1. FINANCIAL ACCOUNTING a user perspective Sixth Canadian Edition Prepared by: Lynn de Grace C.A. Chapter 9 Current Liabilities, Contingencies, and Commitments

2. Recognition Criteria for Liabilities John Wiley & Sons Canada, Ltd. ©2011  Classify as liabilities if: Transfer of assets or the performance of services or other benefits Company has little or no discretion to avoid the obligation Result from a transaction or event that has already occurred. 2

3. Contingent Liability John Wiley & Sons Canada, Ltd. ©2011 A liability may not be recognized in the financial statements when: There is uncertainty with either the timing or the amount of the future transfer of assets The future obligation is contingent on certain events occurring Should be disclosed in the notes to the financial statements 3

4. Valuation Alternatives John Wiley & Sons Canada, Ltd. ©2011 Alternative 1  Gross amount of the obligation Represents the total of the payments to be made May not adequately measure the obligation Ignores the time value of money 4

5. Valuation Alternatives John Wiley & Sons Canada, Ltd. ©2011 Alternative 2  Net present value of the obligation Recognizes the time value of money Requires assumption for discount rate Future payments of principal and interest are discounted back to the current period using a discount rate 5

6. Valuation Methods John Wiley & Sons Canada, Ltd. ©2011  Canadian practice Record liabilities at the present value of the future payments Exception: short-term liabilities because the difference in the amounts would not be material. 6 IAS 37

7. Accounts Payable John Wiley & Sons Canada, Ltd. ©2011  Created when a company buys goods or services on credit  Called trade accounts payable  Payment deferred for 30-60 days  Generally do not carry interest charges, unless payment is delayed 7

8. Wages & Other Payroll Liabilities  Each reporting period – must accrue wages earned since the last pay period  Government benefits Medical insurance, employment insurance, Canada Pension Plan (CPP)  Other Fringe benefits or withholdings Disability and life Insurance, pension plan, union dues  Company acts as government agent in collecting taxes Income taxes, CPP (QPP), EI John Wiley & Sons Canada, Ltd. ©2011 8

9. Wages and Other Payroll Payables  Recording deductions from employees’ earned income Wages expense (SE) 10,000 Employee income tax payable (L) 2,500 CPP contribution payable (L) 1 495 EI taxes payable (L) 2 173 Cash (A) 3 6,832 1 4.95% x $10,000 2 1.73% x $10,000 3 [10,000 – 2,500 – 495 – 173] John Wiley & Sons Canada, Ltd. ©2011 9

10. Wages & Other Payroll Payables  Recording contribution paid by employer Wages expense (SE) 737.20 CPP contribution payable (L) [same as employee amt] 495.00 EI taxes payable (L) [1.4 times employee amt] 242.20  To record the remittance: Employee income taxes payable (L)2,500.00 CPP contributions payable (L)990.00 EI premiums payable (L)415.20 Cash (A)3,905.20 John Wiley & Sons Canada, Ltd. ©2011 10

11. Corporate Income Taxes John Wiley & Sons Canada, Ltd. ©2011  Companies are subject to taxes Federal corporate income taxes Provincial corporate taxes  Payment of taxes does not always coincide with the incurrence of the tax  Most companies are required to make installments based on the previous years’ tax payable 11

12. Warranty Obligations John Wiley & Sons Canada, Ltd. ©2011  The sale of goods or services sold may result in implicit or explicit guarantees to the buyer  Warranty service is included in the price of the product  Estimate the amount of warranty expense to match to the revenue from the sale Estimate percentage based on past history of claims  IFRS have moved towards measuring warranty obligations as the sales value of the warranty service rather than the company’s cost to provide it. 12

13. Warranty Obligations John Wiley & Sons Canada, Ltd. ©2011  Record the estimated warranty obligation in the period of the sale Warranty expense (SE) 3,000 Estimated warranty obligation (L) 3,000 13  Record the repair work in the period when the work is done. Estimated warranty obligation (L) 1,700 Cash (A) 1,700

14. Unearned Revenues John Wiley & Sons Canada, Ltd. ©2011  If customers are required to pay deposits or make down payments prior to the receipt of goods or services  Seller must defer the recognition of revenue because they have not fulfilled their part of the contract.  Liabilities Unearned revenues, or Deferred revenues 14

15. Gift Certificates & Prepaid Cards  Major source of revenue for many businesses  According to accounting standards, gift card revenue is recognized only when the cards are redeemed for goods or services.  Why ? – because the revenues are known, but the related costs cannot be measured until the card is used.  Company must create a liability when cash is received for the card – unearned revenues. John Wiley & Sons Canada, Ltd. ©2011 15

16. Gift Certificates & Prepaid Cards  Example: In December 2011, a company sells gift cards worth $10,000. Twenty percent of these are redeemed in December, for merchandise with a cost of $1,500. Sixty percent of the cards are redeemed in January 2012, for merchandise with a cost of $5,000. The remaining 20 percent of the cards are still outstanding at the end of January. John Wiley & Sons Canada, Ltd. ©2011 16

17. Gift Certificates & Prepaid Cards December 2011 Entries: Cash (A) 10,000 Unearned revenue/Gift Cards (L) 10,000 Unearned revenue/Gift Cards (L)2,000 Sales (SE) 2,000 Cost of goods sold (SE)1,500 Inventory (A)1,500 January 2012 Entries: Unearned revenue/Gift Cards (L)6,000 Sales (SE) 6,000 Cost of goods sold (SE)5,000 Inventory (A)5,000 John Wiley & Sons Canada, Ltd. ©2011 17

18. Customer Rewards & Loyalty Programs  Accounting issues are similar to those with warranty obligations  The traditional approach was to estimate the cost of the free goods and services that were expected to be provided in the future, and accrue this as an expense in the period when the sales revenue was recorded. The offsetting credit was to a liability account with a title such as Loyalty Program Obligations.  Recent standards under IFRS have moved towards measuring loyalty program liabilities as the sales value of the goods or services that will be required to satisfy the reward redemptions, rather than the company’s acquisition cost for these goods and services. John Wiley & Sons Canada, Ltd. ©2011 18

19. Warranty Sales  Warranty coverage is sold as a separate product  When sold, the company has to record the amount received as unearned revenue and carry this as a liability on its statement of financial position, until either the warranty services are provided or the warranty period ends.  Gift certificates, loyalty programs and warranty sales are referred to as non-financial liabilities under IFRS. John Wiley & Sons Canada, Ltd. ©2011 19

20. Working Capital Loans & Lines of Credit Includes:  Short-term loans from a bank, line of credit  Overdraft protection  Often secured by accounts receivable or inventory balances  Results in negative cash balance John Wiley & Sons Canada, Ltd. ©2011 20

21. Short-Term Notes & Interest Payable  Short-term notes Borrowings that required repayment in the next year or operating cycle Carry explicit interest rates, or are structured to include implicit interest amounts in the payment schedule.  Interest expense and payable Recognized over the life of the loans Passage of time is the critical event John Wiley & Sons Canada, Ltd. ©2011 21

22. Short-Term Notes & Interest Payable  Example: Borrowing of $10,000 at 9% Six monthly payments of $1,710.69 Monthly installments including reductions of the principal, plus interest Interest is calculated on the decreasing amount of principal. John Wiley & Sons Canada, Ltd. ©2011 22

23. Short-Term Notes & Interest Payable MonthPaymentInterest Principal Reduction Principal Balance 10,000.00 July 311,710.69 75.00 a 1,635.69 8,364.31 Aug 311,710.69 62.73 b 1,647.96 6,716.35 Sep 301,710.69 50.371,660.32 5,056.03 Oct 311,710.69 37.921,672.77 3,383.26 Nov 301,710.69 25.371,685.32 1,697.94 Dec 311,710.69 12.75 c 1,697.94 -0- $10,264.14$264.14$10,000 John Wiley & Sons Canada, Ltd. ©2011 a.$10,000 x.09 x 1/12 = $75.00 b.8,364.31 x.09 x 1/12 = $62.73 c.rounded

24. Short-Term Notes & Interest Payable  Entry at the end of the first month Interest expense (SE) 75.00 Short-term note payable (L) 1,635.69 Cash (A) 1,710.69 John Wiley & Sons Canada, Ltd. ©2011 24

25. Current Portion of Long-Term Debt  The portion of long-term debt due in the coming fiscal year.  Must be reclassified as a current liability  May have negative impact on liquidity ratios John Wiley & Sons Canada, Ltd. ©2011 25

26. Statement Analysis Considerations  Current liabilities are key component in current and quick ratios  Accounts payable turnover is a major component of the company’s cash cycle Accounts payable = Credit Purchases turnover ratioAverage Accts Payable John Wiley & Sons Canada, Ltd. ©2011 26

27. Statement Analysis Considerations  Purchases are not usually shown on the financial statements – necessary to start with cost of goods sold and adjust for the difference between beginning and ending inventory. Purchases = Cost of goods sold – Beginning inventory + Ending inventory Using H&M’s financial statements: Purchases = SEK 38,919 – SEK 8,500 + SEK 10,240 = SEK 40,659 Accts Payable turnover =SEK 40,659 = 11.1 times [(SEK 3,667 + SEK 3,658) ÷ 2] Average pay period = 365=32.9 days 11.1 John Wiley & Sons Canada, Ltd. ©2011 27 H & M Financial Statements

28. Commitments John Wiley & Sons Canada, Ltd. ©2011  Purchase commitment An agreement to purchase items in the future for a pre-arranged price Discuss in a note to the financial statements if this results in a material effect to future operations.  Take-or-pay contract: The company must pay for a specified quantity at the specified price, whether it actually takes that much from the supplier or not. 28

29. Contingencies John Wiley & Sons Canada, Ltd. ©2011  Contingent liabilities (losses) Refers to a situation in which a liability is conditional. When the incurrence of the liability is contingent upon the occurrence of some future event. Examples: Company is the defendant in a lawsuit Guarantee of another company’s debt commonly a parent company guarantees the subsidiary’s debt. 29 Research In Motion Note Disclosure

30. Contingencies John Wiley & Sons Canada, Ltd. ©2011  Under IFRS, recognize a contingent loss in the accounts if: It is probable that some future event will result in a liability for the company, and The amount of the liability can be reasonably estimated  If either of these criteria is not met, and there exists a potential for liability, the company would not record the liability but should provide details in a note disclosure.  IFRS utilizes the term ‘contingent liability’ only for those liabilities that are not recorded in the accounts. 30

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