Slide

10-1

Chapter

10
Text book pp.
424-473

McGraw-Hill/Irwin

Liabilities

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Slide
10-2

The
The Nature
Nature of
of Liabilities
Liabilities
Defined
Defined as
as debts
debts or
or obligations
obligations
arising
arising from
from past
past transactions
transactions or
or
events.
events.
Maturity = 1 year or less

Maturity > 1 year

Current
Liabilities

Noncurrent
Liabilities

Part 1 of our lectures on

Chap 10
McGraw-Hill/Irwin

Part 2 of our lectures on

Chap 10

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Slide
10-3

Distinction
Distinction Between
Between
Debt
Debt and
and Equity
Equity
The acquisition of assets is financed from two
sources:
DEBT
DEBT

Funds from creditors, with

a definite due date, and
sometimes bearing
interest.
McGraw-Hill/Irwin

EQUITY
EQUITY

Funds from
owners

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Slide
10-4

Liabilities
Liabilities Question
Question
Devon
Devon Mfg.
Mfg. borrows
borrows $100,000
$100,000 from
from First
First
Bank.
Bank. The
The loan
loan will
will be
be repaid
repaid in
in 20
20 years
years and
and
has
has an
an annual
annual interest
interest rate
rate of
of 8%.
8%.

Is
Is this
this aa current
current liability
liability or
or aa
noncurrent
noncurrent liability?
liability?
The
The obligation
obligation will
will not
not be
be paid
paid
within
within one
one year
year or
or one
one operating
operating
cycle,
cycle, so
so itit is
is aa noncurrent
noncurrent liability.
liability.
McGraw-Hill/Irwin

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Slide
10-5

Evaluating
Evaluating Liquidity
Liquidity
An
An important
important indicator
indicator of
of aa companys
companys ability
ability
to
to meet
meet its
its current
current obligations.
obligations.
Two
Two commonly
commonly used
used measures:
measures:
Working Capital = Current Assets - Current Liabilities
Current Ratio = Current Assets Current Liabilities
McGraw-Hill/Irwin

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Slide
10-6

Liabilities
Liabilities Question
Question
Devon
Devon Mfg.
Mfg. has
has current
current liabilities
liabilities of
of
$230,000
$230,000 and
and current
current assets
assets of
of $322,000.
$322,000.

What
What is
is Devons
Devons current
current ratio?
ratio?

McGraw-Hill/Irwin

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Slide
10-7

Current
Current Ratio
Ratio

2.23

2.04

McGraw-Hill/Irwin

1.87

1.80

1.77

1.55

1.57

1.35

1.13

1.15

The McGraw-Hill Companies, Inc.

Slide
10-8

Accounts
Accounts Payable
Payable
Short-term
Short-termobligations
obligationsto
tosuppliers
suppliersfor
for purchases
purchasesof
of
merchandise
merchandiseand
andto
to others
othersfor
for goods
goodsand
andservices.
services.

Office
Office
supplies
supplies
invoices
invoices

Merchandise
Merchandise
inventory
inventory
invoices
invoices
Shipping
Shipping
charges
charges
McGraw-Hill/Irwin

Utility
Utilityand
and
phone
phonebills
bills

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Slide
10-9

Notes
Notes Payable
Payable
When
Whenaacompany
companyborrows
borrowsmoney,
money,aanote
notepayable
payable is
is
created.
created.

Current
Current Portion
Portion of
of Notes
Notes Payable
Payable
The
Theportion
portionof
of aanote
notepayable
payablethat
that is
isdue
duewithin
withinone
one
year,
year,or
orone
oneoperating
operatingcycle,
cycle,whichever
whicheveris
islonger.
longer.

Total Notes
Payable
McGraw-Hill/Irwin

Current Notes Payable

Noncurrent Notes Payable

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Slide
10-10

Notes
Notes Payable
Payable
PROMISSORY NOTE
Miami, Fl
Location
Six months after this date
promises to pay to the order of
the sum of
of

12.0%

$10,000.00

Nov. 1, 2003
Date
Porter Company
Security National Bank
with interest at the rate

per annum.
signed
title

McGraw-Hill/Irwin

John Caldwell
treasurer

The McGraw-Hill Companies, Inc.

Slide
10-11

Notes
Notes Payable
Payable
On November 1, 2003, Porter Company
would make the following entry.

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Slide
10-12

Interest
Interest Payable
Payable

Interest
Interest expense
expense is
is the
the

compensation
compensation to
to the
the lender
lender for
for
giving
giving up
up the
the use
use of
of money
money for
for aa
period
period of
of time.
time.

The
The liability
liability is
is called
called interest
interest
payable.
payable.

To
Tothe
the lender,
lender, interest
interest is
is aa revenue.
revenue.

To
Tothe
the borrower,
borrower, interest
interest is
is an
an

Interest
Rate
Up!

expense
expense..

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Slide
10-13

Interest
Interest Payable
Payable
The
The interest
interest formula
formula includes
includes three
three variables
variables
that
that must
must be
be considered
considered when
when computing
computing
interest:
interest:
Interest = Principal Interest Rate Time
When
Whencomputing
computinginterest
interestfor
forone
oneyear,
year,Time
Time
equals
equals1.
1. When
Whenthe
thecomputation
computationperiod
periodis
isless
less
than
thanone
oneyear,
year,then
thenTime
Timeis
isaafraction.
fraction.
For
Forexample,
example,ififwe
weneeded
neededto
tocompute
computeinterest
interestfor
for
33months,
months,Time
Timewould
wouldbe
be3/12.
3/12.
McGraw-Hill/Irwin

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Slide
10-14

Interest
Interest Payable
Payable Example
Example
What
What entry
entry would
would Porter
Porter Company
Company make
make
on
on December
December 31,
31, the
the fiscal
fiscal year-end?
year-end?

22
$10,00012%

$10,00012% //1212 == $200

$200
McGraw-Hill/Irwin

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Slide
10-15

Payroll
Payroll Liabilities
Liabilities
Gross Pay
Net Pay

Medicare

McGraw-Hill/Irwin

Income Tax

Terminal
benefits

Voluntary
Deductions

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Slide
10-16
Dec

31, 20X1 Salary expense (gross amount)

$xxxxxx

Accounting
Accounting for
foremployers
employerspayroll
payroll expenditure
expenditure
Employees income tax payable

$xxxx

Payable to health insurance

$xxxx

Payable for voluntary charity/scholarship

$xxxx

Payable for retirement benefits

$xxxx

Salary payable / cash

(take home salary)

$xxxx

To record salary expense for Dec 20X1

Dec 31, 20X1 Employees benefits expense
Employees benefits payable

$yyyyy
$yyyyy

To record employees benefits payable by the

employer
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Slide
10-17

Exhibit
Exhibitfor
forpayroll
payrollliability
liability
(extracts
(extractsfrom
fromFCCL,
FCCL,annual
annualrpt
rpt2014)
2014)

McGraw-Hill/Irwin

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Slide
10-18

Accounting
Accounting for
foremployers
employerspayroll
payroll expenditure
expenditure

Wear, a clothing store employs one sales person, Mr.

Bean. Mr. Beans monthly salary is PKR 40,000. Wear
withholds income tax from Mr. Bean equal to 10% of
the gross salary. In addition Wear withholds 6% of the
gross salary amount of Mr. Bean as the employees
contribution for terminal (retirement) benefits, with an
equal amount of contribution added by the employer.
Compute Mr. Beans net pay for a month,
How Wear should record the payroll expense for Mr.
Bean at the end of each month and for the actual
disbursement, assuming that salary is actually paid on
the 15th of each following month?
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Slide
10-19

Unearned
Unearned Revenue
Revenue
Cash
Cash is
is sometimes
sometimes collected
collected from
from the
the
customer
customer before
before the
the revenue
revenue is
is
actually
actually earned.
earned.
As the earnings
process is
completed .
Cash is
received
in
advance.
McGraw-Hill/Irwin

Deferred
revenue is
recorded.

aaliability
liabilityaccount.
account.

.
Earned
revenue is
recorded.

The McGraw-Hill Companies, Inc.

Slide
10-20

Contingent
Contingent liabilities
liabilities

A potential / possible (rather than an actual)

liability that depends on a future event, OR

a present obligation but payment is not probable

or the amount cannot be measured reliably

For example, pending law suits, warranties.

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Slide
10-21

Three
Three categories
categories of
of contingent
contingent
liabilities
liabilities
Likelihood of an actual
expense/loss

How to report the contingency

Remote

Ignore

Reasonably possible

Describe the situation in notes to the

financial statements, e.g. the company
is the defendant in a lawsuit and the
outcome is uncertain

Probable (and the amount of the

expense/loss can be estimated)
creating provisions

Record an expense and an actual

liability based on estimated amounts,
e.g. warranty.

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Slide
10-22

Recognition of a provision
An

entity must recognise a provision if, and only if:

[IAS 37.14]
a present obligation (legal or constructive) has arisen as
a result of a past event (the obligating event),
payment is probable ('more likely than not'), and
the amount can be estimated reliably.

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Slide
10-23

Accounting
Accounting for
forWarranties
Warranties
Date

Date of sales

Description
Accounts Receiveable

Debit

Credit

$ xxxx

Sales revenue

$ xxxx

(Sales on account)
Date of sales

Warranty expense

$ yyy

Estimated warranty payable

$yyy

(to record warranty payable connected

with the current sales)
Date of
warranty claim

Estimated warranty payable

Cash

$zz
$zz

(to pay warranty claims)

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Slide
10-24

Long-Term
Long-Term Debt
Debt
Large
Large debt
debt needs
needs are
are often
often filled
filled by
by
banks
banks (notes
(notes payable)
payable) and
and issuing
issuing
bonds.
bonds.

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Slide
10-25

Installment
Installment Notes
Notes Payable
Payable
Long-term
Long-term notes
notes that
that call
call for
for aa series
series of
of
installment
installment payments.
payments.

Each
Eachpayment
payment covers
covers
interest
interestfor
for the
theperiod
period
AND
ANDaaportion
portionof
ofthe
the
principal.
principal.
McGraw-Hill/Irwin

With
Witheach
eachpayment,
payment,the
the
interest
interest portion
portion gets
gets
smaller
smaller and
and the
theprincipal
principal
portion
portion gets
getslarger.
larger.

The McGraw-Hill Companies, Inc.

Slide
10-26

Exhibit
Exhibitfor
forLong-term
Long-termliabilities
liabilities
(extracts
(extractsfrom
fromFCCL,
FCCL,annual
annualrpt
rpt2014)
2014)

McGraw-Hill/Irwin

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Slide
10-27

Allocating
Allocating Installment
Installment Payments
Payments
Between
Between Interest
Interest and
and Principal
Principal

Identify
Identify the
theunpaid
unpaid principal
principal

balance.
balance.

Unpaid
Unpaid Principal
Principal Interest
Interest rate
rate ==
Interest
Interest expense.
expense.

Installment
Installment payment
payment -- Interest
Interest
expense
expense == Reduction
Reduction in
in unpaid
unpaid
principal
principal balance.
balance.

Compute
Compute new
newunpaid
unpaid principal
principal
balance.
balance.
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Slide
10-28

Allocating
Allocating Installment
Installment Payments
Payments
Between
Between Interest
Interest and
and Principal
Principal
On
On January
January 1,
1, 2003,
2003, Rocket
Rocket Corp.
Corp.
borrowed
borrowed $7,581.57
$7,581.57 from
from First
First Bank.
Bank.
The
The loan
loan was
was aa five-year
five-year loan
loan and
and had
had
an
an interest
interest rate
rate of
of 10%.
10%. The
The annual
annual
payment
payment is
is $2,000.
$2,000.
Prepare
Prepare an
an amortization
amortization table
table for
for
Rocket
Rocket Corp.s
Corp.s loan.
loan.

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Slide
10-29

Allocating
Allocating Installment
Installment Payments
Payments
Between
Between Interest
Interest and
and Principal
Principal

Now,
Now,prepare
preparethe
theentry
entryfor
for the
thefirst
first payment
paymenton
on
December
December31,
31,2003.
2003.
McGraw-Hill/Irwin

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Slide
10-30

Allocating
Allocating Installment
Installment Payments
Payments
Between
Between Interest
Interest and
and Principal
Principal
The
Theinformation
informationneeded
neededfor
for the
thejournal
journal entry
entrycan
canbe
be
found
foundon
onthe
theamortization
amortizationtable.
table. The
Thepayment
payment
amount,
amount,the
theinterest
interestexpense,
expense,and
andthe
the amount
amountto
to
credit
creditto
toprincipal
principalare
are all
allon
onthe
thetable.
table.

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Slide
10-31

Installments Notes
Payable

Annual
payment
s are
constant.

The
The amount
amount applied
applied to
to the
the principal
principal increases
increases
each
each year.
year. The
The amount
amount of
of interest
interest decreases
decreases
each
each year.
year.
10-31 Inc.
The McGraw-Hill Companies,
McGraw-Hill/Irwin

Slide
10-32

Bond
Bond Liabilities
Liabilities

Long-term
Long-term borrowing
borrowing of
of aa large
large sum
sum

of
of money
money raised
raised from
from aa pool
pool of
of large
large
investors
investors (bondholders).
(bondholders).

Principal
Principal isis usually
usually paid
paid back
back as
as aa
lump
lump sum
sum at
at maturity.
maturity.

McGraw-Hill/Irwin

10-32 Inc.
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Slide
10-33

Exhibit
Exhibit for
forBond
Bond liabilities
liabilities (extract
(extract from
from PIA
PIA
annual
annual report,
report, 2013)
2013)

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Slide
10-34

Important
Important points/terms
points/terms
Principal amount: The amount the borrower must
pay back to the bondholders on the maturity date
(also called maturity value or par value)
Maturity date: the date on which the borrower
must pay the principal amount to the bondholders
Stated interest rate / coupon rate: the rate of
interest (as stated on the bond) that the borrower
pays the bondholders

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Slide
10-35

Par value: Example, a $1,000 bond issued for $1,000.

Also called bond maturity (or face) value

Discount: a price below maturity (par) value. Example,

a $1000 bond issued for $980. The discount is $20.

Premium: a price above maturity (par) value. Example,

a $1,000 bond issued for $1,015. Premium is $15

Remember! The issue price of a bond does not affect

the required payment at maturity.
McGraw-Hill/Irwin

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Slide
10-36

Bond
Bond Valuation:
Valuation:
Determining
Determining Bond
Bond Prices
Prices

Price of a bond issue is determined by finding the

present value (PV) of future cash flows:

the PV of the interest payment annuity (at the stated
or coupon rate of interest), plus
the PV of the redemption (face, par) value,
both discounted at the market (yield) rate of interest
in effect at issue date
When market rate stated rate bond sells at discount
When market rate stated rate bond sells at premium
McGraw-Hill/Irwin

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Slide
10-37

Accounting
Accounting for
for Bond
Bond issue
issue

STL has $100,000 of 9% bonds payable that

mature in five years. Interest is payable semiannually.
A. STL issues the bonds at par value on January 1,
2010
B.STL issues the bonds on January 1,2010 at a
Discount at 98.149% when the market interest
rate is 10%
C.STL issues the bonds on January 1, 2010 at a
premium at 104% when the market interest rate is
8%
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Slide
10-38

AA- Bond
Bond issued
issued at
at par
par
Date

1 Jan 2010

Description
Cash

Debit ($)

Credit ($)

100,000
Bonds payable

100,000

(Issued 9% bonds at par)

30 June 2010 (Bonds) Interest expense

4,500

Cash

4,500

(paid semiannual interest)

Each semi-annual interest will be recorded in similar way.
31 Dec 2014

(Bonds) Interest expense

4,500

Bonds payable

100,000

Cash

104,500

(paid semiannual interest and retired the

bond at maturity)
McGraw-Hill/Irwin

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Slide
10-39

Date
1 Jan 2010

Bissued
at
discount
B- Bond
Bond
issued
at
discount
Description
Debit ($)
Cash

98,149

Discount on bonds payable

1,851

Bonds payable

Credit ($)

100,000

(Issued 9% bonds at discount)

30 June 2010 (Bonds) Interest expense

4,685

Cash

4,500

Discount on bonds payable

185

(paid semiannual interest and amortised

discount)
Each semi-annual interest and amortisation discount will be recorded in similar way.
31 Dec 2014

(Bonds) Interest expense

4,685

Bonds payable

100,000

Cash

104,500

Discount on bonds payable

185

(paid semiannual interest, amortised

McGraw-Hill/Irwin discount and retired the bond at maturity)

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Slide
10-40

Date
1 Jan 2010

Cissued
at
premium
C- Bond
Bond
issued
at
premium
Description
Debit ($)
Credit ($)
Cash

104,000
Bonds payable

100,000

Premium on bonds payable

4,000

(Issued 9% bonds at premium)

30 June 2010 (Bonds) Interest expense
Premium on bonds payable

4,100
400

Cash

4,500

(paid semiannual interest and amortised

premium)
Each semi-annual interest and amortisation of premium will be recorded in similar way.
31 Dec 2014

(Bonds) Interest expense

4,100

Premium on bonds payable

400

Bonds payable

100,000

Cash
(paid semiannual interest, amortised
premium and retired the bond at
McGraw-Hill/Irwin maturity)

104,500

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Slide
10-41

Interest
Interest rates
rates and
and bond
bond price
price

Bond stated Issued

interest rate when
9%

McGraw-Hill/Irwin

Market Interest
Rates

Bonds Sell
at

8%

Premium

9%

Face Value

10%

Discount

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Slide
10-42

Amortizing
Amortizing the
the Bond
Bond
Discount/Premium
Discount/Premium
A premium effectively decreases the
annual interest expense for the
corporation

The discount effectively increases the

annual interest expense for the issuing
corporation
McGraw-Hill/Irwin

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Slide
10-43

Test
Test yourself
yourself

VW Company has 8%, 10-year bonds payable that

mature on June 30, 2024. The bonds are issued on June
30, 2014 and VW pays interest each June 30 and
December 31.
Requirements:
Were

the bonds issued at par, premium or discount if the

market interest rate on 30-June-2014 was 7%? 9%?
VW issued $100,000 of the bonds at 94,
Record the issuance of the bonds on 30-June-2014
Record the interest payment and amortisation of the
discount on December 31, 2014 and June 30, 2015, also
compute the bonds carrying amount.
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Slide
10-44

Retiring
Retiring bonds
bonds payable
payable prior
prior to
to maturity
maturity

Main reason for corporations to retire bonds payable

prior to maturity is to relieve paying interest
Callable bonds the issuer may call the bond at an
specified call-price
The issuer may either pay off the bonds at the call price
or purchase at their current market price

For example: suppose on 30 June 2010 STL decides to retire the

$100,000 bonds with a remaining discount balance of $1,666 (the
original discount ($1,851) less amortisation ($185)). The call price
is 100 whereas the current market price is 95.

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Slide
10-45

Maturity Value

$100,000

Less discount

(1,666)

Carrying amount/book value as of 30 June 2010

$ 98,334

Price paid to retire the bond ($100000 x 0.95)

Gain on retirement

Date
30 June 2010

95,000
$

Description
Bonds payable

3,334

Debit ($)

Credit ($)

100,000

Discount on bonds payable

1,666

Cash

95,000

Gain on retirement of bonds

3,334

(retired bonds payable)

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Slide
10-46

Sinking
Sinking fund
fund

A bond sinking fund investment is a fund established to

accumulate assets to pay off bonds when they mature.
Not all corporations with bonds payable are required to
have a bond sinking fund. However, bonds with
sinking funds are likely to be viewed as less risky.
A bond sinking fund is reported on the bond
issuer's balance sheet under the caption Investments,
the first long-term (non-current) section appearing
immediately after current assets.
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Slide
10-47

Long-Term
Long-Term Debt
Debt Analysis
Analysis
Debt to Total Assets: Total debt
Total assets
Level or percentage of assets that is financed through debt
Times Interest Earned:
Income before taxes and interest (EBIT)
Interest Expense
The ratio shows the amount of resources generated
for each rupee/dollar of interest expense. In
general, a high ratio is viewed more favorable than
a low ratio.
McGraw-Hill/Irwin

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Slide
10-48

End
End of
of Chapter
Chapter 10
10
Any
questions?

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