Chapter 13: Current Liabilities and Contingencies Sid Glandon, DBA, CPA Assistant Professor of Accounting

2 Liability FASB Concepts Statement #6 – Present obligation Probable future transfer or use of cash, goods, or services – Unavoidable obligation – Transaction or event has already occurred

3 Current Liabilities Obligations whose liquidation will require – Use of current assets or – Creation of other current liabilities

4 Examples of Current Liabilities Accounts payable – Purchases on open account in the normal course of business Notes payable – Interest bearing – Zero-interest-bearing Current maturities of long-term debt

5 Line of Credit (Interest-Bearing Note) Spencer Company took out a line of credit with the Bank of the West on April 1, 2004 for $100,000. The term is six months and the interest rate is 9%. Prepare the journal entries to record: – The issuance of the line of credit – The payment of the line of credit

6 Line of Credit (Interest-Bearing Note)

7 Noninterest-Bearing Note Spencer Company took out borrowed $100,000 from Bank of the West on April 1, The instrument was a zero-interest bearing note for six months at 9% interest. Prepare the journal entries to record: – The issuance of the zero-interest bearing note – The payment of the zero-interest bearing notes

8 Noninterest-Bearing Note

9 Short-Term Obligations Expected to be Refinanced Refinancing criteria – Must intend to refinance the obligation on a long- term basis, and – Must demonstrate an ability to consummate the refinancing Actual refinancing after balance sheet date Entering into a financing agreement

10 Other Current Liabilities Dividends payable Returnable deposits Unearned revenues Sales taxes payable Property taxes payable Income taxes payable

11 Sales Taxes Payable Spencer Company has sales for the month of March 2004 of $150,000. All sales are subject to a 6.5% state sales tax and a 0.5% local sales tax. Prepare the journal entries: – To record sales – To record the payment of sales taxes

12 Sales Taxes Payable

13 Contingencies, SFAS #5 “An existing condition, situation, or set of circumstances involving uncertainty as to possible gain or loss to an enterprise that will ultimately be resolved when one or more future events occur or fail to occur”

14 Gain Contingencies Based on the constraint of conservatism gain contingencies are not recorded until resolved Under certain circumstances such contingencies may be disclosed in the notes to the financial statements

15 Loss Contingencies Likelihood that liability exists – Probable confirming event is likely to occur – Reasonably possible the chance that a confirming event will occur is more than remote but less than likely – Remote The chance the confirming event will occur is slight.

16 Loss Contingencies Criteria for recording – It is probable that a liability has been incurred at the balance sheet date, and – The loss is reasonably estimated Criteria for disclosing – If it is reasonably possible that a liability has been incurred at the balance sheet date, and – The loss is reasonably estimated

17 Contingent Liability

18 What amount of loss should the company accrue at December 31, 2003? A.$0 B.$250,000 C.$400,000 D.$500,000

19 What amount of loss should the company accrue at December 31, 2003?

20 Guarantee and Warranty Costs Cash basis – Not GAAP but used for tax purposes Accrual basis – Expense warranty approach Integral part of the sale transaction Accrue warranty in year of sale – Sales warranty approach Sold as a separate contract Extended warranties-deferred revenue

21 Warranty Expense Spencer Company sells 100 pet video units for $500 per unit during The video units have a three-year warranty covering parts and labor. Based on past experience management estimates that warranty costs will be $10 in the first year, $20 in the second year and $25 in the third year. During 2003 the company incurs $900 in warranty costs.

22 Prepare the Journal Entry to Record Sales and Warranty Expense for 2003

23 Prepare the Journal Entry to Record Warranty Costs Incurred During 2003

24 Employee-Related Liabilities Payroll deductions – Payroll expense – Payroll tax expense Compensated absences – Services already rendered – Rights vested or accumulated – Compensation is probable – Amount is reasonably estimated Bonus Agreements

25 Gross Payroll

26 Journal Entry to Record Gross Payroll

27 Payroll Taxes

28 Journal Entry to Record Payroll Taxes