Debt Financing: Current and Long-term Liabilities

Chapter 9: Debt Financing

Debt Classification

  • Current Liabilities:

    • Expected to be paid within one year or one operating cycle, whichever is longer.

    • Examples: Accounts payable, wages payable, unearned revenue, short-term notes payable.

  • Long-term Liabilities:

    • Expected to be paid beyond one year or one operating cycle.

    • Examples: Mortgages, long-term bank loans, bonds payable.

Learning Objectives

  • LO1: Identify and explain the distinctions between current and long-term liabilities.

  • LO2: Record and disclose known current liabilities such as payroll, taxes, and accounts payable.

  • LO3: Record and disclose estimated current liabilities, primarily warranties and income taxes.

  • LO4: Identify, describe, and record bonds, including their characteristics and accounting treatments.

  • LO5: Explain, calculate, and record long-term loans with associated journal entries.

Current and Estimated Liabilities

  • Known Current Liabilities: Amount, payee, and timing of payment are known.

    • Examples: Payroll liabilities, taxes payable.

  • Estimated Current Liabilities: Amount uncertain but can be estimated (e.g., warranties).

  • Contingent Liabilities: Not recorded unless probable and reliably estimated; disclosed in notes otherwise.

Bonds Payable

  • Bonds interest paid at regular intervals; principal repaid at maturity.

  • Bond types include secured, unsecured, registered, and bearer bonds.

  • Bonds can be issued:

    • At par when market interest = bond rate.

    • At a premium when market interest < bond rate.

    • At a discount when market interest > bond rate.

Long-term Loans

  • Loans are secured and often paid back through equal blended payments combining principal and interest.

  • Loan entries involve recording cash received and interest expenses, similar to bonds but without discounts or premiums.

Accounting Entries

  • Bonds at Par:

    • Debit: Cash, Credit: Bonds Payable.

  • Bonds at Premium:

    • Debit: Cash, Credit: Bonds Payable, Premium on Bonds Payable.

  • Bonds at Discount:

    • Debit: Cash, Debit: Discount on Bonds Payable, Credit: Bonds Payable.

Key Takeaways

  • Accurate liability classification on the balance sheet is crucial for understanding liquidity and financial health.

  • Both current and long-term liabilities must be recorded precisely, considering their implications for financial decision-making.