Financial Reporting

Mgt 6410

Chapter 12
Current Liabilities and Contingencies

Objectives:
1. What are Current Liabilities?
2. Notes Payable
3. Unearned or Deferred Revenues
4. Contingencies
5. Short-term obligations expected to be refinanced
6. Warranties
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Current Liabilities: “What is a Liability?”
The FASB, defined liabilities as:
“Probable Future Sacrifices of Economic Benefits
arising from present obligations of a particular entity
to transfer assets or provide services to other entities
in the future as a result of past transactions or events.”
Recall: Current assets are cash or other assets that companies
reasonably expect to convert into cash, sell, or consume in
operations within a single operating cycle or within a year.
Current liabilities are “obligations whose liquidation is reasonably
expected to require use of existing resources properly classified as
current assets, or the creation of other current liabilities.”
Operating cycle: Period between the acquisition of goods and
services and the final cash realization resulting from sales and
subsequent collections.
• LO 1
Current Liabilities
Typical Current Liabilities
1. Accounts payable.
2. Notes payable.
3. Sales taxes payable.
4. Income taxes payable.
5. Employee-related liabilities.
6. Unearned or deferred revenues
7. Accrued liabilities

• LO 1
Notes Payable
Interest-Bearing: Assume that Wells Fargo agrees to lend
$100,000 to EatStreet on March 1, 2025, if EatStreet signs
a $100,000, 6%, 4-month note. Therefore, the principal
and interest on the note would be due July 1, 2025.
Zero-Interest: Assume that EatStreet issues a
$102,000, 4-month, zero-interest bearing note to
Wells Fargo. The present value of the note is
100,000

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Notes Payable (Interest-bearing vs Zero interest)
Cash 100,000
Notes Payable 100,000

Interest Expense($100,000 × 6% × 4/12 2,000

Interest Payable 2,000
Notes Payable 100,000
Interest Payable 2,000
Cash 102,000

Cash 100,000
Discount on Notes Payable 2,000
Notes Payable 102,000
Notes Payable 102,000
Interest Expense 2,000
Cash 102,000
Discount on Note payable 2,000 5
Unearned Revenue and Revenue
Accounts
A magazine publisher such as Conde Nast receives
payment when a customer subscribes to The New Yorker.
An airline company such as American Airlines sells tickets
for future flights. And software companies like Microsoft
issue coupons that allow customers to upgrade.
Type of Business Account Title: Unearned Account Title: Revenue (Income
(Deferred) Revenue (Balance Statement)
Sheet)
Airline Unearned Ticket Revenue Passenger Revenue
Magazine publisher Unearned Subscription Revenue Subscription Revenue
Hotel Unearned Rent Revenue Rent Revenue
Retailers Unearned Gift Card Revenue Sales Revenue

• LO 2 6
Gift Cards Illustration
In March 2025, Haven Retailers sells 10 gift cards at
$200 per gift card, or $2,000 (10 × $200).
In April 2025, six of the gift cards are redeemed. Haven
estimates that cost of goods sold will be 70% of the
sales price, or $140 per gift card.
The remaining four cards are expected to be redeemed
in May 2025. Thus, 60% (6/10) of the revenue is
recognized in April, and 40% (4/10) is recognized as
revenue in May.
The following entries should be recorded when the gift
cards are issued and redeemed.
Gift Cards
To Record Sale of 10 Gift Cards (March 2025)
Cash (10 × $200) 2,000
Unearned Gift Card Revenue 2,000
Record Redemption of 6 Gift Cards (April 2025)
Unearned Gift Card Revenue 1,200
Sales Revenue (6 × $200) 1,200
Cost of Goods Sold (6 × $200 × .70) 840
Inventory 840
To Record Redemption of 4 Remaining Gift Cards (May 2025)

Unearned Gift Revenue 800

Sales Revenue (4 × $200) 800
Cost of Goods Sold 560
Inventory (4 × $200 x .70) 560 8
Gift Card Issues (lost or Stolen)
One problem that complicates the accounting for gift cards
is that the gift card may never be used (this situation is
often referred to as breakage or forfeiture)
Starbucks, for example, recently recognized $212.7 million
of breakage revenue in 2022. Here is a summary.

What if $1,000 of gift cards are redeemed, what entries are made?

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Contingencies
“An existing condition, situation, or set of circumstances
involving uncertainty as to possible gain (gain contingency) or
loss (loss contingency) to an enterprise that will ultimately be
resolved when one or more future events occur or fail to occur.”

FASB uses three areas of probability:

Classification Likelihood of loss is:
Probable Likely
Reasonably possible More than remote but less than likely
Remote Slight

Conditions for Accrual of Loss Contingency

1.

2.

• LO 3
Loss Contingencies Requires
judgment

Probability Accounting

& estimable Accrue &

Probable
Describe in Notes

Footnote
Reasonably Nature of Loss &
Possible Range of Loss

Optional
Remote Footnote Disclosure

• LO 3
Loss Contingencies

Illustration 13-10

• LO 3
Contingencies

Gain Contingencies
Typical Gain Contingencies are:
1. Possible receipts of monies from gifts, donations, asset
sales, and so on.

2. Possible refunds from the government in tax disputes.

3. Pending court cases with a probable favorable outcome.

4. Tax loss carryforwards (Chapter 19).

Gain contingencies are not recorded.

Disclosed only if probability of receipt is high.

• LO 3
Loss Contingencies
Warranty Costs
Promise made by a seller to a buyer to make good on a
deficiency of quantity, quality, or performance in a
product.
Companies often provide one of two types of
warranties to customers:
1.Assurance-type warranty
2.Service-type warranty

• LO 3
Guarantee and Warranty Costs
1. Assurance-Type Warranty
Warranty that the product meets agreed-upon
specifications in the contract at the time the product is
sold.
• Should be expensed in the period the goods are
provided or services performed.
• Should record a warranty liability.
2. Service-Type Warranty
Warranty that provides an additional service beyond the assurance-
type warranty.
Recorded as a separate performance obligation.
Usually recorded in an Unearned Warranty Revenue account.
Recognize revenue on a straight-line basis over the period the service-
type warranty is in effect.
• LO 3
Assurance-Type Warranty
Illustration: Candy Machine Company begins production of
a new vending machine in July 2025 and sells 100 of these
machines for $5,000 cash by year-end for a total sales
revenue of $500,000 (100 × $5,000).
Each vending machine is under warranty for one year.
Candy Machinery estimates, based on past experience
with similar machines, that the warranty cost will average
$200 per unit for a total expected warranty expense of
$20,000 (100 × $200).
Further, as a result of parts replacements and services
performed in compliance with machinery warranties, it
incurs $4,000 in warranty costs in 2025 and $16,000 in
2026.

• LO 3
Assurance-Type Warranty

• LO 3 17
Assurance-Type Warranty

• LO 3 18
Service-Type Warranties
Illustration: You purchase a car from Hamlin Auto for
$30,000 on January 2, 2025. Hamlin estimates the
assurance-type warranty costs on the automobile to be
$700 (Hamlin will pay for repairs for the first 36,000 miles
or three years, whichever comes first).
You also purchase for $900 a service-type warranty for an
additional three years or 36,000 miles.
Hamlin incurs warranty costs related to the assurance-type
warranty of $500 in 2025 and expects costs of $100 in
2026 and 2027. Hamlin records revenue on the service-
type warranty on a straight-line basis.

What entries should Hamlin make in 2025 and 2028?

• LO 3
Service-Type Warranty

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 Put It into Practice LO 12.3 Account
for Contingencies
Liability for Loss
Record a Liability Loss
Lawsuit Loss 250,000
Lawsuit Liability 250,000
A loss and a liability have been recorded for $250,000 because (1)
information is available prior to the issuance of the financial
statements that indicates it is probable that a liability had been
incurred at the date of the financial statements, and (2) the
amount is reasonably estimable. The $60,000 legal case should
not be recorded, as the loss is unlikely to occur.

• LO 3 21
Best Buy Current Liabilities

Feb 1, 2020
Current assets (including Cash, $2,249; Accounts receivable, $1,149; and Short
term investments, $118) $8,857
Current Liabilities
Accounts Payable $5,288
Unredeemed gift card liabilities 281
Deferred revenue 501
Accrued compensation and related expenses 410
Accrued liabilities 906
Current portion of operating lease liabilities 660
Current portion of long term debt 14
Total current liabilities $8,060

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Current Liabilities

Short-Term Obligations Expected to Be

Refinanced
Exclude from current liabilities if both of the following
conditions are met:
1. Must intend to refinance the obligation on a long-term basis.

2. Must demonstrate an ability to refinance:

 Actual refinancing.

 Enter into a financing agreement.

Current Liabilities

Short-Term Obligations Expected to be Refinanced

NO
Management Intends to Refinance Classify as
YES Current
Liability
Demonstrates Ability to Refinance
NO
YES
Actual Refinancing after Financing Agreement
balance sheet date but or Noncancellable with Capable
before issue date Lender

Exclude Short-Term Obligations from Current

Liabilities and Reclassify as LT Debt
Classification of Debt

Illustration: Marquart Company pays off debt of

$40,000 on January 17, 2026. On February 17, 2026,
Marquart issues long-term debt of $100,000.
Marquardt’s financial statements, dated December 31,
2025, are to be issued March 1, 2026.

Should Marquette exclude the $40,000 short-term

debt from current liabilities in its 2025 balance sheet?

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Classification of Debt
Solution

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