CHAPTER 13

1 13-1 CHAPTER 13 Current Liabilities and ContingenciesASSIGNMENT CLASSIFICATION TABLE (BY TOPIC)TopicsQuestionsBriefExercisesExerc isesProblems Conceptsfor Analysis1. Concept of liabilities;definition and classificationof current , 2, 3, 4,5, 6, 81, 161, 212. Accounts and notespayable; dividends , 11, 291, 2, 32, 161, 21, 23. Short-term obligationsexpected to be , 1043, 43, 44. Deposits and Compensated , 14, 1585, 6, 166. Collections for third , 77, 8, 9, 163, 47. Contingent liabilities(General).17, 18, 19,20, 2210, 1113, 1610, 11, 135, 6, 78. Guaranties and , 2313, 1410, 11, 165, 6, 7,12, 157, 89. Premiums and awardsoffered to , 251512, 15, 168, 9, 12, 1510. Self-insurance, litigation,claims, and assessments,asset retirement , 27, 2812142, 10,11, 136, 711. Presentation and , 30, 3117, 18, 1993*12. Bonus , 1620, 21, 2214, 15*This material is covered in an Appendix to the CLASSIFICATION TABLE (BY LEARNING OBJECTIVE)Learning Objectives the nature, type, and valuationof current , 2, 3, 4,5, 61, 2, 71, the classification issues of short-termdebt expected to be , types of employee-related , 8, 95, 6, 8, 93, the criteria used to account for anddisclose gain and loss , 11, 12,13, 14, 15137, 10, 11, the accounting for different typesof loss , 11, 12,13, 14, 1510, 11, 12,13, 14, 152, 5, 6, 7, 8,9, 10, 11, 12,13, how to present and analyze liabilitiesand , 17,18, 199* employee bonuses under , 21, 2214, 1513-3 ASSIGNMENT CHARACTERISTICS TABLEItemDescriptionLevel ofDifficultyTime(minutes)

2 E13-1 Balance sheet classification of various 15 E13-2 Accounts and notes 20 E13-3 Refinancing of short-term 12 E13-4 Refinancing of short-term 25 E13-5 Compensated 30 E13-6 Compensated 30 E13-7 Adjusting entry for sales 7 E13-8 Payroll tax 15 E13-9 Payroll tax 20 15 20 E13-12 Premium 20 30 E13-14 Asset retirement 30 30 E13-16 Financial statement impact of liability 35 E13-17 Ratio computations and 15 E13-18 Ratio computations and 25 E13-19 Ratio computations and effect of 25*E13-20 Bonus 15*E13-21 Bonus computation and income statement 20*E13-22 Bonus 20 P13-1 Current liability entries and 30 P13-2 Liability entries and 35 P13-3 Payroll tax 30 P13-4 Payroll tax 25 P13-5 Warranties, accrual, and cash 20 P13-6 Extended 20 P13-7 Warranties, accrual, and cash 35 P13-8 Premium 25 P13-9 Premium entries and financial statement 45 P13-10 Loss contingencies: entries and 30 P13-11 Loss contingencies: entries and 45 P13-12 Warranties and 30 P13-13 Liability 35*P13-14 Bonus 30*P13-15 Warranty, bonus, and coupon 25 C13-1 Nature of 25 C13-2 Current versus noncurrent 20 C13-3 Refinancing of short-term 40 C13-4 Refinancing of short-term 25 C13-5 Loss 20 C13-6 Loss 20 C13-7 Warranties and loss 20 2513-4 ANSWERS TO QUESTIONS1.

3 Current liabilities are obligations whose liquidation is reasonably expected to require use ofexisting resources properly classified as current assets or the creation of other current debt consists of all liabilities not properly classified as current You might explain to your friend that the accounting profession at one time prepared financialstatements somewhat in accordance with the broad or loose definition of a liability submitted bythe AICPA in 1953: Something represented by a credit balance that is or would be properlycarried forward upon a closing of books of account according to the rules or principles ofaccounting, provided such credit balance is not in effect a negative balance applicable to an the word is used broadly to comprise not only items which constitute liabilities in the propersense of debts or obligations (including provision for those that are unascertained), but also creditbalances to be accounted for which do not involve the debtor and creditor relation.

4 Since your friend may not have completely understood the above definition (if it may be calledthat), you might indicate that more recent definitions of liabilities call for the disbursement of assetsor services in the future and that the present value of all of a person s or company s futuredisbursements of assets constitutes the total liabilities of that person or company. But, accountantsquantify or measure only those liabilities or future disbursements which are reasonably determinableat the present time. And, accountants have accepted the completed transaction as providing theobjectivity or basis necessary for financial recognition. Therefore, a liability may be viewed as anobligation to convey assets or perform services at some time in the future and is based upon apast or present transaction or event.

5 A formal definition of liabilities presented in ConceptsStatement No. 6 is as follows: Probable future sacrifices of economic benefits arising from presentobligations of a particular entity to transfer assets or provide services to other entities in the futureas a result of past transactions or As a lender of money, the banker is interested in the priority his/her claim has on the company sassets relative to other claims. Close examination of the liability section and the related footnotesdiscloses amounts, maturity dates, collateral, subordinations, and restrictions of existing con-tractual obligations, all of which are important to potential creditors. The assets and earning powerare likewise important to a banker considering a liabilities are obligations whose liquidation is reasonably expected to require the use ofexisting resources properly classified as current assets, or the creation of other current current liabilities are by definition tied to current assets and current assets by definitionare tied to the operating cycle, liabilities are related to the operating Unearned revenue is a liability that arises from current sales but for which some future services orproducts are owed to customers in the future.

6 At the time of a sale, customers pay not only for thedelivered product, but they also pay for future products or services ( , another plane trip, hotelroom, or software upgrade). In this case, the company recognizes revenue from the currentproduct and part of the sale proceeds is recorded as a liability (unearned revenue) for the value offuture products or services that are owed to customers. Market analysts indicate that an increasein the unearned revenue liability, rather than raising a red flag, often provides a positive signalabout sales and profitability. When the sales are growing, its unearned revenue account shouldgrow. Thus, an increase in a liability may be good news about company performance. In contrast,when unearned revenues decline, the company owes less future amounts but this also means thatsales of new products may have Payables and receivables generally involve an interest element.

7 Recognition of the interestelement (the cost of money as a factor of time and risk) results in valuing future payments at theircurrent value. The present value of a liability represents the debt exclusive of the interest CHAPTER 13 (Continued)7. A discount on notes payable represents the difference between the present value and the facevalue of the note, the face value being greater in amount than the discounted amount. It should betreated as an offset (contra) to the face value of the note and amortized to interest expense overthe life of the note. The discount represents interest expense chargeable to future Liabilities that are due on demand (callable by the creditor) should be classified as a currentliability. Classification of the debt as current is required because it is a reasonable expectation thatexisting working capital will be used to satisfy the debt.

8 Liabilities often become callable by thecreditor when there is a violation of the debt agreement. Only if it can be shown that it is probablethat the violation will be cured (satisfied) within the grace period usually given in these agreementscan the debt be classified as An enterprise should exclude a short-term obligation from current liabilities only if (1) it intends torefinance the obligation on a long-term basis, and (2) it demonstrates an ability to consummate The ability to consummate the refinancing may be demonstrated (i) by actually refinancing theshort-term obligation through issuance of long-term obligation or equity securities after the date ofthe balance sheet but before it is issued, or (ii) by entering into a financing agreement that clearlypermits the enterprise to refinance the debt on a long-term basis on terms that are A cash dividend formally authorized by the board of directors would be recorded by a debit toRetained Earnings and a credit to Dividends Payable.

9 The Dividends Payable account should beclassified as a current accumulated but undeclared dividend on cumulative preferred stock is not recorded in theaccounts as a liability until declared by the board, but such arrearages should be disclosed eitherby a footnote to the balance sheet or parenthetically in the capital stock stock dividend distributable, formally authorized and declared by the board, does not appear asa liability because a stock dividend does not require future outlays of assets or services and isrevocable by the board prior to issuance. Even so, an undistributed stock dividend is generallyreported in the stockholders equity section since it represents retained earnings in the process oftransfer to paid-in Unearned revenue arises when a company receives cash or other assets as payment from acustomer before conveying (or even producing) the goods or performing the services which it hascommitted to the revenue is assumed to represent the obligation to the customer to refund the assetsreceived in the case of nonperformance or to perform according to the agreement and thus earnthe unrestricted right to the assets received.

10 While there may be an element of unrealized profitincluded among the liabilities when unearned revenues are classified as such, it is ignored on thegrounds that the amount of unrealized profit is uncertain and usually not material relative to thetotal revenues arise from the following activities:1. The sale by a transportation company of tickets or tokens that may be exchanged or used topay for future The sale by a restaurant of meal tickets that may be exchanged or used to pay for future The sale of gift certificates by a retail The sale of season tickets to sports or entertainment The sale of subscriptions to CHAPTER 13 (Continued)13. Compensated absences are employee absences such as vacation, illness, and holidays for whichit is expected that employees will be A liability should be accrued for the cost of compensated absences if all of the following conditionsare met:(a) The employer s obligation relating to employees rights to receive compensation for futureabsences is attributable to employees services already rendered.