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9-1 Odd-numbered Solutions CHAPTER 9 LIABILITIES: INTRODUCTION Questions, Short Exercises, Exercises, Problems, and Cases: Answers and Solutions 9.1 See the text or the glossary at the end of the book. 9.3 The expected value of the liability is $90,000 in both cases (.90 X $100,000 = $90,000; .09 X $1 X 1,000,000 = $90,000). Accounting would probably report the liability from the lawsuit as $100,000 and the liability for the coupons as $90,000. This inconsistency seems curious since the two situations differ only with respect to the number of possible outcomes (that is, all or nothing with respect to the lawsuit, whereas the coupon redemption rate conceivably ranges from one to one million). 9.5 The Parker School should accrue the salary in ten monthly installments of $360,000 each at the end of each month, September through June. It will have paid $300,000 at the end of each of these months, so that by the end of the reporting year, it reports a current liability of $600,000 [= $3,600,000 – (10 X $300,000)]. 9.7 It is cheaper (and, therefore, more profitable) to repair a few sets than to have such stringent quality control that the manufacturing process produces zero defectives. An allowance is justified when firms expect to have warranty costs. Manufacturers of TV sets for use on space ships or heart pacemakers should strive for zero defects. 9.9 The coupon rate and par value of the bonds, the market rate of interest, and the market's opinion of the firm as a borrower. If the coupon rate is 8 percent, the market rate is 12 percent and the market views the firm as a relatively poor credit risk, the bonds will sell at a price to yield say, 15 percent. This means that the firm will receive less than the par value of the bonds it issues. We are told that when bonds are brought to the market, the investment banker attempts to set the coupon rate so the bonds will sell close to par. 9.11 Generally, accountants initially record assets at acquisition cost and then allocate this amount to future periods as an expense. Changes in the market value of most assets (except for use of the lower-of-cost-or-market method for inventories; the market value method for marketable securities and investments in securities; and impairments) do not appear in the accounting records. Similarly, using the market interest rate at the time of
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Odd-numbered Solutions 9-2 9.11 continued. issue to account for bonds results in an initial liability equal to the amount of cash received and a subsequent liability that reflects amortization of this initial amount. Changes in the market value of bonds do not appear in the accounting records. 9.13 Zero coupon bonds offer no cash payments to the investor until maturity. The issuer benefits by delaying cash payments. The issuer also gets a tax deduction for interest expense (that is, amortization of bond discount) during the period the bonds are outstanding even though it has no immediate cash outflow for interest. The investor locks in a yield at the time of purchase.
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