Download Chapter 13: Current Liabilities and Contingencies

Chapter 13: Current Liabilities
and Contingencies
Sid Glandon, DBA, CPA
Assistant Professor of Accounting
Liability

FASB Concepts Statement #6
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Present obligation

–
–
Probable future transfer or use of cash, goods, or
services
Unavoidable obligation
Transaction or event has already occurred
Current Liabilities

Obligations whose liquidation will require
–
–
Use of current assets or
Creation of other current liabilities
Examples of Current Liabilities

Accounts payable
–
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Notes payable
–
–

Purchases on open account in the normal course
of business
Interest bearing
Zero-interest-bearing
Current maturities of long-term debt
Line of Credit (Interest-Bearing Note)


Spencer Company took out a line of credit
with the Bank of the West on April 1, 2004 for
$100,000. The term is six months and the
interest rate is 9%.
Prepare the journal entries to record:
–
–
The issuance of the line of credit
The payment of the line of credit
Line of Credit (Interest-Bearing Note)
DATE
ACCOUNT
4/1/04 Cash
Notes payable
DEBIT
100,000
CREDIT
100,000
To record the issuance of a line of credit for six months at 9% interest
10/1/04 Interest expense
4,500
Notes payable
100,000
Cash
104,500
To record the payment of principal and interest on the line of credit
Analysis of interest expense:
Face amount of note
Interest rate
Annual interest
Short period
Interest expense
100,000
9%
9,000
6/12
4,500
Noninterest-Bearing Note


Spencer Company took out borrowed
$100,000 from Bank of the West on April 1,
2004. The instrument was a zero-interest
bearing note for six months at 9% interest.
Prepare the journal entries to record:
–
–
The issuance of the zero-interest bearing note
The payment of the zero-interest bearing notes
Noninterest-Bearing Note
DATE
ACCOUNT
DEBIT
CREDIT
4/1/04 Cash
95,500
Discount on notes payable
4,500
Notes payable
100,000
To record the issuance of a zero-interest-bearing note for six months
at 9% interest
Analysis of discount on notes payable:
Face amount of note
Interest rate
Annual interest
Short period
Discount on notes payable
100,000
9%
9,000
6/12
10/1/04 Interest expense
4,500
Discount on notes payable
Notes payable
100,000
Cash
To record the payment of the zero-interest-bearing note
4,500
4,500
100,000
Short-Term Obligations
Expected to be Refinanced

Refinancing criteria
–
–
Must intend to refinance the obligation on a longterm basis, and
Must demonstrate an ability to consummate the
refinancing


Actual refinancing after balance sheet date
Entering into a financing agreement
Other Current Liabilities






Dividends payable
Returnable deposits
Unearned revenues
Sales taxes payable
Property taxes payable
Income taxes payable
Sales Taxes Payable


Spencer Company has sales for the month of
March 2004 of $150,000. All sales are
subject to a 6.5% state sales tax and a 0.5%
local sales tax.
Prepare the journal entries:
–
–
To record sales
To record the payment of sales taxes
Sales Taxes Payable
DATE
ACCOUNT
DEBIT
CREDIT
3/31/04 Accounts receivable
160,500
Sales
150,000
Sales taxes payable
10,500
To record sales and sales tax collected for the month of March 2004
Analysis of sales taxes payable:
Gross sales
State sales tax rate
Local sales tax rate
Combined rate
Discount on notes payable
150,000
6.50%
0.50%
4/15/04 Sales tax payable
10,500
Cash
To record payment of sales taxes collected in March 2004
7%
10,500
10,500
Contingencies, SFAS #5

“An existing condition, situation, or set of
circumstances involving uncertainty as to
possible gain or loss to an enterprise that will
ultimately be resolved when one or more
future events occur or fail to occur”
Gain Contingencies


Based on the constraint of conservatism gain
contingencies are not recorded until resolved
Under certain circumstances such
contingencies may be disclosed in the notes
to the financial statements
Loss Contingencies

Criteria for recording
–
–
It is probable that a liability has been incurred at
the balance sheet date, and
The loss is reasonably estimated
Contingent Liability
On October 2, 2003, a company truck was involved in an accident with a
car driven by Alexander. On January 12, 2004 the company was notified
that Alexander had filed a lawsuit seeking damages for personal injuries in
the amount of $800,000. The company's counsel believes it is reasonably
possible that Alexander will be awarded between $250,000 and $500,000
and the $400,000 is a better estimate of potential liability than any other
amount. The company's financial statements were issued on March 1,
2004.
What amount of loss should the company accrue at
December 31, 2003?
A.$0
B.$250,000
C.$400,000
D.$500,000
Guarantee and Warranty Costs

Cash basis
–

Not GAAP but used for tax purposes
Accrual basis
–
Expense warranty approach


–
Integral part of the sale transaction
Accrue warranty in year of sale
Sales warranty approach


Sold as a separate contract
Extended warranties-deferred revenue
Warranty Expense

Spencer Company sells 100 pet video units
for $500 per unit during 2003. The video
units have a three-year warranty covering
parts and labor. Based on past experience
management estimates that warranty costs
will be $10 in the first year, $20 in the second
year and $25 in the third year. During 2003
the company incurs $900 in warranty costs.
Prepare the Journal Entry to
ACCOUNT
Accounts receivable
Sales
To record sales for 2003
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Sales and Warranty Expense for 2003
Warranty expense
Estimated liability under warranties
To record warranty expense on 2003 sales
Analysis of warranty expense:
Estimated warranty cost per unit
Units sold
Warranty expense
DEBIT
50,000
CREDIT
50,000
5,500
5,500
$55
100
$5,500
Prepare the Journal Entry to Record Warranty Costs Incurred During
2003
ACCOUNT
DEBIT
Estimated liability under warranties
900
Cash, payroll, parts
To record warranty costs incurred during 2003 on 2003 sales
CREDIT
900
Employee-Related Liabilities

Payroll deductions
–
–

Compensated absences
–
–
–
–

Payroll expense
Payroll tax expense
Services already rendered
Rights vested or accumulated
Compensation is probable
Amount is reasonably estimated
Bonus Agreements
Gross Payroll
For the month of March 2004 Spencer Company had the following
Percentage
Gross salaries and wages
Income tax withheld
Social security tax withheld
Union dues withheld
Total withheld
Net payroll
15.0%
7.5%
Amount
Totals
$100,000
$15,000
7,500
2,500
25,000
$75,000
Journal Entry to Record Gross Payroll
ACCOUNT
Salaries and wages
Income taxes payable
Social security payable
Union dues payable
Cash
To record payroll for the month of March 2004
DEBIT
$100,000
CREDIT
15,000
7,500
2,500
75,000
Payroll Taxes
Employer Payroll Taxes Associated with the March 2004 Payroll
Gross salaries and wages
Social security (FICA)
State unemployment (SUTA)
Federal unemployment (FUTA)
Workmen's comp.
Total payroll taxes
Gross Payroll Percentage
$100,000
7.50%
9.00%
0.80%
2.75%
Totals
$7,500
9,000
800
2,750
$20,050
Journal Entry to Record Payroll Taxes
ACCOUNT
DEBIT
20,050
Payroll taxes
Social security payable
State unemployment payable
Federal unemployment payable
Workmen's comp. Payable
To record payroll taxes associated with March 2004 payroll
CREDIT
7,500
9,000
800
2,750