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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

    Unamortized premium 7/1/09 $ 18,000

    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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