Other Significant Liabilities Financial Accounting, Sixth Edition Appendix F Other Significant Liabilities Financial Accounting, Sixth Edition

Study Objectives Describe the accounting and disclosure requirements for contingent liabilities. Contrast the accounting for operating and capital leases. Identify additional fringe benefits associated with employee compensation. 1. On the topic, “Challenges Facing Financial Accounting,” what did the AICPA Special Committee on Financial Reporting suggest should be included in future financial statements? Non-financial Measurements (customer satisfaction indexes, backlog information, and reject rates on goods purchases). Forward-looking Information Soft Assets (a company’s know-how, market dominance, marketing setup, well-trained employees, and brand image). Timeliness (no real time financial information)

Contingent Liabilities 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. SO 1 Describe the accounting and disclosure requirements for contingent liabilities.

Contingent Liabilities Probability Accounting Probable Accrue Reasonably Possible Footnote Remote Need not record or disclose SO 1 Describe the accounting and disclosure requirements for contingent liabilities.

Contingent Liabilities Question A contingent liability should be recorded in the accounts when: it is probable the contingency will happen, but the amount cannot be reasonably estimated. it is reasonably possible the contingency will happen, and the amount can be reasonably estimated. it is probable the contingency will happen, and the amount can be reasonably estimated. it is reasonably possible the contingency will happen, but the amount cannot be reasonably estimated. SO 1 Describe the accounting and disclosure requirements for contingent liabilities.

Contingent Liabilities Recording a Contingent Liability Product Warranties Promise made by a seller to a buyer to make good on a deficiency of quantity, quality, or performance in a product. Estimated cost of honoring product warranty contracts should be recognized as an expense in the period in which the sale occurs. SO 1 Describe the accounting and disclosure requirements for contingent liabilities.

Contingent Liabilities Exercise: On December 1, Diaz Company introduces a new product that includes a one-year warranty on parts. In December, 1,000 units are sold. Management believes that 5% of the units will be defective and that the average warranty costs will be $80 per unit. Prepare the adjusting entry at December 31 to accrue the estimated warranty cost. 1,000 units x 5% x $80 = $4,000 Dec. 31 Warranty Expense 4,000 Warranty Liability 4,000 SO 1 Describe the accounting and disclosure requirements for contingent liabilities.

Contingent Liabilities Disclosure of Contingent Liabilities Disclosure should identify the Nature of the item. Amount of the contingency. Expected outcome of the future event. SO 1 Describe the accounting and disclosure requirements for contingent liabilities.

Lease Liabilities Lease Liabilities A lease is a contractual arrangement between a lessor (owner of the property) and a lessee (renter of the property). Illustration F-3 SO 2 Contrast the accounting for operating and capital leases.

Lease Liabilities Operating Lease Capital Lease The issue of how to report leases is the case of substance versus form. Although technically legal title may not pass, the benefits from the use of the property do. Operating Lease Capital Lease Journal Entry: Rent Expense xxx Cash xxx Journal Entry: Leased Equipment xxx Lease Liability xxx A lease that transfers substantially all of the benefits and risks of property ownership should be capitalized (only noncancellable leases may be capitalized). Statement of Financial Accounting Standard No. 13, “Accounting for Leases,” 1980 SO 2 Contrast the accounting for operating and capital leases.

Lease Liabilities To capitalize a lease, one or more of four criteria must be met: Transfers ownership to the lessee. Contains a bargain purchase option. Lease term is equal to or greater than 75 percent of the estimated economic life of the leased property. The present value of the minimum lease payments (excluding executory costs) equals or exceeds 90 percent of the fair value of the leased property. SO 2 Contrast the accounting for operating and capital leases.

Lease Liabilities Exercise: On January 1, 2007, Burke Corporation signed a 5-year noncancelable lease for a machine. The machine has an estimated useful life of 6 years and the present value of the lease payments is $36,144, which is equal to the fair market value of the equipment. There is no transfer of ownership during the lease term, nor is there any bargain purchase option. Instructions (a) What type of lease is this? Explain. (b) Prepare the journal entry to record the lease on January 1, 2007. SO 2 Contrast the accounting for operating and capital leases.

Lease Liabilities Exercise: (a) What type of lease is this? Explain. Capitalization Criteria: Transfer of ownership Bargain purchase option Lease term => 75% of economic life of leased property Present value of minimum lease payments => 90% of FMV of property Capital Lease? NO NO Lease term 5 yrs. Economic life 6 yrs. YES 83.3% YES - PV and FMV are the same. SO 2 Contrast the accounting for operating and capital leases.

Lease Liabilities Exercise: (b) Prepare the journal entry to record the lease on January 1, 2007. 1/1/07 Leased Asset - Equipment 36,144 Lease Liability 36,144 The portion of the lease liability expected to be paid in the next year is a current liability. The remainder is classified as a long-term liability. SO 2 Contrast the accounting for operating and capital leases.

Question Lease Liabilities The lessee must record a lease as an asset if the lease: transfers ownership of the property to the lessor. contains any purchase option. term is 75% or more of the useful life of the leased property. payments equal or exceed 90% of the fair market value of the leased property. SO 2 Contrast the accounting for operating and capital leases.

Additional Liabilities For Employee Fringe Benefits Illustration F-4 SO 2 Contrast the accounting for operating and capital leases.

Additional Employee Fringe Benefits Paid Absences Paid absences for vacation, illness, and holidays. Accrue a liability if: Payment of the compensation is probable. The amount can be reasonably estimated. Accrual Example: Vacation Benefits Expense 3,300 Vacation Benefits Payable 3,300 SO 3 Identify additional fringe benefits associated with employee compensation.

Additional Employee Fringe Benefits Postretirement Benefits Benefits provided by employers to retired employees for health care and life insurance (accrual basis) pensions SO 3 Identify additional fringe benefits associated with employee compensation.

Pension Plans A Pension Plan is an arrangement whereby an employer provides benefits (payments) to employees after they retire for services they provided while they were working. Pension Plan Administrator                                      Employer Contributions Retired Employees Benefit Payments Assets & Liabilities SO 3 Identify additional fringe benefits associated with employee compensation.

Defined-Contribution Plan Types of Pension Plans Defined-Contribution Plan Defined-Benefit Plan Employer contribution determined by plan (fixed) Risk borne by employees Benefits based on plan value Benefit determined by plan Employer contribution varies (determined by Actuaries) Risk borne by employer Companies record Pension costs as an expense. A liability when pension expense to date is more than the company’s contributions to date. An asset when pension expense to date is less than the company’s contributions to date. SO 3 Identify additional fringe benefits associated with employee compensation.

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