Current Liabilities and Fair Value Accounting

Current Liabilities and Fair Value Accounting 10

Management Issues Related to Current Liabilities OBJECTIVE 1: Identify the management issues related to current liabilities.

Key Ratios • Payables turnover • Days’ payable

Figure 1: Payables Turnover for Selected Industries

Figure 2: Days’ Payable for Selected Industries

Management Issues Related to Current Liabilities • Liabilities are legal obligations that must be satisfied through the future payment of assets or performance of services. • A liability should be recognized when it is incurred; end-of-period adjustments may be necessary. • Failure to record a liability often results in an understatement of expenses.

Management Issues Related to Current Liabilities • Liabilities are legal obligations that must be satisfied through the future payment of assets or performance of services.(cont.) • Liabilities are valued at the amount due or at the fair market value of goods or services to be delivered.

Management Issues Related to Current Liabilities • Liabilities are legal obligations that must be satisfied through the future payment of assets or performance of services.(cont.) • Liabilities are classified as current or long-term. • A current liability is a liability due within one year or within the normal operating cycle, whichever is longer. • A long-term liability is a liability due beyond the normal operating cycle.

Management Issues Related to Current Liabilities • Two common measures of the length of time creditors allow for payment are the payables turnover and the days’ payable. • The payables turnover is the average number of times that accounts payable are paid in an accounting period and shows the relative size of a company’s accounts payable. • The days’ payable shows the average length of time a company takes to pay its accounts payable.

Management Issues Related to Current Liabilities • Required disclosures for liabilities include the following: • Balances • Maturity dates • Interest rates • Lines of credit • Other special credit arrangements

Common Types of Current Liabilities OBJECTIVE 2: Identify, compute, and record definitely determinable and estimated current liabilities.

Figure 3: Promissory Note

Figure 4: Illustration of Payroll Costs

Common Types of Current Liabilities • Current liabilities consist of definitely determinable liabilities and estimated liabilities.

Common Types of Current Liabilities • A definitely determinable liability can be measured precisely. • Accounts payable • Bank loans and commercial paper

Common Types of Current Liabilities • A definitely determinable liability can be measured precisely. (cont.) • Notes Payable • Notes payable with interest stated separately. • Issue note. • Accrue interest. • Pay note. • Notes payable with interest included in the face amount. • Issue note. • Accrue interest. • Pay note.

Common Types of Current Liabilities • A definitely determinable liability can be measured precisely.(cont.) • Accrued liabilities (such as interest payable) • Dividends payable • Sales and excise taxes. • Current portion of long-term debt

Common Types of Current Liabilities • A definitely determinable liability can be measured precisely.(cont.) • Payroll liabilities • Record the payroll. • Record employer payroll taxes. • Unearned revenues • Receipt of revenues in advance. • Performance of services for revenues received in advance.

Common Types of Current Liabilities • Estimated liabilities are definite obligations whose exact amounts cannot be known until a later date. • Record estimated income taxes. • Property taxes • Estimated expense. • Payment of property taxes.

Common Types of Current Liabilities • Estimated liabilities are definite obligations whose exact amounts cannot be known until a later date. (cont.) • Promotion costs • Examples: coupons, rebate, frequent flyer programs • Usually recorded as a reduction in revenue (contra-sales account)

Common Types of Current Liabilities • Estimated liabilities are definite obligations whose exact amounts cannot be known until a later date. (cont.) • Product warranties • Estimated expense. • Replacement of product under warranty. • Vacation pay • Estimated vacation pay expense. • Payment of vacation pay.

Common Types of Current Liabilities

Contingent Liabilities and Commitments OBJECTIVE 3: Distinguish contingent liabilities from commitments.

Contingent Liabilities and Commitments • A contingent liability is a potential liability that may or may not become an actual liability. Examples are as follows: • Pending lawsuits • Tax disputes • Failure to comply with government regulations

Contingent Liabilities and Commitments • There are two criteria for recording a contingent liability: • Occurrence is probable. • The amount can be reasonably estimated.

Contingent Liabilities and Commitments • A commitment is a legal obligation that does not meet the technical requirements for recognition as a liability. Examples are as follows: • Purchase agreements • Leases

Valuation Approaches to Fair Value Accounting OBJECTIVE 4: Identify the valuation approaches to fair value accounting, and define time value of money and interest and apply them to present values.

Table 1: Present Value of $1 to Be Received at the End of a Given Number of Periods

Table 2: Present Value of an Ordinary $1 Annuity Received in Each Period for a Given Number of Periods

Valuation Approaches to Fair Value Accounting • Fair value is the price for which an asset or liability could be sold. • Market approach • Involves identical or comparable assets or liabilities. • Ready market not as available, as in case of special-purpose equipment.

Valuation Approaches to Fair Value Accounting • Fair value is the price for which an asset or liability could be sold.(cont.) • Income (or cash flow) approach • Converts future cash flows into a single present value. • Based on reasonable internally generated information.

Valuation Approaches to Fair Value Accounting • Fair value is the price for which an asset or liability could be sold.(cont.) • Cost approach • The amount that currently would be required to replace an asset. • Inventory usually valued at lower of cost or market. • Plant value would take into account asset’s age, condition, depreciation, and obsolescence.

Valuation Approaches to Fair Value Accounting • Interest and the time value of money • Time value of money is the effects of the passage of time on holding or not holding money.

Valuation Approaches to Fair Value Accounting • Interest and the time value of money (cont.) • Interest is the cost of using money. • With simple interest, interest is not computed on accrued interest. • With compound interest, interest is computed on accrued interest.

Valuation Approaches to Fair Value Accounting • Calculating present value • Illustrate the computation of the present value of an amount, using Table 1 in the text. • Illustrate the computation of the present value of an annuity, using Table 2 in the text.

Valuation Approaches to Fair Value Accounting • Calculating present value (cont.) • Discuss time periods of less than one year for which interest is compounded. • Some savings accounts can record interest quarterly. • Some bonds pay interest semiannually.

Current Liabilities and Fair Value Accounting