ACG2021 FALL 2014 PIERNO CHAPTER 10 Current Liability Debt a company expects to pay o 1 From existing current assets or creation of current assets o 2 Within one year of operating cycle Notes Payable obligations in form of written notes usually require interest Finding Sales Tax o 1 Subtract sales from total receipts o 2 Multiply sales by sales tax rate OR Payroll and Payroll Tax Payable Gross Pay Payroll deductions Net Pay Payroll deductions Insurance pensions and or union dues FICA taxes Federal income tax State and city income taxes Charity Payroll Taxes Within every payroll the employer incurs liabilities to pay payroll the employer incurs liabilities to pay payroll taxes Includes employers share of social security FICA state federal unemployment tax Bonds Long term liabilities interest bearing note payable used by corporations universities and government agencies Long term liabilities Obligations that a company expects to pay more than one year in the future TYPES OF BONDS Secured Bonds Have specific assets of the issuer pledged as collateral for the bonds Unsecured bonds Issued against the general creditor borrower Convertible bonds Bonds that can be converted into common stock at bondholders option Callable bonds Bonds that the issuing company can redeem buy back at a stated dollar Bond Certificate Issued to investor to provide evidence of the investors claim against the company amount prior to maturity Shows 1 Name of company that issued bond 2 Face value Amount of principle due at maturity date 3 Maturity date Date final payment is due to investor 4 Contractual interest rate Rate used to determine the amount of cash interest borrower pays to investors annual rate Time Value of Money Indicates relationship between time and money Present Value current market price Equivalent value today 1 Dollar amounts to be received 2 Length of time until amounts are received 3 Market interest rate ACG2021 FALL 2014 PIERNO CHAPTER 10 Bonds may be issued at 1 DISCOUNT Below face value 2 PREMIUM Above face value Discount or Premium on Bonds Contractual Stated Effective Market Contractual Interest Rate Is the rate applied to face par value to arrive at the interest paid in a year Market Interest Rate Rate investors demand for loaning funds to corporation CONTRACTUAL VALUE MARKET VALUE bonds sell at face value LESS THE FACE VALUE Discount MORE THAN FACE VALUE Premium 8 PREMIUM EXAMPLE BOND CONTRACTUAL INTEREST RATE 10 ISSUED WHEN 10 FACE VALUE Discounts are not assets contra account deducted from bonds payable 12 DISCOUNT Difference between issuance price and face value of bonds discount is an additional cost of borrowing Company records as interest expense Annual interest payment and bond discount total cost of borrowing Principal at maturity and annual interest payments cash to be paid to bondholders Cash to be paid to bond holders cash received from bond holders Cash received from bondholders total cost of borrowing Amortizing discount allocate bond discount expense in each period Increase amount of interest expense reported each year Carrying value of bonds will increase Balance declines 2009 2010 2011 2012 YEARS 100 000 E U L A V G N I Y R R A C 99 000 98 000 BOND CONTRACTUAL INTEREST RATE 10 ISSUED WHEN8 PREMIUM10 FACE VALUE12 DISCOUNT ACG2021 FALL 2014 PIERNO CHAPTER 10 Issuing Bonds at Premium Add premium on bonds payable to the bonds payable account Sale of bonds above face value causes total cost of borrowing to be less than the bond interest paid because borrower is not required to pay the bond premium at maturity date Premium is considered to be a reduction in the cost of borrowing that reduced bond interest expense over life of bonds 1 Annual interest payments bond premium Total cost of borrowing 2 Principle at maturity rate annual interest payments cash to be paid to bond holder 3 Cash to be paid to bond holder cash received from bond holder total coast of borrowing Amortizing the premium allocate bond premium to expense in each period Decreases the amount of interest expense report each year Balance declines as premium is amortized 102 000 101 000 100 000 E U L A V G N I Y SUMMARY R R A C Contractual Stated Contractual Stated Effective Market Effective Market PREMIUM 100 DISCOUNT 100 Interest Expense Interest Cash Paid Amortization of Discount Premium Carrying Value 2009 2010 2011 2012 Decreases Constant YEARS Absolute Value Increases Increases Constant Increases Decreases Increases Accounting for Bond Redemption Bonds are redeemed when the issuing corporations buy them back Book value of the bonds at maturity will equal face value WHEN BONDS ARE REDEEMED BEFORE MATURITY Eliminate the carrying value of the bonds at redemption rate Record the cash paid Recognize the gain or loss on redemption ACG2021 FALL 2014 PIERNO CHAPTER 10 Liquidity Ratio measure short term ability of a company to pay its maturing obligations and to meet unexpected needs for cash CURRENT RATIO Current Assets Current Liabilities Bank Line of Credit prearranged agreement between a company and a lender that permits the company should it be necessary to borrow up to an agreed upon amount Solvency Ratios Measure the ability of a company to survive over a long period of time DEBTS TO ASSETS RATIO Total Liabilities Total Assets TIMES INTEREST EARNED Income Before Interest Expense and Income Taxes Interest Expense Off Balance Sheet Financing International effort by a company to structure its financing arrangement so as to avoid showing liabilities on its balance sheet Contingencies Events with uncertain outcomes that may represent potential liabilities o Example lawsuits Leasing 1 Operating leases Treated like rentals no assets or liabilities in books 2 Capital leases treated like debt financed purchase increase assets and liabilities as a result many companies structure their lease agreements to avoid meeting the criteria of a capital lease Declaration date board of directors announces a dividend will be paid BOND DISCOUNT AMORTIZATION BOND PREMIUM AMORTIZATION Bond Discount Number of Interest Periods Bond Discount Number of Interest Periods AMORTIZATION AMOUNT Bond Interest Expense Bond Interest Paid Carrying Value of Bonds at Beginning of Period X Effective Interest Rate Bond Interest Expense Face Amount of Bond X Contractual Interest Rate Bond Interest Paid ACG2021 FALL 2014 PIERNO CHAPTER 10 TO RECORD A NOTE ACCRUED INTEREST WHEN PAID OFF Cash Notes Payable Interest Expense Interest Payable Notes Payable
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