Chapter 08 – Current Liabilities
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Chapter 8
Current Liabilities
INSTRUCTOR’S MANUAL
Authors’ Perspectives
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.
PART A: Current Liabilities
LO8-1 Distinguish between current and long-term liabilities.
Current versus Long-Term – 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.
Notes Payable – The discussion of notes payable and the recording of interest expense are
written to parallel the discussion of notes receivable in Chapter 5. See the Flip Side discussion.
Payroll Liabilities – A basic understanding of employee and employer payroll costs is important
Deferred revenue – There is brief coverage of deferred revenues in the context of gift cards and
Chapter 08 – Current Liabilities
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gift card breakage. Using the context of gift cards to discuss deferred revenue is familiar to
students and makes the topic more interesting, which in turn makes it easier for them to grasp the
Sales tax payable – Students are familiar with sales taxes, but they probably haven’t stopped to
realize that at the time of the sale, the company acts as a collection agency for the government.
This creates a current liability (sales tax payable). Of course, not all states have sales taxes, so
PART B: Contingencies
LO8-5 Apply the appropriate accounting treatment for contingencies.
Part B includes coverage of contingencies. One idea is to begin with an example (like Jeeps, Inc.,
discussed at the beginning of Part B) and ask students whether decision makers would be
interested in knowing about contingencies. After generating discussion on the topic, we can then
ANALYSIS
LO8-6 Assess liquidity using current liability ratios.
Liquidity Analysis – 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
Chapter 08 – Current Liabilities
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Self-Study Materials
■ Let’s Review—Notes payable and interest (p. 401).
■ Let’s Review—Deferred revenue (p. 407).
Chapter 08 – Current Liabilities
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Key Points by Learning Objective
Throughout the chapter, Key Points provide quick synopses of the critical pieces of information
students should be understanding. These Key Points are summarized by Learning Objective at
the end of the chapter, providing students with a convenient study guide.
LO8-1 Distinguish between current and long-term liabilities.
In most cases, current liabilities are payable within one year from the balance sheet date, and
LO8-2 Account for notes payable and interest expense.
We record interest expense in the period we incur it, rather than in the period in which we pay it.
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 from customers, it debits Cash and credits Deferred
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.
Chapter 08 – Current Liabilities
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LO8-6 Assess liquidity using current liability ratios.
Working capital is the difference between current assets and current liabilities. The current ratio
Chapter 08 – Current Liabilities
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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
current and long-term liabilities
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
Explain why it is important to distinguish between
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
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
LO8-5
Determine the proper reporting of a contingent gain
5
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
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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
Calculate gift card revenue
5
BE8-8
LO8-4
Record sales tax
5
BE8-9
LO8-4
Report current portion of long-term debt
5
BE8-10
LO8-5
Calculate warranty liability
5
BE8-11
LO8-5
Determine the financial statement effect of a
5
contingent liability
BE8-12
LO8-5
Account for a contingent liability
5
BE8-13
LO8-5
Account for a contingent gain
5
BE8-14
LO8-5
Determine the financial statement effect of a
contingent liability
5
BE8-15
LO8-5
Account for contingent liabilities
5
BE8-16
LO8-6
Calculate current and acid-test ratios
5
BE8-17
LO8-6
Determine effect of transactions on liquidity 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
Analyze and record deferred revenues
15
LO8-4
Record gift card transactions
15
LO8-5
Analyze and record a contingent liability
10
LO8-5
Determine proper treatment of a contingent liability
15
LO8-5
Record warranties
15
LO8-5
Record warranties over two years
15
LO8-5
Analyze disclosure of contingent liabilities
10
LO8-6
Calculate and analyze liquidity ratios
15
Complete the accounting cycle using current
liability transactions
Chapter 08 – Current Liabilities
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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
P8-8A
LO8-5
15
P8-9A
LO8-6
20
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
Buckle, Inc.
AP8-5
20
AP8-6
20
AP8-7
15
20
Chapter 08 – Current Liabilities
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Alternate Let’s Review
Problem #1
Assume Blue Sky Airlines borrows $1,000,000 from Midtown Bank on November 1, 2021,
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, 2021.
3. Record the payment of the note at maturity.
Solution:
1. November 1, 2021
Debit
Credit
Cash
1,000,000
Notes Payable
2. December 31, 2021
Interest Expense ($1,000,000 × 8% × 2/12)
Interest Payable
3. May 1, 2022
Notes Payable
Interest Expense ($1,000,000 × 8% × 4/12)
Interest Payable ($1,000,000 × 8% × 2/12)
Chapter 08 – Current Liabilities
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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 $24 million in season tickets prior to the beginning of the season.
2. Record the revenue recognized after the first home game.
The journal entry to record season ticket sales is:
Chapter 08 – Current Liabilities
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Problem #3
Selected financial data regarding current assets and current liabilities for two competing airlines
are as follows.
($ 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
$6,791
÷
$7,728
=
0.88
Company B
$7,748
÷
$9,797
=
0.79
2.
($ in millions)
Quick
Assets
÷
Total
Current
Liabilities
=
Acid-Test
Ratio
Company A
$5,925
÷
$7,728
=
0.77
Company B
$6,575
÷
$9,797
=
0.67
Chapter 08 – Current Liabilities
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Common Mistakes
Common Mistakes made by students are highlighted in each of the chapters. With greater
awareness of the potential pitfalls, students can avoid making the same mistakes and gain a
deeper understanding of the chapter material.
Common Mistake
September 1 to December 31 includes both September and December, so there are four months.
If you are ever in doubt, count out the months on your fingers. Your fingers never lie.
When calculating the number of months of interest, students sometimes mistakenly subtract
Common Mistake
Many people think FICA taxes are paid only by the employee. The employer is required to
match the amount withheld for each employee, effectively doubling the amount paid into Social
Security.
Common Mistake
Some students incorrectly think the Deferred Revenue account is a revenue account since the
account has the word “Revenue” in the title. As indicated above, Deferred Revenue is a liability
account, not a revenue account.
Common Mistake
for the company selling the goods or service. For the company, sales taxes are simply additional
Some students want to debit Sales Tax Expense. Note that a Sales Tax Expense account does not
Common Mistake
Expense. Remember, the Warranty Liability account is increased when the estimated warranty
liability is recorded but then is reduced over time by actual warranty expenditures.
Some students think the balance in the Warranty Liability account is always equal to Warranty
Common Mistake
positive signal. Companies having difficulty collecting receivables or holding excessive
inventory will also have a higher current ratio. Managers must balance the incentive for strong
liquidity (yielding a high current ratio) with the need to minimize levels of receivables and
inventory (yielding a lower current ratio).
As a general rule, a higher current ratio is better. However, a high current ratio is not always a
Chapter 08 – Current Liabilities
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Decision Points and Decision Maker’s Perspective
Decision Points and Decision Maker’s Perspectives are provided throughout each chapter to give
insight into how measurement and communication of financial accounting information help
decision makers.
Decision Points
Question
Accounting Information
Analysis
line of credit?
and interest rates.
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
Companies are required to disclose all
contingencies, including litigation,
with at least a reasonable possibility
of payment. This information can then
be used to help estimate their
potential financial impact.
Question
Accounting Information
Analysis
have enough cash to
pay current liabilities
as they come due?
and acid-test ratio
or acid-test ratio generally indicates
the ability to pay current liabilities on
a timely basis.
Does the company
Working capital, current ratio,
A high working capital, current ratio,
Decision Maker’s Perspective
Current or Long-Term?
Given a choice, do you suppose management would prefer to report an obligation as a current
liability or a long-term liability? Other things being equal, most managers would choose the
Chapter 08 – Current Liabilities
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Indicators of Liquidity
If the firm’s current ratio or acid-test ratio is lower than that of the industry as a whole, does that
mean liquidity is a problem? Perhaps, but perhaps not. It does, though, raise a red flag that
Chapter 08 – Current Liabilities
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 states 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?
Option 1: Purchase inventory on credit to meet the current ratio
• By purchasing $600,000 of inventory on credit before year-end, the company maintains a
Option 2: Do not intervene and report the current ratio at what it is
• The purchase of additional inventory on credit results in additional costs to the company.