FINANCIAL ACCOUNTING

Tools for Business Decision-Making

KIMMEL  WEYGANDT  KIESO  TRENHOLM  IRVINE

CHAPTER 10:
REPORTING AND ANALYZING LIABILITIES
 LEARNING OBJECTIVES
SO 1: Account for current liabilities.
SO 2: Account for instalment notes payable.
SO 3: Identify the requirements for the financial
statement presentation and analysis of liabilities.
SO 4: Account for bonds payable (Appendix 10A).
 Liabilities

• (present) Obligations resulting from past

transactions
• Classified as current and non-current

Liabilities must be settled in the

future by transfer of assets or
services
 Current Liabilities

• Types of current liabilities include:

– Bank indebtedness from operating lines of credit
– Accounts payable and accrued liabilities
– Unearned revenue
– Notes and loans payable
– Sales taxes
– Property taxes
– Payroll
– Current maturities of non-current debt
– Provisions and contingent liabilities
 Sales Taxes

• Federal Goods and Services Tax (GST)

• Provincial Sales Tax (PST or QST)
• Combined into one harmonized sales tax (HST)
in some provinces

• Must be remitted periodically to respective governments:

– When paid, debit Sales Tax Payable account and credit Cash
 Property 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 value of
the property
 Property Taxes Payable

• Upon receipt of the (calendar year) property tax bill

(assume in March), an expense is recorded for the
months that have passed (assume in January and
February)
 Property Taxes Payable (Continued)

• When paid (assume in May), expense is

recorded for additional months that have
passed, and prepaid is set up for remaining
months
 Property Taxes Payable (Continued)

• Prepaid is cleared to expense at the end of

year
 Practice

Brief Exercise 2 (Page 560)

Entries for Property Taxes
 Payroll

• Three types of liabilities related to employee

salaries and wages:
1. Salary and wages owed to employees (known as
gross pay)
2. Payroll deductions required 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
 Employee Payroll Deductions

• Mandatory payroll deductions:

– Canada pension plan (CPP)
– Employment insurance (EI)
– Federal and provincial income taxes
• Voluntary payroll deductions:
– Benefits such as health and pension
– Union dues
– Charitable contributions
 Employer Payroll Obligations

• Employer’s share of CPP and EI

• Workers’ compensation
• Employee benefits:
– Compensated absences (vacation, statutory
holidays)
– Employer-sponsored health plans and pensions
 Short-Term Notes Payable

Remember Notes Receivable –

now you’re on the other side of the desk!
 Short-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
 Current 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
Uncertain Liabilities
 Uncertain 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 (warranties/gift card/cust. loyalty)
• 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)
 Practice

IFRS Test:
1) Outcome is probable (more likely than not, >50%)
(disclose);
2) Amount can be estimated (record).

Brief Exercise 5 (Page 560) Contingent

Liabilities (Provision)
Non-Current Liabilities/Instalment Notes
 Non-Current Liabilities

• Obligations to be paid after one year or longer

• 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
 Instalment Notes Payable

• Normally repayable in a series of periodic

payments called instalments
• Instalment payments usually take one of two
forms:
– Fixed principal payments plus interest (fixed or
floating interest)
– Blended principal and interest payments
 Instalment Payment Schedule
— Fixed Principal Payments
• Loan is repayable in equal periodic amounts
plus interest
• To illustrate, assume that Belanger Ltée
borrows $120,000 for five years at 7%:
– Terms provide for monthly installment payments
of $2,000 ($120,000 ÷ 60 months)
• Monthly interest expense is calculated by
multiplying the outstanding principal balance
by the interest rate
 Instalment Payment Schedule
— Fixed Principal Payments (Continued)
 Instalment Payment Schedule
— Blended Payments
• Loan is repayable in equal periodic amounts
including interest
• To illustrate, assume that instead of fixed principal
payments, Belanger Ltée repays its $120,000, 7%,
5-year loan payable in equal monthly installments
of $2,376
• Monthly interest expense is still calculated by
multiplying the outstanding principal balance by
the interest rate
 Instalment Payment Schedule
— Blended Payments (Continued)
Final Payments – Periods 44 to 60
44 $2,376.14 $223.71 $2,152.43 $36,197.61
45 $2,376.14 $211.15 $2,164.99 $34,032.62
46 $2,376.14 $198.52 $2,177.62 $31,855.01
47 $2,376.14 $185.82 $2,190.32 $29,664.69
48 $2,376.14 $173.04 $2,203.10 $27,461.59
49 $2,376.14 $160.19 $2,215.95 $25,245.64
50 $2,376.14 $147.27 $2,228.87 $23,016.77
51 $2,376.14 $134.26 $2,241.88 $20,774.89
52 $2,376.14 $121.19 $2,254.95 $18,519.94
53 $2,376.14 $108.03 $2,268.11 $16,251.83
54 $2,376.14 $94.80 $2,281.34 $13,970.50
55 $2,376.14 $81.49 $2,294.65 $11,675.85
56 $2,376.14 $68.11 $2,308.03 $9,367.82
57 $2,376.14 $54.65 $2,321.49 $7,046.33
58 $2,376.14 $41.10 $2,335.04 $4,711.29
59 $2,376.14 $27.48 $2,348.66 $2,362.63
60 $2,376.14 $13.78 $2,362.36 $0.27 (rounding)
 Practice

Exercise 6 (Page 563/4)

Instalment Note Payable (note: annual blended payments)
 Practice

Exercise 6 (Page 563/4)

Instalment Note Payable (note: annual blended payments)
EXERCISE 10-6
(a)
(B) (C) (D)
Annual (A) Interest Reduction Principal
Interest Cash Expense of Principal Balance
Period Payment (D) × 4% (A) – (B) (D) – (C)

July 1, 2017 $15,000

June 30, 2018 $7,953 $600 $7,353 7,647
June 30, 2019 7,953 306 7,647 0
 Practice
Exercise 6 (Page 563/4)
Instalment Note Payable (note: annual blended payments)

(b) 2017
(1) July 1 Cash 15,000
Notes Payable 15,000

(2) Dec. 31 Interest Expense ($600 × 6/12)

300
Interest Payable
300

(3) 2018
June 30Interest Expense
300
Interest Payable
 Practice
Exercise 6 (Page 563/4)
Instalment Note Payable (note: annual blended payments)

(c) On December 31, 2018 another accrual for interest expense would be made as
follows:

Dec. 31 Interest Expense ($306 × 6/12)

153
Interest Payable 153

After making the above entry the company would have two current liabilities
relating to the note as follows:

Current liability
Interest payable $153
Statement Presentation
 Statement 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
 Analysis of Debt Obligations

• Liquidity – measure short-term ability to pay

maturing obligations and meet cash needs:
– Current ratio
– Inventory turnover ratio
– Receivables turnover ratio
• Solvency – measure ability to meet long-term
obligations:
– Debt to total assets
– Times interest earned
 Debt to Total Assets

• Indicates the extent to which a company’s

assets are financed by debt

Total Liabilities
Debt to Total Assets = Total Assets

Lower is better
 Times Interest Earned

• Provides an indication of a company’s ability to

meet interest payments as they come due

Times Interest Earned = Profit + Interest Expense +

Income Tax Expense (EBIT)
Interest Expense

Higher is better
Operating Leases
 Operating Leases

• Treated as periodic rentals – no assets or

liabilities are recorded
• Usually short-term:
– If longer-term, considered to be “off-balance-sheet
financing”
• Must be disclosed in the notes to the financial
statements
Appendix 10A
Bonds Payable
 Appendix 10A
Bonds Payable - Terminology
• 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 (debenture)
• Payable at maturity (term bonds) or in
instalments (serial bonds)
• Redeemable bonds can be retired before
maturity
 Terminology

• Face value:
– Amount of principal due at maturity
• Present value(Price):
– 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
of interest
 Terminology

• Convertible bonds can be converted to

common shares at a stated price
• Bonds can also be traded on exchanges:
– Bond prices are quoted as a percentage of the face
value of the bonds
• Market (or effective) interest rate (yield):
– Rate investors demand for loaning funds
 Pricing A Bond

• The value of “anything” is the Present Value of

its future cash flows.

How much would you pay for this:

$10 $10 $10

$?
Yr 1 Yr 2 Yr 3
 Pricing A Bond

• The value of “anything” is the Present Value of

its future cash flows.
$10 $10 $10
Today
Yr 1 Yr 2 Yr 3
$9.80
$9.61
$9.42
$28.83

Assume current market interest rate = 4%

 Pricing A Bond

• When a bond sells – the investor is buying its

future cash flows

$
$ $ $
Price
Yr 1 Yr 2 Yr 3
 Pricing A Bond

• When a bond sells – the investor is buying its

future cash flows:
– Maturity
– Face Value
– Coupon Rate
– Frequency

$
$ $ $
Price
Yr 1 Yr 2 Yr 3
 Example

• When a bond sells – the investor is buying its

future cash flows:
– Maturity 3 Years
– Face Value
– Coupon Rate
– Frequency

$
$ $ $
Price
Yr 1 Yr 2 Yr 3
 Example

• When a bond sells – the investor is buying its

future cash flows:
– Maturity 3 Years
– Face Value $100,000
– Coupon Rate
– Frequency

$100,000
$ $ $
Price
Yr 1 Yr 2 Yr 3
 Example

• When a bond sells – the investor is buying its

future cash flows:
– Maturity 3 Years
– Face Value $100,000
– Coupon Rate 5% ($5,000=$100,000x0.05)
– Frequency

$100,000
$5,000 $5,000 $5,000
Price
Yr 1 Yr 2 Yr 3
 Example

• When a bond sells – the investor is buying its

future cash flows:
– Maturity 3 Years
– Face Value $100,000
– Coupon Rate 5% ($5,000=$100,000x0.05)
– Frequency annual (interest paid once per year)

$100,000
$5,000 $5,000 $5,000
Price
Yr 1 Yr 2 Yr 3
 Example

• When a bond sells – the investor is buying its

future cash flows:
– Market rate is the rate of interest investors are
willing to accept based on:
» Inflation
» Cost of money
» Risk (credit/liquidity)
$100,000
$5,000 $5,000 $5,000
Price
Yr 1 Yr 2 Yr 3

Assume Market Rate = 6%

 Example

• When a bond sells – the investor is buying its

future cash flows:
$100,000
$5,000 $5,000 $5,000
Price = $97,326.99
Yr 1 Yr 2 Yr 3

Assume Market Rate = 6%

 BAII Plus Calculator

• When a bond sells – the investor is buying its

future cash flows:
$100,000
$5,000 $5,000 $5,000
Price = $97,326.99
Yr 1 Yr 2 Yr 3

N=3
I/Y = 6% Note: the calculator will show your answer

PV=?
as a negative amount (opposite of input)

PMT=$5,000
FV=$100,000
 Determining 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
Determining the Price of a Bond—Using
Present Value Tables
Determining the Price of a Bond—Using
Present Value Tables
Determining the Price of a Bond—Using
Present Value Tables

Table 1:
0.83962 x $100,000 = $83,962.00
Table 2:
2.67301 x $5,000 = $13,365.05

Price: $97,327.05

Versus Calculator: $97,326.99 (due to # of decimal places)

 You Practice

• Bond details:
– Maturity 4 Years
– Face Value $500,000
– Coupon Rate 5%
– Frequency semi-annual (interest paid twice per year)

Market Rate = 4%

Price
Per. 1 Per. 2 Per. 3 Per. 4 Per. 5 Per. 6 Per. 7 Per. 8
 You Practice

• Bond details:
– Maturity 4 Years
– Face Value $500,000
– Coupon Rate 5%
– Frequency semi-annual (interest paid twice per year)

Interest payments $500,000 x 0.05 / 2 = $12,500

Price
Per. 1 Per. 2 Per. 3 Per. 4 Per. 5 Per. 6 Per. 7 Per. 8

Market Rate = 4%
 You Practice

• Bond details:
– Maturity 4 Years
– Face Value $500,000
– Coupon Rate 5%
– Frequency semi-annual (interest paid twice per year)

$500,000
$12,500 $12,500 $12,500
$12,500 $12,500 $12,500 $12,500 $12,500

Price
Per. 1 Per. 2 Per. 3 Per. 4 Per. 5 Per. 6 Per. 7 Per. 8

Market Rate = 4%
 You Practice

• Bond details:
– Maturity 4 Years
N=8
– Face Value $500,000 I/Y = 2% (4%/2)
– Coupon Rate 5% PV=?
– Frequency semi-annual (interest paid twice per year) PMT=$12,500
Table 1: FV=$500,000
0.85349 x $500,000 = $426,745.00
Table 2:
7.32548 x $12,500 = $91,568.50
Price: $518,313.50
Note: 2%(4%/2), 8 Periods
$500,000
$12,500 $12,500 $12,500
$12,500 $12,500 $12,500 $12,500 $12,500

Price=$518,313.70
Per. 1 Per. 2 Per. 3 Per. 4 Per. 5 Per. 6 Per. 7 Per. 8

Market Rate = 4%
• See Trading Example
 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

 Issuing Bonds at Face Value

Journal Entries
 Accounting for Bond Issues

• Bonds may be issued at:

– Face value (par)
– Below face value (discount)
• If market rate is higher than coupon rate
– Above face value (premium)
• If market rate is lower than coupon rate
 Issuing Bonds at Face Value

• Assume that Candlestick, Inc. issued five-year

$1 million 5% bonds dated January 1 at 100
(100% of face value)

Jan. 1 Cash $1,000,000

Bonds Payable $1,000,000
 Practice

Problem 9A (Page 569)

Able Ltd – do Part a) only.
Issuing Bond a Face Value
 Practice

Problem 9A (Page 569)

Able Ltd – do Part a) only.
Issuing Bond a Face Value

General Journal
Date Account Titles and Explanation Debit Credit
2018
Jan. 1 Cash $100,000
Bonds Payable $100,000
 Issuing 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
 Issuing Bonds at a Discount (Continued)

• Assume that on January 1, Candlestick, Inc.

sells $1 million, five-year, 5% bonds at 98.1417
of face value:
– Issue price of $981,417 results in a discount of
$18,583

Jan. 1 Cash $981,417

Bonds Payable $981,417
 Practice

Problem 9A (Page 569)

Beta Corp. – do Part a) only.
Issuing Discount Bond
 Practice

Problem 9A (Page 569)

Beta Corp. – do Part a) only.
Issuing Discount Bond

General Journal
Date Account Titles and Explanation Debit Credit
2018
Jan. 1 Cash $94,000
Bonds Payable $94,000
 Issuing 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
 Issuing Bonds at a Premium (Continued)

• Assume that on January 1, Candlestick, Inc.

sells $1 million, five-year, 5% bonds at
101.9043 of face value:
– Issue price of $1,019,043 results in a premium of
$19,043

Jan. 1 Cash $1,019,043

Bonds Payable $1,019,043
 Practice

Problem 9A (Page 569)

Charles Inc. – do Part a) only.
Issuing Premium Bond
 Practice

Problem 9A (Page 569)

Charles Inc. – do Part a) only.
Issuing Premium Bond

General Journal
Date Account Titles and Explanation Debit Credit
2018
Jan. 1 Cash $105,000
Bonds Payable $105,000
Amortization of Bond
Premium or Discount
 Amortizing a Discount Bond

• Bond: FV=$100,000, Coupon=5%, Mkt %=6%, 3 Years

Yr 1 Yr 2 Yr 3

$100,000
Balance Sheet
Carrying Value $97,326.99
 Amortizing a Discount Bond

• Bond: FV=$100,000, Coupon=5%, Mkt %=6%, 3 Years

Yr 1 Yr 2 Yr 3

Discount = $2,673.01 $100,000

Balance Sheet $98,166.61
Carrying Value $97,326.99

Cash Interest Disc/Amort Unamort. Carrying

Period Payment Expense Amortization Disc/Prem Amount
0 $2,673.01 $97,326.99
1 $5,000.00 $5,839.62 $839.62 $1,833.39 $98,166.61
$100,000 $97,326.99 $5,000-
X 5% X 6% $5,839.62
=$5,000 =$5,839.62 =$839.62

General Journal
Date Account Titles and Explanation Debit Credit

Year 1 Interest Expense $5,839.62

Bonds Payable $839.62
Cash $5,000.00
 Amortizing a Discount Bond

• Bond: FV=$100,000, Coupon=5%, Mkt %=6%, 3 Years

Yr 1 Yr 2 Yr 3

Discount = $2,673.01 $100,000

$99,056.61
Balance Sheet
Carrying Value $97,326.99
Cash Interest Disc/Amort Unamort.
Period Payment Expense Amortization Disc/Prem Carrying Amount
0 $2,673.01 $97,326.99
1 $5,000.00 $5,839.62 $839.62 $1,833.39 $98,166.61
2 $5,000.00 $5,890.00 $890.00 $943.39 $99,056.61
3 $5,000.00 $5,943.40 $943.40 $0 $100,000.00

General Journal
Date Account Titles and Explanation Debit Credit

Year 2 Interest Expense $5,890.00

Bonds Payable $890.00
Cash $5,000.00
 Amortizing a Discount Bond

• Bond: FV=$100,000, Coupon=5%, Mkt %=6%, 3 Years

Yr 1 Yr 2 Yr 3
$100,000
$99,056.61
Discount = $2,673.01 $98,166.61
Balance Sheet
Carrying Value $97,326.99
Cash Interest Disc/Amort Unamort. Carrying
Period Payment Expense Amortization Disc/Prem Amount
0 $2,673.01 $97,326.99
1 $5,000.00 $5,839.62 $839.62 $1,833.39 $98,166.61
2 $5,000.00 $5,890.00 $890.00 $943.39 $99,056.61
3 $5,000.00 $5,943.40 $943.40 $0 $100,000.00

General Journal
Date Account Titles and Explanation Debit Credit

Year 3 Interest Expense $5,943.40

Bonds Payable $943.40
Cash $5,000.00
 Amortization of Bond
Premium or Discount
• Premiums and discounts amortized using
effective-interest method:
1. Calculate bond interest expense
2. Calculate bond interest paid
3. Calculate amortization amount
 Amortizing the Discount or Premium

• Bond discount (or premium) is allocated to

interest expense over the life of the bonds –
called amortizing the discount (or amortizing
the premium)
• Difference between interest expense (at the
market rate or yield) and interest paid (at the
coupon rate) is the discount or premium to be
amortized
 Practice

Problem 9A (Page 569)

Do Part b) for each company.
Recording interest
Note: For Premium Bonds Amortization Amount is DEDUCTED from bonds
payable.
More Practice:
Problem 10A (Page 569)
Calculate Bond Price/Prepare Amortization Schedule/Record
Transactions

PV Tables on pages 550 ($1) & 551 (annuity)

 Carrying Amount

• Carrying amount is face value of bond less/plus

unamortized discount/premium
• Discount increases until it reaches maturity
value; premium decreases
 Accounting for Bond Retirements

• Bonds can be retired at maturity or earlier (by

purchasing on the open market)
• 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