Question

Q10.

a. Jenson Co. is considering the following alternative plans for financing the company:

Plan 1 Plan 2

Issue 10% bonds (at face) — $2,000,000

Issue $10 common stock $3,000,000 1,000,000

Income tax is estimated at 40% of income.

Determine the earnings per share of common stock under the two alternative financing plans,

assuming income before bond interest and income tax is $1,000,000.

b. Present entries to record the selected transactions described below.

(a) Issued $2,750,000 of 10-year, 8% bonds at 97.

(b) Amortized bond discount for a full year, using the straight-line method.

(c) At the end of the third year, called bonds at 98. The bonds were carried at $2,692,250 at the

time of the redemption.

c. Brubeck Co. issued $10,000,000 of 30-year, 8% bonds on May 1 of the current year, with interest

payable on May 1 and November 1. The fiscal year of the company is the calendar year. Journalize

the entries to record the following selected transactions for the current year:

May 1 Issued the bonds for cash at their face amount.

Nov. 1 Paid the interest on the bonds.

Dec. 31 Recorded accrued interest for two months.

Answer 1

Q10.

Required a.

Answer:

	Plan 1	Plan 2
Earnings per share on common stock	2.0	4.8

Calculation:

Here we need to calculate the earnings per share of common stock under the two alternative financing plans.

For that first we need to take the Earnings before bond interest and income tax which is 1,000,000 for both the plans and deduct the interest on bonds. For plan 1 there is no bonds, but for plan 2 , that will be 2,000,000 * 10% = 200,000.

Then we get the income before income tax. From that we need to calculate the income tax with 40% rate. After deducting the calculated income tax, we get the net income. There are no preferred stocks for both the plans, hence no preferred dividend need to be paid. So, the total net income is available for dividends on common stock.

Then we need to calculate the Shares of common stock outstanding:

Plan 1 :

Total value of common stock = 3,000,000

Par value = 10

so, the number of shares = 3,000,000 / 10 = 300,000

Plan 2:

Total value of common stock = 1,000,000

Par value = 10

so, the number of shares = 1,000,000/ 10 = 100,000

Then divide the net income with the above calculated number of shares to get the EPS. The calculation is done below:

	Plan 1	Plan 2
Earnings before bond interest and income tax	1,000,000	1,000,000
Deduct: interest on bonds	-	200,000
Income before income tax	1,000,000	800,000
Deduct: income tax	400,000	320,000
Net income	600,000	480,000
Dividends on preferred stock	0	0
Available for dividends on common stock	600,000	480,000
Shares of common stock outstanding	300,000	100,000
Earnings per share on common stock	2.0	4.8

Required b.

Answer:

(a)

General Journal	Debit	Credit
Cash	2,667,500
Discount on bonds payable		82,500
Bonds Payable		2,750,000

(b)

General Journal	Debit	Credit
Interest Expense	8,250
Discount on bonds payable		8,250

(c)

General Journal	Debit	Credit
Bonds Payable	2,750,000
Loss on Redemption of bonds	2,750
Discount on bonds payable		57,750
Cash		2,695,000

Calculation:

(a) Issued $2,750,000 of 10-year, 8% bonds at 97.

So, value of bonds payable = 2,750,000

The cash received is the bond price at 97. So, the cash = 2,750,000/ 100 = 27,500 * 97 =2,667,500

Then the discount will be = 2,750,000 - 2,667,500 = 82,500

(b) Amortized bond discount for a full year, using the straight-line method.

Then the Interest Expense will be Discount on bonds payable divided by the number of years = 82,500 / 10 = 8,250

(c) At the end of the third year, called bonds at 98. The bonds were carried at $2,692,250 at the time of the redemption.

Value of bonds payable = 2,750,000

The bonds were called at 98. so cash received = 2,750,000/ 100 = 27,500 * 98 = 2,695,000

Discount on bonds payable will be = Bonds value - Carrying value at third year = 2,750,000 - 2,692,250 = 57,750

There is loss on redemption which will be debited = 2,695,000 + 57,750 - 2,750,000 = 2,750

Required c.

Answer:

Date	General Journal	Debit	Credit
May-01	Cash	10,000,000
	Bonds Payable		10,000,000
Nov-01	Interest Expense	400,000
	Cash		400,000
Dec-31	Interest Expense	133,333
	Interest Payable		133,333

Calculation:

May 1 Issued the bonds for cash at their face amount.

So, the cash received will be the issue price of 10,000,000

Nov. 1 Paid the interest on the bonds.

The interest percentage is 8% and paid on Nov 1. That wil be 6 months from May.

So the cash paid = 10,000,000 * 8% * 6/12 = 400,000

Dec. 31 Recorded accrued interest for two months.

The interest percentage is 8% and accrued for 2 months

So the cash Payable = 10,000,000 * 8% * 2/12 = 133,333