Presentation on theme: "ACG 2021 Financial Accounting"— Presentation transcript:
1ACG 2021 Financial Accounting Current & Long-Term Liabilities
2Learning ObjectivesAccount for current liabilities and contingent liabilitiesAccount for bonds-payable transactionsMeasure interest expenseUnderstand the advantages and disadvantages of borrowingStatement of Cash Flow Effects
3Current LiabilitiesLiabilities due within 1 year or the company’s operating cycle if longerKnown amountsAccounts PayableShort-term Notes PayableSales Tax PayableCurrent Installment of Long-Term DebtAccrued ExpensesPayroll LiabilitiesUnearned RevenuesWe 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, debita corresponding expense account (accrued expenses)Cash (deferred liability)Long-term debtCash (if recording receipt from a note payable)
4Accounts PayableAmounts owed for purchases of goods or services on accountThe purchase can be for an AssetInventory (generally largest)The purchase could also be an ExpenseLegal Fees (service)No interest associated with money owed, and it is assumed the A/P will be paid quicklyIf we have an A/P for Inventory purchased on account, what does the company we purchased the inventory from have?An Accounts Receivable
5Note Payable Unlike Accounts Payable Usually contains interest payments that are dueRecord:Issuance of Note PayableWe borrowed Cash and have an obligation to pay backInterest ExpensePayment of Note Payable
6Notes PayableOn Jan. 30, 20X5 the company received a one year $8,000 note payable at 10% interest to purchase inventory.Jan 30 Cash 8,000Note Payable, Short-term 8,000Purchase of inventory by issuing a1-year 10% note payableInterest must be accrued at fiscal year end (April 30) forinterest owed but not yet due.Apr 30 Interest Expense (8,000 x .10 x 3/12) 200Interest Payable 200Adjusting entry to accrue interest expense
7Notes Payable To record repayment at maturity Jan 30 20x6: Jan. 30 Note Payable, short-term 8,000Interest Payable 200Interest Expense ($8,000 x .10 x 9/12) 600Cash [($8,000 x .10) + 8,000] 8,800Payment of a note payable and interest at maturityStep 1: Reverse the balance in the Note Payable account to 0Step 2: Reduce the amount of any Interest Payable from a previous period to 0Step 3: Record the Interest Expense for the periodStep 4: Record the cash (Principal and Interest paid)
8Payroll Liabilities Types of Compensation Salary expense is gross pay. WageCommissionBonusSalary expense is gross pay.Salary payable is net pay.
9Payroll Liabilities To record payroll Jan. 30 Salary Expense 10,000 Employee Income Tax Payable 1,200FICA Tax Payable 800Salary Payable to Employees 8,000To record salary expense
10Sales Tax Payable To record sales of $200,000 plus 5% sales tax: Cash (200,000 x 1.05) 210,000Sales Revenue 200,000Sales Tax Payable (200,000 x .05) 10,000To record cash sales and related sales tax
11Unearned RevenuesTo record collection of cash in payment for future services:Jan 30 Cash 1,200Unearned Ticket Revenue 1,200Received cash in advance for ticket salesTo record revenue after 50% of services have been performed.Apr 30 Unearned Ticket Revenue 600Ticket Revenue 600Earned revenue that was collected in advance
12Current Liabilities Amounts that must be estimated Estimated Warranty PayableHow many products will need repair / replacementMatching PrincipleEstimate based on past historical dataContingent LiabilitiesAn company may incur an expense in the futureMost commonly associated with law suits
13Estimated 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 Expense 6,000Estimated Warranty Payable 6,000To accrue warranty expenseWhen $5,800 of products are replaced under the warranty:Estimated Warranty Payable 5,800Inventory 5,800To replace defective products under warranty
14Contingent Liabilities Contingent liability depends on a future event arising out of past events.To account for contingent losses: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.Do not report a contingent loss that is not likely to occur.
15ACG 2021 Financial Accounting Long – Term LiabilitiesBonds Payable
16Bonds IOU’s $1000 or $5000 Increments Sold in the “Market” Structure: Maturity DateInterest RateInterest Payment DatesProvide two payments:Interest every 6 monthsPrincipal amount of Bond
19Bonds PayableBonds payable are debt (i.e. a liability) of the issuing company.Types of bonds:term bondsAll bonds mature at the same time (end of the term)serial bondsBonds mature in installments over a period of time.secured bonds (mortgage bonds)debentures (unsecured bonds)
20Bonds Payable Bonds can be issued (bought) at face valuefor a premiumat a discountBond Price is determined by:Market Interest Rate – Effective RateBond’s Interest Rate – Contract RateTHESE RATES ARE USUALLY DIFFERENT!
21Bond Interest RatesBonds are sold at market price - amount that investors are willing to pay at any given timeMarket price represents:present value of periodic interest paymentspresent value of principal to be received at maturity
22Present ValueThe amount invested today to receive a greater amount at a future dateIt depends on:amount of the future receiptlength of time to future receiptinterest rate for the period
24Present Value Calculation (Discount) $100, year bond, 9% stated interest, 10% market rateTwo parts: PV of principle and PV of interest payments$100,000 x .614* = $61,400100,000 x. 045 x 7.722* = $34,749PV of Bonds $96,149* From Appendix C
25Bond Prices Bond Face Value = Stated Principal Bond issued above face (par) value - premiumBond issued at below face (par) value - discountAs a bond nears maturity, its market price moves toward par value
26Bond PricesQuoted 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 × = $
27Bond Payable Purchase a $1,000 Bond Bond Pays = 9% Bond Pays = 10% Bond Interest = $90Bond Pays = 10%Bond Interest = $100Bond Pays = 8%Bond Interest = $80Invest $1,000 in Market at 9%Market Interest = $90How much would you pay for 9% bond, 10% bond, 8% bond?
28ACG 2021 Financial Accounting Accounting for Bonds Payable
29Accounting for Bonds Record Issuance of Bond Record Payment of InterestRecord Accrual of InterestRecord Amortization of Discount/PremiumEffective Interest MethodStraight-Line MethodRecord Retirement of BondCredit CashCredit Interest Payable
30Bonds Payable$50 million in 9%, 5 year bonds are issued on Jan 1, 2006 at par.Cash 50,000,000Bonds Payable 50,000,000To issue bonds at parFirst interest payment on July 1.Interest Expense 2,250,000Cash 2,250,000To pay semiannual interest$50,000,000 x .09 x 6/12
31Bonds PayableAt year end, accrue interest to be paid on Jan.1Interest Expense 2,250,000Interest Payable 2,250,000To accrue interest$50,000 x .09 x 6/12
32Bonds Payable at Discount $100,000 in 9%, 5 year bonds are issued when the market rate is 10% for $96,149.Cash 96,149Discount on Bonds Payable 3,851Bonds Payable 100,000To issue bonds at a discount
33Bonds Payable at Discount Discount on Bonds Payable is a contra account to 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.
34Bonds Payable Premium$100,000 in 9%, 5 year bonds are issued when the market rate is 8% for $104,100.Cash 104,100Premium on Bonds Payable 4,100Bonds Payable 100,000To issue bonds at a premium
35Bonds Payable at Premium 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.Interest payments are fixed by contract, but interest expense varies as the bond premium is amortized.
36Bonds Payable Discount Example Issue Date – January 1, 2006Maturity value - $100,000Stated interest rate – 9%Interest paid – 4 ½% semiannuallyMarket rate at time of issue – 10% annually, 5% semiannuallyIssue Price – $96,149
37Bonds Payable Discount Example Amortization Table (partial)3851
38Bonds Payable Discount Journal Entries First semiannual interest payment at Jul 1.Interest Expense 4,807Discount on Bonds Payable 307Cash 4,500To pay semiannual interest and amortize bond discountSecond semiannual interest accrual at Dec 31.Interest Expense 4,823Discount on Bonds Payable 323Interest Payable 4,500To accrue semiannual interest and amortize bond discount
39Bonds Payable Premium Example Issue Date – January 1, 2006Maturity value - $100,000Stated interest rate – 9%Interest paid – 4 ½% semiannuallyMarket rate at time of issue – 8% annually, 4% semiannuallyIssue Price – $104,100
40Bonds Payable Premium Example Amortization Table (partial)
41Bonds Payable Premium Example First semiannual interest payment at Jul 1.Interest Expense 4,164Premium on Bonds Payable 336Cash 4,500To pay semiannual interest and amortize bond premiumSecond semiannual interest accrual at Dec 31.Interest Expense 4,151Premium on Bonds Payable 349Interest Payable 4,500To accrue semiannual interest and amortize bond premium
43Straight-Line Amortization Divide bond discount (or premium) into equal periodic amounts over the bond’s term.This equal amount is Interest ExpenseInterest expense is the same each period.GAAP permits straight line only when the amounts differ insignificantly from amounts determined using the effective interest method.
44Straight-Line Using the previous Chrysler Example Premium Amortization = $4100/10 = $41010 = 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.
45Straight Line Journal Entries First semiannual interest payment at Jul 1.Interest Expense 4,090Premium on Bonds Payable 410Cash 4,500To pay semiannual interest and amortize bond premiumSecond semiannual interest accrual at Dec 31.Interest Expense 4,090Premium on Bonds Payable 410Interest Payable 4,500To accrue semiannual interest and amortize bond premium
46Issuing Bonds Payable at a Discount Chrysler’s balance sheet immediately after issuance of the bonds:Total current liabilities $ XXXLong-term liabilities:Bonds payable, 9%, due $100,000Discount on bonds payable ( 3,851) 96,149Discount on Bonds Payable - contra accountto Bonds Payable
47Issuing Bonds Payable at a Premium Chrysler’s balance sheet immediately after issuance of the bonds:Total current liabilities $ XXXLong-term liabilities:Bonds payable $100,000Premium on bonds payable ,100 $104,100
50Bonds Retired at Maturity After Recording final interest paymentReduce Bond PayableReduce Cash AccountBonds Payable 100,000Cash ,000
51Retiring Callable Bonds Bonds that can be paid off earlyCall PriceOften at greater then par value (101 or 102)Thus management has to decide to pay call premium orBuy Bonds on the Open Market
52Early 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.
53Early Retirement of Bonds Payable Par value of bonds $70,000Less: Unamortized discount ( )Carrying amount of the bonds $69,650Market price ($70,000 × ) 69,475Extraordinary gain on retirement $Bonds Payable 70,000Discount on Bonds Payable 350Cash 69,475Gain on Retirement of Bonds 175To record bond retirement
54Convertible Bonds and Notes May be converted into the issuing company’s common stock.Assume note holders convert half of $300 million convertible notes into 4 million shares of stock ($1 par).Notes Payable 150,000,000Common Stock (4 million at $1 par) 4,000,000Paid-in Capital in Excess of par-Common 146,000,000To record conversion of notes payable
55Financing with Bonds or Stock? Issuing stockcreates no liabilitiesincurs no interest expenseless risky to issuing corporationIssuing notes or bonds payabledoes not dilute stock ownership or control of the corporationusually results in higher earnings per share [EPS is the amount of net income for each share of its stock]
56Reporting Financing Activities on the Statement of Cash Flows Cash Flow from Financing Activities:Proceeds from issuance of bonds $754Proceeds from long-term borrowings 32Payment of long-term debt (29)Proceeds from issuance of common stock 351Payments of cash dividends (371)Other, net (4)Net cash provided by financing activities $733Amounts in millionsYear EndedDecember 31
57ACG 2021 Financial Accounting Ratio AnalysisTimes Interest Earned
58Times interest earned ratio Income from OperationsTimes interest earned=Interest ExpenseThe ability of a company to pay it’s Interest Expense Obligationsfrom Earnings Generated from Operations