Lecture Slides on Accounting for Current Liabilities | ACC 101, Study notes of Financial Accounting

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ACC101 – CHAPTER 9

Accounting for Current Liabilities

Key Terms and Concepts to Know

Liabilities Definition Past/Present/Future elements

Classification Current Long-term

Uncertainty Amount Payee Payment date

Types of known liabilities

Estimated liabilities

Contingent liabilities

KNOWN LIABILITIES

Known liabilities involve little, if any, uncertainty. Whom to pay, when to pay and how much to pay are definitely determinable. In previous chapters, many of the most common known liabilities have been discussed:

 Accounts Payable  Sales Taxes Payable  Unearned Revenues

Known liabilities include short-term notes payable.

NOTES PAYABLE

Notes Payable are promissory notes given that state a promise to pay a specific dollar amount, usually with interest, within a specified time period. They are the “opposite” of the notes receivable discussed in the chapter on accounts receivable.

With an interest-bearing note, the interest expense is recorded when the note is paid.

 Notes Receivable generate Interest Income  Notes Payable generate Interest Expense

Example # A business issues a 90-day, 10% note for $12,000 to a creditor for an overdue account.

Entry to record issuance of the note

Accounts Payable 12, Notes Payable 12,

Entry to record payment of the note

Interest: 12,000 * .10 * 90/360 = 300

Notes Payable 12, Interest Expense 300 Cash 12,

Discounted Notes – Non-interest bearing notes may be given to a creditor who “discounts them”—deducts his discount (interest) in advance. The interest expense is recorded when the note is issued.

Example # Aztec, Inc. borrowed 21,000 from First National Bank issuing a 120-day non-interest bearing note. The bank discounted the note at 12%.

Entry to record issuance of the note

Discount: 21,000 * .12 * 120/360 = 840 Proceeds: 21,000 - 840 = 20,

Cash 20, Interest Expense 840 Notes Payable 21,

Entry to record payment of the note

Notes Payable 21, Cash 21,

Accrual of Interest – Interest Expense must be accrued on all outstanding Notes Payables at the end of the accounting period to properly match revenues and expenses.

Example # On December 1, issued a 60-day, 8% note for $15,000 on account. Journalize the entry to accrue interest expense on December 31.

There are 30 days left in the period (December 1 through December 31) Interest Expense = 15,000 * .08 * 30/360 = 100

Interest Expense 100 Interest Payable 100

Practice Problem # Journalize the following transactions.

March 15 Purchased merchandise on account from Terrier Co., $33,000, terms n/30. April 14 issued a 30-day, 8% note for $33,000 to Terrier Co. on account May 14 Paid Terrier Co. the amount due on the note of April 14. June 15 Borrowed $90,000 from Midland Bank, issuing a series of ten 12% notes for $9,000 each, coming due at 30-day intervals. July 7 Purchased merchandise by issuing a $72,000, 60-day note to Petco Company, which discounted the note at the rate of 9%.

CONTINGENT LIABILITIES

A contingent liability requires the same three elements to be present as a known liability in order to be recorded: a PAST event must have occurred which results in PRESENT obligation to pay a third party which will be paid at some FUTURE date. The difference between a contingent liability and a known liability is that a contingent liability is a potential liability, uncertain as to whether the future event will occur.

1. Contingent liabilities are recorded when the future event is probable and the amount is known or can be reasonably estimated.
2. Contingent liabilities are disclosed in the footnotes to the financial statements when the future event is probable and the amount is not known or cannot be reasonably estimated or when the future event is possible and the amount is not known or cannot be reasonably estimated.
3. Contingent liabilities are not recorded or disclosed when the future event is unlikely to occur.

SAMPLE MULTIPLE CHOICE QUESTIONS

1. On June 5, Apex Co. issued a $30,000, 8% 120-day note payable to Jones Co. Assume the fiscal of Apex Co. ends June 30. What is the amount of interest expense recognized by Apex in the current year? a. $166. b. $800. c. $333. d. $633.
2. On June 5, Apex Co. issued a $30,000, 8% 120-day note payable to Jones Co. Assume the fiscal year of Jones Co. ends June 30. What is the amount of interest revenue recognized by Jones in the following year? a. $633. b. $400. c. $333. d. $166.
3. Proceeds of $24,250 were received from discounting a $25,000, 90-day, non-interest- bearing note at a bank. The discount rate used by the bank in computing the proceeds was: a. 12% b. 14% c. 6% d. 10%
4. The cost of a product warranty should be included as an expense in the: a. Period the cash is collected for a product sold on account b. Future period when the cost of repairing the product is paid c. Future period when the product is repaired or replaced d. Period of the sale of the product
5. Jergens Co. issued a $17,500, 60-day, non-interest-bearing note to River City Bank. The discount rate is 9%. The cash proceeds to Jergens Co. is: a. $16,975. b. $17,500. c. $17,237. d. $17,762.

The Land Company manufactures motorcycle helmets. The company is the defendant in a lawsuit which it is certain will result in a settlement of $500,000 against the company. Three other lawsuits have been filed with total damages exceeding $1,000,000. The company is concerned about rumors that other lawsuits may be filed in the future.

10. Land should record expense in the amount of: a. $500, b. $1,000, c. $1,500, d. Some other amount
11. Land should disclose: a. One lawsuit with $500,000 of damages b. Three lawsuits with damages exceeding $1,000, c. Four lawsuits with damages exceeding $1,500, d. All lawsuits whether filed or rumored

SOLUTIONS TO PRACTICE PROBLEMS

SOLUTIONS TO MULTIPLE CHOICE QUESTIONS

1. A: 30,000 * .08 * 25/360 = $166.

2. B: 30,000 * .08 * 95/360 = $633.

3. A: 25,000 * X * 90/360 = (25,000 - 24,250)

6,250X = 1,

X = 12%

4. D

5. C: Discount: 17,500 * .09 * 60/360 = 262. Proceeds: 17,500 - 262.50 = 17,237.
6. B
7. D: Interest: 70,000 * .09 * 150/360 = $2,
8. C: Discount: 5,000 * .06 * 90/360 = 75 Proceeds: 5,000 - 75 = 4,
9. D: Interest: 12,000 * .08 * 60/360 = 160 Notes Payable 12, Interest Expense 160 Cash 12,
10. A
11. B