Ch. 8 Current Liabilities

Question 1

Liability

Answer 1

A PRESENT responsibility to sacrifice assets in the FUTURE due to a transaction or other event that happened in the PAST.

Question 2

Current Liabilities

Answer 2

Debts that, in most cases, are due within one year. However, when a company has an operating cycle of longer than a year, its current liabilities are defined by the operating cycle rather than by the length of a year.

• can also be called short-term liabilities
• Given a choice, most companies would prefer to report a liability as long-term rather than current, because doing so may cause the firm to appear less risky.

Question 3

Notes payable

Answer 3

Written promises to repay amounts borrowed plus interest.

-About 2/3 of bank loans are short-term. Short-term funds usually offer lower interest rates than long-term debt.

Question 4

Line of credit

Answer 4

An informal agreement that permits a company to borrow up to a prearranged limit without having to follow formal loan procedures and prepare paperwork.

• Rather than wait until borrowing becomes necessary, many companies prearrange the terms of a note payable by establishing a line of credit with a bank.
• The recording for a line of credit is exactly the same as the recording for notes payable.

Question 5

Commercial paper

Answer 5

Borrowing from another company rather than from a bank.

• commercial paper is sold with maturities ranging from 30 to 270 days. Beyond 270 days, the issuing firm is required to file a registration statement with the SEC.
• The interest rate on commercial paper is usually lower than on a bank loan.

Question 6

FICA taxes

Answer 6

Based on the Federal Insurance Contribution Act; tax withheld from employees’ paychecks.

• Social security and medicare taxes.
• This act requires employers to withhold a 6.2% social security tax up to a maximum base amount plus a 1.45% Medicare tax with no maximum.
• Therefore, the total FICA tax is 7.65% (6.2% + 1.45%) on income up to a base amount ($106,800 in 2010) and 1.45% on all income above the base amount.

Question 7

Unemployment taxes

Answer 7

A tax to cover federal and state unemployment costs paid by the employer on behalf of its employees.

• Federal Unemployment Tax Act (FUTA) requires a tax of 6.2% on the first $7,000 made by each employee. This amount is reduced by a 5.4% (max) credit for contributions to state unemployment programs, so the net federal rate often is 0.8%.
• under the State Unemployment Tax Act (SUTA), in many states the maximum state unemployment tax rate is 5.4%, but many companies pay a lower rate based on past employment history.

Question 8

Fringe benefits

Answer 8

Additional employee benefits paid for by the employer.

-ie: in the airline industry, the ability for the employee and family to fly free.

Question 9

Unearned revenue

Answer 9

A liability account used to record cash received in advance of the sale or service.

Question 10

Sales tax payable

Answer 10

Sales tax collected from customers by the seller, representing current liabilities payable to the government.
-The selling company records sales revenue in one account and sales tax payable in another

Question 11

Current portion of long-term debt

Answer 11

Debt that will be paid within the next year.

• Long-term obligations (notes, mortgages, bonds) usually are reclassified and reported as current liabilities when they become payable within the upcoming year (or operating cycle, if longer than a year)
• ie: a firm reports a 10-year note payable as a long-term liability for 9 years but as a current liability on the balance sheet prepared during the 10th year of its term to maturity.

Question 12

Contingencies

Answer 12

Uncertain situations that can result in a gain or a loss for a company.

Question 13

Contingent liability

Answer 13

An existing uncertain situation that might result in a loss.

-Includes: lawsuits, product warranties, environmental problems, and premium offers.

Question 14

Contingent gain

Answer 14

An existing uncertain situation that might result in a gain.
-We do not record contingent gains until the gain is certain and no longer a contingency.

Question 15

Liquidity

Answer 15

Having sufficient cash (or other assets convertible to cash in a relatively short time) to pay currently maturing debts.
-3 liquidity measures: working capital, the current ratio, and the acid-test ratio

Question 16

Working capital

Answer 16

The difference between current assets and current liabilities.

Question 17

Current ratio

Answer 17

Current assets divided by current liabilities; measures the availability of current assets to pay current liabilities.

Question 18

Acid-test ratio

Answer 18

Cash, current investments, and accounts receivable divided by current liabilities; measures the availability of liquid current assets to pay current liabilities.

Question 19

Quick assets

Answer 19

Includes only cash, current investments, and accounts receivable.
-(only assets that can be quickly converted to cash)

Question 20

Debt covenant

Answer 20

An agreement between a borrower and a lender that requires that certain minimum financial measures be met or the lender can recall the debt.
-ie suppose a company has entered into a debt covenant with its bank that requires a minimum current ratio of 1.25.

Question 21

Deferred Taxes

Answer 21

• Net income in the income statement is not the same amount as taxable income reported to the IRS.
• There are many differences between financial accounting rules and tax accounting rules (most use straight-line depreciation for financial accounting. But they use a different depreciation method called MACRS for tax accounting
• Differences between financial accounting and tax accounting can result in a company recording financial income now, but deferring payment of some of its income tax expense to future years. In such a case, it will report a deferred tax liability (both current and long-term). (or the company may record an expense now, but deduct it for taxes in future years, in which case it will report a deferred tax asset)