Study: Define Common Liability Accounts
|
Study the (11m:57s) video for this topic provided below:
|
Alternative Topic Formats Audio File MP3 Download MP3 Transcript Files Transcript MS Word Download Transcript MS Word, Transcript PDF Download Transcript PDF PowerPoint Slides Slides MS PowerPoint Download Slides MS PowerPoint, Slides PDF Download Slides PDF |
Take the topic quiz, by clicking here or clicking the "Next" button at the bottom right of this page.
Score at least 4 out of 5 on the quiz before moving on. If you do not score at least 4 out of 5 on the quiz, restudy the material and try again.
I will keep your highest score.
The videos, images and transcripts below provide the same content as provided in Step #1 above. It has simply been broken down into smaller, bite-sized pieces for easier access and review.
Slides 1-2 (:44s):
Links to an external site.
Welcome to Introduction to Accounting Preparing for a User’s Perspective. Define common liability accounts.
How are liabilities defined by the FASB?
“Liabilities
Links to an external site.are probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as result of past transactions or events.”
Statement of Financial Accounting Concepts No. 6 Elements of Financial Statements – a replacement of FASB Concepts Statement No. 3 (incorporating an amendment of FASB Concepts No. 2) CON6-12.25
Copyrighted by, and reproduced with permission of, the Financial Accounting Foundation, 401 Merritt 7, Norwalk, CT 06856, USA.
An example of a liability would be an account payable Links to an external site.. For example, if you buy inventory from a company and promise to pay later. The past transaction is you bought inventory, and you are obligated to sacrifice in the future some assets because of that obligation. You are currently obligated to make that sacrifice in the future.
Let’s look at some common liability accounts and see how they meet this definition.
Slide 3 (:15s):
Links to an external site.These are the common liability accounts [see the list below] that we will discuss as we work through this topic.
As you will notice many of these have the word payable on them indicating that an amount needs to be paid in the future. But not all liabilities use the word payable as can be see here on unearned sales revenue.
Slide 4 (:30s):
Links to an external site. You should already be familiar with the T-account
Links to an external site. format that we introduced when we talked about assets.
As you can see liabilities and equity are on the right-hand side of the balance sheet equation Links to an external site.. Therefore, liabilities will normally have a balance on the right-hand side [see the diagram below].
We’ll start with the beginning balance on the right. All increases will be recorded on the right and decreases recorded on the left, which is exactly opposite of what we do with assets.
Why is it opposite? It’s because they are on the opposite side of the equation and you should normally wind up with an ending balance on the right-hand side.
Slide 5 (1m:05s):
Links to an external site.Accounts payable. We just gave an example of buying inventory on account.
Accounts payable increase when you purchase from suppliers on account, or we sometimes call that on credit.
They, the accounts payable, decrease when you make payments to the suppliers, therefore, we no longer owe the money.
Sometimes suppliers will give you a discount on the amount that you owe if you pay early. For example, if you pay within 10 days, the suppliers will give you a discount. Discounts can reduce the amount of accounts payable that you owe.
Also, if you return previously purchased on-account items, your accounts payable will decrease [see the diagram below].
Example: Accounts Payable
Company A began the day owing $3. That’s our beginning point. Today it purchased $5 on account asking to pay later thus increasing the account payable.
Tomorrow it will pay off $7 of what it owed, thus reducing the account payable.
What is Company A’s ending accounts payable balance? We started with $3 of accounts payable, added $5 by buying on account, that puts us up to $8. We then deducted the $7, ending with $1 still owing our vendors, or our suppliers.
Slide 6 (1m:14s):
Links to an external site.Salaries and wages payable. Salaries are contractual amounts for employees based on an annual contract for work to be performed. They usually are paid monthly or bi-monthly, but the salary is based on an annual contract. Wages are amounts that are paid based on an hourly rate to hourly employees.
Salaries and wages payable represent amounts owed to salary and hourly employees who performed work for the company but they haven’t been paid for it yet.
Salaries and wages payable will decrease when payments are made to the salary and hourly employees. If the amounts owed are paid off, that would decrease this payable.
Companies also withhold taxes and insurance from the amounts owed to employees which amounts will be sent on to the government and respective insurance companies [see the diagram below].
Example: Salaries and Wages Payable
Company A began the month owing its employees $8,000, so that’s our beginning balance here on the right-hand side.
Employees worked for two weeks and earned another $7,000.
When the employer does pay the $8,000, that will decrease the salaries and wages payable.
We started with $8,000, added $7,000, got up to $15,000 in salaries and wages payable, paid $8,000, they now owe only $7,000 in salaries and wages payable.
Slide 7 (:39s):
Links to an external site.Income taxes payable. Income taxes payable
Links to an external site. represents amounts owed to various governmental entities based on the company’s income.
It increases when the company earns income and estimates the taxes it will have to pay on them.
It decreases when the company makes the required tax payments [see the diagram below].
Example: Income Taxes Payable
Company A began the month owing $10,000 in taxes to the government.
During the month it sent $7,000 to the government of the amounts it owed, thus decreasing the income taxes payable. So we are down to $3,000 now.
This month it earned additional income resulting in $2,000 of estimated taxes. We were down to $3,000 but we increased it by another $2,000. That puts us up to $5,000 in income taxes payable.
Slide 8 (:35s):
Links to an external site.Dividends payable. These represent amounts owed to investors for the dividends that have been declared. It increases when the company declares a dividend
Links to an external site.. It decreases when the dividends are paid [see the diagram below].
Example: Dividends Payable
Company A owed $13,000 in dividends it declared last year but hasn’t paid yet, so that would be the beginning balance on the right hand side here.
During the year it declared another $4,000 in dividends. So the investor will be expecting to receive these in the future.
So now we are up to $17,000 in dividends payable to the investors.
If the company cuts a check for all $17,000, dividends payable will decrease, thus resulting in an ending balance of $0.
Slide 9 (:53s):
Links to an external site.Interest Payable. Interest payable represents amounts owed to lenders for interest on amounts borrowed that has not been paid yet. Interest payable increases when interest is accrued, that means it has been computed and recorded. It decreases when the interest is paid [see the diagram below].
Example: Interest Payable
Company A began this year owing $400 in interest from prior loans, so that’s our beginning balance here on the right-hand side.
On January 1st of this year it entered a new $10,000, 5 year loan, with 12% interest due January 1st of each year.
On January 2nd it paid the $400 of interest it owed, thus reducing interest payable.
As of December 31st, so this is now a year later, it computed that it owed $1,200 in interest on the new loan.
Take the $10,000 amount they owed, times the 12% annual interest rate, and the time period of one year, and therefore, they owe another $1,200 in interest payable. Since they haven’t paid yet, this would be interest payable of $1,200.
Slide 10 (1m:25s):
Links to an external site.Unearned Sales Revenue. By seeing the word “unearned” that means they’ve received a customer payment, but because they haven’t provided a good or service yet, they can’t call it sales revenue and put it on the income statement. They must first classify it as a liability until they deliver the good or service as promised.
This liability account, unearned sales revenue Links to an external site., increases when companies receive prepayments for future goods and services. When customers pay you now expecting to receive goods and services later, you as the company, have future obligations.
Unearned sales revenue decrease when companies deliver the promised goods and services, or, if the customers cancel their orders and receive a refund [see the diagram below].
Example: Unearned Sales Revenue
Assume the supplier began the month owing $5 in ice cream to customers who prepaid for it.
Then, during the month customers prepaid for another $100 in ice cream that they expect to receive later. Also, during the same month, after customers made the prepayments, they went in and collected $80 worth of ice cream.
How much does the supplier still owe these customers? $105 is what was owed at a point in time, because they started with $5 and then had another $100 of prepayment. Then, $80 worth of goods or services were delivered to the customers. Resulting in $25 remaining of unearned sales revenue. So their remaining unearned revenue is $25. The $80 here is now earned revenue, so it comes out of the liability [unearned sales revenues] and goes on the income statement as sales revenue.
Slide 11 (:51s):
Links to an external site.Utilities Payable. These represent utilities services received that haven’t been paid for yet. They reduce when you actually pay for those services [see the diagram below].
Example: Utilities Payable
Company A began the month owing $900 to the electric company.
It then received a $300 bill for last month’s water services. So they received the services, used the water, and they have not paid for it yet, thus increasing their utilities payable, which represents a liability owing to the water company.
Company A then made a $500 payment for its electric bill, that it owed at the beginning of the month, thus reducing its utilities payable.
How much does Company A now owe for utilities, water, electric, and any other utilities? You take the $900 [beginning balance] + $300 [for the bills received for prior utility services], that’s $1,200, less $500 in payments for utility services, it still owes $700 in utilities payable.
Slide 12 (1m:04s):
Links to an external site.Notes payable. Notes payable represent amounts owed under a note agreement.
Notes payable increase when amounts have been borrowed and a promise to repay has been given.
Notes payable decrease when the principle portion of the notes are paid off [see the diagram below].
Example: Notes Payable
Company A began the year owing $4,000 as its beginning balance. This amount is due January 3rd.
On January 1st of this year, it entered a new five year loan, for $10,000, at an annual rate of 12%, and its due January 1st, X6 [five years from now]. That’s when the principle portion of the $10,000 will be repaid.
On January 3rd, it paid off the $4,000 note, as well as $1,000 of principle on the new note. The $1,000 payment was a little premature and hopefully there is no prepayment penalty for paying that off early. The interest payable related to both of these principle repayment amounts would also have to be paid, but that’s not shown in this example. By doing so, at the end of the year, it would owe $9,000, which is $14,000, the beginning $4,000 plus $10,000 in new borrowings minus $5,000 principle payments, gives you $9,000.
Slide 13 (1m:43s):
Links to an external site.Mortgage Payable. This one is pretty common in that many of you have heard of mortgages before.
A mortgage payable increases when you borrow under a mortgage agreement. A mortgage payable represents an amount a company owes in relation to a loan it has received on something of value, such as a home or a building, or something else that has significant value being used as collateral.
When you borrow a principle amount of money and provide something of value as collateral in case of non-payment, that will be called a mortgage. If you don’t pay, they can foreclose on these items, sell them, and they can hopefully recover the amounts lent to you.
Mortgages payable decrease when you actually pay off the mortgage principle [see the diagram below].
Example: Mortgage Payable
In this case a company purchased a $500,000 building by paying down $100,000 in cash and borrowing the remaining $400,000 on a fully amortizing mortgage. Fully amortizing meaning a portion of the principle gets paid off with each payment that’s made over that time frame, at which point it is fully amortized, meaning it’s paid off, and the monthly payment will be $1,909.66 due at the first of every month.
On February 1st, X2, this is one month after the loan was issued, Company A made its first mortgage payment of $1,909.66, of which $1,333.33 was just for interest. That means only the excess portion paid will go toward reducing the mortgage principle.
This $1,333.33 will certainly reduce the interest payable, but it does not reduce the mortgage payable. Only the excess amount after the interest has been paid, will reduce the mortgage payable.
So, how much is still owed immediately after the February 1st payment? $399,423.67.
In the early years of a loan, most of the payment goes toward interest.
Slides 14-15 (1m:31s):
Links to an external site.Bonds Payable. Bonds payable are simply another means of borrowing money from others. Usually this will be borrowed from debt investors or other companies. Bonds payable increase when bonds are issued and they decrease when they pay off the bonds upon maturity. Or, if they are allowed to call the bonds, which means pay them off early, the bonds payable will decrease at that point in time [see the diagram below].
Example: Bonds Payable.
In this example, we started the period with $10,000 in bonds payable. Then, let’s assume during the period that the company issued twenty $1,000 bonds. That would be 20 * $1,000 (assuming they issue at their face value [of $1,000 each]), that would increase bonds payable by $20,000.
As you can see here, this is a twenty year bond, so the due date, when it matures, is specified on the bond itself.
The interest rate is 3 ½% per year. So that would be 3 1/2 % times $1,000 every year [=$35] that will have to be paid in interest. On 20 bonds, that would be a total of $700 [in interest] per year [3 ½% X $1,000 X 20 bonds = $700].
If investors were to purchase these for $20,000, bonds payable would increase by $20,000 and the company’s assets would increase by an equal $20,000.
If Standard Electric chooses to pay off some bonds, it will decrease its bonds payable, resulting in an ending balance of $23,000.
We have just completed a whirlwind tour of some common liability accounts. Liabilities are amounts that a company will have to pay or services they will have to render in the future as a result of some past transactions or events that obligated them to make those payments.