chapter 8 financial 3 ed

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Spiceland | Thomas | Herrmann Financial Accounting Current Liabiliti es Chapter 8 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Educa

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Page 1: Chapter 8 Financial 3 Ed

Spiceland | Thomas | Herrmann

Financial Accounting

Current Liabilities

Chapter 8

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Page 2: Chapter 8 Financial 3 Ed

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.

Page 3: Chapter 8 Financial 3 Ed

Part A

Current Liabilities

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8-3

Page 4: Chapter 8 Financial 3 Ed

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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.

Page 5: Chapter 8 Financial 3 Ed

Learning Objective 1

Distinguish between current and long-term liabilities

8-5

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Page 6: Chapter 8 Financial 3 Ed

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.

Page 7: Chapter 8 Financial 3 Ed

Learning Objective 2

Account for notes payable and interest expense

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Page 8: Chapter 8 Financial 3 Ed

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Notes Payable

• Note signed by a firm promising to repay the amount borrowed plus interest

• Interest on notes is calculated as:

InterestFace value

Annualinterest rate ×=

Fractionof the year×

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Page 9: Chapter 8 Financial 3 Ed

Recording Notes Payable8-9

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Page 10: Chapter 8 Financial 3 Ed

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Recording Interest Payable and Repayment of Notes Payable

• Interest payable

• Repayment of note

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Page 11: Chapter 8 Financial 3 Ed

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Notes Payable Recorded as Notes Receivable for Lender

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Page 12: Chapter 8 Financial 3 Ed

8-12

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.

Page 13: Chapter 8 Financial 3 Ed

8-13

Accounts Payable

• Amounts owed to suppliers of merchandise or services

• Sometimes called trade accounts payable

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Page 14: Chapter 8 Financial 3 Ed

Learning Objective 3

Account for employee and employer payroll liabilities

8-14

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Page 15: Chapter 8 Financial 3 Ed

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Illustration 8.3—Payroll Costs forEmployees and Employers

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Page 16: Chapter 8 Financial 3 Ed

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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

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Page 17: Chapter 8 Financial 3 Ed

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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

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Page 18: Chapter 8 Financial 3 Ed

Illustration 8.4—Payroll Example8-18

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Page 19: Chapter 8 Financial 3 Ed

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Recording Fringe Benefits and Employer Payroll Taxes

• Recording employer-provided fringe benefits

• Recording employer payroll taxes

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Page 20: Chapter 8 Financial 3 Ed

Learning Objective 4

Explain the accounting for other current liabilities

8-20

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Page 21: Chapter 8 Financial 3 Ed

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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

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Page 22: Chapter 8 Financial 3 Ed

Example—Unearned Revenues8-22

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Page 23: Chapter 8 Financial 3 Ed

Example—Sales Tax Payable8-23

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Page 24: Chapter 8 Financial 3 Ed

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Current Portion of Long-Term Debt

• Debt that will be paid within the next year• Provides information about a company’s

bankruptcy risk

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Page 25: Chapter 8 Financial 3 Ed

8-25

Illustration 8.6—Current Portion ofLong-Term Debt

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Page 26: Chapter 8 Financial 3 Ed

Part B

Contingencies

8-26

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Page 27: Chapter 8 Financial 3 Ed

Learning Objective 5

Apply the appropriate accounting treatment for contingencies

8-27

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Page 28: Chapter 8 Financial 3 Ed

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Contingent Liabilities

• An existing uncertain situation that might result in a loss

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Page 29: Chapter 8 Financial 3 Ed

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Illustration 8.8—Accounting Treatment of Contingent Liabilities

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Page 30: Chapter 8 Financial 3 Ed

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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

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Page 31: Chapter 8 Financial 3 Ed

Accounting Warranties8-31

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Page 32: Chapter 8 Financial 3 Ed

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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

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Page 33: Chapter 8 Financial 3 Ed

Learning Objective 6

Assess liquidity using current liability ratios

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Page 34: Chapter 8 Financial 3 Ed

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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

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Page 35: Chapter 8 Financial 3 Ed

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Working Capital

• A large positive working capital is an indicator of liquidity

• Not the best measure of liquidity for comparison

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Page 36: Chapter 8 Financial 3 Ed

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Current Ratio

• Ratio of 1 or higher often reflects an acceptable level of liquidity

• Higher the current ratio, the greater the company’s liquidity

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Page 37: Chapter 8 Financial 3 Ed

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Acid-Test Ratio or Quick Ratio

• Based on a more conservative measure• Quick assets are readily convertible into cash

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Page 38: Chapter 8 Financial 3 Ed

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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

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Page 39: Chapter 8 Financial 3 Ed

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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

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Page 40: Chapter 8 Financial 3 Ed

End of Chapter 8

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