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© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Chapter 7
Accounting for and Presentation of
Liabilities
McGraw-Hill/Irwin
McGraw-Hill/Irwin
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The©McGraw-Hill
Companies,
Inc., All
Reserved.
Copyright
2011 by The McGraw-Hill
Companies,
Inc.,Rights
All Rights
Reserved.
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LO1



Nature of Liabilities
Liabilities are obligations that represent
“probable future sacrifice of economic
benefits.”
The term accrued expenses is often used
on the balance sheet to describe liabilities.
Current liabilities are those liabilities that
will be paid within one year of the current
balance sheet date.
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Nature of Liabilities
LO1
Current liabilities include:
• Accounts payable
• Short-term debt (Notes payable)
• Current maturities of long-term debt
• Unearned revenue or deferred credits
• Other accrued liabilities
Noncurrent liabilities include:
• Long-term debt (Bonds payable)
• Deferred tax liabilities
• Minority interest in subsidiaries
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LO2
Interest Calculation Methods
Straight Interest
Interest = Principal × Rate × Time in years
= $25,000 × 0.09 × 1
= $ 2,250 per year or $187.50 per month
Annual Percentage Interest Rate (APR)
APR = Interest Paid ÷ Money available × Time
= $2,250 ÷ $25,000 × 1
= 9%
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LO2
Interest Calculation Methods
Discount Basis - Interest is Paid in Advance
Proceeds = Principal − Interest
= $25,000 − $2,250
= $22,750
Annual Percentage Interest Rate (APR)
APR = Interest Paid ÷ Money available × Time
= $2,250 ÷ $22,750 × 1
= 9.89%
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Unearned Revenue or Deferred
Credits
LO3
Unearned revenue is created when customers pay for
services or products before delivery.
On January 1, 2010, Matrix, Inc. receives $2,400 cash as
an advance payment for a one-year subscription to its
monthly investment newsletter.
Cash received
for one-year
subscription
1/1/10
< – – – – –12-month subscription – – – – – >
1/31/10
Month end
2/28/10
Month end
3/31/10
Month end
Our goal is to recognize
revenue as the subscription
is fulfilled each month.
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Payroll Taxes
LO4
Gross Pay
FICA Taxes
Medicare
Taxes
=
McGraw-Hill/Irwin
- Deductions
Federal
Income Tax
State and
Local Income
Taxes
Voluntary
Deductions
Net Pay
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Liability for Warranties
LO5
It is appropriate to recognize the estimated warranty expense in the same
period as the sale is recorded.
During 2010, Matrix, Inc. sells 1,000 DVD recorders for $500 each.
Each DVD has a two-year warranty. Matrix estimates that
warranty costs will be $30 per recorder.
GENERAL JOURNAL
Date
Account Titles and Explanation
2010
Dec. 31 Cash
Sales revenue
Debit
Credit
500,000
500,000
Financial statement effect of this transaction
Balance Sheet
Assets
Cash
+500,000
McGraw-Hill/Irwin
=
Liabilities
+
Income Statement
Owners'
Equity
Net
income
=
Revenues
Sales
revenue
+500,000
-
Expenses
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Noncurrent Liabilities
LO6
Long-Term Debt
Interest on debt is tax deductible
but dividends on stock are not.
The after-tax cost of debt can be
less than the cost of equities.
Long-term debt can provide positive
financial leverage. Leverage is the
difference between the ROI and the ROE.
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LO6
Financial Leverage
Without Leverage
With Leverage
Balance Sheet
Balance Sheet
Assets
Liabilities
Owners' equity
Total
$ 500,000
500,000
$ 500,000
Assets
Liabilities (8% interest)
Owners' equity
Total
$ 500,000
150,000
350,000
$ 500,000
Income Statement
Income before interest $ 100,000
Interest expense
Net income
$ 100,000
Income Statement
Income before interest $ 100,000
Interest expense
12,000
Net income
$ 88,000
ROI = $100,000 ÷ $500,000 = 20%
ROI = $100,000 ÷ $500,000 = 20%
ROE = $100,000 ÷ $500,000 = 20%
ROE = $88,000 ÷ $350,000 = 25.1%
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LO7
Bonds Payable - Terminology
Interest 10%
Face Value $1,000
6/30 & 12/31
BOND PAYABLE
Maturity Date 12/31/14
Bond Date 1/1/10
Face value is the amount an investor will receive at maturity.
Bond date is the date the bond was issued.
Stated interest rate is typically an annual rate.
Interest payment dates are dates when an investor is paid interest.
Maturity date is the date when the face value of the bond is
repaid to an investor.
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LO8
Issuance of Bonds Payable at a
Discount or a Premium
Market Rate Effect of Bond
Selling Prices
Above the market rate
A premium
Equal to the market rate
Face amount (at par)
Below the market rate
A discount
In the previous example, par value was illustrated:
Stated Rate = Market Rate
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Deferred Tax Liability
LO9
To recognize income taxes for 2010, Matrix
would record the following entry:
GENERAL JOURNAL
Date
Account Titles and Explanation
2010
Dec. 31 Income tax expense
Deferred tax liability
Income tax payable
Debit
Credit
45,000
36,000
9,000
Financial statement effect of this transaction
Balance Sheet
Assets
=
Liabilities
Income tax
payable
+9,000
Deferred tax
liability
+36,000
McGraw-Hill/Irwin
Income Statement
+
Owners'
Equity
Net
income
=
Revenues
-
Expenses
Income tax
expense
−45,000
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LO 9
Other Noncurrent Liabilities
Obligations relating to pension plans and other
employee benefit plans, including deferred
compensation and bonus plans.
Expenses relating to these
plans are accrued and
reflected in the income
statement of the fiscal
period in which the benefits
are earned by the
employees.
McGraw-Hill/Irwin
Some companies pay
postretirement benefits.
For pragmatic reasons,
postretirement benefits
are measured in a
different manner.
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LO 10
Other Noncurrent Liabilities
Minority Interest in Subsidiaries
Financial statements of a parent company and its
subsidiaries are usually combined or consolidated at
the end of the accounting period.
If a parent company owns more than 50% but less
than 100% of a subsidiary, the minority shareholders’
interest in the subsidiary is shown on the balance
sheet of the parent.
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Gain/Loss Contingency
LO 10
Dollar Amount of Potential Loss
Likelihood of
Reasonably
Not Reasonably
Adverse Outcome
Known
Estimable
Estimable
Remote
No Disclosure Note
No Disclosure Note
No Disclosure Note
Reasonably
Disclosure Note Only Disclosure Note Only Disclosure Note Only
Possible
Liability Accrued &
Liability Accrued &
Probable
Disclosure Note Only
Disclosure Note
Disclosure Note
Remote
Reasonably
Possible
Probable
Occurrence
Probability
is Slight.
Occurrence Probability
is More Than Remote
but Less Than Likely.
Occurrence
Probability
is Likely.
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