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Lecture

Chapter 10

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Department
Business
Course
BU227
Professor
James Moore
Semester
Fall

Description
CHAPTER 1Reporting and Interpreting Current Liabilities LIABILITIES debtsobligations arising from past transactions that will be paid with assets or servicesWhen a liability is first recorded it is measured in terms of its current cash equivalent which is the cash amount that a creditor would accept to settle the liability immediately Interest payable in the future is not included in the amount of the liability because it accrues and becomes a liabilityCURRENT LIABILITIES ST obligations paid within the normal operating cycle or 1 year longerBecause most companies have an operating cycle that is shorter than one year current liabilities usually are due within one year Noncurrent liabilities include all other liabilitiesLIQUIDITY is the ability to pay current obligationsCURRENT RATIO Does the company currently have the resources to pay its shortterm debtindicator of the amount of current assets available to satisfy current liabilitiesCurrent RatioCurrent AssetsCurrent LiabilitiesA high ratio normally suggests good liquidity but too high a ratio suggests inefficient use of resources An old guideline was between 1 and 2 Today many strong companies use sophisticated techniques to minimize funds invested in current assets and have current ratios below 1Misleading measure of liquidity if significant funds are tied up in assets that will not be easily converted into cashex slowmoving inventory Analysts recognize that managers can manipulate the current ratio by engaging in particular types of transactions just before the close of the fiscal yearpaying creditors immediately prior to the preparation of financial statementsFINANCIAL POSITION RATIOS AND DEBT CONTRACTS When firms borrow money they agree to make specific payments of interest and principal in the future They also often agree to other restrictions Lenders impose these conditions to ensure that the borrower does not increase debt relative to equity which increases the borrowers financial riskex maintain a minimum specified current ratio and a maximum debttoequity ratio Maintaining a specified level of the current ratio assures creditors that the company has sufficient liquidity WORKING CAPITALcurrent assetscurrent liabilitiessignificant impact on the health and profitability of a companyIf a business has too little working capital it runs the risk of not being able to meet its obligations to creditors But too much working capital may tie up resources in unproductive assets and incur additional costs ex excess inventoryThe current ratio and working capital are measures of a companys liquidityCurrent liabilities are usually grouped according to type of creditor separating liabilities owed to suppliers and other trade creditors tradeother payables from those owed to banks shortterm borrowings providers of services accrued liabilities governments taxes payable and others Most liabilities are recorded as they occur during the accounting period like trade payables for merchandise purchases loans from banks and notes payable to creditors However specific liabilities that can be determined with accuracy such as salaries payable and interest payable require accrual through adjusting entries at the end of the accounting periodFor other types of liabilities the exact amount will not be known until a future event but they must be estimated and recorded based on past experience or percentage of net salesif they relate to transactions that occurred during the accounting period Matching processIn particular cases it may not be possible to provide a reasonable estimate of a potential future liability that is contingent on a future event Relevant information about contingent liabilities must therefore be disclosed in notes to the financial statements
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