{ACCT 101} Chapter 8: Current Liabilities Exam-3

Southwest incur for the six-month period of the note from September 1, 2018, to March 1, 2019? Now to apply 19 we must look at notecard 18. Now calculate interest on the note.

$3,000=$100,000 x 6% x 6/12

PART B: CONTINGENCIES

(SECTION BELOW) We look at contingent liabilities first and then their flip side, contingent gains.

Long-Term Liabilities

(are payable more than one year from now)

Current Liabilities

(are payable within one year/also called short-term liabilities or short-term debt)

Deferred Revenue

(liability) Arises when a company receives payment in advance of providing the product o service it's selling. (giving up inventory or services rather than cash)

Accounts payable,

-Sometimes called trade accounts payable, are amounts the company owes to suppliers of merchandise or services that it has bought on credit. -When a company purchases inventory on account (if it does not pay immediately with cash), it increases Inventory and Accounts Payable. -When the company pays the amount owed, it decreases both Cash and Accounts Payable. -Most accounts are payable within one year and are therefore classified as current liabilities. -Any accounts payable in more than one year would be classified as long-term liabilities.

Deloitte was the auditor for a client we'll call Jeeps, Inc. The client sold accessories for jeeps, such as tops, lights, cargo carriers, and hitches. One of the major issues that appeared in Deloitte's audit of Jeeps, Inc., was outstanding litigation. Several lawsuits against the company alleged that the jeep top (made of vinyl) did not hold in a major collision. The jeep manufacturer, Chrysler, also was named in the lawsuits. The damages claimed were quite large, about $100 million. Although the company had litigation insurance, there was some question whether the insurance company could pay because the insurance carrier was undergoing financial difficulty. The auditor discussed the situation with the outside legal counsel representing Jeeps, Inc. What, if anything, should the auditor require Jeeps, Inc., to report because of the litigation? The outcome of the litigation was not settled by the end of the year, so no amount is yet legally owed. There are three options to consider for Jeeps, Inc. (PG. 386 and need more info)

1. Report a liability in the balance sheet for the full $100 million (or perhaps some lesser amount that is more likely to be owed), 2. Do not report a liability in the balance sheet, but provide full disclosure of the litigation in a note to the financial statements, or 3. Do not report a liability in the balance sheet and provide no disclosure in a note. The option we choose depends on (1) the likelihood of payment and (2) the ability to estimate the amount of payment. Illustration 8-7 provides details for each of these criteria.

Criteria for Reporting a Contingent Liability

1. The likelihood of payment is a.Probable—likely to occur; b.Reasonably possible—more than remote but less than probable; or c.Remote—the chance is slight. 2. The amount of payment is a. Reasonably estimable; or b. Not reasonably estimable.

Liabilities Characteristics

1: Probable future sacrifices of economic benefits. 2: Arising from present obligations to other entities. 3: Resulting from past transactions or events.

contingent gain As discussed earlier, we record contingent liabilities when the loss is probable and the amount is reasonably estimable. However, we do not record contingent gains until the gain is certain. The nonparallel treatment of contingent gains follows the same conservative reasoning that motivates reporting some assets (like inventory) at lower of cost and net realizable value. Specifically, it's desirable to anticipate losses, but recognizing gains should await their final settlement. Though firms do not record contingent gains in the accounts, they sometimes disclose them in notes to the financial statements.

A contingent gain is an existing uncertain situation that might result in a gain, which often is the flip side of contingent liabilities. In a pending lawsuit, one side—the defendant—faces a contingent liability, while the other side—the plaintiff—has a contingent gain. For example, Polaroid sued Kodak for patent infringement of its instant photography technology. Polaroid had a contingent gain, while Kodak faced a contingent loss.

KEY POINT

A contingent liability is recorded only if a loss is probable and the amount is reasonably estimatable.

fringe benefits

Additional employee benefits paid for by the employer.

To understand how employee and employer payroll costs are recorded, assume that Hawaiian Travel Agency has a total payroll for the month of January of $100,000 for its 20 employees. Federal and state income tax withheld $24,000 Health insurance premiums (Blue Cross) paid by employer 5,000 Contribution to retirement plan (Fidelity) paid by employer 10,000 FICA tax rate (Social Security and Medicare) 7.65% Federal and state unemployment tax rate 6.2%

Agency records the employee salary expense, withholdings, and salaries payable on January 31: January 31 D C Salaries Expense 100000 Income Tax Payable 24000 FICA Tax Payable (=.0765x100000) 7650 Salaries Payable(to balance) 68350 (Record employee salary expense and withholdings) Agency also records its employer-provided fringe benefits as Salaries Expense and records the related credit balances to Accounts Payable: January 31 D C Salaries Expense (fringe benefits) 15000 Accounts Payable (to Blue Cross) 5000 Accounts Payable (to Fidelity) 10000 (Record employer-provided fringe benefits) Agency pays employer's FICA taxes at the same rate that the employees pay (7.65%) and also pays unemployment taxes at the rate of 6.2%. The agency records its employer's payroll taxes as follows: January 31 D C Payroll Tax Expense (total) 13850 FICA Tax Payable (=.0765x100000) 7650 Unemployment Tax Payable(=.062x100000) 6200 (Record employer payroll taxes) Hawaiian Travel Agency incurred an additional $28,850 in expenses ($15,000 for fringe benefits plus $13,850 for employer payroll taxes) beyond the $100,000 salary expense. Also notice that the FICA tax payable in the employee withholding is the same amount recorded for employer payroll tax. That's because the employee pays 7.65% and the employer matches this amount with an additional 7.65%. The amounts withheld are then transferred at regular intervals, monthly or quarterly, to their designated recipients. Income taxes, FICA taxes, and unemployment taxes are transferred to various government agencies, and fringe benefits are paid to the company's contractual suppliers.

Accounting treatment of contingent liabilities: LoP: Likelihood of payment RE: Reasonably Estimable NRE: Not Reasonably Estimable

Amount of payment: LoP/RE/NRE: Probable///Liability Recorded///Disclodure required Reasonably possible///Disclosure required///Disclosure required Remote///Disclosure not required///Disclosure not required

Common Mistake

As a general rule, a higher current ratio is better. However, a high current ratio is not always a positive signal. Companies having difficulty collecting receivables or holding excessive inventory will also have a higher current ratio. Managers must balance the incentive for strong liquidity (yielding a higher current ratio) with the need to minimize levels of receivables and inventory (yielding a lower current ratio).

Assets represent? Liabilities represent?

Assets: probable future benefits. Lianilities: probable future sacrifices of benefits (future sacrifice of cash: accounts payable, notes payable, and salaries)

Why do companies prefer to report liabilities as long -term rather than current?

Because it makes the company appear less risky.

By law employer pays?

By law, the employer pays an additional (matching) FICA tax on behalf of the employee. The employer's limits on FICA tax are the same as the employee's. Thus, the government actually collects 15.3% (7.65% employee + 7.65% employer) on each employee's salary.

Effect of Various Changes on the Liquidity Ratios

Changes that Increase the Ratio Changes that Decrease the Ratio Current Ratio • Increase in current assets •Decrease in current assets •Decrease in current liabilities •Increase in current liabilities Acid-Test Ratio •Increase in quick assets •Decrease in quick assets •Decrease in current liabilities •Increase in current liabilities

What are companies required by law to do?

Companies are required by law to withhold federal and state income taxes from employees' paychecks and remit these taxes to the government. The amount withheld varies according to the amount the employee earns and the number of exemptions the employee claims.

Why are about two-thirds of bank loans short-term?

Companies often use short-term debt because it usually offers lower interest rates than long-term debt.

Assume Apple Inc. sells an iTunes gift card to a customer for $100. Apple records the sale of the gift card as follows:

Debit Credit Cash 100 Deferred Revenue 100 (Receive cash for gift card) As you can see, Apple records the receipt of cash, but does not credit Sales Revenue. Rather, since the music has not been downloaded yet, the company credits Deferred Revenue, a liability account. While it may seem unusual for an account called Deferred Revenue to be a liability, think of it this way: Having already collected the cash, the company now has the obligation to provide a good or service.

Suppose you buy lunch in the airport for $15 plus 10% sales tax. The airport restaurant records the transaction this way:

Debit Credit Cash 16.50 Sales Revenue 15.00 Sales Tax Payable(=15x10%) 1.5 (Record sales and sales tax)

When the customer purchases and downloads, say, $15 worth of music, Apple records the following: As the company earns revenue from music downloads, it decreases (debits) Deferred Revenue and increases (credits) Sales Revenue. The customer has a balance of $85 on his gift card, and Apple has a balance in Deferred Revenue, a liability account, of $85 for future music downloads.

Debit Credit Deferred Revenue 15 Sales Revenue 15 (Record revenue from music downloaded)

A contingent liability is recorded only if a loss is probable and the amount is reasonably estimable. In the case of Jeeps, Inc., above, if the auditor believes it is probable that Jeeps, Inc., will lose the $100 million lawsuit at some point in the future, Jeeps, Inc., would report a contingent liability for $100 million at the end of the year.

December 31 ($ in millions) D C Loss 100 Contingent Liability 100 (Record a contingent liability)

Warranties are perhaps the most common example of contingent liabilities. When you buy a new Dell laptop, it comes with a warranty covering the hardware from defect for either a 90-day, one-year, or two-year period depending on the product. Why does Dell offer a warranty? To increase sales, of course. A company needs to record warranty expense in the same accounting period it sells you a product. The warranty for the computer represents an expense and a liability for Dell at the time of the sale because it meets the criteria for recording a contingent liability: Because warranties almost always entail an eventual expenditure, it's probable that a cost will be incurred. And even though Dell doesn't know exactly what that cost will be, it can, based on experience, reasonably estimate the amount. Let's look at a warranty example in more detail. Dell introduces a new laptop computer in December that carries a one-year warranty against manufacturer's defects. Based on industry experience with similar product introductions, Dell expects warranty costs will be an amount equal to approximately 3% of sales. New laptop sales for the month of December are $1.5 million. Dell records the warranty liability on December 31 as follows:

December 31 Debit Credit Warranty Expense($1.5millionx3%) 45000 Warranty Liability 45000 (Record liability for warranties) When customers make warranty claims and Dell incurs costs to satisfy those claims, the liability is reduced. Let's say that customers make warranty claims costing Dell $12,000 in January of the following year. We record the payment for warranty work performed as follows: January 31 Debit Credit Warranty Liability 12000 Cash 12000 (Record actual warranty expenditures) The entry above assumes Dell pays for all warranty costs with cash to simplify the transaction. Companies may also use employee labor hours, parts from inventory, or supplies in satisfying warranty claims. In that more complex case, we might credit Salaries Payable, Inventory, or Supplies rather than Cash. Any time you need to calculate a balance, it's often helpful to make a T-account and record the transactions. Remember, journal entries show the transaction, while T-accountsPage 389 give you the balance. The balance in the Warranty Liability account at the end of January is $33,000 as follows:

However, if Southwest's reporting period ends on December 31, 2018, the company should not wait until March 1, 2019, to record interest. Instead, the company records the four months' interest incurred during 2018 in an adjustment prior to preparing the 2018 financial statements. Since the firm will not pay the 2018 interest until the note becomes due (March 1, 2019), it records interest payable, as follows:

December 31, 2018 Debit: Credit: Interest Expense (=100,000x6%x4/12) 2000 Interest Payable 2000 (Record interest incurred, but not paid)

Now assume you hire an employee at a starting annual salary of $60,000. Your costs for this employee will be much more than $5,000 per month. Besides the $5,000 monthly salary, you will incur significant costs for (1) federal and state unemployment taxes; (2) the employer portion of Social Security and Medicare; (3) employer contributions for health, dental, disability, and life insurance; and (4) employer contributions to retirement or savings plans. With these additional costs, a $5,000 monthly salary could very easily create total costs in excess of $6,000 per month. Because this happens there are costs for employee and employer.

Employee Costs: • Federal and state income taxes • Employee portion of Social Security and Medicare • Employee contributions for health, dental, disability, and life insurance • Employee investments in retirement or savings plans Employer Costs: • Federal and state unemployment taxes • Employer matching portion of Social Security and Medicare • Employer contributions for health, dental, disability, and life insurance • Employer contributions to retirement or savings plans

KEY POINT

Employee salaries are reduced by withholdings for federal and state income taxes, FICA taxes, and the employee portion of insurance and retirement contributions. The employer, too, incurs additional payroll expenses for unemployment taxes, the employer portion of FICA taxes, and employer insurance and retirement contributions.

Employers and employee benefits.

Employers often pay all or part of employees' insurance premiums and make contributions to retirement or savings plans. Many companies provide additional fringe benefits specific to the company or the industry. EX. a fringe benefit in the airline industry is free flights for employees and their families.

FICA taxes

Employers withhold Social Security and Medicare taxes from employees' paychecks. Collectively, Social Security and Medicare taxes are referred to as FICA taxes

Long-term obligations (notes, mortgages, bonds) usually are reclassified and reported as current liabilities when they become payable within the upcoming year (or operating cycle, if longer than a year).

For example, a firm reports a 10-year note payable as a long-term liability for nine years but as a current liability in the balance sheet prepared during the tenth year of its term to maturity.

EXAMPLE FOR NOTECARD 42

For example, if you earn less than $118,500, you will have 7.65% withheld from your check all year. However, if you earn, let's say, $168,500, you would have 7.65% withheld for FICA on the first $118,500 of your annual salary and then only 1.45% withheld on the remaining $50,000 earned during the rest of the year.2

PART A: CURRENT LIABILITIES

INTRODUCTION SECTION

IRS Publication 15?

IRS Publication 15, also called Circular E, is a valuable tool for employers, answering important payroll tax withholding questions as well as providing the individual tax tables.

commercial paper

If a company borrows from another company rather than from a bank

What happens if you are able to claim more exemptions? Do all states require the payment of personal income taxes?

If you are able to claim more exemptions, you will have less tax withheld from your paycheck. Not all states require the payment of personal income taxes: Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming have no state income tax. Two others, New Hampshire and Tennessee, tax only dividend and interest income.

Additionally to FICA

In addition to FICA, the employer also must pay federal and state unemployment taxes on behalf of its employees.

Notes Payable

In contrast, notes payable is a liability that creates interest expense. Definition: Written promises to repay amounts borrowed plus interest. Ex.When a company borrows cash from a bank, the bank requires the company to sign a note promising to repay the amount borrowed plus interest.

When a company borrows money, it pays the lender interest in return for using the lender's money during the term of the loan. Interest is stated in terms of an annual percentage rate to be applied to the face value of the loan. Because the stated interest rate is an annual rate, when calculating interest for a current note payable we must adjust for the fraction of the year the loan spans. We calculate interest on notes as:

Interest = Face Value x Annual Interest Rate x Fraction of the year

Liability

Is a present responsibility to sacrifice assets in the future due to a transaction or other event that happened in the past.

Why is distinguishing between current and long-term liabilities important to investors and creditors?

It helps them asses risk.

If a company has an operating cycle longer than one year?

Its current liabilities are define by the operating cycle rather than by the length of a year.

Less-Risky Firms enjoy?

Lower interest rates on borrowing and command higher stock prices for new stock listings.

COMMON MISTAKE

Many people think FICA taxes are paid only by the employee. The employer is required to match the amount withheld for each employee, effectively doubling the amount paid into Social Security.

Key Point

Many short-term loans are arranged under an existing line of credit with a bank, or for larger corporations in the form of commercial paper, a loan from one company to another.

The purpose of the adjusting entry is to report four months' interest (September, October, November, and December) in 2018. Southwest will report the remaining $1,000 of interest (for January and February) in 2019. Since the firm won't actually pay the 2018 interest until March 1, 2019, its financial statements for the year ended December 31, 2018, will show interest payable of $2,000 along with notes payable of $100,000 as current liabilities in the balance sheet, and the "other expenses" section of the income statement will report interest expense of $2,000. When the note comes due on March 1, 2019, Southwest Airlines will pay the face value of the loan ($100,000) plus the entire $3,000 interest incurred ($100,000 × 6% × 6/12). The $3,000 represents six months of interest—the four months of interest ($2,000) in 2018 previously recorded as interest payable and two months of interest ($1,000) in 2019. Southwest records these transactions on March 1, 2019, as follows:

March 1, 2019 Debit: Credit: Notes Payable (face value) 100,000 Interest Expense(=$100,000x6%x2/12) 1,000 Interest Payable (=$100,000x6%x4/12) 2,000 Cash 103,000 (Pay notes payable and interest) The entry on March 1 does the following: -Removes the note payable ($100,000). -Records interest expense for January and February 2019 ($1,000). -Removes the interest payable recorded in the December 31, 2018 entry ($2,000). -Reduces cash ($103,000). Notice that we record interest expense incurred for four months in 2018 and two months in 2019, rather than recording all six months' interest expense in 2019 when we pay it.. We record interest expense in the period in which we incur it, rather than in the period in which we pay it.

Let's assume you are hired at a $60,000 annual salary with salary payments of $5,000 per month. Before making any spending plans, though, you need to realize that your paycheck will be much less than $5,000 a month. For instance, your employer will "withhold" amounts for (1) federal and state income taxes; (2) Social Security and Medicare; (3) health, dental, disability, and life insurance premiums; and (4) employee investments to retirement or savings plans. Realistically, then, your $5,000 monthly salary translates to much less in actual take-home pay as summarized next.

Monthly salary $5,000 Less: Federal income taxes (750) State income taxes (300) Social Security and Medicare (383) Employee contributions for health insurance (197) Employee investments in retirement plan (220) = Actual take-home pay $3,150

Moct companies list: (Balance Sheet)

Notes payable as "current debt", followed by accounts payable, then other current liabilities.

Decision Point

Question, Accounting information, Analysis How can you tell the amount and interest rate of a company's line of credit? Notes to the financial statements Companies are required to disclose the terms of available lines of credit such as the amounts, maturity dates, and interest rates.

Notes Receivable

Recall that notes receivable is an asset that creates interest revenue.

ACCOUNTS PAYABLE

SECTION BELOW

ACID-TEST RATIO

SECTION BELOW

CONTINGENT GAINS

SECTION BELOW

CONTINGENT LIABILITIES

SECTION BELOW

CURRENT PORTION OF LONG-TERM DEBT

SECTION BELOW

CURRENT VS. LONG TERM CLASSIFICATION

SECTION BELOW

DEFERRED REVENUES

SECTION BELOW

EFFECT OF TRANSACTIONS ON LUIQUIDTY RATIOS

SECTION BELOW

EMPLOYEE COSTS

SECTION BELOW

EMPLOYER COSTS

SECTION BELOW

LIQUIDITY MANAGEMENT

SECTION BELOW

NOTES PAYABLE

SECTION BELOW

WARRANTIES

SECTION BELOW

WORKING CAPITAL

SECTION BELOW

OTHER CURRENT LIABILITIES

SECTION BELOW (Additional current liabilities companies might report include deferred revenues, sales tax payable, and the current portion of long-term debt. We explore each of these in more detail next.)

LITIGATION AND OTHER CAUSES

SECTION BELOW (REVIEW THIS SECTION AGAIN)

PAYROLL LIABILITIES

SECTION BELOW (how payroll is calculated for both the employee and the employer)

ANALYSIS: LQUIDITY ANALYSIS

SECTION BELOW: United Airlines vs. American Airlines

SALES TAX PAYABLE

SECTION UNDER

As another example, Southwest Airlines had total borrowings of $2,692 million. Of that amount, $258 million is due in the next year and the remaining $2,434 million is recorded as long-term debt. In its balance sheet, the company records the $2,692 million in current and long-term debt, as shown in Illustration 8-6.

SOUTHWEST AIRLINES Balance Sheet (partial) ($ in millions) Current liabilities: Current portion of long-term debt $ 258 Long-term liabilities: Long-term debt 2,434 Total borrowings $2,692

The amount of sales tax can also be computed by knowing the total cash for the transaction and the sales tax rate. For example, when the cashier at the airport asked you to pay $16.50 for lunch, you could have figured the amount of the sale versus the amount of the sales taxes if you knew the sales tax rate was 10%. If we divide the total cash of $16.50 by 1.10 (1 + 10% sales tax rate), we get $15 (= $16.50 ÷ 1.10) for the actual sale, leaving $1.50 as sales tax. In this situation, the general formula to determine sales tax can be stated as:

Sales tax=Total cash paid-Total cash paid/1 + Sales tax rate

KEY-POINT

Sales taxes collected from customers by the seller are not an expense. Instead, they represent current liabilities payable to the government.

CURRENT RATIO

Section Below

How would the lender, Bank of America, record this note? For the bank it's a note receivable rather than a note payable, and it generates interest revenue rather than interest expense. The entries for Bank of America's loan are as follows:

September 1, 2018 D C Notes Receivable 100000 Cash 100000 (issue notes receivable) December 31, 2018 D C Interest Receivable 2000 Interest Revenue(=100000x6%x4/12) 2000 (Record interest earned, but not received) March 1, 2019 D C Cash 103000 Interest Revenue(=$100,000x6%x2/12) 1000 Interest Receivable 2000 Notes Receivable 100000 (Collect notes receivable and interest)

Assume Southwest Airlines borrows $100,000 from Bank of America on September 1, 2018, signing a 6%, six-month note for the amount borrowed plus accrued interest due six months later on March 1, 2019. On September 1, 2018, Southwest will receive $100,000 in cash and record the following:

September 1, 2018: Debit: Credit: Cash 100000 Notes Payable 100000 (issue notes payable)

Common Mistake

Some students incorrectly think the Deferred Revenue account is a revenue account, since the account has the word "Revenue" in the title. As indicated above, Deferred Revenue is a liability account, not a revenue account.

Common Mistake

Some students think the balance in the Warranty Liability account is always equal to Warranty Expense. Remember, the Warranty Liability account is increased when the estimated warranty liability is recorded, but then is reduced over time by actual warranty expenditures.

COMMON MISTAKE

Some students want to debit Sales Tax Expense. Note that a Sales Tax Expense account does not even exist. That's because, while sales tax is an expense for the consumer, it is not an expense for the company selling the goods or service. For the company, sales taxes are simply additional cash collected for taxes owed to the local or state government.

Each company selling products subject to sales tax is responsible for collecting the sales tax directly from customers and periodically sending the sales taxes collected to the state and local governments. The selling company records sales revenue in one account and sales tax payable in another. When the company collects the sales taxes, it increases (debits) Cash and increases (credits) Sales Tax Payable.

States that currently don't impose a general state sales tax are Alaska, Delaware, Montana, New Hampshire, and Oregon. However, many cities in Alaska have local sales taxes. The other four states impose sales-type taxes on specific transactions such as lodging, tobacco, or gasoline sales.

Recording of commercial paper:

The recording for commercial paper is exactly the same as the recording for notes payable described earlier. Commercial paper is sold with maturities normally ranging from 30 to 270 days. Since a company is borrowing directly from another company, the interest rate on commercial paper is usually lower than on a bank loan. Because of this, commercial paper has thus become an increasingly popular way for large companies to raise funds.

Operating Cycle

The time it takes to produce revenue.

Is there an order for presenting accounts within the current liabilities section of the balance sheet?

There is NO prescribed order for presenting accounts within the current liabilities section of the balance sheet.

Besides the required deductions for income tax and FICA taxes, employees may opt to have additional amounts withheld from their paychecks. What are some?

These might include the employee portion of insurance premiums, employee investments in retirement or savings plans, and contributions to charitable organizations such as United Way. The employer records the amounts deducted from employee payroll as liabilities until it pays them to the appropriate organizations.

Federal Insurance Contributions Act (FICA)

This act requires employers to withhold a 6.2% Social Security tax up to a maximum base amount plus a 1.45% Medicare tax with no maximum. Therefore, the total FICA tax is 7.65% (6.2% + 1.45%) on income up to a base amount ($118,500 in 2015) and 1.45% on all income above the base amount.

What obligations do firms most frequently report as current liabilities?

Three main categories: -Notes payable -Accounts Payable -Payroll Liabilities Additional current liabilities: -Deferred revenue -Sales tax payable -the current portion of long-term debt.

State Unemployment Tax Act (SUTA)

Under the State Unemployment Tax Act (SUTA), in many states the maximum state unemployment tax rate is 5.4%, but many companies pay a lower rate based on past employment history.

Key Point

Unlike contingent liabilities, contingent gains are not recorded until the gain is certain and no longer a contingency.

When calculating the number of months of interest, students count months as?

WRONG!!! mistakenly subtract December (month 12) from September (month 9) and get three months. CORRECT!!!However, the time from September 1 to December 31 includes both September and December, so there are four months.

KEY--POINT

We report the currently maturing portion of a long-term debt as a current liability in the balance sheet.

KEY POINT

When a company receives cash in advance, it debits Cash and credits Deferred Revenue, a current liability account. When it earns the revenue, the company debits Deferred Revenue and credits Sales Revenue.

KEY POINT

Working capital is the difference between current assets and current liabilities. The current ratio is equal to current assets divided by current liabilities. The acid-test ratio is equal to quick assets (cash, current investments, and accounts receivable) divided by current liabilities. Each measures a company's liquidity, its ability to pay currently maturing debts.

contingent liability

is an existing uncertain situation that might result in a loss depending on the outcome of a future event. ex. lawsuits, product warranties, environmental problems, and premium offers.

line of credit

is an informal agreement that permits a company to borrow up to a prearranged limit without having to follow formal loan procedures and prepare paperwork. Note: Notes payable is recorded each time the company borrows money under the line of credit. However, no entry is made up front when the line of credit is first negotiated, since no money has yet been borrowed.

The Federal Unemployment Tax Act (FUTA)

requires a tax of 6.2% on the first $7,000 earned by each employee. NOTE: This amount is reduced by a 5.4% (maximum) credit for contributions to state unemployment programs, so the net federal rate often is 0.8%.

current portion of long-term debt

the amount that will be paid within the next year. NOTE: Management needs to know this amount in order to budget the cash flow necessary to pay the current portion as it comes due. Investors and lenders also pay attention to current debt because it provides information about a company's bankruptcy risk.