Chapter 10

CHAPTER

1C

HA

PT

ER

Reporting and Analyzing Liabilities

Study Objectives

1. Account for current liabilities.

2. Account for bonds payable.

3. Identify the requirements for the financial statement presentation and analysis of liabilities.

10

Copyright John Wiley & Sons Canada, Ltd.1 10

CHAPTER

1Liabilities

Obligations resulting from past transactions

Classified as current and non-current

2 10

Liabilities must be settled in the future by transfer of assets or services

2 Copyright John Wiley & Sons Canada, Ltd.

CHAPTER

1Current Liabilities

Expected to be paid:– From existing current assets or through the

creation of other current liabilities

– Within one year

Copyright John Wiley & Sons Canada, Ltd.3 10

Debts that do not meet both criteria are classified as non-current (or long-term) liabilities

3

CHAPTER

1Current Liabilities

Types of current liabilities include:– Bank indebtedness from operating lines of credit

– Accounts payable and accrued liabilities

– Unearned revenue

– Notes or loans payable

– Sales taxes

– Property taxes

– Payroll

– Current portion of non-current debt

4 104 Copyright John Wiley & Sons Canada, Ltd.

CHAPTER

1Operating Line of Credit

Prearranged agreement between a company and a lender to allow the company to borrow up to an agreed-upon amount:– To help manage temporary cash shortfalls

Interest is charged using a floating (or variable) interest rate

Security (collateral) may be required by bank

When used, results in bank indebtedness5 105 Copyright John Wiley & Sons Canada, Ltd.

CHAPTER

1Sales Taxes

Expressed as % of the sales price – Provincial Sales Tax (PST 8% or QST) and

– Goods and Services Tax (GST 5%) OR

– Harmonized Sales Tax (HST 13%)

May or may not be included in sale price

Sales taxes payable recorded

On remittance of sales taxes, the payable is decreased


CHAPTER

1Property Taxes

Businesses that own property pay property taxes for each calendar year to municipal or provincial governments

Property taxes are calculated at a specified rate for every $100 of the assessed valued of the property


CHAPTER

1Property Taxes Payable

Upon receipt of the property tax bill (on March 1), an expense is recorded for the months that have passed (Jan and Feb)


CHAPTER

1Property Taxes Payable (Continued)

When paid (on May 31), expense is recorded for additional months that have passed (March, April, May), and prepaid is set up for remaining months (June to Dec)


CHAPTER

1Property Taxes Payable (Continued)

At December 31 (year-end date), prepaid is cleared to expense


CHAPTER

1Payroll

Three types of liabilities related to employee salaries and wages:1. Salary and wages owed to employees (known

as gross pay or gross earnings)

2. Payroll deductions required by law to be withheld from employees’ gross pay

• Employees’ gross pay less payroll deductions is known as net pay (or take home pay)

3. Employer payroll obligations


CHAPTER

1Employee Payroll Deductions

Mandatory payroll deductions:– Canada pension plan (CPP)

– Employment insurance (EI)

– Federal and provincial income taxes

Voluntary payroll deductions:– Benefits such as health, disability, and pension

– Union dues

– Charitable contributions


CHAPTER

1Employer Payroll Obligations

Employer’s share of CPP and EI

Workers’ compensation

Employee benefits:– Compensated absences (vacation, statutory holidays, sick

days)

– Employer-sponsored health plans and pensions

Employer’s share of these costs is recorded as an employment benefits expense

Until payroll deductions and costs are remitted to third parties (whom they are collected for), they are reported as current liabilities


CHAPTER

1Short-Term Notes Payable

A promise to pay a specified amount either at a future date or on demand

Often used instead of accounts payable

Provide written documentation, if needed, for legal remedies

Normally has interest attached (at a fixed annual rate)

Issued for varying periods:– If due within one year of financial statement date, they

are classified as current liabilities


CHAPTER

1Discussion Question

What is the difference between an Accounts Payable and a Notes Payable?


CHAPTER

1Short-Term Notes Payable: Example

HSBC Bank agrees to lend $100,000 on March 1, 2012, if Williams Coffee Shop Ltd. signs a $100,000, 6%, 4-month bank loan maturing on July 1 (interest payable at maturity). Assume year-end is March 31.

What entry is made upon receipt of cash and after note is signed?

Is interest expense recorded periodically? If yes, what is the entry to accrue interest?

What is the entry recorded on maturity date?


CHAPTER


What entry is made upon receipt of cash and after note is signed?

March 1 Cash 100,000

Bank Loan Payable 100,000

(To record issue of 4-mth, 6% bank loan from HSBC)


CHAPTER


Is interest expense recorded periodically? If yes, what is the entry to accrue interest?

Interest accrues over the life of the bank loan and must be recorded periodically. Adjusting entry required to recognize interest expense and interest payable.

Interest Expense 500

Interest Payable 500

($100,000 x 6% x 1/12)

(To accrue interest payable for 1-mth on HSBC loan)


CHAPTER


What is the entry recorded on maturity date?

At maturity on July 1, the face value of the bank loan ($100,000) plus interest accrued over the life of the loan has to be recorded. $500 interest has already been accrued in March.

Interest Expense 1,500

Interest Payable 1,500

($100,000 x 6% x 3/12)

(To accrue interest payable for April, May, and June)

Bank Loan Payable 100,000

Interest Payable 2,000

Cash 102,000

(To record payment of HSBC bank loan and interest at maturity)


CHAPTER

1Current Maturities

of Non-Current Debt

The portion of non-current (long-term) debt that is due within the current year or operating cycle should be classified as a current liability

Journal entry is not required to recognize this classification


CHAPTER

1Non-Current Liabilities

Obligations to be paid after one or more years classified as non-current

Also known as financial liabilities (a type of financial instrument):– A contractual obligation to pay cash in the future

Includes long-term notes, bonds, and lease obligations

May be secured or unsecured:– Secured notes are also known as mortgages


CHAPTER

1Bonds Payable

A form of interest-bearing notes payable

Large amount is divided into smaller denominations:– Makes them attractive to investors

Most have a fixed interest rate (coupon rate)

May be secured or unsecured

Payable at maturity or in installments

Redeemable bonds can be retired before maturity


CHAPTER

1Bond Trading

Convertible bonds can be converted to common shares at a stated price

Bonds can also be traded on stock exchanges:– Bond prices are quoted as a percentage of the

face value of the bonds (i.e. $1,000 bond with quoted price of $97 sells at price 97% of face value or $970)

Market (or effective) interest rate (yield):– Rate investors demand for loaning funds


CHAPTER

1Terminology

Face value:– Amount of principal due at maturity

Present value:– Value today of:

1. Bond face value to be received at maturity, and

2. Interest payments to be received periodically

– The value today is dependent upon when the amounts are to be received, and the market rate on interest


CHAPTER

1Accounting for Bond Issues

Bonds may be issued at:– Face value

• If market rate is equal to coupon rate

– Below face value (discount)

• If market rate is higher than coupon rate

– Above face value (premium)

• If market rate is lower than coupon rate


CHAPTER

1Calculating the Price of a Bond—

Using Present Value Tables

• Issue price = the present value of all future cash inflows (discounted at market rate of interest)

– Face value – use Table 1 (PV of $1) to determine the factor to use to calculate the face value of bond

= PV factor x face value of bond

– Interest – use Table 2 (PV of an annuity of $1) to calculate the present value of bond interest

= PV annuity factor x periodic interest payment (payment calculated using coupon rate)

– Sum the two to arrive at the price of the bond

10Copyright John Wiley & Sons Canada, Ltd.26

CHAPTER

1

Copyright John Wiley & Sons Canada, Ltd.27

Calculating the Price of a Bond—Using Financial Calculator

2nd P/Y, C/Y = Payments/year, compounding periods/year

N = Total number of periods

I/Y = ANNUAL effective interest rate

PV = Present value

PMT = Periodic payments (0 if only calculating the PV of the final FV payment)

FV = Future value

Note: Individual calculators may differ

10

CHAPTER

1Determining Issue Price of Bond— Using a Financial Calculator

• Use the highlighted row of keys for solving for present value

Note: Each calculator may differ in format

n: Number of periodsi: Market interest rate per periodPV: Present valuePMT: Interest payment per periodFV: Future value

1028 Copyright John Wiley & Sons Canada, Ltd.

CHAPTER

1Issuing Bonds at Face Value

Assume that ABC Company Ltd. issued five-year $1 million 5% bonds dated January 1 at 100 (100% of face value). Interest on bonds is payable semi-annually on January 1and July 31.

What is the entry to record the issuance of bonds?

How are the bonds reported in the Statement of Financial Position?

Do we need to record interest expense and accrue any interest for the year?

How is the bond interest reported in the Statement of Financial Position?


CHAPTER

1Issuing Bonds at a Discount

This occurs when investors pays less than the face value of the bond:– The coupon rate is too low – investors can get a

better rate elsewhere

– The bond price must therefore decrease to ensure that the yield (effective interest rate) is competitive

– Since the coupon rate is fixed, a lower bond price will result in a higher yield


CHAPTER

1Issuing Bonds at a Discount

(Continued)

Assume that on January 1, 2012 ABC Company Ltd., sells $1 million, five-year, 5% bonds at 95.7345 of face value. The market (effective) interest rate is 6% with interest payable on July 1 and January 1. – What is the present value of the bonds (issue price)?

– What is the entry to record the issuance of bonds?

– Do we have a discount or premium on the bond?

– What is the carrying amount of the bonds?


CHAPTER

1Amortizing the Discount

• Bond discount is allocated to interest expense over the life of the bonds – called amortizing the discount

• Difference between interest expense (at the market rate or yield) and interest paid (at the coupon rate) is the discount to be amortized

• What is the interest expense and paid for the first period?

• What is the discount to be amortized?

• What is the entry to record the payment of bond interest and amortization of bond discount (on 1st interest date)?

• What is the new carrying amount of the bonds?

• Any adjusting entries at Dec 31 (year-end) required?


CHAPTER

1Issuing Bonds at a Premium

This occurs when investors pays more than the face value of the bond:– The coupon rate is too high – company does not

have to offer such a high interest rate

– The bond price will therefore increase to ensure that the yield (effective interest rate) is competitive

– Since the coupon rate is fixed, a higher bond price will result in a lower yield


CHAPTER

1Issuing Bonds at a Premium

(Continued)

Assume that on January 1, 2012 ABC Company Ltd., sells $1 million, five-year, 5% bonds at 104.4915 of face value. The market (effective) interest rate is 4% with interest payable on July 1 and January 1. – What is the present value of the bonds (issue price)?

– What is the entry to record the issuance of bonds?

– Do we have a discount or premium on the bond?

– What is the carrying amount of the bonds?


CHAPTER

1Amortizing the Premium

• Bond premium is allocated to interest expense over the life of the bonds – called amortizing the premium

• Difference between interest expense (at the market rate or yield) and interest paid (at the coupon rate) is the premium to be amortized

• What is the interest expense and paid for the first period?

• What is the premium to be amortized?

• What is the entry to record the payment of bond interest and amortization of bond premium (on 1st interest date)?

• What is the new carrying amount of the bonds?

• Any adjusting entries at Dec 31 (year-end) required?


CHAPTER

1Carrying Amount

• Carrying amount is face value of bond (-/+) unamortized discount/premium OR

• PV of bond (-/+) amortized discount/premium

• Discount increases carrying amount until it reaches maturity value; premium decreases the carrying amount


CHAPTER

1Redeeming Bonds At Maturity

At maturity, the bonds’ carrying amount is equal to their face value:– Regardless of the issue price of the bonds

– Any premium or discount will be fully amortized

No gain or loss occurs


CHAPTER

1Redeeming Bonds Before Maturity

A company may decide to retire bonds before maturity in order to:– Reduce interest cost

– Remove debt from its balance sheet

When bonds are retired before maturity: – Update any unrecorded interest and amortization

– Eliminate carrying amount of the bonds at the redemption date

– Record the cash paid

– Recognize gain/loss on redemption (gain if cost < carrying amount; loss if cost > carrying amount)


CHAPTER

1Redeeming Bonds Before Maturity

Assume at the end of the fourth year (eighth period), ABE Company Ltd., having sold its bonds at a premium, retires its bonds at 101 after paying the semi-annual interest. The carrying amount of the bonds at the redemption date is $1,009,709.

– What is the entry to record redemption of ABC Company’s bonds at the end of the 8th interest period (Jan 1, 2016)?


CHAPTER

1Statement Presentation

Current liabilities– Reported as the first category of liabilities

– Can be listed separately on statement of financial position or detailed in the notes

– Normally listed in order of liquidity

Non-current liabilities– Report separately in statement of financial

position and detail in notes

– Measured and reported at amortized cost


CHAPTER

1Uncertain Liabilities

Events with uncertain outcomes:– Who is owed

– When it is owed, and/or

– How much is owed

Provisions are uncertain as to timing or amount

Contingent liabilities are possible obligations that are dependent upon some future event:– Should be recognized if more likely than not (IFRS)

– Should be recognized if likely (ASPE)


CHAPTER

1

43

Comparing IFRS and ASPE

Copyright John Wiley & Sons Canada, Ltd. 10

Chapter 10

Documents