Financial accounting 7e harmon chapter 10 reporting and analyzing

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10-1 10 REPORTING AND ANALYZING LIABILITIES 10-2 Financial Accounting, Seventh Edition Learning Learning Objectives Objectives After studying this chapter, you should be able to: 10-3 Explain a current liability and identify the major types of current liabilities Describe the accounting for notes payable Explain the accounting for other current liabilities Identify the types of bonds Prepare the entries for the issuance of bonds and interest expense Describe the entries when bonds are redeemed Identify the requirements for the financial statement presentation and analysis of liabilities Preview of Chapter 10 Financial Accounting Seventh Edition Kimmel Weygandt Kieso 10-4 Current Current Liabilities Liabilities What is a Current Liability? Two key features: Company expects to pay the debt from existing current assets or through the creation of other current liabilities 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 10-5 LO Explain a current liability and identify the major types of current liabilities Current Current Liabilities 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 years d both (a) and (b) 10-6 LO Explain a current liability and identify the major types of current liabilities Current Current Liabilities Liabilities Notes Payable 10-7  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 LO Describe the accounting for notes payable Current Current Liabilities 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 When a company issues an interest-bearing note, the amount of assets it receives generally equals the note’s face value Sept Cash 100,000 Notes payable 100,000 10-8 LO Describe the accounting for notes payable Current Current Liabilities 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 10-9 LO Describe the accounting for notes payable Current Current Liabilities 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 Notes payable Interest payable 100,000 4,000 Cash 104,000 10-10 LO Describe the accounting for notes payable Effective Interest Amortization Appendix Appendix 10B 10B Amortizing Bond Premium Illustration: Candlestick, Inc records the accrual of interest and amortization of premium discount on Dec 31, as follows: Dec 31 Interest expense Premium on bonds payable 9,670 330 Interest payable 10,000 10-66 LO Apply the effective-interest method of amortizing bond discount and bond premium Appendix Appendix 10C 10C Long-Term Notes Payable Long-Term Notes Payable  May be secured by a mortgage that pledges title to specific assets as security for a loan  Typically, the terms require the borrower to make installment payments over the term of the loan Each payment consists of  10-67 interest on the unpaid balance of the loan and a reduction of loan principal Companies initially record mortgage notes payable at face value LO 10 Describe the accounting for long-term notes payable Appendix Appendix 10C 10C Long-Term Notes Payable Illustration: Porter Technology Inc issues a $500,000, 12%, 20year mortgage note on December 31, 2014 The terms provide for semiannual installment payments of $33,231 Illustration 10C-1 10-68 LO 10 Describe the accounting for long-term notes payable Appendix Appendix 10C 10C Long-Term Notes Payable Illustration: Porter Technology records the mortgage loan and first installment payment as follows: Dec 31 Cash 500,000 Mortgage payable Jun 30 Interest expense Mortgage payable Cash 10-69 500,000 30,000 3,231 33,231 LO 10 Describe the accounting for long-term notes payable Appendix Appendix 10C 10C Long-Term Notes Payable Question Each payment on a mortgage note payable consists of: a interest on the original balance of the loan b reduction of loan principal only c interest on the original balance of the loan and reduction of loan principal d interest on the unpaid balance of the loan and reduction of loan principal 10-70 LO 10 Describe the accounting for long-term notes payable Key Points 10-71  Liabilities are defined by the IASB as a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits Liabilities may be legally enforceable via a contract or law but need not be That is, they can arise due to normal business practices or customs  IFRS requires that companies classify liabilities as current or noncurrent on the face of the statement of financial position (balance sheet) except in industries where a presentation based on liquidity would be considered to provide more useful information (such as financial institutions) When current liabilities are presented, they are generally presented in order of liquidity LO 11 Key Points 10-72  Under IFRS, liabilities are classified as current if they are expected to be paid within 12 months  Similar to GAAP, items are normally reported in order of liquidity Companies sometimes show liabilities before assets Also, they will sometimes show non-current (long-term) liabilities before current liabilities  Under both GAAP and IFRS, preferred stock that is required to be redeemed at a specific point in time in the future must be reported as debt, rather than being presented as either equity or in a “mezzanine” area between debt and equity LO 11 Compare the accounting procedures for liabilities under GAAP and IFRS Key Points 10-73  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 straightline method where the difference is not material Under IFRS, companies not use a premium or discount account but instead show the bond at its net amount LO 11 Compare the accounting procedures for liabilities under GAAP and IFRS Key Points 10-74  Unlike GAAP, IFRS splits the proceeds from the convertible bond between an equity component and a debt component The equity conversion rights are reported in equity  Both Boards share the same objective of recording leases by lessees and lessors according to their economic substance—that is, according to the definitions of assets and liabilities However, GAAP for leases is much more “rules-based,” with specific bright-line criteria (such as the “90% of fair value” test) to determine if a lease arrangement transfers the risks and rewards of ownership IFRS is more conceptual in its provisions Rather than a 90% cut-off, it asks whether the agreement transfers substantially all of the risks and rewards associated with ownership LO 11 Key Points 10-75  Under GAAP, some contingent liabilities are recorded in the financial statements, others are disclosed, and in some cases no disclosure is required Unlike GAAP, IFRS reserves the use of the term contingent liability to refer only to possible obligations that are not recognized in the financial statements but may be disclosed if certain criteria are met  For those items that GAAP would treat as recordable contingent liabilities, IFRS instead uses the term provisions Provisions are defined as liabilities of uncertain timing or amount Under IFRS, the measurement of a provision related to an uncertain obligation is based on the best estimate of the expenditure required to settle the obligation LO 11 Looking to the Future The FASB and IASB are currently involved in two projects One project is investigating approaches to differentiate between debt and equity instruments The other project, the elements phase of the conceptual framework project, will evaluate the definitions of the fundamental building blocks of accounting In addition to these projects, the FASB and IASB have also identified leasing as one of the most problematic areas of accounting A joint project will initially focus primarily on lessee accounting One of the first areas to be studied is, “What are the assets and liabilities to be recognized related to a lease contract?” Should the focus remain on the leased item or the right to use the leased item? This question is tied to the Boards’ joint project on the conceptual framework—defining an “asset” and a “liability.” 10-76 LO 11 IFRS Practice Which of the following is false? 10-77 a) Under IFRS, current liabilities must always be presented before non-current liabilities b) Under IFRS, an item is a current liability if it will be paid within the next 12 months c) Under IFRS, current liabilities are shown in order of liquidity d) Under IFRS, a liability is only recognized if it is a present obligation LO 11 Compare the accounting procedures for liabilities under GAAP and IFRS IFRS Practice Under IFRS, a contingent liability is: a) disclosed in the notes if certain criteria are met b) reported on the face of the financial statements if certain criteria are met c) the same as a provision d) not covered by IFRS 10-78 LO 11 Compare the accounting procedures for liabilities under GAAP and IFRS IFRS Practice The joint projects of the FASB and IASB could potentially: a) change the definition of liabilities b) change the definition of equity c) change the definition of assets d) All of the above 10-79 LO 11 Compare the accounting procedures for liabilities under GAAP and IFRS Copyright Copyright “Copyright © 2013 John Wiley & Sons, Inc All rights reserved Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc The purchaser may make back-up copies for his/her own use only and not for distribution or resale The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.” 10-80 [...]... 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 Interest payable 10- 32 10, 000 10, 000 LO 5 Prepare the entries for the issuance of bonds and interest expense... tax rate of 6%), the journal entry is: Mar 25 Cash 10, 600 Sales revenue Sales tax payable * 10, 000 600 * $10, 600 / 1.06 = $10, 000 10- 13 LO 3 Explain the accounting for other current liabilities Current Current Liabilities 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... Value Prepare the entry Devor would make to pay the interest on Jan 1, 2015 Jan 1 Interest payable Cash 10- 33 10, 000 10, 000 LO 5 Prepare the entries for the issuance of bonds and interest expense Accounting Accounting for for Bond Bond Issues 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... is: Mar 25 Cash 10, 600 Sales revenue Sales tax payable 10, 000 600 10- 12 LO 3 Explain the accounting for other current liabilities Current Current Liabilities Liabilities Sometimes companies do not ring up sales taxes separately on the cash register Illustration: Cooley Grocery rings up total receipts of $10, 600 Because the amount received from the sale is equal to the sales price 100 % plus 6% of sales,... amounts 10- 28 LO 4 Identify the types of bonds Bond: Bond: Long-Term Long-Term Liabilities 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- 29 LO 4 Identify the types of bonds Accounting. .. two rates 10- 35 LO 5 Prepare the entries for the issuance of bonds and interest expense Issuing Issuing Bonds Bonds at at aa Discount 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 Discount on bonds payable Bonds payable 10- 36 98,000... entries for the issuance of bonds and interest expense Accounting Accounting for for Bond Bond Issues 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- 31 LO 5 Prepare the entries for the issuance of bonds and interest expense Issuing Issuing Bonds Bonds at at... Cargo Corporation records its payroll for the week of March 7 as follows: Mar 7 Salaries and wages expense 100 ,000 FICA tax payable 7,650 Federal income tax payable 21,864 State income tax payable 2,922 Salaries and wages payable 67,564 Record the payment of this payroll on March 7 Mar 7 Salaries and wages payable Cash 10- 18 67,564 67,564 LO 3 Current Current Liabilities Liabilities Payroll tax expense... payable 5,400 Federal unemployment taxes payable 10- 20 800 LO 3 Explain the accounting for other current liabilities Current Current Liabilities Liabilities Question Employer payroll taxes do not include: a Federal unemployment taxes b State unemployment taxes c Federal income taxes d FICA taxes 10- 21 LO 3 Explain the accounting for other current liabilities 10- 22 Bond: Bond: Long-Term Long-Term Liabilities... than the face value 10- 34 LO 5 Accounting Accounting for for Bond Bond Issues 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
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