LECTURE 10
LIABILITIES
PART 1
10-1
Chapter 10 Liabilities
Learning Objectives
After studying this chapter, you should be able to:
1. Explain a current liability, and identify the major types of current
liabilities.
2. Describe the accounting for notes payable.
3. Explain the accounting for other current liabilities.
4. Explain why bonds are issued, and identify the types of bonds.
5. Prepare the entries for the issuance of bonds and interest expense.
6. Describe the entries when bonds are redeemed.
7. Describe the accounting for long-term notes payable.
8. Identify the methods for the presentation.
10-2
Current Liabilities
Current liability
A debt that the company expects to pay within one
year or the operating cycle, whichever is longer.
Most companies pay current liabilities by using current
assets.
Current liabilities include notes payable, accounts payable, unearned
revenues, and accrued liabilities such as taxes, salaries and wages, and
interest payable.
10-3
LO 1 Explain a current liability, and identify the
major types of current liabilities.
Current Liabilities
Question
The time period for classifying a liability as current is one
year or the operating cycle, whichever is:
a. longer
b. shorter
c. probable
d. possible
10-4
LO 1 Explain a current liability, and identify the
major types of current liabilities.
Current Liabilities
Notes Payable
Recorded obligation in the form of written notes.
Usually require the borrower to pay interest.
Issued for varying periods of time.
Those due for payment within one year of the statement
of financial position date are usually classified as current
liabilities.
10-5 LO 2 Describe the accounting for notes payable.
Current Liabilities
Illustration: Hong Kong National Bank agrees to lend
HK$100,000 on September 1, 2014, if C.W. Co. signs a
HK$100,000, 12%, four-month note maturing on January 1.
Instructions
a) Prepare the journal entry on September 1.
b) Prepare the adjusting journal entry on December 31,
assuming monthly adjusting entries have not been made.
c) Prepare the journal entry at maturity (January 1, 2015).
10-6 LO 2 Describe the accounting for notes payable.
Current Liabilities
Illustration: Hong Kong National Bank agrees to lend
HK$100,000 on September 1, 2014, if C.W. Co. signs a
HK$100,000, 12%, four-month note maturing on January 1.
a) Prepare the journal entry on September 1.
Cash 100,000
Notes payable 100,000
b) Prepare the adjusting journal entry on Dec. 31.
Interest expense 4,000
Interest payable 4,000
HK$100,000 x 12% x 4/12 = HK$4,000
10-7 LO 2 Describe the accounting for notes payable.
Current Liabilities
Illustration: Hong Kong National Bank agrees to lend
HK$100,000 on September 1, 2014, if C.W. Co. signs a
HK$100,000, 12%, four-month note maturing on January 1.
c) Prepare the journal entry at maturity (January 1, 2015).
Notes payable 100,000
Interest payable 4,000
Cash 104,000
10-8 LO 2 Describe the accounting for notes payable.
Current Liabilities
Sales Tax Payable
Sales taxes are expressed as a stated percentage of
the sales price.
Either rung up separately or included in total receipts.
Retailer collects tax from the customer.
Retailer remits the collections to the government’s
department of revenue.
10-9 LO 3 Explain the accounting for other current liabilities.
Current Liabilities
Illustration: The March 25 cash register reading for Cooley
Grocery shows sales of NT$10,000 and sales taxes of NT$600
(sales tax rate of 6%), the journal entry is:
Cash 10,600
Sales revenue 10,000
Sales tax payable 600
10-10 LO 3 Explain the accounting for other current liabilities.
Current Liabilities
Unearned Revenue
Revenues that are received before the company delivers goods
or provides services.
1. Company debits Cash, and credits
a current liability account
(Unearned Revenue).
2. When the company earns the
revenue, it debits the
Unearned Revenue account,
and credits a Revenue account.
10-11 LO 3 Explain the accounting for other current liabilities.
Current Liabilities
Illustration: Busan IPark (KOR) sells 10,000 season football
tickets at W 50,000 each for its five-game home schedule. The
club makes the following entry for the sale of season tickets (in
thousands of W):
Aug. 6 Cash 500,000
Unearned ticket revenue
As each game is500,000
completed, Busan IPark records the revenue
earned.
Sept. 7 Unearned ticket revenue 100,000
Ticket revenue
10-12 100,000
LO 3 Explain the accounting for other current liabilities.
Current Liabilities
Current Maturities of Long-Term Debt
Portion of long-term debt that comes due in the
current year.
Considered a current liability.
No adjusting journal entry required.
10-13 LO 3 Explain the accounting for other current liabilities.
Statement Presentation and Analysis
Presentation
Current liabilities are presented after non-current
liabilities on the statement of financial position.
A common method of presenting current liabilities is to
list them by order of magnitude, with the largest ones
first.
10-14 LO 3 Explain the accounting for other current liabilities.
Statement Presentation and Analysis
Illustration 10-3
10-15 LO 3 Explain the accounting for other current liabilities.
Non-Current Liabilities
Obligations that are expected to be paid after one year.
Bond Basics
A form of interest-bearing notes payable.
To obtain large amounts of long-term capital.
Three advantages over ordinary shares:
1. Shareholder control is not affected.
2. Tax savings result.
3. Earnings per share may be higher.
10-16 LO 4 Explain why bonds are issued, and identify the types of bonds.
Bond Basics
Effects on earnings per share—equity vs. debt.
Illustration 10-7
10-17 LO 4 Explain why bonds are issued, and identify the types of bonds.
Bond Basics
Question
The major disadvantages resulting from the use of bonds
are:
a. that interest is not tax deductible and the principal
must be repaid.
b. that the principal is tax deductible and interest must
be paid.
c. that neither interest nor principal is tax deductible.
d. that interest must be paid and principal repaid.
10-18 LO 4 Explain why bonds are issued, and identify the types of bonds.
Bond Basics
Types of Bonds
10-19 LO 4
Bond Basics
Issuing Procedures
Government laws grant corporations power to issue
bonds.
Board of directors and shareholders must approve bond
issues.
Board of directors must stipulate number of bonds to be
authorized, total face value, and contractual interest rate.
Terms of the bond are set forth in a legal document
called a bond indenture.
Issuing company arranges for printing of bond
certificates.
10-20 LO 4 Explain why bonds are issued, and identify the types of bonds.
Bond Basics
Issuing Procedures
Represents a promise to pay:
► face value at designated maturity date, plus
► periodic interest at a contractual (stated) interest
rate on the maturity amount (face value).
Interest payments usually made semiannually.
Generally issued when the amount of capital needed is
too large for one lender to supply.
10-21 LO 4 Explain why bonds are issued, and identify the types of bonds.
Bond Basics
Issuer
Issuer of
of
Bonds
Bonds Illustration 10-8
2017
Maturity
Maturity
Date
Date
DUE 2017 DUE 2017
Contractual
Contractual
Interest
Interest
Rate
Rate
Face
Face or
or
10-22 Par
Par Value
Value LO 4
Bond Basics
Bond Trading
Bondholders can sell their bonds, at any time, at the
current market price on national securities exchanges.
Bond prices are quoted as a percentage of the face value.
Application
(1) What is the price of a $1,000 bond trading at 95 1/4?
(2) What is the price of a $1,000 bond trading at 101 7/8?
$952.50 $1,018.75
10-23 LO 4 Explain why bonds are issued, and identify the types of bonds.
Bond Basics
Bond Trading
Bondholders can sell their bonds, at any time, at the
current market price on national securities exchanges.
Bond prices are quoted as a percentage of the face value.
Newspapers and the financial press publish bond prices
and trading activity daily.
Illustration 10-9
10-24 LO 4 Explain why bonds are issued, and identify the types of bonds.
Bond Basics
Bond Trading
Bondholders can sell their bonds, at any time, at the
current market price on national securities exchanges.
Bond prices are quoted as a percentage of the face value.
Newspapers and the financial press publish bond prices
and trading activity daily.
A corporation makes journal entries only when it issues
or buys back bonds, or when bondholders exchange
convertible bonds into ordinary shares.
10-25 LO 4 Explain why bonds are issued, and identify the types of bonds.
Bond Basics
Determining the Market Value of Bonds
Market value is a function of the three factors that determine
present value:
1. amounts to be received,
2. length of time until the amounts are received, and
3. market rate of interest.
The features of a bond (callable, convertible, and so on) affect the
market rate of the bond.
10-26 LO 4 Explain why bonds are issued, and identify the types of bonds.
Accounting for Bond Issues
Corporation records bond transactions when it
issues (sells),
retires (buys back) bonds and
when bondholders convert bonds into ordinary shares.
NOTE: If bondholders sell their bond investments to other investors,
the issuing firm receives no further money on the transaction, nor
does the issuing corporation journalize the transaction.
10-27 LO 5 Prepare the entries for the issuance of bonds and interest expense.
Accounting for Bond Issues
Issue at Par, Discount, or Premium?
Illustration 10-10
Bond
Contractual
Interest Rate
of 10%
10-28 LO 5 Prepare the entries for the issuance of bonds and interest expense.
Accounting for Bond Issues
Question
The rate of interest investors demand for loaning funds to
a corporation is the:
a. contractual interest rate.
b. face value rate.
c. market interest rate.
d. stated interest rate.
10-29 LO 5 Prepare the entries for the issuance of bonds and interest expense.
Accounting for Bond Issues
Question
Karson 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.
10-30 LO 5 Prepare the entries for the issuance of bonds and interest expense.
Accounting for Bond Issues
Issuing Bonds at Face Value
Illustration: On January 1, 2014, Candlestick Inc. issues
€100,000, five-year, 10% bonds at 100 (100% of face value).
The entry to record the sale is:
Jan. 1 Cash 100,000
Bonds payable 100,000
10-31 LO 5 Prepare the entries for the issuance of bonds and interest expense.
Issuing Bonds at Face Value
Illustration: On January 1, 2014, Candlestick Inc. issues
€100,000, five-year, 10% bonds at 100 (100% of face value).
Assume that interest is payable semiannually on January 1 and
July 1. Prepare the entry to record the payment of interest on
July 1, 2014, assume no previous accrual.
July 1 Interest expense 5,000
Cash 5,000
(€100,000 x 10% x 6/12)
10-32 LO 5 Prepare the entries for the issuance of bonds and interest expense.
Issuing Bonds at Face Value
Illustration: On January 1, 2014, Candlestick Corporation
issues €100,000, five-year, 10% bonds at 100 (100% of face
value). Assume that interest is payable semiannually on
January 1 and July 1. Prepare the entry to record the accrual
of interest on December 31, 2014, assume no previous
accrual.
Dec. 31 Interest expense 5,000
Interest payable 5,000
10-33 LO 5 Prepare the entries for the issuance of bonds and interest expense.
Accounting for Bond Issues
Issuing Bonds at a Discount
Illustration: On January 1, 2014, Candlestick, Inc. sells
€100,000, five-year, 10% bonds for €92,639 (92.639% of face
value). Interest is payable on July 1 and January 1. The entry
to record the issuance is:
Jan. 1 Cash 92,639
Bonds payable 92,639
10-34 LO 5 Prepare the entries for the issuance of bonds and interest expense.
Issuing Bonds at a Discount
Statement Presentation
Illustration 10-11
Carrying value or
book value
The issuance of bonds below face value—at a discount—causes the
total cost of borrowing to differ from the bond interest paid.
The reason: Borrower is required to pay the difference between the
issuance price and face value—the discount—at the maturity date.
Thus, the discount is considered to be an additional cost of
borrowing.
10-35 LO 5 Prepare the entries for the issuance of bonds and interest expense.
Issuing Bonds at a Discount
Total Cost of Borrowing
Illustration 10-12
Illustration 10-13
10-36 LO 5 Prepare the entries for the issuance of bonds and interest expense.
Accounting for Bond Issues
Issuing Bonds at a Premium
Illustration: On January 1, 2014, Candlestick, Inc. sells
€100,000, five-year, 10% bonds for €108,111 (108.111% of
face value). Interest is payable on July 1 and January 1. The
entry to record the issuance is:
Jan. 1 Cash 108,111
Bonds payable 108,111
10-37 LO 5 Prepare the entries for the issuance of bonds and interest expense.
Issuing Bonds at a Premium
Statement Presentation
Illustration 10-14
The sale of bonds above face value causes the total cost of
borrowing to be less than the bond interest paid.
The reason: The borrower is not required to pay the bond premium at
the maturity date of the bonds. Thus, the bond premium is considered
to be a reduction in the cost of borrowing.
10-38 LO 5 Prepare the entries for the issuance of bonds and interest expense.
Issuing Bonds at a Premium
Total Cost of Borrowing
Illustration 10-15
Illustration 10-16
10-39 LO 5 Prepare the entries for the issuance of bonds and interest expense.
Accounting for Bond Retirements
Redeeming Bonds at Maturity
Assuming that the company pays and records separately the
interest for the last interest period, Candlestick records the
redemption of its bonds at maturity as follows:
Bond payable 100,000
Cash 100,000
10-40 LO 6 Describe the entries when bonds are redeemed.
Accounting for Bond Retirements
Redeeming Bonds before Maturity
When bonds are retired before maturity, it is necessary to:
1. eliminate carrying value of bonds at redemption date;
2. record cash paid; and
3. recognize gain or loss on redemption.
The carrying value of the bonds is the face value of the bonds
adjusted for the bond discount or bond premium amortized up to the
redemption date.
10-41 LO 6 Describe the entries when bonds are redeemed.
Accounting for Bond Retirements
Question
When bonds are redeemed before maturity, the gain or
loss on redemption is the difference between the cash
paid and the:
a. carrying value of the bonds.
b. face value of the bonds.
c. original selling price of the bonds.
d. maturity value of the bonds.
10-42 LO 6 Describe the entries when bonds are redeemed.
Accounting for Bond Retirements
Illustration: Candlestick, Inc. has sold its bonds at a premium.
At the end of the eighth period, Candlestick retires these bonds
at 103 after paying the semiannual interest. The carrying value
of the bonds at the redemption date is €101,623. Candlestick
makes the following entry to record the redemption at the end
of the eighth interest period (January 1, 2018):
Bonds payable 101,623
Loss on bond redemption 1,377
Cash 103,000
10-43 LO 6 Describe the entries when bonds are redeemed.
Statement Presentation
Presentation
Illustration 10-18
10-44
LO 8 Identify the methods for the presentation
and analysis of non-current liabilities.
Computing the Present Value of a Bond
Selling price of a bond is equal to the sum of:
Present value of the face value of the bond discounted
at the investor’s required rate of return
PLUS
Present value of the periodic interest payments
discounted at the investor’s required rate of return
10-45 LO 9 Compute the market price of a bond.
Computing the Market Price of a Bond
Assume a bond issue of 10%, five-year bonds with a face value
of €100,000 with interest payable semiannually on January 1
and July 1.
Illustration 10A-8
10-46 LO 9 Compute the market price of a bond.
Computing the Market Price of a Bond
Assume a bond issue of 10%, five-year bonds with a face value
of €100,000 with interest payable semiannually on January 1
and July 1.
Illustration 10A-9
10-47 LO 9 Compute the market price of a bond.
Computing the Market Price of a Bond
Assume a bond issue of 10%, five-year bonds with a face value
of €100,000 with interest payable semiannually on January 1
and July 1.
Illustration 10A-10
10-48 LO 9 Compute the market price of a bond.
Computing the Market Price of a Bond
Assume a bond issue of 10%, five-year bonds with a face value
of €100,000 with interest payable semiannually on January 1
and July 1.
Illustration 10A-11
10-49 LO 9 Compute the market price of a bond.
THE END
10-50
