Learning Objectives
Distinguish between current and long-term liabilities
Account for notes payable and interest expense
Account for employee and employer payroll liabilities
Explain the accounting for other current liabilities
Apply the appropriate accounting treatment for contingencies
Assess liquidity using current liability ratios
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Current LiabilitiesChapter 8 Learning ObjectivesDistinguish between current and long-term liabilitiesAccount for notes payable and interest expenseAccount for employee and employer payroll liabilitiesExplain the accounting for other current liabilitiesApply the appropriate accounting treatment for contingenciesAssess liquidity using current liability ratiosPart ACurrent LiabilitiesCurrent LiabilitiesLiability: a present responsibility to sacrifice assets in the future due to a transaction or other event that happened in the pastLearning Objective 1Distinguish between current and long-term liabilities8-5Current vs. Long-Term LiabilitiesLearning Objective 2Account for notes payable and interest expense8-7Notes PayableNote signed by a firm promising to repay the amount borrowed plus interestInterest on notes is calculated as:InterestFace valueAnnualinterest rate ×=Fractionof the year×Line of Credit & Commercial PaperLine of credit:Informal agreementPermits a company to borrow up to a prearranged limitNo formal loan procedures and paperworkCommercial paper:Company borrows from another company rather than from a bankSold with maturities normally ranging from 30 to 270 daysInterest rate is usually lower than on a bank loanAccounts PayableAmounts owed to suppliers of merchandise or servicesSometimes called trade accounts payableLearning Objective 3Account for employee and employer payroll liabilities8-11Illustration 8.3—Payroll Costs forEmployees and EmployersEmployee CostsFederal and state income taxesFICA taxes7.65% (6.2% + 1.45%)Collectively, Social Security and Medicare taxes Employees may opt to have additional amounts withheld from their paychecksEmployer records the amounts deducted and pays them to the appropriate organizationsEmployer CostsAdditional (matching) FICA tax on behalf of the employeeEmployers also pay federal and state unemployment taxes on behalf of its employeesFUTA and SUTAFringe benefits: Additional employee benefits paid for by the employerIllustration 8.4—Payroll Example8-15Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.Learning Objective 4Explain the accounting for other current liabilities8-16Other Current LiabilitiesUnearned revenues: liability account used to record cash received in advance of the sale or serviceSales tax payable: collected from customers by the sellerCurrent portion of long-term debt: debt that will be paid within the next yearCurrent Portion of Long-Term DebtDebt that will be paid within the next yearProvides information about a company’s bankruptcy riskIllustration 8.6—Current Portion ofLong-Term DebtPart BContingenciesLearning Objective 5Apply the appropriate accounting treatment for contingencies8-21Contingent LiabilitiesAn existing uncertain situation that might result in a lossIllustration 8.8—Accounting Treatment of Contingent LiabilitiesWarrantiesMost common example of contingent liabilitiesHelp increase salesWarranty expense is recorded in the same accounting period as the saleIt should be probable and the amount can be reasonably estimatedContingent GainsAn existing uncertain situation that might result in a gainNot recorded until the gain is certainConservative reasoningNot recorded in the accountsFirms sometimes disclose them in notes to the financial statementsLearning Objective 6Assess liquidity using current liability ratios8-26Liquidity AnalysisLiquidity: refers to having sufficient cash or other current assets to pay currently maturing debtsLack of liquidity can result in financial difficulties or even bankruptcyThree liquidity measures:Working capitalCurrent ratioAcid-test ratioWorking CapitalA large positive working capital is an indicator of liquidityNot the best measure of liquidity for comparisonCurrent RatioRatio of 1 or higher often reflects an acceptable level of liquidityHigher the current ratio, the greater the company’s liquidityAcid-Test Ratio or Quick RatioBased on a more conservative measureQuick assets are readily convertible into cashEffect of Transactions on Current Ratio and Acid-Test RatioSame denominator: current liabilitiesDecrease in current liabilities will increase the ratiosIncrease in current liabilities will decrease the ratiosDifferent numerator: current assets; quick assetsIncrease in cash, current investments, and accounts receivable will increase both ratiosIncrease to inventory or other current assets will increase the current ratio, but not the acid-test ratioLiquidity ManagementManagement can influence the ratios that measure liquidityDebt covenant: agreement between a borrower and a lender that requires certain minimum financial measures be met or the lender can recall the debtEnd of Chapter 88-33