Chapter 13 Current Liabilities & Contingencies

Four conditions for accrual of paid future absences:

-obligation is attributable to employees' services already performed -paid absence can be taken in a later year—the benefit vests or the benefit can be accumulated over time -payment is probable -amount can be reasonably estimated

characteristics of current liabilities

-obligation payable within 1 year or firm's operating cycle -satisficed from current assets -satisficed by creation of other current liabilities

characteristics of liabilities

-probable, future sacrifices of economic benefits -arise from present obligations -result from past transactions or events

extended warranty

-separate performance obligation -recorded as a deferred revenue liability at the time of sale -recognized as revenue over the contract period via straight line basis

characteristic of short term notes payable

-temporary financing from bank -promissory note is signed -lower interest rates than long-term debt -companies have flexibility while selecting financial alternatives

common collections for third parties

-withholding taxes -social security taxes -employee insurance -employee contributions to retirement plans -union dues

total

The criteria for accruing a contingent loss almost always are met for product warranties or guarantees While we usually can't predict the liability associated with an individual sale, prior experience makes it possible to predict reasonably accurate estimates of the ______ liability for a period

best estimate

The traditional way of measuring a warranty obligation is to report the "______ ________" of future cash flows; which ignores the time value of money

recordation, disclosure, or no treatment

There are three possible scenarios for contingent liabilities, all of which involve different accounting transactions.

probable reasonable possible remote

U.S. GAAP requires that the likelihood that the future event be categorized as 3 things

compensating balance in the bank

When having a credit line, borrower may be required to maintain a

callable

When the creditor has the right to demand payment because an existing violation of a provision of the debt agreement makes the long term debt _______

factoring receivables

When the receivables actually are sold outright to a finance company

likelihood that the confirming event will occur & what can be determined about the amount of loss

Whether a contingency is accrued and reported as a liability depends on

a. Current liabilities are obligations payable within one year or within the firm's operating cycle, whichever is longer

Which of the following statements is true about current liabilities? a. Current liabilities are obligations payable within one year or within the firm's operating cycle, whichever is longer b. Current liabilities are ordinarily recorded at maturity amounts rather than present value c. Current liabilities as those expected to be satisfied with current assets or by the creation of other current liabilities d. All of the above

they do not always do so

While companies should provide extensive disclosure of these contingent liabilities

material; disclosed

_________ gain contingencies are __________ in the notes to the financial statements

probable

confirming event is likely to occur

3 examples of accrued liabilities

-Salaries and wages payable -Income taxes payable -Interest payable

3 types of advance collections

-deposits/advances from customers -gift cards -collections for 3rd parties

2 step process of unasserted claims & assessments

1. Is it probable that a claim will be asserted? If yes then go to step 2. 2. Treat the claim as if the claim has been asserted

incorporates

An alternative expected cash flow approach for warranty obligations is described by SFAC No. 7, ________specific probabilities of cash flows into the analysis

deferred revenue

Cash received for sale of a gift card is recorded as _________ _________

to be lower than a bank loan

Commercial paper being issued directly to the lender & being backed by a line of credit allows the interest rate

discount; directly

Commercial paper is -interest often is __________ at issuance -usually is issued directly to the buyer (lender) and is backed by a line of credit with a bank

prefer

Companies typically _______to report an obligation as noncurrent rather than current

current liability, because the callable date is March 1, 2022 which is within a year of the operating cycle starting Jan 1, 2022

Consider the following liabilities of Future Brands, Inc., at December 31, 2021, the company's fiscal year-end. Should they be reported as current liabilities or long-term liabilities? 1. $77 million of 8% notes are due on May 31, 2025. The notes are callable by the company's bank, beginning March 1, 2022. current or long term liability & why?

long term liability, because I have no clue

Consider the following liabilities of Future Brands, Inc., at December 31, 2021, the company's fiscal year-end. Should they be reported as current liabilities or long-term liabilities? 2. $102 million of 8% notes are due on May 31, 2026. A debt covenant requires Future to maintain a current ratio (ratio of current assets to current liabilities) of at least 2 to 1. Future is in violation of this requirement but has obtained a waiver from the bank until May 2022, since both companies feel Future will correct the situation during the first half of 2022.

loss contingency

Costs of satisfying guarantees should be estimated and recorded as expenses in the same accounting period the products are sold

1. yes, because warranty costs are associated with the products being sold 2. D: A/R 5.2 mil C: S/R 5.2 mil 3. D: warranty exp 208 000 C: warranty lia 208 000 = 5.2 mil * 0.04 4. D: warranty liability 39 500 C: cash 39500

Cupola Awning Corporation introduced a new line of commercial awnings in 2021 that carry a two-year warranty against manufacturer's defects. Based on their experience with previous product introductions, warranty costs are expected to approximate 4% of sales. Sales and actual warranty expenditures for the first year of selling the product were: sales - 5.2 million actual warranty expenditures - 39 500 1. is this a loss contingency? 2. record 2021 sales 3. record the accrued liability and expense. 4. record the actual expenditures.

$168 500 (5.2 mil * 0.04) - 39 500

Cupola Awning Corporation introduced a new line of commercial awnings in 2021 that carry a two-year warranty against manufacturer's defects. Based on their experience with previous product introductions, warranty costs are expected to approximate 4% of sales. Sales and actual warranty expenditures for the first year of selling the product were: sales - 5.2 million actual warranty expenditures - 39 500 What amount should Cupola report as a liability at December 31, 2021?

financing alternatives: short-term debt

commercial paper unsecured loans credit lines secured loans

grace

Debt is not yet callable but will be callable within the year if an existing violation is not corrected within a specified _______ period

requirement to classify a currently maturing debt as a current liability

Debt must be CALLABLE (due on demand) by the creditor in the upcoming year/operating cycle, even if the debt is not expected to be called

deposits collected D: cash 856 000 C: refundable deposits 856 000 containers returned D: refundable deposits 811 000 C: cash 811 000 deposits forfeited - record revenue D: refundable deposits 41000 C: revenue from sale of containers 41000 deposits forfeited - adjust inventory D: COGS 41 000 C: inv of containers 41 000

During 2021, deposits collected on containers shipped were $856,000. Deposits are forfeited if containers are not returned within 18 months. Containers held by customers at January 1, 2021, represented deposits of $587,000. In 2021, $811,000 was refunded and deposits forfeited were $41,000. 1. Record the deposits collected/received 2. Record the containers returned 3. Record the deposits forfeited - record revenue 4. Record the deposits forfeited - adjust inventory

$591, 000 beg bal + deposits collected - deposits refunded/returned - deposits forfeited

During 2021, deposits collected on containers shipped were $856,000. Deposits are forfeited if containers are not returned within 18 months. Containers held by customers at January 1, 2021, represented deposits of $587,000. In 2021, $811,000 was refunded and deposits forfeited were $41,000. Determine the liability for refundable deposits to be reported at year-end/on the December 31, 2021, balance sheet.

D: Cash # C: Deferred gift card revenue #

Entry to record a month of gift card sales

D: deferred gift card revenue # C: gift card revenue # # = amount of gift cards sold - amount of gift cards redeemed

Entry to record the expiration of a month's gift cards

D: Deferred gift card revenue # C: gift card revenue #

Entry to record the redemption of a month's gift cards

contingency

Even if a claim has yet to be made when the financial statements are issued, a _________ may warrant accrual or disclosure

d.$75,000

GK, Inc. has the following outstanding litigation claims against it: •A claim of $100,000. GK thinks it is probable it will lose the claim, and estimates the loss at $75,000 if it occurs. •A claim of $50,000. GK thinks it is probable it will lose the claim, but cannot estimate the amount of loss. •A claim of $10,000. GK thinks it is reasonably possible it will lose the claim, and estimates the loss at $8,000 if it occurs. GK should accrue a contingent liability of: a.$160,000 b.$100,000 c.$83,000 d.$75,000

are not

Gain contingencies are/are not accrued

you can pay the debt off before its due date

If something is callable, what does that mean?

b.$4,000 100,000 * 0.08 * (6/12) 6/12 => july 1 2021 -> december 31 2021

Jamal borrowed $100,000 on July 1, 2021, and signed a one-year note bearing interest at 8%. Interest is payable in full at maturity on June 30, 2022. Jamal should report interest expense at December 31, 2021, of: a.$0 b.$4,000 c.$8,000 d.$32,000

Cash/ A/R 107 Sales Revenue 100 Sales tax payable 7

Journal entry for this? Assume a state sales tax rate of 4% and local sales tax rate of 3%. A sale is made for $100.

c.$5,000,000 3 mil + 2 mil

Kim's Academy had $10,000,000 of X bonds payable due in 2022. Prior to 12/31/2021, Kim's refinanced $3,000,000 of the X bonds with other bonds that mature in 2032. On January 15, 2022, Kim's refinanced another $2,000,000 of the X bonds with others that mature in 2029. Kim's issued its financial statements on February 1, 2022. On February 15, 2022, Kim's refinanced another $4,000,000 of the X bonds with others that mature in 2030. In its 2021 financial statements, Kim's should show noncurrent bonds payable of: a.$2,000,000 b.$3,000,000 c.$5,000,000 d.$9,000,000

present value; payable

Liabilities should be recorded at their _________ _______ except liabilities ________ within one year which are ordinarily recorded at maturity amounts.

Liability accrued and disclosure note

Likelihood: Probable Dollar Amount of potential Loss: Known & Reasonably Estimable

disclosure note only

Likelihood: Probable Dollar Amount of potential Loss: Note Reasonably Estimable

disclosure note only

Likelihood: Reasonably possible Dollar Amount of potential Loss: Known, Reasonably estimable or not reasonable estimable

no disclosure required

Likelihood: Remote Dollar Amount of potential Loss: Known, Reasonably estimable or not reasonable estimable

b.$27,500 25,000 + 2,500

Ling, Inc. sold $30,000 of gift cards during 2021. Also during 2021, $25,000 of gift cards were redeemed, some of which were sold in 2021 and some of which were sold in the prior year. Ling also concluded that $2,500 of gift cards sold in the prior year would never be redeemed, and Ling finished 2021 with a balance of $17,500 in deferred revenue—gift cards. Ling should recognize revenue in 2021 associated with gift cards of: a.$30,000 b.$27,500 c.$25,000 d.$17,500

asmaturity approaches

Long term obligations will soon be "reclassified" as current liabilities,

ultimate settlement

Loss from pending or ongoing litigation is highly uncertain therefore loss is not usually recorded until after

guarantee

Most consumer products are accompanied by a _________, such as a quality-assurance warranty

results

Noncurrent classification _______ in higher working capital and a higher current ratio

c.$10 120 * (3/36) 36 -> 3 year contract in months 3/36 -> oct 2021 - december 31 2021

On October 1, 2021, Majoor, Inc. sold a $480 snow blower with a $120 extended warranty. The warranty covers three years of repairs. During 2021, Majoor would recognize warranty revenue of: a.$120 b.$40 c.$10 d.$3.33

d.$400 2,400 * (1/6) 1/6 => december 1 2021 -> december 31 2021

Perkins Inc. accepted an advance of $2,400 on December 1, 2021, for providing IT helpdesk services for the following six months. Perkins estimates fulfillment of its performance obligation based on the passage of time. On December 31, 2021, Perkins will make an adjusting entry that includes a credit to revenue of: a.$2,400 b.$2,000 c.$800 d.$400

c.$60,000 Event occurring after balance sheet date if provide some evidence relating to the liability or provision of liability existing on balance sheet date should be considered if financial statements are still not issued as in present case Litigation case is existing on balance sheet date and $75000 is the probable liability on balance sheet date. Settlement of the same litigation claim after balance sheet date but before issuance of Financial statements provide more evidence relating to the even existing on balance sheet date so it must be considered to recognize the liability for claim on balance sheet date i.e. 12/31/2020

Portland's Best Coffee has a litigation claim of $100,000 against it. As of 12/31/2021, Portland considered it probable that it would lose $75,000 on the claim. After the 2021 year-end, but before issuance of the financial statements, Portland settled the litigation for $60,000. How much of a litigation liability should Portland show in its 12/31/2021 financial statements? a.$100,000 b.$75,000 c.$60,000 d.$0

D: A/R 819,150 C: sales rev 762, 000 C: sales tax payable 57,150 A/R = [credit sale * (state + local sales)] + credit sale

Record credit sale During December, Rainey Equipment made a $762,000 credit sale. The state sales tax rate is 6% and the local sales tax rate is 1.5%.

D: A/R 975840 C: Sales rev 912000 C: Sales tax payable 63840 A/R= [credit sales * (state + local sales)] + credit sales

Record entry During December, credit sales totaled $912,000. The state sales tax rate is 5% and the local sales tax rate is 2%. (This is a summary journal entry for the many individual sales transactions for the period.)

D: Cash 41000 C: Refundable deposits 41000

Record entry During December, received $41,000 of refundable deposits relating to containers used to transport equipment parts.

D: Cash 7000 C: Deferred Rev 7000

Record entry On December 15, company received $7,000 from Bradley Farms toward the sale by Interstate of a $91,000 tractor to be delivered to Bradley on January 6, 2022.

10/1 D: Cash 82 mil C: N/P 82 mill 12/31 D:Interest Exp 2,665,000 C:Interest Payable 2,665,000 = 82 mil * .13 * (3/12)

Record the issuance of the note & Record the adjusting entry for the note at 12/31 On October 1, Eder Fabrication borrowed $82 million and issued a nine-month, 13% promissory note. Interest was payable at maturity.

liability

Refundable deposits are always classified as what type of account?

warranty obligation spans more than 1 year & we can associate probabilities with possible cash flow outcomes

Requirements of SFAC No. 7

company must INTEND to refinance on a long-term basis & company must actually have demonstrated the ABILITY to refinance on a long-term basis

Short-term obligations that are expected to be refinanced on a long-term basis can be reported as noncurrent liabilities if two conditions are met:

2 million loss on income statement & 2 million loss on balance sheet

Sound Audio manufactures and sells audio equipment for automobiles. Engineers notified management in December 2021 of a circuit flaw in an amplifier that poses a potential fire hazard. An intense investigation indicated that a product recall is virtually certain, estimated to cost the company $2 million. The fiscal year ends on December 31. What loss, if any, should Sound Audio report in its 2021 income statement & What liability, if any, should Sound Audio report in its 2021 balance sheet?

accrued & disclosed because it is both probable that the confirming event will come come and the amount can be at least reasonably estimated

Sound Audio manufactures and sells audio equipment for automobiles. Engineers notified management in December 2021 of a circuit flaw in an amplifier that poses a potential fire hazard. An intense investigation indicated that a product recall is virtually certain, estimated to cost the company $2 million. The fiscal year ends on December 31. Should this loss contingency be accrued & disclosed, only disclosed, or neither? & why?

D: loss - product recall 2,000,000 C: liability- product recall 2,000,000

Sound Audio manufactures and sells audio equipment for automobiles. Engineers notified management in December 2021 of a circuit flaw in an amplifier that poses a potential fire hazard. An intense investigation indicated that a product recall is virtually certain, estimated to cost the company $2 million. The fiscal year ends on December 31. prepare a journal entry if needed

Trade notes receivable

accounts payable vs trade notes receivable -credit instrument written promissory note -longer duration -bear interest

accounts payable

accounts payable vs trade notes receivable -payable on open account -credit instrument invoice -short duration -noninterest-bearing & reported at face amounts

salaries, commissions, & bonuses

accrued liabilities arise in connection with compensation expense when employees have provided services but will be paid after the financial statement date

loss contingency

an existing, uncertain situation involving potential loss depending on a future event aka warranty costs associated with products sold

liabilities

are created when deposits & advances are received from customers

accountant

begin watching federal reserve conferences every wedns. it will take you a long way as an

examples of long term obligations

bonds notes lease liabilities deferred tax liabilities

reasonably possible

chance that confirming event will occur is more than remote but less than likely

remote

chance the confirming event will occur is slight

collections for 3rd parties

collections made from customers or employees and remitted periodically to the appropriate third parties

3 types of common current liabilities

commercial paper dividends payable accrued liabilities

common nonfinancial performance measures

customer satisfaction product/service quality

1. credited 2. debited

debited or credited? 1. premium on note payable 2. discount on note payable

key considerations of accounts payable

determining existence & recording the appropriate accounting period

Disclosure of a contingent liability

disclose the existence of a contingent liability in the notes accompanying the financial statements if the liability is reasonably possible but not probable, or if the liability is probable, but you cannot estimate the amount. aka payment amount is reasonably possible and is reasonably estimable.

1. discount 2. premium

discount or premium on notes payable? 1. asset < notes payable 2. asset > notes payable

No treatment of a contingent liability

do not record or disclose a contingent liability if the probability of its occurrence is remote.

common financial performance measures

earnings per share net income operating income

formula for interest

face amount * annual rate * time to maturity

committed credit lines

formal agreement; commitment fee to bank to keep a credit line amount available to the company

gift cards sold amount - gift cards redeemed

formula to get the breakage of gift cards

examples of advances from customers

gift certificates magazine subscriptions layaway deposits special order deposits airline tickets

noncommitted credit lines

informal agreement; borrow up to a prearranged limit without formal loan procedures

gain contingency

is an uncertain situation that might result in a gain

pending litigation

is not usual, accrual of a loss from this term is rare

D: deferred revenue C: sales D: COGS C: Inventory

journal entry for redemption (use) of gift cards? 2 automatice entries

D: deferred rev C: sales revenue

journal entry to record breakage of gift cards

current liabilities

liabilities due within a short time, usually within a year or operating cycle, whichever one is longer

credit lines

line of credit is an agreement to provide short-term financing, with amounts withdrawn by the borrower only when needed aka an individual's credit score and such

secured loans

loan made by pledging a specified asset of the borrower as collateral or security

accounts payable/trade notes pyable

obligations to suppliers of merchandise or of services

interest

paid by borrowing company during the loan term; return for using lender's money; stated in terms of a percentage rate to be applied to the face amount of the loan

extended warranty

provides warranty protection beyond manufacturer's original warranty

Recordation of a contingent liability

record a contingent liability when it is probable that a loss will occur, and you can reasonably estimate the amount of the loss.

accrued liabilities

recorded by adjusting entries & usually combined and reported under a single caption in the balance sheet

commercial paper

refers to unsecured notes sold in minimum denominations of $25, 000 with maturities ranging from 1 to 270 days

accrued liabilities

represent expenses already incurred but not yet paid

advances from customers

represent liabilities until the product or service is provided or the advance collected

1. interest expense / notes payable 2. annualize it

stated rate

annual bonuses

tied to performance objectives to provide incentive to executives; compensation expense of the period in which they are earned

debit cash credit a liability then use/return/expire debit liability credit revenue/cash/revenue

typical entries for chapter 13

example of conservatism

we record uncertain losses but not uncertain gains

pledging accounts receivable

when accounts receivable serves as a collateral