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Principles of AccountingPrinciples of Accounting•• Kimmel Kimmel •• Weygandt Weygandt •• Kieso Kieso
Chapter 10Chapter 10
Reporting and Analyzing Liabilities
Prepared by Barbara MullerPrepared by Barbara MullerArizona State University WestArizona State University West
John Wiley & Sons, Inc. © 2005
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Chapter 10
Reporting and Analyzing LiabilitiesAfter studying this chapter, you should be able to:
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.
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After studying this chapter, you should be able to:
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.
Chapter 10
Reporting and Analyzing Liabilities
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Current Liabilities STUDY OBJECTIVE 1
Current liabilities are debts which can reasonably be expected to be paid
• From existing current assets or through the creation of other current liabilities
• Within 1 year or the operating cycle, whichever is longer
Debts that do not meet both criteria are Long-Term Liabilities
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Types of Current Liabilities
Notes Payable Accounts Payable Unearned Revenues Accrued Liabilities
• Taxes• Salaries and Wages• Interest
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Let’s ReviewLet’s Review
The time period for classifying a liability as The time period for classifying a liability as current is one year or the operating cycle, current is one year or the operating cycle, whichever is:whichever is:a.a. longer.longer.
d.d. possible. possible.
c.c. probable. probable.
b.b. shorter. shorter.
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Let’s ReviewLet’s Review
The time period for classifying a liability as The time period for classifying a liability as current is one year or the operating cycle, current is one year or the operating cycle, whichever is:whichever is:a.a. longer.longer.
d.d. possible. possible.
c.c. probable. probable.
b.b. shorter. shorter.
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Notes PayableSTUDY OBJECTIVE 2
Notes payable are• Obligations in the form of written notes• Often used instead of accounts payable; they give
written documentation if needed for legal remedies• Used for short-term and long-term financing needs• Usually require the borrower to pay interest
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Remember - Interest accrues over life of the note and must be recorded periodically.
JournalSept 1 Cash 100,000
Notes Payable 100,000 (To record issuance of 12%, 4-month note to bank)
Dec 31 Interest Expense 4,000Interest Payable 4,000
(To accrue interest for 4 months on note)
$100,000 x .12 x 4\12 months
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JournalJan 1 Notes Payable 100,000
Interest Payable 4,000
Cash 104,000
(To record payment of 1st National Bank interest-bearing note
and accrued interest at maturity)
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Sales Taxes Payable STUDY OBJECTIVE 3
Are collected from customers Are expressed as a % of sales
price Are required by state law. Remitted to the state monthly Usually rung separately from
sales on the cash register.
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Journal
Mar 25 Cash 10,600 Sales
10,000Sales Taxes Payable
600(To record daily sales and sales taxes)
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Payroll Taxes
Various payroll taxes are required by law to be withheld from employees’ gross pay• Social Security (FICA) taxes withheld, employer
and employee make equal contributions• Federal income taxes
• State income taxes (if applicable)
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Journal
Mar 7 Salaries and Wages Expense 100,000FICA Taxes Payable (employee’s share)
7,250Federal Income Taxes Payable 21,864States Income Taxes Payable 2,922Salaries and Wages Payable 67,964
Mar 7 Salaries and Wages Payable 67,964 Cash
67,964
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Journal
Mar 7 Payroll Tax Expense 13,450 FICA Taxes Payable (employer’s share) 7,250Federal Unemployment Taxes Payable 800State Unemployment Taxes Payable 5,400
Employers incur a second type of payroll-related activity.1) Employer’s share of FICA2) Federal unemployment3) State unemployment
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Unearned Revenue
Unearned revenue is cash received before service or product is delivered (that is, before revenue is earned)
Recorded as a liability until it is earned
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Unearned Revenues Examples of unearned revenues• Magazine subscriptions
• Rent received in advance
• Customer deposits for future service
• Sale of airline tickets for future travel
• Sale to season sporting events
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As each game is completed
JournalAug 6 Cash 500,000
Unearned Ticket Revenue 500,000
(To record sale of 10,000 tickets at $50 each)
Sept 7 Unearned Ticket Revenue 100,000
Ticket Revenue 100,000
(To record ticket revenue earned)
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Current Maturities of Long-Term Debt
Current maturities of long-term debt are• The portion of long-term debt due within the
current year or operating cycle
• Classified as a current liability
• No adjusting entry is necessary
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FICTICTIOUS COMPANYBalance Sheet
December 31, 2004AssetsCurrent Assets
Cash $ 272Marketable securities (current) 609Receivables 74Other current assets 83
Total current assets 1,038Property and equipment (net) 317
Marketable securities (long-term) 322 Other long-term assets 280 Total Assets $1,957 Liabilities and Stockholders’ Equity Liabilities
Current LiabilitiesAccounts payable $ 527
Notes payable 133Current maturities of long term debt 100Accrued liabilities and expenses 56 Total current liabilities 816
Long-term debt 83 Total liabilities 899
Stockholders’ equityCommon stock 830Retained earnings 228
Total Liabilities and stockholders’ equity $1,957
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Bonds STUDY OBJECTIVE 4
Bonds• A form of long-term, interest-bearing note payable issued by
corporations, universities and governmental agencies
• Sold in small denominations, (usually multiples of $1,000) which makes them attractive to investors
• Are in the form of a legal document that indicates the name of the issuer, the face value of the bonds, the contractual interest rate, and the maturity date
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Bond Features
Bonds have many different features
• Secured bonds have specific assets pledged as collateral, unsecured do not
• Convertible bonds may be converted into common stock at the bondholder’s option
• Callable bonds are subject to retirement at a stated dollar amount prior to maturity
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Accounting for Bond Issues STUDY OBJECTIVE 5
Bonds may be issued at• Face value wheno stated rate = market rate
• Below face value (discount) wheno stated rate < market rate must discount price to get
investors to buy
• Above face value (premium) wheno stated rate > market rate all investors want to own so the
price is bid up
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Bond Terms
Face Value the amount of principal due at the maturity date of the bond
Discount when a bond is sold for less than its face value (the difference between the face value of a bond and its selling price)
Premium - when a bond is sold for more than its face value (the difference between the selling price and the face value of a bond)
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Selling Bonds at Discount
On January 1, 2005, Candlestick, Inc., sells $100,000, 5-year, 10% bonds at 98 with interest payable on January 1.
Jan 1 Cash 98,000 Discount on Bonds Payable 2,000* Bonds Payable 100,000
(To record sale of bonds at a discount)
*The discount account is a contra account to the bond payable, not an asset account.
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Statement Presentation of Discounted Bonds
Long-term liabilities
Bonds payable $ 100,000
Less: Discount on bonds payable 2,000 $98,000
Carrying Value
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Selling Bonds at Premium On January 1, 2005, Candlestick, Inc., sells $100,000, 5-year,
10% bonds at 102 with interest payable on January 1.
Jan 1 Cash 102,000 Bonds
Payable 100,000
Premium Bonds Payable 2,000*
(To record sale of bonds at a premium)
*Premium is added to bonds payable on the balance sheet
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Statement Presentation of Premium Bonds
Long-term liabilities
Bonds payable $ 100,000
Add : Premium on bonds payable 2,000 $102,000
Carrying Value
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Amortizing Bond Discount/Premium
Candlelight would amortize the $2,000 discount/premium as follows
$2,000 ÷ 5 Interest Periods
= $400 Annually
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Redeeming Bonds Before Maturity
A company may decide to retire bonds before maturity to• reduce interest cost • remove debt from its balance sheet
A company should retire debt early only if it has sufficient cash resources
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Redeeming Bonds Before Maturity
When bonds are retired before maturity, it is necessary to • Eliminate the carrying value of the bonds at the
redemption date• Record the cash paid• Recognize the gain or loss on redemption• The carrying value of the bonds is the bond payable
plus the premium or minus the discount
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Financial Statement Presentation and AnalysisSTUDY OBJECTIVE 7
Current liabilities are listed first under “Liabilities” on the balance sheet
A common method is to list the current liabilities in order of magnitude, beginning with the largest
Long-term liabilities are listed in a separate section of the balance sheet
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General Motors Corporation- Automotive Division Statement of Cash Flows (partial)
2001(in millions)
Cash flows from financing activitiesNet increase (decrease) in loans payable $ 194 Long-term debt - borrowings 5,850Long-term debt-repayments (2,602)Repurchases of common and preferred stocks (264)Proceeds from issuing common and preferred stocks 517Cash dividends paid to stockholders (1,201)Net cash (used in) provided by financing activities $2,494
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ANALYSIS Debt to Total Assets Ratio indicates the extent to which a
company’s debt could be repaid by liquidating assets Times Interest Earned Ratio indicates a company’s ability
to meet interest payments as they become due
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ANALYSIS
Unrecorded debt occurs because sometimes a company’s balance sheet does not properly record or disclose all its debts
• Contingencies are events with uncertain outcomes (lawsuits, warranties, etc)
• “Off-balance sheet financing” occurs when the company borrows funds in such a way that the obligations are not recorded (leases)
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Let’s ReviewLet’s Review
What term is used for bonds that have What term is used for bonds that have specific assets pledged as collateral:specific assets pledged as collateral:
a.a. callable bonds.callable bonds.
d.d. discount bonds. discount bonds.
c.c. secured bonds. secured bonds.
b.b. convertible bonds. convertible bonds.
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Let’s ReviewLet’s Review
What term is used for bonds that have What term is used for bonds that have specific assets pledged as collateral:specific assets pledged as collateral:
a.a. callable bonds.callable bonds.
d.d. discount bonds. discount bonds.
c.c. secured bonds.secured bonds.
b.b. convertible bonds. convertible bonds.
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