Chapter 12 Current liabilities

12.1

Describe the nature, valuation, and reporting of current liabilities in the form of payables.

Step 1: Understand and Simplify

This document teaches us about current liabilities—short-term debts a company owes. These debts are typically paid within one year or an operating cycle and include accounts payable, taxes, notes payable, and employee-related obligations.

Step 2: Explain It Like You’re Teaching Someone Else

What Are Current Liabilities?

They are short-term financial obligations, like:

Accounts Payable: Money owed to suppliers for goods bought on credit.

Notes Payable: Loans with agreed repayment terms.

Taxes Payable: Money collected for or owed to governments (like sales tax or income tax). Employee Liabilities: Salaries, vacation pay, bonuses, etc.

Examples and Details

Accounts Payable

When a company buys something on credit, it owes money to the supplier. Terms like 2/10, n/30 mean:

A 2% discount is available if payment is made within 10 days.

Otherwise, pay the full amount within 30 days.

Notes Payable

Loans can be short-term (due within a year) or long-term.

They may accrue interest (like 6% annually).

Example: A $100,000 loan with 4 months of interest:

Interest = Principal × Rate × (Months ÷ 12) = $100,000 × 6% × (4 ÷ 12) = $2,000. Sales Taxes Payable

Companies collect sales tax from customers and pay it to the government. Example: Selling $3,000 worth of goods with a 4% tax:

Austin Vasquez <astn.vsqz@gmail.com>

Tax = $3,000 × 4% = $120. Total cash received = $3,120. Record as:

Debit: Cash $3,120

Credit: Sales Revenue $3,000, Sales Taxes Payable $120. Employee-Related Liabilities

Salaries, bonuses, vacation pay, and payroll taxes.

Example: Weekly payroll of $10,000:

Deductions include taxes (7.65% FICA, 0.8% federal unemployment, 4% state unemployment), income tax withholding, and union dues.

Journal entry reflects gross pay minus deductions, with the remainder paid to employees. Journal Entry Examples

Here’s how companies record these liabilities:

Borrow $90,000 via a 6-month note at 8%:

Debit: Cash $90,000

Credit: Notes Payable $90,000 Record one month’s interest:

Debit: Interest Expense $600

Credit: Interest Payable $600.

Calculation: $90,000 × 8% × (1 ÷ 12).

Purchase $40,000 of inventory with 2/10, n/30 terms:

Debit: Inventory $40,000

Credit: Accounts Payable $40,000.

Pay within 10 days, taking a $800 discount:

Debit: Accounts Payable $40,000 Credit: Cash $39,200

Credit: Purchase Discounts $800.

Step 3: Identify Gaps in Understanding

Questions to Consider:

How do zero-interest loans work?

These loans include a discount on notes payable, recorded as a contra account. Example: Borrow $100,000 but repay $102,000 after 4 months:

Discount = $2,000 (cost of borrowing).

Debit: Cash $100,000, Discount on Notes Payable $2,000. Credit: Notes Payable $102,000.

How are unemployment taxes handled?

Employers pay both federal and state unemployment taxes.

Federal rate: 6% on the first $7,000 of wages, offset by state contributions. Example: For $100,000 taxable payroll with a reduced state rate of 1%: State tax = $100,000 × 1% = $1,000.

Federal tax = $100,000 × (6% - 5.4%) = $600.

Step 4: Review and Refine

Key Takeaways

Current liabilities are debts due within a year.

Accounts payable is for short-term purchases on credit.

Notes payable involves loans with or without interest.

Employee liabilities include wages, bonuses, and payroll taxes.

Sales and income taxes are collected and remitted to the government. 12.1

Describe the nature, valuation, and reporting of current liabilities in the form of payables.

Step 1: Understand and Simplify

This document teaches us about current liabilities—short-term debts a company owes. These debts are typically paid within one year or an operating cycle and include accounts payable, taxes, notes payable, and employee-related obligations.

Step 2: Explain It Like You’re Teaching Someone Else

What Are Current Liabilities?

They are short-term financial obligations, like:

Accounts Payable: Money owed to suppliers for goods bought on credit. Notes Payable: Loans with agreed repayment terms.

Taxes Payable: Money collected for or owed to governments (like sales tax or income tax).

Employee Liabilities: Salaries, vacation pay, bonuses, etc. Examples and Details

Accounts Payable

When a company buys something on credit, it owes money to the supplier. Terms like 2/10, n/30 mean:

A 2% discount is available if payment is made within 10 days.

Otherwise, pay the full amount within 30 days.

Notes Payable

Loans can be short-term (due within a year) or long-term.

They may accrue interest (like 6% annually).

Example: A $100,000 loan with 4 months of interest:

Interest = Principal × Rate × (Months ÷ 12) = $100,000 × 6% × (4 ÷ 12) = $2,000. Sales Taxes Payable

Companies collect sales tax from customers and pay it to the government. Example: Selling $3,000 worth of goods with a 4% tax:

Tax = $3,000 × 4% = $120.

Total cash received = $3,120.

Record as:

Debit: Cash $3,120

Credit: Sales Revenue $3,000, Sales Taxes Payable $120. Employee-Related Liabilities

Salaries, bonuses, vacation pay, and payroll taxes.

Example: Weekly payroll of $10,000:

Deductions include taxes (7.65% FICA, 0.8% federal unemployment, 4% state unemployment), income tax withholding, and union dues.

Journal entry reflects gross pay minus deductions, with the remainder paid to employees.

Journal Entry Examples

Here’s how companies record these liabilities:

Borrow $90,000 via a 6-month note at 8%:

Debit: Cash $90,000

Credit: Notes Payable $90,000 Record one month’s interest:

Debit: Interest Expense $600

Credit: Interest Payable $600.

Calculation: $90,000 × 8% × (1 ÷ 12).

Purchase $40,000 of inventory with 2/10, n/30 terms:

Debit: Inventory $40,000

Credit: Accounts Payable $40,000.

Pay within 10 days, taking a $800 discount:

Debit: Accounts Payable $40,000 Credit: Cash $39,200

Credit: Purchase Discounts $800.

Step 3: Identify Gaps in Understanding

Questions to Consider:

How do zero-interest loans work?

These loans include a discount on notes payable, recorded as a contra account. Example: Borrow $100,000 but repay $102,000 after 4 months:

Discount = $2,000 (cost of borrowing).

Debit: Cash $100,000, Discount on Notes Payable $2,000.

Credit: Notes Payable $102,000.

How are unemployment taxes handled?

Employers pay both federal and state unemployment taxes.

Federal rate: 6% on the first $7,000 of wages, offset by state contributions. Example: For $100,000 taxable payroll with a reduced state rate of 1%: State tax = $100,000 × 1% = $1,000.

Federal tax = $100,000 × (6% - 5.4%) = $600.

Step 4: Review and Refine

Key Takeaways

Current liabilities are debts due within a year.

Accounts payable is for short-term purchases on credit.

Notes payable involves loans with or without interest.

Employee liabilities include wages, bonuses, and payroll taxes.

Sales and income taxes are collected and remitted to the government.

12.2—describing the nature, valuation, and reporting of current liabilities in the form of unearned revenues—we’ll break this down step by step:

Step 1: Explain it Simply

What is Unearned Revenue?

Unearned revenue is money received by a company for goods or services it hasn’t yet delivered. It’s a liability because the company owes either the product or service to the customer. Once the obligation is fulfilled, it gets recorded as revenue on the income statement.

Step 2: Use Analogies and Examples

Think of unearned revenue like a promise. For example:

A magazine publisher collects money in advance for subscriptions but hasn’t yet sent the magazines. The cash collected is recorded as unearned subscription revenue (liability). When the magazines are delivered, the revenue is earned and transferred to the income statement.

An airline sells tickets for a future flight. Until the passenger takes the flight, the airline records the payment as unearned ticket revenue. Once the passenger flies, the airline recognizes passenger revenue.

Step 3: Show the Journal Entries

Let’s use the Allstate University example:

1. Recording Unearned Revenue: On August 6th, the university sells $500,000 in season tickets:

Debit: Cash $500,000 (increases assets)

Credit: Unearned Ticket Revenue $500,000 (increases liabilities)

2. Recognizing Earned Revenue: On September 7th, after one game is played (1/5 of the season tickets are earned):

Debit: Unearned Ticket Revenue $100,000 (reduces liabilities) Credit: Sales Revenue $100,000 (increases revenue)

Step 4: Add Complexity with Gift Cards When a company sells gift cards, it:

1. Records the sale as unearned gift card revenue (liability), as the service or goods are not yet provided. 2. Recognizes revenue when the cards are redeemed.

Example: Haven Retailers

Selling Gift Cards: In March, Haven sells $2,000 in gift cards:

Debit: Cash $2,000

Credit: Unearned Gift Card Revenue $2,000

Redeeming Cards: In April, six cards are redeemed:

Debit: Unearned Gift Card Revenue $1,200

Credit: Sales Revenue $1,200

Debit: Cost of Goods Sold $840 (to match expenses with revenue) Credit: Inventory $840

Step 5: Check for Understanding

What happens to unused gift cards? Companies may estimate breakage revenue, which accounts for gift cards that

won’t be redeemed. This is recognized proportionally to redemptions.

Step 6: Practical Application Using the Congo Corporation example:

1. Subscriptions: Record cash received in December as unearned revenue: Debit: Cash $22,000

Credit: Unearned Subscription Revenue $22,000 2. Gift Cards:

Record sale:

Debit: Cash $1,000

Credit: Unearned Gift Card Revenue $1,000 Record redemption of 30 cards:

Debit: Unearned Gift Card Revenue $300

Credit: Sales Revenue $300

Record breakage for 40 unused cards (assuming a 50% breakage rate):

Debit: Unearned Gift Card Revenue $200 Credit: Sales Revenue $200

3. Security Deposit: Record deposit as a refundable liability: Debit: Cash $5,000

Credit: Refundable Deposits $5,000 Final Check

1. Can I explain this to someone with no accounting background?

2. Can I create journal entries for different scenarios involving unearned revenue? 3. Can I identify unearned revenue on financial statements?

P

art 1: Premium Inventory and Estimated Liabilities

What is happening?

Imagine a company sells products with a promise to give away some free stuff later (called a “premium”). At the beginning of the year, they estimate how much they will need to give out based on how many products they sold and how many customers will actually redeem their offer.

1. Inventory and Premium Redemptions:

The company keeps track of how many “premiums” they’ve purchased and given away.

When the premiums are redeemed (customers actually claim them), the company needs to adjust its inventory and record how much it spent.

For example, if they initially thought 60% of customers would redeem their premium but only 50% did, they would adjust their accounts accordingly. This ensures they don’t keep too much inventory or spend more than necessary.

2. Adjusting the Estimated Liabilities:

At the end of the year, the company also has to estimate how much more they will owe based on redemptions that haven’t happened yet.

This involves figuring out how much of the total premium offer will be claimed by customers, calculating the cost, and adjusting the premium liability.

Key Concepts to Remember:

Premium Expense: This is the cost of giving away the premium.

Premium Liability: This is what the company owes in terms of the value of premiums it still needs to give out or has already promised to give out in the future.

Part 2: Gain Contingencies and Liabilities (Warranties, Lawsuits)

What is happening?

Now, let’s talk about situations where a company faces risks or benefits that are uncertain, like warranties and lawsuits. The company has to decide whether or not to record something in their financial statements based on the likelihood of it happening.

1. Warranties:

When a company sells products with a warranty, they know that some of their products will likely need repairs. So, they estimate the cost of those repairs.

For example, if they sold $400,000 worth of products and expect that 5% of those will require repairs, they set aside a “warranty expense” and record a “warranty liability” in their accounts.

They also need to adjust their records if they actually spend money on fixing products (e.g., repair costs).

2. Lawsuits and Contingent Liabilities:

If a company is sued, it needs to assess how likely it is that they will lose and how much they might have to pay if that happens. For example, if a company is being sued for $350,000 and it seems likely they will lose and need to pay $250,000, they should recognize this liability in their financial statements. However, if they’re in a lawsuit that seems very unlikely to result in a loss, they don’t record anything. Instead, they disclose the possibility in the notes to their financial statements.

3. Gain Contingencies (Uncertain Positive Outcomes):

Sometimes, a company expects to receive money from a lawsuit or settlement. But because it’s uncertain, they don’t recognize this as revenue until it actually happens.

For example, if a company wins a lawsuit but hasn’t yet received the settlement, they don’t record that as income until they know the exact amount and when they will get the money.

Key Concepts to Remember:

Warranty Liability: This is the estimated cost the company expects to pay for warranty claims in the future. Contingent Liability: This is a possible future obligation based on uncertain events, like a lawsuit. It gets recorded only if it’s likely to happen and the amount is reasonably estimated.

Gain Contingency: This is a potential gain, like winning a lawsuit, but it’s not recorded until it becomes certain.

Summary of Both Parts Using the Feynman Technique:

Premiums and Warranties: When a company sells products with bonuses (premiums) or warranties, it must predict how much it will spend on these promises. They create an estimated liability for future costs based on what they think will happen (e.g., how many people will claim the premium or how many products will break and need repair). If they spend money or give out the premiums, they adjust their accounts.

Lawsuits and Contingencies: For lawsuits or possible gains, companies have to evaluate how likely it is that they will lose money (liability) or gain money (contingency). They record the liability if they’re fairly sure they will lose, but they don’t record potential gains until they know for sure they will receive the money.

By following this process, companies keep their financial statements accurate and reflect the true risks and obligations they face.

Step 1: Choose a Concept

The main concepts to simplify here are:

Current Liabilities: What a company owes and needs to pay soon (typically within one year). Presentation of Current Liabilities: How liabilities are shown in financial statements. Liquidity Ratios: Ratios used to evaluate a company’s ability to pay short-term obligations.

Step 2: Explain in Simple Terms

Current Liabilities: Think of a current liability as something the company needs to pay soon, like bills or short-term loans. For example, if you borrow money to buy something today, and you need to pay it back in the next year, that’s like a current liability for the company.

Now, the company lists these liabilities in a specific order in their balance sheet, such as:

1. Order of Maturity: From the soonest payment to the latest.

2. Descending Order of Amounts: The biggest amounts listed first.

3. Order of Liquidation Preference: What the company wants to pay first (i.e., which debts are most important

to pay off first).

An example from Best Buy shows a variety of current liabilities, including accounts payable (what they owe to suppliers) and accrued compensation (what they owe their employees).

Short-Term Obligations Expected to be Refinanced: Let’s say a company owes money soon, but plans to borrow more money to pay it off later. They don’t have to include the short-term debt in current liabilities, but they need to explain the refinancing deal in the notes of their financial statements.

For example, Marquart Company plans to pay off a $40,000 debt in 2026. But before its balance sheet date, in December 2025, they have no long-term refinancing deal yet. So, Marquart must still include that $40,000 debt as a current liability on the balance sheet, because it hasn’t been officially replaced by new long-term debt by the time the financial statements are issued.

Liquidity Ratios: Liquidity ratios measure how easily a company can pay its short-term debts. There are two common ones:

1. Current Ratio:

Formula: Current Assets ÷ Current Liabilities

It gives us an idea of how many times the company can cover its short-term debts with its assets. For Best Buy, they have a current ratio of 1.10 times, meaning they have $1.10 in assets for every $1 they owe in short-term liabilities.

2. Acid-Test Ratio (Quick Ratio):

Formula: Cash + Short-Term Investments + Net Accounts Receivable ÷ Current Liabilities

This ratio is stricter because it only includes the most liquid assets (like cash) to see if the company can pay its short-term debts. For Best Buy, the acid-test ratio is 0.44 times, which means they don’t have enough liquid assets to cover all their short-term liabilities at that moment.

What does this mean?

The current ratio suggests that Best Buy can cover its short-term liabilities with its assets (since 1.10 is above

1).

The acid-test ratio is lower, meaning if they couldn’t sell their inventory quickly, they might struggle to meet their short-term debts.

Step 3: Identify Gaps in Understanding

The key gap to clarify is the acid-test ratio being more stringent than the current ratio because it excludes inventory, which might not be as easily converted to cash. It’s a measure of how well a company could pay off its short-term debts if they needed to use only the most liquid assets (like cash).

Step 4: Review and Refine

The main points to remember:

Current liabilities are debts a company must pay soon (within a year).

Presentation: They’re listed in different ways, like by when they’ll be paid or how much they owe. Short-term debt refinancing: If a company plans to replace short-term debt with long-term debt, they don’t have to show it in current liabilities, but they need to explain the deal.

Liquidity ratios like the current and acid-test ratios help investors understand if a company can pay its short- term debts.

12.5—comparing accounting procedures for current liabilities and contingencies under GAAP and IFRS—using the Feynman Technique.

Step 1: Choose a Concept

We’re comparing how GAAP (Generally Accepted Accounting Principles) and IFRS (International Financial

Reporting Standards) handle liabilities and contingencies, particularly:

Presentation of liabilities

Measurement of provisions (or estimated liabilities) Accounting for contingencies

Step 2: Explain in Simple Terms

1. Presentation of Liabilities: Both GAAP and IFRS have similar rules for presenting liabilities:

Liabilities are listed in two categories on the balance sheet: current (due soon) and non-current (due later).

The only main difference is order: While both systems usually list current liabilities in order of liquidity (how easily they can be paid with cash), IFRS often lists non-current liabilities first, before current liabilities, which is not common under GAAP.

2. Measuring Liabilities for Contingencies: A contingency is a potential liability that depends on the outcome of an uncertain event. Both GAAP and IFRS agree that liabilities must be measured with estimates based on how much it might cost to settle the obligation.

However, the measurement approach differs:

IFRS measures provisions based on the best estimate of what the company expects to pay. If there’s a range of possible amounts, and no amount is more likely than any other, IFRS uses the midpoint of the range. GAAP instead uses the lowest amount in the range of estimates to measure the liability.

3. Accounting for Contingencies:

Both systems prohibit recognizing liabilities for future losses (for example, losses not yet incurred or

uncertain).

However, IFRS has different rules for restructuring. Once a company commits to a restructuring plan, it can recognize a restructuring liability.

GAAP, on the other hand, has stricter rules. A company can’t recognize this liability until it has communicated the restructuring plan to employees.

4. Terminology and Treatment of Contingencies:

Under IFRS, contingencies are not recognized as liabilities in the financial statements. Instead, companies often disclose them in the notes to the financials.

GAAP, however, sometimes recognizes a contingent liability if it’s likely that the company will have to pay and the amount can be estimated.

5. Provisions and Estimated Liabilities:

In IFRS, estimated liabilities are called provisions, and the accounting for them is similar to GAAP’s treatment

of estimated liabilities.

Step 3: Identify Gaps in Understanding

A potential gap to clarify is the use of midpoint vs. minimum in measuring liabilities. IFRS uses the midpoint when the amount is uncertain, while GAAP is more conservative, using the minimum amount. This may affect how much a company records in its financials.

Step 4: Review and Refine

Summary of Key Differences and Similarities: Similarities:

Both require the classification of liabilities as current or non-current. Both require disclosures for contingencies.

Both prohibit recognizing liabilities for future losses.

Differences:

Measurement: IFRS uses the midpoint of a range of estimates, while GAAP uses the minimum amount.

Restructuring Liabilities: IFRS allows recognition once the plan is committed, while GAAP requires communication to employees before recognition.

Terminology: IFRS uses provisions for estimated liabilities, while GAAP uses contingencies for certain liabilities, sometimes recognizing them.

By explaining it in simple terms, the main takeaway is that while both GAAP and IFRS are similar in how they present liabilities and handle contingencies, the differences lie mostly in how uncertain liabilities are measured and when restructuring liabilities can be recognized. Does this help clarify the accounting rules under GAAP and IFRS?