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Slide 10-1
LIABILITIESChapter
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.
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Slide 10-2
I.O.U.
Defined as debts or obligations arising from past transactions or
events.
Defined as debts or obligations arising from past transactions or
events.
Maturity = 1 year or less Maturity > 1 year
Current Liabilities
Noncurrent Liabilities
The Nature of LiabilitiesThe Nature of Liabilities
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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
DEBTDEBT EQUITYEQUITY
Distinction BetweenDebt and Equity
Distinction BetweenDebt and Equity
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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 – QuestionLiabilities – Question
The obligation will not be paid within one year or one operating
cycle, so it is a noncurrent liability.
The obligation will not be paid within one year or one operating
cycle, so it is a noncurrent liability.
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Slide 10-5
Current Ratio = Current Assets ÷ Current LiabilitiesCurrent Ratio = Current Assets ÷ Current Liabilities
Working Capital = Current Assets - Current LiabilitiesWorking 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 LiquidityEvaluating Liquidity
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Slide 10-6
Devon Mfg. has current liabilities of $230,000 and current assets of $322,000.
What is Devon’s current ratio?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?What is Devon’s current ratio?
Liabilities – QuestionLiabilities – Question
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Slide 10-7
Short-term obligations to suppliers for purchases of merchandise and to others for goods and services.
Short-term obligations to suppliers for purchases of merchandise and to others for goods and services.
Merchandise inventory invoices
Merchandise inventory invoices
Shipping charges
Shipping charges
Utility and phone bills
Utility and phone bills
Office supplies invoices
Office supplies invoices
Accounts PayableAccounts Payable
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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 PayableNotes Payable
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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, Fl Nov. 1, 2003
Six months Porter Company
John Caldwell
Security National Bank
$10,000.00
12.0%
treasurer
Notes PayableNotes Payable
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Slide 10-10
On November 1, 2003, Porter Company would make the following entry.
Notes PayableNotes Payable
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Slide 10-11
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 PayableInterest Payable
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Slide 10-12
The interest formula includes three variables that must be considered when computing
interest:
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.
When computing interest for one year, “Time” equals 1. When the computation period is less
than one year, then “Time” is a fraction.
Interest PayableInterest Payable
For example, if we needed to compute interest for 3 months, “Time” would be 3/12.
For example, if we needed to compute interest for 3 months, “Time” would be 3/12.
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Slide 10-13
What entry would Porter Company make on December 31, the fiscal year-end?
What entry would Porter Company make on December 31, the fiscal year-end?
Interest Payable – ExampleInterest Payable – Example
$10,00012% 2/12 = $200$10,00012% 2/12 = $200
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Slide 10-14
Net Pay
Payroll LiabilitiesPayroll Liabilities
NISNHT
Ed TaxesPAYE Tax Voluntary
Deductions
Gross Pay
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Slide 10-15
Deferred revenue is recorded.
a liability account.a liability account.
Cash is received
in advance.
Cash is sometimes collected from the customer before the revenue is
actually earned.
Cash is sometimes collected from the customer before the revenue is
actually earned.
Unearned RevenueUnearned Revenue
Earned revenue is recorded.
As the earnings process is
completed . .
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Slide 10-16
Relatively small debt needs can be filled from
single sources.
Relatively small debt needs can be filled from
single sources.
BanksInsurance
CompaniesPension
Plans
oror oror
Long-Term DebtLong-Term Debt
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Slide 10-17
Large debt needs are often filled by issuing bonds.
Large debt needs are often filled by issuing bonds.
Long-Term DebtLong-Term Debt
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Slide 10-18
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.
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.
Bonds PayableBonds Payable
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Slide 10-19
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 Interest = Principal × Stated Rate × Time
Bonds PayableBonds Payable
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Slide 10-20
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 PayableBonds Payable
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Slide 10-21
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 PayableAccounting for Bonds Payable
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Slide 10-22
Record the interest paymenton July 1, 2003.
Record the interest paymenton July 1, 2003.
Accounting for Bonds PayableAccounting for Bonds Payable
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Slide 10-23
Other types of liabilities (1)Other types of liabilities (1)
Capital Lease/Finance LeasePensions/Other postretirement benefitsDeferred Income Taxes
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Slide 10-24
Other liabilities (2)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
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Slide 10-25
Other liabilities (3)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
DiscloseDisclose in notes unless payment is remote
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Slide 10-26 Scenario 1 –
What should company Y do?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.
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Slide 10-27
Scenario 2 – What should company B do?
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.
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Slide 10-28
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 LeverageFinancial Leverage
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Slide 10-29
Are we having fun
yet?
End of Chapter 10End of Chapter 10
