Chapter 8.1: Liabilities Defined and Classified Flashcards
How do accountants formally define liabilities?
Accountants define liabilities as present debts or obligations arising from an entity’s past transactions that will be paid with assets or services.
How is a liability measured when it is first recorded?
A liability is measured in terms of its current cash equivalent, which is the cash amount that a creditor would accept to settle the liability immediately.
What does the term “current liabilities” refer to?
Current liabilities are obligations that a company needs to settle within one year or its operating cycle, whichever is longer.
They include debts or obligations arising from past transactions that are expected to be paid off with current assets or services.
Why is interest payable in the future not included in the initial amount of a liability?
Interest payable in the future is not included in the initial amount of a liability because it accrues and becomes a liability with the passage of time.
How are current liabilities defined, and when are they settled?
Current liabilities are short-term obligations that will be settled within the coming year by providing cash, goods, other current assets, or services.
If the entity’s operating cycle is longer than one year, obligations settled within the operating cycle are also classified as current liabilities.
What is the difference between current liabilities and non-current liabilities?
Current liabilities are obligations due within one year, while non-current liabilities include all other obligations that extend beyond the coming year.
Why are liabilities important from an analytical perspective for businesses?
Liabilities affect a company’s future cash flows and risk characteristics, making them crucial for financial analysis and planning.
How are current liabilities usually grouped on a company’s statement of financial position?
Current liabilities are typically grouped according to the type of creditor, such as trade suppliers, providers of services, customers, banks, governments, and others.
How are specific liabilities like salaries payable and interest payable recorded in financial accounting?
Specific liabilities like salaries payable and interest payable require accrual through adjusting entries at the end of the accounting period, before the preparation of financial statements.
How are future liabilities, such as product warranty costs, estimated and recorded in financial statements?
Future liabilities like product warranty costs, which are not known until repair work is carried out, are estimated based on past experience or reasonable basis.
These estimated liabilities are recorded through adjusting entries, often based on a percentage of net sales.
What should be done when it’s not possible to provide a reasonable estimate of a potential future liability contingent on a future event?
When it’s not possible to estimate a potential future liability contingent on a future event, relevant information about contingent liabilities must be disclosed in notes to the financial statements.
