Chapter 11 - Solution Manual

C to determine the amount of interest expense for the

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c. To determine the amount of interest expense for the term bonds for 2011, the net carrying value of the term bonds on April 1, 2011, would be multiplied by the effective interest rate (yield) of 10 percent for 9/12 of the year. (April 1, 2011 to December 31, 2011) To determine the amount of interest expense for the serial bonds for 2011, the net carrying value of the serial bonds on November 1, 2011, would be multiplied by the effective interest rate (yield) of 11 percent and by one sixth (November 1, 2011. to December 31, 2011). Case 11-9 The two basic requisites for the accrual of a loss contingency (probability of loss and reasonable estimation) are the results of the interaction of several concepts of accounting theory. Three of these concepts are (1) periodicity (time periods), (2) measurement, and (3) objectivity. The first of these concepts relates to the first characteristic of an event necessary before accruing a loss contingency, and the second and third concepts listed relate to the second necessary requirement for the accrual of a loss contingency. The first requirement that must be satisfied for the accrual of a loss contingency is that at a time prior to the issuance of the financial statements there is an indication that it is probable that an asset has been impaired or a liability has been incurred at the date of the financial statements. A basic objective in the recognition of losses is to record them in the particular period in which they are incurred. With respect to the accrual of a loss contingency, a probable loss should be recognized in the same period in which it resulted in the probable impairment of an asset or the probable incurrence of a liability. The failure to accrue the loss contingency in the period of occurrence will generally overstate earnings initially and understate earnings in future periods. The second requirement for the accrual of a loss contingency states that the amount of the loss must be reasonably estimable. The concept of measurement requires that the event must be quantifiable in terms of a standard unit of measure (dollars). In the case of a loss contingency related to the period covered in the current financial statements, the exact timing and magnitude of the loss may not be known in advance, but based on past experience or other methods of analysis, a reasonable estimate of the loss contingency can be made. In making the estimate, the probability that a reasonable amount will be determined statistically is enhanced by a large population of accounts from which the probable loss will occur (law of large numbers). Also related to the reasonable estimation of the probable future loss, the concept of objectivity requires that the estimate be supported by quantitative data. The basis for the estimate must yield essentially the same estimate when computed by different individuals using the available supporting data. The concept of objectivity is supportive of the contention that future events will confirm
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