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Summary
Current liabilities consist of denitely determinable liabilities and estimated liabilities.
Denitely determinable liabilities are obligations that can be measured exactly. They
include accounts payable, bank loans and commercial paper, notes payable, accrued
liabilities, dividends payable, sales and excise taxes payable, current portions of long-term
debt, payroll liabilities, and unearned revenues. Denitely determinable liabilities include:
00. Accounts payable are short-term obligations to suppliers for goods and services.
20. Short-term notes payable are current obligations evidenced by promissory notes.
Usually, interest is stated separately on the face of the note.
30. Companies often obtain a line of credit with a bank to nance operations. In addition, a
company may borrow short-term funds by issuing commercial paper (unsecured loans
sold to the public).
00. Accrued liabilities are actual or estimated liabilities that exist at the balance sheet
date but are unrecorded. An end-of-period adjustment is needed to record both
expenses and accrued liabilities.
00. Cash dividends are a distribution of earnings to a corporation’s stockholders.
Dividends payable represent an obligation to distribute a corporation’s earnings to its
stockholders. This arises only when the board of directors declares a dividend.
00. Most states and many cities levy a sales tax on retail transactions, and the federal
government also charges an excise tax on some products. The merchant must collect
the taxes at the time of the sale and record the receipt of cash and the proper tax
liabilities.
00. If a portion of long-term debt is due within the next year and is to be paid from current
assets, then that current portion of long-term debt is classied as a current liability. The
remaining debt is classied as a long-term liability.
00. Payroll liabilities consist of the labor-related obligations incurred by a business. Not only
is the business responsible for wages, paid at an hourly rate, and salaries, paid at a
monthly or yearly rate, earned by its employees, but also it is obligated for items such
as social security (FICA) taxes, Medicare tax, and unemployment taxes. The business is
likewise liable for amounts withheld from its employees’ gross earnings that must be
remitted to governmental and other agencies.
00. Unearned revenues represent obligations to deliver goods or services in return for
advance payment. When delivery takes place, Unearned Revenue is debited and a
revenue account is credited.
Estimated liabilities are denite obligations. Nevertheless, the amount of the obligation
must be estimated at the balance sheet date because the exact gure will not be known
until a future date. Examples of estimated liabilities are income taxes, property taxes,
product warranties, and vacation pay.0
00. A corporation’s income tax is dependent on its taxable net income, a gure that often is
not determined until well after the balance sheet date.
00. Property taxes are levied on real and personal property. Often a company’s accounting
period ends before property taxes are assessed, making it necessary to estimate the
property tax applicable to each month of the year.
00. Promotional costs such as coupons, rebates, and frequent 4yer programs are recorded
as a reduction of sales.
00. Warranties for many of the products or services a company sells will still be in e5ect
during the next accounting period. Nevertheless, the warranty expense and liability
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated,
or posted to a publicly accessible website, in whole or in part.
Chapter 11: Current Liabilities and Fair Value Accounting Instructor’s Manual, p. 2
must be recorded in the period of the sale regardless of when the company makes good
on its warranties. Therefore, at the end of each accounting period, the company should
estimate the future warranty expense that applies to the present period’s sales.
00. In most companies, employees accrue vacation pay for working a certain length of
time. Therefore, the company must estimate the vacation pay applicable to each
payroll period, debit Vacation Pay Expense, and credit Estimated Liability for Vacation
Pay.
The following journal entries are introduced in this section:
Cash XX (amount received)
Notes Payable XX (face amount)
Issued promissory note with interest stated
separately
Notes Payable XX (face amount)
Interest Expense XX (amount incurred)
Cash XX (maturity amount)
Payment of note with interest stated separately
Interest Expense XX (amount accrued)
Interest Payable XX (amount accrued)
To record interest expense on note with interest
stated separately
Cash XX (amount collected)
Sales XX (price charged)
Sales Tax Payable XX (amount to remit)
Excise Tax Payable XX (amount to remit)
Sale of merchandise and collection of sales and
excise taxes
Wages Expense XX (gross amount)
Employees’ Federal Income Taxes Payable XX (amount withheld)
Employees’ State Income Taxes Payable XX (amount withheld)
Social Security Tax Payable XX (employees’ share)
Medicare Tax Payable XX (employees’ share)
Medical Insurance Premiums Payable XX (employees’ share)
Pension Contributions Payable XX (employees’ share)
Wages Payable XX (take-home pay)
To record payroll
Payroll Taxes and Benets Expense XX (total employer payroll taxes)
Social Security Tax Payable XX (employer’s share)
Medicare Tax Payable XX (employer’s share)
Medical Insurance Premiums Payable XX (employer’s share)
Pension Contributions Payable XX (employer’s share)
Federal Unemployment Tax Payable XX (amount incurred)
State Unemployment Tax Payable XX (amount incurred)
To record payroll taxes and other costs
Cash XX (amount prepaid)
Unearned Revenue XX (amount to earn)
Receipt of membership dues in advance
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated,
or posted to a publicly accessible website, in whole or in part.
Chapter 11: Current Liabilities and Fair Value Accounting Instructor’s Manual, p. 3
Unearned Revenue XX (amount earned)
Revenue XX (amount earned)
Recognition of revenue for services provided
Product Warranty Expense XX (estimated amount)
Estimated Product Warranty Liability XX (estimated amount)
To record estimated product warranty expense
Cash XX (fee charged)
Estimated Product Warranty Liability XX (cost of part)
Service Revenue XX (fee charged)
Merchandise Inventory XX (cost of part)
Replacement of part under warranty
Vacation Pay Expense XX (amount incurred)
Estimated Liability for Vacation Pay XX (amount owed or accrued)
Estimated vacation pay expense
Estimated Liability for Vacation Pay XX (amount taken)
Cash (or Wages Payable) XX (amount paid or payable)
Wages of employees on vacation
A contingent liability is a potential liability that may or may not become an actual liability.
The uncertainty regarding its outcome is resolved by the occurrence or nonoccurrence of a
future event. Contingent liabilities arise from pending lawsuits, tax disputes, and failure to
follow government regulations. Contingent liabilities are recorded if the occurrence is
probable and the amount can be reasonably estimated. A commitment is a legal obligation
that does not meet the technical requirements for recognition as a liability. The most
common examples are purchase agreements and leases.
Fair value is the price for which an asset or liability can be sold. The three approaches to
measurement of fair value are the market approach, income (or cash 4ow) approach, and
the cost approach.
Time value of money is the e5ects of the passage of time on holding or not holding
money. The timing of the receipt and payment of cash (measured in interest) should be
considered in making business decisions. Interest is the specic cost measure of these
e5ects for a period of time. The amount of principal plus interest after one or more periods is
known as future value. It may be calculated using either simple interest or compound
interest.
10. Simple interest is the interest cost for one or more periods under the assumption that
the amount on which interest is computed does not increase each period (that is,
interest is not computed on previously earned interest).
20. Compound interest is the interest cost for two or more periods under the assumption
that the amount on which interest is computed does increase each period (that is,
interest is computed on previously earned interest).
Present value is the amount that must be invested now at a given rate of interest to
produce a given future value or values. Present value may be computed on a single sum due
in the future; Exhibit 3 facilitates this computation.
Present value may also be computed on an ordinary annuity. Conceptually, the present
value of an ordinary annuity is that amount that may be invested today at a given
percentage to enable periodic withdrawals of the given amount; Exhibit 4 facilitates this
computation.
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated,
or posted to a publicly accessible website, in whole or in part.
Chapter 11: Current Liabilities and Fair Value Accounting Instructor’s Manual, p. 4
Present value may be used in accounting to (a) determine the value of an asset being
considered for purchase, (b) calculate deferred payments for the purchase of an asset, (c)
account for the investment of idle cash, (d) accumulate funds needed to pay o5 a loan, and
(e) determine numerous other accounting values, such as the value of a bond, pension and
lease obligations, and depreciation.
Relevant Examples and Exhibits
Exhibit 1 Promissory Note
Example: Issuance of Note Payable
Example: Payment of Note with Interest
Example: Recognizing Accrual Interest Expense
Example: Recording Sales and Excise Taxes
Exhibit 2 Illustration of Payroll Costs
Example: Recording Payroll and Related Withholdings
Example: Recording Employer Payroll Taxes and Health Insurance Cost and Pension
Benets
Example: Recording Unearned Revenues
Example: Recognizing Unearned Revenues That Are Now Earned
Example: Recording Product Liability
Example: Recording Product Liability and Service
Example: Recording Vacation Pay Expense
Example: Recording Payment When Vacation is Taken
Example: Future Value Using Simple Interest
Example: Future Value Using Compound Interest
Example: Present Value
Exhibit 3 Present Value of $1 to Be Received at the End of a Given Number of Periods
Example: Present Value of an Ordinary Annuity
Exhibit 4 Present Value of an Ordinary $1 Annuity Received in Each Period for a Given
Number of Periods
Example: Present Value When Compounding Period Is Less than One Year
Example: The Present Value of an Asset
Example: Present Value of a Deferred Payment
Exhibit 5 Accrued Expenses and Related Accrued Liabilities
Teaching Strategy
After you dene denitely determinable and estimated liabilities, ask students to identify
several examples of each.
Short Exercise 2 and Exercise 2A pertain to interest expense. Short Exercise 3 and Exercise
4A pertain to payroll concepts and entries.
Discuss the concept of uncertainty and the desire to follow the matching principle at the
expense of perfect accuracy.
Students may also have diEculty understanding the topic of property tax payable. A
time-line diagram by month helps explain prepaid property tax versus estimated property
tax payable.
Students should know that a contingent liability is a possible liability that may or may not
become an actual liability (when a future event occurs or does not occur). Point out that
contingent liabilities such as product warranty liability and vacation pay liability are accrued
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated,
or posted to a publicly accessible website, in whole or in part.
Chapter 11: Current Liabilities and Fair Value Accounting Instructor’s Manual, p. 5
because they are probable, and their amounts can usually be reasonably estimated
(otherwise, just a footnote is required). Have students list some contingent liabilities and
explain why they are described as such. Students should also know that a commitment is a
legal obligation that does not meet the technical requirements for recognition as a liability.
Have students explain why purchase agreements and leases are examples of a commitment.
Cases 2 and 5 are good activities for this topic.
Regarding fair value, although the market and cost approaches are conceptually
straightforward, the income, or cash 4ow, approach requires knowledge of interest and the
time value of money. A good way to begin the topic of the time value of money is by
explaining the basic concept—that it is best to pay out a dollar as far into the future as
possible and to receive a dollar as close to today as possible. Interest is assumed to be
earned on any money currently held (invested).
Make sure your students remember the basic calculation of interest. Then contrast simple
and compound interest using a straightforward example, stressing that compound interest is
built into the time value of money tables. Short Exercise 6 can be used to illustrate the
di5erence between simple and compound interest.
Present value is a diEcult concept for a student to understand. Dene it as the amount that
we would require now to have the equivalent of some other amount payable or receivable in
the future. When working out an example, prove that the present value amount determined
will grow to the given future value amount at the chosen interest rate. For an annuity,
demonstrate that the present value invested in the bank will enable one to withdraw the
given annual amounts with zero remaining. Short Exercise 7 and Exercises 9A through 11A
pertain to present values.
By this time, students should understand that comparing current amounts with future
amounts is like comparing apples and oranges. Make sure to present situations that rely on
present value calculations for their logical valuation on the books, such as valuing an asset
or calculating deferred payments. Short Exercise 8 and Exercises 12A through 14A provide
several applications of present values. Case 3 provides a good group activity that combines
the time value of money with estimated liabilities.
Section 3: Business Applications
Business Applications
Liquidity
Cash 4ows
Lecture Outline
I. Failure to manage the cash 4ows related to current liabilities can have serious
consequences for a business.
A. The operating cycle is the length of time it takes to purchase inventory, sell
inventory, and collect the resulting receivable.
B. Analysts often use working capital and current ratio as measures of liquidity.
1. Working Capital = Current Assets – Current Liabilities
2. Current Ratio = Current Assets ÷ Current Liabilities
C. Measurements commonly used to assess a company’s ability to pay within a
certain time frame are payables turnover and days’ payable.
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated,
or posted to a publicly accessible website, in whole or in part.
Chapter 11: Current Liabilities and Fair Value Accounting Instructor’s Manual, p. 6
1. Payables turnover is the number of times, on average, that a company pays
its accounts payable in an accounting period.
2. Payables Turnover = Cost of Goods Sold + Change in Merchandise Inventory
÷ Average Accounts Payable
3. Days’ payable shows how long, on average, a company takes to pay its
accounts payable.
4. Days’ Payable = 365 days ÷ Payables Turnover
Summary
To evaluate a company’s ability to pay its current liabilities, analysts often use two measures
of liquidity, both of which were dened in an earlier chapter:
Working Capital = Current Assets – Current Liabilities
Current Ratio = Current Assets ÷ Current Liabilities
Two common measures of a company’s ability to pay within a certain time frame are the
payables turnover and the days’ payable. The payables turnover is the number of times,
on average, that accounts payable are paid in an accounting period and shows the relative
size of a company’s accounts payable. The days’ payable, on the other hand, shows the
average length of time a company takes to pay its accounts payable.
Management must carefully manage the cash 4ows related to current liabilities; the
appropriate level of liabilities is critical to business success.
Relevant Examples and Exhibits
Example: Working capital and current ratio for Nike
Example: Payables Turnover for Nike
Example: Days’ Payable for Nike
Teaching Strategy
Emphasize the importance of carefully managing cash 4ows related to current liabilities.
Many new businesses fail due to cash 4ow problems and the inability to pay creditors on
time. Explain that creditors use several measures to assess a company’s creditworthiness.
Discuss working capital, the current ratio, payables turnover, and days’ payable in terms of
both what they measure and how they are calculated.
Short Exercise 9 and Exercise 15A apply this section. Case 4 provides for application of the
discussed measures in the evaluation of real companies.
Student Engagement Tactics
10. Assign Case 8 to small groups in class. Use previously established groups or assign
groups randomly. Each group should select a representative to speak for the group.
20. Be clear on the expected output of the learning activity. Identify questions to address
and determine whether written answers are necessary. For example, ask one person
from each group to present one alternative and explain why that alternative would be
best.
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated,
or posted to a publicly accessible website, in whole or in part.
Chapter 11: Current Liabilities and Fair Value Accounting Instructor’s Manual, p. 7
30. Elicit as many alternatives as possible for the class to consider. After each group has
presented one alternative, if time permits, ask if any other alternatives might be
available.
40. Allow groups one or two minutes to consider which alternative they prefer and why. Poll
the class as to their preferred response.
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated,
or posted to a publicly accessible website, in whole or in part.
