chapter 08 current liabilities mcgraw-hill/irwin copyright © 2011 by the mcgraw-hill companies,...
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Chapter 08
Current Liabilities
McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.
Part A
Current Liabilities
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Current Liabilities
Liability - A present responsibility to sacrifice assets in the future due to a transaction or other event that happened in the past.
o Current liabilities are usually, but not always, due within one year. Notes payable, accounts payable, and payroll liabilities are the three main categories.
_ Note: If a company has an operating cycle longer than one year, its current liabilities are defined by the operating cycle rather than by the length of a year.
o Current liabilities are also sometimes called short-term liabilities.
Liability - A present responsibility to sacrifice assets in the future due to a transaction or other event that happened in the past.
o Current liabilities are usually, but not always, due within one year. Notes payable, accounts payable, and payroll liabilities are the three main categories.
_ Note: If a company has an operating cycle longer than one year, its current liabilities are defined by the operating cycle rather than by the length of a year.
o Current liabilities are also sometimes called short-term liabilities.
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LO1 Distinguish between current and long-term liabilities
Three characteristics of liabilities:o probable future sacrifices of economic
benefits.o arising from present obligations to other
entities.o resulting from past transactions or events.
Three characteristics of liabilities:o probable future sacrifices of economic
benefits.o arising from present obligations to other
entities.o resulting from past transactions or events.
Reporting LiabilitiesReporting Liabilities
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Current vs. Long-Term Liabilities
LIABILITIESLIABILITIES
Payable within oneyear
With in the company
LONG-TERM
Payable more thanone year
CURRENT
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Reporting Current Liabilities
o Distinguishing between current and long-term liabilities helps investors and creditors assess risk.
o Companies often prefer to report a liability as long-term because it may cause the firm to appear less risky.
o Many companies list notes payable first, followed by accounts payable, and then other current liabilities from largest to smallest.
o Distinguishing between current and long-term liabilities helps investors and creditors assess risk.
o Companies often prefer to report a liability as long-term because it may cause the firm to appear less risky.
o Many companies list notes payable first, followed by accounts payable, and then other current liabilities from largest to smallest.
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LO2 Account for Notes Payable and Interest Expense
o Notes Payableo A company borrowing cash (borrower) from a bank is
required to sign a note promising to repay the amount borrowed plus interest.
o The borrower reports its liability as notes payable.o Notes payable is a liability that creates interest expense
o Small firms rely heavily on short-term financing. o Large companies also use short-term debt as a
significant part of their capital structure.
o Notes Payableo A company borrowing cash (borrower) from a bank is
required to sign a note promising to repay the amount borrowed plus interest.
o The borrower reports its liability as notes payable.o Notes payable is a liability that creates interest expense
o Small firms rely heavily on short-term financing. o Large companies also use short-term debt as a
significant part of their capital structure.
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LO3 Account for Employee and Employer Payroll Liabilities
o Prior to depositing a monthly payroll check, an employer withholdso Federal and state income taxes,
o Social Security and Medicare,
o Health, dental, disability, and life insurance premiums, and
o Employee investments to retirement or savings plans.
o Prior to depositing a monthly payroll check, an employer withholdso Federal and state income taxes,
o Social Security and Medicare,
o Health, dental, disability, and life insurance premiums, and
o Employee investments to retirement or savings plans.
o As an employer, the costs of hiring an employee are higher than the salary.
o Significant costs include
o Federal and state unemployment taxes,
o The employer portion of Social Security and Medicare,
o Employer contributions for health, dental, disability, and life insurance,
o Employer contributions to retirement or savings plans.
o As an employer, the costs of hiring an employee are higher than the salary.
o Significant costs include
o Federal and state unemployment taxes,
o The employer portion of Social Security and Medicare,
o Employer contributions for health, dental, disability, and life insurance,
o Employer contributions to retirement or savings plans.
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Employee Payroll Costs Employer Payroll CostsFederal and state income taxes Federal and state unemployment taxesSocial Security and Medicare Employer matching portion of Social
Security and MedicareHealth, dental, disability, and life insurance Employer contributions for health, dental,premiums disability, and life insuranceEmployee investments in retirement or Employer contributions to retirement orsavings plans savings plans
Employee Payroll Costs Employer Payroll CostsFederal and state income taxes Federal and state unemployment taxesSocial Security and Medicare Employer matching portion of Social
Security and MedicareHealth, dental, disability, and life insurance Employer contributions for health, dental,premiums disability, and life insuranceEmployee investments in retirement or Employer contributions to retirement orsavings plans savings plans
Summary of Payroll Costs
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LO4 Demonstrate the Accounting for other Current Liabilities
Additional current liabilities companies report:o Unearned revenueso Sales taxes payableo The current portion of long-term debto Deferred taxes
Additional current liabilities companies report:o Unearned revenueso Sales taxes payableo The current portion of long-term debto Deferred taxes
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Part B
Contingencies
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LO5 Apply the appropriate accounting treatment for contingencies
o Contingent liability: o An existing, uncertain situation that might result in
a loss. o Examples: Lawsuits, product warranties,
environmental problems, and premium offers o A contingent liability may not be a liability at all.
Whether it is, depends on whether an uncertain event that might result in a loss occurs or not.
o Contingent liability: o An existing, uncertain situation that might result in
a loss. o Examples: Lawsuits, product warranties,
environmental problems, and premium offers o A contingent liability may not be a liability at all.
Whether it is, depends on whether an uncertain event that might result in a loss occurs or not.
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Litigations and Other Causes
Deloitte was the auditor for a client we’ll call Jeeps, Inc. The client sold accessories for jeeps such as tops, lights, cargo carriers, and hitches. One of the major issues in Deloitte’s audit of Jeeps, Inc., was outstanding litigation. Several lawsuits against the company alleged that the jeep top (made of vinyl) did not hold during a major collision. The jeep manufacturer, Chrysler, also was named in the lawsuits. The damages claimed were quite large, about $100 million. Although the company had litigation insurance, there was some question whether the insurance company could pay because the insurance carrier was undergoing financial difficulty. Legal counsel representing Jeeps, Inc. indicated that the possibility of payment was remote and that if the case went to trial, Jeeps would almost surely win.
As the auditor, you could choose one of three options to report the situation: (1) report a liability for the full $100 million or for some lesser amount, (2) provide full disclosure in a financial statement footnote but not report a liability in the balance sheet, or (3) provide no disclosure at all.
Deloitte was the auditor for a client we’ll call Jeeps, Inc. The client sold accessories for jeeps such as tops, lights, cargo carriers, and hitches. One of the major issues in Deloitte’s audit of Jeeps, Inc., was outstanding litigation. Several lawsuits against the company alleged that the jeep top (made of vinyl) did not hold during a major collision. The jeep manufacturer, Chrysler, also was named in the lawsuits. The damages claimed were quite large, about $100 million. Although the company had litigation insurance, there was some question whether the insurance company could pay because the insurance carrier was undergoing financial difficulty. Legal counsel representing Jeeps, Inc. indicated that the possibility of payment was remote and that if the case went to trial, Jeeps would almost surely win.
As the auditor, you could choose one of three options to report the situation: (1) report a liability for the full $100 million or for some lesser amount, (2) provide full disclosure in a financial statement footnote but not report a liability in the balance sheet, or (3) provide no disclosure at all.
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Accounting Treatment of ContingentLiabilities
If payment is:Known or Reasonably
EstimableNot Reasonably
Estimable
ProbableLiability recorded anddisclosure required Disclosure required
Reasonably possible Disclosure required Disclosure required
Remote Disclosure not required Disclosure not required
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Contingent Liabilities
Back to Jeeps, Inc.
How do you think Deloitte, as the auditor of Jeeps, Inc., treated the litigation described earlier?
oBased on the response of legal counsel, the likelihood of the payment occurring was considered to be remote, so disclosure was not required.
oHowever, because the amount was so large, and because there were concerns about the firm’s primary insurance carrier undergoing financial difficulty, Deloitte insisted on full disclosure of the litigation in the footnotes to the financial statements.
Back to Jeeps, Inc.
How do you think Deloitte, as the auditor of Jeeps, Inc., treated the litigation described earlier?
oBased on the response of legal counsel, the likelihood of the payment occurring was considered to be remote, so disclosure was not required.
oHowever, because the amount was so large, and because there were concerns about the firm’s primary insurance carrier undergoing financial difficulty, Deloitte insisted on full disclosure of the litigation in the footnotes to the financial statements.
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LO6 Assess liquidity using current liability ratios
o Liquidity Analysiso Liquidity refers to having sufficient cash to pay currently
maturing debts.
o Working Capital:o It is the difference between current assets and current
liabilities.
o Current ratio:o We calculate it by dividing current assets by current
liabilities. o Acid-test ratio/Quick ratio:
o We calculate it by dividing “quick assets” by current liabilities.
o Quick assets include cash, short-term investments, and accounts receivable.
o Liquidity Analysiso Liquidity refers to having sufficient cash to pay currently
maturing debts.
o Working Capital:o It is the difference between current assets and current
liabilities.
o Current ratio:o We calculate it by dividing current assets by current
liabilities. o Acid-test ratio/Quick ratio:
o We calculate it by dividing “quick assets” by current liabilities.
o Quick assets include cash, short-term investments, and accounts receivable.
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End of chapter 08
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