Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Chapter 10 Reporting and Interpreting Liabilities McGraw-Hill/Irwin

10-2 Learning Objective 1 Explain how the reporting of liabilities assists decision- makers.

10-3 Decisions Related To Liabilities Before extending credit, a credit manager for a company must assess: 1. How much does the borrower owe to others? 2.What was the reason for the past borrowings? 3.Will the company be able to repay the amount borrowed on time? Before extending credit, a credit manager for a company must assess: 1. How much does the borrower owe to others? 2.What was the reason for the past borrowings? 3.Will the company be able to repay the amount borrowed on time?

10-4 Current Liabilities Due within one year or the company’s operating cycle, whichever is longer. Long-Term Liabilities Due after one year or the company’s operating cycle, whichever is longer. Reporting Liabilities

10-5 Learning Objective 2 Explain how to account for common types of current liabilities.

10-6 Exh. 9.2 Current and Long-Term Liabilities

10-7 Measurement of Liabilities The dollar amount reported for liabilities results from: 1.The initial amount of the liabilities 1.The initial amount of the liabilities. A liability is recorded at its cash equivalent, which is the amount of cash that a creditor would accept to settle the liability immediately. 2.Additional amounts owed to the creditor 2.Additional amounts owed to the creditor. Liabilities are increased whenever additional obligations arise, including interest charges. 3.Payments or services provided to the creditor 3.Payments or services provided to the creditor. Liabilities are reduced whenever the company makes payments or provides services to the creditor. The dollar amount reported for liabilities results from: 1.The initial amount of the liabilities 1.The initial amount of the liabilities. A liability is recorded at its cash equivalent, which is the amount of cash that a creditor would accept to settle the liability immediately. 2.Additional amounts owed to the creditor 2.Additional amounts owed to the creditor. Liabilities are increased whenever additional obligations arise, including interest charges. 3.Payments or services provided to the creditor 3.Payments or services provided to the creditor. Liabilities are reduced whenever the company makes payments or provides services to the creditor.

10-8 Accounts Payable – Purchase of goods or services on credit. Accrued Liabilities – An expense is incurred in one accounting period, the cash payment in a later period. Sales Tax Payable – Liability resulting when a company collects sales tax for the state. Notes Payable – Occurs when one company borrows money from another. Current Liabilities Unearned Revenue – The receipt of cash before goods or services are provided.

10-9 Accrued Payroll Taxes Employers incur several expenses and liabilities from having employees.

10-10 Exh. 9.5 Accrued Payroll Taxes FICA Taxes Medicare Taxes Federal Income Tax State and Local Income Taxes Voluntary Deductions Gross Pay Net Pay

10-11 FICA Taxes Medicare Taxes 2006: 6.2% of the first $94,200 earned in the year. 2006: 1.45% of all wages earned in the year. Employers owe the FICA amount withheld from employees’ gross pay to the IRS. FICA Taxes

10-12 Here is information about the payroll for General Mills: Recording Payroll

10-13 Exh. 9.3 Notes Payable PROMISSORY NOTE Face Value Date after date promise to pay to the order of National Bank, Boston, MA Dollars plus interest at the annual rate of. PROMISSORY NOTE Face Value Date after date promise to pay to the order of National Bank, Boston, MA Dollars plus interest at the annual rate of. $200,000Sept. 30, 2007 One YearI Two hundred thousand and no/ % Janet Smith, CFO For Matrix, Inc. Matrix, Inc. borrows $200,000 from National Bank

10-14 On September 30, 2007, Matrix, Inc. would do the following: Notes Payable Leading to this journal entry:

10-15 Notes Payable Interest = Principal × Rate × Time Interest = $200,000 × 12% × 3/12 9/30/0712/31/0712/31/08 Note Issues Year End Note Due

10-16 Notes Payable On December 31, 2007, Matrix, Inc. would prepare this journal entry...

10-17 On September 30, 2008, Matrix, Inc. must pay the interest and principal on the note. Notes Payable $24,000 = $200,000 × 12% × 12/12

10-18 Notes Payable On September 30, 2008, Matrix, Inc. would prepare these journal entries...

10-19 Sales Tax Payable Frank’s Sporting Goods sells a raft for $750 and collects the required 6% sales tax for the state.

10-20 On 6/1/07, Excel Catering received $1,500 in advance for catering a party on 7/4/07. Unearned Revenues

10-21 Unearned Revenues Excel finished catering the party on July 4 th and does the following...

10-22 Learning Objective 3 Analyze and record bond liability transactions.

10-23 Long-term Liabilities

10-24 Prepare the entry for Jan. 1, 2008, to record the following bond issue by Matrix, Inc. Face Value = $10,000,000 Stated Interest Rate = 10% Interest Date = December 31 Bond Date = Jan. 1, 2008 Maturity Date = Dec. 31, 2010 (3 years) Prepare the entry for Jan. 1, 2008, to record the following bond issue by Matrix, Inc. Face Value = $10,000,000 Stated Interest Rate = 10% Interest Date = December 31 Bond Date = Jan. 1, 2008 Maturity Date = Dec. 31, 2010 (3 years) Bonds Issued at Face Value

10-25 Bonds Issued at Face Value 1/1/08 Bonds Issued $10,000,000 Received 12/31/08 Interest Paid 12/31/09 Interest Paid 12/31/10 Interest Paid $10,000,000 Repaid Face Amount Interest $10,000,000 × 10% × 12/12 = $1,000,000

10-26 Bonds Issued at Face Value On January 1, 2008, the bonds are issued to the public.

10-27 Bonds Issued at Face Value On 12/31/08 the first annual interest payment is due to the bondholders. $10,000,000 × 10% = $1,000,000

10-28 Bond Issued Below or Above Face Value 6% Stated Rate Rate 4% Market Rate Wow, I’ll pay extra PremiumPremium What lenders expect What lenders think What lenders pay 6% Market Rate It’s just enough Face Value What lenders expect What lenders think What lenders pay 8% Market Rate I’m not attracted (yet) DiscountDiscount What lenders expect What lenders think What lenders pay

10-29 Bond Issued Below or Above Face Value Face value Stated interest rate Issue price Market interest rate Used only to determine cash interest payments Used to determine the bond liability and interest expense

10-30 On Jan. 1, 2008, Matrix, Inc. issues these bonds: Face Value = $10,000,000 Issue Price = % of par value Stated Interest Rate = 10% Market Interest Rate = 12% Interest Date = December 31 Bond Date = January 1, 2008 Maturity Date = December 31, 2010 (3 years) On Jan. 1, 2008, Matrix, Inc. issues these bonds: Face Value = $10,000,000 Issue Price = % of par value Stated Interest Rate = 10% Market Interest Rate = 12% Interest Date = December 31 Bond Date = January 1, 2008 Maturity Date = December 31, 2010 (3 years) Bonds Issued at a Discount

10-31 $10,000,000  % Issuing Bonds at a Discount

10-32 Issuing Bonds at a Discount On January 1, 2008, Matrix will record the issuance of the bonds with the following journal entry.

10-33 $9,519,634 × 12% = $1,142,356 $1,142,356 - $1,000,000 = $142,356 Issuing Bonds at a Discount

10-34 Maturity Value Carrying Value Issuing Bonds at a Discount

10-35 Issuing Bonds at a Discount $480,366 - $142,356 = $338,010

10-36 On January 1, 2008, Matrix, Inc. issues these bonds: Par Value = $10,000,000 Issue Price = % of par value Stated Interest Rate = 10% Market Interest Rate = 8% Interest Date = December 31 Bond Date = January 1, 2008 Maturity Date = December 31, 2010 (3 years) On January 1, 2008, Matrix, Inc. issues these bonds: Par Value = $10,000,000 Issue Price = % of par value Stated Interest Rate = 10% Market Interest Rate = 8% Interest Date = December 31 Bond Date = January 1, 2008 Maturity Date = December 31, 2010 (3 years) Bonds Issued at a Premium

10-37 Bonds Issued at a Premium $10,000,000  %

10-38 Bonds Issued at a Premium On January 1, 2008, Matrix will record the issuance of the bonds with the following journal entry.

10-39 Bonds Issued at a Premium $10,515,419 × 8% = $841,234 $1,000,000 - $841,234 = $158,766

10-40 Bonds Issued at a Premium Maturity Value Carrying Value

10-41 Bonds Issued at a Premium $515,419 - $158,766 = $356,653

10-42 Early Retirement of Debt On January 1, 2009, Matrix retires the bonds issued at a premium shown below. Matrix paid $10,200,000 to retire the bonds.

10-43 Early Retirement of Debt The retirement will have the following impact on the balance sheet of Matrix, Inc:

10-44 Learning Objective 4 Interpret the current ratio and times interest earned ratio.

10-45 Evaluate the Results Current Assets Current Liabilities Net Income Before Interest and Taxes Interest Expense

10-46 Current Ratio = Current Assets Current Liabilities Measures whether the company has enough current assets to pay what it currently owes.

10-47 Times Interest Earned Ratio = Net Income + Interest Expense + Income Tax Expense Interest Expense This ratio shows the amount of resources generated for each dollar of interest expense.

10-48 Understanding Common Features of Debt

10-49 Learning Objective 5 Describe the additional liabilities information reported in the notes to the financial statements.

10-50 Contingent Liability PossiblePossible Don’t mention it RemoteRemote Record a liability Contingent liability ProbableProbable YesYes Describe in notes NoNo How likely is the liability? Can we estimate the amount? Accounting required.

10-51 End of Chapter 10