Reporting and Analyzing Liabilities Current liability An obligation

Reporting and Analyzing Liabilities

Current liability • An obligation that will be satisfied within one year or the operating cycle, whichever is longer • Will be satisfied from existing current assets or through the creation of other current liabilities • Obligations that do not meet these tests are longterm liabilities

Notes Payable • A note payable has two parties-maker and payee • A written instrument, not an “open account. ” • If note is due within one year of the balance sheet date, note is a current liability • Interest may be paid at maturity, or it may be deducted in advance from the proceeds

Other Current Liabilities • Current maturities of long term debt—what is not currently maturing remains as a long-term liability • Taxes Payable-retailer usually collects and remits to state —usually a separate item customer must pay • Unearned revenues (customer deposits, sales of future services) • Payroll and payroll taxes payable • Accrued liabilities—owed but not yet on balance sheet prior to adjusting entries

Payroll and Payroll Tax Expense • Wages Exp. xx • Payroll Tax Exp xx FICA Pyble xx Federal IT Pyble xx Fed Unemp Tx State IT Pyble xx Health Ins. Pyble xx State Unemp Tx Wages Pyble xx Record the payroll-employer This is the employer’s share forwards employees’ of taxes. contributions to taxes, etc.

Contingent Liabilities • Not every event has a certain outcome, for example a lawsuit • Record contingent liabilities in financial statements if probable and can be reasonably estimated • Note—we never record contingent assets • How record—increase an expense accounts and credit a liability account

Contingent Liabilities, cont’d • Examples—warranty liability, litigation • If potential liability is probable, but cannot be reasonably estimated, note disclosure is required • We are concerned that liabilities may be understated on the balance sheet by failing to record contingent liabilities or off-balance sheet financing (this will affect solvency ratios like debt/total assets)

Presentation of CL • Usually will see A/P, N/P and Current Maturities of Long Term Debt listed first in C/L section • Then may be listed in order of magnitude, but it varies from company to company

Long-Term Liabilities • We expect to pay these after one year from the balance sheet date • Usually bonds or long-term notes

Bond Characteristics • A bond consists of two components—principal and periodic interest. Calculate value of bonds using present value of the cash flows, see page 487. • Face value or par value-denomination of bond, the principal value due at maturity, e. g. $10, 000 bond • Contractual or stated interest rate-rate of interest company pays on principal amount to bondholders, e. g $10, 000 bond, 10%, interest payable semiannually • Maturity date-date principal will be paid to bondholders.

Bonds Characteristics cont’d • May be secured by collateral or unsecured (debentures) • May be convertible to common stock • May be callable (why would a company call? ) • May be term bonds (principal due at one date) or serial (principal due in installments)

Why issue bonds vs. stock • Bond interest is tax deductible; dividends on C/S are not • Bondholders do not vote—control of company remains with stockholders • EPS may be higher with bonds vs. stock because fewer shares issued, although NI will be lower due to interest expense • Bonds often publicly traded—secondary market improves their liquidity and makes them good vehicles to raise large amounts of capital

Issue Price of Bonds • Bonds will sell at par when the contractual (stated) interest rate is equal to the market (effective) interest rate. $100, 000 bond sells at 100 ($100, 000). • Bonds will sell at a discount when market rate is greater than stated rate. $100, 000 bond sells at 98 ($98, 000). • Bonds will sell at a premium when market rate is less that stated rate. $100, 000 bond sells at 104 ($104, 000).

Issuance of Bonds Cash Bonds Payable At par Cash Discount on Bonds Payable At a discount (98) Cash Premium on Bonds Payable At a premium (104) 10, 000 9, 800 200 10, 000 10, 400 10, 000

What Does the Balance Sheet Look Like? Long-Term Liabilities: At Par Bonds Payable $10, 000 At a Discount Bonds Payable Less: Discount $10, 000 200 $9, 800 At a Premium Bonds Payable Add: Premium $10, 000 400 $10, 400

Bond Interest Expense-Par • Suppose we have a $10, 000 5 -year bond paying 8% annual interest issued 1/1/2017 at par 12/31 Bond Interest Expense 800 Bond Interest Payable 800 Interest accrual. 2018 1/1 Bond Interest Payable 800 Cash 800 Payment of interest.

Bond Interest Expense-Amortize Discount • Suppose we have a $10, 000 5 -year bond paying 8% annual interest issued 1/1/2017 at 97 (means that bond sold for 9700, $3007 discount to amortize—will amortize S/L) 12/31 Bond Interest Expense 860 Discount on Bonds Payable 60 (300/5 years) Bond Interest Payable 800 Interest accrual. 2018 1/1 Bond Interest Payable 800 Cash 800 Payment of interest.

Bond Interest Expense-Premium • Suppose we have a $10, 000 5 -year bond paying 8% annual interest issued 1/1/2017 at 105 (means that bond sold for 10500, $500 premium to amortize over life of bond—will amortize S/L) 12/31 Bond Interest Expense 700 Premium on Bonds Payable 100 (500/5 years) Bond Interest Payable 800 Interest accrual. 2018 1/1 Bond Interest Payable 800 Cash 800 Payment of interest.

Amortizing Bond Discount or Premium • Amortizing bond discount increases interest expense • Amortizing bond premium decreases interest expense • At maturity, bond discount or premium will have been eliminated

Redemption of Bonds (no gain or loss) Bonds Payable Cash 10, 000

Redemption Before Maturity Compare the difference between carrying value of bonds and cash paid to retire—assume issued $300, 000 of bonds at a premium; bonds now have a CV of 310, 000 and are retired at 96. CV $310, 000 -Cash paid 288, 000 (300*. 96) Gain (loss)$ 22, 000 (so CV-Cash paid will give you the right sign)

Redemption Before Maturity, cont’d JE Bonds payable 300, 000 Premium on bonds payable 10, 000 Cash Gain on bond redemption 288, 000 22, 000