Chapter
Seven
Accounting
for
Liabilities
© 2015 McGraw-Hill Education.
Accounting for Notes Payable
09/01/14 Borrowing
On September 1, 2014 Herrera Supply Company
(HSC) borrowed $90,000 from the National Bank.
HSC issued a note payable due in one year with an
annual interest rate of 9%.
Assets =
Cash =
90,000 =
Liab.
+
Stockholders' Equity
Notes
Com.
Pay. + Int. Pay. + Stk. + Ret. Earn.
+ n/a +
90,000 +
n/a
n/a
Net
Revenue - Expenses = Income
n/a - n/a = n/a
Cash
Flow
90,000 FA
7-2
Accrual of Interest Expense
12/31/14 Recognition of Interest Expense
At the end of 2014, HSC must accrue interest on its
note payable.
$90,000 × 9% × 4/12 = $2,700 interest expense
Assets
Cash
n/a
=
Liabilities
= Notes Pay. +
=
n/a
+
+
Int. Pay. +
2,700 +
Stockholders' Equity
Com.
Stk.
+ Ret. Earn.
n/a
+
(2,700)
Revenue - Expenses =
n/a
2,700 =
Net
Income
(2,700)
Cash Flow
n/a
7-3
Paying principal & interest at
maturity date
08/31/15 Recognition of interest expense. Payment of
principal and interest on the maturity date, August 31.
$90,000 × 9% × 8/12 = $5,400 interest expense
Assets
Cash
n/a
=
Liabilities
= Notes Pay. +
=
n/a
+
+
Int. Pay. +
5,400 +
Stockholders' Equity
Com.
Stk.
+ Ret. Earn.
n/a
+
(5,400)
Revenue - Expenses =
n/a
5,400 =
Net
Income
(5,400)
Cash Flow
n/a
Now, record payment of principal and interest payable.
Assets
=
Liabilities
Cash
= Notes Pay. +
(8,100) =
n/a
+
=
(90,000)
(90,000) +
+
Int. Pay.
+
(8,100) +
+
n/a
Stockholders' Equity
Com.
Stk.
+ Ret. Earn.
n/a
+
n/a
n/a
+
n/a
Revenue
n/a
n/a
-
Expenses
n/a
n/a
=
=
=
Net
Income
n/a
n/a
Cash Flow
(8,100) OA
(90,000) FA
7-4
Accounting for Sales Tax
Most states require retail companies to collect sales
tax on items sold to their customers. The retailer then
remits the tax to the state at regular intervals. Sales
tax is a liability to the retailer until paid to the state.
HSC sells merchandise to a customer for $2,000 cash in a
state where the sales tax rate is 6%.
Assets
=
Liabilities +
Sales Tax
Cash
=
Pay
+
2,120 =
120 +
Stockholders' Equity
Com.
Stk.
+ Ret. Earn.
n/a
+
2,000
Revenue 2,000 -
Expenses =
n/a
=
Net
Income
2,000
Cash Flow
2,120 OA
7-5
Accounting for Sales Tax
Remitting the tax (paying cash to the state tax
authority) is an asset use transaction.
Assets
= Liabilities +
Sales Tax
Cash
=
+
Pay
(120) =
(120) +
Stockholders' Equity
Com.
Ret.
+ Earn.
Stk.
n/a
+
n/a
Revenue - Expenses =
n/a
n/a
=
Net
Income
n/a
Cash
Flow
(120) OA
7-6
Reporting Contingent Liabilities
7-7
Warranty Obligations
To attract customers, many companies guarantee their
products or services. Within the warranty period, the
seller promises to replace or repair defective products
without charge.
Event 1
Sale of Merchandise
HSC sells $7,000 of merchandise for cash. The merchandise
had a cost of $4,000.
Assets
Cash
Liab.
+ Inventory =
7,000 +
n/a
=
+
n/a
+
Equity
+
Ret. Earn.
=
n/a
+
7,000
(4,000) =
n/a
+
(4,000)
Rev.
-
7,000 n/a
-
Net
Income
Exp.
=
Cash Flow
n/a
=
7,000
7,000
4,000 =
(4,000)
n/a
OA
7-8
Warranty Obligations
Event 2 Recognition of Warranty Expense
HSC estimates that warranty expense associated with
the current sale will be $100.
Assets
n/a
=
=
=
Liabilities
Warr. Pay
100
+
Equity
+ Ret. Earn.
+
(100)
Revenue
n/a
-
Expenses
100
=
=
Net
Income
(100)
Cash Flow
n/a
7-9
Warranty Obligations
Event 3 Settlement of Warranty Obligation
HSC pays $40 cash to repair defective merchandise
returned by a customer.
Assets
=
Cash
=
(40) =
Liabilities
+
Warr. Pay +
(40) +
Equity
Ret. Earn.
n/a
Revenue
n/a
-
Expenses
n/a
=
=
Net
Income
n/a
Cash Flow
(40) OA
7-10
Financial Statements
Balance Sheet
Income Statement
Sales Revenue
Cost of Goods Sold
Gross Margin
Warranty Expense
Net Income
$
$
7,000
(4,000)
3,000
(100)
2,900
Assets
Cash
Inventory
Total Assets
Liabilities
Warranties Payable
Stockholders' Equity
Common Stock
Retained Earnings
Total Liab. & Stockholders' Equity
$
$
8,960
2,000
10,960
60
$
5,000
5,900
10,960
Statement of Cash Flows
Operating Activities
Inflow from Customers
Outflows for Warranty
Net Inflows From Oper.
Investing Activities
Financing Activities
Beginning Cash Balance
Ending Cash Balance
$
$
7,000
(40)
6,960
0
0
2,000
8,960
7-11
Installment Notes Payable
Cash payment determined using present value
concepts presented in a later chapter.
Unpaid
Cash
Amount
Amount
Principal
Accounting Balance on Payment on Applied to Applied to
Period
January 1 December 31 Interest Principal
2014
$
100,000 $
25,709 $
9,000 $ 16,709
2015
83,291
25,709
7,496
18,213
2016
65,078
25,709
5,857
19,852
2017
45,226
25,709
4,070
21,639
2018
23,587
25,710
2,123
23,587
All computations rounded to the nearest dollar; after the 2018 payment the loan balance is 0.
7-12
Installment Notes Payable
Annual
payments are
constant.
$30,000
$25,000
$20,000
Interest
Principal
$15,000
$10,000
$5,000
$Year 1
Year 2
Year 3
Year 4
Year 5
With each payment the amount applied to the principal
increases and the amount applied to interest decreases.
7-13
Line of Credit
Lagoon Company borrows money using a line of credit to finance
building up its inventory. Lagoon repays the loan over the summer
using cash generated from sales. (Interest rates generally fluctuate based
on a designated interest rate benchmark.)
Each borrowing is an asset source transaction. Each
repayment is an asset use transaction.
7-14
Bonds Issued at Face Value
Mason Company issues bonds on January 1, 2011.
2014.
Principal = $100,000
Stated Interest Rate = 9%
Interest Date = 12/31
Maturity Date = Dec. 31, 2015
2018 (5 years)
Bond Selling Price
Mason
Company
Bond Certificate
at Face Value
Investors
7-15
Bonds Issued at Face Value
Event 1 Issue Bonds for Cash
Issuing the bonds has the following effect on Mason’s 2014
financial statements:
Assets
Cash
100,000
=
=
=
Liabilities
Bonds
Pay.
100,000
+
Equity
+
+
Revenue
n/a
n/a
-
Expenses
n/a
=
=
Net
Income
n/a
Cash
Flow
100,000 FA
Event 2 Investment in Land
Paying $100,000 cash to purchase land is an asset
exchange transaction.
Assets
Cash
(100,000)
=
+
Land
100,000
=
Liabilities +
n/a
Equity
+
n/a
Net
Revenue - Expenses = Income
n/a
-
n/a
=
n/a
Cash
Flow
(100,000) IA
7-16
Bonds Issued at Face Value
Event 3 Revenue Recognition
Recognizing $12,000 cash revenue from renting the
property is an asset source transaction.
Assets
Cash
12,000
=
=
=
Liabilities
n/a
+
+
+
Equity
Ret.
Earn.
12,000
Revenue
12,000
-
Expenses
n/a
=
=
Net
Income
12,000
Cash
Flow
12,000 OA
Event 4 Expense Recognition
Mason’s $9,000 ($100,000 x 0.09) cash payment in each of
the 5 years represents interest expense.
Assets
=
Cash
=
(9,000) =
Liabilities
n/a
+
Equity
+ Ret. Earn.
+
(9,000)
Revenue
n/a
-
Expenses
9,000
=
=
Net
Income
(9,000)
Cash Flow
(9,000) OA
7-17
Bonds Issued at Face Value
Event 5 Sale of Investment in Land
Selling the land for cash equal to its $100,000 book value is
an asset exchange transaction.
Assets
Cash
100,000
=
+
Land
(100,000)
Liabilities +
=
Equity
+
n/a
n/a
Cash
Flow
100,000
Net
Income
Revenue - Expenses =
n/a
-
n/a
=
n/a
IA
Event 6 Payoff of Bond Liability
The principal repayment on December 31, 2018 will have the
following effect on Mason’s 2018 financial statements:
Assets
=
Liabilities
+
Cash
= Bonds Pay. +
(100,000) =
(100,000) +
Equity
n/a
Revenue
n/a
-
Expenses
n/a
=
=
Net
Income
n/a
Cash Flow
(100,000) FA
7-18
Bonds Issued at a Discount
$100,000 face issued at 95:
Bonds Payable
Less: Discount on Bonds Payable
Carrying Value
$100,000
(5,000)
$ 95,000
Bond Selling Price
Mason
Company
Bond Certificate
at Face Value
Investors
7-19
Bonds Issued at a Premium
$100,000
Mason
Company
face issued
issues
at 105:
bonds on January 1, 2011.
Principal
= $100,000
Bonds
Payable
$100,000
Stated
InterestonRate
= 9%
Plus:
Premium
Bonds
Payable
5,000
Interest Date = 12/31
Carrying Value
$ 105,000
Maturity Date = Dec. 31, 2015 (5 years)
Bond Selling Price
Mason
Company
Bond Certificate
at Face Value
Investors
7-20
Current Versus Noncurrent
Current assets are expected to be converted to cash or
consumed within one year or an operating cycle,
whichever is longer. Current assets include:
•Cash
•Marketable Securities
•Accounts Receivable
•Short-Term Notes Receivable
•Interest Receivable
•Inventory
•Supplies
•Prepaid Items
7-21
Current Versus Noncurrent
Current liabilities are due within one year or an
operating cycle, whichever is longer. Current liabilities,
also called short-term liabilities, include:
•Accounts Payable
•Short-Term Notes Payable
•Wages Payable
•Taxes Payable
•Interest Payable
7-22
End of Chapter Seven
7-23