Prof Johnson Acct 202 Chapter 8 & Appd B Powerpoint Lecture Slides

Prof Johnson Acct 202
CHAPTER 8 & Appd B

PowerPoint Lecture Slides
Ch8-- Accounting for Current and

Long-Term Liabilities
Appd B-- Time Value of Money
Opening Vignette - AMR
Corporation
Alliances between companies in different industries
Transportation = airlines
Hospitality = hotels
often create obligations for one party in the alliance.
Refer to the AMR Corporation situation described

in the opening pages of the textbook
Corporation
Corporation
Holiday Inn and other partner
companies pay AMR to credit
air miles to customer frequent
flyer accounts
These payments represent
liabilities for AMR Corporation
Payments represent obligation
to provide future transportation
to frequent flyers
Chapter Learning Objectives
1. Account for current liabilities

2. Identify and report contingent
liabilities
3. Account for basic bonds payable
transactions
4. Measure interest expense, amortize
bond discount and premium by the
effective-interest method
Chapter Learning Objectives
5. Explain the advantages and

disadvantages of borrowing
6. Account for lease transactions
7. Report liabilities on the balance
sheet
Chapter Objective 1
Account for current liabilities
Liabilities
Obligation to transfer assets

Or provide future services
Resulting from past transactions
Liabilities
Obligation to transfer assets
Or provide future services
Resulting from past transactions
Can you think of examples?
Liabilities Incurred When a
Business ...
Purchases inventory
on account
SAN
T
ORD AS
ERS
Business ...
Borrows money and

makes (signs) a
note payable
Business ...
Accrues interest
payable on a note or
loan with the
passage of time
Current Liabilities
Payable within one year

Companys operating cycle, if longer than
one year
Current liabilities classified in two ways
(1) Known amount
(2) Estimated amount
Current Liabilities of Known
Amount
Accounts Payable
Short-Term Notes Payable
Short-Term Notes Issued at Discount
Sales Tax Payable
Current Portion of Long-Term Debt
Accrued Expenses
Accounts Payable
Amounts owed to
vendors (suppliers)
for goods or
services purchased
on account
Journalize Asian Art,
Inc.s $350 purchase
of office supplies on
account
Accounts Payable
9/28/x6 Office Supplies $350
A/P $350
To record supplies purchased on account
Businesses often maintain subsidiary A/P

ledgers to track amounts owed to individual
vendors
Task made easier by computers
Promissory note signed by the company payable
within the year
Company recognizes liability to repay principal
amount borrowed
Plus accrued interest expense/payable
EXAMPLE:
The Valley Chamber Orchestra signs a $10,000,
60-day note payable in exchange for some
remodeling done in its leased office space.
The 60-day note bears interest at 9% annually,
and is made on November 15, 1998.
11/15/98 Leasehold Improvements $10,000

Note Payable, Short-Term $10,000
To record note issued for leasehold improvement
At fiscal year-end, December 31, the Orchestra
must accrue interest payable on the note.
12/31/98 Interest Expense $115

Interest Payable $115
To accrue 1998 interest expense on note
($10,000 x .09 x 46*/360)
* Nov. = 15 days Dec. = 31 days
Short-Term Notes Payable Issued
at a Discount
Entity taking the note
deducts interest from
amount being
borrowed
Remits less than
notes face value to
the borrower
Borrower repays face
value at notes
maturity
at a Discount
Same $10,000, 60-day,
$150 interest
9% note as a discounted
note payable ...
$9,850
proceeds
remitted to
borrower
at a Discount
Same $10,000, 60-day,
$150 interest
FACE VALUE = $10,000

note payable ...
$10,000 x .09 x 60/360 =
$150 total interest
at a Discount
Same $10,000, 60-day,
$150 interest

note payable ...
$10,000 x .09 x 60/360 = $9,850
$150 total interest proceeds
remitted to
$10,000 - $150 = $9,850
borrower
remitted to borrower
at a Discount
Same $10,000, 60-day,
$150 interest

note payable ...
$10,000 x .09 x 60/360 = $9,850
$150 total interest proceeds
$10,000 - $150 = $9,850
remitted to
borrower
remitted to borrower
Borrower repays $10,000
face value on January 15,
1999
at a Discount
11/15/98 Cash $9,850
Discount on Note Payable 500
Notes Payable, Short-Term $10,000
To record discounted note payable
Accrued interest expense at year-end:

12/31/98 Interest Expense $150
Discount on Note Payable $150
To record 1998 interest expense
Sales Tax Payable
State and local taxes
assessed on retail sales
DEPT. OF REVENUE Sales tax collected by
company along with
sales revenue
Sales tax periodically
remitted to local/state
government agencies
Sales Tax Payable
Rays Seafood Shack sold $3,475 of
food and beverages (excluding tax)
on a busy summer Friday evening
Florida state sales tax is 6%, and
Monroe County imposes a Tourist
Development tax of .5%
What is the journal entry to
recognize Rays sales tax payable?
Sales Tax Payable
7/9/x3 Cash $3,701
Sales Revenue $3,475
State Sales Tax Payable 209
County Sales Tax Payable 17
To record sales revenue for July 9
Retail POS systems easily capture sales

revenue and related tax data
Current Portion of Long-Term
Debt
Portion of long-term debt principal due within one
year
Adjusting entry reclassifies principal from long-term
liability to current liability
12/31/x7 Cur. Portion of Long-Term Debt $5,000

Note Payable, Long-Term $5,000
To adjust current liabilities for current portion of
long-term note payable
Debt
Liability section of Asian Art, Inc.s balance sheet
Current Liabilities
Accounts Payable $20,000
Interest Payable 6,000
Debt
Current Liabilities
Current Portion of Long-Term Debt 21,000
Debt
Current Liabilities
Total Current Liabilities $47,000
Debt
Current Liabilities
Long-Term Notes Payable 190,000
Debt
Current Liabilities
Long-Term Notes Payable 190,000
TOTAL LIABILITIES $237,000
Accrued Expenses
Result of adjusting entries accruing expenses
incurred but not yet recognized
Wages/Salary Payable
Interest Payable
Taxes Payable
AMR Corporations Air Traffic Liability
Marriott Internationals Other Payables and
Accruals, including such frequent stay programs as
Marriott Miles, INNsiders Club, and Courtyard Club
Payroll Liabilities
Significant expense for many companies
Total wages, salary, commissions, bonuses
paid to company employees in exchange for
their services
Refer to Textbook Exhibit 8-1 for adjusting
entry prepared at end of accounting period to
recognize payroll expense and related current
liabilities
Payroll Liabilities
Deductions from employee payroll include:
Federal income taxes
Social Security taxes
State/local income taxes
Group insurance (health/life) premiums
Union dues
Credit union savings or loan repayment
Contribution to 401(k) pension plans
Unearned Revenues
Cash received from
customers prior to
earning revenue
Prior to delivering
goods or providing
services to
customers
Unearned Revenues
When customer prepays for a
product or service, company has
obligation to:
(1) Provide the
product/service in the
future
(2) Refund the unearned
revenue to customer
Unearned Revenues
Customers of the Des

Moines Register can
prepay a 52-week
newspaper subscription
in advance. If the
subscription costs $108,
how does the Register
adjust its balance sheet
for unearned revenues?
Unearned Revenues
A customer prepays her 52-week newspaper
subscription beginning October 13, 19x4
10/13/x4 Cash $108

Unearned Subscription Rev. $108
To record prepaid 52-week subscription
The Registers fiscal year ends on December 27,

19x4. What adjusting entry must be made?
Unearned Revenues
12/27/x4 Unearned Subscript. Rev. $22.55

Subscription Revenue $22.55
To recognize revenue earned in 19x4*
*$108 / 52 weeks = $2.0769 / week

$2.0769 / 7 days = $.2967 / day
$.2967 x 76 days (October 13 through December 27)
Current Liabilities That Must Be
Estimated
Estimated Warranty
Payable
Estimated Vacation
Pay and Sick Pay
Liability
Estimated Warranty Payable
Manufacturing and retailing companies often
provide guarantees on products
30-60-90 days or one year in length
Matching principle requires company to
estimate expense of providing warranty and
recognize it in same accounting period as
revenue earned from product sale
Suppose Cisco Systems -
a manufacturer of
networking hubs and
routers
offers a 90-day warranty on
equipment it sells
Further, suppose Ciscos

recent actual warranty work
amounts to .75% of all
products sold.
If Ciscos December 19x1 revenues are
$3,500,000, what adjusting entry is necessary to
estimate expense and current liability?
12/31/x1 Warranty Expense $26,250

Est. Warranty Payable $26,250
To record December warranty expense
When Cisco Systems
actually replaces hubs
or routers under
warranty ...
When Cisco Systems
actually replaces hubs
or routers under
warranty ...
2/2/x2 Est. Warranty Payable $2,000

Inventory $2,000
To record products replaced under warranty
Estimated Vacation
and Sick Pay
Estimated Vacation and Sick Pay
Vacation and sick pay accrued in
accounting period when earned
If Asian Art, Inc. employees earn
one sick day and one vacation
day per month, what adjusting
entry is necessary at end of June
to accrue these liabilities?
Estimated Vacation and Sick Pay
Use a 40-hour work week (160 hours per month) and
total monthly payroll of $8,700
6/30/x6 Vacation Pay Expense $435

Sick Pay Expense 435
Estimated Vacation Pay Liab. $435
Estimated Sick Pay Liab. 435
To record vacation and sick pay accruals for June
Chapter Objective 2
Identify and report contingent liabilities
Contingent Liabilities
Liability related to a
past transaction
Dependent upon a
future event
Guaranteeing debts of
others
Awaiting outcome of
pending lawsuit
Reporting guidelines rooted in several
accounting principles:
Full disclosure
Conservatism
Materiality
Representational faithfulness
3 Ways to
Classify
Contingencies
Probable
Possible
Remote
Probable
More likely than not that a loss will be incurred
$ amount of loss can be reasonably estimated
Possible
Reasonably possible loss will be incurred
Remote
Not likely that loss will be incurred
Probable and reasonably
estimable
Asian Art agrees to pay
note payable of one of its
suppliers if the supplier
defaults on the note
At time supplier defaults,
Asian Art knows the
liability is probable LOAN
(certain) and knows the PAYMENT
amount of the loss
Probable and reasonably

estimable
Asian Art will record
adjusting entry to accrue
expense and liability
Disclose additional
information about liability LOAN
in footnotes to financial PAYMENT
statement
Possible
Rays Seafood Shack is
defendant in negligence lawsuit
Customer slipped off
sailboat during one of Rays
sunset champagne cruises
At year-end, case has not been
decided
Rays lawyer does not believe
the plaintiff will be successful
in her claim against restaurant
Possible
Rays Seafood Shack would
prepare a brief disclosure to be
included in the financial
statement footnotes only
Remote
A former member of the Valley Chamber
Orchestras staff sues the organization for wrongful
discharge after being fired
The Orchestras labor attorney is confident the
organization will be found innocent, especially in
light of the former employees work record which
includes warnings about sexual and discriminatory
harassment of organization employees
Remote
The Orchestra neither accrues
the estimated gain/loss nor
reports details in footnotes to
the financials
Begin Discussion of Appendix B:
Time Value of Money
Appendix B: Accounting and the Time Value of Money
After studying this chapter you should be able to:

Identify accounting topics where time value of money is
relevant.
Distinguish between simple and compound interest.
Learn how to use appropriate compound interest tables.
Identify variables fundamental to solving interest
problems.
Solve future and present value of 1 problems.
Solve future value of ordinary problems.
Solve present value of ordinary annuity problems.
Introduction
Concept of the time value of money is very
important especially when interest rates are high
and/or time periods are long.
Simply put--You are not indifferent as to when you
receive or pay an identical sum of money. That is, a
dollar received or paid today (the present) is not
worth a dollar received or paid tomorrow (the future).
Someone owes you, a rational person, $100. They
say to you--Which would you prefer: I pay you $100
today or I pay you $100 one year from now?
3
Introduction
Your response should be--Pay me $100 today (present).
WHY? Assuming there is no inflation, would your
answer change?
Again, your response should be to be paid today. You
could take the funds today, invest them, earn a return
and have more than $100 a year from now. How much
more than $100 would depend on the return you could
earn (interest).
Suppose, instead, someone offers you $100 one year
from today. You wish the funds now (today), however.
Will you accept less than $100 in settlement of the debt?
4
Introduction
Considering the interest rates, you will accept less than $100 today
to settle the debt. WHY?
If you had the settlement today you could invest it, earn a return and
have $100 one year from now. If the interest rate is high you would
accept less to settle the debt than if the interest rate was low.
Simply put, at any interest rate:

A dollar received today is worth
more than a dollar in the future.
A dollar in the future is worth less
than a dollar today. 5
Introduction
The concept of the time value of money is pervasive. We
see this concept in many topics including (to name a few):
Leases
Pensions
Non-interest bearing notes
Installment contracts
Valuation of bonds
Sinking fund provisions
The FASB will simplify calculations by stating, at times, the
time value of money is to be ignored. You must realize the
import of that assumption as well!
6
Interest
Definitions of interest:
A fee for the use of money
Principle x Interest Rate x Time = Interest
Principle: The amount borrowed or invested.
Interest rate: A percentage of the
outstanding principle. Always expressed
as an annual rate.
Time: The number of years or fraction
thereof that the principle is outstanding.
7
Interest
Selection of appropriate
interest rate is critical
and, at times, very
difficult. Would you be a
wealthy person if you
could accurately predict
the interest rate?
The interest for us will be
a given figure. In
practice it can be the
hardest figure to derive
accurately.
8
Interest
Elements of the interest rate: The interest rate is the sum of

Pure rate of interest (system risk) Initial rate charged
assuming no possibility of default and no inflation.
Credit risk rate of interest (individual risk) Additional
rate charged as a result of an individual entitys risk
of default.
Expected inflation rate of interest (inflation premium)
Additional rate charged to compensate for the
decrease in the purchasing power of the dollar over
time.
9
Interest
Simple interest is computed on the principle only.

That is, interest is earned and removed. The interest
does not earn interest.
Compound interest is computed on the principle and

any accumulated interest. Both the principal and interest
then earn interest.
10
Types of Problems
For our calculations we will assume compound interest.

The greater the number of periods and the higher the
interest rate, the greater will be the effect of compounding
interest.
Types of problems we will be working with:
Single Sum.
Sum One sum ($1) will be received or paid
either in the
Present (Present Value of a Single Sum or
PV)
PV
Future (Future Value of a Single Sum or FV)
FV
11
Types of Problems
Types of annuity problems:

problems
Ordinary annuity (OA)
OA
A series of equal payments (or rents) received
or paid at the end of a period, assuming a
constant rate of interest.
Value today of a series of equal, end-of-period
payments received in the future is the Present
Value of an Ordinary Annuity or PV-OA.
PV-OA
Value in the future of a series of equal, end-of-
period payments received in the future is the
Future Value of an Ordinary Annuity or FV-
OA.
12
Types of Problems
Annuity Due (AD)
AD
A series of equal payments (or rents) received or
paid at the beginning of a period, assuming a
constant rate of interest.
Value today of a series of equal, beginning-of-
period payments received in the future is the
Present Value of an annuity due or PV-AD.
PV-AD
Value in the future of a series of equal, beginning-
of-period payments received in the future is the
Future Value of an annuity due or FV-AD.
13
Types of Problems
Note: The difference between an ordinary annuity and an annuity due is that:
Each rent or payment compounds (interest added) one more

period in a annuity due, future value situation.
Each rent or payment is discounted (interest removed) one
less period under the annuity due situation.
Given the same i, n and periodic rent, the annuity due will
always yield a greater present value (less interest removed)
and a greater future value (more interest added).
14
Calculation Variables
There will always be at least four variables in any
present or future value problem. Three of the four will
be known and you will solve for the fourth.
Single sum problems:
problems
n = number of compounding periods
i = interest rate
PV = Value today of a single sum ($1)
FV = Value in the future of a single sum
($1)
15
Calculation Variables
Annuity problems:
problems
n = number of payments or rents
i = interest rate
R = Periodic rent received or paid
And either:
FV-OA or AD = Value in the future of a series of future
payments (either ordinary or due). OR
PV-OA or AD= Value today of a series of payments in
the future (either ordinary or due).
Note: The n and the i must match. That is, if the time
period is semi-annual then so must the interest rate. Interest
rates are assumed to be annual unless otherwise stated so
you may have to adjust the rate to match the time period.
16
Single Sum Problems
Lets review the derivation of the single sum formula:
Suppose you have $100 today (present) and wish to deposit it at
10% for three periods, in this case years. What is the value of
this single sum in the future?
At the end of the first year (n = 1): (Compound interest)
$100 + $100(.1) = $110
At the end of the second year ( n = 2)
$110 + $110(.1) = $121
At the end of third year (n = 3)
$121 + $121(.1) = $133 (rounded)
So the future value of $100 three years hence at 10% = $133
17
Single Sum Problems
I realize there is a simpler way to approach this:
$100 (1 +.1)(1+.1)(1+.1) = $133
$100 (1+.1)3 = $133
Generally for any n and i the single sum formula would be:
PV (1+ i)n = FV
$100 (1+.1)3 = $133
18
Single Sum Problems
Not wishing to have to constantly raise the term to the
required power I name the term (1+ i)n, the Future
Value Factor for a single term (FVFn,i ). I then employ
the table on page 320-321. The table is the result of the
required multiplications at various n and i and is to be
read vertically for the n and horizontally for the i.
To solve my problem using the table:
PV(FVFn,i ) = FV where n = 3 and i = 10%
$100 (1.331) = $133
19
Single Sum Problems
Note:
For single sum problems the n refers to
periods not necessarily defined as years!
The period may be annual, semi-annual,
quarterly or another time frame.
In manual calculations the use of the table is
strongly recommended. It enhances both
speed and accuracy.
20
Single Sum Problems
Now suppose instead of $100 today I am to receive $133
three years from now. Again the interest rate is 10%. I dont
want to wait three years for my money. How much will I
accept today in lieu of the future payment?
Going back to the general formula for a single sum:
PV(FVFn,i ) = FV
I realize I can isolate the term I wish to solve for on one side
of the equation:
PV = FV divided by (FVFn,i )
and rearranging terms:
PV = FV ( 1/ FVFn,i )
21
Single Sum Problems
Not wishing to have to constantly raise the term to the required
power and then divide it into 1, I name the term 1/ FVF n,i the
Present Value Factor for a single sum (PVF n,i ).) I restate the
formula
PV = FV (PVF n,i )
I then employ the table on page ???. The table is the result of the
required multiplications and division at various n and i and is to
be read vertically for the n
and horizontally for the i
22
Single Sum Problems
To solve my problem using the table:
Please look up the values on the tables as we go
along!
n = 3, i = 10%, FV = $133
PV = FV (PVF n,i )
PV = $133 (.75132)
PV = $100
23
Single Sum Problems
Note: Review the tables and note their characteristics.
They are very logical.
All sums in the future are worth less than themselves in
the present. All factors on the present value of a single
sum table are less than one.
All factors on the future value of a single sum table are
greater than one. All present sums are worth more than
themselves in the future.
Notice how the factors change dramatically as the i
increases and the n lengthens!
24
Single Sum Problems
Single Sum problems, other unknowns.
Suppose you have $6,000 today (PV ) and you need $9,000
five years hence. What rate of annual interest must you earn
to achieve your goal?
Note: This can be solved as either a future or present value of a

single sum problem. The formulas are reciprocals of each other.
25
Single Sum Problems
To solve as a future value of a single sum problem:
PV(FVFn,i ) = FV where n = 5 and i = ?
$6,000 (FVFn,i ) = $9,000
FVFn,i = $9,000/$6,000 = 1.500
Looking on the future of a single sum table (page ???) for n

= 3 and a FVF of 1.500, I find the corresponding i to
be between 8-9%.
26
Single Sum Problems
Alternatively, suppose I have $750 today. How long will I have to
wait to have $1,200 when the interest rate is 10%? I will solve this
as a PV problem.
PV = FV (PVF n,i )
$750 = $1,200 (PVF n,i ) where n = ? and i = 10%
PVF n,i = $750/$1,200 = .625
Reading on the present value of a single sum table (page ???) for
10% the n for the factor .625 is between 4-5 periods.
A more precise answer may be derived through the use of the

mathematical technique of interpolation.
27
Annuity Problems
Suppose I am to receive three equal $100 payments (R) each at the
end of the period (in this case a period is a year) when the interest
rate is a constant 15%. This is an ordinary annuity since payments
are at the end of the period. What is the value to me at the end of
the third year from receiving this annuity? This is a future value of
an ordinary annuity problem. How do I go about solving it?
I realize an annuity is really a series of single sums.
If I take the FV for each single sum and add them I will have the
value of the entire stream of payments.
I will use the FV formula which is:
PV(FVFn,i ) = FV
28
Annuity Problems
Rent # Cmpd periods Sum FVF FV All at i =
15%
1 2 $100 1.322 $132
2 1 $100 1.150 $115
3 0 $100 1.000 $100
Totals 3.472 $347
This is tedious! I notice I am multiplying a constant rent ($100)
by a changing interest factor. What if I added the three factors
and multiplied the total by the rent? That would be less work!
Ill call the sum of the appropriate factors the FVF-AO n,i. Ill
derive the general formula where R equals the constant rent:
FV-OA = R (FVF-AO n,i ) when I = 15% and n = 3 payments
FV-OA = $100 (3.472) = $347 (rounded)
29
Annuity Problems
Where do I get these summed factors? From
the future value of an ordinary annuity table
on pages ???. The addition for the
appropriate n and i has already been
done. The annuity tables are derived directly
from the single sum tables.
30
Annuity Problems
Lets take the case of the present value of an ordinary
annuity. That is, what is a stream of future payments worth
today? What sum do you need today to draw out a series of
equal payments and have nothing left over? This situation is
very common in retirement cases or the payment of debt.
Bonds Payable
ABC Company
32
Annuity Problems
Suppose you are to pay three rents of $500, each at the

end of the next three years. The interest rate is 8%. How
much should I set aside today to have the required rents?
Again I realize an annuity is simply a series of single
sums. I take the same approach as before in that I
discount (remove) interest from each of the rents.
I take the present value of each, add, and I will have
the required sum (total present value) that I will need.
I use the formula: PV = FV (PVF n,i )
33
Annuity Problems
Rent # Disc periods Sum PVF PV All at i =
8%
1 1 $500 .92593 $463
2 2 $500 .85734 $429
3 3 $500 .79383 $397
Totals 2.5771 $1,289
This is tedious! I notice I am multiplying a constant rent ($500)
by a changing interest factor. What if I added the three factors
and multiplied the total by the rent? That would be less work!
Ill call the sum of the appropriate factors the PVF-AO n,i. Ill
derive the general formula where R is the constant rent:
PV-OA = R (PVF-AO n,i) for n = 3 payments and i = 8%
PV-OA = $500 (2.5771) = $1,289 (rounded)
34
Annuity Problems
Where do I get these summed factors? From
the present value of an ordinary annuity table
on pages ???. The addition for the
appropriate n and i has already been
done. The annuity tables are derived directly
from the single sum tables.
35
End Discussion of Appendix B:
Time Value of Money and Start
Discussion of Long Term
Liabilities-- Bonds Payable
Chapter Objective 3
Account for basic bonds
payable transactions
Financing Operations with
Long-Term Debt
Large corporations
borrow huge amounts
of money by issuing
bonds to lenders
Individuals
Corporate investors
Pension plans
Insurance
Long-Term Debt
Bonds are interest-bearing, long-term notes
payable
Bond certificate provides written evidence of
borrowing companys obligation to repay
lender for principle borrowed plus
accumulated interest
Refer to textbook Exhibit 8-2 for a picture of a
bond certificate
Long-Term Debt
Bond certificate states

Debenture Bonds
Long-Term Debt

Debenture Bonds Principle (face or maturity
MGM Grand, Inc. value)
$10,000.00
Long-Term Debt

$10,000.00 Contract interest rate
Eight percent (annual %)
Long-Term Debt

$10,000.00 Contract interest rate
Eight percent (annual %)
Interest payment dates
November 30, 2008 (usually semi-annually)
Types of Bonds
Secured (mortgage) bonds
Entitle bondholders rights to specific assets
in event company defaults on bond interest
payments or maturity payment
Unsecured (debenture) bonds
Bondholders backed by reputation and
integrity of the company
More risky, therefore pay higher interest
rate than secured bonds
Bond Prices
Initial bond issue
prices
determined by
borrower and
bond underwriter
Prices of bonds
traded on
secondary
market based on
variety of factors
Bond Prices
Affected by:
Time to maturity
Credit rating of
issuing company
Contract interest
rate compared to
market interest rate
Bond Prices
Expressed in terms
of percent of face
value
Bond Prices
Expressed in terms
of percent of face
value $10,000 face value bond
Bond Prices
Expressed in terms
of percent of face
Bond price might be:
98.75
Bond Prices
Expressed in terms
of percent of face
98.75 98.75% of face value
$9,875
BOND SOLD AT A DISCOUNT
Bond Prices
Expressed in terms
of percent of face
100
Bond Prices
Expressed in terms
of percent of face
100 100% of face value

$10,000
BOND SOLD AT PAR
Bond Prices
Expressed in terms
of percent of face
104.5
Bond Prices
Expressed in terms
of percent of face
104.5 104.5% of face value

$10,450
BOND SOLD AT A PREMIUM
Present Value
Money earns income (interest) with passage of time
Present Value
Amount of a dollar invested
today is referred to as the
present value of a future
amount
Amounts invested today
accumulate interest and
grow to a larger amount in
the future
Present Value
$1,000 invested
today is worth more
than $1,000 to be
received two years
from now
You can invest the
$1,000 now
It will be worth more
in three years
Issuing Bonds Payable to
Borrow Money
The City of Blacksburg, Virginia, issues
$15,000,000 of 6% 10-year bonds on
May 1, 19x3, to fund construction of a
new water treatment plant
What is the Citys journal entry if the
bonds are issued at par?
Borrow Money
5/1/x3 Cash $15,000,000
Bonds Payable $15,000,000
To record bonds issued at par
After initial bond issue, secondary market bond

transactions do not involve the City of Blacksburg
City makes no journal entries
Keeps record of bond owners only for payment of

periodic interest
Borrow Money
The Citys bonds
pay interest each
May 1 and
November 1
What is the journal
entry to record the
first interest
payment on Nov. 1,
19x3?
Borrow Money
11/1/x3 Interest Expense $450,000
Cash $450,000
To record interest expense
Can you think of the adjusting entry necessary on

November 30, 19x3, the Citys fiscal year-end?
Borrow Money

Interest Payable $75,000
To record interest accrual for 19x3
Issuing Bonds and Notes Payable
Between Interest Dates
Bonds issued between interest payment dates
are priced to include accrued interest
WHY?
Semiannual interest payments are paid in full to
the current bondholder of record
Too time-consuming and impractical to track all
bondholders during the semiannual period
Consider that some bondholders may hold
bonds only for several days or weeks before
selling them
Suppose the City of Blacksburg issued its bonds
(dated 5/1/x3) on July 1, 19x3
7/1/x3 Cash $15,150,000

Interest Payable $150,000
Bonds Payable 15,000,000
To record bonds issued between interest
dates
How would the first interest payment on November
1 would be recorded?

Cash $450,000
To record interest expense
Interest Expense Interest Payable
$150,000 7/1
11/1 $300,000 $150,000 7/1

11/1 $300,000 11/1 $150,000 $150,000 7/1

Issuing Bonds Payable at a
Discount
When would bonds be
issued at a discount?
When contractual rate
of interest is lower
than market rate
Bondholders will pay
amount less than face
value for investment
yielding less than
current market rate
Discount
Suppose the City of Blacksburg, Virginia,
issues the $15,000,000 of 6% 10-year
bonds on May 1, 19x3, when similar
bonds of comparable quality and risk pay
8% interest
What is the Citys journal entry if the
bonds are issued at a discount?
Discount
5/1/x3 Cash $12,955,500
Discount on Bonds Payable 2,044,500
Bonds Payable $15,000,000
To record bonds issued at discount
Discount on Bonds Payable is a contra account to

Bonds Payable
Net amount of Discount and Bonds Payable accounts
referred to as the bonds carrying value
Discount
Discount represents
additional interest
expense to be
allocated over life of
bonds
Effect is to increase
entitys interest
expense incurred on
bond to equivalent of
the market rate of
interest
Discount
City of Blacksburg would report its newly-issued
bonds on the balance sheet:
Bonds Payable (6%, due 5/1/20x3) $15,000,000
Less Bond Discount 2,044,500
Carrying Value $12,955,500
Discount
Carrying value is
Discount
Carrying value is face value

Discount
City of Blacksburg would report its newly-issued bonds on
the balance sheet:
Carrying value is face value minus unamortized bond
discount
Chapter Objective 4
Measure interest expense; amortize
bond discount and premium by the
Effective-Interest Method of
Debt Amortization
GAAP requires bond discount to be amortized
(allocated) over life of bond to yield interest
expense equivalent to market interest rate
Known as effective-interest method
Semiannual cash interest payment to
bondholders remains same
Interest expense recognized by entity grows
slightly each period
Debt Amortization
Textbook Exhibit 8-6

shows an
amortization
schedule for a bond
issued at a discount
Notice ....
Debt Amortization
Interest payments to bondholders do not
change over time
Interest expense recognized by company
increases as bond carrying value increases
Unamortized bond discount decreases as
bonds get closer to maturity
Bond carrying value rises to face value as it
nears maturity
Interest Expense on Bonds
Issued at a Discount - Amortizing
Discount on Bonds Payable
Bond discount represents additional interest
expense to entity
Unstated cost of issuing bonds when
contractual interest rate is lower than market
rate of interest on similar bonds
Refer to textbook Exhibit 8-7 to see
relationship between interest payments and
interest expense
Issued at a Discount - Amortizing
Discount on Bonds Payable
Lets amortize the first semiannual interest
payment for the City of Blacksburgs bonds

Discount on Bonds Payable $68,220
Cash 450,000
To record bond interest payment
Issued at a Discount - Amortizing Discount
on Bonds Payable
After recording interest expense, related
account balances look like this:
Discount on Interest
Bonds Payable Expense
on Bonds Payable
5/1 $2,044,500
on Bonds Payable
5/1 $2,044,500
$68,220 11/1
on Bonds Payable
5/1 $2,044,500
$68,220 11/1 11/1 $518,220
on Bonds Payable
5/1 $2,044,500
$68,220 11/1 11/1 $518,220
Bal $1,976,280
Premium
Suppose the City of
Blacksburg had issued its
water treatment plant
bonds at an interest rate
higher than market rates
How would the May 1,
19x3, journal entry
change if the contract rate
of the bonds was 10% and
the market rate of interest
at 8%?
Premium
5/1/x3 Cash $17,032,500

Premium on Bonds Payable $2,032,500
Bonds Payable 15,000,000
To record bonds issued at premium
Net amount of Premium and Bonds Payable accounts

equal bonds carrying value
Premium
Premium, like a discount, is amortized over
life of bond
Premium represents a reduction in total
interest expense
Created by bondholders willingness to pay
more than face value for the bond issue
Effect of premium is to reduce bond interest
expense
Premium
City of Blacksburg would report its bonds on the
balance sheet:
Plus Bond Premium
2,032,500
Premium
City of Blacksburg would report its bonds on the balance
sheet:
Plus Bond Premium 2,032,500
Carrying value is
Premium
sheet:
Carrying value is face value

Premium
sheet:
Carrying value is face value plus unamortized bond

premium
Premium
How would the Citys first semi-annual interest

payment on the bonds be recorded?

Premium on Bonds Payable 68,700
Cash $750,000
To record bond interest payment
Issued at a Premium - Amortizing
Premium on Bonds Payable
Textbook Exhibit 8-9
shows a bond
premium
amortization
schedule
Observe the
differences between
it and Exhibit 8-6
Interest payments to bondholders do not change
over time
Interest expense recognized by company decreases
as bond carrying value decreases toward maturity
Unamortized bond premium decreases as bonds
get closer to maturity, similar to unamortized bond
discount
Bond carrying value falls to its face value as it nears
maturity
Bond premium represents a reduction of
interest expense to entity
Reduction in cost of issuing bonds when
contractual interest rate is higher than market
rate of interest on similar bonds
Refer to textbook Exhibit 8-10 to see
relationship between interest payments and
interest expense
Straight-Line Amortization
of Bond Discount and Bond Premium
GAAP requires bond
discounts and premiums
to be amortized using
Companies permitted to
use straight-line method
provided it yields similar
results
That is, differences are
not material
Consider the difference for the City of Blacksburg
bonds issued at a premium:
Effective-interest method
Bond premium - $2,032,500
First period amortization - $68,700
Straight-line method
Bond premium - $2,032,500
First period amortization -
$101,625
Straight-line amortization
understates period interest
expense by almost 5%
$681,300 - effective rate
$648,375 - straight-line rate
Amt. Amortized Total Interest Straight-line method
$700,000 Bond premium - $2,032,500

$600,000 First period amortization -
$500,000 $101,625
$400,000
$300,000
$200,000 Straight-line amortization
$100,000 understates period interest
expense by almost 5%
$-
$681,300 - effective rate
Straihgt-
Effective
Method
Interest
Interest
Method
line
$648,375 - straight-line rate

Early Retirement of Bonds
Payable
Bonds typically
retired (paid off) at
maturity date
Some bonds
retired prior to
maturity date
Why?
Payable
Early retirement allows entity to reduce bond
interest payments
By paying off debt early
Eliminating interest expense and cash outflow
associated with bond interest payments
Or by reissuing bonds at a lower interest rate
Reducing interest expense and cash outflow
related to interest payments
Payable
Issuer can retire bonds before
maturity by:
Purchasing bonds on the
secondary market (buying
up all bonds currently held
by bondholders)
Exercising call option
Clause allowing issuer
to redeem bonds at
specified price as of
specific date
Payable
After 6 years, the City of Blacksburg decides
to call its 10% bonds
Perhaps interest rates have fallen, and the
City believes it can reissue the debt at lower
rate
Suppose the bonds came with a call
provision, allowing the City to call bonds at
101
Payable
What journal entry should the City make to retire
these bonds?
5/1/x9 Bonds Payable $15,000,000

Premium on Bonds Payable 1,000,229
Gain on Bond Retirement $850,229
Cash 15,150,000
To record early bond retirement
Payable
GAAP requires gain or
loss on bond retirement
to be shown as an
extraordinary item on
entitys income
statement
Reported on separate
section of income
statement, net of
income tax effect
Convertible Bonds and Notes
Convertible bonds allow bondholder to exchange
bonds for specified number of shares of common
stock in the company
Bonds issued with conversion feature generally
carry lower interest rate
Bondholder willing to accept lower rate due to
benefits of stock ownership
When bonds converted into common stock,
company increases stockholders equity for
carrying value of bonds
Chapter Objective 5
Explain the advantages and
disadvantages of borrowing
Advantage of Financing
Operations with Bonds v. Stock
Businesses can acquire
assets through debt or
equity
Debt: can issue bonds,
take mortgages, borrow
funds to purchase assets
Equity: can issue stock in
the company, use
proceeds to purchase
assets
Financing with debt
Doesnt dilute ownership in
company
Usually results in higher earnings
per share
Refer to textbook Exhibit 8-12
Reduces total net income
Increases debt ratios and may
impose financial restrictions on
company
Financing with equity
No liabilities = no increase in debt ratios
No fixed interest payments
Generally higher total net income
Will dilute ownership interest and
earnings per share of current
stockholders
Chapter Objective 6
Account for lease transactions
Lease Liabilities
Rental agreement
permitting lessee
(user) to possess
and use asset
without long-term
commitments or large
cash down-payment
Lease Liabilities
Operating leases
2 types of
leases
Lease Liabilities
Operating leases
2 types of
leases
Capital leases
Operating Leases
Short-term in nature
Generally cancelable
Right to undisturbed use of asset during lease
period
6/1/98 Prepaid Rent $12,000

Cash $12,000
To record 12-month rent prepayment
Capital Leases
Long-term, non-cancelable
method of financing asset
purchases
Airlines, railways, large retailers
enter into long-term leases for
many of their plant assets
Lease must meet 1 of 4 criteria to
be classified as a capital lease
Capital Leases
1. Leased asset becomes property of lessee at end
of lease period
2. Lease includes bargain purchase option - for
example, can buy asset for $100 at conclusion of
lease
3. Lease term is 75% or more of assets estimated
useful life
4. Present value of lease payments is greater than
90% of assets market value
Accounting for Capital Leases
Accounting similar to purchased assets
Lessee records leased asset and related
lease liability
Lessor removes asset from its records
Record depreciation on lease cost
Recognize interest expense as part of cost
of acquiring leased asset (financing the asset
acquisition over time)
Off-Balance-Sheet Financing
Some business financing
activities use debt that is
not required to be reported
on the balance sheet
STA
Operating leases are an TEM
ENT
FOO A N D S
example TNO
TES
Operating lease
disclosures in footnotes
are important to
understanding companys
future obligations
Pension Liabilities
A pension is money employees receive after
their retirement from an organization
Companies match (accrue) pension expense in
the accounting period employees worked to
generate revenues
If company doesnt accrue sufficient funds,
excess liability is recognized as long-term
pension liability
Detailed footnotes explain the current and future
pension liabilities of the company
Chapter Objective 7
Report liabilities on the balance sheet
Reporting Current and Long-Term
Liabilities on the Balance Sheet
Balance sheets of
actual companies
have wide variety of
account titles and
situations for which
liabilities are recorded
Reported on face of
balance sheet
Disclosed in footnotes
to statements
Reporting Financing Activities on
the Statement of Cash Flows
Financing activities on the statement of
cash flows include:
Cash received from issuing debt
Cash paid to retire debt
Cash received upon sale of stock
Cash dividends paid to stockholders
World Wide Web Sites to Visit
AMR Corporation
http://www.amrcorp.com/amr/amr_home.htm
Chrysler Corporation
http://www.chrysler.com/
THE END
Of Ch 8
Presentation
Slides
Ch 8 Teaching Slides are Next
Categories of Current Liabilities
Amount of Liability Known When Recorded
Trade accounts payable
Short-term notes payable
Sales taxes payable
Current portion of long-term debt
Accrued expenses:
Interest payable
Payroll liabilities such as:
Salaries and wages payable
FICA tax payable
Employee income tax payable
Unearned revenues (collected in advance)
Amount of Liability Must Be Estimated When Recorded

Estimated warranty payable
Income tax payable
Estimated vacation pay liability 1998 by Prentice Hall, Inc.
Contingent liabilities
Potential liability dependent
upon a future event arising out
of a past transaction
Accounting treatment
Record a liability if probable
and the amount of loss can
be reasonably estimated
Report in a note only if
reasonably possible
No need to report if remote
(unlikely to occur)
1998 by Prentice Hall, Inc.
Nature and Types of Bonds
Nature of Bonds
In effect, a long-term note payable that bears
interest. $1,000
States that the issuer will repay the principal Bond
and specific interest payments.
Usually in units of $1,000 called face value,
maturity value, or par value.
Interest is paid annually or semi-annually.
Types of Bonds
Term bonds - mature at the same time
Serial bonds - mature in installments over time
Secured (mortgage) bonds - give the bond holder the right
to claim of assets if the issuer defaults
Debenture bonds - unsecured bonds
Interest Payments and Interest
Expense
on Bonds Payable Bonds Issued at a Discount
$5,000
$4,900
Interest Expense
$4,800
$4,700
$4,600
$4,500
$4,400 Interest Payments
$4,300
$4,200
1 2 3 4 5 6 7 8 9 10
Bonds Issued at a Premium

$4,500
Interest Payments
$4,400
$4,300
$4,200
$4,100
$4,000 Interest Expense
$3,900
$3,800 1998 by Prentice Hall, Inc.
$3,700
1 2 3 4 5 6 7 8 9 10
Financing with Debt Versus Stock
Long-term Common
Debt Stock
Investment Risk Low High
Corporate Obligation Yes No

to Repay
Dividends Tax- Dividends

or Interest deductible
Interest
Obligation to Pay At Fixed Only After

Dividends or Interest Dates Declaration
Market Value
Fluctuations under Low High
Normal Conditions

Other Types of Liabilities
Current Portion of Long-term Debt
The amount of long-term notes or bonds payable within the
current period
Mortgage Notes
Borrowing agreement with assets pledged as collateral
Leases
Capital leases long-term non-cancelable financing obligation
reported as a liability
Operating lease short-term cancelable rental agreements
Off-balance-sheet Financing
Acquisition of assets or services with debt that is not reported
on the balance sheet
Pensions and Post-retirement Benefits
Employee compensation and health benefits that will be
received during retirement
Deferred Income Taxes 1998 by Prentice Hall, Inc.
Income tax liabilities that the company can defer and pay later
Financing Activities on the
Statement of Cash Flows
Cash Flows From Financing Activities
Proceeds from issuance of

long-term debt $12,000
Other short-term borrowings 10,000
Payments on long-term debt (4,000)
Payments on capital leases (11,000)
Payment of cash dividends (8,000)
Net Cash used for Financing Activities $( 1,000)

App D: Accounting for
Partnership Slides Should be
Inserted Here!

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Prof Johnson Acct 202

CHAPTER 8 & Appd B

Ch8-- Accounting for Current and

Refer to the AMR Corporation situation described

1. Account for current liabilities

5. Explain the advantages and

Obligation to transfer assets

Borrows money and

Payable within one year

Businesses often maintain subsidiary A/P

11/15/98 Leasehold Improvements $10,000

12/31/98 Interest Expense $115

FACE VALUE = $10,000

FACE VALUE = $10,000

FACE VALUE = $10,000

Accrued interest expense at year-end:

Retail POS systems easily capture sales

12/31/x7 Cur. Portion of Long-Term Debt $5,000

Customers of the Des

10/13/x4 Cash $108

The Registers fiscal year ends on December 27,

12/27/x4 Unearned Subscript. Rev. $22.55

*$108 / 52 weeks = $2.0769 / week

Further, suppose Ciscos

12/31/x1 Warranty Expense $26,250

2/2/x2 Est. Warranty Payable $2,000

6/30/x6 Vacation Pay Expense $435

Probable and reasonably

After studying this chapter you should be able to:

Simply put, at any interest rate:

Elements of the interest rate: The interest rate is the sum of

Simple interest is computed on the principle only.

Compound interest is computed on the principle and

For our calculations we will assume compound interest.

Types of annuity problems:

Each rent or payment compounds (interest added) one more

$100 (1+.1)3 = $133

$100 (1+.1)3 = $133

$100 (1.331) = $133

and horizontally for the i

Note: This can be solved as either a future or present value of a

$6,000 (FVFn,i ) = $9,000

FVFn,i = $9,000/$6,000 = 1.500

Looking on the future of a single sum table (page ???) for n

A more precise answer may be derived through the use of the

Suppose you are to pay three rents of $500, each at the

Bond certificate states

Bond certificate states

Bond certificate states

Bond certificate states

100 100% of face value

104.5 104.5% of face value

After initial bond issue, secondary market bond

Keeps record of bond owners only for payment of

Can you think of the adjusting entry necessary on

11/30/x3 Interest Expense $75,000

7/1/x3 Cash $15,150,000

11/1/x3 Interest Expense $300,000

Interest Expense Interest Payable

Interest Expense Interest Payable

11/1 $300,000 $150,000 7/1

Interest Expense Interest Payable

11/1 $300,000 11/1 $150,000 $150,000 7/1