Slide
13-1
Chapter Thirteen
Current Liabilities
and Contingencies
McGraw-Hill/Irwin
Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide
13-2
Liabilities
Probable
future
sacrifices or
economic
benefits . . .
McGraw-Hill/Irwin
. . . Arising
from present
obligations
to other
entities . . .
. . . Resulting
from past
transactions
or events.
Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide
13-3
What is a Current Liability?
LIABILITIES
Current Liabilities
Long-term 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.
McGraw-Hill/Irwin
Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide
13-4
Current Liabilities
Accounts
payable
Taxes
payable
Unearned
revenues
McGraw-Hill/Irwin
Cash dividends
payable
Current
Liabilities
Accrued
expenses
Short-term
notes payable
Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide
13-5
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.
McGraw-Hill/Irwin
Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide
13-6
Credit Lines
Prearranged
agreements with a
bank that allow a
company to borrow
cash without following
normal loan
procedures and
paperwork.
McGraw-Hill/Irwin
Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide
13-7
Interest
Interest on notes is calculated as follows:
Face
Amount
Amount
borrowed
McGraw-Hill/Irwin
×
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.
Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide
13-8
Interest-Bearing Notes
Example
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.
GENERAL JOURNAL
56
Page:
Date
Description
PR
Sept. 1 Cash
Notes Payable
to record receipt of short-term
loan proceeds from Cooke
Bank
McGraw-Hill/Irwin
Debit
Credit
80,000
80,000
Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide
13-9
Interest-Bearing Notes
Example
How much interest is due to Cooke
Bank at year-end, on December 31?
a.
b.
c.
d.
McGraw-Hill/Irwin
$2,400
$3,600
$7,200
$87,200
Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide
13-10
Interest-Bearing Notes
Example
How much interest is due to Cooke
Bank at year-end, on December 31?
a.
b.
c.
d.
McGraw-Hill/Irwin
$2,400
$3,600
$7,200
$87,200
Interest is calculated as:
Face
Annual
Time to
× Rate
× maturity =
Amount
$80,000
×
9%
×
4/12
=
$2,400 interest due to Cooke Bank.
Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide
13-11
Interest-Bearing Notes
Example
Assume Eagle Boats’ year-end is December 31.
Record the necessary adjustment at year-end.
GENERAL JOURNAL
28
Page:
Date
McGraw-Hill/Irwin
Description
PR
Debit
Credit
Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide
13-12
Interest-Bearing Notes
Example
Assume Eagle Boats’ year-end is December 31.
Record the necessary adjustment at year-end.
GENERAL JOURNAL
28
Page:
Date
Description
PR
Dec. 31 Interest Expense
Interest Payable
to accrue interest on note due
to Cooke Bank
McGraw-Hill/Irwin
Debit
Credit
2,400
2,400
Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide
13-13
Interest-Bearing Notes
Example
Assume Eagle Boats’ year-end is December 31.
Record the necessary journal entry when the
note matures on February 28.
GENERAL JOURNAL
12
Page:
Date
McGraw-Hill/Irwin
Description
PR
Debit
Credit
Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide
13-14
Interest-Bearing Notes
Example
Assume Eagle Boats’ year-end is December 31.
Record the necessary journal entry when the
note matures on February 28.
GENERAL JOURNAL
12
Page:
Date
Description
Feb. 28 Interest Payable
Interest Expense
Note Payable
Cash
to pay off note and interest
McGraw-Hill/Irwin
PR
Debit
Credit
2,400
1,200
80,000
83,600
Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide
13-15
Short-Term Notes Payable
Noninterest-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.
McGraw-Hill/Irwin
Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide
13-16
Noninterest-Bearing Notes
Example
On May 1, 2005, Batter-Up, Inc. issued a oneyear, 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 Received
=
$10,600
$10,000
=
$600
McGraw-Hill/Irwin
Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide
13-17
Noninterest-Bearing Notes
Example
On May 1, 2005, Batter-Up, Inc. issued a oneyear, 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
=
Borrowed
Rate
$600.00 ÷ $ 10,000.00 = 6.00%
Interest ÷
McGraw-Hill/Irwin
Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide
13-18
Liabilities from Advance
Collections
Refundable Deposits
Advances from
Customers
Collections for Third
Parties
McGraw-Hill/Irwin
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Slide
13-19
Short-Term Obligations Expected
to Be Refinanced
A short-term liability may be reclassified
as long-term if:
The short-term
liability is actually
refinanced before
the statement
issue date.
McGraw-Hill/Irwin
or
The expected refinancing
is evidenced by good
faith entrance into a
long-term, noncancelable
refinancing agreement
with a viable lender.
Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide
13-20
Let’s look at
Contingent
Liabilities
McGraw-Hill/Irwin
Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide
13-21
Contingencies
A loss contingency is
an existing uncertain
situation involving
potential loss
depending on
whether some future
event occurs.
McGraw-Hill/Irwin
Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide
13-22
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.
McGraw-Hill/Irwin
Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide
13-23
Contingencies – Likelihood of
Occurrence
Probable

A confirming event is likely to occur.
Reasonably Possible

The chance the confirming event will occur
is > remote, but < likely.
Remote

The chance the confirming event will occur
is slight.
McGraw-Hill/Irwin
Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide
13-24
Loss Contingencies
Accounting Treatments
Likelihood
Probable
Reasonably
Possible
Remote
McGraw-Hill/Irwin
Dollar Amount of Potential Loss
Reasonably
Not Reasonably
Known
Estimable
Estimable
Liability
Liability
Disclosure
Accrued &
Accrued &
Note
Disclosure Note Disclosure Note
Only
Disclosure
Disclosure
Disclosure
Note
Note
Note
Only
Only
Only
No
No
No
Disclosure
Disclosure
Disclosure
Note
Note
Note
Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide
13-25
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:
GENERAL JOURNAL
15
Page:
Date
McGraw-Hill/Irwin
Description
Debit
Warranty Expense
Estimated Warranty Liability
$$$
Credit
$$$
Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide
13-26
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.
McGraw-Hill/Irwin
Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide
13-27
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.
McGraw-Hill/Irwin
Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide
13-28
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.
McGraw-Hill/Irwin
Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide
13-29
Subsequent Events
Events occurring between the year-end date
and report date can affect the appearance of
disclosures on the financial statements.
Cause of Loss Contingency
Fiscal Year Ends
McGraw-Hill/Irwin
Clarification
Financial Statements
Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide
13-30
Unasserted Claims and
Assessments
End
No
Is a claim or
assessment
probable?
Yes
Disclosure
claim or
assessment
McGraw-Hill/Irwin
No
Can amount
be estimated?
Yes
Record
estimated claim
or assessment
Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide
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.
McGraw-Hill/Irwin
Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide
13-32
End of Chapter 13
You said that I will owe
you $1,000,000 if I miss
the next putt.
So does that mean I
have to disclose a
contingent loss on my
personal financial
statement?
McGraw-Hill/Irwin
Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved.