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Chapter 11
Current Liabilities and Fair Value Accounting
| Question | Answer |
|---|---|
| What are current liabilities? | debts and obligations that a company expects to satisfy within one year or within its normal operating cycle, whichever is longer |
| Liabilities require... | careful management of liquidity and cash flows and also close monitoring |
| Timing is important in the __________ of liabilities. | recognition |
| Failure to record a liability often goes along with failure to record an expense and leads to an _________ of expense and an ________ of income. | understatement; overstatement |
| When does GAAP require a liability to be recorded? | when an obligation occurs, as when goods are bought on credit |
| Accrued liabilities include: | salaries payable and interest payable; taxes payable must be recognized through adjusting entries |
| On the balance sheet, a liability is generally _______ at the amount of money needed to pay the debt or reported at the _________ of the goods and services to be delivered. | valued; fair market value |
| If a company's Notes payable account is large, it should ______ the balances, maturity dates, interest rates, and other features of the debts in an _______ note. | disclose; explanatory |
| Disclosure of the fair value and the basis for estimating the fair value of short-term notes payable, loans payable, and other short term debts are ______ unless it is not practical to estimate the value. | required |
| What is a line of credit? | Allows a company to borrow funds when they are needed to finance current operations. Unused lines of credit allow a company to borrow on short notice up to the credit limit, with little or no negotiation. |
| A company incurs current ______ to meet its needs for cash during the operating cycle. | liabilities |
| Liabilities fall into two major groups: | definitely determinable liabilities and estimated liabilities |
| definitely determinable liabilities | current liabilities that are set by contract or statute and that can be measured exactly |
| The objective in accounting for definitely determinable liabilities are to: | determine their existence and amount; record them properly |
| The most common definitely determinable liabilities are: | Accounts payable and notes payable |
| Accounts payable | (trade accounts payable) are short-term obligations to suppliers for goods and services |
| Notes payable | short-term notes payable are represented by promissory notes which are written agreements to pay according to certain terms. Bank loans, pay suppliers for goods and services,or secure credit from other sources are examples. |
| Commercial paper: | companies with excellent credit ratings can borrow short-term funds by issuing commercial paper. Commercial paper refers to unsecured loans that are sold to the public, usually investment firms. These papers can be easily lost if credit rating drops. |
| Only the used portion of a line of credit is recognized as a _______ in the _______ ___________. | liability; financial statements |
| The portion of the line of credit currently used and amount of commercial paper issued are usually combined with ______ _______. | notes payable in the current liabilities section of the balance sheet |
| What is the key reason for making adjusting entries? | recognize liabilities that are not already in the accounting records; accrued liabilities can include estimated liabilities |
| Interest payable, a definitely determinable liability, is also an.... | accrued liability. Interest accrues daily on interest bearing notes. An adjusting entry is made at the end of each period to record the interest obligation up to that point. |
| Dividends Payable | are a distribution of earnings to a corporation's stockholders, and a corporation's board of directors has the sole authority to declare them. Not a liability until the date of declaration. |
| Sales and Excise Taxes Payable | Most states and many cities levy a sales tax on retail transactions, and the federal government imposes an excise tax on some products such as gasoline |
| Current Portion of Long-Term Debt | The portion of long-term debt that is due within the next year and is to be paid from current assets is classified as a current liability; no journal entry required; total debt is reclassified as short-term and long-term in financial statements |
| payroll liabilities | employer is liable to employees for wages and salaries and to various agencies for amounts withheld from wages and salaries and related taxes |
| Wages | compensation of employees at an hourly rate |
| salaries | compensation of employees at a monthly or yearly rate |
| The employer pays all federal, state, and local taxes on income. The employee and employer share FICA and Medicare taxes. The employer bears... | Federal unemployment insurance and state unemployment taxes |
| Unearned revenues | are advance payments for goods and services that a company must provide in the future |
| Estimated Liabilities | definite debts or obligations whose exact dollar amount cannot be known until a later date |
| Estimated liabilities are recorded and presented on financial statements the same way as definitely determinable liabilities except for.... | the computation of estimated liabilities involves some uncertainty |
| The following are examples of estimated liabilities... | Income taxes payable, property taxes payable, promotional costs, product warranty liability |
| Income taxes payable | depends on the results of a corporation's operations which are often not known until the end of the fiscal year; an adjusting entry is necessary. Sole proprietorships and partnerships do not pay income tax their owners must report income on individ taxes |
| Property taxes payable | main source of revenue for local gov.; levied annually on real property, such as land and buldings, and on personal property, such as inventory and equip. Fiscal years of local gov rarely match a company's |
| promotional costs | coupons and rebates part of companies' marketing strategies; record the costs as a reduction in sales (contra-account) |
| product warranty liabiltiy | warranty is feature of the product and is included in selling price; cost should be debited to an expense account in the period of the sale; estimate based on past experience |
| Recording a product warranty expense in the period of the sale is an application of what? | accrual accounting |
| vacation pay liability | vacation pay represents 4 percent of an employee's pay |
| What does FASB require companies to disclose in their financial statements? | To disclose a note to their financial statements any contingent liabilities and commitments |
| contingent liability | is a potential liability because it depends on a future event arising out of a past transaction |
| Contingent liabilities involve: | lawsuits, income tax disputes, discounted notes receivable, guarantees of debt,failure to follow government regulations |
| When are contingencies recorded? | when they are probable and ca be reasonably estimated |
| commitment | is a legal obligation that does not meet the technical requirements for recognition as a liability and so is not recorded |
| fair value | is the price for which an asset or liability could be sold, or exit the company, as opposed to the price for which the company could buy the asset or liability; applies to cash equivalents and investments as well as notes payable |
| FASB identifies three approaches to the measurement of fair value: | 1) market approach 2) income (or cash flow) approach 3) cost approach |
| time value of money | refers to the cost or benefits of holding or not holding money over time |
| interest | is the cost of using money for a specific period |
| future value | the amount of principal plus interest after one or more periods |
| simple interest | is the interest cost for one or more periods when the principal sum- the amount on which interest is computed-stays the same from period to period |
| compound interest | is the interest cost for two or more periods when, after each period, the interest earned in that period is added to the amount on which interest is computed in future periods |
| why is compound interest is useful in business? | because it helps decision makers choose among alternative courses of action |
| Present value | is the amount that must be invested today at a given rate of interest to produce a given future value; thus, present value and future value are closely related |
| Present value is a method of determining today the value of future cash flows. Financial analysts commonly compute present value to determine what? | value of potential investments |
| The interest rate used when compounding interest for less than one year is... | the annual rate divided by the number of periods in a year |
| The concept of present value is _____ used in business decision making and financial reporting. | widely |
| Valuing an asset at present value | an asset is something that will provide future benefits to the company that owns it. Purchase price of an asset represents the present value of those future benefits. |
| Present value of a deferred payment | to encourage buyers to make a purchase, sellers sometimes agree to defer payments for a sale. Common among companies that sell ag equipment to farmers who need new equip. in the spring but cannot pay until the fall |
| The application of accrual accounting to unearned revenues and accrued expenses impacts what on the financial statements? | current liabilities on the balance sheet and revenues and expenses on the income statement |
| What is the primary reason why a company incurs current liabilities? | to meet its needs for cash during the operating cycle |
| operating cycle | is the amount of time it takes to purchase inventory, sell inventory, and collect the resulting receivable |
| to evaluate a company's ability to pay its current liabilities, analysts use two measures of liquidity | working capital= current assets- current liabilities; current ratio= current assets divided by current liabilities |
| Payables Turnover | is the number of times, on average, that a company pays its accounts payable in an accounting period. This measure reflects the relative size of accounts payable, credit terms offered by suppliers, and a company's diligence in paying its suppliers |
| Days' payable | shows how long, on average, a company takes to pay its accounts payable |
Created by:
krystalamber04
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