Chapter 8

Chapter 8 - ACG 2021 ACG 2021 Financial Accounting Current...

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Unformatted text preview: ACG 2021 ACG 2021 Financial Accounting Current & Long­Term Liabilities Learning Objectives Learning Objectives ► Account for current liabilities and contingent liabilities ► Account for bonds­payable transactions ► Measure interest expense ► Understand the advantages and disadvantages of borrowing ► Statement of Cash Flow Effects Current Liabilities Current Liabilities ► Liabilities due within 1 year or the company’s operating cycle if longer Known amounts ► ► ► Accounts Payable ► Short­term Notes Payable ► Sales Tax Payable ► Current Installment of Long­ Term Debt ► Accrued Expenses ► Payroll Liabilities ► Unearned Revenues ► We increase Liabilities with a credit. So to increase any of the Known payables on the left, we credit the payable for the known amount. We must therefore, debit a corresponding expense account (accrued expenses) Cash (deferred liability) Long­term debt Cash (if recording receipt from a note payable) Accounts Payable Accounts Payable ► Amounts owed for purchases of goods or services on account The purchase can be for an Asset ► Inventory (generally largest) The purchase could also be an Expense ► Legal Fees (service) No interest associated with money owed, and it is assumed the A/P will be paid quickly ► If we have an A/P for Inventory purchased on account, what does the company we purchased the inventory from have? An Accounts Receivable Note Payable Note Payable ► Unlike Accounts Payable ► Usually contains interest payments that are due ► Record: Issuance of Note Payable ►We borrowed Cash and have an obligation to pay back Interest Expense Payment of Note Payable Notes Payable Notes Payable On Jan. 30, 20X5 the company received a one year $8,000 note payable at 10% interest to purchase inventory. Jan 30 Cash Note Payable, Short-term 8,000 8,000 Purchase of inventory by issuing a 1-year 10% note payable Interest must be accrued at fiscal year end (April 30) for interest owed but not yet due. Apr 30 Interest Expense (8,000 x .10 x 3/12) Interest Payable 200 Adjusting entry to accrue interest expense 200 Notes Payable Notes Payable To record repayment at maturity Jan 30 20x6: Jan. 30 Note Payable, short-term Interest Payable 8,000 200 Interest Expense ($8,000 x .10 x 9/12) 600 Cash [($8,000 x .10) + 8,000] 8,800 Payment of a note payable and interest at maturity Step 1: Reverse the balance in the Note Payable account to 0 Step 2: Reduce the amount of any Interest Payable from a previous period to 0 Step 3: Record the Interest Expense for the period Step 4: Record the cash (Principal and Interest paid) Payroll Liabilities Payroll Liabilities ► Types of Compensation Salary Wage Commission Bonus ► Salary expense is gross pay. ► Salary payable is net pay. Payroll Liabilities Payroll Liabilities To record payroll Jan. 30 Salary Expense Employee Income Tax Payable FICA Tax Payable Salary Payable to Employees To record salary expense 10,000 1,200 800 8,000 Sales Tax Payable Sales Tax Payable To record sales of $200,000 plus 5% sales tax: Cash (200,000 x 1.05) 210,000 Sales Revenue Sales Tax Payable (200,000 x .05) To record cash sales and related sales tax 200,000 10,000 Unearned Revenues Unearned Revenues To record collection of cash in payment for future services: Jan 30 Cash Unearned Ticket Revenue 1,200 1,200 Received cash in advance for ticket sales To record revenue after 50% of services have been performed. Apr 30 Unearned Ticket Revenue Ticket Revenue 600 Earned revenue that was collected in advance 600 Current Liabilities Current Liabilities ► Amounts that must be estimated Estimated Warranty Payable ►How many products will need repair / replacement ►MatchingPrinciple ►Estimate based on past historical data Contingent Liabilities ►An company may incur an expense in the future Most commonly associated with law suits Estimated Warranty Payable Estimated Warranty Payable Warranty expense should be recognized in the year the product is sold. For example, a company made sales of $200,000 subject to product warranties. They estimate that 3% of the products will require repair or replacement. Warranty Expense Estimated Warranty Payable 6,000 6,000 To accrue warranty expense When $5,800 of products are replaced under the warranty: Estimated Warranty Payable Inventory 5,800 To replace defective products under warranty 5,800 Contingent Liabilities Contingent Liabilities ► Contingent liability depends on a future event arising out of past events. ► To account for contingent losses: Record liability if it is probable and can be reasonably estimated. Report the liability in the notes to the financial statements (but do not record an entry) if it is reasonably possible that a loss will occur. Do not report a contingent loss that is not likely to occur. ACG 2021 ACG 2021 Financial Accounting Long – Term Liabilities Bonds Payable Bonds Bonds ► IOU’s ► $1000 or $5000 Increments ► Sold in the “Market” ► Structure: Maturity Date Interest Rate Interest Payment Dates ► Provide two payments: Interest every 6 months Principal amount of Bond Bond Market Bond Market ► Bloomberg.com Bonds Payable Bonds Payable ► Bonds payable are debt (i.e. a liability) of the issuing company. ► Types of bonds: term bonds ►All bonds mature at the same time (end of the term) serial bonds ►Bonds mature in installments over a period of time. secured bonds (mortgage bonds) debentures (unsecured bonds) Bonds Payable Bonds Payable ► Bonds can be issued (bought) at face value for a premium at a discount ► Bond Price is determined by: Market Interest Rate – Effective Rate Bond’s Interest Rate – Contract Rate THESE RATES ARE USUALLY DIFFERENT! Bond Interest Rates Bond Interest Rates ► Bonds are sold at market price ­ amount that investors are willing to pay at any given time ► Market price represents: present value of periodic interest payments present value of principal to be received at maturity Present Value Present Value The amount invested today to receive a greater amount at a future date It depends on: amount of the future receipt length of time to future receipt interest rate for the period Bond Interest Rates Bond Interest Rates ► Contract rate – stated rate ► Market rate – effective rate Present Value Calculation (Discount) Present Value Calculation (Discount) ► $100,000 10 year bond, 9% stated interest, 10% market rate ► Two parts: PV of principle and PV of interest payments $100,000 x .614* = $61,400 100,000 x. 045 x 7.722* = $34,749 PV of Bonds $96,149 * From Appendix C Bond Prices Bond Prices ► Bond Face Value = Stated Principal ► Bond issued above face (par) value ­ premium ► Bond issued at below face (par) value ­ discount ► As a bond nears maturity, its market price moves toward par value Bond Prices Bond Prices Quoted at a percent of their maturity value. A $1,000 bond quoted at 101½ sells for… $1,000 × 1.015 = $1,015. A $1,000 bond quoted at 88-3/8 sells for… $1,000 × 0.88375 = $883.75. Bond Payable Bond Payable ► Purchase a $1,000 Bond ► Bond Pays = 9% Bond Interest = $90 ► Invest $1,000 in Market at 9% ► Market Interest = $90 ► Bond Pays = 10% Bond Interest = $100 ► Bond Pays = 8% Bond Interest = $80 How much would you pay for 9% bond, 10% bond, 8% bond? ACG 2021 ACG 2021 Financial Accounting Accounting for Bonds Payable Accounting for Bonds Accounting for Bonds ► Record Issuance of Bond ► Record Payment of Interest ► Record Accrual of Interest Credit Cash Credit Interest Payable Record Amortization of Discount/Premium ►Effective Interest Method ►Straight­Line Method ► Record Retirement of Bond Bonds Payable Bonds Payable $50 million in 9%, 5 year bonds are issued on Jan 1, 2006 at par. Cash Bonds Payable 50,000,000 50,000,000 To issue bonds at par First interest payment on July 1. Interest Expense Cash 2,250,000 2,250,000 To pay semiannual interest $50,000,000 x .09 x 6/12 Bonds Payable Bonds Payable At year end, accrue interest to be paid on Jan.1 Interest Expense Interest Payable 2,250,000 To accrue interest $50,000 x .09 x 6/12 2,250,000 Bonds Payable at Discount Bonds Payable at Discount $100,000 in 9%, 5 year bonds are issued when the market rate is 10% for $96,149. Cash Discount on Bonds Payable Bonds Payable To issue bonds at a discount 96,149 3,851 100,000 Bonds Payable at Discount Bonds Payable at Discount ► Discount on Bonds Payable is a contra account to Bonds Payable. ► Carrying amount of the bonds equals Bonds Payable less Discount on Bonds Payable. ► Interest payments are fixed by contract, but interest expense varies as the bond discount is amortized. Bonds Payable Premium Bonds Payable Premium $100,000 in 9%, 5 year bonds are issued when the market rate is 8% for $104,100. Cash 104,100 Premium on Bonds Payable Bonds Payable To issue bonds at a premium 4,100 100,000 Bonds Payable at Premium Bonds Payable at Premium ► Premium on Bonds Payable is normal liability account (not a contra­account) ► Carrying amount of the bonds equals Bonds Payable plus Premium on Bonds Payable. ► Interest payments are fixed by contract, but interest expense varies as the bond premium is amortized. Bonds Payable Discount Bonds Payable Discount Example ► Issue Date – January 1, 2006 ► Maturity value ­ $100,000 ► Stated interest rate – 9% ► Interest paid – 4 ½% semiannually ► Market rate at time of issue – 10% annually, 5% semiannually ► Issue Price – $96,149 Bonds Payable Discount Bonds Payable Discount Example Amortization Table (partial) A Semiannual interest Date Jan 1, 2006 Jul 1 Jan 1, 2007 Jul 1 * * * Jan 1, 2011 B C D Interest Interest Expense Payment (5% of (4 ½% Preceding Discount of Discount Account Bond Maturity Carrying Amortization Balance Value (B-A) (Preceding D -C) Amount) 3851 4,500 $ 4,807 $ 307 $3,544 4,500 4,823 323 3,221 4,500 4,839 339 2,882 * * * * * * * * * * * * 4,500 4,961 461 -0- E Bond Carrying Amount ($100,000 – D) $ 96,149 96,456 96,779 97,118 * * * 100,000 Bonds Payable Discount Journal Entries Bonds Payable Discount Journal Entries First semiannual interest payment at Jul 1. Interest Expense 4,807 Discount on Bonds Payable 307 Cash 4,500 To pay semiannual interest and amortize bond discount Second semiannual interest accrual at Dec 31. Interest Expense 4,823 Discount on Bonds Payable 323 Interest Payable 4,500 To accrue semiannual interest and amortize bond discount Bonds Payable Premium Bonds Payable Premium Example ► Issue Date – January 1, 2006 ► Maturity value ­ $100,000 ► Stated interest rate – 9% ► Interest paid – 4 ½% semiannually ► Market rate at time of issue – 8% annually, 4% semiannually ► Issue Price – $104,100 Bonds Payable Premium Bonds Payable Premium Example Amortization Table (partial) A B C D Interest Interest Expense Payment (4% of Semi(4 ½% Preceding Premium annual of Premium Account Bond interest Maturity Carrying Amortization Balance Date Value (A - B) (Preceding D -C) Amount) Jan 1, 2006 $4,100 Jul 1 4,500 $ 4,164 $ 336 3,764 Jan 1, 2007 4,500 4151 349 3415 Jul 1 4,500 4137 363 3052 * * * * * * * * * * * * * * * Jan 1, 2011 4,500 3,955 545 -0- E Bond Carrying Amount ($100,000 +D) $ 104,100 103,764 103,415 103,052 * * * 100,000 Bonds Payable Premium Bonds Payable Premium Example First semiannual interest payment at Jul 1. Interest Expense 4,164 Premium on Bonds Payable 336 Cash 4,500 To pay semiannual interest and amortize bond premium Second semiannual interest accrual at Dec 31. Interest Expense 4,151 Premium on Bonds Payable 349 Interest Payable 4,500 To accrue semiannual interest and amortize bond premium Exercise 8­13 Exercise 8­13 Straight­Line Amortization Straight­Line Amortization ► Divide bond discount (or premium) into equal periodic amounts over the bond’s term. This equal amount is Interest Expense Interest expense is the same each period. ► GAAP permits straight line only when the amounts differ insignificantly from amounts determined using the effective interest method. Straight­Line Straight­Line ► Using the previous Chrysler Example $100,000 in 9%, 5 year bonds are issued when the market rate is 8% for $104,100. ► Premium Amortization = $4100/10 = $410 10 = 5 years x 2 interest payments per year Straight Line Journal Entries Straight Line Journal Entries First semiannual interest payment at Jul 1. Interest Expense 4,090 Premium on Bonds Payable 410 Cash 4,500 To pay semiannual interest and amortize bond premium Second semiannual interest accrual at Dec 31. Interest Expense 4,090 Premium on Bonds Payable 410 Interest Payable 4,500 To accrue semiannual interest and amortize bond premium Issuing Bonds Payable Issuing Bonds Payable at a Discount Chrysler’s balance sheet immediately after issuance of the bonds: Total current liabilities Long-term liabilities: Bonds payable, 9%, due 2009 Discount on bonds payable $ XXX $100,000 ( 3,851) 96,149 Discount on Bonds Payable - contra account to Bonds Payable Issuing Bonds Payable Issuing Bonds Payable at a Premium Chrysler’s balance sheet immediately after issuance of the bonds: Total current liabilities Long-term liabilities: Bonds payable $100,000 Premium on bonds payable 4,100 $ XXX $104,100 Exercise 8­10 Exercise 8­10 ACG 2021 ACG 2021 Financial Accounting Retiring Bonds Bonds Retired at Maturity Bonds Retired at Maturity ► After Recording final interest payment Reduce Bond Payable Reduce Cash Account Bonds Payable 100,000 Cash 100,000 Retiring Callable Bonds Retiring Callable Bonds ► Callable Bonds Bonds that can be paid off early Call Price ►Often at greater then par value (101 or 102) Thus management has to decide to pay call premium or Buy Bonds on the Open Market Early Retirement of Bonds Early Retirement of Bonds Payable Air Products and Chemicals, Inc., has $70,000 of debenture bonds outstanding with unamortized discount of $350. The market price is 99¼. Early Retirement of Bonds Early Retirement of Bonds Payable Par value of bonds Less: Unamortized discount Carrying amount of the bonds Market price ($70,000 × 0.9925) Extraordinary gain on retirement Date General Journal Accounts and Explanations PR Bonds Payable Discount on Bonds Payable Cash Gain on Retirement of Bonds To record bond retirement $70,000 ( 350) $69,650 69,475 $ 175 Debit Credit 70,000 350 69,475 175 Convertible Bonds and Notes Convertible Bonds and Notes ► May be converted into the issuing company’s common stock. ► Assume note holders convert half of $300 million convertible notes into 4 million shares of stock ($1 par). Notes Payable 150,000,000 Common Stock (4 million at $1 par) 4,000,000 Paid-in Capital in Excess of par-Common 146,000,000 To record conversion of notes payable Financing with Bonds or Stock? Financing with Bonds or Stock? ► Issuing stock creates no liabilities incurs no interest expense less risky to issuing corporation ► Issuing notes or bonds payable does not dilute stock ownership or control of the corporation usually results in higher earnings per share [EPS is the amount of net income for each share of its stock] Reporting Financing Activities on Reporting Financing Activities on the Statement of Cash Flows Amounts in millions Cash Flow from Financing Activities: Proceeds from issuance of bonds Proceeds from long-term borrowings Payment of long-term debt Proceeds from issuance of common stock Payments of cash dividends Other, net Net cash provided by financing activities Year Ended December 31 $754 32 (29) 351 (371) (4) $733 ACG 2021 ACG 2021 Financial Accounting Ratio Analysis Times Interest Earned Times interest earned ratio Times interest earned ratio Income from Operations Times interest earned = Interest Expense The ability of a company to pay it’s Interest Expense Obligations from Earnings Generated from Operations BlackBoard Inc. BlackBoard Inc. BlackBoard T.I.E. BlackBoard T.I.E. ► 2006 ­11,826 / 5354 = ­2.21 ► 2005 24,447 / 49 = 498.92 ► 2004 10,033 / 179 = 56.05 Best Buy, Inc. Best Buy, Inc. Best Buy – T.I.E. Best Buy – T.I.E. ► 2007 1,999 / 31 = 64.48 ► 2006 1,644 / 30 = 54.8 ► 2005 1,442 / 44 = 32.77 End of Chapter 8 End of Chapter 8 ...
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