McGraw-Hill /Irwin© 2009 The McGraw-Hill Companies, Inc. CURRENT LIABILITIES AND CONTINGENCIES Chapter 13

Slide Characteristics of Liabilities... Resulting from past transactions or events.... Arising from present obligations to other entities... Probable future sacrifices of economic benefits...

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

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 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 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 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. Notes without a stated interest rate carry an implicit, or effective rate. The face of the note includes the amount borrowed and the interest.

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

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?

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. 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.

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

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.

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. 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. 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.

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 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 entry:

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 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. 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.

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.