Chapter 8 Current Liabilities PDF

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Part A Current Liabilities Liabilities have 3 characteristics: 1. Probable future sacrifices of economic benefits 2. Arising from present obligations to other entities 3. Resulting from past transactions or events Liability: present responsibility to sacrifice assets in the future due to a transaction or other event that happened in the past Current vs Long-Term Classification Current liabilities are payable within one year from the balance sheet date and long term liabilities are payable in more than one year Distinguishing between current and long term liabilities is important in helping investors and creditors assess risk Key point: in most cases current liabilities are payable within one year from the balance sheet date and long term liabilities are payable in more than one year Notes Payable About ⅔ of bank loans are short term Companies often use short term debt because it usually offers lower interest rates than long term debts Interest = face value x annual interest rate x fraction of the year Key point: we record interest expense in the period in which we incur it rather than the period in which we pay it How can you tell the amount and interest rate of a company’s line of credit? Notes to the financial statements Companies are required to disclose the terms of available lines of credit such as the amounts, maturity dates, and interest rates Commercial paper: if a company borrows from another company rather than from a bank Key point: many short term loans are arranged under an existing line of credit with a bank or for larger corporations in the form of commercial paper, a loan from one company to another Accounts payable (trade accounts payable) Payroll Liabilities

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Mkae up a significant portio of current liabilities for thse companies

Besides the salary you will have other costs: 1. Federal and state unemployment taxes 2. The employer portion of social security and medicare 3. Employer contributions for health, dental, disability, and life insurance 4. Employer contributions to retirement or savings plans

Federal Insurance Contributions Act (FICA) taxes: social security and medicare taxes Fringe benefits: additional employee benefits paid for by the employer - Many companies provide additional fringe benefits specific to the company industry - Ex. fringe in airline industry is free flights for employers and families Key point: employee salaries are reduced by withholdings for federal and state income taxes, FICA taxes, and the employee portion of insurance and retirement contributions. The employer too incurs additional payroll expenses for unemployment taxes the employer portion of FICA taxes and employer insurance and retirement contributions

Other Current Liabilities

Key point: when a company receives cash in advance from customers, it debits cash and credits deferred revenue to a current liability account. When the company provides those goods to its customers it debits deferred revenue and credits sales revenue The selling company records sales revenue in one account and sales tax payable in another. When the company collects sales taxes it increases (debits) cash and increases (credits) sales tax payable Key point: sales taxes collected from customers by the seller are not an expense. Instead they represent current liabilities payable to the government Current portion of long term debt: amount that will be paid within one year from the balance sheet date Long term obligations (notes, mortgages, bonds) usually are reclassified and reported as current liabilities when they become payable within the upcoming year Key point: we report the currently maturing portion of a long term debt as a current liability in the balance sheet Part B Contingencies Contingencies: uncertain positions in litigation disputes Contingent Liabilities Contingent liability: existing uncertain situation that might results in loss depending on the outcome of a future event Ex. lawsuits, product warranties, environmental problems, premium offers

Litigation and Other Causes

Key point: a contingent liability is recorded only if a loss is probable and the amount is reasonably estimable Is the company involved in litigation? Notes to the financial statements Companies are required to disclose all contingencies including litigation with at least a reasonable possibility of payment. This information can be used to help estimate their potential financial impact Warranties **most common example of contingent liabilities 1. Probable: warranties almost always entail and eventual expenditure 2. Reasonably estimable: formulate a reasonable prediction Contingent gain: an existing uncertain situation that might result in a gain which often is the flipside of contingent liabilities Do not record contingent gains until the gain is known with certainty Key point: unlike contingent liabilities contingent gains are not recorded until the gain is certain and no longer a contingency Analysis Liquidity Analysis

Liquidity: having sufficient cash (or other current assets convertible to cash in a relatively short time) to pay currently maturing debts Working Capital Difference between current assets and current liabilities Working capital = current assets - current liabilities Current ratio = ratio greater than 1 indicates there is more assets than liabilities Acid-Test Ratio (quick ratio) Based on a more conservative measure of current assets available to pay current liabilities

Acid-test ratio= Key point: working capital is the difference between current assets and current liabilities. The current ratio is equal to current assets divided by current liabilities. The acid test ratio is equal to quick assets divided by current liabilities, Each measures a company’s liquidity its ability to pay maturing debts...