Chapter 9
Reporting and Interpreting Liabilities
ANSWERS TO QUESTIONS
1.
Liabilities are obligations that result from past transactions that require future
payment of assets or the future performance of services, that are definite in amount
or are subject to reasonable estimation. A liability usually has a definite payment
date known as the maturity or due date. A current liability is a shortterm liability;
that is, one that will be paid during the coming year or the current operating cycle of
the business, whichever is longer. It is assumed that the current liability will be paid
out of current assets. All other liabilities are defined as longterm liabilities.
2.
External parties have difficulty determining the amount of liabilities of a business in
the absence of a balance sheet. Therefore, about the only sources available to
external parties for determining the number, type, and amounts of liabilities of a
business are the published financial statements. These statements have more
credibility when they have been audited by an independent CPA.
3.
A liability is measured at acquisition at its current cash equivalent amount.
Conceptually, this amount is the present value of all of the future payments of
principal and interest. For a shortterm liability the current cash equivalent usually is
the same as the maturity amount. The current cash equivalent amount for an
interestbearing liability at the going rate of interest is the same as the maturity
value. For a longterm liability, the current cash equivalent amount will be less than
the maturity amount: (1) if there is no stated rate of interest, or (2) if the stated rate
of interest is less than the going rate of interest.
4.
Most debts specify a definite amount that is due at a specified date in the future.
However, there are situations where it is known that an obligation or liability exists
although the exact amount is unknown. Liabilities that are known to exist but the
exact amount is not yet known must be recorded in the accounts and reported in
the financial statements at an estimated amount. Examples of a known obligation of
an estimated amount are estimated income tax at the end of the year, property
taxes at the end of the year, and obligations under warranty contracts for
merchandise sold.
5.
Working capital is computed as total current assets minus total current liabilities. It
is the amount of current assets that would remain if all current liabilities were paid,
assuming no loss or gain on liquidation of those assets.
6.
The current ratio is the percentage relationship of current assets to current
liabilities. It is computed by dividing current assets by current liabilities. For
example, assuming current assets of $200,000 and current liabilities of $100,000,
the current ratio would be $200,000/$100,000 = 2.0 (for each dollar of current
liabilities there are two dollars of current assets). The current ratio is influenced by
the amount of current liabilities. Therefore, it is particularly important that liabilities
1
This preview has intentionally blurred sections. Sign up to view the full version.
View Full Documentbe considered carefully before classifying them as current versus long term. The
This is the end of the preview.
Sign up
to
access the rest of the document.
 Spring '10
 sarzgowic
 Balance Sheet

Click to edit the document details