ACG 3113 CH 13

Gift Cards

* when company receives cash - it records it as unearned revenue * when used or use is remote then it is recognizes revenue

Obligations Callable by the Creditor

**The requirement to classify currently maturing debt as a current liability includes debt that is callable, in other words, due on demand, by the creditor in the upcoming year or operating cycle, if longer, even if the debt is not expected to be called.

Commercial Paper

-Form of Note Payable (so record as same) -unsecured notes sold in minimum denominations of $25,000 with maturities ranging from 30 to 270 days -way to obtain temporary financing -often purchased by other companies as a short-term investment -Interest Discounted at time of issuance - Usually commercial paper is issued directly to the buyer (lender) and is backed by a line of credit with a bank -popular way for companies to raise money -lower interest rate than bank loan

Short Term Notes Payable

-most common way for a corporation to obtain temporary financing -sign an IOU -firm's liability is reported as notes payable

Third Party Collections

-represent liabilities until paid -example - sales taxes to government and amounts in connection with payroll ss,etc

From a financial reporting perspective, a liability has three essential characteristics. Liabilities:

1. Are probable, future sacrifices of economic benefits. 2. Arise from present obligations (to transfer goods or provide services) to other entities. 3. Result from past transactions or events.

A two-step process is involved in deciding how the unasserted claim should be reported:

1. Is it probable that a claim will be asserted? If the answer to that question is "no," stop. No accrual or disclosure is necessary. If the answer is "yes," go on to step 2. 2. Treat the claim as if the claim has been asserted. That requires evaluating (a) the likelihood of an unfavorable outcome and (b) whether the dollar amount of loss can be estimated, just as we already have discussed for other loss contingencies for which a claim has already been asserted.

4 Conditions for Accrual of Paid Future Absences - ALL must be met

1. The obligation is attributable to employees' services already performed. 2. The paid absence can be taken in a later year—the benefit vests (will be compensated even if employment is terminated) or the benefit can be accumulated over time. 3. Payment is probable. 4. The amount can be reasonably estimated.

Current Liabilities

1. obligations payable within one year or within the firm's operating cycle, whichever is longer. 2. those expected to be satisfied with current assets or by the creation of other current liabilities.

Line of Credit

A line of credit allows a company to borrow cash without having to follow formal loan procedures and paperwork. Can be committed or non-committed.

VACATIONS, SICK DAYS, AND OTHER PAID FUTURE ABSENCES.

Accrued at current wage rate. An employer should accrue an expense and the related liability for employees' compensation for future absences, such as vacation pay, if the obligation meets all of the four conditions 1. The obligation is attributable to employees' services already performed. 2. The paid absence can be taken in a later year—the benefit vests (will be compensated even if employment is terminated) or the benefit can be accumulated over time. 3. Payment is probable. 4. The amount can be reasonably estimated.

Salaries, Commissions, and Bonuses

Accrued liabilities arise in connection with compensation expense when employee services have been performed as of a financial statement date, but employees have yet to be paid.

Dollar amount of possible loss contingency

Also key to reporting a contingent liability is its dollar amount. The amount of the potential loss is classified as either known, reasonably estimable, or not reasonably estimable.

REFUNDABLE DEPOSITS

Apartment deposits for example. Similarly, deposits sometimes are required on returnable containers, to be refunded when the containers are returned.

Most common performance measures

Are Earnings per share, net income, and operating income. Nonfinancial performance measures, such as customer satisfaction and product or service quality, also are used.

Accrued Interest Payable

Assume Dec 31 is 2 months after a 6 month note is established. 2 months interest has accrued - Dec 31 $700*6%*2/6 Debit Interest Expense Credit Interest Payable

Interest

Because the stated rate typically is an annual rate, when calculating interest for a short-term note we must adjust for the fraction of the annual period the loan spans. Interest on notes is calculated as: face amount times interest rate times time to maturity

Extended Warranties

By the accrual concept, revenue is recognized when earned, not necessarily when cash is received. Because the earning process for an extended warranty continues over the entire warranty period, revenue should be recognized over the same period. However, cash typically is received up front, when the extended warranty is sold. So, revenue from separately priced extended warranty contracts is deferred as a liability at the time of sale and recognized on a straight-line basis over the contract period.

Liability Payments

Can be a cash payment but doesnt have to be. Can be a service or transfer of stock. Doesnt have to have a certain time or amount.

Premiums

Cash Rebates or non cash rebates such as toys, dishes, utensils **almost always accrued

Statement of Cash Flows

Cash received from note and Cash to pay note back = FINANCING Activity Accounts Payable, Interest Payable, Bonuses Payable are normal procedures = OPERATING activities

Subsequent Events #1

Clarifying events between the end of the year and the filing of financial documents can be included to clarify or record a contingency.

Deposits and Advanced Collections from Customers

Collecting cash from a customer as a refundable deposit or as an advance payment for products or services creates a liability to return the deposit or to supply the products or services.

accrual of a loss contingency recorded

Debit Loss or expense. Credit Liability. or if impairs an asset then would be Debit loss or expense. Credit Asset or valuation account

Expected cash flow approach:

Discounts the expected cash flow at the risk-free rate.

Subsequent Events #3

For a loss contingency to be accrued, the cause of the lawsuit must have occurred before the accounting period ended. It's not necessary that the lawsuit actually was filed during that reporting period.

Before a Business buys an asset it must raise money buy 1 of 2 ways -

Funds are provided by the owners or funds must be borrowed.

Important Subsequent Event Disclosures

In fact, any event occurring after the fiscal year-end but before the financial statements are issued that has a material effect on the company's financial position must be disclosed in a subsequent events disclosure note. Examples are an issuance of debt or equity securities, a business combination, and discontinued operations.

Coupon Actual Firm Practices

In practice, most firms either - a. recognize the entire expense with the liability in the period the coupons are issued, like we record premiums, or - b. recognize no liability in the period the coupons are issued, recording the expense when reimbursements are made.

Accounting for warranty obligation: An alternative expected cash flow approach is described by SFAC No. 7

Incorporates specific probabilities of cash flows into the analysis. Required conditions: When the warranty obligation spans more than one year and We can associate probabilities with possible cash flow outcomes

Coupons

Issuing the coupons creates a contingent liability to be recorded in the period the coupons are issued. Logically, since the purpose of coupon offers is to stimulate sales, the expense properly should be deferred as an asset until the coupons are redeemed - when the future sales occur.

Important Sidenote

It's important to remember that several weeks usually pass between the end of a company's fiscal year and the date the financial statements for that year actually are issued. Events occurring during that period can be used to clarify the nature of financial statement elements at the reporting date. Here we consider refinancing agreements and actual securities transactions to support a company's ability to refinance on a long-term basis.

Accrued Liabilities

Liabilities accrue for expenses that are incurred but not yet paid.

company's assets

Liabilities and owners' equity accounts represent specific sources of a company's assets.

Current Maturities of Long-Term Debt

Long-term obligations - bonds, notes, lease liabilities, deferred tax liabilities - usually are reclassified and reported as current liabilities when they become payable within the upcoming year - or operating cycle, if longer than a year. For example, a 20-year bond issue is reported as a long-term liability for 19 years but normally is reported as a current liability on the balance sheet prepared during the 20th year of its term to maturity.

Gain Contingencies

Not Accrued Only when realized Maybe in disclosure notes but must be careful not to be misleading

Loss Contingency Timing

Note that the event that gives rise to the potential liability must occur before the financial statement date. Otherwise, regardless of the likelihood of the eventual outcome, no liability could have existed at the statement date.

Liability

Notice that the definition of a liability involves the present, the future, and the past. It is a present responsibility to sacrifice assets in the future because of a transaction or other event that already has happened.

A common contingent loss

Occurs when a company is being sued. While companies may accrue estimated lawyer fees and other legal costs, they usually do not record a loss until after the ultimate settlement has been reached or negotiations for settlement are substantially completed.

Premiums

Premiums The costs of promotional offers should be recorded as expenses in the same accounting period the products are sold.

Likelihood an event will occur

Probable - Confirming event is likely to occur. Reasonably possible - The chance the confirming event will occur is more than remote but less than likely. Remote - The chance the confirming event will occur is slight.

Expected Cash Flow Approach for Product Warranty

Product Warranty Probabilities are associated with possible cash outcomes. The probability-weighted cash outcomes provide the expected cash flows. The present value of the expected cash flows is the estimated liability.

Traditional Approach for Product Warranty

Product Warranty The costs of satisfying guarantees should be recorded as expenses in the same accounting period the products are sold.

The traditional way of measuring a warranty obligation:

Report the "best estimate" of future cash flows, ignoring the time value of money on the basis of immateriality

When Short-Term Obligations Are Expected to Be Refinanced

Short-term obligations - including the callable obligations - that are expected to be refinanced on a long-term basis can be reported as noncurrent, rather than current, liabilities only if two conditions are met: (1) the firm must intend to refinance on a long-term basis, and (2)the firm must actually have demonstrated the ability to refinance on a long-term basis. Short-term obligations can be reported as noncurrent liabilities if the company (a)intends to refinance on a long-term basis and (b) demonstrates theability to do so by a refinancing agreement or by actual financing.

short term can be classified as noncurrent IF:

Short-term obligations can be reported as noncurrent liabilities if the company - a.intends to refinance on a long-term basis and - b. demonstrates theability to do so by a refinancing agreement or by actual financing.

Rebate Recorded

So it follows that the estimated amount of the cash rebates or the cost of noncash premiums estimated to be given out represents both an expense and an estimated liability in the reporting period the product is sold.

Factoring Receivables

Sometimes, the receivables actually are sold outright to a finance company as a means of short-term financing.

Classifying Warranty Liabilities current vs long term

The estimated liability may be classified as current or as part current and part long-term, depending on when costs are expected to be incurred.

Manufacturers Original Warranty

There may be a future sacrifice of economic benefits such as cost of satisfying the guarantee, due to an existing circumstance - the guaranteed products have been sold, that depends on an uncertain future event - customer claim.

Recording Accrued Liabilities for Salaries, Commissions, and Bonuses

These accrued expenses/accrued liabilities are recorded by adjusting entries at the end of the reporting period, prior to preparing financial statements.

IFRS vs GAAP Classification of Liabilities to be Refinanced.

Under U.S. GAAP, liabilities payable within the coming year are classified as long-term liabilities if refinancing is completed before the date of issuance of the financial statements. Under IFRS, refinancing must be completed before the balance sheet date

Subsequent Events #2

When a contingency comes into existence after the company's fiscal year-end, a liability cannot be accrued because it didn't exist at the end of the year. A disclosure note is needed.

Pledged Accounts Receivable

When accounts receivable serve as collateral, we refer to the arrangement as pledging accounts receivable.

Non-Interest Bearing Notes Discount

When interest is discounted from the face amount of a note, the effective interest rate is higher than the stated discount rate.

Cost associated with repairs from extended warranties

Will be recorded over the warranty period, achieving a proper matching of revenues and expenses. debit unearned revenues and credit cash or other payment method.

Committed Line of Credit

a more formal agreement that usually requires the firm to pay a commitment fee to the bank. A typical annual commitment fee is ¼% of the total committed funds, and may also require a compensating balance.

Most Common Current Liabilities

accounts payable notes payable commercial paper income tax liability dividends payable accrued liabilities

Product warranty and guarantees are

almost always accrued. you can determine approximate amount based on prior years experience. ** Accrued in period warranty sold.

Liabilities are created when

amounts are received that will be returned or remitted to others.

Accounts Payable

are obligations to suppliers of merchandise or of services purchased on open account. Usually only formal instrument is the invoice. Usually payable within 30/60/90 days and doesnt include interest.

Important Reminder - Notice that the treatment of contingent liabilities is consistent with the accepted definition of liabilities

as - a. probable, future sacrifices of economic benefits. b. that arise from present obligations to other entities and - c. that result from past transactions or events. The inherent uncertainty involved with contingent liabilities means additional care is required to determine whether future sacrifices of economic benefits are probable and whether the amount of the sacrifices can be quantified.

Unearned revenue liability accounts produced by customer deposits and advances are classified

as current or long-term liabilities depending on when the obligation is expected to be satisfied.

loss contingency example of asset type

bad debt expense allowance for uncollectible accounts

Bonuses Are

compensation expenses in the period in which they are earned. used in place of a raise. A wide variety of bonus plans provide compensation tied to performance other than stock prices. Bonuses sometimes take the place of permanent annual raises.

Discount on Non-Interest Bearing Loans

contra liability account

Risk Analysis - Current Ratio

current assets divided by current liabilities

Key Accounting Considerations to Account Payable:

determining their existence and ensuring that they are recorded in the appropriate accounting period.

Trade Notes Payable

differ from accounts payable in that they are formally recognized by a written promissory note. Often these are of a somewhat longer term than open accounts and bear interest.

Ability to refinance on a long-term basis can be demonstrated by

either an existing refinancing agreement or by actual financing prior to the issuance of the financial statements.

Loss Contingency

existing, uncertain situation involving potential loss depending on whether some future event occurs.

Non-Committed Line of Credit

informal agreement that permits a company to borrow up to a prearranged limit without having to follow formal loan procedures and paperwork. Banks sometimes require the company to maintain a compensating balance on deposit with the bank, say, 5% of the line of credit.

essential characteristics of a liability:

is that it results "from past transactions or events."

What is the difference between a Loss Contingency and a Liability?

is uncertainty as to whether an obligation really exists. The circumstance giving rise to the contingency already has occurred, but there is uncertainty about whether a liability exists that will be resolved only when some future event occurs or doesn't occur.

A liability is accrued if-

it is both probable that the confirming event will occur and the amount can be at least reasonably estimated.

Manufacturers Original Warranty

it is in the period of sale that the company becomes obligated to eventually make good on a guarantee, so it makes sense that it recognizes a liability in the period of sale. There may be a future sacrifice of economic benefits (cost of satisfying the guarantee) due to an existing circumstance (the guaranteed products have been sold) that depends on an uncertain future event (customer claim).

How are Current Liabilities recorded?

liabilities payable within one year ordinarily are recorded instead at their maturity amounts. Debit expense and credit liability

Secured Loans

meaning a specified asset of the borrower is pledged as collateral or security for the loan. -secured by inventory or accounts receivable.

Current vs Non-Current

most prefer non current - leads to better and higher working capital. Current assets minus current liabilities. and a higher current ratio - current assets divided by current liabilities. seen as less risky than something that has to be paid now

unasserted claims and assessments

must be probable

Non-Interest Bearing Notes

noninterest-bearing note notes that bear interest, but the interest is deducted, or discounted, from the face amount to determine the cash proceeds made available to the borrower at the outset. when recorded - record at discount (658 not 700) but then record discount on note payable

ADVANCES FROM CUSTOMERS

payments from customers that will be applied to the purchase price when goods are delivered or services provided **These customer advances, also called unearned revenue or deferred revenue, represent liabilities until the related product or service is provided.** Examples: Gift certificates magazine subscriptions* layaway deposits special order deposits airline tickets

Accrued Liabilities Recorded & B/S

recorded in separate liability accounts, accrued liabilities usually are combined and reported under a single caption or perhaps two accrued liability captions in the balance sheet.

Loss Contingencies Chart

refer to notes

Accrued Liabilities

represent expenses already incurred but not yet paid (accrued expenses). These liabilities are recorded by adjusting entries at the end of the reporting period, prior to preparing financial statements.

Accrued Liabilities Examples

salaries and wages payable income taxes payable interest payable

Premium - B/S

the remaining liability after some is used is reported in the balance sheet

Liabilities created when a company buys on credit or borrows cash:

trade accounts and trade notes bank loans commercial paper