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Liabilities

Liabilities. obligations of an entity to make a future payment or to deliver goods or services to the third parties in the future in return for cash borrowed or service used or goods acquired Definite vs. estimated liabilities classified according to their due dates

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Liabilities

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  1. Liabilities • obligations of an entity to make a future payment or to deliver goods or services to the third parties in the future in return for cash borrowed or service used or goods acquired • Definite vs. estimated liabilities • classified according to their due dates • due within one year or the operating cycle are classified as current liabilities • loans or credits that mature in more than one year are classified as long-term liabilities Mugan-Akman 2007

  2. Recognition of Liabilities • recognized when the obligation occurs for an entity • If not recognized • Understatement of liabilities and assets • Understatement of liabilities and expenses • to satisfy the matching and periodicity principles, adjustments are made at the end of the accounting periods Mugan-Akman 2007

  3. Valuation of Liabilities • valued at the cash amount necessary to pay back the liability or at the fair value of the goods or services to be provided • Value • may be certain • may be estimated Mugan-Akman 2007

  4. Current Liabilities • Short Term Bank Loans • Current Portion of Long-term Debt • Trade Payables • Accounts Payable • Notes Payable • Accruals • Unearned Revenues (deferred income) • Payroll Liabilities • Corporate Income Taxes • Value Added Taxes • Product Warranty Liability Mugan-Akman 2007

  5. Notes Payable • Classification • Purchases on credit • Trade Payables • Borrowing • Financial Liabilities • Presentation • Notes with additional interest • Notes Payable+Interest Payable • Discounted Notes • Notes Payable-Discount on Notes Payable Mugan-Akman 2007

  6. Payroll Related Liabilities • An employee usually receives a payment that is less than the gross pay of that employee- the net pay • Deductions: • Required deductions that must be paid by the employee according to tax and social security regulations • Optional deductions authorized by the employee for special purposes (such as private pension plans Mugan-Akman 2007

  7. Payroll Liabilities • Employee Income Taxes • Stamp Duty • Social Security Premiums • Unemployment Insurance Premium Mugan-Akman 2007

  8. Mugan-Akman 2007

  9. Payroll Entry cost of the employee to the employer is TL 2.450 - employee receives TL 1.444 * SSK premiums – Employer share TL 390 Unemployment insurance premium- Employer share 60 SSK premium-Employee share 280 Unemployment insurance premium – Employee share 40 Total payable to SSK TL 770 Mugan-Akman 2007

  10. Corporate Income Taxes • Corporations and limited corporations • At a rate of 20% • Quarterly Prepaid: • as of March 31, June 30, September 30 and December 31 • annual corporate tax payment computed for the fiscal year and declared in April the following year Mugan-Akman 2007

  11. Corporate Income Taxes-Example During 2008: Mercan jewelry paid a total of TL 13.850 Net Income for 2008 TL 123.750 Assume Tax rate: 20% Income Tax expense = TL 24.750. The entry at the end of the fiscal year: Mugan-Akman 2007

  12. Deferred Taxation Mugan-Akman 2007

  13. Deferred Taxation Mugan-Akman 2007

  14. Value Added Taxes • When a good is sold or service provided • VAT is added to sales price and collected from the customer • NOT a Revenue • When a purchase of a good or a service realized • VAT is added to the purchase price and paid to supplier • NOT an Expense • VAT received from customers should be reimbursed to the Tax Offices • if VAT on sales > the VAT on purchases →the entity is required to pay the difference to the Tax Office • if VAT on purchases exceeds the VAT on sales → the difference is carried forward to the next month Mugan-Akman 2007

  15. Accounting for VAT transactions 14 April: Purchased 10 items for TL17.110 on credit including 18% VAT 20 April: Sold 22 items for TL 37.642 on credit including 18% VAT 20 May: Filed the VAT return 26 May: Paid the necessary amount Mugan-Akman 2007

  16. VAT entries Mugan-Akman 2007

  17. Provisions and Contingent Liabilities • a potential liability arising from a past transaction and that depends on a future event • could be disclosed in the body of the balance sheet with the liabilities • could be disclosed within notes to financial statements • certainty of the amount and the payment date determines where they will be disclosed Mugan-Akman 2007

  18. Is the amount of the liability known? YES NO YES Can the amount of Liability be reasonably Estimated? YES Is the liability likely to occur? (Probable) NO NO Recognize liability on the balance sheet Disclose in the notes To the financial Statements (CONTINGENT LIABILITY) Mugan-Akman 2007

  19. Product Warranty Liabilities • When goods and services are sold under warranty coverage • A good example of provision • matching principle - warranty expenses of sales in a period should be recorded in the same period • Subsequent expenditures of warranties are charged against warranty liability Mugan-Akman 2007

  20. Mugan-Akman 2007

  21. Long-term Financing • Capital or Long-term Liability • advantages of raising capital • capital stock is not paid back by the entity • dividends are distributed only if the entity has enough income and cash • advantages of long-term liabilities : • Shareholder Control • Tax Effects: Interest payments on liabilities are tax deductible • Financial leverage: Financial leverage or trading on equity means using borrowed money to increase the rate of return to the shareholders Mugan-Akman 2007

  22. Types of Long Term Liabilities • Bank Loans • Bonds Issued- • bond indenture • bond certificate • interest paid: quarterly, semi-annually or annually Mugan-Akman 2007

  23. Mugan-Akman 2007

  24. Types of Long Term Liabilities • Bank Loans • Bonds Issued- • bond indenture • bond certificate • interest paid: quarterly, semi-annually or annually • Installment Loans (consumer loans) • Lease Obligations Mugan-Akman 2007

  25. Types of Bonds • Time or Serial Bonds • Callable Bonds • Registered or Bearer Bonds • Convertible Bonds Mugan-Akman 2007

  26. Bond terminology • Stated rate or coupon rate or nominal rate = contractual rate written on the face of the bond • Face value or nominal value = value written on the face of the note • Maturity date = date when the bonds will be paid • Life of the bond = duration of the bond • Maturity value = nominal value • Market rate or effective rate of interest or yield = prevalent rate on the market for similar term and risk bonds Mugan-Akman 2007

  27. Stated Interest and Market Interest Rate Stated Interest Rate = Market Interest Rate Bond is sold at Par Stated Interest Rate < Market Interest Rate Bond is sold at Discount Stated interest Rate > Market Interest Rate Bond is Sold at Premium Mugan-Akman 2007

  28. Price Determination • Sumatek Corp. decided to issue TL100.000 bonds with a stated interest rate of 11% maturing in 5 years. The interest is payable semiannually on 30 June and 31 December of each year. Interest paid every six months is TL 11.000/2 =TL 5.500. If the market rate on 1 January 2004, was 12% Present Value of the Maturity Value (Principal) (100.000 x 0,558; n=10 i=6%)(Table1) = TL 55.800 Present Value of Interest Payments (5.500 x 7,360; n=10 i=6%)(Table 2) = 40.480 Price of the Bond TL 96.280 If the market rate on 1 January 2004, was 10% Present Value of the Maturity Value (Principal) (100.000 x 0,614; n=10 i=5%)(Table 1) = TL 61.400 Present Value of Interest Payments (5.500 x 7,722; n=10 i=5%)(Table 2) = 42.471 Price of the Bond TL 103.871 Mugan-Akman 2007

  29. Bond Interest Expense Mugan-Akman 2007

  30. Bonds issued at par • Sumatek Corp. ,TL100.000 bonds, 11%,5yrs 30 June 2004 , the first interest payment date, the Company will pay TL5.500 Mugan-Akman 2007

  31. Accounting for Discounts on Bonds Payable The market interest rate on 1 January 2004 - 12% and the TL 100.000 bonds were issued at TL 96.280 or at 96.28 partial balance sheet of Sumatek Corp. after the issue of the bonds will show Mugan-Akman 2007

  32. Effective Interest Method of Amortization of Bond Discounts • acceptable method of amortizing the bond discounts • interest expense of each period is computed using the market interest rate over the carrying value of the bonds Mugan-Akman 2007

  33. Amortization of Bond Discount (Effective Interest) Mugan-Akman 2007

  34. Amortization of Bond Discount (Effective Interest) Mugan-Akman 2007

  35. Amortization of Bond Discount (Effective Interest) Mugan-Akman 2007

  36. Accounting for Premiums on Bonds Payable Sumatek Corp. issued TL100.000 bonds, stated interest rate of 11% maturing in 5 years on 1 January 2004. The interest on the bonds are payable semiannually on 30 June and 31 December each year. The market interest rate on 1 January 2004 was 10% and the bonds were issued at TL 103.871 partial balance sheet Mugan-Akman 2007

  37. Amortization of Bond Premium Principal Payment at Maturity TL 100.000 Total Interest Paid in Cash (100.000*11%*5) 55.000 Total Cash Payments till Maturity TL 155.000 Total Cash Received at the Issue Date 103.871 Total Interest Expense of the Bond Issue TL 51.129 Mugan-Akman 2007

  38. Effective Interest Method of Amortization of Bond Premiums Mugan-Akman 2007

  39. Effective Interest Method of Amortization of Bond Premiums Mugan-Akman 2007

  40. Effective Interest Method of Amortization of Bond Premiums Mugan-Akman 2007

  41. Installment (consumer) Loans Principal Loan amount: TL 30.000 Loan period: 2 years Monthly installments: TL 2.174 Annual Interest Rate 60% Mugan-Akman 2007

  42. 30.000 * .05= TL 1.500 29.326 * .05= TL 1.466 Repayment Schedule of Consumer Loan Mugan-Akman 2007

  43. Lease Obligations • operating or a capital (finance) lease • Capital Lease • Significant risks and benefits of the ownership belong to lessee • Present Value of Future Lease Payments- • Recorded as a Liability • Recorded as an asset and depreciated Mugan-Akman 2007

  44. For example: 8,000 per year for 8 years at 10% interest rate Net Present Value of Future Lease Payments at the date of the lease agreement is TL 42.680 10% * 42.680 Mugan-Akman 2007

  45. Mugan-Akman 2007

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