CHAPTER 10
Reporting and Analyzing Liabilities
Learning Objectives
1. Explain how to account for current liabilities.
2. Describe the major characteristics of bonds.
3. Explain how to account for bond transactions
4. Discuss how liabilities are reported and analyzed.
*5. Apply the straight-line method of amortizing bond discount and bond premium.
*6. Apply the effective-interest method of amortizing bond discount and bond premium.
*7. Describe the accounting for long-term notes payable.
Summary of Questions by Learning Objectives and Bloom’s Taxonomy
Item
LO
BT
Item
LO
BT
Item
LO
BT
LO
BT
Item
LO
BT
Questions
1.
1
C
7.
1
K
13.
2, 3
C
4
K
25.
4
C
2.
1
C
8.
2
C
14.
3
C
4
C
26.
5*
C
3.
1
AP
9.
2
AN
15.
3
AP
4
C
27.
5*
AP
4.
1
AP
10.
2
C
16.
3
AP
4
C
28.
6*
C
5.
1
K
11.
2
C
17.
3
AP
4
C
29.
6*
C
6.
1
C
12.
2
K
18.
4
C
4
C
30.
31.
7*
7*
C
C
Brief Exercises
1.
1
C
5.
1
AP
9.
3
AP
4
AP
17.
5*
AP
2.
1
AP
6.
1
AP
10.
3
AP
4
AP
18.
6*
AP
3.
1
AP
7.
1
AP
11.
3
AP
4
AN
19.
7*
AP
4.
1
AP
8.
3
AP
12.
4
AP
5*
AP
Do It! Exercises
1a.
1
AP
2.
2
C
3b.
3
AP
1b.
1
AP
3a.
3
AP
4.
4
AN
Exercises
1.
1
AP
6.
1
AP
11.
3
AP
4
AP
21.
3, 5
AP
2.
1
AP
7.
1
AP
12.
3
AN
4
AN
22.
3, 6*
AP
3.
1
AP
8.
3
AP
13.
3
AP
4
AN
23.
5, 6*
AP
4.
1
AP
9.
3
AP
14.
3
AP
4
C
24.
7*
AP
5.
1
AP
10.
3
AP
15.
4
AP
3, 5
AP
25.
7*
AP
Problems: Set A
1.
1, 4
AP
5.
3, 4
AP
8.
3, 4,
5*
AP
3, 4,
6*
AP
2.
1, 4
AP
6.
4
AN
9.
3, 4,
5*
AP
4, 7*
AP
3.
3
AP
7.
3, 5
AP
4.
3, 4
AP
10.
3, 6*
AP
4, 7*
AP
*Continuing Cookie Solutions for this chapter are available online.
ASSIGNMENT CHARACTERISTICS TABLE
Problem
Number
Description
Difficulty
Level
Time
Allotted (min.)
*1A
Prepare current liability entries, adjusting entries, and
current liabilities section.
Moderate
30–40
*2A
Journalize and post note transactions; show balance sheet
presentation.
Moderate
30–40
3A
Prepare journal entries to record interest payments and
redemption of bonds.
Moderate
30–40
4A
Prepare journal entries to record issuance of bonds,
interest, balance sheet presentation, and bond
redemption.
Moderate
30–40
*5A
Prepare journal entries to record issuance of bonds,
show balance sheet presentation, and record bond
redemption.
Simple
30–40
6A
Calculate and comment on ratios.
Moderate
30–40
*7A
Prepare journal entries to record interest payments,
straight-line discount amortization, and redemption
of bonds.
Moderate
30–40
**8A
Prepare journal entries to record issuance of bonds,
interest, straight-line amortization, and balance sheet
presentation.
Simple
30–40
**9A
Prepare journal entries to record issuance of bonds,
interest, straight-line amortization, and balance sheet
presentation.
Moderate
30–40
**10A
Prepare journal entries to record issuance of bonds,
payment of interest, and amortization of bond discount
using effective-interest method.
Moderate
30–40
**11A
Prepare journal entries to record issuance of bonds,
payment of interest, effective-interest amortization, and
balance sheet presentation.
Moderate
30–40
**12A
Prepare installment payments schedule, journal entries,
and balance sheet presentation for a mortgage note
payable.
Moderate
30–40
*13A
Prepare journal entries to record payments for long-term
note payable, and balance sheet presentation.
Moderate
30–40
ANSWERS TO QUESTIONS
1. While this is generally true, more precisely a current liability is a debt that can reasonably be
2. In the balance sheet, Notes Payable of $20,000 and Interest Payable of $450 ($20,000 X 9% X
3/12) should be reported as current liabilities. In the income statement, Interest Expense of $450
3. (a) Disagree. The company only serves as a collection agent for the taxing authority. It does not
report sales taxes as an expense; it merely forwards the amount paid by the customer to the
4. (a) The entry when the tickets are sold is:
Cash ……………………………………………………………………………… 900,000
5. Three taxes commonly withheld by employers from employees’ gross pay are (1) federal income
6. (a) Three taxes commonly paid by employers on employees’ salaries and wages are (1) social
security (FICA) taxes, (2) state unemployment taxes, and (3) federal unemployment taxes.
7. The liabilities that Apple identified as current are: Accounts payable, Accrued expenses, Deferred
8. (a) Long-term liabilities are obligations that are expected to be paid after one year. Examples
include bonds and long-term notes.
9. (a) Secured bonds have specific assets of the issuer pledged as collateral. In contrast, unsecured
bonds are issued against the general credit of the borrower.
10. (a) Face value is the amount of principal due at the maturity date.
(b) The contractual interest rate is the rate used to determine the amount of cash interest the
11. (a) A convertible bond permits bondholders to convert it into common stock at the option of the
(1) a lower rate of interest than other debt securities, (2) a higher selling price.
LO 2 BT: C Difficulty: Medium TOT: 3 min. AACSB: None AICPA FC: Reporting
12. The two major obligations incurred by a company when bonds are issued are the interest
13. Less than. Investors were required to pay more than the face value; therefore, the market interest
14. No, Lee is not right. The market price on any bond is a function of three factors: (1) the dollar
15. $48,000. $800,000 X 6% X 1 year = $48,000.
LO 3 BT: AP Difficulty: Easy TOT: 2 min. AACSB: Analytic AICPA FC: Reporting
16. $664,000. The balance of the Bonds Payable account minus the balance of the Discount on
17. Debits: Bonds Payable (for the face value) and Premium on Bonds Payable (for the
18. Two issues need to be considered. First, by financing a major purchase such as this with short–
term financing the company will reduce its liquidity. In the case of Johnson Inc., its current ratio
will decrease from 2.2:1 to a less acceptable level of 1.5:1. However, of equal concern is that by
19. (a) The nature and the amount of each long-term liability should be presented in the balance
sheet or in schedules in the accompanying notes to the financial statements. The notes
20. No, Ernie is not correct. Liquidity involves measuring the short-term ability of a company to pay
21. When companies are trying to overcome customer skepticism about the quality of their product
they often consider providing a more generous warranty. While this may be effective in increasing
sales, it is not without costs. Clearly a longer warranty will usually result in more warranty claims.
22. One alternative to purchasing the assets is to lease them through an operating lease agreement.
In an operating lease, the lease payments are recorded as an expense. This allows the lessee to
keep the leased assets and, more importantly, lease liabilities off the balance sheet (referred to as
23. Jon is not correct. In order to reduce costs, many companies today keep low amounts of inventory
on hand. Consequently, liquidity ratios are generally lower than they used to be. Companies that
24. If a company has significant operating leases, most analysts would argue that its recorded
25. Two criteria must be met: (1) the contingency must be probable and (2) the company must be
*26. The straight-line method of amortization results in the same amortized amount being assigned
*27. The total amount of interest expense is $10,800. Interest expense is the interest to be paid in cash
less the premium amortization for the year. Cash to be paid equals 6% X $200,000 or $12,000.
*28. Honore is probably indicating that since the borrower has the use of the bond proceeds over the
term of the bonds, the borrowing rate in each period should be the same. The effective-interest
*29. Decrease. Under the effective-interest method the interest expense per period is determined
by multiplying the carrying value of the bonds by the effective-interest rate. When bonds are
*30. The installment note requires equal payments. Each payment will pay any interest that has been
incurred during the time that has past since the previous payment. The remaining amount of the
*31. No, Tim is not right. Each payment by Tim consists of: (1) interest on the unpaid balance of the
loan and (2) a reduction of loan principal. The interest decreases each period while the portion
applied to the loan principal increases each period.
LO 7 BT: C Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting
SOLUTIONS TO BRIEF EXERCISES
BRIEF EXERCISE 10-1
(a) A note payable due in two years is a long-term liability, not a current
liability.
BRIEF EXERCISE 10-2
(a) July 1 Cash ………………………………………………….. 90,000
BRIEF EXERCISE 10-3
Sales tax payable
(1) Sales = ($10,388 ÷ 1.06) = $9,800
Mar. 16 Cash …………………………………………………………. 10,388
BRIEF EXERCISE 10-4
(a) Cash (3,500 X $80) ………………………………………….. 280,000
Unearned Ticket Revenue ………………………… 280,000
(To record sale of 3,500 season tickets)
BRIEF EXERCISE 10-5
Gross earnings:
Regular pay (40 X $16) …………………………..……….. $640.00
Overtime pay (7 X $24) ……………………………………. 168.00 $808.00
BRIEF EXERCISE 10-6
Jan. 15 Salaries and Wages Expense ………………. 808.00
FICA Taxes Payable ($808 X 7.65%) 61.81
BRIEF EXERCISE 10-7
Jan. 15 Payroll Tax Expense ……………………………. 61.81
BRIEF EXERCISE 10-8
Cash ($300,000 X .98) …………………………... 294,000
Discount on Bonds Payable …………………. 6,000
BRIEF EXERCISE 10-9
Cash ($400,000 X 1.01) …………………………………………… 404,000
Bonds Payable ………………………………………….. 400,000
BRIEF EXERCISE 10-10
2017
(a) Jan. 1 Cash …………………………………………… 3,000,000
Bonds Payable
(3,000 X $1,000) …………………. 3,000,000
BRIEF EXERCISE 10-11
Bonds Payable …………………………………………………. 2,000,000
Loss on Bond Redemption
($2,040,000 – $1,955,000) ………………………………. 85,000
BRIEF EXERCISE 10-12
Long-term liabilities
Bonds payable (due 2021) …………………………. $700,000
BRIEF EXERCISE 10-13
O’BRIAN INC.
Balance Sheet (Partial)
December 31, 2017
Current liabilities
Notes payable ………………………………………
$ 20,000
Accounts payable …………………………………
157,000
Unearned rent revenue …………………………
240,000
Interest payable ……………………………………
FICA taxes payable ………………………………
Income taxes payable …………………………..
Sales taxes payable ……………………………..
Total current liabilities………………………
Long-term liabilities
Bonds payable (due 2021) …………………….
900,000
Less: Discount on bonds payable ………..
Notes payable (due 2019) ……………………..
Total long-term liabilities …………………
Total liabilities …………………………………………….
BRIEF EXERCISE 10-14
(a) Working capital = $4,485 – $2,836 = $1,649
(b) Current ratio = $4,485 ÷ $2,836 = 1.58:1
Working capital and the current ratio measure a company’s ability to pay
maturing obligations and meet cash needs. adidas’s current assets are
58% larger than the amount of its current liabilities which indicates a
relatively high degree of liquidity.
BRIEF EXERCISE 10-15
(a) Debt to assets:
Without operating leases
$14,180
= 59%
$24,004
With operating leases
= 60%
*BRIEF EXERCISE 10-16
(a) Jan. 1 Cash (99% X $2,000,000) …………….. 1,980,000
(b) Dec. 31 Interest Expense ………………………… 142,000
Cash ($2,000,000 X 7%) ……….. 140,000
LO 5 BT: AP Difficulty: Medium TOT: 6 min. AACSB: Analytic AICPA FC: Reporting
*BRIEF EXERCISE 10-17
(a) Jan. 1 Cash (102% X $4,000,000) ………….. 4,080,000
Bonds Payable ……………………. 4,000,000
Premium on Bonds Payable …. 80,000
*BRIEF EXERCISE 10-18
(a) Interest Expense ……………………………………….. 48,070
Discount on Bonds Payable ………………… 3,070
Cash ………………………………………………….. 45,000
*BRIEF EXERCISE 10-18 (Continued)
(c) Interest expense increases each period because the bond carrying
*BRIEF EXERCISE 10-19
Interest
Period
(A)
Cash
Payment
(B)
Interest
Expense
(D) X 10%
(C)
Reduction
of Principal
(A) – (B)
(D)
Principal
Balance
(D) – (C)
Issue Date
$800,000
1
$130,196
$80,000
$50,196
749,804
SOLUTIONS TO DO IT! EXERCISES
DO IT! 10-1a
1. $60,000 X 10% X 5/12 = $2,500
2. $42,000/1.05 = $40,000; $40,000 X 5% = $2,000
DO IT! 10-1b
(a) To determine wages payable, reduce wages expense by the withholdings
for FICA, federal income tax, and state income tax.
Feb. 28 Salaries and Wages Expense …………………… 74,000
FICA Taxes Payable …………………………….. 5,661
(b) Payroll taxes would be for the company’s share of FICA, as well as for
federal and state unemployment tax.
Feb. 28 Payroll Tax Expense ……………………………….. 5,931
DO IT! 10-2
1. False. Convertible bonds can be converted into common stock at the
2. True.
4. True.
LO 2 BT: C Difficulty: Easy TOT: 4 min. AACSB: None AICPA FC: Measurement
DO IT! 10-3a
(a) Cash …………………………………………………………….. 315,000
Bonds Payable …………………………………………. 300,000
DO IT! 10-3b
Bonds Payable ……………………………………………… 400,000
DO IT! 10–4
(a) Current ratio $11,500 ÷ $12,000 = .96:1
Working capital $11,500 – $12,000 = ($500)
SOLUTIONS TO EXERCISES
EXERCISE 10-1
2017
(a) June 1 Cash ………………………………………………….. 15,000
Notes Payable …………………………….. 15,000
(c) Interest payable accrued each month …………………. $100
Number of months from borrowing
EXERCISE 10-2
(a) Principal X .08 X 4/12 = $480
Principal = $480 ÷ (.08 X 4/12)
EXERCISE 10-2 (Continued)
Repayment:
Sept. 15 Notes Payable …………………………………… 18,000
EXERCISE 10-3
(a) June 1 Cash ……………………………………………………. 60,000
Notes Payable ………………………………. 60,000
(b) June 30 Interest Expense ($60,000 X .08 X 1/12) …. 400
EXERCISE 10-4
CERVIQ COMPANY
Apr. 10 Cash …………………………………………………………….. 23,100
QUARTZ COMPANY
15 Cash …………………………………………………………….. 13,780
Sales Revenue ($13,780 ÷ 1.06) ………………. 13,000
EXERCISE 10-5
(a) Mar. 31 Salaries and Wages Expense …………… 64,000
FICA Taxes Payable …………………. 4,896
Federal Income Taxes Payable …. 7,500
(b) Mar. 31 Payroll Tax Expense ……………………….. 5,596
EXERCISE 10-6
(a) $1,728,000 ÷ $320 = 5,400 season tickets sold.
(c) Cash ……………………………………………………………….. 1,728,000
Unearned Ticket Revenue …………………………. 1,728,000
EXERCISE 10-7
(a) Nov. Cash (6,300 X $28) …………………………... 176,400
Unearned Subscription Revenue . 176,400
EXERCISE 10-7 (Continued)
(c) Mar. 31 Unearned Subscription Revenue ……… 44,100
EXERCISE 10-8
2017
(a) Aug. 1 Cash ……………………………………………….. 600,000
Bonds Payable …………………………. 600,000
2018
(c) Aug. 1 Interest Expense
($600,000 X 7% X 7/12) ………………….. 24,500
EXERCISE 10-9
(a) Jan. 1 Cash ……………………………………………….. 300,000
Bonds Payable …………………………. 300,000