1.

Liability Definition
Liability. For most it is a nuisance, inconvenience and answerability. It is usually hated by many
but still being practiced by the same people. However, like everything else, it has its own pros
and cons. Yes, liabilities can be good, too. In fact, liabilities drive the economy. In a business, a
smart manager uses these liabilities in the best way, like, purchase of inventories, cash
advances from customers, and loans for equipment used in production. It can be settled
through a sum of money, goods, or services. The bottomline is, it’s an obligation that needs to
be ironed out because, in the first place it isn’t yours, whether partially or completely.

2. Essential Characteristics of an Accounting Liability

First, it is a present obligation. The term 'present' should not be confused as to when it
happened. Because it is, in fact, a past event that gave this present obligation to the company.
Also, this ‘present’ obligation does not include any future losses a company may incur.
Second, it is a past transaction or event. It may be a year ago, a month, a week, or even just a
second earlier as long as it already happened and not from a future or expected event. 
Third, it requires a probable future sacrifice of assets or other economic benefits. Most liabilities
that are included in financial statements are fit to be called as liabilities because they require
the company to sacrifice assets in future. Thus, accounts and bills payable, wages and salary
payable, long term debt, interest and dividends payable, and similar requirements to pay cash
apparently qualify as liabilities.

3. Difference of Current and Non-current Liabilities

First, based on their meanings and the words used in these two terms, they only differ in time.
Current liabilities are those liabilities which are to be settled within one financial year, while
non-current liabilities are those that are not likely to be settled within one financial year or 12
months. Second, they differ in the presentation in the balance sheet since the former can only
be seen once in the balance sheet, while the latter can be seen multiple times because they are
payable over more than a year. Third, they differ in their impact on working capital. Repayment
of the former reduces working capital while the latter doesn’t have any impact at all. Fourth,
the former generally accrue as a result of obligations arisen during day to day operations of the
company, while the latter generally accrue as a result of more long term funding needs of the
business. As for the interest, the former doesn’t usually have it, while the latter does.

4. Measuring Short-term Liabilities

Short-term liabilities are initially measured at fair value, that is, the estimated price in which a
liability is settled in a transaction to another party under current market conditions. In practice,
recording short-term obligations are not discounted anymore because the discount or the
difference between the face amount and the present value is usually not material and therefore
ignored.

5. Measuring Long-term Liabilities

Long-term liability is initially measured at present value and subsequently measured at
amortized cost. Amortized cost is the difference between the face amount and present value on
financial liability and is amortized through interest expense using the effective interest method.
If the long term note payable is interest bearing, it is initially and subsequently measured at
face amount. In this case, the face amount is equal to the present value of the note payable.
 6. Contingent Liabilities
A contingent liability is a liability that may occur depending on the outcome of an uncertain
future event. Though it is a present obligation from the past event, it is recorded only if the
contingency is likely and the amount of the liability can be reasonably estimated. The liability
may be disclosed in a footnote on the financial statements. The amount of this type obligation
cannot be measured without sufficient reliability. But if the amount can be estimated, the
company sets aside that amount separately to be paid out when the liability arises.
It may also be a potential loss in the future. Examples of these are potential lawsuits, product
warranties, and pending investigation. 

7. Estimated Liabilities
Estimated Liabilities are liabilities that are known to exist but the amount is still unknown, so it
is recorded through the estimate of the accountant, hence the name. It may sound confusing
for a company to have a liability without knowing the exact amount but this is known to be a
common practice. Estimating these liabilities, however, is not just a 1-2-3 boom. It uses
different bases such as number of employees, the rates usually used by the company. Hence,
despite being estimated, the difference will not be too much than what could be the actual.

Problem 1-1
A. Cash/Accounts Receivable 160,000x
Sales 160,000x

Premium Inventory 240,000

     Cash/Accounts Payable 240,000

      Premium Expense 160,000

      Premium Inventory 160,000

      Premium Expense 224,000

      Premium Liability 224,000

B. Premium Liability
Expected coupons to be redeemed 160,000 * 60% = 96,000
Actual redeemed coupons      (40,000)
Coupons not yet redeemed     56,000
Coupons required for one premium ÷  5
Premium Inventory 11,200
Cost per Unit * 20
Premium Liability 224,000

Problem 1-2
A. Cash/Accounts Receivable 100,000x
 Sales 100,000x

Cash Discount Coupon Expense 600,000

Est. Coupon Liability 600,000

Est. Coupon Liability 250,000

Cash 250,000

B. Face Amount of Coupons to be redeemed 12,000

Discount + Reimbursement to Retailers * 50
Total Coupon Liability 600,000
Payment to Retailers (250,000)
Coupon Liability, Dec 31 350,000

Problem 1-3
A. Cash/Accounts Receivable 300,000x
Sales 300,000x

Premium Inventory 360,000

     Cash/Accounts Payable 360,000

      Premium Expense 202,500

      Premium Inventory 202,500

      Premium Expense 135,000

      Premium Liability 135,000

B. Premium Liability
Expected coupons to be redeemed 300,000 * 50% = 150,000
Actual redeemed coupons       (90,000)
Coupons not yet redeemed     60,000
Coupons required for one premium ÷   20
Premium Inventory 3,000
Cost per Unit * 45
Premium Liability 135,000

Problem 1-4
Expected coupons to be redeemed 675,000 * 60% = 405,000
Actual redeemed coupons       (330,000)
Coupons not yet redeemed     75,000
Coupons required for one premium ÷   3
Premium Inventory 25,000
Cost per Unit (P25-P10) * 15
Premium Liability 375,000

Problem 1-5
A. Cash/Accounts Receivable 1,000,000
Sales 1,000,000

Warranty Expense 1,000,000

     Warranty Payable 1,000,000

      Warranty Payable 750,000

      Cash 750,000

B. Warranty Payable, Beg 650,000

Add: Additional Estimates 1,000,000
Less: Payments (750,000)
Warranty Payable, End 900,000

Problem 1-6
A. Cash/Accounts Receivable 16,000,000
Sales 1,000,000

Warranty Expense 960,000

     Warranty Payable 960,000

      Warranty Payable 390,000

      Cash 390,000

B. 4% + 2% = 6%
16,000,000 * 6% = 960,000
960,000 – 390,000 = 570,000

Problem 1-7
Warranty Expense for the current year (300 * 2400) 720,000

Problem 1-8
Warranty Expense (30,000 * 80) 2,400,000
Warranty Paid (700,000)
Est Warranty Liability 1,700,000

Problem 1-9
Warranty Liability, Beg 60,000
Warranty Expense (4,000,000 * 2%) 80,000
Warranty Payments (50,000)
Warranty Liability, End 90,000
Problem 1-10
Accounts Payable 800,000
Deposits and Advances from Customers 450,000
Notes Payable – Current 1,250,000
Credit Balances in Customers’ Accounts 200,000
Serial Bonds Payable 1,500,000
Accrued Interest on Bonds Payable 150,000
Unearned Rent Income 100,000
TOTAL CURRENT LIABILITIES 4,450,000

Problem 1-11
*Only a disclosure is necessary because it is not probable that the company will be liable,
although the amount can be measured reliably

Retained Earnings 200,000

Estimated Liability for Income Tax 200,000

Accounts Receivable – Moonlight 120,000

Loss on Guaranty 80,000
Note Payable – bank 200,000