Financial Accounting: Tools for Business

Decision Making
Ninth Edition
Kimmel ● Weygandt ● Kieso

Chapter 10
Reporting and Analyzing Liabilities
Prepared by
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Chapter Outline
Learning Objectives
LO 1 Explain how to account for current liabilities.
LO 2 Describe the major characteristics of bonds.
LO 3 Explain how to account for bond transactions.
LO 4 Discuss how liabilities are reported and analyzed.

Copyright ©2019 John Wiley & Sons, Inc. 2

Learning Objective 1
Explain How to Account for Current
Liabilities

LO1 Copyright ©2019 John Wiley & Sons, Inc. 3

What Is a Current Liability? (1 of 3)
• A debt that a company expects to pay
• from existing current assets or through the creation of
other current liabilities, and
• within one year or the operating cycle, whichever is
longer.
• Current liabilities include notes payable, accounts
payable, unearned revenues, and accrued liabilities
such as taxes, salaries and wages, and interest.

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What Is a Current Liability? (2 of 3)
Review Question
To be classified as a current liability, a debt must be
expected to be paid within
a. 1 year.
b. the operating cycle.
c. 2 years.
d. (a) or (b), whichever is longer.

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What Is a Current Liability? (3 of 3)
Review Question
To be classified as a current liability, a debt must be
expected to be paid within
a. 1 year.
b. the operating cycle.
c. 2 years.
d. (a) or (b), whichever is longer.

LO1 Copyright ©2019 John Wiley & Sons, Inc. 6

Notes Payable
• Written promissory note
• Usually requires borrower to pay interest
• Frequently issued to meet short-term financing needs
• Issued for varying periods of time
• Usually classified as current liability if due for
payment within one year of balance sheet date

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Accounting for Notes Payable (1 of 3)
Illustration: First National Bank agrees to lend $100,000 on
September 1, 2022, if Cole Williams Co. signs a $100,000,
12%, four-month note maturing on January 1. When a
company issues an interest-bearing note, the amount of
assets it receives generally equals the note’s face value.

Sept. 1 Cash 100,000  

  Notes Payable   100,000
       

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Accounting for Notes Payable (2 of 3)
Illustration: If Cole Williams Co. prepares financial statements
annually, it makes an adjusting entry at December 31 to
recognize interest.

Interest Expense = $100,000 x 12% x 4/12 = $4,000

Dec. 31 Interest Expense 4,000  

  Interest Payable   4,000
       

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Accounting for Notes Payable (3 of 3)
Illustration: At maturity (January 1), Cole Williams Co. must
pay the face value of the note plus interest.
It records payment as follows.

Jan. 1 Notes Payable 100,000  

  Interest Payable 4,000  
  Cash   104,000
       

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Sales Taxes Payable
• Sales taxes are expressed as a stated percentage of
the sales price
• Selling company
 Collects tax from customer
 Remits collections to the state’s department of
revenue

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Sales Taxes Payable (1 of 2)
Illustration: The March 25 cash register readings for Cooley
Grocery show sales of $10,000 and sales taxes of $600 based
on a sales tax rate of 6%.
Journal entry to record the sales and sales taxes

Mar. 25 Cash 10,600  

  Sales Revenue   10,000
  Sales Taxes Payable   600
       

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Sales Taxes Payable (2 of 2)
If sales taxes are not rung up separately on the cash register
Illustration: Cooley Grocery rings up total receipts of $10,600
and has a 6% sales tax rate. Because the amount received
from the sale is equal to the sales price 100% plus 6% of sales,
the journal entry is
Sales revenue = $10,600 ÷ 1.06 = $10,000

Mar. 25 Cash 10,600  

  Sales Revenue   10,000
  Sales Taxes Payable   600
       

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Unearned Revenues (1 of 2)
Revenues that are received before goods are delivered or
services are performed.
1. Company increases (debits) Cash and increases
(credits) a current liability account, Unearned
Revenue.
2. When the company recognizes revenue, it decreases
(debits) the unearned revenue account and increases
(credits) a revenue account.

Type of Business = Airline, Magazine publisher, Hotel

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Unearned Revenues (2 of 2)
Illustration: Superior University sells 10,000 season football
tickets at $50 each for its five-game home schedule.
Entry for the sales of season tickets
Aug. 6 Cash (10,000 × $50) 500,000  
  Unearned Ticket Revenue   500,000
       

As each game is completed, Superior records the earning

of revenue.
Sep. 7 Unearned Ticket Revenue 100,000  
  Ticket Revenue   100,000
       

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Current Maturities of Long-Term Debt
• Portion of long-term debt that comes due in current year
• No adjusting entry required
Illustration: Wendy Construction issues a five-year, interest-
bearing $25,000 note on January 1, 2022. This note specifies that
each January 1, starting January 1, 2023, Wendy should pay
$5,000 of the note. When the company prepares financial
statements on December 31, 2022, what amount should be
reported as a
1. Current liability? $5,000
2. Long-term liability? $20,000

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Do It! 1a: Current Liabilities (1 of 2)
You and several classmates are studying for the next
accounting examination. Answer the following questions.
1. If cash is borrowed on a $50,000, 6-month, 12% note on
September 1, how much interest expense will be incurred
by December 31?

Interest expense = $50,000 × 12% × 4/12 = $2,000

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Do It! 1a: Current Liabilities (2 of 2)
Answer the following questions.
2. The cash register total including sales taxes is $23,320, and
the sales tax rate is 6%. What is the sales taxes payable?
Sales revenue = $23,320 ÷ 1.06 = $22,000
Sales taxes = $23,320 − $22,000 = $1,320

3. If $15,000 is collected in advance on November 1 for 3

months’ rent, what amount of rent revenue should be
recognized by December 31?
Rent revenue = $15,000 x 2/3 = $10,000

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Payroll and Payroll Taxes Payable (1 of 4)
• The term “payroll” pertains to both
• Salaries
• managerial, administrative, and sales
personnel (fixed monthly or yearly rate)
• Wages
• Store clerks, factory employees, and manual
laborers (rate per hour)
• Determining the payroll involves computing
• Gross earnings
• Payroll deductions
• Net pay

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Payroll and Payroll Taxes Payable (2 of 4)
Illustration: Assume Cargo Corporation records its payroll for
the week of March 7 as follows:
Mar. 7 Salaries and Wages Expense 100,000  
  FICA Taxes Payable   7,650
  Federal Income Taxes Payable   21,864
  State Income Taxes Payable   2,922
  Salaries and Wages Payable   67,564
       

Record the payment of this payroll on March 7.

Mar. 7 Salaries and Wages Payable 67,564  
  Cash   67,564
       

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Payroll and Payroll Taxes Payable (3 of 4)
Payroll tax expense results from three taxes that
governmental agencies levy on employers
These taxes are
• FICA tax
• Federal unemployment tax
• State unemployment tax

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Payroll and Payroll Taxes Payable (4 of 4)
Illustration: Based on Cargo Corp.’s $100,000 payroll, the
company would record the employer’s payroll tax expense
and liability for these payroll taxes on March 7 as follows.

Mar. 7 Payroll Tax Expense 13,850  

  FICA Taxes Payable   7,650
  Federal Unemployment Taxes Payable   800
  State Unemployment Taxes Payable   5,400
       

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Payroll Taxes (1 of 2)
Review Question
Employer payroll taxes do not include
a. federal unemployment taxes.
b. state unemployment taxes.
c. federal income taxes.
d. FICA taxes.

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Payroll Taxes (2 of 2)
Review Question
Employer payroll taxes do not include
a. federal unemployment taxes.
b. state unemployment taxes.
c. federal income taxes.
d. FICA taxes.

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Do It! 1b: Wages and Payroll Taxes (1 of 2)
During September, Lake Corporation’s employees earned wages of
$60,000. Withholdings related to these wages were $4,590 for Social
Security (FICA), $6,500 for federal income tax, and $2,000 for state
income tax. Costs incurred for unemployment taxes were $90 for
federal and $150 for state. Prepare the September 30 journal entries
for (a) salaries and wages expense and salaries and wages payable,
assuming that all September wages will be paid in October.

Sept. 30 Salaries and Wages Expense 60,000  

  FICA Taxes Payable   4,590
  Federal Income Taxes Payable   6,500
  State Income Taxes Payable   2,000
  Salaries and Wages Payable   46,910
       

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Do It! 1b: Wages and Payroll Taxes (2 of 2)
During September, Lake Corporation’s employees earned wages of
$60,000. Withholdings related to these wages were $4,590 for Social
Security (FICA), $6,500 for federal income tax, and $2,000 for state
income tax. Costs incurred for unemployment taxes were $90 for
federal and $150 for state. Prepare the September 30 journal entries
for (b) the company’s payroll tax expense.

Sept. 30 Payroll Tax Expense 4,830  

  FICA Taxes Payable   4,590
  Federal Unemployment Taxes Payable   90
  State Unemployment Taxes Payable   150
       

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Learning Objective 2
Describe the Major Characteristics of
Bonds

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Major Characteristics of Bonds
• Bonds
• A form of interest-bearing notes payable issued
by corporations, universities, and governmental
agencies
• Sold in small denominations
• Usually $1,000 or multiples of $1,000
• When a corporation issues bonds, it is borrowing
money.
• The person who buys the bonds (the bondholder) is
investing in bonds.
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Types of Bonds (1 of 2)
Secured and Unsecured Bonds
• Secured bonds have specific assets of issuer pledged
as collateral for bonds
• Unsecured bonds are issued against general credit of
borrower

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Types of Bonds (2 of 2)
Convertible and Callable Bonds
• Convertible bonds can be
converted into common stock at
bondholder’s option
• Callable bonds can be redeemed
(bought back), by issuing company,
at a stated dollar amount prior to
maturity

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Bond Terminology
• Bond certificate
 Issued to investor
 Provides name of company issuing bonds, face
value, maturity date, and contractual (stated)
interest rate
• Face value - principal due at maturity
• Maturity date - date final payment is due
• Contractual interest rate – annual rate used to
determine cash interest paid
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Bond Certificate

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Bond Trading
• Bondholders can sell their bonds at any time on
national securities exchanges
• Prices are quoted as a percentage of face value
• Corporation makes journal entries only when it
issues or buys back bonds, or when bondholders
convert bonds into common stock
• Market information for bonds
Issuer Bonds Maturity Close Yield
Time Warner Cable 6.75 June 15, 2039 116.4 5.49

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Determining the Price of a Bond (1 of 2)
• Current market price, the present value of a bond is a
function of three factors
• Dollar amounts to be received
• Length of time until amounts are received
• Market rate of interest
• Discounting
• The process of finding the present value of bonds
• Removing interest from future bon cash flows

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Determining the Price of a Bond (2 of 2)
Illustration: Assume that Acropolis Company on January 1,
2022, issues $100,000 of 9% bonds, due in five years, with
interest payable annually at year-end.

Present value of $100,000 received in 5 years $ 64,993

Present value of $9,000 received annually for 5 years 35,007
Market price of bonds $100,000

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Do It! 2: Bond Terminology
Indicate whether each of the following statements is true or false.
1. Mortgage bonds and sinking fund bonds are both
True
examples of secured bonds.
2. Unsecured bonds are also known as debenture
True
bonds.
3. The contractual interest rate is the rate investors
demand for loaning funds. False
4. The face value is the amount of principal the issuing
company must pay at the maturity date. True
5. The market price of a bond is equal to its maturity False
value.
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Learning Objective 3
Explain How to Account for Bond
Transactions

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Accounting for Bond Transactions
• A corporation records bond transactions when
 it issues (sells) or redeems (buys back) bonds
 bondholders convert bonds into common stock
• Bonds may be issued at
 face value
 below face value at a discount
 above face value at a premium
• Bond prices are quoted as a percentage of face value

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Issuing Bonds (1 of 2)
Review Question
The market interest rate:
a. is the contractual interest rate used to
determine the amount of cash interest paid by
the borrower.
b. is listed in the bond indenture.
c. is the rate investors demand for loaning funds.
d. more than one of the above is true.

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Issuing Bonds (2 of 2)
Review Question
The market interest rate:
a. is the contractual interest rate used to
determine the amount of cash interest paid by
the borrower.
b. is listed in the bond indenture.
c. is the rate investors demand for loaning funds.
d. more than one of the above is true.

LO3 Copyright ©2019 John Wiley & Sons, Inc. 40

Bonds Issued at Face Value (1 of 2)
Illustration: Candlestick Inc. issues 100, five-year, 10%, $1,000
bonds dated January 1, 2022, at 100 (100% of face value).
Journal entry to record the issuance
Jan. 1 Cash 100,000  
  Bonds Payable   100,000
       

Journal entry Candlestick would make to accrue interest on

December 31
Interest expense = $100,000 x 10% x 12/12) = $10,000
Dec. 31 Interest Expense 10,000  
  Interest Payable   10,000
       

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Bonds Issued at Face Value (2 of 2)
Journal entry to be made by Candlestick to pay the interest
on Jan. 1, 2023

Jan. 1 Interest Payable 10,000  

  Cash   10,000
       

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Discount or Premium on Bonds (1 of 3)
Interest Rates and Bond Prices

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Discount or Premium on Bonds (2 of 3)
Review Question
Laurel Inc. issues 10-year bonds with a maturity value of $200,000.
If the bonds are issued at a premium, this indicates that:
a. the contractual interest rate exceeds the market interest
rate.
b. the market interest rate exceeds the contractual interest
rate.
c. the contractual interest rate and the market interest rate
are the same.
d. no relationship exists between the two rates.

LO3 Copyright ©2019 John Wiley & Sons, Inc. 44

Discount or Premium on Bonds (3 of 3)
Review Question
Laurel Inc. issues 10-year bonds with a maturity value of $200,000.
If the bonds are issued at a premium, this indicates that:
a. the contractual interest rate exceeds the market interest
rate.
b. the market interest rate exceeds the contractual interest
rate.
c. the contractual interest rate and the market interest rate
are the same.
d. no relationship exists between the two rates.

LO3 Copyright ©2019 John Wiley & Sons, Inc. 45

Issuing Bonds at a Discount (1 of 2)
Illustration: Assume that on January 1, 2022, Candlestick Inc.
sells $100,000, five-year, 10% bonds at 98 (98% of face value)
with interest payable on January 1.
Journal entry to record the issuance

Jan. 1 Cash 98,000  

  Discount on Bonds Payable 2,000 
  Bonds Payable   100,000
       

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Issuing Bonds at a Discount (2 of 2)
Statement Presentation
Candlestick Inc.
Balance Sheet (partial)
Long-term liabilities
Bonds payable $100,000
Less: Discount on bonds payable2,000 $98,000

Issuing corporation must pay

• Contractual interest payments over the term of the bonds
• Face value of bonds at maturity

LO3 Copyright ©2019 John Wiley & Sons, Inc. 47

Total Cost of Borrowing (1 of 2)
Bonds Issued at a Discount
Annual interest payments
($100,000 × 10% = $10,000; $10,000 × 5) $50,000
Add: Bond discount ($100,000 − $98,000) 2,000
Total cost of borrowing $52,000

Bonds Issued at a Discount

Principal at maturity $100,000
Annual interest payments ($10,000 × 5) 50,000
Cash to be paid to bondholders 150,000
Less: Cash received from bondholders 98,000
Total cost of borrowing $52,000

LO3 Copyright ©2019 John Wiley & Sons, Inc. 48

Amortization of Bond Discount
• Allocated to expense in each period
• Increases amount of interest expense reported each
period
• Amount of interest expense reported each period will
exceed contractual amount paid
• As discount is amortized, its balance declines
• Carrying value of bonds will increase, until at maturity
carrying value of bonds equals their face amount

LO3 Copyright ©2019 John Wiley & Sons, Inc. 49

Issuing Bonds at a Premium (1 of 2)
Illustration: Assume that the Candlestick Inc. bonds
previously described sell at 102 rather than at 98.
Journal entry to record the sale

Jan. 1 Cash 102,000  

  Bonds Payable   100,000
  Premium on Bonds Payable   2,000
       

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Issuing Bonds at a Premium (2 of 2)
Statement Presentation
Candlestick Inc.
Balance Sheet (partial)
Long-term liabilities
Bonds payable $100,000
Add: Premium on bonds payable 2,000 $102,000

• Borrower pays only the face value of the bonds at maturity

• Not required to pay the bond premium at the maturity date
• Bond premium is considered a reduction in the cost of
borrowing
LO3 Copyright ©2019 John Wiley & Sons, Inc. 51
Total Cost of Borrowing (2 of 2)
Bonds Issued at a Premium
Annual interest payments Blank
($100,000 × 10% = $10,000; $10,000 × 5 years) $50,000
Add: Bond discount ($102,000 − $100,000) 2,000
Total cost of borrowing $48,000

Bonds Issued at a Premium

Principal at maturity $100,000
Annual interest payments ($10,000 × 5 years) 50,000
Cash to be paid to bondholders 150,000
Less: Cash received from bondholders 102,000
Total cost of borrowing $ 48,000

LO3 Copyright ©2019 John Wiley & Sons, Inc. 52

Amortization of Bond Premium
• Allocated to expense in each period
• Decreases amount of interest expense reported each
period
• Amount of interest expense reported each period will be
less than contractual amount paid
• As premium is amortized, its balance declines
• Carrying value of bonds will decrease, until at maturity
carrying value of bonds equals their face amount

LO3 Copyright ©2019 John Wiley & Sons, Inc. 53

Do It! 3a: Bond Issuance
Giant Corporation issues $200,000 of bonds for $189,000.
(a) Journal entry to record the issuance of the bonds

Cash 189,000  
  Discount on Bonds Payable 11,000  
  Bonds Payable   200,000
       

(b) Show how the bonds would be reported on the balance

sheet at the date of issuance.
Long-term liabilities
Bonds payable $200,000
Less: Discount on bonds payable 11,000 $189,000
LO3 Copyright ©2019 John Wiley & Sons, Inc. 54
Redeeming Bonds at Maturity
Candlestick records the redemption of its bonds at maturity
as follows:

Jan. 1 Bonds Payable 100,000  

  Cash   100,000
       

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Redeeming Bonds before Maturity (1 of 2)
• When a company retires bonds before maturity, it is
necessary to
• Eliminate carrying value of bonds at redemption date
• Record cash paid
• Recognize gain or loss on redemption
• Carrying value of the bonds at the redemption date
• Face value of the bonds less unamortized bond discount
or
• Face value of the bonds plus unamortized bond premium

LO3 Copyright ©2019 John Wiley & Sons, Inc. 56

Redeeming Bonds before Maturity (2 of 2)
Illustration: At the end of the fourth period, Candlestick Inc.,
having sold its bonds at a premium, retires the bonds at 103
after paying the annual interest. The carrying value of the bonds
at the redemption date is $100,400 (principal $100,000 and
premium $400). Candlestick records the redemption at the end
of the fourth interest period, January 1, 2026, as
Jan. 1 Bonds Payable 100,000  
  Premium on Bonds Payable 400  
  Loss on Bond Redemption 2,600  
  Cash   103,000
       

LO3 Copyright ©2019 John Wiley & Sons, Inc. 57

Do It! 3b: Bond Redemption
R & B Inc. issued $500,000, 10-year bonds at a discount. Prior
to maturity, when the carrying value of the bonds is $496,000,
the company redeems the bonds at 98.
Prepare the entry to record the redemption of the bonds.

Jan. 1 Bonds Payable 500,000  

  Discount on Bonds Payable   4,000
  Cash   490,000
  Gain on Bond Redemption   6,000
       

LO3 Copyright ©2019 John Wiley & Sons, Inc. 58

Learning Objective 4
Discuss How Liabilities Are Reported
and Analyzed

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Presentation of Liabilities on the Balance Sheet
Marais Company
Balance Sheet (partial)

Liabilities
Current liabilities
Notes payable $ 250,000
Accounts payable 125,000
Current maturities of long-term debt 300,000
Accrued liabilities 75,000
Total current liabilities $ 750,000
Long-term liabilities
Bonds payable 1,000,000
Less: Discount on bonds payable 80,000 920,000
Notes payable, secured by plant assets 540,000
Lease liability 500,000
Total long-term liabilities 1,960,000
Total liabilities $2,710,000
LO4 Copyright ©2019 John Wiley & Sons, Inc. 60
Analysis (1 of 5)
General Motors Company
Balance Sheets
December 31, 2017 and 2016
(in millions)

Assets 2017 2016

Total current assets $ 68,744 $ 76,203
Noncurrent assets 143,738 145,487
Total assets $212,482 $221,690
Liabilities and Stockholders’ Equity
Total current liabilities $ 76,890 $ 85,181
Noncurrent liabilities 99,392 92,434
Total liabilities 176,282 177,615
Total stockholders’ equity 36,200 44,075
Total liabilities and stockholders’ equity $212,482 $221,690
LO4 Copyright ©2019 John Wiley & Sons, Inc. 61
Analysis (2 of 5)
Liquidity General Motors
(in millions)
Ratio 2017 2016
Current Ratio $68,744 $76,203
= .89:1 = .89:1
$76,890 $85,181

Liquidity ratios measure the short-term ability of a

company to pay its maturing obligations and to meet
unexpected needs for cash.

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Analysis (3 of 5)
Solvency
Total Liabilities
Debt to Assets Ratio =
Total Assets

Net Income + Interest Expense +

Income Tax Expense
Times Interest Earned =
Interest Expense

Solvency ratios measure the ability of a company to

survive over a long period of time.
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Analysis (4 of 5)
Solvency
($ in millions) 2017 2016
Net income $(3,882) $9,268
Interest expense 575 563
Income tax expense 11,533 2,739

General Motors (in millions)

Ratio 2017 2016
$176,282
Debt to Assets Ratio = 83% 80%
$212,482

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Analysis (5 of 5)
($ in millions) 2017 2016
Solvency Net income $(3,882) $9,268
Interest expense 575 563
Income tax expense 11,533 2,739

General Motors (in millions)

Ratio 2017
Times Interest $(3,882) + $575 + $11,533
Earned = 14.3 times
$575
2016
22.3 times
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Contingencies
• Events with uncertain outcomes that may represent
potential liabilities
• Common types of contingencies
 Lawsuits
 Product warranties
 Environmental cleanup obligations

• Accounting rules require that companies disclose

contingencies in the notes

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Off-Balance-Sheet-Financing
Intentional effort by a company to structure its financing
arrangements so as to avoid showing liabilities on its
balance sheet.

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Do It! 4: Analyzing Liabilities (1 of 3)
Trout Company provides you with the following balance sheet information as of
December 31, 2022.
Current assets $10,500 Current liabilities $ 8,000
Long-term assets 24,200 Long-term liabilities 16,000
Total assets $34,700 Stockholders’ equity 10,700
Total liabilities and
stockholders’ equity $34,700

Trout reported net income for 2022 of $14,000, income tax expense of $2,800,
and interest expense of $900.
(a) Compute the current ratio and working capital for Trout for 2022.
Current ratio = $10,500 ÷ $8,000 = 1.31:1
Working capital = $10,500 − $8,000 = $2,500

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Do It! 4: Analyzing Liabilities (2 of 3)
Trout Company provides you with the following balance sheet information as of
December 31, 2022.
Current assets $10,500 Current liabilities $ 8,000
Long-term assets 24,200 Long-term liabilities 16,000
Total assets $34,700 Stockholders’ equity 10,700
Total liabilities and
stockholders’ equity $34,700

Trout reported net income for 2022 of $14,000, income tax expense of $2,800,
and interest expense of $900.
(b) Assume that Trout used $2,000 cash to pay off $2,000 of accounts payable.
Current ratio = $8,500 ÷ $6,000 = 1.42:1
Working capital = $8,500 − $6,000 = $2,500

LO4 Copyright ©2019 John Wiley & Sons, Inc. 69

Do It! 4: Analyzing Liabilities (3 of 3)
Trout Company provides you with the following balance sheet information as of
December 31, 2022.
Current assets $10,500 Current liabilities $ 8,000
Long-term assets 24,200 Long-term liabilities 16,000
Total assets $34,700 Stockholders’ equity 10,700
Total liabilities and
stockholders’ equity $34,700

Trout reported net income for 2022 of $14,000, income tax expense of $2,800,
and interest expense of $900.
(c) Compute debt to assets ratio and times interest earned for Trout for 2022.
Debt to assets ratio = $24,000 ÷ $34,700 = 69.2%
Times interest earned = ($14,000 + $2,800 + $900) ÷ $900 = 19.67 times

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Learning Objective 5
Apply the Straight-Line Method of
Amortizing Bond Discount and Bond
Premium

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Straight-Line Amortization
Amortizing Bond Discount
To follow the expense recognition principle, companies
allocate bond discount to expense in each period in which
the bonds are outstanding.

Bond Number of Bond Discount

÷ =
Discount Interest Periods Amortization

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Amortizing Bond Discount
Illustration: Candlestick, Inc. sold $100,000, five-year, 10%
bonds on January 1, 2022, for $98,000 (discount of $2,000).
Interest is payable on January 1 of each year.
Journal entry to accrue interest and amortize the bond
discount at Dec. 31, 2022

Dec. 31 Interest Expense 10,400  

  Discount on Bonds Payable   400
  Interest Payable   10,000
       

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Bond Discount Amortization Schedule
Candlestick Inc.
Bond Discount Amortization Schedule
Straight-Line Method—Annual Interest Payments
$100,000 of 10%, 5-Year Bonds

(A) (B) (C) (D) (E)

Interest to Interest Expense Discount Unamortized Bond
Interest Be Paid to Be Recorded Amortization Discount Carrying Value
Periods (10% x $100,000) (A) + (C) ($2,000 ÷ 5) (D) − (C) ($100,000 − D)
Issue date $2,000 $98,000
1 10,000 10,400 400 1,600 98,400
2 10,000 10,400 400 1,200 98,800
3 10,000 10,400 400 800 99,200
4 10,000 10,400 400 400 99,600
5 10,000 10,400 400 0 100,000
$50,000 $52,000 $2,000

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Amortizing Bond Premium
Illustration: Candlestick, Inc., sold $100,000, five-year, 10%
bonds on January 1, 2022, for $102,000 (premium of $2,000).
Interest is payable on January 1 of each year.
Journal entry to accrue interest and amortize the bond
premium at Dec. 31, 2022

Dec. 31 Interest Expense 9,600  

  Premium on Bonds Payable 400  
  Interest Payable   10,000
       

LO5 Copyright ©2019 John Wiley & Sons, Inc. 75

Bond Premium Amortization Schedule
Candlestick Inc.
Bond Premium Amortization Schedule
Straight-Line Method—Annual Interest Payments
$100,000 of 10%, 5-Year Bonds

(A) (B) (C) (D) (E)

Interest to Interest Expense Premium Unamortized Bond
Interest Be Paid to Be Recorded Amortization Premium Carrying Value
Periods (10% x $100,000) (A) + (C) ($2,000 ÷ 5) (D) − (C) ($100,000 − D)
Issue date $2,000 $102,000
1 10,000 9,600 400 1,600 101,600
2 10,000 9,600 400 1,200 101,200
3 10,000 9,600 400 800 100,800
4 10,000 9,600 400 400 100,400
5 10,000 9,600 400 0 100,000
$50,000 $48,000 $2,000

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Learning Objective 6
Apply the Effective-Interest Method of
Amortizing Bond Discount and Bond
Premium

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Effective-Interest Method (1 of 2)
• Amortization of the discount or premium results in
interest expense equal to a constant percentage of the
carrying value.
• Required steps
1. Compute bond interest expense.
2. Compute bond interest paid or accrued.
3. Compute amortization amount.

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Effective-Interest Method (2 of 2)
Amortization of the discount or premium results in
interest expense equal to a constant percentage of the
carrying value.

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Amortizing Bond Discount (1 of 4)
Illustration: Candlestick, Inc., sold $100,000, five-year,
10% bonds on January 1, 2022, for $98,000. The effective-
interest rate is 10.5348% and interest is payable on Jan. 1
of each year.
Prepare the bond discount amortization schedule.

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 Amortizing Bond Discount (2 of 4)
Candlestick Inc.
Bond Discount Amortization Schedule
Effective-Interest Method—Annual Interest Payments
10% Bonds Issued at 10.5348%

(B)
(A) Interest Expense (C) (D) (E)
Interest to to Be Recorded Discount Unamortized Bond
Interest Be Paid (10.5348% × Preceding Amortization Discount Carrying Value
Periods (10% x $100,000) Bond Carrying Value) (B) – (A) (D) − (C) ($100,000 − D)
Issue date $2,000 $ 98,000
1 $10,000 $10,324 (10.5348% × $98,000) $ 324 1,676 98,324
2 10,000 10,358 (10.5348% × $98,324) 358 1,318 98,682
3 10,000 10,396 (10.5348% × $98,682) 396 922 99,078
4 10,000 10,438 (10.5348% × $99,078) 438 484 99,516
5 10,000 10,484 (10.5348% × $99,516) 484 0 100,000
$50,000 $52,000 $2,000

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Amortizing Bond Discount (3 of 4)
Illustration: Candlestick, Inc. records the accrual of interest
and amortization of bond discount on Dec. 31, as follows:

Dec. 31 Interest Expense 10,324  

  Discount on Bonds Payable   324
  Interest Payable   10,000
       

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Amortizing Bond Discount (4 of 4)
For the second interest period
Bond interest expense = $98,324 × 10.5348% = $10,358
Discount amortization =$358
At December 31, Candlestick makes the following adjusting
entry.
Dec. 31 Interest Expense 10,358  
  Discount on Bonds Payable   358
  Interest Payable   10,000
       

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Amortizing Bond Premium (1 of 3)
Illustration: Candlestick Inc. sells the bonds described
above for $102,000 rather than $98,000.
This would result in
Bond premium = $102,000 − $100,000 = $2,000
This premium results in an effective-interest rate of
approximately 9.4794%.

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 Amortizing Bond Premium (2 of 3)
Candlestick Inc.
Bond Premium Amortization Schedule
Effective-Interest Method—Annual Interest Payments
10% Bonds Issued at 9.4794%

(B)
(A) Interest Expense (C) (D) (E)
Interest to to Be Recorded Premium Unamortized Bond
Interest Be Paid (9.4794% × Preceding Amortization Premium Carrying Value
Periods (10% x $100,000) Bond Carrying Value) (A) – (B) (D) − (C) ($100,000 − D)
Issue date $2,000 $ 102,000
1 $10,000 $ 9,669 (9.4794% × $102,000) $ 331 1,669 101,669
2 10,000 9,638 (9.4794% × $101,669) 362 1,307 101,307
3 10,000 9,603 (9.4794% × $101,307) 397 910 100,910
4 10,000 9,566 (9.4794% × $100,910) 434 476 100,476
5 10,000 9,524* (9.4794% × $100,476) 476* 0 100,000
$50,000 $48,000 $2,000

* Rounded
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Amortizing Bond Premium (3 of 3)
Illustration: Candlestick, Inc. records the accrual of interest
and amortization of premium discount on Dec. 31, as follows:

Dec. 31 Interest Expense 9,669  

  Premium on Bonds Payable 331  
  Interest Payable   10,000
       

LO6 Copyright ©2019 John Wiley & Sons, Inc. 86

Learning Objective 7
Explain How to Account for Long-Term
Notes Payable

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Accounting for Long-Term Notes Payable
• May be secured by a mortgage that pledges title to
specific assets as security for a loan
• Typically terms require borrower to make
installment payments over term of loan. Each
payment consists of
1. interest on unpaid balance of loan
2. a reduction of loan principal
• Companies initially record mortgage notes payable
at face value

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Long-Term Notes Payable (1 of 2)
Illustration: Porter Technology Inc. issues a $500,000, 8%, 20-
year mortgage note on December 31, 2022. The terms
provide for annual installment payments of $50,926.
(B) (C) (D)
(A) Interest Reduction of Principal
Interest Cash Expense Principal Balance
Period Payment (D) × 8% (A) − (B) (D) − (C)
Issue date $500,000
1 $50,926 $40,000 $10,926 489,074
2 50,926 39,126 11,800 477,274
3 50,926 38,182 12,744 464,530
4 50,926 37,162 13,764 450,766

LO7 Copyright ©2019 John Wiley & Sons, Inc. 89

Long-Term Notes Payable (2 of 2)
Illustration: Porter Technology records the mortgage loan and
first installment payment as follows:

Dec. 31 Cash 500,000  

  Mortgage Payable   500,000
       

  Interest Expense 40,000  

  Mortgage Payable 10,926  
  Cash   50,926
       

LO7 Copyright ©2019 John Wiley & Sons, Inc. 90

Learning Objective 8
Compare the Accounting for Liabilities
Under GAAP and IFRS

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A Look at IFRS (1 of 5)
Similarities
• The basic definition of a liability under GAAP and IFRS is very
similar.
• Liabilities as defined by the IASB
• A present obligation of the entity arising from past
events, the settlement of which is expected to result in
an outflow from the entity of resources embodying
economic benefits

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A Look at IFRS (2 of 5)
Similarities
• Accounting for current liabilities such as notes payable,
unearned revenue, and payroll taxes payable are similar
between GAAP and IFRS.
• IFRS requires that companies classify liabilities as current or
noncurrent on the face of the statement of financial position
• Except in industries where a presentation based on liquidity
would be considered to provide more useful information
(such as financial institutions)
• When current liabilities (also called short-term liabilities)
are presented, they are generally presented in order of
liquidity.

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A Look at IFRS (3 of 5)
Similarities
• Under IFRS, liabilities are classified as current if they are
expected to be paid within 12 months.
• Similar to GAAP, items are normally reported in order of
liquidity.
• Companies sometimes show liabilities before assets.
• Sometimes long-term liabilities are shown before current
liabilities.
• The basic calculation for bond valuation is the same under
GAAP and IFRS. In addition, the accounting for bond liability
transactions is essentially the same between GAAP and IFRS.

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A Look at IFRS (4 of 5)
Similarities
• IFRS requires use of the effective-interest method for
amortization of bond discounts and premiums.
• GAAP also requires the effective-interest method, except that
it allows use of the straight-line method where the difference
is not material.
• Under IFRS, companies do not use a premium or discount
account but instead show the bond at its net amount. For
example, if a $100,000 bond was issued at 97, under IFRS a
company would record:
Cash 97,000
Bonds Payable 97,000
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A Look at IFRS (5 of 5)
Differences
• Accounting for convertible bonds differs between IFRS and
GAAP.
• Unlike GAAP, IFRS splits the proceeds from the convertible
bond between an equity component and a debt
component.
• The equity conversion rights are reported in equity.
• Under IFRS, companies sometimes will net current liabilities
against current assets to show working capital on the face of
the statement of financial position.

LO8 Copyright ©2019 John Wiley & Sons, Inc. 96

Copyright
Copyright © 2019 John Wiley & Sons, Inc.
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Section 117 of the 1976 United States Act without the express written permission of the
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responsibility for errors, omissions, or damages, caused by the use of these programs or
from the use of the information contained herein.

Copyright ©2019 John Wiley & Sons, Inc. 97