Topic 1 CURRENT LIABILITIES AND CONTINGENCIES Slide 2
Topic 1 CURRENT LIABILITIES AND CONTINGENCIES
Slide 2 Characteristics of Liabilities Statement of Accounting Concepts #6 Para 35 Probable future sacrifices of economic benefits. . . Arising from present obligations to other entities. . . Resulting from past transactions or events. Not defined in FASC. 13 -2
Slide 3 What is a Current Liability? LIABILITIES Current Liabilities Long-term Liabilities 210 -10 -45 -6 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. 13 -3
Slide 4 Current Liabilities Accounts payable Taxes payable Unearned revenues Cash dividends payable Current Liabilities Wages & Benefits Payable Accrued expenses Short-term notes payable 13 -4
Slide 5 Current Ratio = Current Assets Current Liabilities This ratio measures the ability of the company to pay current debts as they become due. As a rule of thumb, a current ratio of 2. 0 is considered indicative of adequate liquidity. 13 -5
Slide 6 Acid-Test Ratio Acid-Test = Ratio Quick Assets Current Liabilities Quick assets are Cash (including temporary cash investments) and Accounts Receivable. This ratio provides information about an almost worst-case situation—the firm’s ability to meet its current obligations even if none of the inventory can be sold. As a rule of thumb, an acid-test ratio of 1. 0 is considered indicative of adequate liquidity. 13 -6
Slide 7 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. 13 -7
Slide 8 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. 13 -8
Slide 9 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. 13 -9
Slide 10 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%. How much interest is due to Cooke Bank at year-end, on December Interest is calculated as: 31? a. b. c. d. $2, 400 $3, 600 $7, 200 $87, 200 Face Annual Time to = × Rate maturity × Amount $80, 000 9% 4/12 × × = $2, 400 interest due to Cooke Bank. 13 -10
Slide 11 Interest-Bearing Notes Assume Eagle Boats’ year-end is December 31. Record the necessary adjustment at year-end. 13 -11
Slide 12 Interest-bearing Notes Assume Eagle Boats’ year-end is December 31. Record the necessary journal entry when the note matures on February 28. 13 -12
Slide 13 Exercise 13 -1 Open Excel worksheet on portal under topic 1 PDF file there has the exercises from textbook 13 -13
Noninterest-Bearing Notes Slide 14 Imputation of Interest Notes without a stated interest rate carry an implicit, or effective rate. The face of the note includes the amount borrowed and the interest. FASC 835 -30 -25 -10 13 -14
Noninterest-Bearing Notes Imputation of Interest – ASC Topic 835 -30 25 -10 In circumstances where interest is not stated, the stated amount is unreasonable, or the stated face amount of the note is materially different from the current cash sales price for the same or similar items or from the market value of the note at the date of the transaction, the note, the sales price, and the cost of the property, goods, or service exchanged for the note shall be recorded at the fair value of the property, goods, or service or at an amount that reasonably approximates the market value of the note, whichever is the more clearly determinable. That amount may or may not be the same as its face amount, and any resulting discount or premium shall be accounted for as an element of interest over the life of the note. Mc. Graw-Hill /Irwin © 2008 The Mc. Graw-Hill Companies, Inc.
Slide 16 Noninterest-Bearing Notes 25 -8 Notes exchanged for property, goods, or services are valued and accounted for at the present value of the consideration exchanged between the contracting parties at the date of the transaction in a manner similar to that followed for a cash transaction. On May 1, Batter-Up, Inc. issued a one-year, noninterest-bearing note with a face amount of $10, 600 in exchange for equipment valued at $10, 000. How much interest will Batter-Up pay on the note? Interest = Face Amount - Amount Borrowed = $10, 600 - $10, 000 = $600 13 -16
Slide 17 Noninterest-Bearing Notes On May 1, Batter-Up, Inc. issued a one-year, noninterest-bearing note with a face amount of $10, 600 in exchange for equipment valued at $10, 000. What is the effective interest rate on the note? 25 -8 Notes exchanged for property, goods, or services are valued and accounted for at the present value of the consideration exchanged between the contracting parties at the date of the transaction in a manner similar to that followed for a cash transaction. 13 -17
Slide 18 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. Commercial paper is issued directly to the lender and is backed by a line of credit with a bank. Commercial paper is recorded in the same manner as notes payable. 13 -18
Slide 19 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. 13 -19
Slide 20 Vacations, Sick Days, and Other Paid Future Absences An employer should accrue an expense and the related liability for employees’ compensation for future absences (such as vacation pay) if the obligation meets all four of these conditions: 1. The obligation is for services already performed. 2. The paid absence can be taken in a later year—the benefit vests or the benefit can be accumulated over time. 3. Payment is probable. 4. The amount can be reasonably estimated. Sick pay quite often meets the conditions for accrual, but accrual is not mandatory because future absence depends on future illness, which usually is not a certainty. 13 -20
Slide 21 Liabilities from Advance Collections Refundable Deposits Advances from Customers Collections for Third Parties 13 -21
Slide 22 Exercise 13 -8 13 -22
Slide 23 Gift Cards During their December 2012 Christmas promotion, Meglo. Mart sold 20, 000 gift cards at $25 each. All gift card sales were for cash. On December 31, 2012, only 1, 000 gift cards had been redeemed. Unused gift cards expire on December 31, 2013, if not used to purchase Meglo. Mart merchandise. Prepare the journal entries on December 31, 2012, to record the December 2012 sale and redemption of gift cards. December 31, 2012: Cash (20, 000 × $25) . . Unearned revenue …. . . 500, 000 To record cash received from gift card sales. December 31, 2012: Unearned revenue (1, 000 × $25) . . . . Sales revenue …. . . . 25, 000 To record revenue from gift card redemptions. 13 -23
Slide 24 Gift Cards By December 31, 2013, 18, 500 additional gift cards had been redeemed. Prepare the journal entry on December 31 to record the 2013 redemptions. December 31, 2013: Unearned revenue (18, 500 × $25) …. . . . Sales revenue (18, 500 × $25) …. . 462, 500 To record revenue from gift card redemptions. On December 31, 2013, the 500 remaining cards had not been redeemed. Prepare the journal entry on December 31 to record the gift card expirations. December 31, 2013: Unearned revenue (500 × $25) …. . . . . Gift card breakage revenue ………. . 12, 500 To record revenue from gift card expirations. 13 -24
Slide 25 Quick question Which of the following is not a liability? A. An unused line of credit. B. Estimated income taxes. C. Sales tax collected from customers. D. Advances from customers. 13 -25
Slide 26 A Closer Look at the Current and Noncurrent 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. ASC 210 -10 -45 -7 13 -26
Short-Term Obligations Expected to be Refinanced Slide 27 A company may reclassify a short-term liability as long-term only if two conditions are met: It has the intent to refinance on a long-term basis. and It has demonstrated the ability to refinance. The ability to refinance on a long-term basis can be demonstrated by an: existing refinancing agreement, or actual financing prior to issuance of the financial statements. ASC 210 -10 -45 -7 13 -27
Slide 28 Contingencies A loss contingency is an existing uncertain situation involving potential loss depending on whether some future event occurs. FASC 450 -20 -20 13 -28
Slide 29 Contingencies Two factors affect whether a loss contingency must be accrued and reported as a liability: 1. the likelihood that the confirming event will occur. 2. whether the loss amount can be reasonably estimated. 13 -29
Slide 30 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. 13 -30
Slide 31 Contingencies A loss contingency is accrued only if a loss is probable and the amount can reasonably be estimated. 13 -31
Slide 32 Product Warranties and Guarantees Product warranties inevitably entail costs. The amount of those costs can be reasonably estimated using commonly available estimation techniques. The estimate requires the following adjusting journal entry: 13 -32
Slide 33 Warranty Expenses Incurred During Period When a cost is incurred during the period between the sale and the adjusting entry to record warranty liability and expense, most firms will debit the warranty expense account and credit cash, inventory, or accounts payable depending on how repairs are made. These costs reduce the adjusting entry for the estimated liability at the end of the period. Demo. Problem. docx 13 -33
Slide 34 Extended Warranties 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. 13 -34
Slide 35 Product Warranties and Guarantees Obligations > One Year 13 -35
Slide 36 Premiums – rebates & other promotions 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. Examples of a premium are cash rebates, free giveaways, frequency awards 13 -36
Slide 37 Litigation Claims 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. 13 -37
Slide 38 Subsequent Events occurring between the year-end date and report date can affect the appearance of disclosures on the financial statements. Cause of Loss Contingency Fiscal Year Ends Clarification Financial Statements 13 -38
Slide 39 Unasserted Claims and Assessments Unasserted claim No disclosure needed No Is a claim or assessment probable? 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 be accrued if an unfavorable outcome is probable and the amount can be reasonably estimated. 13 -39
Slide 40 Gain Contingencies Note that the prior rules have supported the recording of LOSS contingencies. As a general rule, we never record GAIN contingencies. 13 -40
U. S. GAAP vs. IFRS Classification of Liabilities to be Refinanced • Liabilities payable within the coming year are classified as long‐term liabilities if refinancing is completed before date of issuance of the financial statements. 13 - 41 • Liabilities payable within the coming year are classified as long‐term liabilities if refinancing is completed before the balance sheet date.
U. S. GAAP vs. IFRS Contingencies • Defines probable as an event is likely to occur. • Refers to both accrued and non-accrued obligations as contingent liabilities. • Requires use of low end of a range of equally likely outcomes. • Allows using present value under some circumstances. 13 - 42 • Defines probable as more likely than not, a lower threshold than U. S. GAAP. • Refers to accrued liabilities as provisions and non-accrued as contingent liabilities. • Requires use of midpoint of a range of equally likely outcomes. • Requires reporting present values when material.
Slide 43 Appendix 13 ─ Payroll-Related Liabilities Employers incur several expenses and liabilities from having employees. 13 -43
Slide 44 Payroll-Related Liabilities Gross Pay FICA Taxes Medicare Taxes Federal Income Tax State and Local Voluntary Income Taxes Deductions Net Pay 13 -44
Slide 45 Employees’ Withholding 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. 13 -45
Slide 46 Employees’ Withholding Taxes Federal Insurance Contributions Act (FICA) FICA Taxes 4. 2% of the first $110, 100 earned in the year. Medicare Taxes 1. 45% of all wages earned in the year. Employers must pay withheld taxes to the Internal Revenue Service (IRS). 13 -46
Slide 47 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. 13 -47
Slide 48 Employers’ Payroll Taxes FICA Taxes Medicare Taxes Federal and State Unemployment Taxes Employers pay amounts equal to that withheld from the employee’s gross pay. 13 -48
Slide 49 Federal and State Unemployment Taxes Federal Unemployment Tax Act (FUTA) State Unemployment Tax Act (SUTA) 6. 2% on the first $7, 000 of wages paid to each employee (A credit up to 5. 4% is given for SUTA paid. ) Basic rate of 5. 4% on the first $7, 000 of wages paid to each employee (Merit ratings may lower SUTA rates. ) 13 -49
Slide 50 Fringe Benefits In addition to salaries and wages, withholding taxes, and payroll taxes, most companies provide a variety of fringe benefits. Health insurance premiums Life insurance premiums Retirement plan contributions Employers must pay the amounts promised to fund employee fringe benefits to the designated agency. 13 -50
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