ACC 402 Chapter 13

Average time to pay

= # days in the time period / AP turnover

Avg. Collection Period

= # days in time period / AR Turnover

Avg. Days in Inventory

= # days in time period / inventory turnover

A/P Turnover

= COGS / Avg. AP = # of times we pay off AP during the time period

Inventory Turnover

= COGS / Avg. Inv. = # of times we sell (turnover) inventory during the time period

A/R Turnover

= Sales / Avg. AR = # of times we collect AR during the time period

Secured Loans

A company pledges another asset as collateral or security for the loan. In the event of a default, the borrower receives the asset. Inventory & A/R are often used to secure loans cuz they are easiest to monetize

Journal Entry - Interest Bearing Note

Cash $60k Note Payable $60k Interest Expense $1.8k Interest Payable $1.8k - AJE (12%, 3/12months)

Collections for Third Parties

Collections made from customers or employees and remitted periodically to the appropriate third parties Examples: payroll-related deductions such as - withholding taxes - social securities taxes - employee insurance - employee contributions to retirement plans - union dues

U.S. GAAP & IFRS unasserted claims

LO 13-7 Reference

Accounting Treatment of Loss Contingencies

LOOK AT THE CHART LO13-6

ECFA Journal Entry

REFERENCE P13-8

Credit Lines

is an agreement to provide short-term financing, with amounts withdrawn by the borrower only when needed

Liabilities from advance collections

liabilities are created when deposits & advances are received from customers Gift Cards (Gift Certifications): - Cash received for sale of gift card recorded as deferred revenue

When loss contingency is resolved using a noncash asset

loss (or expense) xxxx Asset (or valuation account) xxxx

Obligations Callable by the Creditor

The requirement to classify currently maturing debt as a current liability includes: - debt that is callable (due on demand) by the creditor in the upcoming year/operating cycle, even if debt is not expected to be called - when the creditor has the right to demand payment because an existing violation of a provision of debt agreement makes it callable - Debt is not yet callable but will be within the year if an existing violation is not corrected within grace period

Salaries, Commissions, & Bonuses

- Accrued Liabilities arise with compensation expenses when employees provided services but will be paid after the financial statement date Ex: Vacations, Sick Days, & other paid future absences 4 Conditions for Accrual of Paid Future Absences: 1. Obligation is attributable to employees' services already performed 2. Paid absence can be taken in a later year - the benefit vests or the benefit can be accumulated over time 3. Payment is probable 4. The amount can be reasonably estimated

Trade Notes Payable

- Credit instrument: written promissory note - Longer duration - Bear interest

Accrued Liabilities

- Expenses already incurred but not yet paid (accrued expenses) - Recorded by adjusting entries - Usually combined & reported under a single caption in the balance sheet Examples: salaries & wages payable, income taxes payable, interest payable

IFRS Contingencies

- Gain contingencies are accrued if future realization is "virtually certain" to occur - Disclose when gain realization is "probable" but uses a lower threshold for "probable"

U.S. GAAP Contingencies

- Gain contingencies are never accrued - Disclose when gain realization is "probable" but uses higher threshold for "probable"

Product Warranties & Guarantees

- Guarantee: quality-assurance warranty - This is a loss contingency - Costs of satisfying guarantees should be estimated & recorded as expenses in the same accounting period the products are sold Quality assurance warranties - are not separate performance obligations (we do not account for them during revenue recognition)

Accounts Payable

- Payable on open account - Credit instrument: invoice - Short duration - Noninterest-bearing and reported at face amounts

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

Expected Cash Flow Approach

- Traditional way of measuring warranty obligation is to report the "best estimate" of future cash flows (method ignores time value of money) - Alternative is ECFA by SFAC No. 7 : Incorporates specific probabilities of cash flows into the analysis Required conditions: - When warranty obligation spans more than 1 year & - Can associate probabilities with possible cash flow outcomes

Gain Contingency

- an uncertain situation that might result in a gain - are not accrued - Conservatism: record uncertain losses but not uncertain gains - Material gain contingencies are disclosed in the notes to the financial statements

Non-interest bearing notes

- do not have a stated interest rate - interest is calculated (based on market rate or negotiated rate) and deducted from face value - borrower receives the net amount, but pays back the face value

When Short-Term Obligations are Expected to Be Refinanced

- expected to be refinanced on a long-term basis can be reported as noncurrent liability under 2 conditions: 1. Company must intend to refinance on a long-term basis and 2. Company must actually have demonstrated the ability to refinance on a long-term basis * demonstrated by an existing refinancing agreement or actual financing prior to the issuance of financial statements

What makes a liability current?

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

Disclosure of Litigation Contingencies

- pending litigation is not unusual - Accrual of a loss from pending or ongoing litigation is rare (outcome highly uncertain & loss usually not recorded until after ultimate settlement) While companies should provide extensive disclosure of these contingent liabilities, they do not always do so

Extended Warranty Contracts

- provides warranty protection beyond manufacturer's original warranty - are not loss contingencies - they are separate performance obligations - revenue from warranties & any costs to service the warranties should be recognized over the period of the warranty

Commercial Paper

- unsecured notes sold in minimum denominations of $25,000 with maturities ranging from 1 - 270 days - Interest often is discounted at issuance - Usually issued directly to the buyer (lender) and is backed by a line of credit with a bank (allows interest rate to be lower than in a bank loan) Generally for the big boys (large, financially stable companies) can issue commercial paper

Cash Conversion Cycle

1. Average days in inventory 2. Average collection period 3. Average time to pay *Combined to determine how long, on average, it takes to complete the operating (cash conversion) cycle. (Avg. Days in Inv. + Avg. Collection Period - Avg. Time to Pay) = Cash Conversion Cycle

What is a liability?

1. Probable, future - sacrifices of economic benefits 2. Present - arise from present obligations 3. Past - result from past transactions or events

Unasserted Claims & Assessments

Even if a claim has yet to be made when the financial statements are issued, a contingency may warrant accrual or disclosure Two-step process: 1. probable (if no, stop, otherwise proceed) 2. Treat the claim as if the claim has been asserted

Journal Entry - Noninterest Bearing Note

Face Value = $60k Discount Rate = 12% # months = 9 Discount on Note = $5.4k Cash $54.6k Discount on Note Payable $5.4k Note Payable $60k Interest Expense $1.8k Discount on Note Payable $1.8k - AJE (12%, 3/12 months) Cuz we pay interest on $60k, but only receive $54.6k, the effective interest rate is greater than 12% Eff. Int Rate = Discount/Cash Rec'd = 9.89% for 9 months 13.19% annual effective int. rate

Example for U.S. GAAP & IFRS

Fiscal Year - 12/31/21 Financial Statements Released - 3/15/22 Refinanced on - 12/15/21 Long Term (GAAP/IFRS) Refinanced on - 1/12/21 Long Term (US GAAP); Current (IFRS)

What amount are current liabilities recorded?

Generally recorded at present value, but liabilities due within 1 year are recorded at maturity amount (amount due/face value)

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

When loss contingency is accrued as a liability

Loss (or expense) xxxx Liability xxxx

Journal Entry EWC

Reference E 13-16

Accrual of Litigation Contingencies

Subsequent events can clarify a pre-existing claim's - probability that a loss will occur - Estimated amount of loss If contingency comes into existence after fiscal year-end (no liability accrues, but description provided in notes)

Why do we subtract the Avg. Time to Pay?

The CCC calculates the amount of time between cash outflows (paying for inventory/paying off AP) and cash inflows (collecting AR)

IFRS

To be classified as long-term, liabilities must be refinanced before the balance sheet date

What amount should we record for a loss contingency?

Traditionally - take the most likely amount, if no amount is most likely, take the lowest amount.

Interest on borrowed money

Typically will have a stated annual interest rate, a face amount (principal) that must be repaid, and a term/due date. Interest = Face amount x annual rate x (Months outstanding/12*) *short-term debt, due within the year

Journal Entry for Warranties & Guarantees

Warranty Expense $150,000 Warranty Liability $150,000 Warranty Liability $20,000 Cash $20,000

Loss Contingencies

an existing, uncertain situation involving potential loss depending on future event. Whether it is accrued & reported as a liability depends: 1. likelihood that confirming event will occur 2. Determine estimated amount of loss U.S. GAAP requires that the likelihood of the future event be categorized as - probable - reasonably possible - remote

Current and Noncurrent Classification

companies prefer to report obligation as noncurrent rather than current - noncurrent classification results in higher working capital and a higher current ratio