13 current liabilities

Intermediate Financial Accounting I

Current Liabilities and Contingencies

Current Liabilities and Contigencies 2

Objectives of the Chapter

1. Accounting for current liabilities with definite amount (i.e., trade related liabilities, employee payroll related liabilities and accrued liabilities.)

2. Accounting for estimated liabilities (i.e., warranty obligations, coupons and premiums obligations).

3. Accounting for contingent liabilities.


Liabilities

Legal obligations require future payments of cash or services or the creation of other liabilities as a result of past transactions.

Current liabilities: Obligations must be fulfilled in one year or one operating cycle, whichever is longer.


Current Liabilities

Examples of current liabilities with definite amount as a result of a business transaction: A/P (accounts payable) N/P (notes payable including commercial

paper issued) Current maturity portion of a long-term

debt Sales taxes payable Accrued liabilities Payroll taxes withholdings

Current and Long-Term Liabilities 5

Sales Taxes Payable

Sales taxes are taxes levied by states on retail sales, not on manufacturers (i.e., GE, GM, etc).

Every state, except Alaska, Delaware, Montana, New Hampshire, and Oregon, levies state sales taxes on retail sales.

The rate varies state by state (for example, Starting 4/1/2009, California has a statewide sales tax at 8.25% with a local supplementary tax for up to 10.75%).


Sales Taxes Payable (contd.)

Retailers charge their customers the sales taxes in addition to the price of the merchandise.

The retailers have to forward the collected sales taxes to the state at regular intervals.


Example

Assume that the 12/22/x9 sales of Macy’s in California totaled $2,000,000. The state tax rate is 8.25%. The business would record the day’s sales as follows:Cash 2,165,000

Sales Revenue 2,000,000 Sales Taxes Payable

165,000


Accrued Liabilities

Obligations accumulated on a daily basis but not recorded until the end of period through adjusting entries (i.e., Interest payable, salaries payable, rent payable…)


Employee Related Liabilities: FICA, Federal I/T, state I/T, Medical Insurance Premiums…

Salaries Expense 50,000

Employee F.I.C.A. Taxes Payable* 3,825Federal I/T Payable 10,000

State I/T Payable 2,500Cash 32,675

*(6.2% +1.45%) *$50,000 or 7.65% x $50,000F.I.C.A. taxes include Social Security tax of 6.2% (max earnings taxable is $106,800 for 2009) and 1.45% of Medicare tax (no limit on maximum earnings taxable).


Employee Related Liabilities (contd.)

Employer payroll taxes:

Payroll Taxes Expense 6,925

Employer F.I.C.A. Taxes Payable 3,825

F.U.T.A. Taxes Payablea 400

State Unemployment Tax Payableb 2,700

a. 6.2% of the first $7,000 of salaries paid to employees.

b. assuming a state unemployment tax = 5.4%.


Refundable DepositsCash xxx

Refund Deposit Liabilitiesxxx

Dividends Payable Unearned Revenue

Other Current Liabilities


Estimated Liabilities

Liabilities exist but the amount is unknown:

A. Property taxes

B. Warranty obligations

C. Coupon and premium obligations

D. Compensated absences

E. Environmental liabilities


A. Property Taxes

Property taxes are assessed by local governments (city, state …) on the value of properties. The assessed property taxes become a lien on the properties on a day specified by law (i.e., July 1)

In general, the bills of the property taxes are not received until a few months after the lien day. The property taxes must be estimated and recognized on a monthly basis (recommended by the AICPA) starting the lien day.


A. Property Taxes (contd.)

Also, the property taxes expenses should be allocated over the fiscal year of the local government (i.e., 7/1/x1 ~ 6/30/x2).

If there are differences between the estimates and the actual taxes, the adjustments are considered as an estimate change and are spread to the remaining tax period (no retroactive effect).


Example

The fiscal year of the local government => 7/1/x8 - 6/31/x9

The property tax becomes a lien on the property on=> 7/1/x8

Estimated property tax expenses (for 7/1/x8 - 6/30/x9) =>$12,000

Tax bill received on => 10/29/x8Actual tax expense => $13,800Tax paid on =>11/30/x8


Example (contd.)Prepare journal entries regarding the property tax for the period of 7/1/x8 - 6/30/x9:

7/1/x8 No journal entry (accrued the liability, on a monthly basis)7/31/x8 Property Tax Expenses 1,000

Property Tax Payable 1,000 ($12,000/12=$1,000)

8/31/x8 P/T Exp 1,000P/T Payable 1,000



(($13,800 -$3,000)/(12-3) = $1,200 the difference is treated as changes in estimates; no retroactive effect. (APB 20))


Prepare journal entries regarding the property tax for the period of 7/1/x8 - 6/30/x9: (contd.)

11/30/x8 P/T Payable 4,200Prepaid P/T 9,600

Cash 13,800P/T Expense 1,200

Prepaid P/T 1,20012/31/x8 P/T Exp 1,200

Prepaid P/T 1,200::

6/30/x9 P/T Exp 1,200Prepaid P/T 1,200


B. Warranty Obligations (Product Warranty)

1. Cash basis (for Income Tax Filing Purposes, not GAAP)

2. Expense warranty using accrued method (GAAP)


1. Cash Basis (for tax filing)

(Not Acceptable for Financial Reporting Purpose)

Warranty expenses are recognized when these expenses are paid for (violating the matching principle)

Journal Entry: Warranty Exp xxx

Cash xxx(only for I/T filling)


2. Expense Warranty Using Accrued Method

(for financial Reporting Purposes) Estimate the warranty exp. associated

with the sales (of the period) at the end of the period and recognize it.


2. Expense Warranty Using Accrued Method (contd.)

Journal Entry:

Warranty Expenses xxxEstimated Warranty Liabilities xxx

When warranty services provided:Estimated warranty liabilities xxx

Cash (or Inventory) xxx

If the estimated warranty liabilities are not enough to cover the current year’s warranty services, treat it as a change in accounting estimates (i.e., no retroactive effect).


ExampleThe estimated warranty liabilities account has an ending balance of $2,000 before the following year end adjustment:12/31/x2 Warranty Expenses 3,000

Estimated Warranty Liability3,000

During 20x3, the actual warranty expenses amounted to $5,800.

20x3:Estimated warranty liability 5,000* Warranty Expenses 800

Cash (or Inventory)5,800

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C. Premiums and Coupons Obligations

Liabilities of premiums and coupons should be estimated and recognized in the year when sales are made.

Journal Entry

Premium (or Coupon) Expense xxx

Estimated Premium Claims

(or coupon) outstandingxxx


C. Premiums and Coupons Obligations (contd.)

When premiums (or coupons) are claimed:Journal Entry Estimated Premium Claims (coupon) outstanding xxx

Inventory xxx* If the actual redemption of coupons (or premiums)

is greater than the estimated liabilities, the underestimated amount would be recognized as the expense of the current year.

D. Compensated Absences Compensation for vacation, illness and

holidays. Companies should estimate the amount of

liabilities and recognize them at the end of the reporting period if:

a. Employee’s services needed to receive these rights have been rendered.

b. The obligation relates to these rights are vested.

c. Payment of the compensation is probable.

d. The amount of liabilities can be reasonably estimated.


E. Environmental Liabilities (SFAS 143) A company must recognize an asset

retirement obligation (ARO) when

1) it has an existing legal obligation associated with the retirement of a long-lived asset , and

2) the liability can be reasonably estimated.

Examples of obligating events: decommissioning nuclear facilities, dismantling, restoring and reclamation of oil and gas properties, etc.


Recognition and Allocation of ARO

The estimated fair value of ARO is capitalized on 1/1/2002 :

Nuclear Plant 50,000

Asset Retirement Obligation 50,000 The cost of ARO will be subsequently

allocated as depre. expense over the life of the asset (i.e., 5 years):

Depre. Expense 10,000

Acc. Depre. – Nuclear Plant 10,000


Recognition and Allocation of ARO (contd.) The accrued interest of ARO should be

recognized periodically (assuming 10% interest):

12/31/2002Interest expense (10% x50,000) 5,000 ARO 5,000

On 1/1/2008, the decommissioning cost amounted to $78,000, the following will be recorded:

ARO 80,525 Cash 78,000 Gain on Settlement of ARO 2,525



Contingencies

Contingent Liabilities

Contingent Losses

Contingent Gains



Obligations may arise because of the occurrence or not occurrence of future event(s). (i.e., warranty obligations)



Liabilities may arise because of the occurrence or not occurrence of future event(s).

(i.e., guarantee and warranty costs, litigation and claims, premiums and coupons, environment al liabilities, etc.)


Contingent Gains

Gains may arise because of the occurrence or not occurrence of future events). (i.e., pending lawsuit gains)


Accounting Treatments of Contingencies The accounting treatments of the contingencies

depend on the occurrence probability of the related future event(s).(FASB 5)

1. Probable: The future event(s) is(are) likely to occur.

2. Reasonably possible: The chance for the future event(s) to occur is less than probable but greater than remote

3. Remote: The chance of the future event to occur is unlikely (slight).


Accounting Treatments of Contingencies (contd.) If the future event(s) is(are)

a. Probable, and

b. amount of liability can be estimated

The loss (liability) should be estimated, and recognized (accrued).


Accounting Treatments of Contingencies (contd.)

Examples:

Warranty Expense xxx Estimated Warranty Liabilities xxx

Lawsuit Expenses xxx

Estimate Liability under litigation xxx


Accounting Treatments of Contingencies (contd.) If the future event is probable, but the amount

of loss (or liability) cannot be estimated, the contingent loss (or liability) should only be footnoted (not accrued).

Contingent gains: If the event is probable and the amount of

contingent gains is determinable, only footnote the information. No unrealized gain can be recognized under the current accounting standards (conservatism!!!)


Additional Notes For Current Liabilities1. Obligations that are callable by the creditors

within the longer period of one year or one operating cycle: reported as current liabilities.

2. Obligation that matures in one year or one operating cycle, whichever is longer: reported as current liabilities.

3. Short-term obligations that are expected to be refinanced by a long-term debt: reported as a long-term debt if conditions (i.e., intention and ability to do so) are met.

13 current liabilities

Documents

payable current liabilities

longterm liabilities

property taxes property

1130x8current liabilities

contingent liabilities

property tax payable

sales taxes payablesales

employee related liabilities