9‐1

Understanding the Business

The acquisition of assets is

Reporting and Interpreting Liabilities
financed from two sources:
Chapter 9

PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Debt Equity
Cynthia J. Rooney, Ph.D., CPA Funds from Funds from
creditors owners

9-1 Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. 9-2

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Understanding the Business Liabilities Defined and Classified

Debt is considered riskier than equity. Defined as probable debts or obligations of the
entity that result from past transactions, which will
be paid with assets or services.
Interest is Creditors
a legal can force
obligation. bankruptcy. Maturity = 1 year or less Maturity > 1 year

Current Noncurrent
Liabilities Liabilities

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Quick Ratio Liabilities Defined and Classified

Liabilities are
recorded at their
current cash
While a high quick ratio normally
suggests good liquidity, too high Quick assets are defined as including equivalent, which is
a ratio suggests inefficient use
of resources.
cash, marketable securities,
and accounts receivable.
the cash amount a
creditor would
accept to settle the
liability
immediately.

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 9‐2

Current Liabilities Accounts Payable Turnover

Account Also
Name Called Definition
Cost of Goods Sold ÷ Average Accounts Payable
Trade Obligations to pay for goods and Measures how quickly management is paying trade accounts.
Accounts
Accounts services used in the basic operating
Payable
Payable activities of the business.
A high accounts payable ratio normally suggests that a
Obligations related to expenses that
Accrued Accrued have been incurred but have not been company is paying its suppliers in a timely manner.
Liabilities Expenses paid at the end of the accounting
period.
The ratio can be stated more intuitively by dividing it into the
Notes Obligations due supported by a formal
N/A number of days in a year:
Payable written contract.
Obligations arising when cash is Average Age of Payables = 365 Days ÷ Turnover Ratio
Deferred Unearned
received prior to the related revenue
Revenues Revenues
being earned.

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Payroll Taxes Notes Payable

Gross Pay
A note payable specifies the interest
rate associated with the borrowing.
Net Pay
Less Deductions:
To the lender, interest is a revenue.
To the borrower, interest is an expense.

Interest = Principal × Interest Rate × Time

Pension and
Income Retirement Unemployment
Taxes Taxes Taxes When computing interest for one
year, “Time” equals 1. When the
computation period is less than
one year, then “Time” is a
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fraction.

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Notes Payable International Perspective—IFRS

Refinanced Debt: Current or Noncurrent?

Nestlé borrows $100,000

Instead of repaying a debt from current cash, a company may
for 2 months at an refinance it either by negotiating a new loan agreement with a
annual interest rate of new maturity date or by borrowing money from a new creditor
12%. Compute the and repaying the original creditor.
interest on the note for
the loan period. US GAAP and IFRS differ with respect to the timing of the
refinancing.

Under GAAP, the ability to In the case of IFRS, the

Interest = Principal × Interest Rate × Time refinance must be in place actual refinancing must
2
Interest = $ 100,000 × 12% × / 12 before the financial take place by the balance
Interest = $ 2,000 statements are issued. sheet date.
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 9‐3

Deferred Revenues Estimated Liabilities

Contingent liabilities are potential liabilities that are
Revenues that have been collected but not created as a result of a past event.
earned.
Probable Reasonably Possible Remote
Deferred revenues are reported as a liability because cash has Subject to estimate Record as liability Disclose in note Disclosure not required
Not subject to estimate Disclose in note Disclose in note Disclosure not required
been collected but the related revenue has not been earned by
the end of the accounting period.
The probabilities of occurrence are defined in the following manner:
1. Probable—the chance that the future event or events will
occur is high.
2. Reasonably possible—the chance that the future event or
events will occur is more than remote but less than likely.
3. Remote—the chance that the future event or events will
occur is slight.

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International Perspective—IFRS Working Capital Management

It’s a Matter of Degree

The assessment of future probabilities is inherently subjective

but both US GAAP and IFRS provide some guidance.

Under U.S. GAAP, “probable” In the case of IFRS, Working Capital = Current Assets – Current Liabilities
has been defined as likely probable is defined as more
which is interpreted as having likely than not which would
a greater than 70% chance of imply more than a 50%
occurring.
Changes in working capital accounts are
chance of occurring.
important to managers and analysts because
This difference means that companies reporting under IFRS
they have a direct impact on cash flows from
would record a liability when other companies reporting under operating activities reported on the statement of
U.S. GAAP would report the same event as a contingency. cash flows.
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Long-Term Liabilities Long-Term Notes Payable and Bonds

Relatively small debt

Creditors often require the borrower to needs can be filled from
pledge specific assets as security for single sources.
the long-term liability.

Maturity = 1 year or less Maturity > 1 year

Current Noncurrent
Banks Insurance Pension
Liabilities Liabilities Companies Plans
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 9‐4

Long-Term Notes Payable and Bonds International Perspective

Borrowing in Foreign Currencies

Significant debt needs are Companies may elect to borrow in foreign markets
often filled by issuing •To lessen exchange rate risk.
bonds to the public. •Because interest rates often are low in other countries.

For reporting purposes, accountants must convert, or translate, foreign debt

Bonds Cash into U.S. dollars.

Assume that Nestlé borrowed 1 million pounds (£). For the Nestlé annual
report, the accountant must use the conversion rate as of the balance sheet
date, which we assume was £1.00 to $2.00.

£1,000,000  $2.00 = $2,000,000

The debt will be reported at $2,000,000 on Nestlé’s financial statements.

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Lease Liabilities Present Value Concepts

Capital
Operating Lease
Lease

Long-term lease; Meets

Short-term lease; No
one of 4 criteria; Results
liability or asset
in recording an asset $1,000 In 1 year it In 5 years it
recorded
and a liability invested will be worth will be worth
Capital Lease Criteria today at 10%. $1,100. $1,610!
1. Lease term is 75% or more of the asset’s expected economic life.
2. Ownership of the asset is transferred to the lessee at the end of the lease.
3. Lease permits lessee to purchase the asset at a price that is lower than its fair
Money can grow over time, because it
market value. can earn interest.
4. The present value of the lease payments is 90% or more of the fair market value
of the asset when the lease is signed.
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Present Value Concepts Present Value of a Single Amount

The present value of a single amount is
The growth is a mathematical function the worth to you today of receiving that
of four variables: amount some time in the future.
1. The value today (present value).
2. The value in the future (future
value).
3. The interest rate.
4. The time period.

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 9‐5

Present Value of a Single Amount Present Values of an Annuity

How much do we need to invest today at 10% interest, An annuity is a series of
compounded annually, if we need $1,331 in three years?
a. $1,000.00 consecutive equal periodic
b. $ 990.00 payments.
c. $ 751.30
d. $ 970.00 The required future amount is $1,331.
i = 10% & n = 3 years
Using the present value of a single
amount table, the factor is .7513.
$1,331 × .7513 = $1,000 (rounded)

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Present Values of an Annuity Present Values of an Annuity

What is the value today of a series of What is the present value of receiving $1,000 each year for
payments to be received or paid out in three years at an interest rate of 10%, compounded
annually?
the future? a. $3,000.00
Payment 1 Payment 2 Payment 3 b. $2,910.00
c. $2,700.00
The consecutive equal payment
Present d. $2,486.90 amount is $1,000.
Interest compounding periods
Value i = 10% & n = 3 years
Using the present value of an
annuity table, the factor is 2.4869.
Today
$1,000 × 2.4869 = $2,486.90

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Accounting Applications of Present Accounting Applications of Present

Values Values
On January 1, 2011, Nestlé bought some new
delivery trucks. The company signed a note GENERAL JOURNAL
agreeing to pay $200,000 on December 31, 2012. Date Description Debit Credit
The market interest rate for this note is 12%. Jan. 1 Delivery trucks 159,440
Notes payable 159,440

Future value $ 200,000 Now, let’s look at the journal entry at

Present Value × Interest Rate = Interest
PV of $1 December 31,=2011.
$159,440 × 12% $19,133
(i=12%, n=2) × 0.79720
Present value $ 159,440 GENERAL JOURNAL
Date Description Debit Credit
Dec. 31 Interest expense 19,133
Let’s prepare the journal entry to record the purchase. Notes payable 19,133
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 9‐6

Accounting Applications of Present Supplement A: Present Value

Values Computations Using Excel
Now, let’s look at the journal entries at
Present Value of A Single Amount Formula
December 31, 2012. = Payment/(1 + i)^n

GENERAL JOURNAL
Present Value of An Annuity Formula
Date Description Debit Credit Use the present value of an annuity formula
Dec. 31 Interest expense 21,429 programmed in Excel by selecting the
Notes payable 21,429 function button (fx ). In the drop down
menu, under the Select Category heading,
pick "Financial" and scroll down under
31 Notes payable 200,000
Select Function and click on "PV." In the
Cash 200,000
new drop down box, enter the specific
information for your problem and click
Present Value × Interest Rate = Interest "OK."
($159,440 + $19,133) × 12% = $21,429
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Supplement B: Deferred Taxes Supplement C: Future Value Concepts

Exist because of timing differences Future value is the sum to which an amount will
caused by reporting revenues and
expenses according to GAAP on a
increase as the result of compound interest.
Deferred Taxes company’s income statement and
according to the Internal Revenue
How much will an amount today be worth in the future?
Code on the tax return.

Timing differences that cause

Temporary deferred income taxes and will
Differences reverse, or turn around, in the
future.

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Future Value of a Single Amount Future Value of an Annuity

If we invest $1,000 today earning 10% interest, compounded • Equal payments are made each period.
annually, how much will it be worth in three years?
• The payments and interest accumulate over time.
a. $1,000
b. $1,010
c. $1,100
d. $1,331 The invested amount is $1,000.
i = 10% & n = 3 years
Using the future value of a single
amount table, the factor is 1.331.
$1,000 × 1.331 = $1,331

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Future Value of an Annuity End of Chapter 9

If we invest $1,000 each year at an interest rate of 10%,
compounded annually, how much will we have at the end
of three years?
a. $3,000
b. $3,090
c. $3,300
d. $3,310 The annual investment amount is $1,000.
i = 10% & n = 3 years
Using the future value of an annuity
table, the factor is 3.3100.
$1,000 × 3.3100 = $3,310

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