ch10 Analyzing Liabilities

10-1
10
REPORTING AND
ANALYZING LIABILITIES
Financial Accounting, Sixth Edition

10-2
Study Objectives
1. Explain a current liability and identify the major types of current
liabilities.
2. Describe the accounting for notes payable.
3. Explain the accounting for other current liabilities.
4. Identify the types of bonds.
5. Prepare the entries for the issuance of bonds and interest

expense.
6. Describe the entries when bonds are redeemed.
7. Identify the requirements for the financial statement presentation

and analysis of liabilities.
10-3
Reporting and Analyzing Liabilities
Financial
Bonds: Long- Accounting Accounting
Current Statement
Term for Bond for Bond
Liabilities Presentation
Liabilities Issues Retirements
and Analysis
What is a Types of Issuing bonds Redeeming Balance sheet
current bonds at face value bonds at presentation
liability? Issuing Discount or maturity Analysis
Notes payable procedures premium on Redeeming Off-balance-
Sales taxes Determining bonds bonds before sheet financing
payable the market Issuing bonds maturity
Unearned value of bonds at a discount
revenues Issuing bonds
Current at a premium
maturities of
long-term debt
Payroll and
payroll taxes
payable
10-4
Current Liabilities
What is a Current Liability?

Two key features:
1. Company expects to pay the debt from existing current
assets or through the creation of other current
liabilities.
2. Company will pay the debt within one year or the
operating cycle, whichever is longer.
Current liabilities include notes payable, accounts payable, unearned

revenues, and accrued liabilities such as taxes, salaries and wages, and
interest payable.
SO 1 Explain a current liability and identify the

10-5
major types of current liabilities.
Current Liabilities
Question
To be classified as a current liability, a debt must be
expected to be paid:
a. out of existing current assets.
b. by creating other current liabilities.
c. within 2 years.
d. both (a) and (b).
SO 1 Explain a current liability, and identify the

10-6
major types of current liabilities.
Current Liabilities
Notes Payable
 Written promissory note.
 Require the borrower to pay interest.
 Those due within one year of the balance sheet date

are usually classified as current liabilities.
10-7 SO 2 Describe the accounting for notes payable.

Current Liabilities
Illustration: First National Bank agrees to lend $100,000 on

September 1, 2012, if Cole Williams Co. signs a $100,000,
12%, four-month note maturing on January 1. When a
company issues an interest-bearing note, the amount of
assets it receives generally equals the note’s face value.
Sept. 1 Cash 100,000

Notes payable 100,000

Current Liabilities
Illustration: If Cole Williams Co. prepares financial statements

annually, it makes an adjusting entry at December 31 to
recognize interest.
Dec. 31 Interest expense 4,000 *

Interest payable 4,000
* $100,000 x 12% x 4/12 = 4,000

Current Liabilities
Illustration: At maturity (January 1), Cole Williams Co. must

pay the face value of the note plus interest. It records payment
as follows.
Jan. 1 Notes payable 100,000

Cash 104,000

Current Liabilities
Sales Tax Payable

 Sales taxes are expressed as a stated percentage of
the sales price.
 Retailer collects tax from the customer.
 Retailer remits the collections to the state’s

department of revenue.
10-11 SO 3 Explain the accounting for other current liabilities.

Current Liabilities
Illustration: The March 25 cash register readings for Cooley

Grocery show sales of $10,000 and sales taxes of $600 (sales
tax rate of 6%), the journal entry is:
Mar. 25 Cash 10,600

Sales revenue 10,000
Sales tax payable 600

Current Liabilities
Sometimes companies do not ring up sales taxes separately

on the cash register.
Illustration: Cooley Grocery rings up total receipts of $10,600.

Because the amount received from the sale is equal to the
sales price 100% plus 6% of sales, (sales tax rate of 6%), the
journal entry is:
Mar. 25 Cash 10,600

Sales revenue 10,000 *
Sales tax payable 600
* $10,600 / 1.06 = 10,000

Current Liabilities
Unearned Revenue
Revenues that are received before the company delivers
goods or provides services.
1. Company debits Cash, and credits
a current liability account
(unearned revenue).
2. When the company earns the
revenue, it debits the Unearned
Revenue account, and credits a
revenue account.

Current Liabilities
Illustration: Superior University sells 10,000 season football

tickets at $50 each for its five-game home schedule. The entry
for the sales of season tickets is:
Aug. 6 Cash 500,000

Unearned ticket revenue 500,000
As each game is completed, Superior records the earning of

revenue.
Sept. 7 Unearned ticket revenue 100,000

Ticket revenue 100,000

Current Liabilities
Current Maturities of Long-Term Debt

 Portion of long-term debt that comes due in the
current year.
 No adjusting entry required.
Illustration: Wendy Construction issues a five-year, interest-bearing

$25,000 note on January 1, 2011. This note specifies that each January
1, starting January 1, 2012, Wendy should pay $5,000 of the note. When
the company prepares financial statements on December 31, 2011,
$5,000
1. What amount should be reported as a current liability? _________
$20,000
2. What amount should be reported as a long-term liability? _______

Current Liabilities
Payroll and Payroll Taxes Payable

The term “payroll” pertains to both:
Salaries - managerial, administrative, and sales

personnel (monthly or yearly rate).
Wages - store clerks, factory employees, and manual

laborers (rate per hour).
Determining the payroll involves computing three amounts: (1)

gross earnings, (2) payroll deductions, and (3) net pay.

Current Liabilities
Illustration: Assume Cargo Corporation records its payroll for

the week of March 7 as follows:
Mar. 7 Salaries and wages expense 100,000

FICA tax payable 7,650
Federal tax payable 21,864
State tax payable 2,922
Salaries and wages payable 67,564
Record the payment of this payroll on March 7.
Mar. 7 Salaries and wages payable 67,564

Cash 67,564
10-18
SO 3
Current Liabilities
Payroll tax expense results from three taxes that

governmental agencies levy on employers.
These taxes are:
 FICA tax
 Federal unemployment tax
 State unemployment tax

Current Liabilities
Illustration: Based on Cargo Corp.’s $100,000 payroll,

the company would record the employer’s expense and
liability for these payroll taxes as follows.
Payroll tax expense 13,850

FICA tax payable 7,650
State unemployment tax payable 800
Federal unemployment tax payable 5,400

Current Liabilities
Question
Employer payroll taxes do not include:
a. Federal unemployment taxes.
b. State unemployment taxes.
c. Federal income taxes.
d. FICA taxes.

10-22
Bond: Long-Term Liabilities
Bonds are a form of interest-bearing notes payable

issued by corporations, universities, and governmental
agencies.
Sold in small denominations (usually $1,000 or

multiples of $1,000).
10-23 SO 4 Identify the types of bonds.

Types of Bonds
 Secured
 Unsecured
 Convertible
 Callable

10-25
Issuing Procedures
 Bond certificate
 Issued to the investor.
 Provides name of the company issuing bonds, face

value, maturity date, and contractual (stated)
interest rate.
 Face value - principal due at the maturity.

 Maturity date - date final payment is due.
 Contractual interest rate – rate to determine cash
interest paid, generally semiannually.
Illustration 10-3
10-27
SO 4
Determining the Market Value of Bonds

Market value is a function of the three factors that determine
present value:
1. the dollar amounts to be received,
2. the length of time until the amounts are received, and
3. the market rate of interest.
The process of finding the present value is

referred to as discounting the future amounts.

Illustration: Assume that Acropolis Company on January 1,

2012, issues $100,000 of 9% bonds, due in five years, with
interest payable annually at year-end.
Illustration 10-4
Time diagram
depicting cash
flows
Illustration 10-5
Computing the
market price of
bonds

Accounting for Bond Issues
A corporation records bond transactions when it

 issues or retires (buys back) bonds and
 when bondholders convert bonds into common stock.
Bonds may be issued at

 face value,
 below face value (discount), or
 above face value (premium).
Bond prices are quoted as a percentage of face value.
10-30 SO 5 Prepare the entries for the issuance of bonds and interest expense.
Question
The rate of interest investors demand for loaning
funds to a corporation is the:
a. contractual interest rate.
b. face value rate.
c. market interest rate.
d. stated interest rate.
Issuing Bonds at Face Value
Illustration: Devor Corporation issues 100, five-year, 10%,

$1,000 bonds dated January 1, 2012, at 100 (100% of face
value). The entry to record the sale is:
Jan. 1 Cash 100,000
Bonds payable 100,000
Prepare the entry Devor would make to accrue interest on

December 31.
Dec. 31 Interest expense 10,000
Issuing Bonds at Face Value
Prepare the entry Devor would make to pay the interest on Jan.
1, 2013.
Jan. 1 Interest payable 10,000
Cash 10,000
Assume Contractual Rate of 10%
Market Interest Bonds Sold At
8% Premium
10% Face Value
12% Discount
Question
Karson Inc. issues 10-year bonds with a maturity value of
$200,000. If the bonds are issued at a premium, this
indicates that:
a. the contractual interest rate exceeds the market
interest rate.
b. the market interest rate exceeds the contractual
interest rate.
c. the contractual interest rate and the market interest
rate are the same.
d. no relationship exists between the two rates.
Issuing Bonds at a Discount
Illustration: Assume that on January 1, 2012, Candlestick Inc.

sells $100,000, five-year, 10% bonds at 98 (98% of face value)
with interest payable on January 1. The entry to record the
issuance is:
Jan. 1 Cash 98,000
Discount on bonds payable 2,000
Illustration 10-8
Computation of total cost of
borrowing—bonds issued at
discount
Statement Presentation
Illustration 10-7
Statement presentation of
discount on bonds payable
Question
Discount on Bonds Payable:
a. has a credit balance.
b. is a contra account.
c. is added to bonds payable on the balance sheet.
d. increases over the term of the bonds.
Issuing Bonds at a Premium
Illustration: Assume that the Candlestick Inc. bonds previously

described sell at 102 rather than at 98. The entry to record the
sale is:
Jan. 1 Cash 102,000
Premium on bonds payable 2,000
Illustration 10-12
Computation of total cost of
borrowing—bonds issued at
premium
Issuing Bonds at a Premium
Statement Presentation
Illustration 10-11
Statement presentation of
premium on bonds payable
Accounting for Bond Retirements
Redeeming Bonds at Maturity

Candlestick records the redemption of its bonds at maturity as
follows:

Cash 100,000
10-41 SO 6 Describe the entries when bonds are redeemed.

Redeeming Bonds at Maturity

When a company retires bonds before maturity, it is
necessary to:
1. eliminate the carrying value of the bonds at the redemption
date;
2. record the cash paid; and
3. recognize the gain or loss on redemption.
The carrying value of the bonds is the face value of the bonds less
unamortized bond discount or plus unamortized bond premium at the
redemption date.

Question
When bonds are redeemed before maturity, the gain or loss
on redemption is the difference between the cash paid and
the:
a. carrying value of the bonds.
b. face value of the bonds.
c. original selling price of the bonds.
d. maturity value of the bonds.

Illustration: Assume at the end of the fourth period, Candlestick

Inc., having sold its bonds at a premium, retires the bonds at 103
after paying the annual interest. Assume that the carrying value of
the bonds at the redemption date is $100,400 (principal $100,000
and premium $400). Candlestick records the redemption at the end
of the fourth interest period (January 1, 2016) as:

Premium on bonds payable 400
Loss on bond redemption 2,600
Cash 103,000

Question
When bonds are converted into common stock:
a. a gain or loss is recognized.
b. the carrying value of the bonds is transferred to paid-

in capital accounts.
c. the market price of the stock is considered in the

entry.
d. the market price of the bonds is transferred to paid-in

capital.

Financial Statement Analysis and Presentation
Balance Sheet Presentation

Illustration 10-15
10-46
SO 7
Analysis
Illustration 10-16
10-47
SO 7
Liquidity
Illustration 10-17
Liquidity ratios measure the short-term ability of a company to pay

its maturing obligations and to meet unexpected needs for cash.
SO 7 Identify the requirements for the financial statement

10-48
presentation and analysis of liabilities.
Solvency
Solvency ratios measure the ability of a company to survive over a

10-49
long period of time.
SO 7
10-50
Off-Balance-Sheet Financing
 Contingencies
 Leasing
► Operating lease
► Capital lease
SO 7 Identify the requirements for the financial statement

10-51
presentation and analysis of liabilities.
10-52
Straight-Line
appendix 10A Amortization
Amortizing Bond Discount

To follow the matching principle, companies allocate bond
discount to expense in each period in which the bonds are
outstanding.
Illustration 10A-1
SO 8 Apply the straight-line method of amortizing

10-53
bond discount and bond premium.
Straight-Line

Illustration: Candlestick, Inc., sold $100,000, five-year, 10%
bonds on January 1, 2012, for $98,000 (discount of $2,000).
Interest is payable on January 1 of each year. Prepare the
entry to accrue interest at Dec. 31, 2012.

Discount on bonds payable 400

10-54
Straight-Line

Illustration 10A-2

10-55
Straight-Line
Amortizing Bond Premium

bonds on January 1, 2012, for $102,000 (premium of
$2,000). Interest is payable on January 1 of each year.
Prepare the entry to accrue interest at Dec. 31, 2012.


10-56
Straight-Line

Illustration 10A-4

10-57
Effective Interest
appendix 10B Amortization
Under the effective-interest method, the amortization of the

discount or premium results in interest expense equal to a
constant percentage of the carrying value.
Required steps:
1. Compute the bond interest expense.
2. Compute the bond interest paid or accrued.
3. Compute the amortization amount.
Illustration 10B-1
10-58
Effective Interest

bonds on January 1, 2012, for $98,000. The effective-interest
rate is 10.53% and interest is payable on Jan. 1 of each year.
Prepare the bond discount amortization schedule.
SO 9 Apply the effective-interest method of amortizing

10-59
Effective Interest

Illustration 10B-2

10-60
Effective Interest

Illustration: Candlestick, Inc. records the accrual of interest
and amortization of bond discount on Dec. 31, as follows:

Discount on bonds payable 319

10-61
Effective Interest

bonds on January 1, 2012, for $102,000. The effective-interest
rate is 9.48% and interest is payable on Jan. 1 of each year.
Prepare the bond premium amortization schedule.

10-62
Effective Interest

Illustration 10B-4

10-63
Effective Interest

Illustration: Candlestick, Inc. records the accrual of
interest and amortization of premium discount on Dec. 31,
as follows:


10-64
Long-Term
appendix 10C Notes Payable
Long-Term Notes Payable

 May be secured by a mortgage that pledges title to specific
assets as security for a loan.
 Typically, the terms require the borrower to make installment
payments over the term of the loan. Each payment consists
of
1. interest on the unpaid balance of the loan and
2. a reduction of loan principal.
 Companies initially record mortgage notes payable at face
value.
10-65 SO 10 Describe the accounting for long-term notes payable.

Long-Term
Illustration: Porter Technology Inc. issues a $500,000, 12%,

20-year mortgage note on December 31, 2012. The terms
provide for semiannual installment payments of $33,231.
Illustration 10C-1

Long-Term
Illustration: Porter Technology records the mortgage loan and

first installment payment as follows:
Dec. 31 Cash 500,000

Mortgage payable 500,000
Jun. 30 Interest expense 30,000

Mortgage payable 3,231
Cash 33,231

Long-Term
Question
Each payment on a mortgage note payable consists of:
a. interest on the original balance of the loan.
b. reduction of loan principal only.
c. interest on the original balance of the loan and

reduction of loan principal.
d. interest on the unpaid balance of the loan and

reduction of loan principal.

Key Points
 The basic definition of a liability under GAAP and IFRS is very
similar. In a more technical way, liabilities are defined by the
IASB as a present obligation of the entity arising from past
events, the settlement of which is expected to result in an
outflow from the entity of resources embodying economic
benefits.
 IFRS requires that companies classify liabilities as current or
non-current on the face of the statement of financial position
(balance sheet), except in industries where a presentation
based on liquidity would be considered to provide more useful
information (such as financial institutions).
10-69
Key Points
 Under IFRS, liabilities are classified as current if they are
expected to be paid within 12 months.
 Similar to GAAP, items are normally reported in order of
liquidity. Companies sometimes show liabilities before assets.
Also, they will sometimes show non-current (long-term)
liabilities before current liabilities.
 Under both GAAP and IFRS, preferred stock that is required to
be redeemed at a specific point in time in the future must be
reported as debt, rather than being presented as either equity
or in a “mezzanine” area between debt and equity.
10-70
Key Points
 Under IFRS, companies sometimes will net current liabilities
against current assets to show working capital on the face of
the statement of financial position.
 IFRS requires use of the effective-interest method for
amortization of bond discounts and premiums. GAAP allows
use of the straight-line method where the difference is not
material. Under IFRS, companies do not use a premium or
discount account but instead show the bond at its net amount.
 Unlike GAAP, IFRS splits the proceeds from the convertible
bond between an equity component and a debt component. The
equity conversion rights are reported in equity.
10-71
Key Points
 The IFRS leasing standard is IAS 17. Both Boards share the
same objective of recording leases by lessees and lessors
according to their economic substance—that is, according to
the definitions of assets and liabilities. However, GAAP for
leases is much more “rules-based,” with specific bright-line
criteria (such as the “90% of fair value” test) to determine if a
lease arrangement transfers the risks and rewards of
ownership; IFRS is more conceptual in its provisions. Rather
than a 90% cut-off, it asks whether the agreement transfers
substantially all of the risks and rewards associated with
ownership.
10-72
Key Points
 Under GAAP, some contingent liabilities are recorded in the
financial statements, others are disclosed, and in some cases
no disclosure is required. Unlike GAAP, IFRS reserves the use
of the term contingent liability to refer only to possible
obligations that are not recognized in the financial statements
but may be disclosed if certain criteria are met.
 For those items that GAAP would treat as recordable
contingent liabilities, IFRS instead uses the term provisions.
Provisions are defined as liabilities of uncertain timing or
amount. Examples of provisions would be provisions for
warranties, employee vacation pay, or anticipated losses.
10-73
Looking into the Future
The FASB and IASB are currently involved in two projects. One
project is investigating approaches to differentiate between debt
and equity instruments. The other project, the elements phase of
the conceptual framework project, will evaluate the definitions of
the fundamental building blocks of accounting. The results of
these projects could change the classification of many debt and
equity securities. In addition to these projects, the FASB and IASB
have also identified leasing as one of the most problematic areas
of accounting. A joint project will initially focus primarily on lessee
accounting.
10-74
Which of the following is false?
a) Under IFRS, current liabilities must always be

presented before non-current liabilities.
b) Under IFRS, an item is a current liability if it will be paid

within the next 12 months.
c) Under IFRS, current liabilities are shown in order of

liquidity.
d) Under IFRS, a liability is only recognized if it is a

present obligation.
10-75
Under IFRS, a contingent liability is:
a) disclosed in the notes if certain criteria are met.
b) reported on the face of the financial statements if

certain criteria are met.
c) the same as a provision.
d) not covered by IFRS.
10-76
The joint projects of the FASB and IASB could potentially:
a) change the definition of liabilities.
b) change the definition of equity.
c) change the definition of assets.
d) All of the above.
10-77
Copyright
“Copyright © 2011 John Wiley & Sons, Inc. All rights reserved.
Reproduction or translation of this work beyond that permitted in
Section 117 of the 1976 United States Copyright Act without the
express written permission of the copyright owner is unlawful.
Request for further information should be addressed to the
Permissions Department, John Wiley & Sons, Inc. The purchaser
may make back-up copies for his/her own use only and not for
distribution or resale. The Publisher assumes no responsibility for
errors, omissions, or damages, caused by the use of these
programs or from the use of the information contained herein.”
10-78

ch10 Analyzing Liabilities

Hochgeladen von

Dokumentinformationen

Originaltitel

Copyright

Verfügbare Formate

Dieses Dokument teilen

Dokument teilen oder einbetten

Freigabeoptionen

Stufen Sie dieses Dokument als nützlich ein?

Sind diese Inhalte unangemessen?

Copyright:

Verfügbare Formate

ch10 Analyzing Liabilities

Hochgeladen von

Copyright:

Verfügbare Formate

10-1

Financial Accounting, Sixth Edition

2. Describe the accounting for notes payable.

3. Explain the accounting for other current liabilities.

4. Identify the types of bonds.

5. Prepare the entries for the issuance of bonds and interest

6. Describe the entries when bonds are redeemed.

7. Identify the requirements for the financial statement presentation

What is a Current Liability?

Current liabilities include notes payable, accounts payable, unearned

SO 1 Explain a current liability and identify the

SO 1 Explain a current liability, and identify the

 Require the borrower to pay interest.

 Those due within one year of the balance sheet date

10-7 SO 2 Describe the accounting for notes payable.

Illustration: First National Bank agrees to lend $100,000 on

Sept. 1 Cash 100,000

10-8 SO 2 Describe the accounting for notes payable.

Illustration: If Cole Williams Co. prepares financial statements

Dec. 31 Interest expense 4,000 *

* $100,000 x 12% x 4/12 = 4,000

10-9 SO 2 Describe the accounting for notes payable.

Illustration: At maturity (January 1), Cole Williams Co. must

Jan. 1 Notes payable 100,000

10-10 SO 2 Describe the accounting for notes payable.

Sales Tax Payable

 Retailer collects tax from the customer.

 Retailer remits the collections to the state’s

10-11 SO 3 Explain the accounting for other current liabilities.

Illustration: The March 25 cash register readings for Cooley

Mar. 25 Cash 10,600

10-12 SO 3 Explain the accounting for other current liabilities.

Sometimes companies do not ring up sales taxes separately

Illustration: Cooley Grocery rings up total receipts of $10,600.

Mar. 25 Cash 10,600

Sales tax payable 600

* $10,600 / 1.06 = 10,000

10-14 SO 3 Explain the accounting for other current liabilities.

Illustration: Superior University sells 10,000 season football

Aug. 6 Cash 500,000

As each game is completed, Superior records the earning of

Sept. 7 Unearned ticket revenue 100,000

10-15 SO 3 Explain the accounting for other current liabilities.

Current Maturities of Long-Term Debt

 No adjusting entry required.

Illustration: Wendy Construction issues a five-year, interest-bearing

10-16 SO 3 Explain the accounting for other current liabilities.

Payroll and Payroll Taxes Payable

Salaries - managerial, administrative, and sales

Wages - store clerks, factory employees, and manual

Determining the payroll involves computing three amounts: (1)

10-17 SO 3 Explain the accounting for other current liabilities.

Illustration: Assume Cargo Corporation records its payroll for

Mar. 7 Salaries and wages expense 100,000

Record the payment of this payroll on March 7.

Mar. 7 Salaries and wages payable 67,564

Payroll tax expense results from three taxes that

These taxes are:

 Federal unemployment tax

 State unemployment tax

10-19 SO 3 Explain the accounting for other current liabilities.

Illustration: Based on Cargo Corp.’s $100,000 payroll,

Payroll tax expense 13,850