H-1

Other Significant
Appendix H Liabilities
Learning Objectives
After studying this chapter, you should be able to:

1. Describe the accounting and disclosure requirements for provisions

and contingent liabilities.
2. Contrast the accounting for operating and finance leases.
3. Identify additional fringe benefits associated with employee
compensation.

H-2
 Provisions and Contingent Liabilities

IFRS Guidelines:
 Provision – if a loss is probable (> 50% chance) and if
a reasonable estimate can be made of the amount, then
a liability should be recorded.
 Contingent Liability – if a loss is not probable a
liability should not be recorded and the details of
situation should be disclosed in the notes to the financial
statements.
 Remote Possibility (< 10%) – no disclosure.

H-3
LO 1 Describe the accounting and disclosure requirements
for provisions and contingent liabilities.
 Provisions and Contingent Liabilities

Probability Accounting

Probable Accrue

Reasonably
Footnote
Possible

Need not record

Remote or disclose

H-4
LO 1 Describe the accounting and disclosure requirements
for provisions and contingent liabilities.
 Provisions and Contingent Liabilities

Question
A provision should be recorded in the accounts when:
a. it is probable an outflow of assets will happen but the
amount cannot be reasonably estimated.
b. it is reasonably possible an outflow of assets will happen
and the amount can be reasonably estimated.
c. it is reasonably possible an outflow of assets will happen
but the amount cannot be reasonably estimated.
d. it is probable an outflow of assets will happen and the
amount can be reasonably estimated.

H-5
LO 1 Describe the accounting and disclosure requirements
for provisions and contingent liabilities.
 Provisions and Contingent Liabilities

Recording a Provision
Product Warranties
Future costs that companies may incur in replacing defective
units or repairing malfunctioning units.

Estimated cost of honoring product warranty contracts should

be recognized as an expense in the period in which the sale
occurs.

H-6
LO 1 Describe the accounting and disclosure requirements
for provisions and contingent liabilities.
 Provisions and Contingent Liabilities

Illustration: In 2014, Denson Manufacturing Company sells

10,000 washers and dryers at an average price of $600 each.
The selling price includes a one-year warranty on parts.
Denson expects that 500 units (5%) will be defective and that
warranty repair costs will average $80 per unit. In 2014, the
company honors warranty contracts on 300 units, at a total cost
of $24,000. At December 31, compute the estimated warranty
liability.

Illustration H-1
Computation of estimated
product warranty liability

H-7 LO 1
 Provisions and Contingent Liabilities

Illustration: In 2014, Denson Manufacturing Company sells

10,000 washers and dryers at an average price of $600 each.
The selling price includes a one-year warranty on parts.
Denson expects that 500 units (5%) will be defective and that
warranty repair costs will average $80 per unit. In 2014, the
company honors warranty contracts on 300 units, at a total cost
of $24,000. At December 31, compute the estimated warranty
liability. Make the required adjusting entry.

Warranty expense 40,000

Warranty liability 40,000

H-8
LO 1 Describe the accounting and disclosure requirements
for provisions and contingent liabilities.
 Provisions and Contingent Liabilities

Illustration: Prepare the entry to record the repair costs

incurred in 2014 to honor warranty contracts on 2014 sales.

Warranty liability 24,000

Repair parts 24,000

Assume that the company replaces 20 defective units in

January 2015, at an average cost of $80 in parts and labor.

Warranty liability 1,600

Repair parts 1,600

H-9
LO 1 Describe the accounting and disclosure requirements
for provisions and contingent liabilities.
 Provisions and Contingent Liabilities

Disclosure of Contingent Liabilities

Disclosure should identify the:
 Nature of the item.

 Amount of the contingency, if known.

 Expected outcome of the future event.

H-10
LO 1 Describe the accounting and disclosure requirements
for provisions and contingent liabilities.
 Lease Liabilities

A lease is a contractual arrangement between a lessor (owner

of the property) and a lessee (renter of the property).

Illustration H-3
Types of leases

H-11 LO 2 Contrast the accounting for operating and finance leases.

 Lease Liabilities

Operating Lease Finance Lease

Journal Entry: Journal Entry:
Rent Expense xxx Leased Equipment xxx
Cash xxx Lease Liability xxx

A lease that transfers substantially all of the benefits and risks of

property ownership should be capitalized.

H-12 LO 2 Contrast the accounting for operating and finance leases.

 Lease Liabilities

IFRS does not prescribe criteria for determining classification,

however if any one of the following conditions exists, the
lessee should record a lease as a finance lease:
1. The lease transfers ownership of the property to the lessee.

2. The lease contains a bargain purchase option.

3. The lease term is a major portion of the economic life of the

leased property.

4. The present value of the lease payments represents

substantially all of the fair value of the leased property.

H-13 LO 2 Contrast the accounting for operating and finance leases.

 Lease Liabilities

Illustration: Gonzalez Company decides to lease new

equipment. The lease period is four years; the economic life of
the leased equipment is estimated to be five years. The present
value of the lease payments is $190,000, which is equal to the
fair market value of the equipment. There is no transfer of
ownership during the lease term, nor is there any bargain
purchase option.

Instructions
(a) What type of lease is this? Explain.
(b) Prepare the journal entry to record the lease.

H-14 LO 2 Contrast the accounting for operating and finance leases.

 Lease Liabilities

Illustration: (a) What type of lease is this? Explain.

Capitalization Conditions: Finance Lease?

1. Transfer of ownership NO
2. Bargain purchase option NO
3. Lease term major portion of Lease term
economic life of leased
4 yrs.
property
Economic life
4. Present value is substantially
the FMV of the leased 5 YES
yrs. - PV and FMV
YESare the same.
property

H-15 80%
LO 2 Contrast the accounting for operating and finance leases.
 Lease Liabilities

Illustration: (b) Prepare the journal entry to record the lease.

Leased Asset - Equipment 190,000

Lease Liability
190,000

The portion of the lease liability expected to be paid in the next year
is a current liability. The remainder is classified as a non-current
liability.

H-16 LO 2 Contrast the accounting for operating and finance leases.

 Employee Fringe Benefits

Paid Absences
Paid absences for vacation, illness, and holidays.

Accrue a liability if:

 Payment of the compensation is probable.
 The amount can be reasonably estimated.

H-17
LO 3 Identify additional fringe benefits associated
with employee compensation.
 Employee Fringe Benefits

Illustration: Academy Company employees are entitled to one

day’s vacation for each month worked. If 30 employees earn an
average of $110 per day in a given month.

Vacation benefits expense 3,300

Vacation benefits liability 3,300

Academy pays vacation benefits for 10 employees.

Vacation benefits liability 1,100

Cash 1,100

H-18
LO 3 Identify additional fringe benefits associated
with employee compensation.
 Employee Fringe Benefits

Postretirement Benefits
Post-retirement benefits are benefits that employers
provide to retired employees for

1. health care and life insurance

2. pensions.

Companies account for post-retirement benefits on the

accrual basis.

H-19
LO 3 Identify additional fringe benefits associated
with employee compensation.
 Employee Fringe Benefits

Postretirement Health-Care and Life Insurance

Benefits
 Companies estimate and expense postretirement costs
during the working years of the employee.
 Companies rarely sets up funds to meet the cost of the
future benefits.
► Pay-as-you-go basis for these costs.
► Major reason is that the company does not receive a tax
deduction until it actually pays the medical bill.

H-20
LO 3 Identify additional fringe benefits associated
with employee compensation.
 Employee Fringe Benefits Pension
Plans
An arrangement whereby an employer provides benefits to employees
after they retire for services they provided while they were working.

Pension
PensionPlan
Plan
Administrator
Administrator

Employer
Employer Contributions

Retired
Employees Benefit Payments Assets &
Liabilities

H-21
LO 3 Identify additional fringe benefits associated
with employee compensation.
 Employee Fringe Benefits Pension
Plans

Defined-Contribution Plan Defined-Benefit Plan

 Employer contribution  Benefit determined by plan
determined by plan (fixed)  Employer contribution varies
 Risk borne by employees (determined by Actuaries)
 Benefits based on plan value  Risk borne by employer

 Companies record pension costs as an expense.

 Actuaries estimate the employer contribution by considering
mortality rates, employee turnover, interest and earning rates, early
retirement frequency, future salaries, etc.

H-22
LO 3 Identify additional fringe benefits associated
with employee compensation.
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H-23