1. REPORTING AND ANALYZING LIABILITIES
Chapter 10
REPORTING AND ANALYZING LIABILITIES

2. Current Liabilities 11 1
Current liabilities are debts which can reasonably be expected to be paid
From existing current assets or through the creation of other current liabilities, and
Within 1 year or the operating cycle, whichever is longer
Debts that do not meet both criteria are Long-Term Liabilities

3. Types of Current Liabilities
Notes Payable
Accounts Payable
Unearned Revenues
Accrued Liabilities
Taxes
Salaries and Wages
Interest

4. Notes Payable Notes payable are 211 2
Notes Payable
Notes payable are
Obligations in the form of written notes
Often used instead of accounts payable; they give written documentation if needed for legal remedies
Used for short-term and long-term financing needs
Most often interest-bearing, requiring the borrower to pay interest

5. Note Payable

6. Review Question
On July 1, 2010, Madeline, Inc. borrowed $70,000 from Gramy Bank via a 6-month, 9% note payable. On January 1, 2011, what amount of cash will Madeline, Inc. pay the bank?
$70,000.
$66,850.
$76,300.
$73,150.

7. Review Question
On July 1, 2010, Madeline, Inc. borrowed $70,000 from Gramy Bank via a 6-month, 9% note payable. On January 1, 2011, what amount of cash will Madeline, Inc. pay the bank?
$70,000.
$66,850.
$76,300.
$73,150.

8. Journal
On 9/1/07 First National Bank lends $100,000 to Cole Williams Co. on a four-month, 12% note maturing 1/1/08.

9. Journal
On 9/1/07 First National Bank lends $100,000 to Cole Williams Co. on a four-month, 12% note maturing 1/1/08.
Sept 1 Cash 100,000
Notes Payable 100,000
To record issuance of 12%, 4-month note to bank
Dec 31 Interest Expense ,000
Interest Payable 4,000
To accrue interest for 4 months on note.

10. Journal Jan 1 Notes Payable 100,000 Interest Payable 4,000
Cash ,000
To record payment of 1st National Bank interest-
bearing note and accrued interest at maturity.

11. Review Question $1,000 interest expense. $11,000 note payable.
Windy Co. borrowed $10,000 cash on July 1, 2007, from Main Bank by signing a one-year, 10% note payable. Windy Co.’s financial statements at December 31, 2007, should reflect?
$1,000 interest expense.
$11,000 note payable.
$500 interest payable.
$1,000 interest revenue.

12. Review Question
Windy Co. borrowed $10,000 cash on July 1, 2007, from Main Bank by signing a one-year, 10% note payable. Windy Co.’s financial statements at December 31, 2007, should reflect?
$1,000 interest expense.
$11,000 note payable.
$500 interest payable.
$1,000 interest revenue.

13. Computing Interest
Compound Interest--Interest computed on principal plus previously accumulated interest.

14. Compounding Periods The period of time for which interest is computed.
Interest is compounded annually or semi-annually.
The interest rate per compounding period is the yearly interest rate divided by compounding periods per year.

15. Effects of Compound Interest
Comparing
the value
of $100 lump sum
invested at 10%
for 20 years with
simple interest
and compound
interest.

16. Sales Taxes Payable Are collected from customers11
Sales Taxes Payable
Are collected from customers
Are expressed as a % of sales price
Are required by state law.
Remitted to the state monthly
Usually rung separately from sales on the cash register.

17. Journal Mar 25 Cash 10,600 Sales 10,000 Sales Taxes Payable 600
To record daily sales and sales taxes.

18. Payroll Deductions

19. Prepare the journal entry
Payroll Taxes
Various payroll taxes are required by law to be withheld from employees’ gross pay
Social Security (FICA) taxes withheld, employer and employee make equal contributions ($7,250)
Federal income taxes ($21,864)
State income taxes ($2,922)
Net pay ($67,964)
Prepare the journal entry

20. Journal Record payment of payroll
Mar 7 Salaries and Wages Expense 100,000
FICA Taxes Payable (employee’s share) 7,250
Federal Income Taxes Payable ,864
States Income Taxes Payable ,922
Salaries and Wages Payable ,964
Record payroll earned by employees
Mar 7 Salaries and Wages Payable , Cash ,964
Record payment of payroll

21. Review Question
Amounts withheld from employee paychecks for FICA taxes and federal income taxes withheld should be reported by the employer as?
Prepaid expenses Current liabilities Unearned Revenues
Yes Yes No
No Yes No
No No Yes
Yes No No

22. Review Question
Amounts withheld from employee paychecks for FICA taxes and federal income taxes withheld should be reported by the employer as?
Prepaid expenses Current liabilities Unearned Revenues
Yes Yes No
No Yes No
No No Yes
Yes No No

23. Journal Employers incur a second type of payroll-related activity.
1) Employer’s share of FICA
2) Federal unemployment
3) State unemployment
Mar 7 Payroll Tax Expense ,450
FICA Taxes Payable (employer’s share) 7,250 Federal Unemployment Taxes Payable State Unemployment Taxes Payable 5,400
Record Employer payroll taxes

24. Unearned Revenue
Unearned revenue is cash received before service or product is delivered (that is, before revenue is earned)
Recorded as a liability until it is earned

25. Unearned Revenues Examples of unearned revenues Magazine subscriptions
Rent received in advance
Customer deposits for future service
Sale of airline tickets for future travel
Sale of season tickets to sporting events

26. Journal As each game is completed Aug 6 Cash 500,000
Unearned Ticket Revenue ,000
Record sale of 10,000 tickets at $50 ea.
As each game is completed
Sept 7 Unearned Ticket Revenue ,000
Ticket Revenue ,000
To record ticket revenue earned

27. Current Maturities of Long-Term Debt
The portion of long-term debt due within the current year or operating cycle
Classified as a current liability
No adjusting entry is necessary

28. Bonds 11
Bonds
A form of long-term, interest-bearing note payable issued by corporations, universities and governmental agencies
Sold in small denominations, (usually multiples of $1,000) which makes them attractive to investors
Are in the form of a legal document that indicates the name of the issuer, the face value of the bonds, the contractual interest rate, and the maturity date

29. Bond Certificate

30. Cash Flow of Bonds

31. Bond Features Bonds have many different features
Secured bonds have specific assets pledged as collateral, unsecured do not
Convertible bonds may be converted into common stock at the bondholder’s option
Callable bonds are subject to retirement at a stated dollar amount prior to maturity

32. Accounting for Bond Issues11
Bonds may be issued at
Face value when
stated rate = market rate
Below face value (discount) when
stated rate < market rate must discount price to get investors to buy
Above face value (premium) when
stated rate > market rate all investors want to own so the price is bid up

33. Interest Rates and Bond Prices

34. Selling Bonds at Discount
On January 1, 2009, Candlestick, Inc., sells $100,000, 5-year, 10% bonds at 98 with interest payable on January 1.
Jan 1 Cash 98,000
Discount on Bonds Payable ,000* Bonds Payable ,000
Record sale of bonds at a discount
*The discount account is a contra account to the bond payable, not an asset account.

35. Statement Presentation of Discounted Bonds
Long-term liabilities
Bonds payable $ 100,000
Less: Discount on bonds payable ,000 $98,000
Carrying Value

36. Selling Bonds at Premium
On January 1, 2009, Candlestick, Inc., sells $100,000, 5-year, 10% bonds at 102 with interest payable on January 1.
Jan 1 Cash 102, Bonds Payable ,000
Premium Bonds Payable ,000*
Sale of bonds at a premium
*Premium is added to bonds payable on the balance sheet

37. Candlestick’s Statement Presentation of Premium Bonds
Long-term liabilities
Bonds payable $ 100,000
Add : Premium on bonds payable ,000 $102,000
Carrying Value

38. Bond Premium/Discount Amortization Methods
Straight-Line Method--A method of systematically writing off a bond premium or discount, resulting in equal amounts being amortized each period.

39. Bond Premium/Discount Amortization Methods
Straight-Line Method
Effective-Interest Method--A method of systematically writing off a bond premium or discount, taking into consideration the time value of money.

40. Bond Premium/Discount Amortization Methods
Straight-Line Method
Effective-Interest Method
The effective-interest method is the preferred method for GAAP.

41. Bond Premium/Discount Amortization Methods
For simplicity, we will assume discounts and premiums are amortized using straight line.
Candlestick, Inc. would amortize the $2,000 discount/premium as follows
$2,000 ÷ 5 Interest Periods
= $400 Annually

42. Amortization of Bond Discount

43. Amortization of Bond Premium

44. Review Question
If bonds sell at a premium, the market rate of interest must be?
Equal to the stated interest rate.
Greater than the stated interest rate.
Less than the stated interest rate.
Cannot be determined from the information given.

45. Review Question
If bonds sell at a premium, the market rate of interest must be?
Equal to the stated interest rate.
Greater than the stated interest rate.
Less than the stated interest rate.
Cannot be determined from the information given.

46. Review Question True or False
If bonds sell at a premium, interest expense will be more than cash interest paid.

47. Review Question
False
If bonds sell at a premium, interest expense will be more than cash interest paid.
If bonds sell at a premium, amortization will decrease interest expense, making it less than cash interest paid.

48. Bond Retirements Bonds may be redeemed at maturity or before maturity11
Bonds may be redeemed at maturity or before maturity

49. Redeeming Bonds Before Maturity
A company may decide to retire bonds before maturity to
reduce interest cost
remove debt from its balance sheet
A company should retire debt early only if it has sufficient cash resources

50. Redeeming Bonds Before Maturity
When bonds are retired before maturity, it is necessary to
Eliminate the carrying value of the bonds at the redemption date
Record the cash paid
Recognize the gain or loss on redemption
The carrying value of the bonds is the bond payable plus the premium or minus the discount

51. Financial Statement Presentation and Analysis11
Current liabilities are listed first under “Liabilities” on the balance sheet
A common method is to list the current liabilities in order of magnitude, beginning with the largest
Long-term liabilities are listed in a separate section of the balance sheet

52. ANALYSIS
Liquidity ratios measure the short-term ability of a company to pay its maturing obligations and to meet unexpected needs for cash.
Current Ratio = current assets/current liabilities
Solvency ratios measure the ability of a company to survive over a long period of time.
Debt to Total Assets Ratio = total liabilities/total assets
Times Interest Earned Ratio = net income + interest expense + tax expense/interest expense

53. ANALYSIS
Off-balance sheet financing concerns whether a company has properly recorded all of its obligations
Common types of off-balance sheet financing include
Contingencies are events with uncertain outcomes (lawsuits, warranties, etc)
Leases structured to avoid meeting the criteria of a capital lease, thus avoiding the recording of an asset and a liability

54. Review Question
The term used for bonds that have specific assets pledged as collateral is?
Callable bonds.
Convertible bonds.
Secured bonds.
Discount bonds.

55. Review Question
The term used for bonds that have specific assets pledged as collateral is?
Callable bonds.
Convertible bonds.
Secured bonds.
Discount bonds.

56. Other Long-Term Liabilities
Deferred Income Taxes--An account to record the difference between income tax expense on the income statement and income taxes payable for the year to federal and state governments.
Pension Liability--A contract between a company and its employees whereby the company agrees to pay benefits to employees after their retirement.