Learning Objectives
1. Describe the recording and reporting of various current liabilities.
2. Describe the reporting of long-term liabilities and the cash flows associated with those liabilities.
3. Understand the nature of bonds and record a bond’s issuance, interest payments, and maturity.
Learning Objectives
4. Account for a bond that is redeemed prior to maturity.
5. Understand additional liabilities such as leases and contingent liabilities.
6. Evaluate liabilities through the calculation and interpretation of horizontal, vertical, and ratio analyses.
Learning Objectives
7. Appendix: Determine a bond’s issuance price.
8. Appendix: Record bond interest payments under the effective interest method.
Current LiabilitiesA current liability is an obligation of a business that is
expected to be satisfied or paid within one year.
LOI
Taxes as Current Liabilities
Businesses have a number of current tax obligations.
Income Taxes
Sales Taxes
Taxes Withheld
from Employee
Wages
Payroll Taxes
Income Taxes PayableCorporations, like individuals, are subject to federal taxation of income, which are typically current liabilities. Assume a company has $25,000 of annual income tax expense and plans to pay it in the next period. The company records:
Sales Taxes PayableAnother current liability example is sales taxes. Each time a company makes a retail sale, it collects sales tax according to state and/or local regulations. Assume on August 1, a $1,000 item is sold and the company collects 8% sales tax.
GENERAL J OURNAL
Date Description Debit Credit 2010 Aug.
1
Cash
1,080
Sales 1,000 Sales Tax Payable 80
Withheld Taxes PayableOther current liabilities include taxes withheld from employees’ pay checks. Assume an employee earns a monthly salary of $10,000. Based on the employee’s filing status, the company must withhold 15% of the salary for federal income taxes, 12% for state income taxes, and 7.65% for Social Security taxes.
GENERAL J OURNAL
Date Description Debit Credit 2010 Aug.
31
Salaries Expense
10,000
Fed. Income Taxes Payable 1,500 State Income Taxes Payable 1,200 FICA Taxes Payable 765 Cash 6,535
Payroll Taxes PayableIn addition to withholding taxes on behalf of employees, employers must also pay Social Security taxes of 7.65% on employee wages. These additional taxes are an expense for the company, as well as a current liability.
GENERAL J OURNAL
Date Description Debit Credit 2010 Aug.
31
Payroll Tax Expense
765
FICA Taxes Payable 765
Recording a Notes PayableAssume that on March 1, Brown Company borrows $30,000 by signing an 8%, 6-month note with Miller Street Bank. The note calls for interest to be paid when the note is repaid on August 31. The entry to record the note on March 1 is as follows:
GENERAL J OURNAL
Date Description Debit Credit 2010 Mar.
1
Cash
30,000
Note Payable 30,000
Calculation of InterestOn August 31, Brown must pay Miller Street Bank the original $30,000 borrowed plus the interest on the note. Interest over the six months is calculated as shown:
Payment of a Notes PayableBrown would pay $31,200 to the bank and
make the following entry on August 31, which increases Interest Expense to reflect the cost of
borrowing the $30,000, decreases the Note Payable account because the note is paid back, and decreases
Cash for the principal and interest payment.
GENERAL J OURNAL
Date Description Debit Credit 2010 Aug.
31
Note Payable
30,000
Interest Expense 1,200 Cash 31,200
Current Portion on Long-Term Debt
From Note 10 in the financial statements
Long-Term LiabilitiesLO2
A long-term liability is any obligation of a business that is expected to be satisfied or paid in more than one
year.
Like current liabilities, the type and size of long-termliabilities can vary across companies.
However, the most common and largest long-term liabilities often arise from borrowing money.
Balance Sheet Example
Detail in financial statement note
Revolving credit is a type of loan that does not require fixed principal
payments.
A term loan is simply an interest-bearing loan with principal due at
maturity.
Advanced Auto has two types of long-
term debt.
Statement of Cash Flows Example
Cash Inflows - BORROWING
Cash Outflows – REPAYING DEBT
BondsLO3
A bond is a financial instrument in which aborrower promises to pay future interest and
principal to a creditor in exchange for the creditor’s cash today.
The borrower “sells” or “issues” the bond and records a liability.
The creditor “buys” the bond and records aninvestment.
Bond TermsA number of terms and features are associated
with bonds, including:
Face Value: The amount that is repaid at maturity
of a bond.
Market (or effective) rate of interest: The rate of
return that investors in the bond markets demand for
a bond of similar risk.
Stated Interest Rate: The contractual rate at which
interest is paid to the creditor.
Maturity Date: The date on which the face value must be repaid to the
creditor.
1 2
3 4
Bond Rate Relationships
Bond Issuance at Face ValueAssume on January 1, 2010, York Products sells bonds with a face value of $100,000. The bonds carry a 6% interest rate and a January 1, 2025, maturity date. Interest is to be paid semiannually on July 1 and January 1. The market rate of interest is also 6%.
GENERAL J OURNAL
Date Description Debit Credit 2010 Jan.
1
Cash
100,000
Bonds Payable 100,000
Recording Interest PaymentsYork Products pays interest on July 1 and January 1 of each year.
GENERAL J OURNAL
Date Description Debit Credit 2010 July
1
Interest Expense
3,000
Cash 3,000
Recording Accrued Interest PaymentsYork Products pays interest on July 1 and January 1 of each year.
GENERAL J OURNAL
Date Description Debit Credit 2010 Dec
31
Interest Expense
3,000
Interest Payable 3,000
2011 Jan
1
Interest Payable
3,000
Cash 3,000
Bond Repayment at Maturity On January 1, 2025, York would record the
repayment of the bonds in addition to the last interest payment.
GENERAL J OURNAL
Date Description Debit Credit 2025 Jan.
1
Bonds Payable
100,000
Cash 100,000
Bond Issuance at a DiscountAssume on January 1, 2010, Agnew Company issues bonds with a face value of $200,000, a stated rate of 7%, and a maturity date of December 31, 2014. Interest is payable semiannually on June 30 and Dec. 31. The bonds sell at 98% of the face or $196,000.
GENERAL J OURNAL
Date Description Debit Credit 2010 Jan.
1
Cash
196,000
Discount on Bonds Payable 4,000 Bonds Payable 200,000
Reporting Discounted Bonds on the Balance Sheet
Recording Interest PaymentsAgnew Company pays interest on June 30 and December 31 .
GENERAL J OURNAL
Date Description Debit Credit 2010 June
30
Interest Expense
7,400
Discount on Bonds Payable 400 Cash 7,000
Two Methods of AmortizationStraight-line method: Equal amount of interest is amortized each time interest is paid. Easy to compute.
Effective Interest Rate: Amortizes the bond discount or premium so that interest expense each period is a constant percentage of the bond’s carrying value.
Bond Repayment at Maturity On Dec. 31, 2014, Agnew would record the
repayment of the bonds in addition to the last interest payment.
GENERAL J OURNAL
Date Description Debit Credit 2014 Dec.
31
Bonds Payable
200,000
Cash 200,000
Bond Issuance at a PremiumAssume on January 1, 2010, McCarthy Company issues bonds with a face value of $50,000, a stated interest rate of 8%, and a maturity date of December 31, 2012. Interest is payable semiannually on June 30 and December 31. The bonds were sold at a premium of 101.2 or ($50,000 x 101.2% = $50,600).
GENERAL J OURNAL
Date Description Debit Credit 2010 Jan.
1
Cash
50,600
Premium on Bonds Payable 600 Bonds Payable 50,000
Recording Interest PaymentsMcCarthy pays interest on June 30 and December 31 of each year.
GENERAL J OURNAL
Date Description Debit Credit 2010 June
30
Interest Expense
1,900
Premium on Bonds Payable 100 Cash 2,000
Bond Repayment at Maturity On Dec. 31, 2012, McCarthy
would record the repayment of the bonds in addition to the last interest payment.
GENERAL J OURNAL
Date Description Debit Credit 2014 Dec.
31
Bonds Payable
50,000
Cash 50,000
Redeeming a Bond Before Maturity
LO4
Bonds are retired for a number of reasons:•A company may want to reduce future interest expense; or•A company may want to take advantage of falling interest rates and replace existing bonds with less costly bonds.
Accounting for the early retirement bond consists of three steps:
Recording the Gain or Loss on the Redemption
Example of a RedemptionAssume Doyle Township issues a $20,000 eight-year bond on January 1, 2010, to fund the conversion of a warehouse to a youth activity center. The bond has a stated interest rate of 5% and is callable at 103 any time after 2014. The bond pays interest semiannually on June 30 and December 31. The bond sells for $19,200, or an $800 discount. Doyle decides to retire the bond early on December 31, 2016.
GENERAL J OURNAL
Date Description Debit Credit 2010 Jan.
1
Bonds Payable
20,000
Loss on Redemption 700 Discount on Bonds Payable 100 Cash 20,600
Additional LiabilitiesLO5
Two additional types of liabilities that are common to many organizations:lease liabilities and contingent liabilities.
A lease is a contractual agreement in which the lessee obtains the right to use an asset by making periodic payments to the lessor.
A contingent liability is an obligation that arises from an existing condition whose outcome is uncertain and whose resolution depends on a future event.
Types of Leases
Operating leases are popular off-balance sheet
financing tools.
Contingent Liabilities
Evaluating a Company’s Management of Liabilities
LO6
Ratio Analyses
Capital Structure: The mix of debt and equity that a company uses to generate its assets.
Appendix: Determining A Bond’s Issuance Price
LO7
The bond’s issuance price will always be the present value of those future cash flows discounted
backat the current market rate of interest.
Assume that the market rate of interest is 8% when Bowman Corporation issues a $100,000 4-year bond that
pays interest annually at a rate of 10%.
Bowman Example
$100,000 X 0.7350
$10,000 X 3.3121
Bond Interest Relationship
Ethics and Decision Making
In today’s business environment, companies have to be aware not only of the economic impact of their decisions,
but also of their ethical impact.
Information being used
for?
To falsify records??
To ignore product
safety??
To exceed
government
limits??
Appendix: Effective Interest
Method of AmortizationUnder this method, interest expense is calculated
by multiplying the bond’s carrying value by the market rate of interest at issuance by the time
outstanding.
Amortization CalculationOnce interest expense is known, the amount of discount or premium amortized is the difference
between interest expense and interest paid.
Bowman Example – Recording the Issuance
GENERAL J OURNAL
Date Description Debit Credit 2010 June
30
Cash
106,621
Premium on Bonds Payable 6,621 Bonds Payable 100,000
Recording the First Interest Payment
At the end of the first year, interest expense would be recorded as follows:
GENERAL J OURNAL
Date Description Debit Credit 2010 June
30
Interest Expense
8,530
Premium on Bonds Payable 1,470 Cash 10,000
Amortization Schedule
End of Chapter 9
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