Financial & Managerial
Accounting 2002e
Belverd E. Needles, Jr.
Marian Powers
Susan Crosson
----------Multimedia Slides by:
Harry Hooper
Santa Fe Community College
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1
Chapter 9
Current Liabilities
LEARNING OBJECTIVES
1. Identify the management issues
related to recognition, valuation,
classification, and disclosure of
current liabilities.
2. Identify, compute, and record
definitely determinable and
estimated current liabilities.
3. Define contingent liability.
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3
SUPPLEMENTAL OBJECTIVE
4. Compute and record the
liabilities associated with payroll
accounting.
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4
Management Issues Related to
Accounting for Current Liabilities
OBJECTIVE 1
Identify the management issues
related to recognition, valuation,
classification, and disclosure of
current liabilities.
Management Issues Related to Accounting
for Current Liabilities
Current
liabilities are incurred to meet
cash needs during the operating cycle.
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6
Managing Liquidity and Cash
Flows
 The
primary purpose of current liabilities is
to meet needs for cash during the operating
cycle.
The operating cycle converts cash to purchases, to
sales, to accounts receivable, and back to cash.
 Most current liabilities support this cycle.

 Failure
to manage related cash flows can have
serious consequences.
If suppliers are not paid, they may not ship.
 A continued inability to meet payments when due
can lead to bankruptcy.

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7
Payables Turnover and
Average Days’ Payable
Payables turnover and average days’
payable are the common measures of
time that creditors are willing to give
a company to pay its accounts
payable.
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8
Payables Turnover
Payables Turnover = COGS+/-Change in Merchandise Inventory
Average Accounts Payable
= $2,042.7 - $50.7
($234.8 + $206.4) ÷ 2
= $1,992.0
$220.6
= 9.0 times
The number of times on average that accounts payable are paid in
an accounting period.
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9
Average Day Payable
Average Day Payable =
365 days
= 365 days = 40.6 days
Payables Turnover
9.4
 How
long on average a company takes to pay
its accounts payables.
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10
Payable Turnover for Selected Industries
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11
Recognition of Liabilities
 Timing
is important in the recognition of liabilities.
 Failure to record a liability may go along with
failure to record an expense.
 These errors lead to an understatement of expenses
and an overstatement of income.
 A liability is recorded when an obligation occurs.
This rule is difficult to apply.
 Adjusting entries recognize unrecorded liabilities.

 Liabilities
only relate to past, not future
transactions or commitments.
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12
Valuation of Liabilities
 Liabilities
are generally valued on the balance sheet
at either:
The amount of money needed to pay the debt, or
 The Fair Market Value of goods or services to be
delivered.

 The
amount of the liability is usually known, but
sometimes the amount must be estimated.
Service warranties on cars.
 Estimates are based on past experience and anticipated
changes in the business environment.

 Additional
financial statement disclosure may be
required.
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13
Classification of Liabilities
 Current
liabilities are:
Expected to be satisfied within one year or within the
normal operating cycle, whichever is longer.
 Paid out of current assets or with cash generated from
operations.

 Long-term
liabilities are:
Due beyond one year or beyond the normal operating
cycle.
 Used to finance long-term assets.

 It
is important to distinguish between current and
long-term liabilities because of the effect on
liquidity.
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14
Disclosure of Liabilities

Supplemental disclosure may be
required in the notes to the financial
statements.
 Large
amount of notes payable.
 Special credit arrangements.
 Commercial paper.
 Lines of credit.
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15
Discussion
Q. What is the rule for classifying a
liability as current?
A. A liability is current if the obligation
will be satisfied within one year or
within the normal operating cycle,
whichever is longer.
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16
Common Categories of
Current Liabilities
OBJECTIVE 2
Identify, compute, and record
definitely determinable and
estimated current liabilities.
Definitely Determinable Liabilities
Definitely
determinable liabilities are
set by contract or by statute and can
be measured exactly.
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18
Types of Definitely
Determinable Liabilities
 Accounts
payable.
 Bank loans and commercial paper.
 Notes payable.
 Accrued liabilities.
 Dividends payable.
 Sales and excise taxes payable.
 Current portions of long-term debt.
 Payroll liabilities.
 Unearned or deferred revenues.
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(Trade) Accounts Payable
 Short-term
obligations to suppliers for
goods and services.
 Amount in Accounts Payable account in the
general ledger is generally supported by an
Accounts Payable subsidiary ledger.
 Accounts Payable subsidiary ledger
contains an individual account for each
person or company to which money is
owed.
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20
Bank Loans and Commercial Paper
A line
of credit allows a company to
borrow funds when needed to finance
current operations.
The bank may require the company to
meet certain financial goals.
 Maintain
specific profit margins.
 Maintain current ratios.
 Maintain debt to equity ratios.
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21
Commercial Paper
Unsecured
loans that are sold to the
public.
The portion of the line of credit
borrowed and the amount of
commercial paper issued are usually
combined with notes payable in the
current liabilities section of the
balance sheet.
Details are disclosed in a note to the
financial statements.
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22
Notes Payable
 Obligations
represented by promissory
notes.
 Notes payable can be used to secure
bank loans, pay suppliers, or obtain
other credit.
 The interest may be:
 Stated
separately on the face of the note.
 Deducted in advance by discounting it from
the face value of the note.
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23
Two Promissory Notes: One with Interest Stated
Separately; One with Interest in Face Amount
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Issued Note:
Interest Stated Separately
Aug. 31 Cash
Notes Payable
To record 60-day,
12% promissory note
with interest stated
separately
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5,000
5,000
25
Payment of Note:
Interest Stated Separately
Oct. 30
Notes Payable
5,000
Interest Expense
100
Cash
Payment of note with
interest stated separately
$5,000 x (60) x .12 = $100
360
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5,100
26
Issued Note:
Interest in Face Amount
Aug. 31 Cash
4,900
Discount on Notes Payable
100
Notes Payable
5,000
To record 60-day
promissory note with
$100 interest included in
face amount
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27
Payment of Note:
Interest in Face Amount
Oct. 30 Notes Payable
Cash
5,000
5,000
Payment of note
with interest
included in face amount
Interest Expense
Discount on Notes
Payable
100
100
Interest expense on note payable
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28
Accrued Liabilities
Adjusting
entries are required to
recognize and record liabilities that
are not already in the accounting
records.
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29
Accrued Liabilities:
Interest Stated Separately
Sept. 30 Interest Expense
50
Interest Payable
To record interest
expense for 30 days on
note with interest stated
separately
$5,000 x (30) x .12 = $50
360
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50
30
Accrued Liabilities:
Interest in Face Amount
Sept. 30 Interest Expense
Discount on Notes Payable
To record interest
expense on note
with interest included
in face amount
$100 x (30) = $50
60
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50
50
31
Dividends Payable
 Cash
dividends are a distribution of
earnings by a corporation.
 The decision to pay dividends is solely up to
the board of directors.
 There is no liability until the board declares
a dividend.
 During the short time between the date of
declaration and the date of payment,
dividends are a current liability.
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32
Sales and Excise Taxes Payable
Most
states and many cities levy a sales
tax on retail transactions.
Sales taxes are collected by the
merchant and forwarded to the
appropriate government agency.
The amount of tax collected is a current
liability until remitted to the
government.
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33
Example of Sales and
Excise Taxes Payable
June 1
Cash
Sales
Sales Tax Payable
Excise Tax Payable
Sale of merchandise and
collection of sales and
excise taxes
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115
100
5
10
34
Current Portions of Long-Term Debt
That
portion of long-term debt that is
due within the next year and is to be
paid from current assets is classified as
a current liability.
No journal entry is required.
Debt is reclassified when financial
statements are prepared.
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35
Payroll Liabilities
 Payroll
accounting is important because complex
laws and significant liabilities are involved.
 The employer is liable to employees for wages
and salaries.
 The employer is responsible to various
government and other agencies for amounts
withheld and related taxes.
 It is important to distinguish between employees
and independent contractors.
 The journal entry to record payroll is lengthy.
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36
Illustration of Payroll Liabilities
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37
Unearned Revenues
Unearned
revenues are obligations
for goods or services that the
company must provide or deliver in a
future accounting period in return
for an advance payment from a
customer.
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38
Example of Unearned
Revenues
Cash
Unearned Subscriptions
Receipt of annual subscriptions
in advance
Unearned Subscriptions
Subscription Revenues
Delivery of monthly magazine
issues
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240
240
20
20
39
Estimated Liabilities
 Definite
debts or obligations of which the
exact dollar amount cannot be known until a
later date.
 There is no doubt about the existence of the
legal obligation.
 The primary accounting problem is to
estimate and record the amount of the
liability.
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40
Examples of
Estimated Liabilities
Income
taxes.
Property taxes.
Product warranties.
Vacation pay.
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41
Income Taxes



The amount of income taxes liability depends on the results
of operations.
The amount may not be known until after the end
of the year.
The company must make an adjusting entry to record the
estimated tax liability.
Dec. 31 Income Taxes Expense
53,000
Estimated Income
Taxes Payable
53,000
To record estimated federal
income taxes

Sole proprietorships and partnerships do not pay income
taxes. Their owners pay on their individual returns.
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42
Property Tax Payable
Property
taxes are levied on real and
personal property.
They
are assessed annually, but the
government unit’s fiscal year and the
company’s may not correspond.
The
company must estimate the amount
of property tax that applies to each
month of the year.
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43
Example of Property Tax Payable
July 31 Property Tax Expense
Estimated Property Tax Payable
To record estimated property tax
expense for the month
$24,000 ÷ 12 months = $2,000
2,000
Nov. 30 Property Tax Expense
Estimated Property Tax Payable
To record estimated property tax
2,300
Dec. 15
2,000
2,300
Estimated Property Tax Payable 10,300
Prepaid Property Tax
14,420
Cash
24,720
Payment of property tax
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44
Product Warranty Liability
The
liability exists for the length of the
warranty.
The cost of the warranty is debited to
an expense account in the period of
sale.
A company can estimate the future cost
of the liability based on past experience
with claims for the product or services.
A company usually uses an average
cost.
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45
Computation of Product
Warranty Liability Expense
July 31 Product Warranty Expense
Estimated Product Warranty
Liability
Based on:
Number of units sold
Rate of replacement
Est. units to be replaced
Est. cost per unit
Est. product warranty liability
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525
525
350
x .06
21
x $25
$525
46
Example of
Product Warranty Liability
Dec. 5 Cash
Estimated Product Warranty
Liability
Service Revenue
Merchandise Inventory
Replacement of muffler
under warranty
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10
20
10
20
47
Vacation Pay Liability


Vacation pay (and other payroll costs, such as bonuses and
pensions) is a cost to the company.
The cost should be allocated over the entire year so that
periods are not distorted.
Apr. 20 Vacation Pay Expense
600
Estimated Liability for
Vacation Pay
600
Estimated vacation pay expense
Aug. 31 Estimated Liability for
Vacation Pay
1,000
Cash (or Wages Payable)
1,000
Wages of employees on vacation
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48
Discussion
Q. Indicate whether each of the following is
(a) a definitely determinable liability or
(b) an estimated liability.
1. Dividends payable
2. Income taxes payable
3. Current portion of long-term debt
4. Vacation pay liability
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49
KEY
(a) a definitely
determinable
liability
(b) an estimated
liability
A.
1. a
2. b
3. a
4. b
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50
Contingent Liabilities
OBJECTIVE 3
Define contingent liability.
Contingent Liabilities
 A contingent
liability is potential liability that
depends on a future event arising out of a past
transaction, such as a lawsuit.
 Two conditions have been established by the FASB
for determining when a contingency should be
entered in the accounting records.
1. Liability must be probable.
2. Liability must be reasonably estimated.
Examples: vacation pay, income taxes, and
warranty liability
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52
Accounting for
Contingent Liabilities
Contingent
liabilities are accrued in
the accounting records.
Potential liabilities that do not meet
the two conditions are reported in the
notes to the financial statements.
Losses from potential liabilities are
recorded when the conditions set by
the FASB are met.
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53
Discussion
Q. What is a contingent liability, and how does
it differ from an estimated liability?
A. A contingent liability is a potential liability
that depends on a future event arising out
of a past transaction. It differs from an
estimated liability in that an estimated
liability is not a potential liability but a
current liability for which the amount is
uncertain and must be estimated.
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54
Payroll Accounting Illustrated
SUPPLEMENTAL OBJECTIVE 4
Compute and record the liabilities
associated with payroll accounting.
Computation of an Employee’s Take-Home Pay

Fair Labor Standards Act sets
minimum wage and regulates overtime
pay.
Method:
1. Calculate total earnings, including
overtime.
2. Subtract all deductions (including
federal income tax, based on number
of exemptions) and voluntary
contributions.
3. Result equals Net (take-home) pay.
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56
Payroll
Register is a detailed listing of
a firm’s total payroll, prepared each
pay period.
Recording the Payroll - the column
totals from the payroll register are
used to make the payroll journal
entry.
Employee Earnings Record shows the
year-to-date earnings for each
employee and is used for legal
reporting requirements at year end.
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57
Payroll Taxes – the total payroll
taxes expense and liabilities for each type of
payroll tax are taken from the payroll
register and entered in the journal.
 Payment of Payroll and Payroll Taxes - Any
Wages Payable liability at the end of the pay
period is paid based on the system used by
the company. Payroll tax liabilities and
liabilities for any other payroll deductions
are paid as required by the law of the
relevant contract or agreement.
 Recording
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58
Sample Withholding Table
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59
OK, LET’S REVIEW . . .
1. Identify the management issues related to
recognition, valuation, classification, and
disclosure of current liabilities.
2. Identify, compute, and record definitely
determinable and estimated current
liabilities.
3. Define contingent liability.
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60
AND FINALLY . . .
SUPPLEMENTAL OBJECTIVE
4. Compute and record the liabilities
associates with payroll accounting.
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61