REPORTING AND ANALYZING LIABILITIES - PowerPoint Presentation

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REPORTING AND ANALYZING LIABILITIES

Accounting, Fourth Edition

10Slide3

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.

Identify the types of bonds.

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

Describe the entries when bonds are redeemed.

Identify the requirements for the financial statement presentation and analysis of liabilities.

Study ObjectivesSlide4

Current Liabilities

Bonds: Long-Term Liabilities

Accounting for Bond Issues

Accounting for Bond Retirements

Financial Statement Presentation and Analysis

Reporting and Analyzing Liabilities

What is a current liability?

Notes payable

Sales taxes payable

Unearned revenues

Current maturities of long-term debt

Payroll and payroll taxes payable

Types of bonds

Issuing procedures

Determining the market value of bonds

Issuing bonds at face value

Discount or premium on bonds

Issuing bonds at a discount

Issuing bonds at a premium

Redeeming bonds at maturity

Redeeming bonds before maturity

Balance sheet presentation

Analysis

Off-balance-sheet financingSlide5

Two key features

:

Company expects to pay the debt from existing current assets or through the creation of other current liabilities.

Company will pay the debt within one year or the operating cycle

, whichever is longer.

Current Liabilities

SO 1 Explain a current liability and identify the major types of current liabilities.

Current liabilities include

notes payable

,

accounts payable

,

unearned revenues

, and accrued liabilities such as

taxes

,

salaries and wages, and

interest payable.

What is a Current Liability?Slide6

To be classified as a current liability, a debt must be expected to be paid:

out of existing current assets.

by creating other current liabilities.

within 2 years.both (a) and (b).

SO 1 Explain a current liability, and identify the major types of current liabilities.

Current Liabilities

QuestionSlide7

SO 2 Describe the accounting for notes payable.

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.

Current LiabilitiesSlide8

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.

Notes payable 100,000

Cash 100,000

SO 2 Describe the accounting for notes payable.

Current Liabilities

Sept. 1Slide9

Illustration:

If Cole Williams Co. prepares financial statements annually, it makes an adjusting entry at December 31 to recognize interest.

Interest payable 4,000

Interest expense 4,000

*

SO 2 Describe the accounting for notes payable.

Current Liabilities

Dec. 31

*

$100,000 x 12% x

4/12 = 4,000Slide10

Illustration:

At maturity (January 1), Cole Williams Co. must pay the face value of the note plus interest. It records payment as follows.

Interest payable 4,000

Notes payable 100,000

SO 2 Describe the accounting for notes payable.

Current Liabilities

Jan. 1

Cash 104,000Slide11

SO 3 Explain the accounting for other 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.

Current LiabilitiesSlide12

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:

SO 3 Explain the accounting for other current liabilities.

Current Liabilities

Mar. 25

Sales revenue 10,000

Cash 10,600

Sales tax payable 600Slide13

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:

SO 3 Explain the accounting for other current liabilities.

Current Liabilities

Mar. 25

Sales revenue 10,000

Cash 10,600

Sales tax payable 600

Sometimes companies do not ring up sales taxes separately on the cash register.

*

$10,600 / 1.06

= 10,000

*

Slide14

SO 3 Explain the accounting for other current liabilities.

Unearned Revenue

Revenues that are received before

the company delivers goods or provides services.

Current Liabilities

Company

debits Cash

, and

credits a current liability

account (unearned revenue).

When the company earns the revenue, it

debits the Unearned Revenue

account, and

credits a revenue

account.Slide15

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:

SO 3 Explain the accounting for other current liabilities.

Unearned ticket revenue 500,000

Cash 500,000

Aug. 6

Ticket revenue 100,000

Unearned ticket revenue 100,000

Sept. 7

Current Liabilities

As each game is completed, Superior records the earning of revenue. Slide16

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,

What amount should be reported as a current liability? _________What amount should be reported as a long-term liability? _______

Current Maturities of Long-Term Debt

Portion of long-term debt that comes due in the current year.

No adjusting entry required.

SO 3 Explain the accounting for other current liabilities.

Current Liabilities

$5,000

$20,000Slide17

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.

SO 3 Explain the accounting for other current liabilities.

Payroll and Payroll Taxes Payable

Current LiabilitiesSlide18

Illustration:

Assume Cargo Corporation records its payroll for the week of March 7 as follows:

Salaries and wages expense 100,000

Federal tax payable 21,864

FICA tax payable 7,650

State tax payable 2,922

Salaries and wages payable 67,564

SO 3

Cash 67,564

Salaries and wages payable 67,564

Mar. 7

Record the payment of this payroll on March 7.

Mar. 7

Current LiabilitiesSlide19

Payroll tax expense

results from three taxes that governmental agencies levy

on employers.

These taxes are:

FICA tax

Federal unemployment taxState unemployment tax

SO 3 Explain the accounting for other current liabilities.

Current LiabilitiesSlide20

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

State unemployment tax payable 800

FICA tax payable 7,650

Federal unemployment tax payable 5,400

SO 3 Explain the accounting for other current liabilities.

Current LiabilitiesSlide21

Employer payroll taxes do

not

include:Federal unemployment taxes.

State unemployment taxes.Federal income taxes.

FICA taxes.

Question

SO 3 Explain the accounting for other current liabilities.

Current LiabilitiesSlide22
Slide23

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).

SO 4 Identify the types of bonds.

Bond: Long-Term LiabilitiesSlide24

Types of Bonds

Secured

Unsecured

Convertible

Callable

SO 4 Identify the types of bonds.

Bond: Long-Term LiabilitiesSlide25
Slide26

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.

SO 4 Identify the types of bonds.

Bond: Long-Term Liabilities

Issuing ProceduresSlide27

Bond: Long-Term Liabilities

SO 4

Illustration 10-3Slide28

Determining the Market Value of Bonds

The process of finding the present value is referred to as

discounting

the future amounts.

Bond: Long-Term Liabilities

SO 4 Identify the types of bonds.

Market value is a function of the three factors that determine

present value

:

the dollar amounts to be received,

the length of time until the amounts are received, and

the market rate of interest. Slide29

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.

Bond: Long-Term Liabilities

Illustration 10-5

Computing the market price of bonds

Illustration 10-4

Time diagram depicting cash

flows

SO 4 Identify the types of bonds.Slide30

A corporation records bond transactions when it

issues or retires (buys back) bonds and

when bondholders convert bonds into common stock.

Accounting for Bond Issues

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.

SO 5 Prepare the entries for the issuance of bonds and interest expense.Slide31

The rate of interest investors demand for loaning funds to a corporation is the:

contractual interest rate.

face value rate.

market interest rate. stated interest rate.

Question

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

Accounting for Bond IssuesSlide32

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

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

Issuing Bonds at Face Value

Bonds payable 100,000

Prepare the entry Devor would make to accrue interest on December 31.

Dec. 31

Interest expense 10,000

Interest payable 10,000Slide33

Prepare the entry Devor would make to pay the interest on Jan. 1, 2013.

Jan. 1

Interest payable 10,000

Cash 10,000

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

Issuing Bonds at Face ValueSlide34

8%

10%

12%

Premium

Face Value

Discount

Assume Contractual Rate of 10%

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

Bonds Sold At

Market Interest

Accounting for Bond IssuesSlide35

Karson Inc. issues 10-year bonds with a maturity value of $200,000. If the bonds are issued at a premium, this indicates that:

the contractual interest rate exceeds the market interest rate.

the market interest rate exceeds the contractual interest rate.

the contractual interest rate and the market interest rate are the same.

no relationship exists between the two rates.

Question

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

Accounting for Bond IssuesSlide36

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:

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

Issuing Bonds at a Discount

Jan. 1

Cash 98,000

Discount on bonds payable 2,000

Bonds payable 100,000

Illustration 10-8

Computation of total cost of borrowing—bonds issued at discountSlide37

Statement Presentation

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

Issuing Bonds at a Discount

Illustration 10-7

Statement presentation of discount on bonds payableSlide38

Discount on Bonds Payable:

has a credit balance.

is a contra account.

is added to bonds payable on the balance sheet. increases over the term of the bonds.

Question

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

Issuing Bonds at a DiscountSlide39

Illustration:

Assume that the Candlestick Inc. bonds previously described sell at 102 rather than at 98. The entry to record the sale is:

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

Jan. 1

Cash 102,000

Bonds payable 100,000

Premium on bonds payable 2,000

Illustration 10-12

Computation of total cost of borrowing—bonds issued at premium

Issuing Bonds at a PremiumSlide40

Statement Presentation

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

Illustration 10-11

Statement presentation of premium on bonds payable

Issuing Bonds at a PremiumSlide41

Redeeming Bonds at Maturity

SO 6 Describe the entries when bonds are redeemed.

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

Accounting for Bond Retirements

Bonds payable 100,000

Cash 100,000Slide42

When a company retires bonds before maturity, it is necessary to:

eliminate the carrying value of the bonds at the redemption date;

record the cash paid; and

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.

Accounting for Bond Retirements

SO 6 Describe the entries when bonds are redeemed.

Redeeming Bonds at MaturitySlide43

When bonds are redeemed before maturity, the gain or loss on redemption is the difference between the cash paid and the:

carrying value of the bonds.

face value of the bonds.

original selling price of the bonds.

maturity value of the bonds.

Question

Accounting for Bond Retirements

SO 6 Describe the entries when bonds are redeemed.Slide44

Cash 103,000

Loss on bond redemption 2,600

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:

Accounting for Bond Retirements

Bonds payable 100,000

Premium on bonds payable 400

SO 6 Describe the entries when bonds are redeemed.Slide45

When bonds are converted into common stock:

a gain or loss is recognized.

the carrying value of the bonds is transferred to paid-in capital accounts.

the market price of the stock is considered in the entry.

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

Question

Accounting for Bond Retirements

SO 6 Describe the entries when bonds are redeemed.Slide46

Balance Sheet Presentation

SO 7

Financial Statement Analysis and Presentation

Illustration 10-15Slide47

Analysis

Financial Statement Analysis and Presentation

Illustration 10-16

SO 7Slide48

Liquidity

Financial Statement Analysis and Presentation

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 presentation and analysis of liabilities.

Illustration 10-17Slide49

Solvency

Financial Statement Analysis and Presentation

Solvency ratios

measure the ability of a company to survive over a long period of time.

SO 7Slide50
Slide51

Off-Balance-Sheet Financing

Contingencies

Leasing

Operating lease

Capital lease

Financial Statement Analysis and Presentation

SO 7 Identify the requirements for the financial statement presentation and analysis of liabilities.Slide52
Slide53

To follow the matching principle, companies allocate bond discount to expense in each period in which the bonds are outstanding.

Illustration 10A-1

Amortizing Bond Discount

SO 8 Apply the straight-line method of amortizing bond discount and bond premium.

appendix 10A

Straight-Line AmortizationSlide54

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

Interest expense 10,400

Dec. 31

Interest payable 10,000

SO 8 Apply the straight-line method of amortizing bond discount and bond premium.

Amortizing Bond Discount

appendix 10A

Straight-Line AmortizationSlide55

Illustration 10A-2

SO 8 Apply the straight-line method of amortizing bond discount and bond premium.

Amortizing Bond Discount

appendix 10A

Straight-Line AmortizationSlide56

Amortizing Bond Premium

Illustration:

Candlestick, Inc., sold $100,000, five-year, 10% 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.

Premium on bonds payable 400

Interest expense 9,600

Dec. 31

Interest payable 10,000

SO 8 Apply the straight-line method of amortizing bond discount and bond premium.

appendix 10A

Straight-Line AmortizationSlide57

Illustration 10A-4

SO 8 Apply the straight-line method of amortizing bond discount and bond premium.

Amortizing Bond Premium

appendix 10A

Straight-Line AmortizationSlide58

Illustration 10B-1

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:

Compute the bond interest expense.

Compute the bond interest paid or accrued.

Compute the amortization amount.

appendix 10B

Effective Interest AmortizationSlide59

SO 9 Apply the effective-interest method of amortizing bond discount and bond premium.

Illustration:

Candlestick, Inc., sold $100,000, five-year, 10% 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.

appendix 10B

Effective Interest Amortization

Amortizing Bond DiscountSlide60

Illustration 10B-2

SO 9 Apply the effective-interest method of amortizing bond discount and bond premium.

appendix 10B

Effective Interest Amortization

Amortizing Bond DiscountSlide61

Illustration:

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

SO 9 Apply the effective-interest method of amortizing bond discount and bond premium.

Discount on bonds payable 319

Interest expense 10,319

Dec. 31

Interest payable 10,000

appendix 10B

Effective Interest Amortization

Amortizing Bond DiscountSlide62

Illustration:

Candlestick, Inc., sold $100,000, five-year, 10% 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.

appendix 10B

Effective Interest Amortization

Amortizing Bond Premium

SO 9 Apply the effective-interest method of amortizing bond discount and bond premium.Slide63

Illustration 10B-4

appendix 10B

Effective Interest Amortization

Amortizing Bond Premium

SO 9 Apply the effective-interest method of amortizing bond discount and bond premium.Slide64

Illustration:

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

Premium on bonds payable 330

Interest expense 9,670

Dec. 31

Interest payable 10,000

appendix 10B

Effective Interest Amortization

Amortizing Bond Premium

SO 9 Apply the effective-interest method of amortizing bond discount and bond premium.Slide65

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 interest on the unpaid balance of the loan and

a reduction of loan principal.

Companies initially record mortgage notes payable at face value.

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

appendix 10C

Long-Term Notes Payable

Long-Term Notes PayableSlide66

Illustration 10C-1

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.

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

appendix 10C

Long-Term Notes PayableSlide67

Illustration:

Porter Technology records the mortgage loan and first installment payment as follows:

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

Mortgage payable 500,000

Cash 500,000

Dec. 31

Mortgage payable 3,231

Interest expense 30,000

Jun. 30

Cash 33,231

appendix 10C

Long-Term Notes PayableSlide68

Each payment on a mortgage note payable consists of:

interest on the original balance of the loan.

reduction of loan principal only.

interest on the original balance of the loan and reduction of loan principal.

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

Question

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

appendix 10C

Long-Term Notes PayableSlide69

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).Slide70

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.Slide71

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.Slide72

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.Slide73

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. Slide74

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. Slide75

Which of the following is false?

Under IFRS, current liabilities must always be presented before non-current liabilities.

Under IFRS, an item is a current liability if it will be paid within the next 12 months.

Under IFRS, current liabilities are shown in order of liquidity.

Under IFRS, a liability is only recognized if it is a present obligation.Slide76

Under IFRS, a contingent liability is:

disclosed in the notes if certain criteria are met.

reported on the face of the financial statements if certain criteria are met.

the same as a provision.

not covered by IFRS.Slide77

The joint projects of the FASB and IASB could potentially:

change the definition of liabilities.

change the definition of equity.

change the definition of assets.

All of the above.Slide78

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