Accounting Chapter 10
What's involved in the journal entry for Bonds issued at Face value?
dr (debit/increase) Cash cr (credit/increase) bonds payable
What's the quick ratio formula? What does it tell me?
(Cash + short term investments + Accounts receivable, net (minus) doubtful accounts) / current liabilities Tells me how much of my current liabilities I'm able to pay w/ my current, liquid assets. The higher the number, the more I am able to pay.
What's the times Interest earned ratio?
(net income + interest expense + income tax expense)/interest expense The higher the number, the better the ability a company has to cover its interest costs w/ its resources. In other words, a company w/ a .90 when compared to a company w/ a score of .80 has more sufficient resources to cover its interest costs. However, any company w/ a score below 1.0 doesn't have sufficient resources to cover its interest expense. Issuing more bonds will decrease a company's times interest earned ratio, which means these bonds are making it harder for the company to cover its interest expenses. This makes sense bc bonds naturally have interest payments that will accrue over time I'll have to pay off. It's just more and more money (in the form of accruing interest) the company will owe to bondholders. If the company never issued bonds, there'd be less interest payments to make, which in turn would make them more able to cover their interest expenses.
When do bonds sell at: 1) premiums 2) discounts
1) Bonds sell at a premium if the stated interest rate is greater than the market interest rate 2) Bonds sell at a Discount if the stated interest rate is lower than the market interest rate
What are the 3 key elements in a bond?
1) maturity date of the bond 2) face value of the bond 3) the stated interest rate of the bond
What's "Current Portion of Long Term Debt"?
A current Liability account. Pretend I have a loan that must b repaid in 2 yrs, since it's longer than 1 year it's classified as long-term debt. Interest accrued during the 1st yr is recorded as a current liability on the balance sheet for that year. However, once that 1st year is over, the loan itself turns from long term debt into a current liability since it only has 1 year left, so now I must also report the loan in the current Liabilities section of the balance sheet. What accountants do is they remove the amt to be repaid at the end of this 2nd year from total long term debt account and report it as a current liability, called Current Portion of Long Term Debt. In other words, when a long term debt loan becomes a current liability bc it only has 1 year left to repay everything, I must move the interest accrued from the Total Long Term Debt account into a Current Liability account called Current Portion of Long-Term Debt
What's an Accrued Liability?
A liability that's been incurred but not yet paid, such as: - Payroll incurred that hasn't been paid yet - Taxes incurred but not paid yet - Interest
What is an employer required to do w/ employee's payroll reductions taken from their gross pay?
They're required to send the deduction to the appropriate govt agency or company
How are bonds reported on the balance sheet?
Bonds are reported on the balance sheet in the liabilities section as the total Face Value + any premiums or - any discounts. The amount of the bond liability after taking into account any premiums or discounts is the Bond's Carrying Value
What's the concept behind the interest rate of a bond and how it affects bondholders? What does the interest rate mean to me as someone who is looking to invest in bonds?
By investing in a bond, the company is promising me it'll pay me the principal I paid to invest in them as well as periodic interest payments. Interest rates & bond prices have an "inverse relationship", meaning that when 1 goes up, the other goes down. If I decide that paying for a bond at face value w/ its advertised interest rate is a good deal when compared to the rest of the market, I will go ahead and purchase the bond at this face value. Pretend in a different scenario I'm looking to invest in bonds as a bondholder and I see that one is being offered at a face value of $1,000 w/ a 7% interest rate, but I know I can find other bonds in the market at $1,000 w/ a 8% interest rate, I won't invest in the 7% bond bc i'll get higher interest payments from the company offering 8%. Therefore, to get bondholders to invest in bonds, the 7% rate company will have to offer its bonds at a lower price (discount) to basically meet the same ratio of bond price vs interest rate that's going hot on the market. Instead of selling bonds at $1,000, the company sells them at about $850 Discount still w/ a 7% interest rate. On the other hand, if a company is selling bonds for $1,000 at a 7% interest rate but other companies are selling bonds of the same price at a lower interest rate, then the bond is technically worth more in the current market. This is bc as a bondholder I want the highest interest rate possible bc it'll give me the best interest payments. For this reason, the bond can be sold at a higher principal, aka a premium, bc bondholders are willing to pay it since your company has the best interest rate in the market.
What does FICA include? Is it required? If so, by who?
FICA includes Social Security and Medicare. It's required for employers to deduct a % for both of these (seen simply as a FICA deduction) out of each employee's payroll.
Which payroll taxes are paid only by the employer?
FUTA & SUTA
How do you calculate interest on a bond?
Face Value x Stated Interest Rate x Fraction of Year (if payments are made semiannually)
If a bond is being paid off at its maturity, what can I assume? What will the journal entry look like?
I can assume the interest has been fully paid off over time and now all I have to do is pay the principal face value amount. debit bonds payable liability for face value amount credit cash for the face value amount
What happens part of a long term liability debt is due this year but I forget to record it as a current liability?
I should've reclassified the current portion (the portion of the long-term liability due this year) of the long-term liability to Current Liabilities. By not doing so, current liabilities are understated, which makes the current ratio (=current assets/current liabilities) overstated.
Explain bond amortization:
If a bond is issued w/ a stated interest rate above the market rate, it will be sold at a premium bc ppl are willing to pay that premium to get your rate. However, this premium amt isn't free money, but is instead a REDUCTION IN THE COST OF BORROWING for the company. Therefore, each period that the bond remains unpaid, the process of Bond Amortization will decrease the amount of Interest Expense the company records while not decreasing the actual interest payments it makes to bondholders, while at the same decreasing the balance in the liability account Premium on Bonds Payable, so when it's time for the company to repay the investors their principal amts they paid, it will have received more cash than it has to repay at maturity. - Interest Expense acct is decreased periodically bc the Premium on Bonds Payable (liability acct) is also decreased the same amt at the same time, which makes sense bc in the end this decrease in the Premium on Bonds Payable account will result in less money I owe to bondholders, - Interest payments to bondholders remain the same - Premium on bonds payable liability decreases periodically - Therefore, at the bond's maturity when it's time to repay bondholders, the process of bond amortization will have reduced the premium on bonds payable (liability) balance down to 0, which means I don't have to pay it off, I just have to pay off the face value of the bond to bondholders. - Basically, the premium on bond payable liability account amount was brought down to zero through the process of bond amortization since this extra money that the people paid (the premium) they didn't have to pay me. Even though they paid a premium, I didn't owe them that whole amount back. I only owed them the face value of the bond back. So, while I never had more tangible cash to use, selling at a premium DID lower my interest expense account gradually as the Premium on Bond Payable liability account was gradually decreased.
US federal Corporations pay federal taxes on?
Income & Payroll
What type of accounts is Premium on Bonds Payable? When is it increased
Liability It's increased (credited) when bonds are issued at a premium price. The amount this account is increased is the difference bw the amt of the bonds including the premium (for example: 103) and the face value (ex: 100). With this example, the premium was 3, so the Premium on Bonds Payable liability account should be credited (increased) by 3.
How do I retire bonds when they're retired at their maturity (Given all interest payments have been paid)?
Most bonds are paid off at maturity w: dr (debit/decrease) Bond Payable (Liability) for face value amt of bond cr (credit/decrease) Cash for face value amt of bond
What must I do when making a payment on a notes payable when complete payment is due for the note when that note has accrued interest over time (and been recorded periodically but not paid off)?
Must account for: - Cash is paid (credited/reduced) equal to principal amt of note plus the total amt of interest that's accrued over the entire life of the note if none of it has been paid - Every time I accounted for accrued but unpaid interest over the life of the note, I had increased the interest expense account for the amt the interest had accrued since I'd last reported it. Now, as I'm paying everything off, I must 1 more time account for the interest that has accrued since I last reported it by increasing the Interest expense acct by the amt of interest that accrued since I last reported any accrued interest as an expense. For example, if by the last period I had accounted for $120 of interest expense for the note and calculate that $20 has accrued since then, I'd debit (increase) interest expense by $20 one more time. - I must decrease (debit) Notes Payable liability account by the principal amt I originally took on to show that I no longer have that liability over my head. - I must decrease (debit) the Interest Payable account by the balance it had last been reported at. For example, if the balance in the end of the last period was $120, then I need to debit $120 to show I no longer have that interest liability hanging over my head. I didn't continue adding to this account w/ $20 more bc I am paying the $120 plus the $20 off w/ cash! They both are no longer liabilities, and the total for Interest Expense after paying these off should total $140 (since I just added the last $20 incurred since the last period adjustment I made).
For Notes Payable, if the length of two notes is different, does that change the amount of interest that's owed per month for them if they have the same interest rates?
No, the amt owed per month will not be different for the two notes. The Notes Payable interest calculation formula is (I = Principle x rate x time (meaning the fraction of the year (?/12) that's gone by that I'm trying to calculate for)). The difference bw the two notes is that I have less time to pay one off when compared to the other, but since they have the same rate and principle, there won't be different interest accrual amounts per month.
What do corporations pay taxes on? How do they calculate taxable income? How do I record?
Payroll as well as income they earn. First, subtract any expenses that are tax allowed from your revenues. Tax allowed means they won't be taxed. Then, multiply the taxable income amt by the tax rate, which is usually abt 35% for corps increase (cr) income tax payable liability increase (dr) income tax expense by same amt
What's involved in the journal entry for Bonds issued at a discount?
Pretend I offer a bond at a face value of $100 for a discount of $93 dollars in order to entice investors to buy into it. I would: db (debit/increase) Cash $93 db (debit/increase) Discount on Bonds Payable Contra-Liability Account $7 (the amt of the discount) cr (credit/increase) Bonds Payable Liability $100 I increased cash by the exact cash amt I was given bc obvi that's the only cash I got. I record the Bonds Payable and Discount on Bonds Payable separately just so I can keep track of them separately. What I did was I just recorded Bonds Payable Liability at face value ($100) then showed the discount I gave the bondholder/investor by increasing (debiting) the Contra-Liability Discount on Bonds Payable account. Bc it's a contra account, it technically decreases the actual liabilities account, which makes up for the fact that I recorded Bonds Payable at the face value ($100) which is actually higher than the amt I actually owe back to the bondholder.
What's involved in the journal entry for Bonds issued at a premium?
Remember, the company is issuing the bond at a premium (higher issue price than face value) bc they know investors will pay it to get that interest rate. Therefore, the company has more cash coming in than the face value of the bond is worth. For example, a company sells bonds w/ a face value of $100 at a premium price of $107. Therefore, db (debit/increase) Cash $107 cr (credit/increase) Bond Payable Liability by $100 since it's the face value of the bond cr (credit/increase) Premium on Bonds Payable Liability account by $7 since that's the amt the premium is worth you sold your bonds for. I use separate liability accounts for Bonds Payable & Premium on Bonds Payable bc they're both liabilities & I'll have to pay each customer back this full issue price, but I still want to personally as a company keep track of how much money I owe back to bondholders that was technically borrowed just bc of premiums I added onto the bonds, & then also how much money I borrowed from bondholders from just the face value of the issue price.
An adjusting entry at the end of the period that Debits the Unearned Revenue Liability account will most likely Credit the ______ account?
Revenue account. This is bc when I debit unearned revenue account, it means I'm decreasing the liability, which must mean bc the revenue is now earned. Since the revenue is earned, I show this by increasing the revenue acccount. The reason why I had to wait until an adjusting entry to credit the revenue account was bc it wasn't earned initially but now by the end of the period it had been earned, meaning it's time to get rid of the liability (unearned revenue) and increase the revenue account that shows it's been earned.
How is sales tax recorded?
Sales tax is recorded as a liability. Sales Tax Liability. It should not be included in the Sales Revenue account bc that would cause the net income to be overstated... AKA it would appear the company made more money than it actually did bc it forgot to account for the fact that a bunch of that revenue was actually money (tax) owed to the govt.
Under US GAAP, what should a Contingent Liability do?
Should not be reported if the loss is remote and unable to be estimated. Should be in the notes in financial statements if loss is possible and can be reasonably estimated. Should be reported on the Balance Sheet if the loss will probably occur and can be reasonably estimated.
What's a Bond's Carrying Value?
The amount a bond is worth after any premiums have been added or any discounts have been subtracted from the Face Value amount on the liabilities section on the balance sheet.
What's the issue price of a bond? Who establishes the issue price of a bond? How?
The amount investors are willing to spend (invest) on a bond on the date it's issued. The Investors establish this issue price of bonds bc a company can't issue a bond at a certain price of nobody will invest in it at that price. Since the investors are technically the people enabling the company to get cash in exchange for issuing the bond, they dictate how much the company can issue the bond for, which is the issue price. Basically, the investors willingness to spend is the market conditions that dictate the issue price of bonds.
What's the Face Value of a bond? How much is it normally?
The amount payable on the bond's maturity date. This amount is normally $1000.
How does the quick ratio differ from the current ratio? How are they alike?
The quick ratio focuses on assets that can be quickly converted into cash. They both compare a firm's current assets to its current liabilities.
What are bondholders thinking and what happens when bondholders desire a market interest rate that's lower than the advertised interest rate of a bond?
They're thinking: "I'll pay more than face value to invest in this bond bc it has the best interest rate on the market" What happens is that the company issues bonds at a premium, knowing investors are willing to pay that extra "premium" in order to get that high interest rate you're offering since no one else in the market is offering rates so high. The reason I'd do this in the first place as a company is bc it just enables me to get more money to work with from my investors.
What are bondholders thinking and what happens when bondholders desire a market interest rate that's higher than the advertised interest rate of a bond?
They're thinking: "I'm not attracted (yet) bc I can find bonds elsewhere in the market that have higher interest rates that will pay me higher interest payments." As a result, what happens is that the company issues bonds at a discount issue price in order to entice investors/bondholders to think the bond is a good deal that is competitive w/ the issue prices/interest rates going on in the market.
What are bondholders thinking and what happens when bondholders desire a market interest rate that's equal to the advertised interest rate of a bond?
They're thinking: "It's just enough & I'll invest in this since I can't find other bonds on the market w/ either a lower Issue Price or higher interest rate." What happens is that the company issues bonds at Face Value bc investors are willing to buy their bonds at that price w/ that interest rate bc it's competitive/similar to everything else is in the market.
What type of account is Discount on Bonds Payable? What's its normal balance?
This is a Contra-liability account. Because I sold bonds for a discount, which is a price lower than the face value, I technically owe less money to the bondholders than if the bonds were sold at face value. To show this, I'm supposed to record bonds payable (liability account) at the face value of the bond, but then the Discount on Bonds Payable (contra-liability) at the amount of the discount. Since it's a contra account associated w/ Bonds Payable, as it increases it will decrease the Bonds Payable account balance, which will show the discount amount while keeping track of the discount and the bonds payable liabilities in different accounts. It's normal balance is therefore Debit, bc it increases w/ debits. Again, as it is debited, the Bonds Payable (liability) is also debited (decreased).
How is the stated interest rate of a bond always expressed?
This is always expressed annually. When using it in the bond interest calculation, just make it a decimal.
What's up w/ analyzing/recording interest on bonds issued at Face Amount?
To account for interest that needs to be paid: Increase (debit) Interest expense account Increase (credit) Interest Payable Liability account To account for interest that has been paid: decrease (debit) Interest Payable liability decrease (credit) Cash
Sales Tax Payable. How do I record?
When I record a sale that had sales tax on it I must: dr cash for the sale amt + the amt of sales tax on top of it cr sales tax payable liability by the amt of the tax that was on top cr sales revenue by the amt of the sale w/o the sales tax on top of it. This is bc I technically was given more money than the item was worth, but I only get to keep the money I earned (which is not the sales tax bc that has to go to the govt etc)
What's up w/ analyzing/recording interest on bonds issued at Premiums?
When bonds issue at a premium, the bond issuer receives more cash on the issue date than the total face amount that will be repaid at maturity. The $ amt of the premium isn't exactly free money for the company, but is rather a deduction in the amt they'll have to pay back to the bondholder. I must make the interest expense smaller than the actual interest payment and
How do I retire a bond early? What financial effects does retiring bonds early have? When is a gain recorded when retiring bonds early? When is a loss recorded when retiring bonds early?
financial effects 1) Company pays cash 2) eleminates bond payable liability 3) reports gain or loss A gain is reported when the retirement price of the bond is less than the Carrying Value of the bond. This makes sense bc the premium amt tacked on is not additional money that I have to pay investors, it's actually making my bond amt owed in the end less by that amt. If the market has changed such so that the bond is currently able to be sold for a premium then I'll be able to pay it off for the original face value, which is less than the current carrying value. If I sell at the face value, the diff bw the face and carrying value equals the gain that was made from retiring the bond. In other words, EX: - Bond is initially worth $100. - The Market changes, the bonds in this new market are being sold for a premium of say $103 bc ppl are willing to pay that premium for my dope interest rate. - However, I want to retire the bond so I retire it at $100 (the original face value). - The carrying value of a bond is the face value +- premiums/discounts, so the carrying value of this bond is now $103. Each time I issue bonds at this price it saves me $3 that I'd have to repay the investor later - cr (credit/decrease) cash by $100 to pay off the face value of the bond. - A loss is recognized when the repurchase price is more than the Carrying value of the bond
What must (is required) an employer deduct from an employee's payroll?
required by law deductions: Federal income tax (and possibly state, county, city income tax). Medicare & Social Security is also supported through the FICA tax deductions requested by employees: Charitable Donations, parking, union dues, retirement savings, etc
What's a Bond's maturity date?
the date on which the bond principal will be repaid in full