Prepared by Coby Harmon University of California, Santa Barbara Westmont College 10-1 10 Liabilities Learning Objectives 10-2 Explain how to account for current liabilities Describe the major characteristics of bonds Explain how to account for bond transactions Explain how to account for long-term notes payable Discuss how liabilities are reported and analyzed LEARNING OBJECTIVE Explain how to account for current liabilities What Is a Current Liability? A debt that a company expects to pay within one year or the operating cycle, whichever is longer Current liabilities include notes payable, accounts payable, unearned revenues, and accrued liabilities such as taxes payable, salaries and wages payable, and interest payable 10-3 LO What Is a Current Liability? Question To be classified as a current liability, a debt must be expected to be paid within: a one year b the operating cycle c years d (a) or (b), whichever is longer 10-4 LO Current Liabilities Notes Payable 10-5 Written promissory note Frequently issued to meet short-term financing needs Requires the borrower to pay interest Issued for varying periods LO Notes Payable Illustration: First National Bank agrees to lend $100,000 on September 1, 2019, if Cole Williams Co signs a $100,000, 12%, four-month note maturing on January Instructions a) Prepare the entry on September 1st b) Prepare the adjusting entry on December 31st, assuming monthly adjusting entries have not been made c) Prepare the entry required on January 1, 2020, the maturity date 10-6 LO Notes Payable Illustration: First National Bank agrees to lend $100,000 on September 1, 2019, if Cole Williams Co signs a $100,000, 12%, four-month note maturing on January a) Prepare the entry on September 1st Cash 100,000 Notes Payable 100,000 b) Prepare the adjusting entry on December 31st Interest Expense 4,000 Interest Payable $100,000 x 12% x 4/12 = $4,000 10-7 4,000 LO Notes Payable Illustration: First National Bank agrees to lend $100,000 on September 1, 2019, if Cole Williams Co signs a $100,000, 12%, four-month note maturing on January 1, 2020 c) Prepare the entry at maturity Notes Payable Interest Payable 100,000 4,000 Cash 104,000 10-8 LO Current Liabilities Sales Taxes Payable 10-9 Sales taxes are expressed as a stated percentage of the sales price Selling company (retailer) ► collects tax from the customer ► enters tax separately in cash register or includes in total receipts ► remits the collections to the state’s department of revenue LO Sales Taxes Payable Illustration: The March 25 cash register reading for Cooley Grocery shows sales of $10,000 and sales taxes of $600 (sales tax rate of 6%), the journal entry is: Mar 25 Cash Sales Revenue 10,600 10,000 Sales Taxes Payable 600 10-10 LO Effective-Interest Method Required steps: Compute the bond interest expense Compute the bond interest paid or accrued Compute the amortization amount Illustration 10B-1 Computation of amortization using effective-interest method 10-87 LO Effective-Interest Method Amortizing Bond Discount Illustration: Candlestick, Inc issues $100,000 of 10%, five-year bonds on January 1, 2019, for $98,000, with interest payable each January This results in a discount of $2,000 Illustration 10B-2 Illustration 10B-2 Bond discount amortization schedule 10-88 LO Amortizing Bond Discount Illustration 10B-2 Bond discount amortization schedule Candlestick, Inc records the accrual of interest and amortization of bond discount on December 31 as follows Dec 31 Interest Expense Interest Payable Discount on Bonds Payable 10-89 10,324 10,000 324 LO Amortizing Bond Discount Illustration 10B-2 Bond discount amortization schedule For the second interest period, at December 31, Candlestick makes the following adjusting entry Dec 31 Interest Expense Interest Payable Discount on Bonds Payable 10-90 10,358 10,000 358 LO Amortizing Bond Premium Illustration: Candlestick, Inc issues $100,000 of 10%, five-year bonds on January 1, 2019, for $102,000, with interest payable January This results in a premium of $2,000 Illustration 10B-4 Bond premium amortization schedule 10-91 LO Amortizing Bond Premium Illustration 10B-4 Bond premium amortization schedule The entry Candlestick makes on December 31 is: Dec 31 Interest Expense Premium on Bonds Payable Interest Payable 10-92 9,669 331 10,000 LO LEARNING OBJECTIVE Compare the accounting for liabilities under GAAP and IFRS Key Points Similarities 10-93 The basic definition of a liability under GAAP and IFRS is very similar Liabilities are defined by the IASB as a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits The accounting for current liabilities such as notes payable, unearned revenue, and payroll taxes pa y able are similar between GAAP and IFRS LO Key Points 10-94 IFRS requires that companies classify liabilities as current or noncurrent on the face of the statement of financial position (balance sheet), except in industries where a presentation based on liquidity would be considered to provide more useful information (such as financial institutions) When current liabilities (also called short-term liabilities) are presented, they are generally presented in order of liquidity Under IFRS, liabilities are classified as current if they are expected to be paid within 12 months Similar to GAAP, items are normally reported in order of liquidity Companies sometimes show liabilities before assets Also, they will sometimes show long-term liabilities before current liabilities LO Key Points The basic calculation for bond valuation is the same under GAAP and IFRS In addition, the a c counting for bond liability transactions is essentially the same between GAAP and IFRS IFRS requires use of the effective-interest method for amortization of bond discounts and premiums GAAP allows use of the straight-line method where the difference is not material Under IFRS, companies not use a premium or discount account but instead show the bond at its net amount For example, if a $100,000 bond was issued at 97, under IFRS a company would record: Cash Bonds Payable 10-95 97,000 97,000 LO Key Points Differences 10-96 Under IFRS, companies sometimes will net current liabilities against current assets to show working capital on the face of the statement of financial position LO Looking to the Future The FASB and IASB are currently involved in two projects, each of which has implications for the accounting for liabilities One project is investigating approaches to differentiate between debt and equity instruments The other project, the elements phase of the conceptual framework project, will evaluate the definitions of the fundamental building blocks of accounting The results of these projects could change the classification of many debt and equity securities 10-97 LO IFRS Self-Test Questions The accounting for bonds payable is: a) essentially the same under IFRS and GAAP b) differs in that GAAP requires use of the straight-line method for amortization of bond premium and discount c) the same except that market prices may be different because the present value calculations are different between IFRS and GAAP d) not covered by IFRS 10-98 LO IFRS Self-Test Questions Which of the following is false? a) Under IFRS, current liabilities must always be presented before noncurrent liabilities b) Under IFRS, an item is a current liability if it will be paid within the next 12 months c) Under IFRS, current liabilities are shown in order of liquidity d) Under IFRS, a liability is only recognized if it is a present obligation 10-99 LO IFRS Self-Test Questions The joint projects of the FASB and IASB could potentially: a) change the definition of liabilities b) change the definition of equity c) change the definition of assets d) All of the above 10-100 LO Copyright “Copyright © 2017 John Wiley & Sons, Inc All rights reserved Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc The purchaser may make back-up copies for his/her own use only and not for distribution or resale The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.” 10-101 ... next accounting examination They ask you to answer the following questions If cash is borrowed on a $50,000, 6-month, 12% note on September 1, how much interest expense would be incurred by December... next accounting examination They ask you to answer the following questions If $15,000 is collected in advance on November for months’ rent, what amount of rent revenue should be recognized by December... they have been approved by the Board of Education and entered into the payroll system No employees should be entered into the payroll system until they have been approved by a supervisor All paychecks