Essay about Chapter 12 Presentation

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Chapter 12


James D. Stice

Earl K. Stice
PowerPoint presented by Douglas Cloud
Professor Emeritus of Accounting, Pepperdine
© 2014 Cengage Learning


Definition of Liabilities
The FASB defined liabilities as “probable future sacrifices of economic benefits arising from present obligations to a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events.” The FASB is currently considering a revision of this liability definition.


Classification of Liabilities

For reporting purposes liabilities are usually classified as current or noncurrent.

If a liability arises in the course of an entity’s normal operating cycle, it is considered current if current assets are used to satisfy the obligation within one year or one operating cycle, whichever period is longer.

Classification of Liabilities

The classification of a liability as current or noncurrent can impact significantly a company’s ability to raise additional funds.

When debt classified as noncurrent will mature within the next year, the liability should be reported as a current liability.

The distinction between current and noncurrent is important because of the impact on a company’s current ratio.


Measurement of Liabilities
For measurement purposes, liabilities can be divided into three categories:
1. Liabilities that are definite in amount
2. Estimated liabilities
3. Contingent liabilities
The measurement of liabilities always involves some uncertainty because a liability, by definition, involves a future outflow of resources. 12-5

Short-Term Operating Liabilities

The term account payable usually refers to the amount due for the purchase of materials by a manufacturing company or the purchase of merchandise by a wholesaler or retailer.

Accounts payable are not recorded when purchase orders are placed but instead when legal title to the goods passes to the buyer. 12-6

Short-Term Debt

In most cases, debt is evidenced by a promissory note, which is a formal written promise to pay a sum of money in the future, and is usually reflected on the debtor’s books as Notes Payable.

Notes issued to trade creditors for the purchase of goods or services are called trade notes payable.

Short-Term Debt

Nontrade notes payable include notes issued to banks or to officers and stockholders for loans to the company.

If a note has no stated rate of interest, or if the stated rate is unreasonable, then the face value of the note would be discounted to the present value to reflect the effective rate of interest implicit in the note.


Short-Term Obligations
Expected to be Refinanced

A short-term obligation that is expected to be refinanced on a long-term basis should not be reported as a current liability.
This applies to the currently maturing portion of a long-term debt and to all other short-term obligations except those arising in the normal course of operations that are due in customary terms.

Short-Term Obligations
Expected to be Refinanced
According to FASB ASC Topic 470
(Debt), both of the following conditions must be met before a short-term obligation can be properly excluded from the current liability classification.
1. Management must intend to refinance the obligation on a long-term basis.
2. Management must demonstrate an ability to refinance the obligation.

Short-Term Obligations
Expected to be Refinanced
Concerning the second point, the ability to refinance may be demonstrated by either of the following:
a) Actually refinancing the obligation during the period between the balance sheet date and the date the statements are issued. b) Reaching a firm agreement that clearly provides for refinancing on a long-term basis. (continued)


Short-Term Obligations