Accounting Intermediate
Financial I
Current Liabilities and
Contingencies
Objectives of the Chapter
1. Accounting for current liabilities with definite
amount (i.e., trade related liabilities,
employee payroll related liabilities and
accrued liabilities.)
2. Accounting for estimated liabilities (i.e.,
warranty obligations, coupons and premiums
obligations).
3. Accounting for contingent liabilities.
Current Liabilities and Contigencies
2
Liabilities
s
s
Legal obligations require future
payments of cash or services or the
creation of other liabilities as a result of
past transactions.
Current liabilities: Obligations must be
fulfilled in one year or one operating
cycle, whichever is longer.
Current Liabilities and Contigencies
3
Current Liabilities
s
Examples of current liabilities with definite
amount as a result of a business transaction:
x A/P (accounts payable)
x N/P (notes payable including commercial
paper issued)
x Current maturity portion of a long-term
debt
x Sales taxes payable
x Accrued liabilities
x Payroll taxes withholdings
Current Liabilities and Contigencies
4
Sales Taxes Payable
ales taxes are taxes levied by states on retail
sales, not on manufacturers (i.e., GE, GM,
etc).
very state, except Alaska, Delaware, Montana,
New Hampshire, and Oregon, levies state
sales taxes on retail sales.
he rate varies state by state (for example,
Current and Long-Term Liabilities
5
Sales Taxes Payable (contd.)
s
s
Retailers charge their customers the
sales taxes in addition to the price of
the merchandise.
The retailers have to forward the
collected sales taxes to the state at
regular intervals.
Current and Long-Term Liabilities
6
Example
s
Assume that the 12/22/x9 sales of
Macys in California totaled $2,000,000.
The state tax rate is 8.25%. The
business would record the days sales
as follows:
Cash
2,165,000
Sales Revenue
2,000,000
Sales Taxes Payable
165,000
Current and Long-Term Liabilities
7
Accrued Liabilities
s
Obligations accumulated on a daily
basis but not recorded until the end of
period through adjusting entries (i.e.,
Interest payable, salaries payable, rent
payable)
Current Liabilities and Contigencies
8
Employee Related Liabilities: FICA, Federal
I/T, state I/T, Medical Insurance Premiums
Salaries Expense
50,000
Employee F.I.C.A. Taxes Payable* 3,825
Federal I/T Payable
10,000
State I/T Payable
2,500
Cash
32,675
*(6.2% +1.45%) *$50,000 or 7.65% x $50,000
F.I.C.A. taxes include Social Security tax of 6.2% (max earnings
taxable is $106,800 for 2009) and 1.45% of Medicare tax (no
limit on maximum earnings Ctaxable). and Contigencies
urrent Liabilities
9
Employee Related Liabilities (contd.)
s
Employer payroll taxes:
Payroll Taxes Expense
6,925
Employer F.I.C.A. Taxes Payable
3,825
F.U.T.A. Taxes Payablea
400
State Unemployment Tax Payableb 2,700
a. 6.2% of the first $7,000 of salaries paid to
employees.
b. assuming a state unemployment tax = 5.4%.
Current Liabilities and Contigencies
10
Other Current Liabilities
s
s
s
Refundable Deposits
Cash
Refund Deposit Liabilities
xxx
xxx
Dividends Payable
Unearned Revenue
Current Liabilities and Contigencies
11
Estimated Liabilities
s
Liabilities exist but the amount is
unknown:
A. Property taxes
B. Warranty obligations
C. Coupon and premium obligations
D. Compensated absences
E. Environmental liabilities
Current Liabilities and Contigencies
12
A. Property Taxes
s
s
Property taxes are assessed by local
governments (city, state ) on the value of
properties. The assessed property taxes
become a lien on the properties on a day
specified by law (i.e., July 1)
In general, the bills of the property taxes are
not received until a few months after the lien
day. The property taxes must be estimated
and recognized on a monthly basis
(recommended by the AICPA) starting the
lien day.
Current Liabilities and Contigencies
13
A. Property Taxes (contd.)
s
s
Also, the property taxes expenses should be
allocated over the fiscal year of the local
government (i.e., 7/1/x1 ~ 6/30/x2).
If there are differences between the
estimates and the actual taxes, the
adjustments are considered as an estimate
change and are spread to the remaining tax
period (no retroactive effect).
Current Liabilities and Contigencies
14
Example
The fiscal year of the local government
=> 7/1/x8 - 6/31/x9
The property tax becomes a lien on the property on
=> 7/1/x8
Estimated property tax expenses (for 7/1/x8 - 6/30/x9)
=>$12,000
Tax bill received on
=> 10/29/x8
Actual tax expense
=> $13,800
Tax paid on
=>11/30/x8
Current Liabilities and Contigencies
15
Example (contd.)
Prepare journal entries regarding the property
tax for the period of 7/1/x8 - 6/30/x9:
7/1/x8 No journal entry (accrued the liability, on a monthly basis)
7/31/x8 Property Tax Expenses
1,000
Property Tax Payable
1,000
3 ($12,000/12=$1,000)
8/31/x8 P/T Exp
1,000
P/T Payable
1,000
9/30/x8 P/T Exp
1,000
P/T Payable
1,000
10/31/x8 P/T Exp
1,200
P/T Payable
1,200
3 (($13,800 -$3,000)/(12-3) = $1,200 the difference is treated as
changes in estimates; no retroactive effect. (APB 20))
Current Liabilities and Contigencies
16
Prepare journal entries regarding the property
tax for the period of 7/1/x8 - 6/30/x9: (contd.)
11/30/x8 P/T Payable
Prepaid P/T
Cash
P/T Expense
Prepaid P/T
12/31/x8 P/T Exp
Prepaid P/T
4,200
9,600
13,800
1,200
1,200
1,200
1,200
:
:
6/30/x9
P/T Exp
1,200
Prepaid P/T
Current Liabilities and Contigencies
1,200
17
B. Warranty Obligations (Product Warranty)
1. Cash basis (for Income Tax Filing
Purposes, not GAAP)
2. Expense warranty using accrued
method (GAAP)
Current Liabilities and Contigencies
18
1. Cash Basis (for tax filing)
(Not Acceptable for Financial Reporting Purpose)
s
Warranty expenses are recognized when
these expenses are paid for (violating the
matching principle)
Journal Entry:
Warranty Exp
Cash
(only for I/T filling)
s
xxx
xxx
Current Liabilities and Contigencies
19
2. Expense Warranty Using Accrued
Method
(for Reporting financial Purposes)
s
Estimate the warranty exp. associated
with the sales (of the period) at the
end of the period and recognize it.
Current Liabilities and Contigencies
20
2. Expense Warranty Using Accrued
Method (contd.)
s
Journal Entry:
Warranty Expenses
xxx
Estimated Warranty Liabilities
xxx
When warranty services provided:
Estimated warranty liabilities
Cash (or Inventory)
xxx
xxx
If the estimated warranty liabilities are not enough
to cover the current years warranty services, treat
it as a change in accounting estimates (i.e., no
retroactive effect).
Current Liabilities and Contigencies
21
Example
The estimated warranty liabilities account has an
ending balance of $2,000 before the following year
end adjustment:
12/31/x2 Warranty Expenses
3,000
Estimated Warranty Liability
3,000
During 20x3, the actual warranty expenses
amounted to $5,800.
20x3:
Estimated warranty liability
5,000
* Warranty Expenses
800
Cash (or Inventory)
5,800
Current Liabilities and Contigencies
22
C. Premiums and Coupons
Obligations
s
s
Liabilities of premiums and coupons
should be estimated and recognized in
the year when sales are made.
Journal Entry
Premium (or Coupon) Expensexxx
Estimated Premium Claims
(or coupon) outstanding
Current Liabilities and Contigencies
xxx
23
C. Premiums and Coupons
Obligations (contd.)
s
When premiums (or coupons) are claimed:
Journal Entry
Estimated Premium Claims
(coupon) outstanding
xxx
Inventory
xxx
* If the actual redemption of coupons (or
premiums) is greater than the estimated
liabilities, the underestimated amount would be
recognized as the expense of the current year.
Current Liabilities and Contigencies
24
D. Compensated Absences
Compensation for vacation, illness and
holidays.
Companies should estimate the amount of
liabilities and recognize them at the end of
the reporting period if:
a. Employees services needed to receive these
rights have been rendered.
b. The obligation relates to these rights are vested.
c. Payment of the compensation is probable.
d. The amount of liabilities can be reasonably
estimated.
Current Liabilities and Contigencies
25
E. Environmental Liabilities (SFAS
143)
A company must recognize an asset
retirement obligation (ARO) when
1) it has an existing legal obligation
associated with the retirement of a longlived asset , and
2) the liability can be reasonably
estimated.
Examples of obligating events: decommissioning
nuclear facilities, dismantling, restoring and
reclamation of oil and gas properties, etc.
Current Liabilities and Contigencies
26
Recognition and Allocation of ARO
The estimated fair value of ARO is
capitalized on 1/1/2002 :
Nuclear Plant
50,000
Asset Retirement Obligation 50,000
The cost of ARO will be subsequently
allocated as depre. expense over the life of
the asset (i.e., 5 years):
Depre. Expense 10,000
Acc. Depre. Nuclear Plant 10,000
Current Liabilities and Contigencies
27
Recognition and Allocation of ARO
(contd.)
The accrued interest of ARO should be
recognized periodically (assuming 10% interest):
12/31/2002Interest expense (10% x50,000) 5,000
ARO
5,000
On 1/1/2008, the decommissioning cost
amounted to $78,000, the following will be
recorded:
ARO 80,525
Cash
Gain on Settlement of ARO
Current Liabilities and Contigencies
78,000
2,525
28
Contingencies
x
Contingent Liabilities
x
Contingent Losses
x
Contingent Gains
Current Liabilities and Contigencies
29
Contingent Liabilities
s
Obligations may arise because of the
occurrence or not occurrence of future
event(s). (i.e., warranty obligations)
Current Liabilities and Contigencies
30
Contingent Liabilities
s
Liabilities may arise because of the
occurrence or not occurrence of future
event(s).
(i.e., guarantee and warranty costs, litigation
and claims, premiums and coupons,
environment al liabilities, etc.)
Current Liabilities and Contigencies
31
Contingent Gains
s
Gains may arise because of the
occurrence or not occurrence of future
events). (i.e., pending lawsuit gains)
Current Liabilities and Contigencies
32
Accounting Treatments of
Contingencies
s
The accounting treatments of the contingencies
depend on the occurrence probability of the
related future event(s).(FASB 5)
1. Probable: The future event(s) is(are) likely to
occur.
2. Reasonably possible: The chance for the
future event(s) to occur is less than probable
but greater than remote
3. Remote: The chance of the future event to
occur is unlikely (slight).
Current Liabilities and Contigencies
33
Accounting Treatments of
Contingencies (contd.)
s
If the future event(s) is(are)
a. Probable, and
b. amount of liability can be estimated
The loss (liability) should be estimated,
and recognized (accrued).
Current Liabilities and Contigencies
34
Accounting Treatments of
Contingencies (contd.)
s
Examples:
Warranty Expense
xxx
Estimated Warranty Liabilities
xxx
Lawsuit Expenses
xxx
Estimate Liability under litigation
Current Liabilities and Contigencies
xxx
35
Accounting Treatments of
Contingencies (contd.)
s
s
If the future event is probable, but the amount
of loss (or liability) cannot be estimated, the
contingent loss (or liability) should only be
footnoted (not accrued).
Contingent gains:
x If the event is probable and the amount of
contingent gains is determinable, only
footnote the information. No unrealized
gain can be recognized under the current
accounting standards (conservatism!!!)
Current Liabilities and Contigencies
36
Additional Notes For Current
Liabilities
1. Obligations that are callable by the creditors
within the longer period of one year or one
operating cycle: reported as current
liabilities.
2. Obligation that matures in one year or one
operating cycle, whichever is longer:
reported as current liabilities.
3. Short-term obligations that are expected to
be refinanced by a long-term debt: reported
as a long-term debt if conditions (i.e.,
intention and ability to do so) are met.
Current Liabilities and Contigencies
37