Current Liabilities and Contingencies

Insert Book Cover Picture Current Liabilities and Contingencies 13

Learning Objectives Define liabilities and distinguish between current and long-term liabilities. LO1

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

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.

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

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.

Learning Objectives Account for the issuance and payment of various forms of notes and record the interest on notes. LO2

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.

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.

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

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

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

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

Short-Term Notes PayableNoninterest-Bearing • Notes without a stated interest rate carry an implicit, or effective, rate. • The face of the note includes the amount borrowed and the interest.

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? Short-Term Notes PayableNoninterest-Bearing Interest = Face Amount - Amount Borrowed = $10,600 - $10,000 = $600

Short-Term Notes PayableNoninterest-Bearing 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?

Learning Objectives Characterize accrued liabilities and liabilities from advance collection and describe when and how they should be recorded. LO3

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

Learning Objectives Determine when a liability can be classifiedas a noncurrent obligation. LO4

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 • By actual financing prior to issuance of the financial statements. Short-Term ObligationsExpected to Be Refinanced • It has the intent to refinance on a long-term basis. • It has demonstrated the ability to refinance. and

Learning Objectives Identify situations that constitute contingencies and the circumstances under which they should be accrued. LO5

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

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

Contingencies –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.

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

Learning Objectives Demonstrate the appropriate accounting treatment for contingencies, including unasserted claims and assessments. LO6

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

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

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

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

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

Unasserted Claims and Assessments Is a claim orassessmentprobable? End No Yes Can amountbe estimated? Disclosureof claim orassessment Recordestimated claimor assessment No Yes

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

Payroll-Related Liabilities Appendix 13

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

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

Employee FICA Taxes Federal Insurance Contributions Act (FICA) Medicare Taxes FICA Taxes 6.2% of the first $90,000 earned in the year. 1.45% of all wages earned in the year. Employers must pay withheld taxesto the Internal Revenue Service (IRS).

Employee Income Taxes State and Local Income Taxes Federal Income Tax 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.

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

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

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 (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 (SUTA) Federal and StateUnemployment Taxes

Fringe Benefits In addition to salaries and wages,withholding taxes, and payroll taxes, most companies provide a varietyof fringe benefits. Healthinsurancepremiums Lifeinsurancepremiums Retirementplancontributions Employers must pay the amounts promised to fund employee fringe benefits to the designated agency.

End of Chapter 13

Current Liabilities and Contingencies