©2004 prentice hall business publishing financial accounting, 5/e harrison/horngren 8 - 1 current...

8 - 1©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren

Current and Long-Term

Liabilities

Chapter 8


Learning Objective 1

Account for current liabilities

and contingent liabilities.


Current Liabilities

Current liabilities are obligations due withinone year or within the company’s normal

operating cycle if it is longer than one year.

Known amount

Amount must be estimated


Current Liabilities

Accounts payableShort-term notes payable

Sales tax payableCurrent portion of long-term debt

Accrued expensesPayroll liabilities

Unearned revenues


Current Liabilities

Accounts payable are amounts owed to suppliersfor goods or services purchased on account.

Short-term notes payable are notespayable due within one year.


Short-Term Notes Payable

In addition to recording the note payable,the business must also pay interest expense.

On January 30, a business purchased inventoryfor $8,000 by issuing a 1-year, 10% note payable.

The fiscal year ends on April 30.



January 30Inventory 8,000

Notes Payable 8,000Purchase of inventory by issuing a one-year,10% note

How much interest was accrued as of April 30?

$8,000 × 10% × (3/12) = $200



How is the payment at maturity recorded?

January 30Note Payable 8,000Interest Payable 200Interest Expense 600

Cash 8,800

$8,000 × 10% × (9/12) = $600


Sales Tax Payable

Suppose one day’s sales at aHome Depot Store totaled $200,000.

Suppose one day’s sales at aHome Depot Store totaled $200,000.

How is the day’s sales recorded?How is the day’s sales recorded?

The business collected an additional5% in sales tax.

The business collected an additional5% in sales tax.


Sales Tax Payable

Cash ($200,000 × 1.05) 210,000Sales Revenue 200,000Sales Tax Payable($200,000 × .05) 10,000

To record cash sales and the related sales tax

Cash ($200,000 × 1.05) 210,000Sales Revenue 200,000Sales Tax Payable($200,000 × .05) 10,000

To record cash sales and the related sales tax


Current Installment ofLong-Term Debt

It is the amount of the principal thatis payable within one year.

At the end of the year, a company reclassifiesthe amount of its long-term debt that must

be paid during the upcoming year.


Accrued Expenses

These are expenses that have been incurredbut not recorded.

These are expenses that have been incurredbut not recorded.

SalariesTaxes withheldInterestUtilities

SalariesTaxes withheldInterestUtilities


Payroll Liabilities

Salary Expense 10,000Employee Income Tax Payable 1,200FICA Tax Payable 800Salary Payable 8,000

To record salary expense


Unearned Revenues

The Dun & Bradstreet (D&B) Corporationprovides credit evaluation services to subscribers.

The Dun & Bradstreet (D&B) Corporationprovides credit evaluation services to subscribers.

What are the entries?What are the entries?

Assume that D&B charges a client$750 for a three-year subscription.Assume that D&B charges a client$750 for a three-year subscription.


Unearned Revenues

January 1Cash 750

Unearned Revenue 750To receive cash for a three-year subscription

December 31Unearned Revenue 250

Subscription Revenue 250To record revenue earned at the end of the year


Unearned Revenues

December 31,Balance Sheet Year 1 Year 2 Year 3

Current liabilities: Unearned subscription revenue $250 $250 $-0-Long-term liabilities: Unearned subscription revenue $250 $-0- $-0-

Income Statement Year 1 Year 2 Year 3

Revenues: Subscription revenue $250 $250 $250


Current Liabilities ThatMust Be Estimated

Estimated Warranty Payable

Assume that Black & Decker made sales of$200,000,000 subject to product warranties.

What is the estimated warranty expense?

Black & Decker estimates that 3% of the productsit sells this year will require repair or replacement.



$200,000,000 × .03 = $6,000,000$200,000,000 × .03 = $6,000,000

Warranty Expense 6,000,000Estimated Warranty Payable 6,000,000

To accrue warranty expense

Warranty Expense 6,000,000Estimated Warranty Payable 6,000,000

To accrue warranty expense



Assume that defective merchandisetotals $5,800,000.

Estimated Warranty Payable 5,800,000Inventory 5,800,000

To replace defective products sold under warranty

Black & Decker will replace itand record the following:


Contingent Liabilities

They are a potential liability that dependson a future event arising out of past events.

They are a potential liability that dependson a future event arising out of past events.

1. Record an actual liability if it is probable that the loss will occur and the amount can be reasonably estimated.

1. Record an actual liability if it is probable that the loss will occur and the amount can be reasonably estimated.


Contingent Liabilities

2. Report a contingent liability in the notes to the financial statement if it is reasonably possible that a loss or expense will occur.

2. Report a contingent liability in the notes to the financial statement if it is reasonably possible that a loss or expense will occur.

3. There is no reason to report a contingent loss that is remote – unlikely to occur.3. There is no reason to report a contingent loss that is remote – unlikely to occur.


Bonds: An Introduction

A bond is an interest bearinglong-term note payable.

A bond is an interest bearinglong-term note payable.

Bonds are groups of notes payable issuedto multiple lenders called bondholders.

Bonds are groups of notes payable issuedto multiple lenders called bondholders.

PrincipalPrincipal Interest rateInterest rate Payment datesPayment dates


Types of Bonds

Term bonds

Serial bonds

Secured, ormortgage, bonds

Unsecured bonds(debentures)


Bond Prices

Bond prices are quoted at apercent of their maturity value.

A quote of 101½ means that a $1,000bond sells for $1,000 × 1.015 = $1,015.

A $1,000 bond quoted at 883/8 is pricedat $1,000 × 0.88375 = $883.75.


Bond Prices

A bond issued at a price above its face(par) value is issued at a premium.

A bond issued at a price belowface (par) value has a discount.

As a bond nears maturity, its marketprice moves toward par value.


Present Value

The amount invested today receives a greateramount at a future date, which is called the

present value of a future amount.

the amount of the future receipt.

the length of time to the future receipt.

the interest rate for the period.


Bond Interest Rates

Bonds are sold at market price, whichis the amount that investors are willing

to pay at any given time.

present value ofthe principal to be

received at maturity.

present value ofperiodic interest

payments.


Bond Interest Rates

Contract rate(stated rate)

Market rate(effective rate)



Account for bonds

payable transactions.


Issuing Bonds Payable at Par Value

On January 1, Chrysler Corporation issued$50,000,000 of 9%, 5-year bonds at par.

On January 1, Chrysler Corporation issued$50,000,000 of 9%, 5-year bonds at par.

January 1Cash 50,000,000

Bonds Payable 50,000,000To issue 9%, 5-year bonds at par

January 1Cash 50,000,000

Bonds Payable 50,000,000To issue 9%, 5-year bonds at par



What is the entry for the interest payment of July 1?What is the entry for the interest payment of July 1?

$50,000,000 × 9% × 6/12 = $2,250,000$50,000,000 × 9% × 6/12 = $2,250,000

July 1Interest Expense 2,250,000

Cash 2,250,000To pay semiannual interest

July 1Interest Expense 2,250,000

Cash 2,250,000To pay semiannual interest



What is the entry to accrue interest on December 31?What is the entry to accrue interest on December 31?

$50,000,000 × 9% × 6/12 = $2,250,000$50,000,000 × 9% × 6/12 = $2,250,000

December 1Interest Expense 2,250,000 Interest Payable 2,250,000To accrue interest

December 1Interest Expense 2,250,000 Interest Payable 2,250,000To accrue interest


Chrysler issues $100,000 of its 9%, five-yearbonds when the market interest rate is 10%.

Cash 96,149Discount on Bonds Payable 3,851

Bonds Payable 100,000To issue 9%, 5-year bonds at a discount

Issuing Bonds Payableat a Discount

Chrysler receives $96,149 at issuance.


Issuing Bonds Payableat a Discount

Chrysler’s balance sheet immediatelyafter issuance of the bonds:

Total current liabilities $ XXXLong-term liabilities:Bonds payable, 9%, due 2009 $100,000Discount on bonds payable – 3,851 $96,149

Discount on Bonds Payable is a contra accountto Bonds Payable, a decrease in liabilities.



Measure interest expense.


Amortization Table on Bonds Issued at a Discount

1/1/047/1/041/1/057/1/05

1/1/09

$4,500 4,500 4,500

4,500

$4,807 4,823 4,839

4,961

$307 323 339

461

$3,851 3,544 3,221 2,882

-0-

$ 96,149 96,456 96,779 97,118

100,000

InterestDate

InterestPayment

InterestExpense

DiscountAmort.

DiscountAccountBalance

BondCarryingAmount


Interest Expense on BondsIssued at a Discount

On July 1, 2004, Chrysler makes the first$4,500 semiannual interest payment and

also amortizes (decreases) the bond discount.July 1, 2004Interest Expense 4,807

Discount on Bonds Payable 307Cash 4,500

To pay semiannual interest and amortize bond discount



At December 31, 2004, Chrysler accruesinterest and amortizes the bond discount

for July through December.December 31, 2004Interest Expense 4,823

Discount on Bonds Payable 323Interest Payable 4,500

To accrue semiannual interest and amortize bond discount



Bonds Payable Discount on Bonds Payable

100,000 3,851 307 July 1323 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 $100,000of 9%, five-year bonds when the

market interest rate is 8%.

Cash 104,100Bonds Payable 100,000Premium on Bonds Payable 4,100

To issue 9% bonds at a premium

Issuing Bonds Payableat a Premium

Chrysler receives $104,100 at issuance.


Issuing Bonds Payableat a Premium

Chrysler’s balance sheet immediatelyafter issuance of the bonds:

Total current liabilities $ XXXLong-term liabilities:Bonds payable $100,000Premium on bonds payable 4,100 $104,100

Premium on Bonds Payable is added to the Balanceof Bonds Payable to determine the carrying amount.


Amortization Table on Bonds Issued at a Premium

1/1/047/1/041/1/057/1/05

1/1/09

$4,500 4,500 4,500

4,500

$4,164 4,151 4,137

3,955

$336 349 363

545

$4,100 3,764 3,415 3,052

-0-

$104,100 103,764 103,415 103,052

100,000

InterestDate

InterestPayment

InterestExpense

PremiumAmort.

PremiumAccountBalance

BondCarryingAmount


Interest Expense on BondsIssued at a Premium

On July 1, 2004, Chrysler makes the first$4,500 semiannual interest payment and

also amortizes (decreases) the bond premium.July 1, 2004Interest Expense 4,164Premium on Bonds Payable 336

Cash 4,500To pay semiannual interest and amortize bond premium


Straight-Line Amortization

This method amortizes the bond discountor premium by dividing it into equal

amounts for each interest period.

Chrysler would amortize the $4,100premium over 10 periods.

$4,100 ÷ 10 = $410 per period


Early Retirement of Bonds Payable

Air Products and Chemicals, Inc., has $70 millionof debenture bonds outstanding with unamortizeddiscount of $350,000. The market price is 99¼.

Par value of bonds being retired $70,000,000Less: Unamortized discount – 350,000Carrying amount of the bonds $69,650,000Market price ($70,000,000 × 0.9925) 69,475,000Extraordinary gain on retirement $ 175,000


Convertible Bonds and Notes

Texas Instruments has convertiblenotes payable of $250,000,000.

Notes Payable 125,000,000Common Stock 4,000,000Paid-in Capital 121,000,000

To record conversion of notes payable

Assume that noteholders convert half the notesinto 4 million shares, $1 par common stock.



Understand the advantages

and disadvantages

of borrowing.


Financing OperationsWith Bonds or Stocks

Issuing Stock Issuing Notes or Bonds

Creates no liabilitiesor interest expense

Less risky to theissuing corporation

Does not dilute stockownership or control

of the corporation

Results in higher earningsper share because the earningson borrowed money usually

exceeds interest expense



Suppose a corporation needs $500,000 for expansion.

Plan 1 is to issue $500,000 of 10% bonds payable.

Plan 2 is to issue 50,000 shares of common stock for $500,000.

It has net income of $300,000 and 100,000 sharesof common stock outstanding.

Management is considering two financing plans:



Net income before expansion $300,000Project income before interest and taxes $200,000Less interest expense ($500,000 × 0.10) – 50,000Project income before income tax $150,000Less income tax expense (40%) – 60,000Expected project net income 90,000Total company net income $390,000Earnings per share after expansion: ($390,000/100,000 shares) $3.90

Plan 1: Borrow $500,000 at 10%



Net income before expansion $300,000Project income before interest and taxes $200,000Less interest expense 0Project income before income tax $200,000Less income tax expense (40%) – 80,000Expected project net income 120,000Total company net income $420,000Earnings per share after expansion: ($420,000/150,000 shares) $2.80

Plan 2: Issue 50,000 Shares of Common Stock for $500,000


Long-Term Liabilities:Leases and Pensions

A lease is a rental agreement in whichthe tenant (lessee) agrees to make rent

payments to the property owner (lessor).

Operating

Capital



It transfers title at the end of the term.

The present value of the lease payments is 90%or more of the market value of the leased asset.

It contains a bargain purchase option.

The lease terms cover 75% or more of theestimated useful life of the leased asset.



Companies record pension and retirement benefitexpenses while employees work for the company.Companies record pension and retirement benefitexpenses while employees work for the company.

At the end of each period, the company comparesthe fair market value of the assets in the pension

plan – cash and investments – with the plan’saccumulated benefit obligation.

At the end of each period, the company comparesthe fair market value of the assets in the pension

plan – cash and investments – with the plan’saccumulated benefit obligation.



If the accumulated benefit obligationexceeds plan assets, the plan is underfunded,

and the company must report the excessliability amount as a long-term pension

liability on the balance sheet.

If the accumulated benefit obligationexceeds plan assets, the plan is underfunded,

and the company must report the excessliability amount as a long-term pension

liability on the balance sheet.



Report liabilities on

the balance sheet.


Reporting Liabilities

Accounts payable $1,976Accrued salaries and related expenses 627Sales tax payable 298Other accrued expenses 1,402Income taxes payable 78Current installments of long-term debt 4Total current liabilities $4,385Long-term debt 1,545Other long-term liabilities 451

Amounts in millions


Reporting Fair Market Valueof Long-Term Debt

FASB Statement No. 107 requires companiesto report the 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 $754Proceeds from long-term borrowings 32Payment of long-term debt (29)Proceeds from issuance of common stock 351Payments of cash dividends (371)Other, net (4)Net cash provided by financing activities $733

Amounts in millionsYear Ended

December 31


End of Chapter 8

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