ACCT1006 S1 2021 Lecture Week 9 PDF

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ACCT1006: Accounting and Financial ManagementTimothy Ganghua WangWeek 9: Recording, Analysing,Managing & Reporting LiabilitiesFinancial AccountingIntroduction, GAAP & Business EntitiesStatement of Profit or LossStatement of Financial PositionStatement of Cash FlowsInternalControlInternalCont...

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ACCT1006: Accounting and Financial Management

Week 9: Recording, Analysing, Managing & Reporting Liabilities Timothy Ganghua Wang

Introduction,GAAP&BusinessEntities AccountingConcepts&TransactionAnalysis

RecordingTransactions

Merchandising AccountingSubsystems Receivables Non‐currentAssets Liabilities Equity

Statementof ProfitorLoss Statementof Financial Position Statementof CashFlows

FinancialStatementAnalysis

InternalControl

FinancialAccounting

Active Learning Opportunity – Take a moment to write down the liabilities arising from the following transactions: Purchase inventory on account Accounts payable

Employees performed services and haven’t paid them Salaries & wages payable

Receive cash but hasn’t provided services/goods Revenue received in advance or Unearned revenue Interest accrues on a loan over time Interest payable

In this lecture we will learn about how businesses account for and manage liabilities

The University of Sydney

Page 3

Learning Objectives/Outcomes 1. Explain the differences between current and non-current liabilities. 2. Identify common types of current liabilities and explain how to account for them. 3. Identify common types of non-current liabilities, such as debentures and unsecured notes, and explain how to account for them. 4. Prepare journal entries for loans payable by instalment and distinguish between current and non-current components of long term debt. 5. Prepare journal entries to account for GST 6. Reporting liabilities on financial statements 7. Evaluate an entity’s liquidity and solvency The University of Sydney

Readings: Chapter 9

Page 4

Not in student slides

Learning Objectives/Outcomes 1. Explain the differences between current and non-current liabilities. 2. Identify common types of current liabilities and explain how to account for them. 3. Identify common types of non-current liabilities, such as debentures and unsecured notes, and explain how to account for them. 4. Prepare journal entries for loans payable by instalment and distinguish between current and non-current components of long term debt. 5. Prepare journal entries to account for GST 6. Reporting liabilities on financial statements 7. Evaluate an entity’s liquidity and solvency The University of Sydney

Page 5

LO1 Current Liabilities – A current liability is an obligation that can reasonably be expected to be settled or discharged within one year. – Examples include: – notes payable – accounts payable – revenue received in advance – accrued liabilities

Why not use the word “paid”?

– Liabilities that do not meet this definition are classified as noncurrent

The University of Sydney

Page 6

Not in student slides

LO2 Learning Objectives/Outcomes 1. Explain the differences between current and non-current liabilities. 2. Identify common types of current liabilities and explain how to account for them. 3. Identify common types of non-current liabilities, such as debentures and unsecured notes, and explain how to account for them. 4. Prepare journal entries for loans payable by instalment and distinguish between current and non-current components of long term debt. 5. Prepare journal entries to account for GST 6. Reporting liabilities on financial statements 7. Evaluate an entity’s liquidity and solvency The University of Sydney

Page 7

Notes Payable Note issuer (a firm) (borrower)

Issue a note to Provides goods or cash

Note holder (e.g., a bank, or supplier) (lender)

– Notes payable record obligations in the form of written notes – Usually require borrower to pay interest or borrowing costs – Frequently issued to 1. meet short-term financing needs 2. purchase inventory on account. – Issued for varying periods of time – They can be reported on the Statement of Financial Position as either current or non-current liabilities The University of Sydney

Page 8

Active Learning Opportunity - Revision › Journal entry when $100 000 note issued for 4 months at 12% 1 Mar

Cash at bank

100 000

Notes payable (To record issue of 12% - 4-month note)

100 000

› YOUR TURN record journal entry for accrued interest on 30 June 30 Jun

Interest Expense

4 000

Interest Payable (To accrue interest for 4 months on note payable)

4 000

$100 000 x 0.12 = $12 000 per annum 4 months is ($12,000 / 12) *4 = $4 000 The University of Sydney

Page 9

Notes Payable – Journal entry to settle liabilities on 1 July 1 Jul

Notes Payable Interest Payable Cash at bank

100 000 4 000 104 000

(To record payment of note payable and accrued interest)

The University of Sydney

Page 10

Payroll and Payroll Deductions Payable

Dr Salaries and Wages Expense Cr Salaries and Wages Payable

Dr Salaries and Wages Payable Cr Cash at Bank

– Employers deduct amounts from employees’ wages and salaries if they are required to be paid to other parties – These include deductions for: – Tax (pay-as-you-go or PAYG) – Superannuation – Trade union fees – Health insurance – Employers are responsible to remit these withheld funds to the appropriate parties The University of Sydney

Page 11

Payroll and Payroll Deductions Payable › Entry for payroll accrual on 7 March 7 Mar

Salaries and Wages Expense Pay-As-You-Go Tax Payable

100 000 ATO

32 036

Employees Salaries and Wages Payable 67 964 (To record payroll and withheld taxes weekending 7 March)

› Entry for salaries and wages payment 7 Mar

Salaries and Wages Payable Cash at Bank

67 964 67 964

(To record payment of Payroll)

– Entry for PAYG payment 6 Apr

Pay-As-You-Go Tax Payable Cash at Bank

32 036 32 036

(To record payment of withheld taxes) The University of Sydney

Page 12

Revenues Received in Advance – Occurs when customers pay ahead of time for goods or services e.g. Purchase of plane tickets Magazine subscriptions Season passes to sporting events › Journal entry to record revenue received in advance 6 Aug

Cash at Bank

500 000

Ticket Revenue Received in Advance

500 000

(To record sale of 10 000 season tickets)

› Journal entry when $100 000 service is delivered 15 Aug Ticket Revenue Received in Advance Ticket Revenue (To record ticket revenue) The University of Sydney

100 000 100 000

Page 13

Not in student slides

Learning Objectives/Outcomes 1. Explain the differences between current and non-current liabilities. 2. Identify common types of current liabilities and explain how to account for them. 3. Identify common types of non-current liabilities, such as debentures and unsecured notes, and explain how to account for them. 4. Prepare journal entries for loans payable by instalment and distinguish between current and non-current components of long term debt. 5. Prepare journal entries to account for GST 6. Reporting liabilities on financial statements 7. Evaluate an entity’s liquidity and solvency The University of Sydney

Page 14

LO5 Overview of the GST Process (Appendix Chapter 4) › The GST is a value-added tax i.e., tax is levied on the valued added by a business at each stage of production and distribution chain › For GST purposes, goods and services are classified into three categories: 1. Taxable supplies are goods and services subject to the GST 2. GST-free supplies - basic food, education, health services, exports 3. Input taxed supplies - financial services and residential rents › Supplier can obtain an input tax credit for (2) but not for (3) › GST rates - Australia: 10% from 1 July 2000 - New Zealand: 15% from 1 October 2010

The University of Sydney

Page 15

Overview of the GST Process Refund $40 GST to the company $400 for a table

$40 GST

$40 GST $ 440 total Company (as a buyer)

Supplier (as a seller)

The tax office

b) Does the GST registered business claim input tax credits? Yes.

Overview of the GST Process – For GST purpose, goods and services are classified into three categories: Types of goods and serves

a) Does the GST b) Does the GST registered registered business (as a business (as a seller) collect GST buyer) claim input from customers tax credits? on behalf of ATO?

1) Taxable supplies (e.g., most goods and services) 2) GST free supplies (e.g., basic food, education, health services, exports) 3) Input taxed supplies (e.g., financial services, residential rents) The University of Sydney

Page 17

Accounting for GST

Purchasing inventory Example: Retailer purchases a table from manufacturer for $440 (GST inclusive) GST Inclusive

25 Jul

Price after GST/1.1 = Price before GST Inventory GST Paid

Asset, receivable from ATO

Cash at bank (To record purchase of inventory – furniture) The University of Sydney

GST Exclusive

400 40 440

Page 18

Accounting for GST Selling inventory Example: Retailer sells a table for cash $550 (GST inclusive) 30 Jul

Cash at bank GST Collected

550 50

Liability, payable to ATO

Sales Revenue Cost of Sales Inventory

500 400 400

(To record sale of inventory - furniture)

The University of Sydney

Page 19

Accounting for GST Remitting GST to the taxation authority – Where GST collected greater than GST paid difference to be remitted to ATO Net GST paid to ATO $10 = GST collected $50 - GST paid $40 = (selling price $500 - purchase price $400) * GST rate 10% 5 Aug

GST Collected GST Paid

Liability, payable to ATO Asset, receivable from ATO

Cash at Bank (To record payment of GST to ATO)

50 40 10

– Where GST collected is less than GST paid, the difference is to be refunded by the ATO The University of Sydney

Page 20

Accounting for GST 25 Jul

30 Jul

Inventory

400

GST Clearing Cash at bank

40

Cash at bank GST Clearing

550

440

50

Sales Revenue Cost of Sales Inventory 5 Aug

GST Clearing Cash at Bank

500 400 400 10 10

(To record payment of GST to ATO) – Alternatively a business can use one GST clearing account to record GST collected from customers and paid suppliers The University of Sydney

Page 21

Not in student slides

Learning Objectives/Outcomes 1. Explain the differences between current and non-current liabilities. 2. Identify common types of current liabilities and explain how to account for them. 3. Identify common types of non-current liabilities, such as debentures and unsecured notes, and explain how to account for them. 4. Prepare journal entries for loans payable by instalment and distinguish between current and non-current components of long term debt. 5. Prepare journal entries to account for GST 6. Reporting liabilities on financial statements 7. Evaluate an entity’s liquidity and solvency The University of Sydney

Page 22

LO3 Non-Current Liabilities – Obligations expected to be settled after 1 year – Common forms of these obligations are: – Bank loans – Long-term notes – Debentures are notes that are subject to a secured charge on the issuers assets – Unsecured notes are not subject to a security over assets

The University of Sydney

Page 23

Why Issue Long-Term Notes? Advantages of Debt Financing – Shareholder control is not affected – Current owners retain full control of company – Tax savings result – Interest is deductible for tax purposes; dividends on shares are not – Earnings per share may be higher – Although interest expense reduces net profit, earnings per share may be higher because no additional shares are issued Earnings per share ൌ

The University of Sydney

Earnings Number of shares Page 24

Why Issue Long-Term Notes? Disadvantage of Debt Financing – Company is locked into fixed payments which must be made in good and bad times – Interest must be paid on periodic basis – Principal must be paid at maturity – Company with fluctuating earnings and relatively weak cash flow may experience difficulty in meeting interest payments in periods of low earnings

The University of Sydney

Page 25

Long-Term Note Issue

Note issuer (a firm) (borrower)

Issue a note to Pays cash to

Note holder (i.e., investors) (lender)

› A note issuer receives cash in exchange for issuing long-term notes › When a note issuer decides to issue long-term notes, it must decide: - The number of long-term notes to be issued - At what price every long-term note should be issued i.e., Issue price - Contract interest rate used to determine the amount of interest the borrower pays and the investor receives - The principal that is due at maturity (i.e. face value) › Market value of the note is the price at which it is traded by willing parties, and may vary over time The University of Sydney

Page 26

Determining the Market Value of Long-term Notes – The present value of a note is the face value plus the contractual interest rate for the life of the debt, stated in today’s equivalent dollar terms: – affected by cash amounts to be received (face value + contractual interest rate) – by length of time until investor receives cash – by current market rates ► Present value = current market value

The University of Sydney

Page 27

Determining the Market Value of Long-term Notes Face value Contractual interest rate – Illustrative example 1: – 1 Jan 2012 Issue $100 000 of 9%, 5yr unsecured notes – Calculation of present value of future payments Present value of $100 000 received in 5 years Present value of $9 000 received annually for 5 years Issue or market price of notes This is the current “market” rate! Issue price

The University of Sydney

Page 28

Accounting for Issues of Unsecured Notes and Debentures – Journal entries are required when long-term debt is issued or repaid – If one investor sells to another investor, no journal entry is required – Face value of long-term debt is often different than amount of cash received from investors: Issue price vs face value

Contract interest rate vs market interest rate

contract interest rate = market interest rate Notes issued issue price = face value 8% = 8% at face value Notes issued at a discount

issue price < face value

contract interest rate < market interest rate 8% < 10%

Notes issued contract interest rate > market interest rate issue price > face value 10% > 8% at a premium The University of Sydney

Page 29

Active Learning Opportunity – Illustrative example 2: Complete the journal entry for issuing 100, 10%, 10 year $1 000 debentures issued at face value on 30 June $1000 * 100 = $100 000 30 Jun

Cash at bank

100 000

Debentures Payable (To record issue of debentures at face value)

100 000

– Journal entry to record payment of interest 31 Dec Interest Expense Cash at Bank

5 000 5 000

(To record payment of debenture interest)

The University of Sydney

$100 000 X 0.10 = 10 000 per annum 6 months is 10 000 ÷ 2 = 5 000

Page 30

Redeeming Unsecured Notes and Debentures at Maturity – Notes are redeemed when they are purchased (repaid) by the issuing company – At maturity carrying amount of the notes will always equal their face value – Entry to record redemption at maturity 30 Jun

Debentures Payable

100 000

Cash at bank (To record redemption of debentures at maturity)

The University of Sydney

100 000

Page 31

Redeeming Unsecured Notes and Debentures at Maturity – Notes may be redeemed before maturity – A company may decide to redeem notes early to reduce interest cost and remove debt – Company must: – Eliminate carrying amount of notes at redemption date – Record cash paid – Recognise gain or loss on redemption – Journal entry to record redemption of debenture early at 103% of face value 30 Jun

Debentures Payable Loss on Redemption of Debenture

100 000 3 000

Cash at bank (To record redemption of debentures at 103) The University of Sydney

103 000 Page 32

Not in student slides

Learning Objectives/Outcomes 1. Explain the differences between current and non-current liabilities. 2. Identify common types of current liabilities and explain how to account for them. 3. Identify common types of non-current liabilities, such as debentures and unsecured notes, and explain how to account for them. 4. Prepare journal entries for loans payable by instalment and distinguish between current and non-current components of long term debt. 5. Prepare journal entries to account for GST 6. Reporting liabilities on financial statements 7. Evaluate an entity’s liquidity and solvency The University of Sydney

Page 33

LO4 Loans Payable by Instalment – Entities may borrow money from a single lender in the form of loan – It is common for such loans to be repayable by instalment, e.g. mortgages – A mortgage is a loan secured by a charge over property – If the borrower is unable to repay the loan, the lender may sell the property used as security over the loan and use the proceeds to repay the loan

The University of Sydney

Page 34

Accounting for Loans Payable by Instalment – Mortgage payments consist of: – Interest expense and – Reduction of loan liability – Journal entry to record mortgage payment 30 Jun

Loan Payable

1 000

Interest Expense Cash at bank

9 000 10 000

(To record loan repayment including interest)

The University of Sydney

Page 35

Not in student slides

Learning Objectives/Outcomes 1. Explain the differences between current and non-current liabilities. 2. Identify common types of current liabilities and explain how to account for them. 3. Identify common types of non-current liabilities, such as debentures and unsecured notes, and explain how to account for them. 4. Prepare journal entries for loans payable by instalment and distinguish between current and non-current components of long term debt. 5. Prepare journal entries to account for GST 6. Reporting liabilities on financial statements 7. Evaluate an entity’s liquidity and solvency The University of Sydney

Page 36

LO6 Reporting Liabilities on Financial Statements – Current component: – Entities often have a portion of long-term debt that falls due within the coming year – This portion of the long-term debt should be classified as a current liability – Non-current component: – The remainder will be classified as a non-current liability – An adjusting entry is not necessary to recognise the current portion of the liability. It is recognised by proper classification o...