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ACG 2021 Financial Accounting Current & Long-Term Liabilities.

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Presentation on theme: "ACG 2021 Financial Accounting Current & Long-Term Liabilities."— Presentation transcript:

1 ACG 2021 Financial Accounting Current & Long-Term Liabilities

2 Learning Objectives Account for current liabilities and contingent liabilities Account for current liabilities and contingent liabilities Account for bonds-payable transactions Account for bonds-payable transactions Measure interest expense Measure interest expense Understand the advantages and disadvantages of borrowing Understand the advantages and disadvantages of borrowing Statement of Cash Flow Effects Statement of Cash Flow Effects

3 Current Liabilities Liabilities due within 1 year or the companys operating cycle if longer Liabilities due within 1 year or the companys operating cycle if longer Known amounts Known amounts Accounts Payable Accounts Payable Short-term Notes Payable Short-term Notes Payable Sales Tax Payable Sales Tax Payable Current Installment of Long-Term Debt Current Installment of Long-Term Debt Accrued Expenses Accrued Expenses Payroll Liabilities Payroll Liabilities Unearned Revenues Unearned Revenues We increase Liabilities with a credit. So to increase any of the Known payables on the left, we credit the payable for the known amount. We must therefore, debit a corresponding expense account (accrued expenses) Cash (deferred liability) Long-term debt Cash (if recording receipt from a note payable)

4 Accounts Payable Amounts owed for purchases of goods or services on account Amounts owed for purchases of goods or services on account The purchase can be for an Asset The purchase can be for an Asset Inventory (generally largest) Inventory (generally largest) The purchase could also be an Expense The purchase could also be an Expense Legal Fees (service) Legal Fees (service) No interest associated with money owed, and it is assumed the A/P will be paid quickly No interest associated with money owed, and it is assumed the A/P will be paid quickly If we have an A/P for Inventory purchased on account, what does the company we purchased the inventory from have? If we have an A/P for Inventory purchased on account, what does the company we purchased the inventory from have? An Accounts Receivable An Accounts Receivable

5 Note Payable Unlike Accounts Payable Unlike Accounts Payable Usually contains interest payments that are due Usually contains interest payments that are due Record: Record: Issuance of Note Payable Issuance of Note Payable We borrowed Cash and have an obligation to pay back We borrowed Cash and have an obligation to pay back Interest Expense Interest Expense Payment of Note Payable Payment of Note Payable

6 Notes Payable On Jan. 30, 20X5 the company received a one year $8,000 note payable at 10% interest to purchase inventory. Jan 30Cash8,000 Purchase of inventory by issuing a 1-year 10% note payable Note Payable, Short-term8,000 Interest must be accrued at fiscal year end (April 30) for interest owed but not yet due. Apr 30Interest Expense (8,000 x.10 x 3/12)200 Adjusting entry to accrue interest expense Interest Payable200

7 Notes Payable To record repayment at maturity Jan 30 20x6: Jan. 30Note Payable, short-term8,000 Payment of a note payable and interest at maturity Interest Expense ($8,000 x.10 x 9/12)600 Cash [($8,000 x.10) + 8,000]8,800 Interest Payable200 Step 1: Reverse the balance in the Note Payable account to 0 Step 2: Reduce the amount of any Interest Payable from a previous period to 0 Step 3: Record the Interest Expense for the period Step 4: Record the cash (Principal and Interest paid)

8 Payroll Liabilities Types of Compensation Types of Compensation Salary Salary Wage Wage Commission Commission Bonus Bonus Salary expense is gross pay. Salary expense is gross pay. Salary payable is net pay. Salary payable is net pay.

9 Payroll Liabilities To record payroll Jan. 30Salary Expense10,000 To record salary expense FICA Tax Payable800 Salary Payable to Employees8,000 Employee Income Tax Payable1,200

10 Sales Tax Payable To record sales of $200,000 plus 5% sales tax: Cash (200,000 x 1.05)210,000 To record cash sales and related sales tax Sales Tax Payable (200,000 x.05)10,000 Sales Revenue200,000

11 Unearned Revenues To record collection of cash in payment for future services: Jan 30Cash1,200 Received cash in advance for ticket sales Unearned Ticket Revenue1,200 To record revenue after 50% of services have been performed. Apr 30Unearned Ticket Revenue600 Earned revenue that was collected in advance Ticket Revenue600

12 Current Liabilities Amounts that must be estimated Amounts that must be estimated Estimated Warranty Payable Estimated Warranty Payable How many products will need repair / replacement How many products will need repair / replacement Matching Principle Matching Principle Estimate based on past historical data Estimate based on past historical data Contingent Liabilities Contingent Liabilities An company may incur an expense in the future An company may incur an expense in the future Most commonly associated with law suits Most commonly associated with law suits

13 Estimated Warranty Payable Warranty expense should be recognized in the year the product is sold. For example, a company made sales of $200,000 subject to product warranties. They estimate that 3% of the products will require repair or replacement. Warranty Expense6,000 To accrue warranty expense Estimated Warranty Payable6,000 Estimated Warranty Payable5,800 To replace defective products under warranty Inventory5,800 When $5,800 of products are replaced under the warranty:

14 Contingent Liabilities Contingent liability depends on a future event arising out of past events. Contingent liability depends on a future event arising out of past events. To account for contingent losses: To account for contingent losses: Record liability if it is probable and can be reasonably estimated. Record liability if it is probable and can be reasonably estimated. Report the liability in the notes to the financial statements (but do not record an entry) if it is reasonably possible that a loss will occur. Report the liability in the notes to the financial statements (but do not record an entry) if it is reasonably possible that a loss will occur. Do not report a contingent loss that is not likely to occur. Do not report a contingent loss that is not likely to occur.

15 ACG 2021 Financial Accounting Long – Term Liabilities Bonds Payable

16 Bonds IOUs IOUs $1000 or $5000 Increments $1000 or $5000 Increments Sold in the Market Sold in the Market Structure: Structure: Maturity Date Maturity Date Interest Rate Interest Rate Interest Payment Dates Interest Payment Dates Provide two payments: Provide two payments: Interest every 6 months Interest every 6 months Principal amount of Bond Principal amount of Bond

17

18 Bond Market Bloomberg.com Bloomberg.com Bloomberg.com

19 Bonds Payable Bonds payable are debt (i.e. a liability) of the issuing company. Bonds payable are debt (i.e. a liability) of the issuing company. Types of bonds: Types of bonds: term bonds term bonds All bonds mature at the same time (end of the term) All bonds mature at the same time (end of the term) serial bonds serial bonds Bonds mature in installments over a period of time. Bonds mature in installments over a period of time. secured bonds (mortgage bonds) secured bonds (mortgage bonds) debentures (unsecured bonds) debentures (unsecured bonds)

20 Bonds Payable Bonds can be issued (bought) Bonds can be issued (bought) at face value at face value for a premium for a premium at a discount at a discount Bond Price is determined by: Bond Price is determined by: Market Interest Rate – Effective Rate Market Interest Rate – Effective Rate Bonds Interest Rate – Contract Rate Bonds Interest Rate – Contract Rate THESE RATES ARE USUALLY DIFFERENT! THESE RATES ARE USUALLY DIFFERENT!

21 Bond Interest Rates Bonds are sold at market price - amount that investors are willing to pay at any given time Bonds are sold at market price - amount that investors are willing to pay at any given time Market price represents: Market price represents: present value of periodic interest payments present value of periodic interest payments present value of principal to be received at maturity present value of principal to be received at maturity

22 Present Value The amount invested today to receive a greater amount at a future date It depends on: amount of the future receipt amount of the future receipt length of time to future receipt length of time to future receipt interest rate for the period interest rate for the period

23 Bond Interest Rates Contract rate – stated rate Contract rate – stated rate Market rate – effective rate Market rate – effective rate

24 Present Value Calculation (Discount) $100, year bond, 9% stated interest, 10% market rate $100, year bond, 9% stated interest, 10% market rate Two parts: PV of principle and PV of interest payments Two parts: PV of principle and PV of interest payments $100,000 x.614* = $61,400 $100,000 x.614* = $61, ,000 x. 045 x 7.722* = $34, ,000 x. 045 x 7.722* = $34,749 PV of Bonds $96,149 PV of Bonds $96,149 * From Appendix C

25 Bond Prices Bond Face Value = Stated Principal Bond Face Value = Stated Principal Bond issued above face (par) value - premium Bond issued above face (par) value - premium Bond issued at below face (par) value - discount Bond issued at below face (par) value - discount As a bond nears maturity, its market price moves toward par value As a bond nears maturity, its market price moves toward par value

26 Bond Prices Quoted at a percent of their maturity value. A $1,000 bond quoted at 101½ sells for… $1,000 × = $1,015. A $1,000 bond quoted at 88-3/8 sells for… $1,000 × = $

27 Bond Payable Purchase a $1,000 Bond Purchase a $1,000 Bond Bond Pays = 9% Bond Pays = 9% Bond Interest = $90 Bond Interest = $90 Bond Pays = 10% Bond Pays = 10% Bond Interest = $100 Bond Interest = $100 Bond Pays = 8% Bond Pays = 8% Bond Interest = $80 Bond Interest = $80 Invest $1,000 in Market at 9% Market Interest = $90 How much would you pay for 9% bond, 10% bond, 8% bond?

28 ACG 2021 Financial Accounting Accounting for Bonds Payable

29 Accounting for Bonds Record Issuance of Bond Record Issuance of Bond Record Payment of Interest Record Payment of Interest Record Accrual of Interest Record Accrual of Interest Record Amortization of Discount/Premium Record Amortization of Discount/Premium Effective Interest Method Effective Interest Method Straight-Line Method Straight-Line Method Record Retirement of Bond Record Retirement of Bond Credit Cash Credit Interest Payable

30 Bonds Payable $50 million in 9%, 5 year bonds are issued on Jan 1, 2006 at par. Cash50,000,000 To issue bonds at par Bonds Payable50,000,000 Interest Expense2,250,000 To pay semiannual interest Cash2,250,000 First interest payment on July 1. $50,000,000 x.09 x 6/12

31 Bonds Payable At year end, accrue interest to be paid on Jan.1 Interest Expense2,250,000 To accrue interest Interest Payable2,250,000 $50,000 x.09 x 6/12

32 Bonds Payable at Discount $100,000 in 9%, 5 year bonds are issued when the market rate is 10% for $96,149. Cash96,149 To issue bonds at a discount Discount on Bonds Payable3,851 Bonds Payable100,000

33 Bonds Payable at Discount Discount on Bonds Payable is a contra account to Bonds Payable. Discount on Bonds Payable is a contra account to Bonds Payable. Carrying amount of the bonds equals Bonds Payable less Discount on Bonds Payable. Carrying amount of the bonds equals Bonds Payable less Discount on Bonds Payable. Interest payments are fixed by contract, but interest expense varies as the bond discount is amortized. Interest payments are fixed by contract, but interest expense varies as the bond discount is amortized.

34 Bonds Payable Premium $100,000 in 9%, 5 year bonds are issued when the market rate is 8% for $104,100. Cash104,100 To issue bonds at a premium Premium on Bonds Payable4,100 Bonds Payable100,000

35 Bonds Payable at Premium Premium on Bonds Payable is normal liability account (not a contra-account) Premium on Bonds Payable is normal liability account (not a contra-account) Carrying amount of the bonds equals Bonds Payable plus Premium on Bonds Payable. Carrying amount of the bonds equals Bonds Payable plus Premium on Bonds Payable. Interest payments are fixed by contract, but interest expense varies as the bond premium is amortized. Interest payments are fixed by contract, but interest expense varies as the bond premium is amortized.

36 Bonds Payable Discount Example Issue Date – January 1, 2006 Issue Date – January 1, 2006 Maturity value - $100,000 Maturity value - $100,000 Stated interest rate – 9% Stated interest rate – 9% Interest paid – 4 ½% semiannually Interest paid – 4 ½% semiannually Market rate at time of issue – 10% annually, 5% semiannually Market rate at time of issue – 10% annually, 5% semiannually Issue Price – $96,149 Issue Price – $96,149

37 Bonds Payable Discount Example Amortization Table (partial) 3851

38 Bonds Payable Discount Journal Entries Interest Expense4,807 To pay semiannual interest and amortize bond discount Discount on Bonds Payable307 Cash4,500 First semiannual interest payment at Jul 1. Interest Expense4,823 To accrue semiannual interest and amortize bond discount Discount on Bonds Payable323 Interest Payable4,500 Second semiannual interest accrual at Dec 31.

39 Bonds Payable Premium Example Issue Date – January 1, 2006 Issue Date – January 1, 2006 Maturity value - $100,000 Maturity value - $100,000 Stated interest rate – 9% Stated interest rate – 9% Interest paid – 4 ½% semiannually Interest paid – 4 ½% semiannually Market rate at time of issue – 8% annually, 4% semiannually Market rate at time of issue – 8% annually, 4% semiannually Issue Price – $104,100 Issue Price – $104,100

40 Bonds Payable Premium Example Amortization Table (partial)

41 Bonds Payable Premium Example Interest Expense4,164 To pay semiannual interest and amortize bond premium Premium on Bonds Payable336 Cash4,500 First semiannual interest payment at Jul 1. Interest Expense4,151 To accrue semiannual interest and amortize bond premium Premium on Bonds Payable349 Interest Payable4,500 Second semiannual interest accrual at Dec 31.

42 Exercise 8-13

43 Straight-Line Amortization Divide bond discount (or premium) into equal periodic amounts over the bonds term. Divide bond discount (or premium) into equal periodic amounts over the bonds term. This equal amount is Interest Expense This equal amount is Interest Expense Interest expense is the same each period. Interest expense is the same each period. GAAP permits straight line only when the amounts differ insignificantly from amounts determined using the effective interest method. GAAP permits straight line only when the amounts differ insignificantly from amounts determined using the effective interest method.

44 Straight-Line Using the previous Chrysler Example Using the previous Chrysler Example Premium Amortization = $4100/10 = $410 Premium Amortization = $4100/10 = $ = 5 years x 2 interest payments per year 10 = 5 years x 2 interest payments per year $100,000 in 9%, 5 year bonds are issued when the market rate is 8% for $104,100.

45 Straight Line Journal Entries Interest Expense4,090 To pay semiannual interest and amortize bond premium Premium on Bonds Payable410 Cash4,500 First semiannual interest payment at Jul 1. Interest Expense4,090 To accrue semiannual interest and amortize bond premium Premium on Bonds Payable410 Interest Payable4,500 Second semiannual interest accrual at Dec 31.

46 Issuing Bonds Payable at a Discount Chryslers balance sheet immediately after issuance of the bonds: Total current liabilities$ XXX Long-term liabilities: Bonds payable, 9%, due 2009$100,000 Discount on bonds payable ( 3,851)96,149 Discount on Bonds Payable - contra account to Bonds Payable

47 Issuing Bonds Payable at a Premium Chryslers balance sheet immediately after issuance of the bonds: Total current liabilities$ XXX Long-term liabilities: Bonds payable$100,000 Premium on bonds payable 4,100 $104,100

48 Exercise 8-10

49 ACG 2021 Financial Accounting Retiring Bonds

50 Bonds Retired at Maturity After Recording final interest payment After Recording final interest payment Reduce Bond Payable Reduce Bond Payable Reduce Cash Account Reduce Cash Account Bonds Payable 100,000 Cash 100,000 Cash 100,000

51 Retiring Callable Bonds Callable Bonds Callable Bonds Bonds that can be paid off early Bonds that can be paid off early Call Price Call Price Often at greater then par value (101 or 102) Often at greater then par value (101 or 102) Thus management has to decide to pay call premium or Thus management has to decide to pay call premium or Buy Bonds on the Open Market Buy Bonds on the Open Market

52 Early Retirement of Bonds Payable Air Products and Chemicals, Inc., has $70,000 of debenture bonds outstanding with unamortized discount of $350. The market price is 99¼.

53 Early Retirement of Bonds Payable Par value of bonds$70,000 Less: Unamortized discount( 350) Carrying amount of the bonds$69,650 Market price ($70,000 × ) 69,475 Extraordinary gain on retirement$ 175 Bonds Payable70,000 Discount on Bonds Payable350 Cash69,475 Gain on Retirement of Bonds175 To record bond retirement

54 Convertible Bonds and Notes May be converted into the issuing companys common stock. May be converted into the issuing companys common stock. Assume note holders convert half of $300 million convertible notes into 4 million shares of stock ($1 par). Assume note holders convert half of $300 million convertible notes into 4 million shares of stock ($1 par). Notes Payable150,000,000 To record conversion of notes payable Common Stock (4 million at $1 par)4,000,000 Paid-in Capital in Excess of par-Common146,000,000

55 Financing with Bonds or Stock? Issuing stock Issuing stock creates no liabilities creates no liabilities incurs no interest expense incurs no interest expense less risky to issuing corporation less risky to issuing corporation Issuing notes or bonds payable Issuing notes or bonds payable does not dilute stock ownership or control of the corporation does not dilute stock ownership or control of the corporation usually results in higher earnings per share [EPS is the amount of net income for each share of its stock] usually results in higher earnings per share [EPS is the amount of net income for each share of its stock]

56 Reporting Financing Activities on the Statement of Cash Flows Cash Flow from Financing Activities: Proceeds from issuance of bonds$754 Proceeds from long-term borrowings32 Payment of long-term debt(29) Proceeds from issuance of common stock351 Payments of cash dividends(371) Other, net (4) Net cash provided by financing activities$733 Amounts in millions Year Ended December 31

57 ACG 2021 Financial Accounting Ratio Analysis Times Interest Earned

58 Times interest earned ratio Times interest earned = Income from Operations Interest Expense The ability of a company to pay its Interest Expense Obligations from Earnings Generated from Operations

59 BlackBoard Inc.

60 BlackBoard T.I.E ,826 / 5354 = ,826 / 5354 = ,447 / 49 = ,447 / 49 = ,033 / 179 = ,033 / 179 = 56.05

61 Best Buy, Inc.

62 Best Buy – T.I.E ,999 / 31 = ,999 / 31 = ,644 / 30 = ,644 / 30 = ,442 / 44 = ,442 / 44 = 32.77

63 End of Chapter 8


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