REPORTING AND ANALYZING LIABILITIES

1. Chapter 10 REPORTING AND ANALYZING LIABILITIES

2. 11 1 Current Liabilities • Current liabilities are debts which can reasonably be expected to be paid • From existing current assets or through the creation of other current liabilities, and • Within 1 year or the operating cycle, whichever is longer • Debts that do not meet both criteria are Long-Term Liabilities

3. Types of Current Liabilities • Notes Payable • Accounts Payable • Unearned Revenues • Accrued Liabilities • Taxes • Salaries and Wages • Interest

4. 11 2 Notes Payable Notes payable are • Obligations in the form of written notes • Often used instead of accounts payable; they give written documentation if needed for legal remedies • Used for short-term and long-term financing needs • Most often interest-bearing, requiring the borrower to pay interest

5. Note Payable

6. Review Question On July 1, 2010, Madeline, Inc. borrowed $70,000 from Gramy Bank via a 6-month, 9% note payable. On January 1, 2011, what amount of cash will Madeline, Inc. pay the bank? • $70,000. • $66,850. • $76,300. • $73,150.

7. Review Question On July 1, 2010, Madeline, Inc. borrowed $70,000 from Gramy Bank via a 6-month, 9% note payable. On January 1, 2011, what amount of cash will Madeline, Inc. pay the bank? • $70,000. • $66,850. • $76,300. • $73,150.

8. Journal On 9/1/07 First National Bank lends $100,000 to Cole Williams Co. on a four-month, 12% note maturing 1/1/08.

9. Journal On 9/1/07 First National Bank lends $100,000 to Cole Williams Co. on a four-month, 12% note maturing 1/1/08. Sept 1 Cash 100,000 Notes Payable 100,000 To record issuance of 12%, 4-month note to bank Dec 31 Interest Expense 4,000 Interest Payable 4,000 To accrue interest for 4 months on note.

10. Journal Jan 1 Notes Payable 100,000 Interest Payable 4,000 Cash 104,000 To record payment of 1st National Bank interest- bearing note and accrued interest at maturity.

11. Review Question Windy Co. borrowed $10,000 cash on July 1, 2007, from Main Bank by signing a one-year, 10% note payable. Windy Co.’s financial statements at December 31, 2007, should reflect? • $1,000 interest expense. • $11,000 note payable. • $500 interest payable. • $1,000 interest revenue.

12. Review Question Windy Co. borrowed $10,000 cash on July 1, 2007, from Main Bank by signing a one-year, 10% note payable. Windy Co.’s financial statements at December 31, 2007, should reflect? • $1,000 interest expense. • $11,000 note payable. • $500 interest payable. • $1,000 interest revenue.

13. Computing Interest • Compound Interest--Interest computed on principal plus previously accumulated interest.

14. Compounding Periods • The period of time for which interest is computed. • Interest is compounded annually or semi-annually. • The interest rate per compounding period is the yearly interest rate divided by compounding periods per year.

15. Effects of Compound Interest Comparing the value of $100 lump sum invested at 10% for 20 years with simple interest and compound interest.

16. 11 Sales Taxes Payable • Are collected from customers • Are expressed as a % of sales price • Are required by state law. • Remitted to the state monthly • Usually rung separately from sales on the cash register.

17. Journal Mar 25 Cash 10,600 Sales 10,000 Sales Taxes Payable 600 To record daily sales and sales taxes.

18. Payroll Deductions

19. Payroll Taxes Various payroll taxes are required by law to be withheld from employees’ gross pay • Social Security (FICA) taxes withheld, employer and employee make equal contributions ($7,250) • Federal income taxes ($21,864) • State income taxes ($2,922) • Net pay ($67,964) Prepare the journal entry

20. Journal Mar 7 Salaries and Wages Expense 100,000 FICA Taxes Payable (employee’s share) 7,250 Federal Income Taxes Payable 21,864 States Income Taxes Payable 2,922 Salaries and Wages Payable 67,964 Record payroll earned by employees Mar 7 Salaries and Wages Payable 67,964 Cash 67,964 Record payment of payroll

21. Review Question Amounts withheld from employee paychecks for FICA taxes and federal income taxes withheld should be reported by the employer as? Prepaid expensesCurrent liabilitiesUnearned Revenues • Yes Yes No • No Yes No • No No Yes • Yes No No

22. Review Question Amounts withheld from employee paychecks for FICA taxes and federal income taxes withheld should be reported by the employer as? Prepaid expensesCurrent liabilitiesUnearned Revenues • Yes Yes No • No Yes No • No No Yes • Yes No No

23. Journal Employers incur a second type of payroll-related activity. 1) Employer’s share of FICA 2) Federal unemployment 3) State unemployment Mar 7 Payroll Tax Expense 13,450 FICA Taxes Payable (employer’s share) 7,250 Federal Unemployment Taxes Payable 800 State Unemployment Taxes Payable 5,400 Record Employer payroll taxes

24. Unearned Revenue • Unearned revenue is cash received before service or product is delivered (that is, before revenue is earned) • Recorded as a liability until it is earned

25. Unearned Revenues • Examples of unearned revenues • Magazine subscriptions • Rent received in advance • Customer deposits for future service • Sale of airline tickets for future travel • Sale of season tickets to sporting events

26. Journal Aug 6 Cash 500,000 Unearned Ticket Revenue 500,000 Record sale of 10,000 tickets at $50 ea. As each game is completed Sept 7 Unearned Ticket Revenue 100,000 Ticket Revenue 100,000 To record ticket revenue earned

27. Current Maturities of Long-Term Debt Current maturities of long-term debt • The portion of long-term debt due within the current year or operating cycle • Classified as a current liability • No adjusting entry is necessary

28. 11 Bonds Bonds • A form of long-term, interest-bearing note payable issued by corporations, universities and governmental agencies • Sold in small denominations, (usually multiples of $1,000) which makes them attractive to investors • Are in the form of a legal document that indicates the name of the issuer, the face value of the bonds, the contractual interest rate, and the maturity date

29. Bond Certificate

30. Cash Flow of Bonds

31. Bond Features Bonds have many different features • Secured bonds have specific assets pledged as collateral, unsecured do not • Convertible bonds may be converted into common stock at the bondholder’s option • Callable bonds are subject to retirement at a stated dollar amount prior to maturity

32. 11 Accounting for Bond Issues Bonds may be issued at • Face value when stated rate = market rate • Below face value (discount) when stated rate < market rate must discount price to get investors to buy • Above face value (premium) when stated rate > market rate all investors want to own so the price is bid up

33. Interest Rates and Bond Prices

34. Selling Bonds at Discount On January 1, 2009, Candlestick, Inc., sells $100,000, 5-year, 10% bonds at 98 with interest payable on January 1. Jan 1 Cash98,000 Discount on Bonds Payable 2,000* Bonds Payable 100,000 Record sale of bonds at a discount *The discount account is a contra account to the bond payable, not an asset account.

35. Carrying Value Statement Presentation of Discounted Bonds Long-term liabilities Bonds payable $ 100,000 Less: Discount on bonds payable 2,000 $98,000

36. Selling Bonds at Premium On January 1, 2009, Candlestick, Inc., sells $100,000, 5-year, 10% bonds at 102 with interest payable on January 1. Jan 1 Cash 102,000 Bonds Payable 100,000 Premium Bonds Payable 2,000* Sale of bonds at a premium *Premium isadded to bonds payable on the balance sheet

37. Carrying Value Candlestick’s Statement Presentation of Premium Bonds Long-term liabilities Bonds payable $ 100,000 Add : Premium on bonds payable 2,000 $102,000

38. Bond Premium/Discount Amortization Methods • Straight-Line Method--A method of systematically writing off a bond premium or discount, resulting in equal amounts being amortized each period.

39. Bond Premium/Discount Amortization Methods • Straight-Line Method • Effective-Interest Method--A method of systematically writing off a bond premium or discount, taking into consideration the time value of money.

40. Bond Premium/Discount Amortization Methods • Straight-Line Method • Effective-Interest Method • The effective-interest method is the preferred method for GAAP.

41. Bond Premium/Discount Amortization Methods For simplicity, we will assume discounts and premiums are amortized using straight line. Candlestick, Inc. would amortize the $2,000 discount/premium as follows $2,000 ÷ 5 Interest Periods = $400 Annually

42. Amortization of Bond Discount

43. Amortization of Bond Premium

44. Review Question If bonds sell at a premium, the market rate of interest must be? • Equal to the stated interest rate. • Greater than the stated interest rate. • Less than the stated interest rate. • Cannot be determined from the information given.

45. Review Question If bonds sell at a premium, the market rate of interest must be? • Equal to the stated interest rate. • Greater than the stated interest rate. • Less than the stated interest rate. • Cannot be determined from the information given.

46. Review Question True or False If bonds sell at a premium, interest expense will be more than cash interest paid.

47. Review Question False If bonds sell at a premium, interest expense will be more than cash interest paid. If bonds sell at a premium, amortization will decrease interest expense, making it less than cash interest paid.

48. 11 Bond Retirements • Bonds may be redeemed at maturity or before maturity

49. Redeeming Bonds Before Maturity • A company may decide to retire bonds before maturity to • reduce interest cost • remove debt from its balance sheet • A company should retire debt early only if it has sufficient cash resources

50. Redeeming Bonds Before Maturity • When bonds are retired before maturity, it is necessary to • Eliminate the carrying value of the bonds at the redemption date • Record the cash paid • Recognize the gain or loss on redemption • The carrying value of the bonds is the bond payable plus the premium or minus the discount