Liabilities Chapter 10 Chapter 10: Liabilities

The Nature of Liabilities Defined as debts or obligations arising from past transactions or events. Maturity = 1 year or less Maturity > 1 year Current Liabilities Noncurrent Liabilities Liabilities are debts owed from past transactions. Liabilities can be separated into two categories: Current and Non-current. Current liabilities are due to be paid within one year or the normal operating cycle of the business, whichever is longer. For most businesses, one year is longer than the operating cycle. Noncurrent liabilities are due to be paid sometime after one year.

Distinction Between Debt and Equity The acquisition of assets is financed from two sources: DEBT EQUITY Funds from creditors, with a definite due date, and sometimes bearing interest. A company can finance its operations from two sources. One is debt. Debt is a borrowing from a creditor, such as a bank. It has a definite due date and in most cases bears an interest rate. Another way a company can finance its operations is through equity. This requires companies to sell additional stock in the company to new or existing shareholders. Funds from owners.

Estimated Liabilities Estimated liabilities have two basic characteristics: The liability is known to exist, The precise dollar amount cannot be determined until a later date. An estimated liability has two basic characteristics: (1) the liability is known to exist, and (2) the precise dollar amount cannot be determined until a later date. An example of an estimated liability is the warranty associated with a new car provided by the manufacturer. The warranty usually extends for a number of years. As each car is sold, the automaker incurs a liability to perform any work that may be required under the warranty. The dollar amount of the liability, however, can only be estimated at the date of sale. Example: An automobile warranty obligation.

Current Liabilities: Accounts Payable Short-term obligations to suppliers for purchases of merchandise and to others for goods and services. Merchandise inventory invoices Office supplies invoices Accounts Payable are short-term obligations for purchases of merchandise and other goods and services that are used in the normal operations of a business. Examples Utility and phone bills Shipping charges

Current Liabilities: Notes Payable When a company borrows money, a note payable is created. Current Portion of Notes Payable The portion of a note payable that is due within one year, or one operating cycle, whichever is longer. Many Notes Payable require payments on a regular basis during the life of the note. For example, many home mortgages are for fifteen or thirty years. But homeowners do not wait until the end of the fifteen or thirty years to make a payment. They usually make monthly payments during the loan term. Remember that any debt due within one year is classified as current. The portion of a note payable that is due within one year would be classified as a current liability. The remainder of the note that is due outside of one year is classified as noncurrent. Total Notes Payable Current Notes Payable Noncurrent Notes Payable

Current Liabilities: Notes Payable PROMISSORY NOTE Location Date after this date promises to pay to the order of the sum of with interest at the rate of per annum. Miami, Fl Nov. 1, 2011 Six months Porter Company John Caldwell Security National Bank $10,000.00 12.0% Treasurer and Senior VP Signed: Title: A note is a written promise to pay a specific amount at a specific future date. A note includes the following necessary information about the agreement. The payee on the note is the recipient of the cash at maturity. In this example, the payee is Security National Bank. The maker on the note is the debtor who owes the money. In this example, the maker is Porter Company. Notes also include information about the principal, interest rate, and due date. This note is for $10,000, has an interest rate of 12%. The note amount plus interest is due six-months from November 1st, the date of the note.

Accrued Liabilities Accrued liabilities arise from the recognition of expenses for which payment will be made in the future. Accrued liabilities are often referred to as accrued expenses. Examples include: Interest payable, Income taxes payable, and Accrued payroll liabilities. Accrued liabilities arise from the recognition of expenses for which payment will be made in the future. Accrued liabilities are often referred to as accrued expenses. Examples of accrued liabilities include interest payable and income taxes payable. As accrued liabilities stem from the recording of expenses, the matching principle governs the timing of their recognition. All companies incur accrued liabilities. In most cases, however, these liabilities are paid at frequent intervals.

Long-Term Liabilities Relatively small debt needs can be filled from single sources. Banks Insurance Companies Pension Plans or When a company has a relatively small need for cash, the need can usually be met by a single lender, such as a bank.

Long-Term Liabilities Large debt needs are often filled by issuing bonds. However, when a company needs large amounts of cash, one creditor may not be willing to take on all the risk of repayment. In this case, many companies issue bonds to lots of different people and entities to spread out the risk.

Maturing Obligations Intended to be Refinanced One special type of long-term liability is an obligation that will mature in the current period but that is expected to be refinanced on a long-term basis. If management has both the intend and ability to refinance soon-to-mature obligations on a long-term basis, these obligations are classified as long-term liabilities. One special type of long-term liability is an obligation that will mature in the current period but that is expected to be refinanced on a long-term basis. If management has both the intend and ability to refinance soon-to-mature obligations on a long-term basis, these obligations are classified as long-term liabilities.

Bonds Payable Bonds usually involve the borrowing of a large sum of money, called principal. The principal is usually paid back as a lump sum at the end of the bond period. Individual bonds are often denominated with a par value, or face value, of $1,000. As mentioned earlier, when companies need large amounts of cash, they often issue bonds. The principal on bonds is typically paid at the end of the bond period. Bonds are often denominated with a face value, or par value, of $1,000.

Principal × Stated Rate × Time = Interest Bonds Payable Bonds usually carry a stated rate of interest, also called a contract rate. Interest is normally paid semiannually. Interest is computed as: Principal × Stated Rate × Time = Interest Bonds normally have an interest rate called a stated or contract rate. Interest is normally paid semiannually and is computed as Principal times Rate times Time. This computation should look familiar to you.

Types of Bonds Mortgage Bonds Debenture Bonds Convertible Bonds There are several types of bonds. For Mortgage bonds, the issuer pledges specific assets as collateral. Debenture bonds are backed by the issuer’s general credit standing. Convertible bonds can be exchanged for a fixed number of common shares of the issuing corporation. Junk bonds have very high risk associated with them. Convertible Bonds Junk Bonds

End of Chapter 10 End of chapter 10.