Liabilities Chapter 10 Learning Objectives

Liabilities Chapter 10 Learning Objectives
After studying this chapter, you should be able to: Explain a current liability, and identify the major types of current liabilities. Describe the accounting for notes payable. Explain the accounting for other current liabilities. Explain why bonds are issued, and identify the types of bonds. Prepare the entries for the issuance of bonds and interest expense. Describe the entries when bonds are redeemed. Describe the accounting for long-term notes payable. Identify the methods for the presentation and analysis of non-current liabilities.

Preview of Chapter 10 Financial Accounting IFRS Second Edition
Weygandt Kimmel Kieso

Current Liabilities Current liability
A debt that the company expects to pay within one year or the operating cycle, whichever is longer. Most companies pay current liabilities by using current assets. Current liabilities include notes payable, accounts payable, unearned revenues, and accrued liabilities such as taxes, salaries and wages, and interest payable. LO 1 Explain a current liability, and identify the major types of current liabilities.

Current Liabilities Question
The time period for classifying a liability as current is one year or the operating cycle, whichever is: longer shorter probable possible LO 1 Explain a current liability, and identify the major types of current liabilities.

Current Liabilities Notes Payable
Recorded obligation in the form of written notes. Usually require the borrower to pay interest. Issued for varying periods of time. Those due for payment within one year of the statement of financial position date are usually classified as current liabilities. LO 2 Describe the accounting for notes payable.

Current Liabilities Illustration: Hong Kong National Bank agrees to lend HK$100,000 on September 1, 2014, if C.W. Co. signs a HK$100,000, 12%, four-month note maturing on January 1. Instructions Prepare the journal entry on September 1. Prepare the adjusting journal entry on December 31, assuming monthly adjusting entries have not been made. Prepare the journal entry at maturity (January 1, 2015). LO 2 Describe the accounting for notes payable.

Current Liabilities Illustration: Hong Kong National Bank agrees to lend HK$100,000 on September 1, 2014, if C.W. Co. signs a HK$100,000, 12%, four-month note maturing on January 1. a) Prepare the journal entry on September 1. Cash 100,000 Notes payable 100,000 b) Prepare the adjusting journal entry on Dec. 31. Interest expense 4,000 Interest payable 4,000 HK$100,000 x 12% x 4/12 = HK$4,000 LO 2 Describe the accounting for notes payable.

Current Liabilities Illustration: Hong Kong National Bank agrees to lend HK$100,000 on September 1, 2014, if C.W. Co. signs a HK$100,000, 12%, four-month note maturing on January 1. c) Prepare the journal entry at maturity (January 1, 2015). Notes payable 100,000 Interest payable 4,000 Cash 104,000 LO 2 Describe the accounting for notes payable.

Current Liabilities Sales Tax Payable
Sales taxes are expressed as a stated percentage of the sales price. Either rung up separately or included in total receipts. Retailer collects tax from the customer. Retailer remits the collections to the government’s department of revenue. LO 3 Explain the accounting for other current liabilities.

Current Liabilities Illustration: The March 25 cash register reading for Cooley Grocery shows sales of NT$10,000 and sales taxes of NT$600 (sales tax rate of 6%), the journal entry is: Cash 10,600 Sales revenue 10,000 Sales tax payable 600 LO 3 Explain the accounting for other current liabilities.

Current Liabilities Unearned Revenue
Revenues that are received before the company delivers goods or provides services. Company debits Cash, and credits a current liability account (Unearned Revenue). When the company earns the revenue, it debits the Unearned Revenue account, and credits a Revenue account. LO 3 Explain the accounting for other current liabilities.

Current Liabilities Illustration: Busan IPark (KOR) sells 10,000 season football tickets at W 50,000 each for its five-game home schedule. The club makes the following entry for the sale of season tickets (in thousands of W): Aug. 6 Cash 500,000 Unearned ticket revenue 500,000 As each game is completed, Busan IPark records the revenue earned. Sept. 7 Unearned ticket revenue 100,000 Ticket revenue 100,000 LO 3 Explain the accounting for other current liabilities.

Current Liabilities Current Maturities of Long-Term Debt
Portion of long-term debt that comes due in the current year. Considered a current liability. No adjusting journal entry required. LO 3 Explain the accounting for other current liabilities.

Statement Presentation and Analysis
Current liabilities are presented after non-current liabilities on the statement of financial position. A common method of presenting current liabilities is to list them by order of magnitude, with the largest ones first. LO 3 Explain the accounting for other current liabilities.

Illustration 10-3 LO 3 Explain the accounting for other current liabilities.

Illustration 10-4 Liquidity refers to the ability to pay maturing obligations and meet unexpected needs for cash. The current ratio permits us to compare the liquidity of different-sized companies and of a single company at different times. Illustration 10-5 LO 3 Explain the accounting for other current liabilities.

ANATOMY OF A FRAUD Art was a custodial supervisor for a large school district. The district was supposed to employ between 35 and 40 regular custodians, as well as 3 or 4 substitute custodians to fill in when regular custodians were missing. Instead, in addition to the regular custodians, Art “hired” 77 substitutes. In fact, almost none of these people worked for the district. Instead, Art submitted time cards for these people, collected their checks at the district office, and personally distributed the checks to the “employees.” If a substitute’s check was for $1,200, that person would cash the check, keep $200, and pay Art $1,000. Total take: $150,000 The Missing Control Human Resource Controls. Thorough background checks should be performed. No employees should begin work until they have been approved by the Board of Education and entered into the payroll system. No employees should be entered into the payroll system until they have been approved by a supervisor. All paychecks should be distributed directly to employees at the official school locations by designated employees. Independent internal verification. Budgets should be reviewed monthly to identify situations where actual costs significantly exceed budgeted amounts.

Non-Current Liabilities
Obligations that are expected to be paid after one year. Bond Basics A form of interest-bearing notes payable. To obtain large amounts of long-term capital. Three advantages over ordinary shares: Shareholder control is not affected. Tax savings result. Earnings per share may be higher. LO 4 Explain why bonds are issued, and identify the types of bonds.

Bond Basics Effects on earnings per share—equity vs. debt.
Illustration 10-7 LO 4 Explain why bonds are issued, and identify the types of bonds.

Bond Basics Question The major disadvantages resulting from the use of bonds are: that interest is not tax deductible and the principal must be repaid. that the principal is tax deductible and interest must be paid. that neither interest nor principal is tax deductible. that interest must be paid and principal repaid. LO 4 Explain why bonds are issued, and identify the types of bonds.

Bond Basics Types of Bonds LO 4

Bond Basics Issuing Procedures
Government laws grant corporations power to issue bonds. Board of directors and shareholders must approve bond issues. Board of directors must stipulate number of bonds to be authorized, total face value, and contractual interest rate. Terms of the bond are set forth in a legal document called a bond indenture. Issuing company arranges for printing of bond certificates. LO 4 Explain why bonds are issued, and identify the types of bonds.

Bond Basics Issuing Procedures Represents a promise to pay:
face value at designated maturity date, plus periodic interest at a contractual (stated) interest rate on the maturity amount (face value). Interest payments usually made semiannually. Generally issued when the amount of capital needed is too large for one lender to supply. LO 4 Explain why bonds are issued, and identify the types of bonds.

Bond Basics Issuer of Bonds Maturity Date Contractual Interest Rate
Illustration 10-8 Maturity Date 2017 DUE 2017 DUE 2017 Contractual Interest Rate Face or Par Value LO 4

Bond Basics Bond Trading $952.50 $1,018.75
Bondholders can sell their bonds, at any time, at the current market price on national securities exchanges. Bond prices are quoted as a percentage of the face value. Application Application (1) What is the price of a $1,000 bond trading at 95 1/4? (2) What is the price of a $1,000 bond trading at 101 7/8? $952.50 $1,018.75 LO 4 Explain why bonds are issued, and identify the types of bonds.

Bond Basics Bond Trading
Bondholders can sell their bonds, at any time, at the current market price on national securities exchanges. Bond prices are quoted as a percentage of the face value. Newspapers and the financial press publish bond prices and trading activity daily. Illustration 10-9 LO 4 Explain why bonds are issued, and identify the types of bonds.

Bond Basics Bond Trading
Bondholders can sell their bonds, at any time, at the current market price on national securities exchanges. Bond prices are quoted as a percentage of the face value. Newspapers and the financial press publish bond prices and trading activity daily. A corporation makes journal entries only when it issues or buys back bonds, or when bondholders exchange convertible bonds into ordinary shares. LO 4 Explain why bonds are issued, and identify the types of bonds.

Bond Basics Determining the Market Value of Bonds
Market value is a function of the three factors that determine present value: amounts to be received, length of time until the amounts are received, and market rate of interest. The features of a bond (callable, convertible, and so on) affect the market rate of the bond. LO 4 Explain why bonds are issued, and identify the types of bonds.

Accounting for Bond Issues
Corporation records bond transactions when it issues (sells), retires (buys back) bonds and when bondholders convert bonds into ordinary shares. NOTE: If bondholders sell their bond investments to other investors, the issuing firm receives no further money on the transaction, nor does the issuing corporation journalize the transaction. LO 5 Prepare the entries for the issuance of bonds and interest expense.

Issue at Par, Discount, or Premium? Illustration 10-10 Bond Contractual Interest Rate of 10% LO 5 Prepare the entries for the issuance of bonds and interest expense.

Question The rate of interest investors demand for loaning funds to a corporation is the: contractual interest rate. face value rate. market interest rate. stated interest rate. LO 5 Prepare the entries for the issuance of bonds and interest expense.

Question Karson Inc. issues 10-year bonds with a maturity value of $200,000. If the bonds are issued at a premium, this indicates that: the contractual interest rate exceeds the market interest rate. the market interest rate exceeds the contractual interest rate. the contractual interest rate and the market interest rate are the same. no relationship exists between the two rates. LO 5 Prepare the entries for the issuance of bonds and interest expense.

Issuing Bonds at Face Value Illustration: On January 1, 2014, Candlestick Inc. issues €100,000, five-year, 10% bonds at 100 (100% of face value). The entry to record the sale is: Jan. 1 Cash 100,000 Bonds payable 100,000 LO 5 Prepare the entries for the issuance of bonds and interest expense.

Issuing Bonds at Face Value
Illustration: On January 1, 2014, Candlestick Inc. issues €100,000, five-year, 10% bonds at 100 (100% of face value). Assume that interest is payable semiannually on January 1 and July 1. Prepare the entry to record the payment of interest on July 1, 2014, assume no previous accrual. July 1 Interest expense 5,000 Cash 5,000 (€100,000 x 10% x 6/12) LO 5 Prepare the entries for the issuance of bonds and interest expense.

Issuing Bonds at Face Value
Illustration: On January 1, 2014, Candlestick Corporation issues €100,000, five-year, 10% bonds at 100 (100% of face value). Assume that interest is payable semiannually on January 1 and July 1. Prepare the entry to record the accrual of interest on December 31, 2014, assume no previous accrual. Dec. 31 Interest expense 5,000 Interest payable 5,000 LO 5 Prepare the entries for the issuance of bonds and interest expense.

Issuing Bonds at a Discount Illustration: On January 1, 2014, Candlestick, Inc. sells €100,000, five-year, 10% bonds for €92,639 (92.639% of face value). Interest is payable on July 1 and January 1. The entry to record the issuance is: Jan. 1 Cash 92,639 Bonds payable 92,639 LO 5 Prepare the entries for the issuance of bonds and interest expense.

Issuing Bonds at a Discount
Statement Presentation Illustration 10-11 Carrying value or book value The issuance of bonds below face value—at a discount—causes the total cost of borrowing to differ from the bond interest paid. The reason: Borrower is required to pay the difference between the issuance price and face value—the discount—at the maturity date. Thus, the discount is considered to be an additional cost of borrowing. LO 5 Prepare the entries for the issuance of bonds and interest expense.

Issuing Bonds at a Discount
Total Cost of Borrowing Illustration 10-12 Illustration 10-13 LO 5 Prepare the entries for the issuance of bonds and interest expense.

Issuing Bonds at a Premium Illustration: On January 1, 2014, Candlestick, Inc. sells €100,000, five-year, 10% bonds for €108,111 ( % of face value). Interest is payable on July 1 and January 1. The entry to record the issuance is: Jan. 1 Cash 108,111 Bonds payable 108,111 LO 5 Prepare the entries for the issuance of bonds and interest expense.

Issuing Bonds at a Premium
Statement Presentation Illustration 10-14 The sale of bonds above face value causes the total cost of borrowing to be less than the bond interest paid. The reason: The borrower is not required to pay the bond premium at the maturity date of the bonds. Thus, the bond premium is considered to be a reduction in the cost of borrowing. LO 5 Prepare the entries for the issuance of bonds and interest expense.

Issuing Bonds at a Premium
Total Cost of Borrowing Illustration 10-15 Illustration 10-16 LO 5 Prepare the entries for the issuance of bonds and interest expense.

Accounting for Bond Retirements
Redeeming Bonds at Maturity Assuming that the company pays and records separately the interest for the last interest period, Candlestick records the redemption of its bonds at maturity as follows: Bond payable 100,000 Cash 100,000 LO 6 Describe the entries when bonds are redeemed.

Redeeming Bonds before Maturity When bonds are retired before maturity, it is necessary to: eliminate carrying value of bonds at redemption date; record cash paid; and recognize gain or loss on redemption. The carrying value of the bonds is the face value of the bonds adjusted for the bond discount or bond premium amortized up to the redemption date. LO 6 Describe the entries when bonds are redeemed.

Question Accounting for Bond Retirements
When bonds are redeemed before maturity, the gain or loss on redemption is the difference between the cash paid and the: carrying value of the bonds. face value of the bonds. original selling price of the bonds. maturity value of the bonds. LO 6 Describe the entries when bonds are redeemed.

Illustration: Candlestick, Inc. has sold its bonds at a premium. At the end of the eighth period, Candlestick retires these bonds at 103 after paying the semiannual interest. The carrying value of the bonds at the redemption date is €101,623. Candlestick makes the following entry to record the redemption at the end of the eighth interest period (January 1, 2018): Bonds payable 101,623 Loss on bond redemption 1,377 Cash 103,000 LO 6 Describe the entries when bonds are redeemed.

Accounting for Long-Term Notes Payable
May be secured by a mortgage that pledges title to specific assets as security for a loan. Typically, terms require borrower to make installment payments over the term of the loan. Each payment consists of interest on the unpaid balance of the loan and a reduction of loan principal. Companies initially record mortgage notes payable at face value. LO 7 Describe the accounting for long-term notes payable.

Accounting for Other Long-Term Liabilities
Illustration: Mongkok Technology Inc. issues a HK$500,000, 12%, 20-year mortgage note on December 31, The terms provide for semiannual installment payments of HK$33,231. The installment payment schedule for the first two years is as follows. Illustration 10-17 LO 7 Describe the accounting for long-term notes payable.

Illustration: Mongkok Technology Inc. issues a HK$500,000, 12%, 20-year mortgage note on December 31, The terms provide for semiannual installment payments of HK$33,231. The installment payment schedule for the first two years is as follows. Dec. 31 Cash 500,000 Mortgage payable 500,000 Jun. 30 Interest expense 30,000 Mortgage payable 3,231 Cash 33,231 LO 7 Describe the accounting for long-term notes payable.

Question Each payment on a mortgage note payable consists of: interest on the original balance of the loan. reduction of loan principal only. interest on the original balance of the loan and reduction of loan principal. interest on the unpaid balance of the loan and reduction of loan principal. LO 7 Describe the accounting for long-term notes payable.

Illustration 10-18 LO 8 Identify the methods for the presentation and analysis of non-current liabilities.

Two ratios that provide information about debt-paying ability and long-run solvency are: Debt to Total Assets Ratio Times Interest Earned Ratio LO 8 Identify the methods for the presentation and analysis of non-current liabilities.

Illustration: LG’s (KOR) had total liabilities of ,048 billion, total assets of ,782 billion, interest expense of billion, income taxes of 1,092 billion, and net income of ,967 billion. Illustration 10-19 LG has a relatively high debt to total assets percentage of 60.3%. Its interest coverage of 6.22 times is considered safe. LO 8

APPENDIX 10A PRESENT VALUE CONCEPTS RELATED TO BOND PRICING
Present Value of Face Value Illustration: Assume that you are willing to invest a sum of money that will yield HK$1,000 at the end of one year, and you can earn 10% on your money. What is the HK$1,000 worth today? To compute the answer, divide the future amount by 1 plus the interest rate (HK$1,000/1.10 = HK$ OR use a Present Value of 1 table. (HK$1,000 X ) = HK$ (10% per period, one period from now). LO 9 Compute the market price of a bond.

Present Value of Face Value
To compute the answer, divide the future amount by 1 plus the interest rate (HK$1,000/1.10 = HK$ Illustration 10A-1 LO 9 Compute the market price of a bond.

To compute the answer, use a Present Value of 1 table. (HK$1,000 X ) = HK$ (10% per period, one period from now). LO 9 Compute the market price of a bond.

The future amount (HK$1,000), the interest rate (10%), and the number of periods (1) are known Illustration 10A-2 LO 9 Compute the market price of a bond.

If you are to receive the single future amount of HK$1,000 in two years, discounted at 10%, its present value is HK$ [($1, ) 1.10]. Illustration 10A-3 LO 9 Compute the market price of a bond.

To compute the answer using a Present Value of 1 table. (HK$1,000 X ) = HK$ (10% per period, two periods from now). LO 9 Compute the market price of a bond.

Present Value of Interest Payments (Annuities)
In addition to receiving the face value of a bond at maturity, an investor also receives periodic interest payments (annuities) over the life of the bonds. To compute the present value of an annuity, we need to know: interest rate, number of interest periods, and amount of the periodic receipts or payments. LO 9 Compute the market price of a bond.

Assume that you will receive HK$1,000 cash annually for three years and the interest rate is 10%. Illustration 10A-5 LO 9 Compute the market price of a bond.

Assume that you will receive HK$1,000 cash annually for three years and the interest rate is 10%. Illustration 10A-6 LO 9 Compute the market price of a bond.

HK$1,000 annual payment x 2.48685 = HK$2,486.85
Present Value of Interest Payments (Annuities) Assume that you will receive HK$1,000 cash annually for three years and the interest rate is 10%. HK$1,000 annual payment x = HK$2,486.85 LO 9 Compute the market price of a bond.

Computing the Present Value of a Bond
Selling price of a bond is equal to the sum of: Present value of the face value of the bond discounted at the investor’s required rate of return PLUS Present value of the periodic interest payments discounted at the investor’s required rate of return LO 9 Compute the market price of a bond.

Computing the Market Price of a Bond
Assume a bond issue of 10%, five-year bonds with a face value of €100,000 with interest payable semiannually on January 1 and July 1. Illustration 10A-8 LO 9 Compute the market price of a bond.

APPENDIX 10B EFFECTIVE-INTEREST METHOD OF BOND AMORTIZATION
Under the effective-interest method, the amortization of bond discount or bond premium results in period interest expense equal to a constant percentage of the carrying value of the bonds. Required steps under the effective-interest method: Illustration 10B-1 LO 10 Apply the effective-interest method of amortizing bond discount and bond premium.

Effective-Interest Method of Bond Amortization
Amortizing Bond Discount Illustration: Candlestick, Inc. issues €100,000 of 10%, five-year bonds on January 1, 2014, for €92,639, with interest payable each July 1 and January 1. This results in a discount of €7,361. Illustration 10B-2 LO 10

Amortizing Bond Discount
Illustration: Candlestick, Inc. issues €100,000 of 10%, five-year bonds on January 1, 2014, for €92,639, with interest payable each July 1 and January 1. This results in a discount of €7,361. Journal entry on July 1, 2014, to record the interest payment and amortization of discount is as follows: Interest Expense ,558 July 1 Bonds Payable 558 Cash 5,000 LO 10 Apply the effective-interest method of amortizing bond discount and bond premium.

Amortizing Bond Premium
Illustration: Candlestick, Inc. issues €100,000 of 10%, five-year bonds on January 1, 2014, for €108,111, with interest payable each July 1 and January 1. This results in a premium of €8,111. Illustration 10B-4 LO 10 Apply the effective-interest method of amortizing bond discount and bond premium.

Illustration: Candlestick, Inc. issues €100,000 of 10%, five-year bonds on January 1, 2014, for €108,111, with interest payable each July 1 and January 1. This results in a premium of €8,111. Journal entry on July 1, 2014, to record the interest payment and amortization of premium is as follows: Interest Expense ,324 July 1 Bonds Payable Cash 5,000 LO 10 Apply the effective-interest method of amortizing bond discount and bond premium.

APPENDIX 10C STRAIGHT-LINE AMORTIZATION
Amortizing Bond Discount The effective-interest method is the method required by IFRS to determine amortized cost. Under U.S. GAAP, companies are allowed to use straight-line amortization when the results do not differ materially from the effective-interest method. Illustration 10C-1 LO 11

APPENDIX 10C STRAIGHT-LINE AMORTIZATION
Amortizing Bond Discount Illustration: Candlestick, Inc., sold €100,000, five-year, 10% bonds on January 1, 2014, for €92,639 (discount of €7,361). Interest is payable on July 1 and January 1. Illustration 10C-2 LO 11

Amortizing Bond Discount
Illustration: Candlestick, Inc., sold €100,000, five-year, 10% bonds on January 1, 2014, for €92,639 (discount of €7,361). Interest is payable on July 1 and January 1. The bond discount amortization for each interest period is €736 (€7,361÷10). Journal entry on July 1, 2014, to record the interest payment and amortization of discount is as follows: Interest Expense ,736 July 1 Bonds Payable Cash 5,000 LO 11 Apply the straight-line method of amortizing bond discount and bond premium.

Illustration: Candlestick, Inc., sold €100,000, five-year, 10% bonds on January 1, 2014, for €108,111 (premium of €8,111). Interest is payable on July 1 and January 1. Illustration 10C-4 LO 11 Apply the straight-line method of amortizing bond discount and bond premium.

Illustration: Candlestick, Inc., sold €100,000, five-year, 10% bonds on January 1, 2014, for €108,111 (premium of €8,111). Interest is payable on July 1 and January 1. The bond premium amortization for each interest period is €811 (€8,111÷10). Journal entry on July 1, 2014, to record the interest payment and amortization of premium is as follows: Interest Expense ,189 July 1 Bonds Payable Cash 5,000 LO 11 Apply the straight-line method of amortizing bond discount and bond premium.

APPENDIX 10D PAYROLL-RELATED LIABILITIES
Every employer incurs liabilities relating to employees’ salaries and wages. Salaries and Wages Payable — amounts owed to employees. Withholding taxes (U.S. federal and state income taxes, and Social Security taxes) — amounts owed to the governmental taxing authorities. Determining the payroll involves computing three amounts: (1) gross earnings, (2) payroll deductions, and (3) net pay. LO 12 Prepare entries for payroll and payroll taxes under U.S. law.

Payroll-Related Liabilities
Illustration: Assume a corporation records its payroll for the week of March 7 as follows: Mar. 7 Salaries and wages expense 100,000 FICA tax payable 7,650 Federal income tax payable 21,864 State income tax payable 2,922 Salaries and wages payable 67,564 Record the payment of this payroll on March 11. Mar. 11 Salaries and wages payable 67,564 Cash 67,564 LO 12

Payroll tax expense results from three taxes that governmental agencies levy on employers. These taxes are: FICA tax Federal unemployment tax State unemployment tax LO 12 Prepare entries for payroll and payroll taxes under U.S. law.

Illustration: Based on the corporation’s $100,000 payroll, the company would record the employer’s expense and liability for these payroll taxes as follows. Payroll tax expense 13,850 FICA tax payable 7,650 Federal unemployment tax payable 800 State unemployment tax payable 5,400 LO 12 Prepare entries for payroll and payroll taxes under U.S. law.

Question Employer payroll taxes do not include: Federal unemployment taxes. State unemployment taxes. Federal income taxes. FICA taxes. LO 12 Prepare entries for payroll and payroll taxes under U.S. law.

Another Perspective Key Points
The basic definition of a liability under GAAP and IFRS is very similar. Liabilities may be legally enforceable via a contract or law but need not be; that is, they can arise due to normal business practice or customs. Both GAAP and IFRS classify liabilities as current or non-current on the face of the statement of financial position. IFRS specifically states, however, that industries where a presentation based on liquidity would be considered to provide more useful information (such as financial institutions) can use that format instead.

Under IFRS, companies sometimes show liabilities before assets. Also, they will sometimes show non-current liabilities before current liabilities. Neither of these presentations is used under GAAP. Under IFRS, companies sometimes will net current liabilities against current assets to show working capital on the face of the statement of financial position. This practice is not used under GAAP. The basic calculation for bond valuation is the same under GAAP and IFRS. In addition, the accounting for bond liability transactions is essentially the same between GAAP and IFRS.

IFRS requires use of the effective-interest method for amortization of bond discounts and premiums. GAAP allows use of the straight-line method where the difference is not material. GAAP often uses a separate discount or premium account to account for bonds payable. IFRS records discounts or premiums as direct increases or decreases to Bonds Payable. The accounting for convertible bonds differs between IFRS and GAAP. GAAP requires that the proceeds from the issuance of convertible debt be shown solely as debt. Unlike GAAP, IFRS splits the proceeds from the convertible bond between an equity component and a debt component. The equity conversion rights are reported in equity.

IFRS reserves the use of the term contingent liability to refer only to possible obligations that are not recognized in the financial statements but may be disclosed if certain criteria are met. Under GAAP, contingent liabilities are recorded in the financial statements if they are both probable and can be reasonably estimated. If only one of these criteria is met, then the item is disclosed in the notes. IFRS uses the term provisions to refer to liabilities of uncertain timing or amount. Examples of provisions would be provisions for warranties, employee vacation pay, or anticipated losses. Under GAAP, these are considered recordable contingent liabilities.

Another Perspective Looking to the Future
The FASB and IASB are currently involved in two projects, each of which has implications for the accounting for liabilities. One project is investigating approaches to differentiate between debt and equity instruments. The other project, the elements phase of the conceptual framework project, will evaluate the definitions of the fundamental building blocks of accounting. The results of these projects could change the classification of many debt and equity securities.

Another Perspective GAAP Self-Test Questions
Which of the following is false? Under GAAP, current liabilities are presented before non- current liabilities. Under GAAP, an item is a current liability if it will be paid within the next 12 months or the operating cycle, whichever is longer. Under GAAP, current liabilities are shown in order of magnitude. Under GAAP, a liability is only recognized if it is a present obligation.

Which of the following is true regarding accounting for amortization of bond discount and premium? Both IFRS and GAAP must use the effective-interest method. GAAP must use the effective-interest method, but IFRS may use either the effective-interest method or the straight-line method. IFRS is required to use the effective-interest method. GAAP is required to use the straight-line method.

The joint projects of the FASB and IASB could potentially: change the definition of liabilities. change the definition of equity. change the definition of assets. All of the above.

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