Chapter 07 – Accounting for Liabilities
7-1
Operating Activities
Inflow from Customers
$ 7,000
$ 7,000
$ 7,000
Outflow for Interest
(6,000)
(4,187)
(2,193)
Investing Activities
-0-
-0-
-0-
Financing Activities
Inflow from Note Issue
60,000
Outflow to Repay Note
(18,127)
(19,940)
(21,934)
Net Change in Cash
42,873
(17,127)
(17,127)
Beginning Cash Balance
-0-
42,873
25,746
Ending Cash Balance
$42,873
$25,746
$ 8,619
*The one dollar negative balance in the note payable account is due to rounding.
Demonstration Problem 7-4: Solution
Financial Statements
Land Development Company
Bonds Issued at Face Value with Interest Payable Annually
Income Statements
2014
2015
2016
2017
2018
Rent Revenue
$ 7,000
$ 7,000
$ 7,000
$ 7,000
$ 7,000
Interest Expense
(6,000)
(6,000)
(6,000)
(6,000)
(6,000)
Net Income
$ 1,000
$ 1,000
$ 1,000
$ 1,000
$ 1,000
Balance Sheets
Assets
Cash
$ 1,000
$ 2,000
$ 3,000
$ 4,000
$ 5,000
Land
50,000
50,000
50,000
50,000
-0-
Total Assets
$51,000
$52,000
$53,000
$54,000
$ 5,000
Liabilities
Bond Payable
$50,000
$50,000
$50,000
$50,000
-0-
Equity
Retained Earnings
1,000
2,000
3,000
4,000
5,000
Total Liabilities and Equity
$51,000
$52,000
$53,000
$54,000
$ 5,000
Statements of Cash Flows
Operating Activities
Inflow from Customer
$ 7,000
$ 7,000
$ 7,000
$ 7,000
$ 7,000
Chapter 07 – Accounting for Liabilities
7-2
Outflow for Interest
(6,000)
(6,000)
(6,000)
(6,000)
$(6,000)
Investing Activities
Outflow to Purchase Land
(50,000)
Inflow from Sale of Land
50,000
Financing Activities
Inflow from Bond Issue
50,000
Outflow to Repay Bond
(50,000)
Net Change in Cash
1,000
1,000
1,000
1,000
1,000
Beginning Cash Balance
-0-
1,000
2,000
3,000
4,000
Ending Cash Balance
$ 1,000
$2,000
$3,000
$4,000
$5,000
WORK PAPERS FOR
DEMONSTRATION PROBLEMS
Demonstration Problem 7-1: Work Paper, Parts A & B,
Accounting Equation
Assets
=
Liab.
+
Equity
2014 Part A
Cash
+
Land
=
Notes
Payable
+
Int.
Pay.
+
Com.
Stock
+
Ret.
Ear.
Beginning Balances
$ -0–
$ -0–
$ -0–
$ -0-
$ -0-
$ -0-
1. Effect of Borrowing
2. Purch. of Land
3. Earned Revenue
4. Accrued Int. Exp.
End. / Beg. Balances
$ 600
+
$10,000
=
$10,000
+
$ 400
+
$ -0-
+
$ 200
2015 Part B
1. Earned Revenue
2. Sold Land
3. Accrued Int. Exp.
4. Paid Interest
5. Repaid Loan
−−−−−
−−−−
−−−−
−−−−
−−−−−
−−−−−
Ending Balances
$ 750
+
$ -0-
=
$ -0-
+
$ -0-
+
$ -0-
+
$ 750
═══
════
════
════
═════
═════
Demonstration Problem 7-1: Work Paper, Parts A & B, Financial Statements
Canton Company
Income Statements
For the Years Ended December 31,
2014
2015
Rent Revenue
Chapter 07 – Accounting for Liabilities
7-3
Interest Expense
Net Income
Statements of Retained Earnings
Beginning Retained Earnings
Net Income
Dividends
Ending Retained Earnings
$200
$750
Balance Sheets at December 31
Assets
Cash
Land
Total Assets
$10,600
$750
Liabilities
Interest Payable
Note Payable
Equity
Retained Earnings
Total Liabilities and Equity
$10,600
$750
Statements of Cash Flows
Cash Flows from Operating Activities
Inflow from Rent Revenue
Outflow for Interest Expense
Net Inflow from Operating Activities
Cash Flow from Investing Activities
Inflow from Sale of Land
Outflow for Purchase of Land
Net Inflow (Outflow) from Investing Act.
Cash Flows from Financing Activities
Inflow from Issue of Note
Outflow for Repayment of Note
Net Inflow (Outflow) from Financing Act.
Net Change in Cash
Beginning Cash Balance
Ending Cash Balance
$ 600
$ 750
Demonstration Problem 7-2: Work Paper
Johnson’s 2014 interest expense equals McCoy’s 2014 interest revenue, as follows:
Date Note Issued
Principal
x
Rate
x
Time
=
Accrued Interest
April 1, 2014
x
x
=
June 1, 2014
x
x
=
Chapter 07 – Accounting for Liabilities
7-4
October 1, 2014
x
x
=
Demonstration Problem 7-3: Work Paper, part a. Amortization Table
Column 1
Column 2
Column 3
Column 4
Column 5
Accounting
Period
Principal
Balance on
Jan. 1
Cash
Payment
Dec. 31
Applied
to
Interest
Applied
to
Principal
2014
60,000
24,127
2015
2016
Demonstration Problem 7-3: Work Paper, part b. Financial Statements
Financial Statements
Income Statements
2014
2015
2016
Revenue
$7,000
$7,000
$7,000
Interest Expense
Net Income
Balance Sheets
Assets
Cash
$42,873
$25,746
$ 8,619
Liabilities
Note Payable
(1)*
Equity
Retained Earnings
Total Liabilities and Equity
Statements of Cash Flows
Operating Activities
Inflow from Customers
Outflow for Interest
Chapter 07 – Accounting for Liabilities
7-5
Investing Activities
Financing Activities
Inflow from Note Issue
Outflow to Repay Note
Net Change in Cash
42,873
(17,127)
(17,127)
Beginning Cash Balance
Ending Cash Balance
*The one dollar negative balance in the note payable account is due to rounding.
Chapter 07 – Accounting for Liabilities
7-6
Demonstration Problem 7-4: Work Paper
Financial Statements
Land Development Company
Bonds Issued at Face Value with Interest Payable Annually
Income Statements
2014
2015
2016
2017
2018
Rent Revenue
$ 7,000
$ 7,000
$ 7,000
$ 7,000
$ 7,000
Interest Expense
Net Income
Balance Sheets
Assets
Cash
Land
Total Assets
Liabilities
Bond Payable
Equity
Retained Earnings
Total Liabilities and Equity
Statements of Cash Flows
Operating Activities
Inflow from Customer
Outflow for Interest
Investing Activities
Outflow to Purchase Land
Inflow from Sale of Land
Financing Activities
Inflow from Bond Issue
Outflow to Repay Bond
Net Change in Cash
1,000
1,000
1,000
1,000
1,000
Beginning Cash Balance
Ending Cash Balance
Quiz Questions for Chapter 7
7-7
Education.
1. On January 1, 2014, Ink, Inc. borrowed $100,000 cash from Fidelity Bank on a note that had a 6 percent
annual interest rate and a five-year term. The loan is to be repaid in annual payments of $23,741.69 on
January 1 each year. The amount of the January 1, 2015, payment applied to interest and to principal would
be
a. $6,000 / $94,000.
b. $17,741.69 / $94,000.
c. $4,935.50 / $82,258.31.
d. $6,000 / $17,741.69.
2. Indigo Company can borrow up to $50,000 on its bank line of credit. The company agrees to pay interest
monthly at 2 percent above prime. Funds are borrowed or repaid on the first day of each month.
Month
Amounts Borrowed or (Repaid)
Prime Rate
Jan.
$15,000
6 percent
Feb.
$ (5,000)
5 percent
March
$30,000
4 percent
The amount of interest to be accrued on March 31 is
a. $225.00.
b. $100.00.
c. $133.33.
d. $200.00.
Use the following information to answer the next two questions. Yeats Company issued a $5,000 face value note
to the State Bank on December 1, 2014. The note had a 12 percent annual rate of interest and a one–year term.
3. The adjusting entry to record accrued interest on December 31, 2014, would
a. decrease liabilities by $50.
b. decrease equity by $50.
c. increase net income by $50.
d. none of the above.
4. The amount of cash paid for interest in 2015 is:
a. $550.
b. $50.
c. $600.
d. none of the above.
Use the following information to answer the next two questions. On May 1, 2014, Arrow Company borrowed
$10,000 from the State Bank at 9 percent annual interest. The note issued by Arrow had a one-year term. Arrow
reported cash revenue of $3,400 and $800 in 2014 and 2015, respectively.
5. Arrow’s net income for 2014 and 2015 would be
a. $2,500 / $100.
b. $2,800 / $500.
c. $2,400 / $800.
d. $2,500 / $800.
6. The cash flow from operating activities Arrow would report on the 2014 and 2015 statements of cash flows
would be
a. $2,800 / $500.
b. $2,500 / $800.
c. $2,800 / $(100).
Chapter 07 – Accounting for Liabilities
7-8
d. $3,400 / $(100).
7. Which of the following illustrates the recognition of sales tax collected at the point of sale?
Balance Sheet
Income Statement
Statement of
Assets
=
Liab.
+
Equity
Rev.
−
Exp.
=
Net Inc.
Cash Flow
a.
+
+
n/a
n/a
n/a
n/a
n/a
b.
+
+
n/a
+
n/a
+
n/a
c.
−
−
n/a
n/a
+
−
− OA
d.
+
+
n/a
n/a
n/a
n/a
+ OA
8. Issuance of a note payable with a six month term to maturity is what type of transaction?
a. Asset source.
b. Asset use.
c. Claims exchange.
d. Claims decrease.
9. A contingent liability that is remote is
a. shown in the balance sheet and disclosed in the footnotes.
b. not shown in the balance sheet but is disclosed in the footnotes.
c. shown in the balance sheet but not in the footnotes.
d. not shown in the balance sheet and is not disclosed in the footnotes.
10. Select the true statement.
a. If the likelihood of a contingent liability is probable and the amount can be estimated, it must be shown
in the balance sheet.
b. If the likelihood of a contingent liability is reasonably possible it does not have to be shown in the
balance sheet but must be disclosed in the footnotes.
c. If the likelihood of a contingent liability is remote it does not have to be shown in the balance sheet nor
disclosed in the footnotes.
d. All of the above are true.
Solutions to Quiz Questions
Question
Answer
1
D
2
D
3
B
4
C
5
B
6
D
7
D
8
A
9
D
10
D
Chapter 07 – Accounting for Liabilities
Summary Outline of a Lesson Plan for Chapter 7
I. Use Demonstration Problem 7-1 to introduce accrued interest payable. In this
problem, the amount of interest has already been calculated to allow you to concentrate
on how interest expense affects the financial statements.
II. Hand out Demonstration Problem 7-2. Use this problem to show students how to
compute accrued interest.
III. Use an exercise in the text to demonstrate sales taxes. Exercise 7-3 serves as a good
demonstration problem. Exercise 7-4 works well as a reinforcement exercise for
homework.
IV. Use exercises in the text to demonstrate contingent liabilities and product
warranties. Exercise 7-5 provides a good basis for a discussion about contingent
liabilities. Exercises 7-6 and 7-7 provide comprehensive problems dealing with
warranties. They serve as excellent demonstration problems for a brief lecture on how to
report warranty obligations.
V. Demonstration Problem 7-3 illustrates accounting for a term loan repaid with equal
annual payments of principal and interest.
VI. Lines of credit. You can use Exercise 7-13 as a demonstration problem or a homework
assignment related to lines of credit.
VII. Demonstration Problem 7-4 illustrates accounting for a bond liability across five
consecutive accounting cycles. The text covers bonds issued at face amount; it does not
cover bond discounts or premiums.
VIII. Time considerations and homework assignments. Current liabilities (Demonstration
Problems 7-1 and 7-2) should take at least an hour of class time. Exercises 7-1 and 7-2
are good to use as reinforcement for interest expense recognition. Spend approximately
15 minutes each on sales tax and warranty obligations. Plan to spend less than one hour
of class time covering installment loans and lines of credit. Demonstration Problem 7-3
provides an example of an installment loan, and you may wish to use Exercises 7-10 and
7-11 to reinforce accounting for installment loans. Problem 7-33 pertains to lines of
credit. Allow an additional 30 to 45 minutes of class time to cover bond liabilities.
Exercise 7-22 may be used as homework or in-class practice in preparing a classified
balance sheet.