2. Chapter 10: Current Liabilities and Contingencies
What is a liability?
“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.”

3. Reporting Liabilities on the Balance Sheet: Economic Consequences
Shareholders and investors
interest expense is tax deductible, but more debt means more risk to shareholders
equity ownership is subordinated to creditors
Creditors
restrictive covenants regarding debt limits
Management
wants to minimize debt on the balance sheet
often looks for “off-balance sheet” financing
less debt now improves ability to borrow in the future

4. Current Liabilities Classification
expected to require the use of current assets (or the creation of other current liabilities) to settle the obligation.
Valuing current liabilities on the balance sheet
Ignore present value (report at face value)
Reporting current liabilities
Primary problem is ensuring that all existing current liabilities are reported on the balance sheet.

5. Determinable Current Liabilities
1. Accounts payable (Ch 7)
2. Short-term notes
3. Current maturities of long-term debts
4. Dividends payable
5. Unearned revenues (Ch 5)
6. Sales taxes
7. Income taxes payable (App 10B)
8. Payroll taxes

6. Determinable CL - continued
9. Accrued liabilities - accrue expense and liability at the end of the current period, and usually paid sometime during the next year. For each item, debit expense and credit liability. Examples include:
Wages payable
Salary payable
Interest payable
Rent payable
Insurance payable
Property taxes payable
Employee bonuses

7. Contingent Liabilities
Contingent on some future event or activity in order to know the exact amount.
Examples: warranties, coupons and lawsuits
Current Examples?
Changes in estimate may be made in subsequent periods, when future event is concluded.

8. Figure 10-5

9. Contingent Liabilities - continued
1. Warranties
Uncertain future costs
Record estimated expense and liability when products are sold (matching concept):
Warranty Expense xx
Estimated Warranty Liability xx
As costs are incurred (usually in subsequent periods), charge expenditure to warranty liability:
Cash, etc. xx

10. Contingent Liabilities - continued
2. Coupons and Premiums
Record estimated expense and liability when products are sold (matching concept):
Promotion Expense xx
Estimated Coupon Liability xx
As costs are incurred, as coupons or promotional offerings are redeemed (usually in subsequent periods), charge expenditure to liability:
Cash, etc. xx

11. Contingent Liabilities - continued
3. Lawsuits
If contingency should be accrued:
Estimated Loss on Lawsuit xx
Estimated Liability xx
(and disclose information regarding case)

12. Class 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.

13. Class Problem: P10-4, Part c:
Adjusting journal entry for 2008:
Estimated loss 742,000
Estimated liability ,000
(Best guess in the range)
Journal entry at settlement (8/12/09):
Estimated liability 742,000
Recovery of estimated loss 52,000
Cash ,000

14. Warranty A promise by a manufacturer or seller to ensure the quality or performance of the product for a specific period of time
I’ll stand behind it
for 50 miles
or 50 minutes
whichever comes first
Almost Honest
JOHN’S
Used Cars 13

15. Class Exercise: E10-10(a)
(1) GJE to record sale in 2008 $250 each):
Cash 50,000
Sales revenue ,000
(2) AJE in 2008 to record estimated warranty for the sales $20):
Warranty expense 4,000
Estimated Warr. Liability 4,000
(3) GJE to record payment in 2008 for repairs:
Est. Warr. Liability 1,400
Cash 1,400
GJE to record payment in 2009 for repairs:
Est. Warr. Liability 2,600
Cash 2,600

16. Class Exercise: E10-10(b)
Income effects for the revenue and warranty expense under the two alternative for recognition of expense (expressed in thousands):
Accrue Expense Expense as Paid
Revenues , ,
Warr. Expense (4,000) (1,400) (2,600)
Note that the accrual method recognizes the expense in the same period as the revenues generated by the sale.

17. Deferred Taxes Journal entry for historical treatment:
I. T. Expense xx net income x %
DIT (debit or credit) xx / xx plug
I. T. Payable xx tax income x %
Problems:
after many years, the difference, primarily due to things like depreciation, had become one of the larger liabilities on the balance sheet.
in some cases, the liability was greater than anything else in the balance sheet.
Solution (in SFAS 109): prepare a detailed schedule to calculate the amount for IT Payable and DIT, and let IT Expense be the plug.

18. SFAS 109 Journal entry for SFAS 109: I. T. Expense xx plug
DIT xx / xx schedule
I. T. Payable xx schedule
Before developing the schedule, we first need to discuss what items need to go into the schedule.
Permanent differences (like income on municipal bonds) are excluded from the DIT schedule.
Only temporary differences are included in the schedule.
Temporary differences fall into two categories:
those differences that lead to lower taxable income at the time of origination (future taxable).
those differences that lead to higher taxable income at the time of origination (future deductible).

19. SFAS 109 - Future Taxable Items
Future taxable (FT) items are amounts that are taxable in the future, because they are not taxable now. They include:
Revenues or gains that are recognized in taxable income after they are recognized in financial income (such as income from equity investments in excess of dividends received).
Expenses or losses that are recognized in taxable income before they are recognized in financial income (such as MACRS depreciation used for taxable income, while straight-line depreciation used for financial income.)

20. SFAS 109 - Future Deductible Items
Future deductible (FD) items are amounts that lead to more tax now, but less tax in the future They include:
Revenues or gains that are recognized in taxable income before they are recognized in financial income (such as cash received in advance for future services).
Expenses or losses that are recognized in taxable income after they are recognized in financial income (this includes most estimates, such as bad debt expense, warranty expense loss contingencies, and pension expense in excess of cash paid).

21. Illustration of Schedule in First Year
Assume a 30% tax rate for current and future years.
Current year Future years
I. T. Payable Deferred I.T.
Pretax financial income $100,000
Future taxable:
Exp: excess MACRS depr (1,000) 1,000
Taxable income
Deferred amount
Tax rate
Income tax payable
Deferred tax liability
Journal entry (income tax expense is the plug):
$ 99,000
1,000
$29,700
$300
Income tax expense ,000
Income tax payable 29,700
Deferred tax liability

22. Copyright
© 2008 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein. 22 22