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LIABILITIES
CHAPTER NO 10

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The Nature of Liabilities

Defined
Defined asas debts
debts oror obligations
obligations
arising
arising from
from past
past transactions
transactions or
or
events.
events.
Maturity = 1 year or less Maturity > 1 year

Current Noncurrent
Liabilities Liabilities
I.O.U.

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Distinction Between
Debt and Equity
The acquisition of assets is financed from two
sources:
DEBT
DEBT EQUITY
EQUITY

Funds from creditors, with Funds from

a definite due date, and owners
sometimes bearing
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Liabilities – Question

Devon
Devon Mfg.
Mfg. borrows
borrows $100,000
$100,000 from
from First
First
Bank.
Bank. The
The loan
loan will
will be
be repaid
repaid in
in 20
20 years
years
and
and has
has an
an annual
annual interest
interest rate
rate of
of 8%.
8%.
Is
Is this
this aa current
current liability
liability or
or aa
noncurrent
noncurrent liability?
liability?
The
The obligation
obligation will will not
not be
be paid
paid
within
within one
one yearyear oror one
one operating
operating
cycle,
cycle, so
so itit is
is aa noncurrent
noncurrent liability.
liability.

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Evaluating Liquidity
An
An important
important indicator
indicator of
of aa company’s
company’s ability
ability to
to
meet
meet its
its current
current obligations.
obligations.

Two
Two commonly
commonly used
used measures:
measures:

Working Capital = Current Assets - Current Liabilities

Current Ratio = Current Assets ÷ Current Liabilities

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Liabilities – Question

Devon
Devon Mfg.
Mfg. has
has current
current liabilities
liabilities of
of
$230,000
$230,000 and
and current
current assets
assets ofof $322,000.
$322,000.
What
What is
is Devon’s
Devon’s current
current ratio?
ratio?

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Accounts Payable

Short-term
Short-term obligations
obligationsto tosuppliers
suppliersfor
for purchases
purchasesofof
merchandise
merchandiseand
andtoto others
othersfor
for goods
goodsand
andservices.
services.

Office
Office
Merchandise supplies
supplies
Merchandise
inventory invoices
invoices
inventory
invoices
invoices
Utility
Utilityand
and
Shipping phone
phonebills
bills
Shipping
charges
charges
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Notes Payable
When
Whenaacompany
companyborrows
borrowsmoney,
money,aanote
notepayable
payableis
is
created.
created.
Current
Current Portion
Portion of
of Notes
Notes Payable
Payable
The
Theportion
portionofofaanote
notepayable
payablethat
that is
isdue
duewithin
within one
one
year,
year,or
or one
oneoperating
operatingcycle,
cycle, whichever
whicheveris islonger.
longer.

Current Notes Payable

Total Notes
Payable Noncurrent Notes Payable

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Notes Payable
PROMISSORY NOTE
Miami, Fl Nov. 1, 2003
Location Date
Six months after this date Porter Company
promises to pay to the order of Security National Bank
the sum of $10,000.00 with interest at the rate
of 12.0% per annum.
signed John Caldwell
title treasurer

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Notes Payable
On November 1, 2003, Porter Company
would make the following entry.

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Interest Payable
•• Interest
Interest expense
expense is is the
the
compensation
compensation to to the
the lender
lender for for
giving
giving upup the
the use
use of of money
money for for aa
period
period ofof time.
time.
•• The
The liability
liability is
is called
called interest
interest
payable.
payable.
•• To
To the
the lender,
lender, interest
interest is is aa revenue.
revenue. Interest
Rate
Up!
•• To
To the
the borrower,
borrower, interest
interest is
is an
an
expense
expense..

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Interest Payable
The
The interest
interest formula
formula includes
includes three
three variables
variables that
that
must
must bebe considered
considered when
when computing
computing interest:
interest:

Interest = Principal × Interest Rate × Time

When
Whencomputing
computinginterest
interestfor
forone
oneyear,
year,“Time”
“Time”
equals
equals1.
1. When
Whenthethecomputation
computationperiod
periodis isless
less
than
thanone
oneyear,
year,then
then“Time”
“Time”isisaafraction.
fraction.
For
Forexample,
example,ififwe
weneeded
neededto tocompute
computeinterest
interestfor
for
33months,
months,“Time”
“Time”would
wouldbebe3/12.
3/12.

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Interest Payable – Example

What
What entry
entry would
would Porter
Porter Company
Company make
make
on
on December
December 31,
31, the
the fiscal
fiscal year-end?
year-end?

$10,00012% 
$10,00012%  //1212 == $200
22
$200
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Payroll Liabilities
Gross Pay

Net Pay

State and Voluntary

Medicare Federal Local Income Deductions
FICA Taxes
Taxes Income Tax Taxes
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Unearned Revenue
Cash
Cash is
is sometimes
sometimes collected
collected from
from the
the
customer
customer before
before the
the revenue
revenue is
is
actually
actually earned.
earned.
As the earnings
process is
completed . .
Cash is
Deferred Earned
received
revenue is revenue is
in
recorded. recorded.
advance.

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Long-Term Debt
Relatively
Relatively small
small debt
debt
needs
needs can
can be
be filled
filled from
from
single
single sources.
sources.

or Insurance
or Pension
Banks Companies Plans
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Long-Term Debt
Large
Large debt
debt needs
needs are
are often
often
filled
filled by
by issuing
issuing bonds.
bonds.

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Installment Notes Payable

Long-term
Long-term notes
notes that
that call
call for
for aa series
series of
of
installment
installment payments.
payments.

Each
Eachpayment
paymentcovers
covers With
With each
eachpayment,
payment, the
the
interest
interestfor
for the
theperiod
period interest
interest portion
portion gets
gets
AND
ANDaaportion
portionofof the
the smaller
smaller and
and the
theprincipal
principal
principal.
principal. portion
portiongets
getslarger.
larger.
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Allocating Installment Payments

Between Interest and Principal

Identify
Identifythe
theunpaid
unpaidprincipal
principalbalance.
balance.

Unpaid
UnpaidPrincipal
Principal××Interest
Interestrate
rate==
Interest
Interestexpense.
expense.

Installment
Installmentpayment
payment--Interest
Interest
expense
expense==Reduction
Reductionin
inunpaid
unpaid
principal
principalbalance.
balance.

Compute
Computenewnewunpaid
unpaidprincipal
principal
balance.
balance.

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Allocating Installment Payments

Between Interest and Principal
On
On January
January 1,1, 2003,
2003, Rocket
Rocket
Corp.
Corp. borrowed
borrowed $7,581.57
$7,581.57 from
from
First
First Bank
Bank of
of River
River City.
City. The
The
loan
loan was
was aa five-year
five-year loan
loan and
and
had
had anan interest
interest rate
rate of
of 10%.
10%. The
The
annual
annual payment
payment isis $2,000.
$2,000.

Prepare
Prepare an
an amortization
amortization table
table for
for
Rocket
Rocket Corp.’s
Corp.’s loan.
loan.
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Allocating Installment Payments

Between Interest and Principal

Now,
Now, prepare
preparethe
theentry
entryfor
forthe
thefirst
firstpayment
payment on
on
December
December31,31,2003.
2003.
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Allocating Installment Payments

Between Interest and Principal
The
Theinformation
informationneeded
neededfor
forthe
thejournal
journalentry
entrycan
canbebe
found
foundon onthe
theamortization
amortizationtable.
table. The
Thepayment
paymentamount,
amount,
the
theinterest
interestexpense,
expense,and
andthe
theamount
amountto tocredit
creditto
to
principal
principalare
areall
allon
onthe
thetable.
table.

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What is a bond?
• A long-term debt instrument in which a
borrower agrees to make payments of
principal and interest, on specific dates, to
the holders of the bond.

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Sample

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Government Bonds
Government bond is a debt security loaned by a
government to assist government spending, most
often issued in the country’s local interest.
The various types of Government bonds issued
by the Govt. of Pakistan are as follows:
Pakistan Investment Bonds
US Special Dollar Bonds
Wapda Bonds
National Saving Bonds
and Sukuk

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

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Corporate Bond
• Corporate Bond is a debt security which is
issued by company and sold to investors to
meet its financial requirements. In Pakistan
this is commonly known as Term Finance
Certificate (TFC).

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

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Bonds Payable

 Bonds
Bonds usually
usually involve
involve the
the
borrowing
borrowing of of aa large
large sum
sum ofof
money,
money, called
called principal.
principal.
 The principal is usually paid
The principal is usually paid
back
back asas aa lump
lump sumsum atat the
the end
end
of
of the
the bond
bond period.
period.
 Individual bonds are often
Individual bonds are often
denominated
denominated with with aa par
par value,
value,
or
or face
face value,
value, of of $1,000.
$1,000.

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Bonds Payable
• Bonds usually carry a stated rate
of interest, also called a contract
rate.
• Interest is normally paid
semiannually.
• Interest is computed as:

Interest
Interest == Principal
Principal ×× Stated
Stated Rate
Rate ×× Time
Time

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Bonds Payable
•• Bonds
Bonds areare issued
issued through
through an an
intermediary
intermediary called
called anan
underwriter.
underwriter.
•• Bonds
Bonds cancan bebe sold
sold onon organized
organized
securities
securities exchanges.
exchanges.
•• Bond
Bond prices
prices are
are usually
usually quoted
quoted
as
as aa percentage
percentage of of the
the face
face
amount.
amount.
–– For
For example,
example, aa $1,000
$1,000 bond
bond
priced
priced at
at 102
102 would
would sell
sell for
for
$1,020.
$1,020.
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Types of Bonds

Mortgage
Mortgage Debenture
Debenture
Bonds
Bonds Bonds
Bonds

Convertible
Convertible Junk
JunkBonds
Bonds
Bonds
Bonds

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Accounting for Bonds Payable

On
On January
January1,1, 2003,
2003, Rocket
Rocket Corp.
Corp. issues
issues $1,500,000
$1,500,000 of
of
12%,
12%, 10-year
10-yearbonds
bondspayable.
payable. Interest
Interestis
ispayable
payable
semiannually,
semiannually,each
eachJuly
July11and
andJanuary
January1.1.

Assume
Assumethe
thebonds
bondsare
areissued
issuedatatface
facevalue.
value.
Record
Record the
theissuance
issuanceofofthe
thebonds.
bonds.

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Accounting for Bonds Payable

Record
Record the
the interest
interest payment
payment
on
on July
July 1,
1, 2003.
2003.

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Bonds Sold Between Interest Dates

•• Bonds
Bonds are
are often
often sold
sold between
between interest
interest dates.
dates.
•• The
The selling
selling price
price of
of the
the bond
bond isis computed
computed as:
as:

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The Concept of Present Value

$1,000 In 5 years it In 25 years it

invested will be worth will be worth
today at 10%. $1,610.51. $10,834.71!

Present
Present Future
Future
Value
Value Money can grow over time, Value
Value
because it can earn interest.
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The Concept of Present Value

How
Howmuch
How
How muchisis aa future
much amount
future amount worth
amountworth
amount today?
worthtoday?
worth today?
today?
Three
Three pieces
pieces of
of information
information must
must be
be known
known to
to
solve
solve aa present
present value
value problem:
problem:
Present
The future amount.
Interest compounding periods Future
The
Value
future amount. Value
The
 Theinterest
interestrate
rate(i).
(i).
The
 Thenumber
numberof ofperiods
periods(n)
(n)the
theamount
amountwill
willbe
be
Today
invested.
invested.

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The Concept of Present Value

Two types of cash flows are involved
with bonds:
Periodic interest payments called annuities.

Today Maturity

Principal payment
at maturity.
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The Present Value Concept and

Bond Prices
The selling price of the bond is determined by
the market based
on the time value of money.

= =

< <

> >
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Early Retirement of Debt

B o n d s c a n b e r e tire d b y . . .

E x e r c i s i n g a c a ll P u r c h a s in g th e
p r o v is io n . b o n d s o n th e
o p e n m a r k e t.

Gains
Gainsor
orlosses
lossesincurred
incurredas
asaaresult
resultof
ofretiring
retiringbonds
bonds
should
shouldbe
bereported
reportedasasextraordinary
extraordinaryitems
itemsononthe
the
income
incomestatement.
statement.
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