Accounts Payable,

Commitments,
Contingencies, and Risks

Chapter 8
Types of Current Liabilities
• Current liabilities are short-term
obligations that usually must be paid
from current assets within a year.
Three Types of Current
Liabilities
• Obligations to pay cash to another
entity
• Obligations to provide goods or
services to another entity
• Obligations to honor product
warranties
 Current Liabilities
Current Liabilities
Accounts payable - trade $ 859.8
Short term debt 166.4
Accrued compensation and benefits 710.1
Current portion of long-term debt 7.4
Advance payments from customers 362.7
Accrued product warranties 165.6
Accrued income taxes 94.1
Accrued restructuring costs 62.1
Other 562.7
Total current liabilities $2,990.9
Accounts Payable
• Accounts payable represent debts that
the firm incurs in purchasing
inventories and supplies, as well as
amounts that the firm owes for other
services used in its operations.
Accounts Payable

ASSETS = LIABILITIES + OWNERS’ EQUITY

Inventory Accounts
+$100,000 payable
+$100,000
Discounts
• Suppliers often offer discounts to
induce early payment.
Discounts
• If a company purchases $5,000 of
supplies with terms of 2/10, n/30 and
intends to pay within the discount
period, then it generally records the
purchase at the net price (in this case,
$4,900).
Discounts
• If the company fails to pay within the
discount period and must remit the
full $5,000, then the $100 discount not
taken becomes interest expense.
Discounts

ASSETS = LIABILITIES + OWNERS’ EQUITY

Inventory Accounts
+$98,000 payable
+$98,000
Discounts

ASSETS = LIABILITIES + OWNERS’ EQUITY

Inventory Accounts Retained earnings
–$100,000 payable –$2,000
–$98,000 (interest expense)
Notes Payable
• Notes payable are more formal
promises to pay a lender.
• They are usually in writing and
involve payment of interest.
Notes Payable
• Notes may be interest-bearing.
Notes Payable
• When a borrower goes to a bank to
borrow $50,000, he is given the entire
$50,000.
Notes Payable
• At the maturity date, he must repay
not only the principal of $50,000 but
also interest.
Interest-Bearing Note

ASSETS = LIABILITIES + OWNERS’ EQUITY

Cash Notes
+$200,000 payable
+$200,000
Interest-Bearing Note

ASSETS = LIABILITIES + OWNERS’ EQUITY

Cash Notes Retained earnings
–$212,000 payable –$12,000
–$200,000 (interest expense)
Discounted Note
• Notes may also be discounted.
Discounted Note
• A firm signs a note, with an interest
rate of 10%, promising to repay
$50,000 in six months, but receives
only $47,500.
Discounted Note
• The bank has deducted the interest
($50,000 X .10 X 6/12) at the time of
the borrowing.
Discounted Note
• Despite the receipt of $47,500, the
company must repay $50,000 at the
maturity date.
Discounted Note
• At that time the company will
recognize interest expense of $2,500.
Discounted Note

ASSETS = LIABILITIES + OWNERS’ EQUITY

Cash Notes
+$188,000 payable
+$188,000
Discounted Note

ASSETS = LIABILITIES + OWNERS’ EQUITY

Cash Notes Retained earnings
–$200,000 payable –$12,000
–$188,000 (interest expense)
Accrued Liabilities
• Accrued liabilities represent expenses
that have been incurred prior to the
balance sheet date which have been
neither paid nor included with
liabilities as of the balance sheet date.
Accrued Liabilities
• An adjustment, increasing both an
expense and a liability, must be made
at the balance sheet date.
Accrued Liabilities
• For many companies, these accrued
liabilities include accrued wages and
salaries and accrued vacation and sick
pay.
Accrued Liabilities

ASSETS = LIABILITIES + OWNERS’ EQUITY

Accrued Retained earnings
compensation -$160 million
+$160 million (compensation
expense)
Accrued Liabilities

ASSETS = LIABILITIES + OWNERS’ EQUITY

Cash Accrued Retained earnings
–$400 compensation –$240 million
million –$160 million (compensation
expense)
Long-Term Debts
• Long-term debts often have a current
portion or become current as time
goes by.
Long-Term Debts
• An example of the current portion is a
30-year mortgage — each mortgage
payment consists of both principal
and interest.
Long-Term Debts
• On the balance sheet date, the
principal component of the next 12
payments must be classified as a
current liability.
Long-Term Debts
• An example of the become current is a
5-year note payable, a long-term
liability.
Long-Term Debts
• Twelve months before the maturity
date, the entire note must be classified
as a current liability.
Accrued Income Taxes
• Accrued income taxes are certainly a
current liability because they are due
within one year and generally sooner
than that.
Restructuring Costs
• Restructuring costs occur when a
company decides to downsize and to
refocus its operations.
Restructuring Costs
• When a firm decides to restructure,
the total estimated costs of
restructuring are expensed in the
current year.
Restructuring Costs
• This involves increasing both an
expense and a liability.
Accrued Restructuring
Costs

ASSETS = LIABILITIES + OWNERS’ EQUITY

Accrued Retained earnings
restructuring –$271.5 million
costs (restructuring
+$271.5 expense)
million
Accrued Restructuring
Costs

ASSETS = LIABILITIES + OWNERS’ EQUITY

Various Accrued
assets restructuring
–$209.4 costs
million –$209.4 million
Advance Payments from
Customers
• A company may also have obligations
to provide goods or services.
Advance Payments from
Customers
• A magazine publisher is a good
example.
Advance Payments from
Customers
• When a person subscribes to take the
magazine for one year, the company
receives the entire year's subscription
amount in advance.
Advance Payments from
Customers
• The Cash account is increased, as is a
liability account called Advance
Payments from Customers.
Advance Payments from
Customers
• The liability represents the company's
obligation to provide the subscriber
not with money but with a magazine
each month over the next twelve
months.
Advance Payments from
Customers
• As each magazine is sent, the
company reduces its liability and
finally recognizes revenue.
Advance Payments from
Customers

ASSETS = LIABILITIES + OWNERS’ EQUITY

Cash Advance
+$800 payments from
million customers
+$800 million
Advance Payments from
Customers

ASSETS = LIABILITIES + OWNERS’ EQUITY

Advance Retained earnings
payments from +$437.3 million
customers (revenue)
–$437.3 million
Advance Payments from
Customers

ASSETS = LIABILITIES + OWNERS’ EQUITY

Advance Retained earnings
payments from +$362.7 million
customers (revenue)
–$362.7 million
Obligations for Warranties
• Companies usually stand behind the
quality of the products they sell and
offer to repair defective products or to
refund the purchase price.
Obligations for Warranties
• The matching principle dictates that
these possible costs must be matched
with current sales revenues.
Obligations for Warranties
• The future costs must be estimated
and recorded in the period of the sale.
Obligations for Warranties
• This will involve an increase in both
Warranty Expense and Warranty
Obligation.
Obligations for Warranties
• Estimates are derived from the
company's past experience and from
industry averages.
Obligation for Warranty

ASSETS = LIABILITIES + OWNERS’ EQUITY

Warranty Retained earnings
obligation –$165.6 million
+$165.6 million (warranty expense)
Obligation for Warranty

ASSETS = LIABILITIES + OWNERS’ EQUITY

Cash Warranty
–$165.6 obligation
million -$165.6 million
Accounts Payable,
Commitments,
Contingencies, and Risks

End of Chapter 8