1. Financial Accounting Lesson 8: Liabilities and Present Value
Ben Trnka/Boz Bostrom

2. Liabilities will differ by company and industry

3. Overview Understand how to account for liabilities
Understand how to compute future value of a single amount and an annuity
Understand how to compute present value of a single amount and an annuity

4. Current vs. Long-Term Liabilities
Current liabilities are those expected to be paid with current assets
Thus, expected to be paid off within one year
Most creditors expect to be paid off within one year, thus the majority of liabilities are current
Exceptions for certain loans/bonds, leases, pensions, and deferred taxes

5. Accounts Payable
Items purchased but not paid for right away with cash – purchased “on account”
Generally paid off within 30 days and not-interest bearing
Most often used when a company purchases inventories, supplies, and services
Example: Walgreens purchases $1,000 of medicine from Johnson & Johnson and will make payment next month
Dr Inventory $1,000
Cr Accounts Payable $1,000
Dr Accounts Payable $1,000
Cr Cash $1,000

6. Accrued Expenses/Liabilities
Recorded when a company receives services/supplies by the end of a period, but does not pay until the next fiscal period
Often used with estimates for a bill that has not yet been received
Goal is to match expense with financial statement income
Example: Walgreen’s electric bill is estimated to be $2,000 for the month of September, but the bill won’t be received until mid-October
Dr Utilities Expense $2,000
Cr Utilities payable $2,000
Dr Utilities payable $2,000
Cr Cash $2,000

7. Income Taxes Payable
Tax expense is recorded when a company earns income, and not when the cash is paid to the government.
Example, Walgreens earned pre-tax income of $6 billion for its year ended August 31, 2018 and pays tax at a rate of 21%
Dr Income Tax Expense $1.26B
Cr Income Taxes Payable $1.26B
Dr Income Taxes Payable $1.26B
Cr Cash $1.26B

8. Compensation
Companies record compensation expense in the period in which it was earned.
Example: Assume a worker earns $200 per day and on December 31st hasn’t been paid for 5 days of work. Also assume the worker has earned but not been paid for 2 days of vacation and a $150 bonus.
Dr Wages expense $1,000 ($200 * 5)
Dr Bonus expense $150
Dr Vacation expense $400 ($200 * 2)
Cr Wages and benefits payable $1,550
Dr Wages and benefits payable $1,550
Cr Cash $1,550

9. Payroll Taxes
Employees have certain deductions withheld from their paychecks
Payroll taxes
Social security tax – 6.2% of the first $128,400 of their wages
Medicare tax – 1.45% of their wages
Employer must match these amounts
Federal and state income taxes withheld
Health insurance, Retirement savings, and many others

10. Payroll Taxes - Example
An employee earns $1,000. The employer withholds payroll taxes, $100 of federal income taxes, $50 of state income taxes, and $85 of health insurance premium
Gross Wages $1,000.00
Social security taxes ($62.00)
Medicare taxes ($14.50)
Federal income taxes ($100.00)
State income taxes ($50.00)
Health insurance premiums ($85.00)
Take home pay $688.50

11. Payroll Taxes - Journal entries
Dr Wages Expense $1,000
Cr Payroll taxes withheld and payable $76.50 (Social security + Medicare)
Cr Income taxes withheld and payable $150 (State and Federal)
Cr Health insurance withheld and payable $85
Cr Cash $688.50
Dr Payroll tax expense $76.50
Cr Payroll taxes payable $76.50
Thus, the company’s total expense is $1,076.50

12. Payroll Taxes - Journal entries
Dr Payroll taxes withheld and payable $76.50
Dr Income taxes withheld and payable $150
Dr Health insurance withheld and payable $85
Dr Payroll taxes payable $76.50
Cr Cash $388

13. Unearned (Deferred) Revenues
When a company receives cash before it delivers the goods or provides the services, it must setup a temporary liability account
The company has an obligation to deliver goods / provide services
Example: Boeing receives $100M from Delta Airlines for a 737 plane to be delivered next year
Dr Cash $100M
Cr Unearned Revenues $100M
Dr Unearned Revenues $100M
Cr Revenues $100M

14. Accrued Warranties
Many companies offer warranties on products they sell. If the product is defective, the company will fix or replace it
Record estimated warranty expense at the time of sale, not when the warranty claim is made
Example: Toyota provides a limited warranty whenever it sells a vehicle. Each time it sells a Camry, it estimates warranty cost of $800
Dr Warranty expense $800
Cr Accrued warranties $800
Dr Accrued warranties $800
Cr Cash $800

15. Short term debt / Current portion of long-term debt
Companies frequently borrow funds with payment due more than one year away.
Initially, record Long-term note payable or Long-term Debt.
When amount becomes due in one year or less, reclassify the amount as current
Example: Walgreens borrows $2M on a 5-year loan to construct a new store.
Dr Cash $2M
Cr Long-term Debt $2M
Dr Long-term Debt $2M
Cr Current portion of Long-term Debt $2M

16. Leases of Fixed Assets
Accounting depends on the term of the lease, and other factors
Short term classified as operating leases – record expense each year
Long term classified as capital leases – accounted for as a fixed asset and loan payable
Will learn more about leases in intermediate accounting courses

17. Contingent Liabilities
Companies may face lawsuits, and the question is when to record anticipated expenses/payments
If payment is probable and can be reasonably estimated – record the expense
If payment is probable but amount can’t be estimated – disclose in footnotes
If payment is reasonably possible – disclose in footnotes
If chance of payment is remote – no recording/disclosure

18. Contingent Liabilities
Wal-Mart paid bribes to government officials in Mexico in order to help generate business. That is illegal and they are subject to fines. For many years, Wal-Mart could not estimate the amount of the fine and thus simply disclosed the issue in the financial statement footnotes. But in its January 31, financials, Wal-Mart accrued a fine of $283 million.
Dr Fines and penalties expense $283M
Cr Fines and penalties payable $283M
Dr Fines and penalties payable $283M
Cr Cash $283M

19. Additional Long-Term Liabilities
Deferred income taxes
Recorded in order to match income tax expense against financial statement income
Covered in intermediate accounting or tax courses
Pension liabilities
A company may promise to pay a former/retired an employee a set amount per month/year for the rest of their lives.
Usually a cash payment, and may also include health benefits

20. Notes Payable
A company may borrow cash from the bank to fund operating needs, capital investments, acquisitions, expansions, etc.
Notes are formal written agreements
Contain a repayment schedule with specific dates and interest rates
Journal entry upon borrowing:
Dr Cash
Cr Notes Payable

21. Notes Payable
On March 31, 2018, a company borrows $10,000 at a 10% annual interest rate. Principal/interest due on September 30, 2018
March 31:
Dr Cash $10,000
Cr Note Payable $10,000
September 30:
Dr Note Payable $10,000
Dr Interest Expense $500 ($10,000 * 10% * 6/12)
Cr Cash $10,500

22. Notes Payable
On March 31, 2018, a company borrows $10,000 at a 10% annual interest rate. Principal/interest due on March 31, 2019
March 31, 2018:
Dr Cash $10,000
Cr Note Payable $10,000
December 31, 2018:
Dr Interest Expense $750
($10,000 * 10% * 9/12)
Cr Interest Payable $750
March 31, 2019:
Dr Note Payable $10,000
Dr Interest Payable $750
Dr Interest Expense $250
($10,000 * 10% * 3/12)
Cr Cash $11,000

23. Future Value and Present Value Concepts
Many transactions involve paying/receiving money in the future
As a company can earn interest on investments, the general theory is that a dollar today is worth more than a dollar in the future
For example, a company would rather have $100 today than one year from now.
Even if it could just earn 1% interest, taking $100 today an investing it would give the company $101 one year from now.
Conversely, a company would rather pay $100 one year from now than today.
At a 1% interest rate, a company could take $99 today, invest it for a year, and pay the $100 in a year.

24. Future Value of $1 Current amount * Factor = FV
If a first year college student invests $1,000 today, how much will they have when they retire in 50 years? Assume the investment earns a 10% interest rate.

26. Future Value of $1 Current amount * Factor = FV
If a first year college student invests $1,000 today, how much will they have when they retire in 50 years? Assume the investment earns a 10% interest rate.
$1,000 * = $117,390.90
$117, balance
- $1, invested
$116, interest earned

27. Future Value of an Annuity
An annuity is a series of equal payments
Annuity amount * Factor = FV of annuity
If a first year college student invests $1,000 at the end of each of the next 50 years, how much will they have when they retire in 50 years? Assume they can earn a 10% interest rate.

29. Future Value of an Annuity
An annuity is a series of equal payments
Annuity amount * Factor = FV of annuity
If a first year college student invests $1,000 at the end of each of the next 50 years, how much will they have when they retire in 50 years? Assume they can earn a 10% interest rate.
$1,000 * = $1,163,909
$1,163,909 balance
- $50,000 invested ($1,000 per year * 50 years)
$1,113,909 interest earned

30. Present Value of $1 Future amount * Factor = PV
If a couple expects to pay $30,000 to purchase a new car in five years, how much would they need to set aside today? Assume they can earn a 6% interest rate.

32. Present Value of $1 Future amount * Factor = PV
If a couple expects to pay $30,000 to purchase a new car in five years, how much would they need to set aside today? Assume they can earn a 6% interest rate
$30,000 * = $22,417.80
$30, balance
- $22, invested today
$7, interest earned

33. Present Value of an Annuity
Amount of each future annuity payment * Factor = PV of Annuity
If you play (and win) the Powerball, you could either receive $40.6M today or $2.37M per year for the next 30 years ($71.1M total).
If you believe an appropriate interest rate is 3%, which option should you choose?

35. Present Value of an Annuity
Amount of each future annuity payment * Factor = PV of Annuity
If you play (and win) the Powerball, you could either receive $40.6M today or $2.37M per year for the next 30 years ($71.1M total).
If you believe an appropriate interest rate is 3%, which option should you choose?
$2.37M * = $46.45M. Choose the annuity option!
If you believe an appropriate interest rate is 8%, which option should you choose?

37. Present Value of an Annuity
Amount of each future annuity payment * Factor = PV of Annuity
If you play (and win) the Powerball, you could either receive $40.6M today or $2.37M per year for the next 30 years ($71.1M total).
If you believe an appropriate interest rate is 3%, which option should you choose?
$2.37M * = $46.45M. Choose the annuity option!
If you believe an appropriate interest rate is 8%, which option should you choose?
$2.37M * = $26.68M. Choose the cash now option!

38. Thanks for tuning in! Key Takeaways
Liabilities are recorded when it is probable that a company will need to make a payment, or provide goods/services
The future value of a dollar is worth more than a dollar today, and the future value is greater the higher the interest rate
The present value of a future cash flow is less than the amount of that future cash flow, and the present value is lower the higher the interest rate
Thanks for tuning in!