L> Chapter 10 - Financial Accounting . College of San Mateo Accounting 121 Rosemary Nurre . Course Info Announcements Assignments Student Info Home Page Chapter 10

Reporting and Assessing Liabilities

Study Objectives Exordinary a current licapability and also identify the significant forms of present liabilities. Describe the audit for notes payable. Exsimple the accountancy for other present liabilities. Identify the types of bonds. Prepare the entries for the issuance of bonds and interest expense. Describe the entries when bonds are redeemed. Identify the needs for the financial statement presentation and also analysis of liabilities. (Appendix 10A) Apply the straight-line method of amortizing bond discount and bond premium. (Appendix 10B) Apply the effective-interemainder method of amortizing bond discount and also bond premium. (Appendix 10C) Describe the accounting for permanent notes payable.

Study Ojective 1 - Exsimple a Current Liability and Identify the Major Types of Current Liabilities

Liabilities are identified as “creditors" claims on total assets” and also as “existing debts and also duties.” These clintends, debts, and obligations have to be settled or passist at some time in the future by the move of assets or services. A existing liability is a debt that can reasonably be intended to be phelp (1) from existing existing assets or via the creation of various other present liabilities, and (2) within one year or the operating cycle, whichever before is longer. Debts that do not meet both of these criteria are classified as long-term liabilities. The different kinds of current liabilities include notes payable, muzic-ivan.info payable, unearned earnings, and also accrued liabilities such as taxes, salaries and weras, and interest.

Do you have any personal liabilities? Are those liabilities existing liabilities or long-term liabilities? Why is it important that you understand whether they are present or long-term? If you were going to the bank to borrow money would it be essential to the banker to know which of the liabilities were present and which were long-term?

Study Objective 2 - Describe the Accounting for Notes Payable

Obligations in the create of written notes are tape-recorded as notes payable.

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Notes payable are regularly used instead of muzic-ivan.info payable because they offer the lender created documentation of the responsibility in case legal remedies are required to collect the debt. normally call for the borrower to pay interest and also frequently are issued to accomplish momentary financing demands. are issued for varying durations of time Notes due for payment within one year of the balance sheet date are primarily classified as present liabilities.

A discussion of accounting for long-term installment notes payable is presented in Appendix 10C at the end of the chapter.

Study Objective 3 - Exsimple the Accounting for Other Current Liabilities


Sales taxes payable - Sales taxes are expressed as a portion of the sales price. The seller collects the sales taxes from the customer as soon as the sale occurs and also remits the tax built up to the state"s department of revenue periodically (usually monthly). Many claims call for that the sales taxation built up be rung up independently on the cash register. (Gasoline sales are a major exemption.) When sales taxes are not rung up individually on the cash register, full receipts are split by 100% plus the sales taxes portion to determine sales.
Payroll and payroll taxes payable - Eincredibly employer incurs liabilities relating to employees" salaries and wperiods. One is the amount of wperiods and salaries owed to employees—weras and salaries payable. Anvarious other is the withholding taxes—federal and state revenue and also FICA, required by legislation to be withheld from employees" gross pay. Until the withholding taxes are remitted to the government taxing authorities, they are lugged as present liabilities. Employers additionally incur a second form of payroll-related liability. With eexceptionally payroll, the employer incurs miscellaneous payroll taxes levied upon the employer. These payroll taxes incorporate the employer’s share of Social Security (FICA) taxes and also state and federal unemployment taxes.
If you occupational 40 hours a week, making $10 per hour, is your take house pay for the week $400? Why not? If the employer pays you $10 an hour for the 40 hours or $400 is this all of the expense the employer has actually family member to the student’s job-related week? Why not? Unearned profits – Companies such as magazine publishers and airlines typically receive cash before goods are delivered or solutions are rendered. The providers account for these unearned revenues as follows: When the breakthrough is got, both Cash and a current licapability account identifying the source of the unearned revenue are increased. When the revenue is earned, the unearned revenue account is decreased (debited) and also an earned revenue account is increased (credited).
Current maturities of long-term debt - The existing percentage of a long-term debt have to be included in current liabilities. Current maturities of irreversible debt are frequently figured out in the current liabilities portion of the balance sheet as long-term debt due within one year. It is not crucial to prepare an ad justing entry to identify the current maturity of long-term debt.

Study Objective 4 - Identify the Types of Bonds

Long-term liabilities are obligations that are supposed to be phelp after one year and are frequently in the develop of bonds or long-term notes.
Bonds are a type of interest-bearing notes payable issued by corporations, universities, and governmental agencies. Bonds, like prevalent stock, are marketed in tiny denomicountries (usually $1,000 or multiples of $1,000). Secured bonds have actually particular assets of the issuer pledged as collateral for the bonds. Unsecured bonds are issued versus the general credit of the borrower. Convertible bonds deserve to be converted into common stock at the bondholder’s alternative. The convariation frequently gives bondholders an chance to benefit if the industry price of the widespread stock increases dramatically. For the issuer, the bonds sell at a greater price and pay a lower rate of interest than similar debt securities that perform not have a convariation option. Callable bonds are sub ject to retirement at a proclaimed dollar amount before maturity at the choice of the issuer.

Bondholders are creditors whereas stockholders are owners of a corporation.

Issuing procedures: A bond certificate is issued to the investor to provide evidence of the investor’s case versus the firm. The confront value is the amount of major due at the maturity date. The maturity date is the date that the last payment is because of the bond holder from the agency.
The contractual interemainder rate, often referred to as the declared rate, is the rate offered to determine the amount of cash interemainder the borrower pays and also the bond holder receives. The contractual interemainder rate is mainly proclaimed as an yearly rate and also interemainder is typically passist semiyearly.
Determining the Market Value of Bonds The term time value of money is offered to suggest the relationship between time an money – that a dollar received now is worth more than a dollar promised at some time in the future. If someone is going to give you $1 million 20 years from currently, you would want to discover its indistinguishable today or its existing value. The existing market worth (current value) of a bond is a duty of 3 factors: The dollar quantities to be obtained in the future. Length of time till the amounts are received. The sector price of interemainder. The market interest rate is the rate investors demand for loaning funds to the corporation. The procedure of finding the present worth is referred to as discounting the future quantities. Study Objective 5 – Prepare the Entries for the Issuance of Bonds and also Interemainder Expense
A corporation records bond transactions when it problems or retires (buys back) bonds, and also when bondholders transform bonds right into prevalent stock. If a bondholder sells a bond to another investor, the issuing firm receives no even more money on the transaction, nor is the transactivity journalized by the issuing corporation. Accounting for Bond worries - Bonds may be issued at challenge worth, below challenge value (discount), or over confront worth (premium). Bond prices, for both new concerns and existing bonds, are quoted as a percent of the face value of the bond. Therefore, a $1,000 bond via a quoted price of 97 sells at a price of ($1,000 X 97%) $970. Issuing Bonds at Face Value—To show, assume that Devor Corporation issued 100, 5-year, 10%, $1,000 bonds dated January 1, 2007, at 100 (100% of face value). Assume interemainder is payable annually on January 1. The enattempt to record the sale is:

Jan. 1 ............Cash ............100,000 .............................Bonds Payable............. 100,000 (To record sale of bonds at face value)

The bonds are reported in the irreversible licapability section of the balance sheet because the maturity day is more than one year amethod. The ad justing enattempt to record the accrued interemainder on December 31 is:

Dec. 3l ........Bond Interest Expense..... 10,000 .................................Bond Interemainder Payable........... 10,000 (To accrue bond interest)

Bond interemainder payable is classified as a existing liability bereason it is scheduled for payment within the following year.

The enattempt to document the payment on January 1:

Jan. 1 ............Bond Interemainder Payable........ 10,000 ................................Cash ..........................................10,000 (To document payment of bond interest)

Discount or Premium on Bonds The contractual or proclaimed interemainder rate is the rate used to the face (par) to arrive at the amount of interest phelp in a year. The sector (effective) interemainder rate is the rate investors demand also for loaning funds to the corporation. Bonds offer at confront or par value just when the contractual (stated) interest price and also the industry interest price are the exact same. However before, the industry rates change everyday. When the contractual and also industry interest rates differ, bonds offer listed below or above challenge worth. Issuing Bonds at a Discount If the contractual interemainder rate is much less than the market rate, bonds offer at a discount or at a price less than 100% of face worth. Although Discount on Bonds Payable has a delittle balance, it is not an asset; it is a contra account, which is deducted from bonds payable on the balance sheet. To show bonds offered at a discount, assume that on January 1, 2007, Candlestick, Inc., sells $100,000, 5-year, 10% bonds at 98 (98% of face value) via interest payable on January 1. The entry to record the issuance is: Jan. 1 .............Cash ......................................98,000 .......................Discount on Bonds Payable..... 2,000 ...........................................Bonds Payable ....................100,000 (To document sale of bonds at a discount) The $98,000 represents the transporting amount of the bonds. The issuance of bonds listed below face value reasons the total cost of borrowing to differ from the bond interest paid. The distinction in between the issuance price and also the face worth of the bonds—the discount—represents an additional cost of borrowing and also have to be recorded as bond interest expense over the life of the bond. The total expense of borrowing $98,000 for Candlestick, Inc. is $52,000 computed as follows:

Annual interest payments

($100,000 x 10% = $10,000; $10,000 x 5)..... = $50,000 Add: Bond discount ($100,000 - $98,000) .....= ....2,000 Total price of borrowing ....................................$52,000

To follow the matching principle, bond discount is allocated to expense in each period in which the bonds are exceptional. This is referred to as amortizing the discount. Amortization of the discount increases the amount of interest expense reported each duration. As the discount is amortized, its balance will certainly decrease and also as a repercussion, the transferring value of the bonds will certainly boost, till at maturity the transporting value of the bonds equals their face amount. Issuing Bonds at a Premium If the contractual interemainder rate is higher than the market price, bonds market at a premium or at a price greater than 100% of face value. To illustrate bonds sold at a premium, assume the Candlestick, Inc. bonds explained prior to are sold at 102 (102% of challenge value) fairly than 98. The entry to record the sale is:

Jan 1 .........Cash ....................102,000 .................................Bonds Payable ....................100,000 .................................Premium on Bonds Payable .....2,000 (To document sale of bonds at a premium)

The premium on bonds payable is added to bonds payable on the balance sheet, as presented below: ....................Long-term liabilities ................... Bonds payable ..................................$100,000 Add: Premium on bonds payable................................ 2,000 ...............................................................................$102,000 The sale of bonds over face value reasons the total cost of borrowings to be much less than the bond interest paid because the borrower is not required to repay the bond premium at the maturity day of the bonds. Thus, the premium is considered to be a reduction in the price of borrowing that reduces bond interemainder price over the life of the bonds. A bond premium, prefer a bond discount, is alsituated to cost in each duration in which the bonds are impressive. This is described as amortizing the premium. Amortization of the premium decreases the amount of interemainder expense reported each duration. That is, the amount of interest expense reported in a period will certainly be much less than the contractual amount. As the premium is amortized, its balance will certainly decline and as a repercussion, the carrying value of the bonds will decrease, until at maturity the carrying value of the bonds equates to their confront amount. Bonds offered at a discount execute not necessary imply the bonds are inferior. Also, bonds that are offered at a premium perform not essential suggest the bonds are remarkable to the bonds that are marketed at a discount.

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Procedures for amortizing bond premium and discount are questioned in Appendix 10A and Appendix 10B at the finish of this chapter.

Study Objective 6 - Describe the Entries when Bonds are Redeemed

Bonds are reexhausted once they are purchased (redeemed) by the issuing corporation. Redeeming Bonds at Maturity Regardless of the problem price of bonds, the book worth of the bonds at maturity will equal their face value. Assuming that the interest for the last interemainder duration is phelp and also taped individually, the interest to document the redemption of the Candlestick bonds at maturity is:

Bonds Payable ........................100,000 .............. Cash.......................................... 100,000 (To document redemption of bonds at maturity)

¨ Redeeming Bonds before Maturity A agency might decide to retire bonds prior to maturity to reduce interemainder expense and also remove debt from its balance sheet. A agency have to retire debt beforehand only if it has sufficient cash resources. When bonds are reworn down prior to maturity, it is important to: (1) get rid of the transferring value of the bonds at the redemption date, (2) record the cash phelp, and also (3) recognize the acquire or loss on redemption. The carrying worth is the face worth of the bonds much less unamortized bond discount or plus unamortized bond premium at the redemption date. Assume at the end of the fourth period Candlestick, inc., having actually marketed its bonds at a premium, retires its bonds at 103 after paying the annual interemainder. The carrying worth of the bonds at the redemption date is $100,400. The enattempt to document the redemption of Candlestick"s bonds at the end of the fourth interest period (January 1, 2011) is:

Jan. 1 Bonds Payable.................100,000 Premium on Bonds Payable............. 400 Loss on Bond Redemption............ 2,600 .............Cash .................................................103,000 (To record redemption of bonds at 103)

The loss of $2,600 is the difference in between the cash passist of $103,000 and also the delivering worth, $100,400.

Study Ob jective 7 - Identify the Requirements for the Financial Statement Presentation and Analysis of Liabilities

Balance Sheet Presentation Current liabilities are the initially category under Liabilities on the balance sheet. Each of the major forms of current liabilities is listed individually within the category. Within the existing liabilities section, service providers normally list notes payable first, followed by muzic-ivan.info payable. Other items then follow in the order of their magnitude. The current maturities of long-term debt need to be reported as current liabilities if they are to be phelp from present assets. Long-term liabilities are reported in a separate section of the balance sheet immediately adhering to “Current Liabilities.” Disclocertain of debts is incredibly necessary. Summary information regarding debts might be presented in the balance sheet through detailed information (such as interemainder prices, maturity days, convariation privileges, and also assets pledged as collateral) presented in a sustaining schedule in the notes. Statement of Cash Flows Presentation Information concerning cash inflows and outflows that resulted from the major portion of debt transactions is gave in the “Financing activities” section of the statement of cash flows. Interest cost is reported in the “Operating activities” section, even though it resulted from debt transactions. Analysis Careful examination of debt responsibilities helps assess a company’s capability to pay its existing responsibilities. It also helps to recognize whether a company can attain long-term financing in order to thrive. Liquidity ratios measure the temporary capacity of a agency to pay its maturing duties and to meet unintended requirements for cash. A generally provided meacertain of liquidity is the current ratio (presented in Chapter 2), calculated as existing assets divided by existing liabilities. In current years many type of companies have intentionally reduced their liquid assets (such as cash, muzic-ivan.info receivable, and also inventory) bereason they price also much to hold. Companies that save fewer liquid assets on hand must depend on various other resources of liquidity. One such source is a financial institution line of credit—a prearranged agreement in between a agency and also a lender that permits the firm to borrow approximately an agreed-upon amount. Solvency ratios measure the capacity of a company to survive over a long period of time.