Financial Accounting Ch 8 PPT PDF

Financial Accounting Fourth Edition Current Liabilities CHAPTER 8 Spiceland Thomas Herrmann Copyright ©2016 McGraw-Hill Education....

Financial Accounting Fourth Edition Current Liabilities CHAPTER 8 Spiceland Thomas Herrmann Copyright ©2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written conse 1 nt of McGraw-Hill Education. Part A CURRENT LIABILITIES Copyright ©2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 2 Current vs. Long-Term Liabilities Current Long-Term Due within one Due in more than year or an operating one year or cycle operating cycle Operating cycle = Time it takes to perform the activities that produce revenues (for example, buy inventory, sell to customers, and collect cash) Copyright ©2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written conse 3 nt of McGraw-Hill Education. Notes Payable Note signed by a firm promising to repay the amount borrowed plus interest Interest on notes is calculated as: Face Annual Fraction Interest = × interest rate × value of the year Copyright ©2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written conse 4 nt of McGraw-Hill Education. Recording Notes Payable Assume Southwest Airlines borrows $100,000 from Bank of America on September 1, 2018, signing a 6%, six- month note. September 1, 2018 Debit Credit Cash …………………………………………. 100,000 Notes Payable …………….......... 100,000 (Issue notes payable) Copyright ©2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written conse 5 nt of McGraw-Hill Education. Recording Interest Payable and Repayment of Notes Payable Year-end adjusting entry for interest payable December 31, 2018 Sept. 1 to Dec. 31 Debit Credit Interest Expense (= $100,000 × 6% × 4/12) … 2,000 Interest Payable ……………........................ 2,000 Repayment of note (Record interest incurred, but not paid) March 1, 2019 Debit Credit Jan. 1 to Mar. 1 Notes Payable (face value)………………..………... 100,000 Interest Expense (= $100,000 × 6% × 2/12) … 1,000 Interest Payable (= $100,000 × 6% × 4/12) …. 2,000 Copyright ©2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written conse nt of McGraw-Hill Education. 6 Key Point We record interest expense in the period in which we incur it, rather than in the period in which we pay it. Copyright ©2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written conse 7 nt of McGraw-Hill Education. Accounts Payable Amounts owed to suppliers of merchandise or services Sometimes called trade accounts payable Copyright ©2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written conse 8 nt of McGraw-Hill Education. Payroll Costs for Employees and Employers Employee Costs Employer Costs Federal and state income Federal and state taxes unemployment taxes Employer matching portion of Employee portion of Social Social Security and Medicare Security Employer contributions for and Medicare health, Employee contributions for dental, disability, and life health, insurance dental, disability, and life Employer contributions to insurance retirement or savings plans Employee investments in retirement or savings plans Copyright ©2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written conse 9 nt of McGraw-Hill Education. Employee Costs Federal and state income taxes FICA taxes  7.65% (6.2% + 1.45%)  Collectively, Social Security and Medicare taxes Employees may have additional amounts withheld from their paychecks for health, dental, disability, and life insurance Employees may also have amounts deducted for retirement or employee savings plans Copyright ©2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written conse 10 nt of McGraw-Hill Education. Employer Costs Additional (matching) FICA tax on behalf of the employee Employers also pay federal and state unemployment taxes on behalf of employees  FUTA and SUTA Fringe benefits: Additional employee benefits paid for by the employer  Health, dental, disability, and life insurance  Contributions to retirement or savings plans Copyright ©2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written conse 11 nt of McGraw-Hill Education. Payroll Example Hawaiian Travel Agency has a total payroll for the month of January of $100,000 for its 20 employees. Details are provided below: Federal and state income tax withheld $24,000 Health insurance premiums (Blue Cross) paid by employer 5,000 Contribution to retirement plan (Fidelity) paid by employer 10,000 Record FICA taxemployee salary and rate (Social Security expense and Medicare) January 7.65% withholdings31 Debit Credit Federal andExpense Salaries state unemployment tax rate …………………...……..….….….…….. 100,000 6.2% Income Tax Payable ……………………………………. 24,000 FICA Tax Payable (= 0.0765 × $100,000) ……… 7,650 Salaries Payable (to balance) ………………………. Copyright ©2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written conse nt of McGraw-Hill Education. 12 Recording Employer-Provided Fringe Benefits Federal and state income tax withheld $24,000 Health insurance premiums (Blue Cross) paid by employer 5,000 Contribution to retirement plan (Fidelity) paid by employer 10,000 Record FICA tax employer-provided fringe benefits rate (Social Security and Medicare) 7.65% January 31 Debit Credit Federal and state unemployment tax rate Salaries Expense (fringe benefits)...….….….… 15,000 6.2% Payable (to Blue Cross)……………5,000 Accounts Accounts Payable (to Fidelity) …………………10,000 (Record employer-provided fringe benefits) Copyright ©2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written conse 13 nt of McGraw-Hill Education. Recording Employer Payroll Taxes Federal and state income tax withheld $24,000 Health insurance premiums (Blue Cross) paid by employer 5,000 Contribution to retirement plan (Fidelity) paid by employer 10,000 FICA tax employer Record rate (Social Security payroll and Medicare) taxes 7.65% January Federal and31state unemployment tax rate Debit Credit Payroll Tax Expense (total)...….….….…………………….. 6.2% 13,850 FICA Tax Payable (= 0.0765 × $100,000) ……………. 7,650 Unemployment Tax Payable (= 0.062 × $100,000) 6,200 (Record employer payroll taxes) Copyright ©2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written conse 14 nt of McGraw-Hill Education. Other Current Liabilities Deferred revenues: liability account used to record cash received in advance of the sale or service Sales tax payable: sales taxes collected from customers by the seller Current portion of long-term debt: debt that will be paid within the next year Copyright ©2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written conse 15 nt of McGraw-Hill Education. Example Deferred Revenues When a company receives cash in advance, it debits Cash and credits Deferred Revenue, a current liability account Assume Apple sells iTunes gift cards Debit to a Credit customer Cash for $100 ………………………………………………….. 100 Deferred Revenue ……………………… 100 (Receive cash for gift card) When it earns the revenue, the company debits Deferred Revenue and credits Sales Revenue Suppose the customer downloads $15 worth of music Debit Credit Deferred Revenue ……………………………… 15 Sales Revenue …………………………….. 15 (Record revenue for music downloaded) Copyright ©2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written conse 16 nt of McGraw-Hill Education. Example Sales Tax Payable In some states, companies are required to collect sales tax when selling goods or services and then remitting those back to the state or local government The collection of cash from the customer creates a liability for the company Assume you buy lunch in the airport for $15 plus 10% sales tax. The airport restaurant records the journal entry as shown. Debit Credit Cash …………………………………………. …….. 16.50 Sales Revenue ……………………. …….. 15.00 Sales Tax Payable (= $15 × 10%)… Copyright ©2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written 17 consent of McGraw-Hill Education. Current Portion of Long-Term Debt Debt that will be paid within the next year For example, a 20-year mortgage is split and reported as the portions that are due: 1. Within the next year (current liability) 2. After the next year (long-term liability) Long-term obligations are reclassified and reported as current liabilities when they become payable within the upcoming year For example, a note payable that matures in 10 years is reported as a long-term liability for the first 9 years, but as a current liability in the tenth year Copyright ©2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written conse 18 nt of McGraw-Hill Education. Part B CONTINGENCIES Copyright ©2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written conse 19 nt of McGraw-Hill Education. Contingent Liabilities An existing uncertain situation that might result in a loss depending on the outcome of a future event Copyright ©2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written conse 20 nt of McGraw-Hill Education. Criteria for Reporting a Contingent Liability 1. The likelihood of payment is a. Probable—likely to occur; b. Reasonably possible—more than remote but less than probable; or c. Remote—the chance is slight. 2. The amount of payment is a. Reasonably estimable; or b. Not reasonably estimable. A contingent liability is recorded only if: 1. The loss is probable and, 2. The amount is reasonably estimable Copyright ©2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written conse 21 nt of McGraw-Hill Education.  Accounting Treatment of Contingent Liabilities Amount of payment is: Likelihood of Reasonably Not Reasonably payment is: Estimable Estimable Probable Liability recorded Disclosure c ord required required Reasonably possibleDisclosure Disclosure re Remote required not required Disclosure Disclosure not required December 31 Debit Credit Loss………………………………….…………………………. Estimate Contingent Liability …………….................... Estimate (Record a contingent liability) Copyright ©2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written conse 22 nt of McGraw-Hill Education. Accounting for Warranties Assume warranty costs are estimated to be 3% of sales. December sales are $1.5 million and customers make warranty claims of $12,000 in January of the following year. $1.5 December 31 M× Debit 3% = Credit Warranty Expense……………….…………………... 45,000 Warranty Liability …………….................... 45,000 (Record liability for warranties) January 31 Debit Credit Warranty Liability……………….………………… 12,000 Cash ……………...................................... 12,000 Warranty (Record actual warranty expenditures) Liability 45,000 Estimated Actual 12,000 expense payment 33,00 0 Final balance Copyright ©2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written conse 23 nt of McGraw-Hill Education. Contingent Gains An existing uncertain situation that might result in a gain In a lawsuit, the defendant faces a contingent liability, while the other side— the plaintiff—has a contingent gain Contingent gains are not recorded until the gain is certain  Nice example of conservatism  Unlike contingent liabilities, contingent gains are not recorded until the gain is certain and no longer a contingency. Copyright ©2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written conse 24 nt of McGraw-Hill Education. Liquidity Analysis Liquidity: refers to having sufficient cash or other current assets to pay currently maturing debts Lack of liquidity can result in financial difficulties or even bankruptcy Three liquidity measures:  Working capital  Current ratio  Acid-test ratio Copyright ©2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written conse 25 nt of McGraw-Hill Education. Working Capital Working Current assets − Current capital Measure liabilities = of current assets remaining after paying current liabilities A large positive working capital is an indicator of liquidity Not the best measure of liquidity for comparing across companies, because the ratio does not control for the relative size of each company Copyright ©2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written conse 26 nt of McGraw-Hill Education. Current Ratio Current Current Ratio assets = The amount of current Current assets available for liabilities every $1 of current liabilities The higher the current ratio, the greater the company’s liquidity A current ratio of, say, 1.5 indicates that for every dollar of current liabilities, the company has $1.50 of current assets As a general rule, a higher current ratio is better. Copyright ©2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written conse 27 nt of McGraw-Hill Education. Acid-Test Ratio Cash + Current investments + Accounts receivable Acid-test Current liabilities ratio = The amount of “quick assets” available for every $1 of current liabilities Quick assets are current assets more readily convertible to cash  Exclude current assets such as inventory and prepaid rent By excluding less liquid current assets, the acid-test ratio may provide a better overall indication of a company’s liquidity 28 Copyright ©2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written conse nt of McGraw-Hill Education. End of Chapter 8 Copyright ©2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written conse 29 nt of McGraw-Hill Education.