Download Chapter 9 - McGraw Hill Higher Education

Accounting for
Liabilities
Chapter 07
McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
7-2
Learning Objectives
1. Show how notes payable and related interest expense affect financial
statements.
2. Show how sales tax liabilities affect financial statements.
3. Define contingent liabilities and explain how they are reported in financial
statements.
4. Explain how warranty obligations affect financial statements.
5. Show how installment notes affect financial statements.
6. Show how a line of credit affects financial statements.
7. Explain how to account for bonds issued at face value and their related
interest costs.
8. Use the straight-line method to amortize bond discounts and premiums.
9. Distinguish between current and noncurrent assets and liabilities.
10. Prepare a classified balance sheet.
11. Use the effective interest rate method to amortize bond discounts and
premiums (Appendix).
7-3
Reporting Contingent Liabilities
7-4
Installment Notes Payable
Long-term installment notes are liabilities that usually
have terms from two to five years.
Principal
Payments
Company
Each payment covers
interest for the period
and a portion of the
principal.
Lender
As payments are made, the
amount allocated to
interest gets smaller and to
principal gets larger.
7-5
Installment Notes Payable
Annual
payments are
constant.
$30,000
$25,000
$20,000
Interest
Principal
$15,000
$10,000
$5,000
$Year 1
Year 2
Year 3
Year 4
Year 5
With each payment the amount applied to the principal
increases and the amount applied to interest decreases.
7-6
Line of Credit
Lines of credit are
pre-approved
financing plans that
allow companies to
borrow and repay
funds as needed up
to the maximum
credit line set by the
creditor.
Lines of credit are
normally used for
relatively shortterm borrowing to
finance seasonal
business needs.
7-7
Bonds Issued at Face Value
Mason Company issues bonds on January 1, 2012.
2011.
Principal = $100,000
Stated Interest Rate = 9%
Interest Date = 12/31
Maturity Date = Dec. 31, 2016
2015 (5 years)
Bond Selling Price
Mason
Company
Bond Certificate
at Face Value
Investors
7-8
Bonds Issued at Face Value
On each yearly interest payment date, Mason Company
will pay $9,000 in interest. The amount is computed
as follows:
$100, 000 × 9% = $9,000
Bond Interest Payments
Mason
Company
Investors
7-9
Bonds Issued at Face Value
On December 31, 2016, Mason Company will return
the $100,000 principal amount to the investors.
Bond Principal
at Maturity Date
Mason
Company
Investors
7-10
Bonds Issued at a Discount
Mason
issues
bonds
on January
1, 2012.1, 2011.
MasonCompany
Company
issues
bonds
on January
Principal
Principal= =$100,000
$100,000
Issued at 95 instead of face; cash proceeds of $95,000
Stated Interest Rate = 9%
Stated Interest Rate = 9%
Interest
Date
= 12/31
Interest Date
= 12/31
Maturity
Date
= Dec.
(5 years)
Maturity Date
= Dec.
31, 31,
20162015
(5 years)
Bond Selling Price
Mason
Company
Bond Certificate
at Face Value
Investors
7-11
Bonds Issued at a Discount
$100,000
Mason
Company
face issued
issues
at 95:
bonds on January 1, 2011.
Principal
= $100,000
Bonds
Payable
$100,000
Stated
InterestonRate
= 9%
Less:
Discount
Bonds
Payable
(5,000)
Interest Date = 12/31
Carrying Value
$ 95,000
Maturity Date = Dec. 31, 2015 (5 years)
Bond Selling Price
Mason
Company
Bond Certificate
at Face Value
Investors
7-12
Bonds Issued at a Discount
Expense Recognition for Bond issued at 95
Mason’s cash payment is $9,000 ($100,000 x 0.09)
Amortization of the discount of $5,000 over 5 years is $1,000
per year.
Interest expense recognized is $9,000 plus $1,000 = $10,000
Cash
=
(9,000) =
Carrying
Value of
Bond
Liability
1,000
+
+
Ret. Earn.
(10,000)
Revenue
n/a
-
Expenses
10,000
=
=
Net
Income
(10,000)
Cash
Flow
(9,000) OA
7-13
Current Versus Noncurrent
Current assets are expected to be converted to cash or
consumed within one year or an operating cycle,
whichever is longer. Current assets include:
•Cash
•Marketable Securities
•Accounts Receivable
•Short-Term Notes Receivable
•Interest Receivable
•Inventory
•Supplies
•Prepaid Items
7-14
Current Versus Noncurrent
Current liabilities are due within one year or an
operating cycle, whichever is longer. Current liabilities,
also called short-term liabilities, include:
•Accounts Payable
•Short-Term Notes Payable
•Wages Payable
•Taxes Payable
•Interest Payable
7-15
End of Chapter Seven