actg201 chap010 ppt

Chapter 10Reporting and Interpreting Liabilities

PowerPoint Authors:Susan Coomer Galbreath, Ph.D., CPACharles W. Caldwell, D.B.A., CMAJon A. Booker, Ph.D., CPA, CIAFred Phillips, Ph.D., CA

Learning Objective 1

Explain the role of liabilities in financing a business.

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The Role of Liabilities

Current liabilities are short-term obligations that will be paid with current assets within the company’s current operating cycle or within one year of the

balance sheet date, whichever is longer.

Current liabilities are short-term obligations that will be paid with current assets within the company’s current operating cycle or within one year of the

balance sheet date, whichever is longer.

Buys goods and services

on credit

Obtains short-term

loans

Issues long-term

debt

Liabilities are created when a company:

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The Role of LiabilitiesThe liability section of the General Mills 2007 and 2008

comparative balance sheets.

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Explain how to account for common types of current

liabilities.

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Measuring Liabilities

Initial Amount of the Liability Cash EquivalentCash Equivalent

Additional Liability Amounts Increase LiabilityIncrease Liability

Payments Made Decrease LiabilityDecrease Liability

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Current Liabilities

Accounts Payable

Accrued LiabilitiesLiabilities that have been incurred but not yet paid.

Increases(Credited)Increases(Credited)

Decreases(Debited)

Decreases(Debited)

when a company receives goods or services on credit

when a company pays on its account

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Accrued Payroll

Payroll Liabilities1.Payroll Deductions

2.Employer Payroll Taxes

Payroll DeductionsPayroll deductions are either required by law or voluntarily requested by employees and create a current liability for the company. Examples include:1.Income tax2.FICA tax3.Other deductions (charitable donations, union dues, etc.)

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Accrued Payroll

Gross Pay 600.00$ Payroll Deductions: Federal Income Taxes 58.00$ FICA Taxes 48.80 Other 10.00 Total Payroll Deductions 116.80 Net Pay 483.20$

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Accrued Payroll

1 Analyze

Assets = Liabilities + Stockholders' EquityCash (-A) -$483.20 FIT Withheld (+L) +$58.00 Payroll Expense

FICA Payable (+L) +$48.80 (+E, -SE) -$600.00United Way (+L) +$10.00

dr Wages and Salaries Expense (+E, -SE) 600.00 cr Withheld Income Taxes Payable (+L) 58.00 cr FICA Payable (+L) 48.80 cr United Way Payable (+L) 10.00 cr Cash (-A) 483.20

2 Record

Adam Palmer earned gross pay of $600 in the current payroll period. General Mills withheld $58 in Federal income taxes, $48.80 for FICA, and

$10 for United Way, resulting in net pay of $483.20.

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Accrued Payroll

1 AnalyzeAssets = Liabilities + Stockholders' Equity

FICA Payable (+L) +16,400 Payroll Tax ExpenseFUTA Payable (+L) +250 (+E, -SE) -18,000SUTA Payable (+L) +1,350

2 Recorddr Payroll Tax Expense (+E, -SE) 18,000

cr FICA Tax Payable (+L) 16,400 cr Federal Unemployment Tax Payable (+L) 250 cr State Unemployment Tax Payable (+L) 1,350

Employer Payroll TaxesEmployers have other liabilities related to payroll.1.FICA tax (a “matching” contribution)2.Federal unemployment tax3.State unemployment tax

Assume General Mills was required to contribute $16,400 for FICA, $250 for federal unemployment tax, and $1,350 for state unemployment tax.

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Accrued Income Taxes

Corporations calculate taxable income by subtracting tax-allowed expenses from revenues. This taxable income is then multiplied by a tax

rate, which for most large corporations is about 35 percent.

General Mill calculated taxable income to be $1,000,000, and is subject to a 35% tax rate, so income taxes owed are $350,000 ($1,000,000 × 35%)

Assets = Liabilities + Stockholders' EquityIncome Tax Payable Income Tax Expense(+L) +350,000 (+E, -SE) +350,000

1 Analyze

2 Recorddr Income Tax Expense (+E, -SE) 350,000

cr Income Tax Payable (+L) 350,000

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Notes PayableFour key events occur with any note payable: 1.establishing the note, 2.accruing interest incurred but not paid, 3.recording interest paid, and 4.recording principal paid.

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Notes Payable

2 Recorddr Cash (+A) 100,000

cr Notes Payable (+L) 100,000

1. Establish the note on November 1, 2009.

Assume that on November 1, 2009, General Mills borrowed $100,000 cash on a one-year note that required General Mills to pay 6 percent interest and

$100,000 principal, both on October 31, 2010.

Assume that on November 1, 2009, General Mills borrowed $100,000 cash on a one-year note that required General Mills to pay 6 percent interest and

$100,000 principal, both on October 31, 2010.

Assets = Liabilities + Stockholders' EquityCash (+A) $100,000 Notes Payable (+L) $100,000

1 Analyze

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Notes Payable

2 Recorddr Interest Expense (+E, -SE) 1,000

cr Interest Payable (+L) 1,000

Assets = Liabilities + Stockholders' EquityInterest Payable (+L) $1,000 Interest Expense

(+E, -SE) $1,000

1 Analyze

2. Accrue interest owed but not paid on December 31, 2009.

$100,000 × 6% × $100,000 × 6% × 2/122/12 = $1,000 accrued interest = $1,000 accrued interest$100,000 × 6% × $100,000 × 6% × 2/122/12 = $1,000 accrued interest = $1,000 accrued interest

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Notes Payable3. Record interest paid on October 31, 2010.

$100,000 × 6% × 12/12 = $6,000 interest paid$100,000 × 6% × 12/12 = $6,000 interest paid

2 Recorddr Interest Expense (+E, -SE) 5,000 dr Interest Payable (-L) 1,000

cr Cash (-A) 6,000

Assets = Liabilities + Stockholders' EquityCash (-A) -$6,000 Interest Payable (-L) -$1,000 Interest Expense

(+E, -SE) $5,000

1 Analyze

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Notes Payable4. Record principal paid of $100,000 on October 31, 2010.

2 Recorddr Note Payable (-L) 100,000

cr Cash (-A) 100,000

Assets = Liabilities + Stockholders' EquityCash (-A) -$100,000 NotePayable (-L) -$100,000

1 Analyze

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Current Portion of Long-Term Debt

Long-Term Debt

Current Portion of Long-term Debt

Noncurrent Portion of Long-term Debt

Borrowers must report in Current Liabilities the portion of long-term debt that is due to be paid within one year.

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Additional Current Liabilities

Sales Tax Payable

Payments collected from customers at time of sale create a liability that is due to the state

government.

Unearned Revenue

Cash received in advance of providing services creates a liability of services due to the

customer .

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Additional Current Liabilities

Best Buy sells a television for $1,000 cash plus 5 percent sales tax.Best Buy sells a television for $1,000 cash plus 5 percent sales tax.Best Buy sells a television for $1,000 cash plus 5 percent sales tax.Best Buy sells a television for $1,000 cash plus 5 percent sales tax.


cr Sales Tax Payable (+L) 50 cr Sales Revenue (+R, +SE) 1,000

Assets = Liabilities + Stockholders' EquityCash (+A) +$1,050 Sales Tax Payable (+L) +$50 Sales Revenue

(+R, +SE)

1 Analyze

$1,000 × 5% = $50 sales tax collected$1,000 × 5% = $50 sales tax collected

When Best Buy pays the sales tax to the state government, its accountants will reduce Sales Tax Payable (with a debit) and

reduce Cash (with a credit).

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Additional Liabilities

On October 1 IAC, an internet provider, received $30 cash for three-On October 1 IAC, an internet provider, received $30 cash for three-months of internet access, paid in advance.months of internet access, paid in advance.

On October 1 IAC, an internet provider, received $30 cash for three-On October 1 IAC, an internet provider, received $30 cash for three-months of internet access, paid in advance.months of internet access, paid in advance.

2 Recorddr Cash (+A) 30

cr Unearned Revenue (+L) 30

Assets = Liabilities + Stockholders' EquityCash (+A) +$30 Unearned Revenue (+L) $30

1 Analyze

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Additional Liabilities

At the end of October, IAC provided one month of internet service At the end of October, IAC provided one month of internet service to its customer. to its customer.

At the end of October, IAC provided one month of internet service At the end of October, IAC provided one month of internet service to its customer. to its customer.

2 Recorddr Unearned Revenue (-L) 10

cr Subscription Revenue (+R, +SE) 10

Assets = Liabilities + Stockholders' EquityUnearned Revenue (-L) $10 Subscription Revenue

(+R, +SE) $10

1 Analyze

$30 ÷ 3 months = $10 per month$30 ÷ 3 months = $10 per month

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Analyze and record bond liability transactions.

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Long-Term Liabilities

Bonds are financial instruments that outline the future payments a company promises to make

in exchange for receiving a sum of money now.

Common Long-Term Liabilities1.Long-term notes payable 2.Deferred income taxes3.Bonds payable

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Bonds

Bond PricingThe bond price involves present value computations and is the amount

that investors are willing to pay on the issue date for the bonds.

Key Elements of a Bond1.Maturity date2.Face value3.Stated interest rate

1212$1,000 × 6% × = $60

Interest Computation

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BondsBalance Sheet Reporting of Bond Liability

Relationships between Interest Rates and Bond Pricing

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Bonds


cr Bonds Payable (+L) 100,000

Assets = Liabilities + Stockholders' EquityCash (+A) +$100,000 Bonds Payable (+L) $100,000

1 Analyze

General Mills receives $100,000 cash in exchange for issuing General Mills receives $100,000 cash in exchange for issuing 100 bonds at their $1,000 face value, so the bonds are issued at 100 bonds at their $1,000 face value, so the bonds are issued at

total face value (1,000 × $1,000 = $100,000).total face value (1,000 × $1,000 = $100,000).

General Mills receives $100,000 cash in exchange for issuing General Mills receives $100,000 cash in exchange for issuing 100 bonds at their $1,000 face value, so the bonds are issued at 100 bonds at their $1,000 face value, so the bonds are issued at

total face value (1,000 × $1,000 = $100,000).total face value (1,000 × $1,000 = $100,000).

Bonds Issued at Face Value

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Bonds

General Mills issues 100 of its $1,000 bonds at a price of General Mills issues 100 of its $1,000 bonds at a price of 107.26 percent of face value, the company will receive 107.26 percent of face value, the company will receive

$107,260 (100 × $1,000 × 1.0726).$107,260 (100 × $1,000 × 1.0726).

General Mills issues 100 of its $1,000 bonds at a price of General Mills issues 100 of its $1,000 bonds at a price of 107.26 percent of face value, the company will receive 107.26 percent of face value, the company will receive

$107,260 (100 × $1,000 × 1.0726).$107,260 (100 × $1,000 × 1.0726).

Bonds Issued at a Premium


cr Bonds Payable (+L) 100,000 cr Premium on Bonds Payable (+L) 7,260


Premium on Bonds Payable(+L) $7,260

1 Analyze

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$100,000 - $93,376 = $6,624 discount$100,000 - $93,376 = $6,624 discount

Bonds

General Mills receives $93,376 for bonds with a total face value of General Mills receives $93,376 for bonds with a total face value of $100,000, the cash-equivalent amount is $93,376, which represents $100,000, the cash-equivalent amount is $93,376, which represents

the liability on that date. These bonds are issued at a discount the liability on that date. These bonds are issued at a discount because the cash received is less than the face value of the bonds.because the cash received is less than the face value of the bonds.

General Mills receives $93,376 for bonds with a total face value of General Mills receives $93,376 for bonds with a total face value of $100,000, the cash-equivalent amount is $93,376, which represents $100,000, the cash-equivalent amount is $93,376, which represents

the liability on that date. These bonds are issued at a discount the liability on that date. These bonds are issued at a discount because the cash received is less than the face value of the bonds.because the cash received is less than the face value of the bonds.

Bonds Issued at a Discount

2 Recorddr Cash (+A) 93,376 dr Discount on Bonds Payable (+xL, -L) 6,624

cr Bonds Payable (+L) 100,000


Discount on Bonds Payable(+xL, -L) $6,624

1 Analyze

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Interest on Bonds Issued at Face Value

General Mills issues bonds on January 1, 2010, at their total face General Mills issues bonds on January 1, 2010, at their total face value of $100,000. The bonds have an annual stated interest rate of value of $100,000. The bonds have an annual stated interest rate of 6 percent payable in cash on December 31 of each year, General 6 percent payable in cash on December 31 of each year, General Mills will need to accrue an expense and liability for interest at the Mills will need to accrue an expense and liability for interest at the

end of each accounting period. The end of the first accounting end of each accounting period. The end of the first accounting period is January 31, 2010.period is January 31, 2010.

$100,000 × 6% × 1/12 = $500 interest$100,000 × 6% × 1/12 = $500 interest

2 Recorddr Interest Expense (+E, -SE) 500

cr Interest Payable (+L) 500

Assets = Liabilities + Stockholders' EquityInterest Payable (+L) $500 Interest Expense (+E, -SE) $500

1 Analyze

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Interest on Bonds Issued at a Premium

Cash proceeds > Face valueCash proceeds > Face value

Cash proceeds – Face value = PremiumCash proceeds – Face value = Premium

Interest expense < Cash interest paidInterest expense < Cash interest paid

Interest expense = Cash interest paid – Premium amortizationInterest expense = Cash interest paid – Premium amortization

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Interest on Bonds Issued at a Discount

Cash proceeds < Face valueCash proceeds < Face value

Face value – Cash proceeds = DiscountFace value – Cash proceeds = Discount

Interest expense > Cash interest paidInterest expense > Cash interest paid

Interest expense = Cash interest paid+ Discount amortizationInterest expense = Cash interest paid+ Discount amortization

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Bond RetirementGeneral Mills’ bonds were retired with a payment

equal to their $100,000 face value. Let’s analyze and record this transaction.

2 Recorddr Bonds Payable (-L) 100,000

cr Cash (-A) 100,000

Assets = Liabilities + Stockholders' EquityCash (-A) -$100,000 Bonds Payable (-L) $100,000

1 Analyze

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Assume that in 2000, General Mills issued $100,000 of bonds at face value. Assume that in 2000, General Mills issued $100,000 of bonds at face value. Ten years later, in 2010, the company retired the bonds early. At the time, Ten years later, in 2010, the company retired the bonds early. At the time, the bond price was 103, so General Mills made a payment of $103,000.the bond price was 103, so General Mills made a payment of $103,000.

Assume that in 2000, General Mills issued $100,000 of bonds at face value. Assume that in 2000, General Mills issued $100,000 of bonds at face value. Ten years later, in 2010, the company retired the bonds early. At the time, Ten years later, in 2010, the company retired the bonds early. At the time, the bond price was 103, so General Mills made a payment of $103,000.the bond price was 103, so General Mills made a payment of $103,000.

Cash Payment $103,000Carrying Value 100,000Loss on Retirement $3,000

Bond Retirement

2 Recorddr Bonds Payable (-L) 100,000 dr Loss on Bond Retirement (+E, -SE) 3,000

cr Cash (-A) 103,000

Assets = Liabilities + Stockholders' EquityCash (-A) -$103,000 Bonds Payable (-L) $100,000 Loss on Bond

Retirement (+E, -SE)$3,000

1 Analyze

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The early retirement of bonds has three financial effects. The company1. pays cash,2. eliminates the bond liability, and3. reports either a gain or a loss.


Describe how to account for contingent liabilities.

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Contingent Liabilities

Contingent liabilities are potential liabilities that arise from past transactions or events, but their ultimate resolution depends

(is contingent) on a future event.

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Calculate and interpret the quick ratio and the times

interest earned ratio.

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Evaluate the ResultsTwo financial ratios are commonly used to assess a

company’s ability to generate resources to pay future amounts owed:

1.Quick ratio2.Times interest earned ratio

Quick Ratio = (Cash + Short-term Investments + Accounts Receivable, Net)

Current Liabilities

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Evaluate the ResultsIn 2008, General Mills reported $661 million of cash and cash equivalents, no short-term investments, and $1,082 million of net accounts receivable.

The company reported $4,856 million in total current liabilities.

In 2008, General Mills reported $661 million of cash and cash equivalents, no short-term investments, and $1,082 million of net accounts receivable.

The company reported $4,856 million in total current liabilities.

Quick Ratio = (Cash + Short-term Investments + Accounts Receivable, Net)

Current Liabilities

$661 + 0 + 1,0824,856

= 0.359

A quick ratio of 0.359 implies that General Mills would be able to pay only 35.9 percent of its current

liabilities, if forced to pay them immediately. However, not all current liabilities are to be paid immediately.

A quick ratio of 0.359 implies that General Mills would be able to pay only 35.9 percent of its current

liabilities, if forced to pay them immediately. However, not all current liabilities are to be paid immediately.

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Evaluate the Results

In 2008, General Mills reported net income of $290 million and interest expense of $100 million, and income tax expense of $230 million. Let’s

calculate the times interest earned for 2008.

In 2008, General Mills reported net income of $290 million and interest expense of $100 million, and income tax expense of $230 million. Let’s

calculate the times interest earned for 2008.

$290 + $100 + $230$100

= 6.20 times

The ratio means that General Mills generates $6.20 of income (before the costs of financing and taxes) for each dollar of

interest expense. No doubt this ratio is part of the reason that General Mills has earned a favorable credit rating of BBB+.

The ratio means that General Mills generates $6.20 of income (before the costs of financing and taxes) for each dollar of

interest expense. No doubt this ratio is part of the reason that General Mills has earned a favorable credit rating of BBB+.

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Chapter 10Supplement 10A

Straight-Line Method of Amortization

Cash Interest $6,000Amortization of Premium (1,815)Interest Expense $4,185

Cash Interest $6,000Amortization of Premium (1,815)Interest Expense $4,185

Bond PremiumBond premium or discount decreases each year, until it is completely

eliminated on the bond’s maturity date. This process is called amortizing the bond premium or discount. The straight-line method of amortization

reduces the premium or discount by an equal amount each period.

Bond premium or discount decreases each year, until it is completelyeliminated on the bond’s maturity date. This process is called amortizing the bond premium or discount. The straight-line method of amortization

reduces the premium or discount by an equal amount each period.

Recall our example when General Mills received $107,260 on the issue date Recall our example when General Mills received $107,260 on the issue date (January 1, 2010) but repays only $100,000 at maturity (December 31, 2013). (January 1, 2010) but repays only $100,000 at maturity (December 31, 2013). Under the straight-line method, this $7,260 is spread evenly as a reduction in Under the straight-line method, this $7,260 is spread evenly as a reduction in

interest expense over the four years ($7,260 ÷ 4 = interest expense over the four years ($7,260 ÷ 4 = $1,815 $1,815 per year).per year).

Recall our example when General Mills received $107,260 on the issue date Recall our example when General Mills received $107,260 on the issue date (January 1, 2010) but repays only $100,000 at maturity (December 31, 2013). (January 1, 2010) but repays only $100,000 at maturity (December 31, 2013). Under the straight-line method, this $7,260 is spread evenly as a reduction in Under the straight-line method, this $7,260 is spread evenly as a reduction in

interest expense over the four years ($7,260 ÷ 4 = interest expense over the four years ($7,260 ÷ 4 = $1,815 $1,815 per year).per year).

2 Recorddr Interest Expense (+E, -SE) 4,185 dr Premium on Bonds Payable (-L) 1,815

cr Cash (-A) 6,000

Assets = Liabilities + Stockholders' EquityCash (-A) -$6,000 Premium on Bonds Payable Interest Expense

(-L) -$1,815 (+E, -SE) $4,185

1 Analyze

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Bond PremiumAmortization Schedule of Bonds Issued at a Premium

$7,260 ÷ 4 = $1,815$7,260 ÷ 4 = $1,815

$100,000 × 6% × 12/12 = $6,000$100,000 × 6% × 12/12 = $6,000

$6,000 - $1,815 = $4,185$6,000 - $1,815 = $4,185

$7,260 - $1,815 = $5,445$7,260 - $1,815 = $5,445

$107,260 – $1,815 = $105,445$107,260 – $1,815 = $105,445

Notice that each of these amounts would plot as a straight-line!

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Cash Interest $6,000Amortization of Discount 1,656Interest Expense $7,656

Cash Interest $6,000Amortization of Discount 1,656Interest Expense $7,656

Bond Discount

Recall our example where General Mills received $93,376 for four-year Recall our example where General Mills received $93,376 for four-year bonds with a total face value of $100,000, implying a discount of $6,624. bonds with a total face value of $100,000, implying a discount of $6,624.

The annual amortization of the discount is The annual amortization of the discount is $1,656$1,656 ($6,624 ÷ 4). ($6,624 ÷ 4).

Recall our example where General Mills received $93,376 for four-year Recall our example where General Mills received $93,376 for four-year bonds with a total face value of $100,000, implying a discount of $6,624. bonds with a total face value of $100,000, implying a discount of $6,624.

The annual amortization of the discount is The annual amortization of the discount is $1,656$1,656 ($6,624 ÷ 4). ($6,624 ÷ 4).


cr Discount on Bonds Payable (-xL, +L) 1,656 cr Cash (-A) 6,000

Assets = Liabilities + Stockholders' EquityCash (-A) -$6,000 Discont on Bonds Payable Interest Expense

(-xL, +L) -1,656 (+E, -SE) +$7,656

1 Analyze

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Bond DiscountAmortization Schedule of Bonds Issued at a Discount

$6,624 ÷ 4 = $1,656$6,624 ÷ 4 = $1,656

$100,000 × 6% × 12/12 = $6,000$100,000 × 6% × 12/12 = $6,000

$6,000 + $1,656 = $7,656$6,000 + $1,656 = $7,656

$6,624 - $1,656 = $4,968$6,624 - $1,656 = $4,968

$93,376 + $1,656 = $95,032$93,376 + $1,656 = $95,032

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Chapter 10Supplement 10B

Effective-Interest Method of Amortization

Effective Interest AmortizationThe effective-interest method of amortization is considered a conceptually superior method of accounting for bonds because it correctly calculates interest expense by

multiplying the market interest rate times the carrying value of the bonds.

The effective-interest method of amortization is considered a conceptually superior method of accounting for bonds because it correctly calculates interest expense by

multiplying the market interest rate times the carrying value of the bonds.

Interest (I) = Principal (P) × Rate (R) × Time (T)Interest Expense = Carrying Value × Market Rate × n/12

$4,290 = $107,260 × 4% × 12/12

When General Mills adds this $7,260 premium to the $100,000 face value, When General Mills adds this $7,260 premium to the $100,000 face value, it reports a carrying value of $107,260 ($100,000 + $7,260) on January 1, it reports a carrying value of $107,260 ($100,000 + $7,260) on January 1, 2010. The proceeds indicates that the market interest rate was 4 percent.2010. The proceeds indicates that the market interest rate was 4 percent.

When General Mills adds this $7,260 premium to the $100,000 face value, When General Mills adds this $7,260 premium to the $100,000 face value, it reports a carrying value of $107,260 ($100,000 + $7,260) on January 1, it reports a carrying value of $107,260 ($100,000 + $7,260) on January 1, 2010. The proceeds indicates that the market interest rate was 4 percent.2010. The proceeds indicates that the market interest rate was 4 percent.

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$4,290 = $107,260 × 4% × 12/12

Cash Interest $ 6,000Effective Interest 4,290Amortization of Premium $1,710

Cash Interest $ 6,000Effective Interest 4,290Amortization of Premium $1,710

Effective Interest Amortization

General Mills issued 6% stated rate bonds for $107,260. The market General Mills issued 6% stated rate bonds for $107,260. The market rate of interest on these bonds is 4%. The face amount of the bonds, rate of interest on these bonds is 4%. The face amount of the bonds, $100,000, results in cash interest is $6,000 ($100,000 × 6%). Let’s $100,000, results in cash interest is $6,000 ($100,000 × 6%). Let’s

amortize the premium on the bonds at the first interest payment date. amortize the premium on the bonds at the first interest payment date.

General Mills issued 6% stated rate bonds for $107,260. The market General Mills issued 6% stated rate bonds for $107,260. The market rate of interest on these bonds is 4%. The face amount of the bonds, rate of interest on these bonds is 4%. The face amount of the bonds, $100,000, results in cash interest is $6,000 ($100,000 × 6%). Let’s $100,000, results in cash interest is $6,000 ($100,000 × 6%). Let’s

amortize the premium on the bonds at the first interest payment date. amortize the premium on the bonds at the first interest payment date.

2 Recorddr Interest Expense (+E, -SE) 4,290 dr Premium on Bonds Payable (-L) 1,710

cr Cash (-A) 6,000

Assets = Liabilities + Stockholders' EquityCash (-A) -$6,000 Premium on Bonds Payable Interest Expense

(-L) +1,710 (+E, -SE) +$4,290

1 Analyze

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Effective Interest Amortization of Bonds Issued at a Premium

$107,260 × 4% × 12/12 = $4,290$107,260 × 4% × 12/12 = $4,290

$100,000 × 6% × 12/12 = $6,000$100,000 × 6% × 12/12 = $6,000 $107,260 - $1,710 = $105,550$107,260 - $1,710 = $105,550

$6,000 - $4,290 = $1,710$6,000 - $4,290 = $1,710 $7,290 - $1,710 = $5,550$7,290 - $1,710 = $5,550

Interest Expense decreases and Premium Amortizationincreases each period. Cash interest is unchanged.

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$7,470 = $93,376 × 8% × 12/12

General Mills issued $100,000 face value, 6%, 4-year bonds at a market General Mills issued $100,000 face value, 6%, 4-year bonds at a market price to yield investors 8%. The bonds were issued at a discount of $6,624. price to yield investors 8%. The bonds were issued at a discount of $6,624. Let’s determine the effective interest for the first interest payment period. Let’s determine the effective interest for the first interest payment period.

General Mills issued $100,000 face value, 6%, 4-year bonds at a market General Mills issued $100,000 face value, 6%, 4-year bonds at a market price to yield investors 8%. The bonds were issued at a discount of $6,624. price to yield investors 8%. The bonds were issued at a discount of $6,624. Let’s determine the effective interest for the first interest payment period. Let’s determine the effective interest for the first interest payment period.

Cash Interest $ 6,000Effective Interest 7,470Amortization of Discount $ 1,470

Cash Interest $ 6,000Effective Interest 7,470Amortization of Discount $ 1,470


cr Discount on Bonds Payable (+xL, -L) 1,470 cr Cash (-A) 6,000

Assets = Liabilities + Stockholders' EquityCash (-A) -$6,000 Discount on Bonds Payable Interest Expense

(-xL, +L) +1,470 (+E, -SE) $7,470

1 Analyze

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$93,376 × 8% × 12/12 = $7,470$93,376 × 8% × 12/12 = $7,470

$100,000 × 6% × 12/12 = $6,000$100,000 × 6% × 12/12 = $6,000 $93,376 + $1,470 = $94,846$93,376 + $1,470 = $94,846

$7,470 - $6,000 = $1,470$7,470 - $6,000 = $1,470 $7,470 - $1,470 = $5,154$7,470 - $1,470 = $5,154

Effective Interest Amortization of Bonds Issued at a Discount

Both Interest Expense and Discount Amortizationincrease each period. Cash interest is unchanged.

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Chapter 10Supplement 10C

Simplified Effective-Interest Amortization

Accounting for Bond Issue.

The shortcut method records the bonds at issuance at Bonds Payable, Net. That is face amount less discount or face amount plus premium.

The following journal entries demonstrate how the shortcut is applied tobonds issued at a premium, at face value, and at a discount.

Description Debit Creditdr Cash (+A) 107,260 cr Bonds Payable, Net (+L) 107,260 Bonds i ssued at a premium

dr Cash (+A) 100,000 cr Bonds Payable, Net (+L) 100,000 Bonds i ssued at face amount

dr Cash (+A) 93,376 cr Bonds Payable, Net (+L) 93,376 Bonds i ssued at a discount

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Bond Premium

Interest (I) = Principal (P) × Rate (R) × Time (T)Interest Expense = Bonds Payable, Net × Market Rate × n/12

Interest Expense $4,290 = $107,260 × 4% × 12/12

2 Recorddr Interest Expense (+E, -SE) 4,290 dr Bonds Payable, Net (-L) 1,710

cr Cash (-A) 6,000

Assets = Liabilities + Stockholders' EquityCash (-A) -$6,000 Bonds Payable, Net (-L) -$1,710 Interest Expense

(+E, -SE) -$4,290

1 Analyze

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Bond Discount

Interest (I) = Principal (P) × Rate (R) × Time (T)Interest Expense = Bonds Payable, Net × Market Rate × n/12

Interest Expense $7,470 = $93,376 × 8% × 12/12


cr Bonds Payable, Net (+L) 1,470 cr Cash (-A) 6,000

Assets = Liabilities + Stockholders' EquityCash (-A) -$6,000 Bonds Payable, Net (+L) +$1,470 Interest Expense

(+E, -SE) -$7,470

1 Analyze

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Chapter 10Solved Exercises

M10-5, E10-2, E10-3, E10-8, E10-10, PA10-3

M10-5 Reporting Current and Noncurrent Portions of Long-Term DebtAssume that on December 1, 2010, your company borrowed $14,000, a portion of which is to be repaid each year on November 30. Specifically, your company will make the following principal payments: 2011, $2,000; 2012, $3,000; 2013, $4,000; and 2014, $5,000. Show how this loan will be reported in the December 31, 2011 and 2010 balance sheets, assuming that principal payments will be made when required.

2011 2010Current Liabilities: Current Portion of Long-term Debt 3,000$ 2,000$

Long-term Debt 9,000 12,000 Total Liabilities 12,000$ 14,000$

As of December 31,

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E10-2 Recording a Note Payable through Its Time to MaturityMany businesses borrow money during periods of increased business activity to finance inventory and accounts receivable. Target Corporation is one of America’s largest general merchandise retailers.Each Christmas, Target builds up its inventory to meet the needs of Christmas shoppers. A large portion of Christmas sales are on credit. As a result, Target often collects cash from the sales several months after Christmas. Assume that on November 1, 2010, Target borrowed $6 million cash from Metropolitan Bank and signed a promissory note that matures in six months. The interest rate was 7.5 percent payable at maturity. The accounting period ends December 31.Required:1.Give the journal entry to record the note on November 1, 2010.2.Give any adjusting entry required on December 31, 2010.3.Give the journal entry to record payment of the note and interest on the maturity date, April 30, 2011, assuming that interest has not been recorded since December 31, 2010.

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E10-2 Recording a Note Payable through Its Time to Maturity

November 1, 2010:

Borrowed on 6-month, 7.5%, note payable.

December 31, 2010 (end of the accounting period):

Adjusting entry for 2 months’ accrued interest ($6,000,000 x 7.5% x 2/12 = $75,000).

April 30, 2011 (maturity date):

Paid note plus interest at maturity.

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E10-3 Recording Payroll Costs with DiscussionMcLoyd Company completed the salary and wage payroll for March 2010. The payroll provided the following details:

Required:1.Considering both employee and employer payroll taxes, use the preceding information to calculate the total labor cost for the company.2.Prepare the journal entry to record the payroll for March, including employee deductions (but excluding employer payroll taxes).3.Prepare the journal entry to record the employer’s FICA taxes and unemployment taxes.

Salaries and wages earned 230,000$ Employee income taxes withheld 50,200 FICA taxes withheld 16,445 Unemployment taxes 1,600

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The total labor cost was $248,045, made up of the $230,000 in gross salaries and wages plus the $16,445 for employer FICA taxes and $1,600 for unemployment taxes.

Req. 1

Req. 2dr Salaries and Wages Expense (+E, -SE) 230,000 cr Withheld Income Taxes Payable (+L) 50,200 cr FICA Taxes Payable—employees (+L) 16,445 cr Cash (-A) 163,355Payroll for March including employee deductions.

March 31, 2010Req. 3dr Payroll Tax Expense (+E,-SE) 18,045 cr FICA Taxes Payable—employer (+L) 16,445 cr Unemployment Taxes Payable (+L) 1,600Employer payroll taxes on March payroll.

March 31, 2010

E10-3 Recording Payroll Costs with Discussion

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E10-8 Preparing Journal Entries to Record Issuance of Bonds at Face Value, Payment of Interest, and Early RetirementOn January 1, 2010, Innovative Solutions, Inc., issued $200,000 in bonds at face value. The bonds have a stated interest rate of 6 percent. The bonds mature in 10 years and pay interest once per year on December 31.Required:1.Prepare the journal entry to record the bond issuance.2.Prepare the journal entry to record the interest payment on December 31, 2010. Assume no interest has been accrued earlier in the year.3.Assume the bonds were retired immediately after the first interest payment at a quoted price of 102. Prepare the journal entry to record the early retirement of the bonds.

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Req. 1

Req. 2

Req. 3

dr Cash (+A) 200,000 cr Bonds Payable (+L) 200,000

dr Interest Expense (+E, -SE) 12,000 cr Cash (-A) 12,000

($200,000 x 6% x 12/12) = $12,000

dr Bonds Payable (-L) 200,000dr Loss on Bonds Retired (+E, -SE) 4,000 cr Cash (-A) 204,000

($200,000 x 102%) = $204,000

E10-8 Preparing Journal Entries to Record Issuance of Bonds at Face Value, Payment of Interest, and Early Retirement

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E10-10 Calculating and Interpreting the Quick Ratio and Times Interest Earned RatioAccording to its Web site, Kraft Foods Inc. sells enough Kool-Aid® mix to make 1,000 gallons of the drink every minute during the summer and over 560 million gallons each year. At December 31, 2008, the company reported no short-term investments but did report the following amounts (in millions) in its financial statements:

Required:1.Compute the quick ratio and times interest earned ratio (to two decimal places) for 2008 and 2007.2.Did Kraft appear to have increased or decreased its ability to pay current liabilities and future interest obligations as they become due? How can you explain the seemingly conflicting findings of your ratio analysis?

2008 2007Cash and Cash Equivalents 1,244$ 567$ Accounts Receivable, Net 4,704 5,197 Total Current Liabilities 11,044 17,086 Interest Expense 1,240 604 Income Tax Expense 728 1,002 Net Income 2,901 2,590

10-65

Req. 1

Req. 2

E10-10 Calculating and Interpreting the Quick Ratio and Times Interest Earned Ratio

10-66

Req. 3 The times interest earned ratio has decreased from 6.95 to 3.93, suggesting a decline in Kraft’s ability to cover its interest through profitable operations. The quick ratio has increased from 0.34 in 2007 to 0.54 in 2008, suggesting Kraft is in a better position to quickly pay its current liabilities at the end of 2008. These findings seem to conflict, but can be explained as follows. In 2008, when the economy was suffering, Kraft realized that it could no longer rely as much on obtaining short-term financing to cover cash needs. Consequently, Kraft borrowed more funds through long-term debt, which doubled the amount the company held in Cash and Cash Equivalents. Obtaining more long-term debt financing came at a cost, however, as indicated by the doubling of Interest Expense. The results of these shifts were an increase in the quick ratio (associated with the increase in Cash) and a decrease in the times interest earned ratio (associated with the increase in Interest Expense).

E10-10 Calculating and Interpreting the Quick Ratio and Times Interest Earned Ratio

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PA10-3 Recording and Reporting Current LiabilitiesDuring 2010, Lakeview Company completed the following two transactions. The annual accounting period ends December 31.a.On December 31, 2010, calculated the payroll, which indicates gross earnings for wages ($80,000), payroll deductions for income tax ($8,000), payroll deductions for FICA ($6,000), payroll deductions for American Cancer Society ($2,000), employer contributions for FICA (matching), state unemployment taxes ($500), and federal unemployment taxes ($100). Employees were paid in cash, but these payments and the corresponding payroll deductions and employer taxes have not yet been recorded.b.Collected rent revenue of $3,600 on December 10, 2010, for office space that Lakeview rented to another business. The rent collected was for 30 days from December 11, 2010, to January 10, 2011, and was credited in full to Rent Revenue.Required:1.Give the journal entries to record payroll on December 31, 2010.2.Give ( a ) the journal entry for the collection of rent on December 10, 2010, and ( b ) the adjusting journal entry on December 31, 2010.3.Show how any liabilities related to these items should be reported on the company’s balance sheet at December 31, 2010.4.Explain why the accrual basis of accounting provides more relevant information to financial analysts than the cash basis.

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Req. 1

Req. 2

dr Wage Expense (+E, -SE) 80,000 cr Withheld Income Tax Payable (+L) 8,000 cr FICA Payable (+L) 6,000 cr American Cancer Society Payable (+L) 2,000 cr Cash (-A) 64,000

dr Payroll Tax Expense (+E, -SE) 6,600 cr FICA Payable (+L) 6,000 cr State Unemployment Tax Payable (+L) 500 cr Federal Unemployment Tax Payable (+L) 100

(a) December 10, 2010:dr Cash (+A) 3,600 cr Rent Revenue (+R, +SE) 3,600

Collection of rent revenue for one month.

(b) December 31, 2010:dr Rent Revenue (-R, -SE) 1,200 cr Unearned Rent Revenue (+L) 1,200Earned 20 days of rent but initially recorded as if all was earned. Need to reduce revenue for 10 days unearned (10/30 x $3,600 = $1,200).

PA10-3 Recording and Reporting Current Liabilities

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Req. 3

Req. 4

Balance sheet at December 31, 2010:Current Liabilities: Withheld Income Taxes Payable 8,000 FICA Payable 12,000 American Cancer Society Payable 2,000 State Unemployment Tax Payable 500 Federal Unemployment Tax Payable 100 Unearned Rent Revenue 1,200

Accrual basis accounting is beneficial to financial analysts because it records revenues when they are earned and expenses when they are incurred, regardless of when the related cash is received or paid. Cash basis accounting only records revenues when they are received and expenses when they are paid. A financial analyst is looking towards the future of the company, so it is helpful to know how much cash will be coming into and out of the company at later dates. Cash basis accounting limits financial analysts to only what has happened in prior periods and tells them very little about future events and cash flows that will affect the financial health of the company.

PA10-3 Recording and Reporting Current Liabilities

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End of Chapter 10

actg201 chap010 ppt

Documents

total labor

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reporting

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equity interest