Financial Accounting -- Liabilities

types of current liabilities

accounts payable, short-term notes payable, accrued liabilities, unearned revenue, sales tax payable, current portion of long-term debt

current liabilities

payable within one year from balance sheet date

long-term liabilities

payable in more than one year from the balance sheet date

short term notes payable

amount due in ONE year

accrued liabilities

liabilities that result from accrued expenses, i.e expenses that the business has incurred but not yet paidliabil

unearned revenue (Deferred revenue)

liability account used to record cash received in advance of the sale or service

sales tax payable

sales taxes collected from customers by the seller and owed to the government → collecting sales taxes creates a liability for the company, is NOT an expense

current portion of long-term debt

debt that will be paid within the next year

contingent liabilities

existing uncertain situation that might result in a loss depending on the outcome of a future event

reporting as provision liability

if a loss is “probable” and if a reasonable estimate can be made of the amount

contingent liability

if a loss is not probable, no liability should be recorded and the details of the situation should be disclosed in the notes to the financial statements

contingent assets

possible assets whose existence will be confirmed by the occurrence or non-occurrence of uncertain future events that are not wholly within the control of the entity

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

liquidity measures

working capital, current ratio, acid-test ratio

working capital definition

a measure of current assets remaining after paying current liabilities

working capital equation

= current assets - current liabilities

current ratio definition

the amount of current assets available for every $1 of current liabilities; high current ratio is generally better but not always positive

current ratio equation

= current assets / current liabilities

acid test definition

the amount of “quick assets” available for every $1 of current liabilities

acid-test ratio equation

= (cash + current investments + accts receivable) / current liabilities

increase in current ratio

increase in current assets and decrease in current liabilities

increase in acid-test ratio

increase in quick assets, decrease in current liabilities

bonds

formal debt instrument that obligates the borrower to repay a stated amount at a specified maturity date, and the borrower also agrees to pay interest over the life of the bond

secured bonds

bond backed by collateralt

bond term

bond issue matures on a single date

bond serial

bond issue matures in installments

callable bond

issuing company can pay off bonds early

convertible bond

investor can convert bonds to common stock

collateral

something given to the lender as a promise to pay back the bond

maturity date

date that the bond must be paid back

stated interest rate vs market interest rate

stated is specified in bond contract, market is not

carrying value for a bond issued at a PREMIUM

decreases over time

carrying value of a bond issued at a DISCOUNT

increases over time

if bonds are retired at maturity

carrying value = face amount, and bond payable is debited and cash is creditedb

if bonds are retired before maturity

there is early extinguishment of debt that may result in a gain or loss; equals the difference between the book value of the bond and the price paid to retire the bond

issue price of a bond = 

present value of the bond’s face amount + present value of its periodic interest payments

in calculating issue price of bond, look for these in the contract (except mkt interest rate):

1. face amount of bond

2. interest payment of each period based on the stated interest rate of the bond

3. the number of periods until the bond matures

4. the market interest rate per perio

ratios used to measure financial risk related to long term liabilities

debt to equity ratio and times interest earned ratio

debt to equity ratio definition

measure of financial leverage; more debt (higher leverage) can be good or bad depending on whether the company earns a return in excess of the cost of borrowed funds

debt to equity ratio equation

= total liabilities / SE

times interest earned ratio definition

measures company’s ability to meet interest payments as they become due

times interest earned ratio equation

= (net income + interest expense + tax expense) / interest expense