ACG 2021
Financial Accounting
Current & Long-Term Liabilities
Learning Objectives
► Account
for current liabilities and contingent
liabilities
► Account for bonds-payable transactions
► Measure interest expense
► Understand the advantages and
disadvantages of borrowing
► Statement of Cash Flow Effects
Current Liabilities
►
Liabilities due within 1 year
or the company’s operating
cycle if longer
 Known amounts
Payable
► Short-term Notes Payable
► Sales Tax Payable
► Current Installment of
Long-Term Debt
► Accrued Expenses
► Payroll Liabilities
► Unearned Revenues
►
►
► Accounts
►
We increase Liabilities with
a credit.
So to increase any of the
Known payables on the
left, we credit the payable
for the known amount.
We must therefore, debit
 a corresponding expense
account (accrued expenses)
 Cash (deferred liability)
 Long-term debt
 Cash (if recording receipt
from a note payable)
Accounts Payable
► Amounts
owed for purchases of goods or services
on account
 The purchase can be for an Asset
► Inventory
(generally largest)
 The purchase could also be an Expense
► Legal
Fees (service)
 No interest associated with money owed, and it is
assumed the A/P will be paid quickly
we have an A/P for Inventory purchased on
account, what does the company we purchased
the inventory from have?
► If
 An Accounts Receivable
Note Payable
► Unlike
Accounts Payable
► Usually contains interest payments that are
due
► Record:
 Issuance of Note Payable
►We
borrowed Cash and have an obligation to pay
back
 Interest Expense
 Payment of Note Payable
Notes Payable
On Jan. 30, 20X5 the company received a one year $8,000
note payable at 10% interest to purchase inventory.
Jan 30
Cash
Note Payable, Short-term
8,000
8,000
Purchase of inventory by issuing a
1-year 10% note payable
Interest must be accrued at fiscal year end (April 30) for
interest owed but not yet due.
Apr 30
Interest Expense (8,000 x .10 x 3/12)
Interest Payable
200
Adjusting entry to accrue interest expense
200
Notes Payable
To record repayment at maturity Jan 30 20x6:
Jan. 30
Note Payable, short-term
Interest Payable
8,000
200
Interest Expense ($8,000 x .10 x 9/12) 600
Cash [($8,000 x .10) + 8,000]
8,800
Payment of a note payable and interest at maturity
Step 1: Reverse the balance in the Note Payable account to 0
Step 2: Reduce the amount of any Interest Payable from a previous period to 0
Step 3: Record the Interest Expense for the period
Step 4: Record the cash (Principal and Interest paid)
Payroll Liabilities
► Types




of Compensation
Salary
Wage
Commission
Bonus
expense is gross pay.
► Salary payable is net pay.
► Salary
Payroll Liabilities
To record payroll
Jan. 30
Salary Expense
Employee Income Tax Payable
FICA Tax Payable
Salary Payable to Employees
To record salary expense
10,000
1,200
800
8,000
Sales Tax Payable
To record sales of $200,000 plus 5% sales tax:
Cash (200,000 x 1.05)
210,000
Sales Revenue
Sales Tax Payable (200,000 x .05)
To record cash sales and related sales tax
200,000
10,000
Unearned Revenues
To record collection of cash in payment for future services:
Jan 30
Cash
Unearned Ticket Revenue
1,200
1,200
Received cash in advance for ticket sales
To record revenue after 50% of services have been
performed.
Apr 30
Unearned Ticket Revenue
Ticket Revenue
600
Earned revenue that was collected in advance
600
Current Liabilities
► Amounts
that must be estimated
 Estimated Warranty Payable
►How
many products will need repair / replacement
►Matching Principle
►Estimate based on past historical data
 Contingent Liabilities
►An
company may incur an expense in the future
 Most commonly associated with law suits
Estimated Warranty Payable
Warranty expense should be recognized in the year the
product is sold. For example, a company made sales of
$200,000 subject to product warranties. They estimate that
3% of the products will require repair or replacement.
Warranty Expense
Estimated Warranty Payable
6,000
6,000
To accrue warranty expense
When $5,800 of products are replaced under the warranty:
Estimated Warranty Payable
Inventory
5,800
To replace defective products under warranty
5,800
Contingent Liabilities
► Contingent
liability depends on a future
event arising out of past events.
► To account for contingent losses:
 Record liability if it is probable and can be
reasonably estimated.
 Report the liability in the notes to the financial
statements (but do not record an entry) if it is
reasonably possible that a loss will occur.
 Do not report a contingent loss that is not likely
to occur.
ACG 2021
Financial Accounting
Long – Term Liabilities
Bonds Payable
Bonds
► IOU’s
► $1000
or $5000 Increments
► Sold in the “Market”
► Structure:
 Maturity Date
 Interest Rate
 Interest Payment Dates
► Provide
two payments:
 Interest every 6 months
 Principal amount of Bond
Bond Market
► Bloomberg.com
Bonds Payable
► Bonds
payable are debt (i.e. a liability) of
the issuing company.
► Types of bonds:
 term bonds
►All
bonds mature at the same time (end of the term)
 serial bonds
►Bonds
mature in installments over a period of time.
 secured bonds (mortgage bonds)
 debentures (unsecured bonds)
Bonds Payable
► Bonds
can be issued (bought)
 at face value
 for a premium
 at a discount
► Bond
Price is determined by:
 Market Interest Rate – Effective Rate
 Bond’s Interest Rate – Contract Rate
 THESE RATES ARE USUALLY DIFFERENT!
Bond Interest Rates
► Bonds
are sold at market price - amount that
investors are willing to pay at any given time
► Market price represents:
 present value of periodic interest payments
 present value of principal to be received at maturity
Present Value
The amount invested today to receive a greater
amount at a future date
It depends on:
 amount of the future receipt
 length of time to future receipt
 interest rate for the period
Bond Interest Rates
► Contract
rate – stated rate
► Market rate – effective rate
Present Value Calculation (Discount)
► $100,000
10 year bond, 9% stated interest,
10% market rate
► Two parts: PV of principle and PV of interest
payments
 $100,000 x .614*
= $61,400
 100,000 x. 045 x 7.722* = $34,749
 PV of Bonds
$96,149
* From Appendix C
Bond Prices
► Bond
Face Value = Stated Principal
► Bond issued above face (par) value -
premium
► Bond
issued at below face (par) value -
discount
► As
a bond nears maturity, its market price
moves toward par value
Bond Prices
Quoted at a percent of their maturity value.
A $1,000 bond quoted at 101½ sells for…
$1,000 × 1.015 = $1,015.
A $1,000 bond quoted at 88-3/8 sells
for… $1,000 × 0.88375 = $883.75.
Bond Payable
► Purchase
a $1,000
Bond
► Bond Pays = 9%
► Invest
$1,000 in
Market at 9%
► Market Interest = $90
 Bond Interest = $90
► Bond
Pays = 10%
 Bond Interest = $100
► Bond
Pays = 8%
 Bond Interest = $80
How much would you pay for 9% bond, 10% bond, 8% bond?
ACG 2021
Financial Accounting
Accounting for Bonds Payable
Accounting for Bonds
► Record
Issuance of Bond
► Record Payment of Interest
► Record Accrual of Interest
Credit Cash
Credit Interest Payable
 Record Amortization of Discount/Premium
►Effective
Interest Method
►Straight-Line Method
► Record
Retirement of Bond
Bonds Payable
$50 million in 9%, 5 year bonds are issued on Jan 1, 2006 at
par.
Cash
Bonds Payable
50,000,000
50,000,000
To issue bonds at par
First interest payment on July 1.
Interest Expense
Cash
2,250,000
2,250,000
To pay semiannual interest
$50,000,000 x .09 x 6/12
Bonds Payable
At year end, accrue interest to be paid on Jan.1
Interest Expense
Interest Payable
2,250,000
To accrue interest
$50,000 x .09 x 6/12
2,250,000
Bonds Payable at Discount
$100,000 in 9%, 5 year bonds are issued when the market
rate is 10% for $96,149.
Cash
Discount on Bonds Payable
Bonds Payable
To issue bonds at a discount
96,149
3,851
100,000
Bonds Payable at Discount
► Discount
on Bonds Payable is a contra
account to Bonds Payable.
► Carrying amount of the bonds equals
Bonds Payable less Discount on Bonds
Payable.
► Interest payments are fixed by contract, but
interest expense varies as the bond discount
is amortized.
Bonds Payable Premium
$100,000 in 9%, 5 year bonds are issued when the market
rate is 8% for $104,100.
Cash
104,100
Premium on Bonds Payable
Bonds Payable
To issue bonds at a premium
4,100
100,000
Bonds Payable at Premium
► Premium
on Bonds Payable is normal
liability account (not a contra-account)
► Carrying amount of the bonds equals
Bonds Payable plus Premium on Bonds
Payable.
► Interest payments are fixed by contract, but
interest expense varies as the bond
premium is amortized.
Bonds Payable Discount Example
► Issue
Date – January 1, 2006
► Maturity value - $100,000
► Stated interest rate – 9%
► Interest paid – 4 ½% semiannually
► Market rate at time of issue – 10%
annually, 5% semiannually
► Issue Price – $96,149
Bonds Payable Discount Example
Amortization Table (partial)
A
Semiannual
interest
Date
Jan 1, 2006
Jul 1
Jan 1, 2007
Jul 1
*
*
*
Jan 1, 2011
B
C
D
Interest
Interest Expense
Payment
(5% of
(4 ½% Preceding
Discount
of
Discount
Account
Bond
Maturity Carrying Amortization
Balance
Value
(B-A)
(Preceding D -C)
Amount)
3851
4,500
$ 4,807
$ 307
$3,544
4,500
4,823
323
3,221
4,500
4,839
339
2,882
*
*
*
*
*
*
*
*
*
*
*
*
4,500
4,961
461
-0-
E
Bond
Carrying
Amount
($100,000 – D)
$ 96,149
96,456
96,779
97,118
*
*
*
100,000
Bonds Payable Discount Journal Entries
First semiannual interest payment at Jul 1.
Interest Expense
4,807
Discount on Bonds Payable
307
Cash
4,500
To pay semiannual interest and amortize bond discount
Second semiannual interest accrual at Dec 31.
Interest Expense
4,823
Discount on Bonds Payable
323
Interest Payable
4,500
To accrue semiannual interest and amortize bond discount
Bonds Payable Premium Example
► Issue
Date – January 1, 2006
► Maturity value - $100,000
► Stated interest rate – 9%
► Interest paid – 4 ½% semiannually
► Market rate at time of issue – 8% annually,
4% semiannually
► Issue Price – $104,100
Bonds Payable Premium Example
Amortization Table (partial)
A
Semiannual
interest
Date
Jan 1, 2006
Jul 1
Jan 1, 2007
Jul 1
*
*
*
Jan 1, 2011
B
C
D
Interest
Interest Expense
Payment
(4% of
(4 ½% Preceding
Premium
of
Premium
Account
Bond
Maturity Carrying Amortization
Balance
Value
(A - B)
(Preceding D -C)
Amount)
$4,100
4,500
$ 4,164
$ 336
3,764
4,500
4151
349
3415
4,500
4137
363
3052
*
*
*
*
*
*
*
*
*
*
*
*
4,500
3,955
545
-0-
E
Bond
Carrying
Amount
($100,000 +D)
$ 104,100
103,764
103,415
103,052
*
*
*
100,000
Bonds Payable Premium Example
First semiannual interest payment at Jul 1.
Interest Expense
4,164
Premium on Bonds Payable
336
Cash
4,500
To pay semiannual interest and amortize bond premium
Second semiannual interest accrual at Dec 31.
Interest Expense
4,151
Premium on Bonds Payable
349
Interest Payable
4,500
To accrue semiannual interest and amortize bond premium
Exercise 8-13
Straight-Line Amortization
► Divide
bond discount (or premium) into
equal periodic amounts over the bond’s
term.
 This equal amount is Interest Expense
 Interest expense is the same each period.
► GAAP
permits straight line only when the
amounts differ insignificantly from amounts
determined using the effective interest
method.
Straight-Line
► Using
the previous Chrysler Example
$100,000 in 9%, 5 year bonds are issued when the market
rate is 8% for $104,100.
►
Premium Amortization = $4100/10 = $410
 10 = 5 years x 2 interest payments per year
Straight Line Journal Entries
First semiannual interest payment at Jul 1.
Interest Expense
4,090
Premium on Bonds Payable
410
Cash
4,500
To pay semiannual interest and amortize bond premium
Second semiannual interest accrual at Dec 31.
Interest Expense
4,090
Premium on Bonds Payable
410
Interest Payable
4,500
To accrue semiannual interest and amortize bond premium
Issuing Bonds Payable
at a Discount
Chrysler’s balance sheet immediately after issuance
of the bonds:
Total current liabilities
Long-term liabilities:
Bonds payable, 9%, due 2009
Discount on bonds payable
$ XXX
$100,000
( 3,851) 96,149
Discount on Bonds Payable - contra account
to Bonds Payable
Issuing Bonds Payable
at a Premium
Chrysler’s balance sheet immediately after issuance
of the bonds:
Total current liabilities
Long-term liabilities:
Bonds payable
$100,000
Premium on bonds payable
4,100
$ XXX
$104,100
Exercise 8-10
ACG 2021
Financial Accounting
Retiring Bonds
Bonds Retired at Maturity
► After
Recording final interest payment
 Reduce Bond Payable
 Reduce Cash Account
Bonds Payable 100,000
Cash
100,000
Retiring Callable Bonds
► Callable
Bonds
 Bonds that can be paid off early
 Call Price
►Often
at greater then par value (101 or 102)
 Thus management has to decide to pay call
premium or
 Buy Bonds on the Open Market
Early Retirement of Bonds
Payable
Air Products and Chemicals, Inc., has $70,000
of debenture bonds outstanding with
unamortized discount of $350. The market
price is 99¼.
Early Retirement of Bonds
Payable
Par value of bonds
Less: Unamortized discount
Carrying amount of the bonds
Market price ($70,000 × 0.9925)
Extraordinary gain on retirement
$70,000
( 350)
$69,650
69,475
$ 175
General Journal
Date
Accounts and Explanations
Bonds Payable
Discount on Bonds Payable
Cash
Gain on Retirement of Bonds
To record bond retirement
PR
Debit
Credit
70,000
350
69,475
175
Convertible Bonds and Notes
► May
be converted into the issuing company’s
common stock.
► Assume note holders convert half of $300 million
convertible notes into 4 million shares of stock ($1
par).
Notes Payable
150,000,000
Common Stock (4 million at $1 par)
4,000,000
Paid-in Capital in Excess of par-Common
146,000,000
To record conversion of notes payable
Financing with Bonds or Stock?
► Issuing
stock
 creates no liabilities
 incurs no interest expense
 less risky to issuing corporation
► Issuing
notes or bonds payable
 does not dilute stock ownership or control of
the corporation
 usually results in higher earnings per share
[EPS is the amount of net income for each
share of its stock]
Reporting Financing Activities on
the Statement of Cash Flows
Amounts in millions
Cash Flow from Financing Activities:
Proceeds from issuance of bonds
Proceeds from long-term borrowings
Payment of long-term debt
Proceeds from issuance of common stock
Payments of cash dividends
Other, net
Net cash provided by financing activities
Year Ended
December 31
$754
32
(29)
351
(371)
(4)
$733
ACG 2021
Financial Accounting
Ratio Analysis
Times Interest Earned
Times interest earned ratio
Income from Operations
Times interest earned =
Interest Expense
The ability of a company to pay it’s Interest Expense Obligations
from Earnings Generated from Operations
BlackBoard Inc.
BlackBoard T.I.E.
► 2006
 -11,826 / 5354 = -2.21
► 2005
 24,447 / 49 = 498.92
► 2004
 10,033 / 179 = 56.05
Best Buy, Inc.
Best Buy – T.I.E.
► 2007
 1,999 / 31 = 64.48
► 2006
 1,644 / 30 = 54.8
► 2005
 1,442 / 44 = 32.77
End of Chapter 8