Chapter9

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Toronto Metropolitan University *

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100

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Accounting

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Jun 18, 2024

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docx

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101

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Chapter 9 – Liabilities Blast from the past BFTP9-1 You run a merchandising business and this is your second year of operations. A few of the transactions for the year are provided below. 1. Your purchase 100 units of inventory for $10 each from a supplier, 2/10, n/30, FOB destination. 2. You purchase a computer on account, n/45, for $1,500, plus HST. 3. A customer has ordered a special product and provided a down payment of $500 cash. 4. You borrow $20,000 from the bank at an interest rate of 3% for 2 years. 5. Your accountant tells you that you owe Revenue Canada $6,000 of taxes on the income from the business. You have not paid any income taxes yet this year. 6. You have decided that there is too much work for one person and you hire an employee at $12 per hour. They have worked for you for 37.5 hours this week and you need to determine how much to pay them. Required: Analyze the transactions using the critical and enhancing questions. What elements are affected and why? (See the example in Chapter 3 to remind yourself about how to analyze each transaction!) 1 | P a g e

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What will you learn in this chapter? If you answered BFTP9-1 you likely realized the topic of this chapter: liabilities. Assets on the balance sheet have been the focus of many of the previous chapters but understanding liabilities and their effect on business decisions is critical for the long term success of any business. This is because assets, such as the long-lived assets from Chapter 8, are often purchased on account (or for credit). This allows businesses to delay payment and better manage cash flows. Remember, if a business provides credit terms to their customers the cash inflow from sales is delayed. By also purchasing on account the business can delay outflows of cash. In addition, many businesses would not be able to expand without borrowing money from creditors and lenders (banks). Finally, as businesses expand they hire employees and that involves not just salary expense but other expenses that must be paid to the government on behalf of the employee. Overall, understanding and managing your liabilities is an important part of managing a business's cash flows. What is the most frequently used liability account? Accounts payable is a commonly used liability account. In Chapter 3 you recorded purchases of office supplies and advertising material on account and in Chapter 5 you purchased inventory on account. Recall that Accounts Payable is used when you purchase, from a supplier, either goods or services and you owe the supplier cash in the future, due to a past purchase. What about an example? On May 1 your business, Educational Toys Inc., purchases 20 toys for $5 each, credit terms n/30. On May 31 you pay the supplier the amount owning. Analyzing the May 1 transaction first, what did the business get? Toys, which are owned, can be sold in the future for a higher price, and are due to a past purchase: an asset. You record an increase in Inventory for the cost of the toys, $100 (20 * $5). What did the business give away? An "I owe you" (IOU), a promise to pay your supplier cash in the future: a liability. You record an increase in Accounts Payable, $100. Analyzing the May 31 transaction next, what did the business get? You got back your IOU from the supplier, meaning that you do not owe anyone anything any more: Accounts Payable decreases by $100. 3 | P a g e

What did the business give away? Cash, which no longer has any future benefit because it is no longer available: Cash decreases by $100. Record both transactions into the accounting equation using account names. (Remember, on the final exam you will not be given account names but must provide them yourself.) Date Assets Liabilities Equity Owner' s capital Retained earnings Profit Revenu e Expenses Cash Inventory Accounts payable Owner's capital Sales revenue Cost of goods sold May- 01 100 100 May- 31 -100 -100 Are accounts payable a current or a long term liability? Recall from Chapter 4 that liabilities are divided into current and long term liabilities. Because accounts payable are generally paid within the upcoming 12 months (1 year) they are considered a current liability. They are always listed first under the heading "Current Liabilities" on the balance sheet. Check your understanding (CYU9-1) In June your business has the following transactions: 1. On June 1 you purchase supplies for $400, plus HST, using your credit card. 2. On June 12 you purchase inventory from a supplier for $8,350, credit terms 2/10, n/45. 3. On June 22 you pay the supplier for the purchase of inventory on June 12. 4. On June 30 you pay the balance on your credit card. 5. On June 30 a review of your supplies shows that you have only $250 of supplies remaining. Record the above noted transactions into the expanded accounting equation using account names. You are required to provide the account names for this question. 4 | P a g e

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Date Assets Liabilities Equity Owner's capital Retained earnings Profit Revenue Expenses Cash Owner's capital Retained Earnings What about the deferred revenue liability account? Sometimes customers pay you in advance. An example would be a business that provides access to a gym (gym memberships) or a publishing business (magazine subscriptions). Many smaller businesses offer deals if a customer pays in advance, such as a dog walking service offering a cheaper price if you pay for 10 walks in advance. Advance payments from customers are NOT revenue because the business has not done their job YET but they WILL do their job in the future. Therefore, advance payments are considered liabilities because the business received cash but has provided nothing in return AS YET. Instead, the business will provide a good or a service at some point in the future. The account used for this type of transaction is called Deferred revenue : a good or service owed to a customer in the future which is due to the past receipt of cash from that customer. What about an example? On October 12 Educational Toys Inc. announces that 150 copies of a new book in the Harry Potter® series will be available for pre-order. To reserve a copy, customers must pay in advance and they are guaranteed to receive the book before December 15. Within hours all 150 copies have been pre-ordered for $35 each. On December 10 Educational Toys Inc. receives the books, purchasing them on account, n/30, for $15 each from the publisher. On December 11 the books are shipped to all 150 customers. On December 22 Educational 6 | P a g e

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