To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter Liabilities Short Exercises (10 min.) S 8-1 Journal DATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT 2010 Sept 30 Inventory…………………………………… 5,000 Note Payable, Short-Term…………… 5,000 Purchased inventory by issuing a note payable 2011 June 30 Interest Expense ($5,000 × 08 × 9/12)… Interest Payable………………………… Accrued interest expense 300 300 Sept 30 Note Payable, Short-Term……………… 5,000 Interest Payable…………………………… 300 Interest Expense ($5,000 × 08 × 3/12)… 100 Cash……………………………………… 5,400 Paid note payable and interest at maturity Chapter Liabilities 605 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com S 8-2 (5-10 min.) Req ASSETS Balance Sheet June 30, 2011 LIABILITIES Current liabilities: Note payable, shortterm Interest payable ($5,000 × 08 × 9/12)… $5,000 300 Income Statement Year Ended June 30, 2011 Revenues: Expenses: Interest expense ($5,000 × 08 × 3/12)…………… $ 300 Req The 2012 income statement will report: Interest expense ($5,000 × 08 × 3/12)……… 606 Financial Accounting 8/e Solutions Manual $100 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com (10 min.) S 8-3 Req Journal DATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT Cash ($483,000 × 30)………………… … Notes Receivable ($483,000 − $144,900) Sales Revenue…………………………… To record sales on account 144,900 338,100 Warranty Expense ($483,000 × 06)……… Estimated Warranty Payable……….… To accrue warranty expense 28,980 Estimated Warranty Payable…………… Cash…………………………………….… To pay warranty claims 19,000 483,000 28,980 9,000 Req Estimated Warranty Payable Bal 11,000 19,000 28,980 Bal 20,980 Chapter Liabilities 607 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com (5-10 min.) S 8-4 Warranty expense = $28,980 The matching principle addresses this situation The warranty expense for the year does not necessarily equal the year’s cash payments for warranties Cash payments for warranties not determine the amount of warranty expense for that year Instead, the warranty expense is estimated and matched against revenue during the period of the sale, regardless of when the company pays for warranty claims Student responses may vary 608 Financial Accounting 8/e Solutions Manual To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com (5-10 min.) S 8-5 These are contingent liabilities because at the time of the note Marley David, Inc., was not liable for any of these product losses In the United States, the contingency can become a real liability if the user of a Marley David product suffers a loss for which the company is responsible Marley David must pay for all losses up to $3.2 million and all losses above $25.2 million The company is insured against losses between $3.2 million and $25.2 million Outside the United States, the contingency becomes a real liability the same way — if a Marley David user suffers a loss for which the company is responsible Outside the United States, Marley David must pay only for losses above $25.2 million because the company is insured against losses up to $25.2 million Chapter Liabilities 609 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com a $227,250 ($ 300,000 × 7575) b $308,250 ($ 300,000 × 1.0275) c $283,500 ($ 300,000 × 9450) d $313,500 ($ 300,000 × 1.0450) a Discount b Premium c Par (face) value d Discount 610 Financial Accounting 8/e Solutions Manual (5-10 min.) S 8-6 (5 min.) S 8-7 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com (5-10 min.) S 8-8 Journal DATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT 2010 a July Cash…………………………………………… 80,000 Bonds Payable…………………………… 80,000 To issue bond at par b Dec 31 Interest Expense ($80,000 × 055 × 6/12) 2,200 Interest Payable………………………… 2,200 To accrue interest expense 2011 c Jan Interest Payable…………………………… Cash……………………………………… To pay semiannual interest on bonds 2,200 2,200 2025 d July Bonds Payable……………………………… 80,000 Cash……………………………………… 80,000 To pay bonds at maturity Chapter Liabilities 611 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com (10-15 min.) S 8-9 Amortization table A Interest Payment Semiannual (2.5% of Interest Maturity Date Value) B C $138,000 $3,480 134,520 $15,000 $462,000 465,480 $18,480 15,000 3,619 130,901 469,099 3,764 127,137 472,873 18,619 Mar 31, 2011 Sept 30, 2011 E Interest Expense (4 % of Discount Bond Preceding Account Carrying Bond Discount Balance Amount Carrying Amortization (Preceding ($600,000 Amount) (B - A) D - C) - D) Mar 31, 2010 Sept 30, 2010 D 15,000 18,764 Journal DATE 2010 Mar 31 Sept 30 612 ACCOUNT TITLES AND EXPLANATION DEBIT Cash ($600,000 × 77)…………… Discount on Bonds Payable…… Bonds Payable………………… 462,000 138,000 Interest Expense………………… Discount on Bonds Payable… Cash…………………………… 18,480 Financial Accounting 8/e Solutions Manual CREDIT 600,000 3,480 15,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com (10 min.) S 8-10 Borrowed $462,000 Pay back $600,000 at maturity Pay cash interest of $15,000 each six months Interest expense: Sept 31, 2010…………… Mar 31, 2011……………… $18,480 $18,619 Interest expense increases because the bond carrying amount increases as the bonds move toward maturity An increasing bond carrying amount produces an increasing amount of interest expense each period (5-10 min.) $1,825,000 S 8-11 ($5,000,000 × 365) $5,000,000 on July 1, 2020 $75,000 ($5,000,000 × 03 × 6/12) $5,000,000 − $1,825,000 $233,750 $75,000 + × 12 10 Chapter Liabilities 613 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com (10 min.) S 8-12 Journal DATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT 2010 a July Cash ($500,000 × 94)……………………… 470,000 Discount on Bonds Payable…………… 30,000 Bonds Payable………………………… 500,000 To issue bonds at a discount b Dec 31 Interest Expense…………………………… Discount on Bonds Payable ($30,000 / 10 × 6/12)………………… Interest Payable ($500,000 × 08 × 6/12) To accrue interest and amortize bonds 2011 c Jan Interest Payable…………………………… Cash……………………………………… To pay semiannual interest 614 Financial Accounting 8/e Solutions Manual 21,500 1,500 20,000 20,000 20,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Ethical Issue The ethical issue is whether to structure this lease to avoid its having to be disclosed as a capital lease The company will that if it is possible It appears that Gocker and Moran have some flexibility in setting the life of the lease (4-6 years) If they set the term of the lease at years, it will be only 66 2/3 percent of the economic life of the asset (6 years) Thus, the lease will fail all of the mechanical tests for the lease to be treated as a capital lease, and by default, it will be treated as an operating lease, and Gocker can avoid capitalizing the asset and including the liability on her financial statements If they set the term of the lease at or years, it will exceed 75% of the economic life of the asset, and thus the lease will have to be capitalized The stakeholders are Gocker, the lessee; Morgan, the lessor; and Last National Bank, Gocker’s present creditor The potential consequences to the stakeholders are: a economic: If the lease is structured as a capital lease, Gocker will violate its long-term loan covenant with Last National Bank As a result, the bank might demand immediate payment of their loan This may damage Gocker’s credit rating and create Chapter Liabilities 703 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com (continued) Ethical Issue difficulty getting future bank loans Alternatively, Last National Bank may waive the loan covenant in exchange for a higher interest rate or more stringent repayment terms This too could cause Gocker financial difficulties Morgan is not affected economically, because Morgan will receive its payments on the leased property regardless of how the transaction is disclosed b legal: If we assume that GAAP substitutes for legal requirements, if Gocker is careful to structure the lease terms so that it avoids the requirements for a capital lease, there should be no problem stating that the lease agreement complies with GAAP c ethical: The substance of a capital lease is one that transfers the risks and rewards of ownership to the lessee If in fact, the substance of the terms of this lease that, the equipment should be capitalized by the lessee regardless of the form of the lease terms To use mechanical rules to avoid recognizing assets and liabilities hardly seems like a truthful way to business Nevertheless, U.S GAAP presently allow it! Student responses will vary on this question Some will say that, if the rules allow it, then why not engineer the transaction 704 Financial Accounting 8/e Solutions Manual To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com (continued) Ethical Issue in such as way as to benefit Gocker by keeping the asset, and the lease obligation, off the books After all, this is perfectly legal, and perfectly in accordance with existing U.S GAAP (FAS 13) In the view of the authors, Gocker should evaluate whether, in fact, she obtains the rights and rewards associated with ownership of the machine If so, she could so structure the lease that it fits the economic substance of the transaction, which is what should also be disclosed in the financial statements If it turns out that the equipment and the related lease obligation will have to be added to assets and liabilities in the balance sheet, thus causing Gocker to default on the loan covenant, she should attempt to obtain a waiver of the covenant This option is going to prove costly for Gocker, so she’s going to have to be convinced that she did the right thing in order to be motivated to follow this course of action The FASB and IASB are working on a proposed new lease standard that removes the mechanical criteria for lease capitalization discussed in the chapter in favor of the more theoretically and substantively correct, but also more subjective, ―risks and rewards‖ approach As a result, more companies will be faced with making the judgment as to whether their lease agreements actually transfer risks and Chapter Liabilities 705 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com (continued) Ethical Issue rewards to lessees This will not remove the temptation to deliberately twist the facts Under a ―principles‖ based standard, there will exist the opportunity for ―strategic noncompliance‖ (that is, simply decide that risks and rewards are not transferred and thus achieve the same result as the ―financial engineering‖ allowed by current GAAP judgment requires better ethics What you think will happen? (Student responses will vary on this question) 706 Financial Accounting 8/e Solutions Manual More To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Focus on Financials: Amazon.com, Inc (20 min.) Req Amazon.com, Inc.’s accounts payable increased from $2,795 million in 2007 to $3,594 million in 2008, an increase of about 28.5 percent The most obvious reason for this significant increase is that the company is growing Inventories increased from $1,200 million to $1,399 million The company expanded and diversified its lines of merchandise during 2008 This excerpt, taken from Management’s Discussion and Analysis (not included in Appendix B but available on the SEC website), is very useful in interpreting management’s payables strategy: Because of our [business] model we are able to turn our inventory quickly and have a cash-generating operating cycle On average…we generally collect from our customers before our payments to suppliers come due… Accounts payable days were 62, 57, and 53 for 2008, 2007 and 2006 (Author note: This is a computation that is not included in the chapter, but is computed by dividing cost of sales by average accounts payable to get a turnover, and then dividing the turnover into 365 Using this computation, it took them about 62 days to pay a supplier in 2008, compared with 57 days in 2007 and 53 days in 2006) We expect some variability in accounts payable days over time since they are affected by several factors, including the mix of product sales, the mix of sales by other sellers, the mix of suppliers, seasonality, and changes in payment terms over time, including the effect of balancing pricing and timing of payment terms with suppliers Chapter Liabilities 707 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com The upward trend in accounts payable days means that the company is taking longer to pay its suppliers If this period lengthens too much, some suppliers might be reluctant to business with Amazon.com, Inc However, this is unlikely due to the company’s size and name recognition The key to interpreting the trend is the comment, ―we generally collect from our customers before payments to suppliers come due.‖ This means that the company is generating plenty of cash from operations and can afford to ―lean on‖ their suppliers without fear of being cut off Req Income tax provision is the amount of income tax expense for the whole year Amazon.com, Inc.’s income tax provision for 2008 was $247 million ($252 million in current taxes, netted against $5 million deferred (postponed until a later period) As reflected in Note 12, the $252 million in current consisted of $227 million in U.S and state taxes, and $25 million for income generated in foreign countries The company’s cash taxes paid were $53 million, $24 million, and $15 million in 2008, 2007, and 2006, respectively These two amounts differed so much because the company had substantial net operating losses for tax purposes in its early years of operation Since those losses cannot be used to file for refunds of taxes in the years in which 708 Financial Accounting 8/e Solutions Manual To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com they are incurred, the Internal Revenue Service allows the company to carry the losses over and deduct them against subsequent profits for up to 20 years The company has been enjoying the cash benefits of those losses in recent years, and has saved several hundred million dollars in taxes because of them In a few years, those loss carryovers will be used up, and the company’s cash taxes paid will increase substantially Req Refer to Note 5—Long Term Debt Based on this information, the company’s long term debt (after current maturities) decreased from $1,282 in 2007 to $409 in 2008 The biggest change occurred by the redemption (elimination) of the 4.75% convertible subordinated notes ($899 million) As described in Note 5, the holders of these notes elected to convert $605 million in principal amount of these notes to common stock As a result, the company issued an additional 7.8 million shares of common stock The company redeemed the remaining $294 million of these notes for cash Chapter Liabilities 709 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Req Refer to Note 7—Commitments and Contingencies The company has about $3,059 million in commitments as of December 31, 2008 This consists of debt principal, interest, capital leases (including interest), operating leases, and taxes These are all scheduled by year ($417 million being due in 2009, $710 million in 2010, and so forth The company is also required to pledge or otherwise restrict about $308 million in cash and marketable securities as collateral against various debt obligations, such as letters of credit and real estate leases The company also is involved in numerous legal proceedings (lawsuits) that could result in future adverse impact on the financial statements These legal proceedings are of the nature of ―disclosed‖ loss contingencies, as discussed in the chapter The criteria for ―disclosure‖ of these contingent liabilities is that it is reasonably possible, but not probable, that they may materialize in the future, and/or that their amounts are not subject to reasonable estimation as of December 31, 2008 710 Financial Accounting 8/e Solutions Manual To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Req Ratio Debt ratio 2008 2007 $4,746+$409+$487 = 81.5% $3,714+$1,282+$292 = $8,314 $6,485 Times interest $842 $655 earned $71 Current ratio = 11.9 times $6,157 $4,746 $77 67.9% = 8.5 times $5,164 = 1.3:1 $3,714 = 1.4:1 Amazon.com, Inc.’s leverage increased during 2008, as reflected in the drastic increase of its debt to total asset ratios from 2007 to 2008 This was mostly due to a billion dollar increase in current liabilities However, because of strong earnings, the times interest earned (operating income/interest expense) ratios improved substantially Current ratio has remained relatively stable Cash provided by operating activities on the Consolidated Statements of Cash Flows increased more than doubled from $702 million in 2006 to $1,697 in 2008 On this basis, Amazon.com, Inc appears to be experiencing vigorous growth, and is ―digging out‖ of its debt position by converting longterm debt to common stock and by generating steadily increasing cash flows from operations, with which they will likely pay off their current liabilities They appear to be Chapter Liabilities 711 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com positioned well for more growth, profitability and substantially improved liquidity and leverage positions in the future 712 Financial Accounting 8/e Solutions Manual To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Focus on Financials: Foot Locker, Inc (30 min.) Req Note 13 of the Notes to Consolidated Financial Statements reflects the details Foot Locker, Inc.’s ―accrued and other liabilities.‖ The four largest accrued liabilities are for expenses related to other operating costs, such as utilities, advertising and promotional expenses ($68 million); payroll and payroll related costs, excluding taxes ($52 million); taxes other than income taxes ($44 million); and customer deposits (unredeemed gift cards and gift certificates) ($34 million) Req Obligations under capital leases are treated identically with long-term debt, because they are like incurring long-term notes payable in order to purchase long-term assets It is therefore logical to combine long-term liabilities with obligations under capital leases In summary, this section of the balance sheet consists of the following: Chapter Liabilities 713 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 8.5% debentures due 2022 $175 million term loan Total long-term debt Obligations under capital leases Less: current portion Net long term portion 2007 2006 (in millions) $133 $130 88 90 221 220 14 221 234 14 $221 $220 The major change that has occurred is that the company has repaid all of its obligations under capital leases ($14 million) You can trace this amount to the financing activities portion of the Consolidated Statements of Cash Flows in 2007 The other changes are explained in Note 15 As of the end of fiscal 2007, $88 million remains outstanding on a $175 million term loan obtained in 2004 That amount is due in 2009 The 8.5% debentures are not payable until 2022, which gives the company plenty of time to obtain the cash to retire them 714 Financial Accounting 8/e Solutions Manual To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Req Foot Locker’s overall debt position as of the end of fiscal 2007 would be rated safe The ratios that allow us to rate Foot Locker, Inc.’s debt position are as follows (dollar amounts in millions): Ratio Fiscal 2007 Debt ratio $977 = Times interest earned* 30.0% $954 = 29.3% $3,248 $3,249 ($50) $392 $1 Current ratio Fiscal 2006 = (negative 50) $3 $2,064 $501 = 131 times $2,034 = 4.1:1 $516 = 3.9:1 *based on income from operations The company has very little debt, making its debt to total assets ratios extremely strong This is also reflected in times interest earned, although the company experienced an operating loss in fiscal 2007 Their current ratios for the two fiscal years are also extremely strong Chapter Liabilities 715 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Req Carrying the analysis into fiscal 2008 will allow students to gain a perspective on the impact of a business recession on midlevel retailers such as Foot Locker, Inc The company’s debt position rating probably moved to average, mostly because their profits have nose-dived Based on the company’s fiscal 2008 annual report (year ended February 2, 2009) the debt ratio, times interest earned, and current ratios, respectively, are (dollars in millions): Debt ratio: Total liabilities/Total Assets = $1,924/$2,877 = 66.9% Times interest earned: NI from operations/interest expense = ($100)/$5 = (negative 200) Current ratio: Current Assets/Current Liabilities = $1,764/$418 = 4.22 The company’s debt ratio more than doubled Their operating loss doubled from $50 million to $100 million Nevertheless, their interest bearing debt remains very low (net interest expense only $5 million) In this type situation, the times interest earned ratio becomes meaningless Their current ratio is still very strong Although the company remains in sound shape regarding leverage and liquidity, the recession is taking its toll 716 Financial Accounting 8/e Solutions Manual To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Group Projects Student responses will vary Chapter Liabilities 717 ... ebook, solutions and test bank, visit http://downloadslide.blogspot.com Payroll tax payable………………………………… 620 Financial Accounting 8/e Solutions Manual 800 To download more slides, ebook, solutions... company pays for warranty claims Student responses may vary 608 Financial Accounting 8/e Solutions Manual To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com... Premium c Par (face) value d Discount 610 Financial Accounting 8/e Solutions Manual (5-10 min.) S 8-6 (5 min.) S 8-7 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com