Current Liabilities and Contingencies

1. Current Liabilities and Contingencies

2. JOIN KHALID AZIZ • ACCOUNTING(FINANCIAL & COST) OFICMAP STAGE 1,2,3,4 (CRASH CLASSES)CA..MODULE A,B,C,DPIPFA (FOUNDATION,INTERMEDIATE,FINAL)ACCA-F1,F2,F3BBA,MBAB.COM(FRESH),M.COMMA-ECONOMICS..O/A LEVELSKHALID AZIZ…..0322-3385752http://finance.groups.yahoo.com/group/cost-accountants

3. CHARACTERISTICS OF LIABILITIES • Most liabilities obligate the debtor to pay cash at specified times and result from legally enforceable agreements. • Some liabilities are not contractual obligations and may not be payable in cash. • A liability has three essential characteristics. Liabilities: • 1. are probable, future sacrifices of economic benefits • 2. that arise from present obligations (to transfer goods or provide services) to other entities • 3. that result from past transactions or events

4. What is a Current Liability? LIABILITIES Current Liabilities Long-term Liabilities Generally, payable within one year. Formally, expected to be satisfied with current assets (or by the creation of other current liabilities). Conceptually, should be recorded at present value, but ordinarily are reported at maturity amounts.

5. GENERAL MILLS, INC. BALANCE SHEET MAY 30, 2007 AND MAY 28, 2006 (Rs in millions) ASSETS [BY CLASSIFICATION] LIABILITIES Current Liabilities: 2007 2006 Accounts payable Rs 778 Rs 673 Current portion of long-term debt 1,734 2,131 Notes payable 1,254 1,503 Other current liabilities 2,0791,831 Total current liabilities Rs5,845 Rs6,138 Long-term Liabilities: [LISTED INDIVIDUALLY] Shareholders’ equity [BY SOURCE]

6. 8: Notes Payable The components of notes payable and their respective weighted average interest rates at the end of the period are as follows: 20072006 Weighted Weighted Dollars in millions: Average Average Note Interest Note Interest Payable Rate Payable Rate U.S. commercial paper Rs477 5.4% Rs 713 5.1% Euro commercial paper 639 5.4 462 5.1 Financial institutions 138 9.8 328 5.2 Total notes payable Rs1,254 Rs1,503

7. 8: Notes Payable (cont.) To ensure availability of funds, we maintain bank credit lines sufficient to cover our outstanding short-term borrowings. Our commercial paper borrowings are supported by Rs2.95 billion of fee-paid committed credit lines and Rs351 million in uncommitted lines. As of May 27, 2007, there were no amounts outstanding on the fee-paid committed credit lines and Rs133 million was drawn on the uncommitted lines, all by our international operations. Our committed lines consist of a Rs1.1 billion credit facility expiring in October 2007, a Rs750 million credit facility expiring in January 2009, and a Rs1.1 billion credit facility expiring in October 2010.

8. Interest Interest on notes is calculated as : Amount borrowed Interest rate is always stated as an annual rate. Interest owed is adjusted for the portion of the year that the debt is outstanding.

9. Note Issued for Cash On May 1, Affiliated Technologies, Inc., a consumer electronics firm, borrowed Rs700,000 cash from First BancCorp under a noncommitted short-term line of credit arrangement and issued a 6-month, 12% promissory note. Interest was payable at maturity. May 1 Cash 700,000 Notes payable 700,000 November 1 Interest expense (Rs700,000 x 12% x 6/12)42,000 Notes payable 700,000 Cash (Rs700,000 + 42,000) 742,000

10. Example On September 1, Tru Fashions borrows Rs80,000 from Second Bank. The note is due in 6 months and has a stated interest rate of 9%. Cash 80,000 Notes payable 80,000 How much interest does Tru owe at year-end, on Dec. 31? a. Rs 2,400 b. Rs 3,600 c. Rs 7,200 d. Rs87,200

11. Example Interest is calculated as: Face Annual Time to Amount Rate maturity Rs80,000 9% 4/12 Rs2,400 interest. × × = × × = On September 1, Tru Fashions borrows Rs80,000 from Second Bank. The note is due in 6 months and has a stated interest rate of 9%. How much interest does Tru owe at year-end, on Dec. 31? a. Rs 2,400 b. Rs 3,600 c. Rs 7,200 d. Rs87,200

12. Noninterest-Bearing Note  The proceeds of the note are reduced by the interest in a “noninterest-bearing” note.  Situation: Rs700,000 noninterest-bearing note, with a 12% “discount rate.” The Rs42,000 interest is “discounted” at the outset, rather than explicitly stated: May 1 Cash (difference) 658,000 Discount on notes (Rs700,000 x 12% x 6/12) 42,000 Notes payable (face amount) 700,000 November 1 Interest expense 42,000Discount on notes 42,000 Notes payable (face amount) 700,000Cash 700,000

13. Noninterest-Bearing Note The amount borrowed is only Rs658,000, but the interest is calculated as the discount rate times the Rs700,000 face amount. This causes the effective interest rate to be higher than the 12% stated rate: Rs 42,000 interest for 6 months ÷ Rs658,000 amount borrowed = 6.38% rate for 6 months x 12/6 to annualize the rate __________ = 12.76% effective interest rate

14. ACCRUED LIABILITIES  Liabilitiesaccrue forexpenses that are incurred, but not yet paid.  Recorded by adjusting entries at the end of the reporting period, prior to preparing financial statements.  Common examples are: salaries and wages payable, income taxes payable, and interest payable.

15. ACCRUED INTEREST PAYABLE  Assume the fiscal period for Affiliated Technologies ends on June 30, two months after the 6-month note is issued. The issuance of the note, intervening adjusting entry, and note payment would be recorded as shown below: Issuance of note May 1 Cash 700,000Note payable 700,000 Accrual of interest on June 30 Interest expense (Rs700,000 x 12% x 2/12) 14,000Interest payable 14,000 Note payment November 1 Interest expense (Rs700,000 x 12% x 4/12) 28,000 Interest payable (from adjusting entry) 14,000 Note payable 700,000Cash (Rs700,000 + 42,000) 742,000

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

17. Customer Advance Tomorrow Publications collects magazine subscriptions from customers at the time subscriptions are sold. Subscription revenue is recognized over the term of the subscription. Tomorrow collected Rs20 million in subscription sales during its first year of operations. At December 31, the average subscription was one-fourth expired. (Rs in millions) When Advance is Collected Cash 20 Unearned subscriptions revenue 20 When Product is Delivered Unearned subscriptions revenue 5 Subscriptions revenue 5

18. Short-Term Obligations Expected to Be Refinanced Short-term obligations can be reported as noncurrent liabilities only if the company: (a) intends to refinance on a long-term basis and (b) demonstrates theability to do so: by either an existing refinancing agreement byactual financing (prior to the issuance of the financial statements) or The specific form of the long-term refinancing (bonds, bank loans, equity securities) is irrelevant. The concept of substance over form.

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

20. 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.

21. Contingencies – Likelihood of Occurrence Probable A confirming event is likely to occur. Reasonably Possible The chance the confirming event will occur is > remote, but < likely. Remote The chance the confirming event will occur is slight.

22. Loss ContingenciesAccounting Treatments

23. Product Warranties and Guarantees • The contingent liability for product warranties almost always is accrued. Caldor Health introduced a new therapeutic chair carrying a 2-year warranty against defects. Estimates indicate warranty costs of 3% of sales during the first 12 months following the sale and 4% the next 12 months. During December of 2009, its first month of availability, Caldor sold Rs2 million of the chairs. • During December • Cash (and accounts receivable) 2,000,000 Sales revenue 2,000,000 • December 31, 2006 (adjusting entry) • Warranty expense ([3% + 4%] x Rs2,000,000) 140,000 Estimated warranty liability 140,000

24. Subsequent Events If information becomes available that sheds light on a contingency that existed when the fiscal year ended, that information should be used in determining the probability of a loss contingency materializing and in estimating the amount of the loss. Cause of Loss Contingency Clarification Fiscal Year Ends Financial Statements

25. UNASSERTED CLAIMS AND ASSESSMENTS  It must be probable that an unasserted claim or assessment or an unfiled lawsuit will occur before considering whether and how to report the possible loss. Example: The EPA is in the process of investigating the possibility of environmental violations at a company’s site, but has not proposed a penalty assessment. Since the claim or assessment is unasserted as yet, a two-step process is involved in deciding how it should be reported: 1. Is a claim or assessment probable? {If not, no disclosure is needed.} 2. Only if a claim or assessment is probable should we evaluate (a) thelikelihood of an unfavorable outcome and (b) whether the dollar amount can be estimated.  If the conclusion of step 1 is that the claim or assessment is not probable, no further action is required.

26. Gain Contingencies Desirable to anticipate losses, but recognizing gains should await their realization. As a general rule, we never record GAIN contingencies.  Should be disclosed in notes to the financial statements. Care should be taken that the disclosure note not give "misleading implications as to the likelihood of realization."

27. ATTENTION COMMERCE STUDENTSACCOUNTING(FINANCIAL & COST) OFICMAP STAGE 1,2,3,4 (CRASH CLASSES)CA..MODULE A,B,C,DPIPFA (FOUNDATION,INTERMEDIATE,FINAL)ACCA-F1,F2,F3BBA,MBAB.COM(FRESH),M.COMMA-ECONOMICS..O/A LEVELSKHALID AZIZ…..0322-3385752http://finance.groups.yahoo.com/group/cost-accountants