The following items pertain to the liabilities of Brent Foods. You may assume that Brent Foods began business on January 1, 2014; therefore, the beginning balance of all accounts was zero.
a. On January 1, 2014, Brent Foods issued bonds with a face value of $50,000. The bonds are due in five years and have a face interest rate of 10%. The market rate on January 1 for similar bonds was 12%. The bonds pay interest annually each December 31. Brent has chosen to use the effective interest method of amortization for any premium or discount on the bonds.
b. On December 31, 2014, Brent Foods signed a lease agreement with Cordova Leasing. The agreement requires Brent to make annual lease payments of $3,000 per year for four years, with the first payment due on January 1, 2016. The agreement stipulates that ownership of the property is transferred to Brent at the end of the four-year lease. Assume that an 8% interest rate is used for the leasing transaction.
c. On January 1, 2015, Brent redeems its bonds payable at the specified redemption price of 101. Because this item occurs in 2015, it does not affect the balance sheet prepared for year-end 2014.
Required
1. Prepare journal entries on December 31, 2014 for interest adjustment in (a) and the signing of the lease in (b).
2. Develop the Long-Term Liabilities section of Brent Foods’ balance sheet as of December 31, 2014, based on (a) and (b). You do not need to consider the notes that accompany the balance sheet.
3. Would the company prefer to treat the lease in (b) as an operating lease? Why or why not?
4. Calculate the gain or loss on the bond redemption for (c).