Ch10 Liabilities

Chapter
10-1
Reporting and
Analyzing Liabilities
Chapter
10-2 Accounting, Third Edition
Study Objectives
1. Explain a current liability and identify the major types of current
liabilities.
2. Describe the accounting for notes payable.
3. Explain the accounting for other current liabilities.
4. Identify the types of bonds.
5. Prepare the entries for the issuance of bonds and interest expense.
6. Describe the entries when bonds are redeemed.
7. Identify the requirements for the financial statement presentation and

analysis of liabilities.
8. Apply the straight-line method of amortizing bond discount and bond

premium.
9. Apply the effecive-interest method of amortizing bond discount and bond

Chapter premium.
10-3
10. Describe the accounting for long-term notes payable.
Reporting and Analyzing Liabilities
Financial
Bonds: Long- Accounting Accounting for
Current Statement
Term for Bond Bond
Liabilities Presentation
Liabilities Issues Retirements
and Analysis
What is a Types of Issuing bonds Redeeming Balance sheet

current bonds at face value bonds at presentation
liability? Issuing Discount or maturity Analysis
Notes payable procedures premium on Redeeming Off-balance-
Sales taxes Determining bonds bonds before sheet financing
payable the market Issuing bonds maturity
Unearned value of bonds at a discount
revenues Issuing bonds
Current at a premium
maturities of
long-term debt
Payroll and
payroll taxes
payable
Chapter
10-4
Current Liabilities
Current liability is debt with two key features:

• Company expects to pay the debt from
existing current assets or through the
creation of other current liabilities.
• Company will pay the debt within one year or
the operating cycle, whichever is longer.
Current liabilities include notes payable, accounts payable,

unearned revenues, and accrued liabilities such as taxes,
salaries and wages, and interest payable.
Chapter SO 1 Explain a current liability and identify

10-5
the major types of current liabilities.
Current Liabilities
Question
To be classified as a current liability, a debt must be
expected to be paid:
a. out of existing current assets.
b. by creating other current liabilities.
c. within 2 years.
d. both (a) and (b).
Chapter SO 1 Explain a current liability, and identify

10-6
the major types of current liabilities.
Current Liabilities
Notes Payable
Written promissory note.
Require the borrower to pay interest.
Those due within one year of the balance sheet
date are usually classified as current liabilities.
Chapter
10-7 SO 2 Describe the accounting for notes payable.
Current Liabilities
Illustration: First National Bank agrees to lend

$100,000 on September 1, 2010, if Cole Williams Co.
signs a $100,000, 12%, four-month note maturing on
January 1. When a company issues an interest-bearing
note, the amount of assets it receives generally equals
the note’s face value.
Sept. 1 Cash 100,000

Notes payable
100,000
Chapter
Current Liabilities
Illustration: If Cole Williams Co. prepares financial

statements annually, it makes an adjusting entry at
December 31 to recognize interest.
Dec. 31 Interest expense 4,000 *

Interest payable
4,000
* $100,000 x 12% x 4/12 = 4,000

Chapter
Current Liabilities
Illustration: At maturity (January 1), Cole Williams Co.

must pay the face value of the note plus interest. It
records payment as follows.
Jan. 1 Notes payable 100,000

Interest payable 4,000
Cash
104,000
Chapter
Current Liabilities
Sales Tax Payable

Sales taxes are expressed as a stated
percentage of the sales price.
Retailer collects tax from the customer.
Retailer remits the collections to the state’s

department of revenue.
Chapter
10-11 SO 3 Explain the accounting for other current liabilities.
Current Liabilities
Illustration: March 25, cash register readings for

Cooley Grocery show sales of $10,000 and sales taxes of
$600 (sales tax rate of 6%), the journal entry is:
Mar. 25 Cash 10,600

Sales
Sales tax payable 10,000
600
Chapter
Current Liabilities
Sometimes companies do not ring up sales taxes

separately on the cash register.
Illustration: Cooley Grocery rings up total receipts of

$10,600. Because the amount received from the sale is
equal to the sales price 100% plus 6% of sales,
(sales tax rate of 6%), the journal entry is:
Mar. 25 Cash 10,600

Sales *
Sales tax payable 10,000
* $10,600 / 1.06 = 10,000

600
Chapter
Current Liabilities
Unearned Revenue
Revenues that are received before the company
delivers goods or provides services.
1. Company debits Cash, and
credits a current liability
account (unearned revenue).
2. When the company earns
the revenue, it debits the
Unearned Revenue account,
and credits a revenue account.
Chapter
Current Liabilities
Illustration: Superior University sells 10,000 season

football tickets at $50 each for its five-game home
schedule. The entry for the sales of season tickets is:
Aug. 6 Cash 500,000

Unearned ticket revenue
Superior records the earning of revenue with the

500,000
following entry.
Sept. 7 Unearned ticket revenue 500,000

Ticket revenue
Chapter
10-15
500,000
SO 3 Explain the accounting for other current liabilities.
Current Liabilities
Current Maturities of Long-Term Debt

Portion of long-term debt that comes due in the
current year.
No adjusting entry required.
Illustration: Wendy Construction issues a five-year, interest-bearing

$25,000 note on January 1, 2009. This note specifies that each January
1, starting January 1, 2010, Wendy should pay $5,000 of the note. When
the company prepares financial statements on December 31, 2009,
$5,000
1. What amount should be reported as a current liability? _________
$20,000
2. What amount should be reported as a long-term liability? _______
Chapter
Current Liabilities
Payroll and Payroll Taxes Payable

The term “payroll” pertains to both:
Salaries - managerial, administrative, and sales
personnel (monthly or yearly rate).
Wages - store clerks, factory employees, and
manual laborers (rate per hour).
Determining the payroll involves computing three

amounts: (1) gross earnings, (2) payroll deductions,
and (3) net pay.
Chapter
Current Liabilities
Illustration: Assume Cargo Corporation records its

payroll for the week of March 7 as follows:
Mar. 7 Salaries and wages expense 100,000
FICA tax payable 7,650
Federal tax payable 21,864
State tax payable 2,922
Salaries and wages payable 67,564
Record the payment of this payroll on March 7.

Mar. 7 Salaries and wages payable 67,564
Cash 67,564
Chapter
Current Liabilities
Payroll tax expense results from three taxes that

governmental agencies levy on employers.
These taxes are:

FICA tax
Federal unemployment tax
State unemployment tax
Chapter
Current Liabilities
Illustration: Based on Cargo Corp.’s $100,000 payroll,

the company would record the employer’s expense and
liability for these payroll taxes as follows.
Payroll tax expense 13,850

FICA tax payable 7,650
State unemployment tax payable 800
Federal unemployment tax payable 5,400
Chapter
Current Liabilities
Question
Employer payroll taxes do not include:
a. Federal unemployment taxes.
b. State unemployment taxes.
c. Federal income taxes.
d. FICA taxes.
Chapter
Bond: Long-Term Liabilities
Bonds are a form of interest-bearing notes payable

issued by corporations, universities, and
governmental agencies.
Sold in small denominations (usually $1,000 or

multiples of $1,000).
Chapter
10-22 SO 4 Identify the types of bonds.
Types of Bonds
Secured
Unsecured
Convertible
Callable
Chapter
Chapter
10-24
Issuing Procedures
• Bond certificate
 Issued to the investor.
 Provides information such as the
 name of the company issuing bonds,
 face value,
 maturity date, and
 contractual interest rate (stated rate).
• Face value - principal due at the maturity.
• Maturity date - date final payment is due.
• Contractual interest rate – rate to determine cash
interest paid, generally semiannually.
Chapter
Issuer of
Bonds
Illustration 10-3
Maturity
Date
Contractual
Interest
Rate
Face or
Chapter
10-26 Par Value SO 4 Identify the types of bonds.
Determining the Market Value of Bonds

Market value is a function of the three factors that
determine present value:
1. the dollar amounts to be received,
2. the length of time until the amounts are received, and
3. the market rate of interest.
The process of finding the present value is

referred to as discounting the future amounts.
Chapter
Illustration: Assume that Acropolis Company on January 1,

2010, issues $100,000 of 9% bonds, due in five years, with
interest payable annually at year-end.
Illustration 10-4
Time diagram
depicting cash
flows
Illustration 10-5
Computing the
market price of
bonds
Chapter
Accounting for Bond Issues
A corporation records bond transactions when it

 issues or retires (buys back) bonds and
 when bondholders convert bonds into common stock.
Bonds may be issued at

 face value,
 below face value (discount), or
 above face value (premium).
Bond prices are quoted as a percentage of face value.
Chapter
10-29 SO 5 Prepare the entries for the issuance of bonds and interest expense.
Question
The rate of interest investors demand for loaning
funds to a corporation is the:
a. contractual interest rate.
b. face value rate.
c. market interest rate.
d. stated interest rate.
Chapter
Issuing Bonds at Face Value
Illustration: Devor Corporation issues 100, five-year, 10%,

$1,000 bonds dated January 1, 2010, at 100 (100% of face
value). The entry to record the sale is:
Jan. 1 Cash 100,000
Bonds payable 100,000
Prepare the entry Devor would make to accrue interest on

December 31.
Dec. 31 Bond interest expense 10,000
Bond interest payable 10,000
Chapter
Issuing Bonds at Face Value
Prepare the entry Devor would make to pay the interest on

Jan. 1, 2011.
Jan. 1 Bond interest payable 10,000
Cash 10,000
Chapter
Assume Contractual Rate of 10%

Market Interest Bonds Sold At
8% Premium
10% Face Value
12% Discount
Chapter
Question
Karson Inc. issues 10-year bonds with a maturity value
of $200,000. If the bonds are issued at a premium,
this indicates that:
a. the contractual interest rate exceeds the market
interest rate.
b. the market interest rate exceeds the contractual
interest rate.
c. the contractual interest rate and the market
interest rate are the same.
d. no relationship exists between the two rates.
Chapter
Issuing Bonds at a Discount
Illustration: Assume that on January 1, 2010, Candlestick

Inc. sells $100,000, five-year, 10% bonds at 98 (98% of face
value) with interest payable on January 1. The entry to
record the issuance is:
Jan. 1 Cash 98,000

Discount on bonds payable 2,000
Illustration 10-8
Computation of total cost of
borrowing—bonds issued at
discount
Chapter
Statement Presentation
Illustration 10-7
Statement presentation of
discount on bonds payable
Chapter
Question
Discount on Bonds Payable:
a. has a credit balance.
b. is a contra account.
c. is added to bonds payable on the balance sheet.
d. increases over the term of the bonds.
Chapter
Issuing Bonds at a Premium
Illustration: Assume that the Candlestick Inc. bonds

previously described sell at 102 rather than at 98. The
entry to record the sale is:
Jan. 1 Cash 102,000

Premium on bonds payable 2,000
Illustration 10-12
Computation of total cost of
borrowing—bonds issued at
premium
Chapter
Issuing Bonds at a Premium
Statement Presentation
Illustration 10-11
Statement presentation of
premium on bonds payable
Chapter
Accounting for Bond Retirements
Redeeming Bonds at Maturity

Candlestick records the redemption of its bonds at maturity
as follows:

Cash 100,000
Chapter
10-40 SO 6 Describe the entries when bonds are redeemed.
Redeeming Bonds before Maturity

When a company retires bonds before maturity, it is
necessary to:
1. eliminate the carrying value of the bonds at the
redemption date;
2. record the cash paid; and
3. recognize the gain or loss on redemption.
The carrying value of the bonds is the face value of the bonds
less unamortized bond discount or plus unamortized bond premium
at the redemption date.
Chapter
Question
When bonds are redeemed before maturity, the gain
or loss on redemption is the difference between the
cash paid and the:
a. carrying value of the bonds.
b. face value of the bonds.
c. original selling price of the bonds.
d. maturity value of the bonds.
Chapter
Illustration: Assume at the end of the fourth period,

Candlestick Inc., having sold its bonds at a premium, retires
the bonds at 103 after paying the annual interest. Assume
that the carrying value of the bonds at the redemption
date is $100,400 (principal $100,000 and premium $400).
Candlestick records the redemption at the end of the fourth
interest period (January 1, 2014) as:

Premium on bonds payable 400
Cash 103,000
Loss on bond redemption 2,600
Chapter
Question
When bonds are converted into common stock:
a. a gain or loss is recognized.
b. the carrying value of the bonds is transferred
to paid-in capital accounts.
c. the market price of the stock is considered in
the entry.
d. the market price of the bonds is transferred to
paid-in capital.
Chapter
Financial Statement Analysis and Presentation
Balance Sheet Presentation

Illustration 10-15
Chapter SO 7 Identify the requirements for the financial statement

10-45
presentation and analysis of liabilities.
Analysis
Illustration 10-16

10-46
Liquidity
$99,823 $91,387
= 1.0:1 = 1.07:1
$99,680 $85,373
Liquidity ratios measure the short-term ability of a company to pay

its maturing obligations and to meet unexpected needs for cash.

10-47
Solvency
$175,678 = 64%
$275,941
$13,927+$418+$7,609
= 52.5
$418 times
Solvency ratios measure the ability of a company to survive

Chapter over a long period of time.
10-48
Chapter
10-49
Off-Balance-Sheet Financing
Contingencies
Leasing
 Operating lease
 Capital lease

10-50
Chapter
10-51
Straight-Line Amortization Appendix 10A
Amortizing Bond Discount and Premium

To follow the matching principle, companies allocate
bond discount and bond premium to expense in each
period in which the bonds are outstanding.
Illustration 10A-1
Chapter SO 8 Apply the straight-line method of amortizing

10-52 bond discount and bond premium.
Amortizing Bond Discount

Illustration: Candlestick, Inc., sold $100,000, five-
year, 10% bonds on January 1, 2010, for $98,000
(discount of $2,000). Interest is payable on January 1
of each year. Prepare the entry to accrue interest at
Dec. 31, 2010.

Discount on bonds payable
Bond interest payable
400
10,000

Illustration 10A-2

Amortizing Bond Premium

Illustration: Candlestick, Inc., sold $100,000, five-
year, 10% bonds on January 1, 2010, for $102,000
(premium of $2,000). Interest is payable on January 1
of each year. Prepare the entry to accrue interest at
Dec. 31, 2010.

10,000

Illustration 10A-2

Effective-Interest Amortization Appendix 10B
Under the effective-interest method, the amortization

of the discount or premium results in interest expense
equal to a constant percentage of the carrying value.
Required steps:
1. Compute the bond interest expense.
2. Compute the bond interest paid or accrued.
3. Compute the amortization amount.
Illustration 10B-1
Chapter
10-57

Illustration: Candlestick, Inc., sold $100,000, five-year,
10% bonds on January 1, 2010, for $98,000. The
effective-interest rate is 10.53% and interest is payable
on Jan. 1 of each year. Prepare the bond discount
amortization schedule.
Chapter SO 9 Apply the effective-interest method of amortizing


Illustration 10B-2

Illustration: Candlestick, Inc. records the accrual of

interest and amortization of bond discount on Dec. 31,
as follows:

Discount on bonds payable
Bond interest payable 319
10,000


Illustration: Candlestick, Inc., sold $100,000, five-year,
10% bonds on January 1, 2010, for $102,000. The
effective-interest rate is 9.48% and interest is payable on
Jan. 1 of each year. Prepare the bond premium
amortization schedule.


Illustration 10B-4

Illustration: Candlestick, Inc. records the accrual of

interest and amortization of premium discount on Dec.
31, as follows:

10,000

Long-Term Notes Payable Appendix 10C
Long-Term Notes Payable

• May be secured by a mortgage that pledges title to
specific assets as security for a loan.
• Typically, the terms require the borrower to make
installment payments over the term of the loan. Each
payment consists of
1. interest on the unpaid balance of the loan and
2. a reduction of loan principal.
Companies initially record mortgage notes payable at

face value.
Chapter
10-64 SO 10 Describe the accounting for long-term notes payable.
Illustration: Porter Technology Inc. issues a $500,000,

12%, 20-year mortgage note on December 31, 2010. The
terms provide for semiannual installment payments of
$33,231.
Illustration 10C-1
Chapter
Illustration: Porter Technology records the mortgage

loan and first installment payment as follows:
Dec. 31 Cash 500,000

Mortgage notes payable
500,000
Jun. 30 Interest expense 30,000

Mortgage notes payable 3,231
Cash
33,231
Chapter
Question
Each payment on a mortgage note payable consists
of:
a. interest on the original balance of the loan.
b. reduction of loan principal only.
c. interest on the original balance of the loan and
reduction of loan principal.
d. interest on the unpaid balance of the loan and
reduction of loan principal.
Chapter
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Chapter
10-68

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Chapter

2. Describe the accounting for notes payable.

3. Explain the accounting for other current liabilities.

4. Identify the types of bonds.

6. Describe the entries when bonds are redeemed.

7. Identify the requirements for the financial statement presentation and

8. Apply the straight-line method of amortizing bond discount and bond

9. Apply the effecive-interest method of amortizing bond discount and bond

What is a Types of Issuing bonds Redeeming Balance sheet

Current liability is debt with two key features:

Current liabilities include notes payable, accounts payable,

Chapter SO 1 Explain a current liability and identify

Chapter SO 1 Explain a current liability, and identify

Illustration: First National Bank agrees to lend

Sept. 1 Cash 100,000

Illustration: If Cole Williams Co. prepares financial

Dec. 31 Interest expense 4,000 *

* $100,000 x 12% x 4/12 = 4,000

Illustration: At maturity (January 1), Cole Williams Co.

Jan. 1 Notes payable 100,000

Sales Tax Payable

Retailer collects tax from the customer.

Retailer remits the collections to the state’s

Illustration: March 25, cash register readings for

Mar. 25 Cash 10,600

Sometimes companies do not ring up sales taxes

Illustration: Cooley Grocery rings up total receipts of

Mar. 25 Cash 10,600

Sales tax payable 10,000

* $10,600 / 1.06 = 10,000

Illustration: Superior University sells 10,000 season

Aug. 6 Cash 500,000

Superior records the earning of revenue with the

Sept. 7 Unearned ticket revenue 500,000

Current Maturities of Long-Term Debt

No adjusting entry required.

Illustration: Wendy Construction issues a five-year, interest-bearing

Payroll and Payroll Taxes Payable

Determining the payroll involves computing three

Illustration: Assume Cargo Corporation records its

Record the payment of this payroll on March 7.

Payroll tax expense results from three taxes that

These taxes are:

Illustration: Based on Cargo Corp.’s $100,000 payroll,

Payroll tax expense 13,850

Bonds are a form of interest-bearing notes payable

Sold in small denominations (usually $1,000 or

Determining the Market Value of Bonds

The process of finding the present value is

Illustration: Assume that Acropolis Company on January 1,

A corporation records bond transactions when it

Bonds may be issued at

Illustration: Devor Corporation issues 100, five-year, 10%,

Jan. 1 Cash 100,000

Bonds payable 100,000

Prepare the entry Devor would make to accrue interest on

Dec. 31 Bond interest expense 10,000

Bond interest payable 10,000

Prepare the entry Devor would make to pay the interest on

Jan. 1 Bond interest payable 10,000

Assume Contractual Rate of 10%

10% Face Value

Illustration: Assume that on January 1, 2010, Candlestick

Jan. 1 Cash 98,000