1. Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

2. Chapter 10 Reporting and Interpreting Liabilities PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Fred Phillips, Ph.D., CA

3. The Role of Liabilities Current liabilities are short-term obligations that will be paid with current assets within the company’s current operating cycle or within one year of the balance sheet date, whichever is longer. Buys goods and services on credit Obtains short-term loans Issues long-term debt Liabilities are created when a company: 10-3

4. The Role of Liabilities The liability section of the General Mills 2007 and 2008 comparative balance sheets. 10-4

5. Measuring Liabilities Initial Amount of the Liability Cash Equivalent Additional Liability Amounts Increase Liability Payments Made Decrease Liability 10-5

6. Current Liabilities Accounts Payable Accrued Liabilities Liabilities that have been incurred but not yet paid. Increases (Credited) Decreases (Debited) Decreases (Debited) when a company receives goods or services on credit when a company pays on its account 10-6

7. Notes Payable Four key events occur with any note payable: 1.establishing the note, 2.accruing interest incurred but not paid, 3.recording interest paid, and 4.recording principal paid. 10-7

8. Current Portion of Long-Term Debt Long-Term Debt Current Portion of Long-term Debt Noncurrent Portion of Long-term Debt Borrowers must report in Current Liabilities the portion of long-term debt that is due to be paid within one year. 10-8

9. Additional Current Liabilities Sales Tax Payable Payments collected from customers at time of sale create a liability that is due to the state government. Unearned Revenue Cash received in advance of providing services creates a liability of services due to the customer. 10-9

10. Long-Term Liabilities Bonds are financial instruments that outline the future payments a company promises to make in exchange for receiving a sum of money now. Common Long-Term Liabilities 1.Long-term notes payable 2.Deferred income taxes 3.Bonds payable 10-10

11. Bonds Balance Sheet Reporting of Bond Liability Relationships between Interest Rates and Bond Pricing 10-11

12. Contingent Liabilities Contingent liabilities are potential liabilities that arise from past transactions or events, but their ultimate resolution depends (is contingent) on a future event. 10-12

13. Evaluate the Results Two financial ratios are commonly used to assess a company’s ability to generate resources to pay future amounts owed: 1.Quick ratio 2.Times interest earned ratio Quick Ratio = (Cash + Short-term Investments + Accounts Receivable, Net) Current Liabilities Times Interest Earned Ratio = (Net Income + Interest Expense + Income Tax Expense) Interest Expense 10-13

14. Cash Interest$6,000 Amortization of Premium (1,815) Interest Expense$4,185 Cash Interest$6,000 Amortization of Premium (1,815) Interest Expense$4,185 Bond Premium Bond premium or discount decreases each year, until it is completely eliminated on the bond’s maturity date. This process is called amortizing the bond premium or discount. The straight-line method of amortization reduces the premium or discount by an equal amount each period. Recall our example when General Mills received $107,260 on the issue date (January 1, 2010) but repays only $100,000 at maturity (December 31, 2013). Under the straight-line method, this $7,260 is spread evenly as a reduction in interest expense over the four years ($7,260 ÷ 4 = $1,815 per year). 2 Record 1 Analyze 10-14

15. Bond Premium Amortization Schedule of Bonds Issued at a Premium $7,260 ÷ 4 = $1,815 $100,000 × 6% × 12/12 = $6,000 $6,000 - $1,815 = $4,185 $7,260 - $1,815 = $5,445 $107,260 – $1,815 = $105,445 Notice that each of these amounts would plot as a straight-line! 10-15

16. Effective Interest Amortization Interest (I) = Principal (P) × Rate (R) × Time (T) Interest Expense = Carrying Value × Market Rate × n/12 $7,470 = $93,376 × 8% × 12/12 General Mills issued $100,000 face value, 6%, 4-year bonds at a market price to yield investors 8%. The bonds were issued at a discount of $6,624. Let’s determine the effective interest for the first interest payment period. Cash Interest $ 6,000 Effective Interest 7,470 Amortization of Discount $ 1,470 Cash Interest $ 6,000 Effective Interest 7,470 Amortization of Discount $ 1,470 2 Record 1 Analyze 10-16

17. Effective Interest Amortization $93,376 × 8% × 12/12 = $7,470 $100,000 × 6% × 12/12 = $6,000 $93,376 + $1,470 = $94,846 $7,470 - $6,000 = $1,470 $7,470 - $1,470 = $5,154 Effective Interest Amortization of Bonds Issued at a Discount Both Interest Expense and Discount Amortization increase each period. Cash interest is unchanged. 10-17

18. End of Chapter 10