Slides - 11. Liabilities

Characteristics of liabilities: Probable (BLANK) sacrifices of economic benefits., Arise from (BLANK) obligations to other entities., Result from (BLANK) transactions or events.

future, present, past

Liabilities are recorded at the cash amount a (BLANK) would accept to settle the liability immediately

creditor

A liability with Maturity = 1 year or less

Current liabilities

A liability with maturity > 1 year

non-current liabilities

If you purchase inventory as a liability the account recorded would be

accounts payable

If you use electricity as a liability the account would be

accrued liabilities

If employees perform work as a liability the account would be

accrued wages

If customers pay in advance for future purchases as a liability the account would be

deferred revenue

Formal written contract that specifies the amount borrowed, repayment date, and interest rate.

Note payable

To the lender interest is

revenue

To the borrower interest is an

expense

has similar cash flow streams to notes payable but are publicly-traded and involve many parties

bonds

Payment for the use of money

interest

Interest is calculated using the formula

principal x rate x time

calculates interest on only the principal amount owed without considering any interest already earned

Simple interest

generally only used in short-term credit arrangements

simple interest

calculates interest on both the principal and any previously earned interest that has not been paid

compound interest

Computes interest on interest

compound interest

A note in which the terms include a fixed periodic payment amount which includes both principal and interest components

Installment loan

For installment loans because the payment amount is the same each period, progressively (BLANK) of it goes to pay down the principal with each successive payment

more

What most consumer loans are (car loans, student loans, mortgages)

installment loans

(BLANK) liabilities are known obligations resulting from past events.

Non-contingent

(BLANK) liabilities are potential obligations resulting from past events

Contingent

Examples of contingent liabilities include:

warranty, lawsuits, environmental cleanup costs

The accounting treatment for contingent liabilities depends on

the likelihood of the future event and the ability to measure the obligation

Draw determining contingent liabilities chart

y

(BLANK) are always disclosed even if likelihood is remote

credit guarantees

Material (BLANK) should also always be disclosed

purchase commitments

are short-term obligations that will be paid within the current operating cycle or within one year of the balance sheet date, whichever is longer.

current liabilities

obligations related to expenses that have been incurred but have not been paid at the end of the accounting period

accrued liabilities

These expenses include items such as rent, wages, and utilities

Accrued liabilities

obligations arising when cash is received prior to the related revenue being earned

deferred revenue

 offer greater liquidity potential because sometimes the capital needs of a particular firm exceeds what a single creditor can lend

bonds

Contingent liabilities: the chance that the future event or events will occur is high (greater than 70%)

probable

Contingent liabilities: the chance that the future event or events will occur is more than remote but less than likely.

Reasonably possible

Contingent liabilities: the chance that the future event or events will occur is slight.

remote

is defined as the difference between current assets and current liabilities.

working capital

working capital =

current assets - current liabilities

In general, (BLANK) working capital is preferable and viewed as a sign of a stronger financial position.

higher

liquidity is assessed using the

current ratio and the quick ratio

Working capital management involves a delicate (BLANK). On one hand, working capital provides liquidity and a margin of safety. On the other hand, excess money tied up in a checking account or inventory is not productive because it does not generate profits.

balance

Current ratio =

current assets/current liabilities

Quick ratio =

(cash and cash equivalents + short-term investments + accounts receivable)/current liabilities

Cash and cash equivalents, short-term investments and accounts receivable are known as “(BLANK)” because they are more quickly converted into cash than other current assets such as inventory.

quick assets

Provides an indication of a company’s ability to make periodic interest payments to its creditors.

times-interest-earned ratio

Used to assess solvency

times-interest-earned ratio

Times-interest-earned ratio =

Income before interest expense and income taxes/interest expense

The times-interest earned ratio should be at least in the (BLANK) range

3-4

Usually less then 10% chance

remote

a promise by a guarantor (typically a bank or insurance company) to cover a portion or all of a borrower's debt if the borrower defaults on the loan or other credit obligation

credit guarantee