Chapter 13
CURRENT LIABILITIES
AND CONTINGENCIES
McGraw-Hill /Irwin
© 2009 The McGraw-Hill Companies, Inc.
Slide 2
Characteristics of Liabilities
Probable
future
sacrifices of
economic
benefits . . .
. . . Arising
from
present
obligations
to other
entities . . .
...
Resulting
from past
transactions
or events.
13-2
Slide 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.
13-3
Slide 4
Current Liabilities
Accounts
payable
Taxes
payable
Unearned
revenues
Cash dividends
payable
Current
Liabilities
Accrued
expenses
Short-term
notes payable
13-4
Slide 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.
• Credit lines
Prearranged agreements with a bank that
allow a company to borrow cash without
following normal loan procedures and
paperwork.
13-5
Slide 6
Interest
Interest on notes is calculated as follows:
Face
Amount
Amount
borrowed
×
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.
13-6
Slide 7
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.
GENERAL JOURNAL
56
Page:
Date
Description
Sept. 1 Cash
Notes Payable
To record receipt of short-term
loan proceeds from Cooke
Bank
PR
Debit
Credit
80,000
80,000
13-7
Slide 8
Interest-Bearing Notes
How much interest is due to Cooke
Bank at year-end, on December 31?
a.
b.
c.
d.
$2,400
$3,600
$7,200
$87,200
Interest is calculated as:
Face
Annual
× Rate
Amount
×
$80,000
×
×
9%
Time to
=
maturity
4/12
=
$2,400 interest due to Cooke Bank.
13-8
Slide 9
Interest-Bearing Notes
Assume Eagle Boats’ year-end is December 31.
Record the necessary adjustment at year-end.
GENERAL JOURNAL
28
Page:
Date
Description
Dec. 31 Interest Expense
Interest Payable
to accrue interest on note due
to Cooke Bank
PR
Debit
Credit
2,400
2,400
13-9
Slide 10
Interest-bearing Notes
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
PR
Debit
Credit
2,400
1,200
80,000
83,600
13-10
Slide 11
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.

13-11
Slide 12
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
13-12
Slide 13
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%
13-13
Slide 14
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.
Normally, commercial paper is issued directly to the
lender and is backed by a line of credit with a bank.
Commercial paper is recorded in the
same manner as notes payable.
13-14
Slide 15
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.
13-15
Slide 16
Liabilities from Advance Collections
Refundable Deposits
 Advances from Customers
 Collections for Third Parties

13-16
Slide 17
A Closer Look at the Current and
Noncurrent Classification
Current maturities of long-term obligations are
usually 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 (due on demand) by the
lender in the coming year, (or operating cycle, if
longer than a year) should be classified as a
current liability, even if the debt is not expected to
be called.
13-17
Short-Term Obligations Expected
to be Refinanced
Slide 18
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.
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.
13-18
Slide 19
Contingencies
A loss contingency is an
existing uncertain situation
involving potential loss
depending on whether
some future event occurs.
13-19
Slide 20
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.
13-20
Slide 21
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.
13-21
Slide 22
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.
13-22
Slide 23
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
Description
Debit
Warranty Expense
Estimated Warranty Liability
$$$
Credit
$$$
13-23
Slide 24
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.
13-24
Slide 25
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.

13-25
Slide 26
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.

13-26
Slide 27
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
Clarification
Financial Statements
13-27
Slide 28
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.
13-28
Slide 29
Gain Contingencies
Note that the prior rules have
supported the recording of LOSS
contingencies.
As a general rule, we
never record GAIN
contingencies.
13-29