Chapter Thirteen Current Liabilities and Contingencies

Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

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Chapter ThirteenChapter ThirteenCurrent Liabilities

and Contingencies


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Liabilities

. . . Resulting from past

transactions or events.

. . . Resulting from past

transactions or events.

. . . Arising from present obligations

to other entities . . .

. . . Arising from present obligations

to other entities . . .

Probable future

sacrifices or economic

benefits . . .

Probable future

sacrifices or economic

benefits . . .


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What is a Current Liability?

LIABILITIESLIABILITIES

Long-term LiabilitiesLong-term Liabilities

Expected to be satisfied with current assets or by the creation

of other current liabilities.

Expected to be satisfied with current assets or by the creation

of other current liabilities.

Current LiabilitiesCurrent Liabilities

Obligations payable within one year or one operating cycle, whichever is

longer.

Obligations payable within one year or one operating cycle, whichever is

longer.


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Current Liabilities

Current Liabilities

Short-term notes payable

Accrued expenses

Cash dividends payable

Taxes payable

Accounts payable

Unearned revenues


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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.

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.


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Credit Lines

Prearranged agreements with a bank that allow a

company to borrow cash without following

normal loan procedures and

paperwork.

Prearranged agreements with a bank that allow a

company to borrow cash without following

normal loan procedures and

paperwork.


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InterestInterest on notes is calculated as follows:

Amount borrowed

Amount borrowed

Interest rate is always stated as an annual

rate.

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.

Interest owed is adjusted for the

portion of the year that the face

amount is outstanding.


Slide13-8 Interest-Bearing Notes

Example

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.

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.



Example

How much interest is due to Cooke Bank at year-end, on December 31?

a. $2,400

b. $3,600

c. $7,200

d. $87,200


a. $2,400

b. $3,600

c. $7,200

d. $87,200


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a. $2,400

b. $3,600

c. $7,200

d. $87,200


a. $2,400

b. $3,600

c. $7,200

d. $87,200

Interest-Bearing NotesExample

Interest is calculated as: Face Annual Time to Amount Rate maturity

$80,000 9% 4/12

$2,400 interest due to Cooke Bank.

Interest is calculated as: Face Annual Time to Amount Rate maturity

$80,000 9% 4/12

$2,400 interest due to Cooke Bank.

× ×

× ×

=

=



Example

Assume Eagle Boats’ year-end is December 31.

Record the necessary adjustment at year-end.





Example







Example


Record the necessary journal entry when the note matures on February 28.





Example






Slide13-15 Short-Term Notes Payable

Noninterest-Bearing

Notes without a stated interest rate carry an implicit, or effective, rate.

The face of the note includes the amount borrowed and the 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.


Slide13-16 Noninterest-Bearing Notes

Example

On May 1, 2005, 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?



How much interest will Batter-Up pay on the note?

Interest = Face Amount - Amount Received

= $10,600 - $10,000

= $600

Interest = Face Amount - Amount Received

= $10,600 - $10,000

= $600


Slide13-17 Noninterest-Bearing Notes

Example



What is the effective interest rate on the note?



What is the effective interest rate on the note?


Slide13-18 Liabilities from Advance

Collections

Refundable Deposits

Advances from Customers

Collections for Third Parties


Slide13-19 Short-Term Obligations Expected

to Be Refinanced

A short-term liability may be reclassified as long-term if:

The short-term liability is actually refinanced before

the statement issue date.

The short-term liability is actually refinanced before

the statement issue date.

The expected refinancing is evidenced by good faith entrance into a

long-term, noncancelable refinancing agreement

with a viable lender.

The expected refinancing is evidenced by good faith entrance into a

long-term, noncancelable refinancing agreement

with a viable lender.

or


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Let’s look at Contingent Liabilities


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Contingencies

A loss contingency is an existing uncertain

situation involving potential loss depending on

whether some future event occurs.

A loss contingency is an existing uncertain

situation involving potential loss depending on

whether some future event occurs.


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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.

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.


Slide13-23 Contingencies – Likelihood of

Occurrence

Probable A confirming event is likely to occur.

Reasonably Possible The chance the confirming event will occur

is > remote, but < likely.

Remote The chance the confirming event will occur

is slight.

Probable A confirming event is likely to occur.

Reasonably Possible The chance the confirming event will occur

is > remote, but < likely.

Remote The chance the confirming event will occur

is slight.


Slide13-24 Loss Contingencies

Accounting Treatments


Slide13-25 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 entry:

Product warranties inevitably entail costs.

The amount of those costs can be reasonably estimated using commonly available estimation techniques.

The estimate requires the following entry:


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Extended Warranties

• Extended warranties are Extended warranties are sold separately from the sold separately from the product.product.

• The related revenue is not The related revenue is not earned untilearned until• Claims are made against the Claims are made against the

extended warranty, orextended warranty, or• The extended warranty period The extended warranty period

expires.expires.

• Extended warranties are Extended warranties are sold separately from the sold separately from the product.product.

• The related revenue is not The related revenue is not earned untilearned until• Claims are made against the Claims are made against the

extended warranty, orextended warranty, or• The extended warranty period The extended warranty period

expires.expires.


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Premiums

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.

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.


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Litigation Claims

• The majority of medium The majority of medium and large-size and large-size corporations annually corporations annually report loss contingencies report loss contingencies due to litigation.due to litigation.

• The most common The most common disclosure is a note to disclosure is a note to the financial statements.the financial statements.

• The majority of medium The majority of medium and large-size and large-size corporations annually corporations annually report loss contingencies report loss contingencies due to litigation.due to litigation.

• The most common The most common disclosure is a note to disclosure is a note to the financial statements.the financial statements.


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Subsequent Events

Events occurring between the year-end date and report date can affect the appearance of

disclosures on the financial statements.

Events occurring between the year-end date and report date can affect the appearance of

disclosures on the financial statements.

Fiscal Year Ends Financial Statements

ClarificationCause of Loss Contingency


Slide13-30 Unasserted Claims and

Assessments

Is a claim orIs a claim orassessmentassessmentprobable?probable?

Is a claim orIs a claim orassessmentassessmentprobable?probable?

EndEndEndEnd

Can amountCan amountbe estimated?be estimated?Can amountCan amount

be estimated?be estimated?

No

Yes

No

DisclosureDisclosureclaim orclaim or

assessmentassessment

DisclosureDisclosureclaim orclaim or

assessmentassessment Yes

RecordRecordestimated claimestimated claimor assessmentor assessment

RecordRecordestimated claimestimated claimor assessmentor assessment


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Gain Contingencies

As a general rule, we As a general rule, we never record never record GAINGAIN

contingencies.contingencies.

Note that the prior rules have Note that the prior rules have supported the recording of supported the recording of LOSSLOSS

contingencies.contingencies.


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You said that I will owe you $1,000,000 if I miss

the next putt.

So does that mean I have to disclose a

contingent loss on my personal financial

statement?

End of Chapter 13

Chapter Thirteen Current Liabilities and Contingencies

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