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CHAPTER 11 LIABILITIES. STUDY OBJECTIVES After studying this chapter, you should understand:. STUDY OBJECTIVE 1 TYPES OF CURRENT LIABILITIES. Key features of a current liability: It is expected to be paid from existing current assets or through the creation of other current liabilities

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slide1

CHAPTER 11

LIABILITIES

STUDY OBJECTIVES

After studying this chapter, you should understand:

slide2

STUDY OBJECTIVE 1

TYPES OF CURRENT LIABILITIES

Key features of a current liability:

It is expected to be paid from existing current assets or through the creation of other current liabilities

It will be paidwithin one year or the

operating cycle, whichever is longer.

Notes Payable

Accounts Payable

Unearned Revenues

Accrued Liabilities

slide3

STUDY OBJECTIVE 2

NOTES PAYABLE

Key features of a note payable:

Promissory note

Interest

Notes due within a year

are current liabilities

slide4

NOTES PAYABLE

ISSUANCE DATE

General Journal

Date

Account Titles

Debit

Credit

March 1 Cash 100,000

Notes Payable 100,000

Assume First National Bank agrees to

lend $100,000 on March 1, 2006, if

Cole Williams Co. 12%, 4-month note.

Assets received = face value of note

slide5

INTEREST FORMULA

If the loan term is expressed in days,

use the number of days divided by 365.

If loan term is expressed in months,

use the number of months divided by 12.

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

Using the Cole Williams Co. data:

Annual

Interest

Rate

Time in

Terms

of One Year

Face Value

of Note

Interest

slide6

NOTES PAYABLE

INTEREST ACCRUAL

General Journal

Date

Account Titles

Debit

Credit

June 30 Interest Expense 4,000

Interest Payable 4,000

If Cole Williams Co. prepares financial statements semiannually, an adjusting entry is required to recognize interest expense and interest payable of $4,000 at June 30.

slide7

NOTES PAYABLE

MATURITY DATE

General Journal

Date

Account Titles

Debit

Credit

July 1 Notes Payable 100,000

Interest Payable 4,000

Cash 104,000

When the loan is paid, the FACE VALUE is

debited, any interest accrued is removed,

and cash is decreased by this combined amount.

slide8

REVIEW QUESTION

INTEREST ACCRUAL

Shari Uecker Company borrows $88,500 on September 1, 2006

From Egg Harbor State Bank by signing a one year, 12% note.

What is the accrued interest at December 31, 2006?

Answer:

$88,500 x 12% x 4/12 = $3,540

slide9

STUDY OBJECTIVE 3

OTHER CURRENT LIABILITIES

SALES TAXES PAYABLE

  • Sales tax is expressed as a stated percentage of the sales price on goods sold to customers by a retailer.
  • The retailer collects the tax from the customer when the sale occurs. Retailer periodically remits the collections to the state’s department of revenue.

Retailer is a collection agent

for the tax authority.

slide10

SALES TAXES PAYABLE

SALE DATE

General Journal

Date

Account Titles

Debit

Credit

Mar. 25 Cash 10,600

Sales 10,000

Sales Tax Payable 600

On March 25th cash register readings for Cooley

Grocery show sales of $10,000 and sales taxes of $600.

Sales tax rate = 6%

slide11

EXTRACTING SALES TAX

FROM TOTAL RECEIPTS

If Cooley Grocery “rings up” total receipts

of $10,600, and the sales tax percentage

is 6%, we can figure sales as follows:

$10,600 / 1.06 = $10,000

Total receipts – Sales = Tax collected

$10,600 - $10,000 = $600

payroll and payroll taxes payable
PAYROLL AND PAYROLL TAXES PAYABLE

Liabilities relating to employee wages and salaries include:

Wages and salaries payable

Withholding taxes

Date

Account

Debit

Credit

March 7

Salaries & Wages Expense

100,000

FICA Taxes Payable

7,650

Federal Income Taxes Payable

21,864

State Income Taxes Payable

2,922

Salaries & Wages Payable

67,564

(record payroll & w/h taxes for week of March 7)

March 11

Salaries & Wages Payable

67,564

Cash

67,564

(to record payment of March 7 payroll)

payroll and payroll taxes payable1
PAYROLL AND PAYROLL TAXES PAYABLE

Various payroll taxes are levied upon the employer:

Matching FICA taxes

Federal unemployment taxes

State unemployment taxes

Date

Account

Debit

Credit

March 7

Payroll Tax Expense

13,850

FICA Taxes Payable

7,650

FUTA Taxes Payable

800

SUTA Taxes Payable

5,400

(record employer’s payroll taxes for week of March 7)

slide16

UNEARNED REVENUES

Unearned Revenues occur when a company

receives cash before a service is rendered.

Examples:

Airline sells a ticket for future flights

Attorney receives legal fees before work is done.

slide17

UNEARNED REVENUES

CASH RECEIPT

General Journal

Date

Account Titles

Debit

Credit

Aug. 6 Cash 500,000

Unearned Football Ticket Revenue 500,000

Superior University sells10,000season football

tickets at$50each for itsfive-gamehome schedule.

slide18

UNEARNED REVENUES

EARNINGS DATE

General Journal

Date

Account Titles

Debit

Credit

Sept. 7 Unearned Football Ticket Revenue 100,000

Football Ticket Revenue 100,000

As each game is completed, Unearned Football Ticket Revenue is debited for 1/5 of the unearned revenue. The earned revenue, Football Ticket Revenue, is credited.

slide19

UNEARNED AND EARNED

REVENUE ACCOUNTS

Shown below are specific unearned and earned

revenue accounts in selected types of businesses.

Account Title

Type of Business

Unearned Revenue

Earned Revenue

Unearned passenger

Passenger

Airline

Ticket Revenue

Revenue

Unearned

Magazine

Subscription

Subscription

Publisher

Revenue

Revenue

Unearned Rental

Hotel

Revenue

Rental Revenue

Insurance

Unearned Premium

Company

Revenue

Premium Revenue

slide20

CURRENT MATURITIES

OF LONG-TERM DEBT

That portion of long-term debt

due within 1 year.

Classified as a current liability

on the balance sheet

working capital formula
WORKING CAPITAL FORMULA

$ 16,791 - $ 12,621 = $ 4,170

Working Capital

The excess of current assets over current liabilities.

A measure of short-term liquidity.

-

Current

Liabilities

Current

Assets

=

Working

Capital

current ratio formula
CURRENT RATIO FORMULA

$16,791 / $12,621 = 1.33 : 1

Current Ratio

The ratio of current assets to current liabilities.

A measure of short-term liquidity.

Current

Liabilities

/

Current

Ratio

=

Current

Assets

slide24

STUDY OBJECTIVE 4

BONDS PAYABLE

A form of interest-bearing notes

payable issued by corporations,

universities, & governmental agencies.

Can be sold in small denominations

to attract many investors.

Sold to obtain long term capital.

An alternative to issuing stock.

slide25

ADVANTAGES OF BOND

FINANCING OVER STOCK

slide26

EFFECTS ON EPS

BONDS VS. STOCK

slide28

STUDY OBJECTIVE 5

BOND ISSUANCE PROCEDURES

  • Corporate bonds are traded on securities exchanges.
  • Bond prices are quoted as a percentage of the face value of the bond (usually $1,000).
  • Transactions between a bondholder and other investors are not journalized by the issuing corporation.
  • A corporation records entries when it issues/buys back bonds, and when bondholders convert bonds into stock.
slide29

DETERMINING MARKET

VALUE OF BONDS

The present value (PV) of a bond

is a function of three factors:

1. Dollar amount

2. Time

3. Market rate of interest

The process of determining

the PV is discounting.

slide30

ISSUING BONDS

AT FACE VALUE

Assume that Devor Corporation issues

1000 10-year, 9% $1,000 bonds dated

January 1, 2006, at 100 (100% of face value).

The entry to record the sale is:

Date

Account

Debit

Credit

Jan 1

Cash

1,000,000

Bonds payable

1,000,000

(record sale of bonds at face value)

1000 bonds x $1000 = $1,000,000

slide31

BOND INTEREST PAYMENT

Assume that interest is payable semi-annually

on January 1 and July 1. Next payment

Is due July 1, 2006. The entry is:

Date

Account

Debit

Credit

July 1

Bond Interest Expense

45,000

Cash

45,000

(record semi-annual bond interest payment)

$1,000,000 x 9% x 6/12 = $45,000

slide32

BOND INTEREST ACCRUAL

Assume that interest is payable semi-annually

on January 1 and July 1. Next payment

Is due January 1, 2006. At December 31, 2005

the entry to accrue interest is:

Date

Account

Debit

Credit

Dec 31

Bond Interest Expense

45,000

Bond Interest Payable

45,000

Record bond interest accrual at year end

$1,000,000 x 9% x 6/12 = $45,000

interest rates and bond prices
INTEREST RATES AND BOND PRICES

Market Rates Bonds Sell at:

Issued

when:

8%

Premium

BOND

CONTRACTUAL

INTEREST

RATE 10%

10%

Face Value

Discount

12%

issuing bonds at a discount
ISSUING BONDS AT A DISCOUNT

On January 1, 2006, Candlestick, Inc. sells

$100,000, 5-year, 10% bonds for $92,639 with

interest payable on payable on July 1 & January 1. The entry to record the issuance is:

Date

Account

Debit

Credit

Jan 1

Cash

92,639

Discount on Bonds Payable

7,361

Bonds Payable

100,000

(record issuance of bonds at a discount)

Market value of bonds = $92,639

financial statement presentation discount
FINANCIAL STATEMENT PRESENTATION--DISCOUNT

Discount on Bonds Payable is a contra account, which

is deducted from bonds payable on the balance sheet:

CANDLESTICK, INC.

Balance Sheet (partial)

Long

-

term liabilities

Bonds payable

$100,000

Less:

Discount on Bond Payable

$7,361

$92,639

Carrying value of bonds = $92,639

total cost of borrowing bonds issued at a discount
TOTAL COST OF BORROWINGBONDS ISSUED AT A DISCOUNT
  • The the discount is an additional cost of borrowing that is recorded as bond interest expense over the life of the bonds.
  • The total cost of borrowing for Candlestick, Inc., is computed as follows:

Bonds Issued at a Discount

Semiannual Interest Payments

($100,000*10%*.5=$5,000; $5,000*10)

$50,000

Add: Bond Discount ($100,000-$92,639)

$7,361

Total Cost of Borrowing

$57,361

issuing bonds at a premium
ISSUING BONDS AT A PREMIUM

On January 1, 2006, Candlestick, Inc. sells

$100,000, 5-year, 10% bonds for $108,111 with

interest payable on payable on July 1 & January 1. The entry to record the issuance is:

Date

Account

Debit

Credit

Jan 1

Cash

108,111

Premium on Bonds Payable

8,111

Bonds Payable

100,000

(record issuance of bonds at a premium)

Market value of bonds = $108,111

financial statement presentation premium
FINANCIAL STATEMENT PRESENTATION—PREMIUM

Premium on Bonds Payable is added to

bonds payable on the balance sheet:

CANDLESTICK, INC.

Balance Sheet (partial)

Long

-

term liabilities

Bonds payable

$100,000

Add: Premium on Bonds Payable

$

8,

111

$

108,111

Carrying value of bonds = $108,111

total cost of borrowing bonds issued at a premium
TOTAL COST OF BORROWINGBONDS ISSUED AT A PREMIUM

The premium is considered to be a reduction

in the cost of borrowing that should

be credited to Bond Interest Expense

over the life of the bonds.

Bonds Issued at a Premium

Semiannual Interest Payments

($100,000*10%*.5=$5,000; $5,000*10)

$50,000

Less: Bond Premium ($108,111-$100,000)

$8,111

Total Cost of Borrowing

$41,889

study objective 6 redeeming bonds at maturity
STUDY OBJECTIVE 6REDEEMING BONDS AT MATURITY

Book value of the bonds at maturity

will equal their face value.

The entry to record the redemption

of the Candlestick bonds at maturity is:

Date

Account

Debit

Credit

Maturity date

Bonds Payable

100,000

Cash

100,000

(record payment of bonds at maturity)

This assumes all interest has been paid to maturity.

The entry will be the same regardless of whether

The bonds were issued at face value, discount, or premium

study objective 7 long term notes payable
STUDY OBJECTIVE 7LONG-TERM NOTES PAYABLE
  • Terms exceed one year.
  • May be secured by a specific assets (mortgage).
  • Mortgage N/P are recorded initially at face value.
  • Subsequent entries required for installment payments.

Porter Technology Inc. issues a $500,000, 12%, 20-year

mortgage note on December 31, 2006, to build a research lab.

The terms provide for semiannual installment payment of $33,231.

The installment payment schedule for the first year is shown below:

(B)

(C)

(D)

Semiannual

(A)

Interest

Reduction

Principal

Interest

Cash

Expense

Of Principal

Balance

Period

Payment

(D) x 6%

(A) – (B)

(D) –(C)

Issue date $500,000

1 33,231 $30,000 $3,231 496,769

2 $33,231 29,806 3,425 493,344

long term notes payable journal entries
LONG-TERM NOTES PAYABLEJOURNAL ENTRIES

The entries to record the issuance

and first interest payment are:

Date

Account

Debit

Credit

Dec 31

Cash

500,000

Mortgage Notes Payable

500,000

(record mortgage loan)

June 30

Interest Expense

30,000

Mortgage Notes Payable

3,231

Cash

33,231

(record first installment payment)

study objective 8 presentation analysis
STUDY OBJECTIVE 8PRESENTATION & ANALYSIS

The long-term liabilities for LAX

Corporation are shown below:

LAX Corporation

Balance Sheet (partial)

Long-term liabilities

$1,000,000

Bonds payable 10% due in 2012

80,000

$920,000

Less: Discount on bonds payable

Mortgage notes payable, 11%, due in 2018

500,000

and secured by plant assets

540,000

Lease liability

$1,960,000

Total long-term liabilities

debt to total assets ratio
DEBT TO TOTAL ASSETS RATIO

44.3% = $21,394 / $48,263

Measures the percentage of total assets provided

by creditors, indicating the degree of leverage.

Data from Johnson & Johnson’s

2003 annual report appears below:

TOTAL DEBT DEBT TO TOTAL ASSETS = ———————— TOTAL ASSETS

times interest earned ratio
TIMES INTEREST EARNEDRATIO

Indicates the company’s ability to meet

interest payments as they come due.

Johnson & Johnson’s 2003

annual report data is used below:

50.8 times = ($7197 + $3111 + $207)

$207

TIMES INT INCOME BEFORE INC. TAXES & INTEREST EXPENSE EARNED = ——————————————————————————— INTEREST EXPENSE

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