ch10

Chapter 10-1

Chapter 10-2

Reporting and Reporting and

Analyzing LiabilitiesAnalyzing Liabilities

Accounting, Third Edition

Chapter 10-3

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.

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

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

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

Study ObjectivesStudy ObjectivesStudy ObjectivesStudy Objectives

Chapter 10-4

Current Current LiabilitiesLiabilitiesCurrent Current

LiabilitiesLiabilities

Bonds: Long-Bonds: Long-Term Term


Bonds: Long-Bonds: Long-Term Term


Accounting Accounting for Bond for Bond IssuesIssues

Accounting Accounting for Bond for Bond IssuesIssues

Accounting for Accounting for Bond Bond

RetirementsRetirements

Accounting for Accounting for Bond Bond

RetirementsRetirements

Financial Financial Statement Statement

Presentation Presentation and Analysisand Analysis

Financial Financial Statement Statement

Presentation Presentation and Analysisand Analysis

Reporting and Analyzing LiabilitiesReporting and Analyzing LiabilitiesReporting and Analyzing LiabilitiesReporting and Analyzing Liabilities

What is a What is a current current liability?liability?

Notes payableNotes payable

Sales taxes Sales taxes payablepayable

Unearned Unearned revenuesrevenues

Current Current maturities of maturities of long-term debtlong-term debt

Payroll and Payroll and payroll taxes payroll taxes payablepayable

Types of Types of bondsbonds

Issuing Issuing proceduresprocedures

Determining Determining the market the market value of bondsvalue of bonds

Issuing bonds Issuing bonds at face valueat face value

Discount or Discount or premium on premium on bondsbonds

Issuing bonds Issuing bonds at a discountat a discount

Issuing bonds Issuing bonds at a premiumat a premium

Redeeming Redeeming bonds at bonds at maturitymaturity

Redeeming Redeeming bonds before bonds before maturitymaturity

Balance sheet Balance sheet presentationpresentation

AnalysisAnalysis

Off-balance-Off-balance-sheet financingsheet financing

Chapter 10-5

Current liability is debt with 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

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

Current liabilities include notes payable, accounts payable, unearned revenues, and accrued liabilities such as taxes, salaries and wages, and interest payable.

Chapter 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).

QuestionQuestion

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


Chapter 10-7 SO 2 Describe the accounting for notes SO 2 Describe the accounting for notes

payable.payable.

Notes Payable

Written promissory note.

Require the borrower to pay interest.

Those due within one year of the balance sheet date are usually classified as current liabilities.


Chapter 10-8

Illustration: Illustration: First National Bank agrees to lend $100,000 on September 1, 2010, 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

SO 2 Describe the accounting for notes SO 2 Describe the accounting for notes payable.payable.


Sept. 1

Chapter 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

Chapter 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

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

Sales Tax Payable

Sales taxes are expressed as a stated percentage of the sales price.

Retailer collects tax from the customer.

Retailer remits the collections to the state’s department of revenue.


Chapter 10-12

Illustration: 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:

SO 3 Explain the accounting for other current liabilities.SO 3 Explain the accounting for other current liabilities.


Mar. 25 Sales

10,000

Cash 10,600

Sales tax payable

600

Chapter 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

10,000

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

*

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

Unearned Revenue

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

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.


Chapter 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

500,000

Unearned ticket revenue 500,000Sept. 7


Superior records the earning of revenue with thefollowing entry.

Chapter 10-16

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

bearing $25,000 note on January 1, 2009. This note specifies that

each January 1, starting January 1, 2010, Wendy should pay $5,000

of the note. When the company prepares financial statements on

December 31, 2009,

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 DebtPortion of long-term debt that comes due in the current year.

No adjusting entry required.



$5,000

$20,000

Chapter 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).

Determining the payroll involves computing three amounts: (1) gross earnings, (2) payroll deductions, and (3) net pay.


Payroll and Payroll Taxes Payable


Chapter 10-18

Illustration: Assume Cargo Corporation records its payroll for the week of March 7 as follows:

Salaries and wages expense 100,000

Federal tax payable21,864

FICA tax payable7,650

State tax payable 2,922Salaries and wages payable 67,564


Cash

67,564

Salaries and wages payable 67,564Mar. 7

Record the payment of this payroll on March 7.

Mar. 7


Chapter 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



Chapter 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 tax payable800

FICA tax payable7,650

Federal unemployment tax payable 5,400



Chapter 10-21

Employer payroll taxes do not include:

a. Federal unemployment taxes.

b. State unemployment taxes.

c. Federal income taxes.

d. FICA taxes.

QuestionQuestion



Chapter 10-22

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).

SO 4 Identify the types of bonds.SO 4 Identify the types of bonds.

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

Chapter 10-23

Types of Bonds

Secured

Unsecured

Convertible

Callable



Chapter 10-24

Chapter 10-25

Issuing ProceduresBond certificate

Issued to the investor.

Provides information such as the

name of the company issuing bonds, face value, maturity date, and contractual interest rate (stated 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.



Chapter 10-26


MaturityDate

MaturityDate

Illustration 10-3

Contractual Interest

Rate

Contractual Interest

Rate

Face or Par ValueFace or

Par Value

Issuer of Bonds

Issuer of Bonds


Chapter 10-27

Determining the Market Value of Bonds

Market value is a function of the three factors that determine present value:

1. the dollar amounts to be received,

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

3. the market rate of interest.

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



Chapter 10-28

Illustration: Assume that Acropolis Company on January 1, 2010, 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


Chapter 10-29

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.

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

Chapter 10-30

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.

QuestionQuestion



Chapter 10-31

Illustration: Devor Corporation issues 100, five-year, 10%, $1,000 bonds dated January 1, 2010, 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.

Dec. 31 Bond interest expense 10,000

Bond interest payable 10,000

Chapter 10-32

Prepare the entry Devor would make to pay the interest on Jan. 1, 2011.

Jan. 1 Bond interest payable 10,000

Cash 10,000


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

Chapter 10-33

8%

10%

12%

Premium

Face Value

Discount

Assume Contractual Rate of 10%Assume Contractual Rate of 10%


Bonds Sold AtMarket Interest


Chapter 10-34

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.

QuestionQuestion



Chapter 10-35

Illustration: Assume that on January 1, 2010, 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 payable2,000


Illustration 10-8Computation of total cost of borrowing—bonds issued at discount

Chapter 10-36

Statement Statement

PresentationPresentation



Illustration 10-7Statement presentation ofdiscount on bonds payable

Chapter 10-37

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.

QuestionQuestion



Chapter 10-38

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

Illustration 10-12Computation of total cost of borrowing—bonds issued at premium

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

Chapter 10-39

Statement Statement

PresentationPresentation


Illustration 10-11Statement presentation ofpremium on bonds payable

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

Chapter 10-40

Redeeming Bonds at Maturity

SO 6 Describe the entries when bonds are redeemed.SO 6 Describe the entries when bonds are redeemed.

Candlestick records the redemption of its bonds at maturity as follows:

Accounting for Bond RetirementsAccounting for Bond RetirementsAccounting for Bond RetirementsAccounting for Bond Retirements


Cash 100,000

Chapter 10-41

Redeeming Bonds before Maturity

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.



Chapter 10-42

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.

QuestionQuestion



Chapter 10-43

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 redemptiondate is $100,400 (principal $100,000 and premium $400). Candlestick records the redemption at the end of the fourth interest period (January 1, 2014) as:



Premium on bonds payable 400

Loss on bond redemption 2,600

Cash 103,000


Chapter 10-44

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.

QuestionQuestion



Chapter 10-45

Balance Sheet Presentation

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

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

Illustration 10-15

Chapter 10-46

Analysis



Illustration 10-16

Chapter 10-47

Liquidity


$99,823

$99,680= 1.0:1

$91,387

$85,373= 1.07:1

Liquidity ratios measure the short-term ability of a company to pay its maturing obligations and to meet unexpected needs for cash.


Chapter 10-48

Solvency


$175,678$275,941

= 64%

$13,927+$418+$7,609

$418= 52.5

times

Solvency ratios measure the ability of a company to survive over a long period of time.

Chapter 10-49

Chapter 10-50

Off-Balance-Sheet Financing

Contingencies

Leasing

Operating lease

Capital lease



Chapter 10-51

Chapter 10-52

To follow the matching principle, companies allocate bond discount and bond premium to expense in each period in which the bonds are outstanding. Illustration 10A-1

Amortizing Bond Discount and Premium

Straight-Line AmortizationStraight-Line AmortizationStraight-Line AmortizationStraight-Line Amortization

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

Appendix 10A

Chapter 10-53

Illustration: Candlestick, Inc., sold $100,000, five-year, 10% bonds on January 1, 2010, 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, 2010.

Amortizing Bond Discount


Discount on bonds payable

400

Bond interest expense 10,400Dec. 31

Bond interest payable

10,000SO 8 Apply the straight-line method of SO 8 Apply the straight-line method of

amortizing bond discount and bond amortizing bond discount and bond premium.premium.

Appendix 10A

Chapter 10-54

Illustration 10A-2




Appendix 10A

Chapter 10-55

Illustration: Candlestick, Inc., sold $100,000, five-year, 10% bonds on January 1, 2010, 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, 2010.

Amortizing Bond Premium





10,000SO 8 Apply the straight-line method of SO 8 Apply the straight-line method of

amortizing bond discount and bond amortizing bond discount and bond premium.premium.

Appendix 10A

Chapter 10-56

Illustration 10A-2


Straight-Line AmortizationStraight-Line AmortizationStraight-Line AmortizationStraight-Line Amortization Appendix 10A


Chapter 10-57

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 AmortizationEffective-Interest AmortizationEffective-Interest AmortizationEffective-Interest Amortization Appendix 10B

Chapter 10-58


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


Illustration: Candlestick, Inc., sold $100,000, five-year, 10% bonds on January 1, 2010, 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.

Chapter 10-59

Illustration 10B-2




Chapter 10-60

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




Discount on bonds payable319



10,000

Chapter 10-61




Illustration: Candlestick, Inc., sold $100,000, five-year, 10% bonds on January 1, 2010, 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.

Chapter 10-62

Illustration 10B-4




Chapter 10-63

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







10,000

Chapter 10-64

Long-Term Notes Payable

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.

Long-Term Notes PayableLong-Term Notes PayableLong-Term Notes PayableLong-Term Notes Payable

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

Appendix 10C

Chapter 10-65

Illustration 10C-1

Illustration: Porter Technology Inc. issues a $500,000, 12%, 20-year mortgage note on December 31, 2010. The terms provide for semiannual installment payments of $33,231.

Long-Term Notes PayableLong-Term Notes PayableLong-Term Notes PayableLong-Term Notes Payable Appendix 10C


Chapter 10-66

Illustration: Porter Technology records the mortgage loan and first installment payment as follows:



Mortgage notes payable500,000

Cash 500,000Dec. 31

Mortgage notes payable 3,231

Interest expense 30,000Jun. 30

Cash33,231

Chapter 10-67

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.

QuestionQuestion



Chapter 10-68

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ch10

Business

current liabilities

analysis of liabilities

accrued liabilities

sales tax payable sales

longterm notes payable

accounts payable

sales price

sales tax rate