AFM 191 - chp 9 - current liabilities, long-term liabilities, shareholder's equity Flashcards
define liabilities under ASPE
obligations of an entity arising from past transactions or events. the settlement of which may result in the transfer or use of assets, provision of services or other yielding of economic benefits in the future
what are the characteristics of a liability
- there’s a duty/responsibility to others that requires settlement in the future, through the transfer or use of assets, provision of services, or some other provision of economic benefits at a specified or determinable date on occurrence of a specified event or on demand
- the entity has little or no discretion to avoid the duty of settling obligation
- the transaction or event results in the obligation has already occurred
current vs long-term liabilities
current: expected to be paid within 1 year
long-term: paid off over a period greater than 1 year
how are current liabilities categorized?
known or estimated
define known liabilities
where a clear obligation to pay exists and the amount is certain
define estimated liabilities
an obligation to pay is likely but the timing and amount of that obligation is subject to reasonable estimation
what’s a common estimated liability? why?
warranties - a placeholder to cover a future liability that relates to current revenues - consistent with matching principle to estimate the cost to remedy all the effects at the time of sales based on past experience of an industry standard
contingencies - situation that might trigger an obligation in the future, depending on the outcome of an uncertain future event
how can estimated liabilities be recognized?
if the amount can be estimated reliably and the likelihood of payment is high
what’s the journal entry to account for the potential liability
DR. warranty expense
CR. warranty payable
to setup a provision for warranty expenses
what’s the journal entry to book when work is completed to fix any defects covered under the warranty
DR. estimated warranty payable
CR. inventory
CR. salaries and wages payable
to account for warranty work completed
inventory is credited to reflect that parts were replaced to fix the problem
credit salaries + wages to reflect cost of labour required to service the defect
what happens to the warranty when it expires?
reverse any unused warranty expense/payable
what are some common contingency
lawsuit
when would a lability not be presented on the balance sheet? where would they be at instead?
if the probability of the obligation arising is unknown or the amount cannot be reasonably estimated
it will be disclosed in the notes to the financial statement, describing the nature of the potential contingency
what are short-term borrowing/debt
represents amounts owing to banks or other lenders that are typically used to manage working capital + cover other short-term obligations
most common as a line of credit
what’s a line of credit
similar to a loan but does not have a maturity date
lender grants access to credit up to a certain amount and the company pays interest only on the amount that is outstanding
what’s an accounts payable
represents amount owing to suppliers and vendors for purchases made on account (typically due within 30-90 days)
what’s accrued liabilities
reflect expenses that the business has incurred but not paid for yet
what are some common accrued liabilities
accrued interest expense, salaries + wages payable, taxes payable
what’s note payable
represents a written promise to pay a specified amount of money to another party at a future date, typically greater than 90 days and with interest
what’s unearned revenue
represents money that hs already been received for work not yet performed, or work that does not meet revenue recognition criteria
reflects an obligation to perform work in the future
what’s the current portion of long-term debt
the portion of long-term debt that is due within 1 year of the reporting date
what’s long-term debt
represents money that needs to be paid back to a longer over a period of greater than 1 year and includes instruments such as bank loans, bonds, and mortgages
long-term debt is always reported on the balance sheet in 2 components (____ and ____), with the exception of _____
2 components of current and non-current(shown as long-term debt)
exception: bonds
both the components of long-term debt ____
both components add up together to represent that total amount of debt outstanding as at the reporting period
define bank loan
borrowed money from a bank that needs to be repaid by a set maturity date and carries an interest charge
similarities + difference between bank loans + notes payable
similarity: both have interest + principal components
difference: bank loans are long-term in nature so principal repayments would be made periodically rather than at once like a notes payable
repayment info would be contained in the terms of the loan and typically disclosed in ____ of financial statements
notes
what does it mean when a company has defaulted on a loan
a company being unable to repay a loan (in full)
what are bonds
debt instruments that represent loans from an investor to the issuer
unique type of long-term debt that is commonly issued by the public than private companies
why are bonds issued more typically in a public than private company?
bonds = common way for public corporations + governments to raise money
what are the obligations if a private company issues bonds
they are required to provide financial statement to their bondholders (typically on a quarterly basis)
what are mortgages
loans that are secure by property
for large loans, banks require ___. why?
collateral
they require it for security purposes
what’s a collateral
something pledged as security in case of default on the loan
what does the “other long-term liabilities” line item acts as
acts as a catch-all for non-current liabilities that don’t include long-term debts
what are some common other long-term liabilities
leases + post-employment benefits
what’s a lease
rental agreement where payments are exchanged for the right to use an asset
define lessee
the party that rents the asset
define lessor
the party that owns the asset
what’s a benefit of leases
they provide access to assets without having to pay the large-up front costs required to purchase them
what are the 2 types of leases?
- operating lease
- capital lease
define an operating lease
substantially all the risks + rewards of ownership remain the lessor
define capital lease
substantially all the risks + rewards of ownership are transferred to the lessee even though formal legal title remains with the lessor
what are some examples of operating lease
leasing office space from Brookfield properties,
what are some examples of capital lease
leasing airplanes from boeing
what’s the criteria for capital lease (under ASPE)?
- at the end of the lease term, ownership of the asset is transferred to the lessee
- per the lease contract, the lessee has the option to purchase the asset for an amount less than its fair market value throughout the term of the lease
- the lease term spans 75% or more of the asset’s expected useful life
- the present value of the lease payments is 90% or more of the fair market value of the leased asset when the contract is signed
define lease term
length of time the asset is being rented
what’s the accounting treatment for operating lease
the lessee accounts for the lease payments as rent expense on the income statement; an asset or a liability are not recorded on the balance sheet
what’s accounting treatment for capital lease?
the lessee accounts for the lease as an asset and a corresponding lease liability on the balance sheet; depreciation expense is recorded on the income statement (and accumulated on the balance sheet), similar to a long-term asset PP&E, while interest expense (corresponding to the liability) is recorded on the income statement
what are post-employment benefits
benefits that apply to employees after they have completed their employment at a company
what are some common post-employment benefits
pension benefits, medical + dental insurance, prescription drug coverage, life insurance, tuition reimbursements
define shareholder’s equity or owner’s equity
used when there is 1 shareholder/owner
define shareholders’ equity or owners’ equity
used when there are multiple shareholders/owners
what are some components that are common on the balance sheet of a private company
share capital
contributed surplus (paid-in capital)
non-controlling interests (NCI)
define share capital
the money a company raises from investors by issuing common or preferred stocks + includes any original shares issued to the founder(s) of the company
define contributed surplus (paid-in capital)
comprises amounts paid in by equity holders, usually representing a premium paid on purchased shares
define non-controlling interests (NCI)
represents equity in a subsidiary that’s not attributable to the parent company (directly or indirectly)
what the types of shares?
- common shares
- preferred shares
what are common shares
the most basic form of equity ownership in a company.
every corporation issues common shares. which entitle the shareholder to 4 rights:
1. selling those shares
2. voting
3. receiving dividends
4. residual assets upon liquidation
what are preferred shares
a more specialized form of equity ownership that is not necessarily issued by every company
they have the same rights as common shares except voting
they have advantages of earning a fixed dividend which is received before common shareholder and they receive assets before common shareholders upon liquidation
fill in the blanks:
both ___ and ____ companies issue ____ and ____ shares. Within each type, they can issue multiple ____ of shares which generally distinguish _____ for the shareholders
private and public
common and preferred
classes
specific rights
a common share transaction would use a
common shares stock account
a preferred share transaction would use a
preferred shares account
how are common and preferred shares presented on the equity section of the balance sheet?
as separate line items in the equity section of the balance sheet
both are included in the “share capital” section with the details of common and preferred shares being disclosed in the notes of the financial statements
what’s the journal entry to the sale/issuance of common shares
DR. Cash
CR. Common shares (common stock)
to record sale of common shares on incorporation/to raise additional capital through sale of shares
if there are multiple shareholders, control of the company depends
on who is the controlling shareholder (individual or group)
what’s the journal entry to purchase assets in exchange for shares? why do companies do this?
DR. building
DR. equipment
CR. Common Shares
to record purchase of building + equipment in exchange for shares
companies can also be formed by purchasing assets rather than receiving money in exchange for shares
how is the market value of shares of a private company determined?
determined by professional business valuators when there’s an interest by shareholder(s) to sell their shares
private shares are sold at ______ which differs from their ______
sold at market value
differs from their book value
what does the book value of a private company’s common shares represent
represents the proportional net assets
what’s the formula for when a company issues only common shares
book value per common share = (total shareholder’s equity)/(number of common shares outstanding)
define number of common shares outstanding
represents total number of shares that have been issued by the company (sum of all the shares owned by shareholders)
what’s the formula for when a company issues both common + preferred shares
book value per common share = (total shareholder’s equity - preferred shareholder’s equity)/(number of common shares outstanding)
define return on equity (ROE)
accounting performance measure that shows how effectively a company uses equity holders’ investments to generate income - ROE tells us how goo a company is at turning equity into profit
what’s the formula for ROE?
ROE = (net income)/(average shareholders’ equity) x 100%
what’s the formula to average shareholders’ equity
(shareholders’ equity, beginning of period + shareholders’ equity, end of period)/2
how can we see if the ROE we get is considered good?
ROE must be taken into context of industry averages or to competitors
