CHAPTER 2

CURRENT LIABILITIES, PROVISIONS, AND

CONTINGENCIES

3-1
 CURRENT LIABILITIES
“What is a Liability?”

Liability is defined as present obligation of the company

arising from past events, the settlement of which is expected
to result in an outflow from the company of resources,
embodying economic benefits.

Three essential characteristics:

1. Present obligation.

2. Arises from past events.

3. Results in an outflow of resources

(cash, goods, services).
3-2
 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.”

A current liability is reported if one of two conditions exists:

1. Liability is expected to be settled within its normal operating cycle; or

2. Liability is expected to be settled within 12 months after the reporting

date.

The operating cycle is the period of time elapsing between the acquisition of
goods and services and the final cash realization resulting from sales and
subsequent collections.
3-3
 CURRENT LIABILITIES

Typical Current Liabilities:

1. Accounts payable. 6. Customer advances and
deposits.
2. Notes payable.
7. Unearned revenues.
3. Current maturities of long-
term debt. 8. Sales and value-added
taxes payable.
4. Short-term obligations
expected to be refinanced. 9. Income taxes payable.

5. Dividends payable. 10. Employee-related liabilities.

3-4
 CURRENT LIABILITIES

Accounts Payable (trade accounts payable)

Balances owed to others for goods, supplies, or services
purchased on open account.

 Arises because of 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.

 These liabilities typically are noninterest-bearing and are

reported at their face amounts.
3-5
 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.

 Notes classified as short-term or long-term.

 Notes may be interest-bearing or zero-interest-bearing.

3-6
 CURRENT LIABILITIES

E13-2: (Accounts and Notes Payable) The following are selected

2015 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.

3-7 LO 1
 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

3-8
 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

3-9
 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

Notes Payable 75,000

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

Dec. 31 Interest Expense 1,500

Notes Payable 1,500

3-10
 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.
Note: May be classified as current or non-current liabilities.
The classification of these items as current or noncurrent liabilities
depends on the time between the date of the deposit and the
termination of the relationship that required the deposit.
3-11
 CURRENT LIABILITIES: Unearned Revenues
Payment received before providing goods or performing
services.
How do these companies account for unearned revenues ?
1. When a company receives an advance payment, it debits Cash, and
credits a current liability account identifying the source of the
unearned revenue.
2. When a company recognizes revenue, it debits the unearned revenue
account, and credits a revenue account.

3-12
 CURRENT LIABILITIES

BE13-6: Sports Pro Magazine sold 12,000 annual subscriptions

on August 1, 2015, for €18 each. Prepare Sports Pro’s August 1,
2015, journal entry and the December 31, 2015, annual adjusting
entry.

Aug. 1 Cash 216,000

Unearned Revenue 216,000
(12,000 x €18)

Dec. 31 Unearned Revenue 90,000

Subscription Revenue 90,000
(€216,000 x 5/12 = €90,000)

3-13 LO 2
 CURRENT LIABILITIES

Sales and Value-Added Taxes Payable

Consumption taxes are generally either

 a sales tax or

 a value-added tax (VAT).

Purpose is to generate revenue for the government.

The two systems use different methods to accomplish this

objective.

3-14
 Sales Taxes Payable

Illustration: Halo Supermarket sells loaves of bread to

consumers on a given day for €2,400. Assuming a sales tax
rate of 15 percent, Halo Supermarket makes the following entry
to record the sale.
Cash 2,760
Sales Revenue 2,400
Sales Taxes Payable 360

3-15
 Value-Added Taxes Payable

Illustration: The VAT is collected every time a business

purchases products from another business in the product’s
supply chain. To illustrate,

1. Hill Farms Wheat Company grows wheat and sells it to

Sunshine Baking for €1,000. Hill Farms Wheat makes the
following entry to record the sale, assuming the VAT is 15
percent.

Cash 1,500
Sales Revenue 1,000
Value-Added Taxes Payable 150

3-16
 Value-Added Taxes Payable

2. Sunshine Baking makes loaves of bread from this wheat and

sells it to Halo Supermarket for €2,000. Sunshine Baking
makes the following entry to record the sale, assuming the
VAT is 15 percent.

Cash 2,300
Sales Revenue 2,000
Value-Added Taxes Payable 300

Sunshine Baking then remits €150 to the government, not €300. The
reason: Sunshine Baking has already paid €150 to Hill Farms Wheat.

3-17
 Value-Added Taxes Payable

3. Halo Supermarket sells the loaves of bread to consumers for

€2,400. Halo Supermarket makes the following entry to
record the sale, assuming the VAT is 15 percent.

Cash 2,760
Sales Revenue 2,400
Value-Added Taxes Payable 360

Halo Supermarket then sends only €60 to the tax authority as it

deducts the €300 VAT already paid to Sunshine Baking.

3-18
 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 and accounting income

sometimes occur. Because of these differences, the amount of
income taxes payable to the government in any given year may
differ substantially from income tax expense as reported on the
financial statements.
3-19
 FINANCIAL LIABILITIES

 Under IFRS 9, financial liabilities are obligations to deliver cash or

another financial asset.
Examples:
 Loans and Borrowings: Money borrowed that must be repaid, often
with interest.
 Trade Payables: Amounts owed to suppliers for goods or services
received.
 Bonds Payable: Long-term debt securities issued by a company to
raise capital.
Recognition and Measurement:
 Initially recorded at fair value.
 Subsequently measured at either amortized cost or fair value
depending on classification.

3-20
 Non-Financial Liabilities
 Obligations that do not require delivering cash or another financial
asset.
 Examples:
 Deferred Revenue: Cash received in advance for services to be
provided later.
 Employee Benefits: Liabilities for employee-related costs (e.g.,
salaries, pensions).
 Provisions: Obligations with uncertain timing/amount, such as legal
or environmental provisions.
 Recognition and Measurement:Recorded based on the best
estimate of the expenditure required to settle the obligation.Not
discounted unless the time value of money is material.

3-21
 Employee-Related Liabilities
Payroll Deductions
To the extent that a company has not remitted the amounts
deducted to the proper authority at the end of the accounting
period, it should recognize them as current liabilities.
Taxes:
► Social Security Taxes

► Income Tax Withholding

3-22
 Employee-Related Liabilities

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

Social Security taxes (8%), with income tax withholding of $1,320 and
union dues of $88 deducted. The company records the wages and
salaries paid and the employee payroll deductions as follows.

Wages and Salaries Expense 10,000

Withholding Taxes Payable 1,320
Social Security Taxes Payable 800
Union Dues Payable 88
Cash 7,792

3-23
 Employee-Related Liabilities

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

subject to Social Security taxes (8%), with income tax
withholding of $1,320 and union dues of $88 deducted.
The company records the employer payroll taxes as
follows.
Payroll Tax Expense 800
Social Security Taxes Payable 800

The employer must remit to the government its share of

Social Security tax along with the amount of Social
Security tax deducted from each employee’s gross
compensation.
3-24
 Decommissioning and Restoration Obligations

 Decommissioning obligations arise when an entity is legally or

constructively required to dismantle, remove, or restore an asset after its
useful life. This typically applies to industries like mining, oil, gas, and
nuclear power where dismantling and site restoration are necessary.
 Under IAS 37 an entity must recognize a provision for decommissioning
obligations if:
1. There is a present legal or constructive obligation as a result of past
events.
2. It is probable that an outflow of resources will be required to settle the
obligation.
3. The obligation can be reliably estimated.

3-25
 Reported either as
PROVISIONS
current or non-current liability.

 Provision is a liability of uncertain timing or amount.

Present obligation from past event outflow of benefits

Legal obligation creates constructive obligation

3-26
 When to Recognize Provision?

present obligation probable outflow reliable estimates

Are all conditions met?

Provision Contingent liability

3-27
 When to recognize a provision?

Can you avoid the obligation by your future action?

Yes No

Do not recognize a Provision Recognize a Provision

Example: Training of Personnel Warranty repairs

3-28
 How to measure a Provision?

Judgment

Individual most likely outcome

Expected Value
51% or more

 Risk and uncertainties  Future events

 Present Value  No gains from disposal of asset
3-29
 Provision
Future operating losses Onerous Contract Restructuring

Liability Unavoidable cost › economic benefit Program planned and controlled by

Management that changes scope or
manner of business

No Provision Provision Detailed Plan

Impairment of asset
Penalty
Net cost of fulfilling
Lower of it
3-30
 Common Types of Provisions

Common Types:
1. Lawsuits 4. Environmental

2. Warranties 5. Onerous contracts

3. Consideration payable 6. Restructuring

IFRS requires extensive disclosure related to provisions in the notes to

the financial statements. Companies do not record or report in the notes
general risk contingencies inherent in business operations (e.g., the
possibility of war, strike, uninsurable catastrophes, or a business
recession).

3-31
 CONTINGENCIES

 Possible obligation

 Confirmed by future uncertain events

 Present obligation unmeasurable or not probable

 Not recorded  disclosed

 Nature of events

 Estimates

3-32
 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.

3-33