How should governments report their capital projects and debt service activities in their government-wide statements?

Ch 6. Questions for Review and Discussion

6. How should governments report their capital projects and debt service activities in their government-wide statements?

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The agreement under which Patterson, Inc., issued its long-term debt requires the restriction of $200,000 of the company's retained earnings balance

The agreement under which Patterson, Inc., issued its long-term debt requires the restriction of $200,000 of the company's retained earnings balance. Total retained earnings is $250,000 and total paid in capital is $500,000.

Required
Show how to report stockholder's equity on Patterson's balance sheet, assuming the following:
A. Patterson discloses the restrictions in a note. Write the note.
B. Patterson appropriates retained earnings in the amount of the restriction and includes no note in its statements.
C. Patterson's cash balance is $100,000. What is the maximum amount of dividends Patterson can declare?

Click here for the solution: The agreement under which Patterson, Inc., issued its long-term debt requires the restriction of $200,000 of the company's retained earnings balance

A company has a debt with a yield to maturity of 6.3%, a cost of equity of 14.5%, and a cost of preferred stock of 9.2%

A company has a debt with a yield to maturity of 6.3%, a cost of equity of 14.5%, and a cost of preferred stock of 9.2%. The market values of its debt, preferred stock and equity are $15.2 million, $2.9 million, and $20.6 million, respectively, and its tax rate is 35%.

What is the firm’s weighted average cost of capital (WACC)?


Click here for the solution: A company has a debt with a yield to maturity of 6.3%, a cost of equity of 14.5%, and a cost of preferred stock of 9.2%

Georgia Lazenby believes a current liability is a debt that can be expected to be paid in one year

Georgia Lazenby believes a current liability is a debt that can be expected to be paid in one year. Is Georgia correct? Explain.


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Foren Corporation had the following transactions pertaining to debt investments

ACC 291 Week 4 Assignment

E12-2 Foren Corporation had the following transactions pertaining to debt investments.

Jan. 1 Purchased 50 8%, $1,000 Choate Co. bonds for $50,000 cash plus brokerage fees of $900. Interest is payable semiannually on July 1 and January 1.
July 1 Received semiannual interest on Choate Co. bonds.
July 1 Sold 30 Choate Co. bonds for $34,000 less $500 brokerage fees.

Instructions
(a) Journalize the transactions.
(b) Prepare the adjusting entry for the accrual of interest at December 31.


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Sanderson Manufacturing Company would like to achieve a capital structure consistent with a Baa2/BBB senior debt rating

B2. (Choosing financial targets) Sanderson Manufacturing Company would like to achieve a capital structure consistent with a Baa2/BBB senior debt rating. Sanderson has identified six comparable firms and calculated the credit statistics shown here.

a. Sanderson’s return on assets is 5.3%. It has a total capitalization of $600 million. What are reasonable targets for long-term debt/cap, funds from operations/LT debt, and fixed charge coverage?

b. Are there any firms among the six who are particularly good or bad comparable? Explain.
c. Suppose Sanderson’s current ratio of long-term debt to total cap is 60% but its fixed charge coverage is 3.00. What would you recommend?

FIRM A B C D E F
Senior debt rating Baa2/BBB Baa3/BBB− Baa2/BBB Baa1/A− Baa1/BBB− Baa2/BBB+
Return on assets 5.2% 5.0% 5.4% 5.7% 5.2% 5.3%
Long-term debt/cap 38% 41% 45% 40% 25% 43%
Total cap ($MM) 425 575 525 650 210 375
Funds from operations/LT debt 39% 43% 28% 46% 57% 43%
Fixed charge cov 2.57 2.83 2.75 2.38 3.59 2.15


Click here for the solution: Sanderson Manufacturing Company would like to achieve a capital structure consistent with a Baa2/BBB senior debt rating

In January 2010, the management of Noble Company concludes that it has sufficient cash to permit some short-term investments in debt and stock securities

P16-2A In January 2010, the management of Noble Company concludes that it has sufficient cash to permit some short-term investments in debt and stock securities. During the year, the following transactions occurred.

Feb. 1 Purchased 600 shares of Hiens common stock for $31,800, plus brokerage fees of $600.
Mar. 1 Purchased 800 shares of Pryce common stock for $20,000, plus brokerage fees of $400.
Apr. 1 Purchased 50 $1,000, 7% Roy bonds for $50,000, plus $1,000 brokerage fees. Interest is payable semiannually on April 1 and October 1.
July 1 Received a cash dividend of $0.60 per share on the Hiens common stock.
Aug. 1 Sold 200 shares of Hiens common stock at $58 per share less brokerage fees of $200.
Sept. 1 Received a $1 per share cash dividend on the Pryce common stock.
Oct. 1 Received the semiannual interest on the Roy bonds.
Oct. 1 Sold the Roy bonds for $50,000 less $1,000 brokerage fees.

At December 31, the fair value of the Hiens common stock was $55 per share. The fair value of the Pryce common stock was $24 per share.

Hint: Journalize investment transactions, prepare adjusting entry, and show statement presentation.

Instructions
(a) Journalize the transactions and post to the accounts Debt Investments and Stock Investments. (Use the T-account form.)
Gain on stock sale $600
(b) Prepare the adjusting entry at December 31, 2010, to report the investment securities at fair value. All securities are considered to be trading securities.
(c) Show the balance sheet presentation of investment securities at December 31, 2010.
(d) Identify the income statement accounts and give the statement classification of each account.


Click here for the solution: In January 2010, the management of Noble Company concludes that it has sufficient cash to permit some short-term investments in debt and stock securities

Jill Loomis believes a current liability is a debt that can be expected to be paid in one year

1. Jill Loomis believes a current liability is a debt that can be expected to be paid in one year. Is Jill correct? Explain.

2. Frederickson Company obtains $40,000 in cash by signing a 9%, 6-month, $40,000 note payable to First Bank on July 1. Frederickson’s fiscal year ends on September 30. What
information should be reported for the note payable in the annual financial statements?


Click here for the solution: Jill Loomis believes a current liability is a debt that can be expected to be paid in one year

On December 31, 2010, Federal Bank enters into a debt restructuring agreement with Carson Company which is experiencing financial difficulties

On December 31, 2010, Federal Bank enters into a debt restructuring agreement with Carson Company which is experiencing financial difficulties. The bank restructures a $3,000,000 note receivable by:

1. Reducing the principal obligation from $3,000,000 to $2,400,000.
2. Extending the maturity date from 12/31/10 to 12/31/13, and
3. Reducing the interest rate from 12% to 6%.
Interest has been paid up to date as of 12/31/10

Instructions
Discuss the nature of this transaction, indicating whether any gain or loss is recognized by either party and preparing any 12/31/10 journal entries that may be required by the debtor (Carson).


Click here for the solution: On December 31, 2010, Federal Bank enters into a debt restructuring agreement with Carson Company which is experiencing financial difficulties

Williams Glassware has estimated, at various debt ratios, the expected earnings per share

P12-21 (EPS and Optimal Debt Ratio) Williams Glassware has estimated, at various debt ratios, the expected earnings per share and the standard deviation of the earnings per share as shown in the following table.

Debt ratio Earnings per share (EPS) Standard deviation of EPS
0% $2.30 $1.15
20 3.00 1.80
40 3.50 2.80
60 3.95 3.95
80 3.80 5.53

a. Estimate the optimal debt ratio on the basis of the relationship between earnings per share and the debt ratio. You will probably find it helpful to graph the relationship.
b. Graph the relationship between the coefficient of variation and the debt ratio. Label the areas associated with business risk and financial risk.


Click here for the solution: Williams Glassware has estimated, at various debt ratios, the expected earnings per share

Lance Lawn Services reports bad debt expense using the allowance method

E 16-5 Temporary difference; future deductible amounts; taxable income given

Lance Lawn Services reports bad debt expense using the allowance method. For tax purposes, the expense is deducted when accounts prove uncollectible (the direct write-off method). At December 31, 2011, Lance has accounts receivable and an allowance for uncollectible accounts of $20 million and $1 million, respectively, and taxable income of $75 million. At December 31, 2010, Lance reported a deferred tax asset of $435,000 related to this difference in reporting bad debts, its only temporary difference. The enacted tax rate is 40% each year.

Required:
Prepare the appropriate journal entry to record Lance's income tax provision for 2011.

Click here for the solution: Lance Lawn Services reports bad debt expense using the allowance method

Colorado Coal Company has estimated the costs of debt and equity capital (with bankruptcy and agency costs) for various proportions of debt in its capital structure

Colorado Coal Company has estimated the costs of debt and equity capital (with bankruptcy and agency costs) for various proportions of debt in its capital structure.

debt ratio pretax cost cost of equity weighted average
[B/(B+E)] of debt cost of capital

0.00 12.00
0.15 13.00 11.68
0.30 8.00 14.50
0.45 16.50 11.775
14.00 19.00 12.64

The company’s income tax rate is 40 percent.

a. Fill in the missing entries in the table.
b. Determine the capital structure (i.e., debt ratio) that minimizes the firm’s weighted average cost of capital


Click here for the solution: Colorado Coal Company has estimated the costs of debt and equity capital (with bankruptcy and agency costs) for various proportions of debt in its capital structure

A government's interest expenditure as reported in its debt service fund differs significantly from its interest expense as reported in its government-wide statements

A government's interest expenditure as reported in its debt service fund differs significantly from its interest expense as reported in its government-wide statements. What is the most likely explanation for the difference?

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Piedmont Instruments Corporation has estimated the following costs of debt and equity capital for various fractions of debt in its capital structure

Piedmont Instruments Corporation has estimated the following costs of debt and equity capital for various fractions of debt in its capital structure.

Debt Fractions ki ke with financial ke with financial distress w/o agency costs distress with agency costs
0.00 12.00% 12.00%
0.10 4.80% 12.05% 12.05%
0.30 4.90% 12.10% 12.20%
0.40 5.00% 12.20% 12.60%
0.45 5.20% 12.40% 13.40%
0.50 5.70% 12.80% 14.80%
0.60 7.00% 15.00% 18.00%

a. Based on these data, determine the company’s optimal capital structure (i) with financial distress costs and without agency costs and (ii) with financial distress and agency costs.
b. Suppose the company’s actual capital structure is 50 percent debt and 50 percent equity. How much higher is ka at this capital structure than at the optimal value of ka with financial distress and agency costs?

c. Is it necessary in practice for the company to know precisely its optimal capital structure? Why?

Click here for the solution: Piedmont Instruments Corporation has estimated the following costs of debt and equity capital for various fractions of debt in its capital structure

In January 2012, the management of Sarah Company concludes that it has sufficient cash to purchase some short-term investments in debt and stock securities

PE-2 In January 2012, the management of Sarah Company concludes that it has sufficient cash to purchase some short-term investments in debt and stock securities. During the year, the following transactions occurred.

Feb. 1 Purchased 1,200 shares of NJF common stock for $50,600 plus brokerage fees of $1,000.
Mar. 1 Purchased 500 shares of SEK common stock for $18,000 plus brokerage fees of $500.
Apr. 1 Purchased 70 $1,000, 8% CRT bonds for $70,000 plus $1,200 brokerage fees. Interest is payable semiannually on April 1 and October 1.
July 1 Received a cash dividend of $0.80 per share on the NJF common stock.
Aug. 1 Sold 200 shares of NJF common stock at $42 per share less brokerage fees of $350.
Sept. 1 Received $2 per share cash dividend on the SEK common stock.
Oct. 1 Received the semiannual interest on the CRT bonds.
Oct. 1 Sold the CRT bonds for $77,000 less $1,300 brokerage fees.
At December 31, the fair values of the NJF and SEK common stocks were $39 and $30 per share, respectively.

Instructions
(a) Journalize the transactions and post to the accounts Debt Investments and Stock Investments. (Use the T account form.)
(b) Prepare the adjusting entry at December 31, 2012, to report the investments at fair value. All securities are considered to be trading securities.
(c) Show the balance sheet presentation of investment securities at December 31, 2012.
(d) Identify the income statement accounts and give the statement classification of each account.

Click here for the solution: In January 2012, the management of Sarah Company concludes that it has sufficient cash to purchase some short-term investments in debt and stock securities

Prepare a debt amortization schedule for a bond issued at discount

Prepare a debt amortization schedule for a bond issued at discount. Assume that the bond matures in 12 years with market interest rate at time of issue—10% annually and 5% semiannually. The stated interest rate is 8%. The interest is paid semiannually.

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