10-1
10
REPORTING AND
ANALYZING LIABILITIES
10-2
Financial Accounting, Sixth Edition
Study Objectives
10-3
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.
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.
7.
Identify the requirements for the financial statement presentation
and analysis of liabilities.
Reporting and Analyzing Liabilities
Current
Liabilities
What is a
current
liability?
Notes payable
Sales taxes
payable
Unearned
revenues
Current
maturities of
long-term debt
Payroll and
payroll taxes
payable
10-4
Bonds: LongTerm
Liabilities
Accounting
for Bond
Issues
Accounting
for Bond
Retirements
Types of
bonds
Issuing
procedures
Determining
the market
value of bonds
Issuing bonds
at face value
Discount or
premium on
bonds
Issuing bonds
at a discount
Issuing bonds
at a premium
Redeeming
bonds at
maturity
Redeeming
bonds before
maturity
Financial
Statement
Presentation
and Analysis
Balance sheet
presentation
Analysis
Off-balancesheet financing
Current Liabilities
What is a Current Liability?
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, salaries and wages, and
interest payable.
10-5
SO 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).
10-6
SO 1 Explain a current liability, and identify the
major types of current liabilities.
Current Liabilities
Notes Payable
10-7

Written promissory note.

Require the borrower to pay interest.

Those due within one year of the balance sheet date
are usually classified as current liabilities.
SO 2 Describe the accounting for notes payable.
Current Liabilities
Illustration: First National Bank agrees to lend $100,000 on
September 1, 2012, if Cole Williams Co. signs a $100,000,
12%, four-month note maturing on January 1. When a
company issues an interest-bearing note, the amount of
assets it receives generally equals the note’s face value.
Sept. 1
Cash
100,000
Notes payable
10-8
100,000
SO 2 Describe the accounting for notes payable.
Current Liabilities
Illustration: If Cole Williams Co. prepares financial statements
annually, it makes an adjusting entry at December 31 to
recognize interest.
Dec. 31
Interest expense
Interest payable
4,000 *
4,000
* $100,000 x 12% x 4/12 = 4,000
10-9
SO 2 Describe the accounting for notes payable.
Current Liabilities
Illustration: At maturity (January 1), Cole Williams Co. must
pay the face value of the note plus interest. It records payment
as follows.
Jan. 1
Notes payable
Interest payable
Cash
10-10
100,000
4,000
104,000
SO 2 Describe the accounting for notes payable.
Current Liabilities
Sales Tax Payable
10-11

Sales taxes are expressed as a stated percentage of
the sales price.

Retailer collects tax from the customer.

Retailer remits the collections to the state’s
department of revenue.
SO 3 Explain the accounting for other current liabilities.
Current Liabilities
Illustration: The March 25 cash register readings for Cooley
Grocery show sales of $10,000 and sales taxes of $600 (sales
tax rate of 6%), the journal entry is:
Mar. 25
Cash
10,600
Sales revenue
Sales tax payable
10-12
10,000
600
SO 3 Explain the accounting for other current liabilities.
Current Liabilities
Sometimes companies do not ring up sales taxes separately
on the cash register.
Illustration: Cooley Grocery rings up total receipts of $10,600.
Because the amount received from the sale is equal to the
sales price 100% plus 6% of sales, (sales tax rate of 6%), the
journal entry is:
Mar. 25
Cash
10,600
Sales revenue
Sales tax payable
10,000
*
600
* $10,600 / 1.06 = 10,000
10-13
SO 3 Explain the accounting for other current liabilities.
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.
10-14
SO 3 Explain the accounting for other current liabilities.
Current Liabilities
Illustration: Superior University sells 10,000 season football
tickets at $50 each for its five-game home schedule. The entry
for the sales of season tickets is:
Aug. 6
Cash
500,000
Unearned ticket revenue
500,000
As each game is completed, Superior records the earning of
revenue.
Sept. 7
Unearned ticket revenue
Ticket revenue
10-15
100,000
100,000
SO 3 Explain the accounting for other current liabilities.
Current Liabilities
Current Maturities of Long-Term Debt

Portion of long-term debt that comes due in the
current year.

No adjusting entry required.
Illustration: Wendy Construction issues a five-year, interest-bearing
$25,000 note on January 1, 2011. This note specifies that each January
1, starting January 1, 2012, Wendy should pay $5,000 of the note. When
the company prepares financial statements on December 31, 2011,
$5,000
1. What amount should be reported as a current liability? _________
$20,000
2. What amount should be reported as a long-term liability? _______
10-16
SO 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.
10-17
SO 3 Explain the accounting for other current liabilities.
Current Liabilities
Illustration: Assume Cargo 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 tax payable
21,864
State tax payable
Salaries and wages payable
2,922
67,564
Record the payment of this payroll on March 7.
Mar. 7
Salaries and wages payable
Cash
10-18
67,564
67,564
SO 3
Current Liabilities
Payroll tax expense results from three taxes that
governmental agencies levy on employers.
These taxes are:
10-19

FICA tax

Federal unemployment tax

State unemployment tax
SO 3 Explain the accounting for other current liabilities.
Current Liabilities
Illustration: Based on Cargo Corp.’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
State unemployment tax payable
Federal unemployment tax payable
10-20
7,650
800
5,400
SO 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.
10-21
SO 3 Explain the accounting for other current liabilities.
10-22
Bond: Long-Term Liabilities
Bonds are a form of interest-bearing notes payable
issued by corporations, universities, and governmental
agencies.
Sold in small denominations (usually $1,000 or
multiples of $1,000).
10-23
SO 4 Identify the types of bonds.
Bond: Long-Term Liabilities
Types of Bonds
10-24

Secured

Unsecured

Convertible

Callable
SO 4 Identify the types of bonds.
10-25
Bond: Long-Term Liabilities
Issuing Procedures

Bond certificate
 Issued to the investor.
 Provides name of the company issuing bonds, face
value, maturity date, and contractual (stated)
interest rate.
10-26

Face value - principal due at the maturity.

Maturity date - date final payment is due.

Contractual interest rate – rate to determine cash
interest paid, generally semiannually.
SO 4 Identify the types of bonds.
Bond: Long-Term Liabilities
Illustration 10-3
10-27
SO 4
Bond: Long-Term Liabilities
Determining the Market Value of Bonds
Market value is a function of the three factors that determine
present value:
1. the dollar amounts to be received,
2. the length of time until the amounts are received, and
3. the market rate of interest.
The process of finding the present value is
referred to as discounting the future amounts.
10-28
SO 4 Identify the types of bonds.
Bond: Long-Term Liabilities
Illustration: Assume that Acropolis Company on January 1,
2012, issues $100,000 of 9% bonds, due in five years, with
interest payable annually at year-end.
Illustration 10-4
Time diagram
depicting cash
flows
Illustration 10-5
Computing the
market price of
bonds
10-29
SO 4 Identify the types of bonds.
Accounting for Bond Issues
A corporation records bond transactions when it

issues or retires (buys back) bonds and

when bondholders convert bonds into common stock.
Bonds may be issued at

face value,

below face value (discount), or

above face value (premium).
Bond prices are quoted as a percentage of face value.
10-30
SO 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.
10-31
SO 5 Prepare the entries for the issuance of bonds and interest expense.
Issuing Bonds at Face Value
Illustration: Devor Corporation issues 100, five-year, 10%,
$1,000 bonds dated January 1, 2012, at 100 (100% of face
value). The entry to record the sale is:
Jan. 1
Cash
100,000
Bonds payable
100,000
Prepare the entry Devor would make to accrue interest on
December 31.
Dec. 31
Interest expense
Interest payable
10-32
10,000
10,000
SO 5 Prepare the entries for the issuance of bonds and interest expense.
Issuing Bonds at Face Value
Prepare the entry Devor would make to pay the interest on Jan.
1, 2013.
Jan. 1
Interest payable
Cash
10-33
10,000
10,000
SO 5 Prepare the entries for the issuance of bonds and interest expense.
Accounting for Bond Issues
Assume Contractual Rate of 10%
10-34
Market Interest
Bonds Sold At
8%
Premium
10%
Face Value
12%
Discount
SO 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.
10-35
SO 5 Prepare the entries for the issuance of bonds and interest expense.
Issuing Bonds at a Discount
Illustration: Assume that on January 1, 2012, Candlestick Inc.
sells $100,000, five-year, 10% bonds at 98 (98% of face value)
with interest payable on January 1. The entry to record the
issuance is:
Jan. 1
Cash
Discount on bonds payable
Bonds payable
98,000
2,000
100,000
Illustration 10-8
Computation of total cost of
borrowing—bonds issued at
discount
10-36
SO 5 Prepare the entries for the issuance of bonds and interest expense.
Issuing Bonds at a Discount
Statement Presentation
Illustration 10-7
Statement presentation of
discount on bonds payable
10-37
SO 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.
10-38
SO 5 Prepare the entries for the issuance of bonds and interest expense.
Issuing Bonds at a Premium
Illustration: Assume that the Candlestick Inc. bonds previously
described sell at 102 rather than at 98. The entry to record the
sale is:
Jan. 1
Cash
Bonds payable
Premium on bonds payable
102,000
100,000
2,000
Illustration 10-12
Computation of total cost of
borrowing—bonds issued at
premium
10-39
SO 5 Prepare the entries for the issuance of bonds and interest expense.
Issuing Bonds at a Premium
Statement Presentation
Illustration 10-11
Statement presentation of
premium on bonds payable
10-40
SO 5 Prepare the entries for the issuance of bonds and interest expense.
Accounting for Bond Retirements
Redeeming Bonds at Maturity
Candlestick records the redemption of its bonds at maturity as
follows:
Bonds payable
Cash
10-41
100,000
100,000
SO 6 Describe the entries when bonds are redeemed.
Accounting for Bond Retirements
Redeeming Bonds at Maturity
When a company retires bonds before maturity, it is
necessary to:
1. eliminate the carrying value of the bonds at the redemption
date;
2. record the cash paid; and
3. recognize the 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.
10-42
SO 6 Describe the entries when bonds are redeemed.
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.
10-43
SO 6 Describe the entries when bonds are redeemed.
Accounting for Bond Retirements
Illustration: Assume at the end of the fourth period, Candlestick
Inc., having sold its bonds at a premium, retires the bonds at 103
after paying the annual interest. Assume that the carrying value of
the bonds at the redemption date is $100,400 (principal $100,000
and premium $400). Candlestick records the redemption at the end
of the fourth interest period (January 1, 2016) as:
Bonds payable
100,000
Premium on bonds payable
Loss on bond redemption
Cash
10-44
400
2,600
103,000
SO 6 Describe the entries when bonds are redeemed.
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 paidin 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.
10-45
SO 6 Describe the entries when bonds are redeemed.
Financial Statement Analysis and Presentation
Balance Sheet Presentation
Illustration 10-15
10-46
SO 7
Financial Statement Analysis and Presentation
Analysis
Illustration 10-16
10-47
SO 7
Financial Statement Analysis and Presentation
Liquidity
Illustration 10-17
Liquidity ratios measure the short-term ability of a company to pay
its maturing obligations and to meet unexpected needs for cash.
10-48
SO 7 Identify the requirements for the financial statement
presentation and analysis of liabilities.
Financial Statement Analysis and Presentation
Solvency
10-49
Solvency ratios measure the ability of a company to survive over a
long period of time.
SO 7
10-50
Financial Statement Analysis and Presentation
Off-Balance-Sheet Financing
10-51

Contingencies

Leasing
►
Operating lease
►
Capital lease
SO 7 Identify the requirements for the financial statement
presentation and analysis of liabilities.
10-52
Straight-Line
Amortization
appendix 10A
Amortizing Bond Discount
To follow the matching principle, companies allocate bond
discount to expense in each period in which the bonds are
outstanding.
Illustration 10A-1
10-53
SO 8 Apply the straight-line method of amortizing
bond discount and bond premium.
Straight-Line
Amortization
appendix 10A
Amortizing Bond Discount
Illustration: Candlestick, Inc., sold $100,000, five-year, 10%
bonds on January 1, 2012, for $98,000 (discount of $2,000).
Interest is payable on January 1 of each year. Prepare the
entry to accrue interest at Dec. 31, 2012.
Dec. 31
Interest expense
Discount on bonds payable
Interest payable
10-54
10,400
400
10,000
SO 8 Apply the straight-line method of amortizing
bond discount and bond premium.
Straight-Line
Amortization
appendix 10A
Amortizing Bond Discount
Illustration 10A-2
10-55
SO 8 Apply the straight-line method of amortizing
bond discount and bond premium.
Straight-Line
Amortization
appendix 10A
Amortizing Bond Premium
Illustration: Candlestick, Inc., sold $100,000, five-year, 10%
bonds on January 1, 2012, for $102,000 (premium of
$2,000). Interest is payable on January 1 of each year.
Prepare the entry to accrue interest at Dec. 31, 2012.
Dec. 31
Interest expense
Premium on bonds payable
Interest payable
10-56
9,600
400
10,000
SO 8 Apply the straight-line method of amortizing
bond discount and bond premium.
Straight-Line
Amortization
appendix 10A
Amortizing Bond Premium
Illustration 10A-4
10-57
SO 8 Apply the straight-line method of amortizing
bond discount and bond premium.
appendix 10B
Effective Interest
Amortization
Under the effective-interest method, the amortization of the
discount or premium results in interest expense equal to a
constant percentage of the carrying value.
Required steps:
1. Compute the bond interest expense.
2. Compute the bond interest paid or accrued.
3. Compute the amortization amount.
Illustration 10B-1
10-58
Effective Interest
Amortization
appendix 10B
Amortizing Bond Discount
Illustration: Candlestick, Inc., sold $100,000, five-year, 10%
bonds on January 1, 2012, for $98,000. The effective-interest
rate is 10.53% and interest is payable on Jan. 1 of each year.
Prepare the bond discount amortization schedule.
10-59
SO 9 Apply the effective-interest method of amortizing
bond discount and bond premium.
Effective Interest
Amortization
appendix 10B
Amortizing Bond Discount
Illustration 10B-2
10-60
SO 9 Apply the effective-interest method of amortizing
bond discount and bond premium.
Effective Interest
Amortization
appendix 10B
Amortizing Bond Discount
Illustration: Candlestick, Inc. records the accrual of interest
and amortization of bond discount on Dec. 31, as follows:
Dec. 31
Interest expense
Discount on bonds payable
Interest payable
10-61
10,319
319
10,000
SO 9 Apply the effective-interest method of amortizing
bond discount and bond premium.
Effective Interest
Amortization
appendix 10B
Amortizing Bond Premium
Illustration: Candlestick, Inc., sold $100,000, five-year, 10%
bonds on January 1, 2012, for $102,000. The effective-interest
rate is 9.48% and interest is payable on Jan. 1 of each year.
Prepare the bond premium amortization schedule.
10-62
SO 9 Apply the effective-interest method of amortizing
bond discount and bond premium.
Effective Interest
Amortization
appendix 10B
Amortizing Bond Premium
Illustration 10B-4
10-63
SO 9 Apply the effective-interest method of amortizing
bond discount and bond premium.
Effective Interest
Amortization
appendix 10B
Amortizing Bond Premium
Illustration: Candlestick, Inc. records the accrual of
interest and amortization of premium discount on Dec. 31,
as follows:
Dec. 31
Interest expense
Premium on bonds payable
Interest payable
10-64
9,670
330
10,000
SO 9 Apply the effective-interest method of amortizing
bond discount and bond premium.
appendix 10C
Long-Term
Notes Payable
Long-Term Notes Payable

May be secured by a mortgage that pledges title to specific
assets as security for a loan.

Typically, the terms require the borrower to make installment
payments over the term of the loan. Each payment consists
of
1. interest on the unpaid balance of the loan and
2. a reduction of loan principal.

10-65
Companies initially record mortgage notes payable at face
value.
SO 10 Describe the accounting for long-term notes payable.
appendix 10C
Long-Term
Notes Payable
Illustration: Porter Technology Inc. issues a $500,000, 12%,
20-year mortgage note on December 31, 2012. The terms
provide for semiannual installment payments of $33,231.
Illustration 10C-1
10-66
SO 10 Describe the accounting for long-term notes payable.
appendix 10C
Long-Term
Notes Payable
Illustration: Porter Technology records the mortgage loan and
first installment payment as follows:
Dec. 31
Cash
500,000
Mortgage payable
Jun. 30
Interest expense
Mortgage payable
Cash
10-67
500,000
30,000
3,231
33,231
SO 10 Describe the accounting for long-term notes payable.
appendix 10C
Long-Term
Notes Payable
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.
10-68
SO 10 Describe the accounting for long-term notes payable.
Key Points
10-69

The basic definition of a liability under GAAP and IFRS is very
similar. In a more technical way, 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.

IFRS requires that companies classify liabilities as current or
non-current 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).
Key Points
10-70

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 both GAAP and IFRS, preferred stock that is required to
be redeemed at a specific point in time in the future must be
reported as debt, rather than being presented as either equity
or in a “mezzanine” area between debt and equity.
Key Points
10-71

Under IFRS, companies sometimes will net current liabilities
against current assets to show working capital on the face of
the statement of financial position.

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.

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.
Key Points

10-72
The IFRS leasing standard is IAS 17. Both Boards share the
same objective of recording leases by lessees and lessors
according to their economic substance—that is, according to
the definitions of assets and liabilities. However, GAAP for
leases is much more “rules-based,” with specific bright-line
criteria (such as the “90% of fair value” test) to determine if a
lease arrangement transfers the risks and rewards of
ownership; IFRS is more conceptual in its provisions. Rather
than a 90% cut-off, it asks whether the agreement transfers
substantially all of the risks and rewards associated with
ownership.
Key Points
10-73

Under GAAP, some contingent liabilities are recorded in the
financial statements, others are disclosed, and in some cases
no disclosure is required. Unlike GAAP, IFRS reserves the use
of the term contingent liability to refer only to possible
obligations that are not recognized in the financial statements
but may be disclosed if certain criteria are met.

For those items that GAAP would treat as recordable
contingent liabilities, IFRS instead uses the term provisions.
Provisions are defined as liabilities of uncertain timing or
amount. Examples of provisions would be provisions for
warranties, employee vacation pay, or anticipated losses.
Looking into the Future
The FASB and IASB are currently involved in two projects. 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. In addition to these projects, the FASB and IASB
have also identified leasing as one of the most problematic areas
of accounting. A joint project will initially focus primarily on lessee
accounting.
10-74
Which of the following is false?
a) Under IFRS, current liabilities must always be
presented before non-current 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.
10-75
Under IFRS, a contingent liability is:
a) disclosed in the notes if certain criteria are met.
b) reported on the face of the financial statements if
certain criteria are met.
c) the same as a provision.
d) not covered by IFRS.
10-76
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.
10-77
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10-78