Kế toán tài chính - Current liabilities and contingencies

PREVIEW OF CHAPTER 13Intermediate Accounting16th EditionKieso ● Weygandt ● Warfield Describe the nature, valuation, and reporting of current liabilities. Explain the classification issues of short-term debt expected to be refinanced.LEARNING OBJECTIVESExplain the accounting for gain and loss contingencies.Indicate how to present and analyze liabilities and contingencies.After studying this chapter, you should be able to:Current Liabilities and Contingencies13LO 1CURRENT LIABILITIES“What is a Liability?”The FASB, defined 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.”LO 1Recall: Current assets are cash or other assets that companies reasonably expect to convert into cash, sell, or consume in operations within a single operating cycle or within a year.Operating cycle: Period of time elapsing between the acquisition of goods and services and the final cash realization resulting from sales and subsequent collections.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.”CURRENT LIABILITIESLO 1Typical Current Liabilities:Accounts payable.Notes payable.Current maturities of long-term debt.Short-term obligations expected to be refinanced.Dividends payable.Customer advances and deposits.Unearned revenues.Sales taxes payable.Income taxes payable.Employee-related liabilities.CURRENT LIABILITIESLO 1Balances 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.Accounts Payable (trade accounts payable)CURRENT LIABILITIESLO 1Written promises to pay a certain sum of money on a specified future date.Arise from purchases, financing, or other transactions.Classified as short-term or long-term.May be interest-bearing or zero-interest-bearing.Notes PayableCURRENT LIABILITIESLO 1Illustration: Castle National Bank agrees to lend $100,000 on March 1, 2017, 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 100,000Interest-Bearing Note IssuedCURRENT LIABILITIESLO 1If Landscape prepares financial statements semiannually, it makes the following adjusting entry to recognize interest expense and interest payable at June 30:Interest Expense 2,000 Interest Payable 2,000($100,000 x 6% x 4/12) = $2,000Interest calculation =CURRENT LIABILITIESLO 1At maturity (July 1), Landscape records payment of the note and accrued interest as follows.Notes Payable 100,000Interest Payable 2,000 Cash 102,000CURRENT LIABILITIESLO 1Illustration: 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 100,000Discount on Notes Payable 2,000 Notes Payable 102,000Zero-Interest-Bearing Note IssuedCURRENT LIABILITIESLO 1Discount on Notes Payable is a contra account to Notes Payable, and therefore is subtracted from Notes Payable on the balance sheet.ILLUSTRATION 13-1Balance Sheet Presentation of DiscountDiscount on notes payable:Represents the cost of borrowing.Debited to interest expense over the life of the note.Represents interest expense chargeable to future periods. CURRENT LIABILITIESLO 1Illustration: (Accounts and Notes Payable) The following are selected 2017 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.CURRENT LIABILITIESLO 1Sept. 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 50,000CURRENT LIABILITIESLO 1Oct. 1 Accounts Payable 50,000 Notes Payable 50,000Interest calculation =Oct. 1 - Issued a $50,000, 12-month, 8% note to Orion in payment of account.Dec. 31 Interest Expense 1,000 Interest Payable 1,000($50,000 x 8% x 3/12) = $1,000CURRENT LIABILITIESLO 1Dec. 31 Interest Expense 1,500 Discount on Notes Payable 1,500Oct. 1 Cash 75,000 Discount on Notes Payable 6,000 Notes Payable 81,000($6,000 x 3/12) = $1,500Interest calculation =Oct. 1 - Borrowed $75,000 from the Shore Bank by signing a 12-month, zero-interest-bearing $81,000 note.CURRENT LIABILITIESLO 1Amount 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 reported in stockholders’ equity.Dividends PayableCURRENT LIABILITIESLO 1Returnable cash deposits received from customers and employees.To guarantee performance of a contract or service or as guarantees to cover payment of expected future obligations.May be classified as current or long-term liabilities.Customer Advances and DepositsCURRENT LIABILITIESLO 1Payment received before delivering goods or rendering services.Unearned RevenuesILLUSTRATION 13-3Unearned and Earned Revenue AccountsCURRENT LIABILITIESLO 1Illustration: Allstate University sells 10,000 season football tickets at $50 each for its five-game home schedule. Allstate University records the sales of season tickets as follows.Aug. 6 Cash 500,000 Unearned Sales Revenue 500,000 (10,000 x $50 = $500,000)As each game is completed, Allstate makes the following entry.Sept. 7 Unearned Sales Revenue 100,000 Sales Revenue 100,000 ($500,000 ÷ 5 games = $100,000 per game) CURRENT LIABILITIESLO 1Users of financial statements generally examine current liabilities to assess a company’s liquidity and overall financial flexibility. Companies must pay many current liabilities, such as accounts payable, wages payable, and taxes payable, sooner rather than later. A substantial increase in these liabilities should raise a red flag about a company’s financial position. This is not the case for all current liabilities. For example, Microsoft has a current liability entitled “Short-term unearned revenue” of $25,318 million in 2015 that has increased year after year. Unearned revenue is a liability that arises from sales of Microsoft products such as Internet Explorer and Windows. Microsoft also has provided coupons for upgrades to its programs to bolster sales of its XBox consoles and Surface tablets. At the time of a sale, customers pay not only for the current version of the product but also for future upgrades. Microsoft recognizes sales revenue from the current version of the software or product and records as a liability (unearned revenue) the value of future upgrades that it “owes” to customers. WHAT’S YOUR PRINCIPLEWHAT DO THE NUMBERS MEAN? MICROSOFT’S LIABILITIES—GOOD OR BAD?(continued)LO 1Market analysts read such an increase in unearned revenue as a positive signal about Microsoft’s sales and profitability. When Microsoft’s sales are growing, its unearned revenue account increases. Thus, an increase in a liability is good news about Microsoft sales. At the same time, a decline in unearned revenue is bad news. As one analyst noted, a slowdown or reversal of the growth in Microsoft’s unearned revenues indicates slowing sales, which is bad news for investors. Thus, increases in current liabilities can sometimes be viewed as good signs instead of bad.Sources: Adapted from David Bank, “Some Fans Cool to Microsoft, Citing Drop in Old Indicator,” Wall Street Journal (October 28, 1999); Bloomberg News, “Microsoft Profit Hit by Deferred Sales; Forecast Raised,” The Globe and Mail (January 26, 2007), p. B8; and D. Bass, “Microsoft Unearned Revenue Tops Estimates on Upgrades,” Bloomberg Business (July 19, 2012).WHAT’S YOUR PRINCIPLEWHAT DO THE NUMBERS MEAN? MICROSOFT’S LIABILITIES—GOOD OR BAD?LO 1Retailers must collect sales taxes from customers on transfers of tangible personal property and on certain services and then remit to the proper governmental authority.Sales Taxes PayableCURRENT LIABILITIESLO 1 Cash 3,120 Sales Revenue 3,000 Sales Taxes Payable ($3,000 x 4% = $120) 120Illustration: Prepare the entry to record sales taxes assuming there was a sale of $3,000 when a 4 percent sales tax is in effect.CURRENT LIABILITIESLO 1Many companies do not segregate the sales tax and the amount of the sale at the time of sale. Instead, the company credits both amounts in total in the Sales Revenue account. Illustration: Assume the Sales Revenue account balance of $150,000 includes sales taxes of 4 percent. Prepare the entry to record the amount due the taxing unit. Sales Revenue 5,769.23 Sales Taxes Payable 5,769.23Tax calculation =($150,000 ÷ 1.04 = $144,230.77,$150,000 - $144,230.77 = $5,769.23)CURRENT LIABILITIESLO 1Businesses 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 (tax law) and accounting income (GAAP) sometimes occur (Chapter 19).Income Tax PayableCURRENT LIABILITIESLO 1Amounts owed to employees for salaries or wages are reported as a current liability.Employee-Related LiabilitiesCurrent liabilities related to employee compensation may include:Payroll deductions.Compensated absences.Bonuses.CURRENT LIABILITIESLO 1Payroll DeductionsMost common types of payroll deductions are taxes, insurance premiums, employee savings, and union dues.Social Security Taxes (since January 1, 1937).Federal Old Age, Survivor, and Disability Insurance (OASDI) benefits for certain individuals and their families.Funds from taxes levied on both employer and employee.Current rate 6.2 percent based on the employee’s gross pay up to a $118,500 annual limit. OASDI tax is usually referred to as FICA.CURRENT LIABILITIESLO 1Social Security Taxes (since January 1, 1937)In 1965, Congress passed the first federal health insurance program for the aged—popularly known as Medicare.Alleviates the high cost of medical care for those over age 65.Hospital Insurance tax, paid by both employee and employer at the rate of 1.45 percent on the employee’s total compensation.OASDI tax (FICA) and the federal Hospital Insurance Tax is referred to as the Social Security tax.Payroll DeductionsCURRENT LIABILITIESLO 1Unemployment TaxesProvides a system of unemployment insurance.Federal Unemployment Tax Act (FUTA):Only employers pay the unemployment tax.Rate is 6.2 percent on the first $7,000 of compensation paid to each employee during the calendar year. If employer is subject to a state unemployment tax of 5.4 percent or more it receives a tax credit (not to exceed 5.4 percent) and pays only 0.8 percent tax to the federal government.Payroll DeductionsCURRENT LIABILITIESLO 1Unemployment TaxesState unemployment compensation laws differ both from the federal law and among various states. Employers must refer to the unemployment tax laws in each state in which they pay wages and salaries.Payroll DeductionsCURRENT LIABILITIESLO 1Income Tax WithholdingFederal and some state income tax laws require employers to withhold from each employee’s pay the applicable income tax due on those wages.Payroll DeductionsILLUSTRATION 13-5Summary of Payroll LiabilitiesCURRENT LIABILITIESLO 1Illustration: 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: Salaries and Wages Expense 10,000 Withholding Taxes Payable 1,320 FICA Taxes Payable 765 Union Dues Payable 88 Cash 7,827CURRENT LIABILITIESLO 1Illustration: 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 400CURRENT LIABILITIESLO 1Compensated AbsencesPaid 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.CURRENT LIABILITIESLO 1Compensated AbsencesILLUSTRATION 13-7Balance Sheet Presentation of Accrual for Compensated AbsencesCURRENT LIABILITIESLO 1Illustration: Amutron Inc. employs 10 individuals and pays each $480 per week. Employees earned 20 unused vacation weeks in 2017. In 2018, the employees used the vacation weeks, but now they each earn $540 per week. Amutron accrues the accumulated vacation pay on December 31, 2017, as follows. Salaries and Wages Expense 9,600 Salaries and Wages Payable ($480 x 20) 9,600In 2018, it records the payment of vacation pay as follows. Salaries and Wages Payable 9,600 Salaries and Wages Expense 1,200 Cash ($540 x 20) 10,800CURRENT LIABILITIESLO 1Payments 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. Bonus AgreementsCURRENT LIABILITIESLO 1Illustration: Palmer Inc. shows income for the year 2017 of $100,000. It will pay out bonuses of $10,700 in January 2018. Palmer makes an adjusting entry dated December 31, 2017, to record the bonuses as follows. Salaries and Wages Expense 10,700 Salaries and Wages Payable 10,700In 2018, Palmer records the payment of the bonus as follows. Salaries and Wages Payable 10,700 Cash 10,700CURRENT LIABILITIESLO 1Portion 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:Current Maturities of Long-Term DebtRetired by assets accumulated that have not been shown as current assets,Refinanced, or retired from the proceeds of a new debt issue, orConverted into capital stock.CURRENT LIABILITIESLO 1Describe the nature, valuation, and reporting of current liabilities. Explain the classification issues of short-term debt expected to be refinanced.LEARNING OBJECTIVESExplain the accounting for gain and loss contingencies.Indicate how to present and analyze liabilities and contingencies.After studying this chapter, you should be able to:Current Liabilities and Contingencies13LO 2Exclude from current liabilities if both of the following conditions are met:Short-Term Obligations Expected to Be RefinancedMust intend to refinance the obligation on a long-term basis.Must demonstrate an ability to refinance:Actual refinancing.Enter into a financing agreement.CURRENT LIABILITIESLO 2orShort-Term Obligations Expected to be RefinancedManagement Intends of RefinanceDemonstrates Ability to RefinanceActual Refinancing after balance sheet date but before issue dateFinancing Agreement Noncancellable with Capable LenderYESYESClassify as Current LiabilityNONOExclude Short-Term Obligations from Current Liabilities and Reclassify as LT DebtCURRENT LIABILITIESLO 2Illustration: On December 31, 2017, Alexander Company had $1,200,000 of short-term debt in the form of notes payable due February 2, 2018. On January 21, 2018, 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, 2018, 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, 2017, balance sheet is issued on February 23, 2018.Instructions: Show how the $1,200,000 of short-term debt should be presented on the December 31, 2017, balance sheet.LO 2CURRENT LIABILITIESPartial Balance SheetCurrent liabilities: Notes payable $300,000 Long-term debt: Notes payable refinanced 900,000 Total liabilities $1,200,000 December 31, 2017Balance sheet dateLiability of $1,200,000 How to classify?LO 2January 21, 2018February 2, 2018February 23, 2018Issued stock for $900,000Liability of $1,200,000 paid offFinancial statements issuedCURRENT LIABILITIESThe evaluation of credit quality involves more than simply assessing a company’s ability to repay loans. Credit analysts also evaluate debt management strategies. Analysts and investors will reward what they view as prudent management decisions with lower debt service costs and a higher stock price. The wrong decisions can bring higher debt costs and lower stock prices. General Electric Capital Corp., a subsidiary of General Electric, experienced the negative effects of market scrutiny of its debt management policies. Analysts complained that GE had been slow to refinance its mountains of short-term debt. GE had issued these current obligations, with maturities of 270 days or less, when interest rates were low. However, in light of expectations that the Fed would raise interest rates, analysts began to worry about the higher interest costs GE would pay when it refinanced these loans. Some analysts recommended that it was time to reduce dependence on short-term credit. The reasoning goes that a shift to more dependable long-term debt, thereby locking in slightly higher rates for the long-term, is the better way to go. Thus, scrutiny of GE debt strategies led to analysts’ concerns about GE’s earnings prospects. Investors took the analysis to heart, and GE experienced a two-day 6 percent drop in its stock price. Recently, GE and other companies, such as UPS and Apple, have responded to these criticisms and have been increasing issuance of long-term debt to lock-in continuing low interest rates.WHAT’S YOUR PRINCIPLEWHAT DO THE NUMBERS MEAN? WHAT ABOUT THAT SHORT-TERM DEBT?Sources: Adapted from Steven Vames, “Credit Quality, Stock Investing Seem to Go Hand in Hand,” Wall Street Journal (April 1, 2002), p. R4; V. Monga, ”Companies Feast on Cheap Money Market for 30-Year Bonds, Priced at Stark Lows, Brings Out GE, UPS and Other Once-Shy Issuers,” Wall Street Journal (October 8, 2012); and K. Burne and M. Cheney, “Apple’s Record Plunge into the Debt Pool,” Wall Street Journal (May, 1, 2013).Describe the nature, valuation, and reporting of current liabilities. Explain the classification issues of short-term debt expected to be refinanced.LEARNING OBJECTIVESExplain the accounting for gain and loss contingencies.Indicate how to present and analyze liabilities and contingencies.After studying this chapter, you should be able to:Current Liabilities and Contingencies13LO 3“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* FASB ASC 450-10-05-4. [Predecessor literature: “Accounting for Contingencies,” Statement of Financial Accounting Standards No. 5 (Stamford, Conn.: FASB, 1975), par. 1.]LO 3Typical Gain Contingencies are:Possible receipts of monies from gifts, donations, asset sales, and so on.Possible refunds from the government in tax disputes.Pending court cases with a probable favorable outcome.Tax loss carryforwards (Chapter 19).Gain contingencies are not recorded.Disclosed only if probability of receipt is high.Gain ContingenciesCONTINGENCIESLO 3Involves possible losses.Loss ContingenciesFASB uses three areas of probability:Probable.Reasonably possible.Remote.Likelihood of LossCONTINGENCIESLO 3AccountingProbabilityAccrueFootnoteIgnoreProbableReasonablyPossibleRemoteLoss ContingenciesLO 3Illustration: Scorcese Inc. is involved in a lawsuit at December 31, 2017. (a) Prepare the December 31 entry assuming it is probable that Scorcese will be liable for $900,000 as a result of this suit. (b) Prepare the December 31 entry, if any, assuming it is not probable that Scorcese will be liable for any payment as a result of this suit.(a) Lawsuit Loss 900,000 Lawsuit Liability 900,000Loss Contingencies(b) No entry is necessary. The loss is not accrued because it is not probable that a liability has been incurred at 12/31/17.LO 3ILLUSTRATION 13-13Accounting Treatment of Loss ContingenciesLO 3Loss ContingenciesCommon loss contingencies:Litigation, claims, and assessments. Guarantee and warranty costs.Premiums and coupons.Environmental liabilities.LO 3Loss ContingenciesCompanies 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.Litigation, Claims, and AssessmentsTime period in which the action occurred.Probability of an unfavorable outcome.Ability to make a reasonable estimate of the loss.LO 3Loss ContingenciesPromise made by a seller to a buyer to make good on a deficiency of quantity, quality, or performance in a product.Guarantee and Warranty CostsCompanies often provide one of two types of warranties to customers:Assurance-type warrantyService-type warrantyLO 3Guarantee and Warranty CostsWarranty that the product meets agreed-upon specifications in the contract at the time the product is sold.Should be expensed in the period the goods are provided or services performed. Should record a warranty liability. Assurance-Type WarrantyLO 3Assurance-Type WarrantyIllustration: Denson Machinery Company begins production of a new machine in July 2017 and sells 100 of these machines for $5,000 cash by year-end. Each machine is under warranty for one year. Denson estimates, based on past experience with similar machines, that the warranty cost will average $200 per unit. Further, as a result of parts replacements and services performed in compliance with machinery warranties, it incurs $4,000 in warranty costs in 2017 and $16,000 in 2018. What are the journal entries for the sale and the related warranty costs for 2017 and 2018?LO 3Assurance-Type WarrantyPrepare the journal entry to record the sale of the machines and accrue the warranty liability (July–December 2017).Cash 500,000 Warranty Expense 20,000 Warranty Liability 20,000 Sales Revenue 500,000Prepare the journal entry to record payment for warranty costs incurred (July–December 2017).Warranty Liability 4,000 Cash, Inventory, Accrued Payroll 4,000LO 3Assurance-Type WarrantyPrepare the journal entry to record payment for warranty costs incurred in 2018 related to 2017 machinery sales (January 1–December 31, 2018).Warranty Liability 16,000 Cash, Inventory, Accrued Payroll 16,000At the end of 2018, no warranty liability is reported for the machinery sold in 2017.LO 3Guarantee and Warranty CostsWarranty that provides an additional service beyond the assurance-type warranty.Recorded as a separate performance obligation.Usually recorded in an Unearned Warranty Revenue account. Recognize revenue on a straight-line basis over the period the service-type warranty is in effect. Service-Type WarrantyLO 3Service-Type WarrantyIllustration: You purchase an automobile from Hamlin Auto for $30,000 on January 2, 2017. Hamlin estimates the assurance-type warranty costs on the automobile to be $700 (Hamlin will pay for repairs for the first 36,000 miles or three years, whichever comes first). You also purchase for $900 a service-type warranty for an additional three years or 36,000 miles. Hamlin incurs warranty costs related to the assurance-type warranty of $500 in 2017 and $200 in 2018. Hamlin records revenue on the service-type warranty on a straight-line basis. What entries should Hamlin make in 2017 and 2020?LO 3Service-Type WarrantyPrepare the journal entry to record the sale of the automobile and related warranties (January 2, 2017).Cash ($30,000 + $900) 30,900 Warranty Expense 700 Warranty Liability 700 Unearned Warranty Revenue 900 Sales Revenue 30,000LO 3Service-Type WarrantyPrepare the journal entry to record warranty costs incurred in 2017 (January 2–December 31 2017).Warranty Liability 500 Cash, Inventory, Accrued Payroll 500Prepare the journal entry to record revenue recognized in 2020 on the service-type warranty (January 1–December 31, 2020).Unearned Warranty Revenue ($900 ÷ 3) 300 Warranty Revenue 300 LO 3Loss ContingenciesCompanies should charge the costs of premiums and coupons to expense in the period of the sale that benefits from the plan.Consideration PayableCompany 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 Premium Liability.LO 3Consideration PayableIllustration: Fluffy Cake Mix Company sells boxes of cake mix for $3 per box. In addition, Fluffy Cake Mix offers its customers a large durable mixing bowl in exchange for $1 and 10 box tops. The mixing bowl costs Fluffy Cake Mix $2, and the company estimates that customers will redeem 60 percent of the box tops. The premium offer began in June 2017. During 2017, Fluffy Cake Mix purchased 20,000 mixing bowls at $2, sold 300,000 boxes of cake mix for $3 per box, and redeemed 60,000 box tops. Prepare the journal entry to record the purchase of 20,000 mixing bowls at $2 per bowl.Premium inventory (20,000 mixing bowls × $2) 40,000 Cash 40,000LO 3Fluffy Cake Mix determines its premium expense and related premium liability. This computation is as follows. Total box tops sold in 2017 300,000 Estimated redemptions (in percent) 60% Total estimated redemptions 180,000 Cost of estimated redemptions [(180,000 box tops ÷ 10) × ($2 − $1)] $18,000Consideration PayablePrepare the entry to record the sale of the cake mix boxes and premium expense and premium liability. Cash (300,000 boxes of cake mix × $3) 900,000 Premium Expense 18,000 Sales Revenue 900,000 Premium Liability 18,000LO 3Prepare the entry to record the actual redemption of 60,000 box tops, the receipt of $1 per 10 box tops, and the delivery of the mixing bowls.Consideration PayableThe December 31, 2017, balance sheet of Fluffy Cake Mix reports Premium inventory of $28,000 ($40,000 − $12,000) as a current asset and Premium Liability of $12,000 ($18,000 − $6,000) as a current liability. The 2017 income statement reports $18,000 premium expense as a selling expense.Cash [(60,000 ÷ 10) × $1] 6,000 Premium Liability 6,000 Premium inventory [(60,000 ÷ 10) × $2] 12,000 LO 3Numerous companies offer premiums to customers in the form of a promise of future goods or services as an incentive for purchases today. Premium plans that have widespread adoption are the frequent-flyer programs used by all major airlines. On the basis of mileage accumulated, frequent-flyer members receive discounted or free airline tickets. Airline customers can earn miles toward free travel by making expenditures for such items as staying in hotels and charging gasoline and groceries on a credit card. Those free tickets represent an enormous potential liability because people using them may displace paying passengers.When airlines first started offering frequent-flyer bonuses, everyone assumed that they could accommodate the free-ticket holders with otherwise-empty seats. That made the additional cost of the program so minimal that airlines didn’t accrue it or report the small liability. But, as more and more paying passengers have been crowded off flights by frequent-flyer awardees, the loss of revenues has grown enormously. For example, Delta Air Lines reported liabilities of over $4.2 billion for frequent-flyer tickets.WHAT’S YOUR PRINCIPLEWHAT DO THE NUMBERS MEAN? FREQUENT FLYERSLO 3Loss ContingenciesA 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.ARO’s should be recorded as fair value.Environmental LiabilitiesLO 3Loss ContingenciesEnvironmental LiabilitiesObligating Events. Examples of existing legal obligations, which require recognition of a liability include, but are not limited to:Decommissioning nuclear facilities;Dismantling, restoring, and reclamation of oil and gas properties;Certain closure, reclamation, and removal costs of mining facilities;Closure and post-closure costs of landfills.LO 3Environmental LiabilitiesIllustration: On January 1, 2017, 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 620,920LO 3Illustration: 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.Depreciation Expense ($620,920 ÷ 5) 124,184 Accumulated Depreciation 124,184December 31, 2017 through 2021Environmental LiabilitiesLO 3Illustration: 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, 2017, as follows.December 31, 2017Interest Expense ($620,092 x 10%) 62,092 Asset Retirement Obligation 62,092Environmental LiabilitiesLO 3Illustration: On January 10, 2022, Wildcat contracts with Rig Reclaimers, Inc. to dismantle the platform at a contract price of $995,000. Wildcat makes the following journal entry torecord settlement of the ARO.Asset Retirement Obligation 1,000,000 Gain on Settlement of ARO 5,000 Cash 995,000January 10, 2022Environmental LiabilitiesLO 3Loss ContingenciesSelf-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.Self-InsuranceILLUSTRATION 13-18Disclosure of Self-InsuranceLO 3Describe the nature, valuation, and reporting of current liabilities. Explain the classification issues of short-term debt expected to be refinanced.LEARNING OBJECTIVESExplain the accounting for gain and loss contingencies.Indicate how to present and analyze liabilities and contingencies.After studying this chapter, you should be able to:Current Liabilities and Contingencies13LO 4PRESENTATION AND ANALYSISPresentation of Current LiabilitiesUsually reported at their full maturity value.Difference between present value and the maturity value is considered immaterial.Companies may list the accounts in Order of maturity, Descending order of amount, or Order of liquidation preference.LO 4ILLUSTRATION 13-19Balance Sheet Presentation of Current LiabilitiesLO 4If 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:A general description of the financing agreement.The terms of any new obligation incurred or to be incurred.The terms of any equity security issued or to be issued.Presentation of Current LiabilitiesLO 4Actual Refinancing of Short-Term DebtPresentation of Current LiabilitiesILLUSTRATION 13-20Actual Refinancing of Short-Term DebtLO 4Companies should disclose certain other contingent liabilities.Guarantees of indebtedness of others.Obligations of commercial banks under “stand-by letters of credit.”Guarantees to repurchase receivables (or any related property) that have been sold or assigned.Disclosure should include:Nature of the contingency.An estimate of the possible loss or range of loss or a statement that an estimate cannot be made. Presentation of ContingenciesPRESENTATION AND ANALYSISLO 4ILLUSTRATION 13-21Disclosure of Loss Contingency through LitigationLO 4Two ratios to help assess liquidity:Analysis of Current LiabilitiesILLUSTRATION 13-19Balance Sheet Presentation of Current LiabilitiesILLUSTRATION 13-25Computation of Current and Acid-Test Ratios for Best Buy Co.LO 4As indicated in the comparison of liquidity for Best Buy and Wal-Mart, Best Buy appears to be the more liquid company. However, a closer look at the elements of working capital may suggest a different story. This is because Wal-Mart could be using a strategy adopted by a number of retailers recently: to extend the period of time for paying their vendors. By pushing out payments to suppliers to three and four months, companies can pursue any number of other projects. For example, Mondelez is buying back stock. Kellogg’s is in the middle of a restructuring. Procter & Gamble’s move to extend its payment terms to 75 days in 2013 has probably added $1 billion so far to its cash flow. These strategies result in higher current liabilities and lower liquidity ratios. So while Wal-Mart looks less liquid, its strategy may pay off in the form of lower overall financing costs. According to a Kellogg’s spokesperson, by extending payments to 120 days, “it gives Kellogg’s and our suppliers more flexibility to manage our businesses effectively through better cash flow management.” Suppliers, however, may not share the same enthusiasm for extended paying terms. Receiving payments later is often crippling for suppliers, especially smaller businesses that have little cushion. In Britain, the Marketing AgenciesWHAT’S YOUR PRINCIPLEWHAT DO THE NUMBERS MEAN? I’LL PAY YOU LATER(continued)LO 4Association called on its member advertising agencies to “strike” in April against Anheuser-Busch InBev, after the company began seeking new terms. Those included acceptance of a payment period longer than 120 days and a request for pro bono work. According to one accounting analyst, “the additional financing costs that suppliers incur because they aren’t being paid promptly work their way back into higher prices for consumers.” In addition, this makes it difficult for investors to compare companies, if some are able to squeeze suppliers and others do not. Those with power in the supply chain, like Wal-Mart, may appear less liquid. So to make valid comparisons of liquidity ratios, you need know something about the company’s supply chain strategy.Source: S. Strom, “Big Companies Pay Later, Squeezing Their Suppliers,” The New York Times (April 7, 2015).WHAT’S YOUR PRINCIPLEWHAT DO THE NUMBERS MEAN? I’LL PAY YOU LATERLO 4LO 5 Compare the accounting procedures for current liabilities and contingencies under GAAP and IFRS.RELEVANT FACTS - SimilaritiesSimilar 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. RELEVANT FACTS - SimilaritiesThe 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.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).LO 5RELEVANT FACTS - DifferencesUnder 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 “midpoint” of the range is used to measure the liability. In GAAP, the minimum amount in a range is used. 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.LO 5RELEVANT FACTS - DifferencesIFRS and GAAP are similar in the treatment of asset retirement obligations (AROs). However, the recognition criteria for an ARO are more stringent under GAAP: The ARO is not recognized unless there is a present legal obligation and the fair value of the obligation can be reasonably estimated. Under IFRS, short-term obligations expected to be refinanced can be classified as non-current if the refinancing is completed by the financial statement date. GAAP uses the date the financial statements are issued.LO 5RELEVANT FACTS - DifferencesIFRS 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.LO 5Under IFRS, a provision is the same as:a contingent liability. an estimated liability. a contingent gain.None of the above.IFRS SELF-TEST QUESTIONLO 5IFRS SELF-TEST QUESTIONA typical provision is:bonds payable. cash. a warranty liability.accounts payable.LO 5In determining the amount of a provision, a company using IFRS should generally measure:using the midpoint of the range between the lowest possible loss and the highest possible loss.using the minimum amount of the loss in the range.using the best estimate of the amount of the loss expected to occur.using the maximum amount of the loss in the range.IFRS SELF-TEST QUESTIONLO 5“Copyright © 2016 John Wiley & Sons, Inc. All rights reserved. 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