1. 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 Current Liabilities and Contingencies 13 McGraw-Hill/Irwin Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved.

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

3. 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.

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

5. 13 - 5 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.

6. 13 - 6 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.

7. 13 - 7 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 journal entry. September 1: Cash.................................................... 80,000 Notes payable....................... 80,000 To record short-term note payable to Cooke Bank. How much interest is owed to Cooke Bank at year-end, on December 31? $80,000 × 9% × 4/12 = $2,400

8. 13 - 8 Interest-bearing Notes Assume Eagle Boats’ year-end is December 31. Record the necessary adjustment at year-end. December 31: Interest expense................................... 2,400 Interest payable....................... 2,400 To accrue interest on note due to Cooke Bank. Record the journal entry for the loan repayment when the note matures on February 28. February 28: Interest payable................................... 2,400 Interest expense................................... 1,200 Note payable …………………………….80,000 Cash ……………………………83,600 To pay off note and interest.

9. 13 - 9 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.

10. 13 - 10 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. 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

11. 13 - 11 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?

12. 13 - 12 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. Issued directly to the lender and is backed by a line of credit with a bank. Recorded in the same manner as notes payable.

13. 13 - 13 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.

14. 13 - 14 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.

15. 13 - 15 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

16. 13 - 16 Gift Cards During their December 2010 Christmas promotion, MegloMart sold 20,000 gift cards at $25 each. All gift card sales were for cash. On December 31, 2010, only 1,000 gift cards had been redeemed. Unused gift cards expire on December 31, 2011, if not used to purchase MegloMart merchandise. December 31, 2010: Cash (20,000 × $25)................................... 500,000 Unearned revenue …....................... 500,000 To record cash received from gift card sales. Prepare the journal entries on December 31, 2010 to record the December 2010 sale and redemption of gift cards. December 31, 2010: Unearned revenue (1,000 × $25)............... 25,000 Sales revenue …............................. 25,000 To record revenue from gift card redemptions.

17. 13 - 17 Gift Cards By December 31, 2011, 18,500 additional gift cards had been redeemed. Prepare the journal entry on December 31 to record the 2011 redemptions. On December 31, 2011, the 500 remaining cards had not been redeemed. Prepare the journal entry on December 31 to record the gift card expirations. December 31, 2011: Unearned revenue (18,500 × $25) …................. 462,500 Sales revenue (18,500 × $25) …......... 462,500 To record revenue from gift card redemptions. December 31, 2011: Unearned revenue (500 × $25) …..................... 12,500 Gift card breakage revenue ………..….. 12,500 To record revenue from gift card expirations.

18. 13 - 18 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).

19. 13 - 19 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

20. 13 - 20 U.S. GAAP vs. IFRS Liabilities payable within the coming year are classified as long ‐ term liabilities if refinancing is completed before date of issuance of the financial statements. Liabilities payable within the coming year are classified as long ‐ term liabilities if refinancing is completed before the balance sheet date. Classification of Liabilities to be Refinanced

21. 13 - 21 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.

22. 13 - 22 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. 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. Loss Contingencies

23. 13 - 23 Loss Contingencies A loss contingency is accrued only if a loss is probable and the amount can reasonably be estimated.

24. 13 - 24 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.

25. 13 - 25 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.

26. 13 - 26 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.

27. 13 - 27 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.

28. 13 - 28 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

29. 13 - 29 Subsequent Events Events occurring after the year-end date and report date can also affect the appearance of disclosures on the financial statements. Fiscal Year EndsFinancial Statements ClarificationCause of Loss Contingency

30. 13 - 30 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.

31. 13 - 31 U.S. GAAP vs. IFRS Defines probable as more likely than not, a lower threshold than U.S. GAAP. Refers to accrued liabilities as provisions and non-accrued as contingent liabilities. Requires use of midpoint of a range of equally likely outcomes. Requires reporting present values when material. Defines probable as an event is likely to occur. Refers to both accrued and non-accrued obligations as contingent liabilities. Requires use of low end of a range of equally likely outcomes. Allows using present value under some circumstances. Contingencies

32. 13 - 32 Gain Contingencies As a general rule, we never record GAIN contingencies. Note that the prior rules have supported the recording of LOSS contingencies.

33. 13 - 33 Appendix 13 Payroll-Related Liabilities Employers incur several expenses and liabilities from having employees.

34. 13 - 34 FICA Taxes Medicare Taxes Federal Income Tax State and Local Income Taxes Voluntary Deductions Gross Pay Net Pay Payroll-Related Liabilities

35. 13 - 35 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 Employees’ Withholding Taxes

36. 13 - 36 FICA Taxes Medicare Taxes 6.2% of the first $106,800 earned in the year. 1.45% of all wages earned in the year. Employers must pay withheld taxes to the Internal Revenue Service (IRS). Employees’ Withholding Taxes Federal Insurance Contributions Act (FICA)

37. 13 - 37 Amounts withheld depend on the employee’s request. Employers owe voluntary amounts withheld from employees’ gross pay to the designated agency. Examples include union dues, savings accounts, pension contributions, insurance premiums, charities. Voluntary Deductions

38. 13 - 38 FICA Taxes Medicare Taxes Federal and State Unemployment Taxes Employers pay amounts equal to that withheld from the employee’s gross pay. Employers’ Payroll Taxes

39. 13 - 39 6.2% 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 Act (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 Act (SUTA) Federal and State Unemployment Taxes

40. 13 - 40 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.

41. End of Chapter 13