Liabilities

Under liquidation basis of accounting, what should assets be valued at?

Amount expected to be generated upon liquidation Per ASC 205, the liquidation basis of accounting, when an entity is no longer a going concern and liquidation is considered to be imminent, the assets are valued at the amount expected to be generated upon liquidation. Liabilities are valued according to U.S. GAAP and costs expected to be incurred during liquidation should be accrued.

Can you solve this? InterSlice Co.'s payroll for the month ended March 31, 20X4, is summarized as follows: Total wages$12,000 Federal income tax withheld 1,440 All wages paid were subject to FICA. FICA tax rates were 7% each for employee and employer. In InterSlice's jurisdiction, employers must also pay unemployment taxes under FUTA at a 2% rate. InterSlice remits taxes on the 15th of the following month. As a result of March 20X4 wages, what amounts should InterSlice record in its journal entry for March payroll tax expense and March withholdings due to IRS?

An employer's payroll tax liability consists of the taxes it is required to pay that are based on its payroll. This will include FICA at 7% and FUTA at 2% for a total of 9% of $12,000 in wages or $1,080. Withholdings due to the IRS represent taxes that are paid by the employees by having the employer withhold them from the employees' wages and remitting the amounts to the taxing authority. This will include income taxes withheld of $1,440 and the employees' FICA withheld, which is 7% of $12,000 or $840, for a total of $2,280.

Just do it: FlanCrest Enterprises, Inc. has $800,000 of notes payable due June 15, 20X6. FlanCrest signed an agreement on December 1, 20X5, to borrow up to $800,000 to refinance the notes payable on a long-term basis with no payments due until 20X7. The financing agreement stipulated that borrowings may not exceed 80% of the value of the collateral FlanCrest was providing. At the date of issuance of the December 31, 20X5 financial statements, the value of the collateral was $950,000 and is not expected to fall below this amount during 20X6. In FlanCrest's December 31, 20X5 balance sheet, the obligation for these notes payable should be classified as

Answer: Short-term: 40,000 and Long-term 760,000 An entity may report a short-term liability that is expected to be refinanced on a long-term basis as a noncurrent asset provided the entity can demonstrate both the ability and intent to do so. Signing an agreement to refinance notes payable on a long-term basis is sufficient to support the intent and ability. The amount that may be reported as noncurrent, however, is limited to the amount the entity is able to refinance on a long-term basis as of the balance sheet date. Since FlanCrest is limited to 80% of the value of the collateral, which is $760,000 (80% x $950,000), that is the amount that would be reported as noncurrent. The remainder would be reported as current.

Tricky question: On January 2 of the current year, Cruises, Inc. borrowed $3 million at a rate of 10% for three years and began construction of a cruise ship. The note states that annual payments of principal and interest in the amount of $1.3 million are due every December 31. Cruises used all proceeds as a down payment for construction of a new cruise ship that is to be delivered two years after start of construction. What should Cruise report as interest expense related to the note in its income statement for the second year?

Answer: $0 Interest expense on self-constructed long-term assets may be capitalized to the extent that interest is actually paid, subject to certain rules. The entire amount of interest paid in the second year is capitalized. The amount expensed is $0.

Present Value Question: On December 31, Year 1 Harper Co. finances the purchase of equipment by issuing a $15,000 non-interest-bearing note payable. The note will be paid off in 10 equal annual installments beginning on December 31, Year 2. The market rate of interest for notes of this type is 5%. Considering the information below, at what amount should Harper Co. record the equipment on its books as of December 31, Year 1? The present value of $1 at 5% for 10 periods 0.61391 The present value of an ordinary annuity of $1 at 5% for 10 periods 7.72173 The present value of an annuity due of $1 at 5% for 10 periods is 8.10782

Answer: $11,583 When an asset is received in exchange for a noninterest bearing note, the transaction is recognized at the fair value of the note, the fair value of the asset, or the present value of the payments called for under the note, whichever is more readily determinable. With a note signed on December 31, Year 1, and annual payments beginning on December 31, Year 2, the payments represent an ordinary annuity and the present value will be $1,500, the amount of each of the 10 payments, x 7.72173 or $11,583.

Understanding how to classify liabilities, under IFRS: Arden, Inc., a company that prepares its financial statements in accordance with IFRS, has a $5,000,000 note payable that comes due on October 1, 20X2. The company has both the ability and the intent to refinance the obligation on a long-term basis. As of December 31, 20X1, it has entered into an agreement with a financial institution that allows it to refinance $2,000,000 for a 24-month period. In addition, it intends to issue a new 20 year $3,500,000 bond in May, 20X2 and knows that it will be able to because it has excellent credit and the bond market is very strong. How will Arden report this on their balance sheet at December 31, 20X1?

Answer: $2,000,000 will be reported as a noncurrent liability and the remaining $3,000,000 will be reported as a current liability. Under IFRS, a short-term obligation may be reported as noncurrent only if, as of the balance sheet date, it has entered into an agreement as of the balance sheet date to refinance the obligation for a period of at least 12 months. The intent and ability to issue a bond does not qualify. As a result, Arden would report $2,000,000 as noncurrent based on the agreement with the financial institution and the remainder would be reported as current.

Small difference with IFRS: Arden, Inc., a company that prepares its financial statements in accordance with IFRS, has a $5,000,000 note payable that comes due on October 1, 20X2. The company has both the ability and the intent to refinance the obligation on a long-term basis. As of December 31, 20X1, it has entered into an agreement with a financial institution that allows it to refinance $2,000,000 for a 24-month period. In addition, it intends to issue a new 20 year $3,500,000 bond in May, 20X2 and knows that it will be able to because it has excellent credit and the bond market is very strong. How will Arden report this on their balance sheet at December 31, 20X1?

Answer: $2,000,000 will be reported as a noncurrent liability and the remaining $3,000,000 will be reported as a current liability. Under IFRS, a short-term obligation may be reported as noncurrent only if, as of the balance sheet date, it has entered into an agreement as of the balance sheet date to refinance the obligation for a period of at least 12 months. The intent and ability to issue a bond does not qualify. As a result, Arden would report $2,000,000 as noncurrent based on the agreement with the financial institution and the remainder would be reported as current.

Good note payable question: On October 1, year 1, Gold Co. borrowed $900,000 to be repaid in three equal, annual installments. The note payable bears interest at 5% annually. Gold paid the first installment of $300,000 plus interest on September 30, year 2. What amount should Gold report as a current liability on December 31, year 2?

Answer: $307,500 The amount to be reported in current liabilities will include any principal payments to be made within one year of the balance sheet date and any interest that has accrued from the date of the most recent payment until the end of the period. There is a $300,000 principal payment due on September 30 of year 3, 9 months from the date of the financial statements, making it a current liability. In addition, as a result of the payment on September 30 of year 2, the principal balance was reduced to $600,000. Interest from October 1 until December 31 will be $600,000 x 5% x 3/12 = $7,500. As a result, $307,500 will be reported in current liabilities.

Warranty expense question: Hill Corp. began production of a new product. During the first calendar year, 1,000 units of the product were sold for $1,200 per unit. Each unit had a two-year warranty. Based on warranty costs for similar products, Hill estimates that warranty costs will average $100 per unit. Hill incurred $12,000 in warranty costs during the first year and $22,000 in warranty costs during the second year. The company uses the expense warranty accrual method. What should be the balance in the estimated liability under warranties account at the end of the first calendar year?

Answer: $88,000

Answer to flashcard number 54

Answer: $900

When do you refinance short-term obligations to long-term?

Current liabilities are obligations that will be settled within one year or operating cycle, whichever is longer. If an entity plans to refinance a short-term obligation to a longer time period, the obligation is reclassified from current to long-term if the intent and ability to refinance can be demonstrated. Proving intent and ability to refinance can occur in various ways, including incurring additional long-term debt to pay an existing short-term obligation. Although Ames, Inc. intends to refinance the entire note payable, the amount Ames is able to refinance is limited by the lender to 80% of the collateral provided. As such, only $480,000 (80% × $600,000 collateral) would be reclassified as long-term. The remaining $20,000 ($500,000 note balance − $480,000 refinanced) would be classified as current because it is still due within one year. Things to remember:If the intent and ability to refinance a short-term obligation to a long-term obligation can be demonstrated, the classification changes from a current liability to a long-term liability. If an entity is able to refinance only a portion of a short-term obligation, only the amount refinanced is reclassified to long-term.

What are the key differences between current and long-term liabilities? What happens to a long-term liability if a lender does not waive their right to the debt covenant?

Current liabilities are obligations that will be settled within one year or the operating cycle (the amount of time it takes a company to take its inventory and turn it into cash), whichever is longer. Common examples of current liabilities include accounts payable, short-term borrowings, and the current portion due of any long-term debt. A debt covenant is a loan agreement that limits the activities of the borrower while funds are owed to the lender. For example, the borrower may need to maintain a certain debt-to-equity ratio or provide audited financial statements each period. Sometimes, the violation of a covenant allows the lender to call the debt (ie, demand immediate payment). If the lender does not waive this right, the violation typically results in the entire debt being classified as current

When should a debtor report a gain or loss in a troubled debt restructuring?

For a modification of terms (eg, reduced interest rate) restructuring, the sum of the total future cash payments under the new terms of the debt is compared with the carrying value of the existing debt. If the future payments are less than the carrying value, the debtor is relieved of a portion of the debt and will record a restructuring gain (and vice versa) for the difference. If there is a restructuring gain, the new, modified debt does not distinguish principal and interest. All future payments are considered payment of the debt itself. Things to remember:For a troubled debt restructuring involving only a modification of terms, the sum of the total future cash payments under the new terms for the debtor is compared with the existing debt's carrying value to determine a restructuring gain or loss. The creditor (not the debtor) compares the present value of the debt under the new arrangement using a fair interest rate to the carrying value of the existing debt (conservative approach). The interest rate could be the original rate associated with the debt or a modified rate, depending on the terms of the modification

See information for accrual adjustments

It is common in business for cash and goods or services to be exchanged at different points in time. For example, goods can be purchased on account before cash is provided to a seller (ie, accounts payable) or goods can be provided to a buyer before cash is received (ie, accounts receivable). Unearned (ie, deferred) revenue occurs when an entity receives cash before providing goods or services to a customer. Unearned revenue is a liability because the entity has an obligation to perform future services upon receipt of the cash. Once the services have been provided, previously postponed revenue can be recognized, and the unearned revenue liability is reduced. If the entity is unable to provide those services, it is generally required to provide a refund to the customer. Rent collected but not yet earned is considered unearned revenue from the landlord's (ie, seller's) perspective. Upon receipt of the cash, the landlord has a future obligation to provide the leased space to the tenant (ie, buyer) for the paid-for period.

Does a company need to accrue for the employers and employees payroll taxes?

No- only the employer's (i.e Company). Payroll taxes need to be accrued at the time related payroll expenses are recognized. It is important, however, to distinguish employer taxes from the employee taxes on payroll. The latter (employee) are not costs of the company, but instead represent withholdings from the gross pay of the employees. As a result, only employer taxes meet the definition of accrued expenses (costs recognized on the income statement before payment).

When there is a probably and estimable loss contingency within a range, should you take the lowest of the range or the estimate?

Take the estimate. If the estimate is not known, then take the lowest of the range. Things to remember:When a range of potential loss estimates is available for a contingent liability that is probable and estimable, the loss estimate that is most likely to occur (if known) should be reported in the financial statements (F/S). A Type 1 subsequent event provides evidence of conditions existing at the balance sheet date and may require a F/S adjustment.

You should begin to like these.... For the week ended February 20, 20X5, Epsilon Co. paid gross wages of $15,000, from which federal income taxes of $1,500 were withheld. All wages paid were subject to FICA tax rates of 7% each for employer and employee. Epsilon must also pay the 2% FUTA tax employers are subject to. Epsilon makes all payroll-related disbursements from a special payroll checking account. What amount should Epsilon have deposited in the payroll checking account to cover payroll and related payroll taxes for the week ended February 20, 20X5?

The amount that would be required to cover payroll will be equal to gross wages of $15,000 plus the employer's share of payroll taxes, which will be FICA of 7% and FUTA of 2% or a total of 9% or $1,350. Amounts withheld from employees for income taxes and for their share of FUTA reduce the portion of the $15,000 in gross wages that will be paid to employees but do not increase the employer's cash requirement.

See answer to escrow problem

The beginning escrow liability of $500,000 is increased by escrow receipts of $1,200,000 and interest income of $40,000 and is decreased by the $1,450,000 in real estate taxes paid during the year. As a result, the balance is $500,000 + $1,200,000 + $40,000 - $1,450,000 = $290,000. Hemple is entitled to 10% of the interest, which is $4,000, indicating a liability of the difference of $286,000.

Answer, this good problem: A company finances the purchase of equipment with a $500,000 five-year note payable. The note has an interest rate of 12% and a monthly payment of $11,122. After two payments have been made, what amount should the company report as the note payable balance in its December 31 balance sheet?

The first payment will include interest of $500,000 x 12% x 1/12 or $5,000. The entire payment was $11,122, indicating a principal reduction of $6,122 and an ending balance of $500,000 - $6,122 or $493,878. The second payment will include interest of $493,878 x 12% x 1/12 or $4,939, indicating a principal reduction of $6,183. After the second payment, the liability will have a balance of $493,878 - $6,183 or $487,695.

A little tricky, but you can do it: On September 30, World Co. borrowed $1,000,000 on a 9% note payable. World paid the first of four quarterly payments of $264,200 when due on December 30. In its December 31, balance sheet, what amount should World report as note payable?

The initial $264,200 payment included interest expense, calculated by multiplying the principle by the yearly interest rate prorated for the portion of the year the loan was actually outstanding (1,000,000 X (9% X (3/12)) = 22,500). The principle portion of the $264,200 payment is therefore $241,700 (264,200 - 22,500 = 241,700). The amount World should report as note payable on its December 31 balance sheet is therefore $758,300 (1,000,000 - 241,700 = 758,300).

Answer: This seems like a hard problem Sunk Co. is unable to service its $500,000, 8%, 5-year note payable with First Bank, which agrees to restructure the debt by accepting an asset from Sunk and modifying the terms of the debt agreement. The asset given up by Sunk has a fair value of $200,000 and a carrying value of $150,000. The transfer was applied against the face amount of the note. The carrying value of Sunk's debt liability before the transfer, which includes accrued interest of $40,000, was $414,771. First Bank agrees to forgive the accrued interest, reduce the principle by $100,000, lower the interest rate to 7%, and extend the loan term to 10 years total, meaning Sunk now has exactly eight years to repay the note. After accounting for any gain on the disposal of the asset, what amount of gain will Sunk record as a result of the modification of terms?

The transfer of the asset will be recognized by Sunk as if the asset was sold for its fair value of $200,000, at a gain of $50,000, with the proceeds used to reduce the debt. As a result, the carrying value of the debt would be reduced by $200,000 to $214,771, and the face amount of the liability will be reduced to $300,000. Under the modification of terms, the principle is being further reduced by $100,000, to $200,000, accrued interest is forgiven, and the interest rate for the remaining extended term of 8 years will be 7%. As a result, the total payments to be made under the new terms will include principle of $200,000 plus interest for 8 years at 7% of $200,000 per year or $112,000. Since the $312,000 in total payments to be made under the modified terms exceeds the revised carrying value of the liability of $214,771, there will be no gain recognized.

What are the key factors in determining whether you need to book a contingent loss?

Things to remember:An accrual for a contingent loss (eg, threatened litigation) depends on (1) the probability of an unfavorable outcome, (2) the ability to make a reasonable estimate of the loss, and (3) the period in which the underlying cause of the potential liability occurred. As long as management knew about the threatened litigation before the F/S were issued, the period the litigation became known is not relevant in determining if an accrual is appropriate. This is because even if management found out at the beginning of the next fiscal period, the pending litigation is a Type 1 subsequent event. For example, whether a calendar-year entity is alerted of litigation in December or January does not change the amount or likelihood of the potential liability the entity could be responsible for as of the balance sheet date.

Another good conceptual question: Paxton Co. signed contracts for the purchase of raw materials to be executed the following year at a firm price of $5 million. The market price of the materials dropped to $3 million on December 31. What amount should Paxton record as an estimated liability on purchase commitments as of December 31?

Things to remember:An unconditional purchase obligation is a legal commitment to purchase goods at a set price for a specific period. If the market price falls below the contract price at year end, a loss for the difference is accrued on the financial statements. Gains from increases in market price are not recorded.

Can you solve this? A customer is considering buying a television set with a retail price of $2,000. The customer asks the store manager if the store will consider paying the sales tax so that the total cash payment is $2,000. The sales tax is 8%. The store manager agrees to accept $2,000 cash. What should the accountant credit in this transaction?

Things to remember:Customers generally pay more than the stated sales price of a good or service due to sales taxes collected by the seller. These collections are reported as a liability until they are remitted. If a customer arranges to pay a different amount, both the sales price and sales tax payable amounts must be adjusted accordingly.

What's the difference between type 1 and 2 subsequent events?

Things to remember:Subsequent events occur after the financial statement (F/S) date but before the F/S are issued. Type 2 (nonrecognized) events are not related to any condition that existed as of the F/S date and are not recognized in the F/S apart from a potential note disclosure.

Can you explain the matching principle?

Things to remember:The matching principle states that revenues and any related expenses must be recognized together in the same period. Liabilities are expenses incurred in the current period that will be paid in a future period. Expenses should match the exact time frame reported on the financial statement.

Solve this? Pane Co. had the following borrowings on its books at the end of the current year: $100,000, 12% interest rate, borrowed five years ago on September 30; interest payable March 31 and September 30. $75,000, 10% interest rate, borrowed two years ago on July 1; interest payable April 1, July 1, October 1, and January 1. $200,000, noninterest bearing note, borrowed July 1 of current year, due January 2 of next year; proceeds $178,000. What amount should Pane report as interest payable in its December 31 balance sheet?

Things to remember:To reflect proper matching, interest expense that has been accrued but not yet paid on notes payable is recorded each reporting period. Interest is not accrued on a noninterest-bearing note; instead, the discount is amortized to interest expense each period.

This should be easy, yet I got it wrong: For the week ended June 30, 20X5, Free Co. paid gross wages of $20,000, from which federal income taxes of $2,500 and FICA were withheld. All wages paid were subject to FICA tax rates of 7% each for employer and employee. Free makes all payroll related disbursements from a special payroll checking account. What amount should Free have deposited in the payroll checking account to cover net payroll and related payroll taxes for the week ended June 30, 20X5?

To cover its net payroll and related payroll taxes for the week, Free must have enough for gross wages ($20,000) and for the employer portion of the FICA tax ($20,000 X 7% = $1,400). The total that Free Co. needs is $21,400.

Under IFRS, what is the difference between a contingency and a provision.

Under IFRS, a provision or contingency is a liability, uncertain as to timing and amount, associated with a present obligation resulting from a past event. Contingencies are those that are not probable, not estimable, or neither probable nor estimable and are disclosed in the notes to the financial statements but are not recognized on the balance sheet. Provisions are those that are both probable and estimable and are recognized on the balance sheet.

What are the 3 ways to restructure debt? see.

When a debtor cannot pay a debt as it comes due, the obligation is considered a troubled debt. Creditors will often make concessions in these situations to make it easier for the debtors to pay. There are three ways to restructure the debt, including a modification of debt terms.

Good conceputal question in the image

When a note is discounted, the issuer will receive the maturity value, which will be the face amount when the note is noninterest bearing, reduced by the discount. As a result, cash received will be lower than the face value of the note. The amount of the discount will be the discount rate multiplied by the maturity value and adjusted for the length of time until the note matures. Upon repayment, the effective rate paid will be higher than the discount rate. A $1,000 noninterest bearing note, for example, maturing in one year that is discounted at 10% will result in cash received of $1,000 - $100 or $900. At maturity, the borrower remits the $1,000 to the lender, which is repayment of the $900 received plus the $100 discount. A cost of $100 to borrow $900 for one year would indicate an effective rate in excess of 11%, higher than the 10% discount rate.

A good PV question, in the image:

When an asset is received in exchange for a noninterest bearing note, the transaction is recognized at the fair value of the note, the fair value of the asset, or the present value of the payments called for under the note, whichever is more readily determinable. With a note signed on December 31, Year 1, and annual payments beginning on December 31, Year 2, the payments represent an ordinary annuity and the present value will be $1,500, the amount of each of the 10 payments, x 7.72173 or $11,583.

If both vacation and sick days can be carried over indefinitely, do you need to accrue for them? What if there is a pay rate change the following year (after balance sheet end)

Yes. You need to accrue for things that will carry over into the following year. You need to accrue for them at the price you expect to pay. Vacation pay is required to be accrued if it vests or accumulates because it is assumed that employees will ultimately take or take payment for all vacation days to which they are entitled before leaving the entity's employ. Sick pay may be accrued if it accumulates but is only required to be accrued if it vests because it is assumed that sick pay will only be given when an employee is sick, which may or may not occur. Only the 250 vacation days would normally be required to be accrued. When sick days can be used by employees regardless of whether or not they are actually sick they are treated similar to vacation days and are also required to be accrued if they vest or accumulate, or both. As a result, the accrual will be 350 days, which will be recognized at the $110 per day rate at which they are expected to be paid (instead of the $100 in current year). The amount that will be reported as a liability is 350 x $110 or $38,500.