Spiceland | Thomas | Herrmann Financial Accounting Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 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. 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. 8-3 Part A Current Liabilities

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 8-4 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. 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. 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. Learning Objective 2 Account for notes payable and interest expense 8-7

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 8-8 Notes Payable Note signed by a firm promising to repay the amount borrowed plus interest Interest on notes is calculated as: Interest Face value Annual interest rate ×= Fraction of the year ×

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 8-9 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 Accounts Payable Amounts owed to suppliers of merchandise or services Sometimes called trade accounts payable

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Learning Objective 3 Account for employee and employer payroll liabilities 8-11

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education Illustration 8.3—Payroll Costs for Employees and Employers

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education Employee Costs Federal and state income taxes FICA taxes 7.65% (6.2% %) 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

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

Illustration 8.4—Payroll Example 8-15 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Learning Objective 4 Explain the accounting for other current liabilities 8-16

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

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education Current Portion of Long-Term Debt Debt that will be paid within the next year Provides information about a company’s bankruptcy risk

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education Illustration 8.6—Current Portion of Long-Term Debt

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

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Learning Objective 5 Apply the appropriate accounting treatment for contingencies 8-21

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education Contingent Liabilities An existing uncertain situation that might result in a loss

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education Illustration 8.8—Accounting Treatment of Contingent Liabilities

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

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

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Learning Objective 6 Assess liquidity using current liability ratios 8-26

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

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education Working Capital A large positive working capital is an indicator of liquidity Not the best measure of liquidity for comparison

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education Current Ratio Ratio of 1 or higher often reflects an acceptable level of liquidity Higher the current ratio, the greater the company’s liquidity

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education Acid-Test Ratio or Quick Ratio Based on a more conservative measure Quick assets are readily convertible into cash

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

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

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