Chapter 13

How are deposits accounted for?

The accounting for deposits depends upon the amount the entity returns upon completion of the transaction: 1. Returns the entire deposit: The entity simply debits the same liability account and credits cash. 2. Returns part of the deposit: The entity debits the entire liability account and the credit will depend upon the reason for the forfeiture of the deposit. 3. Deposit is not returned: The entity credits a revenue account and debits the liability account. If repairs to the property are required the entity credits cash as repairs are made.1

How much on an Unearned Revenue is a current liability and how much is a long-term liability?

The amount of the good/service to be earned in the next 12 months is a current liability, the rest is a long term liability.

How do loss contingencies differ from other liabilities?

They involve a substantial degree of uncertainty.

True or False: Contingencies should not be accrued but should be disclosed if they are either (1) probable but not estimable or (2) reasonably possible.

True

True or False: Both accounts payable and trade notes payable are usually current liabilities because they are generally due within one year

True. Also, Companies recognize both types of payables when title passes.

How are ARO's accounted for?

- A company recognizes the amount of the ARO as a liability and records accretion expense over the life of the obligation using the effective interest rate method of amortization. - Companies capitalize the ARO liability amount as part of the initial carrying amount of the related asset. - A company depreciates the total cost of the asset, including the capitalized amount for the ARO, over its life. - When retiring the asset, the company will record a gain or loss if the actual costs differ from the balance in the ARO account.

Required Disclosures for Contingencies

- A company that accrues a loss contingency should disclose the nature of the accrual. - It may be necessary for the entity to disclose the amount accrued to avoid misleading financial statement users. - The firm must also include a disclosure indicating that it is at least reasonably possible that the estimate of the probable liability could change in the near term. - A company must disclose a contingency if it is at least reasonably possible that it may have incurred a loss that did not meet the conditions for recognition of a loss contingency.

What is accretion expense?

- Accretion expense is the expense, reported in operating income, resulting from the increase in the carrying amount of the liability.

Types of warranties?

- An assurance-type warranty (also referred to as a base warranty) does not provide an additional good or service to the customer. The seller is merely providing a guarantee of quality. - A service-type warranty (also referred to as an extended warranty) exists if the customer has the option to purchase the warranty separately or if the warranty provides a service to the customer beyond the period covered by the assurance-type warranty.

How do firms account for warranty costs?

- Ideally, firms account for assurance-type warranties by using an accrual-basis approach where the cost of providing the warranty is matched with sales revenue. - The firm expenses the estimated expenditures related to providing the repairs or product replacement in the year of the sale and accrues the estimated liability for repair costs in the year of the sale. - Customer claims under warranty (in the year the actual repair takes place) satisfy the liability without charging any additional expenses.

For a loss contingency, management must determine whether the loss is probable, remote, or reasonably possible:

- Probable: If the loss is likely to occur, it is considered probable. - Reasonably possible: The probability of occurrence is less than likely, but more than remote. - Remote: The probability of occurrence is only slight.

How does the remote method work for breakage?

- The company/seller recognizes revenue from gift card breakage and removes the liability for the advance collection only when the probability of redemption becomes remote. (i.e., Debit the unearned revenue liability and Credit revenue) - The company also considers whether it has a legal obligation to remit the value of the unredeemed gift cards to the relevant jurisdictions.

How does the proportional method work?

- Under the proportional method, breakage revenue is recognized ratably as actual card redemptions occur. - The company must have reliable estimates of breakage and the time period of actual gift card redemption. - The company must pool together all gift cards sold over a certain time period. - The company estimates the breakage percentage of these cards as well as the time period over which these cards will be redeemed. - The company then recognizes the estimated breakage revenue (and derecognizes the liability) over the estimated time period of redemption.

How to account for warranty costs?

- When a company sells the warranty contract, it accounts for the warranty as an advance collection and records a liability for unearned revenue. - As time passes and warranty coverage is provided, the company earns the revenue and records it on the income statement.

Which rates are used for compensation absences?

- When the future rate is uncertain, companies measure the obligation at the current rate rather than estimating the future salary or wage rate expected to be in effect when the employee uses the compensated absence. - When future rates are known, the employer should use the future wage rates in the accrual. If compensation rates change in the period of actual payment, the company debits the difference between the new, higher rate and the lower, accrued rate to compensation expense in the year it pays the compensated absence.

Based on the company's assessment of the probability of a loss and its ability to reasonably estimate the amount, there are three possible accounting alternatives for contingencies:

1. Accrue a loss contingency. Recognize the event in the current financial statements, with adequate note disclosure. 2. Disclose a loss contingency. Include a note disclosure, but do not accrue the contingency. 3. Do not recognize or disclose. Do not accrue the contingency, and do not disclose the contingency in the notes.

How do you account for sale of gift cards?

1. Records the transaction as unearned revenue when issuing the gift card by debiting cash and crediting a liability for the unearned revenue on the date it sells the cards. 2. Maintains a liability on the balance sheet until the gift card is redeemed and then recognizes sales revenue (credit) earned upon redemption with a corresponding reduction of the liability (debit).

Contingency Disclosures should include:

1. The nature of the contingency. 2. An estimate of the possible loss or range of loss or a statement that such an estimate cannot be made.

An employer must meet four criteria to report an expense and accrue a liability for future paid absences:

1. The obligation for future payment is a result of services already performed by the employee. 2. The benefits to be paid either vest or accumulate. 3. The future payment must be probable. 4. The future payment must be reasonably estimable.

A company records (accrues) a contingent loss if, prior to issuing financial statements, the situation meets the following two conditions:

1. There is evidence that it is probable that the company has incurred a liability as of the date of the financial statements. 2. The company can reasonably estimate the amount of the loss. If management can estimate a range for the loss, but cannot identify a single most likely outcome within that range, it accrues the minimum point of the range.

What is a contingency?

A contingency is an existing condition, situation, or set of circumstances involving uncertainty that will ultimately be resolved when one or more future events occur or fail to occur.

What is a gain contingency?

A contingency that involves uncertainty about a possible gain to an entity that will be resolved when one or more future events occur or fail to occur. Also known as a contingent asset. Contingent gains are often not recognized or disclosed in the financial statements due to conservatism, they're only disclosed when there's a high chance of realization.

What is a warranty?

A warranty is a company's promise or guarantee to repair or replace any defective goods for a specified period of time after the date of purchase.

What are accumulated rights?

Accumulated rights permit an employee to carry forward unused benefits to future periods.

What is a loss contingency?

An existing condition, situation, or set of circumstances involving uncertainty as to a possible loss to an entity that will ultimately be resolved when one or more future events occur or fail to occur. Also known as contingent liability. Recognition of a contingent liability either increases an obligation or reduces the carrying value of an asset.

What are Asset Retirement Obligations?

Asset retirement obligations (AROs) are long-term legal obligations to dismantle and scrap assets or to restore property used for business purposes.

How are compensated absences accounted for (if accrued)?

If a compensated absence should be accrued, the company determines the rate of compensation to use: current or future rates.

What are the two methods used for determining the breakage amounts of gift cards?

If the companies can estimate the the breakage amount, they should use the proportional method. If not, then they use the remote method.

What are vested rights?

Vested rights exist when an employer has the obligation to make compensation payments if it terminates employment.

Define accounts payable

amounts owed for goods, supplies, or services purchased on open account.

What is a deposit?

an amount a buyer remits to a seller that will be returned to the buyer at some point in time when a specific event occurs. When an entity receives the deposit, it credits a liability account.

Operating liabilities

are obligations arising from the firm's primary business operations. Include short-term obligations

What are compensated absences?

employer-paid time off for vacation, illness, holidays, military service, jury duty, and maternity leave.

Define trades notes payable

formal, written promises to pay a certain sum of money on a specified date in the future that arise from the purchase of goods, supplies, or services.

What is breakage?

revenue gained by retailers through unredeemed, expired, or lost gift cards

What is a liability?

the firm must transfer resources (e.g., cash, goods, or services) in the future to fulfill a responsibility resulting from a past event.