1 PowerPointPresentation by PowerPoint Presentation by Gail B. Wright Professor of Accounting Bryant University © Copyright 2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star Logo, and South-Western are trademarks used herein under license. FINANCIAL ACCOUNTING 2 ND EDITION BY DUCHAC, REEVE, & WARREN 10 Liabilities

2 CURRENT LIABILITIES Current liabilities include –Accounts payable –Notes payable –Payroll liabilities LG 1

3 ACCOUNTS PAYABLE Accounts payable –Short term debt –Used for Buying goods, services for use in operations Buying merchandise for resale LG 1

4 NOTES PAYABLE Notes payable –Short term debt –Used for Buying goods, other assets Borrowing cash from bank Example: Issued 90-day, 12%, $1,000 interest bearing note to satisfy overdue account. Continued LG 1

5 DISCOUNTED NOTES Discounted notes –Do not specify interest rate on note –Interest deducted from face of note Called “discount” “discount rate” used to compute discount –Creditor set rate of interest Example: Issued $20,000, 90-day, 15%, discounted note to purchase inventory. Continued LG 1

6 PAYROLL LIABILITIES Payroll liabilities –Are short term liabilities –Include employee taxes withheld –Include employer taxes LG 1

7 PAYROLL TAXES Employee taxes withheld –FICA tax –Employees federal income tax –Employees state income tax Employer taxes include –FICA tax –State and federal unemployment taxes LG 1

8 BONDS Most common form of long term debt –Bond issue divided into individual bonds Most common face value (denomination): $1,000 –Interest paid annually, semi-annually, or quarterly LG 2

9 TYPES OF BONDS Term bonds –All bonds due at same time Serial bonds –Bond maturities spread over several dates Convertible bonds can be converted into equity Callable bonds can be redeemed early Debenture bonds issued on general credit LG 2

10 TIME VALUE of $1 If Apex Corp. deposited $55,840 in the bank at an annual interest rate of 6%, how much would they have in 10 years? LG 2

11 EXHIBIT 6 1 Deposit LG 2

12 TIME VALUE CALCULATION $1 Present value =Future amount *Present value $1 $55,840 =$100,000 * Over a 10 year period invested at 6%, $44,160 interest earned. LG 2

13 TIME VALUE OF ANNUITY How much would Apex Corp. have to deposit in a bank today in order to withdraw $6,000 each year for 10 years with an annual interest rate of 6%? LG 2

14 TIME VALUE CALCULATION ANNUITY Present value annuity = Annuity payment *Present value annuity $44, = $6,000 * Payments of $6,000 over 10 6% are worth $44, TODAY. LG 2

15 EXHIBIT 7 Annuity LG 2

16 CALCULATING BOND PRICE Bond price is function of –Face value of bond –Interest payments made –Bond market rate LG 2

17 EXHIBIT 10 + LG 2

18 LG 2 How does a firm record the sale of $100,000 of bonds at face value?

19 1/1 ENTRY: Bond Issuance 1/1 Cash Bonds Payable 100,000 Issued bonds at face value Increases financing cash flow Increases assets, liabilities on balance sheet No effect on income statement LG 2 SCFBSIS

20 LG 2 If the bonds pay 6% interest semiannually, how does the firm record the first interest payment?

21 6/30 ENTRY: Interest Payment 6/30 Interest Expense Cash 6,000 Paid semi-annual interest payment Decreases operating cash flow Decreases assets, equity on balance sheet Increases expenses on income statement LG 2 SCFBSIS E

22 BOND SOLD AT DISCOUNT Bonds sold below face value –Are sold at a discount –Contract rate is less than market interest rate Bonds sold below face value –Are sold at a discount –Contract rate is less than market interest rate LG 2

23 1/1 ENTRY: Bond Issuance 1/1 Cash Discount Bonds Payable 96,406 3, ,000 Issued bonds at discount Increases financing cash flow Increases assets, liabilities on balance sheet No effect on income statement LG 2 SCFBSIS

24 6/30 ENTRY: Interest Payment with Discount Amortization 6/30 Interest Expense Discount Cash 6, , Paid semi-annual interest payment Decreases operating cash flow Decreases assets, equity, increases liabilities on balance sheet Increases expenses on income statement LG 2 SCFBSIS E

25 BOND SOLD AT PREMIUM Bonds sold above face value –Are sold at a premium –Contract rate is more than market interest rate Bonds sold above face value –Are sold at a premium –Contract rate is more than market interest rate LG 2

26 1/1 ENTRY: Bond Issuance 1/1 Cash Bonds Payable Premium 103, ,000 3,769 Issued bonds at premium Increases financing cash flow Increases assets, liabilities on balance sheet No effect on income statement LG 2 SCFBSIS

27 6/30 ENTRY: Interest Payment with Premium Amortization 6/30 Interest Expense Premium Cash 5, ,000 Paid semi-annual interest payment Decreases operating cash flow Decreases assets, liabilities, equity on balance sheet Increases expenses on income statement LG 2 SCFBSIS E

28 BOND REDEMPTION When bonds redeemed –All related accounts removed –Gain or loss recognized When bonds redeemed –All related accounts removed –Gain or loss recognized LG 2

29 6/30 ENTRY: Bond Redemption 6/30 Bonds payable Premium Loss on B/P Cash 100,000 4,000 1, ,000 Called bonds Decreases operating cash flow Decreases assets, liabilities, equity on balance sheet Increases expenses on income statement LG 2 SCFBSIS E

30 DEFERRED LIABILITIES Deferred revenue –Cash received before revenue earned –Ex.: unearned revenue Deferred expense –Expense recorded before cash payment –Ex.: tax expense LG 3

31 CONTINGENT LIABILITIES Contingent liabilities –Arise from past transactions –Are often estimated –Must be paid if certain events occur in future –Ex.: warranty expense LG 4

32 EXHIBIT 15 How to account for different contingent liabilities On Balance Sheet In footnotes LG 4

33 REPORTING LIABILITIES Liabilities segregated between –Current liabilities Due within the next year or operating cycle –Long term liabilities Due later than 1 year Liabilities listed in order of liquidity LG 5

34 CURRENT LIQUIDITY RATIOS Current liquidity analysis –Measures ability to pay current liabilities when they come due Current ratio Quick ratio LG 6 Current assets/ Current liabilities Quick assets/ Current liabilities

35 LONG TERM LIABILITY RATIOS Times Interest Earned indicates the ability to cover interest charges Leverage is a measure of relative debt financing LG 6 Total liabilities / Total Assets (Income before tax + Interest Exp) / Interest Exp.

36 TIMES INTEREST EARNED: Basic Information B&N, Inc (millions) Borders, Inc. (millions) Interest Exp$14.5$9.1 Income before tax LG 6

37 TIMES INTEREST EARNED: Calculations Barnes & Noble’s Times interest earned ratio is ($ $14.5) / $14.5 = 16.1 What is Border’s ratio? Which company is in a better position? A higher ratio is better. LG 6

38 DEBT-to-ASSETS: Basic Information B&N, Inc (millions) Borders, Inc. (millions) Total liabilities $2,135.6$1,538.5 Total Assets3,301.52,628.8 LG 6

39 LEVERAGE: Calculations Barnes & Noble’s leverage ratio is $2,135.6 / $3,301.5 = 0.65 What is Border’s ratio? Which company is in a better position? Higher leverage represents higher risk. LG 6

40 Two peanuts walk into a bar. One was a salted. A sandwich walks into a bar. The bartender says, "Sorry we don't serve food in here."