Chapter 08 – Current Liabilities
8-1
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.
Chapter 08 – Current Liabilities
8-2
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 company’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 a bit 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 deferred 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—
United Airlines vs. American Airlines. The decision maker’s perspective in this section 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 good for
the company overall, but it may result in less impressive current and acid-test ratios.
Chapter 08 – Current Liabilities
8-3
A
As
ss
si
ig
gn
nm
me
en
nt
t
C
Ch
ha
ar
rt
ts
s
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
5
4
LO8-1
Provide examples of current liabilities in the airline
industry
5
5
LO8-2
Explain why we record interest in the period in
which we incur it rather than in the period we pay it
5
6
LO8-2
Describe how a line of credit works
5
7
LO8-2
Explain how commercial paper differs from an
ordinary bank loan
5
8
LO8-3
Identify at least four items withheld from employee
payroll checks
5
9
LO8-3
Identify at least four employer costs in addition to
the employee’s salary
5
10
LO8-3
Explain how the deduction for Social Security and
Medicare is computed
5
11
LO8-4
Explain how companies account for the sale of gift
certificates
5
12
LO8-4
Describe entries to record deferred 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
5
15
LO8-5
Define a contingent liability and give three common
examples
5
16
LO8-5
List and briefly describe the three categories of
likelihood for a contingent liability
5
17
LO8-5
Explain under what circumstances a firm should
report a contingent liability
5
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
5
23
LO8-6
Explain how transactions affect the current ratio and
the acid-test ratio
5
Chapter 08 – Current Liabilities
8-4
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 deferred revenues
5
BE8-7
LO8-4
Record sales tax
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
5
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
5
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 deferred revenues
15
E8-11
LO8-5
Analyze and record a contingent liability
10
E8-12
LO8-5
Determine proper treatment of a contingent liability
15
E8-13
LO8-5
Record warranties
15
E8-14
LO8-5
Analyze disclosure of contingent liabilities
10
E8-15
LO8-6
Calculate and analyze liquidity ratios
15
E8-16
LO8-1, 8-2,
8-4, 8-6
Complete the accounting cycle using current
liability transactions
60
Chapter 08 – Current Liabilities
8-5
Problems
Learning
Objective(s)
Time
(Min.)
P8-1A
LO8-1
15
P8-2A
LO8-2
30
P8-3A
LO8-3
20
P8-4A
LO8-3
20
P8-5A
LO8-4
15
P8-6A
LO8-4
15
P8-7A
LO8-5
15
P8-8A
LO8-5
15
P8-9A
LO8-6
20
P8-1B
LO8-1
15
P8-2B
LO8-2
30
P8-3B
LO8-3
20
P8-4B
LO8-3
20
P8-5B
LO8-4
15
P8-6B
LO8-4
15
P8-7B
LO8-5
15
P8-8B
LO8-5
15
P8-9B
LO8-6
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.
25
AP8-5
Ethics
20
AP8-6
Internet Research
20
AP8-7
Written Communication
15
AP8-8
Earnings Management
20
Chapter 08 – Current Liabilities
8-6
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?
LO8-1
2. Which of the following is not a characteristic of a liability?
LO8-2
3. If Executive Airways borrows $10 million on September 1, 2018, for one year at 6% interest,
how much interest expense does it record for the year ended December 31, 2018?
LO8-2
4. On November 1, 2018, a company signed a $200,000, 12%, six-month note payable with the
amount borrowed plus accrued interest due six months later on May 1, 2019. The company
LO8-3
5. Which of the following is paid by both the employee and the employer?
Chapter 08 – Current Liabilities
8-7
LO8-4
6. When a product or service is delivered to a customer that previously paid in advance, the
delivery is recorded as:
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:
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?
LO8-6
9. The current ratio is:
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?
Chapter 08 – Current Liabilities
Alternate Let’s Review
Problem #1
Assume Blue Sky Airlines borrows $1,000,000 from Midtown Bank on November 1, 2018,
signing an 8%, six-month note payable.
Required:
1. Record the issuance of the note.
2. Record the appropriate adjusting entry for the note on December 31, 2018.
3. Record the payment of the note at maturity.
Solution:
1. November 1, 2018
Debit
Credit
Cash
Notes Payable
1,000,000
2. December 31, 2018
Interest Expense ($1,000,000 x 8% x 2/12)
Interest Payable
3. May 1, 2019
Notes Payable
1,000,000
Interest Expense ($1,000,000 x 8% x 4/12)
Interest Payable ($1,000,000 x 8% x 2/12)
Problem #2
The Nebraska Cornhuskers football stadium has a seating capacity of about 81,000. The
Cornhuskers hold six regular season games at home. Nebraska season football tickets have sold
out each year for almost 50 years. Let’s assume the Cornhuskers collect $24 million in season
ticket sales prior to the beginning of the season.
Required:
1. Record the sale of $24 million in season tickets prior to the beginning of the season.
2. Record the revenue recognized after the first home game.
The journal entry to record season ticket sales is:
($ in millions)
8-10
Problem #3
Selected financial data regarding current assets and current liabilities for two competing airlines
are as follows.
($ in millions)
Company A
Company B
Current Assets
Cash and Cash Equivalents
$911
$5,044
Short-Term Investments
4,246
71
Net Receivables
768
1,460
Inventory
557
327
Other Current Assets
309
846
Total Current Assets
$6,791
$7,748
Current Liabilities
Accounts Payable
$3,103
$3,437
Short/Current Long-Term Debt
1,194
1,672
Other Current Liabilities
3,431
4,688
Total Current Liabilities
$7,728
$9,797
Required:
1. Calculate the current ratio for both airlines. Which has the better current ratio?
2. Calculate the acid-test (quick) ratio for both airlines. Which has the better acid-test ratio?
Solution:
1.
($ in millions)
Total
Current
Assets
÷
Total
Current
Liabilities
=
Current
Ratio
Company A
=
0.88
Company B
=
0.79
2.
($ in millions)
Quick
Assets
÷
Total
Current
Liabilities
=
Acid-Test
Ratio
Company A
=
0.77
Company B
=
0.67
Chapter 08 – Current Liabilities
8-11
Key Points by Learning Objective
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.
Employee salaries are reduced by withholdings for federal and state income taxes, FICA taxes,
LO8-4 Explain the accounting for other current liabilities.
When a company receives cash in advance, it debits Cash and credits Deferred Revenue, a
current liability account. When it earns the revenue, the company debits Deferred Revenue and
credits Sales Revenue.
LO8-5 Apply the appropriate accounting treatment for contingencies.
A contingent liability is recorded only if a loss is probable and the amount is reasonably
estimable.
Analysis
LO8-6 Assess liquidity using current liability ratios.
Chapter 08 – Current Liabilities
8-12
Chapter 08 – Current Liabilities
8-13
Common Mistakes
Common Mistake
December (month 12) from September (month 9) and get three months. However, the time from
When calculating the number of months of interest, students sometimes mistakenly subtract
Common Mistake
Common Mistake
Common Mistake
Some students want to debit Sales Tax Expense. Note that a Sales Tax Expense account does not
Common Mistake
Some students think the balance in the Warranty Liability account is always equal to Warranty
Common Mistake
As a general rule, a higher current ratio is better. However, a high current ratio is not always a
Chapter 08 – Current Liabilities
8-14
Decision Points
Question
Accounting Information
Analysis
How can you tell the
Notes to the financial
Companies are required to disclose
Question
Accounting Information
Analysis
Is the company
involved in any
litigation?
Notes to the financial
statements
Question
Accounting Information
Analysis
Does the company
Working capital, current ratio,
A high working capital, current ratio,
Companies are required to disclose all
contingencies, including litigation,
with at least a reasonable possibility
Chapter 08 – Current Liabilities
8-15
Career Corner
Career Corner
When comparing compensation among different career opportunities, don’t base your final
decision on salary alone. Various employers offer fringe benefits—also called “perquisites,” or
“perks”—that catch the attention of would-be employees: a pound of coffee every month at
Starbucks, free skiing for employees at Vail Ski Resort, or scuba and kayaking in the pool at
Chapter 08 – Current Liabilities
8-16
Ethical Dilemma
Ethical Dilemma
Airport Accessories (AA) has several loans outstanding with a local bank. The loan contract
contains an agreement that AA must maintain a current ratio of at least 0.90. Micah, the assistant
controller, estimates that the year-end current assets and current liabilities will be $2,100,000 and
$2,400,000, respectively. These estimates provide a current ratio of only 0.875. Violation of the
debt agreement will increase AA’s borrowing costs because the loans will be renegotiated at
higher interest rates.
Key Issues
• Purchasing inventory on credit increases the current ratio above the agreement in the loan
contract that AA must maintain a current ratio of at least 0.90.
• Is it ethical to manipulate the current ratio in order to meet a contract obligation?