Fall 2010 Class 1

Fall 2010 Class 1 - BUS 321 INTERMEDIATE ACCOUNTING —...

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Unformatted text preview: BUS 321: INTERMEDIATE ACCOUNTING — EQUITIES About the Prof. About the Prof. • Name: Yasheng Chen • Education: Ph.D. in Accounting from Richard Education: Ivey School of Business at the University of Western Ontario Western • Professional Designation: CGA • Office: WMC 3373 • Phone: 778-782-4485 • E-mail: [email protected] E-mail: [email protected] • Office Hour: 15:30-17:30, Thursday About the TA About the TA • • • • Name: Tota Panggabean Office: WMC 4303 E-mail: [email protected] Office Hours: 14:00-16:00, Wednesday Grading Grading • • • Class Participation Hand-in Assignments Midterm Exam 10% 10% 10% 35% (25%) (25%) – (2 hours in Class 8) • Final Examination Final – (3 hours comprehensive exam) (3 Total Total 45% (55%) (55%) 100% Course Contents Concepts Assets Liability Equity Disclosure Requirements Financial Reports Common / Prefer Shares Hybrid Instruments Transactions Short-term / Long-term Liabilities Off Balance Sheet Items GAAP: Accrue-based GAAP: Cash-based Non-GAAP: Tax Law Balance Income Cash Flow Tax Return Sheet Statement Statement CHAPTER 13 Current Liabilities and Contingencies Questions We Need to Answer 1. What is a liability and what is a current 1. What liability? liability? 2. How to record and disclose common How current liabilities? current 3. How to record and disclose liabilities with How uncertainty? uncertainty? 4. How to analyze a company’s current How liabilities? liabilities? Liabilities in General Liabilities in General Three essential characteristics of a liability are: 1. Obligation to be settled on a determinable date or on the occurrence of an event, requiring the transfer of an asset or provision of service transfer 2. There is little or no discretion to avoid the 2. no obligation obligation 3. Obligation arises from a transaction or event 3. which has already occurred which Financial Liabilities Financial Liabilities • Contractual obligation to deliver cash or other Contractual financial asset, or to exchange financial financial or instruments under conditions that are instruments potentially unfavourable potentially Current Liabilities Current Liabilities • Current liability described as : described “Amounts payable within one year from the date Amounts of the balance sheet or within the normal operating cycle where this is longer than a year.” operating obligations that will be paid off using current obligations assets. assets IAS 1.69 IAS 1.69 • An entity shall classify a liability as current An when6: – (a) It expects to settle the liability in its normal (a) operating cycle; operating – (b) It holds the liability primarily for the purpose of trading; – (c) The liability is due to be settled within twelve (c) months after the reporting period; or months – (d) The entity does not have an unconditional (d) right to defer settlement of the liability for at least twelve months after the reporting period. Common Current Liabilities Common Current Liabilities 1. Bank indebtedness and Bank credit facilities credit 2. Accounts Payable 3. Notes payable 4. Current maturities of longterm debt 5. Dividends payable 6. Returnable deposits 7. Unearned revenues 9. Sales taxes payable Sales 10. Goods and Services Tax 10. 11. Income taxes payable 12. Employee-related Employee-related liabilities liabilities 13. Rents and Royalties Rents Payable Payable Unearned Revenues Unearned Revenues • When cash is received before the product or When before service is rendered service • When cash is received: When cash Dr. Cash Cr. Unearned Revenue • When revenue is earned (service or good is When revenue provided) provided) Dr. Unearned Revenue Cr. Revenue Cr. Goods and Services Tax (GST) Goods and Services Tax (GST) • GST Payable – Represents amount collected on eligible sales Represents sales • GST Recoverable – GST paid on eligible purchases GST purchases • Net amount remitted to CRA Dr. Inventory Dr. GST Recoverable Cr. Accounts Payable Dr. Accounts Receivable Cr. Sales Cr. GST Payable Estimated Liabilities Estimated Liabilities • The total amount of the obligation needs to be The amount estimated. • Recognized in the current period because the Recognized current obligation is derived from revenue that is recognized in the current period recognized • Example: product guarantee and warranty, Example: royalty points, redeemable coupons, mail-in royalty redeemable rebate, contests, …… rebate contests, Product Guarantee and Product Guarantee and Warranty Obligations • Warranty - promise made by a seller to a buyer Warranty promise to make good on a deficiency (quantity, quality, or performance) or • Warranties entail future “post-sale costs” • Under PE GAAP, warranty accounting dependent Under on how the warranty is “sold” on – Embedded warranty provided as part of the product price product – Extended warranty sold as a separate item Warranty Embedded in Sales Price Warranty Embedded in Sales Price of Product • Considered as an estimated cost/liability Considered estimated • Accounted for using the expense warranty Accounted method (expense approach) method – Warranty costs expensed in year of sale Warranty year – Warranty liability recognized Expense Warranty Method: Expense Warranty Method: Example Given: • Units sold in July 2009: 100 units at $5,000 • Expected repair cost per unit:$200 (from July Expected 2009 to July 2010) • Actual repair costs incurred in 2009: $4,000 • The entity has December 31 as its fiscal year The end. end. Required: Record the warranty expense for 2009 Expense Warranty Method: Expense Warranty Method: Example (Method A) Warranty Expense Recognition (Time of Sale): No entry made Actual Warranty Costs in 2009: Warranty Expense 4,000 Cash/Inventory/Payroll 4,000 Year-end adjusting entry, Dec. 31, 2009: Warranty Expense 16,000 Estimated Warranty Liability 16,000 Expense Warranty Method: Example (Method B) Warranty Expense Recognition (Time of Sale): Warranty Warranty Expense 20,000 Estimated Warranty Liability 20,000 100 units @ $200 Actual Warranty Costs in 2007: Estimated Warranty Liability 4,000 Cash/Inventory/Payroll 4,000 Year-end adjusting entry, Dec 31, 2007: No entry required No Summary: Warranty Embedded in Sales Price of Product Method A Method B • Warranty costs charged to the • Total estimated warranty Warranty expense as incurred expense and liability expense recognized and recorded at • Adjusting entry required at Adjusting the point of the sale the period end to accrue remaining remaining estimated liability and expense • Warranty costs charged Warranty on current period sales against liability as incurred on against • Warranty liability reported for • Warranty liability reported for Warranty liability Warranty liability the estimated amount of the estimated amount of outstanding claims outstanding claims outstanding outstanding Warranty Sold Separately Warranty Sold Separately • Accounted for using sales warranty method Accounted (revenue approach) (revenue – Revenue from warranty sale deferred – Recognized over life of the warranty using Recognized straight-line method straight-line – Warranty costs charged to the expense as Warranty incurred incurred Sales Warranty Method: Example Sales Warranty Method: Example You have just purchased a new vehicle and an You extended warranty on your new vehicle extended • Price of the of the vehicle: $20,000 – Vehicle has a 3-year build-in warranty included in Vehicle price of car, valued at $ 300. • Cost of the extended warranty: $600 • Extended Warranty period: 3 years, starts from Extended the beginning of Year 4 the • Actually warranty expenses $90 / year for the Actually first three years; $180 / year starting from the 4th year. Sales Warranty Method: Example Record the initial sale: Record Cash 20,600 Cash Sales 19,700 Sales 19,700 Unearned Warranty Revenue Entries in Year 1, 2 and 3: Entries Year Unearned Warranty Revenue Warranty Revenue Warranty ($300 ÷ 3 years) ($300 Warranty Expense 180 Cash/Inventory/Payroll 900 100 100 180 Sales Warranty Method: Example Entries in Year 4, 5 and 6: Year Unearned Warranty Revenue Warranty Revenue Warranty ($600 ÷ 3 years) ($600 Warranty Expense 180 Cash/Inventory/Payroll 200 200 180 Premiums, Coupons, Rebates, and Premiums, Coupons, Rebates, and Loyalty Points • Costs of these offers expensed in the period Costs of the underlying sale of • Costs of outstanding offers estimated and Costs recorded/reported as current liability recorded/reported Provision v.s. Contingent Liability Provision v.s. Contingent Liability • A provision is a liability of uncertain timing or amount. provision • A contingent liability is (a) a possible obligation …whose existence will be (a) possible confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity; or within (b) a present obligation…but is not recognized because (a) it is not probable…, or (b) the amount cannot be measure with sufficient reliability. the IAS 37 Requirements for Accounting IAS 37 Requirements for Accounting and Reporting for Provision and Contingent Liability Probability Loss can be measured with sufficient reliability? Yes No Yes No Likely Likely A provision: provision: Accrue & Notes * Accrue Notes A contingent liability: Notes* Not Likely A contingent liability: contingent No Disclosure No A contingent liability: No Disclosure Not Determinable A contingent liability: Notes* Notes* A contingent liability: Notes* * Appropriate detail regarding the nature of the provisions and uncertainties Appropriate should be disclosed. Measurement of Provisions Measurement of Provisions Provision relating to Methodology Large number of items Expected value method—assess all outcomes and assign probabilities to each outcome. Large number of items with a continuous range of possible outcomes, each as likely as the other Use the midpoint of the range Single item Use the most likely outcome but take into account the probability of possible outcomes to refine if the information is available. Example of Provision Example of Provision Garaway Limited produces machines that are used in large institutions to make soft ice cream. All sales are accompanied by a one-year warranty, under which the company will fix the machine (on-site) or replace it. At year end, the accounting staff is looking to estimate the warranty provision and have the following historical data: • 1,000 units were sold during the year. • Over the past five years, 3% of the machines were defective in some way and had to be fixed. • Of the above-noted 3%, half required a full replacement of the equipment at a cost of $5,000 per unit and half were fixable at an average cost of $500. Garaway feels that the data are indicative of the current situation. In addition, the company is concerned about a potential liability relating to a recent lawsuit. The company’s lawyers estimate that it is likely that it will lose the lawsuit and have to pay $100,000. Example of Provision Example of Provision For the warranty costs (since there are multiple items and the likelihood of outcomes are different), a provision of $82,500 will be recognized. (1,000*3%*50%*$5,000)+(1,000*3%*50%*$500)=$82,500 For the lawsuit (since this is a single item and this is the most likely outcome), a provision of $100,000 will be recognized. Dr. Lawsuit Loss Cr. Estimated Lawsuit Liability $100,000 $100,000 Toyota Recall Toyota Recall http://www.youtube.com/watch?v=NDYou3B8-hs If you were the controller of Toyota Canada, how will you account for the costs related to the recall? Presentation of Current Liabilities Presentation of Current Liabilities • Current liabilities are commonly presented as Current the first classification in the B/S’ Liabilities and Shareholders’ Equity section. • Accounts are listed in order of maturity or in Accounts maturity order of liquidation preference. liquidation IFRS Example, IAS 1 IFRS Example, IAS 1 Current Maturities of Current Maturities of Long­Term Debt • The portion of long-term debt maturing within 12 The months from the balance sheet date is reported months as a current liability current • However, long-term debts should not be reported However, as current liabilities if: as 1. they are retired by assets not classified as they current assets current 2. they are refinanced or retired by new issues of they long-term debt long-term 3. they are converted into share capital they • Why? Short­Term Debt Expected to be Short­Term Debt Expected to be Refinanced • Short-term debt may be excluded from current liabilities if: Short-term excluded from • there is intent to refinance on a long-term basis, and there intent long-term and • the entity demonstrates the ability to complete the refinancing the ability • Under PE GAAP, the entity has the ability to refinance if: • the debt is actually refinanced before issue of the financial the before statements, or statements, • the entity enters into a refinancing agreement the refinancing • Under IFRS, reclassification is only allowed when Under • The entity has an existing agreement at the balance sheet The date, and it is solely at the entity’s discretion. date and • Why? Analysis of Current Liabilities Analysis of Current Liabilities Current Ratio= Current Assets Current Liabilities Current Acid-Test Ratio= Cash + Marketable Securities + Net Receivables Current Liabilities Days Payables Outstanding= Average Trade Accounts Payable Average Average Daily Cost of Goods Sold Average Summary Summary • A lliability is iability – – – • • • A highly probable future sacrifice of economic highly interests interests A present obligation The result of a past transaction or event. The Short-term liabilities require the use of existing Short-term current assets current Estimated liabilities and contingent liabilities has Estimated uncertainty with the amount and the possibility of the obligation. the Analysis of current liabilities helps to assess liquidity ...
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