Digital Telephony issued 10% bonds, dated January 1, with a face amount of $32 m
ID: 2472796 • Letter: D
Question
Digital Telephony issued 10% bonds, dated January 1, with a face amount of $32 million on January 1, 2016. The bonds mature in 2026 (10 years). For bonds of similar risk and maturity the market yield is 12%. Interest is paid semiannually on June 30 and December 31. Digital recorded the issue as follows: (FV of $1, PV of $1, FVA of $1, PVA of $1, FVAD of $1 and PVAD of $1) (Use appropriate factor(s) from the tables provided.) General Journal Debit Credit Cash 28,329,472 Discount on bonds 3,670,528 Bonds payable 32,000,000 Digital also leased switching equipment to Midsouth Communications, Inc., on September 30, 2016. Digital purchased the equipment from MDS Corp. at a cost of $6 million. The five-year lease agreement calls for Midsouth to make quarterly lease payments of $391,548, payable each September 30, December 31, March 31, and June 30, with the first payment on September 30, 2016. Digital’s implicit interest rate is 12%. Required: 1. What would be the amount(s) related to the bonds that Digital would report in its statement of cash flows for the year ended December 31, 2016? (Do not round intermediate calculations. Enter your answers in whole dollars. List cash outflows as negative amounts.) 2. What would be the amounts related to the lease that Midsouth would report in its statement of cash flows for the year ended December 31, 2016? (Do not round intermediate calculations. Enter your answers in whole dollars. List cash outflows as negative amounts.) 3. What would be the amounts related to the lease that Digital would report in its statement of cash flows for the year ended December 31, 2016? (Do not round intermediate calculations. Enter your answers in whole dollars. List cash outflows as negative amounts.) 4. Assume MDS manufactured the equipment at a cost of $5 million and that Midsouth leased the equipment directly from MDS. What would be the amounts related to the lease that MDS would report in its statement of cash flows for the year ended December 31, 2016? (Do not round intermediate calculations. Enter your answers in whole dollars. List cash outflows as negative amounts.) rev: 05_05_2014_QC_49109
Explanation / Answer
a) Date Cash Interest = 10%/2 x Face Value Effective Interest = 12%/2 x Outstanding Bal. Increase in Blance Outstanding Balance Discount Reduction Jan 1, 2016 $28,329,472 Jun 30, 2016 $1,600,000 $1,699,768.32 $99,768.32 $28,429,240.32 Dec 31, 2016 $1,600,000 $1,705,754.42 $105,754.42 $28,534,994.74 Digital would report the cash inflow of $28,329,472 from the sale of the bonds as a cash inflow from financing activities in its statement of cash flows. The $3,200,000 ($1,600,000 + 1,600,000) cash interest paid is a cash outflow from operating activities because interest is an income statement (operating) item. By the indirect method of reporting cash flows from operating activities, we would add back to net income the $99,768 and $105,754 discount amortization since net income was reduced by interest expense each period but cash decreased by only $1,600,000 each period. b) Lease Cost $6,000,000 Rate = 12%/4 3.00% Nper = 5 x 4 20 Payments(PMT) $391,548 Interest portion of Payment (3% x [$6 million – 391,548]) $168,253.56 Principal = ($391,548 - $168,254) $223,294.44 The interest portion, $168,254, from the December 31 payment, is reported as a cash outflow from operating activities. The principal portion, $614,842 ($391,548 + 223,294), is reported as a cash outflow from financing activities. Amortization expense ($6 million / 5 years x 14 year) $300,000 By the indirect method of reporting cash flows from operating activities, we would add back to net income the $300,000 amortization expense since it didn’t actually reduce cash. The $168,254 interest expense that reduced net income actually did reduce cash no adjustment to net income is necessary. 3) The $783,096 ($391,548 + 391,548 ) - $168,253.56 (interest) = $614,842, must be added to net income as a cash inflow from operating activities. 4) The $783,096 ($391,548 + 391,548 ) - $168,253.56 (interest) = $614,842, must be added to net income as a cash inflow from operating activities.