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Accounting for Long-Term Debt
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The three typical accounting events associated with borrowing money through a bond issue are:
Required
a. Assuming the bonds are issued at face value, show the effect of each of the three events on the financial statements using a horizontal statements model like the following one. Use + for increase, − for decrease, and NA for not affected.
b. Repeat the requirements in Requirement a, but assume instead that the bonds are issued at a discount.
c. Repeat the requirements in Requirement a, but assume instead that the bonds are issued at a premium.
On January 1, Year 1, Twain Corp. sold $500,000 of its own 7 percent, 10-year bonds. Interest is payable annually on December 31. The bonds were sold to yield an effective interest rate of 8 percent. The bonds sold for $477,422.
Required
a. Prepare the journal entry for the issuance of the bonds.
b. Prepare the journal entry for the amortization of the bond discount and the payment of the interest at December 31, Year 1. (Assume effective interest amortization.)
c. Prepare the journal entry for the amortization of the bond discount and the payment of interest on December 31, Year 1. (Assume straight-line amortization.)
d. Calculate the amount of interest expense for Year 2. (Assume effective interest amortization.)
e. Calculate the amount of interest expense for Year 2. (Assume straight-line amortization.)
The following information pertains to Austin, Inc. and Huston Company:
| Account Title | Austin | Huston |
|---|---|---|
| Current assets | $40,000 | $40,000 |
| Total assets | $300,000 | $300,000 |
| Current liabilities | $15,000 | $20,000 |
| Total liabilities | $200,000 | $240,000 |
| Stockholders’ equity | $100,000 | $60,000 |
| Interest expense | $14,000 | $17,000 |
| Income tax expense | $28,000 | $27,000 |
| Net income | $52,000 | $50,000 |
Required
a. Compute each company’s debt-to-assets ratio, current ratio, and times interest earned (EBIT must be computed). Identify the company with the greater financial risk.
b. Compute each company’s return-on-equity ratio and return-on-assets ratio. Use EBIT instead of net income when computing the return-on-assets ratio. Identify the company that is managing its assets more effectively. Identify the company that is producing the higher return from the stockholders’ perspective. Explain how one company was able to produce a higher return on equity than the other.
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