13 Current Liabilities

Current Liabilities and Contigencies*

Objectives of the Chapter

1. Accounting for current liabilities with definite amount (i.e., trade related liabilities, employee payroll related liabilities and accrued liabilities.)2. Accounting for estimated liabilities (i.e., warranty obligations, coupons and premiums obligations).3. Accounting for contingent liabilities.

Current Liabilities and Contigencies

Current Liabilities and Contigencies*LiabilitiesLegal obligations require future payments of cash or services or the creation of other liabilities as a result of past transactions.Current liabilities: Obligations must be fulfilled in one year or one operating cycle, whichever is longer.


Current Liabilities and Contigencies*Current LiabilitiesExamples of current liabilities with definite amount as a result of a business transaction: A/P (accounts payable)N/P (notes payable including commercial paper issued)Current maturity portion of a long-term debtSales taxes payable Accrued liabilitiesPayroll taxes withholdings


Current and Long-Term Liabilities* Sales Taxes PayableSales taxes are taxes levied by states on retail sales, not on manufacturers (i.e., GE, GM, etc). Every state, except Alaska, Delaware, Montana, New Hampshire, and Oregon, levies state sales taxes on retail sales.The rate varies state by state (for example, Starting 4/1/2009, California has a statewide sales tax at 8.25% with a local supplementary tax for up to 10.75%).

Current and Long-Term Liabilities

Current and Long-Term Liabilities* Sales Taxes Payable (contd.)Retailers charge their customers the sales taxes in addition to the price of the merchandise. The retailers have to forward the collected sales taxes to the state at regular intervals.


Current and Long-Term Liabilities*ExampleAssume that the 12/22/x9 sales of Macys in California totaled $2,000,000. The state tax rate is 8.25%. The business would record the days sales as follows:Cash2,165,000 Sales Revenue 2,000,000 Sales Taxes Payable165,000


Current Liabilities and Contigencies*Accrued LiabilitiesObligations accumulated on a daily basis but not recorded until the end of period through adjusting entries (i.e., Interest payable, salaries payable, rent payable)


Current Liabilities and Contigencies*Employee Related Liabilities: FICA, Federal I/T, state I/T, Medical Insurance Premiums

Salaries Expense50,000Employee F.I.C.A. Taxes Payable*3,825Federal I/T Payable10,000State I/T Payable2,500Cash32,675*(6.2% +1.45%) *$50,000 or 7.65% x $50,000F.I.C.A. taxes include Social Security tax of 6.2% (max earnings taxable is $106,800 for 2009) and 1.45% of Medicare tax (no limit on maximum earnings taxable).


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Current Liabilities and Contigencies*Employee Related Liabilities (contd.)Employer payroll taxes:Payroll Taxes Expense6,925Employer F.I.C.A. Taxes Payable3,825F.U.T.A. Taxes Payablea400State Unemployment Tax Payableb2,700

a. 6.2% of the first $7,000 of salaries paid to employees.b. assuming a state unemployment tax = 5.4%.


Current Liabilities and Contigencies*Refundable DepositsCashxxxRefund Deposit LiabilitiesxxxDividends PayableUnearned RevenueOther Current Liabilities


Current Liabilities and Contigencies*Estimated LiabilitiesLiabilities exist but the amount is unknown: A. Property taxesB. Warranty obligationsC. Coupon and premium obligationsD. Compensated absencesE. Environmental liabilities


Current Liabilities and Contigencies*A. Property TaxesProperty taxes are assessed by local governments (city, state ) on the value of properties. The assessed property taxes become a lien on the properties on a day specified by law (i.e., July 1)In general, the bills of the property taxes are not received until a few months after the lien day. The property taxes must be estimated and recognized on a monthly basis (recommended by the AICPA) starting the lien day.


Current Liabilities and Contigencies*A. Property Taxes (contd.)Also, the property taxes expenses should be allocated over the fiscal year of the local government (i.e., 7/1/x1 ~ 6/30/x2).If there are differences between the estimates and the actual taxes, the adjustments are considered as an estimate change and are spread to the remaining tax period (no retroactive effect).


Current Liabilities and Contigencies*ExampleThe fiscal year of the local government => 7/1/x8 - 6/31/x9The property tax becomes a lien on the property on=> 7/1/x8Estimated property tax expenses (for 7/1/x8 - 6/30/x9) =>$12,000Tax bill received on=> 10/29/x8Actual tax expense=> $13,800Tax paid on=>11/30/x8


Current Liabilities and Contigencies*Example (contd.)Prepare journal entries regarding the property tax for the period of 7/1/x8 - 6/30/x9:7/1/x8 No journal entry (accrued the liability, on a monthly basis)7/31/x8 Property Tax Expenses1,000Property Tax Payable1,000($12,000/12=$1,000)8/31/x8 P/T Exp1,000P/T Payable1,0009/30/x8 P/T Exp1,000P/T Payable1,00010/31/x8 P/T Exp1,200P/T Payable1,200(($13,800 -$3,000)/(12-3) = $1,200 the difference is treated as changes in estimates; no retroactive effect. (APB 20))


Current Liabilities and Contigencies*Prepare journal entries regarding the property tax for the period of 7/1/x8 - 6/30/x9: (contd.)11/30/x8P/T Payable4,200Prepaid P/T9,600Cash13,800P/T Expense1,200Prepaid P/T1,20012/31/x8P/T Exp1,200Prepaid P/T1,200::6/30/x9P/T Exp1,200Prepaid P/T1,200


Current Liabilities and Contigencies*B. Warranty Obligations (Product Warranty)

1. Cash basis (for Income Tax Filing Purposes, not GAAP)2. Expense warranty using accrued method (GAAP)


Current Liabilities and Contigencies*1. Cash Basis (for tax filing)(Not Acceptable for Financial Reporting Purpose)Warranty expenses are recognized when these expenses are paid for (violating the matching principle)Journal Entry: Warranty ExpxxxCashxxx(only for I/T filling)


Current Liabilities and Contigencies*2. Expense Warranty Using Accrued Method(for financial Reporting Purposes) Estimate the warranty exp. associated with the sales (of the period) at the end of the period and recognize it.


Current Liabilities and Contigencies*2. Expense Warranty Using Accrued Method (contd.)Journal Entry:Warranty ExpensesxxxEstimated Warranty LiabilitiesxxxWhen warranty services provided:Estimated warranty liabilitiesxxxCash (or Inventory)xxxIf the estimated warranty liabilities are not enough to cover the current years warranty services, treat it as a change in accounting estimates (i.e., no retroactive effect).


Current Liabilities and Contigencies*

ExampleThe estimated warranty liabilities account has an ending balance of $2,000 before the following year end adjustment:12/31/x2Warranty Expenses3,000Estimated Warranty Liability3,000During 20x3, the actual warranty expenses amounted to $5,800.20x3:Estimated warranty liability5,000* Warranty Expenses 800Cash (or Inventory)5,800

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Current Liabilities and Contigencies*C. Premiums and Coupons ObligationsLiabilities of premiums and coupons should be estimated and recognized in the year when sales are made.Journal Entry Premium (or Coupon) ExpensexxxEstimated Premium Claims (or coupon) outstandingxxx


Current Liabilities and Contigencies*C. Premiums and Coupons Obligations (contd.)When premiums (or coupons) are claimed:Journal Entry Estimated Premium Claims (coupon) outstandingxxxInventoryxxx* If the actual redemption of coupons (or premiums) is greater than the estimated liabilities, the underestimated amount would be recognized as the expense of the current year.


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D. Compensated AbsencesCompensation for vacation, illness and holidays. Companies should estimate the amount of liabilities and recognize them at the end of the reporting period if:a. Employees services needed to receive these rights have been rendered.b. The obligation relates to these rights are vested. c. Payment of the compensation is probable.d. The amount of liabilities can be reasonably estimated. Current Liabilities and Contigencies*


E. Environmental Liabilities (SFAS 143)A company must recognize an asset retirement obligation (ARO) when 1) it has an existing legal obligation associated with the retirement of a long-lived asset , and 2) the liability can be reasonably estimated.Examples of obligating events: decommissioning nuclear facilities, dismantling, restoring and reclamation of oil and gas properties, etc.Current Liabilities and Contigencies*


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Recognition and Allocation of AROThe estimated fair value of ARO is capitalized on 1/1/2002 :Nuclear Plant 50,000 Asset Retirement Obligation 50,000The cost of ARO will be subsequently allocated as depre. expense over the life of the asset (i.e., 5 years): Depre. Expense 10,000 Acc. Depre. Nuclear Plant 10,000 Current Liabilities and Contigencies*


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Recognition and Allocation of ARO (contd.)The accrued interest of ARO should be recognized periodically (assuming 10% interest):

12/31/2002Interest expense (10% x50,000) 5,000 ARO 5,000

On 1/1/2008, the decommissioning cost amounted to $78,000, the following will be recorded: ARO 80,525 Cash 78,000 Gain on Settlement of ARO 2,525Current Liabilities and Contigencies*


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Current Liabilities and Contigencies*ContingenciesContingent LiabilitiesContingent LossesContingent Gains


Current Liabilities and Contigencies*Contingent LiabilitiesObligations may arise because of the occurrence or not occurrence of future event(s). (i.e., warranty obligations)


Current Liabilities and Contigencies*Contingent LiabilitiesLiabilities may arise because of the occurrence or not occurrence of future event(s).(i.e., guarantee and warranty costs, litigation and claims, premiums and coupons, environment al liabilities, etc.)


Current Liabilities and Contigencies*Contingent GainsGains may arise because of the occurrence or not occurrence of future events). (i.e., pending lawsuit gains)


Current Liabilities and Contigencies*Accounting Treatments of ContingenciesThe accounting treatments of the contingencies depend on the occurrence probability of the related future event(s).(FASB 5)1. Probable: The future event(s) is(are) likely to occur.2. Reasonably possible: The chance for the future event(s) to occur is less than probable but greater than remote 3. Remote: The chance of the future event to occur is unlikely (slight).


Current Liabilities and Contigencies*Accounting Treatments of Contingencies (contd.)If the future event(s) is(are)a. Probable, andb. amount of liability can be estimatedThe loss (liability) should be estimated, and recognized (accrued).


Current Liabilities and Contigencies*Accounting Treatments of Contingencies (contd.)Examples:Warranty Expense xxx Estimated Warranty Liabilities xxxLawsuit Expensesxxx Estimate Liability under litigation xxx


Current Liabilities and Contigencies*Accounting Treatments of Contingencies (contd.)If the future event is probable, but the amount of loss (or liability) cannot be estimated, the contingent loss (or liability) should only be footnoted (not accrued).Contingent gains:If the event is probable and the amount of contingent gains is determinable, only footnote the information. No unrealized gain can be recognized under the current accounting standards (conservatism!!!)


Current Liabilities and Contigencies*Additional Notes For Current Liabilities1. Obligations that are callable by the creditors within the longer period of one year or one operating cycle: reported as current liabilities.2. Obligation that matures in one year or one operating cycle, whichever is longer: reported as current liabilities.3. Short-term obligations that are expected to be refinanced by a long-term debt: reported as a long-term debt if conditions (i.e., intention and ability to do so) are met.


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13 Current Liabilities