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J-2 Learning Objectives Describe the accounting and disclosure requirements for contingent liabilities. 1 Discuss the accounting for lease liabilities and off-balance-sheet financing. 2 Appendix J Other Significant Liabilities Discuss additional fringe benefits associated with employee compensation. 3

J-3 Potential liability that may become an actual liability in the future. Three levels of probability:  Probable  Reasonably possible  Remote LO 1 LEARNING OBJECTIVE Describe the accounting and disclosure requirements for contingent liabilities. 1

J-4 AccountingProbability Accrue Footnote Ignore Probable Reasonably Possible Remote Contingent Liabilities LO 1

J-5 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. Question Contingent Liabilities LO 1

J-6 Product warranty contracts result in future costs that companies may incur in replacing defective units or repairing malfunctioning units. Estimated cost of honoring product warranty contracts should be recognized as an expense in the period in which the sale occurs. Recording a Contingent Liability Contingent Liabilities LO 1

J-7 Illustration: Denson Manufacturing Company sells 10,000 washers and dryers at an average price of $600 each. The selling price includes a one-year warranty on parts. Denson expects that 500 units (5%) will be defective and that warranty repair costs will average $80 per unit. In 2017, the company honors warranty contracts on 300 units, at a total cost of $24,000. At December 31, compute the estimated warranty liability. Illustration J-1 Computation of estimated product warranty liability Recording a Contingent Liability LO 1

J-8 Warranty Expense 40,000 Warranty Liability 40,000 Illustration: Denson Manufacturing Company sells 10,000 washers and dryers at an average price of $600 each. The selling price includes a one-year warranty on parts. Denson expects that 500 units (5%) will be defective and that warranty repair costs will average $80 per unit. In 2017, the company honors warranty contracts on 300 units, at a total cost of $24,000. At December 31, compute the estimated warranty liability. Make the required adjusting entry. LO 1 Recording a Contingent Liability

J-9 Illustration: Prepare the entry to record the repair costs incurred in 2017 to honor warranty contracts on 2017 sales. Warranty Liability24,000 Repair Parts 24,000 Assume that the company replaces 20 defective units in January 2018, at an average cost of $80 in parts and labor. Warranty Liability1,600 Repair Parts 1,600 LO 1 Recording a Contingent Liability

J-10 Illustration J-2 Disclosure of contingent liability LO 1 Disclosure of Contingent Liabilities

J-11 A lease is a contractual arrangement between a lessor (owner of the property) and a lessee (renter of the property). Illustration J-3 Types of leases LO 2 LEARNING OBJECTIVE Discuss the accounting for lease liabilities and off-balance-sheet financing. 2

J-12 Operating Lease Capital Lease Rent Expense xxx Cash xxx Leased Equipment xxx Lease Liability xxx Although technically legal title may not pass, the benefits from the use of the property do. Substance versus Form Leases LO 2

J-13 For a capital lease, the FASB has identified four criteria. 1.Lease transfers ownership of the property to the lessee. 2.Lease contains a bargain-purchase option. 3.Lease term is equal to 75 percent or more of the estimated economic life of the leased property. One or more must be met for capital lease accounting. 4.The present value of the minimum lease payments (excluding executory costs) equals or exceeds 90 percent of the fair value of the leased property. Capital Leases LO 2

J-14 Illustration: Gonzalez Company decides to lease new equipment. The lease period is four years; the economic life of the leased equipment is estimated to be five years. The present value of the lease payments is $190,000, 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. LO 2 Capital Leases

J-15 Illustration: (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 NO Lease term 4 yrs. Economic life5 yrs. YES 80% YES - PV and FMV are the same. Capital Lease? LO 2 Capital Leases

J-16 Illustration: (b) Prepare the journal entry to record the lease. Leased Asset - Equipment 190,000 Lease Liability190,000 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. LO 2 Capital Leases

J-17 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. Question LO 2 Capital Leases

J-18 Paid absences for vacation, illness, and holidays. Accrue a liability if:  Payment of the compensation is probable.  The amount can be reasonably estimated. Paid Absences LO 3 LEARNING OBJECTIVE Discuss additional fringe benefits associated with employee compensation. 3

J-19 Vacation Benefits Expense 3,300 Vacation Benefits Liability3,300 Illustration: Academy Company employees are entitled to one day’s vacation for each month worked. If 30 employees earn an average of $110 per day in a given month. Vacation Benefits Liability1,100 Cash1,100 Academy pays vacation benefits for 10 employees. Paid Absences LO 3

J-20 Postretirement Benefits Post-retirement benefits are benefits that employers provide to retired employees for 1.health care and life insurance 2.pensions. Companies account for post-retirement benefits on the accrual basis. LO 3

J-21 POSTRETIREMENT HEALTHCARE AND LIFE INSURANCE BENEFITS  Companies estimate and expense postretirement costs during the working years of the employee.  Companies rarely sets up funds to meet the cost of the future benefits. ► Pay-as-you-go basis for these costs. ► Major reason is that the company does not receive a tax deduction until it actually pays the medical bill. LO 3 Postretirement Benefits

J-22 An arrangement whereby an employer provides benefits to employees after they retire for services they provided while they were working. Pension Plan Administrator Pension Plan Administrator Contributions Employer Retired Employees Benefit Payments Assets & Liabilities PENSION PLANS LO 3 Postretirement Benefits

J-23 Defined-Contribution PlanDefined-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.  Actuaries estimate the employer contribution by considering mortality rates, employee turnover, interest and earning rates, early retirement frequency, future salaries, etc. PENSION PLANS LO 3 Postretirement Benefits

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