Prepared by Gabriela H. Schneider, CMA; Grant MacEwan College INTERMEDIATE ACCOUNTING INTERMEDIATE ACCOUNTING Sixth Canadian Edition KIESO, WEYGANDT, WARFIELD, IRVINE, SILVESTER, YOUNG, WIECEK

C H A P T E R 14 Current Financial and Other Liabilities

Learning Objectives 1. Define liabilities and differentiate between financial and other liabilities. 2. Define current liabilities, describe how they are valued, and identify common types of current liabilities. 3. Explain the classification issues of short-term debt expected to be refinanced. 4. Identify and account for the major types of employee-related liabilities.

Learning Objectives 5. Explain the accounting for common estimated liabilities. 6. Explain the accounting and reporting standards for loss contingencies. 7. Indicate how financial and other current liabilities and contingencies are presented and analysed.

Current Financial and Other Liabilities Liabilities Financial liabilities Presentation and Analysis Current liabilities Contingencies Analysis of current liabilities Current Liabilities Accounts payable Notes payable Current maturities of long-term debt Short-term refinancing Dividends payable Returnable deposits Unearned revenues Sales taxes Goods & services tax Property taxes Income taxes Employee-related liabilities Rents and royalties Contingencies Types of contingencies Litigation, claims assessments Guarantee & warranty costs Premiums and coupons Environmental liabilities Self-insurance risks Estimated Liabilities Guarantee and warranty obligations Premiums and coupons

Liabilities in General Liabilities are: Probable future sacrifices of economic benefits Arising from past transactions or events To transfer assets or to provide services in the future Defined in Section 1000 of CICA Handbook

Liabilities in General Three essential characteristics of a liability 1.Obligation to be settled on a determinable date or on the occurrence of an event, requiring the transfer or use of an asset or provision of a good or service 2.There is little or no opportunity to avoid the obligation 3.Obligation arises from a transaction or event which has already occurred

Financial Liabilities Obligation to deliver cash or other financial asset Key distinction is the measurement at historic cost (financial liability) and fair value (non-financial liability)

Current Liabilities Important for a business to manage liabilities for: their effect on liquidity investor & creditor perceptions future funding opportunities A current liability is defined as: “Amounts payable within one year from the date of the balance sheet or within the normal operating cycle where this is longer than a year.”

Current Liabilities Sales taxes payable Goods and Services Tax Property taxes payable Income taxes payable Employee-related liabilities Rents and royalties payable Accounts Payable Notes payable Current maturities of long-term debt Short-term obligations expected to be refinanced Dividends payable Returnable deposits Unearned revenues Common current liabilities encountered include:

Notes Payable Notes payable may be interest-bearing or zero-interest-bearing (non-interest-bearing) In both cases interest expense is accrued whenever financial statements are prepared For zero-interest-bearing notes, the difference between the present value of the note and the face value of the note represents the discount on the note payable The discount is the interest expense chargeable to future periods

Interest-Bearing Notes Payable Given: Landscape Corp. borrows $100,000 Signs a 4-month, 12 percent note on March 1 Journal Entries: March 1: Cash100,000 Notes Payable 100,000 July 1: Notes Payable 100,000 Interest Expense 4,000 Cash 104,000 (100,000 * 4% * 4/12)

Zero-Interest-Bearing Notes Payable Journal Entries: March 1: Cash96,293 Discount on Note Payable 3,707 Notes Payable 100,000 PV of $100,000 where n=4/12, i=12% = $96,293 Given: Landscape Corp. borrows $100,000 Signs a 4-month, zero- interest-bearing note on March 1 The current market rate on similar notes is 12 percent July 1: Notes Payable 100,000 Interest Expense 3,707 Discount on N/P 3,707 Cash 100,000

Current Maturities of Long-Term Debt The portion of long-term debt maturing within the next fiscal year is reported as a current liability Long-term debts should not be reported as current liabilities if: 1. they are retired by assets not classified as current assets 2. they are refinanced or retired by new issues of debt, or converted into share capital Any liability due on demand is reported as a current liability

Short-Term Obligations Expected to be Refinanced Short-term debt must be excluded from current liabilities if: there is intent to refinance on a long-term basis, and the entity demonstrates the ability to complete the refinancing The entity has the ability to refinance if: the debt is actually refinanced before issue of the financial statements, or the entity enters into a refinancing agreement

Employee-Related Liabilities Employee-related liabilities are the following: salaries or wages owed to employees at end of the accounting period payroll deductions compensated absences Bonuses Reported as current liabilities

Employee Payroll Deductions Payroll deductions include statutory and discretionary deductions Statutory (mandatory) deductions include: Canada (Quebec) Pension Plan [CPP/QPP] Employment Insurance (EI) Income Tax Withholding (Federal and Provincial) Discretionary deductions might include: Medical insurance Union dues

Employee Compensated Absences Compensated absences are absences from employment for which employees are paid A liability for such absences must be accrued if: employer’s liability relates to services already rendered by employees the liability relates to employee’s vested or accumulated rights payment of the compensation is probable, and the amount can be reasonably estimated. The liability is recognized in the year it is earned by employees

Guarantee and Warranty Obligations Warranty - promise made by a seller to a buyer to make good on a deficiency (quantity, quality or performance) Warranties entail future “post-sale costs” Two methods of accounting for warranty costs – Cash Basis – Accrual Basis Extended warranty revenues are deferred and recognized over the life of the warranty contract

Guarantee and Warranty Obligations Warranty costs charged to the period in which the costs are paid Acceptable for accounting purposes when: –Not likely a liability exists, or –Liability amount cannot be estimated Acceptable for income tax purposes Used when the warranty is integral and inseparable part of the sale Warranty expense recognized in the year of sale (based on estimate) Warranty liability reported for the estimated amount of outstanding claims Cash BasisAccrual Basis

Guarantee and Warranty Costs: Example Given: Units sold in 2000: 10,000 units at $300 Expected return rate for repair: 3% Expected repair cost per unit: parts, $5; labor, $10 Units returned in 2001: 170 units Actual repair costs: same as estimated The entity has the calendar year as its fiscal year Record the warranty expense for 2000

Guarantee and Warranty Costs: Example Estimated warranty costs: 3% of 10,000 units at $15 each = $4,500 Adjusting journal entry (Dec 31, 2000): Warranty Expense4,500 Estimated Warranty Liability4,500 Entry in 2001 (170 units at $15 each): Estimated Warranty Liability 2,550 Parts Inventory 850 Accrued Payroll 1,700

Extended Warranties: Example Refer to the previous example. Assume that the seller sold extended warranties on the 4,000 units as follows: $30 per unit for years 2002 and 2003 Record the sale in 2000 and show recognition of warranty revenue in 2002

Extended Warranties: Example Journal entry in 2000: Cash 3,120,000 Sales Revenue 3,000,000 Unearned Warranty Revenue 120,000 Journal entry in 2002: (relating to year 2000 sales) Unearned Warranty Revenue 60,000 Warranty Revenue 60,000 (1/2 of deferred revenue now recognized)

Contingency: Definition A contingency is (CICA Handbook, Section 3290): An existing condition or situation involving uncertainty as to possible gain (gain contingency) or loss (loss contingency)… that will ultimately be resolved when one or more future events occur or fail to occur

Loss Contingencies: General Loss contingencies involve situations of possible loss A liability incurred as a result of a loss contingency is a contingent liability The likelihood of occurrence of the event may be: Likely (high chance of occurrence) Unlikely (remote chance of occurrence) Not determinable (a chance or likelihood of the event occurrence cannot be determined)

Loss Contingencies: Accrual Estimated losses from loss contingencies are accrued as liabilities if both of the following conditions are met: it is likely that a liability has been incurred, and the amount of loss can be reasonably estimated It is not necessary that the exact payee or the exact date of payment be known

Gain Contingencies Gain contingencies are claims or rights to receive assets; these claims or rights may eventually become valid Examples are: Pending litigation whose probable outcome is favourable Possible tax refunds in tax disputes Gain contingencies are not accrued (conservatism)

Accounting and Reporting Standard for Loss Contingencies * Disclose the nature of the contingency and either an estimate of the amount or an explanation that an estimate cannot be made Notes* Not Determinable No Disclosure Not Likely Accrue NotesLikely Loss can be reasonably estimated? Yes No Probability

Litigation, Claims, and Assessments To determine whether a liability should be recorded, evaluate: the time period in which the underlying cause of action occurred the probability of an unfavourable outcome the ability to make a reasonable estimate of loss To determine the probability of a possible outcome, evaluate: nature of litigation and progress of case opinion of legal counsel response by management

Environmental Liabilities Environmental liabilities represent estimated costs to clean-up waste and toxic sites CICA Handbook, Section 3061 requires that companies must accrue the minimum expected cost (if reasonably determinable) If not, then a contingent liability may be required

Analysis of Current Liabilities Current Ratio: Current Assets_ Current Liabilities Acid-Test Ratio: Cash+Marketable securities + Net Receivables Current Liabilities

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