Current Liabilities and Contingencies

The issuer of preferred stock (and in some vases the holder) often has the right to call the stock within a specific period of time – making it similar to a repayment or principal

The dividend on the preferred stock is in many cases almost guaranteed (the cumulative provision) making is look like interest

Liabilities – probably 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

It is a present obligation that entails settlement by probable future transfer or use of cash, goods, or services

It is an unavoidable obligation

The transaction or other event creating the obligation has already occurred

Because liabilities involve future disbursements of assets or services, one of their most important features is the date on which they are payable

Current Liabilities – obligations whose liquidation is reasonably expected to require use of existing resources properly classified as current assets, or the creating of other current liabilities

Examples – Accounts Payable, Notes Payable, Dividends Payable, Customer Advances and Deposits, Unearned Revenues, Sales Tax Payable, Income Taxed Payable, Employee-Related Liabilities, Current Maturities of Long-Term Debt, and Short-Term Obligations Expected to be Refinanced

Operating Cycle – the period of time elapsing between the acquisition of goods and services involved in the manufacturing process and the final cash realization resulting from sales and subsequent collections

Accounts Payable (Trade Accounts Payable) – balances owed to other for goods, supplies, or services purchased on open account

Arise because of the time lag between the receipt of services or acquisition of assets and the payment for them; usually stated in the terms of sale (2/10, n/30 or 1/10, EOM)

A company must ascertain that the records of goods received (the inventory) agrees with the liability (accounts payable) and that it records both in the proper period

Notes Payable – written promises to pay a certain sum of money on a specified future date; short-term or long-term; interest-bearing or zero-interest-bearing

Arise from purchases, financing, or other transactions

Trade Notes Payable – some industries require notes as part of the sales / purchases transaction in lieu of the normal extension of open account credit

Notes payable to bank or loan companies generally arise from cash loans

Interest-Bearing Note Issued

Example: Bank agreed to lend $100,000, 6 percent, four-month note

Cash 100,000

Notes Payable 100,000

To recognize interest expense and interest payable (100,000 6% 4/12)

Interest expense 2,000

Interest Payable 2,000

At maturity the company must pay the face value of the note plus interest

Notes Payable 100,000

Interest Payable         2,000

Cash 102,000

Zero-Interest Bearing Note Issued

Note does not explicitly state an interest rate on the face of the note, but interest is still charged, at maturity, the borrower must pay back an amount greater than the cash received at the issuance date 

The borrower received in cash the present value of the note – the present value equals the face vale of the note at maturity minus the interest or discount charger by the lender for the term of the note; the bank takes the fee upfront rather than on the date the note matures

Example: Company issues a $102,000, four-month, zero-interest bearing note to the Bank; present value is $100,000, the $2000 represents the cost of borrowing the money

Cash 100,000

Discount on Notes Payable     2,000

Notes Payable 102,000

Discount on Notes Payable is a contra account to Notes Payable and therefore is subtracted from Notes Payable on the Balance Sheet

Notes Payable xxx

Less: Discount on Notes Payable xxx xxx

Charge the discount to interest expense over the life of the note

The Discount on Notes Payable balance represents interest expense chargeable to future periods 

Cash Dividend Payable – an amount owed by a corporation to its stockholders as a result of its board of directors’ authorization

At the end of declaration, the corporation assumes a liability that places the stockholders in the position of creditors in the amount of dividends declared, because companies always pay cash dividends within one year of declarations they classify them as current liabilities but do not recognize accumulated but undeclared dividends on cumulative preferred stock as a liability

Preferred Dividends in Arrears – are not an obligation until the board of directors authorized the payment, nevertheless, companies should disclose the amount of cumulative dividends unpaid in a note, or show it parenthetically in the capital stock section

Stock Dividends do not require future outlays of assets of services; generally, report undistributed stock dividends in the stockholders’ equity section because they represent retained earnings in the process of transfer to Paid-In Capital

Returnable Cash Deposits – companies may receive deposits from customers to guarantee performance of a contract or service or as guarantees to cover payment of expected future obligations

The classification of these items as current or noncurrent liabilities depends on the time between the date of the deposit and the termination of the relationship that requires the deposit

Unearned Revenues – received before delivering goods or rendering services

When a company received an advance payment, it debits Cash, and credits a current liability account identifying the source of the unearned revenue

When a company recognizes revenue, it debits the unearned revenue account, and credits a revenue account

Unearned Sales Revenue represents unearned revenue, reported as a current liability in the balance sheet and has an obligation to fulfill the service

Example: University records the sale of 10,000 season tickets for $50 each for 5-game season

Cash 500,000

Unearned Service Revenue 500,000

When the first game is plated, the University records sales Revenue

Unearned Service Revenue 100,000

Sales Revenue 100,000

As subsequent games are played, University satisfies a performance obligation and records sales revenue as it reduces Unearned Sales Revenue

The balance sheet reports obligations for any commitments that are redeemable in goods and services and the income statement reports revenues related to performance obligations satisfied during the period

Sales Tax Payable – retailers must collect sales taxes from customers on transfer of tangible personal property and on certain services and then must remit these taxes to the proper governmental authority

Sales Tax Payable should reflect the liability for sales taxes due various governments 

Example: Sales Tax on a sale of $3000 with a 4% sales tax

Cash 3120

Sales Revenue 3000

Sales Tax Payable   120

Sometimes the sales tax collections credited to the liability account are not equal to the liability as computer by the governmental formula, and makes an adjustment of the liability account by recognizing a gain or a loss on sales tax collections

Many company’s do not segregate the sales tax and the amount of the sale at the time of the sale; the company credits both amounts in total in the Sales Revenues account and then debit the Sales Revenue account for the amount of the sales taxes due to the government on these sales and would credit the Sales Tax Payable account for the same amount

Example: Assume that the Sales Revenue account balance of $150,000 includes sales taxes of 4% thus the amount recorded in the Sales Revenue account is compromised to the sales amount plus sales tax of 4% of the sale amount.

Therefore, the Sales are $144,230.77 ($150,000 / 1.04) and the sales tax liability is $5,769.23 ($150,000 - $144,230.77) 

To record the amount due to the taxing unit

Sales Revenue 5769.23

Sales Taxed Payable 5769.23

Income Taxes Payable – any federal or state tax varies in proportion to the amount of annual income; a business must prepare an income tax return and compute the income taxes payable resulting from the operating of the current period

Corporations should classify as a current liability the taxes payable on taxable income, as computer per the tax return

Proprietorships and partnerships are not taxable entities, because the individual proprietor and the members of a partnership are subject to personal income taxes on their share of the business’s taxable income, income tax liabilities do not appear on the financial statements of proprietorships and partnerships

Most corporations make periodic tax payments throughout the year in an authorized bank account depository or a Federal Reserve Bank; if in a later year the taxing authority assesses an additional tax on the income of an earlier year, the company should credit Income Taxes Payable and charge the related debit to current operations

Employee-Related Liabilities – report current liability amounts owed to employees for salaries or wages at the end of an accounting period

Often include Payroll Deductions, Compensated Absences, and Bonuses

Payroll Deductions – most common types include taxes, insurance premiums, employee savings and union dues; to the extent that a company has not remitted the amounts deducted to the proper authority at the end of the accounting period, it should recognize them as current liabilities

Social Security Taxes – the combination of FICA / OASDI and the federal Hospital Insurance Tax; companies should report the amount of unremitted employee and employer Social Security Tax on gross wages paid as a current liability

Old Age, Survivor, and Disability Insurance (OASDI) provides benefits for certain individuals and their families where payments come from tax levied on both the employer and the employee

Hospital Insurance Tax paid by both the employee and employer provides for hospital and other institutional services (Medicare)

Unemployment Taxes – another payroll tax levied by the federal government in cooperation with state governments provides a system of unemployment insurance; generally only employers pay the unemployment tax 

Merit rating reduces the state unemployment contribution rate

Companies pay federal unemployment tax quarterly and file a tax form annually and generally pay state contributions quarterly as well

Because both federal and the state unemployment taxes accrue on earned compensation, companies should record the amount of accrued but unpaid employer contributions as an operating expense and as a current liability when preparing financial statements at year-end

Example: Company has a taxable payroll of $100,000 that is subject to a federal rate of 6% and a state contribution rate of 5.7% however, its stable employment experience reduced the company’s state rate to 1%

State Unemployment Tax Payment (1% * $100,000) $1000

Federal Unemployment Tax [(6% - 5.4%) * $100,000)     600

Total Federal and State Unemployment Tax $1600

Income Tax Withholding – federal and some state income tax laws require employers to withhold from each employees’ pay the applicable income tax due to those wages; the amount depends on the length of the pay period and each employee’s taxable wages, marital status, and claimed dependents

If the income tax withheld plus the employee and the employer Social Security Taxes exceeds specified amounts per month, the employer must make remittances to the government during the month

Example: Assume a weekly payroll of $10,000 entirely subject to FICA and Medicare (7.65%) and Federal (0.8%) and State (4%) unemployment taxes with income tax withholding of $1,230 and Union Dues of $88 deducted

To Record Sales and Wages Paid and the Employee Payroll Deductions:

Salaries and Wages Expense 10,000

Withholding Taxes Payable 1320

FICA Taxes Payable   765

Union Dues Payable     88

Cash 7827

To Record Employer Payroll Taxes:

Payroll Tax Expense 1,245

FICA Taxes Payable 765

FUTA Taxes Payable   80

SUTA Taxes Payable 400

The employer must remit to the government its share of FICA tax along with the amount of FICA tax deducted from each employee’s gross compensation and records all unremitted employer FICA taxes as payroll tax expense and payroll taxes payable

Compensated Absences – paid absences from employment such as vacation, illness, and holidays

Companies should accrue a liability for the cost of compensation for future absences if all of the follow conditions

1. The employer’s obligation relating to employee’s rights to receive compensation for future absences is attributable to employee’s services already rendered

2. The obligations related to the rights that vest or accumulate

3. Payment of the compensation is probable

4. The amount can be reasonable estimated

Vested Rights – exist when an employer has an obligation to make payment to an employee even after terminating their employment; not contingent on an employee’ future service

Accumulated Rights – those that employees can carry forward to future periods is not used in the period for which they are earned

Sick Pay – if sick pay benefits vest, a company must accrue them, if sick pay benefits accumulate but do not vest, a company may choose whether to accrue them

If employees receive sick pay only if illness causes their illness, these companies may or may not accrue a liability because its payment depends on future employee illness

If companies allow employees to accumulate unused sick pay and take compensated time off from work even when not ill, a company must accrue a liability because the company will pay it regardless of whether employees become ill

Companies should recognize the expense and related liability for compensated absences in the year earned by employees

Example: A company employs 10 individuals and pays each $480 per week, employees earned 20 unused vacation weeks in 2017. In 2018 the employees used the vacation weeks but now they earn $540 per week

December 31, 2017 ($480 * 20)

Salaries and Wages Expense 9,600

Sales and Wages Payable 9,600

In 2018 they record the payment of vacation pay ($540 * 20)

Salaries and Wages Payable 9,600

Sales and Wages Expense 1,200

Cash 10,800

In 2018, the use of vacation weeks extinguishes the liability and records the difference between the amount of cash paid and the reduction in the liability account as an adjustment to Sales and Wages Expense in the period when paid

Bonus Agreements – to certain or all employees in addition to their regular salaries or wages, frequently depends on the company’s yearly profit

A company may consider bonus payments to employees as additional wages and should include them as a deduction in determining the net income for the year

Example: Company shows income for the year 2017 of $100,000 and will pay out bonuses of $10,700 in January 2018

Adjusting Entry for December 31, 2017 to Record the Bonuses

Salaries and Wages Expense 10,700

Salaries and Wages Payable 10,700

Bonuses Paid in January 2018

Sales and Wages Payable 10,700

Cash 10,700

The liability, Salaries and Wages Payable, is usually payable within a short period of time, companies should include it as a current liability in the balance sheet; shows the expense account in the income statement as an operating expense

Conditional Expenses – contractual agreements

Current Maturities of Long-Term Debt – reported as part of its current liabilities the portion of bonds, mortgage notes, and other long-term indebtedness that matures within the next fiscal year

Exclude long-term debts maturing currently as current liabilities if they are to be

1. Retired by assets accumulated for this purpose that properly have not been shown as current assets

2. Refinanced, or retired from the proceeds of a new debt issue

3. Converted into capital stock

A company should disclose the plan for liquidation of such a debt either parenthetically or by a note to the financial statements

When only part of a long-term debt is to be paid within the next 12 months, the company reports the maturing portion of long-term debt as a current liability and the remaining portion as a long-term debt

A company should classify as current any liability that is due on demand or will be due on demand within a year (or operating cycle is longer)

Only if a company can show that it is probably that the company will cure (satisfy) the violation within the grace period specified in the agreements can it classify the debt as noncurrent

Short Term Obligations – 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 – expected to be refinanced on a long-term basis; these short-term obligations will not require the use of working capital during the next year (or operating cycle, if longer)

Refinancing Criteria – to resolve classification problems, the accounting profession has developed criteria for determining the circumstances under which short-term obligations may be properly excluded from current liabilities

A company is required to exclude a short-term obligation from current liabilities if both of the following conditions are met

1. It must intend to refinance the obligation on a long-term basis

2. It must demonstrate an ability to consummate the refinancing

Intention to refinance on a long-term basis means that the company intends to refinance the short-term obligation so that it will not require the use of working capital during the ensuing fiscal year (or operating cycle, if longer)

The company demonstrates the ability to consummate the refinancing by

1. Actually refinancing the short-term obligation by issuing a long-term obligation or equity securities after the date of the balance sheet but before it is issued

2. Entering into a financing agreement that clearly permits the company to refinance the debt on a long-term basis on terms that are readily determinable

If an actual refinancing occurs, the portion of the short-term obligation to be excluded from current liabilities may not exceed the proceeds from the new obligation or equity securities used to retire the short-term obligation

Repayment of the short-term obligation required the use if existing current assets before the company obtained funds through long-term financing therefore the company must include the short-term obligations in current liabilities at the balance sheet date

Contingency – 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 resolves when one or more future events occur or fail to occur

Gain Contingencies – claims or rights to receive assets (or have a liability reduced) whose existence is uncertain, but which may become valid eventually

1. Possible receipts of monies from gifts, donations, asset 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 carryforwards

Companies do not record gain contingencies; they disclose gain contingencies in the notes only when a high probability exists for realizing them

Loss Contingencies – involve possible losses; a liability incurred as a result of a loss contingency is by definition a contingent liability

Contingency Liability – depends on the occurrence of one or more future events to confirm either the amount payable, the payee, the date payable, or its existence

When a loss contingency exists, the likelihood that the future event or events will confirm the incurrence of a liability can range from probable to remote

1. Probable – the future events are likely to occur

2. Reasonable Possible – the chance of the future event or events occurring is more than remote by less than likely

3. Remote – the chance of the future event occurring is slight

Companies should accrue as estimated loss from a loss contingency by a chance to expense and a liability recorded only if both of the following conditions are met

1. Information available prior to the issuance of the financial statements indicated 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

To record a liability, a company does not need to know the exact payee nor the exact date payable; what a company must know is whether it is probable that it incurred a liability

To determine a reasonable estimate of the liability, a company may use its own experience, experience of other companies in the industry, engineering or research studies, legal advice, or educated guesses by qualified personnel

Common loss contingencies – litigation, claims and assessments, guarantee and warranty costs, consideration payable (premiums and coupon) and environmental liabilities

Accounting Treatment of Loss Contingencies

Usually Accrued

Loss Related To

1. Collectability of Receivables

2. Obligations Relates 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 Risk

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 Assessments

4. Guarantees of Indebtedness of Others

5. Obligations of Commercial Banks under “Standby Letters of Credit”

6. Agreement to Repurchase Receivables (or the Related Property) that have been sold

Companies must consider the following factors, among others, in determining whether to record a liability with respect to pending or threatened litigation and actual or possible claims and assessments

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 litigation must have occurred on or before the date of the financial statements

To evaluate the probability of an unfavorable outcome, a company considers the nature of the litigation, the progress of the case, the opinion of legal counsel, its own and others’ experience in similar cases, and any management response to the lawsuit

For unfiled suits and unasserted claims and assessments, a company must determine the degree of probability that a suit may be filed, or a claim or assessment may be asserted and the probability of an unfavorable outcome

Warranty (Product Guarantee) – promise made by a seller to a buyer to make good on a deficiency of quantity, quality, or performance in a product

As estimated amount of the liability includes all the costs that the company will incur after sale and delivery and that are incident to the correction of defects or deficiencies required under the warranty provisions

1. Warranty that the product meets agreed-upon specifications in the contract at the time the product is sold, this type of warranty is included in the sales price of a company’s product and is often referred to as an assurance-type warranty

2. Warranty that provides an additional service beyond the assurance-type warranty, this warranty is not included in the sales price of the product and is referred to as a service-type warranty and as a result is recorded as a separate performance obligation

Assurance-Type Warranty – this type of warranty is nothing more than a quality guarantee that the good or service is free from defects at the point of sale

These obligations should be expensed in the period the goods are provided or services performed, and in addition, the company should record a warranty liability

The estimated amount of the liability includes all costs that the company will incur in the future due to the correction of defects or deficiencies required under the warranty provisions

Example: Company produces machines in 2017 and sells 100 for $5,000 cash by year end for total revenue of $500,000 (100 $5000) each machine is under warranty for one year; the warranty cost will average $200 per unit for a total expected warranty expense of $20,000 (100 $200) and $4,00 in warranty costs in 2017 and $16,00 in 2018 for parts replacements and services performed

To Recognize Sales of Machines

Cash 500,000

Sales Revenue 500,000

To Record Payment for Warranty Costs Incurred in 2017

Warranty Expense 4,000

Cash, Inventory, Accrued Payroll 4,000

Adjusting Entry to Record Estimated Warranty Expense and Liability for Expected Claims in 2018

Warranty Expense 16,000

Warranty Liability 16,000

Record Payment for Warranty Costs Incurred in 2018 related to the 2017 Machines

Warranty Liability 16,000

Cash, Inventory, Accrued Payroll 16,000

Service-Type Warranty – sometimes sold separately from the product; provide the customer a service beyond fixing defects that existed at the time of sale

Recorded as a separate performance obligation and usually recorded in an Unearned Warranty Revenue account

Example: You purchase a warranty for $30,00 on 2017, the company estimates the assurance-type warranty costs to be $700 (Company will pay for the repairs for the first 36,000 miles or three years, whichever comes first), you also purchase $900 service-type warranty for an additional three years or 36,000 miles. The company incurs warranty costs related to the assurance-type warranty of $500 in 2017 and $100 in 2018 and 2019; revenue recorded on the service-type warranty on a straight-line basis

Record the Sale of the Automobile and Related Warranties ($30,000 + $900)

Cash 30,900

Sales Revenue 30,000

Unearned Warranty Revenue     900

Record Warranty Costs Incurred in 2017

Warranty Expense 500

Cash, Inventory, Accrued Payroll 500

Adjusting Entry to Record Estimated Warranty Expense and Liability for Expected Assurance Warranty Claims in 2018

Warranty Expense 200

Warranty Liability 200

Record Revenue Recognized in 2020 on the Service-Type Warranty ($900 / 3)

Unearned Warranty Revenue 300

Warranty Revenue 300

Consideration Payable – companies often make payments to their customers as part of a revenue agreement; may indicate discounts, volume rebates, free products, or services 

Offer premiums, printed coupons, cash rebate to stimulate sales that reflect a material promise to the customer and a performance obligation exists and should be recorded as a liability

Example: Company sells boxes of cake mix for $3 per box and offers its customers a large durable mixing bowl in exchange for $1 and 10 box tops; mixing bowl costs the company $2 and estimates that customers will redeem 60% of the box tops. The premium offer began in 2017, 20,000 mixing bowls at 2$ were purchased and 300,000 boxes of cake mix for $3 per box and redeemed 60,000 box tops

Record Purchase of 20,000 mixing bowls at $2 per bowl (20,000 * $2)

Inventory of Premiums 40,000

Cash 40,000

Record the Sale of Cake Mix Boxes in 2017 (300,000 * $3)

Cash 900,000

Sales Revenue 900,000

Record the Actual Redemption of 60,000 Box Tops, the Receipts of $1 per 10 Box Tops and the Delivery of Mixing Bowls

Cash [(60,000 / 10) * $1) 6,000

Premium Expense 6,000

Inventory of Premiums [(60,000 / 2) * $2) 12,000

Adjusting Entry to Record Additional Premium Expense and the Estimated Premium Liability

Premium Expense 12,000

Premium Liability 12,000

Computation of Premium Liability

Total Box Tops Sold in 2017 300,000

Estimated Redemptions       60%

Total Estimated Redemptions 180,000

Cost of Estimated Redemptions

  [(180,000 Box Tops / 10) * ($2 - $1)]   18,000

Redemptions to Date    (6,000)

Liability at 12/31/17   12,000

Environmental Liabilities – federal legislation provides the Environmental Protection Agency (EPA) with the power to clean up waste sites and charge the cleanup costs to parties the EPA deems responsible for contaminating the site

Potentially responsible parties can have a significant liability

Asset Retirement Obligation (ARO) – when it has an existing legal obligation associated with the retirement of a long-lived asset and when it can reasonable estimate the amount of the liability

Examples of obligating events – decommissioning of nuclear facilities, dismantling, restoring, and reclaiming of oil and gas properties, certain closure, reclamation, and removal costs of mining facilities and closure and post-closure costs of landfills

The company is generally legally obligated for the costs associated with retirement of the asset, whether the company hires another party to perform the retirement activities or performs the activities with its own workforce and equipment

Companies should estimate fair value based on the best information available

To record an ARO in the financial statements, a company includes the cost associated with the ARO in the carrying amount of the related long-lived asset, and records a liability for the same amount

It records an asset retirement cost as part of the related asset because these costs are directly related to operating the asset and are necessary to prepare the asset for its intended use

Therefore, the specific asset should be increased because the future economic benefit comes from the use of this productive asset

Companies should not record the capitalized asset retirement costs in a separate account because there is no future economic benefit that van associated with these costs alone

Companies allocate the cost of the ARO to expense over the period of the related asset’s useful life

Example: Assume that on 01/01/17 an Oil Company erected an oil platform and is legally required to dismantle and remove the platform at the end od its useful life, estimated to be five years; estimates that dismantling and remove will cost $1,000,000 and based on a 10% discount rate, the fair value of the asset retirement obligation is estimated to be $620,920 ($1,000,000 * .62092) 

Drilling Platform 620,920

Asset Retirement Obligation 620,920

Allocate the Asset Retirement Cost to Expense using the Straight-Line Method ($620,920 * 5)

Depreciation Expense 124,184

Accumulated Depreciation – Plant Assets 124,184

Accrue Interest Expense each Period ($620,920 * 10%)

Interest Expense 62,092

Asset Retirement Obligation 62,092

Dismantle the Platform at a Contract Price of $995,000

Asset Retirement Obligation 1,000,000

Cash 995,000

Gain on Settlement of ARO     5,000

Companies may not net possible insurance recoveries against liabilities but must show them separately

Self-Insurance – not recognized as a contingency because its not insurance but risk assumption

Any company that assumes its own risks puts itself in the position of incurring expenses or losses as they happen

Unlike an insurance company, which has contractual obligations to reimburse policyholders for losses, a company can have no obligation to itself, and hence, no liability either before or after the occurrence of damage

A contingency exists if exposure to risks of loss resulting from uninsured past injury to others is an existing condition involving uncertainty about the amount and timing of losses that may develop

However, it should not establish a liability for expected future injury to others or damage to the property of others, even if it can be reasonable estimate the amount of losses

Current liabilities are usually recorded and reported in financial statements at their full maturity value 

Because of the short time periods involves, frequently less than one year, the difference between the present value of a current liability and the maturity value is usually not large

The current liabilities accounts are commonly presented as the first classification in the liabilities and stockholders’ equity section of the balance sheet

Within the current liabilities section, companies may list the accounts in order of maturity, in descending order of amount, or in order of liquidation preference

Companies should clearly identify secured liabilities, as well as indicate the related assets pledged as collateral

If the due date of any liability can be extended, a company should disclose the details

Companies should not offset current liabilities against assets that it will apply to their liquidation

Current maturities of long-term debt are classified as current liabilities

A major exception exists when a company will pay a currently maturing obligation from assets classified as long-term 

If a company excludes a short-term obligation from current liabilities because of refinancing it should include the following in the note to the financial statements

1. A general description of the financing agreement

2. The terms of any new obligation incurred or to be incurred

3. The terms of any equity security issued or to be issued

When a company expects to refinance on a long-term basis by issuing equity securities, it is not appropriate to include the short-term obligations in stockholders’ equity

Presentation of Contingencies

A company records a loss contingency and a liability is the loss is both probable and estimable 

If the loss is either probable or estimable but not both, and if there is at least a reasonable possibility that a company may have incurred a liability, it must disclose the following

1. The nature of the contingency

2. An estimate of the possible loss or range of loss or a statement that an estimate cannot be made

Companies should disclose certain contingent liabilities, even though the possibility of loss may be remote as followed

1. Guarantees of indebtedness of others

2. Obligations of commercial banks under “stand-by letters of credit”

3. Guarantees to repurchase receivables (or any related property) that have been sold or assigned

Disclosure should include the nature and amount of the guarantee and, if estimable, the amount that the company can recover from outside parties

The distinction between current liabilities and long-term debt is important because it provides information about the liquidity of the company

Liquidity regarding a liability is the expected time to elapse before its payment; a liability soon to be paid is a current liability

A liquid company is better able to withstand a financial downturn and has a better chance of taking advantage of investment opportunities that develop

Current Ratio – ratio of total current assets to total current liabilities that is frequently expressed as a coverage of so many times

Sometimes called the Working Capital Ratio because working capital is the excess of current assets over current liabilities

Current Ratio = Current AssetsCurrent Liabilities

Acid Test Ratio – relates total current liabilities to cash, short-term investments, and receivables

Also called the Quick Ratio

Acid-Test Ratio = Cash + Short-Term Investments +Acccounts Recievable (Net) Current Liabilities

Example:

Current Ratio = $10,485$7,436 = 1.41 Times

Acid-Test Ratio = $4,209$7,436 = 0.57 Times