chapter 10 Flashcards
what are current liabilities
are present obligations to transfer future economic resources because of past transactions
what are financial liabilities
A form of financial instrument, represented by a contractual obligation to pay cash in the future
how are liabilities be reported if they are current
if they are paid or settled within one year from the date on the statement of financial position
how are liabilities settled
with cash payments, these are referred to as financial liabilities.
what are some common current liabilities
accounts payable, refund liability, taxes payable, deferred revenue.
what are the different sales taxes?
Quebec: federal and provincial sales tax (GST + QST)
Ontario and Atlantic provinces: harmonized sales tax (HST)
Other provinces: federal (GST) and provincial sales tax (PST)
who pays sales taxes
person who buys the final product
companies that provide services or sell goods have to what
pax sales taxes
To account for sales tax collected from customers, companies will use
sales tax payable
how to calculate sales revenue
Total Receipts / (1 + Tax Rate)
wages vs salaries
Wages are based on an hourly rate or amount, while salaries are fixed annual amounts and do not typically provide for overtime pay
how is an employees gross pay calculated
will be their total salaries or wages earned.
what us the amount that employees actually pay
their net pay (withholding certain amounts from their gross pay)
Mandatory payroll deductions
federal and provincial income taxes, Canadian Pension Plan (CPP) contributions and Employment Insurance (EI) contributions.
Voluntary payroll deductions
health plans, union dues, charitable donations and others (depends on the company).
On top of the contributions withheld from employee pay, employers are required to make their own
contributions to CPP and EI (and sometimes to health and pension plans).
The employer’s CPP contribution is equal to
the employee’s contribution
The employer’s EI contribution is
1.4 times the amount contributed by the employee.
these contributions are accounted as what
employee benefits expense.
liabilities can be either
certain or uncertain
what are certain liabilities
Certain liabilities are those with known payees, amounts and dates, such as salaries and sales tax payable we just discussed.
what are uncertain liabitlies
are those that are uncertain in timing, payee or amount. Uncertain liabilities can be either provisions or contingent liabilities.
what are provisions
Liabilities of uncertain timing or amount. They are recorded in the accounts based on reasonable and probable estimates.
Provisions are uncertain as to timing or amount and are recorded as a liability when:
Present obligation exists
Outflow of resources to settle that obligation is probable or likely
Amount can be estimated reliably
examples of common provisions
Product warranties that are included in the price of the product (ex. guarantee against defects)
Damages from lawsuits
Fines from regulator bodies
when does a company not record a provision
if the outcome is not probable or not determinable or an estimate of the outcome cannot be made. in the notes to the financial statements
what are contigent liabilities
Existing or possible obligations arising from past events. The liability is contingent (dependent) on whether some uncertain future event occurs that will confirm either its existence or the amount payable, or both
when do you not disclose a contingent liability
If the possibility of an outflow of resources (settlement through payment) is remote, a company will not need to disclose a contingent liability.
When a company borrows money from a creditor for more than a short period of time, they will be charged what
interest
what is the principal
The original amount borrowed
how is interest payable
In addition to paying off the principal, interest is also payable on the principal amount outstanding.
how can interest be paid
Interest may be paid on a single due date when the principal is due, or interest may be paid on various dates before the principal is due.
Common types of interest-bearing liabilities include the following:
Operating lines of credit that allow a company to borrow up to a preauthorized limit whenever required
Notes with a single principal payment on maturity
Loans that require instalment payments of principal and interest on scheduled dates
what is an operating line
A pre-arranged agreement to borrow money at a bank, up to an agreed-upon amoun
what does an operating line of credit allow
a company to borrow up to the preauthorized limit whenever required.
how are companies required to pay interestfor operating lines
at a floating interest rate – this means the interest rate will vary over time in relation to the bank’s prime rate
when is a line of credit normally used
used when the bank account balance becomes negative, so will be reported as a current liability called bank indebtedness
It is not uncommon for banks to establish
debt covenants or collateral when negotiating lines of credit.
how does a notes payable bear interest
a fixed interest rate, which is constant for the entire term of the note.
interest expense is accrued over time so
is often recorded as an adjusting entry. The interest rates provided in questions will always be yearly
Liabilities with instalment payments include
bank loans payable and mortgages payable (type of bank loan secured by land/buildings).
advantages of debt financing
Normally easier to obtain than equity financing and avoids the dilution of ownership that comes with issuing shares.
Borrowing may allow companies to grow faster (and potentially be more competitive).
A company will be required to pay interest but the “silver lining” is that this interest is deductible for tax purposes.
disadvantages of debt financing
Companies are required to pay back principal and interest on specified due dates. Equity financing does not require any repayment.
There is a risk that interest payments will increase in the future if interest rates rise and the rate is floating.
A company may be required to pledge security to obtain debt financing (such as land or buildings).
how are current liabilities presented
liabilities are reported as the first category of liabilities.
Can be listed separately on statement of financial position or detailed in the notes
Normally listed in order in which they are due
how are non current liabilities presented
are typically presented immediately following current liabilities and detail in notes. They will generally be measured and reported at amount expected to be paid when due
what is analyzing debt
will include an analysis of liquidity (a company’s ability to pay maturing obligations and meet unexpected cash needs within the year year) and solvency (ability to meet long term obligations)
what are liquidity ratios
ratios include the current ratio, inventory turnover and receivables turnover – all covered in earlier chapters.
what are solvency ratios
include debt to total assets and times interest earned. Both will be reviewed here.
what does the debt to total assets measure
measures the proportion of financing provided by creditors as a percentage of assets.
The higher the ratio, the higher the risk that the company may not be able to pay interest + debts coming due.
what does the solvency times interest earned
This provides an indication of a company’s ability to meet interest payments as they come due.
Calculated as: (Net income + Interest expense + Income tax expense) ÷ Interest expense
Higher will be better as it will indicate a company has more earnings as compared to their interest expense. Higher will also mean that there is less risk of not being able to meet interest obligations.
what are credit rating agencies
) will assess a company and provide opinions about a company’s ability to make timely payments on short and loan term debt.
how is short term debt rated
rated using an R scale, with R-1 being the highest quality and R-5 meaning high risk.
how is long term debt rated
using a different scale with AAA being the highest quality and D being speculative.
