Chapter 10 - liabilities

effect-interest method of amortization

amortizes a bond discount or premium on the basis of the market interest rate

premium

for bonds, occurs when the issue price is greater than the face value

discount

for bonds, occurs when the issue price is less than the face value. alternatively used in the context of sales discounts and purchase discounts

helpful reminders

from the employer's perspective, payroll deductions create liabilities, not expenses. they are not expenses because they do not increase the employer's wages and salaries cost; they simply redirect part of the wages and salaries payments to a government agency or other organization, rather than to employees

payroll deductions

gross earnings: computed by time worked x pay rate payroll deductions are subtracted (income tax, FICA tax, charitable donations) net pay = gross earnings - payroll deductions

computation of payroll

net pay to employees + income taxed +FICA = total cost of salaries/ wages FICA taxes + unemployment taxes = total payroll cosdts

contingent liablity

potential liability that has arisen as the result of a past event; not a liability until some future event occurs

accrued liabilities

previously unrecorded expenses that need to be adjusted at the end of the accounting period to reflect the amount incurred and its related liability acount

current liabilities

short-term obligations that will be paid in cash (or fulfilled with other current assets) within 12 months or the next operating cycle, whichever is longer

face value (par value)

the amount of a bond payable at its maturity; used to compute interest payments

issue price

the amount of money that a lender pays (and the company receives) when a bond is issued

market interest rate

the current rate of interest that exists when a debt is incurred. also called yield, discount rate, effective interest rate

present value

the current value of an amount to be received in the future; a future amount discounted for compound interest

maturity date

the date on which a bond is due to be paid in full

alternative terms

the quick ratio is also called the acid test ratio

10-5 calculate and interpret the quick ratio and the times interest earned ratio

the quick ratio measures the company's ability to pay its current liabilities using current assets that are quickly converted into cash -the times interest earned ratio measures a company's ability to meet its interest obligations with resources generated from its profit-making activities

stated interest rate

the rate of cash interest per period specified in a bond contract. also called coupon rate or contract rate

alternative terms

the stated interest rate on a bond is also called the coupon rate or contract rate. the market interest rate is also called the effective interest rate or yield rate

alternative terms

the word amortize comes from the foot word "more" which means to kill or eliminate; as bond discounts and premiums are amortized, they are gradually eliminated

quick ratio

(cash + short-term investment + net account receivable ) / current liability

quick ratio

(cash + short-term investments + net accounts receivable) / current liabilities whether liquid assets are sufficient to pay current liabilities the higher the number the better able to quickly pay the ratio of liquid assets to current liabilities. liquid assets include cash and cash equivalents, short-term investments, and accounts receivable (net of doubtful accounts)

times interest earned ratio

(net income + interest expense + income tax expense) / interest expense whether sufficient resources are generated to cover interest costs the higher the number the better the coverage

10-3 analyze and record bond liability transactions

-for most public issuances of debt (bonds), the amount borrowed by the company does not equalt the amount repaid at maturity. the effect of a bond discount is to provide the borrower less money than the value stated on the face of the bond, which increases the cost of borrowing above the interest rate stated on the bond. the effect of a bond premium is to provide the borrower more money than the face value repaid at maturity, which decreases the cost of borrowing below the stated interest rate. -interest expense reports the cost of borrowing, which equals the periodic interest payments plus (or minus) the amount of the bond discount (or premium) amortized in that interest period

10-1 explain the role of liabilities in financing a business

-liabilities play a vital role in allowing a business to buy goods and services on credit, cover gaps in cash flows, and expand into new regions and markets -liabilities are classified as current if due to be paid with current assets within the current operating cycle of the business or within one year of the balance sheet date (whichever is longer). All other liabilities are considered long-term

define accrued liability, give an example

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define liablity? what are the differences between current and long-term liability?

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describe three ways in which liabilities are used to finance business activities?

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how is interest expense calculated using the effective-interest method of amortization for a bond issued at a) a discount b) a premium?

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how is interest expense calculated using the simplified approach to the effective-interest method for a bond issued at a)discount b) a premium

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how is interest expense calculated using the straight-line method of amortization for a bond issued at a) a discount b) a premium?

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if a company has a long-term loan that has only two years remaining until it matures, how is it reported on the balance sheet a) this year b) next year?

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what are the reasons that some bonds are issued at a discount and others are issued at a premium?

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what is a contingent liability? how is a contingent liability reported under GAAP? how does this differ under IFRS?

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what is the carrying value of a bond payable?

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what is the difference between a secured bond and a debenture? which type carries more risk for the lender?

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what is the difference between the stated interest rate and the market interest rate on a bond?

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what is the quick ratio? how is it related to the classification of liabilities?

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what three factors influence the dollar amount reported for liabilities?

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why are payroll taxes and sales taxes considered liabilities?

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why is unearned revenue considered a liability?

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will the stated interest rate be higher than the market interest rate or will the market interest rate be higher than the stated interest rate when a bond is issued at a) face value b) a discount c) a premium

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your company plans to hire employee at yearly salary of $70mm. someone says the actual cost will be lower b/c of payroll deduction, someone else says it will be higher. who is right and what is the total cost to the company?

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10-4 describe how to account for contingent liabilities

a contingent liability is a potential liability (and loss) that has arisen as a result of a past transaction or event. its ultimate outcome will not be known until a future event occurs or fails to occur. under GAAP, it is recorded when probable and estimable

line of credit

a prearranged agreement that allows a company to borrow any amount of money at any time, up to a prearranged limit

times interest earned ratio

determines the extent to which earnings before taxes and financing costs are sufficient to cover interest expense incurred on debt

accrued interest

dr Interest expense (+E, -SE) cr Interest payable (+L)

note payable issued

dr cash (+A) cr Notes payable (+L)

bond issued

dr cash (+A) cr premium on bond payable (+L) cr bonds payable (+L)

prepaid payments

dr cash (+A) cr unearned revenue (+L)

bond interest accrued (discount)

dr discount on bond payable dr interest expense cr cash

interest (amortization method)

dr interest expense (+E, -SE) dr Premium on bonds payable (-L) cr Cash (-A)

note payable journal entry principal and interest

dr interest payable dr interest expense dr notes payable cr cash (total amount)

employer related payroll

dr payroll tax expense (+E, -SE) cr FICA Payable (+L) cr Unemployment tax payable (+L)

bond accrued interest (straight-line)

dr premium on bonds payable (-L) (# bond payable x # of months/ # of months total) dr interest expense (+E, -SE) (cash - premium) cr Cash (-A) (bond x interest rate x # of months)

salaries and wage costs

dr salaries and wages expense (+E, -SE) cr withheld income taxes payable (+L) cr FICA Payable (+L) cr Cash (-A)

10-2 explain how to account for common types of current liabilities

liabilities are initially reported at their cash equivalent value, which is the amount of cash that a creditor would accept to settle the liability immediately after the transaction or event occurred liabilities are increased whenever additional obligations arise (including interest) and are reduced whenever the company makes payments or provides services to the creditor

straight-line method of amortization

method of amortizing a bond discount or premium that allocates an equal dollar amount to each interest period