reporting and analyzing liabilities

10-1

REPORTING AND ANALYZING LIABILITIES

Financial Accounting, Sixth Edition

10

10-2

1. Explain a current liability and identify the major types of current

liabilities.

2. Describe the accounting for notes payable.

3. Explain the accounting for other current liabilities.

4. Identify the types of bonds.

5. Prepare the entries for the issuance of bonds and interest

expense.

6. Describe the entries when bonds are redeemed.

7. Identify the requirements for the financial statement presentation

and analysis of liabilities.

Study ObjectivesStudy ObjectivesStudy ObjectivesStudy Objectives

10-3

Two key features:

1. Company expects to pay the debt from existing current

assets or through the creation of other current

liabilities.

2. Company will pay the debt within one year or the

operating cycle, whichever is longer.

Current LiabilitiesCurrent LiabilitiesCurrent LiabilitiesCurrent Liabilities

SO 1 Explain a current liability and identify the SO 1 Explain a current liability and identify the major types of current liabilities.major types of current liabilities.

Current liabilities include notes payable, accounts payable, unearned revenues, and accrued liabilities such as taxes, salaries and wages, and interest payable.

What is a Current Liability?

10-4 SO 2 Describe the accounting for notes payable.SO 2 Describe the accounting for notes payable.

Notes Payable

Written promissory note.

Require the borrower to pay interest.

Those due within one year of the balance sheet date

are usually classified as current liabilities.


10-5

Illustration: First National Bank agrees to lend $100,000 on

September 1, 2012, if Cole Williams Co. signs a $100,000,

12%, four-month note maturing on January 1. When a

company issues an interest-bearing note, the amount of

assets it receives generally equals the note’s face value.

Notes payable

100,000

Cash 100,000

SO 2 Describe the accounting for notes payable.SO 2 Describe the accounting for notes payable.


Sept. 1

10-6

Illustration: If Cole Williams Co. prepares financial statements

annually, it makes an adjusting entry at December 31 to

recognize interest.

Interest payable

4,000

Interest expense 4,000 *



Dec. 31

* $100,000 x 12% x 4/12 = 4,000

10-7

Illustration: At maturity (January 1), Cole Williams Co. must

pay the face value of the note plus interest. It records payment

as follows.

Interest payable 4,000

Notes payable 100,000



Jan. 1

Cash

104,000

10-8 SO 3 Explain the accounting for other current liabilities.SO 3 Explain the accounting for other current liabilities.

Sales Tax Payable

Sales taxes are expressed as a stated percentage

of the sales price.

Retailer collects tax from the customer.

Retailer remits the collections to the state’s

department of revenue.


10-9

Illustration: The March 25 cash register readings for Cooley

Grocery show sales of $10,000 and sales taxes of $600 (sales

tax rate of 6%), the journal entry is:

SO 3 Explain the accounting for other current liabilities.SO 3 Explain the accounting for other current liabilities.


Mar. 25

Sales revenue10,000

Cash 10,600

Sales tax payable

600

10-10

Illustration: Cooley Grocery rings up total receipts of $10,600.

Because the amount received from the sale is equal to the

sales price 100% plus 6% of sales, (sales tax rate of 6%), the

journal entry is:



Mar. 25

Sales revenue10,000

Cash 10,600

Sales tax payable

600

Sometimes companies do not ring up sales taxes separately on the cash register.

* $10,600 / 1.06 = 10,000

*

10-11 SO 3 Explain the accounting for other current liabilities.SO 3 Explain the accounting for other current liabilities.

Unearned Revenue

Revenues that are received before the company delivers goods or provides services.


1. Company debits Cash, and credits a current liability account (unearned revenue).

2. When the company earns the revenue, it debits the Unearned Revenue account, and credits a revenue account.

10-12

Illustration: Superior University sells 10,000 season football

tickets at $50 each for its five-game home schedule. The entry

for the sales of season tickets is:


Unearned ticket revenue

500,000

Cash 500,000Aug. 6

Ticket revenue

100,000

Unearned ticket revenue 100,000Sept. 7


As each game is completed, Superior records the earning of

revenue.

10-13

Illustration: Wendy Construction issues a five-year, interest-bearing

$25,000 note on January 1, 2011. This note specifies that each January

1, starting January 1, 2012, Wendy should pay $5,000 of the note. When

the company prepares financial statements on December 31, 2011,

1. What amount should be reported as a current liability? _________

2. What amount should be reported as a long-term liability? _______

Current Maturities of Long-Term Debt

Portion of long-term debt that comes due in the

current year.

No adjusting entry required.



$5,000

$20,000

10-14

The term “payroll” pertains to both:

Salaries - managerial, administrative, and sales

personnel (monthly or yearly rate).

Wages - store clerks, factory employees, and manual

laborers (rate per hour).

Determining the payroll involves computing three amounts: (1) gross earnings, (2) payroll deductions, and (3) net pay.


Payroll and Payroll Taxes Payable


10-15

Illustration: Assume Cargo Corporation records its payroll for

the week of March 7 as follows:

Salaries and wages expense 100,000

Federal tax payable21,864

FICA tax payable7,650

State tax payable 2,922

Salaries and wages payable 67,564

SO 3SO 3

Cash

67,564

Salaries and wages payable 67,564Mar. 7

Record the payment of this payroll on March 7.

Mar. 7


10-16

Payroll tax expense results from three taxes that

governmental agencies levy on employers.

These taxes are:

FICA tax

Federal unemployment tax

State unemployment tax



10-17

Illustration: Based on Cargo Corp.’s $100,000 payroll,

the company would record the employer’s expense and

liability for these payroll taxes as follows.

Payroll tax expense 13,850

State unemployment tax payable800

FICA tax payable7,650

Federal unemployment tax payable 5,400



10-18

Bonds are a form of interest-bearing notes payable

issued by corporations, universities, and governmental

agencies.

Sold in small denominations (usually $1,000 or multiples

of $1,000).

SO 4 Identify the types of bonds.SO 4 Identify the types of bonds.

Bond: Long-Term LiabilitiesBond: Long-Term LiabilitiesBond: Long-Term LiabilitiesBond: Long-Term Liabilities

10-19

Types of Bonds

Secured

Unsecured

Convertible

Callable



10-20

Bond certificate

Issued to the investor.

Provides name of the company issuing bonds, face

value, maturity date, and contractual (stated)

interest rate.

Face value - principal due at the maturity.

Maturity date - date final payment is due.

Contractual (stated) interest rate – rate to determine

cash interest paid, generally semiannually.



Issuing Procedures

10-21


SO 4SO 4

Illustration 10-3

10-22

Determining the Market Value of Bonds

The process of finding the present value is referred to as discounting the future amounts.



Market value is a function of the three factors that determine

present value:

1. the dollar amounts to be received,

2. the length of time until the amounts are received, and

3. the market rate of interest.

10-23

Illustration: Assume that Acropolis Company on January 1,

2012, issues $100,000 of 9% bonds, due in five years, with

interest payable annually at year-end.


Illustration 10-5Computing the market price of bonds

Illustration 10-4 Time diagram depicting cashflows


10-24

A corporation records bond transactions when it

issues or retires (buys back) bonds and

when bondholders convert bonds into common stock (if

they are convertible).

Accounting for Bond IssuesAccounting for Bond IssuesAccounting for Bond IssuesAccounting for Bond Issues

Bonds may be issued at

face value,

below face value (discount), or

above face value (premium).

Bond prices are quoted as a percentage of face value.

SO 5 Prepare the entries for the issuance of bonds and interest expense.

10-25

Illustration: Devor Corporation issues 100, five-year, 10%,

$1,000 bonds dated January 1, 2012, at 100 (100% of face

value). The entry to record the sale is:

Jan. 1 Cash 100,000


Issuing Bonds at Face ValueIssuing Bonds at Face ValueIssuing Bonds at Face ValueIssuing Bonds at Face Value

Bonds payable 100,000

Prepare the entry Devor would make to accrue interest on

December 31.

Dec. 31 Interest expense 10,000

Interest payable 10,000

10-26

Prepare the entry Devor would make to pay the interest on Jan.

1, 2013.

Jan. 1 Interest payable 10,000

Cash 10,000


Issuing Bonds at Face ValueIssuing Bonds at Face ValueIssuing Bonds at Face ValueIssuing Bonds at Face Value

10-27

8%

10%

12%

Premium

Face Value

Discount

Assume Contractual Rate of 10%Assume Contractual Rate of 10%


Bonds Sold AtMarket Interest

Accounting for Bond IssuesAccounting for Bond IssuesAccounting for Bond IssuesAccounting for Bond Issues

10-28

Illustration: Assume that on January 1, 2012, Candlestick Inc.

sells $100,000, five-year, 10% bonds at 98 (98% of face value)

with interest payable on January 1. The entry to record the

issuance is:


Issuing Bonds at a DiscountIssuing Bonds at a DiscountIssuing Bonds at a DiscountIssuing Bonds at a Discount

Jan. 1 Cash 98,000

Discount on bonds payable 2,000


Illustration 10-8Computation of total cost of borrowing—bonds issued at discount

10-29

Statement PresentationStatement Presentation


Issuing Bonds at a DiscountIssuing Bonds at a DiscountIssuing Bonds at a DiscountIssuing Bonds at a Discount

Illustration 10-7Statement presentation of discount on bonds payable

10-30

Illustration: Assume that the Candlestick Inc. bonds previously

described sell at 102 rather than at 98. The entry to record the

sale is:


Jan. 1 Cash 102,000


Premium on bonds payable 2,000

Illustration 10-12Computation of total cost of borrowing—bonds issued at premium

Issuing Bonds at a PremiumIssuing Bonds at a PremiumIssuing Bonds at a PremiumIssuing Bonds at a Premium

10-31

Statement Presentation


Illustration 10-11Statement presentation of premium on bonds payable

Issuing Bonds at a PremiumIssuing Bonds at a PremiumIssuing Bonds at a PremiumIssuing Bonds at a Premium

10-32

Redeeming Bonds at Maturity

SO 6 Describe the entries when bonds are redeemed.SO 6 Describe the entries when bonds are redeemed.

Candlestick records the redemption of its bonds at maturity as

follows:

Accounting for Bond RetirementsAccounting for Bond RetirementsAccounting for Bond RetirementsAccounting for Bond Retirements


Cash 100,000

10-33

When a company retires bonds before maturity, it is

necessary to:

1. eliminate the carrying value of the bonds at the redemption

date;

2. record the cash paid; and

3. recognize the gain or loss on redemption.

The carrying value of the bonds is the face value of the bonds less unamortized bond discount or plus unamortized bond premium at the redemption date.



Redeeming Bonds at Maturity

10-34

Cash 103,000

Loss on bond redemption 2,600

Illustration: Assume at the end of the fourth period, Candlestick

Inc., having sold its bonds at a premium, retires the bonds at 103

after paying the annual interest. Assume that the carrying value of

the bonds at the redemption date is $100,400 (principal $100,000

and premium $400). Candlestick records the redemption at the end

of the fourth interest period (January 1, 2016) as:



Premium on bonds payable 400


10-35

Analysis

Financial Statement Analysis and PresentationFinancial Statement Analysis and PresentationFinancial Statement Analysis and PresentationFinancial Statement Analysis and Presentation

Illustration 10-16

SO 7

10-36

Liquidity


Liquidity ratios measure the short-term ability of a company to pay

its maturing obligations and to meet unexpected needs for cash.

SO 7 Identify the requirements for the financial statement presentation and analysis of liabilities.

Illustration 10-17

10-37

Solvency


Solvency ratios measure the ability of a company to survive over a

long period of time.SO 7

10-38

Off-Balance-Sheet Financing

Contingencies

Leasing

► Operating lease

► Capital lease


SO 7 Identify the requirements for the financial statement presentation and analysis of liabilities.

reporting and analyzing liabilities

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