Chapter 9
Liabilities
Short Exercises
(10 min.) S 9-1 Journal
DATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT
2012
July 31 Inventory……… 11,000
Note Payable, Short-Term……… 11,000
Purchased inventory by issuing a note payable.
2013
Apr. 30 Interest Expense ($11,000 × .12 × 9/12)……….. 990
Interest Payable……….. 990
Accrued interest expense.
July 31 Note Payable, Short-Term………... 11,000
Interest Payable……… 990
Interest Expense ($11,000 × .12 × 3/12)……….. 330
Cash……… 12,320
Paid note payable and interest at maturity.
Balance Sheet on April 30, 2013:
Note payable, short-term $11,000
Interest payable 990
Income Statement, April 30, 2013:
(5-10 min.) S 9-2
Req. 1
2012 2011
Accounts payable turnover:
COGS Average accounts payable
$2,700,000 = 9 $300,000
$2,500,000 = 10 $250,000
Days payable outstanding:
365 Accounts payable turnover
365 = 41 days 9 365 = 37 days 10 Req. 2
The company’s liquidity position has deteriorated during 2012.
(10 min.) S 9-3
Req. 1
Journal
DATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT
Cash ($564,000 × .40)………..….. 225,600
Notes Receivable ($564,000 $255,600)..− 338,400
Sales Revenue……… 564,000
To record sales on account.
Warranty Expense ($564,000 × .05)……… 28,200
Estimated Warranty Payable……….…. 28,200
To accrue warranty expense.
Estimated Warranty Payable………... 18,000
Cash……….…. 18,000
To pay warranty claims.
Req. 2
Estimated Warranty Payable
Bal. 13,000
18,000 28,200
Bal. 23,200
(5-10 min.) S 9-4 Warranty expense = $28,200
The expense recognition principle addresses this situation.
The warranty expense for the year does not necessarily equal the year’s cash payments for warranties. Cash payments for warranties do not determine the amount of warranty expense for that year. Instead, the warranty expense is estimated and deducted from
revenue during the period of the sale, regardless of when the company pays for warranty claims.
Student responses may vary.
(5-10 min.) S 9-5 1. These are contingent liabilities, because, at the time of the note, Tony Chase, Inc.,
was not liable for any of these product losses.
2. In the United States, the contingency can become a real liability if a user of a Tony Chase product suffers a loss for which the company is responsible.
Tony Chase must pay for all individual losses up to $3.8 million and all aggregate losses above $26.3 million. The company is insured against losses between $3.8 million and $26.3 million.
3. Outside the United States, the contingency becomes a real liability the same way — if a Tony Chase user suffers a loss for which the company is responsible.
Outside the United States, Tony Chase must pay only for losses above $26.3 million because the company is insured against losses up to $26.3 million.
(5-10 min.) S 9-6 a. $155,500 ($200,000 × .7775) b. $207,000 ($200,000 × 1.0350) c. $188,500 ($200,000 × .9425) d. $205,000 ($200,000 × 1.0250) (5 min.) S 9-7 a. Discount b. Premium
c. Par (face) value d. Discount
(5-10 min.) S 9-8 Journal
DATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT
2012
a. July 1 Cash……….. 125,000
Bonds Payable……….. 125,000
To issue bond at par.
b. Dec. 31 Interest Expense ($125,000 × .08 × 6/12)……. 5,000
Interest Payable………. 5,000
To accrue interest expense. 2013
c. Jan. 1 Interest Payable……….. 5,000
Cash………. 5,000
To pay semiannual interest on bonds. 2019
d. July 1 Bonds Payable……… 125,000
Cash………... 125,000
(10-15 min.) S 9-9
Req. 1 Amortization table
A B C D E Semiannual Interest Date Interest Payment (3% of Maturity Value) Interest Expense (4.5% of Preceding Bond Carrying Amount) Discount Amortization (B - A) Discount Account Balance (Preceding (D - C) Bond Carrying Amount ($560,000 - D) Mar. 31, 2012 $109,200 $450,800 Sept. 30, 2012 $16,800 $20,286 $3,486 105,714 454,286 Mar. 31, 2013 16,800 20,443 3,643 102,071 457,929 Sept. 30, 2013 16,800 20,607 3,807 98,264 461,736 Req. 2 Journal
DATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT
2012
Mar. 31 Cash ($560,000 × .805)……… 450,800
Discount on Bonds Payable…….. 109,200
Bonds Payable………. 560,000
Sept. 30 Interest Expense……….. 20,286
Discount on Bonds Payable… 3,486
Cash……….. 16,800
(10 min.) S 9-10
Req. 1— Borrowed $450,800. Maturity value is $560,000. Req. 2—Cash interest is $16,800.
Req. 3—Interest expense September 30, 2012 is $20,286.
Interest expense March 31, 2013 is $20,443.
(10-15 min.) S 9-11
Req. 1—Borrowed $2,925,000:
Journal
DATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT
2012
July 1 Cash ($3,000,000 × .975)……… 2,925,000
Discount on Bonds Payable………. 75,000
Bonds Payable……… 3,000,000
Req. 2—Pay back $3,000,000 at maturity, July 1, 2022.
Req. 3—Cash interest is $120,000 ($3,000,000 × 8% × 6/12) each six months.
Req. 4—Interest expense is $123,750 [$120,000 + ($75,000 / 20)]
Journal
DATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT
2012
Dec. 31 Interest Expense... 123,750
Discount on Bonds Payable... 3,750
Interest Payable... 120,000
2013
Jan. 1 Interest Payable... 120,000
(10-15 min.) S 9-12 Req. 1 Best Buy Co. Wal Mart Stores 5 Leverage ratio $17,849 / $7,292 2.45 $180,663 / $71,247 2.53 6 Total debt $17,849 - $7,292 $10,557 $180,663 - $71,247 $109,416 7 Debt ratio $10,557 / $17,849 .59 $109,416 / $180,663 .60 8 Times interest earned $2,114 / $87 24.2 times $25,542 / $1,928 13.2 times Req. 2
Both companies’ debt-paying abilities are strong. From the standpoint of leverage (debt) the companies are about equal. However, Best Buy has a stronger times-interest-earned ratio (24.2 vs. 13.2).
(10-15 min.) S 9-13 Plan A Issue $1,000,000 of 7% Bonds Payable Plan B Issue $1,000,000 of Common Stock Net income before expansion... $400,000 $400,000 Project income before interest
and income tax... $ 100,000 $100,000 Less: interest expense ($1,000,000 × .07) (70,000 ) -0 -Project income before income tax... 30,000 100,000 Less income tax expense (30%)... (9,000 ) (30,000 )
Project net income... 21,000 70,000 Total company net income... $421,000 $470,000 Earnings per share including expansion:
Plan A ($421,000 / 100,000 shares)... $4.21
Plan B ($470,000 / 200,000 shares)... $2.35
Recommendation: To increase earnings per share, Wavetown Marina should borrow the
(5-10 min.) S 9-14
Req. 1
Leverage ratio
$100.0 / $40.0 = 2.5
This means that Evenson has $2.50 of assets for every dollar of stockholders’ equity.
Debt ratio $60.0 / $100.0 = .60
This means that Evenson has $.60 in liabilities (debt) for every dollar of assets.
Times interest earned
$4.1 / $1.1 = 3.73 times This means that for every dollar of interest expense Evenson has earned $3.73 of operating income.
Evenson’s debt ratio is about average and can cover its existing interest expense. I would be willing to lend Evenson $1 million.
(10 min.) S 9-15
LIABILITIES Current:
Accounts payable……….. $ 33,000
Current portion of bonds payable……. 56,000
Interest payable……….. 1,700
Total current liabilities………. 90,700
Long term:
Notes payable, long-term………. 125,000
Bonds payable……… $375,000
Less: Discount on bonds payable……. (11,250 ) 363,750
Exercises
(5-15 min.) E 9-16A
Req. 1
Journal
DATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT
Warranty Expense ($111,000 × .08)………… 8,880
Estimated Warranty Payable……….. 8,880
Estimated Warranty Payable……… 7,000
Cash……….. 7,000 Req. 2 INCOME STATEMENT Sales revenue……… $111,000 Warranty expense……… 8,880 BALANCE SHEET Current liabilities
Estimated warranty payable
($5,000 + $8,880 $7,000)………− $ 6,880
Req. 3
Estimated warranty payable, a current liability, will cause a company’s current ratio to
decrease.
(10-15 min.) E 9-17A Journal
DATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT
2012
Oct. 1 Cash……… 2,616
Unearned Subscription Revenue…………... 2,400
Sales Tax Payable ($2,400 × .09)……… 216
Nov. 15 Sales Tax Payable………... 216
Cash……….. 216
Dec. 31 Unearned Subscription Revenue……… 600
Subscription Revenue ($2,400 × 3/12)…….. 600
BALANCE SHEET Current liabilities: Unearned subscription revenue ($2,400 $600)……− $1,800 (10 min.) E 9-18A INCOME STATEMENT Expenses: Payroll expense………. $150,000 Payroll tax expense ($150,000 × .08)……… 12,000 BALANCE SHEET Current liabilities: Salary payable……… $7,500 Payroll tax payable………... 700
(5-10 min.) E 9-19A Req. 1 Accrued interest, Dec. 31, 2012 = $85,000 × .08 × 9/12 = $5,100 Req. 2 Final payment = $85,000 + ($85,000 × .08) = $91,800 on April 1, 2013 Req. 3
Interest expense for:
2012 = $85,000 × .08 × 9/12 = $5,100
2013 = $85,000 × .08 × 3/12 = $1,700
(10-15 min.) E 9-20A Olsen’s balance sheet at December 31, 2013, reported:
Income tax payable... $166,000* Olsen’s 2013 income statement reported:
Income tax expense ($900,000 × .29)... $261,000 _____
* Beginning income tax payable...……….. $150,000
+ Income tax expense (and payable) for the year...
$900,000 × .29)... 261,000
− Income tax payments during the year... (245,000 )
(10-20 min.) E 9-21A
Req. 1
Accounts payable are amounts owed to suppliers for products or services that have been purchased on account.
Accrued expenses are expenses that the company has incurred but not yet paid. They are liabilities for expenses such as interest and income taxes.
Employee compensation and benefits are amounts owed to employees for salaries and other payroll-related expenses.
Current portion of long-term debt is next year’s payment on the company’s long-term debt.
Long-term debt is the amount of long-term notes and bonds payable that the company expects to pay after the coming year.
Postretirement benefits are the company’s liabilities for providing benefits — mainly health care — to retirees.
The other liabilities are a catch-all group of liabilities that do not fit one of the more specific categories. The other liabilities are long-term, as shown by the fact that they are not listed among the current liabilities.
(continued) E 9-21A Req. 2
Total assets = $3,714 million, the sum of total liabilities and stockholders’ equity.
(in millions) 2012
Leverage
ratio =
Total assets ($3,714)
Total stockholders’ equity ($1,951) = 1.90
Debt ratio = Total liabilities ($3,714 $1,951)*− = 0.47
Total assets ($3,714) For 2011, the leverage ratio was 2.26 and the debt ratio was .56.
Both the leverage ratio and debt ratio improved in 2012. Therefore, the company improved. ____ *Or, $259 + $1,394 + $102 + $8 = $1,763 Req. 3 2012 2011 Accounts payable turnover
Cost of goods sold $1,656
= 11.3 $1,790 = 9.6 Average Accounts payable $146 $186 *($110 + $182) / 2 **($182 + $190) / 2 Days payable outstanding 365 365 = 32.3 365 = 38.0 Accts. payable turnover 11.3 9.6 Current ratio Current assets $661 = 2.55 $600 = 1.52 Current liabilities $259 $394
The company’s ability to cover accounts payable and current liabilities over the year improved.
(5-10 min.) E 9-22A
Req. 1
Smith Security Systems should report this situation in a note to the financial statements. The note should convey essentially the same message given in Note 14.
Req. 2
Smith would report: INCOME STATEMENT
Estimated loss (or expense)……… $3,000,000
BALANCE SHEET
Estimated liability……… $3,000,000
The note disclosure would be similar to Requirement 1. Journal
DATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT
2012
Estimated Loss from Damage Claim 3,000,000
(15-20 min.) E 9-23A Banff Electronics
Balance Sheet (partial) March 31, 2012 Current liabilities:
a. Estimated warranty payable
[$35,000 + ($2,400,000 × .04) $57,000]− ... $ 74,000 b. Current portion of long-term note payable... 16,250 Interest payable ($65,000 × .07 × 1/12)... 379 c. Unearned sales revenue ($100,000 $85,000)− ... 15,000 d. Employee withheld income tax payable... 30,900 FICA tax payable ($320,000 × .0765)…... 24,480 Total current liabilities... $161,009
Long-term liabilities:
Note payable ($65,000 $16,250)− ... $ 48,750
(10-15 min.) E 9-24A
Req. 1
Journal
DATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT
2012
a. Jan. 31 Cash ($8,000,000 × 0.96)... 7,680,000 Discount on Bonds Payable... 320,000
Bonds Payable... 8,000,000 To issue bonds at a discount.
b. July 31 Interest Expense... 312,000
Cash ($8,000,000 × .07 × 6/12)... 280,000
Discount on Bonds Payable
($320,000 / 10)... 32,000 To pay interest and amortize bonds.
c. Dec. 31 Interest Expense... 260,000 Interest Payable
($8,000,000 × .07 × 5/12)... 233,333 Discount on Bonds Payable
($320,000 / 10 × 5/6)... 26,667 To accrue interest and amortize bonds.
(10-15 min.) E 9-25A
1. Cash received = $100,000 × 1.05 = $105,000
2. Principal……… $100,000
Interest ($100,000 × .07 × 20)………... 140,000
Total cash paid……… $240,000
3. Total cash paid……… $240,000
Less: Cash received……….... (105,000 )
Difference = Total interest expense………... $135,000
4. Annual interest expense by the straight-line amortization method:
$100,000 × .07 $100,000 × (1.05 1.00)−
20
$7,000 − $250 = $ 6,750
Cash interest payment Premium amortization
× 20 years
Total interest expense over the life of the bonds $135,000
Chapter 9 Liabilities 9-25
(15-20 min.) E 9-26A
Req. 1 (amortization table)
SEMIANNUAL INTEREST DATE A INTEREST PAYMENT (2 ½ % OF MATURITY VALUE) B INTEREST EXPENSE (3% OF PRECEDING BOND CARRYING AMOUNT) C DISCOUNT AMORTIZATION (B – A) D DISCOUNT ACCOUNT BALANCE (PRECEDING D – C) E BOND CARRYING AMOUNT ($4,000,000 – D) Dec. 31, 2012 $297,550 $3,702,450 June 30, 2013 $100,000 $111,073 $ 11,073 286,477 3,713,524 Dec. 31, 2013 100,000 111,406 11,406 275,071 3,724,929 June 30, 2014 100,000 111,748 11,748 263,323 3,736,677 Dec. 31, 2014 100,000 112,100 12,100 251,223 3,748,777 Req. 2 Journal
DATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT
2012
Dec. 31 Cash……… 3,702,450
Discount on Bonds Payable…………. 297,550
Bonds Payable……… 4,000,000
To issue bonds at a discount. 2013
June 30 Interest Expense... 111,074
Cash... 100,000
Discount on Bonds Payable... 11,074
To pay semiannual interest and amortize bonds.
2013
Dec. 31 Interest Expense... 111,406
Cash... 100,000
To pay semiannual interest and amortize bonds.
(15-20 min.) E 9-27A
Req. 1 (amortization table)
SEMIANNUAL INTEREST DATE A INTEREST PAYMENT (4½% OF MATURITY VALUE) B INTEREST EXPENSE (4% OF PRECEDING BOND CARRYING AMOUNT) C PREMIUM AMORTIZATION (A – B) D PREMIUM ACCOUNT BALANCE (PRECEDING D – C) E BOND CARRYING AMOUNT ($4,000,000 + D) June 30, 2012 $395,800 $4,395,8001 Dec. 31, 2012 $180,000 $175,832 $4,168 391,632 4,391,632 June 30, 2013 180,000 175,665 4,335 387,297 4,387,297 Dec. 31, 2013 180,000 175,492 4,508 382,789 4,382,789 June 30, 2014 180,000 175,312 4,688 378,101 4,378,101 _____ 1$4,000,000 × 1.09895 = $4,395,800
Req. 2 (journal entries)
Journal
DATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT
2012
June 30 Cash ($4,000,000 × 1.09895)……….. 4,395,800
Bonds Payable………... 4,000,000
Premium on Bonds Payable………… 395,800
To issue bonds at a premium.
Dec. 31 Interest Expense……….. 175,832
Premium on Bonds Payable………. 4,168
Cash……….. 180,000
To pay semiannual interest and amortize bonds. 2013
June 30 Interest Expense………. 175,665
Premium on Bonds Payable.………... 4,335
Cash………. 180,000
To pay semiannual interest and amortize bonds.
(15-20 min.) E 9-28A
A B C D E F
1 Bond
2 Interest Interest Discount Discount Carrying
3 Date Payment Expense Amortization Balance Amount
4 5 Jan. 1, 2012 $21,071 $278,929 6 Dec. 31, 2012 $18,000 $19,525 $1,525 19,546 280,454 7 Dec. 31, 2013 18,000 19,632 1,632 17,914 282,086 8 Dec. 31, 2014 18,000 19,746 1,746 16,168 283,832 9 Dec. 31, 2015 18,000 19,868 1,868 14,300 285,700 10 Dec. 31, 2016 18,000 19,999 1,999 12,301 287,699 11 Dec. 31, 2017 18,000 20,139 2,139 10,162 289,838 12 Dec. 31, 2018 18,000 20,289 2,289 7,873 292,127 13 Dec. 31, 2019 18,000 20,449 2,449 5,424 294,576 14 Dec. 31, 2020 18,000 20,620 2,620 2,804 297,196 15 Dec. 31, 2021 18,000 20,804 2,804 0 300,000
(15-20 min.) E 9-29A
Req. 1
The company has the right to occupy space and operate out of leased stores for several years to come. In return, the company is obligated to make payments amounting to over $2.6 billion dollars to various landlords (lessors).
Req. 2
The rights and obligations discussed in Req. 1 are classified as operating leases and are not reported on the balance sheet. Omitting them from the balance sheet improves (lowers) the company’s debt and leverage ratios.
Req. 3
In the future, the FASB and IASB are proposing to eliminate most operating leases. If this rule change occurs, companies like Abercrombie and Fitch Co. will have to capitalize leased property as assets and also record the related lease obligations as liabilities.
(20-25 min.) E 9-30A
Amounts in millions or billions
Company Company Company
Ratio B N V
Current
= Total current assets = $429 ¥5,321 €144,720
ratio Total current liabilities $227 ¥2,217 € 72,000
= 1.89 = 2.40 = 2.01
B N V
Debt
=== = Total liabilities* = $227 + $77 ¥2,217 + ¥2,277 €72,000 + €111,177
ratio Total assets** $429 + $81 ¥5,321 + ¥592 €144,720 + €65,828
= 0.60 = 0.76 = 0.87 B N V Leverage ratio = Total assets = $510 ¥5,913 €210,548
Tot. stockholders’ equity $206 ¥1,419 €27,371
= 2.48 = 4.17 = 7.69
B N V
Times-
= Operating income = $295 ¥230 €5,646
earned Interest expense $41 ¥27 €655
ratio
= 7.2 times = 8.5 times = 8.6 times
_____
B N V
Assets $510 ¥5,913 €210,548
Based on these ratio values, Company N looks the least risky.
(15-20 min.) E 9-31A Req. 1 PLAN A BORROW $600,000 AT 6% PLAN B ISSUE $600,000 OF COMMON STOCK
Net income before expansion……… $300,000 $300,000
Project income before interest and income tax $500,000 $500,000
Less interest expense ($600,000 × .06)………. 36,000 -0-
Project income before income tax………. 464,000 500,000
Less: income tax expense (25%)……… (116,000) (125,000)
Project net income………. 348,000 375,000
Total company net income……… $648,000 $675,000
Earnings per share including new project:
Plan A ($648,000 / 100,000 shares)……... $6.48
(continued) E 9-31A
Req. 2
MEMORANDUM
TO: Board of Directors of Prime Nation Financial Services
FROM: Student Name
SUBJECT: Financing plan to expand operations
Plan A (borrowing) results in much higher earnings per share. Plan A also allows the existing stockholders to retain control of the company because the company issues no new stock. But Plan A also creates more financial risk because borrowing obligates the company to pay the interest and the principal of the debt. I prefer Plan A, assuming the company’s level of debt is not already too high.
Students can defend either plan based on their preferences for control of the business, avoidance of risk, and higher earnings per share.
(5-15 min.) E 9-32B
Req. 1
Journal
DATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT
Warranty Expense ($176,000 × .09)………… 15,840
Estimated Warranty Payable……….. 15,840
Estimated Warranty Payable……… 9,000
Cash……….. 9,000 Req. 2 INCOME STATEMENT Sales revenue……… $176,000 Warranty expense……… 15,840 BALANCE SHEET Current liabilities
Estimated warranty payable
($2,000 + $15,840 $9,000)………...− $ 8,840
Req. 3
Estimated warranty payable, a current liability, will cause a company’s current ratio to
(10-15 min.) E 9-33B Journal
DATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT
2012
Oct. 1 Cash……… 2,247
Unearned Subscription Revenue…………... 2,100
Sales Tax Payable ($2,100 × .07)……… 147
Nov. 15 Sales Tax Payable………... 147
Cash……….. 157
Dec. 31 Unearned Subscription Revenue……… 525
Subscription Revenue ($2,100 × 3/12)…….. 525
BALANCE SHEET Current liabilities:
Unearned subscription revenue ($2,100 $525)……− $1,575
(10 min.) E 9-34B INCOME STATEMENT
Expenses:
Payroll expense………. $190,000
Payroll tax expense ($190,000 × .08)……… 15,200
BALANCE SHEET Current liabilities:
Salary payable……… $ 8,000
Payroll tax payable………... 750
(5-10 min.) E 9-35B Req. 1 Interest to accrue at = $84,000 × .07 × 3/12 = $1,470 Dec. 31, 2012 Req. 2 Final payment = $84,000 + ($84,000 × .07) = $89,880 on October 1, 2013 Req. 3
Interest expense for:
. = $84,000 × .07 × 3/12 = $1,470
(10-15 min.) E 9-36B McKinley’s balance sheet at December 31, 2013 reported:
Income tax payable………... $436,000*
McKinley’s 2013 income statement reported:
Income tax expense ($1,600,000 × .36)……… $576,000
_____
* Beginning income tax payable……….. $210,000
+ Income tax expense (and payable) for the year
($1,600,000 × .36)……… 576,000
− Income tax payments during the year………. (350,000 )
= Ending income tax payable……… $436,000
(10-20 min.) E 9-37B
Req. 1
Accounts payable are amounts owed to suppliers for products or services that have been purchased on account.
Accrued expenses are expenses that the company has incurred but not paid. They are liabilities for expenses such as interest and income taxes.
Employee compensation and benefits are amounts owed to employees for salaries and other payroll-related expenses.
Current portion of long-term debt is next year’s payment on the company’s long-term debt.
Long-term debt is the amount of long-term notes and bonds payable that the company expects to pay after the coming year.
Postretirement benefits are the company’s liabilities for providing benefits — mainly health care — to retirees.
The other liabilities are a catch-all group of liabilities that do not fit one of the more specific categories. The other liabilities are long-term, as shown by the fact that they are not listed among the current liabilities.
(continued) E 9-37B
Req. 2
Total assets = $4,050 million, the sum of total liabilities and stockholders’ equity.
(in millions) 2012
Leverage
ratio =
Total assets ($4,050)
Total stockholders’ equity ($2,027) = 2.0
Debt ratio = Total liabilities ($4,050 $2,027)*− = 0.50
Total assets ($4,050)
For 2011, the leverage ratio was 2.23 and the debt ratio was .55.
Both the leverage ratio and debt ratio improved. Therefore, the company improved. ____ *Or, $368 + $1,497 + $138 + $20 = $2,023 Req. 3 2012 2011 Accounts payable turnover
Cost of goods sold $1,885
= 11.8 $2,196 = 11.6 Average accounts payable $159* $188** *($137 + $181) / 2 **($181 + $195) / 2 Days payable outstanding 365 365 = 30.9 365 = 31.5 Accts. payable turnover 11.8 11.6 Current ratio Current assets $643 = 1.75 $610 = 1.62 Current liabilities $368 $376 Chapter 9 Liabilities 9-41
The company’s ability to cover accounts payable and current liabilities over the year improved.
(5-10 min.) E 9-38B
Req. 1
Clark Security Systems should report this situation in a note to the financial statements. The note should convey essentially the same message given in Note 14.
Req. 2
Clark would report: INCOME STATEMENT
Estimated loss (or expense)……… $2,000,000
BALANCE SHEET
Estimated liability……… $2,000,000
The note disclosure would be similar to Requirement 1.
Journal
DATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT
2012
Estimated Loss from Damage Claim 2,000,000
Estimated Liability from Damage Claim 2,000,000
(15-20 min.) E 9-39B Jasper Electronics
Balance Sheet (partial) June 30, 2012 Current liabilities:
a. Estimated warranty payable
[$36,000 + ($2,100,000 × .06) $51,000]………− $111,000
b. Current portion of long-term note payable……... 11,250
Interest payable ($45,000 × .07 × 1/12)……… 263
c. Unearned sales revenue ($130,000 $75,000)….− 55,000
d. Employee withheld income tax payable…………. 30,300
FICA tax payable ($300,000 × .0765)……… 22,950
Total current liabilities……….. $230,763
Long-term liabilities:
(10-15 min.) E 9-40B
Req. 1
Journal
DATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT
a. Jan. 31 Cash ($9,000,000 × 0.93)……… 8,370,000
Discount on Bonds Payable…………. 630,000
Bonds Payable………... 9,000,000
To issue bonds at a discount.
b. July 31 Interest Expense... 436,500
Cash ($9,000,000 × .09 × 6/12)... 405,000
Discount on Bonds Payable
($630,000 / 20)... 31,500 To pay interest and amortize bonds.
c. Dec. 31 Interest Expense... 363,750 Interest Payable
($9,000,000 × .09 × 5/12)... 337,500 Discount on Bonds Payable
($31,500 × 5/6)... 26,250 To accrue interest and amortize bonds.
(10-15 min.) E 9-41B
1. Cash received = $300,000 × 1.01 = $303,000
2. Principal……… $300,000
Interest ($300,000 × .06 × 20)………... 360,000
Total cash paid……… $660,000
3. Total cash paid……… $660,000
Less: Cash received………... (303,000 )
Difference = Total interest expense………... $357,000
4. Annual interest expense by the straight-line amortization method:
$300,000 × .06 $300,000 × (1.01 1.00)−
20
$18,000 − $150 = $ 17,850
Cash interest payment Premium amortization
× 20 years
Total interest expense over the life of the bonds $357,000
(15-20 min.) E 9-42B
Req. 1 (amortization table)
SEMIANNUAL INTEREST DATE A INTEREST PAYMENT (6% OF MATURITY VALUE) B INTEREST EXPENSE (7% OF PRECEDING BOND CARRYING AMOUNT) C DISCOUNT AMORTIZATION (B – A) D DISCOUNT ACCOUNT BALANCE (PRECEDING D – C) E BOND CARRYING AMOUNT ($3,200,000 – D) Dec. 31, 2012 $339,000 $2,861,000 June 30, 2013 $192,000 $200,270 $8,270 330,730 2,869,270 Dec. 31, 2013 192,000 200,849 8,849 321,881 2,878,119 June 30, 2014 192,000 201,468 9,468 312,413 2,887,587 Dec. 31, 2014 192,000 202,131 10,131 302,282 2,897,718 Req. 2 Journal
DATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT
2012
Dec. 31 Cash... 2,861,000 Discount on Bonds Payable... 339,000
Bonds Payable... 3,200,000 To issue bonds at a discount.
2013
June 30 Interest Expense... 200,270
Cash... 192,000
Discount on Bonds Payable... 8,270
To pay semiannual interest and amortize bonds.
2013
Dec. 31 Interest Expense... 200,849
Cash... 192,000
Discount on Bonds Payable... 8,849
To pay semiannual interest and amortize bonds.
(15-20 min.) E 9-43B
Req. 1 (amortization table)
SEMIANNUAL INTEREST DATE A INTEREST PAYMENT (4% OF MATURITY VALUE) B INTEREST EXPENSE (3-1/2% OF PRECEDING BOND CARRYING AMOUNT) C PREMIUM AMORTIZATION (A – B) D PREMIUM ACCOUNT BALANCE (PRECEDING D – C) E BOND CARRYING AMOUNT ($1,600,000 + D) June 30, 2012 $188,000 $1,788,000 Dec. 31, 2012 $64,000 $62,580 $1,420 186,580 1,786,580 June 30, 2013 64,000 62,530 1,470 185,110 1,785,110 Dec. 31, 2013 64,000 62,479 1,521 183,589 1,783,589 June 30, 2014 64,000 62,426 1,574 182,015 1,782,015 _____ 1$1,600,000 × 1.1175 = $1,788,000
Req. 2 (journal entries)
Journal
DATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT
2012
June 30 Cash ($1,600,000 × 1.1175)……….. 1,788,000
Bonds Payable……… 1,600,000
Premium on Bonds Payable… 188,000
To issue bonds at a premium.
Dec. 31 Interest Expense………. 62,580
Premium on Bonds Payable……… 1,420
Cash ………. 64,000
To pay semiannual interest and amortize bonds. 2013
June 30 Interest Expense………. 62,530
Premium on Bonds Payable.……... 1,470
Cash……….. 64,000
(15-20 min.) E 9-44B
A B C D E F
1 Bond
2 Interest Interest Discount Discount Carrying
3 Date Payment Expense Amortization Balance Amount
4 5 Jan. 1, 2012 $33,120 $416,880 6 Dec. 31, 2012 $22,500 $25,013 $2,513 30,607 419,393 7 Dec. 31, 2013 22,500 25,164 2,664 27,943 422,057 8 Dec. 31, 2014 22,500 25,323 2,823 25,120 424,880 9 Dec. 31, 2015 22,500 25,493 2,993 22,127 427,873 10 Dec. 31, 2016 22,500 25,672 3,172 18,955 431,045 11 Dec. 31, 2017 22,500 25,863 3,363 15,592 434,408 12 Dec. 31, 2018 22,500 26,064 3,564 12,028 437,972 13 Dec. 31, 2019 22,500 26,278 3,778 8,250 441,750 14 Dec. 31, 2020 22,500 26,505 4,005 4,245 445,755 15 Dec. 31, 2021 22,500 26,745 4,245 0* 450,000*
*Note: Computer-generated solutions may contain slight rounding differences.
(15-20 min.) E 9-45B
Req. 1
The company has the right to occupy space and operate out of leased stores for several years to come. In return, the company is obligated to make payments amounting to over $1 billion dollars to various landlords (lessors). A very small portion of these payments may be offset by receipts from sub-leases to other tenants.
Req. 2
The rights and obligations discussed in Req. 1 are classified as operating leases and are not reported on the balance sheet. Omitting them from the balance sheet improves (lowers) the company’s debt and leverage ratios.
Req. 3
In the future, the FASB and IASB are proposing to eliminate most operating leases. If this rule change occurs, companies like Ann Taylor Stores Corporation will have to capitalize leased property as assets and also record the related lease obligations as liabilities.
(20-25 min.) E 9-46B
Amounts in millions or billions
Company Compan
y Company
Ratio F K R
Current
= Total current assets = $434 ¥5,383 €148,526
ratio Total current liabilities $207 ¥2,197 €72,100
= 2.10 = 2.45 = 2.06
F K R
Debt
= Total liabilities = $207 + $107 ¥2,197 + ¥2,318 €72,100 + €110,107
ratio Total assets $434 + $96 ¥5,383 + ¥405 €148,526 + €49,525
= 0.59 = 0.78 = 0.92 F K R Leverage ratio = Total assets = $530 ¥5,788 €198,051
Tot. stockholders’ equity $216 ¥1,273 €15,844
= 2.45 = 4.55 = 12.50
F K R
Times-
interest-=Operating income = $292 ¥224 €5,592
earned Interest expense $46 ¥33 €736
ratio
= 6.4 times = 6.8 times = 7.6 times
_____
F K R
Assets $530 ¥5,788 €198,051
Liabilities $314 ¥4,515 €182,207 Based on these ratio values, Company K looks the least risky.
(15-20 min.) E 9-47B Req. 1 PLAN A BORROW $900,000 AT 10% PLAN B ISSUE $900,000 OF COMMON STOCK
Net income before expansion……….. $600,000 $600,000
Project income before interest and income tax.. $800,000 $800,000
Less: interest expense ($900,000 × .10)………… (90,000) -0-
Project income before income tax………. 710,000 800,000
Less: income tax expense (40%)……… (284,000) (320,000)
Project net income……….. 426,000 480,000
Total company net income………. $1,026,000 $1,080,000
Earnings per share including new project:
Plan A ($1,026,000 / 200,000 shares)………… $5.13
Plan B ($1,080,000 / 450,000 shares)………... $2.40
(continued) E 9-47B
Req. 2
MEMORANDUM
TO: Board of Directors of United Nation Financial Services
FROM: Student Name
SUBJECT: Financing plan to expand operations
Plan A (borrowing) results in much higher earnings per share. Plan A also allows the existing stockholders to retain control of the company because the company issues no new stock. But Plan A also creates more financial risk because borrowing obligates the company to pay the interest and the principal of the debt. I prefer Plan A, assuming the company’s level of debt is not already too high.
Students can defend either plan based on their preferences for control of the business, avoidance of risk, and higher earnings per share.
Quiz Q9-48 d Q9-49 a Q9-50 d Q9-51 c Q9-52 a Q9-53 b [($650,000 + $850,000) × .07] – $5,200 $42,500 = $57,300− Q9-54 d Q9-55 a Q9-56 f Q9-57 b Q9-58 c Q9-59 b ($400,000 × .13) + [($400,000 $388,000) / 10] = $53,200− Q9-60 Interest Expense……….. 39,900
Discount on Bonds Payable
($12,000 / 10 × 9/12)……… 900
Interest Payable ($400,000 × .13 × 9/12)…... 39,000
Q9-61 Interest Payable………... 39,000
Interest Expense……….. 13,300
Discount on Bonds Payable
($12,000 / 10 × 3/12)………. 300 Cash ($400,000 × .13)………... 52,000 Q9-62 d ($295,000 x .07) = $20,650) Q9-63 c Q9-64 c Q9-65 c Q9-66 a Chapter 9 Liabilities 9-57
Problems
(15-20 min.) P 9-67A a. Sales tax payable ($150,000 × .06)... ……… $9,000
b. Note payable, short-term...……… $81,000
Interest payable ($81,000 × .04 × 4/12)... ……… 1,080 c. Unearned service revenue ($3,000 × 4/6)...……… $1, 000 d. Estimated warranty payable
($11,300 + $32,000 $34,500)− ... ………... $8,800 e. Portion of long-term note payable due
within one year... ………. $20,000
Interest payable ($100,000 × .06)... ……….. 6,000
(30-40 min.) P 9-68A Journal
DATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT
2012
Mar. 3 Inventory... 50,000
Note Payable, Short-term... 50,000 May 31 Cash... 85,000
Note Payable, Short-term... 17,000 Note Payable, Long-term... 68,000 Sept. 3 Note Payable, Short-term... 50,000
Interest Expense ($50,000 × .08 × 6/12)…… 2,000
Cash... 52,000 Dec. 31 Warranty Expense ($196,000 × .025)... 4,900
Estimated Warranty Payable... 4,900
31 Interest Expense ($85,000 × .08 × 7/12) 3,967
Interest Payable... 3,967 2013
May 31 Note Payable, Short-term... 17,000 Interest Payable... 3,967
Interest Expense ($85,000 × .08 × 5/12)…… 2,833
(20-25 min.) P 9-69A
Req. 1
Journal
DATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT 2012
a. May 31 Cash ($7,000,000 × 1/2)…………... 3,500,000
Bonds Payable………. 3,500,000
To issue bonds at par.
b. Nov. 30 Interest Expense………... 157,500
Cash ($3,500,000 × .09 × 6/12)…. 157,500
To pay interest on bonds.
c. Dec. 31 Interest Expense
($3,500,000 × .09 × 1/12)……….. 26,250
Interest Payable………... 26,250
To accrue interest. 2013
d. May 31 Interest Payable………. 26,250
Interest Expense
($3,500,000 × .09 × 5/12)……….. 131,250
Cash ($3,500,000 × .09 × 6/12)….. 157,500
To pay interest on bonds.
Req. 2 (reporting the liabilities on the balance sheet at December 31, 2012) Current liabilities: Interest payable... $ 26,250 Long-term liabilities: Bonds payable... $3,500,000 Chapter 9 Liabilities 9-61
30-40 min.) P 9-70A
Req. 1
The 6% bonds issued when the market interest rate is 5% will be priced at a premium. They are relatively attractive in this market, so investors will pay a price above par value to acquire them.
Req. 2
The 6% bonds issued when the market interest rate is 7% will be priced at a discount. They are relatively unattractive in this market, so investors will pay less than par value to acquire them.
(continued) P 9-70A
Req. 3
Journal
DATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT 2012
a. Feb. 28 Cash ($900,000 × .96)... 864,000 Discount on Bonds Payable... 36,000
Bonds Payable... 900,000 To issue bonds at a discount.
b. Aug. 31 Interest Expense... 28,800
Cash ($900,000 × .06 × 6/12)... 27,000 Discount on Bonds Payable
($36,000 / 20)... 1,800 To pay interest and amortize bonds.
c. Dec. 31 Interest Expense... 19,200
Interest Payable ($27,000 × 4/6)... 18,000 Discount on Bonds Payable
($1,800 × 4/6)... 1,200 To accrue interest and amortize bonds.
2013
d. Feb. 28 Interest Payable (from Dec. 31)…………. 18,000
Interest Expense... 9,600
Cash ($900,000 × .06 × 6/12)... 27,000 Discount on Bonds Payable
($1,800 × 2/6)... 600 To pay interest and amortize bonds.
Req. 4 (reporting the liabilities on the balance sheet at December 31, 2012)
Current liabilities:
Interest payable………. $ 18,000
Bonds payable………... $900,000 Less: Discount on bonds payable
($36,000 $1,800 - $1,200)……..− (33,000 ) 867,000
(30-40 min.) P 9-71A
Req. 1
Journal
DATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT
2012
Jan. 1 Cash ($4,000,000 × .95)... 3,800,000 Discount on Bonds Payable... 200,000
Bonds Payable………... 4,000,000
To issue bonds at a discount.
July 1 Interest Expense... 130,000
Cash ($4,000,000 × .06 × 6/12)... 120,000
Discount on Bonds Payable
($200,000 / 20)... 10,000 To pay interest and amortize bonds.
Dec. 31 Interest Expense... 130,000 Interest Payable
($4,000,000 × .06 × 6/12)... 120,000
Discount on Bonds Payable…………... 10,000
To accrue interest and amortize bonds. 2013
Jan. 1 Interest Payable... 120,000
Cash... 120,000 To pay interest.
2022
Jan. 1 Bonds Payable... 4,000,000
Cash... 4,000,000 To pay bonds at maturity.
(continued) P 9-71A
Req. 2
Carrying amount at December 31, 2012.
Bonds payable, net
($4,000,000 $200,000 + $10,000 + $10,000)……… − $3,820,000
Req. 3
a. Interest expense = $130,000
b. Cash interest paid = $120,000
Interest expense exceeds cash interest paid because the company issued the bonds at a discount and must pay back the full face value of the bonds at maturity. Amortization of the bond discount causes the interest expense on the bonds to exceed the amount of cash interest paid.
(30-45 min.) P 9-72A
Req. 1
a. Maturity value is $5,000,000
b. Annual cash interest payment is $300,000 ($5,000,000 × .06)
c. Carrying amount is $4,479,360
Req. 2 (amortization table)
ANNUAL INTEREST DATE A INTEREST PAYMENT (6% OF MATURITY VALUE) B INTEREST EXPENSE (8% OF PRECEDING BOND CARRYING AMOUNT) C DISCOUNT AMORTIZATION (B – A) D DISCOUNT ACCOUNT BALANCE (PRECEDIN G D – C) E BOND CARRYING AMOUNT ($5,000,000–D) Dec. 31, Yr. 1 $520,640 $4,479,360 Dec. 31, Yr. 2 $300,000 $358,349 $58,349 462,291 4,537,709 Dec. 31, Yr. 3 300,000 363,017 63,017 399,274 4,600,726 Dec. 31, Yr. 4 300,000 368,058 68,058 331,216 4,668,784
Interest expense for the year ended December 31, Year 4, is $368,058.
Req. 3 (reporting the liabilities at December 31, Year 4)
Current liabilities:
Current installment of notes payable…….. $ 55,000
Bonds payable………... $5,000,000
Less: Discount on bonds payable………. (331,216 ) 4,668,784
Notes payable……… 275,000
(40-50 min.) P 9-73A
Req. 1 (amortization table)
SEMIANNUAL INTEREST DATE A INTEREST PAYMENT (5.5% OF MATURITY VALUE) B INTEREST EXPENSE (6% OF PRECEDING BOND CARRYING AMOUNT) C DISCOUNT AMORTIZATION (B – A) D DISCOUNT ACCOUNT BALANCE (PRECEDING D – C) E BOND CARRYING AMOUNT ($4,000,000 – D) 12-31-12 $229,400 $3,770,600* 6-30-13 $220,000 $226,236 $6,236 223,164 3,776,836 12-31-13 220,000 226,610 6,610 216,554 3,783,446 6-30-14 220,000 227,007 7,007 209,547 3,790,453 12-31-14 220,000 227,427 7,427 202,120 3,797,880 _____ *$4,000,000 × .94265 = $3,770,600
(continued) P 9-73A
Req. 2
Journal
DATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT
2012
a. Dec. 31 Cash ($4,000,000 × .94265)... 3,770,600 Discount on Bonds Payable... 229,400
Convertible Bonds Payable... 4,000,000
To issue bonds at a discount. 2013
b. June 30 Interest Expense... 226,236
Cash... 220,000
Discount on Bonds Payable... 6,236
To pay interest and amortize bonds.
c. Dec. 31 Interest Expense... 226,610
Cash... 220,000
Discount on Bonds Payable... 6,610
To pay interest and amortize bonds. 2014
d. July 1 Convertible Bonds Payable... 1,600,000 Discount on Bonds Payable
($209,547 × 2/5)... 83,819
Common Stock (90,000 × $1)... 90,000
Paid-in Capital in Excess of
Par — Common... 1,426,181 To record conversion of bonds.
Req. 3 (balance sheet presentation of bonds payable at December 31, 2014)
Convertible bonds payable
($4,000,000 $1,600,000)− ... $2,400,000 Less: Discount on bonds payable
($202,120 × 3/5*)... (121,272 ) 2,278,728
_____
*3/5 of the bonds are outstanding, so 3/5 of the discount remains.
(20-30 min.) P 9-74A
Req. 1
TO: Management of Tony Sporting Goods
FROM: Student Name
SUBJECT: Advantages and disadvantages of borrowing
versus issuing stock to raise cash for expansion
Raising money by borrowing has at least two advantages over issuing common stock. Borrowing does not change the present ownership of the business. It enables the present owners to keep their proportionate interests in the business and to carry out their plans without interference from a new group of stockholders. Under normal conditions, borrowing results in a higher earnings per share of common stock, because the interest expense on the debt is tax-deductible. And higher earnings per share usually lead to higher stock prices for company owners.
The main disadvantage of borrowing is that the debt increases the financial risk of the company. The principal and the related interest expense must be paid whether the company is earning a profit or not. If times get sufficiently bad, the debt burden could threaten the ability of the business to continue as a going concern.
The main advantage of issuing stock is that owners avoid the burden of making interest and principal payments on the debt. Issuing stock creates no liability to pay anything to the owners. If the directors consider it necessary, they can refuse to pay dividends in order to conserve cash. Therefore, it is safer to issue stock.
(continued) P 9-74A
One disadvantage of issuing stock is dilution of the ownership interests of existing stockholders if the purchasers of new stock are outsiders. The new stockholders may have different ideas about how to manage the business and that may pose difficulties for the original stockholder group. Another disadvantage of issuing stock is that earnings per share are usually lower because of (1) the greater number of shares of stock outstanding, and (2) the non-tax-deductibility of dividends paid on the stock.
There is insufficient information available upon which to make a decision. Tony’s management must prepare budgets which indicate the impact of the new stores in terms of net income and cash flow. Management must also estimate the cost of borrowing the funds.
(20-30 min.) P 9-75A
Req. 1
Brighton Foods, Inc. Partial Balance Sheet
December 31, 2012 Property, plant, and
equipment: Current liabilities:*
Equipment... $744,000 Mortgage note
Accumulated payable, current... $ 92,000
depreciation... (166,000) Bonds payable,
578,000 current portion... 500,000
Interest payable... 75,000 Total current liabilities... 667,000 Long-term liabilities: Mortgage note payable... $ 318,000 Bonds payable…. $200,000 Discount on bonds payable…. (25,000)* 175,000 Pension liability... 30,000 ** Total long-term liabilities... 523,000
Notes:
* The order of listing current liabilities and long-term liabilities is optional. However, Discount on Bonds Payable should come immediately after Bonds Payable. Also, it is customary to report Interest Payable after the related liability accounts, Mortgage Note Payable and Bonds Payable, Current
Portion.
** Computation of pension liability:
Accumulated pension benefit obligation……….……... $450,000 Less: Pension plan assets, at market value………... (420,000 ) Pension liability to be reported on the balance sheet…………... $ 30,000
(continued) P 9-75A
Req. 2
a. Carrying amount of bonds payable:
Current portion………. $ 500,000
Long-term portion ($200,000 $25,000)…….− 175,000
Carrying amount……….. $675,000
b. Interest payable is the amount of interest that Brighton owes at year end. Interest expense is the company’s cost of borrowing for the full year.
Req. 3
Times-interest-earned ratio = Operating income = $370,000
Interest expense $229,000 = 1.62 times Req. 4 Leverage ratio = Total assets ($4,500,000)
Total stockholders’ equity ($3,310,000) = 1.36
Debt ratio = Total liabilities [$1,190,000 = $667,000 + $523,000] = 0.26
Total assets ($4,500,000)
The company’s debt ratio and leverage ratios are low, and operating income covers interest payments by 1.62 times. With this limited information, the company appears to be low risk from a leverage point of view. Additional information from prior years and competitors would also be helpful.
(continued) P 9-75A
Req. 5
Leverage
ratio =
Total assets ($7,500,000)
Total stockholders’ equity ($3,310,000) = 2.26
Debt ratio = Total liabilities ($4,190,000) = 0.56
Total assets ($7,500,000)
The leverage ratio and debt ratio would increase. The company would still be considered healthy (average risk) from a leverage point of view.
(15-20 min.) P 9-76B
a. Sales tax payable ($130,000 × .07)... $9,100 b. Note payable, short-term... $80,000 Interest payable ($80,000 × .06 × 4/12)... 1,600 c. Unearned service revenue ($3,000 × 2/6)... $1,000 d. Estimated warranty payable
($11,800 + $34,000 $34,800)− ... $11,000 e. Portion of long-term note payable due
within one year... $30,000 Interest payable ($90,000 × .06)... 5,400
(30-40 min.) P 9-77B Journal
DATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT
2012
Mar. 3 Inventory……… 70,000
Note Payable, Short-term………. 70,000
May 31 Cash………. 70,000
Note Payable, Short-term………. 14,000
Note Payable, Long-term……….. 56,000
Sept. 3 Note Payable, Short-term………... 70,000
Interest Expense ($70,000 × .06 × 6/12).. 2,100
Cash………... 72,100
Dec. 31 Warranty Expense ($194,000 × .02)……. 3,880
Estimated Warranty Payable………... 3,880
Dec. 31 Interest Expense
($70,000 × .05 × 7/12)……….. 2,042
Interest Payable……….. 2,042
2013
May 31 Note Payable, Short-term……….. 14,000
Interest Payable……… 2,042
Interest Expense ($70,000 × 0.05 × 5/12) 1,458
Cash [$14,000 + ($70,000 × .05)] …... 17,500
