13

Current Liabilities and Contingencies

PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA

McGraw-Hill/Irwin Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved.
 Characteristics of Liabilities

Probable
Probable Arise
Arise from
from Result
Result from
from
future
future present
present past
past
sacrifices
sacrifices of
of obligations
obligations transactions
transactions
economic
economic to
to other
other or
or events.
events.
benefits.
benefits. entities.
entities.

13 - 2
 What is a Current Liability?
LIABILITIES
LIABILITIES

Current
Current Liabilities
Liabilities Long-term
Long-term Liabilities
Liabilities

Obligations
Obligations payable
payable within
within
one
one year
year or
or one
one operating
operating
cycle,
cycle, whichever
whichever is
is longer.
longer.

Expected
Expected to to be
be satisfied
satisfied
with
with current
current assets
assets oror by
by
the
the creation
creation ofof other
other current
current
liabilities.
liabilities.
13 - 3
 Current Liabilities

Accounts Cash dividends

payable payable

Taxes Current Accrued

payable Liabilities expenses

Unearned Short-term
revenues notes payable

13 - 4
 Open Accounts and Notes
•• Accounts
Accounts Payable
Payable
Obligations
Obligations to
to suppliers
suppliers for
for goods
goods
purchased
purchased onon open
open account.
account.
•• Trade
Trade Notes
Notes Payable
Payable
Similar
Similar to
to accounts
accounts payable,
payable, but
but
recognized
recognized by by aa written
written promissory
promissory note.
note.
•• Short-term
Short-term Notes
Notes Payable
Payable
Cash
Cash borrowed
borrowed from
from the
the bank
bank and
and
recognized
recognized by
by aa promissory
promissory note.
note.
•• Credit
Credit lines
lines
Prearranged
Prearranged agreements
agreements withwith aa bank
bank that
that
allow
allow aa company
company to to borrow
borrow cash
cash without
without
following
following normal
normal loan
loan procedures
procedures andand
paperwork.
paperwork.
13 - 5
 Interest
Interest on notes is calculated as follows:

Face Annual Time To

Amount × Rate × Maturity

Amount
Amount Interest
Interest rate
rate is
is Interest
Interest owed
owed is is
borrowed
borrowed always
always stated
stated adjusted
adjusted for for the
the
as
as an
an annual
annual portion
portion of of the
the year
year
rate.
rate. that
that the
the face
face
amount
amount is is
outstanding.
outstanding.
13 - 6
 Interest-bearing Notes

On
On September
September 1, 1, Eagle
Eagle Boats
Boats borrows
borrows $80,000
$80,000 from
from
Cooke
Cooke Bank.
Bank. The
The note
note is
is due
due in
in 66 months
months andand has
has aa
stated
stated interest
interest rate
rate of
of 9%.
9%. Record
Record thethe journal
journal entry.
entry.

September 1:
Cash .................................................... 80,000
Notes payable ....................... 80,000
To record short-term note payable to Cooke Bank.

How
How much
much interest
interest is
is owed
owed to
to Cooke
Cooke Bank
Bank at
at year-end,
year-end,
on
on December
December 31?
31?

$80,000 × 9% × 4/12 = $2,400

13 - 7
 Interest-bearing Notes
Assume
Assume Eagle
Eagle Boats’
Boats’ year-end
year-end is
is December
December 31.
31.
Record
Record the
the necessary
necessary adjustment
adjustment atat year-end.
year-end.
December 31:
Interest expense ................................... 2,400 Interest
payable ....................... 2,400
To accrue interest on note due to Cooke Bank.

Record
Record the
the journal
journal entry
entry for
for the
the loan
loan repayment
repayment
when
when the
the note
note matures
matures on on February
February 28.
28.
February 28:
Interest payable ................................... 2,400
Interest expense ................................... 1,200
Note payable ……………………………. 80,000
Cash …………………………… 83,600
To pay off note and interest.
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 Noninterest-bearing Notes

Notes
 Notes without
without aa stated
stated
interest
interest rate
rate carry
carry an
an
implicit,
implicit, or
or effective
effective
rate.
rate.
The
 The face
face of
of the
the note
note
includes
includes the
the amount
amount
borrowed
borrowed and and the
the
interest.
interest.

13 - 9
 Noninterest-bearing Notes

On
On May
May 1,
1, Batter-Up,
Batter-Up, Inc.
Inc. issued
issued aa one-year,
one-year,
noninterest-bearing
noninterest-bearing note
note with
with aa face
face amount
amount
of
of $10,600
$10,600 inin exchange
exchange for for equipment
equipment
valued
valued atat $10,000.
$10,000.
How
How much
much interest
interest will
will Batter-Up
Batter-Up pay
pay onon the
the note?
note?

Interest
Interest == Face
Face Amount
Amount -- Amount
Amount Borrowed
Borrowed
== $10,600
$10,600 -- $10,000
$10,000
== $600
$600
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 Noninterest-bearing Notes

On
On May
May 1, 1, Batter-Up,
Batter-Up, Inc.
Inc. issued
issued aa one-year,
one-year,
noninterest-bearing
noninterest-bearing note note with
with aa face
face amount
amount
of
of $10,600
$10,600 in in exchange
exchange for for equipment
equipment
valued
valued at
at $10,000.
$10,000.
What
What is
is the
the effective
effective interest
interest rate
rate on
on the
the note?
note?

Amount Interest
Interest ÷ =
Borrowed Rate
$ 600 ÷ $ 10,000 = 6.00%

13 - 11
 Commercial Paper
Commercial paper is a term used for
unsecured notes issued in minimum
denominations of $25,000 with maturities
ranging from 30 days to 270 days.

Issued directly to the lender

and is backed by a line of
credit with a bank.

Recorded in the
same manner as notes
payable.
13 - 12
 Salaries, Commissions, and Bonuses
Compensation expenses such as
salaries, commissions, and bonuses
are liabilities at the balance sheet
date if earned but unpaid.

These accrued
expenses/accrued liabilities
are recorded with an
adjusting entry prior to
preparing financial
statements.
13 - 13
 Vacations, Sick Days, and Other
Paid Future Absences
An employer should accrue an expense and the related liability
for employees’ compensation for future absences (such as
vacation pay) if the obligation meets all four of these conditions:
1. The obligation is for services already performed.
2. The paid absence can be taken in a later year—the benefit
vests or the benefit can be accumulated over time.
3. Payment is probable.
4. The amount can be reasonably estimated.

Sick pay quite often meets the conditions for accrual, but
accrual is not mandatory because future absence depends on
future illness, which usually is not a certainty.
13 - 14
 Liabilities from Advance Collections

Refundable
 Refundable deposits
deposits
Advances
 Advances from
from customers
customers
Gift
 Gift cards
cards
Collections
 Collections for
for third
third parties
parties

13 - 15
 Gift Cards
During their December 2010 Christmas promotion, MegloMart
sold 20,000 gift cards at $25 each. All gift card sales were for
cash. On December 31, 2010, only 1,000 gift cards had been
redeemed. Unused gift cards expire on December 31, 2011, if
not used to purchase MegloMart merchandise.

Prepare the journal entries on December 31, 2010 to record the

December 2010 sale and redemption of gift cards.
December 31, 2010:
Cash (20,000 × $25) ................................... 500,000 Unearned
revenue …....................... 500,000
To record cash received from gift card sales.

December 31, 2010:

Unearned revenue (1,000 × $25) ............... 25,000
Sales revenue …............................. 25,000
To record revenue from gift card redemptions.
13 - 16
 Gift Cards
By December 31, 2011, 18,500 additional gift cards had been
redeemed. Prepare the journal entry on December 31 to
record the 2011 redemptions.
December 31, 2011:
Unearned revenue (18,500 × $25) …................. 462,500
Sales revenue (18,500 × $25) …......... 462,500
To record revenue from gift card redemptions.

On December 31, 2011, the 500 remaining cards had not been
redeemed. Prepare the journal entry on December 31 to
record the gift card expirations.
December 31, 2011:
Unearned revenue (500 × $25) …..................... 12,500
Gift card breakage revenue ………..….. 12,500
To record revenue from gift card expirations.

13 - 17
 A Closer Look at the Current and
Noncurrent Classification

Current maturities of long-term obligations usually

are reclassified and reported as current liabilities if
they are payable within the upcoming year (or
operating cycle, if longer than a year).

Debt that is callable by the lender in the coming

year (or operating cycle, if longer) should be
classified as a current liability, even if the debt is
not expected to be called.
13 - 18
 Short-Term Obligations
Expected to be Refinanced
A
A company
company may
may reclassify
reclassify aa short-term
short-term liability
liability
as
as long-term
long-term ifif two
two conditions
conditions are
are met:
met:


 ItIt has
has the
the intent
intent to
to 
 ItIt has
has demonstrated
demonstrated
refinance
refinance on on aa and the
the ability
ability to
refinance.
to
long-term
long-term basis.
basis. refinance.

The
The ability
ability to
to refinance
refinance on
on aa long-term
long-term basis
basis
can
can be
be demonstrated
demonstrated by by an:
an:

 existing
existing refinancing
refinancing agreement,
agreement, or or

 actual
actual financing
financing prior
prior to
to issuance
issuance of
of the
the
financial
financial statements.
statements.
13 - 19
 U.S. GAAP vs. IFRS
Classification of Liabilities to be Refinanced

• Liabilities payable within the • Liabilities payable within the

coming year are classified as
long‐term liabilities if
refinancing is completed
before date of issuance of the
financial statements.
coming year are classified as
long‐term liabilities if
refinancing is completed
before the balance sheet date.

13 - 20
 Loss Contingencies
AA loss
loss contingency
contingency isis an
an existing
existing uncertain
uncertain
situation
situation involving
involving potential
potential loss
loss depending
depending
on
on whether
whether some
some future
future event
event occurs.
occurs.

Two
Two factors
factors affect
affect whether
whether aa loss
loss
contingency
contingency mustmust be be accrued
accrued and
and reported
reported
as
as aa liability:
liability:
1.
1. the
the likelihood
likelihood that
that the
the confirming
confirming
event
event will
will occur.
occur.
2.
2. whether
whether thethe loss
loss amount
amount can can be
be
reasonably
reasonably estimated.
estimated.
13 - 21
 Loss Contingencies
Likelihood
Likelihood of
of occurrence:
occurrence:
Probable
 Probable
AAconfirming
confirming event
event is
is likely
likely to
to occur.
occur.
Reasonably
 Reasonably Possible
Possible
The
The chance
chance the
the confirming
confirming event
event will
will occur
occur
is
is more
more than
than remote,
remote, but
but less
less than
than likely.
likely.
Remote
 Remote
The
The chance
chance the
the confirming
confirming
event
event will
will occur
occur is
is slight.
slight.

13 - 22
 Loss Contingencies

Dollar Amount of Potential Loss

Reasonably Not Reasonably
Likelihood Known Possible Estimable

Probable Liability accrued Liability accrued Disclosure note

and disclosure note and disclosure note only
Disclosure note Disclosure note Disclosure note
Reasonably possible
only only only
No disclosure No disclosure No disclosure
Remote
required required required

AA loss
loss contingency
contingency is
is accrued
accrued only
only ifif aa loss
loss is
is probable
probable
and
and the
the amount
amount can
can reasonably
reasonably be be estimated.
estimated.

13 - 23
 Product Warranties and Guarantees

Product
 Product warranties
warranties inevitably
inevitably entail
entail costs.
costs.
The
 The amount
amount of
of those
those costs
costs can
can be
be reasonably
reasonably
estimated
estimated using
using commonly
commonly available
available estimation
estimation
techniques.
techniques.
The
 The estimate
estimate requires
requires the
the following
following entry:
entry:

Warranty expense ......................................... $,$$$

Estimated warranty liability .............. $,$$$
To accrue warranty expense.

13 - 24
 Extended Warranty Contracts
Extended
 Extended warranties
warranties are
are sold
sold
separately
separately from
from the
the product.
product.
The
 The related
related revenue
revenue is
is not
not earned
earned
until:
until:
 Claims
Claims are
are made
made against
against the
the
extended
extended warranty,
warranty, or
or
 The
The extended
extended warranty
warranty period
period expires.
expires.

13 - 25
 Premiums
Premiums
 Premiums included
included with
with the
the
product
product are
are expensed
expensed in in the
the
period
period of
of sale.
sale.
Premiums
 Premiums thatthat are
are contingent
contingent
on
on action
action byby the
the customer
customer
require
require accounting
accounting similar
similar toto
warranties.
warranties.

13 - 26
 Litigation Claims

The
 The majority
majority ofof medium
medium
and
and large-size
large-size corporations
corporations
annually
annually report
report loss
loss
contingencies
contingencies due due to
to
litigation.
litigation.
The
 The most
most common
common
disclosure
disclosure is is aa note
note to
to the
the
financial
financial statements.
statements.
13 - 27
 Subsequent Events
Events
Events occurring
occurring between
between the
the fiscal
fiscal year-
year-
end
end date
date and
and report
report date
date can
can affect
affect the
the
appearance
appearance of of disclosures
disclosures onon the
the
financial
financial statements.
statements.
Cause of Loss Contingency Clarification

Fiscal Year Ends Financial Statements

13 - 28
 Subsequent Events
Events
Events occurring
occurring after
after the
the year-end
year-end date
date
and
and report
report date
date can
can also
also affect
affect the
the
appearance
appearance ofof disclosures
disclosures onon the
the
financial
financial statements.
statements.
Cause of Loss Contingency Clarification

Fiscal Year Ends Financial Statements

13 - 29
 Unasserted Claims and Assessments
Unasserted
Unasserted
claim
claim

No
No  Is
 Is aa claim
claim
disclosure
disclosure No or
or assessment
assessment
needed
needed probable?
probable?

Yes

Evaluate
Evaluate (a)
(a) the
the likelihood
likelihood ofof an
an unfavorable
unfavorable outcome
outcome and
and
(b)
(b) whether
whether the the dollar
dollar amount
amount can
can be
be estimated.
estimated.
An
An estimated
estimated lossloss and
and contingent
contingent liability
liability would
would be
be
accrued
accrued ifif an
an unfavorable
unfavorable outcome
outcome isis probable
probable and
and the
the
amount
amount can can be
be reasonably
reasonably estimated.
estimated.
13 - 30
 U.S. GAAP vs. IFRS
Contingencies

• Defines probable as an event • Defines probable as more

is likely to occur.
• Refers to both accrued and
non-accrued obligations as
contingent liabilities.
• Requires use of low end of a
range of equally likely
outcomes.
• Allows using present value
under some circumstances.
likely than not, a lower
threshold than U.S. GAAP.
• Refers to accrued liabilities as
provisions and non-accrued as
contingent liabilities.
• Requires use of midpoint of a
range of equally likely
outcomes.
• Requires reporting present
values when material.

13 - 31
 Gain Contingencies

Note that the prior rules have

supported the recording of LOSS
contingencies.

As a general rule, we
never record GAIN
contingencies.

13 - 32
 Appendix 13
Payroll-Related Liabilities

Employers incur
several expenses
and liabilities
from having
employees.

13 - 33
 Payroll-Related Liabilities

Gross Pay

FICA Medicare Federal State and Local Voluntary

Taxes Taxes Income Tax Income Taxes Deductions

Net Pay
13 - 34
 Employees’ Withholding Taxes

State and Local

Federal Income Taxes
Income Tax
Amounts withheld depend on the employee’s earnings,
tax rates, and number of withholding allowances.

Employers
Employers must
must pay
pay the
the taxes
taxes withheld
withheld
from
from employees’
employees’ gross
gross pay
pay to
to the
the
appropriate
appropriate government
government agency.
agency.
13 - 35
 Employees’ Withholding Taxes

Federal Insurance Contributions Act (FICA)

FICA Taxes Medicare Taxes

6.2% of the first $106,800 1.45% of all wages
earned in the year. earned in the year.

Employers
Employers must
must pay
pay withheld
withheld taxes
taxes
to
to the
the Internal
Internal Revenue
Revenue Service
Service (IRS).
(IRS).

13 - 36
 Voluntary Deductions

Amounts withheld
depend on the
employee’s
request.

Examples
Examples include
include union
union dues,
dues, savings
savings accounts,
accounts,
pension
pension contributions,
contributions, insurance
insurance premiums,
premiums, charities.
charities.

Employers
Employers owe
owe voluntary
voluntary amounts
amounts withheld
withheld from
from
employees’
employees’ gross
gross pay
pay to
to the
the designated
designated agency.
agency.

13 - 37
 Employers’ Payroll Taxes

Medicare Federal and

FICA Taxes
Taxes State
Unemployment
Taxes

Employers
Employers pay
pay amounts
amounts equal
equal to
to that
that
withheld
withheld from
from the
the employee’s
employee’s gross
gross pay.
pay.

13 - 38
 Federal and State
Unemployment Taxes
6.2% on the first
Federal $7,000 of wages paid
Unemployment Tax to each employee (A
Act (FUTA) credit up to 5.4% is
given for SUTA paid.)

Basic rate of 5.4% on

State the first $7,000 of
Unemployment Tax wages paid to each
Act (SUTA) employee (Merit
ratings may lower
SUTA rates.)
13 - 39
 Fringe Benefits
In
In addition
addition toto salaries
salaries and
and wages,
wages,
withholding
withholding taxes,
taxes, and
and payroll
payroll taxes,
taxes,
most
most companies
companies provide
provide aa variety
variety
of
of fringe
fringe benefits.
benefits.

Health
Health Life
Life Retirement
Retirement
insurance
insurance insurance
insurance plan
plan
premiums
premiums premiums
premiums contributions
contributions

Employers
Employers must
must pay
pay the
the amounts
amounts promised
promised to
to fund
fund
employee
employee fringe
fringe benefits
benefits to
to the
the designated
designated agency.
agency.
13 - 40
End of Chapter 13