Financial accounting 10th by harmin ch10

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: Mar.. Illustration: Assume Cargo Corporation re

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Learning Objectives

Explain how to account for current liabilities.

Describe the major characteristics of bonds.

Explain how to account for bond transactions.

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 payable,

salaries and wages payable, and interest payable.

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, 2019, 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, 2020, 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, 2019, 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

Cash 104,000

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

September 1, 2019, if Cole Williams Co signs a $100,000,

12%, four-month note maturing on January 1, 2020.

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

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:

Mar 25

Sales Revenue 10,000

Sometimes companies do not enter sales taxes separately in

the cash register

*

Sales Taxes Payable

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 500,000

Illustration: Wendy Construction issues a five-year, interest-bearing

$25,000 note on January 1, 2019 This note specifies that each January 1,

starting January 1, 2020, Wendy should pay $5,000 of the note When the

company prepares financial statements on December 31, 2019,

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

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

Current Liabilities

You and several classmates are studying for the next accounting

examination They ask you to answer the following questions

1 If cash is borrowed on a $50,000, 6-month, 12% note on

September 1, how much interest expense would be incurred by December 31?

Solution

DO IT! 1a Current Liabilities

$50,000 x 12% x 4/12 = $2,000

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

DO IT! 1a Current Liabilities

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

You and several classmates are studying for the next accounting

examination They ask you to answer the following questions

3 If $15,000 is collected in advance on November 1 for 3 months’

rent, what amount of rent revenue should be recognized by December 31?

Solution

DO IT! 1a Current Liabilities

$15,000 x 2/3 = $10,000

Payroll and Payroll Taxes Payable

Illustration: Assume Cargo Corporation records its payroll for the

week of March 7 as follows:

Salaries and Wages Expense 100,000

Federal Income Taxes Payable

21,864

FICA Taxes Payable

7,650

CashSalaries and Wages Payable 67,564Record 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

7,650Federal Unemployment Taxes Payable 5,400

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.

Independent internal verification Budgets should be reviewed monthly to identify

situations where actual costs significantly exceed budgeted amounts.

Source: Adapted from Wells, Fraud Casebook (2007), pp 164–171.

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

DO IT! 1b Wages and Payroll Taxes

Salaries and Wages Expense 60,000

FICA Taxes Payable 4,590Federal Income Taxes Payable 6,500State Income Taxes Payable 2,000

Salaries and Wages Payable 46,910

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

DO IT! 1b Wages and Payroll Taxes

Prepare the September 30 journal entries for

b) the company’s payroll tax expense

DO IT! 1b Wages and Payroll Taxes

Payroll Tax Expense 4,830

FICA Taxes Payable 4,590Federal Unemployment Taxes Payable 90State Unemployment Taxes Payable 150

Long-term liabilities are obligations that are expected to

be paid after one year.

Bonds are 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

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.

 Investment company sells the bonds for the issuing

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

Time Warner Cable has outstanding 6.75%, $1,000 bonds that mature in

2039 They currently yield a 5.49% return At the close of trading, the

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.

Determining the Market Value of a Bond

To illustrate, assume that Acropolis Company on January 1, 2019, issues $100,000 of 9% bonds, due in five years, with interest

payable annually at yearend The purchaser of the bonds would

receive the following two types of cash payments: (1) principal of

$100,000 to be paid at maturity, and (2) five $9,000 interest

payments ($100,000 × 9%) over the term of the bonds

Determining the Market Value of a Bond

The current market price of a bond is equal to the present value of all the future cash payments promised by the bond

Illustration 10-7

Computing the market price of bonds

For those knowledgeable in the use of present value tables, the

computations in this example are $100,000 × 64993 = $64,993,

and $9,000 × 3.88965 = $35,007 (rounded)

State whether each of the following statements is true or false If

false, indicate how to correct the statement

_ 1 Mortgage bonds and sinking fund bonds are both

examples of secured bonds

_ 2 Unsecured bonds are also known as debenture bonds _ 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

DO IT! 2 Bond Terminology

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.

Issue at Face Value, Discount, or Premium?

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

Illustration: On January 1, 2019, 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, 2019, 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, 2019, Candlestick recognizes interest expense incurred with the following entry Assume monthly accruals

have not been made.

Dec 31 Interest Expense 10,000

Issuing Bonds at Face Value

Illustration: On January 1, 2019, 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 on January 1, 2020 as

Illustration: On January 1, 2019,

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:

Sale of bonds below face value (discount) =

total cost of borrowing > interest paid

Reason: Borrower is required to pay the bond discount at the

Statement Presentation Illustration 10-9Statement presentation of

discount on bonds payable

Carrying value or book value

Issuing 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, 2019,

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

Reason: Borrower is not required to pay the bond premium

at the maturity date of the bonds Therefore, the bond

premium is considered to be a reduction in the cost of

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

Illustration 10-16

Amortization of bond 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