Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA 13-1 Chapter 13 Current Liabilities and Contingencies

13-2 Characteristics of Liabilities Result from past transactions or events. Arise from present obligations to other entities. Probable future sacrifices of economic benefits.

13-3 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.

13-4 Current Liabilities Short-term notes payable Accrued expenses Cash dividends payable Taxes payable Accounts payable Unearned revenues

13-5 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.

13-6 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.

13-7 Liabilities from Advance Collections  Refundable deposits  Advances from customers  Gift cards  Collections for third parties  Refundable deposits  Advances from customers  Gift cards  Collections for third parties

13-8 A Closer Look at the Current and Noncurrent Classification Debt that is callable by the lender in the coming year (or operating cycle, if longer) should be classified as a current liability, even if the debt is not expected to be called. Current maturities of long-term obligations usually are reclassified and reported as current liabilities if they are payable within the upcoming year (or operating cycle, if longer than a year).

13-9 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 if two conditions are met:  It has the intent to refinance on a long-term basis.  It has demonstrated the ability to refinance. and

13-10 Loss Contingencies A loss contingency is an existing uncertain situation involving potential loss depending on whether some future event occurs. 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.

13-11 Loss Contingencies A loss contingency is accrued only if a loss is probable and the amount can reasonably be estimated.

13-12 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: Warranty expense $,$$$ Estimated warranty liability $,$$$ To accrue warranty expense.

13-13 Extended Warranty Contracts  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.

13-14 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.

13-15 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.

13-16 Subsequent Events Events occurring between the fiscal year-end date and report date can affect the appearance of disclosures on the financial statements. Fiscal Year EndsFinancial Statements ClarificationCause of Loss Contingency

13-17 Subsequent Events Events occurring after the year-end date but before the financial statements can also affect the appearance of disclosures on the financial statements. Fiscal Year EndsFinancial Statements ClarificationCause of Loss Contingency

13-18 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.

13-19 Gain Contingencies As a general rule, we never record GAIN contingencies. Note that the prior rules have supported the recording of LOSS contingencies.

13-20 End of Chapter 13