Audit of Liabilities

CHAPTER 8 – Audit of Liabilities Problem 1 In conjunction with your December 31, 2007, annual audit of the financial statements of SweetHeart Company, you have obtained and examined the December 31, 2007, accounts payable trial balance. Your examination of this trial balance disclosed the following open vouchers: a. Voucher 761, containing a P380,000 credit to Accounts Payable. This voucher covered a cash transfer to the factory payroll bank account for the pay period ended December 28, 2007. The payroll cash transfer was made January 3, 2008, and payroll checks covering this pay period were distributed to factory employees on January 4, 2008. b. Voucher 778, containing an P180,000 credit to Accounts Payable. The P180,000 credit covered the principal and interest due on a ten-year installment loan. The loan was granted to SweetHeart Company on January 1, 2007. Terms of the loan agreement call for ten equal annual installment payments of P100,000, each plus interest at 8 percent. Principal and interest payments are due January 5, 2008 – 2017. The voucher indicated that the Loan Payable and Interest Expense accounts had been properly charged. c. Voucher 741, containing a credit to Accounts Payable of P50,000. This voucher covered on invoice from AC Company for a new computer machine. The computer machine was installed December 10, 2007, and the Office Equipment account was properly charged. d. Voucher 775, containing a credit to Accounts Payable in the amount of P65,480. This voucher covered income taxes withheld from employees during December 2007. e. Voucher 779, containing a credit to Accounts Payable of P41,460. This credit covered the total interest and principal due on a 180-day P40,000 note payable to the CJ Company. Charges to the Note Payable and Interest Expense had been properly handled. f.

Voucher 751, containing a P200,000 charge to Accounts Payable. This voucher represented a P200,000 advance payment to SS Company for a special order of ten boxes. The P200,000 check was mailed to SS Company on January 2, 2008.

Questions 1. Accounts payable at year-end is a. Overstated by P716,940 b. Overstated by P666,940

c. Overstated by P516,940 d. Overstated by P466,940

2. The entry to adjust Voucher # 778 is a. Accounts payable 180,000 Loans payable 100,000 Interest payable 80,000 b. Accounts payable 180,000 Loans payable 100,000 Interest expense 80,000

c. Loans payable 100,000 Interest expense 80,000 Accounts payable 180,000 d. Loans payable 100,000 Interest payable 80,000 Accounts payable 180,000

3. The entry to adjust Voucher # 741 is a. Accounts payable – others 50,000 Accounts payable

50,000

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b. Accounts payable 50,000 Accounts payable – others c. Accounts payable – others 50,000 Machinery d. No adjustment

50,000 50,000

4. The current liability of the company at year-end is a. Overstated by P340,000 c. Understated by P200,000 b. Overstated by P140,000 d. Understated by P 60,000 Solution 1. Accounts payable Salaries payable 2. Accounts payable Loans payable Interest payable 3. Accounts payable AP – others 4. Accounts payable Income tax payable 5. Accounts payable Notes payable Interest payable 6. Cash Accounts payable Answer: 1. C 2. A

380,000 180,000 50,000 65,480 41,460 200,000 3. B

380,000 100,000 80,000 50,000 65,480 40,000 1,460 200,000 4. C

Problem 2 In conjunction with your firm’s examination of the financial statements of Ronryan Company as of December 31, 2007, you obtained from the voucher register the information shown in the work paper below. Item Entry Date

Description

1.

Supplies, purchased FOB destination, 12/15/07; received, 12/17/07

12/18/07

2.

12/18/07

3.

12/21/07

4.

5. 6. 7.

2

12/21//07

12/21/07 12/26/07 12/28/07

Amount

Account Charged

15,000

Supplies on hand

24,000

Prepaid insurance

19,000

Repairs and Main.

Merchandise shipped FOB shipping point, 12/20/07; received, 12/24/07

12,300

Inventory

Payroll, 12/07/07 – 12/21/07 (12 working days)

69,000

Sal. and wages

Auto insurance, 12/15/07 to 12/15/08 Repair services; received 12/20/07

Subscription to Tax Journals for 2008

5,000

Utilities for December 2007

24,000

Dues & subs Utilities expense

8.

9.

12/28/07

12/28/07

10.

1/5/08

11.

1/10/08

12. 13. 14.

1/14/08 1/15/08 1/15/08

Merchandise shipped FOB destination, 12/24/07; received, 1/2/08

111,000

Inventory

Merchandise shipped FOB shipping point, 12/26/07; received, 1/3/08

84,000

Inventory

72,000

Sal. and wages

38,000

Inventory

30,000

Interest expense

Payroll 12/21/07 – 1/05/08 (12 working days. 4 working days in January) Merchandise shipped FOB destination, 1/03/08, received, 1/10/08 Interest on bank loan, 10/10/07 to 01/10/08 Manufacturing equipment installed, 12/29/07

254,000

Machinery

Dividends declared, 12/15/07

160,000

Dividends payable

Accrued liabilities of 12/31/07 were as follows: Accrued payroll Accrued interest payable Dividends payable

P 48,000 26,667 160,000

The accruals made on December 31, 2007 were reversed effective January 1, 2008. Review the data given above and prepare adjusting journal entries to correct the accounts on December 31, 2007. Assume that the company follows FOB terms for recording inventory purchases. Questions 1. The entry to adjust item #2 is a. Insurance expense 24,000 Prepaid insurance 24,000 b. Insurance expense 1,000 Prepaid insurance 1,000 2. The entry to adjust item #10 is a. Salaries expense 48,000 Accrued payroll 48,000 b. Accrued payroll 48,000 Salaries expense 48,000

c. Insurance expense Prepaid insurance d. No adjustment

c. Accrued payroll Salaries expense Cash d. No adjustment

1,000 1,000

48,000 24,000 72,000

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3. The entry to adjust item #12 is a. Interest expense 26,667 Interest payable 26,667 b. Interest expense 30,000 Interest payable 30,000

c. Interest expense Interest payable Cash d. No adjustment

4. The entry to adjust item #13 a. Machinery 254,000 AP – others 254,000 b. AP – others 254,000 Machinery 254,000 5. The entry to adjust item #14 a. Dividends declared 160,000 Dividends payable 160,000 b. Dividends payable 160,000 Dividends declared 160,000 Solution 1. No Adjustment 2. Insurance expense 1,000 Prepaid insurance 3. No Adjustment 4. No Adjustment 5. No Adjustment 6. Prepaid subscription 5,000 Dues and subscription 7. No adjustment 8. Accounts payable 111,000 Inventory 9. No adjustment 10. No adjustment 11. No adjustment 12. No adjustment 13. Machinery 254,000 AP – others 14. No adjustment Answer: 1. B 2. D 3. D

26,667 3,333 30,000

c. No adjustment d. No adjustment since payment was made on Jan. 15, 2008 c. No adjustment d. No adjustment since payment was made on Jan. 15, 2008.

1,000

5,000 111,000

254,000 4. A

5. C

Problem 3 - ADJUSTMENT FOR LOSS CONTINGENCIES The following items have not been reflected in the financial statements of ALTAGRACIA CORP. for the year ended December 31, 2007. You are asked if the information should be adjusted and disclosed in the financial statements, disclosed only in the financial statement, or no adjustment or disclosure. 1. Altagracia owns a small warehouse located on the banks of a river in which it stores inventory worth approximately P250,000. Altagracia is not insured against flood losses. The river last overflowed its banks 200 years ago. a. Adjusted and disclosed in the financial statements. b. Only disclosure is required in the financial statements. c. No adjustment or disclosure required in the financial statements. 2. Altagracia offers an unconditional warranty on its toys. Based on past experience, Altagracia estimates its warranty expense to be 1% of sales. Sales during 2007 were P5,000,000.

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a. Adjusted and disclosed in the financial statements. b. Only disclosure is required in the financial statements. c. No adjustment or disclosure required in the financial statements. 3. On October 30, 2007, a safety hazard related to one of Altagracia’s toy products was discovered. It is considered probable that Altagracia will be liable for an amount in the range of P50,000 to P250,000. a. Adjusted and disclosed in the financial statements. b. Only disclosure is required in the financial statements. c. No adjustment or disclosure required in the financial statements. 4. On November 29, 2007, Altagracia initiated a lawsuit seeking P125,000 in damages from a patent infringement. a. Adjusted and disclosed in the financial statements. b. Only disclosure is required in the financial statements. c. No adjustment or disclosure required in the financial statements. 5. On December 15, 2007, a former employee filed a lawsuit seeding P50,000 for unlawful dismissal. Altagracia’s attorneys believe the suit is without merit. No court date has been set. a. Adjusted and disclosed in the financial statements. b. Only disclosure is required in the financial statements. c. No adjustment or disclosure required in the financial statements. 6. On December 12, 2007, Conchita guaranteed a bank loan of P500,000 for its president’s personal use. a. Adjusted and disclosed in the financial statements. b. Only disclosure is required in the financial statements. c. No adjustment or disclosure required in the financial statements. 7. On January 5, 2008, a warehouse containing a substantial portion of Altagracia’s inventory was destroyed by fire. Altagracia expects to recover the entire loss, except for a P125,000 deductible from insurance. a. Adjusted and disclosed in the financial statements. b. Only disclosure is required in the financial statements. c. No adjustment or disclosure required in the financial statements. 8. On January 5, 2008, inventory purchased FOB shipping point from a foreign country was detained at that coutnry’s border because of political unrest. The shipment is valued at P750,000. Altagracia’s attorneys have stated that it is probable that Altagracia will be able to obtain the shipment. a. Adjusted and disclosed in the financial statements. b. Only disclosure is required in the financial statements. c. No adjustment or disclosure required in the financial statements. 9. On a. b. c.

January 30, 2008, Altagracia issued P5,000,000 bonds at a premium of P250,000. Adjusted and disclosed in the financial statements. Only disclosure is required in the financial statements. No adjustment or disclosure required in the financial statements.

10. On February 14, 2008, the BIR assessed Altagracia an additional P200,000 for the 2001 tax year. Altagracia’s attorneys and tax accountants have stated that it is likely that the BIR will agree to a P150,000 settlement.

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a. Adjusted and disclosed in the financial statements. b. Only disclosure is required in the financial statements. c. No adjustment or disclosure required in the financial statements. Solution 1. C No adjustment nor disclosure 2. A Accrue at P50,000 3. A Accrue at P50,000 4. B No adjustment – only disclosure for gain contingency 5. C No adjustment nor disclose 6. A No adjustment – disclosure is required 7. B Only disclosure – subsequent events 8. A Accrue since it is probable 9. B Only disclosure – subsequent events 10. A Accrue at P150,000

Problem 4 - BONUS COMPUTATION Maria Rosa, president of the Villa Nova Company, has a bonus arrangement with company under which she receives 10% of the net income (after deducting taxes bonuses) each year. For the current year, the net income before deducting either provision for income taxes or the bonus is P4,650,000. The bonus is deductible for purposes, and the tax rate is 32%. Questions 1. The amount of Maria Rosa’s bonus is a. P 465,000.00 b. P 364,285.71

c. P 339,270.39

2. The appropriate provision for income tax for the year is a. P 1,488,000.00 b. P 1,393,258.43 c. P 1,371,428.57 3. The entry to record the a. Bonus expense Bonus payable b. Bonus expense Bonus payable c. Bonus expense Bonus payable d. No entry

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d. P 296,069.42 d. P 1,379,433.48

bonus (which will be paid in the following year) is 296,069.42 296,069.42 339,270.39 339,270.39 465,000.00 465,000.00

Solution 1. Answer: D B = 10% (P4,650,000 – B – T) T = 32% (P4,650,000 – B) B = 10% (P4,650,000 – B – (32% x P4,650,000 – B) = 10% (P4,650,000 – B – (P1,488,000 - .32B) = 10% (P4,650,000 – B – P1,488,000 + .32B = P465,000 - .10B – P148,800 + .032B = P316,200 - .068B 1.068B = P316,200 = P296,097.42 2. Answer: B T = 32% (P4,650,000 – P296,067.42) = P1,393,258.43 3. Answer: A Bonus expense 296,097.42 Bonus payable 296,097.42

the and the tax

Problem 5 - PREMIUMS In the packages of its products, ALONDRA, INC. includes coupons that may be presented at retail stores to obtain discounts on other Alondra products. Retailers are reimbursed for the face amount of coupons redeemed plus 10% of that amount for handling costs. Alondra honors requests for coupon redemption by retailers up to 3 months after the consumer expiration date. Alondra estimates that 60% of all coupons issued will ultimately be redeemed. Information relating to coupons issued by Alondra during 2007 is as follows: Consumer expiration date Total payments to retailers as of 12/31/07 Liability for unredeemed coupons as of 12/31/07

12/31/07 165,000 99,000

Questions 1. The total face amount of coupons issued in 2007 is a. P 600,000 b. P 440,000 c. P 400,000

d. P 240,000

2. Coupons expense at year-end is a. P 440,000 b. P 400,000

d. P 240,000

c. P 264,000

4. Estimated liability for unredeemed coupons is a. P 219,000 b. P 123,000 c. P 99,000 Solution Coupons issued X Coupons to be redeemed Plus: Handling cost (10%) Total Cost Less: payment Estimated liability

400,000 – squeezed figure 60% 240,000 Answer: 24,000 1. C 2. C 264,000 165,000 99,000

d. P

3,000

3. C

Problem 6 - DEBT RESTRUCTURING: ASSET SWAP, EQUITY SWAP AND MODIFICATION OF TERMS MARIANA CORPORATION is having financial difficulty and therefore has asked NALOOY Bank to restructure its P3 million note outstanding. The presented note has 3 years remaining and pays a current rate of interest of 10%. The present market rate for a loan of this nature is 12%. The note was issued at its face value. Presented below are four independent situations. Determine the journal entry that Mariana would make for each of the following types of debt restructuring. 1. NALOOY Bank agrees to take an equity interest in Mariana by accepting common stock valued at 2,400 in exchange for relinquishing its claim on this note. The common stock has a par value of P1,200,000. a. Notes payable 3,000,000 Common stock 3,000,000 b. Notes payable 3,000,000 Common stock 1,200,000 APIC 1,800,000 c. Notes payable 3,000,000 Common stock 1,200,000 Interest expense 300,000 APIC 1,500,000

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d. No adjustment 2. NALOOY Bank agrees to accept land in exchange for relinquishing its claim on this note. The land has a book value of P2,000,000 and a fair value of P2,500,000. a. Notes payable 3,000,000 Land 2,500,000 Gain on debt restructuring 500,000 b. Notes payable 3,000,000 Land 2,000,000 Interest expense 300,000 Gain on exchange 200,000 Gain on debt restructuring 500,000 c. Notes payable 3,000,000 Land 2,000,000 Gain on exchange 500,000 Gain on debt restructuring 500,000 d. No adjustment 3. NALOOY Bank agrees to modify the terms of the note, indicating that Dolores does not have to pay any interest on the note over the 3-year period. a. Interest payable 300,000 Gain on debt restructuring 300,000 b. Loss on debt restructuring 300,000 Interest expense 300,000 c. Interest expense 900,000 Gain on debt restructuring 900,000 d. No adjustment 4. NALOOY Bank agrees to reduce the principal balance due to P2,000,000 and require interest only in the second and third year at a rate of 10%. a. Notes payable – old 3,000,000 Notes payable – new 2,400,000 Gain on debt restructuring 600,000 b. Notes payable - old 3,000,000 Notes payable – new 3,000,000 c. Notes payable – old 3,000,000 Notes payable – new 2,600,000 Gain on debt restructuring 400,000 d. No adjustment Solution 1. B Notes payable 3,000,000 Common stock APIC 2. C Notes payable 3,000,000 Land Gain on exchange Gain on debt restructuring 3. D No Adjustment 4. A Notes payable – old 3,000,000 Notes payable – new Gain on debt restructuring

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1,200,000 1,800,000 2,000,000 500,000 500,000

2,400,000 600,000

Problem 7 - CURRENT LIABILITY The December 31 trial balance of the Ruel Corporation includes, among others, the following: Long-term Notes – which are payable in annual installment of P10,000 on February 1 of each year Rental income received in advance Notes payable, which are trade notes, with the exception of P20,000 Notes payable to bank on June 30 of the following year Accounts payable which include account with debit balance of P2,000 Notes Receivable which have been reduced by notes discounted of P20,000 that are not yet due and on which the Corporation is contingently liable Accounts Receivable, which include accounts with credit balances of P10,000 and past due accounts of P6,000 on which a loss of 80% is anticipated Merchandise Inventory, which includes goods held for consignment, P8,000, and goods received on December 31 of P12,000; neither of these items having been recorded as a purchase

P 60,000 16,000 60,000 80,000 100,000 200,000 180,000

Questions 1. What is the amount of the current liabilities on December 31? a. P 190,000 b. P 184,000 c. P 178,000

d. P 170,000

2. The long-term debt at year-end is a. P 70,000 b. P 50,000

d. P 0

c. P 30,000

Solution Long-term Notes – which are payable in annual installment of P10,000 on February 1 of each year Rental income received in advance Notes payable, which are trade notes, with the exception of P20,000 Notes payable to bank on June 30 of the following year Accounts payable which include account with debit balance of P2,000 Accounts Receivable, which include accounts with credit balances of P10,000 and past due accounts of P6,000 on which a loss of 80% is anticipated Merchandise Inventory, which includes goods held for consignment, P8,000, and goods received on December 31 of P12,000; neither of these items having been recorded as a purchase TOTAL CURRENT LIABILITIES Answer: 1. A 2. Long-term liability – P50,000

P 10,000 16,000 60,000 82,000 10,000 12,000 P 190,000

Problem 8 Abam Corporation is selling audio and video appliances. The company’s fiscal year ends on March 31. The following information relates the obligations of the company as of March 31, 2007. Notes payable Abam has signed several long- term notes with financial institutions. The maturities of these notes are given below. The total unpaid interest for all of these notes amount to P340,000 on March 31, 2007.

9

Due date April 31, 2007 July 31, 2007 September 1, 2007 February 1, 2008 April 1, 2008- March 31, 2011

Amount P 600,000 900,000 450,000 450,000 2,700,000 P5,100,000

Estimated warranties: Abam has one year product warranty on some selected items. The estimated warranty liability on sales made during the 2005-2006 fiscal year and still outstanding as of March 31, 2006, amounted to P252,000. The warranty costs on sales made from April 1, 2006 to March 31, 2007 are estimated at P630,000. The actual warranty costs incurred during 20062007 fiscal year as follows: Warranty claims honored on 2005- 2006 Warranty claims honored on 2006- 2007 sales Total

P252,000 285,000 P537,000

Trade payables Accounts payable for supplies, goods and services purchases on open account amount to P560,000 as of March 31, 2007. Dividends On march 10, 2007, Abam’s board of directors declared a cash dividend of P0.30 per common share and a 10% common stock dividend. Both dividends were to be distributed on Aptil 5, 2007 to common stockholders on record at the close of business on March 31, 2007. As of March 31, 2007, Abams has 5 million, P2 par value common stock shares issued and outstanding. Bonds payable Abams issued P5,000,000, 12% bonds, on October 1, 2001 at 96. The bonds will mature on October 1, 2011. Interest is paid semi- annually on October 1 and April 1. Abams uses straight line method to amortize bond discount. Based on the forgoing information, determine the adjusted balances of the following as of March 31, 2007: Questions 1. Estimated warranty payable a. P252,000 b. P345,000

c. P630,000

d. P882,000

2. Unamortized bond discount a. P110,000 b. P200,000

c. P100,000

d. P90,000

3. Bond interest payable a. P0

b. P300,000

c. P150,000

d. P250,000

4. Total current liabilities a. P6,445,000

b. P5,105,000

c. P5,445,000

d. P3,945,000

5. Total noncurrent liabilities a. P7,700,000 b. P7,590,000

c. P7,500,000

d. P7,610,000

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Solution 1. B Total Warranty Expense 882,000 Less: Paid warranty 537,000 Est. liability 345,000 2. D Discount on BP (P5M x 4%) 200,000 Amortization (200,000/120 x 66) 110,000 (Oct. 1, 1998 – March 31, 2004) ______ Unamortized discount on BP 90,000 3. D P5M x 12% x 6/12 = P300,000 4. C Notes payable 2,400,000 Interest payable 640,000 (340,000 + 300,000) Est. liability 345,000 Trade payable 560,000 Dividends payable 1,500,000 Total Current Liability 5,445,000 5. D Notes payable 2,700,000 Bonds payable 4,910,000 Total 7,610,000

BONDS PAYABLE Problem 9 On January 1, 2007, LACEA COMPANY issued 7% term bonds with a face amount of P1,000,000 due January 1, 2015. Interest is payable semiannually on January 1 and July 1. On the date of issue, investors were willing to accept an effective interest of 6%. Questions 1. The bonds were issued on January 1, 2007 at a. A premium c. Book value b. An amortized value d. A discount 2. Assume the bonds were issued on January 1, 2007, for P1,062,809. Using the effective interest amortization method, LACEA COMPANY recorded interest expense for the 6 months ended June 30, 2007, in the amount of a. P 70,000 b. P 63,769 c. P 35,000 d. P 31,884 3. Same information in number 2. LACEA COMPANY recorded interest expense for the 6 months ended December 31, 2007, in the amount of a. P 70,000 b. P 63,769 c. P 31,884 d. P 31,791 4. The carrying value of the bonds on July 1, 2008 is: a. P 1,056,578 b. P 1,056,484 c. P 1,053,276

d. P 1,053,179

5. A bond issue sold at a premium is valued on the statement of financial position at the a. Maturity value. b. Maturity value plus the unamortized portion of the premium. c. Cost at the date of investment. d. Maturity value less the unamortized portion of the premium. Solution 1. B If nominal rate is less than the yield rate, there is discount

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2.

3.

If nominal rate is more than the yield rate, there is premium D Date Interest expense Interest paid

Amortization

July 2007 31,884 35,000 December 2007 31,791 35,000 July 2008 31,695 35,000 Interest expense = Carrying value of the note X yield rate x 6/12 Interest paid = Face value of the note X nominal rate x 6/12 Amortization = Interest expense – Interest paid Carrying value – end = Carrying value – beg. – Amortization D 4. D 5. B

3,116 3,209 3,305

Carrying Value 1,062,809 1,059,693 1,056,484 1,053,179

Problem 10 The following data were obtained from the initial audit of Popoy Company: Debit 15%, 10-year Bonds Payable, dated January 1, 2006. Cash proceeds from issue on January 1, 2007 of 500, P1,000 bonds Bonds Interest Expense Cash paid – Jan. 2, 2008 Cash paid – July 1, 2008 Accrual – December 31, 2008

Balance

522,500

522,500

37,500 37,500 37,500

Accrued Interest on Bonds Balance – Jan. 1, 2008 Accrual – Dec. 31 2008 Treasury Bonds Redemption price and interest to date on 100 bonds permanently retired – October 1, 2008

Credit

37,500 75,000 112,500 37,500 37,500

109,000

37,500 75,000

109,000

Questions 1. What should be the correct original entry to account for the issuance of bonds at January 1, 2007? DEBIT CREDIT a. Cash 522,500 Bonds Payable 500,000 Discount on BP 22,500 b. Cash 500,000 Bonds Payable 500,000 c. Cash 522,500 Bonds Payable 500,000 Premium on BP 22,500 d. Cash 522,500 Bonds payable 522,500 2. The adjusting entry to accrue interest DEBIT a. Cash 37,500 b. Interest expense 37,500 c. Interest receivable 37,500 d. Interest expense 37,500

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on bonds payable at December 31, 2007? CREDIT Interest income 37,500 Interest payable 37,500 Interest income 37,500 Interest income 37,500

3. The reversing entry related to accrual DEBIT a. Interest income 37,500 b. Interest payable 37,500 c. Interest payable 37,500 d. Retained earnings 37,500

on bond interest expense at January 1, 2008? CREDIT Cash 37,500 Interest expense 37,500 Retained earnings 37,500 Interest expense 37,500

4. The journal entry to record payment of interest due on July 1, 2008? DEBIT CREDIT a. Cash 37,500 Interest payable 37,500 b. Interest payable 37,500 Cash 37,500 c. Interest receivable 37,500 Cash 37,500 d. Interest expense 37,500 Cash 37,500 5. The reversing entry related to accrual DEBIT a. Interest income 37,500 b. Interest payable 30,000 c. Interest payable 15,000 d. Interest income 37,500

on bond interest expense at January 1, 2009? CREDIT Cash 37,500 Interest expense 30,000 Interest expense 15,000 Interest expense 37,500

6. The adjusting entry that should have been made to amortize December 31, 2007? DEBIT CREDIT a. Premium on BP 2,500 Interest expense b. Premium on BP 2,500 Retained earnings c. Premium on BP 2,250 Interest expense d. Premium on BP 2,250 Retained earnings

on bond premium at 2,500 2,500 2,250 2,250

7. The correcting entry to adjust for the error related to amortization on bond premium in 2008 is? DEBIT CREDIT a. Premium on BP 2,500 Retained earnings 2,500 b. Premium on BP 2,500 Interest expense 2,500 c. Premium on BP 4,875 Interest expense 2,375 Retained earnings 2,500 d. Premium on BP 4,875 Retained earnings 4,875 8. The correct entry to record retirement a. Interest expense 3,750 Bonds payable 100,000 Premium on BP 3,625 Loss on retirement 1,625 b. Interest expense 3,750 Bonds payable 100,000 Premium on BP 3,625 Retained earnings 1,625 c. Interest expense 3,750 Bonds payable 100,000 Premium on BP 3,713 Loss on retirement 1,537 d. Interest expense 3,750 Bonds payable 100,000

of 100 bonds on October 1, 2008? Cash 109,000

Cash

109,000

Cash

109,000

Cash

109,000

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Premium on BP Retained earnings Solution 1. C 2.

B

3.

B

4.

D

5.

B

6.

A

7.

C

8.

A

3,713 1,537

Cash

522,500 Bonds payable 500,000 Bond premium 22,500 Interest expense 37,500 Interest payable 37,500 Interest payable 37,500 Interest expense 37,500 Interest expense 37,500 Cash 37,500 Interest payable 30,000 Interest expense 30,000 Bond premium 2,500 Interest expense 2,500 (P22,500/108 x 12 = P2,500) Bond premium 4,875 Retained earnings 2,500 (P22,500/108 x 12 = P 2,500) Interest expense 2,375 (P22,500/108 x 9 = P 1,875 4/5 x P22,500/108 x 3 = 500) OE: Treasury Bonds 109,000 Cash 109,000 CE: Bonds payable 100,000 Bond premium 3,625 Interest expense 3,750 Loss on retirement 1,625 Cash 109,000 Adj: Bonds payable 100,000 Bond premium 3,625 Interest expense 3,750 Loss on retirement 1,625 Treasury Bodns 109,000

Problem 10 When the LUAYON MANUFACTURING COMPANY was expanding its metal window division, it did not have enough capital to finance the expansion. So, management sought and received approval from the board of directors to issue bonds. The company planned to issue P5,000,000 of 8 percent, five-year bonds in 2007. Interest would be paid on June 30 and December 31 of each year. The bonds would be callable at 104, and each P1,000 bond would be convertible into 30 shares of P10 par value common stock. On January 1, 2007, the bonds were sold at 96 because the market rate of interest for similar investment was 9 percent. The company decided to amortize the bond discount by using the effective interest method. On July 1, 2009, management called and retired half the bonds, and investors converted the other half into common stock. As inducement, the company agrees to pay additional P100,000 to the holders of the convertible bonds. Questions 1. Carrying value of the bonds at December 31, 2007 is: a. P 4,840,000 b. P 4,832,720 c. P 4,832,000

d. P 4,816,000

2. Carrying value of the bonds at December 31, 2008 is: a. P 4,880,000 b. P 4,868,451 c. P 4,866,880

d. P 4,850,000

3. Interest expense at December 31, 2008 is: a. P 432,000 b. P 432,720

d. P 437,339

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c. P 435,731

4. Carrying value of the bonds converted is: a. P 2,500,000 b. P 2,456,235

c. P 2,450,000

d. P 2,443,765

5. Additional paid-in capital in the conversion of bonds is: a. P 1,706,234 b. P 1,793,766 c. P 1,693,766

d. P 1,684,225

6. Carrying value of retired bonds is: a. P 2,500,000 b. P 2,456,235

c. P 2,450,000

d. P 2,443,765

7. Loss on early retirement of bonds is: a. P 156,235 b. P 150,000

c. P 143,765

d. P 100,000

8. Interest expense on the bonds at December 31, 2009 is: a. P 438,161 b. P 400,000 c. P 219,080

d. P 200,000

9. The company should record gain or loss on conversion of: a. Loss of P100,000 c. Loss of P50,000 b. Gain of P100,000 d. No gain or loss on conversion Solution July 1, 2009

Bonds payable Loss on bond retirement Discount on BP Cash Bonds payable Debt conversion expense Discount on BP Common stock APIC Cash Date Interest expense

June 2007 December 2007 June 2008 December 2008 June 2009 Answer: 1. b 6. d

215,000 216,720 217,472 218,259 219,080 2. b 7. a

3. c 8. c

2,500,000 156,235 2,500,000 100,000

Interest paid

56,235 2,600,000 56,235 750,000 1,693,765 100,000 Amortization

200,000 200,000 200,000 200,000 200,000 4. d 9. d

16,000 16,720 17,472 18,259 19,080

Carrying Value 4,800,000 4,816,000 4,832,720 4,850,192 4,868,451 4,887,531

5. c

Problem 11 In connection with your firm’s annual examination of the December 31, 2007 financial statements of the NUNEZA CORPORATION, your have been assigned the duty of auditing long-term liabilities for the year ended December 31, 2007. In the course of performing your work, you obtain the following evidence and information related to a new bond issue sold during 2007: 1. NUNEZA floated a new issue of P800,000 par value, 15-year, 10 percent bonds during the latter half of the second quarter of the year. 2. The new bond issue was dated July 1, 2007 and it was sold on that date for P689,872. This price provided an effective interest rate on the bond issue of 12 percent. 3. Interest on a new bond issue was payable semiannually on January 1 and July 1.

15

4. NUNEZA paid P12,000 cash for printing, legal, and other fees in connection with the issuance of the bonds. 5. The NUNEZA CORPORATION accounts related to this new bond reflect these bond transactions as follows: Bond Payable, 2007 Issue CR 7/1/07 P 800,000 Unamortized Bond Discount, 2007 Bond Issue CD 7/1/07 P110,128 CD 7/1/07 12,000 JV 12/31/07 P 4,070.93 Bond Interest Expense, 2007 Bond Issue JV 12/31/07 P 4,070.93 VR 12/30/07 40,000.00 Legend: CD – Cash Disbursement CR – Cash Receipts JV – Journal Vouchers VR – Voucher Register Questions 1. Amortization of bond issue cost is: a. P 800.00 b. P 400.00

c. P 240.00

d. P 120.00

2. Amortization of bond discount is: a. P 1,392 b. P 2,679

c. P 3,671

d. P 4,071

3. Carrying value of the bonds at year-end is: a. P 693,943 b. P 693,543

c. P 692,551

d. P 691,264

4

The accrued interest expense at year-end is: a. P 40,000 b. P 41,392 c. P 80,000

d. P 82,785

5. The recorded amortization of bond discount is overstated by: a. P 400 b. P 1,392 c. P 2,679

d. P 0

6. The carrying value of the bond issue cost at year-end is: a. P 11,880 b. P 11,760 c. P 11,600

d. P 11,200

Solution 1. B P12,000/15 x 6/12 = P400 2. A 3. D 4. A Date Interest expense

5. 6.

16

December 2007 July 2008 December 2008 C Per record Per audit Adj. C (P12,000 – P400)

41,392 41,476 41,564 - P 4,071 - 1,392 - P 2,679

Interest paid 40,000 40,000 40,000

Amortization 1,392 1,476 1,564

Carrying Value 689,872 691,264 692,740 694,304

Problem 12 On July 1, 2007 Salem Corporation issued P2,000,000 of 7% bonds payable in 10 years. The bonds pay interest semiannually. Each P1,000 bond includes a detachable stock purchase right. Each right gives the bondholder the option to purchase for P30, one share of P1 par value common stock at any time during the next 10 years. The bonds were sold for P2,000,000. The value of the stock purchase rights at the time of issuance was P100,000. Questions 1. How many warrants were issued? a. 2,000,000 b. P 66,667

c. 20,000

d.

2,000

2. If the bondholder will exercise all his rights, the additional paid-in capital will be a. P 158,000 b. P 150,000 c. P 58,000 d. P 0 Solution Cash 2,000,000 Discount on bonds payable 100,000 Bonds payable Common stock warrants outstanding Proceeds Less: Cost of Warrants Cost of the bonds If warrant will exercise: Cash CSWO Common stock APIC Answer: 1. D

2,000,000 100,000

2,000,000 100,000 1,900,000 60,000 100,000 2. A

2,000 158,000

Problem 13 Friendly Corporation issued P500,000, 6%, nonconvertible bonds with detachable stock purchase warrants. Each P1,000 bond carried 20 detachable stock purchase warrants, each of which called for one share of friendly common stock, par P50, at the specified option price of P60 per share. The bonds sold at 106, and the detachable stock purchase warrants were immediately quoted at P1 each on the market. Questions 1. The entry to record the issuance of the bonds is a. Cash 500,000 Bonds payable 500,000 b. Cash 530,000 Bonds payable 500,000 Premium on bonds payable 20,000 CS warrants outstanding 10,000 c. Cash 530,000 Bonds payable 500,000 Premium on bonds payable 30,000 d. Cash 530,000 Bonds payable 500,000 CS warrants outstanding 30,000

17

2. The entry to record the subsequent exercise of the 10,000 stock purchase warrants is a. Cash 600,000 Premium on BP 20,000 Bonds payable 500,000 Additional paid-in capital 120,000 b. Cash 500,000 Common stock 500,000 c. Cash 600,000 Common stock 500,000 Additional paid-in capital 100,000 d. Cash 600,000 CS warrants outstn. 10,000 Common stock 500,000 Additional paid-in capital 110,000 3. Assuming the Goode Company did not exercise the 10,000 stock purchase warrants in questions above, what is the entry for Goode Company (the investor) in the acquisition of the bonds (including the stock purchase warrants). a. Investment in bonds 500,000 Cash 500,000 b. Investment in bonds 500,000 Invest. in warrants 30,000 Cash 530,000 c. Investment in bonds 530,000 Cash 530,000 d. Investment in bonds 470,000 Cash 470,000 4. The entry in the subsequent sale to another investor of half of the stock purchase warrants at P1.50 each is a. No adjustment b. Cash 7,500 Gain on sale 7,500 c. Cash 750 Investment in bonds 500 Gain on sale 250 d. Cash 7,500 Investment in bonds 5,000 (P1 x 10,000 x 1/2) Gain on sale 2,500 5. The entry in the Subsequent exercise of the remaining half of the stock purchase warrants (by tendering them to Friendly Corporation). The market value of the stock was P62 per share is a. Investment in stock 305,000 Cash 300,000 (10,000 warrants x ½ x P60) Investment in bonds 5,000 b. Investment in bonds 305,000 Cash 305,000 c. Investment in stock 300,000 Cash 300,000

18

d. Investment in bonds 5,000 Investment in stock 300,000 Cash

305,000

Solution 1. B Cash

2.

D

3.

C

4.

D

5.

A

530,000 Bonds payable Premium on bonds payable Common stock warrants outstanding Cash 600,000 CS warrants outstanding Common stock APIC Investment in bonds 530,000 Cash Cash 7,500 Investment in bonds (P1 x 10,000 x ½) Gain on sale Investment in stock 305,000 Cash (10,000 warrants x ½ x P60) Investment in bonds

500,000 20,000 10,000 10,000 500,000 110,000 530,000 5,000 2,500 300,000 5,000

Problem 14 In your initial audit of EMILIA CORP., you find the following ledger account balances. 12% Bonds Payable – maturity date, 1/1/2015 1/2/05 CR P5,000,000 Treasury Bonds 10/1/07 CD P1,100,000 Bond Discount 1/2/05

1/1/07 7/1/07

CD P 500,000 Bond Interest Expense CD P 300,000 CD 300,000

The bonds were redeemed for permanent cancellation on October 1, 2007, at 107 plus accrued interest. Questions 1. Adjusted balance of bonds payable on December 31, 2007. a. P 5,000,000 b. P 4,000,000 c. P 3,900,000

d. P 3,000,000

2. Adjusted balance of bond discount on December 31, 2007. a. P 360,000 b. P 352,500 c. P 327,500

d. P 280,000

3. Bond interest expense for 2007. a. P 917,500 b. P 870,000

d. P 617,500

c. P 680,000

19

4. Gain or loss on bond redemption. a. P 170,000 b. P 142,500

c. P 127,500

Solution Retained earnings 100,000 Bond discount 100,000 Retained earnings 300,000 Interest expense 300,000 -------------------------------------------------------------OE: Treasury bonds 1,100,000 Cash 1,100,000 CE: Bonds payable 1,000,000 Interest expense 30,000 Loss on early extinguishment of debt 142,500 Bonds discount 72,500 * Cash 1,100,000 Adj: Loss on early extinguishment of debt 142,500 Interest expense 30,000 Bonds payable 1,000,000 Bonds discount 72,500 Treasury bonds 1,100,000 ---------------------------------------------------------------Interest expense 240,000 Interest payable 240,000 ---------------------------------------------------------------Interest expense 47,500 Bonds discount 47,500 P100,000 bond / 10 years x 9/12 = P 7,500 P400,000 bond / 10 years = 40,000 P47,500 Answer: 1. B 2. D 3. D 4. B

d. P

97,500

* 1/5 x P500,000 = P100,000 100,000/120 x 33 (27,500) Unamortized disc. for the P100,000 bond P 72,500

Problem 15 At December 31, 2006, the Core Corporation had the following liability and equity account balances: 11% Bonds payable, at face value Premium on bonds payable Common stock Additional paid in capital Retained earnings Treasury stock, at cost

P2,500,000 176,190 4,000,000 1,147,500 1,232,500 162,500

Transactions during 2007 and other information relating to the Corporation’s liability and equity accounts were as follows:  The bonds were issued on December 31, 2005, for P2,689,000 to yield 10%. The bonds mature on December 31, 2012. Interest is payable annually on December 31. The Corporation uses the effective interest method to amortize bond premium.  At December 31, 2006, the corporation had 1,000,000 authorized shares of P10 par common stock.

20

 On November 2, 2007, the Corporation borrowed P2,000,000 at 9%, evidenced by a note payable to Premium Bank. The note is payable in five equal annual principal installments of P400,000. The first principal and interest payment is due on November 2, 2008.

Questions 1. How much is the bond premium amortization for 2007? a. P 7,381 b. P 6,710 c. P 6,500

d. P 6,100

2. What is the carrying value of the bonds payable on December 31, 2007? a. P 2,689,000 b. P 2,682,900 c. P 2,676,190 d. P 2,668,809 3. How much is the 2007 interest expense on bonds payable? a. P 275,000 b. P 268,900 c. P 268,290

d. P 267,619

4. What is the treasury stock balance on December 31, 2007? a. P 165,200 b. P 163,500 c. P 162,500

d. P 162,000

5. What is the long-term portion of the note payable to bank as of December 31, 2007? a. P 2,000,000 b. P 1,600,000 c. P 1,400,000 d. P 1,000,000 6. What is the 2007 total interest expense? a. P 305,000 b. P 298,900 Solution

Interest Interest Paid Expense

Dec. 31, 2005 2006 275,000 2007 275,000 2008 275,000 Answer: 1. B 2. C 3. C 6. Notes Payable P2,000,000 x 9% x 2/12 Bonds payable Total

268,900 268,290 267,619 4. C = P 30,000 268,290 298,290

c. P 298,290

d. P 297,619 Carrying Value 2,689,000 2,682,900 2,676,190 2,668,809

Amort. 6,100 6,710 7,381 5. B

Problem 16 The STEPHANY CO. sold P6,000,000 of 9% bonds on October 1, 1999, at P5,747,280 plus accrued interest. The bonds were dated July 1, 1999; interest payable semiannually on January 1 and July 1; redeemable after June 30, 2004 to June 30, 2007, at 101, and thereafter until maturity at 100; and convertible into P10 par value common stock as follows:   

Until June 30, 2004, at the rate of 6 shares for each P1,000 bond. From July 1, 2004, to June 30, 2007, at the rate of 5 shares for each P1,000 bond. After June 30, 2007, at the rate of 4 shares for each P1,000 bond.

The bonds mature 10 years form their issue date. The company adjust its books monthly and closes its books as of December 31 each year.

21

The following transactions occur in connection with the bonds: 2005 July 1 P2,000,000 of bonds were converted into stock. 2006 Dec 31 P1,000,000 face value of bonds were reacquired at 99-1/4 plus accrued interest. These were immediately retired. 2007 July 1 The remaining bonds were called for redemption and accrued interest was paid. For purposes of obtaining funds for redemption and business expansion, an P8,000,000 issue of 7% bonds was sold at 97. These bonds are dated July 1, 2007, and are due in 20 years. Questions 1. What is the carrying value of bonds payable at December 31, 1999? a. P 5,747,280 b. P 6,000,000 c. P 5,753,760 d. P 5,749,440 2. What is the total interest expense for 1999? a. P 128,520 b. P 47,160

c. P 141,480

d. P 135,000

3. In recording the bond conversion on July 1, 2005, how much should be credited to the additional paid-in capital account? a. P 1,796,320 b. P 1,965,440 c. P 1,845,440 d. P 1,865,440 4. What is the gain or loss on bond conversion on July 1, 2005? a. P 0 b. P 1,796,320 c. P 1,865,440

d. P 34,560

5. What is the carrying value of the bonds reacquired on December 31, 2006? a. P 989,200 b. P 957,880 c. P 1,010,800 d. P 981,700 6. What is the gain (loss) on bond reacquisition on December 31, 2006? a. P 3,300 b. (P 3,300) c. P 34,620 d. (P 34,620) 7. What is the carrying value of the bonds retired on July 1, 2007? a. P 3,000,000 b. P 2,974,080 c. P 2,873,640

d. P 3,025,920

8. What is the gain (loss) on bond retirement on July 1, 2007? a. (P 25,920) b. P 25,920 c. (P 12,960)

d. P 0

Solution October 1, 1999 Cash

Dec. 31, 1999

July 1, 2005

Dec. 31, 2005

22

5,882,280 Discount on Bond payable 252,720 Bonds payable Interest expense Interest expense 6,480 Discount on Bond Payable P 252,720/117 x 3 = P6,480 Interest expense 270,000 Interest payable Bond payable 2,000,000 Discount on bonds payable Common stock Additional paid-in capital Bonds payable 1,000,000 Interest expense 45,000

6,000,000 135,000 6,480 270,000 34,560 100,000 1,865,440

Loss on retirement 3,300 Discount on bonds payable Cash Bonds payable 3,000,000 Interest expense 135,000 Loss on retirement 25,920 Discount on bonds payable Cash

July 1, 2007

Answer: 1. C 6. B

2. C 7. B

3. D 8. A

4. A

10,800 1,037,500

25,920 3,135,000

5. A

Problem 17 From the following accounts and supplementary information, prepare working papers and any adjusting entries covering your audit of bonds payable in connection with your first examination of the Corporation, as of December 31, 2007. 6% 25-year Debenture Bonds, Due January 1, 2027 DR January 1, 2002

CR P500,000.00

CR

Balance P500,000.00

Bond Premium DR January 1, 2002

CR

October 1, 2007

CD

CR P 25,000.00

Treasury Bonds DR P104,500.00

CR

Balance P 25,000.00

Balance P104,500.00

Bond Interest Expense January 1, 2007 July 1, 2007

CD

DR CDP 15,000.00 15,000.00

CR

Balance P 15,000.00 30,000.00

The treasury bonds were purchased at a price of 103 plus accrued interest through a broker. The bonds are not to be reissued and the client asked you to prepare an adjusting entry writing off the bonds. Questions 1. The December 31, 2007 Bonds Payable is a. P 500,000 b. P 450,000

c. P 400,000

d. P 395,500

2. The December 31, 2007 Bond Premium is a. P 20,050 b. P 16,000

c. P 15,000

d. P 14,750

3. The December 31, 2007 Accrued Interest Payable is a. P 30,000 b. P 26,050 c. P 15,000

d. P 12,000

4. The December 31, 2007 Bond Interest Expense is a. P 27,550 b. P 26,050 c. P 25,000

d. P 24,050

23

Solution Bond premium 4,000 Retained earnings Bonds payable 100,000 Bonds premium 4,050 Interest expense 1,500 Treasury bonds Gain on bond redemption/retirement Retained earnings 15,000 Interest expense Interest expense 12,000 Interest payable Bonds premium 950 Interest expense P25,000 x 4/5 = P 20,000/25 = P 800 P 5,000 x 9/12 = 150 P 950 Answer: 1. C 2. B 3. D

4,000

104,500 1,050 15,000 12,000 950

4. A

Problem 18 In the course of your initial examination of the accounts of Paul Company, you obtain the following information related to the company’s bonds payable as of December 31, 2007: 12% 25-year Bonds Payable, 2006 issue 01/01/2006 Balance

-

P 4,000,000 Cr

Treasury Bonds 10/01/2007

Balance

-

P 540,000 Dr

Bond Premium 01/01/2006

Balance

-

P 200,000 Cr

Bond Interest Expense 01/01/2007 07/01/2007

Balance Balance

-

P 240,000 Dr P 240,000 Dr

The treasury bonds were acquired at a price of 105 plus accrued interest. bonds will be available for reissuance.

The treasury

Questions Based on the information presented above and the result of your audit, answer the following: 1. The adjusted balance of the bonds payable account as of December 31, 2007 is: a. P 4,000,000 b. P 3,500,000 c. P 3,460,000 d. P 3,360,000 2. The adjusted balance of the treasury bonds account as of December 31, 2007 is: a. P 540,000 b. P 525,000 c. P 500,000 d. P 0 3. The unadjusted balance of the bond premium account as of December 31, 2007 should be a. P 200,000 b. P 160,000 c. P 140,000 d. P 0 4. The total bond interest expense that should be reported by the company for the year 2007 is

24

a. P 480,000

b. P 472,750

c. P 465,000

5. The loss on the acquisition of treasury bonds is a. P 19,750 b. P 15,000 c. P 4,750

d. P 457,250 d. P 0

6. The carrying value of the bonds payable as of December 31, 2007 should be a. P 4,000,000 b. P 3,860,000 c. P 3,640,000 d. P 3,360,000 Solution OE: Treasury bonds 540,000 Cash 540,000 CE: Bonds payable 500,000 Bonds premium 20,250 Interest expense 15,000 Loss on retirement 4,750 Cash 540,000 Proceeds = Principal x 105 + {x (12%) (3/12)} 540,000 = x (105) + .03x 540,000 = 1.03x 500,000 =x 500,000/4,000,000 x 200,000 = 25,000 Discount ( 4,750) 25,000/300 x 57 20,250 Unamortized Bonds Premium Adj: Bonds payable 500,000 Bonds premium 20,250 Interest expense 15,000 Loss on retirement 4,750 Treasury Bonds 540,000 To record the amortization: Bond premium Interest expense Retained earnings

39,750

7,750 * 32,000 (200,000/300 x 48)

3,500,000/4,000,000 x 200,000 = 175,000/300 x 12 500/4,000,000 x 200,000 = 25,000/300 x 9 To record accrual of interest Interest expense Interest payable Answer: 1. B 2. D

210,000 3. C

= 7,000 = 750 7,750

210,000 4. D

5. C

6. D

Problem 19 In the course of your initial examination of the accounts of Maricel Company, you obtain the following information related of the company’s bonds payable as of December 31, 2004. 12% Bonds Payable – Due January 1, 2007 01/01/2004 P3,000,000 face 01/01/1997 value bonds purchased at 90 and retired P 2,700,000 01/01/1997

P 6,000,000

Discount on Bonds Payable P 300,000

25

Questions Based on the above and the result of your audit, answer the following: 1. How much is the Discount on bonds payable as of December 31, 2004? a. P 90,000 b. P 45,000 c. P 30,000 d. P 15,000 2. How much is the carrying amount of bonds payable as of December 31, 2004? a. P 3,000,000 b. P 3,030,000 c. P 2,970,000 d. P 2,955,000 3. How much is the total interest expense for the year ended December 31, 2004? a. P 390,000 b. P 375,000 c. P 360,000 d. P 345,000 4. How much is the gain on early retirement of bonds? a. P 345,000 b. P 270,000 c. P 255,000

d. P 0

Solution Entry – retirement of bonds OE: Bonds payable 2,700,000 Cash 2,700,000 CE: Bonds payable 3,000,000 Gain on retirement 255,000 Discount on bonds payable 45,000 Cash 2,700,000 (3M/6M x 300,000 = 150,000/10 x 3 = P45,000 unamortized) Adj: Bonds payable 300,000 Gain on retirement 255,000 Discount on bonds payable 45,000 Retained earnings 210,000 (300,000/10 x 7 = 210,000) Interest expense 15,000 (3M/6M x 300,000/10) Discount on bonds payable 225,000 Interest expense Interest payable 3,000,000 x 12% = 360,000 Answer: 1. C 2. C

360,000

3. B

360,000 4. C

Problem 20 On January 1, 2007, CPA NAKO company issued eight-year bonds with a face value of P2,000,000 and a stated interest rate of 6% payable semiannually on June 30 and December 31. The bonds were sold to yield 8%. Table values are: Present Present Present Present Present Present Present Present

value value value value value value value value

of of of of of of of of

1 for 8 periods at 6% 1 for 8 periods at 8% 1 for 10 periods at 3% 1 for 10 periods at 4% annuity of 1 for 8 periods at 6% annuity of 1 for 8 periods at 8% annuity of 1 for 10 periods at 3% annuity of 1 for 10 periods at 4%

Questions 1. The present value of the principal is a. P 1,068,000 b. P 1,080,000

26

00.627 00.540 00.623 00.534 6.210 5.747 12.561 11.652

c. P 1,246,000

d. P 1,254,000

2. The present value of the interest is a. P 689,640 b. P 699,120

c. P 745,200

d. P 753,660

3. The issue price of the bonds is a. P 1,767,120 b. P 1,769,640

c. P 1,779,120

d. P 1,999,200

Solution 1. B 2. B

P2,000,000 x .54 = P1,080,000 P2M x 6% x 6/12 = P60,000; P60,000 x 11.652 = P699,120

3.

P1,080,000 + P699,120 = P1,779,120

C

Problem 21 In connection of your audit of the liabilities of Cring-Cring Company, you noted that on December 31, 2006. The company issued P2,000,000 8% serial bonds. To be repaid in the amount of P400,000 each year. Interest is payable annually on December 31. The bonds were issued to yields 10% a year. The bond proceeds were P1,902,800 based on the present value at December 31, 2006 of five annual payments as follows: Due dates 12/31/07 12/31/08 12/31/09 12/31/10 12/31/11

Principal P400,000 400,000 400,000 400,000 400,000

Interest P160,000 128,000 96,000 64,000 32,000

The company uses the effective method in amortizing bond premium or discount. Questions: 1. How much is the amortization of discount for 2007? a. P 19,440 b. P 30,326 c. P 47,770

d. P 97,200

2. How much is the carrying value of the bonds payable as of December 31, 2007? a. P 1,933,080 b. P 1,665,920 c. P 1,633,080 d. P 1,533,586 Solution Principal

Interest

Total

Payment

Payment

Payment

PV factors

Total PV

2007

400,000

160,000

560,000

0.90909

509,091

2008

400,000

128,000

528,000

0.82645

436,366

2009

400,000

96,000

496,000

0.75131

372,650

2010

400,000

64,000

464,000

0.68301

316,917

2011

400,000

32,000

432,000

0.62092

268,237

Total Present Value

1,903,260

Face value

2,000,000

Discount on BP

96,740

27

Int. paid

Int. exp.

Amort

Principal

Book

Payment

Value 1,903,260

2007

160,000

190,326

30,326

400,000

1,533,586

2008

128,000

153,359

25,359

400,000

1,158,945

2009

96,000

115,894

19,894

400,000

778,839

2010

64,000

77,884

13,884

400,000

392,723

2011

32,000

39,272

7,272

400,000

-

Note: Ignore the present value given in the problem. Answer: 1. P 30,326 2. P 1,533,586

Problem 22 The STEPHANY CO. sold P6,000,000 of 9% bonds on October 1, 1999, at P5,747,280 plus accrued interest. The bonds were dated July 1, 1999; interest payable semiannually on January 1 and July 1; redeemable after June 30, 2004 to June 30, 2007, at 101, and thereafter until maturity at 100; and convertible into P10 par value common stock as follows:   

Until June 30, 2004, at the rate of 6 shares for each P1,000 bond. From July 1, 2004, to June 30, 2007, at the rate of 5 shares for each P1,000 bond. After June 30, 2007, at the rate of 4 shares for each P1,000 bond.

The bonds mature 10 years form their issue date. The company adjust its books monthly and closes its books as of December 31 each year. The following transactions occur in connection with the bonds: 2005 July 1 P2,000,000 of bonds were converted into stock. 2006 Dec 31 P1,000,000 face value of bonds were reacquired at 99-1/4 plus accrued interest. These were immediately retired. 2007 July 1 The remaining bonds were called for redemption and accrued interest was paid. For purposes of obtaining funds for redemption and business expansion, an P8,000,000 issue of 7% bonds was sold at 97. These bonds are dated July 1, 2007, and are due in 20 years. Questions 1. What is the carrying value of bonds payable at December 31, 1999? a. P 5,747,280 b. P 6,000,000 c. P 5,753,760 d. P 5,749,440 2. What is the total interest expense for 1999? a. P 128,520 b. P 47,160

28

c. P 141,480

d. P 135,000

3. In recording the bond conversion on July 1, 2005, how much should be credited to the additional paid-in capital account? a. P 1,796,320 b. P 1,965,440 c. P 1,845,440 d. P 1,865,440 4. What is the gain or loss on bond conversion on July 1, 2005? a. P 0 b. P 1,796,320 c. P 1,865,440

d. P 34,560

5. What is the carrying value of the bonds reacquired on December 31, 2006? a. P 989,200 b. P 957,880 c. P 1,010,800 d. P 981,700 6. What is the gain (loss) on bond reacquisition on December 31, 2006? a. P 3,300 b. (P 3,300) c. P 34,620 d. (P 34,620) 7. What is the carrying value of the bonds retired on July 1, 2007? a. P 3,000,000 b. P 2,974,080 c. P 2,873,640

d. P 3,025,920

8. What is the gain (loss) on bond retirement on July 1, 2007? a. (P 25,920) b. P 25,920 c. (P 12,960)

d. P 0

Solution October 1, 1999 Cash

Dec. 31, 1999

July 1, 2005

Dec. 31, 2005

July 1, 2007

Answer: 1. C 6. B

2. C 7. B

5,882,280 Discount on Bond payable 252,720 Bonds payable Interest expense Interest expense 6,480 Discount on Bond Payable P 252,720/117 x 3 = P6,480 Interest expense 270,000 Interest payable Bond payable 2,000,000 Discount on bonds payable Common stock Additional paid-in capital Bonds payable 1,000,000 Interest expense 45,000 Loss on retirement 3,300 Discount on bonds payable Cash Bonds payable 3,000,000 Interest expense 135,000 Loss on retirement 25,920 Discount on bonds payable Cash 3. D 8. A

4. A

6,000,000 135,000 6,480 270,000 34,560 100,000 1,865,440

10,800 1,037,500

25,920 3,135,000

5. A

Problem 23 On January 1, 2005, GEOFFREY Inc. issued P100,000, 10%, 10-year bonds when the market rate of interest was 8%. Interest is payable on June 30 and December 31. The following financial information is available. Sales Cost of Sales Gross profit Interest expense Depreciation expense

P300,000 180,000 120,000 ? (14,500)

29

Other expenses Net income Accounts receivable Inventory Accounts payable

(82,000) ? December 31, 2005 P55,000 87,000 60,000

Jan. 1, 2005 P48,000 93,000 58,000

All purchases of inventory are on account. Other expenses are paid for in cash. The following are present value factors of P1.00 for 20 periods: PV of 1 PV of an ordinary annuity of 1

4% 0.4564 13.5903

5% 0.3769 12.4622

The company uses the straight-line method for amortizing premiums and discounts. Questions: 1. What is the carrying value of bonds on January 1, 2005? a. P 113,592 b. P 100,000 c. P 86,408

d. P 112,223

2. How much was paid to bondholders for interest during 2005? a. P 8,000 b. P 11,087 c. P 10,000

d. P 9,087

3. What is the carrying value of the bonds on December 31, 2005? a. P 98,641 b. P 113,592 c. P 100,000

d. P 112,223

4. What is the interest expense for 2005? a. P 8,641 b. P 10,000

d. P 6,359

c. P 5,000

5. How much was paid for inventory purchases? a. P 172,000 b. P 186,000 c. P 184,000

d. P 174,000

6. What is Geoffrey’s net income for 2005? a. P 13,500 b. P 17,141

d. P 14,859

c. P 23,000

7. How much was received from customers in 2003? a. P 283,000 b. P 245,000 c. P 293,000

d. P 307,000

Solution 1. A Present value / carrying value of bonds on January 1, 2003: P100,000 x 0.4564 P100,000 x 5% = P5,000 x 13.5903 Total 2. C Cash paid for interest (P100,000 x 10%) 3. D Face Value Premium on bonds (P13,592 – P1,359) Carrying value, December 31, 2005 4. A Nominal Interest (P100,000 x 10%) Premium amortization (P13,592 / 10 years) Interest expense

P45,640 67,592 P113,592 P 10,000 P100,000 12,333 P112,233 P 10,000 (1,359) P 8,641

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5. A

Inventory Jan. 1 93,000 Purchases 174,000 Dec. 31

6. D

7. C

Accounts Payable

180,000

CDJ

58,000 Jan.1 174,000 Purchases

Payments 172,000

87,000

Gross Profit Interest expense Depreciation expense Other expense Net Income Jan. 1 Sales

60,000 Dec. 31

Accounts Receivable 48,000 300,000

Dec.31

P120,000 (8,641) (14,500) (82,000) P 14,859

293,000

collections

55,000

Problem 6 In connection with the audit of the company’s financial statements for the year ended December 31, 2004 the Camille Corporation presented to their records. This is the first time the company has been audited. The company issued serial bonds on April 1, 2001. Your audit showed the following details of the issue and the accounts as of December 31, 2004. Total face value P2, 000,000 Date of bond March 1, 2001 Total proceeds P2, 742,400 Interest rate 12% per annum Interest payment date March 1 Maturity dates and amount Date of maturity March 1, 2004 March 1, 2005 March 1, 2006 March 1, 2007 March 1, 2008 March 1, 2009

P

Amount 400,000 400,000 400,000 400,000 200,000 200,000 P2,000,000

Since the corporation had excess cash, bonds o0f P400,000 scheduled March 1, 2006 were retired on April 1, 2004 at 98%. 3/1/04 4/1/04

3/1/04

VR VR

VR

Serial Bonds Payable P 400,000 4/1/01 396,000

to be retired on

CR

P 2,742,400

Accrued Interest Payable 1/2/04 GJ

P 200,000

Interest Expense P 240,000

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Questions: Based on the information presented above and the result of your audit, answer the following. 1. The adjusted balance of the bonds payable accounts as of December 31, 2004 is a. P 2,000,000 b. P 1,600,000 c. P 1,942,400 d. P 1,200,000 2. The unamortized bond premium as of December 31, 2004 should be a. P 192,800 b. P 172,800 c. P 169,976 d. P 174,682 3. The accrued interest payable as of December 31, 2004 is a. P 200,000 b. P 120,000 c. P 144,000

d. P 320,000

4. The bond interest expense that should be reported by the corporation for the year 2004 is a. P 67,208 b. P 63,801 c. P 65,600 d. P 45,960 5. The gain on early retirement of bonds is a. P 63,200 b. P 62,298

c. P 63,801

d. P 0

Solution Computation of amortization rate Dates 2001 2002 2003 2004 2005 2006 2007 2008 2009

Period covered From To Apr 1 Jan 1 Jan 1 Jan 1 Mar 1 Jan 1 Mar 1 Jan 1 Mar 1 Jan 1 Mar 1 Jan 1 Mar 1 Jan 1 Mar 1

Amortization rate

Dec. Dec. Dec. FEB. Dec. FEB. Dec. FEB. Dec. FEB. Dec. FEB. Dec. FEB. Dec.

31 31 31 28 31 28 31 28 31 28 31 28 31 28 31

Bond Months Peso Outstanding Outstanding 2,000,000 2,000,000 2,000,000 2,000,000 1,600,000 1,600,000 1,200,000 1,200,000 800,000 800,000 400,000 400,000 200,000 200,000 = = =

-

9 12 12 2 10 2 10 2 10 2 10 2 10 2

95**

Premium Months

Amortization

18,000,000 24,000,000 24,000,000 4,000,000 16,000,000 3,200,000 12,000,000 2,400,000 8,000,000 1,600,000 4,000,000 800,000 2,000,000 400,000

108,000 144,000 144,000 24,000 96,000 19,200 72,000 14,400 48,000 9,600 24,000 4,800 12,000 2,400 - . 120,400,000 722,400

Total Premium / Total peso month P722,400 / P120,400,000 0.006

*Peso months x amortization rate **term of 96 months (8 x 12) less 1 month after date of bonds 1. D

Bonds payable (P2,000,000 –P400,000 – P400,000) 2. B Total proceeds Less accrued interest payable (P2,000,000 x 12% x 1/12) Issue price Less face value Total bond premium Less: Amortization: Prior years (2001 and 2003) 396,000

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1,200,000 2,742,400 20,000 2,722,400 2,000,000 722,400

Current year (2004) Bonds retired on maturity 4,800 (P400,000 x 0.006 x 2 mos.) Bonds retired prior to maturity 7,200 (P400,000 x 0.006 x 3 mos.) Remaining bonds 86,400 98,400 (P1,200,000 x 0.006 x 12 mos.) Unamortized premium cancelled on bonds retired prior to maturity (P400,000 x 0.006 x 23 mos.) Unamortized bond premium, 12/31/04 Alternative computation: Maturity date March 1, 2005 March 1, 2006 March 1, 2007 March 1, 2008 March 1, 2009 3. B 4. C

Amount 400,000 400,000 200,000 200,000 1,200,000

Remaining months 2 26 38 50

Amortization rate 0.006 0.006 0.006 0.006 0.006

Accrued interest (P1,200,000 x 12% x 10/12)

55,200 . 172,800 Unamortized premium 4,800 62,400 45,600 60,000 172,800 120,000

Interest expense Remaining bonds (P1,200,000 x 12%) Bonds retired on maturity (P400,000 x 12% x 2/12) Bonds retired prior to maturity (P400,000 x 12% x 2/12) Bond premium amortization for 2004 (see computation in no. 2) 5. A Retirement price (P400,000 x 98%) Less carrying value of bonds retired: Face value Add unamortized bond premium, 4/1/04 to 2/28/06 (P400,000 x .006 x 23mos.) Gain on early retirement of bonds

494,400

144,000 8,000 12,000 (98,400) 65,600 392,000 400,000 655,200

455,200 63,200

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