Intermediate Accounting, Current Liabilities

What are the eight most common types of current liabilities?

(1) Accounts payable, (2) notes payable, (3) current maturities of long-term debts, (4) dividends payable, (5) customer advances and deposits, (6) unearned revenue, (7) taxes payable, and (8) employee-related liabilities

The two major ratios used to measure liquidity of an entity are the __

(1) current ratio and the (2) acid-test ratio.

Explain the accounting for asset retirement obligations.

A company must recognize asset retirement obligations when it has an existing legal obligation related to the retirement of a long-lived asset and it can reasonably estimate the amount.

returnable cash deposits

A current liability that results from customers making deposits to guarantee performance of a contract or service, or as a guarantee to cover payment of expected future obligations.

warranty

A seller's promise to a buyer to make good on a deficiency of quantity, quality, or performance in a product. Also called a product guarantee. Companies use two methods of accounting for warranty costs: Under the cash-basis method, the seller expenses warranty costs in the period in which they are incurred. Under the accrual method (expense-warranty approach), the seller charges warranty costs to operating expense in the year of a product's sale.

claims

A type of loss contingency, for which a company may accrue a liability depending on the company's ability to determine the degree of probability that a claim may be asserted, the probability of an unfavorable outcome, and the ability to make a reasonable estimate of the amount of loss. Loss contingencies usually are disclosed in a note to the financial statements; loss contingencies that are probable and can be reasonably estimated are accrued as liabilities in the financial statements.

assessments

A type of loss contingency, for which a company may accrue a liability depending on the company's ability to determine the degree of probability that an assessment may be asserted, the probability of an unfavorable outcome, and the ability to make a reasonable estimate of the amount of loss. Loss contingencies usually are disclosed in a note to the financial statements; loss contingencies that are probable and can be reasonably estimated are accrued as liabilities in the financial statements.

preferred dividends in arrears

Accumulated but undeclared dividends on cumulative preferred stock. Such dividends are not a liability until the board of directors authorizes the distribution of earnings, though companies should disclose the amount of cumulative dividends unpaid in a note or show it parenthetically in the capital stock section of the balance sheet. Dividends in arrears must be paid before any common stock dividends are paid.

cash dividend payable

An amount, payable in cash, that a corporation owes to its stockholders as a result of the board of directors' dividend authorization. At the date of declaration, the dividend becomes a liability of the corporation, classified as a current liability.

asset retirement obligation

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.

trade accounts payable

Balances owed to others for goods, supplies, or services purchased on open account. Also called simply accounts payable. Accounts payable arise because of the time lag between the receipt of services or acquisition of title to assets and the payment for them. The terms of the sale (e.g., 2/10, n/30 or 1/10, E.O.M.) usually state this period of extended credit, commonly 30 to 60 days.

unearned revenues

Cash received before a company completes the earnings process by delivering goods or rendering services. The company records a current liability for the amount of cash received, and then recognizes the revenue in the period in which it completes the earnings process.

gain contingencies

Claims or rights to receive assets (or have a liability reduced) whose existence is uncertain but which may become valid eventually. Typical gain contingen¬cies include: possible receipts of monies from gifts, donations, bonuses; possible refunds from the government in tax disputes; pending court cases; and tax loss carryforwards. Companies do not record gain contingencies; they disclose them in the financial statement notes only when a high prob¬ability of realization exists.

bonus

Compensation in addition to regular salary or wages. Frequently the bonus amount depends on the company's yearly profit. The company shows the bonus expense in the income statement as an operating expense. If the bonus is not paid within the accounting period, the company includes the liability, Bonus Payable, as a current liability in the balance sheet.

accumulated rights

Compensation rights that employees can carry forward to future periods if not used in the period in which earned.

vested rights

Compensation rights that exist when an employer has an obligation to make payment to an employee even after terminating his or her employment. Vested rights are not contingent on an employee's future service.

litigation, claims, and assessments

Different types of loss contingencies. Litigation may be pending or threatened; claims and assessments may be actual or possible. Whether companies should record litigation, claims, and assessments depends on such factors as the time period in which the underlying cause of action occurred, the probability of an unfavorable outcome, and the ability to make a reasonable estimate of the amount of loss. Loss contingencies usually are disclosed in a note to the financial statements; loss contingencies that are probable and can be reasonably estimated are accrued as liabilities in the financial statements.

probable (contingency)

Evaluation of the likelihood of a loss contingency; indicates that a future event or events are likely to occur.

reasonably possible (contingency)

Evaluation of the likelihood of a loss contingency; indicates that the chance of a future event or events occurring is more than remote but less than likely.

remote (contingency)

Evaluation of the likelihood of a loss contingency; indicates that the chance of a future event or events occurring is slight.

Identify the criteria used to account for and disclose gain and loss contingencies.

Gain contingencies are not recorded. The are disclosed in the notes only when the probability is high that a gain contingency will become a reality. A company should accrue an estimated loss from a loss contingency by charging expense and recording a liability only if both of the following conditions are met: (1) Information available prior to the issuance of the financial statements indicates that it is probable that a liability has been incurred at the date of the financial statements, and (2) the amount of the loss can be reasonably estimated.

Explain the accounting for warranties.

If it is probable that customers will make claims under warranties relating to goods or services that have been sold and it can reasonably estimate the costs involved, the company uses the accrual method. Under the accrual basis, it charges warranty costs to operating expense in the year of the sale.

premiums

Issued by companies to stimulate sales. In return for boxtops, certificates, coupons, labels, or wrappers, companies may give away silverware, dishes, small appliances, a toy, or free transportation. Companies should charge the costs of premiums to expense in the period of the sale that benefits from the plan.

contingent liabilities

Liabilities that depend on a contingency, that is, on the occurrence of one or more future events to confirm either the amount payable, the payee, the date payable, or its existence.

working capital ratio

Liquidity ratio that measures the ability of a company to meet its maturing obligations with its available assets and to meet unexpected needs for cash. Also called the current ratio. Computed as total current assets divided by total current liabilities.

acid-test (quick) ratio

Liquidity ratio that measures the ability of a company to meet its maturing obligations with its available assets and to meet unexpected needs for cash. Computed as cash plus short-term investments plus net receivables divided by current liabilities. A variation of the current ratio, the acid-test ratio eliminates inventories and prepaid expenses from the amount of current assets, to provide better information for short-term creditors. The acid-test ratio is often called the quick ratio.

current ratio

Liquidity ratio that measures the ability of a company to meet its maturing obligations with its available assets and to meet unexpected needs for cash. Computed as total current assets divided by total current liabilities. The current ratio is sometimes called the working capital ratio.

What are the different types of loss contingencies?

Litigation, warranties, sales promotions, and asset retirement obligations

contingency

Material events with an uncertain future. The uncertainty can involve a possible gain (gain contingency) or possible loss (loss contingency) that will ultimately be resolved when one or more future events occur or fail to occur. Typical gain contingencies are tax operating loss carryforwards or company litigation against another party. Typical loss contingencies relate to litigation, environmental issues, possible tax assessments, or government investigations.

expense-warranty approach

Method of accounting for a company's warranty expense, in which a company charges warranty costs to operating expense in the year of a product's sale. Also called the accrual method. It is the generally accepted method, and companies should use it whenever the warranty is an integral and inseparable part of the sale and the company can reasonably estimate the costs involved.

sales warranty approach

Method of accounting for an extended warranty sold with a product that has a manufacturer's warranty. The seller recognizes separately the sale of the product with the manufacturer's warranty and the sale of the extended warranty. The seller defers revenue on the sale of the extended warranty and generally recognizes it on a straight-line basis over the life of the contract.

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).

O.A.S.D.I.

Old Age, Survivor, and Disability Insurance; Social Security legislation since 1937 that provides federal benefits for certain individuals and their families, funded by the F.I.C.A. tax.

compensated absences

Paid absences from employment (e.g., for vacation, illness, and holidays). Companies accrue a liability for the cost of compensation for future absences and recognize the expense and related liability for compensated absences in the year in which the benefits are earned by employees.

loss contingencies

Possible losses, which may occur as the result of one or more future events. A liability incurred as a result of a loss contingency is by definition a contingent liability. Loss contingencies are judged on likelihood and are rated probable, reasonably possible, or remote. Companies accrue an estimated loss from a loss contingency by a charge to expense and a recorded liability if the loss is probable and its amount can be reasonably estimated. They also disclose and discuss the loss contingency in the financial statement notes.

Explain the accounting for sales promotions.

Premiums, coupon offers, and rebates are made to stimulate sales. Companies should charge their costs to expense in the period of the sale that benefts from the promotion (premium) plan.

liabilities

Present obligations, as a result of past transactions, that entail settlement by probable future transfer or use of cash, goods, or services.

self-insurance

Risk assumption in lieu of insurance. Self-insurance is not insurance. A company that assumes its own risks incurs expenses or losses as they occur. The company should not establish a liability based on a hypothetical charge to insurance expense, because the event giving rise to the obligation has not occurred.

F.I.C.A.

The Federal Insurance Compensation Act, a payroll tax in which the government taxes both the employer and employee at the same rate, to fund the Old Age, Survivor, and Disability Insurance (O.A.S.D.I.) benefits.

F.U.T.A.

The Federal Unemployment Tax Act, a payroll tax levied by the federal government, in cooperation with state governments, to provide a system of unemployment insurance.

Social Security tax

The combination of the O.A.S.D.I. tax (F.I.C.A.) and the federal Hospital Insurance Tax. The combined rate for these taxes changes intermittently by acts of Congress. Companies report as a current liability the amount of unremitted employee and employer Social Security tax on gross wages paid.

Inidicate how to present and analyze current liabilities and contingencies.

The current liability accounts are commonly presented as the first classification in the liabilities and stockholders' equity section of the balance sheet. Within the current liabilities section, companies may list the accounts in order of maturity, in descending order of amount, or in order of liquidation preference. Detail and supplemental information concerning current liabilities should be sufficient to meet the requirement of full disclosure. If the loss is either probable or estimable, but not both, and if there is at least a reasonable possibility that a company may have incurred a liability, it should disclose in the notes both the nature of the contingency and an estimate of the possible loss. Two ratios used to analyze liquidity are the current and acid-test ratios.

Explain the accounting for litigation.

The following factors must be considered in determining whether a liability should be recorded with respect to pending or threatened litigation and actual or possible claims and assessments: (a) the time period in which the underlying cause for action occured; (b) the probability of an unfavorable outcome; and, (c) the ability to make a reasonable estimate on the amount of loss.

current liabilities

The obligations that a company reasonably expects to liquidate either through the use of current assets or the creation of other current liabilities. This concept includes: payables resulting from the acquisition of goods and services; (2) collections received in advance for the delivery of goods or performance of services; and (3) other liabilities whose liquidation will take place within the operating cycle.

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. Most retail and service establishments have several operating cycles within a year; some manufacturers and capital-intensive industries have an operating cycle of considerably more than one year.

current maturities of long-term debt

The portion of bonds, mortgage notes, and other long-term indebtedness that will mature within the next fiscal year. However, long-term debts maturing currently as current liabilities are excluded from this category if they are to be: retired by assets accumulated for this purpose that properly have not been shown as current assets; refinanced or retired from the proceeds of a new debt issue; or converted into capital stock.

__ is used for accounting for a warranty that is sold separately from the related product.

The sales warranty accrual method

trade notes payable

Written promises to pay a certain sum of money on a specified future date, required in some indus¬tries as part of the sales/purchases transaction in lieu of the normal extension of open account credit.

notes payable (trade notes payable)

Written promises to pay a certain sum of money on a specified future date, which may arise from purchases, financing, or other transactions. Some notes payable (often referred to as trade notes payable) are part of a sales/purchases transaction; notes payable to banks generally arise from cash loans. Notes payable can be short-term or long-term, and they can be interest-bearing or zero-interest-bearing.

An estimated loss from a loss contingency should be __

accrued by a charge to expense and a credit to a liability if both of the following conditions are met: (1) it is probable that a liability has been incurred at the date of the balance sheet, and (2) the amount of the loss can be reasonably estimated. If the loss is either probably or estimable but not both, or if there is at least a reasonable possibility that a liability has been incurred, the contingency must be disclosed in the notes (but not accrued). If it is only remotely possibly (unlikely) that a liability has incurred, no accrual or note disclosure is required (there are some exceptions to this guideline).

The employer bears the burden of __

all unemployment taxes and its share of Social Security, F.I.C.A., and Medicare taxes.

A short-term obligation is excluded from current liabilities if __

both of the following conditions are met: (1) the company must intend to refinance the obligation on a long-term basis, and (2) it must demonstrate an ability to consummate the refinancing.

What's the model for net (take-home) pay?

employee's gross earnings for the current period - federal income tax withholdings - Social Security tax withholdings - withholdings for voluntary deductions; such as for charitable contributions, group health and life insurance premiums, savings, retirement fund contributions, and loan repayments = net pay

Are loss contingencies usually accrued, not accrued, or may be accrued as related to pending or threatened litigation?

may be accrued - when both probable and reasonably estimable

Are loss contingencies usually accrued, not accrued, or may be accrued as related to threat of expropriation of assets?

may be accrued - when both probable and reasonably estimable

Are loss contingencies usually accrued, not accrued, or may be accrued as related to guarantees of indebtedness of others?

may be accrued - when probabe and estimable; should be disclosed even though possibility of loss may be remote

Are loss contingencies usually accrued, not accrued, or may be accrued as related to agreements to repurchase receivables (or the related property) that have been sold?

may be accrued - when probable and estimable; should be disclosed even though possibility of loss may be remote

Are loss contingencies usually accrued, not accrued, or may be accrued as related to obligations of commercial banks under "standby letters of credit"?

may be accrued - when probable and estimable; should be disclosed even though possibility of loss may be remote

Are loss contingencies usually accrued, not accrued, or may be accrued as related to actual or possible claims and assessments?

may be accrued - when probably and estimable; estimated amounts of losses incurred prior to the balance sheet date but settled subsequently should be accrued as of the balance sheet date

Are loss contingencies usually accrued, not accrued, or may be accrued as related to general or unspecified business risks?

not accrued

Are loss contingencies usually accrued, not accrued, or may be accrued as related to risk of loss from catastrophes assumed by property and casualty insurance companies including reinsurance companies?

not accrued

Are loss contingencies usually accrued, not accrued, or may be accrued as related to risk of loss or damage of enterprise property by fire, explosions, or other hazards?

not accrued

Self-insurance is __

not insurance, it is risk assumption. Any companies that assumes its own risks puts itself in the position of incurring expenses or losses as they occur. It is not generally acceptable to charge expense and report a liability prior to the occurence of the event even if the amount of loss is reasonably estimable.

Current liabilities are __

obligations whose liquidation is reasonably expected to require the use of existing resources properly classified as current assets, or the creation of other current liabilities. Noncurrent liabilities are obligations which do not meet the criteria to be classified as current.

A contingent liability is a situation involving __

uncertainty as to possible loss or expense that will ultimately be resolved when one or more future events occur or fail to occur. Examples are pending or threatened lawsuits, pending IRS audits, and product warranties.

Are loss contingencies usually accrued, not accrued, or may be accrued as related to collectibility of receivables?

usually accrued

Are loss contingencies usually accrued, not accrued, or may be accrued as related to obligations related to product warranties and product defects?

usually accrued

Are loss contingencies usually accrued, not accrued, or may be accrued as related to premiums offered to customers?

usually accrued