Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Current Liabilities and Contingencies 13 Insert Book Cover Picture

13-2 Learning Objectives Define liabilities and distinguish between current and long-term liabilities.

13-3 Liabilities... Resulting from past transactions or events.... Arising from present obligations to other entities... Probable future sacrifices of economic benefits...

13-4 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.

13-5 Current Liabilities Short-term notes payable Accrued expenses Cash dividends payable Taxes payable Accounts payable Unearned revenues

13-6 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.  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.

13-7 Credit Lines Prearranged agreements with a bank that allow a company to borrow cash without following normal loan procedures and paperwork.

13-8 Learning Objectives Account for the issuance and payment of various forms of notes and record the interest on notes.

13-9 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.

13-10 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.

13-11 Interest-Bearing Notes 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

13-12 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. ×× ×× = =

13-13 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.

13-14 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.

13-15 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.

13-16 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.

13-17 Short-Term Notes Payable Noninterest-Bearing  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.

13-18 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 Short-Term Notes Payable Noninterest-Bearing

13-19 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? Short-Term Notes Payable Noninterest-Bearing

13-20 Learning Objectives Characterize accrued liabilities and liabilities from advance collection and describe when and how they should be recorded.

13-21 Liabilities from Advance Collections  Refundable Deposits  Advances from Customers  Collections for Third Parties  Refundable Deposits  Advances from Customers  Collections for Third Parties

13-22 Learning Objectives Determine when a liability can be classified as a noncurrent obligation.

13-23 The ability to refinance on a long-term basis can be demonstrated by:  An existing refinancing agreement, or  By 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  By 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

13-24 Learning Objectives Identify situations that constitute contingencies and the circumstances under which they should be accrued.

13-25 Contingencies A loss contingency is an existing uncertain situation involving potential loss depending on whether some future event occurs.

13-26 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.

13-27 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.

13-28 Contingencies A loss contingency is accrued only if a loss is probable and the amount can reasonably be estimated.

13-29 Learning Objectives Demonstrate the appropriate accounting treatment for contingencies, including unasserted claims and assessments.

13-30 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:

13-31 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.

13-32 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.

13-33 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.

13-34 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

13-35 Unasserted Claims and Assessments Is a claim or assessment probable? EndEnd Can amount be estimated? No Yes No Disclosure of claim or assessment Yes Record estimated claim or assessment

13-36 Gain Contingencies As a general rule, we never record GAIN contingencies. Note that the prior rules have supported the recording of LOSS contingencies.

13-37 Appendix 13 Payroll-Related Liabilities

13-38 Employers incur several expenses and liabilities from having employees. Payroll-Related Liabilities

13-39 FICA Taxes Medicare Taxes Federal Income Tax State and Local Income Taxes Voluntary Deductions Gross Pay Net Pay Payroll-Related Liabilities

13-40 FICA Taxes Medicare Taxes 6.2% of the first $90,000 earned in the year. 1.45% of all wages earned in the year. Employers must pay withheld taxes to the Internal Revenue Service (IRS). Employee FICA Taxes Federal Insurance Contributions Act (FICA)

13-41 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 Employee Income Taxes

13-42 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 Employee Voluntary Deductions

13-43 FICA Taxes Medicare Taxes Federal and State Unemployment Taxes Employers pay amounts equal to that withheld from the employee’s gross pay. Employer Payroll Taxes

% 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 (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 (SUTA) Federal and State Unemployment Taxes

13-45 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.

13-46 End of Chapter 13