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Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Liabilities and Contingencie s 13 Insert Book Cover Picture
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Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Current Liabilities and Contingencies
13Insert Book Cover
Picture
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Learning Objectives
Define liabilities and distinguish between current and long-term liabilities.
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Liabilities
. . . Resulting from past
transactions or events.
. . . Resulting from past
transactions or events.
. . . Arising from present obligations
to other entities . . .
. . . Arising from present obligations
to other entities . . .
Probable future
sacrifices of economic
benefits . . .
Probable future
sacrifices of economic
benefits . . .
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What is a Current Liability?
LIABILITIESLIABILITIES
Long-term LiabilitiesLong-term Liabilities
Expected to be satisfied with current assets or by the creation
of other current liabilities.
Expected to be satisfied with current assets or by the creation
of other current liabilities.
Current LiabilitiesCurrent Liabilities
Obligations payable within one year or one operating cycle, whichever is
longer.
Obligations payable within one year or one operating cycle, whichever is
longer.
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Current Liabilities
Current Liabilities
Short-term notes payable
Accrued expenses
Cash dividends payable
Taxes payable
Accounts payable
Unearned revenues
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Open Accounts and Notes
Accounts PayableObligations to suppliers for goods
purchased on open account. Trade Notes Payable
Similar to accounts payable, but recognized by a written promissory note.
Short-term Notes PayableCash borrowed from the bank and
recognized by a promissory note.
Accounts PayableObligations to suppliers for goods
purchased on open account. Trade Notes Payable
Similar to accounts payable, but recognized by a written promissory note.
Short-term Notes PayableCash borrowed from the bank and
recognized by a promissory note.
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Credit Lines
Prearranged agreements with a bank that allow a
company to borrow cash without following
normal loan procedures and
paperwork.
Prearranged agreements with a bank that allow a
company to borrow cash without following
normal loan procedures and
paperwork.
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Learning Objectives
Account for the issuance and payment of various forms of notes and record the interest
on notes.
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Interest
Interest on notes is calculated as follows:
Amount borrowed
Amount borrowed
Interest rate is always stated as an annual
rate.
Interest rate is always stated as an annual
rate.
Interest owed is adjusted for the
portion of the year that the face
amount is outstanding.
Interest owed is adjusted for the
portion of the year that the face
amount is outstanding.
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Interest-Bearing Notes
On September 1, Eagle Boats borrows $80,000 from Cooke Bank. The note is due in 6 months and has a
stated interest rate of 9%.Record the borrowing on September 1.
On September 1, Eagle Boats borrows $80,000 from Cooke Bank. The note is due in 6 months and has a
stated interest rate of 9%.Record the borrowing on September 1.
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Interest-Bearing Notes
How much interest is due to Cooke Bank at year-end, on December 31?
a. $2,400
b. $3,600
c. $7,200
d. $87,200
How much interest is due to Cooke Bank at year-end, on December 31?
a. $2,400
b. $3,600
c. $7,200
d. $87,200
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How much interest is due to Cooke Bank at year-end, on December 31?
a. $2,400
b. $3,600
c. $7,200
d. $87,200
How much interest is due to Cooke Bank at year-end, on December 31?
a. $2,400
b. $3,600
c. $7,200
d. $87,200
Interest-Bearing Notes
Interest is calculated as: Face Annual Time to Amount Rate maturity
$80,000 9% 4/12
$2,400 interest due to Cooke Bank.
Interest is calculated as: Face Annual Time to Amount Rate maturity
$80,000 9% 4/12
$2,400 interest due to Cooke Bank.
× ×
× ×
=
=
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Interest-Bearing Notes
Assume Eagle Boats’ year-end is December 31.
Record the necessary adjustment at year-end.
Assume Eagle Boats’ year-end is December 31.
Record the necessary adjustment at year-end.
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Interest-Bearing Notes
Assume Eagle Boats’ year-end is December 31.
Record the necessary adjustment at year-end.
Assume Eagle Boats’ year-end is December 31.
Record the necessary adjustment at year-end.
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Interest-Bearing Notes
Assume Eagle Boats’ year-end is December 31.
Record the necessary journal entry when the note matures on February 28.
Assume Eagle Boats’ year-end is December 31.
Record the necessary journal entry when the note matures on February 28.
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Interest-Bearing Notes
Assume Eagle Boats’ year-end is December 31.
Record the necessary journal entry when the note matures on February 28.
Assume Eagle Boats’ year-end is December 31.
Record the necessary journal entry when the note matures on February 28.
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Short-Term Notes PayableNoninterest-Bearing
Notes without a stated interest rate carry an implicit, or effective, rate.
The face of the note includes the amount borrowed and the interest.
Notes without a stated interest rate carry an implicit, or effective, rate.
The face of the note includes the amount borrowed and the interest.
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On May 1, Batter-Up, Inc. issued a one-year, noninterest-bearing note with a face amount
of $10,600 in exchange for equipmentvalued at $10,000.
How much interest will Batter-Up pay on the note?
On May 1, Batter-Up, Inc. issued a one-year, noninterest-bearing note with a face amount
of $10,600 in exchange for equipmentvalued at $10,000.
How much interest will Batter-Up pay on the note?
Interest = Face Amount - Amount Borrowed
= $10,600 - $10,000
= $600
Interest = Face Amount - Amount Borrowed
= $10,600 - $10,000
= $600
Short-Term Notes PayableNoninterest-Bearing
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On May 1, Batter-Up, Inc. issued a one-year, noninterest-bearing note with a face amount
of $10,600 in exchange for equipmentvalued at $10,000.
What is the effective interest rate on the note?
On May 1, Batter-Up, Inc. issued a one-year, noninterest-bearing note with a face amount
of $10,600 in exchange for equipmentvalued at $10,000.
What is the effective interest rate on the note?
Short-Term Notes PayableNoninterest-Bearing
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Learning Objectives
Characterize accrued liabilities and liabilities from advance collection and describe when
and how they should be recorded.
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Liabilities from Advance Collections
Refundable Deposits Advances from Customers Collections for Third Parties
Refundable Deposits Advances from Customers Collections for Third Parties
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Learning Objectives
Determine when a liability can be classifiedas a noncurrent obligation.
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The ability to refinance on a long-term basiscan be demonstrated by: An existing refinancing agreement, or By actual financing prior to issuance of the financial statements.
The ability to refinance on a long-term basiscan be demonstrated by: An existing refinancing agreement, or By actual financing prior to issuance of the financial statements.
Short-Term ObligationsExpected to Be Refinanced
A company may reclassify a short-term liability as long-term only if two conditions are met:
A company may reclassify a short-term liability as long-term only if two conditions are met:
It has the intent to refinance on a long-term basis.
It has the intent to refinance on a long-term basis.
It has demonstrated the ability to refinance.
It has demonstrated the ability to refinance.
and
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Learning Objectives
Identify situations that constitute contingencies and the circumstances under which they
should be accrued.
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Contingencies
A loss contingency is an existing uncertain situation
involving potential loss depending on whether
some future event occurs.
A loss contingency is an existing uncertain situation
involving potential loss depending on whether
some future event occurs.
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Contingencies
Two factors affect whether a loss contingency must be accrued and
reported as a liability:
1. the likelihood that the confirming event will occur.
2. whether the loss amount can be reasonably estimated.
Two factors affect whether a loss contingency must be accrued and
reported as a liability:
1. the likelihood that the confirming event will occur.
2. whether the loss amount can be reasonably estimated.
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Contingencies –Likelihood of Occurrence
ProbableA confirming event is likely to occur.
Reasonably PossibleThe chance the confirming event will occur is
more than remote, but less than likely. Remote
The chance the confirming event will occur is slight.
ProbableA confirming event is likely to occur.
Reasonably PossibleThe chance the confirming event will occur is
more than remote, but less than likely. Remote
The chance the confirming event will occur is slight.
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Likelihood KnownReasonably
PossibleNot Reasonably
Estimable
Probable Liability accrued and disclosure note
Liability accrued and disclosure note
Disclosure note only
Reasonably possibleDisclosure note
onlyDisclosure note
onlyDisclosure note
only
RemoteNo disclosure
requiredNo disclosure
requiredNo disclosure
required
Dollar Amount of Potential Loss
Contingencies
A loss contingency is accrued only if a loss is probable and the amount can reasonably be estimated.
A loss contingency is accrued only if a loss is probable and the amount can reasonably be estimated.
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Learning Objectives
Demonstrate the appropriate accounting treatment for contingencies, including unasserted claims and assessments.
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Product Warranties and Guarantees
Product warranties inevitably entail costs. The amount of those costs can be reasonably
estimated using commonly available estimation techniques.
The estimate requires the following entry:
Product warranties inevitably entail costs. The amount of those costs can be reasonably
estimated using commonly available estimation techniques.
The estimate requires the following entry:
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Extended Warranties
Extended warranties are sold separately from the product.
The related revenue is not earned until Claims are made against the
extended warranty, or The extended warranty period expires.
Extended warranties are sold separately from the product.
The related revenue is not earned until Claims are made against the
extended warranty, or The extended warranty period expires.
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Premiums
Premiums included with the product are expensed in the period of sale.
Premiums that are contingent on action by the customer require accounting similar to warranties.
Premiums included with the product are expensed in the period of sale.
Premiums that are contingent on action by the customer require accounting similar to warranties.
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Litigation Claims
The majority of medium and large-size corporations annually report loss contingencies due to litigation.
The most common disclosure is a note to the financial statements.
The majority of medium and large-size corporations annually report loss contingencies due to litigation.
The most common disclosure is a note to the financial statements.
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Subsequent Events
Events occurring between the year-end date and report date can affect the appearance of disclosures on the financial statements.
Events occurring between the year-end date and report date can affect the appearance of disclosures on the financial statements.
Fiscal Year Ends Financial Statements
ClarificationCause of Loss Contingency
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Unasserted Claims and Assessments
Is a claim orIs a claim orassessmentassessmentprobable?probable?
Is a claim orIs a claim orassessmentassessmentprobable?probable?
EndEndEndEnd
Can amountCan amountbe estimated?be estimated?Can amountCan amount
be estimated?be estimated?
No
Yes
No
DisclosureDisclosureof claim orof claim or
assessmentassessment
DisclosureDisclosureof claim orof claim or
assessmentassessment Yes
RecordRecordestimated claimestimated claimor assessmentor assessment
RecordRecordestimated claimestimated claimor assessmentor assessment
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Gain Contingencies
As a general rule, we As a general rule, we never record never record GAINGAIN
contingencies.contingencies.
Note that the prior rules have Note that the prior rules have supported the recording of supported the recording of LOSSLOSS
contingencies.contingencies.
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Appendix 13
Payroll-Related Liabilities
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Employers incur several expenses
and liabilities from having employees.
Payroll-Related Liabilities
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FICA Taxes
Medicare Taxes
Federal Income Tax
State and Local Income Taxes
Voluntary Deductions
Gross Pay
Net Pay
Payroll-Related Liabilities
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FICA Taxes Medicare Taxes
6.2% of the first $90,000 earned in the year.
1.45% of all wages earned in the year.
Employers must pay withheld taxesto the Internal Revenue Service (IRS).Employers must pay withheld taxes
to the Internal Revenue Service (IRS).
Employee FICA Taxes
Federal Insurance Contributions Act (FICA)
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Amounts withheld depend on the employee’s earnings, tax rates, and number of withholding allowances.
Employers must pay the taxes withheld from employees’ gross pay to the appropriate government agency.
Employers must pay the taxes withheld from employees’ gross pay to the appropriate government agency.
Federal Income Tax
State and Local Income
Taxes
Employee Income Taxes
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Amounts withheld depend on the employee’s request.
Employers owe voluntary amounts withheld from employees’ gross pay to the designated agency.Employers owe voluntary amounts withheld from employees’ gross pay to the designated agency.
Voluntary Deductions
Examples include union dues, savings accounts, pension contributions, insurance premiums, charities
Examples include union dues, savings accounts, pension contributions, insurance premiums, charities
Employee Voluntary Deductions
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FICA TaxesMedicare
TaxesFederal and
State Unemployment
Taxes
Employers pay amounts equal to that withheld from the employee’s gross pay.Employers pay amounts equal to that
withheld from the employee’s gross pay.
Employer Payroll Taxes
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6.2% on the first $7,000 of wages paid to each employee (A credit up to 5.4% is
given for SUTA paid.)
Federal Unemployment Tax
(FUTA)
Basic rate of 5.4% on the first $7,000 of
wages paid to each employee (Merit
ratings may lower SUTA rates.)
State Unemployment Tax
(SUTA)
Federal and StateUnemployment Taxes
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Fringe Benefits
In addition to salaries and wages,withholding taxes, and payroll taxes, most companies provide a variety
of fringe benefits.
In addition to salaries and wages,withholding taxes, and payroll taxes, most companies provide a variety
of fringe benefits.
Healthinsurancepremiums
Healthinsurancepremiums
Lifeinsurancepremiums
Lifeinsurancepremiums
Retirementplan
contributions
Retirementplan
contributions
Employers must pay the amounts promised to fund employee fringe benefits to the designated agency.Employers must pay the amounts promised to fund employee fringe benefits to the designated agency.
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End of Chapter 13
