unit 9 Flashcards
what are the 3 characteristics that help determine if something is a liability
- Duty/responsibility to others that require settlement in the future, through some form of repayment at a specified or determinable date, on occurrence of a specified event, or on demand
- Entity has little or no discretion to avoid duty of settling the obligation
- Transaction or event that caused the obligation has already occurred
what are the 2 different categories of current liabilities
known and estimated
what are known current liabilities
Clear obligation to pay exists AND amount is certain
Ex. accrued liabilities such as salaries
what are estimated liabilities
- When obligation to pay is likely AND amount can be reasonably estimated
- Can be current or long-term liabilities
Ex. warranties for defective laptops - Don’t know how many laptops will be defective, but they know some amount will
- Keeping with the matching principle, the estimate of the liability should be booked at the time of the sale, based on pass experience or industry standard
what is the journal entry to record for potential liability
DR account expense (E)
CR estimated account payable (L)
example of account would be warranty - warranty expense & estimated warranty payable
for example if there were defects that are fixed under warranty, what would be the journal entry
DR estimated warranty payable (L) - removing the estimate by debiting it because it is no longer an estimate
CR inventory (A) - using inventory to fix the defect
CR salaries and wages payable (L) - increase; need to pay the people that fixed the defect
what happens to the estimated expense and payable accounts when something like a warranty ends?
if there is any leftover unused warranty expense and estimated warranty payable, there would be a journal entry to reverse the left over amounts
what are contingencies
- Situations that might trigger an obligation in the future, depending on the outcome of an uncertain future event
Ex. lawsuits - Type of estimated liability
- Like other estimated liabilities, recognition depends on reliable estimation and likelihood
when is a liability not recognized
If the likelihood of occurrence is unknown or amount can’t be reasonably estimated, liability is not recognized
what do you do if a liability could not be recognized
a note disclosure would be written in the financial statements describing the nature of the potential contingency
what are examples of current liabilities
- short-term borrowings
- accounts payable
- accrued liabilities
- note payable
- unearned revenue
- current portion of long-term debt
what are short-term borrowings
- Represents amounts owing to banks or other lenders (ex. Credit unions) that are typically used to manage working capital and cover other short-term obligations
- Also sometimes shown as short-term debt
Most commonly are in the form of a line of credit
what is accounts payable
- Amounts owing to suppliers and vendors for purchases made on account
- For merchandising companies, A/P is usually from the purchase of inventory, which usually are due within 30-90 days
- For services companies, A/P is usually from other expenditures like advertising or supplies
what are accrued liabilities
- Expenses that the business has incurred but not paid for yet
- Usually include accrued interest expense, salaries and wages payable, and taxes payable
- Some companies may have dedicated general ledger accounts for the above accrued liabilities accounts (depends on the preference/policy of the company)
what is a note payable
- Written promise to pay a specified amount of money to another party at a future date that is typically greater than 90 days and with interest
- Opposite side of note receivable (borrower’s perspective)
- Like a formal accounts payable
what is the journal entry for when a note payable is first issued
DR inventory (A)
CR notes payable (L)
if there is an interest rate that is payable every 4 months, what is journal entry that is done at the end of each month
DR interest expense (E)
CR interest payable (L)
would be what is done for the first 3 months
if there is an interest rate that is payable every 4 months, what is journal entry that is done at on the 4th month when the first payment of interest is given
DR interest payable (L)
DR interest expense (E) - for the last month
CR Cash (A) - includes all 4 months worth of interest payable
what is the journal entry when the note payable is paid off at the end of its term
DR note payable (L) - the principal amount
DR interest payable (L) - the accrued interest over the past months
DR interest expense (E) - the interest for the last month
CR Cash (A)
is there always a current portion of long-term debt
- There can be situations where there is a long term debt line, but no current portion of long-term debt
- If there is no payment that is due within a year, there is simply no current portion of long-term debt for that fiscal year
Ex. Year-end is Dec. 31 2022, and there is a portion payable by Dec 31, 2023 - Current portion of long term debt would be the amount that is payable by Dec 31, 2023
what is current portion of long-term debt
- Portion of the long-term debt that is due within one year of the reporting date
- Long-term debt is a liability that is paid back over a period greater than a year
how do you calculate the total amount of long-term debt
Current portion of long-term debt + long-term portion = total amount of long-term debt
what is long-term debt
- Money that needs to be paid back to a lender over a period greater than one year
- Includes bank loans, bonds, and mortgages
what are the 2 components long-term debt is reported on the balance sheet
- current & non-current (except for bonds)
- Current is when it needs to be paid within a year
- Labelled current portion of long-term …
- Non-current is when it is paid over a year (the leftover amount that isn’t due within a year)
- Labelled as just long-term …
what is a bank loan
Borrowed money from a bank that needs to be repaid by a set maturity date and carries an interest charge
what is it called when a company is unable to repay a loan
default
ex. a company defaulted on a loan, it means they were unable to repay all of the loan
what are bonds
- Debt instruments that represent loans from an investor to the issuer
- Bond issuer is the borrower
- Like an “IOU”
- Bond issuer is promising to pay back the amount they were given
- Bonds are a common way for public companies and governments to raise money
- If private companies issue bonds, they have to provide financial statements to their bondholders (usually on a quarterly basis)
what are common types of other long-term liabilities
- leases
- post employment benefits
what are is the “other long-term liabilities” account
contains all of the other non-current liabilities
what is a lease
A rental agreement where payments are exchanged for the right to use an asset
who is the lessee
The party that rents the asset
who is the lessor
The party that owns the asset
what are the 2 types of leases
- operating lease
- capital lease
what is an operating lease
- Most of the risks & rewards of ownership remains with the lessor
- Better in the perspective of the lessee
- Lessee accounts for the lease payments like a rent expense on the income statement (should not be called a rent expense!)
- Not recorded as an asset or liability on the balance sheet
- Will only affect retained earnings on the balance sheet
what is a capital leasse
- Most of the risk & rewards of ownership are transferred to the lessee, even though the formal legal title remains with the lessor
- Lessee accounts for the lease as an asset and a corresponding lease liability on the balance sheet
- Depreciation expense is recorded on the income statement
- Accumulated depreciation is recorded on the balance sheet
- Like a long-term asset (PP&E)
- Interest expense corresponding to the liability is recorded on the income statement
what would you do when you buy a leased asset
- When the asset is bought, it then becomes PP&E, and you credit the lease liability
- Would then depreciate based on the actual estimated useful life and not by the lease term (because it is now bought)
what are the criteria that a lease should meet (only 1) to be considered a capital lease otherwise is an operating lease
- At the end of the lease term, ownership transfers to the lessee
- Lessee has the option to purchase asset for < it’s fair market value throughout its lease term (based on the lease contract)
- Lease term spans 75% or more of the assets’ expected useful life
- Present value of lease payments is 90% or more of fair market value of the asset when contract is signed (A dollar today is worth more than a dollar tomorrow, What is the value of the lease payments in the future compared to today)
what are post employment benefits
Applies to employees after they have completed their employment at a company
what does shareholders equity include
- retained earnings
- share capital
and others
what are the two main types of shares
common & preferred
how are shares presented on the balance sheet
- common and preferred shares are shown as separate line items in the equity section of the balance sheet
- or as one line called “share capital”
what is the journal entry when a company is first incorporated/ sells public shares
DR Cash (A)
CR common shares/common stock (OE)
if companies are formed by purchasing assets instead of money for shares, what would be the journal entry for it
DR any assets that were bought (A)
CR common shares (OE)
can you calculate the market value of shares for a private company
- no
- the fair market value of shares of a private company is not readily available
- need a professional business evaluator to determine the market value of shares
what value are private shares sold at
market value
market value does NOT equal book value
what is book value of a private company’s commons hares
represents the porportional net assets
what is the formula for book value per common share - when a company only issues common shares
Book Value per Common Share = Total Shareholder’s Equity / # of Common Shares Outstanding
what is the formula for book value per common share - when a company issues both common and preferred shares
Book Value per Common Share = (Total Shareholder’s Equity - Preferred Shareholder’s Equity) / # of Common Shares Outstanding
what is # of common shares outstanding
of common shares outstanding = total number of shares that have been issued by the company
what is return on equity (ROE)
- An accounting performance measure that shows how effectively a company uses equity holders’ investments to generate income
- ROE tells how good a company is at turning equity into profit
what is the formula for ROE
Return on Equity (ROE) = Net Income / Average Shareholders’ Equity
how do you calculate average shareholders equity
Average Shareholders’ Equity = (Shareholders’ Equity @ Beginning of Period + Shareholders’ Equity @ Ending of Period) / 2
