Accounts Payable, Commitments, Contingencies, and Risks Chapter 8

Types of Current Liabilities Current liabilities are short-term obligations that usually must be paid from current assets within a year.

Three Types of Current Liabilities Obligations to pay cash to another entity Obligations to provide goods or services to another entity Obligations to honor product warranties

Accounts Payable Accounts payable represent debts that the firm incurs in purchasing inventories and supplies, as well as amounts that the firm owes for other services used in its operations.

Accounts Payable

Discounts Suppliers often offer discounts to induce early payment.

Discounts If a company purchases $5,000 of supplies with terms of 2/10, n/30 and intends to pay within the discount period, then it generally records the purchase at the net price (in this case, $4,900).

Discounts If the company fails to pay within the discount period and must remit the full $5,000, then the $100 discount not taken becomes interest expense.

Discounts

Notes Payable Notes payable are more formal promises to pay a lender. They are usually in writing and involve payment of interest.

Notes Payable Notes may be interest-bearing.

Notes Payable When a borrower goes to a bank to borrow $50,000, he is given the entire $50,000.

Notes Payable At the maturity date, he must repay not only the principal of $50,000 but also interest.

Interest-Bearing Note

Discounted Note Notes may also be discounted.

Discounted Note A firm signs a note, with an interest rate of 10%, promising to repay $50,000 in six months, but receives only $47,500.

Discounted Note The bank has deducted the interest ($50,000 X.10 X 6/12) at the time of the borrowing.

Discounted Note Despite the receipt of $47,500, the company must repay $50,000 at the maturity date.

Discounted Note At that time the company will recognize interest expense of $2,500.

Discounted Note

Accrued Liabilities Accrued liabilities represent expenses that have been incurred prior to the balance sheet date which have been neither paid nor included with liabilities as of the balance sheet date.

Accrued Liabilities An adjustment, increasing both an expense and a liability, must be made at the balance sheet date.

Accrued Liabilities For many companies, these accrued liabilities include accrued wages and salaries and accrued vacation and sick pay.

Accrued Liabilities

Long-Term Debts Long-term debts often have a current portion or become current as time goes by.

Long-Term Debts An example of the current portion is a 30-year mortgage — each mortgage payment consists of both principal and interest.

Long-Term Debts On the balance sheet date, the principal component of the next 12 payments must be classified as a current liability.

Long-Term Debts An example of the become current is a 5-year note payable, a long-term liability.

Long-Term Debts Twelve months before the maturity date, the entire note must be classified as a current liability.

Accrued Income Taxes Accrued income taxes are certainly a current liability because they are due within one year and generally sooner than that.

Restructuring Costs Restructuring costs occur when a company decides to downsize and to refocus its operations.

Restructuring Costs When a firm decides to restructure, the total estimated costs of restructuring are expensed in the current year.

Restructuring Costs This involves increasing both an expense and a liability.

Accrued Restructuring Costs

Advance Payments from Customers A company may also have obligations to provide goods or services.

Advance Payments from Customers A magazine publisher is a good example.

Advance Payments from Customers When a person subscribes to take the magazine for one year, the company receives the entire year's subscription amount in advance.

Advance Payments from Customers The Cash account is increased, as is a liability account called Advance Payments from Customers.

Advance Payments from Customers The liability represents the company's obligation to provide the subscriber not with money but with a magazine each month over the next twelve months.

Advance Payments from Customers As each magazine is sent, the company reduces its liability and finally recognizes revenue.

Advance Payments from Customers

Obligations for Warranties Companies usually stand behind the quality of the products they sell and offer to repair defective products or to refund the purchase price.

Obligations for Warranties The matching principle dictates that these possible costs must be matched with current sales revenues.

Obligations for Warranties The future costs must be estimated and recorded in the period of the sale.

Obligations for Warranties This will involve an increase in both Warranty Expense and Warranty Obligation.

Obligations for Warranties Estimates are derived from the company's past experience and from industry averages.

Obligation for Warranty

Accounts Payable, Commitments, Contingencies, and Risks End of Chapter 8