Chapter 9 Liabilities
Liabilities Defined and Classified
💡Liabilities: the probable future sacrifice of economic benefits that
arise from
past transactions
Maturity Category
≤1 year Current Liabilities
>1 year Long Term Liabilities
≤1 year but part of the >1 year
Current Portion of Long Term
balance (e.g. interest on a LT
Liabilities
note)
Liabilities are recorded at current cash equivalent
o Cash amount a creditor would accept to settle the liability
immediately
Current Liabilities
Many have a direct relationship to the operating activities of a
business
Operating Activity Current Liability
Purchase inventory Accounts payable
Current portion of operating lease
Rent space for stores
liability
Employees earn wages Accrued payroll and benefits
Customers pay in advance for Stored value card liability and current
future purchases portion of deferred revenue
Types of Current Liabilities
Account Name Also Called Definition
Obligations to pay for
goods and services
Trade Accounts
Accounts Payable used in the basic
Payable
operating activities of
the business
Obligations related to
expenses that have
Accrued Liabilities Accrued Expenses been incurred but not
paid at the end of the
accounting period
Obligations arising
when cash is received
Deferred Revenues Unearned Revenues
prior to the related
revenue being earned
Obligations supported
Notes Payable N/P by a formal written
contract (note)
Notes Payable
💡A note payable is a formal written contract that specifies:
Amount borrowed
Repayment date
Annual interest rate associated with the borrowing
For the lender, interest is a revenue
For the borrower, interest is an expense
Principal × Annual Interest Rate × Number of Months / 12 Months
= Interest for the Period
Debi Credi
Date Account
t t
Dec Interest 7
31 Expense 250
Interest 7
Payable 250
Current Portion of Long Term Debt
Providing accurate information on what proportion of a long term
debt is due in the next year:
Company should reclassify long term debt as a current liability
Long term debt: $14 659.6m
o Current portion: $1 249.9m
Total debt: $15 909.5m
Estimated Liabilities
💡Estimated Liability: a known obligation of an uncertain amount, but
one that
can be reasonably estimated
E.g. warranty payable
Warranty Payable
Starbucks sells coffee brewing equipment to customers with 1-year
warranty from the date of sales.
It estimates that it will have to provide $150,000 of warranty
services to customers who purchased the equipment this year.
Debit Warranty Expense
Credit Warranty Payable
i.e. Over time, customers return defective equipment
Debit Warranty Payable
Credit Cash
💡Cash is paid to repair the equipment or provide a cash refund to the
customer
💡It is OK for the Warranty Payable balance to be debit (because the
estimation was
wrong) (same as bad debt expense)
Warranty 500
a
Expense 000
Warranty 500
Payable 000
Warranty 400
b
payable 000
Cash 400
000
Contingent Liabilities
💡Contingent Liability: Potential liability has arisen because of a past
event
Obligation depends on whether some future event occurs
e.g. Lawsuits a company is facing (if guilty, obligated, if not, not
obligated)
Probability of Occurrence
Reasonably
Probable Remote
Possible
Amount CAN be Record as Disclose in Disclosure
reasonably estimated? liability footnotes not required
Amount CANNOT be Disclose in Disclose in Disclosure
reasonably estimated? footnotes footnotes not required
Probable Reasonably Possible Remote
Chance is higher than Chance of
Future event or events
remote but less than occurrence
are likely to occur
probably is slight
International Perspective
GAAP: Probable: > 70%
o Likely to occur
IFRS: Probable: > 50%
o More likely than not to occur
Present Value
Value of money can grow over time because money can earn
interest
Compound interest
💡Present Value: The value of the investment at the present moment, in
relation to
its future value
Present Value of a Single Amount
Compound interest
Present Value of an Annuity
Consecutive equal payments with a consecutive period
e.g. $100 payments annually for 10 years
Use annuity table instead
Long Term Liabilities
💡Long-Term Liabilities: All obligations not classified as current
liabilities
(e.g. long term notes payable, bonds payable)
Secured Debt:
o When creditors require the borrower to pledge specific assets
as security for long term liabilities
o Have to put collateral assets to “secure” the debt (if failed to
repay, then the collateral is gone)
Unsecured Debt:
o When the lender relies on the borrower’s integrity and general
earning power to repay the loan
Long Term Notes Payable and Bonds
Companies can raise capital from financial organisations in private
placement
o Banks, Insurance Companies, Pension Plans
If a company needs more capital than any single creditor provides
o Issue publicly traded bonds to the public (bonds payable)
Capital Structure
Acquisition of assets is financed from 2 sources
Debt
Funds from creditors, wanting interest payments
Riskier than equity
Debt payments are legal obligations
If a company cannot make the debt payments, creditors can force
bankruptcy and liquidation of the company
Equity
Funds from owners, wanting profit (dividends)
