Ch 13 Flashcards
3 essential characteristics of a liability
1 present obligation that entails settlement by probable
Future transfer, or use of cash, goods or services
2 unavoidable obligation
3 transaction or event creating obligation has already occurred
Liabilities
Probable future sacrifices of economic benefits arising
From present obligations of particular entity
To transfer assets or services to other entities in future
As a result of past transactions
Current liabilities
Obligations whose liquidation is reasonably expected to
Require use of current assets or the creation of other
Current liabilities
Operating cycle is the period of time elapsing…
btw acquisitions of goods and services involved in
manufacturing and final cash realization from sale
5 Typical current liabilities that don’t end in payable?
1 current maturities on Longterm debt 2 short term obligations expected to be refinanced 3 customer advances and deposits 4 unearned revenues 5 employee related liabilities
Accounts payable AKA Trade accounts payable
Balances owed to others for goods, services or supplies
Purchased on open account
Arise b/c time lag between receipt of product or service
And transfer of payment
Notes Payable AKA Trade notes payable
Written promises to pay certain sum of money on specified
Future date
May arise from purchases, financing or other transactions
Zero interest bearing note 4 things (note 3 and 4 are same thing)
1 Does not state an interest rate on face of note
2 interest is still charged
3 at maturity, borrower must pay back amount greater
Than received on issuance day
4 borrower receives in cash present value of note
Discount on notes payable
Contra account to notes payable
Subtracted from notes payable on balance sheet
Represents interest expense charged in future periods
Current maturities on long term debt
Current liabilities on portion of bonds, mortgage notes,
Other Longterm indebtedness that matures within year
Companies exclude Longterm debts maturing currently
As current liabilities if… 3 things
1 retired by assets accumulated for this purpose that
Properly haven’t been shown as current assets
2 refinanced, or retired from proceeds of new debt issue
3 converted into capital stock
When only a part of Longterm debt is to be paid within the next 12 months the company reports…
The maturing portion of Longterm debt as current liability
Due on demand, callable
Any liability should be classified as current if callable by
Creditor or due on demand in operating cycle
Callable Brought on by violation of agreement
Short term obligations that are expected to be refinanced on long term basis
Will not require use of working capital over next year
2 refinancing criteria for exclusion of short term obligation from current liabilities
1 intend to refinance obligation on long term basis
2 demonstrate ability to consummate refinancing
Intention to refinance on Longterm basis means?
Company intends to refinance short term obligations
So it won’t require use of working capital in fiscal year
2 ways company demonstrates ability to consummate refinancing?
1 actual refinancing
2 entering financing agreement
Ability to consummate the refinancing: Actual refinancing
by issuing long term obligation or Equity securities after date
of balance sheet but before It is issued
Ability to consummate the refinancing: Entering a financing agreement
That clearly permits company to refinance debt on long term
Basis on terms readily determinable
IFRS requires that the current portion of long term debt be classified as…
Current unless agreement to refinance on Longterm basis
Is completed before date of financial statements
Cash dividends payable
Amount owed by corporation to stockholders as result
Of board of directors’ authorization
Preferred dividends in arears
Companies don’t recognize accumulated but undeclared
Dividends on cumulative preferred stock as liability
B/c not obligation til board of directors authorizes payment
Stock dividends
Dividends payable in form of additional shares of stock
Not recognized as liability
Returnable cash deposits
Received from customers and employees
Guarantees performance of contract or service
Or guarantees to cover payment of expected future obligations
Unearned revenues, how are they accounted for (2 steps)
1 when company receives advanced payment, it debits cash
Credits unearned revenues
2 when company recognizes revenue it debits unearned
revenue and credits revenue account
3 types of employee related liabilities
1 payroll deductions
2 compensated absences
3 bonuses
Payroll deductions, 4 most common types?
Taxes, insurance premiums, employee savings, union dues
To the extent that a company has not remitted the amounts deducted to the proper authority at the end of the accounting period…
It should be recognized as a current liability
Old age, Survivor, and Disability Insurance (OASDI) tax AKA FICA (federal insurance contribution act)
Social security taxes levied from employees and employers gross pay
Benefits for certain individuals and their families
6.2% tax
Medicare AKA federal hospital insurance tax
2 part program alleviates high cost of medical care
For those over 65
1.45% tax
Social security tax
Combination of FICA and federal hospital insurance tax
Companies should report the amount of unremitted employee and employer Social security tax on…
Gross wages paid as current liability
All employers who meet the 2 criteria are subject to the Federal Unemployment Tax Act (FUTA)
1 those who paid wages of over $1500 during calendar
Quarter in year of proceeding year
2 those who employed 1 individual on at least 1 day in each
20 weeks during current or preceding calendar year
Merit rating
Reduces state contribution rate for unemployment tax
Paid by employers
Companies should record the amount of accrued but unpaid employer contributions as…
Operating expenses and current liabilities when preparing
Financial statements at year end
3 Examples of employee payroll deductions
1 withholding taxes payable
2 FICA Taxes Payable
3 Union dues payable
3 examples of employer payroll taxes
1 FICA Taxes Payable
2 FUTA Taxes Payable
3 SUTA Taxes Payable
Compensated absences, examples
Paid absences from employment
Ex: vacations, illness, holidays
Companies should accrue liability for the cost of compensation for future absences if all 4 of the following conditions exist
1 employers obligation to pay employee for future absences
Is attributable to employees’ rights to receive compensation services already rendered
2 obligation relates to rights that vest or accumulate
3 payment of compensation is probable
4 amount can be reasonable estimated
Vested rights
Exist when employer has obligation to make payment
To an employee even after terminating his employment
Not contingent on employees’ future service
Accumulated rights
Those that employees can carry forward to future periods
If not used in period in which earned
Sick pay benefits vest or not
If sick pay benefits vest, company must accrue them
If sick pay benefits accumulate but do not vest, company
May choose whether to accrue them
Bonus
Paid to employees depends on company’s profit
Examples of contractual agreements for conditional expenses
Agreements covering rents or royalty payments conditional
On amount of revenues recognized
or quantity of product produced/extracted
Contingency, examples
Existing condition, situation or set of circumstances
Of possible gain or loss
Ex. Lawsuits, warranties, default of a loan
Gain contingencies, define, 4 examples
Claims or rights to receive assets who’s existence is
uncertain but may eventually become valid
1 possible receipt of monies from gifts, donations, asset sales
2 possible refunds from govt tax disputes
3 pending court cases with favorable outcome
4 tax loss carryovers
Loss contingencies: contingent liabilities
Depend on occurrence of 1 or more future events to
Confirm either amt payable, the payee, the date payable,
It existence
Provisions
IFRS term for estimated liabilities
FASB’S term: probable
Future event is likely to occur
FASB’S term: reasonably possible
Chance of future event is more than remote but less likely
FASB’S term: remote
Chance of future events occurring is slight
Companies should accrue an estimated loss from a loss contingency by charge to expense liability if both of the following 2 conditions are met…
1 info available prior to issuance of financial statements
Indicates that it is probable that liability has been incurred
At date of financial statements
2 amount of loss can be reasonably estimated
3 loss contingencies that are usually accrued?
1 collectibility of receivables
2 obligations related to product warranties and product defects
3 premiums offered to customers
3 Loss contingencies not accrued
1 risk or loss or damage of enterprise property to fire,
Explosion or other hazards
2 general or unspecified business risks
3 risk of loss from catastrophes assumed by property
And casualty insurance companies including reinsurance
Companies
6 loss contingencies that may be accrued
1 threat of expropriation of assets
2 pending litigation
3 actual claims and assessments
4 guarantees of indebtedness of others
5 obligations of commercial banks under standby letters of
Credit
6 agreements to repurchase receivables that have been sold
4 of the most common loss contingencies
1 litigation, claims and assessments
2 guarantee and warranty costs
3 premiums and coupons
4 environmental liabilities
Companies must consider the following 3 factors in determining whether to record a liability with respect to pending or threatened litigation and actual or possible claims and assessments?
1 time period where cause of action occurred
2 probability of unfavorable outcome
3 ability to make estimate of amount of loss
Warranty AKA Product Guarantee
Promise made by seller to buyer to make good on
Deficiency of quantity, quality or performance of product
Warranties: cash basis method
Seller or manufacturer charges warranty costs to period
In which it complies with warranty
Warranty costs: accrual method AKA Expense warranty approach
Companies charge warranty costs to operating expense
In year of sale
Sales warranty approach
Companies defer revenue on the sale of the extended warranty
Printed coupons
Can be redeemed for cash discount on items purchased
cash rebate
Buyer can obtain cash by returning the store receipt, rebate
Coupon and universal product code (bar code) to manufacturer
Premiums
Additional bonus product when buying another product
Accounting treatment of premiums and coupons?
Companies should charge costs of premiums and coupons
To expense in period of sale
What do warranties and coupons what are they? What do they satisfy the condition for?
Warranties and coupons are loss contingencies that satisfy
Conditions necessary for a liability
A company must recognize an Asset Retirement Obligation (ARO) when it has an…
2) Companies should record ARO at…
Existing legal obligation associated with retirement of a
Long lived asset
And when it can easily estimate the amount of liability
2) at fair value
Examples of ARO’s
Decommissioning nuclear facilities
Dismantling, restoring, reclamation of oil and gas properties
Closure of mining, landfills
Self-insurance
Not insurance but considered risk assumption
Company that assumes its own risks puts itself in position
Of incurring expense and losses if they happen
Presentation of current liabilities
Recorded and Reported in financial statements at their full maturity value
If a company excludes short term obligation from current liabilities because of refinancing it should include the following note with 3 things in financial statements
1 general description of financing agreement
2 terms of any new obligation incurred or to be incurred
3 terms of any equity security issued or to be issued
If a company has a loss contingency that is either probable or estimable but not both it must disclose the following 2 info items in the notes
1 the nature of the contingency
2 an estimate of possible loss or range of loss or statement
that estimate can’t be made
GAAP VS IFRS: contingencies
GAAP provides more guidance on content of disclosures
About contingencies than does IFRS
Companies should disclose 3 other contingent liabilities, even though the possibility of loss may be remote as follows…
1 guarantees indebtedness of others
2 obligations of commercial banks under “standby letters
Of credit”
3 guarantees to repurchase receivables that have been sold
Or assigned
Current ratio AKA Working capital ratio
Current assets/current liabilities
Acid test ratio AKA Quick ratio
Acid test ratio =
(cash + short term investments + net receivables)/current liabilities
