Accounts Payable, Commitments, Contingencies, and Risks

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Accounts Payable, Commitments, Contingencies, and
Risks

• Chapter 8

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Types of Current Liabilities

• Current liabilities are short-term obligations
  that usually must be paid from current assets
  within a year.

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Three Types of Current Liabilities

• Obligations to pay cash to another entity
• Obligations to provide goods or services to
  another entity
• Obligations to honor product warranties

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Accounts Payable

• Accounts payable represent debts that the firm
  incurs in purchasing inventories and supplies, as
  well as amounts that the firm owes for other
  services used in its operations.

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Accounts Payable
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Discounts

• Suppliers often offer discounts to induce early
  payment.

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Discounts

• If a company purchases 5,000 of supplies with
  terms of 2/10, n/30 and intends to pay within the
  discount period, then it generally records the
  purchase at the net price (in this case, 4,900).

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Discounts

• If the company fails to pay within the discount
  period and must remit the full 5,000, then the
  100 discount not taken becomes interest expense.

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Discounts
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Discounts
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Notes Payable

• Notes payable are more formal promises to pay a
  lender.
• They are usually in writing and involve payment
  of interest.

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Notes Payable

• Notes may be interest-bearing.

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Notes Payable

• When a borrower goes to a bank to borrow 50,000,
  he is given the entire 50,000.

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Notes Payable

• At the maturity date, he must repay not only the
  principal of 50,000 but also interest.

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Interest-Bearing Note
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Interest-Bearing Note
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Discounted Note

• Notes may also be discounted.

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Discounted Note

• A firm signs a note, with an interest rate of
  10, promising to repay 50,000 in six months,
  but receives only 47,500.

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Discounted Note

• The bank has deducted the interest (50,000 X .10
  X 6/12) at the time of the borrowing.

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Discounted Note

• Despite the receipt of 47,500, the company must
  repay 50,000 at the maturity date.

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Discounted Note

• At that time the company will recognize interest
  expense of 2,500.

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Discounted Note
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Discounted Note
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Accrued Liabilities

• Accrued liabilities represent expenses that have
  been incurred prior to the balance sheet date
  which have been neither paid nor included with
  liabilities as of the balance sheet date.

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Accrued Liabilities

• An adjustment, increasing both an expense and a
  liability, must be made at the balance sheet date.

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Accrued Liabilities

• For many companies, these accrued liabilities
  include accrued wages and salaries and accrued
  vacation and sick pay.

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Accrued Liabilities
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Accrued Liabilities
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Long-Term Debts

• Long-term debts often have a current portion or
  become current as time goes by.

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Long-Term Debts

• An example of the current portion is a 30-year
  mortgage each mortgage payment consists of both
  principal and interest.

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Long-Term Debts

• On the balance sheet date, the principal
  component of the next 12 payments must be
  classified as a current liability.

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Long-Term Debts

• An example of the become current is a 5-year note
  payable, a long-term liability.

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Long-Term Debts

• Twelve months before the maturity date, the
  entire note must be classified as a current
  liability.

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Accrued Income Taxes

• Accrued income taxes are certainly a current
  liability because they are due within one year
  and generally sooner than that.

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Restructuring Costs

• Restructuring costs occur when a company decides
  to downsize and to refocus its operations.

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Restructuring Costs

• When a firm decides to restructure, the total
  estimated costs of restructuring are expensed in
  the current year.

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Restructuring Costs

• This involves increasing both an expense and a
  liability.

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Accrued Restructuring Costs
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Accrued Restructuring Costs
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Advance Payments from Customers

• A company may also have obligations to provide
  goods or services.

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Advance Payments from Customers

• A magazine publisher is a good example.

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Advance Payments from Customers

• When a person subscribes to take the magazine for
  one year, the company receives the entire year's
  subscription amount in advance.

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Advance Payments from Customers

• The Cash account is increased, as is a liability
  account called Advance Payments from Customers.

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Advance Payments from Customers

• The liability represents the company's obligation
  to provide the subscriber not with money but with
  a magazine each month over the next twelve months.

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Advance Payments from Customers

• As each magazine is sent, the company reduces its
  liability and finally recognizes revenue.

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Advance Payments from Customers
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Advance Payments from Customers
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Advance Payments from Customers
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Obligations for Warranties

• Companies usually stand behind the quality of the
  products they sell and offer to repair defective
  products or to refund the purchase price.

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Obligations for Warranties

• The matching principle dictates that these
  possible costs must be matched with current sales
  revenues.

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Obligations for Warranties

• The future costs must be estimated and recorded
  in the period of the sale.

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Obligations for Warranties

• This will involve an increase in both Warranty
  Expense and Warranty Obligation.

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Obligations for Warranties

• Estimates are derived from the company's past
  experience and from industry averages.

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Obligation for Warranty
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Obligation for Warranty
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Accounts Payable, Commitments, Contingencies, and
Risks

• End of Chapter 8