ACCT 2113 1st Edition Lecture 8 Outline of Last Lecture II Long term Assets A Categories B Land equipment buildings basket purchase natural resources III Intangible Assets A Patents B Copyrights C Trademarks D Franchises E Goodwill IV Acquisition Improvements A Repairs and Maintenance B Additions C Improvements D Legal defense of intangible assets V Cost Allocation VI Depreciation A Example B Terminology C Methods D Tax depreciation VII Amortization of Intangible Assets A Example B Assets not subject VIII Asset Disposition A Disposal of Long term assets B Recording Disposals C Sale retirement exchange D Asset Analysis Outline of Current Lecture IX Current Liabilities A Current vs long term liabilities B Account for notes payable and interest expense C Example These 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 Interest A Example XI Line of Credit A Employee employer payroll liabilities B Employee employer costs XII Current portion of long term debt A Deferred taxes XIII Contingencies A Litigations and other causes B Contingent liabilities C Accounting treatment D Warranties E Contingent gains XIV Assessing liquidity Current Lecture Chapter 8 Current Liabilities Part A Current Liabilities Liability 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 Liabilitieso 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 Account for Notes payable and interest expenseo Notes Payable o 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 EX Assume Airlines borrows Bank of America September 1 2012 Debit Cash 100 000 Notes Payable Issue notes payable Credit 100 000 Southwest 100 000 from on September 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 InterestWhen 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 December 31 2012 Debit Credit face value of the loan Because the Interest Expense 100 000 x 6 x 4 12 2 000 stated interest rate is an Interest Payable 2 000 annual rate when Record interest incurred but not paid calculating interest for a current 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 year In 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 12 Interest Accrued and repayment of note 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 Notes 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 Credit 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 America How 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 Credito 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 for larger corporations in the form of commercial paper a loan from one company to another Account for employee and employer payroll liabilitieso Prior to