136B: Chapter 12 and Chapter 13

Acid-Test Ratio

(Cash + Short-Term Investments + A/R (net))/ Current Liabilities Excludes inventory and prepaid assets.

Times Interest Earned

(Net Income + Interest Expense + Income Tax Expense) / Interest Expense Indicates company's ability to meet interest payments as they come due.

Fair Value (Other Comprehensive Income) Ex: Assume in the previous example, fair value changes due to. credit rating dropping from AA to BB

- One idea is that if decline in fv for creditworthiness = reflected in income-> debtholders' loss is the shareholders' gain a. The FASB requires that the credit-risk portion of gains or losses on a financial liability be reported in other comprehensive income which flows through to the equity section of the balance sheet. Dr. Bonds Payable 20,000 Cr. Unrealized Holding Gain or Loss - Equity 20,000 (500,000-480,000)

Sick Pay

1. If sick pay benefits vest, a company must accrue them. 2. If sick pay benefits accumulate but do not vest, a company may choose whether to accrue them or not. *Companies record and qualify sick pay in two ways: a. Employees receive sick pay only if illness causes their absence-> Don't have to accrue liability since we don't know if they get sick b. Other companies allow employees to accumulate unused sick pay and take compensated time off from work even when not ill-> Must accrue a liability because the company will pay it, regardless of whether employees become ill.

Pending or threatening litigation OR assessments

1. The time period in which the underlying cause of action occurred. 2. The probability of an unfavorable outcome.-> use the nature of the litigation, the progress of the case, the opinion of legal counsel, its own and others' experience in similar cases, and any management response to the lawsuit. 3. The ability to make a reasonable estimate of the amount of loss. ** TO RECORD, CAUSE FOR LITIGATION MUST AFTER OCCURRED ON OR BEFORE THE DATE OF FINANCIAL STATEMENTS Dr. Estimated Loss on Litigation Cr. Litigtion Liability

Co sells boxes of cake mix for $3 per box. . They offer a mixing bowl to customer in exchange for $1 and 10 box tops. Mixing bowl costs $2, and estimates that customers will redeem 60% of the box tops. Premium offer began in June 2025. During 2025, co purchased 20,000 mixing bowls at $2, sold 300,000 boxes of cake mix for $3 per box, and redeemed 60,000 box tops. What entries should Co record in 2025?

1. To record purcase of 20,0000 mixing bowls at $2 per bowl in 2025: Dr. Premium Inventory 40,000 (20,000*2) Cr. Cash 40,000 2. To record the sale of the cake mix boxes in 2025: Dr. Cash $900,000 (300,000 boxes of cake mix * $3) Cr. Sales Revenue $900,000 3. To record actual redemption of 60,000 box tops, the receipt of $1 per 10 box tops, and the delivery of the mixing bowls: Dr. Cash (60,000/10)*$1= 6,000 Dr. Premium Expense 6,000 (12,000-6000-> plug) Cr. Premium Inventory (60,000/10)*$2= 12,000 4. Adjusting JE to record premium expense and the estimated premium liability as of Dec 31, 2025: Dr. Premium Expense 12,000 Cr. Premium Liability 12,000* *Total boxtops sold in 2025 (300,000) x Estimated redemption percentage (.60) = total estimated redemptions (180,000) Cost of estimated redemptions (180,000/10 * (2-1)= 18,000) - redemptions to date (6000) = liability (12000)

You purchase a car from Hamlin Auto for $30,000 on Jan 2, 2025. Hamlin estimates the assurance-type warranty costs on the car to be $700 (Hamlin will pay for the first $36,000 miles or 3 years, whichever comes first). You also purchase for $900 a service-type warranty for an additional 3 yrs or 36,000 miles. Hamlin incurs warranty costs related to assurance type warranty of $500 in 2025 and expects cost of $100 in 2026 and 2027. Hamlin records revenue on the service-type warranty on a straight-line basis. What are the necessary entries for Hamlin in 2025 and 2028?

1. To record sale of car and related warranties Jan 2, 2025 Dr. Cash (30,000+900)= 30,900 Cr. Unearned Warranty Revenue $900 Cr. Sales Revenue 30,000 2. To record warranty costs incurred in 2023: January 2 - Dec 31, 2025 Dr. Warranty Expense 500 Cr. Cash, Inventory, Accrued Payroll 500 3. Adjusting JE to record estimated warranty expense and liability for expected assurance warranty claims Dec 31, 2025 Dr. Warranty Expense 200 Cr. Warranty Liability 200 4. To record revenue recognized in 2028 on the service-type warranty: Jan 1- Dec 21, 2028 Dr. Unearned Warranty Revenue $300 ($900/3) Cr. Warranty Revemue $300 -> expense this service-type warranty as incurred in 2028-2030

Co begins production of a new vending machine in July 2025 and sells 100 of these machines for $5,000 cash by year-end for a total sales revenue of $500,000 (100* $5,000). Each vending machine is under warranty for one year. Co estimates, based on past experience with similar machines, that the warranty cost will average $200 per unit for a total expected warranty expense of $20,000 (100 * $200). Further, as a result of parts replacements and services performed in compliance with machinery warranties, it incurs $4,000 in warrant costs in 2025 and $16,000 in 2026 related to the 2025 sales. What are the entries for the sale and the related warranty costs for 2025 and 2026? (assurance type)

1. To record sales ov vending machines: Dr. Cash. 500,000 Cr. Sales Revenue ($5,000 * 100) 500,000 2. To record payment for warranty costs incurred in 2025: Dr. Warranty Expense. $4,000 Cr. Cash, Inventory, and Accrued Payroll $4,000 -> this year's Adjusting JE to record estimated warranty expense and liability for expected warranty claims on Dec 31, 2025: Dr. Warranty Expense 16,000 Cr. Warranty Liability $16,000 ($20,000-$4,000) -> next year's 3. To record payment for warranty costs incurred in 2026 related to 2025 vending machne sells Dr. Warranty Liability $16,000 Cr. Cash, Inventory, Accrued Payroll 16,000

debt to assets ratio

=total liabilities/total assets measures the percentage of the total assets provided by creditors. Higher the percentage, the greater the risk that company may be unable to meet maturing obligations

Contingent Liability and Likelihood of Loss

A liability incurred as a result of a loss contingency a. Depend on the occurrence of one or more future events to confirm either the amount payable, the payee, the date payable, or its existence. **Levels: 1. Probable- The future event or events are likely to occur. 2. Reasonably possible- The chance of the future event or events occurring is more than remote but less than likely. 3. Remote- The chance of the future event or events occurring is slight**

service-type warranty

An additional warranty, not included in the sales price of the product, that the product meets agreed-upon specifications in the contract at the time the product is sold. 1. The sale of the service-type warranty is usually recorded in an Unearned Warranty Revenue account. 2. Companies then recognize revenue on a straight-line basis over the period the service-type warranty is in effect.

Bonuses: Ex: Palmer Inc. shows income for the year 2025 of $100,000. It will pay out bonuses of $10700 in January 2026 What are the entries for the bonus plan in 2025 and 2026

Adjusting JE to record bonus: Dec 31, 2025 Dr. Salaries and Wages Expense 10700 Cr. Salaries and Wages Payable 10,700 January 2026 Dr. Salaries and Wages Payable 10,700 Cr. Cash. 10,700

reacquisition price

amount paid on extinguishment before maturity

Current maturities of long-term debt

Classify current maturities of long-term debt as current liabilities. Exceptions to above rule: 1. Retired by assets accumulated for this purpose that properly have not been shown as current assets. 2. Refinanced, or retired from the proceeds of a new debt issue on a long-term basis and must demonstrate an ability to consummate the refinancing. a. If an actual refinancing occurs, the portion of the short-term obligation to be excluded from current liabilities < new obligation or equity securities used to retire the short-term obligation. 3. Converted into capital stock. (use of current asset does not occur so does not make sense to have as a current liability)

bond indenture

Contract governing a bond issue with details of the bonds such as the amounts authorized to be issued, interest rate, due dates, and other important details.

Current Ratio

Current Assets/ Current Liabilities Shows how many times the current assets can cover, or be used to extinguish, the current liabilities a. Doesn't take into account of things like inventories and prepaid assets that are hard to convert to cash and already made revenue-> exclude these in next ratio

Refundable Deposit

When an advance payment is refundable-> cash collected from a customer that a company expects to return after a specified period or when certain conditions are satisfied Ex: equipment deposit in order to ensure the return of keys or insure against property damage JE: Dr. Cash Cr. Refundable Deposit Liability Dr. Refundable Deposit Liability Cr. Cash (if in pristine condition)

Gift Cards

Do not report gift card revenue on day the card was bought-> report a liability **Recognize revenue related to giftcards-> use the proportion of gift cards/ # of gift cards estimated to be redeemed Breakage-> when you never use the giftcard used (when does the company decide that you will not use it and recorde it as an expense-free revenue). a. at time of purchase, records this as a Cr. Sales Revenue (Breakage) based on expectations: Dr. Unearned Gift Card Revenue Cr. Sales Revenue Cr. Sales Revenue (Breakage)

zero-interest-bearing notes

Does not explicitly state an interest rate on face of note BUT INTEREST IS STILL CHARGED Borrower receives pv of note= fv at maturity - interest/discount charged by lender based on note Dr. Cash (PV of the note) Dr. Discount on Notes Payable (FV-PV-> aka the interest expense for the note period) Cr. Notes Payable (FV of the note)

Sales Taxes Payable

Dr. Cash Cr. Sales Revenue Cr. Sales Taxes Payable **Not an expense for us, only for the consumer** Ex: Co's Sales revenue account is worth $150,000, including sales tax of 4%. What is Je to record sales taxes payable? Dr. Sales Revenue 5,769.23 Cr. Sales Taxes Payable 5,769.23 (x+.04x=150,0000 x=144,230.77 To get sales tax liability, 150,000-144,230.77= 5,769.23)

Income Taxes Payable

Dr. Income Tax Expense Cr. Income Taxes Payable *Proprietorships and partnerships are not taxable-> shows up on personal income tax returns of partners**

To record interest expense accrued

Dr. Interest Expense Dr. Premium on Bonds Payable Cr. Interest Payable OR Dr. Interest Expense Cr. Discount on Bonds Payable Cr. Interest Payable

To record interest payment

Dr. Interest Expense (Effective rate * Carrying Value) Cr. Discount on Bonds Payable (Plug) Cr. Cash (Stated rate * par value) OR Dr. Interest Expense (Effective rate * Carrying Value) Dr. Premium on Bonds Payable (Plug) Cr. Cash (Stated rate * par value)

Note Issued for Property, Goods, or Services

Dr. Land (Cash sales price) Dr. Discount on Notes Payable Cr. Notes Payable (PV of debt instrument = FV of the property, goods, or services exchanged)

To record employer payroll taxes

Dr. Payroll Tax Expense Cr. FICA Taxes Payable (.0765*income) Cr. FUTA Taxes Payable (income * .008) Cr. SUTA Taxes Payable (income *.04)

To record Salaries and Wages paid and the employee payroll deductions

Dr. Salaries and Wages Expense Cr. Withholding Taxes Payable Cr. FICA Taxes Payable (income *.0765) Cr. Union Dues Payable Cr. Cash

Payroll Deductions

Employer withholds taxes, union dues, retirement payments, and healthcare a. Like taxes, company acts as an agent to collect deductions and holds them as a liability until paid to government agency or organization 1. Social Security Taxes: a/ Old Age, Survivor, and Disability Insurance (OASCI)- comes from social security and paid by taxes from BOTH EMPLOYER AND EMPLOYEE (rate of 6.2%) Tax paid is called FICA (Federal Insurance Contribution Act) 2. Income Tax Withholding and Other Payroll Deductions: This is required to be withhold, but like said before, there are optional ones like health insurance, union dues, and 401K-> co is like a collecting agent so, **These amounts are not an expense for the employer, but rather a current liability to the employer until the amounts are remitted to the various organizations** 3. Unemployment Taxes: Paid by Federal Unemployment Tax Act (FUTA). ONLY employers pay this if: a. Those who paid wages of $1,500 b. Those who employed at least one individual on at least one day in each of 20 weeks during the current or preceding calendar year. **Not a payroll deduction for employees Recorded as expense for the employer and is debited to Payroll Tax Expense, which is included in operating expenses on the income statement**

When should we accrue an estimated loss from a loss contingency?

If both can be determined: 1. Information available prior to the issuance of the financial statements indicates that it is probable that a liability has been incurred at the date of the financial statements. 2. The amount of the loss can be reasonably estimated. Dr. Loss "on Lon Guaranty" Cr. "Guarantee" Liability

customer advances

If customer makes prior deposit-> Dr. Cash Cr, Unearned Revenue- Customer Advances a. When good/service is provided, Dr. Unearned revenue-customer advanced Cr. revenue

CV of bond - reacquisition price

Reacquisition price < Carrying Value = Gain on Extinguishment Reacquisition Price > Carrying Value = Loss on Extinguishment

liability

Probable future sacrifices of economic benefits (cash, goods, services). a. Arises from present obligation (it is unavoidable), which arises from a past transaction/event DO NOT DO PENDING TRANSACTIONS

Warranty

Promise made by a seller to a buyer to make good on a deficiency of quantity, quality, or performance in a product; aka promises to fix if something goes wrong **The estimated amount of the liability includes all the costs the company will incur related to the correction of defects or deficiencies required under the warranty provisions**

Debt Extinguishment: Gain on Redemption of Bonds

Reacquisition price - CV of bonds receemed (Face value - Unamortized discount) = Loss on Redemption Je: Dr. Bonds Payable (Par Value) Dr. Premium on Bonds Payable (Plug) Cr. Gain on Redemption of Bonds (Calculation above) Cr. Cash (Reacquisition Price)

Debt Extinguishment: Loss on Redemption of Bonds

Reacquisition price - CV of bonds receemed (Face value - Unamortized discount) = Loss on Redemption Je: Dr. Bonds Payable (Par Value) Dr. Loss on Redemption of Bonds (Calculation above) Cr. Discount on Bonds Payable (Plug) Cr. Cash (Reacquisition Price)

To record issuance of a bond at discount/premium (effective interest method)

Step 1: Find PV of the bond-> WHEN USING THE PV TABLE, DISCOUNT USING THE EFFECTIVE INTEREST RATE. BUT WHEN U CALCULATE THE INTEREST RATE DO FACE VALUE * STATED *(DISCOUNT RTE FOR ANNUITY) Step 2: Dr. Cash (Pv of bond at current value) Cr. Discount Cr. Bonds Payable (Par Value) OR Dr. Cash (Pv of bond at current value) Dr. Discount Cr. Bonds Payable (Par Value)

Zero Interest Bearing Note

Step 1: Take the PV of the note a. Implicit interest rate- rate that equates the cash received with the amounts to be paid in the future. Step 2: Take difference between face amount and PV as discount and amortize the amount to int exp over note's life Step 3: JE Dr. Cash (PV) Dr. Discount on Notes Payable (Plug) Cr. Notes Payable (Face Value) Step 4: Dr. Interest Expense (PV * Implicit Rate) Cr. Discount on Notes Payable

Interest Bearing Note

Step One: Take pv of note like you would do for a bond (face + interest separately) Step 2: JE Dr. Cash (PV) Dr. Discount on Notes Payable (Plug) Cr. Notes Payable (Face Value) Step 3: Record the Interest Dr. Interest Expense (market interest * pv) Cr. Discount on Notes Payable Cr. Cash (Face value * interest rate) **OPPOSITE FOR PREMIUM ON NOTE**

Fair Value (Net Income) Ex: Co has issued $500,000 of 6% bonds at face value. Edmonds chooses the fair value for these bonds. At Dec 31, 2025, the value of the bonds is now $480,000 because interest rates in the market have increased to 8%

The value of debt declined because market interest rate increased (investors want to invest in other bonds) Dr. Bonds Payable 20,000 Cr. Unrealized Holding Gain or Loss- Income 20,000 (500,000-480,000)

assurance-type warranty

Warranty that the product meets agreed-upon specifications in the contract at the time the product is sold. a. Included in sales price -> Do not record a separate performance obligation. Expense them in the period goods are provided and service performed. Credit a warranty liability (See example)

Notes payable vs bonds payable

When a single lender or investor loans money to a company vs multiple lenders/investors loan various amounts, in $1,000 increments, to the company a. the lender or bondholder are NOT owners like a stockholders

Off-balance-sheet financing

an attempt to borrow moneys in such a way to prevent recording the obligations. 1. Non-consolidated subsidiary- under GAAP, parent co does not have to consolidate a baby company if owns less than 50% Only reports an investment, not the assets and liabilities of the baby company (can hide all their debt in the baby co) 2. Special-Purpose Entity (SPE)- a co creates this to perform a special project, such as creating a big power plant and isolating it as its own "business" Ability to not report asset or liability on books

contingency

an existing condition, situation, or set of circumstances involving uncertainty as to possible loss (loss contingency) or gain (gain contingency) to an enterprise that will ultimately be resolved when one or more future events occur or fail to occur

Accounts Payable

balances owed to others for goods, supplies, or services purchased on open account (periods of credit) a. record at time of transfer of control, usually at time of receipt Dr. Inventory Cr. A/P

premium

because the stated rate > market rate, selling price> face value because they have higher interest rate so more valuable a. Originally credit the premium and amortize it through debits

gain contingencies

claims or rights to receive assets (or have a liability reduced) whose existence is uncertain but which may become valid eventually. a. Ex: Possible receipts of monies from gifts, donations, and asset sales, Possible refunds from the government in tax disputes, and Pending court cases with a probable favorable outcome. **Do not record gain contingencies. Disclose ONLY WHEN HIGH PROBABILITY EXISTS FOR REALIZING THEM (unusual).**

Due on Demand (Callable Loans)

classify it if due on demand as current liability or will be due on demand within a year or operating cycle, if longer

discount

ebitWhen bonds have stated interest rate < market and to make up for it, they sell the bonds at lower face values to investors (lower value) a. Originally debit the discount and amortize it through credits

Stated (coupon or nominal) rate

interest rate written in the terms of the bond indenture. Will not change over life of bonds and it represents the amount of interest that will be paid over life (aka cash account or interest payable)

Consideration Payable

make payments (provide consideration) to their customers as part of a revenue arrangement. Consideration paid or payable may indicate discounts, volume rebates, free products, or services. a. Ex: gives money to customers in return for box tops, certificates, coupons, labels, or wrappers. b. Premium = the thing in return Accounting wise: For outstanding premium offers at the end of the accounting period, 1. To reflect the existing current liability, the company estimates the number of outstanding premium offers that customers will present for redemption. 2. The company then charges the cost of premium offers to Premium Expense. It credits the outstanding obligations to an account titled Premium Liability

Fair Value Option

noncurrent liabilities, such as bonds and notes payable, are reported at fair value. Report unrealized holding gains or losses as part of net income or in other comprehensive income

Current Liabilities

obligations that a company reasonably expects to liquidate either through the use of current assets or the creation of other current liabilities 1. Payables resulting from the acquisition of goods and services, such as accounts payable, wages payable, taxes payable, etc 2. Collections received in advance for the delivery of goods or performance of services, such as unearned rent revenue or unearned subscriptions revenue. 3. Other liabilities whose liquidation will take place within the operating cycle, such as the portion of long-term bonds to be paid in the current period or short-term obligations arising from the purchase of equipment or other assets.

Expropriation

occurs when a government claims privately owned property against the wishes of its owners. -> we do not record a contigent liability BUT there is a reduction of an asset Dr. Loss on Plant Assets Cr. Plant Assets (BV of asset - compensation amount)

Compensated Absences

paid absences from employment for such items as vacations, illness, holidays, and jury duties. Accrue if: 1. Employer's obligation related to employee's right for compensation is attributable to employees' services already rendered. 2. Obligation related to rights that vest or accumulate a. Vested rights- exist when an employer has an obligation to make payment to an employee even after terminating his or her employment-> not contingent on employee's future service Ex: you have 4 days of vacation by end of year that do not carry over, but you were terminated. In contract, it says you will be paid for this-> this is a vested amount b. Accumulated Rights- earned but unused rights to compensated absences may be carried forward to one or more periods subsequent to that in which they are earned, even though there may be a limit to the amount that can be carried forward. *Recognize in yr earned by employees **Payment is pribably ***Amount can be reasonably estimated ->If meats #1-3, but not #4, you need to disclose that fact To record accrual of vacation pay, Dr. Salaries and Wages Expense (amount of money for 8 hours * number of vacation days) Cr. Salaries and Wages Payable To record payment of vacation pay, Dr. Salaries and Wages Payable-> do amount from accrual Dr. Salaries and Wages Expense-> difference between last year's accrual and current amount Cr. Cash (540 * 20)-> 540 is the new payment

Market (or effective) rate

prevailing interest rate in the investing markets for bonds with similar characteristics CV * Effective Interest Rate= Interest Expense Recognized

Unearned (Deferred) Revenues

receives payments before delivering goods or rendering services (like ticket revenue) When a company receives an advance payment, Dr. Cash Cr. current liability account identifying the source of the unearned revenue. When a company recognizes revenue, Dr. Unearned revenue account Cr. Appropriate revenue account.

Extinguishment of debt

the payment of debt (how to record this)

Notes Payable

written promises to pay a certain sum of money on a specified future date Notes may be short-term or long-term, will impact classification. They may also be interest-bearing or zero-interest-bearing