Financial Accounting: Tools for Business Decision Making, 2nd Ed.

1. Financial Accounting:Tools for Business Decision Making, 2nd Ed. ELS Prepared by: Ellen L. Sweatt Georgia Perimeter College Kimmel, Weygandt, Kieso

2. Chapter 10 Reporting and Analyzing Liabilities

3. Chapter 10 Reporting and Analyzing Liabilities After studying Chapter 10, you should be able to: • Explain a current liability and identify the major types of current liabilities. • Describe the accounting for notes payable. • Explain the accounting for other current liabilities. • Identify the requirements for the financial statement presentation and analysis of current liabilities.

4. Chapter 10 Reporting and Analyzing Liabilities After studying Chapter 10, you should be able to: • Explain why bonds are issued and identify the types of bonds. • Prepare the entries for the issuance of bonds and their interest expense. • Describe the entries when bonds are redeemed. • Identify the requirements for the financial statement presentation and analysis of long-term liabilities.

5. Liabilities are.. • Creditors claims on total assets • Existing debts and obligations Liabilities must be settled in the future by transfer of assets or services.

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

7. Current Liability Types • Notes Payable • Accounts Payable • Unearned Revenues • Accrued Liabilities

8. 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.

9. Illustration 8-9 Notes Payable

10. Journal Mar 1 Cash 100,000 Notes Payable 100,000 (To record issuance of 12%, 4-month note to bank) Remember - Interest accrues over life of the note and must be recorded periodically. June 30 Interest Expense 4,000 Interest Payable 4,000 (To accrue interest for 4 months on note) $100,000 x .12 x 4/12 months

11. Sales Taxes Payable... • Are collected from customers. • Are expressed as a % of sales price. • Are required by law. • Must be sent to state often. • Are often rung separately from sales on the cash register.

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

13. Sales Taxes... When sales taxes are not rung up separately, total receipts are divided by 100% plus the sales taxes percentage. Total Receipts 100% + 6% 10,600 = $10,000 Sales 1.06

14. Sales Taxes... $10,000 x .06 = $ 600 Sales Taxes 10,600 = $10,000 Sales 1.06 Journal Mar 25 Cash 10,600 Sales 10,000 Sales Taxes Payable 600 (To record daily sales and sales taxes)

15. Payroll Taxes... Amount required by law to be withheld from employees’ gross pay. • Social Security taxes withheld (FICA) • Federal Income Taxes • State Income Taxes (if applicable)

16. Journal Mar 7 Salaries and Wages Expense 100,000 FICA Taxes Payable 7,250 Federal Income Taxes Payable 21,864 States Income Taxes Payable 2,922 Salaries and Wages Payable 67,964 Salaries and Wages Payable 67,964 Cash 67,964

17. Payroll Deductions Illustration 10-1

18. Unearned Revenues... Cash received before revenues are earned and recorded as liabilities until they are earned.

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

20. Current Maturities of Long-Term Debt The portion of the long-term debt that is due within the current year or operating cycle should be classified as a current liability.

21. FICTICTIOUS COMPANYBalance Sheet December 31, 2001 Assets Current Assets Cash $ 272 Marketable securities (current) 609 Receivables 74 Other current assets 83 Total current assets 1,038 Property and equipment (net) 317 Marketable securities (long-term) 322 Other long-term assets 280 Total Assets $1,957 Liabilities and Stockholders’ Equity Liabilities Current Liabilities Accounts payable $ 527 Notes payable 133 Current maturities of long term debt 100 Accrued liabilities and expenses 56 Total current liabilities 816 Long-term debt 83 Total liabilities 899 Stockholders’ equity Common stock 830 Retained earnings 228 Total Liabilities and stockholders’ equity $1,957

22. Liquidity Ratios... Measure the short-term ability of a company to pay its maturing obligations and to meet unexpected needs for cash. • Working capital • Current ratio • Acid-test ratio

23. Working Capital Measures short- term ability to pay liabilities Current Assets - Current Liabilities = Working Capital

24. Current Ratio Measure of short-term ability to pay obligations Current Assets Current Liabilities Current Ratio =

25. Cash,Marketable Securities, Net Receivables Current Liabilities Acid-Test Ratio Measure of company’s immediate short-term ability to pay obligations Acid-Test Ratio =

26. Line of Credit... Is a prearranged agreement between a company and a lender to allow the company to borrow up to an agreed-upon amount.

27. Long-Term Liabilities... Are obligations that are expected to be paid after 1 year.

28. Bonds... • Are a form of interest-bearing notes payable issued by corporations, universities and governmental agencies. • Are sold in small denominations, which makes them attractive to investors.

29. Illustration 10-6 Advantages of Bond Financing Over Common Stock

30. Secured Bonds... Have specific assets of the issuer pledged as collateral for bonds. • Mortgage Bond - a bond secured by real estate. • Sinking Fund Bond - a bond secured by specific assets to retire the bonds.

31. Page 463 in book Unsecured or Debenture Bonds... Are issued against the general credit of the borrower.

32. Page 463 in book Term Bonds... Are due for payment (mature) at a single specified future date.

33. Page 463 in book Serial Bonds... mature in installments.

34. Convertible Bonds... Can be changed into common stock at the bondholder’s option. Callable Bonds…Are subject to retirement prior at a stated dollar amount prior to maturityat the option of the issuer.

35. Issuing Bonds... • Requires formal approval by board of directors and stockholders. • Board of Directors must stipulate • Total number of bonds to be authorized • Total face value • Contractual Interest Rate

36. Bond Indenture... • The terms of a bond issue set forth in a legal document. • Summarizes the rights and privileges of bondholders and trustees. • Summarizes obligations and commitments of issuing company.

37. The amount of principle due at maturity date. Face Value... Contractual Interest Rate... Is the rate used to determine the amount of cash interest the borrower pays and investor receives.

38. Present Value... The value today of an amount to be received at some date in the future after taking into account current interest rates.

39. Market Interest Rate... The rate that investors demand for loaning funds. Not the same as contractual or stated rate.

40. Illustration 10-9 Cash Flow of Bonds

41. Accounting for Bond Issues Bonds may be issued at: • Face value • Below face value (discount) or • Above face value (premium).

42. Issuing Bonds at Face Value Assume that Devour Corporation issued 1,000, 10-year 10%, $1,000 bonds dated January 1, 2001 at 100 (100% of face value) with interest payable on July 1 and January 1. 1/1 Cash 1,000,000 Bonds Payable 1,000,00 (To record sale of bonds at face value)

43. Issuing Bonds at Face Value The bonds are reported in the long-term liability section of the balance sheet because the maturity date is more than 1 year away. The entry to record the semiannual interest on July 1 is: 7/1 Bond Interest Expense 50,000 Cash 50,000 (To record the payment of bond interest)

44. Issuing Bonds at Face Value On December 31 the following adjusting entry is required to record the $ 50,000 of interest accrued since July 1: 12/31 Bond Interest Expense 50,000 Bond Interest Payable 50,000 (To accrue bond interest)

45. Discount or Premiums on Bonds Often the contractual (stated) interest rate and the market (effective) interest rate differ… therefore bonds sell above or below face value.

46. Bond Discount... When the investor pays less than the face value of the bond. WHY? To adjust the contractual interest to the market interest rate.

47. Bond Premium... When the investor pays more than the face value of the bond. WHY? To adjust the contractual interest to the market interest rate.

48. Bond Prices Vary Inversely With Changes in Market Interest Rates Illustration 10-11

49. Selling Bonds at Discount January 1, 2001, Candlestick, Inc., sells $1 million, 5-year, 10% bonds at 98 with interest payable on July 1 and January 1. 1/1 Cash 980,000 Discount on Bonds Payable 20,000 Bonds Payable 1,000,000 (To record sale of bonds at a discount)

50. Illustration 10-12 Carrying Value Carrying (Book) Value of Bonds Long-term liabilities Bonds payable $1,000,000 Less: Discount on bonds 20,000 $980,000 payable