# Accounting 209 by fionan

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```									                               Accounting 640
Lecture Notes
March 26, 2007

A.    Chapter 10 - Long-Term Liabilities and Investments

Application of Present Value Techniques – Corporate Bond Accounting
– Issuer Side
Interest rates
a. Contract (nominal) interest rate – Rate given on the bond agreement –
used to determine the amount of interest to the bondholders.

b. Market (yield) interest rate – Interest rate determined by buyers and
sellers in the bond market.

1. If the contract rate exceeds the market rate, the bonds will be issued at
a premium (an amount greater than the face value).

2. If the market rate exceeds the contract rate, the bonds will be issued at
a discount (an amount less than the face value).

3. If the contract rate and the market rate are the same, the bonds will be
issued at face value.

4. Bond premiums and discounts are amortized (written off) using either
the straight-line or effective interest method of amortization.

B.    Accounting for the Issuance of Corporate Bonds – An Illustration

ABC Corporation issued \$500,000 face value, 8% contract interest
rate bonds on July 1, 1998. The bonds mature on July 1, 2003.
Interest is payable semiannually on July 1 and December 31.
Assume the following market (effective) interest rates:
Case 1 - 10%
Case 2 - 6%
Required:
Determine the price of the bonds in each case.
Complete schedules similar to the ones in your text for the first two
years (through July 1, 2000).
Assume the effective interest method of amortization.

Price of bonds – Case 1:
= \$500,000 (0.6139) = \$306,950 (used Table 1 – 10 periods, 5%)
= \$ 20,000 (7.7217) = \$154,434 (used Table 2 – 10 periods, 5%)
= \$306,950 + 154,434 = \$461,384

Price of bonds – Case 2:
= \$500,000 (0.7441) = \$372,050
= \$ 20,000 (8.5302) = \$170,604
= \$372,050 + 170,604 = \$542,654

Journal entry to record bond issuance – Case 1:

Cash                              461,384
Discount on bonds payable          38,616
Bonds payable                                  500,000

Journal entry to record bond issuance – Case 2:

Cash                              542,654
Bonds payable                                500,000

See amortization tables for the first two years for Cases 1 and 2 in
C.      Long-Term Investments in Stock
a. Investments in stock could be classified according to the
percentage of stock of the investee acquired by the investor, i.e.:

0 – 19% - Use same procedures as for short-term investments -
For stock investments classify as either trading
securities or available for sale securities –
For bond investments determine if the bonds are
expected to be held until maturity

20 – 50% - Use the Equity Method
Greater than 50% - Prepare consolidated financial statements

b. Illustration of the equity method:
Ramona Corporation has 10,000 common shares outstanding.
Suppose Miranda Company acquired 3,500 of the Ramona
shares at a price of \$18 per share. The shares are acquired at the
beginning of year 2006. For the year ended December 31,
2006, Ramona reported net income of \$80,000 and declared and
paid dividends of \$.25 per share. Prepare journal entries on
Miranda’s books assuming she uses the equity method to
account for this investment.

c. Solution:
2006
Jan. 1 Investment in Ramona stock       63,000
Cash                                        63,000
(3,500 shares @ \$18 per share)

Dec. 31 Investment in Ramona stock         28,000
Investment income                           28,000
(\$80,000 X .35)
31 Cash                             875
Investment in Ramona stock                   875
(3,500 shares @ \$.25 per share)

D.   Consolidation
Financial information for a company (usually referred to as the
parent) and one or more controlled companies (usually referred to as
the subsidiary or subsidiaries) is combined and reported as if the
companies were one single entity.

Chapter 11 - Stockholders’ Equity

A.   Terms
1. Common stockholders – Major stockholders – They have voting
rights
2. Preferred stockholders – They do not vote but have certain
preferences such as dividend preference and liquidation preference
3. Par value – Arbitrary amount placed on a share of stock through
the corporate charter
4. No par value – Stock issued without a par value
5. No par value with a stated value – No par value stock with an
arbitrary amount placed on it by corporate management
6. Market value – Value of a share of stock according to the market
7. Book value – Value of a share of stock according to the corporate
records
8. Shares authorized – Number of shares that the corporation is
permitted to issue according to the corporate charter
9. Shares issued – Number of shares sold to stockholders
10.Shares outstanding – Number of shares that are on the market and
11.Additional paid-in capital – Difference between the market price
and par value multiplied by the number of shares issued
B.   Recording the Issuance of Stock
1. Suppose a corporation issues 8,000 shares of its \$5 par value
common stock at a price of \$14 per share. The journal entry would
be:

Cash                        112,000
Common stock, \$5 par                         40,000
Additional paid-in capital - common          72,000

2. Suppose a corporation issues 12,000 shares of its 8% preferred
stock. The preferred stock is no par value, but has a \$10 stated
value per share. Issue price is \$24 per share. The journal entry
would be:

Cash                        288,000
8%Preferred stock, \$10 stated value                 120,000
Additional paid-in capital – preferred              168,000

C.   Preferred Stock
1. Dividends preference – Once dividends are declared by the Board
of Directors, preferred shareholders must get their stated dividend

2. Special features of preferred stock contracts:
Cumulative feature – Back dividends (dividends in arrears) must
be paid
Participation feature – Allows the preferred shareholders to share
in excess dividends with common shareholders
Illustration:
The following stockholders’ equity section is given:
8% Preferred stock, \$10 par, cumulative, 10,000 shares
Issued and outstanding                             \$100,000
Common stock, \$5 par, 60,000 shares issued and
Outstanding                                         300,000
Additional paid-in capital – Preferred               30,000
Additional paid-in capital – Common                  50,000
Retained earnings                                   720,000
Total stockholders’ equity                       \$1,200,000

Assume the following dividends were declared:
1999          0
2000       6,000
2001      20,000
2002      10,000
2003         0
2004      16,000
2005      30,000
2006      50,000

What is the amount of dividends that would be allocated to
preferred and common shareholders for each year?
If the preferred stock is cumulative and nonparticipating, what
amount of dividends is distributed to each class of shareholders?

Year             Preferred    Common               Arrears
1999                 0             0               \$8,000
2000             \$6,000            0               10,000
2001             18,000       \$2,000                    0
2002              8,000        2,000                    0
2003                 0             0                8,000
2004             16,000            0                    0
2005              8,000       22,000                    0
2006              8,000       42,000                    0

Suppose the preferred stock is noncumulative and
nonparticipating:

1999                     0                  0
2000                  6,000                 0
2001                  8,000            12,000
2002                  8,000             2,000
2003                     0                  0
2004                  8,000             8,000
2005                  8,000            22,000
2006                  8,000            42,000
Suppose the preferred stock is cumulative and participating. Also,
there is one year of preferred dividends in arrears. Total amount
available for dividends is \$50,000.

Preferred Common Total
Arrears                     \$8,000           \$8,000
Regular preferred div.       8,000            8,000
Equivalent to common                  24,000 24,000
Participation:
Preferred (1/4 x 10,000)     2,500
Common (3/4 x 10,000)                   7,500 10,000
Totals                     \$18,500     31,500 \$50,000

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