IA2e Errata Vol 2 090721

© Cambridge Business Publishers Chapter 15 Current Liabilities and Contingencies 15-40
15-4. Why are most current liabilities recognized at maturity value at the beginning of their term?
15-5. Compute the present value of a $10,000, one-year note payable that specifies no interest, although 10%
would be a realistic rate. Is the present value less than, greater than, or equal to the maturity value?
15-6. In evaluating a balance sheet, some creditors say the liability section is one of the most important sec-
tions. What are some reasons justifying this position?
15-7. Some liabilities are reported at their maturity amount. In general, when should liabilities, prior to the
maturity date, be reported at less than their maturity amount?
15-8. Explain why the amount of cash salaries paid to employees does not equal salaries expense for the
employer.
15-9. Differentiate between secured and unsecured liabilities. Explain the reporting procedures for each.
15-10. What are examples of secured and unsecured liabilities?
15-11. Distinguish between the stated rate and the market rate on a debt.
15-12. Briefly define the following terms related to a note payable: present value of the note and maturity
value of the note.
15-13. Distinguish between an interest-bearing note and a noninterest-bearing note.
15-14. Assume that $4,000 cash is borrowed on a $4,000, 10%, one-year note payable that is interest-bear-
ing and that another $4,000 cash is borrowed on a $4,400 one-year note that is noninterest-bearing.
For each note, provide the following:
a. Present value of the note. b. Maturity amount. c. Total interest paid.
15-15. How is gift card breakage recognized as revenue using the proportional method?
15-16. Why is deferred revenue classified as a liability?
15-17. What is a compensated absence? When should the expense related to compensated absences be
recognized?
15-18. What is the accounting definition of a contingency? What are the three characteristics of a contingen-
cy? Why is this concept important?
15-19. How is the likelihood of the outcome of a contingency measured? In general, how does this affect the
accounting for and reporting of contingencies?
15-20. Briefly explain the accounting and reporting for loss contingencies.
15-21. What costs are recognized for environmental obligations?
15-22. Under what conditions may a debt due within the next year (as measured at year-end) be reported as
a noncurrent liability? Under what conditions may a long-term debt (as measured at year-end) be re-
ported as a current liability?
Brief Exercises
Target Shoppers Inc. reported cash sales of $18,000 for the month of June 2020. Sales taxes payable are recorded Brief Exercise 15-23
at the point of sale. Recording Sales Tax
Payable Entries LO1
a. Assume that sales of Target Shoppers Inc. are subject to a 6% sales tax. Record the sales entry.
b. Now assume that the cash collected on sales includes the 6% sales tax. Record the sales entry.
On June 15, 2020, Red Buckle Inc. purchased merchandise for resale for $12,000 on credit terms 2/10, n/30. On Brief Exercise 15-24
June 20, Red Buckle paid for the merchandise. Record the entry on June 15 and the entry on June 20 using the Recording Accounts
Payable Entries LO1
perpetual inventory system and the gross method for recording discounts. Hint: See Demo 15-1A
Jet Air Inc. collected $300 cash from a customer who purchased a one-way airline ticket on June 1, 2020, for a Brief Exercise 15-25
flight from Minneapolis to New York on August 15, 2020. Record the entry on June 1, and the entry on August Recording Customer
Advances LO2
15 for Jet Air Inc. Hint: See Demo 15-2B
Chica’s Inc. sold a $50 gift card on February 1, 2020. The gift card was redeemed on February 14, 2020. Record Brief Exercise 15-26
the entry on February 1 and the entry on February 14 for Chica’s Inc. Recording Gift Card
Entries LO2
Hint: See Demo 15-2C
BSW Inc. had a weekly payroll of $5,000 for three employees with mandatory withholdings of social security Brief Exercise 15-27
tax (7.65%), federal withholdings of $1,000, and state withholdings of $200. Voluntary withholdings included Recording Payroll
Entries LO3
retirement plan contributions of $100, and health care savings account contributions of $150. Record BSW Inc.’s Hint: See Demo 15-3A
weekly payroll entry.
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15-41 Chapter 15 Current Liabilities and Contingencies © Cambridge Business Publishers
Brief Exercise 15-28 The following information relating to compensated absences was available from Graf Company’s accounting
Recording Liability records at December 31, 2020.
for Compensated
Absences LO3 Employees’ rights to vacation pay vest and are attributable to services already rendered. Payment is prob-
Hint: See Demo 15-3C able, and Graf’s obligation was reasonably estimated at $220,000.
Employees’ rights to sick pay benefits do not vest but accumulate for possible future use. The rights are attrib-
utable to services already rendered, the total accumulated sick pay was reasonably estimated at $100,000, and
payment is possible.
a. What amount is Graf required to report as the liability for compensated absences on its December 31, 2020,
balance sheet?
b. Record the appropriate journal entry on December 31, 2020.
Brief Exercise 15-29 On December 15, 2020, the board of directors of Limited Label Inc. approved a bonus payout of $70,000 to ex-
Recording Bonus ecutives, based upon services performed in 2020. The bonus is payable on January 25, 2021. Record the entries
Payable LO3
Hint: See Demo 15-3D required on (1) December 15, 2020, and (2) January 25, 2021.
Brief Exercise 15-30 On August 31, 2020, Pine Company issued a 9-month, 12% note payable to National Bank in the amount of
Recording Interest- $900,000. Interest is due at maturity. Record the entries for Pine Company on the following dates.
Bearing Note Payable
Entries LO4 a. Issuance of the note on August 31, 2020.
Hint: See Demo 15-4A
b. Adjusting entry on December 31, 2020, Pine Company’s fiscal year-end.
c. Payment of the note payable on May 31, 2021.
Brief Exercise 15-31 First Choice Company buys equipment on October 1, 2020, providing as payment a noninterest-bearing note for
Recording Noninterest- $20,000 to be paid one year from today. The equipment could be purchased for $18,182 in cash today. Record
Bearing Note Payable
Entries LO4 the entries for First Choice Company on the following dates.
a. Issuance of the note on October 1, 2020.
b. Adjusting entry on December 31, 2020, First Choice Company’s fiscal year-end. Amortize the discount on
the note using the straight-line method.
c. Payment of the note payable on October 1, 2021.
Brief Exercise 15-32 The face value of commercial paper borrowings at December 31, 2020, was $6 million. The six-month loan origi-
Recording Debt Issued nated on September 1, 2020.
at a Discount LO4
Hint: See Demo 15-4B a. Prepare the journal entry for issuance of the loan on September 1, 2020, assuming that the loan is discounted
at 5.7%. Hint: Discount on Note Payable is equal to 6 months of interest.
b. Prepare the adjusting entry at December 31, 2020. Amortize the discount on the note using the straight-line
method.
c. Prepare the entry to repay the loan on February 28, 2021.
d. Calculate the market rate of the loan.
Brief Exercise 15-33 Maple Leaf Co. has a $50,000, 5%, 10-year note issued July 31, 2011.
Classifying Refinanced
Debt LO4 a. How will the $50,000 be classified on the December 31, 2020, balance sheet?
Hint: See Demo 15-4C b. If the $50,000 is refinanced into a five-year note on January 31, 2021 (before the 2020 financial statements
are issued), how will the $50,000 note payable be classified on the December 31, 2020, balance sheet?
Brief Exercise 15-34 On December 31, 2020, Mainstreet Inc. recognized a $100,000 note payable due on demand or on June 30, 2025,
Classifying Callable whichever is earlier, to First Bank. The repayment of the note to First Bank is not expected at any point in 2021.
Debt LO4
Hint: See Demo 15-4C How will the $100,000 note payable be classified on Mainstreet’s December 31, 2020, balance sheet?
Brief Exercise 15-35 Finisher Inc. sells merchandise for $250,000 in 2020 that includes a three-year limited warranty. Warranty costs
Recording Assurance- are estimated to be 1% of sales. The company incurred actual costs of $800 in 2020 related to the warranties.
Type Warranty
Liability LO5 a. Record the warranty accrual at the time of sale in 2020.
b. Record the adjustment to the warranty accrual for actual warranty costs in 2020.
Brief Exercise 15-36 Madison Co. sells merchandise for $250,000 in 2020, along with a two-year warranty (for years 2020 and 2021)
Recording Service- for $25 per product. Warranty costs are estimated to be 0.5% of sales. The company sold $2,500 of warranties in
Type Warranty
Liability LO5 2020 and incurred actual costs of $800 in 2020 related to the warranties. The company uses straight-line recog-
Hint: See Demo 15-5C nition of warranty revenue.

a. Record the sale of the merchandise and warranties, ignoring the cost of goods sold entry. Assume cash sales.
b. Record the warranty service costs for 2020. Assume cash payments.
c. Record the warranty revenue recognized in 2020.
On November 5, 2020, a Dunn Corporation truck was in an accident with an auto driven by R. Bell. Dunn received Brief Exercise 15-37
notice on January 12, 2021, of a lawsuit for $350,000 in damages for personal injuries suffered by Bell. Dunn Cor- Reporting a Legal
Contingency LO5
poration’s legal counsel believes it is probable that Bell will be awarded an estimated amount in the range between Hint: See Demo 15-5A
$100,000 and $225,000, and that $150,000 is a better estimate of potential liability than any other amount. Dunn’s
accounting year ends on December 31, and the 2020 financial statements were issued on March 2, 2021.
a. What liability should Dunn accrue on December 31, 2020?
b. How would your answer to (a) change if Dunn Corporation’s legal counsel believes it is reasonably possible
that Bell will be awarded a settlement?
c. How would your answer to (a) change if Dunn Corporation’s legal counsel believes there is only a remote
possibility that Bell will be awarded a settlement?
Pitt Company is the defendant in a lawsuit filed by Hoffman in 2020 disputing the validity of a copyright held Brief Exercise 15-38
by Pitt. At December 31, 2020, Pitt determined that Hoffman would probably be successful against Pitt for an Recording and
Reporting a Legal
estimated amount of $800,000. Appropriately, an $800,000 loss was accrued by a charge to income of Pitt for the Contingency LO5
year ended December 31, 2020. On December 15, 2021, Pitt and Hoffman agreed to a settlement providing for
cash payment of $500,000 by Pitt to Hoffman and transfer of Pitt’s copyright to Hoffman. The carrying amount
of the copyright on Pitt’s accounting records was $120,000 at December 15, 2021.
a. What would be the effect of the settlement of this liability on Pitt’s income before income tax in 2021?
b. Record the entry on December 15, 2021 for Pitt Company.
The following information pertains to a fire insurance policy in effect during the calendar year 2020, covering Brief Exercise 15-39
Vail Company’s inventory: Reporting a Loss
Contingency LO5
Face amount of policy�� $400,000

Deductible�� 25,000
Amount of premium�� 2,000
Vail’s inventory averages $500,000 uniformly throughout the year. How much of a contingent liability should
Vail accrue at December 31, 2020, to cover possible future fire losses?
Marathon Inc. estimates that it will be required to spend approximately $40,000 to remove an underground stor- Brief Exercise 15-40
age tank in 10 years that was constructed in 2020 for $300,000. The present value of this obligation based on the Recording Asset
Retirement
company’s discount rate of 8% is $18,528. Record the entry in 2020 (if any) related to the removal of the storage Obligation LO5
tank in 10 years.
A manufacturer of household appliances has potential losses due to the discovery of a possible defect in one of its Brief Exercise 15-41
products. The occurrence of the loss is reasonably possible, and the costs can be reasonably estimated at $50,000. Reporting a Loss
Contingency LO5
How should this potential loss be treated for financial statement purposes?
The Occupational Safety and Health Administration (OSHA) is in the process of conducting a workplace inspec- Brief Exercise 15-42
tion at Kenny’s Corp. to determine whether the company is in compliance with standards on health and safety in Reporting a Loss
Contingency LO5
the workplace. While the investigation is currently in process, Kenny’s Corp. estimates that it is probable that an
assessment will be made. The range of a reasonably possible assessment is between $25,000 and $100,000. How
should this potential loss be treated for financial statement purposes?
During the year, a driver for Commuters Inc. was involved in an accident. Commuters Inc. brought a suit against Brief Exercise 15-43
the negligent party for $1 million. The suit is pending on December 31, 2020. Commuters Inc. believes it is vir- Analyzing a Gain
Contingency LO5
tually certain that it will receive a settlement of $1 million. How should this potential gain be treated for financial Hint: See Demo 15-5D
statement purposes on December 31, 2020?
In January 2021, an explosion occurred at Nilo Company’s plant, causing damage to area properties. In March Brief Exercise 15-44
2021, Nilo received notification of lawsuits filed against the company. Nilo’s management and legal counsel con- Reporting Subsequent
Events LO5
cluded that it was reasonably possible that Nilo would be held responsible for negligence and that $1,500,000
was a reasonable estimate of the damages. Nilo’s $2,500,000 comprehensive public liability policy contains a

$150,000 deductible clause. In Nilo’s December 31, 2020, financial statements, how should this casualty be re-
ported if the financial statements were released on March 31, 2021?
Brief Exercise 15-45 Compute the (1) current ratio and the (2) quick ratio for Nike, Inc. using the following excerpt from the balance
Calculating Liquidity sheet reported in a recent 10-K of Nike, Inc.
Ratios LO6
Hint: See Demo 15-6
At May 31 (in millions) 2015 At May 31 (in millions) 2015
Current assets Current liabilities

Cash and equivalents �� $ 3,852 Current portion of long-term debt�� $ 107
Short-term investments�� 2,072 Notes payable �� 74
Accounts receivable, net�� 3,358 Accounts payable�� 2,131
Inventories�� 4,337 Accrued liabilities�� 3,951
Deferred income taxes�� 389 Income taxes payable �� 71
Prepaid expenses and other current assets �� 1,968
Total current assets�� $15,976 Total current liabilities�� $ 6,334
Exercises
Exercise 15-46 Cash sales for Zeviae Inc. in 2020 were $9 million. The majority of sales were subject to a sales tax rate of 6%.
Recording Sales Taxes Zeviae records sales taxes payable at the point of sale.
Payable LO1
Required
a. Record the sales and sales tax entry for 2020 assuming that $180,000 of sales were not subject to tax.
b. Now assume that cash collections for 2020 were $9 million, which included a 6% sales tax along with the
sales amount. Of the amount collected, $180,000 of sales were not subject to tax. Record the sales and sales
tax entry for 2020.
Exercise 15-47 On September 1, 2020, Global Tech Inc. purchased merchandise for resale for $8,000 on credit terms 2/15, n/60
Recording Inventory using the gross method and a perpetual inventory system. Global Tech incurred a shipping charge of $300 on the
Purchase LO1
purchase, which was immediately paid. On September 10, 2020, Global Tech paid for half of the merchandise.
On October 25, 2020, Global Tech paid the remaining balance.
Required
Record the following entries for Global Tech related to the merchandise purchase.
a. Record the purchase of inventory on account and the freight payment on September 1, 2020.
b. Record the payment on September 10, 2020.
c. Record the payment on October 25, 2020.
d. Assume that instead of making payments on September 10 and October 25, Global Tech issued a 12-month
note in payment of the $8,000 account balance on October 31, 2020. Interest on the note is 10%, due in full
upon maturity of the note. Record the issuance of the note payable.
Exercise 15-48 Record the entries for the following transactions for Shoppers Inc. Shoppers uses a perpetual inventory system
Recording Inventory and records sales taxes payable at the point of sale.
Purchases and Sales
on Account LO1 a. On January 1, 2020, Shoppers Inc. purchased merchandise for resale for $35,000 on credit terms 1/15, n/30.
Shoppers Inc. incurred a shipping charge of $180 on the purchase, which was immediately paid. Shoppers
Inc. uses the gross method to record purchases.
b. Shoppers Inc. sells $14,000 of inventory during the first week of January 2020, to customers for $25,000, with
a sales tax rate of 5%. Of the total sales for the week, 30% are cash sales, and 70% are credit sales (n/30).
c. On January 14, 2020, Shoppers Inc. pays the balance for purchases on account.
d. Assume instead that Shoppers Inc. sells $15,000 of inventory during the first week of January 2020 to cus-
tomers for $28,000, which includes a 5% sales tax. Of the total sales for the week, 30% are cash sales, and
70% are credit sales. Record the sales entry.

Required
a. Provide the entry for Ulta Inc. to accrue compensated absences on December 31, 2020, and for the payment
of vacation days in 2021. Disregard payroll taxes.
b. Compute the total amount of salaries expense for 2020 and 2021. How would the vacation time carried over
from 2020 affect the December 31, 2020 balance sheet?
Exercise 15-54 Urban Fit Corporation paid salaries and wages of $143,800 to its employees for the month. Of this amount, $3,800
Recording Payroll was paid to employees who had already exceeded wages of $128,400. Also, $43,800 was paid to employees who
and Related
Deductions LO3 had already been paid the SUTA maximum. FICA employee withholdings consist of a social security tax of 6.20%
on the first $128,400 earned, plus a Medicare tax of 1.45% on all wages. Urban Fit pays employer taxes as follows:
its required FICA contribution, plus a FUTA tax of 6.0% on wages up to the SUTA maximum. Of this amount, 5.4%
is payable to the state and 0.6% is payable to the U.S. Treasury. Employee income tax withholding was $35,000. De-
ductions included: union dues (in conformity with the union agreement), $3,000, and insurance premiums, $12,000.
Required
Provide the entries to:
a. Record liabilities for payroll deductions.
b. Record payroll tax expenses.
c. Record remittance of the payroll obligations.
Exercise 15-55 Bloy Company pays all salaried employees on a biweekly basis. Overtime pay, however, is paid in the follow-
Determining Accrued ing biweekly period. Bloy accrues salaries expense only at its December 31 year-end. Data relating to salaries
Salaries LO3
earned in December 2020 are:
Last payroll was paid on December 26, 2020, for the two-week period ended on that day.
Overtime pay earned in the two-week period ended December 26, 2020, was $8,400.
Remaining work days in 2020 were December 29, 30, and 31, on which days there was no overtime.
The recurring biweekly salaries total $150,000.
Required
Assuming a 5-day workweek, what should Bloy record as a liability at December 31, 2020, for accrued salaries?
Exercise 15-56 Anne Taylor Company borrowed cash on August 1, 2020, and signed a $33,300 (face amount), one-year note
Recording Entries for payable, due on July 31, 2021. The accounting period of Anne Taylor ends December 31. Assume an effective
Interest-Bearing and
Noninterest-Bearing interest rate of 11%.
Notes LO4
Required
a. How much cash should Anne Taylor Company receive on the note, assuming the note is an interest-bearing
note?
b. Provide the following entries.
1. August 1, 2020, date of the loan.
2. December 31, 2020, adjusting entry.
3. July 31, 2021, payment of the note.
c. What liability amount(s) should be shown on the December 31, 2020, balance sheet?
d. Answer (a) and (c) above assuming that the note is noninterest-bearing. Use the straight-line method to am-
ortize any discounts on note payable.
Exercise 15-57 Consider the following three separate scenarios for a one-year, $100,000 note payable issued on September 1, 2020.
Analyzing Interest- Use the straight-line method to amortize any discount on note payable.
Bearing and
Noninterest-Bearing
Notes LO4 $100,000 Note payable $100,000 Note payable $100,000 Note payable
12% Interest due at maturity 10% interest due at maturity Noninterest-bearing
12% market rate 10% market rate 12% market rate
Borrower’s FYE*: Dec. 31 Borrower’s FYE: Nov. 30 Borrower’s FYE: Dec. 31
Cash received upon note issuance

Cash paid at maturity date
Total interest paid (cash)
continued

continued from previous page
$100,000 Note payable $100,000 Note payable $100,000 Note payable

12% Interest due at maturity 10% interest due at maturity Noninterest-bearing
12% market rate 10% market rate 12% market rate
Borrower’s FYE*: Dec. 31 Borrower’s FYE: Nov. 30 Borrower’s FYE: Dec. 31
Interest expense in fiscal year 2020

Interest expense in fiscal year 2021
Amount of liabilities reported on
fiscal year 2020 balance sheet:
Note payable (net)
Interest payable
*FYE: Fiscal year-end
Required
Complete the table above based upon the information provided for the three separate scenarios.
Masy’s Department Store supported its operations through short-term note financing in 2020 described as follows: Exercise 15-58
Recording Entries
May 10 The Company entered into a new credit agreement with certain financial institutions providing for Short-term Notes
for revolving credit borrowings and letters of credit in an aggregate amount not to exceed $1.5 Payable LO4
million. Interest rates are adjustable.
Sep. 30 The Company borrowed $500,000 on the revolving credit line, payable in 6 months, at an inter-
est rate of 7.25%, due upon maturity.
Nov. 30 Additional cash needed during peak holiday sale period was funded through the issuance of 60-
day, $200,000 commercial paper, discounted at 4%.
Jan. 29 Paid off the commercial paper debt on due date.
Mar. 31 Paid off the balance of $500,000 on the revolving credit line plus interest.
Required
Record the following journal entries, assuming a 360-day year for interest computations:
a. May 10—Entering into credit line agreement.
b. September 30—Issuance of $500,000 note payable.
c. November 30—Issuance of $200,000 commercial paper. Compute the discount on note payable using 360
days as the base for prorating interest. For the $200,000 note, compute the interest accrual based upon the
exact number of days outstanding.
d. December 31—Adjusting entries.
e. January 29—Payment of $200,000 commercial paper.
f. March 31—Payment of $500,000 note payable.
The following table includes five separate short-term note payable scenarios. Exercise 15-59
Calculating
Accrued Interest
Stated Fiscal Accrued Interest
Expense LO4
Note Payable Issuance Date Term Rate Year-End at Fiscal Year-End
1 $5,000 note payable September 1, 2020 6-month 6% December 31 $
2 $5,000 note payable September 30, 2020 6-month 6% December 31
3 $2,000 note payable November 1, 2020 3-month 8% December 31
4 $2,000 note payable November 30, 2020 3-month 8% December 31
5 $10,000 note payable May 31, 2020 12-month 10% November 30
Required
For each separate scenario, complete the last column in the table by calculating interest expense accrued at the
relevant fiscal year-end.
On December 31, 2020, Millers Grocery Inc. had a 10-year, 7% note payable balance of $100,000. The note pay- Exercise 15-60
able was originally issued on June 30, 2011. The company will issue its financial statements on March 15, 2021. Classifying
Debt LO4, 5
Required
How will the note payable in each of the following separate scenarios be classified on the balance sheet of Mill-
ers Grocery on December 31, 2020?

a. The company intends to pay off the note payable when it comes due.
b. The company intends to refinance the note payable and will begin discussions with the lender in February
2021.
c. The company issues common stock in January 2021. $75,000 of the proceeds of the issuance plus $25,000
in cash are used to pay off the loan.
d. The company enters into a refinancing agreement dated January 31, 2021, which allows the issuance of debt
up to 50% of the company’s inventory balance, which is expected to be $175,000 during 2021. The interest
rate in the refinancing agreement is 6.5% and the debt agreement expires on December 31, 2023.
e. The full $100,000 was extinguished on February 1, 2021, when it was paid off with a $100,000, 8%, inter-
est-bearing note payable, due February 1, 2026.
f. Assume that the note payable was issued on June 30, 2020. The note payable includes a provision that al-
lows for the lender to call the note at any time. However, the lender has indicated that it does not intend to
call the note in 2021.
g. Assume that the note payable was issued June 30, 2019, instead of December 31, 2020. Millers Grocery Inc.
is in violation of a debt covenant that requires a current ratio of 1.5. Millers obtained a waiver of the debt
covenant through September 2021 because it expects to be back at 1.5 by mid-year.
Exercise 15-61 During 2020, Ward Company introduced a new product carrying a two-year warranty against defects, which
Recording is included in the selling price of the product. The estimated warranty costs are 2% of sales within the first 12
and Reporting
Warranties LO5 months following the sale and 4% in the second 12 months following the sale. Sales and actual warranty expen-
ditures for the years ended December 31, 2020, and 2021 are:
Sales Actual Warranty Expenditures

2020�� $ 600,000 $ 9,000
2021�� 1,000,000 30,000
$1,600,000 $39,000
Required
a. At December 31, 2020, what would Ward report as estimated warranty liability on its balance sheet?
b. Record the journal entries required on December 31, 2020.
c. At December 31, 2021, what would Ward report as estimated warranty liability on its balance sheet?
d. Record the journal entries required on December 31, 2021.
Exercise 15-62 Assume the same information in Exercise 15-61, except that the warranty is for three years and has a separate
Recording purchase price. The company collected $20,000, and $35,000 for this extended warranty feature in the years 2020
and Reporting
Warranties LO5 and 2021, respectively. The company uses straight-line recognition of warranty revenue. For simplification, as-
Hint: See Demo 15-5C sume that sales occurred at the first of the year.
Required
a. Record the journal entries required for (1) the sale of the products and warranties on credit, (2) incurred war-
ranty costs, and (3) recognition of warranty revenue for 2020 and 2021.
b. What liability would be reported on the balance sheet at the end of 2020 and 2021?
Exercise 15-63 Macy Furniture sells a line of products that carry a three-year warranty against defects at no extra charge. Based
Recording on industry experience, the estimated warranty costs are as follows: first year following the year of sale, 1% of
and Reporting
Warranties LO5 sales; second year following the year of sale, 3% of sales; and third year following the year of sale, 5% of sales.
Sales and actual warranty expenditures for the first three-year period were:
Cash Sales Actual Warranty Expenditures

2020�� $ 80,000 $1,000
2021�� 110,000 4,100
2022�� 120,000 9,800
Required
a. Provide entries for the three years for (1) credit sales, (2) estimated warranty expense, and (3) actual
expenditures.
b. What amount should be reported as a liability on the balance sheet at the end of each year?

Exercise 15-67 Boston Scientific Corporation is a worldwide developer, manufacturer and marketer of medical devices that are
Analyzing used in a broad range of interventional medical specialties. In a recent annual report on Form 10-K, the company
Contingencies LO5
reported the following regarding its legal expense accrual.
Note K: Commitments and Contingencies (excerpt) Our accrual for legal matters that are probable and
estimable was $1.936 billion as of December 31, 2015 and $1.577 billion as of December 31, 2014, and in-
cludes certain estimated costs of settlement, damages and defense.
Required
a. Record the entry for Boston Scientific Corporation for the accrual of legal expense on December 31, 2015.
Assume that no settlement payments were made in 2015.
b. If legal matters unresolved at the end of 2015 were settled in 2016 for $1.736 billion, record the related en-
try. What impact would this settlement have on the 2015 financial statements?
Exercise 15-68 On January 17, 2021, an explosion occurred at a Cord Company plant, causing extensive property damage to area
Reporting Subsequent buildings. Although no claims had yet been asserted against Cord by March 10, 2021, the company believes it is
Event LO5, 6
probable that claims will be asserted. Cord’s management and counsel concluded that it was reasonably possible
that Cord would be responsible for damages and that $2,500,000 would be a reasonable estimate of its liability.
Cord’s $10,000,000 comprehensive public liability policy has a $500,000 deductible clause.
Required
In Cord’s December 31, 2020, financial statements, which were issued on March 25, 2021, how should this item
be reported?
Exercise 15-69 The following transactions relate to topics in this chapter.

Reporting Liabilities and
Contingencies a. Purchased inventory on account, terms 2/n, n/30, accounted for using the perpetual inventory system.
LO1, 2, 3, 4, 5, 6 b. Collected sales taxes on a customer sale.
c. Received a deposit from a customer as a down payment on a large purchase.
d. Recorded a sale of gift cards to customers.
e. Recognized breakage revenue on gift cards.
f. Accrued weekly payroll including employee withholdings.
g. Accrued payroll tax expense.
h. Recorded vacation time paid that had been previously accrued.
i. Accrued year-end employee bonuses.
j. Accrued interest on a short-term, interest-bearing note payable.
k. Reclassified long-term debt due within the next year as current.
l. Accrued a loss contingency.
m. Settled a loss contingency for considerably less than previously accrued.
n. Recorded the sale of an extended warranty.
o. Discovered as a subsequent event that a large customer unexpectedly filed for bankruptcy. As a result, the
accounts receivable balance is written off before the financial statements are issued.
Required
For each transaction above, indicate the impact on assets, liabilities, and stockholders’ equity.
Exercise 15-70 The following transactions relate to topics in this chapter.

Determining the Impact
on Liabilities of the a. Coupons published in a newspaper that may be redeemed for merchandise or service.
Balance Sheet b. Sales taxes payable.
LO1, 2, 3, 4, 5, 6
c. Probable requirements to clean up toxic wastes.
d. Company contract promises to pay postretirement health benefits.
e. Probable awards (gain) based on product liability suits.
f. Cash dividends declared but not paid.
g. Customer payments for online newsletter subscriptions not yet delivered.
h. Notes payable (trade); due June 30, 2021.
i. Discount on short-term notes payable.
j. Bonds payable (25% installment due each April 1).
k. Accounts payable.
l. Accrued property taxes (estimated).

16-25 Chapter 16 Long-Term Liabilities © Cambridge Business Publishers
. Derecognition of Note Payable

d
Upon maturity, Frazier Inc. would record the payment of the face value of the note to Seattle Corp.
December 31, 2022—To record retirement of note at maturity
Assets 5 Liabilities 1 Equity
21,000
Cash
21,000
Note Payable
Note Payable�� 1,000
1,000 1,000 1,000 Cash�� 1,000
Notes Payable Issued for Noncash Consideration [Property,

Goods, or Services]
Although most notes represent loans, notes payable can also arise from normal purchases of goods or
services or through extension of payment periods of accounts payable. Measuring the value of such
transactions is more difficult because cash is not exchanged. In this case, the transaction should be
recorded at the value of the asset or debt, whichever is more reliable.
If the value of the consideration given is known, the market rate can be measured by equating
the present value of the cash flows called for in the note to the fair value of the consideration. What
happens when the fair value of the consideration received is not readily determinable? The fair
value of the debt can be used to measure the transaction. However, the interest rate stated in a note may
not equal the market rate prevailing on obligations involving a similar credit rating or risk, although
the stated rate is always used to determine the cash interest payments. If the stated and market rates
are different, the market rate (imputed interest rate) is used to measure the note and to measure inter-
est expense. The market rate is the rate accepted by two parties with opposing interests engaged in an
arm’s-length transaction.
835-30-05-2 Business transactions often involve the exchange of cash or property, goods, or service for a note
or similar instrument. When a note is exchanged for property, goods, or service in a bargained transaction entered
into at arm’s length, there should be a general presumption that the rate of interest stipulated by the parties to
the transaction represents fair and adequate compensation to the supplier for the use of the related funds. That
presumption, however, must not permit the form of the transaction to prevail over its economic substance and
thus would not apply if interest is not stated, the stated interest rate is unreasonable, or the stated face amount
of the note is materially different from the current cash sales price for the same or similar items or from the fair
value of the note at the date of the transaction.
The following three examples in Demo 16-6B illustrate the exchange of a note payable for noncash
consideration. In the first example, a note payable is exchanged for equipment with a determinable
fair value. In the second example, the fair value of the equipment and the note are not determinable;
therefore, the note is measured by discounting the note using the prevailing market rate of interest of
notes with similar risks (also called the imputed interest rate). In the third example, rather than ar-
ranging to pay off the entire principal balance at the end of the loan as in the previous examples, the
contract requires the debtor to make periodic, equal payments that include both principal and interest.
This is similar to a typical house or vehicle loan where payments are made up of principal and interest.
This type of note is an installment note, which allows for the obligation to be satisfied at the end of
the note term through equal periodic payments.
Demo 16-6B LO16-6 Note Payable Issued for Noncash Consideration
Demo Example One: Note Payable Exchanged for Equipment [Fair Value of Asset Determinable]
Frazier Inc. purchased equipment on January 1, 2020, and issued a two-year, $1,000 note with a
MBC 5% stated rate. Interest is payable each December 31, and the entire principal is payable Decem-
2021. The equipment has a fair value of $947. The market rate of 8% is implicit in this
ber 31, 2022.
agreement. Record the following entries for Frazier Inc. related to the note payable.
. Record the issuance of the note on January 1, 2020.
a
b. Prepare an amortization schedule over the term of the note payable that uses the effective
interest method to amortize the discount on note payable.
continued
16_InterAcc2e_16.indd 25 5/20/21 4:20 PM

Solution
a. Early Redemption of Bonds Payable
Frazier pays $4,040 upon redemption of the bonds or ($10,000  40%  1.01). Frazier Inc.
derecognizes 40% of the carrying value of the bonds on December 31, 2021. The unamortized
bond discount in total is $184. However, only 40% of this amount (as well as the bonds payable
amount) is derecognized. Frazier Inc. would record the following entry on redemption.
December 31, 2021—To record bond redemption
24,040 24,000
174
2114
Bonds Payable ($10,000 3 40%)�� 4,000
Cash
4,040
Bonds Payable
4,000 10,000 Bal.
Loss on Redemption of Bonds ($4,040 2 [$4,000 2 $74])�� 114
Loss on Bond Red Discount on BP Discount on Bonds Payable ($184 3 40%)�� 74
114 Bal. 184 74
Cash ($10,000 3 40% 3 1.01)�� 4,040
. Interest Payment and Retirement of Remaining Bonds Payable
b
Debt extinguishment does not affect the accounting for the remaining 60% of the bond issue;
60% of the values in the amortization schedule would be used to record entries over the
remaining bond term.
December 31, 2022—To record interest payment on bonds
2360 1110 2470
Interest Expense ($784 3 60%)�� 470
Cash Discount on BP
4,040 184 74 Discount on Bonds Payable ($184 3 60%)�� 110
360 110
Interest Exp Cash ($600 3 60%) �� 360
470
December 31, 2022—To record retirement of remaining bonds at maturity

26,000
Cash
26,000
Bonds Payable
Bonds Payable�� 6,000
4,040
360
4,000
6,000
10,000 Cash ($10,000 3 60%)�� 6,000
6,000
0
Example Three: Extinguishment of Debt Before Maturity with Refunding

On January 1, 2020, Frazier Inc. issues $10,000 of 10-year, 5% bonds at face value with cash
interest payable each June 30 and December 31. On January 1, 2024, Frazier Inc. retires the 5%
bond issue at 86, and immediately issues at face value, $8,600 of 20-year, 8% bonds with the same
interest dates as the 5% bonds. Record Frazier’s entry on January 1, 2024, to retire the 5% bonds
and issue the new 8% bonds.
Solution
January 1, 2024—To record retirement of the 5% bonds payable
28,600 210,000 11,400 Bonds Payable�� 10,000
Cash Bonds Payable
8,600 10,000 10,000 Bal.
Cash ($10,000 3 0.86)�� 8,600
Gain on Bond Ext Gain on Redemption of Bonds ($10,000 2 $8,600)�� 1,400
1,400
January 1, 2024—To record issuance of the 8% bonds payable

18,600
Cash
18,600
Bonds Payable
Cash�� 8,600
8,600 8,600 10,000 10,000 Bal.
8,600
REVIEW 16-7 LO16-7 Accounting for Extinguishment of Debt
Review On January 1, 2020, 5M Inc. issued $300,000 of bonds at 95. The bonds pay 5% cash interest semi-
annually on June 30 and December 31. The bonds are scheduled to mature on December 31, 2024.
MBC The company retired $30,000 of the bonds on October 1, 2020, when the bonds were selling at 89
plus accrued interest. Assume the straight-line interest method is used to amortize the bond discount.
Required
. Record the entry for the bond issuance on January 1, 2020.
a
b. Record the entry for the interest payment on June 30, 2020.
c. Provide the entry to recognize interest expense for the portion of the bond issue retired on
More Practice:
16‑43, 16‑71, 16‑72, 16‑73 October 1, 2020.
Solution on p. 16-74. d. Provide the entry to record the bond retirement on October 1, 2020.

Demo 16-10 LO16-10 Fair Value Option Accounting for Liabilities
Demo On January 1, 2020, Frazier Inc. issued three-year bonds to Seattle Corp. at face value for
$10,000, with cash interest payable annually on December 31 at 4%. On January 1, 2020, Frazier
MBC Inc. chooses to account for the bonds using the fair value option. The fair value of the bonds on
December 31, 2020, is $9,200 because the stated rate is now less than the market rate due to an
increase in the risk-free rate. (A market rate increase will cause comparable debt instruments to
now offer a higher interest rate.)
a. Record the adjusting entry on December 31, 2020, to adjust the bonds to fair value. Assume
that interest expense has been recorded in 2020.
b. Now assume that the bonds were originally issued at a discount to yield a market rate of 5%.
Record the adjusting entry on December 31, 2020, to adjust the bonds to fair value. Assume
that interest expense has been recorded in 2020. Hint: First compute the amortized cost of
the bonds using the effective interest method.
Solution
a. Fair Value Adjustment—Bond Issued at Face Value
At December 31, 2020, the year-end adjusting entry adjusts the bonds to the fair value of
$9,200. Because the change in fair value is attributed to an increase in the risk-free rate, net
income will be adjusted.
December 31, 2020—To record fair value option adjustment and the net unrealized gain
FVA—BP
2800 1800
Unreal Gain—Inc
Fair Value Adjustment—Bond Payable ($10,000 2 $9,200)�� 800
800 800 Unrealized Gain or Loss—Income�� 800
. Fair Value Adjustment—Bond Issued at a Discount

b
The bonds originally sold at a price of $9,728 (PV(0.05,3,−400,−10000)). On December 31,
2020, the amortized cost of the bonds is $9,814 ($9,728 + ($486 − $400)). Frazier would
record an entry to adjust the bonds to fair value from amortized cost.
December 31, 2020—To record fair value option adjustment and the net unrealized gain
FVA—BP
2614 1614
Unreal Gain—Inc
Fair Value Adjustment—Bond Payable ($9,814 2 $9,200)�� 614
614 614 Unrealized Gain or Loss—Income�� 614
AIG Real World—Fair Value Option

American
International American International Group, Inc. (AIG), an insurance organization, reported the following related to
Group [AIG] its election of the fair value method in a recent Form 10-K.
Fair Value Measurements (excerpt)—Under the fair value option, we may elect to measure at fair value
financial assets and financial liabilities that are not otherwise required to be carried at fair value. Subsequent
changes in fair value for designated items are reported in earnings . . . The following table presents the gains
or losses recorded related to the eligible instruments for which we elected the fair value option:
Gain (Loss)
Years Ended December 31
(in millions) 2017 2016 2015
Liabilities:
Long-term debt�� $(49) $(9) $(38)
Other liabilities�� (2) — (3)
REVIEW 16-10 LO16-10 Accounting for Debt Using the Fair Value Option
Review On January 1, 2020, Frazier Inc. issued three-year bonds to Seattle Corp. at face value for $10,000,
MBC with cash interest payable annually on December 31 at 4%. On January 1, 2020, Frazier Inc. chooses
to account for the bonds using the fair value option. The fair value of the bonds on December 31,
More Practice:
16‑46, 16‑78, 16‑79, 16‑99
2020, is $8,000 because Frazier Inc. was in violation of a debt covenant. Record the adjusting entry
Solution on p. 16-75. on December 31, 2020.

© Cambridge Business Publishers Chapter 16 Long-Term Liabilities 16-46
Example Three: Restructuring of Debt at Less than Debt Carrying Value

Now let’s assume that on January 1, 2020, Debb and Credex agree to a debt restructure agree-
ment with the following provisions:
Face value of note is reduced to $400,000.
Accrued interest for 2019 is forgiven.
Maturity is extended to January 1, 2022 (a one-year extension).
Interest rate is reduced to 5%; interest payments are due December 31, 2020, and 2021.
Required
Record the entries for Debb (debtor) related to the debt restructuring on January 1, 2020.
Solution
The excess of the debt book value over the restructured cash flows is calculated as follows.
Book value of debt, January 1, 2020 ($500,000  $50,000)�� $550,000

Sum of restructured cash flows:
Face value payable, January 1, 2022 �� $400,000
December 31, 2020, interest payment (5%  $400,000) �� 20,000
December 31, 2021, interest payment (5%  $400,000) �� 20,000 440,000
Gain on structure for Debb (debtor)�� $110,000
Debb (debtor) will reduce the value of the interest payable and note payable by $110,000.
January 1, 2020—To record troubled debt restructure for Debb (debtor)
Note Payable�� 500,000 2500,000
250,000
1110,000
Interest Payable�� 50,000 Interest Payable

1440,000
Note Payable
Note Payable�� 440,000 50,000 50,000 Bal. 500,000 500,000 Bal.
440,000
Gain on Restructuring of Debt (to balance)�� 110,000 0
440,000
Gain—Debt Restr
110,000
Example Four: Restructuring of Debt when Restructured Payments Exceed Debt Carrying
Value
Let’s assume on January 1, 2020, Debb and Credex agree to a debt restructure agreement provid-
ing the following:
Accrued interest for 2019 is forgiven.
Maturity is extended to January 1, 2022 (a one-year extension), and regular interest payments
are required December 31, 2020, and 2021.
Required
Record the entries for Debb (debtor) related to the (1) debt restructuring on January 1, 2020, (2)
the interest payments on December 31, 2020, and 2021, and (3) the payment of the note on Janu-
ary 1, 2022.
Solution
The excess of the restructured cash flows over the debt book value is calculated as follows.
Sum of restructured cash flows

Face value payable, January 1, 2022 �� $500,000
December 31, 2020, interest payment (10%  $500,000) �� 50,000
December 31, 2021, interest payment (10%  $500,000) �� 50,000 $600,000
Less book value of debt, January 1, 2020�� 550,000
Excess of restructured cash flows over debt book value�� $ 50,000
Debb, the debtor, records no gain on the debt restructure. Instead, Debb computes a new effective
interest rate using the revised debt payment schedule and this rate is computed as follows.
RATE NPER PMT PV FV Excel Formula
Given ? 2 50,000 (550,000) 500,000 RATE(2,50000,550000,500000)
Solution 4.6487%
-550000
continued

Settlement of a Receivable If a receivable (such as a note receivable) is settled by the debtor

making a payment of cash, or transferring asset(s) or equity, the creditor will record the amounts at
fair value and record a loss on the settlement. The loss can be recorded as an offset to the allowance
for doubtful accounts.
Modification of Terms of a Receivable A creditor measures the loss on a receivable by dis-

counting the restructured future cash flows using the historical market rate of interest on the loan.
(This is the same procedure that we used to account for an impairment of receivables in LO 8-9
except now we have officially modified cash flows while with an impairment we used expected
future cash flows.)
310-40-35-12 The effective interest rate for a loan restructured in a troubled debt restructuring is based on the
original contractual rate, not the rate specified in the restructuring agreement. It has been indicated that a troubled
debt restructuring does not result in a new loan but rather represents part of a creditor’s ongoing effort to recover
its investment in the original loan. Therefore, the interest rate used to discount expected future cash flows on a
restructured loan shall be the same interest rate used to discount expected future cash flows on an impaired loan.
Debt Restructuring and Debt Settlement—CREDITOR Perspective LO16-12 Demo 16-12B
Refer to the information in Demo 16-12A, but now record the entries from the perspective of the Demo
creditor.
Example One: Settlement of Debt through Transfer of Assets
MBC
January 1, 2020—To record troubled debt restructure for Credex (creditor)
Land �� 100,000 1100,000
1250,000
2200,000
Building�� 250,000 2500,000

250,000
Settlement of Debt* (to balance) ��

Loss on Restructuring 200,000 Interest Receiv Note Receiv
Bal. 50,000 50,000 Bal. 500,000 500,000
Note Receivable �� 500,000 0 0
Interest Receivable ($500,000 3 10%) �� 50,000 Land

100,000
Building
250,000
Loss—Debt Restr
*Can also debit Bad Debt Expense or offset the Allowance for Doubtful Accounts 200,000
Example Two: Settlement of Debt through Transfer of Equity Interest

Investment in Common Stock (2,500 3 $60)�� 150,000 1150,000
2500,000
2400,000
Settlement of Debt* (to balance) ��

Loss on Restructuring 400,000
250,000
Interest Receiv Note Receiv

Note Receivable �� 500,000 Bal. 50,000 50,000 Bal. 500,000 500,000
0 0
Interest Receivable�� 50,000 Invest—CS Loss—Debt Restr
150,000 400,000
*The company can also debit Bad Debt Expense or offset the Allowance for Doubtful Accounts.
Example Three: Restructuring of Debt at Less than Debt Carrying Value

The creditor will treat the debt restructure as a loan impairment, which calls for a write-down of the
note to the present value of expected future cash flows discounted at the original market rate (10%).
The net carrying value of the note for Credex (creditor) after the restructure is calculated as follows:
RATE NPER PMT PV FV Excel Formula
Given 0.10 2 20,000 ? 400,000 PV(0.1,2,20000,400000)
Solution $(365,289)
Credex recognizes an immediate charge to bad debt expense of $184,711 ($550,000  $365,289)
and then recognizes interest at 10% over the remaining term of the restructure agreement using
the effective interest method.

Note Receivable �� 550,000 1550,000
2184,711
2184,711
Bad Debt Expense�� 184,711

250,000
2500,000
Allowance for Doubtful Accounts �� 184,711 Interest Receiv

Bal. 50,000 50,000
Note Receiv
Bal. 500,000 500,000
Interest Receivable�� 50,000 0
550,000
550,000
Note Receivable �� 500,000 AFDA Bad Debt Exp
184,711 184,711
continued

For the Yale Corporation bonds in Brief Exercise 16-34, show how the bonds and related accounts would be pre- Brief Exercise 16-36
sented on the balance sheet as of June 30, 2020. Reporting Bonds on the
Balance Sheet LO4
Yale Corporation issued to Zap Corporation $60,000, 8% (cash interest payable semiannually on June 30 and De- Brief Exercise 16-37
cember 31) 10-year bonds dated and sold on January 1, 2020. Assume that the company uses the effective interest Recording Debt
Issuance Costs LO4
amortization method and bond issuance costs are $1,500. If the bonds were sold to yield 9%, provide journal entries Hint: See Demo 16-4C
to be made at each of the following dates.
a. January 1, 2020, for issuance of bonds.
b. June 30, 2020, for the interest payment.
Lacey Corp. issued a three-year, $5,000 note with an 8% stated rate to Hayley Co. on January 1, 2020, and re- Brief Exercise 16-38
ceived cash of $5,000. The note requires semiannual interest payments on June 30 and December 31. Provide Recording Entries for
Note Payable LO6
journal entries to be made at each of the following dates. Hint: See Demo 16-6A
a. January 1, 2020, for issuance of the note.
b. June 30, 2020, for the interest payment.
On January 1, 2020, Landry Inc. issued a three-year, $5,000, zero-interest-bearing note to Dillon LLP, and re- Brief Exercise 16-39
ceived $4,198. The implied interest rate is 6% on this note transaction. Provide journal entries to be made at each Recording Entries for
Zero-Interest-Bearing
of the following dates. Note Payable LO6
a. January 1, 2020, for issuance of the note. Hint: See Demo 16-6A
b. December 31, 2020, for accrual of interest.
Fern Company purchased goods on January 1, 2020, and issued a two-year, $2,500 note with a 5% stated rate. The Brief Exercise 16-40
fair value of the goods is $2,366. The note requires annual interest payments on December 31. The market rate of Recording Entries for
Interest-Bearing Note
interest appropriate for this note is 8%. Provide journal entries to be made at each of the following dates. Payable LO6
a. January 1, 2020, for issuance of the note. Hint: See Demo 16-6B
b. December 31, 2020, for the interest payment.
On January 1, 2020, Allen Corp. issued a 3-year, zero-interest-bearing note payable for $10,000 to Town Corp. Brief Exercise 16-41
for a cash receipt of $10,000. In lieu of interest payments, Allen Corp. agreed to sell merchandise to Town Corp. Recording Entries
for Note Payable
at a discount and provide free shipping during the 3-year period. The appropriate market rate for this transaction Exchanged for
is 8%. Record the journal entry for Allen Corp. upon issuance of the note payable. Cash and Noncash
Consideration LO6
On January 1, 2020, a borrower signed a long-term note, face amount $50,000 with time to maturity of 6 years. Brief Exercise 16-42
The interest rate is 7% and equal annual installment payments will pay off the loan after six years. Computing Installment
Payment on Note
a. How much is each annual installment payment? Payable LO6
b. Record the first installment payment on December 31, 2020.
Darien Inc. redeemed $5,000 of its bonds at 102 on January 1, 2020. At this date, the unamortized discount was Brief Exercise 16-43
$690. Prepare the journal entry on January 1, 2020, for the bond redemption. Assume Darien has a December 31 Recording Bond
Redemption LO7
year-end and all adjusting entries were made. Hint: See Demo 16-7
Stonewall Corporation issued $20,000 of 5%, 10-year convertible bonds. Each $1,000 bond is convertible to 10 Brief Exercise 16-44
shares of common stock (par $50) of Stonewall Corporation. The bonds were sold at 105 on January 1, 2020. Recording the Issuance
of Convertible Bonds
Provide the entry for Stonewall Corporation on January 1, 2020, to record the issuance of the bonds. LO8
Hint: See Demo 16-8
On December 1, 2020, Junction Company issued at 104, 4,000 of its 9%, 10-year, $1,000 par value, nonconvert- Brief Exercise 16-45
ible bonds with detachable stock purchase warrants. Each bond carried two detachable warrants; each warrant Recording the
Issuance of Bonds with
was for one share of common stock at a specified option price of $15 per share. Shortly after issuance, the war- Detachable Warrants
rants were quoted on the market for $3 each. No fair value can be determined for the bonds without the warrants. LO9
Interest is payable on December 1 and June 1. Provide the entry to record issuance of the bonds by Junction Hint: See Demo 16-9
Company on December 1, 2020.
Josie Corporation issued 10-year, 8% interest-bearing bonds payable at face value for $10,000 on January 1, Brief Exercise 16-46
2020. At that time, Josie Corporation elected to account for the bonds payable using the fair value option method. Adjusting Bonds
Payable Under the Fair
At December 31, 2020, the fair value of the bonds payable was $9,900 due to an increase in Josie Corporation’s Value Option LO10
borrowing rate because of general market risk.

On May 1, 2020, Setup Inc. sold an issue of 5%, $1,000 bonds dated January 1, 2020, to yield 5%. The bonds pay Exercise 16-52
interest every June 30 and December 31, and mature December 31, 2024. Recording Entries for
Bonds Sold Between
Required Interest Dates LO2, 3
a. Provide journal entries to be made by Setup Inc. at each of the following dates.
1. May 1, 2020, bond issuance.
2. June 30, 2020, first interest payment.
b. Indicate the amount of interest expense to be recorded in the income statement of Setup Inc. for the six
months ended June 30, 2020.
On October 1, 2020, New Co. issued an eight-year, 6%, $1,000 bond at face value, with cash interest payable Exercise 16-53
semiannually on April 1 and October 1. Recording Journal
Entries for At-Par-
Required Bonds LO2, 3
Provide journal entries to be made by New Co. at each of the following dates.
a. October 1, 2020—Issuance.
b. December 31, 2020—Interest expense adjusting entry.
c. April 1, 2021—Interest payment.
On January 1, 2020, Williams Inc. issued 8-year, $50,000, 5% bonds, priced to yield 6%, with cash interest pay- Exercise 16-54
able semiannually on June 30 and December 31. The company amortizes the bond discount using the effective Preparing an
Amortization
interest method. Schedule—Effective
Interest Method LO4
Required
Provide an amortization schedule of interest and discount amortization for the 8-year bond term. Round amounts
to two decimals.
On January 1, 2020, Williams Inc. issued 8-year, $50,000, 5% bonds, priced to yield 6%, with cash interest pay- Exercise 16-55
able semiannually on June 30 and December 31. The company amortizes the bond discount using the straight- Preparing an
Amortization Schedule
line interest method. —Straight-Line Interest
Method LO4
Required Hint: See Demo 16-4B
Provide an amortization schedule of interest and discount amortization for the 8-year bond term. Round amounts
to two decimals.
Mitchell Inc. issued 40, 6%, $1,000 bonds on January 1, 2020, for $38,950. The bonds pay cash interest annually Exercise 16-56
each December 31 and were issued to yield 7%. The bonds mature December 31, 2022, and the company uses Recording Bond
Entries and Preparing
the effective interest method to amortize bond discounts or premiums. an Amortization
Schedule—Effective
Required interest method,
a. Prepare an amortization schedule for the full bond term. Round amounts to the nearest dollar. Discount LO4
b. Prepare journal entries on the following dates.
1. January 1, 2020, bond issuance.
2. December 31, 2020, interest payment.
c. Explain why, in economic terms, the interest expense recognized each year exceeds the cash interest paid.
Mitchell Inc. issued 40, 6%, $1,000 bonds on January 1, 2020. The bonds pay cash interest semiannually each Exercise 16-57
July 1, and December 31, and were issued to yield 7%. The bonds mature December 31, 2022, and the company Recording Bond
uses the effective interest method to amortize bond discounts or premiums. an Amortization
Schedule—Effective
Required interest method,
a. Determine the selling price of the bonds. Discount LO4
b. Prepare an amortization schedule for the full bond term. Hint: See Demo 16-4A
c. Prepare journal entries on the following dates.

2. July 1, 2020, interest payment.
3. December 31, 2020, interest payment.

Mitchell Inc., issued 70, 6%, $1,000 bonds on January 1, 2020. The bonds pay cash interest annually each Janu- Exercise 16-63
ary 1 (beginning January 1, 2021), and were issued to yield 4%. The bonds mature January 1, 2030, and the com- Recording Bond
pany will use the straight-line interest method to amortize the bond discount or premium. Assume that the differ- an Amortization
ence between the effective interest method and the straight-line interest method is not material. Schedule—Straight-
Line Interest Method,
Required Premium LO5
a. Determine the selling price of the bonds.
b. Prepare an amortization schedule for the full bond term.
c. Prepare journal entries on the following dates.
2. December 31, 2020, interest accrual.
3. January 1, 2021, interest payment.
Master Corp. issued 5%, $300,000 bonds on January 1, 2020. The bonds pay cash interest semiannually each Exercise 16-64
July 1 and January 1, and were issued to yield 6%. The bonds mature January 1, 2030, and the company uses the Recording Bond Entries
and Reporting Bonds—
effective interest method to amortize bond discounts or premiums. Effective Interest,
Straight-Line LO4
Required
a. Prepare journal entries on the following dates.
1. January 1, 2020—Issuance of bonds.
2. July 1, 2020—Interest payment.
3. December 31, 2020—Interest accrual.
4. January 1, 2021—Interest payment.
b. Answer part a assuming instead that the company uses the straight-line interest method to amortize dis-
counts and premiums and the bonds were sold on March 1, 2020, for $277,482 (excluding accrued interest).
Hint: Amortize discount on bonds payable over a 118 month bond term.
Master Corp. issued 8%, $80,000 bonds on February 1, 2020. The bonds pay interest semiannually each July 31 Exercise 16-65
and January 31 and were issued to yield 7%. The bonds mature January 31, 2030, and the company uses the ef- Recording Bond Entries
and Reporting Bonds—
fective interest method to amortize bond discounts or premiums. Effective interest
method, Straight-Line
Required LO5
a. Prepare journal entries on the following dates.
1. February 1, 2020—Issuance of bonds.
2. July 31, 2020—Interest payment.
3. December 31, 2020—Interest accrual.
4. January 31, 2021—Interest payment.
b. Indicate how the balance sheet as of December 31, 2020, and 2020 income statement for Master Corp.
would reflect these transactions.
c. What is the total cost of financing assuming that the bonds remain outstanding for the full term?
d. What is the total cost of financing assuming that the bonds remain outstanding for the full term if instead,
the straight-line interest method was used to amortize the premium?
e. If the company were to have instead amortized the premium using the straight-line interest method, would
interest expense recognized be lower or higher in 2020?
f. If the company were to have instead amortized the premium using the straight-line interest method, would
interest expense recognized be lower or higher in 2030?
For the following separate bond issues, assume that the bonds are sold on January 1, 2020, interest is paid semi- Exercise 16-66
annually on July 1 and December 31, and the bond term is 5 years. Computing Amounts
under Effective Interest
and Straight-Line
Face Value Stated Market Amortization Bond Selling Interest Interest Interest Methods LO2,
Case of Bonds Rate Rate Method Price Expense 2020 Paid 2020 4, 5
1�� $ 10,000 5% 6% Effective interest
2�� 40,000 4% 5% Effective interest
3�� 130,000 5% 4% Straight-line
4�� 500,000 0% 7% Straight-line
5�� 80,000 7% 6% Effective interest
6�� 100,000 6% 8% Straight-line

d. Provide the entry to record the bond retirement on September 1, 2020.
On January 1, 2020, Rocket Corporation issued $250,000 of 6%, 20-year bonds at 98. The interest is payable Exercise 16-72
each December 31. Rocket uses straight-line amortization. The company’s accounting period ends December 31. Recording the
Refunding of Long-Term
On January 1, 2029, Rocket issued $250,000, 5% 20-year, refunding bonds at par. On this date, the old 6% Debt LO7
bonds could be purchased in the open market at 102. Rocket immediately purchased all of the 6% bonds.
Required
a. Provide the entry for issuance of the 6% bonds on January 1, 2020.
b. Provide the entry for issuance of the 5% bonds on January 1, 2029.
c. Provide the entry to record the extinguishment of the old bonds on January 1, 2029.
Dillon Corp. issued $100,000 of 6% (cash payable each December 31), 10-year bonds on January 1, 2020. The Exercise 16-73
bonds are callable at any point after 2024 at 103. The bonds sold on January 1, 2020, at 98. Straight-line amor- Recording the
Refunding of Long-Term
tization of bond discounts and premiums is used. Due to a drop in interest rates, Dillon decided to call in half of Debt LO7
the bonds and issue a new series of bonds in the amount of $50,000 (5% cash interest annually, five-year term)
on January 1, 2025, at par.
Required
a. Provide the entry for issuance of the 6% bonds on January 1, 2020.
b. Provide the entry for issuance of the 5% bonds on January 1, 2025.
c. Provide the entry for redemption of the 6% bonds on January 1, 2025.
Stonewall Corporation issued $20,000 of 5%, 10-year convertible bonds. Each $1,000 bond is convertible to 10 Exercise 16-74
shares of common stock (par $50) of Stonewall Corporation. The bonds were sold at 105 on January 1, 2020. Recording Entries for
Convertible Bonds
Required LO8
Hint: See Demo 16-8
a. Provide the entry for Stonewall Corporation on January 1, 2020, for the bond issuance.
b. Provide entries for Stonewall Corporation assuming that the conversion privilege is subsequently exercised
immediately after the end of the third year. Assume that at the date of conversion, 30% of any premium or dis-
count has been amortized and the common stock was selling at $125 per share. Use the book value method.
On January 1, 2020, Sierra Corp. issued 500, $1,000, 6% convertible bonds at face value. Each bond is convert- Exercise 16-75
ible into 15 shares of $1 par value common stock. As an inducement to convert the bonds into common stock in Recording Entries for
Convertible Bonds
2022 prompted by a drop in interest rates, the company offered $35,000 to bondholders, payable upon conver- LO8
sion. All of the bondholders converted to common stock in June of 2022. Hint: See Demo 16-8
Required
a. Provide the entry for issuance of bonds on January 1, 2020.
b. Provide the entry for Sierra Corp. for conversion of the bonds in June of 2022, using the book value method.
Harley Corporation issued $75,000 of 6%, 10-year, nonconvertible bonds with detachable stock purchase war- Exercise 16-76
rants. Each $1,000 bond carried 20 detachable warrants, each of which was for one share of Harley common Recording Entries for
Bonds with Warrants
stock, par $20, at a specified exercise price of $60. The bonds sold at 102 including the warrants (no bond price LO9
without warrants was available), and immediately after the date of issuance, the detachable stock purchase war-
rants were selling at $4 each. All indicated transactions occurred in the same fiscal year.
Required
a. Provide the entry for the issuer at the date of issuance of the bonds.
b. Provide the entry for Harley assuming subsequent tender of all of the warrants by the investors for exercise
at the specified exercise price. At this date, the stock was selling at $75 per share.
On July 1, 2020, Salem Corporation issued $2,000,000 of 7% bonds due in 10 years. The bonds pay cash interest Exercise 16-77
semiannually. Each $1,000 bond includes a detachable stock purchase warrant. Each warrant gives the bondhold- Recording Entries for
Bonds with Warrants
er the right to purchase, for $30, one share of $1 par value common stock at any time during the next 10 years. LO9
The bonds were sold at 101. The value of the stock purchase warrants at the time of issuance was $100,000. The
bonds would sell without warrants at $1,940,000.
Required
a. Record the entry for issuance of bonds using the proportional method.
b. Record the entry for issuance of bonds assuming instead that the warrants are not detachable.

December 31, 2021—To record payment of interest plus principal

219,056
Cash
216,337 22,719
Note Payable
Interest Expense ($33,981 3 8%) (amount rounded)�� 2,719
100,000
19,056
15,127
16,337
49,108 Note Payable�� 16,337
19,056
Interest Exp Cash�� 19,056
3,929
December 31, 2022—To record payment of interest plus principal

2,719

219,056
Cash
217,644 21,412
Note Payable
Interest Expense ($17,644 3 8%)�� 1,412
100,000
19,056
15,127
16,337
49,108 Note Payable�� 17,644
19,056
19,056
17,644
0
Cash�� 19,056
Interest Exp
3,929 *Amount rounded
2,719
1,412
Review 16-7
a. January 1, 2020—To record bond issuance
1285,000 215,000
1300,000
Cash ($300,000 3 0.95)�� 285,000
Cash Bonds Payable Discount on Bonds Payable ($300,000 2 $285,000)�� 15,000
285,000 300,000
Discount on BP Bonds Payable�� 300,000
15,000
b. June 30, 2020—To record payment of interest

27,500 11,500 29,000
Interest Expense �� 9,000
Cash Discount on BP
285,000 7,500 15,000 1,500 Discount on Bonds Payable ($15,000/10) �� 1,500
Interest Exp
9,000
Cash ($300,000 3 5%/2) �� 7,500
c. October 1, 2020—To record payment of interest

2375
Cash
175 2450
Discount on BP
Interest Expense �� 450
285,000 7,500
375
15,000 1,500
75
Discount on Bonds Payable ($15,000/60 3 3 3 0.10)�� 75
Interest Exp Cash ($30,000 3 5% 3 3/12)�� 375
9,000
450
d. October 1, 2020—To record bond extinguishment

Assets 5
226,700
Liabilities 1
230,000
Equity
12,025
Discount on Bonds Payable ($15,000/60 3 51 3 0.10)�� 1,275
11,275
Cash Bonds Payable
285,000 7,500
375
30,000 300,000 Cash ($30,000 3 0.89)�� 26,700
26,700 Discount on BP
Gain on Bond Ext 15,000 1,500
Gain on Redemption of Bonds ([$30,000 2 $1,275] 2 $26,700)�� 2,025
75
2,025 1,275
Review 16-8
a. January 1, 2020—To record bond issuance
1196,000 24,000
1200,000
Cash ($200,000 3 0.98)�� 196,000
Cash Bonds Payable Discount on Bonds Payable ($200,000 2 $196,000)�� 4,000
196,000 200,000
Discount on BP
4,000
b. December 31, 2021—To record conversion of bonds to common stock

2100,000
11,200
1500
198,300 Bonds Payable ($200,000 3 0.50)�� 100,000
Bonds Payable
100,000 200,000
Common Stock
500
Discount on Bonds Payable ($4,000 3 0.60 3 0.50)�� 1,200
Discount on BP Paid in Cap—CS Common Stock ($100,000/$1,000 3 5 shares 3 $1 par)�� 500
4,000 1,200 98,300
Paid-in Capital in Excess of Par—Common Stock (to balance)�� 98,300
Review 16-9
a. To record issuance of bonds with nondetachable warrants
1102,000 1100,000
12,000
Cash ($100,000 3 1.02)�� 102,000
Cash Bonds Payable Premium on Bonds Payable ($102,000 2 $100,000)�� 2,000
102,000 100,000
Premium on BP Bonds Payable�� 100,000
2,000

b. To record issuance of bonds with detachable warrants

Cash ($100,000 3 1.02)�� 102,000 1102,000 23,000
1100,000
15,000
Discount on Bonds Payable ($100,000 1 $5,000 2 $102,000)�� 3,000 102,000

Cash Bonds Payable
100,000
Paid-in Capital—Stock Warrants ($100,000/$1,000 3 10 3 $5)�� 5,000 Discount on BP Paid in Cap—War
Bonds Payable�� 100,000 3,000 5,000
Review 16-10
December 31, 2020—To record fair value option adjustment
Fair Value Adjustment—Bond Payable �� 2,000 FVA—BP
22,000 12,000
Unreal Gain—OCI
Unrealized Gain or Loss—OCI �� 2,000 2,000 2,000
Review 16-11
a. 2.76 b. 0.73 c. 11.77
Review 16-12
Example One
January 1, 2020—Debtor: To record asset appreciation
Equipment�� 4,000 14,000 14,000
Equipment Gain on Disposal

Gain on Disposal ($32,000 2 $28,000)�� 4,000 Bal. 50,000 4,000
4,000
January 1, 2020—Debtor: To record settlement of debt through asset transfer Assets 5 Liabilities 1 Equity
122,000 235,000 13,000
Note Payable�� 35,000 254,000
Equipment Note Payable
Accumulated Depreciation�� 22,000 Bal. 50,000 54,000

4,000
35,000 35,000 Bal.
Equipment�� 54,000 0 0
Accum Deprec Gain on Debt Restr
Settlement of Debt��
Gain on Restructuring 3,000 22,000 22,000 Bal. 3,000
Example Two
January 1, 2020—Debtor: To record settlement of debt through transfer of equity interest
Note Payable�� 35,000

235,000 13,000
127,000
15,000
Common Stock ($1 3 3,000 shares)�� 3,000 Note Payable Gain on Debt Restr
Paid-in Capital in Excess of Par—Common Stock ($30,000 2 $3,000) 27,000 35,000 35,000 Bal. 5,000
Settlement of Debt (to balance)��

0
Gain on Restructuring 5,000 Common Stock Paid in Cap—CS
3,000 27,000
Example Three
Book value of debt�� $35,000

Sum of restructured cash flows:
Face value payable�� $25,000
Interest payments (2 × $25,000 × 5%) �� 2,500 27,500
Gain on restructure�� $ 7,500
January 1, 2020—Debtor: To record restructuring of debt at less than debt book value
Note Payable�� 35,000 235,000
127,500
17,500
Note Payable (restructured) �� 27,500 Note Payable Gain on Debt Restr
35,000 35,000 Bal. 7,500
Gain on Restructuring of Debt�� 7,500 27,500
27,500
Example Four
There is no entry by the debtor because the value of the restructured note ($35,400 or $30,000 plus
interest of $5,400 (= $30,000 × 9% × 2)) exceeds the book value of the debt.

17-41 Chapter 17 Accounting for Leases © Cambridge Business Publishers
Operating Lease Finance Lease
Interest Amortization of
Lease Expense Expense Right-of-Use Asset Total
2020�� $ 33,512 $3,251 $31,873 $ 35,124

2021�� 33,512 1,666 31,873 33,539
2022�� 33,512 — 31,873 31,873
$100,536 $4,917 $95,619 $100,536
Because the amortization of the right-of-use asset differs, the net balance in the right-of-use asset for
the first two years also differs as follows.
Operating Lease Finance Lease

Right-of-Use Asset Right-of-Use Asset
Dec. 31, 2020 �� $65,358 $63,746

Dec. 31, 2021 �� 33,512 31,873
Dec. 31, 2022 �� 0 0
EXPANDING YOUR KNOWLEDGE Leases and Statement of Cash Flows

On the statement of cash flows for an operating lease, the full lease payment is classified as an outflow from operating
activities. Because the full lease payment is reported as expense each period, the cash outflows related to the full lease
payment are incorporated into cash flows from operating activities. However, for a finance lease, only the interest portion
of the lease payment is included in expense, and thus only the cash outflows related to interest are incorporated into cash
flows from operating activities. The reduction in principal is reported as an outflow for financing activities. For a lessor,
lease cash receipts are treated as a cash inflow from operating activities.
Guaranteed Residual Let’s assume that the residual was guaranteed in Demo 17-4B. As you may
recall, a guaranteed residual value is considered an additional payment by the lessee. Therefore, the
present value of lease payments criterion would be reevaluated for the lease classification test.
RATE NPER PMT PV FV Excel Formula Present value of lease payments criterion:
Given 5% 32 (34,972.07) ? =PV(0.05,3,-34972.07,-57882,1)
(57,882) PV(0.05,2,34972.07,57882) $145,000 $150,000 plus lease prepayment of $34,972 less
$147,500 (PV of lease payments of $117,528
Solution $150,000
$117,528 lease incentive of $5,000) . $135,000 (90% of the fair value of $150,000)
Because the present value of the lease payments is greater than 90% of the fair value of the asset, the
lease would be considered a finance lease, not an operating lease, for the lessee.
REVIEW 17-4 LO17-4 Accounting for Operating Lease by Lessee
Review On January 1, 2020, Lessee Inc. signed a ten-year lease for office space for $75,000 annually, with
the first payment due immediately. Lessee Inc. has the option to renew the lease for an additional
MBC four-year period on or before January 1, 2030, at market lease rates at the time of renewal. Lessee
Inc. intends to evaluate rental options at the time of the option to renew. The economic life of the
rental space is 30 years and the fair value of the rental space is $1 million. Lessee Inc. is not aware
of the implicit rate of the lease but has an incremental borrowing rate of 6%. Lessee Inc. paid $1,000
on January 1, 2020, in initial direct costs.
.
a How would Lessee Inc. classify the lease?
b. Prepare an amortization schedule for the lease liability.
More Practice: c. Prepare an amortization schedule for the right-of-use asset.
17-44, 17-45, 17-46, 17-47,
17-76, 17-77, 17-78, 17-79 d. Prepare the entries for Lessee Inc. for years 2020 and 2021, to record the right-of-use asset
Solution on p. 17-84. and lease liability, to record the lease payments, and to record lease expense.

© Cambridge Business Publishers Chapter 17 Accounting for Leases 17-56
c. Merill’s journal entry—December 31, 2020

On December 31, 2020, Merill Inc. records the following entries related to the first lease
payment obtained from the partial amortizations schedules included below.
December 31, 2020—To record lease expense
Lease Expense�� 16,890 211,495
R-of-U Asset
15,395 216,890
Lease Liab
Lease Liability �� 5,395 67,437 11,495 67,437
5,395
Right-of-Use Asset�� 11,495 55,942
Lease Exp
16,890
December 31, 2020—To record lease payment

Lease Liability �� 16,980 216,980 216,980

Cash Lease Liab
Cash�� 16,980 95,000 16,980 16,980 67,437
5,395
Lease Liability Amortization Schedule (Partial) 55,942
Lease Interest on Lease Liability Net Lease

Date Payment Liability Reduction Liability
Jan. 1, 2020 �� $67,437
Dec. 31, 2020 �� $16,890 $5,395 $11,495 55,942
Right-of-Use Asset Amortization Schedule (Partial)
Lease Expense Interest on Right-of-Use Asset Net Right-of-Use

Date Straight-Line Liability Amortization Asset
Jan. 1, 2020 �� $67,437
Dec. 31, 2020 �� $16,890 $5,395 $11,495 55,942
Example Two—To Record a Failed Sale

Let’s assume the same circumstances as Example One, except that the lease term is 8 years and
the payments are now $16,531.40. Answer the following questions from the perspective of Merill Co.
a. Determine the appropriate lease classification.
b. Prepare Merill’s journal entry at January 1, 2020.
c. Prepare Merill’s journal entry at December 31, 2020.
Solution
a. Lease Classification
Lease Classification Lease

Criteria Analysis Criteria Met
1 Ownership transfer Asset reverts to the lessor at the end of the five-year period.
2 Purchase option Lease does not contain a purchase option.
3 Lease term length Length of the lease is 80% of the economic life of warehouse. ✔
4 PV of lease payments $95,000 (PV of lease payments)  $85,500 (90% of fair value of $95,000).
RATE NPER PMT PV Excel Formula
Given 8% 8 (16,531.40) ? PV(0.08,8,14651)
Solution $95,000
5 Alternative use There are alternative uses for the warehouse.
The lease qualifies as a finance lease because two lease criteria are met. This qualification as
a finance lease precludes the recording of a sale of the warehouse to Leasing Solutions Inc.
Thus, this transaction will be recorded similarly to a loan.
b. Merill’s journal entry—January 1, 2020
For a failed sale, the transaction results in the recording of a note payable by Merill.
continued

1 7-13. How does a lessee derecognize a right-of-use asset and lease liability over the term of a finance lease?
17-14. If a lessee records a right-of-use asset related to a finance lease, over what period would the lessee
recognize amortization expense? What conditions impact your answer?
1 7-15. How does a lessor account for an operating lease?
17-16. How does a lessor account for a sales-type lease?
17-17. If a lessor determines that payments from a lessee pertaining to a sales-type lease are not probable,
how would the lessor account for the lease?
1 7-18. What qualifies as a short-term lease and how would a lessee account for a short-term lease?
17-19. What determines whether a lease modification results in a separate lease or in a modification of an
existing lease?
17-20. What types of qualitative information should be disclosed about a company’s leases?
Brief Exercises
On January 1, 2020, Lessee Company leases equipment with a fair value of $2,000 from Lessor Company for 3 Brief Exercise 17-21
years, with no renewal options. The estimated life of the equipment is 5 years and there is no purchase option at Classifying Leases
LO1
the end of the lease term. The annual lease payment is $700, which includes a $50 charge for an annual mainte-
nance contract. The first payment is due immediately. Lessee Company’s incremental borrowing rate is 6% and
the lessee is not readily able to determine the lessor’s implicit interest rate. Title to the equipment remains with
the lessor at lease end and the lessee does not guarantee the residual value at lease end.
a. Determine the classification of the lease for Lessee Company.
b. Determine the classification of the lease for Lessor Company.
On January 1, 2020, Lessee Company leases a vehicle with a fair value of $30,000 from Lessor Company for 3 Brief Exercise 17-22
years, with no renewal options. The estimated life of the vehicle is 6 years and Lessee Company has an option Classifying Leases
LO1
to purchase the vehicle at lease end at the vehicle’s fair value which the lessee is not expected to exercise. The
monthly lease payment is $520, with the first payment due immediately. Lessee Company’s incremental borrow-
ing rate is 6% and the lessee is not readily able to determine the lessor’s implicit interest rate. Title to the equip-
ment remains with the lessor at lease end and the lessee does not guarantee the residual value at lease end. Lessee
Company will pay for the maintenance of the vehicle separately from the lease.
a. Determine the classification of the lease for Lessee Company.
b. Determine the classification of the lease for Lessor Company.
A lessee is evaluating whether a lease term is a major part of the remaining life of an asset in order to determine Brief Exercise 17-23
the proper lease classification. The lessee leases office space through a lease with a 10-year term. The lease has a Classifying Leases
LO1
renewal option for an additional 5 years at a rental price that is adjusted to market at time of renewal. The office
building has a remaining useful life of 20 years from the commencement of the lease. The lessee plans to make
a significant investment in leasehold improvements (useful life of 15 years) at the commencement of the lease.
Based on this information only, how would the lessee classify this lease?
For each of the following four separate finance lease scenarios, determine the lease payment that the lessee Brief Exercise 17-24
should use to determine the appropriate lease classification. Identifying Lease
Payments LO1
a. Lease payments are $3,000 per month plus 5% of lessee net sales. Lessee sales for year one are estimated to
be $100,000.
b. Lease payments are computed as the greater of (a) 5% of lessee net sales or (b) $3,000. Lessee sales for year
one are estimated to be $100,000.
c. Annual lease payments are 10% of lessee annual sales, with no fixed portion. Lessee sales for year one are
estimated to be $100,000.
d. Lease payments total $5,000 in year one and increase each year based on the annual increase in the CPI at
the end of the preceding year. The CPI at the end of the current year is expected to be 2%.
For each of the following three separate finance lease scenarios, determine the lease payment that the lessee Brief Exercise 17-25
should use to determine the appropriate lease classification. Identifying Lease
Payments LO1
a. An annual lease payment for equipment was $50,000 and included a fee of $5,000 for maintenance of the
equipment.

Brief Exercise 17-44 Solutions Inc. signs a 10-year lease for a building owned by Property Inc. that is appropriately classified as an op-
Reporting Operating erating lease by both the lessee and lessor. Lease payments are $150,000 per year. The building has an estimated
Lease LO4
Hint: See Demo 17-4A useful life of 30 years with no salvage value. What amount would Solutions Inc. report in its income statement
(ignoring taxes) for the year ended December 31, 2020?
Brief Exercise 17-45 Gomez Inc. leases a vehicle from CareMax Inc. on January 1, 2020, for a three-year period, appropriately classi-
Recording Operating fied by Gomez Inc. as an operating lease. Gomez agrees to make $6,000 annual payments beginning on January
Lease Journal Entries—
Lessee LO4 1, 2020. Prepare the journal entries for Gomez in 2020 assuming that Gomez is aware of the rate implicit in the
Hint: See Demo 17-4A lease of 6%.
a. January 1, 2020—Record the right-of-use asset.
b. January 1, 2020—Record the lease payment.
c. December 31, 2020—Record the adjusting entry.
Brief Exercise 17-46 Lessor Co. enters into an operating lease of property with Lessee Co. on January 1, 2020, for a five-year term at
Recording Operating an annual fixed lease payment of $10,000 (beginning of period payments). Prepare the journal entries in 2020 for
Lease Journal Entries—
Lessee LO4 the lessee assuming that the lessee is aware of the rate implicit in the lease of 5%.
Hint: See Demo 17-4A a. January 1, 2020—Record the right-of-use asset.
b. January 1, 2020—Record the lease payment.
c. December 31, 2020—Record the adjusting entry.
Brief Exercise 17-47 Kulver’s Inc. leases equipment from Equip Inc. on January 1, 2020, under a 3-year operating lease. Kulver’s
Determining Amounts in agrees to pay Equip Inc. $15,000 annually with the first payment due on January 1, 2020. As an incentive for
Operating Lease LO4
Hint: See Demo 17-4B Kulver’s to sign the lease by January 1, Equip Inc. paid Kulver’s Inc. $700. Kulver’s also incurred legal fees for
the review of the lease agreement ($200) and salaries for employees involved in negotiating the lease ($1,300).
Assuming an incremental borrowing rate of 7% for Kulver’s Inc., determine the value of the lease liability and
the right-of-use asset on January 1, 2020, for Kulver’s.
Brief Exercise 17-48 Referring to the information in Brief Exercise 17-44, and assuming that the building has a fair value of $2,000,000
Reporting Operating at the commencement of the lease, what amounts would Property Inc. recognize in its income statement (ignor-
Lease—Lessor LO5
Hint: See Demo 17-5 ing taxes) for the year ended December 31, 2020? Assume that Property Inc. is using the straight-line method to
depreciate buildings.
Brief Exercise 17-49 Referring to the information in Brief Exercise 17-45, prepare the journal entries in 2020 for CareMax Inc. assum-
Recording Operating ing that the fair value of the vehicle is $28,000 and it has a useful life of 6 years with no salvage value (depreci-
Lease—Lessor LO5
Hint: See Demo 17-5 ated using the straight-line method).
Brief Exercise 17-50 Universal Inc. signed a contract to lease equipment for a 4-year term on January 1, 2020, for $20,000 annually
Remeasuring a Lease beginning immediately. The lease included a purchase option at the end of the lease for $8,000, that at the com-
Liability LO6
Hint: See Demo 17-6 mencement of the lease, Universal did not believe would exercise. However, on December 31, 2021, two years
later, circumstances had changed causing Universal to now reasonably expect to exercise the option. Universal’s
incremental borrowing rate changes from 5% at the lease commencement date to 7% currently. The incremental
borrowing rate at lease commencement did not reflect the purchase option. On December 31, 2021, the lease li-
ability and right-of-use asset had balances of $37,188 and $37,233, respectively. What is the adjusted lease li-
ability on December 31, 2021?
Brief Exercise 17-51 On January 1, 2020, Baker Inc. enters into an operating lease of equipment for one year for $1,000 per month on
Recording Entries for January 1, 2020. The equipment cost $200,000 and has a useful life of 10 years. Assuming that Baker Inc. elects
Short-Term Leases
LO7 to account for the lease under the short-term lease option, prepare Baker’s monthly entry for 2020 assuming pay-
Hint: See Demo 17-7 ments are made at the end of each month.
Exercises
Exercise 17-52 Tropical Products Inc. is in the process of negotiating a lease of equipment with a fair value of $50,000, and it
Classifying Leases must determine the proper lease classification. The following table describes four scenarios under negotiation.
LO1

Exercise 17-56 On December 30, 2019, Drew Company leased equipment under a lease for a period of 5 years. Drew contracted
Recording Entries for to pay $90,000 on December 31, 2019, with an annual increase of 3% (calculated on the previous year’s lease
Finance Lease—No
Residual, Payments payment) for each of the next four years due on December 31. The leased equipment has a useful life of 7 years,
Increase at a Defined a fair value of $450,000, and the interest rate implicit in the lease is 8% and is known to Drew Company.
Rate LO2
Required
a. How would Drew Company classify the lease?
b. Prepare an amortization schedule of the lease liability.
2019,and
c. Prepare the entries for Drew Company for years 2020 2020, and 2021.
2021.
Exercise 17-57 On January 1, 2020, Alex Company signed a 5-year lease contract for equipment with Abel Company. The
Reporting Finance equipment had a normal selling price of $55,000 and an estimated useful life of 6 years. Five annual payments
Lease, Unguaranteed
Residual—Lessee of $11,815 are payable by Abel on January 1, beginning in 2020. The asset reverts to Alex at the end of the lease
LO2 2024, and is estimated to have an unguaranteed residual value on that date of $3,000. Alex’s
term, December 31, 2022,
implicit interest rate is 6%, which is known to Abel.
Required
a. How would Abel Company classify the lease?
c. Prepare the entries for Abel Company for 2020.
Exercise 17-58 Assume the same information in Exercise 17-57 except that the lessee also paid legal fees in the execution of the
Recording Finance lease of $1,800 on January 1, 2020.
Lease, Unguaranteed
Residual, Initial Direct Required
Costs—Lessee LO2
a. How would Abel Company classify the lease?
c. Prepare the entries for Abel Company for 2020.
Exercise 17-59 Mac Leasing Company (lessor) and Ash Corporation (lessee) signed a four-year lease on January 1, 2020. The
Reporting Finance underlying asset has an estimated life of six years, and the property reverts to Mac at the end of the lease term.
Lease, Guaranteed
Residual—Lessee Lease payments of $11,923 are payable on January 1 of each year and were set to yield Mac a return of 8%, which
LO2 was known to Ash. The estimated residual value at the end of the lease term is $10,000 and is guaranteed by Ash
Hint: See Demo 17-2B Corporation. Ash expects the estimated residual value at the end of the lease term to be $10,000. The lease con-
tains no purchase option.
Required
a. How would Ash Corporation classify the lease?
c. Prepare the entries for Ash Corporation for 2020.
d. Let’s now assume that Ash Corporation expects the estimated residual value at the end of the lease term to
be $3,500 instead. Prepare the entries for Ash Corporation for 2020.
Exercise 17-60 On the first day of its accounting year, January 1, 2020, Lessee Inc. leased a building at an annual payment of
Reporting Finance $138,847.84 to be paid at the beginning of each year for 10 years. The first payment was paid immediately. The
Lease, Guaranteed
Residual—Lessee building, which is new, cost $1,100,000 and has an estimated useful life of 12 years. The lessor’s implicit rate
LO2 is 6% and is known to Lessee Inc. The residual value of the building of $30,000 was guaranteed by Lessee Inc.
Hint: See Demo 17-2B who expects the residual value to approximate $20,000. Lessee Inc. incurred the following additional costs and
the lease.
received the following incentives pertaining to this lease on January 1, 2020:
Paid legal fees of $1,000 related to the execution of the lease.
Paid a fixed lease payment of $138,847.84 plus a $3,500 recurring payment to the lessor for hazard insur-
ance on the building.
Received a lease incentive of $1,500 to sign the lease.
Required
a. How would Lessee Inc. classify the lease?
c. Compute the value of the right-of-use asset. as of January 1, 2020.
d. Prepare the entries for Lessee Inc. for years 2020 and 2021. Assume legal fees were paid and the lease in-
centive was received in 2019.

as of January 1, 2020
e. What would be the value of the lease liability if the lessor charged a market price for hazard insurance,
which changed from year to year?
On January 1, 2020, lessor Marcy and lessee Lenox contract for the lease of a machine for five payments of Exercise 17-61
$7,000 each. The $7,000 payments are to be paid at the end of each year. They also agree that at the time of the Reporting Finance
Lease, Purchase
fifth payment, for an added $6,000 purchase option payment, Lenox can buy the property. Lenox reasonably ex- Option—Lessee LO2
pects to exercise the purchase option as the amount is well under the expected fair value at that time. Lenox’s
incremental borrowing rate is 6% per year and Lenox is unaware of the implicit rate of the lease. The economic
life of the asset is six years.
Required
a. How would Lenox classify the lease?
b. Compute the value of the lease liability.
c. Prepare an amortization schedule of the lease liability.
d. Prepare the entries for Lenox for years 2020 and 2021.
On the first day of its accounting year, Lessee Inc. leased certain property at a semiannual payment of $60,000 Exercise 17-62
receivable at the beginning of each period for 8 years. The first payment was paid immediately. The leased prop- Reporting Finance
Lease—Lessee LO2
erty, which is new, cost $1,100,000 and has an estimated useful life of 10 years and no guaranteed residual value. Hint: See Demo 17-2A
The lessee’s incremental borrowing rate is 7% and the lessee is not aware of the lessor’s implicit rate.
Required
a. How would Lessee Inc. classify the lease?
b. What balances (account titles, amounts) appear on Lessee Inc.’s balance sheet at the end of the first year,
related to the lease?
c. What balances (account titles, amounts) appear on Lessee Inc.’s income statement for the first year, related
to the lease?
Flint Company leased equipment to Land Company for a five-year period. Flint paid $46,965 for the equipment, Exercise 17-63
its current carrying value (estimated useful life five years). The lease started on January 1, 2020. Flint uses a Recording Sales-Type
Lease, Unguaranteed
target rate of return of 8% in all lease contracts. The first payment was on January 1, 2020, and the accounting Residual Value—Lessor
periods end on December 31. The equipment reverts to the lessor at the end of the lease term at which time the LO3
lessor estimates that the equipment will have an unguaranteed residual value of $2,000.
Required
a. Compute the annual payment for the lessor.
b. Prepare an amortization schedule of the lease receivable for the lessor.
c. Provide journal entries for 2020 and 2021 for the lessor assuming that the equipment is held in the lessor’s
Inventory account.
d. Record the entry on January 1, 2025, for the return of the equipment assuming the equipment had a fair
value of $2,000.
Use the same information from Exercise 17-63 but assume instead that the lease contract contains a purchase Exercise 17-64
option stating that Land Company can purchase the equipment for $4,000 on January 1, 2025, at which time its Recording Sales-Type
Lease, Purchase
estimated residual value is $6,500. It is reasonably certain that Land Company will exercise the purchase option Option—Lessor LO3
at the end of the lease term.
Required
a. Compute the annual payment for the lessor.
b. Prepare an amortization schedule of the lease receivable for the lessor.
c. Prepare journal entries for 2020 and 2021 for the lessor.
Dunlap Company leased a large copier to Rust Company for a three-year period. Dunlap paid $30,000 for the Exercise 17-65
copier and immediately leased it on January 1, 2020 (estimated useful life is four years, and Dunlap expects the Recording Sales-
Type Lease, Residual
residual value at the end of the lease term to be $6,000). Dunlap used an expected rate of return of 6% (known by Value—Lessor LO3
Rust). The lessee agreed to guarantee two-thirds ($4,000) of the residual value. The first lease payment is due on
January 1, 2020, and the accounting periods for both entities end on December 31. At the lease termination date,

an independent appraiser provided an estimated residual value of $3,000. The lessee immediately paid the differ-
ence of $1,000 ($4,000 guaranteed residual value minus $3,000, the actual residual value).
Required
a. Compute the lease payment for the lessor and the lease receivable to be capitalized by the lessor.
b. Provide the entries for the lessor on January 1, 2020.
c. Provide the entries for the lessor through the lease term.
d. Instead assume that the collectibility of the lease payments by Rust Company was not probable. How would
your answer to part (b) change?
Exercise 17-66 Rex Corporation (lessor) and Lee Company (lessee) agreed to a lease with the following information:
Reporting Sales-Type
Rex’s carrying value of the underlying asset (inventory item) was $400,000.
Lease, Initial Direct
Costs—Lessor LO3 Lease term is four years, beginning January 1, 2020. Lease payments are made each January 1, beginning
January 1, 2020.
Estimated useful life of the underlying asset is four years. Estimated residual value at the end of the lease
is zero.
Sales price of the underlying asset on January 1, 2020, was $460,000.
Rex’s implicit interest rate is 8% on retail price (known to Lee).
Rex paid commission and legal fees in securing the lease of $5,000 on January 1, 2020.
Rex expects to collect all payments from Lee.
Required
a. Compute the lease payment for the lessor and the lease receivable to be capitalized by the lessor.
b. Provide the entries for the lessor during 2020.
Exercise 17-67 On January 1, 2020, the first day of its accounting year, Lessor Inc., leased certain equipment at an annual pay-
Reporting a Sales-Type ment of $10,254.19, receivable at the beginning of each year for 10 years. The first payment was received im-
Lease—Lessor LO3
Hint: See Demo 17-3A mediately. The equipment has an estimated useful life of 12 years and no residual value. Lessor’s implicit rate
is 6%. Lessor had no other costs associated with this lease and properly classified the lease as a sales-type lease.
The leased equipment was carried on Lessor Inc.’s books at $65,000.
Required
a. Calculate the value of the lease receivable at the commencement of the lease.
b. What amounts would be presented in the balance sheet as of December 31, 2020, related to this lease?
c. What amounts would be presented in the income statement for the year ended December 31, 2020, related
to this lease?
Exercise 17-68 On January 1, 2020, the first day of its accounting year, Lessor Inc., leased certain property at an annual payment
Reporting a Sales-Type of $20,000 receivable at the beginning of each year for 5 years. The first payment was received immediately. The
Lease—Lessor LO3
leased property, which is new, has an estimated useful life of 8 years and an estimated residual value of $15,000
(expected to be received by lessor but not guaranteed by the lessee). Lessor’s implicit rate is 6%. Lessor had no
other costs associated with this lease and properly classified the lease as a sales-type lease. The leased equipment was carried
on Lessor Inc.'s books at $65,000.
Required
a. Calculate the value of the lease receivable at the commencement of the lease
b. What amounts would be presented in the balance sheet as of December 31, 2020, related to this lease?
c. What amounts would be presented in the income statement for the year ended December 31, 2020, related
to this lease?
Exercise 17-69 Information for four separate finance/sales-type lease scenarios is provided as follows:
Computing Lease
Payment—Lessor;
Computing Right-of- A B C D
Use Asset and Lease
Liability—Lessee Lessor’s desired rate of return�� 6% 7% 8% 7.5%
LO2, 3 Implicit rate known by the lessee�� yes no yes no
Lessee’s incremental borrowing rate�� 7% 6% 7% 8%
Lease term�� 5 8 5 8
Fair value of underlying asset�� $100,000 $45,000 $275,000 $18,000
Beginning or end of year payments�� Beginning Beginning Beginning End

Required
Answer the following questions for each separate scenario, assuming that the lessee is aware of the lessor’s im-
plicit lease rate.
a. Compute the lessor’s lease payment.
b. Compute the lessee’s balance of the lease liability at the commencement of the lease.
c. Compute the lessee’s balance of the right-of-use asset at the commencement of the lease.
Information for four separate finance/sales-type lease scenarios is provided as follows: Exercise 17-70
Computing Lease
Payment—Lessor;
A B C D Computing Right-of-
Use Asset and Lease
Lessor’s desired rate of return�� 6% 7% 6% 8% Liability—Lessee
Lease term�� 5 10 8 4 LO2, 3
Fair value of underlying asset�� $35,000 $140,000 $18,000 $230,000
Beginning or end of year payments�� Beginning Beginning Beginning End
Guaranteed residual value �� — 12,000 — 80,000
Residual value expected by lessee�� — — — 30,000
Unguaranteed residual value expected by lessor�� — — 3,500 —
Initial direct costs paid by lessee�� 250 1,000 — 1,200
Prepaid lease payment�� — 1,500 — —
Required
Answer the following questions for each separate scenario assuming that the lessee is aware of the lessor’s im-
plicit lease rate.
a. Compute the lessor’s lease payment.
b. Compute the balance of the lessee’s lease liability at the commencement of the lease, prior to the first
payment.
c. Compute the balance of the lessee’s right-of-use asset at the commencement of the lease.
A lessor entered into a 5-year lease appropriately classified as a sales-type lease. The cost of the underlying as- Exercise 17-71
set was $40,000 and the fair value of the asset was $50,000. The lease included a purchase option that allowed Recording Entries for
Sales-Type Lease:
the lessee to purchase the underlying asset for $5,000 at the end of the lease. Because of the discount offered in Lease Payment
the purchase option from the expected residual value of $7,000, the lessor is reasonably certain that the lessee Calculation LO3
will exercise the purchase option. The first lease payment will be made immediately, with annual payments due
throughout the lease term.
Required
a. Assuming that the lessor had a desired rate of return of 6%, compute the annual lease payment.
b. Assume the same facts (original scenario) except that the exercise of the option is not reasonably certain.
Compute the annual lease payment.
c. Assume the same facts (original scenario) except that lessor’s desired rate of return is 8%. Compute the an-
nual lease payment.
d. Assume the same facts (original scenario) except that the lease allows the ownership of the leased asset to
revert to the lessee at lease end. Compute the annual lease payment.
Try-Star Leasing Company enters into a contract with LLX Corporation for equipment under lease for a three- Exercise 17-72
year period. The equipment will have no residual value when the lease term ends and has an economic life of 3 Recording Entries for
Finance Lease: Lessee
years. Try-Star expects to collect all payments from LLX Corporation. The carrying value of the equipment was LO2, 3
$120,000 at the inception of the lease, but the fair value was $140,000. The three equal annual payments (amount
to be determined) are to be paid each January 1, starting January 1, 2020, (at which time the equipment was de-
livered). In addition to the fixed lease payment, LLX Corporation has agreed to pay Try-Star $1,000 annually for
taxes and insurance throughout the lease term, at the time fixed lease payments are due. Try-Star expects an 8%
return (known to LLX Corporation). LLX incurred $1,000 in legal fees for the execution of the lease on January
1, 2020, to be paid in 30 days. The accounting year of both companies ends December 31.
Required
a. Determine the annual lease payment.
b. Determine the classification of the lease to LLX Corporation.
c. Provide all journal entries relating to the lease for LLX Corporation for 2020–2022.

© Cambridge Business Publishers Chapter 18 Income Taxes 18-12
. Income Tax Journal Entry—2021

e
As the warranty costs are actually paid, the deferred tax asset reverses. The entry that
is made to reflect this includes a credit to the Deferred Tax Asset Account and a Debit to
Deferred Tax Expense of $5,000. Along with the entry to
reflect the current income tax expense and income tax Pretax GAAP income�� $40,000
Tax rate�� × 25%
payable of $5,000 for 2021, the combined entry follows.
Income tax expense �� $10,000
December 31, 2021—To record income tax expense
Income Tax Expense ($5,000 1 $5,000)�� 10,000 Taxable income�� $20,000 25,000 15,000 210,000
Tax rate�� × 25% Def Tax Asset Inc Tax Payable

Deferred Tax Asset ($5,000 − $0) �� 5,000 5,000 5,000 5,000
Income tax (tax return)�� $ 5,000
Income Tax Payable�� 5,000 Income Tax Exp
2,500
10,000
a
Coca Col Real World—Deferred Tax Assets
Coca Cola Company provided the following summary of deferred tax assets in a recent Form 10-K. The Coca Cola [KO]
most significant difference between GAAP and tax reporting in 2017 is due to benefit plans. The funding
deductions on a cash basis were less than amounts recorded as pension expense. In later periods, this will
reverse where the funding tax deductions will be greater than pension expense.
Note 14: Income Taxes (excerpt) The tax effects of temporary differences and carryforwards that give rise
to deferred tax assets and liabilities consist of the following:
December 31 (In millions) 2017 2016
assets:
Deferred tax liabilities:
Property, plant and equipment�� $ 99 $ 144
Trademarks and other intangible assets�� 98 114
Equity method investments (including foreign currency translation adjustment)�� 300 684
Derivative financial instruments�� 387 193
Other liabilities�� 861 1,141
Benefit plans �� 977 1,599
Net operating/capital loss carryforwards�� 520 461
Other �� 163 135
Gross deferred tax assets�� 3,405 4,471
Valuation allowances�� (501) (530)
Total deferred tax assets�� $2,904 $3,941
Deductible Temporary Difference Leading to Deferred Tax Asset LO18-2 REVIEW 18-2
On January 1, 2020, Staples Corporation collected $200,000 cash in advance of the satisfaction of Review
performance obligations of a revenue contract and recognized $200,000 in deferred revenue. Sta-
ples Corporation recognized GAAP revenue of $50,000, $50,000, $50,000, and $50,000 in Decem- MBC
ber 2020, 2021, 2022, and 2023, respectively. For tax purposes, the full $200,000 was recognized
as taxable income in 2020. The accounting and tax periods both end December 31. There were no
deferred tax account balances at the beginning of 2020. The tax rate for each year was 25%.
Pretax GAAP income amounts for each of the four years were as follows.
2020�� $145,000 2021�� $155,000 2022�� $150,000 2023�� $148,000

. Compute the increase in income tax payable on December 31, 2020, 2021, 2022, and 2023.
a
b. Prepare a schedule to compute the deferred tax asset balance on December 31, 2020, 2021, More Practice:
18-24, 18-25, 18-26,
2022, and 2023. 18-27, 18-28, 18-49
c. Record the income tax journal entry required for the years 2020 through 2023. Solution on p. 18-62.

18-13. With respect to NOL carryforwards, how does uncertainty affect the accounting treatment?
18-14. Is deferred tax arising from an NOL carryforward classified as current or noncurrent?
18-15. Explain the limitation on the carrying value of deferred income tax assets.
18-16. How does a company account for a change in tax rates?
18-17. Describe the two-step process required when uncertain tax positions are taken.
Brief Exercises
4M Inc. showed income tax on its tax return of $4,800 on December 31, 2020, and had a tax rate of 25%. If tax- Brief Exercise 18-18
able income were equal to pretax GAAP income for 2020, determine the amount of net income that 4M Inc. rec- Computing Net Income
LO1
ognized in 2020 on its financial statements.
Aquafena Inc. recognized taxable income of $100,000 for the year ended December 31, 2020. Aquafena calcu- Brief Exercise 18-19
lated a deferred tax asset and a deferred tax liability of $12,000 and $8,000, respectively, on December 31, 2020. Recording Income Tax
Expense LO1, 2
The tax rate is 25%. Assume zero beginning balances in deferred tax accounts.
a. Determine the increase in income tax payable on December 31, 2020.
b. Prepare the income tax expense journal entry on December 31, 2020.
Alexa Inc. recorded the following deferred tax amounts. Brief Exercise 18-20
Recording Income Tax
Expense LO1, 2
December 31, 2019 December 31, 2020
Deferred tax liability�� $ 5,000 $8,500
Deferred tax asset�� 13,000 6,000
If the company had current tax expense of $26,000 in 2020, determine total income tax expense for 2020.
On December 31, 2020, Lexxus Inc. recorded an unrealized gain in income of $5,000 related to its trading debt Brief Exercise 18-21
securities originally purchased on December 15, 2020, for $20,000. Lexxus recognized pretax GAAP income of Reporting a Deferred
Tax Liability LO1
$80,000 in 2020 and had a tax rate of 25%.
31,
a. Determine the reported amount of trading securities in the financial statements of Lexxus on December 30,
2020.
31, 2020.
b. Determine the tax basis of the trading securities on December 30,
c. Calculate the deferred tax balance and show how it would be reported in the December 31, 2020, balance
sheet of Lexxus.
Assuming the same information from Brief Exercise 18-21, record the income tax journal entry on December 31, Brief Exercise 18-22
2020. Assume zero beginning balances in deferred tax accounts. Recording Income Tax
Expense LO1
Alexa Inc. purchased equipment in 2018 for $50,000 with no residual value. On December 31, 2020, accumu- Brief Exercise 18-23
lated depreciation using the straight-line method for financial reporting was $15,000. For tax purposes, Alexa Recording Income Tax
Expense LO1
uses MACRS depreciation resulting in $35,600 in accumulated depreciation for tax purposes on December 31,
2020. Taxable income was $100,000 for 2020 and the company’s tax rate is 25%.
a. Determine the GAAP basis of equipment (net) on December 30, 2020.
b. Determine the tax basis of equipment on December 30, 2020.
c. Assuming a deferred tax liability balance of $4,900 on December 31, 2019, record income tax expense for 2020.
Underwood Co. had current tax expense of $20,000 for the year ended December 31, 2020. The ending deferred Brief Exercise 18-24
tax asset balance was $6,000, which was a $4,000 increase from January 1, 2020. The tax rate is 25%. Calculate Calculating Income Tax
Expense LO2
income tax expense for 2020.
On December 31, 2020, Delta Inc. recorded $28,000 of deferred revenue (a liability) on customer deposits re- Brief Exercise 18-25
ceived in advance of the satisfaction of performance obligations. However, this amount is taxable in 2020 when Calculating Deferred
Tax Asset Balance
cash was received. Assume a tax rate of 25% and pretax GAAP income of $160,000 for 2020. LO2
a. Determine the GAAP basis of deferred revenue on December 30, 31, 2020.
b. Determine the tax basis of deferred revenue on December 30,
31, 2020.
c. Determine Delta Inc.’s deferred tax asset balance on December 31, 2020.

The company had one temporary difference due to the GAAP basis of equipment exceeding the tax basis of the
equipment. Record the income tax journal entry for 2020, assuming an enacted tax rate of 25%. Assume that the
December 31, 2019, deferred tax liability balance was $5,000.
In 2020, Explorers Inc. completed installment sales of $80,000, recorded in full as accounts receivable and as Brief Exercise 18-37
revenue. For tax purposes, it recognizes income when cash is received. Cash related to the installment sales is Calculating a Deferred
Tax Liability Balance
expected to be received in the following years: 2021 of $10,000; 2022 of $40,000; 2023 of $30,000. The enacted LO1, 5
tax rate
tax for
rate2020, 2021,and
for 2020 and 2021
2022 is 25%. The newly enacted tax rate for 2023 is 40%. Compute the value of the deferred
tax liability on December 31, 2020.
The Jets Company recorded a deferred tax liability in the amount of $18,750 in December 2020, due to the book Brief Exercise 18-38
value of equipment exceeding the tax basis of equipment by $75,000. The difference will reverse equally over Recording Income Tax
with Changing Tax
the next three years. In late 2020, the enacted tax rate increased to 42.5% beginning 2022. Rates LO1, 5
a. Determine the income tax rate that is the enacted rate for 2020. Hint: See Demo 18-5
b. What journal entry should the Jets record to adjust the deferred tax liability, if any?
In 2020, Lambeau Inc. suffered a loss of $100,000. The enacted tax rate is 25%. Prepare Lambeau’s entry for the Brief Exercise 18-39
loss carryforward on December 31, 2020, assuming that management determined that it was more likely than not Recording Net
Operating Loss
that the deferred tax asset would be realized. Carryforward LO6
In 2020, Cardinals Company operated at a tax loss, totaling $88,000 during its first year of business. Assuming a Brief Exercise 18-40
tax rate of 25%, and that income is expected in 2021, record the entry to reflect the tax benefit of the net operat- Recording Net
Operating Loss
ing loss on December 31, 2020. Cardinals Company determined that it was more likely than not that 75% of the Carryforward LO6
deferred tax asset would not be realized.
Springs Inc. has taken a tax position in 2020 that it believes is based on fairly clear tax law for the payment of Brief Exercise 18-41
$80,000 in salaries and benefits to employees. There are no limits on deductibility and all amounts were fully paid Recording Income
Tax Expense with Tax
within the statutory time limit, although there is some question on the company’s policies for capitalization of a por- Uncertainty LO7
tion of the salaries. Management has a fairly high confidence level in the technical merits of this position. It is clear
that it is greater than 50% likely that the full amount of the tax position will be ultimately realized, but it is less than
100%. Springs estimates the probability of sustaining the entire tax position with taxing authorities at 60%. Springs
Inc. taxable income is $100,000, which includes the salary deduction of $80,000 referenced above. If the Springs
Inc. tax rate is 25% (with no other deferred items), record the income tax journal entry required on December 31,
2020.
Kate Club Inc. has determined that there are four temporary differences between the tax basis and the GAAP Brief Exercise 18-42
book value of assets and liabilities that resulted in the following deferred taxes: (a) deferred tax liability related Reporting Deferred
Taxes in Balance Sheet
to accelerated tax depreciation over straight-line depreciation: $20,000; (b) deferred tax asset related to deferred LO8
contract (one-year contracts) revenue collected in advance, $24,000; (c) deferred tax asset related to bad debt Hint: See Demo 18-8
expense recognized on an allowance basis, $10,000; and (d) deferred tax liability related to prepaid automobile
insurance, $8,000. Prepare the balance sheet presentation of deferred taxes.
The following information was obtained from recent annual reports on 10-K for American Eagle Outfitters, Brief Exercise 18-43
Inc. Compute the debt-to-equity ratio (a) including deferred tax liabilities as part of total liabilities, and (b) ex- Computing Ratios LO8
cluding deferred tax liabilities as part of total liabilities.
$ thousands Jan. 28, 2017 Jan. 30, 2016 Jan. 31, 2015
Deferred tax liabilities $ 71,468 $ 67,332 $ 36,289
Total liabilities 578,091 560,870 557,162
Total stockholders’ equity 1,204,569 1,051,376 1,139,746
Exercises
Exercise 18-44
Staples Corporation would have had identical income before taxes on both its income tax returns and its income Recording and
statements for the years 2020 through 2023 except for a depreciable asset that cost $120,000. The asset was de- Reporting Temporary
preciated for income tax purposes using the following amounts: 2020, $48,000; 2021, $36,000; 2022, $24,000; Difference LO1
Hint: See Demo 18-1

18-45 Chapter 18 Income Taxes © Cambridge Business Publishers
Additional information
Environmental fines are not deductible for income tax purposes.
The amount collected in 2020 related to deferred service revenue ($10,000) was taxable in 2020.
Accrued warranty costs of $8,000 are not deductible for income tax purposes until 2021 when the expen-
ditures are made.
Income tax rate is 25% for both years.
At the beginning of 2020, deferred tax asset and liability balances were zero.
Required
a. Prepare a schedule to determine deferred tax balances on December 31, 2020.
b. Prepare a schedule to determine income tax payable on December 31, 2020, and 2021.
c. Record the income tax journal entry on December 31, 2020.
d. Record the income tax journal entry on December 31, 2021.
e. Show how the tax accounts would be reported (excluding income taxes payable) on the income statement
and balance sheet for 2020 and 2021. Include the disclosure of current and deferred tax expense.
f. Compute the effective tax rate for 2020.
Exercise 18-59 Listed below are ten separate situations. For each item indicates whether the difference is (1) temporary creating
Identifying Tax a deferred tax asset or a deferred tax liability or (2) permanent.
Differences LO1,
2, 4
Deferred Income Tax
Account Would Be
Item Asset Liability Permanent

1. Pension fund contributions are less than pension expense for
the current year, resulting in a pension liability on the company’s
balance sheet.
2. Dividend revenue recognized for accounting while a portion is
deductible for taxes (dividends received deduction).
3. Estimated warranty costs: accrual basis for accounting and cash
basis for income tax.
4. Fines expensed for accounting but not deductible for tax purposes.
5. Straight-line depreciation for accounting and accelerated
depreciation for income tax.
6. Unrealized gain on investments: FV-NI recognized for accounting,
but gain recognized only on disposal of the asset for income tax.
7. Rent revenue collected in advance: accrual basis for accounting,
cash basis for income tax.
8. Unrealized loss on investments: FV-NI recognized for accounting,
but loss recognized only on disposal of the asset for income tax.
9. Probable and estimable litigation contingency: accrual basis for
accounting and cash basis for income tax.
10. Interest received on investments in municipal bonds is not taxable.
Exercise 18-60 Fox Corporation purchased a machine on January 1, 2020, that cost $40,000. The machine had an estimated ser-
Recording Income vice life of five years and no residual value. Fox uses straight-line depreciation for accounting purposes and ac-
Tax Journal Entry:
Temporary and celerated depreciation for the income tax return as follows: 2020, 30%; 2021, 25%; 2022, 20%; 2023, 15%; and
Permanent Differences 2024, 10%. Taxable income on the tax return for 2020 was $150,000. The 2020 income statement also showed
LO1, 2, 4, 5 a $15,000 expense for premiums paid for life insurance policies on company executive officers. The income tax
rate is 25% in 2020 and 35% in all subsequent years.
Required
a. Prepare a schedule to determine deferred tax balances on December 31, for the years 2020 through 2024.
b. Record the income tax journal entry on December 31, 2020.
c. Repeat requirements a and b assuming instead that the machine is 100% expensed in 2020 for tax purposes.

Required
a. Compute the increase to income tax payable on December 31, 2020, 2021, and 2022.
b. Prepare a schedule to compute deferred tax accounts on December 31, 2020.
c. Prepare the journal entry to record income taxes in the following years: 2020, 2021, and 2022.
Tyson Corporation reported pretax income from operations in 2020 of $80,000 (the first year of operations). In Exercise 18-70
2021, the corporation experienced a $40,000 NOL (pretax loss from operations). Management is confident the Recording NOL
Carryforward LO6
company will have taxable income in excess of $50,000 in 2022. Assume an income tax rate of 25% in 2020 and
thereafter. Tyson has no other temporary differences.
Required
a. Provide the 2020 and 2021 income tax entries that Tyson should make.
b. Show how all tax-related items would be reported on the 2020 and 2021 income statements and balance sheets.
Decker Corporation experienced a loss in 2020. Additional information for Decker Corporation follows. Exercise 18-71
Recording and
Reporting NOL
2020 Carryforward LO6
Taxable income (loss)�� $(65,000)
Income tax rate�� 25%
in 2018 to 2020 other than any related to a net operating loss carryforward.
There were no temporary differences from
Required
a. Record income taxes for 2020 and 2021 assuming the following.
• For 2021, the company computed taxable income of $45,000 and recognized a deferred tax liability bal-
ance of $2,250 related to acquisition of depreciable assets in its year-end financial statements. These
amounts were consistent with management’s expectations.
• The income tax rate enacted in 2020 and effective for 2021 and thereafter is 30%.
• Management estimates the valuation allowance on the deferred tax asset related to its 2020 NOL to be zero.
b. List the amounts that should be reported on the income statements and balance sheets for 2020 and 2021.
Toner Corporation computed the following taxable income and loss: 2020 taxable income, $10,000 and 2021 tax- Exercise 18-72
able loss, $40,000. At the end of 2021, Toner made the following estimates: 2022 taxable income, $4,000, 2023 Recording NOL
Carryforward LO6
taxable income, $11,000, and 2024 taxable income, $50,000. On the basis of these estimates, Toner believes the
full amount of tax loss carryforward benefit is more likely than not to be realized. There are no other temporary
differences. The tax rates are 25% for years 2020, 2021, and 2022; and 30% for years 2023 and 2024.
Required
a. Provide the income tax entry for 2021.
b. Provide the income tax entry for 2022, assuming that the actual taxable income was $6,000 (tax rate, 25%).
(b), and that the ac-
c. Provide the income tax entry for 2023, assuming that 2022 results were as described in (c),
tual 2023 taxable income was $13,000.
d. Provide the entry for 2024, assuming results for 2022 and 2023 as described above and assuming that the
actual 2024 taxable income was $45,000.
DNSE Inc. began operations in 2019. In its first year the company had a net operating loss of $10,000, which was Exercise 18-73
carried forward and used to reduce income tax payable in 2020. In 2020, DNSE had taxable income of $40,000 be- Recording NOL
Carryforward, Valuation
fore the use of the NOL carryforward. At December 31, 2020, DNSE Inc. determines that it should have a deferred Allowance LO6
tax asset ending balance of 25,000
$25,000 related to 2020 deferred revenue. The income tax rate is 25%. No valuation al-
lowance has been established.
Required
a. Provide the journal entry to record income taxes in 2020, assuming that no valuation allowance is required.
b. Now assume DNSE has encountered stiff competition and is uncertain whether it will have any taxable in-
come in the foreseeable future. DNSE determined that it was more likely than not that none of the deferred
tax asset would be realized. Assume that the temporary differences that give rise to the deferred tax asset
are expected to reverse in 2021 and 2022. Determine what amount, if any, should be recorded as a valuation

19-23 Chapter 19 Pensions and Postretirement Benefits © Cambridge Business Publishers
LO 19-6 Describe the reporting of pensions in financial statements
The entries in the prior section result in account balances that are reported
Pension Reporting
LO 19-6 Overview
in a company’s financial reports and note disclosures. We summarize how

Income statement
pensions are reported in the income statement, statement of comprehensive
Statement of comprehensive income
income, stockholders’ equity statement, and the balance sheet. We then con-
Stockholders’ equity statement
tinue with the Taser Inc. example to illustrate how accounts are shown on its
Balance sheet
financial statements in Demo 19-6.
Disclosure requirements
Income Statement
Components of pension expense are recognized in the income statement as
follows: service cost is included with other employee compensation costs within operations (if the
subtotal is presented) while the remaining components of pension expense are included outside of
operating income.
Sales
Operating expenses (includes service costs)
Operating income
Other revenue (expenses), net
Other
Other components
components of net
of net periodic
periodic pension
pension costcost
Net income
715-20-45-3A An employer shall report in the income statement:

a. The service cost component of net periodic pension cost and net periodic postretirement benefit cost in the
same line item or items as other compensation costs arising from services rendered by the pertinent employees
during the period (except for the amount being capitalized, if appropriate, in connection with the production
or construction of an asset such as inventory or property, plant, and equipment).
b. The other components. . . separately from the service cost component and outside a subtotal of income from
operations, if one is presented. If a separate line item or items are used to present the other components, that
line item or items shall be described appropriately.
Statement of Comprehensive Income and Statement of Stockholders’ Equity

Other comprehensive income is affected by the following pension related items (net of tax) within a
statement of comprehensive income.
Net income
Other comprehensive income
(Deferral of pension loss)
Amortization of pension loss
Deferral of pension gain
(Amortization of pension gain)
(Prior service cost adjustment for additional benefits)
Amortization of prior service cost
Comprehensive income
The other comprehensive income (OCI) accounts are accumulated in accumulated OCI accounts. Both
the activity during the period and the balances in the accumulated OCI accounts are shown on the
statement of stockholders’ equity. The ending balances of the accumulated OCI accounts are carried
over to the balance sheet.
Balance Sheet
The net pension asset or net pension liability is recognized on the balance sheet. A net pension asset is
presented as a noncurrent asset labeled Prepaid pension cost, net. A net pension liability is presented

© Cambridge Business Publishers Chapter 19 Pensions and Postretirement Benefits 19-38
Clark Kent Co. approved a prior service obligation of $120,000 on January 1, 2020, which granted retroactive Brief Exercise 19-30
benefit to employees. Assuming an average remaining service period of 10 years for all active plan participants, Analyzing Prior Service
Cost LO4
what is the effect on pension expense of the prior service cost? Hint: See Demo 19-4
On June 1, 2018, West Corporation established a defined benefit pension plan for its employees. The following Brief Exercise 19-31
information was available in 2020: Amortizing Pension
Gain/Loss LO4
Hint: See Demo 19-4
Balance Jan. 1, 2020
Projected Benefit Obligation �� $3,625,000 Cr.
Plan Assets�� 3,750,000 Dr.
Accumulated OCI—Pension Gain/Loss�� 637,500 Cr.
For 2021, compute the amortization of the account, Accumulated OCI—Pension Gain/Loss, assuming that the
company uses the corridor approach in determining the minimum amortization to recognize. Assume that the av-
erage remaining service life of employees is 10 years.
Kidman Inc. sponsors a defined benefit plan and determined that for the current year of 2020, service cost was Brief Exercise 19-32
$10,000, interest cost was $2,100, and the expected (and actual) return on plan assets was $2,000. Kidman will Recording Pension
Expense and Plan
contribute $1,800 to the plan on December 31, 2020. Record the journal entries for pension expense and to fund the Funding LO5
plan for 2020, assuming no benefits are paid during the year. Hint: See Demo 19-5
LetsGo Inc. sponsors a defined benefit plan and determined that for the current year of 2020, service cost was Brief Exercise 19-33
$250,000, amortization of prior service cost was $1,800, interest cost was $21,100, and the expected (and ac- Recording Pension
Expense, Plan
tual) return on plan assets was $18,000. LetsGo will contribute $45,000 to the plan for 2020 and payments to Funding, Benefit
retirees totaled $15,000 in 2020. Record the journal entries for pension expense, to fund the plan, and to pay Payments LO5
benefits for 2020. Hint: See Demo 19-5
The following pension-related values are determined on December 31, 2020, for BNW Inc. Compute the net pen- Brief Exercise 19-34
sion asset (liability) to be recorded on the balance sheet on December 31, 2020. Computing Net Pension
Asset (Liability) LO6
Projected benefit obligation�� $100,000

Accumulated benefit obligation�� 80,000
Plan assets at fair value �� 90,000
Accumulated OCI—Prior Service Cost (Dr.)�� 12,000
At the end of 2020, after recording pension expense, Talent Co. has the following balances: Accumulated OCI— Brief Exercise 19-35
Pension Gain/Loss $6,000 (debit) and Projected Benefit Obligation $100,000 (credit). During the year 2021, Tal- Reporting the Impact of
Pension Fund LO6
ent Co. experienced a $500 actuarial gain on its PBO and an unexpected loss on plan assets of $80. Net income
for the year totaled $3,800. Talent Co. did not record amortization expense on the pension gain/loss because the
beginning balance in Accumulated OCI—Pension Gain/Loss did not exceed the corridor. The company has no
other items affecting OCI besides pension related items.
2021, reported in the financial statements?
a. What is Talent’s other comprehensive income for 2020,
2021, reported in the financial statements?
b. What is Talent’s comprehensive income for 2020,
c. What is the balance of accumulated other comprehensive income as of December 31, 2021, reported in the
financial statements?
Pharrell Inc. sponsored a defined pension plan for its employees. For the year ended December 31, 2020, Phar- Brief Exercise 19-36
rell recorded pension expense of $2,500 (including service cost of $1,500) and a $200 unexpected loss on plan Reporting the Impact of
Pension Fund LO6
assets. Pharrell calculated the December 31, 2020, balance in Accumulated OCI—Gain/Loss account to be $400 Hint: See Demo 19-6
(debit) and calculated a net pension asset/liability of $250 (credit). Assuming no amortization of pension gain/
loss, what is the impact of this plan on the (a) balance sheet, (b) income statement, and (c) statement of compre-
hensive income?
Levine Co. sponsored a defined benefit plan, which included January 1, 2020, balances of $5,000 and $4,800 in Brief Exercise 19-37
Plan Assets and Projected Benefit Obligation, respectively. During 2020, the company incurred $1,000 in service Preparing a Pension
Worksheet LO7
cost, made plan contributions of $210, and paid benefits to retirees for $150. The discount rate is 9% and the ex- Hint: See Demo 19-7
pected and actual rate of return on plan assets is 10%. Prepare a pension worksheet for 2020.

App—Brief Exercise On January 1, 2020, Allied Co. amended its postretirement benefit plan to grant retroactive benefits for services
19-98 already performed in prior years. The present value of the benefits on January 1, 2020, is $50,000 and it relates to
Amortizing Prior Service
two employees with the following expected years of service: Jeff, 2 years and Eric, 4 years. Determine the amor-
Costs LO10
Hint: See Demo 19-10 tization to be recognized in 2020 by allocating an equivalent amount of prior service cost to each service year.
Appendices—Exercises
App—Exercise 19-99 The following information pertains to YNCA Inc.
Recording
Postretirement
Benefit Expense and APBO: Jan. 1, 2020�� $100,000
Determining Funded Plan Assets: Jan. 1, 2020 �� $75,000
Status LO9 Actual (and expected) return on plan assets�� $7,500
Hint: See Demo 19-9 Discount rate�� 12%
Service cost, 2020�� $25,000
Contribution to asset fund, Dec. 31, 2020�� $35,000
Benefit payments, Dec. 31, 2020 �� $10,000
Required
a. Provide the entry to record 2020 postretirement benefit expense.
31, 2020.
b. Prepare a presentation of funded status on December 21,
App—Exercise The December 31, 2020, presentation of funded status and accrued postretirement benefit cost for Aude Inc. with
19-100 a postretirement benefit plan is as follows.
Recording
Postretirement
Benefit Expense and Balance Dec. 31, 2020 Activity 2021
Determining Funded
Status LO9 APBO�� $(224,000) Service cost�� $50,000
Hint: See Demo 19-9 Plan Assets�� 203,000 Actual return on plan assets �� 20,000
Underfunded APBO (funded status) �� $ (21,000) Contributions (end of year) �� 75,000
Benefit payments (end of year)�� 85,000
At the beginning of 2021, the plan was amended to increase future health-care benefits for retirees. The increase
is attributable to service performed before 2021. As a result, the APBO increased $56,000. The discount rate is
12%, and the expected rate of return on plan assets is 10%. The average remaining years of service to full eligi-
bility for active plan participants is 15 years.
Required
a. Provide the entry for Aude Inc. to record 2021 postretirement benefit expense.
b. Provide a presentation of funded status at December 31, 2021.
App—Exercise Information for the Krysler Company postretirement health care plan is available as follows.
19-101
Calculating
Postretirement APBO, Jan. 1, 2020�� $300,000 Discount rate�� 8%
Benefit—Gain/Loss and Plan Assets, Jan, 1, 2020 �� 100,000 Expected rate of return on plan assets�� 7%
Postretirement Benefit Accumulated OCI—Postretirement Average service period�� 10 years
Expense LO9 Benefit Gain/Loss, Jan. 1, 2020�� 80,000*
Actual return on plan assets, 2020 �� 6,000
Service cost, 2020�� 60,000
* Amount represents an accumulated loss.
Required
a. Calculate the amount of amortization related to Accumulated OCI—Postretirement Benefit Gain/Loss (if
any) for 2020. Krysler uses the corridor approach for the amortization of postretirement gains and losses.
b. Compute postretirement benefit expense for 2020.
App—Exercise A plan provides life insurance benefits to employees who serve 20 years, at which time the employees become
19-102 fully eligible. The benefit equals $50,000. On December 31, 2020, a 45-year-old employee has worked 15 years
Calculating EPBO and
APBO LO8
for the company. He is expected to retire at age 65. The discount rate is 7%.
Hint: See Demo 19-8

Review 19-8
a. 14 years
b. Present value benefit stream�� $55,201 (PV of annuity of $7,500, 10 years, 6%)

Present value on January 1, 2020�� 23,033 (PV of $55,201, 15 years, 6%)
c. 4/14) �� $ 8,226

APBO ($23,033  5/14) $6,581
Attribution Period (14 years) Retirement Period (10 years)
Date of Hire Current Date Eligibility Date Retirement Date Benefit Period Ends
2016 2020 2030 2035 2045
$23,033 $55,201
EPBO (Lump-sum) PV of benefits (annuity)
$6,581 = $23,033 × 5/14
$8,226 4/14
APBO (Attribution)
Review 19-9
Measurement of Postretirement Benefit Expense (2020)

Service cost�� $320,000
Interest cost�� 15,000
Expected return on plan assets (0.06  $125,000)�� (7,500)
Amortization of prior service cost �� 10,000
Total postretirement benefit expense�� $337,500
December 31, 2020—To record postretirement benefit plan expense

17,500 1335,000 2337,500
110,000
Postretirement Benefit Expense �� 337,500
Plan Assets Postret Benefit Exp Plan Assets �� 7,500
Bal.125,000 337,500
7,500 Accumulated Postretirement Benefit Obligation �� 335,000
APBO OCI—PSC
250,000Bal. Bal. 60,000 10,000 OCI—Prior Service Cost �� 10,000
335,000
December 31, 2020—To record funding of plan assets

1150,000
2150,000
Plan Assets �� 150,000
Cash Plan Assets Cash�� 150,000
150,000 Bal.125,000
7,500
150,000
December 31, 2020—To record benefits paid

250,000 250,000
Accumulated Postretirement Benefit Obligation �� 50,000
Plan Assets APBO
Bal.125,000 50,000 50,000 250,000Bal. Plan Assets �� 50,000
7,500 335,000
150,000
535,000
232,500
Review 19-10
a. Year Service Years Annual Amortization
2020�� 2 $80,000  2/7  $22,857
2021�� 2 $80,000  2/7  22,857
2022�� 1 $80,000  1/7  11,429
2023�� 1 $80,000  1/7  11,429
2024�� 1 $80,000  1/7  11,428
$80,000
19_InterAcc2e_19�indd 65 4/19/19 11:02 AM

20
Stockholders’ Equity
Consolidated Statement of Equity
ies
and Subsidiar 2015
PepsiCo, Inc. Balance sheet (excerpt) 2016
Consolidated cember 30, 20
17, 2017
Amount Shares Amount
ended De 15 Shares 41
Fiscal years cember 26, 20 Shares Amount 0.8 $
, 2016 and De $ 41
December 31 $ 41 0.8
llio ns ) 0.8
(in mi
(0.7) (181)
ck
Preferred Sto (0.7) (186)
(5)
ck (192) —
Preferred Sto (0.7) (6)
Repurchased (5) — (186)
ning of year — (192) (0.7)
Balance, begin (197) (0.7)
(0.7)
Redemptions 25
of year 1,488
Balance, end 1,448
24
(1)
24 (40)
on Sto ck 1,428 —
Comm — (20) 24
ce, be gin nin g of year (8) 24 1,448
Balan mon stock 24 1,428
urchased com 1,420
Change in rep
d of year 4,115
Balan ce, en 4,076
Va lue 4,0 91 299
cess of Pa r 28 9
Capital in Ex r 290 (182)
nin g of yea (138)
Balance, begin expense (236)
compensation
Share-based Us, PSUs and
(151)
exe rcis es, RS (130)
Stock option (a) (145)
con ver ted
PEPunits Us and
(5)
on RSUs, PS (6)
Withholding tax (4) 4,076
Pu nits con verted 4,0 91
PE
3,996
Other 49,092
ce, en d of year 50,472
Balan 5,452
ng s 52,518 29
Retaine d Ea rni 6,3
4,857 (4,071)
ce, be gin nin g of year (4, 28 2)
Balan psiCo (1)
ributable to Pe (4,536) (1)
Net income att mon — 50,472
div ide nd s declared - com 52 ,51 8
Cash ferred
s declared - pre 52,839
Cash dividend (10,669)
ce, en d of year (13,319)
PepsiCo, Inc. Balan e Loss
an d Su bs Ot he r Comprehensiv (13,919)
Consolidated idiar lat ed (2,650)
Balance sheet ies Accumu
ning of year (600)
(excerpt) Balance, begin los s) att ributable 86 2 (13,319)
December 31 e/(
hensive incom (13,919)
Other compre (13,057)
Preferred Sto
ck, no par va to PepsiCo (24,985)
Repurchased lue yea r (378)
Preferred Sto Balance, 20en17d of (418) (29,185)
ck 20Sto
16 ck (31 ,46 8) (52 ) (4,999)
PepsiCo Comm Comm on (438) (3,000)
on Shareholde
rs’ Equity Repurchased 41
41r (2,000)
(29)
12 794
Common stock,
par value 12/3¢ Balance,(19 be7)ginning of yea (18)
9 712
repurchased per share (au (192) 10 708
common stock thorized 3,600 are rep urc hases d 5
at par value: shares, issue Sh an
Capital in exc 1,420 and 1,4 d, net of RSUs, PSUs 5 —
ess of par val
ue 28 shares, res Stock op24 tion exercises, 3 — (29,185)
Retained earni pectively) ver ted 24 — 8) (41 8)
ngs PEPunits con (438) (31,46
Accumulated (446) (32,757) 12,068
other compre Other3,996 11,246
Repurchased hensive loss 4,0 91 5
yea r 11, 04
common stock, Ba 52
lan ce,9end of 52
,83 uit y
in excess of pa
Total PepsiCo r value (446 an
,518
areholders’ Eq 110
Common Sh d 438 shares (13,057) Common Sh 107
Noncontrolling areholders’ Eq
uity , respectively Total PepsiCo (13,919) 104 49
interests ) (32,75tro 7) g Int erests 50
Noncon llin (31 ,468) (48)
Total Equity 51
11,045 beginning of year (55 )
Balan ce, 11, 246 res ts
Total Liabilitie ncontrolling inte (62) (2)
s and Equity 92 ributable to no 4
Net income att 104 ts (2)
10,981
ns to11,no 19 nco ntrolling interes —
(2)
trib utio 9
$7Dis
9,804 n adjustment (1) 107
tra$7
nsl atio
3,4 90 10 4
Currency 92 $12,030
Other, net $11,199
d of yea r $10,981
Balance, en
Total Equity
5.
7 million in 201
2016 and $10
$110 million in l statements.
tax benefits of dated financia
Includes total
(a)
s to the consoli
any ing note
See accomp
Chapter
In this chapter, we identify five main components of stockholders’ equity and illustrate how
these components are reported in the stockholders’ equity statement. We then examine in
more detail common stock, preferred stock, and the related additional paid-in capital ac-
Preview
counts, as well as treasury stock, which is a contra equity account. We examine the effect on
retained earnings from different kinds of dividends: cash, property, liquidating, and stock. We
also examine stock splits. Accumulated comprehensive income, a segment of stockholders’
equity, is discussed, as well as the required reporting of the statement of comprehensive
income. We wrap up the topic of equity with a discussion of required financial statement
disclosures and the use of equity-based ratio analyses.
20-1

20-25 Chapter 20 Stockholders’ Equity © Cambridge Business Publishers
This authoritative standard does not come without controversy because of evidence of market adjust-
ments for small stock dividends coupled with the fact that the company does not receive any new
assets upon distribution of a stock dividend. Nonetheless, this is the basis of the accounting treatment
of stock dividends which treats a small stock dividend differently from a large stock dividend: the
accounting standards require small stock dividends to be recorded at fair value and large stock
dividends to be recorded at par value.
Small Stock Dividends

If the proportion of the additional shares issued is small in relation to the shares previously outstanding
(small stock dividend), the fair value of the additional shares is capitalized. Small in the accounting
standards is generally defined as less than 20% to 25% of the outstanding shares.
505-20-25-3 The point at which the relative size of the additional shares issued becomes large enough to
materially influence the unit market price of the stock will vary with individual entities and under differing
market conditions and, therefore, no single percentage can be established as a standard for determining when
capitalization of retained earnings in excess of legal requirements is called for and when it is not. Except for a few
instances, the issuance of additional shares of less than 20 or 25 percent of the number of previously outstanding
shares would call for treatment as a [small] stock dividend.
A small common stock dividend is recorded by a debit to Retained Earnings (at fair value) and a credit
to Common Stock Dividends Distributable (at par value) and Paid-in Capital in Excess of Par—Com-
mon Stock (for the remainder). When the shares are officially issued, the company debits Common
Stock Dividends Distributable and credits Common Stock. With offsetting increases and decreases
to stockholders’ equity accounts, the net balance in stockholders’ equity remains unchanged.
505
05-20-30-3 In accounting for a stock dividend, the corporation shall transfer from retained earnings to the
category of capital stock and additional paid-in capital an amount equal to the fair value of the additional shares
issued. Unless this is done, the amount of earnings that the shareholder may believe to have been distributed to
him or her will be left, except to the extent otherwise dictated by legal requirements, in retained earnings subject
to possible further similar stock issuances or cash distributions.
When a stock dividend is issued, not all shareholders may own exactly the number of shares needed to
receive whole shares. For example, if a company issues a 10% stock dividend and a shareholder owns
15 shares, the stockholder is entitled to 1.5 shares (15 shares 3 10%). The shareholder has a right to 1
full share plus a fractional share of ½ share. A company often pays cash to shareholders for the fair
value of the fractional shares to which they are entitled.
Demo 20-6A LO20-6 Accounting for Small Stock Dividends
Demo Example One— Small Stock Dividend

WayMart Inc. issued a 10% common stock dividend on 100,000 shares of $1 par common stock
MBC issued and outstanding on May 1, 2020. The market price of the common stock is $5 per share.
The small stock dividend will be distributed on May 25, 2020, to stockholders of record on May 10,
2020. Record the entry on (1) the date of declaration and (2) the date of distribution.
Solution
The small stock dividend is recorded at fair value, with the excess of the fair value of $50,000 over
the par value of $10,000 recorded as an increase to additional paid-in capital for $40,000.
May 1, 2020—To record small stock dividend on date of declaration
250,000
110,000 Retained Earnings (100,000 3 10% 3 $5) �� 50,000
140,000
Ret Earnings CS Div Distrib Common Stock Dividends Distributable (100,000 3 10% 3 $1)�� 10,000
50,000 10,000
Paid-in Capital in Excess of Par—Common Stock (to balance)�� 40,000
Paid-in Cap—CS
40,000
May 25, 2020—To record distribution of small stock dividend

210,000
110,000 Common Stock Dividends Distributable �� 10,000
CS Div Distrib Common Stock Common Stock�� 10,000
10,000 10,000 10,000
continued

© Cambridge Business Publishers Chapter 20 Stockholders’ Equity 20-38
Refer to the information in Brief Exercise 20-49. Instead Landry announces a 2-for-1 stock split not effected Brief Exercise 20-50
through a stock dividend. Analyzing a Stock
Split LO6
a. Prepare the journal entry for the declaration of the stock split on September 30, 2020.
b. Prepare the journal entry for the distribution of the stock split on October 15, 2020.
c. What is the total par value of common stock before and after the stock split?
d. What is the par value per share before and after the stock split?
e. What are the total number of shares before and after the stock split?
Fastco Corp. reports net income of $20,000, and other comprehensive income of $5,000 (net of tax) for the year Brief Exercise 20-51
ended December 31, 2020. The December 31, 2019, balance in accumulated other comprehensive income is Determining the
Balance in Accumulated
$18,000 (credit balance) and the balance in retained earnings is $100,000 (credit balance). What is the ending OCI LO7
balance in accumulated other comprehensive income on December 31, 2020? Hint: See Demo 20-7
Identify whether the following items a through j are part of (1) net income or (2) other comprehensive income. Brief Exercise 20-52
a. Sales revenue Identifying Net
Income and Other
b. Bad debt expense Comprehensive Income
foreign currency
c. Loss from foreign current translation adjustment Amounts LO7
d. Gain on sale of an available-for-sale debt investment
e. Unrealized gain on an available-for-sale debt investment
f. Unrealized gain on an equity investment where investor lacks significant influence
g. Prior service cost amortization expense for a defined benefit plan
h. Unrealized loss on cash flow hedge
i. Loss on impairment of investment
j. Loss on sale of land
Bucky’s Apparel Inc. is considering paying a dividend on December 31, 2020. A loan covenant stipulates that the Brief Exercise 20-53
payout ratio must be less than or equal to 10%. If the company has no preferred stock outstanding, and net in- Analyzing Payout
Ratio LO8
come is expected to be $80,000, what is the maximum value that Bucky may pay out in dividends to the common
shareholders?
The following information is provided for the Coca-Cola Company ($ millions). Brief Exercise 20-54
Computing Equity
Ratios LO8
Total common stockholders’ equity on Dec. 31, 2017�� $17,072
Hint: See Demo 20-8
Total common stockholders’ equity on Dec. 31, 2016�� 23,062
Net income, 2017 �� 1,248
Compute the following ratios for 2017, assuming total number of 2017 common shares outstanding of 4.259 billion.
a. Book value per share
b. Return on equity
Exercises
The following data are from the accounts of Mitar Corporation at December 31, 2020 ($ thousands). Exercise 20-55
Reporting Stockholders’
Equity LO1
Retained earnings, beginning balance �� $ 900
Common stock, $__ par, 100,000 shares authorized, 50,000 shares issued�� 1,000
Treasury stock, 1,000 shares �� 20
Paid-in capital in excess of par�� 400
Bonds payable�� 200
Net income for 2020 (not included in retained earnings above) �� 190
Dividends declared and paid during 2020 (not included in retained earnings above)�� 80
Required
a. Determine the value of the following items.
1. Total retained earnings at end of 2020
2. Par value per share
3. Number of shares outstanding

20-37 Chapter 20 Stockholders’ Equity par © Cambridge Business Publishers
Brief Exercise 20-40 On June 30, 2020, Pier5 Inc. issued 500 shares of $1 common stock for $15 per share. On June 30, 2020, Pier5 Inc.
Preparing Entry for reacquired 50 shares of common stock at $12 per share and immediately retired the shares. On December 15, 2020,
Direct Retirement
of Reacquired Pier5 Inc. reacquired 100 shares of common stock at $17 per share and immediately retired the shares. By what
Shares LO3 amount did retained earnings decrease as a result of the reacquisition of common stock on December 15, 2020?
Hint: See Demo 20-3B
Brief Exercise 20-41 Harlee Inc. has 60,000 shares of $5 par common stock outstanding at the beginning of the year 2020. Prepare en-
Preparing Entries tries for the following transactions affecting stockholders’ equity. Assume Paid-in Capital—Treasury Stock has
for Treasury Stock
Transactions LO3 a zero beginning balance.
a. January 15, 2020: Purchased common stock as treasury shares, 2,000 shares at $20. per share.
b. June 15, 2020: Sold common treasury stock, 800 shares at $14. per share.
Brief Exercise 20-42 Charter Inc. has 600,000 shares of $1 par common stock outstanding at the beginning of the year 2020. Prepare
Preparing Entries entries for the following transactions affecting stockholders’ equity. Assume Paid-in Capital—Treasury Stock
for Treasury Stock
Transactions LO3 has a zero beginning balance.
a. January 31, 2020: Purchased common stock as treasury shares, 1,200 shares at $15. per share.
b. September 15, 2020: Sold common treasury stock, 200 shares at $17. per share.
c. December 20, 2020: Sold common treasury stock, 250 shares at $13. per share.
Brief Exercise 20-43 Regency Inc. issued 800 shares of $20 par value, 8%, cumulative preferred stock for $48,000 on June 30, 2020.
Preparing Entry to Issue Prepare Regency’s journal entry on June 30, 2020.
Preferred Stock LO4
Hint: See Demo 20-4
Brief Exercise 20-44 Urban Inc. had the following capital outstanding. In 2020, Urban Inc. distributes $80,000 in cash dividends to
Determining Dividend shareholders.
Distributions LO5
Common, $1 par, 30,000 shares issued and outstanding�� $ 30,000

8% Preferred, $10 par, 20,000 shares issued and outstanding�� 200,000
a. If the preferred stock is cumulative and dividends are in arrears for the past three years, what is the cash dis-
tribution to common shareholders and preferred shareholders?
b. What is the cash distribution to common shareholders and preferred shareholders if the preferred stock is
noncumulative?
Brief Exercise 20-45 On September 1, 2020, Fox Corporation declared a cash dividend of $1 per share on its 800,000 outstanding
Preparing Dividend shares of common stock ($1 par). The dividend is payable on October 15, 2020, to stockholders of record on Oc-
Entries LO5
Hint: See Demo 20-5A tober 1, 2020. Provide all journal entries directly related to this dividend.
Brief Exercise 20-46 Zerizon Inc. holds 6,000 shares of Cable Co. common stock, which it acquired for $25 per share in May of 2020. On
Preparing Entry June 1, 2020, Zerizon Inc. declares a property dividend of 500 shares of Cable Co. common stock when the shares
for Property
Dividends LO5 are selling at $28 per share. Provide the journal entry on June 1, 2020, for the declaration of the property dividend.
Brief Exercise 20-47 Wellington Corp. declared a dividend on common stock of $250,000 on May 18, 2020. Wellington announced to
Preparing Entry for shareholders that $175,000 of the dividend amount was a return of capital. Provide the journal entry on May 18,
Liquidating Dividend
Declaration LO5 2020, for the dividend declaration.
Brief Exercise 20-48 Landry Inc. has 10,000 shares of common stock, $1 par outstanding. On September 30, 2020, Landry declares a
Preparing Entries 10% stock dividend when the fair value of its common stock is $30 per share. Distribution of the dividend will
for Small Stock
Dividends LO6 be on October 15, 2020.
a. Prepare the journal entry for the declaration of the stock dividend on September 30, 2020.
b. Prepare the journal entry for the distribution of the stock dividend on October 15, 2020.
Brief Exercise 20-49 Landry Inc. has 10,000 shares of common stock, $1 par outstanding. On September 30, 2020, Landry declares
Preparing Entries for a stock split effected in the form of a 100% stock dividend when the fair value of its common stock is $30 per
Stock Split Effected
in the Form of a share. Distribution of the dividend will be on October 15, 2020.
Dividend LO6
a. Prepare the journal entry for the declaration of the stock dividend on September 30, 2020.
b. Prepare the journal entry for the distribution of the stock dividend on October 15, 2020.
20_InterAcc2e_20�indd 37 4/16/19 1:23 PM

20-39 Chapter 20 Stockholders’ Equity © Cambridge Business Publishers
4. Total stockholders’ equity

5. Average original selling price per share
6. Cost per share of treasury stock
b. Prepare the stockholders’ equity section of the balance sheet at December 31, 2020.
Exercise 20-56 On December 31, 2020, Nakoma Inc. had the following account balances.
Reporting Stockholders’
Equity LO1
Preferred stock, $100 par, 5,000 shares authorized�� $ 20,000 Cr.
Hint: See Demo 20-1
Paid in capital in excess of par—Preferred stock �� 80,000 Cr.
Common stock, $1 par, 250,000 shares authorized �� 35,000 Cr.
Paid in capital in excess of par—Common stock �� 480,000 Cr.
Retained earnings�� 360,000 Cr.
Accumulated other comprehensive income�� 48,000 Cr.
Treasury stock, 1,200 shares �� 55,000 Dr.
Noncontrolling interests�� 5,000 Cr.
Prepare the stockholders’ equity section of the balance sheet for Nakoma Inc. on December 31, 2020. State the
par value per share, and the number of shares authorized, issued, and outstanding for common stock and pre-
ferred stock on the face of the statement.
Exercise 20-57 Record journal entries for the following separate transactions.
Recording Entries
for Common Stock a. Max Inc. issued 5,000 shares of $1 par value common stock for $20 per share on January 1, 2020.
Issuance LO2 b. Max Inc. issued 1,000 shares of no-par common stock for $25 on January 1, 2020. The state of incorporation
requires a minimum value per share of $2. per share.
c. Max Inc. issued 500 shares of no-par common stock for $18 per share on January 1, 2020.
d. Max Inc. issued 5,000 shares of $1 par value common stock for $18 per share on January 1, 2020, and in-
curred $1,000 in legal fees related to the stock issuance.
e. Max Inc. issued 10,000 shares of common stock ($1 par) in exchange for equipment with a fair value of
$178,000.
f. Max Inc. issued 3,000 shares of Class A common stock ($1 par) and 4,000 shares of Class B common stock
($2 par) at a price of $80,000. At the time of issuance, the market price of the Class A common stock is $15
per share, and the market price of the Class B common stock is $10 per share.
g. Max Inc. issued 3,000 shares of Class A common stock ($1 par) and 4,000 shares of Class B common stock
($2 par) at a price of $85,000. At the time of issuance, the market price of the Class A common stock is $16
per share, and the market price of the Class B common stock is unknown.
Exercise 20-58 Tridint Corporation is authorized to issue 100,000 shares of $5 par value common stock. The shares of stock are
Recording Entries not publicly traded. During 2020, the company completed the following transactions.
for Common Stock
Issuance LO2
Jan. 8, 2020 Issued 40,000 shares of common stock at $12 per share.
Jan. 30, 2020 Issued 10,500 shares of common stock in exchange for equipment with
an appraised value of $136,500.
Required
a. Prepare the journal entry on January 8, 2020.
b. Prepare the journal entry on January 30, 2020.
c. Would the answer to part b change if the stock were traded on a registered stock exchange at $14 per share
on January 30, 2020? If yes, prepare the journal entry on January 30, 2020.
Exercise 20-59 In May of 2012, Facebook raised over $16 billion in its initial public offering. Approximately 421.2 million
Recording Entry for shares of Class A common stock, $0.000006 par value were sold for $38 a share.
Stock Issuance LO2
Required
Ignoring stock issue costs, record the journal entry for this stock issuance.
Exercise 20-60 Gilmore Company has 20,000 authorized shares of common stock, $2 par, and 20,000 authorized shares of pre-
Recording Entries for ferred stock, $10 par. On April 10, 2020, Gilmore sold 600 shares of common stock and 400 shares of preferred
Multiple Securities
Issuance LO2 stock in one transaction for a total cash price of $20,000. The common stock recently had been selling at $26 per
share while the preferred stock recently had been selling at $16 per share.

21-19 Chapter 21 Share-Based Compensation and Earnings per Share © Cambridge Business Publishers
The weighted-average common shares of 152,250 is used to calculate basic EPS.
Net Income Available to Weighted-Average Common

Common Stockholders Shares Outstanding Per Share
Basic EPS�� $300,000 152,250 $1.97
. Stock Split
b
If the stock dividend were instead a 2-for-1 stock split on October 31, 2020, the retroactive
restatement factor would be 2.0. (Had the stock dividend been instead a reverse, 1-for-2 stock
split on October 31, 2020, the retroactive restatement factor would be 0.5.)
A B (A  B)
Actual Retroactive Equivalent Weighted-
Shares Restatement for Shares Months Fraction of Average Shares
Inclusive Dates Outstanding Split
Stock Dividend Outstanding* Outstanding Year Outstanding
Jan.–Mar. . . . . . . . . 100,000 2.0 200,000 3 3/12 50,000
Apr.–Sept.. . . . . . . . 95,000 2.0 190,000 6 6/12 95,000
Oct. . . . . . . . . . . . . . 145,000 2.0 290,000 1 1/12 24,167
Nov.–Dec.. . . . . . . . 290,000 290,000 2 2/12 48,333
12 100.0% 217,500
* Shares outstanding 3 Retroactive restatement.
The weighted-average common shares of 217,500 is used to calculate basic EPS.

Basic EPS�� $300,000 217,500 $1.38
Example Four—Basic EPS Calculationwith Cash Dividends (Noncumulative Preferred)

Madison Co. has 100,000 common shares outstanding during 2020, and net income of $300,000
for 2020. During the year, the company also has 20,000 shares of 4%, $10 par value preferred
stock outstanding. The preferred stock is noncumulative and preferred dividends of $6,000 were
declared and paid in 2020. Calculate Madison Co.’s basic EPS for 2020.
Solution
The preferred dividends of $6,000 are subtracted from net income in calculating basic earnings per
share. With noncumulative preferred stock, dividends are subtracted in the current year when divi-
dends are declared in the current year. (Had the company declared no dividends on noncumulative
preferred stock, no adjustment for dividends would have been required.)
December 31, 2020—To calculate basic EPS with noncumulative preferred stock

Basic EPS�� $294,0001 100,000 $2.94
1
$300,000 (net income)  $6,000 (preferred dividends).
Example Five—Basic EPS Calculationwith Cash Dividends (Cumulative Preferred)

Let’s now assume Madison Co. has 100,000 common shares outstanding during 2020, and net
income of $300,000 for 2020. During the year, the company also had 20,000 shares of 4%, $10 par
value preferred stock outstanding. The preferred stock is cumulative and no preferred stock divi-
dends were declared in 2020. Calculate Madison Co.’s basic EPS for 2020.
continued

© Cambridge Business Publishers Chapter 21 Share-Based Compensation and Earnings per Share 21-22
future that were not included in the computation of diluted EPS because to do so would have been antidilutive
for the period(s) presented. Full disclosure of the terms and conditions of these securities is required even if a
security is not included in diluted EPS in the current period.
EXPANDING YOUR KNOWLEDGE Convertible Bonds Sold at a Discount or Premium

If a convertible bond is sold at a discount or premium, interest expense on the income statement factors into the amorti-
zation of the discount or premium for the reporting period. This means the adjustment to the numerator described above
should reflect effective interest. For example, let’s assume that a $50,000, 10-year, 5% bond, is sold at $48,000 on Janu-
ary 1, 2020, and that the company’s tax rate is 25%. What is the adjustment to the numerator in the diluted EPS calcu-
lation assuming that the discount is amortized using the straight-line method? Answer: The after-tax interest expense
adjustment including the amortization of the discount of $200 [($50,000  $48,000)/10 years] is: $2,025, computed as
([$50,000  5%]  $200)  0.75.
EPS Calculations—Convertible Bonds LO21-6 Demo 21-6A
Net income for 2020 for Gridley Inc. is $600,000. During the entire year, 1,000, 6%, $1,000 bonds, Demo
issued at par, were outstanding, each convertible into 20 common shares. The weighted-average
shares outstanding before considering potentially dilutive securities is 200,000, and the tax rate is MBC
25%.
. Compute basic EPS for Gridley Inc. for 2020.
a
b. Compute diluted EPS for 2020 using the if-converted method. Indicate the EPS amount(s)
that the company would report in its 2020 income statement.
c. Compute diluted EPS for 2020 using the if-converted method, assuming instead that the
convertible bonds were issued on October 1, 2020. Indicate the EPS amount(s) that the
company would report in its 2020 income statement. Note: This is a new scenario
d. Repeat the requirements of parts a and b, but now assume that the company reported a net where net income of $600,000
loss of $600,000. takes into account the bonds
being issued on October 1.
Solution
a. Basic EPS Calculation

Basic EPS�� $600,000 200,000 $3.00
. Diluted EPS Calculationwith Convertible Bond

b
The impact on EPS assuming that all of the bonds were converted into common stock as of
January 1, 2020, follows.
• Adjustment to numerator: After-tax interest of $45,000 is added, computed as (1,000
bonds  $1,000 par  6%)  (1  25%). Had the bonds been converted at the beginning
of the year, no interest would have been paid, causing earnings after tax to increase
$45,000.
• Adjustment to denominator: 20,000 new common shares are added based on the
assumed conversion (1,000 bonds  20 shares per bond).
The impact on diluted EPS follows.

Basic EPS�� $600,000 200,000 $3.00
Effect of convertible bonds:

Add back interest, net of tax �� 45,000
Add new common shares �� 20,000
Diluted EPS �� $645,000 220,000 $2.93
continued

21-18. A dilutive convertible bond was issued at a premium. Explain how to compute the numerator effect
for such a bond when computing dilutive EPS.
21-19. Explain in general how to handle actual conversions of convertible dilutive securities for basic and
diluted EPS purposes (denominator effect only).
21-20. Shares of a parent corporation will be issued in the future based on the number of retail outlets
opened by a recently acquired subsidiary. The subsidiary predicts that 10 new outlets will be opened
in the next three years. However, to date, no outlets have been opened. Describe how the contingent
shares would be calculated for the parent company’s diluted EPS in this situation.
21-21. Would antidilutive securities be included in the calculation of diluted earnings per share?
21-22. Are the following items required to be disclosed on the face of the financial statements, or either on
the face or in the notes to the financial statements?
1. Income (loss) from continuing operations
2. Net income (loss)
3. Income (loss) from discontinued operations
Brief Exercises
Brief Exercise 21-23 On January 1, 2020, Alaska Inc. issued a total of 1,000 shares of $10 par, restricted common stock to five execu-
Recording Entries tives. The fair value of the shares of stock on January 1, 2020, is $60,000. The restricted shares require a vesting
for Restricted
Shares LO1 period of 3 years, which is the requisite service period, and no forfeitures are anticipated.
Hint: See Demo 21-1A a. Prepare the journal entry (if any) required on January 1, 2020.
b. Prepare the adjusting journal entry required on December 31, 2020.
Brief Exercise 21-24 On January 1, 2020, Alaska Inc. granted restricted stock units to five executives for a total of 1,000 shares of $10
Recording Entries par common stock. The fair value of the shares of stock on January 1, 2020, is $60,000. The restricted shares re-
for Restricted Stock
Units LO1 quire a vesting period of 3 years, which is the requisite service period, and no forfeitures are anticipated.
Hint: See Demo 21-1B a. Prepare the journal entry (if any) required on January 1, 2020.
b. Prepare the adjusting journal entry required on December 31, 2020.
Brief Exercise 21-25 On January 1, 2020, Holiday Inc. offered a stock option incentive plan to a top executive. The plan provided
Recording Stock the executive 300 stock options for Holiday Inc. $1 par value, common stock at an option price of $15 per share
Options: Compensation
Expense, through the expiration date of January 1, 2026. The fair value of the options based upon an option-pricing model
Exercise LO2 on January 1, 2020, is $9,000. The market price at year-end of Holiday Inc. stock is $15 per share on January
Hint: See Demo 21-2 1, 2020, and $18 on December 31, 2020. The requisite service period is 3 years. The options were exercised on
March 1, 2023, when the market price of the stock was $20 per share.
a. Prepare the journal entry (if any) required on January 1, 2020.
b. Prepare the adjusting journal entry required on December 31, 2020, the company’s year-end.
c. Prepare the journal entry required on March 1, 2023.
Brief Exercise 21-26 Refer to the information in Brief Exercise 21-25. The options were granted as described, but instead the execu-
Recording Forfeiture of tive left the company on January 1, 2022. Prepare the journal entry required on January 1, 2022, assuming that
Stock Options LO2
the company’s policy is to record forfeitures as incurred.
Brief Exercise 21-27 On January 1, 2020, Spring Co. awards 10,000 stock options to acquire 10,000 shares of common stock ($1 par
Determining value) to executives at an exercise price of $30 per share. The market price of Spring Co. common stock on the
Compensation Expense
Considering Forfeitures grant date is $30 per share. The options are exercisable after January 1, 2024, and expire when the employee
of Options LO2 leaves the company or on December 31, 2026, whichever is first. Management estimates through a fair value
option-pricing model that total compensation expense is $130,000. The requisite service period is considered to
be 4 years. Spring Co.’s policy is to record forfeitures as they are incurred. Determine compensation expense in
2021 considering 1,500 shares were forfeited in that year.
Brief Exercise 21-28 Assume the same information in Brief Exercise 21-25, except that the employees did not exercise the stock op-
Recording Expiration of tions due to the stock price remaining below $15 per share after the vesting period. Record the entry on January
Stock Options LO2
Hint: See Demo 21-2 1, 2026, for the expiration of the stock options.

Required
Compute the required EPS amounts.
At the end of 2020, the records of Block Corporation reflected the following. Exercise 21-55
Computing EPS:
Simple Capital
Common stock, $5 par, authorized 500,000 shares
Structure LO5, 6
Outstanding January 1, 2020, 400,000 shares �� $2,000,000
Sold and issued April 1, 2020, 2,000 shares�� 10,000
Issued 5% stock dividend, September 30, 2020; 20,100 shares�� 100,500
Preferred stock, 6%, $10 par, nonconvertible, noncumulative, authorized 50,000 shares,
outstanding during year, 20,000 shares�� 200,000
Paid-in capital in excess of par, common stock�� 180,000
Paid-in capital in excess of par, preferred stock �� 100,000
Retained earnings (after the effects of current preferred dividends declared during 2020) �� 640,000
Bonds payable, 6.5%, nonconvertible, issued at par January 1, 2020�� 1,000,000
Net income �� 164,000
Income tax rate, 25%
Required
a. What EPS presentation is required—basic, diluted, or both?
b. Compute the required EPS amounts.
c. Compute the required EPS amounts, assuming that the preferred stock is cumulative.
C-Bay Inc.’s accounting year ends on December 31. During the following three years, its common shares out- Exercise 21-56
standing changed as follows. Calculating EPS:
Simple Capital
Structure and 3
2022 2021 2020 years LO5
Hint: See Demo 21-5
Shares outstanding, January 1�� 150,000 120,000 100,000
Sales of shares, April 1, 2020�� 20,000
25% stock dividend, July 1, 2021 �� 30,000
2-for-1 stock split, July 1, 2022�� 150,000
Shares sold, October 1, 2022�� 50,000
Shares outstanding, December 31 �� 350,000 150,000 120,000
Required
a. For purposes of calculating EPS at the end of each year, determine the number of shares outstanding. Hint:
Consider each reporting year separately.
b. For purposes of calculating EPS at the end of 2022, when comparative statements are being prepared on a
three-year basis, determine the number of shares outstanding for each year.
c. Compute EPS for each year based on computations in part b. Assume net income is $375,000, $330,000, and
$299,000, for years 2022, 2021, and 2020, respectively.
Select Corporation was incorporated on January 2, 2020. The following information pertains to Select Corpora- Exercise 21-57
tion’s 2020 common stock transactions. Calculating EPS:
Simple Capital
Structure LO5
Jan. 2 Number of shares authorized �� 250,000 Hint: See Demo 21-5
Jan. 2 Number of shares issued�� 85,000
Jul. 1 Number of shares reacquired but not canceled�� 5,000
Sept. 1 Two-for-one stock split
Dec. 1 Reissued shares of treasury stock �� 5,000
Required
a. Determine the weighted-average number of shares of Select Corporation’s common stock outstanding.
b. Compute earnings per share for 2020 considering the following additional information:
1. Net income: $330,000
2. Preferred stock, 5%, cumulative, 5,000 shares, $10 par value per share
3. Preferred dividends declared in 2020: $0 outstanding

Exercise 21-58 On December 31, 2020, Americana Inc. had 175,000 shares of common stock issued and outstanding. Americana
Calculating EPS: Inc. issued a 40% stock dividend on July 1, 2020. On October 1, 2020, the company purchased 20,000 shares of
Simple Capital
Structure LO5 its common stock for the treasury, and declared a 2-for-1 stock split on December 31, 2020. American also had
10,000 shares of 5%, $20 par value cumulative preferred stock outstanding. No dividends were declared on either
the preferred or the common stock in 2019 or 2020. Net income for 2020 was $1,000,000.
Required
a. Compute the required EPS amount.
b. Compute the required EPS amount assuming instead that Americana Inc. declared and paid the current year
preferred dividend and one year of dividends in arrears in December 2020.
c. Compute the required EPS amount assuming instead that the preferred stock is noncumulative.
Exercise 21-59 Grace Corp. suffered a net loss in 2020 of $100,000. The company has 100,000 common shares outstanding as of
Computing EPS: Simple January 1, 2020, and declared a 1-for-2 reverse stock split on March 31. In addition, the company bought 5,000
Capital Structure and
Net Loss LO5 shares for the treasury on August 31, 2020, and 2,000 shares of stock were issued on November 1, 2020, in ex-
change for legal services. The company had 1,000 shares of 5%, $10 par, cumulative, nonconvertible preferred
stock for the year 2020. No common or preferred stock dividends were declared in 2020. Weighted-average
shares outstanding in 2020 were 110,000 shares for common stock and 10,000 shares for preferred stock.
Required
Compute the required EPS amount.
Exercise 21-60 Jones Corporation’s capital structure follows.

Computing Diluted
EPS: Convertible
Bonds and Convertible December 31 2020
Preferred Stock LO9
Outstanding shares of stock
Common stock, outstanding shares�� 110,000
Convertible preferred stock, outstanding shares�� 10,000
8% Convertible bonds�� $1,000,000
During 2020, Jones declared and paid dividends of $3.00 per share on its preferred stock. The preferred shares
are convertible into 20,000 shares of common stock. The 8% bonds are convertible into 30,000 shares of com-
mon stock. Net income for 2020 is $850,000. Assume that the income tax rate is 25%.
Required
a. Compute basic EPS for 2020.
b. Compute diluted EPS for 2020.
Exercise 21-61 Shaffer Corporation issued 100, $1,000, 10% convertible bonds in 2019 at face value. Each bond is convertible
Computing EPS: into 100 shares of common stock. Shaffer’s net income for 2020 is $1,824,000 ($2,432,000 before tax). Consid-
Convertible
Debt LO6 ering all factors except convertible bonds, average common shares outstanding for 2020 are 1,010,000.
Required
a. Compute basic EPS.
b. Compute diluted EPS.
c. How do the answers to parts a and b change if the bonds were issued on July 1, 2020?
d. Ignoring part c, how do the answers to parts a and b change if one-half of the bonds were converted on July
1, 2020?
Exercise 21-62 Bridgeman Company, headquartered in San Francisco, reported the following data for the current year.
Computing EPS:
Net income, $2,220,000.
Convertible
Preferred with Partial Common shares outstanding at the beginning of the year, 800,000.
Conversion LO6 Nonconvertible cumulative preferred stock, $100 par, $8 dividend per share per year, 100,000 shares out-
standing all year.
Issued 200,000 shares of common stock on October 1.
Convertible cumulative preferred stock, $100 par, $7 dividend per share per year, 50,000 shares outstanding at
the beginning of the year. On March 31, 20,000 shares of preferred stock converted to 40,000 common shares.
For both preferred stock issues, assume dividends are paid for time held.

Required
Rand Inc. had a net income of $800,000. During the year, 200,000 shares were outstanding on average and Exercise 21-63
Rand’s common stock sold at an average market price of $50. In addition, Rand had 20,000 stock options out- Computing Diluted
EPS: Stock
standing to purchase a total of 20,000 common shares at $25 for each option exercised. Options LO7
Required per share.
Spencer Inc.’s 2020 earnings of $500,000 reflect a tax rate of 25%. During the entire year, Spencer had the fol- Exercise 21-64
lowing securities outstanding: Computing EPS
with Multiple
120,000 shares of common stock. Potentially Dilutive
Securities LO9
5,000 shares of 6%, $100 par, nonconvertible, cumulative preferred stock.
Hint: See Demo 21-9
5,000 shares of 6%, $100 par, cumulative preferred stock, each convertible into 1.75 shares of common stock.
500 bonds, $1,000 face value, 8% interest, each convertible into 30 shares of common stock (issued at face value).
200 bonds, $1,000 face value, 6% interest, each convertible into 20 shares of common stock (issued at face value).
Required
Zolar Corporation reported basic earnings per share of $2.18 ($22,875,000/10,500,000) based on the following data. Exercise 21-65
Correcting EPS
Calculation LO5
Net income �� $22,875,000
Common shares
January 1, 2020�� 12,000,000
December 31, 2020�� 9,000,000
Average number of shares outstanding�� 10,500,000
After examining Zolar’s records, we note that Zolar acquired and retired 4 million shares on April 1, 2020, and
issued 1,000,000 shares on September 30, 2020. No equity securities besides common stock are outstanding, and
Zolar has no convertible securities or stock options outstanding.
Required
a. Is Zolar’s basic EPS calculation of $2.18 per share accurate?
b. Revise the EPS calculation if
if you
we believe it is incorrect.
c. Now assume that in addition to the information provided above, Zolar has outstanding 100,000 shares of
$100 par, 5% cumulative preferred, issued on September 9, 2014. The annual dividend was declared and
paid in 2020. Revise the EPS calculation.
At the end of 2020, the records of Wolverine Corporation reflected the following. Exercise 21-66
Calculating EPS
Common stock, $10 par; authorized 100,000 shares: issued and outstanding throughout the year, with Multiple
50,000 shares �� $500,000 Securities LO5, 6,
Preferred stock, $50 par, 7%, cumulative, convertible into common stock, share for share; 7, 9
authorized, 10,000 shares; issued and outstanding throughout year, 2,000 shares�� 100,000
Contributed capital in excess of par, common stock�� 80,000
Retained earnings (no dividends declared during the year) �� 470,000
Bonds payable, 10% nonconvertible, issued at par in 2016�� 150,000
Stock options outstanding (all year for 10,000 shares of common stock at $15 per share).
Income tax rate, 25%.
Average market price of the common stock during 2020, $25 per share.
Required
a. Is this a simple or a complex capital structure?

Exercise 21-67 At the end of 2020, the records of Ruso Corporation reflected the following.
Calculating EPS
with Convertible
Common stock, no-par, authorized 250,000 shares: issued and outstanding throughout the
Debt LO5, 6
period to December 1, 2020, 60,000 shares. A 2-for-1 stock split was issued on December 1,
2020. �� $840,000
Preferred stock, 5%, $10 par, nonconvertible, cumulative, nonparticipating, shares authorized,
issued, and outstanding during year, 10,000 shares�� 100,000
Contributed capital in excess of par, preferred stock �� 30,000
Retained earnings (no cash or property dividends during year)�� 570,000
Bonds payable, 8%, issued January 1, 2020; each $1,000 bond is convertible into 60 shares of
common stock after the stock split on December 1, 2020 (bonds initially sold at par) �� 200,000
Required
a. Is this a simple or a complex capital structure?
Exercise 21-68 StarStruck Inc. granted 500 shares of restricted stock (common shares, $1 par) to its president on January 1, 2020,
Calculating EPS with when the stock was trading at $40 per share. Net income for 2020 was $250,000 and 40,000 shares were out-
Restricted Stock LO7
Hint: See Demo 21-7B standing throughout 2020. On average, the fair value of common shares in 2020 was $40 per share. The restricted
shares vest after 3 years if the president remains with the company.
Required
b. Compute diluted EPS
Exercise 21-69 In 2020, Xonacs acquired Realtest Service. The acquisition agreement included a commitment by Xonacs to the
Calculating Diluted shareholders of Realtest that if 2021 net income exceeded $250,000, an additional 50,000 shares of Xonacs stock
EPS: Contingent
Shares LO8 would be issued to the shareholders in 2022. Realtest’s net income in 2020 was $255,000.
Hint: See Demo 21-8
Required
a. How many contingent shares would Xonacs recognize in its calculation of 2020 diluted EPS?
b. Suppose Realtest’s earnings in 2020 were $200,000. How many contingent shares would Xonacs recognize
in its calculation of 2020 diluted EPS?
Exercise 21-70 Match each term, 1 through 12 with its impact on the EPS calculation, a through e. A scenario may have
Analyzing EPS LO5, more than one impact on the EPS calculation. Assume a simple capital structure unless the scenario indicates
6, 7, 8
otherwise. Ignore the possibility of antidilutive securities and the initial impact on net income of a particular
transaction.
Scenario Impact on EPS Calculation
1. Noncumulative, 7% preferred stock dividend with no dividend a. Effects numerator in basic
declaration. EPS calculation.
2. Cumulative, 7% preferred stock dividend with no dividend declaration. b. Effects denominator in
3. Issuance of stock options. basic EPS calculation.
4. Retirement of common shares. c. Effects numerator in
5. Stock dividend declared during the year. diluted EPS calculation.
6. Stock dividend declared after the calendar year but before financial d. Effects denominator in
statements are issued. diluted EPS calculation.
7. Stock split. e. No impact on EPS
8. Issuance of convertible noncumulative preferred stock with no divi- calculation.
dend declaration.
9. Issuance of convertible bonds.
10. Conditions for issuance are met for unissued contingent shares.
11. Purchase of shares for the treasury.
12. Granting of restricted common stock (not vested).

Problem 21-80 At the end of 2020, the records of Luholtz Corporation showed the following.
Presenting Earnings
per Share: Convertible
Common stock, no-par, authorized 500,000 shares; issued and outstanding throughout period,
Bonds LO5, 6, 9
100,000 shares �� $680,000
Stock dividend issued, December 31, 2020, 50,000 shares (not included in the 100,000 shares
above) �� 340,000
Retained earnings (after effect of dividends on all shares)�� 500,000
Bonds payable, 4.5%; each $1,000 bond is convertible to 80 shares of common stock after
the stock dividend (bonds issued at par in 2018)�� 100,000
Bonds payable, 6.5%; each $1,000 bond is convertible to 90 shares of common stock after
the stock dividend (bonds issued at par in 2018)�� 300,000
Required
Prepare the required EPS presentation for 2020.
Problem 21-81 Wilson Corporation’s financial statements at December 31, 2020, reported the following.
Computing Earnings
per Share with a Net
Accrued interest payable�� $ 1,000
Loss LO5, 6, 7
Long-term notes payable, 10%, due 2023�� 50,000
Bonds payable, 7%; each $1,000 of face value is convertible into 90 shares of common stock;
2030, issued at par in 2018��
bonds mature in 2014, 800,000
Preferred stock, 5%, nonconvertible, cumulative, $100 par, issued in 2011�� 300,000
Common stock, $5 par, outstanding all year�� 700,000
Common stock options outstanding all year entitling holders to acquire 40,000 shares of
common stock at $9 per share�� 200,000
Net loss for 2020�� (125,000)
Additional data
1,000 shares of preferred stock were issued at par on July 1, 2020. Dividends were declared and paid semi-
annually, on May 31 and November 30. On newly issued shares, dividends are prorated from issue date.
Average market price of common stock during 2020 was $10.
Wilson’s income tax rate is 25%.
Required
a. Compute the basic EPS amount that Wilson must report on the income statement for 2020.
b. Compute the diluted EPS amount that Wilson must report on the income statement for 2020.
Problem 21-82 PellCo is subject to an agreement whereby it must issue shares to shareholders of a company it acquired in 2020,
Computing EPS: if certain conditions are met. These shares are issuable the year following the year in which the relevant condi-
Contingently Issuable
Shares LO8 tions are met. The agreement specifies:
1. PellCo will issue 20 shares for each $1,000 in net income of the combined enterprise in excess of $100,000.
2. PellCo will issue 1,000 shares for each new patent awarded to the recently acquired subsidiary (a research
enterprise) during the year.
3. PellCo will issue 50 shares for each $5 increase in the market price of PellCo’s stock above the price at the
beginning of the year.
Data for 2020 follows.
Year Patents Awarded Beginning Stock Price Ending Stock Price Earnings
2020�� 3 $30 $41 $190,000
Required
a. Determine the contingent shares to be included in basic EPS for 2020.
b. Determine the contingent shares to be included in diluted EPS for 2020.

© Cambridge Business Publishers Chapter 22 Statement of Cash Flows Revisited 22-44
and paid dividends of $8,000. As of December 31, 2020, common shares of Towne Corporation were trading at
$20 per share.
Required
a. Assume that Allen Corporation had significant influence over Towne Corporation. Record the entries for
2020 for Allen Corporation.
b. Indicate how the investment transactions would affect the statement of cash flows for 2020, assuming that
the company uses the indirect method in reporting cash flows from operating activities.
United Company signed an 8% installment note with Bank One on January 1, 2020, for $100,000. The install- Exercise 22-47
ment note calls for 5 equal payments at the end of 5 years beginning on December 31, 2020. Presenting Installment
Note on Statement of
Required Cash Flows LO2, 4
a. Calculate the amount of each installment payment.

b. Indicate how the installment note transactions would affect the statement of cash flows for 2020, assuming
that the company uses the indirect method in reporting cash flows from operating activities.
Yale Corporation issued a $60,000 5-year bond dated January 1, 2020, at 8% with 6% interest payable annually Exercise 22-48
on December 31. Assume that the company uses the effective interest amortization method. Presenting Bond
Payable on Statement
Required of Cash Flows LO4
a. Provide journal entries to be made on January 1, 2020, and December 31, 2020.
b. Indicate how the bond transactions would affect the statement of cash flows for 2020, assuming that the
company uses the indirect method in reporting cash flows from operating activities.
On January 1, 2020, Less

LesseeInc.
Inc. signs a three-year non-cancelable agreement to lease equipment (no residual value) Exercise 22-49
from Lessor Inc. Lessee Inc. accounts for the lease as a finance lease, which requires three lease payments of Classifying Lessee
Transactions in
$34,972 each, payable January 1, 2020, December 31, 2020, and December 31, 2021. The lessor’s implicit rate is Statement of Cash
5%, which is known to the lessee, resulting in the recording of right-to-use asset and lease liability of $100,000 Flows LO2, 4, 5
(or 5PV(0.05,3,34972.07,0,1) at the inception of the lease. As a result, the lessee recorded the following entries
in 2020 (amounts rounded).
January 1, 2020—To record right-of-use asset and lease liability
Right-of-Use Asset�� 100,000
Lease Liability �� 100,000
January 1, 2020—To record lease payment
Cash�� 34,972
December 31, 2020—To record lease payment
Interest Expense �� 3,251
Cash�� 34,972
December 31, 2020—To record amortization on right-of-use asset
Amortization Expense�� 33,333
Right-of-Use Asset ($100,000/3) �� 33,333
Required
Determine the effects on the statement of cash flows of Lessee Inc. for 2020 assuming that the company follows
the indirect method in reporting cash flows from operating activities.
The following items are relevant to the preparation of a statement of cash flows for Pier Imports Inc. Exercise 22-50
Determining Investing
1. Comparative balance sheets show a decrease of $6,000 in accrued utilities payable for the current year. and Financing
2. Nontrade short-term notes payable to banks increased $80,000 during the current year due to new borrowings. Activities LO3, 4

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© Cambridge Business Publishers Chapter 15 Current Liabilities and Contingencies 15-40

15_InterAcc2e_15.indd 40 5/21/21 8:51 AM

15_InterAcc2e_15.indd 41 5/21/21 8:51 AM

Face amount of policy�������������������������������������������������� $400,000

15_InterAcc2e_15.indd 42 5/21/21 8:51 AM

Current assets Current liabilities

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Cash received upon note issuance

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continued from previous page

$100,000 Note payable $100,000 Note payable $100,000 Note payable

Interest expense in fiscal year 2020

*FYE: Fiscal year-end

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Sales Actual Warranty Expenditures

Cash Sales Actual Warranty Expenditures

15_InterAcc2e_15.indd 47 5/21/21 8:51 AM

Exercise 15-69 The following transactions relate to topics in this chapter.

Exercise 15-70 The following transactions relate to topics in this chapter.

15_InterAcc2e_15.indd 49 5/21/21 8:51 AM

continued from previous page

. Derecognition of Note Payable

Notes Payable Issued for Noncash Consideration [Property,

Demo 16-6B LO16-6 Note Payable Issued for Noncash Consideration

16_InterAcc2e_16.indd 25 5/20/21 4:20 PM

continued from previous page

December 31, 2022—To record retirement of remaining bonds at maturity

Example Three: Extinguishment of Debt Before Maturity with Refunding

January 1, 2024—To record issuance of the 8% bonds payable

REVIEW 16-7 LO16-7 Accounting for Extinguishment of Debt

16_InterAcc2e_16.indd 31 5/20/21 4:21 PM

Demo 16-10 LO16-10 Fair Value Option Accounting for Liabilities

. Fair Value Adjustment—Bond Issued at a Discount

AIG Real World—Fair Value Option

16_InterAcc2e_16.indd 39 5/20/21 4:21 PM

continued from previous page

Example Three: Restructuring of Debt at Less than Debt Carrying Value

Book value of debt, January 1, 2020 ($500,000  $50,000)������������������������������� $550,000

Interest Payable�������������������������������������������������������������������������������������� 50,000 Interest Payable

Sum of restructured cash flows

16_InterAcc2e_16.indd 46 4/12/19 10:40 AM

Settlement of a Receivable If a receivable (such as a note receivable) is settled by the debtor

Modification of Terms of a Receivable A creditor measures the loss on a receivable by dis-

Debt Restructuring and Debt Settlement—CREDITOR Perspective LO16-12 Demo 16-12B

Settlement of Debt* (to balance) ����������������������������������������

Interest Receivable ($500,000 3 10%) ���������������������������������������� 50,000 Land

Example Two: Settlement of Debt through Transfer of Equity Interest

Settlement of Debt* (to balance) ����������������������������������������

Interest Receiv Note Receiv

Example Three: Restructuring of Debt at Less than Debt Carrying Value

January 1, 2020—To record troubled debt restructure for Credex (creditor)

Bad Debt Expense���������������������������������������������������������������������������������� 184,711

Allowance for Doubtful Accounts ������������������������������������������������ 184,711 Interest Receiv

16_InterAcc2e_16.indd 48 5/20/21 4:21 PM

Company on December 1, 2020.

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c. Prepare journal entries on the following dates.

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d. Provide the entry to record the bond retirement on September 1, 2020.

Face amount of policy�� $400,000

Book value of debt, January 1, 2020 ($500,000  $50,000)�� $550,000

Interest Payable�� 50,000 Interest Payable

Settlement of Debt* (to balance) ��

Interest Receivable ($500,000 3 10%) �� 50,000 Land

Settlement of Debt* (to balance) ��

Bad Debt Expense�� 184,711

Allowance for Doubtful Accounts �� 184,711 Interest Receiv

Discount on Bonds Payable ($100,000 1 $5,000 2 $102,000)�� 3,000 102,000

Accumulated Depreciation�� 22,000 Bal. 50,000 54,000

Settlement of Debt (to balance)��

2020�� $ 33,512 $3,251 $31,873 $ 35,124

Dec. 31, 2020 �� $65,358 $63,746

Lease Liability �� 16,980 216,980 216,980

Tax rate�� × 25% Def Tax Asset Inc Tax Payable

2020�� $145,000 2021�� $155,000 2022�� $150,000 2023�� $148,000

Projected benefit obligation�� $100,000

b. Present value benefit stream�� $55,201 (PV of annuity of $7,500, 10 years, 6%)

c. 4/14) �� $ 8,226