Accounting 1 Exam 3 Study Guide Chapter 10 Liabilities happened o Liabilities Obligation to pay in the future for something that has already o Current Liability Is a debt with two key features 1 the company reasonably expects to pay the debt from existing current assets or through the creation of other current liabilities 2 The company will pay the debt within one year or the operating cycle whichever is longer o Long Term Liability Debts that do not meet the both aforementioned criteria o Notes Payable Is a written promissory note usually require the borrower to pay interest issued for varying periods and interest is always annual unless specifically stated otherwise Example On December 1 2011 RHS Company borrows 10 000 from Bank of America by signing a 90 day 6 note due March 1 2012 12 1 11 Cash Notes Payable 10 000 10 000 The accounting period ends 12 31 11 so an adjusting entry is needed Face Value of Note Interest Rate Time in Terms of One Year Interest 10 000 06 1 12 50 12 31 11 Interest Expense Interest Payable 50 50 On March 1 2012 RHS Company would record 10 000 06 2 12 100 3 1 12 Notes Payable Interest Payable Interest Expense Cash 10 000 50 100 10 150 o Sales Tax Payable Expressed as a stated percentage of the sales price either rung up separately or included in total receipts and the retailer collects from the customer Example If the March 25 register reading for Cooley Grocery shows sales of 10 000 and sales taxes of 600 sales tax rate of 6 the entry is 3 25 11 Cash Sales Sales Tax Payable 10 600 10 000 600 o Payroll and Payroll Tax Payable The term payroll pertains to both Salaries Monthly or yearly rate Wages Hourly pay o Gross Pay All Employee Payroll Deductions Net Pay o Employee Payroll Deductions FICA Taxes Federal Income Taxes Medicare Taxes State and Local Income Taxes and Voluntary Deductions o Employee Taxes Federal Insurance Contributions Act FICA 4 2 of the first 106 800 earned per year Maximum 4 485 60 Medicare Taxes 1 45 of all wages Federal Income Tax State and Local Income Taxes Amount withheld depends on employee s earnings tax rates and number of withdrawal allowance o Employer Payroll Taxes FICA Taxes 6 2 Medicare Taxes 1 45 Federal and State Unemployment Taxes State 2 and Federal 4 with a ceiling of 7 000 o Unearned Revenue Revenues that are received before the company delivers goods or provides services Company debits cash and credits current liability account When company earns revenue debits unearned revenue account and credits revenue account Example University of Maryland sells 10 000 season football tickets at 50 dollars each for its five game home schedule The University of Maryland makes the following entry 8 1 11 Cash 500 000 Unearned Football Ticket Revenue 500 000 As the school completes each of the five home games it earns one fifth of the revenue The following entry records the revenue earned 9 7 11 Unearned Football Ticket Revenue 100 000 Football Ticket Revenue 100 000 o Working Capital The excess of current assets over current liabilities Current Assets Current Liabilities Working Capital o Current Ratio Permits us to compare the liquidity of different sized companies and a of a single company at different times Current Assets Current Liabilities Current Ratio Historically a current ratio of 2 1 is considered the standard for good credit rating o Long Term Liability Obligations that are expected to paid after one year o Bonds Are a form of interest bearing notes payable and bonds offer three advantages over common stocks stockholder control is not affected tax savings result and earnings per share may be higher o Types of Bonds Secured and Unsecured debenture bonds Term and Serial bonds Registered and Bearer or coupon bonds Convertible and Callable bonds o Issuing Bonds In authorizing the bond issue the board of directors must stipulate the number of bonds to be authorized total face value and contractual interest rate Generally issued when the amount of capital needed is too large for one lender to supply o Face Value The amount of principal the issuing company must pay at its o Contractual Interest Rate The rate used to determine the amount of cash interest the borrower pays and the investor receives o Bond Indenture The terms of the bond issue o Bond prices are quoted as a percentage of the face value of the bond which is maturity date usually 1 000 A 1 000 bond with a quoted price of 97 means that the selling price of the bond is 97 of face value of 970 A 1 000 bond with a quoted price of 102 means that the selling price of the bond is 102 of face value of 1020 o Determining the Market Value of Bonds Market value is a function of the three factors that determine present value The dollar amounts to be received The length of time until the amounts are received and The market rate of interest o Accounting for Bond Issues Example of Issuing Bonds at Face Value On January 1 2011 CHS Corporation issues 100 000 five year 10 bonds at 100 100 of face value Assume interest is paid semiannually The entry to record the sale is 1 1 11 Cash Bonds Payable The entry for the interest payment is 100 000 1 6 12 5000 100 000 100 000 7 1 11 Bond Interest Expense Cash 5 000 5 000 At December 31 CHS recognizes the 5 000 of interest expense incurred since July 1 with following adjusting entry 12 31 11 Bond Interest Expense Bond Interest Payable 5 000 5 000 o Discount or Premium on Bonds Example of Issuing Bonds at Discount Assume that on January 1 2011 CHS sells 100 000 five year 10 bonds for 92 639 92 639 of face value Interest is paid semiannually The entry to record the issuance is 1 1 11 Cash Discount on Bonds Payable Bonds Payable 92 639 7 361 100 000 o 92 639 represents to carrying or book value of the bonds o The issuance of bonds below face value at discount causes the total cost of borrowing to differ from the bond interest paid That is the issuing corporation must pay not only the contractual interest rate over the term of the bonds but also the face value rather than the issuance price at maturity o Additional Cost of Borrowing The difference between the issuance price and face value of the bonds Example of Issuing Bonds at Premium Assume that CHS sells 100 000 five year bonds for 108 111 108 111 of face value Entry to record the sale is 1 1 11 Cash Bonds Payable Premium on Bonds Payable 108 111 100 000 8 111 o The sale of bonds above the face value causes the total cost of borrowing to be less than the bond interest paid The bond premium
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