Liabilities Flashcards
What makes a liability to be definitely determinable?
Whether amounts and due dates can be established with considerable certainty
Certainty can be derived from statutory law, contract, or trade custom
What are examples of accrued payroll expenses?
Salaries incurred for last week of accounting period but not payable until next period
Social security taxes and federal unemployment taxes borne by employer (FICA taxes)
Employees’ SS and federal income taxes are NOT accrued payroll expenses, although corporations still have income taxes payable
What are the equations to determine bonus liabilities based on profits?
Bonus calculated on income after tax but before bonus:
B = Br ( I - T )
T = Tr ( I - B )
Bonus calculated on income after tax and bonus:
B = Br ( I - T - B )
T = Tr ( I - B )
Other possibilities too, such as a bonus deducted from pretax income but after bonus:
B = Br ( I - B )
How are contingent liabilities classified?
By (1) the likelihood of incurring the liability and (2) whether the amount can be reasonably estimated
How should probable contingent liabilities be reported?
Probable liabilities with reasonably estimated amounts should be charged and disclosed
If only a range can be estimated, each value being equally likely, the minimum should be accrued
If an amount cannot be estimated, the contingent liability should merely be disclosed
How should improbable contingent liabilities be reported?
If a liability is reasonably possible, no charge should be made, but it should be disclosed in the footnotes
If a liability is merely remote, it does not need to be disclosed
Which remote contingent liabilities should still be disclosed?
- guarantees of indebtedness of others
- banks’ standby letters of credit
- guarantees to repurchase receivables
If a loss is deemed probable and can be reasonably estimated, but is identified between the financial statement date and the issuance date, how should it be reported?
It should still be both incurred and disclosed
When should asset impairments be accrued or disclosed?
They follow the same rules as contingent liabilities
Should subsequent events be accrued or disclosed?
Not accrued and ordinarily not disclosed – they are different from contingent liabilities because (presumably) they are not predicted
What are some subsequent events that should be disclosed?
- purchase of a business
- loss of inventories or plant assets due to casualty
- issuance of bonds or stocks
How should gain contingencies be recorded?
Not accrued, but should be disclosed if not remote
Gain contingencies include gains that have already occurred but are being appealed (e.g. lawsuits)
What journal entries are used if warranty expense is determined at the point of sale?
Warranty Expense X
Est. Warranty Liab. X
(to record estimated warranty expense at point of sale)
Est. Warranty Liab. X
Cash or Other Assets X
(to record actual warranty expenditures as incurred)
What journal entries are used if warranty expense is determined at the end of the accounting period?
Warranty Expense X
Cash or Other Assets X
(to record actual warranty expenditures as incurred)
Warranty Expense X
Est. Warranty Liab. X
(to record estimated warranty expense at end of accounting period)
Do explanations for estimated warranty expenses need to be disclosed?
No
For coupon arrangements where customers must pay cash and coupons in order to get a product, how does this affect the company’s estimated liability for coupons?
It reduces the liability by the amount of cash paid
What conditions must be met for a liability for employees’ compensation for future absences and post-employment benefits to be accrued?
- Payment is probable
- Amount can be reasonably estimated
- Obligation for employee services is already rendered
- The obligation relates to employee rights that vest or accumulate
Also needs to be disclosed
What are vested rights and accumulated rights?
Vested rights hold irrespective of an employee’s termination of employment
Accumulated rights may be carried forward to one or more future periods
How do you value notes payable with unstated or unreasonable interest rates?
Record at FV of goods or services exchanged or at the FV of the note, whichever is more clearly determinable.
If the above cannot be determined, record the note at its PV by discounting all future payments at an imputed interest rate.
In both cases, the difference between the recorded amount and face amount is discount or premium.
How is an imputed interest rate determined?
- debtor’s credit standing
- prevailing rates for similar debt
- rates at which the debtor can obtain funds
How is the discount or premium for a note payable amortized?
Amortized as interest expense
Should result in a constant rate of interest when applied to the note’s carrying amount at the beginning of any given period
Methods other than effective interest method are allowed if difference is immaterial
How is a note with an unstated interest rate accounted for?
Note discounted to PV at imputed rate, difference between PV and face value is discount
Discount amortization for each period is (unamortized discount x imputed rate) and recorded as interest expense
How is a note with an unreasonable interest rate accounted for?
Principal and interest payments (at unreasonable rate) are discounted to PV at imputed rate; any difference between recorded and face amounts is discount or premium
Discount/premium amortized as normal under effective interest method
What are different ways to refinance a short-term obligation?
Replace with long-term obligations or equity securities
Renew, extend, or replace with short-term obligations for an uninterrupted period greater than one year (or operating cycle) from the balance sheet date
How is a liability classified if it is current but refinanced through the issuance of long-term debt?
It is then classified as noncurrent
This includes if stock is issued to pay the liabilities
What counts as evidence of an ability to consummate a refinancing?
A refinancing occurs after the balance sheet date but before the issuance date
A financing agreement before the balance sheet is issued permits the refinancing and extends beyond one year or operating cycle
What other requirements are there for a refinancing to move a liability from current to noncurrent?
- No violation of the agreement can have occurred (and if there has been one, a waiver from the lender must be obtained)
- The lender is financially capable to honor the agreement
What are asset retirement obligations?
AROs handle costs associated with an asset’s dismantlement, restoration, or abandonment
How are AROs initially recognized?
ARO is recorded at FV, or else expected PV
ARO is capitalized by same amount as liability and added to book value of the related asset
How are AROs subsequently measured?
The capitalized ARO is reduced as a depreciation expense – technically, the whole thing (asset + ARO) is depreciated
The liability itself has a periodic accretion expense
What is accretion expense?
AROs are initially recorded at PV, and the discount due to PV will be amortized over time – that is the accretion expense
Accretion expense = liability x discount rate
What does accretion expense have to do with the final amount a company pays to retire an asset?
Accretion expense is offset with an increase to the liability, so that at the end of the asset’s life, the liability is the amount needed to settle the ARO
In short, the PV of the liability is moving towards the FV
What is in-substance defeasance?
Where the debt remains outstanding but the debtor places risk-free monetary assets in a trust that restricts such assets to repaying the debt
How are bankruptcy claims handled in priority and distribution?
Higher-priority claims settled first
If assets are insufficient to settle competing claims of equal priority, they are satisfied pro rata
All remaining liquidation proceeds and assets remaining after claims are satisfied belong to the debtor
How does a debt restructuring count as a troubled debt restructuring?
- Restructuring must involve a “concession”
2. Debtor must be experiencing financial difficulties
What constitutes a concession for troubled debt restructuring?
- Creditor doesn’t expect to collect all amounts due.
- Restructuring involves asset or equity transfer, or change of loan terms
Small changes, like barely-changed interest rates or payment dates do not count
How does the consideration given by the debtor compare to the recorded debt amount for a troubled debt restructuring?
The FV of the consideration must be less than the recorded debt amount, or by definition it is not TDR
How is a gain/loss recognized for troubled debt restructuring where the debt is retired?
Debtor records gain for difference between carrying amount of debt (principal + accrued interest) and FV of assets or equity transferred
-Creditor records loss for same diff.
However, even for this, the debtor will then have a loss on the asset/equity given up for the difference between the FV and carrying value, so the TOTAL gain and loss will be a comparison of carrying values
How does a debtor recognize gain or loss for troubled debt restructuring where the debt is modified?
Debtor should compare (1) old carrying amount of debt and (2) sum of future cash payments under new agreement (NOT discounted to PV)
If (2) < (1), record gain, future payments recorded only as reduction of principal (no interest expenses)
If (2) >= (1), no gain or loss recognized, future payments are allocated to principal and interest
How does a creditor account for troubled debt restructuring where the debt is modified?
Same as for the debtor, except he discounts the future payments to their PV
How should a note payable be reported if it arose from ordinary trade and is due in less than one year?
Reported at face value
What is an important detail when reporting notes payable?
Only the principal amount is recorded as a note payable; the rest is part of interest payable
What does it mean to say that a note payable is “net of current portion”?
It is excluding the current portion
How do you calculate the remaining note payable when it is paid off in installments?
Multiply the face amount by the interest rate to get the total interest charged for all the payments
Divide by the number of payments to get the interest paid per payment
From there, calculate the remaining principal
What dividends qualify as current liabilities?
Cash and property dividends count, but only once they are declared
Stock dividends and undeclared dividends on preferred stock do not count
What are two miscellaneous things which count as current liabilities?
Advanced payments (until the transaction is completed)
Returnable deposits (until the relationship is terminated) – even if the company has good reason to believe the deposit will be lost, it still is a liability until earned
How should gift cards be reported?
As deferred/unearned revenues, which are liabilities
Under what circumstances is the current portion of long-term debt NOT classified as a current liability?
When the current portion will be paid from the proceeds of a new bond issue or from noncurrent assets
What is peculiar about FICA taxes borne by the employer?
He must pay them on top of the wages, rather than withhold the taxes from the wages
Example: 7% FICA taxes on $10,000 gross wages = $10,700 in total payments
When claims of secured creditors are greater than the proceeds from the assets pledged to those creditors, how are those creditors then treated?
As ordinary, unsecured creditors
How do you calculate the deferred tax liability for the depreciation of an asset?
Find the difference between tax depreciation and financial depreciation for each year, not including the upcoming year (so it’s noncurrent)
Multiply these differences by the income tax rate for their respective years
If there is a long-term loan with a current portion, and then a violation of the loan agreement, how is it reported?
Entire loan is current liability
If a number of gift cards/certificates are expected not to be redeemed, how is it recorded?
Those are counted as earned revenues, even before they reach the date when they can’t be redeemed
These are not like refundable deposits, where the probability of keeping the $$ doesn’t matter as to when it is earned
Do annual sinking-fund requirements on long-term debt count as a current portion?
No
When a vendor remits sales taxes to the government, how is it recorded?
The total revenues must first be decreased by the tax rate (since CUSTOMERS pay the sales tax, not the vendor), and the difference is the tax remitted
E.g. $21,200 total revenue with 6% sales tax –> $21,200 / 1.06 = 20,000 of pre-tax revenue –> $1,200 sales tax remitted
In bankruptcy, if assets pledged to secured creditors exceed debts to those creditors, to what are the excess funds applied?
To “liabilities with priority,” and then to unsecured creditors
That is, they do NOT “trickle down” to partially secured creditors and then to unsecured creditors
If a trustee gains control over a bankrupt estate and discovers unrecorded gains, losses, revenues, or expenses, how does he record them?
Direct debit/credit to Estate Equity account
