(10) acctg 311 chapter 10.ppt
TRANSCRIPT
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
1/87
Reporting and AnalyzingLiabilitiesChapter 10
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
2/87
Liabilities
• Definition• Current obligations arising from past transactions and
requiring future settlement of assets or services
• 2 classifications
▫ Current liability !ill be settled !ithin the year "an# indebtedness$ operating lines of credit$
notes payable$ accounts payable and accruedliabilities$ ta%es payable$ interest payable$current portion of long&term debt
▫ 'on¤t !ill be settled beyond one year Long&term debt$ Deferred income ta%es$ bonds
payable
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
3/87
(%ample )1
• *+, Co- orders some equipment- .he
machine costs /10$000 and monthlyinstallments !ill be paid every month oncethe machine has arrived-
▫ s this a liability
At the time of ordering 'o- nce goods arrive +es-
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
4/87
(%ample )2
• 3est4et collects money from customers
before the flights ta#e place▫ s this a liability
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
5/87
(%ample )5
• A parent company guarantees the debt of a
subsidiary company▫ .his means that if the subsidiary company
can6t pay$ then the parent company is onthe hoo# for the loan
▫ s this a liability 7aybe 'ot an obligation to the parent until the
subsidiary defaults
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
6/87
Accounts payable
• Amounts o!ing to creditors
▫ An informal promise to pay
• 'ormally due in 50 days• nterest may be charged on overdue
accounts
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
7/87
perating line of credit
• 8rearranged agreement bet!een a companyand a lender 9usually a ban#: to allo! thecompany to borro! up to an agreed&upon
amount• nterest is normally charged on amounts that
have been dra!n on the line of credit
•
'ormally short&term and repayableimmediately
• Reported as ;ban# indebtedness< on thebalance sheet
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
8/87
=ales ta%
• >ederal ?oods and =ervices .a% 9?=.:
• 8rovincial =ales .a% 98=.:
• @armonized into one combined sales ta%9@=.: in some provinces
• 7ay or may not be included in sale price
• 7ust be remitted periodically to respective
governments
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
9/87
.he seller$ or collector$ of ?=. is an intermediary for the
government
Required to periodically send to the government allsales ta%es collected
Amount o!ing may be reduced by any ?=. paid tosuppliers !ith business purchases
=ales .a%es
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
10/87
1- Record sales ta% collected on every sale
?=.
Assume Crazy Canadian Clothing nc- sold /10$B00 ofgoods in the month of 'ovember- =ales are sub4ect to
B ?=.-
Dr- Cash 9or AR: 112$EB
Cr- ?=. payable B$5B
Cr- Revenue or =ales 10$B00
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
11/87
F Revenue G ?=. H Amount collected
?=. H Revenue I -0B
F Revenue G 9Revenue I 0-0B: H collected
F 1-0B I revenue H collected
F Revenue H Collected 1-0B
?=.
3hat if !e had been told$ instead$ that they hadcollected /112$EB$ !hich included ?=.- @o!do !e determine the sales or ?=.
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
12/87
2- Record ?=. paid on every purchaseJ
Assume Crazy Canadian had made purchases of
/K$000 during 'ovember$ including ?=.'et purchases H/ K$000 1-0B H /K2$5E1
?=. H /K2$5E1 % B R /K$000 /K2$5E1 H /$M1K
DR Asset or e%pense account K2$5E1DR ?=. receivable $M1K
CR Accounts payable or cash K$000
?=.
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
13/87
5- Determine amount o!ing and record remittances made-
At the end of 'ovember$ CCC o!esJ
?=. payable H B$5B
?=. receivable H 9$M1K:
'et o!ing H BM
Assume payment is made for this amount
Dr- ?=. payable B$5B
Cr- ?=. receivable $M1K
Cr- Cash BM
?=.
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
14/87
8roperty ta%es
• A payable$ or an ;accrued liability<
• 8roperty ta% assessments relate to acalendar year$ but are not normally receiveduntil 7ay or Nune-
• >rom Nanuary Nune$ companies mustestimate the e%pense amounts
▫ =till required to record e%penses in thosemonths and recognize the liability that isaccumulating
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
15/87
(vent )1J A"C Company estimates 201 property ta%es!ill be /$200 for the year-
Nanuary 51$ 201
DR 8roperty ta% e%pense 5B0
CR 8roperty ta% payable 5B0
9200 12 H 5B0:
(vent )2J n 7ay 51$ A"C paid /2$000 in property ta%es-
DR 8roperty ta% payable 2$000
CR Cash 2$000
.his entry !ill be repeated in >eb$ 7arch$ April and 7ay
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
16/87
(vent )5J n Nune 50$ A"C receives the property ta% bill for201- Actual ta%es are /5$M00 for the year-
"efore !e can ma#e the Nune entry$ !e need to see !here!e are for the year so farJ
DR CR
Property tax expense
DR CR
Property tax payable
Nan 5B0>eb 5B07ar 5B0 Apr 5B07ay 5B0
5B0 Nan5B0 >eb5B0 7ar 5B0 Apr 5B0 7ay
1B0
7ay 2000
2B0
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
17/87
ABC Company
"y the end of Nune$ the property ta% e%pense should beJ5$M00 % 9M12: H 1$E00
t currently is /1$B0$ therefore$ !e only need to OdebitOthe e%pense Oby /B0O
Dr- 8roperty ta% e%pense B0 Cr- 8roperty ta% payable B0
At Nune 50J.otal e%pense H 1$E00.otal paid H 2$0008repaid H 200 9paid P e%pense:
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
18/87
DR CR
1,750
1,750
Property tax
expense
DR CR
1,750
2,000
250
Property tax
payable
5050
1,800 200
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
19/87
(%ample$ continued
• Let6s thin# about !hat our entry !ould be in Nulyfor the property ta%es$ assuming no other cashpayment !as madeJ
DR 8roperty ta% e%pense 500
CR 8repaid property ta% 200
CR 8roperty ta% payable 100
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
20/87
.here are 2 factors that need to be considered !henloo#ing at prepaid or accrued e%pensesJ
1-.he timing of the e%pense& .his needs to be matched to the related
revenue R the period the e%pense relates to
2-.he cash payment made for the e%pense
3hen the timing of these t!o differ$ !e !ill haveeither a prepaid e%pense 9cash payment P e%pense:R an accrued liability accrued e%pense 9!hene%pense P cash payment:
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
21/87
8ayroll Liabilities
Nust as !ith sales ta%$ governments requireemployers to !ithhold certain amounts fromemployee6s and remit those amounts directlyto them
& ther entities may require or provide anoption for a similar mechanism 9pensionplans$ unions$ etc-
(mployers also have to pay a share of C88and ($ and possibly other benefits-
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
22/87
8ayroll and (mployee "enefits 8ayable
• (mployee payroll deductions
▫ Canada pension plan 9C88:
▫ (mployment insurance 9(:
▫ >ederal and provincial income ta%es▫ ther deductions at source 9union dues$
support payments$ private health planpremiums$ etc-:
• (mployer payroll contributions▫ C88
▫ (
▫
ther
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
23/87
8ayroll liabilities
Crazy Canadian pays employees every second>riday for hours !or#ed the t!o !ee#s previous-.he cut off for hours is the .uesday before payday-
@ours !or#ed from 3ed 'ov B to .uesday'ovember 1E !ere paid on >riday 'ovember 21-(mployees !or#ed 150 hours in the pay period
at /1-00 per hour-
Crazy Canadian is required to !ithhold -KB forC88$ 1- for ( and 1B for income ta%es-
.!o employees belong to the private health care
plan and pay /B per pay period for benefits-
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
24/87
8ayroll and (mployee "enefits 8ayable
1- Record employee earnings and payJ
>irst$ let6s figure out ho! much they !ere paidJ
?ross !ages 9150 % 1: 2$210
LessJ C88 92$210 I-KB: 910K:
( 92$210 % 1-: 95E:
.a% 92$210 % 1B: 9552:
"enefit payments 91B0:
'et pay to employees 1$BE1
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
25/87
8ayroll and (mployee "enefits 8ayable
1- Record employee earnings and payJ
Dr- 3age e%pense 2$210
Cr- C88 payable 10K Cr- ( payable 5E
Cr- .a% !ithheld payable 552
Cr- Due to benefit plan 1B0
Cr- Cash 1$BE1
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
26/87
8ayroll and (mployee "enefits 8ayable
2- Record employer costs
.he government requires that companies also pay
C88 equal to the amount that employees pay$ andto pay ( of 1- times the employee amount-
Crazy Canadian also pays /100 per employee perpay period to the benefit plan-
C88 o!ing H 10K 9same as employees:
( o!ing H B5 95E % 1-:
"enefit plan H 200
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
27/87
8ayroll and (mployee "enefits 8ayable
2- Record employer costs
Dr- "enefit e%penses 5M2
Cr- C88 payable 10KCr- ( payable B5
Cr- Due to benefit plan 200
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
28/87
8ayroll and (mployee "enefits 8ayable
5- Record amounts remitted-
Crazy Canadian o!es the governmentJ
C88 H 10K G 10K H 21E ( H 5E G B5 & K1
ncome ta%es !ithheld H 552
.otal o!ing to the federal gov6t H M1
And o!es the benefit plan providerJ
1B0 G 200 H 5B0
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
29/87
8ayroll and (mployee "enefits 8ayable
5- Record amounts remitted-
C88 payable 21E
( payable K1 .a% !ithheld payable 552
Cash M1
Due to benefit plan 5B0
Cash 5B0
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
30/87
8ayroll liabilities
•
n our e%ample$ everything happened in'ovember-
• 3hat if the pay period spans 2 different months
• >or e%ample$ say employees !or# from
'ovember 1K December 2and are paid for thattime on December B- 3hat needs to happen in'ovember
3e need to record accrued !ages
• Do !e need to record liabilities for !ithholdingsin 'ovember▫ 'o-
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
31/87
'otes payable
• ften used instead of accounts payable
• 8rovide !ritten documentation$ if needed$ for
legal remedies• 'ormally has interest attached
• Qsed for short&term and long&term financingneeds
• .he other side of ;'ote receivable<
• =ee e%amples in the te%tboo#
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
32/87
Current portion of Long&term debt
• .he portion of the long&term debt that is due!ithin the current year or operating cycleshould be classified as a current liability
(%ampleJ Distiller nc- borro!ed /B0$000 onNanuary 1$ 201- .he loan is to be repaidequally over B years-
.he current portion of L. Debt H 10$000
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
33/87
8rovisions and Contingent Liabilities
• 3e have seen many areas !here !e useestimates in accrual accounting
• .hese are the terms used for liabilities that have ahigher degree of uncertainty than ;payables<
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
34/87
8rovisions
F .his is the term used for liabilities that !e arecertain !ill occur$ but !e are not certain aboutthe timing andor the amount- (%amplesJ
F 3arrantiesF Asset retirement costsF 8ension liabilities
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
35/87
Contingencies
• Contingencies are things that may becomea liability do!n the road-
• 3e are unsure about the future settlementJ▫
8ast transaction▫ 8resent obligation▫ >uture settlement
• La!suits are a good e%ample f !e lose
this la!suit !e6ll have to pay /*-▫ 'ot a present obligation until !e actually lose
the la!suit
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
36/87
Contingencies
Accounting rules specify !hen it needs to berecorded as a liability only discussed in thenotes or nothing
.here are t!o factors to considerJ1)Likelioo! of event occurring
2)Amo"nt needed if event occurs
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
37/87
Contingent Liabilities
Likely# $ot Likely
%eas"rable
$ot %eas"rable
Record
Dr- (%pense Cr- Liability
7Q=.discuss in
the notes
7ay discuss in
the notes9disclose:
7ay discuss inthe notes
9disclose:
>R= uses ;probable< H more li#ely than not 9PB0 chanceof happening:
A=8( uses ;li#ely< H higher requirement than ;probable<
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
38/87
Long&term liabilities
• bligations to be paid after one year
•
ncludes long&term notes$ bonds$ and leaseobligations
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
39/87
Long&term notes payable
• 'ormally repayable in a series of periodicpayments called installments
• 7ay be secured by specific assets !hich arecommonly referred to as mortgages
• 7ay be unsecured• nstallment payments usually ta#e one of t!o
formsJ▫
>i%ed principal payments plus interest 9fi%edor floating interest:▫ "lended principal and interest payments
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
40/87
(%ample
Assume nco Ltd- receives a note payable for/120$000 to be repaid over B years and !ithinterest at -
Date loan is receivedJ
Dr- Cash 120$000 Cr- 'ote payable 9or long&term debt: 120$000
nstalment 8ayment =chedule
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
41/87
(A) (B) (C) (D)
Cash Interest Reduction Principal
Interest Payment Expense of Principal BalancePeriod (B + C) (D x 7 x !"!#) (!#$%$$$"&$) ( D ' C )
Issue date !#$%$$$
! #%7$$ 7$$ #%$$$ !!%$$$
# #%& & #%$$$ !!&%$$$
* #%&77 &77 #%$$$ !!%$$$
nstalment 8ayment =chedule S>i%ed 8rincipal 8ayment
Assume that the loan terms provide for monthlyinstallment payments of /2$000 9/120$000M0: plusinterest- .he installment payment schedule for the firstfe! months is sho!n belo!J
nstalment 8ayment =chedule "lended
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
42/87
Assume that instead of fi%ed principal payments$ nco Ltdrepays its /120$000$ percent, B&year note payable inblended monthly installments of /2$5M- .he installmentpayment schedule for the first fe! months is sho!n belo!J
(B) (C) (D)
(A) Interest Reduction Principal
Interest Cash Expense of Principal Balance
Period Payment (D x 7 x !"!#) (A ' B) ( D ' C )
Issue date !#$%$$$
! #%*7& 7$$ !%&7& !!%*#
# #%*7& &,$ !%&& !!&%&*
* #%*7& &$ !%&,& !!%,#
3ith both types of installment notes payable$ the reduction inprincipal for the ne%t year must be reported as a currentliability !hile the remaining unpaid principal is classified as a
long&term liability-
nstalment 8ayment =chedule S "lended8ayment
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
43/87
Nournal entries
1st caseJ
Dr- 'ote payable 2000
Dr- nterest e%pense 00
Cr- Cash 200
2nd caseJ
Dr- 'ote payable 1MM
Dr- nterest e%pense 00
Cr- Cash 25M
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
44/87
"onds
• "onds are a financing tool for companies a !ay for them to get cash into thecompany
• .hey are a form of debt$ as there is noo!nership that goes !ith them▫ .here is a promise to pay the principle
amount at a fi%ed date in the future▫ Also a promise to pay some interest at
predetermined dates 9can be at a 0 rateof interest:
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
45/87
"onds & e%ample
• n Nanuary 1$ 2010$ Cash =trapped nc- issuesB00 B year$ M$ /1$000 bonds
▫ /1000 is the face value
▫ M is the stated interest rate
▫ 7aturity date is December 51$ 201
• =old in small denominations$ !hich ma#es themattractive to investors
• Convertible vs- redeemableretractable
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
46/87
"onds & 8ricing
• Let6s assume you have /1$000 saved up thatyou !on6t need for B years- +ou are loo#ing toinvest that money-
• C= is issuing B year$ /1$000 bonds !ith 0interest-▫ .his entitles the bondholder the right to receive
/1$000 in B years$ but no interest 9interest H 0:▫ 3ould you be !illing to purchase this bond for
/1$000
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
47/87
"onds & 8ricing
• Assume >3C Ltd- is also issuing B year$ /1$000bonds but these bear interest at M▫ .his entitles you to annual interest payments of
/M0 and principle of /1$000 at the end of the Byears-
▫ 3ould you be !illing to purchase this bond for/1$000
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
48/87
"onds
3hat you should be !illing to pay is going todepend on the price of the bond
.he bond price !ill be determined based on ho!the stated rate of interest compares to mar#etrates of interest on similar bonds
.he price of a bond is equal to the present valueof the future cash flo!s generated by the bond-
" d
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
49/87
"onds
• 'eed to understand the concept of present value or
time value of money • "ecause !e can invest our money$ the ;present
value< of a dollar in the future is something lessthan a dollar
• f can earn 10 on my money$ and invest /0-K1today$ !ill have /1-00 in a year
• =o the ;present value< of /1-00 one year from no!$
if interest rates are 10 is /0-K1• .here are established !ays to calculate present
values▫ >ormulas and tables
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
50/87
"ond pricing
• Assume C= issues a 2 year$ /1$000 bond thatoffers interest at 10$ paid annually- Currentmar#et interest rates for investments !ith similarris# are offering E-
• ?iven that C= bonds !ill pay 10$ !hileeverything else in the mar#et is paying E$ !hat!ould investors be !illing to pay for these
bonds• .he ans!er is ;the present value of the future
cash flo!s$ discounted at mar#et interest rates<
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
51/87
"ond pricing
=tep 1J Determine cash flo!s
• .here are 2 cash flo!s presentJ▫ nterest
8aid annually "ased on face value and stated rate of interest /1$000 % 10 H /100 per year
▫ >ace value 8aid at maturity /1$000
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
52/87
"ond pricing
=tep 2J Discount each of the types of cash flo!
•nterest is a different ;type< of cash flo!▫ nterest
Annuity regular$ recurring cash flo!s▫ >ace value
Lump sum one time cash payment
▫ .he present value of an annuity is calculateddifferently from the present value of a lump sum orone&time payment
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
53/87
"ond pricing
=tep 2J Discount each of the types of cash flo!
nterestAnnuityJ !e need to #no!J▫ Cash payments H /100
▫ Discount rate H E &market rate)▫ 'umber of paymentsperiods H 2
3e !ill use the tables presented at the end of thechapter material to determine the factor H 1-E52M % 100 H 1E-55
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
54/87
"ond pricing
• Discount the lump sumJ▫ Cash payments H /1$000
▫ nterest rate H E
▫ 'umber of paymentsperiods H 2
• Qsing the tables presented at the end of theChapter material to determine the factor H 0-EB55K % 1000 H EB-5
=tep 5J Add the t!o amounts togetherJ
H EB-5 G 1E-55 H 1$05B-M
nvestors should be !illing to pay /1$05B-M
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
55/87
"ond premiums
•
.his is an e%ample of a bond premiumJ▫ "ecause C= is offering an interest rate above
anything else offered in the mar#et$ investors !illpay more than the face value for the bond
• =imilarly$ !e can have bond discounts▫ Arise !hen the stated rate T mar#et rates
▫ Assume instead that mar#et rates are 12
▫ Recalculating the bond price$ !e getJ/100 % 1-MK00B H 1MK-01
G /1$000 % 0-K1K H K-1K
KMM-20
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
56/87
3hy do rates differ
• Assume C= identifies on Nanuary 1$ 201B that itrequires cash and that it !ill raise the money byissuing bonds-▫ Advice from under!riters as to pricing based on
the mar#et6s perception of C=6s ris#▫ Consider their situation ho! much interest can
they afford @o! much can they raise !ith theissue based on e%pected pricing (tc-
▫ 3ill determine the rate$ but then must get thecertificates printed and issued ta#es time
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
57/87
8resent value and rates
• As the interest rate used to discount cash flo!sgoes up$ !hat happens to the present value▫ t goes do!n
▫ nverse relationship
• 3hy is this the case▫ Less money is needed today to receive the same
cash in the future more earnings
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
58/87
Accounting for bonds
Dis'o"nts and premi"ms result fromdifferences bet!een bonds6 stated interestrates and mar#et rates at the date of issue of
the bonds-.he discount or premium is a contra accountand is included !ith the legal debt on the
corporation6s balance sheet$ probably notmentioned separately but disclosed in notesif material-
i " d t 8 9f l :
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
59/87
ssuing "onds at 8ar 9face value:
Assume that Artisan nc- issued / 1 million$ five&year$ B$ bonds dated Nanuary 1 at 100 9face value:- 9mar#et interest H B:
Nournal entryJ
Dr- Cash 1$000$000 Cr- "onds payable 1$000$000
.o record bonds payable issued at par
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
60/87
ssuing "onds at Discount
Assume that on Nanuary 1$ Artisan$ nc- sells /1million$ five&year$ B bonds at KE 9mar#et rates arePB:-
Nournal entryJ
Dr- Cash KE0$000
Dr- "ond discount 20$000Cr- "onds payable 1$000$000
.o record bonds issued at a discount
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
61/87
Carrying 9"oo#: Ualue of "onds
"onds payable /1$000$000
LessJ Discount on bonds payable 20$000 /KE0$000
Long-termliabilities
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
62/87
ssuing "onds at 8remium
Assume that on Nanuary 1$ Artisan$ nc- sells/1 million$ five&year$ B bonds at 102- 9mar#etrates are T B:
Nournal entryJ
Dr- Cash 1$020$000
Cr- "ond premium 20$000Cr- "onds payable 1$000$000
.o record bonds issued at a premium
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
63/87
Carrying 9"oo#: Ualue of "onds
"onds payable /1$000$000 AddJ 8remium on bonds payable 20$000 /1$020$000
Long-termliabilities
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
64/87
Amortization of "ond 8remium Discount
• .here are t!o methods to amortize bonddiscount or premiumJ
F =traight&line method S premium ordiscount is amortized to interest e%penseover the life of the bond in equal amounts
F (ffective interest method S the interest
e%pense reflects the same percentage ofthe bond6s carrying value this is thepreferred method
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
65/87
Amortizing "ond Discounts or8remiums
• Amortization spreads the cost of borro!ing overthe life of the bond
• Discount amortization increases intereste%pense
• 8remium amortization reduces interest e%pense
( l
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
66/87
(%ample
• n Nanuary 1$ +ear 1$ 3indemere Ltd- issued year$ /100$000 bonds at !hen mar#et rates!ere K▫ 8rice of bonds H K5$B21
▫
Discount H /M$K
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
67/87
(%ample effective interest method
Nanuary 1$ +ear 1 9issue:Dr- Cash K5$B21
Dr- "ond discount M$K
Cr- "onds payable 100$000
.o record bonds issued at a discount
December 51$ +ear 1 9pay interest:
Dr- nterest e%pense 000 Cr- Cash 000
.o record interest payment
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
68/87
(%ample effective interest method
December 51$ +ear 1 9amortize bond discount:
(ffective interest methodJ
& Amortizes the discount using the effectiveinterest H mar#et interest rate
& Loo# to the bond amortization table at the start
& Qse the amount that is the difference bet!een
actual interest paid and ;effective interest<
( l ff ti i t t th d
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
69/87
December 51$ +ear 1 9amortize bond discount:
DR nterest e%pense 11
CR "ond discount 11
.o amortize bond discount
(%ample effective interest method
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
70/87
(%ample
December 51$ +ear 2 9amortize bond discount:
Dr- nterest e%pense 1B
Cr- "ond discount 1B.o amortize bond discount
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
71/87
(%ample effective interest method
December 51$ +ear 9record redemption of bond:
DR "onds 8ayable 100$000
CR Cash 100$000
( l
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
72/87
(%ample
• Let6s re&do the e%ample using the straight linemethod
• n Nanuary 1$ +ear 1$ 3indemere Ltd- issued year$ /100$000 bonds at !hen mar#et rates
!ere K▫ 8rice of bonds H K5$B21
▫ Discount H /M$K
• 3ith straight line$ !e simply spread the bonddiscount across the yearsJ▫ MK H /1M1K-B
( l t i ht li
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
73/87
(%ample straight line
Nanuary 1$ +ear 1 9issue:Dr- Cash K5$B21
Dr- "ond discount M$K
Cr- "onds payable 100$000
.o record bonds issued at a discount
December 51$ +ear 1 9pay interest:
Dr- nterest e%pense $000 Cr- Cash $000
.o record interest payment
( l t i ht li th d
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
74/87
(%ample straight line method
December 51$ year 1 9amortize bond discount:
Dr- nterest e%pense 1$M1K-B
Cr- "ond discount 1$M1K-B
.o amortize bond discount
(%ample straight line method
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
75/87
December 51$ +ear 2 9amortize bond discount:
Dr- nterest e%pense 1M1K-B
Cr- "ond discount 1M1K-B
December 51$ +ear 9redeem bond:
Dr- "onds payable 100$000 Cr- Cash100$000
(%ample straight line method
Amortizing "ond Discounts or 8remiums
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
76/87
Amortizing "ond Discounts or 8remiums
F =traight&line method Constant periodic e%pense$ varying percent
=impler and !idely used as a result
F (ffective interest method Uarying periodic e%pense$ constant percent
Conceptually superior$ better matches e%pense
Required under >R=
"oth methods result in the same total amount
of interest e%pense over the life of bonds-
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
77/87
Discount8remium =ummary
DiscountJ
F"oo# value T face value
Fnterest e%pense P stated rate
8remiumJ
F"oo# value P face value
Fnterest e%pense T stated rate
R d i " d " f 7 t it
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
78/87
Redeeming "onds "efore 7aturity
• A company may decide to retire bondsbefore maturity in order toJ
▫ Reduce interest cost
▫ Remove debt from its balance sheet
• A company should retire debt early only if
it has sufficient cash resources
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
79/87
Retiring bonds early
• 3hen bonds are retired before maturityJ
▫ (liminate carrying value of the bonds atthe redemption date
▫ Record the cash paid
▫ Recognize the gain or loss on redemption9gain if cost T carrying value loss if cost P
carrying value:
( l
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
80/87
(%ample
•
Assume 3indemere redeemed the bonds onNanuary 1$ +ear $ at KK and had used theeffective interest method to amortize the bonddiscount- 8repare the 4ournal entry
• DR "onds payable100$000
•
DR Loss on bond redemption E5B▫ CR "ond discount 9100$000&KE$1MB: 1$E5B
▫ CR Cash KK$000
=t t t 8 t ti
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
81/87
=tatement 8resentation
• "alance sheet▫ Current liabilities are first in order of
settlement dates
▫
'on¤t liabilities follo!• 'otes
▫ nclude information about repaymentschedules$ interest rates$ securitypledged$ value of the security$ etc-
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
82/87
=tatement 8resentation
• Cash flo!
▫ 7ost current liabilities relate to operations
▫ Receiving cash by issuing debt is a
financing activity▫ 8aying cash to repay debt is also a
financing activity
•
ncome =tatement▫ nterest e%pense is reported as an
operating e%pense
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
83/87
3hat6s the issue !ith liabilities
• Companies sometimes have obligations thatdon6t quite meet the definition of a liability$
and so are not recorded on the balance sheet▫ 7ay be an area sub4ect to manipulation
▫ Can be substantial$ so it6s important to
#no! !here to loo# for these
.i i t t d
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
84/87
.imes interest earned
&Qsed to determine if the company is able to meetinterest payments !hen they are due
& this ratio !ould be used if !e !ere concernedthat a company6s debt load is too high
& relates earnings to annual interest costs
& ban#s and other lenders !ould be particularlyinterested in this ratio-
.i i t t d
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
85/87
.imes interest earned How is it calculated?
( B*+ &earnins be-ore interest an! tax)
*nterest expense
Calculation Results201. ( 75.8/112 ( 5
2012 ( 512/12 ( .1
*nterpretation3
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
86/87
.i i t t d
-
8/20/2019 (10) ACCTG 311 Chapter 10.ppt
87/87
.imes interest earned How is it calculated?
( B*+ &earnins be-ore interest an! tax)
*nterest expense
Calculation Results201. ( 7,5.8 / 1,12 ( 5
2012 ( 5,12 / 12 ( .1
*nterpretation