Current Liabilities and Contingencies

1. Chapter 13 Current Liabilities and Contingencies

2. Characteristics of Liabilities Probable future sacrifices of economic benefits . . . . . . Arising from present obligations to other entities . . . . . . Resulting from past transactions or events.

3. What is a Current Liability? LIABILITIES Current Liabilities Long-term Liabilities Obligations payable within one year or one operating cycle, whichever is longer. Expected to be satisfied with current assets or by the creation of other current liabilities.

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

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.

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. 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 borrowing on September 1.

8. Interest is calculated as: Face Annual Time to Amount Rate maturity $80,000 9% 4/12 $2,400 interest due to Cooke Bank. × × = × × = Interest-Bearing Notes How much interest is due to Cooke Bank at year-end, on December 31? a. $2,400 b. $3,600 c. $7,200 d. $87,200

9. Assume Eagle Boats’ year-end is December 31. Record the necessary adjustment at year-end. Interest-Bearing Notes

10. Assume Eagle Boats’ year-end is December 31. Record the necessary journal entry whenthe note matures on February 28. Interest-bearing Notes

11. 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.

12. On May 1, Batter-Up, Inc. issued a one-year, noninterest-bearing note with a face amountof $10,600 in exchange for equipmentvalued at $10,000. How much interest will Batter-Up pay on the note? Noninterest-Bearing Notes Interest = Face Amount - Amount Borrowed = $10,600 - $10,000 = $600

13. Noninterest-Bearing Notes On May 1, Batter-Up, Inc. issued a one-year, noninterest-bearing note with a face amountof $10,600 in exchange for equipmentvalued at $10,000. What is the effective interest rate on the note?

14. 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. Normally, commercial paper is issued directly to the lender and is backed by a line of credit with a bank. Commercial paper is recorded in thesame manner as notes payable.

15. 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.

16. Liabilities from Advance Collections • Refundable Deposits • Advances from Customers • Collections for Third Parties

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

18. A company may reclassify a short-term liability as long-term only if two conditions are met: • The ability to refinance on a long-term basiscan be demonstrated by an: • existing refinancing agreement, or • actual financing prior to issuance of the financial statements. Short-Term Obligations Expectedto be Refinanced • It has the intent to refinance on a long-term basis. • It has demonstrated the ability to refinance. and

19. A loss contingencyis an existing uncertain situation involving potential loss depending on whether some future event occurs. Contingencies

20. Two factors affect whether a loss contingency must be accrued and reported as a liability: the likelihood that the confirming event will occur. whether the loss amount can be reasonably estimated. Contingencies

21. 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. Contingencies – Likelihood of Occurrence

22. Contingencies A loss contingency is accrued only if a loss is probable and the amount can reasonably be estimated.

23. 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 and Guarantees

24. 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

25. 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

26. 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. Litigation Claims

27. Events occurring between the year-end date and report date can affect the appearance of disclosures on the financial statements. Cause of Loss Contingency Clarification Fiscal Year Ends Financial Statements Subsequent Events

28. Unasserted Claims and Assessments Unassertedclaim  Is a claimor assessmentprobable? Nodisclosureneeded No Yes Evaluate (a) the likelihood of an unfavorable outcome and(b) whether the dollar amount can be estimated.An estimated loss and contingent liability would beaccrued if an unfavorable outcome is probable and theamount can be reasonably estimated.

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