Chapter 10

Slide 10.1

Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011

Chapter 10

Current liabilities

Slide 10.2


Definitions

A liability is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits.

A current liability is a liability, which satisfies any of the following criteria:(a) it is expected to be settled in the entity’s normal operating cycle;(b) it is held primarily for the purpose of being traded;(c) it is due to be settled within 12 months after the financial statement date.

Slide 10.3


Examples

• Bank finance.

• Trade payables (creditors) (suppliers).

• Unpaid expenses (‘accruals’).

• Taxation.

Slide 10.4


Examples (Continued)

• Bank finance – Overdraft, repayable on demand.

• Trade payables (creditors) – Usually set conditions for repayment, for example, within 30 days or 60 days. May charge interest on overdue amounts. Problem of large organisations delaying payment to small suppliers. Companies are required to explain their policy in paying suppliers who have given credit.

Slide 10.5


Examples (Continued)

Taxation: Companies pay taxes on profits after the profit is earned. Large companies pay quarterly, whereas others pay 9 months after the year-end. Both give current liability.

Some tax payments can be delayed for a longer time – called ‘deferred taxation’.

Slide 10.6


Recognition

Recognise if:

(a) item meets the definition of a liability;

(b) there is sufficient evidence that theliability has been created; and

(c) that the item has a cost or value that can be measured with sufficient reliability.

Slide 10.7


Recognition (Continued)

Risk of understatement (see chapter 4 on prudence)

Understatement of liabilities will result in overstatement of the ownership interest.

Slide 10.8


Contingent liabilities

Obligations that are contingent upon (depend upon) some future event happening. Examples are:• Continuing legal proceedings against the company, for example, product failure• Guarantees to bank on behalf of third party borrowing• Possible taxation penalties from a specific transaction undertaken.

Slide 10.9


Recording expenses

• Matching concept: Match all expenses of the period against revenue, whether paid in cash or not.

• Accruals concept: Record all known liabilities at the date of the financial statements.

Slide 10.10


Accrual of expenses

A company starts business on 1 January Year 1. It has a financial year end of 31 December Year 1. During Year 1 it receives four accounts for electricity, all of which are paid ten days after receiving them. The dates of receiving and paying the accounts are as follows:

Slide 10.11


Date invoice received Amount of invoice Date paid

£

31 Mar. Year 1 350 10 Apr. Year 1

30 Jun. Year 1 180 10 Jul. Year 1

30 Sept. Year 1 280 10 Oct. Year 1

31 Dec. Year 1 340 10 Jan. Year 2

1,150

Accrual of expenses (Continued)

Slide 10.12


ASSET LIABILITY OWNERSHIP INTEREST:

PROFIT

Date Transactions with Electricity company

Cash Electricity company

Electricity expense

Year 1 £ £ £

Mar 31 Invoice received £350 350 (350)

Apr 10 Pay electricity company £350 (350) (350)

Jun 30 Invoice received £180 180 (180)

Jul 10 Pay electricity company £180 (180) (180)

Sep 30 Invoice received £280 280 (280)

Oct 10 Pay electricity company £280 (280) (280)

Dec 31 Invoice received £340 340 (340)

Totals (810) 340 (1,150)

Analysis of transaction

Table 10.1 Spreadsheet analysis of transactions relating to the expense of electricity consumed, Year 1

Slide 10.13


Summary of spreadsheet

– £1,150+ £340– £810

Ownership interest =Liability –Asset

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(340)340Accrual for

three monthsDec 31

Electricity

expenseElectricity

companyCashTransactionsDate

OWNERSHIP INTEREST:

PROFIT

LIABILITYASSET

What if the final electricity invoice for the year has not been received on 31 December Year 1? If no invoice has been received then there will be no entry in the accounting records.

Spreadsheet entry for accrual

Summary of spreadsheet (Continued)

Table 10.2 Spreadsheet entry for accrual at the end of the month

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Chapter 10

Bookkeeping supplement

Slide 10.16


DEBIT ENTRIES CREDIT ENTRIES

Left-hand side of the equation

Asset Increase Decrease

Right-hand side of the equation

Liability Decrease Increase

Ownership interest Expense Revenue

Capital withdrawn Capital contributed

Slide 10.17


L1 Expense (electricity)

PARTICULARS P DR CR BAL

Year 1 £ £ £

Mar 31 Invoice from supplier L2 350 350

Jun 30 Invoice from supplier L2 180 530

Sep 30 Invoice from supplier L2 280 810

Dec 31 Estimated accrual L3 340 1,150

Dec 31 Transfer to profit and loss account

L5 (1,150) nil

Analysis of debit and credit

Slide 10.18


L2 Liability to supplier


Year 1 £ £ £

Mar. 31 Invoice for electricity expense

L1 350 (350)

Apr. 10 Cash paid L4 350 nil

June 30 Invoice for electricity expense

L1 180 (180)

July 10 Cash paid L4 180 nil

Sept. 30 Invoice for electricity expense

L1 280 (280)

Oct. 10 Cash paid L4 280 nil

Analysis of debit and credit (Continued)

Slide 10.19


L3 Accrual


Year 1 £ £ £

Dec 31 Estimate of electricity expense

L1 340 (340)


Slide 10.20


Transaction Debit Credit

Year 2

Jan. 4 Receive invoice for electricity £340

Accrual Liability to supplier

What happens when the invoice arrives?It creates a liability to the supplier and cancels the ‘accrual’ previously recorded.


Documents

Chapter 10