Financial and managerial accounting 2nd kimel kieso willey chapter 10

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: Sometimes companies do not enter sales taxes sepa

Liabilities 10

Learning Objectives

Explain how to account for current liabilities.

Describe the major characteristics of bonds.

Explain how to account for bond transactions.

3

2

1

A debt that a

 company expects to pay 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

LEARNING

What Is a Current Liability?

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

Notes Payable

 Written promissory note.

 Frequently issued to meet short-term financing needs.

 Requires the borrower to pay interest.

 Issued for varying periods.

Current Liabilities

Illustration: First National Bank agrees to lend $100,000 on September 1, 2017, if Cole Williams Co signs a

$100,000, 12%, four-month note maturing on January 1

Instructions

a) Prepare the entry on September 1st

b) Prepare the adjusting entry on December 31st, assuming monthly adjusting entries have not been

made

c) Prepare the entry required on January 1, 2018, the maturity date

Notes Payable

Notes Payable

100,000

b) Prepare the adjusting entry on December 31st

Illustration: First National Bank agrees to lend $100,000 on September 1, 2017, if Cole Williams Co signs a

$100,000, 12%, four-month note maturing on January 1

a) Prepare the entry on September 1st

Notes Payable

104,000

Illustration: First National Bank agrees to lend $100,000 on September 1, 2017, if Cole Williams Co signs a

$100,000, 12%, four-month note maturing on January 1, 2018

c) Prepare the entry at maturity

Notes Payable

Sales Taxes Payable

Current Liabilities

 Sales taxes are expressed as a stated percentage of the sales price

 Selling company (retailer)

► collects tax from the customer.

► enters tax separately in cash register or includes in total receipts.

► remits the collections to the state’s department of revenue.

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:

Illustration: Cooley Grocery enters 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:

Sometimes companies do not enter sales taxes separately in the cash register

Sales 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).

Payroll and Payroll Taxes Payable

Determining the payroll involves computing three amounts: (1) gross earnings, (2) payroll deductions,

and (3) net pay.

Current Liabilities

Payroll and Payroll Taxes Payable

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

Federal Income Taxes Payable

21,864

FICA Taxes Payable

7,650

Record the payment of this payroll on March 7

Payroll and Payroll Taxes Payable

Payroll tax expense results from additional taxes that governmental agencies levy on employers

These taxes are:

 Employer’s share of Social Security (FICA) taxes

 Federal unemployment taxes

 State unemployment taxes

Payroll and Payroll Taxes Payable

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

800

FICA Taxes Payable

7,650

Payroll and Payroll Taxes Payable

Employer payroll taxes do not include:

a. Federal unemployment taxes

b. State unemployment taxes

c. Federal income taxes

d. FICA taxes

Question

Payroll and Payroll Taxes Payable

THE MISSING CONTROLS

Human resource controls Thorough background checks should be performed.

No employees should begin work until they have been approved by the Board of

Education and entered into the payroll system No employees should be entered

into the payroll system until they have been approved by a supervisor All paychecks

should be distributed directly to employees at the official school locations by designated

employees.

Total take: $150,000

ANATOMY OF A FRAUD

Art was a custodial supervisor for a large school district The district was supposed to employ between 35 and 40 regular custodians, as well as 3 or 4

substitute custodians to fill in when regular custodians were absent Instead, in addition to the regular custodians, Art “hired” 77 substitutes In fact, almost none of these people worked for the district Instead, Art submitted time cards for these people, collected their checks at the district office, and personally

distributed the checks to the “employees.” If a substitute’s check was for $1,200, that person would cash the check, keep $200, and pay Art $1,000.

During the month of September, Lake Corporation’s employees earned wages of $60,000 Withholdings related to

these wages were $4,590 for Social Security (FICA), $6,500 for federal income tax, and $2,000 for state income tax

Costs incurred for unemployment taxes were $90 for federal and $150 for state

Prepare the September 30 journal entries for

a) salaries and wages expense and salaries and wages payable, assuming that all September wages will be paid

in October, and

b) the company’s payroll tax expense

Salaries and Wages Expense 60,000

FICA Taxes Payable 4,590

Federal Income Taxes Payable 6,500

State Income Taxes Payable 2,000

Prepare the September 30 journal entries for

a) salaries and wages expense and salaries and wages payable, assuming that all September wages will be paid

in October

Prepare the September 30 journal entries for

b) the company’s payroll tax expense

Payroll Tax Expense 4,830

FICA Taxes Payable 4,590

Federal Unemployment Taxes Payable 90

State Unemployment Taxes Payable 150

Illustration: Superior University sells 10,000 season football tickets at $50 each for its five-game home

schedule The entry for the sale of season tickets is:

Unearned Ticket Revenue

Illustration: Wendy Construction issues a five-year, interest-bearing $25,000 note on January 1, 2017 This note specifies that each

January 1, starting January 1, 2018, Wendy should pay $5,000 of the note When the company prepares financial statements on

December 31, 2017,

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

Current Maturities of Long-Term Debt

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

 No adjusting entry required.

Current Liabilities

You and several classmates are studying for the next accounting examination They ask you to answer the following

You and several classmates are studying for the next accounting examination They ask you to answer the following

questions

2. How is the sales tax amount determined when the cash register total includes sales taxes?

Solution

First, divide the total cash register receipts by 100% plus the sales tax percentage to find the sales revenue amount

Second, subtract the sales revenue amount from the total cash register receipts to determine the sales taxes.

You and several classmates are studying for the next accounting examination They ask you to answer the following

Long-term liabilities are obligations that are expected to be paid after one year.

Bondsare a form of interest-bearing notes payable

 Sold in small denominations (usually $1,000 or multiples of $1,000)

 Attract many investors

 Corporation issuing bonds is borrowing money.

 Person who buys the bonds (the bondholder) is investing in bonds.

LEARNING

Types of Bonds

 State laws grant corporations the power to issue bonds.

 Board of directors and stockholders must approve bond issues.

 Board of directors must stipulate number of bonds to be authorized, total face value, and

contractual interest rate

 Bond terms set forth in legal document known as a bond indenture.

 Bond certificate, typically a $1,000 face value.

Bonds

Issuing Procedures

 Represents a promise to pay:

► sum of money at designated maturity date, plus

► periodic interest at a contractual (stated) rate on the maturity amount (face value).

 Interest payments usually made semiannually

 Issued to obtain large amounts of long-term capital.



Bonds

Issuing Procedures

Bonds

Bond Trading

Bondholders can sell their bonds on national exchanges

 Bond prices are quoted as a percentage of the face value.

 A quoted price of 97 means 97% of face value

Illustration 10-5

Market information for bonds

Determining the Market Value of a Bond

Current market price (present value) is a function of the three factors:

1. dollar amounts to be received,

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

3. market rate of interest

The market interest rate is the rate investors demand for loaning funds

State whether each of the following statements is true or false If false, indicate how to correct the statement.

_ 3 The stated rate is the rate investors demand for loaning funds

_ 4 The face value is the amount of principal the issuing company must pay at the maturity date

_ 5 The market price of a bond is equal to its maturity value

True

True

False

True

Corporation records bond transactions when it

 issues (sells),

 redeems (buys back) bonds, and

 when bondholders convert bonds into common stock

NOTE: If bondholders sell their bond investments to other investors, the issuing company receives no further money on

the transaction, nor does the issuing company journalize the transaction.

LEARNING

Issue at Face Value, Discount, or Premium?

Bond Contractual

Interest Rate 10%

Accounting for Bond Transactions

Illustration 10-8

Interest rates and bond prices

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

Accounting for Bond Transactions

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

Question

Accounting for Bond Transactions

Illustration: On January 1, 2017, Candlestick, Inc issues $100,000, five-year, 10% bonds at 100 (100%

of face value) The entry to record the sale is:

Issuing Bonds at Face Value

Illustration: On January 1, 2017, Candlestick, Inc issues $100,000, five-year, 10% bonds at 100 (100%

of face value) Assume that interest is payable annually on January 1 At December 31, 2017,

Candlestick recognizes interest expense incurred with the following entry Assume monthly accruals have not been made

Issuing Bonds at Face Value

Illustration: On January 1, 2017, Candlestick, Inc issues $100,000, five-year, 10% bonds at 100 (100%

of face value) Assume that interest is payable annually on January 1 Candlestick records the payment

Illustration: On January 1, 2017, Candlestick, Inc sells $100,000, five-year,

10% bonds for $98,000 (98% of face value) Interest is payable annually

January 1 The entry to record the issuance is:

Issuing Bonds at a Discount

Sale of bonds below face value (discount) =

total cost of borrowing > interest paid

Statement Presentation

Illustration 10-9

Statement presentation of discount on bonds payable

Carrying value or book valueIssuing Bonds at a Discount

Total Cost of Borrowing

Issuing Bonds at a Discount

Illustration 10-12

Amortization of bond discount

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

Issuing Bonds at a Discount

Jan 1 Cash 102,000

Illustration: On January 1, 2017, Candlestick, Inc sells $100,000,

five-year, 10% bonds for $102,000 (102% of face value) Interest is payable

annually January 1 The entry to record the issuance is:

Issuing Bonds at a Premium

Sale of bonds above face value (premium) =

total cost of borrowing < interest paid

Statement Presentation Illustration 10-13Statement presentation of

discount on bonds payable

Issuing Bonds at a Premium

Total Cost of Borrowing

Issuing Bonds at a Premium

Giant Corporation issues $200,000 of bonds for $189,000 (a) Prepare the journal entry to record the issuance of the

bonds, and (b) show how the bonds would be reported on the balance sheet at the date of issuance

Jan 1 Bonds Payable 100,000

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:

Redeeming Bonds at Maturity

When bonds are redeemed before maturity, it is necessary to:

1. eliminate carrying value of bonds at redemption date;

2. record cash paid; and

3. recognize gain or loss on redemption

The carrying value of the bonds is the face value of the bonds less any remaining bond discount or plus any remaining bond

premium at the redemption date.

Redeeming Bonds Before Maturity

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.

Question

Redeeming Bonds Before Maturity

Illustration: Assume Candlestick, Inc has sold its bonds at a premium At the end of the fourth period,

Candlestick retires these bonds at 103 after paying the annual interest The carrying value of the bonds at the redemption date is $100,400 Candlestick makes the following entry to record the redemption at the end of the fourth interest period (January 1, 2021):

Redeeming Bonds Before Maturity

Until conversion, the bondholder receives interest on the bond

For the issuer, the bonds sell at a higher price and pay a lower rate of interest than comparable debt

securities without the conversion option

Upon conversion, the company transfers the carrying value of the bonds to paid-in capital accounts

No gain or loss is recognized.

Converting Bonds into Common Stock

Illustration: On July 1, Saunders Associates converts $100,000 bonds sold at face value into 2,000

shares of $10 par value common stock Both the bonds and the common stock have a market value of

$130,000 Saunders makes the following entry to record the conversion:

Paid-in Capital in Excess of Par—

Converting Bonds into Common Stock

When bonds are converted into common stock:

a. a gain or loss is recognized

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

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

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

Question

Converting Bonds into Common Stock

How About Some Green Bonds?

Unilever recently began producing popular frozen treats such as Magnums and Cornettos, funded by green bonds Green bonds are debt used to fund activities such as renewable- energy projects In Unilever’s case, the proceeds from the sale of green bonds are used to clean

up the company’s manufacturing operations and cut waste (such as related to energy consumption)

The use of green bonds has taken off as companies now have guidelines as to how to disclose and report on these green-bond proceeds These standardized disclosures provide transparency as to how these bonds are used and their effect on overall profitability Investors are taking a strong interest in these bonds Investing companies are installing socially responsible investing teams and have started to integrate sustainability into their investment processes The disclosures of how companies are using the bond proceeds help investors to make better financial decisions

Source: Ben Edwards, “Green Bonds Catch On.” Wall Street Journal (April 3, 2014), p C5.