Chapter 13: Current Liabilities and Contingencies Flashcards
Self-Insurance
Not actually insurance. Risk assumption
Not GAAP to record in the financial statements, rather just record in notes
May incur liability risk of loss resulting from PAST injury but not for expected future
Accounting recognition of asset requirement obligations
Must recognize Asset Requirement Obligations (ARO) if they exist and can be reasonably estimated (report at fair value - may use discounted rate)
ARO = costs associated with retirement of the asset
Includes cost of ARO in carrying amount of asset and record a liability for that amount
Consideration payable
Payments to customers as part of revenue agreements
- discounts
- volume rebates
- free products or services
- coupons, cash rebates
when a material right is promised to a customer an obligation must be recorded
Recording Considerations Payable
Must estimate any premium liability outstanding at the end of the period
Adjusting entry:
Debit Premium Expense (for matching)
Credit Premium Liability
Recording a Service Type Warranty
(extended warranty - purchased
Recorded as a separate obligation:
Debit Cash or AP
Credit Unearned Warranty Revenue
Credit Sales Revenue
Adjust warranty on straight line basis over the length of the contract
Warranty
Should be recognized as is a performance obligation of the company
Service-type warranty
Not included in sales price
provides for additional service
recorded as separate performance obligation
Assurance-type warranty
Included in product sales price
warranty that the product meets agreed upon specifications in the contract at the time the product is sold
No separate performance obligation is recorded - expensed in period goods are provided and service performed
Adjusting entry to record warranty/ liability
Liabilities related to litigation, claims and assessments
- time period when underlying cause of action accrued must be on or before the date on financial statements (even if company is not aware yet)
- probability of unfavorable outcome
- ability to make reasonable estimate of amount of loss
When to accrue estimated loss from contingency
Only accrued if both of the following are true:
- information available prior to the issuance of the financial statements indicates that it is PROBABLE that a liability has been incurred at the date of financial statements
- the amount of the loss can be reasonably estimated
NOT liabilities that are simply the risks of being in business
Contingency Liability
Liability incurred as a result of a loss contingency
- depends on one or more future events to confirm amount, payable, payee, date payables, existance of liability
Split into:
- probable
- reasonably possible
- remote
IFRS “Provisions”
Provisions = estimated liability
Short-term debt expected to be refinanced
Classified as non-current only if one or both of the following are true:
- liability is contractually due to be settled more more than one year (or ops cycle, if longer) after the balance sheet date
- entity has a contractual right to defer settlement of the liability for at least one year (or operating cycle) after balance sheet date
Treatment of refinancing on balancing
Depends on contractual agreement at balance sheet date (report date)
Gain contingencies
Claims or rights to receive assets (or have a liability reduced) whose existence is uncertain but may become valid eventually
- follow conservative policy: only disclose when high probability of realizing gains
Liabilities
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
- resulting from events that have already occurred
- Unavoidable obligations
Current liabilities
Obligations whose liquidation is reasonably expected to require the use of existing resources properly classified as current assets or the creation of other liabilities
Operating Cycle
Period of time elapsing between the acquisition of goods and services involved in the manufacturing process and final cash realization resulting from sales/ subsequent collections
Typical Current Liabilities
Accounts Payable Notes Payable Dividends payable customer advances & deposits unearned revenues sales tax payable income taxes payable employee-related liabilities Current maturities of long term debt
Types of employee related liabilities
Salaries/wages owed
payroll deductions
compensated absences
bonuses
Vested Rights
When an employer has an obligation to make payment to an employee even after termination of employment
Accumulated Rights
Rights carried forward into future periods if not used in the period earned
Recording accounts payable
Debit inventory / accounts receivable
Credit accounts payable
Purchase discounts are recorded the same way as accounts receivable
Recording a zero-interest bearing note
Debit Cash
Debit Discount on notes payable
Credit notes payable
Discount decreases value of the notes payable on balance sheet
Interest Bearing Notes Payable
Debit Cash
Credit notes payable
to accrue interest
Debit Interest Expense
Credit Interest Payable
Recording cash dividends payable
Becomes a liability on the date of declaration
because usually paid within one year they are classified as a current liability
accumulated dividends on preferred stock NOT a liability until a dividend is declared
Stock dividends are not a liability
Recording customer advances and deposits
Current or long term liability depending on time between date of deposit and termination of the relationship that required the deposit
Recording Unearned revenues
Debit Cash
Credit unearned revenue
then need to do an adjusting entry when revenue is earned:
Debit Unearned revenue
Credit Sales revenue
Recording Sales Tax payable
Recorded with every sale where applicable
Debit Cash
Credit Sales Revenue
Credit Sales tax payable
Sometimes may need to do an adjustment - if math is off, or if it is not recorded at time of sale
Recording income taxes payable
Corporate tax rate is currently a flat percent
Different for partnerships or proprietorships, which are not taxable entities (partners/ proprietor is liable for the taxes on their portion of the business on their income tax)
Corporations make periodic estimated payments
estimates changing causes the payments to change
Recording employee related liabilities - payroll deductions
Any amounts not yet remitted should be recognized as a current liability
- social security tax (OASDI)/ FICA+ medicare: employee and employer make equal contributions
- unemployment taxes (FUTA + SUTA): employers responsibility
- possible to reduce contribution with “ment” rating - paid quarterly, considered operating expenses
salaries and wages journal entry
Debit Salaries and wages expense (tota)
Credit witholding tax payable
Credit FICA tax payable (employee contribution)
Credit other deductions (insurance contributions, union dues)
Credit cash
Recording employer payroll taxes
Debit Payroll tax expense
Credit FICA taxes payable (employer contribution)
Credit FUTA taxes payable
Credit SUTA taxes payable
Recording Employee related liabilities - income tax witholding
Income tax withheld shown as liability until it is remitted to government
Recording salaries and wage expense - manufacturing
May have multiple accounts
- direct labor
- indirect labor
- sales salaries
- executive salaries
- administrative salaries, etc…
Recording employee-related liabilities: compensated absences
Vacation, illness, holidays
Should accrue a liability for compensation of future absences if all the following are true:
- obligation is attributable to services already rendered by the employee
- obligation relates to rights that vest or accumulate
- payment of the compensation is probable
- the amount of the payment can reasonably be estimated
if all four are true then the liability is a legit expense for the period
if all four conditions are not met then obligation should be disclosed in notes
Recording sick pay
If sick pay benefits vest then a company MUST accrue them. if they do not vest the company can choose whether or not to accrue them.
Depends on if sick pay can be used as PTO of if it is limited to illness
if it can be used as PTO then must accrue
recognize the expense/ liability in the period it is earned by the employee, not the period used
Recording if a compensated absence is accrued at a lower rate then held when taken
Original journal entry:
Debit Salaries and Wages Expenses
Credit Salaries and Wages Payable
When taken:
Debit Salaries and Wages Payable
Debit Salaries and Wages Expense (for difference)
Credit cash
Recording employee compensation liabilities - bonuses
Considered wages = deducted from net income
also conditional expenses - agreements with the employees to pay expenses
will be accrued based on the standing agreement
Recording current maturities on long term debt
- long term liabilities due in next fiscal year, except if:
- being retired by assets accumulated for the purpose, not shown in current assets
- being refinanced
- being converted to capital stock
(aka no current asset used or new current liability created
(include note to financial statements)
Recording liabilities due on demand
aka callable liabilities
Classify as current
liabilities that become callable in certain circumstances are recorded as current if circumstances occur (unless can show probable circumstance will pass within specified period)
Acid test ratio
A liquidity ratio
removes show moving inventory from current ratio
= (cash + short term investments + net accounts receivable) / current liabiltiies
Current ratio
Liquidity ratio (aka working capital ratio)
= current assets / current liabilities
Contingencies on financial reports
Loss contingency:
- record if liability is probable AND can be reliably estimated
- if only one or the other then include in notes: reasonable probability, nature of contingency, estimate
Some disclosures are required even when probability remote
- guarantees of indebtedness to others
- obligations of commercial banks under “stand by letters of credit”
- guarantees to repurchase receivables
Refinancing on financial statements
- if short term obligation excluded from current liabilities because of refinancing should note: financing agreement description, terms, equity security
If refinancing by issuing equity DO NOT include liability in equity section
Currently maturing obligations paid with long-term assets on financial statements
Reported in long term liabilities if paying with long term assets
Current liabilities on balance sheet
Recorded and reported at maturity vale
- because short term present value not very different/ immaterial
always the 1st classification of liabilities presented
- identify any secured/ pledged liabilities
- do not offset against assets
- current maturities of long term liabilities are listed as current
to get sales tax from total sales revenue
Total revenue / 1 + tax % = sales revenue
Total revenue - sales revenue = tax amount
Tax % x sales revenue should = total revenue - sales revenue
