LIABILITIES
Liabilities
• obligations of an entity to make a future payment
or to deliver goods or services to the third parties
in the future in return for cash borrowed or
service used or goods acquired
• Definite vs. estimated liabilities
• classified according to their due dates
– due within one year or the operating cycle are
classified as current liabilities
– loans or credits that mature in more than one year
are classified as long-term liabilities
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Recognition of Liabilities
• recognized when the obligation occurs for
an entity
• If not recognized
– Understatement of liabilities and assets
– Understatement of liabilities and expenses
• to satisfy the matching and periodicity
principles, adjustments are made at the
end of the accounting periods
Mugan-Akman 2007
3
Valuation of Liabilities
• valued at the cash amount necessary to
pay back the liability or at the fair value of
the goods or services to be provided
• Value
– may be certain
– may be estimated
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4
Current Liabilities
1.
2.
3.
Short Term Bank Loans
Current Portion of Long-term Debt
Trade Payables
1.
2.
4.
5.
6.
7.
8.
9.
Accounts Payable
Notes Payable
Accruals
Unearned Revenues (deferred income)
Payroll Liabilities
Corporate Income Taxes
Value Added Taxes
Product Warranty Liability
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Notes Payable
• Classification
– Purchases on credit
• Trade Payables
– Borrowing
• Financial Liabilities
• Presentation
• Notes with additional interest
– Notes Payable+Interest Payable
• Discounted Notes
– Notes Payable-Discount on Notes Payable
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Payroll Related Liabilities
• An employee usually receives a payment
that is less than the gross pay of that
employee- the net pay
• Deductions:
– Required deductions that must be paid by the
employee according to tax and social security
regulations
– Optional deductions authorized by the
employee for special purposes (such as
private pension plans
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Payroll Liabilities
•
•
•
•
Employee Income Taxes
Stamp Duty
Social Security Premiums
Unemployment Insurance
Premium
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8
TEMPO CORPORATION
PAYROLL OF NOVEMBER 2008
DAYS
GROSS
EMPLOYEE
EMPLOY
TAX
CUMULATIVE INCOME
WORKED
PAY
UIP
SSKP
EXEMPTION
TAX BASE
BASE
TAX
2.000
40
280
188
9.266
1.493
2.000
40
280
188
9.266
1.493
EE
NAME
ALİ GELİR
TOTAL
30
INCOME
STAMP
TOTAL
NET
DUTY
DEDUCTIONS
PAY
224
12
556
224
12
556
EMPLOYER EMPLOYER
TAX
Mugan-Akman 2007
SSKP
UIP
1.444
390
60
1.444
390
60
9
Payroll Entry
Date
Account Title and Description
30-Nov-08 Salary Expense
SSK premiums-expense
Unemployment Insurance Premium-expense
Cash
Taxes Payable-Income Taxes
Taxes Payable-Stamp Duty
SSK Premiums Payable*
To record November payroll
Debit
Credit
2.000
390
60
1.444
224
12
770
cost of the employee to the employer is TL 2.450 - employee receives TL 1.444
* SSK premiums – Employer share
TL 390
Unemployment insurance premium- Employer share
60
SSK premium-Employee share
280
Unemployment insurance premium – Employee share
40
Total payable to SSK
TL 770
Mugan-Akman 2007
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Corporate Income Taxes
• Corporations and limited corporations
• At a rate of 20%
• Quarterly Prepaid:
• as of March 31, June 30, September 30 and
December 31
• annual corporate tax payment computed for the
fiscal year and declared in April the following
year
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Corporate Income Taxes-Example
During 2008:
Mercan jewelry paid a total of TL 13.850
Net Income for 2008 TL 123.750
Assume Tax rate: 20%
Income Tax expense = TL 24.750.
The entry at the end of the fiscal year:
Date
Account Title and Description
31-Dec-08
Income Tax Expense
Prepaid Tax
Income Taxes Payable
To record taxation on income for 2008
Mugan-Akman 2007
Debit
Credit
24.750
13.850
10.900
12
Deferred Taxation
Mugan-Akman 2007
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Deferred Taxation
Income
Statement in
Accordance with
Statutory International
Income
Accounting
Statement Standards
Net Income before
Depreciation
75.000
75.000
Depreciation Expense
4.000
2.000
Net Income before Tax
71.000
73.000
Income Tax Expense
14.200
14.600
Net Income
56.800
58.400
Mugan-Akman 2007
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Value Added Taxes
• When a good is sold or service provided
– VAT is added to sales price and collected from the customer
– NOT a Revenue
• When a purchase of a good or a service realized
– VAT is added to the purchase price and paid to
supplier
– NOT an Expense
• VAT received from customers should be reimbursed to
the Tax Offices
– if VAT on sales > the VAT on purchases →the entity is
required to pay the difference to the Tax Office
– if VAT on purchases exceeds the VAT on sales → the
difference is carried forward to the next month
Mugan-Akman 2007
15
Accounting for VAT transactions
14 April: Purchased 10 items for TL17.110 on
credit including 18% VAT
20 April: Sold 22 items for TL 37.642 on credit
including 18% VAT
20 May: Filed the VAT return
26 May: Paid the necessary amount
Mugan-Akman 2007
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VAT entries
Date
Account Title and Description
Debit
Credit
14-Apr Merchandise Inventory
14.500
VAT Deductible
2.610
Accounts Payable
17.110
To record merchandise purchased on
credit
20-Apr Accounts Receivable
37.642
Sales
31.900
VAT Payable
5.742
To record sales made on April 20
26-May VAT Payable
5.742
VAT Deductible
2.610
Cash
3.132
To record VAT return filed for April; and
payment for VAT
Mugan-Akman 2007
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Provisions and Contingent
Liabilities
• a potential liability arising from a past
transaction and that depends on a future
event
– could be disclosed in the body of the balance
sheet with the liabilities
– could be disclosed within notes to financial
statements
• certainty of the amount and the payment date
determines where they will be disclosed
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Is the amount of
the
liability known?
Recognize liability
on the balance
sheet
YES
NO
Can the amount of
Liability be reasonably
Estimated?
YES
YES
Is the liability likely to
occur? (Probable)
NO
NO
Disclose in the notes
To the financial
Statements
(CONTINGENT
LIABILITY)
Mugan-Akman
2007
19
Product Warranty Liabilities
• When goods and services are sold under warranty
coverage
• A good example of provision
• matching principle - warranty expenses of sales in a
period should be recorded in the same period
• Subsequent expenditures of warranties are charged
against warranty liability
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Mugan-Akman 2007
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Long-term Financing
• Capital or Long-term Liability
• advantages of raising capital
– capital stock is not paid back by the entity
– dividends are distributed only if the entity has enough
income and cash
• advantages of long-term liabilities :
– Shareholder Control
– Tax Effects: Interest payments on liabilities are tax
deductible
– Financial leverage: Financial leverage or trading on
equity means using borrowed money to increase the
rate of return to the shareholders
Mugan-Akman 2007
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Types of Long Term Liabilities
• Bank Loans
• Bonds Issued– bond indenture
– bond certificate
– interest paid: quarterly, semi-annually or
annually
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Mugan-Akman 2007
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Types of Long Term Liabilities
• Bank Loans
• Bonds Issued– bond indenture
– bond certificate
– interest paid: quarterly, semi-annually or
annually
• Installment Loans (consumer loans)
• Lease Obligations
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Types of Bonds
•
•
•
•
Time or Serial Bonds
Callable Bonds
Registered or Bearer Bonds
Convertible Bonds
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Bond terminology
• Stated rate or coupon rate or nominal rate =
contractual rate written on the face of the bond
• Face value or nominal value = value written on the
face of the note
• Maturity date = date when the bonds will be paid
• Life of the bond = duration of the bond
• Maturity value = nominal value
• Market rate or effective rate of interest or yield =
prevalent rate on the market for similar term and risk
bonds
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Stated Interest and Market
Interest Rate
Stated Interest Rate = Market Interest Rate
Bond is sold at Par
Stated Interest Rate < Market Interest Rate
Bond is sold at Discount
Stated interest Rate > Market Interest Rate
Bond is Sold at Premium
Mugan-Akman 2007
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Price Determination
•
Sumatek Corp. decided to issue TL100.000 bonds with a stated interest rate
of 11% maturing in 5 years. The interest is payable semiannually on 30
June and 31 December of each year. Interest paid every six months is TL
11.000/2 =TL 5.500.
If the market rate on 1 January 2004, was 12%
Present Value of the Maturity Value (Principal)
(100.000 x 0,558; n=10 i=6%)(Table1)
Present Value of Interest Payments
(5.500 x 7,360; n=10 i=6%)(Table 2)
Price of the Bond
= TL 55.800
=
40.480
TL 96.280
If the market rate on 1 January 2004, was 10%
Present Value of the Maturity Value (Principal)
(100.000 x 0,614; n=10 i=5%)(Table 1)
Present Value of Interest Payments
(5.500 x 7,722; n=10 i=5%)(Table 2)
Price of the Bond
Mugan-Akman 2007
= TL 61.400
=
42.471
TL 103.871
29
Bond Interest Expense
Bonds Sold Bonds Sold Bonds Sold
at Discount
at Par
at Premium
Principal Payment at Maturity TL 100.000 TL 100.000
TL 100.000
Total Interest Paid in Cash
(TL 100.000*11% /year*5
years)
55.000
55.000
55.000
Total Cash Payments until
Maturity
TL 155.000 TL 155.000
TL 155.000
Total Cash Received at the
Issue Date
96.280
100.000
103.871
Total Interest Expense of the
Bond Issue
TL 58.720 TL 55.000
TL 51.129
Mugan-Akman 2007
30
Bonds issued at par
• Sumatek Corp. ,TL100.000 bonds, 11%,5yrs
Date
Account Title and Description
1-Jan-04 Cash
Debit
Credit
100.000
Bonds Payable
To record bonds issued at par
100.000
30 June 2004 , the first interest payment date, the Company will pay TL5.500
Date
Account Title and Description
30-Jun-04 Interest Expense
Cash
To record interest paid on bonds
Mugan-Akman 2007
Debit
Credit
5.500
5.500
31
Accounting for Discounts on Bonds Payable
The market interest rate on 1 January 2004 - 12% and the TL 100.000 bonds
were issued at TL 96.280 or at 96.28
Date
Account Title and Description
1-Jan-04 Cash
Unamortized Bond Discount
Bonds Payable
To record bonds issued at market rate of 12%
Debit
Credit
96.280
3.720
100.000
partial balance sheet of Sumatek Corp. after the issue of the bonds will show
(in TL )
Bonds Payable
100.000
Less: Unamortized Bond Discount
Net Bonds Payable (Outstanding Debt)
Mugan-Akman 2007
3.720
96.280
32
Effective Interest Method of
Amortization of Bond Discounts
• acceptable method of amortizing the bond
discounts
• interest expense of each period is
computed using the market interest rate
over the carrying value of the bonds
Mugan-Akman 2007
33
Amortization of Bond Discount
(Effective
Interest)
Interest
Total
Amortization
Carrying
Interest Paid in
Unamortized
Payment Interest
Periods Expense (A)
of Discount
Value of
Discount (D)
(C )
Bonds (E)
Cash (B)
((E)*12%/2) (100.000*11%/2)
Issue
Date
1
(A-B)
(3.720-C)
100.000-(D)
0
0
0
3.720
96.280
5.777
5.500
277
3.443
96.557
Mugan-Akman 2007
34
Amortization of Bond Discount
((E)*12%/2) (100.000*11%/2)
(A-B)
(3.720-C) 100.000-(D)
(Effective
Interest)
Issue
Date
0
0
0
3.720
96.280
1
5.777
5.500
277
3.443
96.557
2
5.793
5.500
293
3.150
96.850
Mugan-Akman 2007
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Amortization of Bond Discount
(Effective Interest)
Interest
Total Interest
Payment
Expense (A)
Periods
((E)*12%/2)
Issue Date
Interest Paid in
Cash (B)
Amortization
of Discount
(C )
Unamortized
Discount (D)
Carrying
Value of
Bonds (E)
(100.000*11%/2)
(A-B)
(3.720-C)
100.000-(D)
0
0
0
3.720
96.280
1
5.777
5.500
277
3.443
96.557
2
5.793
5.500
293
3.150
96.850
3
5.811
5.500
311
2.839
97.161
4
5.830
5.500
330
2.509
97.491
5
5.849
5.500
349
2.160
97.840
6
5.870
5.500
370
1.789
98.211
7
5.893
5.500
393
1.397
98.603
8
5.916
5.500
416
980
99.020
9
5.941
5.500
441
539
99.461
10
6.039
5.500
539
0
100.000
(*) 58.720
55.000
(**) 3.720
Total
(*) Equals to total interest expense over the life of the bond (rounded)
(**) Rounded
Mugan-Akman 2007
36
Accounting for Premiums on Bonds Payable
Sumatek Corp. issued TL100.000 bonds, stated interest rate of 11% maturing
in 5 years on 1 January 2004. The interest on the bonds are payable
semiannually on 30 June and 31 December each year. The market interest
rate on 1 January 2004 was 10% and the bonds were issued at TL 103.871
Date
Account Title and Description
1-Jan-04 Cash
Debit
Credit
103.871
Bonds Payable
Unamortized Bond Premium
To record bonds issued at market rate of 10%
100.000
3.871
partial balance sheet
(in TL )
Bonds Payable
100.000
Plus: Unamortized Premium
Net Bonds Payable (Outstanding Debt)
3.871
103.871
Mugan-Akman 2007
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Amortization of Bond Premium
Principal Payment at Maturity
Total Interest Paid in Cash (100.000*11%*5)
Total Cash Payments till Maturity
TL 100.000
55.000
TL 155.000
Total Cash Received at the Issue Date
Total Interest Expense of the Bond Issue
103.871
TL 51.129
Mugan-Akman 2007
38
Effective Interest Method of Amortization
of Bond Premiums
Interest
Payment
Periods
Issue Date
1
Total Interest
Expense
(A)
((E)*10%/2)
0
5.194
Carrying
Interest Paid in Amortization Unamortized Value of
Cash
of Premium
Premium
Bonds
(B)
(C)
(D)
(E)
(100.000*11%/2)
(B-A)
(3,871-C) 100.000+(D)
0
5.500
Mugan-Akman 2007
0
306
3.871
3.565
103.871
103.565
39
Effective Interest Method of Amortization
of Bond Premiums
Interest
Payment
Periods
Issue Date
1
2
Total Interest
Expense
(A)
((E)*10%/2)
0
5.194
5.178
Carrying
Interest Paid in Amortization Unamortized Value of
Cash
of Premium
Premium
Bonds
(B)
(C)
(D)
(E)
(100.000*11%/2)
(B-A)
(3,871-C) 100.000+(D)
0
5.500
5.500
Mugan-Akman 2007
0
306
322
3.871
3.565
3.243
103.871
103.565
103.243
40
Effective Interest Method of Amortization
of Bond Premiums
Interest
Payment
Periods
Issue Date
1
2
3
4
5
6
7
8
9
10
Total
Total Interest
Expense
(A)
((E)*10%/2)
0
5.194
5.178
5.162
5.145
5.128
5.109
5.089
5.069
5.047
5.008
51.129
Carrying
Interest Paid in Amortization Unamortized Value of
Cash
of Premium
Premium
Bonds
(B)
(C)
(D)
(E)
(100.000*11%/2)
(B-A)
(3,871-C)
100.000+(D)
0
5.500
5.500
5.500
5.500
5.500
5.500
5.500
5.500
5.500
5.500
55.000
Mugan-Akman 2007
0
306
322
338
355
372
391
411
431
453
492
3.871
3.871
3.565
3.243
2.905
2.550
2.178
1.787
1.376
945
492
0
103.871
103.565
103.243
102.905
102.550
102.178
101.787
101.376
100.945
100.492
100.000
41
Installment (consumer)
Loans
Principal Loan amount: TL 30.000
Loan period: 2 years
Monthly installments: TL 2.174
Annual Interest Rate 60%
Mugan-Akman 2007
42
Repayment Schedule of Consumer
Loan
30.000 * .05= TL 1.500
Period
0
1
2
3
4
5
22
23
24
Total
Installment
2.174
2.174
2.174
2.174
2.174
2.174
2.174
2.174
52.176
Outstanding
Balance at
the
Interest Principal
Beginning Expense Payment
30.000
1.500
674
29.326
1.466
708
28.618
1.431
743
27.875
1.394
780
27.095
1.355
819
5.925
296
1.878
4.047
202
1.972
2.076
104
2.076
Outstanding
Balance After
Payment of
the
Installment
30.000
29.326
28.618
27.875
27.095
26.276
4.047
2.076
(0)
29.326 * .05= TL 1.466
Mugan-Akman 2007
43
Lease Obligations
• operating or a capital (finance) lease
• Capital Lease
– Significant risks and benefits of the
ownership belong to lessee
• Present Value of Future Lease
Payments– Recorded as a Liability
– Recorded as an asset and depreciated
Mugan-Akman 2007
44
For example: 8,000 per year for 8 years at 10%
interest rate
Net Present Value of Future Lease Payments at the
date of the lease agreement is TL 42.680
Period
0
1
2
3
4
5
6
7
8
Lease
Payment
8.000
8.000
8.000
8.000
8.000
8.000
8.000
8.000
Interest
Balance of
at each
Repayment Lease
Period
of Principle Obligation
42.680
4.268
3.732
38.948
3.895
4.105
34.843
3.484
4.516
30.327
3.033
4.967
25.360
2.536
5.464
19.896
1.990
6.010
13.885
1.389
6.611
7.274
727
7.274
(0)
Mugan-Akman 2007
10% * 42.680
45
Mugan-Akman 2007
46