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Current Liabilities and Contingencies

Liabilities 1. Are probable, future sacrifices of economic benefits 2. Arise from present obligations ( to transfer goods or provide services) to other entities 3. Result from past transactions of events Current Liabilities 1. are expected to require current assets and usually are payable within one year or the firms operating cycle, whichever is longer 2. ordinarily are reported at their maturity amounts Accounts Payable 1. obligations to suppliers of merchandise or of services purchased on open account Open Account the only formal credit instrument is the invoice 2. Noninterest-bearing and are reported at their face amounts 3. The key accounting considerations relating to A/P are determining their existence and ensuring that they are recorded in the appropriate accounting period Trade Notes Payable 1. Differ from A/P in that they are formally recognized by a written promissory note 2. Often these are of a somewhat longer term than open accounts and bear interest Short-Term Notes Payable 1. Most common way for a corporation to obtain temporary financing is to arrange a short term bank loan 2. About 2/3 of bank loans are short term, but because many are routinely renewed, some tend to resemble long-term debt 3. Short-term financing generally preferred because of lower interest rates and flexibility Credit Lines 1. Non-committed line of credit an informal agreement that permits a company to borrow up to a prearranged limit without having to follow formal loan procedures and paperwork 2. Committed line of credit more formal agreement that usually requires the firm to pay a commitment fee to the bank a) A typical annual commitment fee is % of the total committed funds b) May also require a compensating balance Interest 1. Face amount X Annual Rate X Time to Maturity 2. Non-interest Bearing Note a) Actually do bear interest b) Interest is deducted or discounted from the face amount to determine the cash proceeds made available to the borrower at the outset c) The proceeds of the note are reduced by the interest in a noninterest-bearing note d) When interest is discounted from the face amount of a note, the effective interest rate is higher than the stated discount rate Secured Loans 1. Sometimes short-term loans are secured, meaning a specified asset of the borrower is pledged as a collateral or security for the loan 2. Although many kinds of assets can be pledged, the secured loans most frequently encountered in practice are secured by inventory or A/R 3. When A/R serve as collateral, we refer to the arrangement as pledging A/R 4. Sometimes, the receivables actually are sold outright to a finance company as a means of short-term financing, called factoring receivables Commercial Paper 1. Some large corporations obtain temporary financing by issuing commercial paper, often purchased by other companies as a short-term investment

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2. Large, highly rated firms sometimes sell commercial paper to borrow funds at a lower rate than through a bank loan. 3. Commercial paper refers to unsecured notes sold in minimum denominations of $25,000 with maturities ranging from 30 270 days 4. Interest discounted at the issuance of the note 5. Commercial paper is issue directly to the buyer (lender) and is backed by a line of credit with a bank. -This allows the interest rate to be lower than in a bank loan 6. Commercial paper is a form of notes payable Accrued Liabilities 1. Represent expenses already incurred but not yet paid 2. Recorded by adjusting entries at the end of the reporting period Salaries, Commissions, Bonuses 1. An employer should accrue an expense and the related liability for employees compensation for future absences if the obligation meets all of the four conditions 1. The obligation is attributable to employees services already performed 2. The paid absence can be taken in a later year, the benefit vests (will be compensated even if employment is terminated) or the benefit can be accumulated over time. 3. Payment is probable 4. The amount can be reasonably estimated 2. We accrue loss contingencies only when the obligation is both probable and can be reasonably estimated. 3. Bonuses are compensation expense of the period in which they are earned Current and Non Current Classification 1. Short term obligations that are expected to be refinanced on a long-term basis can be reported as noncurrent rather than current liabilities only if 2 conditions are met: 1. The firm must intend to refinance on a long-term basis 2. The firm must actually have demonstrated the ability to refinance on a long-term basis

Contingencies
Loss Contingencies 1. An existing, uncertain situation involving potential loss depending on whether some future event occurs. 2. Whether a contingency is accrued and reported as a liability depends on: 1. The likelihood that the confirming event will occur 2. What can be determined about the amount of the loss 3. Accrual of a loss contingency = Asset Impairment Product Warranties and Guarantees 1. Cost of promotional offers should be recorded as expenses in the same accounting period the products are sold 2. Subsequent Events Cause of Loss Contingency Fiscal Year Ends Clarification Financial Statements Unasserted Claims and Assessments 1. It must be probably that an unasserted claim or assessment or an unfiled lawsuit will occur before considering whether and how to report the possible loss 2. The treatment of contingent liabilities is consistent with the accepted definition of liabilities as 1. Probably, future sacrifices of economic benefits 2. That arise from present obligations to other entities and 3. That result from past transactions or events Gain Contingencies 1. An uncertain situation that might result in a gain 2. Gain contingencies are not accrued 3. Recognizing gains should await their realization