Week 9 Key Concepts

Question 1

Liability

Answer 1

The obligations of the firm to non-owners who lend economic resources. Three
essential characteristics:
- The obligation involves a probable future sacrifice of resources -a future transfer of cash,
goods, or services or the foregoing of a future cash receipt - at a specified or determinable
date. The cash equivalent value of resources to be sacrificed must be measurable with
reasonable precision.
- The entity has little or no discretion to avoid the transfer.
- The transaction or event giving rise to the entity’s obligation has already occurred.

Question 2

Current vs long-term liabilities:

Answer 2

The criterion generally used for dividing current from noncurrent liabilities is the length of time that will elapse before payment must be made. The dividing
line between the two is one year, or the length of the operating cycle if more than one year.

Question 3

Contingencies:

Answer 3

The criterion generally used for dividing current from non-current liabilities is
the length of time that will elapse before payment must be made. The dividing line between the
two is one year, or the length of the operating cycle if more than one year.

Question 4

Long-term liabilities:

Answer 4

They are initially recorded at the present value of all promised payments
to be made using the market interest rate at the time the liability is incurred.

Question 5

Bonds:

Answer 5

Whenever funds can be borrowed from one lender, the firm usually issues mortgages or
notes. When larger amounts are needed, the firm may have to borrow from the general investing
public with a bond issue. The contract (coupon, nominal) rate of interest is used to compute the
payments (the actual cash flow). Usually stated as annual rate. The market (effective) rate used
to compute interest expense (the charge against current earnings). Usually stated as annual rate.

Question 6

Bond issue price:

Answer 6

The issue price of a bond is equal to the present value of the bond’s future
cash payments for (interest + the repayment of principal). Bonds may be sold in the market at a
price equal to, below, or above the face value of the bond.