Docstoc

Chapter 10_ Reporting and Analyzing Liabilities

Document Sample
Chapter 10_ Reporting and Analyzing Liabilities Powered By Docstoc
					Chapter 10: Reporting and Analyzing Liabilities; and
Appendix C: Time Value of Money
Liabilities – claims, debts and obligations that must be settled (_________) at some time in the
                        future by the transfer of ______________________________

Current Liabilities
              Accounts Payable
              Interest Payable
              Taxes Payable
              Wages Payable


Notes Payable – similar to accounting for notes receivable (instead of using “Receivable”
                     accounts, will be using “Payable” accounts)
   - give lender written documentation
   - usually require payment of _____________
   - frequently used to meet short-term cash needs
   - terms of N/P and other important information are disclosed in the footnotes
   - if payment on N/P is due within 1 year of the balance sheet date, the N/P is classified as current
       liability


Class Exercise: The following transactions occurred between Spoke Company (the seller) and
                Bryden Company (the buyer.)

       November 1: Spoke Co. sold $80,000 in merchandise to Bryden Co. on account, with terms n/30.

       December 1: Spoke Co. granted Bryden CO. a 90-day extension on the account receivable.
                   Bryden Co. signed an $80,000, 10% 90-day note as evidence of the time extension.

       March 1:       Bryden Co. paid Spoke Co. the amount due on the note.

   A.) Journalize the transactions from the seller’s perspective:




   B.) Journalize the transactions from the buyer’s perspective:




Chapter 10: pg 1 of 11
Other Current Liabilities

Sales Taxes Payable: retailers collect taxes from customers when a sale occurs and remits the
                              tax to the state’s Department of Revenue periodically.

Payroll: employers must pay employees for their time, but must also deduct from their employees’
              paychecks, taxes due to third parties

Payroll Taxes Payable: employers are responsible for matching some taxes paid by employees as well as
for paying unemployment taxes

Unearned Revenue
- when payment for goods or services are received in advance of the goods being delivered or services
   being performed

   Example:
   Superior University sold 10,000 season football tickets at $50 each for its five-game home schedule.

       To record the sale of season tickets:               Cash   500,000
                                                                  Unearned Revenue       500,000

       To record recognized revenue after each game:       Unearned Revenue 100,000
                                                                 Game Revenue      100,000




Long-Term Liabilities

Companies raise large amounts of funds by:
  a. ___________________________

   b. ___________________________




Bonds
  Characteristics:    1. issued with face values of ___________________

                      2. usually pay interest ________________________

                      3. prices are quoted as a ____________________________



Chapter 10: pg 2 of 11
                                              Types of Bonds
- secured bonds – assets are pledged as collateral on the bond (gives bondholder a claim on
       specified assets if the company fails to make bond payments)

- unsecured bonds (debenture bonds) – have no collateral attached (bonds are backed only by the
       credit of the issuing corporations)

- convertible bonds give the bondholder the right to exchange his bonds for shares of stock if
       certain conditions exist
               - the ____________ chooses whether or not to convert
                       (and will do so only if it is to their benefit)

- callable bonds may be redeemed by the corporation at its option
               - the ________________ chooses whether or not to redeem
                      (and will do so only if it is to their benefit)

- term bonds – all bonds of an issue mature at the same time (entire principal amount from the
       issue is received at one time)

- serial bonds – maturity dates of the bonds are spread over several dates (staggers repayment of
        the principal over several years)

- junk bonds – may be issued by a corporation to finance the takeover of another company
       - secured by the assets and expected profits of the company targeted for takeover
       - usually offer a high interest rate to make them attractive


Steps to Issuing a Bond
   1. The corporation’s board of directors approves a bond issue, specifying the amount of bonds that
        will be issued, the maturity date, the stated interest rate, and any special bond characteristics (i.e.,
        conversion features, call features, collateral, etc.)

    2. The company prepares a prospectus, which gives information about the company and the bond
       issue. This prospectus is filed with the Securities and Exchange Commission (SEC). The SEC
       reviews the prospectus to see that it provides investors with the information they will need to
       evaluate the bond issue. If the prospectus contains the appropriate information, the SEC approves
       the issue.

                Note: SEC approval doesn’t mean that the bond is a good investment, only that
                      the company has disclosed adequate information for a knowledgeable investor to
                      determine whether it is a good investment.

    3. An underwriter is contracted.

    4. The bonds are sold.

             What happens if the interest rates have changed from those specified by the board of
              directors?




Chapter 10: pg 3 of 11
Example: Assume that your bond has an interest rate of 10% when other bonds are paying 12%.
Investors will not want to buy your bond if they can earn 12% elsewhere. What can you do to get
investors to buy your 10% bond?


       If contract rate = market rate, bond sells at _____________________

       If contract rate > market rate, bonds sells at a _____________________

       If contract rate < market rate, bond sells at a _____________________


Example: A company sold $1,500,000, 12%, 10-year bonds on January 1, 2006. The bonds pay interest
annually on January 1st. The company uses the straight-line method to amortize bond premium or
discount.

   Assume the bonds were sold at face value

          a. Record issuance of the bonds on Jan 1, 2006




          b. Record bond interest expense at Jan 1, 2007




          c. Record bond interest expense for Jan 1, 2008




   Assume the bonds above were sold at 95

          a. Record issuance of the bonds on Jan 1, 2006




Chapter 10: pg 4 of 11
                                    Amortizing a Bond Discount
   Using above example:
   1. the investor loans the company _________________ by buying the bond

   2. at the end of the 10 years, the company repays the investor _____________________

   3. therefore, the investor gets $_________ more at maturity than he paid for the bonds
      - the $________ discount is really just ____________________ that is paid in one lump sum at
      maturity

   4. because the $________ discount is really just extra interest, it must be recorded as
      _____________________
      - this interest must be spread across the 10 year __________________________
      - the process of recognizing a portion of the discount as interest each time an interest
              payment is made to the bondholder is called ______________________________




                               Cash         Discount         Interest      Carrying
                              Interest     Amortization      Expense         Value
         January 1, 2006                                                   1,425,000
         January 1, 2007      180,000          7,500         187,500       1,432,500
         January 1, 2008      180,000          7,500         187,500       1,440,000
         January 1, 2009      180,000          7,500         187,500       1,447,500
         January 1, 2010      180,000          7,500         187,500       1,455,000
         January 1, 2011      180,000          7,500         187,500       1,462,500
         January 1, 2012      180,000          7,500         187,500       1,470,000
         January 1, 2013      180,000          7,500         187,500       1,477,500
         January 1, 2014      180,000          7,500         187,500       1,485,000
         January 1, 2015      180,000          7,500         187,500       1,492,500
         January 1, 2016      180,000          7,500         187,500       1,500,000




          b. Record bond interest expense at Jan 1, 2007




          c. Record bond interest expense for Jan 1, 2008




Chapter 10: pg 5 of 11
(Same Scenario) Now, assume the bonds were sold at 103

          a. Record issuance of the bonds on Jan 1, 2006




                                     Amortizing a Bond Premium
   Using above example:
   1. the investor loans the company _________________ by buying the bond

   2. at the end of the 10 years, the company repays the investor _____________________

   3. therefore, the investor gets $_________ less at maturity than he paid for the bonds
      - the $________ premium is really just ____________________________________

   4. because the $________ premium is really just a reduction in interest, it must be recorded as
      ______________________________________________



                                Cash         Discount         Interest       Carrying
                               Interest     Amortization      Expense          Value
         January 1, 2006                                                     1,545,000
         January 1, 2007       180,000          4,500         175,500        1,540,500
         January 1, 2008       180,000          4,500         175,500        1,536,000
         January 1, 2009       180,000          4,500         175,500        1,531,500
         January 1, 2010       180,000          4,500         175,500        1,527,000
         January 1, 2011       180,000          4,500         175,500        1,522,500
         January 1, 2012       180,000          4,500         175,500        1,518,000
         January 1, 2013       180,000          4,500         175,500        1,513,500
         January 1, 2014       180,000          4,500         175,500        1,509,000
         January 1, 2015       180,000          4,500         175,500        1,504,500
         January 1, 2016       180,000          4,500         175,500        1,500,000



          b. Record bond interest expense at Jan 1, 2007




          c. Record bond interest expense for Jan 1, 2008




Chapter 10: pg 6 of 11
Time Value of Money

       ♦ Future Value of $1 (What will be the dollar value in the FUTURE)

Calculate how much money you would have in one year if you invested $100 and earned 8% interest on
that money.




Calculate how much money you would have after 2 years, assuming both the principal ($100) and the
interest during the first year remain in the account.




       ♦ Present Value of $1 (What is the dollar value TODAY)

Calculate how much money you need to invest today in order to have $100 in one year if interest rates are
8%.



Calculate how much money you would need to invest today to have $100 in 2 years, assuming an 8%
interest rate.




Annuity:

       ♦ Future Value of an Annuity:

       Annuity Amount * Factor from FV Table for Annuities

Assume that you invest $4,000 at the end of each year for 5 years, and earn 10%. How much will you
have at the end of the 5 years?




       ♦ Present Value of an Annuity:

       Annuity Amount * Factor from PV Table for Annuities

Assume that you have won a sweepstakes with a $5 million grand prize. Now you have to choose how to
take your winnings: $500,000 per year for 10 years or $3 million now. If interest rates are 12%, which
option would you choose?




Chapter 10: pg 7 of 11
Class Exercise: Determine whether you are finding the (future vs. present) value of ($1 vs. an annuity),
then solve.

   1. Ellen Saber is contemplating paying several years’ rent on her business office in advance. By
      paying in advance, she can avoid a rent increase that goes into effect the first of next year. Ellen’s
      rent payment is $4,800 per year. Calculate the sum that Ellen would have to pay now in order to
      prepay 5 years of rent. Interest rates are 9%.



   2. Marty and Renee invested $7,000 in a saving account paying 8% annual interest when their son
      was born. How much will be in the savings account in 19 years?



   3. Craig Jones owns a computer sales and repair business. He has decided to sell maintenance
      contracts with new computers that cover all repairs needed within 3 years of purchase. On
      average, each new computer needs $100 in repairs and maintenance per year during the first 3
      years it is operated. How much should Craig charge for a maintenance contract (in order to simply
      break-even) if interest rates are 15%?



   4. You are considering an investment which will return a lump sum of $500,000 five years from
      now. What amount should you pay today for this investment to earn a 12% return?



   5. Your Aunt Sally is looking forward to retirement but she is concerned about having enough
      money to enjoy her golden years. Sally wants to be sure that before she retires, she has saved
      enough money to cover her expenses for the rest of her life.

       Sally estimates that after retirement, she will spend $20,000 per year. Based on average life
       expectancies, she will probably live 15 years past retirement, but as a margin of safety, Sally
       wants to have enough money for 20 years. What sum of money will Sally need at her retirement
       to cover her financial needs for the rest of her life? Assume that Sally can earn 6% interest on her
       money.



   6. You have just started working and want to begin contributing regularly to a savings account. You
      decide to deposit $6000 per year, and earn 5% on that money. How much will the account grow
      to in 25 years?



   7. You have just started working and want to begin contributing regularly to a savings account. You
      decide to deposit $6000 per year, and earn 12% on that money. How much will the account grow
      to in 25 years?




Chapter 10: pg 8 of 11
Calculating the Selling Price of Bonds

When determining the present value of a bond, the following two components must be treated separately:

   1. Principal – repaid when bond matures (____________________________)

   2. Interest payments – usually made semiannually (________________________)


Example: On January 1, a corporation issued a $1 million, 5 year, 10% bond that pays interest annually.
The market interest rate on January 1 was 12%.

Principal =

Interest payments =


PV of bond =

       PV of principal:

       PV of interest payments:

               Selling Price of bond


Journal entry to record issuing the bond:



Example: On January 1, a corporation issued a $3 million, 10 year, 9% bond that pays interest semi-
annually. The market interest rate on January 1 was 8%.

Principal =

Interest payments =


PV of bond =

       PV of principal:

       PV of interest payments:

               Selling Price of bond


Journal entry to record issuing the bond:




Chapter 10: pg 9 of 11
Bond Redemptions
● Bonds can be retired at maturity:


● Bonds can be retired before they mature by:      1. exercising a ________________________
                                                   2. purchasing bonds on _________________




       - when redeeming a bond, compare the bond’s carrying value to the price paid to redeem the
         bonds
              - if carrying value > the cost to redeem, a _____________ is recognized

               - if carrying value < the cost to redeem, a _____________ is recognized



Example:
Assume that a $500,000 bond with a $7,000 unamortized premium is called for redemption at 102.




Assume that a $500,000 bond with a $6,000 unamortized discount is called for redemption at 96.




Balance Sheet Presentation of B/P
- unless bonds are due to mature within the next year, they are listed as a __________________________
       and presented at their carrying value


Example: a $100,000 bond with a $7,000 unamortized discount should appear on the B/S of the
         issuing company as follows:




Chapter 10: pg 10 of 11
Analysis of Current Liabilities

♦ Liquidity Ratios – indicate company’s ability to pay its short-term debt
       - “Liquidity” refers to a “nearness to cash”

       Current Ratio = Current Assets / Current Liabilities

♦ Solvency Ratios – indicate company’s ability to pay its long-term debt

       Debt to Total Assets Ratio = Total Liabilities / Total Assets

       Times Interest Earned Ratio




Contingent Liabilities
- contingencies are events with _______________________________

- a contingency must be recorded in the financial statements if the company can :
       1. determine a ____________________________ of the expected loss; and
       2. if it is ___________________ that it will lose the suit

                    -   if both of the above are not met, disclose the basic facts regarding the
                        contingency in the notes




Chapter 10: pg 11 of 11

				
DOCUMENT INFO
Shared By:
Categories:
Stats:
views:47
posted:2/12/2010
language:English
pages:11