Chapter 8. Current Liabilities. Current Liabilities. Usually, but not always, due within one year. Note: If a company has an operating cycle longer than one year, its current liabilities are defined by the operating cycle rather than by the length of a year. Liability:
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A present responsibility to sacrifice assets in the future due to a transaction or other event that happened in the past.
With in the
Payable more than
Payable within one
Distinguishing between current and long-term liabilities helps investors and creditors assess risk.
Companies often prefer to report a liability as long-term because it may cause the firm to appear less risky.
Many companies list notes payable first, followed by accounts payable, and then other current liabilities from largest to smallest.
Interest = Face value x Annual rate x Fraction of the Year
How much interest cost does Southwest incur for the six-month period of the note from September 1, 2010 to March 1, 2011?
$3,000 = $100,000 x 6% x 6/12
If Southwest’s reporting period ends on December 31, 2010, it records the four months’ interest incurred during 2010 in an adjusting entry prior to preparing the 2010 financial statements:
On maturity, Southwest Airlines will pay the face value of the loan plus the entire interest incurred. It makes the following journal entry
Deloitte was the auditor for a client we’ll call Jeeps, Inc. The client sold accessories for jeeps such as tops, lights, cargo carriers, and hitches. One of the major issues in the audit of Jeeps, Inc., was outstanding litigation. Several lawsuits against the company alleged that the jeep top (made of vinyl) did not hold during a major collision. The jeep manufacturer, Chrysler, also was named in the lawsuits. The damages claimed were quite large, about $100 million.
Although the company had litigation insurance, there was some question whether the insurance company could pay because the insurance carrier was undergoing financial difficulty. The auditor discussed the situation carefully with the outside legal counsel representing Jeeps, Inc. Legal counsel indicated that the possibility of loss was remote and that if the case went to trial, Jeeps would almost assuredly win.
If you were the auditor, how would you report this situation? Consider four options. You could (1) report a liability for the full $100 million, (2) report a liability for less than $100 million based on estimated outcomes, (3) provide full disclosure in one of the financial statements’ footnotes and not report any liability in the balance sheet, or (4) provide no disclosure at all since the possibility of loss is remote.
Which approach did Deloitte take?
Selected financial data regarding current assets and current liabilities for United and Southwest Airlines are as follows.
1. Calculate the current ratio for United Airlines and Southwest Airlines. Which has the better current ratio?
2. Calculate the acid-test (quick) ratio for United Airlines and Southwest Airlines. Which has the better acid-test ratio?