AFM 191 - chp 9 - current liabilities, long-term liabilities, shareholder's equity

Question 1

define liabilities under ASPE

Answer 1

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

Question 2

what are the characteristics of a liability

Answer 2

1. 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
2. the entity has little or no discretion to avoid the duty of settling obligation
3. the transaction or event results in the obligation has already occurred

Question 3

current vs long-term liabilities

Answer 3

current: expected to be paid within 1 year
long-term: paid off over a period greater than 1 year

Question 4

how are current liabilities categorized?

Answer 4

known or estimated

Question 5

define known liabilities

Answer 5

where a clear obligation to pay exists and the amount is certain

Question 6

define estimated liabilities

Answer 6

an obligation to pay is likely but the timing and amount of that obligation is subject to reasonable estimation

Question 7

what’s a common estimated liability? why?

Answer 7

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

Question 8

how can estimated liabilities be recognized?

Answer 8

if the amount can be estimated reliably and the likelihood of payment is high

Question 9

what’s the journal entry to account for the potential liability

Answer 9

DR. warranty expense
CR. warranty payable
to setup a provision for warranty expenses

Question 10

what’s the journal entry to book when work is completed to fix any defects covered under the warranty

Answer 10

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

Question 11

what happens to the warranty when it expires?

Answer 11

reverse any unused warranty expense/payable

Question 12

what are some common contingency

Answer 12

lawsuit

Question 13

when would a lability not be presented on the balance sheet? where would they be at instead?

Answer 13

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

Question 14

what are short-term borrowing/debt

Answer 14

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

Question 15

what’s a line of credit

Answer 15

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

Question 16

what’s an accounts payable

Answer 16

represents amount owing to suppliers and vendors for purchases made on account (typically due within 30-90 days)

Question 17

what’s accrued liabilities

Answer 17

reflect expenses that the business has incurred but not paid for yet

Question 18

what are some common accrued liabilities

Answer 18

accrued interest expense, salaries + wages payable, taxes payable

Question 19

what’s note payable

Answer 19

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

Question 20

what’s unearned revenue

Answer 20

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

Question 21

what’s the current portion of long-term debt

Answer 21

the portion of long-term debt that is due within 1 year of the reporting date

Question 22

what’s long-term debt

Answer 22

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

Question 23

long-term debt is always reported on the balance sheet in 2 components (____ and ____), with the exception of _____

Answer 23

2 components of current and non-current(shown as long-term debt)
exception: bonds

Question 24

both the components of long-term debt ____

Answer 24

both components add up together to represent that total amount of debt outstanding as at the reporting period

Question 25

define bank loan

Answer 25

borrowed money from a bank that needs to be repaid by a set maturity date and carries an interest charge

Question 26

similarities + difference between bank loans + notes payable

Answer 26

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

Question 27

repayment info would be contained in the terms of the loan and typically disclosed in ____ of financial statements

Answer 27

notes

Question 28

what does it mean when a company has defaulted on a loan

Answer 28

a company being unable to repay a loan (in full)

Question 29

what are bonds

Answer 29

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

Question 30

why are bonds issued more typically in a public than private company?

Answer 30

bonds = common way for public corporations + governments to raise money

Question 31

what are the obligations if a private company issues bonds

Answer 31

they are required to provide financial statement to their bondholders (typically on a quarterly basis)

Question 32

what are mortgages

Answer 32

loans that are secure by property

Question 33

for large loans, banks require ___. why?

Answer 33

collateral

they require it for security purposes

Question 34

what’s a collateral

Answer 34

something pledged as security in case of default on the loan

Question 35

what does the “other long-term liabilities” line item acts as

Answer 35

acts as a catch-all for non-current liabilities that don’t include long-term debts

Question 36

what are some common other long-term liabilities

Answer 36

leases + post-employment benefits

Question 37

what’s a lease

Answer 37

rental agreement where payments are exchanged for the right to use an asset

Question 38

define lessee

Answer 38

the party that rents the asset

Question 39

define lessor

Answer 39

the party that owns the asset

Question 40

what’s a benefit of leases

Answer 40

they provide access to assets without having to pay the large-up front costs required to purchase them

Question 41

what are the 2 types of leases?

Answer 41

1. operating lease
2. capital lease

Question 42

define an operating lease

Answer 42

substantially all the risks + rewards of ownership remain the lessor

Question 43

define capital lease

Answer 43

substantially all the risks + rewards of ownership are transferred to the lessee even though formal legal title remains with the lessor

Question 44

what are some examples of operating lease

Answer 44

leasing office space from Brookfield properties,

Question 45

what are some examples of capital lease

Answer 45

leasing airplanes from boeing

Question 46

what’s the criteria for capital lease (under ASPE)?

Answer 46

1. at the end of the lease term, ownership of the asset is transferred to the lessee
2. 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
3. the lease term spans 75% or more of the asset’s expected useful life
4. 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

Question 47

define lease term

Answer 47

length of time the asset is being rented

Question 48

what’s the accounting treatment for operating lease

Answer 48

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

Question 49

what’s accounting treatment for capital lease?

Answer 49

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

Question 50

what are post-employment benefits

Answer 50

benefits that apply to employees after they have completed their employment at a company

Question 51

what are some common post-employment benefits

Answer 51

pension benefits, medical + dental insurance, prescription drug coverage, life insurance, tuition reimbursements

Question 52

define shareholder’s equity or owner’s equity

Answer 52

used when there is 1 shareholder/owner

Question 53

define shareholders’ equity or owners’ equity

Answer 53

used when there are multiple shareholders/owners

Question 54

what are some components that are common on the balance sheet of a private company

Answer 54

share capital
contributed surplus (paid-in capital)
non-controlling interests (NCI)

Question 55

define share capital

Answer 55

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

Question 56

define contributed surplus (paid-in capital)

Answer 56

comprises amounts paid in by equity holders, usually representing a premium paid on purchased shares

Question 57

define non-controlling interests (NCI)

Answer 57

represents equity in a subsidiary that’s not attributable to the parent company (directly or indirectly)

Question 58

what the types of shares?

Answer 58

1. common shares
2. preferred shares

Question 59

what are common shares

Answer 59

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

Question 60

what are preferred shares

Answer 60

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

Question 61

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

Answer 61

private and public

common and preferred

classes

specific rights

Question 62

a common share transaction would use a

Answer 62

common shares stock account

Question 63

a preferred share transaction would use a

Answer 63

preferred shares account

Question 64

how are common and preferred shares presented on the equity section of the balance sheet?

Answer 64

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

Question 65

what’s the journal entry to the sale/issuance of common shares

Answer 65

DR. Cash
CR. Common shares (common stock)
to record sale of common shares on incorporation/to raise additional capital through sale of shares

Question 66

if there are multiple shareholders, control of the company depends

Answer 66

on who is the controlling shareholder (individual or group)

Question 67

what’s the journal entry to purchase assets in exchange for shares? why do companies do this?

Answer 67

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

Question 68

how is the market value of shares of a private company determined?

Answer 68

determined by professional business valuators when there’s an interest by shareholder(s) to sell their shares

Question 69

private shares are sold at ______ which differs from their ______

Answer 69

sold at market value

differs from their book value

Question 70

what does the book value of a private company’s common shares represent

Answer 70

represents the proportional net assets

Question 71

what’s the formula for when a company issues only common shares

Answer 71

book value per common share = (total shareholder’s equity)/(number of common shares outstanding)

Question 72

define number of common shares outstanding

Answer 72

represents total number of shares that have been issued by the company (sum of all the shares owned by shareholders)

Question 73

what’s the formula for when a company issues both common + preferred shares

Answer 73

book value per common share = (total shareholder’s equity - preferred shareholder’s equity)/(number of common shares outstanding)

Question 74

define return on equity (ROE)

Answer 74

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

Question 75

what’s the formula for ROE?

Answer 75

ROE = (net income)/(average shareholders’ equity) x 100%

Question 76

what’s the formula to average shareholders’ equity

Answer 76

(shareholders’ equity, beginning of period + shareholders’ equity, end of period)/2

Question 77

how can we see if the ROE we get is considered good?

Answer 77

ROE must be taken into context of industry averages or to competitors