REPORTING AND ANALYZING LIABILITIES

1. REPORTING AND ANALYZING LIABILITIES 10 Financial Accounting, Sixth Edition

2. 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. Identify the types of bonds. Prepare the entries for the issuance of bonds and interest expense. Describe the entries when bonds are redeemed. Identify the requirements for the financial statement presentation and analysis of liabilities. Study Objectives

3. Current Liabilities What is a Current Liability? • Two key features: • Company expects to pay the debt from existing current assets or through the creation of other current liabilities. • Company will pay the debt within one year or the operating cycle, whichever is longer. Current liabilities include notes payable, accounts payable, unearned revenues, and accrued liabilities such as taxes, salaries and wages, and interest payable. SO 1 Explain a current liability and identify the major types of current liabilities.

4. Current Liabilities Notes Payable • Written promissory note. • Require the borrower to pay interest. • Those due within one year of the balance sheet date are usually classified as current liabilities. SO 2 Describe the accounting for notes payable.

5. Current Liabilities Illustration: First National Bank agrees to lend $100,000 on September 1, 2012, if Cole Williams Co. signs a $100,000, 12%, four-month note maturing on January 1. When a company issues an interest-bearing note, the amount of assets it receives generally equals the note’s face value. Sept. 1 Cash 100,000 Notes payable 100,000 SO 2 Describe the accounting for notes payable.

6. Current Liabilities Illustration: If Cole Williams Co. prepares financial statements annually, it makes an adjusting entry at December 31 to recognize interest. Dec. 31 Interest expense 4,000 * Interest payable 4,000 * $100,000 x 12% x 4/12 = 4,000 SO 2 Describe the accounting for notes payable.

7. Current Liabilities Illustration: At maturity (January 1), Cole Williams Co. must pay the face value of the note plus interest. It records payment as follows. Jan. 1 Notes payable 100,000 Interest payable 4,000 Cash 104,000 SO 2 Describe the accounting for notes payable.

8. Current Liabilities Sales Tax Payable • Sales taxes are expressed as a stated percentage of the sales price. • Retailer collects tax from the customer. • Retailer remits the collections to the state’s department of revenue. SO 3 Explain the accounting for other current liabilities.

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

10. Current Liabilities Sometimes companies do not ring up sales taxes separately on the cash register. Illustration: Cooley Grocery rings up total receipts of $10,600. Because the amount received from the sale is equal to the sales price 100% plus 6% of sales, (sales tax rate of 6%), the journal entry is: Mar. 25 Cash 10,600 * Sales revenue 10,000 Sales tax payable 600 * $10,600 / 1.06 = 10,000 SO 3 Explain the accounting for other current liabilities.

11. 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. SO 3 Explain the accounting for other current liabilities.

12. Current Liabilities Illustration: Superior University sells 10,000 season football tickets at $50 each for its five-game home schedule. The entry for the sales of season tickets is: Aug. 6 Cash 500,000 Unearned ticket revenue 500,000 As each game is completed, Superior records the earning of revenue. Sept. 7 Unearned ticket revenue 100,000 Ticket revenue 100,000 SO 3 Explain the accounting for other current liabilities.

13. Current Liabilities Current Maturities of Long-Term Debt • Portion of long-term debt that comes due in the current year. • No adjusting entry required. • Illustration: Wendy Construction issues a five-year, interest-bearing $25,000 note on January 1, 2011. This note specifies that each January 1, starting January 1, 2012, Wendy should pay $5,000 of the note. When the company prepares financial statements on December 31, 2011, • What amount should be reported as a current liability? _________ • What amount should be reported as a long-term liability? _______ $5,000 $20,000 SO 3 Explain the accounting for other current liabilities.

14. Current Liabilities Payroll and Payroll Taxes Payable The term “payroll” pertains to both: Salaries - managerial, administrative, and sales personnel (monthly or yearly rate). Wages - store clerks, factory employees, and manual laborers (rate per hour). Determining the payroll involves computing three amounts: (1) gross earnings, (2) payroll deductions, and (3) net pay. SO 3 Explain the accounting for other current liabilities.

15. Current Liabilities Illustration: Assume Cargo 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 tax payable 21,864 State tax payable 2,922 Salaries and wages payable 67,564 Record the payment of this payroll on March 7. Mar. 7 Salaries and wages payable 67,564 Cash 67,564 SO 3

16. Current Liabilities Payroll tax expense results from three taxes that governmental agencies levy on employers. • These taxes are: • FICA tax • Federal unemployment tax • State unemployment tax SO 3 Explain the accounting for other current liabilities.

17. Current Liabilities Illustration: Based on Cargo Corp.’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 State unemployment tax payable 800 Federal unemployment tax payable 5,400 SO 3 Explain the accounting for other current liabilities.

18. Bond: Long-Term Liabilities Bondsare a form of interest-bearing notes payable issued by corporations, universities, and governmental agencies. Sold in small denominations (usually $1,000 or multiples of $1,000). SO 4 Identify the types of bonds.

19. Bond: Long-Term Liabilities • Types of Bonds • Secured • Unsecured • Convertible • Callable SO 4 Identify the types of bonds.

20. Bond: Long-Term Liabilities Issuing Procedures • Bond certificate • Issued to the investor. • Provides name of the company issuing bonds, face value, maturity date, and contractual (stated) interest rate. • Face value- principal due at the maturity. • Maturity date- date final payment is due. • Contractual (stated) interest rate– rate to determine cash interest paid, generally semiannually. SO 4 Identify the types of bonds.

21. Bond: Long-Term Liabilities Illustration 10-3 SO 4

22. Bond: Long-Term Liabilities Determining the Market Value of Bonds • Market value is a function of the three factors that determine present value: • the dollar amounts to be received, • the length of time until the amounts are received, and • the market rate of interest. The process of finding the present value is referred to as discountingthe future amounts. SO 4 Identify the types of bonds.

23. Bond: Long-Term Liabilities Illustration: Assume that Acropolis Company on January 1, 2012, issues $100,000 of 9% bonds, due in five years, with interest payable annually at year-end. Illustration 10-4 Time diagram depicting cash flows Illustration 10-5 Computing the market price of bonds SO 4 Identify the types of bonds.

24. Accounting for Bond Issues • A corporation records bond transactions when it • issues or retires (buys back) bonds and • when bondholders convert bonds into common stock (if they are convertible). • Bonds may be issued at • face value, • below face value (discount), or • above face value (premium). Bond prices are quoted as a percentage of face value. SO 5 Prepare the entries for the issuance of bonds and interest expense.

25. Issuing Bonds at Face Value Illustration: Devor Corporation issues 100, five-year, 10%, $1,000 bonds dated January 1, 2012, at 100 (100% of face value). The entry to record the sale is: Jan. 1 Cash 100,000 Bonds payable 100,000 Prepare the entry Devor would make to accrue interest on December 31. Dec. 31 Interest expense 10,000 Interest payable 10,000 SO 5 Prepare the entries for the issuance of bonds and interest expense.

26. Issuing Bonds at Face Value Prepare the entry Devor would make to pay the interest on Jan. 1, 2013. Jan. 1 Interest payable 10,000 Cash 10,000 SO 5 Prepare the entries for the issuance of bonds and interest expense.

27. Accounting for Bond Issues Assume Contractual Rate of 10% Market Interest Bonds Sold At 8% Premium 10% Face Value Discount 12% SO 5 Prepare the entries for the issuance of bonds and interest expense.

28. Issuing Bonds at a Discount Illustration: Assume that on January 1, 2012, Candlestick Inc. sells $100,000, five-year, 10% bonds at 98 (98% of face value) with interest payable on January 1. The entry to record the issuance is: Jan. 1 Cash 98,000 Discount on bonds payable 2,000 Bonds payable 100,000 Illustration 10-8 Computation of total cost of borrowing—bonds issued at discount SO 5 Prepare the entries for the issuance of bonds and interest expense.

29. Issuing Bonds at a Discount Statement Presentation Illustration 10-7 Statement presentation of discount on bonds payable SO 5 Prepare the entries for the issuance of bonds and interest expense.

30. Issuing Bonds at a Premium Illustration: Assume that the Candlestick Inc. bonds previously described sell at 102 rather than at 98. The entry to record the sale is: Jan. 1 Cash 102,000 Bonds payable 100,000 Premium on bonds payable 2,000 Illustration 10-12 Computation of total cost of borrowing—bonds issued at premium SO 5 Prepare the entries for the issuance of bonds and interest expense.

31. Issuing Bonds at a Premium Statement Presentation Illustration 10-11 Statement presentation of premium on bonds payable SO 5 Prepare the entries for the issuance of bonds and interest expense.

32. Accounting for Bond Retirements Redeeming Bonds at Maturity Candlestick records the redemption of its bonds at maturity as follows: Bonds payable 100,000 Cash 100,000 SO 6 Describe the entries when bonds are redeemed.

33. Accounting for Bond Retirements Redeeming Bonds at Maturity • When a company retires bonds before maturity, it is necessary to: • eliminate the carrying value of the bonds at the redemption date; • record the cash paid; and • recognize the gain or loss on redemption. The carrying value of the bonds is the face value of the bonds less unamortized bond discount or plus unamortized bond premium at the redemption date. SO 6 Describe the entries when bonds are redeemed.

34. Accounting for Bond Retirements Illustration:Assume at the end of the fourth period, Candlestick Inc., having sold its bonds at a premium, retires the bonds at 103 after paying the annual interest. Assume that the carrying value of the bonds at the redemption date is $100,400 (principal $100,000 and premium $400). Candlestick records the redemption at the end of the fourth interest period (January 1, 2016) as: Bonds payable 100,000 Premium on bonds payable 400 Loss on bond redemption 2,600 Cash 103,000 SO 6 Describe the entries when bonds are redeemed.

35. Financial Statement Analysis and Presentation Analysis Illustration 10-16 SO 7

36. Financial Statement Analysis and Presentation Liquidity Illustration 10-17 Liquidity ratiosmeasure the short-term ability of a company to pay its maturing obligations and to meet unexpected needs for cash. SO 7 Identify the requirements for the financial statement presentation and analysis of liabilities.

37. Financial Statement Analysis and Presentation Solvency Solvency ratios measure the ability of a company to survive over a long period of time. SO 7

38. Financial Statement Analysis and Presentation Off-Balance-Sheet Financing • Contingencies • Leasing • Operating lease • Capital lease SO 7 Identify the requirements for the financial statement presentation and analysis of liabilities.