Lecture Intermediate accounting (IFRS/e) - Chapter 13: Current liabilities and contingencies

After reading the material in this chapter, you should be able to: Define liabilities and distinguish between current and long-term liabilities, account for the issuance and payment of various forms of notes and record the interest on the notes, characterize accrued liabilities and liabilities from advance collection and describe when and how they should be recorded,...

CURRENT LIABILITIES AND

CONTINGENCIES

Chapter 13

Arising from past events

Present

Obligation

Present

Obligation

What is a Current Liability?

LIABILITIES

Long-term Liabilities

Other situations:

For trading purposes, or does

not have the right to defer

Other situations:

For trading purposes, or does

not have the right to defer

Current 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.

Current Liabilities

Current Liabilities

Short-term notes payable

Accrued expenses

Open Accounts and Notes

Accounts Payable

Obligations to suppliers for goods

purchased on open account.

Trade Notes Payable

Similar to accounts payable, but

recognized by a written promissory note.

Short-term Notes Payable

Cash borrowed from the bank and

recognized by a promissory note.

• Credit lines

Prearranged agreements with a bank that

allow a company to borrow cash without

following normal loan procedures and

Accounts Payable

Obligations to suppliers for goods

purchased on open account.

Trade Notes Payable

Similar to accounts payable, but

recognized by a written promissory note.

Short-term Notes Payable

Cash borrowed from the bank and

recognized by a promissory note.

• Credit lines

Prearranged agreements with a bank that

allow a company to borrow cash without

following normal loan procedures and

paperwork.

as an annual

rate.

Interest owed is adjusted for the portion of the year that the face

amount is outstanding.

Interest owed is adjusted for the portion of the year that the face

amount is outstanding.

Interest-Bearing Notes

On September 1, Eagle Boats borrows $80,000 from Cooke Bank The note is due in 6 months and has a

stated interest rate of 9%.

Record the borrowing on September 1.

On September 1, Eagle Boats borrows $80,000 from Cooke Bank The note is due in 6 months and has a

stated interest rate of 9%.

Record the borrowing on September 1.

How much interest is due to Cooke

Bank at year-end, on December 31?

a $2,400

b $3,600

c $7,200

d $87,200

How much interest is due to Cooke

Bank at year-end, on December 31?

Interest is calculated as:

Principal Annual Time to Amount Rate maturity

$80,000 9% 4/12

$2,400 interest due to Cooke Bank.

Interest is calculated as:

Principal Annual Time to Amount Rate maturity

Interest-bearing Notes

Assume Eagle Boats’ year-end is December 31

Record the necessary journal entry when

the note matures on February 28

Assume Eagle Boats’ year-end is December 31

Record the necessary journal entry when

the note matures on February 28

Noninterest-Bearing Notes

Notes without a stated

interest rate carry an

implicit, or effective

rate.

The principal of the

note includes the

amount borrowed and

the interest.

Notes without a stated

interest rate carry an

implicit, or effective

rate.

The principal of the

note includes the

amount borrowed and

the interest.

On May 1, Batter-Up Ltd issued a one-year, noninterest-bearing note with a face amount

of $10,600 in exchange for equipment

valued at $10,000

How much interest will Batter-Up pay on the note?

On May 1, Batter-Up Ltd issued a one-year, noninterest-bearing note with a face amount

of $10,600 in exchange for equipment

valued at $10,000

How much interest will Batter-Up pay on the note?

Interest = Face Amount - Amount Borrowed = $10,600 - $10,000

What is the effective interest rate on the note?

On May 1, Batter-Up Ltd issued a one-year, noninterest-bearing note with a face amount

of $10,600 in exchange for equipment

valued at $10,000

What is the effective interest rate on the note?

Commercial Paper

Commercial paper is a term used for unsecured notes issued in minimum denominations of say $25,000 with maturities

usually ranging from 30 days to 270 days

Commercial paper is a term used for unsecured notes issued in minimum denominations of say $25,000 with maturities

usually 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 the same manner as notes payable

Commercial paper is recorded in the same manner as notes payable

Salaries, Commissions, and Bonuses

Compensation expenses such as

salaries, commissions, and bonuses

are liabilities at the financial reporting

date if earned but unpaid

These accrued expenses/accrued liabilities

are recorded with an adjusting entry prior to preparing financial

statements

Compensated absences

Accumulated compensated

absences

Non-accumulating compensated absences

Current and past leave entitlement

can be used in future periods. Unused leave expires and are not carried forward to a future period

Recognize expected cost of

employee benefits in the same

period when the employee renders

service

Recognizes expense on paid leave only when the leave is utilized

Liabilities from Advance Collections

Deposits (Refundable or

Non-Refundable)

Advances from Customers

Collections for Third Parties

Deposits (Refundable or

Non-Refundable)

Advances from Customers

Collections for Third Parties

A Closer Look at the Current and

Noncurrent Classification

The classification of financial liabilities

requires the consideration of

• The terms of contract including the date of

settlement,

• The right of the creditor to call back the loan,

• The right of the borrower to reschedule the loan

repayment, and

• The provision of a grace period in the event that

the borrower breaches a covenant in the debt

agreement etc.

A Closer Look at the Current and

Noncurrent 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

A Closer Look at the Current and

Noncurrent Classification

Conversely, even if the obligation is due within a shorter period, the long-term classification applies

if the borrowing entity expects and has the

discretion to refinance or roll over an obligation for

at least 12 months after the reporting period

Conversely, even if the obligation is due within a

shorter period, the long-term classification applies

if the borrowing entity expects and has the

discretion to refinance or roll over an obligation for

at least 12 months after the reporting period

If the debt becomes callable due to a default (i.e by violation of contract covenant), and the creditor extends a grace period, the long-term

classification would still apply if the following conditions are met

The lender agrees to the

during which the lender cannot demand

immediate repayment

It is probable that the borrower can make rectification of the violation within the extended grace period

Short-Term Obligations Expected

to 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.

 It has demonstrated the ability to

 existing refinancing agreement, or

 actual refinancing at the financial year-end

Short-Term Obligations Expected

to be Refinanced

There are discussions between IASB and FASB to change

the definition of “short term” to mean “within one year”,

Contingent Liabilities

A contingent liability is

recorded for (1) a possible

obligation; or (2) a present

obligation with future

outflows that are not

obligation with future

outflows that are not

probable or cannot be

reliably measured.

The uncertainties relate to:

1 The existence of the obligation or

2 The probability/amount of outflow

A contingent liability is never accrued, but is

only disclosed in the footnotes to the financial

statements:

1 The reporting entity must:

• Describe the nature of the contingent liability, and

• Provide an estimate of the financial effect,

1 And if practicable

• Indicate the uncertainties relating to the amount and timing of

the outflows, and

• State the possibility of any reimbursement.

1 Note that the cause of the uncertainty must occur before the

financial statement date.

A contingent liability is never accrued, but is

only disclosed in the footnotes to the financial

statements:

1 The reporting entity must:

• Describe the nature of the contingent liability, and

• Provide an estimate of the financial effect,

1 And if practicable

• Indicate the uncertainties relating to the amount and timing of

the outflows, and

• State the possibility of any reimbursement.

1 Note that the cause of the uncertainty must occur before the

financial statement date.

A provision is a liability as it has all the three characteristics of a one.

(1) past obligating event has occurred

(2) present obligation that leads to a

 (3) future outflow of benefits.

A provision is a liability as it has all the three characteristics of a one.

(1) past obligating event has occurred

(2) present obligation that leads to a

 (3) future outflow of benefits.

Provisions are not “off balance sheet”

They are recognized if the three conditions below are met

An entity has present

obligation that arises as

a result of a past event

It is probable that an outflow of resources will

be required the settle the obligation

A reliable estimate can

be made of the amount

of the obligation

Provisions

Onerous Contracts

Product Warranties

Product warranties inevitably entail costs

Like other provisions, 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

Like other provisions, the amount of those costs can be reasonably estimated using commonly

available estimation techniques

The estimate requires the following entry:

Extended Warranties

Extended warranties are sold

separately from the product.

The related revenue is not earned

Extended warranties are sold

separately from the product.

The related revenue is not earned

Litigation Claims

The majority of medium

and large-size corporations

annually report contingent

liabilities due to litigation.

The most common

disclosure is a note to the

financial statements.

The majority of medium

and large-size corporations

annually report contingent

liabilities due to litigation.

The most common

disclosure is a note to the

financial statements.

Subsequent Events

When the cause of a loss contingency occurs before the

year-end, an adjusting event before financial

statements are issued can be used to determine how

the contingency is reported.

When the cause of a loss contingency occurs before the

year-end, an adjusting event before financial

statements are issued can be used to determine how

the contingency is reported.

Unasserted Claims and Assessments

Q1 Is a claim

or assessment probable?

Q1 Is a claim

or assessment probable?

Unasserted claim

Q2 Evaluate (a) the likelihood of

an unfavorable outcome and (b) whether the dollar amount can be estimated.

Q2 Evaluate (a) the likelihood of

an unfavorable outcome and (b) whether the dollar amount can be estimated.

If the answer to question 1 and 2 are _ and _ respectively

No, [n.a.] Yes, Yes Yes, No Make a subjective evaluation whether the

likelihood of loss is remote or possible

No disclosure is required for contingencies

Recognize

a provision

Disclose a contingent liability

IAS 37 does not deal

specifically with these

claims; this process is

from U.S GAAP

Contingent Assets

As a general principle,

we never record contingent assets

Note that the we have to record liabilities even if the likelihood is

“probable” and not certain.

Social

Security

Taxes

Medical Insurance

National Income Tax

State and Local Income Taxes

Voluntary Deductions

Gross Pay

Payroll-Related Liabilities

Amounts withheld depend on each country’s laws,

the employee’s earnings, tax rates, and number of

withholding allowances.

Employers must pay the taxes withheld from

employees’ gross pay to the appropriate

government agency.

Employers must pay the taxes withheld from

employees’ gross pay to the appropriate

government agency.

National Income Tax

State and Local Income Taxes

Employees’ Withholding Taxes

Amounts withheld depend on the employee’s request.

Employers owe voluntary amounts withheld from

employees’ gross pay to the designated agency.

Employers owe voluntary amounts withheld from

employees’ gross pay to the designated agency.

Voluntary Deductions

Examples include union dues, savings accounts,

pension contributions, insurance premiums,

charities.

Examples include union dues, savings accounts,

pension contributions, insurance premiums,

charities.

Voluntary Deductions

Social Security Taxes

Medical insurance

Payroll taxes and other welfare-related taxes payable

by employer

Employers pay amounts equal to that

withheld from the employee’s gross pay.

Employers pay amounts equal to that

withheld from the employee’s gross pay.

Employers’ Payroll Taxes

Fringe Benefits

In addition to salaries and wages, withholding taxes, and payroll taxes, most companies provide a variety

of fringe benefits.

In addition to salaries and wages, withholding taxes, and payroll taxes, most companies provide a variety

Life insurance premiums

Retirement

plan contributions

Retirement

plan contributions

Employers must pay the amounts promised to fund

employee fringe benefits to the designated agency.

Employers must pay the amounts promised to fund

employee fringe benefits to the designated agency.