1. Liabilities
Chapter 10
Chapter 10: Liabilities 1

2. Learning objectives:
After studying this chapter, you should be able to:
Define liabilities and distinguish between current and long-term liabilities.
Describe the costs and the basic accounting activities relating to payrolls.
Prepare an amortization table allocating payments between interest and principal.
describe corporate bonds and explain the tax advantage of debt financing.
account for bonds issued at a discount or premium.
Explain the concept of present value as it relates to bond prices.
Explain how estimated liabilities, loss contingencies, and commitments are disclosed in financial statements.
Evaluate the safety of creditors' cliams.
Describe reporting issues related to leases, postretirement benefits, and deferred taxes.

3. 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. 3

4. Distinction between debt and equity
All debt eventually mature, come due
Owners’ equity does not mature

5. 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.

6. 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

7. 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

8. 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. 8

9. State and Local Income Taxes
Payroll Liabilities
Gross Pay
Net Pay
Ever wondered what happens to the money deducted from your paycheck? Employers do not keep this money; instead it’s remitted to the appropriate entity. For example, money withheld for taxes is remitted to the proper taxing authority. Money voluntarily taken out of your paycheck for retirement funds and insurance is also remitted to the proper place.
All of these withholdings are liabilities for employers. They are due and payable to the appropriate entity within certain time periods.
Medicare Taxes
State and Local Income Taxes
FICA Taxes
Federal Income Tax
Voluntary Deductions

10. Amounts withheld from employees’ pay
Employees’ take-home pay
Do not represent taxes on the employer
Employer must withhold amount of federal and state income taxes, employees share in paying social security and medicare taxes from their employees’ pay and forward them directly to the appropriate tax authorities.

11. As the earnings process is completed
Unearned Revenue
Cash is sometimes collected from the customer before the revenue is actually earned.
As the earnings process is completed
Most of the time people in debt owe money, but sometimes a business can be in debt for services. For example, assume a new client asks his accounting firm to perform next year’s audit. After checking, the firm sees that it has just enough time to add one client to the schedule next year. The firm tells the client it would be glad to perform the audit but needs $10,000 to hold their spot on the schedule. The client agrees and gives the accounting firm $10,000.
When it is time to do the audit, how happy would the client be if the accounting firm just gave them back the $10,000 instead of performing the audit? Not too happy. They do not want money; they want auditing services. The accounting firm is not in debt for money but for auditing services valued at $10,000.
When the client paid in advance for the audit services, the firm debited Cash and credited a liability called Unearned Revenue.
Cash is received in advance.
a liability account.

12. 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.

13. 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.

14. Installment Notes Payable
Long-term notes that call for a series of installment payments.
Installment notes call for a series of payments. Each payment includes some payment on the principal and some payment for interest. Most car loans and home loans are set up on installment payments. Often, the required payments are the same each month. For each payment made, the amount of the principal payment increases and the amount of the interest payment decreases.
Each payment covers interest for the period AND a portion of the principal.
With each payment, the interest portion gets smaller and the principal portion gets larger.

15. 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.

16. 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.

17. 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