current liabilities

Current Liabilities A. Classification 1. Current Liabilities--current liabilities are liabilities that will mature in less than one year or one operating cycle, whichever is longer 2. Long-term Liabilities--long-term liabilities are liabilities that will mature in greater than one year or one operating cycle, whichever is longer Accounts Payable--accounts payable are oral promises to others to pay for goods or services purchased on open account 1. Valuation--in practice, interest expense related to the accounts payable is ignored because the amount of the discount is not usually material in relation to the net income for the period 2. Cash Discounts--when cash discounts are offered as an inducement for prompt payment, the amount of the accounts payable may be recorded using either the gross method or the net method a. Gross Method--the gross method assumes that cash discounts will not be taken and highlights the discounts taken 1) Accounting a) Date of Borrowing--accounts payable and the related expense/asset are recorded at the gross invoice price b) Date of Payment--any discounts taken are recorded as a reduction in the related expense/asset 2) Illustrations a) A corporation purchased inventory on open account at an invoice price of $5,000; terms were 2/10,n/30; the corporation paid the invoice within the discount period Purchases 5,000 Accounts Payable 5,000 Accounts Payable Cash (5,000 – 2% x 5,000) Purchase Discounts b) 5,000 4,900 100 B. A corporation purchased inventory on open account at an invoice price of $5,000; terms were 2/10,n/30; the corporation did not pay the invoice within the discount period Purchases 5,000 Accounts Payable 5,000 Accounts Payable Cash 5,000 5,000 1 b. Net Method--the net method assumes that cash discounts will be taken and highlights the discounts not taken 1) Accounting a) Date of Borrowing--accounts payable and the related expense/asset are recorded at the gross invoice price less any available cash discount b) Date of Payment--any discounts not taken are recorded as a financing expense 2) Illustrations a) A corporation purchased inventory on open account at an invoice price of $5,000; terms were 2/10,n/30; the corporation paid the invoice within the discount period Purchases 4,900 (5,000 – 2% x 5,000) Accounts Payable 4,900 Accounts Payable Cash b) 4,900 4,900 A corporation purchased inventory on open account at an invoice price of $5,000; terms were 2/10,n/30; the corporation did not pay the invoice within the discount period Purchases 4,900 (5,000 – 2% x 5,000) Accounts Payable 4,900 Accounts Payable Purchase Discounts Lost Cash 4,900 100 5,000 C. Notes Payable--notes payable are written promises to pay a certain sum of money at a specified future date 1. Interest-bearing Note--the borrower is required to pay at the date of maturity the face value of the note plus an explicitly stated rate of interest on the face value of the note a. Accounting 1) Date of Borrowing--the amount of cash or the value of the goods or services received is equal to the face value of the note a) Notes Payable--the notes payable account is credited for the face value of the note 2) Date of Payment a) Notes Payable--the notes payable account is debited for the face value of the note b) Interest Expense--interest expense is recorded for an amount equal to the explicitly stated rate of interest on the face value of the note 2 b. Illustration- a corporation purchased inventory by issuing a $10,000, 8%, 6-month note on March 1; the note was paid on September 1 March 1: Purchases 10,000 Notes Payable 10,000 September 1: Notes Payable 10,000 Interest Expense 400 (8% x 10,000 x 6 / 12) Cash 10,400 2. Noninterest-bearing Note--the borrower is required to pay at the date of maturity the face value of the note a. Accounting 1) Date of Borrowing--the amount of cash or the value of the goods goods or services received is equal to the face value of the note less the implied rate of interest on the face value of the note a) Notes Payable--the notes payable account is credited for the face value of the note b) Discount on Notes Payable--the discount on notes payable account is debited for an amount equal to the implied rate of interest on the face value of the note 2) Date of Payment a) Notes Payable--the notes payable account is debited for the face value of the note b) Discount on Notes Payable--the discount on notes payable is amortized as interest expense over the life of the note b. Illustration- a corporation purchased inventory by issuing a $10,000, 6-month noninterest bearing note on March 1; the note was paid on September 1 March 1: Purchases 9,600 Discount on Notes Payable 400 (8% x 10,000 x 6 / 12) Notes Payable 10,000 September 1: Notes Payable Cash Interest Expense Discount on Notes Payable 10,000 10,000 400 400 D. Currently Maturing Long-term Debt--the portion of bonds, mortgages, and other long-term liabilities that matures within the next fiscal year or 3 operating cycle, whichever is longer, should be reported as a current liability 1. Short-term Obligations Expected To Be Refinanced--short-term obligations expected to be refinanced on a long-term basis should not be reported as current liabilities a. Refinancing Criteria--short-term obligations should be excluded from current liabilities if both of the following conditions are met 1) Intent--the business intends to refinance the short-term obligations so that current assets, existing at the balance sheet date, will not be required to retire the debt 2) Ability To Refinance--the business demonstrates an ability to refinance the short-term obligations in either of two ways a) Actual Refinancing--the business refinances the short-term obligations by issuing long-term obligations or equity securities after the date of the balance sheet and the date of the retirement of the short-term obligations, but before the issue date of the financial statements I) Amount--the amount of the short-term obligations to be excluded from current liabilities is the lesser of the amount of the short-term obligations or the proceeds from the actual refinancing b) Financing Agreement--the business enters into a financing agreement that clearly permits it to refinance the shortterm obligations on a long-term basis on terms that are readily determinable I) Amount--the amount of the short-term obligations to be excluded from current liabilities is the lesser of the amount of the short-term obligations or the proceeds available from the financing agreement b. Illustrations 1) On December 31 of year 1 a corporation had a $100,000 note that matured on February 15 of year 2; the corporation issued common stock on February 1 of year 2 for $105,000 and used the proceeds to retire the note; the corporation issued its financial statements on March 1 of year 2 Long-term Liabilities = 100,000 or 105,000 = 100,000 Current Liabilities = 100,000 – 100,000 = 0 2) On December 31 of year 1 a corporation had a $100,000 note that matured on February 15 of year 2; the corporation issued common stock on February 1 of year 2 for $95,000 and used the proceeds to help retire the note; the corporation issued its financial statements on March 1 of year 2 Long-term Liabilities = 100,000 or 95,000 = 95,000 4 Current Liabilities = 100,000 – 95,000 = 5,000 3) On December 31 of year 1 a corporation had a $100,000 note that matured on February 15 of year 2; the corporation issued common stock on February 25 of year 2 for $105,000 and used the proceeds to replenish the current assets used to retire the note; the corporation issued its financial statements on March 1 of year 2 Long-term Liabilities = 100,000 or 0 = 0 Current Liabilities = 100,000 – 0 = 100,000 4) On December 31 of year 1 a corporation had a $100,000 note that matured on August 15 of year 2; the corporation entered into a financing agreement on February 1 of year 2 that provided for a line of credit of $105,000; the corporation issued its financial statements on March 1 of year 2 Long-term Liabilities = 100,000 or 105,000 = 100,000 Current Liabilities = 100,000 – 100,000 = 0 2. 3. Convertible Debt--short-term obligations to be converted into capital stock should not be reported as current liabilities Sinking Fund--short-term obligations to be retired by assets that have been accumulated for this purpose and have correctly not been shown as current assets should not be reported ac current liabilities E. Unearned Revenues--amounts that are received before goods are delivered or services are rendered are recognized as a current liability until the goods are delivered or the services are rendered 1. Illustration--during year 1 a corporation that sells televisions sold 100 5-year extended warranties on its televisions evenly throughout the year at a price of $200 per extended warranty; the estimated warranty costs for each extended warranty is $150; actual warranty costs incurred during year 1 were $1,800; during year 2 the corporation sold 125 5-year extended warranties on it televisions evenly throughout the year at a price of $200 per extended warranty; the estimated warranty costs for each extended warranty contract is $150; actual warranty costs incurred during year 2 were $5,000 Year 1: Cash 20,000 (100 x 200) Unearned Warranty Revenue 20,000 Warranty Expense Cash, etc. 1,800 1,800 5 Unearned Warranty Revenue (1/2 x 20,000 / 5) Warranty Revenue Year 2: Cash (125 x 200) Unearned Warranty Revenue Warranty Expense Cash, etc. Unearned Warranty Revenue (20,000 / 4 + 1/2 x 25,000 / 5 Warranty Revenue F. 2,000 2,000 25,000 25,000 5,000 5,000 6,500 6,500 Contingencies--a contingency is an existing condition, situation, or set of circumstances involving uncertainty as to possible gain or loss that will ultimately be resolved when one or more future events occur or fail to occur 1. Gain Contingencies--claims or rights that are dependent upon the occurrence or nonoccurrence of one or more future events to confirm either the amount receivable, the payor, the date receivable, or its existence a. Accounting--gain contingencies are not recorded 2. Loss Contingencies--obligations that are dependent upon the occurrence or nonoccurrence of one or more future events to confirm either the amount payable, the payee, the date payable, or its existence a. Accounting--an estimated loss from a loss contingency should be accrued if both of the following conditions are met 1) Probable--information available at the date of issuance of the financial statements indicates that it is probable that a liability has been incurred at the date of the financial statements 2) Estimation--the amount of the loss can be reasonably estimated b. Illustration--during year 1 a corporation that sells televisions sold 600 televisions evenly throughout the year; the corporation sells the televisions with a 60-day warranty for free parts and labor; the estimated warranty cost under the 60-day warranty is $50; actual warranty costs incurred during year 1 were $27,000; during year 2 the corporation sold 900 televisions evenly throughout the year; actual warranty costs incurred during year 2 were $44,500 Year 1: Warranty Expense 30,000 Estimated Warranty Liability 30,000 (600 x 50) 6 Estimated Warranty Liability Cash, etc. Estimated Warranty Liability ((1/6 x 600 x 1/2 x 50) – (30,000 – 27,000)) Warranty Expense Year 2: Warranty Expense Estimated Warranty Liability (900 x 50) Estimated Warranty Liability Cash, etc. 27,000 27,000 500 500 45,000 45,000 44,500 44,500 Warranty Expense 750 Estimated Warranty Liability 750 ((1/6 x 900 x 1/2 x 50) – (2,500 + 45,000 – 44,500)) G. Asset Retirement Obligations--asset retirement obligations are existing legal obligations associated with the retirement of long-lived assets, such as decommissioning nuclear facilities; dismantling, restoring, and reclamation of oil and gas properties and mining facilities; closure and post-closure costs of landfills; etc. 1. Accounting a. Asset Retirement Obligation--an asset retirement obligation should be recorded equal to the present value of the estimated future costs associated with the retirement of the long-lived asset 1) Long-lived Asset--the carrying value of the long-lived is increased by the asset retirement obligation and amortized over the life of the long-lived asset because these costs are necessary to prepare the asset for its intended use b. Interest Expense--interest expense should be recorded each year equal to the discount rate multiplied by the beginning carrying value of the asset retirement obligation Asset Retirement Obligation--the carrying value of the asset retirement obligation is increased by the interest expense c. Gain/Loss on Asset Retirement--a gain/loss on asset retirement should be recognized for the difference between the actual asset retirement obligation and the estimated asset retirement obligation 2. Illustration--on January 1 of year 1 a corporation purchased a mine; the mine has an estimated useful life of 3 years; the corporation is legally required to restore the land to its natural state at the end of the useful life of the mine; the corporation estimated that the cost of restoring the land to its natural state would be $400,000; the prevailing rate of interest was 8%; the corporation paid $405,000 to restore the land to its natural state on January 1 of year 4 7 Year 1: Natural Resources Asset Retirement Obligation (400,000 x .79383) Interest Expense Asset Retirement Obligation Year 2: Interest Expense Asset Retirement Obligation Year 3: Interest Expense Asset Retirement Obligation Year 4: Asset Retirement Obligation Loss on Asset Retirement Cash 317,532 317,352 25,403 25,403 27,435 27,435 29,630 29,630 400,000 5,000 405,000 Amortization Schedule: Beginning Ending _ Year _ _Balance_ _Interest _Payment_ _Balance_ 1 317,532 + 25,403 --= 342,935 2 342,935 + 27,435 --= 370,370 3 370,370 + 29,630 - 400,000 = --Year 1 Interest Expense = 8% x 396,915 = 31,753 Year 2 Interest Expense = 8% x 342,935 = 27,435 Year 3 Interest Expense = 8% x 370,370 = 29,630 8