CHAPTER 10
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. EXPLAIN HOW TO ACCOUNT FOR LONG-TERM
NOTES PAYABLE.
5. DISCUSS HOW LONG-TERM LIABILITIES ARE
REPORTED AND ANALYZED.
CHAPTER REVIEW
Current Liabilities
Notes Payable
2. Notes payable are obligations in the form of written notes that usually
3. When an interest-bearing note is issued, the assets received generally equal the face value of
the note:
Sales Taxes Payable
4. A sales tax is expressed as a percentage of the sales price on goods sold to customers. The
entry by the selling company to record sales taxes is as follows:
Cash …………………………………………………………………………………… XXXX
Payroll and Payroll Taxes Payable
5. The amount of unpaid pay owed to employees is wages and salaries payable. Manadatory
payroll deductions remitted to government authorities are withholding taxes, such as personal state
6. The payroll and payroll tax liability accounts are classified as current liabilities.
Unearned Revenues
7. Unearned Revenues (advances from customers) are recorded by a debit to Cash and a credit to
Current Maturities of Long-Term Debt
Bonds
9. (L.O. 2) Long-term liabilities are obligations that are expected to be paid after one year. Long-term
liabilities include bonds, long-term notes, and lease obligations.
Types of Bonds
12. Secured bonds have specific assets of the issuer pledged as collateral for the bonds. A mortgage
bond is secured by real estate.
13. Unsecured bonds are issued against the general credit of the borrower; they are also called
debenture bonds.
Market Value of Bonds
17. The market value (present value) of a bond is a function of three factors: (a) the dollar amounts to
be received, (b) the length of time until the amounts are received, and (c) the market rate of interest.
The process of finding the present value is referred to as discounting the future amounts.
Bond Transactions
18. (L.O. 3) The issuance of bonds at face value results in a debit to Cash and a credit to Bonds
Payable.
Bond Issues at Discount
20. When bonds are issued at a discount,
a. The market rate of interest exceeds the stated rate.
Bond Issues at Premium
21. When bonds are issued at a premium,
a. The market rate of interest is less than the stated rate.
Bond Redemption and Conversion
22. When bonds are redeemed at maturity and the last interest payment has been recorded, the
Bonds Payable account debited and the Cash account credited for the face value of the bond.
Long-term Notes Payable
25. (L.O. 4) A long-term note payable may be secured by a document called a mortgage that pledges
title to specific assets as security for a loan.
Statement Presentation and Analysis
26. (L.O. 5) Current liabilities are the first category of liabilities on the balance sheet.
a. Usually notes payable are listed first and then accounts payable.
b. The other current liabilities are listed in order of magnitude.
c. Return on stockholders’ equity may be higher.
Straight-Line Method
*31. (L.O. 6) When a bond sells at a discount, the straight-line method of amortization allocates the
same amount of bond discount to each interest period. The formula is:
Bond Discount ÷ Number of Interest Periods = Bond Discount Amortization
*32. The entries to record the accrual and payment of periodic interest when the bond sells at a
discount are:
Cash……………………………………………….. XXX
*33. When a bond sells at a premium, the straight-line method of amortization allocates the same
amount of bond premium to each interest period. The formula is:
Effective-Interest Method
*36. (L.O. 7) The effective-interest method of amortization is an alternative to the straight-line
method. Under this method,
a. Interest Expense is computed first by multiplying the carrying value of the bonds at the
Compare the Accounting for Liabilities Under GAAP and IFRS
*38. (L.O. 8) The following are the key similarities and differences between GAAP and IFRS as related
to the recording process for liabilities.
a. Similarities
(1) The basic definition of a liability under GAAP and IFRS is very similar.
b. Differences
(1) Unlike GAAP, IFRS splits the proceeds from the convertible bond between an equity
LECTURE OUTLINE
A. Accounting for Current Liabilities.
1. A current liability is a debt that a company:
2. Current liabilities include notes payable, accounts payable, unearned
revenues, and accrued liabilities such as taxes, salaries and wages, and
interest payable.
a. Companies record obligations in the form of written notes as notes
payable. Companies frequently issue notes to payable to meet short-
d. Cash received from customers before goods are delivered or services
are rendered is called unearned revenues. When a company receives
B. Why Issue Bonds?
1. Bonds are sold in small denominations (usually $1,000), and as a result,
they attract many investors.
C. Types of Bonds.
1. Bonds may be classified by certain features. Some types of bonds com–
monly issued include:
2. Issuing procedures.
a. In authorizing the bond issue, the board of directors must stipulate
3. Determining the market value of bonds.
a. Present value is the amount that must be invested today at a given
interest rate to have a specified sum of money at a specified date.
(3) The market rate of interest.
D. Issuing Bonds at Face Value.
1. When bonds are issued, Cash is debited for the cash proceeds and Bonds
Payable is credited for the face value of the bonds.
E. Issuing Bonds at a Discount or Premium.
1. If the market interest rate is higher than the contractual (stated) rate, the
bonds will sell at a discount (less than face value).
4. The entry to record bonds issued at a premium includes a debit to Cash
for the cash proceeds, a credit to Bonds Payable for the face value of
the bonds, and a credit to Premium on Bonds Payable for the difference.
F. Redeeming Bonds Before Maturity.
1. Bonds may be redeemed before maturity because a company may decide
to reduce interest cost and to remove debt from its balance sheet.
G. Converting Bonds into Common Stock.
1. Convertible bonds give bondholders an opportunity to benefit if the market
H. Accounting for Long-Term Notes Payable.
1. Long-term notes payable are similar to short-term interest-bearing notes
payable except that the term of the notes exceeds one year.
I. Statement Presentation and Analysis.
1. Companies usually list current liabilities by order of magnitude, with the
largest ones first.
4. The current ratio is also a measure of liquidity and permits analysts to
compare the liquidity of different-sized companies. It is computed by
dividing current assets by current liabilities.
8. The long-run solvency of a company may be analyzed by computing the
debt to assets ratio and times interest earned.
INVESTOR INSIGHT
In many corporate loans the lending agreement specifies debt covenants—
specific financial measures that a company must maintain during the life of the
loan. Covenants protect lenders because they enable lenders to step in and try to
get their money back before the borrower gets too deep into trouble.
How can financial ratios such as those covered in this chapter provide protection
for creditors?
*J. Straight-Line Amortization.
1. The straight-line method of amortization results in a constant amount of
amortization and interest expense per period.
*K. Effective-Interest Method of Bond Amortization.
1. Under the effective-interest method of amortization, the amortization of bond
discount or bond premium results in periodic interest expense equal to a
constant percentage of the bonds’ carrying value.
3. When the difference between the straight-line method and the effective-
interest method of amortization is material, GAAP requires the use of the
effective-interest method.
IFRS
A Look at IFRS
IFRS and GAAP have similar definitions of liabilities but have a different
approach for recording certain liabilities.
KEY POINTS
SIMILARITIES
• The basic definition of a liability under GAAP and IFRS is very similar. In a
• Under IFRS, liabilities are classified as current if they are expected to be
paid within 12 months.
• Similar to GAAP, items are normally reported in order of liquidity.
Companies sometimes show liabilities before assets. Also, they will
sometimes show long-term liabilities before current liabilities.
Differences
• The accounting for convertible bonds differs between IFRS and GAAP.
LOOKING TO THE FUTURE
The FASB and IASB are currently involved in two projects, each of which has
implications for the accounting for liabilities. One project is investigating
20 MINUTE QUIZ
Circle the correct answer.
True/False
1. A liability is always classified as current if it is due in less than one year.
True False
2. With an interest-bearing note, the amount of cash received upon issuance of the note will
be less than the note’s face value.
True False
3. An unearned revenue arises when payment is accepted in advance of the goods or
services being provided.
True False
4. If the market rate of interest is higher than the contractual rate, the bonds will sell at a
premium.
True False
5. The amount that must be invested today at current interest rates in order to receive a
specified sum of money at a specified date is the present value.
True False
6. When bonds are issued at face value, the debit to Cash is equal to the credit to Bonds
Payable.
True False
7. Bonds with a higher contractual interest rate than the market rate for similar bonds will
probably sell at a discount.
True False
8. The sale of bonds above face value causes the total cost of borrowing to be more than
the bond interest paid.
True False
*9. Under the straight-line method of amortization, the amortization of a bond premium will
increase each year over the life of the bond.
True False
*10. Under the effective-interest method, the amortization of a bond discount will result in an
increasing interest expense each year over the life of the bond.
True False
Multiple Choice
1. The account Unearned Subscription Revenue
a. is considered a miscellaneous revenue account.
b. has a normal debit balance.
c. is a contra account to Subscription Revenue.
d. is a current liability.
2. The total cost of borrowing on a 10-year, 9%, $1,000 bond that sold for $960 is
a. $960.
b. $940.
c. $860.
d. $870.
3. If bonds payable are issued at a discount, the contractual interest rate is
a. higher than the market rate of interest.
b. lower than the market rate of interest.
c. equal to the market rate of interest.
d. changed to reflect the market rate of interest.
4. A $2,000,000 bond issue with a carrying value of $2,080,000 is called at 103 and retired.
Which of the following is true?
a. A gain of $80,000 is recorded.
b. A loss of $20,000 is recorded.
c. A gain of $20,000 is recorded.
d. No gain or loss is recorded.
*5. When the effective-interest method is used, the interest expense for the period is
calculated by multiplying the
a. face value of the bonds at the beginning of the period by the contractual interest
rate.
b. carrying value of the bonds at the beginning of the period by the contractual interest
rate.
c. face value of the bonds at the beginning of the period by the effective-interest rate.
d. carrying value of the bonds at the beginning of the period by the effective-interest
rate.
ANSWERS TO QUIZ
True/False
Multiple Choice