13
Current CHAPTER Liabilities and Contingencies
ASSIGNMENT CLASSIFICATION TABLE (BY TOPIC)
Topics 1. Concept of liabilities; definition and classification of current liabilities. Accounts and notes payable; dividends payable. Short-term obligations expected to be refinanced. Deposits and advance payments. Compensated absences. Collections for third parties. Contingent liabilities (General). Guaranties and warranties. Premiums and awards offered to customers. Self-insurance, litigation, claims, and assessments, asset retirement obligations. Presentation and analysis. Questions 1, 2, 3, 4, 6, 8 7, 11 9, 10 5, 12 13, 14, 15 16 17, 18, 19, 20, 22 21, 23 24, 25 26, 27, 28 1, 2, 3 4 5 8 6, 7 10, 11 13, 14 15 10, 11, 12 5, 6, 16 7, 8, 9, 16 13, 16 10, 11, 16 12, 15, 16 14 3, 4 10, 11, 13 5, 6, 7, 12, 14 8, 9, 12, 14 2, 10, 11, 13 9 6, 7 5, 6, 7 7, 8 Brief Exercises Exercises 1, 16 Problems 1, 2 Concepts for Analysis 1, 2
2. 3. 4. 5. 6. 7. 8. 9. 10.
2, 16 3, 4
1, 2
1, 2 3, 4 2
11.
29, 30, 31
17, 18, 19
3
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ASSIGNMENT CLASSIFICATION TABLE (BY LEARNING OBJECTIVE)
Learning Objectives 1. 2. 3. 4. 5. Describe the nature, type, and valuation of current liabilities. Explain the classification issues of short-term debt expected to be refinanced. Identify types of employee-related liabilities. Identify the criteria used to account for and disclose gain and loss contingencies. Explain the accounting for different types of loss contingencies. Indicate how to present and analyze liabilities and contingencies. Brief Exercises 1, 2, 3, 4, 5, 6 4 7, 8, 9 10, 11, 12, 13, 14, 15 10, 11, 12, 13, 14, 15 Exercises 1, 2, 7 3, 4 5, 6, 8, 9 13 10, 11, 12, 13, 14, 15 16, 17, 18, 19 3, 4 7, 10, 11, 13 2, 5, 6, 7, 8, 9, 10, 11, 12, 13, 14 9 Problems 1, 2
6.
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ASSIGNMENT CHARACTERISTICS TABLE
Item E13-1 E13-2 E13-3 E13-4 E13-5 E13-6 E13-7 E13-8 E13-9 E13-10 E13-11 E13-12 E13-13 E13-14 E13-15 E13-16 E13-17 E13-18 E13-19 P13-1 P13-2 P13-3 P13-4 P13-5 P13-6 P13-7 P13-8 P13-9 P13-10 P13-11 P13-12 P13-13 P13-14 CA13-1 CA13-2 CA13-3 CA13-4 CA13-5 CA13-6 CA13-7 CA13-8 Description Balance sheet classification of various liabilities. Accounts and notes payable. Refinancing of short-term debt. Refinancing of short-term debt. Compensated absences. Compensated absences. Adjusting entry for sales tax. Payroll tax entries. Payroll tax entries. Warranties. Warranties. Premium entries. Contingencies. Asset retirement obligation. Premiums. Financial statement impact of liability transactions. Ratio computations and discussion. Ratio computations and analysis. Ratio computations and effect of transactions. Current liability entries and adjustments. Liability entries and adjustments. Payroll tax entries. Payroll tax entries. Warranties, accrual, and cash basis. Extended warranties. Warranties, accrual, and cash basis. Premium entries. Premium entries and financial statement presentation. Loss contingencies: entries and essay. Loss contingencies: entries and essays. Warranties and premiums. Liability errors. Warranty and coupon computation. Nature of liabilities. Current versus noncurrent classification. Refinancing of short-term debt. Refinancing of short-term debt. Loss contingencies. Loss contingency. Warranties and loss contingencies. Warranties. Level of Difficulty Simple Moderate Simple Simple Moderate Moderate Simple Simple Simple Simple Moderate Simple Moderate Moderate Moderate Moderate Simple Simple Moderate Simple Simple Moderate Simple Simple Simple Moderate Moderate Moderate Simple Moderate Moderate Moderate Moderate Moderate Moderate Moderate Moderate Simple Simple Simple Moderate Time (minutes) 1015 1520 1012 2025 2530 2530 57 1015 1520 1015 1520 1520 2030 2530 2030 2025 1015 2025 1525 2530 2535 2030 2025 1520 1020 2535 1525 3045 2530 3545 2030 2535 2025 2025 1520 3040 2025 1520 1520 1520 2025
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SOLUTIONS TO CODIFICATION EXERCISES
CE13-1
Master Glossary (a) (b) An obligation associated with the retirement of a tangible long-lived asset. Current liabilities is used principally to designate obligations whose liquidation is reasonably expected to require the use of existing resources properly classifiable as current assets, or the creation of other current liabilities. See paragraphs 210-10-45-5 through 45-12. The chance of the future event or events occurring is more than remote but less than likely. A guarantee for which the underlying is related to the performance (regarding function, not price) of nonfinancial assets that are owned by the guaranteed party. The obligation may be incurred in connection with the sale of goods or services; if so, it may require further performance by the seller after the sale has taken place.
(c) (d)
CE13-2
According to FASB ASC 410-20-50 (Asset Retirement and Environmental Obligations): 50-1 An entity shall disclose all of the following information about its asset retirement obligations: (a) (b) (c) A general description of the asset retirement obligations and the associated long-lived assets The fair value of assets that are legally restricted for purposes of settling asset retirement obligations A reconciliation of the beginning and ending aggregate carrying amount of asset retirement obligations showing separately the changes attributable to the following components, whenever there is a significant change in any of these components during the reporting period: 1. 2. 3. 4. Liabilities incurred in the current period Liabilities settled in the current period Accretion expense Revisions in estimated cash flows.
50-2 If the fair value of an asset retirement obligation cannot be reasonably estimated, that
fact and the reasons therefor shall be disclosed.
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CE13-3
According to FASB ASC 450-10-55 (Contingencies --Implementation Guidance and Illustrations): Depreciation 55-2 The fact that estimates are used to allocate the known cost of a depreciable asset over the period of use by an entity does not make depreciation a contingency; the eventual expiration of the utility of the asset is not uncertain. Thus, depreciation of assets is not a contingency, nor are such matters as recurring repairs, maintenance, and overhauls, which interrelate with depreciation. This Topic is not intended to alter depreciation practices as described in Section 360-10-35.
Estimates Used in Accruals 55-3 Amounts owed for services received, such as advertising and utilities, are not contingencies even though the accrued amounts may have been estimated; there is nothing uncertain about the fact that those obligations have been incurred.
Changes in Tax Law 55-4 The possibility of a change in the tax law in some future year is not an uncertainty.
CE13-4
According to FASB ASC 710-10-25-1 (Compensation Recognition--Compensated Absences), an employer must accrue a liability for employees' compensation for future absences if all of the following conditions are met: (a) (b) The employer's obligation relating to employees' rights to receive compensation for future absences is attributable to employees' services already rendered. The obligation relates to rights that vest or accumulate. Vested rights are those for which the employer has an obligation to make payment even if an employee terminates; thus, they are not contingent on an employee's future service. Accumulate means that earned but unused rights to compensated absences may be carried forward to one or more periods subsequent to that in which they are earned, even though there may be a limit to the amount that can be carried forward. Payment of the compensation is probable. The amount can be reasonably estimated.
(c) (d)
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ANSWERS TO QUESTIONS
1. Current liabilities are obligations whose liquidation is reasonably expected to require use of existing resources properly classified as current assets or the creation of other current liabilities. Long-term debt consists of all liabilities not properly classified as current liabilities. 2. You might explain to your friend that the accounting profession at one time prepared financial statements somewhat in accordance with the broad or loose definition of a liability submitted by the AICPA in 1953: "Something represented by a credit balance that is or would be properly carried forward upon a closing of books of account according to the rules or principles of accounting, provided such credit balance is not in effect a negative balance applicable to an asset. Thus the word is used broadly to comprise not only items which constitute liabilities in the proper sense of debts or obligations (including provision for those that are unascertained), but also credit balances to be accounted for which do not involve the debtor and creditor relation." Since your friend may not have completely understood the above definition (if it may be called that), you might indicate that more recent definitions of liabilities call for the disbursement of assets or services in the future and that the present value of all of a person's or company's future disbursements of assets constitutes the total liabilities of that person or company. But, accountants quantify or measure only those liabilities or future disbursements which are reasonably determinable at the present time. And, accountants have accepted the completed transaction as providing the objectivity or basis necessary for financial recognition. Therefore, a liability may be viewed as an obligation to convey assets or perform services at some time in the future and is based upon a past or present transaction or event. A formal definition of liabilities presented in Concepts Statement No. 6 is as follows: Probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events. 3. As a lender of money, the banker is interested in the priority his/her claim has on the company's assets relative to other claims. Close examination of the liability section and the related footnotes discloses amounts, maturity dates, collateral, subordinations, and restrictions of existing contractual obligations, all of which are important to potential creditors. The assets and earning power are likewise important to a banker considering a loan. 4. 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. Because current liabilities are by definition tied to current assets and current assets by definition are tied to the operating cycle, liabilities are related to the operating cycle. 5. Unearned revenue is a liability that arises from current sales but for which some future services or products are owed to customers in the future. At the time of a sale, customers pay not only for the delivered product, but they also pay for future products or services (e.g., another plane trip, hotel room, or software upgrade). In this case, the company recognizes revenue from the current product and part of the sale proceeds is recorded as a liability (unearned revenue) for the value of future products or services that are "owed" to customers. Market analysts indicate that an increase in the unearned revenue liability, rather than raising a red flag, often provides a positive signal about sales and profitability. When the sales are growing, its unearned revenue account should grow. Thus, an increase in a liability may be good news about company performance. In contrast, when unearned revenues decline, the company owes less future amounts but this also means that sales of new products may have slowed. 6. Payables and receivables generally involve an interest element. Recognition of the interest element (the cost of money as a factor of time and risk) results in valuing future payments at their current value. The present value of a liability represents the debt exclusive of the interest factor.
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Questions Chapter 13 (Continued) 7. A discount on notes payable represents the difference between the present value and the face value of the note, the face value being greater in amount than the discounted amount. It should be treated as an offset (contra) to the face value of the note and amortized to interest expense over the life of the note. The discount represents interest expense chargeable to future periods. 8. Liabilities that are due on demand (callable by the creditor) should be classified as a current liability. Classification of the debt as current is required because it is a reasonable expectation that existing working capital will be used to satisfy the debt. Liabilities often become callable by the creditor when there is a violation of the debt agreement. Only if it can be shown that it is probable that the violation will be cured (satisfied) within the grace period usually given in these agreements can the debt be classified as noncurrent. 9. An enterprise should exclude a short-term obligation from current liabilities only if (1) it intends to refinance the obligation on a long-term basis, and (2) it demonstrates an ability to consummate the refinancing. 10. The ability to consummate the refinancing may be demonstrated (i) by actually refinancing the shortterm obligation through issuance of long-term obligation or equity securities after the date of the balance sheet but before it is issued, or (ii) by entering into a financing agreement that clearly permits the enterprise to refinance the debt on a long-term basis on terms that are readily determinable. 11. A cash dividend formally authorized by the board of directors would be recorded by a debit to Retained Earnings and a credit to Dividends Payable. The Dividends Payable account should be classified as a current liability. An accumulated but undeclared dividend on cumulative preferred stock is not recorded in the accounts as a liability until declared by the board, but such arrearages should be disclosed either by a footnote to the balance sheet or parenthetically in the capital stock section. A stock dividend distributable, formally authorized and declared by the board, does not appear as a liability because a stock dividend does not require future outlays of assets or services and is revocable by the board prior to issuance. Even so, an undistributed stock dividend is generally reported in the stockholders' equity section since it represents retained earnings in the process of transfer to paid-in capital. 12. Unearned revenue arises when a company receives cash or other assets as payment from a customer before conveying (or even producing) the goods or performing the services which it has committed to the customer. Unearned revenue is assumed to represent the obligation to the customer to refund the assets received in the case of nonperformance or to perform according to the agreement and thus earn the unrestricted right to the assets received. While there may be an element of unrealized profit included among the liabilities when unearned revenues are classified as such, it is ignored on the grounds that the amount of unrealized profit is uncertain and usually not material relative to the total obligation. Unearned revenues arise from the following activities: (1) The sale by a transportation company of tickets or tokens that may be exchanged or used to pay for future fares. (2) The sale by a restaurant of meal tickets that may be exchanged or used to pay for future meals. (3) The sale of gift certificates by a retail store. (4) The sale of season tickets to sports or entertainment events. (5) The sale of subscriptions to magazines.
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13-7
Questions Chapter 13 (Continued) 13. Compensated absences are employee absences such as vacation, illness, and holidays for which it is expected that employees will be paid. 14. A liability should be accrued for the cost of compensated absences if all of the following conditions are met: (a) The employer's obligation relating to employees' rights to receive compensation for future absences is attributable to employees' services already rendered. (b) The obligation relates to employees' rights that vest or accumulate. (c) Payment of the compensation is probable. (d) The amount can be reasonably estimated. If an employer meets conditions (a), (b), and (c), but does not accrue a liability because of failure to meet condition (d), that fact should be disclosed. 15. An employer is required to accrue a liability for "sick pay" that employees are allowed to accumulate and use as compensated time off even if their absence is not due to illness. An employer is permitted but not required to accrue to liability for sick pay that employees are allowed to claim only as a result of actual illness. 16. Employers generally hold back from each employee's wages amounts to cover income taxes (withholding), the employee's share of FICA taxes, and other items such as union dues or health insurance. In addition, the employer must set aside amounts to cover the employer's share of FICA taxes and state and federal unemployment taxes. These latter amounts are recorded as payroll expenses and will lower Battle's income. In addition, the amount set aside (both the employee and the employer share) will be reported as current liabilities until they are remitted to the appropriate third party. 17. (a) A contingency is defined as an existing condition, situation, or set of circumstances involving uncertainty as to possible gain (gain contingency) or loss (loss contingency) to an enterprise that will ultimately be resolved when one or more future events occur or fail to occur. (b) A contingent liability is a liability incurred as a result of a loss contingency. 18. A contingent liability should be recorded and a charge accrued to expense only if: (a) 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 (b) the amount of the loss can be reasonably estimated. 19. A current determinable liability is susceptible to precise measurement because the date of payment, the payee, and the amount of cash needed to discharge the obligation are reasonably certain. There is nothing uncertain about (1) the fact that the obligation has been incurred and (2) the amount of the obligation. A contingent liability is an obligation that is dependent upon the occurrence or nonoccurrence of one or more future events to confirm the amount payable, the payee, the date payable, or its existence. It is a liability dependent upon a "loss contingency." Determinable current liabilities--accounts payable, notes payable, current maturities of longterm debt, dividends payable, returnable deposits, sales and use taxes, payroll taxes, and accrued expenses. Contingent liabilities--obligations related to product warranties and product defects, premiums offered to customers, certain pending or threatened litigation, certain actual and possible claims and assessments, and certain guarantees of indebtedness of others.
13-8
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Questions Chapter 13 (Continued) 20. The terms probable, reasonably possible, and remote are used in GAAP to denote the chances of a future event occurring, the result of which is a gain or loss to the enterprise. If it is probable that a loss has been incurred at the date of the financial statements, then the liability (if reasonably estimable) should be recorded. If it is reasonably possible that a loss has been incurred at the date of the financial statements, then the liability should be disclosed via a footnote. The footnote should disclose (1) the nature of the contingency and (2) an estimate of the possible loss or range of loss or a statement that an estimate cannot be made. If the incurrence of a loss is remote, then no liability need be recorded or disclosed (except for guarantees of indebtedness of others, which are disclosed even when the loss is remote). 21. Under the cash-basis method, warranty costs are charged to expense in the period in which the seller or manufacturer performs in compliance with the warranty, no liability is recorded for future costs arising from warranties, and the period of sale is not necessarily charged with the costs of making good on outstanding warranties. Under the accrual method, a provision for warranty costs is made at the time of sale or as the productive activity takes place; the accrual method may be applied two different ways: expense warranty versus sales warranty method. But under either method, the attempt is to match warranty expense to the related revenues. 22. Under U.S. GAAP, companies may not record provisions for future operating losses. Such provisions do not meet the definition of a liability, since the amount is not the result of a past transaction (the losses have not yet occurred). Therefore the liability has not been incurred. Furthermore, operating losses reflect general business risks for which a reasonable estimate of the loss could not be determined. Note that use of provisions in this way is one of the examples of earnings management discussed in Chapter 4. By reducing income in good years through the use of loss contingencies, companies can smooth out their income from year-to-year. 23. The expense warranty approach and the sales-warranty approach are both variations of the accrual method of accounting for warranty costs. The expense warranty approach charges the estimated future warranty costs to operating expense in the year of sale or manufacture. The sales-warranty approach defers a certain percentage of the original sales price until some future time when actual costs are incurred or the warranty expires. 24. Southeast Airlines Inc.'s award plan is in the nature of a discounted ticket sale. Therefore, the fullfare ticket should be recorded as unearned transportation revenue (liability) when sold and recognized as revenue when the transportation is provided. The half-fare ticket should be treated accordingly; that is, record the discounted price as unearned transportation revenue (liability) when it is sold and recognize it as revenue when the transportation is provided. 25. Although the accounting for this transaction has been studied, no authoritative guideline has been developed to record this transaction. In the case of a free ticket award, AcSEC proposed that a portion of the ticket fares contributing to the accumulation of the 50,000 miles (the free ticket award level) be deferred as unearned transportation revenue and recognized as revenue when free transportation is provided. The total amount deferred for the free ticket should be based on the revenue value to the airline and the deferral should occur and accumulate as mileage is accumulated. 26. An asset retirement obligation must be recognized when a company has an existing legal obligation associated with the retirement of a long-lived asset and when the amount can be reasonably estimated. 27. The absence of insurance does not mean that a liability has been incurred at the date of the financial statements. Until the time that an event (loss contingency) occurs there can be no diminution in the value of property or incurrence of a liability. If an event has occurred which exposes an enterprise to risks of injury to others and/or damage to the property of others, then a contingency exists. Expected future injury, damage, or loss resulting from lack of insurance need not be recorded or disclosed if no contingency exists. And, a contingency exists only if an uninsurable event which causes probable loss has occurred. Lack of insurance is not in itself a basis for recording a liability or loss.
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13-9
Questions Chapter 13 (Continued) 28. In determining whether or not to record a liability for pending litigation, the following factors must be considered: (a) The time period in which the underlying cause for action occurred. (b) The probability of an unfavorable outcome. (c) The ability to make a reasonable estimate of the amount of loss. Before recording a liability for threatened litigation, the company must determine: (a) The degree of probability that a suit may be filed, and (b) The probability of an unfavorable outcome. If both are probable, the loss reasonably estimable, and the cause for action dated on or before the date of the financial statements, the liability must be accrued. 29. There are several defensible recommendations for listing current liabilities: (1) in order of maturity, (2) according to amount, (3) in order of liquidation preference. The authors' recent review of published financial statements disclosed that a significant majority of the published financial statements examined listed "notes payable" first, regardless of relative amount, followed most often by "accounts payable," and ending the current liability section with "current portion of long-term debt." 30. The acid-test ratio and the current ratio are both measures of the short-term debt-paying ability of the company. The acid-test ratio excludes inventories and prepaid expenses on the basis that these assets are difficult to liquidate in an emergency. The current ratio and the acid-test ratio are similar in that both numerators include cash, short-term investments, and net receivables, and both denominators include current liabilities. 31. (a) A liability for goods purchased on credit should be recorded when title passes to the purchaser. If the terms of purchase are f.o.b. destination, title passes when the goods purchased arrive; if f.o.b. shipping point, title passes when shipment is made by the vendor. (b) Officers' salaries should be recorded when they become due at the end of a pay period. Accrual of unpaid amounts should be recorded in preparing financial statements dated other than at the end of a pay period. (c) A special bonus to employees should be recorded when approved by the board of directors or person having authority to approve, if the bonus is for a period of time and that period has ended at the date of approval. If the period for which the bonus is applicable has not ended but only a part of it has expired, it would be appropriate to accrue a pro rata portion of the bonus at the time of approval and make additional accruals of pro rata amounts at the end of each pay period. (d) Dividends should be recorded when they have been declared by the board of directors. (e) Usually it is neither necessary nor proper for the buyer to make any entries to reflect commitments for purchases of goods that have not been shipped by the seller. Ordinary orders, for which the prices are determined at the time of shipment and subject to cancellation by the buyer or seller, do not represent either an asset or a liability to the buyer and need not be reflected in the books or in the financial statements. However, an accrued loss on purchase commitments which results from formal purchase contracts for which a firm price is in excess of the market price at the date of the balance sheet would be shown in the liability section of the balance sheet. (See Chapter 9 on purchase commitments.)
13-10
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SOLUTIONS TO BRIEF EXERCISES
BRIEF EXERCISE 13-1 July 1 Purchases .................................................................... Accounts Payable ........................................... Freight-in ...................................................................... Cash..................................................................... July 3 Accounts Payable...................................................... Purchase Returns and Allowances........... July 10 Accounts Payable...................................................... Cash ($54,000 X 98%) .................................... Purchase Discounts....................................... BRIEF EXERCISE 13-2 11/1/12 12/31/12 Cash.......................................................................... Notes Payable ............................................. Interest Expense................................................... Interest Payable ($40,000 X 9% X 2/12) ............................ Notes Payable........................................................ Interest Payable .................................................... Interest Expense................................................... Cash [($40,000 X 9% X 3/12) + $40,000]..... 40,000 40,000 600 600 40,000 600 300 40,900 60,000 60,000 1,200 1,200 6,000 6,000 54,000 52,920 1,080
2/1/13
BRIEF EXERCISE 13-3 11/1/12 Cash............................................................................. Discount on Notes Payable ................................. Notes Payable................................................ Interest Expense...................................................... Discount on Notes Payable ($1,350 X 2/3) ..............................................
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12/31/12
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13-11
BRIEF EXERCISE 13-3 (Continued) 2/1/13 Interest Expense....................................................... Discount on Notes Payable........................ Notes Payable............................................................ Cash ................................................................... BRIEF EXERCISE 13-4 (a) Since both criteria are met (intent and ability), none of the $500,000 would be reported as a current liability. The entire amount would be reported as a long-term liability. Because repayment of the note payable required the use of existing 12/31/12 current assets, the entire $500,000 liability must be reported as current. (This assumes Burr had not entered into a long-term agreement prior to issuance.) 450 450 61,350 61,350
(b)
BRIEF EXERCISE 13-5 8/1/12 Cash ........................................................................... Unearned Sales Revenue (12,000 X $18)............................................ Unearned Sales Revenue.................................... Sales Revenue ($216,000 X 5/12 = $90,000) .................. 216,000 216,000 90,000 90,000
12/31/12
BRIEF EXERCISE 13-6 (a) Accounts Receivable ...................................................... Sales Revenue........................................................ Sales Taxes Payable ($30,000 X 6% = $1,800).................................... Cash...................................................................................... Sales Revenue........................................................ Sales Taxes Payable ($20,670 1.06 = $19,500)................................
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(b)
13-12
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BRIEF EXERCISE 13-7 Salaries and Wages Expense ................................................. FICA Taxes Payable ........................................................ Withholding Taxes Payable.......................................... Insurance Premiums Payable...................................... Cash ..................................................................................... 24,000 1,836 3,910 250 18,004
BRIEF EXERCISE 13-8 Salaries and Wages Expense ................................................. Salaries and Wages Payable (30 X 2 X $500)............................................................... 30,000 30,000
BRIEF EXERCISE 13-9 12/31/12 Salaries and Wages Expense............................. Salaries and Wages Payable ................... Salaries and Wages Payable .............................. Cash................................................................. 350,000 350,000 350,000 350,000
2/15/13
BRIEF EXERCISE 13-10 (a) Lawsuit Loss ...................................................................... Lawsuit Liability...................................................... 900,000 900,000
(b)
No entry is necessary. The loss is not accrued because it is not probable that a liability has been incurred at 12/31/12.
BRIEF EXERCISE 13-11 Buchanan should record a litigation accrual on the patent case, since the amount is both estimable and probable. This entry will reduce income by $300,000 and Buchanan will report a litigation liability of $300,000. The $100,000 self-insurance allowance has no impact on income or liabilities.
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13-13
BRIEF EXERCISE 13-12 Oil Platform ................................................................................. Asset Retirement Obligation ...................................... 450,000 450,000
BRIEF EXERCISE 13-13 2012 Warranty Expense ................................................ Inventory ........................................................... Warranty Expense ................................................ Warranty Liability................................................ 70,000 70,000 400,000 400,000
12/31/12
BRIEF EXERCISE 13-14 (a) Cash..................................................................................... 1,980,000 Unearned Warranty Revenue (20,000 X $99) ..................................................... Warranty Expense........................................................... Inventory.................................................................. Unearned Warranty Revenue ...................................... Warranty Revenue ($1,980,000 X 180/1,080*) ................................ *180,000 + 900,000 180,000 180,000 330,000 330,000
1,980,000
(b)
(c)
BRIEF EXERCISE 13-15 Premium Expense......................................................................... Premium Liability ............................................................... *UPC codes expected to be sent in (30% X 1,200,000)..... UPC codes already redeemed ................................................. Estimated future redemptions................................................. Cost of estimated claims outstanding (240,000 3) X ($1.10 + $0.60 $0.50)............................... 96,000 96,000* 360,000 120,000 240,000 $ 96,000
13-14
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SOLUTIONS TO EXERCISES
EXERCISE 13-1 (1015 minutes)
(a) (b) (c) (d) (e) (f) (g) (h) (i) (j) (k) (l) (m) (n) (o) (p) Current liability. Current liability. Current liability or long-term liability depending on term of warranty. Current liability. Footnote disclosure (assume not probable and/or not reasonably estimable). Current liability. Current or noncurrent liability depending upon the time involved. Current liability. Current liability. Current liability. Current liabilities or long-term liabilities as a deduction from face value of note. Current liability. Current liability. Current liability. Footnote disclosure. Separate presentation in either current or long-term liability section.
EXERCISE 13-2 (1520 minutes) (a) Sept. 1 Purchases....................................................... Accounts Payable ............................. Accounts Payable ........................................ Notes Payable..................................... Cash.................................................................. Discount on Notes Payable ...................... Notes Payable..................................... Interest Expense........................................... Interest Payable ($50,000 X 8% X 3/12).................... Interest Expense........................................... Discount on Notes Payable ($6,000 X 3/12) .................................
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50,000 50,000 50,000 50,000 75,000 6,000 81,000 1,000 1,000 1,500 1,500
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Oct. 1
Oct. 1
(b)
Dec. 31
Dec. 31
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13-15
EXERCISE 13-2 (Continued) (c) 1. Note payable........................................................................... Interest payable ..................................................................... $ 50,000 1,000 $ 51,000 $ 81,000 4,500 $ 76,500
2.
Note payable........................................................................... Less discount ($6,000 $1,500).......................................
EXERCISE 13-3 (1012 minutes) ALEXANDER COMPANY Partial Balance Sheet December 31, 2012 Current liabilities: Notes payable (Note 1)............................................................... Long-term debt: Notes payable refinanced in February 2013 (Note 1) ...... $300,000
900,000
Note 1. Short-term debt refinanced. As of December 31, 2012, the company had notes payable totaling $1,200,000 due on February 2, 2013. These notes were refinanced on their due date to the extent of $900,000 received from the issuance of common stock on January 21, 2013. The balance of $300,000 was liquidated using current assets. OR Current liabilities: Notes payable (Note 1)............................................................... Long-term debt: Short-term debt expected to be refinanced (Note 1) ....... (Same footnote as above.) $300,000 900,000
13-16
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EXERCISE 13-4 (2025 minutes) SANTANA COMPANY Partial Balance Sheet December 31, 2012 Current liabilities: Notes payable (Note 1) .............................................................. Long-term debt: Notes payable expected to be refinanced in 2013 (Note 1)........................................................................................ $4,000,000*
3,000,000
Note 1. Under a financing agreement with Golden State Bank the Company may borrow up to 60% of the gross amount of its accounts receivable at an interest cost of 1% above the prime rate. The Company intends to issue notes maturing in 2017 to replace $3,000,000 of short-term, 15%, notes due periodically in 2013. Because the amount that can be borrowed may range from $3,000,000 to $4,800,000, only $3,000,000 of the $7,000,000 of currently maturing debt has been reclassified as long-term debt. *[$7,000,000 ($5,000,000 X 60%)]
EXERCISE 13-5 (2530 minutes) (a) 2012 To accrue the expense and liability for vacations Salaries and Wages Expense.............................. 8,640 Salaries and Wages Payable..................... To accrue the expense and liability for sick pay Salaries and Wages Expense.............................. 5,184 Salaries and Wages Payable..................... To record sick leave paid Salaries and Wages Payable ............................... Cash ..................................................................
8,640 (1)
5,184 (2)
3,456 (3) 3,456
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EXERCISE 13-5 (Continued) 2013 To accrue the expense and liability for vacations Salaries and Wages Expense ............................. 9,360 Salaries and Wages Payable .................... To accrue the expense and liability for sick pay Salaries and Wages Expense ............................. 5,616 Salaries and Wages Payable .................... To record vacation time paid Salaries and Wages Expense ............................. Salaries and Wages Payable............................... Cash.................................................................. To record sick leave paid Salaries and Wages Expense ............................. Salaries and Wages Payable............................... Cash.................................................................. 9 employees X $12.00/hr. X 8 hrs./day X 10 days 9 employees X $12.00/hr. X 8 hrs./day X 6 days 9 employees X $12.00/hr. X 8 hrs./day X 4 days 9 employees X $13.00/hr. X 8 hrs./day X 10 days 9 employees X $13.00/hr. X 8 hrs./day X 6 days 9 employees X $12.00/hr. X 8 hrs./day X 9 days 9 employees X $13.00/hr. X 8 hrs./day X 9 days 9 employees X $12.00/hr. X 8 hrs./day X (64) days 9 employees X $13.00/hr. X 8 hrs./day X (52) days (9) 9 employees X $13.00/hr. X 8 hrs./day X 5 days (1) (2) (3) (4) (5) (6) (7) (8)
9,360 (4)
5,616 (5)
648 7,776 (6) 8,424 (7)
144 4,536 (8) 4,680 (9) = = = = = = = = = = $8,640 $5,184 $3,456 $9,360 $5,616 $7,776 $8,424 $1,728 +2,808 = $4,536 $4,680
Note: Vacation days and sick days are paid at the employee's current wage. Also, if employees earn vacation pay at different pay rates, a consistent pattern of recognition (e.g., first-in, first-out) could be employed which liabilities have been paid.
13-18
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EXERCISE 13-5 (Continued) (b) Accrued liability at year-end: 2012 Vacation Sick Pay Wages Wages Payable Payable $ 0 $ 0 8,640 5,184 ( 0) (3,456) $8,640(1) $1,728(2) 2013 Vacation Wages Payable $ 8,640 9,360 (7,776) $10,224(3) Sick Pay Wages Payable $1,728 5,616 (4,536) $2,808(4) $ 8,640 $ 1,728 $ 864 +9,360 $10,224
Jan. 1 balance + accrued paid Dec. 31 balance (1) (2) (3)
9 employees X $12.00/hr. X 8 hrs./day X 10 days = 9 employees X $12.00/hr. X 8 hrs./day X (64) days = 9 employees X $12.00/hr. X 8 hrs./day X (109) days = 9 employees X $13.00/hr. X 8 hrs./day X 10 days =
(4)
9 employees X $13.00/hr. X 8 hrs./day X (2 + 6 5) days =
$ 2,808
EXERCISE 13-6 (2530 minutes) (a) 2012 To accrue the expense and liability for vacations Salaries and Wages Expense ................... 9,288 (1) Salaries and Wages Payable .......... To record sick leave paid Salaries and Wages Expense ................... 3,456 (2) Cash........................................................ To record vacation time paid No entry, since no vacation days were used.
9,288
3,456
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EXERCISE 13-6 (Continued) 2013 To accrue the expense and liability for vacations Salaries and Wages Expense .................. 9,864 (3) Salaries and Wages Payable ......... To record sick leave paid Salaries and Wages Expense .................. 4,680 (4) Cash ....................................................... To record vacation time paid Salaries and Wages Expense .................. 65 Salaries and Wages Payable.................... 8,359 (5) Cash .......................................................
9,864
4,680
8,424 (6)
(1) 9 employees X $12.90/hr. X 8 hrs./day X 10 days = $9,288 (2) 9 employees X $12.00/hr. X 8 hrs./day X 4 days = $3,456 (3) 9 employees X $13.70/hr. X 8 hrs./day X 10 days = $9,864 (4) 9 employees X $13.00/hr. X 8 hrs./day X 5 days = $4,680 (5) 9 employees X $12.90/hr. X 8 hrs./day X 9 days = $8,359 (6) 9 employees X $13.00/hr. X 8 hrs./day X 9 days = $8,424 (b) Accrued liability at year-end: 2012 Jan. 1 balance + accrued paid Dec. 31 balance (1) (2) $ 0 9,288 (0) $9,288(1) 2013 $ 9,288 9,864 (8,359) $10,793(2) $ 9,288 929 9,864 $10,793
(For Instructor Use Only)
9 employees X $12.90/hr. X 8 hrs./day X 10 days = 9 employees X $12.90/hr. X 8 hrs./day X 1 day = 9 employees X $13.70/hr. X 8 hrs./day X 10 days =
$
13-20
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EXERCISE 13-7 (57 minutes) June 30 Sales Revenue............................................................................. 23,700 Sales Taxes Payable....................................................... Computation: Sales plus sales tax ($265,000 + $153,700) $418,700 Sales exclusive of tax ($418,700 1.06) (395,000) Sales tax $ 23,700
23,700
EXERCISE 13-8 (1015 minutes) Salaries and Wages Expense ................................................. 480,000 Withholding Taxes Payable.......................................... FICA Taxes Payable* ...................................................... Union Dues Payable........................................................ Cash ..................................................................................... *[($480,000 $140,000) X 7.65% = $26,010] $140,000 X 1.45% = $2,030; $26,010 + $2,030 = $28,040 Payroll Tax Expense.................................................................. FICA Taxes Payable ........................................................ (See previous computation.) FUTA Taxes Payable [($480,000 $410,000) X .8%) ................................... SUTA Taxes Payable [$70,000 X (3.5% 2.3%)]........................................... 29,440 28,040
80,000 28,040 9,000 362,960
560 840
EXERCISE 13-9 (1520 minutes) (a) Computation of taxes Salaries and wages Social security taxes (FICA) Federal unemployment taxes (FUTA) State unemployment taxes (SUTA) Total Cost Factory $140,000 10,710 (7.65% X $140,000) 320 (.8% X $40,000) 1,000 (2.5% X $40,000) $152,030
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EXERCISE 13-9 (Continued) Sales $32,000 1,208* 32 (.8% X $4,000) 100 (2.5% X $4,000) $33,340
Salaries and wages Social security taxes (FICA) Federal unemployment taxes (FUTA) State unemployment taxes (SUTA) Total Cost
*$12,000 X 7.65% = $918; $20,000 X 1.45% = $290; $918 + $290 = $1,208 Admin. $36,000 2,754 0 0 $38,754
Salaries and Wages Social security taxes (FICA) Federal unemployment taxes (FUTA) State unemployment taxes (SUTA) Total Cost Schedule Total Salaries and Wages FICA Taxes FUTA Taxes SUTA Taxes Total Cost $208,000 14,672 352 1,100 $224,124
(7.65% X $36,000)
Factory $140,000 10,710 320 1,000 $152,030
Sales $32,000 1,208 32 100 $33,340
Admin. $36,000 2,754 0 0 $38,754
(b) Factory Payroll: Salaries and Wages Expense...................................... Withholding Taxes Payable .............................. FICA Taxes Payable............................................. Cash .......................................................................... Payroll Tax Expense....................................................... FICA Taxes Payable............................................. FUTA Taxes Payable ........................................... SUTA Taxes Payable ...........................................
140,000 16,000 10,710 113,290 12,030 10,710 320 1,000
13-22
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EXERCISE 13-9 (Continued) Sales Payroll: Salaries and Wages Expense ...................................... Withholding Taxes Payable ............................... FICA Taxes Payable ............................................. Cash........................................................................... Payroll Tax Expense ....................................................... FICA Taxes Payable ............................................. FUTA Taxes Payable............................................ SUTA Taxes Payable............................................ Administrative Payroll: Salaries and Wages Expense ...................................... Withholding Taxes Payable ............................... FICA Taxes Payable ............................................. Cash........................................................................... Payroll Tax Expense ....................................................... FICA Taxes Payable .............................................
32,000 7,000 1,208 23,792 1,340 1,208 32 100
36,000 6,000 2,754 27,246 2,754 2,754
EXERCISE 13-10 (1015 minutes) (a) Cash (150 X $4,000).......................................................... Sales Revenue......................................................... Warranty Expense ............................................................ Inventory ................................................................... Warranty Expense ($45,000* $17,000) .................... Warranty Liability ................................................... *(150 X $300) (b) Cash ...................................................................................... Sales Revenue......................................................... Warranty Expense ............................................................ Inventory ................................................................... 600,000 600,000 17,000 17,000 600,000 600,000 17,000 17,000 28,000 28,000
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EXERCISE 13-11 (1520 minutes) (a) Cash................................................................................... 3,000,000 Sales Revenue (500 X $6,000) ........................ Warranty Expense......................................................... Inventory................................................................ Warranty Expense......................................................... Warranty Liability ($120,000 $30,000) ....................................... (b) 30,000 30,000 90,000 90,000
3,000,000
Cash................................................................................... 3,000,000 Sales Revenue..................................................... Unearned Warranty Revenue.......................... Warranty Expense......................................................... Inventory................................................................ Unearned Warranty Revenue .................................... Warranty Revenue [$160,000 X ($30,000/$120,000)] ................. 30,000
2,840,000 160,000
30,000 40,000 40,000
EXERCISE 13-12 (1520 minutes) Inventory of Premiums (8,800 X $.90) .............................. Cash.................................................................................. Cash (120,000 X $3.30) .......................................................... Sales Revenue............................................................... Premium Expense................................................................... Inventory of Premiums [(44,000 10) X $.90] ..... Premium Expense................................................................... Premium Liability ......................................................... *[(120,000 X 60%) 44,000] 10 X $.90 = 2,520 7,920 7,920 396,000 396,000 3,960 3,960 2,520* 2,520
13-24
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EXERCISE 13-13 (2030 minutes) (1) The FASB requires that, when some amount within the range of expected loss appears at the time to be a better estimate than any other amount within the range, that amount is accrued. When no amount within the range is a better estimate than any other amount, the dollar amount at the low end of the range is accrued and the dollar amount at the high end of the range is disclosed. In this case, therefore, Maverick Inc. would report a liability of $800,000 at December 31, 2012. The loss should be accrued for $6,000,000. The potential insurance recovery is a gain contingency--it is not recorded until received. According to FASB ASC 410-30-35-8, claims for recoveries may be recorded if the recovery is deemed probable. This is a gain contingency because the amount to be received will be in excess of the book value of the plant. Gain contingencies are not recorded and are disclosed only when the probabilities are high that a gain contingency will become reality.
(2)
(3)
EXERCISE 13-14 (2530 minutes) (a) Plant Assets..................................................................... Cash......................................................................... Plant Assets..................................................................... Asset Retirement Obligation ........................... (b) Depreciation Expense .................................................. Accumulated Depreciation-- Plant Assets ...................................................... Depreciation Expense .................................................. Accumulated Depreciation-- Plant Assets ...................................................... Interest Expense ............................................................ Asset Retirement Obligation ........................... *$39,087/10. **$39,087 X .06.
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600,000 600,000 39,087 39,087 60,000 60,000 3,909 3,909* 2,345 2,345**
13-25
EXERCISE 13-14 (Continued) (c) Asset Retirement Obligation ..................................... Loss on ARO Settlement ............................................ Cash ........................................................................ 70,000 10,000 80,000
EXERCISE 13-15 (2030 minutes) 1. Liability for stamp redemptions, 12/31/11 ............... Cost of redemptions redeemed in 2012 ................... Cost of redemptions to be redeemed in 2013 (5,200,000 X 80%)..................................................... Liability for stamp redemptions, 12/31/12 ............... 2. Total coupons issued ..................................................... Redemption rate............................................................... To be redeemed................................................................ Handling charges ($510,000 X 10%) .......................... Total cost ............................................................................ Total cost ............................................................................ Total payments to retailers........................................... Liability for unredeemed coupons ............................. 3. Boxes ................................................................................... Redemption rate............................................................... Total redeemable ............................................................. Coupons to be redeemed (420,000 250,000) ....... Cost ($6.50 $4.00) ......................................................... Liability for unredeemed coupons ............................. $13,000,000 (6,000,000) 7,000,000 4,160,000 $11,160,000 $ X 850,000 60% 510,000 51,000 561,000 561,000 (330,000) 231,000 600,000 70% 420,000 170,000 $2.50 425,000
$ $ $
X
X $
13-26
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EXERCISE 13-16 (2025 minutes) # 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. Assets I NE NE I NE I D NE NE I NE I NE D NE D NE NE Liabilities I NE I I I I I I I I I I I D I NE D I Owners' Equity NE NE D NE D I D D D NE D I D NE D D I D Net Income NE NE D NE D I D D D NE D I D NE D D I D
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EXERCISE 13-17 (1015 minutes) (a) Current ratio = Current Assets Current Liabilities = $210,000 $70,000 = 3.00
Current ratio measures the short-term ability of the company to meet its currently maturing obligations. (b)
Acid-test ratio = Cash + Short-term Investments + Net Receivables = $115,000 Current Liabilities $70,000 = 1.64
Acid-test ratio also measures the short-term ability of the company to meet its currently maturing obligations. However, it eliminates assets that might be slow moving, such as inventories and prepaid expenses. (c) Debt to total assets = Total Liabilities Total Assets = $210,000 $430,000 = 48.84%
This ratio provides the creditors with some idea of the corporation's ability to withstand losses without impairing the interests of creditors. (d)
Rate of return on assets = Net Income Average Total Assets = $25,000 $430,000 = 5.81%
This ratio measures the return the company is earning on its average total assets and provides one indication related to the profitability of the enterprise.
EXERCISE 13-18 (2025 minutes) (a) (1) Current ratio = $733,000 $240,000 = 3.05
(2) Acid-test ratio =
$52,000 + $158,000 + $80,000 = 1.21 $240,000 $80,000 + $158,000 2 = 13.8 Times (or approximately every 26 days)
(3) Accounts receivable turnover = $1,640,000
13-28
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EXERCISE 13-18 (Continued) (4) Inventory turnover = $360,000 + $440,000 = 2 times (or approximately $800,000 2 every 183 days) Rate of return on assets = $1,400,000 + $1,630,000 $320,000 2
(5)
= 21.12%
(6) (b)
Profit margin on sales = $320,000 $1,640,000 = 19.51%
Financial ratios should be evaluated in terms of industry peculiarities and prevailing business conditions. Although industry and general business conditions are unknown in this case, the company appears to have a relatively strong current position. The main concern from a short-term perspective is the apparently low inventory turnover. The rate of return on assets and profit margin on sales are extremely good and indicate that the company is employing its assets advantageously.
EXERCISE 13-19 (1525 minutes) (a) (1) (2) (3) (4) (5) (6) $318,000 $87,000 = 3.66 times $820,000 $200,000 + $170,000 = 4.43 times (or approximately 2 82 days).
$1,400,000 $95,000 = 14.74 times (or approximately 25 days). $210,000 52,000 = $4.04 $210,000 $1,400,000 = 15.0% $210,000 $488,000 = 43.03%
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13-29
EXERCISE 13-19 (Continued) (b) (1) No effect on current ratio, if already included in the allowance for doubtful accounts. Weaken current ratio by reducing current assets. Improve current ratio by reducing current assets and current liabilities by a like amount. No effect on current ratio. Weaken current ratio by increasing current liabilities. No effect on current ratio.
(2) (3)
(4) (5) (6)
13-30
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TIME AND PURPOSE OF PROBLEMS
Problem 13-1 (Time 2530 minutes) Purpose--to present the student with an opportunity to prepare journal entries for a variety of situations related to liabilities. The situations presented are basic ones including purchases and payments on account, and borrowing funds by giving a zero-interest-bearing note. The student is also required to prepare year-end adjusting entries. Problem 13-2 (Time 2535 minutes) Purpose--to present the student with the opportunity to prepare journal entries for several different situations related to liabilities. The situations presented include accruals and payments related to sales, use, and asset retirement obligations. Year-end adjusting entries are also required. Problem 13-3 (Time 2030 minutes) Purpose--to present the student with an opportunity to prepare journal entries for four weekly payrolls. The student must compute income tax to be withheld, FICA tax, and state and federal unemployment compensation taxes. The student must realize the fact that in the fourth week only a portion of one employee's payroll is subject to unemployment tax. Problem 13-4 (Time 2025 minutes) Purpose--to provide the student with the opportunity to prepare journal entries for a monthly payroll. The student must compute income tax to be withheld, FICA tax, and state and federal unemployment compensation taxes. The student must be aware that the unemployment taxes do not apply to three employees as their earnings exceed the statutory maximum subject to the taxes. Problem 13-5 (Time 1520 minutes) Purpose--to provide the student with an opportunity to prepare journal entries and balance sheet presentations for warranty costs under the cash-basis and the expense warranty accrual methods. Entries in the sales year and one subsequent year are required. The problem highlights the differences between the two methods in the accounts and on the balance sheet. Problem 13-6 (Time 1020 minutes) Purpose--to provide the student with a basic problem covering the sales-warranty method. The student is required to prepare journal entries in the year of sale and in subsequent years when warranty costs are incurred. Also required are balance sheet presentations for the year of sale and one subsequent year. While the problem is basic in nature it does test the student's ability to understand and apply the sales warranty method. Problem 13-7 (Time 2535 minutes) Purpose--to provide the student with an opportunity to prepare journal entries for warranty costs under the expense warranty method and the cash-basis method. The student is also required to indicate the proper balance sheet disclosures under each method for the year of sale. Finally, the student is required to comment on the effect on net income of applying each method. The problem highlights the differences between the two methods in the accounts and on the balance sheet. Problem 13-8 (Time 1525 minutes) Purpose--to provide the student with a basic problem in accounting for premium offers. The student is required to prepare journal entries relating to sales, the purchase of the premium inventory, and the redemption of coupons. The student must also prepare the year-end adjusting entry reflecting the estimated liability for premium claims outstanding. A very basic problem.
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13-31
Time and Purpose of Problems (Continued) Problem 13-9 (Time 3045 minutes) Purpose--to present the student with a slightly complicated problem related to accounting for premium offers. The problem is more complicated in that coupons redeemed are accompanied by cash payments, and in addition to the cost of the premium item postage costs are also incurred. The student is required to prepare journal entries for various transactions including sales, purchase of the premium inventory, and redemption of coupons for two years. The second year's entries are more complicated due to the existence of the liability for claims outstanding. Finally the student is required to indicate the amounts related to the premium offer that would be included in the financial statements for each of two years. This very realistic problem challenges the student's ability to account for all transactions related to premium offers. Problem 13-10 (Time 2530 minutes) Purpose--to present the student with the problem of determining the proper amount of and disclosure for a contingent loss due to lawsuits. The student is required to prepare a journal entry and a footnote. The student is also required to discuss any liability incurred by a company due to the risk of loss from lack of insurance coverage. A straightforward problem dealing with contingent losses. Problem 13-11 (Time 3545 minutes) Purpose--to provide the student with a comprehensive problem dealing with contingent losses. The student is required to prepare journal entries for each of three independent situations. For each situation the student must also discuss the appropriate disclosure in the financial statements. The situations presented include a lawsuit, an expropriation, and a self-insurance situation. This problem challenges the student not only to apply the guidelines set forth in GAAP, but also to develop reasoning as to how the guidelines relate to each situation. Problem 13-12 (Time 2030 minutes) Purpose--to provide the student with a problem to calculate warranty expense, estimated warranty liability, premium expense, inventory of premiums, and premium liability. Problem 13-13 (Time 2535 minutes) Purpose--to present the student a comprehensive problem in determining various liabilities and present findings in writing. Issues addressed relate to contingencies, warranties, and litigation. Problem 13-14 (Time 2025 minutes) Purpose--to present the student with a comprehensive problem in determining the amounts of various liabilities. The student must calculate (for independent situations) the estimated liability for warranties, and an estimated liability for premium claims outstanding. Journal entries are not required. This problem should challenge the better students.
13-32
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SOLUTIONS TO PROBLEMS
PROBLEM 13-1 (a) February 2 Purchases ($70,000 X 98%) ........................................... Accounts Payable ................................................. February 26 Accounts Payable............................................................. Purchase Discounts Lost............................................... Cash........................................................................... April 1 Trucks................................................................................... Cash........................................................................... Notes Payable......................................................... May 1 Cash ...................................................................................... Discount on Notes Payable ........................................... Notes Payable......................................................... August 1 Retained Earnings (Dividends) .................................... Dividends Payable ................................................ September 10 Dividends Payable............................................................ Cash........................................................................... (b) December 31 1. No adjustment necessary 2. Interest Expense ($46,000 X 12% X 9/12) ............ Interest Payable ..................................................... 3. Interest Expense ($9,000 X 8/12)............................ Discount on Notes Payable................................ 4. No adjustment necessary
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68,600 68,600
68,600 1,400 70,000
50,000 4,000 46,000
83,000 9,000 92,000
300,000 300,000
300,000 300,000
4,140 4,140 6,000 6,000
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PROBLEM 13-2
1.
Dec. 5
Cash ................................................................... Due to Customer .................................
500 500
2.
Dec. 1-31
Cash ................................................................... 798,000 Sales Revenue ($798,000 1.05) .............................. Sales Taxes Payable ($760,000 X .05) ................................ Trucks ($120,000 X 1.05).............................. 126,000 Cash......................................................... Land Improvements ...................................... Asset Retirement Obligation ........... 84,000
760,000 38,000
3.
Dec. 10
126,000
4.
Dec. 31
84,000
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PROBLEM 13-3
Entries for Payroll 1 Salaries and Wages Expense .............................................. Withholding Taxes Payable (10% X $1,040)* ....... FICA Taxes Payable (7.65% X $1,040).................... Union Dues Payable (2% X $1,040) ......................... Cash .................................................................................. *$200 + $150 + $110 + $250 + $330 = $1,040 Payroll Tax Expense............................................................... FICA Taxes Payable (7.65% X $1,040).................... FUTA Taxes Payable [0.8% X ($200 + $150 + $110)]................................ SUTA Taxes Payable (2.5% X $460)........................ Entries for Payroll 2 and 3 Salaries and Wages Payable (Vacation) .......................... Salaries and Wages Expense .............................................. Withholding Taxes Payable (10% X $1,040)......... FICA Taxes Payable (7.65% X $1,040).................... Union Dues Payable (2% X $1,040) ......................... Cash .................................................................................. *($300 + $220 + $660) 2 Payroll Tax Expense............................................................... FICA Taxes Payable (7.65% X $1,040).................... FUTA Taxes Payable (0.8% X $460) ........................ SUTA Taxes Payable (2.5% X $460)........................
1,040.00* 104.00 79.56 20.80 835.64
94.74 79.56 3.68 11.50
590.00* 450.00 104.00 79.56 20.80 835.64
94.74 79.56 3.68 11.50
Entries for Payroll 4 Salaries and Wages Expense .............................................. 1,040.00 Withholding Taxes Payable (10% X $1,040)......... FICA Taxes Payable (7.65% X $1,040).................... Union Dues Payable (2% X $1,040) ......................... Cash ..................................................................................
104.00 79.56 20.80 835.64
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13-35
PROBLEM 13-3 (Continued) Payroll Tax Expense .............................................................. FICA Taxes Payable (7.65% X $1,040) ................... FUTA Taxes Payable (0.8% X $460) ....................... SUTA Taxes Payable (2.5% X $460) ....................... 94.74 79.56 3.68 11.50
Monthly Payment of Payroll Liabilities Withholding Taxes Payable ($104.00 X 4)....................... 416.00 FICA Taxes Payable ($79.56 X 8) ....................................... 636.48 Union Dues Payable ($20.80 X 4)....................................... 83.20 FUTA Taxes Payable ($3.68 X 4) ........................................ 14.72 SUTA Taxes Payable ($11.50 X 4)...................................... 46.00 Cash..................................................................................
1,196.40
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Kieso, Intermediate Accounting, 14/e, Solutions Manual
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PROBLEM 13-4
(a)
Name B. D. Williams D. Raye K. Baker F. Lopez A. Daniels B. Kingston Total Earnings to Aug. 31 $ 6,800 6,500 7,600 13,600 107,000 112,000 $253,500 September Earnings 800 700 1,100 1,900 13,000 16,000 $33,500 $ Income Tax Withholding 80 70 110 190 1,300 1,600 $3,350 $ FICA $ 61.20 53.55 84.15 145.35 188.50a 232.00b $764.75 FUTA $2.00* 5.00*** $7.00 SUTA $1.60** 4.00**** $5.60
*($7,000 $6,800) X 1% = $2.00 **($7,000 $6,800) X .8% = $1.60 ***($7,000 $6,500) X 1% = $5.00 ****($7,000 $6,500) X .8% = $4.00
a
b
$13,000 X 1.45% = $188.50 $16,000 X 1.45% = $232.00
Salaries and Wages Expense .................................... 33,500.00 Withholding Taxes Payable ............................. FICA Taxes Payable ........................................... Cash......................................................................... (b) Payroll Tax Expense ..................................................... FICA Taxes Payable ........................................... FUTA Taxes Payable .......................................... SUTA Taxes Payable.......................................... Withholding Taxes Payable........................................ FICA Taxes Payable ...................................................... FUTA Taxes Payable..................................................... SUTA Taxes Payable .................................................... Cash......................................................................... 777.35
3,350.00 764.75 29,385.25
764.75 5.60 7.00 3,350.00 1,529.50 5.60 7.00 4,892.10
(c)
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13-37
PROBLEM 13-5
(a)
Cash (400 X $2,500)..................................................... Sales Revenue.................................................... Cash (400 X $2,500)..................................................... Sales Revenue.................................................... Warranty Expense (400 X [$155 + $185]).............. Warranty Liability ..............................................
1,000,000 1,000,000 1,000,000 1,000,000 136,000 136,000
(b)
(c)
No liability would be disclosed under the cash-basis method relative to future costs due to warranties on past sales. Current Liabilities: Warranty Liability ............................................... Long-term Liabilities: Warranty Liability ...............................................
(d)
$68,000
$68,000 61,300 21,400 39,900 61,300 21,400 39,900
(e)
Warranty Expense......................................................... Inventory................................................................ Salaries and Wages Payable .......................... Warranty Payable .......................................................... Inventory................................................................ Salaries and Wages Payable ..........................
(f)
13-38
Copyright 2011 John Wiley & Sons, Inc.
Kieso, Intermediate Accounting, 14/e, Solutions Manual
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PROBLEM 13-6
(a)
Cash .................................................................................... Sales Revenue (300 X $900) ............................. Unearned Warranty Revenue (270 X $90)........ Current Liabilities: Unearned Warranty Revenue ($24,300/3)..... (Note: Warranty costs assumed to be incurred equally over the threeyear period) Long-term Liabilities: Unearned Warranty Revenue ($24,300 X 2/3)....................................................
294,300 270,000 24,300
(b)
$ 8,100
$16,200 8,100 8,100 6,000 2,000 4,000
(c)
Unearned Warranty Revenue...................................... Warranty Revenue ............................................... Warranty Expense .......................................................... Inventory ................................................................. Salaries and Wages Payable ............................
(d)
Current Liabilities: Unearned Warranty Revenue ........................... Long-term Liabilities: Unearned Warranty Revenue ...........................
$ 8,100
$ 8,100
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Kieso, Intermediate Accounting, 14/e, Solutions Manual
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PROBLEM 13-7
(a)
(1)
Cash ......................................................................... Sales Revenue (600 X $7,400) ................. Warranty Expense ([$600 X $390] / 2) ........... Inventory ($170 X 600 X 1/2)..................... Salaries and Wages Payable ($220 X 600 X 1/2)...................................... Warranty Expense ............................................... Warranty Liability (600 machines X $390) $117,000...... Warranty Liability................................................. Inventory ........................................................ Salaries and Wages Payable ................... Cash ......................................................................... Sales Revenue.............................................. Warranty Expense ............................................... Inventory ........................................................ Salaries and Wages Payable ...................
4,440,000 4,440,000 117,000 51,000 66,000 117,000 117,000 117,000 51,000 66,000 4,440,000 4,440,000 117,000 51,000 66,000
(2)
(3)
(4)
(b)
(1)
(2)
(3)
Under the cash-basis method, the total warranty expense is recorded through entries 2 and 4 which recognize warranty costs as incurred. Warranty expense for 2013 is $117,000 under the cash basis. Warranty Expense ............................................... Inventory ........................................................ Salaries and Wages Payable ................... 117,000 51,000 66,000
(4)
(c)
Cash-basis method: No liability for future costs to be incurred under outstanding warranties is recorded or normally disclosed under the cash basis method.
13-40
Copyright 2011 John Wiley & Sons, Inc.
Kieso, Intermediate Accounting, 14/e, Solutions Manual
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PROBLEM 13-7 (Continued) Expense warranty accrual method: As of 12/31/12 the balance sheet would disclose a current liability in the amount of $117,000 for Warranty Liability. (d) In the case of Alvarado Company, the expense warranty accrual method reflects properly the income resulting from operations in 2012 and 2013 because the warranty costs are matched with the revenues resulting from the sale, which required such costs to be incurred. Under the cash-basis method, the warranty costs appearing on the 2013 income statement are charged against unrelated revenues; 2012 net income is overstated and 2013 net income is understated.
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13-41
PROBLEM of 13-8
Inventory Premiums.............................................................. Cash...................................................................................... (To record purchase of 40,000 puppets at $1.50 each)
60,000 60,000
Cash ................................................................................................ 1,800,000 Sales Revenue................................................................... 1,800,000 (To record sales of 480,000 boxes at $3.75 each) Premium Expense....................................................................... Inventory of Premiums................................................... [To record redemption of 115,000 coupons. Computation: (115,000 5) X $1.50 = $34,500] Premium Expense....................................................................... Premium Liability ............................................................. [To record estimated liability for premium claims outstanding at December 31, 2013.] Computation: Total coupons issued in 2013..................... Total estimated redemptions (40%) ...................................... Coupons redeemed in 2013..................................................... Estimated future redemptions................................................ Cost of estimated claims outstanding (77,000 5) X $1.50 = $23,100 34,500 34,500
23,100 23,100
480,000 192,000 115,000 77,000
13-42
Copyright 2011 John Wiley & Sons, Inc.
Kieso, Intermediate Accounting, 14/e, Solutions Manual
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PROBLEM 13-9
(a) 2012 Inventory of Premiums .......................................................... Cash .................................................................................. (To record the purchase of 250,000 CDs at $2.25 each) Cash ............................................................................................. Sales Revenue ............................................................... (To record the sale of 2,895,400 candy bars at 30 cents each) Cash [$600,000 (240,000 X $.50)] .................................... Premium Expense ................................................................... Inventory of Premiums................................................ [To record the redemption of 1,200,000 wrappers, the receipt of $600,000 (1,200,000 5) X $2.50, and the mailing of 240,000 CDs]
562,500 562,500
868,620 868,620
480,000 60,000 540,000
Computation of premium expense: 240,000 CDs @ $2.25 each =.................................. $540,000 Postage--240,000 X $.50 = ..................................... 120,000 $660,000 Less: Cash received-- 240,000 X $2.50............................................ 600,000 Premium expense for CDs issued ...................... $ 60,000 Premium Expense ................................................................... Premium Liability.......................................................... (To record the estimated liability for premium claims outstanding at 12/31/10) *(290,000 5) X ($2.25 + $.50 $2.50) = $14,500 14,500* 14,500
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PROBLEM 13-9 (Continued) 2013 Inventory of Premiums.......................................................... Cash.................................................................................. (To record the purchase of 330,000 CDs at $2.25 each) Cash ............................................................................................ Sales Revenue............................................................... (To record the sale of 2,743,600 candy bars at 30 cents each) Cash ($750,000 $150,000) ................................................. Premium Liability .................................................................... Premium Expense................................................................... Inventory of Premiums............................................... (To record the redemption of 1,500,000 wrappers, the receipt of $750,000 [(1,500,000 5) X $2.50], and the mailing of 300,000 CDs.) 742,500 742,500
823,080 823,080
600,000 14,500 60,500 675,000
Computation of premium expense: 300,000 CDs @ $2.25 =............................................ $675,000 Postage--300,000 @ $.50 = ................................. 150,000 825,000 Less: Cash received-- (1,500,000 5) X $2.50................................... 750,000 Premium expense for CDs issued .......................... 75,000 Less: Outstanding claims at 12/31/12 charged to 2012 but redeemed in 2013..... 14,500 Premium expense chargeable to 2013.................. $ 60,500 Premium Expense................................................................... $ 17,500* Premium Liability ......................................................... *(350,000 5) X ($2.25 + $.50 $2.50) = $17,500
17,500
13-44
Copyright 2011 John Wiley & Sons, Inc.
Kieso, Intermediate Accounting, 14/e, Solutions Manual
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PROBLEM 13-9 (Continued) (b) Account Inventory of Premiums Premiums Liability Premium Expense Amount 2012 2013 Classification $22,500* $90,000** Current asset 14,500 17,500 Current liability 74,500*** 78,000**** Selling expense
* $2.25 (250,000 240,000) ** $2.25 (10,000 + 330,000 300,000) *** $60,000 + $14,500 **** $60,500 + $17,500
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13-45
PROBLEM 13-10
(a)
Because the cause for litigation occurred before the date of the financial statements and because an unfavorable outcome is probable and reasonably estimable, Windsor Airlines should report a loss and a liability in the December 31, 2012, financial statements. The loss and liability might be recorded as follows: Lawsuit Loss ($9,000,000 X 60%)..................................................... 5,400,000 Lawsuit Liability ..................................................
5,400,000
Note to the Financial Statements Due to an accident which occurred during 2012, the Company is a defendant in personal injury suits totaling $9,000,000. The Company is charging the year of the casualty with $5,400,000 in estimated losses, which represents the amount that the company legal counsel estimates will finally be awarded. (b) Windsor Airlines need not establish a liability for risk of loss from lack of insurance coverage itself. GAAP does not require or allow the establishment of a liability for expected future injury to others or damage to the property of others even if the amount of the losses is reasonably estimable. The cause for a loss must occur on or before the balance sheet date for a loss contingency to be recorded. However, the fact that Windsor is self-insured should be disclosed in a note.
13-46
Copyright 2011 John Wiley & Sons, Inc.
Kieso, Intermediate Accounting, 14/e, Solutions Manual
(For Instructor Use Only)
PROBLEM 13-11
(a)
1.
Lawsuit Loss.......................................................... Lawsuit Liability.........................................
250,000 250,000
2.
Loss from Expropriation.................................... 1,925,000 Allowance for Expropriation [$5,725,000 (40% X $9,500,000)] ...... No entry required.
1,925,000
3. (b) 1.
A loss and a liability have been recorded in the first case because (i) information is available prior to the issuance of the financial statements that indicates it is probable that a liability had been incurred at the date of the financial statements and (ii) the amount is reasonably estimable. That is, the occurrence of the uninsured accidents during the year plus the outstanding injury suits and the attorney's estimate of probable loss required recognition of a loss contingency. An entry to record a loss and establish an allowance due to threat of expropriation is necessary because the expropriation is imminent as evidenced by the foreign government's communicated intent to expropriate and the prior settlements for properties already expropriated. That is, enough evidence exists to reasonably estimate the amount of the probable loss resulting from impairment of assets at the balance sheet date. The amount of the loss is measured by the amount that the carrying value (book value) of the assets exceeds the expected compensation. At the time the expropriation occurs, the related assets are written off against the allowance account. In this problem, we established a valuation account because certain specific assets were impaired. A valuation account was established rather than a liability account because the net realizability of the assets affected has decreased. A more appropriate presentation would, therefore, be provided for balance sheet purposes on the realizability of the assets. It does not seem appropriate at this point to write off the assets involved because it may be difficult to determine all the specific assets involved, and because the assets still have not been expropriated.
2.
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PROBLEM 13-11 (Continued) 3. Even though Polska's chemical product division is uninsurable due to high risk and has sustained repeated losses in the past, as of the balance sheet date no assets have been impaired or liabilities incurred nor is an amount reasonably estimable. Therefore, this situation does not satisfy the criteria for recognition of a loss contingency. Also, unless a casualty has occurred or there is some other evidence to indicate impairment of an asset prior to the issuance of the financial statements, there is no disclosure required relative to a loss contingency. The absence of insurance does not of itself result in the impairment of assets or the incurrence of liabilities. Expected future injuries to others or damage to the property of others, even if the amount is reasonably estimable, does not require recording a loss or a liability. The cause for loss or litigation or claim must have occurred on or prior to the balance sheet date and the amount of the loss must be reasonably estimable in order for a loss contingency to be recorded. Disclosure is required when one or both of the criteria for a loss contingency are not satisfied and there is a reasonable possibility that a liability may have been incurred or an asset impaired, or, it is probable that a claim will be asserted and there is a reasonable possibility of an unfavorable outcome.
13-48
Copyright 2011 John Wiley & Sons, Inc.
Kieso, Intermediate Accounting, 14/e, Solutions Manual
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PROBLEM 13-12
(1)
Sales of musical instruments and sound equipment .......... Estimated warranty cost................................................................ Warranty expense for 2012 ................................................ Estimated liability for warranties--1/1/12 ................................ 2012 warranty expense (Requirement 1) ................................. Subtotal .................................................................................... Actual warranty costs during 2012 ............................................ Estimated liability from warranties--12/31/12........................ Coupons issued (1 coupon/$1 sale) .......................................... Estimated redemption rate ........................................................... Estimated number of coupons to be redeemed .................... Exchange rate (200 coupons for a CD player) ....................... Estimated number of premium CD players to be issued.................................................................................... Net cost of CD players ($32 $20)............................................. Premium expense for 2012 ................................................ Inventory of premium CD players--1/1/12............................... Premium CD players purchased during 2012 (6,500 X $32)................................................................................... Premium CD players available .................................................... Premium CD players exchanged for coupons during 2012 (1,200,000/200 X $32) .......................................... Inventory of premium CD players--12/31/12 .......................... Estimated liability for premiums--1/1/12 ................................. 2012 premium expense (Requirement 3) ................................. Subtotal .................................................................................... Actual redemptions during 2012 [1,200,000/200 X ($32 $20)]..................................................... Estimated liability for premiums--12/31/12 ............................
$5,700,000 X .02 $ 114,000 $ 136,000 114,000 250,000 (164,000) $ 86,000 1,500,000 .60 900,000 200 4,500 12 54,000 37,600 208,000 245,600 192,000 $ 53,600 $ 44,800 54,000 98,800 72,000 26,800
(2)
(3)
X $ $
(4)
(5)
$
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13-49
PROBLEM 13-13
1.
Memo prepared by: Date:
Millay Corporation December 31, 2012 Recognition of Warranty Expense During June of this year, the client began the manufacture and sale of a new line of dishwasher. Sales of 120,000 dishwashers during this period amounted to $60,000,000. These dishwashers were sold under a one-year warranty, and the client estimates warranty costs to be $25 per appliance. As of the balance sheet date, the client paid out $1,000,000 in warranty expenses which was also the amount expensed in its income statement. No recognition of any further liability associated with the warranty had been made. Because Millay accounts for warranties on the accrual basis, it must recognize the entire $3,000,000 as warranty expense in the year of sale. The client should have made the following journal entries: (a) Cash ............................................................................... 60,000,000 Sales Revenue (120,000 X $500)................. 60,000,000 (To record sale of 120,000 dishwashers) Warranty Expense...................................................... Inventory ............................................................ (To record warranty costs incurred) Warranty Expense [(120,000 X $25) $1,000,000] ............................ Warranty Liability ............................................ (To accrue estimated warranty costs) 1,000,000 1,000,000
(b)
(c)
2,000,000 2,000,000
13-50
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PROBLEM 13-13 (Continued) 2. Memo prepared by: Date:
Millay Corporation December 31, 2012 Loss Contingency from Violation Of EPA Regulations I contacted the client's counsel via a routine attorney letter, asking for information about possible litigation in which the company might be involved. Morgan Sondgeroth, Millay's attorney, informed me about court action taken against Millay for dumping toxic waste in the Kishwaukee River. Although the litigation is pending, Sondgeroth believes that the suit will probably be lost. A reasonable estimate of clean up costs and fines is $2,750,000. The client neither disclosed nor accrued this loss in the financial statements. Because this loss is both probable and reasonably estimable, it must be accrued as a contingent liability. I advised the client to record the following entry to accrue this liability. Lawsuit Loss .................................................................. Lawsuit Liability ................................................. 2,750,000 2,750,000
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PROBLEM 13-13 (Continued) 3. Memo prepared by: Date:
Millay Corporation December 31, 2012 Loss Contingency on Patent Infringement Litigation In answer to my attorney letter requesting information about any possible litigation associated with the client, Morgan Sondgeroth informed me that the client is in the middle of a patent infringement suit with Megan Drabek over a hydraulic compressor used in several of Millay's appliances. The possible loss of this suit is only reasonably possible. Millay did not in any way disclose this information. Because the loss is reasonably possible and can be estimated at $5,000,000, it must be disclosed in the notes to the financial statements. I advised the client to include as a footnote to the financial statements a discussion of this pending litigation along with the attorney's assessment that the loss is reasonably possible. In addition, I advised the client to disclose the estimated amount of this loss contingency.
13-52
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Kieso, Intermediate Accounting, 14/e, Solutions Manual
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PROBLEM 13-14
1.
Estimated warranty costs: On 2011 sales $ 800,000 X .10....................................... $ 80,000 On 2012 sales $1,100,000 X .10....................................... 110,000 On 2013 sales $1,200,000 X .10....................................... 120,000 Total estimated costs ............................................... 310,000 Total warranty expenditures................................... 85,700* Balance of liability, 12/31/13 ....................................................... $224,300 *2011--$6,500; 2012--$17,200, and 2013--$62,000. The liability account has a balance of $224,300 at 12/31/13 based on the difference between the estimated warranty costs (totaling $310,000) for the three years' sales and the actual warranty expenditures (totaling $85,700) during that same period.
2.
Computation of liability for premium claims outstanding: Unredeemed coupons for 2012 ($9,000 $8,000) ................................................................ 2013 coupons estimated to be redeemed ($30,000 X .40) .................................................................... Total .................................................................................
$ 1,000 12,000 $13,000
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13-53
TIME AND PURPOSE OF CONCEPTS FOR ANALYSIS
CA 13-1 (Time 2025 minutes) Purpose--to provide the student with the opportunity to define a liability, to distinguish between current and long-term liabilities, and to explain accrued liabilities. The student must also describe how liabilities are valued, explain why notes payable are usually reported first in the current liabilities section, and to indicate the items that may comprise "compensation to employees." CA 13-2 (Time 1520 minutes) Purpose--to provide three situations that require the application of judgment about the current or longterm nature of the items. The student must think about when typical short-term items might not be classified as current. CA 13-3 (Time 3040 minutes) Purpose--to provide the student with a comprehensive case covering refinancing of short-term debt. Four situations are presented in which the student must determine the proper classification and disclosure of the debt in the financial statements. In order to thoroughly resolve the issues presented, the student is expected to research the FASB codification. CA 13-4 (Time 2025 minutes) Purpose--to provide the student with an opportunity for the student to analyze a situation in which short-term debt is refinanced. The student must comment on the proper balance sheet classification for the debt at three different balance sheet dates. The student is also required to determine the proper balance sheet classifications if instead of actually refinancing the debt, a financing agreement had been initiated. A structural case which calls for the student to apply the principles related to refinancing of short-term debt. CA 13-5 (Time 1520 minutes) Purpose--to provide the student with an opportunity to comment on the proper treatment in the financial statements of a contingent loss incurred after the balance sheet date but before issuance of the financial statements. In order to thoroughly answer the case the student will need to understand proper accounting for contingencies. CA 13-6 (Time 1520 minutes) Purpose--to provide the student with an opportunity to specify the conditions by which a loss contingency can be recorded in the accounts. The student is also required to indicate the proper disclosure in the financial statements of the situations where the amount of loss cannot be reasonably estimated. CA 13-7 (Time 1520 minutes) Purpose--to provide the student with an opportunity to discuss how product warranty costs and the fact that a company is being sued should be reported. CA 13-8 (Time 2025 minutes) Purpose--to provide the student with an opportunity to examine the ethical issues related to estimates for bad debts and warranty obligations.
13-54
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Kieso, Intermediate Accounting, 14/e, Solutions Manual
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SOLUTIONS TO CONCEPTS FOR ANALYSIS
CA 13-1
(a) A liability is defined as "probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events." In other words, it is an obligation to transfer some type of resource in the future as a result of a past transaction. (b) Current liabilities are "obligations whose liquidation is reasonably expected to require use of existing resources properly classified as current assets or the creation of other current liabilities." In other words, they are liabilities generally payable within one year or the operating cycle, whichever is longer. (c) Accrued liabilities (sometimes called accrued expenses) arise through accounting recognition of unpaid expenses that come into existence as a result of past contractual commitments or past services received. Examples are wages and salaries payable, interest payable, property taxes payable, income tax payable, payroll taxes payable, bonus payable, postretirement benefits payable, and so on.
(d) Theoretically, liabilities should be measured by the present value of the future outlay of cash required to liquidate them. But in practice, current liabilities are usually recorded in accounting records and reported in financial statements at their maturity value. Because of the short time periods involved--frequently less than one year--the difference between the present value of a current liability and the maturity value is not large. The slight overstatement of liabilities that results from carrying current liabilities at maturity value is accepted on the grounds it is immaterial. (e) Notes payable are listed first in the balance sheet because in liquidation they would probably be paid first. (f) The item compensation to employees might include: 1. Wages, salaries, or bonuses payable. 2. Compensated absences payable. 3. Postretirement benefits payable.
CA 13-2
1. Since the notes payable are due in less than one year from the balance sheet date, they would generally be reported as a current liability. The only situation in which this short-term obligation could possibly be excluded from current liabilities is if Rodriguez Corp. intends to refinance it. For those notes to qualify for exclusion from current liabilities, the company must meet the following criteria: (1) It must intend to refinance the obligation on a long-term basis, and (2) It must demonstrate an ability to consummate the refinancing. The second criteria, ability to refinance, can be demonstrated either by actually refinancing before the balance sheet is issued or by entering into a noncancelable financing agreement, which has not been violated, with a capable lender. Only that portion of the $25,000,000 which has been refinanced can be reclassified.
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13-55
CA 13-2 (Continued)
2. Generally, deposits from customers would be classified as a current liability. However, the classification of deposits as current or noncurrent depends on the time involved between the date of deposit and the termination of the relationship that required the deposit. In this case, the $6,250,000 would be excluded from current liabilities only if the equipment would not be delivered for more than one year (or one operating cycle, if longer). Salaries payable is an accrued liability which in almost all circumstances would be reported as a current liability (could not be excluded).
3.
CA 13-3
(This case requires some research of FASB Codification.) (a) No. GAAPs indicate that refinancing a short-term obligation on a long-term basis means either replacing it with a long-term obligation or with equity securities, or renewing, extending, or replacing it with short-term obligations for an uninterrupted period extending beyond one year (or the operating cycle, if applicable) from the date of an enterprise's balance sheet. Management's intent to refinance the obligation on a long-term basis is not enough to warrant reclassification of the short-term obligation. The enterprise's intent must be supported by an ability to consummate the refinancing. (b) Yes. The events described will have an impact on the financial statements. Since Dumars Corporation refinanced the long-term debt maturing in March 2013 in a manner that meets the conditions set forth in GAAP that obligation should be excluded from current liabilities. The $10,000,000 should be classified as long-term at December 31, 2012. A short-term obligation, other than one classified as a current liability, shall be excluded from current liabilities if the enterprise's intent to refinance the short-term obligation on a long-term basis is supported by an ability to consummate the refinancing demonstrated in one of the ways stipulated in GAAP. One of the ways stipulated is the issuance of long-term debt or equity securities after the date of the balance sheet but before that balance sheet is issued. The issuance of the long-term debt or equity securities must be for the purpose of refinancing the short-term obligation on a longterm basis. (c) No. since Dumars Corporation refinanced the long-term debt maturing in March 2013 in a manner that meets the conditions set forth in GAAP that obligation should be excluded from current liabilities.
(d) (1) No. The $10,000,000 should be shown under the caption of either "Long-Term Debt," "Interim Debt," "Short-Term Debt Expected to Be Refinanced," or "Intermediate Debt." (2) Yes. GAAP provides that total current liabilities shall be presented in classified balance sheets. If a short-term obligation is excluded from current liabilities pursuant to the provisions of this statement, the notes to the financial statements shall include a general description of the financing agreement and the terms of any new obligation incurred or expected to be incurred or equity securities issued or expected to be issued as a result of a refinancing.
13-56
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CA 13-4
(a) The $3,000,000 of commercial paper liquidated in January would be classified as a current liability in the corporation's balance sheet at December 31, 2012. Since the $3,000,000 of commercial paper is liquidated in January 2013, this amount would not appear on either the January 31, 2013 or February 28, 2013 balance sheets. The $7,000,000 of commercial paper liquidated in March 2013 but refinanced by the long-term debt offering in February 2013 would be excluded from current liabilities in the balance sheets at the end of December 2012, January 2013, and February 2013; this $7,000,000 would be classified as long-term debt. At the end of February 2013, $7,000,000 of cash would be excluded from current assets or if included in current assets, a like amount of debt would be classified as a current liability. The position of the FASB is that if a short-term obligation is repaid after the balance sheet date and subsequently long-term debt is issued, whose proceeds are used to replenish current assets before the balance sheet is issued, the short-term obligation should be included in current liabilities. (b) The classifications are the same as in part (a). The intent to refinance accompanied with a financing agreement is considered equivalent to an actual refinancing for purposes of classifying the shortterm obligation.
CA 13-5
Because the casualty occurred subsequent to the balance sheet date, it does not meet the criteria of a loss contingency; that is, an asset had not been impaired or a liability incurred at the date of the balance sheet. Therefore, a loss contingency should not be accrued by a charge to expense due to the explosion. However, because it had become known before the financial statements were issued that assets were impaired and liabilities were incurred after the balance sheet date, disclosure is necessary to keep the financial statements from being misleading. The financial statements should indicate the nature of and an estimate of the loss to the company's assets as a result of the explosion and the nature of and an estimate of the loss contingency anticipated from suits that will be filed and claims asserted for injuries and damages. If the loss to assets or the liability incurrence can be reasonably estimated, disclosure may best be made by supplementing the historical financial statements with pro forma financial data giving effect to the loss as if it had occurred at the date of the financial statements.
CA 13-6
(a) Two conditions must exist before a loss contingency is recorded: 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. 2. The amount of the loss can be reasonably estimated. (b) When some amount within the range appears at the time to be a better estimate than any other amount within the range, that amount is accrued. When no amount within the range is a better estimate than any other amount, the dollar amount at the low end of the range is accrued and the dollar amount at the high end of the range is disclosed. (c) If the amount of the loss is uncertain, the following disclosure in the notes is required: 1. The nature of the contingency. 2. An estimate of the possible loss or range of loss or a statement that an estimate cannot be made.
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CA 13-7
Part 1. For Product Grey, the estimated product warranty costs should be accrued by a charge to expense and a credit to a liability because both of the following conditions were met: 1. It is probable that a liability has been incurred based on past experience. 2. The amount of the loss can be reasonably estimated as 1% of sales. For Product Yellow, the estimated product warranty costs should not be accrued by a charge to income because the amount of loss cannot be reasonably estimated. Since only one condition is satisfied, a disclosure by means of a note should be made. Part 2. The probable judgment ($1,000,000) should be accrued by a charge to expense and a credit to a liability because both of the following conditions were met: 1. It is probable that a liability has been incurred because Constantine's lawyer states that it is probable that Constantine will lose the suit. 2. The amount of loss can be reasonably estimated because Constantine's lawyer states that the most probable judgment is $1,000,000. Constantine should disclose in its financial statements or notes the following: The amount of the suit ($4,000,000). The nature of the accrual. The nature of the contingency. The range of possible loss ($400,000 to $2,000,000).
CA 13-8
(a) No, Hamilton should not follow his owner's directive if his (Hamilton's) original estimates are reasonable. (b) Rich Clothing Store benefits in lower rental expense. The Dotson Company is harmed because the misleading financial statement deprives it of its rightful rental fees. In addition, the current stockholders of Rich Clothing Store are harmed because the lower net income reduces the current value of their holdings. (c) Rich is acting unethically to avoid the terms of his rental agreement at the expense of his landlord and his own stockholders.
13-58
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FINANCIAL REPORTING PROBLEM
(a) P&G's short-term borrowings were $16,320 million at June 30, 2009. SHORT-TERM DEBT (In millions) Current portion of long-term debt Commercial paper Floating rate notes Other Total short-term debt The weighted average interest rate is 2.0%. (b) 1. Working capital = Current assets less current liabilities. ($8,996,000,000) = ($21,905,000,000 $30,901,000,000) 2. Acid-test ratio = Cash + short-term investments + net receivables Current liabilities
2009 $ 6,941 5,027 4,250 102 $16,320
0.34 times
=
$4,781,000,000 + $5,836,000,000 $30,901,000,000 Current assets Current liabilities 21,905,000,000 30,901,000,000
3.
Current ratio
=
0.71 times
=
While P&G's current and acid-test ratios are below one, this may not indicate a weak liquidity position. Many large companies carry relatively high levels of accounts payable, which charge no interest. For example, P&G has almost $6,000 million of these short-term obligations, which can be viewed as very cheap forms of financing. Nonetheless, its shortterm debt (see part (a)) has increased significantly (from $13,084 million to $16,320 million) in 2009, which raises some liquidity/working capital concerns.
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FINANCIAL REPORTING PROBLEM (Continued) (c) P&G provided the following discussion related to commitments and contingencies: Note 10: Commitments and Contingencies Guarantees In conjunction with certain transactions, primarily divestitures, we may provide routine indemnifications (e.g., indemnification for representations and warranties and retention of previously existing environmental, tax and employee liabilities) which terms range in duration and in some circumstances are not explicitly defined. The maximum obligation under some indemnifications is also not explicitly stated and, as a result, the overall amount of these obligations cannot be reasonably estimated. Other than obligations recorded as liabilities at the time of divestiture, we have not made significant payments for these indemnifications. We believe that if we were to incur a loss on any of these matters, the loss would not have a material effect on our financial position, results of operations or cash flows. In certain situations, we guarantee loans for suppliers and customers. The total amount of guarantees issued under such arrangements is not material. Off-Balance Sheet Arrangements We do not have off-balance sheet financing arrangements, including variable interest entities, that have a material impact on our financial statements.
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FINANCIAL REPORTING PROBLEM (Continued) Purchase Commitments We have purchase commitments for materials, supplies, services and property, plant and equipment as part of the normal course of business. Commitments made under take-or-pay obligations are as follows: 2010--$1,258; 2011--$872; 2012--$787; 2013--$525; 2014-- $156; and $299 thereafter. Such amounts represent future purchases in line with expected usage to obtain favorable pricing. Approximately 43% of our purchase commitments relate to service contracts for information technology, human resources management and facilities management activities that have been outsourced to third-party suppliers. Due to the proprietary nature of many of our materials and processes, certain supply contracts contain penalty provisions for early termination. We do not expect to incur penalty payments under these provisions that would materially affect our financial position, results of operations or cash flows. Operating Leases We lease certain property and equipment for varying periods. Future minimum rental commitments under noncancelable operating leases are as follows: 2010--$305; 2011--$272; 2012--$223; 2013--$202; 2014--$176; and $442 thereafter. Operating lease obligations are shown net of guaranteed sublease income. Litigation We are subject to various legal proceedings and claims arising out of our business which cover a wide range of matters such as governmental regulations, antitrust and trade regulations, product liability, patent and trademark matters, income taxes and other actions.
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FINANCIAL REPORTING PROBLEM (Continued) As previously disclosed, the Company is subject to a variety of investigations into potential competition law violations in Europe, including investigations initiated in the fourth quarter of fiscal 2008 by the European Commission with the assistance of national authorities from a variety of countries. We believe these matters involve a number of other consumer products companies and/or retail customers. The Company's policy is to comply with all laws and regulations, including all antitrust and competition laws, and to cooperate with investigations by relevant regulatory authorities, which the Company is doing. Competition and antitrust law inquiries often continue for several years and, if violations are found, can result in substantial fines. In other industries, fines have amounted to hundreds of millions of dollars. At this point, no significant formal claims have been made against the Company or any of our subsidiaries in connection with any of the above inquiries. In response to the actions of the European Commission and national authorities, the Company has launched its own internal investigations into potential violations of competition laws, some of which are ongoing. The Company has identified violations in certain European countries and appropriate actions are being taken. It is still too early for us to reasonably estimate the fines to which the Company will be subject as a result of these competition law issues. However, the ultimate resolution of these matters will likely result in fines or other costs that could materially impact our income statement and cash flows in the period in which they are accrued and paid, respectively. As these matters evolve the Company will, if necessary, recognize the appropriate reserves. With respect to other litigation and claims, while considerable uncertainty exists, in the opinion of management and our counsel, the ultimate resolution of the various lawsuits and claims will not materially affect our financial position, results of operations or cash flows. We are also subject to contingencies pursuant to environmental laws and regulations that in the future may require us to take action to correct the effects on the environment of prior manufacturing and waste disposal practices. Based on currently available information, we do not believe the ultimate resolution of environmental remediation will have a material adverse effect on our financial position, results of operations or cash flows.
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COMPARATIVE ANALYSIS CASE
(a) The working capital position of the two companies is as follows: PepsiCo, Inc. Current assets ............................................. Current liabilities ....................................... Working capital ........................................... The Coca-Cola Company Current assets ............................................. Current liabilities ........................................ Working capital ........................................... (b) $ 12,571,000,000 (8,756,000,000) $ 3,815,000,000 $ 17,551,000,000 (13,721,000,000) $ 3,830,000,000
The overall liquidity of both companies is good as indicated from the ratio analysis provided below:
(all computations in millions) Coca-Cola PepsiCo, Inc. Current cash debt $6,796 $8,186 = 0.77 = 0.61 coverage ratio $8,756 + $8,787 $13,721 + $12,988 2 2 Cash debt coverage ratio $6,796 = 0.30 $22,406+$23,412 2 $12,751 = 1.46 $8,756 $8,186 = 0.38 $23,325 + $19,657 2 $17,551 = 1.28 $13,721 $7,021+$2,130+$3,758 = 0.94 $13,721 $30,990 = 9.05 $3,758 + $3,090 2 $11,088 = 4.88 $2,354 + $2,187 2
Current ratio Acid-test ratio Receivables turnover Inventory turnover
$3,943 + $192 + $4,624 = 1.00 $8,756 $43,232 = 9.29 $4,624 + $4,683 2 $20,099 = 7.82 $2,618 + $2,522 2
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COMPARATIVE ANALYSIS CASE (Continued) (c) As indicated in the chapter, a company can exclude a short-term obligation from current liabilities only if both of the following conditions are met: 1. It must intend to refinance the obligation on a long-term basis, and 2. It must demonstrate an ability to consummate the refinancing. At year-end 2008, $1,259 million of short-term borrowings were classified as long-term debt, reflecting PepsiCo's intent and ability, through the existence of the unused credit facilities, to refinance these borrowings (none was classified as such in 2009). These credit facilities exist largely to support the issuance of short-term borrowings and are available for acquisitions and other general purposes. (d) Coca-Cola discusses its contingencies in the following note: Note 8: COMMITMENTS AND CONTINGENCIES (in part) As of December 31, 2009, we were contingently liable for guarantees of indebtedness owed by third parties in the amount of approximately $245 million. These guarantees primarily are related to third-party customers, bottlers and vendors and have arisen through the normal course of business. These guarantees have various terms, and none of these guarantees was individually significant. The amount represents the maximum potential future payments that we could be required to make under the guarantees; however, we do not consider it probable that we will be required to satisfy these guarantees. On September 3, 2008, we announced our intention to make cash offers to purchase China Huiyuan Juice Group Limited, a Hong Kong listed company which owns the Huiyuan juice business throughout China (``Huiyuan''). The Company had accepted irrevocable undertakings from three shareholders for acceptance of the offers, in aggregate representing approximately 66 percent of the Huiyuan shares. The making of the offers was subject to preconditions relating to Chinese regulatory approvals. On March 18, 2009, the Chinese Ministry of Commerce declined approval for the Company's proposed purchase of Huiyuan. Consequently, the Company was unable to proceed with the proposed ash offers, and the irrevocable undertakings terminated.
13-64
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COMPARATIVE ANALYSIS CASE (Continued) We believe our exposure to concentrations of credit risk is limited due to the diverse geographic areas covered by our operations. The Company is involved in various legal proceedings. We establish reserves for specific legal proceedings when we determine that the likelihood of an unfavorable outcome is probable and the amount of loss can be reasonably estimated. Management has also identified certain other legal matters where we believe an unfavorable outcome is reasonably possible and/or for which no estimate of possible losses can be made. Management believes that any liability to the Company that may arise as a result of currently pending legal proceedings will not have a material adverse effect on the financial condition of the Company taken as a whole. PepsiCo discusses its contingencies in the following note: NOTE 2: COMMITMENTS AND CONTINGENCIES We are subject to various claims and contingencies related to lawsuits, taxes and environmental matters, as well as commitments under contractual and other commercial obligations. We recognize liabilities for contingencies and commitments when a loss is probable and estimable. For additional information on our commitments, see Note 9. NOTE 9--DEBT OBLIGATIONS AND COMMITMENTS (in part)
Long-Term Contractual Commitments(a) Payments Due by period 2011 2012 $1,322 666 356 960 314 $3,628 2013 2014 $2,063 500 203 260 78 $3,104 2015 and beyond $4,005 873 235 45 141 $5,299
Long-term debt obligations Interest on debt obligations(c) Operating leases Purchasing commitments Marketing commitments
(b)
Total $ 7,400 2,386 1,076 2,066 793 $13,721
2010 $ -- 347 282 801 260 $1,690
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13-65
COMPARATIVE ANALYSIS CASE (Continued) (a) Reflects non-cancelable commitments as of December 26, 2009 based on year-end foreign exchange rates and excludes any reserves for uncertain tax positions as we are unable to reasonably predict the ultimate amount or timing of settlement. (b) Excludes current maturities of long-term debt obligations of $102 million. Includes $151 million of principal and accrued interest related to our zero coupon notes. (c) Interest payments on floating-rate debt are estimated using interest rates effective as of December 26, 2009. Most long-term contractual commitments, except for our long-term debt obligations, are not recorded on our balance sheet. Non-cancelable operating leases primarily represent building leases. Non-cancelable purchasing commitments are primarily for oranges and orange juice, packaging materials and cooking oil. Non-cancelable marketing commitments are primarily for sports marketing. Bottler funding is not reflected in our long-term contractual commitments as it is negotiated on an annual basis. See Note 7 regarding our pension and retiree medical obligations and discussion below regarding our commitments to noncontrolled bottling affiliates and former restaurant operations.
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FINANCIAL STATEMENT ANALYSIS CASE 1
NORTHLAND CRANBERRIES (a) Working capital is calculated as current assets current liabilities, while the current ratio is calculated as current assets/current liabilities. For Northland Cranberries these ratios are calculated as follows:
Current year Working capital $6,745,759 $10,168,685 = $3,422,926 Current ratio ($6,745,759/$10,168,685) = .66 Prior year $5,598,054 $4,484,687 = $1,113,367 ($5,598,054/$4,484,687) = 1.25
Historically, it was generally believed that a company should maintain a current ratio of at least 2.0. In recent years, because companies have been able to better maintain their inventory, receivables and cash, many healthy companies have ratios well below 2.0. However, Northland Cranberries has negative working capital in the current year, and current ratios in both years are extremely low. This would be cause for concern and additional investigation. As you will see in the next discussion point, there may well be a reasonable explanation. (b) This illustrates a potential problem with ratios like the current ratio, that rely on balance sheet numbers that present a company's financial position at a particular point in time. That point in time may not be representative of the average position of the company during the course of the year, and also, that point in time may not be the most relevant point for evaluating the financial position of the company. If the company does not like the representation that these commonly used measures give of the company's position, it could change its year-end or suggest other measures that it considers to be more relevant for a company in this business. Also, it is possible that by using averages calculated across quarterly data some of this problem might be alleviated. As discussed in Chapter 5, you will also learn about measures that employ cash flows, which addresses at least part of the point-in-time problem of balance sheet ratios.
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FINANCIAL STATEMENT ANALYSIS CASE 2
MOHICAN COMPANY (a) Under the cash basis, warranty costs are charged to expense as they are incurred; in other words, warranty costs are charged in the period in which the seller or manufacturer performs in compliance with the warranty. No liability is recorded for future costs arising from warranties, nor is the period in which the sale is recorded necessarily charged with the costs of making good on outstanding warranties. If it is probable that customers will make claims under warranties relating to goods or services that have been sold, and a reasonable estimate of the costs involved can be made, the accrual method must be used. Under the accrual method, a provision for warranty costs is made in the year of sale or in the year that the productive activity takes place. (b) When the warranty is sold separately from the product, the sales warranty approach is employed. Revenue on the sale of the extended warranty is deferred and is generally recognized on a straight-line basis over the life of the contract. Revenue is deferred because the seller of the warranty has an obligation to perform services over the life of the contract. The general approach is to use the straight-line method to recognize deferred revenue on warranty contracts. If historical evidence indicates that costs incurred do not follow a straight-line approach, then revenue should be recognized over the contract period in proportion to the costs expected to be incurred in performing services under the contract. Only costs that vary with and are directly related to the acquisition of the contracts (mainly commissions) should be deferred and amortized. Costs such as employee's salaries, advertising, and general and administrative expenses that would have been incurred even if no contract were acquired should be expensed as incurred.
(c)
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FINANCIAL STATEMENT ANALYSIS CASE 3
(a) BOP's working capital and current ratio have declined in 2012 compared to 2011. While this would appear to be bad news, the acid test ratio has improved. This is due to BOP carrying relatively more liquid receivables in 2012 (receivable days has increased.) And while working capital has declined, the amount of the operating cycle that must be financed with more costly borrowing has declined. That is, BOP is using relatively inexpensive accounts payable to finance its operating cycle. Note that the overall operating cycle has declined because inventory is being managed at a lower level (inventory days has declined by more than 60 days. Answers will vary depending on the companies selected. This activity is a great spreadsheet exercise. The analysis for Best Buy and Circuit City for the years 2005 2007 is presented below. Best Buy reports both a lower current ratio and acid-test ratio. However, much more of Best Buy's operating cycle in financed with relatively inexpensive accounts payable as indicated by Best Buy's longer payable days.
(b)
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FINANCIAL STATEMENT ANALYSIS CASE 3 (Continued) Note to Instructor: Although the analysis above is for 2005 2007, this analysis is particularly useful as Circuit City subsequently filed for bankruptcy.
Best Buy (in millions) 2005 2006 Cash $ 470 $748 Accounts Receivable 375 449 Inventory 2,851 3,338 Accounts Payable 2,824 3,234 Purchases 20,496 22,432 Cost of Goods Sold 20,983 23,122 Sales 30,848 Operating Cycle Receivable Days Inventory Days Operating Cycle Less: Accounts Payable Days Days to be Financed Working Capital Current Ratio Acid Test Ratio 2007 1,205 548 4,028 3,934 31,193 27,165 35,934 Circuit City (in thousands) 2005 2006 2007 879,660 315,970 141,141 230,605 222,869 382,555 1,455,170 1,698,026 1,636,507 635,674 850,359 922,205 7,618,508 8,765,202 11,137,945 7,861,364 8,703,683 9,501,438 10,413,524 11,514,151 12,429,754
5.3 52.7 58.0
5.6 54.1 59.7
7.1 71.2 78.3
11.2 62.9 74.1
52.62 5.38 $1,301 1.40 0.37
46.03 13.67 $1,847 1.47 0.45
35.41 42.89 $1,386,506 2.63 0.63
30.22 43.88 $1,237,998 2.34 0.57
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ACCOUNTING, ANALYSIS, AND PRINCIPLES
Accounting (a) During 2012 Warranty Expense......................................... Cash ........................................................ Warranty Expense......................................... Warranty Payable................................
6,000 6,000 45,000 45,000
12/31/12
(b) 2/28/12
Interest Expense ($5,000 X 2/3)................. Interest Payable ($5,000 X 1/3).................. Cash ($200,000 X 10% X 3/12)......... Interest Expense............................................ Cash ($200,000 X 10% X 3/12)......... Interest Expense............................................ Cash ($200,000 X 10% X 3/12)......... Interest Expense............................................ Cash ($200,000 X 10% X 3/12)......... Interest Expense............................................ Interest Payable ($5,000 X 1/3) .......
3,333 1,667 5,000 5,000 5,000 5,000 5,000 5,000 5,000 1,667 1,667
5/31/12 8/31/12 11/30/12 12/31/12
(c) 1/1/12 1/1/12
Plant Assets .................................................... 5,000,000 Cash ........................................................ Plant Assets .................................................... Asset Retirement Obligation........... ($192,770 = $500,000 X 0.38554) Depreciation Expense.................................. Acc. Depr.--Plant Assets................. ($519,277 = [$5,000,000 + $192,770]/10) Interest Expense............................................ Asset Retirement Obligation........... ($19,277 = $192,770 X 10%) 192,770
5,000,000 192,770
12/31/12
519,277 519,277 19,277 19,277
12/31/12
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13-71
ACCOUNTING, ANALYSIS, AND PRINCIPLES (Continued) Analysis The warranty liability and the interest payable are current liabilities, so all else equal, these will decrease both the current and acid-test ratios. Because of the commitment letter from First Trust Corp., the $200,000 loan can be classified as a noncurrent liability. Without this letter, YellowCard would likely not be able to demonstrate the ability to refinance the obligation on a long-term basis. This would mean the $200,000 loan would have to be classified as a current liability, further depressing YellowCard's current and acid-test ratios. The asset retirement obligation can be classified as a noncurrent liability, so it will not affect the current and acidtest ratios. Principles According to FASB Concepts Statement No. 6, liabilities are probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events. With respect to the new warranty plan, YellowCard would be currently obligated to provide repair service to its customers, arising from the prior sales of its products. So even though customers are making an upfront payment, YellowCard still has an obligation to provide services in the future. Thus the company should record the payments as unearned revenue until it is no longer obligated to make repairs. That is, the current accounting reflects application of the expense-warranty approach. The new plan would be accounted for under the sales-warranty approach, which defers a certain percentage of the original sales price until some future time when the company incurs actual costs or the warranty expires.
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PROFESSIONAL RESEARCH
(a)
FASB ASC 605-20-25 addresses how revenue and costs from a separately priced extended warranty or product maintenance contract should be recognized. An Extended Warranty is an agreement to provide warranty protection in addition to the scope of coverage of the manufacturer's original warranty, if any, or to extend the period of coverage provided by the manufacturer's original warranty. Product Maintenance Contracts are agreements to perform certain agreed-upon services to maintain a product for a specified period of time. The terms of the contract may take different forms, such as an agreement to periodically perform a particular service a specified number of times over a specified period of time, or an agreement to perform a particular service as the need arises over the term of the contract. Separately Priced Contracts are agreements under which the customer has the option to purchase an extended warranty or a product maintenance contract for an expressly stated amount separate from the price of the product. FASB ASC 605-20-20-20 (Glossary)
(b)
(c)
Costs that are directly related to the acquisition of a contract and that would have not been incurred but for the acquisition of that contract (incremental direct acquisition costs) shall be deferred and charged to expense in proportion to the revenue recognized. All other costs, such as costs of services performed under the contract, general and administrative expenses, advertising expenses, and costs associated with the negotiation of a contract that is not consummated, shall be charged to expense as incurred. FASB ASC 605-20-25-4
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PROFESSIONAL SIMULATION
Journal Entries (a) Unearned Sales Revenue ............................................ Sales Revenue...................................................... (To record subscriptions earned during 2012) Book balance of liability account at December 31, 2012 .......................................... Adjusted balance ($600,000 + $500,000 + $800,000) ............... Credit to revenue account................................ (b) 400,000 400,000
$2,300,000 (1,900,000) $ 400,000
No entry should be made to accrue for an expense, because the absence of insurance coverage does not mean that an asset has been impaired or a liability has been incurred as of the balance sheet date. The company may, however, appropriate retained earnings for selfinsurance as long as actual costs or losses are not charged to the appropriation of retained earnings and no part of the appropriation is transferred to income. Appropriation of retained earnings and/or disclosure in the notes to the financial statements are not required, but are recommended. Lawsuit Loss..................................................................... Lawsuit Liability.................................................... (To record estimated minimum damages on breach-of-contract litigation) 300,000 300,000
(c)
Explanation If a liability is scheduled to mature within one year after the date of an enterprise's balance sheet or within an operating cycle that is longer than one year, then the liability is classified as current (unless the liability will be retired using a noncurrent asset or a long-term debt). Current liabilities will be liquidated (retired, discharged, paid) by the use of a resource properly classified as a current asset or by the creation of another current liability. Obligations are classified as noncurrent liabilities when they mature beyond one year or the operating cycle (whichever is longer) or if they are to be retired, discharged, or paid by using noncurrent assets.
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PROFESSIONAL SIMULATION (Continued) Generally all three of these liabilities (accounts payable, notes payable, bonds payable) would be classified as current liabilities on the company's balance sheet prepared as of December 31, 2012. However, the bonds payable, and possibly the notes payable, could be classified as noncurrent liabilities if the company intends to refinance the obligations on a long-term basis and the company's intent to refinance the current obligations on a long-term basis can be demonstrated by: (1) issuance of long-term obligations or equity securities after the balance sheet date but before issuance of the financial statements and before the maturity date of the debt; or (2) by entering into a financing agreement before the balance sheet is issued and before the maturity date of the debt. The financing agreement should outline the terms of refinancing the current obligations on a long-term basis. Alternatively, the bonds and notes could be classified as noncurrent if they are to be retired, discharged, or paid using noncurrent assets.
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IFRS CONCEPTS AND APPLICATION
IFRS13-1 A company should exclude a short-term obligation from current liabilities only if (1) it intends to refinance the obligation on a long-term basis, and (2) it has an unconditional right to defer settlement of the liability for at least twelve months after the reporting date.
IFRS13-2 The ability to defer settlement of short-term debt may be demonstrated by entering into a financing agreement that clearly permits the company to refinance the debt on a long-term basis on terms that are readily determinable before the next reporting date.
IFRS13-3 A provision is defined as a liability of uncertain timing or amount and is sometimes referred to as an estimated liability. Common types of provisions are obligations related to litigation, warranties, product guarantees, business restructurings, and environmental damage.
IFRS13-4 A provision should be recorded and a charge accrued to expense only if: (a) (b) (c) the company has a present obligation (constructive or legal) as a result of a past event, it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation, and a reliable estimate can be made of the amount of the obligation.
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IFRS13-5 A current liability such as accounts payable is susceptible to precise measurement because the date of payment, the payee, and the amount of cash needed to discharge the obligation are reasonably certain. There is nothing uncertain about (1) the fact that the obligation has been incurred and (2) the amount of the obligation. A provision is a liability of uncertain timing or amount and has greater uncertainty about the timing or amount of the future expenditure required to settle the obligation.
IFRS13-6 Onerous contracts are ones in which the unavoidable costs of meeting the obligations exceed the economic benefits expected to be received. Examples include a loss to be recognized on an unfavorable noncancellable purchase commitment for inventory, and a lease cancellation fee for a facility that is no longer being used.
IFRS13-7 ALEXANDER COMPANY Partial Statement of Financial Position December 31, 2012 Current liabilities: Notes payable (Note 1)............................................................... $300,000 NOTE 1: Short-term debt refinanced. As of December 31, 2012, the company had notes payable totaling $1,200,000 due on February 2, 2013. These notes were refinanced on their due date to the extent of $900,000 received from the issuance of ordinary shares on January 21, 2013. The balance of $300,000 was liquidated using current assets.
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IFRS13-8 (1) Mckee should classify $100,000 of the obligation as a current maturity of long-term debt (current liability) and the $300,000 balance as a noncurrent liability. While the maturity of the obligation was extended to February 15, 2015, the agreement was not reached with the lender until January 15, 2013. Since the agreement was not in place as of the reporting date (December 31, 2012), the obligation should be reported as a current liability.
(2)
IFRS13-9 1. Warranty Expense..................................................... 5,000,000* Warranty Payable ...........................................
5,000,000
* Expected warranty costs: % 60% 10% 30% 100% Units 600,000 100,000 300,000 1,000,000 Costs per Unit $0 5 15 Total Costs $ 0 500,000 4,500,000 $5,000,000
No defects Minor defects Major defects
2.
Income Taxes Expense ........................................... Income Taxes Payable..................................
400,000 400,000
IFRS13-10 (a) No. IFRS indicate that refinancing a short-term obligation on a longterm basis also requires that a company have an unconditional right to defer settlement of the liability for at least 12 months after the reporting date.
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IFRS13-10 (Continued) (b) No. The events described will not have an impact on the financial statements. Since Kobayashi Corporation's refinancing of the longterm debt maturing in March 2013 does not meet the conditions set forth in IFRS that obligation should be included in current liabilities. The $10,000,000 should continue to be classified as current at December 31, 2012. A short-term obligation, other than one classified as a current liability, shall be excluded from current liabilities if the entity's intent to refinance the short-term obligation on a long-term basis is supported by an unconditional right to defer the settlement of the liability for at least 12 months after the reporting date. Yes. The debt should be included in current liabilities. The issuance of ordinary shares in January does not meet the criteria to have an unconditional right to defer the settlement of the liability for at least 12 months after the reporting date.
(c)
IFRS13-11 (a) (b) IAS 37, Provisions, Contingent Liabilities and Contingent Assets. Recognizing a liability from restructuring (IAS 37, 72 79). A constructive obligation to restructure arises only when an entity: (a) has a detailed formal plan for the restructuring identifying at least: (i) the business or part of a business concerned; (ii) the principal locations affected; (iii) the location, function, and approximate number of employees who will be compensated for terminating their services; (iv) the expenditures that will be undertaken; and (v) when the plan will be implemented; and (b) has raised a valid expectation in those affected that it will carry out the restructuring by starting to implement that plan or announcing its main features to those affected by it.
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IFRS13-11 (Continued) Evidence that an entity has started to implement a restructuring plan would be provided, for example, by dismantling plant or selling assets or by the public announcement of the main features of the plan. A public announcement of a detailed plan to restructure constitutes a constructive obligation to restructure only if it is made in such a way and in sufficient detail (ie setting out the main features of the plan) that it gives rise to valid expectations in other parties such as customers, suppliers and employees (or their representatives) that the entity will carry out the restructuring. For a plan to be sufficient to give rise to a constructive obligation when communicated to those affected by it, its implementation needs to be planned to begin as soon as possible and to be completed in a timeframe that makes significant changes to the plan unlikely. If it is expected that there will be a long delay before the restructuring begins or that the restructuring will take an unreasonably long time, it is unlikely that the plan will raise a valid expectation on the part of others that the entity is at present committed to restructuring, because the timeframe allows opportunities for the entity to change its plans. A management or board decision to restructure taken before the end of the reporting period does not give rise to a constructive obligation at the end of the reporting period unless the entity has, before the end of the reporting period: (a) started to implement the restructuring plan; or (b) announced the main features of the restructuring plan to those affected by it in a sufficiently specific manner to raise a valid expectation in them that the entity will carry out the restructuring. If an entity starts to implement a restructuring plan, or announces its main features to those affected, only after the reporting period, disclosure is required under IAS 10 Events after the Reporting Period, if the restructuring is material and non-disclosure could influence the economic decisions that users make on the basis of the financial statements.
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IFRS13-11 (Continued) Although a constructive obligation is not created solely by a management decision, an obligation may result from other earlier events together with such a decision. For example, negotiations with employee representatives for termination payments, or with purchasers for the sale of an operation, may have been concluded subject only to board approval. Once that approval has been obtained and communicated to the other parties, the entity has a constructive obligation to restructure, if the conditions of paragraph 72 are met. In some countries, the ultimate authority is vested in a board whose membership includes representatives of interests other than those of management (eg employees) or notification to such representatives may be necessary before the board decision is taken. Because a decision by such a board involves communication to these representatives, it may result in a constructive obligation to restructure. No obligation arises for the sale of an operation until the entity is committed to the sale, ie there is a binding sale agreement. Even when an entity has taken a decision to sell an operation and announced that decision publicly, it cannot be committed to the sale until a purchaser has been identified and there is a binding sale agreement. Until there is a binding sale agreement, the entity will be able to change its mind and indeed will have to take another course of action if a purchaser cannot be found on acceptable terms. When the sale of an operation is envisaged as part of a restructuring, the assets of the operation are reviewed for impairment, under IAS 36. When a sale is only part of a restructuring, a constructive obligation can arise for the other parts of the restructuring before a binding sale agreement exists. Costs to include (IAS 37, 80) A restructuring provision shall include only the direct expenditures arising from the restructuring, which are those that are both: (a) necessarily entailed by the restructuring; and (b) not associated with the ongoing activities of the entity.
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IFRS13-11 (Continued) Costs to exclude (IAS 37, 81 82) A restructuring provision does not include such costs as: (a) retraining or relocating continuing staff; (b) marketing; or (c) investment in new systems and distribution networks. These expenditures relate to the future conduct of the business and are not liabilities for restructuring at the end of the reporting period. Such expenditures are recognised on the same basis as if they arose independently of a restructuring. Identifiable future operating losses up to the date of a restructuring are not included in a provision, unless they relate to an onerous contract as defined in paragraph 10. As required by paragraph 51, gains on the expected disposal of assets are not taken into account in measuring a restructuring provision, even if the sale of assets is envisaged as part of the restructuring. (c) The current warranty contract is considered an onerous contract. The required accounting related to an onerous contract is in IAS 37, 81 82. If an entity has a contract that is onerous, the present obligation under the contract shall be recognised and measured as a provision. Many contracts (for example, some routine purchase orders) can be cancelled without paying compensation to the other party, and therefore there is no obligation. Other contracts establish both rights and obligations for each of the contracting parties. Where events make such a contract onerous, the contract falls within the scope of this Standard and a liability exists which is recognised. Executory contracts that are not onerous fall outside the scope of this Standard. This Standard defines an onerous contract as a contract in which the unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received under it. The unavoidable costs under a contract reflect the least net cost of exiting from the contract, which is the lower of the cost of fulfilling it and any compensation or penalties arising from failure to fulfil it.
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IFRS13-11 (Continued) Before a separate provision for an onerous contract is established, an entity recognises any impairment loss that has occurred on assets dedicated to that contract (see IAS 36). Hincapie shoud therefore record a liability for the service contract at $75,000, the amount of the termination fee.
IFRS13-12 (a) M&S's short-term borrowings were 554.8 million at April 3, 2010. SHORT-TERM DEBT (In millions) Bank loans and overdrafts Syndicated bank factility Finance lease liabilties Total short-term debt Partnership liability to M&S UK Pension Scheme Total short-term debt
2010 249.5 219.8 13.6 482.9 71.9 554.8
The weighted-average interest rate is only provided for the finance lease liabilities (4.7%). (b) 1. Working capital = Current assets less current liabilities. (370,300,000) = (1,520,200,000 1,890,500,000) 2. Acid-test ratio = Cash + short-term investments + net receivables Current liabilities
0.48 times
=
405,800,000 + 48,100,000 + 281,400,000 + 171,700,000 1,890,500,000
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IFRS13-12 (Continued) 3. Current ratio = Current assets Current liabilities 1,520,200,000 1,890,500,000
.804 times
=
While M&S's acid-test ratio is below one, working capital and the current ratio appear strong. The lower acid-test ratio may not be a problem. Many large companies carry relatively high levels of accounts payable, which charge no interest. For example, M&S has over 1 billion of these short-term obligations, which can be viewed as very cheap forms of financing. M&S has also substantially reduced its short-term borrowing during the year. Comparisons to industry are required to fully assess liquidity. (c) M&S provided the following discussion related to commitments and contingencies: Note 27: Contingencies and Commitments A. Capital commitments 2010 m Commitments in respect of properties in the course of construction 69.0 2009 m 52.1
In respect of its interest in a joint venture (see note 16), the Group is committed to incur capital expenditure of 0.9m (last year 19.3m). B. Other material contracts In the event of a material change in the trading arrangements with certain warehouse operators, the Group has a commitment to purchase property, plant and equipment, at values ranging from historical net book value to market value, which are currently owned and operated by them on the Group's behalf.
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IFRS13-12 (Continued) C. Commitments under operating leases The Group leases various stores, offices, warehouses and equipment under non-cancellable operating lease agreements. The leases have varying terms, escalation clauses and renewal rights. 2010 m Total future minimum rentals payable under non-cancellable operating leases are as follows: Within one year 228.6 Later than one year and not later than five years 815.2 Later than five years 3,005.2 Total 4,049.0 2009 m 215.1 778.1 3,173.1 4,166.4
The total future sublease payments to be received are 51.9m (last year 64.9m).
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