Chapter 9
Liabilities
Account for current liabilities and contingent
liabilities
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Current Liabilities
• Obligations due within one year
• Two types:
▫ Known amounts
▫ Estimated amounts
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Current Liabilities: Known Amount
Accounts Short-term Sales tax
payable notes payable payable
Accrued Payroll Unearned
liabilities liabilities revenues
Current
portion of
long-term debt
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Current Liabilities: Known Amount
• Accounts payable
▫ Amounts owed for products or services purchased
on account
• Short-term notes payable
▫ Due within one year
▫ Used to borrow cash or purchase asset
▫ Accrue interest
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Accounting for Short-Term Notes
Payable
JOURNAL
Date Accounts and explanation Debit Credit
Mar 31 Inventory 8,000
Note payable, short-term 8,000
Purchase of inventory by issuing a note payable
Dec 31 Interest expense (8,000 x 10% x 9/12) 600
Interest payable 600
Accrued interest on note payable
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Accounting for Short-Term Notes
Payable
JOURNAL
Date Accounts and explanation Debit Credit
Mar 31 Note payable, short-term 8,000
Interest payable 600
Interest expense (8,000 x 10% x 3/12) 200
Cash 8,800
To record payment of note payable
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Sales Tax Payable
• Levied on retail sales
• Collected from customers and remitted to state
JOURNAL
Date Accounts and explanation Debit Credit
Cash 210,000
Sales 200,000
Sales tax payable 10,000
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Accrued Liabilities
• Result from expenses incurred but not yet paid
• Categories:
▫ Salaries and wages payable
▫ Interest payable
▫ Income taxes payable
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Payroll
• Major expense of most companies
• Many different forms:
▫ Salary
▫ Wage
▫ Commission
JOURNAL
Date Accounts and explanation Debit Credit
Salary expense
Employee income taxes payable
FICA taxes payable
Salaries payable
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Payroll Liabilities
Employee
FICA tax
income tax
payable
payable
Salaries
payable
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Unearned Revenues
• Business receives cash before earning revenue
• Results in a liability
JOURNAL
Date Accounts and explanation Debit Credit
Cash
Unearned revenue
Received advance payment from customer
Unearned revenue
Revenue
Earned revenue that was collected in advance
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Current Portion of Long-Term Debt
• Long-term debt often paid in installments
• Amount of principal payable within one year
• Company reclassifies amount from long-term to
current
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Estimated Current Liabilities
Provision for
Contingent
Warranty
Liabilities
Repairs
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Provision for Warranty Repairs
• Warranty expense is estimated in the year
product is sold
▫ Matching principle
JOURNAL
Date Accounts and explanation Debit Credit
Warranty expense
Provision for Warranty Repairs
To accrue warranty expense
Provision for Warranty Repairs
Inventory
To replace defective products sold under warranty
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Contingent Liabilities
• Possible obligation that depends on future
outcome of past events, or
• Present obligation that may, but probably will
not, require outflow of resources, or
• Sufficiently reliable estimate of the amount of a
present obligation cannot be made
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Long-Term Liabilities
Bonds Notes
payable payable
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Bonds Payable
• Debts of issuing company
• Bond certificate states:
▫ Company name
▫ Principal
▫ Maturity date
▫ Interest rate
▫ Interest payment dates
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Types of Bonds
Term Secured
Serial Unsecured
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Bond Prices
• Quoted as percent of maturity value
Premium Discount
Price above face Price below face
Credit balance Debit balance
Market price decreases Market price increases
towards maturity value towards maturity value
At
maturity Face Market
date value value
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Time Value of Money
• Dollar received today is worth more than one
received in the future
• Dollar invested earns income
• Amount invested now to receive more later
▫ Present Value
• Present value depends on:
▫ Amount of future payment
▫ Length of time
▫ Interest rate
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Interest Rates & Bond Prices
• Bonds always sold at market price
▫ Bond’s present value
• Two interest rates set bond price
▫ Stated interest rate (coupon rate)
Printed on bond certificate
Determines cash interest paid to bondholders
▫ Market interest rate (effective interest rate)
Demanded by investors for loaning money
Can fluctuate after bond issuance
Stated rate usually differs from market rate
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Issue Price of Bonds Payable
Case A
Stated = Market Therefore, Issued at
interest rate interest rate Par
Case B
Stated < Market Therefore, Issued at
interest rate interest rate Discount
Case C
Stated > Market Therefore, Issued at
interest rate interest rate Premium
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Account for bonds payable and measure
interest expense
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Issuing Bonds Payable at Par
JOURNAL
Date Accounts and explanation Debit Credit
Jan 1 Cash 50,000
Bonds payable 50,000
To issue bonds at par
Jul 1 Interest expense 2,250
Cash 2.250
To pay semi-annual interest
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Issuing Bonds Payable at Par
JOURNAL
Date Accounts and explanation Debit Credit
Bonds payable 100,000
Cash 100,000
To pay bonds at maturity
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Issuing Bonds Payable at a Discount
JOURNAL
Date Accounts and explanation Debit Credit
Cash 96,149
Discount on bonds payable 3,851
Bonds payable 100,000
To issue bonds at a discount
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Balance Sheet Presentation
Balance Sheet
Long-term liabilities:
Bonds payable $100,000
Less: Discount on bonds payable (3,851) $96,149
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Interest Payment vs. Interest Expense
Interest Stated
Face
payment value
interest 1/2
rate
Interest Market
Carrying
expense amount
interest 1/2
rate
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Bond Discount Example
Issue Date January 1, 2010
Face value $100,000
Stated interest rate 9%
Interest payments Semi-annual
Maturity date January 1, 2015
Market interest rate 10%
Issue price $96,149
Interest paid – 4.5% $4,500
semiannually
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A B C D D
Bond
Interest Interest Discount Discount
Date carrying
payment expense amortization balance
amount
1-10 $3,851 $96,149
7-10 $4,500 $4,807 $307 3,544 96,456
1-11 $4,500 4,823 323 3,221 96,779
1-15 $4.500 4,961 461 0 100,000
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5,000
I
n
t
e
r 4,800
e
s
t
Discount
E Amortization
x
p 4,600
e
n
s
Interest Payment
e
4,400
1 2 3 4 5 6 7 8 9 10
Semiannual Interest Payment
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101,000
Face value
B 100,000
o
n
d
99,000
C
a
r 98,000
r
y
i
n 97,000
g
A
m 96,000
o
u
n
95,000
t
94,000
1 2 3 4 5 6 7 8 9 10 11
Semiannual Interest Payments
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JOURNAL
Date Accounts and explanation Debit Credit
2010
Jul 1 Interest expense 4,807
Discount on bonds payable 307
Cash 4,500
To pays semiannual interest and amortize bond discount
Dec. 31 Interest expense 4,823
Discount on bonds payable 323
Interest payable 4,500
To accrue semiannual interest and amortise bond discount.
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Balance Sheet
December 31, 2010
Long-term liabilities:
Bonds payable $100,000
Less: Discount on bonds payable (3,221) $96,779
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Partial-Period Interest Payments
JOURNAL
Date Accounts and explanation Debit Credit
Dec. 31 Interest expense 2,880
Discount on bonds payable 213
Interest payable 2,667
$96,000 carrying amount x 9% market rate x 4/12
$100,000 face value x 10% market rate x 4/12
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Bond Premium Example
Issue Date January 1, 2010
Face value $100,000
Stated interest rate 9%
Interest payments Semi-annual
Maturity date January 1, 2015
Market interest rate 8%
Issue price $104,100
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A B C D D
Bond
Interest Interest Premium Premium
Date carrying
payment expense amortization balance
amount
1-10 $4,100 $104,100
7-10 $4,500 $4,164 $336 3,764 103,764
1-11 $4,500 4,137 349 3,415 103,415
1-15 $4,500 3,955 545 0 100,000
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4,600
Interest Payment
I
n
t
e
4,400
r
e
s Premium Amortization
t
E
x
p 4,200
e
n
s
e
4,000
1 2 3 4 5 6 7 8 9 10
Semiannual Interest Payment
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B 105,000
o
n
d
104,000
C
a
r
r
y 103,000
i
n
g
A 102,000
m
o
u
n
t 101,000
100,000
Face value
99,000
1 2 3 4 5 6 7 8 9 10 11
Semiannual Interest Payments
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Straight-Line Method
Discount or premium
Amortization
Number of interest payments
Interest Interest Amortization
OR
expense payment
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Retiring Bonds Before Maturity
• Reasons to pay off bonds early
▫ Can relieve high interest payments
▫ Can borrow at a lower interest rate
• Callable feature
▫ Issuer can pay off bonds at a prearranged price
▫ Results in a gain or loss
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Convertible Bonds
• Bondholders can exchange bonds for share
• Investors benefit from:
▫ Guaranteed receipt of principal and interest on
bonds
▫ Potential for gains on shares
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Account for capital and operating leases
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Leases
OPERATING CAPITAL
• Lessee has right to use • Lessee has rights to use
the asset asset
• Lessor retains risks and • Lessee assumes risks
rewards of owing and rewards of ownership
• Lessee records Rent and associated
Expense obligations
• Present value of lease
payment capitalized
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Capital Lease Criteria
Transfer of title Bargain
at end of lease purchase option
Present value of
Lease term > lease payments
75% of useful life >90% of fair
value of asset
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Accounting for Capital Leases
• Lessee will record the present value of lease
payments on its books
• Depreciated in accordance to the entity’s usual
depreciation policy
• Lease payments made will be set off against
lease interest expense, and remaining balance
used to reduce the outstanding lease payment
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Journal Entries for Capital Leases
• On signing the lease on July 1 20X1
20X1
July 1 Lease Asset 43, 295
Lease Liability 43,295
To record capital lease ($10,000 per year
for 5 years @5%).
• On making 1st lease payment on June 30 20X2
20X2
June 30 Lease Liability 7,835
Interest Expense 2,165
Cash 10,000
To record first capital lease payment.
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Lease Amortization Schedule
Period Begin LL Payment Interest Principal End LL
1 $ 43,295 $10,000 $ 2,165 $ 7,835 $35,460
2 $35,460 $10,000 $ 1,773 $ 8,227 $ 27, 232
3 $27,232 $10,000 $ 1,362 $ 8,638 $ 18,594
4 $18,594 $10,000 $ 930 $ 9,070 $ 9,524
5 $9,524 $10,000 $ 476 $ 9,524 $ -0-
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Understand the advantages and disadvantages
of borrowing
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Financing Operations
Issuing Retained
shares earnings
Issuing
bonds
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Earnings per Share
Plan 1 Plan 2
Borrow $500,000 6% Issue $500,000 of shares
Net income before
expansion $300,000 $300,000
Expected project income
before interest & taxes $200,000 $200,000
Interest expense (30,000) 0
Income taxes (40%) (68,000) (80,000)
Expected project net income 102,000 120,000
Total net income 402,000 420,000
Common shares 100,000 150,000
Earnings per share $4.02 $2.80
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Times Interest Earned
Operating Income
Interest Expense
High ratio = Low ratio =
ease in paying difficulty in
interest paying interest
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Pensions and Postretirement
Liabilities
• Expense recorded while employees work for the
company
• Cash contributed into pension plan assets
• Obligations grows for future payments to
employees
Underfunded Overfunded
Plan assets less Plan assets greater
than obligation than obligation
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Report liabilities on the balance sheet
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Partial Balance Sheet Note 10: Financial Instruments
December 31, 2011 Long-term debt
Liabilities Revolving credit $400
Current liabilities: 9% notes due 2015 350
Accounts payable $650 8% notes due 2018 750
Accrued liabilities 985 U.K. credit arrangement 600
Unearned revenue 877 7.5$ notes due 2017 585
Current portion of long-term debt 225 Total long-term debt 2,685
Total current liabilities 2,737 Less: current maturities (225)
Long-term debt 2,460 Long-term debt $2,460
Other long-term liabilities 1.987
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