ACG 2021 Financial Accounting Current & Long-Term Liabilities.

ACG 2021ACG 2021Financial AccountingFinancial Accounting

Current & Long-Term Current & Long-Term LiabilitiesLiabilities

Learning ObjectivesLearning Objectives

►Account for current liabilities and Account for current liabilities and contingent liabilitiescontingent liabilities

►Account for bonds-payable Account for bonds-payable transactionstransactions

►Measure interest expenseMeasure interest expense►Understand the advantages and Understand the advantages and

disadvantages of borrowingdisadvantages of borrowing►Statement of Cash Flow EffectsStatement of Cash Flow Effects

Current LiabilitiesCurrent Liabilities

► Liabilities due within 1 Liabilities due within 1 year or the company’s year or the company’s operating cycle if operating cycle if longerlonger Known amountsKnown amounts

► Accounts PayableAccounts Payable► Short-term Notes Short-term Notes

PayablePayable► Sales Tax PayableSales Tax Payable► Current Installment of Current Installment of

Long-Term DebtLong-Term Debt► Accrued ExpensesAccrued Expenses► Payroll LiabilitiesPayroll Liabilities► Unearned RevenuesUnearned Revenues

► We increase Liabilities We increase Liabilities with a credit.with a credit.

► So to increase any of the So to increase any of the Known payables on the Known payables on the left, we credit the left, we credit the payable for the known payable for the known amount.amount.

► We must therefore, debitWe must therefore, debit a corresponding expense a corresponding expense

account (accrued expenses)account (accrued expenses) Cash (deferred liability)Cash (deferred liability) Long-term debtLong-term debt Cash (if recording receipt Cash (if recording receipt

from a note payable)from a note payable)

Accounts PayableAccounts Payable

► Amounts owed for purchases of goods or Amounts owed for purchases of goods or services services on accounton account The purchase can be for an AssetThe purchase can be for an Asset

► Inventory (generally largest)Inventory (generally largest) The purchase could also be an ExpenseThe purchase could also be an Expense

► Legal Fees (service)Legal Fees (service) No interest associated with money owed, and it No interest associated with money owed, and it

is assumed the A/P will be paid quicklyis assumed the A/P will be paid quickly► If we have an A/P for Inventory purchased If we have an A/P for Inventory purchased

on account, on account, what does the company we what does the company we purchased the inventory from have?purchased the inventory from have? An Accounts ReceivableAn Accounts Receivable

Note PayableNote Payable

►Unlike Accounts PayableUnlike Accounts Payable►Usually contains interest payments Usually contains interest payments

that are duethat are due►Record:Record:

Issuance of Note PayableIssuance of Note Payable►We borrowed Cash and have an obligation to We borrowed Cash and have an obligation to

pay backpay back Interest ExpenseInterest Expense Payment of Note PayablePayment of Note Payable

Notes PayableNotes PayableOn Jan. 30, 20X5 the company received a one year $8,000 note payable at 10% interest to purchase inventory.

Jan 30 Cash 8,000

Purchase of inventory by issuing a 1-year 10% note payable

Note Payable, Short-term 8,000

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

Adjusting entry to accrue interest expense

Interest Payable 200

Notes PayableNotes Payable

To record repayment at maturity Jan 30 20x6:

Jan. 30 Note Payable, short-term 8,000

Payment of a note payable and interest at maturity

Interest Expense ($8,000 x .10 x 9/12) 600

Cash [($8,000 x .10) + 8,000] 8,800

Interest Payable 200

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)

Payroll LiabilitiesPayroll Liabilities

►Types of CompensationTypes of Compensation SalarySalary WageWage CommissionCommission BonusBonus

►Salary expense is Salary expense is gross paygross pay..►Salary payable is Salary payable is net paynet pay..

Payroll LiabilitiesPayroll Liabilities

To record payroll

Jan. 30 Salary Expense 10,000

To record salary expense

FICA Tax Payable 800

Salary Payable to Employees 8,000

Employee Income Tax Payable 1,200

Sales Tax PayableSales Tax Payable

To record sales of $200,000 plus 5% sales tax:

Cash (200,000 x 1.05) 210,000

To record cash sales and related sales taxSales Tax Payable (200,000 x .05) 10,000

Sales Revenue 200,000

Unearned RevenuesUnearned RevenuesTo record collection of cash in payment for future services:

Jan 30 Cash 1,200

Received cash in advance for ticket sales

Unearned Ticket Revenue 1,200

To record revenue after 50% of services have been performed.

Apr 30 Unearned Ticket Revenue 600

Earned revenue that was collected in advance

Ticket Revenue 600

Current LiabilitiesCurrent Liabilities

►Amounts that must be estimatedAmounts that must be estimated Estimated Warranty PayableEstimated Warranty Payable

►How many products will need repair / How many products will need repair / replacementreplacement

►Matching PrincipleMatching Principle►Estimate based on past historical dataEstimate based on past historical data

Contingent LiabilitiesContingent Liabilities►An company may incur an expense in the An company may incur an expense in the

futurefuture Most commonly associated with law suitsMost commonly associated with law suits

Estimated Warranty PayableEstimated Warranty PayableWarranty 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

To accrue warranty expense

Estimated Warranty Payable 6,000

Estimated Warranty Payable 5,800

To replace defective products under warranty

Inventory 5,800

When $5,800 of products are replaced under the warranty:

Contingent LiabilitiesContingent Liabilities

►Contingent liability depends on a future Contingent liability depends on a future event arising out of past events.event arising out of past events.

►To account for contingent losses:To account for contingent losses: RecordRecord liability if it is liability if it is probableprobable and and can be can be

reasonably estimated.reasonably estimated. ReportReport the liability in the notes to the the liability in the notes to the

financial statements (but do not record an financial statements (but do not record an entry) if it is reasonably possible that a loss entry) if it is reasonably possible that a loss will occur.will occur.

Do not report a contingent loss that is not Do not report a contingent loss that is not likely to occur.likely to occur.


Long – Term LiabilitiesLong – Term Liabilities

Bonds PayableBonds Payable

BondsBonds

► IOU’sIOU’s► $1000 or $5000 Increments$1000 or $5000 Increments► Sold in the “Market”Sold in the “Market”► Structure:Structure:

Maturity DateMaturity Date Interest RateInterest Rate Interest Payment DatesInterest Payment Dates

► Provide two payments:Provide two payments: Interest every 6 monthsInterest every 6 months Principal amount of BondPrincipal amount of Bond

Bond MarketBond Market

►Bloomberg.comBloomberg.com


►Bonds payable are debt (i.e. a liability) Bonds payable are debt (i.e. a liability) of the issuing company.of the issuing company.

►Types of bonds:Types of bonds: term bondsterm bonds

►All bonds mature at the same time (end of the All bonds mature at the same time (end of the term)term)

serial bondsserial bonds►Bonds mature in installments over a period of Bonds mature in installments over a period of

time.time. secured bonds (mortgage bonds)secured bonds (mortgage bonds) debentures (unsecured bonds)debentures (unsecured bonds)


►Bonds can be issued (bought)Bonds can be issued (bought) at face valueat face value for a premiumfor a premium at a discountat a discount

►Bond Price is determined by:Bond Price is determined by: Market Interest Rate – Effective RateMarket Interest Rate – Effective Rate Bond’s Interest Rate – Contract RateBond’s Interest Rate – Contract Rate THESE RATES ARE USUALLY DIFFERENT!THESE RATES ARE USUALLY DIFFERENT!

Bond Interest RatesBond Interest Rates

► Bonds are sold at market price - amount Bonds are sold at market price - amount that investors are willing to pay at any given that investors are willing to pay at any given timetime

► Market price represents:Market price represents: present value of periodic interest paymentspresent value of periodic interest payments present value of principal to be received at present value of principal to be received at

maturitymaturity

Present ValuePresent Value

The amount invested today to receive a The amount invested today to receive a greater amount at a future dategreater amount at a future date

It depends on:It depends on: amount of the future receiptamount of the future receipt length of time to future receiptlength of time to future receipt interest rate for the periodinterest rate for the period

Bond Interest RatesBond Interest Rates

►Contract rate – stated rateContract rate – stated rate►Market rate – effective rateMarket rate – effective rate

Present Value Calculation Present Value Calculation (Discount)(Discount)

►$100,000 10 year bond, 9% stated $100,000 10 year bond, 9% stated interest, 10% market rateinterest, 10% market rate

►Two parts: PV of principle and PV of Two parts: PV of principle and PV of interest paymentsinterest payments $100,000 x .614* = $61,400$100,000 x .614* = $61,400 100,000 x. 045 x 7.722* = 100,000 x. 045 x 7.722* = $34,749$34,749 PV of Bonds $96,149PV of Bonds $96,149

* From Appendix C* From Appendix C

Bond PricesBond Prices

►Bond Face Value = Stated PrincipalBond Face Value = Stated Principal►Bond issued above face (par) value - Bond issued above face (par) value -

premiumpremium►Bond issued at below face (par) value - Bond issued at below face (par) value -

discountdiscount►As a bond nears maturity, its market As a bond nears maturity, its market

price moves toward par valueprice moves toward par value

Bond PricesBond Prices

Quoted at a percent of their maturity Quoted at a percent of their maturity value.value.

A $1,000 bond quoted atA $1,000 bond quoted at 101½ sells for…101½ sells for…

$1,000 × 1.015 = $1,015.

A $1,000 bond quoted at 88-3/8 sellsfor… $1,000 × 0.88375 = $883.75.

Bond PayableBond Payable

► Purchase a $1,000 Purchase a $1,000 BondBond

► Bond Pays = 9%Bond Pays = 9% Bond Interest = $90Bond Interest = $90

► Bond Pays = 10%Bond Pays = 10% Bond Interest = Bond Interest =

$100$100

► Bond Pays = 8%Bond Pays = 8% Bond Interest = $80Bond Interest = $80

► Invest $1,000 in Invest $1,000 in Market at 9%Market at 9%

► Market Interest = Market Interest = $90$90

How much would you pay for 9% bond, 10% bond, 8% bond?


Accounting for Bonds PayableAccounting for Bonds Payable

Accounting for BondsAccounting for Bonds

►Record Issuance of BondRecord Issuance of Bond►Record Payment of InterestRecord Payment of Interest►Record Accrual of InterestRecord Accrual of Interest

Record Amortization of Discount/PremiumRecord Amortization of Discount/Premium►Effective Interest MethodEffective Interest Method►Straight-Line MethodStraight-Line Method

►Record Retirement of BondRecord Retirement of Bond

Credit Cash

Credit Interest Payable

Bonds PayableBonds Payable$50 million in 9%, 5 year bonds are issued on Jan 1, 2006 at par.

Cash 50,000,000

To issue bonds at par

Bonds Payable 50,000,000

Interest Expense 2,250,000

To pay semiannual interest

Cash 2,250,000

First interest payment on July 1.

$50,000,000 x .09 x 6/12

Bonds PayableBonds PayableAt year end, accrue interest to be paid on Jan.1

Interest Expense 2,250,000

To accrue interest

Interest Payable 2,250,000

$50,000 x .09 x 6/12

Bonds Payable at DiscountBonds Payable at Discount$100,000 in 9%, 5 year bonds are issued when the market rate is 10% for $96,149.

Cash 96,149

To issue bonds at a discount

Discount on Bonds Payable 3,851Bonds Payable 100,000

Bonds Payable at DiscountBonds Payable at Discount

►Discount on Bonds Payable is a contra Discount on Bonds Payable is a contra account to Bonds Payable.account to Bonds Payable.

►Carrying amountCarrying amount of the bonds equals of the bonds equals Bonds Payable less Discount on Bonds Bonds Payable less Discount on Bonds Payable.Payable.

► Interest Interest paymentspayments are are fixedfixed by by contract, but interest contract, but interest expenseexpense variesvaries as the bond discount is amortized.as the bond discount is amortized.

Bonds Payable PremiumBonds Payable Premium$100,000 in 9%, 5 year bonds are issued when the market rate is 8% for $104,100.

Cash 104,100

To issue bonds at a premium

Premium on Bonds Payable 4,100Bonds Payable 100,000

Bonds Payable at PremiumBonds Payable at Premium

►Premium on Bonds Payable is normal Premium on Bonds Payable is normal liability account (not a contra-account)liability account (not a contra-account)

►Carrying amountCarrying amount of the bonds equals of the bonds equals Bonds Payable plus Premium on Bonds Bonds Payable plus Premium on Bonds Payable.Payable.

► Interest Interest paymentspayments are are fixedfixed by by contract, but interest contract, but interest expenseexpense variesvaries as the bond premium is amortized.as the bond premium is amortized.

Bonds Payable Discount Bonds Payable Discount ExampleExample

► Issue Date – January 1, 2006Issue Date – January 1, 2006►Maturity value - $100,000Maturity value - $100,000►Stated interest rate – 9%Stated interest rate – 9%► Interest paid – 4 ½% semiannuallyInterest paid – 4 ½% semiannually►Market rate at time of issue – 10% Market rate at time of issue – 10%

annually, 5% semiannuallyannually, 5% semiannually► Issue Price – $96,149Issue Price – $96,149

Bonds Payable Discount Bonds Payable Discount ExampleExample

Amortization Table (partial)

A B C D E

Semi-annual interest

Date

Interest Payment (4 ½%

of Maturity

Value

Interest Expense (5% of

Preceding Bond

Carrying Amount)

Discount Amortization

(B-A)

Discount Account Balance

(Preceding D -C)

Bond Carrying Amount

($100,000 – D) Jan 1, 2006 $ 96,149 Jul 1 4,500 $ 4,807 $ 307 $3,544 96,456 Jan 1, 2007 4,500 4,823 323 3,221 96,779 Jul 1 4,500 4,839 339 2,882 97,118

* * *

* * *

* * *

* * *

* * *

* * *

Jan 1, 2011 4,500 4,961 461 -0- 100,000

3851

Bonds Payable Discount Journal Bonds Payable Discount Journal EntriesEntries

Interest Expense 4,807

To pay semiannual interest and amortize bond discount

Discount on Bonds Payable 307Cash 4,500

First semiannual interest payment at Jul 1.


To accrue semiannual interest and amortize bond discount

Discount on Bonds Payable 323Interest Payable 4,500

Second semiannual interest accrual at Dec 31.

Bonds Payable Premium Bonds Payable Premium ExampleExample

► Issue Date – January 1, 2006Issue Date – January 1, 2006►Maturity value - $100,000Maturity value - $100,000►Stated interest rate – 9%Stated interest rate – 9%► Interest paid – 4 ½% semiannuallyInterest paid – 4 ½% semiannually►Market rate at time of issue – 8% Market rate at time of issue – 8%

annually, 4% semiannuallyannually, 4% semiannually► Issue Price – $104,100Issue Price – $104,100


A B C D E

Semi-annual interest

Date

Interest Payment (4 ½%

of Maturity

Value

Interest Expense (4% of

Preceding Bond

Carrying Amount)

Premium Amortization

(A - B)

Premium Account Balance

(Preceding D -C)

Bond Carrying Amount

($100,000 +D) Jan 1, 2006 $4,100 $ 104,100 Jul 1 4,500 $ 4,164 $ 336 3,764 103,764 Jan 1, 2007 4,500 4151 349 3415 103,415 Jul 1 4,500 4137 363 3052 103,052

* * *

* * *

* * *

* * *

* * *

* * *

Jan 1, 2011 4,500 3,955 545 -0- 100,000

Amortization Table (partial)



To pay semiannual interest and amortize bond premium

Premium on Bonds Payable 336Cash 4,500



To accrue semiannual interest and amortize bond premium

Premium on Bonds Payable 349Interest Payable 4,500


Exercise 8-13Exercise 8-13

Straight-Line AmortizationStraight-Line Amortization

►Divide bond discount (or premium) Divide bond discount (or premium) into equal periodic amounts over the into equal periodic amounts over the bond’s term.bond’s term. This equal amount is Interest ExpenseThis equal amount is Interest Expense Interest expense is the same each period.Interest expense is the same each period.

►GAAP permits straight line only when GAAP permits straight line only when the amounts differ insignificantly from the amounts differ insignificantly from amounts determined using the amounts determined using the effective interest method.effective interest method.

Straight-LineStraight-Line

►Using the previous Chrysler ExampleUsing the previous Chrysler Example

► Premium Amortization = $4100/10 = Premium Amortization = $4100/10 = $410$410 10 = 5 years x 2 interest payments per 10 = 5 years x 2 interest payments per

yearyear

$100,000 in 9%, 5 year bonds are issued when the market rate is 8% for $104,100.

Straight Line Journal EntriesStraight Line Journal Entries


To pay semiannual interest and amortize bond premium

Premium on Bonds Payable 410Cash 4,500



To accrue semiannual interest and amortize bond premium

Premium on Bonds Payable 410Interest Payable 4,500


Issuing Bonds PayableIssuing Bonds Payableat a Discountat a Discount

Chrysler’s balance sheet immediately after Chrysler’s balance sheet immediately after issuance of the bonds:issuance of the bonds:

Total current liabilities $ XXXLong-term liabilities:Bonds payable, 9%, due 2009 $100,000Discount on bonds payable ( 3,851) 96,149

Discount on Bonds Payable - contra accountto Bonds Payable

Issuing Bonds PayableIssuing Bonds Payableat a Premiumat a Premium

Chrysler’s balance sheet immediately after Chrysler’s balance sheet immediately after issuance of the bonds:issuance of the bonds:

Total current liabilities $ XXXLong-term liabilities:Bonds payable $100,000Premium on bonds payable 4,100 $104,100

Exercise 8-10Exercise 8-10


Retiring BondsRetiring Bonds

Bonds Retired at MaturityBonds Retired at Maturity

►After Recording final interest paymentAfter Recording final interest payment Reduce Bond PayableReduce Bond Payable Reduce Cash AccountReduce Cash Account

Bonds Payable 100,000Bonds Payable 100,000

Cash 100,000Cash 100,000

Retiring Callable BondsRetiring Callable Bonds

►Callable BondsCallable Bonds Bonds that can be paid off earlyBonds that can be paid off early Call PriceCall Price

►Often at greater then par value (101 or 102)Often at greater then par value (101 or 102)

Thus management has to decide to pay Thus management has to decide to pay call premium orcall premium or

Buy Bonds on the Open MarketBuy Bonds on the Open Market

Early Retirement of Bonds Early Retirement of Bonds PayablePayable

Air Products and Chemicals, Inc., has Air Products and Chemicals, Inc., has $70,000 of debenture bonds $70,000 of debenture bonds outstanding with unamortized discount outstanding with unamortized discount of $350. The market price is 99¼.of $350. The market price is 99¼.

Early Retirement of Bonds Early Retirement of Bonds PayablePayable

Par value of bonds $70,000Less: Unamortized discount ( 350)Carrying amount of the bonds $69,650Market price ($70,000 × 0.9925) 69,475Extraordinary gain on retirement $ 175

General Journal

Date Accounts and Explanations PR Debit Credit

Bonds Payable 70,000 Discount on Bonds Payable 350

Cash 69,475Gain on Retirement of Bonds 175

To record bond retirement

Convertible Bonds and NotesConvertible Bonds and Notes

► May be converted into the issuing May be converted into the issuing company’s common stock. company’s common stock.

► Assume note holders convert half of $300 Assume note holders convert half of $300 million convertible notes into 4 million million convertible notes into 4 million shares of stock ($1 par).shares of stock ($1 par).

Notes Payable 150,000,000

To record conversion of notes payable

Common Stock (4 million at $1 par) 4,000,000Paid-in Capital in Excess of par-Common 146,000,000

Financing with Bonds or Financing with Bonds or Stock?Stock?

► Issuing stockIssuing stock creates no liabilitiescreates no liabilities incurs no interest expenseincurs no interest expense less risky to issuing corporationless risky to issuing corporation

► Issuing notes or bonds payableIssuing notes or bonds payable does not dilute stock ownership or does not dilute stock ownership or

control of the corporationcontrol of the corporation usually results in higher earnings per usually results in higher earnings per

share [EPS is the amount of net income share [EPS is the amount of net income for each share of its stock]for each share of its stock]

Reporting Financing Activities Reporting Financing Activities on the Statement of Cash on the Statement of Cash

FlowsFlows

Cash Flow from Financing Activities:Proceeds from issuance of bonds $754Proceeds from long-term borrowings 32Payment of long-term debt (29)Proceeds from issuance of common stock 351Payments of cash dividends (371)Other, net (4)Net cash provided by financing activities $733

Amounts in millionsYear Ended

December 31


Ratio AnalysisRatio Analysis

Times Interest EarnedTimes Interest Earned

Times interest earned ratioTimes interest earned ratio

Times interest earned =Income from Operations

Interest Expense

The ability of a company to pay it’s Interest Expense Obligationsfrom Earnings Generated from Operations

BlackBoard Inc.BlackBoard Inc.

BlackBoard T.I.E.BlackBoard T.I.E.

►20062006 -11,826 / 5354 = -2.21-11,826 / 5354 = -2.21

►20052005 24,447 / 49 = 498.9224,447 / 49 = 498.92

►20042004 10,033 / 179 = 56.0510,033 / 179 = 56.05

Best Buy, Inc.Best Buy, Inc.

Best Buy – T.I.E.Best Buy – T.I.E.

►20072007 1,999 / 31 = 64.481,999 / 31 = 64.48

►20062006 1,644 / 30 = 54.81,644 / 30 = 54.8

►20052005 1,442 / 44 = 32.771,442 / 44 = 32.77

End of Chapter 8End of Chapter 8

ACG 2021 Financial Accounting Current & Long-Term Liabilities.

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Transcript of ACG 2021 Financial Accounting Current & Long-Term Liabilities.