Current Liabilities and Contingencies

• Current liability: present obligation expected to be liquidated with current assets or creation of current liability

• Gross method: record accounts payable (and inventory) at the full invoice

• net method: record the purchase of goods at the net price, assuming any available discounts will be taken

• perpetual system: directly adjust the Inventory account

• Periodic system: use separate temporary accounts like Purchase Discounts

• How is sales taxes recorded?

  1. at the same time of sale or

  2. through a periodic adjusting entry

• returnable deposit (refundable deposit): cash from a customer to guarantee future required customer payments, or to compensate for possible damage to property

• in the event of a customer advance payment, the seller will recognize deferred revenue (a form of a contract liability) for its obligation to transfer goods and services in the future

Gift Cards

• gift card breakage: the value of unredeemed gift cards

• proportional method: revenue on unused gift cards is recognized in the account Gift Card Breakage Revenue based on the rate of actual gift card redemptions to total expected gift card redemption

  • to use the proportional method, you have to be able to estimate what your returns are going to be, must be probable that a significant reversal of breakage of revenue will not occur

1. To calculate rate of redemption: actual redemptions / estimated redemptions

2. To calculate proportional breakage: total estimated breakage*rate of redemption

• remote chance: recognize breakage revenue

• more than a remote chance: do not recognize breakage revenue

Short Term Note Payable

Contingencies

• A loss contingency must be accrued (debit loss or expense and credit liability or contra-asset) if the loss is both probable and reasonably estimable.

• A loss contingency must be disclosed (and not accrued) if the loss is at least reasonably possible and either of the following conditions exists:

  1. the loss is not both probable and estimable or

  2. there is an exposure to a range of loss where only the minimum point in the range was accrued

• The general rule is that a loss contingency is neither accrued nor disclosed if the loss is remote

Is the likelihood of the future event (loss) remote?

  - Yes → ❌ No disclosure required.

  - No → Go to Step 2.

Is the likelihood of the event probable?

  - Yes → Go to Step 3.

  - No (reasonably possible) → Go to Step 4.

Is the amount of loss reasonably estimable?

  - Yes → ✅ Accrue the loss and disclose.

  - No → 📄 Disclose the contingency only.

(From Step 2 – Likelihood is reasonably possible)

  - Regardless of estimability → 📄 Disclose the contingency only.

Subsequent Events

• Recognized subsequent event: If the event reflects conditions existing during Year1, recognize the effect in the Year 1 financial statements.

• Nonrecognized subsequent events: If the event does not reflect conditions existing during Year 1 and is required to keep financial statements from being misled, disclose the event in the Year 1 financial statements.

Special Loss Contingencies

/

• Unasserted claims and assessments

• If it is probable that an unasserted claim or assessment will be asserted, follow loss contingency steps

• Injury caused by products sold

• Accrue if probable that a claim resulting from injury will arise

• Risk of loss

  • Risk of a future loss (i.e., lack of insurance) is not a contingency

    Expropriation of asset

    Loss is probable if expropriation is imminent and compensation will be less than carrying amount of assets

Assurance-Type Warranty

At the time of sale:

• Recognize revenue on (combined) sale of product and warranty

• recognize estimated warranty expense and warranty liability

Over the warranty period:

• reduce liability for actual warranty costs incurred

Service-Type Warranty

At the time of sale:

• Recognize revenue on sale of product

• recognize deferred revenue on warranty

Over warranty period:

• Recognize warranty expense as cost are incurred

• Recognize

• warranty revenue as performance obligation is satisfied, typically on a straight-line basis

Disclosures and Liquidity Ratios

Current ration = Current Assets / Current liabilities

Quick ratio = (Cash + Marketable securities + Receivables) / Current liabilities