1. Cash, Short-term Investments and Accounts Receivable
Chapter 4
Cash, Short-term Investments and Accounts Receivable
Chapter 4

2. Chapter 7
Liabilities

3. Chapter 7 Learning Objectives
Account for the major types of transactions and events affecting current liabilities.
Define the key characteristics of, and account for, contingent liabilities.
Account for the major types of transactions and events affecting bonds payable.
Distinguish between operating leases and capital leases.
Discuss accounting issues for long-term liabilities stemming from pension and other postretirement employee benefit plans.
Define the key information needs of decision makers regarding liabilities.
Compute and interpret the current, long-term debt to equity, and times interest earned ratios as well as the amount of working capital.
(Appendix) Compute the issue price of bonds and prepare journal entries related to discount and premium amortization.
Chapter 7
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4. Definition
The Financial Accounting Standards Board defines liabilities as "probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events." *
*Financial Accounting Standards Board, Statement of Financial Accounting Concepts No. 6, “Elements of Financial Statements” (Stamford, Conn.: FASB, 1985), paragraph 35.
Chapter 7

5. Current Liabilities Accounts Payable Notes Payable Salaries Payable
Current Portion of Long-term Debt
Chapter 7

6. Notes Payable Interest = Principal x Rate x Time Common Terms: Maker
Payee
Principal
Term of Note
Maturity Date/Value
Interest = Principal x Rate x Time
*Use a 360 day year
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7. Entries for Notes Payable
Suppose that Bonney’s Dress Shop borrows $5,000 from a local bank on October 2, 2009, and signs a 120-day, 12% note payable.
The note’s maturity date is January 30, 2010.
Bonney’s Dress Shop would prepare the following entries on Oct. 2 and Dec. 31, 2009.
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8. Entries for Notes Payable Continued
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9. Entries for Notes Payable Continued
On Jan. 30, 2010, Bonney’s Dress Shop repays the bank the $5,000 principal amount plus 12% interest for the note’s 120-day term.
Bonney’s Dress Shop prepares the following entry.
Chapter 7

10. Review
John Company issued a 6%, 60-day, $2,000 note on November 16, 2010, to purchase equipment. The accrued interest on December 31, 2010, is
$20.
$120.
$15.
$10.
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11. Review
John Company issued a 6%, 60-day, $2,000 note on November 16, 2010, to purchase equipment. The accrued interest on December 31, 2010, is
$20.
$120.
$15.
$10.
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12. Review
John Company issued a 6%, 60-day, $5,000 note on December 1, 2010, to purchase equipment. The entry on maturity date will include a debit to interest expense for
$50.
$30.
$25.
$45.
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13. Review
John Company issued a 6%, 60-day, $5,000 note on December 1, 2010, to purchase equipment. The entry on maturity date will include a debit to interest expense for
$50.
$30.
$25.
$45.
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14. Entries for Installment Notes Payable
Assume that Ryan Company purchases a $25,000 truck on January 31, 2009.
The company signs a five-year note payable, and payments of $483 are to be made at the end of each month at an annual interest rate of 6%.
The next slide shows the computations for the first six months of principal and interest payments.
Chapter 7

15. Installment Notes Payable
Chapter 7

16. Entries for Installment Notes Payable
The following entries reflect the first two installment payments for Ryan Co.
Chapter 7

17. Other Accrued Liabilities
Product Warranty
Vacation Pay
Accrued Payroll
Chapter 7

18. Entries for Product Warranty Liabilities
Suppose a ball point pen manufacturer expects that 2% of its pens sold will need to be replaced or repaired at a cost of $15 per pen.
If 200,000 pens are sold in 2009, the firm expects to eventually repair or replace 4,000 pens at a cost of $60,000.
During 2010, the company incurs $15,100 of warranty costs ($10,000 for parts, and $5,100 for labor).
The following entries are prepared in 2009 and 2010 respectively.
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19. Entries for Product Warranty Liability
2009
2010
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20. Review debit to Warranty Expense for $30,000.
Gilbert Company provides a warranty on its primary product sold. Gilbert estimates the warranty will run $2 per unit and in 2010 sold 15,000 products. The adjusting entry will include a
debit to Warranty Expense for $30,000.
credit to Warranty Expense for $30,000.
debit to Warranty Liability for $30,000.
debit to Cash for $30,000.
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21. Review debit to Warranty Expense for $30,000.
Gilbert Company provides a warranty on its primary product sold. Gilbert estimates the warranty will run $2 per unit and in 2010 sold 15,000. The adjusting entry will include a
debit to Warranty Expense for $30,000.
credit to Warranty Expense for $30,000.
debit to Warranty Liability for $30,000.
debit to Cash for $30,000.
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22. Vacation Pay Liability
Assume that Linton & Co. provides each employee an annual two-week paid vacation and employees work 50 weeks per year.
Each payroll period, vacation pay accumulated by Linton employees equals 4% (2/50) of that week’s payroll.
If the two-week payroll is $350,000 vacation pay earned by employees is $14,000.
In a typical year, 10% of all vacation pay accumulated by Linton employees is forfeited.
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23. Entry for Vacation Pay Liability
Chapter 7

24. Contingent Liabilities
The two factors to consider in determining the accounting treatment for a loss contingency are whether (1) it is likely that an actual loss will result from the contingency and (2) the amount of the potential loss can be reasonably estimated.
Probable Reasonably Possible Remote
Chapter 7

25. Contingent Losses and Related Contingent Liabilities
Chapter 7

26. Long-term Liabilities
Bonds Payable
Mortgage Payable
Long-Term Notes Payable
Lease Obligations
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27. Bonds Payable Callable Convertible Stated/Contract Rate
Effective/Market Rate
Maturity Value
Maturity Value= PV(Principal) + PVA(Interest Payments)
Effective Rate > Stated Rate = Discount
Effective Rate < Stated Rate = Premium
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28. Determining the Issue Price of Bonds
The relationship of a bond’s stated interest rate to interest rates being paid in the market is a primary determinant of issue price.
Assume Hardin Manufacturing sells 100 five-year bonds with a face value of $1,000 and a stated interest rate of 10% for $1,000 each.
The market rate of interest on similar bonds is also 10%.
Hardin Manufacturing would prepare the following journal entry.
Chapter 7

29. Journal Entry to Sell Bonds at Face Value
Chapter 7

30. Determining the Issue Price of Bonds
The relationship of a bond’s stated interest rate to interest rates being paid n the market is a primary determinant of issue price.
Assume Hardin Manufacturing sells 100 five-year bonds with a face value of $1,000 and a stated interest rate of 10% for $1,000 each.
Investors are also considering other bonds paying 11%.
If Hardin wants to attract buyers for its bonds, it will have to sell the bonds at 95 (or $950 per bond).
Hardin Manufacturing would prepare the following journal entry.
Chapter 7

31. Journal Entry to Sell Bonds at Less than Face Value
Chapter 7

32. Determining the Issue Price of Bonds
The relationship of a bond’s stated interest rate to interest rates being paid n the market is a primary determinant of issue price.
Assume Hardin Manufacturing sells 100 five-year bonds with a face value of $1,000 and a stated interest rate of 10% for $1,000 each.
Investors are also considering other bonds paying 9%.
Investors are willing to pay Hardin 104% of face, since Hardin’s bonds have a better interest rate.
Hardin Manufacturing would prepare the following journal entry.
Chapter 7

33. Journal Entry to Sell Bonds at More than Face Value
Chapter 7

34. Accounting for Bonds Issued at a Discount
On April 1, 2009, Hardin Manufacturing issues $100,000, 10%, five-year bonds when the market rate of interest is 12%.
Using present value tables, the issuance price of the bonds is determined to be $93,641.
Using the straight-line method, Hardin would prepare the following journal entries to issue the bonds, record the adjusting entry, make interest payments and amortize the discount.
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35. Entries for Bonds Issued at a Discount
Chapter 7

36. Accounting for Bonds Issued at a Premium
On April 1, 2009, Hardin Manufacturing issues $100,000, 10%, five-year bonds when the market rate of interest is 8%.
Using present value tables, the issuance price of the bonds is determined to be $108,115.
Using the straight-line method, Hardin would prepare the following journal entries to issue the bonds, record the adjusting entry, make interest payments and amortize the premium.
Chapter 7

37. Entries for Bonds Issued at a Premium
Chapter 7

38. Review a premium. face value. a discount. par.
Gilbert Company sold $200,000 8%, 10-year bonds at 95. The bonds were sold at
a premium.
face value.
a discount.
par.
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39. Review a premium. face value. a discount. par.
Gilbert Company sold $200,000 8%, 10-year bonds at 95. The bonds were sold at
a premium.
face value.
a discount.
par.
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40. Review
Heedy Company sold $200,000 8%, 10-year bonds at 102. Cash proceeds from the sale of the bonds amounted to
$216,000.
$204,000.
$206,000.
$202,000.
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41. Review
Heedy Company sold $200,000 8%, 10-year bonds at 102. Cash proceeds from the sale of the bonds amounted to
$216,000.
$204,000.
$206,000.
$202,000.
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42. Effect of Market Interest Rate on Bond Accounting
Chapter 7

43. Problem Review
Heedy Company issued $500,000, 10%, 10-year bonds at 102 on January 1, The bonds pay interest semiannually on June 30 and Dec The discount or premium is amortized using the straight-line method. Prepare entries needed for 2010.
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44. Problem Review Solution
Date
Description
Debit
Credit
Jan. 1
Cash
510,000
Bonds Payable
500,000
Premium on Bonds Payable
10,000
June 30
Interest Expense
24,500
500
25,000
Dec. 31
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45. Problem Review
Heedy Company issued $600,000, 10%, 10-year bonds at 96 on January 1, The bonds pay interest semiannually on June 30 and Dec The discount or premium is amortized using the straight-line method. Prepare entries needed for 2010.
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46. Problem Review Solution
Date
Description
Debit
Credit
Jan. 1
Cash
576,000
Discount on Bonds Payable
24,000
Bonds Payable
600,000
June 30
Interest Expense
31,200
1,200
30,000
Dec. 31
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47. Leases RULES Capitalize a Lease if:
Present Value of Minimum Lease payments>90% FMV
Lease Term > 75% of Estimated Useful Life
Title Transfer
Bargain Purchase Option
Chapter 7

48. Capitalized Leases: Record and depreciate Asset Record Liability
Recognize Interest Expense
Chapter 7

49. Postretirement Benefit Liabilities
Defined Contribution Plan
Defined Benefit Plan
401(k), IRA
Other non-financial benefits
Chapter 7

50. Ratios Current Ratio = Current Assets Current Liabilities
Working Capital = Current Assets – Current Liabilities
Net Interest Income Taxes
Times Interest Income + Expense Expense
Earned Ratio = Interest Expense
Chapter 7

51. THE END!
Chapter 7
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