13-1

PREVIEW OF CHAPTER 13

Intermediate Accounting
16th Edition
Kieso ● Weygandt ● Warfield
13-2
 Current Liabilities and
13 Contingencies
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1 Describe the nature, valuation, 3 Explain the accounting for gain
and reporting of current and loss contingencies.
liabilities.
4 Indicate how to present and
2 Explain the classification issues analyze liabilities and
of short-term debt expected to be contingencies.
refinanced.

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 CURRENT LIABILITIES

“What is a Liability?”
The FASB, defined liabilities as:
“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.”

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 CURRENT LIABILITIES

Recall: Current assets are cash or other assets that companies

reasonably expect to convert into cash, sell, or consume in
operations within a single operating cycle or within a year.

Current liabilities are “obligations whose liquidation is

reasonably expected to require use of existing resources
properly classified as current assets, or the creation of other
current liabilities.”

Operating cycle: Period of time elapsing between the acquisition of goods

and services and the final cash realization resulting from sales and
subsequent collections.

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 CURRENT LIABILITIES

Typical Current Liabilities:

◆ Accounts payable. ◆ Customer advances and
deposits.
◆ Notes payable.
◆ Unearned revenues.
◆ Current maturities of long-
term debt. ◆ Sales taxes payable.

◆ Short-term obligations ◆ Income taxes payable.

expected to be refinanced.
◆ Employee-related liabilities.
◆ Dividends payable.

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 CURRENT LIABILITIES

Accounts Payable (trade accounts payable)

Balances owed to others for goods, supplies, or services
purchased on open account.
◆ Time lag between the receipt of services or acquisition of
title to assets and the payment for them.

◆ Terms of the sale (e.g., 2/10, n/30 or 1/10, E.O.M.) usually

state period of extended credit, commonly 30 to 60 days.

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 CURRENT LIABILITIES

Notes Payable
Written promises to pay a certain sum of money on a
specified future date.
◆ Arise from purchases, financing, or other transactions.

◆ Classified as short-term or long-term.

◆ May be interest-bearing or zero-interest-bearing.

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 CURRENT LIABILITIES

Interest-Bearing Note Issued

Illustration: Castle National Bank agrees to lend $100,000 on
March 1, 2017, to Landscape Co. if Landscape signs a $100,000,
6 percent, four-month note. Landscape records the cash received
on March 1 as follows:

Cash 100,000
Notes Payable 100,000

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 CURRENT LIABILITIES

If Landscape prepares financial statements semiannually, it

makes the following adjusting entry to recognize interest
expense and interest payable at June 30:

Interest calculation = ($100,000 x 6% x 4/12) = $2,000

Interest Expense 2,000

Interest Payable 2,000

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 CURRENT LIABILITIES

At maturity (July 1), Landscape records payment of the note and

accrued interest as follows.

Notes Payable 100,000

Interest Payable 2,000
Cash 102,000

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 CURRENT LIABILITIES

Zero-Interest-Bearing Note Issued

Illustration: On March 1, Landscape issues a $102,000, four-
month, zero-interest-bearing note to Castle National Bank. The
present value of the note is $100,000. Landscape records this
transaction as follows.

Cash 100,000
Discount on Notes Payable 2,000
Notes Payable 102,000

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 CURRENT LIABILITIES

Discount on Notes Payable is a contra account to Notes

Payable, and therefore is subtracted from Notes Payable on the
balance sheet. ILLUSTRATION 13-1
Balance Sheet Presentation of Discount

Discount on notes payable:

◆ Represents the cost of borrowing.
◆ Debited to interest expense over the life of the note.
◆ Represents interest expense chargeable to future periods.

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 CURRENT LIABILITIES

Illustration: (Accounts and Notes Payable) The following are

selected 2017 transactions of Darby Corporation.

Sept. 1 - Purchased inventory from Orion Company on account

for $50,000. Darby records purchases gross and uses a
periodic inventory system.

Oct. 1 - Issued a $50,000, 12-month, 8% note to Orion in

payment of account.

Oct. 1 - Borrowed $75,000 from the Shore Bank by signing a

12-month, zero-interest-bearing $81,000 note.

Prepare journal entries for the selected transactions.

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 CURRENT LIABILITIES

Sept. 1 - Purchased inventory from Orion Company on

account for $50,000. Darby records purchases gross and uses
a periodic inventory system.

Sept. 1 Purchases 50,000

Accounts Payable 50,000

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 CURRENT LIABILITIES

Oct. 1 - Issued a $50,000, 12-month, 8% note to Orion in payment

of account.

Oct. 1 Accounts Payable 50,000

Notes Payable 50,000

Interest calculation = ($50,000 x 8% x 3/12) = $1,000

Dec. 31 Interest Expense 1,000

Interest Payable 1,000

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 CURRENT LIABILITIES

Oct. 1 - Borrowed $75,000 from the Shore Bank by signing a 12-

month, zero-interest-bearing $81,000 note.

Oct. 1 Cash 75,000

Discount on Notes Payable 6,000
Notes Payable 81,000

Interest calculation = ($6,000 x 3/12) = $1,500

Dec. 31 Interest Expense 1,500

Discount on Notes Payable 1,500

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 CURRENT LIABILITIES

Dividends Payable
Amount owed by a corporation to its stockholders as a
result of board of directors’ authorization.

◆ Generally paid within three months.

◆ Undeclared dividends on cumulative preferred stock not

recognized as a liability.

◆ Dividends payable in the form of additional shares of

stock are reported in stockholders’ equity.

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 CURRENT LIABILITIES

Customer Advances and Deposits

Returnable cash deposits received from customers and
employees.
◆ To guarantee performance of a contract or service or

◆ as guarantees to cover payment of expected future

obligations.

◆ May be classified as current or long-term liabilities.

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 CURRENT LIABILITIES

Unearned Revenues
Payment received before delivering goods or rendering
services.

ILLUSTRATION 13-3
Unearned and Earned Revenue Accounts

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 CURRENT LIABILITIES

Illustration: Allstate University sells 10,000 season football tickets

at $50 each for its five-game home schedule. Allstate University
records the sales of season tickets as follows.

Aug. 6 Cash 500,000

Unearned Sales Revenue 500,000
(10,000 x $50 = $500,000)

As each game is completed, Allstate makes the following entry.

Sept. 7 Unearned Sales Revenue 100,000

Sales Revenue 100,000
($500,000 ÷ 5 games = $100,000 per game)

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 WHAT DO THE NUMBERS MEAN? MICROSOFT’S LIABILITIES—GOOD OR
BAD?
WHAT’S YOUR PRINCIPLE
Users of financial statements generally examine current liabilities to
assess a company’s liquidity and overall financial flexibility. Companies
must pay many current liabilities, such as accounts payable, wages
payable, and taxes payable, sooner rather than later. A substantial
increase in these liabilities should raise a red flag about a company’s
financial position. This is not the case for all current liabilities. For example,
Microsoft has a current liability entitled “Short-term unearned revenue” of
$25,318 million in 2015 that has increased year after year. Unearned
revenue is a liability that arises from sales of Microsoft products such as
Internet Explorer and Windows.
Microsoft also has provided coupons for upgrades to its programs to
bolster sales of its XBox consoles and Surface tablets. At the time of a
sale, customers pay not only for the current version of the product but also
for future upgrades. Microsoft recognizes sales revenue from the current
version of the software or product and records as a liability (unearned
revenue) the value of future upgrades that it “owes” to customers.
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 WHAT DO THE NUMBERS MEAN? MICROSOFT’S LIABILITIES—GOOD OR
BAD?
WHAT’S YOUR PRINCIPLE
Market analysts read such an increase in unearned revenue as a positive
signal about Microsoft’s sales and profitability. When Microsoft’s sales are
growing, its unearned revenue account increases. Thus, an increase in a
liability is good news about Microsoft sales. At the same time, a decline in
unearned revenue is bad news. As one analyst noted, a slowdown or
reversal of the growth in Microsoft’s unearned revenues indicates slowing
sales, which is bad news for investors. Thus, increases in current liabilities
can sometimes be viewed as good signs instead of bad.

Sources: Adapted from David Bank, “Some Fans Cool to Microsoft, Citing Drop in Old
Indicator,” Wall Street Journal (October 28, 1999); Bloomberg News, “Microsoft Profit Hit
by Deferred Sales; Forecast Raised,” The Globe and Mail (January 26, 2007), p. B8; and
D. Bass, “Microsoft Unearned Revenue Tops Estimates on Upgrades,” Bloomberg
Business (July 19, 2012).

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 CURRENT LIABILITIES

Sales Taxes Payable

Retailers must collect sales taxes from customers on
transfers of tangible personal property and on certain services
and then remit to the proper governmental authority.

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 CURRENT LIABILITIES

Illustration: Prepare the entry to record sales taxes assuming

there was a sale of $3,000 when a 4 percent sales tax is in effect.

Cash 3,120
Sales Revenue 3,000
Sales Taxes Payable ($3,000 x 4% = $120) 120

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 CURRENT LIABILITIES

Many companies do not segregate the sales tax and the amount of
the sale at the time of sale. Instead, the company credits both
amounts in total in the Sales Revenue account.

Illustration: Assume the Sales Revenue account balance of

$150,000 includes sales taxes of 4 percent. Prepare the entry to
record the amount due the taxing unit.

Tax calculation = ($150,000 ÷ 1.04 = $144,230.77,

$150,000 - $144,230.77 = $5,769.23)

Sales Revenue 5,769.23

Sales Taxes Payable 5,769.23

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 CURRENT LIABILITIES

Income Tax Payable

Businesses must prepare an income tax return and compute
the income tax payable.

◆ Taxes payable are a current liability.

◆ Corporations must make periodic tax payments.

◆ Differences between taxable income (tax law) and

accounting income (GAAP) sometimes occur (Chapter 19).

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 CURRENT LIABILITIES

Employee-Related Liabilities
Amounts owed to employees for salaries or wages are
reported as a current liability.

Current liabilities related to employee compensation may

include:

◆ Payroll deductions.

◆ Compensated absences.

◆ Bonuses.

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 CURRENT LIABILITIES

Payroll Deductions
Most common types of payroll deductions are taxes,
insurance premiums, employee savings, and union dues.

Social Security Taxes (since January 1, 1937).

► Federal Old Age, Survivor, and Disability Insurance
(OASDI) benefits for certain individuals and their families.

► Funds from taxes levied on both employer and employee.

► Current rate 6.2 percent based on the employee’s gross pay

up to a $118,500 annual limit.

► OASDI tax is usually referred to as FICA.

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 CURRENT LIABILITIES

Payroll Deductions
Social Security Taxes (since January 1, 1937)
► In 1965, Congress passed the first federal health insurance
program for the aged—popularly known as Medicare.

► Alleviates the high cost of medical care for those over age 65.

► Hospital Insurance tax, paid by both employee and employer

at the rate of 1.45 percent on the employee’s total
compensation.

► OASDI tax (FICA) and the federal Hospital Insurance Tax is

referred to as the Social Security tax.

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 CURRENT LIABILITIES

Payroll Deductions
Unemployment Taxes
Provides a system of unemployment insurance.
◆ Federal Unemployment Tax Act (FUTA):
► Only employers pay the unemployment tax.

► Rate is 6.2 percent on the first $7,000 of compensation paid

to each employee during the calendar year.

► If employer is subject to a state unemployment tax of 5.4

percent or more it receives a tax credit (not to exceed 5.4
percent) and pays only 0.8 percent tax to the federal
government.
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 CURRENT LIABILITIES

Payroll Deductions
Unemployment Taxes
State unemployment compensation laws differ both from the
federal law and among various states.

Employers must refer to the unemployment tax laws in each

state in which they pay wages and salaries.

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 CURRENT LIABILITIES

Payroll Deductions
Income Tax Withholding
► Federal and some state income tax laws require employers to
withhold from each employee’s pay the applicable income tax
due on those wages.
ILLUSTRATION 13-5
Summary of Payroll Liabilities

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 CURRENT LIABILITIES

Illustration: Assume a weekly payroll of $10,000 entirely subject to

F.I.C.A. and Medicare (7.65%), federal (0.8%) and state (4%)
unemployment taxes, with income tax withholding of $1,320 and union
dues of $88 deducted. The company records the salaries and wages
paid and the employee payroll deductions as follows:

Salaries and Wages Expense 10,000

Withholding Taxes Payable 1,320
FICA Taxes Payable 765
Union Dues Payable 88
Cash 7,827

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 CURRENT LIABILITIES

Illustration: Assume a weekly payroll of $10,000 entirely subject to

F.I.C.A. and Medicare (7.65%), federal (0.8%) and state (4%)
unemployment taxes, with income tax withholding of $1,320 and union
dues of $88 deducted. The company records the employers payroll
taxes as follows:

Payroll Tax Expense 1,245

FICA Taxes Payable 765
FUTA Taxes Payable 80
SUTA Taxes Payable 400

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 CURRENT LIABILITIES

Compensated Absences
Paid absences for vacation, illness, and holidays.

Accrue a liability if all the following conditions exist.

◆ The employer’s obligation is attributable to employees’

services already rendered.

◆ The obligation relates to rights that vest or accumulate.

◆ Payment of the compensation is probable.

◆ The amount can be reasonably estimated.

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 CURRENT LIABILITIES

Compensated Absences
ILLUSTRATION 13-7
Balance Sheet Presentation of
Accrual for Compensated Absences

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 CURRENT LIABILITIES

Illustration: Amutron Inc. employs 10 individuals and pays each $480

per week. Employees earned 20 unused vacation weeks in 2017. In
2018, the employees used the vacation weeks, but now they each
earn $540 per week. Amutron accrues the accumulated vacation pay
on December 31, 2017, as follows.

Salaries and Wages Expense 9,600

Salaries and Wages Payable ($480 x 20) 9,600

In 2018, it records the payment of vacation pay as follows.

Salaries and Wages Payable 9,600

Salaries and Wages Expense 1,200
Cash ($540 x 20) 10,800
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 CURRENT LIABILITIES

Bonus Agreements
Payments to certain or all employees in addition to their
regular salaries or wages.
◆ Bonuses paid are an operating expense.

◆ Unpaid bonuses should be reported as a current

liability.

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 CURRENT LIABILITIES

Illustration: Palmer Inc. shows income for the year 2017 of $100,000.
It will pay out bonuses of $10,700 in January 2018. Palmer makes an
adjusting entry dated December 31, 2017, to record the bonuses as
follows.

Salaries and Wages Expense 10,700

Salaries and Wages Payable 10,700

In 2018, Palmer records the payment of the bonus as follows.

Salaries and Wages Payable 10,700

Cash 10,700

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 CURRENT LIABILITIES

Current Maturities of Long-Term Debt

Portion of bonds, mortgage notes, and other long-term
indebtedness that matures within the next fiscal year.

Exclude long-term debts maturing currently if they are to be:

1. Retired by assets accumulated that have not been shown as

current assets,

2. Refinanced, or retired from the proceeds of a new debt issue,

or

3. Converted into capital stock.

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 Current Liabilities and
13 Contingencies
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1 Describe the nature, valuation, 3 Explain the accounting for gain
and reporting of current liabilities. and loss contingencies.
2 Explain the classification 4 Indicate how to present and
issues of short-term debt analyze liabilities and
expected to be refinanced. contingencies.

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 CURRENT LIABILITIES

Short-Term Obligations Expected to Be

Refinanced
Exclude from current liabilities if both of the following
conditions are met:
1. Must intend to refinance the obligation on a long-term basis.

2. Must demonstrate an ability to refinance:

◆ Actual refinancing.

◆ Enter into a financing agreement.

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 CURRENT LIABILITIES

Short-Term Obligations Expected to be Refinanced

NO
Management Intends of Refinance Classify as
YES Current
Liability
Demonstrates Ability to Refinance
NO
YES
Actual Refinancing after Financing Agreement
balance sheet date but or Noncancellable with Capable
before issue date Lender

Exclude Short-Term Obligations from Current

Liabilities and Reclassify as LT Debt
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 CURRENT LIABILITIES

Illustration: On December 31, 2017, Alexander Company had

$1,200,000 of short-term debt in the form of notes payable due
February 2, 2018. On January 21, 2018, the company issued 25,000
shares of its common stock for $36 per share, receiving $900,000
proceeds after brokerage fees and other costs of issuance. On
February 2, 2018, the proceeds from the stock sale, supplemented by
an additional $300,000 cash, are used to liquidate the $1,200,000
debt. The December 31, 2017, balance sheet is issued on February
23, 2018.
Instructions:
Show how the $1,200,000 of short-term debt should be presented on
the December 31, 2017, balance sheet.

13-45 LO 2
 CURRENT LIABILITIES
Liability of $1,200,000 Issued stock Liability of Financial
How to classify? for $900,000 $1,200,000 statements
paid off issued

December 31, 2017 January 21, 2018 February 2, 2018 February 23, 2018
Balance sheet date

Partial Balance Sheet

Current liabilities:
Notes payable $300,000
Long-term debt:
Notes payable refinanced 900,000
Total liabilities $1,200,000

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 WHAT DO THE NUMBERS MEAN? WHAT’S
WHAT ABOUTYOUR PRINCIPLE
THAT SHORT-TERM DEBT?

The evaluation of credit quality involves more than simply assessing a company’s ability
to repay loans. Credit analysts also evaluate debt management strategies. Analysts and
investors will reward what they view as prudent management decisions with lower debt
service costs and a higher stock price. The wrong decisions can bring higher debt costs
and lower stock prices. General Electric Capital Corp., a subsidiary of General
Electric, experienced the negative effects of market scrutiny of its debt management
policies. Analysts complained that GE had been slow to refinance its mountains of short-
term debt. GE had issued these current obligations, with maturities of 270 days or less,
when interest rates were low. However, in light of expectations that the Fed would raise
interest rates, analysts began to worry about the higher interest costs GE would pay
when it refinanced these loans. Some analysts recommended that it was time to reduce
dependence on short-term credit. The reasoning goes that a shift to more dependable
long-term debt, thereby locking in slightly higher rates for the long-term, is the better way
to go. Thus, scrutiny of GE debt strategies led to analysts’ concerns about GE’s earnings
prospects. Investors took the analysis to heart, and GE experienced a two-day 6 percent
drop in its stock price. Recently, GE and other companies, such as UPS and Apple,
have responded to these criticisms and have been increasing issuance of long-term debt
to lock-in continuing low interest rates.
Sources: Adapted from Steven Vames, “Credit Quality, Stock Investing Seem to Go Hand in Hand,” Wall Street Journal (April 1, 2002), p. R4; V.
Monga, ”Companies Feast on Cheap Money Market for 30-Year Bonds, Priced at Stark Lows, Brings Out GE, UPS and Other Once-Shy Issuers,”
13-47 Wall Street Journal (October 8, 2012); and K. Burne and M. Cheney, “Apple’s Record Plunge into the Debt Pool,” Wall Street Journal (May, 1, 2013).
 Current Liabilities and
13 Contingencies
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1 Describe the nature, valuation, 3 Explain the accounting for
and reporting of current liabilities. gain and loss contingencies.
2 Explain the classification issues 4 Indicate how to present and
of short-term debt expected to be analyze liabilities and
refinanced. contingencies.

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 CONTINGENCIES

“An existing condition, situation, or set of circumstances

involving uncertainty as to possible gain (gain
contingency) or loss (loss contingency) to an enterprise
that will ultimately be resolved when one or more future
events occur or fail to occur.”*

* FASB ASC 450-10-05-4. [Predecessor literature: “Accounting for

Contingencies,” Statement of Financial Accounting Standards No. 5
(Stamford, Conn.: FASB, 1975), par. 1.]

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 CONTINGENCIES

Gain Contingencies
Typical Gain Contingencies are:
1. Possible receipts of monies from gifts, donations, asset
sales, and so on.

2. Possible refunds from the government in tax disputes.

3. Pending court cases with a probable favorable outcome.

4. Tax loss carryforwards (Chapter 19).

Gain contingencies are not recorded.

Disclosed only if probability of receipt is high.

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 CONTINGENCIES

Notes:
Companies follow a conservative policy in this area; they do not
record gain contingencies.

A company discloses gain contingencies in the notes only when a

high probability exists for realizing them.

As a result, it is unusual to find information about contingent gains

in the financial statements and the accompanying notes.

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 CONTINGENCIES

Loss Contingencies
◆ Involves possible losses.

Likelihood of Loss
FASB uses three areas of probability:
◆ Probable.
◆ Reasonably possible.
◆ Remote.

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 Loss Contingencies

Probability Accounting

Probable Accrue

Reasonably
Footnote
Possible

Remote Ignore

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 Loss Contingencies

Illustration: Scorcese Inc. is involved in a lawsuit at December 31,

2017. (a) Prepare the December 31 entry assuming it is probable
that Scorcese will be liable for $900,000 as a result of this suit. (b)
Prepare the December 31 entry, if any, assuming it is not probable
that Scorcese will be liable for any payment as a result of this suit.

(a) Lawsuit Loss 900,000

Lawsuit Liability 900,000

(b) No entry is necessary. The loss is not accrued because it

is not probable that a liability has been incurred at
12/31/17.

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 ILLUSTRATION 13-13
13-55 Accounting Treatment of Loss Contingencies LO 3
 Loss Contingencies

Common loss contingencies:

1. Litigation, claims, and assessments.
2. Guarantee and warranty costs.
3. Premiums and coupons.
4. Environmental liabilities.

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 Loss Contingencies

Litigation, Claims, and Assessments

Companies must consider the following factors, in determining
whether to record a liability with respect to pending or
threatened litigation and actual or possible claims and
assessments.

◆ Time period in which the action occurred.

◆ Probability of an unfavorable outcome.

◆ Ability to make a reasonable estimate of the loss.

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 Loss Contingencies

Guarantee and Warranty Costs

Promise made by a seller to a buyer to make good on a
deficiency of quantity, quality, or performance in a product.
Companies often provide one of two types of warranties to
customers:
1. Assurance-type warranty

2. Service-type warranty

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 Guarantee and Warranty Costs

Assurance-Type Warranty
Warranty that the product meets agreed-upon
specifications in the contract at the time the product is sold.

◆ Should be expensed in the period the goods are

provided or services performed.

◆ Should record a warranty liability.

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 Assurance-Type Warranty

Illustration: Denson Machinery Company begins production of a

new machine in July 2017 and sells 100 of these machines for
$5,000 cash by year-end for a total sales revenue of $500,000
(100 × $5,000). Each machine is under warranty for one year.
Denson estimates, based on past experience with similar
machines, that the warranty cost will average $200 per unit for a
total expected warranty expense of $20,000 (100 × $200). Further,
as a result of parts replacements and services performed in
compliance with machinery warranties, it incurs$4,000 in warranty
costs in 2017 and $16,000 in 2018.

What are the journal entries for the sale and the related
warranty costs for 2017 and 2018?
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 Assurance-Type Warranty

1. Prepare the journal entry to record the sale of the machines

and related warranty costs for 2017 (July–December 2017).

Cash 500,000
Sales Revenue 500,000

2. Prepare the journal entry to record payment for warranty costs

incurred in 2017 (July–December 2017).

Warranty Expense 4,000

Cash, Inventory, Accrued Payroll 4,000

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 Assurance-Type Warranty

3. Prepare the adjusting entry to record estimated warranty

expense and warranty liability for expected warranty claims in
2018 (December 31, 2018).

Warranty Expense 16,000

Warranty Liability 16,000

As a result of this adjusting entry at December 31, 2017:

• Balance sheet reports a warranty liability (current) of $16,000
($20,000 – $4,000)
• Income statement for 2017 reports sales revenue of $500,000
and warranty expense of $20,000

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 Assurance-Type Warranty

4. Prepare the entry to record payment for warranty costs

incurred in 2018 related to 2017 machinery sales.

Warranty Liability 16,000

Cash, Inventory, Accrued Payroll 16,000

At the end of 2018, no warranty liability is reported for the

machinery sold in 2017.

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 Guarantee and Warranty Costs

Service-Type Warranty
Warranty that provides an additional service beyond the
assurance-type warranty.

◆ Recorded as a separate performance obligation.

◆ Usually recorded in an Unearned Warranty Revenue

account.

◆ Recognize revenue on a straight-line basis over the

period the service-type warranty is in effect.

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 Assurance and Service-Type Warranty

Illustration: You purchase an automobile from Hamlin Auto for

$30,000 on January 2, 2017. Hamlin estimates the assurance-type
warranty costs on the automobile to be $700 (Hamlin will pay for
repairs for the first 36,000 miles or three years, whichever comes
first). You also purchase for $900 a service-type warranty for an
additional three years or 36,000 miles. Hamlin incurs warranty
costs related to the assurance-type warranty of $100 in 2017 and
$100 in 2018 and 2019. Hamlin records revenue on the service-
type warranty on a straight-line basis..

What entries should Hamlin make in 2017 and 2020?

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 Assurance and Service-Type Warranty

1. Record the sale of the automobile and related warranties

(January 2, 2017).

Cash ($30,000 + $900) 30,900

Unearned Warranty Revenue 900
Sales Revenue 30,000

2. Record warranty costs incurred in 2017 (January 2–December

31 2017).

Warranty Expense 100

Cash, Inventory, Accrued Payroll 100

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 Assurance and Service-Type Warranty

3. Prepare the adjusting entry to record estimated warranty

expense and warranty liability for expected assurance warranty
claims in 2018 (December 31, 2017):

Warranty Expense 200

Warranty Liability 200

4. Record revenue recognized in 2020 on the service-type

warranty:

Unearned Warranty Revenue ($900 ÷ 3) 300

Warranty Revenue 300

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 Loss Contingencies

Consideration Payable
Companies should charge the costs of premiums and
coupons to expense in the period of the sale that benefits
from the plan.

◆ Company estimates the number of

outstanding premium offers that
customers will present for redemption.

◆ Company charges the cost of

premium offers to Premium Expense
and credits Premium Liability.

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 Consideration Payable

Illustration: Fluffy Cake Mix Company sells boxes of cake mix for $3
per box. In addition, Fluffy Cake Mix offers its customers a large
durable mixing bowl in exchange for $1 and 10 box tops. The mixing
bowl costs Fluffy Cake Mix $2, and the company estimates that
customers will redeem 60 percent of the box tops. The premium offer
began in June 2017. During 2017, Fluffy Cake Mix purchased 20,000
mixing bowls at $2, sold 300,000 boxes of cake mix for $3 per box,
and redeemed 60,000 box tops.

1. Prepare the journal entry to record the purchase of 20,000

mixing bowls at $2 per bowl.

Premium inventory (20,000 mixing bowls × $2) 40,000

Cash 40,000
13-69 LO 3
 Consideration Payable

2. Fluffy Cake Mix determines its premium expense and related

premium liability. This computation is as follows.
Total box tops sold in 2017 300,000
Estimated redemptions (in percent) 60%
Total estimated redemptions 180,000
Cost of estimated redemptions
[(180,000 box tops ÷ 10) × ($2 − $1)] $18,000

Prepare the entry to record the sale of the cake mix boxes and
premium expense and premium liability.
Cash (300,000 boxes of cake mix × $3) 900,000
Premium Expense 18,000
Sales Revenue 900,000
13-70
Premium Liability 18,000 LO 3
 Consideration Payable

3. Prepare the entry to record the actual redemption of 60,000

box tops, the receipt of $1 per 10 box tops, and the delivery of
the mixing bowls.

Cash [(60,000 ÷ 10) × $1] 6,000

Premium Liability 6,000
Premium inventory [(60,000 ÷ 10) × $2] 12,000

The December 31, 2017, balance sheet of Fluffy Cake Mix reports
Premium inventory of $28,000 ($40,000 − $12,000) as a current
asset and Premium Liability of $12,000 ($18,000 − $6,000) as a
current liability. The 2017 income statement reports $18,000
premium expense as a selling expense.
13-71 LO 3
 WHAT DO THE NUMBERS MEAN? WHAT’S YOUR PRINCIPLE
FREQUENT FLYERS

Numerous companies offer premiums to customers in the form of a promise of

future goods or services as an incentive for purchases today. Premium plans
that have widespread adoption are the frequent-flyer programs used by all
major airlines. On the basis of mileage accumulated, frequent-flyer members
receive discounted or free airline tickets. Airline customers can earn miles
toward free travel by making expenditures for such items as staying in hotels
and charging gasoline and groceries on a credit card. Those free tickets
represent an enormous potential liability because people using them may
displace paying passengers.
When airlines first started offering frequent-flyer bonuses, everyone assumed
that they could accommodate the free-ticket holders with otherwise-empty
seats. That made the additional cost of the program so minimal that airlines
didn’t accrue it or report the small liability. But, as more and more paying
passengers have been crowded off flights by frequent-flyer awardees, the loss
of revenues has grown enormously. For example, Delta Air Lines reported
liabilities of over $4.2 billion for frequent-flyer tickets.

13-72 LO 3
 Loss Contingencies

Environmental Liabilities
A company must recognize an asset retirement obligation
(ARO) when it has an existing legal obligation associated with
the retirement of a long-lived asset and when it can reasonably
estimate the amount of the liability.

ARO’s should be recorded as fair value.

13-73 LO 3
 Loss Contingencies

Environmental Liabilities
Obligating Events. Examples of existing legal obligations,
which require recognition of a liability include, but are not
limited to:
◆ Decommissioning nuclear facilities;

◆ Dismantling, restoring, and reclamation of oil and gas

properties;

◆ Certain closure, reclamation, and removal costs of mining

facilities;

◆ Closure and post-closure costs of landfills.

13-74 LO 3
 Environmental Liabilities

Illustration: On January 1, 2017, Wildcat Oil Company erected an

oil platform in the Gulf of Mexico. Wildcat is legally required to
dismantle and remove the platform at the end of its useful life,
estimated to be five years. Wildcat estimates that dismantling and
removal will cost $1,000,000. Based on a 10 percent discount rate,
the fair value of the asset retirement obligation is estimated to be
$620,920 ($1,000,000 x .62092). Wildcat records this ARO as
follows.

Drilling Platform 620,920

Asset Retirement Obligation 620,920

13-75 LO 3
 Environmental Liabilities

Illustration: During the life of the asset, Wildcat allocates the asset
retirement cost to expense. Using the straight-line method, Wildcat
makes the following entries to record this expense.

December 31, 2017 through 2021

Depreciation Expense ($620,920 ÷ 5) 124,184

Accumulated Depreciation 124,184

13-76 LO 3
 Environmental Liabilities

Illustration: In addition, Wildcat must accrue interest expense each

period. Wildcat records interest expense and the related increase in
the asset retirement obligation on December 31, 2017, as follows.

December 31, 2017

Interest Expense ($620,920 x 10%) 62,092

Asset Retirement Obligation 62,092

13-77 LO 3
 Environmental Liabilities

Illustration: On January 10, 2022, Wildcat contracts with Rig

Reclaimers, Inc. to dismantle the platform at a contract price of
$995,000. Wildcat makes the following journal entry to
record settlement of the ARO.

January 10, 2022

Asset Retirement Obligation 1,000,000

Gain on Settlement of ARO 5,000
Cash 995,000

13-78 LO 3
 Example

Oil Products Company purchases an oil tanker depot on

January 1, 2017, at a cost of $600,000. Oil Products expects
to operate the depot for 10 years, at which time it is legally
required to dismantle the depot and remove the underground
storage tanks. It is estimated that it will cost $75,000 to
dismantle the depot and remove the tanks at the end of the
depot’s useful life.
Instructions
a) Prepare the journal entries to record the depot and the
asset retirement obligation for the depot on January 1, 2017.
Based on an effective-interest rate of 6%, the present value
of the asset retirement obligation on January 1, 2017, is
13-79 $41,879.
 Example

b) Prepare any journal entries required for the depot and the
asset retirement obligation at December 31, 2017. Oil
Products uses straight-line depreciation; the estimated
salvage value for the depot is zero.
c) On December 31, 2026, Oil Products pays a demolition firm
to dismantle the depot and remove the tanks at a price of
$80,000. Prepare the journal entry for the settlement of the
asset retirement obligation.

13-80
 Solution

a)

Plant Assets 600,000

Cash 600,000

Plant Assets 41,879

Asset Retirement Obligation 41,879

13-81
 Solution

b)
Depreciation Expense 60,000
Accumulated Depreciation – Plant Assets 60,000

Depreciation Expense 4,188

Accumulated Depreciation – Plant Assets 4,188 *

Interest Expense 2,513

Asset Retirement Obligation 2,513 **

* 41,879/10
13-82 ** 41,879 X .06
 Solution

c)
Asset Retirement Obligation 75,000
Loss on ARO Settlement 5,000
Cash 80,000

13-83
 Loss Contingencies

Self-Insurance
Self-insurance is not insurance, but risk assumption.
There is little theoretical justification for the establishment of a
liability based on a hypothetical charge to insurance expense.
ILLUSTRATION 13-18
Disclosure of Self-Insurance

13-84
LO 3
 Current Liabilities and
13 Contingencies
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1 Describe the nature, valuation, 3 Explain the accounting for gain
and reporting of current liabilities. and loss contingencies.
2 Explain the classification issues 4 Indicate how to present and
of short-term debt expected to be analyze liabilities and
refinanced. contingencies.

13-85 LO 4
 PRESENTATION AND ANALYSIS

Presentation of Current Liabilities

◆ Usually reported at their full maturity value.
◆ Difference between present value and the maturity
value is considered immaterial.
◆ Companies may list the accounts in
► Order of maturity,

► Descending order of amount, or

► Order of liquidation preference.

13-86 LO 4
 ILLUSTRATION 13-19
Balance Sheet Presentation of Current Liabilities
13-87 LO 4
 Presentation of Current Liabilities

If a company excludes a short-term obligation from current

liabilities because of refinancing, it should include the
following in the note to the financial statements:
1. A general description of the financing agreement.

2. The terms of any new obligation incurred or to be incurred.

3. The terms of any equity security issued or to be issued.

13-88 LO 4
 Presentation of Current Liabilities

Actual Refinancing of Short-Term Debt

ILLUSTRATION 13-20
Actual Refinancing of Short-Term Debt

13-89 LO 4
 PRESENTATION AND ANALYSIS

Presentation of Contingencies
Disclosure should include:
◆ Nature of the contingency.

◆ An estimate of the possible loss or range of loss or a

statement that an estimate cannot be made.

Companies should disclose certain other contingent liabilities.

1. Guarantees of indebtedness of others.
2. Obligations of commercial banks under “stand-by letters of
credit.”
3. Guarantees to repurchase receivables (or any related property)
that have been sold or assigned.
13-90 LO 4
 ILLUSTRATION 13-21
13-91 Disclosure of Loss Contingency through Litigation LO 4
 ILLUSTRATION 13-19
Balance Sheet Presentation of Current Liabilities
Analysis of
Current
Liabilities

Two ratios to help

assess liquidity:

ILLUSTRATION 13-25
13-92 Computation of Current and Acid-Test Ratios for Best Buy Co. LO 4
 WHAT DO THE NUMBERS MEAN? I’LL PAY
WHAT’S YOUR YOU LATER
PRINCIPLE
As indicated in the comparison of liquidity for Best Buy and Wal-Mart, Best
Buy appears to be the more liquid company. However, a closer look at the
elements of working capital may suggest a different story. This is because Wal-
Mart could be using a strategy adopted by a number of retailers recently: to
extend the period of time for paying their vendors. By pushing out payments to
suppliers to three and four months, companies can pursue any number of other
projects. For example, Mondelez is buying back stock. Kellogg’s is in the
middle of a restructuring. Procter & Gamble’s move to extend its payment
terms to 75 days in 2013 has probably added $1 billion so far to its cash flow.
These strategies result in higher current liabilities and lower liquidity ratios. So
while Wal-Mart looks less liquid, its strategy may pay off in the form of lower
overall financing costs. According to a Kellogg’s spokesperson, by extending
payments to 120 days, “it gives Kellogg’s and our suppliers more flexibility to
manage our businesses effectively through better cash flow management.”
Suppliers, however, may not share the same enthusiasm for extended paying
terms. Receiving payments later is often crippling for suppliers, especially
smaller businesses that have little cushion. In Britain, the Marketing Agencies
13-93 (continued) LO 4
 WHAT DO THE NUMBERS MEAN? I’LL PAY
WHAT’S YOUR YOU LATER
PRINCIPLE
Association called on its member advertising agencies to “strike” in April
against Anheuser-Busch InBev, after the company began seeking new terms.
Those included acceptance of a payment period longer than 120 days and a
request for pro bono work. According to one accounting analyst, “the additional
financing costs that suppliers incur because they aren’t being paid promptly
work their way back into higher prices for consumers.” In addition, this makes it
difficult for investors to compare companies, if some are able to squeeze
suppliers and others do not. Those with power in the supply chain, like Wal-
Mart, may appear less liquid. So to make valid comparisons of liquidity ratios,
you need know something about the company’s supply chain strategy.
Source: S. Strom, “Big Companies Pay Later, Squeezing Their Suppliers,” The New York
Times (April 7, 2015).

13-94 LO 4
 RELEVANT FACTS - Similarities
◆ Similar to U.S. practice, IFRS requires that companies present current
and non-current liabilities on the face of the statement of financial
position (balance sheet), with current liabilities generally presented in
order of liquidity. However, many companies using IFRS present non-
current liabilities before current liabilities on the statement of financial
position.

LO 5 Compare the accounting procedures for current

13-95
liabilities and contingencies under GAAP and IFRS.
 RELEVANT FACTS - Similarities
◆ The basic definition of a liability under GAAP and IFRS is very similar. In
a more technical way, liabilities are defined by the IASB as a present
obligation of the entity arising from past events, the settlement of which
is expected to result in an outflow from the entity of resources
embodying economic benefits. Liabilities may be legally enforceable via
a contract or law but need not be. That is, they can arise due to normal
business practices or customs.
◆ IFRS requires that companies classify liabilities as current or non-current
on the face of the statement of financial position (balance sheet), except
in industries where a presentation based on liquidity would be
considered to provide more useful information (such as financial
institutions).

13-96 LO 5
 RELEVANT FACTS - Differences
◆ Under IFRS, the measurement of a provision related to a contingency is
based on the best estimate of the expenditure required to settle the
obligation. If a range of estimates is predicted and no amount in the
range is more likely than any other amount in the range, the “midpoint”
of the range is used to measure the liability. In GAAP, the minimum
amount in a range is used.
◆ Both IFRS and GAAP prohibit the recognition of liabilities for future
losses. However, IFRS permits recognition of a restructuring liability,
once a company has committed to a restructuring plan. GAAP has
additional criteria (i.e., related to communicating the plan to employees)
before a restructuring liability can be established.

13-97 LO 5
 RELEVANT FACTS - Differences
◆ IFRS and GAAP are similar in the treatment of asset retirement
obligations (AROs). However, the recognition criteria for an ARO are
more stringent under GAAP: The ARO is not recognized unless there is
a present legal obligation and the fair value of the obligation can be
reasonably estimated.
◆ Under IFRS, short-term obligations expected to be refinanced can be
classified as non-current if the refinancing is completed by the financial
statement date. GAAP uses the date the financial statements are issued.

13-98 LO 5
 RELEVANT FACTS - Differences
◆ IFRS uses the term provisions to refer to estimated liabilities. Under
IFRS, contingencies are not recorded but are often disclosed. The
accounting for provisions under IFRS and estimated liabilities under
GAAP are very similar.
◆ GAAP uses the term contingency in a different way than IFRS.
Contingent liabilities are not recognized in the financial statements under
IFRS, whereas under GAAP, a contingent liability is sometimes
recognized.

13-99 LO 5
 IFRS SELF-TEST QUESTION
Under IFRS, a provision is the same as:
a. a contingent liability.
b. an estimated liability.
c. a contingent gain.
d. None of the above.

13-100 LO 5
 IFRS SELF-TEST QUESTION
A typical provision is:
a. bonds payable.
b. cash.
c. a warranty liability.
d. accounts payable.

13-101 LO 5
 IFRS SELF-TEST QUESTION
In determining the amount of a provision, a company using IFRS
should generally measure:
a. using the midpoint of the range between the lowest possible
loss and the highest possible loss.
b. using the minimum amount of the loss in the range.
c. using the best estimate of the amount of the loss expected to
occur.
d. using the maximum amount of the loss in the range.

13-102 LO 5
 COPYRIGHT

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Reproduction or translation of this work beyond that permitted in
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express written permission of the copyright owner is unlawful.
Request for further information should be addressed to the
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may make back-up copies for his/her own use only and not for
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errors, omissions, or damages, caused by the use of these programs
or from the use of the information contained herein.”

13-103
 Company Name

Payroll statement

Deductions Deductions
Gross
‫الرقم‬

Emploee Name Position Basic salary All Deductions Net salary

Salary
Abear B. Risk B. Work N. Meals B Soci. Sec. Tax Social security Absence Advances
O

1 Ahmad GM 100,000 10,000 - 8,000 6,000 9,000 133,000 20,500 15,000 - - 35,500 97,500

2 Mohammed Mang. 80,000 8,000 6,000 6,000 7,200 107,200 17,940 12,000 - 5,000 34,940 72,260

3 Muadh Eng. 70,000 - 10,000 6,000 6,000 6,300 98,300 16,160 10,500 - 6,000 32,660 65,640

4 - - - - - - - - - - - - -

5 - - - - - - - - - - - - -

Total 250,000 18,000 10,000 20,000 18,000 22,500 338,500 54,600 37,500 - 11,000 103,100 235,400

13-104