ACG 2021 Financial Accounting

1. ACG 2021Financial Accounting Current & Long-Term Liabilities

2. Learning Objectives • Account for current liabilities and contingent liabilities • Account for bonds-payable transactions • Measure interest expense • Understand the advantages and disadvantages of borrowing • Statement of Cash Flow Effects

3. Liabilities due within 1 year or the company’s operating cycle if longer Known amounts Accounts Payable Short-term Notes Payable Sales Tax Payable Current Installment of Long-Term Debt Accrued Expenses Payroll Liabilities Unearned Revenues We increase Liabilities with a credit. So to increase any of the Known payables on the left, we credit the payable for the known amount. We must therefore, debit a corresponding expense account (accrued expenses) Cash (deferred liability) Long-term debt Cash (if recording receipt from a note payable) Current Liabilities

4. Accounts Payable • Amounts owed for purchases of goods or services on account • The purchase can be for an Asset • Inventory (generally largest) • The purchase could also be an Expense • Legal Fees (service) • No interest associated with money owed, and it is assumed the A/P will be paid quickly • If we have an A/P for Inventory purchased on account, what does the company we purchased the inventory from have? • An Accounts Receivable

5. Note Payable • Unlike Accounts Payable • Usually contains interest payments that are due • Record: • Issuance of Note Payable • We borrowed Cash and have an obligation to pay back • Interest Expense • Payment of Note Payable

6. Notes Payable On Jan. 30, 20X5 the company received a one year $8,000 note payable at 10% interest to purchase inventory. Jan 30 Cash 8,000 Note Payable, Short-term 8,000 Purchase of inventory by issuing a 1-year 10% note payable Interest must be accrued at fiscal year end (April 30) for interest owed but not yet due. Apr 30 Interest Expense (8,000 x .10 x 3/12) 200 Interest Payable 200 Adjusting entry to accrue interest expense

7. Notes Payable To record repayment at maturity Jan 30 20x6: Jan. 30 Note Payable, short-term 8,000 Interest Payable 200 Interest Expense ($8,000 x .10 x 9/12) 600 Cash [($8,000 x .10) + 8,000] 8,800 Payment of a note payable and interest at maturity Step 1: Reverse the balance in the Note Payable account to 0 Step 2: Reduce the amount of any Interest Payable from a previous period to 0 Step 3: Record the Interest Expense for the period Step 4: Record the cash (Principal and Interest paid)

8. Payroll Liabilities • Types of Compensation • Salary • Wage • Commission • Bonus • Salary expense is gross pay. • Salary payable is net pay.

9. Payroll Liabilities To record payroll Jan. 30 Salary Expense 10,000 Employee Income Tax Payable 1,200 FICA Tax Payable 800 Salary Payable to Employees 8,000 To record salary expense

10. Sales Tax Payable To record sales of $200,000 plus 5% sales tax: Cash (200,000 x 1.05) 210,000 Sales Revenue 200,000 Sales Tax Payable (200,000 x .05) 10,000 To record cash sales and related sales tax

11. Unearned Revenues To record collection of cash in payment for future services: Jan 30 Cash 1,200 Unearned Ticket Revenue 1,200 Received cash in advance for ticket sales To record revenue after 50% of services have been performed. Apr 30 Unearned Ticket Revenue 600 Ticket Revenue 600 Earned revenue that was collected in advance

12. Current Liabilities • Amounts that must be estimated • Estimated Warranty Payable • How many products will need repair / replacement • Matching Principle • Estimate based on past historical data • Contingent Liabilities • An company may incur an expense in the future • Most commonly associated with law suits

13. Estimated Warranty Payable Warranty expense should be recognized in the year the product is sold. For example, a company made sales of $200,000 subject to product warranties. They estimate that 3% of the products will require repair or replacement. Warranty Expense 6,000 Estimated Warranty Payable 6,000 To accrue warranty expense When $5,800 of products are replaced under the warranty: Estimated Warranty Payable 5,800 Inventory 5,800 To replace defective products under warranty

14. Contingent Liabilities • Contingent liability depends on a future event arising out of past events. • To account for contingent losses: • Record liability if it is probable and can be reasonably estimated. • Report the liability in the notes to the financial statements (but do not record an entry) if it is reasonably possible that a loss will occur. • Do not report a contingent loss that is not likely to occur.

15. ACG 2021Financial Accounting Long – Term Liabilities Bonds Payable

16. Bonds • IOU’s • $1000 or $5000 Increments • Sold in the “Market” • Structure: • Maturity Date • Interest Rate • Interest Payment Dates • Provide two payments: • Interest every 6 months • Principal amount of Bond

18. Bond Market • Bloomberg.com

19. Bonds Payable • Bonds payable are debt (i.e. a liability) of the issuing company. • Types of bonds: • term bonds • All bonds mature at the same time (end of the term) • serial bonds • Bonds mature in installments over a period of time. • secured bonds (mortgage bonds) • debentures (unsecured bonds)

20. Bonds Payable • Bonds can be issued (bought) • at face value • for a premium • at a discount • Bond Price is determined by: • Market Interest Rate – Effective Rate • Bond’s Interest Rate – Contract Rate • THESE RATES ARE USUALLY DIFFERENT!

21. Bond Interest Rates • Bonds are sold at market price - amount that investors are willing to pay at any given time • Market price represents: • present value of periodic interest payments • present value of principal to be received at maturity

22. Present Value The amount invested today to receive a greater amount at a future date It depends on: • amount of the future receipt • length of time to future receipt • interest rate for the period

23. Bond Interest Rates • Contract rate – stated rate • Market rate – effective rate

24. Present Value Calculation (Discount) • $100,000 10 year bond, 9% stated interest, 10% market rate • Two parts: PV of principle and PV of interest payments • $100,000 x .614* = $61,400 • 100,000 x. 045 x 7.722* = $34,749 • PV of Bonds $96,149 * From Appendix C

25. Bond Prices • Bond Face Value = Stated Principal • Bond issued above face (par) value - premium • Bond issued at below face (par) value - discount • As a bond nears maturity, its market price moves toward par value

26. Bond Prices Quoted at a percent of their maturity value. A $1,000 bond quoted at101½ sells for… $1,000 × 1.015 = $1,015. A $1,000 bond quoted at 88-3/8 sellsfor… $1,000 × 0.88375 = $883.75.

27. Purchase a $1,000 Bond Bond Pays = 9% Bond Interest = $90 Bond Pays = 10% Bond Interest = $100 Bond Pays = 8% Bond Interest = $80 Invest $1,000 in Market at 9% Market Interest = $90 Bond Payable How much would you pay for 9% bond, 10% bond, 8% bond?

28. ACG 2021Financial Accounting Accounting for Bonds Payable

29. Accounting for Bonds • Record Issuance of Bond • Record Payment of Interest • Record Accrual of Interest • Record Amortization of Discount/Premium • Effective Interest Method • Straight-Line Method • Record Retirement of Bond Credit Cash Credit Interest Payable

30. Bonds Payable $50 million in 9%, 5 year bonds are issued on Jan 1, 2006 at par. Cash 50,000,000 Bonds Payable 50,000,000 To issue bonds at par First interest payment on July 1. Interest Expense 2,250,000 Cash 2,250,000 To pay semiannual interest $50,000,000 x .09 x 6/12

31. Bonds Payable At year end, accrue interest to be paid on Jan.1 Interest Expense 2,250,000 Interest Payable 2,250,000 To accrue interest $50,000 x .09 x 6/12

32. Bonds Payable at Discount $100,000 in 9%, 5 year bonds are issued when the market rate is 10% for $96,149. Cash 96,149 Discount on Bonds Payable 3,851 Bonds Payable 100,000 To issue bonds at a discount

33. Bonds Payable at Discount • Discount on Bonds Payable is a contra account to Bonds Payable. • Carrying amount of the bonds equals Bonds Payable less Discount on Bonds Payable. • Interest payments are fixed by contract, but interest expensevaries as the bond discount is amortized.

34. Bonds Payable Premium $100,000 in 9%, 5 year bonds are issued when the market rate is 8% for $104,100. Cash 104,100 Premium on Bonds Payable 4,100 Bonds Payable 100,000 To issue bonds at a premium

35. Bonds Payable at Premium • Premium on Bonds Payable is normal liability account (not a contra-account) • Carrying amount of the bonds equals Bonds Payable plus Premium on Bonds Payable. • Interest payments are fixed by contract, but interest expensevaries as the bond premium is amortized.

36. Bonds Payable Discount Example • Issue Date – January 1, 2006 • Maturity value - $100,000 • Stated interest rate – 9% • Interest paid – 4 ½% semiannually • Market rate at time of issue – 10% annually, 5% semiannually • Issue Price – $96,149

37. Amortization Table (partial) Bonds Payable Discount Example 3851

38. Bonds Payable Discount Journal Entries First semiannual interest payment at Jul 1. Interest Expense 4,807 Discount on Bonds Payable 307 Cash 4,500 To pay semiannual interest and amortize bond discount Second semiannual interest accrual at Dec 31. Interest Expense 4,823 Discount on Bonds Payable 323 Interest Payable 4,500 To accrue semiannual interest and amortize bond discount

39. Bonds Payable Premium Example • Issue Date – January 1, 2006 • Maturity value - $100,000 • Stated interest rate – 9% • Interest paid – 4 ½% semiannually • Market rate at time of issue – 8% annually, 4% semiannually • Issue Price – $104,100

40. Amortization Table (partial) Bonds Payable Premium Example

41. Bonds Payable Premium Example First semiannual interest payment at Jul 1. Interest Expense 4,164 Premium on Bonds Payable 336 Cash 4,500 To pay semiannual interest and amortize bond premium Second semiannual interest accrual at Dec 31. Interest Expense 4,151 Premium on Bonds Payable 349 Interest Payable 4,500 To accrue semiannual interest and amortize bond premium

42. Exercise 8-13

43. Straight-Line Amortization • Divide bond discount (or premium) into equal periodic amounts over the bond’s term. • This equal amount is Interest Expense • Interest expense is the same each period. • GAAP permits straight line only when the amounts differ insignificantly from amounts determined using the effective interest method.

44. Straight-Line • Using the previous Chrysler Example • Premium Amortization = $4100/10 = $410 • 10 = 5 years x 2 interest payments per year $100,000 in 9%, 5 year bonds are issued when the market rate is 8% for $104,100.

45. Straight Line Journal Entries First semiannual interest payment at Jul 1. Interest Expense 4,090 Premium on Bonds Payable 410 Cash 4,500 To pay semiannual interest and amortize bond premium Second semiannual interest accrual at Dec 31. Interest Expense 4,090 Premium on Bonds Payable 410 Interest Payable 4,500 To accrue semiannual interest and amortize bond premium

46. Issuing Bonds Payableat a Discount Chrysler’s balance sheet immediately after issuance of the bonds: Total current liabilities $ XXX Long-term liabilities: Bonds payable, 9%, due 2009 $100,000 Discount on bonds payable ( 3,851) 96,149 Discount on Bonds Payable - contra account to Bonds Payable

47. Issuing Bonds Payableat a Premium Chrysler’s balance sheet immediately after issuance of the bonds: Total current liabilities $ XXX Long-term liabilities: Bonds payable $100,000 Premium on bonds payable 4,100 $104,100

48. Exercise 8-10

49. ACG 2021Financial Accounting Retiring Bonds

50. Bonds Retired at Maturity • After Recording final interest payment • Reduce Bond Payable • Reduce Cash Account Bonds Payable 100,000 Cash 100,000