1. BSAD 221 Introductory Financial Accounting Donna Gunn, CA

2. Liabilities Current Liabilities Noncurrent Liabilities
Obligations that result from past transactions, which will be paid with assets or services.
Maturity = 1 year or less
Maturity > 1 year
Current Liabilities
Noncurrent Liabilities

3. Liabilities Defined and Classified
Liabilities are measured at their current cash equivalent (the amount a creditor would accept to cancel the debt) at the time incurred.

4. Known Current Liabilities
Accounts payable
Short-term notes payable
Goods and services tax payable
Accrued expenses
Payroll liabilities
Unearned revenues
Current portion of long-term debt
Current portion of capital leases

5. Account Name Also Called Definition
Accounts Payable
Trade Accounts Payable
Obligations to pay for goods and services used in the basic operating activities of the business.
Accrued Liabilities
Accrued Expenses
Obligations related to expenses that have been incurred, but will not be billed or paid until the subsequent period.
Notes Payable
N/A
Obligations due supported by a formal written contract.
Deferred Revenues
Unearned Revenues
Obligations arising when cash is received prior to the related revenue being earned.
These are likely the most common current liabilities.

6. Short-Term Notes Payable
In addition to recording the note payable,
the business must also pay interest expense.

7. Short-Term Notes Payable
The interest formula includes three variables that must be considered when computing interest:
Interest = Principal × Interest Rate × Time
When computing interest for one year, “Time” equals 1. When the computation period is less than one year, then “Time” is a fraction.

8. Short-Term Notes Payable
On October 1, a business purchased inventory
for $8,000 by issuing a 6-month,
10% note payable.
How much interest was accrued at December 31st?

9. Short-Term Notes Payable
On October 1, a business purchased inventory
for $8,000 by issuing a 6-month,
10% note payable.
How much interest was accrued at December 31st?
$8,000 × 10% × (3/12) = $200

10. Short-Term Notes Payable
October 31st
Inventory ,000
Notes Payable, Short-Term 8,000
Purchase of inventory by issuing a note payable
December 31st
Interest Expense
Accrued Interest
To record interest accrued at year end

11. Short-Term Notes Payable
March 31, 2012
Note Payable, Short-Term 8,000
Interest Payable
Interest Expense*
Cash ,400
*$8,000 x 0.10 x 3/12 – interest for Jan-Mar

12. Unearned revenue is a liability account. Cash is received in advance.
Unearned Revenues
Cash is collected from the customer before the revenue is actually earned.
Unearned revenue is a liability account.
Cash is received in advance.
Unearned revenue is recorded.
Generally with liabilities it is that you owe someone money. In this case you don’t owe them money but you do owe them the product or service that they paid for. That’s still an obligation to you and you have to recognize it on the balance sheet.

13. Unearned Revenues
Cash is collected from the customer before the revenue is actually earned.
As the earnings process is completed . . .
Cash is received in advance.
Unearned revenue is recorded.
As you meet the obligation (e.g. you provide the product or service) you remove the liability and recognize the revenue.
Earned revenue is recorded.

14. The flight to Montreal will occur on
Unearned Revenues
Assume on September 1st WestJet collects $800 for a round-trip from Vancouver to Montreal (taxes and fees are not considered in this example)
The flight to Montreal will occur on
September 26th.

15. Unearned Revenues
Assume on September 1st WestJet collects $800 for a round-trip from Vancouver to Montreal (taxes and fees are not considered in this example)
September 1st
Cash
Unearned Revenue
To receive cash for plane fare

16. Unearned Revenues The passenger flies from Vancouver
to Montreal on September 26, 2011.
September 26
Unearned Revenue
Revenue ($800/2)
To record revenue earned on Sept. 26th flight

17. Unearned Revenues The passenger flies from Vancouver
to Montreal on September 26, 2011.
September 26
Unearned Revenue
Revenue ($800/2)
To record revenue earned on Sept. 26th flight
The balance in the unearned revenue account is
now the remaining $400, which will be recognized
when the return flight is taken

18. Warranties Examples of products with warranties: Automobiles
An agreement that obligates the seller to pay for replacing or repairing the product (or service) when it fails to perform as expected within a specified period.
Examples of products with warranties:
Automobiles
Appliances
Computers

19. Warranties
The estimated liability and expense related to the warranty is recorded in the period when the revenue from the sale is recorded. Example: Warranty Expense 1,000 Estimated Warranty Liability 1,000 To record estimated warranty expense and liability.

20. Warranties
As the warranty work is done, the costs related to the warranty is applied to the liability account. Warranty Liability* 700 Cash 400 Accounts Payable 300 To record costs of warranty repairs. *The actual warranty costs may differ from the estimated expense. This is monitored by management and may require adjustments in future estimates.

21. Warranties
T-World sold $12,000 worth of trampolines with an extended warranty. It estimates that 2% of the sales will result in warranty work. T-World should:   
Recognize warranty expense at the time of sale.  
Recognize warranty expense at the time warranty work is performed.  
Recognize warranty liability at the time of sale.  
Both A and C.  
Both B and C.

22. Warranties
T-World sold $12,000 worth of trampolines with an extended warranty. It estimates that 2% of the sales will result in warranty work. T-World should:   
Recognize warranty expense at the time of sale.  
Recognize warranty expense at the time warranty work is performed.  
Recognize warranty liability at the time of sale.  
Both A and C.  
Both B and C.
You debit the expense and credit the liability. When you actually perform the warranty work the expense will already have been recorded so you just remove the liability.

23. Contingent Liabilities
Per the CICA Handbook –
A contingency is defined as an existing condition or situation involving uncertainty as to possible gain or loss to an enterprise that will ultimately be resolved when one or more future events occur or fail to occur.

24. Contingent Liabilities
Potential liabilities that arise because of events or transactions that have already occurred.

25. Long-Term Liabilities

26. Capital Structure – Long-term Debt
Significant debt needs of a company are often filled by issuing notes and bonds.
Bonds
Cash
One way to get cash is to sell bonds.

27. Advantages of Bonds
Bonds are debt, not equity, so the ownership and control of the company are not diluted.
Cash payments are limited to the scheduled payments of interest and principal.
Interest expense is tax deductible.
The impact on earnings is often positive (positive financial leverage) because money can often be borrowed at a low interest rate and invested at a higher interest rate.
Bonds have some significant pros and some significant cons. What is in the best interest of the company depends on their particular circumstances and on how much risk the company is willing to take on.

28. Disadvantages of Bonds
Risk of bankruptcy exists because the interest and principal are legal obligations and must be paid back as scheduled or creditors will force legal action.
A single, large principal payment is required at the maturity date.
Negative impact on cash flows exists because interest and principal must be repaid in the future.

29. Characteristics of Bonds Payable
At Bond Issuance Date
$$$$
Company Issuing Bonds
Investor Buying Bonds
Bond Certificate
Bonds payable are long-term debt for the issuing company. 5

30. Characteristics of Bonds Payable
Periodic Interest Payments $
Company Issuing Bonds
Investor Buying Bonds
Principal Payment at End of Bond Term $
One of the great things about bonds vs. regular debt is you don’t have large regular payments – you just pay interest. It does mean, however, that at the end you pay the principal back all at once. 6

31. Reporting Bond Transactions
When a company issues bonds, it specifies two cash flows related to the transaction:
1) Principal
2) Interest
Assume Dino Oil issues $100,000 in bonds at par on January 1, The bonds pay 8% interest annually on December 31.
What journal entry should be made on January 1, 2011?

32. Reporting Bond Transactions
When a company issues bonds, it specifies two cash flows related to the transaction:
1) Principal
2) Interest
Assume Dino Oil issues $100,000 in bonds at par on January 1, The bonds pay 8% interest annually on December 31.
What journal entry should be made on January 1, 2011?
Cash ,000
Bonds Payable 100,000

33. Reporting Bond Transactions
Periodically, interest must be accrued and recorded.
Annual interest = principal x stated interest rate
Dino Oil issues $100,000 in bonds at par on Jan. 1/11.
The bonds pay 8% interest annually on December 31.
What journal entry should be made on December 31, 2011?

34. Reporting Bond Transactions
Periodically, interest must be accrued and recorded.
Annual interest = principal x stated interest rate
Dino Oil issues $100,000 in bonds at par on Jan. 1/11.
The bonds pay 8% interest annually on December 31.
What journal entry should be made on December 31, 2011?
Interest Expense* 8,000
Cash ,000
*$100,000 x 8% x 1year

35. Characteristics of Bonds Payable
Bonds Characteristics
Face Value
Maturity Date
Stated Interest Rate
Interest Payment Dates
Bond date

36. Characteristics of Bonds Payable
Bonds Characteristics
Face Value
Maturity Date
Stated Interest Rate
Interest Payment Dates
Bond date
External Factors
Market interest rate
Issue date
One of the major factors in how much you pay for a bond is the interest rate. Interest rates of a bond don’t always match what the rest of the market is paying. This can be for a variety of reasons. One of the main ones is that bonds are constantly bought and sold (just like shares) on the market. The stated interest rate doesn’t change, so as market rates change the variance between the stated rate and the market rate will change as well.

37. Time Value of Money The amount invested today receives a greater
amount at a future date, which is called the
present value of a future amount.
It depends upon...
1.) the amount of the future receipt.
2.) the length of time to the future receipt.
3.) the interest rate for the period.

38. Reporting Bond Transactions
The issue price of the bond is determined by the market, based on the time value of money. The interest rate used to compute the present value is the market interest rate.

39. Reporting Bond Transactions
The stated rate is only used to compute the periodic interest payments.
Interest = Principal x Stated Rate x Time

40. The difference is accounted
Interest
Bond
Accounting for
Rates
Price
the Difference
Stated =
Market
Par Value
There is no difference
Rate
of the Bond
to account for.
<
The difference is accounted
for as a bond discount.
>
for as a bond premium.

41. This bond is issued at a par.
Bonds Issued at Par
January 1, 2012, Petro-Canada issues:
$400,000 in bonds
Stated rate of 10% annually
The bonds mature in 10 years and interest is paid semiannually.
The market rate is 10% annually.
This bond is issued at a par.

42. January 1, 2012, Petro-Canada issues $400,000 in bonds at par.
Bonds Issued at Par
January 1, 2012, Petro-Canada issues $400,000 in bonds at par.
Cash ,000
Bond Payable ,000

43. Bonds Issued at Par
Every 6 months Petro-Canada will make an interest payment on the bond, and the following entry will be made.
Interest Expense* 20,000
Cash ,000
*$400,000 x 10% x 6/12

44. At maturity, Petro Canada will repay the principal to the bondholder.
Bonds Issued at Par
At maturity, Petro Canada will repay the principal to the bondholder.
Bond Payable 400,000
Cash ,000

45. Are Petro-Canada bonds issued at par, at a discount, or at a premium?
Issuing Bonds
On Jan 1, 2012, Petro-Canada issues $400,000 in bonds having a stated rate of 10%. The bonds mature in 10 years and interest is paid semiannually. The market rate is 12% annually.
Are Petro-Canada bonds issued at par, at a discount, or at a premium?

46. Bonds Issued at a Discount
On January 1, 2012, Petro-Canada issues $400,000 in bonds having a stated rate of 10% annually. The bonds mature in 10 years (Dec. 31, 2016) and interest is paid semiannually. The market rate is 12% annually.
If the bond is paying less than what you would get from investing your money in the market, than you will purchase the bond at a discount. It’s like it’s on sale. 
Basically you’ll pay less for it than the face value because the interest you are missing out on will be compensated with a higher amount of principal at maturity.
Stated
<
Market
Bond
Par Value
The difference is accounted
Rate
Price
of the Bond
for as a bond discount.

47. Bonds Issued at a Discount
The issue price of a bond is composed of the present value of two items:
Principal (a single amount)
Interest (an annuity)

48. Note: You are not responsible for calcualating the issuance price of a bond. We will give that to you. I have included slides on how to do it because, in my opinion, if you understand that it makes understanding the amortization of the bond easier.

49. Bonds Issued at a Discount
First, let’s compute the present value of the principal.
Market rate of 12% ÷ 2 interest periods per year = 6%
Term of 10 years × 2 periods per year = 20 periods

50. Bonds Issued at a Discount
First, let’s compute the present value of the principal.
Market rate of 12% ÷ 2 interest periods per year = 6%
Term of 10 years × 2 periods per year = 20 periods

51. Bonds Issued at a Discount
Now, let’s compute the present value of the interest.
Market rate of 12% ÷ 2 interest periods per year = 6%
Term of 10 years × 2 periods per year = 20 periods

52. Bonds Issued at a Discount
Now, let’s compute the present value of the interest.
Market rate of 12% ÷ 2 interest periods per year = 6%
Term of 10 years × 2 periods per year = 20 periods

53. Bonds Issued at a Discount
The $354,118 is less than the face amount of $400,000, so the bonds are issued at a discount of $45,882.

54. Bonds Issued at a Discount
Here is the journal entry to record the bond issued at a discount:
Cash ,118
Discount on Bond Payable 45,882
Bond Payable ,000
This is a contra-liability account and appears in the liability section of the balance sheet.

55. Bonds Issued at a Discount Financial Statement Presentation
The discount will be amortized over the 10-year life of the bonds.
Two methods of amortization are commonly used:
Straight-line or Effective-interest.
Effective interest is the proper method, however for simplicity we will only ever test the straight line method in large problems.

56. Reporting Interest Expense: Straight-line Amortization
Identify the amount of the bond discount.
Divide the bond discount by the number of interest periods.
Include the discount amortization amount as part of the periodic interest expense entry.
The discount will be reduced to zero by the maturity date.

57. Reporting Interest Expense: Effective-interest Amortization
The effective interest method is the theoretically preferred method.
Compute interest expense by multiplying the current unpaid balance times the market rate of interest.
The discount amortization is the difference between interest expense and the cash paid (or accrued) for interest.

58. Reporting Interest Expense: Effective-interest Amortization
Petro-Canada issued their bonds on Jan. 1, 2012.
Issue Price: $354,118
Face Value: $400,000
Market Rate: 12%
Stated Rate: 10%
Interest Expense = Balance × Market Rate × Time
$354,118 × 12% × 6/12 = $21,247

59. Reporting Interest Expense: Effective-interest Amortization
Here is the journal entry to record the payment of interest and the discount amortization for the six months ending on June 30, 2012:
Interest Expense 21,247
Discount on Bond Payable 1,247
Cash ,000

61. PV of the Principal = Issue Price of the Bonds
Zero Coupon Bonds
Zero coupon bonds do not pay periodic interest
Because there is no interest annuity . . .
This is called a deep discount bond
PV of the Principal = Issue Price of the Bonds

62. Bonds Issued at a Premium
On January 1, 2012, Petro-Canada issues $400,000 in bonds having a stated rate of 10% annually.
The bonds mature in 10 years (Dec. 31, 2021) and interest is paid semiannually.
The market rate is 8% annually.
This bond is issued at a premium.
A premium is when the bond is paying a higher interest rate than what you would get if you invested elsewhere in the market. If you want that higher rate you are going to pay more for the bond.
Stated
>
Market
Bond
Par Value
The difference is accounted
Rate
Price
of the Bond
for as a bond premium.

63. Bonds Issued at a Premium
The issue price of a bond is composed of the present value of two items:
Principal (a single amount)
Interest (an annuity)

64. Bonds Issued at a Premium
First, let’s compute the present value of the principal.
Market rate of 8% ÷ 2 interest periods per year = 4%
Term of 10 years × 2 periods per year = 20 periods

65. Bonds Issued at a Premium
Now, let’s compute the present value of the interest.
Market rate of 8% ÷ 2 interest periods per year = 4%
Term of 10 years × 2 periods per year = 20 periods

66. Bonds Issued at a Premium
The $454,366 is more than the face amount of $400,000, so the bonds are issued at a premium of $54,366.

67. Bonds Issued at a Premium
Here is the journal entry to record the bond issued at a premium:
Cash ,366
Premium on Bond Payable ,366
Bond Payable ,000
This is called an adjunct-liability account and appears in the liability section of the balance sheet as an addition to Bonds Payable.

68. Bonds Issued at a Premium Financial Statement Presentation
The premium will be amortized over the 10-year life of the bonds.
Let’s look at the amortization tables using
Straight-line and Effective-interest.

69. Reporting Interest Expense: Effective-interest Amortization
Petro-Canada issued their bonds on Jan. 1, 2012.
Issue Price: $454,366
Face Value: $400,000
Market Rate: 8%
Stated Rate: 10%
Interest Expense = Balance × Market Rate × Time
$454,366 × 8% × 6/12 = $18,175

71. Reporting Interest Expense: Effective-interest Amortization
Here is the journal entry to record the payment of interest and the premium amortization for the six months ending on June 30, 2012:
Interest Expense ,175
Premium on Bond Payable ,825
Cash ,000

72. Early Retirement of Debt
Occasionally, the issuing company will call (repay early) some or all of its bonds.
Gains/losses are calculated by comparing the bond call amount with the book value of the bond.
Book Value > Retirement Price = Gain
Book Value < Retirement Price = Loss