Liabilities and Stockholders Equity Chapter 8 and Chapter 9 A200 Survey of Accounting University of Tennessee 2 Ch 8 Debt Financing or Equity Financing Debt Financing Creates a liability principal must be repaid Creates an additional cost Interest Equity Financing Stock issued Dilutes control of the business by creating new owners stockholders Stockholders expect to receive a return on their investment Increase in market price per share of stock Dividends share of business profit Equity Financing Retained Earnings Creates no liability or new owners Creates no additional costs Only earnings not distributed to owners as dividends are retained Leverage Using borrowed funds debt rather than owner funds equity to finance asset purchases and operations A high Debt to Equity ratio means high risk levels for stockholders slide 29 3 Ch 8 Current Liabilities CL are increased when a business purchases goods or services prior to making payment expense is incurred before cash is paid Transaction 1 Simba Corporation s employees worked through the end of the month which ended on Tuesday Simba will pay the 12 000 of wages on Friday STATEMENT OF CASH FLOWS INCOME STATEMENT and STATEMENT OF RETAINED EARNINGS BALANCE SHEET Assets Liabilities Equity Wages Payable Retained Earnings 12 000 12 000 12 000 Wages Expense 4 Ch 8 Current Liabilities CL are decreased when the business satisfies them Transaction 2 Simba Corporation pays the amount owed to employees STATEMENT OF CASH FLOWS 12 000 Cash out Operating INCOME STATEMENT and STATEMENT OF RETAINED EARNINGS BALANCE SHEET Assets Liabilities Cash Wages Payable 12 000 12 000 Equity 5 Ch 8 Current Liabilities CL are increased when a business receives cash from a customer before rendering a service or providing goods cash is received before revenue is earned Transaction 3 Simba Corporation received 300 000 from a customer for whom Simba performed services this year and 5 000 from a customer as an advance on work Simba will do next year STATEMENT OF CASH FLOWS 305 000 Cash in Operating INCOME STATEMENT and STATEMENT OF RETAINED EARNINGS BALANCE SHEET Assets Liabilities Equity Cash Unearned Fees Retained Earnings 305 000 5 000 300 000 300 000 Fees Revenue 6 Ch 8 Notes Payable Notes Payable are amounts owed by the business under a written contract with a stated principal face amount with a stated rate of interest market rate with a stated term and due date maturity date Current Liability if the due date is within one year of the issue date Long term Liability if the due date is longer than one year The portion of a long term note payable due within the year is usually recorded as a current liability Notes Payable generate a related expense Interest Expense and a related liability Interest Payable Interest Expense is computed as P x R x T using a 360 day year 7 Ch 8 Current Liabilities Note Payable Transaction 4 On 10 01 12 Simba Corporation purchased supplies for 40 000 giving a 90 day 6 note payable INCOME STATEMENT STATEMENT OF CASH FLOWS BALANCE SHEET Assets Liabilities Supplies Note Payable 40 000 40 000 and STATEMENT OF RETAINED EARNINGS Equity 8 Ch 8 Current Liabilities Note Payable Transaction 5 On 10 31 12 in an end of period adjustment Simba recognized that it owed 30 days of interest on the note INCOME STATEMENT STATEMENT OF CASH FLOWS BALANCE SHEET Assets and STATEMENT OF RETAINED EARNINGS Liabilities Equity Interest Payable Retained Earnings 200 200 200 Interest Expense 9 Ch 8 Current Liabilities Note Payable Transaction 6 On 11 30 12 in an end of period adjustment Simba recognized that it owed another 30 days of interest on the note INCOME STATEMENT STATEMENT OF CASH FLOWS BALANCE SHEET Assets and STATEMENT OF RETAINED EARNINGS Liabilities Equity Interest Payable Retained Earnings 200 200 200 Interest Expense 10 Ch 8 Current Liabilities Note Payable Transaction 7 On 12 29 12 the maturity date of the note Simba paid both principal and interest STATEMENT OF CASH FLOWS 40 600 Cash out Operating INCOME STATEMENT and STATEMENT OF RETAINED EARNINGS BALANCE SHEET Assets Cash 40 600 Liabilities Equity Note Payable Interest Payable Retained Earnings 40 000 400 200 200 Interest Expense 11 Ch 8 Contingent Liabilities Amounts the business will owe in the future if certain events occur GAAP requires businesses to record contingent liabilities only if the future event is probable and the amount is estimable Transaction 8 In April Simba sold goods on account 200 000 with a warranty It is probable that some of these goods will need repair during the warranty period and Simba can estimate the cost of repairs historical repair costs are 3 of sales STATEMENT OF CASH FLOWS INCOME STATEMENT and STATEMENT OF RETAINED EARNINGS BALANCE SHEET Assets Liabilities Equity Accounts Receivable Warranty Payable Retained Earnings 200 000 6 000 200 000 200 000 Sales Revenue 6 000 6 000 Warranty Expense 12 Ch 8 Long Term Liabilities Bonds Payable Bond terms Par value 100 of the face value bonds often sell above or below par If a bond sells at par then the buyer paid what the seller was asking Face or Principal the amount of each bond the amounts borrowed loaned Bonds are sold in 1 000 increments Term the length of the bond contract aka the number of years until the face amount principal must be paid back Maturity date redemption date the end of the term The borrowing business must repay both principal and any unpaid interest on the maturity date Contract rate coupon rate rate of interest promised to bondholders lenders Market rate rate of interest of comparable bonds offered Represents the going rate rate at which buyers and sellers are willing to contract This determines whether bonds sell at par above par or below par Bondholder lender or party who received purchased the bond Bond Issuer borrower or party who issued sold the bond 13 Ch 8 Long Term Liabilities Bonds Payable Transaction 9 On 4 15 12 Simba Corporation issued at par 3 500 000 of 20 year 8 bonds for cash with interest payable semi annually INCOME STATEMENT STATEMENT OF CASH FLOWS BALANCE SHEET Assets Liabilities Cash Bonds Payable 3 500 000 3 500 000 And STATEMENT OF RETAINED EARNINGS Equity 14 Ch 8 Long Term Liabilities Bonds Payable Transaction 10 On 10 15 12 Simba pays 140 000 interest to the bondholders 3 500 000 X 08 280 000 2 140 000 semi annual interest payment STATEMENT OF CASH FLOWS INCOME STATEMENT and STATEMENT OF RETAINED EARNINGS BALANCE SHEET Assets Liabilities Retained Earnings Cash 140 000 Cash out