I). The factors can also be manually calculated
from the formula: (1 + i)n where i = the interest rate and
n = the number of interest payment periods.
10-6
33. The future value of $10,000 invested at 8% interest for 4
years is $13,605:
$10,000 x (1 + .08)4 = $10,000 x 1.3604890 =

$13,604.890 ≈ $13,605
Alternatively, the factor can be found in Table I by moving

down the column marked “n” to period 4 and across to
the column marked 8%. The factor found here is
1.360489.
34. The present value of an investment is the worth today of

an amount to be received at some specific date in the
future at a specific interest rate.
Present value is calculated by multiplying the amount of

the investment by a present value conversion factor.
Conversion factors can be calculated as 1/(1 + i)n, where
“i” is the interest rate and “n” is the number of interest
payment periods. Present value factors can also be
found in prepared tables (Table II).
35. Present value of $25,000 to be received in 3 years,

discounted at 8% is $19,846:
$25,000 x [1/(1 + .08)3] or;
25,000 x .793832241 = $19,845.80603 ≈ $19,846
Alternatively, the present value factor can be found in
Table II by looking down the column marked “n” to 3 and
across to the 8% column. The factor there is .793832.
36. The present value of a $4,000 annuity received for 4

years at 8% is $13,248:
$4,000 x 3.312127 = $13,248.508 ≈ $13,249
37. The effective interest method applies a constant rate of

interest (market rate) to the changing carrying value of
the bond to calculate interest expense. The
premium/discount amortization is the difference between
interest expense and interest payment (stated rate).
10-7
Straight-line amortization charges an equal amount of
premium/discount to interest expense each year over the
term of the bond.
The effective interest method is conceptually more

correct than the straight-line method because interest
expense changes as the carrying value of the liability
changes. GAAP requires the effective interest method if
it yields a materially different expense from that of
straight-line.
10-8
SOLUTIONS TO EXERCISES - SERIES A - CHAPTER 10
EXERCISE 10-1A
a. Year 1
Option 1 - annual interest only:

$100,000 x 9% = $9,000
Option 2 - annual interest and $10,000 on principal:

$100,000 x 9% = $9,000
Note: The amount of interest paid in year 1 is the same under

both options because no payment was made on the principal
until the end of the year under option two.
b. Year 2
Option 1 - annual interest only:

$100,000 x 9% = $9,000
Option 2 - annual interest and $10,000 on principal:

Original principal: $100,000
Less, payment at end of year one (10,000)
Balance of principal for year two$ 90,000
$90,000 x 9% = $8,100
Note: Under option two, less interest will be paid in year two
and in future years because the amount subject to interest is
less.
c. Under option one, only annual interest is paid. This is a

desirable option if a company expects cash flow problems in
the early years. More interest will be paid, but less cash is
required in the short term. Option two is more
advantageous if the business has enough cash to pay both
principal and interest each year. This option is less costly.
10-9
10-10
EXERCISE 10-2A
Wallace Company
Amortization Schedule
$80,000, 4-Yr. Term Note, 9% Interest Rate
Prin. Bal. Cash Pay. Applied Applied Prin. Bal.
Year on Jan 1 Dec. 31 to to End of
Interest Principal Period
2 $80,000 $24,693 $7,200 $17,493 $62,507
004
2 62,507 24,693 5,626 19,067 43,440
005
2 43,440 24,693 3,910 20,783 22,657
006
2 22,657 24,693 2,036* 22,657 -0-
007
*Adjusted due to rounding.
10-11
EXERCISE 10-3A
The first four years are provided for the use of the instructor:
Yang Company
Prin. Bal. Cash Pay. Applied Applied Prin Bal.
Year on Jan 1 Dec. 31 to to end of
2 $100,000 $14,903 $8,000 $6,903 $93,097
004
2 93,097 14,903 7,448 7,455 85,642
005
2 85,642 14,903 6,851 8,052 77,590
006
2 77,590 14,903 6,207 8,696 68,894
007
a.
1. $8,000
2. $6,903
b. $93,097
c.
1. $7,448
2. $7,455
10-12
EXERCISE 10-4A
a. $13,500 ÷ $150,000 = .09
b.
Effect of Transactions on Financial Statements
Balance Sheet Income Statement Statement

of
No Assets = Liab. + S. Rev. − Exp. = Net Cash Flows
. Equity Inc.
1. 150,000 = 150,000 + NA NA − NA = NA 150,000
FA
2. (38,563 = (25,063 + (13,500 NA − 13,50 = (13,50 (25,063)
) ) ) 0 0) FA
(13,500)
OA
c. (1)
Revenue $100,00
0
Expenses
Operating $50,000
Expenses
Interest Expense 13,500
Total Expenses 63,500
Net Income $ 36,500
c. (2)
Cash Flows From Operating
Activities:
Inflow from Customers $100,000
Outflow for Expenses (63,500)
Net Cash Flow from Operating $ 36,500
Activities
c. (3)
Cash Flows From Financing
Activities:
10-13
Inflow from Issue of Note $150,000
Outflow to Repay Note (25,063)
Net Cash Flow from Financing $124,937
Activities
d. Principal 1/1/04: $97,618 ($124,937 − $27,319)

$97,618 x 9% = $8,785.62 or $8,786 rounded to nearest
dollar.
10-14
EXERCISE 10-5A
Amount Balance Interes Interes

Month Borrowed End of t Rate t
(Repaid) Month Expens
e
January $100,000 $100,000 .08/12 $667
Februar 50,000 150,000 .07/12 875
y
March (60,000) 90,000 .075/1 563
2
April 10,000 100,000 .07/12 583
Date Account Titles Debit Credit

2004
Jan. 1 Cash 100,000
Line of Credit Payable 100,000
Jan. 31 Interest Expense 667
Cash 667
Feb. 1 Cash 50,000
Feb. 28 Interest Expense 875
Cash 875
March 1 Line of Credit Payable 60,000
Cash 60,000
March Interest Expense 563
31
Cash 563
April 1 Cash 10,000
April 30 Interest Expense 583
Cash 583
10-15
10-16
EXERCISE 10-6A
a. $50,000 x 9% = $4,500
b. $50,000 x 9% x 6/12 = $2,250 on June 30

$50,000 x 9% x 6/12 = $2,250 on December 31
or a total of $4,500 will be paid in 2004.
c. The total amount of interest paid each year will be the

same regardless of whether it is paid annually or
semiannually. Because of the time value of money,
semiannual interest works to the advantage of the lender
(bondholder) and the disadvantage of the issuer of the
bonds. Huggins would prefer the annual interest; cash only
has to be paid at the end of the year.
10-17
EXERCISE 10-7A
Face x Selling Cash Discount or

Price Proceeds Premium
a. $100,000 x 101% $101,000 Premium
b. $150,000 x 98% 147,000 Discount
c. $200,000 x 204,500 Premium
102.25%
d. $40,000 x 97.5% 39,000 Discount
10-18
EXERCISE 10-8A
a. Premium
b. Discount
c. Discount
d. Premium
e. Face
EXERCISE 10-9A
a. Discount (Stated rate is less than market rate.)
b. Discount (Stated rate is less than market rate.)
c. Premium (Stated rate is greater than market rate.)
EXERCISE 10-10A
a. $60,000 x 4% = $2,400; Premium
b. $90,000 x 1.5% = $1,350; Premium
c. $200,000 x 1.75% = $3,500; Discount
d. $150,000 x 4% = $6,000; Discount
10-19
EXERCISE 10-11A
a.

of
No Assets = Liab. + S. Rev. − Exp. = Net Cash
. Equity Inc. Flows
1. + = + + NA NA − NA = NA + FA
2. NA = + + − NA − + = − NA
3. − = NA + − NA − + = − − OA
b. Amortization of bond discount, 2004: $4,000 ÷ 10 = $400

per year
Carrying Value, December 31, 2002:

Bonds Payable $200,000
Less: Discount on Bonds Payable (3,600)
Carrying Value, December 31, 2002$196,400
c. Interest Expense, 2002:

Stated Interest ($200,000 x 10%)$20,000
Amortization of Bond Discount 400
d. Carrying Value, December 31, 2003:

Carrying Value, December 31, 2003$196,800
e. Interest Expense, 2003:
Stated Interest ($200,000 x 10%)$20,000

10-20
EXERCISE 10-12A
a.
Balance Sheet Income Statement Stmt. of

. Equity Inc. Flows
1. + = + + NA NA − NA = NA + FA
2. NA = − + + NA − − = + NA
3. − = NA + − NA − + = − − OA
b. Amortization of bond premium, 2002: $4,000 ÷ 10 = $400

per year

Plus: Premium on Bonds Payable ($4,000 − $400)
3,600
Carrying Value, December 31, 2002 $203,600

Stated Interest ($200,000 x 10%) $20,000
Amortization of Bond Premium (400)

3,200

10-21
EXERCISE 10-13A
a.
Home Supplies, Inc.
General Journal
2003
July 1 Cash1 95,000
Discount on Bonds Payable 5,000
Bonds Payable 100,000
Dec. Interest Expense 3,250
31
Discount on Bonds 250
Payable2
Cash3 3,000
Dec. Retained Earnings 3,250
31
2004
June Interest Expense 3,250
30
Discount on Bonds Payable 250
Cash 3,000
31
Cash 3,000
31
1
$100,000 x .95 = $95,000
2
$5,000 ÷ 10 = $500; $500 x 6/12 = $250
3
$100,000 x 6% x 6/12 = $3,000
10-22
EXERCISE 10-13A a.(cont.)
Home Supplies, Inc.

T-accounts
Assets = Liabilities + Stockholders’ Equity
Cash Bonds Payable Retained Earnings

2003 2003 2003
7/1 95,000 12/31 7/1 100,000 cl 3,250
3,000
Bal. 92,000 Bal. Bal. 3,250
100,000
2004 2004
6/30 3,000 cl 6,500
12/31 Disc. on Bonds Pay. Bal. 9,750
3,000
Bal. 86,000 2003
7/1 5,000 12/31 250 Interest Expense
Bal. 4,750 2003
2004 12/313,250 cl 3,250
6/30 250 Bal. -0-
12/31 250 2004
Bal. 4,250 6/30 3,250
12/313,250 cl 6,500
Bal. -0-
10-23
EXERCISE 10-13A (cont.)
b.
Home Supplies, Inc.
Balance Sheet
Liabilities 2003 2004
Bonds Payable $100,00 $100,000
0
Discount on Bonds (4,750) (4,250)
Payable
Net Carrying Value of 95,250 95,750
Bonds
Total Liabilities $95,250 $95,750
c. Interest Expense 2003 2004

$3,250 $6,500
d. Cash Outflow for Interest 2003 2004

$3,000 $6,000
10-24
EXERCISE 10-14A
Hammond Corp.
General Journal
2003
Jan.1 Cash 200,000
Dec. Interest Expense* 16,000
31
Cash 16,000
2004
31
Cash 16,000
*$200,000 x 8% = $16,000 interest expense per year
10-25
EXERCISE 10-15A
Macy Co.
General Journal
2004
Jan. 1 Cash1 192,000
Dec. Interest Expense2 1,600
31
31
Cash 16,000
2005
31
31
Cash 16,000
1
$200,000 x .96 = $192,000 cash proceeds
2
$8,000 ÷ 5 = $1,600 discount amortization per year
3
$200,000 x 8% = $16,000 interest payment per year
10-26
EXERCISE 10-16A
Bay Company
General Journal
2004
Jan. 1 Cash1 204,000
Premium on Bonds Payable 4,000
Dec. Premium on Bonds Payable2 800
31
Interest Expense 800
31
Cash 16,000
2005
Dec. Premium on Bonds Payable 800
31
31
Cash 16,000
1
$200,000 x 1.02 = $204,000 cash proceeds
2
$4,000 ÷ 5 = $800 premium amortization per year
3
10-27
EXERCISE 10-17A
a.
Goode Company
General Journal
2001
Jan. 1 Cash 500,000
Jan. 1 Land 500,000
Cash 500,000
Dec. Cash 60,000
31
Lease Revenue 60,000
Dec. Interest Expense ($500,000 x 40,000
31 8%)
Cash 40,000
Dec. Lease Revenue 60,000
31
Retained Earnings 20,000
2002
Dec. Cash 60,000
31
31
Cash 40,000
31
10-28
EXERCISE 10-17A a. (cont.)
Goode Company
Assets = Liabilities + Stockholders’
Equity
2001 2001 2001
1/1 500,000 1/1 500,000 1/1 500,000 cl 20,000
12/31 60,000 12/31 40,000 Bal. 500,000 Bal. 20,000
Bal. 20,000 2002
2002 cl 20,000
12/31 60,000 12/31 40,000 Bal. 40,000
Bal. 40,000
Lease Revenue
2001
Land cl 60,000 12/31 60,000
2001 Bal. -0-
1/1 500,000 2002
Bal. 500,000 cl 60,000 12/31 60,000
Bal. -0-
Interest Expense
2001
12/31 cl 40,000
40,000
Bal. -0-
2002
12/31 cl 40,000
40,000
Bal. -0-
10-29
EXERCISE 10-17A (cont.) b.
Goode Company Financial Statements
Income Statements 2001 2002
Lease Revenue $60,000 $60,000
Interest Expense (40,000) (40,000)
Net Income $20,000 $20,000
Balance Sheets
Assets
Cash $ 20,000 $ 40,000
Land 500,000 500,000
Total Assets $520,000 $540,000
Liabilities
Bonds Payable $500,000 $500,000
Stockholders’ Equity
Common Stock -0- -0-
Retained Earnings 20,000 40,000
Total Stockholders’ Equity 20,000 40,000
Total Liab. and Stockholders’ $520,000 $540,000
Equity
Statements of Cash Flows
Activities:
Inflow from Revenue $ 60,000 $ 60,000
Outflow for Interest (40,000) (40,000)
Net Cash Flow from Operating 20,000 20,000
Act.
Cash Flows From Investing
Activities:
Outflow to Purchase Land (500,000) -0-
Activities:
Inflow from Bond Issue 500,000 -0-
Net Change in Cash 20,000 20,000
10-30
Plus: Beginning Cash Balance -0- 20,000
Ending Cash Balance $ 20,000 $ 40,000
EXERCISE 10-18A
Boark Company
2004
Jan. 1 Cash 400,000
2007
Dec. Loss on Bond Redemption 8,000
31
Cash 408,000
10-31
EXERCISE 10-19A
a.
Ames Co. Cox Co. Douglas

Co.
Bonds Payable $200,000 $500,000 $800,000
Interest Rate 8% 7% 6%
Before Tax Interest $ 16,000 $ 35,000 $ 48,000
Cost
b.
Ames Co. Cox Co. Douglas
Co.
Before Tax Interest $16,000 $35,000 $48,000
Cost
x (1 − Tax Rate) 65% 80% 75%
After Tax Interest $10,400 $28,000 $36,000
Cost
c. There are two ways to determine the after-tax interest

cost as a percentage of the face value of the bonds.
1.
Ames Co. Cox Co. Douglas Co.
After Tax Interest Cost $ 10,400 $ 28,000 $ 36,000
÷ Bonds Payable $200,000 $500,000 $800,000
= After Tax Interest 5.2% 5.6% 4.5%
Rate
OR 2.
Interest Rate x (1 − Tax .08 x ( 1−. .07 x (1 − .06 x (1 −
Rate) 35) .2) .25)
= After Tax Interest = 5.2% = 5.6% = 4.5%
Rate
10-32
EXERCISE 10-20A
1. $25,000 x 1.628895 = $40,722 (Table I, 5%, 10 years)
2. $1,500 x 10.636628 = $15,955 (Table III, 8%, 8 years)
3. $100,000 x .747258 = $74,726 (Table II, 6%, 5 years)
4. Annual Payment x 7.02358 = $80,000; (Table IV, 7%, 10

years)
$80,000 ÷ 7.023582 = $11,390 annual payment
EXERCISE 10-21A
a. Payment amount x 3.312127 = $25,000 (Table IV, 8%, 4

years)
$25,000 ÷ 3.312127 = $7,548
b. $6,000 x 3.312127 = $19,873 (Table IV, 8%, 4 years)
EXERCISE 10-22A
a. Annual payment x 14.486562 = $225,000; (Table III, 8%,

10 years)
$225,000 ÷ 14.486562 = $15,531.64
b. $225,000 x .463193 = $104,218 (Table II, 8%, 10 years)
10-33
EXERCISE 10-23A
a.
Present Value of $50,000 x .5083491 = $
Principal 25,417
Present Value of $4,000 x 7.02358 = 28,094
Interest 22
Selling Price $53,511
1
Table II, 7%, 10 years
2
Table IV, 7%, 10 years
b.
Account Titles Debit Credit
Cash 53,511
c. Interest payment amount: $50,000 x .08 = $4,000
Interest expense: Carrying value x effective interest rate

$53,511 x 7% = $3,745.77
Amortization of Premium: Interest Payment

$4,000.00
Less: Interest Expense( 3,745.77)
Amortization $ 254.23

Interest Expense 3,745.7
7
Premium on Bonds Payable 254.23
Cash 4,000.00
10-34
EXERCISE 10-24A
The effective interest considers the time value of money. As

the premium or discount is amortized, the carrying value of
the bond changes. The effective interest method computes
the amount of interest on the constantly changing carrying
value of the bond liability while the straight-line method
simply allocates the premium or discount ratably over the life
of the bond. The effective interest method is theoretically the
correct method.
10-35
SOLUTIONS TO PROBLEMS - SERIES A - CHAPTER 10
PROBLEM 10-25A
a.
Jones Company
Prin. Cash Pay. Applied Applied Prin. Bal.
Year Bal. on Dec. 31 to to End of
Jan 1 Interest Principa Period
l
2 $80,000 $31,043 $6,400 $24,643 $55,357
001
2 55,357 31,043 4,429 26,614 28,743
002
2 28,743 31,043 2,300* 28,743 -0-
003
*Adjusted due to rounding
10-36
PROBLEM 10-25A (cont.)
b. Provided for the use of the Instructor:
Cash Notes Payable Retained Earnings

2001 2001 2001
1/1 80,000 1/1 80,000 1/1 80,000 cl 29,600
12/31 12/31 12/31 Bal. 29,600
36,000 31,043 24,643
Bal. 4,957 Bal. 2002
55,357
2002 2002 cl 31,571
12/31 12/31 12/3126,614 Bal. 61,171
36,000 31,043
Bal. 9,914 Bal. 2003
28,743
2003 2003 cl 33,700
12/31 12/31 12/3128,743 Bal. 94,871
36,000 31,043
Bal. 14,871 Bal. -0-
Rent Revenue
Land 2001
2001 cl 36,000 12/31
36,000
1/1 80,000 Bal. -0-
Bal. 80,000 2002
cl 36,000 12/31
36,000
Bal. -0-
2003
cl 36,000 12/31
36,000
Bal. -0-
Interest Expense
2001
12/31 6,400 cl 6,400
Bal. -0-
2002
12/31 4,429 cl 4,429
Bal. -0-
2003
12/31 2,300 cl 2,300
Bal. -0-
10-37
Jones Company
Financial Statements
Income Statements 2001 2002 2003
Rent Revenue $36,00 $36,00 $36,00
0 0 0
Interest Expense (6,400) (4,429) (2,300)
Net Income $29,60 $31,57 $33,70
0 1 0
Balance Sheets
Assets
Cash $ $ $14,87
4,957 9,914 1
Land 80,000 80,000 80,000
Total Assets $84,95 $89,91 $94,87
7 4 1
Liabilities
Notes Payable $55,35 $28,74 $
7 3 -0-
Retained Earnings 29,600 61,171 94,871
Total Liab. and Stockholders’ $84,95 $89,91 $94,87
Equity 7 4 1
Act.:
Inflow from Rental $36,00 $36,00 $36,00
0 0 0
Outflow for Interest (6,400) (4,429) (2,300)
Net Cash Flow from 29,600 31,571 33,700
Operating Act.
Cash Flow From Investing
Act.:
Outflow to Purchase Land (80,000 -0- -0-
)
10-38
Cash Flow From Financing
Act.:
Inflow from Loan 80,000 -0- -0-
Outflow to Repay Loan (24,643 (26,614 (28,743
) ) )
Net Cash Flow from Financing 55,357 (26,614 (28,743
Act. ) )
Net Change in Cash 4,957 4,957 4,957
Plus: Beginning Cash Balance -0- 4,957 9,914
Ending Cash Balance $ $ $14,87
4,957 9,914 1
c. Because the company is making both principal and

interest payments on the loan each year, the amount paid
on the principal reduces the balance of the loan and
consequently the amount of interest paid on the loan
each year. Even though the total amount of the payment
is the same each year, the amount paid on the principal
increases and the amount paid on the interest decreases.
Consequently, the cash flow from financing activities
increases and the cash flow from operating activities
decreases.
10-39
PROBLEM 10-26A
Computation of Interest Expense

Amount End of Interest Interest
Month Borrowed Month x Rate per = Expense
(Repaid) Balance Month
January $80,000 $ 80,000 .07/12 $ 467
February 50,000 130,000 .07/12 758
March (30,000) 100,000 .08/12 667
April -0- 100,000 .08/12 667
May -0- 100,000 .08/12 667
June -0- 100,000 .08/12 667
July -0- 100,000 .08/12 667
August -0- 100,000 .08/12 667
Septemb -0- 100,000 .08/12 667
er
October -0- 100,000 .08/12 667
Novemb (60,000) 40,000 .08/12 267
er
Decembe (40,000) -0- .07/12 -0-
r
Total $6,828
a.
Powell Company
Income Statement
For the Year Ended December 31, 2003
Service Revenue $18,000
Expenses
Interest Expense (6,828)
Net Income $11,172
10-40
PROBLEM 10-26A a. (cont.)
Powell Company
Balance Sheet
As of December 31, 2003
Assets
Cash $11,172
Total Assets $11,17
2
Liabilities $
-0-
Common Stock $ -0-
Total Stockholders’ Equity 11,172
Total Liabilities and Stockholders’ $11,17
Equity 2
Statement of Cash Flows

Activities:
Inflow from Revenue $18,000
Outflow for Interest (6,828)
Net Cash Flow from Operating $11,17
Activities 2
Cash Flows From Investing -0-
Activities:
Activities:
Inflow from Loan 130,000
Outflow to Repay Loan (130,000
)
Net Cash Flow from Financing -0-
Activities
10-41
Net Change in Cash 11,172
Plus: Beginning Cash Balance -0-
Ending Cash Balance $11,17
2
10-42
b. When a business has an established line of credit, the

business can access funds without having to apply for a
loan and wait for approval to receive the cash. It can save
time and expense for the business.
10-43
PROBLEM 10-27A
Provided for the instructor’s use:
Transactions:
1. Issued bonds at 105. Cash proceeds = $157,500; Premium =
$7,500.
2. Purchased land for $157,500.
3. Land rental, $17,500 per year, 2004, 2005, 2006.
4. Interest payments per year, $15,000, 2004, 2005, 2006.
5. Amortized premium per year, $500.
6. Sold the land for $160,000, 1/1/07.
7. Paid off bonds at 106, cash payment of $159,000.
10-44
PROBLEM 10-27A (cont.) T-Accounts Provided for Instructor’s
Use:
2004 2004 2004
1. 157,500 2.157,500 1. 150,000 cl 3,000
3. 17,500 4. 15,000 Bal. Bal. 3,000
150,000
Bal. 2,500 2007 2005
2005 7. cl. 3,000
150,000
3. 17,500 4. 15,000 Bal. -0- Bal. 6,000
Bal. 5,000 2006
2006 Premium on Bonds cl. 3,000
Pay.
3. 17,500 4. 15,000 2004 Bal. 9,000
Bal. 7,500 5. 500 1. 7,500 2007
2007 Bal. 7,000 cl 500
6. 160,000 7.159,000 2005 Bal. 8,500
Bal. 8,500 5. 500
Bal. 6,500 Rental Income
Land 2006 2004
2004 5. 500 cl 17,500 3. 17,500
2. 157,500 Bal. 6,000 2005
Bal.157,500 2007 cl 17,500 3. 17,500
2007 7. 6,000 2006
6.157,500 Bal. -0- 17,500 3. 17,500
Bal. -0- Bal. -0-
Interest Expense
2004
4. 15,000 5. 500
cl 14,500
2005
4. 15,000 5. 500
cl 14,500
2006
4. 15,000 5. 500
cl 14,500
Bal. -0-
Gain on Sale of Land
2007
cl 2,500 6. 2,500
Bal. -0-
Loss on Bond Redempt.
2007
7. 3,000 cl 3,000
10-45
Bal. -0-
10-46
Maywood Company
Income Statements 2004 2005 2006 2007
Rent Revenue $17,50 $17,50 $17,50 $ -0-
0 0 0
Interest Expense (14,50 (14,50 (14,50 -0-
0) 0) 0)
Operating Income 3,000 3,000 3,000 -0-
Non-Operating
Inc./Expense
Gain on Sale of Land -0- -0- -0- 2,500
Loss on Bond -0- -0- -0- (3,000)
Redemption
Net Income $ $ $ $ (500)
3,000 3,000 3,000
Statement of Changes in Stockholders’ Equity
Common Stock $ $ -0- $ $ -0-
-0- -0-
Beginning Retained -0- 3,000 6,000 $9,000
Earnings
Plus Net Income (Loss) 3,000 3,000 3,000 (500)
Ending Retained 3,000 6,000 9,000 8,500
Earnings
Total Stockholders’ $3,000 $6,000 $9,000 $8,500
Equity
10-47
Maywood Company Financial Statements
Balance Sheets 2004 2005 2006 2007
Assets
Cash $ 2,500 $ $ 7,500 $8,500
5,000
Land 157,500 157,500 157,500 -0-
Total Assets $160,000 $162,50 $165,000 $8,500
0
Liabilities
Bonds Payable $150,000 $150,00 $150,000 $ -0-
0
Premium on Bonds Pay. 7,000 6,500 6,000 -0-
Total Liabilities 157,000 156,500 156,000 -0-
Retained Earnings 3,000 6,000 9,000 8,500
Total Liab. and Stk. $160,000 $162,50 $165,000 $8,500

Equity 0
Cash Flow From Oper.

Act.:
Inflow from Rental $ 17,500 $17,500 $17,500 $ -0-
Outflow for Interest (15,000) (15,000) (15,000) -0-
Net Cash Flow Oper. Act. 2,500 2,500 2,500 -0-
Cash Flow From Inv. Act.:

Inflow from Sale of -0- -0- -0- 160,000
Land
Outflow to Purchase (157,500) -0- -0- -0-
Land
Net Cash Flow from Inv. (157,500) -0- -0- 160,000
Act.
Cash Flow Financing Act.

Inflow from Bond Issue 157,500 -0- -0- -0-
Outflow to Repay Bond -0- -0- -0- (159,000)
Net Cash Flow Fin. Act. 157,500 -0- -0- (159,000)
Net Change in Cash 2,500 2,500 2,500 1,000

Plus Beginning Cash Bal. -0- 2,500 5,000 7,500
Ending Cash Balance $ 2,500 $ 5,000 $ 7,500 $ 8,500
10-48
PROBLEM 10-28A
a. The market rate of interest was greater than the stated
rate of interest. Consequently, the bonds sold at a
discount. If the bonds had sold at face value, Adams would
have received $50,000.
b.
General Journal
2002
Mar. 1 Cash 48,000
Sept. Interest Expense ($50,000 x 9% 2,250
1 x ½)
Cash 2,250
Dec. Interest Expense ($50,000 x 9% x 1,500
31 4/12)
Interest Payable 1,500
Dec. Interest Expense ($2,000 ÷ 8 x 208
31 10/12)
31
2003
Mar. 1 Interest Expense 750
Cash 2,250
Sept. Interest Expense 2,250
1
Cash 2,250
31
10-49
Dec. Interest Expense 250
31
31
c.
2002 2003
Liabilities
Interest Payable $ 1,500 $ 1,500
Bonds Payable 50,000 50,000
Less: Discount on Bonds (1,792) (1,542)
Payable
Carrying Value of Bonds 48,208 48,458
Payable
d 2002 2003
.
Interest Expense Reported on Income $3,95 $4,75
Statement 8 0
e 2002 2003
.
Interest Paid in Cash to Bondholders $2,25 $4,50
0 0
10-50
PROBLEM 10-29A
Western Land Co.

Even Type Common Retaine Net
t No. of Assets = Liabilitie + Stock + d Income Cash
Event s Earning Flow
s
1. AS + = NA + + + NA NA + FA
2. AS + = + + NA + NA NA + FA
3. AE +− = NA + NA + NA NA − IA
4. AS + = NA + NA + + + + OA
5. CE NA = − + NA + + + NA
6. AU − = NA + NA + − − − OA
7. Closin NA = NA + NA + +/− NA NA
g
g
9. AS + = NA + NA + + + + OA
10. CE NA = − + NA + + + NA
11. AU − = NA + NA + − − − OA
g
g
14. AS/AE + = NA + NA + + + + IA
15. AU − = − + NA + NA NA − FA
10-51
PROBLEM 10-30A
a.
Rev. Exp./
No Assets = Liab. +S. G − Loss = Net Cash Flows
. Equity ain Inc.
1 100,000 = 100,000 + NA NA − NA = NA 100,000 FA
2. (10,000) = NA + (10,000 NA − 10,00 = (10,00 (10,000)
) 0 0) OA
3. (101,50 = (100,000 + (1,500) NA − 1,500 = (1,500) (101,500)
0) ) FA
b.
1. Cash 100,000
2. Interest Expense1 10,000
Cash 10,000
3. Bonds Payable 100,000
Loss on Redemption of Bonds 1,500
Cash2 101,500
1
$100,000 x 10% = $10,000
2
$100,000 x 101.5% = $101,500
10-52
PROBLEM 10-31A
Rev. Exp./
No Assets = Liab. + S. /
. − Loss = Net Cash
Equity Gain Inc. Flows
a. + = + + NA NA − NA = NA + FA
b. − = NA + − NA − + = − − OA
c. − = − + − NA − + = − − FA/OA
d. + = + + NA NA − NA = NA + FA
e. − = NA + − NA − + = − − OA
f. + = + + NA NA − NA = NA + FA
g. − = + + − NA − + = − − OA
h. NA = + + − NA − + = − NA
i. + = + + NA NA − NA = NA + FA
j. − = NA + − NA − + = − − OA
k. NA = − + + NA − − = + NA
10-53
PROBLEM 10-32A (APPENDIX)
a. Computation of Selling Price:

Amount Table Factor Present Value
Principal Amount $200,000 x .508349 = $101,670
Interest Payments 16,000 x 7.023582 = 112,377
b.
Date Account Title Debit Credit
1/1/02 Cash 214,047
c. Calculation of Interest Expense and Premium Amortization:

Bond Interest Premium
Unamortz. Carrying Exp. Interest Paid Amortized
Date Bond Pay. Premium Value (CV x 7%) (BP x 8%) (Exp - Paid)
2002 $200,000 $14,047 $214,047 $14,983 $16,000 $1,017
2003 200,000 13,030 213,030 14,912 16,000 1,088
2004 200,000 11,942 211,942 14,836 16,000 1,164
2005 200,000 10,778 210,778 14,754 16,000 1,246
Date Account Title Debit Credit

12/1/04 Interest Expense 14,836
Cash 16,000
d. See schedule above: $14,754.
10-54
SOLUTIONS TO EXERCISES - SERIES B - CHAPTER 10
EXERCISE 10-1B
Points that should be noted:
a. The carrying value of the amortized note (option 2) will be

reduced by the amount of the principal payments for each
period. However, the carrying value of the note with all
principal due at maturity (option 1) will not change until the
liability is paid off.
b. The amount of annual interest on the amortized loan

(option 2) will decrease each year as the amount of the
liability (carrying value) decreases. Interest on the lump
sum payment note (option 1) will remain constant because
the amount borrowed remains constant.
c. The total amount of interest paid will be greater under the

lump sum payment note (option 1) because the liability was
greater over the life of the loan.
d. The amortized loan (option 2) will have a greater amount of

cash outflow each year except the year of maturity. Cash
outflow is being made on both principal and interest, while
cash is being paid only for interest on the term loan (option
1). However, in the year of maturity, the lump sum loan
(option 1) will require the greater cash outlay.
10-55
EXERCISE 10-2B
Baco Company
Prin. Bal. Cash Pay. Applied Applied Prin. Bal.
Year on Jan 1 Dec. 31 to to End of
2 $120,000 $30,055 $9,600 $20,455 $99,545
006
2 99,545 30,055 7,964 22,091 77,454
007
2 77,454 30,055 6,196 23,859 53,595
008
2 53,595 30,055 4,288 25,767 27,828
009
2 27,828 30,055 2,227* 27,828 -0-
010
*Adjusted $1 due to rounding.
10-56
EXERCISE 10-3B
Provided for the use of the Instructor:
Amer Company
Prin. Bal. Cash Pay. Applied Applied Prin Bal.
Year on Jan 1 Dec. 31 to to end of
2 $80,000 $21,104 $8,000 $13,104 $66,896
004
2 66,896 21,104 6,690 14,414 52,482
005
2 52,482 21,104 5,248 15,856 36,626
006
2 36,626 21,104 3,663 17,441 19,185
007
2 19,185 21,104 1,919* 19,185 -0-
008
*Adjusted due to rounding
a.
1. $8,000
2. $13,104
b. $66,896
c.
1. $6,690
2. $14,414
10-57
EXERCISE 10-4B
a.

of
No Assets = Liab. + S. Rev. − Exp. = Net Cash Flows
. Equity Inc.
1. 200,000 = 200,000 + NA NA − NA = NA 200,000
FA
2. (32,549 = (12,549 + (20,000 NA − 20,00 = (20,00 (12,549)
) ) ) 0 0) FA
(20,000)
OA
b. (1)
Revenue $100,00
0
Expenses
Operating $50,000
Expenses
Total Expenses 70,000
Net Income $ 30,000
b. (2)
Activities:
Inflow from Customers $100,000
Outflow for Expenses (70,000)
Net Cash Flow from Operating $ 30,000
Activities
b. (3)
Activities:
Inflow from Issue of Note $200,000
10-58
Outflow to Repay Note (12,549)
Net Cash Flow from Financing $187,451
Activities
c. Principal 1/1/04: $158,463 ($173,647 − $15,184)

Interest Rate: $20,000 ÷ $200,000 = 10%
$158,463 x 10% = $15,846 interest expense
10-59
EXERCISE 10-5B
Amount Balance Interes Interes

Month Borrowed End of t Rate t
(Repaid) Month Expens
e
January $50,000 $50,000 .05/12 $208
Februar 30,000 80,000 .06/12 400
y
March (40,000) 40,000 .065/1 217
2

2007
Jan. 1 Cash 50,000
Jan. 31 Interest Expense 208
Cash 208
Feb. 1 Cash 30,000
Feb. 28 Interest Expense 400
Cash 400
March 1 Line of Credit Payable 40,000
Cash 40,000
March Interest Expense 217
31
Cash 217
10-60
EXERCISE 10-6B
The total amount of interest paid each year will be the same
regardless of whether it is paid annually or semiannually. If
the interest is paid annually, the company will make one
payment of $800 ($10,000 x 8%) on December 31. If the
interest is paid semiannually, the company will make two
payments of $400 each ($10,000 x 8% x 6/12). One payment
would be made on June 30; the other payment would be made
on December 31. However, due to the time value of money,
semiannual interest works to the advantage of the lender of
the money and to the disadvantage of the borrower.
10-61
EXERCISE 10-7B
Face x Selling Cash Discount or

Price Proceeds Premium
a. $200,000 x 103% $206,000 Premium
b. $80,000 x 95.5% 76,400 Discount
c. $100,000 x 101,750 Premium
101.75%
d. $50,000 x 98% 49,000 Discount
10-62
EXERCISE 10-8B
a. Face
b. Premium
c. Discount
d. Premium
e. Discount
EXERCISE 10-9B
a. Premium (Stated rate is greater than market rate.)
b. Discount (Stated rate is less than market rate.)
c. Discount (Stated rate is less than market rate.)
EXERCISE 10-10B
a. $80,000 x 2% = $1,600; Premium
b. $50,000 x 2% = $1,000; Discount
c. $100,000 x 2.25% = $2,250; Premium
d. $500,000 x 1.75% = $8,750; Discount
10-63
EXERCISE 10-11B
a.

of
. Equity Inc. Flows
1. + = + + NA NA − NA = NA + FA
2. NA = + + − NA − + = − NA
3. − = NA + − NA − + = − − OA
b. Amortization of bond discount, 2004: $4,000 ÷ 5 = $800

per year

Carrying Value, December 31, 2004$ 96,800


Carrying Value, December 31, 2005$ 97,600

10-64
EXERCISE 10-12B
a.
Balance Sheet Income Statement Stmt. of

. Equity Inc. Flows
1. + = + + NA NA − NA = NA + FA
2. NA = − + + NA − − = + NA
3. − = NA + − NA − + = − − OA
b. Amortization of bond premium, 2004: $2,000 ÷ 5 = $400

per year

1,600


1,200

10-65
EXERCISE 10-13B
a.
Farm Supplies, Inc.
General Journal
2003
July 1 Cash1 208,000
31
Premium on Bonds Payable2 400
Cash3 6,000
31
2004
30
Premium on Bonds Payable 400
Cash 6,000
31
Premium on Bonds Payable 400
Cash 6,000
31
1
$200,000 x 1.04 = $208,000
2
$8,000 ÷ 10 = $800; $800 x 6/12 = $400
3
$200,000 x 6% x 6/12 = $6,000
10-66
EXERCISE 10-13B a.(cont.)
Farm Supplies, Inc.

T-accounts
Assets = Liabilities + Stockholders’ Equity

2003 2003 2003
7/1 208,000 12/31 7/1 200,000 cl 5,600
6,000
Bal. Bal. Bal. 5,600
202,000 200,000
2004 2004
6/30 6,000 cl 11,200
12/31 Premium on Bonds Bal. 16,800
6,000 Pay.
Bal. 2003
190,000
12/31 400 7/1 8,000 Interest Expense
Bal. 7,600 2003
2004 12/31 5,600 cl 5,600
6/30 400 Bal. -0-
12/31 400 2004
Bal. 6,800 6/30 5,600
12/31 5,600 cl 11,200
Bal. -0-
10-67
EXERCISE 10-13B (cont.)
b.
Farm Supplies, Inc.
Balance Sheet
Liabilities 2003 2004
Bonds Payable $200,00 $200,000
0
Premium on Bonds 7,600 6,800
Payable
Net Carrying Value of 207,600 206,800
Bonds
0
c. Interest Expense 2003 2004

$5,600 $11,200
d. Cash Outflow for Interest 2003 2004

$6,000 $12,000
10-68
EXERCISE 10-14B
Miller Corp.
General Journal
2001
Jan.1 Cash 100,000
Dec. Interest Expense* 9,000
31
Cash 9,000
2002
31
Cash 9,000
*$100,000 x 9% = $9,000 interest expense per year
10-69
EXERCISE 10-15B
Creason Co.
General Journal
2005
Jan. 1 Cash1 97,500
Dec. Interest Expense2 500
31
31
Cash 8,000
2006
31
31
Cash 8,000
1
$100,000 x .975 = $97,500 cash proceeds
2
$2,500 ÷ 5 = $500 discount amortization per year
3
10-70
EXERCISE 10-16B
Vickers Company
General Journal
2006
Jan. 1 Cash1 206,000
June Premium on Bonds Payable2 600
30
June Interest Expense3 12,000
30
Cash 12,000
31
31
Cash 12,000
2007
June Premium on Bonds Payable 600
30
30
Cash 12,000
31
31
Cash 12,000
10-71
1
$200,000 x 1.03 = $206,000 cash proceeds
2
$6,000 ÷ 5 = $1,200; $1,200 x 6/12 = $600 premium
amortization per year
3
$200,000 x 12% = $24,000; $24,000 x 6/12 = $12,000 interest
payment per year
10-72
EXERCISE 10-17B
a.
Upton Company
General Journal
2004
Jan. 1 Cash 1,000,000
Bonds Payable 1,000,000
Jan. 1 Land 1,000,000
Cash 1,000,000
Dec. Cash 140,000
31
Dec. Interest Expense ($1,000,000 x 100,000
31 10%)
Cash 100,000
31
2005
Dec. Cash 140,000
31
31
Cash 100,000
31
10-73
EXERCISE 10-17B a. (cont.)
Upton Company
Assets = Liabilities + Stockholders’
Equity
2004 2004 2004
1/1 1/1 1,000,000 1/1 cl 40,000
1,000,000 1,000,000
12/31 12/31 100,000 Bal. Bal. 40,000
140,000 1,000,000
Bal. 40,000 2005
2005 cl 40,000
12/31 12/31 Bal. 80,000
140,000 100,000
Bal. 80,000
Lease Revenue
2004
Land cl 140,000 12/31
140,000
2004 Bal. -0-
1/1 2005
1,000,000
Bal. cl 140,000 12/31
1,000,000 140,000
Bal. -0-
Interest Expense
2004
12/31 cl 100,000
100,000
Bal. -0-
2005
12/31 cl 100,000
100,000
Bal. -0-
10-74
EXERCISE 10-17B (cont.) b.
Upton Company Financial Statements
Income Statements 2004 2005
Lease Revenue $140,000 $140,000
Interest Expense (100,000) (100,000)
Net Income $ 40,000 $ 40,000
Balance Sheets
Assets
Cash $ 40,000 $
80,000
Land 1,000,000 1,000,000
Total Assets $1,040,00 $1,080,00
0 0
Liabilities
Bonds Payable $1,000,00 $1,000,00
0 0
Common Stock -0- -0-
Retained Earnings 40,000 80,000
Total Stockholders’ Equity 40,000 80,000
Total Liab. and Stockholders’ $1,040,00 $1,080,00
Equity 0 0
Activities:
Inflow from Revenue $ 140,000 $ 140,000
Outflow for Interest (100,000) (100,000)
Act.
Cash Flows From Investing
Activities:
Outflow to Purchase Land (1,000,00 -0-
0)
10-75
Activities:
Inflow from Bond Issue 1,000,000 -0-
Plus: Beginning Cash Balance -0- 40,000
Ending Cash Balance $ 40,000 $ 80,000
EXERCISE 10-18B
Han Company
2005
Jan. 1 Cash 500,000
2009
Dec. Loss on Bond Redemption 20,000
31
Cash 520,000
10-76
EXERCISE 10-19B
a.
Pace Co. Pile Co. Park Co.

Bonds Payable $300,000 $600,000 $500,000
Interest Rate 10% 9% 8%
Before Tax Interest $ 30,000 $ 54,000 $ 40,000
Cost
b.
Before Tax Interest $30,000 $54,000 $40,000
Cost
x (1 − Tax Rate) 60% 70% 65%
After Tax Interest $18,000 $37,800 $26,000
Cost
c. There are two ways to determine the after-tax interest

cost as a percentage of the face value of the bonds.
1.
After Tax Interest Cost $ 18,000 $ 37,800 $ 26,000
÷ Bonds Payable $300,000 $600,000 $500,000
= After Tax Interest 6.0% 6.3% 5.2%
Rate
OR 2.
Interest Rate x (1 − Tax .10 x ( 1−. .09 x (1 − .08 x (1 −
Rate) 4) .3) .35)
= After Tax Interest = 6.0% = 6.3% = 5.2%
Rate
10-77
EXERCISE 10-20B
1. $10,000 x 1.262477 = $12,625 (Table I, 6%, 4 years)
2. $2,000 x 6.105100 = $12,210 (Table III, 10%, 5 years)
3. $200,000 x .422411 = $84,482 (Table II, 9%, 10 years)
4. Annual Payment x 3.992710 = $100,000; (Table IV, 8%, 5

years)
$100,000 ÷ 3.992710 = $25,045.65 annual payment
EXERCISE 10-21B
a. Payment amount x 3.790787 = $30,000 (Table IV, 10%, 5

years)
$30,000 ÷ 3.790787 = $7,913.92
b. $4,000 x 3.790787 = $15,163 (Table IV, 10%, 5 years)
EXERCISE 10-22B
a. Annual payment x 37.450244 = $500,000; (Table III, 8%,

18 years)
$500,000 ÷ 37.450244 = $13,351.05
b. $500,000 x .250249 = $125,125 (Table II, 8%, 18 years)
10-78
EXERCISE 10-23B
a.
Present Value of $100,00 x .4224111 = $
Principal 0 42,241
Present Value of $10,000 x 6.41765 = 64,177
Interest 82
8
1
Table II, 9%, 10 years
2
Table IV, 9%, 10 years
b.
Cash 106,41
8
c. Interest payment amount: $100,000 x .10 = $10,000
Interest expense: Carrying value x effective interest rate

$106,418 x 9% = $9,577.62
Amortization of Premium: Interest Payment

$10,000.00
Less, Interest Expense( 9,577.62)
Amortization $ 422.38

Interest Expense 9,577.6
2
Premium on Bonds Payable 422.38
Cash 10,000.0
0
10-79
10-80
EXERCISE 10-24B
An investor would rather collect semiannual interest as

opposed to annual interest because of the time value of
money. When interest is paid every six months, half of the
interest payment amount will be received six months earlier
than the total payment when interest is paid only annually.
The investor can invest that six months of interest so that it
can be earning interest. The effective interest rate is greater
when the interest is paid semiannually.
10-81
SOLUTIONS TO PROBLEMS - SERIES B CHAPTER 10
PROBLEM 10-25B
a.
Mixon Company
Prin. Cash Pay. Applied Applied Prin. Bal.
Year Bal. on Dec. 31 to to End of
Jan 1 Interest Principa Period
l
2 $100,00 $31,547 $10,000 $21,547 $78,453
001 0
2 78,453 31,547 7,845 23,702 54,751
002
2 54,751 31,547 5,475 26,072 28,679
003
2 28,679 31,547 2,868 28,679 -0-
004
10-82
PROBLEM 10-25B (cont.)
b. Provided for the use of the Instructor:
Cash Notes Payable Retained Earnings
2001 2001 2001
1/1 100,000 1/1 100,000 1/1 100,000 cl 30,000
12/3140,000 12/31 31,547 12/3121,547 Bal. 30,000
Bal. 8,453 Bal. 78,453 2002
2002 2002 cl 32,155
12/3140,000 12/31 31,547 12/3123,702 Bal. 62,155
Bal. 16,906 Bal. 54,751 2003
2003 2003 cl 34,525
12/3140,000 12/31 31,547 12/3126,072 Bal. 96,680
Bal. 25,359 Bal. 28,679 2004
2004 2004 cl 37,132
12/3140,000 12/31 31,547 12/3128,679 Bal.133,812
Bal. 33,812 Bal. -0-
Rent Revenue
Land 2001
2001 cl 40,000 12/3140,000
1/1100,000 Bal. -0-
Bal.100,000 2002
cl 40,000 12/3140,000
Bal. -0-
2003
cl 40,000 12/3140,000
Bal. -0-
2004
cl 40,000 12/3140,000
Bal. -0-
Interest Expense
2001
12/3110,000 cl 10,000
Bal. -0-
2002
12/31 7,845 cl 7,845
Bal. -0-
2003
12/31 5,475 cl 5,475
Bal. -0-
2004
12/31 2,868 cl 2,868
Bal. -0-
10-83
PROBLEM 10-25B b. (cont.)
Mixon Company Financial Statements
Rent Revenue $40,000 $40,000 $40,000 $40,000
Interest Expense (10,000) (7,845) (5,475) (2,868)
Net Income $30,000 $32,155 $34,525 $37,132
Balance Sheets
Assets
Cash $ $ $ $ 33,812
8,453 16,906 25,359
Land 100,000 100,000 100,000 100,000
Total Assets $108,45 $116,90 $125,35 $133,81
3 6 9 2
Liabilities
Notes Payable $ $ $ $ -0-
78,453 54,751 28,679
Equity 3 6 9 2
Cash Flows From Oper.
Act.:
Inflow from Rental $40,000 $40,000 $40,000 $40,000
Outflow for Interest (10,000) (7,845) (5,475) (2,868)
Net Cash Flow fm. Op. 30,000 32,155 34,525 37,132
Act.:
Cash Flows From Inv.
Act.:
Outflow to Purchase (100,000 -0- -0- -0-
Land )
Cash Flows From Fin.
Act.:
Inflow from Loan 100,000 -0- -0- -0-
10-84
Outflow to Repay Loan (21,547) (23,702) (26,072) (28,679)
Net Cash Flow from Fin. 78,453 (23,702 (26,072) (28,679)
Act.
Plus: Beginning Cash -0- 8,453 16,906 25,359
Balance
Ending Cash Balance $ 8,453 $16,906 $25,359 $33,812
c. Because the company is making both principal and interest

payments on the loan each year, the amount paid on the
principal reduces the balance of the loan and consequently
the amount of interest paid on the loan each year. Even
though the total amount of the payment is the same each
year, the amount paid on the principal increases and the
amount paid on the interest decreases.
10-85
PROBLEM 10-26B
Computation of Interest Expense

Amount End of Interest Interest
Month Borrowed Month x Rate per = Expense
(Repaid) Balance Month
January $100,000 $100,000 .07/12 $ 583
February 50,000 150,000 .08/12 1,000
March (40,000) 110,000 .09/12 825
April -0- 110,000 .09/12 825
May -0- 110,000 .09/12 825
June -0- 110,000 .09/12 825
July -0- 110,000 .09/12 825
August -0- 110,000 .09/12 825
Septemb -0- 110,000 .09/12 825
er
October -0- 110,000 .09/12 825
Novemb (80,000) 30,000 .08/12 200
er
Decembe (20,000) 10,000 .07/12 58
r
Total $8,441
a.
Libby Company
Income Statement
Service Revenue $30,000
Expenses
Interest Expense (8,441)
Net Income $21,559
10-86
PROBLEM 10-26B a. (cont.)
Libby Company
Balance Sheet
As of December 31, 2006
Assets
Cash ($10,000 + $21,559) $31,559
Total Assets $31,55
9
Liabilities $10,00
0
Common Stock $ -0-
Total Stockholders’ Equity 21,559
Total Liabilities and Stockholders’ $31,55
Equity 9
Statement of Cash Flows
Activities:
Inflow from Revenue $30,000
Outflow for Interest (8,441)
Net Cash Flow from Operating $21,55
Activities 9
Cash Flows From Investing -0-
Activities
Activities:
Inflow from Loan 150,000
Outflow to Repay Loan (140,000
)
Net Cash Flow from Financing 10,000
Activities
10-87
Net Change in Cash 31,559
Plus: Beginning Cash Balance -0-
Ending Cash Balance $31,55
9
10-88
b. Libby used debt financing instead of equity financing.

Libby borrowed the cash to operate the business. The
difference in the revenue generated and the interest
expense incurred amounts to the net income. When the
revenue produced by borrowing exceeds the cost of the
borrowing, retained earnings (profits) will increase.
10-89
PROBLEM 10-27B
Provided for the instructor’s use:
Transactions:
1. Issued bonds at 96. Cash proceeds = $384,000; Discount =
$16,000.
2. Purchased land for $384,000.
3. Land rental, $50,000 per year, 2005, 2006, 2007.
4. Interest payments per year, $32,000, 2005, 2006, 2007.
5. Amortized discount per year, $800.
6. Sold the land for $400,000, 1/1/08.
7. Paid off bonds at 98, Cash payment of $392,000.
10-90
PROBLEM 10-27B (cont.) T-Accounts Provided for Instructor’s
Use:
2005 2005 2005
1. 384,000 2. 384,000 1. 400,000 cl 17,200
3. 50,000 4. 32,000 Bal. Bal. 17,200
400,000
Bal. 18,000 2008 2006
2006 7. cl. 17,200
400,000
3. 50,000 4. 32,000 Bal. -0- Bal. 34,400
Bal. 36,000 2007
2007 Discount on Bonds cl. 17,200
Pay.
3. 50,000 4. 32,000 2005 Bal. 51,600
Bal. 54,000 1. 16,000 5. 800 2008
2008 Bal. cl 10,400
15,200
6. 400,000 7. 392,000 2006 Bal. 62,000
Bal. 62,000 5. 800
Bal. Rental Income
14,400
Land 2007 2005
2005 5. 800 cl 50,000 3. 50,000
2. 384,000 Bal.13,600 2006
Bal. 2008 cl 50,000 3. 50,000
384,000
2008 7. 13,600 2007
6. 384,000 Bal. -0- 50,000 3. 50,000
Bal. -0- Bal. -0-
Interest Expense
2005
4. 32,000
5. 800 cl 32,800
2006
4. 32,000
5. 800 cl 32,800
2007
4. 32,000
5. 800 cl 32,800
Bal. -0-
Gain on Sale of Land
2008
cl 16,000 6. 16,000
Bal. -0-
10-91
Loss on Bond
Redempt.
2008
7. 5,600 cl 5,600
Bal. -0-
10-92
Box Company
Rent Revenue $50,00 $50,00 $50,00 $
0 0 0 -0-
Interest Expense (32,800 (32,800 (32,80 -0-
) ) 0)
Operating Income 17,200 17,200 17,200 -0-
Non-Operating
Income/Expense
Gain on Sale of Land -0- -0- -0- 16,000
Loss on Bond Redemption -0- -0- -0- (5,600)
Net Income $17,20 $17,20 $17,20 $10,40
0 0 0 0
Statement of Changes in
Stockholders’ Equity 2005 2006 2007 2008
Common Stock $ $ $ $ -0-
-0- -0- -0-
Beginning Retained -0- 17,200 34,400 51,600
Earnings
Plus: Net Income 17,200 17,200 17,200 10,400
Ending Retained Earnings 17,200 34,400 51,600 62,000
Total Stockholders’ Equity $17,20 $34,40 $51,60 $62,00
0 0 0 0
10-93
Box Company Financial Statements

Balance Sheets 2005 2006 2007 2008
Assets
Cash $ 18,000 $ $ $62,000
36,000 54,000
Land 384,000 384,000 384,000 -0-
Total Assets $402,000 $420,00 $438,00 $62,000
0 0
Liabilities
Bonds Payable $400,00 $400,00 $400,00 $ -0-
0 0 0
Discount on Bonds (15,200) (14,400) (13,600) -0-
Payable
Total Liabilities 384,800 385,600 386,400 -0-
Equity 0 0
Cash Flows From Oper.
Act.:
Inflow from Rental $50,000 $50,000 $50,000 $ -0-
Outflow for Interest (32,000) (32,000) (32,000) -0-
Net Cash Flow from Opr. 18,000 18,000 18,000 -0-
Act.
Cash Flows From Inv.
Act.:
Inflow from Sale of -0- -0- -0- 400,000
Land
Outflow to Purchase (384,000) -0- -0- -0-
Land
Net Cash Flow from Inv. (384,000 -0- -0- 400,000
Act. )
Cash Flows From Fin.
Act.:
10-94
Inflow from Bond Issue 384,000 -0- -0- -0-
Outflow to Repay Bond -0- -0- -0- (392,000
)
Net Cash Flow from Fin. 384,000 -0- -0- (392,000
Act. )
Plus: Beginning Cash -0- 18,000 18,000 54,000
Balance
Ending Cash Balance $ $36,000 $54,000 $62,000
18,000
10-95
PROBLEM 10-28B
a. The bonds sold for less than the face amount; therefore,
the bonds were sold at a discount. This means that the
stated rate of interest is less than the market rate of
interest. The amount of the discount acts to equate the
two interest rates. If the bonds had been sold at the face
amount, Joy would have received $100,000 in cash.
b.
2006
Jan. 1 Cash 96,000
31
Cash 10,000
Dec. Interest Expense2 400
31
31
2007
31
Cash 10,000
31
31
1
$100,000 x 10% = $10,000
10-96
2
$4,000 ÷ 10 = $400
10-97
c.
2006 2007
Liabilities
Bonds Payable $100,000 $100,000
Less: Discount on Bonds (3,600) (3,200)
Payable
Carrying Value of Bonds $ 96,400 $ 96,800
Payable
2006 2007
d Interest Expense Reported on Income $10,40 $10,40
. Statement: 0 0
2006 2007
e Interest Paid in Cash to Bondholders: $10,00 $10,00
. 0 0
10-98
PROBLEM 10-29B
Stafford Co.
Even Type Common Retaine Net
t No. of Assets = Liabilitie + Stock + d Income Cash
Event s Earning Flow
s
1. AS + = NA + + + NA NA + FA
2. AS + = + + NA + NA NA + FA
3. AE +− = NA + NA + NA NA − IA
4. AS + = NA + NA + + + + OA
5. CE NA = + + NA + − − NA
6. AU − = NA + NA + − − − OA
g
8. Closin NA = NA + NA + −/+ NA NA
g
9. AS + = NA + NA + + + + OA
10. CE NA = + + NA + − − NA
11. AU − = NA + NA + − − − OA
g
13. Closin NA = NA + NA + −/+ NA NA
g
14. AS/AE + = NA + NA + + + + IA
15. AU − = − + NA + NA NA − FA
10-99
PROBLEM 10-30B
a.
Rev./ Exp./
No. Assets = Liab. + S. Gain − Loss =Net Inc. Cash Flows
Equity
1. 300,000 = 300,000 + NA NA − NA = NA 300,000 FA
2. (30,000) = NA +(30,000 NA − 30,00 =(30,000 (30,000) OA
) 0 )
3. (315,000 = (300,000 +(15,000 NA − 15,00 =(15,000 (315,000) FA
) ) ) 0 )
b.
General Journal
1. Cash 300,000
2. Interest Expense1 30,000
Cash 30,000
3. Bonds Payable 300,000
Loss on Redemption of Bonds 15,000
Cash2 315,000
1
$300,000 x 10% = $30,000
2
$300,000 x 105% = $315,000
10-
100
PROBLEM 10-31B
a.
Bond Issued at Face Value

. Equity Inc. Flows
1. + = + + NA NA − NA = NA + FA
2. − = NA + − NA − + = − − OA
3. − = − + NA NA − NA = NA − FA
b.
Bond Issued at a Discount

. Equity Inc. Flows
1. + = + + NA NA − NA = NA + FA
2a − = NA + − NA − + = − − OA
.
2b NA = + + − NA − + = − NA
.
3. − = − + NA NA − NA = NA − FA
c.
Bond Issued at a Premium

. Equity Inc. Flows
1. + = + + NA NA − NA = NA + FA
2a − = NA + − NA − + = − − OA
.
2b NA = + + + NA − − = + NA
.
3. − = − + NA NA − NA = NA − FA
10-
101
PROBLEM 10-32B
a. Computation of Selling Price:

Amount Table Factor Present Value
Principal Amount $500,000 x .422411 = $211,206
Interest Payments 40,000 x 6.417658 = 256,706
b.
1/1/04 Cash 467,912
c.
Calculation of Interest Expense and Discount Amortization:
Bond Interest Discount
Bond Unamort. Carrying Exp. Interest Paid Amortized
Date Payable Discount Value (CV x 9%) (BP x 8%) (Exp. − Paid)
2004 $500,000 32,088 $467,912 $42,112 $40,000 $2,112

2005 500,000 29,976 470,024 42,302 40,000 2,302

12/31/04 Interest Expense 42,112
Cash 40,000
d. See schedule above: $42,302
ATC 10-1
10-
102
a. Dell’s balance sheet lists “Long-term debt” of $509
million and “Other” noncurrent debt of $761 million.
The “Long-term Debt and Interest Rate Risk
Management” note on page 36 indicates that $200
million of this is for notes payable due in 2008, and
$300 million is for debentures due in 2028. The
“Other” noncurrent liabilities of $761 million are
described on page 42 as consisting of $306 million
for “Deferred income,” and $455 million for “Other”.
b. The debt with the longest maturity are the

debentures that mature in 2028.
c. $250 million. See “Financing Arrangements” on

page 36 of the annual report.
10-
103
ATC 10-2
a.
(1)(a)
Lot, Inc.: $100,000 x 102.25% = $102,250
Max, Inc.: $100,000 x 98% = $98,000
Par, Inc.: $100,000 x 104% = $104,000
(1)(b)
Interest Expense = Interest paid +/− amortized discount/premium.
Amortization of premium or discount:
Lot, Inc.: Premium amortization = $2,250 ÷ 5 = $450 per year.
Max, Inc.: Discount amortization = $2,000 ÷ 5 = $400 per year.
Par, Inc.: Premium amortization = $4,000 ÷ 5 = $800 per year.
Interest Expense:
Lot, Inc.: $8,000 − $450 = $7,550 per year.
Max, Inc.: $8,000 + $400 = $8,400 per year.
Par, Inc.: $8,000 − $800 = $7,200 per year.
(1)(c )
Interest Paid:
Lot, Inc.: Interest paid = $100,000 x 8% = $8,000 per year.
Max, Inc.: Interest paid = $100,000 x 8% = $8,000 per year.
Par, Inc.: Interest paid = $100,000 x 8% = $8,000 per year.
(2)
December 31, 2006
Lot Max Par
Liabilities
Bonds Payable $100,00 $100,00 $100,00
0 0 0
Less: Discount on Bonds (1,600)
Payable
Plus: Premium on Bonds 1,800 3,200
Payable
Carrying Value of Bonds $101,80 $ $103,20
Payable 0 98,400 0
10-
104
Lot, Inc. $2,250 − $450 = $1,800; Par, Inc. $4,000 − $800 =
$3,200
Max, Inc. $2,000 − $400 = $1,600
10-
105
ATC 10-2 (cont.)
c. The amount of interest expense is different for each of the three

companies because the issue price was different; consequently
the amount of premium or discount amortized is different for each
company.
d. The amount of interest paid is the same for each of the

companies because the face amount of the bond and the interest
rate is the same for all three.
e. The amount of liabilities is different for each of the companies

because the amount of premium or discount is different for each
making the carrying value of the bonds different.
10-
106
ATC 10-3
The credit ratings and the company to which each relates are as
follows:
A = Alltel
BB = Barnes & Noble (B&N)
CCC+ = Ameriking
D = Carmike
Students will probably identify the companies with the two

lowest ratings as Ameriking and Carmike, since both had net
losses during 1998 and 1999. Upon closer examination, they can
probably identify Carmike as the company with the D rating,
since is the only company with a negative return-on-assets ratio,
and it has a lower current ratios and a higher debt-to-assets
ratios than Ameriking. The information presented in the
textbook intentionally omitted disclosing that Carmike was in
Chapter 11 proceedings at the time this case was written.
Students may have more trouble deciding whether Alltel or B&N

is the company with the A versus the BB rating. B&N has the
advantage in that its current ratios and times-interest-earned
ratios are higher than Alltel’s, and its debt-to-assets ratios are
lower. Conversely, Alltel had better return-on-assets ratios in
1998 and 1999 than did B&N. Also, though most students will
not think to compute it, Alltel had a higher ratio of cash flows
from operations to net earnings than did B&N, as computed
below.
Cash flow from Operating Net Income for

Company Activities for 1998 + 1999 ÷ 1998 + 1999 =
Ratio
Alltel $2,905,877 ÷ $1,386,761 =

2.10
B&N $ 364,999 ÷ $ 216,874 =

1.68
10-
107
There is also the fact that Alltel is a larger company than B&N,
and it is in an industry with more growth potential than is B&N.
Obviously the analysts at Standard & Poor’s had a lot more

information to use than is presented in the textbook, but after
considering all the factors, they gave Alltel a rating of A, and
B&N a rating of BB.
10-
108
ATC 10-4
a. First, compute the EBIT for each company:
Quality Super Lawn
Landscaping Care
Net Income $ 46,500 $ 51,000

Interest Expense 27,500 20,000
Tax Expense 31,000 34,000
EBIT $105,000 $105,000
Debt-to-assets:
Quality Landscaping: $300,000 ÷ $350,000 = 85.7%

Super Lawn Care: $220,000 ÷ $350,000 = 62.9%
Current ratio:
Quality Landscaping: $20,000 ÷ $35,000 = .57 to 1.00

Super Lawn Care: $20,000 ÷ $25,000 = .80 to
1.00
Times interest earned:
Quality Landscaping: $105,000 ÷ $27,500 = 3.82 times

Super Lawn Care: : $105,000 ÷ $20,000 = 5.25
times
Quality Landscaping appears to have a greater financial risk

because it has:
a higher debt-to-assets ratio.
a lower current ratio.
a lower times interest earned ratio.
b. Return-on-equity:

Super Lawn Care: $51,000 ÷ $130,000 = 39.2%
Return-on-assets:

Super Lawn Care: $105,000 ÷ $350,000 = 30.0%
10-
109
ATC 10-4 b.(cont.)
Even though the return-on-assets ratios of Quality Landscaping and

Super Lawn Care are equal, Quality Landscaping generated a much
higher return-on-equity than Super Lawn Care through the use of
financial leverage. The ratios in part a. show that Quality
Landscaping is using debt to a greater extent than Super Lawn Care.
10-
110
ATC 10-5
a. Note to Instructor: Students may be able to solve

this problem more easily if they first prepare a table
showing the balances in current assets, total assets,
current liabilities, and total liabilities for each
situation. Then, they can more easily compute the
new ratios and determine the effects of each
transaction on each ratio.
Current Total Current Total

Situation Assets Assets Liabilities Liabilities
Currently $100,000$325,000 $65,000
$225,000
Using bonds 200,000 425,000 65,000
325,000
Using stock 200,000 425,000 65,000
225,000
If Bonds If
Stock
Currently Are Issued Is
Issued
Current ratio 1.54/1 (1) 3.08/1 (2)
3.08/1 (2)
Debt to assets ratio 69.2% (3) 76.5% (4)
52.9% (5)
(1) $100,000 ÷ $ 65,000 = 1.54 to 1.00

(2) $200,000 ÷ $ 65,000 = 3.08 to 1.00
(3) $225,000 ÷ $325,000 =69.2%
(4) $325,000 ÷ $425,000 =76.5%
(5) $225,000 ÷ $425,000 =52.9%
b. Bonds Stock
EBIT $50,000 $50,000
Interest expense 10,000 -0-
10-
111
Pretax earnings 40,000
50,000
Tax expense (30%) 12,000
15,000
Net earnings 28,000 35,000
Dividends -0-
10,000
Additional retained earnings $28,000
$25,000
10-
112
ATC 10-6
a.
Mack Company
Selected Financial Statements for 2003
Type of Financing
Debt Equity
Income Statement for 2003
Rental Revenue ($50,000 x .15) $7,500 $7,500
Interest Expense (5,000) -0-
Net Income Before Tax 2,500 7,500
Income Tax Expense (30%) (750) (2,250)
Net Income After Tax $1,750 $5,250
Statement of Cash Flows for 2003
Activities
Inflow from Revenue $7,500 $7,500
Outflow for Interest Expense (5,000) -0-
Outflow for Tax Expense (750) (2,250)
Activities
Cash Flows from Investing Activities -0- -0-
Cash Flows From Financing Activities
Issue of Bonds 50,000 -0-
Issue of Stock -0- 50,000
Payment of Dividends -0- (5,000)
Net Cash Flow from Financing 50,000 45,000
Activities
Add, Beginning Cash Balance -0- -0-
Ending Cash Balance $51,750 $50,250
10-
113
ATC 10-6 (cont.)
b. The students should explain that the net income will

be higher under the equity alternative, because
interest is a deductible expense with debt financing.
However, the students should also note that the net
cash inflow will be greater when debt financing is
used. The difference is caused by the amount of tax
paid under the two alternatives.
10-
114
ATC 10-7
a. Forecast Statements
Forecast Forecast Forecast
Financial Statements 1 2 3
Income Statements
Revenue $120,000 $160,000 $160,000
Operating Expenses (70,000) (77,000) (77,000)
Income Before Interest and Taxes 50,000 83,000 83,000
Interest Expense -0- -0- (11,620)
Income Tax Expense (30%) (15,000) (24,900) (21,414)
Net Income $ 35,000 $ 58,100 $ 49,966
Statements of Changes in Stockholders’ Equity
Beginning Retained Earnings $15,000 $15,000 $15,000
Plus: Net Income 35,000 58,100 49,966
Less: Dividend to Watson -0- (11,620) -0-
Ending Retained Earnings $50,000 $61,480 $64,966
Balance Sheets
Assets (see Note 1 below) $400,000 $511,480 $514,966
Liabilities $ -0- $ -0- $100,000
Common Stock 350,000 450,000 350,000
Retained Earnings 50,000 61,480 64,966
Total Liab. And Stockholders’ Equity $400,000 $511,480 $514,966
Note 1: The asset balance for the current period is

computed as the beginning balance of $365,000 plus net
income of $35,000. The balance for the forecasted
statements is computed as the beginning balance of
$365,000, plus the $100,000 cash investment, plus net
income of $58,100, less the $11,620 dividend.
Alternatively, total assets can be computed by
determining the amount of total claims (.i.e., Total Assets
= Total Claims).
10-
115
ATC 10-7 (cont.)
b. The difference in retained earning between forecast 2

and 3 is:
Forecast 3 − Forecast 2=
Differenc
e
Ret. $64,966 − $61,480 = $3,486
Earnings
c. Harbert’s proposal violates the tax law. The personal

checks provide evidence of an intentional scheme to
evade taxes. Entering into the agreement constitutes
activity that is subject to criminal prosecution.
Accordingly, Watson should reject Harbert’s proposal.
d. As indicated above, misrepresenting the truth on a

tax return constitutes a fraudulent activity that is not
only unethical but illegal as well. Further, it would
behoove Watson to consider the fact that if Harbert is
willing to defraud the IRS, she is likely to be willing to
defraud her business associates as well. Watson’s
safest course of action is to disassociate himself from
not only the proposed transaction but from any and
all business ventures associated with Harbert.
10-
116
ATC 10-8 Using the EDGAR Database
NOTE: This solution was accurate as of January 3,

2002. However, the EDGAR database is subject
to update at any time, so this solution will likely
be “dated” at the time you assign this case to
your students.
These data are from the December 31, 2000 financial

statements and dollar amounts are in millions.
a. Total assets were $21,931 and total debt was

$16,588 (Total debt was not stated; it must be
determined by subtracting equity from assets.)
The debt-to-assets ratio was 75.6%
b. Delta’s net interest expense in 2000 was $271.
c. Delta had capital leases totaling $139 ($40 + $99)

and total liabilities of $16,588. Thus, capital leases
comprises less than 1% of liabilities.
(The balance sheet for Delta shows capital leases of

$99 in the long-term debt section, and $40 under
current liabilities.
d. Long-term debt totaled $10,251 at the end of 2000.

Thus, debt arising from capital leases was slightly
less than 1% of long term debt. ($99 ÷ $10,251)
e. Capital leases cause a company’s liabilities (and

assets) to be higher. By avoiding capital leases, a
company’s liabilities (and assets) will be lower,
resulting in “better” ratios, such as the debt-to-assets
and return-on-assets ratios. Consider that as of
December 31, 2000, Delta had committed to make
future payments of $171 for capital leases. The $139
present-value of these future payments showed up on
its balance sheet as liabilities. However, as of that
10-
117
same date, Delta had committed to make future
payment of $15,120(!) for operating leases, of which
none showed up on the balance sheet as liabilities.
10-
118

Chapter 10 Solution of Fundamental of Financial Accouting by EDMONDS (4th Edition)

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Chapter 10 Solution of Fundamental of Financial Accouting by EDMONDS (4th Edition)

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ANSWERS TO QUESTIONS - CHAPTER 10

1. Short-term notes mature within one year or one

Interest expense in year 1 and 2 is $5,760 and $4,921,

3. A line of credit is a preapproved amount of credit that is

4. A business may need to borrow funds for a short period

5. One of the primary advantages of bond financing is that

6. One of the primary disadvantages of a bond issue is the

7. One reason that a company may be able to borrow money

8. Tax rules seem to encourage borrowing (debt financing)

9. Financial leverage is the concept of acquiring additional

11. Restrictive covenants are limitations placed on a

13. Term bonds mature on a specific date in the future. For

Serial bonds mature at specified intervals over the life of

14. A sinking fund is a fund into which a company makes

16. The issuance of $100,000, 5%, 10-year bonds at face will

Annual interest expense and interest payments will be

17. Bonds can be issued at a premium or discount (an

19. The issuance of bonds by a company is an asset source

20. The passage of time is usually the cause of the effective

The total liability to be paid at maturity is $25,000. That

25. The issuer of a bond would prefer to pay interest annually

26. The $2,850 loss, if material, is shown as an extraordinary

27. Debt financing has a tax advantage over equity financing

28. The after-tax cost of the debt is $7,000, computed as

Interest Expense $10,000

Note: A $10,000 dividend paid to stockholders is not

29. Debt financing increases the risk factor of a business.

30. The times-interest-earned ratio (EBIT/Interest Expense)

31. Simple Interest is interest on the principal only and is

Compound interest means that interest earned is

32. The future value of an investment is the amount that an

The future value of an investment can be calculated by

$10,000 x (1 + .08)4 = $10,000 x 1.3604890 =

Alternatively, the factor can be found in Table I by moving

34. The present value of an investment is the worth today of

Present value is calculated by multiplying the amount of

35. Present value of $25,000 to be received in 3 years,

36. The present value of a $4,000 annuity received for 4

37. The effective interest method applies a constant rate of

The effective interest method is conceptually more

Option 1 - annual interest only:

Option 2 - annual interest and $10,000 on principal:

Note: The amount of interest paid in year 1 is the same under

Option 1 - annual interest only:

Option 2 - annual interest and $10,000 on principal:

c. Under option one, only annual interest is paid. This is a

*Adjusted due to rounding.

Balance Sheet Income Statement Statement

d. Principal 1/1/04: $97,618 ($124,937 − $27,319)

Amount Balance Interes Interes

Date Account Titles Debit Credit

b. $50,000 x 9% x 6/12 = $2,250 on June 30

or a total of $4,500 will be paid in 2004.

c. The total amount of interest paid each year will be the

Face x Selling Cash Discount or

a. Discount (Stated rate is less than market rate.)

b. Discount (Stated rate is less than market rate.)

c. Premium (Stated rate is greater than market rate.)

a. $60,000 x 4% = $2,400; Premium

b. $90,000 x 1.5% = $1,350; Premium

c. $200,000 x 1.75% = $3,500; Discount

d. $150,000 x 4% = $6,000; Discount