Intermediate Accounting Seventeenth Edition Kieso Weygandt Warfield Chapter

Intermediate Accounting Seventeenth Edition Kieso ● Weygandt ● Warfield Chapter 13 Current Liabilities and Contingencies This slide deck contains animations. Please disable animations if they cause issues with your device.

Learning Objectives After studying this chapter, you should be able to: 1. Describe the nature, valuation, and reporting of current liabilities. 2. Explain the classification issues of short-term debt expected to be refinanced. 3. Explain the accounting for gain and loss contingencies. 4. Indicate how to present and analyze liabilities and contingencies. Copyright © 2019 John Wiley & Sons, Inc. 2

Preview of Chapter 13 Current Liabilities and Contingencies Current Liabilities • • • Accounts payable Notes payable Dividends payable Customer advances and deposits Unearned revenues Taxes payable Employee-related liabilities Current maturities of long-term debt Short-term obligations Copyright © 2019 John Wiley & Sons, Inc. 3

Preview of Chapter 13 Current Liabilities and Contingencies Short-Term Obligations • Refinancing illustration Contingencies • Gain contingencies • Loss contingencies Copyright © 2019 John Wiley & Sons, Inc. 4

Preview of Chapter 13 Current Liabilities and Contingencies Presentation and Analysis • Presentation of current liabilities • Presentation of contingencies • Analysis of current liabilities Copyright © 2019 John Wiley & Sons, Inc. 5

Learning Objective 1 Describe the Nature, Valuation, and Reporting of Current Liabilities LO 1 Copyright © 2019 John Wiley & Sons, Inc. 6

Current Liabilities “What is a Liability? ” The FASB, defined liabilities as: “Probable Future Sacrifices 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. ” LO 1 Copyright © 2019 John Wiley & Sons, Inc. 7

Current Liabilities Recall: Current assets are cash or other assets that companies reasonably expect to convert into cash, sell, or consume in operations within a single operating cycle or within a year. Current liabilities are “obligations whose liquidation is reasonably expected to require use of existing resources properly classified as current assets, or the creation of other current liabilities. ” Operating cycle: Period of time elapsing between the acquisition of goods and services and the final cash realization resulting from sales and subsequent collections. LO 1 Copyright © 2019 John Wiley & Sons, Inc. 8

Current Liabilities Typical Current Liabilities 1. Accounts payable. 6. Sales taxes payable. 2. Notes payable. 7. Income taxes payable. 3. Dividends payable. 8. Employee-related liabilities. 4. Customer advances and deposits. 5. Unearned revenues. LO 1 9. Current maturities of long-term debt. Copyright © 2019 John Wiley & Sons, Inc. 9

Current Liabilities Accounts Payable (trade accounts payable) Balances owed to others for goods, supplies, or services purchased on open account. • Time lag between the receipt of services or acquisition of title to assets and the payment for them. • Terms of the sale (e. g. , 2/10, n/30 or 1/10, E. O. M. ) usually state period of extended credit, commonly 30 to 60 days. LO 1 Copyright © 2019 John Wiley & Sons, Inc. 10

Current Liabilities Notes Payable Written promises to pay a certain sum of money on a specified future date. • Arise from purchases, financing, or other transactions. • Classified as short-term or long-term. • May be interest-bearing or zero-interest-bearing. LO 1 Copyright © 2019 John Wiley & Sons, Inc. 11

Notes Payable Interest-Bearing Note Issued Illustration: Castle National Bank agrees to lend $100, 000 on March 1, 2020, to Landscape Co. if Landscape signs a $100, 000, 6 percent, four-month note. Landscape records the cash received on March 1 as follows: Cash 100, 000 Notes Payable LO 1 Copyright © 2019 John Wiley & Sons, Inc. 100, 000 12

Interest-Bearing Note Issued Recording Interest If Landscape prepares financial statements semiannually, it makes the following adjusting entry to recognize interest expense and interest payable at June 30: Interest calculation = ($100, 000 x 6% x 4/12) = $2, 000 Interest Expense 2, 000 Interest Payable LO 1 Copyright © 2019 John Wiley & Sons, Inc. 2, 000 13

Interest-Bearing Note Issued Payment at Maturity At maturity (July 1), Landscape records payment of the note and accrued interest as follows. Notes Payable Interest Payable Cash LO 1 100, 000 2, 000 Copyright © 2019 John Wiley & Sons, Inc. 102, 000 14

Current Liabilities Zero-Interest-Bearing Note Issued Illustration: On March 1, Landscape issues a $102, 000, four-month, zero-interest-bearing note to Castle National Bank. The present value of the note is $100, 000. Landscape records this transaction as follows. Cash Discount on Notes Payable LO 1 100, 000 2, 000 Copyright © 2019 John Wiley & Sons, Inc. 102, 000 15

Zero-Interest-Bearing Note Issued Balance Sheet Presentation Current liabilities Notes payable Less: Discount on notes payable $102, 000 $100, 000 Discount on notes payable: • Contra account to notes payable. • Represents the cost of borrowing. • Debited to interest expense over the life of the note. LO 1 Copyright © 2019 John Wiley & Sons, Inc. 16

Accounts and Notes Payable Illustration The following are selected 2020 transactions of Astin Corporation. Sept. 1 - Purchased inventory from Encino Company on account for $50, 000. Astin records purchases gross and uses a periodic inventory system. Oct. 1 - Issued a $50, 000, 12 -month, 8% note to Encino in payment of account. Oct. 1 - Borrowed $50, 000 from the Shore Bank by signing a 12 -month, zero-interest-bearing $54, 000 note. LO 1 Copyright © 2019 John Wiley & Sons, Inc. 17

Accounts and Notes Payable Journal Entries Prepare the journal entries for the selected transactions. Sept. 1 Purchases Accounts Payable 50, 000 Oct. 1 Accounts Payable Notes Payable 50, 000 Cash Discount on Notes Payable 50, 000 4, 000 Oct. 1 LO 1 Copyright © 2019 John Wiley & Sons, Inc. 50, 000 54, 000 18

Accounts and Notes Payable Adjusting Journal Entries Prepare the adjusting journal entries for the transactions. Dec. 31 Interest Expense Interest Payable 1, 000 ($50, 000 x 8% x 3/12) = $1, 000 Dec. 31 Interest Expense Discount on Notes Payable 1, 000 ($4, 000 x 3/12) = $1, 000 LO 1 Copyright © 2019 John Wiley & Sons, Inc. 19

Accounts and Notes Payable Balance Sheet December 31 Compute the total net liability to be reported on the December 31 balance sheet for: 1. Interest-bearing note. 2. Zero-interest bearing note. 1. Notes payable Interest payable $50, 000 1, 000 $51, 000 2. Notes payable Less discount ($4, 000 - $1, 000) $54, 000 3, 000 $51, 000 LO 1 Copyright © 2019 John Wiley & Sons, Inc. 20

Current Liabilities Dividends Payable Amount owed by a corporation to its stockholders as a result of board of directors’ authorization. • Generally paid within three months. • Undeclared dividends on cumulative preferred stock not recognized as a liability. • Dividends payable in the form of additional shares of stock are reported in stockholders’ equity. LO 1 Copyright © 2019 John Wiley & Sons, Inc. 21

Current Liabilities Customer Advances and Deposits Returnable cash deposits received from customers and employees. • To guarantee performance of a contract or service or • as guarantees to cover payment of expected future obligations. • May be classified as current or long-term liabilities. LO 1 Copyright © 2019 John Wiley & Sons, Inc. 22

Current Liabilities Unearned Revenues Payment received before delivering goods or rendering services. Account Title Type of Business Airline Unearned Revenue Earned Revenue Unearned Ticket Revenue Passenger Revenue Magazine publisher Unearned Subscription Revenue Hotel Unearned Rent Revenue Auto dealer Unearned Warranty Revenue Retailers Unearned Gift Card Revenue Sales Revenue LO 1 Copyright © 2019 John Wiley & Sons, Inc. 23

Current Liabilities Illustration: Allstate University sells 10, 000 season football tickets at $50 each for its five-game home schedule. Allstate University records the sales of season tickets as follows. Aug. 6 Cash Unearned Sales Revenue (10, 000 × $50 = $500, 000) 500, 000 As each game is completed, Allstate makes the following entry. Sept. 7 LO 1 Unearned Sales Revenue 100, 000 Sales Revenue ($500, 000 ÷ 5 games = $100, 000 per game) Copyright © 2019 John Wiley & Sons, Inc. 100, 000 24

Current Liabilities Sales Taxes Payable Retailers must collect sales taxes from customers on transfers of tangible personal property and on certain services and then remit to the proper governmental authority. LO 1 Copyright © 2019 John Wiley & Sons, Inc. 25

Sales Taxes Payable Illustration: Prepare the entry to record sales taxes assuming there was a sale of $3, 000 when a 4 percent sales tax is in effect. Cash Sales Revenue Sales Taxes Payable ($3, 000 × 4% = $120) LO 1 Copyright © 2019 John Wiley & Sons, Inc. 3, 120 3, 000 120 26

Sales Taxes Payable Alternate Calculation Many companies do not segregate the sales tax and the amount of the sale at the time of sale. Instead, the company credits both amounts in total in the Sales Revenue account. Illustration: Assume the Sales Revenue account balance of $150, 000 includes sales taxes of 4 percent. Prepare the entry to record the amount due the taxing unit. Tax calculation = ($150, 000 ÷ 1. 04 = $144, 230. 77, $150, 000 −$144, 230. 77 = $5, 769. 23) 5, 769. 23 Sales Revenue Sales Taxes Payable 5, 769. 23 LO 1 Copyright © 2019 John Wiley & Sons, Inc. 27

Current Liabilities Income Taxes Payable Businesses must prepare an income tax return and compute the income tax payable. • Taxes payable are a current liability. • Corporations must make periodic tax payments. • Differences between taxable income (tax law) and accounting income (GAAP) sometimes occur (Chapter 19). LO 1 Copyright © 2019 John Wiley & Sons, Inc. 28

Current Liabilities Employee-Related Liabilities Amounts owed to employees for salaries or wages are reported as a current liability. Current liabilities related to employee compensation may include: • Payroll deductions. • Compensated absences. • Bonuses. LO 1 Copyright © 2019 John Wiley & Sons, Inc. 29

Employee-Related Liabilities Payroll Deductions Most common types of payroll deductions are taxes, insurance premiums, employee savings, and union dues. Social Security Taxes (since January 1, 1937). • Federal Old Age, Survivor, and Disability Insurance (O AS DI) benefits for certain individuals and their families. • Funds from taxes levied on both employer and employee. • Current rate 6. 2 percent based on the employee’s gross pay up to a $128, 400 annual limit. • OASDI tax is usually referred to as FICA. LO 1 Copyright © 2019 John Wiley & Sons, Inc. 30

Payroll Deductions Social Security Taxes • In 1965, Congress passed the first federal health insurance program for the aged—popularly known as Medicare. • Alleviates high cost of medical care for those over age 65. • Hospital Insurance tax, paid by both employee and employer at the rate of 1. 45 percent on the employee’s total compensation. • OASDI tax (FICA) and the federal Hospital Insurance Tax is referred to as the Social Security tax. LO 1 Copyright © 2019 John Wiley & Sons, Inc. 31

Payroll Deductions Unemployment Taxes Federal Unemployment Tax Act (F U T A): • Only employers pay the unemployment tax. • Rate is 6 percent on the first $7, 000 of compensation paid to each employee during the calendar year. • If employer is subject to a state unemployment tax of 5. 2 percent or more it receives a tax credit (not to exceed 5. 4 percent) and pays only 0. 8 percent tax to the federal government. LO 1 Copyright © 2019 John Wiley & Sons, Inc. 32

Unemployment Taxes State unemployment compensation laws differ both from the federal law and among various states. Employers must refer to the unemployment tax laws in each state in which they pay wages and salaries. LO 1 Copyright © 2019 John Wiley & Sons, Inc. 33

Payroll Deductions Income Tax Withholdings Federal and some state income tax laws require employers to withhold from each employee’s pay the applicable income tax due on those wages. Item Who Pays Income tax withholding FICA taxes —employee share Union dues Employee FICA taxes—employer share Federal unemployment State unemployment Employer LO 1 Copyright © 2019 John Wiley & Sons, Inc. Employer reports these amounts as liabilities until remitted. 34

Payroll Deductions Example Employee Illustration: Assume a weekly payroll of $10, 000 entirely subject to F. I. C. A. and Medicare (7. 65%), federal (0. 8%) and state (4%) unemployment taxes, with income tax withholding of $1, 320 and union dues of $88 deducted. The company records the salaries and wages paid and the employee payroll deductions as follows: Salaries and Wages Expense Withholding Taxes Payable FICA Taxes Payable Union Dues Payable Cash LO 1 Copyright © 2019 John Wiley & Sons, Inc. 10, 000 1, 320 765 88 7, 827 35

Payroll Deductions Example Employer Illustration: Assume a weekly payroll of $10, 000 entirely subject to F. I. C. A. and Medicare (7. 65%), federal (0. 8%) and state (4%) unemployment taxes, with income tax withholding of $1, 320 and union dues of $88 deducted. The company records the employers payroll taxes as follows: Payroll Tax Expense FICA Taxes Payable FUTA Taxes Payable ($10, 000 × 0. 8%) SUTA Taxes Payable ($10, 000 × 4%) LO 1 Copyright © 2019 John Wiley & Sons, Inc. 1, 245 765 80 400 36

Employee-Related Liabilities Compensated Absences Paid absences for vacation, illness, and holidays. Accrue a liability if all the following conditions exist. • The employer’s obligation is attributable to employees’ services already rendered. • The obligation relates to rights that vest or accumulate. • Payment of the compensation is probable. • The amount can be reasonably estimated. LO 1 Copyright © 2019 John Wiley & Sons, Inc. 37

Compensated Absences Balance Sheet Presentation Clarcor Inc. Current liabilities Accounts payable Accrued salaries, wages and commissions Compensated absences Accrued pension liabilities Other accrued liabilities LO 1 Copyright © 2019 John Wiley & Sons, Inc. $ 6, 308 2, 271 1, 023 4, 572 $16, 452 38

Compensated Absences Illustration: Amutron Inc. employs 10 individuals and pays each $480 per week. Employees earned 20 unused vacation weeks in 2020. In 2021, the employees used the vacation weeks, but now they each earn $540 per week. Amutron accrues the accumulated vacation pay on December 31, 2020, as follows. Salaries and Wages Expense Salaries and Wages Payable ($480 × 20) 9, 600 In 2021, it records the payment of vacation pay as follows. Salaries and Wages Payable Salaries and Wages Expense Cash ($540 × 20) LO 1 Copyright © 2019 John Wiley & Sons, Inc. 9, 600 1, 200 10, 800 39

Employee-Related Liabilities Bonus Agreements Payments to certain or all employees in addition to their regular salaries or wages. • Bonuses paid are an operating expense. • Unpaid bonuses should be reported as a current liability. LO 1 Copyright © 2019 John Wiley & Sons, Inc. 40

Bonus Agreements Illustration: Palmer Inc. shows income for the year 2020 of $100, 000. It will pay out bonuses of $10, 700 in January 2021. Palmer makes an adjusting entry dated December 31, 2020, to record the bonuses as follows. Salaries and Wages Expense Salaries and Wages Payable 10, 700 In 2021, it records the payment of the bonus as follows. Salaries and Wages Payable Cash LO 1 Copyright © 2019 John Wiley & Sons, Inc. 10, 700 41

Current Liabilities Current Maturities of Long-Term Debt Portion of bonds, mortgage notes, and other long-term indebtedness that matures within the next fiscal year. Exclude debts maturing currently if they are to be: 1. Retired by assets accumulated that have not been shown as current assets, 2. Refinanced, or retired from the proceeds of a new debt issue, or 3. Converted into capital stock. LO 1 Copyright © 2019 John Wiley & Sons, Inc. 42

Learning Objective 2 Explain the Classification Issues of Short-Term Debt Expected to Be Refinanced LO 2 Copyright © 2019 John Wiley & Sons, Inc. 43

Short-Term Obligations Expected to Be Refinanced Exclude from current liabilities if both of the following conditions are met: 1. The liability is contractually due to be settled more than one year (or operating cycle, if longer) after the balance sheet date. 2. The entity has a contractual right to defer settlement of the liability for at least one year (or operating cycle, if longer) after the balance sheet date. LO 2 Copyright © 2019 John Wiley & Sons, Inc. 44

Refinancing Illustration On November 30, 2020, Montavon Winery issued a note payable of $3, 000. The note is due on February 28, 2021 and their balance sheet date is December 31, 2020. Montavon issued is financial statements on March 1, 2021. At that time it plans to extend the maturity date of the loan to June 15, 2022. The refinancing events are shown in the following timeline. LO 2 Copyright © 2019 John Wiley & Sons, Inc. 45

Questions: 1. What is the accounting treatment for Montavon’s short-term debt to be refinanced if a contract to refinance is completed on January 15, 2021? 2. What is the accounting treatment for the short-term debt to be refinanced if a contract to refinance is completed by December 31, 2020? Solutions: 1. Classify note payable as a current liability because contract for refinancing is not completed by December 31, 2020. 2. Classify note payable as noncurrent because it has a contract, which gives it the right to defer payment to June 15, 2022, and the contract is in effect as of December 31, 2020. LO 2 Copyright © 2019 John Wiley & Sons, Inc. 46

Learning Objective 3 Explain the Accounting for Gain and Loss Contingencies LO 3 Copyright © 2019 John Wiley & Sons, Inc. 47

Contingencies “An existing condition, situation, or set of circumstances involving uncertainty as to possible gain (gain contingency) or loss (loss contingency) to an enterprise that will ultimately be resolved when one or more future events occur or fail to occur. ” LO 3 Copyright © 2019 John Wiley & Sons, Inc. 48

Contingencies Gain Contingencies Typical Gain Contingencies are: 1. Possible receipts of monies from gifts, donations, asset sales, and so on. 2. Possible refunds from the government in tax disputes. 3. Pending court cases with a probable favorable outcome. 4. Tax loss carryforwards (Chapter 19). Gain contingencies are not recorded, disclosed only if probability of receipt is high. LO 3 Copyright © 2019 John Wiley & Sons, Inc. 49

Contingencies Loss Contingencies • Involves possible losses. Likelihood of Loss FASB uses three areas of probability: • Probable. • Reasonably possible. • Remote. LO 3 Copyright © 2019 John Wiley & Sons, Inc. 50

Loss Contingencies LO 3 Probability Accounting Probable Accrue Reasonably Possible Footnote Remote Ignore Copyright © 2019 John Wiley & Sons, Inc. 55

Loss Contingencies Illustration Scorcese Inc. is involved in a lawsuit at December 31, 2020. (a) Prepare the December 31 entry assuming it is probable that Scorcese will be liable for $900, 000 as a result of this suit. (b) Prepare the December 31 entry, if any, assuming it is not probable that Scorcese will be liable for any payment as a result of this suit. (a) Lawsuit Loss Lawsuit Liability 900, 000 (b) No entry is necessary. The loss is not accrued because it is not probable that a liability has been incurred at 12/31/20. LO 3 Copyright © 2019 John Wiley & Sons, Inc. 52

Loss Contingencies Usually Accrued Loss Related to: 1. Collectibility of receivables. 2. Obligations related to product warranties and product defects. 3. Premiums offered to customers. LO 3 Copyright © 2019 John Wiley & Sons, Inc. 53

Loss Contingencies Not Accrued Loss Related to: 4. Risk of loss or damage of enterprise property by fire, explosion, or other hazard. 5. General or unspecified business risk. 6. Risk of loss from catastrophes assumed by property and casualty insurance companies, including reinsurance companies LO 3 Copyright © 2019 John Wiley & Sons, Inc. 54

Loss Contingencies May Be Accrued* Loss Related to: 7. Threat of expropriation of assets. 8. Pending or threatened litigation. 9. Actual or possible claims and assessments. 10. Guarantees of indebtedness of others. LO 3 Copyright © 2019 John Wiley & Sons, Inc. 55

Loss Contingencies May Be Accrued Loss Related to: 11. Obligations of commercial banks under "standby letters of credit. “ 12. Agreements to repurchase receivables (or the related property) that have been sold *Should be accrued when both criteria—probable arid reasonably estimable—are met. LO 3 Copyright © 2019 John Wiley & Sons, Inc. 56

Loss Contingencies Common loss contingencies: 1. Litigation, claims, and assessments. 2. Guarantee and warranty costs. 3. Premiums and coupons. 4. Environmental liabilities. LO 3 Copyright © 2019 John Wiley & Sons, Inc. 57

Loss Contingencies Litigation, Claims, and Assessments Companies must consider the following factors, in determining whether to record a liability with respect to pending or threatened litigation and actual or possible claims and assessments. • Time period in which the action occurred. • Probability of an unfavorable outcome. • Ability to make a reasonable estimate of the loss. LO 3 Copyright © 2019 John Wiley & Sons, Inc. 58

Loss Contingencies Guarantee and Warranty Costs Promise made by a seller to a buyer to make good on a deficiency of quantity, quality, or performance in a product. Companies often provide one of two types of warranties to customers: 1. Assurance-type warranty 2. Service-type warranty LO 3 Copyright © 2019 John Wiley & Sons, Inc. 59

Guarantee and Warranty Costs Assurance-Type Warranty that the product meets agreed-upon specifications in the contract at the time the product is sold. • Should be expensed in the period the goods are provided or services performed. • Should record a warranty liability. LO 3 Copyright © 2019 John Wiley & Sons, Inc. 60

Assurance-Type Warranty Illustration: Denson Machinery Company begins production of a new machine in July 2020 and sells 100 of these machines for $5, 000 cash by year-end for a total sales revenue of $500, 000 (100 × $5, 000). Each machine is under warranty for one year. Denson estimates, based on past experience with similar machines, that the warranty cost will average $200 per unit for a total expected warranty expense of $20, 000 (100 × $200). Further, as a result of parts replacements and services performed in compliance with machinery warranties, it incurs $4, 000 in warranty costs in 2020 and $16, 000 in 2021. LO 3 Copyright © 2019 John Wiley & Sons, Inc. 61

Assurance-Type Warranty Recognize Sale of Machines 1. Prepare the journal entry to record the sale of the machines and related warranty costs (July-Dec. 2020). Cash Sales Revenue ($5, 000 × 100) LO 3 500, 000 Copyright © 2019 John Wiley & Sons, Inc. 500, 000 62

Assurance-Type Warranty Record Payment 2020 2. Prepare the journal entry to record payment for warranty costs incurred (July-Dec. 2020). Warranty Expense Cash, Inventory, Accrued Payroll LO 3 Copyright © 2019 John Wiley & Sons, Inc. 4, 000 63

Assurance-Type Warranty Adjusting Entry 3. Prepare the adjusting entry to record estimated warranty expense and warranty liability for expected warranty claims in 2021 (Dec. 31, 2020): Warranty Expense 16, 000 Warranty Liability ($20, 000 − $4, 000) 16, 000 Balance sheet reports a warranty liability (current) of $16, 000 ($20, 000 – $4, 000). Income statement for 2020 reports sales revenue of $500, 000 and warranty expense of $20, 000. LO 3 Copyright © 2019 John Wiley & Sons, Inc. 64

Assurance-Type Warranty Record Payment 2021 4. Prepare the entry to record the payment for warranty costs incurred in 2021 related to 2020 machinery sales (Jan. 1 – Dec. 31, 2021): Warranty Liability Cash, Inventory, Accrued Payroll 16, 000 At the end of 2021, no warranty liability is reported for the machinery sold in 2020. LO 3 Copyright © 2019 John Wiley & Sons, Inc. 65

Guarantee and Warranty Costs Service-Type Warranty that provides an additional service beyond the assurance-type warranty. • Recorded as a separate performance obligation. • Usually recorded in an Unearned Warranty Revenue account. • Recognize revenue on a straight-line basis over the period the service-type warranty is in effect. LO 3 Copyright © 2019 John Wiley & Sons, Inc. 66

Service-Type Warranty Illustration: You purchase an automobile from Hamlin Auto for $30, 000 on January 2, 2020. Hamlin estimates the assurance-type warranty costs on the automobile to be $700 (Hamlin will pay for repairs for the first 36, 000 miles or three years, whichever comes first). You also purchase for $900 a service-type warranty for an additional three years or 36, 000 miles. Hamlin incurs warranty costs related to the assurancetype warranty of $500 in 2020 and $200 in 2021. Hamlin records revenue on the service-type warranty on a straightline basis. What entries should Hamlin make in 2020 and 2023? LO 3 Copyright © 2019 John Wiley & Sons, Inc. 67

Service-Type Warranty Record the Sale 1. Prepare the journal entry to record the sale of the automobile and related warranties (January 2, 2020). Cash ($30, 000 + $900) Unearned Warranty Revenue Sales Revenue LO 3 30, 900 Copyright © 2019 John Wiley & Sons, Inc. 900 30, 000 68

Service-Type Warranty Record Warranty Costs 2. Prepare the journal entry to record the warranty costs incurred in 2020 (January 2, - December 31, 2020). Warranty Expense Cash, Inventory, Accrued Payroll LO 3 Copyright © 2019 John Wiley & Sons, Inc. 500 69

Service-Type Warranty Adjusting Entry 3. Prepare the adjusting entry to record estimated warranty expense and warranty liability for expected assurance warranty claims in 2021 (Dec. 31, 2020): Warranty Expense Warranty Liability 200 Balance sheet reports a warranty liability of $200 for the assurancetype warranty costs in 2021 and 2022. Income statement for 2020 reports sales revenue of $30, 000 and warranty expense of $700. LO 3 Copyright © 2019 John Wiley & Sons, Inc. 70

Service-Type Warranty Revenue Recognized in 2023 4. Prepare the entry to record revenue recognized in 2023 on the service-type warranty (Jan. 1 – Dec. 31, 2023): Unearned Warranty Revenue ($900 ÷ 3) Warranty Revenue 300 Warranty costs under the service-type warranty will be expensed as incurred in 2023– 2025. LO 3 Copyright © 2019 John Wiley & Sons, Inc. 71

Loss Contingencies Consideration Payable Companies should charge the costs of premiums and coupons to expense in the period of the sale that benefits from the plan. • Company estimates the number of outstanding premium offers that customers will present for redemption. • Company charges the cost of premium offers to Premium Expense and credits Premium Liability. LO 3 Copyright © 2019 John Wiley & Sons, Inc. 72

Consideration Payable Illustration: Fluffy Cake Mix Company sells boxes of cake mix for $3 per box. In addition, Fluffy Cake Mix offers its customers a large durable mixing bowl in exchange for $1 and 10 box tops. The mixing bowl costs Fluffy Cake Mix $2, and the company estimates that customers will redeem 60 percent of the box tops. The premium offer began in June 2020. During 2020, Fluffy Cake Mix purchased 20, 000 mixing bowls at $2, sold 300, 000 boxes of cake mix for $3 per box, and redeemed 60, 000 box tops. 1. Prepare the journal entry to record the purchase of 20, 000 mixing bowls at $2 per bowl. Premium Inventory (20, 000 bowls × $2) 40, 000 Cash LO 3 Copyright © 2019 John Wiley & Sons, Inc. 73

Consideration Payable Sale of Cake Boxes and Redemption of Box Tops 2. Prepare the journal entry to record the sale of the cake mix boxes in 2020. Cash (300, 000 boxes × $3) Sales Revenue 900, 000 3. Prepare the entry to record the redemption of 60, 000 box tops, receipt of $1 per 10 box tops, and delivery of mixing bowls: Cash [(60, 000 ÷ 10) × $1] Premium Expense Premium Inventory [(60, 000 ÷ 10) × $2] LO 3 Copyright © 2019 John Wiley & Sons, Inc. 6, 000 12, 000 74

Consideration Payable Adjusting Entry 4. Prepare the adjusting entry to record additional premium expense and the estimated premium liability at Dec. 31, 2020. Premium Expense Premium Liability 12, 000 Total box tops sold in 2020 Estimated redemptions (in percent) Total estimated redemptions Cost of estimated redemptions [(180, 000 box tops ÷ 10) × ($2 − $1)] Redemptions to date Liability at 12/31/20 LO 3 Copyright © 2019 John Wiley & Sons, Inc. 12, 000 300, 000 60% 180, 000 $ 18, 000 (6, 000) $ 12, 000 75

Loss Contingencies Environmental Liabilities A company must recognize an asset retirement obligation (ARO) when it has an existing legal obligation associated with the retirement of a long-lived asset and when it can reasonably estimate the amount of the liability. ARO’s should be recorded as fair value. LO 3 Copyright © 2019 John Wiley & Sons, Inc. 76

Environmental Liabilities Obligating Events Examples of existing legal obligations, which require recognition of a liability include, but are not limited to: • Decommissioning nuclear facilities; • Dismantling, restoring, and reclamation of oil and gas properties; • Certain closure, reclamation, and removal costs of mining facilities; • Closure and post-closure costs of landfills. LO 3 Copyright © 2019 John Wiley & Sons, Inc. 77

Environmental Liabilities Illustration On January 1, 2020, Wildcat Oil Company erected an oil platform in the Gulf of Mexico. Wildcat is legally required to dismantle and remove the platform at the end of its useful life, estimated to be five years. Wildcat estimates that dismantling and removal will cost $1, 000. Based on a 10 percent discount rate, the fair value of the asset retirement obligation is estimated to be $620, 920 ($1, 000 ×. 62092). Wildcat records this ARO as follows. Drilling Platform Asset Retirement Obligation LO 3 Copyright © 2019 John Wiley & Sons, Inc. 620, 920 78

Environmental Liabilities December 31, 2020, 2021, 2022, 2023, 2024 Illustration: During the life of the asset, Wildcat allocates the asset retirement cost to expense. Using the straight-line method, Wildcat makes the following entries to record this expense. December 31, 2020 through 2024 124, 184 Depreciation Expense ($620, 920 ÷ 5) 124, 184 Accumulated Depreciation—Plant Assets LO 3 Copyright © 2019 John Wiley & Sons, Inc. 79

Environmental Liabilities December 31, 2020 Illustration: In addition, Wildcat must accrue interest expense each period. Wildcat records interest expense and the related increase in the asset retirement obligation on December 31, 2020, as follows. December 31, 2020 Interest Expense ($620, 920 × 10%) Asset Retirement Obligation LO 3 Copyright © 2019 John Wiley & Sons, Inc. 62, 092 80

Environmental Liabilities January 10, 2025 Illustration: On January 10, 2025, Wildcat contracts with Rig Reclaimers, Inc. to dismantle the platform at a contract price of $995, 000. Wildcat makes the following journal entry to record settlement of the ARO. January 10, 2025 Asset Retirement Obligation Gain on Settlement of ARO Cash LO 3 1, 000 Copyright © 2019 John Wiley & Sons, Inc. 5, 000 995, 000 81

Loss Contingencies Self-Insurance Self-insurance is not insurance, but risk assumption. There is little theoretical justification for the establishment of a liability based on a hypothetical charge to insurance expense. LO 3 Copyright © 2019 John Wiley & Sons, Inc. 82

Self-Insurance Disclosure Molson Coors Brewing Company Notes to Financial Statements (in part) Note 21: Insurance. We are self-insured for certain insurable risks consisting primarily of employee health insurance programs, as well as workers' compensation, general liability, automobile liability, and property insurance deductibles or retentions. . . we fully insured future risks for long-term disability, and, in most states, workers' compensation, but maintained a self-insured position for workers' compensation for certain self-insured states and for claims incurred prior to the inception of the insurance coverage in Colorado in 1997. LO 3 Copyright © 2019 John Wiley & Sons, Inc. 83

Learning Objective 4 Indicate How to Present and Analyze Liabilities and Contingencies LO 4 Copyright © 2019 John Wiley & Sons, Inc. 84

Presentation and Analysis Presentation of Current Liabilities • Usually reported at their full maturity value. • Difference between present value and the maturity value is considered immaterial. • Companies may list the accounts in LO 4 § Order of maturity, § Descending order of amount, or § Order of liquidation preference. Copyright © 2019 John Wiley & Sons, Inc. 85

Current Liabilities Presentation LO 4 Copyright © 2019 John Wiley & Sons, Inc. 86

Presentation of Current Liabilities If a company excludes a short-term obligation from current liabilities because of refinancing, it should include the following in the note to the financial statements: 1. A general description of the financing agreement. 2. The terms of any new obligation incurred or to be incurred. 3. The terms of any equity security issued or to be issued. LO 4 Copyright © 2019 John Wiley & Sons, Inc. 87

Actual Refinancing of Short-Term Debt LO 4 Copyright © 2019 John Wiley & Sons, Inc. 88

Presentation of Contingencies Disclosure should include: • Nature of the contingency. • An estimate of the possible loss or range of loss or a statement that an estimate cannot be made. Companies should disclose certain other contingent liabilities. 1. Guarantees of indebtedness of others. 2. Obligations of commercial banks under “stand-by letters of credit. ” 3. Guarantees to repurchase receivables (or any related property) that have been sold or assigned. LO 4 Copyright © 2019 John Wiley & Sons, Inc. 89

Disclosure of Loss Contingency through Litigation LO 4 Copyright © 2019 John Wiley & Sons, Inc. 90

Analysis of Current Liabilities Two ratios to help assess liquidity based on the information for Best Buy Co. previously provided. LO 4 Copyright © 2019 John Wiley & Sons, Inc. 91

Learning Objective 5 Compare the Accounting Procedures for Current Liabilities and Contingencies Under GAAP and IFRS LO 5 Copyright © 2019 John Wiley & Sons, Inc. 92

IFRS Insights Relevant Facts – Similarities • Similar to U. S. practice, IFRS requires that companies present current and non-current liabilities on the face of the statement of financial position (balance sheet), with current liabilities generally presented in order of liquidity. However, many companies using IFRS present noncurrent liabilities before current liabilities on the statement of financial position. • The basic definition of a liability under GAAP and IFRS is very similar. In a more technical way, liabilities are defined by the IASB as a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits. Liabilities may be legally enforceable via a contract or law but need not be. That is, they can arise due to normal business practices or customs. LO 5 Copyright © 2019 John Wiley & Sons, Inc. 93

IFRS Insights Relevant Facts – Similarities • IFRS requires that companies classify liabilities as current or noncurrent on the face of the statement of financial position (balance sheet), except in industries where a presentation based on liquidity would be considered to provide more useful information (such as financial institutions). • Under IFRS, short-term obligations expected to be refinanced can be classified as non-current if the refinancing is completed by the financial statement date. GAAP now also uses the balance sheet date. LO 5 Copyright © 2019 John Wiley & Sons, Inc. 94

IFRS Insights Relevant Facts – Differences • Under IFRS, the measurement of a provision related to a contingency is based on the best estimate of the expenditure required to settle the obligation. If a range of estimates is predicted and no amount in the range is more likely than any other amount in the range, the “midpoint” of the range is used to measure the liability. In GAAP, the minimum amount in a range is used. • Both IFRS and GAAP prohibit the recognition of liabilities for future losses. However, IFRS permits recognition of a restructuring liability, once a company has committed to a restructuring plan. GAAP has additional criteria (i. e. , related to communicating the plan to employees) before a restructuring liability can be established. LO 5 Copyright © 2019 John Wiley & Sons, Inc. 95

IFRS Insights Relevant Facts – Differences • IFRS and GAAP are similar in the treatment of asset retirement obligations (AROs). However, the recognition criteria for an ARO are more stringent under GAAP: The ARO is not recognized unless there is a present legal obligation and the fair value of the obligation can be reasonably estimated. • IFRS uses the term provisions to refer to estimated liabilities. Under IFRS, contingencies are not recorded but are often disclosed. The accounting for provisions under IFRS and estimated liabilities under GAAP are very similar. • GAAP uses the term contingency in a different way than IFRS. Contingent liabilities are not recognized in the financials under IFRS, whereas under GAAP, a contingent liability is sometimes recognized. LO 5 Copyright © 2019 John Wiley & Sons, Inc. 96

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