ACC 1101

FINANCIAL
ACCOUNTING
AND
REPORTING 1
 What are liabilities?

• Liabilities are debts that are owed to

creditors.
• Liabilities have three main characteristics:
1. They occur because of a past transaction or
event.
2. They create a present obligation for future
payment of cash or services.
3. They are an unavoidable obligation.

© 2018 Pearson Education, Inc. 11-2

Classification of Liabilities
 Trade Payables

• It is a one party’s contractual obligation to pay

cash to other corresponding party.
• Trade payables are classified as current liabilities
when:
a) it is a present obligation
b) it is a result of past transactions or other past
events
c) it can be measured reliably or using a substantial
degree of estimation
d) It is classified as cash or a cash equivalent
unless the assets are restricted from being
exchanged or used to settle a liability for at least
after 12 months (after the reporting period)

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 Example

• An entity shall measure trade payables at the fair

value plus transaction cost.
• An entity purchased goods amounting to
RM10,000 from its supplier. The entity agreed to
settle the credit on day 15 after the purchase.
The trade payable would be recorded as below:
Dr Purchases a/c 3,000
Cr Trade payables a/c 3,000
When cash is paid on day 15
Dr Trade payables 3,000
Cr Cash 3,000

© 2018 Pearson Education, Inc. 11-5

 Other current liabilities

• An entity shall recognized other current

liabilities when:
(a) It is probable that an outflow of
resources embodying economic benefits
will result from the settlement of a
present obligation.
(b) The amount of the settlement can
be measured reliably.

© 2018 Pearson Education, Inc. 11-6

 Example

• Other current liabilities are measured at

historical cost which is the amount of
proceeds received in exchange for the
obligation.

• An entity owes its employees, RM5,000 for

salaries at the end of the accounting
period.

Dr Salaries 5,000
Cr Accrued salaries 5,000

© 2018 Pearson Education, Inc. 11-7

Presentation of Trade and Other
Liabilities

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 Short-term Notes Payable

• A short-term note payable represents a written

promise by a business to pay a debt, usually
involving interest, within one year or less.
• On May 1, Smart Touch Learning purchases
merchandise inventory with a 10%, 90-day note
payable, for $8,000. Assume a perpetual inventory
system.

© 2018 Pearson Education, Inc. 11-9

 Short-term Notes Payable

On July 30, when the note is due, Smart Touch

Learning pays the note plus interest.

© 2018 Pearson Education, Inc. 11-10

 Current Portion of Long-term
Notes Payable
• Long-term notes payable are typically
reported in the long-term liability section
of the balance sheet.
• When a long-term debt is paid in
installments, the business reports the
current portion of notes payable as a
current liability.
• The remainder is classified as long term.

© 2018 Pearson Education, Inc. 11-11

 BONDS

• Bonds payable are long-term debts issued

to multiple lenders called bondholders,
usually in increments of $1,000 per bond.
• The face value is the amount a borrower
must pay back to the bondholders on the
maturity date.

Principa
Face Maturity Par
l
value value value
amount

© 2018 Pearson Education, Inc. 14-12

 BONDS

• The maturity date is the date on which the

borrower must pay the principal amount to
the bondholders.
• The stated interest rate is the interest rate
that determines the amount of cash
interest the borrower pays and the
investor receives each year.

Stated Face Coupon Nominal

rate rate rate rate

© 2018 Pearson Education, Inc. 14-13

 BONDS

A five-year, 9% bond issued at a face value of $100,000

on January 1, 2018, will pay 10 semiannual interest
payments of $4,500 ($100,000 × 0.09 × 6/12) in
addition to the face value payment at the maturity date.
The cash flow pattern for this bond is as follows:

© 2018 Pearson Education,

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Inc.
 BONDS

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 Types of Bonds
• Term bonds are bonds that all mature at the
same time.
• Serial bonds are bonds that mature in
installments at regular intervals.
• Secured bonds are bonds that give
bondholders the right to take specified assets
of the issuer if the issuer fails to pay principal
or interest.
• Debentures are unsecured bonds backed only
by the credit worthiness of the bond issuer.

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 Bond Prices
• A bond can be issued at any price agreed
upon by the issuer and the bondholders. A
bond can be issued at face value, at a
discount, or at a premium.
– A discount on bonds payable occurs when
the issue price is less than face value.
– A premium on bonds payable occurs when
the issue price is above face value.

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 Present Value and Future Value

• Money earns interest over time.

• The time value of money is the recognition
that money earns interest over time.
• The present value is the amount a person
invests now to receive a greater amount in
the future.
• The future value is the value of an
investment at the end of a specific time
frame.

© 2018 Pearson Education, Inc. 14-18

 Present Value and Future Value

• Assume that a $1,000 bond reaches maturity three

years from now and carries no interest. $750 is a fair
price.
• By investing $750 now to receive $1,000 later, you
will earn $250 over the three years.

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 Bond Interest Rates

• The stated rate is the rate printed on a bond.

• The market interest rate (also known as the
effective interest rate) is the rate that investors
demand to earn for loaning their money.

© 2018 Pearson Education, Inc. 14-20

 Issuing Bonds Versus Issuing
Stock
• Borrowing by issuing bonds payable
carries a risk: The company may be
unable to pay off the bonds and the
related interest.
• However, debt is a less expensive source
of capital than stock and does not affect
the ownership percentage.
• Earning more income on borrowed money
than the related interest expense is called
financial leverage.

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 JOURNAL ENTRIES

Accounting for bonds

(i) Issuance of bonds
(ii) Amortisation of interest on bond (effective interest rate)
(iii) Retirement of bonds

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 1. Issuing Bonds Payable at Face
Value
Smart Touch Learning has $100,000 of 9% bonds
payable that mature in five years. The company issues
these bonds at face value on January 1, 2018.

© 2018 Pearson Education, Inc. 14-23

 Issuing Bonds Payable at Face
Value
Interest payments occur each June 30 and December
31. Smart Touch Learning’s first semiannual interest
payment is journalized as follows:

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 2. Issuing Bonds Payable at a
Discount
Smart Touch Learning issues $100,000 of 9%, five-year
bonds that pay interest semiannually. The market rate
of interest is 10%. Smart Touch Learning actually
receives $96,149 and records a discount of $3,851.

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 Issuing Bonds Payable at a
Discount
After posting:

Smart Touch Learning reports these bonds payable on

the balance sheet as follows:

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 Issuing Bonds Payable at a
Discount
• Discount on Bonds Payable is a contra
account to Bonds Payable.
• Bonds Payable minus the discount gives
the carrying amount of bonds, also known
as the carrying value.

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 Effective-Interest Amortization
for a Bond Discount
• Smart Touch Learning issues $100,000 of
9% bonds at a time when the market rate
of interest is 10%.
• The interest expense is calculated using
the carrying amount of the bonds and the
market interest rate.

14-28
© 2018 Pearson Education, Inc.
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 Effective-Interest Amortization
for a Bond Discount
Using the discount amortization table, record Smart
Touch Learning’s first interest payment on June 30.

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 3. Issuing Bonds Payable at a
Premium
• When the stated interest rate is greater
than the market interest rate, the bonds
are sold at a premium.
• Premium on Bonds Payable is an adjunct
account to Bonds Payable.
• An adjunct account is an account that is
directly related to another account.

© 2018 Pearson Education, Inc. 14-31

 Issuing Bonds Payable at a
Premium
Smart Touch Learning issues its 9%, five-year bonds
when the market interest rate is 8%. Assume that the
bonds are priced at 104.10, and Smart Touch Learning
receives $104,100 cash upon issuance.

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 Issuing Bonds Payable at a
Premium
After posting, the bond accounts have the following
balances:

Smart Touch Learning reports these bonds payable on

the balance sheet as follows:

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 Effective-Interest Amortization
of a Bond Premium
• Smart Touch Learning issues $100,000 of
9% bonds at a time when the market rate
of interest is 8%.
• The interest expense is calculated using
the carrying amount of the bonds and the
market interest rate, similar to the method
used for discounted bonds.

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 Effective-Interest Amortization
of a Bond Premium
Using the premium amortization table, record
Smart Touch Learning’s first interest payment on
June 30.

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RETIREMENT OF BONDS PAYABLE

• Retirement of bonds payable involves

paying the face value of the bonds.
• Bonds can be retired at or before the
maturity date.
• When a bond is matured, the carrying
value always equals the face value.

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1.Retirement of Bonds at Maturity

Smart Touch Learning has $100,000 of 9% bonds that

mature on December 31, 2022. (Note that all interest
has already been paid, and the discount is fully
amortized.)

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 2. Retirement of Bonds Before
Maturity
• Companies sometimes retire their bonds
prior to maturity.
• The main reason is to relieve the pressure
of paying interest payments.
• Some bonds are callable bonds, which
means the company may call, or pay off,
the bonds at a specified price.

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 Retirement of Bonds Before
Maturity
On December 31, 2018, Smart Touch Learning has
$100,000 of bonds payable outstanding, with a
remaining discount balance of $3,081. The company can
buy the bonds in the open market for 95.

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 Retirement of Bonds Before
Maturity
The following entry records retirement of the bonds,
immediately after the December 31, 2018, interest
payment:

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 Retirement of Bonds Before
Maturity
To retire bonds before maturity:
1. Record partial-period amortization of discount or
premium and partial-period interest payment if
the retirement date does not fall on an interest
payment date.
2. Remove the portion of unamortized Discount or
Premium that relates to the bonds being retired.
3. Debit Bonds Payable at face value.
4. Credit a gain or debit a loss on retirement.
5. Credit Cash for the amount paid to retire the
bonds.
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Inc.
 Provision/Estimated Liabilities

• A business may know that a liability exists

but may not know the exact amount.
• It must estimate the amount of the
liability and report it on the balance sheet.
• Common examples of estimated liabilities:
– Bonus plans
– Vacation pay
– Health and pension expense benefits
– Warranties

© 2018 Pearson Education, Inc. 11-43

 Warranties

• Many businesses guarantee their products

against defects under warranty
agreements.
• The time period of warranties varies by
product and company.
• The matching principle requires a business
to record Warranty Expense in the same
period that the company records the
revenue related to the warranty.

© 2018 Pearson Education, Inc. 11-44

 Warranties
Smart Touch Learning made sales on account of $50,000
(cost of merchandise inventory sold, $35,000) subject to
product warranties on June 10 and estimates that
warranty costs will be 3% of sales.

© 2018 Pearson Education, Inc. 11-45

 Warranties
Some of Smart Touch Learning’s customers make claims
that must be honored through the warranty offered by
the company. The warranty costs total $800 and are
made on June 27. The company replaces the defective
goods and makes the following journal entry:

© 2018 Pearson Education, Inc. 11-46

 Contingent Liability

• A contingent liability is a potential liability

that depends on a future event.
• For a contingent liability to be paid, some
event must happen in the future.
• How businesses record contingent
liabilities is based on the likelihood of
events occurring in the future:
– Remote
– Reasonably possible
– Probable

© 2018 Pearson Education, Inc. 11-47

ACCOUNTING FOR CONTINGENT
LIABILITIES

© 2018 Pearson Education, Inc. 11-48