Chapter 13: Current Liabilities and Contingencies

Liabilities

Probable, future sacrifices of economic benefits arising from present obligations that result from past transactions or events.

Current Liabilities

Obligations that are payable within one year or the firm's operating cycle, satisfied from current assets or by creating other current liabilities.

Accounts Payable

Obligations to suppliers of merchandise or services purchased on open account, typically non-interest bearing.

Short-Term Notes Payable

Temporary financing from banks that require a promissory note, usually with lower interest rates than long-term debt.

Line of Credit

An agreement that allows a company to borrow up to a prearranged limit without formal procedures.

Committed Line of Credit

A formal agreement requiring a commitment fee to keep a credit line available to the company.

Interest

The cost of borrowing, expressed as a percentage of the loan's face amount, paid by the borrowing company.

Effective Interest Rate

The actual rate of interest paid on a loan after considering any discounts or deductions from the face amount.

Secured Loans

Loans made by pledging a specified asset of the borrower as collateral or security.

Accrued Liabilities

Expenses that have been incurred but not yet paid, typically recorded through adjusting entries.

Deferred Revenue

Cash received from customers for services/products not yet delivered, recorded as a liability until service is performed.

Contingent Liabilities

Possible obligations that may occur depending on the outcome of future events, categorized as probable, reasonably possible, or remote.

Payroll-related Liabilities

Legal requirements for employers to withhold taxes and obligations to pay for employee benefits, such as Social Security and income tax.

Refundable Deposits

Advance payments made by customers that are refundable upon fulfillment of contractual obligations.

Gain Contingency

An uncertain situation that might result in a gain, which is not accrued but disclosed when realization is probable.

Fringe Benefits

Employer contributions to employee insurance premiums and/or retirement plans, classified as payroll-related liabilities.

Current Portion of Long-Term Debt

The portion of long-term debt that is due within the current year, classified as a current liability on the balance sheet.

Interest-bearing Note

A loan instrument on which interest is charged on the principal amount, often formalized in a promissory note.

Accrual of Interest

The process of recognizing and recording interest expense as it is incurred, whether or not it has been paid.

Commercial Paper

Unsecured notes sold in minimum denominations, typically used for short-term financing by companies.

Interest payable

arises in connection with notes payable

Advance from customers or collections

made from the third party where the services are provided in the future

Management prefers

a non current liability over a current liability because the current payable liability is riskier than the noncurrent one

Loss contingency

a set of circumstances pointing to a potential loss in the future

product warranties and guarantees

promises that a company makes regarding a product after the product is bought

Extended warranty

provides warranty protection above and beyond the manufacturer’s original warranty

Larger firms suffer

heavy losses due to pending litigation claims by other organizations

Subsequent events

time between the end of a company’s fiscal year and the date the financial statements for that year

Unasserted claims

potential claim that has not yet been made

Klein Corp. obtains a 6-month noninterest-bearing loan from its financial institution. The company signs a note for $10,000 and receives $9,500 from the bank. What is the annualized effective interest rate on this loan?

10.53%

Reason: ($500/$9,500) x 12/6

On January 1, 2024, Merkel Company received $1,814 from a customer related to products to be delivered on December 31, 2025. The company normally sells the products for $2,000 in cash. The company's effective interest rate is 5%. On December 31, 2024, Merkel should recognize

interest expense of $91

Reason: $1,814 x 0.05

Walden Company collects the annual fee for 100 magazine renewals. The annual price is $104 per subscription and covers 52 weekly magazines. The subscription period is from July 1 of the current year until June 30 of the following year. During the current calendar year for each subscription, Walden should recognize

revenue of $52. ½ of the one year subscription price

Which of the following transactions will increase a company's working capital?

Receipt of cash on a long-term note

On January 1, 2024, Merkel Company receives $1,814 from a customer related to products to be delivered on December 31, 2025. The company's effective interest rate is 5%. The company regularly sells the products for $2,000 in cash. On January 1, 2024, Merkel should recognize deferred revenue of: (round to whole dollars)

$1,814

Reason: $2,000 x 0.9073 (present value factor, n=2, i=5%)

Walden Company collects the annual fee for 100 magazine renewals. The annual price is $104 per subscription and covers 52 weekly magazines. When Walden Company receives payment for each subscription renewal, the company should recognize

a liability for $104.

If a liability is classified as current, rather than noncurrent, the company's working capital will Blank______.

decrease

Spencer Corp.'s attorney estimates that the company will ultimately have to pay between $250,000 and $500,000 relating to current litigation. Spencer should accrue a contingent liability and loss of

$250,000.

Reason: When no amount within the range appears more likely than others, we record the minimum amount.

Supreme Inc. sells its products with a 3-year warranty. The company estimates warranty costs relating to sales during the current year as follows: Current Year (Year 1): $10,000; Year 2: $25,000; Year 3: $15,000. Assume that actual warranty costs during the current year were as estimated. What is the amount of warranty expense that Supreme should recognize in its current year income statement?

$50,000

Reason: The full amount is recognized in the year of sale to match the expense with the related revenue.

Pledging

When accounts receivable serve as collateral

Factoring

The receivables are actually sold outright to a finance company as a means of short-term financing

Face amount x Interest rate x Time

Interest on debt

Payable with current assets

Current liabilities

Short-term debt to be refinanced with common stock

Long-term liability

Present value of interest plus present value of principal

Usual valuation of liabilities

Noninterest-bearing

Accounts payable

Noncommitted line of credit

Informal agreement

Pledged accounts receivable

Secured loan

Reclassification of debt

Refinancing prior to the issuance of the financial statements

Purchased by other corporations

Commercial paper

Expenses not yet paid

Accrued liabilities

Liability until refunded

Customer deposits

Liability until satisfy performance obligation

Customer advances