Transcript Chapter 10 Chapter 10 Reporting and Analyzing Liabilities After studying Chapter 10, you should be able to: Explain a current liability and identify the major.

Chapter 10
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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 types of bonds.
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Chapter 10
Reporting and Analyzing Liabilities
After studying Chapter 10, you should
be able to:
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
liabilities.
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Liabilities are..
Creditors claims on total assets
Existing debts and obligations
Liabilities must be settled in the
future by transfer of assets or
services.
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Current Liabilities
Can reasonably be expected to be 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.
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Types 0f Current Liability
Notes Payable
Accounts Payable
Unearned Revenues
Accrued Liabilities
Taxes
Salaries and Wages
Interest
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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.
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Journal
Sept 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.
Dec 31 Interest Expense
4,000
Interest Payable
4,000
(To accrue interest for 4 months on note)
$100,000 x .12 x 4\12 months
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Journal
Jan 1 Notes Payable
100,000
Interest Payable
4,000
Cash
104,000
(To record payment of 1st National Bank interestbearing note and accrued interest at maturity)
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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.
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Journal
Mar 25 Cash
10,600
Sales
Sales Taxes Payable
(To record daily sales and
sales taxes)
10,000
600
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Payroll Deductions
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Payroll Taxes...
Amount required by law to be withheld
from employees’ gross pay.
Social Security taxes withheld
(FICA- 7.65 for 2003)
Federal income taxes
State income taxes (if applicable)
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Journal
Mar 7 Salaries and Wages Expense 100,000
FICA Taxes Payable
7,650
Federal Income Taxes Payable
21,864
States Income Taxes Payable
2,922
Salaries and Wages Payable
67,564
Mar 7 Salaries and Wages Payable
Cash
67,564
67,564
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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
13,850
FICA Taxes Payable
Federal Unemployment Taxes Payable
State Unemployment Taxes Payable
7,250
800
5,400
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Unearned Revenues...
Cash received before revenues
are earned and recorded as
liabilities until they are earned.
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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
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Journal
Aug 6
Cash
500,000
Unearned Ticket Revenue
500,000
(To record sale of 10,000 tickets)
Sept 7
Unearned Ticket Revenue 100,000
Ticket Revenue
(To record ticket revenue earned)
100,000
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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.
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FICTICTIOUS COMPANY
Balance Sheet
December 31, 2004
Assets
Current Assets
Cash
Marketable securities (current)
Receivables
Other current assets
Total current assets
Property and equipment (net)
Marketable securities (long-term)
Other long-term assets
Total Assets
Liabilities and Stockholders’ Equity
Liabilities
Current Liabilities
Accounts payable
Notes payable
Current maturities of long term debt
Accrued liabilities and expenses
Total current liabilities
Long-term debt
Total liabilities
Stockholders’ equity
Common stock
Retained earnings
Total Liabilities and stockholders’ equity
$ 272
609
74
83
1,038
317
322
280
$1,957
$
527
133
100
56
816
83
899
830
228
$1,957
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Line of Credit...
Is a prearranged agreement
between a company and a
lender to allow the company
to borrow up to an agreedupon amount.
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Long-Term Liabilities...
Are obligations that are
expected to be paid after 1
year.
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Bonds...
Are a form of interest-bearing notes
payable issued by corporations,
universities and governmental
agencies.
Are sold in small denominations,
(usually multiples of
$1,000) which makes
them attractive to
investors.
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Bonds
A legal document that indicates:
name of the issuer
face value of the bonds
contractual interest rate
maturity date
other data
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Secured Bonds...
Have specific assets
of the issuer pledged
as collateral for
bonds.
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Unsecured or Debenture
Bonds...
Are issued against the general credit
of the borrower.
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Convertible Bonds...
Can be changed into
common stock at the
bondholder’s option.
Callable Bonds…
subject to retirement at a
stated dollar amount prior
to maturity at the option
of the issuer.
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Issuing Bonds...
Requires formal approval by
Board of Directors and/or
stockholders.
Board of Directors must stipulate
Total number of bonds to be
authorized
Total face value
Contractual
interest rate
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Accounting for Bond Issues
Bonds may be issued at:
Face value
Below face value (discount) or
Above face value (premium).
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Bond Terms
Face Value - Amount of principal due
at the maturity date of the bond.
Discount - The difference between
the face value of a bond and its
selling price, when a bond is sold
for less than its face value.
Premium - The difference between
the selling price and the face value
of a bond when a bond is sold for
more than its face value.
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Bond Terms
Present Value - value today of an amount
to be received at some date in future
after taking into account current interest
rates
Contractual Interest Rate - rate used to
determine the amount of interest the
borrower pays and the investor receives
Market Interest Rate - rate investors
demand for loaning money to the
corporation
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Cash Flow of Bonds
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Issuing Bonds at Face Value
Devor Corporation issued 100, 5-year,
10%, $1,000 bonds dated January 1,
2004 at 100 (100% of face value) with
interest payable annually January 1.
Jan 1 Cash
100,000
Bonds Payable
100,000
(To record sale of bonds at face value)
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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 annual interest on
December 31 is:
Dec 31 Bond Interest Expense 10,000
Bond Interest Payable
10,000
(To accrue bond interest)
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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.
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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.
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Selling Bonds at Discount
On January 1, 2004, Candlestick, Inc., sells $100,000,
5-year, 10% bonds at 98 with interest payable on
January 1.
Jan 1 Cash
98,000
Discount on Bonds Payable 2,000
Bonds Payable
(To record sale of bonds at a discount)
100,000
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Carrying (Book) Value of Bonds
Long-term liabilities
Bonds payable
Less: Discount on bonds
payable
$ 100,000
2,000
$98,000
Carrying Value
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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.
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Selling Bonds at Premium
On January 1, 2004, Candlestick, Inc., sells
$100,000, 5-year, 10% bonds at 102 with interest
payable on January 1.
Jan 1 Cash
102,000
Bonds Payable
Premium Bonds Payable
100,000
2,000
(To record sale of bonds at a premium)
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Carrying (Book) Value of Bonds
Long-term liabilities
Bonds payable
Add : Premium on bonds
payable
$ 100,000
2,000 $102,000
Carrying Value
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Amortizing Bond
Discount/Premium
Candlelight would amortize the
$2,000 discount/premium as
follows:
$2,000 ÷ 5 Interest Periods
= $400 Annually
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Bond Retirement
Bonds may be
redeemed at
maturity or
before
maturity.
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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.
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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.
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Partial Balance Sheet
Long-term liabilities
Bonds payable 10% due in 2009 $1,000,000
Less: Discount on bonds payable
80,000
Notes payable, 11%, due in 2015
and secured by plant assets
Lease liability
Total long-term liabilities
$ 920,000
500,000
540,000
$1,960,000
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General Motors CorporationDivision
Cash Flows (partial)
(in millions)
Automotive
Statement of
2001
Cash flows from financing activities
Net increase (decrease) in loans payable
Long-term debt - borrowings
Long-term debt-repayments
Repurchases of common and preferred stocks
Proceeds from issuing common and preferred stocks
Cash dividends paid to stockholders
Net cash (used in) provided by financing activities
$ 194
5,850
(2,620)
(264)
517
(1,201)
$2,476
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Debt to Total Assets Ratio...
Indicates the extent to which a
company’s debt could be repaid by
liquidating assets.
Debt to Total Assets Ratio =
Total Liabilities
Total Assets
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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
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Working Capital
Measures short- term ability to
pay liabilities
Current Assets - Current Liabilities =
Working Capital
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Current Ratio
Measure of short-term ability
to pay obligations
Current Ratio =
Current Assets
Current Liabilities
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Acid-Test Ratio
Measure of company’s
immediate short-term ability
to pay obligations
Acid-Test
Ratio =
Cash,Marketable
Securities, Net Receivables
Current Liabilities
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Leverage/Solvency Ratios
Measure the ability of a company
to survive over a long-period of
time.
Debt to Equity Ratio
Debt to Assets Ratio
Times Interest Earned Ratio
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Debt to Equity Ratio
Indicates the extent to which
a company has borrowed
relative to its equity.
Debt to Equity
Ratio
=
Total Liabilities
Total Equity
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Debt to Total Assets Ratio
Indicates the extent to which
a company used debt to
finance its assets.
Debt to Total Assets =
Ratio
Total Liabilities
Total Assets
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Times Interest Earned Ratio...
Provides an indication of company’s
ability to meet interest payments as
they come due.
Times Interest Earned Ratio=
Income Before Interest Expense & Tax Expense
Interest Expense
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