Financial Accounting and Analysis Notes

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					     ACG 2021
Financial Accounting
Current & Long-Term Liabilities
          Learning Objectives
► Account    for current liabilities and contingent
  liabilities
► Account for bonds-payable transactions
► Measure interest expense
► Understand the advantages and
  disadvantages of borrowing
► Statement of Cash Flow Effects
                     Current Liabilities
►   Liabilities due within 1 year    ► We increase Liabilities with
    or the company’s                   a credit.
    operating cycle if longer        ► So to increase any of the
     Known amounts                    Known payables on the
        ► Accounts   Payable           left, we credit the payable
        ► Short-term Notes Payable
                                       for the known amount.
        ► Sales Tax Payable
        ► Current Installment of
                                     ► We must therefore, debit
          Long-Term Debt                  a corresponding expense
        ► Accrued Expenses                 account (accrued expenses)
        ► Payroll Liabilities             Cash (deferred liability)
        ► Unearned Revenues               Long-term debt
                                          Cash (if recording receipt
                                           from a note payable)
                   Accounts Payable
► Amounts        owed for purchases of goods or services
  on account
    The purchase can be for an Asset
       ► Inventory   (generally largest)
    The purchase could also be an Expense
       ► Legal   Fees (service)
    No interest associated with money owed, and it is
     assumed the A/P will be paid quickly
► Ifwe have an A/P for Inventory purchased on
  account, what does the company we purchased
  the inventory from have?
    An Accounts Receivable
               Note Payable
► Unlike Accounts Payable
► Usually contains interest payments that are
  due
► Record:
   Issuance of Note Payable
     ►We borrowed Cash and have an obligation to pay
      back
   Interest Expense
   Payment of Note Payable
                   Notes Payable
 On Jan. 30, 20X5 the company received a one year $8,000
 note payable at 10% interest to purchase inventory.

Jan 30   Cash                                    8,000
          Note Payable, Short-term                            8,000
         Purchase of inventory by issuing a
         1-year 10% note payable
 Interest must be accrued at fiscal year end (April 30) for
 interest owed but not yet due.
Apr 30   Interest Expense (8,000 x .10 x 3/12)      200
           Interest Payable                                    200
         Adjusting entry to accrue interest expense
                              Notes Payable
      To record repayment at maturity Jan 30 20x6:


 Jan. 30        Note Payable, short-term                                 8,000
                Interest Payable                                            200
                Interest Expense ($8,000 x .10 x 9/12) 600
                     Cash [($8,000 x .10) + 8,000]             8,800
                Payment of a note payable and interest at maturity
Step 1: Reverse the balance in the Note Payable account to 0
Step 2: Reduce the amount of any Interest Payable from a previous period to 0
Step 3: Record the Interest Expense for the period
Step 4: Record the cash (Principal and Interest paid)
             Payroll Liabilities
► Types   of Compensation
     Salary
     Wage
     Commission
     Bonus
► Salary expense  is gross pay.
► Salary payable is net pay.
                Payroll Liabilities
  To record payroll


Jan. 30   Salary Expense                  10,000
           Employee Income Tax Payable             1,200
            FICA Tax Payable                         800
            Salary Payable to Employees            8,000
          To record salary expense
            Sales Tax Payable
To record sales of $200,000 plus 5% sales tax:


      Cash (200,000 x 1.05)                210,000
        Sales Revenue                                200,000
        Sales Tax Payable (200,000 x .05)             10,000
      To record cash sales and related sales tax
             Unearned Revenues
 To record collection of cash in payment for future services:

Jan 30   Cash                                   1,200
          Unearned Ticket Revenue                          1,200
         Received cash in advance for ticket sales

   To record revenue after 50% of services have been
 performed.
Apr 30   Unearned Ticket Revenue                    600
          Ticket Revenue                                        600
         Earned revenue that was collected in advance
              Current Liabilities
► Amounts     that must be estimated
   Estimated Warranty Payable
     ►How  many products will need repair / replacement
     ►Matching Principle
     ►Estimate based on past historical data

   Contingent Liabilities
     ►An   company may incur an expense in the future
         Most commonly associated with law suits
   Estimated Warranty Payable
Warranty expense should be recognized in the year the
product is sold. For example, a company made sales of
$200,000 subject to product warranties. They estimate that
3% of the products will require repair or replacement.
      Warranty Expense                    6,000
       Estimated Warranty Payable                     6,000
      To accrue warranty expense
When $5,800 of products are replaced under the warranty:

       Estimated Warranty Payable           5,800
         Inventory                                    5,800
       To replace defective products under warranty
         Contingent Liabilities
► Contingent  liability depends on a future
  event arising out of past events.
► To account for contingent losses:
   Record liability if it is probable and can be
    reasonably estimated.
   Report the liability in the notes to the financial
    statements (but do not record an entry) if it is
    reasonably possible that a loss will occur.
   Do not report a contingent loss that is not likely
    to occur.
     ACG 2021
Financial Accounting
   Long – Term Liabilities
      Bonds Payable
                       Bonds
► IOU’s
► $1000  or $5000 Increments
► Sold in the “Market”
► Structure:
   Maturity Date
   Interest Rate
   Interest Payment Dates
► Provide   two payments:
   Interest every 6 months
   Principal amount of Bond
            Bond Market
► Bloomberg.com
                 Bonds Payable
► Bonds  payable are debt (i.e. a liability) of
  the issuing company.
► Types of bonds:
   term bonds
     ►All   bonds mature at the same time (end of the term)
   serial bonds
     ►Bonds    mature in installments over a period of time.
   secured bonds (mortgage bonds)
   debentures (unsecured bonds)
              Bonds Payable
► Bonds   can be issued (bought)
   at face value
   for a premium
   at a discount
► Bond   Price is determined by:
   Market Interest Rate – Effective Rate
   Bond’s Interest Rate – Contract Rate
   THESE RATES ARE USUALLY DIFFERENT!
           Bond Interest Rates
► Bonds  are sold at market price - amount that
  investors are willing to pay at any given time
► Market price represents:
   present value of periodic interest payments
   present value of principal to be received at maturity
                 Present Value
The amount invested today to receive a greater
   amount at a future date
It depends on:
   amount of the future receipt
   length of time to future receipt
   interest rate for the period
         Bond Interest Rates
► Contract rate – stated rate
► Market rate – effective rate
Present Value Calculation (Discount)
► $100,000 10 year bond, 9% stated interest,
  10% market rate
► Two parts: PV of principle and PV of interest
  payments
    $100,000 x .614*        = $61,400
    100,000 x. 045 x 7.722* = $34,749
    PV of Bonds               $96,149

* From Appendix C
                Bond Prices
► Bond Face Value = Stated Principal
► Bond issued above face (par) value -
 premium
► Bond   issued at below face (par) value -
 discount
   a bond nears maturity, its market price
► As
 moves toward par value
                Bond Prices
Quoted at a percent of their maturity value.
A $1,000 bond quoted at 101½ sells for…


            $1,000 × 1.015 = $1,015.

   A $1,000 bond quoted at 88-3/8 sells
   for… $1,000 × 0.88375 = $883.75.
                    Bond Payable
► Purchase    a $1,000              ► Invest$1,000 in
  Bond                                Market at 9%
► Bond Pays = 9%                    ► Market Interest = $90
   Bond Interest = $90
► Bond   Pays = 10%
   Bond Interest = $100
► Bond   Pays = 8%
   Bond Interest = $80

         How much would you pay for 9% bond, 10% bond, 8% bond?
     ACG 2021
Financial Accounting
 Accounting for Bonds Payable
        Accounting for Bonds
► Record Issuance  of Bond
► Record Payment of Interest      Credit Cash

► Record Accrual of Interest     Credit Interest Payable

   Record Amortization of Discount/Premium
    ►EffectiveInterest Method
    ►Straight-Line Method

► Record Retirement    of Bond
                 Bonds Payable
$50 million in 9%, 5 year bonds are issued on Jan 1, 2006 at
par.
      Cash                          50,000,000
       Bonds Payable                             50,000,000
      To issue bonds at par

First interest payment on July 1.

       Interest Expense             2,250,000
         Cash                                      2,250,000
       To pay semiannual interest

                               $50,000,000 x .09 x 6/12
                Bonds Payable
At year end, accrue interest to be paid on Jan.1

      Interest Expense              2,250,000
        Interest Payable                           2,250,000
      To accrue interest


                      $50,000 x .09 x 6/12
     Bonds Payable at Discount
$100,000 in 9%, 5 year bonds are issued when the market
rate is 10% for $96,149.
      Cash                           96,149
      Discount on Bonds Payable       3,851
           Bonds Payable                         100,000
      To issue bonds at a discount
    Bonds Payable at Discount
► Discount  on Bonds Payable is a contra
  account to Bonds Payable.
► Carrying amount of the bonds equals
  Bonds Payable less Discount on Bonds
  Payable.
► Interest payments are fixed by contract, but
  interest expense varies as the bond discount
  is amortized.
       Bonds Payable Premium
$100,000 in 9%, 5 year bonds are issued when the market
rate is 8% for $104,100.
      Cash                        104,100
        Premium on Bonds Payable                   4,100
        Bonds Payable                            100,000
      To issue bonds at a premium
    Bonds Payable at Premium
► Premium on    Bonds Payable is normal
  liability account (not a contra-account)
► Carrying amount of the bonds equals
  Bonds Payable plus Premium on Bonds
  Payable.
► Interest payments are fixed by contract, but
  interest expense varies as the bond
  premium is amortized.
Bonds Payable Discount Example
► Issue Date – January 1, 2006
► Maturity value - $100,000
► Stated interest rate – 9%
► Interest paid – 4 ½% semiannually
► Market rate at time of issue – 10%
  annually, 5% semiannually
► Issue Price – $96,149
Bonds Payable Discount Example
                       Amortization Table (partial)
                A          B         C               D                E
                        Interest
              Interest Expense
              Payment    (5% of
   Semi-       (4 ½% Preceding                   Discount           Bond
   annual         of      Bond   Discount        Account           Carrying
  interest    Maturity Carrying Amortization     Balance           Amount
    Date       Value   Amount)     (B-A)     (Preceding D -C)   ($100,000 – D)
Jan 1, 2006                                       3851                $ 96,149
Jul 1           4,500  $ 4,807    $ 307           $3,544                96,456
Jan 1, 2007     4,500    4,823      323            3,221                96,779
Jul 1           4,500    4,839      339            2,882                97,118
      *           *         *        *               *                *
      *           *         *        *               *                *
      *           *         *        *               *                *
Jan 1, 2011     4,500    4,961      461               -0-              100,000
Bonds Payable Discount Journal Entries
First semiannual interest payment at Jul 1.

    Interest Expense                 4,807
        Discount on Bonds Payable                     307
        Cash                                        4,500
    To pay semiannual interest and amortize bond discount

Second semiannual interest accrual at Dec 31.

   Interest Expense                    4,823
       Discount on Bonds Payable                      323
       Interest Payable                             4,500
   To accrue semiannual interest and amortize bond discount
Bonds Payable Premium Example
► Issue Date – January 1, 2006
► Maturity value - $100,000
► Stated interest rate – 9%
► Interest paid – 4 ½% semiannually
► Market rate at time of issue – 8% annually,
  4% semiannually
► Issue Price – $104,100
Bonds Payable Premium Example
                       Amortization Table (partial)
                A          B         C               D               E
                        Interest
              Interest Expense
              Payment    (4% of
   Semi-       (4 ½% Preceding                   Premium            Bond
   annual         of      Bond   Premium         Account           Carrying
  interest    Maturity Carrying Amortization     Balance           Amount
    Date       Value   Amount)    (A - B)    (Preceding D -C)   ($100,000 +D)
Jan 1, 2006                                       $4,100          $ 104,100
Jul 1           4,500  $ 4,164    $ 336            3,764            103,764
Jan 1, 2007     4,500     4151      349             3415            103,415
Jul 1           4,500     4137      363             3052            103,052
      *           *         *        *               *                *
      *           *         *        *               *                *
      *           *         *        *               *                *
Jan 1, 2011     4,500    3,955      545               -0-           100,000
Bonds Payable Premium Example
First semiannual interest payment at Jul 1.

     Interest Expense                 4,164
     Premium on Bonds Payable            336
         Cash                                       4,500
   To pay semiannual interest and amortize bond premium

Second semiannual interest accrual at Dec 31.


   Interest Expense                    4,151
   Premium on Bonds Payable              349
       Interest Payable                             4,500
   To accrue semiannual interest and amortize bond premium
Exercise 8-13
     Straight-Line Amortization
► Dividebond discount (or premium) into
 equal periodic amounts over the bond’s
 term.
   This equal amount is Interest Expense
   Interest expense is the same each period.
► GAAPpermits straight line only when the
 amounts differ insignificantly from amounts
 determined using the effective interest
 method.
                 Straight-Line
► Using   the previous Chrysler Example
$100,000 in 9%, 5 year bonds are issued when the market
rate is 8% for $104,100.

►   Premium Amortization = $4100/10 = $410
     10 = 5 years x 2 interest payments per year
    Straight Line Journal Entries
First semiannual interest payment at Jul 1.

     Interest Expense                 4,090
     Premium on Bonds Payable            410
         Cash                                       4,500
   To pay semiannual interest and amortize bond premium

Second semiannual interest accrual at Dec 31.


   Interest Expense                    4,090
   Premium on Bonds Payable              410
       Interest Payable                             4,500
   To accrue semiannual interest and amortize bond premium
          Issuing Bonds Payable
               at a Discount
Chrysler’s balance sheet immediately after issuance
  of the bonds:

Total current liabilities                 $ XXX
Long-term liabilities:
Bonds payable, 9%, due 2009      $100,000
Discount on bonds payable         ( 3,851) 96,149

 Discount on Bonds Payable - contra account
              to Bonds Payable
        Issuing Bonds Payable
             at a Premium
Chrysler’s balance sheet immediately after issuance
  of the bonds:

Total current liabilities                    $ XXX
Long-term liabilities:
Bonds payable             $100,000
Premium on bonds payable     4,100         $104,100
Exercise 8-10
     ACG 2021
Financial Accounting
     Retiring Bonds
     Bonds Retired at Maturity
► After   Recording final interest payment
   Reduce Bond Payable
   Reduce Cash Account

  Bonds Payable 100,000
     Cash               100,000
       Retiring Callable Bonds
► Callable Bonds
   Bonds that can be paid off early
   Call Price
    ►Often   at greater then par value (101 or 102)
   Thus management has to decide to pay call
    premium or
   Buy Bonds on the Open Market
     Early Retirement of Bonds
              Payable
Air Products and Chemicals, Inc., has $70,000
  of debenture bonds outstanding with
  unamortized discount of $350. The market
  price is 99¼.
       Early Retirement of Bonds
                Payable
Par value of bonds                                  $70,000
Less: Unamortized discount                           ( 350)
Carrying amount of the bonds                        $69,650
Market price ($70,000 × 0.9925)                       69,475
Extraordinary gain on retirement                    $ 175
                          General Journal
Date       Accounts and Explanations        PR   Debit    Credit
       Bonds Payable                             70,000
          Discount on Bonds Payable                          350
          Cash                                            69,475
          Gain on Retirement of Bonds                        175
       To record bond retirement
    Convertible Bonds and Notes
► May   be converted into the issuing company’s
  common stock.
► Assume note holders convert half of $300 million
  convertible notes into 4 million shares of stock ($1
  par).

 Notes Payable                    150,000,000
  Common Stock (4 million at $1 par)            4,000,000
  Paid-in Capital in Excess of par-Common     146,000,000
 To record conversion of notes payable
Financing with Bonds or Stock?
► Issuing   stock
   creates no liabilities
   incurs no interest expense
   less risky to issuing corporation
► Issuing   notes or bonds payable
   does not dilute stock ownership or control of
    the corporation
   usually results in higher earnings per share
    [EPS is the amount of net income for each
    share of its stock]
 Reporting Financing Activities on
  the Statement of Cash Flows
                                            Year Ended
Amounts in millions                         December 31
Cash Flow from Financing Activities:
Proceeds from issuance of bonds                $754
Proceeds from long-term borrowings               32
Payment of long-term debt                       (29)
Proceeds from issuance of common stock          351
Payments of cash dividends                     (371)
Other, net                                       (4)
Net cash provided by financing activities      $733
     ACG 2021
Financial Accounting
      Ratio Analysis
   Times Interest Earned
     Times interest earned ratio


                        Income from Operations
Times interest earned =
                            Interest Expense


The ability of a company to pay it’s Interest Expense Obligations
from Earnings Generated from Operations
BlackBoard Inc.
           BlackBoard T.I.E.
► 2006
   -11,826 / 5354 = -2.21
► 2005
   24,447 / 49 = 498.92
► 2004
   10,033 / 179 = 56.05
Best Buy, Inc.
            Best Buy – T.I.E.
► 2007
   1,999 / 31 = 64.48
► 2006
   1,644 / 30 = 54.8
► 2005
   1,442 / 44 = 32.77
End of Chapter 8

				
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