AFM101 Lecture and textbook Chapter 10 Notes - Reporting and Interpreting Current Liabilities.docx

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University of Waterloo
Accounting & Financial Management
AFM 101
Donna Psutka

Chapter 10 Notes - Reporting and Interpreting Current Liabilities Liabilities Defined and Classified - When 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 liability with the passage of time - Current liabilities are defined as short-term obligations that will be paid within the current operating cycle of the business or within one year of the statement of financial position date, whichever is longer Current Ratio - Current Ratio = Current Assets / Current Liabilities - Indicator of the amount of current assets available to satisfy current liabilities - In general, a high ratio normally suggests good liquidity, but too high suggests inefficient use of resources. Best between 1 and 2. - May be misleading measure of liquidity if significant funds are tied up in assets that will not be easily converted into cash - Analysts recognize that managers can manipulate the ratio by engaging in particular types of transactions just before the close of the fiscal year (paying creditors immediately prior to preparation of financial statements) Current Liabilities Trade Payables - Purchasing goods and services from other businesses on credit, with cash payments occurring after the goods and services have been provided - Inexpensive way to finance the purchase of inventory because interest does not normally accrue - To encourage more sales, some vendors may offer very generous credit terms that allow merchandiser to resell and collect cash before payment to original vendor (aggressive/efficient cash management) - Some managers tempted to delay payment as long as possible to conserve cash, but not good for maintaining positive working relationships with suppliers (which ensure quality goods and services) o Financial analysts see delayed payment as an indication of a company experiencing financial difficulties Trade Payables Turnover Ratio - Trade Payables Turnover = Cost of Sales / Average Net Trade Payables - Cost of sales usually, can alternatively be net credit purchases (cost of sales + end inv - beg inv) - High ratio suggests company paying suppliers in timely manner - Average Age of Payables = Average Trade Payables / (Cost of Sales/365) - Or Average Age of Payables = 365 / Trade Payables Turnover Ratio - Ratio is an average associated with all trade payables, so company could pay some creditors on time but late with others - Managers can be late with payments during entire year but catch up at year-end to bring the ratio up to an acceptable level - Low ratio can indicate either: o Liquidity problems - cannot generate enough cash to meet obligations (bad) o Aggressive cash management - company maintains only the minimum amount of cash necessary to support operating activities (good) Accrued Liabilities - Expenses incurred before the end of an accounting period but have not yet been paid - Ex. Salaries, wages, rent, interest, income taxes - Recorded as adjusting entries at year-end - Income Taxes Payable o Income Tax expense for each year has two components: current and deferred o Current portion is payable within prescribed time limits o Deferred portion arises because of differences between the accounting rules used for financial reporting and the tax rules corporations must use to determine their taxable income - Taxes Other Than Income Taxes o Companies are often required to pay other types of taxes and fees, depending on specific industry and geographical location of operation o These taxes add to the cost of producing and selling, and are eventually passed on to the customers through higher sales prices o Sales of most goods and services in Canada are subject to sales tax at both federal and provincial levels o Sales taxes are added to the sales price but are not revenue for the seller (they are liabilities remitted periodically, monthly or quarterly to respective governments) o The balance of the account GST payable is reduced by the amount of GST that the company pays on its own purchases of goods and services, and the net amount is remitted to the federal government o In Europe this consumption tax is called a value-added tax, or VAT. - Payroll Liabilities o Employees usually will ha
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