Chapter 10

1. Chapter 10 Reporting and Interpreting Liabilities McGraw-Hill/Irwin

2. Learning Objective 1 Explain how the reporting of liabilities assists decision-makers.

3. Decisions Related To Liabilities • Before extending credit, a credit manager for a company must assess: • How much does the borrower owe to others? • What was the reason for the past borrowings? • Will the company be able to repay the amount borrowed on time?

4. Current Liabilities Long-Term Liabilities Due within one year or the company’s operating cycle, whichever is longer. Due after one year or the company’s operating cycle, whichever is longer. Reporting Liabilities

5. Learning Objective 2 Explain how to account for common types of current liabilities.

6. Exh. 9.2 Current and Long-Term Liabilities

7. Measurement of Liabilities • The dollar amount reported for liabilities results from: • The initial amount of the liabilities.A liability is recorded at its cash equivalent, which is the amount of cash that a creditor would accept to settle the liability immediately. • Additional amounts owed to the creditor.Liabilities are increased whenever additional obligations arise, including interest charges. • Payments or services provided to the creditor.Liabilities are reduced whenever the company makes payments or provides services to the creditor.

8. Current Liabilities Accounts Payable – Purchase of goods or services on credit. Accrued Liabilities – An expense is incurred in one accounting period, the cash payment in a later period. Notes Payable – Occurs when one company borrows money from another. Sales Tax Payable – Liability resulting when a company collects sales tax for the state. Unearned Revenue – The receipt of cash before goods or services are provided.

9. Employers incur several expenses and liabilities from having employees. Accrued Payroll Taxes

10. Exh. 9.5 Accrued Payroll Taxes Gross Pay Medicare Taxes Federal Income Tax State and Local Income Taxes Voluntary Deductions FICA Taxes Net Pay

11. FICA Taxes Medicare Taxes FICA Taxes 2006: 6.2% of the first $94,200 earned in the year. 2006: 1.45% of all wages earned in the year. Employers owe the FICA amount withheld from employees’ gross pay to the IRS.

12. Recording Payroll Here is information about the payroll for General Mills:

13. PROMISSORY NOTE Face Value Date after date promise to pay to the order of National Bank, Boston, MA Dollars plus interest at the annual rate of . $200,000 Sept. 30, 2007 One Year I Two hundred thousand and no/100---------------------- 12% Janet Smith, CFO For Matrix, Inc. Exh. 9.3 Notes Payable Matrix, Inc. borrows $200,000 from National Bank

14. Leading to this journal entry: Notes Payable On September 30, 2007, Matrix, Inc. would do the following:

15. 9/30/07 12/31/07 12/31/08 NoteIssues YearEnd NoteDue Notes Payable Interest = Principal × Rate × Time Interest = $200,000 × 12% × 3/12

16. Notes Payable On December 31, 2007, Matrix, Inc. would prepare this journal entry . . .

17. Notes Payable On September 30, 2008, Matrix, Inc. must pay the interest and principal on the note. $24,000 = $200,000 × 12% × 12/12

18. Notes Payable On September 30, 2008, Matrix, Inc. would prepare these journal entries . . .

19. Sales Tax Payable Frank’s Sporting Goods sells a raft for $750 and collects the required 6% sales tax for the state.

20. Unearned Revenues On 6/1/07, Excel Catering received $1,500 in advance for catering a party on 7/4/07.

21. Unearned Revenues Excel finished catering the party on July 4th and does the following . . .

22. Learning Objective 3 Analyze and record bond liability transactions.

23. Long-term Liabilities

24. Bonds Issued at Face Value Prepare the entry for Jan. 1, 2008, to record the following bond issue by Matrix, Inc. Face Value = $10,000,000 Stated Interest Rate = 10% Interest Date = December 31 Bond Date = Jan. 1, 2008 Maturity Date = Dec. 31, 2010 (3 years)

25. $10,000,000 × 10% × 12/12 = $1,000,000 Bonds Issued at Face Value 12/31/08InterestPaid 12/31/09InterestPaid 12/31/10InterestPaid 1/1/08BondsIssued Interest $10,000,000Received $10,000,000Repaid Face Amount

26. Bonds Issued at Face Value On January 1, 2008, the bonds are issued to the public.

27. Bonds Issued at Face Value On 12/31/08 the first annual interest payment is due to the bondholders. $10,000,000 × 10% = $1,000,000

28. What lenders expect What lenders think What lenders pay 4% Market Rate Wow, I’ll pay extra Premium What lenders think What lenders pay What lenders expect 6% Market Rate It’s just enough Face Value What lenders expect What lenders think What lenders pay 8% Market Rate I’m not attracted (yet) Discount Bond Issued Below or Above Face Value 6%Stated Rate

29. Used only to determine cash interest payments Used to determine the bond liability and interest expense Bond Issued Below or Above Face Value Face valueStated interest rate Issue priceMarket interest rate

30. Bonds Issued at a Discount On Jan. 1, 2008, Matrix, Inc. issues these bonds: Face Value = $10,000,000 Issue Price = 95.19634% of par value Stated Interest Rate = 10% Market Interest Rate = 12% Interest Date = December 31 Bond Date = January 1, 2008 Maturity Date = December 31, 2010 (3 years)

31. $10,000,00095.19634% Issuing Bonds at a Discount

32. Issuing Bonds at a Discount On January 1, 2008, Matrix will record the issuance of the bonds with the following journal entry.

33. Issuing Bonds at a Discount $1,142,356 - $1,000,000 = $142,356 $9,519,634 × 12% = $1,142,356

34. Maturity Value Carrying Value Issuing Bonds at a Discount

35. $480,366 - $142,356 = $338,010 Issuing Bonds at a Discount

36. Bonds Issued at a Premium On January 1, 2008, Matrix, Inc. issues these bonds: Par Value = $10,000,000 Issue Price = 105.15419% of par value Stated Interest Rate = 10% Market Interest Rate = 8% Interest Date = December 31 Bond Date = January 1, 2008 Maturity Date = December 31, 2010 (3 years)

37. $10,000,000105.15419% Bonds Issued at a Premium

38. Bonds Issued at a Premium On January 1, 2008, Matrix will record the issuance of the bonds with the following journal entry.

39. Bonds Issued at a Premium $10,515,419 × 8% = $841,234 $1,000,000 - $841,234 = $158,766

40. Maturity Value Carrying Value Bonds Issued at a Premium

41. $515,419 - $158,766 = $356,653 Bonds Issued at a Premium

42. Early Retirement of Debt On January 1, 2009, Matrix retires the bonds issued at a premium shown below. Matrix paid $10,200,000 to retire the bonds.

43. Early Retirement of Debt The retirement will have the following impact on the balance sheet of Matrix, Inc:

44. Learning Objective 4 Interpret the current ratio and times interest earned ratio.

45. Net Income Before Interest and TaxesInterest Expense Current AssetsCurrent Liabilities Evaluate the Results

46. CurrentRatio Current AssetsCurrent Liabilities = Current Ratio Measures whether the company has enough current assets to pay what it currently owes.

47. Times InterestEarned Ratio Net Income + Interest Expense + Income Tax ExpenseInterest Expense = Times Interest Earned Ratio This ratio shows the amount of resources generated for each dollar of interest expense.

48. Understanding Common Features of Debt

49. Learning Objective 5 Describe the additional liabilities information reported in the notes to the financial statements.

50. Yes Record a liability Probable No Contingentliability Possible Describe in notes Remote Don’t mention it Contingent Liability Can weestimate the amount? How likely is the liability? Accountingrequired.