15-1 Chapter 10 Liabilities Learning Objectives After studying this chapter, you should be able to: 15-2 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 or converted. 7. Describe the accounting for long-term notes payable. 8. Identify the methods for the presentation and analysis of long-term liabilities. Preview of Chapter 10 Financial Accounting Eighth Edition Weygandt Kieso Kimmel 15-3 Current Liabilities Current liability is debt with two key features: 1. Company expects to pay the debt from existing current assets or through the creation of other current liabilities. 2. Company will pay the debt 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 payable, salaries payable, and interest payable. 15-4 LO 1 Explain a current liability, and identify the major types of current liabilities. Current Liabilities Question To be classified as a current liability, a debt must be expected to be paid: a. out of existing current assets. b. by creating other current liabilities. c. within 2 years. d. both (a) and (b). 15-5 LO 1 Explain a current liability, and identify the major types of current liabilities. Current Liabilities Notes Payable 15-6 Written promissory note. Require the borrower to pay interest. Issued for varying periods. LO 2 Describe the accounting for notes payable. Current Liabilities Illustration: First National Bank agrees to lend $100,000 on September 1, 2014, if Cole Williams Co. signs a $100,000, 12%, four-month note maturing on January 1. Instructions a) Prepare the entry on September 1. b) Prepare the adjusting entry on December 31, assuming monthly adjusting entries have not been made. c) Prepare the entry at maturity (January 1, 2015). 15-7 LO 2 Describe the accounting for notes payable. Current Liabilities Illustration: First National Bank agrees to lend $100,000 on September 1, 2014, if Cole Williams Co. signs a $100,000, 12%, four-month note maturing on January 1. a) Prepare the entry on September 1. Cash 100,000 Notes payable 100,000 b) Prepare the adjusting entry on Dec. 31. Interest expense 4,000 Interest payable 4,000 $100,000 x 12% x 4/12 = $4,000 15-8 LO 2 Describe the accounting for notes payable. Current Liabilities Illustration: First National Bank agrees to lend $100,000 on September 1, 2014, if Cole Williams Co. signs a $100,000, 12%, four-month note maturing on January 1. c) Prepare the entry at maturity (January 1, 2015). Notes payable Interest payable Cash 15-9 100,000 4,000 104,000 LO 2 Describe the accounting for notes payable. Current Liabilities Sales Tax Payable 15-10 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 state’s department of revenue. LO 3 Explain the accounting for other current liabilities. Current Liabilities Illustration: The March 25 cash register reading for Cooley Grocery shows sales of $10,000 and sales taxes of $600 (sales tax rate of 6%), the journal entry is: Cash 10,600 Sales revenue Sales tax payable 15-11 10,000 600 LO 3 Explain the accounting for other current liabilities. Current Liabilities Payroll and Payroll Taxes Payable The term “payroll” pertains to both: Salaries - managerial, administrative, and sales personnel (monthly or yearly rate). Wages - store clerks, factory employees, and manual laborers (rate per hour). Determining the payroll involves computing three amounts: (1) gross earnings, (2) payroll deductions, and (3) net pay. 15-12 LO 3 Explain the accounting for other current liabilities. Current Liabilities Illustration: Assume a corporation records its payroll for the week of March 7 as follows: Mar. 7 Salaries and wages expense 100,000 FICA tax payable 7,650 Federal income tax payable 21,864 State income tax payable 2,922 Salaries and wages payable 67,564 Record the payment of this payroll on March 11. Mar. 11 Salaries and wages payable Cash 15-13 67,564 67,564 LO 3 Current Liabilities Payroll tax expense results from three taxes that governmental agencies levy on employers. These taxes are: 15-14 FICA tax Federal unemployment tax State unemployment tax LO 3 Explain the accounting for other current liabilities. Current Liabilities Illustration: Based on the corporation’s $100,000 payroll, the company would record the employer’s expense and liability for these payroll taxes as follows. Payroll tax expense 13,850 FICA tax payable Federal unemployment tax payable State unemployment tax payable 15-15 7,650 800 5,400 LO 3 Explain the accounting for other current liabilities. Current Liabilities Question Employer payroll taxes do not include: a. Federal unemployment taxes. b. State unemployment taxes. c. Federal income taxes. d. FICA taxes. 15-16 LO 3 Explain the accounting for other current liabilities. 15-17 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. 15-18 LO 3 Explain the accounting for other current liabilities. Current Liabilities Illustration: Assume that Superior University sells 10,000 season football tickets at $50 each for its five-game home schedule. The university makes the following entry for the sale of season tickets: Aug. 6 Cash Unearned revenue 500,000 500,000 As the school completes each of the five home games, it would record the revenue earned. Sept. 7 15-19 Unearned revenue Ticket revenue 100,000 100,000 LO 3 Explain the accounting for other current liabilities. Current Liabilities Current Maturities of Long-Term Debt 15-20 Portion of long-term debt that comes due in the current year. No adjusting entry required. LO 3 Explain the accounting for other current liabilities. Statement Presentation and Analysis Illustration 10-5 15-21 LO 3 Current Liabilities Question Working capital is calculated as: a. current assets minus current liabilities. b. total assets minus total liabilities. c. long-term liabilities minus current liabilities. d. both (b) and (c). 15-22 LO 3 Explain the accounting for other current liabilities. Statement Presentation and Analysis Analysis Illustration 10-6 Liquidity refers to the ability to pay maturing obligations and meet unexpected needs for cash. The current ratio permits us to compare the liquidity of differentsized companies and of a single company at different times. 15-23 Illustration 10-7 LO 3 Explain the accounting for other current liabilities. ANATOMY OF A FRAUD Art was a custodial supervisor for a large school district. The district was supposed to employ between 35 and 40 regular custodians, as well as 3 or 4 substitute custodians to fill in when regular custodians were missing. Instead, in addition to the regular custodians, Art “hired” 77 substitutes. In fact, almost none of these people worked for the district. Instead, Art submitted time cards for these people, collected their checks at the district office, and personally distributed the checks to the “employees.” If a substitute’s check was for $1,200, that person would cash the check, keep $200, and pay Art $1,000. Total take: $150,000 The Missing Control Human Resource Controls. Thorough background checks should be performed. No employees should begin work until they have been approved by the Board of Education and entered into the payroll system. No employees should be entered into the payroll system until they have been approved by a supervisor. All paychecks should be distributed directly to employees at the official school locations by designated employees. Independent internal verification. Budgets should be reviewed monthly to identify situations where actual costs significantly exceed budgeted amounts. 15-24 Long-Term Liabilities Bond Basics A form of interest-bearing notes payable. To obtain large amounts of long-term capital. Three advantages over common stock: 1. Stockholder control is not affected. 2. Tax savings result. 3. Earnings per share may be higher. 15-25 LO 4 Explain why bonds are issued, and identify the types of bonds. Bond Basics Effects on earnings per share—stocks vs. bonds. Illustration 10-9 15-26 LO 4 Explain why bonds are issued, and identify the types of bonds. Current Liabilities 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. 15-27 LO 4 Explain why bonds are issued, and identify the types of bonds. Bond Basics Secured and Unsecured (debenture) bonds. ♦ Term and Serial bonds. ♦ Bonds issued in the name of the owner. Convertible and Callable bonds. 15-28 Bonds that mature at a single specified future date. Registered and Bearer (or coupon) bonds. ♦ ♦ Have specific assets of issuer pledged as collateral for the bonds. Bonds that can be converted into common stock at the bondholder’s option. Bond Basics Types of Bonds 15-29 LO 4 Bond Basics Issuing Procedures 15-30 State laws grant corporations the power to issue bonds. Board of directors and stockholders must approve bond issues. Board of directors must stipulate number of bonds to be authorized, total face value, and contractual interest rate. Bond contract known as a bond indenture. Paper certificate, typically a $1,000 face value. LO 4 Explain why bonds are issued, and identify the types of bonds. Bond Basics Issuing Procedures 15-31 Represents a promise to pay: ► sum of money at designated maturity date, plus ► periodic interest at a contractual (stated) 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. LO 4 Explain why bonds are issued, and identify the types of bonds. Bond Basics Issuer of Bonds Illustration 10-10 Maturity Date 2017 DUE 2017 DUE 2017 Contractual Interest Rate 15-32 Face or Par Value LO 4 Bond Basics Determining the Market Value of Bonds Market value is a function of the three factors that determine present value: 1. dollar 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. 15-33 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 common stock. 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. 15-34 LO 5 Prepare the entries for the issuance of bonds and interest expense. Accounting for Bond Issues Issue at Par, Discount, or Premium? Illustration 10-12 Bond Contractual Interest Rate of 10% 15-35 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. 15-36 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. 15-37 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 Corporation issues $100,000, five-year, 10% bonds at 100 (100% of face value). The entry to record the sale is: Jan. 1 Cash Bonds payable 15-38 100,000 100,000 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 payment of interest on July 1, 2014, assume no previous accrual. July 1 Interest expense Cash 15-39 5,000 5,000 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 Interest payable 15-40 5,000 5,000 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 Discount on bonds payable Bond payable 15-41 92,639 7,361 100,000 LO 5 Prepare the entries for the issuance of bonds and interest expense. Issuing Bonds at a Discount Statement Presentation Illustration 10-13 Carrying value or book value Sale of bonds below face value causes the total cost of borrowing to be more than the bond interest paid. The reason: Borrower is required to pay the bond discount at the maturity date. Thus, the bond discount is considered to be a increase in the cost of borrowing. 15-42 LO 5 Prepare the entries for the issuance of bonds and interest expense. Issuing Bonds at a Discount Total Cost of Borrowing Illustration 10-14 Illustration 10-15 15-43 LO 5 Prepare the entries for the issuance of bonds and interest expense. Issuing Bonds at a Discount Question Discount on Bonds Payable: a. has a credit balance. b. is a contra account. c. is added to bonds payable on the balance sheet. d. increases over the term of the bonds. 15-44 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 Bonds payable Premium on bond payable 15-45 108,111 100,000 8,111 LO 5 Prepare the entries for the issuance of bonds and interest expense. Issuing Bonds at a Premium Statement Presentation Illustration 10-16 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. 15-46 LO 5 Prepare the entries for the issuance of bonds and interest expense. Issuing Bonds at a Premium Total Cost of Borrowing Illustration 10-17 Illustration 10-18 15-47 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 Cash 15-48 100,000 100,000 LO 6 Describe the entries when bonds are redeemed or converted. 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 less unamortized bond discount or plus unamortized bond premium at the redemption date. 15-49 LO 6 Describe the entries when bonds are redeemed or converted. 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. 15-50 LO 6 Describe the entries when bonds are redeemed or converted. Accounting for Bond Retirements Illustration: Assume 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 Premium on bonds payable 1,623 Loss on bond redemption 1,377 Cash 15-51 100,000 103,000 LO 6 Describe the entries when bonds are redeemed or converted. Accounting for Bond Retirements Converting Bonds into Common Stock Until conversion, the bondholder receives interest on the bond. For the issuer, the bonds sell at a higher price and pay a lower rate of interest than comparable debt securities without the conversion option. Upon conversion, the company transfers the carrying value of the bonds to paid-in capital accounts. No gain or loss is recognized. 15-52 LO 6 Describe the entries when bonds are redeemed or converted. Accounting for Bond Retirements Illustration: On July 1 Saunders Associates converts $100,000 bonds sold at face value into 2,000 shares of $10 par value common stock. Both the bonds and the common stock have a market value of $130,000. Saunders makes the following entry to record the conversion: Bonds payable 15-53 100,000 Common stock (2,000 x $10) 20,000 Paid-in capital in excess of par value 80,000 LO 6 Describe the entries when bonds are redeemed or converted. Accounting for Bond Retirements Question When bonds are converted into common stock: a. a gain or loss is recognized. b. the carrying value of the bonds is transferred to paid-in capital accounts. c. the market price of the stock is considered in the entry. d. the market price of the bonds is transferred to paid-in capital. 15-54 LO 6 Describe the entries when bonds are redeemed or converted. 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 the term of the loan. Each payment consists of interest on the unpaid balance of the loan and a reduction of loan principal. Companies initially record mortgage notes payable at face value. 15-55 LO 7 Describe the accounting for long-term notes payable. Accounting for Other Long-Term Liabilities Illustration: Porter Technology Inc. issues a $500,000, 12%, 20year mortgage note on December 31, 2014. The terms provide for semiannual installment payments of $33,231 (not including real estate taxes and insurance). The installment payment schedule for the first two years is as follows. Illustration 10-19 15-56 LO 7 Describe the accounting for long-term notes payable. Accounting for Other Long-Term Liabilities Illustration: Porter Technology Inc. issues a $500,000, 12%, 20year mortgage note on December 31, 2014. The terms provide for semiannual installment payments of $33,231 (not including real estate taxes and insurance). The installment payment schedule for the first two years is as follows. Dec. 31 Cash 500,000 Mortgage payable Jun. 30 Interest expense Mortgage payable Cash 15-57 500,000 30,000 3,231 33,231 LO 7 Describe the accounting for long-term notes payable. Accounting for Other Long-Term Liabilities Question Each payment on a mortgage note payable consists of: a. interest on the original balance of the loan. b. reduction of loan principal only. c. interest on the original balance of the loan and reduction of loan principal. d. interest on the unpaid balance of the loan and reduction of loan principal. 15-58 LO 7 Describe the accounting for long-term notes payable. 15-59 Statement Presentation and Analysis Presentation Illustration 10-20 15-60 LO 8 Identify the methods for the presentation and analysis of long-term liabilities. Statement Presentation and Analysis Analysis Two ratios that provide information about debt-paying ability and long-run solvency are: 15-61 Debt to Total Assets Ratio Times Interest Earned Ratio LO 8 Identify the methods for the presentation and analysis of long-term liabilities. Statement Presentation and Analysis Analysis Illustration: Kellogg had total liabilities of $8,925 million, total assets of $11,200 million, interest expense of $295 million, income taxes of $476 million, and net income of $1,208 million. The higher the percentage of debt to total assets, the greater the risk that the company may be unable to meet its maturing obligations. 15-62 LO 8 Statement Presentation and Analysis Analysis Illustration: Kellogg had total liabilities of $8,925 million, total assets of $11,200 million, interest expense of $295 million, income taxes of $476 million, and net income of $1,208 million. Times interest earned indicates the company’s ability to meet interest payments as they come due. 15-63 LO 8 15-64 APPENDIX 10A PRESENT VALUE CONCEPTS RELATED TO BOND PRICING Present Value of Face Value Illustration: Assume that you are willing to invest a sum of money that will yield $1,000 at the end of one year, and you can earn 10% on your money. What is the $1,000 worth today? To compute the answer, 1. divide the future amount by 1 plus the interest rate ($1,000/1.10 = $909.09 OR 2. use a Present Value of 1 table. ($1,000 X .90909) = $909.09 (10% per period, one period from now). 15-65 LO 9 Compute the market price of a bond. Present Value of Face Value To compute the answer, 1. divide the future amount by 1 plus the interest rate ($1,000/1.10 = $909.09. Illustration 10A-1 15-66 LO 9 Compute the market price of a bond. Present Value of Face Value To compute the answer, 2. use a Present Value of 1 table. ($1,000 X .90909) = $909.09 (10% per period, one period from now). 15-67 LO 9 Compute the market price of a bond. Present Value of Face Value The future amount ($1,000), the interest rate (10%), and the number of periods (1) are known Illustration 10A-2 15-68 LO 9 Compute the market price of a bond. Present Value of Face Value If you are to receive the single future amount of $1,000 in two years, discounted at 10%, its present value is $826.45 [($1,000 1.10) 1.10]. Illustration 10A-3 15-69 LO 9 Compute the market price of a bond. Present Value of Face Value To compute the answer using a Present Value of 1 table. ($1,000 X .82645) = $826.45 (10% per period, two periods from now). 15-70 LO 9 Compute the market price of a bond. Present Value of Interest Payments (Annuities) In addition to receiving the face value of a bond at maturity, an investor also receives periodic interest payments (annuities) over the life of the bonds. To compute the present value of an annuity, we need to know: 1) interest rate, 2) number of interest periods, and 3) amount of the periodic receipts or payments. 15-71 LO 9 Compute the market price of a bond. Present Value of Interest Payments (Annuities) Assume that you will receive $1,000 cash annually for three years and the interest rate is 10%. Illustration 10A-5 15-72 LO 9 Compute the market price of a bond. Present Value of Interest Payments (Annuities) Assume that you will receive $1,000 cash annually for three years and the interest rate is 10%. Illustration 10A-6 15-73 LO 9 Compute the market price of a bond. Present Value of Interest Payments (Annuities) Assume that you will receive $1,000 cash annually for three years and the interest rate is 10%. $1,000 annual payment x 2.48685 = $2,486.85 15-74 LO 9 Compute the market price of a bond. 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 15-75 Present value of the periodic interest payments discounted at the investor’s required rate of return LO 9 Compute the market price of a bond. Computing the Present Value 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 15-76 LO 9 Compute the market price of a bond. Computing the Present Value 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 15-77 LO 9 Compute the market price of a bond. Computing the Present Value 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 15-78 LO 9 Compute the market price of a bond. Computing the Present Value 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 15-79 LO 9 Compute the market price of a bond. APPENDIX 10B EFFECTIVE-INTEREST METHOD OF BOND AMORTIZATION Under the effective-interest method, the amortization of bond discount or bond premium results in period interest expense equal to a constant percentage of the carrying value of the bonds. Required steps: 1. Compute the bond interest expense. 2. Compute the bond interest paid or accrued. 3. Compute the amortization amount. 15-80 LO 10 Apply the effective-interest method of amortizing bond discount and bond premium. Effective-Interest Method of Bond Amortization Amortizing Bond Discount Illustration: Candlestick, Inc. issues $100,000 of 10%, five-year bonds on January 1, 2014, for $92,639, with interest payable each July 1 and January 1. This results in a discount of $7,361. Illustration 10B-2 15-81 LO 10 Apply the effective-interest method of amortizing bond discount and bond premium. Amortizing Bond Discount Illustration: Candlestick, Inc. issues $100,000 of 10%, five-year bonds on January 1, 2014, for $92,639, with interest payable each July 1 and January 1. This results in a discount of $7,361. Journal entry on July 1, 2014, to record the interest payment and amortization of discount is as follows: July 1 Interest Expense Cash 5,000 Discount on Bonds Payable 15-82 5,558 558 LO 10 Apply the effective-interest method of amortizing bond discount and bond premium. Amortizing Bond Premium Illustration: Candlestick, Inc. issues $100,000 of 10%, five-year bonds on January 1, 2014, for $108,111, with interest payable each July 1 and January 1. This results in a premium of $8,111. Illustration 10B-4 15-83 LO 10 Apply the effective-interest method of amortizing bond discount and bond premium. Amortizing Bond Premium Illustration: Candlestick, Inc. issues $100,000 of 10%, five-year bonds on January 1, 2014, for $108,111, with interest payable each July 1 and January 1. This results in a premium of $8,111. Journal entry on July 1, 2014, to record the interest payment and amortization of premium is as follows: July 1 Interest Expense Premium on Bonds Payable Cash 15-84 4,324 676 5,000 LO 10 Apply the effective-interest method of amortizing bond discount and bond premium. APPENDIX 10B STRAIGHT-LINE AMORTIZATION Amortizing Bond Discount Illustration: Candlestick, Inc., sold $100,000, five-year, 10% bonds on January 1, 2014, for $92,639 (discount of $7,361). Interest is payable on July 1 and January 1. Illustration 10C-2 15-85 LO 11 Apply the straight-line method of amortizing bond discount and bond premium. Amortizing Bond Discount Illustration: Candlestick, Inc., sold $100,000, five-year, 10% bonds on January 1, 2014, for $92,639 (discount of $7,361). Interest is payable on July 1 and January 1. The bond discount amortization for each interest period is $736 ($7,361/10). Journal entry on July 1, 2014, to record the interest payment and amortization of discount is as follows: July 1 Interest Expense 5,736 Discount on Bonds Payable Cash 15-86 736 5,000 LO 11 Apply the straight-line method of amortizing bond discount and bond premium. Amortizing Bond Premium Illustration: Candlestick, Inc., sold $100,000, five-year, 10% bonds on January 1, 2014, for $108,111 (premium of $8,111). Interest is payable on July 1 and January 1. Illustration 10C-4 15-87 LO 11 Apply the straight-line method of amortizing bond discount and bond premium. Amortizing Bond Discount Illustration: Candlestick, Inc., sold $100,000, five-year, 10% bonds on January 1, 2014, for $108,111 (premium of $8,111). Interest is payable on July 1 and January 1. The bond premium amortization for each interest period is $811 ($8,111/10). Journal entry on July 1, 2014, to record the interest payment and amortization of premium is as follows: July 1 Interest Expense 4,189 Premium on Bonds Payable Cash 15-88 811 5,000 LO 11 Apply the straight-line method of amortizing bond discount and bond premium. Key Points 15-89 Liabilities are defined by the IASB as 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. Liabilities may be legally enforceable via a contract or law but need not be; that is, they can arise due to normal business practice or customs. IFRS requires that companies classify liabilities as current or noncurrent on the face of the statement of financial position (balance sheet), 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. Key Points 15-90 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. Also, they will sometimes show non-current (long-term) liabilities before current liabilities. Under IFRS, companies sometimes will net current liabilities against current assets to show working capital on the face of the statement of financial position. (This is evident in the Zetar financial statements in Appendix C.) The basic calculation for bond valuation is the same under GAAP and IFRS. Key Points IFRS requires use of the effective-interest method for amortization of bond discounts and premiums. GAAP 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 15-91 97,000 Key Points 15-92 The accounting for convertible bonds differs across 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. Looking to the Future The FASB and IASB are currently involved in two projects, each of which has implications for the accounting for liabilities. One project is investigating approaches to differentiate between debt and equity instruments. The other project, the elements phase of the conceptual framework project, will evaluate the definitions of the fundamental building blocks of accounting. The results of these projects could change the classification of many debt and equity securities. 15-93 IFRS Self-Test Questions Which of the following is false? a) Under IFRS, current liabilities must always be presented before noncurrent liabilities. b) Under IFRS, an item is a current liability if it will be paid within the next 12 months. c) Under IFRS, current liabilities are shown in order of liquidity. d) Under IFRS, a liability is only recognized if it is a present obligation. 15-94 IFRS Self-Test Questions The accounting for bonds payable is: a) essentially the same under IFRS and GAAP. b) differs in that GAAP requires use of the straight-line method for amortization of bond premium and discount. c) the same except that market prices may be different because the present value calculations are different between IFRS and GAAP. d) not covered by IFRS. 15-95 IFRS Self-Test Questions The joint projects of the FASB and IASB could potentially: a) change the definition of liabilities. b) change the definition of equity. c) change the definition of assets. d) All of the above. 15-96 Copyright “Copyright © 2012 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.” 15-97