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Chapter 8: Problem 5

a. Discuss the differences between current and long-term liabilities. b. Identify three types of each. c. Indicate how such current liabilities reduce a firm's need for cash. d. Discuss how noncurrent liabilities are used as a source of capital.

Short Answer

Expert verified
Current liabilities are short-term debts due within a year, like accounts payable, wages payable, and notes payable. They reduce a firm's need for cash by giving the company short-term credit. Long-term liabilities are debts due in more than a year, like bonds payable, long-term lease obligations, and pension liabilities. These can be used as a source of capital for business expansion or investment.

Step by step solution

01

Understanding Current and Long-term Liabilities

Current liabilities are debts that are due within one year or within the firm's operating cycle if it's longer than a year. Long-term liabilities, also known as non-current liabilities, are debts or obligations that are due in more than one year's time. They are recorded on the balance sheet and include items like bonds payable and long-term lease obligations.
02

Identifying Types of Current and Long-term Liabilities

Three types of current liabilities include accounts payable, wages payable and notes payable. Three types of long-term liabilities include bonds payable, long-term lease obligations and pension liabilities.
03

Current Liabilities and Firm's Need for Cash

Current liabilities reduce a firm's need for cash because they are essentially short-term loans from creditors. These creditors are providing the company with goods or services now, allowing the firm to postpone payment (often without interest) until a later time. This delay in payment allows the company to use their cash in other ways, such as for operating expenses or investment opportunities.
04

Noncurrent Liabilities as a Source of Capital

Noncurrent liabilities can be used as a source of capital. For example, when a company issues bonds, it obtains long-term financing from investors who buy these bonds. The capital obtained from the issued bonds can be used to finance business expansion or be invested in profitable projects.

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Current Liabilities
Current liabilities are financial obligations that a company must pay within a short period, usually within one year or the firm's operating cycle if it's longer. These are crucial for managing a firm's day-to-day cash flow and include items like:
  • Accounts Payable: Money owed to suppliers for goods or services purchased on credit.
  • Wages Payable: Salaries due to employees that have not yet been paid.
  • Notes Payable: Short-term loans that need to be repaid within the year.
Businesses manage these liabilities to keep operations running smoothly. By delaying payments, companies can retain cash to fund other immediate operational needs, leveraging what is essentially short-term credit.
Long-term Liabilities
Long-term liabilities, also known as non-current liabilities, are debts that a company will settle over a period longer than one year. These liabilities are key for funding large-scale expansion projects or acquiring fixed assets. Examples of long-term liabilities include:
  • Bonds Payable: Debt securities issued by a company to investors, often used to raise significant amounts of capital.
  • Long-term Lease Obligations: Financial commitments on lease agreements lasting more than one year.
  • Pension Liabilities: Future pension payments owed to employees.
Due to their nature, long-term liabilities are often accompanied by interest payments, which need careful planning and management to ensure financial stability.
Balance Sheet
The balance sheet is a financial statement that provides a snapshot of a company's financial condition at a specific point in time. It lists assets, liabilities, and shareholders' equity, divided into:
  • Assets: What a company owns, such as cash, equipment, and buildings.
  • Liabilities: What a company owes, which includes both current and long-term liabilities.
  • Shareholders' Equity: The residual interest in the assets of the company after deducting liabilities.
On the balance sheet, liabilities are divided into current and long-term. This classification helps investors and stakeholders understand the company's financial obligations and liquidity position. It is a critical tool for assessing a business's overall financial health.
Bonds Payable
Bonds payable are a type of long-term liability on the balance sheet. When a company issues bonds, it borrows money from bondholders, agreeing to pay back the principal amount on a future date, with periodic interest payments in the meantime. Key characteristics of bonds include:
  • Interest Payments: Regular payments to bondholders as compensation for lending their money.
  • Face Value: The amount paid back to bondholders at the maturity date.
  • Maturity Date: The date on which the principal amount is due to be repaid.
Bonds are an essential tool for companies looking to raise capital without diluting ownership through issuing new shares. They offer investors a fixed income and provide companies with a predictable debt repayment schedule.

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Most popular questions from this chapter

Describe four separate items that are typically included in the current liability section of the balance sheet.

Use the balance sheet equation to analyze the effects of the following transactions: 1\. Jill's Slipper Shop was formed with an original investment of \(\$ 100,000\) in exchange for common stock. 2\. Jill's signed a 12 -month rental agreement for its retail shop. Jill's pays a deposit of \(\$ 2,000,\) along with the first month's rent of \(\$ 2,000\). 3\. Jill's ordered and received merchandise for resale on account at an invoice cost of \(\$ 32,000\). 4\. Jill's returned \(\$ 1,800\) worth of merchandise because it has been water stained in transit. 5\. Jill's paid the balance of its liability for the merchandise. 6\. Jill's two employees worked in the shop for the first month, but Jill's cannot pay them until the end of the next month. Each employee earns a salary of \(\$ 2,000\) and commissions of \(\$ 1,200 .\) Ignore any payroll taxes or other employer obligations that may normally be recorded in conjunction with payroll transactions. 7\. What effect does not paying the employees have on Jill's balance sheet? What effect is it likely to have on the employees? Which is more significant? 8\. What is the long-term effect of not paying employees? What are the possible long-term effects of not paying suppliers? In other words, if Jill's continues to defer its employees' salaries and commissions, and if Jill's fails to pay for its merchandise, what will happen to the shop?

Indicate which, if any, of the following items would be reported as a current liability: a. Advance payments from customers for services to be performed at future dates. b. Agreements signed with suppliers to purchase inventory at future dates. c. Agreements signed with customers to deliver completed products at future dates. d. Advanced payment to suppliers for inventory to be shipped at future dates. e. Accrued wages for work already performed by employees. f. Accrued vacation and holiday benefits earned by employees.

Set up the following accounts and balances at December \(31,2000,\) in an accounting equation: 1\. Show the effects of each of the following transactions on the firm's balance sheet: a. Borrowed \(\$ 150,000,000\) cash on June \(1,2001,\) and signed a nine-month note at an \(8 \%\) annual interest rate. b. During 2001 , sold goods during 2001 costing \(\$ 8,000,000\) for \(\$ 18,000,000\) cash. c. Paid warranty claims of \(\$ 1,600,000\) during 2001. d. Accrued interest on the note at December 31,2001. 2\. Discuss the meaning of the remaining warranty obligation. Discuss the underlying business reasons for offering warranties. What might the firm do if it expects warranty claims to continue at the same rate for another year? 3\. What is the maturity date of the note? Assuming no additional interest has been accrued since December 31,2001 , what is the effect on the firm's balance sheet when the note is paid (including all the accrued interest)?

Use the accounting equation to analyze the effects of the following transactions on Town Floral, Inc.: 1\. Acquired 2,000 floral bouquets at a billed cost of \(\$ 15\) per bouquet. Terms of payment are \(2 / 10,\) n/30. Town Floral records purchases, net of the discount. 2\. Signed a 120 -day note for \(\$ 15,000\). The bank discounted the note at an annual rate of \(10 \%\) and deposited the proceeds in Town Floral's bank account. 3\. Borrowed \(\$ 18,000\) from the president's rich uncle at \(10 \%\) annual interest. The company made no entry for the interest. 4\. Paid the bills to the suppliers of the bouquets after the discount period had lapsed. 5\. Paid six months interest to the president's rich uncle. 6\. Recorded interest incurred for 90 of the 120 days on the note described in transaction 2.
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