ACCT CH 8

SP 25

Liabilities

probable future sacrifices of economic benefits

Liabilities

• debts or obligations arising from activities that have already occurred

• represent creditors’ claims on total assets

contingent liabilities

those that may or may not end up turning into actual obligations:

• depend on the outcome of a future event (lawsuit)

• ex) Can we make a reasonable estimate? Likelihood of occurrence?

1. Payment of cash

2. Certainty

3. Legal enforceability

4. Payment recipient

Liability Characteristics:

Payment of Cash

Although liabilities frequently require the payment of cash, some may require the transfer of assets other than cash, or the performance of services.

Certainty

Although the exact amount and timing of future payments are usually known, for some liabilities they may not be.

Legal enforceability

Although many liabilities are legally enforceable claims, some may represent merely probable claims.

Payment recipient

Although liabilities usually identify the entity to be paid, the definition does not exclude payment to as yet unidentified recipients.

Current Liabilities

any dept that can reasonably expect to be satisfied or paid by:

• existing current assets OR other current liabilities

• perfomring a service (”satisfied”)

• within one year or operating cycle

Current liabilities

if criteria not met, it is long-term

Current liabilities examples

• Accounts Payable

• Notes Payable

• Taxes Payable

• Unearned Revenue

• Other Accrued Liabilities

Accounts Payable

arise when a business purchases goods or services on credit(2/10, n/30)

do not require a formal agreement or contract

Notes Payable

formal debt instruments-used in place of Accounts Payable financing

• a legal doc/ agreement

• current or long term

• can occur when open account terms cannot be met

• usually require interest to be paid

• payment within one yr of balance sheet date are CURRENT

Interest

Face X Rate X Time

Accrued Liabilities

originate from adjusting entries (accumulate)

• usually represent the completed portion of activities that are in process at the end of the period

  • Future Salaries (accrued wages)

  • Future Services to be performed (accrued services)

  • Future Interest payments (accrued interest)

Current portion of long term debt

the amount of long term debt due within the next year

Other payables for most retail companies include sales taxes, usage taxes, or excise taxes for various state, local, and federal taxing authorities.

Other payables for most retail companies include sales taxes, usage taxes, or excise taxes for various state, local, and federal taxing authorities.

Other payables: Sales Tax

collected by seller on behalf of these entities:

• not additional revenue to the seller

• % of sales price

• obligation for the seller to pay the authority

these tax collections are liabilities until they are paid to the taxing authority

Businesses are required to withhold taxes from employees’ earnings and to pay
taxes based on wages and salaries paid to employe

Businesses are required to withhold taxes from employees’ earnings and to pay
taxes based on wages and salaries paid to employe

withholding and payroll taxes

are liabilities until they are paid to the taxing authority

• employers who must pay certain taxes that are “withheld” from their paychecks. This is the difference between gross (before taxes) and net (after taxes) pay.

• the business itself, which must pay certain taxes based o employee payrolls, like matching contributions of Social Security and Medicare and fringe benefits.

2 sources for withholding and payroll taxes are:

other current liabilities: Unearned Revenue

• receive cash before revenue is earned

• creates a liability for the seller

• requires adjusting journal entry

  • recognized when the goods or services purchased are provided

contingent liabilities

measurement of the liabilities described so far was not affected by uncertainties about the amount, timing, or recipient of future asset outflows

contingent liabilities

• only recognized when:

  • the event on which it is contingent is probable and

  • a reasonable estimate of the loss can be made

contingent liabilties classic example

lawsuits filed against a business

warranties

when the goods are sold, the customer is often provided with a warranty against certain defects

warranty

usually guarantees the repair or replacement of defective goods during a period (ranging from a few days to several years) following the sale.

The recognition of warranty expense and (estimated) warranty liability is normally
recorded as an adjusting entry at the end of the period.

The recognition of warranty expense and (estimated) warranty liability is normally
recorded as an adjusting entry at the end of the period.

As warranty claims are paid to customers or related expenditures are made, the liability is reduced.

As warranty claims are paid to customers or related expenditures are made, the liability is reduced.

ability to meet its short term obligations

both investors and creditors are interested in a company’s liquidity

Current Ratio= Current Assets/ Current Liabilities

Current Ratio= Current Assets/ Current Liabilities

A higher current ratio

indicates a better short term/ current finical health and suggests that the company has more assets readily available to cover obligations

Quick Ratio= (cash + Marketable Securities+ Accounts Receivable)/ Current Liabilities

Quick Ratio= (cash + Marketable Securities+ Accounts Receivable)/ Current Liabilities

A higher quick ratio

means a stronger ability to meet obligations (short terms) without relying on sales inventory

liability to meet its short term obligations

both investors and creditors are interested in a company’s liquidity

Cash Ratio= (Cash + Marketable Securities)/ Current Liabilities

Cash Ratio= (Cash + Marketable Securities)/ Current Liabilities

Current Ratio

a conservative measure of the company’s liquidity

• ability to cover liabilities with cash only

• Higher ratio= strong ability to cover liabilities

Operating Cash Flow Ratio= Cash flows from Operating Activites/ Current Liabilities

Operating Cash Flow Ratio= Cash flows from Operating Activites/ Current Liabilities

Operating cash flow

assess the company’s ability to generate cash from core operating activities as compared to current liabilities

• A higher ratio= strong ability to cover liabilities with operating cash from day to day operations