copyright © 2007 by the mcgraw-hill companies, inc. all rights reserved. current liabilities and...

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.   

Current Liabilities and Contingencies

13Insert Book Cover

Picture

13-2

Learning Objectives

Define liabilities and distinguish between current and long-term liabilities.

13-3

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 . . .

13-4

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.

13-5

Current Liabilities

Current Liabilities

Short-term notes payable

Accrued expenses

Cash dividends payable

Taxes payable

Accounts payable

Unearned revenues

13-6

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.

13-7

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.

13-8

Learning Objectives

Account for the issuance and payment of various forms of notes and record the interest

on notes.

13-9

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.

13-10

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.

13-11

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

13-12

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.

× ×

× ×

=

=

13-13

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.

13-14

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.

13-15

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.

13-16

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.

13-17

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.

13-18

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

13-19

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

13-20

Learning Objectives

Characterize accrued liabilities and liabilities from advance collection and describe when

and how they should be recorded.

13-21

Liabilities from Advance Collections

Refundable Deposits Advances from Customers Collections for Third Parties

Refundable Deposits Advances from Customers Collections for Third Parties

13-22

Learning Objectives

Determine when a liability can be classifiedas a noncurrent obligation.

13-23

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

13-24

Learning Objectives

Identify situations that constitute contingencies and the circumstances under which they

should be accrued.

13-25

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.

13-26

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.

13-27

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.

13-28

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.

13-29

Learning Objectives

Demonstrate the appropriate accounting treatment for contingencies, including unasserted claims and assessments.

13-30

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:

13-31

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.

13-32

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.

13-33

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.

13-34

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

13-35

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

13-36

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.

13-37

Appendix 13

Payroll-Related Liabilities

13-38

Employers incur several expenses

and liabilities from having employees.

Payroll-Related Liabilities

13-39

FICA Taxes

Medicare Taxes

Federal Income Tax

State and Local Income Taxes

Voluntary Deductions

Gross Pay

Net Pay

Payroll-Related Liabilities

13-40

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)

13-41

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

13-42

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

13-43

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

13-44

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

13-45

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.

13-46

End of Chapter 13