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 Payroll-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
Analysis
Analyzing solvency
10-9
Analysis, communication,
judgment
Analysis, communication,
judgment
Analysis
Topic
Analysis, communication,
judgment
Analysis, communication
Real World: DuPont
After-tax cost of borrowing
10.15
Real World: Home Depot,
Inc. Identifying debt
10-1, 10-2, 10-4,
10-5, 10-6, 10-8
Analysis
Analysis, communication,
judgment
Analysis, communication
Analysis, communication
Analysis, communication
Analysis, communication
Analysis
Effects of transactions upon
financial statements
Analysis
Analysis
CHAPTER 10
LIABILITIES
Skills
Learning
Objectives
OVERVIEW OF BRIEF EXERCISES, EXERCISES, PROBLEMS, AND CRITICAL
THINKING CASES
Topic
Analysis
Analysis
Analysis
Analysis, communication
Recording bonds issued at a
premium
Pension and other
postretirement benefits
Analysis
Skills
Recording bonds issued at a
discount
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.”
Critical Thinking Cases
Real World: Abbott Labs Factors
affecting bond prices
Real World: 8 Companies Nature
of liabilities
(Ethics, fraud & corporate governance)
10-5, 10-6,
10-9
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
Preparation and use of an
amortization table
Analysis, communication
Analysis
Analysis, communication,
judgment
Analysis, communication
Analysis, communication,
judgment
Analysis, communication,
judgment
Analysis, communication,
judgment
Analysis, communication.
Judgment
DESCRIPTIONS OF PROBLEMS AND CRITICAL THINKING CASES
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
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.
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.
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.”
30 Medium
Discuss the nature of various liabilities appearing in the balance sheets
of well-known companies.
10.2
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.
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.
10.5
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 QUESTIONS
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
A note payable maturing in 30 days could be classified as a long-term liability if (a)
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-
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
6.
7.
Annual interest payments ($5 million x 5%) ………………………………………..
$250,000
8.
9.
10.
11.
12.
From an investor’s perspective, a bond represents a series of future cash receipts that are fixed
The income tax advantage of raising capital by issuing bonds rather than stock is that interest
deductible in the determination of taxable income.
The return on assets represents the average return that a business earns from all capital. If this
payable, and an accrual of a liability relating to a loss contingency.
Estimated liabilities have two basic characteristics: (1) the liability is known to exist at the
countries has impaired the value of assets in those locations.
A loss contingency is a possible loss (or expense) stemming from past events that will be
Annual after-tax cost of borrowing …………………………………………………
$162,500
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,
The lessee accounts for an operating lease (Type B) as a rental arrangement; the lease
payments are recorded as rental expense and no asset or liability (other than a short-term
Postretirement costs are recognized as expense as workers earn the right to receive these
B.Ex. 10.1
B.Ex. 10.2
$25,000 x .40
$500,000 x .03 = $15,000
5% (1 – .40) = 3.0%
Interest cost, net of income tax
Effective interest rate, net of income tax, is:
Tax savings via deduction of interest:
$500,000 x 5%
B.Ex. 10.3
B.Ex. 10.4
B.Ex. 10.5
$500,000 x 5% = $25,000
($500,000 – $485,000)/10 years =
Interest expense recognized in first year:
Cash paid (above)
Plus: Amortization of discount:
Cash paid for interest in first year:
Cash received from sale of bonds:
$500,000 x .97 = $485,000
$1,000,000 x 1.02 = $1,020,000
$50,000/4 = $12,500 quarterly
Quarterly and annual cash interest required:
$1,000,000 x .05 = $50,000 annual
Amount received from sale of bonds:
$1,000,000 x .06 = $60,000 annual
$60,000/4 = $15,000 quarterly
$1,000,000 x .98 = $980,000
Quarterly and annual cash interest required:
Amount received from sale of bonds:
SOLUTIONS TO BRIEF EXERCISES
Cash payments required in Yr. 1:
Interest cost (before income tax):
Repayment of loan
Cash payments required in Yr. 2:
B.Ex. 10.6
B.Ex. 10.7
B.Ex. 10.8
$20,000 x 1/2 = $10,000
$1,000,000 – ($1,000,000 x .98) = $20,000
Balance of discount at date of retirement of bonds:
Loss on sale of retirement of bonds:
Repurchase price ($500,000 x 1.02)
Carrying amount of bonds purchased
($1,000,000 x .50) $500,000
Discount remaining
($10,000 x .50) (5,000)
Loss on repurchase
Face value
B.Ex. 10.9
84,000
75,000
*$459,000 – $300,000 = $159,000
Deferred income tax
**$159,000 – $75,000 = $84,000
Cash received from sale of bonds:
Tiger Company:
$3,100,000/($3,100,000 + $5,000,000) = 38.3%
$2,000,000/($2,000,000 + $4,200,000) = 32.3%
Wolfe Company:
Original discount on sale of bonds:
Income tax expense* 159,000
Income tax payable**
$800,000 x 1.02 = $816,000
Cash paid for interest in first year:
$800,000 x .065 = $52,000
Interest expense recognized in first year:
Cash paid (above)
Less: amortization of premium:
($816,000 – $800,000)/10 years =
B.Ex. 10.10
To record annual pension expense:
Pension expense 250,000
Unfunded liability for postretirement benefits
Postretirement benefits expense 140,000
Ex. 10.1
Annual Unpaid
Payment Balance
10,000$
Ex. 10.2
Trans- Net
Current Owners’
action Revenue – Expenses= Income
Assets = Liab. + Liab. + Equity
a. NE I D
NE INE D
NE I D NE
g. NE I D
NE I I D
Net Cash
Current
Net from all
Liabilities
Income Sources
a. D
NE D
b. D
D D
D D
NE
D
Interest
Annual
Expense @ 8%
Ex. 10.3
Net Cash Flow
from Operating
Activities
Trans-
action
NE
NE
D
D
SOLUTIONS TO EXERCISES
Long-Term
Liabilities
Long-Term
Reduction
in Unpaid
Balance
Income Statement
Balance Sheet
You would need to save $7,760, as shown in the following loan amortization table:
Interest
Period
Date of Graduation
Ex. 10.4 a.
$ 7,200,000
Ex. 10.5 a. 250,000
State Income Tax Payable ……………………………………..
Federal Income Tax Payable …………………………………….
Social Security and Medicare Taxes Payable ……………………
Cash (or Wages Payable) …………………………………………..
To record gross wages, employee withholdings,
take-home pay in February.
b. 43,125
Social Security and Medicare Taxes Payable ……………………………
c. 10,000
22,875
Prepaid Employee Health and Life Insurance ………………….
Cash (or Pension Liability) ……………………………….
d.
Total payroll related costs:
Wages and salaries expense ……………………………………………..
Wages Expense ………………………………………………………..
Payroll Tax Expense ……………………………………………………….
The $56,000 amount withheld from the employees’ gross wages does not represent
Employee Health and Life Insurance Expense ……………………….
Pension Expense ………………………………………………….
b.
Amounts withheld from employees’ pay ………………………………….
“Take-home pay” ………………………………………………………
Total payroll related costs ………………………………………………
Wages and salaries earned …………………………………………………
Payroll taxes …………………………………………………………….
Workers’ compensation premiums …………………………………….
Group health insurance premiums ………………………………………
Employees’ “take-home pay”:
Contributions to employees’ pension plan …………………………..
128% ($9,205,000 ÷ $7,200,000)
184% ($9,205,000 ÷ $5,000,000)
(A) (B)
Interest Expense
Monthly (1% of the Last Unpaid
Payment Unpaid Balance) Balance
— — $150,000
$1,543 $1,500 149,957
c.
Ex. 10.7 a. $19,435,000
c.
Less: Income tax savings ($19,435,000 x 27%) …………………………….
Annual after-tax cost of borrowing …………………………………………………..
Ex. 10.6
a.
Amortization Table
(12% Note Payable for $150,000; Payable
in Monthly Installments of $1,543)
Original balance
1
Interest
Period
Decrease. Interest expense is based on the unpaid principal balance at the end of each
Annual interest expense ($299 million x 6.50%) ……………………………………..
—
$43
Monthly
Unpaid Balance
(A) – (B)
Reduction in
2
Cash …………………………………………………………
Interest Expense ………………………………………………………………
Ex. 10.8 a. Apr. 30 50,375
Bonds Payable …………………………………………………….
50,000
Cash ………………………………………………………………
d.
This practice enables the corporation to pay a full six months’ interest on all bonds
outstanding at the semiannual interest payment date, regardless of when the bonds
Bond Interest Payable ……………………………………
Cash …………………………………………………
Bond Interest Payable …………………………………….
Bond Interest Payable ………………………………………
Bond Interest Expense ……………………………………….
Bond Interest Expense …………………………………………..
Ex. 10.9 a. 2018
Apr. 1 8,160,000
160,000
c. 2038
Mar. 31 160,000
158,000
320,000
Mar. 31 8,000,000
Cash …………………………………………………………
Premium on Bonds Payable ……………………………………..
Bonds Payable …………………………………………………….
Cash ………………………………………………………….
(2)
Cash ……………………………………………………………………….
Premium on Bonds Payable ………………………………………..
Bond Interest Payable ……………………………………………
Bond Interest Expense …………………………………………..
at maturity are both classified as financing activities.)
Amortization of a bond premium is a noncash component of the annual
consequently, increases annual net income.
320,000
[$160,000 ÷ 20 yrs.] x 1/2 ……………………
Bond Payable ……………………………………………….
Bond Interest Expense ………………………………………………
Premium on Bonds Payable ………………………………………
$8,000,000 x 8% x 1/2 ……………………….
Cash …………………………………………………….
Ex. 10.10 a. 2018
July 1 4,900,000
100,000
(2)
Cash ……………………………………………………………
Discount on Bonds Payable ………………………………….
Amortization of bond discount is a noncash component of annual interest
Bond Interest Expense ……………………………………….
Discount on Bonds Payable …………………………….
Bonds Payable ………………………………………..
Cash ………………………………………………….
Bond Interest Expense ………………………………………….
Discount on Bonds Payable ……………………………
$5,000,000 x 9 1/2% x 1/2 ……..
Cash ………………………………………………………
Bond Payable ………………………………………………..
Cash …………………………………………………
Ex. 10.11 a. (1)
(2)
b.
Debt ratio:
Long-term creditors probably would regard Pemco as the safer investment.
Pemco has a smaller percentage of its assets financed by creditors’ capital, and
thereby provides its creditors with a bigger “buffer” of equity capital. Also,
Interest coverage ratio:
Ex. 10.12 a. 2,500
Cash …………………………………………………………………..
2,500
c.
d.
Ex. 10.13 a. 2,300,000
Cash ……………………………………………………………………
2,300,000
b. 750,000
300,000
c.
d.
Eastern Electric does not have an ethical (or legal) responsibility to fund its
Postretirement Benefits Expense ……………………….
Because the pension plan is fully funded each year, and because the plan is an
Rent Expense ………………………………………………………………
Pension Expense ………………………………………………………..
Under an operating lease, no asset or liability (other than perhaps a short-term
If the lease is unquestionably a capital lease, it would be unacceptable, unethical
Capital Lease Obligation ……………………………………………
73,521
Cash …………………………………………………………………………
2,500
Leased Equipment ………………………………………………………
Ex. 10.14 a.
Ex. 10.15
a.
(1) Current assets 1/31/16 16,993$
(1) Cash and receivables 1/31/16 4,106$
Quick Ratio:
b.
(1) Total liabilities 1/31/16 36,233$
c.
The company reports current liabilities of almost $12,526 million as of 1/31/16.
Debt Ratio:
Current Ratio:
Deferred taxes are the income taxes that will become due in future years upon earnings
that already have been reported in a company’s income statement. Deferred taxes arise
Current liabilities:
Long-term liabilities:
25 Minutes, Easy
Current Long-Term Owners’
Transaction Revenue – Expenses = Net Income Assets = Liabilities + Liabilities + Equity
a. NE I D NE INE D
b. NE NE NE NE I D NE
SOLUTIONS TO PROBLEMS SET A
PROBLEM 10.1A
TECHNOLOGY SPECIALISTS, INC.
Income Statement
Balance Sheet