Current Liabilities

Question 1

Key Elements of Liabilities from Framework.

Answer 1

a. Liabilities represent probable future sacrifices of economic benefits;
b. Liabilities are obligations to transfer assets or provide services in the future;
c. Liabilities are the result of past transactions or events

Question 2

Valuation of Liabilities

Answer 2

a. CLs are reported valued at the amount due, or nominal amount. Liabilities for services are measured at the amount received. For example, the unearned revenue (liability) for an amount received by an airline before a flight is provided is measured at the amount received for the ticket.
b. NCLs are reported at the present value of all future payments (principal and interest), discounted at the prevailing rate of interest for similar debt on the date of issuance. Present value is the current sacrifice to retire the debt. Interest is the difference between the total future payments and present value. Interest is not recognized until time passes.

Caution: A CL and NCL reported in the balance sheet at equal values (for example, both $100,000) may require greatly different cash payment totals over their terms due to interest on the NCL principal.

Question 3

CL and Refinancing

Answer 3

CLs that are continuously refinanced (rolled over) by replacing them with other CLs due later (but within one year of the balance sheet date) must still be classified as CL, even though no current asset will be used to extinguish them in the year after the balance sheet date.

Although the expectation is that no current asset will be used to retire the debt, there is no certainty that the debtor firm will be able to continue this practice. For example, the debtor firm cannot control the creditor who may decide not to refinance. Interest rates may increase substantially changing the strategy of the debtor firm.

Question 4

Most liabilities due within one year of the balance sheet are CLs. But there are exceptions - some are classified as NCL.

Answer 4

2. A note is due 5 months from the balance sheet date but payable in the common stock of the debtor. The debtor does not reduce current assets in payment of this debt. A later lesson discusses another example - the refinancing of short-term debt on a long-term basis.
3. A bond liability due next year for which the firm has created a sinking fund investment (noncurrent asset) for bond retirement is classified as an NCL because payment will reduce noncurrent assets not current assets.

Question 5

Caution: Most liabilities due later than one year after the balance sheet date are NCLs, but there are exceptions - some are classified as CLs.

Answer 5

Long-term obligations callable on demand by the creditor are classified as current. Because the creditor can call in the debt, the debtor must report it as current. A creditor may require this provision in the debt contract to reduce the risk of losing principal. Such provisions also may be added in case the debtor violates a debt restriction. For example, a debt contract requires the debtor to maintain a current ratio (CA/CL) of 3.0 or more. If the ratio falls below 3.0, the debt is due on demand by the creditor, unless the debtor “cures” the violation within the next reporting period.

Question 6

Payroll Liabilities

Answer 6

Driven by Employer expenses and with-holdings (no expense to employer).

Question 7

Employer Costs Expensed

Answer 7

Gross Salary, FUTA, SUTA, and SHARED portion of FICA and Medicare (1/2) and Fringe Benefits

Question 8

Employee with-holding

Answer 8

Tax (State and Federal), Share of FICA/Medicare/Fringe and any personal expenses like Dues.

Employee costs withheld from paychecks including income tax withholding, employee share of FICA, Medicare and fringe benefits, and also personal expenses such as parking, union dues and others. The employer does not recognize an expense for these costs but acts as a collection point resulting in an employer liability.

Question 9

Bonus Compensation Liabilities

Answer 9

A bonus is an additional amount of compensation in excess of a base salary. Frequently, liabilities related to bonus compensation are dependent on operating results for the accounting period. The bonus may be based on income before or after the bonus, and before or after income tax effects. We recommend converting the problem statement directly into an equation. These types of problems require solving for up to two unknowns.

Question 10

1. An employee’s bonus is based on operating income after income taxes but before deducting the bonus. Operating Income before bonus and taxes is $90,000, the bonus rate is 10%, and the tax rate is 40%. Let B = bonus, T = tax.

Answer 10

B	=	.10 ($90,000 − T)
T	=	.40 ($90,000 − B)
B	=	.10 ($90,000 − .40 ($90,000-B))
B	=	$5,625

Question 11

2. An employee’s bonus is based on operating income after income taxes and bonus. Operating income before bonus and tax is $90,000, the bonus rate is 10%, and the tax rate is 40%. Let B = bonus, T = tax.

Answer 11

B	=	.10 (90,000-T-B)
T	=	.40 (90,000-B)
B	=	.10(90,000 − .40(90,000-B) − B)
B	=	$5,094

Question 12

Current portion of LT Debt

Answer 12

NEEDS REVIEW

Question 13

On December 27, 2004, Black wrote and recorded checks to creditors totaling $400,000, causing an overdraft of $100,000 in Black’s bank account at December 31, 2004. The checks were mailed out on January 10, 2005.

Answer 13

Plus checks not sent to creditors until Jan. 10 (this amount was debited to accounts payable and must be reversed because the checks have not been sent - accounts payable has not been reduced as of December 31)

Question 14

Goods shipped F.O.B. destination on December 20 were received and recorded by Acme on January 2. The invoice cost was $45,000.

Answer 14

The $45,000 shipment is not part of the inventory of Acme as of December 31 nor is it a liability (accounts payable) because title to the goods did not transfer to Acme until January 2. FOB destination means that title does not transfer until goods reach their destination. Acme treated this item correctly because it was recorded January 2.

Question 15

The deferred income tax liability is not related to an asset for financial accounting purposes and is expected to reverse in 2004

Answer 15

This answer does not include the deferred income tax liability, which will reverse in 2004. It is a current liability and should be included.

Question 16

$1,000,000 line of credit maturing in one year on which it has drawn $250,000, a $750,000 secured note due in five annual installments, and a $300,000 three-year balloon note.

Answer 16

three debt instruments that need to be categorized into current or long-term. The line of credit is due in one year so it is all current. The secured note is due in 5 annual installments so 1/5 is current and 4/5 is long-term

Question 17

Accrued Liabilities vs Expense in MCQs

Answer 17

Think of the Adjusting Entry needed to accrue to the proper liability. Rent may be paid Mid month, so need to accrue 1/2 a month at month end (year end). Keep it simple.

Question 18

Payments and impact to AP

Answer 18

Checks must be RECORDED and SENT OUT to be reflected as a Dr (decrease) to AP. i.e. Add back (Dr Cash and Cr AP) if recorded as Dr and not sent until after year end.

Question 19

Rabb Co. records its purchases at gross amounts but wishes to change to recording purchases net of purchase discounts. Discounts available on purchases recorded from October 1, 2003 to September 30, 2004, totaled $2,000. Of this amount, $200 is still available in the accounts payable balance.

Answer 19

Only the discounts still available on accounts yet to be paid can be deducted from the accounts payable balance, which now stands at gross.
The firm owes $30,000 at gross, which means that if none of the cash discounts available are taken, the firm will pay $30,000. The net counterpart of that amount is $29,800 ($30,000 - $200). If the firm pays all its remaining accounts within the cash discount period, it would pay only $29,800.

Question 20

Accrued Interest Payable Formula

Answer 20

Beg (PY Bal) + Interest Expense (Due) - Payments (Cash) = End

Question 21

Deferred Tax Liability

Answer 21

NEEDS REVIEW (Current if will reverse the next year?)

The deferred tax liability could not be current because deferred tax liabilities are classified based on the underlying item, giving rise to the future temporary difference. The reversal of the temporary difference does not begin until 2007, which is more than one year after the balance sheet date.

Therefore, the underlying accounts that give rise to the deferred tax liability must be noncurrent, which causes the deferred tax liability to be also noncurrent

Question 22

Trade AP vs. Interest Liabilities

Answer 22

AP implies TRADE AP

Accounts payable is also labeled: accounts payable, trade. The accounts payable account is used only for routine trade payables, typically for purchases of inventory and supplies.
Interest accrued is recorded in accrued interest payable, and secured debt is recorded in other specifically-labeled liability accounts.

Question 23

On December 31, 2005, special insurance costs, incurred but unpaid, were not recorded.
If these insurance costs were related to work-in-process, what is the effect of the omission on accrued liabilities and retained earnings in the December 31, 2005 balance sheet?

Answer 23

Accrued liabilities are understated because the insurance costs were incurred but not paid. The firm has an obligation for coverage received. The omitted journal entry is:
Accrued liabilities are understated because the insurance costs were incurred but not paid. The firm has an obligation for coverage received. The omitted journal entry is:
Work in process
Accrued payables
Retained earnings is unaffected because no expense has been incurred. The omission of the above entry has no effect on expenses or retained earnings.
Work in process is an asset. When work in process is completed and sold, this part of the total cost of work in process will be expensed

Question 24

On December 27, 2002, a vendor authorized Kew to return, for full credit, goods shipped and billed at $70,000 on December 3, 2002. The returned goods were shipped by Kew on December 28, 2002. A $70,000 credit memo was received and recorded by Kew on January 5, 2003

Answer 24

Less credit for returned goods shipped back to vendor before year-end

Question 25

Goods shipped to Kew F.O.B. shipping point on December 22, 2002 were lost in transit. The invoice cost of $40,000 was not recorded by Kew. On January 7, 2003, Kew filed a $40,000 claim against the common carrier.

Answer 25

Plus cost of goods in transit. The goods became the property of Kew at the shipping point (FOB shipping point). Kew owes the vendor for the goods.

Question 26

Current vs. Non-Current Example

Answer 26

For Wilk Co., accounts payable-trade, short-term borrowings, and the other bank loan, which matures during next year, are all (conventional) current liabilities.
The bank loan for $3,500,000 also must be classified in total as a current liability because Wilk is in violation of the terms of the loan agreement, and the creditor has not waived its right to demand immediate loan payment.

Question 27

Bonus Liability and Tax impact (ex Bonus Impact)

Answer 27

NEEDS REVIEW

B = .25($60,000 - B)

B = $15,000 - .25B (JET: aka 1B = 15k - .25B and then bring -.25B to the Left Side)

1.25B = $15,000

B = $15,000/1.25 = $12,000

Question 28

Business liquidation and secured vs unsecured claims

Answer 28

Free assets must first be allocated to any unsecured priority claims. In addition, the excess of assets pledged for fully secured creditors over fully secured debt is available for payment of unsecured claims.

Partially Secured claims in EXCESS of Assets pledged to partially secured claims become general UNSECURED.

Question 29

Accrued Salaries Payable Forumula

Answer 29

BEG + EXPENSE - PAID = END

Don’t forget Beginning when calculating Ending off of Expense Incurred vs Paid.

Question 30

Dividend Liabilities

Answer 30

Dividends are not a Liability UNTIL declared. Dividends in Arrears are NOT declared and not a liability until declared.