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Current and Long-Term Liabilities

Current and Long-Term Liabilities. Chapter 8. Learning Objective 1. Account for current liabilities and contingent liabilities. Current Liabilities. Current liabilities are obligations due within one year or within the company’s normal operating cycle if it is longer than one year.

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Current and Long-Term Liabilities

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  1. Current and Long-Term Liabilities Chapter 8

  2. Learning Objective 1 Account for current liabilities and contingent liabilities.

  3. Current Liabilities Current liabilities are obligations due within one year or within the company’s normal operating cycle if it is longer than one year. Known amount Estimated amount

  4. Known Current Liabilities Accounts payable Short-term notes payable Goods and services tax payable Sales tax payable Current portion of long-term debt Accrued expenses Payroll liabilities Unearned revenues

  5. Current Liabilities Accounts payable are amounts owed to suppliers for goods or services purchased on account. Short-term notes payable are notes payable due within one year.

  6. Short-Term Notes Payable In addition to recording the note payable, the business must also pay interest expense. On September 30, a business purchased inventory for $8,000 by issuing a 1-year, 10% note payable. The fiscal year ends on December 31.

  7. Short-Term Notes Payable September 30 Inventory 8,000 Notes Payable 8,000 Purchase of inventory by issuing a one-year, 10% note How much interest was accrued as of Dec. 31? $8,000 × 10% × (3/12) = $200

  8. Short-Term Notes Payable How is the payment at maturity recorded? September 30, 2004 Note Payable 8,000 Interest Payable 200 Interest Expense 600 Cash 8,800 $8,000 × 10% × (9/12) = $600

  9. Goods and Services Tax (GST) Payable GST of 7% is a consumption tax charged on almost all business transactions. Only the ultimate consumer pays GST. GST registrants who are not final consumers can deduct GST paid from GST collected and only remit the difference to the federal government.

  10. Current Installment ofLong-Term Debt It is the amount of the principal that is payable within one year. At the end of the year, a company reclassifies the amount of its long-term debt that must be paid during the upcoming year.

  11. Accrued Expenses These are expenses that have been incurred but not recorded. Salaries Taxes withheld Other expenses Income taxes

  12. Payroll Liabilities Salary Expense 10,000 Employee Income Tax Payable 1,350 Canada Pension Plan Payable 320 Employment Insurance Payable 270 Employee Union Dues Payable 272 Salary Payable [take-home pay] 7,788 To record salary expense

  13. Unearned Revenues CanWest Global Communications Corp. owns a number of newspapers. Assume that National Post charges a subscriber $690 for a three-year subscription. What are the entries?

  14. Unearned Revenues September 1 Cash 690 Unearned Revenue 690 To receive cash for a three-year subscription August 31 Unearned Revenue 230 Subscription Revenue 230 To record revenue earned at the end of the year

  15. Income Statement 2004 2005 2006 Revenues: Subscription revenue $230 $230 $230 Unearned Revenues August 31, Balance Sheet 2004 2005 2006 Current liabilities: Unearned subscription revenue $230 $230 $-0- Long-term liabilities: Unearned subscription revenue $230 $-0- $-0-

  16. Current Liabilities ThatMust Be Estimated Estimated Warranty Payable Assume that Black & Decker made sales of $200,000 subject to product warranties. Black & Decker estimates that 3% of the products it sells this year will require repair or replacement. What is the estimated warranty expense?

  17. Estimated Warranty Payable $200,000,000 × 0.03 = $6,000 Warranty Expense 6,000 Estimated Warranty Payable 6,000 To accrue warranty expense

  18. Estimated Warranty Payable Assume that defective merchandise totals $5,800. Black & Decker will replace it and record the following: Estimated Warranty Payable 5,800 Inventory 5,800 To replace defective products sold under warranty

  19. Contingent Liabilities They are a potential liability that depends on a future event arising out of past events. CICA Guidelines 1. Record an actual liability if it is likely that the loss will occur and the amount can be reasonably estimated.

  20. Contingent Liabilities 2. Report a contingency in the notes to the financial statement if the loss is likely and an amount cannot be estimated. 3. There is no reason to report a contingent loss that is unlikely to occur.

  21. Bonds: An Introduction A bond is an interest bearing long-term note payable. Bonds are groups of notes payable issued to multiple lenders called bondholders. Principal Interest rate Payment dates

  22. Types of Bonds Secured, or mortgage, bonds Term bonds Unsecured bonds (debentures) Serial bonds

  23. Bond Prices Bond prices are quoted at a percent of their maturity value. A quote of 101½ means that a $1,000 bond sells for $1,000 × 1.015 = $1,015. A $1,000 bond quoted at 883/8 is priced at $1,000 × 0.88375 = $883.75.

  24. Bond Prices A bond issued at a price above its face (par) value is issued at a premium. A bond issued at a price below face (par) value has a discount. As a bond nears maturity, its market price moves toward par value.

  25. Present Value The amount invested today receives a greater amount at a future date, which is called the present value of a future amount. It depends upon... the amount of the future receipt. the length of time to the future receipt. the interest rate for the period.

  26. Bond Interest Rates Bonds are sold at market price, which is the amount that investors are willing to pay at any given time. Market price represents… present value of periodic interest payments. present value of the principal to be received at maturity.

  27. Bond Interest Rates Contract rate (stated rate) Market rate (effective rate)

  28. Learning Objective 2 Account for bonds payable transactions.

  29. Issuing Bonds Payable at Par Value On January 1, TELUS Corporation issued $50,000,000 of 9%, 5-year bonds at par. January 1 Cash 50,000,000 Bonds Payable 50,000,000 To issue 9%, 5-year bonds at par

  30. Issuing Bonds Payable at Par Value What is the entry for the interest payment of July 1? $50,000,000 × 9% × 6/12 = $2,250,000 July 1 Interest Expense 2,250,000 Cash 2,250,000 To pay semiannual interest

  31. Issuing Bonds Payable at Par Value What is the entry to accrue interest on December 31? $50,000,000 × 9% × 6/12 = $2,250,000 December 31 Interest Expense 2,250,000 Interest Payable 2,250,000 To accrue interest

  32. Issuing Bonds Payableat a Discount TELUS issues $100,000 of its 9%, five-year bonds when the market interest rate is 10%. TELUS receives $96,149 at issuance. Cash 96,149 Discount on Bonds Payable 3,851 Bonds Payable 100,000 To issue 9%, 5-year bonds at a discount

  33. Issuing Bonds Payableat a Discount TELUS’ 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 is a contra account to Bonds Payable, a decrease in liabilities.

  34. Learning Objective 3 Measure interest expense.

  35. Interest Date Interest Payment Interest Expense Discount Amort. Discount Account Balance Bond Carrying Amount 1/1/04 1/7/04 1/1/05 1/7/05 1/1/09 $4,500 4,500 4,500 4,500 $4,807 4,823 4,839 4,961 $307 323 339 461 $3,851 3,544 3,221 2,882 -0- $ 96,149 96,456 96,779 97,118 100,000 Amortization Table on Bonds Issued at a Discount

  36. Interest Expense on BondsIssued at a Discount On July 1, 2004, TELUS makes the first $4,500 semiannual interest payment and also amortizes (decreases) the bond discount. July 1, 2004 Interest Expense 4,807 Discount on Bonds Payable 307 Cash 4,500 To pay semiannual interest and amortize bond discount

  37. Interest Expense on BondsIssued at a Discount At December 31, 2004, TELUS accrues interest and amortizes the bond discount for July through December. December 31, 2004 Interest Expense 4,823 Discount on Bonds Payable 323 Interest Payable 4,500 To accrue semiannual interest and amortize bond discount

  38. Discount on Bonds Payable Bonds Payable 307 July 1 323 Dec. 31 100,000 3,851 3,221 Interest Expense on BondsIssued at a Discount TELUS’ bond accounts as of December 31, 2004. Bond carrying amount: $100,000 – $3,221 = $96,779

  39. Issuing Bonds Payableat a Premium TELUS Corporation issues $100,000 of 9%, five-year bonds when the market interest rate is 8%. TELUS receives $104,100 at issuance. Cash 104,100 Bonds Payable 100,000 Premium on Bonds Payable 4,100 To issue 9% bonds at a premium

  40. Issuing Bonds Payableat a Premium TELUS’ 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 Premium on Bonds Payable is added to the balance of Bonds Payable to determine the carrying amount.

  41. Interest Date Interest Payment Interest Expense Premium Amort. Premium Account Balance Bond Carrying Amount 1/1/04 1/7/04 1/1/05 1/7/05 1/1/09 $4,500 4,500 4,500 4,500 $4,164 4,151 4,137 3,955 $336 349 363 545 $4,100 3,764 3,415 3,052 -0- $104,100 103,764 103,415 103,052 100,000 Amortization Table on Bonds Issued at a Premium

  42. Interest Expense on BondsIssued at a Premium On July 1, 2004, TELUS makes the first $4,500 semiannual interest payment and also amortizes (decreases) the bond premium. July 1, 2004 Interest Expense 4,164 Premium on Bonds Payable 336 Cash 4,500 To pay semiannual interest and amortize bond premium

  43. Straight-Line Amortization This method amortizes the bond discount or premium by dividing it into equal amounts for each interest period. TELUS would amortize the $4,100 premium over 10 periods. $4,100 ÷ 10 = $410 per period

  44. Early Retirement of Bonds Payable Air Products and Chemicals Inc. has $70 million of debenture bonds outstanding with unamortized discount of $350,000. The market price is 99¼. Par value of bonds being retired $70,000,000 Less: Unamortized discount – 350,000 Carrying amount of the bonds $69,650,000 Market price ($70,000,000 × 0.9925) 69,475,000 Gain on retirement of bonds payable $ 175,000

  45. Convertible Bonds and Notes Sherritt International has convertible debentures payable of $600,000,000. Assume that debenture-holders convert half the debentures into 34,188,000 common shares. Debentures Payable 300,000,000 Common Shares 300,000,000 To record conversion of debentures payable

  46. Learning Objective 4 Understand the advantages and disadvantages of borrowing.

  47. Creates no liabilities or interest expense Does not dilute share ownership or control of the corporation Less risky to the issuing corporation Results in higher earnings per share because the earnings on borrowed money usually exceeds interest expense Financing OperationsWith Bonds or Shares Issuing Shares Issuing Notes or Bonds

  48. Financing OperationsWith Bonds or Shares Suppose a corporation needs $500,000 for expansion. It has net income of $300,000 and 100,000 common shares outstanding. Management is considering two financing plans: Plan 1 is to issue $500,000 of 10% bonds payable. Plan 2 is to issue 50,000 common shares for $500,000.

  49. Financing OperationsWith Bonds or Shares Plan 1: Borrow $500,000 at 10% Net income before expansion $300,000 Project income before interest and taxes $200,000 Less interest expense ($500,000 × 0.10) – 50,000 Project income before income tax $150,000 Less income tax expense (40%) – 60,000 Expected project net income 90,000 Total company net income $390,000 Earnings per share after expansion: ($390,000/100,000 shares) $3.90

  50. Financing OperationsWith Bonds or Shares Plan 2: Issue 50,000 Common Shares for $500,000 Net income before expansion $300,000 Project income before interest and taxes $200,000 Less interest expense 0 Project income before income tax $200,000 Less income tax expense (40%) – 80,000 Expected project net income 120,000 Total company net income $420,000 Earnings per share after expansion: ($420,000/150,000 shares) $2.80

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