Ch9 ACCT1101 DE S1 2223 MOODLE

ACCT1101
Dr. Olivia Leung chapter 9 Reporting and Interpreting

Liabilities
Financial Accounting
11e
Libby • Libby • Hodge
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.
Learning Objectives
After studying this chapter, you should be able to:
9-1 Define, measure, and report current liabilities. (P9-1)
9-3 Report notes payable and explain the time value of money. (M9-4)
9-4 Report contingent liabilities. (P9-6; E9-9)
9-7 Compute and explain present values. (E9-14; AP9-10)
9-6 & 9-8 Report long-term liabilities and Apply the present value
concept to the reporting of long-term liabilities. (M9-12)
9-2 Accounts payable turnover ratio (pg 475 in textbook)

Debt-to-equity ratio, Times interest earned (pg 708 in textbook)
(P9-7; M13-8)
Copyright ©2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
9-2
2
Learning Objective 9-1
9-1 Define, measure, and report current liabilities.

Lecture Exercise: P9-1
9-3
3
Liabilities Defined & Classified
Defined as the probable future sacrifice of economic benefits that
arise from past transactions.
Maturity = 1 year or less Maturity > 1 year
Current Liabilities Long-Term Liabilities

(to be paid with current assets)
Liabilities are recorded at their current cash equivalent,

which is the cash amount a creditor would accept to
settle the liability immediately.
9-4
Exhibit 9.1
Liability Section of Starbucks’s Balance Sheets
5-5
Current Liabilities (1 of 2)
Many current liabilities have a direct relationship to the operating activities of
a business. Below are some examples from Starbucks's balance sheet:
Operating Activity Current Liability
Purchase coffee
Accounts payable
inventory
Current portion
Rent space for
of operating lease
stores
liability
Employees earn Accrued payroll

wages and benefits
Customers pay in Stored value card

liability and current
advance for portion of deferred
future purchases revenue
9-6
Current Liabilities (2 of 2)
Account Name Also Called Definition
Obligations to pay for goods and

Trade Accounts
Accounts Payable services used in the basic operating
Payable
activities of the business.
Obligations related to expenses that

have been incurred but have not been
Accrued Liabilities Accrued Expenses
paid at the end of the accounting
period.
Obligations arising when cash is

Deferred Revenues Unearned Revenues received prior to the related revenue
being earned.
Obligations supported by a formal

Notes Payable N/A
written contract.
9-7
9-8
9-9
9-10
9-11
9-12
9-3 Report notes payable and explain the time value of money
Lecture Exercise: M9-4
9-13
13
9-14
Notes Payable (1 of 2)
A note payable is a formal written contract that specifies:

• The amount borrowed
• The repayment date
• The annual interest rate associated with the borrowing
ØTo the lender, interest is a revenue.

ØTo the borrower, interest is an expense.
Principal × Annual Interest Rate × Number of Months / 12 Months =

Interest for the Period
9-15
Notes Payable (2 of 2)
Ø Interest is an expense incurred when companies borrow money.

Ø Companies record interest expense for a given accounting period, regardless
of when they actually pay the bank cash for interest.
9-16
Notes Payable, illustration (1 of 3)
Assume that on November 1, a company with a December 31 fiscal

year-end borrows $100,000 cash for six months.
• The annual interest rate is 12%.
• The principal and interest is payable on April 30 of the following
year.
On November 1, the note is recorded in the accounts as follows:
9-17
By the end of the fiscal year, December 31, the company incurred two months of
interest calculated as follows:
The entry to record interest expense and interest payable for the two months is:
On April 30, the company has incurred an additional four months of interest expense
for the period January–April. The entry to record the interest and liability is:
Also on April 30, the company pays the bank $6,000 cash for six months of
interest and pays back the principal since the loan was a six-month loan.
The cash payment for interest consists of the $2,000 of interest owed for
November and December, plus the $4,000 of interest owed for January–April.
The following journal entry reflects the cash payment to the bank to repay the
principal amount and to pay for interest.
Current Portion of Long-Term Debt
To provide accurate information on how much of its long-term debt is
due in the current year, a company must reclassify its long-term debt as
a current liability within a year of its maturity date.
Starbucks expects to pay $1,249.9 million of its long-term debt in the
current year. The remaining $14,659.6 million is due sometime after the
current year.
In the footnotes to its 2020 Annual Report, Starbucks explains that its long-
term debt consists of notes that mature on various dates out to 2050.
9-20
9-4 Report contingent liabilities.

Lecture Exercises: P9-6; E9-9
9-21
P4 Estimated Liabilities
An estimated liability
= a known obligation
of an uncertain amount,
but one that can be
reasonably estimated.
e.g. warranty payable

9-22
22
P4 Warranty Payable
Starbucks sells coffee brewing equipment to customers

with 1-year warranty from the date of sales. It estimates that
it will have to provide $150,000 of warranty services to
customers who purchased the equipment this year.
Dr. Warranty Expense $150,000
Cr. Warranty Payable $150,000
Over time, when customers return defective equipment:

Dr. Warranty Payable $1,000
Cr. Cash* $1,000
(*either to repair the equipment or give cash refund to customer)
9-23
23
9-24
24
9-25
25
Contingent Liabilities
A contingent liability is a potential liability that has arisen as the result of a

past event; it is not a definitive liability until some future event occurs.
PROBABILITY OF OCCURRENCE
Probable Reasonably Possible Remote
Amount can be
reasonably estimated Record as liability Disclose in footnotes Disclosure not required
Amount cannot be
reasonably estimated Disclose in footnotesDisclose in footnotes Disclosure not required
The probabilities of occurrence are defined in the following manner:

• Probable—The future event or events are likely to occur.
• Reasonably possible—The chance of the future event or events
occurring is more than remote but less than likely.
• Remote—The chance of the future event or events occurring is
slight.
9-26
International Perspective: It’s a Matter of Degree
The assessment of future probabilities is inherently subjective,

but both U.S. GAAP and IFRS provide some guidance.
GAAP defines “probable” as IFRS defines “probable” as

likely to occur. more likely than not to occur.
> 70% > 50%
For some contingent liabilities, IFRS would require the reporting of a

liability on the balance sheet, whereas GAAP would simply require
footnote disclosure.
9-27
9-28
9-29
9-7 Compute and explain present values.

Lecture Exercises: E9-14; AP9-10
9-30
9-31
Present Value Concepts
$1,000 In one year, it will In five years, it will

invested be worth $1,100. be worth $1,610!
today at 10
percent.
The value of money can grow over time because

money can earn interest.
9-32
Future Value of a Single Amount
If you deposited $100 today in a savings account that earns 10%

interest, how much would you have after one year?
Answer: $110
9-33
Present Value of a Single Amount (1 of 2)
If you needed $110 in one year, how much would you need to deposit
in a savings account today if the savings account earns 10% interest?
Answer: $100
9-34
Present Value of a Single Amount (2 of 2)
Assume that you need to make a $1,000 cash payment in

three years.
At an interest rate of 10% per year, how much would you
need to deposit today to have exactly $1,000 at the end
of three years?
a. $1,000.00
b. $ 990.00
c. $ 751.31
d. $ 970.00
The future amount is $1,000.

i = 10% & n = 3 years
Using the Present Value of $1 table, the factor is 0.75131.
$1,000 × 0.75131 = $751.31
9-35
9-36
9-37
Exhibit 9.2
How a Deposit Grows to $1,000
9-38
9-39
Present Value of an Annuity (1 of 2)
An annuity is a series of consecutive payments:
1. An equal dollar amount each period
2. Interest periods of equal length (e.g., a year, half a year, quarterly, or
monthly)
3. The same interest rate each period.
9-40
Present Value of an Annuity (2 of 2)
Assume you purchase a piece of equipment and agree to pay
$1,000 cash each December 31 for three years.
How much would you need to deposit today at an annual
interest rate of 10% to make each $1,000 payment?
a. $3,000.00
The consecutive equal payment amount is
b. $2,910.00
$1,000.
c. $2,700.00 i = 10% & n = 3 years
d. $2,486.85 Using the Present Value of an Annuity table,
the factor is 2.48685.
$1,000 × 2.48685 = $2,486.85
9-41
Illustration of an Annuity over Time
Assume you purchase a piece of equipment and agree to pay $1,000 cash
each December 31 for three years. How much would you need to deposit
today at an annual interest rate of 10% to make each $1,000 payment?
The amount of the deposit, which is the present value of the annuity, is
$2,486.85.
The following chart shows the balance in the account as the $1,000
payment is made each year:
9-42
Required:
In (a), determine the present value of the debt.
9-43
9-44
9-45
Learning Objectives 9-6 and 9-8
9-6 Report long-term liabilities

9-8 Apply the present value concept to the reporting of long-term
liabilities.
Lecture Exercise: M9-12
9-46
46
9-47
47
Long-Term Liabilities
Long-term liabilities include all obligations not classified as current
liabilities, such as long-term notes payable and bonds payable.
Maturity = 1 year or less Maturity > 1 year
Current Liabilities Long-Term Liabilities
Secured debt: when creditors require the borrower to pledge

specific assets as security for long-term liabilities.
Unsecured debt: when the lender relies on the borrower’s
integrity and general earning power to repay the loan.
9-48
Long-Term Notes Payable and Bonds
Companies can raise capital from a number of

financial service organizations in a private placement
(notes payable).
Banks Insurance Companies Pension Plans
If a company needs more capital than any single

creditor can provide, the company may issue publicly
traded bonds to the public (bonds payable).
9-49
Accounting Applications of Present Values (1 of 3)
• On January 1, 2022, Starbucks bought new delivery trucks by
signing a note and agreeing to pay $200,000 on December 31,
2023.
• This note is a “non-interest-bearing-note” because no interest
payments are required over the life of the note. The interest is
built into the final payment.
• Assume that the market interest rate applicable to the note is
12%.
• Compute the present value of the single amount to be paid in
the future:
$200,000 × 0.79719 = $159,438
9-50
Record the purchase of the delivery truck.
At the end of each year, record the implied interest expense.

Interest for 2022 is calculated as follows: $159,438 × 0.12 = $19,133
Interest for 2023 is calculated as follows:

$159,438 + $19,133 = $178,571 × 0.12 = $21,429.
9-51
Initial loan balance $ 159,438

Interest added 12/31/2022 19,133
Interest added 12/31/2023 21,429
Loan balance at end of loan $ 200,000
At the end of two years (12/31/2023), repay the loan amount.
9-52
Computing the Amount of a Liability with an Annuity (1 of 3)
On 1/1/2022, Starbucks purchased espresso machines with a note payable
to be paid off in three end-of-year payments of $163,685. Each payment
includes principal plus interest on any unpaid balance. The annual interest
rate is 11%. What is the present value of this annuity?
a. $399,999
b. $407,060 The annuity payment is $163,685.
c. $450,783 i = 11% & n = 3 years
d. $491,055 Using the Present Value of an Annuity table,
the factor is 2.44371.
$163,685 × 2.44371 = $399,999
The present value of the note is the amount the company must
deposit today at 11% interest to cover the $163,685 payments.
9-53
Record the purchase of the espresso machines:
Calculate interest expense for the first year:

$399,999 note payable balance × 0.11 annual interest rate = $44,000
interest expense.
At the end of the first year the company makes this journal entry:
The remaining payable balance after recording this entry is $280,314

($399,999 − $119,685 = $280,314).
9-54
Calculate interest expense for the second year:
$280,314 note payable balance * 11% annual interest rate = $30,835
interest expense. The remaining payable balance after recording this
entry is $147,464.
Calculate interest expense for the third year:

$147,464 note payable balance * 11% annual interest rate = $16,221
interest expense.
The remaining Note payable balance after recording this entry is $0.
9-55
Present Values Involving Both an Annuity and a Single
Payment
Starbucks bought new coffee roasting equipment and agreed to pay the
supplier $1,000 per month for 20 months and an additional $40,000 at the
end of 20 months. The supplier charges 12 percent interest per year, or 1%
per month.
Step 1: Compute the present value of the annuity using Appendix E. The
factor of 18.04555 is based on the interest rate of 1 percent over 20
periods.
$1,000 × 18.04555 = $18,046
Step 2: Compute the present value of the single payment using Appendix E.
The factor of 0.81954 is based on the interest rate of 1 percent over 20
periods.
$40,000 × 0.81954 = $32,782
Step 3: Add the two amounts to determine the present value of the total
obligation.
$18,046 + $32,782 = $50,828
9-56
9-2 Accounts payable turnover ratio (pg 472 in textbook)

Debt-to-equity ratio, Times interest earned (pg 694 in textbook)
Lecture Exercise: P9-7; M13-8
9-57
Accounts Payable Turnover
Accounts Payable = Cost of Goods ÷ Average Accounts

Turnover Sold Payable
Measures how quickly management is paying its suppliers.

A high accounts payable ratio normally suggests that a company is paying its
suppliers in a timely manner.
The 2020 accounts payable turnover ratio for Starbucks was 7.04.
The ratio is more intuitive by dividing it into the number of days in a year:
Average Days to pay payables = 365 Days ÷ Accounts Payable Turnover Ratio
9-58
9-59
9-60
Understanding the Business
The acquisition of assets is financed from two sources:
CAPITAL STRUCTURE
Debt
Funds from Equity
Funds from owners
creditors
From the firm’s perspective, debt is considered riskier than equity.
Debt payments are legal obligations.

If a company cannot make the required debt payment, creditors
can force bankruptcy and require the sale of assets.
9-61
Times Interest Earned Ratio
This ratio compares the income available to pay interest in a period to a

company’s interest obligation for the same period.
This ratio indicates a margin of protection for creditors. Interest expense
and income tax expense are included in the numerator because these
amounts are available to pay interest.
A high ratio indicates a secure position for creditors.

In fiscal 2020, The Home Depot generated $13.60 in income for
each $1.00 of interest expense.
Some analysts believe that the times interest earned ratio is

flawed because interest expense is paid in cash, not with net
income. These analysts prefer to use the cash coverage ratio.
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 9-62
Debt-to-Equity Ratio
This ratio expresses a company’s debt as a proportion of its
stockholders’ equity.
In fiscal 2020, for each $1.00 of stockholders’ equity, The Home

Depot had $20.39 of liabilities.
Debt is risky because interest payments must be made even if the

company has not earned sufficient income to pay them.
In contrast, dividends are always at the company’s discretion and are
not legally enforceable until they are declared.
Comparison with Lowes: Lowe’s debt-to-equity ratio was higher at

$31.52, indicating increased risk compared to The Home Depot.
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 9-63
9-64
9-65
9-66
9-67

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Dr. Olivia Leung chapter 9 Reporting and Interpreting

9-1 Define, measure, and report current liabilities. (P9-1)

9-4 Report contingent liabilities. (P9-6; E9-9)

9-7 Compute and explain present values. (E9-14; AP9-10)

9-2 Accounts payable turnover ratio (pg 475 in textbook)

9-1 Define, measure, and report current liabilities.

Maturity = 1 year or less Maturity > 1 year

Current Liabilities Long-Term Liabilities

Liabilities are recorded at their current cash equivalent,

Employees earn Accrued payroll

Customers pay in Stored value card

Obligations to pay for goods and

Obligations related to expenses that

Obligations arising when cash is

Obligations supported by a formal

A note payable is a formal written contract that specifies:

ØTo the lender, interest is a revenue.

Principal × Annual Interest Rate × Number of Months / 12 Months =

Ø Interest is an expense incurred when companies borrow money.

Assume that on November 1, a company with a December 31 fiscal

On November 1, the note is recorded in the accounts as follows:

9-4 Report contingent liabilities.

e.g. warranty payable

Starbucks sells coffee brewing equipment to customers

Over time, when customers return defective equipment:

(*either to repair the equipment or give cash refund to customer)

A contingent liability is a potential liability that has arisen as the result of a

The probabilities of occurrence are defined in the following manner:

The assessment of future probabilities is inherently subjective,

GAAP defines “probable” as IFRS defines “probable” as

For some contingent liabilities, IFRS would require the reporting of a

9-7 Compute and explain present values.

$1,000 In one year, it will In five years, it will

The value of money can grow over time because

If you deposited $100 today in a savings account that earns 10%

Assume that you need to make a $1,000 cash payment in

The future amount is $1,000.

9-6 Report long-term liabilities

Maturity = 1 year or less Maturity > 1 year

Current Liabilities Long-Term Liabilities

Secured debt: when creditors require the borrower to pledge

Companies can raise capital from a number of

Banks Insurance Companies Pension Plans

If a company needs more capital than any single

At the end of each year, record the implied interest expense.

Interest for 2023 is calculated as follows:

Initial loan balance $ 159,438

At the end of two years (12/31/2023), repay the loan amount.

Calculate interest expense for the first year:

The remaining payable balance after recording this entry is $280,314

Calculate interest expense for the third year:

9-2 Accounts payable turnover ratio (pg 472 in textbook)

Accounts Payable = Cost of Goods ÷ Average Accounts

Measures how quickly management is paying its suppliers.

The acquisition of assets is financed from two sources:

From the firm’s perspective, debt is considered riskier than equity.

Debt payments are legal obligations.

This ratio compares the income available to pay interest in a period to a

A high ratio indicates a secure position for creditors.

Some analysts believe that the times interest earned ratio is

In fiscal 2020, for each $1.00 of stockholders’ equity, The Home