Chapter_9-solutions - Chapter 9 Reporting and Interpreting...

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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. 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 be considered carefully before classifying them as current versus long term. The shifting of a liability from one of these categories to the other often may affect the current ratio significantly. This ratio is used by creditors because it is an important index of ability to meet short-term obligations. Thus, the proper classification of liabilities is particularly significant.
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7. 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 incurred 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: Wage expense (+E, -SE)…………………………………… 2,000 Wages payable (+L) . ..... …………………………………. . 2,000
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This note was uploaded on 02/14/2012 for the course ECON 241 taught by Professor Cummings during the Spring '11 term at University of Texas at Austin.

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Chapter_9-solutions - Chapter 9 Reporting and Interpreting...

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