中级财务会计英文ch08

Liabilities

Chapter8IntermediateAccounting12thEditionKieso,Weygandt,andWarfield

PreparedbyCobyHarmon,UniversityofCalifornia,SantaBarbaraExplainthecharacteristicsofaliability.Accountforcompensatedabsences.Understandandrecordpayrolltaxesanddeductions.Recordpropertytaxes.Accountforwarrantycosts.Explaintheterms“probable,”“reasonablypossible,”and“remote”relatedtocontingencies.Recordandreportalosscontingency.Discloseagaincontingency.LearningObjectives10.Explainthereasonsforissuinglong-termliabilities.11.Understandthecharacteristicsofbondspayable.12.Recordtheissuanceofbonds.13.Amortizediscountsandpremiumsunderthestraight-linemethod.14.Computethesellingpriceofbonds.15.Amortizediscountsandpremiumsundertheeffectiveinterestmethod.16.Explainextinguishmentofliabilities.17.Understandbondswithequitycharacteristics.18.Accountforlong-termnotespayable.19.Understandthedisclosureoflong-termliabilities.LearningObjectivesDefinedbySFACNo.6as:Probablefuturesacrificesofeconomicbenefitsarisingfrompresentobligationsofaparticularentitytotransferassetsorprovideservicestootherentitiesinthefutureasaresultofpasttransactionsorevents.LiabilitiesItinvolvesapresentdutyorresponsibilityofthecompanytooneormoreentitiesthatwillbesettledbytheprobablefuturetransferoruseofassetsataspecifiedordeterminabledate,onoccurrenceofaspecificevent,orondemand.Thedutyorresponsibilityobligatesthecompany,leavingitlittle

ornodiscretiontoavoidthefuturesacrifice.Thetransactionorothereventobligatingthecompanyhasalreadyhappened.ThreeEssentialCharacteristicsofaLiabilityInterestthatisnotexplicitlyspecifiedinthetermsoftheliability.Neednotberecognized.Liabilities-ImplicitInterestCurrentliabilitiesareobligationswhoseliquidationisexpectedtorequiretheuseofexistingcurrentassetsorthecreationofothercurrentliabilitieswithinoneyearoranoperatingcycle,whicheverislonger.CurrentLiabilitiesHavingContractualAmountAccountspayableNotespayableCurrentlymaturingportionoflong-termdebtDividendspayableAdvancesandrefundabledepositsAccrueditemsUnearneditemsTypeofCurrentLiabilitiesAmountDependsonOperationsSales(use)taxesPayrolltaxesIncometaxesBonusesTypeofCurrentLiabilitiesAmountMustBeEstimatedPropertytaxesWarrantiesPremiumsandcouponsOthercontingenciesTypeofCurrentLiabilitiesObligationsarisingfromthecompany’songoingoperations--includestheacquisitionofinventory,supplies,materialsandservices.Commonlycalledtradepayables.Othercurrentpayablesshouldbereportedseparately.AccountsPayableNotesthatarisefromthesametypesoftransactionsastradepayables.Canbesecuredorunsecured.Canbeinterest-bearingornoninterest-bearing.--Interest-bearingnotescarryastatedrate

ofinterest.--Noninterest-bearingnotesreflectan

effectiverate

ofinterestorayield.Short-TermNotesPayableTherateofinterestisspecifiedandiscalledthestatedrate.Thedebtor(orborrower)receivescash,otherassets,orservices.Thedebtorrepaysthefaceamountofthenoteplusinterestatthestatedrate.

Short-TermNotesPayable

Interest-BearingOnSeptember1,EagleBoatsborrows$80,000fromCookeBank.Thenoteisduein180daysandhasastatedinterestrateof9%.RecordtheborrowingonSeptember1.

Interest-BearingNotes

ExampleOnSeptember1,EagleBoatsborrows$80,000fromCookeBank.Thenoteisduein180daysandhasastatedinterestrateof9%.RecordtheborrowingonSeptember1.

Interest-BearingNotes

ExampleHowmuchinterestisduetoCookeBankatyear-end,onDecember31?

a. $2,400 b. $3,600 c. $7,200 d. $87,200

Interest-BearingNotes

ExampleHowmuchinterestisduetoCookeBankatyear-end,onDecember31?

a. $2,400

b. $3,600 c. $7,200 d. $87,200Interestiscalculatedas:PrincipalStatedPortionAmount RateofofYear=ofNoteInterestOutstanding$80,000×9%×4/12=

$2,400interestduetoCookeBank.

Interest-BearingNotes

ExampleAssumeEagleBoats’fiscalyear-endisDecember31.

Recordthenecessaryadjustmentatyear-end.

Interest-BearingNotes

ExampleAssumeEagleBoats’fiscalyear-endisDecember31.

Recordthenecessaryadjustmentatyear-end.

Interest-BearingNotes

ExampleAssumeEagleBoats’fiscalyear-endisDecember31.

RecordthenecessaryjournalentrywhenthenotematuresonFebruary28.

Interest-BearingNotes

ExampleAssumeEagleBoats’fiscalyear-endisDecember31.

Recordthenecessaryjournalentrywhenthenotematureson

February28.

Interest-BearingNotes

ExampleNoteswithoutastatedinterestratecarryanimplicit,oreffective,rate.Thefaceofthenoteincludestheprincipalandtheinterest.Theborrowerreceivesthedifferencebetweenthefaceamountandtheinterestonthenote.--Thecashreceivedisthediscountedpresentvalue

ofthefaceofthenote.Short-TermNotesPayable

Noninterest-BearingOnMay1,2007,Batter-Up,Inc.issuedaone-year,noninterest-bearingnotewithafaceamountof$10,000inexchangeforequipmentvaluedat$9,434.Howmuch

interestwillBatter-Uppayonthenote?

Noninterest-BearingNotes

ExampleOnMay1,2007,Batter-Up,Inc.issuedaone-year,noninterest-bearingnotewithafaceamountof$10,000inexchangeforequipmentvaluedat$9,434.HowmuchinterestwillBatter-Uppayonthenote?Interest=FaceAmount-AmountReceived=$10,000-$9,434=$566

Noninterest-BearingNotes

ExampleOnMay1,2007,Batter-Up,Inc.issuedaone-year,noninterest-bearingnotewithafaceamountof$10,000inexchangeforequipmentvaluedat$9,434.Whatistheimplicitinterestrateonthenote?

Noninterest-BearingNotes

ExampleOnMay1,2007,Batter-Up,Inc.issuedaone-year,noninterest-bearingnotewithafaceamountof$10,000inexchangeforequipmentvaluedat$9,434.Whatistheimplicitinterestrateonthenote?

Noninterest-BearingNotes

ExampleScripDividendsPayableAccruedLiabilitiesAdvancesandReturnableDepositsUnearnedRevenuesShort-TermLiabilitiesCollectedfromcustomersonbehalfofthestateorlocalgovernmentsatthepointofsale.Requiresadebittocashandacredittosalestaxespayable.Heldinaliabilityaccountuntiltimetomakeremittancetothetaxingauthority.Requiresadebittosalestaxespayableandacredittocash.SalesTaxesSelleroyCompanysellsmerchandiseforcashwitharetailsalespriceof$50,000onwhichasalestaxof6%islevied.Thecompanycollects$53,000.Cash 53,000Sales 50,000SalesTaxesPayable 3,000SalesTaxesAttheendofJanuarytheSalesaccountisadjustedtorecordthetaxonallgoodssold[$169,000-($169,000÷1.06)]=$9,600.Cash 169,000Sales 169,000

IfthesalestaxisincludedinthepricechargedtothecustomerSales 9,600SalesTaxesPayable 9,600

SalesTaxesWithholdingsfromemployeepayEmployee’sportionofFICAEmployeeFederalIncomeTaxWithholdingsExpensesdeductedfromincomeEmployerportionofFICAFederalUnemploymentTax(FUTA)StateUnemploymentTax(SUTA)PayrollTaxesBatter-Up,Inc.has5employees.Eachemployeereceivesasalaryof$1,000perweek.TheFICArateis7.65%andincometaxiswithheldattherateof20%.

PayrollTaxes-Employee

ExamplecPreparethejournalentrytorecordthepayrollforBatter-UpfortheweekendingJune14,2007.

PayrollTaxes-Employee

ExamplePreparethejournalentrytorecordthepayrollforBatter-UpfortheweekendingJune14,2007.

PayrollTaxes-Employee

ExampleNote:Theexpensetothecompanyis$5,000whiletheactualpaymenttotheemployeesis$3,617.50.

PayrollTaxes-Employee

ExampleNote:Theemployertransfersthetaxamountstothegovernmentontheemployees’behalf.

PayrollTaxes-Employee

ExampleBatter-Up,Inc.hasalsoincurredFUTAof$50andSUTAof$200.PrepareBatter-Up’sjournalentryforalloftheirtaxesrelatedtotheJune16payroll.

PayrollTaxes-Employer

Example

PayrollTaxes-Employer

ExampleNote:TheemployermatchestheFICAthatwaswithheldfromtheemployees’paychecks.Ineffect,thetotalFICAtaxrateis15.3%;halfispaidbytheemployee(7.65%)andhalfispaidbytheemployer(7.65%).

PayrollTaxes-Employer

ExampleEzzellCompanyclosesitsbooksannuallyeachDecember31.ThefiscalyearforthetownandcountyinwhichthefirmislocatedendsonJune30.TheestimatedpropertytaxesfortheperiodJuly1,2007,toJune30,2008,are$7,200.ThetaxbillismailedinOctoberwitharequirementthatthetaxbepaidbeforeDecember31,2007.Thetaxbillreportedanactualtaxof$7,290,andthecorporationpaysthisamountonOctober31,2007.PropertyTaxesThreeMonthlyEntriesJuly31-September30,2007PropertyTaxExpense 600 PropertyTaxesPayable 600October31,2007:PaymentofPropertyTaxesPropertyTaxPayable 1,800PrepaidPropertyTaxes 5,490 Cash 7,290ThreeMonthlyEntries:October31-Dec.31,2007PropertyTaxExpense 610 PrepaidPropertyTaxes 610$7,200÷12PropertyTaxesPercentageofnetincomebeforethebonus--Multiplythenetincomebeforethebonusbythebonuspercentage.Percentageofnetincomeafterthebonus--Algebraicallyexpressed:Bonus=%×(NetIncome-Bonus)BonusesBasedonIncomeLindaBall,Batter-Up’sCEO,Inc.getsayear-endbonusof15%ofnetincomeafterdeductingherbonus.2007Netincomeis$250,000.ComputeLinda’sbonusfor2007.Bonus

ExampleLindaBall,Batter-Up’sCEO,Inc.getsayear-endbonusof15%ofnetincomeafterdeductingherbonus.2007Netincomeis$250,000.ComputeLinda’sbonusfor2007.Bonus

ExampleOccurswhenunusedvacationtimeiscarriedovertofutureyears.Anexpense/liabilitymustbeaccruediffourcriteriaaremet:Absencerelatestoservicesalreadyperformed.Benefitsaccumulate,orvest.Paymentisprobable.Amountcanbereliablyestimated.Compensated-AbsenceLiabilityAvestedrightexistswhenanemployerhasanobligationtomakepaymentstoanemployeethatisnotcontingentontheemployee’sfutureservices.Compensated-AbsenceLiabilityAccumulatedrightsarethosethatcanbecarriedforwardbytheemployeetofutureperiodsifnottakenintheperiodinwhichtheyareearned.Compensated-AbsenceLiabilityMiltonCompanyhas100employeeswhoarepaidanaverageof$200perday.Companypolicyallowseachemployee12daysofpaidvacationperyear.SalesSalariesExp.CompensatedAbsences 30,000OfficeSalariesExp.CompensatedAbsences 30,000LiabilityforEmployees’CompensationforFutureAbsences

(3/12x$240,000) 60,000March31,2008Compensated-AbsenceLiabilityThe$200,000April30,2008,payroll,includingpaidvacationtimetakenbythesalesandofficestaff,isasfollows:PayrollforTimeWorkedVacationTaken

Salesstaff $194,000 $6,000Officestaff 193,000 7,000ContinuedCompensated-AbsenceLiabilitySalesSalariesExpense 194,000OfficeSalariesExpense 193,000LiabilityforEmployees’Compen-sationforFutureAbsences 13,000 Cash 400,000April30,2008Compensated-AbsenceLiabilityTheportionoflong-termdebtmaturingwithinthenextfiscalyearisreportedasacurrentliabilit Long-termdebtsshouldnotbereportedascurrent

liabilitiesif:1.theyareretiredbyassetsnotclassifiedas

currentassets2.theyarerefinancedbynewissuesofdebt3.theyareconvertedintocapitalstock.

CurrentMaturitiesofLong-TermDebtObligationsthatarepayableondemandorthatwillbecomepayableondemandwithinthenextoperatingcycle.Long-termobligationsthatarecallablebythecreditorduetoaviolationofunderlyingterms.ObligationsThatAreCallablebytheCreditorAcurrentliabilitymaybereclassifiedtoanoncurrentstatustoimprovethecompany’sworkingcapitalposition.Generally,thisisallowediftheshort-termliabilityisexpectedtoberefinancedlong-term.Short-TermObligationsExpectedtoBeRefinancedTheexpectedrefinancingisevidencedbyactualrefinancingbeforethestatementissuedate.ORTheexpectedrefinancingisevidencedbygoodfaith

entranceintoalong-term,noncancelablerefinancingagreementwithaviablelender.CriteriaforReclassifyingShort-TermLiabilitiesSFASNo.6requires:Theagreementmustbenoncancelablebyallpartiesandmustextendbeyondoneyear.Thecompanymustnotbeinviolationoftheagreementonthebalancesheetortheissuedate.Thelendermustbefinanciallycapableofhonoringtheagreement.RefinancingAgreementCriteria“Anexistingcondition,situation,orsetofcircumstancesinvolvinguncertaintyastopossiblegainoralosstoanenterprisethatultimatelywillberesolvedwhenoneormorefutureeventsoccurorfailtooccur.”

SFASNo.5ContingenciesCONDITIONS:ProbableThefutureeventislikelytooccur.ReasonablyPossibleThechanceofoccurrenceofthefutureeventismorethanremote,butlessthanlikely.RemoteThechanceofoccurrenceofthefutureeventisslight.ContingenciesLossContingencies

AccountingTreatmentsAwarrantyisapromise(futurecost)madebyasellertoabuyertomakegoodonadeficiency.Underthecashbasismethod,warrantycostsarechargedtotheperiodinwhichthecostsarepaid.Undertheaccrualbasismethod:1.warrantycosts(forwarrantiessoldwiththeproduct)are

estimatedandmatchedwithrevenue.2.extendedwarrantyrevenuesaredeferredand

recognizedoverthelifeofthewarrantycontract.WarrantyObligationsCashorAccountsReceivable 1,200,000 Sales 1,200,000Warrantycostpermachineisestimatedat$150.WarrantyExpense 30,000 EstimatedLiabilityunderWarranties 30,000ExpenseWarrantyAccrualMethodAngleeMachineryCorporationbeginsproductiononanewmachineinApril2007andsells200ofthesemachinesat$6,000eachbyDecember31,2007.WarrantyObligationsThecorporationspent$5,000in2007tofulfillwarrantyagreementsforthe200machines.EstimatedLiabilityunderWarranties 5,000 Cash(orotherassets) 5,000Thecorporationspent$25,150in2008tofulfillwarrantyagreementsforthe200machines.EstimatedLiabilityunderWarranties 25,000 WarrantyExpense 150 Cash(orotherassets) 25,150WarrantyObligationsAngleeMachineryCorporationsells200machinesfor$6,000.Thisamountincludesaservicecontractsaleof$150andamachinesaleof$5,850.CashorAccountsReceivable 1,200,000 Sales($5,850x200) 1,170,000 UnearnedWarrantyRevenue 30,000SalesWarrantyAccrualMethodContinuedWarrantyObligationsRecognitionofwarrantyexpenseforperiod,April-December,2007.WarrantyExpense 5,000 Cash(orotherassets) 5,000Recognitionofwarrantyrevenueforperiod,April-December,2007.UnearnedWarrantyRevenue 5,000 WarrantyRevenue 5,000ContinuedWarrantyObligationsRecognitionofwarrantyexpenseduring2008.WarrantyExpense 25,150 Cash(orotherassets) 25,150Recognitionofwarrantyrevenueduring2008.UnearnedWarrantyRevenue 25,000 WarrantyRevenue 25,000WarrantyObligationsOnOctober1,2007,theAmericanMeatballCorporationbeganofferingtocustomersaservingdiskinreturnfor30meatballcanlabels.TheofferexpiresonApril1,2008.Thecostofeachpremiumservingdiskis$2.Itisestimatedthat60%ofthelabelswillberedeemed.PremiumandCouponObligationsPurchased12,000servingdishesat$2each.InventoryofPremiumServingDishes 24,000 Cash(orAccountsPayable) 24,000Sold300,000cansofmeatballat$1.80each...Cash(orAccountsReceivable) 540,000 Sales 540,000ContinuedPremiumandCouponObligationsReceived105,000labelsfromcustomers:.PremiumExpense 7,000 InventoryofPremiumServingDishes 7,000Estimatedthat75,000labelswillbesubmittednextyear:PremiumExpense 5,000 EstimatedPremiumClaimsOutstanding 5,000Estimatedlabelsthatwillberedeemed(300,000x.60) 180,000Deductlabelsredeemedduring2007 (105,000 )Estimatednumberoffuturelabelredemptions 75,000Premiumexpenseforestimatedfutureredemptions:(75,000÷30)x$2 $5,000(105,000÷30)

x$2PremiumandCouponObligationsTodeterminewhetheraliabilityshouldberecorded,evaluate:ThetimeperiodinwhichtheunderlyingcauseofactionoccurredTheprobabilityofanunfavorableoutcomeTheabilitytomakeareasonableestimateofloss

Litigation,ClaimsandAssessmentsYousaidthatIwilloweyou$1,000,000ifImissthenextputt.SodoesthatmeanIhavetodiscloseacontingentlossonmypersonalfinancialstatement?Obligationsthatextendbeyondoneyearortheoperatingcycle,whicheverislongerLong-termLiabilitiesDebtfinancingmaybetheonlyavailablesourceoffunds.Debtfinancingmayhavealowercost.Debtfinancingofferstheopportunityforleverage.Debtfinancingoffersanincometaxadvantage.Thevotingprivilegeisnotshared.ReasonsforIssuanceofLong-TermLiabilitiesRecordlong-termliabilitiesatthefairvalueofthegoodsorservicesreceived.Interestexpenseisbasedonthemarketinterestrateonthedateofthedebtissuanceandthebeginningbalanceoftheliability.Bookvalueisthepresentvalueofallfuturecashpayments,discountedatthemarketinterestrateatissuance.Long-termLiabilities

MeasurementandValuationCompanyIssuingBondsInvestorBuyingBondsBondSellingPriceBondCertificateAtBondIssuanceDateBondsPayable

CashFlowCompanyIssuingBondsInvestorBuyingBondsFaceValuePaymentatEndofBondTermInterestPaymentsOverBondTermBondsPayable

CashFlowIssuingEntityCollateralPurposeofIssuePaymentofInterestMaturityBondsPayable

ClassificationIssuingEntityIndustrialBondsMunicipalBondsCollateralSecuredBonds

－MortgageBonds－GuaranteedBondsDebentureBondsBondsPayable

ClassificationPurposeofInterestPurchaseMoneyBondsRefundingBondsConsolidatedBondsPaymentofInterestOrdinaryBondsIncomeBondsRegisteredBondsBearerBondsBondsPayable

ClassificationMaturityTermsBondsSerialBondsCallableBondsRedeemableBondsConvertibleBondsBondsPayable

ClassificationBONDPAYABLEFaceValue$1,000Interest10%6/30&12/31MaturityDate1/1/X5BondDate1/1/X01.FaceValue=MaturityorParValue2.MaturityDate3.StatedInterestRate 4.InterestPaymentDates 5.BondDate BondsPayableBONDPAYABLEFaceValue$1,000Interest10%6/30&12/31MaturityDate1/1/X5BondDate1/1/X01.FaceValue=MaturityorParValue2.MaturityDate3.StatedInterestRate 4.InterestPaymentDates 5.BondDate

OtherFactors:6.MarketInterestRate7.IssueDateBondsPayableMarketrate=statedrateBondssellatfaceorparvalue.Marketrate>statedrateBondssellatadiscount(belowfacevalue).Marketrate<statedrateBondssellatapremium(abovefacevalue).BondsPricesOn12/31/X0GraphicsInc.issues10bondsatfacevalue.Themarketinterestrateis10%.Thebondshavethefollowingterms:FaceValue=$1,000MaturityDate=12/31/X5(5years)StatedInterestRate=10%InterestDates=6/30&12/31BondDate=12/31/X0BondsIssuedatFaceValueonBondDatePreparethejournalentrytorecordtheissuanceofthebondson12/31/X0.BondsIssuedatFaceValueonBondDatePreparethejournalentrytorecordtheissuanceofthebondson12/31/X0.Long-termLiabilityBondsIssuedatFaceValueonBondDatePreparethejournalentryrequiredevery6/30and12/31topayinterest.BondsIssuedatFaceValueonBondDatePreparethejournalentryrequiredevery6/30and12/31topayinterest.BondsIssuedatFaceValueonBondDatePreparethejournalentrytorecordthematurityofthebondon12/31/X5.BondsIssuedatFaceValueonBondDatePreparethejournalentrytorecordthematurityofthebondon12/31/X5.BondsIssuedatFaceValueonBondDateWhathappenswhenthemarketinterestratesaredifferentfromthebond’sstatedinterestrate?

Forexample,themarketisearning8%.WouldyouwanttoinvestinGraphicsInc.’s10%bond?BondsIssuedAboveFaceValueonBondDateWhathappenswhenthemarketinterestratesaredifferentfromthebond’sstatedinterestrate?

Forexample,themarketisearning8%.WouldyouwanttoinvestinGraphicsInc.’s10%bond?YES!BondsIssuedAboveFaceValueonBondDate

Ifthebondispaying10%interestandthemarketispaying8%interest,GraphicsInc.would:Sellthebondabovefacevalue--atapremiumBUTPayinterestononlythefacevalueANDRepayonlythefacevalueatmaturity.BondsIssuedAboveFaceValueonBondDateThisarrangementwilldecreasetheeffectiveinterestrateofGraphicsInc.bondstothemarketrate.

BondsIssuedAboveFaceValueonBondDateOn12/31/X0GraphicsInc.sells1,000bondsat108.1105.Themarketinterestrateis8%.Thebondshavethefollowingterms:FaceValue=$1,000MaturityDate=12/31/X5(5years)StatedInterestRate=10%InterestDates=6/30&12/31BondDate=12/31/X0

BondsIssuedAboveFaceValueonBondDateHowmuchcashisGraphicsInc.goingtoreceivefortheentirebondissue?BondsIssuedAboveFaceValueonBondDateHowmuchcashisGraphicsInc.goingtoreceivefortheentirebondissue?

$1,000facevalue×1,000sold=$1,000,000

$1,000,000×108.1105%=$1,081,105cashBondsIssuedAboveFaceValueonBondDateGraphicsInc.agreestorepaythefullfacevalueatmaturity.

$1,000facevalue×1,000sold=$1,000,000BondsIssuedAboveFaceValueonBondDateThedifferencebetweenthefacevalueofthebondsandthecashreceivedisthepremium.

$1,081,105-$1,000,000=$81,105

ThepremiumisareductionintheinterestfactorforGraphicsInc.ThepremiumwillbeamortizedtoInterestExpense.BondsIssuedAboveFaceValueonBondDatePreparethejournalentrytorecordtheissueofthebondson12/31/X0.BondsIssuedAboveFaceValueonBondDatePreparethejournalentrytorecordtheissueofthebondson12/31/X0.Adjunct-LiabilityAccountBondsIssuedAboveFaceValueonBondDateBookValueMaturityValueBondsIssuedAboveFaceValueonBondDatePreparethejournalentriesrequiredevery6/30and12/31.Usestraight-lineamortizationofthepremium.

(Theinterestmethodwillbediscussedlaterinthelecture.)BondsIssuedAboveFaceValueonBondDateInadditiontotheinterestpaymententry,wealsoneedtoamortizethepremiumtoInterestExpense.BondsIssuedAboveFaceValueonBondDateBondsIssuedAboveFaceValueonBondDatePremiumonBondsPayable 81,1058,111 72,994Asthepremiumaccountisamortized,thebookvalueofthebondspayabledecreasestowardthematurityvalue.BondsIssuedAboveFaceValueonBondDateBookValueMaturityValueBondsIssuedAboveFaceValueonBondDateNow,let’scalculatehowGraphics,Inc.determinedthesellingpriceofthebond.BondsIssuedAboveFaceValueonBondDateBondsIssuedAboveFaceValueonBondDateInterestExpenseforeachperiodiscalculatedasfollows:BookValueofBondatBeginningofPeriod×MarketInterestRateatDateofBondIssuanceInterestExpenseTheamortizationforthediscountorpremiumiscalculatedasfollows:CashPaymentforInterest-InterestExpenseAmortizationAmount

InterestMethodInterestMethod

AmortizationTable**RoundedInterestMethod

AmortizationTableWhathappenswhenthemarketinterestratesaredifferentfromthebond’sstatedinterestrate?

Forexample,themarketisearning12%.WouldyouwanttoinvestinGraphicsInc.’s10%bond?BondsIssuedBelowFaceValueonBondDateWhathappenswhenthemarketinterestratesaredifferentfromthebond’sstatedinterestrate?

Forexample,themarketisearning12%.WouldyouwanttoinvestinGraphicsInc.’s10%bond?NO!BondsIssuedBelowFaceValueonBondDateIfthebondispaying10%interestandthemarketispaying12%interest,GraphicsInc.would:Sellthebondbelowfacevalue--atadiscountBUTPayinterestonthefullfacevalueANDRepaythefullfacevalueatmaturity.BondsIssuedBelowFaceValueonBondDateThisarrangementwillincreasetheeffectiveinterestrateofGraphicsInc.bondstothemarketrate.BondsIssuedBelowFaceValueonBondDateOn12/31/X0GraphicsInc.sells1,000bondsat92.6395.Themarketinterestrateis12%.Thebondshavethefollowingterms:FaceValue=$1,000MaturityDate=12/31/X5(5years)StatedInterestRate=10%InterestDates=6/30&12/31BondDate=12/31/X0BondsIssuedBelowFaceValueonBondDateHowmuchcashisGraphicsInc.goingtoreceivefortheentirebondissue?BondsIssuedBelowFaceValueonBondDateHowmuchcashisGraphicsInc.goingtoreceivefortheentirebondissue?

$1,000facevalue×1,000sold=$1,000,000

$1,000,000×92.6395%=$926,395cashBondsIssuedBelowFaceValueonBondDateGraphicsInc.agreestorepaythefullfacevalueatmaturity.

$1,000facevalue×1,000sold=$1,000,000BondsIssuedBelowFaceValueonBondDateThedifferencebetweenthefacevalueofthebondsandthecashreceivedisthediscount.

$1,000,000-$926,395=$73,605

ThediscountisanadditionalinterestfactorforGraphicsInc.ThediscountwillbeamortizedtoInterestExpense.BondsIssuedBelowFaceValueonBondDatePreparethejournalentrytorecordtheissueofthebondson12/31/X0.BondsIssuedBelowFaceValueonBondDa