1. Current Liabilities and the Fair Value of Accounting
Chapter 8
Current Liabilities and the Fair Value of Accounting

2. Managing Liquidity and Cash Flows
Current liabilities arise to support the operating cycle or to raise cash during periods of inventory build up
Companies must be able to pay debts
Measurements like working capital and the current ratio depend on current liabilities
The amount of time suppliers give a company to pay for purchases is also a factor in managing cash flow and liquidity
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3. Payables Turnover
Number of times, on average, that a company pays its accounts payables in an accounting period
Payables Turnover =
Cost of Goods Sold + Change in Merchandise Inventory
Average Accounts Payable
Microsoft’s 2007 Payables Turnover =
$10,693 + $351
($3, $2,909) ÷ 2
= times
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4. Payables Turnover for Selected Industries
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5. How long, on average, a company takes to pay its accounts payables
Days’ Payable
example SE2, hwk E 4
How long, on average, a company takes to pay its accounts payables
Days’ Payable =
Payables Turnover
365 days
Microsoft’s
Days’ Payable =
365 days
3.4
= days
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6. Days’ Payable for Selected Industries
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7. Recognition of Liabilities
Timing is important when recognizing liabilities
Failure to record a liability often means that an expense has also not been recorded
Transaction obligates company to make future payments
Accrue liabilities like salaries or interest payable
Estimate and accrue liabilities like taxes payable
Agreements for future transactions do not have to be recognized
When an obligation occurs, a liability should be recorded.
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8. Valuation of Liabilities
Balance Sheet
Liabilities
Valued at the amount needed to pay off the debt, or at the fair market value of the goods or services to be delivered
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9. Classification and Disclosure
Current Liabilities
Companies may be required to include additional explanation of liability accounts in the notes to the financial statements
Debts and obligations that a company expects to satisfy within one year or within its normal operating cycle, whichever is longer
Maturity dates, interest rates, special credit agreements
Long-Term Liabilities
Due beyond one year or beyond the normal operating cycle
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10. Common Types of Current Liabilities
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11. Definitely Determinable Liabilities
Current liabilities that are set by contract or statute and that can be measured exactly
Accounts Payable
Bank loans and commercial paper
Notes payable
Accrued liabilities
Dividends payable
Sales and excise taxes payable
Current portion of long-term debt
Payroll liabilities
Unearned revenues
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12. Individual accounts for each person or business to which money is owed
Accounts Payable
Short-term obligations to suppliers for goods and services
Also called trade accounts payable
Amount in Accounts Payable account is generally supported by an accounts payable (A/P) subsidiary ledger
A/P Subsidiary Ledger
Individual accounts for each person or business to which money is owed
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13. Bank Loans
Companies often borrow funds when they are needed using a line of credit
Company signs a note for the full amount of a line of credit
Company may use all or only some of funds
Interest rate may change daily
Bank may require firm to meet certain financial goals to retain its line of credit
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14. Commercial Paper
categories and terms example SE3, hwk P1
Short-term unsecured loans available to firms with excellent credit ratings
On the Balance Sheet:
Current Liabilities: The line of credit currently borrowed and the amount of commercial paper issued are usually combined with notes payable in the current liabilities section of the balance sheet
Usually issued to the public through professionally managed investment firms
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15. Short-Term Notes Payable
Obligations represented by promissory notes
Used to:
Secure bank loans
Pay suppliers
Obtain more credit
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16. Recording Notes Payable
example SE4, hwk E5
Issuance of 60-day, 12 percent promissory note on August 31
Payment of note
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17. Accrued Liabilities
Adjusting entries recognize liabilities that are not already in the accounting records
Example:
A $10,000, 60-day, 12% promissory note is issued on August 31. The fiscal year ends on September 30. The interest to be accrued is calculated as follows:
$10,000 x x 30/365 = $98.63
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18. Dividends Payable
Cash dividends are a distribution of earnings to a corporation’s stockholders
A corporation’s board of directors has the sole authority to declare dividends
A corporation has no liability for dividends until the date of declaration
During the time between the date of declaration and the date of payment, the dividends declared are considered current liabilities
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19. Sales and Excise Taxes Payable
Sales taxes are often levied on retail transactions
Excise taxes are imposed on certain goods like gasoline
Merchants collect the sales taxes from customers and pay them over to the appropriate taxing authority
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20. Current Portion of Long-Term Debt
If a portion of long-term debt is due within the next year and is to be paid from current assets, that portion is classified as a current liability.
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21. Payroll Liabilities Payroll liabilities include: Cost of labor
Salaries & Wages
Payroll taxes
FICA, Medicare, FUTA, and SUTA
Employers are responsible to various government agencies and other entities for amounts withheld
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22. Payroll Costs
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23. Recording Payroll
example SE5 , hwk E7
Feb. 15: Record payroll, total employee wages, $65,000
Note that employees earned $65,00 but their take home pay was only $42,428
Feb. 15: Record payroll taxes and benefit costs
Payroll taxes and benefits increase the total cost of payroll to $83,802
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24. Unearned Revenues
Obligations for goods or services that the company must provide or deliver in a future accounting period in return for an advance payment from a customer
Deposits received in advance, gift certificates, and subscriptions are all current liabilities
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25. Recording Unearned Revenues
Received advanced one year subscription totaling $3,600
Microsoft now has a liability that will be reduced gradually as monthly services are provided
Monthly Service Performed
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26. Estimated Liabilities
Definite obligations whose exact dollar amount cannot be known until a later date
Estimate and record these types of liabilities
Income taxes
Property taxes
Promotional costs
Product warranties
Vacation pay
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27. Income Taxes Payable
A corporation’s income is taxed by the federal government and most state governments
The amount of tax is not known until the end of the year, but should be accrued in an adjusting entry
Sole proprietorships and partnerships do not pay income taxes; their owners pay on their individual tax returns
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28. Property Tax Payable
Property taxes are levied on real and personal property
The fiscal years of local governments and of businesses rarely correspond
Companies must estimate the amount of property tax applicable to each month of the year
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29. Product Warranty Liabilities
When a firm sells a product or service with a warranty, it has a liability for the length of the warranty
Illustration:
Midas Muffler guarantees that it will replace free of charge any muffler it sells that fails during the time the buyer owns the car. In the past, 6 percent of mufflers sold have been returned for replacement. The average cost for a muffler is $50. If the company sold 700 mufflers during July, what is the amount of liability to be accrued?
700 X = 42 x $50 = $2,100
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30. Recording Product Warranty Liabilities
example SE6, hwk E8
Record warranty expense:
Record replacement of a defective muffler, which cost $60, and receipt of $30 service fee to have it replaced:
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31. Vacation Pay Liability
Vacation pay is often accrued as employees work during the year
The cost should be allocated over the entire year so that month-to-month costs will not be distorted (applies to bonus plans and pension plan contributions as well)
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32. Vacation Pay Liability: Illustrated
April 20: Employees earn two weeks paid vacation for every 50 weeks worked, and it is assumed only 75 percent of employees will ultimately collect vacation pay. The weekly payroll is $42,000, of which $2,000 is paid to employees on vacation. How is estimated vacation pay liability recorded?
The computation of vacation pay expense is based on the payroll of employees not on vacation
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33. Contingent Liabilities
Potential liabilities that depend on future events arising out of past transactions
Past Transaction: Building of a bridge
Future Event: Outcome of a lawsuit
Conditions for determining when a contingency should be entered in the accounting records:
The liability must be probable
The liability can be reasonably estimated
(Vacation pay, income taxes, and warranty liability)
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34. Commitments
Legal obligations that do not meet the technical requirements for recognition as a liability and so are not recorded
Examples include purchase agreements and leases
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35. Valuation Approaches to Fair Value Accounting
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36. Does Time Affect Money? Time Value of Money
Effects of the passage of time on
holding or not holding money
Interest
Measures these effects for a given period of time
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37. Interest Simple Interest Compound Interest
return on principal for one or more periods
principal sum stays the same from period to period
return on principal for two or more periods
computed by adding the interest earned in one period to the amount on which interest is computed in future periods
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38. Simple Interest Illustrated
Willy Wang accepts an 8 percent, $15,000 note due in 90 days. What total amount will Sanchez receive?
The total that Sanchez will receive is $15,
($15, principal + $ interest)
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39. Compound Interest Illustrated
Terry Soma deposits $10,000 in an account that pays 6 percent interest. She expects to leave the principal and accumulated interest in the account for three years. Interest is paid at the end of each year. What total amount will be in the account at the end of three years?
Soma will have $11, at the end of three years.
Note that the annual amount of interest increases each year by the interest rate times the interest of the previous year.
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40. Present Value Way of valuing future cash flows
Amount that must be invested today at a given rate to produce a given future value
Present value and future value are closely related
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41. Present Value It depends upon... the amount of the future receipt.
the length of time to the future receipt.
interest rate for the period.

42. The present value (PV) is the PRESENT VALUE
amount that would have to be invested now to accumulate to some specified future amount.
Present Value = Future Value * Factor
The process of computing present value is called discounting.

43. CALCULATING PRESENT VALUE
The present value of a single sum can be computed using The Present Value of $1 table
Find the factor in the table that corresponds with the number of interest periods and the interest rate.
Multiply that factor by the future value.

45. Present Value of a Single Sum Due in the Future
Ron More wants to have $8,000 at the end of three years. How much must he invest today in a 5 percent savings account to achieve this goal?
Year 3
Future value $8,000
Year 2
Year 1
Present value $6,910
Using tables (Table 1), the calculation is:
Future Value × Factor = Present Value
$8, × = $6,910
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46. Present Value of an Annuity
An annuity is a stream of payments of equal amounts at equal time intervals.
The Present Value of an Annuity:
PVa = Payment (pmt) * Factor (f)

47. Present Value of an Annuity
The present value of an annuity is determined by using the factors in the Present Value of an Annuity table.
To compute the present value of an annuity, find the factor in the table that corresponds with the number of periods and the interest rate.
Multiply that factor by the amount of the periodic payment (receipt).

49. Present Value of an Ordinary Annuity
Example SE7-8, hwk E13
Vickie Long sold a piece of property and is to receive $18,000 in three equal payments of $6,000 beginning one year from today. What is the present value of this sale if the current interest rate is 5 percent?
Year 3
$6,000
Year 2
Year 1
Present value $16,338
Using the table factor (Table 2), the calculation is:
Periodic payment × Factor = Present Value
$6, × = $16,338
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50. Time Periods When using tables, the left-hand column refers to periods
Interest can, of course, be paid on a quarterly or semiannual basis
To use the tables in these cases, it is necessary to (1) divide the annual interest rate by the number of periods in the year, and (2) multiply the number of periods in one year by the number of years
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51. Applications Using Present Values
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52. How Is the Time Value of Money Used in Accounting?
Valuing an asset
Differed payment
Investment of idle cash
Accumulation of a fund for loan repayment
Other applications
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53. Valuing an Asset
An asset is something that will provide future benefits to the company that owns it
The purchase price of an asset represents the present value of these future benefits
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The proposed purchase price can be evaluated by comparing it with the present value of the asset to the company
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54. Evaluating the Proposed Purchase Price of an Asset
Mike Yeboah is thinking about buying a new machine that will reduce his annual labor cost by $1,400 per year. The machine will last for 8 years. The interest rate used for management decisions is 10 percent. What is the maximum amount Yeboah should pay for the machine?
The present value of the machine is equal to the present value of an ordinary annuity of $1,400 per year for 8 years at compound interest of 10 percent
Example SE9, hwk E14
Using Table 2, the factor for 10 percent and 8 periods is 5.335
Yeboah should not pay more than $7, for the new machine.
This amount equals the present value of the benefits that he will receive from owning the machine.
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55. Determining the Sales Price When Payment Is Deferred
Field Helpers Corporation sells a tractor to Sasha Ptak for $100,000 on February 1, agreeing to take payment ten months later on December 1. The prevailing annual interest rate is 12 percent. What is the actual price of the tractor?
The actual price of the tractor is equal to the present value of the future payment
Using Table 1, the factor for 1 percent and 10 periods is .905
12% annual rate ÷ 12 months per year = 1 percent per month
12 months per year x 10/12 of a year = 10 months
The sale price of the tractor is $90,500
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56. Recording Deferred Sales
The transaction is recorded in both the seller’s and purchaser’s books at the present value, $90,500.
Ptak’s Journal (Purchaser)
Helpers’ Journal (Seller)
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57. Recording Deferred Sales
When Ptak pays for the tractor, the entries are as follows:
Ptak’s Journal (Purchaser)
Helpers’ Journal (Seller)
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