Current Liabilities and
Contingencies
I N T ERMEDIATE ACCOU N T I NG I I
CHA PT ER 1 3
CHARACTERISTICS OF LIABILITIES
A liability is a present obligation to sacrifice assets in the
future because of something that already has occurred.
 A liability has three essential characteristics.
Liabilities:
1. are probable, future sacrifices of economic benefits
2. arise from present obligations (to transfer goods or provide services) to other
entities
3. result from past transactions or events
 Most liabilities obligate the debtor to pay cash at specified times and result from
legally enforceable agreements.
 Some liabilities are not contractual obligations and may not be payable in cash.
CURRENT LIABILITIES
Classifying liabilities as either current or long-term helps investors and
creditors assess the relative risk of a company’s liabilities.
 Generally, current liabilities are payable within one year.
 Current liabilities are expected to require current assets (or create
current liabilities).
 Conceptually, liabilities should be recorded at their present values, but
ordinarily are reported at their maturity amounts.
SOME COMMON CURRENT LIABILITY ACCOUNTS
 Accounts Payable – obligations to suppliers of merchandise or services purchased on open
account; generally payable within 30-60 days of the purchase
 Trade Notes Payable – similar to accounts payable but are formally recognized by a written
promissory note
 Short-term Notes Payable – is created when a company borrows cash from a financial
institution by signing a formal promissory note with a stated maturity date and interest
charges; due within one year or less
 Interest Payable – an account used to record interest charges that have accrued but have not
yet been paid
 Salaries/Wages Payable – an account used to record amounts earned by employees that not
yet been paid; generally only used for adjusting entries at the end of the accounting period
 Sales Tax Payable – an account used to record amounts due to federal and state tax agencies
but not yet paid
ACCRUED LIABILITIES
 Liabilities accrue for expenses that are
incurred, but not yet paid.
 Recorded by adjusting entries at the end of
the reporting period, prior to preparing
financial statements.
 Common examples are: salaries and wages
payable, income taxes payable, and interest
payable.
LINE OF CREDIT
A line of credit allows a company to borrow cash without having to follow formal
loans procedures and fill out loan paperwork each time the cash is needed.
 Noncommitted Line of Credit – an informal agreement that permits a company to
borrow up to a prearranged limit without having to follow formal loan procedures and
paperwork.
 Committed Line of Credit – a more formal agreement that usually requires payment of
a commitment fee to the bank
 Compensating Balance – a deposit kept by a company in an account at the bank; the
required deposit is usually a small percentage of the line of credit limit.
The establishment of a line of credit does not require a journal entry.
However, a disclosure note should be included with the financial statements
describing the details of the line of credit.
COMMERCIAL PAPER
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Unsecured note
Minimum denomination of $25,000
Fixed maturity between 30 and 270 days
Lower-cost alternative to line of credit
Only sold by blue-chip companies (large, highly-rated firms)
Interest is often discounted at the issuance of the note
Accounted for in the same manner as a note
In this context, discounting interest means that the interest is paid “up front”
when the note is issued.
Brief Exercise 13–1, page 772
Date
Oct 1
Account
Cash
Debit
60,000,000
Notes Payable
Dec 31
Interest Expense
60,000,000
1,800,000
Interest Payable
Jun 1
Credit
Notes Payable
1,800,000
60,000,000
Interest Payable
1,800,000
Interest Expense
3,600,000
Cash
65,400,000
2013 interest expense ($60,000,000 x 12% x 3/12) = $1,800,000
2014 interest expense ($60,000,000 x 12% x 6/12) = $3,600,000
Brief Exercise 13–4, page 772
Date
Mar 1
Account
Cash
Debit
11,190,000
Discount on Notes Payable
810,000
Notes Payable
Nov 1
Interest Expense
12,000,000
810,000
Discount on Notes Payable
Nov 1
Credit
Notes Payable
810,000
12,000,000
Cash
Discount ($12,000,000 x 9% x 9/12) = $810,000
12,000,000
EFFECTIVE INTEREST RATE
Interest rate actually incurred on proceeds received from financing.
When notes are discounted, the effective interest rate will be higher than the stated
interest rate.
For a discounted note, calculate as follows:
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
Discount/Cash Proceeds = Effective Interest for Note Period
Effective Interest for Note Period/Note Period X 12 = Annual Effective Interest Rate
Effective Interest Calculation – Using Data From Brief Exercise 13–4, page 772
Date
Mar 1
Account
Cash
Debit
Credit
11,190,000
Discount on Notes Payable
810,000
Notes Payable
$810,000/11,190,000 = .072386 / 9 X 12 = .0965136
9.65% (rounded)
12,000,000
CUSTOMER ADVANCES AND
THIRD PARTY COLLECTIONS
 A customer advance produces an obligation that is satisfied when
the product or service is provided. A customer advance occurs
when a company collects cash from a customer as a refundable
deposit or as an advance payment for productions or services.
 A third-party collection occurs when the business collects funds
on behalf of another agency.

CUSTOMER ADVANCES AND
THIRD PARTY COLLECTIONS
Customer Advances
 Unearned revenue
• Record unearned revenue liability when pre-payment is received
• Reduce the liability and recognize the revenue as the product is provided or service is
rendered
 Gift Cards/Certificates
• Record gift card liability when the card is sold
• Reduce the liability and recognize the revenue when the gift card is redeemed or expires
• Reduce the liability and recognize the revenue if the probability of redemption is viewed as
remote

Collections for third parties
 Sales taxes collected from customers represent liabilities until remitted
 Payroll-related deductions such as withholding taxes are liabilities until remitted
• Record a liability (payable) when the collection occurs
• Reduce the liability when payment is remitted to the appropriate agency
Example – Customer Advances
Tomorrow Publications collects magazine subscriptions from customers at the time subscriptions are
sold. Subscription revenue is recognized over the term of the subscription. On October 1,Tomorrow
collected $20 million in subscription sales. At December 31, the average subscription was one-fourth
expired.
Date
Oct 1
Account
Cash
Debit
20,000,000
Unearned Subscriptions Revenue
Dec 31
Unearned Subscriptions Revenue
Subscriptions Revenue
Credit
20,000,000
5,000,000
5,000,000
Subscriptions Revenue Earned: ($20,000,000 x 3/12) = $5,000,000
Example – Third Party Collections
Pet Depot sold goods for $6,000 cash on August 1. The sale was subject to a 10% state sales tax. On
October 15, Pet Depot remitted the sales tax collected to the state revenue agency.
Date
Aug 1
Account
Cash
Debit
Credit
6,600
Sales Revenue
6,000
Sales Tax Payable
Oct 15
Sales Tax Payable
600
600
Cash
Only the revenue portion of the August 1 sale was recorded; Cost of
Goods sold was ignored for purposes of this example.
600
CONTINGENCIES
When an uncertainty exists as to whether an obligation actually
exists that will be resolved only when some future event or outcome
occurs (or not).
CONTINGENCY STANDARDS
 Probable – likely to occur
 Reasonably possible – more than remote but
less than probably
 Remote – unlikely or slight chance
LOSS CONTINGENCIES
A loss contingency involves an existing uncertainty as to whether a loss really
exists, where the uncertainty will be resolved only when some future event occurs.
 The cause of the uncertainty must occur before the statement date; otherwise,
regardless of the likelihood of the eventual outcome, no liability could have
existed at the statement date.
 Contingent liabilities deemed to be reasonably possible or probable but the
amount is not reasonably estimable should be disclosed in a note to the financial
statements.
 Contingent liabilities deemed to be remote do not require any disclosure.
 A liability is accrued if it is both (a) probable that the confirming event will
occur and (b) the amount can be at least reasonably estimated:
Loss (or expense)
Liability
x,xxx
x,xxx
GAIN CONTINGENCIES
 Uncertain situations that might result in a gain.
 Gain contingencies are not accrued.
 Desirable to anticipate losses, but recognizing gains
should await their realization.
 Should be disclosed in notes to the financial
statements.
 Care should be taken that the disclosure note not
give "misleading implications as to the likelihood
of realization."
UNASSERTED CLAIMS
 A claim has not yet been made or a lawsuit has not yet been
filed.
 First, determine if the claim is probable.
 If not probable, no accrual or disclosure is required.
 If the claim is probable, evaluate the likelihood of an
unfavorable outcome and whether the dollar amount can be
estimated.
 Must meet the probable/reasonably estimable criteria.
 If both criteria are met, a liability should be accrued.
 If one of the criteria are met and there is a reasonable
possibility that the loss will occur, a disclosure note should
describe the contingency.
PRODUCT WARRANTIES
A written guarantee, issued to the purchaser of an article by its
manufacturer, promising to repair or replace it if necessary
within a specified period of time.
 The contingent liability for product warranties is almost
always accrued.
 Warranty estimates are often based on past experience.
 The liability is recognized in the period in which the
product associated with the warranty is sold.
Brief Exercise 13–12, page 773
Exercise adjustment: Assume a one-year rather than five-year warranty period
Date
Account
Warranty Expense
Debit
Credit
150,000
Estimated Warranty Liability
150,000
(15,000,000 X 1%)
To record estimated warranty liability.
Nov 1
Estimated Warranty Liability
Cash (etc)
20,000
20,000
Based on the exercise assumption, an estimated warranty liability of $130,000
will appear as a current liability on the balance sheet for the current period.
If the warranty were recorded for the original five-year period, the “expected
cash flow approach” reporting the present value of the expected cash flows as
the liability would provide the most reliable accounting information.
Current Liabilities and
Contingencies
I N T ERMEDIATE ACCOU N T I NG I I - CHA PT ER 1 3
E N D OF P R ESENTATION