Liabilities

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Chapter 7
Liabilities
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Chapter 7 Objectives

• Account for the major types of transactions and
  events affecting current and long-term
  liabilities, including bonds.
• Define the key characteristics of, and account
  for, contingent liabilities.
• Distinguish between operating leases and capital
  leases.
• Discuss accounting issues for long-term
  liabilities stemming from pension and other
  postretirement employee benefit plans.
• Define the key information needs of decision
  makers regarding liabilities.
• Compute and interpret the current, working
  capital, long-term debt to equity, and times
  interest earned ratios.

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Definition
The Financial Accounting Standards Board defines
liabilities as "probable future sacrifices of
economic benefits arising from present
obligations of a particular entity to transfer
assets or provide services to other entities in
the future as a result of past transactions or
events." Financial Accounting Standards
Board, Statement of Financial Accounting Concepts
No. 6, Elements of Financial Statements
(Stamford, Conn. FASB, 1985), paragraph 35.
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Current Liabilities

• Accounts Payable
• Notes Payable
• Salaries Payable
• Current Portion of Long-term Debt

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Notes Payable
Common Terms Maker Payee Principal Term of
Note Maturity Date/Value
Interest Principal x Rate x Time
Use a 360 day year
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Other Accrued Liabilities

• Product Warranty
• Vacation Pay
• Accrued Payroll

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Contingent Liabilities
The two factors to consider in determining the
accounting treatment for a loss contingency are
whether (1) it is likely that an actual loss will
result from the contingency and (2) the amount of
the potential loss can be reasonably estimated.
Probable Reasonably Possible Remote
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Long-term Liabilities

• Bonds Payable
• Mortgage Payable
• Long-Term Notes Payable
• Lease Obligations

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Bonds Payable

• Callable
• Convertible
• Stated/Contract Rate
• Effective/Market Rate
• Maturity Value

Maturity Value PV(Principal) PVA(Interest
Payments)
Effective Rate gt Stated Rate Discount Effective
Rate lt Stated Rate Premium
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Journal Entries for a Bond Issued at a
Discount   Date Description Debit Credit 2003
Apr. 1 Cash 96,231 Discount on Bonds
Payable 3,769 Bonds Payable 100,000 To
record issuance of 100,000, 10, 5-year
bonds at a market rate of 11.
Sept. 30 Interest Expense 5,377 Cash 5,000
Discount on Bonds Payable 377 To record
payment of semiannual interest and
amortization of discount. Dec. 31 Interest
Expense 2,689 Interest Payable 2,500 Disc
ount on Bonds Payable 189 To record accrual
of 3 month's of interest and amortization of
discount.
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2004 Mar. 31 Interest Expense 2,688 Interest
Payable 2,500 Cash 5,000 Discount on
Bonds Payable 188 To record payment of
semiannual interest and amortization of
discount.
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Journal Entries for a Bond Issued at a Premium  
Date Description Debit Credit 2003 Apr.
1 Cash 103,957 Bonds Payable 100,000 Pr
emium on Bonds Payable 3,957 To record
issuance of 100,000, 10, 5-year bonds at a
market rate of 9. Sept. 30 Interest
Expense 4,604 Premium on Bonds
Payable 396 Cash 5,000 To record payment
of semiannual interest and amortization of
premium. Dec. 31 Interest Expense 2,302 Pre
mium on Bonds Payable 198 Interest
Payable 2,500 To record accrual of 3 month's
of interest and amortization of premium.
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2004 Mar. 31 Interest Expense 2,302 Interest
Payable 2,500 Premium on Bonds
Payable 198 Cash 5,000 To record payment
of semiannual interest and amortization of
premium.
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Leases

• RULES
• Capitalize a Lease if
• Present Value of Minimum Lease paymentsgt90 FMV
• Lease Term gt 75 of Estimated Useful Life
• Title Transfer
• Bargain Purchase Option

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Capitalized Leases

• Record and depreciate Asset
• Record Liability
• Recognize Interest Expense

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Postretirement Benefit Liabilities

• Defined Contribution Plan
• Defined Benefit Plan
• 401(k), IRA
• Other non-financial benefits

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Ratios
Current Ratio Current Assets
Current Liabilities
Working Capital Current Assets Current
Liabilities
Net Interest Income Taxes
Times Interest Income Expense
Expense__ Earned Ratio
Interest Expense