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Chapter 9
KNOWLEDGE CHECK 9.1
 According to IFRS, what is the definition of a liability?
According to IFRS liabilities are obligations arising from past transactions or
economic events that require the sacrifice of economic resources to settle.
 What is a current liability? Why might stakeholders want to know the amount of
current liabilities?
Current liabilities are obligations that will be satisfied in one year or one
operating cycle. Information about current obligations is important for assessing
the short-term liquidity of an entity.
 Explain why amounts owing to employees should be considered a liability.
Amounts owing to employees are liabilities because they are the result of past
transactions (the employees worked) and the sacrifice of economic resources will
be required to settle them (the employees will have to be paid in cash).
KNOWLEDGE CHECK 9.2
 On January 1, 2017, Krydor Inc. (Krydor) issued a two-year, $1,000,000 bond
with a 10 percent coupon, with interest paid annually on December 31. The bond
matures on December 31, 2025. The effective interest rate for this bond is 11
percent.
o What price will Krydor sell the bond for?
The price investors would pay for Krydor’s bond would be the present value of
two interest payments of $100,000 paid on December 31, 2017 and 2018 plus
return of the bonds face value of $1,000,000 on December 31, 2017, discounted at
11%.
PV1, 0.11 = 1/(1 + 0.11)1 x $100,000
=
$90,090.09
PV2, 0.11 = 1/(1 + 0.11)2 x $1,100,000
=
892,784.68
Present value
$982,874.77
o What journal entry will Krydor make to record the issue of the bond?
Dr. Cash (asset +)
Dr. Bond discount (contra-liability +)
Cr. Long-term debt—bonds (liability +)
901,712.52
98,287.48
1,000,000
o Record journal entries that would be made on December 31, 2017 and
2024, to record the interest expense for the year (use straight-line method).
The entries made on December 31, 2017 and 2024 are as follows. This assumes
the bond discount is amortized using the effective interest rate method.
Dr. Interest expense (expense +, shareholders equity –)
108,116.22
Cr. Bond discount (contra-liability –)
Cr. Cash (asset –)
Dr. Interest expense (expense +, shareholders equity –)
Cr. Bond discount (contra-liability –)
Cr. Cash (asset –)
8,116.22
100,000.00
109,009.01
9,009.01
100,000.00
o What journal entry will Krydor make when the bond is derecognized and
the investors are repaid the principal? Don’t include the interest portion of
the entry.
Dr. Long-term debt—bonds (liability –)
Cr. Cash (asset –)
1,000,000
1,000,000
KNOWLEDGE CHECK 9.3
 Explain the difference between capital and operating leases. How does each affect
the financial statements?
A capital lease transfers the risks and rewards of ownership to the lessee. An
operating lease doesn’t transfer the risk and rewards of ownership. The
classification is a matter of judgment. At the beginning of a capital lease the
leased asset and a liability are recorded on the lessee’s balance sheet at the present
value of the lease payments to be made over the life of the lease. The leased asset
is accounted for in the same way as an owned asset, including being depreciated
over its useful life (or the term of the lease if it’s shorter than the useful life). With
an operating lease, the lessee doesn’t record the leased assets or the associated
liability on its balance sheet. Instead, the lessee recognizes an expense when a
payment to the lessor is paid or payable.
 On January 1, 2017, a company enters into a 10-year lease for some equipment.
The lease requires annual payments of $25,000 on December 31 of each year. If
the appropriate discount rate for the lease is 7 percent, how much would be
recorded on the balance sheet for the equipment if the lease was classified as a
capital lease?
The present value of a series of 10 payments of $25,000 at a discount rate of 7%
is $175,590 so the equipment asset and corresponding lease liability should be
recorded at $175,590 at the inception of the lease.