Current Liabilities and Contingencies

Liability Defined

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 (page 702 of text)

Current Liability Defined

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 (page 702 of text)

Examples of Current Liabilities

Accounts payableNotes payableCurrent maturities of long-term debtDividends payableCustomer advances and depositsUnearned revenuesSales taxes payableIncome taxes payableEmployee-related liabilities

• Theoretically, they should be measured at the present value of the amounts owed, taking into consideration the timing of the payment(s) and an appropriate interest rate

• For convenience, GAAP allows them to be measured at their face amount (i.e., not discounted)

Measurement of Current Liabilities

• General rule – should be included in current liabilities

• Exceptions

If the debt will be paid off with assets that appropriately have not been classified as current assets (e.g., a bond “sinking fund” that can be used for no purpose other than to pay off the bonds

If the debt is “refinanced on a long-term basis”

Current Maturities of Long-Term Debt

Short-Term Obligations Expectedto be Refinanced

Exclude from current liabilities (include in l.t. liab.) if

Management intends to refinance the obligation on a long-term basis.

Management, by the date the financial statements are issued, demonstrates the ability to refinance on a long-term basis by either:

Actually refinancing on a long-term basis or

Enter into a qualifying financing agreement

Short-Term Obligations Expectedto be Refinanced

See E13-3 of text

Short-Term Obligations Expectedto be Refinanced

See E13-4 of text

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

Contingencies

Gain Contingencies

Typical Gain Contingencies are:

Possible receipts of monies from gifts, donations, and

bonuses.

Possible refunds from the government in tax disputes.

Pending court cases with a probable favorable

outcome.

Gain contingencies are not recognized (recorded) until

realized

May be necessary to disclose, however

Loss Contingencies

Likelihood of confirming event

FASB uses three classifications of likelihood:

Probable – likely to occur

Reasonably possible – chance is more than remote but less than probable

Remote – chance of occurring is slight

Loss Contingencies

Common loss contingencies:

• Litigation, claims, and assessments.

• Guarantee and warranty costs.

• Premiums and coupons.

• Environmental liabilities.

Determinable Liabilitiesvs. Contingent Liabilities

Determinable liabilities – the transaction or other event obligating the entity has already occurred

• Liability is known – amount may be known (e.g., salaries payable) or may have to be estimated (e.g., income taxes payable)

• “Confirming” critical event has already occurred

• Recognize liability at known or estimated amount

Contingent Liabilities

Contingent liabilities – “confirming” critical event has not yet occurred

• Example – lawsuit resulting from employee having accident in company’s delivery truck

• A first event has occurred (the accident) but the confirming event has not occurred – the judge or jury has not yet decided if the company is at fault

Recognize (Record) Contingent Liability

• Probable that liability has been incurred (or asset impaired) at the date of the balance sheet

• Amount of the loss can be reasonably estimated

May be necessary to disclose

Only Disclose Contingent Liability

• Reasonably possible that liability has been incurred (or asset impaired) at the date of the balance sheet

• Amount of the loss can be reasonably estimated

Generally No Disclosure Necessary

• Likelihood that liability has been incurred (or asset impaired) is remote

Examples of Loss Contingencies

See E13-13 of text

Nature of compensated absences:

Compensated Absences

Paid absences for vacations, illnesses, and holidays.

Accounting for Compensated Absences

Accrue (record) a liability if all the following conditions are met

The employer’s obligation is attributable to employees’ services already rendered

The obligation relates to rights that vest or accumulate

Payment of the compensation is probable

The amount can be reasonably estimated

Litigation, Claims and Assessments

Companies must consider the following factors, in

determining whether to record a liability with respect

to pending or threatened litigation and actual or

possible claims and assessments.

Time period in which the action occurred

Probability of an unfavorable outcome

Ability to make a reasonable estimate of the loss.

Asserted Litigations, Claims & Assessments

Recognize (record) in current year if

• Related critical event occurred by balance sheet date

• Probable that contingent loss will be incurred

• Can reasonable estimate loss amount

Unasserted Litigations, Claims & Assessments

Recognize (record) in current year only if

• Related critical event occurred by balance sheet date

• Probable that unasserted LCA will be asserted (filed)

• Probable that the “asserted” claim will result in a loss

• Amount of the loss can be reasonably estimated

Unasserted Litigations, Claims & Assessments

Disclose in current year (but do not record) if

• Related critical event occurred by balance sheet date

• Only reasonably possible that unasserted LCA will be asserted (filed)

• Probable that the “asserted” claim will result in a loss

• Amount of the loss can be reasonably estimated

Asset Retirement Obligations

A company must recognize an asset retirement

obligation (ARO) when it has an existing legal obligation

associated with the retirement of a long-lived asset and

when it can reasonably estimate the amount of the

liability.

Asset Retirement Obligations

• See illustration on page 724 of text

• See E13-14

Presentation

Presentation of Current Liabilities

Usually reported at their full maturity value.

Difference between present value and the maturity

value is considered immaterial.

Presentation of Contingencies

Disclosure should include:

Nature of the contingency.

An estimate of the possible loss or range of loss.

Other

See E13-16 of text