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Liabilities • 2 types: • Current Liabilities • Long-term Liabilities • 2 criterias of current liabilities: • Current liabilities- obligations that must be settled within 1-year or within one operating cycle. • The payment will be paid from current assets or involving a newly acquired current liability. Any liabilities that do not meet the above criterias- Long-term Liabilities
Most common current liabilities: accounts payable, notes payable, interest payable, accrued salaries & unearned revenue. • Long term liabilities: bonds payable, mortgage payable & long-term notes payable.
Recognition of Liabilities • Issue: • When to record a liability? 2 ways: • When a transaction is involved to make payment to another entity in the future (ex: goods purchased from a supplier on credit). • When the period has elapsed in respect of the services received by the entity (the recognition is made through an adjustment in the general journal at the end of operating period).
Accounts Payable • A current liability from the amount owed to the supplier for the purchase of goods or services. • Involves a certain credit period; 30-days. • Usually no interest is imposed on a credit purchase, a cash discount is given if payment is made within the credit period. RM RM Dr. Purchases 3,100 Cr. Accounts Payable 3,100 (to record purchase on credit) Dr. Accounts Payable 3,100 Cr. Cash 3,100 (to record the payment for credit purchase)
Ways to control accounts payable: • Segregation of the purchasing function from the payment and recording function. • Ensuring that all payments are scrutinized and payments are made for authorized liabilities only. • Purchase & liabilities are verified by checking specific documents such as invoices, purchase order & receiving reports. • Use of voucher system.
Notes Payable • A form of promissory note. • A written agreement to make payment of a certain amount at a specified date. • Is issued by an entity to another entity for specific reasons: • To obtain bank loans • To extend credit period of accounts payable whenever the debts cannot be settled in the specified period. • To purchase specific assets such as inventories and machines. • To pay accounts receivable immediately to obtain the cash discounts.
Bank Loans • Banks can give loans on the basis of notes payable using 2 types of promissory notes: • Interest-bearing notes- a promissory notes prepared by the bank and signed by the borrower with the promise to pay the debts on a specified date with interest. • Discounted note- the bank gives a loan based on discounting (bank will discount the loan by imposing interest on the date the promissory note is issued).
Recording of Notes • Interest-bearing notes RM RM Dr. Cash xx Cr. Notes Payable xx (to record interest-bearing notes payable) Dr. Interest expense xx Cr. Interest Payable xx (to record accrued interest associated with notes payable)
RM RM Dr. Notes Payable xx Interest Payable xx Interest Expense xx Cr. Cash xx (to record the settlement of notes payable)
Discounted notes RM RM Dr. Cash xx Discount on Notes Payable xx Cr. Notes Payables xx (to record discounted notes payable)