Exam 7: Current Liabilities and Long-Term Liabilities

Cambridge Corporation issued $1,200,000 of 7% bonds that mature in five years. Compute the bond issue price assuming that the market rate for similar bonds is: a. 8% per year compounded annually (and interest is paid annually) b. 10% per year compounded semi-annually (and interest is paid semi-annually)

The market rate of interest is equal to the risk-free rate plus a credit-rating premium.

The Progressive Corporation (a property and casualty insurance company) reported the following in its 2016 annual report: *For purposes of this exercise, assume the entire debt amount is long-term. Required: a. Explain in layman's terms the liabilities labeled "Unearned premiums" and "Loss reserves." b. What percentage of Progressive's total liabilities relates to current operating liabilities for 2016? Do you believe that this number is higher than most companies or lower? Why? c. Which current liability reported by Progressive is the least reliably measured - that is, the most subjective? Explain.

Chang, Inc. issued a 120-day note in the amount of $360,000 on 12/16/17 with an annual rate of 5%. What amount of interest has accrued as of 12/31/17?

Unlike stock, once sold, bonds can only be traded in private transactions between arms' length parties.

Washington Inc. issued $705,000 of 6%, 20-year bonds at 98 on January 1, 2009. Through January 1, 2017, Washington amortized $8,200 of the bond discount. On January 1, 2017, Washington Inc. retired the bonds at 102 (after making the interest payment on that date). What is the gain or loss that Washington Inc. would report for the retirement of this bond?

If accrued liabilities are overestimated in the current period, the reported income in a following period will be lower than it should be.

What determines the effective cost of debt?

Hamilton Company issues $5,250,000 in 7% bonds due in five years with semiannual interest payments. How much should Hamilton expect to receive if the market return for similar bonds is 8%?

Progressive Corp. (a property and casualty insurance company) reported "Loss and loss adjustment expense reserves" (an operating liability) of $11,368.0 million its 2016 Form 10-K. What is the allowance for loan and lease losses? How could Progressive's managers use the reserve to manage income? Provide a numerical example of the income statement effect of this sort of earnings management.

Progressive Corporation (a property and casualty insurance company) reported the following in its 2016 annual report: During 2016, we renewed the unsecured, discretionary line of credit (the "Line of Credit") with PNC Bank, National Association (PNC) in the maximum principal amount of $100 million. The prior line of credit, entered into in March 2015, had expired. The Line of Credit is on substantially the same terms and conditions as the prior line of credit. Subject to the terms and conditions of the Line of Credit documents, advances under the Line of Credit (if any) will bear interest at a variable rate equal to the higher of PNC's Prime Rate or the sum of the Federal Funds Open Rate plus 50 basis points. Each advance must be repaid on the 30th day after the advance or, if earlier, on April 30, 2017, the expiration date of the Line of Credit. Prepayments are permitted without penalty. All advances under the Line of Credit are subject to PNC's discretion. We had no borrowings under the Line of Credit or the prior line of credit in 2016 or 2015. Aggregate principal payments on debt outstanding at December 31, 2016, is as follows: Continued next page Required: a. What amount does Progressive report for long-term debt on its balance sheet? b. Why is there a difference between the fair value and the carrying value of Progressive's long-term debt? c. Were the 3.75% notes originally issued at par, at a discount or at a premium? How do you know? d. What is the amount of the unamortized discount on the 6.25% notes as of December 31, 2016? e. What cash interest payment did Progressive make for the 6 5/8 notes in 2016? What interest expense did Progressive record for these notes during 2016? Assume for this question that Progressive pays interest annually. f. If Progressive were to repurchase all of its bonds on January 1, 2017, how would the income statement be affected? g. How much does the company owe under the line of credit with PNC Bank at year end? Why does Progressive discuss this in its debt footnote? h. What does the footnote reveal about timing of debt due in 2017 and thereafter?

Heller Company issues $950,000 of 10% bonds that pay interest semiannually and mature in 10 years. What is the bonds' issue price assuming that the bonds' market interest rate is 14% per year?

Following is the debt footnote from the Lowe's 2017 form 10-K: Required: a. What is the amount of debt on Lowe's balance sheet as of February 3, 2017? b. What proportion of Lowe's long-term debt is due before February 2, 2018? c. How much of Lowe's assets were pledged as collateral as of February 3, 2017? d. What effect, if any, does Lowe's collateral have on its credit risk and interest costs? e. Assume that the notes due fiscal 2042-2046 outstanding at the beginning of the year were 4.26% notes issued to yield 4.4%. At the beginning of the year, these notes had an unamortized discount of $132 million. What cash interest payment did Lowe's make for these notes, assuming interest is paid annually? What interest expense did Lowe's record for these notes during the current year?

Reed Corp. sells $700,000 of bonds to private investors. The bonds are due in five years, have a 4% coupon rate and interest is paid semiannually. The bonds were sold to yield 6%. What proceeds does Reed receive from the investors?

Washington Inc. issued $675,000 of 6%, 20-year bonds at 98 on January 1, 2009. Through January 1, 2017, Washington amortized $7,500 of the bond discount. On January 1, 2017, Washington Inc. retired the bonds at 103 (after making the interest payment on that date). Calculate the net book value of the bond on January 1, 2017 and the gain or loss that Washington Inc. would report for this retirement.

EZ Wheels Corporation manufactures kick scooters. The company offers a one-year warranty on all scooters. During 2017, the company recorded net sales of $1,900 million. Historically, about 4% of all sales are returned under warranty and the cost of repairing and or replacing goods under warranty is about 30% of retail value. Assume that at the start of the year EZ Wheels' balance sheet included an accrued warranty liability of $16.3 million and at the end of the year, the accrued warranty liability balance was $12.4 million. How much did EZ Wheels pay during the year to repair and/or replace scooters under warranty?

Credit ratings are an opinion of a company's relative default risk.

InterTech Corporation needed financing to build a new manufacturing plant. On June 30th, 2017, InterTech issued $4,350,000 of 8-year bonds with a 6% coupon rate (payments due on December 31^st and June 30^th). The effective interest rate was 8%. What amount in interest expense did InterTech record for the December 31, 2017 payment?

What are some ratios used by Moody's to measure default risk? What are some other relevant (non-ratio) factors used to determine debt ratings?

Gold Enterprises recently issued $40 million of 12% coupon bonds, payable semiannually, which mature in 10 years. The bonds were sold for $37,796,299 to yield a 13% annual rate. Use the table below to show the amortization of the discount, interest expense, and the carrying amount of the bonds from issuance till the end of Period 4.