© 2004 the mcgraw-hill companies, inc. mcgraw-hill/irwin chapter 13 current liabilities and...
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© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Chapter 13
Current Liabilities and Contingencies
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide13-2
Liabilities
. . . Resulting from past
transactions or events.
. . . Resulting from past
transactions or events.
. . . Arising from present obligations
to other entities . . .
. . . Arising from present obligations
to other entities . . .
Probable future
sacrifices or economic
benefits . . .
Probable future
sacrifices or economic
benefits . . .
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide13-3
What is a Current Liability?
LIABILITIESLIABILITIES
Long-term LiabilitiesLong-term Liabilities
Expected to be satisfied with current assets or by the creation
of other current liabilities.
Expected to be satisfied with current assets or by the creation
of other current liabilities.
Current LiabilitiesCurrent Liabilities
Obligations payable within one year or one operating cycle, whichever is
longer.
Obligations payable within one year or one operating cycle, whichever is
longer.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide13-4
Current Liabilities
Current Liabilities
Short-term notes payable
Accrued expenses
Cash dividends payable
Taxes payable
Accounts payable
Unearned revenues
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide13-5
Open Accounts and Notes
Accounts Payable Obligations to suppliers for goods
purchased on open account.
Trade Notes Payable Similar to accounts payable, but
recognized by a written promissory note.
Short-term Notes Payable Cash borrowed from the bank and
recognized by a promissory note.
Accounts Payable Obligations to suppliers for goods
purchased on open account.
Trade Notes Payable Similar to accounts payable, but
recognized by a written promissory note.
Short-term Notes Payable Cash borrowed from the bank and
recognized by a promissory note.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide13-6
Credit Lines
Prearranged agreements with a bank that allow a
company to borrow cash without following
normal loan procedures and
paperwork.
Prearranged agreements with a bank that allow a
company to borrow cash without following
normal loan procedures and
paperwork.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide13-7
InterestInterest on notes is calculated as follows:
Amount borrowed
Amount borrowed
Interest rate is always stated as an annual
rate.
Interest rate is always stated as an annual
rate.
Interest owed is adjusted for the
portion of the year that the face
amount is outstanding.
Interest owed is adjusted for the
portion of the year that the face
amount is outstanding.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide13-8 Interest-Bearing Notes
Example
On September 1, Eagle Boats borrows $80,000 from Cooke Bank. The note is due in 180 days and has a
stated interest rate of 9%.Record the borrowing on September 1.
On September 1, Eagle Boats borrows $80,000 from Cooke Bank. The note is due in 180 days and has a
stated interest rate of 9%.Record the borrowing on September 1.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide13-9 Interest-Bearing Notes
Example
How much interest is due to Cooke Bank at year-end, on December 31?
a. $2,400
b. $3,600
c. $7,200
d. $87,200
How much interest is due to Cooke Bank at year-end, on December 31?
a. $2,400
b. $3,600
c. $7,200
d. $87,200
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide13-10
How much interest is due to Cooke Bank at year-end, on December 31?
a. $2,400
b. $3,600
c. $7,200
d. $87,200
How much interest is due to Cooke Bank at year-end, on December 31?
a. $2,400
b. $3,600
c. $7,200
d. $87,200
Interest-Bearing NotesExample
Interest is calculated as: Face Annual Time to Amount Rate maturity
$80,000 9% 4/12
$2,400 interest due to Cooke Bank.
Interest is calculated as: Face Annual Time to Amount Rate maturity
$80,000 9% 4/12
$2,400 interest due to Cooke Bank.
× ×
× ×
=
=
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide13-11 Interest-Bearing Notes
Example
Assume Eagle Boats’ year-end is December 31.
Record the necessary adjustment at year-end.
Assume Eagle Boats’ year-end is December 31.
Record the necessary adjustment at year-end.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide13-12 Interest-Bearing Notes
Example
Assume Eagle Boats’ year-end is December 31.
Record the necessary adjustment at year-end.
Assume Eagle Boats’ year-end is December 31.
Record the necessary adjustment at year-end.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide13-13 Interest-Bearing Notes
Example
Assume Eagle Boats’ year-end is December 31.
Record the necessary journal entry when the note matures on February 28.
Assume Eagle Boats’ year-end is December 31.
Record the necessary journal entry when the note matures on February 28.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide13-14 Interest-Bearing Notes
Example
Assume Eagle Boats’ year-end is December 31.
Record the necessary journal entry when the note matures on February 28.
Assume Eagle Boats’ year-end is December 31.
Record the necessary journal entry when the note matures on February 28.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide13-15 Short-Term Notes Payable
Noninterest-Bearing
Notes without a stated interest rate carry an implicit, or effective, rate.
The face of the note includes the amount borrowed and the interest.
Notes without a stated interest rate carry an implicit, or effective, rate.
The face of the note includes the amount borrowed and the interest.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide13-16 Noninterest-Bearing Notes
Example
On May 1, 2003, Batter-Up, Inc. issued a one-year, noninterest-bearing note with a face
amount of $10,600 in exchange for equipment valued at $10,000.
How much interest will Batter-up pay on the note?
On May 1, 2003, Batter-Up, Inc. issued a one-year, noninterest-bearing note with a face
amount of $10,600 in exchange for equipment valued at $10,000.
How much interest will Batter-up pay on the note?
Interest = Face Amount - Amount Received
= $10,600 - $10,000
= $600
Interest = Face Amount - Amount Received
= $10,600 - $10,000
= $600
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide13-17 Noninterest-Bearing Notes
Example
On May 1, 2003, Batter-Up, Inc. issued a one-year, noninterest-bearing note with a face
amount of $10,600 in exchange for equipment valued at $10,000.
What is the implicit interest rate on the note?
On May 1, 2003, Batter-Up, Inc. issued a one-year, noninterest-bearing note with a face
amount of $10,600 in exchange for equipment valued at $10,000.
What is the implicit interest rate on the note?
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide13-18 Liabilities from Advance
Collections
Refundable Deposits
Advances from Customers
Collections for Third Parties
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide13-19 Short-Term Obligations Expected
to Be Refinanced
A short-term liability may be reclassified as long-term if:
The short-term liability is actually refinanced before
the statement issue date.
The short-term liability is actually refinanced before
the statement issue date.
The expected refinancing is evidenced by good faith entrance into a
long-term, noncancelable refinancing agreement
with a viable lender.
The expected refinancing is evidenced by good faith entrance into a
long-term, noncancelable refinancing agreement
with a viable lender.
or
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide13-20
Refinancing Agreement Criteria
1.1. The agreement must be The agreement must be noncancelable by all parties and noncancelable by all parties and must extend beyond one year.must extend beyond one year.
2.2. The company must not be in The company must not be in violation of the agreement on the violation of the agreement on the balance sheet or the issue date.balance sheet or the issue date.
3.3. The lender must be financially The lender must be financially capable of honoring the agreement.capable of honoring the agreement.
1.1. The agreement must be The agreement must be noncancelable by all parties and noncancelable by all parties and must extend beyond one year.must extend beyond one year.
2.2. The company must not be in The company must not be in violation of the agreement on the violation of the agreement on the balance sheet or the issue date.balance sheet or the issue date.
3.3. The lender must be financially The lender must be financially capable of honoring the agreement.capable of honoring the agreement.
SFAS No. 6 requires:
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide13-21
Let’s look at Contingent Liabilities
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide13-22
Contingencies
A loss contingency is an existing uncertain
situation involving potential loss depending on
whether some future event occurs.
A loss contingency is an existing uncertain
situation involving potential loss depending on
whether some future event occurs.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide13-23
Contingencies
Two factors affect whether a loss contingency must be accrued and
reported as a liability:
1. the likelihood that the confirming event will occur.
2. whether the loss amount can be reasonably estimated.
Two factors affect whether a loss contingency must be accrued and
reported as a liability:
1. the likelihood that the confirming event will occur.
2. whether the loss amount can be reasonably estimated.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide13-24 Contingencies – Likelihood of
Occurrence
Probable A confirming event is likely to occur.
Reasonably Possible The chance the confirming event will occur
is > remote, but < likely.
Remote The chance the confirming event will occur
is slight.
Probable A confirming event is likely to occur.
Reasonably Possible The chance the confirming event will occur
is > remote, but < likely.
Remote The chance the confirming event will occur
is slight.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide13-25 Loss Contingencies
Accounting Treatments
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide13-26 Product Warranties and
Guarantees
Product warranties inevitably entail costs.
The amount of those costs can be reasonably estimated using commonly available estimation techniques.
The estimate requires the following entry:
Product warranties inevitably entail costs.
The amount of those costs can be reasonably estimated using commonly available estimation techniques.
The estimate requires the following entry:
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide13-27
Extended Warranties
• Extended warranties are Extended warranties are sold separately from the sold separately from the product.product.
• The related revenue is not The related revenue is not earned untilearned until• Claims are made against the Claims are made against the
extended warranty, orextended warranty, or• The extended warranty period The extended warranty period
expires.expires.
• Extended warranties are Extended warranties are sold separately from the sold separately from the product.product.
• The related revenue is not The related revenue is not earned untilearned until• Claims are made against the Claims are made against the
extended warranty, orextended warranty, or• The extended warranty period The extended warranty period
expires.expires.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide13-28
Premiums
Premiums included with the product are expensed in the period of sale.
Premiums that are contingent on action by the customer require accounting similar to warranties.
Premiums included with the product are expensed in the period of sale.
Premiums that are contingent on action by the customer require accounting similar to warranties.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide13-29
Litigation Claims
• The majority of medium The majority of medium and large-size and large-size corporations annually corporations annually report loss contingencies report loss contingencies due to litigation.due to litigation.
• The most common The most common disclosure is a note to disclosure is a note to the financial statements.the financial statements.
• The majority of medium The majority of medium and large-size and large-size corporations annually corporations annually report loss contingencies report loss contingencies due to litigation.due to litigation.
• The most common The most common disclosure is a note to disclosure is a note to the financial statements.the financial statements.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide13-30
Subsequent Events
Events occurring between the year-end date and report date can affect the appearance of
disclosures on the financial statements.
Events occurring between the year-end date and report date can affect the appearance of
disclosures on the financial statements.
Fiscal Year Ends Financial Statements
ClarificationCause of Loss Contingency
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide13-31
Generally, for Generally, for unasserted claims and unasserted claims and assessments, apply the assessments, apply the same rules as for other same rules as for other
contingencies.contingencies.
Unasserted Claims and Assessments
Even claims that have not been Even claims that have not been asserted must be recorded if they are asserted must be recorded if they are
probable and the amount can be probable and the amount can be reasonably estimated.reasonably estimated.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide13-32
Gain Contingencies
As a general rule, we As a general rule, we never record never record GAINGAIN
contingencies.contingencies.
Note that the prior rules have Note that the prior rules have supported the recording of supported the recording of LOSSLOSS
contingencies.contingencies.
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