CHAPTER 15

NON-CURRENT LIABILITIES
CHAPTER STUDY OBJECTIVES

1. Describe the characteristics of bonds. Debt offers the following advantages over equity:
(1) shareholder control is not affected, (2) income tax savings result, (3) earnings per share may
be higher, and (4) return on equity may be higher. Bonds are a common form of long-term debt
issued by entities. Bonds have many different features and may be secured, unsecured,
convertible, and callable. The terms of the bond are set forth in the bond indenture, and a bond
certificate provides the specific information about the bond itself.

2. Calculate the price of a bond. Because interest rates fluctuate, the market price of a bond
may vary. Bond pricing is determined using time value of money concepts. To calculate the
price of a bond, it is necessary to calculate the present value of the following two cash flows
associated with the bond: (1) the present value of the interest payments over the life of the bond
and (2) the present value of the principal to be repaid. This calculation may be done using either
present value tables or a financial calculator.

3. Account for bond transactions. When bonds are issued, the Bonds Payable account is
credited for the bonds’ market value (present value). Bonds are issued at a discount if the
market interest rate is higher than the contractual interest rate. Bonds are issued at a premium if
the market interest rate is lower than the contractual interest rate.
Bond discounts and bond premiums are amortized to interest expense over the life of the bond
using the effective-interest method of amortization. Amortization of the bond discount or
premium is the difference between the interest paid and the interest expense. Interest paid is
calculated by multiplying the face value of the bonds by the contractual interest rate. Interest
expense is calculated by multiplying the amortized cost of the bonds at the beginning of the
interest period by the market interest rate. The amortization of a bond discount increases
interest expense. The amortization of a bond premium decreases interest expense.

4. Account for the retirement of bonds. When bonds are retired at maturity, Bonds Payable is
debited and Cash is credited. There is no gain or loss at retirement. When bonds are redeemed
before maturity, it is necessary to (1) pay and record any unrecorded interest, (2) eliminate the
amortized cost of the bonds at the redemption date, (3) record the cash paid, and (4) recognize
any gain or loss on redemption.

5. Account for instalment notes payable. Instalment notes payable are repayable in a series
of instalments. Each payment consists of (1) interest on the unpaid balance of the note, and (2)
a reduction of the principal balance. These payments can be either (1) fixed principal plus
interest payments or (2) blended principal and interest payments. With fixed principal payments,
the reduction in principal is constant but the cash payment and interest decrease each period

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15 - 2 Exercises for Accounting Principles, Seventh Canadian Edition

(as the principal decreases). With blended payments, the cash payment is constant but the
interest decreases and the principal reduction increases each period.

6. Account for leases. For an operating lease, lease (or rental) payments are recorded as an
expense by the lessee (renter). For a finance or capital lease, the transaction is considered to
be equivalent to a purchase of an asset. The lessee records the asset and the related obligation
at the present value of the future lease payments. The income statement reflects both the
interest expense and depreciation expense.

7. Explain and illustrate the methods for the presentation and analysis of non-current
liabilities. The current portion of debt is the amount of the principal that must be paid within one
year of the balance sheet date. This amount is reported as a current liability in the balance
sheet, and the remaining portion of the principal is reported as a non-current liability. The nature
of each liability should be described in the notes accompanying the financial statements. A
company’s long-term solvency may be analyzed by calculating two ratios. Debt to total assets
indicates the proportion of company assets that is financed by debt. Interest coverage measures
a company’s ability to meet its interest payments as they come due.

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 Non-Current Liabilities 15 - 3

EXERCISES

Exercise 1
On June 30, 2017, Layton, Inc. sold $1,200,000 (face value) of bonds. The bonds are dated
June 30, 2017, pay interest semi-annually on December 31 and June 30, and will mature on
June 30, 2020. The following schedule was prepared by the accountant for 2017:
Semi-annual Interest to Interest Unamortized Bond
Interest Period be Paid Expense Amortization Amount Amortized cost
$62,906 $1,137,094
Dec 31, 2017 $36,000 $45,484 $9,484 53,422 1,146,578

Instructions
On the basis of the above information, answer the following questions. (Round your answer to
the nearest dollar or percent.)
a) What is the contractual rate of interest for this bond issue?
b) What is the market rate of interest for this bond issue?
c) What was the selling price of the bonds as a percentage of the face value?
d) Prepare the journal entry to record the sale of the bond issue on June 30, 2017.
e) Prepare the journal entry to record the payment of interest and amortization on December
31, 2017.

Solution 1 (12–17 min.)

a) $36,000 ÷ $1,200,000 =.03 × 2 = 6%

b) $45,484 ÷ $1,137,094 =.04 × 2 = 8%

c) $1,137,094 ÷ $1,200,000 =.95 The bonds were sold at 95.

d) June 30, 2017

Cash ............................................................................................. 1,137,094
Bonds Payable ....................................................................... 1,137,094

e) December 31, 2017

Interest Expense ........................................................................... 45,484
Bonds Payable ....................................................................... 9,484
Cash....................................................................................... 36,000

Bloomcode: Application
Difficulty: Medium
Learning Objective: Describe the characteristics of bonds.
Section Reference: Non-Current Liabilities—Bonds Payable
Learning Objective: Calculate the price of a bond.
Section Reference: Bond Pricing
Learning Objective: Account for bond transactions.
Section Reference: Accounting for Bond Issues
CPA: Financial Reporting

Exercise 2

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15 - 4 Exercises for Accounting Principles, Seventh Canadian Edition

On September 1, 2017, Olynik Corporation issued $1,000,000, 6%, 10-year bonds. Interest is
payable annually with the first payment due on September 1, 2018.

Instructions
a) For each of the following market rate assumptions, identify whether Olynik would issue the
bonds at face value, at a discount or at a premium: (1) 5%, (2) 6%, and (3) 7%.
b) Provide the appropriate journal entry on September 1, 2017 to record the issuance of the
bond if the market rate of interest is 7%. Round your answer to the nearest dollar.
c) Assuming Olynik has a December 31 year end, prepare the year end adjusting entry to
account for accrued interest on the bond.

Solution 2 (10 min.)

a) (1) Market rate of interest of 5% is lower than the contractual rate = Premium
(2) Market rate of interest of 6% is equal to the contractual rate = Face Value
(3) Market rate of interest of 7% is higher than the contractual rate = Discount

b) Sep 1 Cash ............................................................................. 929,765

Bonds Payable ....................................................... 929,765

Calculation with PV tables:

1) PV of the maturity value = $1,000,000 x 0.50835 = $508,350
2) PV of annuity payments = ($1,000,000 x 0.06) x 7.02358 = $421,415
$929,765
Calculation using calculation:
10N; 7I; -60,000PMT; -1,000,000FV; PV = $929,764

c) Dec 31 Interest Expense ........................................................... 21,695

Interest Payable ..................................................... 21,695
Interest accrual = $929,765 x 7% x 4/12 = $21,695

Bloomcode: Application
Difficulty: Medium
Learning Objective: Describe the characteristics of bonds.
Section Reference: Non-Current Liabilities—Bonds Payable
Learning Objective: Calculate the price of a bond.
Section Reference: Bond Pricing
Learning Objective: Account for bond transactions.
Section Reference: Accounting for Bond Issues
CPA: Financial Reporting

Exercise 3
On September 1, 2017, Erving Corporation issued $1,000,000, 6%, 10-year bonds. Interest is
payable annually with the first payment due on September 1, 2018.

Instructions
a) Provide the appropriate journal entry on September 1, 2017 to record the issuance of the
bond if the market rate of interest is 5%. Round your answer to the nearest dollar.
b) Assuming Erving has a December 31st year end, prepare the 2017 year end adjusting entry
to account for accrued interest on the bond. Round your answer to the nearest dollar.

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 Non-Current Liabilities 15 - 5

c) Prepare a partial balance sheet at December 31, 2017 for Erving Corporation displaying all
amounts related to the bond.
d) Prepare the journal entry on September 1, 2018 to record the first interest payment.
e) Assume the bonds were redeemed for $1,050,000 at September 31, 2020 when the
amortized cost was $1,035,000. Record the redemption of the bonds.

Solution 3 (20 min.)

2017
a) Sep 1 Cash ............................................................................. 1,077,213
Bonds Payable ....................................................... 1,077,213

Calculation with PV tables:

1) PV of the maturity value = $1,000,000 x 0.61391 = $613,910
2) PV of annuity payments = ($1,000,000 x 0.06) x 7.72173 = $463,303
$1,077,213
Calculation using calculation:
10N; 5I; -60,000PMT; -1,000,000FV; PV = $1,077,217

b) Dec 31 Interest Expense ........................................................... 17,954

Interest Payable ..................................................... 17,954
Interest accrual = $1,077,217 x 5% x 4/12 = $17,954
c)
ERVING CORPORATION
Balance Sheet (partial)
December 31, 2017
Current liabilities
Interest payable............................................................................. $ 17,954

Non-current liabilities
Bond payable ............................................................................... $ 1,077,213

2018
d) Sep 1 Interest Expense ........................................................... 35,907
Interest Payable ............................................................ 17,954
Bonds Payable .............................................................. 6,139
Cash ....................................................................... 60,000
Interest accrual = $1,077,217 x 5% x 8/12 = $35,907

2020
e) Sep 1 Bonds Payable .............................................................. 1,035,000
Loss on Bond Redemption ............................................ 15,000
Cash ....................................................................... 1,050,000

Bloomcode: Application
Difficulty: Hard
Learning Objective: Describe the characteristics of bonds.
Section Reference: Non-Current Liabilities—Bonds Payable
Learning Objective: Calculate the price of a bond.
Section Reference: Bond Pricing
Learning Objective: Account for bond transactions.

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15 - 6 Exercises for Accounting Principles, Seventh Canadian Edition

Section Reference: Accounting for Bond Issues

Learning Objective: Explain and illustrate the methods for the presentation and analysis of non-
current liabilities.
Section Reference: Statement Presentation and Analysis
CPA: Financial Reporting

Exercise 4
On September 1, 2017, Olynik Corporation issued $1,000,000, 6%, 10-year bonds. Interest is
payable annually with the first payment due on September 1, 2018.

Instructions
Prepare the appropriate journal entry to record the bond issuance on September 1, 2017 under
each of the following market rate assumptions: a) 6%, b) 5%, and c) 7%. Round answers to the
nearest dollar.

Solution 4 (10 min.)

a) Sep 1 Cash ............................................................................. 1,000,000
Bonds Payable ....................................................... 1,000,000

b) Sep 1 Cash ............................................................................. 1,077,213

Bonds Payable ....................................................... 1,077,213

Calculation with PV tables:

1) PV of the maturity value = $1,000,000 x 0.61391 = $613,910
2) PV of annuity payments = ($1,000,000 x 0.06) x 7.72173 = $463,303
$1,077,213
Calculation using calculation:
10N; 5I; -60,000PMT; -1,000,000FV; PV = $1,077,217

c) Sep 1 Cash ............................................................................. 929,765

Bonds Payable ....................................................... 929,765

Calculation with PV tables:

3) PV of the maturity value = $1,000,000 x 0.50835 = $508,350
4) PV of annuity payments = ($1,000,000 x 0.06) x 7.02358 = $421,415
$929,765
Calculation using calculation:
10N; 7I; -60,000PMT; -1,000,000FV; PV = $929,764

Bloomcode: Application
Difficulty: Easy
Learning Objective: Calculate the price of a bond.
Section Reference: Bond Pricing
CPA: Financial Reporting

Exercise 5
On February 1, 2017, the Mary Miles Corporation issued $100,000, 5%, 5-year bonds. Interest
is payable semi-annually on August 1 and February 1.

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 Non-Current Liabilities 15 - 7

Instructions
a) Prepare the journal entries that Mary Miles would make on February 1 if it issued the bonds
at (1) 100, (2) 98, and (3) 102.
b) How much interest would Mary Miles Corporation pay on August 1, 2017 under each of the
three issue prices listed in a)?

Solution 5 (10 min.)

a) (1) Feb 1 Cash ......................................................................... 100,000
Bonds Payable ................................................... 100,000

(2) Feb 1 Cash ($100,000 × 0.98) ............................................ 98,000

Bonds Payable ................................................... 98,000

(3) Feb 1 Cash ($100,000 × 1.02) ............................................ 102,000

Bonds Payable ................................................... 102,000

b) Mary Miles would pay interest of $2,500 ($100,000 × 5% × 6 ÷ 12) each semi-annual period
regardless of the issue price. The cash paid for interest is based on the contractual interest
rate. The interest expense would vary, depending on whether the bonds were issued at a
discount or at a premium.

Bloomcode: Application
Difficulty: Easy
Learning Objective: Calculate the price of a bond.
Section Reference: Bond Pricing
CPA: Financial Reporting

Exercise 6
On January 1, 2017, Teddy Corporation issued $300,000, 5%, 10-year bonds dated January 1,
2017, to yield 4%. The bonds pay semi-annual interest on January 1 and July 1.

Instructions
Calculate the selling price of the bond and prepare the journal entry to record the issue of the
bond.

Solution 6 (5 min.)

Present value of $300,000 received in 20 periods

$300,000 x 0.67297 (n = 20, i = 2%) .................................................... $ 201,891
Present value of ($300,000 x 5% x 6 ÷ 12) received for 20 periods
$7,500 x 16.35143 (n = 20, i = 2%) ...................................................... 122,636
Total..................................................................................................... $ 324,527

January 1, 2017
Cash ............................................................................................. 324,527
Bonds Payable ....................................................................... 324,527
To record sale of bonds at a premium

Bloomcode: Application

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15 - 8 Exercises for Accounting Principles, Seventh Canadian Edition

Difficulty: Easy
Learning Objective: Calculate the price of a bond.
Section Reference: Bond Pricing
CPA: Financial Reporting

Exercise 7
On January 1, 2017, Callahan Corporation issued $600,000, 9%, 5-year bonds, dated January
1, 2017, at 104. The bonds pay interest semi-annually on January 1 and July 1. The company
has a December 31 year end. Assume amortization of $1,700 and $2,100 respectively for the first
two semi-annual interest periods.

Instructions
Prepare the journal entries that Callahan Corporation would make related to the bond issue on
the dates indicated below:
January 1, 2017 July 1, 2017 December 31, 2017 January 1, 2018

Solution 7 (8–11 min.)

January 1, 2017
Cash (600,000 X 104%) ................................................................ 624,000
Bonds Payable ....................................................................... 624,000
To record sale of bonds issued at a premium

July 1, 2017
Bond Interest Expense .................................................................. 25,300
Bonds Payable .............................................................................. 1,700
Cash....................................................................................... 27,000
To record semi-annual payment of interest and
amortization of premium

December 31, 2017

Bond Interest Expense .................................................................. 24,900
Bonds Payable .............................................................................. 2,100
Bond Interest Payable ............................................................ 27,000
To record accrued bond interest and amortization of
bond premium

January 1, 2018
Bond Interest Payable ................................................................... 27,000
Cash....................................................................................... 27,000
To record payment of bond interest liability

Bloomcode: Application
Difficulty: Medium
Learning Objective: Calculate the price of a bond.
Section Reference: Bond Pricing
CPA: Financial Reporting

Exercise 8

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 Non-Current Liabilities 15 - 9

On January 1, 2017, Digeridoo Corporation issued $900,000, 8%, 5-year bonds dated January
1, 2017, to yield 9%. The bonds pay semi-annual interest on January 1 and July 1. The
company has a December 31 year end.

Instructions
a) Calculate the selling price of the bond (round final answer to the nearest $1,000).
b) Prepare all the journal entries that Digeridoo Corporation would make related to this bond
issue from issue date through to January 1, 2018.

Solution 8 (8–12 min.)

a) Present value of $900,000 received in 10 periods
$900,000 x 0.64393 (n = 10, i = 4.5%) .......................................... $ 579,537
Present value of ($900,000 x 8% x 6 ÷ 12) received for 10 periods
$36,000 x 7.91272 (n = 10, i = 4.5%) ............................................ 284,858
Total .............................................................................................. $ 864,395

Rounded to nearest $1,000 ........................................................... $ 864,000

b)
January 1, 2017
Cash ............................................................................................. 864,000
Bonds Payable ....................................................................... 864,000
To record sale of bonds at a discount

July 1, 2017
Bond Interest Expense (864,000x 9% x 6 ÷ 12) ............................ 38,880
Bonds Payable ....................................................................... 2,880
Cash....................................................................................... 36,000
To record semi-annual payment of interest and
amortization of discount

December 31, 2017

Bond Interest Expense ((864,000+2,880) x 9% x 6 ÷ 12) .............. 39,010
Bonds Payable ....................................................................... 3,010
Bond Interest Payable ............................................................ 36,000
To record accrued bond interest and amortization of
bond discount

January 1, 2018
Bond Interest Payable ................................................................... 36,000
Cash....................................................................................... 36,000
To record payment of bond interest liability

Bloomcode: Application
Difficulty: Medium
Learning Objective: Calculate the price of a bond.
Section Reference: Bond Pricing
Learning Objective: Account for bond transactions.
Section Reference: Accounting for Bond Issues
CPA: Financial Reporting

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15 - 10 Exercises for Accounting Principles, Seventh Canadian Edition

Exercise 9
On January 1, 2017, LeDrew Corporation issued $900,000, 8%, 10-year bonds at face value.
Interest is payable semi-annually on July 1 and January 1. LeDrew Corporation has a calendar
year end.

Instructions
Prepare all entries related to the bond issue for 2017.

Solution 9 (6–10 min.)

2017
Jan 1 Cash .................................................................................. 900,000
Bonds Payable ............................................................ 900,000

Jul 1 Bond Interest Expense....................................................... 36,000

Cash ........................................................................... 36,000
($900,000 × 8% × 6 ÷ 12 = $36,000)

Dec 31 Bond Interest Expense....................................................... 36,000

Bond Interest Payable ................................................. 36,000

Bloomcode: Application
Difficulty: Easy
Learning Objective: Calculate the price of a bond.
Section Reference: Bond Pricing
Learning Objective: Account for bond transactions.
Section Reference: Accounting for Bond Issues
CPA: Financial Reporting

Exercise 10
Stead, Inc. issued $600,000, 6%, 20-year bonds on January 1, 2017, at 102. Interest is payable
semi-annually on July 1 and January 1. Stead has a December 31 year end. Assume
amortization of $250 and $260 respectively for the first two semi-annual interest periods.

Instructions
Prepare all journal entries made in 2017 related to the bond issue.

Solution 10 (8–12 min.)

Jan 1 Cash ($600,000 × 102%) ................................................... 612,000
Bonds Payable ............................................................ 612,000

Jul 1 Bond Interest Expense....................................................... 17,750

Bonds Payable................................................................... 250
Cash ........................................................................... 18,000
($600,000 × 6% × 6 ÷ 12 = $18,000)

Dec 31 Bond Interest Expense....................................................... 17,740

Bonds Payable................................................................... 260
Bond Interest Payable ................................................. 18,000

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 Non-Current Liabilities 15 - 11

($600,000 × 6% × 6 ÷ 12 = $18,000)

Bloomcode: Application
Difficulty: Medium
Learning Objective: Calculate the price of a bond.
Section Reference: Bond Pricing
Learning Objective: Account for bond transactions.
Section Reference: Accounting for Bond Issues
CPA: Financial Reporting

Exercise 11
Chanti Limited issued $200,000, 6%, 10-year bonds on December 31, 2017, for $190,000.
Interest is payable semi-annually on June 30 and December 31. Chanti has a December 31
year end. Amortization for the first semi-annual interest period is $360.

Instructions
Prepare the appropriate journal entries on
a) December 31, 2017.
b) June 30, 2018.

Solution 11 (8–12 min.)

a) 2017
Dec 31 Cash .................................................................................. 190,000
Bonds Payable ............................................................ 190,000

b) 2018
Jun 30 Bond Interest Expense....................................................... 6,360
Bonds Payable ............................................................ 360
Cash ........................................................................... 6,000
($200,000 × 6% × 6 ÷ 12 = $6,000)

Bloomcode: Application
Difficulty: Medium
Learning Objective: Calculate the price of a bond.
Section Reference: Bond Pricing
Learning Objective: Account for bond transactions.
Section Reference: Accounting for Bond Issues
CPA: Financial Reporting

Exercise 12
On January 1, 2017, Kramer International Inc. issued $200,000, 9%, 5-year bonds for $192,278.
The bonds were sold to yield an effective-interest rate of 10%. Interest is paid semi-annually on
June 30 and December 31. The company uses the effective-interest method of amortization.

Instructions
a) Prepare a bond discount amortization schedule which shows the amortization of discount
for the first two interest payment dates. (Round to the nearest dollar.)
b) Prepare the journal entries that Kramer International would make on January 1, June 30,

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15 - 12 Exercises for Accounting Principles, Seventh Canadian Edition

and December 31, 2017, related to the bond issue.

Solution 12 (15–22 min.)

a)
KRAMER INTERNATIONAL INC.
Bond Discount Amortization
Effective-Interest Method—Semi-annual Interest Payments
9% Bonds Issued at 10%
Interest Interest to Interest Discount Amortized
Periods be Paid Expense Amortization Cost
Jan 1 , 2017 (Issue date) $192,278
Jun 30, 2017 $9,000 $9,614 $614 192,892
Dec 31, 2017 9,000 9,645 645 193,537

b) January 1, 2017
Cash ............................................................................................. 192,278
Bonds Payable ....................................................................... 192,278
To record issue of bonds at a discount

June 30, 2017

Bond Interest Expense .................................................................. 9,614
Bonds Payable ....................................................................... 614
Cash....................................................................................... 9,000
To record payment on interest and amortization of discount

December 31, 2017

Bond Interest Expense .................................................................. 9,645
Bonds Payable ....................................................................... 645
Cash....................................................................................... 9,000
To record payment of interest and amortization of discount

Bloomcode: Application
Difficulty: Medium
Learning Objective: Calculate the price of a bond.
Section Reference: Bond Pricing
Learning Objective: Account for bond transactions.
Section Reference: Accounting for Bond Issues
CPA: Financial Reporting

Exercise 13
Prairie Corporation issued $100,000 of 10 year, 6% bonds payable on January 1, 2017 for
$92,900, at a time when market interest rates were 7%. Interest is payable semi-annually on
June 30 and December 31. On January 1, 2018, 20% of the bonds were redeemed at 101.
Prairie has a December 31 year end and uses the effective-interest method in accounting for
bonds payable.

Instructions
a) Record the issue of the bonds on January 1, 2017.
b) Record the payment of interest on June 30 and December 31, 2017.

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 Non-Current Liabilities 15 - 13

c) Show how the bonds would be reported on Prairie’s December 31, 2017 balance sheet.
d) Record the redemption of the bonds on January 1, 2018.

Solution 13 (25 min.)

a)
Jan 1, 2017 Cash ........................................................................... 92,900
Bond Payable ....................................................... 92,900

b)
Jun 1, 2017 Bond Interest Expense ($92,900 x 7% x 6 ÷12) .......... 3,252
Bond Payable ($3,252 – $3,000) .......................... 252
Cash ($100,000 x 6% x 6 ÷12) ............................. 3,000

Dec 31, 2017 Bond Interest Expense (($92,900 + 252) × 7% × 6 ÷12) 3,260
Bond Payable ($3,260 – $3,000) .......................... 260
Cash .................................................................... 3,000

c)
PRAIRIE CORPORATION
Balance Sheet (partial)
December 31, 2017

Non-current liabilities
Bond payable ($92,900 + $252 + $260) ........................................ $ 93,412

d)
Jan 1, 2018 Bond Payable (93,412 x 20%)..................................... 18,682
Loss on Bond Redemption .......................................... 1,518
Cash ($100,000 x 20% x 1.01) ............................. 20,200

Bloomcode: Application
Difficulty: Hard
Learning Objective: Calculate the price of a bond.
Section Reference: Bond Pricing
Learning Objective: Account for bond transactions.
Section Reference: Accounting for Bond Issues
Learning Objective: Account for the retirement of bonds.
Section Reference: Accounting for Bond Retirements
Learning Objective: Explain and illustrate the methods for the presentation and analysis of non-
current liabilities.
Section Reference: Statement Presentation and Analysis
CPA: Financial Reporting

Exercise 14
On January 1, 2017, Wallgrub Wholesale Ltd. issued $500,000 of 10-year, 6% bonds payable at
99. Interest is payable semi-annually on June 30 and December 31. Semi-annual amortization
for this bond is $250.

Instructions

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15 - 14 Exercises for Accounting Principles, Seventh Canadian Edition

a) Record all entries required for this bond during 2017.

b) Show how the bonds would be reported on Wallgrub’s December 31, 2017 balance sheet.

Solution 14 (10 min.)

a)
Jan 1 Cash ($500,000 x 99%) ..................................................... 495,000
Bonds Payable ............................................................ 495,000

Jun 30 Bond Interest Expense....................................................... 15,250

Bonds Payable ............................................................ 250
Cash ($500,000 x 6% x 6 ÷ 12) ................................... 15,000

Dec 31 Bond Interest Expense....................................................... 15,250

Bonds Payable ............................................................ 250
Cash ($500,000 x 6% x 6 ÷ 12) ................................... 15,000

b)

WALLGRUB WHOLESALE LTD.

Balance Sheet (partial)
December 31, 2017

Non-Current liabilities
Bonds payable, due 2027 ............................................................. $ 495,500

Bloomcode: Application
Difficulty: Medium
Learning Objective: Calculate the price of a bond.
Section Reference: Bond Pricing
Learning Objective: Account for bond transactions.
Section Reference: Accounting for Bond Issues
Learning Objective: Explain and illustrate the methods for the presentation and analysis of non-
current liabilities.
Section Reference: Statement Presentation and Analysis
CPA: Financial Reporting

Exercise 15
Butler Holdings Inc. issued $400,000 of 20-year, 5% bonds payable on July 1, 2017 providing
an effective-interest rate of 4.75%, for proceeds of $412,820. Interest is payable semi-annually
on December 31 and June 30. Butler’s year end is June 30 and the effective-interest method is
used in accounting for bonds payable.

Instructions
a) Record the issuing of the bonds on July 1, 2017.
b) Prepare an amortization table for the first year (two payments).
c) Record the payments on December 31, 2017 and June 30, 2018.
d) Show how the bond payable would be presented on Butler’s June 30, 2018 balance sheet.

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 Non-Current Liabilities 15 - 15

Solution 15 (25 min.)

a)
Jul 1, 2017 Cash ........................................................................... 412,820
Bond Payable ....................................................... 412,820

b)
(A) Interest (B) Interest (D) Bond
(C) Premium
Semi-annual payment expense Amortized cost
Amortization =
interest period ($400,000 x (412,820 x = $412,820 –
(A) – (B)
5% x 6 ÷ 12) 4.75% x 6 ÷ 12) (C)
Jun 30, 2017 $ 412,820
Dec 31, 2017 10,000 9,804 196 412,624
Jun 30, 2018 10,000 9,800 200 412,424

c)
Dec 31, 2017 Bond Interest Expense ................................................ 9804
Bond Payable ............................................................. 196
Cash .................................................................... 10,000

Jun 30, 2018 Bond Interest Expense ................................................ 9800

Bond Payable ............................................................. 200
Cash .................................................................... 10,000

d)
BUTLER HOLDINGS INC.
Balance Sheet (partial)
June 30, 2018

Non-Current liabilities
Bond payable ................................................................................ $ 412,424

Bloomcode: Application
Difficulty: Medium
Learning Objective: Calculate the price of a bond.
Section Reference: Bond Pricing
Learning Objective: Account for bond transactions.
Section Reference: Accounting for Bond Issues
Learning Objective: Explain and illustrate the methods for the presentation and analysis of non-
current liabilities.
Section Reference: Statement Presentation and Analysis
CPA: Financial Reporting

Exercise 16
The board of directors of Bobcat Corporation is considering two plans for financing the purchase
of new plant equipment. Plan #1 would require the issue of $4,000,000, 6%, 20-year bonds at
face value. Plan #2 would require the issue of 200,000 common shares for $20 per share.
Bobcat Corporation currently has 100,000 common shares issued at a book value of $20 each
and retained earnings of $750,000. The income tax rate is expected to be 30%. Assume that
income before interest and income taxes is expected to be $800,000 if the new factory

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15 - 16 Exercises for Accounting Principles, Seventh Canadian Edition

equipment is purchased. Assume that the debt or equity will be issued at the beginning of the
year.

Instructions
a) Prepare a schedule which shows the expected profit, earnings per share, and return on
equity under each of the plans that the board of directors is considering.
b) If the board of directors’ stated goal is to maximize the common shareholders’ return, which
alternative is preferable? If the board’s stated goal is to maximize solvency, which
alternative is preferable?

Solution 16 (14–18 min.)

a)
Plan #1 Plan #2
Issue Bonds Issue Shares
Profit before interest and taxes ....................................... $800,000 $800,000
Interest expense ($4,000,000 × 6%) ............................... 240,000 —
Profit before income taxes .............................................. 560,000 800,000
Income tax expense (30%).............................................. 168,000 240,000
Profit ............................................................................... $392,000 $560,000

Issued shares ................................................................. 100,000 300,000

Earnings per share.......................................................... $3.92 $1.87

Equity
Common shares (currently) 100,000 x $20 ..................... $ 2,000,000 $ 2,000,000
New shares (200,000*$20) ............................................. -0- 4,000,000
Retained earnings, beginning.......................................... 750,000 750,000
Current year profit ........................................................... 392,000 560,000
Total shareholders’ equity ............................................... $ 3,142,000 $ 7,310,000

Return on equity.............................................................. 12.5% 7.67%

b) The first alternative (issuing bonds) is preferable if the goal is maximization of shareholder
return, as evidenced by the return on equity. However, this alternative will result in a higher
debt to assets ratio, which indicates less solvency.

Bloomcode: Analysis
Difficulty: Hard
Learning Objective: Account for bond transactions.
Section Reference: Accounting for Bond Issues
CPA: Financial Reporting

Exercise 17
United Health is considering two alternatives for the financing of some high technology medical
equipment. These two alternatives are:
1. Issue 50,000 common shares at $50 per share.
2. Issue $2,500,000, 5%, 10-year bonds at face value.

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 Non-Current Liabilities 15 - 17

It is estimated that the company will earn $900,000 before interest and taxes as a result of
acquiring the medical equipment. The company has an estimated tax rate of 30% and has
100,000 common shares issued prior to the new financing.

Instructions
Determine the effect on profit and earnings per share for these two methods of financing.

Solution 17 (10–15 min.)

The alternative effects on net income and earnings per share are as follows:

Issue Shares Issue Bonds

Profit before interest and taxes ......................................... $900,000 $900,000
Interest expense (5% × $2,500,000) ................................. — 125,000
Profit before income taxes ................................................ 900,000 775,000
Income tax expense (30%)................................................ 270,000 232,500
Profit ................................................................................. $630,000 $542,500

Issued shares ................................................................... 150,000 100,000

Earnings per share............................................................ $4.20 $5.43

Profit is higher if the equipment is financed through the issue of shares. However, earnings per
share is lower because of the additional number of common shares.

Bloomcode: Analysis
Difficulty: Medium
Learning Objective: Account for bond transactions.
Section Reference: Accounting for Bond Issues
CPA: Financial Reporting

Exercise 18
Three plans for financing a $20,000,000 corporation are under consideration by its organizers.
The bonds will be issued at their face value and the income tax rate is estimated at 20%.

Plan 1 Plan 2 Plan 3

6% Bonds — — $10,000,000
$8 Preferred Shares, issued at $100 — $10,000,000 5,000,000
Common Shares, issued at $10 $20,000,000 10,000,000 5,000,000
Total $20,000,000 $20,000,000 $20,000,000

It is estimated that profit before interest and taxes will be $4,000,000.

Instructions
For each plan, determine the expected profit and the earnings per share. Prior to obtaining
financing there are no common shares outstanding.

Solution 18 (14–19 min.)

Plan 1 Plan 2 Plan 3
Profit before interest and income tax ........................ $4,000,000 $4,000,000 $4,000,000
Deduct interest on bonds (10,000,000 × 6%) ........... 0 0 (600,000)

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15 - 18 Exercises for Accounting Principles, Seventh Canadian Edition

Profit before income tax .................................... 4,000,000 4,000,000 3,400,000

Deduct income tax (20%) ......................................... (800,000) (800,000) (680,000)
Net Income........................................................ 3,200,000 3,200,000 2,720,000
Dividends on preferred shares ................................. (800,000)* (400,000)**
Profit ........................................................................ $3,200,000 $2,400,000 $2,320,000
*$10,000,000 / $100 per share *$8
**$5,000,000 / $100 per share * $4

Common shares issued ........................................... 2,000,000 1,000,000 500,000

Earnings per share................................................... $1.60 $2.40 $4.64

Bloomcode: Analysis
Difficulty: Hard
Learning Objective: Account for bond transactions.
Section Reference: Accounting for Bond Issues
CPA: Financial Reporting

Exercise 19
Hanson Holdings Inc. requires $5,000,000 in new financing in order to expand its operations.
The management team is in discussion about the best way to finance the expansion and has
asked you, their accountant, for assistance. In order to provide them with the information they
need, you analyze the following two options:
1. Issue 1,000,000 common shares at $5, which is the current market price of Hanson’s
2,000,000 issued common shares.
2. Issue $5,000,000 of 10-year, 4% bonds at par. Hanson currently has no bonds payable
issued.

The financing would be required at the beginning of the next fiscal year. Hanson’s tax rate is
30%. The management team projects profit of $1,750,000 before financing costs and taxes.
They are interested in comparing the net income after tax, the earnings per share, and the
return on equity under each alternative. The management team’s goal is to maximize return on
equity in the first year. Hanson’s shareholder equity other than share capital includes retained
earnings and accumulated other comprehensive income totaling $17,500,000.

Instructions
Calculate the amounts requested by the management team and present the two alternatives in
comparative format. Recommend which alternative should be chosen.

Solution 19 (10 min.)

Issue shares Issue bonds

Profit before financing .............................................. $ 1,750,000 $ 1,750,000
Less interest...................................................... (200,000)
$5,000,000 x 4%

Profit before taxes .................................................... 1,750,000 1,550,000

Income tax expense (30%)....................................... 525,000 465,000
Profit ........................................................................ $ 1,225,000 $ 1,085,000

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 Non-Current Liabilities 15 - 19

Return on equity
Equity....................................................................... 22,500,000* 17,500,000
ROE ......................................................................... 5.4% 6.2%
Earnings per share
Number of shares ................................................... 3,000,000 2,000,000
EPS ......................................................................... $ 0.41 $ 0.54
*(1,000,000 * $5 per share + $17,500,000)

Because the manager’s goal is to maximize return on equity in the near future, the bond issue
should be chosen.

Bloomcode: Analysis
Difficulty: Medium
Learning Objective: Account for bond transactions.
Section Reference: Accounting for Bond Issues
CPA: Financial Reporting

Exercise 20
Southern Merchandising Inc. is considering new financing to pay out $2,500,000 of existing 10%
bonds payable at the beginning of the next fiscal year. The company wants to maximize ROE in
the new year. They are considering two alternative ways of financing the payout:
1. Do not pay out existing bonds;
2. Issue a 5% bond payable at face value, or issue 250,000 common shares at $10.

Other information about Southern:

 Southern’s tax rate is 25%.
 Southern currently has $4,000,000 in shareholder equity prior to any new share issue.
 Southern’s average profit before financing costs and taxes is $800,000.
 A one-time penalty of $150,000 will be incurred to pay out the 10% bonds early, which is
fully tax deductible.

Instructions
Calculate the following amounts for Southern, compare the two alternatives to the current bonds
payable, and make a recommendation on refinancing, assuming the goal is to maximize return
on equity for the next year.

Existing bonds 5% bonds Shares

Profit before interest
Interest expense
Bond payout penalty
Profit before taxes
Income Tax expense
Profit
Shareholders’ equity
Return on equity

Solution 20 (15 min.)

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15 - 20 Exercises for Accounting Principles, Seventh Canadian Edition

Existing
5% bonds Shares
bonds
Profit before interest $ 800,000 $ 800,000 $ 800,000
Interest expense (250,000) (125,000)
Bond payout penalty (150,000)
Profit before taxes 550,000 525,000 800,000
Income tax expense (25%) (137,500) (131,250) (200,000)
Profit 412,500 393,750 600,000
Shareholders’ equity 4,000,000 4,000,000 6,500,000
Return on equity 10.3% 9.8% 9.2%

Because Southern’s goal is to maximize return on equity for the next year, the choice should be
to not pay out the bonds at this time. However, the payout penalty is a one-time cost, and in the
future, ROE will be greater with the 5% bonds. If the management takes a more long term view,
the issue of replacement bonds would be the better choice.

Bloomcode: Analysis
Difficulty: Medium
Learning Objective: Account for bond transactions.
Section Reference: Accounting for Bond Issues
CPA: Financial Reporting

Exercise 21
Presented below are two independent situations:
a) Hillman Corporation redeemed $150,000 of its bonds on June 30, 2017, at 102. The
amortized cost of the bonds on the retirement date was $137,700. The bonds pay semi-
annual interest and the interest payment due on June 30, 2017, has been made and
recorded.
b) Dalton Inc. redeemed $200,000 of its bonds at 96 on June 30, 2017. The amortized cost of
the bonds on the retirement date was $196,500. The bonds pay semi-annual interest and
the interest payment due on June 30, 2017, has been made and recorded.

Instructions
For each of the independent situations, prepare the journal entries to record the retirement or
conversion of the bonds.

Solution 21 (13–16 min.)

a)
Jun 30 Bonds Payable................................................................... 137,700
Loss on Redemption .......................................................... 15,300
Cash ........................................................................... 153,000

b)
Jun 30 Bonds Payable................................................................... 196,500
Gain on Bond Redemption .......................................... 4,500
Cash ........................................................................... 192,000

Bloomcode: Application

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 Non-Current Liabilities 15 - 21

Difficulty: Medium
Learning Objective: Account for the retirement of bonds.
Section Reference: Accounting for Bond Retirements
CPA: Financial Reporting

Exercise 22
Presented below are two independent situations:
a) On December 31, 2017, Legault Corporation had $1,000,000, 8% bonds payable issued.
The bonds pay interest on January 1 and June 1 of each year, and mature on January 1,
2021. On January 2, 2018, Legault redeemed 60% of these bonds at 101. The amortized
cost of the entire bond issue on the retirement date was $1,026,000. The interest payment
due on January 1, 2018, has been made and recorded.
b) Antonio Inc. redeemed $500,000 of its bonds at 98 on December 31, 2017. The amortized
cost of the bonds on the retirement date was $497,500. The bonds pay semi-annual
interest and the interest payment due on December 31, 2017, has been made and
recorded.

Instructions
For each of the independent situations, prepare the journal entries to record the retirement of
the bonds.

Solution 22 (13–16 min.)

a) 2018
Jan 2 Bonds Payable ($1,026,000 x 60%) ................................... 615,600
Cash ($600,000 x 1.01)............................................... 606,000
Gain on Redemption ................................................... 9,600
($615,600 - $606,000 = $9,600)

b) 2017
Dec 31 Bonds Payable................................................................... 497,500
Cash ($500,000 x 0.98)............................................... 490,000
Gain on Bond Redemption .......................................... 7,500
($490,000 – $497,500 = $7,500)

Bloomcode: Application
Difficulty: Medium
Learning Objective: Account for the retirement of bonds.
Section Reference: Accounting for Bond Retirements
CPA: Financial Reporting

Exercise 23
Asgar Corporation issues a $350,000, 4%, 20-year mortgage note payable on December 31,
2017, to obtain needed financing for the construction of a building addition. The terms provide
for semi-annual blended payments of $12,795 on June 30 and December 31.

Instructions
a) Prepare the journal entries to record the mortgage loan on December 31, 2017, and the first
instalment payment.

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15 - 22 Exercises for Accounting Principles, Seventh Canadian Edition

b) Will the amount of principal reduction in the second instalment payment be more or less
than with the first instalment payment?

Solution 23 (5–8 min.)

a)
Dec 31 Cash .................................................................................. 350,000
Mortgage Notes Payable ............................................. 350,000

Jun 30 Interest Expense ................................................................ 7,000

Mortgage Notes Payable ................................................... 5795
Cash ........................................................................... 12,795
($350,000 × 4% × 6 ÷ 12 = $7,000)

b) The amount of principal reduction will increase with each instalment payment.

Bloomcode: Application
Difficulty: Easy
Learning Objective: Account for instalment notes payable.
Section Reference: Instalment Notes Payable
CPA: Financial Reporting

Exercise 24
Hanna Manufacturing Limited receives $240,000 on January 1, 2017 when it issues a 6%, 3-
year note payable to finance the purchase of equipment. The terms provide for annual
payments each December 31. The first payment is due December 31, 2017.

Instructions
Prepare the journal entries to record the note and the first two instalment payments assuming:
a) the payment is a fixed principal payment of $80,000.
b) the payment is a blended payment of $89,786.76.

Solution 24 (15–20 min.)

a)
(B) (C) (D)
(A) Interest Reduction Principal
Semi-annual Cash Expense of Principal Balance
Interest Period Payment (D) × 6% (A) – (B) (D) – (C)
Jan 1, 2017 $240,000
Dec 31, 2017 $94,400 $14,400 $80,000 160,000
Dec 31, 2018 89,600 9,600 80,000 80,000

Issue of Note 2017

Jan 1 Cash .................................................................................. 240,000
Note Payable .............................................................. 240,000

First Instalment Payment 2017

Dec 31 Interest Expense ($240,000 × 6%) ..................................... 14,400
Note Payable ..................................................................... 80,000
Cash ........................................................................... 94,400

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 Non-Current Liabilities 15 - 23

Second Instalment Payment 2018

Dec 31 Interest Expense ($160,000 × 6%) ..................................... 9,600
Note Payable .................................................................... 80,000
Cash ........................................................................... 89,600

b)
(B) (C) (D)
(A) Interest Reduction Principal
Semi-annual Cash Expense of Principal Balance
Interest Period Payment (D) × 6% (A) – (B) (D) – (C)
Jan 1, 2017 $240,000.00
Dec 31, 2017 $89,786.76 $14,400.00 $75,386.76 164,613.24
Dec 31, 2018 89,786.76 9,876.79 79,909.97 84,703.27

Issue of Note 2017

Jan 1 Cash .................................................................................. 240,000.00
Note Payable .............................................................. 240,000.00

First Instalment Payment 2017

Dec 31 Interest Expense ($240,000 × 6%) ..................................... 14,400.00
Note Payable ..................................................................... 75,386.76
Cash ........................................................................... 89,786.76

Second Instalment Payment 2018

Dec 31 Interest Expense [($240,000 – $75,386.76) × 6%] ............. 9,876.79
Note Payable .................................................................... 79,909.97
Cash ........................................................................... 89,786.76

Bloomcode: Application
Difficulty: Hard
Learning Objective: Account for instalment notes payable.
Section Reference: Instalment Notes Payable
CPA: Financial Reporting

Exercise 25
Roblin Manufacturing Inc. intends to finance the acquisition of new manufacturing equipment
that costs $150,000 by issuing a 5-year, 3.5% note payable. The note would be issued on
January 1, 2017. Roblin’s year end is December and would require annual payments on
December 31. The finance company has given Roblin the choice of making blended payments
of $33,222, or making fixed payments of $30,000 plus interest.

Instructions
a) Assuming the blended payment option is selected; prepare the amortization table for the
first two years of the note payable. Record the issue of the note and the December 31,
2017 payment under this alternative.
b) Assuming the fixed principal payment option is selected; prepare the amortization table for
the first two years of the note payable. Record the December 31, 2017 payment under this
alternative.

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15 - 24 Exercises for Accounting Principles, Seventh Canadian Edition

Solution 25 (20 min.)

a)
Semi-annual (B) Interest expense (C) Reduction of (D) Principal
(A) Cash
interest = (D) x 3.5% x 12 ÷ principal = (A) – balance = (D) –
payment
period 12 (B) (C)
Jan 1, 2017 $ 150,000
Dec 31, 2017 33,222 5,250 27,972 122,028
Dec 31, 2018 33,222 4,271 28,951 93,077

Jan 1, 2017 Equipment................................................................... 150,000

Note Payable ....................................................... 150,000

Dec 31, 2017 Interest Expense ......................................................... 5,250

Note Payable .............................................................. 27,972
Cash .................................................................... 33,222

b)
(A) Cash (B) Interest expense (D) Principal
Semi-annual (C) Reduction
payment = (B) = (D) x 3.5% x 12 ÷ balance = (D) –
interest period of principal
+ (C) 12 (C)
Jan 1, 2017 $150,000
Dec 31, 2017 35,250 5,250 30,000 120,000
Dec 31, 2018 34,200 4,200 30,000 90,000

Dec 31, 2017 Interest Expense ......................................................... 5,250

Note Payable .............................................................. 30,000
Cash .................................................................... 35,250

Bloomcode: Application
Difficulty: Medium
Learning Objective: Account for instalment notes payable.
Section Reference: Instalment Notes Payable
CPA: Financial Reporting

Exercise 26
On July 1, 2017, Jasper Distributors Inc. finances the purchase of a new pickup truck by making
a cash down payment of $5,000 and issuing a $30,000 two year, 10% note payable for the
balance. The note is payable in four equal semi-annual blended payments of $8,460 due on
December 31, and June 30 of each year.

Instructions
a) Record the purchase of the truck.
b) Prepare the amortization table for the note payable.
c) Record the first and last payments made on the note.

Solution 26 (25 min.)

a)
Jul 1, 2017 Truck .......................................................................... 35,000
Cash ................................................................... 5,000

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 Non-Current Liabilities 15 - 25

Note Payable ...................................................... 30,000

b)
Semi-annual (B) Interest expense (D) Principal
(A) Cash (C) Reduction of
interest = (D) x 10% x 6 ÷ balance = (D) –
payment principal = (A) – (B)
period 12 (C)
Jul 1, 2017 $ 30,000
Dec 31, 2017 8,460 1,500 6,960 23,040
Jun 30, 2018 8,460 1,152 7,308 15,732
Dec 31, 2018 8,460 787 7,673 8,059
Jun 30, 2019 *8,462 403 8,059
* Round to clear remaining balance

c)
Dec 31, 2017 Interest Expense ......................................................... 1,500
Note Payable .............................................................. 6,960
Cash .................................................................... 8,460

Jun 30, 2019 Interest Expense ......................................................... 403

Note Payable .............................................................. 8,059
Cash .................................................................... 8,462

Bloomcode: Application
Difficulty: Medium
Learning Objective: Account for instalment notes payable.
Section Reference: Instalment Notes Payable
CPA: Financial Reporting

Exercise 27
Millet Sales Corp., a public company, is planning to acquire new computers with a total value of
$60,000 on January 1, 2017. They have a choice of leasing the computers for a three year
period, or purchasing them and financing the purchase by issuing a note payable. Details of the
two alternative arrangements are as follows:
Lease option: Three annual lease payments of $22,446 due on December 31 of each year.
Millet would purchase the computers at the end of the three years for $2.00.
Financing option: Millet would make a down payment of $10,000 and issue a 6%, 3-year note
payable for the remaining balance, with annual blended payments of $18,705 required on
December 31 of each year.

Instructions
a) Is the lease arrangement operating or finance? Explain your choice. Record any entry
required on January 1, 2017.
b) Prepare the amortization table for the note payable. Record any entry required on January
1, 2017.

Solution 27 (15 min.)

a) This is a finance lease because of the option to purchase the system at a very reduced
price at the end of the lease.

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15 - 26 Exercises for Accounting Principles, Seventh Canadian Edition

Jan 1, 2017 Leased Computer Equipment...................................... 60,000

Lease Liability ...................................................... 60,000

b)
(B) Interest (C) Reduction of (D) Principal
Semi-annual (A) Cash
expense = (D) x principal = (A) – balance = (D) –
interest period payment
6% x 12 ÷ 12 (B) (C)
Jan 1, 2017 $ 50,000
Dec 31, 2017 18,705 3,000 15,705 34,295
Dec 31, 2018 18,705 2,058 16,647 17,648
Dec 31, 2019 18,707 1,059 17,648 0

Jan 1, 2017 Computer Equipment .................................................. 60,000

Note Payable ....................................................... 50,000
Cash .................................................................... 10,000

Bloomcode: Application
Difficulty: Medium
Learning Objective: Account for instalment notes payable.
Section Reference: Instalment Notes Payable
Learning Objective: Account for leases.
Section Reference: Lease Liabilities
CPA: Financial Reporting

Exercise 28
Lalapalooza Corporation issues a $600,000, 5%, 5-year note payable on January 1, 2017. The
terms provide for semi-annual blended payments of $68,555 on July 1 and January 1.

Instructions
a) Prepare the journal entries to record the note on January 1, 2017, and the first instalment
payment.
b) Assuming Erving has a December 31 year end, prepare the 2017 year end adjusting entry
to account for accrued interest on the note payable. Round your answer to the nearest
dollar.
c) Prepare a partial balance sheet at December 31, 2017 for Erving Corporation displaying all
amounts related to the note payable.

Solution 28 (20 min.)

a)
Jan 1 Cash .................................................................................. 600,000
Notes Payable............................................................. 600,000

Jul 1 Interest Expense ................................................................ 15,000

Notes Payable ................................................................... 53,555
Cash ..................................................................... 68,555
($600,000 × 5% × 6 ÷ 12 = $15,000)

b)
Dec 31Interest Expense ....................................................................... 13,611

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 Non-Current Liabilities 15 - 27

Interest Payable .......................................................... 13,611

($600,000 – $53,555) x 5% x 6/12 = $13,611

c)
LALPALOOZA CORPORATION
Balance Sheet (partial)
December 31, 2017
Current liabilities
Interest payable ............................................................................ $ 13,611
Current portion of note payable ..................................................... 111,211

Non-current liabilities
Bond payable ................................................................................ $ 435,234

Calculations
Total carrying value of note payable at December 31, 2017 = $600,000 – $53,555 = $546,445
Current Portion:
Principal repayment due within one year = $54,944 + $56,267 = $111,211 (see calc below)
January 1, 2018 = $54,944 ($68,555 – $13,611)
July 1, 2018 = ($600,000 – $53,555 – $54,944) x 5% x 6/12 = $12,288 interest expense
$68,555 – $12,288 = $56,267

Non-Current Portion = $546,445 – $111,211 = $435,234

Bloomcode: Application
Difficulty: Hard
Learning Objective: Account for instalment notes payable.
Section Reference: Instalment Notes Payable
Learning Objective: Explain and illustrate the methods for the presentation and analysis of non-
current liabilities.
Section Reference: Statement Presentation and Analysis
CPA: Financial Reporting

Exercise 29
Presented below are three different aircraft lease transactions that occurred for Canada Airways
in 2017. All the leases start on January 1, 2017. In no case does Canada receive title to the
aircraft during or at the end of the lease period. Canada Airways is a public company.
Lessor
Zorowski Insurance Lloyd Leasing Chan Leasing
Type of property 747 Aircraft 727 Aircraft L-1011 Aircraft
Yearly rental $6,589,186 $4,205,863 $2,851,861
Lease term 15 years 15 years 12 years
Estimated economic life 25 years 25 years 25 years
Fair market value of
leased asset $61,000,000 $42,000,000 $32,000,000
Present value of lease
rental payments $56,000,000 $36,000,000 $20,000,000

Instructions
Which of the above leases are operating leases and which are finance leases? Explain your

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15 - 28 Exercises for Accounting Principles, Seventh Canadian Edition

answer.

Solution 29 (8–10 min.)

The Zorowski Insurance and Lloyd Leasing are finance leases since they meet one of the four
criteria; i.e., the present value of the lease payments amounts to substantially all of the fair
market value of the leased asset. The Chan Leasing lease is an operating lease since it meets
none of the criteria.

Bloomcode: Analysis
Difficulty: Medium
Learning Objective: Account for leases.
Section Reference: Lease Liabilities
CPA: Financial Reporting

Exercise 30
Lance Corporation, a public corporation, entered into the following transactions:
1. On January 1, 2017, Gagne Car Rental leased a car to Lance Corporation for one year.
Terms of the operating lease call for monthly payments of $550.
2. On January 1, 2017, Lance Corporation entered into an agreement to lease 20 machines
with a fair market value of $160,000 from Wells Corporation. The terms of the lease
agreement require an initial payment of $50,000 and then three annual rental payments of
$60,000 beginning on December 31, 2017. The present value of the three rental payments
is $149,211.

Instructions
a) Identify each lease as either operating or finance.
b) Prepare the appropriate journal entries to be made by Lance Corporation on January 1
related to the lease transactions.

Solution 30 (3–9 min.)

a) 1. This lease is operating, as none of the criteria for capitalization appear to exist.
2. This lease is a finance lease because the present value of the lease payments
amounts to substantially all of the fair market value of the leased asset.

b)
2017
1. Jan 1, 2017 Rental Expense........................................................... 550
Cash .................................................................... 550

2. Leased Equipment ...................................................... 199,211

Lease Liability ...................................................... 149,211
Cash .................................................................... 50,000

Bloomcode: Analysis
Difficulty: Medium
Learning Objective: Account for leases.
Section Reference: Lease Liabilities
CPA: Financial Reporting

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 Non-Current Liabilities 15 - 29

Exercise 31
Kemba Corporation has acquired equipment on January 1, 2017 by engaging in a 5-year lease
transaction that requires annual lease payments of $24,000 beginning January 1, 2017.

Instructions
Prepare all the journal entry to record the lease inception at January 1, 2017 assuming:
a) The lease is classified as an operating lease.
b) The lease is classified as a finance lease and the present value of the minimal lease
payments has been determined to be $100,077.

Solution 31 (5 min.)
a)
Jan 1, 2017 Rental Expense........................................................... 24,000
Cash .................................................................... 24,000

b)
Leased Equipment ...................................................... 100,077
Lease Liability ...................................................... 76,077
Cash .................................................................... 24,000

Bloomcode: Analysis
Difficulty: Easy
Learning Objective: Account for leases.
Section Reference: Lease Liabilities
CPA: Financial Reporting

Exercise 32
Windemere Merchandising Corp., a public company, provides automobiles for its sales agents.
The typical automobile that is provided has a retail value of $40,000 and in the past Windemere
has purchased the automobiles, paying 10% on the financing. Now Windemere is considering
leasing the automobiles instead, and has been offered one of two alternative lease
arrangements. The lease arrangements would begin on June 1, 2017.
Alternative 1:
The automobile is leased for $320 per month on a one-year term, with renewal possible for a
second year on similar terms. Each month’s lease payment is due at the beginning of the
month.
Alternative 2:
The automobile is leased for 5 years (60 months) with $5,000 down payment and monthly
payments of $675 due on the last day of each month. At the end of the 60 months, Windemere
would have the option of purchasing the automobile for $1.00.

Instructions
a) For Alternative 1, indicate whether the lease is operating or finance and explain why.
Record any entry required on June 1, 2017.
b) For Alternative 2, indicate whether the lease is operating or finance and explain why.
Record any entry required on June 1, 2017.

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15 - 30 Exercises for Accounting Principles, Seventh Canadian Edition

Solution 32 (10 min.)

a) This is an operating lease. There is no commitment that Windemere will acquire ownership
of the automobile under the terms of this lease.

Jun 1, 2017 Automobile Rent Expense ........................................... 320

Cash .................................................................... 320

b) This is a finance lease. Because Windemere will have an option to purchase the asset at the
end of the lease term much below its fair value (bargain purchase option).

Jun 1, 2017 Leased Automobile ..................................................... 40,000

Lease Liability ...................................................... 35,000
Cash .................................................................... 5,000

Bloomcode: Analysis
Difficulty: Medium
Learning Objective: Account for leases.
Section Reference: Lease Liabilities
CPA: Financial Reporting

Exercise 33
Kemba Corporation has acquired equipment with a fair market value of $145,000 on January 1,
2017 by engaging in a 5-year lease transaction that requires annual lease payments of $24,000
beginning January 1, 2017. The leased asset will revert back to the lessor after the lease term.
Kemba has the option to purchase the equipment at the end of the lease term at the
equipment’s fair market value at that time. The economic life of the asset is 8 years and the
present value of the minimum lease payments is $100,077.

Instructions
Analyze the details of this transaction and determine whether it should be classified as am
operating or a finance lease in accordance with IFRS.

Solution 33 (5 min.)
Criteria:
1. Transfer of ownership and option to buy – The leased asset will revert back to the lessor
after the lease term and no bargain purchase option exists since Kemba would pay fair
market value for the equipment. The criteria is not met.
2. The lease term is 62.5% (5/8 years) of the leased assets economic life. This is not
considered the majority of the asset’s economic life therefore this criteria is not met.
3. The present value of the minimum lease payments represents 69% ($100,077 / $145,000).
This does not represent substantially all of the fair value of the lease property, therefore this
criteria is not met.

Conclusion: Since none of the above criteria have not been, this leased equipment would be
classified as an operating lease.

Bloomcode: Analysis
Difficulty: Easy
Learning Objective: Account for leases.

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 Non-Current Liabilities 15 - 31

Section Reference: Lease Liabilities

CPA: Financial Reporting

Exercise 34
The adjusted trial balance for Raines Corporation at the end of the 2017 fiscal year contained
the following accounts:
Bonds payable, 5% .............................................................. $460,000
Bond interest payable .......................................................... 20,000
Lease liability ....................................................................... 50,000
Mortgage notes payable, 6%, due 2033 ............................... 80,000
Accounts payable ................................................................. 120,000

Other information: The mortgage note is payable in monthly payments of $700 principal plus
interest.

Instructions
a) Prepare the non-current liabilities section of the balance sheet.
b) Indicate the proper balance sheet classification for the accounts listed above that do not
belong in the non-current liabilities section.

Solution 34 (4–7min.)
a) Non-current liabilities
Bonds payable 5% ................................................................. $460,000
Mortgage notes payable ($80,000 – ($700 x 12)) ................... 71,600
Lease liability .......................................................................... 50,000
Total non-current liabilities ............................................... $581,600

b) Bond interest payable ($20,000), accounts payable ($120,000), and the current portion of
the mortgage payable ($700 x 12 = $8,400) should be classified as current liabilities.

Bloomcode: Application
Difficulty: Hard
Learning Objective: Explain and illustrate the methods for the presentation and analysis of non-
current liabilities.
Section Reference: Statement Presentation and Analysis
CPA: Financial Reporting

Exercise 35
Excerpts from Chung Corporation’s Income Statement and Balance Sheet for 2017 are
presented below:
2017 Income Statement Detail 2017 Balance Sheet Detail
Sales ......................................... $110,000 Cash .................................... $ 10,000
Cost of Goods Sold ................... 50,000 Accounts Receivable ............ 100,000
Gross Profit ............................... 60,000 Inventories ........................... 90,000
Interest Expense ....................... 10,000 Accounts Payable ................ 20,000
Profit Before Taxes ................... 50,000 Loan Payable ....................... 30,000
Income Tax ............................... 15,000 Shareholders’ Equity ............ 150,000
Profit ......................................... $ 35,000

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15 - 32 Exercises for Accounting Principles, Seventh Canadian Edition

Instructions
a) Calculate the interest coverage ratio.
b) Calculate the debt to total assets ratio.
c) What do the two ratios tell you?

Solution 35 (5–7 min.)

(Profit + Interest expense + Income taxes)
a) Interest coverage ratio = ——————————————————————
(Interest expense)

$35,000 + $10,000 + $15,000

= ————————————--— = 6
$10,000

b) Debt to total assets ratio = Total Liabilities ÷ Total Assets

= $50,000 ÷ $200,000 = 25%

c) The interest coverage ratio measures the ability of the company to meet interest payments
when they are due. The debt to total assets ratio indicates the fraction or percentage of total
assets that are owed to creditors.

Bloomcode: Application
Difficulty: Easy
Learning Objective: Explain and illustrate the methods for the presentation and analysis of non-
current liabilities.
Section Reference: Statement Presentation and Analysis
CPA: Financial Reporting

Exercise 36
Company A has a high debt to total assets ratio and a high interest coverage ratio. Company B
has a low debt to total assets ratio and a high interest coverage ratio. Company C has a high
debt to total assets ratio and a low interest coverage ratio. Company D has a low debt to total
assets ratio and a low interest coverage ratio.

Instructions
Based solely on the information provided above, which company or companies would you
consider loaning money to? Explain your reasoning.

Solution 36 (8–10 min.)

Company B is the most solvent and the best choice to loan money to. A low debt to total assets
ratio means that the company has a smaller proportion of debt compared to total assets than
the other companies. A high interest coverage ratio means that the company has sufficient profit
to cover its interest payments.

Company D may also be worthy to consider loaning money to as long as its interest coverage
ratio is sufficient to cover any interest payments that may come due.

Bloomcode: Analysis

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 Non-Current Liabilities 15 - 33

Difficulty: Medium
Learning Objective: Explain and illustrate the methods for the presentation and analysis of non-
current liabilities.
Section Reference: Statement Presentation and Analysis
CPA: Financial Reporting

Exercise 37
The following is a summarized balance sheet of Falcon Corporation at December 31, 2017. All
amounts are in $000’s.
Current assets...................................................................................... $ 1,000
Property, plant and equipment ............................................................. 15,000
Total assets ......................................................................................... 16,000

Current liabilities .................................................................................. $ 650

Long term debt ..................................................................................... 9,500
Total liabilities ...................................................................................... 10,150

Shareholders' equity
Common shares................................................................................... 4,000
Retained earnings ................................................................................ 1,850
Total shareholders' equity .................................................................... 5,850
Total liabilities and equity ..................................................................... $ 16,000

Falcon requires additional financing of $5,000,000 to finance an expansion of its business. The
two choices are:
Alternative 1: Issue a 20-year, $5,000,000 5% bond payable at face value.
Alternative 2: Issue 250,000 common shares at $20 each.

In Falcon’s industry, a safe debt to total assets ratio is considered to be between 50% and 60%.
Falcon’s board of directors is risk adverse. Assume that the financing is made at the beginning
of the year.

Instructions
a) Calculate the debt to total assets ratio under the two proposed financing methods.
b) Make a recommendation to Falcon on the better financing alternative and explain your
choice.

Solution 37 (10 min.)

a) Current Issue bonds Issue shares
Debt – no change $ 10,150 $ 10,150
Debt – new ($10,150 + 5,000) $ 15,150
Total assets – before change 16,000
Total assets – after change ($16,000 + $5,000) 21,000 21,000
Debt to total assets 63.4% 72.1% 48.3%

b) The debt to total assets ratio that results from the issue of bonds (72.1%) is significantly
higher than the level considered safe. Since the board is risk adverse, the issue of shares is
a better choice.

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15 - 34 Exercises for Accounting Principles, Seventh Canadian Edition

Bloomcode: Application
Difficulty: Hard
Learning Objective: Explain and illustrate the methods for the presentation and analysis of non-
current liabilities.
Section Reference: Statement Presentation and Analysis
CPA: Financial Reporting

Copyright © 2016 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.
 Non-Current Liabilities 15 - 35

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