Ch.8 - Liabilities - MH

Chapter 8
Liabilities
1
Chapter 8’s Learning Objectives
1. Explain and account for current liabilities

2. Explain the types, features, and pricing of bonds payable
3. Account for bonds payable
4. Calculate and account for interest expense on bonds
payable
5. Explain the advantages and disadvantages of financing
with debt versus equity
6. Analyze and evaluate a company’s debt-paying ability
7. Describe other types of long-term liabilities
8. Report liabilities on the balance sheet
• .
2
Learning Objective One
Explain and account for current liabilities
3
Liabilities
• Liabilities are present obligations of the entity arising from past

events, the settlement of which is expected to result in an outflow of
resources embodying economic benefits
• There are two types of liabilities on the classified Balance Sheet:

1. Current liabilities (maturity less than 1 year or within operating
cycle, if longer than 1 year)
2. Non-current liabilities (maturity more than 1 year or beyond
operating cycle, if longer than 1 year)
Maturity = 1 year or less Maturity > 1 year
Current Liabilities Non-current Liabilities
4
Current Liabilities
• Current liabilities are obligations due within one year or within the
company’s normal operating cycle if longer than a year.
• Current liabilities are of two types:
 Known amounts
– E.g., Short-term borrowings, accounts payable, accrued
liabilities, short-term notes payable, sales tax payable,
payroll liabilities, income tax payable, unearned revenues,
and current portion of long-term debt.
 Estimated amounts
– E.g., Warranties, provisions, and contingent liabilities.
5
Current Liabilities: Known Amount
Short term
Accounts payable Accrued liabilities
borrowings
Short-term notes
Sales tax payable Payroll liabilities
payable
Income taxes Unearned Current portion of

payable revenues long-term debt
6
Short Term Borrowings
• Short term borrowing are amounts owed to banks or other

lenders.
• Companies sometimes need to borrow money on a short-
term basis to cover shortfalls in cash needed run their
business.
• For example, a ski resort that earns most of its revenues
during winter, may need to temporarily borrow money to
supplement the minimal cash flow it generates from
operations during summer.
• A line of credit allows a company to access credit on an as-
needed basis up to a maximum amount set by the lender.
7
Accounts Payable
• Accounts payable are amounts owed to suppliers for

goods or services purchased on account.
 Usually, one of merchandisers’ most common
transactions is the credit purchase of inventory.
• Normally, A/Ps need to be paid within 30-60 days.
8
Short-Term Notes Payable
• Remember: we covered promissory notes (notes receivable) in
Chapter 4.
 What is recorded as notes receivable in the lender’s books

is recorded as notes payable (N/P) in the borrower’s
books.
• A note payable specifies the amount borrowed, the date by

which it must be paid, and the interest rate associated with the
borrowing.
• Short-term N/P are notes due within one year.
• Companies can issue short-term N/P to borrow cash or purchase

assets.
• On its notes payable, a company accrues interest expense at

the end of each reporting period.
9
Short-Term Notes Payable - JE
(1) Issuance of note (JE):
Date Accounts Debit Credit
Cash or Asset (+A) XXX
Note payable, short-term (+L) XXX
(2) Accrual of interest at period-end (AJE):

Interest expense (+E → -SE) XXX
Interest payable (+L) XXX
(3) Payment of note at maturity (JE):

Note payable, short-term (-L) XXX
Interest expense (+E → -SE) XXX
Interest payable (-L) XXX
Cash (-A) XXX
10
Short-Term Notes Payable - Example
• On October 1, 2017, Robertson Construction Inc.

purchased inventory for $8,000 by issuing a 6-month,
10% note payable. The fiscal year ends on December 31.
The N/P is due on March 31, 2018.
• The following sequence of entries covers the (1)
purchase of inventory, (2) accrual of interest expense,
and (3) payment of a short-term note payable and its
interest at maturity .
11
Short-Term Notes Payable – Example (cont’d)
(1) JE to record purchase of inventory using N/P on Oct.1, 2017:
Oct. 1, 2017 Inventory (+A) 8,000

Notes Payable, Short-Term (+L) 8,000
(2) AJE to accrue interest expense at year-end (Dec. 31, 2017):
Dec. 31, Interest Expense (+E  -SE) [$8K x 10% x 3/12] 200
2017 Interest Payable (+L) 200
(3) JE to record the payment of N/P and interest at maturity (March 31,
2018):
March 31, Notes Payable, Short-Term (-L) 8,000
2018 Interest Payable (-L) 200
Interest Expense (+E  -SE) [$8K x 10% x 3/12] 200
Cash [$8K + ($8K x 10% x 6/12)] 8,400
12
Sales Taxes Payable
• The federal government and most provincial governments levy taxes on
the sale of goods and services.
• Sellers add these taxes to the sales price, collect them from customers,
and then remit them to the respective governments periodically (monthly,
quarterly, annually).
• Thus, sellers act as intermediaries between the customer and the
governments.
• The sales taxes collected from customers represent liabilities for the
sellers between the date of collection and the date of remittance to the
government  Sales tax payable to the government levying the tax.
13
Sales Taxes Payable
• Canada has 3 types of sales taxes:
1. GST (Goods and Services Tax) is a value-added tax levied by the
federal government. It applies to most goods and services.
2. PST (Provincial/regional Sales Tax) is a retail tax applied to
goods and services purchased by individuals or businesses for
their own use, not for resale, with the rates varying by province or
region.
3. HST (Harmonized Sales Tax) which combines PST and GST, is
also a value-added tax.
14
Sales Taxes Payable - GST or HST Payable
• The final consumer of a GST-/HST-taxable product/service bears the
tax.
• Hence, when entities farther down the supply chain from the end
consumer pay GST or HST, they receive an input tax credit (ITC) equal
to the tax they have paid.
• These ITCs are deducted from any GST or HST collected to arrive at the
net GST or HST payable to the government.
• For example, if a company collected 10,000 in HST on its sales and paid
$8,000 in HST on goods and services it purchased, then it would end the
period with HST payable of $2,000 ($10,000 in HST collected less
$8,000 in ITCs).
• GST- or HST-taxable is always a current liability as it is payable quarterly
or monthly, depending on the payer’s volume of business.
15
Sales Taxes Payable - GST or HST Payable
Kitchen Hardware Ltd. headquartered in Alberta (GST=5%, and PST=0%)
purchases lawn rakes for $3,000 plus 5% GST for a total of $3,150.
Consequently, it sells the rake for $6,000 plus GST of $300.
The following sequence of JEs covers the:
1. purchase of the rakes
2. sale of the rakes
3. remittance of the GST payable to the federal government
16
Sales Taxes Payable – Example (cont’d)
1. JE to record purchase of inventory:
Inventory 3,000
GST Recoverable 150
Accounts Payable 3,150
2. JE to record the sale inventory:

A/R 6,300
COGS 3,000
Sales Revenue 6,000
Inventory 3,000
GST Payable 300
3. JE to record payment of GST collected less GST paid to the gov’t:

GST Payable 300
GST ITC [$300 in GST collected less $150 paid] 150
Cash 150
17
Sales Taxes Payable - Provincial Sales Tax (PST)
Payable
• PST is levied at the point of sale to the final consumer.
• Because only the final consumer pays PST, there are no ITCs
for provincial taxes (except for Quebec’s QST).
• PST payable is always a current liability as it is payable
quarterly or monthly, depending on the payer’s volume of
business.
18
Accrued Liabilities
• An accrued liability usually results from an expense that the

business has incurred but not yet paid.
• Therefore, an accrued expense creates a liability, which explains
why it is also called an accrued expense.
• For example, a business’s salary expense and salary payable
occur as employees work for the company.
• There are several categories of accrued expenses:
 Salaries and Wages Payable
 Interest Payable
 Income Taxes Payable
19
Accrued Liabilities (cont’d)
• Salaries and Wages Payable is the liability for payroll

expenses not yet paid at the end of the period. This category
includes salaries, wages, and payroll taxes withheld from
employee paychecks.
• Interest Payable is the company’s interest payable on notes

payable.
• Income Taxes Payable is the amount of income tax the

company owes.
20
Payroll Liabilities
• Salary expense is the amount of salaries and wages earned by

employees in exchange for services rendered by them to a business,
plus the cost of employers’ contribution to CPP, EI, and etc.
 Salary expense represents gross pay, while Salaries and Wages
Payable is the employees’ net (take-home) pay (refer to slide 18).
• Payroll Liabilities (Salaries and Wages Payable) are the salaries and
wages earned by employees at the end of the accounting period, but not
paid by the company until in a subsequent period.
• Employee compensation takes many different forms:
1. A salary is employee pay stated at a monthly or yearly rate.
2. A wage is employee pay stated at an hourly rate.
3. A commission is a percentage of the sales the employee has
made
4. A bonus is an amount over and above regular compensation.
21
Employee Deductions
• Employee Deductions: employees pay income tax and contribute to

several programs such as Canada Pension Plan (CPP) and Employee
Insurance (EI).
• Employers withhold these amounts from their employees’ salaries or
wages and then remit them to the Canada Revenue Agency (CRA).
 Thus, employers act as intermediaries between the employees and
CRA.
 These deductions withheld represent liabilities for the employer
between the date of collection and the date of remittance  until
these deductions are remitted, they are reported as current
liabilities.
22
Employers’ Contributions
• Employers contribute to CPP and EI based on their employees’

salaries:
 Typically, employers match the employee’s CPP remittance.
 Employers, are required by CRA to pay $1.40 for every $1.00

remitted by the employee for EI.
Employer has to contribute for the employee 1.4$

for every 1 $ that employees pays form their salary
23
Salary Expense
• Salary expense represents gross pay (that is, pay before subtractions
for taxes and other deductions). Salary expense creates several payroll
entries, expenses, and liabilities:
1. Salaries and Wages Payable is the employees’ net (take-home)
pay.
2. Employee Income Tax Payable is the employees’ income tax that
has been withheld from paycheques.
3. CPP and EI Payable are the employees’ contributions to those
two government programs that have been withheld from their
paycheques, plus the employer’s contributions to these programs.
4. CPP and EI Expense is the cost of the employer’s contribution to
these two government programs.
24
Payroll Liabilities - Example
• Salary expense represents gross pay (pay before subtractions for taxes
and other deductions such as CPP payable and EI payable).
• JE to record salary expense and employee withholdings:
Salary Expense (+E  -SE) [gross pay) 10,000
Employee Income Tax Payable (+L) 1,350
Canada Pension Plan Payable (+L) 495
Employment Insurance Payable (+L) 183
Employee Union Dues Payable (+L) 272
Salary Payable (+L) [take-home pay] 7,700
• JE to record employer’s share of CPP and EI:

CPP and Employment Insurance Expense (+E  -SE) 751
Canada Pension Plan Payable (+L) 495
Employment Insurance Payable (+L) 256
25
26
Income Taxes Payable

• Like individuals, corporations must pay taxes on their incomes.
• Income taxes payable represents the amount of income taxes due at the
end of the accounting period.
• The accounting for corporate taxes is complicated since income for
accounting purposes differs from income for tax purposes.
 Accounting income is determined based on IFRS or ASPE rules and
is used to determine income tax expense:
 While, taxable income is determined based on the federal and
provincial Income Tax Acts rules and is used to determine income tax
payable:
26
Unearned (Deferred) Revenues
• Businesses sometimes collect cash from their customers before

earning the revenue (i.e., before they provide the goods/services to
their customers).This results in a liability called unearned revenues.
Cash (+A) XXX

Unearned Revenue (+L) XXX
• Later, when the revenue (or a portion thereof) is earned:

 This is often done through the adjusting process.
Unearned Revenue (-L) XXX

Revenue (+R → +SE) XXX
27
Unearned (Deferred) Revenues - Example
• Assume that on Nov. 5, 2017 WestJet collects $1,000 for a round-

trip ticket from Vancouver to Montreal, departing Dec. 15, 2017 and
returning February 20, 2018. Fiscal year end is Dec. 31.
• JE to record cash received in advance for airfare from Vancouver
to Montreal:
Nov. 5, 2017 Cash (+A) 1,000
Deferred Revenue (+L) 1,000
• AJE to record the portion of deferred revenue earned in 2017 at the

year end:
Dec. 31, 2017 Deferred Revenue (+L) 500
Ticket Revenue (+R) [$1,000/2] 500
28
Current Portion of Long-Term Debt
• Some long-term debt must be paid in installments.
• The current portion of long-term debt is the amount of the

principal that is payable within one year from the balance
sheet date.
• At the end of each year, a company reclassifies (from long-

term debt to a current liability) the amount of its long-term
debt that must be paid next year.
29
Current Portion of Long-Term Debt - Example
• ABC Inc. received a 2-year loan for $30K on Jan. 1, 2017 with
maturity in Dec. 31, 2018.
• $15K due on Dec. 31, 2017  Maturity < 1 year (current portion
of LT Debt)
• $15K due on Dec. 31, 2018  Maturity > 1 year (long-term
liability)
Current liability $15K

Total Loan
$30K
Non-current liability $15K
30
31
Current Liabilities: Estimated Amounts
31
Current Liabilities – Estimated Amounts
• A business may know that it has a present obligation and that it is

probable it will have to settle this obligation in the future, but it
may be uncertain of the timing or amount of the liabilities.
• Common current liabilities with estimated amounts are:
1. Provisions (e.g., Warranties), and
2. Contingent liabilities (e.g., law suit).
32
Provisions
• A provision is an amount set up to cover a future liability (e.g.,

warranty expense) related to current revenues (i.e., matching
principle). It is recognized when the following conditions are met:
1. an entity has a present obligation as a result of a past
event,
2. it is probable that cash or other assets will be required to
settle the obligation, and
3. a reliable estimate can be made of the amount of the
obligation.
• However, the timing or the amount of the future liability is
uncertain.
33
Provision - Estimated Warranty Payable
• Many companies guarantee their products under warranty

agreements.
• Whatever the warranty’s life, the matching principle demands that

the company records the warranty expense in the same period
that the business records sales revenue.
• At the time of the sale, the company doesn’t know which products
are defective.
• Hence, the exact amount of warranty expense cannot be known

with certainty, so the business must estimate the warranty
expense and the related liability.
• The amount is estimated based on past experience or industry

standards.
34
Provision - Estimated Warranty Payable - JEs
• To record estimated warranty liability (i.e., to accrue warranty

expense):
Warranty Expense (+E) XXX
Estimated Warranty Payable (+L) XXX
• When actual warranty work is performed (i.e., to replace defective

products sold under warranty):
Estimated Warranty Payable (-L) XXX

Inventory (for parts used) (-A) XXX
35
Estimated Warranty Payable - example
• Assume that Black & Decker Canada Inc., which manufactures

power tools, sold 4,000 tools subject to one-year warranties this
year. Black & Decker estimates that 3% of the products it sells this
year will require replacement. It costs an average of $50 to replace
each tool. Record the warranty expense for the year:
Warranty Expense (+E) (4,000 * 3% * $50) 6,000
Estimated Warranty Payable (+L) 6,000
• If Black & Decker ends up replacing 100 defective tools with new
tools costing $4,800 in total, it would record the following:
Estimated Warranty Payable (-L) 4,800

Inventory (for parts used) (-A) 4,800
• At year-end, B&D reports estimated warranty payable of $1,200

and warranty expense of $6,000.
36
Contingent Liabilities
A Contingent liability is a potential liability that may occur,
depending on the outcome of an uncertain future event
 E.g., Lawsuit, environmental problems, tax disputes, and

etc.
 The accounting for contingent liabilities depends on:

1. The probability of the future economic sacrifice.
2. The ability to reliably estimate the amount of liability.
37
Contingent Liabilities (cont’d)
Level of certainty of the present or possible

obligation
Probable Possible Remote
(Likely)
Amount of liability No recognition
Recognize No recognition
can be estimated Disclose
liability or disclosure.
reliably contingency.
Amount of liability No recognition No recognition No recognition,
cannot be Disclose Disclose but disclose
estimated reliably contingency. contingency. contingency.
38
Mid-Chapter Summary Problem
• Carefully study the Mid-chapter summary problem on

page 386.
• Then, try to solve it on your own without looking at the
solution.
39
Explain the impact of the time value of
money
40
Present Value of Single Payment
Would you prefer $1000 today or $1000 in 3 years?
 A rational person would prefer $1000 today because, he can

invest the money so than in 3 years, he can have more.
41
Time Value of Money
$1 received today > $1 received in the future
because $1 today can be invested to generate interest revenue.
$1,000 invested In 5 years it will be

today at 10%. worth $1,610.51. In 25 years it will be
worth $10,834.71!
 Money can grow over time, because it can earn interest.

42
Time Value of Money
Time value of money: money earns interest over time, so that $1 now is
worth more than $1 in the future, because of the potential to earn interest.
Present Value (PV) is the value on a given date of a future payment or
series of future payments, discounted to reflect the time value of money.
Future Value (FV) is the amount of money that a given current investment
will be worth at a specified time in the future, assuming a certain interest
rate.
Present value Future value
Time = 0 Earns interest 1 year

Ex. $1,000 10% ($100) $1,100
Present value × (1 + interest rate) = Future value

43
Present Value
Present value: value on a future payment discounted to present

date to reflect the time value of money.
 Single amount (e.g., principal)
 Annuity (e.g., series of interest payments)
• Three inputs needed to calculate present value of an investment:

1. Amount of future payment
2. Length of time until future receipt
3. Interest rate
• The process of computing a present value is called discounting
because the present value is always less than the future value.
44
Present Value of a Single Payment
Or use PV table –
Exhibit 7.9 (p. 352)
1
PV of a Single Payment = Future Amount x
(1+i )n
Where n = number of periods and i = interest rate.
45
Present Value of a Single Payment
What is the present value of $1,000 that you will receive in 3

years? Assume that the market interest rate is 5%.
Future value
Present value (PV) =
(1 + Interest rate)n
$1,000
PV = = $863.84
(1 + 0.05)3
46
Present Value Tables – Single payment
• Another way to calculate present values is to use present-value

tables, which provides the PV of $1 (PV factor). This simplifies the
calculation:
Present value = Future payment x PV factor
• We use the junction of the number of periods and the interest rate
per period to find the relevant PV factor
• For example, if we were interested in finding the PV of a payment that
will be paid in two years with an interest rate of 6%, our PV factor of
interest is 0.890
47
Present Value Tables – Single Payment Example
What is the present value of $1,000 that you will receive in 3 years.
Assume that the market interest rate is 5%
PV (P) = P x PV factor
PV = $1,000 x 0.864 = $864
1
PV ($1,000 in 3 years) = $1,000 x = $863.84
p.352 (1 + 0.5)3
 Note, you obtain the same PV by using the equation from slide 46:
Future value
Present value (PV) =
(1 + Interest rate)n
PV = $1,000 / (1.05)3 = $864

48
Present Value of an Annuity – Illustration
PV of an Annuity = Sum of individual present values
Annuity Annuity Annuity
= + + … +
(1+i )2 (1+i )n
(1+i )1
1
1 -
(1+i )n
= Annuity x
i
Or use PV table - Exhibit

Where n = number of periods and i = interest rate. 7.10 (p. 353)
49
Present Value Tables – Annuity
• Another way to calculate present value of annuities is to use present-

value of annuity tables, which provides the PV of $1 annuity payment
(PV of annuity factor). This simplifies the calculation:
Present value of annuity = annuity payment x PV of annuity factor
• Again, we use the junction of the number of periods and the interest
rate per period to find the relevant PV of annuity factor
• For example, if we were interested in finding the PV of an annuity
payment that pays $1,000 for each of the next three years and market
interest rate is 6%, our PV factor of interest is 2.673.
Exhibit 7-10
p.353
50
Present Value Tables – Annuity
Suppose an investment promises annual cash receipts of $10,000 to be
received at the end of each of three years. Assume that the market
interest rate is 12%. What is the investment’s present value? That is,
what would you pay today to acquire the investment?
PV (annuity) = annuity payment x PV of annuity factor
= $10,000 x 2.402 = $24,020
Exhibit 7-10
p.353
51
Present Value of Money - Example
It is Jan. 1, 2015. You have just developed an electronic app that allows
individuals to view up to date financial statements of all companies on
the TSX in real time. This is quite an invention because interested
readers no longer have to wait for the annual report to view financial
statements and they can download them onto their smart-phone at any
time.
Sensing that the world will soon be taken over by an unprecedented love
for accounting information, Apple, BlackBerry and Samsung make you
an offer to purchase the invention:
• Apple offers to pay $1M on Jan 1. 2015.
• BlackBerry offers to pay $250 K on Dec. 31 of each year for the
next 5 years.
• Samsung offers to pay $1.5 M at end of 5 years (Dec. 31, 2019).
 The annual interest rate that can be earned is 5%. Which offer will you
take?
52
 BlackBerry offers to pay $250 K on Dec. 31 of each year for the
next 5 years. The annual interest rate that can be earned is 5%.
 PV of BlackBerry’s offer:
PV = $250,000 x 4.329* = $1,082,250
*from exhibit 7-10: junction of 5% and 5 periods is 4.329.
53
 Samsung offers to pay $1.5 M at end of 5 years (Dec. 31, 2019).
The annual interest rate that can be earned is 5%.
 PV of Samsung’s offer:
PV = $1,500,000 x 0.784* = $1,176,000
*from exhibit 7-9: junction of 5% and 5 periods is 0.784.
54
Offers PV of offers
Apple offers to pay $1M to be paid on Jan 1. $1,000,000
2015
BlackBerry offers to pay $250K on Dec. 31 of $1,082,250
each year for the next 5 years.
Samsung offers to pay $1.5 M at end of 5 years $1,176,000
(Dec. 31, 2019).
 Offer with the highest present value is Samsung’s.

Hence, you should take Samsung’s offer.
55
The remaining slides will be added for
Wednesday’s class
Learning Objective Two
Explain the types, features, and pricing of

bonds payable
57
Bonds payable
• Bonds payable are groups of notes issued to multiple lenders, called
bondholders.
• Bonds payable are issued to borrow large sums of money from the
public.
• Each bond is, in effect, a long-term note payable.
• Each bond has a principal amount (face value or maturity value), which
is the principal amount due at the end of its maturity (maturity date).
• Companies pay interest on the money borrowed at a stated interest

rate at set payment dates specified by the bond.
• Normally, an intermediary, such as a securities firm, facilitates the

issuance of bonds by purchasing the bonds from the issuing company
and reselling them to clients.
58
Bond Certificate
Purchasers of bonds receive a bond certificate, which specifies:
 Issuing Company Name
 Face Value (Maturity Value, Par Value, Principal) - typically stated in
units of $1,000
 Maturity Date: date at which the issuing company is obligated to pay
back the debt (face value)
 Coupon rate (Stated Interest Rate) - the rental fee on borrowed
money
 Interest Payment Dates - dates that the interest payments are due
(generally twice a year)
 Bond Date
Bond Certificate
Face Value $1,000 Coupon rate 10%
BOND PAYABLE June 30 & Dec.31
Bond Date 1/1/2017 Maturity Date 1/1/2025

59
Bonds Payable
At Bond Issuance Date

$ Bond Issue Price $
Company Investor Buying

Issuing Bonds Bonds
Bond Certificate
Periodic
Company
$ Interest Payments
$ Investor Buying
Issuing Bonds Bonds
Principal
$ Payment at End of Bond $
Term
60
Types of Bonds
• Term bonds: when all the bonds in a particular issue mature at the
same time.
• Serial bonds: when the bonds in a particular issue mature in
installments over a period of time.
 Serial bonds are like installment notes payable.
• Bonds can be secured or unsecured:
• Secured (mortgage) bonds: give the bondholder the right to take
specified assets of the issuer if the company defaults—that is, fails
to pay interest or principal.
• Unsecured bonds (debentures): are backed only by the good
faith of the borrower.
 Debentures carry a higher rate of interest than secured bonds
because debentures are riskier investments.
61
Bond Prices
• Bond prices are quoted at a percentage of their face value. For
example,
 A $1,000 bond quoted at 100 is bought or sold for $1,000,
which is 100% of its face value  issued at par (price = face
value)
 The same bond quoted at 101.5 has a market price of $1,015
(101.5% of face value = $1,000 × 1.015)  issued at a
premium (price > face value)
 A $1,000 bond quoted at 88.375 is priced at $883.75
(88.375% of face value = $1,000 × 0.88375)  issued at a
discount (price < face value)
• What determines bond prices?
62
Interest Rates and Bond Prices
• Bonds are always sold at market price, which is the amount investors are
willing to pay  market price is the bond’s present value (PV).
Bond’s PV = PV(future principal payment) + PV(future interest payments)
• Two interest rates determine the bond price:

1. Stated interest rate (coupon rate)
– Rate stated on bond certificate
– Determines amount of interest payment to bondholders
2. Market interest rate (effective interest rate)
– Rate demanded by investors for loaning money
– Varies minute to minute
• In most cases, when a company issues a bond, the two interest rates
often differ because of the time that passes between when a bond issue is
established and when it is actually sold.
63
Bond Price Calculation
Bond Price = PV (Face Value) + PV of Interest Payments
1. PV of future principal payment (single payment)
1
PV of a Face Value = Face Value x
(1+i )n
Or, get the value from PV

Table Exhibit 7-9 (page 352)
2. PV of future interest payments [face value x stated interest rate] (annuity)
1
1 -
(1+i )n
PV of an Annuity = Annuity x
i
i = Market Interest Rate Or, get the value from PV of

n = Number of Periods annuity table Exhibit 7-10
(page 353) 64
Bond Price Calculation: Discount - Example
Suppose Air Canada issued $100,000 of 9%, five-year bonds. The
coupon interest rate is 9% annually. The bond pays interest semi-
annually. At issuance, the market interest rate is assumed to be 10%
annually.
Bond Price = PV (Face Value) + PV (Interest Payments)
 Since the bond pays interest semi-annually, we must calculate the PV
using the semi-annual periods.
• Number of periods = 5 years x 6/12 = 10 periods
• Coupon semi-annual interest rate = 9% annual x 6/12 = 4.5%
• Market semi-annual interest rate = 10% annual x 6/12 = 5%
65
Bond Price Calculation: Discount Example (cont’d)

annually.
 PV (face value) = $100,000 x 0.614 = $61,400
Exhibit 7-9
Principal payment (i=5%, n=10)
Semi-annual
Exhibit 7-10
interest payment
(i=5%, n=10)
 PV (interest payments) = $100,000 x 0.045 x 7.722 = $34, 749

 Bond price = $61,400 + $34,749 = $96,149
66
Bond Price Calculation: Premium - Example
annually.
 Since the bond pays interest semi-annually, we must calculate the PV
using the semi-annual periods.
• Number of periods = 5 years x 6/12 = 10 periods
• Coupon semi-annual interest rate = 9% annual x 6/12= 4.5%
• Market semi-annual interest rate = 8% annual x 6/12 = 4%
67
Bond Price Calculation: Premium – Example (cont’d)

annually.
 PV (face value) = $100,000 x 0.676 = $67,600
Exhibit 7-9
Principal payment (i=4%, n=10)
Semi-annual
Exhibit 7-10
interest payment
(i=4%, n=10)
 PV (interest payments) = $100,000 x 0.045 x 8.111 = $36,500

 Bond price = $67,600 + $36,500 = $104,100
68
Bond Issue Prices (cont’d)
Bonds can be issued at:
1. Par: Issue Price = Face Value  When coupon rate = market rate
2. Discount: Issue Price < Face Value  When coupon rate < market rate
3. Premium: Issue Price > Face Value  When coupon rate > market rate
>
=
<
On the maturity date, a bond’s market value exactly equals its face value
69
Learning Objective Three
Account for bonds payable
70
Case 1: Issuing Bonds Payable at Par
• The JE to record bonds sold at par (bond price = bond face value):
Date of bond Cash (+A) XXX
issuance Bonds Payable (+L) XXX
• Assume it is a 3-year bond that pays interest semi-annually. At each semi-annual

interest payment date, interest expense is recorded.
 When interest payment does not have any accrued amount related to it:
Date of interest Interest Expense (+E-SE) XXX
payment Cash (-A) XXX
 AJE at year-end to accrue interest expense because interest is paid after

books are closed.
Fiscal year- Interest Expense (+E-SE) XXX
end Interest Payable (+L) XXX
• At maturity, the issuing company pays off the bonds:

Date of bond Bond Payable (-L) XXX
maturity Cash (-A) XXX 71
Case 1: Issuing Bonds Payable at Par - Example
 Assume a corporation issues $50,000, 6%, five-year bonds at par on Jan. 1, 2017.
The bond pays interest semi-annually.
Jan. 1, 2017 Cash (+A) 50,000
Bonds Payable (+L) 50,000
 To determine the cash interest payment, multiply the face value of the bond by the
coupon rate and then multiply by the number of months in each period divided total
# months in year (i.e., 12) ($50,000 × 0.06 x 6/12 = $1,500)
July 1, 2017 Interest Expense (+E-SE) 1,500
Cash (-A) 1,500
 AJE at year-end (Dec. 31, 2017) to accrue interest expense:
Dec. 31, 2017 Interest Expense (+E-SE) 1,500

Interest Payable (+L) 1,500
 At maturity (Jan. 1, 2022) company pays off the bonds:

Jan. 1, 2022 Bond Payable (-L) 50,000
Cash (-A) 50,000
72
Case 2: Issuing Bonds Payable at a Discount
• The JE to record bonds sold at a discount (bond price < bond face value):
Jan. 1, 2017 Cash (+A) XXX

Discount on Bonds Payable (+XL) XXX
Bonds Payable (+L) XXX
• Discount on Bonds Payable is a contra account to Bonds Payable

 Hence, it decreases the net carrying amount of Bonds Payable
Net carrying amount of Bonds Payable

= Bonds Payable - Discount on Bonds Payable
• We will cover the JE to record interest expense and AJE to accrue interest
expense at year-end for bonds issued at a discount in Objective 4.
73
Case 2: Issuing Bonds Payable at a Discount -
Example
• Suppose a corporation issued $100,000 of 9%, five-year bonds
when the market interest rate is 10%.
• The market price of the bonds drops, and the corporation
receives $96,149 at issuance.
• The entry to record the issuance includes:
• debit to Cash for the price received
• debit to Discount on Bonds Payable for the difference
between face value and the issue price
• credit to Bonds Payable for the face value.
Jan. 1, 2017 Cash (+A) 96,149

Discount on Bonds Payable (+XL) 3,851
74
Case 2: Issuing Bonds Payable at a Discount –
Example (cont’d)
• Discount on bonds payable is a contra account to Bonds Payable:

= Bonds Payable - Discount on Bonds Payable
• Thus, the corporation’s liability is $96,149, which is the amount the

company borrowed. After the bonds are issued, the accounts would
appear on the balance sheet as shown below.
Balance Sheet Presentation

Balance Sheet
Long-term liabilities:
Bonds payable $100,000
Less: Discount on bonds payable (3,851) $96,149
Net carrying amount (book

value) of Bonds Payable =
$100,000 - $3,851
75
Case 3: Issuing Bonds Payable at a Premium
• The JE to record bonds sold at a Premium (bond price > bond face value):
Jan. 1, Cash (+A) XXX
2017 Bonds Payable (+L) XXX
Premium on Bonds Payable (+L) XXX
• Premium on Bonds Payable is an adjunct account to Bonds Payable. An

adjunct account contrasts with the contra account; it is the opposite.
 Hence, the premium increases the issuing company’s Bond Payable.

= Bonds Payable + Premium on Bonds Payable
• We will cover the JE to record interest expense and AJE to accrue interest
expense at year-end for bonds issued at a premium in Objective 4.
76
Case 3: Issuing Bonds Payable at a Premium -
Example
• Suppose a corporation issued $100,000 of 9%, five-year bonds when
the market interest rate is 8%.
• The market price of the bonds increases, and the corporation receives
$104,100 at issuance.
• The entry to record the issuance includes:

• debit to Cash for the price received
• credit to Premium on Bonds Payable for the difference
between face value and the issue price
• credit to Bonds Payable for the face value.
Jan. 1, 2017 Cash (+A) 104,100

Premium on Bonds Payable (+L) 4,100
77
Case 3: Issuing Bonds Payable at a Premium – Example
(cont’d)
• Premium on bonds payable is an adjunct account to Bonds payable.

= Bonds Payable + Premium on Bonds Payable
• Thus, the corporation’s liability is $104,100, which is the amount the

company borrowed. After the bonds are issued, the accounts would
appear on the balance sheet as shown below.
Balance Sheet Presentation
Balance Sheet
Add: Premium on bonds payable 4,100 $104,100
Net carrying amount (book

value) of Bonds Payable =
$100,000 + $4,100
78
Learning Objective Four
Calculate and account for interest

expense on bonds payable
79
Discounts and Premiums
• What happens to the balance of the discount account and premium
account over the life of the bond issue (i.e., from the issuance date until
maturity)?
 They are amortized
o In the case of discounts: the discount is allocated to interest
expense through amortization each period over the term of the
bond  the discount on the bonds increases the bonds’ interest
expense each period over the term of the bonds.
o In the case of premiums: the premium is allocated to the interest
expense through amortization each period over the term of the
bond  the premium on the bonds decreases the bonds’ interest
expense each period over the term of the bonds.
o As the discount and premium are amortized, they approach a
balance of zero and therefore, at maturity the carrying amount of
Bonds payable will always be equal to the face value.
80
Bond Amortization Methods
• There are two methods for bond amortization:

1. Effective Interest Rate method:
 Amortizes a bond discount or premium based on the market
interest rate at the issuance date and the carrying amount
of the bond.
2. Straight-line Amortization method:
 Amortizes a bond discount or premium by allocating an
equal amount to each interest period.
 IFRS do not allow public companies to use this method.
 We will focus on the effective interest rate method, which is the

method permitted under IFRS.
81
Interest Payment vs. Interest Expense
• Interest Payment: interest payment amount is fixed by the bond

contract and therefore remains the same over the life of the bonds.
• Interest Expense using the EIR method:
 For bonds issued at a discount: interest expense increases as
the bonds reach maturity (through amortization using the effect
interest rate method)
 For bonds issued at a premium: interest expense decreases as
the bonds reach maturity (through amortization using the effect
interest rate method)
 For bonds issued at par: interest expense = interest payment
and therefore, remains the same over the life of the bond.
82
Effective Interest Rate (EIR) Method
Effective Interest Rate method for bonds paying interest annually:
Bond Carrying Market Interest

Annual Interest Expense = Amount (BV) at the X Rate at the
Beg. of each Period Issuance Date
Effective Interest Rate method for bonds paying interest semi-annually:
Bond Carrying Market Interest

Semi-annual Interest Expense = Amount (BV) at the X Rate at the X 6 / 12
Beg. of each Period Issuance Date
• As the carrying value changes from period to period, the interest expense
also changes.
• However, interest payment remains the same over the life of the bond
and is calculated as follows:
Annual Interest Payment = Face Value X Coupon Rate
Semi-annual Interest Payment = Face Value X Coupon Rate X 6 / 12
83
Bond Amortization Table – Effective Interest Rate
Method
Amortization table for a Bond Discount with semi-annual interest payment:
Interest Interest Interest Bond Bond Discount Bond Carrying
payment Payment Expense Discount Balance Amount
date Amortization
A B C (B-A) D (Beg.D – C) E (Face value - D)
Coupon Beg. CV Bonds Interest Beg. Bond Face value - Bond
interest Payable x Expense – Discount Balance Discount Balance
rate x face market interest Interest – Bond Discount
value rate Payment Amortization
Amortization table for a Bond Premium with semi-annual interest payment:

Interest Interest Interest Bond Bond Premium Bond Carrying
payment Payment Expense Premium Balance Amount
date Amortization
A B C (A-B) D (Beg.D – C) E (Face value + D)
Coupon Beg. CV Bonds Interest Beg. Bond Face value + Bond
interest Payable x Payment – Premium Balance Premium Balance
rate x face market interest Interest – Bond Premium
value rate Expense Amortization
84
Effective Interest Rate Method - Bond Discount
Example
• Case 2 example cont’d: Suppose on January 1, 2017, a corporation issued
$100,000 of 9%, five-year bonds when the market interest rate is 10%.
Issue Date January 1, 2017
Face value $100,000
Stated interest rate 9%
Interest payments Semi-annual
Maturity date January 1, 2022
Market interest rate 10%
Issue price $96,149 (see slide 65-66)
• Calculate interest expense based on the Effective Interest Rate method.

 It is helpful to set up an amortization table for bonds showing the
interest payments, interest expense, discount amortization, discount
balance, and the bond carrying amount for each interest payment
date.
85
Example (cont’d)
Amortization table
A B C D E
Bond carrying
Discount Discount
Interest payment Interest expense amount
Date amortization balance
($100K X 4.5%) (Beg. period BV X 5%) (Face value -
(B-A) (D-C)
Discount balance)
Jan 1, 2017 $3,851 $96,149

($100,000-$3,851)
-
Jul 1, 2017 $4,500 < $4,807 $307 = 3,544 96,456
($100,000-$3,544)
-
Jan 1, 2018 $4,500 < 4,823 323 = 3,221 96,779
($100,000-$3,221)
Jan 1, 2022 $4.500 < 4,961 461 0 100,000
Due to space constraints only the first two and last interest payment dates are
shown
At maturity: Book Value = Face Value
86
Interest Expense on Bonds Payable Issued at a
Discount
• This graph depicts the bond amortization table on the previous slide.
• The interest payment remains constant, while the interest expense
increases over the bond terms. Also, interest expense is always greater
than the interest payment amount.
• The space between the two lines represents the discount amortization.
Discount
amortization
87
Amortizing Bonds Payable Issued at a Discount
This graph shows how the bond carrying amount begins at the bond
price and increases each period until it equals face value at maturity.
88
Example (cont’d)
• Journal entries for each interest payment:
 Note: All the amounts can be located on the amortization table.
Discount on Bonds Payable (-XL) 307
Cash (-A) 4,500
Dec. 31, Interest Expense (+E-SE) 4,823

2017 Discount on Bonds Payable (-XL) 323
• The bonds are shown at their carrying amount on the December 31,
2017 balance sheet:
Balance Sheet
Less: Discount on bonds payable (3,221) $96,779
89
Effective Interest Rate Method – Bond Premium
Example
• Case 3 example cont’d: Suppose on January 1, 2017, a corporation issued
$100,000 of 9%, five-year bonds when the market interest rate is 8%.

Face value $100,000
Issue price $104,100 (see slide 67-68)
• Calculate interest expense based on the Effective Interest Rate method.
 It is helpful to set up an amortization table for bonds showing the
interest payments, interest expense, premium amortization, premium
balance, and the bond carrying amount for each interest payment
date.
90
Effective Interest Rate Method - Bond Premium
Example (cont’d)
A B C D E
Interest Interest
Premium Premium
payment expense Bond carrying amount
Date amortization balance
($100K X (Beg. period (Beg. period BV - C)
(A-B) (D-C)
4.5%) BV X 4%)
Jan 1, 2017 $4,100 $104,100

- ($100,000 + $4,100)
Jul 1,2017 $4,500 =
> $4,164 $336 3,764 103,764
- ($100,000 + $3,764)
Jan 1,2018 $4,500 > 4,151 349 = 3,415 103,415
($100,000 + $3,415)
Jan 1,2022 $4,500 > 3,955 545 0 100,000
Due to space constraints only the first two and last interest payment dates are shown
At maturity: Book Value = Face Value
91
Interest Expense on Bonds Payable Issued at a
Premium
• This graph depicts the bond amortization table on the previous slide.
• The interest payment remains constant, while the interest expense
decreases over the bond terms. Also, interest expense is also smaller
than the interest payment amount.
• The space between the two lines represents the premium amortization.
Premium
amortization
92
Amortizing bonds payable issued at a premium
This graph shows how the bond carrying amount begins at the bond
price and decreases each period until it equals face value at maturity.
93
Effective Interest Rate Method - Bond Premium Example
(cont’d)
• The journal entry made each interest payment:
 Note: All the amounts can be located on the amortization table.
Premium on Bonds Payable (-L) 336
Cash (-A) 4,500
Dec. 31, Interest Expense (+E-SE) 4,151

2017 Premium on Bonds Payable (-L) 349
• The bonds are shown at their carrying amount. The balances as of

December 31, 2017 on the balance sheet:
Balance Sheet
Add: Premium on bonds payable 3,415 $103,415
94
Summary of the Three Cases
Case 1: Bonds bonds issued at par:
 Periodic interest payment is constant over the life of the bonds
 Periodic interest expense is constant over the life of the bonds
 Periodic interest expense = periodic interest payment
Case 2: Bonds issued at a discount:

 Periodic interest expense increases over the life of the bonds
 Periodic interest expense > periodic interest payment
Case 3: Bonds issued at a premium:

 Periodic interest expense decreases over the life of the bonds
 Periodic interest expense < periodic interest payment
95
Partial-Period Interest Payments
• Companies don’t always issue bonds at the beg. or the end of their
accounting year. They issue bonds when market conditions are most
favorable.
• When this occurs, an year-end accrual of interest must be made.
• To illustrate, assume a company issued $100,000, 10-year 8% bonds on
August 31, at a price of $96,000 when the market rate was 9%. The bonds
pay semi-annual interest on February 28 and August 31 each year. On
December 31, four months’ of interest must be accrued.
Dec. 31 Interest Expense 2,880

Discount on Bonds Payable 213
Interest Payable 2,667
$96,000 carrying amount × 9% market rate × 4/12

$100,000 face value × 8% stated rate × 4/12
96
Effective Interest Rate Method – Example 1
• Suppose on January 1, 2015, a corporation issued $100,000 of 9%, two-
year bonds when the market interest rate is 10%. Assume a Dec. 31 fiscal
year-end. The following are the terms of the bond:
Face value $100,000
• Record the JEs related to:

i. The issuance of the bonds payable
ii. Each interest payment (JE) and interest accruals at year-end (AJE).
iii. Repayment of bond at maturity.
97
Effective Interest Rate Method – Example 1 (cont’d)
• Price of Bond:
• PV (Bond) = PV(face value) + PV(interest payments)
= ($100,000 * 0.82270) + ($100,000*0.045) * 3.54595
= $82,270 + $15,957 Interest payment [1- (1/(1.05)4) ]/0.05.
Note that Exhibit 7-
= $98,227 1/(1.05)4 . Note that
10 (i=5%, n=4) can
Exhibit 7-9 (i=5%,
be used, but factor
n=4) can be used, but
is rounded to third
factor is rounded to
Issuance of Bond: decimal place.
third decimal place.
Jan. 1, Cash (+A) 98,227

2015 Discount on Bonds Payable (+XL) 1,773
98
Interest Interest Discount Discount
Date payment expense amortization balance Bond CV
Jan. 1, 2015 1,773 98,227
July 1, 2015 4,500 4,911 411 1,362 98,638
Jan. 1, 2016 4,500 4,932 432 930 99,070
July 1, 2016 4,500 4,954 454 476 99,524
Jan. 1, 2017 4,500 4,976 476 - 100,000
July 1, Interest Expense (+E, -SE) 4,911

Cash (-A) 4,500
Dec. 31, Interest Expense (+E, -SE) 4,932

Jan. 1, Interest Payable (-L) 4,500

2016 Cash (-A) 4,500
99
Jan. 1, 2015 1,773 98,227
July 1, 2015 4,500 4,911 411 1,362 98,638
Jan. 1, 2016 4,500 4,932 432 930 99,070
July 1, 2016 4,500 4,954 454 476 99,524
Jan. 1, 2017 4,500 4,976 476 - 100,000
July 1, Interest Expense (+E, -SE) 4,954

Cash (-A) 4,500
Dec. 31, Interest Expense (+E, -SE) 4,976

100
Repayment of Bonds Payable at Maturity:

2017 Cash (-A) 4,500
Jan. 1, Bonds Payable (-L) 100,000

2017 Cash (-A) 100,000
OR
2017 Bonds Payable (-L) 100,000
Cash (-A) 104,500
101
Effective Interest Rate Method – Example 2
• Suppose on October 1, 2015, a corporation issued $100,000 of 9%, two-
year bonds when the market interest rate is 8%. The corporation’s year-
end is December 31. The following are the terms of the bond:
Issue Date October 1, 2015
Face value $100,000
Interest payments Annual annu
divide
Maturity date October 1, 2017
• Record the JEs related to:

i. The issuance of the bonds payable
ii. Each interest payment (JE) and interest accruals at year-end (AJE).
iii. Repayment of bond at maturity.
102
• Price of Bond:
• PV (Bond) = PV(face value) + PV(interest payments)
= ($100,000 * 0.85734) + ($100,000*0.09) * 1.78326
= $85,734 + $16,049 Interest payment [1- (1/(1.08)2) ]/0.08.
Note that Exhibit 7-
= $101,783 1/(1.08)2 . Note that
10 (i=8%, n=2) can
Exhibit 7-9 (i=8%,
be used, but factor
n=2) can be used, but
is rounded to third
factor is rounded to
Issuance of Bond: decimal place.
third decimal place.
Oct. 1, Cash (+A) 101,783

2015 Premium on Bonds Payable (+L) 1,783
103
Oct. 1, 2015 1,783 101,783
Oct. 1, 2016 9,000 8,143 857 926 100,926
Oct. 1, 2017 9,000 8,074 926 - 100,000
Dec. 31, Interest Expense (+E, -SE) ($8,143 x 2,035.75

2015 3/12)
Premium on Bonds Payable (-L) 214.25
Interest Payable (+L) ($9,000 x 2,250
3/12)
Oct. 1, Interest Payable (-L) 2,250

2016 Interest expense ($8,143 x 9/12) (+E) 6,107.25
Cash (-A) 9,000
104
Oct. 1, 2015 1,783 101,783
Oct. 1, 2016 9,000 8,143 857 926 100,926
Oct. 1, 2017 9,000 8,074 926 - 100,000
Dec. 31, Interest Expense (+E, -SE) ($8,074 x 2,018.50

2016 3/12)
Interest Payable (+L) ($9,000 x 2,250
3/12)
105
Repayment of Bonds Payable at Maturity:
Oct. 1, Interest Payable (-L) 2,250

2017 also
Interest expense ($8,074 x 9/12) (+E) 6.055.50
pay
Premium on Bonds Payable (-L) 694.50 acc
Cash (-A) 9,000
Oct. 1, Bonds Payable (-L) 100,000

2017 Cash (-A) 100,000
106
Straight-Line Method
• ASPE permits a less precise, but simpler, way to amortize bond
discount or premium.
• The straight-line amortization method divides a bond discount (or
premium) into equal periodic amounts over the bond’s term.
• The amount of interest expense is the same for each interest period.
• IFRS does not allow the straight-line method.
Discount or Premium
Amortization =
# of Interest Payments over the Bond’s Term
Interest Expense = Interest Payment + Discount Amortization

OR
= Interest Payment – Premium Amortization
107
Learning Objective Five
Explain the advantages and

disadvantages of financing with debt
versus equity
108
Financing Operations
• Managers must decide how to get the money needed to fund

business activities (e.g., acquisitions, expansions, etc.)
• There are three main ways to finance business activities:
1. Use excess cash not needed for operating activities (retained
earnings)
2. Raise capital by issuing shares
3. Borrow money using loans, bonds, or notes
109
Ways to Financing Operations –Issuing Shares
Versus Debt
Issuing Shares Issuing Debt

Dividends are optional. More flexible Interest and repayment of principal are
cash outflow. required. Less flexibility in cash
outflow.
Dividends are not an expense; not Interest is an expense; tax-deductible.
tax-deductible.
No increase in liabilities. Increases liabilities
No covenant constraints. Debt covenant constraints.
Dilutes control and EPS of existing Does not dilute control or EPS of
shareholders existing shareholders
110
Earnings per Share
• Earnings per share (EPS) is the amount of a company’s net income

earned by each share of its shares.
• Useful for evaluating earnings performance and assessing impact
of various financing options on earnings.
111
Earnings per Share - Example
Suppose a company needs $500,000 for expansion. Assume it has net
income of $300,000 and 100,000 common shares outstanding. Management
is considering two financing plans: (1) Plan 1 is to issue $500,000 of 6%
bonds payable, and (2) plan 2 is to issue 50,000 shares of common shares for
$500,000. Management believes the new cash can be invested in operations
to earn income of $200,000 before interest and taxes.
Plan 1 Plan 2
Borrow $500,000 6% Issue $500,000 of shares
Net income before expansion $300,000 $300,000
Expected project income before
interest & taxes $200,000 $200,000
Interest expense ($500,000 x 6%) (30,000) 0
Income before income taxes $170,000 $200,000
Income taxes (40%) (68,000) (80,000)
Expected project net income 102,000 120,000
Total net income 402,000 420,000
Common shares 100,000 150,000
Earnings per share $4.02 $2.80
112
Earnings per Share – Example (cont’d)
Plan 1 Plan 2
Borrow $500,000 6% Issue $500,000 of shares
Net income before expansion $300,000 $300,000
Expected project income before
interest & taxes $200,000 $200,000
Interest expense (30,000) 0
Income before income taxes $170,000 $200,000
Income taxes (40%) (68,000) (80,000)
Expected project net income 102,000 120,000
Total net income 402,000 420,000
Common shares 100,000 150,000
Earnings per share $4.02 $2.80
• The company’s EPS amount is higher if the company borrows by issuing bonds, but
the total net income is higher if the company issues shares.
• Sometimes, the interest expense may be high enough to eliminate net income from
the project.
113
Learning Objective Six
Analyze and evaluate a company’s debt-

paying ability
114
Accounts Payable Turnover
• The accounts payable turnover measures the number of times a year a

company is able to pay its accounts payable.
• Once the turnover is computed, it is usually expressed in number of days,
or days payable outstanding (DPO) by dividing the turnover into 365.
• Varies across industries because different industries have different
business models and standard business practices.
• Generally, a high turnover ratio (short period in days) is better than a low
turnover ratio.
Cost of goods sold

A/P turnover (T/O) =
Average A/P
Days payable 365

=
outstanding A/P turnover
115
The Leverage Ratio
• Leverage ratio (equity multiplier) shows a company’s total assets

per dollar of shareholders' equity.
• A leverage ratio of 1.0 mean a company has no debt, because total
assets would equal total shareholders' equity. However, this is very
rare; most companies have liabilities. Hence, most companies will
have leverage ratios greater than 1.0.
• The lower the leverage ratio, the lower the debt.
Total assets
Leverage ratio =
Shareholders’ Equity
116
Times Interest Earned
• This ratio measures the number of times that operating income can
cover interest expense.
• A high times-interest-earned ratio indicates ease in paying interest
expense; a low value suggests difficulty.
• Operating income = earnings BEFORE interest and taxes
Operating income
Times Interest- Net Earnings - Interest Expense - Income Tax Expense

=
Earned Ratio Interest Expense
117
Learning Objective Seven
Describe other types of long-term liabilities
118
Term Loans
• Like bonds, term loans are used to borrow a fixed amount of money
that is repaid over several years at a specified interest rate.
• Unlike bonds, term loans are typically arranged with a single lender.
• Often secured by certain assets of the borrower. If secured by real

property, such as land and buildings → called mortgages.
• Like other forms of long-term debt, term loans are split between their
current and long-term portions on the balance sheet.
• The terms of the loans (e.g., principle payments and etc.) are
disclosed in the notes to the financial statements.
119
Leases
• A lease is a rental agreement in which the renter (lessee) agrees to
make rent payments to the owner (lessor) in exchange for the use
of an asset.
• Lease agreement allows the lessee to acquire the use of a needed
asset without having to make the large up-front payment that
purchases require.
• Accountants distinguish between two types of leases:
1. Operating leases, and
2. Capital (Financing) leases.
120
Capital (Financing) vs. Operating Leases
• IFRS and ASPE definitions:

 Capital (financing) lease: transfers to the lessee
substantially all the risks and rewards incidental to the
ownership of an asset, even though formal legal title of the
asset may remain with the lessor.
 Operating lease: substantially all the risks and rewards of
ownership remain with the lessor.
 Difference : who has the reward and risk
121
Lease Liabilities
CAPITAL (FINANCING)
OPERATING LEASES LEASES
• Lessee has right to use the • Lessee has right to use the
asset. asset,
BUT AND
• Lessor retains risks and • Lessee assumes risks and
rewards of ownership. rewards of ownership.
• Lessee records lease payment
• Lessee capitalizes the leased
as Rent Expense. Does not
asset and records a liability.
record an asset or a liability.
Operating Lease Capital Lease
Lessor retains substantially Lessee assumes substantially
all the risk and reward of all the risk and reward of
asset asset
122
Accounting for Lease Liabilities
• Under an operating lease, the lessee expenses the operating lease

payments as they come due (Debit to rent expense).
 The lessee discloses at least the next 5 years of operating lease
commitments in the notes to the financial statements.
• Under a capital (financing) lease, the lessee records the leased property
as an asset, and records a liability that reflects the future payments to be
made according to the terms of the lease.
• Because financing leases result in recording of assets and liabilities on
the balance sheet, it can affect some important financial ratios.
 The detailed accounting for finance leases will be covered in an

intermediate accounting course.
123
Capital Lease Criteria
• A lease is considered as Capital Lease if it meets all of the following

criteria:
 The lease term is 75% or more of the asset’s expected

economic life.
 Ownership of the asset is transferred to the lessee at the end
of the lease term.
 The lease contract permits the lessee to purchase the asset at a
price that is lower than its fair market value.
 The PV of the lease payments is 90% or more of the fair
market value of the asset when the lease is signed.
124
Post-Employment Benefits
• Special type of employee benefits that do not become payable until

after a person has completed employment at a company. Examples
include:
– Pension benefits
– Medical and dental insurance
– Prescription drug benefits
 The accounting for post-employment benefits will be covered in an

intermediate accounting course.
 Post-Employment Benefits is a long term liability 125

Learning Objective Eight
Report liabilities on the balance sheet
126
WestJet
Consolidated Balance Sheet (Partial, Adapted)
As at September 30, 2015
(amounts in thousands)
Current liabilities:
Accounts payable and accrued liabilities $ 546
Advance ticket sales 625
Deferred Rewards program 114
Nonrefundable guest credits 37
Current portion of maintenance provisions 70
Current portion of long-term debt 150
Total current liabilities 1,542
Non-current liabilities:
Maintenance provisions 233
Long-term debt 1,048
Other liabilities 17
Deferred income tax 315
3,155
127
8. LONG-TERM DEBT (Partial, Adapted)
Term loan — purchased aircraft $ 249,286
Term loan — purchased aircraft 203,106
Term loan — purchased aircraft 347,649
Senior unsecured notes 397,919
1,197,960
Current portion (150,264)
$ 1,047,696
14. COMMITMENTS (Partial, Adapted)

(b) Leases and contractual commitments
The Corporation has entered into operating leases and commitments for aircraft,
land, buildings, equipment, computer hardware, software licences and inflight
entertainment.
As at September 30, 2015, the future payments under these commitments are
as follows:
Within 1 year $ 313,695
1–5 years 646,528
Over 5 years 136,513
$ 1,096,736
128

Ch.8 - Liabilities - MH

Caricato da

Informazioni sul documento

Titolo originale

Copyright

Formati disponibili

Condividi questo documento

Condividi o incorpora il documento

Opzioni di condivisione

Hai trovato utile questo documento?

Questo contenuto è inappropriato?

Copyright:

Formati disponibili

Ch.8 - Liabilities - MH

Caricato da

Copyright:

Formati disponibili

Chapter 8

1. Explain and account for current liabilities

Explain and account for current liabilities

• Liabilities are present obligations of the entity arising from past

• There are two types of liabilities on the classified Balance Sheet:

Current Liabilities Non-current Liabilities

Income taxes Unearned Current portion of

• Short term borrowing are amounts owed to banks or other

• Accounts payable are amounts owed to suppliers for

 What is recorded as notes receivable in the lender’s books

• A note payable specifies the amount borrowed, the date by

• Short-term N/P are notes due within one year.

• Companies can issue short-term N/P to borrow cash or purchase

• On its notes payable, a company accrues interest expense at

(2) Accrual of interest at period-end (AJE):

(3) Payment of note at maturity (JE):

• On October 1, 2017, Robertson Construction Inc.

Oct. 1, 2017 Inventory (+A) 8,000

(2) AJE to accrue interest expense at year-end (Dec. 31, 2017):

2. JE to record the sale inventory:

3. JE to record payment of GST collected less GST paid to the gov’t:

• An accrued liability usually results from an expense that the

• Salaries and Wages Payable is the liability for payroll

• Interest Payable is the company’s interest payable on notes

• Income Taxes Payable is the amount of income tax the

• Salary expense is the amount of salaries and wages earned by

• Employee Deductions: employees pay income tax and contribute to

• Employers contribute to CPP and EI based on their employees’

 Typically, employers match the employee’s CPP remittance.

 Employers, are required by CRA to pay $1.40 for every $1.00

Employer has to contribute for the employee 1.4$

• JE to record employer’s share of CPP and EI:

Income Taxes Payable

• Businesses sometimes collect cash from their customers before

Cash (+A) XXX

• Later, when the revenue (or a portion thereof) is earned:

Unearned Revenue (-L) XXX

• Assume that on Nov. 5, 2017 WestJet collects $1,000 for a round-

• AJE to record the portion of deferred revenue earned in 2017 at the

• Some long-term debt must be paid in installments.

• The current portion of long-term debt is the amount of the

• At the end of each year, a company reclassifies (from long-

Current liability $15K

Non-current liability $15K

Current Liabilities: Estimated Amounts

• A business may know that it has a present obligation and that it is

• Common current liabilities with estimated amounts are:

1. Provisions (e.g., Warranties), and

2. Contingent liabilities (e.g., law suit).

• A provision is an amount set up to cover a future liability (e.g.,

• Many companies guarantee their products under warranty

• Whatever the warranty’s life, the matching principle demands that

• Hence, the exact amount of warranty expense cannot be known

• The amount is estimated based on past experience or industry

• To record estimated warranty liability (i.e., to accrue warranty

• When actual warranty work is performed (i.e., to replace defective

Estimated Warranty Payable (-L) XXX

• Assume that Black & Decker Canada Inc., which manufactures

Estimated Warranty Payable (-L) 4,800

• At year-end, B&D reports estimated warranty payable of $1,200

 E.g., Lawsuit, environmental problems, tax disputes, and

 The accounting for contingent liabilities depends on:

Level of certainty of the present or possible