Chapter 9: Current Liabilities, Contingencies, and the Time Value of Money Flashcards
What is the definition of current liabilities? Why is it important to distinguish between current and long-term liabilities?
Current liabilities are obligations which will be satisfied within one year. Current liabilities are important to determine a firm’s liquidity, i.e., its ability to pay for those items due within a short time period.
Is the account Discount on Notes Payable an income statement or a balance sheet account? Does it have a debit or credit balance?
The account Discount on Notes Payable is a balance sheet account. The account has a debit balance and should be classified as a contra liability.
A firm’s year ends on December 31. Its tax is computed and submitted to the U.S. Treasury on March 15 of the following year. When should the taxes be reported as a liability?
Income tax is an item that should be accrued as a liability as of year-end. If the firm’s year-end is December 31, then the amount should appear as a current liability on the balance sheet dated December 31.
If a company has current liabilities that have increased during the year, how will they appear on the statement of cash flows? In what category? Will they appear as positive or negative amounts?
Increases in current liabilities will be reflected on the statement of cash flows as positive amounts because the liabilities have not been paid. Generally, the current liabilities will appear in the operating category of the cash flow statement.
A company has the following current liabilities at the beginning of the period: Accounts Payable, $30,000; Taxes Payable, $10,000. At the end of the period, the balances of the account are as follows: Accounts Payable, $20,000; Taxes Payable, $15,000. What amounts will appear in the cash-flow statement? In what category of the statement will they appear?
The amounts appearing in the cash-flow statement should be in the Operating Activities category of the statement. The amounts shown should be the changes in the balances of the accounts.
Accounts Payable decreased by $10,000 and should appear as a decrease in the cash-flow statement.
Taxes Payable increased by $5,000 and should appear as an increase in the cash-flow statement.
What is a contingent liability? Why are contingent liabilities accounted for differently than contingent assets?
A contingent liability involves an existing condition where the outcome of that condition is not known with certainty and is dependent on some event that will occur in the future. Contingent liabilities are accounted for differently than contingent assets because of the principle of conservatism. Generally, contingent gains or contingent assets are not reported until the gain actually occurs. That is, contingent liabilities may be accrued, but contingent assets are not accrued.
Assume that a lawsuit has been filed against your firm. Your legal counsel has assured you that a loss is not probable. How should the lawsuit be disclosed on the financial statements?
The lawsuit should be described in as much detail as possible in the notes to the financial statements. The nature of the lawsuit and the expected resolution should be described. If the dollar amount can be estimated, it should be disclosed. If it cannot be estimated, it may be possible to determine and disclose a range of values that represents the potential loss to the firm.
Omega Company is involved in two unrelated lawsuits, one as the plaintiff and one as the defendant. As a result of these two lawsuits, the company has a contingent asset and a contingent liability. How should Omega record these on its balance sheet?
A contingent liability must be recorded as a liability on the balance sheet if the likelihood of loss is probable, and the amount can be reasonably estimated. It must be disclosed in the footnotes if the likelihood of loss is at least reasonably possible.
A contingent asset is treated more conservatively. It normally is not recorded as an asset on the balance sheet until the asset is received.
What is the meaning of the terms present value and future value? How can you determine whether to calculate the present value or the future value of an amount?
A future value represents the amount that will be accumulated at a future time if a known amount is invested for a given time at a given interest rate. The present value represents the value today of an amount to be received or paid at a future time. You can determine whether or not to calculate a present value or future value based on the timing of the known and unknown quantities.
What is the meaning of the word annuity? Can the present value of an annuity be calculated as a series of single amounts? If so, how?
The word annuity means a series of payments of the same amount. The present value of an annuity could be calculated as a series of single amounts, but not with a single calculation. Tables have been developed to calculate the present value of an annuity based on one calculation.
Assume that you know the total dollar amount of a loan and the amount of the monthly payments. How can you determine the interest rate as a percentage of the loan?
The interest rate of the loan could be calculated by dividing the total dollar amount of the loan by the dollar amount of the monthly payments. The result is a number that represents an interest factor or table value in the table for the present value of an annuity. Find the table value that corresponds to the number of years of the loan, and then read across that row to find the interest rate.
