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Liabilities
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Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.
1
Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.
22
LiabilitiesChapter 9
Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.
3
Account for current liabilities and contingent liabilities
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4
Current Liabilities
•Obligations due within one year•Two types:
▫Known amounts▫Estimated amounts
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Current Liabilities: Known Amount
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Current Liabilities: Known Amount•Accounts payable
▫Amounts owed for products or services purchased on account
Accounts payable turnover
Cost of goods sold
Average accounts payable
Days payable
outstanding
365Accounts payable turnover
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7
Short-term notes payable
•Due within one year•Used to borrow cash or purchase asset•Accrue interest
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Accounting for Short-Term Notes Payable
JOURNAL
Date Accounts and explanation Debit Credit
Dec 1 Inventory 30,000
Note Payable, Short-Term 30,000
Purchase of inventory by issuing a 3-month, 9% note payable.
Dec 31
Interest expense 225
Interest payable 225
Accrued interest on note payable.
(30,000 × 9% × 1/12)
Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.
9
Accounting for Short-Term Notes Payable
JOURNAL
Date Accounts and explanation Debit Credit
Mar 1 Note payable, short-term 30,000
Interest payable 225
Interest expense (30,000 x 9% x 2/12) 450
Cash 30,675
To record payment of note payable and interest at maturity.
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Sales Tax Payable
•Levied on retail sales•Collected from customers and remitted to
state
JOURNAL
Date Accounts and explanation Debit Credit
Cash 105,000
Sales Revenue 100,000
Sales Tax Payable 5,000
To record cash sales and the related sales tax.
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Accrued Liabilities
•Result from expenses incurred but not yet paid
•Categories:▫Salaries and Wages Payable▫Interest Payable▫Income Taxes Payable
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Payroll
• Major expense of most companies• Many different forms:
▫ Salary▫ Wage▫ Commission
JOURNAL
Date Accounts and explanation Debit Credit
Salary Expense
Employee Income Taxes payable
FICA Taxes Payable
Salary Payable to Employees
To record sales expense.
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13
Payroll Liabilities
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Unearned Revenues
•Business receives cash before earning revenue
•Results in a liabilityJOURNAL
Date Accounts and explanation Debit Credit
Cash
Unearned Revenue
Received advance payment from customer.
Unearned Revenue
Revenue
To record earned portion of unearned revenue.
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Exercise 9-17AJOURNAL
Date Accounts and explanation Debit Credit
Oct 1 Cash 2,616
Unearned Subscription Revenue 2,400
Sales Tax Payable 216
Received subscription fees in advance.
Nov 15 Sales Tax Payable 216
Cash 216
Remitted sales tax.
Dec 31 Unearned Subscription Revenue 600
Subscription Revenue ($2,400 ×3/12)
600
Earned revenue that was collected in advance.
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Current Portion of Long-Term Debt•Long-term debt often paid in installments•Amount of principal payable within one
year•Company reclassifies amount from long-
term to current
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Estimated Current Liabilities
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Estimated Warranty Payable
•Warranty expense is estimated in the year product is sold▫Matching principle
JOURNAL
Date Accounts and explanation Debit Credit
Warranty Expense
Estimated Warranty Payable
To accrue warranty expense.
Estimated Warranty Payable
Inventory
To replace defective parts under warranty.
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19
Contingent Liabilities
•Potential liability that depends on future outcome of past events
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Account for bonds payable, notes payable and interest expense
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Long-Term Liabilities
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Bonds Payable
•Debts of issuing company•Bond certificate states:
▫Company name▫Principal▫Maturity date▫Interest rate▫Interest payment dates
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23
Types of Bonds
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Bond Prices
•Quoted as percent of maturity valuePremium Discount
Price above face Price below face
Credit balance Debit balance
Market price decreases towards maturity value
Market price increases towards maturity value
At maturity
dateFace value
Marketvalue
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Interest Rates & Bond Prices
•Bonds always sold at market price▫Bond’s present value
•Two interest rates set bond price▫Stated interest rate (coupon rate)
Printed on bond certificate Determines cash interest paid to bondholders
▫Market interest rate (effective interest rate) Demanded by investors for loaning money Varies minute to minuteStated rate usually differs from
market rate
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Issue Price of Bonds Payable
Case A
Stated interest rate
= Market interest rate
Therefore, Issued at Par
Case B
Stated interest rate
< Market interest rate
Therefore, Issued at Discount
Case C
Stated interest rate
> Market interest rate
Therefore, Issued at Premium
Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.
27
Issuing Bonds Payable at Par
JOURNAL
Date Accounts and explanation Debit Credit
Cash 100,000
Bonds Payable 100,000
To issue bonds at par.
Interest Expense 4,000
Cash 4,000
To pay semi-annual interest.
Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.
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Issuing Bonds Payable at Par
JOURNAL
Date Accounts and explanation Debit Credit
Bonds payable 100,000
Cash 100,000
To pay bonds at maturity.
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Issuing Bonds Payable at a Discount
JOURNAL
Date Accounts and explanation Debit Credit
Cash 96,149
Discount on bonds payable 3,851
Bonds payable 100,000
To issue bonds at a discount.
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Balance Sheet Presentation
Balance Sheet
Long-term liabilities:
Bonds payable $100,000
Less: Discount on bonds payable
(3,851) $96,149
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Semiannual Interest Payment vs. Semiannual Interest ExpenseSemiannualInterest payment
Face value
Stated interest rate
1/2
SemiannualInterest expense
SemiannualInterest expense
Preceding Bond
Carrying amount
Preceding Bond
Carrying amount
Market
interest rate
Market
interest rate
1/21/2
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Bond Discount Example
Issue Date January 1, 2012
Face value $100,000
Stated interest rate
9%
Interest payments Semi-annual
Maturity date January 1, 2017
Market interest rate
10%
Issue price $96,149
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A B C D E
DateInterest paymen
t
Interest
expense
Discount amortizatio
n
Discount
balance
Bond carrying amount
Jan 1, 2012
$3,851 $96,149
Jun 1, 2012
$4,500 $4,807 $307 3,544 96,456
Jan 1, 2013
$4,500 4,823 323 3,221 96,779
Jan 1, 2017
$4.500 4,961 461 0 100,000
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Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.
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Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.
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JOURNAL
Date Accounts and explanation Debit Credit
2012
July 1 Interest Expense 4,807
Discount on Bonds Payable 307
Cash 4,500
To pay semiannual bond interest and amortize discount
Dec. 31
Interest expense 4,823
Discount on Bonds Payable 323
Interest Payable 4,500
To pay semiannual bond interest and amortize discount.
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37
Balance Sheet Presentation
Balance Sheet
Long-term liabilities:
Bonds payable $100,000
Less: Discount on bonds payable
(3,221) $96,779
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Partial-Period Interest Payments
JOURNAL
Date Accounts and explanation Debit Credit
Dec. 31
Interest Expense 2,880
Discount on Bonds Payable 213
Interest Payable 2,667
To accrue interest and amortize discount at year-end.
$96,000 carrying amount x 9% market rate x 4/12
$96,000 carrying amount x 9% market rate x 4/12
$100,000 face value x 8% stated rate x 4/12$100,000 face value x 8% stated rate x 4/12
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39
Bond Premium Example
Issue Date January 1, 2012
Face value $100,000
Stated interest rate
9%
Interest payments Semi-annual
Maturity date January 1, 2017
Market interest rate
8%
Issue price $104,100
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A B C D E
DateInterest paymen
t
Interest
expense
Premium amortizatio
n
Premium balance
Bond carrying amount
Jan 1, 2012
$4,100 $104,100
Jun 1,2012
$4,500 $4,164 $336 3,764 103,764
Jan 1, 2013
$4,500 4,151 349 3,415 103,415
Jan 1, 2017
$4,500 3,955 545 0 100,000
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Straight-Line Method
AmortizationDiscount or premium
Number of interest payments
Interest expenseInterest expense
Amortization
Amortization
Interest paymentInterest payment
OR
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Retiring Bonds Before Maturity
•Reasons to pay off bonds early▫Can relieve high interest payments ▫Can borrow at a lower interest rate
•Callable feature▫Issuer can pay off bonds at a prearranged
price▫Results in a gain or loss
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Convertible Bonds and Notes
•Bondholders can exchange bonds for stock
•Investors benefit from:▫Guaranteed receipt of principal and
interest on bonds▫Potential for gains on stock
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46
Analyze and differentiate financing with debt vs. equity
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Financing Operations
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Earnings per SharePlan 1 Plan 2
Borrow $500,000 6% Issue $500,000 of stock
Net income before expansion $300,000 $300,000
Expected project income before interest & taxes $200,000 $200,000
Interest expense (30,000) 0
Income taxes (40%) (68,000) (80,000)
Expected project net income 102,000 120,000
Total net income 402,000 420,000
Common shares 100,000 150,000
Earnings per share $4.02 $2.80
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49
The Leverage Ratio
Total assetsTotal assets
Total stockholders’ equityTotal stockholders’ equity
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Times Interest Earned
Interest ExpenseInterest Expense
Operating IncomeOperating Income
High ratio = ease in paying
interest
High ratio = ease in paying
interest
Low ratio = difficulty in
paying interest
Low ratio = difficulty in
paying interest
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51
Understand other long-term liabilities
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OPERATING CAPITAL
• Lessee has right to use the asset
• Lessor retains risks and rewards of owing
• Lessee records Rent Expense
• Lessee has right to use the asset
• Lessee assumes risks and rewards of ownership
• Lessee capitalizes the leased asset and records a long-term liability
Leases
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Capital Lease Criteria
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Pensions and Postretirement Liabilities•Expense recorded while employees work
for the company•Cash contributed into pension plan assets•Obligations grows for future payments to
employees
UnderfundedPlan assets less than obligation
OverfundedPlan assets
greater than obligation
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55
Report liabilities
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Partial Balance SheetDecember 31, 2011
Note 10: Financial Instruments
Long-term debt
Liabilities Revolving credit $400
Current liabilities: 9% notes due 2015 350
Accounts payable $650 8% notes due 2018 750
Accrued liabilities 985 U.K. credit arrangement
600
Unearned revenue 877 7.5$ notes due 2017 585
Current portion of long-term debt
225 Total long-term debt 2,685
Total current liabilities 2,737 Less: current maturities
(225)
Long-term debt 2,460 Long-term debt $2,460
Other long-term liabilities 1.987
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Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.
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