REPORTING AND ANALYZING LIABILITIES
Claims on total assets
- obligations to employees (current and retired), governments, suppliers, banks and financiers, law suit settlements, customers, etc
“Current” if due within 1 year
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201Lec10.PPTXREPORTING AND ANALYZING LIABILITIESClaims on total assets - obligations to employees (current and retired), governments, suppliers, banks and financiers, law suit settlements, customers, etc“Current” if due within 1 year110Similar calculations to notes receivable. Record principle. Interest only as incurredSometimes, notes are paid off over several years. If so, balance shows split as follows: Current Liabilities: Current Maturity of Long-Term Debt $ xxxxx Long-term Liabilities: Long-term Debt $ xxxxx2Notes PayableAlso called Installment notes. - Make periodic payments over the life of note. Installment payment schedule3Mortgage Notes PayableEXAMPLE: On January 1, 2015 Konk borrowed $20,000 at an annual interest rate of 10%. The loan requires 6 annual payments of $4,592.15. Prepare an installment payment schedule.Payment Amount Interest** Principal Balance (Balance)(10%) (Amount-Interest)4** Use 5% if semi-annual payments, use 2.5% if quarterly payments!1-1-15 20000.001-1-16 4592.15 2000.00 2592.15 17407.851-1-17 4592.15 1740.78 2851.37 14556.481-1-18 4592.15 1455.65 3136.50 11419.981-1-19 4592.15 1142.00 3450.15 7969.831-1-20 4592.15 796.98 3795.17 4174.661-1-21 4592.12 417.46 4174.66 0 Balance sheet at 12/31/15Current liabilities:Interest payable (recorded by AJE on 12/31/15) >>>>>> $ 2,000.00Current portion of long-term debt 2,592.15Long term liabilities: – Notes payable $17,407.85 Assessed on buyer but collected by seller. - Seller is liable for determining when sales tax applies and how much to charge. Generally on tangible goods, not services. States have varying rules and exceptions. - Required for sales to an in-state buyer.Once collected, sales tax payable is a liability of seller. If seller isn’t liable, states assess a “use” tax payable by the buyer.5Current Liabilities – Sales Tax PayableEMPLOYEE’S TAXES WITHHELD:FICA (or OASDI) is made up of two components: - Social Security (up to a maximum) - Medicare (on unlimited wages) Both are a percentage of gross wagesFederal income tax FIT - Based on filing status State income tax SIT “ “ “ “6Current Liabilities – Payroll PayablesEMPLOYERS TAX EXPENSE: Match employee FICA (Social Security & Medicare)Federal Unemployment FUTA State Unemployment SUTA (or SUI)- Depends on state Employers also have required workers comp insurance and other optional fringes (health insurance, pension, vacation, etc).7Current Liabilities – Payroll PayablesEXAMPLE: Record $10,000 of wages & related payroll taxes.To record wages and EMPLOYEE withholdings:Wage Expense 10000.00 FICA payable (assume amount given in facts) 765.00 FIT payable (assume amount given in facts) 1500.00 SIT payable (assume amount given in facts) 400.00 Wage payable (or cash if payday) 7335.00 To record EMPLOYER payroll tax expense:Payroll Tax Expense FICA payable (Match employee) 765.00 FUTA payable (assume amount given in facts) 80.00 SUTA payable (assume amount given in facts) 360.008(Plug) 1205.00Cash received before revenue is earned creates a liability. For example:Customer deposits for future service (retainers)Sale of airline tickets for future travelSale of season tickets to sporting eventsRent received in advanceMagazine subscriptions Packers9Unearned Revenues (also in chapters 3, 4)BONDS Form of debt similar to notes payable.Typically very Long-Term borrowing where large $ needed.Somewhat like common stock in that bonds are sold to general public in small denominations.All Bonds have: Face value - Basis for interest and principal. Contract Rate - Fixed interest rate.10Bond Issue is registered with the SEC.Bond Indenture is a legal document which provides all details, agreements, etc about a bond issue. - contract rate, face amount - security if default - payment terms - callable or convertible, etc.Bonds are usually sold through an underwriter (often a stock broker) to the public.11Issuing corporation gets face value now.Investor gets interest over bond life + face value at maturity. 1/1/15 $200 million Every 6 months for 50 years $12 million issuer 1/1/65 $200 million 12EXAMPLE: On 1/1/15, issue bond with: Face Value = $200 million. Matures in 50 years. Contract rate = 12%, paid semi annually. interest payment = 200 million x .12 x 6/12 = $12 million investorBond Cash Flows Contract Rate is fixed rate over life of bondRATEL I F E O F B O N D Market Rate is current borrowing rate. Changes daily! L I F E O F B O N DRATE13Amount received by issuing company depends on current market interest rate on date of sale.EXAMPLE: Assume on 1/1/15 issuer has approval by SEC for a bond issue with a contract rate of 12%. Several $20,000 bonds are sold over a 6 month period.Assume market rate on 1/15/15 = 12%. Bond will sell for Price = “100” or “Par”. Means 100% of Face value Assume market rate on 3/1/15 = 13%. Bond will sell at a “discount. Price less than 100. Assume market rate on 6/1/15 = 11%.Bond will sell at a “premium”. Price more than 100. Sold 1/15/15Sold 3/1/15Sold 6/1/1514Contract rate (Fixed) is Blue lineMarket rate (varies daily) is red line R 11%A 12%T 13%EL I F E O F B O N DSell at premiumSell at loss15Sell at parMarket rate to price Inverse relationshipIssuing the bond at par (face value): Cash 20000 Bonds Payable 2000016Journal EntriesIssuing the bond at $1,000 DISCOUNT: Cash 19,000 Discount on Bonds Payable 1,000 Bonds Payable 20,000 Note: Discount on Bonds Payable is a “contra-liability” account.17Journal EntriesCarrying (Book) Value of BondsBalance Sheet Long-term liabilities: Bonds payable $20,000 Less: DISCOUNT on bonds payable 1,000 $19,000 * * Called “carrying value” of bonds18Issuing the bond at $1,000 PREMIUM: Cash 21,000 Premium on Bonds Payable 1,000 Bonds Payable 20,000 Note: Premium on Bonds Payable is ADDED to the bond liability on the balance sheet.19Journal EntriesGAAP treats difference between par and actual sale price of bond as an adjustment to interest. ADJUSTMENT is referred to changing the yield of the bond from the contract interest rate to the market interest rate.Adjustment is recorded each time interest is paid using a straight-line amortization of discount or premium. We won’t cover the effective interest amortization option. It is sort of like a double declining balance method.20GAAP rules for Discount or PremiumExample: Assume $20,000 bond paying 12% semi annually was issued at a $1,000 discount. $1,200 of interest is due every 6 months for 50 years (100 interest payments).Amount due at maturity 20,000Amount received on issue 19,000Additional interest (per GAAP) 1,000 Discount amortization = $1,000 / 100 = $10 * * Add to interest expense for each 6 month payment21Journal entry - Interest payment (Every 6 months): Interest Expense (1200 + 10) 1210 Cash 1200 Discount on Bonds Payable 1022Balance Sheet Long-term liabilities: Bonds payable $20,000 Less: DISCOUNT on bonds payable 990 * $19,010 * 1,000 – 10 amortization = 990 Note: A premium gets added. 23Variation: Say it was issued at a $1,000 Premium.That means interest adjustment is negative!Journal entry to record interest expense every 6 months: Interest Expense (1200 – 10) 1190 PREMIUM on Bonds Payable 10 Cash 1200 Bonds Payable 20000 Cash 20000 Note: Balance in discount or premium account would have been amortized down to zero by the time the bond is redeemed. If redeemed at maturity, face amount is payable if issued at par, discount or premium24If redeemed before maturity, record gain or loss = Cash paid less bond carrying value.Journal Entries – Redeeming BondsAre events with uncertain outcomes. Lawsuits, money back guaranties, mail in rebatesGAAP rule: Must be recorded as a liability if: - the company can determine a reasonable estimate of the expected loss and - it is probable it will occur.Otherwise, mention in footnotes25Other Issues – Contingent LiabilitiesGAAP Rule for Capital Lease Treatment:Sometimes, a lease is really a disguised asset purchase. For example: Lease a car worth $22,000 for 2 years with monthly payments of $1,000. ($24,000 total payments) Also get option to purchase it for $1 at end of lease.GAAP requires this type of lease to be recorded as if it were an asset purchase and future lease payments to be recorded as liabilities. - Rigorous calculations are needed using present values. (A normal lease (like in chapter 9), is called an operating lease)26Other Issues – Lease LiabilitiesLIQUIDITY RATIOS: - Current Ratio Previously discussed in chapter 2.SOLVENCY RATIOS: - Debt to Total Assets Ratio Previously discussed in chapter 2. - Times Interest Earned Ratio - Discussed next27RatiosTimes Interest Earned Ratio... Provides an indication of company’s ability to meet interest payments as they come due. Times Interest Earned Ratio = Income Before Interest Expense & Income TaxInterest Expense28