CURRENT LIABILITIES CURRENT LIABILITIES AND CONTINGENCIESAND CONTINGENCIES

Chapter 13

© 2009 The McGraw-Hill Companies, Inc.

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Slide 2

Characteristics of LiabilitiesCharacteristics of Liabilities

. . . Resulting from past

transactions or events.

. . . Resulting from past

transactions or events.

. . . Arising from

present obligations

to other entities . . .

. . . Arising from

present obligations

to other entities . . .

Probable future

sacrifices of economic

benefits . . .

Probable future

sacrifices of economic

benefits . . .

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Slide 3

What is a Current Liability?What is a Current Liability?

LIABILITIESLIABILITIES

Long-term LiabilitiesLong-term Liabilities

Expected to be satisfied with current assets or by

the creation of other current liabilities.

Expected to be satisfied with current assets or by

the creation of other current liabilities.

Current LiabilitiesCurrent Liabilities

Obligations payable within one year or one operating cycle, whichever is longer.

Obligations payable within one year or one operating cycle, whichever is longer.

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Open Accounts and NotesOpen Accounts and NotesAccounts Payable

Obligations to suppliers for goods purchased on open account.

Trade Notes PayableSimilar to accounts payable, but recognized by a written promissory note.

Short-term Notes PayableCash borrowed from the bank and recognized by a promissory note.

• Credit linesPrearranged agreements with a bank that allow a company to borrow cash without following normal loan procedures and paperwork.

Accounts PayableObligations to suppliers for goods purchased on open account.

Trade Notes PayableSimilar to accounts payable, but recognized by a written promissory note.

Short-term Notes PayableCash borrowed from the bank and recognized by a promissory note.

• Credit linesPrearranged agreements with a bank that allow a company to borrow cash without following normal loan procedures and paperwork.

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Noninterest-Bearing NotesNoninterest-Bearing Notes

Notes without a stated interest rate carry an implicit, or effective rate.

The face of the note includes the amount borrowed and the interest.

Notes without a stated interest rate carry an implicit, or effective rate.

The face of the note includes the amount borrowed and the interest.

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Slide 6

Commercial PaperCommercial Paper

Commercial paper is a term used for unsecured notes issued in minimum

denominations of $25,000 with maturities ranging from 30 days to 270 days.

Commercial paper is a term used for unsecured notes issued in minimum

denominations of $25,000 with maturities ranging from 30 days to 270 days.

Normally, commercial paper is issued directly to the lender and is backed by a line of credit with a bank.Normally, commercial paper is issued directly to the lender and is backed by a line of credit with a bank.

Commercial paper is recorded in thesame manner as notes payable.

Commercial paper is recorded in thesame manner as notes payable.

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Salaries, Commissions, and BonusesSalaries, Commissions, and Bonuses

Compensation expenses such as salaries, commissions, and bonuses

are liabilities at the balance sheet date if earned but unpaid.

These accrued expenses/accrued liabilities

are recorded with an adjusting entry prior to

preparing financial statements.

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Slide 8

A Closer Look at the Current andA Closer Look at the Current andNoncurrent ClassificationNoncurrent Classification

Current maturities of long-term obligations are usually reclassified and reported as current

liabilities if they are payable within the upcoming year (or operating cycle, if longer than a year).

Current maturities of long-term obligations are usually reclassified and reported as current

liabilities if they are payable within the upcoming year (or operating cycle, if longer than a year).

Debt that is callable (due on demand) by the lender in the coming year, (or operating cycle, if

longer than a year) should be classified as a current liability, even if the debt is not expected to

be called.

Debt that is callable (due on demand) by the lender in the coming year, (or operating cycle, if

longer than a year) should be classified as a current liability, even if the debt is not expected to

be called.

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Slide 9

The ability to refinance on a long-term basiscan be demonstrated by an: existing refinancing agreement, or actual financing prior to issuance of the financial statements.

The ability to refinance on a long-term basiscan be demonstrated by an: existing refinancing agreement, or actual financing prior to issuance of the financial statements.

Short-Term Obligations ExpectedShort-Term Obligations Expectedto be Refinancedto be Refinanced

A company may reclassify a short-term liability as long-term only if two conditions are met:

A company may reclassify a short-term liability as long-term only if two conditions are met:

It has the intent to refinance on a long-term basis.

It has the intent to refinance on a long-term basis.

It has demonstrated the ability to refinance.

It has demonstrated the ability to refinance.

and

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Slide 10

ContingenciesContingencies

A loss contingency is accrued only if a loss is probable and the amount can reasonably be estimated.

A loss contingency is accrued only if a loss is probable and the amount can reasonably be estimated.

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Slide 11

Product Warranties and GuaranteesProduct Warranties and Guarantees

Product warranties inevitably entail costs.The amount of those costs can be reasonably

estimated using commonly available estimation techniques.

The estimate requires the following entry:

Product warranties inevitably entail costs.The amount of those costs can be reasonably

estimated using commonly available estimation techniques.

The estimate requires the following entry:

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Extended WarrantiesExtended Warranties

Extended warranties are sold separately from the product.

The related revenue is not earned until: Claims are made against the extended

warranty, or The extended warranty period expires.

Extended warranties are sold separately from the product.

The related revenue is not earned until: Claims are made against the extended

warranty, or The extended warranty period expires.

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Slide 13

Litigation ClaimsLitigation Claims

The majority of medium and large-size corporations annually report loss contingencies due to litigation.

The most common disclosure is a note to the financial statements.

The majority of medium and large-size corporations annually report loss contingencies due to litigation.

The most common disclosure is a note to the financial statements.

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Slide 14

Subsequent EventsSubsequent Events

Events occurring between the year-end date and report date can affect the

appearance of disclosures on the financial statements.

Events occurring between the year-end date and report date can affect the

appearance of disclosures on the financial statements.

Fiscal Year Ends Financial Statements

ClarificationCause of Loss Contingency

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Unasserted Claims and AssessmentsUnasserted Claims and Assessments

Is a claimIs a claimor assessmentor assessment

probable?probable?

Is a claimIs a claimor assessmentor assessment

probable?probable?No

Yes

NoNodisclosuredisclosure

neededneeded

NoNodisclosuredisclosure

neededneeded

UnassertedUnassertedclaimclaim

UnassertedUnassertedclaimclaim

Evaluate (a) the likelihood of an unfavorable outcome andEvaluate (a) the likelihood of an unfavorable outcome and(b) whether the dollar amount can be estimated.(b) whether the dollar amount can be estimated.

An estimated loss and contingent liability would beaccrued if an unfavorable outcome is probable and the

amount can be reasonably estimated.

Evaluate (a) the likelihood of an unfavorable outcome andEvaluate (a) the likelihood of an unfavorable outcome and(b) whether the dollar amount can be estimated.(b) whether the dollar amount can be estimated.

An estimated loss and contingent liability would beaccrued if an unfavorable outcome is probable and the

amount can be reasonably estimated.

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Slide 16

Gain ContingenciesGain Contingencies

As a general rule, we As a general rule, we never record never record GAINGAIN

contingenciescontingencies..

Note that the prior rules have Note that the prior rules have supported the recording of supported the recording of LOSSLOSS

contingencies.contingencies.

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End of Chapter 13End of Chapter 13

© 2009 The McGraw-Hill Companies, Inc.