1 Chapter 10

2 Chapter 10 Reporting and Analyzing Liabilities After studying Chapter 10, you should be able to: zExplain a current liability and identify the major types of current liabilities. zDescribe the accounting for notes payable. zExplain the accounting for other current liabilities. zIdentify the types of bonds.

3 After studying Chapter 10, you should be able to: zPrepare the entries for the issuance of bonds and their interest expense. zDescribe the entries when bonds are redeemed. zIdentify the requirements for the financial statement presentation and analysis of liabilities. Chapter 10 Reporting and Analyzing Liabilities

4 Liabilities are.. zCreditors claims on total assets zExisting debts and obligations Liabilities must be settled in the future by transfer of assets or services.

5 Current Liabilities Can reasonably be expected to be paid zFrom existing current assets or through the creation of other current liabilities. zWithin 1 year or the operating cycle, whichever is longer. Debts that do not meet both criteria are Long-Term Liabilities.

6 Types 0f Current Liability zNotes Payable zAccounts Payable zUnearned Revenues zAccrued Liabilities yTaxes ySalaries and Wages yInterest

7 Notes Payable are... zObligations in the form of written notes. zOften used instead of accounts payable - they give written documentation if needed for legal remedies. zUsed for short-term and long-term financing needs.

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

9 Journal Jan 1 Notes Payable100,000 Interest Payable 4,000 Cash 104,000 (To record payment of 1st National Bank interest- bearing note and accrued interest at maturity)

10 Sales Taxes Payable... zAre collected from customers. zAre expressed as a % of sales price. zAre required by law. zMust be sent to state often. zAre often rung separately from sales on the cash register.

11 Journal Mar 25Cash10,600 Sales10,000 Sales Taxes Payable 600 (To record daily sales and sales taxes)

12 Payroll Deductions

13 Payroll Taxes... Amount required by law to be withheld from employees’ gross pay. ySocial Security taxes withheld (FICA for 2003) yFederal income taxes yState income taxes (if applicable)

14 Journal Mar 7 Salaries and Wages Expense 100,000 FICA Taxes Payable7,650 Federal Income Taxes Payable 21,864 States Income Taxes Payable2,922 Salaries and Wages Payable 67,564 Mar 7Salaries and Wages Payable 67,564 Cash 67,564

15 Journal Mar 7 Payroll Tax Expense 13,850 FICA Taxes Payable 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

16 Unearned Revenues... Cash received before revenues are earned and recorded as liabilities until they are earned.

17 Unearned Revenues... zMagazine subscriptions zRent received in advance zCustomer deposits for future service zSale of airline tickets for future travel zSale to season sporting events

18 Journal Aug 6Cash 500,000 Unearned Ticket Revenue 500,000 (To record sale of 10,000 tickets) Sept 7 Unearned Ticket Revenue 100,000 Ticket Revenue 100,000 (To record ticket revenue earned)

19 Current Maturities of Long-Term Debt The portion of the long-term debt that is due within the current year or operating cycle should be classified as a current liability.

20 FICTICTIOUS COMPANY Balance Sheet December 31, 2004 Assets Current Assets Cash $ 272 Marketable securities (current) 609 Receivables 74 Other current assets 83 Total current assets 1,038 Property and equipment (net) 317 Marketable securities (long-term) 322 Other long-term assets 280 Total Assets $1,957 Liabilities and Stockholders’ Equity Liabilities Current Liabilities Accounts payable$ 527 Notes payable133 Current maturities of long term debt100 Accrued liabilities and expenses 56 Total current liabilities816 Long-term debt 83 Total liabilities899 Stockholders’ equity Common stock 830 Retained earnings228 Total Liabilities and stockholders’ equity $1,957

21 Line of Credit... Is a prearranged agreement between a company and a lender to allow the company to borrow up to an agreed- upon amount.

22 Long-Term Liabilities... Are obligations that are expected to be paid after 1 year.

23 Bonds... zAre a form of interest-bearing notes payable issued by corporations, universities and governmental agencies. zAre sold in small denominations, (usually multiples of $1,000) which makes them attractive to investors.

24 Bonds A legal document that indicates: éname of the issuer éface value of the bonds écontractual interest rate ématurity date éother data

25 Secured Bonds... Have specific assets of the issuer pledged as collateral for bonds.

26 Unsecured or Debenture Bonds... Are issued against the general credit of the borrower.

27 Convertible Bonds... Can be changed into common stock at the bondholder’s option. Callable Bonds… subject to retirement at a stated dollar amount prior to maturity at the option of the issuer.

28 Issuing Bonds... zRequires formal approval by Board of Directors and/or stockholders. zBoard of Directors must stipulate yTotal number of bonds to be authorized yTotal face value yContractual interest rate

29 Accounting for Bond Issues Bonds may be issued at: zFace value zBelow face value (discount) or zAbove face value (premium).

30 Bond Terms Face Value - Amount of principal due at the maturity date of the bond. Discount - The difference between the face value of a bond and its selling price, when a bond is sold for less than its face value. Premium - The difference between the selling price and the face value of a bond when a bond is sold for more than its face value.

31 Bond Terms Present Value - value today of an amount to be received at some date in future after taking into account current interest rates Contractual Interest Rate - rate used to determine the amount of interest the borrower pays and the investor receives Market Interest Rate - rate investors demand for loaning money to the corporation

32 Cash Flow of Bonds

33 Issuing Bonds at Face Value Devor Corporation issued 100, 5-year, 10%, $1,000 bonds dated January 1, 2004 at 100 (100% of face value) with interest payable annually January 1. Jan 1Cash100,000 Bonds Payable 100,000 (To record sale of bonds at face value)

34 Issuing Bonds at Face Value The bonds are reported in the long-term liability section of the balance sheet because the maturity date is more than 1 year away. The entry to record the annual interest on December 31 is: Dec 31 Bond Interest Expense 10,000 Bond Interest Payable 10,000 (To accrue bond interest)

35 Discount or Premiums on Bonds Often the contractual (stated) interest rate and the market (effective) interest rate differ… therefore bonds sell above or below face value.

36 Bond Discount... When the investor pays less than the face value of the bond. WHY? To adjust the contractual interest to the market interest rate.

37 Selling Bonds at Discount On January 1, 2004, Candlestick, Inc., sells $100,000, 5-year, 10% bonds at 98 with interest payable on January 1. Jan 1Cash 98,000 Discount on Bonds Payable 2,000 Bonds Payable 100,000 (To record sale of bonds at a discount)

38 Carrying (Book) Value of Bonds Long-term liabilities Bonds payable $ 100,000 Less: Discount on bonds 2,000 $98,000 payable Carrying Value

39 Bond Premium... When the investor pays more than the face value of the bond. WHY? To adjust the contractual interest to the market interest rate.

40 Selling Bonds at Premium On January 1, 2004, Candlestick, Inc., sells $100,000, 5-year, 10% bonds at 102 with interest payable on January 1. Jan 1Cash102,000 Bonds Payable 100,000 Premium Bonds Payable 2,000 (To record sale of bonds at a premium)

41 Carrying (Book) Value of Bonds Long-term liabilities Bonds payable $ 100,000 Add : Premium on bonds 2,000 $102,000 payable Carrying Value

42 Amortizing Bond Discount/Premium Candlelight would amortize the $2,000 discount/premium as follows: $2,000 ÷ 5 Interest Periods = $400 Annually

43 Bond Retirement Bonds may be redeemed at maturity or before maturity.

44 Redeeming Bonds Before Maturity zA company may decide to retire bonds before maturity to: yreduce interest cost yremove debt from its balance sheet. zA company should retire debt early only if it has sufficient cash resources.

45 Redeeming Bonds Before Maturity zWhen bonds are retired before maturity, it is necessary to: yEliminate the carrying value of the bonds at the redemption date yRecord the cash paid yRecognize the gain or loss on redemption.

46 Partial Balance Sheet Long-term liabilities Bonds payable 10% due in 2009 $1,000,000 Less: Discount on bonds payable 80,000 $ 920,000 Notes payable, 11%, due in 2015 and secured by plant assets 500,000 Lease liability 540,000 Total long-term liabilities $1,960,000

47 General Motors Corporation- Automotive Division Statement of Cash Flows (partial) 2001 (in millions) Cash flows from financing activities Net increase (decrease) in loans payable $ 194 Long-term debt - borrowings 5,850 Long-term debt-repayments (2,620) Repurchases of common and preferred stocks (264) Proceeds from issuing common and preferred stocks 517 Cash dividends paid to stockholders (1,201) Net cash (used in) provided by financing activities $2,476

48 Debt to Total Assets Ratio... Indicates the extent to which a company’s debt could be repaid by liquidating assets. Debt to Total Assets Ratio = Total Liabilities Total Assets

49 Liquidity Ratios Measure the short-term ability of a company to pay its maturing obligations and to meet unexpected needs for cash. zWorking capital zCurrent ratio zAcid-test ratio

50 Working Capital Measures short- term ability to pay liabilities Current Assets - Current Liabilities = Working Capital

51 Current Ratio Measure of short-term ability to pay obligations Current Ratio = Current Assets Current Liabilities

52 Acid-Test Ratio Measure of company’s immediate short-term ability to pay obligations Acid-Test Ratio = Securities, Net Receivables Current Liabilities Cash,Marketable

53 Leverage/Solvency Ratios Measure the ability of a company to survive over a long-period of time. zDebt to Equity Ratio zDebt to Assets Ratio zTimes Interest Earned Ratio

54 Debt to Equity Ratio Indicates the extent to which a company has borrowed relative to its equity. Debt to Equity = Ratio Total Liabilities Total Equity

55 Debt to Total Assets Ratio Indicates the extent to which a company used debt to finance its assets. Debt to Total Assets = Ratio Total Liabilities Total Assets

56 Times Interest Earned Ratio... Provides an indication of company’s ability to meet interest payments as they come due. Times Interest Earned Ratio= Income Before Interest Expense & Tax Expense Interest Expense