1 Financial Accounting: Tools for Business Decision Making, 4th Edition Kimmel ∙ Weygandt ∙ Kieso CHAPTER 10 Prepared by Ellen L. Sweatt Georgia Perimeter College and Barbara Muller Arizona State University West

2 REPORTING AND ANALYZING LIABILITIES Chapter 10

3 Chapter 10 Reporting and Analyzing Liabilities After studying this chapter, you should be able to: 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.

4 After studying this chapter, you should be able to: 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. Chapter 10 Reporting and Analyzing Liabilities

5 Current Liabilities  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 11 1

6 Types of Current Liabilities  Notes Payable  Accounts Payable  Unearned Revenues  Accrued Liabilities Taxes Salaries and Wages Interest

7 Review Question The time period for classifying a liability as current is one year or the operating cycle, whichever is? a.Probable. b.Shorter. c.Possible. d.Longer.

8 Review Question The time period for classifying a liability as current is one year or the operating cycle, whichever is? a.Probable. b.Shorter. c.Possible. d.Longer.

9 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 11 2

10 Note Payable

11 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 1Cash100,000 Notes Payable100,000 (To record issuance of 12%, 4-month note to bank) Dec 31Interest Expense 4,000 Interest Payable4,000 (To accrue interest for 4 months on note. Interest accrues over life of the note and must be recorded periodically.) $100,000 x.12 x 4\12 months

12 Journal Jan 1 Notes Payable 100,000 Interest Payable 4,000 Cash 104,000 (To record payment of 1st National Bank interest-bearing note and accrued interest at maturity.)

13 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. 11 3

14 Journal Mar 25Cash 10,600 Sales10,000 Sales Taxes Payable600 (To record daily sales and sales taxes).

15 Payroll Deductions

16 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  Federal income taxes  State income taxes (if applicable)

17 Journal Mar 7 Salaries and Wages Expense 100,000 FICA Taxes Payable (employee’s share) 7,250 Federal Income Taxes Payable 21,864 States Income Taxes Payable 2,922 Salaries and Wages Payable 67,964 Mar 7 Salaries and Wages Payable 67,964 Cash 67,964

18 Journal Mar 7 Payroll Tax Expense 13,450 FICA Taxes Payable (employer’s share) 7,250 Federal Unemployment Taxes Payable 800 State Unemployment Taxes Payable 5,400 Employers incur a second type of payroll-related activity. 1) Employer’s share of FICA 2) Federal unemployment 3) State unemployment

19 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

20 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

21 As each game is completed Journal Aug 6Cash 500,000 Unearned Ticket Revenue 500,000 (To record sale of 10,000 tickets at $50 each) Sept 7 Unearned Ticket Revenue 100,000 Ticket Revenue 100,000 (To record ticket revenue earned)

22 Current Maturities of Long- Term Debt 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

23 Review Question On July 1, 2007, Madeline, Inc. borrowed $70,000 from Gramy Bank via a 6-month, 9% note payable. At December 31, 2007, what amount of cash will Madeline, Inc. pay the bank? a.$70,000. b.$66,850. c.$76,300. d.$73,150.

24 Review Question On July 1, 2007, Madeline, Inc. borrowed $70,000 from Gramy Bank via a 6-month, 9% note payable. At December 31, 2007, what amount of cash will Madeline, Inc. pay the bank? a.$70,000. b.$66,850. c.$76,300. d.$73,150.

25 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 Deferred Revenues a.YesYesNo b.NoYesNo c.NoNoYes d.YesNoNo

26 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 Deferred Revenues a.YesYesNo b.NoYesNo c.NoNoYes d.YesNoNo

27 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? a.$1,000 interest expense. b.$11,000 note payable. c.$500 interest payable. d.$1,000 interest revenue.

28 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? a.$1,000 interest expense. b.$11,000 note payable. c.$500 interest payable. d.$1,000 interest revenue.

29 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 11 4

30 Bond Certificate

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 Issues 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 11 5

33 Interest Rates and Bond Prices

34 Bond Terms  Face Value the amount of principal due at the maturity date of the bond  Discount when a bond is sold for less than its face value (the difference between the face value of a bond and its selling price)  Premium - when a bond is sold for more than its face value (the difference between the selling price and the face value of a bond)

35 Cash Flow of Bonds

36 Selling Bonds at Discount On January 1, 2007, 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 2,000* Bonds Payable 100,000 (To record sale of bonds at a discount) *The discount account is a contra account to the bond payable, not an asset account.

37 Statement Presentation of Discounted Bonds Long-term liabilities Bonds payable $ 100,000 Less: Discount on bonds payable 2,000 $98,000 Carrying Value

38 Selling Bonds at Premium On January 1, 2007, Candlestick, Inc., sells $100,000, 5-year, 10% bonds at 102 with interest payable on January 1. Jan 1 Cash 102,000 Bonds Payable 100,000 Premium Bonds Payable 2,000* (To record sale of bonds at a premium) *Premium is added to bonds payable on the balance sheet

39 Statement Presentation of Premium Bonds Long-term liabilities Bonds payable $ 100,000 Add : Premium on bonds payable 2,000 $ 102,000 Carrying Value

40 Amortizing Bond Discount/Premium Candlestick, Inc. would amortize the $2,000 discount/premium as follows $2,000 ÷ 5 Interest Periods = $400 Annually

41 Amortization of Bond Discount

42 Amortization of Bond Premium

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

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

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

46 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.

47 Bond Retirements  Bonds may be redeemed at maturity or before maturity 11 6

48 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

49 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

50 Financial Statement Presentation and Analysis  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 11 7

51 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

52 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

53 Review Question The term used for bonds that have specific assets pledged as collateral is? a.Callable bonds. b.Convertible bonds. c.Secured bonds. d.Discount bonds.

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

55 Review Question The amount of interest paid by a firm on its bonds payable is equal to? a.The carrying value of the bonds times the market rate of interest. b.The carrying value of the bonds times the stated rate of interest. c.The face value of the bonds times the market rate of interest. d.The face value of the bonds times the stated rate of interest.

56 Review Question The amount of interest paid by a firm on its bonds payable is equal to? a.The carrying value of the bonds times the market rate of interest. b.The carrying value of the bonds times the stated rate of interest. c.The face value of the bonds times the market rate of interest. d.The face value of the bonds times the stated rate of interest.

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