Liabilities

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Financial Accounting, Seventh Edition
Chapter 10

• Liabilities

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Liabilities
Long-Term Liabilities
Current Liabilities
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What is a Current Liability?
Section 1 Current Liabilities

• Current liability is debt with 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 payable, salaries
payable, and interest payable.
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What is a Note Payable?
Notes Payable

• Written promissory note.
• Require the borrower to pay interest.
• Issued for varying periods.

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Illustration Note Issued to Borrow Funds from a
Bank
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Record Journal entry to Borrow Funds from a Bank
On December 1, 2012, R H Smith Company borrows
10,000 from Bank of Maryland by signing a
90-day, 6 note. Principal and interest are due
on March 1, 2013. Record the transaction.
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Record End of Period Adjustment to Note
End of Period
Note Date
Maturity Date
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Record End of Period Adjustment to Note
On Dec 31, 2012, RHS Company would record
Record Payment of Note at maturity
On March 1, 2013, RHS Company would record
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Knowledge Check Question 1 On November 1, 2012,
Brown Company signed a 12,000, 90 day, 8 note
to a supplier for purchase of merchandise. If
Brown Companys accounting period ends on
December 31, and the note is paid on February 1,
2013, which one of the following statements will
be TRUE for Brown Company?

1. On February 1, 2013, they will debit Interest
   Payable for 80
2. On December 31, 2012, they will credit Interest
   Payable for 160
3. On February 1, 2013, they will credit Interest
   Payable for 160
4. On December 31, 2012, they will debit Interest
   Expense for 80

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Sales Tax Payable
Sales Tax Payable

• Sales taxes are expressed as a stated percentage
  of the sales price.
• Either rung up separately or included in total
  receipts.
• Retailer collects tax from the customer.
• Retailer remits the collections to the states
  department of revenue.

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Accounting for Sales Tax Payable
Best Buy Company sold a HD TV to a customer for
700 that is subject to a 6 sales tax. Record
the journal entry.
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Knowledge Check 2George Company reports total
cash receipts from sales to customers of 4,515.
If the proceeds include sales tax of 5, what
amount should be credited to sales?

1. 4,289.25
2. 4,300.00
3. 4,740.75
4. 4,000.00

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Payroll and Payroll Tax Payable
Payroll and Payroll Taxes Payable
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).
Determining the payroll involves computing three
amounts (1) gross earnings, (2) payroll
deductions, and (3) net pay.
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Employee Payroll Deductions
Gross Pay
Voluntary Deductions
FICA (Social Security) Taxes
Medicare Taxes
Federal Income Tax
State and Local Income Taxes
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Employee FICA Taxes
Federal Insurance Contributions Act (FICA)
FICA (Social Security) Taxes
Medicare Taxes
2013 6.2 of the first 113,700 earned in the
year ( Max 7,049.40).
2013 1.45 of all wages earned in the year.
Employers must pay withheld taxes to the Internal
Revenue Service (IRS).
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Employee Income Taxes Withheld
Federal Income Tax
State and Local Income Taxes
Amounts withheld depend on the employees
earnings, tax rates, and number of withholding
allowances.
Employers must pay the taxes withheld from
employees gross pay to the appropriate
government agency.
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Recording Employee Payroll Deductions
Assume an employee earned a gross salary of
4,000 for the month of January 2013. The
employee is subject to the following
withholdings FICA for Social Security 6.2 FICA
for Medicare 1.45 Federal Income Tax 20 State
Income Tax 6 Employee Health Care Dues 5 Make
the journal entry to record the payroll
transaction on January 31, 2013.
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Employer Payroll Taxes
Medicare Taxes
Federal and State Unemployment Taxes
FICA (Social Security) Taxes
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Accounting for Payroll Tax
Using the rates given below, Record the journal
entry to record the employer payroll taxes for an
employee whose gross pay was 4,000 for the month
of January
FICA (Social Security) 6.2 FICA (Medicare)
1.45 State Unemployment Taxes 4 Federal
Unemployment Taxes Payable 2
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• Knowledge Check Question 3
• The 2013 rate (for employers) for FICA social
  security is 6.2 (for the first 113,700 of an
  employees salary) and the FICA Medicare rate is
  1.45 for all salary. Also, the current FUTA tax
  rate is 0.8, and the SUTA tax rate is 5.4, both
  of which apply only to the first 7,000 of an
  employee's salary. Assume that an employee
  earned 150,000 in 2013. What is the employers
  total payroll-related expense for this employee
  for 2011 (rounded to the nearest dollar)?
• 170,775
• 158,434
• 159,658
• 157,803

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Accounting for Unearned Revenue
Unearned Revenue
Revenues that are received before the company
delivers goods or provides services.

• Company debits Cash, and credits a current
  liability account
  (unearned revenue).
• When the company earns the revenue, it debits the
  Unearned Revenue
  account, and credits a revenue account.

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Accounting for Unearned Revenue

• Best Buy Companys Unredeemed Gift Card
  Liabilities account had a balance of 474 million
  on Feb 26, 2011, and 456 million on March 3,
  2012. During the fiscal year 2012, Best Buy
  Company sold 1,000 million of gift cards.
  Determine Best Buys revenue recognized from gift
  cards.

How does Best Buy deal with unredeemed gift
cards?
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Best Buy Companys Gift card Policy (excerpted
from Best Buys 2012 10K Statement)

• We sell gift cards to our customers in our retail
  stores, through our Web sites and through
  selected third parties. We do not charge
  administrative fees on unused gift cards, and our
  gift cards do not have an expiration date. We
  recognize revenue from gift cards when (i) the
  gift card is redeemed by the customer, or (ii)
  the likelihood of the gift card being redeemed by
  the customer is remote ("gift card breakage"),
  and we determine that we do not have a legal
  obligation to remit the value of unredeemed gift
  cards to the relevant jurisdictions. We determine
  our gift card breakage rate based upon historical
  redemption patterns. Based on our historical
  information, the likelihood of a gift card
  remaining unredeemed can be determined 24 months
  after the gift card is issued. At that time, we
  recognize breakage income for those cards for
  which the likelihood of redemption is deemed
  remote and we do not have a legal obligation to
  remit the value of such unredeemed gift cards to
  the relevant jurisdictions. Gift card breakage
  income is included in revenue in our Consolidated
  Statements of Earnings.
• Gift card breakage income was as follows in
  fiscal 2012, 2011 and 2010 54 million, 51
  million, 41 million.

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Section 2 Long-Term Liabilities
Bond Basics
Bonds are a form of interest-bearing notes
payable. Three advantages over common stock

1. Stockholder control is not affected.
2. Tax savings result.
3. Earnings per share may be higher.

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What is a Bond?(Excerpted from SmartMoney.com)

• TECHNICALLY SPEAKING, a bond is a loan and you
  are the lender. Who's the borrower? Usually, it's
  either the U.S. government, a state, a local
  municipality or a big company like General
  Motors. All of these entities need money to
  operate -- to fund the federal deficit, for
  instance, or to build roads and finance factories
  -- so they borrow capital from the public by
  issuing bonds.
• Now for a little bond-speak. When a bond is
  issued, the price you pay is known as its "face
  value." Once you buy it, the issuer promises to
  pay you back on a particular day -- the "maturity
  date" -- at a predetermined rate of interest --
  the "coupon." Say, for instance, you buy a bond
  with a 1,000 face value, a 5 coupon and a
  10-year maturity. You would collect interest
  payments totaling 50 in each of those 10 years.
  When the decade was up, you'd get back your
  1,000 and walk away.
• A key difference between stocks and bonds is that
  stocks make no promises about dividends or
  returns. General Electric's dividend may be as
  regular as a heartbeat, but the company is under
  no obligation to pay it. And while GE stock
  spends most of its time moving upward, it has
  been known to spend months -- even years -- going
  the other way.
• When GE issues a bond, however, the company
  guarantees to pay back your principal (the face
  value) plus interest. If you buy the bond and
  hold it to maturity, you know exactly how much
  you're going to get back (unless the company
  defaults on its bond obligations). This is why
  bonds are also known as "fixed-income"
  investments -- they assure you a steady payout or
  yearly income. And although they can carry plenty
  of risk, this regular income is what makes them
  inherently less volatile than stocks.

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Bond Basics

• Types of Bonds
• Secured and Unsecured (debenture) bonds.
• Term and Serial bonds.
• Registered and Bearer (or coupon) bonds.
• Convertible and Callable bonds.

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Bond Basics

• Issuing Procedures
• Bond contract known as a bond indenture.
• 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).
• Typically a 1,000 face value.
• Interest payments usually made semiannually.
• Generally issued when the amount of capital
  needed is too large for one lender to supply.

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Bond Basics

• Bond Trading
• Bonds are traded on national securities
  exchanges.
• Bond Prices and Yield rates fluctuate
  continuously, and are often reported in Yahoo
  Finance as below

Type Issue Price Coupon () Maturity YTM() CurrentYield() Fitch Ratings Callable
Corp CVS CORP 121.62 6.125 15-Sep-2039 4.720 5.036 BBB No
Read as CVS CAREMARK CORPORATION has bonds with
a coupon rate of 6.125 (annual) outstanding that
will mature on Sep 15, 2039. Closing Price on
the day was 121.62 of face value. If these
bonds are held to maturity, they will yield a
4.720 (annual) return. The current yield on
these bonds is 5.036 (6.125/121.62). The
ratings (such as Standard Poors, Moodys or
Fitch)reflect the quality of the bonds (highest
AAA, in default D). These bonds are also not
callable.
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Bond Basics

• Determining the Market Value of Bonds
• Market value is a function of the three factors
  that determine present value
• the dollar amounts to be received,
• the length of time until the amounts are
  received, and
• the market rate of interest.

The features of a bond (callable, convertible,
and so on) affect the market rate of the bond.
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Accounting for Bond Issues
Issuing Bonds at Face Value/Par Value
Illustration On January 1, 2013, CVS Company
issued 100,000, ten-year, 5 bonds at 100 (100
of face value). The entry to record the sale on
January 1, 2013
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Recording Interest Expense on Bonds
Illustration On January 1, 2013, CVS Company
Company issued 100,000, ten-year, 5 bonds at
100 (100 of face value). Assume that interest
was payable semiannually on January 1 and July 1.
Prepare the entry to record the payment of
interest on July 1, 2013, assume no previous
accrual.
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Issuing Bonds at Face Value
Illustration On January 1, 2013, CVS Company
issued 100,000, ten-year, 5 bonds at 100 (100
of face value). Assume that interest was payable
semiannually on January 1 and July 1. Prepare
the entry to record the accrual of interest on
December 31, 2013, assume no previous accrual.
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Accounting for Bond Issues
Market Rate
Bond Sold at
Bond Contract Interest Rate 8
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Sample Bond Offerings (Source Yahoo Finance)
Company MICHAELS STORES RITE AID CORP CITIGROUP INC
At Par Discount Premium
Price 100.00 93.75 107.55
Coupon Rate 7.75 8.625 6.875
Current Yield 7.75 9.20 6.392
Coupon Payment Frequency Semiannual Semiannual Semiannual
First Coupon Date Nov 1, 2011 Sep 1, 2007 Aug 15, 1998
Fitch Ratings CCC CCC A
Callable Yes Yes No
Maturity Date Nov 1, 2018 March 1, 2015 15 Feb, 2098
Bond Price (market value) are expressed as a
percent of their par value.
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Accounting for Bond Issues
Issuing Bonds at a Discount
Illustration On March 1, 2007, Rite Aid
Corporation 100,000, five-year, 8.625 bonds for
93.75 of face value). Interest is payable
semiannually on September 1 and March 1. The
entry to record the issuance is
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Issuing Bonds at a Discount
Total Cost of Borrowing
Alternative approach
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Issuing Bonds at a Discount
Statement Presentation
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Accounting for Bond Issues
Issuing Bonds at a Premium
Illustration On Feb 15, 1998, CITIGROUP Inc.
sold 100,000, 10-year, 6.875 bonds for 107.55
of face value). Interest is payable semiannually
on Aug 15 and Feb 15. The entry to record the
issuance is
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Issuing Bonds at a Premium
Statement Presentation
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Issuing Bonds at a Premium
Total Cost of Borrowing
Alternative approach
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Knowledge Check Question 4 Mendez Corporation
issues 3,000, 10-year, 8, 1,000 bonds dated
January 1, 2011, at 103. The journal entry to
record the issuance will show a A. debit to Cash
of 3,000,000. B. credit to Bonds Payable for
3,015,000. C. credit to Cash for 3,090,000. D.
credit to Premium on Bonds Payable for 90,000.
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Knowledge Check Question 5 Reliable Company
issued 6, 5 year bonds paying semiannual
interest. The bonds had a par value of 250,000,
and were issued at a price of 96.5. What will be
Reliable Companys Total cost of borrowing the
life of the bonds? A. 241,250. B. 83,750. C. 75
,000. D. 66,250.
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Accounting for Bond Retirements
Redeeming Bonds at Maturity
Assuming that the company pays and records
separately the interest for the last interest
period, a company records the redemption of its
bonds at maturity as follows
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Accounting for Bond Retirements

• Redeeming Bonds before Maturity
• When a company retires bonds before maturity, it
  is necessary to
• eliminate the carrying value of the bonds at the
  redemption date
• record the cash paid and
• 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.
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Bond Retirement before Maturity
Skins Company has outstanding 200,000, 4 percent
bonds, which are now selling for 95. On March 1,
2013, the bonds have a carrying value of
197,000. If the company decides to purchase
these bonds and retire them, what entry is needed?
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Bond Retirement before Maturity
Skins Company has outstanding 200,000, 4 percent
bonds, which are callable at 110. On March 1,
2013, the bonds have a carrying value of
207,000. If the company decides to call these
bonds, and retire them, what entry is needed?
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• Knowledge Check Question 6
• Hogan Company has 250,000 of bonds outstanding.
  The unamortized premium is 3,600. If the company
  retired the bonds at 101, what would be the gain
  or loss on the retirement?
• 2,500 gain
• 2,500 loss
• 1,100 gain
• 1,100 loss

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Accounting for Bond Retirements
Converting Bonds into Common Stock Until
conversion, the bondholder receives interest on
the bond. For the issuer, the bonds sell at a
higher price and pay a lower rate of interest
than comparable debt securities without the
conversion option. Upon conversion, the company
transfers the carrying value of the bonds to
paid-in capital accounts. No gain or loss is
recognized.
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End of Chapter 10
Its not what you don't know that hurts you, its
what you know that just ain't so. Leroy "Satchel"
Paige