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Current Liabilities and Contingencies
Current Liabilities and Contingencies
Chapter12
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1. Explain the characteristics of a liability.2. Define current liabilities.3. Account for compensated absences.4. Understand and record payroll taxes and
deductions.5. Record property taxes.6. Account for warranty costs.
ObjectivesObjectives
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7. Explain the terms “probable,” “reasonably possible,” and “remote” related to contingencies.
8. Record and report a loss contingency.
9. Disclose a gain contingency.
ObjectivesObjectives
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Conceptual Overview of Liabilities
Conceptual Overview of Liabilities
Liabilities are probable future sacrifices of
economic benefits arising from present obligations of a company to transfer assets or provide services
to other entities in the future as a result of past transactions or events.
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Three Essential Characteristicsof a Liability
Three Essential Characteristicsof a Liability
1. It involves a present duty or responsibility of the company to one or more entities that will be settled by the probable future transfer or use of assets at a specified or determinable date, on occurrence of a specific event, or on demand.
2. The duty or responsibility obligates the company, leaving it little or no discretion to avoid the future sacrifice.
3. The transaction or other event obligating the company has already happened.
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Current LiabilitiesCurrent Liabilities
Current liabilities are obligations whose
liquidation is expected to require the used of
existing current assets...
Current liabilities are obligations whose
liquidation is expected to require the used of
existing current assets...
…or the creation of other current liabilities within one year or an operating
cycle, whichever is longer.
…or the creation of other current liabilities within one year or an operating
cycle, whichever is longer.
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Operating CycleOperating Cycle
Cash
Inventory
Receivables
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LiquidityLiquidity Classify current liabilities and assets (mixture of
operating-cycle and maturity-date approach). Classify current liabilities and assets using the “pure”
operating-cycle approach. Classify current liabilities and assets under the
maturity-date approach only. Adopt a different classification scheme, possibly using
more classes. Leave the balance sheet unclassified but arranging
items in order of liquidity.
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Liquidity RatiosLiquidity Ratios
Cash flows to total debt. Net income to total assets (return on total
assets ratio). Total debt to total assets. Current assets to current liabilities (current
ratio). Cash to current liabilities.
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Types of Current LiabilitiesTypes of Current Liabilities
Having Contractual Amount
Having Contractual Amount
Accounts payableNotes payableCurrently maturing portion of long-term debt
Dividends payableAdvances and refundable deposits
Accrued itemsUnearned items
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Amount Depends on Operations
Amount Depends on Operations
Sales (use) taxesPayroll taxesIncome taxesBonuses
Types of Current LiabilitiesTypes of Current Liabilities
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Amount Must Be Estimated
Amount Must Be Estimated
Property taxesWarrantiesPremiums and coupons
Other contingencies
Types of Current LiabilitiesTypes of Current Liabilities
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Current Liabilities HavingA Contractual Amount
Current Liabilities HavingA Contractual Amount
Trade accounts payable arise from the purchase of inventory, supplies, or services on an open charge-account
basis.
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Current Liabilities HavingA Contractual Amount
Current Liabilities HavingA Contractual Amount
A note payable is an unconditional written
agreement to pay a sum of money to the bearer on
a specific date.
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Current Liabilities HavingA Contractual Amount
Current Liabilities HavingA Contractual Amount
Trishan Corporation uses a perpetual inventory system and purchases merchandise for $7,000 on September 1, 2001 by
issuing a $7,000, 12%, 30-day note to the supplier.
Trishan Corporation uses a perpetual inventory system and purchases merchandise for $7,000 on September 1, 2001 by
issuing a $7,000, 12%, 30-day note to the supplier.
September 1, 2001Inventory 7,000 Notes Payable 7,000October 1, 2001Interest Expense ($7,000 x 0.12 x30/360) 70Notes Payable 7,000 Cash 7,070
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Current Liabilities HavingA Contractual Amount
Current Liabilities HavingA Contractual Amount
On December 1, 2000, the Trollingwood Corporation borrows money at First National Bank by issuing a $10,000, 90 -day, non-interest-bearing note that is
discounted on a 12% basis.
On December 1, 2000, the Trollingwood Corporation borrows money at First National Bank by issuing a $10,000, 90 -day, non-interest-bearing note that is
discounted on a 12% basis.
December 1, 2000Cash 9,700Discount on Notes Payable 300 Notes Payable 10,000
ContinuedContinuedContinuedContinued
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Current Liabilities HavingA Contractual Amount
Current Liabilities HavingA Contractual Amount
December 31, 2000Interest Expense 100 Discount on Notes Payable 100
March 1, 2001Interest Expense 200 Discount on Notes Payable 200
Notes Payable 10,000 Cash 10,000
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Current Liabilities HavingA Contractual Amount
Current Liabilities HavingA Contractual Amount
On July 1, 1999, Rexlow Corporation issues 13% serial bonds with a face value of $1 million.
These bonds are to be retired in installments of $100,000, beginning on July 1, 2001.
On July 1, 1999, Rexlow Corporation issues 13% serial bonds with a face value of $1 million.
These bonds are to be retired in installments of $100,000, beginning on July 1, 2001.
Current liability:Bonds Payable, due July , 2001 $100,000
Long-term liability:Bonds payable $900,000
December 31, 2000 Balance SheetDecember 31, 2000 Balance Sheet
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Compensated AbsencesCompensated Absences
The company’s obligation relating to the employee’s rights to receive compensation for future absences is attributed to the employee’s services already rendered.
The obligation relates to rights that vest or accumulate. Payment of the compensation is probable. The amount can be reasonably estimated.
The company’s obligation relating to the employee’s rights to receive compensation for future absences is attributed to the employee’s services already rendered.
The obligation relates to rights that vest or accumulate. Payment of the compensation is probable. The amount can be reasonably estimated.
A company recognizes an expense and accrues a liability for employees’ compensation for future absences if all the following conditions are met:
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Compensated AbsencesCompensated Absences
Milton Company has 100 employees who are paid an average of $100 per day. Company policy
allows each employee 12 days of paid vacation per year. Assume no vacation days were taken.
Milton Company has 100 employees who are paid an average of $100 per day. Company policy
allows each employee 12 days of paid vacation per year. Assume no vacation days were taken.
Sales Salaries Exp. Compensated Absences 15,000Office Salaries Exp. Compensated Absences 15,000 Liability for Employees’ Compensation for Future Absences (3/12 x $120,000) 30,000
March 31, 2001March 31, 2001
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Compensated AbsencesCompensated Absences
The $200,000 April 30, 2001 payroll, including paid vacation time taken by the
sales and office staff, is as follows:
The $200,000 April 30, 2001 payroll, including paid vacation time taken by the
sales and office staff, is as follows:
Payroll for
Time Worked Vacation Taken
Sales staff $97,000 $3,000Office staff 96,500 3,500
ContinuedContinuedContinuedContinued
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Sales Salaries Expense 97,000Office Salaries Expense 96,500Liability for Employees’ Compen- sation for Future Absences 6,500
Cash 200,000
April 30, 2001April 30, 2001
Compensated AbsencesCompensated Absences
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Current Liabilities Whose Amounts Depend on
Operations
Current Liabilities Whose Amounts Depend on
Operations
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Sales and Use TaxesSales and Use Taxes
Selleroy Company sells merchandise for cash with a retail sales price of $50,000 on which a sales tax of 6% is levied. The company collects $53,000.
Selleroy Company sells merchandise for cash with a retail sales price of $50,000 on which a sales tax of 6% is levied. The company collects $53,000.
Cash 53,000 Sales 50,000 Sales Taxes Payable 3,000
Typical SituationTypical SituationTypical SituationTypical Situation
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Sales and Use TaxesSales and Use Taxes
At the end of January the Sales account is adjusted to record the tax on all goods sold [$53,000 -
($53,000 ÷ 1.06)] = $3,000.
At the end of January the Sales account is adjusted to record the tax on all goods sold [$53,000 -
($53,000 ÷ 1.06)] = $3,000.
Cash 53,000 Sales 53,000
The Sales Tax is Included in the Price The Sales Tax is Included in the Price Charged to the CustomerCharged to the Customer
The Sales Tax is Included in the Price The Sales Tax is Included in the Price Charged to the CustomerCharged to the Customer
Sales 3,000 Sales Taxes Payable 3,000
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Liabilities Related to PayrollsLiabilities Related to Payrolls
Involuntary Taxes Involuntary Taxes Withheld from Withheld from
EmployeesEmployees
Involuntary Taxes Involuntary Taxes Withheld from Withheld from
EmployeesEmployees
Federal income taxState income taxF.I.C.A. taxes: O.A.S.D.I. Medicare
Federal income taxState income taxF.I.C.A. taxes: O.A.S.D.I. Medicare
Involuntary Taxes Involuntary Taxes Withheld from Withheld from
EmployersEmployers
Involuntary Taxes Involuntary Taxes Withheld from Withheld from
EmployersEmployers
F.I.C.A. taxes: O.A.S.D.I. MedicareFederal unemploy-
ment taxState unemployment
tax
F.I.C.A. taxes: O.A.S.D.I. MedicareFederal unemploy-
ment taxState unemployment
tax
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Liabilities Related to PayrollsLiabilities Related to Payrolls
Voluntary Payroll Voluntary Payroll Deductions Withheld Deductions Withheld
from Employeesfrom Employees
Voluntary Payroll Voluntary Payroll Deductions Withheld Deductions Withheld
from Employeesfrom Employees
Union duesGovernment bondsGroup hospital insurance
Accident insuranceLife insuranceOthers
Union duesGovernment bondsGroup hospital insurance
Accident insuranceLife insuranceOthers
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Accounting for Payroll Taxes and Deductions
Accounting for Payroll Taxes and Deductions
To record salaries and employee withholding items:
Sales Salaries Expense 10,000Office Salaries Expense 4,000 F.I.C.A. Taxes Payable (8% x $14,000) 1,120
Employee Federal Income Taxes Withholding Payable 990Employee State Income Taxes Withholding Payable 500Employee Union Dues Withholding Payable 180Cash 11,210
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To record employer payroll taxes:
Payroll Taxes Expense 1,988F.I.C.A. Taxes Payable (8% x $14,000) 1,120Federal Unemployment Taxes Payable ((0.8% x $14,000) 112State Unemployment Taxes Payable (5.4% x $14,000) 756
Accounting for Payroll Taxes and Deductions
Accounting for Payroll Taxes and Deductions
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Bonus ObligationsBonus Obligations
The bonus is based on the corporation’s income after deducting income taxes, but before deducting the bonus.
The bonus is based on the corporation’s net income after deducting both the bonus and the income tax.
The bonus is based on the corporation’s income after deducting income taxes, but before deducting the bonus.
The bonus is based on the corporation’s net income after deducting both the bonus and the income tax.
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Bonus ObligationsBonus Obligations
Bonex Corporation’s reported income for the current year is $260,000 before deducting income
taxes and bonus. The effective tax rate is 30% and the bonus is 10%.
Bonex Corporation’s reported income for the current year is $260,000 before deducting income
taxes and bonus. The effective tax rate is 30% and the bonus is 10%.
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Bonus ObligationsBonus Obligations
Method 1: Bonus computed on income after deducting taxes but before deducting the bonus:B = 0.10($260,000 - T)T = 0.30($260,000 - B)B = 0.10[($260,000 - .30($260,000 - B)] B = 0.10($260,000 - $78,000 + 0.30B)
B = $26,000 - $7,800 + 0.03B)B - 0.03 B = $18,200 0.97 B = $18,200
B = $18,200 ÷ 0.97B = $18,763 (rounded)
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Bonus ObligationsBonus Obligations
Method 2: Bonus computed on income after deducting both taxes and the bonus:B = 0.10($260,000 - B - T)T = 0.30($260,000 - B) B = 0.10[$260,000 - B - .30($260,000 -B)]
B = 0.10[$260,000 - B - $78,000 + 0.30B]B = $26,000 - 0.10B - $7,800 + 0.03B
B+0.10B-0.03B = $18,200 1.07B = $18,200
B = $18,200 ÷ 1.07B = $17,009 (rounded)
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Bonus ObligationsBonus Obligations
Salaries Expense (Officer’s Bonus) 17,009 Officer’s Bonus Payable 17,009
To record the bonus:
Income Tax Expense 72,897 Income Taxes Payable 72,897
To record the income tax expense:
Current Liability
Current Liability
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Current Liabilities Requiring Amounts to be
Estimated
Current Liabilities Requiring Amounts to be
Estimated
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Property TaxesProperty Taxes
Ezzell Company closes its books annually each December 31. The fiscal year for the town and county in which the firm is located ends on June 30. The estimated property taxes for the period
July 1, 2001 to June 30, 2002 are $7,200. The tax bill is mailed in October with a requirement that
the tax be paid before December 31, 2001. The tax bill reported an actual tax of $7,290, and the
corporation pays this amount on October 31, 2001.
Ezzell Company closes its books annually each December 31. The fiscal year for the town and county in which the firm is located ends on June 30. The estimated property taxes for the period
July 1, 2001 to June 30, 2002 are $7,200. The tax bill is mailed in October with a requirement that
the tax be paid before December 31, 2001. The tax bill reported an actual tax of $7,290, and the
corporation pays this amount on October 31, 2001.
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Property TaxesProperty TaxesThree Monthly Entries July 31-September 30, 2001
Property Tax Expense 600Property Taxes Payable 600
October 31, 2001: Payment of Property Taxes
Property Tax Payable 1,800Prepaid Property Taxes 5,490
Cash 7,290Three Monthly Entries: October 31-December 31, 2001
Property Tax Expense 610Prepaid Property Taxes 610
$7,200 ÷ 12
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Warranty ObligationsWarranty Obligations
Cash or Accounts Receivable 1,200,000Sales 1,200,000
Warranty cost per machine is estimated at $150.Warranty cost per machine is estimated at $150.
Warranty Expense 30,000Estimated Liability under Warranties 30,000
Expense Warranty Expense Warranty Accrual MethodAccrual Method
Expense Warranty Expense Warranty Accrual MethodAccrual Method
Anglee Machinery Corporation begins production on a new machine in April 2001 and sells 200 of these
machines at $6,000 each by December 31, 2001.
Anglee Machinery Corporation begins production on a new machine in April 2001 and sells 200 of these
machines at $6,000 each by December 31, 2001.
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Warranty ObligationsWarranty Obligations
The corporation spent $5,000 in 2001 to fulfill warranty agreements for the 200 machines.
The corporation spent $5,000 in 2001 to fulfill warranty agreements for the 200 machines.
Estimated Liability under Warranties 5,000Cash (or other assets) 5,000
The corporation spent $25,150 in 2002 to fulfill warranty agreements for the two machines.
The corporation spent $25,150 in 2002 to fulfill warranty agreements for the two machines.
Estimated Liability under Warranties 25,000Warranty Expense 150
Cash (or other assets) 25,150
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Anglee Machinery Corporation sells 200 machines for $6,000. This amount includes a service contract
sale of $150 and a machine sale of $5,850.
Anglee Machinery Corporation sells 200 machines for $6,000. This amount includes a service contract
sale of $150 and a machine sale of $5,850.
Cash or Accounts Receivable 1,200,000Sales ($5,850 x 200) 1,170,000Unearned Warranty Revenue 30,000
Sales Warranty Sales Warranty Accrual MethodAccrual MethodSales Warranty Sales Warranty Accrual MethodAccrual Method
Warranty ObligationsWarranty Obligations
ContinuedContinuedContinuedContinued
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Warranty ObligationsWarranty Obligations
Recognition of warranty expense for period, April-December, 2001.
Recognition of warranty expense for period, April-December, 2001.
Warranty Expense 5,000Cash (or other assets) 5,000
Recognition of warranty revenue for period, April-December, 2001.
Recognition of warranty revenue for period, April-December, 2001.
Unearned Warranty Revenue 5,000Warranty Revenue 5,000
ContinuedContinuedContinuedContinued
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Warranty ObligationsWarranty Obligations
Recognition of warranty expense during 2002.Recognition of warranty expense during 2002.
Warranty Expense 25,150Cash (or other assets) 25,150
Recognition of warranty revenue during 2002.Recognition of warranty revenue during 2002.
Unearned Warranty Revenue 25,000Warranty Revenue 25,000
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ContingenciesContingencies
A contingency is an existing condition involving uncertainty as to possible gain or loss that
will ultimately be resolved.
A contingency is an existing condition involving uncertainty as to possible gain or loss that
will ultimately be resolved.
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• Probable. The future event or events is likely to occur.
• Reasonably possible. The chance of the future event occurring is more than remote but less than likely.
• Remote. The chance of the future event occurring is slight.
ContingenciesContingencies
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ContingenciesContingencies
Criteria Disclosure
NoNo Future event probable? Yes
NoNoAmount reasonably
estimated? Yes
Report amount in financial statements
Report amount in financial statements
Yes NoNoReasonable possibility
of loss
Disclose in notes to financial statementsDisclose in notes to financial statements
or and
and
Disclose in notes to financial statements
Not required to disclose
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Disclosure of Gain Contingencies
Disclosure of Gain Contingencies
(a) Contingencies that might result in gains usually are not reflected in [a company’s] accounts since to do so might be to recognize revenue prior to its realization.
(b) Adequate disclosure shall be made of contingencies that might result in gains, but care shall be exercised to avoid misleading implications as to the likelihood of realization.
FASB Statement No. 5 requires that these gains be disclosed in the notes to the company’s financial statements.
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Short-Term Debt Expected to be Refinanced
Short-Term Debt Expected to be Refinanced
When a company relies on a financing agreement to
demonstrate the ability to refinance, the amount of the short-
term debt that it excludes from current liabilities is reduced to an
amount that is the lesser of...
When a company relies on a financing agreement to
demonstrate the ability to refinance, the amount of the short-
term debt that it excludes from current liabilities is reduced to an
amount that is the lesser of...
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Short-Term Debt Expected to be Refinanced
Short-Term Debt Expected to be Refinanced
The amount available for refinancing under the agreement, or
The amount obtainable under the agreement after considering the restrictions included in other agreements, or
A reasonable estimate of the minimum amount expected to be available for future refinancing if the amount that could be obtained fluctuates.
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Chapter12