Reporting and Interpreting Liabilities
Chapter 9
McGraw-Hill/Irwin
© 2009 The McGraw-Hill Companies, Inc.
Understanding the Business
The acquisition of assets is financed
from two sources:
Debt - funds
from creditors
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Equity - funds
from owners
Slide 2
Understanding the Business
Debt is considered riskier than equity.
Interest is
a legal
obligation.
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Creditors
can force
bankruptcy.
Slide 3
Liabilities Defined and Classified
Defined as probable debts or obligations of the
entity that result from past transactions, which will
be paid with assets or services.
Maturity = 1 year or less
Maturity > 1 year
Current
Liabilities
Noncurrent
Liabilities
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Slide 4
Liabilities Defined and Classified
Liabilities are
measured at their
current cash
equivalent (the
amount a creditor
would accept to
cancel the debt) at
the time incurred.
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Slide 5
Current Liabilities
Account
Name
Accounts
Payable
Accrued
Liabilities
Notes
Payable
Deferred
Revenues
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Also
Called
Trade
Accounts
Payable
Definition
Obligations to pay for goods and
services used in the basic operating
activities of the business.
Obligations related to expenses that
Accrued
have been incurred, but will not be
Expenses
paid until the subsequent period.
Obligations due supported by a formal
N/A
written contract.
Obligations arising when cash is
Unearned
received prior to the related revenue
Revenues
being earned.
Slide 6
Working Capital and Cash Flows
Working Capital = Current Assets - Current Liabilities
Current Ratio =Current Assets/Current Liabilities
Current Ratio = CA/CL
Changes in working capital accounts are
important to managers and analysts
because they have a direct impact on cash
flows from operating activities reported on
the statement of cash flows.
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Slide 7
Notes Payable
A note payable specifies the interest
rate associated with the borrowing.
To
the lender, interest is a revenue.
To the borrower, interest is an expense.
Interest = Principal × Interest Rate × Time
When computing interest for one
year, “Time” equals 1. When the
computation period is less than
one year, then “Time” is a fraction.
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Slide 8
Notes Payable
Toyota borrows
$100,000 for 2 months at
an annual interest rate
of 12%. Compute the
interest on the note for
the loan period.
Interest
Interest
Interest
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= Principal
= $ 100,000
= $ 2,000
× Interest Rate ×
×
12%
×
Time
2
/12
Slide 9
Estimated Liabilities
Contingent Liability Examples
Lawsuits
Environmental
Problems
Product
Warranties
Probable
Reasonably Possible
Remote
Subject to estimate
Record as liability Disclose in note
Disclosure not required
Not subject to estimate Disclose in note Disclose in note
Disclosure not required
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Slide 10
Quick Ratio
While a high quick ratio normally
suggests good liquidity, too high
a ratio suggests inefficient use
of resources.
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Quick assets are defined as including
cash, marketable securities,
and accounts receivable.
Slide 11
Long-Term Liabilities
Creditors often require the borrower to
pledge specific assets as security for
the long-term liability.
Maturity = 1 year or less
Maturity > 1 year
Current
Liabilities
Long-term
Liabilities
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Slide 12
Long-Term Notes Payable and Bonds
Significant debt needs are
often filled by issuing
bonds to the public.
Bonds
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Cash
Slide 13
Present/Future Value Concepts
PV/FV is a mathematical function of three
variables:
1. The principal amount.
2. The interest rate.
3. The time period.
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Slide 14
Present Value of a Single Amount
The present value of a single amount is
the worth to you today of receiving that
amount some time in the future.
Present
Value
Future
Value
Interest compounding periods
Today
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Future
Slide 15
Present Value of an Annuity
An annuity is a series of
consecutive equal periodic
payments.
Today
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Slide 16
Present Value of an Annuity
What is the value today of a series of
payments to be received or paid out
in the future?
Payment 1
Present
Value
Payment 2
Payment 3
Interest compounding periods
Today
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Slide 17
Accounting Applications of Present Value
On January 1, 2009, Starbucks bought some new
delivery trucks. The company signed a note
agreeing to pay $200,000 on December 31, 2010.
The market interest rate for this note is 12%.
Future value
$ 200,000
PV of $1
(i=12%, n=2)
Present value
×
0.79720
$ 159,440
Let’s prepare the journal entry to record the purchase.
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Slide 18
Accounting Applications of Present Value
GENERAL JOURNAL
Date
Description
Jan. 1 Delivery trucks
Notes payable
Debit
159,440
Credit
159,440
Present
Interest
Rate
Interest 31,
Now, let’s
look Value
at the ×journal
entry
at =December
$159,440 2009.
× 12% = $19,133
GENERAL JOURNAL
Date
Description
Dec. 31 Interest expense
Notes payable
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Debit
19,133
Credit
19,133
Slide 19
Accounting Applications of Present Value
Now, let’s look at the journal entries at
December 31, 2010.
GENERAL JOURNAL
Description
Date
Dec. 31 Interest expense
Notes payable
31 Notes payable
Cash
Debit
21,429
Credit
21,429
200,000
200,000
Present Value × Interest Rate = Interest
($159,440 + $19,133) × 12% = $21,429
McGraw-Hill/Irwin
Slide 20
End of Chapter 9
© 2008 The McGraw-Hill Companies, Inc.