Chapter 10 Notes

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Financial Accounting
Liang Chen

Chapter 10 Reporting and Analyzing Liabilities Notes Current Liabilities N current liabilitydebt that will be paid within year and from existing current assets or through creation of other current liabilities N debts that do not meet both criteria are classified as long-term liabilities N financial statement users want to know whether companys obligations are current or long-term, which is important since a company that has more current liabilities than current assets often lacks liquidityi.e., short-term debt-paying ability N users must look at total liabilities in order to assess companys solvencyits ability to pay its interest and debt when due N finally, users want to know types of liabilities a company has N different types of current liabilities include bank indebtedness arising from operating lines of credit, notes payable, accounts payable, unearned revenue, accrued liabilities such as salaries and interest, and current portion of long-term debt Operating Line of Credit N current assets do not always turn into cash at exact time that current liabilities must be paid, consequently most company have an operating line of credit at their bank to help them manage temporary cash shortfalls N operating line of credita pre-arranged agreement to borrow money at a bank, up to an agreed-upon amount N floating (or variable) interest ratean interest rate that changes over the term of the debt with fluctuating market rates N collateralassets pledged as security for the payment of a debt (e.g., land, buildings, and equipment in the case of a mortgage; accounts receivable or inventory in the case of a bank loan) N borrowings normally on short-term basis and are repayable immediately upon request by bank, rarely happening without notice N with line of credit, bank simply covers any cheques written in excess of the bank account balance, up to the approved credit limit N amounts drawn on operating line of credit result in negative, or overdrawn, cash balance at year end, but no special entry is required to record overdrawn amountnormal credits to Cash will simply accumulate and are reported as bank indebtedness in current liability section of balance sheet and with a suitable note disclosure N amounts available to be drawn in future from operating line of credit adds to companys liquidity Short-Term Notes Payable N notes payableobligations in form of written notes; used instead of accounts payable because give lender written documentation of obligation, which helps if legal action is needed to collect debt; frequently issued to meet short-term financing needs N notes that are due for payment within year of balance sheet date are classified as current liabilities N most notes are interest-bearing, with interest due monthly or at maturity N while short-term notes can have floating interest rates, it is more usual for them to have a fixed interest rate N fixed interest ratean interest rate that is constant (unchanged) over the term of the debt N account payable is informal promise to pay, while note payable is written promise to pay that gives payee stronger legal claim N account payable arises only from credit purchases (amounts owed to suppliers), while note payable can be used for credit purchases, extending account payable beyond normal amounts or due dates, or to borrow money N account payable is usually due within short period of time, while note payable can extend for longer periods N account payable does not incur interest unless account is overdue, while note payable bears interest for entire period of duration N interest rates are always expressed as annual rate, regardless of term of note Sales Taxes N sales taxes may take form of Goods and Services Tax (GST), Provincial Sales Tax (PST), or Harmonized Sales Tax (HST) N in Quebec, the PST is known as Quebec Sales Tax (QST) N in many provinces, sales taxes are collectively known as retail sales tax (RST) N in 2008, federal GST was assessed at rate of 5% across Canada, which is subject to change and PST rates vary from 0% to 10% N in Newfoundland and Labrador, Nova Scotia, and New Brunswick, PST and GST have been combined into 13% HST N retailer collects sales tax from customer when sale occurs, and periodically (normally monthly) remits (sends) sales tax collected to designated federal and provincial collecting authorities N in case of GST and HST, collections may be offset against payments (i.e., sales tax payments made by company on its own eligible purchases) and only net amount owing or recoverable will be paid or refunded N when sales taxes are remitted, GST and PST (or HST) Payable are debited and Cash is credited N company does not report sales taxes as expense; it simply forwards amount paid by customer to respective government N in all but 2 provinces, GST is charged on selling price of item before PST is applied, thus avoiding GST being charged on PST N in Quebec and Prince Edward Island, PST is charged on GST Property Taxes N businesses that own property pay property taxes each year, which are charged by municipal and provincial governments, and are calculated at specified rate for every $100 of assessed value of property (i.e., land and building) N property taxes are generally for calendar year, although bills are not usually issued until spring of each year Payroll N every employer incurs 3 types of liabilities related to employees salaries or wages: (1) net pay owed to employees, (2) employee payroll deductions, and (3) employer payroll deductions N first type of liability is amount of salary or wages owed to employeesmanagement personnel are generally paid salaries, which are expressed as specific amount per week, per month, or per year; part-time employees or employees paid on an hourly basis or by the work produced (an amount per unit of product) are normally paid wages
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