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March 29, 2008
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PRINCIPLES
of
ACCOUNTING II
(AC202)
___________
CHAPTER 12
CURRENT
AND
LONG-TERM LIABILITIES
LIABILITIES
DEFINED:
A probable future payment of assets or services a company is presently obligated to make as a result of past transactions or events.
Fundamentally liabilities are measured by the cost principle however:
Liabilities are comprised of known obligations of a definite amount and known obligations of an estimated amount (i.e. warranties)
CURRENT LIABILITIES:
Obligations expected to be paid using current assets or by creating other current liabilities
LONG-TERM LIABILITIES:
Obligations not expected to be paid within one year. Includes long-term notes payable; mortgages payable; warranty liabilities; lease liabilities; and bonds payable.
MEASUREMENT OF LIABILITIES
Conceptually, the dollar amount of a liability, at any point in time, is the present value of the future outlays of assets required to pay the debt in full.
i.e. the present value of principal plus all future interest payments
The present value amount may be called the current cash equivalent amount
-What both parties would settle for today!
A liability that requires the going rate of interest will always have a present value equal to its maturity amount (i.e. interest bearing notes)
When the required rate of interest is different from the going rate, or interest is unspecified, the present value will be different from the maturity amount. (i.e. bonds sold at a premium or discount)
As such liabilities approach maturity, the current cash equivalent amount approaches the maturity amount
CURRENT LIABILITIES
Accounts Payable
Short-term Notes Payable
Unearned (deferred) Revenues
Payroll Liabilities
-Employee Payroll Deductions
-Employer Payroll Taxes
Warranty Liabilities
Employee Health/Pension Benefits Payable
Vacation Pay (employee benefits)
Tax Liabilities for Businesses
(Federal Income Tax - Corporation only; State and/or local income taxes - Corporation only; property taxes; sales taxes; etc.)
Deferred Income Taxes for Corporations
Contingent Liabilities
-Legal Claims (Potential)
-Debt Guarantees
-Other Contingencies
INTEREST & NON-INTEREST NOTES
Interest Bearing Notes:
Specifies:
-A stated rate of interest
-Interest is to be paid at maturity in addition to the face or principal amount of the note.
Non-Interest Bearing Notes:
Does not specify a rate of interest
Includes the interest in the face amount of the note
An overdue non-interest bearing note immediately draws interest at a legal rate (usually specified by law) from the due date.
EXAMPLE:
The business needs to borrow $2,000 cash from the bank for 60 days on December 16, 1999
a. interest bearing note, 6%
b. non-interest bearing note, $2,040
UNEARNED REVENUES
Arise from revenues that have been collected in advance during the current period but will not be earned until a later accounting period.
-Also called;
Deferred Revenue,
Revenue collected in Advance, or Precollected Revenue
Unearned Revenues constitute a liability since cash has been collected but the goods or services have not been provided (i.e. the revenue has not been earned)
-There is a present obligation to render, in the future, the product or services.
EXAMPLE: Textbook, page 499
PAYROLL LIABILITIES
Recording Employee salary expense and amounts withheld.
-Textbook, page 507
Recording Employer Payroll taxes
-Textbook, page 508
Payroll Reports, Records and Procedures
-Appendix 12A, page 523
Payroll reports are filed within one month after the end of each calendar quarter
Payments:
-Less than $500, pay with report
-Most companies are required to pay monthly or semiweekly
-If taxes are over $100,000 they must be paid at the end of the next business day
Employers are required to provide employees with a W-2 before January 31 of the following year
Companies with many employees often use a special payroll bank account to pay employees.
CONTINGENT LIABILITIES
A contingent liability is not a legal or effective debt -- rather it is a potential future liability
It is a potential liability that has arisen as a result of an event that already has occurred but its conversion to an effective liability is dependent upon the occurrence of one or more future events
REPORTING:
-A contingent liability is not recorded in the accounting records unless there is a high probability of loss.
-They are generally reported in a footnote(s) to the financial statements
An example is a pending lawsuit. Before recording in the financial records work with the legal representation to insure proper recording
CURRENT LIABILITIES
Working Capital:
The difference between total current assets and total current liabilities
Current Ratio or
Workinng Capital Ratio:
______Current Assets_____
Current Liabilities
Example: The balance sheet for ABC Company, December 31, 2000, reported total current assets of $900,000 and total current liabilities of $300,000.
Working Capital:
$900,000 - $300,000 = $600,000
Current Ratio:
$ 900,000__
300,000 = 3.00 or 3 to 1
LONG-TERM LIABILITIES
Includes ALL obligations of the entity not properly classified as current liabilities.
Generally arise from the purchase of fixed assets or borrowing on large sums of money
-Long-term Notes Payable
-Bonds Payable
-Mortgages Payable
Frequently, a long term liability is supported by a mortgage on specified assets of the borrower which are pledged as security for the liability.
Secured debt -- a liability (i.e. Mortgage Payable) supported by a building/land
Unsecured debt -- Creditor relies on the integrity and general earning power of the borrower
As a long-term debt approaches the maturity date, the portion of it that is to be paid in the next current period is reclassified as a current liability
Notes Payable
Defined:
A written promise to pay a stated sum at one or more specified dates in the future
Notes Payable require the payment of interest and the recording of interest expense.
Interest expense is incurred on liabilities because of the time value of money
In calculating interest we must consider
-Principal
-Interest rate
-Duration of time
Interest formula is:
Interest = Principal x Rate x Time
The accounting for a note payable is the same whether it is classified as a current or as a long-term liability. Balance sheet presentation is different.
Word Count: 968
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