CHAPTER 10

REPORTING AND ANALYZING LIABILITIES

Current liability is a liability that is due to be paid within the year or the operating cycle.

Known liabilities

Accounts payable Short-term notes payable Sales tax payable Payroll and payroll taxes Unearned revenues Current portion of long-term debt

Notes payable

Borrow cash Issued to settle an Accounts Payable Interest bearing Accrued interest Payable within a year

JOURNAL ENTRIES

1

NOTES PAYABLE

On December 1, Thomas Company borrowed $100,000 issuing a 4 month 12% note.

December 1 issue date

CASH 100,000NOTES PAYABLE 100,000

December 31 adjusting entry

INTEREST EXPENSE 1,000INTEREST PAYABLE 1,000

April 1 payment date

NOTES PAYABLE 100,000INTEREST PAYABLE 1,000INTEREST EXPENSE 3,000

CASH 104,000

SALES TAX PAYABLE

2

Who pays the sales tax?

Who collects the Sales tax?

Who receives the Sales tax?

A big screen TV was purchased from Paul’s with a ticket price of $4000. The Sales Tax is 8%.Why Paul’s?

Record the sale for Paul’s

CASH 4,320SALES 4,000SALES TAX PAYABLE 320

3

UNEARNED REVENUE

Money magazine received $500,000 in subscriptions during the year. What is the adjusting entry on Dec.31 if Money had earned 20% of the subscriptions?

Record the receipt of the cash as a credit to unearned subscription revenue.

CASH 500,000unearned subscription revenue 500,000

Record the adjusting entry on December 31

unearned subscription revenue 100,000SUBSCRIPTION REVENUE 100,000

4

PAYROLL

When first hired what was the form you completed regarding taxes?

What information did you provide your new employer with when you completed the form

Required deductions:

Federal and state income tax

Fica taxes

Social security

Medicare

SDI state disability insurance

Other deductions:

Medical insurance Garnishments

Charities

401k

5

Union dues

PAYROLL TAXES OF THE EMPLOYER The tax levied on the employer is based on the employee earnings

Fica a matching tax

State unemployment tax

Federal unemployment tax

6

COMPUTATION OF:PAYROLLJOURNAL ENTRY TO RECORD PAYROLLTHE ENTRY TO RECORD THE EMPLOYER'S LIABILITY.

ONE EMPLOYEE COSMO KRAMER

Hourly rate $12Hours worked 48overtime rate 1,5 over 40 hoursCumulative earnings to this payroll $7,000

REQUIRED DEDUCTIONS

Federal tax withheld $120Fica TaxesSocial security and Medicare 7.65% of earnings up to $106,800

OTHER DECUCTIONS

medical insurance $20401 k contribution $100

7

PAYROLL TAXES OF THE EMPLOYER

FICA taxStatement unemployment tax 2.50% of $8,000 of employee earnings.Federal unemployment tax .8% of $8,000 of employee earnings

The journal entry to record payroll:

WAGES EXPENSE 624FEDERAL INCOME TAX PAY. 120FICA TAX PAYABLE 48MEDICAL INSURANCE PAY. 20401 CONTRIBUTION PAY 100WAGES PAYABLE 336

The journal entry to pay employee

WAGES PAYABLE 336CASH 336

The journal entry to record the employer liability

PAYROLL TAXES EXPENSE 68.60FICA TAX PAYABLE 48STATE UNEMPLOY. TAX PAY 15.60FEDERAL UNEMPLY. TAX PAY 5

8

BONDS

Bonds are groups of notes payable issued to lenders (bondholders)

Steps to issue bonds

Board of directors approve the issue Amount Maturity date Interest Special features

Prepare a prospectus for the SEC

Value of the issues will continue to fluctuate possibly up to the day before the issue is sold

Sale of issue to underwriters

Factors that affect the issue price of the bonds and later the market value of the bonds

Bond maturity Financial condition of the company Interest Alternative investments

9

TermsPrincipal/par value/maturity value/face value

Prices

Face value $1,000QuotesBase on a percentage

$1,000 par

98 ¼discount

104 3/8premium

10

Two interest rates work to set the price of a bond

Contract (stated) rate Determines the amount of cash interest the

borrower pays It is a set amount paid over the life of the bond Normally paid every six months

Market (effective) rate /yield rate The return investors demand for lending their

money The market rate changes daily It depends on various factors

You paid $1,000 for a 10 year bond with a contract rate of interest of 8%.

If investors are currently getting 10% for their money, how does your return of 8% look?

If you wanted to sell the bond would you be able to get $1,000?

11

ISSUING BONDS

Bonds issued at face value

Ford issued $2,000,000 of 10 year 8% bonds with interest to be paid semi-annually

How much did Ford Receive? $2,000.000How much cash must Ford pay in interest every 6 months? $80,000How much will ford pay at maturity?

$2,000,000Journal entry to record the issue

Cash 2,000,000Bonds payable 2,000,000

Journal entry to record the semi-annual interest payment

Interest expense 80,000Cash 80,000

12

BONDS ISSUED AT DISCOUNT

On January 1 Ford issue 10 year $200,000 bonds at 98 paying interest at 10% compounded semiannually.

How much cash did Ford receive?

200,000 X 98% = 196,000

What caused Ford to sell the bond issue at discount?

How much cash will Ford pay at maturity?

MARKET RATE IS GREATER

The discount represents and additional cost of borrowing for Ford. This additional interest will not be paid until the bonds mature in 10 years.

Amortizing the discount

Since the discount represents interest its cost must be spread over the interest payment schedule of 20 pay periods.

13

Journal entry to record the issuance

Cash 196,000Discount on bonds payable 4,000

Bonds 200,000

Computing the interest payment of a discounted bond using the straight line method

CASH + AMORTIZED DISCOUNT = INTEREST EXPENSE

10,000 + ( 4000/20=800) =10,800 Journal entry to record the first interest payment

Interest expense 10,800Discount on bonds payable 800Cash 10,000

BALANCE SHEETBefore after

Bonds payable 200,000 200,000Disc. on bonds pay. 4,000 3,200Carrying value/ book value 196,000 196,800

14

BONDS ISSUED AT PREMIUM

Why at a premium?

How much will Ford pay the bondholders at maturity?

The premium represents an additional savings to Ford

The premium reduces the interest expense.

Like the discount the premium will be spread over the life of the bond but unlike the discount it will reduce the interest expense.

On January 1 Ford issue 10 year $200,000 bonds at 105 paying interest at 10% compounded semiannually.

15

Journal entry to record the issuance

Cash 210,000Premium on bonds payable 10,000Bonds payable 200,000

Journal entry to record the first interest paymentUsing straight line to compute the interest

CASH - AMORTIZE PREMIUM = INTEREST EXPENSE

10,000 - (10,000/20 = 500) = 9,500

Interest expense 9,500Premium on bonds payable 500

Cash 10,000

Balance sheet before

afterBonds payable 200,000 200,000Prem.on bonds pay. +10,000 -9,500Carrying value/ book value 210,000 209,500

16

The effective-interest method of amortizing a discount or a premium.

It follows the matching principle preferred by gaap Interest is a constant % of the carrying value More difficult to compute

FINANCIAL STATEMENTS

Balance sheet

Current liabilitiesListed large to small

Current portion of long term debt

Liquidity ratios

Current ratio

Solvency ratios

Debt ratio

Times interest earned ratio

17

LEASINGOff-balance sheet financingLiabilities not reported on the balance sheet

CAPITAL LEASES

Booked as a operating lease

CONTINGENCIES possible liabilitiesAn event that may or may not occur

Probable- future event likely to occurReasonably possible- more remote less likely to occurRemote- slight chance

DEBT VERSUS EQUITY FINANCINGStocks

Stockholders are owners Dividends are optional Dividends are not an expense; not tax deductible Stockholders do not have a fixed return; nor a

maturity date

Debt (bonds) Bondholders are creditors Interest is required Interest is an expense; tax deductible Company must pay interest over the life of the

bond plus the maturity value at maturity.

18