1. Electronic Presentation by Douglas Cloud Pepperdine University
Chapter 10
Liabilities
Electronic Presentation by Douglas Cloud Pepperdine University

2. After studying this chapter, you should be able to:
Learning Goals
1. Define and give examples of liabilities.
2. Manage accounts payable, using the days’ purchases in accounts payable ratio.
3. Describe the accounting for short-term notes payable and maturities currently due.
4. Describe the accounting treatment for contingent liabilities, including product warranties.
After studying this chapter, you should be able to:
Continued

3. Learning Goals
5. Describe the accounting for employer liabilities for payroll and fringe benefits.
6. Analyze and interpret current position with the current and quick ratios.
7. Describe the characteristics of long-term liabilities.
8. Describe the accounting for bonds payable issuances and redemptions, and interpret bonds payable footnote disclosures.
Continued

4. Learning Goals
9. Describe the accounting for the purchase, interest, discount and premium amortization, and sale of bond investments.
10. Analyze and interpret long-term liability position with the number of times interest charges are earned and the ratio of total liabilities to total assets. .

5. Learning Goal 1
Define and give examples of liabilities.

6. The Nature of Current Liabilities
When a business or bank advances credit, it is making a loan and the lender is referred to as a creditor.

7. The Nature of Current Liabilities
Individuals or businesses that receive the credit are called debtors (or borrowers).

8. The Nature of Current Liabilities
Obligations that are to be paid out of current assets and are due within a short time, usually within one year, are called current liabilities.

9. Learning Goal 2
Manage accounts payable, using the days’ purchases in accounts payable ratio.

10. Days’ Purchases in Accounts Payable Ratio
Average accounts payable
Cost of change in
merchandise sold inventory
($903 + $1,107)/2
x 365 days
$10,050 + ($1,633 – $1,758) +
= 37 days
Circuit City

11. Days’ Purchases in Accounts Payable Ratio
Average accounts payable
Cost of change in
merchandise sold inventory
($1,773 + $2,449)/2
x 365 days
$15,167 + ($2,258 – $1,767) +
= 49 days
Best Buy

12. Learning Goal 3
Describe the accounting for short-term notes payable and maturities currently due.

13. Short-Term Notes Payable
A firm issues a 90-day, 12% note for $1,000, dated August 1, 2004 to Murray Co. for a $1,000 overdue account.
Aug. 1 Accounts Payable—Murray Co. 1,000
Notes Payable 1,000

14. Short-Term Notes Payable
When the note matures, the liability is cancelled and the payment, including interest ($1,000 x 12% x 90/360) is recorded.
Oct. 30 Notes Payable 1,000
Interest Expense 30
Cash 1,030
Appears on the income statement as an “Other Expense.”

15. Short-Term Notes Payable
May 1. Bowden Co. purchased merchandise on account from Coker Co., $10,000, 2/10, n/30. The merchandise cost Coker Co. $7,500.
Description Debit Credit
Bowden Co. (Borrower)
Coker Co. (Creditor)
Description Debit Credit
Mdse. Inventory 10,000
Accounts Payable 10,000
Accounts Receivable 10,000
Sales 10,000
Cost of Mdse. Sold 7,500
Mdse. Inventory 7,500

16. Short-Term Notes Payable
May 31. Bowden Co. issued a 60-day, 12% note for $10,000 to Coker on account.
Description Debit Credit
Bowden Co. (Borrower)
Accounts Payable 10,000
Notes Payable 10,000
Coker Co. (Creditor)
Notes Receivable 10,000
Accounts Receivable 10,000
Description Debit Credit

17. Short-Term Notes Payable
July 30. Bowden Co. paid Coker Co. the amount due on the note of May 31.
Description Debit Credit
Bowden Co. (Borrower)
Notes Payable 10,000
Interest Expense 200
Cash 10,200
Coker Co. (Creditor)
Cash 10,200
Interest Revenue 200
Notes Receivable 10,000
Description Debit Credit
$10,000 x 12% x 60/360

18. Discounted Notes Payable
On August 10, Cary Company issues a $20,000, 90-day note to Seinfeld Company in exchange for inventory. Seinfeld discounts the note at a rate of 15%.
Aug. 10 Merchandise Inventory 19,250
Interest Expense 750
Notes Payable 20,000
$20,000 x .15 x 90/360
Continued

19. Discounted Notes Payable
On November 8, the note is paid.
Nov. 8 Notes Payable 20,000
Cash 20,000
If the accounting period ends before a discounted note is paid, an adjusting entry should record the prepaid (deferred) interest that is not yet an expense.

20. Current Maturities of Long-Term Debt
Long-term liabilities that mature within the coming year must be classified as current liabilities.

21. Learning Goal 4
Describe the accounting treatment for contingent liabilities, including product warranties.

22. Some past transactions will result in liabilities if certain events occur in the future. These potential liabilities are called contingent liabilities.

23. Product Liability
On June 30, a company sells a product for $60,000 on which there is a 36-month warranty. Past experience indicates that repairs of defects cost 5% of the sales price over the warranty period.
June 30 Product Warranty Expense 3,000
Product Warranty Payable 3,000
$60,000 x 5%

24. Product Liability
On August 16, a customer needed a defective part replaced. Cost to the company was $200 for the part.
Aug. 16 Product Warranty Payable 200
Supplies 200

25. Accounting Treatment of Contingent Liabilities
Likelihood of Occurring
Accounting Treatment
Measurement
Probable
Estimable
Record Liability
Not Estimable
Contingency
Possible
Disclose Liability
Disclose Liability

26. Learning Goal 5
Describe the accounting for employer liabilities for payroll and fringe benefits.

27. Recording Payroll
Employers are required to withhold federal income tax from each employee based on the withholding table and information provided by the employee’s W-4 form.
Federal income tax and FICA tax must be withheld from the pay of each employee.
Deductions for other purposes may be withheld by mutual agreement.

28. Payroll and Payroll Taxes
McDermott Co. had a gross payroll of $13,800 for the week ending April 11. Assume that the FICA tax was 7.5% of the gross payroll, and that federal and state withholding was $1,655 and $280, respectively.
Apr. 11 Wage and Salary Expense 13,800
FICA Tax Payable 1,035
Employees Federal Income
Taxes Payable 1,655
Employees State Income
Taxes Payable 280
Cash 10,830

29. Liability for Employer Payroll Taxes

30. Liability for Employer Payroll Taxes
FICA Tax
Employers are required to contribute to the social security and Medicare programs for each employee.

31. Liability for Employer Payroll Taxes
FICA Tax
Also, the employer must match the employee’s contribution to each program.

32. Liability for Employer Payroll Taxes
Federal Unemployment Compensation Tax
FUTA provides for temporary payments to those who become unemployed as a result of layoffs due to economic causes beyond their control.

33. Liability for Employer Payroll Taxes
State Unemployment Compensation Tax
SUTA also provides for payments to unemployed workers.
Both FUTA and SUTA are, for the most part, levied upon employers only.

34. Recording and Paying Payroll Taxes
On April 11, the payroll information for McDermott Co. indicates that the amount of FICA tax that the company must pay to match the employees’ deduction is $1,035. The SUTA and FUTA taxes are $145 and $25 respectively.
Apr. 11 Payroll Tax Expense 1,205
FICA Tax Payable 1,035
SUTA Tax Payable 145
FUTA Tax Payable 25

35. Employees’ Fringe Benefits
Fringe benefits include such items as vacation time off, medical benefits, and pension plans.

36. Retirement and savings plans Social security and Medicare
Benefit Dollars as a Percent of Total
24%
Vacation and sick pay
25%
Medical
12%
Other
18%
Retirement and savings plans
21%
Social security and Medicare
Source: U.S. Chamber of Commerce

37. Employees’ Fringe Benefits
Most employees grant compensated absences to their employees. Assume the employees earn one day of vacation for each month worked during the year. The estimated vacation pay for the period ending May 5 is $2,000.
May 5 Vacation Pay Expense 2,000
Vacation Pay Payable 2,000

38. Learning Goal 6
Analyze and interpret current position with the current and quick ratios.

39. Financial ratios that measure the degree to which current assets are available to satisfy current liabilities are called liquidity ratios.

40. Current Ratio 2.186 $481,000 Current assets Current liabilities
Marx Co. Holt Co.
Current assets:
Cash and cash equivalents $ 100,000 $ 55,000
Receivables (net) 47,000 65,000
Merchandise inventories 250, ,000
Prepaid expenses and other
current assets , ,000
Total current assets $481,000 $362,000
Total current liabilities $220,000 $ 85,000
$481,000
Current assets
Current liabilities
= Current Ratio
2.186
$220,000

41. Current Ratio 4.259 Current assets $362000 Current liabilities
Marx Co. Holt Co.
Current assets:
Cash and cash equivalents $ 100,000 $ 55,000
Receivables (net) 47,000 65,000
Merchandise inventories 250, ,000
Prepaid expenses and other
current assets , ,000
Total current assets $481,000 $362,000
Total current liabilities $220,000 $ 85,000
Current assets
Current liabilities
$362000
= Current Ratio
4.259
$85,000

42. Quick Ratio .668 Quick assets Current liabilities = Quick Ratio
Marx Co. Holt Co.
Current assets:
Cash and cash equivalents $ 100,000 $ 55,000
Receivables (net) 47,000 65,000
Merchandise inventories 250, ,000
Prepaid expenses and other
current assets , ,000
Total current assets $481,000 $362,000
Total current liabilities $220,000 $ 85,000
Quick assets
Current liabilities
= Quick Ratio
$147,000
.668
$220,000

43. Quick Ratio 1.412 Quick assets Current liabilities = Quick Ratio
Marx Co. Holt Co.
Current assets:
Cash and cash equivalents $ 100,000 $ 55,000
Receivables (net) 47,000 65,000
Merchandise inventories 250, ,000
Prepaid expenses and other
current assets , ,000
Total current assets $481,000 $362,000
Total current liabilities $220,000 $ 85,000
Quick assets
Current liabilities
= Quick Ratio
$120,000
1.412
$85,000

44. Learning Goal 7
Describe the characteristics of long-term liabilities.

45. A bond is simply a form of long-term interest-bearing note
A bond is simply a form of long-term interest-bearing note. It requires periodic interest payments, and the face amount must be repaid at maturity.

46. A corporation that issues bonds enters into a contract, called a bond indenture or trust indenture with the bondholders.

47. When all bonds mature at the same time, they are called term bonds
When all bonds mature at the same time, they are called term bonds. When the maturities are spread over several dates, they are called serial bonds.

48. Bonds that may be exchanged for other securities, such as common stock, are called convertible bonds.

49. Bonds that corporation reserves the right to redeem before their maturity are called callable bonds.

50. Bonds issued on the basis of the general credit of the corporation are called debenture bonds.

51. Learning Goal 8
Describe the accounting for bonds payable issuances and redemptions, and interpret bonds payable footnote disclosures.

52. The price that buyers are willing to pay for the bonds depends upon:
The face amount of the bonds, which is the amount due at the maturity date.
The periodic interest to be paid on the bonds.
The market rate of interest.

53. The percentage or rate of interest that is expressed as a percentage of the face amount of the bond is the contract rate or coupon rate.
If the market rate is higher than the contract rate, the bonds will sell at a discount (or less than their face amount).
The market rate or effective rate of interest is determined by transactions between buyers and sellers of similar bonds.
If the market rate is lower than the contract rate, the bonds will sell at a premium (or more than their face amount).

54. Bonds Issued at Face Amount
On January 1, 2004, a corporation issues for cash $100,000 of 12%, five-year bonds, with interest of $6,000 payable semiannually.
Jan. 1 Cash 100,000
Bonds Payable 100,000
Every six months after the bonds have been issued, interest payments of $6,000 are made.
June 30 Interest Expense 6,000
Cash 6,000

55. Bonds Issued at Face Amount
At the maturity date, the payment of the principal of $100,000 is recorded.
Dec. 31 Bonds Payable 100,000
Cash 100,000

56. Bonds Issued at a Discount
On January 1, $100,000, 12%, five-year bonds are sold for $96,406 (which is at a discount).
Jan. 1 Cash 96,406
Discount on Bonds Payable 3,594
Bonds Payable 100,000
Contra long-term liability

57. Bonds Issued at a Discount
On June 30, the entry to record payment of six-months’ interest and to amortize the discount is:
June 30 Interest Expense 6,359.40
Discount on Bonds Payable
Cash 6,000.00
$3,594 ÷ 10
$100,000 x .12 x 6/12

58. Bonds Issued at a Premium
On January 1, $100,000, 12%, five-year bonds are sold for $103,769, or a yield of 11%.
Jan. 1 Cash 103,769
Bonds Payable 100,000
Premium on Bonds Payable 3,769

59. Bonds Issued at a Premium
On June 30, an entry is required to record payment of interest and to amortize the premium.
June 30 Interest Expense 5,623.10
Premium on Bonds Payable
Cash 6,000.00
$3,769 ÷ 10
$100,000 x .12 x 6/12

60. On December 31, an adjusting entry is required.
Zero-Coupon Bonds
On January 1, a $100,000 zero-coupon bond due in five years is issued at $53,273.
Jan Cash 53,273
Discount on Bonds Payable 46,727
Bonds Payable 100,000
$46,727 ÷ 5
On December 31, an adjusting entry is required.
Dec. 31 Interest Expense 9,345
Discount on Bonds Payable 9,345

61. Bond Redemption
On June 30 a corporation has a bond issue of $100,000 outstanding, on which there is an unamortized premium of $4,000. One fourth of the bonds are redeemed for $24,000.
June 30 Bonds Payable 25,000
Premium on Bonds Payable 1,000
Cash 24,000
Gain on Redemption of Bond 2,000
¼ of $100,000
¼ of $4,000

62. Learning Goal 9
Describe the accounting for the purchase, interest, discount and premium amortization, and sale of bond investments.

63. Note that the revenue account is debited.
Investment in Bonds
On April 2 an investor purchases a $1,000 bond at 102 plus a brokerage fee of $5.30 and accrued interest of $10.20.
Apr. 2 Investment in Lewis Co. Bonds 1,025.30
Interest Revenue 10.20
Cash 1,035.50
($1,000 x 1.02) + $5.30
Note that the revenue account is debited.

64. Investment in Bonds
On July 1, 2003, Crenshaw Inc. purchases $50,000 of 8% bonds of Deitz Corporation, due in 8 ¾ years at a price of $41,706 plus interest of $1,000 accrued from April 1, 2003.
July 1 Investment in Deitz Co. Bonds 41,706
Interest Revenue 1,000
Cash 42,706
2003
$50,000 x 8% x 3/12
Continued

65. Received semiannual interest for April 1 to October 1.
Investment in Bonds
Received semiannual interest for April 1 to October 1.
Oct. 1 Cash 2,000
Interest Revenue 2,000
2003
$50,000 x 8% x 6/12
Continued

66. Investment in Bonds
On December 31, record adjusting entries for interest accrued from October 1 to December 31 and to record the amortization from July 1.
Dec. 31 Interest Receivable 1,000
Interest Revenue 1,000
2003
31 Investment in Deitz Corp. Bonds 474
Interest Revenue 474
$8,294 ÷ 105 months x 6

67. Investment in Bonds—Sale
The Deitz Corporation bonds are sold for $47,350 plus accrued interest on June 30, The carrying amount of the bond as of January 1, 2010 was $47,868.
June 30 Investment in Deitz Corp. Bonds 474
Interest Revenue 474
2010
$8,294 ÷ 105 months x 6

68. Investment in Bonds—Sale
The Deitz Corporation bonds are sold for $47,350 plus accrued interest on June 30, The carrying amount of the bond as of January 1, 2010 was $47,868.
$47,350 + ($50,000 x 8% x 3/12)
June 30 Cash 48,350
Loss on Sale of Investment Interest Revenue 1,000
Investment in Deitz Corp.
Bonds 48,342
2010
$50,000 x 8% x 3/12
$47,868 + $474

69. Learning Goal 1
Analyze and interpret long-term liability position with the number of times interest charges are earned and the ratio of total liabilities to total assets.

70. Number of times interest charges are earned
Income before income tax + Interest Expense
Interest Expense
SBC Communications, Inc.
$12,888 million + $1,592 million
$1,592 million
= 9.1

71. Number of times interest charges are earned
The creditors of SBC have their interest receipts protected by over nine times earnings.

72. Ratio of Total Liabilities to Total Assets
SBC Communications, Inc.
$68,188 million
$98,651 million
= 69%

73. Ratio of Total Liabilities to Total Assets
SBC’s debt at 69% of total assets is slightly higher than other companies in the industry.

74. Chapter 10
The End