978-0078025549 Chapter 8 Lecture Note Part 1

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Chapter 8

Current Liabilities

INSTRUCTOR’S MANUAL

Learning Objectives

 LO8-1 Distinguish between current and long-term liabilities.

 LO8-2 Account for notes payable and interest expense.

 LO8-3 Account for employee and employer payroll liabilities.

 LO8-4 Explain the accounting for other current liabilities.

 LO8-5 Apply the appropriate accounting treatment for contingencies.

Analysis

 LO8-6 Assess liquidity using current liability ratios.

Teaching Suggestions

Chapter 8 is the shortest chapter in the book. It is a welcome relief for students from the more challenging

material on receivables, inventory, and long-term assets in Chapters 5, 6, and 7. The first part of Chapter 8

focuses on current liabilities beginning with a discussion of how we categorize liabilities as either current

or long-term. In most cases, current liabilities are payable within one year and long-term liabilities are

payable more than one year from the balance sheet date being examined. It’s helpful to point out why

categorizing liabilities between current and long-term is important. Distinguishing between current and

long-term liabilities helps investors and creditors assess the riskiness of a business’s obligations. Given a

choice, most companies would prefer to report a liability as long-term rather than current because it may

cause the firm to appear less risky.

Part A then proceeds with a discussion of notes payable and the recording of interest expense. The

discussion is written to parallel the discussion of notes receivable in Chapter 5. Payroll liabilities are

covered in more detail than competing texts. A basic understanding of employee and employer payroll

costs is important for all business students, not just accounting majors, as many students will someday

make employment decisions. Other current liabilities specifically addressed include unearned revenues,

sales tax payable, and the current portion of long-term debt.

Part B includes coverage of contingencies and ends with liquidity analysis. Contingent liabilities are

also covered in greater detail than competing textbooks. Reviewer feedback on this section has been very

positive. One idea is to begin with an example (like Jeeps, Inc., discussed at the beginning of Part B) to

generate discussion on the topic, review the reporting guidelines, and then refer back to the example and

have students determine the proper reporting of the contingency. It’s also fun to discuss the flip side (i.e.,

the plaintiff rather than the defendant in a pending lawsuit) and the nonparallel treatment of gains in

relation to losses.

The chapter concludes with a section on liquidity analysis. Working capital, the current ratio and the

acid-test ratio are calculated for two competing companies in the airline industry. As expected, the

liquidity ratios for United Airlines were better than those for American Airlines (American Airlines went

into bankruptcy as this edition went to print.) The decision maker’s perspective in this section is

interesting as it points out that a higher liquidity ratio is not always better. Management may be very

efficient so that some current assets—receivables or inventory—remain at minimum amounts. This is ood

for the company overall, but it may result in less impressive current and acid-test ratios.

Assignment Charts

Questions

Learning

Objective(s) Topic

Time

(Min.)

1 LO8-1 Describe the essential characteristics of liabilities 5

2 LO8-1 Define current and long-term liabilities 5

3 LO8-1 Explain why it is important to distinguish between

current and long-term liabilities

4 LO8-1 Provide several examples of current liabilities in the

airline industry

5 LO8-2 Explain why we record interest in the period in which we

incur it rather than in the period we pay it

6 LO8-2 Describe how a line of credit works 5

7 LO8-2 Explain how commercial paper differs from an ordinary

bank loan

8 LO8-3 Identify at least four items withheld from employee

payroll checks

9 LO8-3 Identify at least four employer costs in addition to the

employee’s salary

10 LO8-3 Explain how the deduction for Social Security and

Medicare is computed

11 LO8-4 Explain how companies account for the sale of gift

certificates

12 LO8-4 Describe entries to record unearned revenue 5

13 LO8-4 Provide the journal entry to record sales with sales tax 5

14 LO8-4 Describe how a note payable is presented within current

and long-term liabilities

15 LO8-5 Define a contingent liability and give three common

examples

16 LO8-5 List and briefly describe the three categories of

likelihood for a contingent liability

17 LO8-5 Explain under what circumstances a firm should report a

contingent liability

18 LO8-5 Determine the proper reporting of a contingent liability 5

19 LO8-5 Determine the proper reporting of a contingent liability 5

20 LO8-5 Determine the proper reporting of a contingent gain 5

21 LO8-6 Define liquidity and explain how it is evaluated 5

22 LO8-6 Explain the difference between the current ratio and the

acid-test ratio

23 LO8-6 Explain how transactions affect the current ratio and the

acid-test ratio

Brief Exercises

Learning

Objective(s) Topic

Time

(Min.)

BE8-1 LO8-2 Record notes payable 5

BE8-2 LO8-2 Record notes receivable 5

BE8-3 LO8-2 Determine interest expense 5

BE8-4 LO8-2 Record commercial paper 5

BE8-5 LO8-3 Calculate FICA taxes 5

BE8-6 LO8-4 Record unearned revenues 5

BE8-7 LO8-4 Record sales taxes 5

BE8-8 LO8-4 Report current portion of long-term debt 5

BE8-9 LO8-5 Calculate warranty liability 5

BE8-10 LO8-5 Determine the financial statement effect for a contingent

liability

BE8-11 LO8-5 Account for a contingent liability 5

BE8-12 LO8-5 Account for a contingent gain 5

BE8-13 LO8-5 Determine the financial statement effect of a contingent

liability

BE8-14 LO8-5 Account for contingent liabilities 5

BE8-15 LO8-6 Calculate current and acid-test ratios 5

Exercises

Learning

Objective(s) Topic

Time

(Min.)

E8-1 LO8-1 Determine proper classification of liabilities 10

E8-2 LO8-2 Record notes payable 15

E8-3 LO8-2 Record notes payable 15

E8-4 LO8-2 Record notes receivable 15

E8-5 LO8-2 Determine interest expense 10

E8-6 LO8-2 Record a line of credit 10

E8-7 LO8-3 Calculate payroll withholdings and payroll taxes 15

E8-8 LO8-3 Record payroll 15

E8-9 LO8-3 Record payroll 15

E8-10 LO8-4 Analyze and record unearned revenues 15

E8-11 LO8-4 Record unearned revenue 10

E8-12 LO8-5 Analyze and record a contingent liability 10

E8-13 LO8-5 Determine proper treatment of a contingent liability 15

E8-14 LO8-5 Record warranties 15

E8-15 LO8-5 Analyze disclosure of contingent liabilities 10

E8-16 LO8-6 Calculate and analyze liquidity ratios 15

Problems

Learning

Objective(s) Topic

Time

(Min.)

P8-1A LO8-1 Review current liability terms and concepts 15

P8-2A LO8-2 Record notes payable and notes receivable 30

P8-3A LO8-3 Record payroll 20

P8-4A LO8-3 Record payroll 20

P8-5A LO8-4 Record unearned revenues 15

P8-6A LO8-4 Record unearned revenues and sales taxes 15

P8-7A LO8-5 Record contingencies 15

P8-8A LO8-5 Record contingencies 15

P8-9A LO8-6 Calculate and analyze ratios 20

P8-1B LO8-1 Review current liability terms and concepts 15

P8-2B LO8-2 Record notes payable and notes receivable 30

P8-3B LO8-3 Record payroll 20

P8-4B LO8-3 Record payroll 20

P8-5B LO8-4 Record unearned revenues 15

P8-6B LO8-4 Record unearned revenues and sales taxes 15

P8-7B LO8-5 Record contingencies 15

P8-8B LO8-5 Record contingencies 15

P8-9B LO8-6 Calculate and analyze ratios 20

Additional

Perspectives Topic

Time

(Min.)

AP8-1 Continuing Problem: Great Adventures 15

AP8-2 Financial Analysis: American Eagle Outfitters, Inc. 20

AP8-3 Financial Analysis: The Buckle, Inc. 20

AP8-4 Comparative Analysis: American Eagle Outfitters, Inc., vs. The Buckle,

Inc.

AP8-5 Ethics 20

AP8-6 Internet Research 20

AP8-7 Written Communication 15

AP8-8 Earnings Management 20

Chapter Quiz Questions

The following multiple-choice questions are 10 unique quiz questions that correspond to the 10 questions

at the end of each chapter. Each question covers the same learning objective but with a little different

twist. The correct answer is highlighted in bold for each item.

LO8-1

1. Which of the following statements regarding liabilities is true?

a. Liabilities are always payable in cash.

b. Liabilities are all reported as current in the balance sheet.

c. Liabilities result from future transactions.

d. Liabilities represent probable future sacrifices of benefits.

LO8-1

2. Which of the following is not a characteristic of a liability?

a. It represents a probable, future sacrifice of economic benefits.

b. It must be payable in cash.

c. It arises from present obligations to other entities.

d. It results from past transactions or events.

LO8-2

3. If Executive Airways borrows $10 million on September 1, 2015, for one year at 6% interest, how

much interest expense does it record for the year ended December 31, 2015?

a. $0.

b. $150,000.

c. $200,000.

d. $600,000.

LO8-2

4. On November 1, 2015, a company signed an $200,000, 12%, six-month note payable with the amount

borrowed plus accrued interest due six months later on May 1, 2016. The company should report the

following adjusting entry at December 31, 2015:

a. Debit interest expense and credit interest payable, $4,000.

b. Debit interest expense and credit cash, $4,000.

c. Debit interest expense and credit interest payable, $12,000.

d. Debit interest expense and credit cash, $12,000.

LO8-3

5. Which of the following is paid by both the employee and the employer?

a. FICA taxes.

b. Federal unemployment taxes.

c. State unemployment taxes.

d. Personal income taxes.

LO8-4

6. When a product or service is delivered to a customer that previously paid in advance, the delivery is

recorded as:

a. A debit to a revenue and a credit to a liability account.

b. A debit to a revenue and a credit to an asset account.

c. A debit to an asset and a credit to a revenue account.

d. A debit to a liability and a credit to a revenue account.

LO8-5

7. Management can estimate the amount of loss that will occur due to litigation against the company. If

the likelihood of loss is probable, a contingent liability should be

a. disclosed but not reported as a liability.

b. disclosed and reported as a liability.

c. neither disclosed or reported as a liability.

d. reported as a liability but not disclosed.

LO8-5

8. Allied Partners filed suit against Big Sky, Inc., seeking damages for patent infringement. Big Sky’s

legal counsel believes it is probable that Big Sky will settle the lawsuit for an estimated amount in the

range of $500,000 to $700,000, with all amounts in the range considered equally likely. How should

Big Sky report this litigation?

a. As a liability for $700,000 with disclosure of the range.

b. As a liability for $600,000 with disclosure of the range.

c. As a liability for $500,000 with disclosure of the range.

d. As a disclosure only. No liability is reported.

LO8-6

9. The current ratio is

a. current assets divided by current liabilities.

b. current liabilities divided current assets.

c. cash, short-term investments, and accounts receivable divided by current liabilities.

d. cash, short-term investments, accounts receivable, and inventory divided by current liabilities.

LO8-6

10. Assuming a current ratio of 1.0 and an acid-test ratio of 0.75, how will the borrowing of cash to be

paid back in five years affect each ratio?

a. Increase the current ratio and increase the acid-test ratio.

b. No change to the current ratio and decrease the acid-test ratio.

c. Decrease the current ratio and decrease the acid-test ratio.

d. Increase the current ratio and decrease the acid-test ratio.