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Current Liabilities

and Contingencies

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JOIN KHALID AZIZJOIN KHALID AZIZ

• ACCOUNTING(FINANCIAL & COST) OFACCOUNTING(FINANCIAL & COST) OFICMAP STAGE 1,2,3,4 (CRASH CLASSES)ICMAP STAGE 1,2,3,4 (CRASH CLASSES)CA..MODULE A,B,C,DCA..MODULE A,B,C,DPIPFA (FOUNDATION,INTERMEDIATE,FINAL)PIPFA (FOUNDATION,INTERMEDIATE,FINAL)ACCA-F1,F2,F3ACCA-F1,F2,F3BBA,MBABBA,MBAB.COM(FRESH),M.COMB.COM(FRESH),M.COMMA-ECONOMICS..O/A LEVELSMA-ECONOMICS..O/A LEVELSKHALID AZIZ…..0322-3385752KHALID AZIZ…..0322-3385752http://finance.groups.yahoo.com/group/cost-http://finance.groups.yahoo.com/group/cost-accountantsaccountants

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CHARACTERISTICS OF CHARACTERISTICS OF LIABILITIESLIABILITIES Most liabilities obligate the debtor to pay cash at specified times and result from legally enforceable agreements. Some liabilities are not contractual obligations and may not be payable in cash.

A liability has three essential characteristics. Liabilities:1. are probable, future sacrifices of economic benefits2. that arise from present obligations (to transfer goods or provide services) to other entities3. that result from past transactions or events

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What is a Current Liability?What is a Current Liability?LIABILITIESLIABILITIES

Long-term LiabilitiesLong-term Liabilities

Formally, expected to be satisfied with current assets (or by the

creation of other current liabilities).

Formally, expected to be satisfied with current assets (or by the

creation of other current liabilities).

Current LiabilitiesCurrent Liabilities

Generally, payable within one year.Generally, payable within one year.

Conceptually, should be recorded at present value, but ordinarily are reported at maturity amounts.

Conceptually, should be recorded at present value, but ordinarily are reported at maturity amounts.

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GENERAL MILLS, INC. GENERAL MILLS, INC. BALANCE SHEET BALANCE SHEET

MAY 30, 2007 AND MAY 28, 2006MAY 30, 2007 AND MAY 28, 2006(Rs in millions)

ASSETS[BY CLASSIFICATION]

LIABILITIES

Current Liabilities: 20072006

Accounts payable Rs 778 Rs 673 Current portion of long-term debt 1,734

2,131 Notes payable 1,254 1,503 Other current liabilities 2,079 1,831 Total current liabilities Rs5,845

Rs6,138

Long-term Liabilities: [LISTED INDIVIDUALLY]

Shareholders’ equity[BY SOURCE]

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8: Notes Payable8: Notes PayableThe components of notes payable and their respective The components of notes payable and their respective

weighted average interest rates at the end of the period weighted average interest rates at the end of the period are as follows:are as follows:

20072007 20062006WeightedWeighted

WeightedWeightedDollars in millions:Dollars in millions: AverageAverage

AverageAverageNoteNote InterestInterest Note Note

InterestInterestPayablePayable Rate Rate PayablePayable Rate Rate

U.S. commercial paper U.S. commercial paper Rs477Rs477 5.4% 5.4% Rs 713 Rs 713 5.1% 5.1%

Euro commercial paper Euro commercial paper 639 639 5.4 5.4 462 462 5.1 5.1Financial institutions Financial institutions 138 138 9.8 9.8 328328

5.2 5.2Total notes payableTotal notes payable Rs1,254 Rs1,254 Rs1,503 Rs1,503

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8: Notes Payable (cont.)8: Notes Payable (cont.)To ensure availability of funds, we maintain To ensure availability of funds, we maintain bank credit lines sufficient to cover our bank credit lines sufficient to cover our outstanding short-term borrowings. Our outstanding short-term borrowings. Our commercial paper borrowings are supported commercial paper borrowings are supported by Rs2.95 billion of fee-paid committed credit by Rs2.95 billion of fee-paid committed credit lines and Rs351 million in uncommitted lines. lines and Rs351 million in uncommitted lines. As of May 27, 2007, there were no amounts As of May 27, 2007, there were no amounts outstanding on the fee-paid committed credit outstanding on the fee-paid committed credit lines and Rs133 million was drawn on the lines and Rs133 million was drawn on the uncommitted lines, all by our international uncommitted lines, all by our international operations. Our committed lines consist of a operations. Our committed lines consist of a Rs1.1 billion credit facility expiring in October Rs1.1 billion credit facility expiring in October 2007, a Rs750 million credit facility expiring in 2007, a Rs750 million credit facility expiring in January 2009, and a Rs1.1 billion credit facility January 2009, and a Rs1.1 billion credit facility expiring in October 2010expiring in October 2010..

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InterestInterestInterest on notes is calculated as :

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 debt is

outstanding.

Interest owed is adjusted for the

portion of the year that the debt is

outstanding.

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Note Issued for CashNote Issued for Cash

On May 1, Affiliated Technologies, Inc., a consumer electronics firm, borrowed Rs700,000 cash from First BancCorp under a noncommitted short-term line of credit arrangement and issued a 6-month, 12% promissory note. Interest was payable at maturity.

May 1

Cash 700,000 Notes payable 700,000

November 1

Interest expense (Rs700,000 x 12% x 6/12) 42,000 Notes payable 700,000 Cash (Rs700,000 + 42,000) 742,000

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ExampleExample

On September 1, Tru Fashions borrows Rs80,000 from Second Bank. The note is due in 6 months and has a stated interest rate of 9%.

Cash 80,000 Notes payable 80,000

How much interest does Tru owe at year-end, on Dec. 31?a. Rs 2,400b. Rs 3,600c. Rs 7,200d. Rs87,200

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ExampleExample

On September 1, Tru Fashions borrows Rs80,000 from Second Bank. The note is due in 6 months and has a stated interest rate of 9%.

How much interest does Tru owe at year-end, on Dec. 31?a. Rs 2,400b. Rs 3,600c. Rs 7,200d. Rs87,200

Interest is calculated as: Face Annual Time to Amount Rate maturity

Rs80,000 9% 4/12

Rs2,400 interest.

Interest is calculated as: Face Annual Time to Amount Rate maturity

Rs80,000 9% 4/12

Rs2,400 interest.

× ×

× ×

=

=

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Noninterest-Bearing Noninterest-Bearing NoteNote

The proceeds of the note are reduced by the interest in a The proceeds of the note are reduced by the interest in a “noninterest-bearing” note.“noninterest-bearing” note.

Situation: Rs700,000 noninterest-bearing note, with a 12% Situation: Rs700,000 noninterest-bearing note, with a 12% “discount rate.” The Rs42,000 interest is “discounted” at the “discount rate.” The Rs42,000 interest is “discounted” at the outset, rather than explicitly stated:outset, rather than explicitly stated:

May 1May 1Cash Cash (difference)(difference) 658,000658,000Discount on notes Discount on notes (Rs700,000 x 12% x 6/12)(Rs700,000 x 12% x 6/12) 42,000 42,000

Notes payable Notes payable (face amount)(face amount) 700,000700,000

November 1November 1Interest expense Interest expense 42,000 42,000

Discount on notes Discount on notes 42,000 42,000

Notes payable Notes payable (face amount)(face amount) 700,000700,000Cash Cash 700,000700,000

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Noninterest-Bearing Noninterest-Bearing NoteNote

The amount borrowed is only Rs658,000, but The amount borrowed is only Rs658,000, but the interest is calculated as the the interest is calculated as the discount ratediscount rate times the Rs700,000 face amount. This times the Rs700,000 face amount. This causes the causes the effectiveeffective interest rate interest rate to be to be higher than the 12% stated rate: higher than the 12% stated rate:

Rs 42,000Rs 42,000 interest for 6 monthsinterest for 6 months ÷ ÷ Rs658,000Rs658,000 amount borrowedamount borrowed = 6.38%= 6.38% rate for 6 monthsrate for 6 months x x 1212//66 to annualize the rateto annualize the rate

____________________ = = 12.76%12.76% effective interest rateeffective interest rate

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ACCRUED LIABILITIESACCRUED LIABILITIES

LiabilitiesLiabilities accrue foraccrue for expenses expenses that are that are incurred, but incurred, but not yet paidnot yet paid..

Recorded by Recorded by adjusting entriesadjusting entries at at the the end of the reporting period, prior end of the reporting period, prior to to preparing financial statements. preparing financial statements.

Common examples are: salaries Common examples are: salaries and and wages payable, income taxes wages payable, income taxes payable, payable, and interest payable.and interest payable.

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ACCRUED INTEREST ACCRUED INTEREST PAYABLEPAYABLE

Assume the fiscal period for Affiliated Technologies ends Assume the fiscal period for Affiliated Technologies ends on on June 30, two months after the 6-month note is June 30, two months after the 6-month note is issuedissued. The issuance of the note, intervening adjusting . The issuance of the note, intervening adjusting entry, and note payment would be recorded as shown entry, and note payment would be recorded as shown below:below:

Issuance of note May 1Issuance of note May 1Cash Cash 700,000700,000

Note payableNote payable 700,000700,000

Accrual of interest on June 30Accrual of interest on June 30Interest expense Interest expense (Rs700,000 x 12% x 2/12)(Rs700,000 x 12% x 2/12) 14,000 14,000

Interest payableInterest payable 14,000 14,000

Note payment November 1Note payment November 1Interest expense Interest expense (Rs700,000 x 12% x 4/12)(Rs700,000 x 12% x 4/12) 28,000 28,000Interest payable Interest payable (from adjusting entry)(from adjusting entry) 14,000 14,000Note payableNote payable 700,000700,000

Cash Cash (Rs700,000 + 42,000)(Rs700,000 + 42,000) 742,000742,000

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Liabilities from Advance Liabilities from Advance CollectionsCollections• Refundable Refundable

DepositsDeposits

• Advances from Advances from CustomersCustomers

• Collections for Collections for Third PartiesThird Parties

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Customer AdvanceCustomer AdvanceTomorrow Publications collects magazine Tomorrow Publications collects magazine subscriptions from customers at the time subscriptions from customers at the time subscriptions are sold. Subscription revenue is subscriptions are sold. Subscription revenue is recognized over the term of the subscription. recognized over the term of the subscription. Tomorrow collected Rs20 million in subscription sales Tomorrow collected Rs20 million in subscription sales during its first year of operations. At December 31, during its first year of operations. At December 31, the average subscription was one-fourth expired. (Rs the average subscription was one-fourth expired. (Rs in millions)in millions)

When Advance is CollectedWhen Advance is CollectedCashCash 2020

Unearned subscriptions revenue Unearned subscriptions revenue 2020

When Product is DeliveredWhen Product is DeliveredUnearned subscriptions revenueUnearned subscriptions revenue 5 5

Subscriptions revenueSubscriptions revenue 5 5

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Short-Term Obligations Short-Term Obligations Expected to Be RefinancedExpected to Be Refinanced

Short-term obligations can be reported as noncurrent Short-term obligations can be reported as noncurrent liabilities only if the company:liabilities only if the company:

(a)(a) intends intends to refinance on a long-term basis and to refinance on a long-term basis and (b) demonstrates the(b) demonstrates the abilityability to do so: to do so:

by either an existing refinancing agreement

by either an existing refinancing agreement

by actual financing (prior to the issuance of the financial

statements)

by actual financing (prior to the issuance of the financial

statements)or

The specific form of the long-term refinancing (bonds, bank loans, equity securities) is irrelevant. The concept of substance over form.

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ContingenciesContingencies

A A loss contingencyloss contingency is is an existing an existing

uncertain situation uncertain situation involving potential involving potential loss depending on loss depending on

whether some future whether some future event occurs.event occurs.

A A loss contingencyloss contingency is is an existing an existing

uncertain situation uncertain situation involving potential involving potential loss depending on loss depending on

whether some future whether some future event occurs.event occurs.

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ContingenciesContingencies

Two factors affect whether a loss Two factors affect whether a loss contingency must be accrued and contingency must be accrued and

reported as a liability:reported as a liability:

1.1. the likelihood that the confirming the likelihood that the confirming event will occur.event will occur.

2.2. whether the loss amount can be whether the loss amount can be reasonably estimated.reasonably estimated.

Two factors affect whether a loss Two factors affect whether a loss contingency must be accrued and contingency must be accrued and

reported as a liability:reported as a liability:

1.1. the likelihood that the confirming the likelihood that the confirming event will occur.event will occur.

2.2. whether the loss amount can be whether the loss amount can be reasonably estimated.reasonably estimated.

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Contingencies – Likelihood Contingencies – Likelihood of Occurrenceof Occurrence

• ProbableProbable– A confirming event is likely to occur.A confirming event is likely to occur.

• Reasonably PossibleReasonably Possible– The chance the confirming event will The chance the confirming event will

occur is > remote, but < likely.occur is > remote, but < likely.

• RemoteRemote– The chance the confirming event will The chance the confirming event will

occur is slight.occur is slight.

• ProbableProbable– A confirming event is likely to occur.A confirming event is likely to occur.

• Reasonably PossibleReasonably Possible– The chance the confirming event will The chance the confirming event will

occur is > remote, but < likely.occur is > remote, but < likely.

• RemoteRemote– The chance the confirming event will The chance the confirming event will

occur is slight.occur is slight.

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Loss ContingenciesLoss ContingenciesAccounting TreatmentsAccounting Treatments

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Product Warranties and Product Warranties and GuaranteesGuaranteesThe contingent liability for product warranties almost always is

accrued.

Caldor Health introduced a new therapeutic chair carrying a 2-year warranty against defects. Estimates indicate warranty costs of 3% of sales during the first 12 months following the sale and 4% the next 12 months. During December of 2009, its first month of availability, Caldor sold Rs2 million of the chairs.

During DecemberCash (and accounts receivable)2,000,000 Sales revenue 2,000,000

December 31, 2006 (adjusting entry)Warranty expense ([3% + 4%] x Rs2,000,000) 140,000 Estimated warranty liability 140,000

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Subsequent EventsSubsequent Events

If information becomes available that sheds light on a If information becomes available that sheds light on a contingency that existed when the fiscal year ended, contingency that existed when the fiscal year ended, that information should be used in determining the that information should be used in determining the probability of a loss contingency materializing and in probability of a loss contingency materializing and in estimating the amount of the loss.estimating the amount of the loss.

If information becomes available that sheds light on a If information becomes available that sheds light on a contingency that existed when the fiscal year ended, contingency that existed when the fiscal year ended, that information should be used in determining the that information should be used in determining the probability of a loss contingency materializing and in probability of a loss contingency materializing and in estimating the amount of the loss.estimating the amount of the loss.

Fiscal Year Ends Financial Statements

ClarificationCause of Loss Contingency

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UNASSERTED CLAIMS UNASSERTED CLAIMS AND ASSESSMENTS AND ASSESSMENTS

It must be It must be probableprobable that an unasserted claim or that an unasserted claim or assessment or an unfiled lawsuit will occur before assessment or an unfiled lawsuit will occur before considering whether and how to report the possible loss.considering whether and how to report the possible loss.

Example:Example: The EPA is in the process of investigating the The EPA is in the process of investigating the

possibility of environmental violations at a company’s possibility of environmental violations at a company’s site, but has not proposed a penalty assessment. Since site, but has not proposed a penalty assessment. Since the claim or assessment is unasserted as yet, a two-step the claim or assessment is unasserted as yet, a two-step process is involved in deciding how it should be process is involved in deciding how it should be reported:reported:1.1. Is a claim or assessment Is a claim or assessment probableprobable?? {If not, no {If not, no

disclosure is needed.} disclosure is needed.} 2. Only if a claim or assessment is 2. Only if a claim or assessment is probable probable should we should we

evaluate (a) theevaluate (a) the likelihood of an unfavorable outcome likelihood of an unfavorable outcome and (b) whether the dollar amount can be estimated.and (b) whether the dollar amount can be estimated.

If the conclusion of step 1 is that the claim or If the conclusion of step 1 is that the claim or assessment is assessment is notnot probable, no further action is required. probable, no further action is required.

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Gain ContingenciesGain Contingencies

As a general rule, we As a general rule, we never record never record GAINGAIN

contingencies.contingencies.

Desirable to anticipate losses, Desirable to anticipate losses, but recognizing gains should but recognizing gains should

await their realization. await their realization.

Should be disclosed in notes to the financial statements. Care should be taken that the disclosure note not give "misleading implications as to the likelihood of realization."

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ATTENTION COMMERCE ATTENTION COMMERCE STUDENTSSTUDENTS

ACCOUNTING(FINANCIAL & COST) OFACCOUNTING(FINANCIAL & COST) OFICMAP STAGE 1,2,3,4 (CRASH CLASSES)ICMAP STAGE 1,2,3,4 (CRASH CLASSES)CA..MODULE A,B,C,DCA..MODULE A,B,C,DPIPFA (FOUNDATION,INTERMEDIATE,FINAL)PIPFA (FOUNDATION,INTERMEDIATE,FINAL)ACCA-F1,F2,F3ACCA-F1,F2,F3BBA,MBABBA,MBAB.COM(FRESH),M.COMB.COM(FRESH),M.COMMA-ECONOMICS..O/A LEVELSMA-ECONOMICS..O/A LEVELSKHALID AZIZ…..0322-3385752KHALID AZIZ…..0322-3385752http://finance.groups.yahoo.com/group/cost-accountantshttp://finance.groups.yahoo.com/group/cost-accountants