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Introduction to Liabilities: Economic Consequences, Current Liabilities, and Contingencies

Introduction to Liabilities: Economic Consequences, Current Liabilities, and Contingencies. Presentations for Chapter 10 by Glenn Owen. Key Points. Definition of a liability. Economic consequences associated with reporting liabilities on the financial statements.

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Introduction to Liabilities: Economic Consequences, Current Liabilities, and Contingencies

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  1. Introduction to Liabilities:Economic Consequences, Current Liabilities, and Contingencies Presentations for Chapter 10 by Glenn Owen

  2. Key Points • Definition of a liability. • Economic consequences associated with reporting liabilities on the financial statements. • Determinable and contingent liabilities. • Current liabilities. • Bonus systems and profit-sharing arrangements and the reporting incentives they create. • Methods used to account for contingencies.

  3. What is a Liability? • “Probable future sacrifice of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events.” • Present obligations. • Unavoidable obligations. • Transaction or event must have already happened.

  4. Liabilities as a Percentage of Total Assets

  5. Reporting Liabilities on the Balance Sheet: Economic Consequences • Stockholders and investors • Creditors • Management • Auditors

  6. Current Liabilities as a Percentage of Total Liabilities

  7. Current Liabilities • Valuing current liabilities on the balance sheet • Ignore present value • Report at face value • Reporting current liabilities • Primary problem is ensuring that all existing current liabilities are reported on the balance sheet.

  8. Determinable Current Liabilities • Accounts payable • Short-term debts • Short-term notes • Current maturities of long-term debts • Dividends payable • Unearned revenues • Third-party collections • Income taxes • Incentive compensation

  9. Accrued Liabilities • Normal accrued liabilities • Wages payable • Salary payable • Interest payable • Rent payable • Insurance payable • Property taxes payable • Conditional accrued liabilities • Income tax liabilities • Incentive compensation

  10. Contingencies and Contingent Liabilities • Alternatives to loss contingencies • Ignore • Disclose • Accrue • Warranties • Uncertain future costs • Record expense and liability when products are sold (matching concept) • As costs are incurred, charge expenditure to warranty liability

  11. High Reasonable Remote Estimable? Yes No Accrue Disclose Disclose Ignore Accounting for Contingencies Contingent Loss Probability of Occurrence Accounting Treatment

  12. High Reasonable Remote Disclose Ignore Ignore Accounting for Contingencies Contingent Gain Probability of Occurrence Accounting Treatment

  13. Review Problem Current Assets Current Liabilities Current Ratio Beg. Bal. $69,000 $38,000 1.82

  14. Journal Entries and T-accounts (1) Inventory (+A) 5,000 Accounts Payable (+L) 5,000 To record merchandise in-transit. Current Assets Current Liabilities Current Ratio Beg Bal $69,000 $38,000 1.82 (1)+5,000 +5,000 1.72

  15. Journal Entries and T-accounts (2) Interest Expense (E, -SE) 500 Discount on Note (+L) 500 To accrue interest on note. Current Assets Current Liabilities Current Ratio Beg Bal $69,000 $38,000 1.82 (1) +5,000 +5,000 1.72 (2) +500 1.70

  16. Journal Entries and T-accounts (3) No entry required for future payment on long-term debt obligation. Current Assets Current Liabilities Current Ratio Beg Bal $69,000 $38,000 1.82 (1) +5,000 +5,000 1.72 (2) +500 1.70 (3) 1.70

  17. Journal Entries and T-accounts (4) Unearned Revenue (-L) 1,000 Earned Revenue (R, +SE) 1,000 To record earned revenue. Current Assets Current Liabilities Current Ratio Beg Bal $69,000 $38,000 1.82 (1) +5,000 +5,000 1.72 (2) +500 1.70 (3) 1.70 (4) -1,000 1.74

  18. Journal Entries and T-accounts (5) Wage Expense (E, -SE) 4,000 Wages/Tax Payable (+L) 4,000 To record wages and taxes owed. Current Assets Current Liabilities Current Ratio Beg Bal $69,000 $38,000 1.82 (1) +5,000 +5,000 1.72 (2) +500 1.70 (3) 1.70 (4) -1,000 1.74 (5) +4,000 1.59

  19. Journal Entries and T-accounts (5) Tax Expense (E, -SE) 400 Tax Payable (+L) 400 To record accrued taxes. Current Assets Current Liabilities Current Ratio Beg Bal $69,000 $38,000 1.82 (1) +5,000 +5,000 1.72 (2) +500 1.70 (3) 1.70 (4) -1,000 1.74 (5) +4,000 1.59 +400 1.58

  20. Journal Entries and T-accounts (6) Income Tax Expense (E, -SE) 2,000 Income Tax Payable (+L) 2,000 To record income tax liability. Current Assets Current Liabilities Current Ratio Beg Bal $69,000 $38,000 1.82 (1) +5,000 +5,000 1.72 (2) +500 1.70 (3) 1.70 (4) -1,000 1.74 (5) +4,000 1.59 +400 1.58 (6) +2,000 1.51

  21. Journal Entries and T-accounts (7) Contingent Loss (E, -SE) 8,000 Contingent Liability (+L) 8,000 To record contingent loss on lawsuit. Current Assets Current Liabilities Current Ratio Beg Bal $69,000 $38,000 1.82 (1) +5,000 +5,000 1.72 (2) +500 1.70 (3) 1.70 (4) -1,000 1.74 (5) +4,000 1.59 +400 1.58 (6) +2,000 1.51 (7) +8,000 1.30

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