.Explain a current liability, and identify the major types of current liabilities. 2.Describe the accounting for notes payable. 3.Explain the accounting for other current liabilities. 4.Explain why bonds are issued, and identify the types of bonds. 5.Prepare the entries for the issuance of bonds and interest expense.

QUESTION

1.Explain a current liability, and identify the major types of current liabilities.

2.Describe the accounting for notes payable.

3.Explain the accounting for other current liabilities.

4.Explain why bonds are issued, and identify the types of bonds.

5.Prepare the entries for the issuance of bonds and interest expense.

6.Describe the entries when bonds are redeemed or converted.

7.Describe the accounting for long-term notes payable (theory only)

8.Identify the methods for the presentation and analysis of long-term liabilities (theory only)

9.(not covered – Appendix 10-A)

10.(not covered – Appendix 10-B

11.Apply the straight line method of amortizing bond discount and bond premium (Appendix 10-C)

ANSWER

Accounting for Liabilities: Current and Long-Term, Bonds, and Notes Payable

 A current liability refers to a financial obligation that a company is expected to settle within the next operating cycle or within one year, whichever is longer. It represents the company’s short-term debts and obligations that are due in the near future. Current liabilities are important because they help evaluate a company’s short-term financial obligations and its ability to meet them.

Major types of current liabilities include:

Accounts Payable: These are the amounts owed by a company to its suppliers or vendors for goods or services received on credit. Accounts payable typically arise from the purchase of inventory or other operating expenses.

 Accrued Expenses: These are expenses that have been incurred but not yet paid for. They include items such as wages payable, interest payable, and taxes payable.

Short-Term Notes Payable: These are short-term loans that a company borrows from banks or other financial institutions, usually with a maturity period of less than one year.

Current Portion of Long-Term Debt: This represents the portion of long-term debt that is due within the next operating cycle or one year, whichever is longer. It is classified as a current liability even though it is part of a long-term debt obligation.

Unearned Revenues: These are payments received from customers in advance for goods or services that have not yet been delivered (Liberto, 2022). They are classified as a current liability until the company fulfills its obligations to the customers.

The accounting for notes payable involves recording the initial borrowing of funds, recognizing interest expense over the term of the note, and eventually repaying the principal amount.

When a company borrows funds through a note payable, it initially records a liability for the principal amount borrowed. This is typically recorded as a debit to Cash (or other asset accounts) and a credit to Notes Payable.

Interest expense is recognized over the term of the note using the effective interest method. The interest expense is calculated by multiplying the outstanding principal balance of the note by the stated interest rate and the time period for which the interest is accrued. The interest expense is typically recorded by debiting Interest Expense and crediting Notes Payable.

When the note matures, the company makes the principal payment to the lender. This is recorded by debiting Notes Payable and crediting Cash.

Other current liabilities encompass various short-term obligations that are not categorized under the major types mentioned earlier. These may include items such as:

Customer Deposits: Amounts received from customers as a deposit for future goods or services.

Sales Tax Payable: Amounts collected from customers as sales tax, which are required to be remitted to the tax authorities.

Dividends Payable: Amounts declared by a company’s board of directors as dividends to be paid to shareholders but not yet distributed (Dividends Payable | Definition + Journal Entry Examples, 2023).

Current Portion of Deferred Revenue: Unearned revenues that will be recognized as revenue within the next operating cycle or one year, whichever is longer.

Current Portion of Contingent Liabilities: Estimated liabilities arising from pending legal claims or potential losses that are likely to be settled within the next operating cycle or one year.

The accounting treatment for these other current liabilities involves recognizing them as liabilities and adjusting their balances as they are settled or fulfilled.

Bonds are issued by companies and governments to raise capital by borrowing money from investors. The primary reasons for issuing bonds are:

To raise funds for business expansion, acquisitions, or capital expenditures.

 To refinance existing debt at more favorable interest rates.

To support research and development activities.

To finance infrastructure projects undertaken by governments.

Types of bonds include:

Corporate Bonds: Issued by corporations to raise capital for various business purposes. They offer interest payments to bondholders and have a specified maturity date when  the principal amount is repaid.

 Government Bonds: Issued by national governments or governmental agencies to finance public projects and operations. They are considered less risky and may offer lower interest rates compared to corporate bonds.

Municipal Bonds: Issued by state and local governments or their agencies to finance public projects such as schools, hospitals, or infrastructure. Interest earned from municipal bonds is often exempt from federal income taxes.

Convertible Bonds: These bonds can be converted into a specified number of shares of the issuer’s common stock. They provide bondholders with the option to participate in potential stock price appreciation.

Zero-Coupon Bonds: These bonds do not pay regular interest payments. Instead, they are issued at a discount to their face value and mature at the face value, providing the investor with a return on investment through the price difference.

The entries for the issuance of bonds and interest expense involve the following:

 Issuance of Bonds: When a company issues bonds, it typically receives cash from investors. The journal entry to record the issuance of bonds would include a debit to Cash for the amount received and a credit to Bonds Payable for the face value of the bonds issued.

 Interest Expense: Interest expense is recognized over the term of the bond. The interest payment is calculated based on the face value of the bond, the stated interest rate, and the time period for which the interest is accrued. The journal entry to record the interest expense typically involves debiting Interest Expense and crediting Cash or Interest Payable.

The entries when bonds are redeemed or converted depend on the specific circumstances. Here are two common scenarios:

Redemption of Bonds: When bonds are redeemed or mature, the company repays the principal amount to bondholders. The journal entry for the redemption of bonds includes a debit to Bonds Payable (to reduce the liability) and a credit to Cash (to record the cash outflow).

Conversion of Bonds: If convertible bonds are converted into common stock, the journal entry would involve debiting Bonds Payable and crediting Common Stock for the face value of the converted bonds. Additionally, any remaining premium or discount on the bonds may be adjusted through a separate entry.

The accounting for long-term notes payable follows similar principles as notes payable, but with an extended term beyond one year. Long-term notes payable are typically recorded as a liability on the balance sheet, and the interest expense is recognized over the term of the note using the effective interest method. The entries for repayment of principal and interest are made as they become due.

 The methods for the presentation and analysis of long-term liabilities include:

Balance Sheet Presentation: Long-term liabilities are presented separately from current liabilities on the balance sheet. They provide information about a company’s long-term debt obligations, such as bonds payable and long-term notes payable.

Ratio Analysis: Financial ratios can be calculated to analyze a company’s long-term debt position and its ability to meet its obligations. Examples include the debt-to-equity ratio, interest coverage ratio, and long-term debt ratio.

 Footnote Disclosures: Additional information about long-term liabilities, such as maturity dates, interest rates, and any related covenants, is usually disclosed in the footnotes to the financial statements.

Cash Flow Analysis: Long-term liabilities can impact a company’s cash flows. Analyzing cash flows from financing activities helps assess the impact of long-term borrowing and repayment on a company’s overall cash position.

The straight-line method of amortizing bond discount and bond premium involves allocating the bond discount or premium over the term of the bond in equal amounts. The entries for amortizing bond discount and bond premium are as follows:

 Amortizing Bond Discount: A bond discount arises when the issue price of the bond is lower than its face value. To amortize the bond discount, a company debits Interest Expense (for the amortization amount) and credits Discount on Bonds Payable (to reduce the discount balance) over each interest period. This continues until the bond reaches its maturity date (Bragg, 2023).

 Amortizing Bond Premium: A bond premium occurs when the issue price of the bond is higher than its face value. To amortize the bond premium, a company debits Interest Expense (for the amortization amount) and credits Premium on Bonds Payable (to reduce the premium balance) over each interest period. This continues until the bond matures.

The straight-line method ensures that the interest expense recognized each period is a constant amount, resulting in a smooth amortization of the discount or premium over the bond’s life.

In conclusion, understanding current liabilities, the accounting for notes payable, other current liabilities, bond issuance, and the accounting for long-term liabilities is crucial for evaluating a company’s financial obligations and analyzing its financial position. Proper accounting and presentation of these liabilities provide transparency and enable stakeholders to make informed decisions about the company’s financial health.

References

Bragg, S. (2023). Amortization of discount on bonds payable —  AccountingTools. AccountingTools. https://www.accountingtools.com/articles/what-is-the-amortization-of-discount-on-bonds-payable.html 

Dividends Payable | Definition + Journal Entry Examples. (2023, June 14). Wall Street Prep. https://www.wallstreetprep.com/knowledge/dividends-payable/ 

Liberto, D. (2022). Unearned Revenue: What It Is, How It Is Recorded and Reported. Investopedia. https://www.investopedia.com/terms/u/unearnedrevenue.asp#:~:text=Key%20Takeaways-,Unearned%20revenue%20is%20money%20received%20by%20an%20individual%20or%20company,debt%20owed%20to%20the%20customer.