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Slide

10-1

Chapter

10

Liabilities
Financial Accounting, IFRS Edition
Weygandt Kimmel Kieso
Slide
10-2

Study
Study Objectives
Objectives

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10-3

1.

Explain a current liability, and identify the major types of current


liabilities.

2.

Describe the accounting for notes payable.

3.

Explain the accounting for other current liabilities.

4.

Explain why bonds are issued, and identify the types of bonds.

5.

Prepare the entries for the issuance of bonds and interest


expense.

6.

Describe the entries when bonds are redeemed.

7.

Describe the accounting for long-term notes payable.

8.

Identify the methods for the presentation and analysis of noncurrent liabilities.

Liabilities
Liabilities

Current Liabilities
Notes payable

Bond basics

Sales taxes payable

Accounting for bond issues

Unearned revenues

Accounting for bond


retirements

Current maturities of longterm debt


Statement presentation
and analysis

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10-4

Non-Current Liabilities

Accounting for long-term


notes payable
Statement presentation and
analysis

Section 1 Current Liabilities


What
What is
is aa Current
Current Liability?
Liability?
Current liability is debt with two key features:
1. Company expects to pay the debt from existing

current assets or through the creation of other current


liabilities.
2. 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.
Slide
10-5

SO 1 Explain a current liability, and identify the


major types of current liabilities.

What
What is
is aa Current
Current Liability?
Liability?

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 2 years.
d. both (a) and (b).

Slide
10-6

SO 1 Explain a current liability, and identify the


major types of current liabilities.

What
What is
is aa Current
Current Liability?
Liability?
Notes Payable
Written promissory note.
Require the borrower to pay interest.
Issued for varying periods.

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10-7

SO 2 Describe the accounting for notes payable.

What
What is
is aa Current
Current Liability?
Liability?
Illustration: On March 1, 2011, Cole Williams borrows
$100,000 from First National Bank on a 4-month, 12% note.
Instructions
a) Prepare the entry on March 1.
b) Prepare the adjusting entry on June 30, assuming
monthly adjusting entries have not been made.
c) Prepare the entry at maturity (July 1).

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10-8

SO 2 Describe the accounting for notes payable.

What
What is
is aa Current
Current Liability?
Liability?
Illustration: On March 1, 2011, Cole Williams borrows
$100,000 from First National Bank on a 4-month, 12% note.
a) Prepare the entry on March 1.
Cash

100,000

Notes payable

100,000

b) Prepare the adjusting entry on June 30.


$100,000 x 12% x 4/12 = $4,000

Interest expense
Interest payable
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10-9

4,000
4,000
SO 2 Describe the accounting for notes payable.

What
What is
is aa Current
Current Liability?
Liability?
Illustration: On March 1, 2011, Cole Williams borrows
$100,000 from First National Bank on a 4-month, 12% note.
c) Prepare the entry at maturity (July 1).
Notes payable
Interest payable
Cash

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10-10

100,000
4,000
104,000

SO 2 Describe the accounting for notes payable.

What
What is
is aa Current
Current Liability?
Liability?
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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10-11

SO 3 Explain the accounting for other current liabilities.

What
What is
is aa Current
Current Liability?
Liability?
Illustration: The March 25 cash register reading for Cooley
Grocery shows sales of $10,000 and sales taxes of $600 (sales
tax rate of 6%), the journal entry is:
Cash

10,600

Sales

10,000

Sales tax payable

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10-12

600

SO 3 Explain the accounting for other current liabilities.

What
What is
is aa Current
Current Liability?
Liability?
Unearned Revenue
Revenues that are received before the company delivers
goods or provides services.
1. Company debits Cash, and credits
a current liability
account (unearned revenue).
2. When the company earns the
revenue, it debits the
Unearned Revenue account,
and credits a revenue account.
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10-13

SO 3 Explain the accounting for other current liabilities.

What
What is
is aa Current
Current Liability?
Liability?
Illustration: Assume that Superior University sells 10,000
season football tickets at $50 each for its five-game home
schedule. The university makes the following entry for the sale
of season tickets:
Aug. 6

Cash
Unearned revenue

500,000

As the school completes


500,000 each of the five home games, it would
record the revenue earned.
Sept. 7

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10-14

Unearned revenue
Ticket revenue
100,000
SO 3

100,000

Explain the accounting for other current liabilities.

What
What is
is aa Current
Current Liability?
Liability?
Unearned Revenue

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10-15

Illustration 10-2
Unearned and earned
revenue accounts

SO 3 Explain the accounting for other current liabilities.

What
What is
is aa Current
Current Liability?
Liability?
Current Maturities of Long-Term Debt
Portion of long-term debt that comes due in the
current year.
No adjusting entry required.

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10-16

SO 3 Explain the accounting for other current liabilities.

Statement
Statement Presentation
Presentation and
and Analysis
Analysis
Presentation

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10-17

Illustration 10-3
Statement of financial position presentation
of current liabilities (in thousands)

SO 3 Explain the accounting for other current liabilities.

Statement
Statement Presentation
Presentation and
and Analysis
Analysis
Analysis
Illustration 10-4

The current ratio permits


us to compare the liquidity
of different-sized
companies and of a single
company at different
times.

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10-18

Liquidity refers to the


ability to pay maturing
obligations and meet
unexpected needs for
cash.
Illustration 10-5

SO 3 Explain the accounting for other current liabilities.

Statement
Statement Presentation
Presentation and
and Analysis
Analysis

Question
Working capital is calculated as:
a. current assets minus current liabilities.
b. total assets minus total liabilities.
c. non-current liabilities minus current liabilities.
d. both (b) and (c).

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10-19

SO 3 Explain the accounting for other current liabilities.

P10-2A. The following are selected transactions of Winsky Company. Winsky prepares
financial statements quarterly.
Jan. 2

Purchased merchandise on account from Yokum Company, $30,000, terms


2/10, n/30.
Feb. 1
Issued a 9%, 2-month, $30,000 note to Yokum in payment of account.
Mar. 31 Accrued interest for 2 months on Yokum note.
Apr. 1
Paid face value and interest on Yokum note.
July 1
Purchased equipment from Korsak Equipment paying $11,000 in cash and
signing a 10%, 3-month, $40,000 note.
Sept. 30 Accrued interest for 3 months on Korsak note.
Oct. 1
Paid face value and interest on Korsak note.
Dec. 1
Borrowed $15,000 from the Otago Bank by issuing a 3-month, 8%
interest-bearing note with a face value of $15,000.
Dec. 31 Recognized interest expense for 1 month on Otago Bank note.
Instructions
(a)Prepare journal entries for the above transactions and events.
(b)Post to the accounts Notes Payable, Interest Payable, and Interest Expense.
(c)Show the statement of financial position presentation of notes and interest payable at
December 31.
(d)What is total interest expense for the year?

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10-20

Section 2 Non-Current Liabilities


Bond
Bond Basics
Basics
Bonds are a form of interest-bearing notes payable.
Three advantages over ordinary shares:
1. Stockholder control is not affected.
2. Tax savings result.
3. Earnings per share may be higher.

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10-21

SO 4 Explain why bonds are issued, and identify the types of bonds.

Bond
Bond Basics
Basics
Effects on earnings per shareequity vs. debt.
Illustration 10-7

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10-22

SO 4 Explain why bonds are issued, and identify the types of bonds.

Bond
Bond Basics
Basics

Question
The major disadvantages resulting from the use of bonds
are:
a. that interest is not tax deductible and the principal
must be repaid.
b. that the principal is tax deductible and interest must
be paid.
c. that neither interest nor principal is tax deductible.
d. that interest must be paid and principal repaid.

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10-23

SO 4 Explain why bonds are issued, and identify the types of bonds.

Bond
Bond Basics
Basics
Types of Bonds
Secured and Unsecured (debenture) bonds.

Mortgage bond, Sinking fund bond

Term and Serial bonds.


Registered and Bearer (or coupon) bonds.
Convertible and Callable bonds.

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10-24

SO 4 Explain why bonds are issued, and identify the types of bonds.

Bond
Bond Basics
Basics
Issuing Procedures
Bond contract known as a bond indenture.
Represents a promise to pay:
(1) sum of money at designated maturity date, plus
(2) periodic interest at a contractual (stated) rate on the
maturity amount (face value).

Paper certificate, 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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10-25

SO 4 Explain why bonds are issued, and identify the types of bonds.

Bond
Bond Basics
Basics

Issuer
Issuer of
of
Bonds
Bonds
Illustration 10-8

Maturity
Maturity
Date
Date

2013

DUE 2013

DUE 2013

Contractual
Contractual
Interest
Interest
Rate
Rate

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10-26

Face
Face or
or
Par
Par Value
Value

SO 4

Bond
Bond Basics
Basics
Bond Trading
Bonds traded on national securities exchanges.
Newspapers and the financial press publish bond prices and
trading activity daily.

Read as: Outstanding 5.125%, $1,000 bonds that mature in 2014.


Currently yield a 5.747% return. On this day, $33,965,000 of these
bonds were traded. Closing price was 96.595% of face value, or
$965.95.
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10-27

SO 4 Explain why bonds are issued, and identify the types of bonds.

Bond
Bond Basics
Basics
Determining the Market Value of Bonds
Market value is a function of the three factors that determine
present value:
1. dollar amounts to be received,
2. length of time until the amounts are received, and
3. 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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10-28

SO 4 Explain why bonds are issued, and identify the types of bonds.

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10-29

SO 4 Explain why bonds are issued, and identify the types of bonds.

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.

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10-30

SO 4 Explain why bonds are issued, and identify the types of bonds.

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
rate are the same.
d. no relationship exists between the two rates.
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10-31

SO 4 Explain why bonds are issued, and identify the types of bonds.

Accounting
Accounting for
for Bond
Bond Issues
Issues
Issuing Bonds at Face Value
Illustration: On January 1, 2011, Candlestick
Corporation issues $100,000, five-year, 10% bonds at 100
(100% of face value). The entry to record the sale is:
Jan. 1

Cash
Bonds payable

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10-32

100,000
100,000

SO 4 Explain why bonds are issued, and identify the types of bonds.

Issuing
Issuing Bonds
Bonds at
at Face
Face Value
Value
Illustration: On January 1, 2011, Candlestick
Corporation issues $100,000, five-year, 10% bonds at 100
(100% of face value). Assume that interest is
payable semiannually on January 1 and July 1. Prepare
the entry to record the payment of interest on July 1, 2011,
assume no previous accrual.
July 1

Bond interest expense


Cash

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10-33

5,000
5,000

SO 4 Explain why bonds are issued, and identify the types of bonds.

Issuing
Issuing Bonds
Bonds at
at Face
Face Value
Value
Illustration: On January 1, 2011, Candlestick
Corporation issues $100,000, five-year, 10% bonds at 100
(100% of face value). Assume that interest is
payable semiannually on January 1 and July 1. Prepare
the entry to record the accrual of interest on December 31,
2011, assume no previous accrual.
Dec. 31

Bond interest expense


Bond interest payable

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10-34

5,000
5,000

SO 4 Explain why bonds are issued, and identify the types of bonds.

Accounting
Accounting for
for Bond
Bond Issues
Issues
Assume Contractual Rate of 8%

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10-35

Market Interest

Bonds Sold At

6%

Premium

8%

Face Value

10%

Discount

SO 5 Prepare the entries for the issuance of bonds and interest expense.

Accounting
Accounting for
for Bond
Bond Issues
Issues
Issuing Bonds at a Discount
Illustration: On January 1, 2011, Candlestick, Inc. sells
$100,000, five-year, 10% bonds for $92,639 (92.639% of
face value). Interest is payable on July 1 and January 1.
The entry to record the issuance is:
Jan. 1

Cash
Bond payable

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10-36

92,639
92,639

SO 5 Prepare the entries for the issuance of bonds and interest expense.

Issuing
Issuing Bonds
Bonds at
at aa Discount
Discount
Statement Presentation

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10-37

Illustration 10-11
Statement presentation of
bonds issued at a discount

SO 5 Prepare the entries for the issuance of bonds and interest expense.

Issuing
Issuing Bonds
Bonds at
at aa Discount
Discount
Total Cost of Borrowing
Illustration 10-12

Illustration 10-13

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10-38

SO 5 Prepare the entries for the issuance of bonds and interest expense.

Issuing
Issuing Bonds
Bonds at
at aa Discount
Discount

Question
Discount on Bonds Payable:
a. has a credit balance.
b. is a contra account.
c. is added to bonds payable on the statement of
financial position.
d. increases over the term of the bonds.

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10-39

SO 5 Prepare the entries for the issuance of bonds and interest expense.

Accounting
Accounting for
for Bond
Bond Issues
Issues
Issuing Bonds at a Premium
Illustration: On January 1, 2011, Candlestick, Inc. sells
$100,000, five-year, 10% bonds for $108,111 (108.111% of
face value). Interest is payable on July 1 and January 1.
The entry to record the issuance is:
Jan. 1

Cash
Bonds payable

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10-40

108,111
108,111

SO 5 Prepare the entries for the issuance of bonds and interest expense.

Issuing
Issuing Bonds
Bonds at
at aa Premium
Premium
Statement Presentation

Illustration 10-14
Statement presentation of
bonds issued at a premium

Issuing bonds at an amount different from face value is quite


common. By the time a company prints the bond certificates and
markets the bonds, it will be a coincidence if the market rate and the
contractual rate are the same.

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10-41

SO 5 Prepare the entries for the issuance of bonds and interest expense.

Issuing
Issuing Bonds
Bonds at
at aa Premium
Premium
Total Cost of Borrowing
Illustration 10-15

Illustration 10-16

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10-42

SO 5 Prepare the entries for the issuance of bonds and interest expense.

Accounting
Accounting for
for Bond
Bond Retirements
Retirements
Redeeming Bonds at Maturity
Assuming that the company pays and records separately
the interest for the last interest period, Candlestick records
the redemption of its bonds at maturity as follows:
Bond payable
Cash

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10-43

100,000
100,000

SO 6 Describe the entries when bonds are redeemed.

Accounting
Accounting for
for Bond
Bond Retirements
Retirements
Redeeming Bonds before Maturity
When retiring bonds before maturity, it is necessary to:
1. eliminate the carrying value of the bonds at the redemption
date;
2. record the cash paid; and
3. 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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10-44

SO 6 Describe the entries when bonds are redeemed.

Accounting
Accounting for
for Bond
Bond Retirements
Retirements

Question
When bonds are redeemed before maturity, the gain or
loss on redemption is the difference between the cash
paid and the:
a. carrying value of the bonds.
b. face value of the bonds.
c. original selling price of the bonds.
d. maturity value of the bonds.

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10-45

SO 6 Describe the entries when bonds are redeemed.

Accounting
Accounting for
for Bond
Bond Retirements
Retirements
Illustration: Assume Candlestick, Inc. has sold its bonds at a
premium. At the end of the eighth period, Candlestick retires
these bonds at 103 after paying the semiannual interest. The
carrying value of the bonds at the redemption date is $101,623.
Candlestick makes the following entry to record the redemption
at the end of the eighth interest period (January 1, 2015):
Bonds payable
Loss on redemption
Cash

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10-46

101,623
1,377
103,000

SO 6 Describe the entries when bonds are redeemed.

Accounting
Accounting for
for Long-Term
Long-Term Notes
Notes Payable
Payable
Long-Term Notes Payable
May be secured by a mortgage that pledges title to
specific assets as security for a loan.
Typically, terms require the borrower to make installment
payments over the term of the loan. Payment consists of
1. interest on the unpaid balance of the loan and
2. a reduction of loan principal.

Companies initially record mortgage notes payable at


face value.
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10-47

SO 7 Describe the accounting for long-term notes payable.

Accounting
Accounting for
for Long-Term
Long-Term Notes
Notes Payable
Payable
Illustration: Porter Technology Inc. issues a $500,000, 12%, 20year mortgage note on December 31, 2011. The terms provide for
semiannual installment payments of $33,231 (not including real
estate taxes and insurance). The installment payment schedule for
the first two years is as follows.
Illustration 10-17

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10-48

SO 7 Describe the accounting for long-term notes payable.

Accounting
Accounting for
for Long-Term
Long-Term Notes
Notes Payable
Payable
Illustration: Porter Technology Inc. issues a $500,000, 12%, 20year mortgage note on December 31, 2011. The terms provide for
semiannual installment payments of $33,231 (not including real
estate taxes and insurance). The installment payment schedule for
the first two years is as follows.
Dec. 31

Cash

500,000

Mortgage notes payable


Jun. 30

Interest expense
Mortgage notes payable
Cash

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10-49

500,000
30,000
3,231
33,231

SO 7 Describe the accounting for long-term notes payable.

Accounting
Accounting for
for Long-Term
Long-Term Notes
Notes Payable
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.
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10-50

SO 7 Describe the accounting for long-term notes payable.

Slide
10-51

Statement
Statement Presentation
Presentation and
and Analysis
Analysis
Presentation
Illustration 10-18

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10-52

SO 8 Identify the methods for the presentation and


analysis of non-current liabilities.

Statement
Statement Presentation
Presentation and
and Analysis
Analysis
Analysis
Two ratios that provide information about debt-paying
ability and long-run solvency are:
1.

Debt to total
assets

Total debt
=

Total assets

The higher the percentage of debt to total assets, the


greater the risk that the company may be unable to meet
its maturing obligations.
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10-53

SO 8 Identify the methods for the presentation and


analysis of non-current liabilities.

Statement
Statement Presentation
Presentation and
and Analysis
Analysis
Analysis
2.

Times
Interest
Earned

Income before income taxes


and interest expense
=

Interest expense

Indicates the companys ability to meet interest payments


as they come due.

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10-54

SO 8 Identify the methods for the presentation and


analysis of non-current liabilities.

Statement
Statement Presentation
Presentation and
and Analysis
Analysis
Analysis
Illustrate: LGs (KOR) had total liabilities of W39,048
billion, total assets of W64,782 billion, interest expense of
W778 billion, income taxes of W1,092 billion, and net
income of W2,967 billion.
Illustration 10-19

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10-55

SO 8 Identify the methods for the presentation and


analysis of non-current liabilities.

P10-3A. On May 1, 2011, Newby Industries issued CHF600,000, 9%, 5-year


bonds at face value. The bonds were dated May 1, 2011, and pay interest
semiannually on May 1 and November 1. Financial statements are prepared
annually on December 31.
Instructions
(a)Prepare the journal entry to record the issuance of the bonds.
(b)Prepare the adjusting entry to record the accrual of interest on December 31,
2011.
(c)Show the statement of financial position presentation on December 31, 2011.
(d)Prepare the journal entry to record payment of interest on May 1, 2012,
assuming no accrual of interest from January 1, 2012, to May 1, 2012.
(e)Prepare the journal entry to record payment of interest on November 1, 2012.
(f)Assume that on November 1, 2012, Newby calls the bonds at 102. Record the
redemption of the bonds.

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10-56

Slide
10-57

Understanding
Understanding U.S.
U.S. GAAP
GAAP
Key Differences

Liabilities

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. Under GAAP, contingent liabilities are recorded in the
financial statements if they are both probable and can be
reasonably estimated. If only one of these criteria is met, then
the item is disclosed in the notes.

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10-58

IFRS uses the term provisions to refer to liabilities of uncertain


timing or amount. Examples of provisions would be provisions
for warranties, employee vacation pay, or anticipated losses.
Under GAAP, these are considered recordable contingent
liabilities.

Understanding
Understanding U.S.
U.S. GAAP
GAAP
Key Differences

Liabilities

Both GAAP and IFRS classify liabilities industries where a


presentation based on liquidity would be considered to provide
more useful information (such as financial institutions) can use
that format instead.
Under IFRS, companies sometimes show liabilities before
assets. Also, they will sometimes show non-current liabilities
before current liabilities. Neither of these presentations is used
under GAAP.

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10-59

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 practice is not used
under GAAP.

Understanding
Understanding U.S.
U.S. GAAP
GAAP
Key Differences

Liabilities

IFRS requires the effective-interest method for amortization of


bond discounts and premiums. GAAP allows use of the
straight-line method where the difference is not material.
GAAP often uses a separate Discount or Premium account to
account for bonds payable. IFRS records discounts or
premiums as direct increases or decreases to Bonds Payable.
The GAAP accounting 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.
Slide
10-60

Understanding
Understanding U.S.
U.S. GAAP
GAAP
Looking to the Future

Liabilities

The FASB and IASB are currently involved in two projects that
have implications for the accounting for liabilities. The FASB
and IASB have identified leasing as one of the most
problematic areas of accounting. The 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? The main issue is
whether the focus should remain on the leased item or should
instead focus on the right to use the leased item. Finally, the
two standard-setting bodies are involved in a far-reaching
project to significantly change the approach used to account
for pensions.
Slide
10-61

Present
Present Value
Value Concepts
Concepts Related
Related to
to Bond
Bond Pricing
Pricing
Present Value of Face Value

Appendix 10A

To illustrate present value concepts, assume that you are


willing to invest a sum of money that will yield $1,000 at the
end of one year, and you can earn 10% on your money.
What is the $1,000 worth today?
To compute the answer,

Slide
10-62

divide the future amount by 1 plus the interest rate


($1,000/1.10 = $909.09 OR

use a Present Value of 1 table. ($1,000 X .90909) =


$909.09 (10% per period, one period from now).

SO 9 Compute the market price of a bond.

Present
Present Value
Value Concepts
Concepts Related
Related to
to Bond
Bond Pricing
Pricing
Present Value of Face Value
To compute the answer,

divide the future amount by 1 plus the interest rate


($1,000/1.10 = $909.09.
Illustration 10A-1

Slide
10-63

SO 9 Compute the market price of a bond.

Present
Present Value
Value Concepts
Concepts Related
Related to
to Bond
Bond Pricing
Pricing
Present Value of Face Value
To compute the answer,

use a Present Value of 1 table. ($1,000 X .90909) =


$909.09 (10% per period, one period from now).
TABLE 10A-1

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10-64

SO 9 Compute the market price of a bond.

Present
Present Value
Value Concepts
Concepts Related
Related to
to Bond
Bond Pricing
Pricing
Present Value of Face Value
The future amount ($1,000), the interest rate (10%), and the
number of periods (1) are known
Illustration 10A-2

Slide
10-65

SO 9 Compute the market price of a bond.

Present
Present Value
Value Concepts
Concepts Related
Related to
to Bond
Bond Pricing
Pricing
Present Value of Face Value
If you are to receive the single future amount of $1,000 in
two years, discounted at 10%, its present value is $826.45
[($1,000 1.10) 1.10].

Illustration 10A-3

Slide
10-66

SO 9 Compute the market price of a bond.

Present
Present Value
Value Concepts
Concepts Related
Related to
to Bond
Bond Pricing
Pricing
Present Value of Face Value
To compute the answer using a Present Value of 1 table.
($1,000 X .82645) = $826.45 (10% per period, two periods
from now).
TABLE 10A-1

Slide
10-67

SO 9 Compute the market price of a bond.

Present
Present Value
Value Concepts
Concepts Related
Related to
to Bond
Bond Pricing
Pricing
Present Value of Interest Payments (Annuities)
In addition to receiving the face value of a bond at maturity,
an investor also receives periodic interest payments
(annuities) over the life of the bonds.
To compute the present value of an annuity, we need to
know:
1) interest rate,
2) number of interest periods, and
3) amount of the periodic receipts or payments.

Slide
10-68

SO 9 Compute the market price of a bond.

Present
Present Value
Value Concepts
Concepts Related
Related to
to Bond
Bond Pricing
Pricing
Present Value of Interest Payments (Annuities)
Assume that you will receive $1,000 cash annually for three
years and the interest rate is 10%.
Illustration 10A-5

Slide
10-69

SO 9 Compute the market price of a bond.

Present
Present Value
Value Concepts
Concepts Related
Related to
to Bond
Bond Pricing
Pricing
Present Value of Interest Payments (Annuities)
Assume that you will receive $1,000 cash annually for three
years and the interest rate is 10%.
Illustration 10A-6

Slide
10-70

SO 9 Compute the market price of a bond.

Present
Present Value
Value Concepts
Concepts Related
Related to
to Bond
Bond Pricing
Pricing
Present Value of Interest Payments (Annuities)
Assume that you will receive $1,000 cash annually for three
years and the interest rate is 10%.
TABLE 10A-2

$1,000 annual payment x 2.48685 = $2,486.85


Slide
10-71

SO 9 Compute the market price of a bond.

Present
Present Value
Value Concepts
Concepts Related
Related to
to Bond
Bond Pricing
Pricing
Computing the Present Value of a Bond
The selling price of a bond is equal to the sum of:
1) The present value of the face value of the bond
discounted at the investors required rate of return
PLUS
2) The present value of the periodic interest payments
discounted at the investors required rate of return

Slide
10-72

SO 9 Compute the market price of a bond.

Present
Present Value
Value Concepts
Concepts Related
Related to
to Bond
Bond Pricing
Pricing
Assume a bond issue of 10%, five-year bonds with a face
value of $100,000 with interest payable semiannually on
January 1 and July 1.
Illustration 10A-8

Slide
10-73

SO 9 Compute the market price of a bond.

Present
Present Value
Value Concepts
Concepts Related
Related to
to Bond
Bond Pricing
Pricing
Assume a bond issue of 10%, five-year bonds with a face
value of $100,000 with interest payable semiannually on
January 1 and July 1.
Illustration 10A-9

Contractual Rate = Discount Rate


Slide
10-74

Issued at Face Value


SO 9 Compute the market price of a bond.

Present
Present Value
Value Concepts
Concepts Related
Related to
to Bond
Bond Pricing
Pricing
Assume a bond issue of 10%, five-year bonds with a face
value of $100,000 with interest payable semiannually on
January 1 and July 1.
Illustration 10A-10

Contractual Rate < Discount Rate


Slide
10-75

Issued at a Discount
SO 9 Compute the market price of a bond.

Present
Present Value
Value Concepts
Concepts Related
Related to
to Bond
Bond Pricing
Pricing
Assume a bond issue of 10%, five-year bonds with a face
value of $100,000 with interest payable semiannually on
January 1 and July 1.
Illustration 10A-11

Contractual Rate > Discount Rate


Slide
10-76

Issued at a Premium
SO 9 Compute the market price of a bond.

Effective-Interest
Effective-Interest Method
Method of
of Bond
Bond Amortization
Amortization
Appendix 10B

Under the effective-interest method, the amortization of


bond discount or bond premium results in period interest
expense equal to a constant percentage of the carrying value
of the bonds.
Required steps:
1. Compute the bond interest expense.
2. Compute the bond interest paid or accrued.
3. Compute the amortization amount.

Slide
10-77

SO 10 Apply the effective-interest method of amortizing


bond discount and bond premium.

Effective-Interest
Effective-Interest Method
Method of
of Bond
Bond Amortization
Amortization
Amortizing Bond Discount
Assume Candlestick, Inc. issues $100,000 of 10%, five-year bonds
on January 1, 2011, for $92,639, with interest payable each July 1
and January 1.

Illustration 10B-2

Slide
10-78

SO 10

Effective-Interest
Effective-Interest Method
Method of
of Bond
Bond Amortization
Amortization
Amortizing Bond Discount
Assume Candlestick, Inc. issues $100,000 of 10%, five-year bonds
on January 1, 2011, for $92,639, with interest payable each July 1
and January 1.
Journal entry on July 1, 2011, to record the interest payment and
amortization of discount is as follows:
July 1

Interest Expense
Cash

5,000

Bonds Payable

Slide
10-79

5,558
558

SO 10 Apply the effective-interest method of amortizing


bond discount and bond premium.

Effective-Interest
Effective-Interest Method
Method of
of Bond
Bond Amortization
Amortization
Amortizing Bond Premium
Assume Candlestick, Inc. issues $100,000 of 10%, five-year bonds
on January 1, 2011, for $108,111, with interest payable each July 1
and January 1.

Illustration 10B-4

Slide
10-80

SO 10

Effective-Interest
Effective-Interest Method
Method of
of Bond
Bond Amortization
Amortization
Amortizing Bond Premium
Assume Candlestick, Inc. issues $100,000 of 10%, five-year bonds
on January 1, 2011, for $108,111, with interest payable each July 1
and January 1.
Journal entry on July 1, 2011, to record the interest payment and
amortization of premium is as follows:
July 1

Interest Expense
Bonds Payable
Cash

Slide
10-81

4,324
676
5,000

SO 10 Apply the effective-interest method of amortizing


bond discount and bond premium.

P10-6A. On July 1, 2011, Atwater Corporation issued $2,000,000 face


value, 10%, 10-year bonds at $2,271,813. This price resulted in an
effective-interest rate of 8% on the bonds. Atwater uses the effectiveinterest method to amortize bond premium or discount. The bonds pay
semiannual interest July 1 and January 1.
Instructions
(Round all computations to the nearest dollar.)
(a)Prepare the journal entry to record the issuance of the bonds on July
1, 2011.
(b)Prepare an amortization table through December 31, 2012 (3 interest
periods), for this bond issue.
(c)Prepare the journal entry to record the accrual of interest and the
amortization of the premium on December 31, 2011.
(d)Prepare the journal entry to record the payment of interest and the
amortization of the premium on July 1, 2012, assuming no accrual of
interest on June 30.
(e)Prepare the journal entry to record the accrual of interest and the
amortization of the premium on December 31, 2012.
Slide
10-82

Straight-Line
Straight-Line Amortization
Amortization
Amortizing Bond Discount

Appendix 10C

Candlestick, Inc., sold $100,000, five-year, 10% bonds on January


1, 2011, for $92,639 (discount of $7,361). Interest is payable on
July 1 and January 1.

Illustration 10C-2

Slide
10-83

SO 11

Straight-Line
Straight-Line Amortization
Amortization
Amortizing Bond Discount
Candlestick, Inc., sold $100,000, five-year, 10% bonds on January
1, 2011, for $92,639 (discount of $7,361). Interest is payable on
July 1 and January 1. The bond discount amortization for each
interest period is $736 ($7,361/10).
Journal entry on July 1, 2011, to record the interest payment and
amortization of discount is as follows:
July 1

Interest Expense
Bonds Payable
Cash

Slide
10-84

5,736
736
5,000

SO 11 Apply the straight-line method of amortizing


bond discount and bond premium.

Straight-Line
Straight-Line Amortization
Amortization
Amortizing Bond Premium
Candlestick, Inc., sold $100,000, five-year, 10% bonds on January
1, 2011, for $108,111. Interest is payable on July 1 and January 1.
Illustration 10C-4

Slide
10-85

SO 11

Straight-Line
Straight-Line Amortization
Amortization
Amortizing Bond Premium
Candlestick, Inc., sold $100,000, five-year, 10% bonds on January
1, 2011, for $108,111 (premium of $8,111). Interest is payable on
July 1 and January 1. The bond discount amortization for each
interest period is $811 ($8,111/10).
Journal entry on July 1, 2011, to record the interest payment and
amortization of discount is as follows:
July 1

Interest Expense
Bonds Payable
Cash

Slide
10-86

4,189
811
5,000

SO 11 Apply the straight-line method of amortizing


bond discount and bond premium.

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Slide
10-92