Fundamentals of Financial Accounting with Annual Report

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Unformatted text preview: Chapter 10 - Reporting and Interpreting Liabilities Chapter 10 Reporting and Interpreting Liabilities ANSWERS TO QUESTIONS 1. Liabilities are created when a company buys goods and services on credit, obtains short-term bank loans to cover gaps in cash flows, and issues long-term debt to obtain money for expanding into new regions and markets. 2. Liabilities are obligations that result from transactions that require future payment of assets or the future performance of services. A liability usually has a definite payment date known as the maturity or due date. A current liability 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 a current liability will be paid out of current assets. All other liabilities are defined as long-term liabilities. 3. The dollar amount reported for liabilities is the result of three things: 1) The initial amount of the liability . A liability is initially recorded at its cash equivalent, which is the amount of cash that a creditor would accept to settle the liability immediately after the transaction or event occurred. 2) Additional amounts owed to the creditor . Liabilities are increased whenever additional obligations arise, including interest charges that arise as time passes. 3) Payments or services provided to the creditor . Liabilities are reduced whenever the company makes payments or provides services to the creditor. 4. An accrued liability is an expense that was incurred before the end of the current period but has not been paid or recorded. Therefore, an accrued liability is recognized when such a transaction is recorded. A typical example is wages earned during the last few days of the accounting period but not recorded because no payroll was prepared and paid that included these wages. Assuming wages of $2,000 were incurred, the adjusting entry to record the accrued liability and the wage expense would be as follows: December 31: dr Wages Expense (+E, -SE)………………………………… 2,000 cr Wages Payable (+L) ……………………………..….…. 2,000 10-1 Chapter 10 - Reporting and Interpreting Liabilities 5. Unearned revenue is revenue that has been collected in advance of being earned. Because the amount already has been collected and the goods or services have not been provided, there is a liability to provide goods or services to the party who made the payment in advance. 6. An employer collects payroll taxes from its employees on behalf of the government . When an employer withholds payroll taxes from its employees’ pay, the employer has an obligation to forward the payroll taxes to the government. Similarly, retail companies collect sales taxes from customers on behalf of the government . These retailers are obligated to forward the sales taxes to the government. This obligation to forward to the government the money for payroll taxes and sales taxes is why each is considered a liability....
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SM_Chap010 - Chapter 10 Reporting and Interpreting...

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