accounting chapter 10 - Reporting and analyzing LIABILITIES
Determining the Market Price of Bonds - The current market price (present value) of a bond is a function of 3 factors:
1. The dollar amount to be received 2. the length of time until the amounts are received 3. the market interest rate - rate investors demand for loaning funds
Redeeming Bonds before maturity illustration: Assume at the end of the fourth period, Candlestick Inc., having sold its bonds at a premium, retires the bonds at 103 after paying the annual interest. Assume that the carrying value of the bonds at the redemption date is $100,400 (principal $100,000 and premium $400). Candlestick records the redemption at the end of the fourth interest period (January 1, 2021) as:
Jan 1 Debit Bonds Payable 100,000 Debit Premium on Bond 400 Debit Loss on Bond redemption 2,600 Credit Cash (to record redemption of bond) 103,000
Define Secured/ Unsecured bonds
secured: have specific ASSETS of the issuer pledged as *collateral* for the bonds unsecured: are issued *against* the general credit of the borrower (large corp with good credit ratings use unsecured bonds extensively)
Bonds are sold in ____ denominations
small usually $1,000 or multiples of $1,000
Present value
amt to be received in the future AFTER taking into account current interest rates
Contingencies
events with uncertain outcomes that may represent *potential liabilities* - common types: lawsuits, product warranties, environmental cleanup obligations
amortization of bond premium is allocated to ____ in each period!
expense
amortization to bond discount is allocated to ____
expense in each period
T or F: The market price of a bond is equal to its maturity value.
false
Notes payable usually require borrower to ____
pay interest
Bond prices are quoted as "___"
percentage of face value Ex: a $1,000 bonds with a quoted price of 97 means that the selling price of the bonds is 97% of the face value, or $970
CURRENT market price of a bond
present value of all the future cash payments promised by the bond -Present value of 100,000 received in 5 years = 64,993 ???? - Present value of 9,000 revived annually for 5 years 35,007 ?????? - *Market price of bonds* = 100,000
Sale of bonds above face value causes the total cost of borrowing to be ____ than the bond interest paid bc the borrower is not required to pay the bond premium at the maturity date of the bond →
less so, the premium is considered to be a reduction in the cost of borrowing that reduces bond interest expense over the life of the bonds
After the company amortizes the premium, the amount of interest expense it reports in a period will be _____ than the contractual amount
less!
Amount of interest expense reported each period for a premium will be ____ than the contractual amount paid
lesss
Current Liability
*A debt* that a company expects to pay... 1. from *existing* current assets or other current liabilities 2. within 1 yr or operating cycle whichever is longer
Unearned Revenues
- *Revenues that are received before* goods are delivered or services are performed - 2 PARTS! when a company receives advances and when a company recognizes revenues
Current Maturities of Long Term Debt
- PORTION of long term debt that comes due in the current year - NO adjusting entry
Define Sales Tax Payable
- Sales Taxes are expressed as a stated *percentage of the sales price* - Selling company (1) collects tax from the customer (2) remits the collections to the STATES department of revenue
If the market rate of interest is *lower* than the contractual interest rate, investors will have to pay more than face value for the bond
- The price of bonds will increase - When a bond is sold for more than its face value the difference between the face value and its selling price is called a *premium*
How to ACCOUNT for bond transactions
- a corporation records bond transactions when it 1. issues (sells) or redeems (buys back) bonds 2. when bondholders convert bonds into common stock
Liability
- existing debts and obligations - companies must pay/ settle these claims, debt, and obligations at some time in the future by transferring assets or services
Expand on Convertible Bonds
- have features that are attractive to bondholders AND issuer -- conversion feature fives bondholders an opportunity to benefit if the market price of the common stock increases substantially -- Until conversion bondholder receives *interest* on the bond -- for the issuer - the bonds sell at a *higher price* and pay a lower rate of interest than comparable debt securities that do not have a conversion option
Payroll and Payroll Taxes Payable what does the term "payroll" pertain to?
- salaries: managerial, administrative, and sales personnel (monthly or yearly rate) - Wages: store clerks, factory employees, and manual laborers (rate per hour)
Example: Company issues 10% of bonds at a time when other bonds of similar risk are paying 12%. Investors will NOT be interested in buying the 10% bonds, so their value will fall BELOW their face value →
- when a bond is sold less than its face value the difference between the face value of a bond and its selling price is called a *discount*→ result of decline in bonds selling price: the actual interest rate incurred by the company increases to the level of the current market interest rate
facts on notes payable
- written promissory note -frequently issued to meet shirt-term financing needs - NOTES payable is used more frequently than accounts payable bc they provide written documentation of oblig incase legal remedies are needed to collect debt - Notes are used for VARIOUS periods of time - those due for payment within 1 YEAR are usually classified as *current liabilities* - -companies record *obligations* in the form of written notes payable
Example: company issues a $100,000 of 9% bonds, due in 5 years, with interest payable annually at year end. The purchaser of the bond would receive the following 2 types of cash payments
1. *principle* of $100,000 to be paid at maturity 2. *interest payments* of 5 $9,000 over the term of the bond
Expand on the 4 parts of issuing a bind
1. Bond Certificate: issued to the investor to provide evidence of the investors claims against the company (includes name of company that issued bond, face value, maturity date, contractual interest rate) 2. Face Value: amount of principle due at the maturity date 3. Maturity Date: the DATE that the final payment is DUE to the investor from the issuing company 4. Contractual Interest Rate: The rate used to determine the amount of cash interest the issuer pays and the investor receives
What are the 2 parts to Unearned revenues and what are the entries
1. When company receives advance - Debit (increase) Cash - Credit (increase) Current liability account identifying source of unearned revenue 3. When company recognizes revenue - Debit unearned revenue account (decrease) - Credit revenue account (increase)
When bonds are redeemed before maturity it is necessary to (3)
1. eliminate the carrying value of the bond at the redemption date 2. record cash paid 3. recognize the gain or the loss on redemption
Bonds may be issued/sold at ... (3)
1. face value 2. below face value (discount) 3. above face value (premium)
Determining the payroll involves computing what * 3* amounts?!
1. gross earnings 2. payroll deductions 3. net pay
when does a company account for bonds?
1. issues (sells) or redeems (buys back) bonds 2. when bondholders convert bonds into common stock
If $15,000 is collected in advance on November 1 for 3 months' rent, what amount of rent revenue should be recognized by December 31?
15,000 / 3 = 5,000 * 2 months = 10,000
practice The cash register total including sales taxes is $23,320, and the sales tax rate is 6%. What is the sales taxes payable?
23,320 / (100% + 6%) 23,320 / 1.06 = 22,000 = face value 23,320 - 22,000 = 1,320
practice: If cash is borrowed on a $50,000, 6-month, 12% note on September 1, how much interest expense would be incurred by December 31?
50,000 * 4/12 * .12 = 2,000
Total Cost of borrowing for a premium=
=Annual interest payments - Bond premium OR = Principal at maturity + Annual Interest Payment = Cash to be paid to bondholders - Cash received form bondholders
___ and ___ of liabilities are critical importance
AMOUNT TYPE
Illustrating Accounting for Unearned Revenue: Superior University sells 10,000 season football tickets at $50 each for its five-game home schedule. The entry for the sales of season tickets is: As each game is completed, Superior records the earning of revenue.
Aug 6 Debit Cash 500,000 Credit Unearned Ticket Revenue 500,000 Sept 7 Debit Unearned Ticket Revenue 100,000 Credit Ticket Revenue 100,000
Types of Long Term Liabilities
Bonds Other Long term Notes
So under Long Term liabilities on the balance sheet it will state
Bonds Payable Less: Discount on Bonds Payable
How does a premium appear on the balance sheet under Long Term Liabilities?
Bonds Payable 100,000 Add: Premium on Bonds Payable 2,000
The Account 'Discount on bonds payable' is a ______ Which is deducted from _______
Contra Asset!!!!! Bonds Payable
Define Convertible/ Callable bonds
Convertible: bonds that can be converted into *common stock* at the bondholders option Callable: bonds that the issuing company can redeem (buy back) at a stated dollar amount prior to maturity date
What is the entry to redeem a bond
Debit Bonds Payable Debit Premium on Bond Debit Loss on Bond redemption Credit Cash (to record redemption of bond)
Issuing Bonds at Premium Bonds sell at 102 (102 % of face value) Entry:
Debit Cash 102,000 Credit Bonds Payable 100,000 Credit Premium on Bonds Payable 2,000
Illustration for Accounting Payroll Tax Expense Based on Cargo Corp.'s $100,000 payroll, the company would record the employer's expense and liability for these payroll taxes as follows.
Debit Payroll Tax Expense 13,850 Credit FICA Taxes payable 7,650 Credit Fed unemployment taxes payable 800 Credit state unemployment taxes payable 5,400
when the company remits the taxes to the taxing agency the entry will be:
Debit Sales Tax Payable 600 Credit Cash 600
Amortizing Bond Discount with a DISCOUNT Accounting Illustration: Candlestick, Inc., sold $100,000, five-year, 10% bonds on January 1, 2017, for $98,000 (discount of $2,000). Interest is payable on January 1 of each year. Prepare the entry to accrue interest and amortize the bond discount at Dec. 31, 2017 Amortizing Bond Discount with a PREMIUM Accounting Illustration: Candlestick, Inc., sold $100,000, five-year, 10% bonds on January 1, 2017, for $102,000 (premium of $2,000). Interest is payable on January 1 of each year. Prepare the entry to accrue interest and amortize the bond premium at Dec. 31, 2017.
Dec 31 Debit Interest Expense 10,400 Credit Discount on Bonds Payable 400 Credit Interest Payable 10,000 Dec31 Debit Interest Expense 9,600 Debit Premium on Bonds Payable 400 Credit Interest Payable 10,000
If your company needed financing and wanted to attract investors to purchase its bonds, *how would the market set the price for these bonds*?
Determining the Market Price of Bonds
When contractual interest rate and market interest rate are the SAME → bonds sell at ______
FACE VALUE
T or F: there is an adjusting entry for current maturity long term debts
FALSE it is NOT necessary to prepare an adjusting entry to recognize the current maturity of long term debt
component of salaries and wage expense vs components of payroll tax expense
FICA Taxes Payable Federal Income Taxes Payable State Income Taxes Payable Salaries and Wages Payable FICA Taxes Payable! Federal Unemployment Taxes Payable State Unemployment Taxes Payable
Issuing bonds at FACE VALUE example: Devor Corporation issues 100, five-year, 10%, $1,000 bonds dated January 1, 2017, at 100 (100% of face value). The entry to record the sale is: The entry Devor would make to accrue interest on December 31 EntryD evor would make to pay the interest on Jan. 1, 2018.
Jan 1 Debit Cash 100,000 Credit bonds Payable 100,000 100.000* 10% * 12/12 Dec 31 Interest Expense 10,000 Credit Interest Payable 10,000 Jan 1 . Debit Interest Payable 10,000 Credit Cash 10,000
Issuing Bonds at a Discount - Example: Jan 1, 2017 Candlestick Inc. sells $100,000, 5 year, 10% bonds at 98% (98% face value) with interest payable on Jan 1. Entry:
Jan 1 Debit Cash 98,000 Debit Discount on Bonds Payable 2,000 Credit Bonds Payable 100,000
Illustrating Accounting for Payroll and Payroll Taxes Payable Assume Cargo Corporation records its *payroll* for the week of March 7 as follows: Record the *payment* of this payroll on March 7.
Mar 7 Debit Salaries and Wages Expense 100,000 Credit FICA Taxes Payable 7,650 Credit Federal Income Taxes Payable 21,864 Credit State income Taxes Payable 2.2922 Credit Salaries and Wages Payable 67,664 Mar 7 Debit Salaries and Wages Payable 67,564 Credit Cash 67,564
Sometimes companies do not enter sales tax in SEPARATELY from cash register Example: Cooley Grocery rings up total receipts of $10,600. Because the amount receive from the sale is = to the sales price of 100% plus 6%, the entry is: ***To determine the amount of sales do total receipts / (100% + sales Tax %)
March 25 Debit Cash 10,600 Credit Sales Revenue 10,000 Credit Sales Tac Payable 600 (10,600 = 1.06 = 10,000)
Illustrating Accounting for Sales Tax Payable: The March 25th cash register readings for Cooley Grocery show sales of $10,000 and sales taxes of $600 (sales tax rate of 6%). The entry is for the company is:
March 25 Debit Cash 10,600 Credit Sales Revenue 10,000 Credit Sales Tax Payable 600
Current Liabilities include Long Term Liabilities include
Notes payable, accounts payable, Current maturities of long term debt, Accrued Liabilities Bonds payable, Less: Discount on bonds Payable Notes payable - secured by plant assets, Lease Liability
Illustrating Accounting for Notes Payable: On September 1, 2017 Cole Williams Co signs a $100,000, 12%, 4-month note maturing on January 1 with First National Bank. When a company issues an interest -bearing note, the amount of assets it receives generally EQUALS the note's face value. Cole Williams Co. therefore will receive $100,00 cash and will make the following journal entry Interest accrues over the life of the note , and the issuer must periodically record that accrual. IF! Cole Williams Co prepares financial statements annually, it makes an adjusting entry Dec 31 to recognize 4 months of interest expense and interest payable. Entry will be At maturity Jan 1 Cole Williams Co must pay the face value of the note plus interest . The entry is:
Part 1: Sep 1 Debit Cash 100,000 Credit Notes Payable 100,000 Part 2: Dec 31 Debit Interest Expense 4,000 (1,000*4/12*.12) Credit Interest Payable 4,000 Part 3: Jan 1 Debit Notes Payable $100,000 Debit Interest Payable 4,000 Credit cash 104,000
Bond contractual interest rate 10% Issued when Market interest rate is 8% = _____ Issued when Market interest rate is 10% = ______ Issued when Market interest rate is 12% =______
Premium Face Value Discount
Redeeming Bonds at maturity
Regardless of the issue price of bonds, the *book value* of the bonds at maturity will EQUAL their *face value*
During the month of September, Lake Corporation's employees earned wages of $60,000. Withholdings related to these wages were $3,500 for Social Security (FICA), $6,500 for federal income tax, and $2,000 for state income tax. Costs incurred for unemployment taxes were $90 for federal and $150 for state. Prepare the September 30 journal entries for (a) salaries and wages expense and salaries and wages payable, assuming that all September wages will be paid in October, and (b) the company's payroll tax expense.
Sales and Wages Expense 60,000 - FICA Taxes Payable (SS) 3,500 -Federal Income Taxes Payable 6,500 -State Income Taxes Payable 2,000 - Salaries Taxes Payable (Wages- the above 3) 48,000 Payroll Tax Expense 3,740 - FICA Taxes Payable 3,500 - Federal Unemployment Taxes payable 90 - State unemployment taxes payable 150
What are the types of bonds?
Secured/ Unsecured Bonds Convertible/ Callable Bonds
R & B Inc. issued $500,000, 10-year bonds at a discount. Prior to maturity, when the carrying value of the bonds is $496,000, the company redeems the bonds at 98. Prepare the entry to record the redemption of the bonds.
There is a gain on redemption. The cash paid, $490,000 (500,000 & 98%), is less than the carrying vale of the 496,000. Entry: Debit Bonds Payable 500,000 Credit Cash 490,000 Credit Discount on Bonds Payable 4,000 Credit Gain on Bond Redemption 6,000
Total Cost of borrowing
Total cost of borrowing= Annual interest rate + Bond Discount OR = Principal at maturity + Annual Interest Payment = Cash to be paid to bondholders - Cash received form bondholders
T or F: Issuance of bond at discount does not mean financial strength of issuer is suspect and issuance of bond at premium does not mean financial strength of issues is exceptional
True
T or F: there are different types of bonds
True
How are Liabilities reported?
Under Liabilities section on Balance sheet there are 2 categories Current Liabilities Long-term liabilities
How to find Salaries Tax Payable
Wages - (FICA Taxes Payable 3,500, Federal Income Taxes Payable 6,500, State Income Taxes Payable)
Define Bonds
a form of *interest- bearing note payable* issued by corporations, universities, and governmental agencies
Bond Discount Amortization Formula
bond discount / number of interest periods
When a corporation issues bonds, it is _____ money. The person who buys the bonds is ____ money
borrowing investing
Amortizing the discount
companies allocate bond discount to expense in each period in which the bonds are outstanding -Amortization of the discount increases the amount of interest expense reported each period - As the discount is amortized, its balance declines → the carrying value of the bonds will increase, until at maturity the carrying value of the bonds quals their face amount
if current liabilities are > current assets this means...
company lacks liquidity or short term debt paying liability
In the following example - In the Dec 31 financial statements, the ______ section of the balance sheet will show noes payable and interest payable. Interest expense will be reported under ______ in the income statement
current liabilities Other Expenses and Losses
Illustrating accounting for current Maturities of Long Term Debt Wendy Construction issues a 5-year, interest-bearing $25,000 note on January 1, 2016. This note specifies that each January 1, starting January 1, 2017, Wendy should pay $5,000 of the note. When the company prepares financial statements on December 31, 2016, reported current liabilities= reported longterm liabilities=
current liabilities= 5,000 long term liabilities= 20,000
Amortizing the premium: Companies allocate bond premium to expense in each period in which the bonds are outstanding → ________ the amount of interest expense reported at each period
decreases
As the discount is amortized, its balance _______.
declines
As the premium is amortized, its balance _____
declines
Amortization of bond premium decreases or increases the amount of interest expense reported each period
decreases
The Employer payroll taxes does not include which one? federal unemployment taxes state unemployment taxes federal income taxes FICA taxes.
federal income taxes
amortization of bond discount ___ the amount of interest expense reported each period
increases
BOND prices vary_____ with changes in the MARKET interest rate. As market interest rates DECLINE, bond prices______. As market interest rates INCREASE, bond prices______.
inversely!!!! INCREASE decrease
If bonds holders sell their bonds investment to other investors, the issuing corp receives no further money on the transaction and there is NO _________ for the transaction
journal entry
Devor reports bonds payable in the long term or current liabilities section? interest payable?
long term current liabilities
The face value is the amount of principal the issuing company must pay at the _____
maturity date.
Sale of Bonds below face value causes the total cost of borrowing to be _____ than the bond interest paid
more The issuing corporation not only must pay the contractual interest rate over the term of the bonds but also must pay the face value (rather than the issuance price) at maturity
Examples of Current Liabilities
notes payable accounts payable unearned revenue accrued liabilities (taxes, salaries and wages, interest)
Leasing:
off balance sheet financing: an intentional effort by a company to structure its financing arrangements so as to avoid showing liabilities on its balance sheet
The issuance of bonds BELOW face value causes the total cost of borrowing to differ form the bond interest paid → the issuing corp not only must pay the contractual interest rate over the term of the bonds but also must pay the face value (rather than the issuance price) at maturity So, the difference between the issuance price and the face vale of the bonds- the discount- is an additional cost of borrowing → this cost is recorded as interest expense over the life of the bond
ok
Market interest rate:
rate investors demand for loaning funds
Callable bonds can be _____ by the issuing company at a stated dollar amount prior to maturity
redeemed
Define Payroll Tax Expense what are the 3 taxes
results from 3 taxes that governmental agencies levy *on employers* FICA tax Federal unemployment tax State unemployment tax
Laurel Inc. issues 10-year bonds with a maturity value of $200,000. If the bonds are issued at a premium, this indicates that:
the contractual interest rate exceeds the market interest rate
carrying value of a bond:
the face value of the bonds - unamortized bond *discount* or + unamortized bond *premium* at the redemption date
What is the issuing procedure to Bonds? # of parts?
there are 4 parts to the issuing procedure 1. Bond Certificate 2. Face Value: 3. Maturity Date: 4. Contractual Interest Rate:
Amortizing a Bond Discount
to follow the expense recognition principle, companies allocate bond discount to EXPENSE in each period in which bonds are outstanding
T OR F: Under most state laws the selling company must enter *separately* on the cash register the amount of the *sale* and the amount of the *sales* tax collectable
true
T or F: Amount of interest expense reported each period will EXCEED the contractual amount paid.
true
T or F: Company adds the premium on bonds payable to the bonds payable amount on the balance sheet
true
T or F: Secured bonds has specific assets of the issuer pledged as collateral
true
T or F: contingencies must be disclosed in the notes
true
T or F: the company *does NOT* report Sales Tax as an *expense*
true
T or F: the contractual rate is usually an annual rate
true
T or F: Contractual interest rate is the rate applied to the face (par) value to arrive at the ____ paid in a year
true interest
T or F: the future date on which a liability is due or payable (maturity date) is a *significant* feature of the liability
true!
time value of money
used to indicate the relationship between *time and money* - a dollar received today is worth MORE than a dollar promised in the future
As a result of deductions, companies ______ from employee paychecks amounts that must be paid to other parties. The company has incurred a liability to pay these 3rd parties and must report the liability in its ____
withhold balance sheet
are bonds a FORM of notes payable (the liability)
yes
