REVIEW QUESTIONS

9. “Auditors are not qualified to pass on the

legality of a bond issue; this is a question for
the company’s attorneys. It is therefore
unnecessary for the auditors this bond issue
be classified as a current liability.

The auditor normally doesn’t possess a legal

skills by that, they can’t make legal judgments
which concerns on the information coming to
his attention. Auditor must request the client’s
management to send a letter of inquiry to the
lawyers that management consulted
concerning on litigation, claims and
assessment.

10. Kingsfield Corporation has outstanding an

issue of 30-year bonds payable. There is no
sinking fund for these bonds. Under what
circumstance, if any, should this bond issue be
classified as a current liability? EXERCISE 6 : SETTLEMENT OF DEBT
- If sinking fund for the bonds is part of the Miguel Company owes 200,000 plus 18,000 of
requirement in indenture and the company accrued interest to Prime National Bank. The
doesn’t have it then the company commit a debt is a 10-year, 10% note. During 20X7,
violation on indenture. The consequences of it Miguel’s business deteriorated due to a
would be the bonds payable become faltering regional economy. On December 31,
immediately due and should be classified as 20X7, Prime National Bank agrees to accept
current liability. an old machine and cancel the entire debt. The
machine has a cost of 390,000, accumulated
EXERCISE 4: ENTRIES FOR RETIREMENT depreciation of 221,000 and a fair market value
AND ISSUANCE OF BANKS of 190,000.

Required:
Stargazer Company had bonds outstanding
with a maturity value of 300,000. On April 30, A. Prepare journal entries for Miguel Company
20X7, when these bonds had an unamortized and Prime National Bank to record this debt
discount of 10,000, they were called in at 104. settlement.
To pay for these bonds. Stargazer had issued
other bonds a month earlier bearing a lower
interest rate. The newly issued bonds had a life
of 10 years. The new bonds were issued at
103 (face value 300,000). Issue costs related
to the new bonds were 3,000.

Required: Ignoring interest, compute the gain

or loss and record this refunding transaction.

B. How should Miguel report the gain or loss

on the disposition of machine and on
restructuring of debt in its 20X7 statement of PROBLEM 4
comprehensive income?
1. 7
2. 8

Review Questions
7. They have to maintenance the adequate
internal control by using of an independent
trustee. They believe that is is the way to solve
their major problem on internal control over
bonds payable, because the trustee has its
own legal responsibility that if they commit
fraud, there is a consequences to face, and
also they has no access to the issuing
company's assets even in accounting records.
PROBLEM 1 8. The information that should be requested by
the auditors from the trustee regarding on
C. Jelly Inc. Issued 600,000 of 9%, 10-year issue of debentures payable is the bond
bonds on June 30,20X7, for 562,500. This transactions. The information that the trustee
price provides a yield of 10% on the bonds. should give is the precise description of bonds
Interest is payable semiannualy on December with maturity dates, interest rates, bonds,
31 and June 30. If Jelly uses the effective retired, purchased for treasury or converted
interest method, determine the amount of into stock during the year, outstanding at the
interest expense to record if financial balance sheet and sinking fun transactions.
statements are issued on October 31, 20X7.
Exercises 1
A. The following objectives that is served by
each procedures are:
1. Provide the standard bank confirmation
2. Review the notes for terms, provisions,
agreements, interest rates etc.
3. Review the minutes of board meeting
4. Must consider the provision for compliance
of the bank loan
5. Must know the effects of president’s loans
on debt or equity
6. Investigate the purpose of acquiring debt
PROBLEM 2
7. Check the loan proceeds to cash receipts
records
Your client, Sunflower, Inc., has a debt
8. Check the interest and principal payments to
agreement with Valley City Bank that includes
cash disbursements records
a number of restrictions and covenants.
9. Re-compute and compare the computed
Violation of any restriction or covenant results
interest expense and accruals
in the entire amount of the debt becoming due
10. Consider balance sheet presentation or
immediately. For each of the following, provide
disclosure
audit procedures that will address whether
11. Obtain management representation letter
Sunflower has met the restriction or covenant.
B. The disclosures that Esteva should expect
A. A current ratio of at least 1.5 to 1 must be
to find with respect to the loans from the
maintained at year-end
president are:
1. Nature of party’s relationship
- Review balance sheets at year-end and
2. Description of the transaction
determine that the current ratio is in excess of
3. Peso volume of the loans
1.5.
4. Amounts due to president and terms of
settlement.
5.
Exercise 6
A. Journal Entries of Miguel Company (Debtor)
and Primo National Bank (Creditor) to record
the debt settlement: Notes Payable 200,000
Interest Payable 18,000 Accum. Depr. -
Machine 221,000 Machine 390,000 Gain on
Debt Restructuring 21,000 Gain on Debt
Restructuring 28,000 The gain on disposition
of machine is computed as: FMV of Machine P
190,000 Actual cost of Machine P 390,000
Acc. Depr. Of machine P 221,000 P 168,000
Gain on Disp. Of Machine P21,000 The gain
on debt restructuring is computed as: Notes
Payable P 200,000 Accrued Interest P 18,000
P218, 000 FMV of Machine P 190,000 Gain on
debt restrictiring P 28,000 Prime National Bank
(Creditor): Machine 190,000 Allow for Doubtful
Accounts 28,000 Note Receivable 200,000
Ordinary Shares 18,000 B. Miguel should
report the gain on the disposition of machine
and on restructuring of debt as "ordinary gain"
in it the income statement for 20x7. C. Journal
entries of Miguel Company (Debtor) to record
the grant of ordinary shares: Note Payable
200,000 Interest Payable 18,000 Ordinary
Shares 150,000 Additional Paid in Capital
40,000 Gain on Debt Restructuring 28,000
Prime National Bank (Creditor): Investment
(Trading) 190,000 Allowance for Doubtful
Accounts 28,000 Note Receivable 200,000
Interest Receivable 18,000
Problem 4 F. 3