1. Accounting for and Presentation of Liabilities
CHAPTER 7
Accounting for and Presentation of Liabilities
McGraw-Hill/Irwin
© 2007 The McGraw-Hill Companies, Inc., All Rights Reserved.

2. Nature of Liabilities
L O 1
Current liabilities include:
Accounts payable
Short-term debt (Notes payable)
Current maturities of long-term debt
Unearned revenue or deferred credits
Other accrued liabilities
Liabilities are obligations that represent “probable future sacrifice of economic benefits.”
The term accrued expenses is often used on the balance sheet to describe liabilities.
Current liabilities are those liabilities that will be paid within one year of the current balance sheet date.
Noncurrent liabilities include:
Long-term debt (Bonds payable)
Deferred tax liabilities
Minority interest in subsidiaries

3. Nature of Liabilities
L O 1
The recognition of a liability usually means an expense is recorded.
Expenses reduce income.
Lower net income means lower ROI.

4. Current Liabilities Short-Term Debt
L O 1
Short-Term Debt
On January 15, 2007Matrix, Inc. borrows $25,000 from 1st National Bank to provide working capital. The following entry is recorded:
This transaction has the following effect on the financial statements of Matrix:

5. Current Liabilities Interest Expense
L O 1
Interest Expense
The $25,000 note bears interest at 9% per year. Interest is payable to the bank each December 31st. The following entry is recorded to accrue interest each month:
This transaction has the following effect on the financial statements of Matrix:

6. Interest Calculation Methods
L O 2
Straight Interest
Interest = Principal × Rate × Time in years
= $25,000 × 0.09 × 1
= $ 2,250
Annual Percentage Interest Rate (APR)
APR = Interest Paid ÷ Money available × Time
= $2,250 ÷ $25,000 × 1
= 9%

7. Interest Calculation Methods
L O 2
Discount Basis
Proceeds = Principal − Interest
= $25,000 − $2,250
= $22,750
Annual Percentage Interest Rate (APR)
APR = Interest Paid ÷ Money available × Time
= $2,250 ÷ $22,750 × 1
= 9.89%

8. Current Liabilities Discount Basis
L O 2
Discount Basis
On January 15, 2007, Matrix, Inc. borrows $25,000 from 1st National Bank to provide working capital. The note was discounted by the bank and the net proceeds given to Matrix.

9. Current Liabilities
L O 2
The $25,000 note bears interest at 9% per year. Interest is payable to the bank each December 31st. The following entry is recorded to accrue interest each month:

10. Current Maturities on Long-Term Debt
Any portion of long-term debt that is to be repaid within a year of the balance sheet date is reclassified from the noncurrent liability section to the current liability section under the title, current maturities on long-term debt.

11. Otherwise, Net (or Total Invoice Amount) is Due . . .
Accounts Payable
Amounts owed to suppliers for goods and services that have been provided on credit.
Purchase Discounts
2/10, n/30
. . . for this number of days.
Otherwise, Net (or Total Invoice Amount) is Due . . .
. . . in this Number of Days.
Percentage Discount . . .

12. Accounts Payable and Discounts
Matrix, Inc. purchased $62,000 of merchandise for resale.
Gross
Method
Net
Method

13. Accounts Payable and Discounts
Matrix, Inc. paid for the merchandise within the discount period.
Gross
Method
Net
Method
*A contra-expense account to COGS

14. Accounts Payable and Discounts
Matrix, Inc. did not pay for the merchandise within the discount period.
Gross
Method
Net
Method

15. Unearned Revenue or Deferred Credits
L O 3
Unearned Revenue or Deferred Credits
Unearned revenue is created when customers pay for services or products before delivery.
On January 1, 2007, Matrix, Inc. receives $2,400 cash as an advance payment for a one-year subscription to its monthly investment newsletter.
Our goal is to recognize
revenue as the subscription
is fulfilled each month.
1/1/07
1/31/07
Month end
2/28/07
3/31/07
Cash received
for one-year
subscription
< – – – – –12-month subscription – – – – – >

16. Unearned Revenue or Deferred Credits
L O 3
Unearned Revenue or Deferred Credits
On January 1, 2007, Matrix, Inc. receives $2,400 cash as an advance payment for a one-year subscription to its monthly investment newsletter.

17. Unearned Revenue or Deferred Credits
L O 3
Unearned Revenue or Deferred Credits
On January 31, 2007, Matrix would prepare the following adjusting entry to recognize revenue earned.
$2,400 ÷ 12 = $200

18. State and Local Income Taxes
Payroll Taxes
L O 4
Gross Pay
Net Pay
State and Local Income Taxes
Voluntary Deductions
Medicare Taxes
Federal Income Tax
FICA Taxes

19. Liability for Warranties
L O 5
It is appropriate to recognize the estimated warranty expense in the same period as the sale is recorded.
Matrix, Inc. sells 1,000 DVD recorders for $500 each during Each DVD has a two-year warranty. Matrix estimates that warranty costs will be $30 per recorder.

20. Liability for Warranties
L O 5
Matrix, Inc. sells 1,000 DVD recorders for $500 each during Each DVD has a two-year warranty. Matrix estimates that warranty costs will be $30 per recorder.

21. Liability for Warranties
L O 5
During 2007, Matrix paid $3,500 in warranty costs.

22. Noncurrent Liabilities
Long-Term Debt
Interest on debt is tax deductible but dividends on stock are not. The after-tax cost of debt can be less than the cost of equities.
Long-term debt can provide positive financial leverage. Leverage is the difference between the ROI and the ROE.

23. Financial Leverage Without Leverage With Leverage
L O 6
Without Leverage
ROI = $100,000 ÷ $500,000 = 20%
ROE = $100,000 ÷ $500,000 = 20%
With Leverage
ROI = $100,000 ÷ $500,000 = 20%
ROE = $88,000 ÷ $350,000 = 25.1%

24. Bond Terminology Bond Indenture Debenture Bonds Trustee of Bonds
Mortgage Bonds
Registered Bonds
Term Bonds
Coupon Bonds
Serial Bonds
Convertible Bonds

25. BOND PAYABLE Bonds Payable
L O 7
Face Value $1,000
Interest 10%
6/30 & 12/31
Maturity Date 12/31/11
Bond Date 1/1/07
BOND PAYABLE
1. Face Value = Maturity or Par Value, Principal
2. Maturity Date
3. Stated Interest Rate
4. Interest Payment Dates
5. Bond Date
Other Factors:
6. Market Interest Rate
7. Issue Date

26. Issuance of Bonds Payable At Par Value
L O 7
Issuance of Bonds Payable At Par Value
On 1/1/07 Matrix, Inc. issued the following bonds:
Par Value = $1,500,000 (1,500 $1,000 face)
Stated Interest Rate = 10%
Market Interest Rate = 10%
Interest Dates = 6/30 & 12/31 of each year
Bond Date = January 1, 2007
Maturity Date = Dec. 31, 2011 (5 years)

27. Issuance of Bonds Payable at a Discount or a Premium
L O 8
Issuance of Bonds Payable at a Discount or a Premium
On 1/1/07 Matrix, Inc. issued the following bonds:
Par Value = $1,500,000 (1,500 $1,000 face)
Stated Interest Rate = 10%
Market Interest Rate = 10%
Interest Dates = 6/30 & 12/31 of each year
Bond Date = January 1, 2007
Maturity Date = Dec. 31, 2011 (50 years)

28. Bonds Issued at a Discount
L O 8
On 1/1/07 Matrix, Inc. issued the following bonds: Par Value = $1,000,000 (1,000 bonds) Stated Interest Rate = 10% Market Interest Rate = 12% Interest Dates = 6/30 and 12/31 Bond Date = January 1, 2007 Maturity Date = Dec. 31, 2011 (5 years)

29. Bonds Issued at a Discount
L O 8
$1,000,000 × 10% × ½ = $50,000
1. Semiannual rate (i) = 6% (Market rate 12% ÷ 2)
2. Semiannual periods (n) = 10 (5 years × 2)
Let’s look at the issuance of the bonds

30. Bonds Issued at a Discount
L O 8
Bonds Issued at a Discount
* A contra-liability account that will be amortized over the life of the bond as an adjustment to interest expense. A discount amortization increases periodic interest expense and a premium amortization decreases interest expense.

31. Retirement of Bonds Payable
When Matrix retires the bonds at maturity the following entry will be made:

32. Early Retirement of Bonds
On June 18, 2006, Matrix, Inc. retired $1,000,000 face amount bonds by paying bondholders $1,020,000. At the date of retirement the bonds had unamortized discount of $62,000.

33. Deferred Tax Liability
L O 9
The Internal Revenue Code is the set of rules for preparing tax returns.
GAAP is the set of rules for preparing financial statements.
Results in . . .
Usually. . .
Results in . . .
Financial statement income tax expense.
IRS income taxes payable.
The difference between tax expense and tax payable is referred to as deferred taxes.

34. Deferred Tax Liability
L O 9
Here is income information at December 31, 2007, for Matrix, Inc.
Matrix uses straight-line depreciation for financial reporting and MACRS depreciation for income tax reporting. Matrix is subject to a 30% tax rate.

35. Deferred Tax Liability
L O 9
Here is the income tax return and income statement of Matrix for 2007.

36. Deferred Tax Liability
L O 9
To recognize income taxes for 2007, Matrix would record the following entry:

37. Other Noncurrent Liabilities
Obligations relating to pension plans and other employee benefit plans, including deferred compensation and bonus plans.
Expenses relating to these plans are accrued and reflected in the income statement of the fiscal period in which the benefits are earned by the employees.
Some companies pay postretirement benefits. Costs associated with these plans are usually expensed in the fiscal period in which payments are made to providers.

38. Other Noncurrent Liabilities
L O 10
Minority Interest in Subsidiaries
Financial statements of a parent company and its subsidiaries are usually combined or consolidated at the end of the accounting period.
If a parent company owns more than 50% but less than 100% of a subsidiary, the minority shareholders’ interest in the subsidiary is shown on the balance sheet of the parent.

39. Other Noncurrent Liabilities
Contingent Liabilities
Potential claims on the resources of a company arising from pending litigation, environmental hazards, casualty losses to property, product warranties, or unsettled disputes with the Internal Revenue Service.

40. Gain/Loss Contingency
Remote
Reasonably
Possible
Probable
Occurrence Probability
is More Than Remote
but Less Than Likely.
Occurrence
Probability
is Likely.
is Slight.

41. End of Chapter 7