Chapter 10 Liabilities 1 Current Liabilities a Current liability is a debt with 2 key factors i Company reasonably expects to pay the debt from existing current assets or through the creation of other current liabilities ii Company will pay the debt within one year of the operating cycle b If a debt does not meet both criteria are long term liabilities c Companies should carefully monitor their relationship between current liabilities and assets in order to determine short term paying ability i If a company has more liabilities than assets they may not be able to meet its current obligations when they become due d Current liabilities Notes payable accounts payable unearned revenues accrued liabilities i Accrued Liabilities taxes salaries and wages interest payable 2 Notes Payable a Obligations recorded in the form of written promissory notes allows for proof if transaction requires debt collection b Require interest payments from borrower used by companies to meet short term financial needs c Classified as current liabilities if they are expected to be paid within 1 year of the balance sheet d EXAMPLE On March 1 2011 Cole Williams Co signs a 100 000 12 4 month note date payable i Cash Notes Payable 100 000 100 000 June 30 Expense 100 000 x 12 x 4 12 i Interest Expense 4 000 Interest Payable 4 000 interest i Notes Payable Interest Payable Cash 100 000 4 000 104 000 3 Sales Tax Payable e Company will periodically pay the accrual of interest recognizing its first interest expense on f At maturity Cole Williams Co will pay the face value of the note 100 000 and 4 000 of a Sales taxes are stated as a sales percentage of the sales price when the sale occurs b Periodically the retailer remits the collections to the state s department of revenue c EXAMPLE On March 25 Cooley Grocery shows sales of 10 000 and sales taxes of 600 at a sales tax rate of 6 i Cash 10 600 Sales Sales Tax Payable 10 000 600 d Once the company remits the sales tax to the government it credits Cash and debits Sales Tax Payable government i Sales taxes are not expenses companies are only the collection agencies for the e If a company does not ring up sales tax separately on the cash register divide total receipts by 100 sales tax percentage 10 600 1 06 in order to find the sale revenue for the company 4 Payroll and Payroll Taxes Payable a Wages and Salaries Payable The amount of wages and salaries owed to employees b Withholding Taxes The amount required by law to be withheld from employees gross pay i Federal and state income taxes social security taxes ii Until a company remits these taxes to the governmental authorities they are credited to appropriate liability accounts 1 Salaries Wages Payable x FICA Taxes Payable Federal Income TP State Income TP Salaries Wages Payable x x x x 2 Salaries Wages Payable x c With every payroll the employer incurs liabilities to pay various payroll taxes levied upon the Cash x employer i Payroll Tax Expense x FICA Taxes Payable x Federal Unemployment TP x x State Unemployment TP d The payroll and payroll tax liability accounts are current liabilities 5 Unearned Revenues a Revenues that are received before the company delivers goods or provides services b When a company receives the advance payment x i Cash Unearned Revenue Account x c When the company earns the revenue i Unearned Revenue Account x Revenue Account x 6 Current Maturities of Long Term Debt a Portions of long term debt that are due within the current year portion considered a current b Current maturities of long term debt are often termed long term debt due within one year c Do not need to do an adjusting entry liability 7 Balance Sheet a Current liabilities are the first liability category in the balance sheet b Seldom listed in terms of liquidity but rather in terms of magnitude with the largest ones first c Liquidity The ability to pay maturing obligations and meet unexpected needs for cash i Working Capital The excess of current assets over current liabilities ii Current Ratio Permits us to compare the liquidity of different sized companies and of a 1 Current Assets Current Liabilities single company at different times 1 Current Assets Current Liabilities 2 2 1 good credit rating 8 Long Term Liabilities Obligations that are expected to be paid after one year a Bonds Interested bearing notes payable that help firms obtain large amounts of long term capital that are sold in relatively small denominations i Stockholder control is not affected ii Tax savings result interest is deductible for tax purposes iii Earnings per share may be higher No additional shares of common stock are issued b Disadvantages Company pays interest on a periodic basis and repay the yments c Several Types of Bonds i Secured Bond backed by collateral assets ii Unsecured Debenture Issued against credit of the borrower iii Term Bonds Bonds that mature at a specified date iv Serial Bonds Bonds that mature in payment installments v Registered Bonds Bonds issued in the name of the owner vi Bearer Coupon Not registered bonds vii Convertible Can be converted into common stock at bondholder s option viii Callable Can be retired at a stated dollar amount before maturity date d Issuing Procedures i In authorizing bond issue the board of directors must stipulate the number of bonds to be authorized total face value and contractual interest rates 1 Authorization usually exceeds the number actually issued in order to give the company flexibility to issue more bonds when they need more cash ii Face Value Principal that must be paid at maturity date iii Contractual Interest Rate Stated Rate Rate used to determine the amount of cash interest the borrower pays and the investor receives iv Bond Indenture Legal document that states the terms of the bond 1 Shows terms summarizes the rights of bondholders trustees and the obligations of the issuing company 2 Trustee keeps records of each bondholder maintains custody of unissued bonds and holds conditional title to pledged property v Bond Certificates Provides name of issuer face value contractual interest rate and e Bond Trading Bondholders have the opportunity to convert their holdings into cash at any time by selling the bonds at the current market price i Bond prices are quoted as a percentage of the face value of the bond which is usually maturity date 1000 1 EXAMPLE A 1000 bond with quoted price of 97 means that selling price of f Determining Market Value of Bonds bond is 97 of face value i Money has time
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