GSBA 510 Lecture Deck Class 19 20 and 21 F24 V1 (3)

Introduction

• Accounting Concepts and Financial Reporting GSBA 510 Classes 19, 20 and 21: Liabilities (DeFond, Chapter 9)

• USC Leventhal School of Accounting, University of Southern California

Class Recording Announcement

• Classes will be recorded via Zoom and Panopto.

• Be aware that your contributions may be recorded.

Class Topics

• Focus on Liabilities (DeFond, Chapter 9)

Learning Objectives

Learning Objective 1

• Describe the nature of liabilities and define current liabilities.

Learning Objective 2

• Define long-term liabilities.

Learning Objective 3

• Explain bond pricing and amortization methods.

Learning Objective 4

• Describe accounting for leases.

Learning Objective 5

• Define contingent liabilities and their disclosure.

Learning Objective 6

• Define financial ratios related to current liabilities.

Overview of Liabilities

• Definition: Obligations to pay money or provide goods/services in the future, stemming from past transactions.

• Categories of Liabilities:

  • Current Liabilities: Due within one year or operating cycle.

  • Long-term Liabilities: Due after one year.

Types of Current Liabilities

• Accounts Payable: Amounts owed to short-term creditors, typically non-interest bearing.

• Notes Payable: Formal notes with fixed terms that usually bear interest.

• Accrued Interest Payable: Need for adjustments at the end of the period.

• Current Portion of Long-term Debt: Principle portion due within a year.

• Income Taxes Payable: Amount owed to tax authorities.

• Unearned Revenue: Cash received for future deliveries of goods/services.

Interest on Promissory Notes

Two methods of structuring interest:

1. Add-on Interest Method: Interest is shown separately, calculated based on the face amount of the note.

2. Discount Method: Interest is included in the note's face amount.

Interest Calculation - Add-On Method

• Interest paid at maturity is calculated using the formula:Interest = Principal x Interest Rate x Time

• Example: Interest on a 3-month Note Payable for $8,000 at an annual rate of 4% = $80.

Maturity Date

• Determining maturity requires counting days or months.

• Example: A 90-day note dated March 15 matures on June 13.

Recording Notes Payable and Interest

• When issued by Optical Company to settle accounts payable (e.g., a 4-month, 6% note payable for $15,000).

Accrued Interest Payable Example

• For Pomona Corporation’s 3-month note for $10,000 at 6% interest, calculating interest expense and total cash payment.

Unearned Revenue Example

• When cash is received in advance, such as when Southwest Airline sells a ticket for future travel.

  • Journal Effects: Record unearned revenue upon receipt; recognize revenue upon service delivery.

Learning Objective 2: Long-Term Liabilities

• Debt Financing vs. Equity Financing.

• Common long-term financing methods:

  1. Bonds: Publicly issued long-term debt instruments.

  2. Term Loans: Arranged with a single lender.

Advantages/Disadvantages of Long-Term Bonds and Notes

Advantages:

• No dilution of ownership.

• Tax deductibility of interest.

• Leverage to increase shareholder income.

Disadvantages:

• Obligation to pay interest.

• Specific repayment dates.

• May restrict company actions through borrowing agreements.

Bonds Payable

• Types of Bonds:

  • Secured Bonds: Collateral pledged.

  • Debenture Bonds: Based on creditworthiness.

  • Serial Bonds: Mature over years.

  • Convertible Bonds: Can convert to stock.

  • Zero-Coupon Bonds: No interest payments, large discount at issuance.

Bond Features

• Call Provisions: Options for issuer to redeem under specific conditions.

• Sinking Fund Provisions: Annual retirement of bonds or setting aside funds for future bond retirements.

Bond Pricing and Valuation

• Bonds sold at market value, equal to present value of future cash payments (maturity and interest).

• Bonds may sell at premium or discount based on the relationship between coupon rates and market rates.

Times-Interest-Earned Ratio

• Indicates ability to meet interest payments; calculation involves pre-tax income before interest expense.

  • Higher ratios are preferred.

Environmental, Social, and Governance (ESG)

• Companies should leverage their competencies in social responsibility efforts, particularly in managing contingent liabilities associated with environmental practices.

Conclusion

• Class topics will continue in the following classes, including Quiz 4 covering Chapters 8 and 9 and Statement of Cash Flows (Chapter 11).