acc102 chap10 publisher_power_point

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REPORTING AND ANALYZING LIABILITIES

Accounting, Fifth Edition

10

10-3

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.

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.

Learning ObjectivesLearning ObjectivesLearning ObjectivesLearning Objectives

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Preview of Chapter 10

AccountingFifth Edition

Kimmel Weygandt Kieso

10-5

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 LiabilitiesCurrent LiabilitiesCurrent LiabilitiesCurrent Liabilities

LO 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.

What is a Current Liability?

10-6

To be classified as a current liability, a debt must be

expected to be paid:

a. out of existing current assets.

b. by creating other current liabilities.

c. within 2 years.

d. both (a) and (b).

LO 1 Explain a current liability and identify the major types of current liabilities.


Question

10-7 LO 2 Describe the accounting for notes payable.

Notes Payable

Written promissory note.

Usually require the borrower to pay interest.

Those due within one year of the balance sheet date are

usually classified as current liabilities.


10-8

Illustration: First National Bank agrees to lend $100,000 on

September 1, 2014, 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 payable

100,000

Cash 100,000

LO 2 Describe the accounting for notes payable.


Sept. 1

10-9

Illustration: If Cole Williams Co. prepares financial statements

annually, it makes an adjusting entry at December 31 to recognize

interest.

Interest payable

4,000

Interest expense 4,000 *



Dec. 31

* $100,000 x 12% x 4/12 = 4,000

10-10

Illustration: At maturity (January 1), Cole Williams Co. must pay

the face value of the note plus interest. It records payment as

follows.

Interest payable 4,000

Notes payable 100,000



Jan. 1

Cash

104,000

10-11 LO 3 Explain the accounting for other current liabilities.

Sales Tax Payable

Sales taxes are expressed as a stated percentage of the

sales price.

Selling company

► collects tax from the customer.

► remits the collections to the state’s department of

revenue.


10-12

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:

LO 3 Explain the accounting for other current liabilities.


Mar. 25

Sales revenue10,000

Cash 10,600

Sales tax payable

600

10-13

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:



Mar. 25

Sales revenue10,000

Cash 10,600

Sales tax payable

600

Sometimes companies do not ring up sales taxes separately on the cash register.

* $10,600 / 1.06 = $10,000

*

10-14 LO 3 Explain the accounting for other current liabilities.

Unearned Revenue

Revenues that are received before the company delivers goods or provides service.


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.

10-15

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:


Unearned ticket revenue

500,000

Cash 500,000Aug. 6

Ticket revenue

100,000

Unearned ticket revenue 100,000Sept. 7


As each game is completed, Superior records the earning of

revenue.

10-16

Illustration: Wendy Construction issues a five-year, interest-bearing

$25,000 note on January 1, 2011. 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.



$5,000

$20,000

10-17

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).


Payroll and Payroll Taxes Payable


Determining the payroll involves computing three amounts:

(1) gross earnings, (2) payroll deductions, and (3) net

pay.

10-18

Illustration: Assume Cargo Corporation records its payroll for the

week of March 7 as follows:

Salaries and wages expense 100,000

Federal income tax payable 21,864

FICA tax payable 7,650

State income tax payable 2,922

Salaries and wages payable 67,564

LO 3

Cash 67,564

Salaries and wages payable 67,564Mar. 7

Record the payment of this payroll on March 7.

Mar. 7


10-19

Payroll tax expense results from three taxes that

governmental agencies levy on employers.

These taxes are:

FICA tax

Federal unemployment tax

State unemployment tax



10-20

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 expense 13,850

State unemployment taxes payable 800

FICA tax payable 7,650

Federal unemployment taxes payable 5,400



10-21

Employer payroll taxes do not include:

a. Federal unemployment taxes.

b. State unemployment taxes.

c. Federal income taxes.

d. FICA taxes.

Question



10-23

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).

When a corporation issues bonds, it is borrowing money. The

person who buys the bonds (the bondholder) is investing in

bonds.

LO 4 Identify the types of bonds.

Bond: Long-Term LiabilitiesBond: Long-Term LiabilitiesBond: Long-Term LiabilitiesBond: Long-Term Liabilities

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Types of Bonds

Secured

Unsecured

Convertible

Callable



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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 interest rate – rate to determine cash interest

paid, generally semiannually.



Issuing ProceduresAlternative Terminology Thecontractual rate is often referredto as the stated rate.

10-27


LO 4

Illustration 10-3

10-28

Determining the Market Value of Bonds

The process of finding the present value is referred to as discounting the future amounts.



The current market price (present value) of a bond is a function of

three factors:

1. the dollar amounts to be received,

2. the length of time until the amounts are received, and

3. the market rate of interest.

10-29

Illustration: Assume that Acropolis Company on January 1, 2014,

issues $100,000 of 9% bonds, due in five years, with interest

payable annually at year-end.


Illustration 10-5Computing the market price of bonds

Illustration 10-4 Time diagram depicting cashflows


10-30

A corporation records bond transactions when it

issues or retires (buys back) bonds and

when bondholders convert bonds into common stock.

Accounting for Bond IssuesAccounting for Bond IssuesAccounting for Bond IssuesAccounting 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.

LO 5 Prepare the entries for the issuance of bonds and interest expense.

10-31

The rate of interest investors demand for loaning funds

to a corporation is the:

a. contractual interest rate.

b. face value rate.

c. market interest rate.

d. stated interest rate.

Question



10-32

Illustration: Devor Corporation issues 100, five-year, 10%, $1,000

bonds dated January 1, 2014, at 100 (100% of face value). The

entry to record the sale is:

Jan. 1 Cash 100,000


Issuing Bonds at Face ValueIssuing Bonds at Face ValueIssuing Bonds at Face ValueIssuing Bonds at Face Value

Bonds payable 100,000

Prepare the entry Devor would make to accrue interest on

December 31. ($100,000 x 10% x 12/12)

Dec. 31 Interest expense 10,000

Interest payable 10,000

10-33

Prepare the entry Devor would make to pay the interest on Jan. 1,

2015.

Jan. 1 Interest payable 10,000

Cash 10,000


Issuing Bonds at Face ValueIssuing Bonds at Face ValueIssuing Bonds at Face ValueIssuing Bonds at Face Value

10-34 LO 5


Issue at Par, Discount, or Premium?Illustration 10-6

Helpful Hint Bond prices vary inversely with changes in the market interest rate. As market interest rates decline, bond prices increase. When a bond is issued, if the market interest rate is below the contractual rate, the bond price is higher than the face value.

10-35

Karson Inc. issues 10-year bonds with a maturity value of $200,000. If the bonds are issued at a premium, this indicates that:

a. the contractual interest rate exceeds the market interest rate.

b. the market interest rate exceeds the contractual interest rate.

c. the contractual interest rate and the market interest rate are the same.

d. no relationship exists between the two rates.

Question



10-36

Illustration: Assume that on January 1, 2014, 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:


Issuing Bonds at a DiscountIssuing Bonds at a DiscountIssuing Bonds at a DiscountIssuing Bonds at a Discount

Jan. 1 Cash 98,000

Discount on bonds payable 2,000


10-37

Statement Presentation



Illustration 10-7Statement presentation of discount on bonds payable

Sale of bonds below face value causes the total cost of borrowing to be more than the bond interest paid.

The reason: Borrower is required to pay the bond discount at the maturity date. Thus, the bond discount is considered to be a increase in the cost of borrowing.

10-38

Total Cost of Borrowing

Illustration 10-8

Illustration 10-9



10-39

Discount on Bonds Payable:

a. has a credit balance.

b. is a contra account.

c. is added to bonds payable on the balance sheet.

d. increases over the term of the bonds.

Question



Helpful Hint Both a discountand a premium account arevaluation accounts. A valuationaccount is one that is needed tovalue properly the item to whichit relates.

10-40

Illustration: Assume that the Candlestick Inc. bonds previously

described sell at 102 rather than at 98. The entry to record the sale

is:


Jan. 1 Cash 102,000


Premium on bonds payable 2,000

Issuing Bonds at a PremiumIssuing Bonds at a PremiumIssuing Bonds at a PremiumIssuing Bonds at a Premium

10-41 LO 5 Prepare the entries for the issuance of bonds and interest expense.

Illustration 10-11Statement presentation of premium on bonds payable


Sale of bonds above face value causes the total cost of borrowing to be less

than the bond interest paid.

The reason: The borrower is not required to pay the bond premium at the

maturity date of the bonds. Thus, the bond premium is considered to be a

reduction in the cost of borrowing.

Statement Presentation

10-42

Illustration 10-12

Illustration 10-13



Total Cost of Borrowing

10-43

Redeeming Bonds at Maturity

LO 6 Describe the entries when bonds are redeemed.

Candlestick records the redemption of its bonds at maturity as

follows:

Accounting for Bond RedemptionsAccounting for Bond RedemptionsAccounting for Bond RedemptionsAccounting for Bond Redemptions


Cash 100,000

10-44

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 RetirementsAccounting for Bond RetirementsAccounting for Bond RetirementsAccounting for Bond Retirements


Redeeming Bonds at Maturity

10-45

When bonds are redeemed before maturity, the gain or loss

on redemption is the difference between the cash paid and

the:

a. carrying value of the bonds.

b. face value of the bonds.

c. original selling price of the bonds.

d. maturity value of the bonds.

Question



10-46

Cash 103,000

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, 2018) as:



Premium on bonds payable 400


10-47

When bonds are converted into common stock:

a. a gain or loss is recognized.

b. the carrying value of the bonds is transferred to paid-

in capital accounts.

c. the market price of the stock is considered in the

entry.

d. the market price of the bonds is transferred to paid-in

capital.

Question



10-48

Balance Sheet Presentation

LO 7

Financial Statement Analysis and PresentationFinancial Statement Analysis and PresentationFinancial Statement Analysis and PresentationFinancial Statement Analysis and Presentation

Illustration 10-15

10-49

Analysis


Illustration 10-16

LO 7

10-50

Liquidity


Liquidity ratios measure the short-term ability of a company to pay its

maturing obligations and to meet unexpected needs for cash.

LO 7 Identify the requirements for the financial statement presentation and analysis of liabilities.

Illustration 10-17

10-51

Solvency


Solvency ratios measure the ability of a company to survive over a

long period of time.LO 7

Illustration 10-18

10-53

Off-Balance-Sheet Financing

Contingencies

Leasing

► Operating lease

► Capital lease


LO 7 Identify the requirements for the financial statement presentation and analysis of liabilities.

10-55

Appendix 10AAppendix 10AAppendix 10AAppendix 10A

To follow the expense recognition principle, companies allocate

bond discount to expense in each period in which the bonds are

outstanding.

Illustration 10A-1

Amortizing Bond Discount

LO 8 Apply the straight-line method of amortizing bond discount and bond premium.

Straight-Line Amortization

10-56


Illustration: Candlestick, Inc., sold $100,000, five-year, 10%

bonds on January 1, 2014, for $98,000 (discount of $2,000).

Interest is payable on January 1 of each year. Prepare the

entry to accrue interest at Dec. 31, 2014.

Discount on bonds payable

400

Interest expense 10,400Dec. 31

Interest payable

10,000




10-57


Illustration 10A-2




10-58


Amortizing Bond Premium


bonds on January 1, 2014, for $102,000 (premium of $2,000).

Interest is payable on January 1 of each year. Prepare the

entry to accrue interest at Dec. 31, 2014.



Interest payable

10,000



10-59


Illustration 10A-4




10-60

Appendix 10BAppendix 10BAppendix 10BAppendix 10B

Illustration 10B-1

Under the effective-interest method, the amortization of the discount or premium results in interest expense equal to a constant percentage of the carrying value.

Required steps:

1. Compute the bond interest expense.

2. Compute the bond interest paid or accrued.

3. Compute the amortization amount.

Effective Interest Amortization

LO 9

10-61


LO 9 Apply the effective-interest method of amortizing bond discount and bond premium.

Illustration: Candlestick, Inc., sold $100,000, five-year, 10% bonds

on January 1, 2014, for $98,000. The effective-interest rate is

10.53% and interest is payable on Jan. 1 of each year. Prepare the

bond discount amortization schedule.



10-62


Illustration 10B-2




10-63


Illustration: Candlestick, Inc. records the accrual of interest

and amortization of bond discount on Dec. 31, as follows:


Discount on bonds payable319


Interest payable

10,000



10-64



bonds on January 1, 2014, for $102,000. The effective-interest rate

is 9.48% and interest is payable on Jan. 1 of each year. Prepare

the bond premium amortization schedule.




10-65


Illustration 10B-4




10-66


Illustration: Candlestick, Inc. records the accrual of interest and amortization of premium discount on Dec. 31, as follows:



Interest payable

10,000




10-67

Appendix 10CAppendix 10CAppendix 10CAppendix 10C

May be secured by a mortgage that pledges title to specific

assets as security for a loan.

Typically, the terms require the borrower to make installment

payments over the term of the loan. Each payment consists of

1. interest on the unpaid balance of the loan and

2. a reduction of loan principal.

Companies initially record mortgage notes payable at face

value.

LO 10 Describe the accounting for long-term notes payable.

Long-Term Notes Payable


10-68


Illustration 10C-1

Illustration: Porter Technology Inc. issues a $500,000, 12%, 20-

year mortgage note on December 31, 2014. The terms provide for

semiannual installment payments of $33,231.



10-69


Illustration: Porter Technology records the mortgage loan and

first installment payment as follows:


Mortgage payable 500,000

Cash 500,000Dec. 31

Mortgage payable 3,231

Interest expense 30,000Jun. 30

Cash 33,231


10-70


Each payment on a mortgage note payable consists of:

a. interest on the original balance of the loan.

b. reduction of loan principal only.

c. interest on the original balance of the loan and

reduction of loan principal.

d. interest on the unpaid balance of the loan and

reduction of loan principal.

Question



10-71

Key Points

Liabilities are defined by the IASB as a present obligation of the

entity arising from past events, the settlement of which is expected

to result in an outflow from the entity of resources embodying

economic benefits. Liabilities may be legally enforceable via a

contract or law but need not be. That is, they can arise due to

normal business practices or customs.

IFRS requires that companies classify liabilities as current or non-

current on the face of the statement of financial position (balance

sheet) except in industries where a presentation based on liquidity

would be considered to provide more useful information (such as

financial institutions). When current liabilities are presented, they are

generally presented in order of liquidity.LO 11

10-72

Key Points

Under IFRS, liabilities are classified as current if they are expected

to be paid within 12 months.

Similar to GAAP, items are normally reported in order of liquidity.

Companies sometimes show liabilities before assets. Also, they will

sometimes show non-current (long-term) liabilities before current

liabilities.

Under both GAAP and IFRS, preferred stock that is required to be

redeemed at a specific point in time in the future must be reported

as debt, rather than being presented as either equity or in a

“mezzanine” area between debt and equity.

LO 11 Compare the accounting procedures for liabilities under GAAP and IFRS.

10-73

Key Points

Under IFRS, companies sometimes will net current liabilities against

current assets to show working capital on the face of the statement

of financial position. (This is evident in the Zetar financial

statements in Appendix C.)

IFRS requires use of the effective-interest method for amortization

of bond discounts and premiums. GAAP allows use of the straight-

line method where the difference is not material. Under IFRS,

companies do not use a premium or discount account but instead

show the bond at its net amount.


10-74

Key Points

Unlike GAAP, IFRS splits the proceeds from the convertible bond

between an equity component and a debt component. The equity

conversion rights are reported in equity.

Both Boards share the same objective of recording leases by

lessees and lessors according to their economic substance—that is,

according to the definitions of assets and liabilities. However, GAAP

for leases is much more “rules-based,” with specific bright-line

criteria (such as the “90% of fair value” test) to determine if a lease

arrangement transfers the risks and rewards of ownership. IFRS is

more conceptual in its provisions. Rather than a 90% cut-off, it asks

whether the agreement transfers substantially all of the risks and

rewards associated with ownership.LO 11

10-75

Key Points

Under GAAP, some contingent liabilities are recorded in the

financial statements, others are disclosed, and in some cases no

disclosure is required. Unlike GAAP, IFRS reserves the use of the

term contingent liability to refer only to possible obligations that are

not recognized in the financial statements but may be disclosed if

certain criteria are met.

For those items that GAAP would treat as recordable contingent

liabilities, IFRS instead uses the term provisions. Provisions are

defined as liabilities of uncertain timing or amount. Under IFRS, the

measurement of a provision related to an uncertain obligation is

based on the best estimate of the expenditure required to settle the

obligation.LO 11

10-76

Looking to the Future

The FASB and IASB are currently involved in two projects. One project is

investigating approaches to differentiate between debt and equity

instruments. The other project, the elements phase of the conceptual

framework project, will evaluate the definitions of the fundamental building

blocks of accounting. In addition to these projects, the FASB and IASB

have also identified leasing as one of the most problematic areas of

accounting. A joint project will initially focus primarily on lessee accounting.

One of the first areas to be studied is, “What are the assets and liabilities

to be recognized related to a lease contract?” Should the focus remain on

the leased item or the right to use the leased item? This question is tied to

the Boards’ joint project on the conceptual framework—defining an “asset” and a “liability.”

LO 11

10-77

IFRS Practice


Which of the following is false?

a) Under IFRS, current liabilities must always be presented before

non-current liabilities.

b) Under IFRS, an item is a current liability if it will be paid within the

next 12 months.

c) Under IFRS, current liabilities are shown in order of liquidity.

d) Under IFRS, a liability is only recognized if it is a present

obligation.

10-78

IFRS Practice

Under IFRS, a contingent liability is:

a) disclosed in the notes if certain criteria are met.

b) reported on the face of the financial statements if certain

criteria are met.

c) the same as a provision.

d) not covered by IFRS.


10-79

IFRS Practice

The joint projects of the FASB and IASB could potentially:

a) change the definition of liabilities.

b) change the definition of equity.

c) change the definition of assets.

d) All of the above.


10-80

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acc102 chap10 publisher_power_point

Education

current liability

existing current assets

analysis of liabilities

accrued liabilities

accounts payable

notes payable100

sales tax payable sales

types of bonds