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Brief Learning
Exercises Objectives
B. Ex. 10.1 Cash effects of borrowing 10-2
B. Ex. 10.2 Effective interest rate 10-5
B. Ex. 10.3 Bonds issued at a discount 10-6
B. Ex. 10.4 Bonds issued a premium 10-6 Analysis
B. Ex. 10.5
10-6 Analysis
B. Ex. 10.6
10-6 Analysis
B. Ex. 10.7 Debt ratio 10-9
B. Ex. 10.8 Early retirement of bonds 10-7
B. Ex. 10.9 Deferred income taxes 10-10
B. Ex. 10.10
10-10 Analysis
Exercises
10.1 You as a student 10-4
10.2 Accounting equation 10-1-10-
6
10.3
10.4 Pa
y
roll-related costs 10-3
10.5 Payroll-related costs 10-3
10.6 Use of an amortization table 10-4
10.7 10-5
10.8 Bonds payable and interest 10-5
10.9 Accounting for bond premiums 10-5, 10-6
10.10 Accounting for bond discounts 10-5, 10-6
10.11 10-9
10.12 Accounting for leases 10-10
10.13 Accounting for pensions 10-10
10.14 Deferred income taxes 10-10
Analysis
Recording bonds issued at a
premium
Effects of transactions upon
financial statements
Pension and other
postretirement benefits
Analysis
Analysis
Analysis
Analysis
Analysis
Analysis
Analysis
10-1, 10-2, 10-4,
10-5, 10-6, 10-8
Analysis, communication
Analysis
Analysis, communication,
judgment
Analysis, communication
Analysis, communication
Analysis, communication
Analysis, communication
10.15 Real World: Home Depot,
Inc. Identifying debt
CHAPTER 10
LIABILITIES
Skills
Learning
Objectives
OVERVIEW OF BRIEF EXERCISES, EXERCISES, PROBLEMS, AND CRITICAL
THINKING CASES
Topic
Analysis
Topic
Analysis, communication,
judgment
Analysis, communication
Real World: DuPont
After-tax cost of borrowing
Skills
Recording bonds issued at a
discount
Analyzing solvency
10-9
Analysis, communication,
judgment
Analysis, communication,
judgment
Analysis
Problem
Sets A,
10.1 A,B
10.2 A,B Balance sheet presentation 10-1, 10-2,
10-4, 10-8
10.3 A,B Notes payable 10-2
10.4 A,B 10-4
10.5 A,B Bonds issued at face value 10-5
10.6 A,B Bond discount and premium 10-5, 10-6
10.7 A,B Balance sheet presentation 10-1, 10-5,
10-6, 10-10
10.8 A,B Balance sheet presentation 10-1, 10-5,
10-6, 10-8,
10-10
10.1 10-1, 10-10
10.2 10-5–10-7
10.3 Loss contingencies 10-8
10.4 Real World: American Airlines 10-1, 10-10
Off-Balance-Sheet financing
10.5 Real World: Bonds-Online
Credit ratings for bonds
(Internet)
____________
*Supplemental Topic, “Special types of Liabilities.”
Analysis, communication,
judgment
Critical Thinking Cases
Real World: Abbott Labs Factors
affecting bond prices
Real World: 8 Companies Nature
of liabilities
(Ethics, fraud & corporate governance)
Topic
Learning
Objectives Skills
Effects of transactions upon
accounting equation
10-1–10-6,
10-8
Analysis, communication,
judgment, research, technology
Analysis, communication
Analysis, communication
Analysis, communication,
judgment
Analysis, communication,
judgment
10-5, 10-6,
10-9
Preparation and use of an
amortization table
Analysis, communication
Analysis
Analysis, communication,
judgment
Analysis, communication
Analysis, communication,
judgment
Analysis, communication.
Judgment
Analysis, communication,
judgment
DESCRIPTIONS OF PROBLEMS AND CRITICAL THINKING CASE
S
Problems (Sets A and B)
10.1 A,B
10.2 A,B
10.3 A,B
10.4 A,B
10.5 A,B
10.6 A,B
10.7 A,B
10.8 A,B
Below are brief descriptions of each problem and case. These descriptions are accompanied by the
estimated time (in minutes) required for completion and by a difficulty rating. The time estimates
assume use of the partially filled-in working papers.
25 Easy
30 Medium
25 Medium
25 Medium
15 Easy
35 Strong
45 Strong
Technology Specialists, Inc./Philmar, Inc.
Accounting for notes payable with interest stated separately.
Speedy Lube/Jenco
Involves conceptual discussion of an amortization table, use of the
table, and extension of a partially completed table for two more
payments.
Show the effects of various transactions upon the accounting
equation. Also calls for distinction between current and long-term
liabilities. Quick and easy, but quite comprehensive.
Denver Chocolates/Georgia Peach
From an unclassified listing of account balances and other
information, prepare current and long-term liability sections of a
balance sheet. Explain treatment of various items.
Swanson Corporation/Swanlee Corporation
Petersen Corporation/Alexander Company 3 Medium
From a list of items that include liabilities and include additional
information about items that may be mistaken as liabilities, students
are asked to prepare the current and long-term liability sections of a
balance sheet and to explain why the three excluded items are not
included.
Murfreesboro Telephone Corporation/Nevada Utility Company
From an unclassified list of account balances and other information,
students are asked to prepare and discuss the current and long-term
liability sections of a balance sheet.
Green Mountain Power Company/Stevens Manufacturing
Evansville Lumber Company/Rodriguez Plumbing
Journal entries to record issuance of bonds between interest
payment dates, payment of interest, and accrual of interest at year-
end. Requires students to know that bonds are issued at par when
the prevailing market rate of interest equals their contract rate.
Year-end adjusting entries for bond interest when bonds are issued
at a discount and when bonds are issued at a premium.
Critical Thinking Cases
10.1 Liabilities in Published Financial Statements
Abbott Labs
Bond Prices
Loss Contingencies
American Airlines
Ethics, Fraud & Corporate Governance
Bonds-Online
Internet
____________
*Supplemental Topic, “Special Types of Liabilities.”
10.3 25 Medium
Students are asked to evaluate four situations indicating whether each
situation describes a loss contingency and explaining the proper
financial statement treatment of the matter.
30 Medium
Discuss the nature of various liabilities appearing in the balance sheets
of well-known companies.
10.2
10.5
20 Strong
Requires students to understand the relationship between a bond’s issue
price and the effective rate of interest, and to differentiate between cash
flow and interest expense. Also requires that students understand that
the time remaining until a bond matures is a factor in determining the
bond’s current value.
20 Strong
Students are introduced to bond ratings and how they correspond to
bond yields.
10.4 20 Medium
Students are asked to examine and evaluate off-balance-sheet financing
arrangements of American Airlines.
SUGGESTED ANSWERS TO DISCUSSION QUESTION
S
1.
2.
3.
4.
5.
Liabilities are debts or obligations arising from past transactions or events, and which require
settlement at a future date. Liabilities and owners’ equity are the two primary means by which a
In the event of liquidation of a business, the claims of creditors (liabilities) have priority over the
claims of owners (equity). The relative priorities of individual creditors, however, vary greatly.
Current liabilities are those maturing within one year or the company’s operating cycle
(whichever is longer) and expected to be paid from current assets. Liabilities classified as long-
term include obligations maturing more than one year in the future, and also shorter term
Employers are required by law to pay the following payroll taxes and insurance premiums:
Social Security and Medicare taxes, unemployment taxes, and workers’ compensation insurance
The analysis is incorrect, because the principal amount of the mortgage note will not be paid off
at a constant rate of $17.84 per month. The portion of each payment representing an interest
charge is based upon the unpaid balance of the loan. Because the principal amount is being
6.
7. Annual interest payments ($5 million %) ……………………………………….. $400,000
Less: Annual tax savings ($400,000 × 35%) ………………………………………. 140,000
8.
9.
10.
11.
12.
The return on assets represents the average return that a business earns from all capital. If this
average rate is higher than the cost of borrowing, the business can benefit from using borrowed
Estimated liabilities have two basic characteristics: (1) the liability is known to exist at the
A loss contingency is a possible loss (or expense) stemming from past events that will be
resolved as to existence and amount by some future event. Examples include pending litigation,
From an investor’s perspective, a bond represents a series of future cash receipts that are fixed
in amount by the contract rate of interest on the bonds and by the bonds’ maturity value. As
Bonds with contract rates of interest above current market interest rates should be trading at
prices above their face values. Bond prices vary inversely with market interest rates.
The income tax advantage of raising capital by issuing bonds rather than stock is that interest
13.
14.
15.
Deferred income tax liabilities are the portion of this year’s income taxes expense (as shown in
the income statement) which will appear in the income tax returns of future years. Therefore,
due to differences between income tax regulations and accounting principles, the taxpayer is
The lessee accounts for an operating lease as a rental arrangement; the lease payments are
recorded as rental expense and no asset or liability (other than a short-term liability for accrued
rent payable) is recorded. A capital lease, on the other hand, is viewed by the lessee as
Postretirement costs are recognized as expense as workers earn the right to receive these
B.Ex. 10.1
720
B.Ex. 10.2
$40,000
B.Ex. 10.3
B.Ex. 10.5
SOLUTIONS TO BRIEF EXERCISES
Cash payments required in Yr. 1:
$500,000 x 8%
Interest at the end of first three quarters ($12,000 x 8% x
9/12)
Interest cost (before income tax):
$50,000/4 = $12,500 quarterly
Applying that rate to the $500,000 loan supports the interest cost,
net of income tax, calculated above:
$500,000 x .048 = $24,000
Amount received from sale of bonds:
Quarterly and annual cash interest required:
$1,000,000 x .05 = $50,000 annual
Cash paid for interest in first year:
$1,000,000 x .98 = $980,000
$500,000 x 5% = $25,000
Cash received from sale of bonds:
$500,000 x .97 = $485,000
B.Ex. 10.6
$50,400
B.Ex. 10.7
B.Ex. 10.8
$510,000
B.Ex. 10.9
Income tax expense* 159,000
$20,000 x 1/2 = $10,000
Loss on sale of retirement of bonds:
Repurchase price ($500,000 x 1.02)
Carrying amount of bonds purchased
Cash received from sale of bonds:
$800,000 x 1.02 = $816,000
Cash paid for interest in first year:
$800,000 x .065 = $52,000
Wolfe Company:
$2,000,000/($2,000,000 + $4,200,000) = 32.3%
Original discount on sale of bonds:
$1,000,000 - ($1,000,000 x .98) = $20,000
Balance of discount at date of retirement of bonds:
B.Ex. 10.10
250,000
To record annual pension expense:
Pension expense 250,000
To record annual expense for postretirement
benefits other than pensions:
Cash
