JJW ACCT647
C HAPTER 11
C URRENT L IABILITIES

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D EFINING L IABILITIES

C LASSIFYING L IABILITIES
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Expected to be paid within one year or the company ’ s operating cycle, whichever is longer.
Not expected to be paid within one year or the company ’ s operating cycle, whichever is longer.

C URRENT L IABILITIES
Current Liabilities as a Percent of Total Liabilities
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Current Liabilities depend on the type of company operations and whether physical products are involved or just services.

U NCERTAINTY IN L IABILITIES
Uncertainty in
Whom to Pay
Uncertainty in
When to Pay
Uncertainty in How
Much to Pay
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K NOWN
L
Accounts Payable
Sales Taxes Payable
Unearned Revenues
Short-Term Notes Payable
Payroll Liabilities
Multi-Period Known Liabilities

(1) S ALES T AXES P AYABLE
Sales taxes are called goods and services taxes in some countries. On August 31, Harvey Norman sold materials for $6,000 that are subject to a 10% goods and services tax (GST).
$6,000 × 10% = $600
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(2) U NEARNED R EVENUES
On June 30, Beyonce sells $5,000,000 in tickets for eight concerts.
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On Oct. 31, Beyonce performs a concert.
$5,000,000 / 8 = $625,000

(3) S HORT -T ERM N OTES P AYABLE
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N OTE G IVEN TO E XTEND
C REDIT P ERIOD
On August 23, Brady Company asks McGraw to accept $100 cash and a 60-day, 12% $500 note to replace its existing $600 Account Payable.
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N OTE G IVEN TO E XTEND
C REDIT P ERIOD
On October 22, Brady pays the note plus interest to McGraw.
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Interest expense = $500 × 12% × (60 ÷ 360) = $10

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NOTE GIVEN TO BORROW
FROM BANK

N OTE G IVEN TO B ORROW
FROM B ANK
On Sept. 30, a company borrows $2,000 from a bank at 12% interest for 60 days.
On Nov. 29, the company repays the principal of the note plus interest.
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Interest expense = $2,000 × 12% × (60 ÷ 360) = $40

Note
Date
E ND OF -P ERIOD A DJUSTMENT
TO N OTES
End of
Period
An adjusting entry is required to record Interest
Expense incurred to date.
Maturity
Date
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E ND OF -P ERIOD A DJUSTMENT
TO N OTES
On Dec. 16, 2015, a company borrows $2,000 from a bank at
12% interest for 60 days. An adjusting entry is needed on
December 31.
On Feb. 14, 2016, the company repays this principal and interest on the note.
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(4) P AYROLL L IABILITIES
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R ECORDING E MPLOYEE P AYROLL
D EDUCTIONS
An entry to record payroll expenses and deductions for an employee in Singapore might look like this.
Using Singapore as an example, under the law, both the employee and his employer will have to contribute to the Central Provident Fund
(CPF), which is primarily for the employee’s retirement needs.
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(5) M ULTI -P ERIOD K NOWN L IABILITIES
Includes Unearned Revenues and Notes Payable
Unearned Revenues from magazine subscriptions often cover more than one accounting period. A portion of the earned revenue is recognized each period and the Unearned Revenue account is reduced.
Notes Payable often extend over more than one accounting period. A threeyear note would be classified as a current liability for one year and a long-term liability for two years.
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E STIMATED L IABILITIES

W ARRANTY L IABILITIES
Seller ’ s obligation to replace or correct a product
(or service) that fails to perform as expected within a specified period. To comply with the full disclosure and matching principles, the seller reports expected warranty expense in the period when revenue from the sale is reported.
My Maserati
The seller reports this warranty obligation as a liability because such warranty costs are probable and the amount can be estimated using, for instance, past experience with warranties.
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W ARRANTY L IABILITIES
On Dec. 1, 2015, a dealer sells a car for $16,000 with a maximum one-year or 12,000 mile warranty covering parts.
Past experience indicates warranty expenses average 4% of a car ’ s selling price.
On Jan. 9, 2016, the customer returns the car for repairs.
The dealer replaces parts costing $200.
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A CCOUNTING FOR
C ONTINGENT L IABILITIES
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Note: IFRS defines probable as more likely to occur than not, while FASB simply states it as likely to occur.

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P OSSIBLE
C ONTINGENT L IABILITIES
– A potential claim is recorded if the amount can be reasonably estimated and payment for damages is probable.
– The guarantor usually discloses the guarantee in its financial statement notes. If it is probable that the debtor will default, the guarantor should record and report the guarantee as a liability.

T IMES I NTEREST E ARNED
Times interest earned
=
Income before interest expense and income taxes
Interest expense
If income before interest and taxes varies greatly from year to year, fixed interest charges can increase the risk that an owner will not earn a positive return and be unable to pay interest charges.
This measure helps creditors assess the risk of a loan.
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T IMES I NTEREST E ARNED
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When the interest coverage ratio is smaller than one, the company is not generating enough cash from its operations
EBIT to meet its interest obligations.
The Company would then have to either use cash on hand to make up the difference or borrow funds. Typically, it is a warning sign when interest coverage falls below 2.5x.
A lower times interest earned ratio means less earnings are available to meet interest payments and that the business is more vulnerable to increases in interest rates and being unable to meet their existing outstanding loan obligations.

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E ND OF M ATERIAL