Chapter 13

CURRENT LIABILITIES AND CONTINGENCIES

2009 The McGraw-Hill Companies, Inc.

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Characteristics of Liabilities

Probable future sacrifices of economic benefits . . .

. . . Arising from present obligations to other entities . . .

... Resulting from past transactions or events.

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What is a Current Liability?

LIABILITIES

Current Liabilities Obligations payable within one year or one operating cycle, whichever is longer. Expected to be satisfied with current assets or by the creation of other current liabilities.
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Long-term Liabilities

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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 paperwork.
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Noninterest-Bearing Notes
Notes without a stated interest rate carry an implicit, or effective rate. The face of the note includes the amount borrowed and the interest.

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

Commercial paper is recorded in the same manner as notes payable.

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Salaries, Commissions, and Bonuses

Compensation expenses such as salaries, commissions, and bonuses are liabilities at the balance sheet date if earned but unpaid. These accrued expenses/accrued liabilities are recorded with an adjusting entry prior to preparing financial statements.
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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).

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.
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Short-Term Obligations Expected to be Refinanced

A company may reclassify a short-term liability as long-term only if two conditions are met:
It has the intent to refinance on a long-term basis.

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and

It has demonstrated the ability to refinance.

The ability to refinance on a long-term basis can be demonstrated by an: existing refinancing agreement, or actual financing prior to issuance of the financial statements.
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Contingencies

A loss contingency is accrued only if a loss is probable and the amount can reasonably be estimated.

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Product Warranties and Guarantees

Product warranties inevitably entail costs. The amount of those costs can be reasonably estimated using commonly available estimation techniques. The estimate requires the following entry:

GENERAL JOURNAL
Page:

15 Credit

Date

Description

Debit

Warranty Expense Estimated Warranty Liability

$$$ $$$

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Extended Warranties
Extended warranties are sold separately from the product. The related revenue is not earned until:

Claims are made against the extended warranty, or The extended warranty period expires.

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Litigation Claims

The majority of medium and large-size corporations annually report loss contingencies due to litigation. The most common disclosure is a note to the financial statements.

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Subsequent Events
Events occurring between the year-end date and report date can affect the appearance of disclosures on the financial statements.
Cause of Loss Contingency Clarification

Fiscal Year Ends

Financial Statements

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Unasserted Claims and Assessments

Unasserted claim

No disclosure needed

No

Is a claim or assessment probable?

Yes

Evaluate (a) the likelihood of an unfavorable outcome and (b) whether the dollar amount can be estimated. An estimated loss and contingent liability would be accrued if an unfavorable outcome is probable and the amount can be reasonably estimated.
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Gain Contingencies

Note that the prior rules have supported the recording of LOSS contingencies.

As a general rule, we never record GAIN contingencies.

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End of Chapter 13

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2009 The McGraw-Hill Companies, Inc.