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Face add bond premium bonds payable

Reporting and Analyzing Liabilities

©2020 Cambridge Business Publishers

2

Assets = Liabilities + Equity

Assets represent

Liabilities as a Source of Financing

Current Liabilities

they relate

Financial leverage increases when a company acquires assets and finances them with liabilities.

Learning Objective 1

Current Liabilities

 Short-term in nature
 Due within one year
 Categories of current obligations
 Current operating liabilities
 Accounts payable
 Accrued liabilities
 Deferred performance liabilities
 Current nonoperating liabilities
 Short-term interest-bearing debt
 Current maturities of long-term debt
 Most create a corresponding impact on selling, general and administrative expenses on the income statement

$ 3,453 $ 2,645
$ 21,232 $ 19,593

Other

$ 8,352 $ 8,102

Total current liabilities

$ 33,037 $ 30,340
7

account.

(1)
800

Accounts payable (+L)

800

Inventory (A)

Selling Inventory on Account

2)

Bikes R Us sold inventory costing $600 on account for

(2a)

(2a)

9

Sales (+R, +SE)

1,500
600

Sales (R)

1,500

1,500
(2b)
600
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Recording Payments Received on Account

(3)

Cash (+A)

1,100
Accounts receivable (–A) 1,100

Recording a Payment to a Creditor

4)
Balance Sheet Income Statement
Revenues – Expenses = Net
Income
(4)
800
11

Cash Discounts

 Incentives granted to buyers to encourage payment within a specified period of time
 Part of credit terms
 Stated as a percentage of the purchase price

A buyer purchases $1,000 of merchandise on June 1

with terms of 2/10, n/30. Payment is made on June 9.

$20 extra to pay 20 days later
13
$20 ÷ 20 days = $1 per day
or $365 for one year
$365 ÷ $980 = 37.2% per year!
©2020 Cambridge Business Publishers

n/30.

(1) (1)
156.80

(1)

14
Accounts payable (+L) 156.80
Inventory (A) Accounts Payable (L)

156.80

156.80
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Balance Sheet Income Statement
Revenues – Expenses = Net
Income
(2a)

Cash (–A)

156.80

(2a)

15
156.80
©2020 Cambridge Business Publishers

period ends.

(2b)

Interest expense, discounts lost (+E, –SE)

3.20

Cash (–A)

160.00
160.00
Decreases
Increases

 Cash Flows

 Because increased

©2020 Cambridge Business Publishers 17

Accrued Liabilities

Income taxes

18

Rent

Warranty costs

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Accounting for Accruals

1)
(1)

Wages expense (+E, –SE)

300
2)

Bikes R Us paid $300 of wages it had accrued the previous

period.

Balance Sheet Income Statement
Revenues – Expenses = Net
Income

=

(2) 300
300
21
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Contingent Liabilities

 Not all liabilities are certain
 Criteria to be met before recognizing:

©2020 Cambridge Business Publishers 22

23

 What are warranties?

 Commitments made by manufacturers to their customers to repair or replace defective products within a specified time period

Estimating Warranty Accruals

1)

Bikes R Us estimates the warranty liability for current period

(1)

Warranty expense (+E, –SE)

2,000

Warranty Repairs / Replacement

2)

Bikes R Us spent $400 repairing bikes under warranty.

Balance Sheet Income Statement
Revenues – Expenses = Net
Income

Disclosure for Warranties
Excerpt from Apple’s financial statement notes

presented in its 2018 10-K annual report:

©2020 Cambridge Business Publishers

Current Financial Liabilities

29

 Financing is often permanent and seasonal for seasonal operations

Example of a company with higher seasonal sales in summer

 Bank provides a commitment to lend up to a given level with the understanding that the amounts borrowed are repaid in full sometime during the year

 Evidenced by an interest-bearing note

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Calculating Interest

Principal x Annual Rate x Portion of Year

Outstanding

32

each quarter (April 1, July 1, October 1, and January 1).

(1) (1)
33
3,000
Cash (A)

Notes Payable (L)

3,000

3,000
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Balance Sheet Income Statement

Transaction

Cash

+ Noncash Asset

= Liabilities + Contrib. +
Asset Capital Capital
=
–45

Interest

Retained

Payable

Earnings
3)
Balance Sheet Income Statement
Revenues – Expenses = Net
Income

=

Excerpt from Exhibit 9.1

©2020 Cambridge Business Publishers 37

Debt Securities

When a company issues bonds, it is borrowing money.

Explain and illustrate the pricing of long-term nonoperating
liabilities.

Coupon Rate

 Also known as the contract

 The rate that investors
expect to earn on a debt Used to price a bond issue Also known as the yield rate

©2020 Cambridge Business Publishers

41

Valuing Bonds Issued at Par

$400,000 × 8% × 6/12 = $16,000

Interest rate per period:
8% annual rate ÷ 2 payments per year = 4% per period

PV of principal $400,000 x 0.6755642

= $270,226

Valuing Bonds Issued at a Discount

$400,000 × 8% × 6/12 = $16,000

The interest payment is based on the coupon rate so there is NO change.

Market interest rate per period:

10% annual rate / 2 payments per year = 5% per period

Present value of cash flows

= $369,112

Investors wish to value a bond with a face amount of $400,000, an 8% annual coupon rate, 6% market rate, interest payable semiannually, and a maturity of 5 years.

Step 1: Calculate the interest payment.

Step 2: Calculate the present value (PV) of the cash

flows.

PV of interest payments $ $16,000 x 8.53020 = $136,483

PV of annuity for 10 periods @ 3% per period (Table A.3)

= $434,119

Investors wish to value a bond with a face amount of $400,000, an 8% annual coupon rate, 6% market rate, interest payable semiannually, and a maturity of

PV = unknown, the amount to solve for

PMT = the periodic interest payment: $400,000 × 8% × 6/12 = $16,000

Investors wish to value a bond with a face amount of $400,000, an 8% annual coupon rate, 10% market rate, interest payable semiannually, and a maturity

PMT = the periodic interest payment: $400,000 × 8% × 6/12 = $16,000

FV = the principal amount of the debt: $400,000 given

$400,000 bonds

Market

Coupon
Equal to 50
Rate Rate

sold at par

face value

$400,000 bonds
Less than
sold at a discount
$400,000 bonds

$434,121

Greater
than face
sold at a premium
value

©2020 Cambridge Business Publishers

$400,000 bonds

Interest payments

sold at par

=
$160,000

Total
Interest payments

= $190,887

$16,000 x 10 =

 Offers debt
investment to the
public

 Referred to as a
tombstone

52

©2020 Cambridge Business Publishers

Issuing Bonds at Par
$400,000 bonds with 8% coupon rate, issued at par:

Cash (+A)

400,000

369,113
30,887
400,000

Bonds Payable (L)

Issuing Bonds at a Premium
$400,000 bonds with 8% coupon rate, issued at a premium, 6%

market rate:

434,121

434,121
34,121
400,000

Reporting Bonds
on the Balance Sheet

Less bond discount

(30,887)

Bonds payable, face $400,000

Added cost

A benefit

Cash Interest Paid 4%

Discount
Amortization

The $16,000 interest payment was made on the $400,000, 8%

bonds, issued at $369,113 (10% market rate).

Cash
= Liabilities Contra + Contrib. + Earned
Asset Liabilities Capital Capital
=

–2,456

–18,456

interest

and expense

on bonds

60
0 $13,024 $16,000 $2,976

$34,121

$434,121

61
1 31,145 431,145
2 12,934 16,000 3,066 28,079 428,079
3 12,842 16,000 3,158 24,921 424,921
4 12,748 16,000 3,252 21,669 421,669
5 12,650 16,000 3,350 18,319 418,319
6 12,550 16,000 3,450 14,869 414,869
7 12,446 16,000 3,554 11,315 411,315
8 12,339 16,000 3,661 7,654 407,654
9 12,230 16,000 3,770 3,884 403,884
10 12,117 16,000 3,883 0 400,000
3%

$2,976

$16,000 -

$400,000 - $31,145

$13,024
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13,024
2,976
16,000

Cash (A)

Financial Statement Effects of Bond Repurchase

 Bonds trade in secondary markets between

(indenture)

 Call provision gives the company the right to repurchase its bonds

63

Financial Statement Footnotes
Verizon presented a schedule in its note disclosure of

 Interest must be excluded from operating activities section of cash flows statement and from net
operating profit when performing a financial
analysis.

 Interest income

 Interest-bearing bonds and notes

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66

 A measure of solvency

 Measures the corporation’s financial leverage

Applying the Debt-to-Equity ratio to Verizon:

©2020 Cambridge Business Publishers 68

©2020 Cambridge Business Publishers 69

Verizon in Context
Debt-to-Equity Ratio

©2020 Cambridge Business Publishers 70

Times Interest Earned (TIE)
 Measures how many times interest expense is

TIE =
Interest expense
Applying Times Interest Earned ratio to Verizon:

The size of this ratio is driven by two factors—the amount of debt financing, which in turn determines interest expense, as well as profitability.

©2020 Cambridge Business Publishers

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Debt Ratings

 Agencies include

 Moody’s Investors Service

major bond rating services:

Collateral
 Security in the form of assets provided for debt
 Debt holder is in a preferred position with secured debt

Covenants
 Restrictions specified in the debt agreement
 Provide debt holder a means of control over the issuer’s operations

Financial Accounting Sixth Edition

Cambridge Business

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