Chapter 10: Liabilities

Convertible Bond

A bond that may be exchanged (at the bondholder's option) for a specified number of shares of the company's capital stock.

Pension Fund

A fund managed by an independent trustee intro which an employer-company makes periodic payments. The fund is used to make pension payments to retired employees.

Capital Lease

A lease contract that finances the eventual purchase by the lessee of leased property. The lessor accounts for a capital leases as a sale of property; the lessee records an asset and a liability equal to the present value of the future lease payments. Also called a financing lease.

Operating Lease

A lease contract which is in essence a rental agreement. The lessee has the use of the leased property, but the lessor retains the usual risks and rewards of ownership. The periodic lease payments are accounted for as rent expense by the lessee and ad rental revenue by the lessor.

Bankruptcy

A legal status in which the financial affairs of an illiquid business (or individual) are managed in large part, by the U.S. Bankruptcy Court.

Deferred Income Taxes

A liability account to pay income taxes that have been postponed to a future year's income tax return. In some cases, this account can also be an asset account representing income taxes to be saved in a future year's income tax return.

Noncurrent Liabilities

Are due to be paid sometime after one year.

Workers' Compensation

A state-mandated insurance program issuing workers against job-related injuries. Premiums are charged to employers as a percentage of the employees' wages and salaries. The amounts vary by state and by employers' occupations but, in some cases, can be very substantial.

Actuary

A statistician who performs computations involving assumptions as to human life spans. One function is computing companies' liabilities for pensions and A statistician who performs computations involving assumptions as to human life spans. One function is computing companies' liabilities for pensions and post-retirement benefits. benefits.

Accrued Liabilities

Accrued liabilities arise from the recognition of expenses for which payment will be made in the future. Accrued liabilities are often referred to as accrued expenses. Examples of accrued liabilities include interest payable and income taxes payable. As accrued liabilities stem from the recording of expenses, the matching principle governs the timing of their recognition. All companies incur accrued liabilities. In most cases, however, these liabilities are paid at frequent intervals. The liability to pay an expense that has accrued during the period. Also called accrued expenses.

Commitments

Agreements to carryout future transactions. Although they are not a liability (because the transactions have not been transformed), they maybe disclosed in notes to the financial statements.

Off-Balance Sheet Financing

An arrangement in which the use of resources is financed without the obligation for future payments appearing as a liability in the balance sheet. An operating lease is a common example of off-balance sheet financing.

Loss Contingencies

An existing uncertain situation involving potential loss depending on whether some future event occurs. Two factors affect whether a loss contingency must be accrued and reported as a liability: 1. The likelihood that the confirming event will occur. 2. Whether the loss amount can be reasonably estimated. Situation involving uncertainty as to whether a loss has occurred. The uncertainty will be resolved by a future event. An example of a loss contingency is the possible loss relating to a lawsuit pending against a company. Although loss contingencies are sometimes recorded in the accounts, they are more frequently disclosed only in notes to the financial statements.

Current Liabilities

Are due to be paid within one year or the normal operating cycle of the business, whichever is longer. For most businesses, one year is longer than the operating cycle.

Collateral

Assets that have been pledged to secure specific liabilities. Creditors with secured claims can foreclose on (seize title to) these assets if the borrowers default.

Postretirement Benefits

Benefits that will be paid to retired workers. The present value of the future benefits earned by a worker during a current period is expense of the period. If not fully funded, their expense results in a liability for unfunded post-retirement benefits (For many companies, these liabilities have become very large.)

Underwriter

Bonds are issued through an intermediary. An investment banking firm that handles the sale of a corporation's stocks or bonds to the public.

Bonds Payable

Bonds normally have an interest rate called a stated or contract rate. Interest is normally paid semiannually and is computed as Principal times Rate times Time. This computation should look familiar to you. Long-term debt securities that subdivided a very large and long-term corporate debt into transferable increments of $1,000 or multiples thereof.

Junk Bonds

Bonds payable that involve a greater than normal risk of default and, therefore, must pay higher than normal rates of interest in order to be attractive to investors.

Sinking Fund

Cash set aside by a corporation at regular intervals (usually with a trustee) for the purpose of repaying a bond issue at its maturity date.

Debt

Funds from creditors, with a definite due date, and sometimes bearing interest.

Equity

Funds from owners.

Estimated Liabilities

Has two basic characteristics: (1) the liability is known to exist, and (2) the precise dollar amount cannot be determined until a later date. An example of an estimated liability is the warranty associated with a new car provided by the manufacturer. The warranty usually extends for a number of years. As each car is sold, the automaker incurs a liability to perform any work that may be required under the warranty. The dollar amount of the liability, however, can only be estimated at the date of sale. Liabilities known to exist, but that must be recorded in the accounting records at estimated dollar amounts.

Note

Is a written promise to pay a specific amount at a specific future date.

Notes Payable

Is created when a company borrows money. Many of these require payments on a regular basis during the life of the note. Ex: home mortgages are paid over a 10-30 years.

Interest Coverage Ratio

Operating income divided by interest expense. Indicates the number of times that the company was able to earn the amount of its interest charges.

Special Purpose Entities

SEPs are a separate entities established by corporations to accomplish specific purposes. SEPs are often used to borrow money and then transfer it to the sponsoring corporation as an off-balance sheet financing arrangement.

Payroll Taxes

Taxes levied on an employer based on the amount of wages and salaries being paid to employees during the period. They include the employer's share of Social Security and Medicare taxes, unemployment taxes, and (though not called a "tax") workers' compensation premiums.

Present Value (of a future amount)

The amount of money that informed investors would pay today for the right to receive the future amount based on a specific rate of return required by the investor.

Debt Service

The combined cash outlays that required for repayment of principal amounts borrowed and for the payments of interest expenses during the period.

Maturity Date

The date in which a liability becomes due.

Amortization Table

The information needed for the journal entry can be found on this. The cash payment amount, the interest expense, and the principal reduction amount are all in the table. A schedule that indicates how installment payments are allocated between interest expense and repayments of principal.

Lessor

The owner of the property leased to a lessee.

Lessee

The tenant, user, or renter of leased property.

Principal Amount

The unpaid balances of an obligation, exclusive of any interest charges for the current period.

Leverage

The use of borrowed money to finance business operations.

Liabilities

They are debts owed from past transactions. There are two types, can be separated into two categories: Current and Non-current.

Accounts Payable

They are short-term obligations for purchases of merchandise and other goods and services that are used in the normal operations of a business. Ex: Merchandise inventory invoices, Office supplies invoices, Shipping charges, & Utility and phone bills.