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Exercise 14-28

Land (\$450,000 325,000) ......................................... 125,000

Gain on disposition of assets ............................... 125,000

Note payable (face amount) ........................................ 600,000

Accrued interest payable (11% x \$600,000) ............... 66,000

Gain on troubled debt restructuring (difference) .... 216,000

Land (fair value) .................................................... 450,000

Exercise 14-29

Analysis: Carrying amount: \$12 million + \$1.2 million = \$13,200,000

Future payments: (\$1 million x 2) + \$11 million = 13,000,000

Gain to debtor \$ 200,000

1. January 1, 2009

Accrued interest payable (10% x \$12,000,000) ........... 1,200,000

Note payable (\$13 million 12 million)* ................. 1,000,000

Gain on troubled debt restructuring ..................... 200,000

* Establishes a balance in the note account equal to the total cash payments under the

new agreement.

2. December 31, 2010

Note payable ............................................................ 1,000,000

Cash (revised “interest” amount) ............................... 1,000,000

Note: No interest should be recorded after the restructuring. All subsequent cash payments

result in reductions of principal.

3. December 31, 2011

Note payable ............................................................ 1,000,000

Cash (revised “interest” amount) ............................... 1,000,000

Note payable ............................................................ 11,000,000

Cash (revised principal amount) ................................ 11,000,000

Exercise 14-30

Analysis: Carrying amount: \$240,000 + (10% x \$240,000) = \$264,000

Future payments: (\$11,555 x 3) + \$240,000 = (274,665)

Interest \$ 10,665

The discount rate that “equates” the present value of the debt (\$264,000) and

its future value (\$274,665) is the effective rate of interest:

\$264,000 ? \$274,665 = .961 the Table 2 value for n = 2, i = ?

In row 2 of Table 2, the value .961 is in the 2% column. So, this is the new

effective interest rate. A financial calculator will produce the same rate.

1. January 1, 2009

no entry needed

2. December 31, 2009

Interest expense (2% x \$264,000) ............................... 5,280

Accrued interest payable ...................................... 5,280

[Unpaid interest is accrued at the effective rate times the carrying amount of the debt.]

3. December 31, 2010

Interest expense (2% x [\$264,000 + 5,280]) ................. 5,385*

Accrued interest payable ...................................... 5,385

*rounded

Note payable (balance) .............................................. 240,000

Accrued interest payable (\$24,000 + 5,280 + 5,385) .... 34,665

Cash ([\$11,555 x 3] + \$240,000) ............................... 274,665

CPA / CMA REVIEW QUESTIONS

CPA Exam Questions

1. c. At issuance, a bond is valued at the present value of the principal and

interest payments, discounted at the prevailing market rate of interest at

the date of issuance of the bond. Per APB #21, "Interest on Receivables

and Payables."

2. b. Carrying value of bonds at 6/30/09 is \$4,980,000 (\$5,000,000 + \$30,000

- \$50,000).

3. d. Six months interest revenue at stated rate.

Since no yield rate was given, the \$1,800 amortization must be accepted.

Note that the amortization is added to the stated revenue amount since the

bonds were acquired at a discount.

4. b. Present value of payments:.

5. a. A bond issued at a discount reflects that the market rate is greater

than the contract rate.

CPA Exam Questions (concluded)

6. a. The interest payable at September 30, 2009, will be for the three

month's interest that has accrued since the last interest was paid

on June 30, 2009 (\$300,000 × 12% × 3/12 = \$9,000).

7. a. Must determine carrying value at time of extinguishment:

Bond premium at issue \$ 40,000

Amortization of premium 1/1/04 through 7/1/09:

\$40,000/20 = \$2,000 per period

\$2,000 x 11 periods 22,000

Face Value 1,000,000

Carrying value 7/1/09 \$1,018,000

Call (redemption) price 1,010,000

\$1,000,000 x 1.01

Gain on extinguishment \$ 8,000

8. d. The interest expense is for the time the bonds were outstanding

during the reporting period 7 months in this case.

Judgment Case 14-6

Although not specifically discussed in the chapter, concepts studied in this and other chapters provide the logic for addressing the situation described. (APB 21

also addresses this type of situation.)

The company's accountant is incorrect in valuing the note at \$200,000. The note should be valued at the present value of the receivable using the prevailing

market rate and the difference between the present value and the cash given is

regarded as an addition to the cost of products purchased during the contract term.

In this case, the note would be valued at \$136,602, computed as follows:

PV = \$200,000 x .68301

PV of \$1:

n=4, i=10% (from Table 2)

PV = \$136,602

The journal entry to record the initial transaction is as follows

Note receivable (above) .................................. 136,602

Prepaid inventory (difference) ........................ 63,398

Cash ............................................................ 200,000

Interest revenue is recognized over the 4-year life of the note using the effective interest rate of 10%. Accrued interest will increase the receivable

valuation to \$200,000.

Prepaid inventory is credited and inventory is debited as inventory is purchased, thus increasing the cost of inventory from the prices paid to market

value.

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