Chapter 10 - Introduction to liabilities: Economic consequences, current liabilities, and contingencies. This chapter define liability and describe key economic consequences associated with how liabilities are reported on the financial statement. | 1 Chapter 10 Introduction to Liabilities: Economic Consequences, Current Liabilities and Contingencies 2 2 Liabilities What is a liability? FASB - “Probable future sacrifice of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events.” 3 3 4 The Relative Size of Liabilities on the Balance Sheet Figure 10-1 Liabilities as a percentage of total assets 4 Reporting Liabilities on the Balance Sheet: Economic Consequences Shareholders and Investors Interest expense is tax deductible, but more debt means more risk to shareholders Equity ownership is subordinated to creditors Creditors Restrictive covenants regarding debt limits Management When and how to borrow money are important decisions Wants to minimize debt on the balance sheet Often looks for “off-balance sheet” financing Less debt now improves ability to borrow in the future 5 5 Current Liabilities 6 Figure 10-2 Current liabilities as a percentage of total liabilities 6 Current Liabilities Classification Expected to require the use of current assets (or the creation of other current liabilities) to settle the obligation. Valuing current liabilities on the balance sheet Ignore present value (report at face value) Reporting current liabilities Primary problem is ensuring that all existing current liabilities are reported on the balance sheet. 7 7 Determinable / Contingent Liabilities 8 Figure 10-3 Outline of current liabilities Determinable Current Liabilities Accounts payable Short-term debts Short-term notes Current maturities of long-term debts Dividends payable Unearned revenues Third Party Collection Income taxes Incentive compensation 9 The dollar value of these liabilities is relatively straight forward – hence determinable 9 Determinable Current Liabilities Accrued liabilities - accrue expense and liability at the end of the current period, and usually paid sometime during . | 1 Chapter 10 Introduction to Liabilities: Economic Consequences, Current Liabilities and Contingencies 2 2 Liabilities What is a liability? FASB - “Probable future sacrifice of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events.” 3 3 4 The Relative Size of Liabilities on the Balance Sheet Figure 10-1 Liabilities as a percentage of total assets 4 Reporting Liabilities on the Balance Sheet: Economic Consequences Shareholders and Investors Interest expense is tax deductible, but more debt means more risk to shareholders Equity ownership is subordinated to creditors Creditors Restrictive covenants regarding debt limits Management When and how to borrow money are important decisions Wants to minimize debt on the balance sheet Often looks for “off-balance sheet” financing Less debt now improves ability to borrow in the future 5 5 Current Liabilities 6
