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Liabilities
• Current liabilities: due in one year or less– Types– Ratios
• Long-term liabilities: due in more than one year– Bonds– Capital leases versus operating leases
• Contingent liabilities: possible future liabilities
Current Liabilities
• Interest payable• Unearned revenue• Sales tax payable• Payroll taxes payable
Interest PayableAdjusting entry: accrued interest ($100 x 12% x 3/12)
Interest Expense 3
Interest Payable 3
N/P paid:
N/P 100
Interest Expense 9
Interest Payable 3
Cash 112
Interest payable is a
current liability
Unearned RevenueWhen cash is received:
Cash 100
Unearned Revenue 100
When revenue earned:
Unearned Revenue 100
Revenue 100
Unearned
Revenue is a
current liability
Sales Tax PayableSale: Coles County 6.25%
Cash 106.25
Sales (Revenue) 100
Sales Tax Payable 6.25
When sales tax paid to gov:
Sales Tax Payable 6.25
Cash 6.25
Sales tax not an expense for retailer
Why generally no sales tax on Internet purchases ???
Sales Tax payable is a
current liability
Payroll Taxes Payable$400 Employee Wages
Wage expense 400.00
Federal income tax payable (W-4 exemptions, refund?)
46.00
State income tax payable (IL 3%; others 0 – 10%) 12.00
City income tax payable (generally larger cities, none in IL)
4.00
Social security tax payable (employee, 6.25% of $87,000)
25.00
Employee Medicare tax payable (employee, 1.45% of all)
5.80
Pension contribution payable (retire before 80, put max in)
24.00
Health insurance payable (generally dependents) 40.00
Cash (not much….) 243.20
Social Security and Medicare Issues
• Depletion of social security funds– Social security payments
• 2 for 1– Live too long after retirement– Vote often
– Social security contributions• Not enough Gen X, Y, Z, etc.• Company matches your Social Security and Medicare
contributions– Self-employed and independent contractors
• Medicare funds– Health insurance for those collecting social
security
CURRENT LIABILITY RATIOSShort-Term Creditors
RATIOS
CURRENT QUICK (ACID-TEST) WORKING CAPITAL
CA / CL CA – INV / CL CA - CL
> 2?? > 1??? > 0???
Long-term liabilities
• Bonds• Capital leases
BOND BASICS
IBM
$1,000 LOAN
Interest each year at coupon rate$1,000 at maturity
Bond Values• Lend IBM $1,000 for 30 years @ 8%, two years
later rates on similar bonds decrease to 6%– Still receiving $80 per year for 28 more years
• PV of Annuity, 28 years, 6%– $80 x 13.4062 =$1,072.50
– Receiving $1,000 in 28 years• PV of $1, 28 years, 6%
– $1,000 x .1956 = $195.60
– Value of bond = PV of Int Annuity + PV of $1,000• $1,072.50 + $195.60 = $1,268.10
– 26.8% increase in bond value– If coupon rate > required rate of return, value of
bond will be > $1,000
Bond Values
• Discount bond cash flows at required rate of return (yield to maturity)– Don’t use coupon rate– If you do, you’ll find value is $1,000
• Interest rates increase, bond values decrease• Interest rates decrease, bond values increase• Bonds are priced at a percent of par value
– 104, 98, etc.
Bonds
• Advantages– Interest on bonds deducted as an expense
on tax return• Dividends on common stock: not an expense
– No dilution of stockholders’ interest
• Disadvantages– Failure to pay debt can result in bankruptcy– Dividends discretionary; interest is not
Bond Journal EntriesWhen bonds are issued:
Cash 1000
Bonds Payable 1000
When interest is paid:
Interest expense 40
Cash 40
($1000 x 8% x 6/12)
Leasing long-term assets
• Advantages of operating leases– No concern about residual value– Generally smaller down payment– Can deduct rent on tax return– Keeps liability off balance sheet
• However, should disclose lease commitments in footnotes
Leasing long-term assets
• Capital leases– Lease property for most of its useful life– Can purchase the property for nominal
amount at end of lease– Lease payments represent financing– Treat as an asset and long-term liability
Contingent liability
• Possible future liability– Either
• Amount of liability can not be reasonably determined
• Or not sure if liability exists
– Lawsuits, environmental issues, etc.– Generally disclose in footnotes