FMGT 4816

Chapter 6
SPECIFIC ACCOUNTS
Student Version

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 Learning Objectives

▪ Understand the nature of cash and cash equivalents

▪ Learn how companies report short-term and long term investments
▪ Understand accounts receivable and the accounting for bad debts
▪ Learn to account for inventory, including the FIFO and LIFO methods
▪ Understand accounting for property, plant, and equipment,
including the straight-line and double-declining-balance methods
▪ Learn how companies account for current and noncurrent liabilities

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 Cash and Cash Equivalents

▪ Cash
▪ Cash Equivalents
• Highly liquid investments that mature within 90 days of acquisition
➢ Term deposits
➢ Commercial paper
➢ Mutual funds
➢ Securities that are considered safe that can be easily and quickly sold
➢ Treasury Bills
o Short-term debt instruments issued by the federal government
o Purchased at an amount less than the maturity value (discount)
o The difference between the purchase price and value at maturity or date sold is the interest
earned on the investment
o Have a wide variety of maturity dates to a maximum of one year
• Can be sold before their maturity date
• Used to earn revenue that is higher than when leaving cash in a bank account
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 Investments

Why do company’s invest (in shares and bonds?)

▪ Non-strategic reasons
• A company has idle cash on hand, usually because of seasonal fluctuations
• To earn interest income
• To earn dividend income
• To earn capital gains
▪ Strategic reasons
• To influence the operations of the investment
• Buying into another industry
• Future growth by investing in the competition with intension of eventually
taking over completely

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Classification of Investments
▪ Non-strategic investments
Type of Instrument
Short-term debt instruments
Long-term debt instruments
Short- or long-term debt instruments
Equity instruments
Equity instruments
Equity instruments
Investments
The purpose of the investment is the
more important factor in determining the
balance sheet classification and valuation
IFRS/ASPE
Purpose of Investment Classification and Valuation
Held to earn interest income Current assets; Amortized cost
Held to earn interest income Non-current assets; Amortized cost
Held for trading purposes Current assets; Fair value
Held for trading purposes Current assets: Fair Value
Available for sale: short term Current assets; Fair Value
Available for sale: long term Non Current assets; Fair value
Source: Wiley 2016 5
 Investments

Classification of Investments (continued)

▪ Strategic investments
• Includes only equity securities
• Provides some level of authority or influence
• The percentage of ownership or the degree of influence determines how a
strategic investment is classified
• Strategic investments can only be long-term

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 Investments
Classification of Investments (continued)
▪ Amortized Cost (carrying value)
• Maturity value less the unamortized discount or premium
▪ Fair Value through Profit or Loss (FVTPL) Typically Short Term
• Investments that do not meet the criteria established for amortized cost
investments and have not been designated by management as the other
category, fair value through Other Comprehensive Income
➢ Gains and losses, realized or unrealized are reported on the Income Statement
▪ Fair Value Through Other Comprehensive Income (FVTOCI) Typically Long Term
• Any equity securities designated by management to this category
➢ If an investment does not use Amortized Cost or FVTOCI, under IFRS it is automatically
considered to use FVTPL
➢ Gains and losses, realized or unrealized are reported on the Statement of
Comprehensive Income
➢ Not applicable for ASPE as no Other Comprehensive Income category
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 Accounting for Investments

Accounting for Strategic Investments

▪ Cost Method
▪ Fair Value
▪ Equity Method
FVTPL or FVTOCI
▪ Consolidation
Investor’s Ownership
Interest in Investee’s Financial Reporting
Common Shares Presumed Influence on Investee Guidelines
Less than 20% Insignificant Fair Value (IFRS)/Cost Method (ASPE)
20% to 50% Significant Equity Method
Greater than 50% Control Consolidation

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 Accounting for Investments

Cost Method
▪ Easy to use
• Investment is initially recorded at cost
• Usually no fair value adjustment is made until sold
▪ When purchased, the investment is recorded at the amount paid for
the Common Shares
Increase the Investment in Associate—Common Shares account
➢ Reported on the balance sheet as a non-current asset
▪ Dividends received are recorded by increasing Cash and increasing
Dividend Revenue

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 Accounting for Investments

Fair Value
▪ Under IFRS a long-term investment where there is no significant
influence can be reported under
• Fair Value Through Profit or Loss (FVTPL) OR Fair Value Through Other
Comprehensive Income (FVTOCI)
• Same as Non-Strategic Investments covered earlier
▪ Under ASPE, the long-term investment would be reported at fair
value (FVTPL) if there is a quoted market price for the shares
• Would be reported at cost if there is no quoted market price

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 Accounting for Investments

Equity Method
▪ Used when an investor owns 20% to 50% of the common shares of another
company
▪ Presumed significant influence
▪ When purchased, the investment is recorded at the price paid for the common
shares
• The Investment in Associate account is increased for the cost of the shares
• The cost includes the price paid to purchase the shares and any transaction costs paid to
purchase them
▪ Each year, the investor increases the Investment in Associate account and
increases Revenue from Investment in Associate for its share of the associate’s
profit
▪ Dividends received are recorded by increasing Cash and reducing the Investment
in Associate account
▪ No Fair Value adjustment of shares unless deemed to be a permanent reduction

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 Accounts Receivable

Most businesses sell to each other on credit terms

▪ Cash is not used at time of sale
▪ Sale is on account
▪ The account must be paid in the near future with cash

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 Risks of Selling on Credit

Issues
What are the benefits and costs of
extending credit to customers?
Run a credit check on prospective
customers
Design internal control system to
separate duties
Keep a close eye on customers. Send
additional statements to slow-paying
customers
Action
Benefit – increase in sales
Cost – risk of not collecting
Extend credit to only creditworthy
customers
Separate cash-handling and accounting
duties to keep employees from stealing
cash from customers
Pursue collection from customers to
maximize cash flow

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 Net Realizable Value of Accounts Receivable
Businesses will not usually be able to collect all of their accounts
receivables
▪ Some customers will not pay their amounts owing
▪ This becomes an uncollectible amount
Uncollectible amounts must be accounted for
▪ Bad Debt Expense
▪ Allowance for Doubtful Accounts

Difference between Accounts Receivable and Allowance for Doubtful

Accounts is the Net Realizable Value of Accounts Receivable (shown as
Accounts Receivable, Net)
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 Bad Debts Expense

An expense account used to record those accounts receivables that

become uncollectible
Problem: matching principle
▪ Businesses are unaware of which customers will not pay
▪ Timing issue
• A bad debt expense must be recognized on an ongoing basis even before the
actual realization of non payment by a customer
• Direct write off of accounts receivable when business realizes it cannot collect
the amounts owing violates the matching principle
• Allowance Method estimates uncollectible accounts receivable at period ends
➢ Adjustments are then made

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 Allowance Method

Allowance for Doubtful Accounts

▪ Contra asset account
▪ Deduct from Accounts Receivables
▪ Allows Accounts Receivable to be stated at its Net Realizable Value
▪ Balance Sheet presentation:

Accounts Receivable $10000

Allowance for Doubtful Accounts 1000 $9000

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 Allowance for Doubtful Accounts

Business must decide and estimate what it believes its bad debts to be
▪ Calculate a percentage of total Accounts Receivables based on history
(percentage of receivables approach)
• Ensure the Allowance for Doubtful Accounts always reflects this percentage at
each period end

Assume A/R balance at the end of the period will be $200,000. Past history
tells us that 7% are uncollectible. There is a current balance in the Allowance
for Doubtful Accounts of $6,000.

$200,000 X 7% = $14,000 $14,000 - $6,000 = $8,000

Therefore $8,000 has to be added to the Allowance for Doubtful Accounts and the
Bad Debts expense account
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 Allowance for Doubtful Accounts

Business must decide and estimate what it believes its bad debts to be
▪ Calculate variable percentages of outstanding customer accounts
based on the number of days outstanding (aging of receivables
approach)
▪ Need to make an aging schedule
• Next slide
▪ Will provide the total amount necessary for the Allowance for Doubtful
Accounts at the end of a period
• The older the customer’s A/R outstanding – the more likely it could become
uncollectible

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 Allowance for Doubtful Accounts
Aging-of-Receivables Method
Age of Account
1-30 31-60 61-90 Over 90 Total
Customer days days days days Balance
Customer A $1,500 $1,000 $0 $ 2,500 $5,000
Customer B 66,070 57,000 10,300 0 133,370
Totals $67,570 $ 58,000 $ 10,300 $ 2,500 $138,370
Est. % uncollectible × 2% × 5% × 10% × 35%
Allowance balance $1,351 $2,900 $1,030 $875 $6,156
should be:

An adjustment would be made to the Allowance account to end up with an ending balance of $6,156
The Bad Debts expense account would also be effected by the adjustment amount

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Aging of Receivables Approach – In Class Exercise

1. Calculate the desired

Doubtful balance the Allowance for
Doubtful Accounts at
December 31, 2017

2. What is the adjustment

amount to be made as a
result of the aging analysis

3. Prepare the Balance Sheet

presentation of Accounts
Receivable at Dec 31, 2017

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 Aging of Receivables Approach – In Class Exercise

1. Desired balance of Allowance for Doubtful Accounts?

($110,000 × 0.005) + ($60,000 × 0.010) + ($50,000 × 0.06) +
($15,000 × 0.40) = $10,150

2. Current balance of $6,500 in the Allowance for Doubtful Accounts

is too low. Therefore $10,150 - $6,500 = $3,650 increase is
required.

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 Aging of Receivables Approach – In Class Exercise

3. BALANCE SHEET
Current Assets:
Accounts receivable, net of allowance for
doubtful accounts of $10,150 $224,850

OR

Current Assets
Accounts Receivable $235,000
Less Allowance for Doubtful Accounts 10,150
Accounts Receivable, Net 224,850

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 Writing Off Uncollectible Accounts
▪ Most businesses try their best to collect their outstanding accounts
• Send out requests for payment
• Telephone calls on accounts past due
• Suspension of sales or service
• Collection agency
• Write off $50
Allowance for Doubtful Accounts Decrease by $50
Accounts Receivable – Tim Decrease by $50
▪ Accounts Receivable, Net does not change
Balance Before Balance After
Accounts receivable $1,000 $950
Less: Allowance for doubtful accounts (100) (50)
Accounts receivable, net $900 $900
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 Accounts Receivable Ratios

Accounts Receivable Turnover Ratio Net Credit Sales ÷ Accounts Receivable

▪ Shows how many times A/R are collected during Higher

a year, on average Usually stated as “Times”
Accounts Receivable Days 365 Days in Year ÷ A/R Turnover Ratio

▪ Shows days needed to convert A/R into cash Lower

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 Accounting for Inventory
▪ Determine quantity of inventory
• Assign unit costs to inventory to determine
➢ COGS
➢ Cost of ending inventory

▪ Usually units purchased and recorded in inventory have been

purchased at different costs during the period

▪ Methods of the assignment of costs must be consistent and rational

▪ Ensures adherence to the cost principle

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 Accounting for Inventory
Specific Identification
▪ For easily identified high-unit cost items
▪ Easy to track individual items from purchase through to sale

Cost Flow Assumptions

▪ Used when it is difficult to trace individual items purchased and sold
▪ Two commonly used cost flow assumptions
• Weighted-average cost
• First-in, first-out (FIFO)

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 Specific Identification Method - Example

▪ Uses actual cost to value inventory

▪ Used where goods not ordinarily interchangeable or goods are
produced for specific purposes

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 Specific Identification Method - Example

Purchase #1 $50, purchase #2 $75, purchase #3 $100

Therefore total value of the inventory available for sale is $225

▪ Ending Inventory?

If physical count shows only #1 and #3 still on hand

Ending inventory #1 $50
#3 100
Total value $150

▪ COGS?
Sold #2 $75
Total value $75
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 Specific Identification – In Class Exercise
Delta Ltd inventory records for a particular development program show the
following at March 31, 2018:
March 1 Beginning inventory 5 units @ $150 = $ 750
15 Purchase 11 units @ $160 = 1,760
26 Purchase 5 units @ $170 = 850
Goods Available for Sale $3,360
Compute the COGS and Ending Inventory if there are two $150 units, three $160
units and five $170 units still remaining in stock at the end of March.

COGS? Ending Inventory?

Specific unit cost (3 @ $150) = $ 450 (2 @ $150) = $ 300
(8 @ $160) = 1,280 (3 @ $160) = 480
$1,730 (5 @ $170) = 850
$1,630
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 Weighted-Average Cost

As used in a periodic system

▪ Not a simple average where all unit costs added up and then divided by the number
of units
▪ WA Cost=Cost of Goods Available for Sale (COGAFS) ÷ Total Units Available for Sale

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 First-in, First-out (FIFO)

▪ The cost of the oldest goods on hand prior to each sale is allocated to
the COGS
• Usually ensure the highest possible recorded profits
• CRA mandates its use for taxation purposes
▪ The goods most recently purchased are allocated to the ending
inventory
• Ensures that the inventory is valued at close to replacement value
▪ Simulates reality as vendors prefer to sell the oldest items first and
the newest items last
• However, there is no guarantee that actually occurs and it does not have to
for accounting purposes

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 Data Page – Example
On January 1, Barlow Industrials had a beginning inventory of 200 units that cost
$30 each. The following purchases and sales were made during the year:
Pool of Costs
Purchases and Sales
Date Explanation Units Cost
Apr 30 Sale 50
May 5 Purchase 240 $28
Jun 10 Sale 180
Aug 8 Purchase 350 $31
Sept 12 Sale 310
Nov 29 Purchase 300 $33
Dec 1 Sale 50
Dec 31 Ending Inventory 500
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 Weighted Average Example
Cost of Goods Available for Sale (COGAFS)
Date Explanation Units Unit Cost Total Cost
Jan 1 Beg Inv 200 $30 $6000
May 5 Purchase 240 $28 6720
Aug 8 Purchase 350 $31 10850
Nov 29 Purchase 300 $33 9900
1090 $33470

COGAFS ÷ Units = WA Cost $33470 ÷ 1090 = $30.7064

EI = 500 Units X $30.7064 = $15353
COGS = COGAFS – EI $33470 - $15353 = $18117
Proof 590 units sold X $30.7064 = $18117
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 FIFO Example
Cost of Goods Available for Sale (COGAFS)
Date Explanation Units Unit Cost Total Cost
Jan 1 Beg Inv 200 $30 $6000
May 5 Purchase 240 $28 6720
Aug 8 Purchase 350 $31 10850
Nov 29 Purchase 300 $33 9900
1090 $33470
Ending Inventory is 500 Units
Date Units Unit Cost Total Cost
Nov 29 300 $33 $9900
Aug 8 200 $31 6200
$16,100
Therefore COGS = COGAFS less EI
$33470 – $16100 = $17370
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 FIFO Example
Proof of COGS for year ended December 31

Date Units Sold Unit Cost Total Cost

Apr 30 50 $30 $1500
Jun 10 150 $30
30 $28 5340
Sept 12 210 $28
100 $31 8980
Dec 1 50 $31 1550
590 $17370

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 Inventory Valuation – In Class Exercise
Cost of goods available for sale:
Oct. 1 Beginning inventory…………. 5 @ $160 = $ 800
8 Purchase…………………………………. 4 @ 160 640 8 units of inventory are on hand
15 Purchase……………………………… 11 @ 170 1,870 Compute ending inventory and
COGS
26 Purchase………………………………. 5 @ 180 900
31 Goods available for sale………… 25 $4,210

Weighted average cost = $4210/25=$168.40/unit FIFO

EI = 8 units X $168.40 = $1,347 EI = (5 @ $180) + (3 @ $170) = $1,410
COGS = 17 units X $168.40 = $2863 COGS = (9 @ $160) + 8 @ 170) = $2,800
Proof: $2863 + $1,347 = $4210
Proof: $1410 + $2800 = $4210

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 Inventory Ratios

Gross Profit Margin Gross Profit ÷ Sales Revenue Higher

▪ Indicates the margin percentage or profit between sales and its cost
of sales
Inventory Turnover Ratio
▪ Shows the efficiency in managing Cost of Goods Sold ÷ Inventory
and selling Inventory Higher
Usually stated as “Times”

Inventory Days Days in Year ÷ Inventory Turnover Ratio

▪ Shows how many days sales are in inventory Lower

▪ Shows how quickly inventory is sold
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 PROPERTY, PLANT, and EQUIPMENT

▪ Previously known as Fixed Assets

▪ Are tangible and long-lived
▪ Produce economic benefits for more than one year
▪ They have physical substance
▪ Cost includes PST, freight, transit insurance, duty & brokerage etc
▪ Are written off to expense (except land) using various methods as useful life is
reduced
• Depreciation
• Depletion (for mining and oil/gas)
▪ Market value at the end of the useful life, if any is called salvage or residual value
▪ Company management decides on useful life, salvage/residual value and method
of depreciation
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 PROPERTY, PLANT, and EQUIPMENT (continued)

▪ Depreciation Methods
• Straight-line for smoothing out depreciation expense
• Accelerated
➢ Double-Declining Balance for faster write off to expense
➢ Single-Declining Balance
➢ Capital Cost Allowance (CCA) for Canadian Income Tax use
Canada versus USA
• Units of Activity (Production) used when activity level is sporadic
▪ Depletion
• Used for natural resources - oil and gas, mining
• Based on Units of Activity

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 PROPERTY, PLANT, and EQUIPMENT (continued)

▪ Depreciation Example – Straight-line method

The Supper Company purchases equipment for $100,000. Management estimates
that the equipment will have a useful life of eight years and no salvage value.
Calculate depreciation expense and the book value of the equipment at the end of
the first 3 years.

$100,000 ÷ 8 years = $12,500 each year

Cost $100,000
Accumulated Depreciation 37,500
Book Value $ 62,500

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 PROPERTY, PLANT, and EQUIPMENT – In Class Exercise

Dark Shadow Company acquires equipment at a cost of $42,000 on January 3,

2018. Management estimates the equipment will have a residual value of $6,000 at
the end of its four-year useful life. Assume the company uses the straight-line
method of depreciation.

Calculate the depreciation expense for each year of the equipment's life. Dark
Shadow Company has a December 31 fiscal year end.

($42,000 − $6,000) = $36,000 ($36,000  4) = $9,000 per year for 4 years

What is the Book Value at the end of 4 years?

$42,000 - $36,000 = $6,000

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 PROPERTY, PLANT, and EQUIPMENT (continued)
▪ Depreciation Example – Double-declining method
The Supper Company purchases equipment for $100,000. Management estimates
that the equipment will have a useful life of eight years and salvage value of
$11,000.
Calculate depreciation expense and the book value (BV) at the end of the first 3
years.
Accumulated
100% ÷ 8 years = 12.5% per year Begin BV Rate Depreciation Depreciation Ending BV
12.5% X 2 = 25% $100,000 X 25% = $25,000 $25,000 $75,000
$75,000 X 25% = $18,750 $43,750 $56,250
$56,250 X 25% = $14,062 $57,812 $42,188
$42,188 X 25% = $10,547 $68,359 $31,641
$31,641 X 25% = $ 7,910 $76,269 $23,731
$23,731 X 25% = $ 5,933 $82,202 $17,798
$17,798 X 25% = $ 4,450 $86,652 $13,348
$13,348 X 25% = $ 3,337 2,348 $89,989 89,000 $10,011 11,000
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 PROPERTY, PLANT, and EQUIPMENT – In Class Exercise
Dark Shadow Company acquires equipment at a cost of $42,000 on January 3, 2018. Management
estimates the equipment will have a residual value of $6,000 at the end of its four-year useful life.
Dark Shadow Company has a December 31 fiscal year end.

Calculate the depreciation expense for each year of the equipment's life

The double-declining-balance rate is (100%÷ 4 years) = 25% X 2 = 50%

Carrying Amount End of Year 00

Beginning Depr. Depr. Accum. Carrying
Year Of Year × Rate = Expense Depr. Amount

2018 $42,000 50% $21,000 $21,000 $21,000

2019 21,000 50% 10,500 31,500 10,500
2020 10,500 50% 4,500 36,000 6,000

$42,000 - $6,000 = $36,000

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Comparing Depreciation Methods

44
 PROPERTY, PLANT, and EQUIPMENT (continued)

▪ Balance Sheet Presentation

Long-Term Assets
Investment in XYZ Corporation $1,000,000
Capital Assets
Property, Plant, and Equipment
Land $100,000
Equipment $500,000
Less Accumulated Depreciation 350,000 150,000
Total Property, Plant, and Equipment $250,000

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 Sale and Disposal of Property, Plant, and Equipment

Four steps
▪ Update depreciation
▪ Calculate the carrying amount
▪ Calculate the gain or loss
▪ Record the sale, disposal, or exchange

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 Sale and Disposal of Property, Plant, and Equipment
Disposal of a fully depreciated asset (Derecognition)
Equipment bought for $15,000 many years ago is now deemed to be worthless and is
scrapped
No gain or loss

Disposal of a non-fully depreciated asset

Equipment with a 10 year useful life bought for $15,000 on a previous Jan 1 has
accumulated depreciation of $12,600. The current 1/3rd years depreciation of $500 to
the point of disposal has yet to be recorded
Previous depreciation 12,600
Current depreciation 500
Accumulated depreciation 13,100
Original cost 15,000
Book value 1,900
Received 0
Loss on disposal 1,900 TEdwards 2018 47
 Sale and Disposal of Property, Plant, and Equipment

Sale of a partially depreciated asset for a gain

Equipment with a 10 year useful life bought for $15,000 on a previous Jan 1 has
accumulated depreciation of $12,600. The current 1/3rd years depreciation of $500
to the point of sale has yet to be recorded. It was sold for $2,300.
Previous depreciation 12,600
Current depreciation 500
Accumulated depreciation 13,100
Original cost 15,000
Book value 1,900
Received 2,300
Gain on sale 400

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 Sale and Disposal of Property, Plant, and Equipment

Sale of a partially depreciated asset for a loss

Equipment with a 10 year useful life bought for $15,000 on a previous Jan 1 has
accumulated depreciation of $12,600. The current 1/3rd years depreciation of $500
to the point of sale has yet to be recorded. It was sold for $1,600.

Previous depreciation 12,600

Current depreciation 500
Accumulated depreciation 13,100
Original cost 15,000
Book value 1,900
Received 1,600
Loss on sale 300

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 Sale and Disposal of PP&E – In Class Exercise
Western Company sells equipment on March 31, 2018, for $15,000
cash. The equipment was purchased on January 5, 2013, at a cost of
$86,400, and had a useful life of six years and a residual value of
$2,200. Adjusting entries are made annually at the company’s year
end, December 31.
a) Calculate the current depreciation to March 31, 2018
b) Calculate the gain or loss on the sale of the equipment
c) Calculate the gain or loss on the sale of the equipment if sold for
$9,000

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 Sale and Disposal of PP&E – In Class Exercise
(a) Mar. 31
[($86,400 − $2,200) ÷ 6 × 3/12] = 3,508

(b) ¹ [($86,400 − $2,200) ÷ 72 months × 63 months] = $73,675

Cost of equipment $86,400

Less: accumulated depreciation ¹ 73,675 OR
Carrying amount at date of disposal 12,725 (86400 – 2200)
Proceeds from sale 15,000 = 14,033 per year
Gain on disposal $ 2,275 X 5 years
= 70,165
+ 3508 current yr
= 73,673

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 Sale and Disposal of PP&E – In Class Exercise
(c)
Cost of equipment $86,400
Less: accumulated depreciation 73,675
Carrying amount at date of disposal 12,725
Proceeds from sale 9,000
Loss on disposal $ 3,725

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 Current Liabilities
Liabilities with a known amount, payee, and due date. There is no
uncertainty as to their existence, amount or timing
▪ Accounts payable
▪ Unearned revenues
▪ Operating line of credit and bank overdraft
▪ Short-term notes payable
▪ Sales taxes
▪ Accrued Expenses
• Interest Payable
• Salaries and Wages Payable
• Income Taxes Payable (FITAL)
▪ Current maturities of long-term debt
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 Current Liabilities

Accounts Payable
▪ Goods purchased from a supplier with an agreement to pay at a later
date
▪ Can be referred to as trade payables
▪ Are considered current liabilities as payment is due to suppliers a
short time after purchase such as within 10, 15, or 30 days

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 Current Liabilities

Unearned Revenue
▪ The result of receiving a payment in advance of a good being
provided or a service being performed
• Common for many businesses in the publishing, entertainment, and travel
industries
• Lawyer’s retainer

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 Current Liabilities

Operating Line of Credit

▪ Allows a company to borrow money from their bank, up to a pre-
authorized limit
• Helps the company manage temporary cash shortfalls.
• Security, called collateral, is usually required by the bank as protection in case
the loan cannot be repaid
▪ Money borrowed through a line of credit is normally borrowed on a
short-term basis
• Repayable immediately upon request, that is, on demand, by the bank
• In reality, repayment is rarely demanded without notice
▪ An operating line of credit makes it simple to borrow money

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 Current Liabilities

Bank Overdraft
▪ A company may have a negative, or overdrawn, cash balance at the
year end
• Overdraft amounts are reported and disclosed as a current liability, called
bank indebtedness, bank overdraft or bank advances
• This is instead of reporting negative Cash in the asset section of the Balance Sheet
• No special entry is required
• Appropriate disclosure in the Notes to Financial Statements in the company’s
annual report is necessary
• Interest is normally charged on the overdraft amount at a floating rate, such
as prime plus a specified percentage

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 Current Liabilities

Short Term Notes Payable

▪ Obligations in the form of written promissory notes
▪ Are often used instead of accounts payable because they give the
lender formal proof of the obligation in case legal remedies are
required to collect the debt
▪ Usually require the borrower to pay interest (interest due monthly or
at maturity) and are frequently issued instead of accounts payable or
to meet short-term financing needs
▪ Are classified as current liabilities if due for payment within one year
of the balance sheet date
▪ As interest accrues over the life of the note, interest expense must be
recorded in the period when the borrowed money is used
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 Current Liabilities

Sales Taxes
▪ Sales taxes collected from customers are a liability because the
company must pay the amount collected to a provincial or federal
government
▪ Sales Tax is expressed as a stated percentage of the sales price
• Goods and Services Tax (GST) is applied at 5% across Canada
• Provincial Sales Tax (PST) rates vary from 0% (Alberta) to 9.975% (Quebec –
QST) depending on jurisdiction
• BC PST is 7%
• Harmonized Sales Tax (HST) combines the provincial and federal sales tax

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 Current Liabilities

Current Maturities of Long-Term Debt

▪ When a portion of long-term debt comes due in the current year, it is
to be reported as a current liability on the balance sheet
▪ A journal entry is not required
• The proper statement classification of each liability account is recognized
when the balance sheet is prepared
Partial Balance Sheet – Liabilities
Current Liabilities
Accounts Payable $10,000
Current Portion of Long-Term Debt 20,000
30,000
Noncurrent Liabilities
Long-Term Notes Payable $100,000
less Current Portion 20,000 80,000
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 Uncertain Liabilities

Liabilities with an unknown amount, payee, and due date. There is

uncertainty as to their existence, amount or timing
▪ Provisions
• Product Warranties
▪ Contingent Liabilities
• Possible obligations that will become actual obligations only if some
uncertain future event occurs
➢ Example: Lawsuit
• Disclose in the Notes to Financial Statements

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 Uncertain Liabilities

Product Warranties
▪ Promises made by the seller to a buyer to repair or replace the
product if it is defective or does not perform as intended for a certain
period of time
▪ Will lead to future costs for the repair or replacement of defective
units
• Although the amounts and timing of any future warranty costs are unknown
➢ The costs can usually be reasonably estimated
➢ A liability does exist
▪ Record appropriate warranty expense in the same period of the sale
to adhere to Matching Principle

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 Noncurrent Liabilities

Bonds Payable
▪ Represents a promise to repay a specified amount in the future at a
specific date, including a promise to pay periodic interest at a
specified rate
• Issued by governments
• Issued by large corporations
• Can be bought and sold on a securities exchange
• Is considered debt financing
▪ Advantages over equity financing
• No effect on shareholder control as bondholders do not vote
• Bond interest is tax deductible, but dividends are not
• EPS is higher as earnings are spread over fewer shares
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 Noncurrent Liabilities

How is a Bond Priced?

▪ Determined by discounting the future cash flows of a bond, thus its
present value (PV)
▪ The future cash flows are as follows
• The face value (amount) to be repaid at maturity
• The periodic interest payments at the stated interest rate over the life of the
bond
▪ The market and contractual interest rates on bonds are often
different
• As a result, bonds sell either below or above the face value of the bond
➢ Discount or Premium

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 Noncurrent Liabilities

How is a Bond Traded or Sold

▪ Traded or sold on securities exchanges – TSX, NYSE
▪ Can sell for at any time at current market price
• Market price is determined by the PV of its future cash flows
➢ Thus, discount the bonds future cash flows, which includes both principal paid at
maturity and all future interest payments
➢ Also would factor in any corporation risk; that is if the corporation is having financial
issues, the PV of the principal would take this into consideration by discounting
significantly

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 Chapter 6 Homework Assignment

None

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