311-Ch09RevNotes(7th) - Chapter 9 - Reporting and...

Info iconThis preview shows pages 1–2. Sign up to view the full content.

View Full Document Right Arrow Icon
Overview Liabilities are obligations of either a known or estimated amount. Detailed information about the liabilities of an entity is important to many decision makers, whether internal or external to the enterprise, because liabilities represent claims against the resources of an entity. The existence and amount of liabilities sometimes are easy to conceal from outsiders. The accounting model and the verification by an independent CPA are the best assurances that all liabilities are disclosed. Current liabilities are short-term obligations that will be paid within the coming year or within the normal operating cycle of the business, whichever is longer. All other liabilities (except contingent liabilities) are reported as long-term liabilities. A contingent liability is a potential claim due to some event or transaction that has happened, but whether it will materialize as an effective liability is not certain because that depends on some future event or transaction. At the end of the accounting period, a contingent liability must be recorded (as a debit to a loss account and a credit to a liability account) if (a) it is probable that a loss will occur and (b) if the amount of the loss can be reasonably estimated. Contingent liabilities that are reasonably possible must be disclosed in the notes to the financial statements. Future and present value concepts often must be applied in accounting for liabilities. These concepts focus on the time value of money (i.e., interest). Future value is the amount that a principal amount will increase to in the future due to compound interest. Present value is the amount that a future principal amount is worth today. It is computed with a process of compound discounting of future cash flows. Future and present values are related to (a) a single amount or (b) a series of equal periodic amounts (called annuities). Typical applications of future and present values are to create a fund, determine the cost of an asset, account for notes payable, and account for installment debts and receivable. Business Background Businesses finance the acquisition of their assets from funds supplied by creditors (debt) and from funds provided by owners (equity). The mixture of debt and equity used by a business is called its capital structure . The factors managers consider when selecting a capital structure are risk and cost. Debt is more risky than equity because principal and interest payments must be made on debt. Equity is less risky since dividend payments to owners are not legal obligations until declared by the board of directors. Most companies include some debt (borrowed funds) in their capital structure because these funds may be used to earn a higher rate of return for the stockholders. Financial leverage is borrowing at one rate and earning at a different rate. Companies determine the proper balance of short-term and long-term debt for their specific purposes.
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Image of page 2
This is the end of the preview. Sign up to access the rest of the document.

Page1 / 10

311-Ch09RevNotes(7th) - Chapter 9 - Reporting and...

This preview shows document pages 1 - 2. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online