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Chapter
LIABILITIES
10

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The
The Nature
Nature of
of Liabilities
Liabilities

Defined
Defined asas debts
debts oror obligations
obligations
arising
arising from
from past
past transactions
transactions or
or
events.
events.
Maturity = 1 year or less Maturity > 1 year

Current Noncurrent
Liabilities Liabilities
I.O.U.

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Distinction
Distinction Between
Between
Debt
Debt and
and Equity
Equity
The acquisition of assets is financed from two sources:
DEBT
DEBT EQUITY
EQUITY

Funds from creditors, with a Funds from

definite due date, and owners
sometimes bearing interest.
The feature that most clearly distinguishes the claims of creditors from
owners’ equity is that all liabilities eventually mature —that is, they come due.
Owners’ equity does not mature. The date on which a liability comes due is
called the maturity date. The claims of creditors have legal priority over the
claims of owners.
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Evaluating
Evaluating Liquidity
Liquidity

An
An important
important indicator
indicator of
of aa company’s
company’s ability
ability
to
to meet
meet its
its current
current obligations.
obligations.

Two
Two commonly
commonly used
used measures:
measures:

Working Capital = Current Assets - Current Liabilities

Current Ratio = Current Assets ÷ Current Liabilities

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Liabilities
Liabilities –– Question
Question

Devon
Devon Mfg.
Mfg. has
has current
current liabilities
liabilities of
of
$230,000
$230,000 and
and current
current assets
assets ofof $322,000.
$322,000.
What
What is
is Devon’s
Devon’s current
current ratio?
ratio?

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Accounts
Accounts Payable
Payable

Short-term
Short-term obligations
obligationsto tosuppliers
suppliersfor
for purchases
purchasesofof
merchandise
merchandiseand
andtoto others
othersfor
for goods
goodsand
andservices.
services.

Office
Office
Merchandise supplies
supplies
Merchandise
inventory invoices
invoices
inventory
invoices
invoices
Utility
Utilityand
and
Shipping phone
phonebills
bills
Shipping
charges
charges

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Notes
Notes Payable
Payable
When
Whenaacompany
companyborrows
borrowsmoney,
money,aanote
notepayable
payableis
is
created.
created.
Current
Current Portion
Portion of
of Notes
Notes Payable
Payable
The
Theportion
portionofofaanote
notepayable
payablethat
that is
isdue
duewithin
within one
one
year,
year,or
or one
oneoperating
operatingcycle,
cycle, whichever
whicheveris islonger.
longer.

Current Notes Payable

Total Notes
Payable Noncurrent Notes Payable

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Notes
Notes Payable
Payable

PROMISSORY NOTE
Miami, Fl Nov. 1, 2003
Location Date
Six months after this date Porter Company
promises to pay to the order of Security National Bank
the sum of $10,000.00 with interest at the rate
of 12.0% per annum.
signed John Caldwell
title treasurer

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Notes
Notes Payable
Payable

On November 1, 2003, Porter Company

would make the following entry.

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Interest
Interest Payable
Payable


Interest
Interest expense
expense is
is the
the
compensation
compensation to to the
the lender
lender forfor
giving
giving up
up the
the use
use of of money
money for for aa
period
period ofof time.
time.

The
The liability
liability is
is called
called interest
interest
payable.
payable.

To
To the
the lender,
lender, interest
interest is is aa Interest
Rate
revenue.
revenue. Up!


To
To the
the borrower,
borrower, interest
interest is is an
an
expense
expense..
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Interest
Interest Payable
Payable
The
The interest
interest formula
formula includes
includes three
three variables
variables
that
that must
must be
be considered
considered when
when computing
computing
interest:
interest:

Interest = Principal × Interest Rate × Time

When
Whencomputing
computinginterest
interestfor
forone
oneyear,
year,“Time”
“Time”
equals
equals1.
1. When
Whenthethecomputation
computationperiod
periodis isless
less
than
thanone
oneyear,
year,then
then“Time”
“Time”isisaafraction.
fraction.
For
Forexample,
example,ififwe
weneeded
neededto tocompute
computeinterest
interestfor
for
33months,
months,“Time”
“Time”would
wouldbebe3/12.
3/12.

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Interest
Interest Payable
Payable –– Example
Example

What
What entry
entry would
would Porter
Porter Company
Company make
make
on
on December
December 31,
31, the
the fiscal
fiscal year-end?
year-end?

$10,00012% 
$10,00012%  //1212 == $200
22
$200
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Payroll
Payroll Liabilities
Liabilities
Gross Pay

Net Pay

State and Voluntary

Medicare Federal Local Income Deductions
FICA Taxes
Taxes Income Tax Taxes
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Unearned
Unearned Revenue
Revenue

Cash
Cash is
is sometimes
sometimes collected
collected from
from the
the
customer
customer before
before the
the revenue
revenue is
is
actually
actually earned.
earned.
As the earnings
process is
completed . .
Cash is
Deferred Earned
received
revenue is revenue is
in
recorded. recorded.
advance.

aaliability
liability account.
account. © The McGraw-Hill Companies, Inc., 2002
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Long-Term
Long-Term Debt
Debt

Relatively
Relatively small
small debt
debt
needs
needs can
can be
be filled
filled from
from
single
single sources.
sources.

or Insurance
or Pension
Banks Companies Plans
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Long-Term
Long-Term Debt
Debt

Large
Large debt
debt needs
needs are
are often
often
filled
filled by
by issuing
issuing bonds.
bonds.

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Installment
Installment Notes
Notes Payable
Payable

Long-term
Long-term notes
notes that
that call
call for
for aa series
series of
of
installment
installment payments.
payments.

Each
Eachpayment
paymentcovers
covers With
With each
eachpayment,
payment, the
the
interest
interestfor
for the
theperiod
period interest
interest portion
portion gets
gets
AND
ANDaaportion
portionofof the
the smaller
smaller and
and the
theprincipal
principal
principal.
principal. portion
portiongets
getslarger.
larger.
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Allocating
Allocating Installment
Installment Payments
Payments
Between
Between Interest
Interest and
and Principal
Principal
Identify
 Identify the
the unpaid
unpaid principal
principal
balance.
balance.
Unpaid
 Unpaid Principal
Principal ×× Interest
Interest rate
rate ==
Interest
Interest expense.
expense.
Installment
 Installment payment
payment -- Interest
Interest
expense
expense == Reduction
Reduction in in unpaid
unpaid
principal
principal balance.
balance.
Compute
 Compute newnew unpaid
unpaid principal
principal
balance.
balance.

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Allocating
Allocating Installment
Installment Payments
Payments
Between
Between Interest
Interest and
and Principal
Principal
On
On January
January 1,1, 2003,
2003, Rocket
Rocket
Corp.
Corp. borrowed
borrowed $7,581.57
$7,581.57 from
from
First
First Bank
Bank of
of River
River City.
City. The
The
loan
loan was
was aa five-year
five-year loan
loan and
and
had
had anan interest
interest rate
rate of
of 10%.
10%. The
The
annual
annual payment
payment isis $2,000.
$2,000.

Prepare
Prepare an
an amortization
amortization table
table for
for
Rocket
Rocket Corp.’s
Corp.’s loan.
loan.
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Allocating
Allocating Installment
Installment Payments
Payments
Between
Between Interest
Interest and
and Principal
Principal

Now,
Now, prepare
preparethe
theentry
entryfor
forthe
thefirst
firstpayment
payment on
on
December
December31,31,2003.
2003.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
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Allocating
Allocating Installment
Installment Payments
Payments
Between
Between Interest
Interest and
and Principal
Principal
The
Theinformation
informationneeded
neededfor
for the
thejournal
journal entry
entrycan
can be
be
found
foundononthe
theamortization
amortizationtable.
table. The
Thepayment
payment
amount,
amount,thetheinterest
interestexpense,
expense,and andthe
theamount
amounttoto
credit
creditto
toprincipal
principalare
areall
allon
onthe
thetable.
table.

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Bonds
Bonds Payable
Payable

 Bonds
Bonds usually
usually involve
involve the
the
borrowing
borrowing of of aa large
large sum
sum ofof
money,
money, called
called principal.
principal.
 The principal is usually paid
The principal is usually paid
back
back asas aa lump
lump sumsum atat the
the end
end
of
of the
the bond
bond period.
period.
 Individual bonds are often
Individual bonds are often
denominated
denominated with with aa par
par value,
value,
or
or face
face value,
value, of of $1,000.
$1,000.

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Bonds
Bonds Payable
Payable

Bonds usually carry a stated

rate of interest, also called a
contract rate.
Interest is normally paid
semiannually.
Interest is computed as:
Interest
Interest == Principal
Principal ×× Stated
Stated Rate
Rate ×× Time
Time

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Bonds
Bonds Payable
Payable

Bonds
Bonds are
are issued
issued through
through an
an
intermediary
intermediary called
called anan
underwriter.
underwriter.

Bonds
Bonds cancan be
be sold
sold onon organized
organized
securities
securities exchanges.
exchanges.

Bond
Bond prices
prices are
are usually
usually quoted
quoted
as
as aa percentage
percentage ofof the
the face
face
amount.
amount.
 For example, a $1,000 bond
For example, a $1,000 bond
priced
priced at
at 102
102 would
would sell
sell for
for
$1,020.
$1,020.
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Types
Types of
of Bonds
Bonds
Mortgage
MortgageBond: Debentures
A mortgage
Bond:
bond is DebenturesBonds:
Bonds:
A mortgage bond is they
backed they have
 havenonocollateral
collateral
backedby byreal
realproperty.
property. backing, debentures 
In
In the eventof
the event ofaa backing, debentures 
default must
mustrely
relyon
onthe
the
default, mortgage bondho
, mortgage bondho
lders
lders couldsell
could selloff
offthe
the
creditworthiness
creditworthinessand and
underlying property to
underlying property to reputation
reputationof ofthe
the
compensate
compensatefor forthe
the issuer.
issuer.
default.
default.

Junk
Junkbonds issued
bonds issued
A convertible
A convertiblebond is
bond is by
bycompanies
companiesthatthat
a debt
a debtinstrument issued
instrument issued
by are
arestruggling
struggling
byaacompany
companythat
thatcan
can
be exchanged for shares financially
financiallyand
andhave
have
be exchanged for shares
of
ofthat
thatcompany's
company's
aahigh
highrisk
riskof
of
defaulting  
common
commonstock.
stock. defaulting

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Accounting
Accounting for
for Bonds
Bonds Payable
Payable
On
On January
January1,1, 2003,
2003, Rocket
Rocket Corp.
Corp. issues
issues $1,500,000
$1,500,000 of
of
12%,
12%, 10-year
10-yearbonds
bondspayable.
payable. Interest
Interestis
ispayable
payable
semiannually,
semiannually,each
eachJuly
July11and
andJanuary
January1.1.

Assume
Assumethe
thebonds
bondsare
areissued
issuedatatface
facevalue.
value.
Record
Record the
theissuance
issuanceofofthe
thebonds.
bonds.

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Accounting
Accounting for
for Bonds
Bonds Payable
Payable

Record
Record the
the interest
interest payment
payment
on
on July
July 1,
1, 2003.
2003.

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Bonds
Bonds Sold
Sold Between
Between Interest
Interest Dates
Dates


Bonds
Bonds are
are often
often sold
sold between
between interest
interest dates.
dates.

The
The selling
selling price
price of
of the
the bond
bond isis computed
computed as:
as:

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002