12 14 2010 Chapter 10 Liabilities Current liability Debt with two key features o Company expects to pay the debt from existing current assets or through the creating o Company will pay the debt within one year or the operating cycle whichever is of other current liabilities longer o Out of existing current assets o By creating other current liabilities To be classified as a current liability a debt must be expected to be paed Notes Payable Written promissory note Require the borrower to pay interest Issued for varying periods Sales Tax Payable Retailer collects tax from the customer Retailer remits the collections to the state s department of revenue Sales taxes are expressed as a stated percentage of the sales price Either rung up separately or included in total receipts In providing accounting services to small businesses encounter following situations pertaining to cash sales o Some companies ring up sales and sales taxes separately on cash register Have separate total sales and sales taxes o Some do not segregate sales and sales taxes Register total includes sales tax Payroll and Payroll taxes payable payroll pertains to both o salaries managerial administrative and sales personnel monthly or yearly o wages store clerks factory employees manual laborers rate per hour determining payroll involves computing three amounts payroll tax expense results from three takes that governmental agencies levy on employers o gross earnings o payroll deductions o net pay o FICA tax o Federal unemployment tax o State unemployment tax Employer payroll taxes do not include o Federal income taxes Unearned Revenue Revenues that are received before the company delivers goods or provides services o Company debits cash and credits a current liability account unearned revenue o When the company earns the revenue it debits the Unearned Revenue account and credits a revenue account Type of business airline magazine publisher hotel insurance company Current Maturities of Long Term Debt Portion of long term debt that comes due in the current year No adjusting entry required Statement Presentation and Analysis Working capital Current assets Current liabilities o Liquidity the ability to pay maturing obligations and meet unexpected needs for cash Current ratio Current assets Current liabilities o Permits us to compare liquidity of different sized companies of a single company at different times Long Term Liabilities Bonds A form of interest bearing notes payable Three advantages over common stock o Stockholder control is not affected o Tax savings result o Earnings per share may be higher Major disadvantages resulting from use of bonds o Interest must be paid and principal repaid Types of bonds o Secured and unsecured debenture bonds o Term and serial bonds o Registered and Bearer or coupon bonds o Convertible and callable bonds Issuing procedures o Bond contract known as bond indenture o Represents a promise to pay Sum of money at designated maturity date Periodic interest at a contractual stated rate on the maturity amount face value o Paper certificate typically a 1000 face value o Interest payments usually made semiannually o Generally issued when the amount of capital needed is too large for one lender to supply Bond trading o Bonds traded on national securities exchanges o Newspapers and the financial press publish bond prices and trading activity daily Determining Market value of bonds o Market value is a function of the three factors that determine present value Dollar amounts to be received Length of time until the amounts are received Market rate of interest o Features of a bond callable convertible etc affect market rate of bond Market interest rate rate of interest investors demand for loaning funds to a corporation If bonds are issued at a premium it indicates that the contractual interest rate exceeds the market interest rate Discount on Bonds Payable is a contra account Issuing bonds at an amount different from face value is quite common o By the time a company prints the bond certificates and markets the bonds it will be a coincidence if the market rate and the contractual rate are the same Bond retirements Redeeming bonds at maturity Redeeming bonds before maturity o When a company retires bonds before maturity it is necessary to Eliminate the carrying value of the bonds at the redemption date Record cash paid Recognize the gain or loss on redemption o Carrying value face value of the bonds less unamortized bond discount or plus unamortized bond premium at redemption date o Gain or loss on redemption difference between cash paid and carrying value Converting bonds into common stock o Until conversion bondholder receives interest on the bond o For issuer bonds sell at a higher price and pay a lower rate of interest than comparable debt securities without the conversion option o Upon conversion the company transfers the carrying value of the bonds to pain in capital accounts no gain or loss is recognized 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 o Each payment consists of A reduction of loan principal Companies initially record mortgage notes payable at face value Interest on the unpaid balance of the loan Statement presentation and analysis Two ratios that provide information about debt paying ability and long run solvency are o Debt to total assets total debt total assets Higher the percentage of debt to total assets the greater the risk that the company may be unable to meet its maturing obligations o Times interest earned income before income taxes and interest expense interest expense Indicates the company s ability to meet interest payments as they come due Present Value of Face Value To illustrate present value concepts assume that you are willing to invest a sum of money that will yield 1000 at the end of one year and you can earn 10 on your money o What is the 1000 worth today Divide future amount by 1 plus interest rate Or use a present value of 1 table Present Value of Interest Payments annuities In addition to receiving face value of a bond at maturity an investor also receives periodic interest payments annuities over the life of the bonds To compute present value of an annuity we need to know o Interest rate o Number of interest periods o Amount of periodic receipts or payments Computing the Present Value of a
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