Ch14 Required Questions

SOLUTIONS TO EXERCISES

EXERCISE 14-1 (15–20 minutes)

(a) Current liability if current assets are used to satisfy the debt.(b) Current liability, $250,000; long-term liability, $750,000.(c) Current liability.(d) Probably non-current, although if operating cycle is greater than one

year and current assets are used, this item would be classified as current.

(e) Current liability.(f) Current liability unless (a) a fund for liquidation has been accumu-

lated which is not classified as a current asset or (b) arrangements have been made for refinancing.

(g) Current liability.(h) Current liability.


(a) Interest expense (credit balance)—Reclassify to interest payable on statement of financial position.

(b) Bond Issue Costs—Reduction of the issue amount of the bond payable.

(c) Gain on repurchase of debt—Classify as part of Other income and expense on the income statement.

(d) Mortgage payable—Classify one-third as current liability and the remainder as long-term liability on statement of financial position.

(e) Debenture bonds payable—Classify as long-term liability on statement of financial position.

(f) Notes payable—Classify as long-term liability on statement of financial position.

(g) Income bonds payable—Classify as long-term liability on statement of financial position.


1. Divac Company:

(a) 1/1/10 Cash...................................................................................300,000Bonds Payable.........................................................300,000

(b) 7/1/10 Interest Expense (€300,000 X 9% X 3/12)...................................................6,750

Cash..........................................................................6,750

(c) 12/31/10 Interest Expense...............................................................6,750Interest Payable.......................................................6,750

2. Verbitsky Company:

(a) 6/1/10 Cash...................................................................................210,000Bonds Payable.........................................................200,000Interest Expense (€200,000 X 12% X 5/12).......................................10,000

(b) 7/1/10 Interest Expense...............................................................12,000Cash (€200,000 X 12% X 6/12).................................12,000

(c) 12/31/10 Interest Expense...............................................................12,000Interest Payable.......................................................12,000

Note to instructor: Some students may credit Interest Payable on 6/1/10. If they do so, the entry on 7/1/10 will have a debit to Interest Payable for €10,000 and a debit to Interest Expense for €2,000.


(a) 1/1/11 Cash ($800,000 X 1.19792)...............................................958,336Bonds Payable.........................................................958,336

(b) 7/1/11 Interest Expense ($958,336 X 8% X 6/12)...................................................38,333Bonds Payable..................................................................1,667

Cash ($800,000 X 10% X 6/12).................................40,000

(c) 12/31/11 Interest Expense ($958,336 – $1,667) X 8% X 6/12....................................38,267Bonds Payable..................................................................1,733

Interest Payable.......................................................40,000


(a) 1/1/11 Cash ($800,000 X .8495)...................................................679,600Bonds Payable.........................................................679,600

(b) 7/1/11 Interest Expense ($679,600 X 12% X 1/2)...................................................40,776Bonds Payable.................................................................. 776

Cash ($800,000 X 10% X 6/12).................................40,000

(c) 12/31/11 Interest Expense [($679,600 + $776) X 12% X 1/2]....................................40,823

Bonds Payable......................................................... 823Interest Payable.......................................................40,000


The effective-interest or yield rate is 12%. It is determined through trial and error using Table 6-2 for the discounted value of the principal (£1,702,290) and Table 6-4 for the discounted value of the interest (£1,081,434); £1,702,290 plus £1,081,434 equals the proceeds of £2,783,724. (A financial calculator may be used to determine the rate of 12%.)

Schedule of Discount AmortizationEffective-Interest Method (12%)

YearCash Paid

Interest Expense

Discount Amortized

Carrying Amount of

Bonds(1) (2) (3) (4)

Jan. 1, 2010 — — — £2,783,724.00Dec. 31, 2010 £300,000 £334,046.88* £34,046.88 2,817,770.88Dec. 31, 2011 300,000 338,132.51 38,132.51 2,855,903.39Dec. 31, 2012 300,000 342,708.41 42,708.41 2,898,611.80Dec. 31, 2013 300,000 347,833.42 47,833.42 2,946,445.22Dec. 31, 2014 300,000 353,554.78** 53,554.78 3,000,000.00

*£334,046.88 = £2,783,724 X .12.**Rounded.


(a) Bond selling price ($2,500,000 X 1.06231)......................... $ 2,655,775

July 1, 2010Interest expense reported ($2,655,775 X 10% X 6/12)...... $ 132,789

December 31, 2010Interest expense reported [($2,500,000 X .11 X 6/12) X 10% X 6/12]......................... $ 132,553*

*($2,655,775 – $132,789)

EXERCISE 14-7 (Continued)

(b) June 30, 2010Carrying amount of bonds................................................. $562,500Effective-interest rate for the period from June 30 to October 31, 2010 (.10 X 4/12)...................................... X.033333Interest expense to be recorded on October 31, 2010..... $ 18,750*

*Alternative computation: $562,500 X .10 X 4/12

(c) October 1, 2010Cash ($853,382 + $72,000)..................................................925,382

Bonds payable............................................................ 853,382Bond Interest Expense ($800,000 X 12% X 9/12).......................................... 72,000

December 31, 2010Bond Interest Expense.......................................................93,335Bonds Payable.....................................................................2,665*

Cash ($800,000 X 12%).............................................. 96,000

*($800,000 X 12%) – $72,000 = $24,000 net cash paid(21,335) interest expense $853,382 X 10% X 3/12$2,665 premium amortized


(a) (1) June 30, 2010Cash...................................................................................5,376,150

Bonds Payable......................................................... 5,376,150

(2) December 31, 2010Interest Expense ($5,376,150 X 12% X 6/12)..............................................322,569Bonds Payable..................................................................2,431

Cash ($5,000,000 X 13% X 6/12).................................... 325,000

(3) June 30, 2011Interest Expense [($5,376,150 – $2,431) X 12% X 6/12]................................................................322,423Bonds Payable..................................................................2,577

Cash.......................................................................... 325,000

(4) December 31, 2011Interest Expense [($5,376,150 – $2,431 – $2,577) X 12% X 6/12]...................................................322,268Bonds Payable..................................................................2,732

Cash.......................................................................... 325,000


(b) Non-current Liabilities:Bonds payable, 13% (due on June 30, 2030).................. $5,368,410*

*$5,376,150 – ($2,431 + $2,577 + $2,732) = $5,368,410

(c) (1) Interest expense for the period from January 1 to June 30, 2011 from (a) 3..........................$ 322,423Interest expense for the period from July 1 to December 31, 2011 from (a) 4........................ 322,268 Amount of bond interest expense reported for 2011...........................................................$ 644,691

(2) Total interest to be paid for the bond ($5,000,000 X 13% X 20).................................................$13,000,000Less: Premium................................................................. 376,150 Total cost of borrowing over the life

of the bond.....................................................................$12,623,850


(a) January 1, 2010Cash...................................................................................860,651.79

Bonds Payable......................................................... 860,651.79

(b) Schedule of Interest Expense and Bond Premium AmortizationEffective-Interest Method

12% Bonds Sold to Yield 10%

DateCash Paid

Interest Expense

Premium Amortized

Carrying Amount of

Bonds1/1/10 — — — £860,651.7912/31/10 £96,000.00 £86,065.18 £ 9,934.82 850,716.9712/31/11 96,000.00 85,071.70 10,928.30 839,788.6712/31/12 96,000.00 83,978.87 12,021.13 827,767.54

(c) December 31, 2010Interest Expense...............................................................86,065.18Bonds Payable..................................................................9,934.82

Cash.......................................................................... 96,000.00

(d) December 31, 2012Interest Expense...............................................................83,978.87Bonds Payable..................................................................12,021.13

Cash.......................................................................... 96,000.00


Unsecured Bonds

Zero-Coupon Bonds

Mortgage Bonds

(1) Maturity value $10,000,000 $25,000,000 $15,000,000

(2) Number of interest 40 10 10periods

(3) Stated rate per period 3.25% ( 13% ) 0 10%4

(4) Effective rate per period 3% ( 12% ) 12% 12%4

(5) Payment amount per period

$325,000(a) 0 $ 1,500,000(b)

(6) Present value $10,577,900(c) $8,049,250(d) $13,304,880(e)

(a)$10,000,000 X 13% X 1/4 = $325,000(b)$15,000,000 X 10% = $1,500,000(c)Present value of an annuity of $325,000

discounted at 3% per period for 40 periods ($325,000 X 23.11477).................................... $ 7,512,300

Present value of $10,000,000 discountedat 3% per period for 40 periods($10,000,000 X .30656)...................................................... 3,065,600

$10,577,900

(d)Present value of $25,000,000 discountedat 12% for 10 periods($25,000,000 X .32197)...................................................... $ 8,049,250

(e)Present value of an annuity of $1,500,000 discountedat 12% for 10 periods($1,500,000 X 5.65022)...................................................... $ 8,475,330

Present value of $15,000,000 discountedat 12% for 10 years($15,000,000 X .32197)...................................................... 4,829,550

$13,304,880


(a) 1. January 1, 2011Land...................................................................................300,000

Notes Payable.......................................................... 300,000 (The $300,000 capitalized land cost represents the present value of the note discounted for five years at 11%.)

2. Equipment.........................................................................297,079*Notes Payable.......................................................... 297,079

*Computation of the present value of the note:

Present value of $400,000 due in 8 years at 11%— $400,000 X .43393................................................. $173,572Present value of $24,000 payable annually for 8 years at 11% annually— $24,000 X 5.14612................................................. 123,507 Present value of the note $297,079

(b) 1. Interest Expense...............................................................33,000Notes Payable ($300,000 X .11)..................................................... 33,000

2. Interest Expense ($297,079 X .11)..............................................................32,679

Notes Payable.......................................................... 8,679Cash ($400,000 X .06).............................................. 24,000


(a) Face value of the zero-interest-bearing note.................... $600,000Discounting factor (12% for 3 periods)............................. X .71178Amount to be recorded for the land at January 1, 2011..... $427,068

Carrying value of the note at January 1, 2011.................. $427,068Applicable interest rate (12%)............................................ X .12Interest expense to be reported in 2011........................... $ 51,248

(b) January 1, 2011Cash...................................................................................4,000,000

Notes Payable 2,732,040Unearned Revenue 1,267,960*

*$4,000,000 – ($4,000,000 X .68301) = $1,267,960

Carrying value of the note at January 1, 2011 $2,732,040Applicable interest rate (10%) X .10Interest expense to be reported for 2011 $ 273,204


(a) Cash...................................................................................500,000Notes Payable 396,915Unearned Revenue ($500,000 – $396,915) 103,085

Face value $500,000Present value of 1 at 8% for 3 years X .79383Present value $396,915


(b) Interest Expense ($396,915 X 8%)...................................31,753*Notes Payable.......................................................... 31,753*

Unearned Revenue ($103,085 ÷ 3)...................................34,362*Sales......................................................................... 34,362*

*Rounded


(a) Present value of the principal: $1,500,000 X .35218.................................................... $ 528,270Present value of the interest payments: ($1,500,000 X 10%) X 5.88923..................................... 883,385 Present value (selling price) of the bonds...................... $1,411,655

(b) AMORTIZATION SCHEDULE10-Year, 10% Bonds Sold to Yield 11%

DateCash Paid

Interest Expense

Discount Amortized

Carrying Amount of

Bonds1/2/07 — — — $1,411,65512/31/07 $150,000 $155,282 $5,282 1,416,93712/31/08 150,000 155,863 5,863 1,422,80012/31/09 150,000 156,508 6,508 1,429,30812/31/10 150,000 157,224 7,224 1,436,53212/31/11 150,000 158,019 8,019 1,444,551

(c) Bonds Payable ($1,429,308 X $1,000,000/$1,500,000)...........................952,872Loss on Extinguishment of Bonds..................................57,128

Cash ($1,000,000 X 101%)....................................... 1,010,000


(a) June 30, 2011Bonds Payable ($600,000 – $78,979) 521,021Loss on Extinguishment of Bonds 102,979

Cash 624,000

Reacquisition price ($600,000 X 104%) $ 624,000Net carrying amount of bonds redeemed:

($600,000 – $78,979) (521,021 )Loss on extinguishment $ 102,979

Cash ($800,000 X 112.5513%) 900,410Bonds Payable 900,410

(b) December 31, 2011Interest Expense 22,510*Bonds Payable 1,490

Cash 24,000**

*($900,410 X 5% X 6/12)**(.03 X $800,000 = $24,000)


Reacquisition price (¥5,000,000 X 104%)........................ ¥5,200,000Less: Net carrying amount of bonds redeemed:

Par value................................................................¥5,000,000Unamortized discount........................................... (100,000 ) 4,900,000

Loss on redemption.......................................................... ¥ 300,000

Bonds Payable..................................................................4,900,000Loss on Extinguishment of Bonds..................................300,000

Cash........................................................................ 5,200,000 (To record extinguishment of bonds payable)

Cash (¥5,000,000 X 103%)................................................5,015,000 Bonds Payable....................................................... 5,015,000 (To record issuance of new bonds)


(a) Transfer of property on December 31, 2010:

Strickland Company (Debtor):Note Payable............................................................200,000Interest Payable.......................................................18,000Accumulated Depreciation—Machine...................221,000 Machine............................................................ 390,000 Gain on Disposition of Machine..................... 11,000a

Gain on Extinguishment of Debt.................... 38,000b

a$180,000 – ($390,000 – $221,000) = $11,000.b($200,000 + $18,000) – $180,000 = $38,000.

(b) “Gain on Disposition of Machine” and the “Gain on Extinguishment of Debt” should be reported under Other income and expense in the income statement.

(c) Granting of equity interest on December 31, 2010:

Strickland Company (Debtor):Note Payable............................................................200,000Interest Payable.......................................................18,000 Share Capital—Ordinary................................. 150,000 Share Premium—Ordinary.............................. 30,000 Gain on Extinguishment of Debt.................... 38,000


(a) Yes, Barkley can record a gain on extinguishment equal to the difference between the note’s carrying value and the fair value of the restructured note.

The note’s fair value is computed as follows:Present value of restructured cash flows:

Present value of principal £2,400,000 due in 3 years at 15%...........................................£1,578,048a

Present value of interest £240,000 paid annually for 3 years at 15%......................... 547,975 b

Fair value of note..............................................................£2,126,023

a£2,400,000 X .65752 = £1,578,048.b£240,000 X 2.28323 = £547,975.

(b) The amortization schedule is prepared as follows:

BARKLEY COMPANYAmortization Schedule After Debt Modification

Market-Interest Rate 15%

Date

Cash Paid

(10%)

Interest Expense

(15%) AmortizationCarrying

Value12/31/10 — — — £2,126,02312/31/11 £240,000a £318,903b £ 78,903c 2,204,92612/31/12 240,000 330,739 90,739 2,295,66512/31/13 240,000 344,335 * 104,335 2,400,000Total £720,000 £993,977 £273,977

a£2,400,000 X 10% = £240,000.b£2,126,023 X 15% = £318,903.c£318,903 – £240,000 = £78,903.*Rounded £15.


(c) Interest payment entry for Barkley Company is:

December 31, 2012Interest Expense...............................................................330,739

Note Payable............................................................ 90,739Cash.......................................................................... 240,000

(d) The payment entry at maturity is:

January 1, 2014Note Payable.....................................................................2,400,000

Cash........................................................................... 2,400,000


(a) The note’s fair value can be calculated as follows:Present value of restructured cash flows:Present value of principal £1,900,000 due in 3 years at 15%.....................................................£1,249,288a

Present value of interest £190,000 paid annually for 3 years at 15%.................................. 433,814 b

Fair value of note..............................................................£1,683,102

a£1,900,000 X .65752 = £1,249,288b£190,000 X 2.28323 = £433,814

December 31, 2010Note Payable (Old)............................................................1,900,000

Gain on Extinguishment of Debt............................ 216,898Note Payable (New)................................................. 1,683,102


(b) The amortization schedule is prepared as follows:

BARKLEY COMPANYAmortization Schedule After Debt Modification

Market-Interest Rate 15%

Date

Cash Paid

(10%)

Interest Expense

(15%) AmortizationCarrying

Value12/31/10 — — — £1,683,10212/31/11 £190,000a £252,465b £ 62,465c 1,745,56712/31/12 190,000 261,835 71,835 1,817,40212/31/13 190,000 272,598 82,598 1,900,000Total £570,000 £786,898 £216,898

a£1,900,000 X 10% = £190,000.b£1,683,102 X 15% = £252,465.c£252,465 – £190,000 = £62,465.


(c) Interest payment entries for Barkley Company are:







(d) The payment entry at maturity is:

January 1, 2014Note Payable.....................................................................1,900,000

Cash.......................................................................... 1,900,000


(a) Gottlieb Co.’s entry:Note Payable.....................................................................199,800

Property.................................................................... 90,000Gain on Disposition of Property (€140,000 – €90,000)............................................. 50,000Gain on Extinguishment of Debt............................ 59,800*

*€199,800 – €140,000.

(b) Present value of restructured cash flows:Present value of $220,000 due in 2 years at 8%, interest payable annually (Table 6-2); ($220,000 X .85734)........................... $188,615Present value of $11,000 interest payable annually for 2 years at 8% (Table 6-4); ($11,000 X 1.78326)............................................... 19,616

Fair value of note.............................................................. $208,231

Vargo Corp.’s entries:2010 Note Payable (Old)........................................... 270,000 Gain on Extinguishment of Debt............ 61,769 Note Payable (New)................................. 208,231

2011 Interest Expense ($208,231 X 8%).................. 16,658 Note Payable............................................ 5,658 Cash (5% X $220,000)............................. 11,000

2012 Interest Expense [($208,231 + $5,658) X .08]............................ 17,111 Note Payable.................................................... 213,889 Cash [$220,000 + (5% X $220,000)]........ 231,000


(a) December 31, 2010No entry since the carrying value is equal to the notes’ fair value.

December 31, 2011Note Payable..................................................................... 1,500

Unrealized Holding Gain or Loss—Income........... 1,500

December 31, 2012Unrealized Holding Gain or Loss—Income.................... 3,500

Note Payable [(€38,000 – €36,000) + €1,500].......... 3,500

(b) The note will be reported at €42,500 on Fallen’s 2011 statement of financial position.

(c) Fallen’s 2012 income is €3,500 lower since the change in fair value is reported as part of net income.

(d) Fallen’s creditworthiness has declined since the fair value of its debt declined. Since the general market interest rates have been stable, the fair value decline must have been caused by a decline in Fallen’s creditworthiness.


At December 31, 2010, disclosures would be as follows:

Maturities and sinking fund requirements on long-term debt are as follows:

2011 $ 02012 2,500,0002013 4,500,000 ($2,000,000 + $2,500,000)2014 8,500,000 ($6,000,000 + $2,500,000)2015 2,500,000

TIME AND PURPOSE OF PROBLEMS

Problem 14-1 (Time 15–20 minutes)Purpose—to provide the student with the opportunity to interpret a bond amortization schedule. This problem requires both an understanding of the function of such a schedule and the relevance of each of the individual numbers. The student is to prepare journal entries to reflect the information given in the bond amortization schedule.

Problem 14-2 (Time 25–30 minutes)Purpose—to provide the student with an understanding of how to make the journal entry to record the issuance of bonds. In addition, a portion of the bonds are retired and therefore a bond amortization schedule has to be prepared.

Problem 14-3 (Time 20–30 minutes)Purpose—to provide the student with an understanding of how interest rates can be used to deceive a customer. The problem is challenging because for the first year of this transaction, negative amortization results.

Problem 14-4 (Time 40–50 minutes)Purpose—to provide the student with an opportunity to explain what the effective-interest method is, why it is required, and how it is computed. As one part of the problem, an amortization schedule must be prepared.

Problem 14-5 (Time 15–25 minutes)Purpose—to provide the student with an opportunity to become familiar with the application of IFRS, involving the exchange of notes for cash or property, goods, or services. This problem requires the preparation of the necessary journal entries concerning the exchange of a zero-interest-bearing long-term note for a computer, and the necessary adjusting entries relative to depreciation and amortization. The student should construct the relevant Schedule of Note Discount Amortization to support the respective entries.

Problem 14-6 (Time 20–25 minutes)Purpose—to provide the student with an opportunity to become familiar with the application of IFRS, involving the exchange of a note, which is payable in equal installments, for machinery. This problem requires the preparation of the necessary journal entries concerning the exchange and the annual payments and interest. A Schedule of Note Discount Amortization should be constructed to support the respective entries.

Problem 14-7 (Time 15–20 minutes)Purpose—to provide the student with an understanding of the relevant journal entries which are necessi-tated when there is a bond issuance and bond retirement. This problem also provides an opportunity for the student to learn the footnote disclosure required.

Problem 14-8 (Time 50–65 minutes)Purpose—to provide the student with an understanding of the relevant journal entries which are neces-sitated for a bond issuance. This problem involves two independent bond issuances with the assumption that one is sold at a discount and the other at a premium, both utilizing the effective-interest method. This comprehensive problem requires preparing journal entries for the issuance of bonds, related interest payments and amortization (with the construction of amortization tables where applicable), and the retirement of part of the bonds.

Time and Purpose of Problems (Continued)

Problem 14-9 (Time 20–25 minutes)Purpose—to provide the student with an understanding of the relevant journal entries which are necessitated when there is a bond issuance and bond retirement. This problem requires preparing journal entries for the issuance of bonds, related interest payments and amortization, and the retirement of part of the bonds.

Problem 14-10 (Time 20–25 minutes)Purpose—to provide the student with a series of transactions from bond issuance, payment of bond interest, accrual of bond interest, amortization of bond discount, and bond retirement. Journal entries are required for each of these transactions.

Problem 14-11 (Time 15–25 minutes)Purpose—to provide the student with a debt modification situation that requires computation of the debtor’s gain on restructure, entries to recognize the gain and discussion of IFRS relating to this situation.

Problem 14-12 (Time 30–45 minutes)Purpose—to provide the student with three independent and different restructured debt situations where gains must be computed and journal entries recorded on the books of the debtor.

Problem 14-13 (Time 40–50 minutes)Purpose—to provide the student with a complex debt modification situation that requires two amortization schedules, computation of loss on restructure, and entries at different times on the debtor’s books.

Problem 14-14 (Time 20–25 minutes)Purpose—to provide the student with an understanding of a number of areas related to bonds. Specifically, the classification of bonds, determination of cash received with accrued interest, and disclosure requirements.

SOLUTIONS TO PROBLEMS

PROBLEM 14-1

(a) The bonds were sold at a discount of $5,651. Evidence of the discount is the January 1, 2004 book value of $94,349, which is less than the maturity value of $100,000 in 2013.

(b) The stated rate is 11% ($11,000 ÷ $100,000). The effective rate is 12% ($11,322 ÷ $94,349).

(c) January 1, 2004Cash...................................................................................94,349

Bonds Payable......................................................... 94,349

(d) December 31, 2004Interest Expense...............................................................11,322

Bonds Payable......................................................... 322Interest Payable....................................................... 11,000

(e) January 1, 2011 (Interest Payment)Interest Payable................................................................11,000

Cash.......................................................................... 11,000


Bonds Payable......................................................... 712Interest Payable....................................................... 11,000

PROBLEM 14-2

(a) Present value of the principal $2,000,000 X .38554 (PV10, 10%)........................... $ 771,080

Present value of the interest payments $210,000* X 6.14457 (PVOA10, 10%)..................... 1,290,360

Present value (selling price of the bonds)......... $2,061,440

*$2,000,000 X 10.5% = $210,000

Cash...................................................................................2,061,440Bonds Payable......................................................... 2,061,440

(b)

DateCash Paid

Interest Expense

Premium Amortization

Carrying Amount of

Bonds1/1/09 — — — $2,061,4401/1/10 $210,000 $206,144 $3,856 2,057,5841/1/11 210,000 205,758 4,242 2,053,3421/1/12 210,000 205,334 4,666 2,048,6761/1/13 210,000 204,868 5,132 2,043,544

(c) Carrying amount as of 1/1/12................................ $2,048,676Less: Amortization of bond premium

(5,132 ÷ 2)..................................................... 2,566 Carrying amount as of 7/1/12................................ $2,046,110

Reacquisition price................................................ $1,065,000Carrying amount as of 7/1/12 ($2,046,110 ÷ 2).................................................... (1,023,055 )Loss......................................................................... $ 41,945

PROBLEM 14-2 (Continued)

Entry for accrued interestInterest Expense ($204,868 X 1/2 X 1/2)..........................51,217Bonds Payable..................................................................1,283

Cash ($210,000 X 1/2 X 1/2)..................................... 52,500

Entry for reacquisitionBonds Payable..................................................................1,023,055*Loss on Extinguishment of Bonds .................................41,945

Cash.......................................................................... 1,065,000

*Premium as of 7/1/12 to be written off ($2,046,110 – $2,000,000) X 1/2 = $23,055

The loss is reported as other income and expense.

PROBLEM 14-3

(a)

DateCash Paid

Interest Expense

Discount Amortized

Carrying Amount of

Note1/1/10 — — — €32,0004/1/10 €400 €640 €240 32,2407/1/10 400 645 245 32,48510/1/10 400 650 250 32,7351/1/11 400 655 255 32,990

(b) At this point, we see that the customer owes €32,990, or €990 more than at the beginning of the year.

(c) To earn 8% over the next two years the quarterly payments must be €4,503 computed as follows:

€32,990 ÷ 7.32548 (PVOA8, 2%) = €4,503

(d)

DateCash Paid

Interest Expense

Discount Amortized

Carrying Amount of

Note1/1/11 — — — €32,9904/1/11 €4,503 €660 €3,843 29,1477/1/11 4,503 583 3,920 25,22710/1/11 4,503 505 3,998 21,2291/1/12 4,503 425 4,078 17,1514/1/12 4,503 343 4,160 12,9917/1/12 4,503 260 4,243 8,74810/1/12 4,503 175 4,328 4,4201/1/13 4,503 83* 4,420 0*rounded up €5

(e) The new sales gimmick may bring people into the showroom the first time but will drive them away once they learn of the amount of their year 2 and year 3 payments. Many will not have budgeted for these increases, and will be in a bind because they owe more on their car than it’s worth. One should question the ethics of a dealer using this tactic.

Ch14 Required Questions

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Transcript of Ch14 Required Questions