m - Chapter 9 Reporting and Interpreting Liabilities...

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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 short-term 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 long-term 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 short-term liability the current cash equivalent usually is the same as the maturity amount. The current cash equivalent amount for an interest-bearing liability at the going rate of interest is the same as the maturity value. For a long-term 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
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be considered carefully before classifying them as current versus long term. The
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This note was uploaded on 10/28/2010 for the course ACT 211 taught by Professor Sarzgowic during the Spring '10 term at UMass Dartmouth.

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m - Chapter 9 Reporting and Interpreting Liabilities...

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