These solutions are from ancillary material for Financial Accounting
edition, by Albrecht, Stice, Stice,
2008, U.S.A., Thomson/South-Western.
CHAPTER 10-DISCUSSION QUESTIONS
Present values are less when discount rates
are high as compared to when they are low.
This is because the interest owed or the dis-
count reported is proportionate to the in-
terest rate. That is, a company cannot bor-
row as much money on high-interest-paying
loans as on low-interest-paying loans and
yet could be required to pay the same peri-
odic amount to satisfy the terms of the loan.
An annuity is a series of cash flows of equal
amounts at equal time intervals. These cash
flows can either be paid or received.
The stated amount of a liability equals its
present value when the market rate of in-
terest is equal to the stated rate of interest
associated with the liability. For example, if
a bank issues a two-year, $1,000, 8% note
to a company when the market rate of in-
terest is 8%, then the present value compu-
tations will result in a present value of
$1,000—the same as the face amount of
A note payable is an obligation to pay a spe-
cified sum of money on or before some fu-
ture date, whereas a mortgage payable is a
liability that is usually paid in periodic
(monthly) installments. Also, a mortgage
payable is usually secured by the asset that
was purchased with the borrowed money.
For each mortgage payment, a portion is in-
terest, and the remainder is applied to re-
duce the principal. To compute that amount
attributable to principal, the outstanding loan
balance is multiplied by the monthly interest
rate. The result is the interest portion of the
payment. Subtracting this amount from the
total payment gives the amount applied to
reduce the principal.
Under a capital lease, the lease liability at
the inception of the lease is the present
value of the future annual lease payments
discounted at the leasing company’s bor-
rowing rate. In other words, the lease pay-
ments include a principal element and an in-
terest element. By discounting the lease
payments, the present value is equal to the
principal element of the transaction.
Companies prefer to classify leases as
operating leases rather than as capital
leases to reduce the amount of their re-
ported liabilities. The economic obligation
associated with an operating lease is not
classified as a “liability” for accounting
purposes, and thus is not included in the
balance sheet. Because of this, operating
leases are a form of “off-balance-sheet
Companies usually sell bonds through un-
derwriters to individuals, other companies,
pension funds, insurance companies, uni-
versities, or other institutions that perceive
bonds to be an attractive investment.
Because bonds are usually sold in small de-