Kế toán, kiểm toán - Chapter 10: Introduction to liabilities: Economic consequences, current liabilities and contingencies

2Chapter 10:Introduction to Liabilities: Economic Consequences, Current Liabilities and Contingencies3Learning Objective 1Define liability and describe key economic consequences associated with how liabilities are reported on the financial statement.4Liabilities What is a liability?FASB - “Probable future sacrifice 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.”5The Relative Size of Liabilities on the Balance Sheet6Reporting Liabilities on the Balance Sheet: Economic ConsequencesShareholders and InvestorsInterest expense is tax deductible, but more debt means more risk to shareholdersLeverage is a common strategyEquity ownership is subordinated to creditorsCreditorsRestrictive covenants regarding debt limitsManagementWhen and how to borrow money are important decisionsWants to minimize debt on the balance sheetLess debt now improves ability to borrow in the future7AuditorsMust attest to the accuracy of all liabilitiesParticular care is taken because significant unreported liabilities could lead to investor and creditor losses for which auditors could be held liableEnron had billions of unreported liabilities which led to the demise of Arthur Andersen8Concept Practice 1 9Learning Objective 2Define current liability and list important financial metrics that use current liabilities.10The Relative Size of Current Liabilities on the Balance Sheet11Current LiabilitiesClassificationExpected to require the use of current assets (or the creation of other current liabilities) to settle the obligation.Valuing current liabilities on the balance sheetIgnore present value (report at face value)Reporting current liabilitiesPrimary problem is ensuring that all existing current liabilities are reported on the balance sheet.12Which of the following events does not have any impact on total working capital?a. The board of directors declares a cash dividend to be paid next month.b. Warranty expense is accrued.c. Payment of salaries previously accrued.d. Debt which was previously long-term matures next year.13If the current ratio is currently greater than 1.0, which one of the following events would increase the current ratio?a. Purchase of inventory on accountb. Receipt of money from a customer prior to the performance of servicec. Warranty expense is accruedd. Sale of plant asset at a gain14Learning Objective 3Define determinable current liability and list several of the most common ones.15Determinable / Contingent Liabilities16Determinable Current LiabilitiesAccounts payableUsually associated with inventoryMost popular source of financing for small businessShort-term debtsShort-term notesCurrent maturities of long-term debtsDividends payableUnearned revenuesi.e. gift certificates, airline industry, subscriptionsThird Party Collectioni.e. sales taxes, social security taxes, employee income taxesIncome taxesIncentive compensation The dollar value of theseliabilities is relatively straightforward – hence determinable17Incentive Compensation18Concept Practice 3 19Concept Practice 3 (cont.) 20Learning Objective 4Define contingency and describe the difference between accounting methods for contingent losses and contingent gains.21Contingencies and Contingent LiabilitiesContingent on some future event or activity in order to know the exact amount. Examples: warranties, coupons and lawsuitsChanges in estimate may be made in subsequent periods, when future event is concluded.Under IFRS, many of these transactions are reported in a balance sheet account called “provisions”.Provisions are more readily booked than contingent liabilities because IFRS provisions are accrued when the obligation is “more likely than not,” while under US GAAP contingent liabilities are accrued when “highly probable,” which is a much higher threshold. 22Loss Contingencies23Warranties: Accrued Loss Contingencies WarrantiesA promise by a manufacturer or seller to ensure the quality or performance of the product for a specific period of timeRecord estimated expense and liability when products are sold (matching concept):Warranty Expense xx Contingent Warranty Liability xxAs costs are incurred (usually in subsequent periods), charge expenditure to warranty liability:Contingent Warranty Liability xx Cash xx24Class Problem: P10-4, Parts a & b:Issues and recommendations: - Likelihood? Probable - Disclose? Yes - Disclosure? Indicate range and level of probability (250,000 – 1.5 million) - Accrue? Since probable (or greater) and estimable, accrual is required, based on best estimate.25Class Problem: P10-4, Part c:Adjusting journal entry for 2017: Estimated loss 742,000 Estimated liability 742,000(Best guess in the range)Journal entry at settlement (8/12/18): Estimated liability 742,000 Recovery of estimated loss 52,000 Cash 690,00026Class Exercise: E10-10(a)(1) GJE to record sale in 2017 (200 @ $250 each): Cash 50,000 Sales revenue 50,000(2) AJE in 2017 to record estimated warranty for the sales (200 @ $20): Warranty expense 4,000 Contingent Warranty Liability 4,000(3) GJE to record payment in 2017 for repairs: Contingent Warranty Liability 1,400 Cash 1,400 GJE to record payment in 2018 for repairs: Contingent Warranty Liability 2,600 Cash 2,600 27Class Exercise: E10-10(b)Income effects for the revenue and warranty expense under the two alternative for recognition of expense : Accrue Expense Expense as Paid 2017 2018 2017 2018Revenues 50,000 --- 50,000 ---Warr. Expense (4,000) --- (1,400) (2,600)Note: the accrual method recognizes the expense in the same period as the revenues generated by the sale.28If a loss contingency related to a lawsuit against a firm is deemed to have a remote probability of requiring ultimate payment, then the proper accounting treatment of the loss contingency willa. increase the debt/equity ratio.b. increase the debt/asset ratio.c. have no effect on earnings per share.d. increase the quick ratio.29Learning Objective 5Appendix 10ADescribe the basic accounting treatment for defined benefit pension plans and postretirement health care.30Appendix 10A Retirement Costs: Pensions and Postretirement Healthcare and InsurancePensionA sum of money paid to a retired or disable employee usually based on years of serviceDefined Contribution PlansEmployer agrees to make a series of contributions of a specified amount (contribution guaranteed, not benefits)Less expensive than Defined Benefit Plans401(k)s are very commonThe entry to record period contributions is very simple:Dr. Pension Expense Cr. Cash31Cont’d Appendix 10A Retirement CostsDefined Benefit PlansEmployer promises to provide each employee with a specified amount of benefits upon retirementBenefits must be predicted, therefore several assumptions and estimates are requiredThe entry to record the estimated liability is simple, but the calculations can be quite complicated: Dr. Pension Expense Cr. Pension LiabilityThe entry to record periodic payment Dr. Pension Liability Cr. Cash32Cont’d Appendix 10A Retirement CostsPostretirement Healthcare and InsuranceCostsMost large companies provide some after retirement expenses for healthcare and insurance. These items must be estimated and expensed over the employees tenure with the company. These entries are similar to pension entries.33Learning Objective 5Appendix 10BExplain why deferred income tax liabilities are reported on the balance sheet and describe the basic accounting treatment. 34Appendix 10B - Deferred Income TaxesGenerated by the discrepancy between income and expenses for taxation (specified by IRS) and financial reporting (specified by GAAP).These differences are either permanent or timing differences. Example:Equipment purchased on 1/1/15 for $9,0003-year useful lifeNo salvage valueDouble-declining-balance for income tax purposesStraight-line for financial reporting purposesIncome tax rate of 30%35Cont’d Appendix 10B - The Concept of Deferred Income Taxes2015 Deferred income tax liability $9002016 Deferred income tax benefit $3002017 Deferred income tax benefit $60036Cont’d Appendix 10B - Deferred Income Taxes: Additional Issues37Cont’d Appendix 10B – The Conservatism RatioKnowing that companies defer taxable income, a measure around1.0 or less indicates relative conservatism. Reported income is increasingly less conservative at ratios greater than 1.0.Conservatism Ratio: Reported Income before Taxes/Taxable Income38Cont’d Appendix 10B – The Conservatism Ratio39An increase in deferred tax liability is recognized whena. the tax accountant omits the taxable revenue from the tax returns.b. net income measured under GAAP is greater than taxable income on tax returns because of temporary timing differences.c. the amount of tax paid to the government is more than that calculated by the accountant on the company’s tax return.d. a tax audit by the IRS causes and increase in taxes due from a previous year’s tax return.40Wiley © 2018