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Chapter 7

Chapter 7. Liabilities. Chapter 7: Objectives. Account for the major types of transactions and events affecting current and long-term liabilities, including bonds. Define the key characteristics of, and account for, contingent liabilities.

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Chapter 7

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  1. Chapter 7 Liabilities

  2. Chapter 7: Objectives • Account for the major types of transactions and events affecting current and long-term liabilities, including bonds. • Define the key characteristics of, and account for, contingent liabilities. • Distinguish between operating leases and capital leases. • Discuss accounting issues for long-term liabilities stemming from pension and other postretirement employee benefit plans. • Define the key information needs of decision makers regarding liabilities. • Compute and interpret the current, working capital, long-term debt to equity, and times interest earned ratios.

  3. Definition The Financial Accounting Standards Board defines liabilities as "probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events." * *Financial Accounting Standards Board, Statement of Financial Accounting Concepts No. 6, “Elements of Financial Statements” (Stamford, Conn.: FASB, 1985), paragraph 35.

  4. Current Liabilities • Accounts Payable • Notes Payable • Salaries Payable • Current Portion of Long-term Debt

  5. Notes Payable Common Terms: Maker Payee Principal Term of Note Maturity Date/Value Interest = Principal x Rate x Time *Use a 360 day year

  6. Other Accrued Liabilities • Product Warranty • Vacation Pay • Accrued Payroll

  7. Contingent Liabilities The two factors to consider in determining the accounting treatment for a loss contingency are whether (1) it is likely that an actual loss will result from the contingency and (2) the amount of the potential loss can be reasonably estimated. Probable Reasonably Possible Remote

  8. Long-term Liabilities • Bonds Payable • Mortgage Payable • Long-Term Notes Payable • Lease Obligations

  9. Bonds Payable • Callable • Convertible • Stated/Contract Rate • Effective/Market Rate • Maturity Value Maturity Value= PV(Principal) + PVA(Interest Payments) Effective Rate > Stated Rate = Discount Effective Rate < Stated Rate = Premium

  10. Journal Entries for a Bond Issued at a Discount Date Description Debit Credit 2003 Apr. 1 Cash 96,231 Discount on Bonds Payable 3,769 Bonds Payable 100,000 To record issuance of $100,000, 10%, 5-year bonds at a market rate of 11%. Sept. 30 Interest Expense 5,377 Cash 5,000 Discount on Bonds Payable 377 To record payment of semiannual interest and amortization of discount. Dec. 31 Interest Expense 2,689 Interest Payable 2,500 Discount on Bonds Payable 189 To record accrual of 3 month's of interest and amortization of discount.

  11. 2004 Mar. 31 Interest Expense 2,688 Interest Payable 2,500 Cash 5,000 Discount on Bonds Payable 188 To record payment of semiannual interest and amortization of discount.

  12. Journal Entries for a Bond Issued at a Premium Date Description Debit Credit 2003 Apr. 1 Cash 103,957 Bonds Payable 100,000 Premium on Bonds Payable 3,957 To record issuance of $100,000, 10%, 5-year bonds at a market rate of 9%. Sept. 30 Interest Expense 4,604 Premium on Bonds Payable 396 Cash 5,000 To record payment of semiannual interest and amortization of premium. Dec. 31 Interest Expense 2,302 Premium on Bonds Payable 198 Interest Payable 2,500 To record accrual of 3 month's of interest and amortization of premium.

  13. 2004 Mar. 31 Interest Expense 2,302 Interest Payable 2,500 Premium on Bonds Payable 198 Cash 5,000 To record payment of semiannual interest and amortization of premium.

  14. Leases • RULES • Capitalize a Lease if: • Present Value of Minimum Lease payments>90% FMV • Lease Term > 75% of Estimated Useful Life • Title Transfer • Bargain Purchase Option

  15. Capitalized Leases: • Record and depreciate Asset • Record Liability • Recognize Interest Expense

  16. Postretirement Benefit Liabilities • Defined Contribution Plan • Defined Benefit Plan • 401(k), IRA • Other non-financial benefits

  17. Ratios Current Ratio = Current Assets Current Liabilities Working Capital = Current Assets – Current Liabilities Net Interest Income Taxes Times Interest Income + Expense + Expense__ Earned Ratio = Interest Expense

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