©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 1 Current and Long-Term Liabilities Chapter 8

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 2 Learning Objective 1 Account for current liabilities and contingent liabilities.

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 3 Current Liabilities Obligations due within one year or within company’s normal operating cycle if it is longer Known amount Estimated amount

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 4 Known amount Accounts payable Short-term notes payable Sales tax payable Current portion of long-term debt Accrued expenses Payroll liabilities Unearned revenues Current Liabilities

Short-Term Notes Payable On January 30, a business purchased inventory for $8,000 by issuing a 1- year, 10% note payable. The fiscal year ends on April 30. Jan 30Inventory8,000 Notes Payable8,000 Purchased inventory by issuing a one-year, 10% note ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Short-Term Notes Payable Apr 30Interest Expense200 Interest Payable200 To accrue interest at year-end How much interest was accrued as of April 30? $8,000 × 10% × (3/12) = $200 ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Short-Term Notes Payable $8,000 × 10% × (9/12) = $600 Jan 30Note Payable8,000 Interest Payable200 Interest Expense600 Cash8,800 To record payment of loan ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Sales Tax Payable One day’s sales at a Home Depot Store totaled $200,000. The business collected an additional 5% in sales tax. Record the day’s sales. Cash ($200,000 X 1.05)210,000 Sales Revenue200,000 Sales Tax Payable10,000 To record cash sales and related sales tax ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

9 Current Installment of Long-Term Debt Amount of the principal that is payable within one year

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 10 Accrued Expenses Expenses that have been incurred but not recorded Salaries Taxes withheld Interest Utilities

Payroll Liabilities Salary Expense10,000 Employee Income Tax Payable1,200 FICA Tax Payable800 Salary Payable8,000 To record salary expense ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

12 Unearned Revenues The Bradstreet Corporation provides credit evaluation services to subscribers. Bradstreet charges a client $750 for a three-year subscription. Prepare the entry.

Unearned Revenues Jan 1Cash750 Unearned Revenue750 To record receipt for a 3-year subscription Dec 31Unearned Revenue250 Subscription Revenue250 To record revenue earned at year-end (750 x 12/36 months) ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

14 Current Liabilities That Must Be Estimated Black & Decker made sales of $200,000 subject to product warranties. They estimate that 3% of the products it sells this year will require repair or replacement. What is the estimated warranty expense?

Estimated Warranty Payable $200,000 ×.03 = $6,000 Warranty Expense6,000 Estimated Warranty Payable6,000 To accrue warranty expense ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Estimated Warranty Payable Estimated Warranty Payable5,800 Inventory5,800 To replace defective products sold under warranty Defective merchandise totals $5,800. Black & Decker will replace it and record the following: ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

17 Contingent Liabilities Potential liability that depends on a future event arising out of past events. Record liability if: it is probable that the loss will occur and the amount can be reasonably estimated

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 18 Contingent Liabilities Report in the notes to the financial statement if it is reasonably possible that a loss or expense will occur. There is no reason to report contingent loss that is remote – unlikely to occur.

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 19 Bonds: An Introduction Groups of long-term notes payable issued to multiple lenders (bondholders)

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 20 Types of Bonds Term bonds Serial bonds Secured (mortgage) bonds Unsecured (debenture) bonds

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 21 Bond Prices Quoted 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 × = $

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 22 Bond Prices Bond issued above face (par) value - premium Bond issued at below face (par) value - discount As a bond nears maturity, its market price moves toward par value

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 23 Present Value The amount invested today receives a greater amount at a future date - present value of a future amount It depends on: amount of the future receipt length of time to future receipt interest rate for the period

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 24 Bond Interest Rates Bonds are sold at market price - amount that investors are willing to pay at any given time Market price represents: present value of periodic interest payments present value of principal to be received at maturity

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 25 Bond Interest Rates Contract rate – stated rate Market rate – effective rate

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 26 Learning Objective 2 Account for bonds payable transactions.

Issuing Bonds at Par Value On January 1, Chrysler Corporation issued $50,000 of 9%, 5-year bonds at par. Jan 1Cash50,000 Bonds Payable50,000 To issue 9%, 5-years bonds at par ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Issuing Bonds at Par Value Record semiannual interest payments. Jul 1Interest Expense2,250 Cash2,250 To pay semiannual interest $50,000 × 9% × 6/12 = $2,250 ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Issuing Bonds Payable at Par Value Dec 31Interest Expense2,250 Interest Payable2,250 To accrue interest $50,000 × 9% × 6/12 = $2,250 ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Issuing Bonds at a Discount Chrysler issues $100,000 of its 9%, five-year bonds when the market interest rate is 10%. Chrysler receives $96,149 at issuance. Jan 1Cash96,149 Discount on Bonds Payable3,851 Bonds Payable100,000 To issue 9%, 5-years bonds at a discount. ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Issuing Bonds Payable at a Discount Chrysler’s balance sheet immediately after issuance of the bonds: Total current liabilities$ XXX Long-term liabilities: Bonds payable, 9%, due 2009$100,000 Discount on bonds payable ( 3,851)96,149 Discount on Bonds Payable - contra account to Bonds Payable ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

32 Learning Objective 3 Measure interest expense.

Amortization Table on Bonds Issued at a Discount ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Interest Expense on Bonds Issued at a Discount On July 1, 2004, Chrysler makes the first $4,500 semiannual interest payment and also amortizes (decreases) the bond discount Jul 1 Interest Expense4,807 Discount on Bonds Payable307 Cash4,500 To pay semiannual interest & amortize bond discount ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Interest Expense on Bonds Issued at a Discount At December 31, 2004, Chrysler accrues interest and amortizes the bond discount for July through December. Dec 31 Interest Expense4,823 Discount on Bonds Payable323 Interest Payable4,500 To accrue semiannual interest & amortize bond discount ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

36 Interest Expense on Bonds Issued at a Discount Bonds Payable Discount on Bonds Payable 100,0003, July Dec. 31 3,221 Bond carrying amount: $100,000 – $3,221 = $96,779 Chrysler’s bond accounts as of December 31, 2004.

Chrysler Corporation issues $100,000 of 9%, five-year bonds when the market interest rate is 8%. Chrysler receives $104,100 at issuance. Issuing Bonds Payable at a Premium Cash104,100 Premium on Bonds Payable4,100 Bonds Payable100,000 To issue 9%, 5-years bonds at a premium. ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Issuing Bonds Payable at a Premium Chrysler’s balance sheet immediately after issuance of the bonds: Total current liabilities$ XXX Long-term liabilities: Bonds payable$100,000 Premium on bonds payable 4,100 $104,100 ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Amortization Table on Bonds Issued at a Discount ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Interest Expense on Bonds Issued at a Discount On July 1, 2004, Chrysler makes the first $4,500 semiannual interest payment and also amortizes (decreases) the bond premium Jul 1 Interest Expense4,164 Premium on Bonds Payable336 Cash4,500 To pay semiannual interest & amortize bond premium ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

41 Straight-Line Amortization Amortizes discount or premium by dividing it into equal amounts for each interest period Chrysler would amortize the $4,100 premium over 10 periods. $4,100 ÷ 10 = $410 per period

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 42 Early 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.

Early Retirement of Bonds Payable Par value of bonds$70,000 Less: Unamortized discount( 350) Carrying amount of the bonds$69,650 Market price ($70,000 × ) 69,475 Extraordinary gain on retirement$ 175 Bonds Payable70,000 Discount on Bonds Payable350 Cash69,475 Gain on Retirement of Bonds175 To record bond retirement ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Convertible Bonds and Notes Texas Instruments has convertible notes payable of $250,000. Assume that noteholders convert half the notes into 4,000 shares, $1 par common stock. Notes Payable125,000 Common Stock4,000 Paid-in Capital121,000 To record conversion of notes payable ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

45 Learning Objective 4 Understand the advantages and disadvantages of borrowing.

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 46 Financing Operations With Bonds or Stocks Issuing Stock Issuing Notes or Bonds No liabilities No interest expense Less risky to corporation Does not dilute stock ownership or control Results in higher earningsper share

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 47 Long-Term Liabilities: Leases Lease - rental agreement in which the tenant (lessee) agrees to make rent payments to the property owner (lessor). Operating Capital

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 48 Long-Term Liabilities: Leases Capital lease: transfers title at end of the term contains bargain purchase option lease terms cover 75% or more of estimated useful life of leased asset present value of lease payments is 90% or more of the market value of leased asset

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 49 Long-Term Liabilities: Pensions Record pension and retirement benefit expenses while employees work for the company At end of each period, compare the fair market value of the assets in the pension plan – cash and investments – with the plan’s accumulated benefit obligation

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 50 Long-Term Liabilities: Pensions If accumulated benefit obligation exceeds plan assets, the plan is underfunded Report excess liability amount as a long-term pension liability on the balance sheet

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 51 Learning Objective 5 Report liabilities on the balance sheet.

Reporting Liabilities Accounts payable$1,976 Accrued salaries and related expenses627 Sales tax payable298 Other accrued expenses1,402 Income taxes payable78 Current installments of long-term debt 4 Total current liabilities$4,385 Long-term debt1,545 Other long-term liabilities451 Amounts in millions ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

53 Reporting Fair Market Value of Long-Term Debt FASB Statement No. 107 requires companies to report fair market value of their financial instruments, which includes long-term debt.

Reporting Financing Activities on the Statement of Cash Flows Cash Flow from Financing Activities: Borrowing by using commercial paper$754 Proceeds from long-term borrowings32 Payment of long-term debt(29) Proceeds from issuance of common stock351 Payments of cash dividends(371) Other, net (4) Net cash provided by financing activities$733 Amounts in millions Year Ended December 31 ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

55 End of Chapter 8