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
future
sacrifices of
economic
benefits.
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Arise from
present
obligations
to other
entities.
Result from
past
transactions
or events.
What is a Current Liability?
LIABILITIES
Current Liabilities
Obligations payable within
one year or one operating
cycle, whichever is longer.
Expected to be satisfied
with current assets or by
the creation of other current
liabilities.
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Long-term Liabilities
Current Liabilities
Accounts
payable
Taxes
payable
Unearned
revenues
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Cash dividends
payable
Current
Liabilities
Accrued
expenses
Short-term
notes payable
Open Accounts and Notes
•
•
•
•
Accounts Payable
Obligations 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 Payable
Cash borrowed from the bank and
recognized by a promissory note.
Credit lines
Prearranged agreements with a bank that
allow a company to borrow cash without
following normal loan procedures and
paperwork.
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Interest
Interest on notes is calculated as follows:
Face
Amount
Amount
borrowed
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×
Annual
Rate
Interest rate is
always stated
as an annual
rate.
×
Time To
Maturity
Interest owed is
adjusted for the
portion of the year
that the face
amount is
outstanding.
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 journal entry.
September 1:
Cash ....................................................
Notes payable .......................
80,000
80,000
To record short-term note payable to Cooke Bank.
How much interest is owed to Cooke Bank at year-end,
on December 31?
$80,000 × 9% × 4/12 = $2,400
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Interest-bearing Notes
Assume Eagle Boats’ year-end is December 31.
Record the necessary adjustment at year-end.
December 31:
Interest expense ...................................
Interest payable .......................
2,400
2,400
To accrue interest on note due to Cooke Bank.
Record the journal entry for the loan repayment
when the note matures on February 28.
February 28:
Interest payable ...................................
Interest expense ...................................
Note payable …………………………….
Cash ……………………………
To pay off note and interest.
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2,400
1,200
80,000
83,600
Noninterest-bearing Notes
 Notes without a stated
interest rate carry an
implicit, or effective
rate.
 The face of the note
includes the amount
borrowed and the
interest.
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Noninterest-bearing Notes
On May 1, Batter-Up, Inc. issued a one-year,
noninterest-bearing note with a face amount
of $10,600 in exchange for equipment
valued at $10,000.
How much interest will Batter-Up pay on the note?
Interest = Face Amount - Amount Borrowed
=
$10,600
$10,000
=
$600
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Noninterest-bearing Notes
On May 1, Batter-Up, Inc. issued a one-year,
noninterest-bearing note with a face amount
of $10,600 in exchange for equipment
valued at $10,000.
What is the effective interest rate on the note?
Amount
Interest
Interest ÷
=
Borrowed
Rate
$ 600 ÷ $ 10,000 = 6.00%
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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.
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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.
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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.
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Liabilities from Advance Collections
 Refundable deposits
 Advances from customers
 Gift cards
 Collections for third parties
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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) ...................................
Unearned revenue ….......................
500,000
500,000
To record cash received from gift card sales.
December 31, 2010:
Unearned revenue (1,000 × $25) ...............
Sales revenue ….............................
To record revenue from gift card redemptions.
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25,000
25,000
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) ….................
Sales revenue (18,500 × $25) ….........
462,500
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) ….....................
Gift card breakage revenue ………..…..
To record revenue from gift card expirations.
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12,500
12,500
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.
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Short-Term Obligations
Expected to be Refinanced
A company may reclassify a short-term liability
as long-term if two conditions are met:
 It has the intent to
refinance on a
long-term basis.
and
 It has demonstrated
the ability to
refinance.
The ability to refinance on a long-term basis
can be demonstrated by an:
 existing refinancing agreement, or
 actual financing prior to issuance of the
financial statements.
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U.S. GAAP vs. IFRS
Classification of Liabilities to be Refinanced
• Liabilities payable within the
coming year are classified as
long‐term liabilities if
refinancing is completed
before date of issuance of the
financial statements.
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• Liabilities payable within the
coming year are classified as
long‐term liabilities if
refinancing is completed
before the balance sheet date.
Loss Contingencies
A loss contingency is an existing uncertain
situation involving potential loss depending
on whether some future event occurs.
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.
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Loss Contingencies
Likelihood of occurrence:
 Probable
A confirming event is likely to occur.
 Reasonably Possible
The chance the confirming event will occur
is more than remote, but less than likely.
 Remote
The chance the confirming
event will occur is slight.
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Loss Contingencies
Dollar Amount of Potential Loss
Likelihood
Probable
Reasonably possible
Remote
Known
Reasonably
Possible
Liability accrued
Liability accrued
and disclosure note and disclosure note
Disclosure note
Disclosure note
only
only
No disclosure
No disclosure
required
required
Not Reasonably
Estimable
Disclosure note
only
Disclosure note
only
No disclosure
required
A loss contingency is accrued only if a loss is probable
and the amount can reasonably be estimated.
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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:
Warranty expense .........................................
Estimated warranty liability ..............
To accrue warranty expense.
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$,$$$
$,$$$
Extended Warranty Contracts
 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.
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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.
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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.
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Subsequent Events
Events occurring between the fiscal yearend date and report date can affect the
appearance of disclosures on the
financial statements.
Cause of Loss Contingency
Fiscal Year Ends
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Clarification
Financial Statements
Subsequent Events
Events occurring after the year-end date
and report date can also affect the
appearance of disclosures on the
financial statements.
Cause of Loss Contingency
Fiscal Year Ends
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Clarification
Financial Statements
Unasserted Claims and Assessments
Unasserted
claim
No
disclosure
needed
No
 Is a claim
or assessment
probable?
Yes
Evaluate (a) the likelihood of an unfavorable outcome and
(b) whether the dollar amount can be estimated.
An estimated loss and contingent liability would be
accrued if an unfavorable outcome is probable and the
amount can be reasonably estimated.
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U.S. GAAP vs. IFRS
Contingencies
• Defines probable as an event
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.
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• Defines probable as more
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.
Gain Contingencies
Note that the prior rules have
supported the recording of LOSS
contingencies.
As a general rule, we
never record GAIN
contingencies.
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Appendix 13
Payroll-Related Liabilities
Employers incur
several expenses
and liabilities
from having
employees.
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Payroll-Related Liabilities
Gross Pay
FICA
Taxes
Medicare
Taxes
Federal
Income Tax
State and Local Voluntary
Income Taxes Deductions
Net Pay
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Employees’ Withholding Taxes
State and Local
Income Taxes
Federal
Income Tax
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.
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Employees’ Withholding Taxes
Federal Insurance Contributions Act (FICA)
FICA Taxes
6.2% of the first $106,800
earned in the year.
Medicare Taxes
1.45% of all wages
earned in the year.
Employers must pay withheld taxes
to the Internal Revenue Service (IRS).
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Voluntary Deductions
Amounts withheld
depend on the
employee’s
request.
Examples include union dues, savings accounts,
pension contributions, insurance premiums, charities.
Employers owe voluntary amounts withheld from
employees’ gross pay to the designated agency.
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Employers’ Payroll Taxes
FICA Taxes
Medicare
Taxes
Federal and
State
Unemployment
Taxes
Employers pay amounts equal to that
withheld from the employee’s gross pay.
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Federal and State
Unemployment Taxes
Federal
Unemployment Tax
Act (FUTA)
State
Unemployment Tax
Act (SUTA)
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6.2% on the first
$7,000 of wages paid
to each employee (A
credit up to 5.4% is
given for SUTA paid.)
Basic rate of 5.4% on
the first $7,000 of
wages paid to each
employee (Merit
ratings may lower
SUTA rates.)
Fringe Benefits
In addition to salaries and wages,
withholding taxes, and payroll taxes,
most companies provide a variety
of fringe benefits.
Health
insurance
premiums
Life
insurance
premiums
Retirement
plan
contributions
Employers must pay the amounts promised to fund
employee fringe benefits to the designated agency.
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End of Chapter 13