Week 8

Reporting and Analysing Liabilities

Ch. 9, Carlon et al.

Learning objectives

After studying this presentation, you should be able to:

1. Explain the differences between current and non-current
liabilities.
2. Identify common types of current liabilities and explain
how to account for them.
3. Identify common types of non-current liabilities, such as
debentures and unsecured notes, and explain how to
account for them.

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Learning objectives

4. Prepare journal entries for loans payable by instalment and

distinguish between current and non-current components
of long-term debt.
5. Identify the advantages of leasing and explain the
difference between an operating lease and a finance lease.
6. Complete basic journal entries for accounting for leases
and explain how to report leases.
7. Explain the differences between provisions, contingencies
and other types of liabilities.

Learning objectives

8. Explain how to report contingent liabilities.

9. Prepare entries to record provisions for warranties.
10. Evaluate an entity’s liquidity and solvency.

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Current vs. non-current liabilities

• Liabilities are displayed in statement of financial position

in order of liquidity.
• Current liability: an obligation that can reasonably be
expected to be paid within 1 year (or within the operating
cycle).
• All other liabilities are classified as non-current.
• Financial statement users want to know whether an
entity can meet their obligations when they fall due.

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Notes payable

• Notes payable record obligations in the form of written

notes.
• Usually require borrower to pay interest or borrowing
costs.
• Frequently issued to meet short-term financing needs.
• Issued for varying periods of time.

Notes payable
• Journal entry when note issued:

• Journal entry to record interest:

Interest: $100,000 x 12% x 4/12 mths = $4,000

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Notes payable
• Journal entry to settle liabilities:

Payroll and payroll deductions payable

• Employers deduct amounts from employees’ wages and

salaries if they are required to be paid to other parties.
• These include deductions for:
– tax (pay-as-you-go or PAYG)
– superannuation
– trade union fees
– health insurance.

• Employers are responsible to remit these withheld funds

to the appropriate parties.

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Payroll and payroll deductions payable
• Entry for payroll accrual and payment:

Payroll and payroll deductions payable

• Journal entry when payments are made:

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Revenues received in advance

• Occurs when customers pay ahead of time for goods or

services, e.g.
– purchase of plane tickets
– magazine subscriptions
– season passes to sporting events.

• Also called unearned revenue

Revenues received in advance

• Journal entry to record revenue received in advance:

• Journal entry when service is delivered:

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Non-current liabilities

• Obligations expected to be paid after

1 year or outside normal operating cycle.
• Common forms of these obligations are:
– bank loans
– long-term notes.
• Debentures are notes that are subject to a secured
charge on the issuers assets.
• Unsecured notes are not subject to a security over
assets.

Why issue unsecured notes or debentures?

• Advantages of debt financing:

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Why issue unsecured notes or debentures?

• Disadvantage of Debt Financing:

– Company is locked into fixed payments:
– these must be made in good and bad times.
– Interest must be paid on periodic basis.
– Principal must be paid at maturity.
– Company with fluctuating earnings and relatively weak cash
flow may experience difficulty in meeting interest payments in
periods of low earnings.

Determining the market value of unsecured

notes or debentures

• The face value of a note (or principal) is the amount

due at maturity.
• The issue price is the amount paid for the note by the
investor at the time of issue.
• The market value of the note is the price at which it is
traded by willing parties, and may vary over time.
• The contract interest rate is the rate used to determine
the amount of interest the borrower pays and the
investor receives.

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 Determining the market value of unsecured
notes or debentures

• The present value of a note is the face value plus the

contractual interest rate for the life of the debt, stated
in today’s equivalent dollar terms:
– affected by cash amounts to be received (face value +
contractual interest rate),
– by length of time until investor receives cash, and
– by current market rates.

Determining the market value of unsecured

notes or debentures

• Calculation of present value of future payments:

The above figures are calculated using present value tables.

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 Accounting for issues of unsecured notes
and debentures

• Journal entries are required when long-term debt is

issued or repaid.
• If a note holder sells a note to another investor, no
journal entry is required.
• Face value of long-term debt is often different than
amount of cash received from investors:
– Premium: if market rates < contract
– Discount: if market rates > contract

Accounting for issues of unsecured notes

and debentures
• Journal entry to record debentures issued ($1m @ 10%
in 2016):

• Journal entry to record payment of interest (interest paid

six monthly):

Interest: $1,000,000 x 10% x 6/12 mths = $50,000

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Redeeming unsecured notes and debentures
at maturity
• Notes are redeemed when they are purchased (repaid)
by the issuing company.
• Carrying amount of the notes will always equal their face
value.
• Entry to record redemption at maturity.

Redeeming unsecured notes and debentures

before maturity

• Notes may be redeemed before maturity.

• A company may decide to redeem notes early to reduce
interest cost and remove debt from its statement of
financial position.
• Company must:
– Eliminate carrying amount of notes at redemption date.
– Record cash paid.
– Recognise gain or loss on redemption.

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Redeeming unsecured notes and debentures
before maturity

• Journal entry to record redemption before maturity at

103% of face value.

Loans payable by instalment

• Entities may borrow money from a single borrower in

the form of loan.
• It is common for such loans to be repayable by
instalment e.g. mortgages.
• A mortgage is a loan secured by a charge over
property.
• If the borrower is unable to repay the loan, the lender
may sell the property and use the proceeds to repay the
loan.

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 Accounting for loans payable by instalment
• Mortgage payments consist of:
– interest expense, and
– reduction of loan liability.

• Journal entry to record monthly mortgage payment:

– Loan balance $100 000
– Interest rate 12%p.a
– Instalment amount $10 000

Interest: $100,000 x 12% x 1/12 mths = $1,000

Loan reduced by $10,000 - $1,000 = $9,000

Mortgage schedule 106,220 x 12% x 1/12

• Loan amount $106 220
5,000 – 1,062
• Interest rate 12%p.a
106,220 – 3,938
• Monthly payment $5,000

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 Accounting for loans payable by instalment

• January 2016 monthly payment:

Full Mortgage Schedule

At 31st
March ‘16

Current

Non-current

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Current and non-current components of long-
term debt
• The portion of the long-term debt that is due within one
year should be classified as a current liability.
• Assuming a financial year end of 31 March:

Current and non-current components of long-

term debt

• An adjusting entry is not necessary to recognise the

current portion of the liability.
• It is recognised by proper classification on the
statement of financial statement.

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Leasing

• Leases are liabilities payable by instalment.

• A lease is an agreement between a lessee and lessor
where the lessor (owner of the asset) grants the lessee
the right to use the asset for an agreed period of time.
• Advantages of leasing:
– Provide lessee with access to a wide variety of non-current
assets for little or no deposit.
– Reduced risk of obsolescence.
– Shared tax advantage.
– Depending on structure of lease assets and liabilities are not
reported.

Provisions and contingent liabilities

• Accruals are liabilities to pay for goods or services that

have been provided but not yet invoiced:
– e.g. next telephone or electricity account
– involve a low level of uncertainty.
• Provisions are liabilities for which the amount of the
future sacrifice is still uncertain:
– e.g. long service leave, warranties
– involve significant level of uncertainty.

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Provisions and contingent liabilities

• A warranty is an obligation of the supplier of goods or

services to the purchaser that the product will be
functional.
• There is significant uncertainty in measuring the future
sacrifice because:
– It is conditional upon the customer making a claim.
– The costs of satisfying the claim depend on the nature of the
fault.

Contingent liabilities

• Contingent liabilities are liabilities for which the

amount of future sacrifice is so uncertain that it cannot
be measured reliably:
– e.g. an unresolved legal action.
• Contingent liabilities are not recognised in the accounts
because they are neither probable nor able to be
measured reliably.
• However, they must be disclosed in the notes to the
financial statements.

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Recording provisions for warranties
• Entry to record estimation of liability for outstanding
warranties:

• Entry to record goods replaced under warranty:

Recording provisions for warranties

• Entry to increase estimated cost of servicing unexpired
warranty contracts:

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Financial statement analysis

1. Liquidity Ratios:
• Measure the short-term ability of an entity to pay its
maturing obligations and to meet unexpected needs for
cash.
• 3 useful measures:
(a) Working capital
(b) Current ratio
(c) Quick ratio

Liquidity ratios
• Provide a measure of the entities ability to meet its short-
term debts
(a) Working capital:
• A positive working capital indicates that current assets are
available to meet current liabilities

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Liquidity ratios

(b) Current ratio:

• Above 1:1 means current assets exceed current liabilities. A
higher ratio indicates a higher level of liquidity

Liquidity ratios

(c) Quick ratio:

• Focuses on assets that are quickly converted into cash. A higher
ratio indicates a higher level of short-term liquidity

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Solvency Ratios
• Measure the ability of an entity to survive over a long
period of time.
(a) Debt to total assets ratio
• Measures the extent to which the entity's assets are
financed by debt
• A low debt to total assets is preferable

Financial statement analysis

(b) Times interest earned:
• Provides an indication of an entity’s ability to meet
interest payments as they become due.
• Should exceed 3 times – a higher interest coverage
implies a greater capacity to meet interest payments

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Decision toolkit

• Telecom Corporation of New Zealand Ltd (page 563 –

565 of the text).
• Work through on your own and check your results
with the suggested solution provided.

Demonstration problem

• Bird’s-Aflight Pet Store Ltd (page 568 – 570 of the text).

• Work through on your own and check your results with
the suggested solution provided.

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Key concepts

Can you:
1. Explain the differences between current and non-current
liabilities.
2. Identify common types of current liabilities and explain
how to account for them.
3. Identify common types of non-current liabilities, such as
debentures and unsecured notes, and explain how to
account for them.

Key concepts

4. Prepare journal entries for loans payable by instalment and

distinguish between current and non-current components
of long-term debt.
5. Identify the advantages of leasing and explain the
difference between an operating lease and a finance lease.
6. Complete basic journal entries for accounting for leases
and explain how to report leases.
7. Explain the differences between provisions, contingencies
and other types of liabilities.

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Key concepts

8. Explain how to report contingent liabilities.

9. Prepare entries to record provisions for warranties.
10. Evaluate an entity’s liquidity and solvency.

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