Accounting Chapter 8 Textbook

Example of working capital If you have $20 in your pocket and you know you still owe $10 to your friend and $3 for parking, what is your working capital?

$7

Acid-test ratio=

(Cash+current investments+accounts receivable)/current liabilities

Criteria for reporting a contingent liability

1. The likelihood of payment is a. probably- 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. reasonable estimable OR b. not reasonable estimable

What are the three essential characteristics of liabilities?

1. probable future sacrifices of economic benefits 2. arising from present obligations to other entities 3. resulting from past transactions or events

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

5.4%

What is the current portion of long-term debt?

Amount that will be paid within one year from the balance sheet date

What is a debt covenant?

An agreement between a borrower and a lender requiring certain minimum financial measures be met or the lender can recall the debt.

Why is working capital not the best measure of liquidity when comparing one company with another?

Because it does not control for the relative size of each company.

What is the term used to describe uncertain situation that can result in a gain or a loss for a company?

Contingencies

In classified balance sheet, we categorize liabilities as either __________ or _____________.

Current or long-term

When a company receives cash in advance from customers, it _____________ cash and ___________ deferred revenue, a current liability account.

DEBITS cash CREDITS deferred revenue

When the company provides those goods to its customers, it _________ deferred revenue and _____________ sales revenue.

DEBITS deferred revenue CREDITS sales revenue

Current Ratio What are changes that decrease the ratio?

Decrease in current assets Increase in current liabilities

Acid-test ratio What are changes that decrease the ratio?

Decrease in quick assets Increase in current liabilities

What is an example of a warranty

Dell offering warranty covering hardware from defect for either a 90-day, one year, or two-year period

Is this an employee or employer cost? Federal and state income taxes

Employee cost

Is this an employee or employer cost? Employee contributions for health, dental, disability, and life insurance

Employee costs

Is this an employee or employer cost? Employee portion of Social Security and Medicare (FICA taxes)

Employee costs

What are examples of additional amounts some employees choose to have withheld from their paychecks?

Employee portion of insurance premiums, employee investments in retirement or savings plans, and contributions to charitable organizations

Is this an employee or employer cost? Federal and state unemployment taxes

Employer costs

Is this an employee or employer cost? Employer contributions for health, dental, disability, and life insurance

Employer costs

Is this an employee or employer cost? Employer contributions to retirement or savings plans

Employer costs

Is this an employee or employer cost? Employer matching portion of Social Security and Medicare

Employer costs

T or F: Deferred Revenue account is a revenue account.

FALSE Deferred revenue is a liability account, NOT revenue!

T or F: The warranty liability account is always equal to warranty expense.

FALSE; the warranty liability account is increased when the estimated warranty liability is recorded, but then is reduced over time by actual warranty expenditures.

T or F: Sales taxes collected from customers by the seller are an expense.

FALSE; sales taxes collected from customers by the seller are NOT an expense

What are examples of advance payments?

Gift cards from clothing stores, gift cards from restaurants, gift cards for movie tickets, room deposits at hotels, and subscriptions to magazines

Current Ratio What are changes that increase the ratio?

Increase in current assets Decrease in current liabilities

Acid-test ratio What are changes that increase the ratio?

Increase in quick assets Decrease in current liabilities

We calculate interest on notes as....

Interest= face value x annual interest rate x fraction of the year

What is the definition of liability?

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

________________ liabilities are payable in more than one year.

Long-term

What obligations do forms most frequently report as current liabilities?

Motes payable, accounts payable, and payroll liabilities are the three main categories.

Does a sales tax expense account exist?

NO! because sales tax is expense for consumer, not expense for company selling goods or service

Many companies, including those in the airline industry are very labor-intensive. __________________ liabilities make up a significant portion of current liabilities for these companies.

Payroll liabilities

A contingent liability is recorded if a loss is....

Probable AND the amount is reasonable estimable

What is an example of a liability that requires paying something other than cash?

Revenue

2/3 of bank loans are short or long-term?

Short-term

T or F REVIEW: 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

TRUE

T or F: Besides the required deductions for income tax and FICA taxes, employees may opt to have additional amounts withheld from their paychecks.

TRUE

T or F: Companies are required by law to withhold federal and state income taxes from employees' paychecks and remit these taxes to the government.

TRUE

T or F: 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.

TRUE

T or F: 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.

TRUE

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

TRUE

What is an example of revenue recognition?

The company records passenger ticket sales and tickets sold by other airlines for use on United as passenger revenue when transportation is provided. The value of unused passenger tickets is included in current liabilities as Advance ticket sales.

Sales tax =

Total cash paid- (minus) Total cash paid/1=Sales tax rate

What is the most common example of a contingent liability?

Warranties

How do contingent liabilities differ from contingent gains?

We usually do not record contingent gains until the gain is known with certainty and no longer a contingency.

Acid-test ratio is similar to current ratio but is based on...

a more conservative measure of current assets available to pay current liabilities

Pizza Shop sells toaster ovens with a one-year warranty to fix any defects. For the current year, 100 toaster ovens have been sold. By the end of the year 4 ovens have been fixed for an average of $80 each. Management estimates that 5 more of the 100 sold will need to be fixed next year for an estimated $80 each. For how much should Pizza Shop report warranty liability at the end of the current year? a. $400 b. $320 c. $720 d. $0

a. $400

Smith Co. filed suit against Western, Inc., seeking damages for patent infringement. Western's legal counsel believes it is probable that Western will have to pay an estimated amount in the range of $75,000 to $175,000, with al amounts in the range considered equally likely. How should Western report this litigation? a. as a liability for $75,000 with disclosure of the range b. as a liability for $125,000 with disclosure of the range c. as a liability for $175,000 with disclosure for the range d. as a disclosure only. no liability is reported.

a. as a liability for $75,000 with disclosure of the range

Management can estimate the amount of loss that will occur due to litigation against the company. If the likelihood of loss is reasonable possible, a contingent liability should be a. disclosed but not reported as a liability b. disclosed and reported as a liability c. neither disclosed nor reported as a liability d. reported as a liability but not disclosed

a. disclosed but not reported as a liability

Current liabilities a. may include contingent liabilities b. include obligations payable within one year or one operating cycle, whichever is shorter c. can be satisfied only with the payment of cash d. are preferred by most companies over long-term liabilities

a. may include contingent liabilities

Accounts payable are defined as what?

accounts that the company owes to suppliers of merchandise or services that it has bought on credit.

What are Fringe benefits?

additional employee benefits paid for by the employer

What is a contingent gain?

an existing uncertain situation that might result in a gain, which often is the flip side of contingent liabilities.

What is a contingent liability?

an existing uncertain situation that might result in a loss depending on the outcome of a future event.

A local Starbucks sells gift cards of $10,000 during the year. By the end of the year, customers have redeemed $8,000 of gift cards. What will be the year-end balance in the Deferred Revenue account? a. $0 b. $2,000 c. $8,000 d. $10,000

b. $2,000

Express Jet borrows $100 million on October 1, 2021, for one year at 6% interest. For what amount does Express Jet report interest payable for the year ended December 31, 2022? a. $0 b. $4.5 million c. $1.5 million d. $6 million

b. $4.5 million

Assuming a current ratio of 1.00 and an acid-test ratio of 0.75, how will the purchase of inventory with cash affect each ratio? a. increase the current ratio and increase the acid-test ratio b. no change to the current ratio and decrease the acid-test ratio c. decrease the current ratio and decrease the acid-test ratio d. increase the current ratio and decrease the acid-test ratio

b. no change to the current ratio and decrease the acid-test ratio

Which of the following is not deducted from an employee's salary? a. FICA taxes b. unemployment taxes c. income taxes d. employee portion of insurance and retirement payments

b. unemployment taxes

We record interest expense on a note payable in the period in which a. we pay cash for interest b. we incur interest c. we pay cash and incur interest d. we pay cash or incur interest

b. we incur interest

The acid-test ratio is a. current assets divided by current liabilities b. cash and current investments divided by current liabilities c. cash, current investments, and accounts receivable divided buy current liabilities d. cash, current investments, accounts receivable, and inventory divided by current liabilities

c. cash, current investments, and accounts receivable divided buy current liabilities

The city of Summerton has a sales tax rate of 8%. A local convenience store sells merchandise, and the customer pays a total of $38.34. What effect does this transaction have on total liabilities? a. increase of $3.07 b. decrease of $38.34 c. increase of $2.84 d. no effect

c. increase of $2.84

Which of the following statements regarding liabilities is NOT true? a. liabilities can be for services rather than cash b. liabilities are reported in the balance sheet for almost every business c. liabilities result from future transactions d. liabilities represent probable future sacrifices of benefits

c. liabilities result from future transactions

The warranty for the computer represents a liability for Dell at the time of the same because it meets the criteria for recording a _________________ liability.

contingent

In most cases, ____________ liabilities are payable within one year from the balance sheet date.

current

working capital=

current assets-current liabilities

Current ratio=

current assets/current liabilities

Smith Co. filed suit against Western, Inc., seeking damages for patent infringement. Smith's legal counsel believes it is probable that Western will have to pay $125,000, although no final settlement has yet been reached. How should Smith report this litigation? a. as an asset for $125,000 b. as a gain for $125,000 c. as both an asset and a gainer $125,000 d. no asset or gain is reported

d. no asset or gain is reported

The seller collects sales taxes from the customer at the time of sale and reports the sales taxes as a. sales tax expense b. sales tax revenue c. sales tax receivable d. sales tax payable

d. sales tax payable

What are some examples of additional current liabilities companies might report?

deferred revenues, sales tax payable, current portion of long-term, debt

Is this an employee or employer cost? Employee investments in retirement or savings plans

employee costs

Reasonable estimable=

even though Dell doesn't know precisely what the warranty costs will be next year, it can formulate a reasonable prediction from past experiences. industry statistics, and other current business conditions.

Motes payable is a liability that creates interest ____________.

expense

It is desirable to anticipate losses, but recognizing gains should await their....

final settlement

What is the term used to describe the point in time when gift cards expire or when the likelihood of redemption by customers is viewed as remote.

gift card breakage

Define liquidity:

having sufficient cash (or other current assets convertible to cash in a relatively short time) to pay currently maturing debts

We record interest expense in the period in which we __________ it, rather than in the period in which we pay it.

incur

What is a line of credit?

informal agreement that permits a company borrow up to a rearranged limit without having to follow formal loan procedures and prepare paperwork.

When a company borrows money, it pays the lender ____________ in return for using the lender's money during the term of the loan.

interest

Note receivable generates ________ _________ rather than interest expense.

interest revenue

List some examples of contingent liability:

lawsuits, product warranties, environmental problems, and premium offers

If you are able to claim more exemptions, you will have...

less tax withheld from your paycheck

Many companies prearrange the terms of a note payable by establishing a ______ of ________ with bank

line of credit

Most companies would prefer to report a liability as ___________ rather than current because it will cause the firm to appear less risky.

long-term

A contingent liability is recorded only is a loss is _____________ AND the amount is ____________________- ___________________.

loss is Probable AND amount is reasonably estimable.

Key review: In most cases, current liabilities are payable within one year from balance sheet and long-term liabilities are payable in _________ than one year.

more

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. The borrower reports its liability as _________ __________.

notes payable

What are quick assets?

only cash, current investments, and accounts receivable

The loss is reported in the income statement as either an ____________ or a _____________ expense.

operating OR non operating

If a company has a operating cycle longer than one year, its current liabilities are defined by the

operating cycle rather than by length of year

Current ratio and acid-test ratio are better measures of a company's ability to..

pay its debts on time

acid-test ratio is also called

quick ratio

If the likelihood of payment is only _____________ possible rather than probable, we record no entry but make full disclosure in a note to the financial statements to describe the contingency.

reasonable

Distinguishing between current and long-term liabilities is important in helping investors and creditors assess...

risk

Liabilities represent probable future ____________ of benefits.

sacrifices

What is sales tax payable?

sales tax collected from customers by the seller, representing current liabilities payable to the government.

What is working capital?

the difference between current assets and current liabilities

What is an operating cycle?

the length of time from spending cash to provide goods and service to a customer until collection of cash from that customer.

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

unemployment

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.

Probable=

warranties almost always entail an eventual expenditure

What is the difference between current assets and current liabilities?

working capital

What are the three liquidity measures

working capital current ratio acid-test ratio