© the mcgraw-hill companies, inc., 2008 mcgraw-hill/irwin liabilities chapter 10

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

LIABILITIES

Chapter

10


Learning ObjectiveLearning Objective

LO1

To define liabilities an distinguish between

current and long-term liabilities.


I.O.U.

Defined as debts or obligations arising from past transactions or

events.

Defined as debts or obligations arising from past transactions or

events.

Maturity = 1 year or less Maturity > 1 year

Current Liabilities

Noncurrent Liabilities

The Nature of LiabilitiesThe Nature of Liabilities


The acquisition of assets is financedfrom two sources:

Funds from creditors, with a definite due date, and

sometimes bearing interest.

Funds from owners

DEBTDEBT EQUITYEQUITY

Distinction BetweenDebt and Equity

Distinction BetweenDebt and Equity


Current LiabilitiesCurrent Liabilities

Obligations that must be paid within one Obligations that must be paid within one year or within the operating cycle, year or within the operating cycle,

whichever is longer.whichever is longer.

Obligations that must be paid within one Obligations that must be paid within one year or within the operating cycle, year or within the operating cycle,

whichever is longer.whichever is longer.


Devon Mfg. borrows $100,000 from First Bank. The loan will be repaid in 20 years

and has an annual interest rate of 8%.

Is this a current liability or a noncurrent liability?

Devon Mfg. borrows $100,000 from First Bank. The loan will be repaid in 20 years

and has an annual interest rate of 8%.

Is this a current liability or a noncurrent liability?

Liabilities – QuestionLiabilities – Question

The obligation will not be paid within one year or one operating

cycle, so it is a noncurrent liability.

The obligation will not be paid within one year or one operating

cycle, so it is a noncurrent liability.


Short-term obligations to suppliers for purchases of merchandise and to others for goods and services.

Short-term obligations to suppliers for purchases of merchandise and to others for goods and services.

Merchandise inventory invoices

Merchandise inventory invoices

Shipping charges

Shipping charges

Utility and phone bills

Utility and phone bills

Office supplies invoices

Office supplies invoices

Accounts PayableAccounts Payable



LO2

To account for notes payable and interest

expense.


Total Notes Payable

Current Notes Payable

Noncurrent Notes Payable

When a company borrows money, a note payable is created.

Current Portion of Notes Payable

The portion of a note payable that is due within one year, or one operating cycle, whichever is longer.

When a company borrows money, a note payable is created.

Current Portion of Notes Payable

The portion of a note payable that is due within one year, or one operating cycle, whichever is longer.

Notes PayableNotes Payable


PROMISSORY NOTE

Location Date

after this date

promises to pay to the order of

the sum of with interest at the rate

of per annum.

signed

title

Miami, Fl Nov. 1, 2007

Six months Porter Company

John Caldwell

Security National Bank

$10,000.00

12.0%

treasurer



On November 1, 2007, Porter Company would make the following entry.



• Interest expenseInterest expense is the is the compensation to the lender for compensation to the lender for giving up the use of money for a giving up the use of money for a period of time.period of time.

• The liability is called The liability is called interest interest payablepayable..

• To the lender, interest is a To the lender, interest is a revenuerevenue..

• To the borrower, interest is an To the borrower, interest is an expenseexpense..

• Interest expenseInterest expense is the is the compensation to the lender for compensation to the lender for giving up the use of money for a giving up the use of money for a period of time.period of time.

• The liability is called The liability is called interest interest payablepayable..

• To the lender, interest is a To the lender, interest is a revenuerevenue..

• To the borrower, interest is an To the borrower, interest is an expenseexpense..

Interest Rate Up!

Interest PayableInterest Payable


The interest formula includes three variables that must be considered when

computing interest:

The interest formula includes three variables that must be considered when

computing interest:

Interest = Principal × Interest Rate × Time

When computing interest for one year, “Time” equals 1. When the computation period is less

than one year, then “Time” is a fraction.

When computing interest for one year, “Time” equals 1. When the computation period is less

than one year, then “Time” is a fraction.

Interest PayableInterest Payable

For example, if we needed to compute interest for 3 months, “Time” would be 3/12.

For example, if we needed to compute interest for 3 months, “Time” would be 3/12.


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

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

Interest Payable – ExampleInterest Payable – Example

$10,00012% 2/12 = $200$10,00012% 2/12 = $200


Porter will pay the note on January 31, 2008. Let’s look at the entry.

Porter will pay the note on January 31, 2008. Let’s look at the entry.

Interest Payable – ExampleInterest Payable – Example

$10,00012% 1/12 = $100$10,00012% 1/12 = $100



LO3

To describe the costs and basic accounting

activities related to payrolls.


Net Pay

Payroll LiabilitiesPayroll Liabilities

Medicare Taxes

State and Local Income

TaxesFICA Taxes

Federal Income Tax

Voluntary Deductions

Gross Pay


Deferred revenue is recorded.

a liability account.a liability account.

Cash is received

in advance.

Cash is sometimes collected from the customer before the revenue is

actually earned.

Cash is sometimes collected from the customer before the revenue is

actually earned.

Unearned RevenueUnearned Revenue

Earned revenue is recorded.

As the earnings process is

completed . .


Relatively small debt needs can be filled from

single sources.

Relatively small debt needs can be filled from

single sources.

BanksInsurance

CompaniesPension

Plans

oror oror

Long-Term LiabilitiesLong-Term Liabilities


Large debt needs are often filled by issuing bonds.

Large debt needs are often filled by issuing bonds.

Long-Term LiabilitiesLong-Term Liabilities


With each payment, the interest portion gets

smaller and the principal portion gets larger.

With each payment, the interest portion gets

smaller and the principal portion gets larger.

Installment Notes PayableInstallment Notes Payable

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

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

Each payment covers interest for the period AND a portion of the

principal.

Each payment covers interest for the period AND a portion of the

principal.


• Identify the unpaid principal balance.

• Interest expense = Unpaid Principal × Interest rate.

• Reduction in unpaid principal balance = Installment payment – Interest expense.

• Compute new unpaid principal balance.

• Identify the unpaid principal balance.

• Interest expense = Unpaid Principal × Interest rate.

• Reduction in unpaid principal balance = Installment payment – Interest expense.

• Compute new unpaid principal balance.

Allocating Installment Payments Between Interest and Principal




LO4

To prepare an amortization table

allocating payments between interest and

principal.


On January 1, 2007, Rocket Corp. borrowed $7,581.57 from First Bank of River City. The loan was a five-year loan and

had an interest rate of 10%. The annual payment is $2,000.

Prepare an amortization table for Rocket Corp.’s loan.

On January 1, 2007, Rocket Corp. borrowed $7,581.57 from First Bank of River City. The loan was a five-year loan and

had an interest rate of 10%. The annual payment is $2,000.

Prepare an amortization table for Rocket Corp.’s loan.




Now, prepare the entry for the first payment on December 31, 2007.

Now, prepare the entry for the first payment on December 31, 2007.




The information needed for the journal entry can be found on the amortization table. The payment

amount, the interest expense, and the amount to debit to principal are all on the table.

The information needed for the journal entry can be found on the amortization table. The payment

amount, the interest expense, and the amount to debit to principal are all on the table.





LO5

To describe corporate bonds and explain the tax advantage of debt

financing.


Bonds usually involve the Bonds usually involve the borrowing of a large sum of borrowing of a large sum of money, called money, called principalprincipal..

The principal is usually paid The principal is usually paid back as a back as a lump sumlump sum at the end at the end of the bond period.of the bond period.

Individual bonds are often Individual bonds are often denominated with a par value, denominated with a par value, or or face valueface value, of $1,000., of $1,000.

Bonds usually involve the Bonds usually involve the borrowing of a large sum of borrowing of a large sum of money, called money, called principalprincipal..

The principal is usually paid The principal is usually paid back as a back as a lump sumlump sum at the end at the end of the bond period.of the bond period.

Individual bonds are often Individual bonds are often denominated with a par value, denominated with a par value, or or face valueface value, of $1,000., of $1,000.

Bonds PayableBonds Payable


Bonds usually carry a stated rate of interest, also called a contract rate.

Interest is normally paid semiannually.

Interest is computed as:

Bonds usually carry a stated rate of interest, also called a contract rate.

Interest is normally paid semiannually.

Interest is computed as:

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



Bonds are issued through an intermediary called an underwriter.

Bonds can be sold on organized securities exchanges.

Bond prices are usually quoted as a percentage of the face amount.

For example, a $1,000 bond For example, a $1,000 bond priced at 102 would sell for priced at 102 would sell for $1,020$1,020..

Bonds are issued through an intermediary called an underwriter.

Bonds can be sold on organized securities exchanges.

Bond prices are usually quoted as a percentage of the face amount.

For example, a $1,000 bond For example, a $1,000 bond priced at 102 would sell for priced at 102 would sell for $1,020$1,020..



Mortgage Bonds

Mortgage Bonds

Convertible Bonds

Convertible Bonds

Junk BondsJunk

Bonds

Debenture Bonds

Debenture Bonds

Types of BondsTypes of Bonds


On January 1, 2007, Rocket Corp. issues $1,500,000 of 12%, 10-year bonds payable. Interest is payable

semiannually, each July 1 and January 1.

Assume the bonds are issued at face value.Record the issuance of the bonds.

On January 1, 2007, Rocket Corp. issues $1,500,000 of 12%, 10-year bonds payable. Interest is payable

semiannually, each July 1 and January 1.

Assume the bonds are issued at face value.Record the issuance of the bonds.

Accounting for Bonds PayableAccounting for Bonds Payable


Record the interest paymenton July 1, 2007.

Record the interest paymenton July 1, 2007.

Accounting for Bonds PayableAccounting for Bonds Payable


Bonds Sold Between Interest DatesBonds Sold Between Interest Dates

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

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



LO6

To account for bonds issued at a discount or

premium.


The Present Value Concept and Bond Prices

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.

==

>>

<<

>>

<<

==


Bonds Issued at a DiscountBonds Issued at a Discount

Matrix, Inc. is attempting to issue $1,000,000 Matrix, Inc. is attempting to issue $1,000,000 principal amount of 9% bonds. The bonds pay principal amount of 9% bonds. The bonds pay

interest on June 30 and December 31 each year interest on June 30 and December 31 each year and mature in 20 years. Investors are unwilling to and mature in 20 years. Investors are unwilling to

pay the full face amount for Matrix’s bonds because pay the full face amount for Matrix’s bonds because they believe the interest rate is too low. To entice they believe the interest rate is too low. To entice

investors, Matrix must lower the price of the bonds. investors, Matrix must lower the price of the bonds. The difference between the new lower issue price The difference between the new lower issue price

and the principal of $1,000,000 is called a discount.and the principal of $1,000,000 is called a discount.

Let’s see how we account for these bonds.Let’s see how we account for these bonds.

Matrix, Inc. is attempting to issue $1,000,000 Matrix, Inc. is attempting to issue $1,000,000 principal amount of 9% bonds. The bonds pay principal amount of 9% bonds. The bonds pay

interest on June 30 and December 31 each year interest on June 30 and December 31 each year and mature in 20 years. Investors are unwilling to and mature in 20 years. Investors are unwilling to

pay the full face amount for Matrix’s bonds because pay the full face amount for Matrix’s bonds because they believe the interest rate is too low. To entice they believe the interest rate is too low. To entice

investors, Matrix must lower the price of the bonds. investors, Matrix must lower the price of the bonds. The difference between the new lower issue price The difference between the new lower issue price

and the principal of $1,000,000 is called a discount.and the principal of $1,000,000 is called a discount.

Let’s see how we account for these bonds.Let’s see how we account for these bonds.


Principal

Cash Proceeds Discount

1,000,000$ - 950,000$ = 50,000$


Matrix, Inc. issues bonds on January 1, 2007.Matrix, Inc. issues bonds on January 1, 2007.Principal = $1,000,000Principal = $1,000,000Issue price = $950,000Issue price = $950,000Stated Interest Rate = 9%Stated Interest Rate = 9%Interest Dates = 6/30 and 12/31Interest Dates = 6/30 and 12/31Maturity Date = Dec. 31, 2026 (20 years)Maturity Date = Dec. 31, 2026 (20 years)

Matrix, Inc. issues bonds on January 1, 2007.Matrix, Inc. issues bonds on January 1, 2007.Principal = $1,000,000Principal = $1,000,000Issue price = $950,000Issue price = $950,000Stated Interest Rate = 9%Stated Interest Rate = 9%Interest Dates = 6/30 and 12/31Interest Dates = 6/30 and 12/31Maturity Date = Dec. 31, 2026 (20 years)Maturity Date = Dec. 31, 2026 (20 years)



To record the bond issue, Matrix, Inc. wouldTo record the bond issue, Matrix, Inc. wouldmake the following entry on January 1, 2007:make the following entry on January 1, 2007:To record the bond issue, Matrix, Inc. wouldTo record the bond issue, Matrix, Inc. wouldmake the following entry on January 1, 2007:make the following entry on January 1, 2007:


Partial Balance Sheet as of January 1, 2007

Long-term Liabilities: Bonds Payable 1,000,000$ Less: Discount on Bonds Payable 50,000 950,000$



Maturity ValueMaturity ValueMaturity ValueMaturity Value

Carrying ValueCarrying ValueCarrying ValueCarrying Value



Amortizing the discount over the term of the Amortizing the discount over the term of the bond increases Interest Expense each bond increases Interest Expense each

interest payment period.interest payment period.

Amortizing the discount over the term of the Amortizing the discount over the term of the bond increases Interest Expense each bond increases Interest Expense each



Using the Using the straight-linestraight-line method, the method, the discount amortization will be $1,250 discount amortization will be $1,250

every six months. every six months.

$50,000 ÷ 40 periods = $1,250$50,000 ÷ 40 periods = $1,250

Using the Using the straight-linestraight-line method, the method, the discount amortization will be $1,250 discount amortization will be $1,250

every six months. every six months.

$50,000 ÷ 40 periods = $1,250$50,000 ÷ 40 periods = $1,250


Amortization of the DiscountAmortization of the Discount

We prepare the following journal entry to recordWe prepare the following journal entry to recordthe first interest payment.the first interest payment.We prepare the following journal entry to recordWe prepare the following journal entry to recordthe first interest payment.the first interest payment.

$1,000,000 × 9% = $90,000 ÷ 2 = $45,000$45,000

Interest paid every six months is calculated as follows:Interest paid every six months is calculated as follows:Interest paid every six months is calculated as follows:Interest paid every six months is calculated as follows:


Partial Balance Sheet as of December 31, 2007






$50,000 – $1,250 – $1,250$50,000 – $1,250 – $1,250$50,000 – $1,250 – $1,250$50,000 – $1,250 – $1,250

The carrying value willThe carrying value willincrease to exactly $1,000,000increase to exactly $1,000,000

on the maturity date.on the maturity date.

The carrying value willThe carrying value willincrease to exactly $1,000,000increase to exactly $1,000,000




To record an the principal repayment, Matrix, IncTo record an the principal repayment, Matrix, Incwould make the following entry on December 31, 2026:would make the following entry on December 31, 2026:To record an the principal repayment, Matrix, IncTo record an the principal repayment, Matrix, Incwould make the following entry on December 31, 2026:would make the following entry on December 31, 2026:



Bonds Issued at a PremiumBonds Issued at a Premium

If bonds of other companies are yielding less thanIf bonds of other companies are yielding less than9 percent, investors will be willing to pay more than9 percent, investors will be willing to pay more thanthe face amount for Matrix’s 9% bonds. The issuethe face amount for Matrix’s 9% bonds. The issue

price of Matrix’s 9% bonds will rise because ofprice of Matrix’s 9% bonds will rise because ofinvestor demand for the 9% bonds. Theinvestor demand for the 9% bonds. The

difference between the higher issue price and thedifference between the higher issue price and theprincipal of $1,000,000 is called a premium.principal of $1,000,000 is called a premium.

Let’s look at accounting for a premium.Let’s look at accounting for a premium.

If bonds of other companies are yielding less thanIf bonds of other companies are yielding less than9 percent, investors will be willing to pay more than9 percent, investors will be willing to pay more thanthe face amount for Matrix’s 9% bonds. The issuethe face amount for Matrix’s 9% bonds. The issue

price of Matrix’s 9% bonds will rise because ofprice of Matrix’s 9% bonds will rise because ofinvestor demand for the 9% bonds. Theinvestor demand for the 9% bonds. The

difference between the higher issue price and thedifference between the higher issue price and theprincipal of $1,000,000 is called a premium.principal of $1,000,000 is called a premium.

Let’s look at accounting for a premium.Let’s look at accounting for a premium.


Cash Proceeds Principal Premium

1,050,000$ - 1,000,000$ = 50,000$

Matrix, Inc. issues bonds on January 1, 2007.Matrix, Inc. issues bonds on January 1, 2007.Principal = $1,000,000Principal = $1,000,000Issue price = $1,050,000Issue price = $1,050,000Stated Interest Rate = 9%Stated Interest Rate = 9%Interest Dates = 6/30 and 12/31Interest Dates = 6/30 and 12/31Maturity Date = Dec. 31, 2026 (20 years)Maturity Date = Dec. 31, 2026 (20 years)

Matrix, Inc. issues bonds on January 1, 2007.Matrix, Inc. issues bonds on January 1, 2007.Principal = $1,000,000Principal = $1,000,000Issue price = $1,050,000Issue price = $1,050,000Stated Interest Rate = 9%Stated Interest Rate = 9%Interest Dates = 6/30 and 12/31Interest Dates = 6/30 and 12/31Maturity Date = Dec. 31, 2026 (20 years)Maturity Date = Dec. 31, 2026 (20 years)

The only change fromprevious Matrix example.



To record the bond issue, Matrix, Inc. wouldTo record the bond issue, Matrix, Inc. wouldmake the following entry on January 1, 2007:make the following entry on January 1, 2007:To record the bond issue, Matrix, Inc. wouldTo record the bond issue, Matrix, Inc. wouldmake the following entry on January 1, 2007:make the following entry on January 1, 2007:




Long-term Liabilities: Bonds Payable 1,000,000$ Add: Premium on Bonds Payable 50,000 1,050,000$







Amortizing the premium over the term of the Amortizing the premium over the term of the bond decreases Interest Expense each bond decreases Interest Expense each


Amortizing the premium over the term of the Amortizing the premium over the term of the bond decreases Interest Expense each bond decreases Interest Expense each


Using the Using the straight-linestraight-line method, the method, the premium amortization will be premium amortization will be

$1,250 every six months. $1,250 every six months.

$50,000 ÷ 40 periods = $50,000 ÷ 40 periods = $1,250$1,250

Using the Using the straight-linestraight-line method, the method, the premium amortization will be premium amortization will be

$1,250 every six months. $1,250 every six months.

$50,000 ÷ 40 periods = $50,000 ÷ 40 periods = $1,250$1,250




To record an interest payment, Matrix, Inc. would makeTo record an interest payment, Matrix, Inc. would makethe following entry on each June 30 and December 31:the following entry on each June 30 and December 31:To record an interest payment, Matrix, Inc. would makeTo record an interest payment, Matrix, Inc. would makethe following entry on each June 30 and December 31:the following entry on each June 30 and December 31:









$50,000 – $1,250 – $1,250$50,000 – $1,250 – $1,250$50,000 – $1,250 – $1,250$50,000 – $1,250 – $1,250

The carrying value willThe carrying value willdecrease to exactly $1,000,000decrease to exactly $1,000,000


The carrying value willThe carrying value willdecrease to exactly $1,000,000decrease to exactly $1,000,000



To record an the principal repayment, Matrix would makeTo record an the principal repayment, Matrix would makethe following entry on December 31, 2026:the following entry on December 31, 2026:To record an the principal repayment, Matrix would makeTo record an the principal repayment, Matrix would makethe following entry on December 31, 2026:the following entry on December 31, 2026:




LO7

To explain the concept of present value as it

relates to bond prices.


Present Value

Present Value

The Concept of Present ValueThe Concept of Present Value

Future Value

Future Value

$1,000 invested

today at 10%.

In 25 years it will be worth $10,834.71!

Money can grow over time, because it can earn interest.

In 5 years it will be worth

$1,610.51.


How much is a future amount worth today?How much is a future amount worth today?

Present Value

FutureValue

Interest compounding periods

Today




How much is a future amount worth today?

Three pieces of information must be known to solve a present value problem:

o The future amount.o The interest rate (i).o The number of periods (n) the

amount will be invested.

How much is a future amount worth today?

Three pieces of information must be known to solve a present value problem:

o The future amount.o The interest rate (i).o The number of periods (n) the

amount will be invested.


Two types of cash flows are involved with bonds:

Today

Principal payment at maturity.

Periodic interest payments called annuities.

Maturity



Gains or losses incurred as a result of retiring bonds should be reported as other income or

other expense on the income statement.

Gains or losses incurred as a result of retiring bonds should be reported as other income or

other expense on the income statement.

Early Retirement of DebtEarly Retirement of Debt



LO8

To explain how estimated liabilities, loss

contingencies, and commitments are

disclosed in financial statements.


Loss ContingenciesLoss Contingencies

An existing uncertain situation involving potential loss depending on whether some future event occurs.

An existing uncertain situation involving potential loss depending on whether some future event occurs.

Two factors affect whether a loss contingency Two factors affect whether a loss contingency must be accrued and reported as a liability:must be accrued and reported as a liability:

1.1. The likelihood that the confirming event willThe likelihood that the confirming event willoccur.occur.

2.2. Whether the loss amount can be reasonablyWhether the loss amount can be reasonablyestimated.estimated.

Two factors affect whether a loss contingency Two factors affect whether a loss contingency must be accrued and reported as a liability:must be accrued and reported as a liability:

1.1. The likelihood that the confirming event willThe likelihood that the confirming event willoccur.occur.

2.2. Whether the loss amount can be reasonablyWhether the loss amount can be reasonablyestimated.estimated.


Estimated LiabilitiesEstimated Liabilities

1.1. Liabilities that are known to exist.Liabilities that are known to exist.

2.2. Uncertain as to dollar amount.Uncertain as to dollar amount.

3.3. Reasonable estimate of dollar Reasonable estimate of dollar amount is available.amount is available.

1.1. Liabilities that are known to exist.Liabilities that are known to exist.

2.2. Uncertain as to dollar amount.Uncertain as to dollar amount.

3.3. Reasonable estimate of dollar Reasonable estimate of dollar amount is available.amount is available.

Example: Product warranties



LO9

To evaluate the safety of creditor’s claims.


Evaluating the Safetyof Creditors’ Claims

Evaluating the Safetyof Creditors’ Claims

This ratio indicates a margin of protection for creditors.

This ratio indicates a margin of protection for creditors.

Operating Income

Interest Expense

Interest

Coverage

Ratio=


Devon Mfg. reports annual operating income of $100,000 and annual interest expense of

$10,000.

What is Devon’s interest coverage ratio?

Devon Mfg. reports annual operating income of $100,000 and annual interest expense of

$10,000.

What is Devon’s interest coverage ratio?

Liabilities – QuestionLiabilities – Question


Borrowing at one rate and

investing at a higher rate.

If we borrow If we borrow $1,000,000 at 8% $1,000,000 at 8%

and invest it at and invest it at 10%, we will clear 10%, we will clear

$20,000 profit!$20,000 profit!

Financial LeverageFinancial Leverage



LO10

To describe reporting issues related to

leases, postretirement benefits, and deferred

taxes.


Lease agreement transfers risks and benefits

associated with ownership to lessee.

Lease agreement transfers risks and benefits

associated with ownership to lessee.

Lessee records a leased asset and lease liability.

Lessee records a leased asset and lease liability.

Lessor retains risks and benefits associated with

ownership.

Lessor retains risks and benefits associated with

ownership.

Lessee records rent expense as incurred.

Lessee records rent expense as incurred.

Lease Payment ObligationsLease Payment Obligations

Operating LeasesOperating Leases Capital LeasesCapital Leases


The lease transfersow nership to the

lessee.

The lease containsa bargain purchase

option.

The lease term is equal toor > 75% of the econom ic

life of the property.

The PV of the m inim umlease paym ents = 90% ofthe FM V of the property.

A lease must be recorded asa Capital Lease if it meets

any of the follow ing criteria.

Capital Lease CriteriaCapital Lease Criteria


Employers offer pension plans to employees.

Employers offer pension plans to employees.

Retirees receive pension

payments from the pension

fund.

Retirees receive pension

payments from the pension

fund.

The employer makes payments to a pension

fund. Usually, this is an independent entity

managed by a professional fund

manager.

The employer makes payments to a pension

fund. Usually, this is an independent entity

managed by a professional fund

manager.

PensionsPensions


Actuaries make the pension expense computations, based on:

• Average age, retirement age, life expectancy.

• Employee turnover rates.

• Compensation levels.

• Expected rate of return for the fund.

Actuaries make the pension expense computations, based on:

• Average age, retirement age, life expectancy.

• Employee turnover rates.

• Compensation levels.

• Expected rate of return for the fund.

The accountant then posts the The accountant then posts the entry to record pension expense entry to record pension expense

and pension liability.and pension liability.

The accountant then posts the The accountant then posts the entry to record pension expense entry to record pension expense

and pension liability.and pension liability.

PensionsPensions


Many companies offer benefits to retirees other than pensions,

such as health coverage or fitness club memberships.

Many companies offer benefits to retirees other than pensions,

such as health coverage or fitness club memberships.

Other Postretirement BenefitsOther Postretirement Benefits

Unfunded liabilityfor nonpensionpostretirement

benefits

Currentliability

Long-termliability

Amount tobe fundednext year

Remainderof unfunded

amount


Corporations pay income

taxes quarterly.

Deferred Income TaxesDeferred Income Taxes


The difference between tax expense and tax payable is recorded in an account called

deferred taxes.

The difference between tax expense and tax payable is recorded in an account called

deferred taxes.

The Internal Revenue Code is the set of

rules for preparing tax returns.

The Internal Revenue Code is the set of

rules for preparing tax returns.

Financial statement income tax expense.Financial statement income tax expense.

IRS income taxes payable.

IRS income taxes payable.

GAAP is the set of rules for preparing

financial statements.

GAAP is the set of rules for preparing

financial statements.

Results in . . . Results in . . .Usually. . .

Deferred Income TaxesDeferred Income Taxes


Examine the December 31, 2007, information for Matrix, Inc.

Matrix uses straight-line depreciation for financial reporting and accelerated depreciation for income

tax reporting. Matrix’s tax rate is 30%.

Deferred Income Taxes – ExampleDeferred Income Taxes – Example


Income TaxStatement Return Difference

Revenues 1,000,000$ Less: Depreciation 200,000 Other expenses 650,000 Income before taxes 150,000$

× Tax rate 30%Income taxes 45,000$

The income tax amount computed based on financial

statement income is income tax expense

for the period.

The income tax amount computed based on financial

statement income is income tax expense

for the period.

Compute Matrix’s income tax expense and income tax payable.



Compute Matrix’s income tax expense and income tax payable.


Revenues 1,000,000$ 1,000,000$ Less: Depreciation 200,000 320,000 Other expenses 650,000 650,000 Income before taxes 150,000$ 30,000$

× Tax rate 30% 30%Income taxes 45,000$ 9,000$

Income taxes based on tax

return income are the taxes

payable for the period.

Income taxes based on tax

return income are the taxes

payable for the period.




Revenues 1,000,000$ 1,000,000$ -$ Less: Depreciation 200,000 320,000 (120,000) Other expenses 650,000 650,000 - Income before taxes 150,000$ 30,000$ 120,000$

× Tax rate 30% 30% 30%Income taxes 45,000$ 9,000$ 36,000$

The deferred tax for the period of $36,000 is the difference between income tax expense of $45,000 and

income tax payable of $9,000.

The deferred tax for the period of $36,000 is the difference between income tax expense of $45,000 and

income tax payable of $9,000.



End of Chapter 1OEnd of Chapter 1O

© the mcgraw-hill companies, inc., 2008 mcgraw-hill/irwin liabilities chapter 10

Documents