1 Slide 10-1 LIABILITIES Chapter 10 present obligation of the enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits.

2 Slide 10-2 I.O.U. Defined as debts or obligations arising from past transactions or events. Maturity = 1 year or lessMaturity > 1 year Current Liabilities Noncurrent Liabilities The Nature of Liabilities

3 Slide 10-3 The acquisition of assets is financed from two sources: Funds from creditors, with a definite due date, and sometimes bearing interest. Funds from owners DEBT EQUITY Distinction Between Debt and Equity

4 Slide 10-4 Devon Mfg. borrows $100,000 from First Bank. The loan will be repaid in 20 years and has an annual interest rate of 8%. Is this a current liability or a noncurrent liability? Devon Mfg. borrows $100,000 from First Bank. The loan will be repaid in 20 years and has an annual interest rate of 8%. Is this a current liability or a noncurrent liability? Liabilities – Question The obligation will not be paid within one year or one operating cycle, so it is a noncurrent liability.

5 Slide 10-5 Current Ratio = Current Assets ÷ Current Liabilities Working Capital = Current Assets - Current Liabilities An important indicator of a company’s ability to meet its current obligations. Two commonly used measures: An important indicator of a company’s ability to meet its current obligations. Two commonly used measures: Evaluating Liquidity

6 Slide 10-6 Devon Mfg. has current liabilities of $230,000 and current assets of $322,000. What is Devon’s current ratio? Devon Mfg. has current liabilities of $230,000 and current assets of $322,000. What is Devon’s current ratio? Liabilities – Question

7 Slide 10-7 Short-term obligations to suppliers for purchases of merchandise and to others for goods and services. Merchandise inventory invoices Shipping charges Utility and phone bills Office supplies invoices Accounts Payable

8 Slide 10-8 Total Notes Payable Current Notes Payable Noncurrent 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. 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. Notes Payable

9 Slide 10-9 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. signed title Miami, FlNov. 1, 2003 Six months Porter Company John Caldwell Security National Bank $10, % treasurer Notes Payable

10 Slide On November 1, 2003, Porter Company would make the following entry. Notes Payable

11 Slide  Interest expense is the compensation to the lender for giving up the use of money for a period of time.  The liability is called interest payable.  To the lender, interest is a revenue..  To the borrower, interest is an expense.  Interest expense is the compensation to the lender for giving up the use of money for a period of time.  The liability is called interest payable.  To the lender, interest is a revenue..  To the borrower, interest is an expense. Interest Rate Up! Interest Payable

12 Slide The interest formula includes three variables that must be considered when computing interest: Interest = Principal × Interest Rate × Time When computing interest for one year, “Time” equals 1. When the computation period is less than one year, then “Time” is a fraction. Interest Payable For example, if we needed to compute interest for 3 months, “Time” would be 3/12.

13 Slide What entry would Porter Company make on December 31, the fiscal year-end? Interest Payable – Example $10,000  12%  2 / 12 = $200

14 Slide Net Pay Payroll Liabilities NIS NHT Ed Taxes PAYE Tax Voluntary Deductions Gross Pay

15 Slide Deferred revenue is recorded. a liability account. Cash is received in advance. Cash is sometimes collected from the customer before the revenue is actually earned. Unearned Revenue Earned revenue is recorded. As the earnings process is completed..

16 Slide Relatively small debt needs can be filled from single sources. Banks Insurance Companies Pension Plans oror Long-Term Debt

17 Slide Large debt needs are often filled by issuing bonds. Long-Term Debt

18 Slide l Bonds usually involve the borrowing of a large sum of money, called principal. l The principal is usually paid back as a lump sum at the end of the bond period. l Individual bonds are often denominated with a par value, or face value, of $1,000. l Bonds usually involve the borrowing of a large sum of money, called principal. l The principal is usually paid back as a lump sum at the end of the bond period. l Individual bonds are often denominated with a par value, or face value, of $1,000. Bonds Payable

19 Slide  Bonds usually carry a stated rate of interest, also called a contract rate.  Interest is normally paid semiannually.  Interest is computed as: Interest = Principal × Stated Rate × Time Bonds Payable

20 Slide  Bonds are issued through an intermediary called an underwriter.  Bonds can be sold on organized securities exchanges.  Bond prices are usually quoted as a percentage of the face amount. For example, a $1,000 bond priced at 102 would sell for $1,020.  Bonds are issued through an intermediary called an underwriter.  Bonds can be sold on organized securities exchanges.  Bond prices are usually quoted as a percentage of the face amount. For example, a $1,000 bond priced at 102 would sell for $1,020. Bonds Payable

21 Slide On January 1, 2003, Rocket Corp. issues $1,500,000 of 12%, 10-year bonds payable. Interest is payable semiannually, each July 1 and January 1. Assume the bonds are issued at face value. Record the issuance of the bonds. On January 1, 2003, Rocket Corp. issues $1,500,000 of 12%, 10-year bonds payable. Interest is payable semiannually, each July 1 and January 1. Assume the bonds are issued at face value. Record the issuance of the bonds. Accounting for Bonds Payable

22 Slide Record the interest payment on July 1, Accounting for Bonds Payable

23 Slide Other types of liabilities (1)  Capital Lease/Finance Lease  Pensions/Other postretirement benefits  Deferred Income Taxes

24 Slide Other liabilities (2) As per IAS 37 Provisions, Contingent Liabilities and Contingent Assets  Provision - A liability of uncertain timing or amount. AccrueAccrue if amount is probable and can be estimated reliably

25 Slide Other liabilities (3) As per IAS 37 Provisions, Contingent Liabilities and Contingent Assets  Contingent Liability a possible obligation depending on whether some uncertain future event occurs, or a present obligation but payment is not probable or the amount cannot be measured reliably Disclose Disclose in notes unless payment is remote

26 Slide Scenario 1 – What should company Y do?  Just prior to year-end, the courts finally settled the lawsuit between Company X against Company Y in favour of the former. 1. The damages have not yet been established but Company Y’s lawyers estimate it to be about $6M 2. The damages have not yet been established and neither lawyer is able to make a reasonable estimate because the case has no precedence.

27 Slide Scenario 2 – What should company B do?  At year-end, the lawsuit between Company A against Company B was still pending. 1. Company B’s lawyers suggest that Company B may lose the case.

28 Slide Borrowing at one rate and investing at a higher rate. If we borrow $1,000,000 at 8% and invest it at 10%, we will clear $20,000 profit! Financial Leverage

29 Slide Are we having fun yet? End of Chapter 10