Intermediate

Accounting

Prepared by
Coby Harmon
13-1
University of California, Santa Barbara
 Current Liabilities and
13 Contingencies

Intermediate Accounting
14th Edition

Kieso, Weygandt, and Warfield

13-2
 Learning
Learning Objectives
Objectives

1. Describe the nature, type, and valuation of current liabilities.

2. Explain the classification issues of short-term debt expected to

be refinanced.

3. Identify types of employee-related liabilities.

4. Identify the criteria used to account for and disclose gain and
loss contingencies.

5. Explain the accounting for different types of loss contingencies.

6. Indicate how to present and analyze liabilities and

contingencies.

13-3
 Current
Current Liabilities
Liabilities and
and Contingencies
Contingencies

Presentation and
Current Liabilities Contingencies
Analysis

What is a liability? Gain contingencies Presentation of

What is a current Loss contingencies current liabilities
liability? Presentation of
contingencies
Analysis of current
liabilities

13-4
 What
What is
is aa Liability?
Liability?

FASB, defines liabilities as:

“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.”

13-5
 What
What is
is aa Current
Current Liability?
Liability?

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.”

The operating cycle is the period of time elapsing between the

acquisition of goods and services and the final cash realization resulting
from sales and subsequent collections.

13-6 LO 1 Describe the nature, type, and valuation of current liabilities.

 What
What is
is aa Current
Current Liability?
Liability?

Typical Current Liabilities:

 Accounts payable.  Customer advances and
deposits.
 Notes payable.
 Unearned revenues.
 Current maturities of long-
term debt.  Sales taxes payable.
 Short-term obligations  Income taxes payable.
expected to be refinanced.
 Employee-related liabilities.
 Dividends payable.

13-7 LO 1 Describe the nature, type, and valuation of current liabilities.

 What
What is
is aa Current
Current Liability?
Liability?

Accounts Payable (trade accounts payable)

Balances owed to others for goods, supplies, or services
purchased on open account.
 Time lag between the receipt of services or acquisition
of title to assets and the payment for them.

 Terms of the sale (e.g., 2/10, n/30 or 1/10, E.O.M.)

usually state period of extended credit, commonly 30 to
60 days.

13-8 LO 1 Describe the nature, type, and valuation of current liabilities.

 What
What is
is aa Current
Current Liability?
Liability?

Notes Payable
Written promises to pay a certain sum of money on a
specified future date.
 Arise from purchases, financing, or other transactions.

 Notes classified as short-term or long-term.

 Notes may be interest-bearing or zero-interest-bearing.

13-9 LO 1 Describe the nature, type, and valuation of current liabilities.

 What
What is
is aa Current
Current Liability?
Liability?

Interest-Bearing Note Issued

Illustration: Castle National Bank agrees to lend $100,000 on
March 1, 2012, to Landscape Co. if Landscape signs a $100,000,
6 percent, four-month note. Landscape records the cash received
on March 1 as follows:

Cash 100,000
Notes Payable 100,000

13-10 LO 1 Describe the nature, type, and valuation of current liabilities.

 What
What is
is aa Current
Current Liability?
Liability?

If Landscape prepares financial statements semiannually, it

makes the following adjusting entry to recognize interest
expense and interest payable at June 30:

Interest calculation = ($100,000 x 6% x 4/12) = $2,000

Interest expense 2,000

Interest payable 2,000

13-11 LO 1 Describe the nature, type, and valuation of current liabilities.

 What
What is
is aa Current
Current Liability?
Liability?

At maturity (July 1), Landscape records payment of the note and

accrued interest as follows.

Notes payable 100,000

Interest payable 2,000
Cash 102,000

13-12 LO 1 Describe the nature, type, and valuation of current liabilities.

 What
What is
is aa Current
Current Liability?
Liability?

Zero-Bearing Note Issued

Illustration: On March 1, Landscape issues a $102,000, four-
month, zero-interest-bearing note to Castle National Bank. The
present value of the note is $100,000. Landscape records this
transaction as follows.

Cash 100,000
Discount on notes payable 2,000
Notes payable 102,000

13-13 LO 1 Describe the nature, type, and valuation of current liabilities.

 What
What is
is aa Current
Current Liability?
Liability?

If Landscape prepares financial statements semiannually, it

makes the following adjusting entry to recognize interest expense
and the increase in the note payable of $2,000 at June 30.

Interest expense 2,000

Discount on notes payable 2,000

At maturity (July 1), Landscape must pay the note, as follows.

Notes payable 102,000

Cash 102,000

13-14 LO 1 Describe the nature, type, and valuation of current liabilities.

 What
What is
is aa Current
Current Liability?
Liability?

E13-2: (Accounts and Notes Payable) The following are selected

2012 transactions of Darby Corporation.

Sept. 1 - Purchased inventory from Orion Company on account

for $50,000. Darby records purchases gross and uses a periodic
inventory system.

Oct. 1 - Issued a $50,000, 12-month, 8% note to Orion in

payment of account.

Oct. 1 - Borrowed $75,000 from the Shore Bank by signing a 12-

month, zero-interest-bearing $81,000 note.

Prepare journal entries for the selected transactions.

13-15 LO 1 Describe the nature, type, and valuation of current liabilities.

 What
What is
is aa Current
Current Liability?
Liability?

Sept. 1 - Purchased inventory from Orion Company on account

for $50,000. Darby records purchases gross and uses a
periodic inventory system.

Sept. 1 Purchases 50,000

Accounts payable 50,000

13-16 LO 1 Describe the nature, type, and valuation of current liabilities.

 What
What is
is aa Current
Current Liability?
Liability?

Oct. 1 - Issued a $50,000, 12-month, 8% note to Orion in payment

of account.

Oct. 1 Accounts payable 50,000

Notes payable 50,000

Interest calculation = ($50,000 x 8% x 3/12) = $1,000

Dec. 31 Interest expense 1,000

Interest payable 1,000

13-17 LO 1 Describe the nature, type, and valuation of current liabilities.

 What
What is
is aa Current
Current Liability?
Liability?

Oct. 1 - Borrowed $75,000 from the Shore Bank by signing a 12-

month, zero-interest-bearing $81,000 note.

Oct. 1 Cash 75,000

Discount on notes payable 6,000
Notes payable 81,000
Interest calculation = ($6,000 x 3/12) = $1,500

Dec. 31 Interest expense 1,500

Discount on notes payable 1,500

13-18 LO 1 Describe the nature, type, and valuation of current liabilities.

 What
What is
is aa Current
Current Liability?
Liability?

Current Maturities of Long-Term Debt

Portion of bonds, mortgage notes, and other long-term
indebtedness that matures within the next fiscal year.

Exclude long-term debts maturing currently if they are to be:

1. Retired by assets accumulated that have not been shown

as current assets,
2. Refinanced, or retired from the proceeds of a new debt
issue, or
3. Converted into capital stock.

13-19 LO 1 Describe the nature, type, and valuation of current liabilities.

 What
What is
is aa Current
Current Liability?
Liability?

Short-Term Obligations Expected to Be

Refinanced
Exclude from current liabilities if both of the following
conditions are met:

1. Must intend to refinance the obligation on a long-term

basis.

2. Must demonstrate an ability to refinance:

 Actual refinancing.
 Enter into a financing agreement.

13-20
LO 2 Explain the classification issues of short-term
debt expected to be refinanced.
 What
What is
is aa Current
Current Liability?
Liability?

Short-Term Obligations Expected to be Refinanced

NO
Mgmt. Intends of Refinance Classify as
YES Current
Liability
Demonstrates Ability to Refinance
NO
YES
Actual Refinancing after Financing Agreement
balance sheet date but before or Noncancellable with Capable
issue date Lender

Exclude Short-Term Obligations from Current

Liabilities and Reclassify as LT Debt

13-21
LO 2 Explain the classification issues of short-term
debt expected to be refinanced.
 What
What is
is aa Current
Current Liability?
Liability?

E13-3 (Refinancing of Short-Term Debt): On December 31, 2012,

Alexander Company had $1,200,000 of short-term debt in the form of
notes payable due February 2, 2013. On January 21, 2013, the
company issued 25,000 shares of its common stock for $36 per share,
receiving $900,000 proceeds after brokerage fees and other costs of
issuance. On February 2, 2013, the proceeds from the stock sale,
supplemented by an additional $300,000 cash, are used to liquidate the
$1,200,000 debt. The December 31, 2012, balance sheet is issued on
February 23, 2013.
Instructions
Show how the $1,200,000 of short-term debt should be presented on the
December 31, 2012, balance sheet, including note disclosure

13-22
LO 2 Explain the classification issues of short-term
debt expected to be refinanced.
 What
What is
is aa Current
Current Liability?
Liability?

Partial Balance Sheet

Current liabilities:
Notes payable
$ 300,000

Long-term debt:
Notes payable refinanced
900,000

Total liabilities
$1,200,000

13-23
LO 2 Explain the classification issues of short-term
debt expected to be refinanced.
 What
What is
is aa Current
Current Liability?
Liability?

Dividends Payable
Amount owed by a corporation to its stockholders as a result
of board of directors’ authorization.
 Generally paid within three months.
 Undeclared dividends on cumulative preferred stock not
recognized as a liability.
 Dividends payable in the form of additional shares of
stock are not recognized as a liability.
 Reported in equity.

13-24
LO 2 Explain the classification issues of short-term
debt expected to be refinanced.
 What
What is
is aa Current
Current Liability?
Liability?

Customer Advances and Deposits

Returnable cash deposits received from customers and
employees.
 May be classified as current or long-term liabilities.

13-25
LO 2 Explain the classification issues of short-term
debt expected to be refinanced.
 What
What is
is aa Current
Current Liability?
Liability?

Unearned Revenues
Payment received before delivering goods or rendering
services? Illustration 13-3
Unearned and Earned
Revenue Accounts

13-26
LO 2 Explain the classification issues of short-term
debt expected to be refinanced.
 What
What is
is aa Current
Current Liability?
Liability?

BE13-5: Sports Pro Magazine sold 12,000 annual subscriptions

on August 1, 2012, for $18 each. Prepare Sports Pro’s August 1,
2012, journal entry and the December 31, 2012, annual adjusting
entry.

Aug. 1 Cash 216,000

Unearned revenue 216,000
(12,000 x $18)

Dec. 31 Unearned revenue 90,000

Subscription revenue 90,000
($216,000 x 5/12 = $90,000)

13-27
LO 2 Explain the classification issues of short-term
debt expected to be refinanced.
 What
What is
is aa Current
Current Liability?
Liability?

Sales Taxes Payable

Retailers must collect sales taxes from customers on
transfers of tangible personal property and on certain services
and then remit to the proper governmental authority.

13-28
LO 2 Explain the classification issues of short-term
debt expected to be refinanced.
 What
What is
is aa Current
Current Liability?
Liability?
BE13-7: Dillons Corporation made credit sales of $30,000 which are
subject to 6% sales tax. The corporation also made cash sales which
totaled $20,670 including the 6% sales tax. (a) prepare the entry to
record Dillons’ credit sales. (b) Prepare the entry to record Dillons’
cash sales.

Accounts receivable 31,800

Sales 30,000
Sales tax payable ($30,000 x 6% = $1,800) 1,800

Cash 20,670
Sales ($20,670  1.06 = $19,500) 19,500
Sales tax payable 1,170

13-29 LO 2
 What
What is
is aa Current
Current Liability?
Liability?

Income Tax Payable

Businesses must prepare an income tax return and
compute the income tax payable.
 Taxes payable are a current liability.
 Corporations must make periodic tax payments.
 Differences between taxable income and accounting
income sometimes occur (Chapter 19).

13-30
LO 2 Explain the classification issues of short-term
debt expected to be refinanced.
 What
What is
is aa Current
Current Liability?
Liability?

Employee-Related Liabilities
Amounts owed to employees for salaries or wages are
reported as a current liability.

Current liabilities may include:

 Payroll deductions.
 Compensated absences.
 Bonuses.

13-31 LO 3 Identify types of employee-related liabilities.

 What
What is
is aa Current
Current Liability?
Liability?

Payroll Deductions
Taxes:
► Social Security Taxes
► Income Tax Withholding Illustration 13-5
Summary of Payroll Liabilities

13-32 LO 3 Identify types of employee-related liabilities.

 What
What is
is aa Current
Current Liability?
Liability?
Illustration: Assume a weekly payroll of $10,000 entirely subject to
F.I.C.A. and Medicare (7.65%), federal (0.8%) and state (4%)
unemployment taxes, with income tax withholding of $1,320 and
union dues of $88 deducted. The company records the salaries and
wages paid and the employee payroll deductions as follows:

Wages and salaries expense 10,000

Withholding taxes payable 1,320
FICA taxes payable 765
Union dues payable 88
Cash 7,827

13-33 LO 3 Identify types of employee-related liabilities.

 What
What is
is aa Current
Current Liability?
Liability?
Illustration: Assume a weekly payroll of $10,000 entirely subject to
F.I.C.A. and Medicare (7.65%), federal (0.8%) and state (4%)
unemployment taxes, with income tax withholding of $1,320 and
union dues of $88 deducted. The company records the employers
payroll taxes as follows:

Payroll tax expense 1,245

FICA taxes payable 765
FUTA taxes payable 80
SUTA taxes payable 400

13-34 LO 3 Identify types of employee-related liabilities.

 What
What is
is aa Current
Current Liability?
Liability?

Compensated Absences
Paid absences for vacation, illness, and holidays.

Accrue a liability if all the following conditions exist.

 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.

13-35 LO 3 Identify types of employee-related liabilities.

 What
What is
is aa Current
Current Liability?
Liability?
Illustration: Amutron Inc. began operations on January 1, 2012. The
company employs 10 individuals and pays each $480 per week.
Employees earned 20 unused vacation weeks in 2012. In 2013, the
employees used the vacation weeks, but now they each earn €540
per week. Amutron accrues the accumulated vacation pay on
December 31, 2012, as follows.

Salaries and wages expense 9,600

Salaries and wages payable 9,600

In 2013, it records the payment of vacation pay as follows.

Salaries and wages payable 9,600

Salaries and wages expense 1,200
Cash 10,800
13-36 LO 3
 What
What is
is aa Current
Current Liability?
Liability?

Profit-Sharing and Bonus Plans

Payments to certain or all employees in addition to their
regular salaries or wages.

 Bonuses paid are an operating expense.

 Unpaid bonuses should be reported as a current
liability.

13-37 LO 3 Identify types of employee-related liabilities.

 Contingencies
Contingencies

“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.”*

* FASB ASC 450-10-05-4. [Predecessor literature: “Accounting for

Contingencies,” Statement of Financial Accounting Standards No. 5
(Stamford, Conn.: FASB, 1975), par. 1.]

13-38
LO 4 Identify the criteria used to account for and
disclose gain and loss contingencies.
 Gain
Gain Contingencies
Contingencies

Typical Gain Contingencies are:

1. Possible receipts of monies from gifts, donations, and
bonuses.

2. Possible refunds from the government in tax disputes.

3. Pending court cases with a probable favorable outcome.

4. Tax loss carryforwards (Chapter 19).

Gain contingencies are not recorded.

Disclosed only if probability of receipt is high.

13-39
LO 4 Identify the criteria used to account for and
disclose gain and loss contingencies.
 Loss
Loss Contingencies
Contingencies

Contingent Liability
The likelihood that the future event will confirm the
incurrence of a liability can range from probable to
remote.

FASB uses three areas of probability:

 Probable.
 Reasonably possible.
 Remote.

13-40
LO 4 Identify the criteria used to account for and
disclose gain and loss contingencies.
 Loss
Loss Contingencies
Contingencies

Probability Accounting

Probable Accrue

Reasonably
Footnote
Possible

Remote Ignore

13-41
LO 4 Identify the criteria used to account for and
disclose gain and loss contingencies.
 Loss
Loss Contingencies
Contingencies
Illustration 13-10

13-42
LO 4 Identify the criteria used to account for and
disclose gain and loss contingencies.
 PROVISIONS
PROVISIONS

Provision is a liability of uncertain timing or amount

(sometimes referred to as an estimated liability).
Reported as either a current liability or a non-current
liability.

Probable means that there is more than a 50% chance

that the event will happen. If the probability is 50% or less,
then it does not need to be recorded as a liability.

13-43
LO 4 Identify the criteria used to account for and
disclose gain and loss contingencies.
 PROVISIONS
PROVISIONS

Companies accrue an expense and related liability for a

provision only if the following three conditions are met.

1. A company has a present obligation (legal or

constructive) as a result of a past eventPremiums and
coupons.

2. It is probable that an outfl ow of resources embodying

economic benefi ts will be required to settle the
obligation; and

3. A reliable estimate can be made of the amount of the

obligation. If these three conditions are not met, no
provision is recognized.
13-44
 PROVISIONS
PROVISIONS

Common Types of Provisions

1. Litigation, claims, and assessments.

2. Guarantee or warranty costs.

3. Consideration Payable

4. Environmental liabilities.

5. Onerous Contracts

6. Restructurin

13-45
LO 4 Identify the criteria used to account for and
disclose gain and loss contingencies.
 Common
Common Types
Types of
of Provision
Provision

1. Litigation or Lawsuit
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.

13-46 LO 5 Explain the accounting for different types of loss contingencies.

 Common
Common Types
Types of
of Provision
Provision

1. Litigation or Lawsuit
Ilustration: Scorcese Inc. was involved in a lawsuit on December 31, 2010.
(a) Prepare the journal entry as of December 31, 31 assuming that it is
probable that Scorcese will be fined $900,000 as a result of this lawsuit. (b)
Prepare the journal entries as of December 31, if any, assuming that there is
no possibility that Scorcese will be liable for any payments as a result of this
claim.
a.
. Expense 900.000
Ligitation Liability 900.0000

b. No journaling required. The loss is not recognized because it

is impossible to incur a liability on 12/31/10.

13-47 LO 5 Explain the accounting for different types of loss contingencies.

 Common
Common Types
Types of
of Provision
Provision

2. Guarantee and Warranty Costs

Promise made by a seller to a buyer to make good on a
deficiency of quantity, quality, or performance in a product.

If it is probable that customers will make warranty claims

and a company can reasonably estimate the costs involved,
the company must record an expense.

13-48 LO 5 Explain the accounting for different types of loss contingencies.

 Common
Common Types
Types of
of Provision
Provision

2. Guarantee and Warranty Costs

Two basic methods of accounting for warranty costs:

Cash-Basis method
 Expense warranty costs as incurred, because
1. it is not probable that a liability has been
incurred, or
2. it cannot reasonably estimate the amount of
the liability.

13-49 LO 5 Explain the accounting for different types of loss contingencies.

 Common
Common Types
Types of
of Provision
Provision

2. Guarantee and Warranty Costs

Two basic methods of accounting for warranty costs:

Accrual-Basis method
 Charge warranty costs to operating expense in the
year of sale.
1. Method is the generally accepted method.
2. Referred to as the expense warranty approach.

13-50 LO 5 Explain the accounting for different types of loss contingencies.

 Common
Common Types
Types of
of Provision
Provision
Ilustration: Streep Factory provides a 2-year warranty with one of its
products which was first sold in 2012. In that year, Streep spent
$70,000 servicing warranty claims. At year-end, Streep estimates that
an additional $400,000 will be spent in the future to service warranty
claims related to 2012 sales. Prepare Streep’s journal entry to record
the $70,000 expenditure, and the December 31 adjusting entry.

2012 Warranty expense 70,000

Cash 70,000

12/31/12 Warranty expense 400,000

Warranty liability 400,000

13-51 LO 5 Explain the accounting for different types of loss contingencies.

 Common
Common Types
Types of
of Provision
Provision

3. Consideration Payable
Companies should charge the costs of premiums and
coupons to expense in the period of the sale that benefits
from the plan.

Accounting:
 Company estimates the number of outstanding premium
offers that customers will present for redemption.
 Company charges the cost of premium offers to Premium
Expense and credits Estimated Liability for Premiums.

13-52 LO 5 Explain the accounting for different types of loss contingencies.

 Common
Common Types
Types of
of Provision
Provision

Illustration: Fluffy Cakemix Company offered its customers a large

nonbreakable mixing bowl in exchange for 25 cents and 10 boxtops.
The mixing bowl costs Fluffy Cakemix Company 75 cents, and the
company estimates that customers will redeem 60 percent of the
boxtops. The premium offer began in June 2012 and resulted in the
transactions journalized below. Fluffy Cakemix Company records
purchase of 20,000 mixing bowls as follows.

Inventory of Premium 15,000

Cash
15,000
$20,000 x .75 = $15,000

13-53 LO 5 Explain the accounting for different types of loss contingencies.

 Common
Common Types
Types of
of Provision
Provision

Illustration: The entry to record sales of 300,000 boxes of cake mix

would be: 300,000 x .80 = $240,000

Cash 240,000
Sales Revenue
240,000
Fluffy records the actual redemption of 60,000 boxtops, the receipt
of 25 cents per 10 boxtops, and the delivery of the mixing bowls as
follows.

Cash [(60,000 / 10) x $0.25] 1,500

Premium Expense 3,000
Inventory of Premium
13-54
4,500 LO 5
 Common
Common Types
Types of
of Provision
Provision

Illustration: Finally, Fluffy makes an end-of-period adjusting entry

for estimated liability for outstanding premium offers (boxtops) as
follows.

Premium Expense 6,000

Premium Liability
6,000

13-55 LO 5 Explain the accounting for different types of loss contingencies.

 Common
Common Types
Types of
of Provision
Provision

4. Environmental Liabilities
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.

NOTE: The SEC argues that if the liability is within a range, and no amount
within the range is the best estimate, then management should recognize
the minimum amount of the range.

13-56 LO 5 Explain the accounting for different types of loss contingencies.

 Common
Common Types
Types of
of Provision
Provision

Illustration: On January 1, 2012, Wildcat Oil Company erected an

oil platform in the Gulf of Mexico. Wildcat is legally required to
dismantle and remove the platform at the end of its useful life,
estimated to be five years. Wildcat estimates that dismantling and
removal will cost $1,000,000. Based on a 10 percent discount rate,
the fair value of the asset retirement obligation is estimated to be
$620,920 ($1,000,000 x .62092). Wildcat records this ARO as
follows.

Drilling platform 620,920

Asset retirement obligation
620,920
13-57 LO 5 Explain the accounting for different types of loss contingencies.
 Common
Common Types
Types of
of Provision
Provision

Illustration: During the life of the asset, Wildcat allocates the asset
retirement cost to expense. Using the straight-line method, Wildcat
makes the following entries to record this expense.

December 31, 2012, 2013, 2014, 2015, 2016

Depreciation expense ($620,920 / 5) 124,184

Accumulated depreciation
124,184

13-58 LO 5 Explain the accounting for different types of loss contingencies.

 Common
Common Types
Types of
of Provision
Provision

Illustration: In addition, Wildcat must accrue interest expense each

period. Wildcat records interest expense and the related increase in
the asset retirement obligation on December 31, 2012, as follows.

December 31, 2012

Interest expense ($620,092 x 10%) 62,092

Asset retirement obligation
62,092

13-59 LO 5 Explain the accounting for different types of loss contingencies.

 Common
Common Types
Types of
of Provision
Provision

Illustration: On January 10, 2017, Wildcat contracts with Rig

Reclaimers, Inc. to dismantle the platform at a contract price of
$995,000. Wildcat makes the following journal entry to
record settlement of the ARO.

January 10, 2017

Asset retirement obligation 1,000,000

Gain on settlement of ARO
5,000
Cash
995,000

13-60 LO 5 Explain the accounting for different types of loss contingencies.

 Common
Common Types
Types of
of Provision
Provision

5. Onerous Contract Provisions

Onerous contract provisions are reserves created by a
company when a contract becomes unprofitable.

The expected cost should reflect the lowest net cost of

contract termination, i.e. the lower of
 costs to fulfill the contract, or
 compensation or fines arising from failure to fulfill the
contract..

13-61 LO 5 Explain the accounting for different types of loss contingencies.

 Common
Common Types
Types of
of Provision
Provision

5. Onerous Contract Provisions

Ilustration: Sumart Sports operates profitably in a leased
factory and pays monthly rent. Sumart decided to move its
operations to another facility. However, the lease on the old
facility continues for another three years. Unfortunately,
Sumart cannot cancel the lease and will not be able to
transfer the factory to another party. The expected cost of
fulfilling this onerous contract is €200,000. In this case,
Sumart makes the following journal entries.

Loss on Lease Contract 200,000

Lease Contract Liability 200,000

13-62 LO 5 Explain the accounting for different types of loss contingencies.

 Common
Common Types
Types of
of Provision
Provision

Self-Insurance
Self-insurance is not insurance, but risk assumption.
There is little theoretical justification for the establishment of a
liability based on a hypothetical charge to insurance expense.

Illustration 13-12

13-63 LO 5 Explain the accounting for different types of loss contingencies.

 Presentation
Presentation and
and Analysis
Analysis

Presentation of Current Liabilities

 Usually reported at their full maturity value.

 Difference between present value and the maturity

value is considered immaterial.

13-64 LO 6 Indicate how to present and analyze liabilities and contingencies.

 Presentation
Presentation of
of Current
Current Liabilities
Liabilities

Illustration 13-13

13-65 LO 6 Indicate how to present and analyze liabilities and contingencies.

 Presentation
Presentation and
and Analysis
Analysis

Presentation of Current Liabilities

If a company excludes a short-term obligation from current
liabilities because of refinancing, it should include the
following in the note to the financial statements:

1. A general description of the financing agreement.

2. The terms of any new obligation incurred or to be incurred.

3. The terms of any equity security issued or to be issued.

13-66 LO 6 Indicate how to present and analyze liabilities and contingencies.

 Presentation
Presentation and
and Analysis
Analysis

Presentation of Current Liabilities

Actual Refinancing of Short-Term Debt Illustration 13-14

13-67 LO 6 Indicate how to present and analyze liabilities and contingencies.

 Presentation
Presentation and
and Analysis
Analysis

Presentation of Contingencies
Disclosure should include:
 Nature of the contingency.
 An estimate of the possible loss or range of loss.

Companies should disclose certain other contingent liabilities.

1. Guarantees of indebtedness of others.

2. Obligations of commercial banks under “stand-by letters of credit.”

3. Guarantees to repurchase receivables (or any related property)

that have been sold or assigned.

13-68 LO 6
 Presentation
Presentation and
and Analysis
Analysis
Illustration 13-15

Disclosure of
Loss
Contingency
through
Litigation

13-69 LO 6
 Analysis
Analysis of
of Current
Current Liabilities
Liabilities

Liquidity regarding a liability is the expected time to elapse

before its payment. Two ratios to help assess liquidity are:

Illustration: Compute these two ratios using the

information for Best Buy Co. in Illustration 13-13.

Illustration 13-19

13-70 LO 6 Indicate how to present and analyze liabilities and contingencies.

 Analysis
Analysis of
of Current
Current Liabilities
Liabilities
E13-17: (Ratio Computations and Discussion) Costner Company has
been operating for several years, and on December 31, 2012,
presented the following balance sheet.

Balance Sheet (in thousands)

Compute the current ratio:
Assets
Cash $ 40,000 $210,000
Accounts recievables, net 75,000 = 3.0 to 1
Inventories 95,000 70,000
Plant assets, net 220,000
Total assets $ 430,000
Liabilities and Equity Compute the acid-test ratio:
Accounts payable $ 70,000
Mortgage payable 140,000 $115,000
Common stock, $1 par 160,000
= 1.64 to 1
Retained earnings 60,000
70,000
Total liabilities and equity $ 430,000
13-71
LO 6 Indicate how to present and analyze liabilities and contingencies.
 RELEVANT FACTS
 Similar to U.S. practice, IFRS requires that companies present
current and non-current liabilities on the face of the statement of
financial position (balance sheet), with current liabilities generally
presented in order of liquidity. However, many companies using
IFRS present non-current liabilities before current liabilities on the
statement of financial position.
 The basic definition of a liability under GAAP and IFRS is very
similar. In a more technical way, liabilities are defined by the IASB as
a present obligation of the entity arising from past events, the
settlement of which is expected to result in an outflow from the entity
of resources embodying economic benefits. Liabilities may be legally
enforceable via a contract or law but need not be; that is, they can
arise due to normal business practices or customs.
13-72
 RELEVANT FACTS
 IFRS requires that companies classify liabilities as current or non-
current on the face of the statement of financial position (balance
sheet), except in industries where a presentation based on liquidity
would be considered to provide more useful information (such as
financial institutions).
 Under IFRS, the measurement of a provision related to a
contingency is based on the best estimate of the expenditure
required to settle the obligation. If a range of estimates is predicted
and no amount in the range is more likely than any other amount in
the range, the “mid-point” of the range is used to measure the
liability. In GAAP, the minimum amount in a range is used.

13-73
 RELEVANT FACTS
 Both IFRS and GAAP prohibit the recognition of liabilities for future
losses. However, IFRS permits recognition of a restructuring liability,
once a company has committed to a restructuring plan. GAAP has
additional criteria (i.e., related to communicating the plan to
employees) before a restructuring liability can be established.
 IFRS and GAAP are similar in the treatment of asset retirement
obligations (AROs). However, the recognition criteria for an ARO are
more stringent under GAAP.
 Under IFRS, short-term obligations expected to be refinanced can be
classified as noncurrent if the refinancing is completed by the
financial statement date. GAAP uses the date the financial
statements are issued.
13-74
 RELEVANT FACTS
 IFRS uses the term provisions to refer to estimated liabilities. Under
IFRS, contingencies are not recorded but are often disclosed. The
accounting for provisions under IFRS and estimated liabilities under
GAAP are very similar.
 GAAP uses the term “contingency” in a different way than IFRS.
Contingent liabilities are not recognized in the financial statements
under IFRS, whereas under GAAP a contingent liability is sometimes
recognized.

13-75
 IFRS SELF-TEST QUESTION
Under IFRS, a provision is the same as:
a. a contingent liability.
b. an estimated liability.
c. a contingent gain.
d. None of the above.

13-76
 IFRS SELF-TEST QUESTION
A typical provision is:
a. bonds payable.
b. cash.
c. a warranty liability.
d. accounts payable.

13-77
 IFRS SELF-TEST QUESTION
In determining the amount of a provision, a company using IFRS
should generally measure:
a. using the midpoint of the range between the lowest possible
loss and the highest possible loss.
b. using the minimum amount of the loss in the range.
c. using the best estimate of the amount of the loss expected to
occur.
d. using the maximum amount of the loss in the range.

13-78
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13-79