MGMT 200 Chapter 8: Current Liabilities

Liability

an obligation of a company to transfer some economic benefit in the future, USUALLY requires the payment of cash in the future

Liabilities, such as deferred revenue, arise when a company receives cash in advance from customers

these liabilities represent an obligation of the company to transfer inventory or services to those customers in the future

Current liabiltiies

usually payable within one year from the balance sheet date

Long-term liabilities

payable in more than one year from the balance sheet date

Operating cycle

the length of time from spending cash to provide goods and services to a customer until collection of cash from that customer

Notes payable

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

Interest equation

Interest = Face Value(Annual Interest Rate)(Fraction of the Year)

Recording interest expense

we record interest expense in the period in which we incur it, rather than in the period which we pay it

Line of credit

informal agreement, permits a company to borrow up to a prearranged limit, recorded similar to notes payable

Commercial paper

borrowing from another company rather than a bank, sold with maturities ranging from 30 to 270 days, interest rate is usually lower than a bank loan

Accounts payable

amounts owed to suppliers of merchandise or services, usually are current liablities

Employee costs

federal and state income taxes, FICA taxes; employees may have additional amounts withheld from their paychecks for health, dental, disability, and life insurance; employees may also have amounts deducted for retirement or employee savings plans

Employer costs

matching FICA tax, FUTA and SUTA, fringe benefits

Sales tax equation

Sales Tax = Total Cash Paid - (Total Cash Paid)/(1 + Sales Tax Rate)

Current portion of long-term debt

amount that will be paid within one year from the balance sheet date, management needs to know this amount in order to budget the cash flow necessary to pay the current portion as it comes due

Contingencies

uncertain situations that can result in a gain or a loss for a company

Contingent liability

an existing uncertain situation that might result in a loss

Criteria for reporting a contingent liability

likelihood of payment and amount of payment, recorded only if a loss is probable and the amount is reasonably estimate

Likelihood of payment

probable, reasonably possible, remote

Amount of payment

reasonably estimate and not reasonably estimate

Warranties

most common example of contingent liabilities, represents a liabilities for a company at the time of the sale if it meets the criteria for recording a contingent liability, warranty liability account is increased when the estimated warranty liability is recorded but then is reduced over time by actual warranty expenditures

Even if the company doesn’t know precisely what the warranty costs will be next year, it can formulate a reasonable prediction from

past experiences, industry statistics, other current business conditions

Contingent gains

an existing uncertain situation that might result in a gain, not recorded until the gain is known with certainty

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

Working capital

measure of current assets remaining after paying current liabilities, a large positive working capitaI is an indicator of liquidity, not best measure of liquidity for comparing one company with another

Working capital equation

Working Capital = Current Assets - Current Liabilities

Current ratio

the amount of current assets available for every $1 of current liabilities, higher current ratio means the company has greater liquidity

Current ratio equation

Current Ratio = Current Assets/Current Liabilities

Acid-test ratio

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

Quick assets

include only cash, current investments, and accounts receivable

Acid-test ratio equation

Acid-Test Ratio = (Cash + Current Investments + Accounts Receivable)/Current Liabilities

Changes that increase the Current ratio

increase in current assets, decrease in current liabilities

Changes that decrease Current ratio

decrease in current assets, increase in current liabilities

Changes that increase the Acid-test ratio

increase in quick assets, decrease in current liabilities

Changes that decrease the Acid-test ratio

decrease in quick assets, increase in current liabilities