Chapter 10 Accounting
State laws grant corporations the power to _____ _____
issue bonds
Investment company sells the bonds for the ___________ ___________
issuing company
Issued to obtain large amounts of _________________
long-term capital
Bondholders can sell their bonds on ______________ _________________ (similar to the way in which stock is traded)
national exchanges
If bondholders sell their bond investments to other investors, the issuing company receives no further money on the transaction, _____________________________________________________________
nor does the issuing company journalize the transaction
Liquidity
refers to the ability to pay maturing obligations and meet unexpected needs for cash
The term "payroll" pertains to both:
salaries (managerial, administrative, and sales personnel (monthly or yearly rate)). wages (store clerks, factory employees, and manual laborers (rate per hour)).
Interest payments usually made _________
semiannually
Bond certificate represents a promise to pay:
sum of money at designated maturity date, plus periodic interest at a contractual (stated) rate on the maturity amount (face value)
The higher the percentage of debt to assets...
the greater the risk that the company may be unable to meet its maturing obligations
Two ratios that provide information about long-run solvency and the ability to meet interest payments as they come due are:
debt to assets ratio time interest earned (you are not responsible for this one)
Board of directors must stipulate number of bonds to be authorized, total _______ ______________, and ____________ ___________ _________.
face value; contractual interest rate
Bond indenture
Bond terms set forth in legal document known as a:
Current market price (present value) is a function of three factors:
(1) dollar amounts to be received (2) length of time until the amounts are received, and (3) market rate of interest
Determining the payroll involves computing three amounts:
(1) gross earnings (2) payroll deductions (3) net pay
To illustrate, assume that Acropolis Company on January 1, 2019, issues $100,000 of 9% bonds, due in five years, with interest payable annually at year-end. The purchaser of the bonds would receive the following two types of cash payments:
(1) principal of $100,000 to be paid at maturity, and (2) five $9,000 interest payments ($100,000 × 9%) over the term of the bonds.
Advantages of Bond financing
(1) stockholder control is not affected - bondholders do not have voting rights, so current owners (stockholders) retain full control of the company (2) tax savings result - bond interest is deductible for tax purposes; dividends on stock are not (3) earnings per share (EPS) may be higher - although bond interest expense reduces net income, earnings per share often is higher under bond financing because no additional shares of common stock are issued.
How do sales tax worth with selling company (vendor or retailer)?
- collects tax from the customer - enter tax separately in cash register or includes in total receipts - remits the collections to the state's department of revenue.
Typically, the terms require the borrower to make installment payments over the term of the loan. Each payment consists of:
- interest on the unpaid balance of the loan - and a reduction of loan principal
Corporation records bond transactions when it:
- issues (sells) - redeems (buys back) bonds, and - when bondholders convert bonds into common stock
Notes payable
- written promissory note - frequently issued to meet short-term financing needs - requires the borrower to pay interest - issued for varying periods
Current Liability
a debt that a company expects to pay within one year or the operating cycle, whichever is longer
How can the relationship between current assets to current liabilities be expressed? (it is critical for analyzing liquidity)
As a dollar amount (working capital) and as a ratio (current ratio)
Superior University sells 10,000 season football tickets at $50 each for its five-game home schedule. The entry for the sale of season tickets is:
August 6 Debit Cash 500,000 Credit Unearned Ticket Revenue, 500,000
How are notes payable different than accounts payable?
Because notes are formalized in writing with a set due date and interest rate. Accounts payable is typically just a vendor offering a customer 30 days to pay an invoice as a courtesy
What is the reason "Sale of bonds above face value (premium) = total cost of borrowing < interest paid."
Borrower is not required to pay the bond premium at the maturity date of the bonds. Therefore, the bond premium is considered to be a reduction in the cost of borrowing.
What is the reason that "Sale of bonds below face value (discount) equals total cost of borrowing > interest paid"?
Borrower is required to pay the bond discount at the maturity date. Therefore, the bond discount is considered to be an increase in the cost of borrowing (like extra interest expense).
Presentation of Liabilities
Current liabilities are the first category. Companies list each of the principal types of current liabilities separately within the category. Companies disclose the terms of notes payable and other key information about the individual items in the notes to the financial statements. Companies seldom list current liabilities in the order of liquidity.
If the March 25 cash register reading for Cooley Grocery shows sales of $10,000 and sales taxes of $600 (sales tax rate of 6%), the journal entry is:
Debit Cash 10,600 Credit Sales Revenue 10,000 Credit Sales Taxes Payable 600
First National Bank agrees to lend $100,000 on September 1, 2019, if Cole Williams Co. signs a $100,000, 12%, four-month note maturing on January 1. All entries made are from the perspective of Cole Williams: a) prepare the entry made on September 1st b) prepare the adjusting entry on December 31st, assuming monthly adjusting entries have not been made
Debit Cash 100,000 Credit Notes Payable 100,000 Debit Interest Expense 4,000 Credit Interest Payable 4,000
On January 1, 2019, Candlestick, Inc. sells $100,000, five-year, 10% bonds for $98,000 (98% of face value). Interest is payable annually January 1. The entry to record the issuance is:
Debit Cash, 98,000 Discount on Bonds Payable, 2,000 Credit Bonds Payable, 100,000
First National Bank agrees to lend $100,000 on September 1, 2019, if Cole Williams Co. signs a $100,000, 12%, four-month note maturing on January 1, 2020. c) prepare the entry at maturity
Debit Notes Payable 100,000 Debit Interest Payable 4,000 Credit Cash 104,000
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 State Unemployment Taxes Payable, 800 Credit Federal Unemployment Taxes Payable, 5,400
Assume Cargo Corporation records its payroll for the week of March 7 as follows - picture that Cargo has 100 employees that each get paid $1,000 per week:
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, 2,922 Credit Salaries and Wages Payable, 67,564
record the payment of this payroll to employees
Debit Salaries and Wages Payable, 67,564 Credit Cash, 67,564 *While the gross pay is $100,000, the total amount of net pay is $67,564. Each employee that gets paid $1,000 per week will receive a check for $675.64 after withholding.* The taxes withheld here are an expense to the employee, not the employer
As each game is completed, Superior records the recognition of revenue with the following entry:
Debit Unearned Ticket Revenue, 100,000 Credit Ticket Revenue, 100,000
On January 1, 2019, Candlestick, Inc. issues $100,000, five-year, 10% bonds at 100 (100% of face value). Assume that interest is payable annually on January 1. At December 31, 2019, Candlestick recognizes interest expense incurred with the following entry (assume monthly accruals have not been made):
December 31 Debit Interest Expense, 10,000 Credit Interest Payable, 10,000
Candlestick, Inc., sold $100,000, five-year, 10% bonds on January 1, 2019, for $102,000 (premium of $2,000. Interest is payable on January 1. The bond premium amortization for each interest period is $400 ($2,000 ÷ 5). The premium is opposite of a discount - it offsets interest expense. Candlestick records the first accrual of interest on December 31 as follows:
December 31 Debit Interest Expense, 9,600 Debit Premium on Bonds Payable, 400 Credit Interest Payable, 10,000
Candlestick, Inc., sold $100,000, five-year, 10% bonds on January 1, 2019, for $98,000 (discount of $2,000). Interest is payable on January 1. The bond discount amortization for each interest period is $400 ($2,000 ÷ 5). The discount is treated like extra interest expense each period. Journal entry to record the first accrual of bond interest and the amortization of bond discount on December 31 as follows:
December 31 Debit Interest Expense, 10,400 Credit Discount on Bonds Payable, 400 Credit Interest Payable, 10,000
Porter Technology Inc. issues a $500,000, 8%, 20-year mortgage note on December 31, 2019. The terms provide for annual installment payments of $50,926 (not including real estate taxes and insurance). Prepare the entries to record the mortgage and first payment:
December 31, 2019 Debit Cash, 500,000 Credit Mortgage Payable, 500,000 December 31, 2020 Debit Interest Expense, 40,000 Debit Mortgage Payable, 10,926 Credit Cash, 50, 296
issuing bonds at a premium
Decreases on (y axis - carrying value), and (x axis - time)
In addition to the taxes that employers withhold from their employees' paychecks, the employers must also pay in certain taxes out of their own pocket (these are an expense to the employer), these taxes are:
Employer's share of Social Security (FICA) taxes federal unemployment taxes state unemployment taxes
payroll and payroll taxes (payable)
Employers (businesses) are required to withhold certain taxes on behalf of their employees
What does it mean that bond prices are quoted as a percentage of the face value?
Example, a quoted price of 97 means 97% of face value
Issuing bonds at a discount
Increases on (y axis - carrying value), and (x axis - time)
If a company needs too raise significant cash, it has several options.
It could take out a loan, issue bonds, or issue additional shares of common stock
Assuming that the company pays and records separately the interest for the last interest period, Candlestick records the redemption of its bonds at maturity as follows:
January 1 Debit Bonds Payable 100,000 Credit Cash 100,000
On January 1, 2019, Candlestick, Inc. issues $100,000, five-year, 10% bonds at 100 (100% of face value). The entry to record the sale is:
January 1 Debit Cash, 100,000 Credit Bonds Payable, 100,000
On January 1, 2019, Candlestick, Inc. sells $100,000, five-year, 10% bonds for $102,000 (102% of face value). Interest is payable annually January 1. The entry to record the issuance is:
January 1 Debit Cash, 102,000 Credit Bonds Payable, 100,000 Credit Premium on Bonds Payable, 2,000
On January 1, 2019, Candlestick, Inc. issues $100,000, five-year, 10% bonds at 100 (100% of face value). Assume that interest is payable annually on January 1. Candlestick records the payment on January 1, 2020 as follows:
January 1 Debit Interest Payable 10,000 Credit Cash, 10,000
Accounting for Long-Term Notes Payable
May be secured by a mortgage that pledges title to specific assets as security for a loan (such as a typical home loan) Companies initially record mortgage notes payable at face value
What does current liabilities include?
Notes payable, accounts payable, unearned revenues, and accrued liabilities such as taxes payable, salaries and wages payable, and interest payable.
Unearned Revenues
Payment received before the company delivers goods or provides services.
Current Maturities of Long-Term Debt
Portion of long-term debt that comes due in the current year. No adjusting entry required (show for financial statement purposes)
Payroll tax expense
Results from additional taxes that governmental agencies levy on employers.
Current assets / Current liabilities = current ratio
The current ratio permits us to compare the liquidity of different-sized companies and of a single company at different times
market interest rate
The rate investors demand for loaning funds
Wendy Construction issues a five-year, interest-bearing $25,000 note on January 1, 2019. This note specifies that each January 1, starting January 1, 2020, Wendy should pay $5,000 of the note. When the company prepares financial statements on December 31, 2019,
They report 5,000 as current liability They report 20,000 as long-term liability
Example of bond quoted price
Time Warner Cable has outstanding 6.75%, $1,000 bonds that mature in 2039. They currently yield a 5.49% return. At the close of trading, the price was 116.4% of face value, or $1,116.40.
General Motors reported total liabilities of $141,653 million, total assets of $177,677 million, interest expense of $403 million, income taxes of $228 million, and net income of $4,018 million.
Total liabilities / total assets = debt to assets ratio 141,653 / 177,677 = 80%
Karson Inc. issues 10-year bonds with a maturity value of $200,000. If the bonds are issued at a premium, this indicates that: a. the contractual interest rate exceeds the market interest rate. b. the market interest rate exceeds the contractual interest rate. c. the contractual interest rate and the market interest rate are the same. d. no relationship exists between the two rates.
a. the contractual interest rate exceeds the market interest rate.
Board of directors and stockholders must _______ bond issues
approve
Bonds
are a form of interest-bearing notes payable - sold in small denominations (usually $1,000 or multiples of $1,000) - attract many investors - corporation issuing bonds is borrowing money (like receiving many small loans from a group of people) - person who buys the bonds (the bondholder) is investing in bonds
Sales taxes (payable)
are expressed as a stated percentage of the sales prices. If vendor sell a taxable item, they must collect sales tax on behalf of the state
Long Term Liabilities
are obligations that are expected to be paid after one year
_________ ____________ typically a $1,000 face value
bond certificate
The current market price of a bond is equal to
the present value of all the future cash payments promised by the bond
Sale of bonds above face value (premium) =
total cost of borrowing < interest paid.
Sale of bonds below face value (discount) equals
total cost of borrowing > interest paid
