MUHASEBE II

Liabilities have three main characteristics: • They occur because of a past transaction or event. • They create a present obligation for future payment of cash or services. • They are an unavoidable obligation. The correct answer is D.

The current liabilities are obligations that will be paid out of current assets and are due within a short time, usually within one year. Current liabilities represent the nature and amounts of outflow of economic benefits from the company in order to fulfill existing obligations in the following fiscal year (one year or operating cycle). Current liabilities include short-term bank loans, current portions of long-term bank loans, accounts payable, notes payable, accruals etc. Current liabilities are listed on the balance sheet in the order in which they are due. The correct answer is D.

Customers may make advanced payments for the goods or services they will receive in the future. When the company receives an advanced payment, an obligation occurs for delivering the goods or rendering the service for which the customer has made payment. Therefore, company must record a liability in its financial statements and this liability is named unearned revenue. In this context, unearned revenues can be defined as the payments received in advance for the products or services being provided. The correct answer is C.

Accounts payable arise from purchasing goods or services for use in a company’s operations. Amounts owed for goods or services purchased on account are accounts payable. Accounts payable are debts incurred in the normal course of a business, resulting from acquisition of inventories and supplies. In these kind of payables, there is no formal document stating the amount or the date of payment except the invoice that supplier issues1. Besides, the maturity of accounts payable is usually very close to issuance date, such as up to three months period. the correct answer is C.

The term “estimated liabilities” is defined as the present obligations with uncertain amounts to settle. That amount is the best estimate of the amount that an entity would rationally pay to settle the obligation at the balance sheet date. The correct answer is B.

A contingent liability is a potential liability because it depends on a future event. If a possible obligation arises from past events but its existence can only be confirmed depending on the occurrence of one or more future events, the obligation under question is a contingent liability. Alternatively, if a present obligation exists but it is not probable that an outflow of economic benefits will be required or even if it is probable, the amount to settle the obligation cannot be measured reliably, the obligation is disclosed as contingent liability. The correct answer is B.

Example: Heat Corporation is a construction company that builds apartments. On June 25, after the end of working day, workers forgot to lock the entrance to the construction area. The children in the neighborhood entered the area and started to play with hoist. One of the children felt down and broke his arm. His parents filed a lawsuit against the company for damages claiming an indemnity of 100,000 TL.

In this case, Heat Corporation should, at first, examine the probability of losing the lawsuit. If it is probable, then the second criteria of measurement reliability is considered. There are three possible cases and three treatments by Heat Corporation;

a. Almost impossible to lose the lawsuit; so does not pay any indemnity – No Liability Reported

b. Probably will lose the lawsuit, however the amount of indemnity cannot be estimated reliably – Liability Disclosed in Footnotes

c. Probably will lose the lawsuit and the amount of indemnity can be estimated reliably – Journalized and Reported in Financial Statements

Suppose that the third option occurs and the experiences from other cases signals that company will pay approximately 30,000 TL as indemnity. Then company must record a liability of 30,000 TL in its balance sheet as well as an expense (for probable loss) in income statement.

The correct answer is D.

There are three possible cases and three treatments ;

a. Almost impossible to lose the lawsuit; so does not pay any indemnity – No Liability Reported

b. Probably will lose the lawsuit, however the amount of indemnity cannot be estimated reliably – Liability Disclosed in Footnotes

c. Probably will lose the lawsuit and the amount of indemnity can be estimated reliably – Journalized and Reported in Financial Statements 

The correct answer is A.

Matching principle requires the recognition of expenses in the period in which they incur to generate revenues. Therefore, as of the end of period, all expenses should be recorded independent from whether they are paid or not. When an expense incurs but is not paid yet, it should be recorded as accrued expense. In other words, accruals can be defined as liabilities for unpaid expenses. The most common examples of accrued expenses are interest payable, salaries payable, income taxes payable etc. The correct answer is A.

Companies may present obligations that the amounts or timing (or both) are not certainly known. According to conservatism principle, these obligations must be reported in the balance sheet as liability, at an amount dependent on managements’ best estimations. These kinds of liabilities are called estimated liabilities or provisions. Some examples of provisions are provisions for employee benefits (severance allowance), provisions for warranties, restructuring provisions, etc. The correct answer is E.

Equity is the “owners’ claims in business”. The correct answer is B.

Debt financing is represented on “Liabilities” section whereas equity financing is represented on the “Equity” section of a balance sheet. As you have learned, equity is the “owners’ claims in business”. Liabilities are “creditors’ claims on total assets” and as “existing debts and obligations of company.” Companies must settle or pay these claims, debts, and obligations at some time in the future by transferring assets or services.

Liabilities have three main characteristics:

• They occur because of a past transaction or event.

• They create a present obligation for future payment of cash or services.

• They are an unavoidable obligation.

The correct answer is B.

Depending on their maturities, liabilities can be split into two main categories as “current liabilities (short term liabilities)” and “non-current liabilities (long term liabilities)”. 

The current liabilities are obligations that will be paid out of current assets and are due within a short time, usually within one year. Current liabilities represent the nature and amounts of outflow of economic benefits from the company in order to fulfill existing obligations in the following fiscal year (one year or operating cycle). Current liabilities include short-term bank loans, current portions of long-term bank loans, accounts payable, notes payable, accruals etc. Current liabilities are listed on the balance sheet in the order in which they are due. The correct answer is C.

In cases of purchases on credit or borrowings, companies may issue promissory notes as an arrangement to formalize the repayment of a certain amount of cash at a certain date to a third party. If it is expected to be paid in the following fiscal year, these promissory notes are recorded as notes payable in current liabilities section of balance sheet. The correct answer is C.

Matching principle requires the recognition of expenses in the period in which they incur to generate revenues. Therefore, as of the end of period, all expenses should be recorded independent from whether they are paid or not. When an expense incurs but is not paid yet, it should be recorded as accrued expense. In other words, accruals can be defined as liabilities for unpaid expenses. The most common examples of accrued expenses are interest payable, salaries payable, income taxes payable etc. The correct answer is D.

Customers may make advanced payments for the goods or services they will receive in the future. When the company receives an advanced payment, an obligation occurs for delivering the goods or rendering the service for which the customer has made payment. Therefore, company must record a liability in its financial statements and this liability is named unearned revenue. The correct answer is D.

A contingent liability is a potential liability because it depends on a future event. If a possible obligation arises from past events but its existence can only be confirmed depending on the occurrence of one or more future events, the obligation under question is a contingent liability. Alternatively, if a present obligation exists but it is not probable that an outflow of economic benefits will be required or even if it is probable, the amount to settle the obligation cannot be measured reliably, the obligation is disclosed as contingent liability. The correct answer is A

Contingent liabilities are reported just in footnotes because of the uncertainty included in its measurement or existence. The correct answer is A.

Contingent liabilities are similar to estimated liabilities in nature, as both of them represent possible future liabilities arising from past events. However, they differ in terms of the level of uncertainty included. The estimated liabilities can be reported in financial statements to the extent they are reliably measured, whereas the contingent liabilities are reported just in footnotes because of the high level of uncertainty included in their measurement or existence. The correct answer is E.

Customers may make advanced payments for the goods or services they will receive in the future. When the company receives an advanced payment, an obligation occurs for delivering the goods or rendering the service for which the customer has made payment. Therefore, company must record a liability in its financial statements and this liability is named unearned revenue. In this context, unearned revenues can be defined as the payments received in advance for the products or services being provided. Unearned revenue should be converted into earned revenue as consistent with the matching principle. The correct answer is E.