2.x Liabilities

Question 1

What are financial liabilities?

Answer 1

Contracts that impose on the entity an obligation to either:

1) Deliver cash or another financial instrument to another entity -OR-
2) Exchange other financial instruments on potentially unfavorable terms with the other entity

Question 2

What is a current liability?

Answer 2

A liability expected to be settled within one year (12 months) or the operating cycle, whichever is longer

Question 3

What value are current liabilities carried at?

Answer 3

Net realizable value (NRV)

Question 4

Differentiate between the gross method and the net method for purchase discounts.

Answer 4

The gross method records a discount that reduces COGS, while the net method “nets” the discount against the Purchase Expense. If the discount period has subsequently passed, additional COGS will be recognized for the gross method, while additional Interest Expense will be recognized for the net method.

Question 5

With regard to FOB shipping point, when is a payable recognized?

Answer 5

When goods are transferred into the hands of the common carrier (same as when seller recognizes the sale)

Question 6

With regard to FOB destination, when is a payable recognized?

Answer 6

When goods are ultimately received into the hands of the purchaser (same as when seller recognizes the sale)

Question 7

Differentiate between accrued liabilities and accrued expenses.

Answer 7

Trick question! They are one in the same, just different ways of saying the same thing: an expense that has been incurred, but yet to be paid (current liability)

Question 8

What is deferred revenue?

Answer 8

Same thing as Unearned Revenue (current liability). Cash has been received from the customer, but the earnings process is incomplete (undelivered, unfulfilled).

Question 9

What are warranties? How are they classified?

Answer 9

Promises of repairs or replacement for a limited time period accompanying the sale of a product. They are classified as a current liability and are recorded at the time the product is sold.

Question 10

How are warranties recognized?

Answer 10

Dr. Warranty expense

Cr. Estimated warranty liability

Question 11

How are a product’s associated expected warranty expenses over multiple years treated? Are they recorded in each of those years?

Answer 11

No, this is bad matching (and not GAAP)! If 1% likelihood in the first year and 3% in the second year, then combine them to arrive at the appropriate warranty expense at the time of sale (4%).

Question 12

How are warranty repairs recognized?

Answer 12

Dr. Estimated warranty liability

Cr. Cash spent on warranty repair/replacement

Question 13

How are service contracts classified and recognized?

Answer 13

Service contracts are a form of deferred (unearned) revenue:

Dr. Cash
Cr. Deferred service revenue

Question 14

With regard to compensated absences (vacation/sick), what does accumulation refer to?

Answer 14

Days not taken in the current period may be used in a future period.

Question 15

With regard to compensated absences (vacation/sick), what does vesting refer to?

Answer 15

Days not used will be paid in cash at the time of the employee’s termination of service with the company.

Question 16

With regard to compensated absences, are the costs associated with sick days recognized?

Answer 16

Only if the sick pay amount VESTS. It is also PERMITTED if the pay only accumulates, but doesn’t vest.

Question 17

With regard to compensated absences (vacation/sick), how are they recognized?

Answer 17

Dr. Vacation/Sick pay expense

Cr. Liability for unused vacation/sick days

Question 18

How are refundable deposits recognized?

Answer 18

Dr. Cash

Cr. Refundable deposit liability

Question 19

Can revenue from refundable deposits be recognized?

Answer 19

Yes. Usually is recognized after returning a significant portion back.
Dr. Refundable deposit liability
Cr. Revenue

Question 20

How are subscriptions treated?

Answer 20

Upon receipt of cash:
Dr. Cash
Cr. Unearned subscription revenue

As subscription is fulfilled (earned):

Dr. Unearned subscription revenue
Cr. Subscription revenue

Question 21

With regard to payroll taxes, do employees pay unemployment taxes?

Answer 21

No, only the employer

Question 22

With regard to payroll taxes, who pays FICA taxes?

Answer 22

Both the employer and the employee

Question 23

Are the employer payroll taxes taken out of the payroll? How is the employer’s payroll recognized?

Answer 23

No! They are expensed in addition to the gross payroll.

Dr. Payroll tax (FICA & FUTA) – ER
Cr. Payroll tax liability (FICA & FUTA)- ER

Dr. Payroll
Cr. Tax withholdings due (IRS, State, & FICA) – EE
Cr. Cash

Question 24

What is a contingency?

Answer 24

A gain or loss that may occur in the future as a result of an existing condition.

Question 25

What are gains or losses that may occur in the future as a result of an existing condition?

Answer 25

Contingencies

Question 26

What are contingent liabilities?

Answer 26

A potential obligation that may be incurred depending on the outcome of a future event. A contingent liability is one where the outcome of an existing situation is uncertain, and this uncertainty will be resolved by a future event.

Question 27

What are some examples of contingent liabilities?

Answer 27

Obligations related to product warranties
Pending or threatened litigation
Guarantees of indebtedness of others (suretyship)
Obligations related to product defects
Threat of expropriation of assets
Collectibility of receivables

Question 28

When are loss contingencies recorded?

Answer 28

If Probable & Estimable - they are accrued and disclosed

If Probable, but not Estimable – they are ONLY disclosed (as lack of estimate hinders accruing)

If Reasonably Possible - they are disclosed

If Remote - don’t accrue or disclose

Question 29

How are loss contingencies recognized?

Answer 29

*if probable and estimable
Dr. Estimated Loss
Cr. Estimated Contingency Liability

Question 30

How are range of losses handled?

Answer 30

Disclose the range and accrue the most likely amount to occur (think estimated cash flows)

Question 31

How are gain contingencies recognized?

Answer 31

They are NEVER accrued until REALIZED due to Conservatism

Question 32

What is a subsequent event?

Answer 32

An event occurring after the balance sheet date, but before the date that the financial statements are issued or are available to be issued.

Question 33

Distinguish between a Type I and Type II subsequent event

Answer 33

Type I – a condition that existed at the balance sheet date that will require an ADJUSTMENT to be RECOGNIZED due to a subsequent event
Type II – a condition that DID NOT exist at the balance sheet date, and as such will only be DISCLOSED (as it still represents important financial information to users)

Question 34

If a note payable occurs in the ordinary course of business, what value is it recorded at?

Answer 34

Face value (don’t present value the note)

Question 35

If a company is planning on refinancing its short-term obligations to long-term liabilities after the balance sheet date, can it reclassify them as long-term liabilites at the balance sheet date?

Answer 35

Yes, as long as the company has the INTENT and ABILITY:
Intent – company is going to issue L/T debt or equity securities after B/S date
Ability – company signed a firm agreement to refinance the obligation with a lender or invester that has the ability to provide the financing

Question 36

What is suretyship? Does it require disclosure?

Answer 36

Guaranteeing the debt of another. Yes, it requires disclosure (but no accrual).

Question 37

What is the debt considered to be when a debtor cannot pay a debt as it comes due?

Answer 37

Troubled Debt

Question 38

What is Troubled Debt?

Answer 38

Debt that a debtor cannot pay when it comes due

Question 39

When is a loan considered impaired?

Answer 39

Probable that all amounts due (principal and interest) will not be received

Question 40

How is an impaired loan reported by the creditor?

Answer 40

Present value of the loan’s expected future cash flows are discounted at the loan’s effective interest rate:

Dr. Bad debt expense
Cr. Allowance for credit losses

Question 41

When undergoing troubled debt restructuring, can a creditor have an extraordinary gain or loss?

Answer 41

No, the creditor will always recognize ORDINARY losses, since the restructuring is at the creditor’s insistence!

Question 42

When is a gain recognized in a debt restructuring?

Answer 42

If terms are modified, and the debtor’s future payments are now less than the carrying amount of the debt, then a Gain is recognized (by the debtor). Conversely, the creditor recognizes a loss

Question 43

What is the gain recognized under a settlement of debt?

Answer 43

Difference between cash paid and carrying amount of debt

Difference between non-cash asset given and re-valued at FMV and debt carrying amount

Question 44

Under Troubled Debt Restructuring, if the future payments are less than the obligation, what do the debtor and creditor recognize, respectively?

Answer 44

The debtor recognizes a gain (presumably extraordinary if unusual and infrequent) and the creditor recognizes an ordinary loss

Question 45

Under Troubled Debt Restructuring, if the future payments are greater than the obligation, what do the debtor and creditor recognize, respectively?

Answer 45

There is no gain or loss recorded as it is considered an adjustment of the interest rate

Question 46

Under Troubled Debt Restructuring, if the debtor elects the fair value option, does this affect the accounting by the creditor?

Answer 46

No, the debtor’s election of the fair value option has no effect on the accounting by the creditor.

Question 47

Under Bankruptcy, what is the general priority list of asset claims against the bankrupt entity?

Answer 47

1) Secured Creditors (those with partially secured claims have those unsecured portions relegated to general/unsecured creditor priority)
2) Priority claims (STOP-IT Drunk Driver)
3) General (unsecured) creditors

Question 48

Under Bankruptcy, what is the priority list within the Priority Claims category?

Answer 48

1) Support and Alimony payments
2) Trustee, Attorney, and Accountant fees
3) Owed to involuntary gap creditors
4) Payroll within 180 days up to $12,475
5) Individual consumer deposits up to $2,775
6) Tax claims within 3 years of the filing
7) Drunk Driver injury claims

“STOP IT, Drunk Driver”

Question 49

The difference between book value and fair value is always what type of gain (or loss)?

Answer 49

Ordinary, as it occurs in the normal course of business (as opposed to extraordinary)

Question 50

For a creditor, how is a loan impairment recorded?

Answer 50

If future cash flows discounted at loan’s Effective Interest Rate are less than Carrying Value:

Effective Rate calculated using original rate; not modified rate

Question 51

Under IFRS, what are the two main types of current liability classifications?

Answer 51

Contingencies and Provisions?

Question 52

Under IFRS, what are contingencies?

Answer 52

A possible obligation arising from past events whose outflows of resources are either not PROBABLE or ESTIMABLE.

Question 53

Under IFRS, what are provisions?

Answer 53

Liabilities that are uncertain in timing or amount and have three conditions met:

1) Present obligation as a result of a past event
2) Probable that an outflow of resources will be required
3) Amount of the obligation can be reliably estimated

Question 54

Under IFRS, can provisions also be considered contingencies?

Answer 54

Yes, provisions are also contingencies in that they are uncertain as to timing or amount, but since provisions are actually reported on the balance sheet, they are treated separately from contingencies.

Question 55

Under IFRS, can contingencies also be considered provisions?

Answer 55

No, as provisions are reported on the balance sheet, while contingencies are only disclosed in the notes. Once contingencies are recognized, they become provisions.

Question 56

How does IFRS differ from GAAP with regard to refinancing (and reclassifying) current liabilities as noncurrent liabilities?

Answer 56

While GAAP emphasizes intent and ability, IFRS mandates that an actual AGREEMENT to refinance must be in place as of the balance sheet date.