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OU ACCT 2113 - Chapter 8 Notes

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ACCT 2113 1st Edition Lecture 8 Outline of Last Lecture II. Long-term AssetsA. CategoriesB. Land, equipment, buildings, basket purchase, natural resourcesIII. Intangible AssetsA. PatentsB. CopyrightsC. TrademarksD. FranchisesE. GoodwillIV. Acquisition & ImprovementsA. Repairs and MaintenanceB. AdditionsC. ImprovementsD. Legal defense of intangible assetsV. Cost AllocationVI. DepreciationA. ExampleB. TerminologyC. MethodsD. Tax depreciationVII. Amortization of Intangible AssetsA. ExampleB. Assets not subjectVIII. Asset DispositionA. Disposal of Long-term assetsB. Recording DisposalsC. Sale, retirement, exchangeD. Asset AnalysisOutline of Current Lecture IX. Current LiabilitiesA. Current vs. long-term liabilitiesB. Account for notes payable and interest expenseC. ExampleThese notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.X. Measuring InterestA. ExampleXI. Line of CreditA. Employee/employer payroll liabilitiesB. Employee/employer costsXII. Current portion of long-term debtA. Deferred taxesXIII. ContingenciesA. Litigations and other causesB. Contingent liabilitiesC. Accounting treatmentD. WarrantiesE. Contingent gainsXIV.Assessing liquidityCurrent Lecture Chapter 8: Current LiabilitiesPart A Current LiabilitiesLiability: A present responsibility to sacrifice assets in the future due to a transaction or other event that happened in the past.Current liabilities are usually, but not always, due within one year. But for some companies (a winery, for example), it takes longer than a year to perform the activities that produce revenue. We call the time it takes to produce revenue—from “cash to cash” as the saying goes (i.e., initial investment to revenue)—the operating cycle. What obligations do firms most frequently report as current liabilities? Notes payable, accounts payable, and payroll liabilities are the three main categories. In addition, companies report a variety of current liabilities in a category headed “Other current liabilities.” Included in this category are liabilities such as unearned revenue, sales taxes payable, and the current portion of long-term debt.Current liabilities are also sometimes called short-term liabilities.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. For now, remember that in most cases (but not all) current liabilities are due within one year.Reporting Liabilities-(1) probable future sacrifices of economic benefits;(2) arising from present obligations to other entities; (3) resulting from past transactions or events.The definition of liabilities touches on the present, the future, and the past. Recall that assets represent probable future benefits. In contrast, liabilities represent probable future sacrifices of benefits. In a classified balance sheet, we categorize liabilities as either current or long-term. In most cases, current liabilities are payable within one year and long-term liabilities are payable more than one year from now.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. oAccount 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 expenseo Small firms rely heavily on short-term financing. o Large companies also use short-term debt as a significant part of their capital structure.EX) Assume Southwest Airlines borrows $100,000 fromBank of America on September September 1, 2012 Debit CreditCash 100,000 Notes Payable 100,000(Issue notes payable)1, 2012, signing a 6%, six-month note for the amount borrowed plus accrued interest due six months later on March 1, 2013. On September 1, 2012, Southwest will receive $100,000 in cash and record the entry debiting Cash account for $100,000 and crediting Notes payable account for $100,000.Measuring Interest-When a company borrows money, it pays the lender interest in return for using the lender’s money during the term of the loan. Interest is stated in terms of an annual percentage rate to be applied to the face value of the loan. Because the statedinterest rate is an annual rate,whencalculatinginterest for acurrent note payable we must adjust for the fraction of the annual period the loan spans.We calculate interest on notes as: Interest = Face value x Annual interest rate x Fraction of the yearIn the example above, how much interest cost does Southwest incur for the six month period of the note from September 1, 2012 to March 1, 2013?$3,000 = $100,000 x 6% x 6/12Interest Accrued and repayment of note-December 31, 2012 Debit CreditInterest Expense ($100,000 x 6% x 4/12) 2,000 Interest Payable 2,000(Record interest incurred, but not paid )If Southwest’s reporting period ends on December 31, 2012, company records the four months’ interest incurred during 2012 in an adjusting entry prior to preparing the 2012 financial statements: March 1, 2013 Debit CreditNotes Payable (face value) 100,000 Interest Expense ($100,000 x 6% x 2/12) 1,000 Interest Payable ($100,000 x 6% x 4/12) 2,000 Cash 103,000(Pay notes payable and interest )On maturity, Southwest Airlines will pay the face value of the loan plus the entire interest incurred. It makes the following journal entry EX) Flip side: Bank of AmericaHow would the lender, Bank of America, record this note? o For the bank it’s a note receivable rather than a note payable.o It generates interest revenue rather than interest expense. o The entries are as follows:Line of Credit-o An informal agreement that permits a company to borrow up to a prearranged limit without having to follow formal loan procedures and prepare paperwork.o Similar to notes payable except the company is able to borrow without having to go through a formal loan approval process each time it borrows money.o Many short-term loans are arranged under an existing line of credit with a bank, or


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