Learning Objectives Understand the Business – LO1 Explain the role of liabilities in financing a business. Study the accounting methods – LO2 Explain how.

Learning Objectives

• Understand the Business– LO1 Explain the role of liabilities in financing a

business.• Study the accounting methods– LO2 Explain how to account for common types of

current liabilities.– LO3 Analyze and record bond liability transactions.– LO4 Describe how to account for contingent liabilities.

• Evaluate the results– LO5 Calculate and interpret the quick ratio and the

times interest earned ratio.• Review the chapter

1© McGraw-Hill Ryerson. All rights reserved.

Measuring Liabilities

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Initial liability = cash equivalent.

Increase with additional obligations.

Decrease when payments are made.

Interest is not recorded when a liability is first recorded. Interest is incurred as time passes.

LO2

+

-

Current Liabilities

• Accounts Payable is increased (credited) when a company buys goods or services on credit.

• Accounts Payable is decreased (debited) when a company pays its account.

• Accounts Payable is interest-free unless it becomes overdue.

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Accounts Payable

LO2

Accrued Liabilities

• Accrued Liabilities are obligations for expenses that have been incurred, but not yet paid at the end of the accounting period.

• Accrued Liabilities often include advertising, electricity, corporate income tax, interest, payroll tax and warranties.

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Accrued Payroll• Payroll Deductions are the amounts deducted from each

employee’s gross pay.• They include Income Taxes, Canada Pension Plan and

Employment Insurance.• These amounts must be remitted to the appropriate

government or agency.• They are liabilities.

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A company has a payroll of $600,000. The total withheld is: employee income tax $100,550;

CPP $28,500; EI $10,250; and United Way Contributions $10,000.

The total cash paid to employees is $450,700.

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1 Analyze

2 Record

Employer Payroll Taxes are additional amounts employers must remit. Employers must match employees’ CPP amounts and

must contribute 1.4 times the employees’ EI amount.

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1 Analyze

2 Record

The employees’ CPP is $28,500, so the company must contribute an additional $28,500 to CPP; the employees’ EI is $10,250, so

the company must contribute an additional $14,350 to EI.

Accrued Income Taxes

• Corporations must file a T2 tax return to determine the amount of federal and provincial tax.

• A corporation’s taxable income is multiplied by the company’s tax rate, which is often about 35%.

• Corporate income taxes are due three months after yearend.

• Most companies are required to pay instalments during the year.

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Notes Payable

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Establishing a Note PayableOn November 1, 2012, a company borrows $100,000 cash on a one-year 6% note payable. Both principal and interest are due October 31, 2013.

Notes Payable is the amount owed as a result of issuing promissory notes.

1 Analyze

2 Record

LO2

Accruing Interest ExpenseOn December 31, 2012, accrued interest revenue is recorded.

LO2© McGraw-Hill Ryerson. All rights reserved. 10

Interest = P x R x T= $100,000 x 6% x 2/12= $1,000

Note Payable Timeline

1 Analyze

2 Record

Recording Interest PaidOn October 31, 2013, the company pays a $6,000

cash interest payment.

LO2© McGraw-Hill Ryerson. All rights reserved. 11

The total interest is $6,000; $1,000 was expensed in 2012 and accrued December 31, 2012,

and $5,000 is expense in 2013.

1 Analyze

2 Record

Recording Principal PaidOn October 31, 2013, the company pays the $100,000

principal that is due.

LO2© McGraw-Hill Ryerson. All rights reserved. 12

1 Analyze

2 Record

Sales Tax Payable

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Recording a Sale with PST and GSTA $1,000 sale is made in a province with 5% PST and 5% GST. The total

cash received is $1,100, of which $50 is PST and $50 is GST.

Most provinces charge PST on retail sales, the federal government charges GST; some provinces have combined both taxes into HST. These taxes must be collected from customers and remitted to the

appropriate government.

1 Analyze

2 Record

LO2

Unearned Revenue

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Receive Cash and Create a LiabilityOn October 1, cash is received for a three-month subscription in advance

at a rate of $10 per month ($30 total).

If a customer pays for goods or services in advance, a liability is created.

LO2

1 Analyze

2 Record

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Fulfill part of the liability and earn revenue

On October 31, one month ($10) has been earned.1 Analyze

2 Record

This entry would be repeated each month until all the Unearned Revenue has been earned.

LO2