Liabilities Current liabilities: due in one year or less –Types –Ratios Long-term liabilities: due in more than one year –Bonds –Capital leases versus operating leases Contingent liabilities: possible future liabilities

Current Liabilities Interest payable Unearned revenue Sales tax payable Payroll taxes payable

Interest Payable Adjusting entry: accrued interest ($100 x 12% x 3/12) Interest Expense3 Interest Payable3 N/P paid: N/P100 Interest Expense 9 Interest Payable 3 Cash112 Interest payable is a current liability

Unearned Revenue When cash is received: Cash100 Unearned Revenue100 When revenue earned: Unearned Revenue100 Revenue 100 Unearne d Revenue is a current liability

Sales Tax Payable Sale: Coles County 6.25% Cash Sales (Revenue)100 Sales Tax Payable6.25 When sales tax paid to gov: Sales Tax Payable6.25 Cash 6.25 Sales tax not an expense for retailer Why generally no sales tax on Internet purchases ??? Sales Tax payable is a current liability

Payroll Taxes Payable $400 Employee Wages Wage expense Federal income tax payable (W-4 exemptions, refund?)46.00 State income tax payable (IL 3%; others 0 – 10%) City income tax payable (generally larger cities, none in IL) 4.00 Social security tax payable (employee, 6.25% of $87,000) Employee Medicare tax payable (employee, 1.45% of all) 5.80 Pension contribution payable (retire before 80, put max in) Health insurance payable (generally dependents)40.00 Cash (not much….)243.20

Social Security and Medicare Issues Depletion of social security funds –Social security payments 2 for 1 –Live too long after retirement –Vote often –Social security contributions Not enough Gen X, Y, Z, etc. Company matches your Social Security and Medicare contributions –Self-employed and independent contractors Medicare funds –Health insurance for those collecting social security

CURRENT LIABILITY RATIOS Short-Term Creditors RATIOS CURRENT CA / CL > 2?? QUICK (ACID-TEST) CA – INV / CL > 1??? WORKING CAPITAL CA - CL > 0???

Long-term liabilities Bonds Capital leases

BOND BASICS IBM $1,000 LOAN Interest each year at coupon rate$1,000 at maturity

Bond Values Lend IBM $1,000 for 30 8%, two years later rates on similar bonds decrease to 6% –Still receiving $80 per year for 28 more years PV of Annuity, 28 years, 6% –$80 x =$1, –Receiving $1,000 in 28 years PV of $1, 28 years, 6% –$1,000 x.1956 = $ –Value of bond = PV of Int Annuity + PV of $1,000 $1, $ = $1, –26.8% increase in bond value –If coupon rate > required rate of return, value of bond will be > $1,000

Bond Values Discount bond cash flows at required rate of return (yield to maturity) –Don’t use coupon rate –If you do, you’ll find value is $1,000 Interest rates increase, bond values decrease Interest rates decrease, bond values increase Bonds are priced at a percent of par value –104, 98, etc.

Bonds Advantages –Interest on bonds deducted as an expense on tax return Dividends on common stock: not an expense –No dilution of stockholders’ interest Disadvantages –Failure to pay debt can result in bankruptcy –Dividends discretionary; interest is not

Bond Journal Entries When bonds are issued: Cash1000 Bonds Payable1000 When interest is paid: Interest expense 40 Cash 40 ($1000 x 8% x 6/12)

Leasing long-term assets Advantages of operating leases –No concern about residual value –Generally smaller down payment –Can deduct rent on tax return –Keeps liability off balance sheet However, should disclose lease commitments in footnotes

Leasing long-term assets Capital leases –Lease property for most of its useful life –Can purchase the property for nominal amount at end of lease –Lease payments represent financing –Treat as an asset and long-term liability

Contingent liability Possible future liability –Either Amount of liability can not be reasonably determined Or not sure if liability exists –Lawsuits, environmental issues, etc. –Generally disclose in footnotes