1. Accounting for Presentation of Liabilities and Owners’ Equity
CHAPTER 7
Accounting for Presentation of Liabilities and Owners’ Equity

2. Overview Current liabilities Interest calculation methods
Non-current liabilities
Contingent liabilities
Contributed capital – ordinary and preference
Retained earnings
Dividends (cash and share) and share splits
Reserves
Outside equity interest in subsidiaries
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3. Liabilities and Owners’ Equity
Financial resources available to an entity for financing its assets
Accounting Equation
A = L + OE
Obligations of the entity
Claim of the entities owners to the assets
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4. Liabilities Current Non-current Accounts payable
Short-term borrowings
Current maturities of long-term borrowings
Unearned revenue
Other accrued liabilities
Provisions
Non-current
Deferred tax liabilities
Finance lease obligations
Bonds
Debentures
Other non-current liabilities
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5. 2/10, n/30 Current Liabilities Accounts payable
Amounts owed to suppliers for goods and services that have been provided on credit.
Discounts offered for prompt payment
2/10, n/30
Percentage discount . . .
. . . for this number of days.
Otherwise, net (or All) is due . . .
. . . in this number of days.
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6. Current Liabilities Specified repayment schedule, or
Short-term borrowings:
working capital loan
revolving line of credit
bank overdraft facility.
Specified repayment schedule, or
repayment at a specified date.
Interest will be charged on the amount of the facility.
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7. Effect of short term-borrowings on the balance sheet
Current Liabilities
Effect of short term-borrowings on the balance sheet
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8. Current Liabilities Straight line Interest calculation methods
– Simple interest
Interest calculation methods
For example, a loan of $1,000 borrowed for one year at an interest rate of 12%.
Interest = Principal x Rate x Time (years)
= 1000 x 12% x 1 year
= $120
At the maturity date, the borrower will repay the principal and interest of $1,120.
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9. Interest calculation methods
Current Liabilities
Interest calculation methods
Discount basis
Subtract interest from loan at beginning of loan period. Borrower receives $880 ($1,000-$120).
Effective interest rate
Interest paid / Money received x Time =
$120 / $880 x 1 year
13.6%
At the maturity date, the borrower will repay just the principal, as interest has already been paid.
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10. Current Liabilities Unearned Revenue
Payment in advance for goods that have not been delivered or services not performed.
Must be allocated to the period when revenue is earned.
MATCHING CONCEPT
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11. Current Liabilities Unearned Revenue Example
A magazine publisher receives payment in advance for subscription.
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12. Other accrued liabilities
Current Liabilities
Other accrued liabilities
Accrued property taxes
Payroll taxes and other withholdings
Accrued expenses
GST obligations
Income tax payable
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13. Payroll, payroll taxes and other withholdings
Current Liabilities
Payroll, payroll taxes and other withholdings
Wages payable
PAYG tax
Employers are responsible for remitting payment to the appropriate entities on behalf of their employees for amounts withheld
Superannuation
Health fund insurance
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14. Amount owing to Australian Tax Office for GST withheld from customers.
Current Liabilities
Amount owing to Australian Tax Office for GST withheld from customers.
GST obligations
Goods and Services Tax
Entity levies GST on sales value of items sold
Entity claims deduction for GST paid on inputs to sales
difference
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15. Current Liabilities Income tax payable
Based on calculation of taxable income
Based on accounting income before tax
Income tax EXPENSE
Different to:
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16. Current Liabilities Provisions Provision for warranty
Amount or timing of future sacrifice of economic benefits is uncertain – liability estimated
Provision for warranty
Provision for annual leave
Provision for other employee entitlements
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17. Non-current Liabilities
Long-term borrowings – for many non-financial firms, this accounts for up to half of the firm’s capital structure.
Capital structure – mix of borrowings and owners’ equity that is used to finance the acquisition of the firm’s assets.
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18. Non-current Liabilities
Advantage of long-term borrowings – interest expense is deductible for tax whereas dividends on capital are not.
Financial leverage – use of borrowed money to enhance returns to owners. Difference between rate of return on assets (ROA) and rate of return earned on owners’ equity (ROE).
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19. Non-current Liabilities
Deferred Tax Liabilities (DTL)
Arises as tax law recognises revenue and expenses in a different reporting period to that used in financial statements.
Represents tax that is expected to be paid more than a year after balance date.
For example, expenses relating to provisions, and different depreciation charges for accounts and tax purposes.
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20. Contingent Liabilities
Potential claims on a company’s resources, arising from such things as pending litigation for environmental hazards or product warranties
Financial statement disclosure: In notes to accounts
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21. Contingent liabilities
When should a contingency be taken up in the balance sheet as a liability?
When it is probable that the loss will be confirmed by a future transaction or event.
The amount of the loss must be reasonably estimable.
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22. Outside equity interest in subsidiaries
Owners’ Equity
Contributed capital
Retained earnings
Reserves
Outside equity interest in subsidiaries
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23. Contributed Capital Ordinary Shares Ordinary shareholders:
Ultimate owners of company
Claim to all assets after liabilities and preference shareholders claims in event of liquidation
Right and obligation to elect members to company’s board of directors
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24. Balance sheet disclosure: Number of shares issued and outstanding
Contributed Capital
Paid-up Capital
Amount contributed by owners
Shares may be issued as fully or partly paid
Once a share is fully paid, no more money is due from shareholders – LIMITED LIABILITY
Balance sheet disclosure: Number of shares issued and outstanding
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25. Contributed Capital Preference Shares Several debt-like features:
Fixed rate dividends
Redemption value fixed
Usually callable
Types
Cumulative dividend
Participating dividends
Convertible
Interest on debt is tax deductible but preference share dividends are not.
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26. Contributed Capital Preference Shares
Preference to dividends and priority of claims to assets in event of liquidation
Do not usually have voting privilege
Less risk than ordinary shares
Balance sheet disclosure: dividend rate, liquidation or redemption value, number of shares issued.
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27. Retained earnings are NOT cash
Cumulative earnings of the company kept rather than distributed as dividends.
Retained earnings are NOT cash
They are increased by a firm’s net profit, based on the accrual basis of accounting. This is different to the operating cash flows.
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28. Cash Dividends Requirements: Company must have retained earnings
Board of directors must declare dividend
Company must have enough cash to pay dividend
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29. Cash Dividends
Once the board of directors declares a dividend it becomes a legally enforceable liability of the company.
Dividends are not an expense and do not appear on the income statement.
Dividends are a distribution of profit and are treated as a direct reduction of retained earnings.
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30. No change in owners’ equity
Share Dividend
Issue of additional shares to existing shareholders in proportion to number of shares held
No change in owners’ equity
Shareholders retain percentage ownership in the company (pre-emptive right)
Reasons for share dividends:
Preserve cash
Decrease market value of each share - shares more affordable
Reduce retained earnings
Maintain loyalty of shareholders
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31. Share Split
Issue of additional shares to existing shareholders proportionately, e.g. 4 for 1 split
Increase the number of shares outstanding
Decrease the market value per share
No change to total owner’s equity
No accounting entry required
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32. Reserves
A reserve may arise from retained earnings or through the application of a particular accounting standard.
For example, asset revaluation reserve, foreign currency reserve.
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33. Financial statement disclosure
Reserves
Financial statement disclosure
Changes in reserves are required to be shown on the face of the Income Statement.
Valuation adjustments represent the consequences of unrealised wealth. So, reserves are the consequences of realised or unrealised income or loss.
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34. Outside equity interest in subsidiaries
Parent company
Subsidiary company
Where the parent company controls less than 100% of the subsidiary, an outside equity interest exists and must be disclosed.
Controlling interest
Where this type of structure exists, the parent company must prepare consolidated accounts for all the companies in the economic entity.
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