Current and Long-Term
Liabilities
Chapter 8
1
©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren
Learning Objective 1
Account for current liabilities and
contingent liabilities.
2
©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren
Current Liabilities
Obligations due within one year
or within company’s normal
operating cycle if it is longer
 Known amount
 Estimated amount
3
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Current Liabilities
 Known amount
 Accounts payable
 Short-term notes payable
 Sales tax payable
 Current portion of long-term debt
 Accrued expenses
 Payroll liabilities
 Unearned revenues
4
©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren
Short-Term Notes Payable
On January 30, a business purchased
inventory for $8,000 by issuing a 1year, 10% note payable. The fiscal
year ends on April 30.
General Journal
Date
Accounts and Explanations
PR
Jan 30 Inventory
Notes Payable
Purchased inventory by issuing
a one-year, 10% note
©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren
Debit
Credit
8,000
8,000
Short-Term Notes Payable
How much interest was accrued as of April 30?
$8,000 × 10% × (3/12) = $200
Date
General Journal
Accounts and Explanations
PR
Apr 30 Interest Expense
Interest Payable
To accrue interest at year-end
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Debit
Credit
200
200
Short-Term Notes Payable
General Journal
Date
Accounts and Explanations
PR
Jan 30 Note Payable
Interest Payable
Interest Expense
Cash
To record payment of loan
Debit
8,000
200
600
$8,000 × 10% × (9/12) = $600
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Credit
8,800
Sales Tax Payable
One day’s sales at a Home Depot
Store totaled $200,000. The business
collected an additional 5% in sales
tax. Record the day’s sales.
General Journal
Date
Accounts and Explanations
PR
Cash ($200,000 X 1.05)
Sales Revenue
Sales Tax Payable
To record cash sales and related
sales tax
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Debit
Credit
210,000
200,000
10,000
Current Installment of
Long-Term Debt
Amount of the principal that is
payable within one year
9
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Accrued Expenses
Expenses that have been
incurred but not recorded
 Salaries
 Taxes withheld
 Interest
 Utilities
10
©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren
Payroll Liabilities
General Journal
Date
Accounts and Explanations
PR
Salary Expense
Employee Income Tax Payable
FICA Tax Payable
Salary Payable
To record salary expense
©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren
Debit
Credit
10,000
1,200
800
8,000
Unearned Revenues
The Bradstreet Corporation provides
credit evaluation services to
subscribers. Bradstreet charges a
client $750 for a three-year
subscription. Prepare the entry.
12
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Unearned Revenues
Date
General Journal
Accounts and Explanations
PR
Debit
Jan 1 Cash
Unearned Revenue
To record receipt for a 3-year
subscription
750
Dec 31 Unearned Revenue
Subscription Revenue
To record revenue earned at
year-end (750 x 12/36 months)
250
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Credit
750
250
Current Liabilities That
Must Be Estimated
Black & Decker made sales of
$200,000 subject to product
warranties. They estimate that 3%
of the products it sells this year will
require repair or replacement.
 What is the estimated warranty
expense?
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Estimated Warranty Payable
$200,000 × .03 = $6,000
General Journal
Date
Accounts and Explanations
PR
Warranty Expense
Estimated Warranty Payable
To accrue warranty expense
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Debit
Credit
6,000
6,000
Estimated Warranty Payable
Defective merchandise totals
$5,800. Black & Decker will
replace it and record the
following:
General Journal
Date
Accounts and Explanations
PR
Estimated Warranty Payable
Inventory
To replace defective products
sold under warranty
©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren
Debit
Credit
5,800
5,800
Contingent Liabilities
 Potential liability that depends on a
future event arising out of past
events.
 Record liability if:
it is probable that the loss will
occur and
 the amount can be reasonably
estimated

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Contingent Liabilities
Report in the notes to the
financial statement if it is
reasonably possible that a loss
or expense will occur.
There is no reason to report
contingent loss that is remote –
unlikely to occur.
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©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren
Bonds: An Introduction
Groups of long-term notes
payable issued to multiple
lenders (bondholders)
19
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Types of Bonds
Term bonds
Serial bonds
Secured (mortgage) bonds
Unsecured (debenture) bonds
20
©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren
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.
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©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren
Bond Prices
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
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©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren
Present Value
The amount invested today receives
a greater amount at a future date present value of a future amount
It depends on:
 amount
of the future receipt
 length of time to future receipt
 interest rate for the period
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©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren
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
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©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren
Bond Interest Rates
Contract rate – stated rate
Market rate – effective rate
25
©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren
Learning Objective 2
Account for bonds payable
transactions.
26
©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren
Issuing Bonds at Par Value
On January 1, Chrysler
Corporation issued $50,000 of
9%, 5-year bonds at par.
General Journal
Date
Accounts and Explanations
PR
Jan 1 Cash
Bonds Payable
To issue 9%, 5-years bonds at par
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Debit
Credit
50,000
50,000
Issuing Bonds at Par Value
Record semiannual interest
payments.
General Journal
Date
Jul 1
Accounts and Explanations
PR
Interest Expense
Cash
To pay semiannual interest
$50,000 × 9% × 6/12 = $2,250
©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren
Debit
Credit
2,250
2,250
Issuing Bonds Payable at Par
Value
General Journal
Date
Accounts and Explanations
PR
Dec 31 Interest Expense
Interest Payable
To accrue interest
$50,000 × 9% × 6/12 = $2,250
©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren
Debit
Credit
2,250
2,250
Issuing Bonds at a Discount
Chrysler issues $100,000 of its 9%,
five-year bonds when the market
interest rate is 10%. Chrysler
receives $96,149 at issuance.
General Journal
Date
Accounts and Explanations
PR
Jan 1 Cash
Discount on Bonds Payable
Bonds Payable
To issue 9%, 5-years bonds at a
discount.
©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren
Debit
Credit
96,149
3,851
100,000
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
©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren
Learning Objective 3
Measure interest expense.
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Amortization Table on Bonds
Issued at a Discount
Interest
Date
Interest
Payment
Interest
Expense
Discount Discount
Amortiza- Account
tion
Balance
307
323
339
$ 3,851
3,544
3,221
2,882
$96,149
96,456
96,779
97,118
461
-0-
100,000
1/1/2004
7/1/2004
1/1/2005
7/1/2005
$ 4,500
4,500
4,500
$ 4,807
4,823
4,839
1/1/2009
4,500
4,961
$
©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren
Bond
Carrying
Amount
Interest Expense on Bonds
Issued at a Discount
On July 1, 2004, Chrysler makes the
first $4,500 semiannual interest
payment and also amortizes
(decreases) the bond discount
General Journal
Date
Jul 1
Accounts and Explanations
PR
Interest Expense
Discount on Bonds Payable
Cash
To pay semiannual interest &
amortize bond discount
©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren
Debit
Credit
4,807
307
4,500
Interest Expense on Bonds
Issued at a Discount
At December 31, 2004, Chrysler
accrues interest and amortizes the
bond discount for July through
December.
General Journal
Date
Accounts and Explanations
PR
Dec 31 Interest Expense
Discount on Bonds Payable
Interest Payable
To accrue semiannual interest &
amortize bond discount
©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren
Debit
Credit
4,823
323
4,500
Interest Expense on Bonds
Issued at a Discount
Chrysler’s bond accounts as of December 31, 2004.
Bonds Payable
100,000
Discount on Bonds Payable
3,851 307 July 1
323 Dec. 31
3,221
Bond carrying amount: $100,000 – $3,221 = $96,779
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©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren
Issuing Bonds Payable
at a Premium
Chrysler Corporation issues $100,000 of
9%, five-year bonds when the market
interest rate is 8%. Chrysler receives
$104,100 at issuance.
General Journal
Date
Accounts and Explanations
PR
Cash
Premium on Bonds Payable
Bonds Payable
To issue 9%, 5-years bonds at a
premium.
©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren
Debit
Credit
104,100
4,100
100,000
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
©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren
$ XXX
$104,100
Amortization Table on Bonds
Issued at a Discount
Interest
Date
Interest
Payment
Interest
Expense
Premium Premium
Amortiza- Account
tion
Balance
336
349
363
$ 4,100
3,764
3,415
3,052
545
-0-
1/1/2004
7/1/2004
1/1/2005
7/1/2005
$ 4,500
4,500
4,500
$ 4,164
4,151
4,137
1/1/2009
4,500
3,955
$
©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren
Bond
Carrying
Amount
$104,100
103,764
103,415
103,052
100,000
Interest Expense on Bonds
Issued at a Discount
On July 1, 2004, Chrysler makes the
first $4,500 semiannual interest
payment and also amortizes
(decreases) the bond premium
General Journal
Date
Jul 1
Accounts and Explanations
PR
Interest Expense
Premium on Bonds Payable
Cash
To pay semiannual interest &
amortize bond premium
©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren
Debit
Credit
4,164
336
4,500
Straight-Line Amortization
Amortizes discount or premium
by dividing it into equal amounts
for each interest period
Chrysler would amortize the
$4,100 premium over 10
periods.
$4,100 ÷ 10 = $410 per period
41
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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.
42
©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren
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
PR
Bonds Payable
Discount on Bonds Payable
Cash
Gain on Retirement of Bonds
To record bond retirement
©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren
Debit
Credit
70,000
350
69,475
175
Convertible Bonds and Notes
Texas Instruments has convertible notes
payable of $250,000. Assume that
noteholders convert half the notes into
4,000 shares, $1 par common stock.
General Journal
Date
Accounts and Explanations
PR
Notes Payable
Common Stock
Paid-in Capital
To record conversion of notes
payable
©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren
Debit
Credit
125,000
4,000
121,000
Learning Objective 4
Understand the advantages and
disadvantages of borrowing.
45
©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren
Financing Operations
With Bonds or Stocks
Issuing Stock
No liabilities
No interest expense
Less risky to
corporation
Issuing Notes or Bonds
Does not dilute stock
ownership or control
Results in higher
earningsper share
46
©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren
Long-Term Liabilities: Leases
Lease - rental agreement in
which the tenant (lessee)
agrees to make rent payments
to the property owner (lessor).
 Operating
 Capital
47
©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren
Long-Term Liabilities: Leases
 Capital lease:
 transfers title at end of the term
 contains bargain purchase option
 lease terms cover 75% or more of
estimated useful life of leased asset
 present value of lease payments is
90% or more of the market value of
leased asset
48
©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren
Long-Term Liabilities: Pensions
 Record pension and retirement
benefit expenses while employees
work for the company
 At end of each period, compare the
fair market value of the assets in
the pension plan – cash and
investments – with the plan’s
accumulated benefit obligation
49
©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren
Long-Term Liabilities: Pensions
If accumulated benefit
obligation exceeds plan assets,
the plan is underfunded
Report excess liability amount
as a long-term pension liability
on the balance sheet
50
©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren
Learning Objective 5
Report liabilities on the balance
sheet.
51
©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren
Reporting Liabilities
Amounts in millions
Accounts payable
Accrued salaries and related expenses
Sales tax payable
Other accrued expenses
Income taxes payable
Current installments of long-term debt
Total current liabilities
Long-term debt
Other long-term liabilities
©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren
$1,976
627
298
1,402
78
4
$4,385
1,545
451
Reporting Fair Market Value
of Long-Term Debt
FASB Statement No. 107
requires companies to report
fair market value of their
financial instruments, which
includes long-term debt.
53
©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren
Reporting Financing Activities
on the Statement of Cash Flows
Amounts in millions
Cash Flow from Financing Activities:
Borrowing by using commercial paper
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
©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren
Year Ended
December 31
$754
32
(29)
351
(371)
(4)
$733
End of Chapter 8
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©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren