REPORTING AND ANALYZING LIABILITIES 201Lec10.PPTX 10 REPORTING AND ANALYZING LIABILITIES Claims on total assets - obligations to employees (current and retired), governments, suppliers, banks and financiers, law suit settlements, customers, etc “Current” if due within 1 year 1

Notes Payable Similar calculations to notes receivable. Record principle. Interest only as incurred Sometimes, notes are paid off in installments over several years. If so, balance shows split as follows: Current Liabilities: Current Maturity of Long-Term Debt $ xxxxx Long-term Liabilities: Long-term Debt $ xxxxx Text in appendix 10C shows a mortgage note installment schedule which calculates current & long-term. 2

EXAMPLE: On January 1, 2016 Konk borrowed $20,000 at an annual interest rate of 10%. The loan requires 6 annual payments of $4,592.15. Prepare an installment payment schedule. Payment Amount Interest** Principal Balance (Balance)(10%) (Amount-Interest) 1-1-16 20000.00 1-1-17 4592.15 2000.00 2592.15 17407.85 1-1-18 4592.15 1740.78 2851.37 14556.48 1-1-19 4592.15 1455.65 3136.50 11419.98 1-1-20 4592.15 1142.00 3450.15 7969.83 1-1-21 4592.15 796.98 3795.17 4174.66 1-1-22 4592.12 417.46 4174.66 0 ** Use 5% if semi-annual payments, use 2.5% if quarterly payments! Balance sheet at 12/31/16 Current liabilities: Interest payable (recorded by AJE on 12/31/16) >>>>>> $ 2,000.00 Current portion of long-term debt 2,592.15 Long term liabilities: – Notes payable $17,407.85 3

Current Liabilities – Sales Tax Payable Assessed on buyer but collected by seller. - Seller is liable for determining when sales tax applies and how much to charge. Generally on tangible goods, not services. States have varying rules and exceptions. - Required for sales to an in-state buyer. Once collected, sales tax payable is a liability of seller. If seller isn’t liable, states assess a “use” tax payable by the buyer. 4

Current Liabilities – Payroll Payables EMPLOYEE’S TAXES WITHHELD: FICA (or OASDI) is made up of two components: - Social Security (up to a maximum) - Medicare (on unlimited wages) Both are a percentage of gross wages Federal income tax FIT - Based on filing status State income tax SIT “ “ “ “ 5

Current Liabilities – Payroll Payables EMPLOYERS TAX EXPENSE: Match employee FICA (Social Security & Medicare) Federal Unemployment FUTA State Unemployment SUTA (or SUI)- Depends on state Employers also have required workers comp insurance and other optional fringes (health insurance, pension, vacation, etc). 6

EXAMPLE: Record $10,000 of wages & related payroll taxes. To record wages and EMPLOYEE withholdings: Wage Expense 10000.00 FICA payable (assume amount given in facts) 765.00 FIT payable (assume amount given in facts) 1500.00 SIT payable (assume amount given in facts) 400.00 Wage payable (or cash if payday) 7335.00 To record EMPLOYER payroll tax expense: Payroll Tax Expense FICA payable (Match employee) 765.00 FUTA payable (assume amount given in facts) 80.00 SUTA payable (assume amount given in facts) 360.00 (Plug) 1205.00 7

Packers Unearned Revenues (also in chapters 3, 4) Cash received before revenue is earned creates a liability. For example: Customer deposits for future service (retainers) Sale of airline tickets for future travel Sale of season tickets to sporting events Rent received in advance Magazine subscriptions Packers 8

BONDS Form of debt similar to notes payable. Typically very Long-Term borrowing where large $ needed. Somewhat like common stock in that bonds are sold to general public in small denominations. All Bonds have: Face value - Basis for interest and principal. Contract Rate - Fixed interest rate. 9

Bond Issue is registered with the SEC. Bond Indenture is a legal document which provides all details, agreements, etc about a bond issue. - contract rate, face amount - security if default - payment terms - callable or convertible, etc. Bonds are usually sold through an underwriter (often a stock broker) to the public. 10

Bond Cash Flows Issuing corporation gets face value now. Investor gets interest over bond life + face value at maturity. EXAMPLE: On 1/1/16, issue bond with: Face Value = $200 million. Matures in 50 years. Contract rate = 12%, paid semi annually. interest payment = 200 million x .12 x 6/12 = $12 million issuer 1/1/16 $200 million investor Every 6 months for 50 years $12 million 1/1/66 $200 million 11

Market Rate is current borrowing rate. Amount received by issuing company depends on current market interest rate on date of sale. Contract Rate is fixed rate over life of bond Market Rate is current borrowing rate. Changes daily! L I F E O F B O N D R A T E R A T E L I F E O F B O N D 12

Assume market rate on 1/15/16 = 12%. EXAMPLE: Assume on 1/1/16 issuer has approval by SEC for a bond issue with a contract rate of 12%. Several $20,000 bonds are sold over a 6 month period. Sold 1/15/16 Assume market rate on 1/15/16 = 12%. Bond will sell for Price = “100” or “Par”. Means 100% of Face value Assume market rate on 3/1/16 = 13%. Bond will sell at a “discount. Price less than 100. Assume market rate on 6/1/16 = 11%. Bond will sell at a “premium”. Price more than 100. Sold 3/1/16 Sold 6/1/15 13

Contract rate (Fixed) is Blue line Market rate (varies daily) is red line 11% A 12% T 13% E Market rate to price Inverse relationship Sell at premium Sell at par Sell at loss L I F E O F B O N D 14

Journal Entries Issuing the bond at par (face value): Cash 20000 Bonds Payable 20000 15

Journal Entries Issuing the bond at $1,000 DISCOUNT: Cash 19,000 Discount on Bonds Payable 1,000 Bonds Payable 20,000 Note: Discount on Bonds Payable is a “contra-liability” account. 16

Carrying (Book) Value of Bonds Balance Sheet Long-term liabilities: Bonds payable $20,000 Less: DISCOUNT on bonds payable 1,000 $19,000 * * Called “carrying value” of bonds 17

Journal Entries Issuing the bond at $1,000 PREMIUM: Cash 21,000 Premium on Bonds Payable 1,000 Bonds Payable 20,000 Note: Premium on Bonds Payable is ADDED to the bond liability on the balance sheet. 18

GAAP rules for Discount or Premium GAAP treats difference between par and actual sale price of bond as an adjustment to total interest over life of bond. ADJUSTMENT is referred to changing the yield of the bond from the contract interest rate to the market interest rate. Adjustment is recorded each time interest is paid using a straight-line amortization of discount or premium. We won’t cover the effective interest amortization option. It is sort of like a double declining balance method. 19

Amount received on issue 19,000 Additional interest (per GAAP) 1,000 Example: Assume $20,000 bond paying 12% semi annually was issued at a $1,000 discount. $1,200 of interest is due every 6 months for 50 years (100 interest payments). Amount due at maturity 20,000 Amount received on issue 19,000 Additional interest (per GAAP) 1,000 Discount amortization = $1,000 / 100 = $10 * * Add to interest expense for each 6 month payment 20

Balance Sheet Journal entry - Interest payment (Every 6 months): Interest Expense (1200 + 10) 1210 Cash 1200 Discount on Bonds Payable 10 Balance Sheet Long-term liabilities: Bonds payable $20,000 Less: DISCOUNT on bonds payable 990 * $19,010 * 1,000 – 10 amortization = 990 Note: A premium gets added. 21

Variation: Say it was issued at a $1,000 Premium. That means interest adjustment is negative! Journal entry to record interest expense every 6 months: Interest Expense (1200 – 10) 1190 PREMIUM on Bonds Payable 10 Cash 1200 22

Journal Entries – Redeeming Bonds If redeemed at maturity, face amount is payable if issued at par, discount or premium Bonds Payable 20000 Cash 20000 Note: Balance in discount or premium account would have been amortized down to zero by the time the bond is redeemed. If redeemed before maturity, record gain or loss = Cash paid less bond carrying value. 23

Other Issues – Contingent Liabilities Are events with uncertain outcomes. Lawsuits, money back guaranties, mail in rebates GAAP rule: Must be recorded as a liability if: - the company can determine a reasonable estimate of the expected loss and - it is probable it will occur. Otherwise, mention in footnotes 24

Other Issues – Lease Liabilities GAAP Rule for Capital Lease Treatment: Sometimes, a lease is really a disguised asset purchase. For example: Lease a car worth $22,000 for 2 years with monthly payments of $1,000. ($24,000 total payments) Also get option to purchase it for $1 at end of lease. GAAP requires this type of lease to be recorded as if it were an asset purchase and future lease payments to be recorded as liabilities. - Rigorous calculations are needed using present values. (A normal lease (like in chapter 9), is called an operating lease) 25

Ratios LIQUIDITY RATIOS: - Current Ratio Previously discussed in chapter 2. SOLVENCY RATIOS: - Debt to Total Assets Ratio Previously discussed in chapter 2. - Times Interest Earned Ratio - Discussed next 26

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 & Income Tax Interest Expense 27