Reference no: EM132597576
Excellence Equipment Corporation is a public Canadian company manufacturing highly specialized equipment. On January 1, 2017, Excellence issued a 12%, $10,000,000 bond, maturing in 10 years. At January 1, 2020, the bond had a carrying value of $9,300,000. Interest is payable semi-annually on June 30 and December 31. The company uses the straight-line method of amortizing any bond premium or discount.
The bond carries covenants that call for the firm's debt to total assets ratio to be no higher than 50% and their times interest earned ratio to be at least 2.
You are the CEO of Excellence. You have been on the job for a year after the previous CEO was fired for missing earnings targets. You are a CPA and MBA with a major in Accounting.
Excellence's business is cyclical and the last two years have been tough. In recent months however, there have been signs of recovery in the industry, and many distributors have placed large orders for Excellence's equipment. Delivery of the equipment is expected in 2021 and 2022. You are under pressure from the board of directors to show improvement in the bottom line.
It is now November 30, 2020, and you have just met with the company's CFO, Ms. Bean. In preparation for the coming year end on December 31, 2020, she has prepared forecasted financial statements, but has not included the effects of the $ 10,000,000 bond issue.
Below is a summary of those statements:
Income Statement
$Sales 28,000,000
COGS 20,000,000
Gross profit 8,000,000
Operating expenses 5,465,000
Operating income before interest expense 2,535,000
Bond interest expense ?
Income before income tax ?
Income tax (35%) ?
Net income ?
Statement of financial position$
Current assets 14,700,000
Non-current assets 22,000,000
Total assets 36,700,000
Current liabilities 9,000,000
Bonds payable ?
Shareholders' equity ?
Total liabilities and equity 36,700,000
Additional Information
a. Except for the bond, the company did not incur any other interest expense.
b. The last time entries were recorded for the bond was at the end of the third quarter (September 30, 2020), when adjusting entries were prepared.
Required
Question a. Prepare the journal entries related to the bond payable for the last quarter of 2020. The entries should reflect the payment of interest and related amortization of the premium ordiscount.
Question b. Complete the forecasted financial statements for December 31, 2020 by including the effects of the bond payable.
Question c. Using the financial statements from part b), calculate the times interest earned and debt to total assets ratios.
Question d. Given your calculations in part c), is Excellence forecasted to be in violation of the debt covenants? If yes, what action(s) would you recommend? Discuss the advantages/disadvantages of each recommendation.