1. Chapter 08 Current Liabilities

2. Participation Questions – Chapter 8  Which publicly traded company was showing a negative working capital in their 2012 financial results? Southwest Airlines; Eastman Kodak; Apple Computers; or Ford Motors  Current liabilities are usually due in more than one year. True or False  What account is “air traffic liability” shown on Southwest Airlines balance sheet similar to? Sales tax payable; Deferred taxes; Unearned revenue; or Accounts Payable  Which public company did we review the contingent liabilities for in class? Southwest Airlines; Target; Apple Computers; or Eastman Kodak  Which publicly traded company was included as an example for their warranty payable estimate? Southwest Airlines; Eastman Kodak; Apple Computers; or Ford Motors

3. Announcements  Exam Results Average 71% Exam reviews – Webcourses, Calendar, Scheduler  Excel Grade Calculator – Exam 2 Wrap-up Module at the start of Block 3 modules  Assignments – Due 11/15/15 SEC Project #2 (Webcourses) – 1 attempt Chapter 8 Homework (Connect) – unlimited attempts Participation questions for Chapter 8 (Webcourses) – 1 attempt  Syllabus Quiz #2 - Available now – Due 11/22/15  Exam 2 – Most missed questions

4. SEC Assignment #2  What – answer questions about JC Penny and Apple Computers Financial statement numbers Notes to the financial statement  Why – practice accessing information about publicly traded companies and to be able to apply the information we are learning.  How graded – multiple choice.

5. Questions to be Answered Overall - What is financial reporting’s role in today’s American society? If there was no systematic way of producing financial reporting, how different might our society look? - A few large monopolies that are self-funded - Only small entities because lending and investing would be minimal - How might our lives be different? Chapter 8 – How are currently liabilities used in an organization to finance the operating cycle – how do they impact the financial statements?

6. Chapters 8 Current Liabilities are used to fund current assets in support of the operating cycle. Current Portion Long-term Debt Warranty Payable/Expense Sales Tax Payable Contingent Liability (Loss) Deferred Taxes Payable (Tax Exp.) Expenses Current Liabilities

7. Part A Current Liabilities 8-7

8. Current Liabilities – What are we Doing? Review the different current liabilities (Known and Estimated) to understand the following for each account type: Purpose Calculation Impact to Balance Sheet Impact to Income Statement

9. Operating Cycle (Activities)

10. Why are Current Liabilities Important? Working Capital – Informational purposes only – not on exam A measure of both a company's efficiency and its short-term financial health. The working capital ratio is calculated as: Working Capital Ratio = Current Assets / Current Liabilities This ratio indicates whether a company has enough short term assets to cover its short term debt. Anything below 1 indicates negative W/C (working capital). While anything over 2 means that the company is not investing excess assets. Most believe that a ratio between 1.2 and 2.0 is sufficient.

11. Brunswick – Boats & Engines

13. Eastman Kodak

15. Current Liabilities Liability - A present responsibility to sacrifice assets in the future due to a transaction or other event that happened in the past. oCurrent liabilities are usually, but not always, due within one year. oNote: If a company has an operating cycle longer than one year, its current liabilities are defined by the operating cycle rather than by the length of a year. 8-15

16. Current vs. Long-Term Liabilities LIABILITIES Payable within one year With in the company LONG-TERM Payable more than one year CURRENT 8-16

17. Current Liabilities  Obligations due within one year  Two types: 17 Known Amounts Accounts Payable Notes Payable Sale Tax Payable Unearned Revenue Current Portion Long- term Debt Deferred Taxes Estimated Amounts Contingencies Losses Warranty Payable Gains http://abcnews.go.com/topics/news/toyota- recall.htm?mediatype=Video

18. Current Liabilities: Known Amount  Accounts payable Amounts owed for products or services purchased on account  Short-term notes payable Due within one year Used to borrow cash or purchase asset Accrue interest at the end of each period 18

19. Accounts Payable 1/1/15 - Bought inventory on Account for $15,000 2/15/15 – paid for inventory 19

20. Accounts Payable 20 JOURNAL DateAccounts and explanationDebitCredit Dec 1 Inventory15,000 Accounts Payable15,000 Purchase of Inventory on account Dec 31 Accounts Payable15,000 Cash15,000 Payment of Accounts Payable

21. Short-term Notes Payable – 12/1/15 - ABC Company borrows $30,000 to purchase equipment. Note matures in 3 months and carries an annual interest rate of 9%. Interest and principal paid at maturity. Interest = Face value x Annual interest rate x Fraction of the Yea r Formula to calculate Interest Expense Complete Journal Entries for the initial transaction, year-end, and maturity.

22. Short-Term Notes Payable 22 JOURNAL DateAccounts and explanationDebitCredit Dec 1 Equipment30,000 Note payable, short-term30,000 Purchase of Equip. using a 3-month note payable @ 9% Dec 31 Interest expense225 Interest payable225 Accrued interest on note payable (30,000 x 9% x 1/12)

23. Accounting for Short-Term Notes Payable 23 JOURNAL DateAccounts and explanationDebitCredit Mar 1 Interest expense (30,000 x 9% x 2/12) 450 Interest payable225 Note payable, short-term 30,000 Cash30,675

24. In-Class Exercise 4/1/15 $100,000 Land Purchase 20% cash payment and 80% promissory note due in 10 months with 12% annual interest Prepare journal entries for initial transaction, financial statements at 12/31/15, and at maturity.

25. LO4 Demonstrate the Accounting for other Current Liabilities oAdditional current liabilities companies report: oUnearned revenues oSales taxes payable oThe current portion of long-term debt oDeferred taxes oWe explore each of these in more detail in the following slides. 8-25

26. Unearned Revenues Business receives cash before services or products are provided to customers, therefore, company cannot recognize any revenue when cash is received. Results in a liability (repay if don’t deliver) Steps: 1. Record cash receipt and set up unearned revenue account (liability) 2. As services or products are provided and revenue is earned, an adjusting journal entry is completed to recognize revenue earned. 1. Debit unearned revenue and credit revenue account. Complete Journal Entries: 2/1 – “I am the Best DJ, Inc.” receives $300 deposit in advance for DJ for a Fraternity Party. 2/28 – Performs the best DJ services 26

27. Unearned Revenues  Business receives cash before earning revenue  Results in a liability (repay if don’t deliver) 27 JOURNAL DateAccounts and explanationDebitCredit 2/1 Cash300 Unearned revenue300 Received advance payment from customer 2/28 Unearned revenue300 Revenue300 To record earned portion of unearned revenue

28. Southwest Airlines 28 As described in Note 1 to the Consolidated Financial Statements, tickets sold for passenger air travel are initially deferred as “Air traffic liability.” Passenger revenue is recognized and air traffic liability is reduced when the service is provided (i.e., when the flight takes place). “Air traffic liability” represents tickets sold for future travel dates and estimated future refunds and exchanges of tickets sold for past travel dates.

29. Current Portion of Long-Term Debt (CPLTD) Example below – $10,000 auto loan payable over 5 years principal due in equal installments each year CPLTD Definition - Amount of principal payable within one year (12 months) When an organization takes out a long-term loan, the debt is typically paid back over multiple years – hence the name “Long-term”. We also need to recognize the portion of long-term debt that will be repaid over the next 12 months and classify it as “Current Portion LTD”. This provides a better mechanism to show decision-makers what will have to paid in the coming year.  Steps for recognizing CPLTD: Initial Transaction  Record (debit) for what is received in the long-term loan – i.e. cash, equipment, auto  Amount of principal due in the next 12 months is recorded into the CPLTD account (Credit).  Amount of principal due after the next 12 months is recorded into the LTD account (Credit). 29

30. Current Portion of Long-Term Debt (CPLTD) Example below – $10,000 auto loan payable over 5 years principal due in equal installments each year  Steps for recognizing CPLTD: Second Year and later:  Step 1: When the principal balance is paid over the next 12 months, the CPLTD account is decreased (debited) and cash is credited. Step 2 – reset balance in CPLTD account.  Credit amount of principal due in the next 12 months  Debit LTD to reduce balance in this account. 30

31. Southwest Airlines 31 http://www.sec.gov/Archives/edgar/data/92380/000119312513041608/d480533d10k.htm

32. Current Portion of Long-Term Debt –  Southwest Airlines Example if they just took out 3.154 million of LTD 32 JOURNAL DateAccounts and explanationDebitCredit 12/31 Cash3,154 Mil. Long-Term Debt2,883 Mil. Current Portion Long-Term Debt271 Mil.

33. Current Portion of Long-Term Debt oCurrently maturing portion of a long-term debt is reported as a current liability on the balance sheet. oAssume Southwest Airlines had total borrowings of $3,154 million at December 31, 2012, of which $271 million was payable in 2013 and the remaining $2,883 million is due after 2013. In its 2012 balance sheet, the company records the $3,154 million in current and long-term debt, as shown below 8-33

34. Sales Taxes Payable oCompany selling products subject to sales taxes is responsible for collecting the sales tax directly from customers and periodically sending the sales taxes collected to the state and local governments. oSales tax collection DO NOT increase revenue recognized. oSteps for when a sale is made and sales tax is collected: oRecord cash receipt or accounts receivable from sale (debit). oRecord revenue earned (credit) oRecord sales tax collected into the ‘Sales Tax Payable Account’ (credit). oWhen sales tax payment is made to the to state, county, etc.: oDebit sales tax payable and credit cash. 8-34

35. Sales Taxes Payable Suppose you buy lunch in the airport for $15 plus 9% sales tax. The airport restaurant records the transaction this way: Florida Sales Tax Form DR-15 8-35

36. Deferred taxes oNet income and taxable income often differ because of differences in financial accounting and tax accounting rules. oDepreciation oStraight Line for financial statements oDouble Declining Balance for tax return oThese differences can result in deferred tax liabilities, in which income is reported now for financial accounting statement but the tax on the income shown to the IRS will not be paid until future years. 8-36

37.  Informational purposes only – Target - Deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted income tax rates in effect for the year the temporary differences are expected to be recovered or settled. Tax rate changes affecting deferred tax assets and liabilities are recognized in income at the enactment date.

38. Check-up… 1. If I have a balance of $10,000 in the unearned revenue account and I provide the services to earn 50% of this balance, what journal entry do I record? 1. Debit cash for $5,000 and credit unearned revenue for $5,000 2. Debit cash for $10,000 and credit unearned revenue for $10,000 3. Debit revenue for $5,000 and credit unearned revenue for $5,000 4. Debit unearned revenue for $5,000 and credit revenue for $5,000 2. I take out a $100,000 loan (and I receive the cash) payable in equal installments (10% of principal each year) over the next 10 years. How do I record the initial transaction? 1. Debit Cash for ____________, Credit CPLTD for _______________, and Credit LTD for _____________. 3. I make a $100 sale of merchandise and also collect an additional 10% in sales tax. How much revenue do I recognize for the sale? 1. $100 2. $110 3. $90 4. None

39. Part B Estimates: Contingencies http://www.the-alternative-accountant.com/funny-videos.html 8-39

40. LO5 Apply the appropriate accounting treatment for contingencies oContingent liability: oAn existing, uncertain situation that might result in a loss. oExamples: Lawsuits, product warranties, or environmental problems. 8-40

41. LO5 Apply the appropriate accounting treatment for contingencies oThree possible actions for a contingent liability oRecord the loss (and post to general ledger account) and denote in the Financial Statement Notes. oImpacts the income statement and balance sheet of the company. oReport in a Financial Statement Note oDoes NOT impact the income statement and balance sheet of the company – only the notes to the financial statements. oDo not report or record oBased on the ensuing criteria, the organization will select one of these three courses of action. 8-41

42. Contingent Liabilities The answers to step 1 & 2 below will dictate which action to take for contingent liabilities: 1.Step #1 – Estimate the likelihood of payment: I.Probable—likely to occur II.Reasonably possible—more than remote but less than probable; or III.Remote—the chance is slight 2.Step #2 – Calculate the ability to estimate the payment amount is either: I.Known or reasonably estimable; or II.Not reasonably estimable. 8-42

43. Likelihood of Payment ProbableReasonably Possible Remote Known or reasonable estimate Estimate Amount Not reasonably estimable REPORT RECORD NO ACTION REPORT Contingent Liabilities – 1 of 2 charts Step 1 Step 2

44. Accounting Treatment of Contingent Liabilities – 2 of 2 charts CircumstanceAction Req.  Payment is probable and Can be reasonably estimated Record Cannot be reasonably estimated Report  Payment is reasonably possible Report  Payment is remote No Action

45. Contingent Liabilities – Target (Notes)  Legal contingencies We are exposed to claims and litigation arising in the ordinary course of business and use various methods to resolve these matters in a manner that we believe serves the best interest of our shareholders and other constituents. Historically, adjustments to our estimates have not been material. We believe the recorded reserves in our consolidated financial statements are adequate in light of the probable and estimable liabilities. We do not believe that any of the currently identified claims or litigation matters will have a material adverse impact on our results of operations, cash flows or financial condition. However, litigation is subject to inherent uncertainties, and unfavorable rulings could occur. If an unfavorable ruling were to occur, there may be a material adverse impact on the results of operations, cash flows or financial condition for the period in which the ruling occurs, or future periods.

46. In the News…  It isn't clear when Mr. Isenberg will receive his $100 million payment, but Nabors said it would record a "contingent liability" for that amount in its fourth quarter. (WSJ)  As of Sept. 30, MBIA Inc. had $432 million of liquid assets. MBIA Corp., its subsidiary, had $386 million of liquid assets, which the insurer said in a regulatory filing was "a modest amount relative to the insurer's contingent liabilities." (WSJ)MBIA Inc.MBIA

47. Contingent Liabilities 47 JOURNAL DateAccounts and explanationDebitCredit Loss50,000 Contingent Liability50,000 Probable Loss on lawsuit oWe RECORD a liability if the loss is probable and the amount is at least reasonably estimable. oHow to record a contingent liability - debit to a loss (or expense) account and a credit to a liability.

48. https://www.youtube.com/watch?v=HrzhqXG cm68

49. Warranties oBased on the matching principle, the company needs to record warranty expense in the same accounting period as the sale. oA warranty represents an expense and a liability at the time of the sale, because it meets the criteria for recording a contingent liability. oStep 1 – likelihood: probable, step 2 – payment: amount can be estimated. oWhen recording warranty expense and warranty payable, the amount is usually estimated as a % of sales. oSteps oAt the time of sale oCalculate warranty estimate oDebit warranty expense and credit warranty payable (creates a type of fund to be used later to actually pay for the warranty work when it occurs months or years later). oWhen warranty work is completed oDebit warranty payable and typically credit cash or inventory. 8-49

50. Warranty Example  Warranties are estimated at 1% of Sales =January Sales = $10,000,000.  Warranty claims can be handled in a number of ways, here are two common methods: Issuing new product (inventory) Repair old product through certified repair centers (cash paid to repair center) Exercise: 1. Calculate Warranty Estimate and record expense 2. Calculate actual warranty work throughout the year based on the following percentages 25% are new product issued (inventory) 75% are repairs paid to certified repair centers (Cash)

51. Estimated Warranty Payable  Warranty expense is estimated in the year product is sold Matching principle 51 JOURNAL DateAccounts and explanationDebitCredit Warranty expense100,000 Warranty payable100,000 Estimate warranty liability for the period Warranty payable100,000 Inventory25,000 Cash 75,000

52. FORD Motors – Warranty Payable

53. In-class Exercise  Beginning Balance in Est. Warranty Payable = $3,000  Sales for 2013 = $161,000  (1) Estimated Warranty Expense = 7% of Sales  (2) During 2013 Paid $8,000 in warranty claims (cash)  Record journal entry for recognizing (1) warrant expense and (2) warranty payments. 53

54. In the News… Quality and recall problems continued to weigh on the bottom line. Auto Maker had to shell out an extra $314 million last quarter on top of continuing costs related to warranty and recall repairs -- an expense that lowered its pretax margins in North America by about two percentage points. (WSJ)

55. Contingent Gains oWe do not record contingent gains until the gain is CERTAIN. oThough firms do not record contingent gains in the accounts, they sometimes disclose them in notes to the financial statements 8-55

56. Check-up’s 1.VW diesel issues – warranty or contingent loss? 2.Our company stocks and sells bicycle parts in the bicycle part vending machine in UCF’s student Union building. There is a $10 warranty claim 10 months after a part was purchased by a UCF student. We send out a new part to the student - how do we record this transaction? 1)Debit warranty expense 2)Debit warranty payable 3)Credit cash 4)Debit warranty expanse

58. Accounting Treatment of Contingent Liabilities CircumstanceAction Req.  Payment is probable and Can be reasonably estimated Record Cannot be reasonably estimated Report  Payment is reasonably possible Report  Payment is remote No Action

64. Questions to be Answered Chapter 8 – How are currently liabilities used in an organization to finance the operating cycle – how do they impact the financial statements?

65. Participation Questions – Chapter 8  Which publicly traded company was showing a negative working capital in their 2012 financial results? Southwest Airlines; Eastman Kodak; Apple Computers; or Ford Motors  Current liabilities are usually due in more than one year. True or False  What account is “air traffic liability” shown on Southwest Airlines balance sheet similar to? Sales tax payable; Deferred taxes; Unearned revenue; or Accounts Payable  Which public company did we review the contingent liabilities for in class? Southwest Airlines; Target; Apple Computers; or Eastman Kodak  Which publicly traded company was included as an example for their warranty payable estimate? Southwest Airlines; Eastman Kodak; Apple Computers; or Ford Motors

66. End of chapter 08 8-66