Copyright © 2016 by McGraw-Hill Education Chapter 10 Liabilities PowerPoint Author: Brandy Mackintosh, CA

Copyright © 2016 by McGraw-Hill Education

Chapter 10Liabilities

PowerPoint Author:Brandy Mackintosh, CA

10-2

Learning Objective 10-1

Explain the role of liabilities in financing a business.

10-3

The Role of Liabilities

Current liabilities are short-term obligations that will be paid with current assets within the company’s current operating cycle or within one year of the

balance sheet date, whichever is longer.

Buys goods and services

on credit

Obtains short-term

loans

Issues long-term

debt

Liabilities are created when a company:

10-4

The Role of LiabilitiesThe liability section of a recent General Mills balance sheet

10-5


Explain how to account for common types of current

liabilities.

10-6

Measuring Liabilities

Initial Amount of the Liability Cash Equivalent

Additional Liability Amounts Increase Liability

Payments Made Decrease Liability

10-7

Current Liabilities

Accounts Payable

Accrued LiabilitiesLiabilities that have been incurred but not yet paid.

Increases(Credited)

Decreases(Debited)

when a company receives goods or services on credit

when a company pays on its account

10-8

Accrued Payroll

Payroll Liabilities1. Payroll Deductions

2. Employer Payroll Taxes

Payroll DeductionsPayroll deductions are either required by law or voluntarily requested by employees and create a current liability for the company. Examples include:1. Income tax2. FICA tax3. Other deductions (charitable donations, union dues, etc.)

10-9

Accrued Payroll

Gross Pay

Payroll Deductions:

Federal Income Taxes

FICA Taxes

Other

Total Payroll Deductions

Net Pay

$ 60.90

45.90

10.00

$ 600.00

116.80

$ 483.20

10-10

Accrued PayrollAdam Palmer earned gross pay of $600 in the current payroll period.

General Mills withheld $60.90 in Federal income taxes, $45.90 for FICA, and $10 for United Way, resulting in net pay of $483.20. Let’s assume

that General Mills has 1,000 workers just like Adam.

1 Analyze

LiabilitiesAssets = Stockholders’ Equity+

Cash (-A) -$483,200 Withheld Income TaxPayable (+L) +$60,900FICA Payable(+L) +$45,900United Way Payable (+L) +$10,000

Salaries and Wages Expense(+E) -$600,000

2 Record

Salaries and Wages Expense Withheld Income Taxes Payable FICA Payable United Way Payable Cash

60,90045,90010,000

483,200

600,000

10-11

Accrued PayrollEmployer Payroll Taxes

Employers have other liabilities related to payroll.1. FICA tax (a “matching” contribution)2. Federal unemployment tax3. State unemployment tax

Assume General Mills was required to contribute $45,900 for FICA, and an additional $4,750 for federal and state unemployment tax.

1 Analyze


FICA Payable +45,900Unemployment TaxPayable +4,750

Payroll TaxExpense (+E) -50,650

2 Record

Payroll Tax Expense FICA Tax Payable Unemployment Tax Payable

45,9004,750

50,650

10-12

Accrued Income TaxesCorporations calculate taxable income by subtracting tax-allowed

expenses from revenues. This taxable income is then multiplied by a tax rate, which ranges for corporations from about 15 to 35 percent.

Let’s assume General Mills calculated taxable income to be $1,000,000, and is subject to a 35% tax rate, so income taxes owed are $350,000

($1,000,000 × 35%)

1 Analyze


Income TaxPayable (+L) +350,000

Income TaxExpense (+E, -SE) -350,000

2 Record

Income Tax Expense Income Tax Payable 350,000

350,000

10-13

Notes PayableFour key events occur with any note payable: 1. establishing the note, 2. accruing interest incurred but not paid, 3. recording interest paid, and 4. recording principal paid.

12

3

4

10-14

Notes Payable1. Establish the note on November 1, 2015.Assume that on November 1, 2015, General Mills borrowed $100,000 cash on a one-year note that required General Mills to pay 6 percent interest and

$100,000 principal, both on October 31, 2016.

1 Analyze


Cash +100,000 NotePayable +100,000

2 Record

Cash Note Payable 100,000

100,000

10-15

Notes Payable2. Accrue interest owed but not paid on December 31, 2012.

1 Analyze


InterestPayable +1,000

InterestExpense (+E) -1,000

2 Record

Interest Expense Interest Payable 1,000

1,000

10-16

Notes Payable3. Record interest paid on October 31, 2016.

2 Record

Interest ExpenseInterest Payable Cash 6,000

5,0001,000

1 Analyze


Cash -6,000 InterestPayable -1,000


10-17

Notes Payable4. Record principal paid of $100,000 on October 31, 2016.

1 Analyze


Cash -100,000 NotePayable -100,000

2 Record

Note Payable Cash 100,000

100,000

10-18

Additional Current Liabilities

Sales Tax Payable

Payments collected from customers at time of sale create a liability that is due to the state

government.

Unearned Revenue

Cash received in advance of providing services creates a liability of services due to the

customer.

10-19

Additional Current Liabilities

Best Buy sells a television for $1,000 cash plus 5 percent sales tax.

$1,000 × 5% = $50 sales tax collected

When Best Buy pays the sales tax to the state government, its accountants will reduce Sales Tax Payable (with a debit) and

reduce Cash (with a credit).

2 Record

Cash Sales Tax Payable Sales Revenue

501,000

1,050

1 AnalyzeLiabilitiesAssets = Stockholders’ Equity+

Cash +1,050 Sales TaxPayable +50

SalesRevenue (+R) +1,000

10-20

Additional Liabilities

On December 9th 2013, Live Nation Entertainment (the owner of Ticketmaster) received $8 million cash for advance ticket sales for

two Lady Gaga concerts to be held on May 12 and 15, 2014.


Cash +8 UnearnedRevenue +8

2 Record

Cash Unearned Revenue 8

8

10-21

Additional LiabilitiesWhen the May 12th concert is held, Live Nation Entertainment can

recognize one half of the unearned revenue as earned revenue, as they have fulfilled part of the liability.


UnearnedRevenue -4

ServiceRevenue (+R) +4

2 Record

Unearned Revenue Service Revenue 4

4

10-22

Current Portion of Long-Term Debt

Long-Term Debt

Current Portion of Long-term Debt

Noncurrent Portion of Long-term Debt

Borrowers must report in Current Liabilities the portion of long-term debt that is due to be paid within one year.

10-23


Analyze and record bond liability transactions.

10-24

Long-Term Liabilities

Bonds are financial instruments that outline the future payments a company promises to make

in exchange for receiving a sum of money now.

Common Long-Term Liabilities1.Long-term notes payable 2.Deferred income taxes3.Bonds payable

10-25

Bonds

Bond PricingThe bond price involves present value computations and is the amount

that investors are willing to pay on the issue date for the bonds.

Key Elements of a Bond1.Maturity date2.Face value3.Stated interest rate

1212$1,000 × 6% × = $60

Interest Computation

10-26

BondsBalance Sheet Reporting of Bond Liability

Relationships between Interest Rates and Bond Pricing

10-27

Bonds

General Mills receives $100,000 cash in exchange for issuing 100 bonds at their $1,000 face value, so the bonds are issued at

total face value (100 × $1,000 = $100,000).

Bonds Issued at Face Value


Cash +100,000 BondsPayable +100,000

2 Record

Cash Bonds Payable 100,000

100,000

10-28

Bonds

General Mills issues 100 of its $1,000 bonds at a price of 107.26 percent of face value, the company will receive

$107,260 (100 × $1,000 × 1.0726).

Bonds Issued at a Premium

2 Record

Cash Bonds Payable Premium on Bonds Payable

100,0007,260

107,260

1 Analyze


Cash +107,260 Bonds Payable +100,000Premium onBonds Payable +7,260

10-29

$100,000 - $93,376 = $6,624 discount

Bonds

General Mills receives $93,376 for bonds with a total face value of $100,000, the cash-equivalent amount is $93,376, which represents

the liability on that date. These bonds are issued at a discount because the cash received is less than the face value of the bonds.

Bonds Issued at a Discount

1 Analyze


Cash +93,376 Bonds Payable +100,000Discount onBonds Payable(+xL) -6,624

2 Record

CashDiscount on Bonds Payable (+xL) Bonds Payable 100,000

93,3766,624

10-30

Interest on Bonds Issued at Face Value

General Mills issues bonds on January 1, 2015, at their total face value of $100,000. The bonds have an annual stated interest rate of 6 percent payable in cash on December 31 of each year, General Mills will need to accrue an expense and liability for interest at the

end of each accounting period. The end of the first accounting period is January 31, 2015.

$100,000 × 6% × 1/12 = $500 interest

2 Record

Interest Expense Interest Payable 500

500

1 Analyze


Interest Payable +500 InterestExpense (+E) -500

10-31

Interest on Bonds Issued at a Premium

Cash proceeds > Face value

Cash proceeds – Face value = Premium

Interest expense < Cash interest paid

Interest expense = Cash interest paid – Premium amortization

10-32

Interest on Bonds Issued at a Discount

Cash proceeds < Face value

Face value – Cash proceeds = Discount

Interest expense > Cash interest paid

Interest expense = Cash interest paid+ Discount amortization

10-33

Bond RetirementGeneral Mills’ bonds were retired with a payment

equal to their $100,000 face value. Let’s analyze and record this transaction.

1 Analyze


Cash -100,000 Bonds Payable -100,000

2 Record

Bonds Payable Cash 100,000

100,000

10-34

Assume that in 2005, General Mills issued $100,000 of bonds at face value. Ten years later, in 2015, the company retired the bonds early. At the time, the bond price was 102, so General Mills made a payment of $102,000.

Cash Payment $103,000Carrying Value 100,000Loss on Retirement $3,000

Bond RetirementThe early retirement of bonds has three financial effects. The company1. pays cash,2. eliminates the bond liability, and3. reports either a gain or a loss.

1 Analyze


Cash -102,000 Bonds Payable -100,000 Loss on BondRetirement(+E) -2,000

2 Record

Bonds PayableLoss on Bond Retirement Cash 102,000

100,0002,000

10-35


Describe how to account for contingent liabilities.

10-36

Contingent Liabilities

Contingent liabilities are potential liabilities that arise from past transactions or events, but their ultimate resolution depends

(is contingent) on a future event.

10-37


Calculate and interpret the debt-to-assets ratio and the times interest earned ratio.

10-38

Evaluate the ResultsTwo financial ratios are commonly used to assess a

company’s ability to generate resources to pay future amounts owed:

1. Debt-to-Assets Ratio2. Times Interest Earned Ratio

Debt-to-Assets Ratio = Total LiabilitiesTotal Assets

Times InterestEarned Ratio

=(Net Income + Interest Expense + Income Tax Expense)

Interest Expense

10-39

Evaluate the ResultsAt the end of a recent fiscal year, General Mills reported $14,560 million of

total liabilities and $22,660 million of total assets

$14,560$22,660

= 0.643

A debt-to-assets ratio of 0.643 implies that creditors have provided financing for nearly two-thirds of the

assets of General Mills

Debt-to-Assets Ratio = Total LiabilitiesTotal Assets

10-40

Evaluate the Results

In 2013, General Mills reported net income of $1,855 million and interest expense of $317 million, and income tax expense of $741 million. Let’s

calculate the times interest earned for 2013.

$1,855 + $317 + $741$317

= 9.19 times

The ratio means that General Mills generates $9.19 of income (before the costs of financing and taxes) for each dollar of interest expense. Reaching this level of interest coverage was important to General Mills because its long-term debt note reported that loan covenants required a minimum ratio of 2.5.

Times InterestEarned Ratio

=(Net Income + Interest Expense + Income Tax Expense)

Interest Expense


Chapter 10Supplement 10A

Straight-Line Method of Amortization

10-42

Learning Objective 10-S1

Use straight-line bond amortization.

10-43

Cash Interest $6,000Amortization of Premium (1,815)Interest Expense $4,185

Bond PremiumBond premium or discount decreases each year, until it is completely

eliminated on the bond’s maturity date. This process is called amortizing the bond premium or discount. The straight-line method of amortization

reduces the premium or discount by an equal amount each period.

Recall our example when General Mills received $107,260 on the issue date (January 1, 2015) but repays only $100,000 at maturity (December 31, 2018). Under the straight-line method, this $7,260 is spread evenly as a reduction in

interest expense over the four years ($7,260 ÷ 4 = $1,815 per year).

1 Analyze


Cash -6,000 Premium onBonds Payable -1,815


2 Record

Interest ExpensePremium on Bonds Payable Cash 6,000

4,1851,815

10-44

Bond PremiumAmortization Schedule of Bonds Issued at a Premium

$7,260 ÷ 4 = $1,815

$100,000 × 6% × 12/12 = $6,000

$6,000 - $1,815 = $4,185

$7,260 - $1,815 = $5,445

$107,260 – $1,815 = $105,445

Notice that each of these amounts would plot as a straight-line!

10-45

Cash Interest $6,000Amortization of Discount 1,656Interest Expense $7,656

Bond Discount

Recall our example where General Mills received $93,376 for four-year bonds with a total face value of $100,000, implying a discount of $6,624.

The annual amortization of the discount is $1,656 ($6,624 ÷ 4).

1 Analyze


Cash -6,000 Discount onBonds Payable(-xL) +1,656


2 Record

Interest Expense Discount on Bonds Payable (-xL) Cash

1,6566,000

7,656

10-46

Bond DiscountAmortization Schedule of Bonds Issued at a Discount

$6,624 ÷ 4 = $1,656

$100,000 × 6% × 12/12 = $6,000

$6,000 + $1,656 = $7,656

$6,624 - $1,656 = $4,968

$93,376 + $1,656 = $95,032


Chapter 10Supplement 10B

Effective-Interest Method of Amortization

10-48


Use effective-interest bond amortization.

10-49

Effective Interest AmortizationThe effective-interest method of amortization is considered a conceptually superior

method of accounting for bonds because it correctly calculates annual interest expense by multiplying the market interest rate times the carrying value of the bonds.

Interest (I) = Principal (P) × Rate (R) × Time (T)Interest Expense = Carrying Value × Market Rate × n/12

$4,290 = $107,260 × 4% × 12/12

When General Mills adds this $7,260 premium to the $100,000 face value, it reports a carrying value of $107,260 ($100,000 + $7,260) on January 1, 2015. The proceeds indicates that the market interest rate was 4 percent.

10-50


$4,290 = $107,260 × 4% × 12/12

Cash Interest $ 6,000Effective Interest 4,290Amortization of Premium $1,710

Effective Interest Amortization

General Mills issued 6% stated rate bonds for $107,260. The market rate of interest on these bonds is 4%. The face amount of the bonds, $100,000, results in cash interest is $6,000 ($100,000 × 6%). Let’s

amortize the premium on the bonds at the first interest payment date.

1 Analyze


Cash -6,000 Premium onBonds Payable -1,710


2 Record

Interest Expense Premium on Bonds Payable Cash 6,000

4,2901,710

10-51


$107,260 × 4% × 12/12 = $4,290

$100,000 × 6% × 12/12 = $6,000 $107,260 - $1,710 = $105,550

$6,000 - $4,290 = $1,710 $7,260 - $1,710 = $5,550

Interest Expense decreases and Premium Amortizationincreases each period. Cash interest is unchanged.

10-52



$7,470 = $93,376 × 8% × 12/12

General Mills issued $100,000 face value, 6%, 4-year bonds at a market price to yield investors 8%. The bonds were issued at a discount of $6,624. Let’s determine the effective interest for the first interest payment period.

Cash Interest $ 6,000Effective Interest 7,470Amortization of Discount $ 1,470

1 Analyze


Cash -6,000 Discount onBonds Payable(-xL) +1,470


2 Record

Interest Expense Discount on Bonds Payable (-xL) Cash

1,4706,000

7,470

10-53


$93,376 × 8% × 12/12 = $7,470

$100,000 × 6% × 12/12 = $6,000 $93,376 + $1,470 = $94,846

$7,470 - $6,000 = $1,470 $6,624 - $1,470 = $5,154

Both Interest Expense and Discount Amortizationincrease each period. Cash interest is unchanged.


Chapter 10Supplement 10C

Simplified Effective-Interest Amortization

10-55


Use simplified effective-interest bond amortization.

10-56

Accounting for Bond Issue

The shortcut method records the bonds at issuance at Bonds Payable, Net. That is face amount less discount or face amount plus premium.

The following journal entries demonstrate how the shortcut is applied tobonds issued at a premium, at face value, and at a discount.

10-57

Bond Premium

Interest (I) = Principal (P) × Rate (R) × Time (T)Interest Expense = Bonds Payable, Net × Market Rate × n/12

Interest Expense $4,290 = $107,260 × 4% × 12/12

1 Analyze


Cash -6,000 BondsPayable, Net -1,710


2 Record

Interest ExpenseBonds Payable, Net Cash 6,000

4,2901,710

10-58

Bond Discount

Interest (I) = Principal (P) × Rate (R) × Time (T)Interest Expense = Bonds Payable, Net × Market Rate × n/12

Interest Expense $7,470 = $93,376 × 8% × 12/12

1 Analyze


Cash -6,000 BondsPayable, Net -1,470


2 Record

Interest Expense Bonds Payable, Net Cash

1,4706,000

7,470


Chapter 10Solved Exercises

M10-5, E10-2, E10-3, E10-8, E10-10, PA10-3

10-60

As of December 31,

Current Liabilities:

Current Portion of Long-term Debt

Long-term Debt

Total Liabilities

2016

$ 3,000

10,000

$ 13,000

2015

$ 2,000

13,000

$ 15,000

M10-5 Reporting Current and Noncurrent Portions of Long-Term DebtAssume that on December 1, 2015, your company borrowed $15,000, a portion of which is to be repaid each year on November 30. Specifically, your company will make the following principal payments: 2016, $2,000; 2017, $3,000; 2018, $4,000; and 2019, $6,000. Show how this loan will be reported in the December 31, 2016 and 2015 balance sheets, assuming that principal payments will be made when required.

10-61

E10-2 Recording a Note Payable through Its Time to MaturityMany businesses borrow money during periods of increased business activity to finance inventory and accounts receivable. Target Corporation is one of America’s largest general merchandise retailers.Each Christmas, Target builds up its inventory to meet the needs of Christmas shoppers. A large portion of Christmas sales are on credit. As a result, Target often collects cash from the sales several months after Christmas. Assume that on November 1, 2015, Target borrowed $6 million cash from Metropolitan Bank and signed a promissory note that matures in six months. The interest rate was 8.0 percent payable at maturity. The accounting period ends December 31.Required:1. Give the journal entry to record the note on November 1, 2015.2. Give any adjusting entry required on December 31, 2015.3. Give the journal entry to record payment of the note and interest

on the maturity date, April 30, 2016, assuming that interest has not been recorded since December 31, 2015.

10-62

E10-2 Recording a Note Payable through Its Time to Maturity

November 1, 2015:

Borrowed on 6-month, 8.0%, note payable.

December 31, 2015 (end of the accounting period):

Adjusting entry for 2 months’ accrued interest ($6,000,000 x 8.0% x 2/12 = $80,000).

April 30, 2016 (maturity date):

Paid note plus interest at maturity.

Cash Note Payable (short-term) 6,000,000

6,000,000

Interest Expense Interest Payable 80,000

80,000

Note Payable (short-term)Interest Payable (per above)Interest Expense ($6,000,000 x 8.0% x 4/12) Cash 6,240,000

6,000,00080,000

160,000

10-63

E10-3 Recording Payroll Costs McLoyd Company completed the salary and wage payroll for March. The payroll provided the following details:

Required:1. Considering both employee and employer payroll taxes, use the

preceding information to calculate the total labor cost for the company.

2. Prepare the journal entry to record the payroll for March, including employee deductions (but excluding employer payroll taxes). Employees were paid in March but amounts withheld were not yet remitted.

3. Prepare the journal entry to record the employer’s FICA taxes and unemployment taxes.

10-64

The total labor cost was $431,380, made up of the $400,000 in gross salaries and wages plus the $28,600 for Employer FICA taxes and $2,780 for unemployment taxes.

Req. 1

Req. 2Salaries and Wages Expense 400,000 Withheld Income Taxes Payable 37,000 FICA Taxes Payable 28,600 Cash 334,400Payroll for March including employee deductions.

March 31Req. 3Payroll Tax Expense 31,380 FICA Taxes Payable 28,600 Unemployment Taxes Payable 2,780Employer payroll taxes on March payroll.

March 31

E10-3 Recording Payroll Costs with Discussion

10-65

E10-8 Preparing Journal Entries to Record Issuance of Bonds at Face Value, Payment of Interest, and Early RetirementOn January 1, Innovative Solutions, Inc., issued $200,000 in bonds at face value. The bonds have a stated interest rate of 6 percent. The bonds mature in 10 years and pay interest once per year on December 31.Required:1. Prepare the journal entry to record the bond issuance.2. Prepare the journal entry to record the interest payment on

December 31. Assume no interest has been accrued earlier in the year.

3. Assume the bonds were retired immediately after the first interest payment at a quoted price of 101. Prepare the journal entry to record the early retirement of the bonds.

10-66

Req. 1

Req. 2

Req. 3

Cash 200,000 Bonds Payable 200,000

Interest Expense 12,000 Cash 12,000

($200,000 x 6% x 12/12) = $12,000

Bonds Payable 200,000Loss on Bonds Retired 2,000 Cash 202,000

($200,000 x 101%) = $202,000

E10-8 Preparing Journal Entries to Record Issuance of Bonds at Face Value, Payment of Interest, and Early Retirement

Early retirement of the bonds.

Interest for one year on the bonds.

Initial bond issuance.

10-67

E10-10 Calculating and Interpreting the Debt-to-Assets Ratio and Times Interest Earned RatioAt April 30, 2013, H. J. Heinz reported the following amounts (in millions) in its financial statements:

Required:1. Compute the debt-to-assets ratio and times interest earned ratio (to two

decimal places) for 2013 and 2012.2. Use your answers to requirement 1 to determine whether, in 2013, (a)

creditors were providing a greater (or lesser) proportion of financing for Heinz’s assets and (b) Heinz was more (or less) successful at covering its interest costs, as compared to 2012.

10-68

Req. 1 and 2

E10-10 Calculating and Interpreting the Debt-to-Assets Ratio and Times Interest Earned Ratio

2013 = = 0.78

$10,060$12,940

2012 = = 0.76

$9,060$12,000

2013 = ($1,040 + $ 260 + $240) ÷ $260 = 5.92

2012 = ($960 + $ 260 + $ 245) ÷ $260 = 5.63

Debt-to-Assets = Total Liabilities Total Assets

10-69

PA10-3 Recording and Reporting Current LiabilitiesLakeview Company completed the following two transactions. The annual accounting period ends December 31.a. On December 31, calculated the payroll, which indicates gross earnings for wages

($80,000), payroll deductions for income tax ($8,000), payroll deductions for FICA ($6,000), payroll deductions for American Cancer Society ($3,000), employer contributions for FICA (matching), state and federal unemployment taxes ($600). Employees were paid in cash, but these payments and the corresponding payroll deductions and employer taxes have not yet been recorded.

b. Collected rent revenue of $6,000 on December 10, for office space that Lakeview rented to another business. The rent collected was for 30 days from December 11, to January 10, and was credited in full to Unearned Rent Revenue.

Required:1. Give the journal entries to record payroll on December 31.2. Give ( a ) the journal entry for the collection of rent on December 10, and ( b ) the

adjusting journal entry on December 31.3. Show how any liabilities related to these items should be reported on the company’s

balance sheet at December 31.

10-70

Req. 1

Req. 2

Salaries and Wage Expense 80,000 Withheld Income Tax Payable 8,000 FICA Payable 6,000 Charitable Contributions Payable 3,000 Cash 63,000

Payroll Tax Expense 6,600 FICA Payable 6,000 State and Federal Unemployment Tax Payable 600

(a) December 10:Cash 6,000 Unearned Revenue 6,000

Collection of rent revenue for one month.

(b) December 31:Unearned Revenue 4,000 Rent Revenue 4,000Earned 20 days of rent and initially recorded all as unearned. Need to reduce unearned revenue for the 20 days and record it as earned revenue (20/30 x $6,000 = $4,000).

PA10-3 Recording and Reporting Current Liabilities

Payroll for December including employee deductions.

Employer payroll taxes on December payroll.

10-71

Req. 3 Balance sheet at December 31:Current Liabilities: Withheld Income Taxes Payable 8,000 FICA Payable 12,000 Charitable Contributions Payable 3,000 State and Federal Unemployment Tax Payable 600 Unearned Revenue 2,000

PA10-3 Recording and Reporting Current Liabilities

10-72

End of Chapter 10

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Copyright © 2016 by McGraw-Hill Education Chapter 10 Liabilities PowerPoint Author: Brandy Mackintosh, CA