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Class 10
Liabilities and Equity
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 Mean: 83 Median:87 Max: 99 (4 students) 98 (10 students)

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Recap

Value in use
Carry Amount vs Recoverable Amount Fair Value less Costs
 Asset Impairment
▪Depreciation (Dr. dep exp xxx / Cr. A/D xxx) incurred up to
 Disposal of PP&E
the point in the year when the asset is sold.
 Intangible Assets ▪Remove asset’s cost
▪Remove accumulated depreciation
 Sales Revenue
▪Record proceeds
▪Record any gain or loss
Amount by which the purchase price exceeds the fair market value of
net assets acquired (M&A).
Total Sales Internally generated goodwill is not recorded.
Credit Card Fees (Operating Expenses)
- Sales Discounts
- Sales Returns and Allowances
Net Sales
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Class progress

Recording Accrual Financial

Introduction
Transactions Accounting Statements

Receivables Non-current Liabilities &

Inventory
and cash Assets Equity

Financial
Statement of
Statement
Cash Flow
Analyses
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Agenda

 Current Liabilities
 Non-Current Liabilities
 Share Issuance
 Share Repurchase
 Dividends
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Liabilities

 The acquisition of assets and

payments for goods and
services is financed from two
sources:
 Equity: funds from owners
Capital
Structure
 Debt: funds from creditors
▪ Current liabilities
▪ Long-term liabilities
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Liabilities

 Defined as probable debts or obligations of the entity that result from past
transactions, which will be paid with assets or services.

Maturity = 1 year or less Maturity > 1 year

Current Liabilities Long-term Liabilities

Why do we need to know whether a liability is current or long-term?

• Evaluate liquidity of a company

• Determine the order of payment in case of bankruptcy.
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Wait! So how are Accrued Ls different from
the AP?
Current Liabilities - AP: Typically what you owe to suppliers
- Normally get an invoice for A/P (exact
calculation vs. estimate for accrued)

Also Called Definition

Accounts Trade Accounts Obligations to pay for goods and services used in the basic
Payable Payable operating activities of the business.

Unearned Obligations arising when cash is received prior to the

Deferred Revenues
Revenues related revenue being earned. (e.g., Starbucks card)

A formal written contract with a bank and reports the

Notes Payable N/A
amount borrowed

Obligations related to expenses that have been incurred,

Accrued
Accrued Expenses but will not be paid until the subsequent period. (e.g., tax
Liabilities payable, wage payable, interest payable)
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Current Liabilities – Accounts Payable

 Accounts Payable represents future obligations to suppliers for goods and services
purchased.
 Think of this as credit extended to the company by a supplier
 Journal entries:
▪ When goods/services have been received (assume the invoice and goods/services come
together):

Inventory (+A) XX
Accounts Payable (+L) XX
▪ When payment is made:

Accounts Payable (-L) XX

Cash (-A) XX
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Current Liabilities – Unearned Revenue

 Cash is received from customers but revenue has not been earned (goods or
services have not yet been provided).
 Instead of crediting “sales revenue” which would flow through to the income
statement, when a firm receives cash:
Cash (+A) XX
Unearned Revenue (+L) XX

 When revenue is earned (perform service or provide product):

Unearned Revenue (-L) XX

Sales Revenue (+R, +SE) XX
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Current Liabilities – Notes Payable

 Pomona Corporation signed a 90-day note on November 1, 2021 for $10,000 with 6
percent annual interest in exchange for equipment. Its fiscal year end date is Dec 31.
Nov. 1 Equipment 10,000
Notes payable 10,000
To record purchase of equipment.

Dec. 31 Interest expense 100

Interest payable 100
To accrue interest expense (($10,000 x 0.06 x 2/12).

Jan. 31 Interest expense 50

Interest payable 100
Notes payable 10,000
Cash 10,150
To record payment of note and interest.
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Current Maturities of Long-Term Debt

 The part of the loan that is due in the coming financial year
 An entity reclassifies (from long-term debt to a current liability) the amount of its
long-term debt that must be paid the next year
 Example: Wendy Construction issues a five-year, interest-bearing $25,000 note on
January 1, 2016. This note specifies that each January 1, starting January 1, 2017,
Wendy should pay $5,000 of the note. When the company prepares financial
statements on December 31, 2016,
What amount should be reported as a current liability?
$5,000
What amount should be reported as a long-term liability?
$20,000
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Quick Question

Purdum Farms borrowed $10 million by signing a five-year note on December 31,
2017. Repayments of the principal are payable annually in installments of $2
million each. Purdum Farms made the first payment on December 31, 2018 and
then prepares its balance sheet. What amount will be reported as current and long-
term liabilities, respectively, in connection with the note at December 31, 2018,
after the first payment is made?

A. $2 million in current liabilities and $8 million in long-term liabilities.

B. $2 million in current liabilities and $6 million in long-term liabilities.
C. Zero in current liabilities and $8 million in long-term liabilities.
D. Zero in current liabilities and $10 million in long-term liabilities.
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Contingent Liabilities

 Potential liabilities that arise because of events or transactions that have already occurred.
▪ Possible obligation to be confirmed by a future event; or
▪ Present obligation that may/may not require outflow of resources; or
▪ Reliable estimate of amount of present obligation cannot be made.
▪ Corporate guarantees, lawsuits, tax disputes, or alleged violations of environmental
protection laws
 Define potential?
▪ Remote: the chance the event creating this liability will occur is slight.. – Do nothing.
▪ Reasonably Possible: Future event is more than remote, but less than likely. – Disclose in a note.
▪ Probable: Future event is likely to occur
o If can estimate the amount – Recognize.
o If can’t estimate – Disclose in a note.
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Contingent Liabilities

 Probable & estimate-able liabilities:

Dr Warranty expense 2,000,000

Cr Estimated warranty liability (Warranty Payable) 2,000,000

 Reasonably Possible Lawsuits (Disclosure of litigation contingencies— JP Morgan Chase)

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Quick Question

Young Company is involved in a lawsuit. When would the lawsuit be recorded as

a liability on the balance sheet?

A. When the loss probability is remote and the amount can be reasonably
estimated.
B. When the loss is probable and the amount can be reasonably estimated.
C. When the loss probability is reasonably possible and the amount can be
reasonably estimated.
D. When the loss is probable regardless of whether the loss can be reasonably
estimated.
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Warranty – Contingent liability

Monthly sales were $150,000. Warranty costs are estimated at 5% of monthly sales.
In the month of sale, the company should record a debit to:
A. Warranty Payable for $7,500.
B. Warranty Expense for $7,500.
C. Sales for $7,500.
D. None of the above. No entry is required since the actual liability amount is not
known. Dr Warranty Expense
Cr Warranty Payable
Jaye's Company paid $750 cash to replace a part on equipment sold under warranty.
To recognize the payment, which of the following is correct?
A. Debit Warranty Payable and credit Cash
B. Debit Warranty Expense and credit Cash
C. Debit Equipment Expense and credit Cash
D. Debit Parts Expense and credit Cash

Dr Warranty Payable
Cr Cash
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Long-term Liabilities

Maturity = 1 year or less Maturity > 1 year

Current Liabilities Long-term Liabilities

 Noncurrent (long-term) liabilities:

All obligations that are not classified as current liabilities.
▪ Lease liabilities
▪ Private financing: Long-term loan (notes payable)
▪ Public financing: Bonds payable
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Lease

 The lessee (e.g., Delta) has the right to use the asset (an aircraft) and in return must
make periodic payments to the lessor (e.g., Boeing), the owner of the asset.
 Two types of leases (from the perspective of Delta)
Finance/Capital Leases Operating Leases

• Treated like a purchase of property • Treated like a rental, sometimes cancelable

• Record Lease Asset and Lease Liability on • Previously, NO asset or liability on the B/S
Balance Sheet • Under old standards, record Lease Expenses
• Record Depreciation Expense and Interest on the Income Statement
Expense on Income Statement

 You are the CEO of a company that uses a lot of equipment. Which of these
treatments would you prefer?
Most CEOs would pick operating lease to report less debt.
Is doing so for this reason OK? Nope.
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Capital/Finance Lease

Is capital lease if meet any of the following criteria:

▪ The lease transfers substantially all risks and rewards of the asset to the lessee
▪ The lease transfers ownership of the asset to the lessee at the end of the lease
▪ The lease term represents a substantial part of the asset’s useful life
▪ The present value of the lease payments represents a substantial part of the fair value
of the asset

Translation: If it looks more like the asset is being purchased rather than used on a short-
term basis, the company must treat it more like a purchase (hence, finance lease treatment).

Many firms structure lease contracts around these requirements such that
they can record operating instead of capital leases.
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Lease

Operating lease requires

disclosure of lease
payments for future years.
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Journal Entries for Leases

After IFRS 16/ASC 842

 No longer distinguish operating vs. capital lease.
 For both operating & capital lease:
▪ Step 1 - record lease asset
Dr. Lease Asset / Right-of-use asset
Cr. Lease Liability
▪ Step 2 - record lease payment
Dr. Lease Liability
Dr. Interest Expense
Cr. Cash

Don’t forget depreciation expense each year.

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Bonds
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Bonds

 Significant debt needs are often filled by issuing debt securities (bonds) to the public.
 Companies are not the only entities that go to the bond markets to raise capital;
governments around the world also issue bonds for the same reason.
 Investors can trade bonds on established exchanges (such as New York Bond
Exchange); provide investors with liquidity.

Why bonds over equity?

 Stockholders maintain control (no voting rights).
 Interest expense is tax deductible.
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Bonds

 Unsecured bond: No assets are pledged as a guarantee of repayment at maturity.

 Secured bond: Specific assets are pledged as a guarantee of repayment at maturity.

 Callable bond: Contains a call feature that allows the bond issuer to retire the bond
early.

 Convertible bond: Contains a conversion feature that allow the bonds to be

converted into issuer’s common stock.

Different types of bonds have different characteristics for good economic reasons.
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Agenda

 Current Liabilities
 Non-Current Liabilities
 Share Issuance
 Share Repurchase
 Dividends
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Corporations – Shareholder Rights

 Vote in election of board of directors and on

actions that require stockholder approval.

 Share the corporate earnings through receipt

of dividends.
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Corporations – Shareholder Rights

 Keep the same percentage ownership when new shares of stock are issued
(preemptive right).

 Share in assets upon liquidation in proportion to their holdings. This is called

residual claim.
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Structure in a Corporation
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Quick Question

A corporation:
A. cannot own property.
B. is managed by the shareholders.
C. has owners who have mutual agency.
D. has owners who have limited liability
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Share Terminology (Chipotle Example)
Management can issue up to 230 million
Authorized Shares shares of common stock per the articles of
incorporation.

As of Dec. 31, 2016, 35.833

Unissued Issued million shares had been issued.
As of Dec. 31, 2016, 194.167 Journal Entries
million shares were unissued.

Outstanding Treasury
(= Issued – Treasury)
As of Dec. 31, 2016, they had bought
Outstanding = Issued – Treasury = 35.833 – 7.019 = 28.814 back 7.019 million shares.
million shares outstanding (use this value in per-share ratios)
Chipotle Mexican Grill, Inc. (from Balance Sheet)
Stockholders’ Equity (in thousands except per-share data)
Common stock—$0.01 par value—230,000 shares authorized, and 35,833 and 35,790 shares issued as of
December 31, 2016 and 2015, respectively.
Additional paid-in capital
Treasury stock, at cost, 7,019 and 5,206 common shares at December 31, 2016 and 2015, respectively.
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Quick Question

RKJ Company has provided the following information:

▪ 100,000 shares of $5 par value common stock are authorized
▪ 70,000 shares have been issued
▪ 65,000 shares are outstanding
Which of the following statements is correct?

A. RKJ can issue an additional 30,000 shares of treasury stock.

B. RKJ has 30,000 shares of treasury stock.
C. RKJ can resell 5,000 shares of treasury stock.
D. RKJ can issue an additional 35,000 shares of common stock.
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Share Terminology

 Ordinary Shares
▪ The most basic type of share capital.
▪ Also called “common stock”
 Preference Shares
▪ Certain advantages over ordinary shareholders.
▪ Dividend preference: entitled to dividend before ordinary shareholders.
▪ Asset distribution preference: In case of liquidations.
▪ Also called “preferred stock”
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Share Terminology

 Par Value
▪ The lowest legal price for which a corporation may sell its shares.
▪ To define legal capital – the minimum amount of contributed capital that
must be maintained.
▪ Of little significance today. Carry-over from old bankruptcy law.
▪ No-par value stock might be permitted under certain regulatory
frameworks. A “stated value” is set for no-par stocks.
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Share Issuance

Ordinary Shares/
Common Stocks
Paid-in Capital in
Paid-in Capital
Excess of Par
Preference Shares/
Preferred Stocks
Additional Paid-in Capital

Two Primary
Sources of Equity Retained Earnings

Paid-in capital is the total amount of cash/assets paid into the corporation by
shareholders in exchange for shares of ownership.
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Share Issuance

 Initial Public Offering (IPO) or Seasoned Equity Offering (SEO)

 Journal entry:
Cash XXX ← Selling price X # shares sold
Common Stock (at Par) YYY ← “Par Value” X # of shares sold
Additional Paid-in Capital ZZZ ← Remainder of selling price
 Stock is valued on the books at its historical cost at the time of issuance,
not the current market value.

Paid-in Capital in Excess of Par Value

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Share Issuance - Example

 Assume that Hydro-Slide, Inc. issues 2,000 shares of $1 par value ordinary
shares. Prepare Hydro-Slide’s journal entry if (a) 1,000 share are issued for $1
per share, and (b) 1,000 shares are issued for $5 per share.
(a) Dr. Cash 1,000
Cr. Ordinary Shares (1,000 x $1) 1,000

(b) Dr. Cash 5,000

Cr. Ordinary Shares (1,000 x $1) 1,000
Cr. Additional Paid-in Capital (APIC) 4,000
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Share Issuance - Example

 Stockholders’ equity section assuming Hydro-Slide, Inc. has retained earnings of

$27,000. How much is the total stockholder’s equity?
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Share Issuance - Example

 Assume that Hydro-Slide, Inc. issues 2,000 shares of no par value ordinary shares.
Prepare Hydro-Slide’s journal entry if 2,000 shares are issued for $3 per share.
(c) Dr. Cash 6,000
Cr. Common Stock(2,000 x $3) 6,000

Ordinary Shares
 Shares Issued for Assets Other than Cash. On November 12, Kahn Corporation
issued 15,000 shares of its $1 par ordinary shares for equipment worth $4,000 and a
building worth $120,000. Kahn’s entry is:
(d) Dr. Equipment 4,000
Dr. Building 120,000
Cr. Common Stock(15,000 x $1) 15,000
Cr. APIC (Paid-in Capital in Excess of Par) 109,000
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Share Issuance - Example

 Ordinary Shares Issued for Services. Kahn Corporation engages a web designer to
create the company’s website. The website designer would ordinarily charge $25,000
for such services but agrees to accept 2,500 shares of $1 par common stock, in
settlement of the fee. The fair market value of the stock is $10 per share.
(e) Dr. Website Development Expenses 25,000
Cr. Ordinary Shares (2,500 x $1) 2,500
Cr. APIC (Paid-in Capital in Excess of Par) 22,500

 Stine Corporation issues 10,000 shares of $10 par value preference shares for $12
cash per share. Journalize the issuance of the preference shares.
Dr. Cash 120,000
Cr. Preference Shares (10,000 x $10) 100,000
Cr. APIC (Paid-in Capital in Excess of Par) 20,000
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Quick Question

Irish Corporation issued (sold) 11,000 shares of common stock for $69 per share.
The bylaws established a stated value of $5 per share. What is the amount of
increase in the common stock account as a result of this transaction?

A. $55,000.
B. $704,000.
C. $0.
D. $759,000.
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Agenda

 Current Liabilities
 Non-Current Liabilities
 Share Issuance
 Share Repurchase
 Dividends
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Treasury Stocks

 How it works:
▪ A company buys back its own stock from investors at the market price
▪ No voting rights, no dividend rights
▪ The repurchase cost is reflected in a contra-equity account called “Treasury
Stock”
▪ When/if resold, the difference between the original repurchase cost and the
sales price is recorded in Additional-Paid-In-Capital (usually credited)
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Treasury Stocks

 Why?
▪ To signal management thinks stocks are undervalued. (Buy low, sell high)
▪ Benefits investors without setting dividend precedent
▪ Reduce shares outstanding, which improves performance metrics (EPS)
▪ To have shares on hand for bonus and stock compensation
▪ To have shares available for use in acquiring other companies.
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Treasury Stocks - Example

 Kitzer Corporation acquires 200 shares of its ordinary shares for $15/share.
Dr. Treasury Stock (+xSE, - SE) 3,000
Cr. Cash (-A) 3,000
To record the purchase of 200 shares of treasury shares
 Kitzer later resells 100 shares of its treasury shares for $20/share.
Dr. Cash (+A) 2,000
Cr. Treasury Stock (-xSE, +SE) 1,500
Cr. APIC (+SE) 500
To record the sale of 100 shares of treasury shares.

 What if the re-issuance price was $10 instead of $20?

Dr. Cash (+A) 1,000
Dr. APIC (-SE) 500
Cr. Treasury Stock (-xSE, +SE) 1,500
To record the sale of 100 shares of treasury shares.
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Treasury Stocks - Example

 Kitzer Corporation used 50 treasury shares for employee compensation, which was
purchased at $15/share.
Dr. Share Compensation Expense 750
Cr. Treasury Shares 750
To record the reissuance of treasury shares for employee share option

 Kitzer decided to retire the rest 50 shares of its treasury shares by canceling them.

Dr. Share Capital 750

Cr. Treasury shares 750

To record the cancellation of 50 shares from treasury shares.

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Quick Question

CGJ Company has provided the following:

• 200,000 shares of $5 par value common stock are authorized
• 140,000 shares of common stock were issued for $11 per share
• 130,000 shares are outstanding
Which of the following statements is false?
A. Common stock is reported at $700,000 on the balance sheet.
B. Additional paid-in capital is reported at $840,000 on the balance sheet.
C. Stockholders' equity decreased $110,000 when the treasury stock was purchased.
D. There are 10,000 shares of treasury stock.