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7/30/2019 ACCT5001 Week 10 Sem 1 2010 Completed for Students
1/6
ACCT5001 Semester 1, 2010Week 10
Reporting and Analysing Liabilities
Developed by Dr Anne AbrahamAdapted by Ron Day
2009 John Wiley & Sons Australia, Ltd
2
0verview Week 10
Text: Chapter 9 LO 1 -4, pp. 498 - 515; LO 10, pp. 523 -527.
Demo Questions: BE9.2, E9.2, PSA9.5,Add iti onal Demon str atio n Ques tio nSelf-Study Questions: Q3, Q8, Q9,; E9.3; E9.5; PSA9.1; PSA9.2; PSA9.4, 5; * BSB9.5
NB. Additional Self Study Questions on Debenture (Bond) Issues
Explain the difference between current and non-current liabilities.
Identify types of current liabilities and explain how to account for them.
Identify types of non-current liabilities, such as debentures and
unsecured notes, and explain how to account for them
Calculate the issue price, and record the debentures (bonds) issues
at: a) par, b) at a discount, c) at a a premium
Calculate and record the relevant interest expense and payment
entries required under the effective interest method
Prepare journal entries forloans payable by instalment and distinguish
between current and non-current components of long term debt.
2
3
CURRENT LIABILITIES
Current liabilities
Def: are obligations that can reasonably be expected to be paid
within one yearor within the operating cycle, whichever is the longer
Eg. - accounts payable, (Chp 2 & 5)
- accrued liabilities and revenue received in advance (Chp 3 & 4)
- other payables (e.g. payroll deductions payable etc.),
- notes payable (due < 1 year )
- Short term provisions (due < 1 year)
Liabilities that dont meet this definition are non-current liabilities
- Eg - Loans payable and Mortgages (loans secured by property)
- Unsecured notes and Debentures (Bonds)
- Long-term provisions (due > 1 year)
- Finance leases
4
Other Payables
Other Payables amounts owing to other than suppliers of inventory
E.g. Wages and other payroll deductions payable
Employers deduct amounts from employees wages and salaries if they
are required to be paid to other parties:
See E9.2
Mar 31 Dr Wages Expense 70 000
Cr ABC Health Fund payable 4 500
Cr Pay-as-you-go withheld tax payable 7 500Cr Superannuation fund payable 2 200
Cr Union Fees payable 500
Cr Wages payable 55 300
(To record payroll and other payables withheld on March 31)
5
Notes Payable
Notes Payable
Formal contract to record obligations in the form of a legal document
- Usually require borrower to pay interest or borrowing costs as well
- Frequently issued to meet short-term financing needs
- Issued for varying medium periods of time (say 3 mths, 6 mths or 1 year)
Eg. BE 9.2
Borrowed $60 000 from XXX Bank 0n July 1 by issuing a one year 10%note (interest payable on settlement at maturity date)
Journal entry when note issued
July 1 DrCash 60 000
CrNotes Payable 60 000
(To record issue of 10%, one year note payable to XXX Bank)
6
Notes Payable (Continued)
Journal entry to record accrued interest at balance-day December 31
Dec 31 Dr Interest expense 3 000
Cr Interest payable 3 000
(Entry to record accrual of interest owing to XXX Bank at end of
period 10% x $60,000 x 6/12)
Journal entry to settle the liability
June 1 Dr Notes payable 60 000
Dr Interest expense 3 000
Dr Interest payable 3 000
Cr Cash 66 000
(To record payment of note and interest to XXX Bank at maturity)
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NON-CURRENT LIABILITIES
are obligations where the future sacrifice of economic benefits is not expected
to be paid until after 1 year Referred to as debt financing/borrowing from single or multiple lenders
Common forms ofsingle lender borrowing are:- Bank loans- Long-term notes payable
Common forms ofmultiple lender borrowing direct from the public
- Unsecured notes no security over assets (therefore higher ri sk and interest)
- Debentures (Bonds)
subject to a secured charge on the issuers assets
Why would a company raise money direct from the publicfrom multiple lenders?
8
Why issue long-term debt?
Advantages of Debt Financing
Shareholder control is not affected Why? Debt is often cheaperWhy?
Financial leverage can benefit shareholders by increasing EPS How?
Disadvantage of Debt Financing
Increases financial risk How?
- Debt creates contractual obligations that must be paid in good or bad times
- Interest must be paid periodically (unlike dividends that can be varied) and the
- Principal must be paid at maturity (unlike shares that are not usually repaid)
9
Loans payable by Instalments
Instalment Loans
money is borrowed from a single lenderin the form ofrepayable loan
If the loan is secured by a charge over property it is called a mortgage.
- if the borrower defaults the lender may sell the property to repay the loan
the total loan repayments - the amount originally borrowed = interest
Equal periodic loan instalments consist of part interest, part principal
- (i) interest expense (fixed percentage by principal balance)
- (ii) remainder of instalment is a reduction of the principal of the loan
Jan 31 Dr Interest Expense 1 062
Dr Mortgage Loan Payable 3 938
Cr Cash at Bank 5 000
(To record loan repayment for January)
10
Loans Payable by Instalments (Continued)
A mortgage schedule can be prepared to outline the amount of each
instalment to apportion between interest and principal reduction, which
provides the details for the journal entry for each mortgage payment
- See Example in Fig 9.6 p.512 for a $106 220 two year loan at 12% p.a
Note:
- Each instalment of cash is the same amount each time
- Interest expense (interest rate x balance of principal decreases over time asthe principal reduces
- Loan payable reduction (instalment - interest expense) increases over timeas the interest portion of the instalment decreases.
- The schedule (calculated on present value principles discussed later)continues these trends until the last instalment at end of loan pays the finalinterest and the remaining portion of the loan payable
Do PSA9.5 - Partial completion of schedule and entries for 1 yr loan at 24% pa
11
Presentation of long-term debtin the financial statements
In presenting long term debt in the Statement of Financial Position
- Reduction of principal within a one year from balance-date is classified as
a current liability, with the remainder as a non-current liability.
The mortgage schedule can be used to calculate the amount of principal
to be reduced in the next year (CL) , and the remainder then is a NCL.
- Refer to Fig. 9.6, p.512 and calculate the current and non-current portion of
mortgage payable as at reporting date of 31 March 2012
- NCL = Mortgage balance at 31/03/2013 (1 yr after balance date)
= $42 833
- CL = Mortgage bal at 31//3/2012 - Mortgage bal at 31/3/2013
= $94 288 - $42 833
= $51 455
- Fig 9.8, p.515 calculates this by summing the reduction in principal amounts for
next 12 months for the CL, and summing the remaining amounts for the NCL.
12
Present Value Concepts
Most long-term debts are required to be measured at present value,
but before proceeding, we need to understand time value of money.
Q. Would you rather receive $1 000 now or $1 000 in a years time?
- If now, you recognise that money received/paid in the future (FV) is worth less
than the same amount in present value (PV) dollars received/paid today. Why?
- The PV of $1 000 in a years time, is equivalent to the present amount you would
need to invest at the current interest rate, to give you $1,000 in a years time.
PV of $1 formula/tables provides a discount factor to convert FV to PV.
The PV of $1 000 in a years time, if interest rate is 10%
PV = FV / (1 + r) n = $1 000/(1 + 0.1)1 = $909.09
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Present Value of a Single Sum(PV of $1 Table)
Example 1:You have won a lottery, and must choose to receive
$90 000 in 3 years time (current interest rate = 10%), or $70 000 now
- To answer, you need to calculate the PV of the $90,000 in 3 yrs by discounting it
at the current int rate, so that you can compare the PVs on an equivalent basis
Present Value of a single sum of $1 table helps us to calculate this by
providing the relevant discount rate for each interest rate and period .
- Refer to the PV of $1 table and find the discount factor at 10% int for 3 periods
- Calculate the PV by multiply the FV by the discount factor
- Compare to the amounts in present value terms
PV [i=10%, n=3] of$90 000 0.751 (see Table 1) = $67 590
Amount to be received immediately 70 000 *Choose
Difference - 2 410
14
Present Value of an Annuity(PV of an annuity of $1)
Assume that you have also received an option to choose to receive
$70 000 now or $30 000 each year for 3 yrs (current int rate = 10%) To answer this, you could calculate the PV of $30 000 in each period by
discounting it at the current interest rate and period, then sum the amounts
Future amount PV factor of 10% PV
$30 000 (1 year away) 0.909 $ 27 270
$30 000 (2 years away) 0.826 24 780
$30 000 (3 years away) 0.751 22 530
2.486 $74 580
Alternatively, you can look up discount factors for a PV of an annuity $1
(Table 2 bottom half of PV tables page)
PV of an annuity of $30 000 per yr for 3yrs [i=10%, n=3]
= $30 000 x 2.487 (see Table 2) = $74 610 *Choose
Amount to be received immediately 70 000
Difference + 4 610
15
Measurement of long-term debt- Debentures (bonds)
Most long-term debt is measured at present value (PV) to report the
fair value of the long-term liability
The present value of a debenture (bond) consists of:
- (i) PV of the principal to be repaid on maturity
- (ii) PV of the annuity of periodic interest payments:
Calculation of present value is affected by the:
- cash amounts to be paid (face value + face or contract interest rate),
- time period over which the payments are made
- relevant market interest rates at the issue date
16
Measurement of long-term debtDebentures (Bonds)
Terminology
Debenture (Bond) Certificate provides details of the contract (name of
issuer, face value due on maturity, maturity date, face rate of interest)
Face Value (FV) is the principal amount due at maturity
Book Value (BV) is the carrying amount of the note/debenture/bond in the
companys ledger and statement of financial position
Face Rate (FR) is the coupon rate on the face of the note/debenture/bond
that determines the amount of interest paid to the holder each period
Market Rate (MR) - the rate ofinterest on similar securities at date of issue,
It is used in discounting the PV of the Principal and PV of interest annuity
when determining issue price, and used to calculate interest exp (FR x FV)
Issue Price- the amount paid by the borrower to the lender at time of issue.
It may be > or < the face value, if the MR differs from FR at time of issue
17
Calculation of Present Value
of Debentures (Bonds)Example 2
Illustrate the calculation of the issue price of 100 $1 000 10% Bonds with 5
years to maturity if the market rate of interest at issue date is 10%,
PV calculations where interest is paid semi-annually (twice a yr)
In this case: i) adjust the interest rate (i) to that rate per period
ii) adjust number of periods (n) to number of interest periods .
Example 3
Calculate issue price of a 10% semi annual 5 yr, $100 000 bond issued at par
(market rate of interest also is 10%), with interest paid semi annually
interest rate becomes 10/2 = 5% and No. of periods becomes 5 2 = 10
Refer to PV Tables [i = 10%, n = 5] PV factor Present Value
PV of a single sum of $100 000 x 0.621 (Table 1) $ 62 100
PV annuity of $ 10 000 x 3.791 (Table 2) $ 37 910
Present value (issue price) $ 100 000 rounded
18
Example 3- Solution
PV of principal (i = 5%, n = 10)
= $100 000 x 0.614 = $ 61 400
PV of interest payments (MR = 5% , n = 10)
= $5 000 x 7.722 = $ 36 110= $ 100 000 rounded
7/30/2019 ACCT5001 Week 10 Sem 1 2010 Completed for Students
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Discount and Premium on Debentures (Bonds)
BondFace Rate (FR)
Of interestrate 10%
Issued when:
8%
10%
12%
Premium
Face Value
Discount
Market Rates Issued at:
See interactive spreadsheet that illustrates the effects when market interest rate ofsimilar securities differs from the face rate at date of issue
20
Discount and Premium on Debentures (Bonds)
Where MR > FR the debentures (Bonds) will be issued at a discount
- Investors are compensated for a lower face rate of interest (FR) that theywill receive, compared to the market rate (MR) on similar investments.
- The discount result in an effective rate = the market rate at date of issue
- Present value calculations using the market rate will = the issue price
Where MR < FR the debentures (Bonds) will be issued at a premium
- Investors will pay more for a higher face rate of interest (FR) that they
will receive, compared to the market rate (MR) on similar investments.
- The premium results in an effective rate = the market rate at issue date
- Present value calculations using the market rate will = the issue price
21
Debentures (Bonds) issued at par
Refer to Additional Demonstration Question
Debentures (bonds) issued on 1/1/2020: Face value $500 000;
face rate of 8%, maturing in 10 years with semi annual interest paid.
(a) Debentures (Bonds) issued at par
(i) Calculate issue price if the market rate is also 8% at issue date
[I = 4%, n = 20]
PV of face value 500 000 x (.456) = 228 000
PV of interest 20 000 x (13.590) = 271 800500 000* (rounding)
(ii) Record the issue of the debentures:
1/1/2010 Dr Cash 500 000
Cr Debentures payable 500 000
(to record issue of debentures at par)
22
Debentures (Bonds) issued at par
(iii) Record interest at semi annual interest dates:
2010
30/06/10 Dr Interest expense 20 000
Cr Cash 20 000
31/12/10 Dr Interest expense 20 000
Cr Cash 20 000
(NB. Above entries would normally be recoded in cash payment journal)
(iv) Record the Balance Sheet presentation:
Non-current Liabilities:
Debentures Payable 500 000
23
Debentures (Bonds) issued at a Discount
Debentures (bonds) issued on 1/1/2010: Face value $500 000;
face rate of 8%, maturing in 10 yrs with semi annual interest paid
(b) Debentures (Bonds) issued at a discount
(i) Calculate the Issue price if the market rate =10% [I = 5% n = 20]:
PV of face value 500 000 x (.377) = 188 500
PV of interest 20 000 x (12.462) = 249 240
437 740
(ii) Record the J ournal entry at issue date:
1/1/10 Dr Cash 437 740
Cr Debentures payable 437 740
(to record issue of debentures at a discount)
24
Debentures (Bonds) issued at a Discount
(iii) Calculate and record the Semi-annual interest Yr 1
Date Interest expense
5% x BV
Interest paid
4% x FV
Increase in
Bond Payable
Book value
01/01/10 437 740
30/06/10 21 887 20 000 + 1,887 439 627
31/12/10 21 981 20 000 + 1,891 441 608
Journal entries to record interest expense and interest payments
30/06/10 Dr Interest expense (5% x 437 740) 21 887Cr Debenture Payable 1 887
Cr Cash (4% x 500 000) 20 000
31/12/10 Dr Interest expense (5% x 439 627) 21 981Cr Debenture Payable 1 981
Cr Cash (4% x 500 000) 20 000
(iv) Prepare an extract of the Balance Sheet (at end of year)
7/30/2019 ACCT5001 Week 10 Sem 1 2010 Completed for Students
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Debentures (Bonds) issued at a Premium
Debentures (bonds) issued on 1/1/2010: Face value $500 000;
face rate of 8%, maturing in 10 yrs with semi annual interest paid
(c) Debentures (Bonds) issued at a premium
(i) Calculate the Issue price if the market rate =6% [i = 3 n =2 0]:
PV of face value 500 000 x 0.544 = 277 000
PV of interest 20 000 x 14.877 = 297 540
574 540
(ii) Record the J ournal entry at issue date:
1/1/10 Dr Cash 574 540
Cr Debentures payable 574 540
(to record issue of debentures at a discount)
26
Debentures (Bonds) issued at a Premium
(iii) Calculate and record the Semi-annual interest Yr 1
Date Interest expense
3% x BV
Interest paid4% x FV
Increase inBond Payable
Book value
01/01/10 574 540
30/06/10 17 236 20 000 - 2 764 571 776
31/12/10 17 153 20 000 -2 847 568 929
Journal entries to record interest expense and interest payments
30/06/10 Dr Interest expense (3% x 574 540) 17 236
Dr Debenture Payable 2 764
Cr Cash (4% x 500,000) 20 000
31/12/10 Dr Interest expense (5% x 571 776) 17 153
Dr Debenture Payable 2 847
Cr Cash (4% x 500 000) 20 000
(iv) Prepare an extract of the Balance Sheet (at end of year)
27
Summary of calculation of effective interest
(1) Calculate debenture (bond) interest expense (BV x MR)
(2) Calculate debenture (bond) interest paid (FV x FR)
(3) Calculate the increase or decrease to debentures (Bonds) payable
by finding the difference between (1) and (2)
Bond int erest expense
Book value (carryingamt) at beg of period
(BV)
Marketrate(MR)
x
Bond interest paid
xFace Rateof interest
(FR)
Facevalue(FV)
28
28
Redeeming debentures (bonds)at maturity date
Redeeming at Maturity
Debentures (bonds) are redeemed at the end of their maturity date bybeing repurchased (repaid) by the issuing company
The Carrying amount of the notes will always equal their face value
- If issued at a discount, debentures payable was increased towards par each
interest period by the difference between interest expense and interest paid
- If issued at a premium debentures payable was decreased towards par each
interest period by the difference between interest expense and interest paid
Entry to record redemption at maturity
30/6/2030 Dr Debentures Payable 1 000 000Cr Cash 1 000 000
(To record redemption of debentures at maturity)
29
Redeeming debentures (bonds)
before maturity Redeeming before maturity
- A company may decide to redeem notes early
- to reduce interest cost or remove debt from its statement of financial position
To account for this, the company must
- eliminate carrying amount of debentures (bonds) at redemption date
- record cash paid
- recognise the difference as a gain or loss on redemption
Eg. Entry to record redemption before maturity at 103% of face value
Dr Debentures Payable 1 000 000
Dr Loss on Redemption of Debentures 30 000
Cr Cash 1 030 000
(To record redemption of debentures at 103)
30
Financial Statement Analysis
- Liquidity ratios
1. Liquidity Ratios
These measure the short-term ability of an entity to pay its maturing
obligations and to meet unexpected needs for cash.
3 useful measures:
(a) Working capital
= Current assets Current liabilities
Example:
($ in millions) 2008 2007
Tel stra $5513 $ 8123 = $2610 $5353 $ 9434 = $4081Corporation
More working capital indicates more current assets available to meetcurrent liabilities.
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Financial Statement AnalysisLiquidity ratios (continued)
(b) Current ratio
= Current assets
Current liabilities
Example:
($ in millions) 2008 2007
Telstra $5513 = 0.68:1 $5353 = 0.57:1Corporation $8123 $9434
A higher ratio indicates better liquidity.
32
Financial Statement AnalysisLiquidity ratios (continued)
(c) Quick ratio
= Cash + Marketable securities + Net receivables
Current liabilities
- Provides a measure of immediate short-term liquidity
Example:
($ in millions) 2008 2007
Telstra $899 + $3952 = 0.60:1 $823 + $3891 = 0.50:1Corporation $8123 $9434
A higher ratio indicates better liquidity.
33
Financial Statement AnalysisSolvency ratios
2. Solvency Ratios
These measure the ability of an entity to surviveover a long period of time
2 useful measures:
(a) Debt to total assets ratio = Total liabilitiesTotal assets
Example:
($ in millions) 2008 2007Telstra $25 676 = 0.68:1 $25 295 = 0.67:1Corporation $37 921 $37 875
The ratio indicates the extent to which the entitys assets are financed bycreditors.
34
Financial Statement AnalysisSolvency ratios (Continued)
(b) Times interest earned
= Profit before income tax + Interest expense
Interest expense
- Provides an indication of an entitys ability to meet interest paymentsas they become due
Example:
($ in millions) 2008 2007Tel st ra $5140 + $1158 = 5.4 t im es $4692 + $1144 = 5.1 t imes
Corporation $1158 $1144
A higher interest coverage is interpreted as indicatinga greater ability to meet interest payments.
35
Before next week
1. Do Week 10 Self-Study Questions.
2. Check solutions on Blackboard after doing the questions yourself.
3. You may want to complete reflective, self-evaluation and learningstrategies exercise.
4. Skim read ch apter 10; LO 1-9, pp.552-585 Start with Summary ofLearning objectives on pp. 587-588
5. Obtain a copy of Week 11 lecture material from Blackboard to b ringto class
Feedback from Mid semester Test available on blackboard this week
Part B of Assignment due Friday May 14 at 2pm