Financial Accounting
Current
Liabilities
Chapter 8
Spiceland | Thomas | Herrmann
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
8-2
Learning Objectives
• Distinguish between current and long-term
liabilities
• Account for notes payable and interest expense
• Account for employee and employer payroll
liabilities
• Explain the accounting for other current liabilities
• Apply the appropriate accounting treatment for
contingencies
• Assess liquidity using current liability ratios
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
8-3
Part A
Current Liabilities
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
8-4
Current Liabilities
• Liability: a present responsibility to sacrifice
assets in the future due to a transaction or other
event that happened in the past
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
8-5
Learning Objective 1
Distinguish between current and long-term liabilities
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
8-6
Current vs. Long-Term Liabilities
Current
• Payable within
one year or an
operating cycle
Long-Term
• Payable more
than one year or
an operating cycle
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
8-7
Learning Objective 2
Account for notes payable and interest expense
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
8-8
Notes Payable
• Note signed by a firm promising to repay the
amount borrowed plus interest
• Interest on notes is calculated as:
Interest
=
Face
value
Annual
× interest rate ×
Fraction
of the year
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
8-9
Line of Credit & Commercial Paper
• Line of credit:
• Informal agreement
• Permits a company to borrow up to a prearranged
limit
• No formal loan procedures and paperwork
• Commercial paper:
• Company borrows from another company rather
than from a bank
• Sold with maturities normally ranging from 30 to
270 days
• Interest rate is usually lower than on a bank loan
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
8-10
Accounts Payable
• Amounts owed to suppliers of merchandise or
services
• Sometimes called trade accounts payable
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
8-11
Learning Objective 3
Account for employee and employer payroll
liabilities
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
8-12
Illustration 8.3—Payroll Costs for
Employees and Employers
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
8-13
Employee Costs
• Federal and state income taxes
• FICA taxes
• 7.65% (6.2% + 1.45%)
• Collectively, Social Security and Medicare taxes
• Employees may opt to have additional amounts
withheld from their paychecks
• Employer records the amounts deducted and
pays them to the appropriate organizations
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
8-14
Employer Costs
• Additional (matching) FICA tax on behalf of the
employee
• Employers also pay federal and state
unemployment taxes on behalf of its employees
• FUTA and SUTA
• Fringe benefits: Additional employee benefits
paid for by the employer
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
8-15
Illustration 8.4—Payroll Example
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
8-16
Learning Objective 4
Explain the accounting for other current liabilities
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
8-17
Other Current Liabilities
• Unearned revenues: liability account used to
record cash received in advance of the sale or
service
• Sales tax payable: collected from customers by
the seller
• Current portion of long-term debt: debt that will
be paid within the next year
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
8-18
Current Portion of Long-Term Debt
• Debt that will be paid within the next year
• Provides information about a company’s
bankruptcy risk
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
8-19
Illustration 8.6—Current Portion of
Long-Term Debt
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
8-20
Part B
Contingencies
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
8-21
Learning Objective 5
Apply the appropriate accounting treatment for
contingencies
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
8-22
Contingent Liabilities
• An existing uncertain situation that might result in
a loss
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
8-23
Illustration 8.8—Accounting
Treatment of Contingent Liabilities
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
8-24
Warranties
• Most common example of contingent liabilities
• Help increase sales
• Warranty expense is recorded in the same
accounting period as the sale
• It should be probable and the amount can be
reasonably estimated
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
8-25
Contingent Gains
• An existing uncertain situation that might result in
a gain
• Not recorded until the gain is certain
• Conservative reasoning
• Not recorded in the accounts
• Firms sometimes disclose them in notes to the
financial statements
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
8-26
Learning Objective 6
Assess liquidity using current liability ratios
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
8-27
Liquidity Analysis
• Liquidity: refers to having sufficient cash or other
current assets to pay currently maturing debts
• Lack of liquidity can result in financial difficulties
or even bankruptcy
• Three liquidity measures:
• Working capital
• Current ratio
• Acid-test ratio
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
8-28
Working Capital
• A large positive working capital is an indicator of
liquidity
• Not the best measure of liquidity for comparison
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
8-29
Current Ratio
• Ratio of 1 or higher often reflects an acceptable
level of liquidity
• Higher the current ratio, the greater the
company’s liquidity
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
8-30
Acid-Test Ratio or Quick Ratio
• Based on a more conservative measure
• Quick assets are readily convertible into cash
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
8-31
Effect of Transactions on
Current Ratio and Acid-Test Ratio
• Same denominator: current liabilities
• Decrease in current liabilities will increase the ratios
• Increase in current liabilities will decrease the ratios
• Different numerator: current assets; quick assets
• Increase in cash, current investments, and accounts
receivable will increase both ratios
• Increase to inventory or other current assets will
increase the current ratio, but not the acid-test ratio
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
8-32
Liquidity Management
• Management can influence the ratios that
measure liquidity
• Debt covenant: agreement between a borrower
and a lender that requires certain minimum
financial measures be met or the lender can recall
the debt
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
8-33
End of Chapter 8
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.