ACCT1110 Chap.7 Balance Sheet: Liabilities and Equity
Balance Sheet: Liabilities and Equity
Every obligation raises two independent questions. How certain is it, which decides whether it is recognised in the totals at all; and when is it due, which decides whether it sits among current or non-current liabilities.
A warranty provision can be estimated and current at the same time, and a debenture can be exactly known and non-current, so the two questions never collapse into one.
Estimated does not mean optional. Goods have been sold with a promise attached and some will come back, so the expense belongs with the sale, which is only possible if the amount is estimated.
That produces the pattern behind every provision question in this course: claims serviced during the period are charged against the provision rather than against expense, and the period end entry restores the provision to whatever the year's revenue requires.
The structure is identical to the allowance for doubtful debts, which means one method covers two question families.
Borrowing questions turn on keeping principal apart from interest. Issuing a note creates a liability for the principal only; interest accrues with time and is recognised at each balance date whether paid or not; and settlement clears both.
An instalment loan splits each payment between interest and principal, and a debenture redeemed above or below its carrying amount produces a loss or a gain. On the equity side, application money is held in trust until allotment, issued capital counts only what has been called, and a declared dividend becomes a liability on the day it is declared.
What this chapter covers
- 01
Certainty, and whether an obligation is recognised
- 02
Timing, and which half of the balance sheet
- 03
Contingent items described rather than recognised
- 04
The provision pattern in four steps
- 05
Notes payable across a balance date
- 06
Splitting an instalment between interest and principal
- 07
Redemption above or below carrying amount
- 08
Application, allotment and call
- 09
Declaring a dividend against paying it
A warranty provision where the claims have overtaken the balance
- +1Charge the claims against the provision, not against expense: debit warranty provision $71,900 and credit wages payable $71,900.
- +1State the running balance. $68,400 less $71,900 leaves $3,500 on the debit side, so the account is overdrawn before the adjustment.
- +1Compute the requirement: 1.80% of $4,150,000 = $74,700, needed as a credit balance at 30 June 2026.
- +1Move the account from $3,500 debit to $74,700 credit, which takes $78,200: debit warranty expense $78,200 and credit warranty provision $78,200.
Key terms
- Provision
- A liability of uncertain amount or timing, recognised because the obligation itself is certain enough even though the figure is estimated.
- Contingent liability
- A possible obligation whose existence depends on a future event. It is described in the notes rather than recognised in the totals.
- Note payable
- A written promise to repay a principal sum, usually with interest. The liability recorded at issue is the principal alone.
- Accrued interest
- Interest that has built up with the passage of time and has not yet been paid, recognised at each balance date as an expense and a payable.
- Debenture
- A long term borrowing issued to investors, redeemable at a stated percentage of face value such as 102 or 98.
- Application money
- Subscription money received before shares are allotted. It is held in a trust account, because the company has no right to it until allotment.
- Issued capital
- The amount shareholders have been called on to pay and have subscribed. An uncalled instalment is not capital until the call is made.
- Declared dividend
- A distribution approved by the directors, which creates a liability to shareholders on the record date regardless of when it is paid.
Balance Sheet: Liabilities and Equity FAQ
Why are warranty claims charged against the provision rather than to expense?
Because the expense was already recognised when the provision was raised, in the period the goods were sold. Charging the servicing cost to expense again would count the same obligation twice and would leave the provision untouched by the very claims it exists to cover. The only entry that reaches profit is the period end adjustment restoring the provision.
When is a borrowing split between current and non-current?
Whenever it is repaid by instalments. The instalments falling due in the next twelve months are current and the rest is non-current, even though it is one loan under one contract. Where a question describes a loan as due to be paid in a single later year, with no instalments, the whole balance is non-current.
How is a gain or loss on redeeming a debenture worked out?
Compare the cash paid with the carrying amount. Redeeming face value of $130,000 at 102 costs $132,600, so paying $2,600 more than the book value is a loss. Redeeming $180,000 at 98 costs $176,400, so paying $3,600 less is a gain. Where the question says the interest due that day has already been paid and recorded, no interest belongs in the entry.
Why is application money held in trust?
Because the company is not entitled to that money before allotment. Until then the subscribers are applicants rather than shareholders, and the amounts could have to be returned. At allotment the shares are issued, share capital is recognised, and the trust balance is transferred into the company's own bank account.
Exam move
Learn the provision sequence as four fixed steps and use it for warranties and doubtful debts alike: opening balance, what consumed it, the requirement, the plug.
Run it twice, once leaving a credit balance and once leaving a debit balance, because the paper alternates between the two and the sign of the adjustment flips.
For borrowings, write out the three stage life of a note on one page: issue, balance date accrual, settlement. Then do the same for an instalment loan and for a redemption.
Most of the marks in this area come from separating principal from interest cleanly, and from noticing the sentence that tells you the interest has already been dealt with.
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