LIABILITIES CURRENT AND
LONG-TERM LIABILITIES
Chapter 11 & 14
DEFINING LIABILITIES
Because of a
past event . . .
Past
McGraw-Hill/Irwin
McGraw-Hill/Irwin
The
company
has a
present
obligation
Present
. . . For future
sacrifices
Future
Slide2
CLASSIFYING LIABILITIES
Current
Liabilities
Long-Term
Liabilities
Expected to be
paid within one
year or the
companys
operating cycle,
whichever is
longer.
Expected not to be
paid within one
year or the
companys
operating cycle,
whichever is
longer.
McGraw-Hill/Irwin
McGraw-Hill/Irwin
Slide3
KNOWN LIABILITIES
Also
called definitely determinable liabilities. They
are set by agreements, contracts, or laws and are
measurable with little uncertainty.
Examples:
Accounts
Payable
Sales Taxes Payable
Unearned Revenues
Short-term Notes Payable
Payroll liabilities
McGraw-Hill/Irwin
McGraw-Hill/Irwin
Slide4
UNEARNED REVENUES
On May 1, 2009, A-1 Catering received
$3,000 in advance for catering a wedding
party to take place on July 12, 2009.
May 1
DR
3,000
Cash
Unearned Revenue - Catering
CR
3,000
To record advance payment.
Jul 12
Unearned Revenue - Catering
Revenue - Catering
DR
3,000
CR
3,000
T o recognize revenue earned.
McGraw-Hill/Irwin
McGraw-Hill/Irwin
Slide5
NOTE GIVEN TO BORROW FROM
BANK
PROMISSORY NOTE
PROMISSORY
$20,000
Face Value
Ninety days after date
Sept. 1, 2009
Date
I
promise to pay to the order of
AmericanBank
Nashville,TN
Twenty thousand and no/100 - - - - - - - - - - - - - - - - Dollars
plus interest at the annual rate of 6% .
JacksonSmith
McGraw-Hill/Irwin
McGraw-Hill/Irwin
Slide6
NOTE GIVEN TO BORROW FROM
BANK
On September 1, 2009, Jackson Smith borrows
$20,000 from American Bank. The note bears
interest at 6% per year. Principal and interest
are due in 90 days (November 30, 2009).
Sep 1
DR
20,000
Cash
Notes payable
CR
20,000
To record note to American Bank.
McGraw-Hill/Irwin
McGraw-Hill/Irwin
Slide7
NOTE GIVEN TO BORROW FROM
BANK
On November 30, 2009, Smith would
make the following entry:
$20,000 6% (90 360) = $300
Notes payable
Interest expense
Cash
DR
20,000
300
CR
20,300
To record payment of note and interest
McGraw-Hill/Irwin
McGraw-Hill/Irwin
Slide8
END-OF-PERIOD ADJUSTMENT
TO NOTES
Note
Date
End of
Period
Maturity
Date
An adjusting entry
is required to
record Interest
Expense incurred
to date.
McGraw-Hill/Irwin
McGraw-Hill/Irwin
Slide9
END-OF-PERIOD ADJUSTMENT
TO NOTES
Dec. 16,
2009
Note
Date
Dec. 31,
2009
End of
Period
Feb. 14,
2010
Maturity
Date
James Burrows borrowed $8,000 on Dec. 16,
2009, by signing a 12%, 60-day note payable.
McGraw-Hill/Irwin
McGraw-Hill/Irwin
Slide10
END-OF-PERIOD ADJUSTMENT
TO NOTES
On December 16, 2009, James Burrows
would make the following entry:
Dec 16 Cash
8,000
Notes payable
8,000
To record amount borrowed
from bank
On December 31, 2009, the adjustment is:
Dec 31 Interest expense
I nterest payable
DR
40
CR
40
To accrue interest on note
$8,000 12% (15 360) = $40
McGraw-Hill/Irwin
McGraw-Hill/Irwin
Slide11
END-OF-PERIOD ADJUSTMENT
TO NOTES
On February 14, 2010, James Burrows
would make the following entry.
Feb 14 Notes payable
Interest payable
Interest expense
Cash
DR
8,000
40
120
CR
8,160
To record payment of note
$8,000 12% (45 360) = $120
McGraw-Hill/Irwin
McGraw-Hill/Irwin
Slide12
NOTE GIVEN TO EXTEND
CREDIT PERIOD
On August 1, 2009, Matrix, Inc. asked Carter, Co.
to accept a 90-day, 12% note to replace its
existing $5,000 account payable to Carter. Matrix
would make the following entry:
Aug 1
Accounts Payable - Carter
Notes Payable - Carter
DR
5,000
CR
5,000
To replace customer account with note.
McGraw-Hill/Irwin
McGraw-Hill/Irwin
Slide13
NOTE GIVEN TO EXTEND
CREDIT PERIOD
On October 30, 2009, Matrix, Inc. pays
the note plus interest to Carter.
Interest expense = $5,000 12% (90 360) = $150
Oct 30
Notes payable - Carter
Interest expense
Cash
5,000
150
5,150
To record payment of note and
i nterest
McGraw-Hill/Irwin
McGraw-Hill/Irwin
Slide14
CURRENT PORTION OF NOTES
PAYABLE
Any debt due within one year or one operating cycle,
Any debt due within one year or one operating cycle,
whichever is longer, is classified as current.
whichever is longer, is classified as current.
The portion of long-term note payable that is due within one
The portion of long-term note payable that is due within one
year would be re-classified as a current liability
year would be re-classified as a current liability
Current Notes Payable
Total Notes
Payable
McGraw-Hill/Irwin
McGraw-Hill/Irwin
Noncurrent Notes Payable
Slide15
ESTIMATED LIABILITIES
An
estimated liability is a known obligation of an
uncertain amount, but one that can be reasonably
estimated.
Examples:
Employee
benefits
Bonus plans
Warranty Liabilities
McGraw-Hill/Irwin
McGraw-Hill/Irwin
Slide16
WARRANTY LIABILITIES
Sellers obligation to replace or correct a product (or
service) that fails to perform as expected within a
specified period. To conform with the matching
principle, the seller reports expected warranty expense
in the period when revenue from the sale is reported.
A dealer sells a car for $32,000, on December 1, 2009, with
a warranty for parts and labor for 12 months, or 12,000
miles. The dealership experiences an average warranty
cost of 3% of the selling price of each car.
McGraw-Hill/Irwin
McGraw-Hill/Irwin
Slide17
WARRANTY LIABILITIES
A dealer sells a car for $32,000, on December 1, 2009, with
a warranty for parts and labor for 12 months, or 12,000
miles. The dealership experiences an average warranty
cost of 3% of the selling price of each car.
Dec. 1
Warranty Expense
Estimated Warranty Liability
DR
960
CR
960
To accrue estimated warranty expense
On February 15, 2010, parts of $200 and labor
of $250 covered under warranty were incurred.
Feb. 15 Estimated Warranty Liability
Auto Parts Inventory
S alaries Payable
McGraw-Hill/Irwin
To record warranty costs
DR
450
CR
200
250
Slide18
CONTINGENT LIABILITIES
A
contingent liabilities is a potential obligation
that depends on a future event arising out of a
past transaction or event.
Examples:
Pending
lawsuits
Debt guarantees
McGraw-Hill/Irwin
McGraw-Hill/Irwin
Slide19
ACCOUNTING FOR CONTINGENT
LIABILITIES
McGraw-Hill/Irwin
McGraw-Hill/Irwin
Slide20
LONG-TERM LIABILITIES
Current
liabilities usually arise from routine
operating transactions.
Long-term
obligations usually arise from major
expenditures, such as acquisitions of plant
assets, the purchase of another company, or
refinancing an existing long-term obligations that
is about to mature.
McGraw-Hill/Irwin
McGraw-Hill/Irwin
Slide21
LONG-TERM LIABILITIES
Long-term
liabilities are regarded as an
alternative to owners equity as a source of
permanent financing.
Although long-term liabilities eventually mature,
they often are refinanced (i.e., the maturing
obligation simply is replaced with a new long-term
liability).
McGraw-Hill/Irwin
McGraw-Hill/Irwin
Slide22
LONG-TERM LIABILITIES
Relatively small debt
Relatively small debt
needs can be filled from
needs can be filled from
single sources.
single sources.
or Insurance Companies or
Pension Plans
Banks
McGraw-Hill/Irwin
McGraw-Hill/Irwin
Slide23
LONG-TERM LIABILITIES
Large debt needs are often
Large debt needs are often
ffilled by issuing bonds.
illed by issuing bonds.
McGraw-Hill/Irwin
McGraw-Hill/Irwin
Slide24
LONG-TERM NOTES PAYABLE
Cash
Company
Note Payable
Note Payable
Lender
When is the repayment of the principal
When
and interest going to be made?
and
Note Maturity
Date
Slide25
LONG-TERM Date
McGraw-Hill/Irwin
McGraw-Hill/Irwin
Note NOTES PAYABLE
Single Payment of
Single
Principal plus Interest
Principal
Company
Lender
Single Payment of
Single
Principal plus
Interest
Interest
Note Date
McGraw-Hill/Irwin
McGraw-Hill/Irwin
Note Maturity
Date
Slide26
LONG-TERM NOTES PAYABLE
Regular Payments of
Principal plus Interest
Company
Lender
Regular Payments of Principal plus Interest
Payments can either be equal
Note Date principal payments plus interest Note Maturity
Date
or equal payments.
McGraw-Hill/Irwin
McGraw-Hill/Irwin
Slide27
INSTALLMENT NOTES WITH EQUAL
PAYMENTS
On January 1, 2009, Foghog borrows $60,000 from a bank to
On January 1, 2009, Foghog borrows $60,000 from a bank to
purchase equipment. It signs an 8% installment note requiring 6
purchase equipment. It signs an 8% installment note requiring 6
annual payments of principal plus interest.
annual payments of principal plus interest.
DR
Jan 1
Cash
Notes Payable
60,000
CR
60,000
Borrowed $60,000 b y signing an 8% note
Compute the periodic payment by dividing the face amount
Compute the periodic payment by dividing the face amount
Compute
off the note by the present value factor.
of the note by the present value factor.
of
o
Computation
Principal divided
by PV factor
McGraw-Hill/Irwin
McGraw-Hill/Irwin
Table
PV of
Annuity of
$1 (B.3)
Table
Value
Present
Value Payment
4.6229 60,000
12,979
Slide28
EXAMPLE: PRESENT VALUE OF AN
ANNUITY
Present Value
1
2
3
4
5
6
at Beg. of Year 1
0.926
0.857
0.794
0.735
0.681
0.630
1
1
1
1
1
1
4.623
McGraw-Hill/Irwin
Slide29
INSTALLMENT NOTES WITH EQUAL
PAYMENTS
Long-term notes that call for a series of
Long-term notes that call for a series of
iinstallment payments.
nstallment payments.
Each payment is first
Each payment is first
applied to any interest
applied to any interest
due, any excess amount
due, any excess amount
paid will be applied to
paid will be applied to
cover a portion of the
cover a portion of the
principal.
principal.
McGraw-Hill/Irwin
McGraw-Hill/Irwin
With each payment, the interest
With each payment, the interest
portion gets smaller and the
portion gets smaller and the
principal portion gets larger.
principal portion gets larger.
Slide30
McGraw-Hill/Irwin
McGraw-Hill/Irwin
Slide31
ALLOCATING INSTALLMENT PAYMENTS
BETWEEN INTEREST AND PRINCIPAL
Identify the unpaid principal balance.
Identify the unpaid principal balance.
Interest expense = Unpaid Principal Interest
Interest expense = Unpaid Principal Interest
rrate.
ate.
Reduction in unpaid principal balance =
Reduction in unpaid principal balance =
IInstallment payment Interest expense.
nstallment payment Interest expense.
Compute new unpaid principal balance.
Compute new unpaid principal balance.
McGraw-Hill/Irwin
McGraw-Hill/Irwin
Slide32
INSTALLMENT NOTES WITH EQUAL
PAYMENTS
Date
31/12/2009
31/12/2010
31/12/2011
31/12/2012
13/12/2013
31/12/2014
Amortization Schedule
(A = 8% * D) (B = C - A)
C
(D = Previous -B)
Interest
Note
Cash
Expense
Amortization*
Payment
Balance
Beginning Balance
$
60,000
$
4,800 $
8,179 $
12,979
51,821
4,146
8,833
12,979
42,988
3,439
9,540
12,979
33,448
2,676
10,303
12,979
23,145
1,852
11,127
12,979
12,017
961
12,017
12,979
0
$
17,873 $
60,000 $
77,874
* Rounded.
McGraw-Hill/Irwin
McGraw-Hill/Irwin
Slide33
INSTALLMENT NOTES WITH EQUAL
PAYMENTS
Lets record the first payment made on December 31, 2009
Lets record the first payment made on December 31, 2009
Lets
Lets
by Foghog to the bank.
by Foghog to the bank.
by
by
DR
Dec 31 Notes Payable
Interest Expense
Cash
8,179
4,800
CR
12,979
To record payment on note payab le
Refer back to the amortization schedule and see if you can
Refer back to the amortization schedule and see if you can
Refer
Refer
make the entry for the second payment on the note.
make the entry for the second payment on the note.
make
make
DR
Dec 31 Notes Payable
Interest Expense
Cash
8,833
4,146
CR
12,979
To record payment on note payable
McGraw-Hill/Irwin
McGraw-Hill/Irwin
Slide34
MORTGAGE NOTES AND
BONDS
A legal agreement that helps protect the lender if the
A legal agreement that helps protect the lender if the
borrower fails to make the required payments on
borrower fails to make the required payments on
notes or bonds.
notes or bonds.
Gives the lender the right to be paid out of the cash
Gives the lender the right to be paid out of the cash
proceeds from the sale of the borrowers assets
proceeds from the sale of the borrowers assets
specifically identified in the mortgage contract.
specifically identified in the mortgage contract.
Accounting for mortgage notes and bonds is similar to
Accounting for mortgage notes and bonds is similar to
tthat for unsecured notes and bonds, except that the
hat for unsecured notes and bonds, except that the
mortgage agreement must be disclosure.
mortgage agreement must be disclosure.
McGraw-Hill/Irwin
McGraw-Hill/Irwin
Slide35
IN-CLASS EXERCISE
On December 1, 2006, Garden Corporation
incurs a 30-year, $400,000 mortgage liability
upon purchase of a warehouse. This mortgage is
payable in monthly installments of $4,116, which
include interest computed at the rate of 12% per
year. The first monthly payment is made on
December 31, 2006.
McGraw-Hill/Irwin
McGraw-Hill/Irwin
Slide36
IN-CLASS EXERCISE
1)
How much of the first payment made on
December 31, 2006, is allocated to repayment of
principal?
2)
What is the total liability related to this mortgage
to be reported in Gardens balance sheet at
December 31, 2006?
3)
The portion of the second monthly payment
made on January 31, 2007, how much
represents interest expense?
McGraw-Hill/Irwin
McGraw-Hill/Irwin
Slide37
IN-CLASS EXERCISE
4)
What is the aggregate amount paid by Garden
over the 30year life of the mortgage?
5)
Over the 30year life of the mortgage, the total
amount Garden will pay for interest charges is
McGraw-Hill/Irwin
McGraw-Hill/Irwin
Slide38
TIMES INTEREST EARNED
Times interest
=
earned
Income before interest
and income taxes
Interest expense
If income before interest and taxes varies greatly from
year to year, fixed interest charges can increase the
risk that an owner will not earn a positive return and
be unable to pay interest charges.
McGraw-Hill/Irwin
McGraw-Hill/Irwin
Slide39
DEBT-TO-EQUITY RATIO
Debt-toEquity Ratio
Total Liabilities
=
Total Equity
This ratio helps investors determine the risk of investing
in a company by dividing its total liabilities by total equity.
Six Flags Debt-to-Equity Ratio
$ in million
Total liabilities
Total equity
Debt-to-equity
Industry debt-to equity
McGraw-Hill/Irwin
McGraw-Hill/Irwin
2006
$ 2,811
376
7.5
1.2
2005
$ 2,799
694
4.0
1.0
2004
$ 2,816
826
3.4
0.9
2003
$ 3,321
1,362
2.4
0.8
Slide40
SIX FLAGS SEEKS CHAPT. 11
BANKRUPTCY PROTECTION
(ABC NEWS: JUNE 13, 2009)
The amusement park company Six Flags is seeking
Chapter 11 bankruptcy protection, saying it needs to
reorganize and shed $1.8 billion of debt.
Six Flags says it actually had a great year in 2008. It saw
25 million visitors and posted record revenues. But
executives are trying to lighten a $2.4 billion debt load that
they say is unsustainable
Saturday's bankruptcy filing came after an earlier plan to
negotiate an out-of-court deal with creditors failed.
Six Flags shares have traded below $1 since September.
They closed at 26 cents on Friday.
McGraw-Hill/Irwin
McGraw-Hill/Irwin
Slide41
END OF CHAPTER 11 &14
McGraw-Hill/Irwin
McGraw-Hill/Irwin
Slide42