Exam 3 Outline
Chapter 8 –Short term Liabilities
What is a short term/current liability?
oLiability that is due within the year
Unearned Revenue- When a customer prepays for a product or service
oRecord journal entry when customer prepays and
DR Cash $XX
CR Unearned Revenue $XX
oWhen you provide good/service to customer.
DR Unearned Revenue $XX
CR Revenue $XX
Sales Tax Payable –
oYou sell an item for $10 + 9% sales tax
DR Cash $10.90
CR Revenue $10
CR Sales Tax Payable $0.90
oRecord journal entry when customer purchases and
DR Cash $10.90
CR Sales Tax Payable $0.90
CR Revenue $10
oWhen pay the taxing authority
DR Sales Tax Payable $0.90
CR Cash $0.90
Payroll Taxes
oYou pay an employee $10,000, deduct $1,000 in federal income tax, $500 in state
income tax and 6.2% in FICA-Social Security and 1.45% in FICA –Medicare. Record the
journal entry.
DR Wages Expense $10,000
CR Federal Income Tax Payable $1,000
CR State Income Tax Payable $500
CR FICA Medicare payable $620 (10,000*6.2%)
CR FICA Social Security payable $145 (10,000*1.45%)
CR Cash $7,735
Contingent Liabilities-
oWhat is a contingent liability?
An existing situation that may potentially result in a loss that will be resolved if
certain future event occurs
Or a liability/expense that is dependent on some future event.
Warranties
oYou provide a warranty and estimate you’ll pay $100k to fix products under warranty.
oRecord warranty expense
DR Warranty Expense $100k
CR Warranty Payable $100k
oYou spend $98k to fix products under warranty
oRecord payment of warranty costs.
DR Warranty Payable $98k
CR Cash $98k
Notes Payable-Short term
oYour company borrows $10,000 for 7 months @ 5% Interest on Nov. 1, 2019
oJournal entry to record loan
DR Cash $10,000
CR Notes Payable $10,000
oDetermine interest expense
Accrue interest, record journal entry on Dec. 31st, 2019
Interest Expense 2019= $10,000*0.05*2/12= $83.33
DR Interest Expense $83.33
CR Interest Payable $83.33
Determine Interest expense when loan matures on May 31st, 2020
Record journal entry when loan matures
DR Notes Payable $10,000
DR Interest Payable $83.33
DR Interest Expense $208.33 (10,000*0.05*5/12)
oCR Cash $10,291.66
Chapter 9- Long term Liabilities
Bonds Payable-what is a bond?
oWhat are term bonds vs serial bonds?
Term Bonds: Bonds issued on the same date and mature on the same date
Serial Bonds: Bonds issued on the same date but mature at different dates
oFace Value, Stated rate/Coupon rate vs market rate/yield
Face Value is on the bond
Stated Rate/Coupon Rate: Rate a company uses to determine interest payment
Market Rate/Yield Rate: What the market demands the company pays in interest
o$1,000 bonds with stated rate of 4% and a yield of 5%
oAssume Interest is paid yearly. How much are interest payments?
$1,000 * 4% = $40 if paid annually
oIf Interest is paid semiannually?
$1,000*4%*6/12 = $20
oHow do you calculate the amount of interest paid each period?
oWhen are Bonds issued at Par?
When stated rate = market rate. So a $1,000 bond will sell for $1,000
oWhen are Bonds issued at a Discount?
When stated rate < market rate/yield rate. So a $1,000 bond will sell for less
than face value
oWhen are Bonds issued at a Premium?
When state rate > market rate/yield rate. So a $1,000 bond will sell for more
than face value.
oBond issued at 97 vs 101
$1,000 bond issued at 97 is issued for $1,000 *.97 = $970 (Discount)
$1,000 bond issued at 101 is issued for $1,000 *1.01 = $1,010 (Premium)
Mortgage Payable
oOn Jan 1, 2018 you obtain a 30 year $500,000 mortgage at 3.5% with yearly mortgage
payments of $27,186.
o Record mortgage
DR Building $500,000
CR Mortgage Payable $500,000
oMortgage Payment
Determine Interest expense
Amount applied to the principal
Loan balance
Date Payment Interest Principal Loan Balance
Jan 1 2018 $500,000
Dec. 31, 2018 $27,186 $500,000*
3.5%= $17,500
$27,186-
$17,500 =
$9,686
$500,000-
$9,686=
$490,314
Dec. 31, 2019 $27,186 $490,314*
3.5%= $17,161
$27,186-
$17,161=
$10,025
$490,314 -
$10,025 =
$480,289
Deferred Taxes
oWhen does a Deferred Tax liability occur?
When income as determined by the IRS is lower than income as determined by
US GAAP deferred income taxes arise
When taxable income under IRS is lower than taxable income under GAAP
What does the leverage ratio measure?
oCalculation of Leverage ratio is =Average Liabilities/Average Stockholders’ Equity
Liabilities Stockholders’ Equity
2018 $5m $2m
2019 $7m $4m
oAverage Liabilities (5+7)/2 = $6m
oAverage Stockholders’ Equity (2+4)/2 = $3m
oLeverage Ratio = $6m/$3m = 2
oCompany with higher ratio is more risky
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