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10-2
REPORTING
AND ANALYZING
LIABILITIES
Accounting, Fifth Edition
10

10-3
After studying this chapter, you should be able to:
1. Explain a current liability and identify the major types of current
liabilities.
2. Describe the accounting for notes payable.
3. Explain the accounting for other current liabilities.
4. Identify the types of bonds.
5. Prepare the entries for the issuance of bonds and interest expense.
6. Describe the entries when bonds are redeemed.
7. Identify the requirements for the financial statement presentation and
analysis of liabilities.
Learning ObjectivesLearning ObjectivesLearning ObjectivesLearning Objectives

10-4
Preview of Chapter 10
Accounting
Fifth Edition
Kimmel Weygandt Kieso

10-5
Two key features:
1. Company expects to pay the debt from existing current
assets or through the creation of other current
liabilities.
2. Company will pay the debt within one year or the
operating cycle, whichever is longer.
Current LiabilitiesCurrent LiabilitiesCurrent LiabilitiesCurrent Liabilities
LO 1 Explain a current liability and identify the
major types of current liabilities.
Current liabilities include notes payable, accounts payable, unearned
revenues, and accrued liabilities such as taxes, salaries and wages, and
interest.
What is a Current Liability?

10-6
To be classified as a current liability, a debt must be
expected to be paid:
a. out of existing current assets.
b. by creating other current liabilities.
c. within 2 years.
d. both (a) and (b).
LO 1 Explain a current liability and identify the
major types of current liabilities.
Question

10-7 LO 2 Describe the accounting for notes payable.
Notes Payable
 Written promissory note.
 Usually require the borrower to pay interest.
 Those due within one year of the balance sheet date are
usually classified as current liabilities.

10-8
Illustration: First National Bank agrees to lend $100,000 on
September 1, 2014, if Cole Williams Co. signs a $100,000, 12%,
four-month note maturing on January 1. When a company issues
an interest-bearing note, the amount of assets it receives
generally equals the note’s face value.
Notes payable
100,000
Cash 100,000
LO 2 Describe the accounting for notes payable.
Sept. 1

10-9
Illustration: If Cole Williams Co. prepares financial statements
annually, it makes an adjusting entry at December 31 to recognize
interest.
Interest payable
4,000
Interest expense 4,000 *
Dec. 31
* $100,000 x 12% x 4/12 = 4,000

10-10
Illustration: At maturity (January 1), Cole Williams Co. must pay
the face value of the note plus interest. It records payment as
follows.
Interest payable 4,000
Notes payable 100,000
Jan. 1
Cash
104,000

10-11 LO 3 Explain the accounting for other current liabilities.
Sales Tax Payable
 Sales taxes are expressed as a stated percentage of the
sales price.
 Selling company
► collects tax from the customer.
► remits the collections to the state’s department of
revenue.

10-12
Illustration: The March 25 cash register readings for Cooley
Grocery show sales of $10,000 and sales taxes of $600 (sales tax
rate of 6%), the journal entry is:
LO 3 Explain the accounting for other current liabilities.
Mar. 25
Sales revenue
10,000
Cash 10,600
Sales tax payable
600

10-13
Illustration: Cooley Grocery rings up total receipts of $10,600.
Because the amount received from the sale is equal to the sales
price 100% plus 6% of sales, (sales tax rate of 6%), the journal
entry is:
Mar. 25
Sales revenue
10,000
Cash 10,600
Sales tax payable
600
Sometimes companies do not ring up sales taxes separately on
the cash register.
* $10,600 / 1.06 = $10,000
*

10-14 LO 3 Explain the accounting for other current liabilities.
Unearned Revenue
Revenues that are received before the company delivers
goods or provides service.
1. Company debits Cash, and credits a
current liability account (Unearned
Revenue).
2. When the company earns the
revenue, it debits the Unearned
Revenue account, and credits a
revenue account.

10-15
Illustration: Superior University sells 10,000 season football
tickets at $50 each for its five-game home schedule. The entry for
the sales of season tickets is:
Unearned ticket revenue
500,000
Cash 500,000Aug. 6
Ticket revenue
100,000
Unearned ticket revenue 100,000Sept. 7
As each game is completed, Superior records the earning of
revenue.

10-16
Illustration: Wendy Construction issues a five-year, interest-bearing
$25,000 note on January 1, 2011. This note specifies that each January 1,
starting January 1, 2012, Wendy should pay $5,000 of the note. When the
company prepares financial statements on December 31, 2011,
1. What amount should be reported as a current liability? ___________
2. What amount should be reported as a long-term liability? _________
Current Maturities of Long-Term Debt
 Portion of long-term debt that comes due in the current
year.
 No adjusting entry required.
$5,000
$20,000

10-17
The term “payroll” pertains to both:
Salaries - managerial, administrative, and sales personnel
(monthly or yearly rate).
Wages - store clerks, factory employees, and manual
laborers (rate per hour).
Payroll and Payroll Taxes Payable
Determining the payroll involves computing three amounts:
(1) gross earnings, (2) payroll deductions, and (3) net
pay.

10-18
Illustration: Assume Cargo Corporation records its payroll for the
week of March 7 as follows:
Salaries and wages expense 100,000
Federal income tax payable 21,864
FICA tax payable 7,650
State income tax payable 2,922
Salaries and wages payable 67,564
LO 3
Cash 67,564
Salaries and wages payable 67,564Mar. 7
Record the payment of this payroll on March 7.
Mar. 7

10-19
Payroll tax expense results from three taxes that
governmental agencies levy on employers.
These taxes are:
 FICA tax
 Federal unemployment tax
 State unemployment tax

10-20
Illustration: Based on Cargo Corp.’s $100,000 payroll,
the company would record the employer’s expense and liability
for these payroll taxes as follows.
Payroll tax expense 13,850
State unemployment taxes payable 800
FICA tax payable 7,650
Federal unemployment taxes payable 5,400

10-21
Employer payroll taxes do not include:
a. Federal unemployment taxes.
b. State unemployment taxes.
c. Federal income taxes.
d. FICA taxes.
Question

10-23
Bonds are a form of interest-bearing notes payable issued
by corporations, universities, and governmental agencies.
Sold in small denominations (usually $1,000 or multiples of
$1,000).
When a corporation issues bonds, it is borrowing money. The
person who buys the bonds (the bondholder) is investing in
bonds.
LO 4 Identify the types of bonds.
Bond: Long-Term LiabilitiesBond: Long-Term LiabilitiesBond: Long-Term LiabilitiesBond: Long-Term Liabilities

10-24
Types of Bonds
 Secured
 Unsecured
 Convertible
 Callable

10-26
 Bond certificate
► Issued to the investor.
► Provides name of the company issuing bonds, face
value, maturity date, and contractual (stated) interest
rate.
 Face value - principal due at the maturity.
 Maturity date - date final payment is due.
 Contractual interest rate – rate to determine cash interest
paid, generally semiannually.
Issuing Procedures Alternative Terminology The
contractual rate is often referred
to as the stated rate.

10-27
LO 4
Illustration 10-3

10-28
Determining the Market Value of Bonds
The process of finding the present value is referred
to as discounting the future amounts.
The current market price (present value) of a bond is a function of
three factors:
1. the dollar amounts to be received,
2. the length of time until the amounts are received, and
3. the market rate of interest.

10-29
Illustration: Assume that Acropolis Company on January 1, 2014,
issues $100,000 of 9% bonds, due in five years, with interest
payable annually at year-end.
Illustration 10-5
Computing the
market price of
bonds
Illustration 10-4
Time diagram
depicting cash
flows

10-30
A corporation records bond transactions when it
 issues or retires (buys back) bonds and
 when bondholders convert bonds into common stock.
Accounting for Bond IssuesAccounting for Bond IssuesAccounting for Bond IssuesAccounting for Bond Issues
Bonds may be issued at
 face value,
 below face value (discount), or
 above face value (premium).
Bond prices are quoted as a percentage of face value.
LO 5 Prepare the entries for the issuance of bonds and interest expense.

10-31
The rate of interest investors demand for loaning funds
to a corporation is the:
a. contractual interest rate.
b. face value rate.
c. market interest rate.
d. stated interest rate.
Question

10-32
Illustration: Devor Corporation issues 100, five-year, 10%, $1,000
bonds dated January 1, 2014, at 100 (100% of face value). The
entry to record the sale is:
Jan. 1 Cash 100,000
Issuing Bonds at Face ValueIssuing Bonds at Face ValueIssuing Bonds at Face ValueIssuing Bonds at Face Value
Bonds payable 100,000
Prepare the entry Devor would make to accrue interest on
December 31. ($100,000 x 10% x 12/12)
Dec. 31 Interest expense 10,000
Interest payable 10,000

10-33
Prepare the entry Devor would make to pay the interest on Jan. 1,
2015.
Jan. 1 Interest payable 10,000
Cash 10,000
Issuing Bonds at Face ValueIssuing Bonds at Face ValueIssuing Bonds at Face ValueIssuing Bonds at Face Value

10-34 LO 5
Issue at Par, Discount, or Premium?
Illustration 10-6
Helpful Hint Bond prices vary inversely with changes in the market interest rate. As
market interest rates decline, bond prices increase. When a bond is issued, if the market
interest rate is below the contractual rate, the bond price is higher than the face value.

10-35
Karson Inc. issues 10-year bonds with a maturity value of
$200,000. If the bonds are issued at a premium, this
indicates that:
a. the contractual interest rate exceeds the market
interest rate.
b. the market interest rate exceeds the contractual
interest rate.
c. the contractual interest rate and the market interest
rate are the same.
d. no relationship exists between the two rates.
Question

10-36
Illustration: Assume that on January 1, 2014, Candlestick Inc.
sells $100,000, five-year, 10% bonds at 98 (98% of face value)
with interest payable on January 1. The entry to record the
issuance is:
Issuing Bonds at a DiscountIssuing Bonds at a DiscountIssuing Bonds at a DiscountIssuing Bonds at a Discount
Jan. 1 Cash 98,000
Discount on bonds payable 2,000

10-37
Statement Presentation
Illustration 10-7
Statement presentation of
discount on bonds payable
Sale of bonds below face value causes the total cost of borrowing to be
more than the bond interest paid.
The reason: Borrower is required to pay the bond discount at the maturity
date. Thus, the bond discount is considered to be a increase in the cost
of borrowing.

10-38
Total Cost of Borrowing
Illustration 10-8
Illustration 10-9

10-39
Discount on Bonds Payable:
a. has a credit balance.
b. is a contra account.
c. is added to bonds payable on the balance sheet.
d. increases over the term of the bonds.
Question
Helpful Hint Both a discount
and a premium account are
valuation accounts. A valuation
account is one that is needed to
value properly the item to which
it relates.

10-40
Illustration: Assume that the Candlestick Inc. bonds previously
described sell at 102 rather than at 98. The entry to record the sale
is:
Jan. 1 Cash 102,000
Premium on bonds payable 2,000
Issuing Bonds at a PremiumIssuing Bonds at a PremiumIssuing Bonds at a PremiumIssuing Bonds at a Premium

10-41 LO 5 Prepare the entries for the issuance of bonds and interest expense.
Illustration 10-11
Statement presentation of
premium on bonds payable
Sale of bonds above face value causes the total cost of borrowing to be less
than the bond interest paid.
The reason: The borrower is not required to pay the bond premium at the
maturity date of the bonds. Thus, the bond premium is considered to be a
reduction in the cost of borrowing.
Statement Presentation

10-42
Illustration 10-12
Illustration 10-13
Total Cost of Borrowing

10-43
Redeeming Bonds at Maturity
LO 6 Describe the entries when bonds are redeemed.
Candlestick records the redemption of its bonds at maturity as
follows:
Accounting for Bond RedemptionsAccounting for Bond RedemptionsAccounting for Bond RedemptionsAccounting for Bond Redemptions
Cash 100,000

10-44
When a company retires bonds before maturity, it is necessary
to:
1. eliminate the carrying value of the bonds at the redemption
date;
2. record the cash paid; and
3. recognize the gain or loss on redemption.
The carrying value of the bonds is the face value of the bonds less
unamortized bond discount or plus unamortized bond premium at the
redemption date.
Accounting for Bond RetirementsAccounting for Bond RetirementsAccounting for Bond RetirementsAccounting for Bond Retirements
Redeeming Bonds at Maturity

10-45
When bonds are redeemed before maturity, the gain or loss
on redemption is the difference between the cash paid and
the:
a. carrying value of the bonds.
b. face value of the bonds.
c. original selling price of the bonds.
d. maturity value of the bonds.
Question

10-46
Cash 103,000
Loss on bond redemption 2,600
Illustration: Assume at the end of the fourth period, Candlestick
Inc., having sold its bonds at a premium, retires the bonds at 103
after paying the annual interest. Assume that the carrying value of
the bonds at the redemption date is $100,400 (principal $100,000
and premium $400). Candlestick records the redemption at the end
of the fourth interest period (January 1, 2018) as:
Premium on bonds payable 400

10-47
When bonds are converted into common stock:
a. a gain or loss is recognized.
b. the carrying value of the bonds is transferred to paid-
in capital accounts.
c. the market price of the stock is considered in the
entry.
d. the market price of the bonds is transferred to paid-in
capital.
Question

10-48
Balance Sheet Presentation
LO 7
Financial Statement Analysis and PresentationFinancial Statement Analysis and PresentationFinancial Statement Analysis and PresentationFinancial Statement Analysis and Presentation
Illustration 10-15

10-49
Analysis
Illustration 10-16
LO 7

10-50
Liquidity
Liquidity ratios measure the short-term ability of a company to pay its
maturing obligations and to meet unexpected needs for cash.
LO 7 Identify the requirements for the financial statement
presentation and analysis of liabilities.
Illustration 10-17

10-51
Solvency
Solvency ratios measure the ability of a company to survive over a
long period of time.
LO 7
Illustration 10-18

10-53
Off-Balance-Sheet Financing
 Contingencies
 Leasing
► Operating lease
► Capital lease
LO 7 Identify the requirements for the financial statement
presentation and analysis of liabilities.

10-55
Appendix 10AAppendix 10AAppendix 10AAppendix 10A
To follow the expense recognition principle, companies allocate
bond discount to expense in each period in which the bonds are
outstanding.
Illustration 10A-1
Amortizing Bond Discount
LO 8 Apply the straight-line method of amortizing bond
discount and bond premium.
Straight-Line
Amortization

10-56
Illustration: Candlestick, Inc., sold $100,000, five-year, 10%
bonds on January 1, 2014, for $98,000 (discount of $2,000).
Interest is payable on January 1 of each year. Prepare the
entry to accrue interest at Dec. 31, 2014.
Discount on bonds payable
400
Interest expense 10,400Dec. 31
Interest payable
10,000
Straight-Line
Amortization

10-57
Illustration 10A-2
Straight-Line
Amortization

10-58
Amortizing Bond Premium
bonds on January 1, 2014, for $102,000 (premium of $2,000).
Interest is payable on January 1 of each year. Prepare the
entry to accrue interest at Dec. 31, 2014.
Interest payable
10,000
Straight-Line
Amortization

10-59
Illustration 10A-4
Straight-Line
Amortization

10-60
Appendix 10BAppendix 10BAppendix 10BAppendix 10B
Illustration 10B-1
Under the effective-interest method, the amortization of the
discount or premium results in interest expense equal to a
constant percentage of the carrying value.
Required steps:
1. Compute the bond interest expense.
2. Compute the bond interest paid or accrued.
3. Compute the amortization amount.
Effective Interest
Amortization
LO 9

10-61
LO 9 Apply the effective-interest method of amortizing bond
Illustration: Candlestick, Inc., sold $100,000, five-year, 10% bonds
on January 1, 2014, for $98,000. The effective-interest rate is
10.53% and interest is payable on Jan. 1 of each year. Prepare the
bond discount amortization schedule.
Effective Interest
Amortization

10-62
Illustration 10B-2
LO 9 Apply the effective-interest method of amortizing bond
Effective Interest
Amortization

10-63
Illustration: Candlestick, Inc. records the accrual of interest
and amortization of bond discount on Dec. 31, as follows:
LO 9 Apply the effective-interest method of amortizing
bond discount and bond premium.
Discount on bonds payable
319
Interest payable
10,000
Effective Interest
Amortization

10-64
bonds on January 1, 2014, for $102,000. The effective-interest rate
is 9.48% and interest is payable on Jan. 1 of each year. Prepare
the bond premium amortization schedule.
Effective Interest
Amortization

10-65
Illustration 10B-4
Effective Interest
Amortization

10-66
Illustration: Candlestick, Inc. records the accrual of interest
and amortization of premium discount on Dec. 31, as follows:
Interest payable
10,000
Effective Interest
Amortization

10-67
Appendix 10CAppendix 10CAppendix 10CAppendix 10C
 May be secured by a mortgage that pledges title to specific
assets as security for a loan.
 Typically, the terms require the borrower to make installment
payments over the term of the loan. Each payment consists of
1. interest on the unpaid balance of the loan and
2. a reduction of loan principal.
 Companies initially record mortgage notes payable at face
value.
LO 10 Describe the accounting for long-term notes payable.
Long-Term
Notes Payable
Long-Term Notes Payable

10-68
Illustration 10C-1
Illustration: Porter Technology Inc. issues a $500,000, 12%, 20-
year mortgage note on December 31, 2014. The terms provide for
semiannual installment payments of $33,231.
Long-Term
Notes Payable

10-69
Illustration: Porter Technology records the mortgage loan and
first installment payment as follows:
Mortgage payable 500,000
Cash 500,000Dec. 31
Mortgage payable 3,231
Interest expense 30,000Jun. 30
Cash 33,231
Long-Term
Notes Payable

10-70
Each payment on a mortgage note payable consists of:
a. interest on the original balance of the loan.
b. reduction of loan principal only.
c. interest on the original balance of the loan and
reduction of loan principal.
d. interest on the unpaid balance of the loan and
reduction of loan principal.
Question
Long-Term
Notes Payable

10-71
Key Points
 Liabilities are defined by the IASB as a present obligation of the
entity arising from past events, the settlement of which is expected
to result in an outflow from the entity of resources embodying
economic benefits. Liabilities may be legally enforceable via a
contract or law but need not be. That is, they can arise due to
normal business practices or customs.
 IFRS requires that companies classify liabilities as current or non-
current on the face of the statement of financial position (balance
sheet) except in industries where a presentation based on liquidity
would be considered to provide more useful information (such as
financial institutions). When current liabilities are presented, they are
generally presented in order of liquidity.
LO 11

10-72
Key Points
 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 non-current (long-term) liabilities before current
liabilities.
 Under both GAAP and IFRS, preferred stock that is required to be
redeemed at a specific point in time in the future must be reported
as debt, rather than being presented as either equity or in a
“mezzanine” area between debt and equity.
LO 11 Compare the accounting procedures for
liabilities under GAAP and IFRS.

10-73
Key Points
 Under IFRS, companies sometimes will net current liabilities against
current assets to show working capital on the face of the statement
of financial position. (This is evident in the Zetar financial
statements in Appendix C.)
 IFRS requires use of the effective-interest method for amortization
of bond discounts and premiums. GAAP allows use of the straight-
line method where the difference is not material. Under IFRS,
companies do not use a premium or discount account but instead
show the bond at its net amount.

10-74
Key Points
 Unlike GAAP, IFRS splits the proceeds from the convertible bond
between an equity component and a debt component. The equity
conversion rights are reported in equity.
 Both Boards share the same objective of recording leases by
lessees and lessors according to their economic substance—that is,
according to the definitions of assets and liabilities. However, GAAP
for leases is much more “rules-based,” with specific bright-line
criteria (such as the “90% of fair value” test) to determine if a lease
arrangement transfers the risks and rewards of ownership. IFRS is
more conceptual in its provisions. Rather than a 90% cut-off, it asks
whether the agreement transfers substantially all of the risks and
rewards associated with ownership.
LO 11

10-75
Key Points
 Under GAAP, some contingent liabilities are recorded in the
financial statements, others are disclosed, and in some cases no
disclosure is required. Unlike GAAP, IFRS reserves the use of the
term contingent liability to refer only to possible obligations that are
not recognized in the financial statements but may be disclosed if
certain criteria are met.
 For those items that GAAP would treat as recordable contingent
liabilities, IFRS instead uses the term provisions. Provisions are
defined as liabilities of uncertain timing or amount. Under IFRS, the
measurement of a provision related to an uncertain obligation is
based on the best estimate of the expenditure required to settle the
obligation.
LO 11

10-76
Looking to the Future
The FASB and IASB are currently involved in two projects. One project is
investigating approaches to differentiate between debt and equity
instruments. The other project, the elements phase of the conceptual
framework project, will evaluate the definitions of the fundamental building
blocks of accounting. In addition to these projects, the FASB and IASB
have also identified leasing as one of the most problematic areas of
accounting. A joint project will initially focus primarily on lessee accounting.
One of the first areas to be studied is, “What are the assets and liabilities
to be recognized related to a lease contract?” Should the focus remain on
the leased item or the right to use the leased item? This question is tied to
the Boards’ joint project on the conceptual framework—defining an “asset”
and a “liability.”
LO 11

10-77
IFRS Practice
Which of the following is false?
a) Under IFRS, current liabilities must always be presented before
non-current liabilities.
b) Under IFRS, an item is a current liability if it will be paid within the
next 12 months.
c) Under IFRS, current liabilities are shown in order of liquidity.
d) Under IFRS, a liability is only recognized if it is a present
obligation.

10-78
IFRS Practice
Under IFRS, a contingent liability is:
a) disclosed in the notes if certain criteria are met.
b) reported on the face of the financial statements if certain
criteria are met.
c) the same as a provision.
d) not covered by IFRS.

10-79
IFRS Practice
The joint projects of the FASB and IASB could potentially:
a) change the definition of liabilities.
b) change the definition of equity.
c) change the definition of assets.
d) All of the above.

10-80
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