Financial accounting tools for business decision making 9 KIeso ppt ch10

Journal entry to record the sales and sales taxes Sales Taxes Payable 600... Bond Terminology• Bond certificate stated interest rate • Face value - principal due at maturity • Maturi

Financial Accounting: Tools for Business Decision Making

Ninth Edition

Kimmel ● Weygandt ● Kieso

Chapter 10

Reporting and Analyzing Liabilities

This slide deck contains animations Please disable animations if they cause issues with your device

Prepared by

COBY HARMON

University of California, Santa Barbara

Chapter Outline

Learning Objectives

Learning Objective 1

Explain How to Account for Current Liabilities

• A debt that a company expects to pay

• from existing current assets or through the creation of other current liabilities, and

• within one year or the operating cycle, whichever is longer.

liabilities such as taxes, salaries and wages, and interest.

What Is a Current Liability? (1 of 3)

What Is a Current Liability? (2 of 3)

What Is a Current Liability? (3 of 3)

Notes Payable

Accounting for Notes Payable (1 of 3)

Illustration: First National Bank agrees to lend $100,000 on September 1, 2022, 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.

Accounting for Notes Payable (2 of 3)

Illustration: If Cole Williams Co prepares financial statements annually, it makes an adjusting entry at

December 31 to recognize interest.

Interest Expense = $100,000 x 12% x 4/12 = $4,000

Accounting for Notes Payable (3 of 3)

Illustration: At maturity (January 1), Cole Williams Co must pay the face value of the note plus interest

It records payment as follows.

Sales Taxes Payable

Sales Taxes Payable (1 of 2)

Illustration: The March 25 cash register readings for Cooley Grocery show sales of $10,000 and sales

taxes of $600 based on a sales tax rate of 6%

Journal entry to record the sales and sales taxes

  Sales Taxes Payable   600

Sales Taxes Payable (2 of 2)

If sales taxes are not rung up separately on the cash register

Illustration: Cooley Grocery rings up total receipts of $10,600 and has a 6% sales tax rate Because the

amount received from the sale is equal to the sales price 100% plus 6% of sales, the journal entry is

Unearned Revenues (1 of 2)

Revenues that are received before goods are delivered or services are performed

Revenue.

and increases (credits) a revenue account.

Type of Business = Airline, Magazine publisher, Hotel

Unearned Revenues (2 of 2)

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

schedule

Entry for the sales of season tickets

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

Current Maturities of Long-Term Debt

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

Illustration: Wendy Construction issues a five-year, interest-bearing $25,000 note on January 1, 2022 This note

specifies that each January 1, starting January 1, 2023, Wendy should pay $5,000 of the note When the

company prepares financial statements on December 31, 2022, what amount should be reported as a

Do It! 1a: Current Liabilities (1 of 2)

You and several classmates are studying for the next accounting examination Answer the following

questions.

1 If cash is borrowed on a $50,000, 6-month, 12% note on September 1, how much interest expense will

be incurred by December 31?

Interest expense = $50,000 × 12% × 4/12 = $2,000

Do It! 1a: Current Liabilities (2 of 2)

Answer the following questions.

2 The cash register total including sales taxes is $23,320, and the sales tax rate is 6% What is the sales

taxes payable?

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?

Sales revenue = $23,320 ÷ 1.06 = $22,000 Sales taxes = $23,320 − $22,000 = $1,320

Payroll and Payroll Taxes Payable (1 of 4)

• managerial, administrative, and sales personnel (fixed monthly or yearly rate)

• Store clerks, factory employees, and manual laborers (rate per hour)

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

Record the payment of this payroll on March 7.

Payroll and Payroll Taxes Payable (3 of 4)

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

These taxes are

• F I C A tax

Payroll and Payroll Taxes Payable (4 of 4)

Illustration: Based on Cargo Corp.’s $100,000 payroll, the company would record the employer’s payroll tax expense and liability for these payroll taxes on March 7 as follows.

Payroll Taxes (1 of 2)

Review Question

Employer payroll taxes do not include

b state unemployment taxes.

d F I C A taxes.

Payroll Taxes (2 of 2)

Review Question

Employer payroll taxes do not include

b state unemployment taxes.

d F I C A taxes.

Do It! 1b: Wages and Payroll Taxes (1 of 2)

During 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

Do It! 1b: Wages and Payroll Taxes (2 of 2)

During 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 (b) the

company’s payroll tax expense

Learning Objective 2

Describe the Major Characteristics of Bonds

Major Characteristics of Bonds

Types of Bonds (1 of 2)

Secured and Unsecured Bonds

• Secured bonds have specific assets of issuer pledged as collateral for bonds

• Unsecured bonds are issued against general credit of borrower

Types of Bonds (2 of 2)

Convertible and Callable Bonds

• Convertible bonds can be converted into common stock at

bondholder’s option

• Callable bonds can be redeemed (bought back), by issuing

company, at a stated dollar amount prior to maturity

Bond Terminology

• Bond certificate

(stated) interest rate

• Face value - principal due at maturity

• Maturity date - date final payment is due

• Contractual interest rate – annual rate used to determine cash interest paid

Bond Certificate

Bond Trading

bondholders convert bonds into common stock

Determining the Price of a Bond (1 of 2)

Illustration: Assume that Acropolis Company on January 1, 2022, issues $100,000 of 9% bonds, due in five

years, with interest payable annually at year-end.

Determining the Price of a Bond (2 of 2)

Do It! 2: Bond Terminology

Indicate whether each of the following statements is true or false.

1. Mortgage bonds and sinking fund bonds are both examples of secured bonds True

3. The contractual interest rate is the rate investors demand for loaning funds False

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

Learning Objective 3

Explain How to Account for Bond Transactions

Accounting for Bond Transactions

Issuing Bonds (1 of 2)

Review Question

The market interest rate:

by the borrower.

b is listed in the bond indenture.

d more than one of the above is true.

Issuing Bonds (2 of 2)

Review Question

The market interest rate:

by the borrower.

b is listed in the bond indenture.

d more than one of the above is true.

Bonds Issued at Face Value (1 of 2)

Illustration: Candlestick Inc issues 100, five-year, 10%, $1,000 bonds dated January 1, 2022, at 100 (100%

of face value).

Journal entry to record the issuance

Journal entry Candlestick would make to accrue interest on December 31

Bonds Issued at Face Value (2 of 2)

Journal entry to be made by Candlestick to pay the interest on Jan 1, 2023

Discount or Premium on Bonds (1 of 3)

Interest Rates and Bond Prices

Discount or Premium on Bonds (2 of 3)

Review Question

Laurel 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

Discount or Premium on Bonds (3 of 3)

Review Question

Laurel 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

Issuing Bonds at a Discount (1 of 2)

Illustration: Assume that on January 1, 2022, Candlestick Inc sells $100,000, five-year, 10% bonds at 98

(98% of face value) with interest payable on January 1

Journal entry to record the issuance

Issuing Bonds at a Discount (2 of 2)

Less: Discount on bonds payable 2,000 $98,000

Issuing corporation must pay

• Contractual interest payments over the term of the bonds

• Face value of bonds at maturity

Total Cost of Borrowing (1 of 2)

Bonds Issued at a Discount

Annual interest payments

($100,000 × 10% = $10,000; $10,000 × 5) $50,000Add: Bond discount ($100,000 − $98,000) 2,000

Bonds Issued at a Discount

Annual interest payments ($10,000 × 5) 50,000

Less: Cash received from bondholders 98,000

Amortization of Bond Discount

• Allocated to expense in each period

• Increases amount of interest expense reported each period

• Amount of interest expense reported each period will exceed contractual amount paid

• As discount is amortized, its balance declines

• Carrying value of bonds will increase, until at maturity carrying value of bonds equals their face amount

Issuing Bonds at a Premium (1 of 2)

Illustration: Assume that the Candlestick Inc bonds previously described sell at 102 rather than at 98

Journal entry to record the sale

Issuing Bonds at a Premium (2 of 2)

Add: Premium on bonds payable 2,000 $102,000

• Borrower pays only the face value of the bonds at maturity

• Not required to pay the bond premium at the maturity date

• Bond premium is considered a reduction in the cost of borrowing

Total Cost of Borrowing (2 of 2)

Bonds Issued at a Premium

($100,000 × 10% = $10,000; $10,000 × 5 years) $50,000Add: Bond discount ($102,000 − $100,000) 2,000

Bonds Issued at a Premium

Annual interest payments ($10,000 × 5 years) 50,000

Less: Cash received from bondholders 102,000

Amortization of Bond Premium

• Allocated to expense in each period

• Amount of interest expense reported each period will be less than contractual amount paid

• As premium is amortized, its balance declines

• Carrying value of bonds will decrease, until at maturity carrying value of bonds equals their face amount

Do It! 3a: Bond Issuance

Giant Corporation issues $200,000 of bonds for $189,000

(a) Journal entry to record the issuance of the bonds

Long-term liabilities

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

Redeeming Bonds at Maturity

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

Redeeming Bonds before Maturity (1 of 2)

• Eliminate carrying value of bonds at redemption date

• Record cash paid

• Recognize gain or loss on redemption

• Face value of the bonds less unamortized bond discount or

• Face value of the bonds plus unamortized bond premium

Redeeming Bonds before Maturity (2 of 2)

Illustration: 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 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, 2026, as

Do It! 3b: Bond Redemption

R & B Inc issued $500,000, 10-year bonds at a discount Prior to maturity, when the carrying value of the bonds is $496,000, the company redeems the bonds at 98

Prepare the entry to record the redemption of the bonds.

  Gain on Bond Redemption   6,000

  Discount on Bonds Payable   4,000

Learning Objective 4

Discuss How Liabilities Are Reported and Analyzed

Presentation of Liabilities on the Balance Sheet

Marais Company Balance Sheet (partial)

Less: Discount on bonds payable 80,000 920,000

Notes payable, secured by plant assets 540,000

Lease liability 500,000

Analysis (1 of 5)

General Motors Company Balance Sheets December 31, 2017 and 2016

Liabilities and Stockholders’ Equity

Total current liabilities $ 76,890 $ 85,181

Noncurrent liabilities 99,392 92,434

Total liabilities 176,282 177,615

Total stockholders’ equity 36,200 44,075

Total liabilities and stockholders’ equity $212,482 $221,690

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

meet unexpected needs for cash

Analysis (3 of 5)

Solvency

Total Assets

Times Interest Earned =

Net Income + Interest Expense + Income Tax Expense

Interest Expense

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

General Motors (in millions)

General Motors (in millions)

Contingencies

Intentional effort by a company to structure its financing arrangements so as to avoid showing

liabilities on its balance sheet.

Do It! 4: Analyzing Liabilities (1 of 3)

Trout Company provides you with the following balance sheet information as of December 31, 2022.

Total liabilities and stockholders’ equity

$34,700 Trout reported net income for 2022 of $14,000, income tax expense of $2,800, and interest expense of $900.

(a) Compute the current ratio and working capital for Trout for 2022.

Do It! 4: Analyzing Liabilities (2 of 3)

Current ratio = $8,500 ÷ $6,000 = 1.42:1

Working capital = $8,500 − $6,000 = $2,500

Trout Company provides you with the following balance sheet information as of December 31, 2022.

Trout reported net income for 2022 of $14,000, income tax expense of $2,800, and interest expense of $900.

(b) Assume that Trout used $2,000 cash to pay off $2,000 of accounts payable.

Total liabilities and stockholders’ equity

$34,700

Do It! 4: Analyzing Liabilities (3 of 3)

Trout Company provides you with the following balance sheet information as of December 31, 2022.

Trout reported net income for 2022 of $14,000, income tax expense of $2,800, and interest expense of $900.

(c) Compute debt to assets ratio and times interest earned for Trout for 2022.

Total liabilities and stockholders’ equity

$34,700

Learning Objective 5

Apply the Straight-Line Method of Amortizing Bond Discount and Bond Premium

Straight-Line Amortization

Amortizing Bond Discount

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

Amortizing Bond Discount

Illustration: Candlestick, Inc sold $100,000, five-year, 10% bonds on January 1, 2022, for $98,000 (discount of

$2,000) Interest is payable on January 1 of each year

Journal entry to accrue interest and amortize the bond discount at Dec 31, 2022