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LIABILITIES

Chapter 10. LIABILITIES. Current Liabilities. Noncurrent Liabilities. I.O.U. The Nature of Liabilities. Defined as debts or obligations arising from past transactions or events. Maturity = 1 year or less. Maturity > 1 year. DEBT. EQUITY.

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LIABILITIES

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  1. Chapter10 LIABILITIES

  2. Current Liabilities Noncurrent Liabilities I.O.U. The Nature of Liabilities Defined as debts or obligations arising from past transactions or events. Maturity = 1 year or less Maturity > 1 year

  3. DEBT EQUITY Funds from creditors, with a definite due date, and sometimes bearing interest. Distinction BetweenDebt and Equity The acquisition of assets is financedfrom two sources: Funds from owners

  4. Current Liabilities Obligations that must be paid within one year or within the operating cycle, whichever is longer.

  5. Liabilities – Question Devon Mfg. borrows $100,000 from First Bank. The loan will be repaid in 20 years and has an annual interest rate of 8%. Is this acurrent liabilityor anoncurrent liability? The obligation will not be paid within one year or one operating cycle, so it is anoncurrent liability.

  6. Accounts Payable Short-term obligations to suppliers for purchases of merchandise and to others for goods and services. Office supplies invoices Merchandise inventory invoices Utility and phone bills Shipping charges

  7. Current Notes Payable Noncurrent Notes Payable Notes Payable When a company borrows money, a note payable is created. Current Portion of Notes Payable The portion of a note payable that is due within one year, or one operating cycle, whichever is longer. Total Notes Payable

  8. Notes Payable PROMISSORY NOTE LocationDate after this date promises to pay to the order of the sum of with interest at the rate of per annum. signed title Miami, Fl Nov. 1, 2007 Porter Company 3 months Security National Bank $10,000.00 12.0% John Caldwell treasurer

  9. Notes Payable On November 1, 2007, Porter Company would make the following entry.

  10. Interest Payable • Interest expenseis the compensation to the lender for giving up the use of money for a period of time. • The liability is called interest payable. • To the lender, interest is a revenue. • To the borrower, interest is an expense. Interest Rate Up!

  11. The interest formula includes three variables that must be considered when computing interest: Interest Payable Interest = Principal × Interest Rate × Time When computing interest for one year, “Time” equals 1. When the computation period is less than one year, then “Time” is a fraction. For example, if we needed to compute interest for 3 months, “Time” would be 3/12.

  12. Interest Payable – Example What entry would Porter Company make on December 31, the fiscal year-end? $10,00012% 2/12 = $200

  13. Interest Payable – Example Porter will pay the note on January 31, 2008. Let’s look at the entry. $10,00012% 1/12 = $100

  14. Net Pay State and Local Income Taxes Voluntary Deductions Medicare Taxes Federal Income Tax FICA Taxes Payroll Liabilities Gross Pay

  15. Cash is received in advance. Earned revenue is recorded. Deferred revenue is recorded. Unearned Revenue Cash is sometimes collected from the customer before the revenue is actually earned. As the earnings process is completed . . a liability account.

  16. Relatively small debt needs can be filled from single sources. or or Insurance Companies Pension Plans Banks Long-Term Liabilities

  17. Long-Term Liabilities Large debt needs are often filled by issuing bonds.

  18. Each payment covers interest for the period AND a portion of the principal. With each payment, the interest portion gets smaller and the principal portion gets larger. Installment Notes Payable Long-term notes that call for a series of installment payments.

  19. Allocating Installment Payments Between Interest and Principal • Identify the unpaid principal balance. • Interest expense = Unpaid Principal × Interest rate. • Reduction in unpaid principal balance = Installment payment – Interest expense. • Compute new unpaid principal balance.

  20. Allocating Installment Payments Between Interest and Principal On January 1, 2007, Rocket Corp. borrowed $7,581.57 from First Bank of River City. The loan was a five-year loan and had an interest rate of 10%. The annual payment is $2,000. Prepare an amortization table for Rocket Corp.’s loan.

  21. Allocating Installment Payments Between Interest and Principal Now, prepare the entry for the first payment on December 31, 2007.

  22. Allocating Installment Payments Between Interest and Principal The information needed for the journal entry can be found on the amortization table. The payment amount, the interest expense, and the amount to debit to principal are all on the table.

  23. Bonds Payable • Bonds usually involve the borrowing of a large sum of money, called principal. • The principal is usually paid back as a lump sum at the end of the bond period. • Individual bonds are often denominated with a par value, or face value, of $1,000.

  24. Bonds Payable • Bonds usually carry a stated rate of interest, also called acontract rate. • Interest is normally paid semiannually. • Interest is computed as: Interest = Principal × Stated Rate × Time

  25. Bonds Payable • Bonds are issued through an intermediary called an underwriter. • Bonds can be sold on organized securities exchanges. • Bond prices are usually quoted as a percentage of the face amount. For example, a $1,000 bond priced at 102 would sell for $1,020.

  26. Types of Bonds Mortgage Bonds Debenture Bonds Convertible Bonds Junk Bonds

  27. Accounting for Bonds Payable On January 1, 2007, Rocket Corp. issues $1,500,000 of 12%, 10-year bonds payable. Interest is payable semiannually, each July 1 and January 1. Assume the bonds are issued at face value.Record the issuance of the bonds.

  28. Accounting for Bonds Payable Record the interest paymenton July 1, 2007.

  29. Bonds Sold Between Interest Dates • Bonds are often sold between interest dates. • The selling price of the bond is computed as:

  30. The selling price of the bond is determined by the market basedon the time value of money. = = < < > > The Present Value Concept and Bond Prices

  31. Bonds Issued at a Discount Matrix, Inc. is attempting to issue $1,000,000 principal amount of 9% bonds. The bonds pay interest on June 30 and December 31 each year and mature in 20 years. Investors are unwilling to pay the full face amount for Matrix’s bonds because they believe the interest rate is too low. To entice investors, Matrix must lower the price of the bonds. The difference between the new lower issue price and the principal of $1,000,000 is called a discount. Let’s see how we account for these bonds.

  32. Bonds Issued at a Discount Matrix, Inc. issues bonds on January 1, 2007. Principal = $1,000,000 Issue price = $950,000 Stated Interest Rate = 9% Interest Dates = 6/30 and 12/31 Maturity Date = Dec. 31, 2026 (20 years)

  33. Bonds Issued at a Discount To record the bond issue, Matrix, Inc. wouldmake the following entry on January 1, 2007:

  34. Bonds Issued at a Discount Maturity Value Carrying Value

  35. Bonds Issued at a Discount Amortizing the discount over the term of the bond increases Interest Expense each interest payment period. Using the straight-line method, the discount amortization will be $1,250 every six months. $50,000 ÷ 40 periods = $1,250

  36. Interest paid every six months is calculated as follows: $1,000,000 × 9% = $90,000 ÷ 2 = $45,000 We prepare the following journal entry to recordthe first interest payment. Amortization of the Discount

  37. Bonds Issued at a Discount $50,000 – $1,250 – $1,250 Maturity Value Carrying Value The carrying value willincrease to exactly $1,000,000on the maturity date.

  38. Bonds Issued at a Discount To record an the principal repayment, Matrix, Incwould make the following entry on December 31, 2026:

  39. Bonds Issued at a Premium If bonds of other companies are yielding less than9 percent, investors will be willing to pay more thanthe face amount for Matrix’s 9% bonds. The issueprice of Matrix’s 9% bonds will rise because ofinvestor demand for the 9% bonds. Thedifference between the higher issue price and theprincipal of $1,000,000 is called a premium. Let’s look at accounting for a premium.

  40. The only change fromprevious Matrix example. Bonds Issued at a Premium Matrix, Inc. issues bonds on January 1, 2007. Principal = $1,000,000 Issue price = $1,050,000 Stated Interest Rate = 9% Interest Dates = 6/30 and 12/31 Maturity Date = Dec. 31, 2026 (20 years)

  41. Bonds Issued at a Premium To record the bond issue, Matrix, Inc. wouldmake the following entry on January 1, 2007:

  42. Bonds Issued at a Premium Maturity Value Carrying Value

  43. Bonds Issued at a Premium Amortizing the premium over the term of the bond decreases Interest Expense each interest payment period. Using the straight-line method, the premium amortization will be $1,250 every six months. $50,000 ÷ 40 periods = $1,250

  44. Bonds Issued at a Premium To record an interest payment, Matrix, Inc. would makethe following entry on each June 30 and December 31:

  45. $50,000 – $1,250 – $1,250 Bonds Issued at a Premium Maturity Value Carrying Value The carrying value willdecrease to exactly $1,000,000on the maturity date.

  46. Bonds Issued at a Premium To record an the principal repayment, Matrix would makethe following entry on December 31, 2026:

  47. $1,000 invested today at 10%. In 5 years it will be worth $1,610.51. In 25 years it will be worth $10,834.71! The Concept of Present Value Present Value Future Value Money can grow over time, because it can earn interest.

  48. The Concept of Present Value How much is a future amount worth today? Present Value FutureValue Interest compounding periods Today

  49. The Concept of Present Value How much is a future amount worth today? Three pieces of information must be known to solve a present value problem: • Thefutureamount. • The interest rate (i). • The number of periods (n) the amount will be invested.

  50. The Concept of Present Value Two types of cash flows are involved with bonds: Periodic interest payments called annuities. Today Maturity • Principal payment at maturity.

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