Lecture 7 - Current Liabilities

Current Liabilities

Days in payables and Payables Turnover are not being covered on the exam and are being skipped in class.

What is a liability? It's an obligation that will require the future resources of the firm.

Typically, what creates a liability is the recognition of an expense. Liabilities are recognized once the firm has an obligation to pay.

By convention, executory contracts are not considered as liabilities and do not appear on the balance sheet. Similarly, lease payments are not reflected on the books as a liability.

Categories of Liabilities

Definitely determinable liabilities: The amount of the liability is clear.

Estimated liabilities: Liabilities which must be estimated in order to know their amounts. Ex: warranty expenses. They're recognized now (even though it's not known if or how much warranty service will need to be delivered) due to the matching principle. Since the sale generated the liability, recognize it at the time of sale.

Contingent Liabilities: Liabilities that may not come into existence. Ex: pending law suits which, if the firm loses, will need to be paid.

Examples of liability accounts

Accounts Payable - There is usually a main, "control" account and subsidiary accounts.

Notes Payable - interest is sometimes stated separately. See class slides for the journal entries for separately stated interest on a loan that was taken, the end of year adjustments and finally the load payoff. (We're skipping the non-separately state interest.)

Liabilities Terminology

Line of credit - An agreement in advance that a bank will lend the firm funds as needed, if the firm maintains good standing with the bank. Not on the balance sheet, but it is disclosed in footnotes. If you use the line of credit, that amount appears under "Notes payable".

Commercial paper - Appears on balance sheet as "Notes payable". (For the lender, it appears as "marketable securities" or "notes receivable" as an asset.)

Accrued liabilities - results from accrued expenses at the end of the year.

Dividends payable - There are 3 associated dates: declaration date, date of record, payment date. The declaration date is the date that the Board of Directors decides that stockholders on the date of record will receive the dividend. The actual payment date may be later.

On the declaration date, Debit Dividends, Credit Dividends payable. Dividends payable is now a current liability. No entry required on the date of record. On the payment date, Debit Dividends payable, Credit Cash.

The "x-dividend" date is the day after the date of record. It indicates that purchasers of the stock on that date (and onward) are no longer entitled to the (current) dividend.

Check with earnings.com. The x-dividend date on earnings.com may be a few days before the date of record because there is a few days lag time between the sale on the exchange and the recording of the sale on the firm's books.

Sales taxes payable: On a sale of a $1 item with 10% tax, the original sale was a Dr. to Cash for $1.10. We need to Cr Sales (revenue account) $1.00 and also Cr. Sales Tax Payable for $0.10.

(ACE Question - Answer is D)

Payroll and Payroll Taxes

The issues with payroll are: What are the accounts? Who pays - employer or employee?

Typical entry is:
Debit Wage Expense
and
Credit all the following accounts -
- employee's FIT (federal income tax) payable - employer must withhold that is expected and send it to the federal government (within 3 days for large employers) not an expense, it's a liability
- employee's SIT (state income tax) payable
- Soc Sec tax payable
- Medicare tax payable - soc sec and medicare total is 7.65%
- Medical insurance payable - employee's contribution to the plan
- Pension contributions payable
- Wages payable or cash - aka take-home pay to the employee

The second major entry is the following
Debit Payroll taxes and benefits expenses
and
Credit all the following accounts
- Soc Sec tax payable (the employer's contribution)
- Medicare tax payable
- Medical insurance payable (if offered by the employer)
- Pension contributions payable (if offered by the employer)
- FUTA payable (Federal unemployment tax) only imposed on the employer, not employee. But the employee gets the benefit, if the employee becomes unemployed.
- SUTA payable (State unemployment tax), state fund generally pays, but if the state fund goes bankrupt, the fed fund pays.