Rt term interest bearing debt nal swings in working

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rt-Term Interest-Bearing Debt nal swings in working capital are often financed with a bank line of credit (short-term debt). -s case the bank commits to lend up to a maximum amount with the understanding that the ts borrowed will be repaid in full sometime during the year. An interest-bearing note evi- res any such borrowing. When the company borrows these short-term funds, it reports the cash received on the bal- heet together with an increase in liabilities (notes payable). The note is reported as a current
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liability because the company expects to repay it within a year. This borrowing has no effect income or equity. The borrower incurs (and the lender earns) interest on the note as time pass GAAP requires the borrower to accrue the interest liability and the related interest expense ea time financial statements are issued. To illustrate, assume that Verizon borrows $1,000 cash on January 1. The note bears interes; at a 12% annual rate, and the interest (3% per quarter) is payable on the first of each subsequ quarter (April 1, July 1, October 1, January 1). Assuming that Verizon issues calendar-quarter financial statements, this borrowing results in the following financial statement effects for Jan ary 1 through April l . 7-11 Module 7 I Liability Recognition and Nonowner Financing Cash 1,000 NP 1.000 Cash 1.OoOT NP r 1.000 IE 30 IP 30 IE 30 I IP 30 IP 30 Cash 30 IP 30 I Cash I 30 Balance Sheet Income Statement Cash Noncash liabil- Contrib. Earned ~ ~ Rev- Expen- " Net Transaction Asset + Assets = ities + Capital + Capital enues - ses :; Income row $1,000 + 1,000 +1,000 cash and Cash = Note issue note Payable payable Mar 31: Accrue quar- terly interest +30 -30 +30 12O/C = Interest Retained - Interest = -30 on 0, Payable Earnings Expense $1,000 note payable = Apr 1: Pay -30 $30 cash for Cash interest due = -30 = Interest Payable ._-------------------------------------------_._----------------------------------------------------------------------~---------------------------------------------------~ The January 1 borrowing increases both cash and notes payable. On March 31, Verizon is its quarterly financial statements. Although interest is not paid until April 1, the compan incurred three months' interest obligation as of March 31. Failure to recognize this liability the expense incurred would not fairly present the financial condition of the company. Acco::.:- ingly, the quarterly accrued interest payable is computed as follows: Interest Expense = Principal X Annual Rate x Portion of Year Outstanding $30 = $1,000 x 12% x 3/12 The subsequent interest payment on April 1 reduces both cash and the interest payable that Y zon accrued on March 31. There is no expense reported on April 1, as it was recorded the pre\- day (March 31) when Verizon prepared its financial statements. (For fixed-maturity borrowi _ specified in days, such as a 90-day note, we assume a 365-day year for interest accrual com tions, see Mid-Module Review 3.) Current Maturities of Long-Term Debt Principal payments that must be made during the upcoming 12 months on long-term debt ( as for a mortgage), or on bonds and notes that mature within the next year, are reported as c liabilities called currentmaturities oflong-term debt.
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