Current Liabilities & Contingencies

Operating Cycle

the period of time elapsing between the acquisition of goods and services involved in the manufacturing process and the final cash realization resulting from sales and subsequent collections

Service-type warranty

An additional warranty, not included in the sales price of the product, that the product meets agreed-upon specifications in the contract at the time the product is sold. A service-type warranty is recorded as a separate performance obligation.

Asset Retirement Obligation (ARO)

An existing legal obligation, whose amount can be reasonably estimated, associated with the retirement of a long-lived asset. Companies should record the ARO at fair value.

Social Security Taxes

FICA and hospital insurance tax combined Rate of 7.65% to $128,400 and 1.45% in excess of 128,400

Sick pay

If vest, must accrue!! If accumulate but don't vest, can decide if you want to accrue.

Income Taxes Payable Entry:

Income Tax Expense (debit) Income Tax Payable (credit) !every company has to file income tax return!

Can you refinance? example

Issued note payable of $3,000,000 on November 30th, 2020 due Feb 28th, 2021, the balance sheet date is Dec 31st, 2020 and statements are issued March 1, 2021 The note must be classified as CURRENT because the refinancing was not completed by the balance sheet date! What if, a contract existed that gave them a right to defer payment until June 30th, 2022 and the contract was in effect by Dec 31st, 2020? YES! Classify as non current because a contract exists by the balance sheet date!

Premium

Liability Valuation Account - Adjunct Account

Discount

Liability Valuation Account - Contra Account

Loss contingencies usually accrued

Loss related to... -collection of receivables -obligations related to product warranties and product defects -premiums offered to customers

Loss Contingency is probable

Make entry and write a note

Returnable Cash Deposit

May receive a deposit to guarantee further performance

Payroll Deductions

Most common are taxes, insurance premiums, employee savings, and union dues If not remitted to a proper authority at the end of the accounting period, should be recognized as a current liability

Stock Dividends

NOT a liability payable account Entry: Retained Earnings (debit) Common Stock Distribution (credit)

Loss contingency is remote

No entry! No note!

Loss contingency is reasonably probable

No entry! Write a note!

Self-insurance

Not insurance but risk assumption. Any company that assumes its own risks puts itself in the position of incurring expenses or losses as they happen. Accrual is required only if uninsured losses resulting from injury to others or damage to other's property took place prior to the financial statement date and a reasonable estimate of the amount can be made.

short-term obligations expected to be refinanced

Obligations that, after refinancing, will be long-term and therefore not require the use of working capital during the next year (or operating cycle) Can be reclassified as long-term IF both criteria are met as of the balance sheet date, 1 - liability is due to be settled more than one year after the balance sheet date 2 - the entity has a contractual right to defer settlement of the liability for at least one year after the balance sheet date Should NOT report as non-current unless a contract exists to support long-term presentation

Current Liabilty

Obligations whose liquidation is reasonably expected to require use of existing resources properly classified as current assets, or the creation of other current liabilities

Current maturities of long-term debt

The maturing portion of long-term debt that is due within one year or the operating cycle, whichever is longer. Should classify any Liability that is "due on demand" (callable) or will be due on demand within a year as current liability

Assurance-type warranty

The warranty, included in the sales price of a company's product, that the product meets agreed-upon specifications in the contract at the time the product is sold.

Computation of premium liability

Total box tops sold x estimated redemptions (percent) = total estimated redemptions Cost of estimated redemptions (total estimates redemptions x cost of premium) - redemptions to date = future liability

Unearned Revenues Entry:

When its Unearned: Cash (debit) Unearned Revenues (credit) When its earned: Unearned Revenues (debit) Revenue (credit)

Notes Payable (trade notes payable)

Written promises to pay a certain sum of money on a specified future date; may arise from purchases, finances, or other transactions

Warranty (product guarantee)

a promise made by a seller to a buyer to make good on a deficiency of quantity, quality, or performance in a product

Cash Dividend Payable

an amount owed by a corporation to its stockholders as a result of board of directors' authorization

Gain contingency

claims or rights to receive assets (or have a liability reduced) whose existence is uncertain but which may become valid eventually DO NOT RECORD! Only disclose when a HIGH PROBABILITY exists for realizing them!!

Loss contingencies (contingent liabilities)

involve possible losses; depend on the occurrence of one or more future events to confirm either the amount payable, the payee, the date payable, or its existence

3 types of employee related liabilities

1 - payroll deductions 2 - compensated absences 3 - bonuses

Acid test ratio (quick ratio)

(Cash + short-term-investments + Net accounts receivable)/current liabilities Does not include inventory

Presentation of Current Liabilities

- Usually reported at their full maturity value. - Difference between present value and the maturity value is considered immaterial. - Companies may list the accounts in Order of maturity, Descending order of amount, or Order of liquidation preference. - IF EXCLUDING a current liability must disclose in a note, the terms of the financing, the terms of the new obligation, and the terms of any equity security issued!

Possibility of loss might be remote but should disclose loss contingency of...

- guarantees of indebtedness to others - obligations of commercial banks under "stand-by letters of credit" - guaranteed to repurchase receivables (or any other property) that have been sold or assigned

Loss contingencies not accrued

-risk of loss or damages by fire, explosion or other hazards -general unspecified business risks -risk of loss from catastrophes

3 Characteristics of a Liabilty

1 - is a present obligation that entails settlement by probably future transfer or use of cash, goods, or services 2 - an unavoidable obligation 3 - the transaction or other event creating the obligation has already occurred

Typical Gain Contingencies are:

1. Possible receipts of monies from gifts, donations, asset sales, and so on. 2. Possible refunds from the government in tax disputes. 3. Pending court cases with a probable favorable outcome. 4. Tax loss carryforwards

Typical current liabilities include:

Accounts payable, notes payable, dividends payable, customer advances and deposits, unearned revenues, sales taxes payable, income taxes payable, employee-related liabilities, current maturities of long term debt

Bonus

Additional wages that should be included as a deduction in determining net income Same entry as compensated absences

Specific Business Unearned Revenue Accounts and their Revenue Accounts

Airline - Unearned Ticket Revenue THEN Passenger Revenue Magazine - Unearned Subscription Revenue THEN Subscription Revenue Hotel - Unearned Rent Revenue THEN Rent Revenue Auto Dealer - Unearned Warranty Revenue THEN Warranty Revenue Retailers - Unearned Gift Card Revenue THEN Sales Revenue

Accounts Payable (trade accounts payable)

Balances owed to others for goods, supplies, or services purchases on an open account; terms of the sale usually state extended credit (ex: 2/10 n/30); should be recorded at the time of the transfer of control

ARO entries:

Buying the Platform: Drilling Platform (debit) 1,000,000 Cash (credit) 1,000,000 Record the ARO: (10% discount 5 years TVM problem) Drilling Platform (debit) 620,920 ARO (credit) 620,920 Deprecation of ARO: Depreciation Expense (debit) (629,920/5) 124,185 Accumulated Depreciation (credit)124,185 Accrued interest on ARO: Interest Expense (debit) (620,920 x .10) 62,092 ARO (credit) 62,092 End of life entry: ARO (debit) 1,000,000 Gain on Settlement of ARO (credit) 5,000 Cash (credit) 995,000

FICA (federal insurance contribution act)

Deducted from employees gross pay Also taxed on employer Rate of 6.2% Used to be called OASDI (old age, survivor, and disability insurance)

Assurance Type Warranty Ex:

Do not record the warranty expense separately! Original sale entry: Cash (debit) Sales revenue (credit) Warranty costs incurred: Warranty Expense (debit) Cash, inventory, accrued payroll (credit) Adjusting entry: Warranty Expense (debit) Warranty Liability (credit)

Who pays which taxes?

Employee - income tax withholding; FICA taxes; & union dues Employer - FICA taxes; federal unemployment; & state unemployment

Zero-Interest Bearing Note Ex: issued $102,000, four month, zero interest note, present value $100,000

Entries: 3/1/20 Cash (debit) 100,000 Discount on Notes Payable (debit) 2,000 Notes Payable (credit) 102,000

Interest Bearing Note Ex: lend $100,000 on March 1, 2020 by signing a 6% note, financial statements are prepared on June 30th

Entries: 3/1/20 Cash (debit) 100,000 Notes Payable (credit) 100,000 6/30/20 Interest Expense (debit) 2,000 Interest Payable (credit) 2,000 Interest Calculations: (100,000 x .06 x 4/12)

Entries for Customer Advances and Deposits:

Entry for Company RECEIVING Deposit: Cash (debit) Customer Deposit (credit)

Sales Taxes (taken out later)

Ex: $150,000 includes sales tax 4% (150,000/1.04 = 144,230.77) (144,230.77 x .04 = 5,769.23) Entry: Sales Revenue (debit) 5,769.23 Sales Taxes Payable (credit) 5,769.23

Sales Taxes (taken out as money is collected) entry:

Ex: Sales of $3,000 with 4% taxes Cash (debit) 3,120 Sales Revenue (credit) 3,000 Sales Taxes Payable (credit) 120

Vested rights

Exist when an employer has an obligation to make payment to an employee even after termination of their employment

Premium (coupons)

Offered to customers in return for box tops, certificates, coupons, labels, or wrappers

Compensated Absenses

Paid absences from employment like vacation, illness, and holidays; should accrue a Liability if ALL 4 conditions exist 1 - employers obligation relating to employers rights to receive compensation for further absences is attributable to employees services already rendered 2 - the obligation relates to rights that vest or accumulate 3 - payment of the compensation is probable 4 - the amount can be reasonably estimated ! If meet first 3 conditions but can't reasonably estimate, disclose in the notes! ! !Should recognize the expense and related liability for compensated absences in the year earned by employees!

Hospital insurance tax

Paid by both employer and employee at 1.45%

Likelihood of loss (loss contingencies)

Probable - the future events are likely to occur Reasonably probable - the chance of the future event or events occurring is more remote but less than likely Remote - the chance of the future event or events occurring is slight Should charge to expense and liability recorded IF both conditions are met... 1 - information prior to issuance of financial statements indicated its PROBABLE a liability has been incurred 2 - amount can be reasonably estimated

Presentation of Contingencies

Record a LOSS contingency if the loss is BOTH PROBABLE AND ESTIMABLE! If it is not both but there is one and there is a reasonable probability, disclose in notes the nature of the contingency, and the estimate or statement that an estimate isn't possible.

Premium (cake box) Ex:

Record purchasing of the premiums: Premium Inventory (debit) Cash (credit) Record sale of item that has box tops or coupons on it: Cash (debit) Sales Revenue (credit) Record redemption of box tops for premiums: Cash (debit) Premium expense (debit) Premium inventory (credit) Adjusting entity for future liability: Premium expense (debit) Premium liability (credit)

Service Type Warranty Ex:

Record the warranty as Unearned warranty revenue at the time of sale! Original sales entry: Cash (debit) Unearned warranty revenue (credit) Sales revenue (credit) Warranty costs entry: Warranty expense (debit) Cash, inventory, accrued payroll (credit) Adjusting entry for expected claims: Warranty expense (debit) Warranty liability (credit) To record revenue from warranty: Unearned warranty revenue (debit) Warranty revenue (credit)

Merit ratinf

Reduced the state contribution rate of FUTA

Cash Dividends Liability Entry:

Retained Earnings (debit) Dividends Payable (credit)

Dividends in Arrears Entry:

Retained Earnings (debit) Dividends Payable (credit) ONLY made when the board of directors authorized payment of dividends

Accumulated rights

Rights an employee can carry forward into future periods if not used in the period in which earned

Compensated Absence Entry:

Salaries and Wages Expense (debit) Salaries and Wages Payable (credit)

Litigation

The cause for litigation must have occurred on or before the date of the financial statements

current ratio (working capital ratio)

current assets/current liabilities (liquidity ratio)

Federal unemployment tax act (FUTA)

employers are subject to a federal unemployment tax on wages and salaries paid to their employees 6% on first 7,000 paid to each employee Tax credit to not exceed 5.4% to a state plan (ex: if state is 5.2% it pays .8% to federal government)

dividends in arrears

preferred dividends that were supposed to be declared but were not declared during a given period

Liability

probably 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 or events