What is a liability?
Probable (highly likely) future sacrifices of economic benefits (cash, goods, services) arising from present obligations (liable now) of a particular entity to transfer assets or provide services to other entities in the future as a result of past transac
A liability has three essential characteristics
1. It is a present obligation that entails settlement by probable future transfer or use of cash, goods, or services.
2. It is an unavoidable obligation
3. the transaction or other event creating the obligation has already occurred.
What is a current liability?
Obligations whose liquidation is reasonably expected to require use of existing resources properly classified as current assets, or the creation of other current liabilities.
Example of a current liability
90 day note There will be an extension on the note and the company will pay this off with a current asset.
Operating cycle
The period of time elapsing between the acquisition of goods and services and the final cash realization resulting from sales and subsequent collections.
Typical current liability
1. Accounts payable
2. Notes payable
3. Current maturities of long term debt
4. Short term obligations expected to be refinanced
5. Dividends payable
6. Customer advances and deposit
7. Unearned revenues
8. Sales taxes payable
9. Income taxes payable
10.
Accounts payable
(Trade accounts payable) Balances owed to others for goods, supplies, or services purchased on open account. Arises because of the time lag between the receipt of services or acquisition of title to assets and the payment for them.
Notes Payable
Written promises to pay a certain sum of money on a specified future date. They may arise from purchases, financing, or other transactions, classified as short term or long term, may be interest bearing or zero interest bearing.
Current maturities of long term debt
Portion of bonds, mortgage notes, and other long term indebtedness that matures within the next fiscal year. The portion that is due within the next fiscal year will be consider a CL, the remaining balance is consider LTL.
Exclude long term debts maturing currently as CL if they are to be:
1. Retired by assets accumulated for this purpose that properly have not been shown as current asset. (ex, bond sinking fund which is classified as long term investment)
2. Refinanced, or retired from the proceeds of a new debt(LTD) issue
3. Converted int
Short term obligations
are debts scheduled to mature within one year after the date of a company's balance sheet or within its operating cycle, whichever is longer.
Short term obligations expected to be refinanced
Exclude from current liabilities if both conditions are met.
1. Must intend to refinance the obligation on a long term basis.
2. Must demonstrate the ability to refinance
a. Actual financing
b. Enter into a financing agreement
Cash dividend payable
An amount owed by a corporation to its stockholders as a result of board of directors' authorization. Because companies always pay cash dividends within one year of declaration, they classify them as current liabilities.
Dividends payable
1.Undeclared dividends on cumulative preferred stock not recognized as a liability.
2. Dividends payable in the form of additional shares of stock are not recognized as a liability
3. Reported in equity.
Customer advances and deposits
Returnable cash deposits received from customers and employees.
Maybe classified as current or long-term liabilities.
Unearned Revenues
Payment received before delivering goods or rendering services.
1. Upon receipt of the advance, debt cash, and credit a current liability account identifying the source of the unearned revenue.
2. Upon earning the revenue, debit the unearned revenue accou
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.
Two way to record sales taxes payable
1. Segregate the sales tax and the amount of sale at the time of sale
2. Do not segregate, credit both amounts in total sales revenue account.
Income tax payable
Businesses must prepare an income tax return and compute the income tax payable. Taxes payable are current liability, corporations must make periodic tax payments, differences between taxable income and accounting income sometimes occur.
Employee-Related liabilities
Amounts owed to employees for salaries or wages are reported as current liability. Include payroll deductions, compensated absences, bonuses.
Employee-Related liabilities may include?
1. Payroll deductions
2.Compensated deductions
3. Bonuses
Payroll Deductions
The most common types of payroll deductions are taxes (social security & income tax withholding), insurance premiums, employee savings, and union dues.
Employee pays
Income tax withholding
FICA taxes - employee share
Union dues
Employer pays
FICA - employer share
Federal unemployment
State unemployement
Compensated absences
Are paid absences from employment such as vacation, illness, and holidays.
Accrue a liability if all the following conditions exist
1. The employer's obligation relating to employees' right to receive compensation for future absences is attributable to employees' services already rendered.
2. The obligation relates to the rights that vest or accumulate.
3. Payment of the compensation
Vested rights
exist when an employer has an obligation to make payment to an employee even after terminating his or her employment. Not contingent on an employee's future service.
Accumulated rights
are those that employees can carry forward to future periods if not used in the period in which earned.
Contingencies
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.
Example of contingencies
For Motor Co. provides a warranty for a car it sells, and any payments are contingent on the number of cars that qualify for benefits under the warranty.
Gain contingencies
are claims or rights to receive assets(or have a liability reduced) whose existence is uncertain but which may become valid eventually.
Typical gain contingencies
1. Possible receipts or monies from gifts, donations, assets sales, and so on.
2. possible refunds from the government in tax disputes
3. Pending court cases with a probable favorable outcome
4. Tax loss carry forwards
Gain contingencies are not recorded.
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 or probability
1. Probable, future event or events are likely to occur (close to 100%)
2. Reasonably possible, chance of the future event or events occurring is more than remote but less than likely (middle)
3. remote, the chance of the future event or events occurring
Companies should accrue an estimated loss from loss of contingency only if both conditions are met
1. Info available prior to the issuance of the financial statements indicates that it is probable that a liability has been incurred at the date of the financial statements.
2. The amount of the loss can be reasonably estimated.
Charge to loss/expense and
Usually accrued loss related to.
1. collectibility of receivables
2. obligations related to product warranties and product defects
3. premiums offered to customers
Not accrued loss related to
1. risk of loss or damage of enterprise property by fire, explosion, or other hazards.
2. general or unspecified business risks
3. risk of loss from catastrophes assumed by property and casualty insurance companies, including reinsurance companies.
May be accrued loss related to
1. threat of expropriation of assets
2. pending or threatened litigation
3. actual or possible claims and assesements
4. Guarantees of indebtedness of other
5. obligations of commercial banks under standby letters of credit
6. agreements to repurchase rec
common loss contingencies
1. litigation, claims, and assessment
2. guarantee and warranty costs
3. premiums and coupons
4. environment liabilites
Litigation, claims, and assessment
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
Factors of litigation, claims, and assessment
1. The time period in which the underlying cause of action occurred
2. the probability of an unfavorable outcome
3. the ability to make a reasonable estimate of the amount of loss
to report a loss and a liability in the financial statements, the cause for
To evaluate the probability of an unfavorable outcome, a company consider the following
1. nature of the litigation
2. progress of the case
3.. opinion of legal counsel
4. its own and others' experience in similar cases
5. any management response to the lawsuit
Guarantee and warranty cost
promise made be a seller to a buyer to make good on a deficiency of quantity, quality, or performance in a product. Manufacturers commonly use it as a sales promotion technique.