1. Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Chapter 10 Reporting and Interpreting Liabilities McGraw-Hill/Irwin

2. 10-2 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. Classification of Liabilities

3. 10-3 Exh. 9.2 Current and Long-Term Liabilities

4. 10-4 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.

5. 10-5 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.

6. 10-6 Payroll Taxes Employers incur several expenses and liabilities from having employees.

7. 10-7 Exh. 9.5 Payroll Taxes FICA Taxes Medicare Taxes Federal Income Tax State and Local Income Taxes Voluntary Deductions Gross Pay Net Pay

8. 10-8 FICA Taxes Medicare Taxes 2004: 6.2% of the first $87,900 earned in the year. 2004: 1.45% of all wages earned in the year. Employers owe the FICA amount withheld from employees’ gross pay to the IRS. FICA Taxes

9. 10-9 Here is information about the payroll for General Mills: Recording Payroll

10. 10-10 Exh. 9.3 Note 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, 2006 One YearI Two hundred thousand and no/100---------------------- 12% Janet Smith, CFO For Matrix, Inc. Matrix, Inc. borrows $200,000 from National Bank

11. 10-11 On September 30, 2006, Matrix, Inc. would make the following entry. What entry would be made on December 31, 2006, the year-end for Matrix? Note Payable

12. 10-12 Note Payable Interest = Principal × Rate × Time Interest = $200,000 × 12% × 3/12 9/30/0612/31/0612/31/07 Note Issues Year End Note Due

13. 10-13 On September 30, 2007, Matrix, Inc. must pay the interest and principal on the note. Note Payable $24,000 = $200,000 × 12% × 12/12

14. 10-14 Sales Tax Payable Frank’s Sporting Goods sells a raft for $750 and collects the required 6% sales tax for the state.

15. 10-15 On June 10, 2006, Excel Catering received $1,500 in advance for catering a party on July 4, 2006. Unearned Revenues

16. 10-16 Unearned Revenues Excel finished catering the party on July 4, 2006, and makes the following entry.

17. 10-17 Long-term Liabilities

18. 10-18 Prepare the entry for Jan. 1, 2006, to record the following bond issue by Matrix, Inc. Par Value = $10,000,000 Stated Interest Rate = 10% Interest Date = December 31 Bond Date = Jan. 1, 2006 Maturity Date = Dec. 31, 2008 (3 years) Prepare the entry for Jan. 1, 2006, to record the following bond issue by Matrix, Inc. Par Value = $10,000,000 Stated Interest Rate = 10% Interest Date = December 31 Bond Date = Jan. 1, 2006 Maturity Date = Dec. 31, 2008 (3 years) Issuing Bonds at Face Amount

19. 10-19 Issuing Bonds at Face Amount 1/1/06 Bonds Issued $10,000,000 Received 12/31/06 Interest Paid 12/31/07 Interest Paid 12/31/08 Interest Paid $10,000,000 Repaid Face Amount Interest $10,000,000 × 10% × 12/12 = $1,000,000

20. 10-20 Issuing Bonds at Face Amount On January 1, 2006, the bonds are issued to the public and the following journal entry is made:

21. 10-21 Issuing Bonds at Face Amount On December 31, 2006, the first annual interest payment is due to the bondholders. Matrix makes the following entry:

22. 10-22 Issuing Bonds at Face Amount At maturity on December 31, 2008, the final interest payment is made and the principal amount is repaid to the bondholders.

23. 10-23 Bond Issued Below or Above Face Value 6% Stated Rate Rate 4% Market Rate Wow, I’ll pay extra PremiumPremium What lenders expects What lenders think What lenders pay 6% Market Rate It’s just enough Face Value What lenders expects What lenders think What lenders pay 8% Market Rate I’m not attracted (yet) DiscountDiscount What lenders expects What lenders think What lenders pay

24. 10-24 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

25. 10-25 On Jan. 1, 2006, Matrix, Inc. issues these bonds: Par Value = $10,000,000 Issue Price = 95.19634% of par value Stated Interest Rate = 10% Market Interest Rate = 12% Interest Dates = December 31 Bond Date = January 1, 2006 Maturity Date = December 31, 2008 (3 years) On Jan. 1, 2006, Matrix, Inc. issues these bonds: Par Value = $10,000,000 Issue Price = 95.19634% of par value Stated Interest Rate = 10% Market Interest Rate = 12% Interest Dates = December 31 Bond Date = January 1, 2006 Maturity Date = December 31, 2008 (3 years) Bonds Issued at a Discount

26. 10-26 $10,000,000  95.19634% Issuing Bonds at a Discount

27. 10-27 $9,519,634 × 12% = $1,142,356 $1,142,356 - $1,000,000 = $142,356 Issuing Bonds at a Discount

28. 10-28 Issuing Bonds at a Discount On December 31, 2006, the first annual interest payment is due to the bondholders. Matrix makes the following entry:

29. 10-29 Maturity Value Carrying Value Issuing Bonds at a Discount

30. 10-30 Issuing Bonds at a Discount $480,366 - $142,356 = $338,010

31. 10-31 On January 1, 2006, Matrix, Inc. issues these bonds: Par Value = $10,000,000 Issue Price = 105.15419% of par value Stated Interest Rate = 10% Market Interest Rate = 8% Interest Dates = December 31, 2006 Bond Date = January 1, 2006 Maturity Date = December 31, 2008 (3 years) On January 1, 2006, Matrix, Inc. issues these bonds: Par Value = $10,000,000 Issue Price = 105.15419% of par value Stated Interest Rate = 10% Market Interest Rate = 8% Interest Dates = December 31, 2006 Bond Date = January 1, 2006 Maturity Date = December 31, 2008 (3 years) Bonds Issued at a Premium

32. 10-32 Bonds Issued at a Premium $10,000,000  105.15419%

33. 10-33 Bonds Issued at a Premium $10,515,419 × 8% = $841,234 $1,000,000 - $841,234 = $158,766

34. 10-34 Bonds Issued at a Premium On December 31, 2006, the first annual interest payment is due to the bondholders. Matrix makes the following entry:

35. 10-35 Bonds Issued at a Premium Maturity Value Carrying Value

36. 10-36 Bonds Issued at a Premium $515,419 - $158,766 = $356,653

37. 10-37 Early Retirement of Debt On January 1, 2006, Matrix, Inc. issues, at face value, $10,000,000 of three-year bonds payable. The bonds pay annual interest at 10% on December 31 of each year. On December 31, 2007, the company retires the bonds by purchasing them in the open market for a total cost of $10,300,000.

38. 10-38 Analyzing the Ability to Pay Amounts Currently Owed Current Ratio = Current Assets Current Liabilities Measures whether the company has enough current assets to pay what it currently owes.

39. 10-39 Analyzing the Ability to Generate Resources to Pay Future Amounts Owed 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.

40. 10-40 Understanding Common Features of Debt

41. 10-41 Contingent LiabilityPossiblePossible Don’t mention it RemoteRemote Record a liability Contingent liability ProbableProbableYesYes Describe in notes NoNo

42. 10-42 End of Chapter 10