Current Liabilities
Liabilities that are payable within one year or the operating cycle, whichever is longer
Issuer
The maker of the note issues the note to the payee, the maker is thus called the issuer
EX: Company of Sept 1, 2012,borrowed $90,000 from the national bank. As evidence of the debt, the company issued a NOTE PAYABLE that had a one year term and an annual interest rate of 9%
Increase cash and increase notes payable
On Dec. 31, 2012, company recognized 4 months (Sept-Dec) of accrued interest
(90,000 x .09 x 4/12)=$2,700
Increase interest payable (liability) and decrease in retained earnings
*accounts as an expense
Company would record 3 events on August 31, 2013 (maturity date)
Event 1: recognize $5400 of interest expense that accrued from January to August)
90,000 x .09 x 8/12
Increase interest payable (liability) and decrease in retained earnings
*accounts as an expense
Event 2: recognizes company's cash payment for interest on August 31.
Total interest = 8,100
decrease in cash and decrease in interest payable
*affects cash flow as an operating activity
Event 3: reflects repaying the principal of $90,000
decrease in cash and decrease in notes payable
On October 1, 2012, Mellon Company issued an interest-bearing note payable to Better Banks Inc. The note had a $24,000 principal amount, a four-month term, and an annual interest rate of 4 percent. Determine the amount of interest expense and the cash out
The computation of accrued interest expense is shown below. Unless otherwise specified, the interest rate is stated in annual terms even though the term of the note is only four months. Interest rates are commonly expressed as an annual percentage regardl
Company sells merchandise to a customer for $2,000 cash plus tax in a state where the sales tax rate is 6%
2120 (2000 + 6% sales tax) increase in cash
120(sales tax) increase in liabilities
2000 increase in retained earnings
*2120 accounts as an operating activity
Remitting the tax (paying cash to the tax authority)
decreases cash and decrease 'sales tax payable' account under liabilities
Contingent Liability
a potential obligation arising from a past event. Such as a pending lawsuit.
1. if future obligation is probable and reasonably estimated, liability
2. if likelihood is reasonably possible, but cannot be reasonably estimated-->no liability is reported
3.
General uncertainties
libailities
all businesses face uncertainties such as competition and damage from floods or storms.
Warranties
to attract customers, many companies guarantee their products or services.
Warranties extend for a specified period of time; seller promised to replace or pair defective products without charge.
HSC (company) sold for $7000 cash merchandise that had cost $4000
1. increase cash and retained earnings --OA
2. decrease inventory and retained earnings
Recognition of Warranty Expense
HSC guaranteed merchandise sold in event 1 to be free from defects for one year following the date of sale
*Assume the warranty obligation is estimated to be $100
increase in warranty payable (liability) and decrease in retained earnings
Settlement of Warranty Obligation
HSC paid $40 cash to repair defective merchandise returned by a customer
decrease in cash and decrease in warranty payable (liabilities)
Financial statement
Flotation Systems, Inc. (FSI) began operations in 2012. Its sales were $360,000 in 2012 and $410,000 in 2013. FSI estimates the cost of its one-year product warranty will be 2 percent of sales. Actual cash payments for warranty claims amounted to $5,400 d
FSI would report Warranty Expense on the December 31, 2012, income statement of $7,200 ($360,000 � .02). Warranty Expense on the December 31, 2013, income statement is $8,200 ($410,000 � .02).
FSI would report Warranties Payable on the December 31, 2012,
Long-term liabilities
long-term debt agreements beyond one year of company's operating cycle
Interest payments on liabilities
fixed interest rate: remains constant during the term of the loan
variable interest rate: fluctuates up or down during the loan period
amortization
repaying portion of the principle with regular payments that also includes interest
Installment notes
loans that require payments of principal and interest at regular intervals are represented as installment notes
Company borrowed 100,000 cash from the national bank; in exchange for the money, Blair issued the bank a five-year installment note with 9% fixed interest rate
increase cash and increase notes payable
On January 1, 2011, Krueger Company issued a $50,000 installment note to State Bank. The note had a 10-year term and an 8 percent interest rate. Krueger agreed to repay the principal and interest in 10 annual payments of $7,451.47 at the end of each year.
Line of credit
enables a company to borrow or repay funds as needed
A business may borrow 50,000 one month and make a partial repayment of 10,000 next month.
Amount borrow: increase assets and liabilities
interest expense: decrease cash and decrease RE
amount repaid: de
Bond liabilities
bond certificates: many companies borrow money directly form the public (issued bonds)
issuer: (seller) is the borrower of the bond
bondholder: buyer of a bond, lender
Advantages of issuing bonds
1. bonds have longer terms than notes issued to banks (20+ years)
2. bond interest rates may be lower than bank interest rates
Issue bonds for cash
***Issuing bonds is an asset source transaction
increases cash and increase bonds payable
FA
Investment in Land
Paying $100,000 cash to purchase land is an asset exchange transaction
decrease in cash and decrease in land
IA
Revenue Recognition
Recognizing $12,000 cash revenue from renting the property is an asset source transaction
increase in cash and retained earnings
Expense Recognition
Mason's $9000 (100,000 x 0.09) cash payment represents interest expense
decrease in cash and retained earnings
Sale of investment in land
selling the land for cash equal to its 100,000 book value is an asset exchange transaction
increase in cash and decrease in land
Payoff of bond liability
repaying the face value of the bond liability is an asset use transaction
decrease in cash and decrease in liabilities
FA
Financial Statement - above example
Effect of semiannual interest payments
Annual interest: 9000 on Dec 31
Semiannual interest: 2 payments of 4500 on June 30 and Dec 31
Bonds issued at a discount
bond discount: Difference between the selling price and the face amount of a bond sold for less than the face amount.
effective interest rate
effective interest rate: actual rate of interest
bond prices
bond prices are normally expressed as a percentage of the face value
Bonds with a face value of $100,000 are issued at 95
Face value os $100,000.
5,000 bond discount (recorded in separate contra liability account, Discount on Bonds Paybale).
Carrying value: face value - the discount on bonds payable
95,000 increase in cash and in carrying value of bond liability (FA)
Recognized interest expense. The interest cost of borrowing has two components: the $9000 paid in cash each year and the $5000 discount paid at maturity
*discount (5000/5 years=1000 per year)
(9000) decrease in cash
1000 increase in carrying value of bond liability
(10000) decrease in RE
*10,000=expense
*9,000=cash flow OA
Paid bond liability
100,000 decrease in cash and bonds payable.
*(95,000) cash flow FA
*(5000) cash flow OA
On January 1, 2012, Moffett Company issued bonds with a $600,000 face value at 98. The bonds had a 9 percent annual interest rate and a 10-year term. Interest is payable in cash on December 31 of each year. What amount of interest expense will Moffett rep
The bonds were issued at a $12,000 ($600,000 � 0.02) discount. The discount will be amortized over the 10-year life at the rate of $1,200 ($12,000 � 10 years) per year. The amount of interest expense for 2014 is $55,200 ($600,000 � .09 = $54,000 annual ca
Bond premium
when bonds are sold for more than their face value, the difference between the amount received and face value
*reduces the effective interest rate
EX: 9% bonds at 105m receiving $105,000 cash on issue dare. Company still required only to repay the $100,00
Market interest rate
when a bond is issued, the effective interest rate is determined by current market conditions. Influences by factors such as economy, government, and law of supply and demand.
market interest rate: effective rate of interest investors are willing to accep
Security for loan agreements
collateral
restrictive covenants
*large loans with long terms to maturity pose more risk to lenders than loans with short terms
collateral
to reduce the risk that they won't get paid, lenders frequently require borrowers to pledge designated assets
EX: car repossession
Restrictive covenants
creditors obtain additional protection by including restrictive covenants in loan agreements.
Such covenants restrict additional borrowing, limit dividend payments, or restrict salary increases.
Liquidy
the more quickly an asset is converted to cash or consumed, the more liquid it is.
Assets are divided into two major classifications: current and concurrent. Current items are also referred to as short term and concurrent items as long term
Current (short-term) asset
expected to be converted to cash or consumed within one year or operating cycle, whichever is longer
Operating cycle
the average time it takes a business to convert cash to inventory, inventory to accounts receivable, and accounts receivable back to cash
current (short-term) liabilities
liabilities due within one year or an operating cycle, whichever is longer
Face value
the market rate of interest is equal to the stated rate
Premium
*the market rate of interest is less than the stated rate
*the stated rate of interest is higher than the market rate
Discount
the market rate of interest is higher than the stated rate
the stated rate of interest is less than the market rate
Classic Corporation borrowed $64,000 from the bank on November 1, 2012. The note had an 7 percent annual rate of interest and matured on April 30, 2013. Interest and principal were paid in cash on the maturity date.
1. What amount of interest expense was paid in cash in 2012? $0 Interest will be paid at maturity of the note, April 30, 2013.
2. What amount of interest expense was reported on the 2012 income statement?
$747 = ($64,000 � 7% = $4,480 ; $4,480 � 2 /12 = $
Compute the cash proceeds from bond issues under the following terms. For each case, indicate whether the bonds sold at a premium or discount.
1. Pro, Inc., issued $196,000 of 8-year, 7 percent bonds at 101
PREMIUM
2.Sim Co. issued $94,000 of 4-year, 6 percent bonds at 98.
DISCOUNT
3.Chu Co. issued $103,000 of 10-year, 7 percent bonds at 102 �.
PREMIUM
4. Sing, Inc., issued $35,000 of 5-year, 6
In each of the following situations, state whether the bonds will sell at a premium or discount.
For each of the following situations, calculate the amount of bond discount or premium, if any
1. Best Co. issued $57,000 of 6 percent bonds at 102.
PREMIUM
2. Morris, Inc., issued $80,000 of 10-year, 8 percent bonds at 96.
DISCOUNT
3. Yang, Inc., issued $224,000 of 15-year, 9 percent bonds at 103 1?4.
PREMIUM
4. Jones Co. issued $103,000 of 20-yea
Use the following information to prepare a classified balance sheet for Steller Co. at the end of 2012
During 2012 and 2013, Gupta Co. completed the following transactions relating to its bond issue. The company's fiscal year ends on December 31. (Use straight-line amortization.)
2012
Mar. 1
Issued $230,000 of 7-year, 8 percent bonds for $226,710. The semi
1. If the bonds had sold at face value, what amount of cash would Gupta Co. have received?
The market rate of interest was greater than the stated rate of interest. Consequently, the bonds sold at a discount. If the bonds had sold at face value, Gupta Co.