Chapter 9 Liabilities Accounting for Current Contingent Liabilities Current liabilities o o Known amounts Estimated amounts Liabilities if Known Amount Are o Accounts payable o Short term notes payable o Sales tax payable o Accrued liabilities o Payroll liability o Unearned revenue o Current portion of long term debt Accounts payable amounts owed for products services purchased on account Accounts payable turnover number of times a year a company is able to pay its accounts payable Turnover cost of goods sold average accounts payable Turnover in days 365 TO o o o High turnover rate short period of days is better than low turnover ratios o o Shorter payment periods have better credit Some with strong credit withhold payments to conserve cash Short term notes payable due in 1 year Sales tax payable retailers collect tax then pay the government Accrued liability expense not yet paid o Wages salaries payable interest payable income tax payable Payroll liabilities Salary stated at monthly yearly expense o o Wage pay stated at hourly rate o Bonus amount over regular compensation o o Salary expense is gross pay pay before subtractions Salary expense creates payroll liabilities Employee income tax payable income tax withheld from paychecks FICA tax payable social security medicare Salary payable take home pay Maybe employer payroll taxes for employee benefits Unearned revenue revenue collected in advance o o Current portion of long term debt amount of principal due in year Current Liabilities that must be estimated Estimated warranty payable o Expense recognition says record warranty expense in same period that business records sales revenue Estimated warranty payable of 200 will be a current liability Contingent Liabilities Contingent liability potential liability that depend on future outcome of past event Future obligations because of lawsuits tax disputes violations of environmental protection laws Ways to account for contingent liabilities o Accrue in journal entry if its probable that loss will occur and amount can be reasonably estimated o Disclose in financial statement if its possible less likely loss will occur Ex lawsuit in progress No need to report contingent loss that is not likely to occur Are all Liabilities reported on Balance sheet If you fail to accrue interest on liability you overstate net income Account for Bonds Payable Notes Payable Interest Expense Bonds payable groups of notes payable issued to multiple lenders bondholders Bonds Bonds payable are debts to issuing company Certificate states Principal par value face value Interest rates o o o Dates of interest payments Types of bonds Term bond bonds mature at same time Serial bond pay installments over period of time o o o Debentures unsecure bonds backed only by faith of borrower Higher interest rate riskier Bond price o Quotes at percentage of maturity value o 1000 at 100 is bought sold at 1000 o 1 000 quotes at 101 5 has price of 1 015 Bond premium bond discount o Premium bond issues at price above face value Has credit balance o Discount bond issued at price below face value Has debit balance Bond discount is a contra liability account o Bond moves toward maturity balance Premium decreases toward maturity value Discount increases toward maturity value On maturity date bond market value equals face value Bond interest rates o Market price amount investors will pay for bond Present value Present value present value of principal present value of cash interest payments o Stated interest rate coupon rate interest printed in bond certificate Determined amount of cash interest the borrower pays o Market interest rate effective interest rate rate investors demand for loaning money Varies by minute Often differs from stated interest rate Issuing Bonds at Par Face Value The transactions through the bond market do not involve issuers Issuing Bonds Payable at a Discount Discount on Bonds Payable is a contra account to Bonds Payable o Decrease in company s liabilities o Bonds payable discount carrying amount on bonds Expense on Bonds Payable Each semi annual interest payment is set by bond contract so it is same over life of bond Interest expense increases as bonds move toward maturity Interest expense on Bonds issued at discount The discount is additional interest to expense added to interest they pay out semiannually Discount is amortized Credit to discount o Adjust carrying amount of bonds toward maturity value o Amortizes discount Discount is amortized down to 0 Partial Period Interest Amounts Issuing Bonds at Premium Bond premium carrying amount Premium decreases interest expense each period over term of bonds Straight line amortization Straight line amortization divides bond discount premium into equal periodic amounts over the bonds term Amount of interest expense is same for each interest period GAAP says straight line method is only used when it differs insignificantly from amounts determined by effective interest method Retire Bonds before Maturity Paying early relieves pressure of making high interest payment Callable issuer may call off bonds for prearranged price call price whenever they want Call price is usually percentage of 2 above par value Alternative to calling is to purchase the bonds on the open market at current market price o Because market price is lower than call price Lower interest rates may convince them to pay off bonds early Gains losses on early retirement of bonds are reported as Other income loss on income statement Convertible Bonds Notes Convertible bonds corporate bonds may be converted into issuing company s common stock o Safety of assured receipt of interest and principal on bonds with opportunity for gains on stock Investors usually accept lower interest rate Lower interest payments benefit issuer If market price of issuing company s stock gets high engouhg bondholders will convert bonds to stock Conversion of notes payable to stock decreases issuer liability and increase equity Leases Lease rental agreement with tenant lessee agrees to make rent payments to property owner lessor in exchange for use of asset Operating leases can be short term and cancelable Lessee can use asset but have no continuing rights to it Lessor remains usual risks and rewards of owning asset Lessee debits rent expense and credits cash for amount of lease payment o o o o Operating lease creates liability Capital lease long term non cancelable debt o Is at lease 1 Lease transfers title at end of term Lease