ACC 326 Exam 2
(Entries for Bond Transactions) Presented below are two independent situations. 1. On January 1, 2020, Simon Company issued $200,000 of 9%, 10-year bonds at par. Interest is payable quarterly on April 1, July 1, October 1, and January 1. 2. On June 1, 2020, Garfunkel Company issued $100,000 of 12%, 10-year bonds dated January 1 at par plus accrued interest. Interest is payable semi-annually on July 1 and January 1. Instructions For each of these two independent situations, prepare journal entries to record the following. a. The issuance of the bonds. b. The payment of interest on July 1. c. The accrual of interest on December 31.
1. The Simon Company 1/1/2020 Dr. Cash 200,000 Cr. Bonds Payable 200,000 7/1/2020 Dr. Interest Expense (200,000 * .09 *3/12) 4500 Cr. Cash 4500 12/31/2020 Dr. Interest Expense 4,500 Cr. Interest Payable 4,500 2. Garfunkel Company 1/1/2020 Dr. Cash 105,000 Cr. Bonds Payable 100,000 Cr. Interest Expense (100,000 * .12 *5/12) 5,000 7/1/2020 Dr. Interest Expense 6,000 Cr. Cash 6,000 12/1/2020 Dr. Interest Expense 6,000 Cr. Interest Payable 6,000
On January 1, 2020 (the date of grant), Lutz Corporation issues 2,000 shares of restricted stock to its executives. The fair value of these shares is $75,000, and their par value is $10,000. The stock is forfeited if the executives do not complete 3 years of employment with the company. Prepare the journal entry (if any) on January 1, 2020, and on December 31, 2020, assuming the service period is 3 years.
1/1/2020 Dr. Unearned Compensation 75,000 Cr. Common Stock 10,000 Cr. Paid in Capital in Excess of Par - Common Stock 65,000 12/31/2020 Dr. Compensation Expense 25,000 Cr. Unearned Compensation 25,000
Rick Kleckner Corporation recorded a right-of-use asset for $300,000 as a result of a finance lease on December 31, 2019. Kleckner's incremental borrowing rate is 8%, and the implicit rate of the lessor was not known at the commencement of the lease. Kleckner made the first lease payment of $48,337 on December 31, 2019. The lease requires eight annual payments. The equipment has a useful life of 8 years with no residual value. Prepare Kleckner's December 31, 2020, entries.
12/31/20 Dr. Interest Expense [($300,000 - $48,337) X .08] 20,133 Dr. Lease Liability 28,204 Cr. Cash 48,337 Dr. Amortization Expense 37,500 Cr. Right-of-Use Asset ($300,000 ÷ 8) 37,500
Will the amortization of Discount on Bonds Payable increase or decrease bond interest expense? Explain.
Amortization of Discount on Bonds Payable will increase interest expense. A discount on bonds payable results when investors demand a rate of interest higher than the rate stated on the bonds. The investors are not satisfied with the nominal interest rate because they can earn a greater rate on alternative investments of equal risk. They refuse to pay par for the bonds and cannot change the nominal rate. However, by lowering the amount paid for the bonds, investors can increase the effective rate of interest.
On January 1, 2020, Henderson Corporation redeemed $500,000 of bonds at 99. At the time of redemption, the unamortized premium was $15,000. Prepare the corporation's journal entry to record the reacquisition of the bonds
Dr. Bonds Payable 500,000 Dr. Premium on Bonds Payable 15,000 Cr. Gain on Redemption of Bonds 20,000 * Cr. Cash (500,000 * .99) 495,000 *(Carrying value - Cash proceeds = Gain/Loss on Redemption of Bonds [($500,000 + $15,000) - $495,000]
Geiberger Corporation manufactures drones. On December 31, 2019, it leased to Althaus Company a drone that had cost $120,000 to manufacture. The lease agreement covers the 5- year useful life of the drone and requires five equal annual rentals of $40,800 payable each December 31, beginning December 31, 2019. An interest rate of 8% is implicit in the lease agreement. Collectibility of the rentals is probable. Prepare Geiberger's December 31, 2019, journal entries
Dr. Lease Receivable ($40,800 X 4.31213*) 175,935 Dr. Cost of Goods Sold 120,000 Cr. Sales Revenue 175,935 Cr. Inventory 120,000 Dr. Cash 40,800 Cr. Lease Receivable 40,800 *Present value of an annuity due of 1 for 5 periods at 8%.
Over what period of time should compensation cost be allocated?
GAAP requires that compensation expense be recognized over the service period. Unless otherwise specified, the service period is the vesting period—the time between the grant date and the vesting date.
Why would a company wish to reduce its bond indebtedness before its bonds reach maturity? Indicate how this can be done and the correct accounting treatment for such a transaction.
It is sometimes desirable to reduce bond indebtedness in order to take advantage of lower prevailing interest rates. Also, the company may not want to make a very large cash outlay all at once when the bonds mature. Bond indebtedness may be reduced by either issuing bonds callable after a certain date and then calling some or all of them, or by purchasing bonds on the open market and then retiring them. When a portion of bonds outstanding is going to be retired, it is necessary for the accountant to make sure any corresponding discount or premium is properly amortized. When the bonds are extinguished, any gain or loss should be reported in income.
The Colson Company issued $300,000 of 10% bonds on January 1, 2020. The bonds are due January 1, 2025, with interest payable each July 1 and January 1. The bonds are issued at 103. Assume the bonds in BE14.2 were issued at 98. Prepare the journal entries for (a) January 1, (b) July 1, and (c) December 31. Assume the Colson Company records straight-line amortization semi-annually.
January 1 Dr. Cash (300,000*.98) 294,000 Dr. Discount on Bonds Payable (300,000-294,000) 6,000 Cr. Bonds Payable 300,000 July 1 Dr. Interest Expense (15,000 + 600) 15,600 Cr. Discount on Bonds Payable (6,000 * 1/10) 600 Cr. Cash (300,000 * .10 * 6/12) 15,000 December 31 Dr. Interest Expense (15,000 + 600) 15,600 Cr. Discount on Bonds Payable (6,000 * 1/10) 600 Cr. Cash (300,000 * .10 * 6/12) 15,000
From a lessee perspective, distinguish between a finance lease and an operating lease.
Lessees generally have two possible lease accounting methods: (a) the finance method and (b) the operating method. Under both methods, the lessee records a right-of-use asset and a related lease liability. However, the subsequent treatment of the right-of-use asset and lease liability differs under each method. For a finance lease, the lessee recognizes interest expense on the lease liability over the life of the lease using the effective interest method and records amortization expense on the right-ofuse asset generally on a straight line basis. A lessee therefore reports both interest expense and amortization of the right to use asset on the income statement. In an operating lease, the lessee also measures interest expense using the effective interest method. However, the lessee amortizes the rightof-use asset, such that the total lease expense is the same from period to period. In other words, for operating leases, only a single lease expense (comprised of interest on the liability and amortization of the right-of-use asset) is recognized on the income statement typically on a straight-line basis. To determine which method to apply, a lessee should classify a lease based on whether the arrangement is effectively a purchase of the underlying asset (i.e. if control transfers to the lessee). If the lease meets one of five classification tests to determine whether the arrangement is effectively a purchase of the underlying asset, the lease is treated as a finance lease. Otherwise, if none of the tests are met, the lessee is deemed to only obtain the right to use the asset (not ownership of the asset itself), and accounts for the lease as an operating lease.
Whiteside Corporation issues $500,000 of 9% bonds, due in 10 years, with interest payable semi-annually. At the time of issue, the market rate for such bonds is 10%. Compute the issue price of the bonds.
PV of the Principal: 500,000 * .37689 (PVF 20**, 5%***) 188,445 PV of the interest payments: $22,500* x 12.46221 (PVF-OA 20**, 5%***) 280,400 Issue Price: 468,845 *(500,000*.09*6/12) **(10*2) ***(.10/2)
Zopf Company sells its bonds at a premium and applies the effective-interest method in amortizing the premium. Will the annual interest expense increase or decrease over the life of the bonds? Explain.
The annual interest expense will decrease each period throughout the life of the bonds. Under the effective-interest method, the interest expense each period is equal to the effective or yield interest rate times the book value of the bonds at the beginning of each interest period. When bonds are sold at a premium, their book value declines to face value over their life; therefore, the interest expense declines also.
What is the fair value option? Briefly describe the controversy of applying the fair value option to financial liabilities.
The fair value option is an accounting option where the company can elect to record fair values in their accounts for most financial assets and liabilities, including bonds and notes payable. With bonds at fair value, we assume that the decline in value of the bonds is due to an interest rate increase. If not related to changes in credit risks, these gains and losses are recorded in income. In other situations, the decline may occur because the issuer becomes more likely to default on the bonds. That is, if the creditworthiness of the issuer declines, the value of its debt also declines. If its creditworthiness declines, its bond investors are receiving a lower rate relative to investors with similar-risk investments. Thus, changes in the fair value of bonds payable for a decline in creditworthiness are included as part of other comprehensive income
What payments are included in the lease liability?
The lease liability is recorded at the present value of the lease payments. This includes the periodic rental payments made by the lessee, bargain-purchase option if any, and amounts probable to be owed under a residual value guarantee. The present value of the lease payments is recorded as a lease liability by the lessee.
Samson Company leases a building and land. The lease term is 6 years and the annual fixed payments are $800,000. The lease arrangement gives Samson the right to purchase the building and land for $11,000,000 at the end of the lease. Based on an economic analysis of the lease at the commencement date, Samson is reasonably certain that the fair value of the leased assets at the end of lease term will be much higher than $11,000,000. What are the total lease payments in this lease arrangement?
The lease payments in the lease arrangement will include both the annual fixed payments of $800,000 each year, plus the $11,000,000 bargain purchase option at the end of the lease term (as it is reasonably certain to be exercised). Thus, the lease payments for the lease agreement total ($800,000 x 6) + $11,000,000 = $15,800,000.
How is compensation expense computed using the fair value approach?
Using the fair value approach, total compensation expense is computed based on the fair value of the options on the date the options are granted to the employees. Fair value is estimated using an acceptable option pricing model (such as the Black-Scholes option-pricing model).
On December 31, 2019, Burke Corporation signed a 5-year, non-cancelable lease for a machine. The terms of the lease called for Burke to make annual payments of $8,668 at the beginning of each year, starting December 31, 2019. The machine has an estimated useful life of 6 years and a $5,000 unguaranteed residual value. The machine reverts back to the lessor at the end of the lease term. Burke uses the straight-line method of depreciation for all of its plant assets. Burke's incremental borrowing rate is 5%, and the lessor's implicit rate is unknown. a. What type of lease is this? Explain. b. Compute the present value of the lease payments. c. Prepare all necessary journal entries for Burke for this lease through December 31, 2020.
(a) This is a finance lease to Burke since the lease term (5 years) is greater than 75% of the economic life (6 years) of the leased asset. The lease term is 831 /3% (5 ÷ 6) of the asset's economic life. (b) Computation of present value of lease payments: $8,668 X 4.54595* = $39,404 *Present value of an annuity due of 1 for 5 periods at 5%. (c) 12/31/19 Dr. Right-of-Use Asset 39,404 Cr. Lease Liability 39,404 Dr. Lease Liability 8,668 Cr. Cash 8,668 12/31/20 Dr. Amortization Expense 7,881 Cr. Right-of-Use Asset 7,881 ($39,404 ÷ 5) Dr. Lease Liability 7,131 Dr. Interest Expense [($39,404 - $8,668) X .05] 1,537 Cr. Cash 8,668
Distinguish between the following interest rates for bonds payable: a. Yield rate. b. Nominal rate. c. Stated rate. d. Market rate. e. Effective rate.
(a) Yield rate—the rate of interest actually earned by the bondholders; it is synonymous with the effective and market rates. (b) Nominal rate—the rate set by the party issuing the bonds and expressed as a percentage of the par value; it is synonymous with the stated rate. (c) Stated rate—synonymous with nominal rate. (d) Market rate—synonymous with yield rate and effective rate. (e) Effective rate—synonymous with market rate and yield rate.
The residual value is the estimated fair value of the leased property at the end of the lease term. a. Of what significance is (1) an unguaranteed and (2) a guaranteed residual value in the lessee's accounting for a finance lease transaction? b. Distinguish between lease payments used to determine lease classification compared to lease payments for measuring the lease liability.
(a) 1. The lessee's accounting for a lease with an unguaranteed residual value is the same as the accounting for a lease with no residual value. That is, unguaranteed residual values are not included in the lessee's lease payments, either for classification or measurement purposes. 2. A guaranteed residual value has significance for the lessee in two ways. First, for classification purposes, the full amount of a guaranteed residual value is used in calculating the present value of the lease payments in determining whether or not a lease meets the present value test. In addition, as far as the initial measurement of the lease liability, a guaranteed residual value may be included, depending on how much a lessee expects to owe under the guarantee. (b) The value of the lease liability may be made up of two components—the periodic rental payments and amounts probable to be owed under a guaranteed residual value. That is, if the expected residual value at the end of the lease term is less than the guaranteed residual value, then the lessee will expect to pay in cash a certain amount to the lessor at the end of the lease term. As such, the lessee should include the present value of the difference between the guaranteed residual and expected residual if the expected residual is less than the guarantee. If the residual value at the end of the lease term differs in any way from the expected residual at the commencement of the lease, the lessee recognizes a loss or gain when the final payment of the guaranteed residual is made
Explain the following concepts: (a) bargain purchase option and (b) bargain renewal option.
(a) A bargain purchase option is a lease purchase option in which the lessee can buy the asset for a price that is significantly lower than the underlying asset's expected fair value at the date the option becomes exercisable, thus making the exercise of the option reasonably certain. A bargain renewal option is essentially the same conceptually as a bargain purchase option, except the option is to renew the lease as opposed to purchasing the asset. That is, a bargain renewal option is an option in which the price of renewal at which the lessee can buy the asset is significantly lower than the underlying asset's expected fair value at the date the option becomes exercisable, thus making the exercise of the option reasonably certain. (b) A bargain purchase option and a bargain renewal option have similar impacts on the initial classification and measurement of the lease. With respect to classification, the existence of a bargain purchase option is one way a lease can meet the finance/sales-type lease classification criteria. In the case of a bargain renewal option, the additional lease term that would be added by exercising the option should be included in the lease term when assessing whether or not the lease meets the lease term test. The present value of the option price would also be used in assessing whether the lease met the present value test. For measurement purposes, the present value of both a bargain purchase option and a bargain renewal option should be included in the initial value of the lease liability and right-of-use asset.
The following items are found in the financial statements. a. Discount on bonds payable. b. Interest expense (credit balance). c. Unamortized bond issue costs. d. Gain on repurchase of debt. e. Mortgage payable (payable in equal amounts over next 3 years). f. Debenture bonds payable (maturing in 5 years). g. Notes payable (due in 4 years). h. Premium on bonds payable. i. Bonds payable (due in 3 years). Instructions Indicate how each of these items should be classified in the financial statements.
(a) Discount on bonds payable—Contra account to bonds payable in long-term liabilities on balance sheet. (b) Interest expense (credit balance)—Reclassify to interest payable on balance sheet. (c) Unamortized bond issue costs—Classified as part of long-term liabilities on balance sheet. (d) Gain on repurchase of debt—Classify as part of other gains and losses on the income statement. (e) Mortgage payable—Classify one-third as current liability and the remainder as longterm liability on balance sheet. (f) Debenture bonds—Classify as long-term liability on balance sheet. (g) Notes payable—Classify as long-term liability on balance sheet. (h) Premium on bonds payable—Classify as adjunct account to Bonds payable in longterm liabilities on balance sheet. (i) Bonds payable—Classify as long-term liability on balance sheet.
Distinguish between the following values relative to bonds payable: a. Maturity value. b. Face value. c. Market (fair) value. d. Par value.
(a) Maturity value—the face value of the bonds; the amount which is payable upon maturity. (b) Face value—synonymous with par value and maturity value. (c) Market (fair) value—the amount realizable upon sale (d) Par value—synonymous with maturity and face value.
Bradley Co. is expanding its operations and is in the process of selecting the method of financing this program. After some investigation, the company determines that it may (1) issue bonds and with the proceeds purchase the needed assets, or (2) lease the assets on a long-term basis. Without knowing the comparative costs involved, answer these questions: a. What are the possible advantages of leasing the assets instead of owning them? b. What are the possible disadvantages of leasing the assets instead of owning them? c. How will the balance sheet be different if Bradley Co. leases the assets rather than purchasing them?
(a) Possible advantages of leasing for the lessee: 1. Leasing may be more flexible in that the lease agreement may contain less restrictive provisions than the bond indenture. 2. Leasing permits 100% financing of assets, as the lease is often signed without requiring any money down from the lessee. 3. Leasing may permit more rapid changes in equipment, reduce the risk of obsolescence, and pass the risk in residual value to the lessor or a third party. 4. Leasing may have favorable tax advantages. (b) Assuming that funds are readily available through debt financing, there may not be great advantages (in addition to the above-mentioned) to signing a noncancelable, long-term lease. One additional advantage of leasing is its availability when other debt financing is unavailable. (c) Given the new reporting standard on leasing the financial statement effects of a long-term noncancelable lease versus the purchase of the asset are somewhat similar. That is assets under a long term lease are capitalized at the present value of the future lease payments and this value is probably equivalent to the purchase price of the assets. On the liability side, the bond payable amount would be equivalent to the present value of the future lease payments. In summary, the amounts presented in the balance sheet would be quite comparable. The description of the leased asset (right-of-use asset) and related liability would however be different than under a bond financing as would the general classifications; the specific labels (leased assets and lease liability) would be different.
Under what conditions of bond issuance does a discount on bonds payable arise? Under what conditions of bond issuance does a premium on bonds payable arise?
A discount on bonds payable results when investors demand a rate of interest higher than the rate stated on the bonds. The investors are not satisfied with the nominal interest rate because they can earn a greater rate on alternative investments of equal risk. They refuse to pay par for the bonds and cannot change the nominal rate. However, by lowering the amount paid for the bonds, investors can alter the effective rate of interest. A premium on bonds payable results from the opposite conditions. That is, when investors are satisfied with a rate of interest lower than the rate stated on the bonds, they are willing to pay more than the face value of the bonds in order to acquire them, thus reducing their effective rate of interest below the stated rate.
What are the two methods of amortizing discount and premium on bonds payable? Explain each.
Bond discount and bond premium may be amortized on a straight-line basis or on an effective-interest basis. The profession recommends the effective-interest method but permits the straight-line method when the results obtained are not materially different from the effective-interest method. The straight-line method results in an even or average allocation of the total interest over the life of the notes or bonds. The effective-interest method results in an increasing or decreasing amount of interest each period. This is because interest is based on the carrying amount of the bond issuance at the beginning of each period. The straight-line method results in a constant dollar amount of interest and an increasing or decreasing rate of interest over the life of the bonds. The effective-interest method results in an increasing or decreasing dollar amount of interest and a constant rate of interest over the life of the bonds.
Cardinal Company is negotiating to lease a piece of equipment to MTBA, Inc. MTBA requests that the lease be for 9 years. The equipment has a useful life of 10 years. Cardinal wants a guarantee that the residual value of the equipment at the end of the lease is at least $5,000. MTBA agrees to guarantee a residual value of this amount though it expects the residual value of the equipment to be only $2,500 at the end of the lease term. If the fair value of the equipment at lease commencement is $70,000, what would be the amount of the annual rental payments Cardinal demands of MTBA, assuming each payment will be made at the beginning of each year and Cardinal wishes to earn a rate of return on the lease of 8%?
Fair value of leased asset: $70,000 Less: Present value of guaranteed residual value: ($5,000 X .50025*) 2,501 Amount to be recovered through lease payments: $67,499 Amount of equal annual lease payments: ($67,499 ÷ 6.74664**) $10,005 *Present value of 1 for 9 periods at 8%. **Present value of an annuity due of 1 for 9 periods at 8%
The Colson Company issued $300,000 of 10% bonds on January 1, 2020. The bonds are due January 1, 2025, with interest payable each July 1 and January 1. The bonds are issued at 103. Prepare the journal entries for (a) January 1 (b) July 1 (c) December 31. Assume the Colson Company records straight-line amortization semi-annually
January 1 Dr. Cash (300,000*1.03) 309,000 Cr. Bonds Payable 300,000 Cr. Premium on Bonds Payable 9,000 July 1 Dr. Interest Expense 14,100 Dr. Premium on Bonds Payable (9,000 * 1/10) 900 Cr. Cash (300,000*.10*6/12) 15,000 December 31 Dr. Interest Expense 14,100 Dr. Premium on Bonds Payable (9,000 * 1/10) 900 Cr. Cash (300,000*.10*6/12) 15,000
On January 1, 2020, JWS Corporation issued $600,000 of 7% bonds, due in 10 years. The bonds were issued for $559,224, and pay interest each July 1 and January 1. JWS uses the effective-interest method. Prepare the company's journal entries for (a) the January 1 issuance, (b) the July 1 interest payment, and (c) the December 31 adjusting entry. Assume an effective-interest rate of 8%.
January 1 Dr. Cash 559,224 Dr. Discount on Bonds Payable 40,776 Cr. Bonds Payable 600,000 July 1 Dr. Interest Expense (559,224 * .08 * 6/12) 22,369 Cr. Cash (600,000 * .07 * 6/12) 21,000 Cr. Discount on Bonds Payable 1,369 December 31 Dr. Interest Expense (560,593 * .08 *6/12) 22,424 Cr. Interest Payable (600,000 * .07 * 6/12) 21,000 Discount on Bonds Payable 1,424 *559,224 + 1,369
On January 1, 2021, Titania Inc. granted stock options to officers and key employees for the purchase of 20,000 shares of the company's $10 par common stock at $25 per share. The options were exercisable within a 5-year period beginning January 1, 2023, by grantees still in the employ of the company, and expiring December 31, 2027. The service period for this award is 2 years. Assume that the fair value option-pricing model determines total compensation expense to be $350,000. On April 1, 2022, 2,000 options were terminated when the employees resigned from the company. The market price of the common stock was $35 per share on this date. On March 31, 2023, 12,000 options were exercised when the market price of the common stock was $40 per share. Instructions Prepare journal entries to record issuance of the stock options, termination of the stock options, exercise of the stock options, and charges to compensation expense, for the years ended December 31, 2021, 2022, and 2023.
January 1 No entry December 31, 2021 Dr. Compensation Expense 175,000 Cr. Paid in Capital- Stock Options (350,000 * 1/2) 175,000 (Compensation Expense) April 1, 2022 Dr. Paid in Capital- Stock Options 17,500 Cr. Compensation Expense (175,000 * 2,000/20,000) (Termination of Stock) December 31, 2022 Dr. Compensation Expense 157,500 Cr. Paid in Capital - Stock Options (350,000 * 1/2 * 18/20) 157,500 March 31, 2023 Dr. Cash (12,000*25) 300,000 Cr. Paid in Capital- Stock Options (350,000 * 12,000/20,000) 210,000 Cr. Common Stock 120,000 Cr. Paid in Capital in Excess of Par 390,000 (To record exercise of stock options)
On January 1, 2020, Barwood Corporation granted 5,000 options to executives. Each option entitles the holder to purchase one share of Barwood's $5 par value common stock at $50 per share at any time during the next 5 years. The market price of the stock is $65 per share on the date of grant. The fair value of the options at the grant date is $150,000. The period of benefit is 2 years. Prepare Barwood's journal entries for January 1, 2020, and December 31, 2020 and 2021. Refer to the data for Barwood Corporation in BE16.6. Repeat the requirements assuming that instead of options, Barwood granted 2,000 shares of restricted stock.
January 1, 2020 Dr. Unearned Compensation 130,000 Cr. Common Stock (2,000 * 5) 10,000 Cr. Paid in Capital in Excess of Par- Common Stock [(65-5) * 2000] 120,000 December 31, 2020 Dr. Compensation Expense 65,000 Cr. Unearned Compensation 65,000
On January 1, 2020, Barwood Corporation granted 5,000 options to executives. Each option entitles the holder to purchase one share of Barwood's $5 par value common stock at $50 per share at any time during the next 5 years. The market price of the stock is $65 per share on the date of grant. The fair value of the options at the grant date is $150,000. The period of benefit is 2 years. Prepare Barwood's journal entries for January 1, 2020, and December 31, 2020 and 2021.
January 1, 2020 No entry December 31, 2020 Dr. Compensation Expense Cr. Paid in Capital- Stock Options 75,000 December 31, 2021 Dr. Compensation Expense Cr. Paid in Capital- Stock Options 75,000
On November 1, 2020, Columbo Company adopted a stock-option plan that granted options to key executives to purchase 30,000 shares of the company's $10 par value common stock. The options were granted on January 2, 2021, and were exercisable 2 years after the date of grant if the grantee was still an employee of the company. The options expired 6 years from date of grant. The option price was set at $40, and the fair value option-pricing model determines the total compensation expense to be $450,000. All of the options were exercised during the year 2023: 20,000 on January 3 when the market price was $67, and 10,000 on May 1 when the market price was $77 a share. Instructions Prepare journal entries relating to the stock option plan for the years 2021, 2022, and 2023. Assume that the employee performs services equally in 2021 and 2022.
January 3, 2023 Dr. Cash (20,000 X $40) 800,000 Dr. Paid-in Capital—Stock Options 300,000 ($450,000 X 20,000/30,000) Cr. Common Stock (20,000 X $10) 200,000 Cr. Paid-in Capital in Excess of Par 900,000 (To record issuance of 20,000 shares of $10 par value stock upon exercise of options at option price of $40) May 1, 2023 Dr. Cash (10,000 X $40) 400,000 Dr. Paid-in Capital—Stock Options 150,000 ($450,000 X 10,000/30,000) Cr. Common Stock 100,000 Cr. Paid-in Capital in Excess of Par Common Stock 450,000 (To record issuance of 10,000 shares of $10 par value stock upon exercise of options at option price of $40)
On January 2, 2015, Banno Corporation issued $1,500,000 of 10% bonds at 97 due December 31, 2024. Interest on the bonds is payable annually each December 31. The discount on the bonds is also being amortized on a straight-line basis over the 10 years. (Straight-line is not materially different in effect from the preferable "interest method.") The bonds are callable at 101 (i.e., at 101% of face amount), and on January 2, 2020, Banno called $900,000 face amount of the bonds and redeemed them. Instructions Ignoring income taxes, compute the amount of loss, if any, to be recognized by Banno as a result of retiring the $900,000 of bonds in 2020 and prepare the journal entry to record the redemption.
Reacquisition price ($900,000* X 1.01) $909,000 Less: Net carrying amount of bonds redeemed: 886,500 Par value $900,000 Unamortized discount (13,500) Loss on redemption $ 22,500 Calculation of unamortized discount— Original amount of discount: $900,000 X (1.00 - .97) = $27,000 $27,000/10 = $2,700 amortization per year; 5 X $2,700 = $13,500. January 2, 2020 Dr. Bonds Payable 900,000 Dr. Loss on Redemption of Bonds 22,500 Cr. Discount on Bonds Payable 13,500 Cr. Cash 909,000
Dr. Alice Foyle (lessee) has a non-cancelable, 20-year lease with Brownback Realty Inc. (lessor) for the use of a medical building. Taxes, insurance, and maintenance are paid by the lessee in addition to the fixed annual payments, of which the present value is equal to the fair value of the leased property. At the end of the lease period, title becomes the lessee's at a nominal price. Considering the terms of this lease, comment on the nature of the lease transaction and the accounting treatment that should be accorded it by the lessee.
The lease agreement between Alice Foyle, M.D. and Brownback Realty, Inc. is in substance a purchase of property. Because the lease has a bargain-purchase option which transfers ownership of the property to the lessee, the lease is a finance lease to Alice Foyle and a sales-type lease to Brownback Realty. As a finance lease, the right-of-use asset and related lease liability should be recorded at the discounted amount of the future lease payments over the economic life of the medical building given the bargain purchase option.
Callaway Golf Co. leases telecommunications equipment from Photon Company. Assume the following data for equipment leased from Photon Company. The lease term is 5 years and requires equal rental payments of $31,000 at the beginning of each year. The equipment has a fair value at the commencement of the lease of $150,000, an estimated useful life of 8 years, and a guaranteed residual value at the end of the lease of $15,500. Photon set the annual rental to earn a rate of return of 6%, and this fact is known to Callaway. The lease does not transfer title or contain a bargain purchase option, and is not a specialized asset. How should Callaway classify this lease?
The lease does not meet the transfer of ownership test, the bargain purchase test, the economic life test [(5 years ÷ 8 years) < 75%], or the specialized asset test. However, it does pass the present value test. The present value of the lease payments [($31,000 X 4.46511*] + [$15,500 X .74726**] = $150,000) is greater than 90% of the FV of the asset (90% X $150,000 = $135,000). Therefore, Callaway should classify the lease as a finance lease. *Present value of an annuity due of 1 for 5 periods at 6%. **Present value of 1 for 5 periods at 6%.
What date or event does the profession believe should be used in determining the value of a stock option? What arguments support this position?
The profession recommends that the fair value of a stock option be determined on the date on which the option is granted to a specific individual. At the date the option is granted, the corporation foregoes the alternative of selling the shares at the then prevailing price. The market price on the date of grant may be presumed to be the value which the employer had in mind. It is the value of the option at the date of grant, rather than the grantor's ultimate gain or loss on the transaction, which for accounting purposes constitutes whatever compensation the grantor intends to pay.
Identify the amounts included in the measurement of the right-of-use asset
The right-of-use asset is initially measured as the same amount as the lease liability (i.e. present value of lease payments), adjusted for initial direct costs, prepayments and lease incentives. Initial direct costs paid by the lessee will increase the initial value of the right-of-use asset. Similarly, prepaid rent paid by the lessee will increase the amount of the right-of-use asset recorded. Lease incentives granted to the lessee by the lessor will decrease the initial value of the right-of-use asset.
U Journeys enters into an agreement with Traveler Inc. to lease a car on December 31, 2019. The following information relates to this agreement. 1. The term of the non-cancelable lease is 3 years with no renewal or bargain purchase option. The remaining economic life of the car is 3 years, and it is expected to have no residual value at the end of the lease term. 2. The fair value of the car was $15,000 at commencement of the lease. 3. Annual payments are required to be made on December 31 at the end of each year of the lease, beginning December 31, 2020. The first payment is to be of an amount of $5,552.82, with each payment increasing by a constant rate of 5% from the previous payment (i.e., the second payment will be $5,830.46 and the third and final payment will be $6,121.98). 4. DU Journeys' incremental borrowing rate is 8%. The rate implicit in the lease is unknown. 5. DU Journeys uses straight-line depreciation for all similar cars. a. Prepare DU Journeys' journal entries for 2019, 2020, and 2021. b. Assume, instead of a constant rate of increase, the annual lease payments will increase according to the Consumer Price Index (CPI). At its current level, the CPI stipulates that the first rental payment should be $5,820. What would be the impact on the journal entries made by DU Journeys at commencement of the lease, as well as for subsequent years?
This is a finance lease, as the lease term is 100% of the asset's economic life, and the present value of the rental payments are 100% of the asset's fair value, as shown below: Present value of first payment: ($5,552.82 X .92593) $5,141.52 Present value of second payment: ($5,830.46 X .85734) $4,998.69 Present value of third payment: ($6,121.98 X .79383) $4,859.81 Present value of the rental payments: $15,000.02 12/31/19 Dr. Right-of-Use Asset 15,000 Cr. Lease Liability 15,000 12/31/20 Dr. Interest Expense ($15,000 X 8%) 1,200.00 Dr. Lease Liability 4,352.82 Cr. Cash 5,552.82 Dr. Amortization Expense ($15,000 ÷ 3) 5,000.00 Cr. Right-of-Use Asset 5,000.00 12/31/21 Dr. Interest Expense ($15,000 - 4352.82) * 8%) 851.77 Dr. Lease Liability 4978.69 Cr. Cash 5830.46 Dr. Amortization Expense ($15,000 ÷ 3) 5,000.00 Cr. Right-of-Use Asset 5,000.00 (b) The initial valuation of the lease liability and related right-of-use asset should not include any unknown increases or decreases in lease payments due to increases or decreases in the CPI. Rather, for the initial measurement of the lease liability, the lessee assumes that all payments will be made as if the CPI level at the commencement date of the lease does not change. Thus, DU Journeys should discount the annual lease payments using the ordinary annuity factor applied to the first lease payment.
