Reporting and Interpreting Current Liabilities

Understanding the Business

The acquisition of assets is financed from two sources…
1. Debt → Funds from creditors. 2. Equity → Funds from owners.

→ The mix of debt and equity for a company is called the capital structure.
→ Debt is considered riskier than equity.
→ Debt payments are legal obligations.
→ Creditors can force bankruptcy.
→ Creditors can require sale of assets.

Current Liabilities

Account name Also called Definition

Accounts payable Trades payable Obligations to pay for goods and services used in the basic
operating activities of the business.

Accrued Liabilities Accrued Expenses Obligations related to expenses that have been incurred
but have not been paid at the end of the accounting period.

Notes Payable N/A Obligations due supported by a formal written contract.

Deferred Revenues Unearned revenues Obligations arising when cash is received prior to the
related revenue being earned.

Key Ratio Analysis – A/P Turnover Ratio

Analytical Question → How efficient is management at meeting its obligations to suppliers?
Ratio And Comparisons → A measure of how quickly management is paying trade suppliers. Analysts
use this ratio as a measure of liquidity. It is computed as follows…

A high turnover ratio normally suggests that a company is paying its suppliers in a timely manner.

Accrued Liabilities
Accrued liabilities → Expenses that have been incurred before the end of an accounting period but have
not yet been paid.
● Income tax payable
● Taxes other than income taxes (e.g., HST/GST & PST)
● Payroll liabilities and employee deductions (e.g., personal income tax, EI, CPP)

Notes Payable
The time value of money is interest that is associated with the use of money over time.
A note payable specifies the interest rate associated with the borrowing.
⤷ Lender → revenue.
⤷ Borrower → expense.

Current Portion of Long-Term Debt

Long-Term debt is split between the current portion and the non-current portion.

Current portion of long-term debt → Any portion of a note payable that is due within one year, or the
operating cycle, whichever is longer.

Deferred Revenues
Deferred Revenue → Revenues that have been collected but not earned.

Deferred revenues are reported as a liability because cash has been collected but the related revenue
has not been earned by the end of the accounting period.

Provisions Reported on the Statement of Financial Position

Provision → When either the amount or the timing of the liability is uncertain.

A provision must be recognized when the following conditions are met…

1. An entity has a present obligation as a result of a past event.
2. It is probable that cash or other assets will be required to settle the obligation.
3. A reliable estimate can be made of the amount of the obligation.

Examples…
● Estimated liabilities for warranties.
● Legal and tax disputes that arise in the ordinary course of business.
● Closing of stores or specific operations.
● Restructuring of the production, sales, or administrative structures.

Liabilities for Warranties

The matching process requires the recognition of the estimated provision for warranty expense in the
same period as the sale is recorded.
Contingent Liabilities
Contingent Liabilities → A possible liability created as a result of a past event. It is not an effective
liability until some future event occurs.

Level of Certainty of the Present or Should a Liability Be Disclosure Requirements

Possible Obligation Recognized?

There is a present obligation that probably

requires an outflow of resources.

1. The amount of the liability can be A provision must be Disclosure of the provision
estimated reliably. recognized. is required.

2. The amount of the liability cannot be No provision shall be Disclosure is required for
estimated reliably. recognized. the contingency.

There is either a present or a possible No provision shall be Disclosure is required for

obligation that may, but probably will not, recognized. the contingency.
require an outflow of resources.

There is either a present or a possible No provision shall be Disclosure is not required.

obligation where the likelihood of an outflow recognized.
of resources is remote.

International Perspective – It is a Matter of Degree of Certainty

Under ASPE, “probable” has been defined as likely which is interpreted as having a greater than 70%
chance of occurring.

In the case of IFRS, probable is defined as more likely than not which would imply more than a 50%
chance of occurring.

This difference means that companies reporting under IFRS would record a liability when other
companies reporting under ASPE would report the same event as a contingency.

Working Capital Management

⤷ Working Capital = Current Assets – Current Liabilities
⤷ Liquidity → The ability to pay current obligations.

Key Ratio Analysis – Quick Ratio

Analytical Question → Does the company currently have the resources to pay its short-term debt?
Ratio And Comparisons → An indicator of the amount of quick assets (cash, short-term investments,
and net receivables) available to satisfy current liabilities. It is computed as follows…
Quick Ratio = Quick Assets / Current Liabilities
A high ratio normally suggests good liquidity, but too high a ratio suggests inefficient use of resources. Many companies use
techniques to minimize funds invested in current assets, and as a result, have quick ratios that are very low.

Appendix 9B: Present Value Concepts

The concept of present value(PV) is based on the time value of money that we introduced earlier in this
chapter.
Present value (PV) → The current cash equivalent of an amount to be received in the future, or a future
amount discounted for compound interest.

Money received today is worth more than money to be received one year from today (or at any other
future date) because it can be used to earn interest.

Future value → The sum to which an amount will increase as a result of compound interest.

Present and future value problems may involve two types of cash flow: a single payment or an annuity (a
series of cash payments).

Therefore, four different situations are related to the time value of money…
● Present value of a single payment
● Future value of a single payment
● Present value of an annuity
● Future value of an annuity

Appendix 9B: Present Value of a Single Amount

Present value of a single amount → The amount of cash you are willing to accept today in lieu of a cash
receipt at some date in the future.

The formula to calculate the present value of a single amount is:

Appendix 9B: Present Value of an Annuity

An annuity is a series of consecutive payments characterized by…
1. An equal dollar amount each interest period.
2. Interest periods of equal length (year, half-year, quarter, or month).
3. An equal interest rate each interest period.

Examples…
● Monthly automobile payments ● Annual contributions to savings account
● Monthly home loan payments ● Monthly retirement benefits

Appendix 9E: Future Value of a Single Amount

Future value of a single amount → Calculating how much money you will have in the future as a result of
investing a certain amount at the present time
To solve a future value problem, you need to know three items…
1. The amount to be invested.
2. The interest rate (i) that the amount will earn.
3. The number of periods (n) in which the amount will earn interest.

Since the future value concept is based on compound interest, the amount of interest for each period is
calculated by multiplying the interest rate by the principal plus any interest not paid out in prior periods.

Appendix 9E: Future Value of an Annuity

The future value of an annuity calculation will tell you how much money you will have in the future, if you
save a fixed amount of money each month.

The future value of an annuity includes compound interest on each payment from the date of payment to
the end of the term of the annuity.

Each new payment accumulates less interest than prior payments only because the number of periods
remaining to accumulate interest decreases.

End of Chapter Summary

● Accountants define liabilities as obligations arising from past transactions that will be settled in
the future by some transfer or use of assets or provision of services.
● They are classified on the statement of financial position as either current or non-current.
● A note payable specifies the amount borrowed, when it must be repaid, and the interest rate
associated with the debt. Accountants must report the debt and the interest as it accrues.
● The time value of money refers to the fact that interest accrues on borrowed money with the
passage of time.
● A contingency is a possible liability that has arisen as a result of a past event.
● Contingencies are disclosed in a note if it is not probable that cash or other assets will be
required to settle the obligation, or if the amount of the obligation cannot be measured with
sufficient reliability.
● Changes in accounts payable and accrued liabilities affect cash flows from operating activities.
● The quick ratio is a comparison of the most liquid or quick assets (cash, short-term investments,
and net receivables) to current liabilities.
Learning Objectives
● Define, measure, and report current liabilities.
● Compute and interpret the accounts payable turnover ratio.
● Report notes payable, and explain the time value of money.
● Report contingent liabilities.
● Explain the importance of working capital and its impact on cash flows.
● Compute and interpret the quick ratio.

Supplementary Material
● Compute and report deferred income taxes.
● Compute and report present values of future cash flows.
● Compute and report the future value of a single amount. (Online)
● Compute and report the future value of an annuity. (Online)