CHAPTER 7 • ACCOUNTING FOR LIABILITIES 347 348 FINANCIAL ACCOUNTING 3/E SOLUTIONS MANUAL

7. How are the interest payments associated with a bond calculated? 4. Liabilities are often estimated because
Chapter 7 a. the related expense needs to be recorded to match the appropriate revenues.
Solution:
b. it gives managers a way to manage assets.
Interest payments for a bond are calculated by multiplying the stated interest rate times the principal amount of the bond.
Accounting for Liabilities c. they are usually not disclosed until they are settled.
d. the related assets are already recorded.
8. Explain the difference between the stated rate and the effective rate of interest on a bond.
5. Advanced Music Technology, Inc., estimated that its warranty costs would be $900 for items sold during the current year, an
LEARNING OBJECTIVES Solution: amount it considers significant. During the year Advanced paid $750 to repair merchandise that was returned by customers.
1. Define definitely determinable liability and explain how payroll is recorded. The stated interest rate determines the cash (interest) payment of the bond. The effective interest rate is the market rate What is the amount of warranty expense for the current year?
of interest that investors actually demand. a. $750
2. Define estimated liability and explain how warranties are recorded. b. $900
3. Explain how long-term notes and mortgages work. 9. What is another name for the face value of a bond? c. $150
4. Record the issue of bonds and payment of interest to bondholders. d. Cannot be determined
Solution:
5. Prepare financial statements that include long-term debt. 6. On January 1, Sonata Company issued 10-year bonds with a face value of $400,000 and a stated rate of 10%. The cash proceeds
The face value of a bond is also called the stated value or par value.
from the bond issue amounted to $354,120. Sonata Company will pay interest to the bondholders annually. How much cash will
6. Explain capital structure and compute the debt-to-equity ratio. Sonata pay the bondholders on the first payment date?
7. Identify the major risk associated with long-term debt and the related controls. 10. When is a bond issued at a discount? When is a bond issued at a premium?
a. $40,000
8. (Appendix 7) Compute present value and proceeds from a bond issue. Solution: b. $48,000
A bond is issued at a discount when the stated rate is less than the market rate. A bond is issued at a premium when the c. $35,412
stated rate is greater than the market rate. d. $42,494
Questions 7. Refer to the information in multiple-choice question 6. How did the market interest rate compare to the stated rate on the date
11. How is the debt-to-equity ratio calculated, and what does this ratio measure? the bonds were issued?
1. What are the two main sources of financing for a business? a. The market rate is higher than the stated rate.
Solution:
Solution: b. The market rate is lower than the stated rate.
The debt-to-equity ratio divides total liabilities by total shareholders’ equity. The ratio compares the amount of credi-
The two main sources of financing for a business are debt and equity. c. Both rates are the same.
tors’ claims to the assets of the firm with owners’ claims to assets of the firm.
d. It cannot be determined.
2. What is the difference between a definitely determinable liability and an estimated liability? Give an example of each. 8. Bonds issued with a stated interest rate that is higher than the prevailing market rate are issued at
12. To what does the term capital structure refer?
a. a premium.
Solution: Solution: b. a discount.
A definitely determinable liability is one that can be measured exactly such as an account payable or a note payable. An Capital structure refers to the relative amounts of debt and equity used to finance the firm. c. par.
estimated liability is a liability whose amount is not certain such as liabilities under a warranty agreement. d. It cannot be determined.
13. Explain financial leverage. 9. A $1,000 bond with a stated rate of 8% is issued when the market rate is 10%. How much interest will the bondholders receive
3. What is a mortgage? each year for the annual interest payments?
Solution:
Solution: a. $100
Financial leverage refers to the use of debt to increase earnings. If a company earns more with the money it borrows than
A mortgage is a long-term liability that gives the lender a claim against property if the borrower does not make payments. b. $80
it has to pay to borrow the money, then it is called “positive financial leverage.”
c. $20
4. When installment loan payments on a mortgage are made, the amount paid reduces cash. What other two items on the financial d. $800
statements are affected? 10. Positive financial leverage means that a company
Multiple-Choice Questions a. has more debt than equity.
Solution: b. earns more with borrowed money than the cost of borrowing it.
Installment loan payments reduce principal and interest expense is recorded. The balance in liabilities (notes payable) 1. Partco hired a secretary for $900 a week. The secretary’s first paycheck had 20% withheld for income taxes, 6.2% for social c. has the correct amount of debt.
decreases on the balance sheet and the interest expense is reported on the income statement. security, and 1.45% for Medicare taxes. What is Partco’s total expense (including payroll tax expense) related to this payment? d. has more equity than debt.
a. $68.85
5. What is the difference between how bonds are repaid compared to other forms of financing that require installment payments? b. $968.85
Solution: c. $651.15 Short Exercises
Bonds are repaid with periodic payments of interest to the bondholders and with the principal amount repaid at the d. $720.00 Set A
maturity date of the bond. Installment payments are part interest and part principal and occur every year or every month 2. All of the following are current liabilities except
a. salaries payable. SE7-1A. Classify liabilities. (LO 1, 2). Tell whether each of the following liabilities is definitely determinable or an estimate:
over the life of the loan.
b. mortgage payable. accounts payable, unearned revenue, and warranty liability.
6. What advantage is there to obtaining financing using bonds compared to getting a loan from a bank? c. unearned revenue. Solution:
d. accounts payable.
Solution: 3. The amount a company owes its employees for current work done is
Advantages to issuing bonds include: the larger amount of money the company is able to borrow, the longer period of a. shown on the balance sheet as pension liability.
time of the loan, and the lower interest rate on the debt. b. shown as a current liability.
c. called postretirement benefits on the balance sheet.
d. not shown on the balance sheet.

346

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SE7-2A. Classify liabilities. (LO 1). Taylor Company has the following obligations at December 31: (a) a note payable for $10,000 due SE7-7A. Account for bonds. (LO 4). If a $1,000 bond is selling at 95, how much cash will the issuing company receive? If a $1,000 Solution:
in six months; (b) unearned revenue of $12,500; (c) interest payable of $15,000; (d) accounts payable of $60,000; and (e) note payable bond is selling at par, how much cash will the issuing company receive? If a $1,000 bond is selling at 101, how much cash will the
due in two years. For each obligation, indicate whether or not it should be classified as a current liability. issuing company receive?
Solution: Solution:

SE7-8A. Account for bonds. (LO 4). For each of the following situations, tell whether the bond described will be issued at a pre-
Set B
SE7-3A. Account for payroll. (LO 1). Jimmy Paycheck earned $1,500 per month as the manager of a recording studio. Jimmy has mium, at a discount, or at par: SE7-12B. Classify liabilities. (LO 1). Tell whether each of the following liabilities is definitely determinable or an estimate: salaries
25% of his earnings withheld for federal income taxes. There are no other amounts withheld except for those required by the fed- payable, warranty liability, and notes payable.
1. Colson Company issued $200,000 worth of bonds with a stated interest rate of 10%. At the time of issue, the market rate of
eral government. What are the other amounts that must be deducted from Jimmy’s earnings? Calculate the net amount Jimmy will
interest for similar investments was 9%. Solution:
receive on his next paycheck.
2. Dean Company issued $100,000 worth of callable bonds with a stated rate of 12%. At the time of issue, the market rate of inter-
Solution: est for similar investments was 9%.
3. Liddy Company issued $200,000 worth of bonds with a stated rate of 8%. At the time of issue, the market rate of interest for
similar investments was 9%.
Solution:
SE7-13B. Classify liabilities. (LO 1, 2). Swift Company has the following obligations at December 31: (a) a note payable for $10,000
due in 18 months; (b) unearned revenue of $12,500; (c) interest payable of $15,000; (d) accounts payable of $60,000; and (e) note
payable due in three months. For each obligation, indicate whether or not it should be classified as a current liability.
Solution:
SE7-9A. Account for bonds. (LO 4). For each of the following situations, compute the proceeds from the bond issue:
SE7-4A. Account for warranties. (LO 2). Key Company offers a three-year warranty on its premium door locks. During the year,
the company had sales of $100,000. Related to the sales, warranty costs should be approximately $3,000 per year. How much war- 1. Haldeman Hair Systems issued $20,000 worth of bonds at 106.
ranty expense related to these sales will Key Company’s income statement show in the year of the sales? How much warranty 2. Erlichman Egg Company issued $100,000 worth of bonds at 99.
expense related to these sales will Key Company have in the two years after the sales? 3. Carl’s Cutlery Company issued $500,000 worth of bonds at 96.5.
Solution: Solution:

SE7-5A. Account for mortgages. (LO 3). Nunez Company has arranged to borrow $25,000 for five years at an interest rate of 8%.
The annual payments will be $6,261.41. When Nunez makes its first payment at the end of the first year of the loan, how much of
the payment will be interest?
Solution:
SE7-14B. Account for payroll. (LO 1). Johnny Worker earns $2,500 per month as the manager of a grocery store. Johnny has 20%
of his earnings withheld for federal income taxes. There are no other amounts withheld except for those required by the federal gov-
ernment. What are the other amounts that must be deducted from Johnny’s earnings? Calculate the net amount Johnny will receive
on his next paycheck.
Solution:
SE7-10A. Account for bonds. (LO 4). Altoona Company was able to issue (sell) $200,000 of 9% bonds for $220,000 because its
credit rating is excellent and market interest rates have fallen. How much interest will be paid in cash during the first year? Will the
interest expense be higher or lower than the interest payment?
Solution:

SE7-6A. Account for mortgages. (LO 3). Feathers and Furs borrowed $75,000 to buy a new faux fur storage facility. The company
borrowed the money for 10 years at 12%, and the monthly payments are $1,076.03. When the company makes the first monthly pay- SE7-15B. Account for warranties. (LO 2). Tom’s Toasters, Inc., began the year with $30,000 in its warranty liability. During the
ment at the end of the first month of the loan, by how much will the payment reduce the principal of the loan? year, the firm spent $20,000 to honor past warranties. Will the $20,000 be the warranty expense for the year? Why or why not?
Solution: Solution:
SE7-11A. Calculate the debt-to-equity ratio. (LO 6). Suppose that for 2010 Axel Company’s current assets totaled $57,855; total
assets totaled $449,999; current liabilities totaled $71,264; and total liabilities totaled $424,424. Calculate the debt-to-equity ratio
for Axel for 2010.
352 FINANCIAL ACCOUNTING 3/E SOLUTIONS MANUAL CHAPTER 7 • ACCOUNTING FOR LIABILITIES 353 354 FINANCIAL ACCOUNTING 3/E SOLUTIONS MANUAL

SE7-16B. Account for mortgages. (LO 3). Curtain Company borrowed $10,000 at 9% for seven years. The loan requires annual pay- SE7-21B. Account for bonds. (LO 4). Data Company was able to issue (sell) $100,000 of 6% bonds for $110,000 because its credit Solution:
ments of $1,986.91. When Curtain Company makes the first annual payment at the end of the first year of the loan, how much of the rating is excellent and market interest rates have fallen. How much interest will be paid in cash during the first year? Will the inter-
payment will be interest and how much will reduce the principal of the loan? est expense be higher or lower than the interest payment?
Solution: Solution:

SE7-17B. Account for mortgages. (LO 3). On July 1, 2006, Maxine’s Equipment Company signed a long-term note with the local
bank for $50,000. The term of the note was 10 years, at an annual interest rate of 8%. If Maxine’s makes annual payments of
$7,451.47, beginning on June 30, 2007, how much of the first payment will be interest?
Solution:
SE7-22B. Calculate the debt-to-equity ratio. (LO 6). Suppose that for 2011 Rod Company’s current assets totaled $35,600; total
assets totaled $70,000; current liabilities totaled $16,000; and total liabilities totaled $25,600. Calculate the debt-to-equity ratio for
Rod Company for 2011.
Solution:
E7-25A. Account for payroll. (LO 1). During February, Winter Company’s employees earned wages of $50,000. Social security
(FICA) withheld was $2,500; federal income taxes withheld were $3,500; and employees’ contributions to United Way withheld
totaled $500. Use the accounting equation to record wages expense and wages payable at the end of February. Winter Company
will pay employees their February wages and pay the payroll taxes to the government during the first week in March.
Solution:

SE7-18B. Account for bonds. (LO 4). If $100,000 of 8% bonds are issued (sold) for $95,000, was the market rate of interest at the
time of issue higher or lower than 8%? What is the amount of the annual interest payments to be received by the bondholders?
Solution:

Exercises
Set A
E7-23A. Classify liabilities. (LO 1). For each item in the following list, tell whether it is a definitely determinable liability, an esti-
mated liability, or neither:
SE7-19B. Account for bonds. (LO 4). For each of the following situations, tell whether the bond described will be issued at a pre- E7-26A. Account for warranties. (LO 2). When Park Avenue Pet Shop sells a puppy, it provides a health warranty for the little crit-
mium, at a discount, or at par: 1. Amount owed to vendor for purchase of inventory
ter. If a puppy becomes ill in the first two years after the sale, Park Avenue Pet Shop will pay the vet bill up to $300. Because this is
2. Potential proceeds from pending lawsuit
1. Kami Company issued $100,000 worth of bonds with a stated interest rate of 9%. At the time of issue, the market rate of inter- normally a significant expense for the shop, the accountant insists that Park Avenue Pet Shop record an estimated warranty liability
3. Amount of warranty obligations
est for similar investments was 10%. at the end of every year before the financial statements are prepared. On December 31, 2010, the accountant estimated that the war-
4. Amount of loan payment due next year
2. Fun Company issued $300,000 worth of callable bonds with a stated rate of 4.5%. At the time of issue, the market rate of inter- ranty costs for puppies sold in 2010 would be $2,000 and made the appropriate entry to record that liability. On March 30, 2011, the
5. Amount of vacation pay to accrue for employees for next year
est for similar investments was 4%. store received a $50 vet bill from one of its customers, who had bought a puppy in 2010. Park Avenue Pet Shop wrote a check for $50
3. Rider Company issued $500,000 worth of bonds with a stated rate of 5%. At the time of issue, the market rate of interest for Solution: to reimburse the puppy’s owner.
similar investments was 5.2%. 1. Enter the transaction into the accounting equation to record the estimated warranty liability at December 31, 2010.
Solution: 2. Enter the transaction into the accounting equation to record the payment of the vet bill on March 30, 2011. What effect did this
payment have on the 2011 financial statements of Park Avenue Pet Shop?

E7-24A. Account for payroll. (LO 1). A company has gross payroll of $30,000; federal income tax withheld of $6,000; FICA (social
SE7-20B. Account for bonds. (LO 4). For each of the following situations, compute the proceeds from the bond issue: security) taxes withheld of $1,860; and Medicare taxes withheld of $435.
1. Quality Bank issued $100,000 worth of bonds at 104. 1. How much will the balance sheet show for salaries payable (to employees)?
2. Tool & Dye Company issued $50,000 worth of bonds at 98. 2. How much will the income statement show for salary expense?
3. Connie’s Can Company issued $400,000 worth of bonds at 97.5. 3. What type of liability is salaries payable?
Solution:

CHAPTER 7 • ACCOUNTING FOR LIABILITIES 355 356 FINANCIAL ACCOUNTING 3/E SOLUTIONS MANUAL CHAPTER 7 • ACCOUNTING FOR LIABILITIES 357

Solution: Solution: E7-31A. Account for bonds. (LO 4). On December 31, 2009, Alejandro Enterprises issued $25,000 worth of 5% bonds at 99. These
are 10-year bonds with interest paid annually on December 31.
1. What are the interest payments for the first two years?
2. Was the market interest rate higher or lower than 5% at the date of issue?
3. Will the interest expense be higher or lower than the interest payment?
Solution:

E7-27A. Account for long-term liabilities. (LO 3, 5). Larry the Locksmith needed some long-term financing and arranged for a
$200,000, 20-year mortgage loan on December 31, 2009. The interest rate is 7% per year, with $20,000 (rounded) payments made
at the end of each year, starting December 31, 2010.
E7-29A. Account for long-term liabilities. (LO 3, 5). Suppose MegaStore, Inc., signed a $750,000, 15-year, 10% note payable to finance
1. What is the amount of interest expense related to this loan for 2010? the expansion of its business on January 1, 2010. The terms provide for semiannual payments of $49,000 on June 30 and December 31,
2. What amount of liability should appear on the December 31, 2010, balance sheet? E7-32A. Account for bonds. (LO 4). On December 31, 2010, Carl’s Cartons, Inc., issued $100,000 worth of 9% bonds at 104. The
2010. On the December 31, 2010, balance sheet, how much will MegaStore show as the principal of this note payable? interest on these bonds is paid annually on December 31.
3. What is the amount of interest expense related to this loan for 2011?
4. What amount of liability should appear on the December 31, 2011, balance sheet? Solution: 1. What are the interest payments for the first two years?
Solution: 2. Was the market interest rate higher or lower than 9% at the date of issue?
3. Will the interest expense be higher or lower than the interest payment?
Solution:

E7-30A. Account for long-term liabilities. (LO 3). On April 1, Mark Hamm borrowed $15,000 on an eight-month, 6% note from
E7-33A. Account for bonds. (LO 4). On January 1, 2010, Conway Computers issued $500,000, 15%, 10-year bonds at face value.
State Bank of New York to open a business, Gymnastics World. The debt was in the company’s name. The note and interest will be
Interest is payable on January 1. Use the accounting equation to record the following:
repaid on November 30.
1. The bond issue
1. Use the accounting equation to show how Gymnastics World would record the receipt of the funds.
2. The accrual of interest on December 31, 2010
2. Suppose Gymnastics World wants to prepare an income statement for the month of April. Use the accounting equation to show
3. The payment of interest on January 1, 2011
how the firm will accrue interest for the month.
3. Assume that Gymnastics World accrues the interest expense related to this note at the end of each month. What is the balance Solution:
in the interest payable account on September 30?
4. Use the accounting equation to show how the firm would record the transaction on November 30, when the loan is repaid with
the interest. (Assume 3. above was completed.)
E7-28A. Account for long-term liabilities. (LO 3, 5). Grace’s Gems purchased some property on December 31, 2011, for $100,000, Solution:
paying $20,000 in cash and obtaining a mortgage loan for the other $80,000. The interest rate is 8% per year, with $2,925 payments
made at the end of March, June, September, and December 2012.
1. What amounts should appear as interest expense on the quarterly income statements and as liabilities on the quarterly balance
sheets during 2012?
2. What amount of interest expense should appear on the income statement for the year ended December 31, 2012?
358 FINANCIAL ACCOUNTING 3/E SOLUTIONS MANUAL CHAPTER 7 • ACCOUNTING FOR LIABILITIES 359 360 FINANCIAL ACCOUNTING 3/E SOLUTIONS MANUAL

E7-34A. Account for bonds. (LO 4). On December 31, 2012, Dave’s Delivery Service issued $10,000 worth of 10% bonds at approx- Solution: E7-40A. Prepare an amortization schedule for a bond issued at a premium. (LO 4). Old School Vacations issued $100,000, 10%,
imately 89. These are 10-year bonds with interest paid semiannually on June 30 and December 31. 10-year bonds on January 1, 2010, when the market rate of interest was 8%. Proceeds were $113,420.16. Interest is payable annu-
ally on January 1. Old School uses the effective interest method to amortize bond premiums and discounts. Prepare an amortization
1. What are the interest payments for the first two years?
schedule for the life of the bonds.
2. Was the market interest rate higher or lower than 10% at the date of issue?
3. Will the interest expense be higher or lower than the interest payment?
Use the following financial data for eBay to answer E7-41A:
Solution:

From the Consolidated Balance Sheet of eBay Inc.

December 31,
2007 2008
(dollars in thousands)
Assets
E7-38A. Calculate interest expense using the effective interest method. (LO 4, 5). On June 30, 2010, Superfast Shoes issued $200,000 Total current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 7,122,505 $ 6,286,590
E7-35A. Account for bonds. (LO 4). On June 30, 2009, Sam’s Office Supplies issued $50,000 face value of 8% bonds at 106. They worth of 15-year, 9% bonds when the market rate was 10%. Proceeds were $184,788. The interest is paid annually on June 30. Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $15,366,037 $15,592,439
were five-year bonds with interest paid semiannually, on December 31 and June 30.
1. What is the annual interest payment? Liabilities and stockholders’ equity
1. What are the interest payments for the first two years? 2. What is the amount of interest expense on the date of the first interest payment? Total current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 3,099,579 $ 3,705,087
2. Was the market interest rate higher or lower than 8% at the date of issue? 3. How would the bonds payable and the interest expense be shown on the year-end financial statements (June 30, 2011)? Total liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,661,435 4,508,581
3. Will the interest expense be higher or lower than the interest payment? Total stockholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11,704,602 11,083,858
Solution: Total liabilities and stockholders’ equity . . . . . . . . . . . . . . . . . . . $15,366,037 $15,592,439
Solution:

Solution:

E7-36A. Account for bonds. (LO 4). On June 30, 2011, Sugar Fudge Co. issued $50,000 worth of 10% bonds for $50,000. The inter-
est is paid annually on June 30.
1. What are the interest payments for the first two years? E7-39A. Prepare an amortization schedule for a bond issued at a discount. (LO 4). Jamison Corporation issued $100,000, 8%, 10-
2. Was the market interest rate higher or lower than 10% at the date of issue? year bonds on January 1, 2012, when the market rate of interest was 10%. Proceeds were $87,710.87. Interest is payable annually
3. Will the interest expense be higher or lower than the interest payment? on January 1. Jamison uses the effective interest method to amortize bond premiums and discounts. Prepare an amortization sched-
ule for the life of the bonds.
Solution:
Solution:

E7-41A. Calculate the debt-to-equity ratio. (LO 6). Using the information provided for eBay, calculate the debt-to-equity ratio at
December 31, 2007, and December 31, 2008. (Notice that eBay puts the most recent year in the right column rather than the usual
left column.) Provide an explanation of what this ratio measures and whether the ratio has improved from 2007 to 2008.
Solution:

E7-37A. Calculate interest expense using the effective interest method. (LO 4, 5). On June 30, 2010, Mako Company issued $50,000
worth of five-year, 10% bonds when the market rate was 9%. Proceeds were $51,945. The interest is paid annually on June 30.
1. What is the annual interest payment?
2. What is the amount of interest expense on the date of the first interest payment?
3. How would the bonds payable and the interest expense be shown on the year-end financial statements (June 30, 2011)?

CHAPTER 7 • ACCOUNTING FOR LIABILITIES 361 362 FINANCIAL ACCOUNTING 3/E SOLUTIONS MANUAL CHAPTER 7 • ACCOUNTING FOR LIABILITIES 363

E7-45B. Account for warranties. (LO 2). When Boyd Pools installs a pool, it provides a three-year warranty (from the date of the sale) Solution:
Set B for any repairs needed that are not considered general maintenance. If a pool should need to be repaired in the first three years after
the sale, Boyd will repair the pool for a cost of up to $1,000. Because this is normally a significant expense, the accountant insists that
E7-42B. Classify liabilities. (LO 1, 2). For each item in the following list, tell whether it is a definitely determinable liability, an esti- Boyd record an estimated warranty liability at the end of every year before the financial statements are prepared. On average, Boyd
mated liability, or neither: spends $400 per pool to fulfill its warranty obligations over the life of the warranty. For the year ended June 30, 2011, the accountant
1. Amount of cash revenue received from customer that is unearned made the appropriate entry to record that liability based on sales and installations for the year of 360 pools. On January 4, 2012, Boyd
2. Corporate income tax for the year paid $750 to an independent contractor to repair a pool for one of its customers, who had purchased the pool on March 15, 2011.
3. Coupons unredeemed at the end of the year (some percentage expected to be redeemed) 1. Enter the transaction into the accounting equation to record the estimated warranty liability at June 30, 2011.
4. Amount of salaries payable to accrue at the end of the year 2. Enter the transaction into the accounting equation to record the payment of the repair bill on January 4, 2012. For the year ended
5. Account payable owed to vendor for purchase on credit June 30, 2012, what effect did this payment have on the financial statements of Boyd Pools?
Solution: Solution:

E7-48B. Account for long-term liabilities. (LO 3). The Decadent Ice Cream Company signed a $250,000, 15-year, 9% note payable
to finance the expansion of its business on January 1. The terms provide for semiannual payments of $15,350 on June 30 and
December 31. Use the accounting equation to record the receipt of the proceeds of the loan and the first two payments.
Solution:
E7-43B. Account for payroll. (LO 1). A company has gross payroll of $30,000; federal income tax withheld of $6,000; and FICA
(social security) taxes and Medicare taxes withheld of $2,295. E7-46B. Account for long-term liabilities. (LO 3, 5). Mark’s Martial Arts Academy needed some long-term financing and arranged
1. How much will the balance sheet show for salaries payable (to employees)? for a $200,000, 20-year mortgage loan on December 31, 2009. The interest rate is 7.5% per year, with $19,620 (rounded) payments
2. How much will the income statement show for salary expense? made at the end of each year, starting December 31, 2010.
3. What type of liability is salaries payable? 1. What is the amount of interest expense related to this loan for 2010?
Solution: 2. What amount of liability should appear on the December 31, 2010, balance sheet?
3. What is the amount of interest expense related to this loan for 2011?
4. What amount of liability should appear on the December 31, 2011, balance sheet?
Solution:

E7-49B. Account for long-term liabilities. (LO 3, 5). On March 1, Delvis Cromartie borrowed $7,500 on a five-month, 8% note
from Florida First Bank & Trust to open a business, Orchids & Such Nursery. The debt was in the company’s name. The note and
E7-44B. Account for payroll. (LO 1). During March, the Wessue Coffee Emporium’s employees earned wages of $18,000. Social security interest will be repaid on July 31.
(FICA) withheld was $1,377; federal income taxes withheld were $3,600; and employees’ contributions to the American Red Cross with-
held totaled $175. Use the accounting equation to record wages expense and wages payable at the end of March. Wessue will pay employ- 1. Use the accounting equation to record the receipt of the funds.
ees their March wages and will pay the withholding taxes during the first week in April. 2. Suppose Orchids & Such Nursery wants to prepare an income statement for the month of March. Use the accounting equation
to accrue interest for the month.
Solution: 3. Assume that Orchids & Such Nursery accrues the interest expense related to this note at the end of each month. What is the bal-
ance in the interest payable account on May 31?
4. Use the accounting equation to record the transaction on July 31, when the loan is repaid with the interest. (Assume 3. above
was completed.)
E7-47B. Account for long-term liabilities. (LO 3, 5). Molly Merry’s Accounting Firm purchased some property on December 31,
2010, for $150,000, paying $30,000 in cash and obtaining a mortgage loan for the other $120,000. The interest rate is 12% per year,
with $8,065 payments made at the end of March, June, September, and December 2011.
1. What amounts should appear as interest expense on the quarterly income statements and as liabilities on the quarterly balance
sheets during 2011?
2. What amount of interest expense should appear on the 2011 year-end income statement?
364 FINANCIAL ACCOUNTING 3/E SOLUTIONS MANUAL CHAPTER 7 • ACCOUNTING FOR LIABILITIES 365 366 FINANCIAL ACCOUNTING 3/E SOLUTIONS MANUAL

Solution: Solution: E7-56B. Calculate interest expense using the effective interest method. (LO 4, 5). On March 30, 2009, Canine Company issued $80,000
worth of 10-year, 6% bonds when the market rate was 5%. Proceeds were $86,177. The interest is paid annually on March 30.
1. What is the annual interest payment?
2. What is the amount of interest expense on the date of the first interest payment?
3. How would the bonds payable and the interest expense be shown on the year-end (March 30, 2010) financial statements?
Solution:

E7-53B. Account for bonds. (LO 4). On June 30, 2010, McCorvey’s Lawn Service issued $7,500 worth of 6% bonds at approxi-
E7-50B. Account for bonds. (LO 4). On June 30, 2010, Kenneth’s Watch Co. issued $50,000 worth of 6% bonds at 110. These are mately 102. These are five-year bonds with interest paid semiannually on December 31 and June 30.
10-year bonds with interest paid annually on June 30.
1. What are the interest payments for the first two years?
1. What are the interest payments for the first two years? 2. Was the market interest rate higher or lower than 6% at the date of issue?
2. Was the market interest rate higher or lower than 6% at the date of issue? 3. Will the interest expense be higher or lower than the interest payment?
3. Will the interest expense be higher or lower than the interest payment?
Solution:
Solution:

E7-57B. Calculate interest expense using the effective interest method. (LO 4, 5). On June 30, 2010, Dogs & Cats Pet Store issued
$250,000 worth of 10-year, 9% bonds when the market rate was 6%. Proceeds from the bond issue were approximately $305,200.
The interest is paid annually on June 30.
1. What is the annual interest payment?
2. What is the amount of interest expense on the date of the first interest payment?
E7-54B. Account for bonds. (LO 4). On December 31, 2012, Advanced Defense Contractors issued $25,000 face value of 10% bonds
3. How would the bonds payable and the interest expense be shown on the year-end (June 30, 2011) financial statements?
E7-51B. Account for bonds. (LO 4). On February 28, 2011, Newman & Spears Enterprises, Inc., issued $150,000 worth of 7% bonds at 95. They were five-year bonds with interest paid semiannually, on June 30 and December 31.
at 92. The interest on these bonds is paid annually on February 28. Solution:
1. What are the interest payments for the first two years?
1. What are the interest payments for the first two years? 2. Was the market interest rate higher or lower than 10% at the date of issue?
2. Was the market interest rate higher or lower than 7% at the date of issue? 3. Will the interest expense be higher or lower than the interest payment?
3. Will the interest expense be higher or lower than the interest payment?
Solution:
Solution:

E7-55B. Account for bonds. (LO 4). On June 30, 2010, Nikki C. Records, Inc., issued $35,000 worth of 8% bonds for $35,000. The
interest is paid annually on June 30.
E7-52B. Account for bonds. (LO 4). On January 1, 2011, Allied Robotics issued $500,000, 4%, five-year bonds at par. Interest is E7-58B. Prepare an amortization schedule for a bond issued at a premium. (LO 4). Designer Clothes, Inc., issued $200,000, 10%,
payable on January 1. Use the accounting equation to record the following: 1. What are the interest payments for the first two years? 10-year bonds on July 1, 2011, when the market rate of interest was 8%. Interest is payable annually on July 1. Proceeds from the
2. Was the market interest rate higher or lower than 8% at the date of issue? bond issue were approximately $226,840.33. Designer uses the effective interest method to amortize bond premiums and discounts.
1. The bond issue
3. Will the interest expense be higher or lower than the interest payment? Prepare an amortization schedule for the life of the bonds.
2. The accrual of interest on December 31, 2011
3. The payment of interest on January 1, 2012 Solution:

CHAPTER 7 • ACCOUNTING FOR LIABILITIES 367 368 FINANCIAL ACCOUNTING 3/E SOLUTIONS MANUAL CHAPTER 7 • ACCOUNTING FOR LIABILITIES 369

Solution: Solution: Requirements

1. Use the accounting equation to show each of the transactions.
2. Use the accounting equation to show the adjustments needed for interest on the notes payable for the month of March and for
salary expense and payroll tax expense.
3. Prepare the current liabilities section of the balance sheet at March 31, 2011.
Solution:

E7-60B. Calculate the debt-to-equity ratio. (LO 6). Using the information provided for Netflix, Inc., calculate the debt-to-equity
E7-59B. Prepare an amortization schedule for a bond issued at a discount. (LO 4). Golden Coast Beach Resorts issued $1,000,000, ratio at December 31, 2007, and December 31, 2008. Provide an explanation of what this ratio measures and whether the ratio has
11%, 10-year bonds on June 30, 2009, when the market rate of interest was 10%. Proceeds from the bond issue were approximately improved from 2007 to 2008.
$1,061,445.67. Interest is payable annually on June 30. Golden Coast uses the effective interest method to amortize bond premiums Solution:
and discounts. Prepare an amortization schedule for the life of the bonds.

Use the following financial data for Netflix, Inc., to answer E7-60B.

Netflix, Inc.
Consolidated Balance Sheet (adapted)

December 31,
2007 2008
(dollars in thousands)
Assets
Total current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $432,423 $361,447 Problems
Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $678,998 $617,946 Set A
Liabilities and Shareholders’ Equity P7-61A. Account for current liabilities. (LO 1, 5). On March 1, 2011, the accounting records of Stein Company showed the follow-
Total current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $208,905 $216,017
249,186 270,791
ing liability accounts and balances: P7-62A. Account for warranties. (LO 2). In 2012, Best Stuff, Inc., had sales of $90,000 of its new video recorders. The company
Total liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total shareholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 429,812 347,155 Accounts payable $21,600 gives a two-year warranty with the purchase of a video recorder. When Best Stuff recorded the sales, the company also estimated
Total liabilities and shareholders’ equity . . . . . . . . . . . . . . . . . . . . . . . $678,998 $617,946 Short-term notes payable 10,000 that it would spend $8,400 to honor those warranties. When the company prepared its annual financial statements for 2012, no video
Interest payable 800 recorders had been brought in for repair. In January 2013, however, 20 people brought in their broken video recorders, and Best Stuff
Unearned service revenue 12,500 spent a total of $750 repairing them (at no charge to the customers, because the video recorders were under warranty). Assume no
additional sales were made in January 2013 (i.e., no new warranties were given in January).
a. On March 1, 2011, Stein Company signed a three-month note for $12,000 at 7.5%.
b. During March, Stein Company paid off the $10,000 short-term note and the interest payable shown on the March 1 Requirements
balance sheet. 1. How much warranty expense related to the sales of video recorders would Best Stuff show on an income statement for the
c. Stein paid off the beginning accounts payable. year 2012?
d. During the month, Stein purchased $25,000 of merchandise on account. 2. Would Best Stuff have a warranty liability on the balance sheet at the end of 2012? If so, how much?
e. Also during March, Stein’s employees earned salaries of $36,000. Withholdings related to these wages were $2,232 for 3. How much warranty expense would Best Stuff show on an income statement for the month of January 2013 related to these
social security (FICA), $3,800 for federal income tax, and $1,140 for state income tax. The company will pay March video recorders?
salaries and taxes withheld on April 1. No entry had been recorded for salaries or payroll tax expense as of March 31. 4. Would Best Stuff have a warranty liability on the balance sheet at January 31, 2013? If so, how much?
370 FINANCIAL ACCOUNTING 3/E SOLUTIONS MANUAL CHAPTER 7 • ACCOUNTING FOR LIABILITIES 371 372 FINANCIAL ACCOUNTING 3/E SOLUTIONS MANUAL

Solution: P7-64A. Account for notes payable with periodic payments of principal and interest. (LO 3). Joe Brinks is making plans to finance P7-64A Solution continued:
the following projects:
a. Purchase a truck for $30,000 to be repaid in equal monthly payments of $601 over the next five years. The bank has
quoted an interest rate of 7.5%.
b. Purchase a piece of land, whose owner is offering to sell it to Joe for $25,000. The seller would accept five annual
payments of $6,595 at 10%.
c. Sell some old equipment for $4,000. Joe is willing to accept quarterly payments of $546 for the next two years at an
interest rate of 8%.
d. Purchase land and building for $50,000, with a down payment of $5,000, and semiannual payments of $3,095 for the next
10 years at an interest rate of 6.5%.
P7-63A. Account for notes payable with periodic payments of principal and interest. (LO 3). Ultra Power, Inc., engaged in the fol- Requirement
lowing transactions related to long-term liabilities during 2011: For each independent scenario, show the transactions in the accounting equation for the first two payments.
a. On March 1, the company borrowed $50,000 for a machine. The loan is to be repaid in equal annual payments of $6,793
at the end of each of the next 10 years (beginning February 28, 2012); the interest rate is 6%. Solution:
b. On October 1, the company borrowed $100,000 from the local credit union at an interest rate of 8%. The loan is for seven
years, and Ultra Power will make annual payments of $19,207 on September 30 of each year.
Requirements
1. For each loan, prepare an amortization schedule for the first four payments. Show the reduction in principal and the interest
expense for each payment.
2. What total interest expense related to these two loans would Ultra Power, Inc., show on its income statement for the year ended
December 31, 2011?
3. How much interest payable would Ultra Power, Inc., show on its balance sheet at December 31, 2011?
Solution:

P7-65A. Account for bonds payable. (LO 4). Julie’s Cleaning Service issued $25,000 worth of 10-year bonds at 105. The bonds have
a stated rate of 9%.
Requirements
1. Was the market interest rate at the time of issue higher or lower than 9%? How do you know?
2. What were the proceeds from the bond issue?
3. Will the interest expense each period be higher or lower than the interest payment?
4. Will the book value of the bonds be higher or lower than $25,000 after five years?
Solution:

CHAPTER 7 • ACCOUNTING FOR LIABILITIES 373 374 FINANCIAL ACCOUNTING 3/E SOLUTIONS MANUAL CHAPTER 7 • ACCOUNTING FOR LIABILITIES 375

P7-66A. Account for bonds payable. (LO 4). Adam Ship Builders issued $5 million of its 7% bonds on February 8, 2010, at 96. The Solution: Solution:
bonds mature on June 30, 2020. Interest is payable semiannually on June 30 and December 31.
Requirements
1. What were the proceeds from the bond issue?
2. Was the market interest rate at the time of issue higher or lower than 7%?
3. Will interest expense each period be higher or lower than the interest payment?
4. What will the book value of the bonds be at maturity?
Solution:

P7-69B. Account for notes payable with periodic payments of principal and interest. (LO 3, 5). Zelda’s Diamond Emporium engaged
in the following transactions related to long-term liabilities during 2009:
a. On July 1, 2009, the company borrowed $150,000 for a new piece of office equipment. The loan is to be repaid in equal
annual payments of $15,444 at the end of each of the next 15 years (beginning June 30, 2010); and the interest rate
Zelda’s is paying for this loan is 6%.
b. On October 1, the company borrowed $250,000 from the local credit union at an interest rate of 8%. The loan is for 15
years, and Zelda’s will make annual payments of $29,207 on September 30 of each year.
Requirements
1. For each loan, prepare an amortization schedule for the first four payments. Show the reduction in principal and the interest
expense for each payment.
Set B 2. What total interest expense related to these two loans would Zelda’s show on its income statement for the year ended December
31, 2009?
P7-67B. Account for current liabilities. (LO 1, 5). On May 1, 2010, the accounting records of Sea Salt Company showed the follow-
3. How much interest payable would Zelda’s show on its balance sheet at December 31, 2009?
ing liability accounts and balances:
Accounts payable $35,600 Solution:
Short-term notes payable 15,000
Interest payable 950
Unearned service revenue 6,000

a. On May 1, 2010, Sea Salt Company signed a six-month note for $20,000 at 6%.
b. During May, Sea Salt Company paid off the $15,000 short-term note and the interest payable shown on the May 1
balance sheet.
c. The company also paid off the beginning balance in accounts payable.
d. During the month, Sea Salt purchased $40,000 of merchandise on account.
e. Also during May, Sea Salt’s employees earned salaries of $25,000. Withholdings related to these wages were $1,550 for
social security (FICA), $5,000 for federal income tax, and $2,500 for state income tax. The company will pay May
salaries and taxes withheld on June 1. No entry had been recorded for salaries or payroll tax expense as of May 31.
Requirements
1. Use the accounting equation to record the transactions described.
2. Show how Sea Salt Company would record the interest on the notes payable for the month of May and the salary expense and
payroll tax expense.
3. Prepare the current liabilities section of the balance sheet at May 31, 2010.
P7-68B. Account for warranties. (LO 2). Fancy Frames prepares monthly financial statements. The following took place during the
months of April and May at Fancy Frames:
a. In April, $15,000 worth of frames was sold. Each is guaranteed for 12 months. Any defective frame will be repaired or
replaced free of charge during that period.
b. Fancy Frames estimated that it would cost $500 during the next year to honor the warranties on the April sales.
c. During May, Fancy Frames spent $150 dollars to honor warranties related to April sales.
Requirements
1. What amount of warranty expense would be shown on the income statement for April?
2. What amount of warranty liability would be shown on the April 30 balance sheet?
3. What effect did recording the warranty expense have on owner’s equity?
4. What amount of warranty expense related to these frames would be shown on the income statement for May?
5. What effect did spending the $150 in May have on owner’s equity?
376 FINANCIAL ACCOUNTING 3/E SOLUTIONS MANUAL CHAPTER 7 • ACCOUNTING FOR LIABILITIES 377 378 FINANCIAL ACCOUNTING 3/E SOLUTIONS MANUAL

P7-70B. Account for notes payable with periodic payments of principal and interest. (LO 3). Black Company is making plans to P7-70B Solution continued: P7-72B. Account for bonds payable. (LO 4). Fischer’s Fishing Gear issued $100,000 worth of 15-year bonds at 105. The bonds have
finance the following projects: a stated rate of 6%.
a. Purchase a boat for $50,000 to be repaid in equal monthly payments of $977.51 over the next six years. The bank has
Requirements
quoted an interest rate of 12%.
b. Purchase a property for $125,000. The seller would accept 10 semiannual payments of $15,411.37 at 8% (annual rate). 1. What were the proceeds from the bond issue?
c. Sell some old equipment for $8,000. Black Company is willing to accept quarterly payments of $1,092 for the next two 2. Describe the change in carrying value of the bonds over the 15-year life.
years at an interest rate of 8% (annual rate). 3. Will interest expense be larger or smaller than the interest payment each year?
d. Purchase land and building for $250,000, with a down payment of $50,000, and semiannual payments of $16,048.52 for Solution:
the next 10 years at an interest rate of 10% (annual rate).
Requirement
For each situation, use the accounting equation to show how the firm would record the first two payments.
Solution:

Financial Statement Analysis

FSA7-1. Calculate debt-to-equity ratio and analyze financial data. (LO 5, 6, 7). The following information comes from the balance
sheet of Nordstrom, Inc.:

Nordstrom, Inc.
Consolidated Balance Sheets (partial)
(in millions)

January 31, February 2,

2009 2008
Liabilities and Shareholders’ Equity
Current liabilities:
Commercial paper . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 275 –
P7-71B. Account for bonds payable. (LO 4). Hard Top Patios issued $225,000 worth of five-year bonds with a stated interest rate of Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 563 $ 556
Accrued salaries, wages and related benefits . . . . . . . . . . . 214 268
9.5% and interest payable annually on December 31. The bonds were issued at 95. The bonds were issued on January 1, 2012. The
Other current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 525 550
fiscal year end is December 31. Current portion of long-term debt . . . . . . . . . . . . . . . . . . . . . 24 261
Total current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,601 1,635
Requirements Long-term debt, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,214 2,236
1. Was the market interest rate at the time of issue higher or lower than 9.5%? Explain. Deferred property incentives, net . . . . . . . . . . . . . . . . . . . . . . . . 435 369
2. Will the interest payment be more or less than the interest expense each year? Other liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 201 245
3. Will the carrying value be more or less than $225,000 after three years? After four years? At maturity? Commitments and contingencies
Shareholders’ equity:
Solution: Common stock, no par value: 1,000 shares authorized;
215.4 and 220.9 shares issued and outstanding . . . . . . . . 997 936
Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 223 201
Accumulated other comprehensive loss . . . . . . . . . . . . . . . . (10) (22)
Total shareholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,210 1,115
Total liabilities and shareholders’ equity . . . . . . . . . . . . . . $5,661 $5,600

1. Calculate the debt-to-equity ratio for the years shown.

2. Who would be interested in this information and why?
3. Suppose you were considering investing in some stock. What do you think of the change in this ratio from one year to the next?
4. If Nordstrom, Inc., has bonds payable, where do you think they might be included on the balance sheet?
5. What risks are associated with the long-term debt on Nordstrom’s balance sheet?

CHAPTER 7 • ACCOUNTING FOR LIABILITIES 379 380 FINANCIAL ACCOUNTING 3/E SOLUTIONS MANUAL CHAPTER 7 • ACCOUNTING FOR LIABILITIES 381

Solution: FSA7-2. Calculate debt-to-equity ratio and analyze financial data. (LO 5, 6, 7). The following information comes from the balance 4. If Micros Systems has bonds payable, where do you think they might be included on the balance sheet?
sheet of Micros Systems, Inc.: 5. What risks are associated with the long-term debt on the balance sheet of Micros Systems, Inc.?
Solution:
Micros Systems, Inc., and Subsidiaries
Consolidated Balance Sheets

June 30,
(in thousands, except par value data) 2008 2007
Assets
Current Assets:
Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 381,964 $242,702
Short-term investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — 86,950
Accounts receivable, net of allowance for doubtful accounts
of $28,348 at June 30, 2008, and $23,110 at June 30, 2007 . . 192,445 180,203
Inventory, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64,575 47,790
Deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18,724 16,683
Prepaid expenses and other current assets . . . . . . . . . . . . . . . . . 29,737 27,650
Total current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 687,445 601,978

Investments, non-current . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65,216 —

Property, plant, and equipment, net . . . . . . . . . . . . . . . . . . . . . . . . . . 29,165 27,955
Deferred income taxes, non-current . . . . . . . . . . . . . . . . . . . . . . . . . 7,108 23,145
Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 159,722 138,332
Intangible assets, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16,168 14,509
Purchased and internally developed software costs, net of
accumulated amortization of $61,691 at June 30, 2008, and
$54,708 at June 30, 2007 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30,846 36,296
Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,336 4,541
Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,003,006 $846,756

Liabilities and shareholders’ equity FSA7-3. Calculate the debt-to-equity ratio and analyze financial data. (LO 6, 7). Use Books-A-Million’s financial statements, which
Current Liabilities: can be found in Appendix A at the back of the book, to answer the following questions:
Bank lines of credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 989 $ 2,308
Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46,843 43,126 1. What types of debt does Books-A-Million have? Where did you find this information?
Accrued expenses and other current liabilities . . . . . . . . . . . . . 124,913 117,142 2. Compute the debt-to-equity ratio for at least two consecutive years. What information do these ratios provide?
Income taxes payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,363 8,094 3. Does Books-A-Million mention any risks associated with its long-term debt? If so, where does it mention them?
Deferred revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 115,398 86,742
Total current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 294,506 257,412 Solution:

Income taxes payable, non-current . . . . . . . . . . . . . . . . . . . . . . . . . . 18,302 —

Deferred income taxes, non-current . . . . . . . . . . . . . . . . . . . . . . . . . 2,181 15,934
Other non-current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,103 17,554
Total liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 323,092 290,900

Minority interests and minority ownership put arrangement . . . . . 6,898 4,723

Commitments and contingencies (Note 12)
Shareholders’ equity:
Common stock, $0.00625 par value; authorized 120,000 shares;
issued and outstanding 80,898 at June 30, 2008 and 81,096
at June 30, 2007 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 506 507
Capital in excess of par . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 131,517 149,089
Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 480,777 382,785
Accumulated other comprehensive income . . . . . . . . . . . . . . . . 60,216 18,752
Total shareholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . 673,016 551,133
Total liabilities and shareholders’ equity . . . . . . . . . . . . . . . . . . . . . . $1,003,006 $846,756

The accompanying notes are an integral part of the consolidated financial statements.

1. Calculate the debt-to-equity ratio for the years shown.

2. Who would be interested in this information and why?
3. Suppose you were considering investing in some of this firm’s stock. What do you think of the change in this ratio from one
year to the next?
382 FINANCIAL ACCOUNTING 3/E SOLUTIONS MANUAL CHAPTER 7 • ACCOUNTING FOR LIABILITIES 383 384 FINANCIAL ACCOUNTING 3/E SOLUTIONS MANUAL

Group Assignment IE7-3. Do owners or creditors have more claims on the Starbucks’ assets? How can you tell?
Critical Thinking Problems With the class divided into groups, assign one of the following companies to each group: Solution:
Risks and Controls Southwest Airlines
One of the risks of borrowing money is changing interest rates. For example, if a company issues bonds when the market rate is 7%, what Delta Airlines
happens if the market rate goes down while the bonds are outstanding? Name some actions a company could take to control this risk. For United Airlines
several companies that have outstanding long-term debt, read the notes to the financial statements that address this interest rate risk. AirTran
Continental Airlines
Solution:
For your company, analyze the liability section of the balance sheet. For each liability, write a short description. Use information IE7-4. What types of financial risks apply to Starbucks?
from the notes to help you. Then, calculate the debt-to-equity ratio for the years with available information. What tentative conclu- Solution:
sions can you draw about the debt position of your airline?
Solution:

Internet Exercise: Starbucks

Starbucks is the number one specialty coffee retailer, operating more than 16,000 coffee shops around the world. The company
also sells coffee beans to restaurants, businesses, airlines, and hotels and offers mail-order and online shopping. Go to CNN
Money, at http://money.com or http://finance.yahoo.com and enter the company symbol SBUX, the stock symbol of the Starbucks
Corporation, and then find the financial statements.
IE7-1. Use the annual balance sheet. Identify amounts reported for total liabilities and total shareholders’ equity at the three most
recent year ends.
Solution:

Ethics
Lucy Shafer wants to borrow $100,000 to expand her dog-breeding business. She is preparing a set of financial statements to take
to the local bank with her loan application. She currently has an outstanding loan from her uncle for $50,000. Lucy’s uncle is let-
ting her borrow the money at a very low interest rate, and she does not need to make any principal payments for five years. Due to
the favorable terms of the loan from her uncle, Lucy has decided that it is not significant enough to disclose on her financial state- IE7-2. Calculate the debt-to-equity ratio (total liabilities to total shareholders’ equity) for each year end.
ments. Instead, Lucy has classified the $50,000 as contributed capital, and the interest payments are included in miscellaneous
expenses on Lucy’s income statement. Solution:

1. What are the effects of Lucy’s classifications of her uncle’s loan and the related interest payments on the financial statements?
2. Are there any ratios that might be of interest to the local bank that will be misstated by Lucy’s actions?
3. Do you think Lucy’s actions are unethical? Suppose Lucy’s uncle agrees to be a partner in the company until Lucy can afford
to buy his share by repaying the $50,000 with interest. Does that change your opinion?
Solution: