Current Liabilities

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Principles of Financial Accounting, 11eReeve • Warren • Duchac

11-2

Describe and illustrate current liabilities related to accounts payable, current portion of long-term debt, and notes payable.

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11-4

11-3

Liabilities that are to be paid out of current assets and are due within a short time, usually within one year, are called current liabilities.• Accounts payable• Current portion of long-term

debt• Notes payable

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11-4

Accounts payable arise from purchasing goods or services for use in a company’s operations or for purchasing merchandise for resale.

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11-5

1Accounts Payable as a Percent of Total Current LiabilitiesExhibit 1

11-6

Current Portion of Long-Term Debt

Long-term liabilities are often paid back in periodic payments, called installments. Installments that are due within the coming year must be classified as a current liability.

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11-7

The total amount of the installments due after the coming year is classified as a long-term liability.

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11-8

A firm issues a 90-day, 12% note for $1,000, dated August 1, 2008 to Murray Co. for a $1,000 overdue account.

Short-Term Notes Payable

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11-9

On October 30, when the note matures, the firm pays the $1,000 principal plus $30 interest ($1,000 × 12% × 90/360).

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Interest Expense appears on the income statement as an “Other Expense.”

11-10

On May 1, Bowden Co. (borrower) purchased merchandise on account from Coker Co. (creditor), $10,000, 2/10, n/30. The merchandise cost Coker Co. $7,500.

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11-11

Description Debit Credit

Bowden Co. (Borrower)

Mdse. Inventory 10,000Accounts Payable 10,000

Coker Co. (Creditor)Description Debit Credit

Accounts Receivable 10,000Sales 10,000

Cost of Mdse. Sold 7,500Mdse. Inventory 7,500

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11-12

On May 31, Bowden Co. issued a 60-day, 12% note for $10,000 to Coker Co. on account.

Accounts Payable 10,000Notes Payable 10,000

Description Debit Credit

Bowden Co. (Borrower)

Notes Receivable 10,000Accounts Receivable 10,000

Coker Co. (Creditor)Description Debit Credit

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11-13

On July 30, Bowden Co. paid Coker Co. the amount due on the note of May 31. Interest: $10,000 × 12% × 60/360.

Notes Payable 10,000Interest Expense 200

Cash 10,200

Description Debit Credit

Bowden Co. (Borrower)

Cash 10,200Interest Revenue 200Notes Receivable 10,000

Coker Co. (Creditor)Description Debit Credit

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11-14

On September 19, Iceburg Company issues a $4,000, 90-day, 15% note to First National Bank.

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11-15

On the due date of the note (December 18), Iceburg Company owes $4,000 plus interest of $150 ($4,000 × 15% × 90/360).

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11-16

Discounting a Note

A discounted note has the following characteristics:

1. The creditor (lender) requires an interest rate, called the discount rate.

2. Interest, called the discount, is computed on the face amount of the note.

3. The debtor (borrower) receives the face amount of the note less the discount, called the proceeds.

4. The debtor pays the face amount of the note on the due date.

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11-17

On August 10, Cary Company issues a $20,000, 90-day note to Rock Company in exchange for inventory. Rock discounts the note at 15%.

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ProceedsDiscount: $20,000

× .15 × 90/360

Discount rate

11-18

On November 8 the note is paid in full.

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The amount paid is the face amount of the note.

11-19

Example Exercise 10-2Proceeds from Notes Payable

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On July 1, Bella Salon Company issued a 60-day note with a face amount of $60,000 to Delilah Hair Product Company for merchandise inventory.

Example Exercise 11-1

For Practice: PE 11-1A, PE 11-1B

Follow My Example 6-1 Follow My Example 11-1

a. $60,000

11-21

a. Determine the proceeds of the note, assuming the note carries an interest rate of 6%.

b. Determine the proceeds of the note, assuming the note is discounted at 6%.

b. $59,400 [$60,000 – ($60,000 × 6% × 60/360)]

11-20

Describe the accounting treatment for contingent liabilities and journalize entries for product warranties.

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11-79

11-21

Some liabilities may arise from past transactions if certain events occur in the future. These potential obligations are called contingent liabilities.

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Contingent Liabilities

11-22

The accounting for contingent liabilities depends on the following two factors:1. Likelihood of occurring: Probable,

reasonably possible, or remote.2. Measurement: Estimable or not

estimable.

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11-23

During June, a company sells a product for $60,000 on which there is a 36-month warranty. Past experience indicates that the average cost to repair defects is 5% of the sales price over the warranty period.

Recording Contingent Liabilities

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11-24

If a customer required a $200 part replacement on August 16, the entry would be:

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11-25

Example Exercise 10-2

Estimated Warranty Liability

5 Example Exercise 11-7

Cook-Rite Inc. sold $140,000 of kitchen appliances during August under a 6 month warranty. The cost to repair defects under the warranty is estimated at 6% of the sales price. On September 11, a customer required a $200 part replacement, plus $90 labor under the warranty.

Provide the journal entries for (a) the estimated warranty expense on August 31 and (b) the September 11 warranty work.

11-85

11-26

Example Exercise 11-7 (continued) 5

a. Product Warranty Expense………………… 8,400Product Warranty Payable…………….. 8,400

To record warranty expense for August, 6% × $140,000.

b. Product Warranty Payable…………………. 290Supplies…………………………………… 200Wages Payable…………………………… 90

Replaced defective part underwarranty.

11-86For Practice: PE 11-7A, PE11-7B

Follow My Example 11-7

11-27

Noble Co. Hart Co.Quick assets:

Cash $147,000 $120,000Accounts receivable (net) 84,000 472,000 Total quick assets $231,000 $592,000

Current liabilities $220,000 $740,000

Quick Ratio

Quick assetsCurrent liabilitiesQuick Ratio =

The quick ratio or acid-test ratio can be used to evaluate a firm’s ability to pay its current liabilities within a short period of time.

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11-28

Noble Co. Hart Co.Quick assets:

Cash $147,000 $120,000Accounts receivable (net) 84,000 472,000 Total quick assets $231,000 $592,000

Current liabilities $220,000 $740,000

Quick Ratio

Quick assetsCurrent liabilitiesQuick Ratio =

Noble Company = $231,000$220,000 = 1.05

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11-29

Noble Co. Hart Co.Quick assets:

Cash $147,000 $120,000Accounts receivable (net) 84,000 472,000 Total quick assets $231,000 $592,000

Current liabilities $220,000 $740,000

Quick Ratio

Quick assetsCurrent liabilitiesQuick Ratio =

Hart Company =

$592,000$740,000 = 0.80

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