ch10: Liabilities Kieso

Slide 10-1
Chapter
10
Liabilities
Financial Accounting, IFRS Edition Weygandt Kimmel Kieso
Slide 10-2
Study Objectives
1. 2. 3. 4. 5. 6. 7. 8.
Slide 10-3
Explain a current liability, and identify the major types of current liabilities. Describe the accounting for notes payable. Explain the accounting for other current liabilities. Explain why bonds are issued, and identify the types of bonds. Prepare the entries for the issuance of bonds and interest expense. Describe the entries when bonds are redeemed. Describe the accounting for long-term notes payable. Identify the methods for the presentation and analysis of noncurrent liabilities.
Liabilities
Current Liabilities
Non-Current Liabilities
Notes payable
Bond basics
Sales taxes payable

Unearned revenues Current maturities of longterm debt
Accounting for bond issues

Accounting for bond retirements Accounting for long-term notes payable Statement presentation and analysis
Statement presentation and analysis
Slide 10-4
Section 1 Current Liabilities

What is a Current Liability?
Current liability is debt with 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 payable, salaries payable, and interest payable.
Slide 10-5
SO 1 Explain a current liability, and identify the major types of 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).
Slide 10-6
SO 1 Explain a current liability, and identify the major types of current liabilities.

Notes Payable
Written promissory note. Require the borrower to pay interest. Issued for varying periods.
Slide 10-7
SO 2 Describe the accounting for notes payable.

Illustration: On March 1, 2011, Cole Williams borrows $100,000 from First National Bank on a 4-month, 12% note. Instructions a) Prepare the entry on March 1.
b) Prepare the adjusting entry on June 30, assuming

monthly adjusting entries have not been made. c) Prepare the entry at maturity (July 1).
Slide 10-8

Illustration: On March 1, 2011, Cole Williams borrows $100,000 from First National Bank on a 4-month, 12% note. a) Prepare the entry on March 1. Cash 100,000
Notes payable
b) Prepare the adjusting entry on June 30.
$100,000 x 12% x 4/12 = $4,000
100,000
Interest expense Interest payable

Slide 10-9
4,000 4,000

Illustration: On March 1, 2011, Cole Williams borrows $100,000 from First National Bank on a 4-month, 12% note. c) Prepare the entry at maturity (July 1). Notes payable 100,000
Interest payable
Cash
4,000
104,000
Slide 10-10

Sales Tax Payable
Sales taxes are expressed as a stated percentage of the sales price. Either rung up separately or included in total receipts. Retailer collects tax from the customer. Retailer remits the collections to the states
department of revenue.
Slide 10-11
SO 3 Explain the accounting for other current liabilities.

Illustration: The March 25 cash register reading for Cooley Grocery shows sales of $10,000 and sales taxes of $600 (sales tax rate of 6%), the journal entry is: Cash Sales Sales tax payable 10,600 10,000 600
Slide 10-12

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.
Slide 10-13

Illustration: Assume that Superior University sells 10,000 season football tickets at $50 each for its five-game home schedule. The university makes the following entry for the sale of season tickets:
Aug. 6 Cash Unearned revenue 500,000
500,000
As the school completes each of the five home games, it would record the revenue earned. Sept. 7 Unearned revenue Ticket revenue 100,000 100,000
Slide 10-14

Unearned Revenue
Illustration 10-2 Unearned and earned revenue accounts
Slide 10-15

Current Maturities of Long-Term Debt
Portion of long-term debt that comes due in the current year. No adjusting entry required.
Slide 10-16
Statement Presentation and Analysis

Presentation
Illustration 10-3 Statement of financial position presentation of current liabilities (in thousands)
Slide 10-17

Analysis
Illustration 10-4
Liquidity refers to the ability to pay maturing obligations and meet unexpected needs for cash.
The current ratio permits us to compare the liquidity of different-sized companies and of a single company at different times.
Illustration 10-5
Slide 10-18
Question
Working capital is calculated as: a. current assets minus current liabilities. b. total assets minus total liabilities. c. non-current liabilities minus current liabilities. d. both (b) and (c).
Slide 10-19
Section 2 Non-Current Liabilities

Bond Basics
Bonds are a form of interest-bearing notes payable. Three advantages over ordinary shares:
1. Stockholder control is not affected.
2. Tax savings result.

3. Earnings per share may be higher.
Slide 10-20
SO 4 Explain why bonds are issued, and identify the types of bonds.
Bond Basics
Effects on earnings per shareequity vs. debt.
Illustration 10-7
Slide 10-21
Bond Basics
Question
The major disadvantages resulting from the use of bonds are: a. that interest is not tax deductible and the principal must be repaid. b. that the principal is tax deductible and interest must be paid. c. that neither interest nor principal is tax deductible. d. that interest must be paid and principal repaid.
Slide 10-22
Bond Basics
Types of Bonds
Secured and Unsecured (debenture) bonds.
Term and Serial bonds.

Registered and Bearer (or coupon) bonds. Convertible and Callable bonds.
Slide 10-23
Bond Basics
Issuing Procedures
Bond contract known as a bond indenture.
Represents a promise to pay:
(1) sum of money at designated maturity date, plus (2) periodic interest at a contractual (stated) rate on the maturity amount (face value).
Paper certificate, typically a $1,000 face value. Interest payments usually made semiannually. Generally issued when the amount of capital needed is too large for one lender to supply.
Slide 10-24
Bond Basics
Issuer of Bonds
Illustration 10-8
2013
Maturity Date
DUE 2013
DUE 2013
Contractual Interest Rate
Slide 10-25
Face or Par Value
SO 4
Bond Basics
Bond Trading
Bonds traded on national securities exchanges.
Newspapers and the financial press publish bond prices and trading activity daily.
Read as: Outstanding 5.125%, $1,000 bonds that mature in 2014. Currently yield a 5.747% return. On this day, $33,965,000 of these bonds were traded. Closing price was 96.595% of face value, or $965.95.
Slide 10-26
Bond Basics
Determining the Market Value of Bonds
Market value is a function of the three factors that determine present value:
1. dollar amounts to be received,
2. length of time until the amounts are received, and

3. market rate of interest.
The features of a bond (callable, convertible, and so on) affect the market rate of the bond.
Slide 10-27
Slide 10-28
Accounting for Bond Issues
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.
Slide 10-29
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.
Slide 10-30

Issuing Bonds at Face Value
Illustration: On January 1, 2011, Candlestick Corporation issues $100,000, five-year, 10% bonds at 100 (100% of face value). The entry to record the sale is: Jan. 1 Cash 100,000
Bonds payable
100,000
Slide 10-31

Illustration: On January 1, 2011, Candlestick Corporation issues $100,000, five-year, 10% bonds at 100 (100% of face value). Assume that interest is payable semiannually on January 1 and July 1. Prepare the entry to record the payment of interest on July 1, 2011, assume no previous accrual. July 1 Bond interest expense Cash 5,000 5,000
Slide 10-32

Illustration: On January 1, 2011, Candlestick Corporation issues $100,000, five-year, 10% bonds at 100 (100% of face value). Assume that interest is payable semiannually on January 1 and July 1. Prepare the entry to record the accrual of interest on December 31, 2011, assume no previous accrual. Dec. 31 Bond interest expense Bond interest payable 5,000 5,000
Slide 10-33

Assume Contractual Rate of 8%
Market Interest Bonds Sold At
6% 8%
Premium Face Value Discount
10%
Slide 10-34
SO 5 Prepare the entries for the issuance of bonds and interest expense.

Issuing Bonds at a Discount
Illustration: On January 1, 2011, Candlestick, Inc. sells $100,000, five-year, 10% bonds for $92,639 (92.639% of face value). Interest is payable on July 1 and January 1. The entry to record the issuance is: Jan. 1 Cash 92,639
Bond payable
92,639
Slide 10-35

Statement Presentation
Illustration 10-11 Statement presentation of bonds issued at a discount
Slide 10-36

Total Cost of Borrowing
Illustration 10-12
Illustration 10-13
Slide 10-37
Question
Discount on Bonds Payable:
a. has a credit balance.

b. is a contra account. c. is added to bonds payable on the statement of financial position. d. increases over the term of the bonds.
Slide 10-38

Issuing Bonds at a Premium
Illustration: On January 1, 2011, Candlestick, Inc. sells $100,000, five-year, 10% bonds for $108,111 (108.111% of face value). Interest is payable on July 1 and January 1. The entry to record the issuance is: Jan. 1 Cash 108,111
Bonds payable
108,111
Slide 10-39

Statement Presentation
Illustration 10-14 Statement presentation of bonds issued at a premium
Issuing bonds at an amount different from face value is quite common. By the time a company prints the bond certificates and markets the bonds, it will be a coincidence if the market rate and the contractual rate are the same.
Slide 10-40

Total Cost of Borrowing
Illustration 10-15
Illustration 10-16
Slide 10-41
Accounting for Bond Retirements

Redeeming Bonds at Maturity
Assuming that the company pays and records separately the interest for the last interest period, Candlestick records the redemption of its bonds at maturity as follows: Bond payable
Cash
100,000
100,000
Slide 10-42
SO 6 Describe the entries when bonds are redeemed.

Redeeming Bonds before Maturity
When retiring 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.
Slide 10-43
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.
Slide 10-44

Illustration: Assume Candlestick, Inc. has sold its bonds at a premium. At the end of the eighth period, Candlestick retires these bonds at 103 after paying the semiannual interest. The carrying value of the bonds at the redemption date is $101,623. Candlestick makes the following entry to record the redemption
at the end of the eighth interest period (January 1, 2015):

Bonds payable Loss on redemption Cash 101,623 1,377 103,000
Slide 10-45
Accounting for Long-Term Notes Payable

Long-Term Notes Payable
May be secured by a mortgage that pledges title to specific assets as security for a loan.
Typically, terms require the borrower to make installment payments over the term of the loan. 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.

Slide 10-46
SO 7 Describe the accounting for long-term notes payable.

Illustration: Porter Technology Inc. issues a $500,000, 12%, 20year mortgage note on December 31, 2011. The terms provide for semiannual installment payments of $33,231 (not including real estate taxes and insurance). The installment payment schedule for the first two years is as follows.
Illustration 10-17
Slide 10-47

Illustration: Porter Technology Inc. issues a $500,000, 12%, 20year mortgage note on December 31, 2011. The terms provide for semiannual installment payments of $33,231 (not including real estate taxes and insurance). The installment payment schedule for the first two years is as follows. Dec. 31 Cash Mortgage notes payable Jun. 30 Interest expense Mortgage notes payable Cash
Slide 10-48
500,000 500,000 30,000 3,231 33,231
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.
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Slide 10-50

Presentation
Illustration 10-18
Slide 10-51
SO 8 Identify the methods for the presentation and analysis of non-current liabilities.

Analysis
Two ratios that provide information about debt-paying ability and long-run solvency are: 1. Debt to total assets
Total debt Total assets
The higher the percentage of debt to total assets, the greater the risk that the company may be unable to meet its maturing obligations.
Slide 10-52

Analysis
2. Times Interest Earned Income before income taxes and interest expense
=
Interest expense
Indicates the companys ability to meet interest payments as they come due.
Slide 10-53

Analysis
Illustrate: LGs (KOR) had total liabilities of W39,048
billion, total assets of W64,782 billion, interest expense of W778 billion, income taxes of W1,092 billion, and net income of W2,967 billion.
Illustration 10-19
Slide 10-54
Slide 10-55
Understanding U.S. GAAP

Key Differences
Liabilities
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. Under GAAP, contingent liabilities are recorded in the
financial statements if they are both probable and can be

reasonably estimated. If only one of these criteria is met, then the item is disclosed in the notes. IFRS uses the term provisions to refer to liabilities of uncertain timing or amount. Examples of provisions would be provisions for warranties, employee vacation pay, or anticipated losses. Under GAAP, these are considered recordable contingent
Slide 10-56
liabilities.

Key Differences
Liabilities
Both GAAP and IFRS classify liabilities industries where a

presentation based on liquidity would be considered to provide more useful information (such as financial institutions) can use that format instead.
Under IFRS, companies sometimes show liabilities before

assets. Also, they will sometimes show non-current liabilities before current liabilities. Neither of these presentations is used under GAAP. Under IFRS, companies sometimes will net current liabilities against current assets to show working capital on the face of the statement of financial position. This practice is not used
Slide 10-57
under GAAP.

Key Differences
Liabilities
IFRS requires 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. GAAP often uses a separate Discount or Premium account to account for bonds payable. IFRS records discounts or premiums as direct increases or decreases to Bonds Payable. The GAAP accounting 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.
Slide 10-58

Looking to the Future
Liabilities
The FASB and IASB are currently involved in two projects that
have implications for the accounting for liabilities. The FASB and IASB have identified leasing as one of the most problematic areas of accounting. The joint project will initially
focus primarily on lessee accounting. One of the first areas to

be studied is, What are the assets and liabilities to be recognized related to a lease contract? The main issue is whether the focus should remain on the leased item or should
instead focus on the right to use the leased item. Finally, the
two standard-setting bodies are involved in a far-reaching project to significantly change the approach used to account for pensions.
Slide 10-59
Present Value Concepts Related to Bond Pricing

Present Value of Face Value
Appendix 10A
To illustrate present value concepts, assume that you are willing to invest a sum of money that will yield $1,000 at the end of one year, and you can earn 10% on your money. What is the $1,000 worth today? To compute the answer,
divide the future amount by 1 plus the interest rate ($1,000/1.10 = $909.09 OR use a Present Value of 1 table. ($1,000 X .90909) = $909.09 (10% per period, one period from now).
Slide 10-60
SO 9 Compute the market price of a bond.

To compute the answer, divide the future amount by 1 plus the interest rate ($1,000/1.10 = $909.09.
Illustration 10A-1
Slide 10-61

To compute the answer, use a Present Value of 1 table. ($1,000 X .90909) = $909.09 (10% per period, one period from now).
TABLE 10A-1
Slide 10-62

The future amount ($1,000), the interest rate (10%), and the number of periods (1) are known
Illustration 10A-2
Slide 10-63

If you are to receive the single future amount of $1,000 in two years, discounted at 10%, its present value is $826.45 [($1,000 1.10) 1.10].
Illustration 10A-3
Slide 10-64

To compute the answer using a Present Value of 1 table. ($1,000 X .82645) = $826.45 (10% per period, two periods from now).
TABLE 10A-1
Slide 10-65

Present Value of Interest Payments (Annuities)
In addition to receiving the face value of a bond at maturity, an investor also receives periodic interest payments (annuities) over the life of the bonds.
To compute the present value of an annuity, we need to know:

1) interest rate,
2) number of interest periods, and

3) amount of the periodic receipts or payments.
Slide 10-66

Assume that you will receive $1,000 cash annually for three years and the interest rate is 10%.
Illustration 10A-5
Slide 10-67

Illustration 10A-6
Slide 10-68

TABLE 10A-2
$1,000 annual payment x 2.48685 = $2,486.85

Slide 10-69

Computing the Present Value of a Bond
The selling price of a bond is equal to the sum of:
1) The present value of the face value of the bond discounted at the investors required rate of return PLUS 2) The present value of the periodic interest payments discounted at the investors required rate of return
Slide 10-70

Assume a bond issue of 10%, five-year bonds with a face value of $100,000 with interest payable semiannually on January 1 and July 1.
Illustration 10A-8
Slide 10-71

Illustration 10A-9
Contractual Rate = Discount Rate

Slide 10-72
Issued at Face Value


Illustration 10A-10
Contractual Rate < Discount Rate

Slide 10-73
Issued at a Discount

Illustration 10A-11
Contractual Rate > Discount Rate

Slide 10-74
Issued at a Premium
Effective-Interest Method of Bond Amortization

Appendix 10B
Under the effective-interest method, the amortization of
bond discount or bond premium results in period interest

expense equal to a constant percentage of the carrying value of the bonds.
Required steps:
1. Compute the bond interest expense. 2. Compute the bond interest paid or accrued. 3. Compute the amortization amount.
SO 10 Apply the effective-interest method of amortizing bond discount and bond premium.
Slide 10-75

Amortizing Bond Discount
Assume Candlestick, Inc. issues $100,000 of 10%, five-year bonds on January 1, 2011, for $92,639, with interest payable each July 1 and January 1. Illustration 10B-2
Slide 10-76
SO 10

Assume Candlestick, Inc. issues $100,000 of 10%, five-year bonds on January 1, 2011, for $92,639, with interest payable each July 1 and January 1. Journal entry on July 1, 2011, to record the interest payment and amortization of discount is as follows: July 1 Interest Expense Cash Bonds Payable 5,558 5,000 558
Slide 10-77

Amortizing Bond Premium
Assume Candlestick, Inc. issues $100,000 of 10%, five-year bonds on January 1, 2011, for $108,111, with interest payable each July 1 and January 1. Illustration 10B-4
Slide 10-78
SO 10

Assume Candlestick, Inc. issues $100,000 of 10%, five-year bonds on January 1, 2011, for $108,111, with interest payable each July 1 and January 1. Journal entry on July 1, 2011, to record the interest payment and amortization of premium is as follows: July 1 Interest Expense 4,324
Bonds Payable
Cash
676
5,000
Slide 10-79
Straight-Line Amortization
Appendix 10C
Candlestick, Inc., sold $100,000, five-year, 10% bonds on January 1, 2011, for $92,639 (discount of $7,361). Interest is payable on July 1 and January 1. Illustration 10C-2
Slide 10-80
SO 11
Candlestick, Inc., sold $100,000, five-year, 10% bonds on January 1, 2011, for $92,639 (discount of $7,361). Interest is payable on July 1 and January 1. The bond discount amortization for each interest period is $736 ($7,361/10). Journal entry on July 1, 2011, to record the interest payment and amortization of discount is as follows: July 1 Interest Expense 5,736
Bonds Payable
Cash
Slide 10-81
736
5,000
SO 11 Apply the straight-line method of amortizing bond discount and bond premium.
Candlestick, Inc., sold $100,000, five-year, 10% bonds on January 1, 2011, for $108,111. Interest is payable on July 1 and January 1.
Illustration 10C-4
Slide 10-82
SO 11
Candlestick, Inc., sold $100,000, five-year, 10% bonds on January 1, 2011, for $108,111 (premium of $8,111). Interest is payable on July 1 and January 1. The bond discount amortization for each interest period is $811 ($8,111/10). Journal entry on July 1, 2011, to record the interest payment and amortization of discount is as follows: July 1 Interest Expense 4,189
Bonds Payable
Cash
Slide 10-83
811
5,000
SO 11 Apply the straight-line method of amortizing bond discount and bond premium.
Payroll-Related 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).
Appendix 10D
Determining the payroll involves computing three amounts:

(1) gross earnings, (2) payroll deductions, and (3) net pay.
Slide 10-84
SO 12 Prepare entries for payroll and payroll taxes under U.S. law.
Illustration: Assume a corporation records its payroll for the week of March 7 as follows:
Mar. 7 Salaries and wages expense FICA tax payable Federal income tax payable State income tax payable Salaries and wages payable 100,000 7,650 21,864 2,922 67,564
Record the payment of this payroll on March 11.

Mar. 11 Salaries and wages payable Cash
Slide 10-85
67,564 67,564
Payroll tax expense results from three taxes that governmental agencies levy on employers. These taxes are: FICA tax Federal unemployment tax State unemployment tax
Slide 10-86
Illustration: Based on the corporations $100,000 payroll, the company would record the employers expense and liability for these payroll taxes as follows. Payroll tax expense FICA tax payable Federal unemployment tax payable State unemployment tax payable 13,850 7,650 800 5,400
Slide 10-87
Question
Employer payroll taxes do not include: a. Federal unemployment taxes. b. State unemployment taxes. c. Federal income taxes. d. FICA taxes.
Slide 10-88
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.
Slide 10-89

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Slide 10-1

Sales taxes payable

Accounting for bond issues

Statement presentation and analysis

Section 1 Current Liabilities

current assets or through the creation of other current liabilities.

operating cycle, whichever is longer.

What is a Current Liability?

b. by creating other current liabilities.

What is a Current Liability?

SO 2 Describe the accounting for notes payable.

What is a Current Liability?

b) Prepare the adjusting entry on June 30, assuming

SO 2 Describe the accounting for notes payable.

What is a Current Liability?

Interest expense Interest payable

What is a Current Liability?

SO 2 Describe the accounting for notes payable.

What is a Current Liability?

SO 3 Explain the accounting for other current liabilities.

What is a Current Liability?

SO 3 Explain the accounting for other current liabilities.

What is a Current Liability?

SO 3 Explain the accounting for other current liabilities.

What is a Current Liability?

SO 3 Explain the accounting for other current liabilities.

What is a Current Liability?

SO 3 Explain the accounting for other current liabilities.

What is a Current Liability?

SO 3 Explain the accounting for other current liabilities.

Statement Presentation and Analysis

SO 3 Explain the accounting for other current liabilities.

Statement Presentation and Analysis

SO 3 Explain the accounting for other current liabilities.

Statement Presentation and Analysis

SO 3 Explain the accounting for other current liabilities.

Section 2 Non-Current Liabilities

2. Tax savings result.

Term and Serial bonds.

Contractual Interest Rate

Face or Par Value

2. length of time until the amounts are received, and

Accounting for Bond Issues

b. face value rate.

Accounting for Bond Issues

Accounting for Bond Issues

Issuing Bonds at Face Value

Issuing Bonds at Face Value

Accounting for Bond Issues

Premium Face Value Discount

Accounting for Bond Issues

Issuing Bonds at a Discount

Issuing Bonds at a Discount

Issuing Bonds at a Discount

a. has a credit balance.

Accounting for Bond Issues

Issuing Bonds at a Premium

Issuing Bonds at a Premium

Accounting for Bond Retirements

SO 6 Describe the entries when bonds are redeemed.

Accounting for Bond Retirements

2. record the cash paid; and

SO 6 Describe the entries when bonds are redeemed.