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    Interpretation of Liabilities (Debt)

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    A review of the accounting records at Corless Co. revealed the following information concerning the company's liabilities that were outstanding at December 31, 2002, and 2001, respectively.

    Debt (thousands) 2002 Year end interest rate 2001 Year end interest rate
    Short term debt:
    Working Capital loans $125 8% $95 7%
    Current maturities of long term debt 40 6% 40 6%

    Long term debt
    Debenture bonds due in 2022 200 9% 200 9%

    Serial bonds due in equal annual installments 120 6% 160 6%
    (see attached file)

    a. Corless Co. has not yet made an adjusting entry to accrue the interest expense related to its working capital loans for the year ended December 31, 2002. Assume that the amount of interest to be accrued can be accurately estimated using an average-for-the-year interest rate applied to the average liability balance. Use the horizontal model (or write the journal entry) to record the effect of the 2002 interest accrual for working capital loans.

    b. Note that the dollar amount and interest rate of the current maturities of long-term debt have not changed from 2001 to 2002. Does this mean that the $40,000 amount owed at the end of 2001 still has not been paid as of December 31, 2002? (Hint: Explain your answer with reference to other information provided in the problem.)

    c. Assume that the debenture bonds were originally issued at their face amount. However, the market rate of interest for bonds of similar risk has decreased significantly in recent years and is 7% at December 31, 2002. If the debenture bonds were both callable by Corless Co. and convertible by its bondholders, which event is more likely to occur? Explain your answer.

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    Solution Preview

    a. Corless Co. has not yet made an adjusting entry to accrue the interest expense related to its working capital loans for the year ended December 31, 2002. Assume that the amount of interest to be accrued can be accurately estimated using an average-for-the-year interest rate applied to the average liability balance. Use the horizontal model (or write the journal entry) to record the effect of the 2002 interest accrual for working capital loans.
    Accrued interest:
    Average for the year interest rate = (7% + 8 %)/2=7.5 %

    Average liability balance = (125 + 95 )/2= 110 ( in thousands)

    Accrued interest = 110 * 1000 * 7.5 % = 8250

    Dr Cr
    Interest expense 8250 ...

    Solution Summary

    Record the effect of the 2002 interest accrual for working capital loans etc.

    $2.49

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