8.2: Current Liabilities Flashcards
Relationships between Operating Activities and Current Liabilities
What are accounts payable, and how do they relate to a company’s day-to-day operations?
Accounts payable, also known as trade accounts payable, are obligations created when a company purchases goods and services on credit.
These obligations are settled with cash payments after the goods and services have been received, and they are a way for companies to finance the purchase of inventory.
How do suppliers’ credit terms impact a company’s accounts payable?
Generous credit terms from suppliers allow buyers to resell merchandise and collect cash before payment to the supplier.
This can encourage more sales and provide financial flexibility to the buying company.
Why is delaying payment to suppliers generally not advisable for a company?
Delaying payment to suppliers can strain relationships, impact the quality of goods and services received, and indicate financial difficulties.
It can also create problems for suppliers, who have their own bills to pay.
How do managers and analysts evaluate a company’s management of accounts payable?
Managers and analysts use the accounts payable turnover ratio to evaluate a company’s effectiveness in managing its accounts payable.
This ratio helps assess how efficiently a company is paying its suppliers and managing its working capital.
How can understanding the relationship between operating activities and current liabilities help financial analysts?
Understanding the relationship between operating activities and current liabilities enables financial analysts to explain changes in various current liability accounts.
This understanding helps analyze how specific operating activities are financed, in part, by related current liabilities.
What does the accounts payable turnover ratio measure, and how is it computed?
The accounts payable turnover ratio measures how quickly a company pays its trade suppliers.
It is computed as the cost of sales divided by the average accounts payable.
The formula is: Accounts payable turnover ratio = Cost of sales / Average accounts payable.
Why might the numerator of the accounts payable turnover ratio be adjusted for merchandising companies, and how is it adjusted?
The numerator of the accounts payable turnover ratio is adjusted for merchandising companies because credit purchases are not usually reported.
To adjust, the formula becomes:
**Purchases = Cost of sales + Ending inventory – Beginning inventory. **
This adjustment helps calculate a more accurate ratio.
What is the average days to pay payables, and how is it calculated?
The average days to pay payables indicates how many days, on average, a company takes to pay its suppliers.
It is calculated by dividing 365 days by the accounts payable turnover ratio:
Average days to pay payables = 365 days / Accounts payable turnover ratio.
How can the average days to pay payables be used for company analysis, and what does it reveal about a company’s payment behavior?
Analysts use the average days to pay payables to compare a company’s payment behavior over time and against competitors.
A decrease in average days to pay indicates faster payment to suppliers.
In the given example, Starbucks paid its suppliers more quickly in 2021 compared to previous years and faster than Monster Beverages but slower than McDonald’s.
What are the limitations of the accounts payable turnover ratio, and why is it important to consider other factors for a comprehensive analysis?
The accounts payable turnover ratio is an average and does not provide insight into individual supplier payments.
A low ratio can indicate liquidity problems or aggressive cash management.
To fully understand the result, analysts need to consider other factors such as the quick ratio and cash flows generated from operating activities.
What are accrued liabilities, and how are they recorded in financial accounting?
Accrued liabilities are expenses that have been incurred before the end of an accounting period but have not yet been paid.
They include items such as employee salaries and wages, rent, and interest.
These expenses are recorded as adjusting entries at year-end to recognize the expense for the period and create an associated liability.
What is the purpose of recording accrued liabilities as adjusting entries, and when are they typically recorded?
Accrued liabilities are recorded as adjusting entries at year-end to recognize the expenses incurred in the period.
This ensures that the financial statements reflect the accurate expenses and associated liabilities, even though the payment has not been made by the end of the accounting period.
What expenses are included in accrued liabilities, as mentioned in the given text?
Expenses included in accrued liabilities can consist of items such as employee salaries and wages, rent, and interest.
These expenses have been incurred but not yet paid by the end of the accounting period.
How do corporations handle income taxes payable, and what are the components of income tax expense or recovery?
Corporations must pay income tax at the appropriate federal and provincial rates. Income tax expense or recovery has two components:
the current portion, which is payable or recoverable within prescribed time limits,
and the deferred portion, which arises due to differences between accounting rules for financial reporting and tax rules used to determine taxable income.
What types of sales taxes do companies collect, and how are these taxes eventually remitted to the government?
Companies collect sales taxes such as the federal Goods and Services Tax (GST), Provincial Sales Tax (PST), or Harmonized Sales Tax (HST) from customers.
These taxes are added to the sales price, collected, and then periodically remitted to the federal and provincial governments.
How do businesses handle the sales taxes they collect, and why are these taxes considered liabilities for the seller?
When businesses collect sales taxes from customers, these amounts are not considered revenue; instead, they represent liabilities.
The collected sales taxes are periodically remitted to the respective governments, making the seller an intermediary between the customer and the government in the tax collection process.
What is an input tax credit (ITC), and how does it apply to businesses regarding sales taxes?
An input tax credit (ITC) allows businesses to recover the GST/HST paid on their purchases related to commercial activities.
Businesses can claim ITCs to offset the sales taxes they owe, effectively reducing the amount of taxes they need to remit to the government.
Are businesses required to pay sales taxes on their purchases, and can they recover all sales taxes paid?
Businesses are required to pay sales taxes on most goods and services they purchase.
They can recover the GST/HST paid on their purchases by claiming input tax credits (ITCs), but recovery of Provincial Sales Tax (PST) depends on the specific province’s tax policies.
Businesses may not recover PST unless it is a value-added tax, as in the case of Quebec sales tax (QST).
What are payroll liabilities, and what do they encompass for a company?
Payroll liabilities include salaries earned by employees but not yet paid, as well as the cost of unpaid benefits like retirement programs, vacation time, employment insurance, and health insurance.
Employers are also responsible for deducting income tax and other social benefit contributions from employees’ earnings and remitting them to the government.
How are income tax deductions from employees’ salaries recorded, and what is the nature of this liability?
Employers deduct income tax from employees’ salaries, recording it as a current liability until the deducted amount is remitted to the government.
This deduction represents an obligation that the employer holds on behalf of the employees.
What are some common employee deductions, and how does the employer handle these deductions?
Common employee deductions include **income tax,
contributions to employment insurance (EI),
Canada Pension Plan (CPP) or
Quebec Pension Plan (QPP),
future retirement benefits,
health insurance, and
other contributions. **
Employers match the employee’s CPP remittance and pay 1.4 times the employee’s contribution for employment insurance. The employer’s share of contributions to various parties can amount to up to 20 percent of the employee’s gross earnings.
How is compensation expense for employee services calculated, and what does it include?
Compensation expense includes all funds earned by employees and funds that must be paid to others on behalf of employees (benefits).
It is calculated by adding salaries and wages earned, as well as the employer’s share of CPP and EI contributions.
What is deferred revenue, and when does it occur in business transactions?
Deferred revenue occurs when a company receives cash from customers before the related revenue has been earned.
It is recognized as a liability until the company fulfills its obligations to the customer by providing the product or service.
How does Starbucks use deferred revenue, and what is an example of deferred revenue in Starbucks’s business model?
Starbucks uses deferred revenue through its stored value cards, allowing customers to pay in advance.
For example, when customers purchase Starbucks cards, the company recognizes the cash received as a liability until the customer places an order and the revenue is earned.
What accounting principle governs the recognition of revenue, and how does it relate to deferred revenue?
**According to the core revenue recognition principle, revenue cannot be recorded until it has been earned. **
In the case of deferred revenue, the obligation to provide a product or service in the future still exists, making it a liability until the service is provided and revenue can be recognized.
How is deferred revenue adjusted and recognized in financial accounting when Starbucks cards are redeemed?
When customers redeem Starbucks cards, Starbucks reduces its “stored value card liability” by the amount of the order and recognizes revenue.
This adjustment is an example of an adjusting journal entry, where the deferred revenue becomes earned revenue when the service is provided.
What is a note payable, and how is it reported in financial accounting?
A note payable is a formal written contract where a company borrows money and agrees to repay the principal amount, specified interest, and the repayment date. It is reported as a liability on the company’s statement of financial position.
What is the time value of money, and how does it relate to interest in financial transactions?
The time value of money is the concept that money available today is worth more than the same amount in the future due to its potential earning capacity.
Interest reflects the cost of using someone else’s money for a period (for borrowers) or the benefit of allowing others to use money (for creditors).
What information is needed to calculate interest, and what is the interest formula?
To calculate interest, you need the principal amount of the loan, the annual interest rate, and the time period of the loan.
The interest formula is:
Interest for the period = (Principal × Annual interest rate × Time period in months) ÷ 12 months.
How is interest expense recorded for a note payable, and when is it recognized in financial accounting?
Interest expense is incurred monthly as long as the debt is outstanding.
It is recorded when incurred, not when the cash is paid.
Interest payable is recognized on the statement of financial position as a current liability until it is paid, representing the future obligation to the lender.
What is the distinction between current and long-term debt, and why is it important for companies?
The distinction between current and long-term debt is crucial for companies to ensure they have enough cash to repay maturing debt.
Current debt refers to obligations that need to be settled within a year, while long-term debt extends beyond a year.
Companies must reclassify long-term debt as a current liability within a year of its maturity date.
How is the current portion of long-term debt reported on the company’s statement of financial position, and why is it essential for accurate financial reporting?
The current portion of long-term debt is reported as a separate line item under current liabilities on the statement of financial position.
It represents the portion of long-term debt that is due within the next year and must be paid off.
Accurate reporting is essential to provide stakeholders with a clear understanding of the company’s short-term financial obligations.
What is a provision in accounting, and what conditions must be met for a provision to be recognized?
A provision is a liability that arises when a business incurs an expense in one accounting period, and the cash payment is made in a future period.
To be recognized, a provision must meet three conditions:
(1) the entity has a present obligation due to a past event,
(2) it is probable that cash or other assets will be required to settle the obligation, and
(3) a reliable estimate can be made of the amount of the obligation.
Can you provide an example of a provision and how it is recorded in financial accounting?
A provision is created when a company offers a warranty with a product it sells.
For example, if Starbucks estimates it will have to provide $150,000 of warranty services to customers who purchased coffee brewing and espresso equipment, it records a provision for product warranty.
This provision is based on historical and anticipated rates of warranty claims and is recorded as a liability and an expense in the period in which the product is sold.
What are some other examples of provisions, and why are they important for financial reporting?
Provisions can also be made for:
product returns and allowances,
legal and tax disputes,
store closures,
and restructuring of business operations.
These provisions are important for financial reporting as they help stakeholders, including creditors, investors, and analysts, understand the potential liabilities and their implications on the company’s financial position and performance.
