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ADMS 2500 Module 11- Liabilities.docx

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Administrative Studies
ADMS 2500
Brian Gaber

ADMS 2500 Oct.27.2011 Module 11- Liabilities Liabilities: A Temporary Source of Capital - funds used to acquire assets come from two sources: ~ owners ~ non-owners - suppliers, employees and customers that provide cash in advance before the delivery of a good are all providing funds for the firm Basic Concept of Liabilities - obligation recognized as a liability of entity and has three characteristic: (1) obligation involves probable future sacrifice of resources—transfer of cash, goods/services or the foregoing of future cash receipts (at specific time). Cash equivalent of resources that are to be sacrificed must be measureable with reasonable precision (2) entity has little or no discretion to avoid transfer (3) transaction or event giving rise to the entity’s obligation has already occurred Measurement and Classification of Liabilities Measurement - long term liabilities valued as present value of payments to be made in future, using interest rate - short term liabilities usually appear with face value on balance sheet because difference between amount payable and present value is immaterial Classification - classified as current or non-current - depends on the length of time that will elapse before payment must be made - dividing time is one year Contingencies- Potential Obligations - firm can find itself anytime liable for past events - contingencies like that not recognized as accounting liabilities, instead future obligations - notes on financial statements must disclose significant contingencies - estimated loss from contingencies should be recognized if both are met: - if contingency is a gain for the firm NO accrual gain is shown Current Liabilities - due within one year or current operating cycle (if more than one year) - continually discharged and replaced with new ones - may not be paid for several weeks or months after current balance sheet date - present value is less then is to be paid - show full amount to be paid Accounts Payable to Creditors - firms rarely pay for goods/services when they’re received, usually deferred until bill is received - sometimes bill isn’t paid immediately either and wait for bills to accumulate and pay at specific time - management tries to obtain as much as capital as possible from creditors by delaying payment Wages, Salary and Other Payroll Items - part of wages goes to government for taxes - employer pays various payroll taxes - employers own EI and CPP so amounts used in books are approximate - employers also provide paid vacation ~ employer accrue cost of earned but unused vacations at time employee earns them, not the time when employee takes vacation are paid - charges each quarter with portion of cost of vacation, rather than allocating it till summer where most employees take vacation time Notes Payable, Interest Payable and Income Tax Payable Short- Term Notes and Interest Payable - borrower records it as a liability - borrower records interest payable and expense Income Tax Payable - must pay income taxes based on taxable income from business activities - partnerships or sole proprietorship don’t pay income taxes - rules for computing income tax always changing Deferred Performance Liability - customers make advance payments for goods/services to be delivered in the future - unearned revenue - liability is discharged by delivering goods/service Product Warranties - can run from 30 days to lifetime - matching principle attempts to place estimated cost of warranty service on sales in the same income statement as that of the associated revenue - firm has to estimate two quantities: ~ % of units sold that’ll come back for service in warranty period ~ average cost of honoring each warranty claim HST Liabilities - government revenue Ex: item sold for $1000 and 13% sales tax Cash 1300 Sales 1000 HST Payable 130 - remittance made to government, liabilities Dr and cash Cr Long Term Liabilities - includes mortgages, notes, bonds and leases - difference between long term and short term is: (1) interest on long term is ordinarily paid at regular intervals during life of obligation, interest on short term is paid in one large lump sum at maturity (2) principle of long term paid back in installments (3) special funds are accumulated by the borrower for retiring long term liability Procedures for Recording Long-Term Liability - initially recorded at present value of all promised payments to be made using market interest rate at time liability incurred - market interest rate also used to compute amount of interest expense throughout the life of liability - portion of cash payment represents interest expense - excess of cash payment over interest expense is used to reduce the liability itself, called principle - if payment is not enough to cover entire interest expense that’s occurred since last payment, principle increases by interest expense over cash payment Mortgages and Interest Bearing Notes - mortgaged property called collateral for the loan - lender is the ‘mortgagee’ and borrower is the ‘mortgagor’ - as long as borrower meets obligations under mortgage agreement, mortgagee cannot possess and use the property - if mortgagor defaults on either principle or interest payments, mortgagee can have the property sold for his/her benefit through process called foreclosure - note works in the same way except there’s no property that’s pledged as collateral Amortization Schedules for Long Term Debt - schedules prepared for long term debts to show principle, cash flows and interest expenses recorded on the books - each period shows beginning balance, interest or the period, payment for the period, reduction of principle for the period and the ending balance Bonds Payable - larger funds needed, firm
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