REPORTING

AND ANALYZING
10
LIABILITIES

Financial Accounting, Seventh Edition

10-1

Learning Objectives

After studying this chapter, you should be able to:

1. Explain a current liability and identify the major types of current

liabilities.

2. Describe the accounting for notes payable.

3. Explain the accounting for other current liabilities.

4. Prepare the entries for the issuance of bonds and interest expense.

5. Describe the entries when bonds are redeemed.

6. Identify the requirements for the financial statement presentation and

analysis of liabilities.

10-2
 Current Liabilities

What is a Current Liability?

Two key features:
1. Company expects to pay the debt from existing current
assets or through the creation of other current
liabilities.
2. Company will pay the debt within one year or the
operating cycle, whichever is longer.

Current liabilities include notes payable, accounts payable, unearned

revenues, and accrued liabilities such as taxes, salaries and wages, and
interest.

LO 1 Explain a current liability and identify the

10-3
major types of current liabilities.

Current Liabilities

Question
To be classified as a current liability, a debt must be
expected to be paid:
a. out of existing current assets.
b. by creating other current liabilities.
c. within 2 years.
d. both (a) and (b).

LO 1 Explain a current liability and identify the

10-4
major types of current liabilities.
 Current Liabilities

Notes Payable
 Written promissory note.

 Usually require the borrower to pay interest.

 Those due within one year of the balance sheet date are
usually classified as current liabilities.

10-5 LO 2 Describe the accounting for notes payable.

Current Liabilities

Illustration: First National Bank agrees to lend $100,000 on

September 1, 2014, if Cole Williams Co. signs a $100,000, 12%,
four-month note maturing on January 1. When a company issues
an interest-bearing note, the amount of assets it receives
generally equals the note’s face value.

Sept. 1 Cash 100,000

Notes payable 100,000

10-6 LO 2 Describe the accounting for notes payable.

 Current Liabilities

Illustration: If Cole Williams Co. prepares financial statements

annually, it makes an adjusting entry at December 31 to recognize
interest.

Dec. 31 Interest expense 4,000 *

Interest payable 4,000

* $100,000 x 12% x 4/12 = 4,000

10-7 LO 2 Describe the accounting for notes payable.

Current Liabilities

Illustration: At maturity (January 1), Cole Williams Co. must pay

the face value of the note plus interest. It records payment as
follows.

Jan. 1 Notes payable 100,000

Interest payable 4,000
Cash 104,000

10-8 LO 2 Describe the accounting for notes payable.

 Current Liabilities

Question
Moss County Bank agrees to lend the Sadowski Brick Company $300,000 on January 1.
Sadowski Brick Company signs a $300,000, 6%, 9-month note. The entry made by Sadowski
Brick Company on January 1 to record the proceeds and issuance of the note is
a. Interest Expense 13,500
Cash. 286,500
Notes Payable 300,000
b. Cash 300,000
Notes Payable 300,000
c. Cash 300,000
Interest Expense 13,500
Notes Payable 313,500
d. Cash 300,000
Interest Expense 13,500
Notes Payable 300,000
Interest Payable 13,500

10-9

Current Liabilities

Question
Moss County Bank agrees to lend the Sadowski Brick Company $300,000 on January 1.
Sadowski Brick Company signs a $300,000, 6%, 9-month note. What is the adjusting entry
required if Sadowski Brick Company prepares financial statements on June 30?
a. Interest Expense 9,000
Interest Payable 9,000
b. Interest Expense 9,000
Cash 9,000
c. Interest Payable 9,000
Cash 9,000
d. Interest Payable 9,000
Interest Expense 9,000

10-10
 Current Liabilities

Question
Moss County Bank agrees to lend the Sadowski Brick Company $300,000 on January 1.
Sadowski Brick Company signs a $300,000, 6%, 9-month note. What entry will Sadowski Brick
Company make to pay off the note and interest at maturity assuming that interest has been
accrued to June 30?
a. Notes Payable 313,500
Cash 313,500
b. Notes Payable 300,000
Interest Payable 13,500
Cash 313,500
c. Interest Expense 13,500
Notes Payable 300,000
Cash 313,500
d. Interest Payable 9,000
Notes Payable 300,000
Interest Expense 4,500
Cash 313,500

10-11

Current Liabilities

Unearned Revenue
Revenues that are received before the company delivers
goods or provides service.

1. Company debits Cash, and credits a

current liability account (Unearned
Revenue).

2. When the company earns the

revenue, it debits the Unearned
Revenue account, and credits a
revenue account.

10-12 LO 3 Explain the accounting for other current liabilities.

 Current Liabilities

Illustration: 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:

Aug. 6 Cash 500,000

Unearned ticket revenue 500,000

As each game is completed, Superior records the earning of

revenue.

Sept. 7 Unearned ticket revenue 100,000

Ticket revenue 100,000

10-13 LO 3 Explain the accounting for other current liabilities.

Current Liabilities

Question
Madson Company typically sells subscriptions on an annual basis, and
publishes six times a year. The magazine sells 75,000 subscriptions in
January at $10 each. What entry is made in January to record the sale of
the subscriptions?
a. Subscriptions Receivable 750,000
Subscription Revenue 750,000
b. Cash 750,000
Unearned Subscription Revenue 750,000
c. Subscriptions Receivable 125,000
Unearned Subscription Revenue 125,000
d. Prepaid Subscriptions 750,000
Cash 750,000

10-14
 Current Liabilities

Current Maturities of Long-Term Debt

 Portion of long-term debt that comes due in the current
year.

 No adjusting entry required.

Illustration: Wendy Construction issues a five-year, interest-bearing

$25,000 note on January 1, 2011. This note specifies that each January 1,
starting January 1, 2012, Wendy should pay $5,000 of the note. When the
company prepares financial statements on December 31, 2011,
$5,000
1. What amount should be reported as a current liability? ___________
$20,000
2. What amount should be reported as a long-term liability? _________

10-15 LO 3 Explain the accounting for other current liabilities.

Bond: Long-Term Liabilities

Bonds are a form of interest-bearing notes payable issued

by corporations, universities, and governmental agencies.

Sold in small denominations (usually $1,000 or multiples of

$1,000).

When a corporation issues bonds, it is borrowing money. The

person who buys the bonds (the bondholder) is investing in
bonds.

10-16 LO 4 Identify the types of bonds.

 Bond: Long-Term Liabilities

Issuing Procedures Alternative Terminology The

contractual rate is often referred
 Bond certificate to as the stated rate.

► Issued to the investor.

► Provides name of the company issuing bonds, face
value, maturity date, and contractual (stated) interest
rate.

 Face value - principal due at the maturity.

 Maturity date - date final payment is due.
 Contractual interest rate – rate to determine cash interest
paid, generally semiannually.

10-17 LO 4 Identify the types of bonds.

Bond: Long-Term Liabilities

Illustration 10-3

10-18
LO 4
 Bond: Long-Term Liabilities

Determining the Market Value of Bonds

The current market price (present value) of a bond is a function of
three factors:
1. the dollar amounts to be received,

2. the length of time until the amounts are received, and

3. the market rate of interest.

The process of finding the present value is referred

to as discounting the future amounts.

10-19 LO 4 Identify the types of bonds.

Bond: Long-Term Liabilities

Illustration: Assume that Acropolis Company on January 1, 2014,

issues $100,000 of 9% bonds, due in five years, with interest
payable annually at year-end.

Illustration 10-4
Time diagram
depicting cash
flows

Illustration 10-5
Computing the
market price of
bonds

10-20 LO 4 Identify the types of bonds.

 $100,000 x .64993 = $64,993

Principal Factor Present Value

10-21

$9,000 x 3.88965 = $35,007

Principal Factor Present Value

10-22
10-23

10-24
 Accounting for Bond Issues

Bonds may be issued at

 face value,
 below face value (discount), or
 above face value (premium).
Bond prices are quoted as a percentage of face value.

10-25 LO 5 Prepare the entries for the issuance of bonds and interest expense.

Accounting for Bond Issues

Issue at Par, Discount, or Premium?

Illustration 10-6

Helpful Hint Bond prices vary inversely with changes in the market interest rate. As
market interest rates decline, bond prices increase. When a bond is issued, if the market
interest rate is below the contractual rate, the bond price is higher than the face value.
10-26 LO 5
 Accounting for Bond Issues

Question
The rate of interest investors demand for loaning funds
to a corporation is the:

a. contractual interest rate.

b. face value rate.

c. market interest rate.

d. stated interest rate.

10-27 LO 5 Prepare the entries for the issuance of bonds and interest expense.

Accounting for Bond Issues

Question
Bonds with a face value of $300,000 and a
quoted price of 97¼ have a selling price of
a. $291,750.
b. $291,075.
c. $291,006.
d. $292,500.

10-28 LO 5 Prepare the entries for the issuance of bonds and interest expense.
 Accounting for Bond Issues

Question
Bonds with a face value of $300,000 and a
quoted price of 102¼ have a selling price of
a. $360,675.
b. $306,075.
c. $300,675.
d. $306,750.

10-29 LO 5 Prepare the entries for the issuance of bonds and interest expense.

Issuing Bonds at Face Value

Illustration: Devor Corporation issues 100, five-year, 10%, $1,000
bonds dated January 1, 2014, at 100 (100% of face value). The
entry to record the sale is:

Jan. 1 Cash 100,000

Bonds payable 100,000

Prepare the entry Devor would make to accrue interest on

December 31. ($100,000 x 10% x 12/12)

Dec. 31 Interest expense 10,000

Interest payable 10,000

10-30 LO 5 Prepare the entries for the issuance of bonds and interest expense.
 Issuing Bonds at Face Value
Prepare the entry Devor would make to pay the interest on Jan. 1,
2015.

Jan. 1 Interest payable 10,000

Cash 10,000

10-31 LO 5 Prepare the entries for the issuance of bonds and interest expense.

Accounting for Bond Issues

Question
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.

10-32 LO 5 Prepare the entries for the issuance of bonds and interest expense.
 Issuing Bonds at a Discount

Illustration: Assume that on January 1, 2014, Candlestick Inc.

sells $100,000, five-year, 10% bonds at 98 (98% of face value)
with interest payable on January 1. The entry to record the
issuance is:

Jan. 1 Cash 98,000

Discount on bonds payable 2,000
Bonds payable 100,000

10-33 LO 5 Prepare the entries for the issuance of bonds and interest expense.

Issuing Bonds at a Discount

Illustration 10-7
Statement Presentation Statement presentation of
discount on bonds payable

Sale of bonds below face value causes the total cost of borrowing to be
more than the bond interest paid.
The reason: Borrower is required to pay the bond discount at the maturity
date. Thus, the bond discount is considered to be a increase in the cost
of borrowing.

10-34 LO 5 Prepare the entries for the issuance of bonds and interest expense.
 Issuing Bonds at a Discount

Total Cost of Borrowing

Illustration 10-8

Illustration 10-9

10-35 LO 5 Prepare the entries for the issuance of bonds and interest expense.

Issuing Bonds at a Discount

Question Helpful Hint Both a discount

and a premium account are
Discount on Bonds Payable: valuation accounts. A valuation
account is one that is needed to
value properly the item to which
a. has a credit balance. it relates.

b. is a contra account.
c. is added to bonds payable on the balance sheet.
d. increases over the term of the bonds.

10-36 LO 5 Prepare the entries for the issuance of bonds and interest expense.
 Straight-Line
Appendix 10A Amortization

Amortizing Bond Discount

To follow the expense recognition principle, companies allocate
bond discount to expense in each period in which the bonds are
outstanding.

Illustration 10A-1

LO 8 Apply the straight-line method of amortizing

10-37
bond discount and bond premium.

Straight-Line
Appendix 10A Amortization

Amortizing Bond Discount

Illustration: Candlestick, Inc., sold $100,000, five-year, 10%
bonds on January 1, 2014, for $98,000 (discount of $2,000).
Interest is payable on January 1 of each year. Prepare the
entry to accrue interest at Dec. 31, 2014.

Dec. 31 Interest expense 10,400

Discount on bonds payable 400
Interest payable 10,000

LO 8 Apply the straight-line method of amortizing

10-38
bond discount and bond premium.
 Straight-Line
Appendix 10A Amortization

Amortizing Bond Discount

Illustration 10A-2

LO 8 Apply the straight-line method of amortizing

10-39
bond discount and bond premium.

Accounting for Bond Issues

Question
On January 1, 2014, $2,000,000, 10-year, 10% bonds,
were issued for $1,940,000. Interest is paid annually on
January 1. If the issuing corporation uses the straight-
line method to amortize discount on bonds payable, the
monthly amortization amount is
a. $19,400.
b. $6,000.
c. $1,616.
d. $500.

10-40
 Issuing Bonds at a Premium

Illustration: Assume that the Candlestick Inc. bonds previously

described sell at 102 rather than at 98. The entry to record the sale
is:

Jan. 1 Cash 102,000

Bonds payable 100,000
Premium on bonds payable 2,000

10-41 LO 5 Prepare the entries for the issuance of bonds and interest expense.

Issuing Bonds at a Premium

Illustration 10-11
Statement Presentation Statement presentation of
premium on bonds payable

Sale of bonds above face value causes the total cost of borrowing to be
less than the bond interest paid.

The reason: The borrower is not required to pay the bond premium at the
maturity date of the bonds. Thus, the bond premium is considered to be a
reduction in the cost of borrowing.

10-42 LO 5 Prepare the entries for the issuance of bonds and interest expense.
 Issuing Bonds at a Premium

Total Cost of Borrowing

Illustration 10-12

Illustration 10-13

10-43 LO 5 Prepare the entries for the issuance of bonds and interest expense.

Straight-Line
Appendix 10A Amortization

Amortizing Bond Premium

Illustration: Candlestick, Inc., sold $100,000, five-year, 10%
bonds on January 1, 2014, for $102,000 (premium of $2,000).
Interest is payable on January 1 of each year. Prepare the
entry to accrue interest at Dec. 31, 2014.

Dec. 31 Interest expense 9,600

Premium on bonds payable 400
Interest payable 10,000

LO 8 Apply the straight-line method of amortizing

10-44
bond discount and bond premium.
 Straight-Line
Appendix 10A Amortization

Amortizing Bond Premium

Illustration 10A-4

LO 8 Apply the straight-line method of amortizing

10-45
bond discount and bond premium.

Accounting for Bond Redemptions

Redeeming Bonds at Maturity

Candlestick records the redemption of its bonds at maturity as
follows:

Bonds payable 100,000

Cash 100,000

10-46 LO 6 Describe the entries when bonds are redeemed.

 Accounting for Bond Retirements

Redeeming Bonds before Maturity

When a company retires bonds before maturity, it is necessary
to:
1. eliminate the carrying value of the bonds at the redemption
date;
2. record the cash paid; and
3. recognize the gain or loss on redemption.

The carrying value of the bonds is the face value of the bonds less
unamortized bond discount or plus unamortized bond premium at the
redemption date.

10-47 LO 6 Describe the entries when bonds are redeemed.

Accounting for Bond Retirements

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, 2018) as:

Bonds payable 100,000

Premium on bonds payable 400
Loss on bond redemption 2,600
Cash 103,000

10-48 LO 6 Describe the entries when bonds are redeemed.

 Accounting for Bond Retirements

Question
When bonds are redeemed before maturity, the gain or loss
on redemption is the difference between the cash paid and
the:

a. carrying value of the bonds.

b. face value of the bonds.

c. original selling price of the bonds.

d. maturity value of the bonds.

10-49 LO 6 Describe the entries when bonds are redeemed.

Financial Statement Analysis and Presentation

Analysis
Illustration 10-16

10-50
LO 7
 Financial Statement Analysis and Presentation

Liquidity
Illustration 10-17

Liquidity ratios measure the short-term ability of a company to pay its

maturing obligations and to meet unexpected needs for cash.

LO 7 Identify the requirements for the financial statement

10-51
presentation and analysis of liabilities.

Financial Statement Analysis and Presentation

Solvency

Illustration 10-18

Solvency ratios measure the ability of a company to survive over a

long period of time.
10-52
LO 7
 Key Points
 Under IFRS, companies sometimes will net current liabilities against
current assets to show working capital on the face of the statement
of financial position. (This is evident in the Zetar financial
statements in Appendix C.)

 IFRS requires use of the effective-interest method for amortization

of bond discounts and premiums. GAAP allows use of the straight-
line method where the difference is not material. Under IFRS,
companies do not use a premium or discount account but instead
show the bond at its net amount.

LO 11 Compare the accounting procedures for

10-53
liabilities under GAAP and IFRS.

10-54
 Accounting for Bond Issues

Question
Winrow Company received proceeds of $565,500 on 10-year, 8%
bonds issued on January 1, 2013. The bonds had a face value of
$600,000, pay interest annually on December 31st, and have a call
price of 101. Winrow uses the straight-line method of amortization.
Winrow Company decided to redeem the bonds on January 1, 2015.
What amount of gain or loss would Winrow report on its 2015 income
statement?
a. $27,600 gain
b. $33,600 gain
c. $33,600 loss
d. $27,600 loss

10-55 LO 5 Prepare the entries for the issuance of bonds and interest expense.

Accounting for Bond Issues

Question
On January 1, Sewell Corporation issues $2,000,000, 5-
year, 12% bonds at 96 with interest payable on January 1.
The entry on December 31 to record accrued bond
interest and the amortization of bond discount using the
straight-line method will include a
a. debit to Interest Expense, $120,000.
b. debit to Interest Expense, $240,000.
c. credit to Discount on Bonds Payable, $16,000.
d. credit to Discount on Bonds Payable, $8,000.

10-56 LO 5 Prepare the entries for the issuance of bonds and interest expense.