Current Liabilities and

Contingencies

Chapter
13
Intermediate Accounting
12th Edition
Kieso, Weygandt, and Warfield

Chapter
13-1 Prepared by Coby Harmon, University of California, Santa Barbara
 Learning Objectives

1. Describe the nature, type, and valuation of current

liabilities.
2. Explain the classification issues of short-term debt
expected to be refinanced.
3. Identify types of employee-related liabilities.
4. Identify the criteria used to account for and disclose gain
and loss contingencies.
5. Explain the accounting for different types of loss
contingencies.
6. Indicate how to present and analyze liabilities and
contingencies.

Chapter
13-2
 Current Liabilities and Contingencies

Presentation and
Current Liabilities Contingencies
Analysis

What is a Gain Presentation of

liability? contingencies current
What is a Loss liabilities
current liability? contingencies Presentation of
contingencies
Analysis of
current
liabilities

Chapter
13-3
 What is a Liability?

FASB, defines liabilities as:

“probable future sacrifices of economic benefits

arising from present obligations of a particular entity
to transfer assets or provide services to other
entities in the future as a result of past transactions
or events.”

Chapter
13-4
 What is a Current Liability?

Current liabilities are “obligations whose liquidation is

reasonably expected to require use of existing
resources properly classified as current assets, or the
creation of other current liabilities.”
Typical Current Liabilities:
Accounts payable. Customer advances and
Notes payable. deposits.
Current maturities of long- Unearned revenues.
term debt. Sales taxes payable.
Short-term obligations Income taxes payable.
expected to be refinanced. Employee-related liabilities.
Dividends payable.
Chapter
13-5 LO 1 Describe the nature, type, and valuation of current liabilities.
 What is a Current Liability?

Accounts Payable (trade accounts payable)

Balances owed to others for goods, supplies, or
services purchased on open account.
Arise because of time lag between receipt of
goods or services and the payment for them.
The terms of the sale (e.g., 2/10, n/30) state
period of extended credit.

Chapter
13-6 LO 1 Describe the nature, type, and valuation of current liabilities.
 What is a Current Liability?

Notes Payable
Written promises to pay a certain sum of money on a
specified future date.
Arise from purchases, financing, or other
transactions.
Notes classified as short-term or long-term.
Notes may be interest-bearing or zero-interest-
bearing.

Chapter
13-7 LO 1 Describe the nature, type, and valuation of current liabilities.
 What is a Current Liability?

E13-2 (Accounts and Notes Payable) The following are

selected 2007 transactions of Sean Astin Corporation.
Sept. 1 - Purchased inventory from Encino Company
on account for $50,000. Astin records purchases
gross and uses a periodic inventory system.
Oct. 1 - Issued a $50,000, 12-month, 8% note to
Encino in payment of account.
Oct. 1 - Borrowed $50,000 from the Shore Bank by
signing a 12-month, zero-interest-bearing $54,000
note.

Chapter
13-8 LO 1 Describe the nature, type, and valuation of current liabilities.
 What is a Current Liability?

Sept. 1 - Purchased inventory from Encino Company on

account for $50,000. Astin records purchases gross
and uses a periodic inventory system.

Sept. 1 Purchases 50,000

Accounts payable 50,000

Chapter
13-9 LO 1 Describe the nature, type, and valuation of current liabilities.
 What is a Current Liability?

Oct. 1 - Issued a $50,000, 12-month, 8% note to

Encino in payment of account.

Oct. 1 Accounts payable 50,000

Notes payable 50,000

Dec. 31 Interest expense 1,000

Interest payable 1,000
($50,000 X 8% X 3/12)

Chapter
13-10 LO 1 Describe the nature, type, and valuation of current liabilities.
 What is a Current Liability?

Oct. 1 - Borrowed $50,000 from the Shore Bank by

signing a 12-month, zero-interest-bearing $54,000
note.

Oct. 1 Cash 50,000

Discount on notes payable 4,000
Notes payable 54,000

Dec. 31 Interest expense 1,000

Discount on notes payable 1,000
($4,000 x 3/12)

Chapter
13-11 LO 1 Describe the nature, type, and valuation of current liabilities.
 What is a Current Liability?

Current Maturities of Long-Term Debt

Exclude long-term debts maturing currently as
current liabilities if they are to be:
1. Retired by assets accumulated that have not been
shown as current assets,
2. Refinanced, or retired from the proceeds of a new
debt issue, or
3. Converted into capital stock.

Chapter
13-12 LO 1 Describe the nature, type, and valuation of current liabilities.
 What is a Current Liability?

Short-Term Obligations Expected to Be

Refinanced
Exclude from current liabilities if both of the
following conditions are met:
1. Must intend to refinance the obligation on a long-
term basis.
2. Must demonstrate an ability to refinance:
 Actual refinancing
 Enter into a financing agreement

Chapter LO 2 Explain the classification issues of short-term

13-13
debt expected to be refinanced.
 What is a Current Liability?
Short-Term Obligations Expected to be Refinanced
NO
Mgmt. Intends of Refinance Classify as
YES Current
Liability
Demonstrates Ability to Refinance
NO
YES
Actual Refinancing after Financing Agreement
balance sheet date but before or Noncancellable with Capable
issue date Lender

Exclude Short-Term Obligations from Current

Liabilities and Reclassify as LT Debt

Chapter LO 2 Explain the classification issues of short-term

13-14
debt expected to be refinanced.
 What is a Current Liability?
E13-3 (Refinancing of Short-Term Debt) On December 31,
2007, Hattie McDaniel Company had $1,200,000 of short-
term debt in the form of notes payable due February 2,
2008. On January 21, 2008, the company issued 25,000
shares of its common stock for $38 per share, receiving
$950,000 proceeds after brokerage fees and other costs
of issuance. On February 2, 2008, the proceeds from the
stock sale, supplemented by an additional $250,000 cash,
are used to liquidate the $1,200,000 debt. The December
31, 2007, balance sheet is issued on February 23, 2008.
Instructions
Show how the $1,200,000 of short-term debt should be
presented on the December 31, 2007, balance sheet,
including note disclosure.
Chapter LO 2 Explain the classification issues of short-term
13-15
debt expected to be refinanced.
 What is a Current Liability?

Partial Balance Sheet

Current liabilities:
Notes payable $ 250,000
Long-term debt:
Notes payable refinanced 950,000
Total liabilities 1,200,000

Chapter LO 2 Explain the classification issues of short-term

13-16
debt expected to be refinanced.
 What is a Current Liability?

Dividends Payable
Amount owed by a corporation to its stockholders
as a result of board of directors’ authorization.
Generally paid within three months.
Undeclared dividends on cumulative preferred
stock not recognized as a liability.
Dividends payable in the form of shares of stock
are not recognized as a liability. Reported in
equity.

Chapter LO 2 Explain the classification issues of short-term

13-17
debt expected to be refinanced.
 What is a Current Liability?

Customer Advances and Deposits

Include returnable cash deposits received from
customers and employees.
May be classified as current or long-term.

Chapter LO 2 Explain the classification issues of short-term

13-18
debt expected to be refinanced.
 What is a Current Liability?

Unearned Revenues
Payment received before delivering goods or
rendering services?

Unearned and Earned Revenue Accounts

Illustration 13-3

Chapter LO 2 Explain the classification issues of short-term

13-19
debt expected to be refinanced.
 What is a Current Liability?

BE13-5 Game Pro Magazine sold 10,000 annual

subscriptions on August 1, 2007, for $18 each. Prepare
Game Pro’s August 1, 2007, journal entry and the
December 31, 2007, annual adjusting entry.

Aug. 1 Cash 180,000

Unearned revenue 180,000
(10,000 x $18)

Dec. 31 Unearned revenue 75,000

Subscription revenue 75,000
 ($180,000 x 5/12 = $75,000)

Chapter LO 2 Explain the classification issues of short-term

13-20
debt expected to be refinanced.
 What is a Current Liability?

Sales Taxes Payable

Retailers must collect sales taxes from customers
on transfers of tangible personal property and on
certain services and then remit to the proper
governmental authority.

Chapter LO 2 Explain the classification issues of short-term

13-21
debt expected to be refinanced.
 What is a Current Liability?
BE13-6 Flintstones Corporation made credit sales of $30,000
which are subject to 6% sales tax. The corporation also made
cash sales which totaled $19,610 including the 6% sales tax. (a)
prepare the entry to record Flintstones’ credit sales. (b)
Prepare the entry to record Flintstones’ cash sales.
Accounts receivable 31,800
Sales 30,000
Sales tax payable 1,800
($30,000 x 6% = $1,800)

Cash 19,610
Sales 18,500
Sales tax payable 1,110
($19,610 ÷ 1.06 = $18,500)
Chapter LO 2 Explain the classification issues of short-term
13-22
debt expected to be refinanced.
 What is a Current Liability?

Income Tax Payable

Businesses must prepare an income tax return and
compute the income tax payable resulting from
the operations of the current period.
• Taxes payable are a current liability
• Corporations must make periodic tax payments
throughout the year.
• Differences between taxable income and
accounting income sometimes occur (Chapter 19).

Chapter LO 2 Explain the classification issues of short-term

13-23
debt expected to be refinanced.
 What is a Current Liability?

Employee-Related Liabilities
Amounts owed to employees for salaries or wages
are reported as a current liability.
In addition, current liabilities may include:
• Payroll deductions.
• Compensated absences.
• Bonuses (Appendix 13A).

Chapter
13-24 LO 3 Identify types of employee-related liabilities.
 What is a Current Liability?

Payroll Deductions
Taxes:
• Social Security Taxes
• Unemployment Taxes
• Income Tax Withholding

Chapter
13-25 LO 3 Identify types of employee-related liabilities.
 What is a Current Liability?
Exercise Assume a weekly payroll of $10,000 entirely subject
to F.I.C.A. and Medicare (7.65%), federal (0.8%) and state
(4%) unemployment taxes, with income tax withholding of
$1,320 and union dues of $88 deducted. The company records
the salaries and wages paid and the employee payroll
deductions as follows:
Journal entry to record salaries and wages paid:

Salaries and wages expense 10,000

Withholding taxes payable 1,320
F.I.C.A taxes payable 765
Union dues payable 88
Cash 7,827
Chapter
13-26 LO 3 Identify types of employee-related liabilities.
 What is a Current Liability?
Exercise Assume a weekly payroll of $10,000 entirely subject
to F.I.C.A. and Medicare (7.65%), federal (0.8%) and state
(4%) unemployment taxes, with income tax withholding of
$1,320 and union dues of $88 deducted. The company records
the salaries and wages paid and the employee payroll
deductions as follows:
Journal entry to record employer payroll taxes:

Payroll tax expense 1,245

F.I.C.A taxes payable 765
Federal unemployment tax payable 80
State unemployment tax payable 400

Chapter
13-27 LO 3 Identify types of employee-related liabilities.
 What is a Current Liability?

Compensated Absences
Paid absences for vacation, illness, and holidays.
Accrue a liability if all the following conditions exist.
The employer’s obligation is attributable to
employees’ services already rendered.
The obligation relates to rights that vest or
accumulate.
Payment of the compensation is probable.
The amount can be reasonably estimated.
Chapter
13-28 LO 3 Identify types of employee-related liabilities.
 What is a Current Liability?

Bonus Agreements
Result in payments to certain or all employees in
addition to their regular salaries or wages.
Bonuses paid are an operating expense.
Unpaid bonuses should be reported as a current
liability.

Chapter
13-29 LO 3 Identify types of employee-related liabilities.
 Contingencies

“An existing condition, situation, or set of

circumstances involving uncertainty as to possible
gain (gain contingency) or loss (loss contingency)
to an enterprise that will ultimately be resolved
when one or more future events occur or fail to
occur.”*

*“Accounting for Contingencies,” Statement of Financial Accounting

Standards No. 5 (Stamford, Conn.: FASB, 1975), par. 1

Chapter LO 4 Identify the criteria used to account for and

13-30
disclose gain and loss contingencies.
 Gain Contingencies

Typical Gain Contingencies are:

Possible receipts of monies from gifts, donations, and
bonuses.
Possible refunds from the government in tax disputes.
Pending court cases with a probable favorable outcome.
Tax loss carryforwards (Chapter 19).

Gain contingencies are not recorded.

Disclosed only if probability of receipt is high.

Chapter LO 4 Identify the criteria used to account for and

13-31
disclose gain and loss contingencies.
 Loss Contingencies

Contingent Liability
The likelihood that the future event will confirm
the incurrence of a liability can range from
probable to remote.

FASB uses three areas of probability:

Probable.
Reasonably possible.
Remote.

Chapter LO 4 Identify the criteria used to account for and

13-32
disclose gain and loss contingencies.
 Loss Contingencies

Probability Accounting

Probable Accrue

Reasonably
Footnote
Possible

Remote Ignore

Chapter LO 4 Identify the criteria used to account for and

13-33
disclose gain and loss contingencies.
 Loss Contingencies
BE13-10 Justice League Inc. is involved in a lawsuit at
December 31, 2007. (a) Prepare the December 31 entry
assuming it is probable that Justice League will be liable for
$700,000 as a result of this suit. (b) Prepare the December 31
entry, if any, assuming it is not probable that Justice League
will be liable for any payment as a result of this suit.

(a) Lawsuit loss 700,000

Lawsuit liability 700,000

(b) No entry is necessary. The loss is not accrued because

it is not probable that a liability has been incurred at
12/31/07.

Chapter LO 4 Identify the criteria used to account for and

13-34
disclose gain and loss contingencies.
 Loss Contingencies

Common loss contingencies:

2. Litigation, claims, and assessments.
3. Guarantee and warranty costs.
4. Premiums and coupons.
5. Environmental liabilities.

Chapter
13-35 LO 5 Explain the accounting for different types of loss contingencies.
 Loss Contingencies

Litigation, Claims, and Assessments

Companies must consider the following factors, in
determining whether to record a liability with
respect to pending or threatened litigation and
actual or possible claims and assessments.
Time period in which the action occurred.
Probability of an unfavorable outcome.
Ability to make a reasonable estimate of the loss.

Chapter
13-36 LO 5 Explain the accounting for different types of loss contingencies.
 Loss Contingencies

Guarantee and Warranty Costs

Promise made by a seller to a buyer to make good
on a deficiency of quantity, quality, or performance
in a product.

If it is probable that customers will make warranty

claims and a company can reasonably estimate the
costs involved, the company must record an expense.

Chapter
13-37 LO 5 Explain the accounting for different types of loss contingencies.
 Loss Contingencies
BE13-13 Frantic Factory provides a 2-year warranty with one of
its products which was first sold in 2007. In that year, Frantic
spent $70,000 servicing warranty claims. At year-end, Frantic
estimates that an additional $500,000 will be spent in the future
to service warranty claims related to 2007 sales. Prepare
Frantic’s journal entry to record the $70,000 expenditure, and
the December 31 adjusting entry.

2007 Warranty expense 70,000

Cash 70,000

12/31/07 Warranty expense 500,000

Warranty liability 500,000

Chapter
13-38 LO 5 Explain the accounting for different types of loss contingencies.
 Loss Contingencies

Premiums and Coupons

Companies should charge the costs of premiums
and coupons to expense in the period of the sale
that benefits from the plan.
Accounting:
Company estimates the number of outstanding premium
offers that customers will present for redemption.
Company charges the cost of premium offers to
Premium Expense and credits Estimated Liability for
Premiums.
Chapter
13-39 LO 5 Explain the accounting for different types of loss contingencies.
 Loss Contingencies

Environmental Liabilities
A company must recognize an asset retirement
obligation (ARO) when it has an existing legal
obligation associated with the retirement of a
long-lived asset and when it can reasonably
estimate the amount of the liability.

Chapter
13-40 LO 5 Explain the accounting for different types of loss contingencies.
 Presentation and Analysis

Presentation of Current Liabilities

Usually reported at their full maturity value.
Difference between present value and the
maturity value is considered immaterial.

Presentation of Contingencies
Disclosure should include:
• Nature of the contingency.
• An estimate of the possible loss or range of loss.
Chapter
13-41 LO 6 Indicate how to present and analyze liabilities and contingencies.
 Presentation and Analysis

Analysis of Current Liabilities

Liquidity regarding a liability is the expected time
to elapse before its payment. Two ratios to help
assess liquidity are:
Current Assets
Current Ratio =
Current Liabilities

Cash + Marketable Securities +

Net Receivables
Acid-Test Ratio =
Current Liabilities

Chapter
13-42 LO 6 Indicate how to present and analyze liabilities and contingencies.
 Presentation and Analysis
E13-17 (Ratio Computations and Discussion) Sprague
Company has been operating for several years, and on
December 31, 2007, presented the following balance sheet.
Balance Sheet (in thousands) Compute the current ratio:
Assets
Cash $ 40,000 $210,000
Accounts recievables, net 75,000 = 2.63 to 1
Inventories 95,000 80,000
Plant assets, net 220,000
Total assets $ 430,000
Liabilities and Equity
Accounts payable $ 80,000 Compute the acid-test ratio:
Mortgage payable 140,000
Common stock, $1 par 150,000 $115,000
Retained earnings 60,000
= 1.44 to 1
Total liabilities and equity $ 430,000 80,000

Chapter
13-43 LO 6 Indicate how to present and analyze liabilities and contingencies.
 Copyright

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Chapter
13-44