Chapter 9: Current Liabilities Flashcards
Current liabilities are those that that the company expects to settle within the
next 12 months
liability (simple)
an amount that the company owes to others.
Liability (accounting standards)
an item that will require the outflow or sacrifice of economic resources in the future to settle an obligation that exists as a result of a transaction that has already taken place
Characteristics of a Liability
- It is a present obligation of the company.
- The company expects to settle it through an outflow of resources that represent future economic benefits.
- The obligation results from an event that has already happened.
Non-current liabilities
Are considered to be long-term liabilities
Working capital
quantified as the difference between a company’s current assets (those assets that are cash or will become cash within the next 12 months) and its current liabilities
At What Amount Are Current Liabilities Reflected on the Statement of Financial Position?
liabilities should initially be recorded at their fair value or at the present value of the payments that will be required to settle them
Time value of money
The concept that a specified sum of money is worth more if it is paid or received now rather than later
-a dollar paid in the future is worth less than a dollar today
Common current liabilities due to lenders include:
What Current Liabilities Arise from Transactions with Lenders?
1) bank indebtedness
2) short-term loans
3) current portion of long-term debt
Bank Indebtedness (or Line of Credit)
The amount that a company has borrowed on its line of credit from its bank
-normally presented as the first current liability because it will be repaid with the company’s subsequent cash deposits
Line of credit
An arrangement with a financial institution that allows a company to overdraw its bank account. The overdrawn amounts become a loan that must be repaid.
Revolving credit facilities
An agreement a company enters into with its bank, enabling it to borrow up to a negotiated limit. The company can use the credit facility as needed and repay it as funds are available
standby fees
Fees or interest charged by financial institutions for any unused portion of revolving credit facilities such as a line of credit, as the cost of having funds available when needed
working capital loan
A short‐term loan, often on a demand basis, that is arranged with a bank to cover a company’s short‐term cash shortages
secured
Characteristic of loans or other debts for which specific assets have been pledged to guarantee repayment of the debt.
collateral
An asset that has been pledged as security for a debt. If the borrower defaults on the debt, the lender can have the collateral seized and sold, with the proceeds used to repay the debt.
unsecured
Characteristic of loans or other debts when no specific assets have been pledged to guarantee repayment of the debt.
-creditors simply rely on the company’s general creditworthiness.
blended instalment payments
Loan payments that consist of both interest and principal, with the total amount remaining constant but the portion for interest becoming smaller as each payment is made and the outstanding loan principal is reduced.
current portion of long-term debt
The portion of long‐term debt that is due within one year (or one operating cycle)
reclassification entry
Journal entry to reclassify an item, such as a non‐current item becoming current.
reclassification entry example
Long-Term Loan Payable XXX
Current Portion of Long-Term Debt XXX
trade payables (aka trade accounts payable)
Amount of goods or services a company has purchased on credit from suppliers.
Why Are Accounts Payable Sometimes Considered “Free Debt”?
Accounts payable generally do not carry explicit interest charges and are commonly thought of as “free debt” for the length of the credit period (usually 30 days)
Interest associated with free debt
Not taking advantage of the discount, or paying a penalty for being late, can be viewed as equivalent to paying interest.
A number of current liabilities arise from ordinary transactions between a company and its customers or clients, including:
- unearned revenue (or deferred revenue)
- gift card liability
- customer loyalty provision
- provision for warranty claims
provision
Liabilities where there is uncertainty about the timing or the amount of the future expenditures
partially executed contracts
A contract between two entities in which one or both of the parties has performed a portion of its part of the agreement.
- ex paying tuition before school starts
- paying insurance on you car for the entire year.
since the sellers have not fulfilled their part of the contract, it would be inappropriate for them to recognize revenue at the time they receive the customer’s payment
Unearned revenues arise only when a
customer has made a payment in advance of receiving goods or services.
unearned (or deferred) revenues are reported as
liabilities on the statement of financial position, rather than as revenues on the statement of income.
A sample entry for accounting for unearned revenue in a fitness club is as follows:
Cash XXX
Unearned Revenue XXX
At the end of each month in which gym services have been provided by the company:
Unearned Revenue XXX
Membership Revenue XXX
Gift cards remain a _____ until such time as the cards are redeemed for goods or services
liability
There are two transactions that must be accounted for in relation to gift cards or prepaid cards:
initial sale (purchase of the gift card) and redemption (usage of the gift card)
Gift cards or prepaid cards example
Initial Sale
Cash XXX
Unearned Revenue (or Gift Card Liability) XXX
Redemption (for goods) Unearned Revenue (or Gift Card Liability) XXX Sales Revenue XXX Cost of Goods Sold XXX Inventory XXX
breakage
The estimate of the amount of gift cards that will not be redeemed by their holders.
-10% and 15% of all gift cards purchased in Canada.
Two common types of loyalty programs:
- Loyalty programs in which points can be redeemed only to purchase goods or services from the company making the sale.
- Loyalty programs in which points are redeemed by another party (not by the company making the sale).
- Loyalty programs in which points can be redeemed only to purchase goods or services from the company making the sale.
- separate performance obligation
- portion of the transaction price must be allocated to the points
- The stand-alone selling price of the points is estimated using the stand-alone selling price of the goods or services that can be purchased with the points.
- Loyalty programs in which points are redeemed by another party (not by the company making the sale).
- separate performance obligation
- portion of the transaction price must be allocated to the points
- The stand-alone selling price of the points is determined using the cost of purchasing the points
assurance-type warranty
assurance type warranty
Warranty insurance that is included in the price of the product; it is not considered to be a separate performance obligation.
-company must estimate the cost it expects to incur in relation to them and record that as an expense (warranty expense) (EG: how many iphone will be returned damaged)
service-type warranty
Separate warranty coverage that customers can purchase; it is considered a separate performance obligation.
- stand-alone selling price of the warranty to allocate a portion of the transaction price to the warranty
- expense is recorded in the period in which warranty claims are made
unearned warranty revenue
The liability recorded at the time of sale of a service‐type warranty
warranty provision (AKA provision for warranty claims)
A liability representing the estimated cost of providing warranty services on goods sold in each period. Synonym for warranty provision.
The entry to record the warranty provision for assurance-type warranties in the period of the sale would be as follows:
Warranty Expense XXX
Warranty Provision XXX
Warranty note
Note that the entire estimated warranty cost is recorded as an expense in the year of sale, regardless of the length of time covered by the warranty
Warranty claims under assurance-type warranties are especially interesting from an accounting perspective because they can result in a number of different outcomes:
1) product replacement
2) product repair (which may include both parts and labour)
3) product returned/cash refund provided
4) product returned/store credit or gift card provided
5) warranty period expires without any claims
wages payable
A current liability representing the amount of wages earned by employees since they were last paid
benefits
Costs for medical insurance, pensions, vacation pay, and other benefits provided by the employer to employees in addition to wages. These benefit are recognized as an expense in the period in which they are incurred and a corresponding liability is established.
source deductions
Amounts withheld from employee wages and remitted to the government by the employer to pay for such things as income taxes, Employment Insurance, and government pension premiums.
Canada Pension Plan (CPP)
The federal government program providing retirement benefits to retired workers based on the premiums they and their employers paid into the plan when they were working.
Employment Insurance (EI) = 1.4x the amount for employer
The federal government program that provides benefits to unemployed individuals looking for work or undergoing retraining, maternity and paternity benefits to parents, and payments to workers who are sick or who have to leave their job to care for a seriously ill family member.
Accounting for a company’s payroll costs involves the following four entries:
- Employee entry
- Employer entry
- Payment of wages
- Remittance of source deductions and employer’s contributions
gross wages
Wages earned by employees before source deductions
net wages
Wages that will be paid to employees after source deductions
pay periods
The time frames for which employees are paid. Normally these are two weeks in duration, with employees being paid 26 times each calendar year.
remittance
The payment of employee source deductions, together with the employer’s share, to the federal or other government.
When Are a Company’s Taxes Due?
A corporation’s income taxes are based on the company’s income before tax (adjusted for a number of tax rules)
corporate tax return (which is known as a T2)
The corporate tax return document required to be filed by corporations with the federal government to indicate the amount of corporate income tax owed
This must be filed no later than (6) six months after the company’s fiscal year end, but the balance of any taxes owed for the year must generally be paid within (2) two months of the year end
What Current Liabilities Arise from Transactions with Shareholders?
Dividends payable is the most common liability that corporations have to their shareholders.
When the board of directors declares dividends, the journal entry is as follows:
Dividends Declared XXX
Dividends Payable XXX
accounts payable turnover
The number of times per year that a company settles (pays) its accounts payable. It is calculated as the credit purchases divided by the average accounts payable
average payment period
The average number of days that a company takes to pay for its credit purchases
Accounts Payable Turnover Ratio =
Credit purchases / Average accounts payable
Average accounts payable =
(Opening Accounts Payable + Ending Accounts Payable)/2
The accounts payable turnover ratio measures
the number of times per year that a company settles its trade payables
Accounts Payable Payment Period =
365 Days / Accounts payable turnover ratio
Very often, failure to record an accrued expense means failure to record a(n)
liability
Dividends declared
1 for shareholders
Are not expenses
Goods purchases =
Cost of goods sold + increase in inventory during the year
______ calculations are generally not used to value short-term liabilities.
Present value
Employer pays
Matches CPP (say it is 4.95%, do 0.0495x100 = $4.95) Ei x 1.4 (1.4x100 = 140)
Current liabilities listed on the statement of financial position include
dividends payable in two weeks.
