Current Liabilities1

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CHAPTER 11
CURRENT LIABILITIES
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DEFINING LIABILITIES
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CLASSIFYING LIABILITIES
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Current
Liabilities
Long-Term
Liabilities
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.
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CURRENT LIABILITIES
Current Liabilities as a Percent of Total Liabilities
Current Liabilities depend on the type of company operations
and whether physical products are involved or just services.
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UNCERTAINTY IN LIABILITIES
Uncertainty in
Whom to Pay
Uncertainty in
When to Pay
Uncertainty in How
Much to Pay
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KNOWN LIABILITIES
Accounts Payable
Sales Taxes Payable
Unearned Revenues
Short-Term Notes Payable
Payroll Liabilities
Multi-Period Known Liabilities
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(1) SALES TAXES PAYABLE
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) UNEARNED REVENUES
On June 30, Beyonce sells $5,000,000 in tickets
for eight concerts.
On Oct. 31, Beyonce performs a concert.
$5,000,000 / 8 = $625,000
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(3) SHORT-TERM NOTES PAYABLE
A written promise to pay a specified
amount on a definite future date within one
year or the company’s operating cycle,
whichever is longer.
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NOTE GIVEN TO EXTEND
CREDIT PERIOD
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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NOTE GIVEN TO EXTEND
CREDIT PERIOD
On October 22, Brady pays the note plus
interest to McGraw.
Interest expense = $500 × 12% × (60 ÷ 360) = $10
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NOTE GIVEN TO BORROW
FROM BANK
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NOTE GIVEN TO BORROW
FROM BANK
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.
Interest expense = $2,000 × 12% × (60 ÷ 360) = $40
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END-OF-PERIOD ADJUSTMENT
TO NOTES
Note
Date
End of
Period
An adjusting entry
is required to
record Interest
Expense incurred
to date.
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Maturity
Date
END-OF-PERIOD ADJUSTMENT
TO NOTES
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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) PAYROLL LIABILITIES
Employers incur
expenses and
liabilities from
having employees.
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RECORDING EMPLOYEE PAYROLL
DEDUCTIONS
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) MULTI-PERIOD KNOWN LIABILITIES
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.
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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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ESTIMATED LIABILITIES
An estimated
liability is a known
obligation of an
uncertain amount,
but one that can
be reasonably
estimated.
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WARRANTY LIABILITIES
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
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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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WARRANTY LIABILITIES
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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ACCOUNTING FOR
CONTINGENT LIABILITIES
Note: IFRS defines probable as more likely to occur
than not, while FASB simply states it as likely to occur.
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POSSIBLE
CONTINGENT LIABILITIES
Potential Legal Claims – A potential claim is
recorded if the amount can be reasonably estimated
and payment for damages is probable.
Debt Guarantees – 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.
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TIMES INTEREST EARNED
Income before interest expense
and income taxes
Times interest
=
earned
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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TIMES INTEREST EARNED
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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END OF MATERIAL
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