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Current and Long-Term Liabilities

Current and Long-Term Liabilities. Chapter 8. Learning Objective 1. Account for current liabilities and contingent liabilities. Current Liabilities. Obligations due within one year or within company’s normal operating cycle if it is longer Known amount Estimated amount. Current Liabilities.

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Current and Long-Term Liabilities

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  1. Current and Long-TermLiabilities Chapter 8

  2. Learning Objective 1 Account for current liabilities and contingent liabilities.

  3. Current Liabilities • Obligations due within one year or within company’s normal operating cycle if it is longer • Known amount • Estimated amount

  4. Current Liabilities • Known amount • Accounts payable • Short-term notes payable • Sales tax payable • Current portion of long-term debt • Accrued expenses • Payroll liabilities • Unearned revenues

  5. Short-Term Notes Payable On January 30, a business purchased inventory for $8,000 by issuing a 1-year, 10% note payable. The fiscal year ends on April 30. Jan 30 Inventory 8,000 Notes Payable 8,000 Purchased inventory by issuing a one-year, 10% note ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

  6. Short-Term Notes Payable How much interest was accrued as of April 30? $8,000 × 10% × (3/12) = $200 Apr 30 Interest Expense 200 Interest Payable 200 To accrue interest at year-end ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

  7. Short-Term Notes Payable Jan 30 Note Payable 8,000 Interest Payable 200 Interest Expense 600 Cash 8,800 To record payment of loan $8,000 × 10% × (9/12) = $600 ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

  8. Sales Tax Payable One day’s sales at a Home Depot Store totaled $200,000. The business collected an additional 5% in sales tax. Record the day’s sales. • Cash ($200,000 X 1.05) 210,000 • Sales Revenue 200,000 • Sales Tax Payable 10,000 • To record cash sales and related sales tax ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

  9. Current Installment ofLong-Term Debt • Amount of the principal that is payable within one year

  10. Accrued Expenses • Expenses that have been incurred but not recorded • Salaries • Taxes withheld • Interest • Utilities

  11. Payroll Liabilities • Salary Expense 10,000 • Employee Income Tax Payable 1,200 • FICA Tax Payable 800 • Salary Payable 8,000 • To record salary expense ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

  12. Unearned Revenues The Bradstreet Corporation provides credit evaluation services to subscribers. Bradstreet charges a client $750 for a three-year subscription. Prepare the entry.

  13. Unearned Revenues • Jan 1 Cash 750 • Unearned Revenue 750 • To record receipt for a 3-year subscription • Dec 31 Unearned Revenue 250 • Subscription Revenue 250 • To record revenue earned at year-end (750 x 12/36 months) ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

  14. Current Liabilities ThatMust Be Estimated Black & Decker made sales of $200,000 subject to product warranties. They estimate that 3% of the products it sells this year will require repair or replacement. • What is the estimated warranty expense?

  15. Estimated Warranty Payable $200,000 × .03 = $6,000 • Warranty Expense 6,000 • Estimated Warranty Payable 6,000 • To accrue warranty expense ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

  16. Estimated Warranty Payable Defective merchandise totals $5,800. Black & Decker will replace it and record the following: • Estimated Warranty Payable 5,800 • Inventory 5,800 • To replace defective products sold under warranty ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

  17. Contingent Liabilities • Potential liability that depends on a future event arising out of past events. • Record liability if: • it is probablethat the loss will occur and • the amount can be reasonably estimated

  18. Contingent Liabilities • Report in the notes to the financial statement if it is reasonably possiblethat a loss or expense will occur. • There is no reason to report contingent loss that is remote – unlikely to occur.

  19. Bonds: An Introduction • Groups of long-term notes payable issued to multiple lenders (bondholders)

  20. Types of Bonds • Term bonds • Serial bonds • Secured (mortgage) bonds • Unsecured (debenture) bonds

  21. Bond Prices Quoted at a percent of their maturity value. A $1,000 bond quoted at101½ sells for… $1,000 × 1.015 = $1,015. A $1,000 bond quoted at 88-3/8 sellsfor… $1,000 × 0.88375 = $883.75.

  22. Bond Prices • Bond issued above face (par) value - premium • Bond issued at below face (par) value - discount • As a bond nears maturity, its market price moves toward par value

  23. Present Value The amount invested today receives a greater amount at a future date -present value of a future amount It depends on: • amount of the future receipt • length of time to future receipt • interest rate for the period

  24. Bond Interest Rates • Bonds are sold at market price - amount that investors are willing to pay at any given time • Market price represents: • present value of periodic interest payments • present value of principal to be received at maturity

  25. Bond Interest Rates • Contract rate – stated rate • Market rate – effective rate

  26. Learning Objective 2 Account for bonds payable transactions.

  27. Issuing Bonds at Par Value On January 1, Chrysler Corporation issued $50,000 of 9%, 5-year bonds at par. • Jan 1 Cash 50,000 • Bonds Payable 50,000 • To issue 9%, 5-years bonds at par ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

  28. Issuing Bonds at Par Value Record semiannual interest payments. • Jul 1 Interest Expense 2,250 • Cash 2,250 • To pay semiannual interest • $50,000 × 9% × 6/12 = $2,250 ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

  29. Issuing Bonds Payable at Par Value • Dec 31 Interest Expense 2,250 • Interest Payable 2,250 • To accrue interest • $50,000 × 9% × 6/12 = $2,250 ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

  30. Issuing Bonds at a Discount Chrysler issues $100,000 of its 9%, five-year bonds when the market interest rate is 10%. Chrysler receives $96,149 at issuance. • Jan 1 Cash 96,149 • Discount on Bonds Payable 3,851 • Bonds Payable 100,000 • To issue 9%, 5-years bonds at a discount. ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

  31. Issuing Bonds Payableat a Discount Chrysler’s balance sheet immediately after issuance of the bonds: Total current liabilities $ XXX Long-term liabilities: Bonds payable, 9%, due 2009 $100,000 Discount on bonds payable ( 3,851) 96,149 Discount on Bonds Payable - contra account to Bonds Payable ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

  32. Learning Objective 3 Measure interest expense.

  33. Amortization Table on Bonds Issued at a Discount ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

  34. Interest Expense on BondsIssued at a Discount On July 1, 2004, Chrysler makes the first $4,500 semiannual interest payment and also amortizes (decreases) the bond discount • Jul 1 Interest Expense 4,807 • Discount on Bonds Payable 307 • Cash 4,500 • To pay semiannual interest & amortize bond discount ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

  35. Interest Expense on BondsIssued at a Discount At December 31, 2004, Chrysler accrues interest and amortizes the bond discount for July through December. • Dec 31 Interest Expense 4,823 • Discount on Bonds Payable 323 • Interest Payable 4,500 • To accrue semiannual interest & amortize bond discount ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

  36. Discount on Bonds Payable Bonds Payable 307 July 1 323 Dec. 31 100,000 3,851 3,221 Interest Expense on BondsIssued at a Discount Chrysler’s bond accounts as of December 31, 2004. Bond carrying amount: $100,000 – $3,221 = $96,779

  37. Issuing Bonds Payableat a Premium Chrysler Corporation issues $100,000 of 9%, five-year bonds when the market interest rate is 8%. Chrysler receives $104,100 at issuance. • Cash 104,100 • Premium on Bonds Payable 4,100 • Bonds Payable 100,000 • To issue 9%, 5-years bonds at a premium. ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

  38. Issuing Bonds Payableat a Premium Chrysler’s balance sheet immediately after issuance of the bonds: Total current liabilities $ XXX Long-term liabilities: Bonds payable $100,000 Premium on bonds payable 4,100 $104,100 ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

  39. Amortization Table on Bonds Issued at a Discount ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

  40. Interest Expense on BondsIssued at a Discount On July 1, 2004, Chrysler makes the first $4,500 semiannual interest payment and also amortizes (decreases) the bond premium • Jul 1 Interest Expense 4,164 • Premium on Bonds Payable 336 • Cash 4,500 • To pay semiannual interest & amortize bond premium ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

  41. Straight-Line Amortization Amortizes discount or premium by dividing it into equal amounts for each interest period Chrysler would amortize the $4,100 premium over 10 periods. $4,100 ÷ 10 = $410 per period

  42. Early Retirement of Bonds Payable Air Products and Chemicals, Inc., has $70,000 of debenture bonds outstanding with unamortized discount of $350. The market price is 99¼.

  43. Early Retirement of Bonds Payable Par value of bonds $70,000 Less: Unamortized discount ( 350) Carrying amount of the bonds $69,650 Market price ($70,000 × 0.9925) 69,475 Extraordinary gain on retirement $ 175 • Bonds Payable 70,000 • Discount on Bonds Payable 350 • Cash 69,475 • Gain on Retirement of Bonds 175 • To record bond retirement ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

  44. Convertible Bonds and Notes Texas Instruments has convertible notes payable of $250,000. Assume that noteholders convert half the notes into 4,000 shares, $1 par common stock. • Notes Payable 125,000 • Common Stock 4,000 • Paid-in Capital 121,000 • To record conversion of notes payable ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

  45. Learning Objective 4 Understand the advantages and disadvantages of borrowing.

  46. No liabilities No interest expense Does not dilute stock ownership or control Less risky to corporation Results in higher earningsper share Financing OperationsWith Bonds or Stocks Issuing Stock Issuing Notes or Bonds

  47. Long-Term Liabilities: Leases Lease - rental agreement in which the tenant (lessee) agrees to make rent payments to the property owner (lessor). • Operating • Capital

  48. Long-Term Liabilities: Leases • Capital lease: • transfers title at end of the term • contains bargain purchase option • lease terms cover 75% or more of estimated useful life of leased asset • present value of lease payments is 90% or more of the market value of leased asset

  49. Long-Term Liabilities: Pensions • Record pension and retirement benefit expenses while employees work for the company • At end of each period, compare the fair market value of the assets in the pension plan – cash and investments – with the plan’s accumulated benefit obligation

  50. Long-Term Liabilities: Pensions • If accumulated benefit obligation exceeds plan assets, the plan is underfunded • Report excess liability amount as a long-term pension liability on the balance sheet

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