PRINCIPLES

of

ACCOUNTING II

(AC202)

___________

CHAPTER 12

CURRENT

AND

LONG-TERM LIABILITIES

LIABILITIES

DEFINED:

A probable future payment of assets or services a company is presently obligated to make as a result of past transactions or events.

Fundamentally liabilities are measured by the "cost principle" however:

Liabilities are comprised of known obligations of a definite amount and known obligations of an estimated amount (i.e. warranties)

CURRENT LIABILITIES:

Obligations expected to be paid using current assets or by creating other current liabilities

LONG-TERM LIABILITIES:

Obligations not expected to be paid within one year. Includes long-term notes payable; mortgages payable; warranty liabilities; lease liabilities; and bonds payable.

MEASUREMENT OF LIABILITIES

Conceptually, the dollar amount of a liability, at any point in time, is the "present value" of the future outlays of assets required to pay the debt in full.

i.e. the present value of principal plus all future interest payments

The present value amount may be called the "current cash equivalent amount"

-What both parties would settle for today!

A liability that requires the "going rate of interest" will always have a present value equal to its maturity amount (i.e. interest bearing notes)

When the required rate of interest is different from the going rate, or interest is unspecified, the present value will be different from the maturity amount. (i.e. bonds sold at a premium or discount)

As such liabilities approach maturity, the current cash equivalent amount approaches the maturity amount

CURRENT LIABILITIES

Accounts Payable

Short-term Notes Payable

Unearned (deferred) Revenues

Payroll Liabilities

-Employee Payroll Deductions

-Employer Payroll Taxes

Warranty Liabilities

Employee Health/Pension Benefits Payable

Vacation Pay (employee benefits)

Tax Liabilities for Businesses

(Federal Income Tax - Corporation only; State and/or local income taxes - Corporation only; property taxes; sales taxes; etc.)

Deferred Income Taxes for Corporations

Contingent Liabilities

-Legal Claims (Potential)

-Debt Guarantees

-Other Contingencies

INTEREST & NON-INTEREST NOTES

Interest Bearing Notes:

Specifies:

-A stated rate of interest

-Interest is to be paid at maturity in addition to the face or principal amount of the note.

Non-Interest Bearing Notes:

Does not specify a rate of interest

Includes the interest in the face amount of the note

An overdue non-interest bearing note immediately draws interest at a legal rate (usually specified by law) from the due date.

EXAMPLE:

The business needs to borrow $2,000 cash from the bank for 60 days on December 16, 1999

a. interest bearing note, 6%

b. non-interest bearing note, $2,040

UNEARNED REVENUES

Arise from revenues that have been collected in advance during the current period but will not be earned until a later accounting period.

-Also called;

Deferred Revenue,

Revenue collected in Advance, or Precollected Revenue

Unearned Revenues constitute a liability since cash has been collected but the goods or services have not been provided (i.e. the revenue has not been earned)

-There is a "present obligation" to render, in the future, the product or services.

EXAMPLE: Textbook, page 499

PAYROLL LIABILITIES

Recording Employee salary expense and amounts withheld.

-Textbook, page 507

Recording Employer Payroll taxes

-Textbook, page 508

Payroll Reports, Records and Procedures

-Appendix 12A, page 523

Payroll reports are filed within one month after the end of each calendar quarter

Payments:

-Less than $500, pay with report

-Most companies are required to pay monthly or semiweekly

-If taxes are over $100,000 they must be paid at the end of the next business day

Employers are required to provide employees with a W-2 before January 31 of the following year

Companies with many employees often use a special "payroll bank account" to pay employees.

CONTINGENT LIABILITIES

A contingent liability is not a legal or effective debt -- rather it is a potential future liability

It is a potential liability that has arisen as a result of an event that "already has occurred" but its conversion to an effective liability is dependent upon the occurrence of one or more "future events"

REPORTING:

-A contingent liability is not recorded in the accounting records unless there is a high probability of loss.

-They are generally reported in a footnote(s) to the financial statements

An example is a pending lawsuit. Before recording in the financial records work with the legal representation to insure proper recording

CURRENT LIABILITIES

Working Capital:

The difference between total current assets and total current liabilities

Current Ratio or

Workinng Capital Ratio:

______Current Assets_____

Current Liabilities

Example: The balance sheet for ABC Company, December 31, 2000, reported total current assets of $900,000 and total current liabilities of $300,000.

Working Capital:

$900,000 - $300,000 = $600,000

Current Ratio:

$ 900,000__

300,000 = 3.00 or 3 to 1

LONG-TERM LIABILITIES

Includes ALL obligations of the entity not properly classified as current liabilities.

Generally arise from the purchase of fixed assets or borrowing on large sums of money

-Long-term Notes Payable

-Bonds Payable

-Mortgages Payable

Frequently, a long term liability is supported by a mortgage on specified assets of the borrower which are "pledged" as security for the liability.

Secured debt -- a liability (i.e. Mortgage Payable) supported by a building/land

Unsecured debt -- Creditor relies on the integrity and general earning power of the borrower

As a long-term debt approaches the maturity date, the portion of it that is to be paid in the next current period is reclassified as a current liability

Notes Payable

Defined:

A written promise to pay a stated sum at one or more specified dates in the future

Notes Payable require the payment of interest and the recording of interest expense.

Interest expense is incurred on liabilities because of the "time value of money"

In calculating interest we must consider

-Principal

-Interest rate

-Duration of time

Interest formula is:

Interest = Principal x Rate x Time

The accounting for a note payable is the same whether it is classified as a current or as a long-term liability. Balance sheet presentation is different.

Word Count: 968