Financial Accounting - Current Liabilities

Financial Accounting - Current Liabilities

• Current Liabilities: Obligations a company expects to pay within one year or an operating cycle. The operating cycle is the time it takes to produce revenues (e.g., buy inventory, sell to customers, collect cash).
• Notes Payable: A firm promises to repay a borrowed amount plus interest. Interest is calculated as: Face value × Annual interest rate × Fraction of the year

Recording Notes Payable

• Example: Southwest Airlines borrows $100,000 on September 1, 2018, for six months at 6%. Debit Cash $100,000, Credit Notes Payable $100,000 (to record note payable).

Recording Interest Payable

• Adjusting entry for interest payable (e.g., from September 1 to December 31 in 2018). Debit Interest Expense, Credit Interest Payable. Interest expense is calculated as the amount borrowed multiplied by the interest rate by the fraction of the year: $100,000 × 6% × 4/12).

Recording Repayment of Notes Payable

• Example: On March 1, 2019, the $100,000 note is repaid. Debit Notes Payable $100,000, Interest Expense $1,000, Credit Cash $101,000.

Accounts Payable

• Amounts owed to suppliers for merchandise or services. Often called trade accounts payable.

Payroll Costs for Employees and Employers

• Employee Costs: Federal and state income taxes, Employee portion of Social Security and Medicare, Employee contributions for health, dental, disability, and life insurance, Employee investments in retirement or savings plans.
• Employer Costs: Federal and state unemployment taxes, Employer matching portion of Social Security and Medicare, Employer contributions for health, dental, disability, and life insurance, Employer contributions to retirement or savings plans.

Payroll Example

• Using Hawaiian Travel Agency example: total payroll $100,000, federal/state income tax withheld $24,000, health insurance $5,000, Fidelity contribution $10,000, debit "Salaries Expense" $100,000, credit "Income Tax Payable" $24,000, credit "FICA Tax Payable" $7,650

Recording Employer-Provided Fringe Benefits

• Journal entries for employer-provided fringe benefits (e.g., January 31). Debit "Salaries Expense", Credit "Accounts Payable (to Blue Cross)" $5,000 and Credit "Accounts Payable (to Fidelity)" $10,000

Recording Employer Payroll Taxes

• Example journal entries (January 31) for payroll taxes; debit Payroll Tax Expense, credit FICA Tax Payable, credit Unemployment Tax Payable

Other Current Liabilities

• Deferred Revenues: Liability used to record cash received in advance of a sale or service.
• Sales Tax Payable: Sales taxes collected from customers for the seller.
• Current Portion of Long-Term Debt: Portion of long-term debt that will be paid within the next year

Example Deferred Revenues

• Example: When a company receives cash for a gift card before delivering.
  • Debit Cash, Credit Deferred Revenue
  • When the company delivers the service/sells the goods, Debit Deferred Revenue, Credit Sales Revenue

Example Sales Tax Payable

• Assume $15 lunch with 10% tax.
  • Debit Cash $16.50, Credit Sales Revenue $15, Credit Sales Tax Payable $1.50

Current Portion of Long-Term Debt

• Debt expected to be paid within the next year. A 20-year mortgage payment is split into current and non-current portions.

Contingencies

• An existing uncertain situation that might result in a loss depending on the outcome of a future event

Criteria for Reporting a Contingent Liability

• Likelihood of payment (probable, reasonably possible, remote)
• Amount of payment - must be reasonably estimable

Accounting Treatment of Contingent Liabilities

• Contingent liability recorded (if loss is probable and reasonably estimable) or not (if not probable and/or not reasonably estimable)
  • Example: If a December 31 estimate of loss was probable and reasonably estimable, record the estimate as a contingent liability for the year.

Accounting for Warranties

• Warranty expense is estimated as a percentage of sales (e.g., 3% of $1.5 million in sales=$45,000). If a warranty claim occurs in the next period (e.g., $12,000), the warranty liability is reduced.

Contingent Gains

• Situation where there's uncertainty about a gain, not recorded until the gain is certain.
• Example example: if a company wins a lawsuit, the gain is recorded when the outcome is certain.

Liquidity Analysis

• Liquidity: Sufficient cash or current assets to settle current debts.
• Lack of liquidity can cause financial problems.
• Measures of liquidity: Working Capital, Current Ratio, Acid-Test ratio

Working Capital

• Current assets less current liabilities.
• Large positive working capital indicates better liquidity.
• Not the best measure for comparing across companies

Current Ratio

• Current assets ÷ Current liabilities
• Higher ratio indicates greater liquidity

Acid-Test Ratio

• (Cash + current investments + accounts receivable) ÷ current liabilities.
• Excludes inventory and prepaid rent, better measure of short-term liquidity than current ratio.

Test your understanding of current liabilities, including notes payable and interest payable. This quiz covers the recording of obligations and the calculation of interest in financial accounting. Refresh your knowledge and solidify your grasp on these essential concepts.