1. Chapter 13 – Current Liabilities and Contingencies
BUS1 121B – Intermediate Accounting II
Dr. Benjamin Anderson

2. Liabilities Basic element in the conceptual framework:
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.

3. Liabilities Probable or future sacrifices of economic benefits
Arise from present obligations to other entities
Result due to past transactions or events

4. Current Liabilities
Payable or result in an outflow of economic resources in one year or one operating cycle, whichever is longer
Normal classification of current vs. long-term

5. Common Types Accounts Payable and Trades Notes Payable
Informal borrowing arrangement paid under customary terms
Short-term Notes Payable
Formal borrowing arrangement for a short term
Accrued Liabilities
Expenses incurred but not yet paid
Liabilities due to Advance Collections
Cash receipts that result in a future payout of cash, goods, or services

6. Accounts Payable
Accounted for in a parallel way to accounts receivable
Cash discounts: use either the gross or the net method

7. Example
Receive invoice for $50,000 inventory on May 4, 2017, terms 2/15 n/45.
Pay on May 10, 2017
Pay on May 24, 2017

8. Short-Term Notes Payable
Often occur under an existing line of credit
Agreement to provide short-term financing according to certain terms
Calculate interest as:
Face amount*Annual Rate*Time To Maturity
Recall that when the stated rate differs from the rate, then interest expense will differ from the interest paid or payable

9. Example 1
Bank loan of $100,000 on March 1, Interest rate is 5%, which is equal to the effective market rate and is due at maturity on October 1, 2017

10. Example 2
Noninterest-bearing note from bank taken on May 1, $500,000 is due on November 1, Appropriate market rate of interest is 8%.

11. Commercial Paper
Commercial paper is when companies loan directly to each other
However, typically they are backed by a line of credit at a bank
Accounting is exactly the same as other short-term notes: the only difference is that the lender is not a bank.

12. Accrued Liabilities
These are expenses that have been incurred but have not yet had a cash outflow

13. Accrued Interest Payable
Interest payable represents cash interest that has been accrued but not yet paid
Note that this will differ from interest expense when the market rate of interest differs from the stated rate

14. Vacations and Other Paid Future Absences
If employees accrue paid vacation time which can be carried over to a following period, and some of it goes unused, then this represents a liability
Calculated as the existing wage rate times amount of time off earned but not used
Can be done on an individual basis or

15. Example
Have 500 employees, which earn 2 weeks of vacation over the year have used all vacation earned in the year have used one week. 50 have used neither week of vacation. The average worker is paid $800 per week

16. Liabilities due to Advance Collections
Liabilities can result from events where a company collects cash, but there is the requirement that, in the future, it may have to repay that cash or provide some good or service

17. Deposits
If a company collects cash from customers that may have to be returned later, upon the completion of some event, then should be recorded as a liability

18. Advances/Prepayments
Sometimes companies will collect cash in advance of services or goods being provided
In this case, we call the liability ‘deferred revenue’
The revenue is subsequently recognized when the performance obligation(s) is(are) satisfied

19. Collections for Third Parties
Collections which are to be remitted to another party are also liabilities
Example:
Company makes $1,000,000 in sales, on which it collects a sales tax of 7%

20. Other Matters Current maturities of long-term debt
Obligations callable by the creditor
Short-term obligations refinanced by long-term debt

21. Dollar Amount of Potential Loss Not Reasonably Estimable
Loss Contingencies
Contingencies arise due to an existing, uncertain situation involving potential loss depending on whether some future event occurs
Dollar Amount of Potential Loss
Known
Reasonably Estimable
Not Reasonably Estimable
Likelihood
Probable
Liability Accrued and Disclosure Note
Disclosure Note Only
Remote
No Disclosure Required

22. Product Warranties and Guarantees
Accruing for product warranties and other guarantees is an example of accruing for a type of loss contingency
If the liability will be resolved within one year and there is a single ‘most probable’ amount, then we

23. Example
Excellent Electronics sells home electronics products, which are covered by a one year warranty against defects.
In 2016, it sold $22.5 million in electronics and had $200,000 in warranty costs this year.
Internal analysts expect warranty costs to equal 2.5% of sales

24. Multiple Possible Amounts
Sometimes, instead of a single expected outflow, there are multiple with certain probabilities
In this case, we use the expected value of the expected outflow

25. Example
Adequate Accentures sells used furniture, which are covered by a one year warranty against defects. In 2017, it sold $30 million of furniture and had warranty expenses of $150,000
40% chance that warranty costs are $400,000, 35% chance that they are $500,000, and 25% chance that they are $550,000

26. Multiple Years until Payment
When more than one year will pass until the liability is resolved, then we must consider the time value of money as well

27. Litigation Litigation represents a potential future loss for companies
However, most companies do not accrue losses related to litigation
Often even after losing a lawsuit, so long as it’s in appeal

28. Subsequent Events
Companies must accrue for or disclose contingencies which become evident following the financial statement end date
If the financial statements have not yet been issued

29. Unasserted Claims
If it is probably that the claim will be asserted, then the claim must be treated as though it has been asserted, even if one has not yet been
For example, fines and penalties due to environmental regulations

30. Gain Contingencies Never accrued
Disclosed when future realization is probable