Chapter 8: Current and Contingent Liabilities Flashcards
the sources of cash and other financial resources used to acquire assets.
liabilities and equity
What are the 3 kinds of business obligations?
- Current liabilities
- Contingent liabilities
- Long-term debt
Contingent liabilities can be either current or long-term, but they are iffy in what two ways?
- they may or may not turn into actual obligations
- for those contingencies that do become obligations, the timing and amount of the required payment is uncertain
probable future sacrifices of economic benefits; usually require the payment of cash, the transfer of assets other than cash, or the performance of services.
liabilities
What are the 4 characteristics of liabilities?
- Payment of Cash
- Certainty
- Legal enforceability
- Payment recipient
What characteristic of liabilities does this describe?
Although liabilities frequently require the payment of cash, some may require the transfer of assets other than cash or the performance of services.
Payment of cash
What characteristic of liabilities does this describe?
Although the exact amount and timing of future payments are usually known, for some liabilities they may not be.
Certainty
What characteristic of liabilities does this describe?
Although many liabilities are legally enforceable claims, some may merely represent probable claims.
Legal enforceability
What characteristic of liabilities does this describe?
Although liabilities usually identify the entity to be paid, the definition does not exclude payment to as yet unidentified recipients.
Payment recipient
Most liabilities are recognized when:
goods or services are received or money is borrowed.
When a liability depends on a future event (ex: a contingent liability), such as the outcome of a lawsuit, recognition depends on how _______ the occurrence of the event is and whether a _______ _______ of the payment amount can be made.
likely; good estimate
If the future payment is judged to be less than likely to occur or the payment is not estimable, the obligation (should/shouldn’t) be recognized. Such obligations may require disclosure in footnotes to financial statements.
shouldn’t
an obligation whose amount or timing is uncertain and depends on future events.
contingent liability
When you owe money you typically pay _________.
interest
How do you calculate Total Payment when interest is involved?
Total Payment = Principal + (Principal x Interest Rate x Period)
How do you calculate interest?
Principal x Interest Rate x Period = Interest
T or F: We ignore the interest for most current liabilities because the amount of interest is relatively small (or “immaterial”). So most current liabilities are simply recorded and reported at the total amount owed.
True
obligations that require the firm to pay cash or another current asset, create a new current liability, or provide goods or services within the longer of 1 year or one operating cycle (since most firms have operating cycles shorter than 1 year, the 1-year rule usually applies).
current liabilities
Current liabilities are reported on the ________ _______.
balance sheet
an obligation that arises when a business purchases goods or services on credit.
accounts payable
Accounts payable are usually due within ______ to _____ days.
30 - 60
T or F: Accounts payable require the payment of interest.
False; they seldom require the payment of interest
T or F: Accounts payable require a formal agreement or contract
False; they do not
liabilities that usually represent the completed portion of activities that are in process at the end of the period; recognized by adjusting entries at the end of the period.
accrued liabilities
What are two examples of accrued liabilities?
Wages payable and income taxes payable
a payable that arises when a business borrows money or purchases goods or services from a company that requires a formal agreement or contract.
notes payable
The agreement for a note payable typically shows the ________ of repayment and ________ (principal and/or interest) to be repaid.
timing; amount
A note payable typically matures between ____-___ months, but can be longer (if its maturity is greater than 12 months, it will be classified as a long-term liability)
3-12
A note payable can be created as an extension of time to pay an ________ ________ amount
accounts payable
A note payable from a bank is called an __________ _________ ______ because it explicitly states an ________ _____.
- interest-bearing note
- interest rate
A note payable from a banks specifies the amount to be repaid _______, stating the ______ and _______ rate.
- indirectly
- principal
- interest
A note payable from a bank is recorded in a transaction at what amount?
at the amount borrowed
Notes payable are often created when a borrower is unable to pay an account payable in a timely manner.
In this case, the borrower is typically granted a ________ ________, but the creditor requires that a formal note be signed to impose interest.
payment extension
T or F: a current liability can be retired through creation of a new current liability. If true, what’s an example of this?
true; rolling an account payable into a short-term note payable
At the end of each accounting period, the long-term debt that is due during the next year is reclassified as a ________ ________.
current liability
T or F: Since the reclassification of most long-term debt as current doesn’t usually change the accounts or amounts involved, journal entries are not required.
true
In some cases, long-term debt that’s due within the next year will be paid with the proceeds of a new long-term debt issue. A new long-term debt issue is creation of a new ______-______, not current, liability. When such refinancing is expected, the maturing obligation is not transferred to current liabilities but is left as a long-term debt.
long-term
What three taxes (which are other payables) are collected by a company on behalf of a local, state, or federal taxing authority?
These are not additions to _______, although collected as part of the selling price.
- Sales, usage, and excise taxes
- revenue
money collected from the customer for the governmental unit levying the tax.
sales taxes
Tax collections are _______ until paid to the taxing authority, usually ______.
liabilities; quarterly
taxes from employee’s earnings which are liabilities until they are paid to the taxing authority.
withholding and payroll taxes
T or F: Employees and employers both incur payroll taxes.
true
Employees must pay certain taxes that are “withheld” from their paycheck. This is the difference between ______ pay and _____ pay.
gross; net
Employee withholdings can include what three things?
- Federal, state, and possibly local income taxes
- Social Security and Medicare taxes (FICA)
- 401(k) retirement, parking, union dues, health insurance, etc.
The business itself must pay certain taxes based on _______ ________. These amounts are not withheld from employee pay; they are additional amounts that must be paid over and above _______ pay.
employee payrolls; gross
Employers withholdings (what they pay) includes what three things?
- Match to employee’s Social Security and Medicare taxes (FICA)
- Federal and state unemployment taxes
- Fringe benefits including 401(k) contributions, health insurance or other.
if you have $400 withheld from your paycheck for Social Security, your employer pays the federal government $______ related to your employment.
$800 (they pay double)
a liability that occurs when a company receives payment for goods (in advance) that will be delivered or services that will be performed in the future.
unearned revenue
A long-term liability that is similar to unearned revenue, called _______ ________, is recorded when customers make advance payments or security deposits that are not expected to be earned or returned soon enough to qualify as current liabilities.
customer deposits
liability that involves the possibility of an existing condition, situation, or set of circumstances that have uncertainties of a gain or loss.
contingent liabilities
A contingent liability is not recognized in the accounts unless both of the following are true (2 things):
- The event on which it is contingent is probable
- A reasonable estimate of the loss can be made
T or F: If the contingent event is considered only reasonably possible, or reliable measurement of the liability is impossible, no liability is recorded, but the event must be disclosed in the financial statements.
true
If the contingent event is considered _________, neither a journal entry nor a disclosure in the financial statements are necessary.
remote
What are 3 examples of contingent liabilities?
- Warranties
- Lawsuits
- Pensions
Most large companies are party to multiple lawsuits at any point in time. Estimating when a loss is probable and determining a reasonable estimate requires information from the attorneys, but businesses _______ record a contingent liability prior to the jury deciding against them.
rarely
The likelihood that a contingent event will occur may change over time. A contingent liability that should not be recorded or disclosed at one time may need to be recorded or disclosed later because the facts and circumstances change. This frequently happens to contingent liabilities arising from _________.
litigation
a guarantee to repair or replace defective goods during a period (ranging from a few days to several years) following the sale.
warranty
Warranty expenses can occur in the accounting period of the sale or in __________ accounting periods.
subsequent
Future warranty costs on the sales that occurred in the current accounting period must be ________.
estimated
Businesses are likely able to make reasonable estimates of their warranty costs based on _____ _______.
past experience
The recognition of warranty expense and (estimated) warranty liability is recorded by an _________ journal entry at the end of the accounting period.
adjustment
As warranty claims are paid to customers or related expenditures are made, the liability is (increased/reduced).
reduced
T or F: the income statement effect of warranties (activity in the equity column) occurs when goods are sold. Payment or other asset outflows associated with the satisfaction of warranty claims do not affect the income statement.
true
Analyzing current liabilities can help determine if a company is able to meet its _____-______ _________.
short-term obligations
What are the four ratios that are often used to analyze a company’s ability to meet its current obligations?
- Current Ratio
- Quick Ratio
- Cash Ratio
- Operating Cash Flow Ratio
How do you calculate Current Ratio?
Current Ratio = Current Assets / Current Liabilities
How do you calculate Quick Ratio?
Quick Ratio = (Cash + Marketable Securities + Accounts Receivable) / Current Liabilities
How do you calculate Cash Ratio?
Cash Ratio = (Cash + Marketable Securities) / Current Liabilities
How do you calculate Operating Cash Flow Ratio?
Operating Cash Flow Ratio = Cash Flows from Operating Activities / Current Liabilities
What ratio does this describe?
- Compares all or parts of current assets to current liabilities
- Calculation greater than 1.0 implies a company can meet its obligations.
Current Ratio
What ratio compares current assets (less inventory) to current liabilities?
Quick Ratio
What ratio looks at the ability of cash generated from operating activities to meet current obligations?
Operating Cash Flow Ratio
Both the quick and cash ratio exclude ________ because including it assumes that sales will be made.
inventories
The quick ratio assumes that accounts receivable are _______. This is true when customers have low credit risk and pay in relatively short amounts of time.
liquid
T or F: As with the current ratio, the operating cash flow ratio assumes that sales will continue into the future.
true
most of the information to calculate the ratios can be found on the ______ _______ (except for cash flows from operating activities, which is on the ______ ____ _____ _____).
- balance sheet
- statement of cash flows
Current ratio depends on how liquid ________ and ________ _______ are. If the inventory is slow moving, then the _____ ______ may be a better indicator of liquidity. If accounts receivable may be difficult to collect, the _____ _____ is the best indicator of liquidity.
- inventory; accounts receivable
- quick ratio
- cash ratio
