Financial Accounting Tools for Business Decision Making chapter 10 reporting and analyzing

Accounting for Bond Issues Accounting for Bond Issues Bonds may be issued at  face value,  below face value discount, or  above face value premium.. LO 5 Prepare the entries for the i

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10-1

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After studying this chapter, you should be able to:

1 Explain a current liability and identify the major types of current

liabilities.

2 Describe the accounting for notes payable.

3 Explain the accounting for other current liabilities.

4 Identify the types of bonds

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

6 Describe the entries when bonds are redeemed.

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

Learning Objectives

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Preview of Chapter 10

Financial Accounting Seventh Edition Kimmel Weygandt Kieso

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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

LO 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.

What is a Current Liability?

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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).

LO 1 Explain a current liability and identify the

major types of current liabilities.

Question

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10-7 LO 2 Describe the accounting for notes payable.

Notes Payable

 Written promissory note

 Usually require the borrower to pay interest

 Those due within one year of the balance sheet date are

usually classified as current liabilities

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Illustration: First National Bank agrees to lend $100,000 on

September 1, 2014, 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 payable100,000

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Illustration: If Cole Williams Co prepares financial statements

annually, it makes an adjusting entry at December 31 to recognize interest

Interest payable4,000

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10-11 LO 3 Explain the accounting for other current liabilities.

Sales Tax Payable

 Sales taxes are expressed as a stated percentage of the

sales price

 Selling company

► collects tax from the customer

► remits the collections to the state’s department of

revenue

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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:

LO 3 Explain the accounting for other current liabilities.

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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

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10-14 LO 3 Explain the accounting for other current liabilities.

Unearned Revenue

Revenues that are received before the company delivers

goods or provides service

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.

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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:

Unearned ticket revenue500,000

Aug 6

Ticket revenue100,000

Unearned ticket revenue 100,000Sept 7

As each game is completed, Superior records the earning of

revenue

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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,

1 What amount should be reported as a current liability? _

2 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

$5,000

$20,000

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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)

Payroll and Payroll Taxes Payable

Determining the payroll involves computing three amounts:

(1) gross earnings, (2) payroll deductions, and (3) net

pay.

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Illustration: Assume Cargo Corporation records its payroll for the

week of March 7 as follows:

Salaries and wages expense 100,000

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Payroll tax expense results from three taxes that

governmental agencies levy on employers

These taxes are:

 FICA tax

 Federal unemployment tax

 State unemployment tax

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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

State unemployment taxes payable 5,400

Federal unemployment taxes payable 800

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Employer payroll taxes do not include:

a Federal unemployment taxes.

b State unemployment taxes.

c Federal income taxes.

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10-22

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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).

When a corporation issues bonds, it is borrowing money The

person who buys the bonds (the bondholder) is investing in

bonds.

LO 4 Identify the types of bonds.

Bond: Long-Term Liabilities

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10-25

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 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

Issuing Procedures Alternative Terminology The

contractual rate is often referred

to as the stated rate.

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LO 4

Illustration 10-3

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Determining the Market Value of Bonds

The process of finding the present value is referred

to as discounting the future amounts.

The current market price (present value) of a bond is a function of three factors:

1 the dollar amounts to be received,

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

3 the market rate of interest

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Illustration: Assume that Acropolis Company on January 1, 2014, issues $100,000 of 9% bonds, due in five years, with interest

payable annually at year-end

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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

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

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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.

Question

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Issuing Bonds at Face Value

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Issuing Bonds at Face Value

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10-34 LO 5

Issue at Par, Discount, or Premium?

Helpful Hint Bond prices vary inversely with changes in the market interest rate As

market interest rates decline, bond prices increase When a bond is issued, if the market

interest rate is below the contractual rate, the bond price is higher than the face value.

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Karson Inc issues 10-year bonds with a maturity value of

$200,000 If the bonds are issued at a premium, this

c the contractual interest rate and the market interest

rate are the same

d no relationship exists between the two rates.

Question

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Illustration: Assume that on January 1, 2014, 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:

Issuing Bonds at a Discount

Discount on bonds payable 2,000

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Statement Presentation

Statement presentation of discount on bonds payable

Sale of bonds below face value causes the total cost of borrowing to be

more than the bond interest paid

The reason: Borrower is required to pay the bond discount at the maturity

date Thus, the bond discount is considered to be a increase in the cost

of borrowing.

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Total Cost of Borrowing

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Discount on Bonds Payable:

a has a credit balance

b is a contra account

c is added to bonds payable on the balance sheet

d increases over the term of the bonds.

Question

Helpful Hint Both a discount

and a premium account are

valuation accounts A valuation account is one that is needed to

value properly the item to which

it relates.

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Illustration: Assume that the Candlestick Inc bonds previously

described sell at 102 rather than at 98 The entry to record the sale is:

Issuing Bonds at a Premium

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10-41 LO 5 Prepare the entries for the issuance of bonds and interest expense.

Statement presentation of premium on bonds payable

Sale of bonds above face value causes the total cost of borrowing to be less

than the bond interest paid

The reason: The borrower is not required to pay the bond premium at the

maturity date of the bonds Thus, the bond premium is considered to be a

reduction in the cost of borrowing.

Statement Presentation

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Total Cost of Borrowing

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Redeeming Bonds at Maturity

LO 6 Describe the entries when bonds are redeemed.

Candlestick records the redemption of its bonds at maturity as

follows:

Accounting for Bond Redemptions

Bonds payable 100,000

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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.

Accounting for Bond Retirements

Redeeming Bonds at Maturity

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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.

Question

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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, 2018) as:

Premium on bonds payable 400

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When bonds are converted into common stock:

a a gain or loss is recognized

b the carrying value of the bonds is transferred to

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Balance Sheet Presentation

LO 7

Financial Statement Analysis and Presentation

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Analysis

LO 7

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Liquidity

Liquidity ratios measure the short-term ability of a company to pay its

maturing obligations and to meet unexpected needs for cash

LO 7 Identify the requirements for the financial statement

presentation and analysis of liabilities.

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Solvency

Solvency ratios measure the ability of a company to survive over a

long period of time.

LO 7

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10-52

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LO 7 Identify the requirements for the financial statement

presentation and analysis of liabilities.

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10-54

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Appendix 10A

To follow the expense recognition principle, companies allocate

bond discount to expense in each period in which the bonds are

outstanding

Illustration 10A-1

Amortizing Bond Discount

LO 8 Apply the straight-line method of amortizing bond

discount and bond premium.

Straight-Line Amortization

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