principles of accounting chapter 10 ppt
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LiabilitiesChapter 10PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPAMcGraw-Hill/Irwin Copyright © 2012 The McGraw-Hill Companies, Inc.The Nature of LiabilitiesDefined as debts or obligations arising from past transactions or events.Maturity = 1 year or lessMaturity > 1 yearCurrent LiabilitiesNoncurrent Liabilities10-2Distinction Between Debt and EquityThe acquisition of asseTRANSCRIPT
Copyright © 2012 The McGraw-Hill Companies, Inc.
PowerPoint Authors:Susan Coomer Galbreath, Ph.D., CPACharles W. Caldwell, D.B.A., CMAJon A. Booker, Ph.D., CPA, CIACynthia J. Rooney, Ph.D., CPA
McGraw-Hill/Irwin
LiabilitiesLiabilities
Chapter 10
10-2
The Nature of LiabilitiesThe Nature of Liabilities
Defined as debts or obligations arising from past transactions or events.
Defined as debts or obligations arising from past transactions or events.
Maturity = 1 year or less Maturity > 1 year
Current Liabilities
Noncurrent Liabilities
10-3
Distinction Between Debt and EquityDistinction Between Debt and Equity
The acquisition of assets is financedfrom two sources:
Funds from creditors, with a definite due date, and
sometimes bearing interest.
Funds from owners.
10-4
Estimated LiabilitiesEstimated Liabilities
Estimated liabilities have two basic characteristics:
1.The liability is known to exist, 2.The precise dollar amount cannot be determined until a later date.
Estimated liabilities have two basic characteristics:
1.The liability is known to exist, 2.The precise dollar amount cannot be determined until a later date.
Example: An automobilewarranty obligation.
10-5
Short-term obligations to suppliers for purchases of merchandise and to others for
goods and services.
Short-term obligations to suppliers for purchases of merchandise and to others for
goods and services.
Merchandise inventory invoices
Merchandise inventory invoices
Shipping chargesShipping charges
Utility and phone billsUtility and phone bills
Office supplies invoices
Office supplies invoices
Current Liabilities: Accounts PayableCurrent Liabilities: Accounts Payable
ExamplesExamples
10-6
Total Notes Payable
Current Notes Payable
Noncurrent Notes Payable
When a company borrows money, a note payable is created.
Current Portion of Notes PayableThe portion of a note payable that is due within one year, or one operating cycle, whichever is longer.
When a company borrows money, a note payable is created.
Current Portion of Notes PayableThe portion of a note payable that is due within one year, or one operating cycle, whichever is longer.
Current Liabilities: Notes PayableCurrent Liabilities: Notes Payable
10-7
Current Liabilities: Notes PayableCurrent Liabilities: Notes Payable
PROMISSORY NOTE
Location Date
after this date
promises to pay to the order of
the sum of with interest at the rate of per annum.
Miami, Fl Nov. 1, 2011
Six months Porter Company
John Caldwell
Security National Bank
$10,000.00 12.0%
Treasurer and Senior VPSigned:
Title:
10-8
Accrued LiabilitiesAccrued Liabilities
Accrued liabilities arise from the recognition of expenses for which payment will be made in the future. Accrued liabilities are often referred to as
accrued expenses.
Accrued liabilities arise from the recognition of expenses for which payment will be made in the future. Accrued liabilities are often referred to as
accrued expenses.
Examples include:1.Interest payable,2.Income taxes payable, and3.Accrued payroll liabilities.
10-9
Payroll LiabilitiesPayroll LiabilitiesGross Pay
Net Pay
Workman’s Compensation
State and Local Income
Taxes
Social Security
and Medicare
Federal Income Tax
Voluntary Deductions
Less Deductions:
10-10
a liability account.a liability account.
Cash is received
in advance.
Cash is sometimes collected from the customer before the revenue is actually earned.
Cash is sometimes collected from the customer before the revenue is actually earned.
Unearned RevenueUnearned Revenue
As the earnings process is completed
10-11
Relatively small debt needs can be filled from single sources.
Relatively small debt needs can be filled from single sources.
Banks Insurance Companies Pension Plansoror oror
Long-Term LiabilitiesLong-Term Liabilities
10-12
Large debt needs are often filled by issuing bonds.
Large debt needs are often filled by issuing bonds.
Long-Term LiabilitiesLong-Term Liabilities
10-13
Maturing Obligations Intended to be Maturing Obligations Intended to be RefinancedRefinanced
One special type of long-term liability is an obligation that will mature in the current
period but that is expected to be refinanced on a long-term basis.
One special type of long-term liability is an obligation that will mature in the current
period but that is expected to be refinanced on a long-term basis.
If management has both the intend and ability to refinance soon-to-mature obligations on a
long-term basis, these obligations are classified as long-term liabilities.
10-14
With each payment, the interest portion gets smaller
and the principal portion gets larger.
With each payment, the interest portion gets smaller
and the principal portion gets larger.
Installment Notes PayableInstallment Notes Payable
Each payment covers interest for the period AND a portion of the
principal.
Each payment covers interest for the period AND a portion of the
principal.
Long-term notes that call for a series of installment payments.
Long-term notes that call for a series of installment payments.
10-15
Allocating Installment Payments Allocating Installment Payments Between Interest and PrincipalBetween Interest and Principal
1. Identify the unpaid principal balance.
2. Interest expense = Unpaid Principal × Interest rate.
3. Reduction in unpaid principal balance = Installment payment – Interest expense.
4. Compute new unpaid principal balance.
On January 1, Year 1, King’s Inn purchased furnishings at a cost of $7,581.57. The loan was a five-year loan
and had an interest rate of 10%. The annual payment is $2,000.
Let’s prepare an amortization table for King’s Inn.
On January 1, Year 1, King’s Inn purchased furnishings at a cost of $7,581.57. The loan was a five-year loan
and had an interest rate of 10%. The annual payment is $2,000.
Let’s prepare an amortization table for King’s Inn.
10-16
Preparing an Amortization TablePreparing an Amortization Table
Date PaymentInterest Expense
Reduction in Unpaid Balance
Unpaid Balance
Jan 1, Year 1 $ 7,581.57 Dec. 31, Year 1 $ 2,000.00 $ 758.16 $ 1,241.84 6,339.73 Dec. 31, Year 2 2,000.00 633.97 1,366.03 4,973.70 Dec. 31, Year 3 2,000.00 497.37 1,502.63 3,471.07 Dec. 31, Year 4 2,000.00 347.11 1,652.89 1,818.18 Dec. 31, Year 5 2,000.00 181.82 1,818.18 0.00
$7,581.57 × 10% = $758.16
$2,000 - $758.16 = $1,241.84
$7,581.57 - $1,241.84 = $6,339.73
10-17
Using the Amortization TableUsing the Amortization Table
Date Description Debit Credit
Dec. 31 Interest Expense758.16
Interest Payable 758.16
The information needed for the journal entry can be found on the amortization table. The cash payment
amount, the interest expense, and the principal reduction amount are all in the table.
The information needed for the journal entry can be found on the amortization table. The cash payment
amount, the interest expense, and the principal reduction amount are all in the table.
10-18
Using the Amortization TableUsing the Amortization Table
Date Description Debit Credit
Jan. 1 Interest Payable758.16
Note Payable1,241.84
Cash 2.000.00
On January 1, Year 2, the first annual payment will be made on the installment note. Refer to the previous
entry and amortization for the amounts shown.
On January 1, Year 2, the first annual payment will be made on the installment note. Refer to the previous
entry and amortization for the amounts shown.
10-19
Bonds PayableBonds Payable
Bonds usually involve the borrowing of a large sum of money, called principalprincipal.
The principal is usually paid back as a lump sum lump sum at the end of the bond period.
Individual bonds are often denominated with a par value, or face valueface value, of $1,000.
Bonds usually involve the borrowing of a large sum of money, called principalprincipal.
The principal is usually paid back as a lump sum lump sum at the end of the bond period.
Individual bonds are often denominated with a par value, or face valueface value, of $1,000.
10-20
Bonds PayableBonds Payable
Bonds usually carry a stated rate of interest, also called a contract ratecontract rate.
Interest is normally paid semiannually.
Interest is computed as:
Principal × Stated Rate × Time = InterestPrincipal × Stated Rate × Time = Interest
10-21
Bonds PayableBonds Payable
Bonds are issued through an intermediary called an underwriterunderwriter.
Bonds can be sold on organized securities exchanges.
Bond prices are usually quoted as a percentagepercentage of the face amount.
For example, a $1,000 bond priced For example, a $1,000 bond priced at 102 would sell for $1,020at 102 would sell for $1,020..
10-22
Mortgage Bonds
Mortgage Bonds
Convertible Bonds
Convertible Bonds
Junk BondsJunk
Bonds
Debenture Bonds
Debenture Bonds
Types of BondsTypes of Bonds
10-23
On March 1, 2011, Wells Corporation issues $1,500,000 of 12%, 10-year bonds payable. Interest
is payable semiannually, each March 1 and September 1.
Assume the bonds are issued at face value.Record the issuance of the bonds.
On March 1, 2011, Wells Corporation issues $1,500,000 of 12%, 10-year bonds payable. Interest
is payable semiannually, each March 1 and September 1.
Assume the bonds are issued at face value.Record the issuance of the bonds.
Accounting for Bonds PayableAccounting for Bonds Payable
Date Description Debit Credit
Mar. 1 Cash 1,500,000
Bonds Payable 1,500,000
10-24
Record the interest payment on September 1, 2011.Record the interest payment on September 1, 2011.
Accounting for Bonds PayableAccounting for Bonds Payable
$1,500,000 × 12% × ½ = $90,000$1,500,000 × 12% × ½ = $90,000
10-25
Bonds Issued Between Interest Bonds Issued Between Interest DatesDates
• Bonds are often sold between interest dates.
• The selling price of the bond is computed as:
10-26
Bonds Issued at a Discount or a Bonds Issued at a Discount or a PremiumPremium
The selling price of the bond is determined by the market based
on the time value of money.Stated interest rate is The bonds sells:
Above market rateAt a premium
(Cash received is greater than face amount)
Equal to market rateAt face amount
(Cash received is equal to face amount)
Below market rateAt a discount
(Cash received is less than face amount)
Stated interest rate is The bonds sells:
Above market rateAt a premium
(Cash received is greater than face amount)
Equal to market rateAt face amount
(Cash received is equal to face amount)
Below market rateAt a discount
(Cash received is less than face amount)
10-27
Principal
Cash Proceeds Discount
1,000,000$ - 950,000$ = 50,000$
Bonds Issued at a DiscountBonds Issued at a Discount
Wells, Corp. issues bonds on January 1, 2011.Principal = $1,000,000Issue price = $950,000Stated Interest Rate = 9%Interest Dates = 6/30 and 12/31Maturity Date = Dec. 31, 2030 (20 years)
Wells, Corp. issues bonds on January 1, 2011.Principal = $1,000,000Issue price = $950,000Stated Interest Rate = 9%Interest Dates = 6/30 and 12/31Maturity Date = Dec. 31, 2030 (20 years)
10-28
Bonds Issued at a DiscountBonds Issued at a Discount
To record the bond issue, Well, Inc. wouldTo record the bond issue, Well, Inc. wouldmake the following entry on January 1, 2011:make the following entry on January 1, 2011:
To record the bond issue, Well, Inc. wouldTo record the bond issue, Well, Inc. wouldmake the following entry on January 1, 2011:make the following entry on January 1, 2011:
10-29
Partial Balance Sheet as of January 1, 2011
Long-term Liabilities: Bonds Payable 1,000,000$ Less: Discount on Bonds Payable 50,000 950,000$
Partial Balance Sheet as of January 1, 2011
Long-term Liabilities: Bonds Payable 1,000,000$ Less: Discount on Bonds Payable 50,000 950,000$
Maturity ValueMaturity ValueMaturity ValueMaturity Value
Carrying ValueCarrying ValueCarrying ValueCarrying Value
Bonds Issued at a DiscountBonds Issued at a Discount
10-30
Amortizing the discount over the term of the Amortizing the discount over the term of the bond increases Interest Expense each bond increases Interest Expense each
interest payment period.interest payment period.
Amortizing the discount over the term of the Amortizing the discount over the term of the bond increases Interest Expense each bond increases Interest Expense each
interest payment period.interest payment period.
Bonds Issued at a DiscountBonds Issued at a Discount
Using the Using the straight-linestraight-line method, the method, the discount amortization will be $1,250 discount amortization will be $1,250
every six months. every six months. $50,000 ÷ 40 periods = $1,250$50,000 ÷ 40 periods = $1,250
Using the Using the straight-linestraight-line method, the method, the discount amortization will be $1,250 discount amortization will be $1,250
every six months. every six months. $50,000 ÷ 40 periods = $1,250$50,000 ÷ 40 periods = $1,250
10-31
Amortization of the DiscountAmortization of the Discount
We prepare the following journal entry to recordWe prepare the following journal entry to recordthe first interest payment.the first interest payment.
We prepare the following journal entry to recordWe prepare the following journal entry to recordthe first interest payment.the first interest payment.
$1,000,000 × 9% × ½ = $45,000
Interest paid every six months is calculated as follows:Interest paid every six months is calculated as follows:Interest paid every six months is calculated as follows:Interest paid every six months is calculated as follows:
10-32
Partial Balance Sheet as of December 31, 2011
Long-term Liabilities: Bonds Payable 1,000,000$ Less: Discount on Bonds Payable 47,500 952,500$
Partial Balance Sheet as of December 31, 2011
Long-term Liabilities: Bonds Payable 1,000,000$ Less: Discount on Bonds Payable 47,500 952,500$
Maturity ValueMaturity ValueMaturity ValueMaturity Value
Carrying ValueCarrying ValueCarrying ValueCarrying Value
$50,000 – $1,250 – $1,250$50,000 – $1,250 – $1,250$50,000 – $1,250 – $1,250$50,000 – $1,250 – $1,250
The carrying value willThe carrying value willincrease to exactly $1,000,000increase to exactly $1,000,000
on the maturity date.on the maturity date.
The carrying value willThe carrying value willincrease to exactly $1,000,000increase to exactly $1,000,000
on the maturity date.on the maturity date.
Bonds Issued at a DiscountBonds Issued at a Discount
10-33
Wells Corporation will repay the principal amount Wells Corporation will repay the principal amount on December 31, 2030 with the following entry: on December 31, 2030 with the following entry:
Wells Corporation will repay the principal amount Wells Corporation will repay the principal amount on December 31, 2030 with the following entry: on December 31, 2030 with the following entry:
Bonds Issued at a DiscountBonds Issued at a Discount
10-34
The Concept of Present ValueThe Concept of Present Value
How much is a future amount worth today?
Present Value
FutureValue
Interest compounding periods
Today
10-35
Two types of cash flows are involved with bonds:
Today Principal payment at maturity is a lump
sum payment.
Periodic interest payments called annuities.
Maturity
The Concept of Present ValueThe Concept of Present Value
10-36
Early Retirement of DebtEarly Retirement of Debt
Gains or losses incurred as a result of retiring bonds should be reported as
other income or other expense on the income statement.
10-37
Loss ContingenciesLoss Contingencies
An existing uncertain situation involving potential loss depending on whether some
future event occurs.
Two factors affect whether a loss contingency must be accrued and reported as a liability:
1. The likelihood that the confirming event will occur.
2. Whether the loss amount can be reasonably estimated.
Two factors affect whether a loss contingency must be accrued and reported as a liability:
1. The likelihood that the confirming event will occur.
2. Whether the loss amount can be reasonably estimated.
10-38
Evaluating the Safety of Creditors’ Evaluating the Safety of Creditors’ ClaimsClaims
This ratio indicates a margin of protection for creditors. From the
creditor’s point of view, the higher this ratio, the better.
This ratio indicates a margin of protection for creditors. From the
creditor’s point of view, the higher this ratio, the better.
Operating Income
Interest Expense
Interest
Coverage
Ratio=
10-39
End of Chapter 10End of Chapter 10