© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin
10-1
Chapter no 10 : liabilities
Chapter no 10 : liabilities
Shah Muhammad
Sarfraz Ahmed Ghumro
Wasiq Burhan
Satia Pal Kumar
© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin
10-2
I.O.U.
Defined as debts or obligations arising from past transactions or
events.
Defined as debts or obligations arising from past transactions or
events.
Maturity = 1 year or less Maturity > 1 year
Current Liabilities
Noncurrent Liabilities
The Nature of LiabilitiesThe Nature of Liabilities
© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin
10-3
The acquisition of assets is financedfrom two sources:
Funds from creditors, with a definite due date, and
sometimes bearing interest.
Funds from owners
DEBTDEBT EQUITYEQUITY
Distinction BetweenDebt and Equity
Distinction BetweenDebt and Equity
© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin
10-4
Devon Mfg. borrows $100,000 from First Bank. The loan will be repaid in 20 years
and has an annual interest rate of 8%.
Is this a current liability or a noncurrent liability?
Devon Mfg. borrows $100,000 from First Bank. The loan will be repaid in 20 years
and has an annual interest rate of 8%.
Is this a current liability or a noncurrent liability?
Liabilities – QuestionLiabilities – Question
The obligation will not be paid within one year or one operating
cycle, so it is a noncurrent liability.
The obligation will not be paid within one year or one operating
cycle, so it is a noncurrent liability.
© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin
10-5
Current RatioCurrent Ratio = Current Assets = Current Assets ÷ Current Liabilities÷ Current LiabilitiesCurrent RatioCurrent Ratio = Current Assets = Current Assets ÷ Current Liabilities÷ Current Liabilities
Working Capital Working Capital = Current Assets= Current Assets - Current Liabilities- Current LiabilitiesWorking Capital Working Capital = Current Assets= Current Assets - Current Liabilities- Current Liabilities
An important indicator of a company’s ability to meet its current obligations.
Two commonly used measures:
An important indicator of a company’s ability to meet its current obligations.
Two commonly used measures:
Evaluating LiquidityEvaluating Liquidity
© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin
10-6
Devon Mfg. has current liabilities of $230,000 and current assets of $322,000.
What is Devon’s current ratio?What is Devon’s current ratio?
Devon Mfg. has current liabilities of $230,000 and current assets of $322,000.
What is Devon’s current ratio?What is Devon’s current ratio?
Liabilities – QuestionLiabilities – Question
© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin
10-7
Short-term obligations to suppliers for purchases of merchandise and to others for goods and services.
Short-term obligations to suppliers for purchases of merchandise and to others for goods and services.
Merchandise inventory invoices
Merchandise inventory invoices
Shipping charges
Shipping charges
Utility and phone bills
Utility and phone bills
Office supplies invoices
Office supplies invoices
Accounts PayableAccounts Payable
© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin
10-8
Total Notes Payable
Current Notes Payable
Noncurrent Notes Payable
When a company borrows money, a note payable is created.
Current Portion of Notes Payable
The portion of a note payable that is due within one year, or one operating cycle, whichever is longer.
When a company borrows money, a note payable is created.
Current Portion of Notes Payable
The portion of a note payable that is due within one year, or one operating cycle, whichever is longer.
Notes PayableNotes Payable
© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin
10-9
PROMISSORY NOTE
Location Date
after this date
promises to pay to the order of
the sum of with interest at the rate
of per annum.
signed
title
Miami, Fl Nov. 1, 2005
Six months Porter Company
John Caldwell
Security National Bank
$10,000.00
12.0%
treasurer
Notes PayableNotes Payable
© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin
10-10
On November 1, 2005, Porter Company would make the following entry.
Notes PayableNotes Payable
© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin
10-11
Interest expense is the compensation to the lender for giving up the use of money for a period of time.
The liability is called interest payable.
To the lender, interest is a revenue.
To the borrower, interest is an expense..
Interest expense is the compensation to the lender for giving up the use of money for a period of time.
The liability is called interest payable.
To the lender, interest is a revenue.
To the borrower, interest is an expense..
Interest Rate Up!
Interest PayableInterest Payable
© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin
10-12
The interest formula includes three variables that must be considered when computing
interest:
The interest formula includes three variables that must be considered when computing
interest:
Interest = Principal × Interest Rate × Time
When computing interest for one year, “Time” equals 1. When the computation period is less
than one year, then “Time” is a fraction.
When computing interest for one year, “Time” equals 1. When the computation period is less
than one year, then “Time” is a fraction.
Interest PayableInterest Payable
For example, if we needed to compute interest for 3 months, “Time” would be 3/12.
For example, if we needed to compute interest for 3 months, “Time” would be 3/12.
© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin
10-13
What entry would Porter Company make on December 31, the fiscal year-end?
What entry would Porter Company make on December 31, the fiscal year-end?
Interest Payable – ExampleInterest Payable – Example
$10,00012% 2/12 = $200$10,00012% 2/12 = $200
© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin
10-14
Net Pay
Payroll LiabilitiesPayroll Liabilities
Medicare Taxes
State and Local Income
TaxesFICA Taxes
Federal Income Tax
Voluntary Deductions
Gross Pay
© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin
10-15
Deferred revenue is recorded.
a liability account.a liability account.
Cash is received
in advance.
Cash is sometimes collected from the customer before the revenue is
actually earned.
Cash is sometimes collected from the customer before the revenue is
actually earned.
Unearned RevenueUnearned Revenue
Earned revenue is recorded.
As the earnings process is
completed . .
© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin
10-16
Relatively small debt needs can be filled from
single sources.
Relatively small debt needs can be filled from
single sources.
BanksInsurance
CompaniesPension
Plans
oror oror
Long-Term LiabilitiesLong-Term Liabilities
© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin
10-17
Large debt needs are often filled by issuing bonds.
Large debt needs are often filled by issuing bonds.
Long-Term LiabilitiesLong-Term Liabilities
© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin
10-18
Long-term notes that call for a series of installment payments.
Long-term notes that call for a series of installment payments.
Each payment covers interest for the period AND a portion of the
principal.
Each payment covers interest for the period AND a portion of the
principal.
With each payment, the interest portion gets
smaller and the principal portion gets larger.
With each payment, the interest portion gets
smaller and the principal portion gets larger.
Installment Notes PayableInstallment Notes Payable
© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin
10-19
Identify the unpaid principal balance.
Unpaid Principal × Interest rate = Interest expense.
Installment payment - Interest expense = Reduction in unpaid principal balance.
Compute new unpaid principal balance.
Identify the unpaid principal balance.
Unpaid Principal × Interest rate = Interest expense.
Installment payment - Interest expense = Reduction in unpaid principal balance.
Compute new unpaid principal balance.
Allocating Installment Payments Between Interest and Principal
Allocating Installment Payments Between Interest and Principal
© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin
10-20
On January 1, 2005, Rocket Corp. borrowed $7,581.57 from First Bank of River City. The loan was a five-year loan and
had an interest rate of 10%. The annual payment is $2,000.
Prepare an amortization table for Rocket Corp.’s loan.
On January 1, 2005, Rocket Corp. borrowed $7,581.57 from First Bank of River City. The loan was a five-year loan and
had an interest rate of 10%. The annual payment is $2,000.
Prepare an amortization table for Rocket Corp.’s loan.
Allocating Installment Payments Between Interest and Principal
Allocating Installment Payments Between Interest and Principal
© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin
10-21
Now, prepare the entry for the first payment on December 31, 2005.
Now, prepare the entry for the first payment on December 31, 2005.
Allocating Installment Payments Between Interest and Principal
Allocating Installment Payments Between Interest and Principal
© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin
10-22
The information needed for the journal entry can be found on the amortization table. The payment
amount, the interest expense, and the amount to debit to principal are all on the table.
The information needed for the journal entry can be found on the amortization table. The payment
amount, the interest expense, and the amount to debit to principal are all on the table.
Allocating Installment Payments Between Interest and Principal
Allocating Installment Payments Between Interest and Principal
© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin
10-23
Bonds usually involve the borrowing of a large sum of money, called principal.
The principal is usually paid back as a lump sum at the end of the bond period.
Individual bonds are often denominated with a par value, or face value, of $1,000.
Bonds usually involve the borrowing of a large sum of money, called principal.
The principal is usually paid back as a lump sum at the end of the bond period.
Individual bonds are often denominated with a par value, or face value, of $1,000.
Bonds PayableBonds Payable
© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin
10-24
Bonds usually carry a stated rate of interest, also called a contract rate.
Interest is normally paid semiannually.
Interest is computed as:
Bonds usually carry a stated rate of interest, also called a contract rate.
Interest is normally paid semiannually.
Interest is computed as:
Interest = Principal × Stated Rate × Time Interest = Principal × Stated Rate × Time
Bonds PayableBonds Payable
© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin
10-25
Bonds are issued through an intermediary called an underwriter.
Bonds can be sold on organized securities exchanges.
Bond prices are usually quoted as a percentage of the face amount.
For example, a $1,000 bond priced at 102 would sell for $1,020.
Bonds are issued through an intermediary called an underwriter.
Bonds can be sold on organized securities exchanges.
Bond prices are usually quoted as a percentage of the face amount.
For example, a $1,000 bond priced at 102 would sell for $1,020.
Bonds PayableBonds Payable
© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin
10-26
Mortgage Bonds
Mortgage Bonds
Convertible Bonds
Convertible Bonds Junk BondsJunk Bonds
Debenture Bonds
Debenture Bonds
Types of BondsTypes of Bonds
© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin
10-27
On January 1, 2005, Rocket Corp. issues $1,500,000 of 12%, 10-year bonds payable. Interest is payable
semiannually, each July 1 and January 1.
Assume the bonds are issued at face value.Record the issuance of the bonds.
On January 1, 2005, Rocket Corp. issues $1,500,000 of 12%, 10-year bonds payable. Interest is payable
semiannually, each July 1 and January 1.
Assume the bonds are issued at face value.Record the issuance of the bonds.
Accounting for Bonds PayableAccounting for Bonds Payable
© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin
10-28
Record the interest paymenton July 1, 2005.
Record the interest paymenton July 1, 2005.
Accounting for Bonds PayableAccounting for Bonds Payable
© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin
10-29
Gains or losses incurred as a result of retiring bonds should be reported as other income or other
expense on the income statement.
Gains or losses incurred as a result of retiring bonds should be reported as other income or other
expense on the income statement.
Exercising a callprovision.
Purchasing thebonds on theopen market.
B o n ds can b e re tired by . . .
Early Retirement of DebtEarly Retirement of Debt
© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin
10-30
End of Chapter 10End of Chapter 10