ACCOUNTING CHP13-14

Liability

Present obligation to transfer an economic benefit (i.e. it exists NOW

A debt that is owed (in other words, the obligation came from a past event)

Timeframe of a liability

Obligation payable within one year from the balance sheet date

or within the firm’s operating cycle, whichever is longer

Current Liabilities are Recorded at…

maturity amounts (total sum of money payable to an investor or policyholder at the end of a financial contract term)

Current Liabilities Examples

Accounts payable

Notes payable

Accrued expenses (i.e. accrued liabilities)

Accrued wages/salaries

Accrued interest expense

Accrued taxes

Some contingent liabilities (potential liabilities) becomes

actual liabilities: probable and known or estimable

Warranties

Accounts Payable

Obligations to suppliers payable on open account; use an invoice as the credit instrument; typically 30–60 days, noninterest-bearing, reported at face amount.

Short-Term Notes Payable

A company's liability when it borrows cash from a bank and signs a promissory note; reported as notes payable, bank loans, or short-term borrowings.

Credit Line (Line of Credit

An agreement to provide short-term financing, with amounts withdrawn by the borrower only when needed; can be committed (formal) or noncommitted (informal).

Accrued Expenses (Accrued Liabilities)

Expenses already incurred but not yet paid; recorded via adjusting entries; reported under "accrued expenses" on the balance sheet.

Vesting

The process by which an employee gains non-forfeitable ownership of employer-provided assets or benefits over time.

Deferred/Unearned Revenue

A liability representing advance collections from customers for products or services not yet delivered (e.g., gift cards, magazine subscriptions, airline tickets).

Working Capital

Current assets minus current liabilities; a measure of short-term financial health.

Refinancing

Replacing short-term debt with new long-term debt; can allow reclassification of short-term obligations as noncurrent if the intent and ability to refinance are demonstrated.

Loss Contingency

An existing, uncertain situation involving a potential loss depending on a future event; accrued only when the loss is both probable and reasonably estimable.

Probable

The future confirming event is likely to occur (used to assess whether to accrue a contingency).

Reasonably Possible

The chance of the future event occurring is more than remote but less than likely; requires disclosure but not accrual.

Extended Warranty

Warranty protection beyond the manufacturer's original warranty; sold separately and recorded as deferred revenue (not a loss contingency), recognized as revenue on a straight-line basis over the contract period.

Gain Contingency

An uncertain situation that might result in a gain; never accrued under U.S. GAAP (conservatism principle); only disclosed in notes if material.

Subsequent Events

Events occurring between the fiscal year-end and the issuance of financial statements; used to refine estimates of contingent liabilities already existing at year-end.

Payroll-Related Liabilities

Liabilities arising from legally required tax withholdings (federal/state income tax, FICA), employer payroll taxes, and voluntary employee deductions (union dues, retirement contributions, insurance).

Bonds

The most common form of corporate debt; debt securities issued by a company that break down a large borrowing into manageable units (usually $1,000 or $5,000 each) sold to many investors, with a promise to repay principal plus interest over more than one year.

Trustee

A commercial bank or financial institution appointed by the bond issuer to represent the rights of bondholders and enforce the bond indenture.

Straight-Line Method

A simplified method of amortizing a bond discount or premium equally over each interest period; can be used if results are not materially different from the effective interest method (an application of the materiality concept).

Accrued Interest

When a fiscal year ends between interest payment dates, interest that has accrued since the last payment date must be recorded via an adjusting entry.

Long-Term Notes Payable

Loans from lenders (e.g., banks) documented by a promissory note with a repayment period extending beyond one year; recorded at face amount when the stated rate equals the market rate.

Implicit Rate of Interest

The interest rate that is not expressly stated in a loan agreement but is implied by the terms of the transaction (e.g., when goods are exchanged for a note).

Installment Note

A loan requiring repayment through a series of equal, scheduled periodic payments, each consisting of both interest and a partial principal reduction; the note is fully paid off at maturity (similar to a mortgage or auto loan).

Unrealized Gain/Loss on Bonds (Fair Value)

When fair value changes, the gain or loss is split: the portion due to changes in general interest rates is reported in net income (NI); the portion due to changes in the company's credit risk is reported in other comprehensive income (OCI).

Credit Risk

The risk that the company will fail to pay the promised interest and maturity amounts when due; changes in credit risk affect the fair value of the company's own debt.

Current Liabilities are recorded at

face value

Long-term Liabilities are recorded at

present value

non-interest-bearing notes

Recorded at PRESENT VALUE

Bond Pricing: WHEN THE RATES ARE EQUAL

Face value

A SALE

Deferred revenue

Redemption

revenue recognized

breakage

Revenue recognized when probable unused

Gift cards that expire unused. Recognized as revenue because the company no longer owes the customer.

Extended Warranties

• Recognize revenue over time

• Monthly or yearly allocation

Assurance-Type Warranties

• Estimate total warranty cost at time of sale

• Record:

  • Dr Warranty Expense

  • Cr Warranty Liability

Subscription Revenue

• Collected in advance → Deferred revenue

• Recognized over time

• Calculate portion earned

Long-Term Debt Refinancing

f refinancing occurs:

• Before financial statements are issued → can classify as noncurrent

• After issuance → cannot reclassify

Noninterest-Bearing Notes

• Recorded at present value

• Discount = Face − Present Value

• Discount amortized as interest expense

Compensated Absences

Accrue compensated absences if:

• Employees have earned it

• It accumulates

• It is probable

• It can be estimated

When are gift card sales recorded as revenue?

ever at sale. It's Deferred Revenue (liability) until redeemed or expired.

Journal entry when gift cards are sold

Dr. Cash 1,000 / Cr. Deferred Gift Card Revenue 1,000

Journal entry when gift cards are redeemed

• Deferred Gift Card Revenue 1,000 / Cr. Revenue – Gift Cards 1,000

Journal entry when gift cards expire (breakage)

Dr. Deferred Gift Card Revenue 1,000 / Cr. Revenue – Gift Cards 1,000

When is warranty expense recorded? →

At the time of sale, not when repairs are made (matching principle).

Journal entry to accrue warranty expense

Dr. Warranty Expense 140,000 / Cr. Warranty Liability 140,000

Journal entry when warranty repairs are actually made for $61,000?

• Dr. Warranty Liability 61,000 / Cr. Cash 61,00

How is extended warranty revenue recognized?

Evenly over the warranty periodEvenly over the warranty period

Journal entry when extended warranty is sold for $60?

Dr. Cash 60 / Cr. Deferred Revenue – Extended Warranties 60

When do you accrue a loss contingency?

only when BOTH: (

1) loss is Probable

(2) amount is Reasonably Estimable.

Loss is probable but can't be estimated — what do you do?

Do NOT accrue. Disclose in footnotes only.

Loss is reasonably possible and estimable — what do you do?

Do NOT accrue. Disclose in footnotes only. Must be probable to record.

Are gain contingencies accrued when probable and estimable? →

FALSE. Gain contingencies are NEVER accrued, only disclosed.

What are the 3 likelihood categories under GAAP? →

Probable (accrue if estimable),

Reasonably Possible (disclose only),

Remote (ignore).

What is a noninterest-bearing note?

No stated interest, but interest is built into the face value. The difference between cash received and face value is the discount (hidden interest).

When is a bond sold at a discount?

Stated rate < Market rate. Investors pay less than face value.

When is a bond sold at a premium? →

Market rate. Investors pay more than face value.

For a discount bond, does carrying value go up or down over time?

Up — starts below face value and grows toward face value at maturity.

What is the net method for recording a bond investment?

Record at actual price paid (present value). Dr. Investment in Bonds [PV] / Cr. Cash [PV]. No separate discount account.

When is debt noncurrent vs. current?

Current if due within 1 year UNLESS refinanced with long-term debt before financial statements are issued.

Are current liabilities recorded at present value?

no

What is deferred revenue and why is it a liability?

Cash collected before it's earned. It's a liability because the company still owes the customer a product or service.

What is the matching principle?

Expenses must be recorded in the same period as the revenues they helped generate, regardless of when cash is paid.