10-1 REPORTING AND ANALYZING LIABILITIES Financial Accounting, Sixth Edition 10

Explain a current liability and identify the major types of current liabilities Describe the accounting for notes payable Explain the accounting for other current liabilities Identify the types of bonds Prepare the entries for the issuance of bonds and interest expense Describe the entries when bonds are redeemed Identify the requirements for the financial statement presentation and analysis of liabilities. Study 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 Liabilities SO 1 Explain a current liability and identify the 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. 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. 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 payable100,000 Cash100,000 SO 2 Describe the accounting for notes payable. Current Liabilities 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 payable4,000 Interest expense4,000 * SO 2 Describe the accounting for notes payable. Current Liabilities 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 payable4,000 Notes payable100,000 SO 2 Describe the accounting for notes payable. Current Liabilities Jan. 1 Cash104,000

10-8 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. Current Liabilities

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. Current Liabilities Mar. 25 Sales revenue10,000 Cash10,600 Sales tax payable600

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: SO 3 Explain the accounting for other current liabilities. Current Liabilities Mar. 25 Sales revenue10,000 Cash10,600 Sales tax payable600 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. Unearned Revenue Revenues that are received before the company delivers goods or provides services. Current Liabilities 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: SO 3 Explain the accounting for other current liabilities. Unearned ticket revenue500,000 Cash 500,000Aug. 6 Ticket revenue100,000 Unearned ticket revenue 100,000Sept. 7 Current Liabilities 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, 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. SO 3 Explain the accounting for other current liabilities. Current Liabilities $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. SO 3 Explain the accounting for other current liabilities. Payroll and Payroll Taxes Payable Current Liabilities

10-15 Illustration: Assume Cargo Corporation records its payroll for the week of March 7 as follows: Salaries and wages expense100,000 Federal tax payable21,864 FICA tax payable7,650 State tax payable2,922 Salaries and wages payable67,564 SO 3 Cash67,564 Salaries and wages payable 67,564Mar. 7 Record the payment of this payroll on March 7. Mar. 7 Current Liabilities

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

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 expense13,850 State unemployment tax payable800 FICA tax payable7,650 Federal unemployment tax payable 5,400 SO 3 Explain the accounting for other current liabilities. Current Liabilities

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. Bond: Long-Term Liabilities

10-19 Types of Bonds  Secured  Unsecured  Convertible  Callable SO 4 Identify the types of bonds. Bond: Long-Term Liabilities

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. SO 4 Identify the types of bonds. Bond: Long-Term Liabilities Issuing Procedures

10-21 Bond: Long-Term Liabilities SO 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. Bond: Long-Term Liabilities SO 4 Identify the types of bonds. 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. Bond: Long-Term Liabilities Illustration 10-5 Computing the market price of bonds Illustration 10-4 Time diagram depicting cash flows SO 4 Identify the types of bonds.

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 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. 1Cash 100,000 SO 5 Prepare the entries for the issuance of bonds and interest expense. Issuing Bonds at Face Value Bonds payable100,000 Prepare the entry Devor would make to accrue interest on December 31. Dec. 31Interest expense 10,000 Interest payable10,000

10-26 Prepare the entry Devor would make to pay the interest on Jan. 1, Jan. 1Interest payable 10,000 Cash10,000 SO 5 Prepare the entries for the issuance of bonds and interest expense. Issuing Bonds at Face Value

% 10% 12% Premium Face Value Discount Assume Contractual Rate of 10% SO 5 Prepare the entries for the issuance of bonds and interest expense. Bonds Sold AtMarket Interest Accounting 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: SO 5 Prepare the entries for the issuance of bonds and interest expense. Issuing Bonds at a Discount Jan. 1Cash 98,000 Discount on bonds payable2,000 Bonds payable100,000 Illustration 10-8 Computation of total cost of borrowing—bonds issued at discount

10-29 Statement Presentation SO 5 Prepare the entries for the issuance of bonds and interest expense. Issuing Bonds at a Discount Illustration 10-7 Statement 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: SO 5 Prepare the entries for the issuance of bonds and interest expense. Jan. 1Cash 102,000 Bonds payable100,000 Premium on bonds payable2,000 Illustration Computation of total cost of borrowing—bonds issued at premium Issuing Bonds at a Premium

10-31 Statement Presentation SO 5 Prepare the entries for the issuance of bonds and interest expense. Illustration Statement presentation of premium on bonds payable Issuing Bonds at a Premium

10-32 Redeeming Bonds at Maturity SO 6 Describe the entries when bonds are redeemed. Candlestick records the redemption of its bonds at maturity as follows: Accounting for Bond Retirements Bonds payable 100,000 Cash100,000

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. Accounting for Bond Retirements SO 6 Describe the entries when bonds are redeemed. Redeeming Bonds at Maturity

10-34 Cash103,000 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: Accounting for Bond Retirements Bonds payable 100,000 Premium on bonds payable400 SO 6 Describe the entries when bonds are redeemed.

10-35 Analysis Financial Statement Analysis and Presentation Illustration SO 7

10-36 Liquidity Financial Statement Analysis and Presentation 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 Financial Statement Analysis and Presentation 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 Financial Statement Analysis and Presentation SO 7 Identify the requirements for the financial statement presentation and analysis of liabilities.