1 Principles of Accounting Kimmel Weygandt Kieso Chapter 10 Reporting and Analyzing Liabilities Prepared by Barbara Muller Arizona State University West John Wiley & Sons, Inc. © 2005

2 Chapter 10 Reporting and Analyzing Liabilities After studying this chapter, 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.

3 After studying this chapter, you should be able to: Prepare the entries for the issuance of bonds and interest expense. Describe the entries when bonds are redeemed. Identify the requirements for the financial statement presentation and analysis of liabilities. Chapter 10 Reporting and Analyzing Liabilities

4 Current Liabilities STUDY OBJECTIVE 1  Current liabilities are debts which 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

5 Types of Current Liabilities  Notes Payable  Accounts Payable  Unearned Revenues  Accrued Liabilities Taxes Salaries and Wages Interest

6 Let’s Review The time period for classifying a liability as current is one year or the operating cycle, whichever is: a. longer. d. possible. c. probable. b. shorter.

7 Let’s Review The time period for classifying a liability as current is one year or the operating cycle, whichever is: a. longer. d. possible. c. probable. b. shorter.

8 Notes Payable STUDY OBJECTIVE 2  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 Usually require the borrower to pay interest

9 Note Payable

10 Remember - Interest accrues over life of the note and must be recorded periodically. Journal Sept 1Cash100,000 Notes Payable100,000 (To record issuance of 12%, 4-month note to bank) Dec 31Interest Expense 4,000 Interest Payable 4,000 (To accrue interest for 4 months on note) $100,000 x.12 x 4\12 months

11 Journal Jan 1 Notes Payable100,000 Interest Payable 4,000 Cash 104,000 (To record payment of 1st National Bank interest-bearing note and accrued interest at maturity)

12 Sales Taxes Payable STUDY OBJECTIVE 3  Are collected from customers  Are expressed as a % of sales price  Are required by state law.  Remitted to the state monthly  Usually rung separately from sales on the cash register.

13 Journal Mar 25Cash10,600 Sales10,000 Sales Taxes Payable 600 (To record daily sales and sales taxes)

14 Payroll Deductions

15 Payroll Taxes  Various payroll taxes are required by law to be withheld from employees’ gross pay Social Security (FICA) taxes withheld, employer and employee make equal contributions Federal income taxes State income taxes (if applicable)

16 Journal Mar 7 Salaries and Wages Expense 100,000 FICA Taxes Payable (employee’s share) 7,250 Federal Income Taxes Payable 21,864 States Income Taxes Payable2,922 Salaries and Wages Payable 67,964 Mar 7Salaries and Wages Payable 67,964 Cash 67,964

17 Journal Mar 7 Payroll Tax Expense 13,450 FICA Taxes Payable (employer’s share) 7,250 Federal Unemployment Taxes Payable 800 State Unemployment Taxes Payable 5,400 Employers incur a second type of payroll-related activity. 1) Employer’s share of FICA 2) Federal unemployment 3) State unemployment

18 Unearned Revenue  Unearned revenue is cash received before service or product is delivered (that is, before revenue is earned)  Recorded as a liability until it is earned

19 Unearned Revenues  Examples of 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 As each game is completed Journal Aug 6Cash 500,000 Unearned Ticket Revenue 500,000 (To record sale of 10,000 tickets at $50 each ) Sept 7 Unearned Ticket Revenue 100,000 Ticket Revenue 100,000 (To record ticket revenue earned)

21 Current Maturities of Long- Term Debt  Current maturities of long-term debt are The portion of long-term debt due within the current year or operating cycle Classified as a current liability No adjusting entry is necessary

22 FICTICTIOUS COMPANY Balance Sheet December 31, 2004 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 payable133 Current maturities of long term debt100 Accrued liabilities and expenses 56 Total current liabilities816 Long-term debt 83 Total liabilities899 Stockholders’ equity Common stock 830 Retained earnings228 Total Liabilities and stockholders’ equity $1,957

23 Bonds STUDY OBJECTIVE 4  Bonds A form of long-term, interest-bearing note payable issued by corporations, universities and governmental agencies Sold in small denominations, (usually multiples of $1,000) which makes them attractive to investors Are in the form of a legal document that indicates the name of the issuer, the face value of the bonds, the contractual interest rate, and the maturity date

24 Bond Certificate

25 Bond Features  Bonds have many different features Secured bonds have specific assets pledged as collateral, unsecured do not Convertible bonds may be converted into common stock at the bondholder’s option Callable bonds are subject to retirement at a stated dollar amount prior to maturity

26 Accounting for Bond Issues STUDY OBJECTIVE 5  Bonds may be issued at Face value when ostated rate = market rate Below face value (discount) when ostated rate < market rate must discount price to get investors to buy Above face value (premium) when ostated rate > market rate all investors want to own so the price is bid up

27 Interest Rates and Bond Prices

28 Bond Terms  Face Value the amount of principal due at the maturity date of the bond  Discount when a bond is sold for less than its face value (the difference between the face value of a bond and its selling price)  Premium - when a bond is sold for more than its face value (the difference between the selling price and the face value of a bond)

29 Cash Flow of Bonds

30 Selling Bonds at Discount On January 1, 2005, Candlestick, Inc., sells $100,000, 5-year, 10% bonds at 98 with interest payable on January 1. Jan 1Cash 98,000 Discount on Bonds Payable 2,000* Bonds Payable 100,000 (To record sale of bonds at a discount) *The discount account is a contra account to the bond payable, not an asset account.

31 Statement Presentation of Discounted Bonds Long-term liabilities Bonds payable $ 100,000 Less: Discount on bonds payable 2,000 $98,000 Carrying Value

32 Selling Bonds at Premium On January 1, 2005, Candlestick, Inc., sells $100,000, 5-year, 10% bonds at 102 with interest payable on January 1. Jan 1Cash102,000 Bonds Payable 100,000 Premium Bonds Payable 2,000* (To record sale of bonds at a premium) *Premium is added to bonds payable on the balance sheet

33 Statement Presentation of Premium Bonds Long-term liabilities Bonds payable $ 100,000 Add : Premium on bonds payable 2,000 $102,000 Carrying Value

34 Amortizing Bond Discount/Premium  Candlelight would amortize the $2,000 discount/premium as follows $2,000 ÷ 5 Interest Periods = $400 Annually

35 Amortization of Bond Discount

36 Amortization of Bond Premium

37 Bond Retirements STUDY OBJECTIVE 6  Bonds may be redeemed at maturity or before maturity

38 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

39 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 The carrying value of the bonds is the bond payable plus the premium or minus the discount

40 Financial Statement Presentation and Analysis STUDY OBJECTIVE 7  Current liabilities are listed first under “Liabilities” on the balance sheet  A common method is to list the current liabilities in order of magnitude, beginning with the largest  Long-term liabilities are listed in a separate section of the balance sheet

41 General Motors Corporation- Automotive Division Statement of Cash Flows (partial) 2001 (in millions) Cash flows from financing activities Net increase (decrease) in loans payable $ 194 Long-term debt - borrowings 5,850 Long-term debt-repayments (2,602) Repurchases of common and preferred stocks (264) Proceeds from issuing common and preferred stocks 517 Cash dividends paid to stockholders (1,201) Net cash (used in) provided by financing activities $2,494

42 ANALYSIS  Debt to Total Assets Ratio i ndicates the extent to which a company’s debt could be repaid by liquidating assets  Times Interest Earned Ratio indicates a company’s ability to meet interest payments as they become due

43 ANALYSIS  Unrecorded debt occurs because sometimes a company’s balance sheet does not properly record or disclose all its debts Contingencies are events with uncertain outcomes (lawsuits, warranties, etc) “Off-balance sheet financing” occurs when the company borrows funds in such a way that the obligations are not recorded (leases)

44 Let’s Review What term is used for bonds that have specific assets pledged as collateral: a. callable bonds. d. discount bonds. c. secured bonds. b. convertible bonds.

45 Let’s Review What term is used for bonds that have specific assets pledged as collateral: a. callable bonds. d. discount bonds. c. secured bonds. b. convertible bonds.

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