1. Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

2. Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Chapter 7 Accounting for and Presentation of Liabilities PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA

3. McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-3 Liabilities are obligations that represent “probable future sacrifice of economic benefits.” 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. 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. Current liabilities are those liabilities that will be paid within one year of the current balance sheet date. Liabilities are obligations that represent “probable future sacrifice of economic benefits.” 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. 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. Current liabilities are those liabilities that will be paid within one year of the current balance sheet date. LO 1 Nature of Liabilities 7-3

4. McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-4 Current liabilities include: Accounts payable Short-term debt (Notes payable) Current maturities of long-term debt Unearned revenue or deferred credits Other accrued liabilities Current liabilities include: Accounts payable Short-term debt (Notes payable) Current maturities of long-term debt Unearned revenue or deferred credits Other accrued liabilities Noncurrent liabilities include: Long-term debt (Bonds payable) Deferred tax liabilities Noncurrent liabilities include: Long-term debt (Bonds payable) Deferred tax liabilities LO 1 Nature of Liabilities 7-4

5. McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-5 Straight Interest Interest = Principal × Rate × Time in years = $25,000 × 0.09 × 1 = $ 2,250 per year or $187.50 per month Annual Percentage Interest Rate (APR) APR = Interest Paid ÷ Money available × Time = $2,250 ÷ $25,000 × 1 = 9% LO 2 Interest Calculation Methods 7-5

6. McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-6 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 of long-term debt. Current Maturities on Long-Term Debt LO 2 7-6

7. McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-7 Unearned Revenue or Deferred Credits Unearned revenue is created when customers pay for services or products before delivery. Our goal is to recognize revenue as the subscription is fulfilled each month. Our goal is to recognize revenue as the subscription is fulfilled each month. 1/1/131/31/13 Month end 2/28/13 Month end 3/31/13 Month end Cash received for one-year subscription On January 1, 2013, Matrix, Inc. receives $2,400 cash as an advance payment for a one-year subscription to its monthly investment newsletter. LO 3 7-7

8. McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-8 Payroll Taxes FICA Taxes Medicare Taxes Federal Income Tax State and Local Income Taxes Voluntary Deductions Net Pay Gross Pay - Deductions = LO 4 7-8

9. McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-9 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. LO 6 7-9

10. McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-10 Financial Leverage 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% LO 6 7-10

11. McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-11 Bonds Payable - Terminology BOND PAYABLE Face Value $1,000 Face value is the amount an investor will receive at maturity. Bond Date 1/1/13 Bond date is the date the bond was issued. Interest 10% Stated interest rate is typically an annual rate. 6/30 & 12/31 Interest payment dates are dates when an investor is paid interest. Maturity Date 12/31/17 Maturity date is the date when the face value of the bond is repaid to an investor. LO 7 7-11

12. McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-12 Issuance of Bonds Payable at a Discount or a Premium Market Rate Effect of Bond Selling Prices In the previous example, par value was illustrated: Stated Rate = Market Rate LO 8 7-12

13. McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-13 The Internal Revenue Code is the set of rules for preparing tax returns. Financial statement income tax expense. IRS income taxes payable. GAAP is the set of rules for preparing financial statements. Usually...Results in... The difference between tax expense and tax payable is referred to as deferred taxes. LO 9 Deferred Tax Liability 7-13

14. McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-14 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 and reflected in the income statement of the fiscal period in which the benefits are earned by the employees. 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 benefits. For pragmatic reasons, postretirement benefits are measured in a different manner. Some companies pay postretirement benefits. For pragmatic reasons, postretirement benefits are measured in a different manner. LO 9 7-14

15. McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-15 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. LO 10 Other Noncurrent Liabilities 7-15

16. McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-16 End of Chapter 7 7-16