MGMT 200 Chapter 8

What is a liability?

A liability is an obligation of a company to transfer some economic benefit in the future.

What are the liabilities that require the payment of cash in the future?

Accounts payable, notes payable, and salaries payable.

When do other 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 Liabilities?

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.

If a company has an operating cycle longer than one year (winery for example), what are its current liabilities defined by?

The operating cycle rather than by the length of a year.

When would a company with a 3-month operating cycle classify their current liabilities as due?

Within one year.

When would a company with a 15-month operating cycle classify current liabilities?

Within 15 months

Notes Payable?

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

How is interest calcualted on notes?

Interest = Face value x Annual interest rate x fraction of the year

When do we record interest expense?

In the period that we incur it, rather than the period in 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 30-270 days, interest rate is usually lower than on a bank loan.

Accounts payable?

Amounts owed to suppliers of merchandise or services, sometimes called trade accounts payable.

Most accounts payable are what kind of liability?

Current liabilities, but they could be long-term depending on the due date.

Employee salaries are reduced by withholdings..?

Federal and state income taxes, FICA taxes, employee portion of insurance and retirement contributions.

What do FICA taxes consist of?

Social Security and Medicare taxes.

Employer incurs additional payroll expenses such as..?

Unemployment taxes (FUTA and SUTA), employer portion of FICA Taxes, and employer insurance and retirement contributions.

What are fringe benefits?

Additional employee benefits paid for by the employer. Health, dental, disability, life insurance, contributions to retirement or savings plans.

Employees are required to match..?

The amount withheld for each employee, effectively doubling the amount paid into Social Security.

What are some other current liabilities?

Deffered revenue, sales tax payable, current portion of long term debt.

Deferred revenue

Cash received in advance from a customer for products or services to be provided in the future.

Sales tax payable?

Sales tax collected from customers by the seller, representing current liabilities payable to the government.

Current Portion of long-term debt.

Debt that will be paid within one year from the balance sheet date.

What are sales tax collected from customers by the seller?

Not an expense, but they represent current liabilities payable to the government.

What are the currently maturing portion of long-term debt reported as?

A long term debt as a current liability in the balance sheet.

Contingencies?

Uncertain situations that can result in a gain or a loss for a company.

Contingent liability?

An existing uncertain situation situation that might result in a loss.

When is a contingent liability recorded?

Only if a loss is probable and the amount is reasonably estimable.

The likelihood of payment to occur is either..?

Probable, reasonably possible, or remote.

If the amount of payment is reasonably estimable..?

Probable - liability recorded
Reasonably possible - disclosure required
Remote - Disclosure not required

If the amount of payment is not reasonably estimable..?

Probable - disclosure required
Reasonably possible - disclosure required
Remote - Disclosure not required

What are the most common example of contingent liabilities?

Warranties

If a warranty for a product represents a liability for a company at the time of sale it meets the criteria for..?

recording a contingency liability: probably and reasonably estimable

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, and other current business conditions.

IS Warranty liability account always equal to warranty expense?

NO

When is warranty liability account increased?

When the estimated warranty liability is recorded

When is warranty liability reduced?

Over time by actual warranty expenditures.

Contingent Gains

An existing uncertain situation that might result in a gain

When is contingent gains recorded?

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 leads to..?

Financial difficulties or even bankruptcy

What are the 3 liquidity measures?

Working capital, current ratio, acid-test ratio.

Working capital formula?

Working capital = current assets - current liabilities

A large positive working capital is an indicatior of..?

indicator of liquidity, whether a company will be able to pay its current onbligations on time.

What is the current ratio formula?

Current ratio = current assets / current liabilities

The higher the current ratio…

the higher the company’s liquidity.

Acid-test ratio formula

Acid-test ratio = ((cash+current investments) + accounts receivable) / current liabilities

What do quick assets include?

cash, current investments, and accounts receivable.

What do quick assets exclude?

current assets, such as inventory and prepaid rent.

Generally higher current ratio is..?

Better, but a not always positive signal. Companies having difficulty collecting receivables or hold excessive inventory will also have a higher current ratio.

For strong liquidity what must managers balance?

The incentive for strong liquidity with the need to minimize levels of receivables and inventory.