Emma Thompson Company has completed a number of transactions during 2008. In January the company purchased under contract a machine at a total price of $1,200,000, payable over 5 years with installments of $240,000 per year. The seller has considered the transaction as an installment sale with the title transferring to Thompson at the time of the final payment.
On March 1, 2008, Thompson issued $10 million of general revenue bonds priced at 99 with a coupon of 10% payable July 1 and January 1 of each of the next 10 years. The July 1 interest was paid and on December 30 the company transferred $500,000 to the trustee, Hollywood Trust Company, for payment of the January 1, 2009, interest.
Due to the depressed market for the company’s stock, Thompson purchased $500,000 par value of their 6% convertible bonds for a price of $455,000. It expects to resell the bonds when the price of its stock has recovered.
As the accountant for Emma Thompson Company, you have prepared the balance sheet as of December 31, 2008, and have presented it to the president of the company. You are asked the following questions about it.
1. Why has depreciation been charged on equipment being purchased under contract? Title has not passed to the company as yet and, therefore, they are not our assets. Why should the company not show on the left side of the balance sheet only the amount paid to date instead of showing the full contract price on the left side and the unpaid portion on the right side? After all, the seller considers the transaction an installment sale.
2. What is bond discount? As a debit balance, why is it not classified among the assets?
3. Bond interest is shown as a current liability. Did we not pay our trustee, Hollywood Trust Company, the full amount of interest due this period?
Instructions
Outline your answers to these questions by writing a brief paragraph that will justify your treatment.