Understanding Liabilities and Equity: A Deep Dive

Posted on Apr 4, 2025 in Finance

Liabilities and Equity

Current Liabilities

Current Liabilities: Accounts payable to suppliers, notes payable, various creditors, taxes payable, customer advances.

Long-Term Liabilities

Long-Term Liabilities: Loans payable (bank loans, bonds payable).

Types of Debts

• Accounts Payable to Suppliers: Generated by credit purchases of merchandise for sale or processing.
• Salaries Payable: Wages owed to employees.
• Utilities Payable: Unpaid water, electricity, and garbage collection services.
• Interest Payable: Accrued interest on outstanding debt.
• Taxes Payable: Outstanding tax payments.

Loan Conditions

Loans payable may have the following conditions:

• Interest Paid at Maturity: Interest is recorded and paid upon loan maturity. Two journal entries are made: one for the initial loan and another for the payment with interest expense.
• Prepaid Interest: Interest is paid upfront and deducted from the loan amount.

Mortgages Payable

Mortgages payable are long-term debts secured by property. Payment can be negotiated:

1. At the End of the Period: Recorded as long-term liability until less than a year remains, then reclassified as current.
2. In Installments: Short-term portion recorded as current liability, the rest as long-term debt.

Other Long-Term Liabilities

• Foreign Currency Debt: Valued at the prevailing exchange rate on the balance sheet date. Fluctuations can create gains or losses.
• Pension Funds: Established for employee retirement.

Stockholders’ Equity

Stockholders’ equity represents resources from owners/shareholders through contributions or retained earnings.

Classification of Stockholders’ Equity

Differences in Share Issuance

Preferred Stock

• Limited Voting Rights: Voting rights typically restricted to extraordinary general meetings.
• Preferred Dividend: Paid before common stock dividends.
• Cumulative Dividend: Unpaid dividends accumulate and are paid in later years if profits allow.

Common Stock

• Right to Vote: One vote per share in regular and special meetings.
• Right of Priority: Priority to purchase newly issued shares, maintaining proportional ownership.

Financial Ratios

Debt Ratio (Leverage Ratio): Measures the proportion of company resources funded by debt, indicating liquidity risk.

Return on Investment (ROI) or Capital: Measures profitability of investments made by partners.

Book Value per Share: Compares a share’s accounting value to its market value, revealing investor sentiment.