Lecture Accounting: What the numbers mean (5/e) - Chapter 7: Accounting for and presentation of liabilities

After reading this chapter, you should be able to answer the following questions: What is the financial statement presentation of short-term debt and current maturities of long-term debt? What is the difference between interest calculated on a straight basis and on a discount basis? What are unearned revenues and how are they presented in the balance sheet?...

CHAPTER ACCOUNTING FOR AND PRESENTATION OF LIABILITIES McGraw­Hill/Irwin ©The McGraw­Hill Companies, Inc., 2002 Learning Objectives What is the financial statement presentation of short-term debt and current maturities of long-term debt? What is the difference between interest calculated on a straight basis and on a discount basis? What are unearned revenues and how are they presented in the balance sheet? McGraw­Hill/Irwin ©The McGraw­Hill Companies, Inc., 2002 Learning Objectives What is the accounting for employer’s liability for payroll and payroll taxes? What is the importance of making estimates for certain accrued liabilities and how are these items presented in the balance sheet? What is leverage and how is it provided by long-term debt? What are the different characteristics of a bond? McGraw­Hill/Irwin ©The McGraw­Hill Companies, Inc., 2002 Learning Objectives 10 Why does bond discount or premium arise and how is it accounted for? What are deferred income taxes and why they arise? What is minority interest, why does it arise, and what does it mean in the balance sheet? McGraw­Hill/Irwin ©The McGraw­Hill Companies, Inc., 2002 Learning Objective • What is the financial statement presentation of short-term debt and current maturities of longterm debt? McGraw­Hill/Irwin ©The McGraw­Hill Companies, Inc., 2002 Current Liabilities • Amounts due within one year or operating cycle • A working capital loan is a short-term loan with the expectation that it will be repaid from the collection of accounts receivable generated by the sale of inventory • A revolving line of credit is a predetermined maximum amount, but flexibility in timing and amount borrowed McGraw­Hill/Irwin ©The McGraw­Hill Companies, Inc., 2002 Notes Payable • A note is a formal promise to pay a stated amount at a stated date, usually with interest • Prime rate is the term frequently used to express the interest rate on short-term loans McGraw­Hill/Irwin ©The McGraw­Hill Companies, Inc., 2002 Learning Objective • What is the difference between interest calculated on a straight basis and on a discount basis? McGraw­Hill/Irwin ©The McGraw­Hill Companies, Inc., 2002 Interest Calculation Methods • Straight interest is calculated as follows: Interest = Principal X Rate X Time (in years) • A discount is interest that is subtracted from the loan principal and the borrower receives the difference • The difference received by the borrower is called the proceeds • The discounted amount is shown in the balance sheet as a contra liability McGrawưHill/Irwin âTheMcGrawưHillCompanies,Inc.,2002 Current Maturities of LongTerm Debt ã The portion of long-term borrowing that must be repaid within a year of the balance sheet date is reported as a current liability • The remainder of the long-term debt is shown in noncurrent liabilities McGrawưHill/Irwin âTheMcGrawưHillCompanies,Inc.,2002 Financial Leverage ã Financial leverage is the difference between the rate of return earned on assets (ROI) and the rate of return earned on owners’ equity (ROE) • A firm can borrow money to purchase assets and use those assets to earn a rate of return greater than the interest incurred on the borrowed funds McGrawưHill/Irwin âTheMcGrawưHillCompanies,Inc.,2002 Learning Objective ã What are the different characteristics of a bond? McGraw­Hill/Irwin ©The McGraw­Hill Companies, Inc., 2002 Bonds Payable • Most long-term debt is issued in the form of bonds • A bond is a formal debt document usually issued in denominations of $1,000 • Bond prices are expressed as a percentage of the bonds principal amount McGraw­Hill/Irwin ©The McGraw­Hill Companies, Inc., 2002 Learning Objective • Why does bond discount or premium arise and how is it accounted for? McGraw­Hill/Irwin ©The McGraw­Hill Companies, Inc., 2002 Bond Premiums and Bond Discounts • A bond premium is the excess of a bond’s market value over its face amount • A bond discount is the excess of the face amount over the market value of the bond • Premiums and discounts usually result from differences between stated interest rates on the bonds and the market rate of interest McGraw­Hill/Irwin ©The McGraw­Hill Companies, Inc., 2002 Reporting Bonds – At Par • Issuance of bond: Cash • Bonds payable XX Recording interest expense: Interest expense Cash • XX XX XX Retirement of bond: Bonds payable Cash McGraw­Hill/Irwin XX XX ©The McGraw­Hill Companies, Inc., 2002 Reporting Bonds – At Discount • Issuance of bond: Cash Discount on bonds payable Bonds payable • XX XX XX Recording interest expense: Interest expense Discount on bonds payable Cash • XX XX XX Retirement of bond: Bonds payable Cash McGraw­Hill/Irwin XX XX ©The McGraw­Hill Companies, Inc., 2002 Reporting Bonds – At Premium • Issuance of bond: Cash • Premium on bonds payable Bonds payable XX XX Recording interest expense: Interest expense Premium on bonds payable Cash • XX XX XX XX Retirement of bond: Bonds payable Cash McGraw­Hill/Irwin XX XX âTheMcGrawưHillCompanies,Inc.,2002 Types of Bonds ã Callable bonds the issuer may payoff the bonds before the scheduled maturity date • Registered bonds – the name and address of the bond owner is known to the issuer • Coupon bonds – the owner is not known to the issuer • Debenture bonds – secured only by the general credit of the issuer McGrawưHill/Irwin âTheMcGrawưHillCompanies,Inc.,2002 More Types of Bonds ã Mortgage bonds – secured by a lien against real estate owned by the issuer • Term bonds – requires a lump-sum payment of the face amount of the bonds at maturity • Serial bonds – repaid in installments • Convertible bonds – may be converted into stock of the issuer corporation at the option of the bondholder McGraw­Hill/Irwin ©The McGraw­Hill Companies, Inc., 2002 Learning Objective • What are deferred income taxes and why they arise? McGrawưHill/Irwin âTheMcGrawưHillCompanies,Inc.,2002 Deferred Tax Liabilities ã Deferred tax liabilities are provided for temporary differences between income tax and financial statement recognition of revenues and expenses • Normally are long-term liabilities • The most significant temporary difference is related to depreciation expense • The deferred tax liability is the difference between income tax expense and income tax payable McGrawưHill/Irwin âTheMcGrawưHillCompanies,Inc.,2002 Other Noncurrent Liabilities ã ã ã Obligations related to pension plans are noncurrent liabilities Obligations related to post-retirement benefits Estimated liability under lawsuits in progress also may be listed as noncurrent liabilities McGrawưHill/Irwin âTheMcGrawưHillCompanies,Inc.,2002 Learning Objective 10 ã What is minority interest, why does it arise, and what does it mean in the balance sheet? McGraw­Hill/Irwin ©The McGraw­Hill Companies, Inc., 2002 Minority Interest in Subsidiaries • A subsidiary is a corporation that is more than 50% owned by the firm for which financial statements have been prepared • The resulting financial statements are called consolidated financial statements • Minority interest arises if the subsidiary is not 100% owned by the parent corporation • The minority is the equity of other shareholders McGraw­Hill/Irwin ©The McGraw­Hill Companies, Inc., 2002 ... liability for payroll and payroll taxes? What is the importance of making estimates for certain accrued liabilities and how are these items presented in the balance sheet? What is leverage and how... Objectives What is the financial statement presentation of short-term debt and current maturities of long-term debt? What is the difference between interest calculated on a straight basis and on... it accounted for? What are deferred income taxes and why they arise? What is minority interest, why does it arise, and what does it mean in the balance sheet? McGraw­Hill/Irwin ? ?The? ?McGraw­Hill Companies, Inc., 2002