CURRENT LIABILITIES AND CONTINGENCIES Topic 1

Slide Characteristics of Liabilities Statement of Accounting Concepts #6 Para Resulting from past transactions or events.... Arising from present obligations to other entities... Probable future sacrifices of economic benefits... Not defined in FASC.

Slide What is a Current Liability? LIABILITIES Long-term Liabilities Expected to be satisfied with current assets or by the creation of other current liabilities. Current Liabilities Obligations payable within one year or one operating cycle, whichever is longer

Slide Current Liabilities Short-term notes payable Accrued expenses Cash dividends payable Taxes payable Accounts payable Unearned revenues Wages & Benefits Payable

Slide Current Ratio This ratio measures the ability of the company to pay current debts as they become due. As a rule of thumb, a current ratio of 2.0 is considered indicative of adequate liquidity. Current Ratio Current Assets Current Liabilities =

Slide Acid-Test Ratio Quick Assets Current Liabilities = Acid-Test Ratio Quick assets are Cash (including temporary cash investments) and Accounts Receivable. This ratio provides information about an almost worst-case situation—the firm’s ability to meet its current obligations even if none of the inventory can be sold. As a rule of thumb, an acid-test ratio of 1.0 is considered indicative of adequate liquidity.

Slide 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. 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.

Slide Interest Interest on notes is calculated as follows: Amount borrowed 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.

Slide 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.

Slide 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%. 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 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%. 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. ×× ×× = =

Slide 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.

Slide 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.

Slide Exercise 13-1 Open Excel worksheet on portal under topic 1 PDF file there has the exercises from textbook

Slide Noninterest-Bearing Notes Noninterest-Bearing Notes Imputation of 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. Notes without a stated interest rate carry an implicit, or effective rate. The face of the note includes the amount borrowed and the interest. FASC

McGraw-Hill /Irwin© 2008 The McGraw-Hill Companies, Inc In circumstances where interest is not stated, the stated amount is unreasonable, or the stated face amount of the note is materially different from the current cash sales price for the same or similar items or from the market value of the note at the date of the transaction, the note, the sales price, and the cost of the property, goods, or service exchanged for the note shall be recorded at the fair value of the property, goods, or service or at an amount that reasonably approximates the market value of the note, whichever is the more clearly determinable. That amount may or may not be the same as its face amount, and any resulting discount or premium shall be accounted for as an element of interest over the life of the note. Noninterest-Bearing Notes Noninterest-Bearing Notes Imputation of Interest – ASC Topic

Slide 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? 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 Interest = Face Amount - Amount Borrowed = $10,600 - $10,000 = $600 Noninterest-Bearing Notes 25-8 Notes exchanged for property, goods, or services are valued and accounted for at the present value of the consideration exchanged between the contracting parties at the date of the transaction in a manner similar to that followed for a cash transaction.

Slide 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? 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? 25-8 Notes exchanged for property, goods, or services are valued and accounted for at the present value of the consideration exchanged between the contracting parties at the date of the transaction in a manner similar to that followed for a cash transaction.

Slide 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. 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.

Slide 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.

Slide Vacations, Sick Days, and Other Paid Future Absences 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. 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.

Slide Liabilities from Advance Collections Refundable Deposits Advances from Customers Collections for Third Parties Refundable Deposits Advances from Customers Collections for Third Parties

Slide Exercise 13-8

Slide Gift Cards During their December 2012 Christmas promotion, MegloMart sold 20,000 gift cards at $25 each. All gift card sales were for cash. On December 31, 2012, only 1,000 gift cards had been redeemed. Unused gift cards expire on December 31, 2013, if not used to purchase MegloMart merchandise. December 31, 2012: Cash (20,000 × $25) ,000 Unearned revenue … ,000 To record cash received from gift card sales. Prepare the journal entries on December 31, 2012, to record the December 2012 sale and redemption of gift cards. December 31, 2012: Unearned revenue (1,000 × $25) ,000 Sales revenue … ,000 To record revenue from gift card redemptions.

Slide Gift Cards By December 31, 2013, 18,500 additional gift cards had been redeemed. Prepare the journal entry on December 31 to record the 2013 redemptions. On December 31, 2013, the 500 remaining cards had not been redeemed. Prepare the journal entry on December 31 to record the gift card expirations. December 31, 2013: Unearned revenue (18,500 × $25) … ,500 Sales revenue (18,500 × $25) … ,500 To record revenue from gift card redemptions. December 31, 2013: Unearned revenue (500 × $25) … ,500 Gift card breakage revenue ………..….. 12,500 To record revenue from gift card expirations.

Slide Quick question Which of the following is not a liability? A. An unused line of credit. B. Estimated income taxes. C. Sales tax collected from customers. D. Advances from customers.

Slide 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. ASC

Slide 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. ASC 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. ASC Short-Term Obligations Expected to be Refinanced 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 demonstrated the ability to refinance. and

Slide Contingencies A loss contingency is an existing uncertain situation involving potential loss depending on whether some future event occurs. FASC

Slide 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.

Slide 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. 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.

Slide Contingencies A loss contingency is accrued only if a loss is probable and the amount can reasonably be estimated.

Slide 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 adjusting journal 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 adjusting journal entry:

Slide Warranty Expenses Incurred During Period When a cost is incurred during the period between the sale and the adjusting entry to record warranty liability and expense, most firms will debit the warranty expense account and credit cash, inventory, or accounts payable depending on how repairs are made. These costs reduce the adjusting entry for the estimated liability at the end of the period. DemoProblem.docx

Slide 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.

Slide Product Warranties and Guarantees Obligations > One Year

Slide Premiums – rebates & other promotions 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. Examples of a premium are cash rebates, free giveaways, frequency awards

Slide 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.

Slide Subsequent Events Events occurring between the year-end date and report date can affect the appearance of disclosures on the financial statements. Fiscal Year EndsFinancial Statements ClarificationCause of Loss Contingency

Slide Unasserted Claims and Assessments  Is a claim or assessment probable? No Yes No disclosure needed Unasserted claim Evaluate (a) the likelihood of an unfavorable outcome and (b) whether the dollar amount can be estimated. 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.

Slide Gain Contingencies As a general rule, we never record GAIN contingencies. Note that the prior rules have supported the recording of LOSS contingencies.

U.S. GAAP vs. IFRS Liabilities payable within the coming year are classified as long ‐ term liabilities if refinancing is completed before date of issuance of the financial statements. Liabilities payable within the coming year are classified as long ‐ term liabilities if refinancing is completed before the balance sheet date. Classification of Liabilities to be Refinanced

U.S. GAAP vs. IFRS 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. 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. Contingencies

Slide Employers incur several expenses and liabilities from having employees. Appendix 13 ─ Payroll-Related Liabilities

Slide FICA Taxes Medicare Taxes Federal Income Tax State and Local Income Taxes Voluntary Deductions Gross Pay Net Pay Payroll-Related Liabilities

Slide 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. Federal Income Tax State and Local Income Taxes Employees’ Withholding Taxes

Slide FICA Taxes Medicare Taxes 4.2% of the first $110,100 earned in the year. 1.45% of all wages earned in the year. Employers must pay withheld taxes to the Internal Revenue Service (IRS). Employees’ Withholding Taxes Federal Insurance Contributions Act (FICA)

Slide Amounts withheld depend on the employee’s request. 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. Voluntary Deductions

Slide FICA Taxes Medicare Taxes Federal and State Unemployment Taxes Employers pay amounts equal to that withheld from the employee’s gross pay. Employers’ Payroll Taxes

Slide % 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 Act (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 Act (SUTA) Federal and State Unemployment Taxes

Slide 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.