Liabilities

2. 2 Liabilities are.. Creditors claims on total assets Existing debts and obligations

3. 3 Current Liabilities Can reasonably be expected to paid From existing current assets or through the creation of other current liabilities. Within 1 year or the operating cycle, whichever is longer.

4. 4 Current Liability Types Notes Payable Accounts Payable Unearned Revenues Accrued Liabilities

5. 5 Notes Payable are... Obligations in the form of written notes. Often used instead of accounts payable - they give written documentation if needed for legal remedies. Used for short-term and long-term financing needs.

6. Remember - Interest accrues over life of the note and must be recorded periodically.

7. 7 Sales Taxes Payable... Are collected from customers. Are expressed as a % of sales price. Are required by law. Must be sent to state often. Are often rung separately from sales on the cash register.

9. 9 Payroll Taxes... Amount required by law to be withheld from employees’ gross pay. Social Security taxes withheld (FICA) Federal Income Taxes State Income Taxes (if applicable)

11. 11 Unearned Revenues... Cash received before revenues are earned and recorded as liabilities until they are earned.

12. 12 Unearned Revenues... Magazine subscriptions Rent received in advance Customer deposits for future service Sale of airline tickets for future travel Sale to season sporting events

13. 13 Current Maturities of Long-Term Debt The portion of the long-term debt that is due within the current year or operating cycle should be classified as a current liability.

15. 15 Liquidity Ratios... Measure the short-term ability of a company to pay its maturing obligations and to meet unexpected needs for cash.

16. 16 Liquidity Ratios... Working Capital Current Ratio

17. 17 Acid-Test Ratio Measure of company’s immediate short-term ability to pay obligations

18. 18 Line of Credit... Is a prearranged agreement between a company and a lender to allow the company to borrow up to an agreed-upon amount.

19. 19 Long-Term Liabilities... Are obligations that are expected to be paid after 1 year.

20. 20 Bonds... Are a form of interest-bearing notes payable issued by corporations, universities and governmental agencies. Are sold in small denominations, which makes them attractive to investors.

22. 22 Secured Bonds... Have specific assets of the issuer pledged as collateral for bonds. Mortgage Bond - a bond secured by real estate. Sinking Fund Bond - a bond secured by specific assets to retire the bonds.

23. 23 Unsecured or Debenture Bonds... Are issued against the general credit of the borrower.

24. 24 Term Bonds... Are due for payment (mature) at a single specified future date.

25. 25 mature in installments. Serial Bonds...

26. 26 Convertible Bonds... Can be changed into common stock at the bondholder’s option.

27. 27 Issuing Bonds... Requires formal approval by board of directors and stockholders. Board of Directors must stipulate Total number of bonds to be authorized Total face value Contractual Interest Rate

28. 28 The amount of principle due at maturity date.

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31. 31 Accounting for Bond Issues Bonds may be issued at: Face value Below face value (discount) or Above face value (premium).

32. 32 Issuing Bonds at Face Value Assume that Devour Corporation issued 1,000, 10-year 10%, $1,000 bonds dated January 1, 2001 at 100 (100% of face value) with interest payable on July 1 and January 1. 1/1 Cash 1,000,000 Bonds Payable 1,000,00 (To record sale of bonds at face value)

33. 33 Issuing Bonds at Face Value The entry to record the semiannual interest on July 1 is: 7/1 Bond Interest Expense 50,000 Cash 50,000 (To record the payment of bond interest) ($1,000,000 x 10% x 6/12)

34. 34 Issuing Bonds at Face Value On December 31 the following adjusting entry is required to record the $50,000 of interest accrued since July 1: 12/31 Bond Interest Expense 50,000 Bond Interest Payable 50,000 (To accrue bond interest)

35. 35 Discount or Premiums on Bonds Often the contractual (stated) interest rate and the market (effective) interest rate differ… therefore bonds sell above or below face value.

36. 36 Bond Discount... When the investor pays less than the face value of the bond.

38. 38 Selling Bonds at Discount Assume that on January 1, 1998, Candlestick, Inc., sells $1 million, 5-year, 10% bonds at 98 with interest payable on July 1 and January 1. 1/1 Cash 980,000 Discount on Bonds Payable 20,000 Bonds Payable 1,000,000 (To record sale of bonds at a discount)

39. 39 Carrying (Book) Value of Bonds Long-term liabilities Bonds payable $1,000,000 Less: Discount on bonds 20,000 $980,000 payable

40. 40 Selling Bonds at Premium Assume that on January 1, 2001, Candlestick, Inc., sells $1 million, 5-year, 10% bonds at 102 with interest payable on July 1 and January 1. 1/1 Cash 1,020 000 Bonds Payable 1,000,000 Premium Bonds Payable 20,000 (To record sale of bonds at a premium)

41. 41 Carrying (Book) Value of Bonds Long-term liabilities Bonds payable $1,000,000 Add : Premium on bonds 20,000 $1,020,000 payable

42. 42 Straight-line Method of Allocation Is Used to Comply with Matching Principle

43. 43 Amortizing Bond Discount/Premium Candlelight would amortize the $20,000 discount/premium as follows: $20,000 ÷ 10 Interest Periods = $2,000 Semiannually

44. 44 Amortizing Bond Discount/Premium Interest Expense 52,000 Bond Discount 2,000 Cash 50,000 Interest Expense 48,000 Bond Premium 2,000 Cash 50,000

45. 45 Bond Retirement Bonds may be redeemed at maturity or before maturity.

46. 46 Redeeming Bonds Before Maturity A company may decide to retire bonds before maturity to: reduce interest cost remove debt from its balance sheet. A company should retire debt early only if it has sufficient cash resources.

47. 47 Redeeming Bonds Before Maturity When bonds are retired before maturity, it is necessary to: Eliminate the carrying value of the bonds at the redemption date Record the cash paid Recognize the gain or loss on redemption.

48. Long-term liabilities Bonds payable 10% due in 2009 $1,000,000 Less: Discount on bonds payable 80,000 $ 920,000 Redeeming Bonds Before Maturity

49. 49 Debt to Total Assets Ratio... Indicates the extent to which a company’s debt could be repaid by liquidating assets.

50. 50 Times Interest Earned Ratio... Provides an indication of company’s ability to meet interest payments as they come due.

51. 51 Contingent Liabilities... Are events with uncertain outcomes. Must be recorded in the financial statements: if the company can determine a reasonable estimate of the expected loss and if it is a probable loss.

52. 52 Lease Liabilities In some instances the lease contract transfers substantially all the benefits and risks of ownership to the lessee, so that the lease is in effect a purchase of the property. The type of lease described above is called a capital lease because the fair value of the leased asset is capitalized by the lessee recording it on its balance sheet.

53. 53 Capital Lease Is it likely that the lessee will end up with the assets at the end of the lease? Will the lessee use the asset for most of its useful life? Will the payments made by the lessee be approximately the same as the payments it would have made if it had purchased the asset?

54. 54 Capital Lease Lessee must record the asset and a related liability for the lease payments. Most lessees do not like to report leases on their balance sheets because the lease liability increases the company's total liabilities. The procedure of keeping liabilities off the balance sheet is often referred to as off-balance sheet financing.

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