Financial Accounting

Eleventh Edition
Global Edition

Chapter 9
Liabilities

Chapter 8 is skipped in ACCT1111.

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Course Overview
Details of common asset accounts:
➢Cash: Bank Reconciliation ✓
➢Receivables: Impairment & notes interests ✓
➢Inventory ✓
➢Property, plant and equipment ✓
Details of common liability accounts (This Lecture)
Details of equity (Lecture 9)
Details of Statement of Cash Flow (Lecture 10)

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Learning Objectives
9.1 Understand the various types of liabilities
9.2 Account for contingent liabilities
9.3 Account for bonds (omitted)
9.4 Account for leases (brief mention)
9.5 Analyze the advantages and disadvantages of borrowing
9.6 Evaluate a company’s debt-paying abilities

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Learning Objective 9.1
Understand the various types of liabilities

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Understand the Various Types of
Liabilities (1 of 20)
The Conceptual Framework defines liability as
• Obligations to transfer economic resources
• Two kinds:
– If short-term → current liability
– If long-term → non-current liability
– Short/long term is determined by whether the liability is
to be settled with cash within the next fiscal year

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Account for Current and Contingent
Liabilities (2 of 20)
Current Liabilities
• Accounts payable
• Payables resulted from accrued liabilities (or accrued
expenses)
• Deposits
• Unearned revenues
• Payroll-related liabilities (including pensions)

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Understand the Various Types of
Liabilities (3 of 20)
Current Liabilities
• Sales tax payable
• Tax payable
• Provisions
• Notes payable
• Debt/Bonds

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Understand the Various Types of
Liabilities (4 of 20)
Accounts Payable
• Amounts owed for products or services purchased on
account
• Typically very short-term, as credit terms are usually
between 30 to 90 days
• Businesses make most of their purchases on account,
especially for raw materials, supplies, and inventory
• Example: credit purchase of inventory

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Understand the Various Types of
Liabilities (5 of 20)
Accrued Liabilities (or Accrued Expenses)
• Results from an expense that the business has incurred
but not yet paid
• Accrued expenses create a liability
• Example:
– Salaries and Wages Payable
– Interest Payable

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Understand the Various Types of
Liabilities (6 of 20)
Deposits
• Amount of cash received for securing goods and property,
or services such as power supplies and telephone services
• Deposits are typically refundable
• *can be interpreted as refundable unearned revenues
• If the company pays another company deposits, there will
be a deposit assets account. Remember no offsetting is
allowed.

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Understand the Various Types of
Liabilities (7 of 20)
Unearned Revenues
• Business has received cash from customers before
earning the revenue
• Creates a liability – an obligation to provide goods or
services to the customer
• Example: airline tickets

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Understand the Various Types of
Liabilities (8 of 20)
Payroll-related Liabilities
• Also called employee compensation
• Major expense account
• Takes many different forms:
– Salary (calculated monthly)
– Wage (calculated hourly)
– Commission
– Bonus
• Payroll-related tax e.g. withheld salary tax, where
company deduct salary tax from employees’ salary
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Exhibit 9-1 Accounting for Payroll
Expenses and Liabilities
Accounting for all forms of compensation follows the pattern
illustrated here (using assumed figures):

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Understand the Various Types of
Liabilities (9 of 20)
• Pension and Postretirement Liabilities
– Employee compensation that will be received during
retirement
– One of the most complex areas of accounting
– Obligation for future pension payments accumulates
over time
– Each period the company must determine if the plan is
over or underfunded by comparing:
▪ Fair market value of assets in the retirement plan, to
▪ Plans’ projected benefit obligation

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Understand the Various Types of
Liabilities (10 of 20)
Sales Tax Payable
• Many jurisdictions levy sales tax on retail sales
– Goods and Services Tax (GST)
– Value-Added Tax (VAT)
• Retailers collect sales tax from customers and then remit
collections to the state.

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Understand the Various Types of
Liabilities (11 of 20)
Sales Tax Payable. Sales at IKEA totaled $200,000 (all in
cash). IKEA collected an additional 5% ($10,000) of sales
tax. The store would record that day’s sales as follows:

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Understand the Various Types of
Liabilities (12 of 20)
Income Tax Payable
• Calculated as the prevailing tax rates multiplied by the
profit before tax of the business
• Corporate tax may be paid in instalments during the year
• Since the treatment of some accounts is different in
financial accounting and tax accounting, net profit usually
does not equal taxable income
• How to present this difference in financial statements will
be discussed in more advanced accounting courses

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Understand the Various Types of
Liabilities (13 of 20)
Provisions
• Liabilities of uncertain timing and amount
• Covered under IAS 37—Provisions, Contingent Assets and
Contingent Liabilities
• Companies may guarantee their products under a warranty
– Time periods for warranties vary
– When and how much warranty is claimed is unknown
• Matching principle demands the company to record the
warranty expense in the same period the business records
sales revenue
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Understand the Various Types of
Liabilities (14 of 20)
Provisions. The company sold 100,000 power tools. From
testing and experience, 1% of products require warranty
service costing $50 average, and 0.25% of products require
warranty service costing $100 average. Under IAS 37 using
“probability-weighted expected value”, the company needs
100,000x(1%x$50+0.5%x100) = $75,000 warranty provision.
This entry record the warranty expense:

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Understand the Various Types of
Liabilities (15 of 20)
Provisions. In the following year, the company spent
$72,000 repairing these faulty products. The expense would
be recorded as:

At year-end, the provision needed for the year is calculated,

and the difference between remaining balance and the
amount needed is the warranty expense
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Understand the Various Types of
Liabilities (16 of 20)
Notes Payable – Short-Term
• Common form of financing
• Due within one year
• Issued to borrow cash or purchase assets
• May accrue interest expense and interest payable at the
end of the period.

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Understand the Various Types of
Liabilities (17 of 20)
Short-Term Notes Payable. The company made a
purchase of inventory costing $8,000 on Apr 1, instead of
paying cash, it issued a 10% short-term note payable due in
one year:

*Typo: Date should be Apr 1

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Understand the Various Types of
Liabilities (18 of 20)
Short-Term Notes Payable. At the year end, an adjusting
entry is needed to accrue the interest expense of the note.
Cash payment is not made yet:

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Understand the Various Types of
Liabilities (19 of 20)
Short-Term Notes Payable. The following entry records the
note’s payment at maturity on March 31, 20X1:

*Typo: Date should be Mar 31

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Understand the Various Types of
Liabilities (20 of 20)
Debts – Current Portion of Long-Term Debt
• Also called current maturity or current installment
• Amount of the principal that is payable within one year
• At the end of each year, company reclassifies amount of
long-term debt that must be paid next year
– Reclassified from long-term to current
• Details of long-term debt/bond is outside the scope of this
course

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Learning Objective 9.2
Account for contingent liabilities

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Account for Contingent Liabilities
(1 of 2)

Contingent Liabilities
• A potential liability that depends on the future outcome of
past events
– Possible obligation to be confirmed by a future event
– Present obligation that may/may not require outflow of resources
– Reliable estimate of amount of present obligation cannot be made

• Examples: future liabilities that may arise due to lawsuits,

tax disputes, or alleged violations of environmental
protection laws
• Either: accrue, disclose, or neither.

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Account for Contingent Liabilities
(2 of 2)

Contingent Liabilities
• Can be overlooked when creating a Balance Sheet as they
aren’t actual debts
• Net income will be overstated if the company fails to
accrue interest on liability

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Summary of Current Liabilities

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Learning Objective 9.4
Account for leases

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Account for Leases
• Lease – rental agreement in which the tenant agrees to
make rent payments to the property owner in exchange for
the use of the assets
• IFRS 16 – effective beginning 1 January 2019
• Under the old standard IAS 17, operating lease (rental
arrangements) is expensed

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Learning Objective 9.5
• Analyze the advantages and disadvantages of borrowing

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Analyze the Advantages and
Disadvantages of Borrowing (1 of 3)
• Businesses have three main ways to finance operations
(pay for assets):
– Financed by retained earnings (past profits)
– Issuing shares
– Issuing bonds or notes payable
• i.e. from the accounting equation, if you want to increase
assets, you need to increase either liabilities or equity

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Analyze the Advantages and
Disadvantages of Borrowing (2 of 3)

• Earnings Per Share (EPS)

– Amount of a company’s net income for each share
outstanding
– Single most important statistic for evaluating a
company
– Standard measure of operating performance

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Exhibit 9-10 Earnings-Per-Share
Advantage of Borrowing

Assume your business needs $500,000 for expansion. Suppose it has net income of
$300,000 for the year and 100,000 shares outstanding. You are considering two financing
plans. Plan 1 is to issue $500,000 of 6% bonds payable, and Plan 2 is to issue 50,000
shares for $500,000. You believe the new cash can be invested in operations to earn
income of $200,000 before interest and taxes.
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Analyze the Advantages and
Disadvantages of Borrowing (2 of 3)

• Advantage of borrowing
– EPS is higher than issuing shares

• Disadvantages of borrowing
– More debt leads to more interest expenses
– Repayment of debts and interests cannot be avoided
even if the company has a bad year in the future

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Analyze the Advantages and
Disadvantages of Borrowing (3 of 3)
Trading on the Equity, or Leverage

Average total assets

Equity Multipler=
Average common stockholder′ s equity

Ratio shows a company’s total assets per amount of share

capital, higher ratio shows that more assets are funded by
debt

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Learning Objective 9.6
• Evaluate a company’s debt-paying ability

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Evaluate a Company’s Debt-Paying
Ability (1 of 2)
Debt Ratio
Measures the proportion of total liabilities to total assets
Total debt (liabilities)
Debt ratio =
Total assets
– Measure of an entity’s indebtedness
– A debt ratio below 50% is considered low

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Evaluate a Company’s Debt-Paying
Ability (2 of 2)
• Times-Interest-Earned Ratio
– Measures the number of times that operating income
can cover interest expense
– Also called the interest-coverage ratio

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Exhibit 9-13 Jardine Matheson’s Consolidated
Statement of Cash Flows

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Chapter Summary
• Current liabilities are important because they need to be
settled in cash within 1 year = the company needs to have
enough cash ready for the settlement
• Payroll-related liabilities are major expenses accounts,
they may include payroll related tax
• Warranty provided for products sold needs to be recorded
in the same period of the sales because of the Matching
Concept, the amount needed is estimated by past
experience
• Warranty used are credited against inventory

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Chapter Summary
• Companies may make payments by signing notes payable,
the interest needs to be accrued at the year end with
adjusting entry
• EPS is the most important statistic people look for when
evaluating a company
• Raising funds by issuing debts has the advantage of
enjoying higher EPS, but having too much debt would
incur large amount of interest expense, and the
repayments cannot be avoided during bad times

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Course Overview
Details of common asset accounts:
➢Cash: Bank Reconciliation ✓
➢Receivables: Impairment & notes interests ✓
➢Inventory ✓
➢Property, plant and equipment ✓
Details of common liability accounts ✓
Details of equity (Next Lecture)
Details of Statement of Cash Flow (Lecture 10)

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Course Overview
Financial Statement Analysis:
•Current Ratio
•Receivable Turnover
•Gross Profit
•Inventory Turnover (Residence Period)
•Return on Assets
•Earnings per Share
•Debt Ratio
•Times-interest-earned Ratio
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Homework Assignments
• E9-23A
• Due 12 Nov, 11:59pm
• Upload to Blackboard
• Late submission is not accepted

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