Question

The following items were taken from the accounting records of Murfreesboro Telephone Corporation (MTC) for the year ended December 31, 2018 (dollar amounts are in thousands).

Accounts payable............................................................................$ 65,600

Accrued expenses payable (other than interest) ..........................................11,347 6¾%

Bonds payable, due Feb. 1, 2019 ...................................................100,000 8½%

Bonds payable, due June 1, 2019 ...................................................250,000

Discount on bonds payable (8½% bonds of 2019) ..........................................260 11%

Bonds payable, due June 1, 2028 ...................................................300,000

Premium on bonds payable (11% bonds of 2028) .........................................1,700

Accrued interest payable ......................................................................7,333

Bond interest expense ........................................................................61,000

Other interest expense ........................................................................17,000

Notes payable (short-term) .................................................................110,000

Lease obligations-capital leases ..........................................................23,600

Pension obligation ..........................................................................410,000

Unfunded obligations for postretirement benefits other than pensions ...............72,000

Deferred income taxes .....................................................................130,000

Income tax expense .........................................................................66,900

Income tax payable ..........................................................................17,300

Operating income ...........................................................................280,800

Net income ..................................................................................134,700

Total assets ................................................................................2,093,500

Other Information 1. The 6¾ percent bonds due in February 2019 will be refinanced in January 2019 through the issuance of $150,000 in 9 percent, 20-year bonds payable.

2. The 8½ percent bonds due June 1, 2019, will be repaid entirely from a bond sinking fund.

3. MTC is committed to total lease payments of $14,400 in 2019. Of this amount, $7,479 is applicable to operating leases, and $6,921 to capital leases. Payments on capital leases will be applied as follows: $2,300 to interest expense and $4,621 to reduction in the capitalized lease payment obligation.

4. MTC's pension plan is fully funded with an independent trustee.

5. The obligation for postretirement benefits other than pensions consists of a commitment to maintain health insurance for retired workers. During 2019, MTC will fund $18,000 of this obligation.

6. The $17,300 in income tax payable relates to income taxes levied in 2018 and must be paid on or before March 15, 2019. No portion of the deferred tax liability is regarded as a current liability.

Instructions

a. Using this information, prepare the current liabilities and long-term liabilities sections of MTC's classified balance sheet as of December 31, 2018. (Within each classification, items may be listed in any order.)

b. Explain briefly how the information in each of the six numbered paragraphs affected your presentation of the company's liabilities.

c. Compute as of December 31, 2018, MTC's (1) debt ratio and (2) interest coverage ratio.

d. Solely on the basis of information stated in this problem, indicate whether this company appears to be an outstanding, medium, or poor long-term credit risk. State specific reasons for your conclusion.

Answer 1

a.

MURFREESBORO TELEPHONE CORPORATION
Partial Balance Sheet
31-Dec-18
Liabilities:						(in thousands)
	Current liabilities:
		Accounts payable				$65,600
		Accrued expenses payable (other than interest)				11,347
		Accrued interest payable				7,333
		Notes payable (short-term)				110,000
		Capital lease obligation (current portion)				4,621
		Unfunded obligation for postretirement benefits
		other than pensions (current portion)				18,000
		Income taxes payable				17,300
			Total current liabilities			$234,201
	Long-term liabilities:
		6-3/4% Bonds payable, due February 1, 2019				$100,000
		8-1/2% Bonds payable, due June 1, 2019			$250,000
		Less: Discount on bonds payable			260	249,740
		11% Bonds payable, due June 1, 2028			$300,000
		Add: Premium on bonds payable			1,700	301,700
		Capital lease obligation (less current portion)				18,979
		Unfunded obligation for postretirement benefits
		other than pensions (less current portion)				54,000
		Deferred income taxes				130,000
			Total long-term liabilities			$854,419
	Total liabilities					$1,088,620
c.	-1	Computation of debt ratio:
			Total liabilities (above)			$1,088,620
			Total assets (given)			$2,093,500
			Debt ratio ($1,088,620 ÷ $2,093,500)			52%
	-2	Computation of interest coverage ratio:
			Operating income (given)			$280,800
			Annual interest expense ($61,000 + $17,000)			$78,000
			Interest coverage ratio ($280,800 ÷ $78,000)			3.6 times

b.        

(1)        As the 6 3/4% bond issue is being refinanced on a long-term basis (that is, paid from the proceeds of a long-term bond issue rather than from current assets), it is classified as a long-term liability rather than a current liability.

(2)        The 8 1/2% bonds will be repaid from a bond sinking fund rather than from current assets. Therefore, this liability continues to be classified as long-term, despite its maturity date in less than one year.

(3)        The portion of the capital lease obligation that will be repaid within one year ($4,621) is classified as a current liability, and the remainder of this obligation is classified as long-term. The payments applicable to operating leases will be recognized as rental expense in the periods in which these costs are incurred.

(4)        As the pension plan is fully funded, the company has no pension liability.

(5)        The $18,000 portion of the unfunded liability for postretirement benefits that will be funded within one year is a current liability, and the remaining $54,000 ($72,000 - $18,000) is classified as long-term.

(6)        Income taxes payable relate to the current year’s income tax return and, therefore, are a current liability. Although deferred income taxes can include a current portion, all of the deferred income taxes are stated to be a long-term liability.

d.         Based solely upon its debt ratio and interest coverage ratio, Murfreesboro Telephone Corporation appears to be a good credit risk. One must consider, however, that MTC is a telephone company. Historically, telephone companies enjoyed somewhat of a “captive market” as sole providers of telephone and related services. More recently, however, they have come under extreme competitive pressure from satellite and other alternative providers that may affect their market share and profitability.

In summary, the fact that MTC is a profitable telephone company with a reasonable debt ratio and interest coverage ratio makes this business entity a positive long-term credit risk.