Chapter 8 and 9 lecture notes.docx

Chapter 8 : liabilities Question #1 On January 1, a company signs a $200,000, 4% 9-month note. Interest is due at maturity. What is the adjusting entry required if the company prepares financial statements on June 30. a. Dr Interest expense; Cr Interest payable, $4,000 b. Dr Interest expense; Cr Cash, $4,000 c. Dr Interest expense; Cr Cash, $6,000 d. Dr Interest expense; Cr Interest payable, $6,000 Soln: 200,000 x 4% x (6/12) = 4000 Question # 2 ABC Company is authorized to issue 50,000 common shares. On Feb. 10, 2009, it issued 10,000 shares at $11 per share. The journal entry to record these facts include a a. Credit to Common shares $110,000 b. Credit to Common shares $550,000 c. Debit to Cash for $550,000 d. Debit to Common shares for $110,000 Soln: 10,000 x 11 = 110,000 Question # 3 XYZ Corporation has 10,000, $2 cumulative preferred shares and 110,000 common shares outstanding. At the beginning of the current year, preferred dividends were 3 years in arrears. The Board of Directors wants to pay a $1.50 cash dividend on each outstanding common share. To accomplish this, what TOTAL amount of dividends must they declare? a. $225,000 b. $165,000 c. $245,000 solution: 10,000 x $2 = 20,000 x 3 years in arrears = 60,000 + 20,000 (current) = 80,000 (amt earned by preffered shareholders) 110,000 CS x 150 = 165000 Therefore 165000+80000 = 245000 Total amt of dividends they must declare Chapter 8 : liabilities Current and Long-Term Liabilities • liabilities are debts • borrowing is one way a company finances its operations • liabilities are classified as current or long-term Learning Objective 1 Account for current liabilities and contingent liabilities. Current liabilities are obligations due within one year or within the company’s normal operating cycle if it is longer Examples: accounts payable, short-term notes payable, taxes payable, current portion of long- term debt, accrued expenses, unearned revenue, etc. Current Liabilities That Must Be Estimated Estimated Warranty Payable Assume that Black & Decker made sales of $200,000 subject to product warranties Black & Decker estimates that 3% of the products it sells this year will require repair or replacement What is the estimated warranty expense? Estimated Warranty Payable $200,000 × 0.03 = $6,000 Warranty Expense 6000 Estimated Warranty Payable 6000 To accrue warranty expense Contingent Liabilities They are a potential liability that depends on a future event arising out of past events Examples: Lawsuits in progress, guarantees of a subsidiary’s debt, audit by Canada Revenue Agency These liabilities are disclosed in the notes to the financial statements (if it is likely that they will become actual liabilities). Bonds: interest bearing long term note payable Bonds are group of notes payable issued to multiple lenders called bondholders. Principle, interest rates, payment date Learning Objective 4 Understand the advantages and disadvantages of borrowing. Issuing Shares (creates no liability or interest exp) Cash xx Capital Stock (Equity) xx Issue Bonds Chapter 8 : liabilities Cash xx Bonds Payable xx Earnings Per Share (EPS) = (Net income – Preffered Stock Dividend)/(Avg # of Common Shares) • measures how much each share is earning Using Debt in Decision Making • liabilities are a popular way to finance operations • managers use ratios to determine how much credit risk it is taking • both creditors and investors worry when a company’s debt grow • there is a risk that the company cannot pay its debts as they become due • 2 ratios to determine how much credit risk the company is taking are: • Times interest earned • Debt ratio • Times Interest Earned = Operating income Interest expense • It measures the number of times that operating income can cover interest expense. • A high ratio indicates ease in paying interest expense • Debt ratio = Total liabilities Total assets • It states the proportion of a company’s assets that is financed with debt Learning Objective 5 : Report liabilities on the balance sheet. Shareholders’ Equity : Chapter 9 Learning Objective 1 : Explain the features of a corporation. Corporations are legal entities apart from their owners Public: shares are traded on stock exchange Private:shares = privately held Chapter 8 : liabilities Advantages 1. Can raise more capital than a proprietorship or partnership can 2. Continuous life 3. Ease of transferring ownership 4. Limited liability of shareholders Disadvantages Separation of ownership 2. Corporate taxation 3. Government regulation Organizing Corporation  articles of incorporations Set Bylaws Authority Structure of a Corporation: shareholders  board of directors  chief executive officer  chief operating officer Shareholder’s rights: right to sell shares, vote, dividends, liquidation, preemption Shareholders’ Equity Assets = Liabilities + Shareholders’ Equ