Chapter 10 – Reporting and Interpreting Liabilities
What You Really Need to Know
Current Liabilities
Much of this section is a review. There are only a couple of new accounts added. If you
need a refresher, go back to Chapter 4 to review adjusting entries for accruals, or return
to Chapter 7 to review timelines, accruals, and the calculation of interest on notes.
Long-term Liabilities
More accounting terminology games! Keep track of these common, equivalent terms for
use in later accounting or finance classes: face value is also called par value; the stated
interest rate is also called the coupon rate or contract rate; and the market interest rate is
also called a yield, a discount rate or an effective-interest rate.
Actual market price is set using present value calculations which are shown in Appendix
D of this textbook. Check with your instructor if you need to review the appendix and/or
be able to perform the calculations!
Bonds issued at Face Value (the amount which is repaid at maturity) – These transactions
look a lot like the ones for notes payable. Cash comes in when the bond is issued.
Interest is accrued and then paid at a later date. Money is repaid at the end of the term.
What the
bonds say
6%
Stated
Interest Rate
What if bondholders
desire….
What bondholders think
The bonds
Issue at
4% Market
Interest Rate
I’ll pay more than
face value
Premium
6% Market
Interest Rate
It’s just enough
Face value
8% Market
Interest Rate
I’m not attracted
(yet)
Discount
Bonds Issued at a Discount – There are two differences in the journal entries from a bond
issued at face value:
1. When the bond is issued, there is less cash received than the face value (the Bonds
Payable amount which is repaid at maturity).
2. The Discount on Bonds Payable (which is a contra-liability account) is amortized
(slowly decreased over the life of the bond) and added to the Interest Expense
account.
Phillips et al. Fundamentals of Financial Accounting, 3Ce
Copyright McGraw-Hill Ryerson, 2012
What You Really Need to Know
Page 10-1
Bonds Issued at a Premium – just the opposite of the above! Premium on Bonds Payable
is the account and its amortization decreases Interest Expense.
If bonds are paid off early, losses are recorded on the bottom half of the income statement
under gains and losses (which are not part of operating income).
Two new ratios are covered in this chapter:
Quick Ratio = Cash + Short Term Investments + Accounts Receivable, Net
Current Liabilities
Times Interest Earned = Net Income + Interest Expense + Income Tax Expense
Interest Expense
Phillips et al. Fundamentals of Financial Accounting, 3Ce
Copyright McGraw-Hill Ryerson, 2012
What You Really Need to Know
Page 10-2