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• Trading in Used Assets for New Ones
• Intangible Assets
– Goodwill
– Patents
– Trademarks and Trade Names
– Franchises
– Copyrights
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Previous Lecture
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Natural Resources
Depletion of Natural Resources
The Units-of-Output Method
Which Depreciation Methods Do Most
Businesses Use?
2
Chapter
LIABILITIES
10
3
Distinction Between
Debt and Equity
The acquisition of assets is financed from two
sources:
DEBT
Funds from creditors, with
a definite due date, and
sometimes bearing
interest.
EQUITY
Funds from
owners
4
Liabilities – Question
Devon Mfg. borrows $100,000 from First
Bank. The loan will be repaid in 20 years
and has an annual interest rate of 8%.
Is this a current liability or a
noncurrent liability?
The obligation will not be paid
within one year or one operating
cycle, so it is a noncurrent liability.
5
The Nature of Liabilities
Defined as debts or obligations
arising from past transactions or
events.
Maturity = 1 year or less
Maturity > 1 year
Current
Liabilities
Noncurrent
Liabilities
I.O.U.
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The Nature of Current Liabilities
Liabilities that are to be paid out of
current assets and are due within a
short time, usually within one year,
are called current liabilities.
Examples:






Accounts payable
Notes payable
Unearned rent
Taxes payable
Wages payable
Current portion of long
term debt
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Short-Term Notes Payable
A firm issues a 90-day, 12% note for
$1,000, dated August 1, 2006 to Murray
Co. for a $1,000 overdue account.
Aug. 1 Accounts Payable—Murray Co.
Notes Payable
Issued a 90-day, 12% note on
1 000 00
1 000 00
account.
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Short-Term Notes Payable
On October 30, when the note matures, the
firm pays the $1,000 principal plus $30
interest ($1,000 x .12 x 90/360).
Oct. 30 Notes Payable
Interest Expense
Cash
1 000 00
30 00
1 030 00
Issued a 90-day, 12% note on
Appears
on the
account.
income statement as
an “Other Expense.”
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Short-Term Notes Payable
Bowden Co. (Borrower)
Description
DebitCredit
Mdse. Inventory
10,000
Accounts Payable
10,000
Coker Co. (Creditor)
Description
DebitCredit
Accounts Receivable
Sales
10,000
Cost of Mdse. Sold
Mdse. Inventory
7,500
10,000
7,500
May 31. Bowden Co. purchased merchandise on
account from Coker Co., $10,000, 2/10, n/30.
The merchandise cost Coker Co. $7,500.
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Short-Term Notes Payable
Bowden Co. (Borrower)
Description
DebitCredit
Mdse. Inventory
10,000
Accounts Payable
10,000
Accounts Payable
Notes Payable
10,000
10,000
Coker Co. (Creditor)
Description
DebitCredit
Accounts Receivable
Sales
10,000
Cost of Mdse. Sold
Mdse. Inventory
7,500
10,000
7,500
Notes Receivable
10,000
Accounts Receivable
10,000
May 31. Bowden Co. issued a 60-day, 12%
note for $10,000 to Coker on account.
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Short-Term Notes Payable
Bowden Co. (Borrower)
Description
DebitCredit
Coker Co. (Creditor)
Description
DebitCredit
July 30. Bowden Co. paid Coker Co. the
Mdse. Inventory
10,000
Accounts Receivable 10,000
amount due on the
note ofSales
May 31. Interest: 10,000
Accounts Payable
10,000
$10,000 x 12% x 60/360 = $200.
Cost of Mdse. Sold
Mdse. Inventory
Accounts Payable
Notes Payable
10,000
Notes Payable
Interest Expense
Cash
10,000
200
7,500
7,500
10,000
Notes Receivable
10,000
Accounts Receivable
10,000
10,200
Cash
Interest Revenue
Notes Receivable
10,200
200
10,000
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Notes Payable
When a company borrows money, a note payable is
created.
Current Portion of Notes Payable
The portion of a note payable that is due within one
year, or one operating cycle, whichever is longer.
Current Notes Payable
Total Notes
Payable
Noncurrent Notes Payable
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Notes Payable
PROMISSORY NOTE
Miami, Fl
Location
Six months after this date
promises to pay to the order of
the sum of
$10,000.00
of
12.0% per annum.
Nov. 1, 2003
Date
Porter Company
Security National Bank
with interest at the rate
signed
title
John Caldwell
treasurer
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Notes Payable
On November 1, 2003, Porter Company
would make the following entry.
Date
Description
Nov. 1 Cash
Note Payable
Debit
Credit
10,000
10,000
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Interest Payable
• Interest expense is the
compensation to the lender for
giving up the use of money for a
period of time.
Interest
Rate
Up!
• The liability is called interest
payable.
• To the lender, interest is a revenue.
• To the borrower, interest is an
expense.
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Interest Payable
The interest formula includes three variables
that must be considered when computing
interest:
Interest = Principal × Interest Rate × Time
When computing interest for one year, “Time”
equals 1. When the computation period is less
than one year, then “Time” is a fraction.
For example, if we needed to compute interest for
3 months, “Time” would be 3/12.
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Interest Payable – Example
What entry would Porter Company make
on December 31, the fiscal year-end?
Date
Description
Dec. 31 Interest Expense
Interest Payable
Debit
Credit
200
200
$10,00012% 2/12 = $200
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Discounted Notes Payable
On August 10, Cary Company issues a $20,000,
90-day note to Rock Company in exchange for
inventory. Rock discounts the note at 15%.
Aug.10 Merchandise Inventory
Interest Expense
19 250 00
750 00
Notes Payable
Issued a 90-day, note to Rock
Co. discounted at 15%.
Proceeds 20 000
Discount: $20,000
x .15 x 90/360
Discount rate
19
00
Discounted Notes Payable
On November 8 the note is paid in full.
Nov. 8 Notes Payable
Cash
20 000 00
20 000 00
Paid note due.
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Contingent
Liabilities
21
Product Liability
On June 30, a company sells a product for $60,000
on which there is a 36-month warranty. Past
experience indicates that repairs of defects cost 5%
of the sales price over the warranty period.
June 30 Product Warranty Expense
Product Warranty Liability
3 000 00
3 000 00
Warranty expenses projected for
June, 5% of $60,000.
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Product Liability
On August 16, a customer needed a
defective part replaced. Cost to the
company was $200 for the part.
Aug.16 Product Warranty Payable
Supplies
200 00
200 00
Replaced defective part under
warranty.
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Accounting Treatment of
Contingent Liabilities
Likelihood
of
Occurring
Measurement
Probable
Estimable
Record
Liability
Not
Estimable
Disclose
Liability
Contingency
Possible
Accounting
Treatment
Disclose
Liability
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Evaluating Liquidity
An important indicator of a company’s ability to
meet its current obligations.
Two commonly used measures:
Working Capital = Current Assets - Current Liabilities
Current Ratio = Current Assets ÷ Current Liabilities
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Liabilities – Question
Devon Mfg. has current liabilities of
$230,000 and current assets of $322,000.
What is Devon’s current ratio?
Current
Ratio
Current
Current
=
÷
Assets
Liabilities
= $ 322,000 ÷ $ 230,000
=
1.4
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Accounts Payable
Short-term obligations to suppliers for purchases of
merchandise and to others for goods and services.
Office
supplies
invoices
Merchandise
inventory
invoices
Shipping
charges
Utility and
phone bills
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Payroll Liabilities
Gross Pay
Net Pay
FICA Taxes
Medicare
Taxes
Federal
Income Tax
State and
Voluntary
Local Income Deductions
Taxes
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Payroll Register
It’s a multicolumn form used to help
What is the assemble and summarize the data
purpose of a needed for each payroll period.
payroll register?
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Payroll Register Summary
Earnings:
Regular
Overtime
Total
Deductions:
Social security tax
Medicare tax
Federal income tax
Retirement savings
United Way
Accounts receivable
Total
Net amount paid
Accounts debited:
Sales Salaries Expense
Office Salaries Expense
Total (as above)
$13,328.00
574.00
$13,902.00
$ 643.07
208.53
3,332.00
680.00
470.00
50.00
5,383.60
$ 8,518.40
$11,122.00
2,780.00
$13,902.00
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Recording Employees’ Earnings
Dec. 27 Sales Salaries Expense
Office Salaries Expense
Social Security Tax Payable
Medicare Tax Payable
Employees Federal Inc. Tax Pay.
Retirement Savings Ded. Payable
United Way Deductions Payable
Accounts Receivable—Fred Elrod
Salaries Payable
Payroll for week ended
December 27.
11 122 00
2 780 00
643
208
3 332
680
470
50
8 518
31
07
53
00
00
00
00
40
Recording Employer’s Payroll Taxes
Employer Taxes for the Week Ended December 27
Social security tax
$ 643.07
Medicare tax
208.53
State unemployment compensation tax
(5.4% x $2,710)
146.34
Federal unemployment compensation
tax (0.8% x $2,710)
21.68
Total payroll tax expense
$1,019.62
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Recording Employer’s Payroll Taxes
Dec. 27 Payroll Tax Expense
Social Security Tax Payable
Medicare Tax Payable
State Unemployment Tax Payable
Federal Unemployment Tax Pay.
Payroll taxes for week ended
December 27.
1 019 62
643
208
146
21
33
07
53
34
68
Flow of Data in a Payroll System
Current Period’s
Variables
(hours worked)
Updated Variables
(cumulative
earnings, taxes)
Constant Data
(rates of pay,
tax, etc.)
EMPLOYEES’
EARNINGS
RECORDS
PAYROLL
REGISTER
GENERAL
LEDGER
Wage and Tax
Statements
W-2
W-2
Payroll Tax
Returns
Payroll Checks
and Statements
Financial
Statements
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Unearned Revenue
Cash is sometimes collected from the
customer before the revenue is
actually earned.
As the earnings
process is
completed .
Cash is
received
in
advance.
Deferred
revenue is
recorded.
a liability account.
.
Earned
revenue is
recorded.
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Long-Term Debt
Relatively small debt
needs can be filled from
single sources.
or
Banks
Insurance
Companies
or
Pension
Plans
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Long-Term Debt
Large debt needs are often
filled by issuing bonds.
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Installment Notes Payable
Long-term notes that call for a series of
installment payments.
Each payment covers
interest for the period
AND a portion of the
principal.
With each payment, the
interest portion gets
smaller and the principal
portion gets larger.
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Allocating Installment Payments
Between Interest and Principal
 Identify the unpaid principal balance.
 Unpaid Principal × Interest rate =
Interest expense.
 Installment payment - Interest
expense = Reduction in unpaid
principal balance.
 Compute new unpaid principal
balance.
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Allocating Installment Payments
Between Interest and Principal
On January 1, 2003, Rocket
Corp. borrowed $7,581.57 from
First Bank of River City. The
loan was a five-year loan and
had an interest rate of 10%. The
annual payment is $2,000.
Prepare an amortization table for
Rocket Corp.’s loan.
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Allocating Installment Payments
Between Interest and Principal
Reduction in
Interest
Unpaid
Expense
Balance
Date
Payment
Jan. 1, 2003
Dec. 31, 2003 $ 2,000.00 $ 758.16 $
Dec. 31, 2004
2,000.00
633.97
Dec. 31, 2005
2,000.00
497.37
Dec. 31, 2006
2,000.00
347.11
Dec. 31, 2007
2,000.00
181.82
1,241.84
1,366.03
1,502.63
1,652.89
1,818.18
Unpaid
Balance
$ 7,581.57
6,339.73
4,973.70
3,471.07
1,818.18
(0.00)
Now, prepare the entry for the first payment on
December 31, 2003.
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Allocating Installment Payments
Between Interest and Principal
The information needed for the journal entry can be
found on the amortization table. The payment
amount, the interest expense, and the amount to
credit to principal are all on the table.
Date
Description
Dec. 31 Interest Expense
Note Payable
Cash
Debit
Credit
758.16
1,241.84
2,000.00
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Other Employees’ Fringe
Benefits
Vacation pay
Vacation pay becomes the employer’s
liability as the employee earns vacation rights.
Pensions
Cash payment to retired employees. Could be
a defined contribution plan or a defined benefit plan
Postretirement Benefits
In addition to pension
benefits, employees may earn rights to other postretirement
benefits such as dental care, eye care, life insurance, etc.
Amount is recorded by debiting Postretirement Benefits
Expense and crediting cash.
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Pensions
Defined contribution plan
Under this plan, a
fixed amount of money is invested on the employee’s
behalf during the employee’s working years. Example:
401K
Defined benefit plan
Under this plan, the pension
benefits are based on a formula and the employer bears
the investment risk in funding a future retirement income
benefit.
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