LEARNING OBJECTIVE 1

Current Liabilities Describe the nature, valuation,

and reporting of current
Current Liabilities
liabilities.

Three essential characteristics: A current liability is reported if one of two conditions

exists:
1. Present obligation.
1. Liability is expected to be settled within its normal operating
2. Arises from past events.
cycle; or
3. Results in an outflow of
2. Liability is expected to be settled within 12 months after the
resources (cash, goods, reporting date.
services).
The operating cycle is the period of time elapsing between the
acquisition of goods and services and the final cash realization resulting
from sales and subsequent collections.

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Current Liabilities Current Liabilities

Typical Current Liabilities: Accounts Payable (trade accounts payable)

1. Accounts payable.
2. Notes payable.
3. Current maturities of long-
term debt.
4. Short-term obligations
expected to be refinanced.
5. Dividends payable.
6. Customer advances and Balances owed to others for goods, supplies, or services
deposits. purchased on open account.
7. Unearned revenues.  Time lag between the receipt of services or acquisition
8. Sales and value-added of title to assets and the payment for them.
taxes payable.  Terms of the sale (e.g., 2/10, n/30 or 1/10, E.O.M.)
9. Income taxes payable. usually state period of extended credit, commonly 30 to
60 days.
10. Employee-related liabilities.

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Current Liabilities Current Liabilities

Notes Payable Interest-Bearing Note Issued

Written promises to pay a certain sum of money on a Illustration: Castle Bank agrees to lend €100,000 on March 1,
specified future date. 2019, to Landscape Co. if Landscape signs a €100,000, 6
percent, four-month note. Landscape records the cash
 Arise from purchases, financing, or other transactions.
received on March 1 as follows:
 Notes classified as short-term or long-term.
Cash 100,000
 Notes may be interest-bearing or zero-interest-bearing.
Notes Payable 100,000

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 Interest-Bearing Note Issued Interest-Bearing Note Issued

If Landscape prepares financial statements semiannually, it At maturity (July 1, 2020), Landscape records payment of the
makes the following adjusting entry to recognize interest note and accrued interest as follows.
expense and interest payable at June 30, 2019:
Notes Payable 100,000
Interest calculation =(€100,000 x 6% x 4/12) = €2,000
Interest Payable 2,000
Interest Expense 2,000
Cash 102,000
Interest Payable 2,000

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Current Liabilities Zero-Interest-Bearing Note Issued

Zero-Interest-Bearing Note Issued If Landscape prepares financial statements semiannually, it

makes the following adjusting entry to recognize interest
Illustration: On March 1, Landscape issues a €102,000, four-
expense and the increase in the note payable of €2,000 at
month, zero-interest-bearing note to Castle Bank. The present
June 30.
value of the note is €100,000. Landscape records this
transaction as follows. Interest Expense 2,000
Notes Payable 2,000
Cash 100,000
Notes Payable 100,000 At maturity (July 1), Landscape must pay the note, as follows.

Notes Payable 102,000

Cash 102,000

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Current Liabilities Current Liabilities

E13-2: (Accounts and Notes Payable) The following are selected Sept. 1 - Purchased inventory from Orion Company on
2019 transactions of Darby Corporation. account for $50,000. Darby records purchases gross and
Sept. 1 - Purchased inventory from Orion Company on uses a periodic inventory system.
account for $50,000. Darby records purchases gross and uses
Sept. 1 Purchases 50,000
a periodic inventory system.
Accounts Payable 50,000
Oct. 1 - Issued a $50,000, 12-month, 8% note to Orion in
payment of account.

Oct. 1 - Borrowed $75,000 from the Shore Bank by signing a

12-month, zero-interest-bearing $81,000 note.

Prepare journal entries for the selected transactions.

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 Current Liabilities Current Liabilities

Oct. 1 - Issued a $50,000, 12-month, 8% note to Orion in Oct. 1 - Borrowed $75,000 from the Shore Bank by signing a
payment of account. 12-month, zero-interest-bearing $81,000 note.

Oct. 1 Accounts Payable 50,000 Oct. 1 Cash 75,000

Notes Payable 50,000 Notes Payable 75,000

Interest calculation =($50,000 x 8% x 3/12) = $1,000 Interest calculation =($6,000 x 3/12) = $1,500

Dec. 31 Interest Expense 1,000 Dec. 31 Interest Expense 1,500

Interest Payable 1,000 Notes Payable 1,500

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Current Liabilities Current Liabilities

Current Maturities of Long-Term Debt Short-Term Obligations Expected to Be

Portion of bonds, mortgage notes, and other long-term
indebtedness that matures within the next fiscal year.
Exclude long-term debts maturing currently 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 long-
term debt issue, or
Refinanced
Exclude from current liabilities if both of the following
conditions are met:
1. Must intend to refinance the obligation on a long-term
basis.
2. Must have an unconditional right to defer settlement of
the liability for at least 12 months after the reporting date.

3. Converted into ordinary shares.

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Current Liabilities Current Liabilities

E13-4 (Refinancing of Short-Term Debt): The CFO for Yong Short-Term Obligation A: Yong has a $50,000 short-term
Corporation is discussing with the company’s chief executive obligation due on March 1, 2019. The CFO discussed with its
officer issues related to the company’s short-term obligations. lender whether the payment could be extended to March 1, 2021,
Presently, both the current ratio and the acid-test ratio for the provided Yong agrees to provide additional collateral. An
company are quite low, and the chief executive officer is agreement is reached on February 1, 2019, to change the loan
wondering if any of these short-term obligations could be terms to extend the obligation’s maturity to March 1, 2021. The
reclassified as long-term. The financial reporting date is financial statements are authorized for issuance on April 1, 2019.
December 31, 2018. Two short-term obligations were discussed,
Liability of Refinance Liability due Statement
and the following action was taken by the CFO. $50,000 completed for payment Issuance

Instructions: Indicate how these transactions should be reported

Dec. 31, 2018 Feb. 1, 2019 Mar. 1, 2019 Apr. 1, 2019
at Dec. 31, 2018, on Yongs’ statement of financial position.

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 Current Liabilities Current Liabilities

Short-Term Obligation A: Yong has a $50,000 short-term Short-Term Obligation B: Yong also has another short-term
obligation due on March 1, 2019. The CFO discussed with its obligation of $120,000 due on February 15, 2019. In its discussion
lender whether the payment could be extended to March 1, 2021, with the lender, the lender agrees to extend the maturity date to
provided Yong agrees to provide additional collateral. An February 1, 2020. The agreement is signed on December 18,
agreement is reached on February 1, 2019, to change the loan 2018. The financial statements are authorized for issuance on
terms to extend the obligation’s maturity to March 1, 2021. The March 31, 2019.
financial statements are authorized for issuance on April 1, 2019.
Refinance Liability of Liability due Statement
Current Liability completed $120,000 for payment Issuance
of $50,000 Since the agreement was not in place as of the reporting
date (December 31, 2018), the obligation should be Dec. 18, 2018 Dec. 31, 2018 Feb. 15, 2019 Mar. 31, 2019
Dec. 31, 2018 reported as a current liability.

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Current Liabilities Current Liabilities

Short-Term Obligation B: Yong also has another short-term Dividends Payable

obligation of $120,000 due on February 15, 2019. In its discussion
Amount owed by a corporation to its stockholders as a result of
with the lender, the lender agrees to extend the maturity date to
board of directors’ authorization.
February 1, 2020. The agreement is signed on December 18,
2018. The financial statements are authorized for issuance on  Generally paid within three months.
March 31, 2019.
 Undeclared dividends on cumulative preference shares are
Non-Current not recognized as a liability.
Refinance Liability of Since the agreement was in place as of
completed $120,000
the reporting date (December 31, 2018),  Dividends payable in the form of additional shares are not
the obligation is reported as a non- recognized as a liability.
Dec. 18, 2018 Dec. 31, 2018
current liability.
► Reported in equity.

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Current Liabilities Current Liabilities

Customer Advances and Deposits Unearned Revenues

Returnable cash deposits received from customers and Payment received before providing goods or performing
employees. services.

 May be classified as current or non-current liabilities.

ILLUSTRATION 13.2
Unearned and Earned Revenue Accounts

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 Current Liabilities Current Liabilities

BE13-6: Sports Pro Magazine sold 12,000 annual subscriptions Sales and Value-Added Taxes Payable
on August 1, 2019, for €18 each. Prepare Sports Pro’s August 1,
Consumption taxes are generally either
2019, journal entry and the December 31, 2019, annual adjusting
entry.  a sales tax or

Aug. 1 Cash 216,000  a value-added tax (VAT).

Unearned Revenue 216,000 Purpose is to generate revenue for the government.
(12,000 x €18)
The two systems use different methods to accomplish this
Dec. 31 Unearned Revenue 90,000 objective.
Subscription Revenue 90,000
(€216,000 x 5/12 = €90,000)

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Sales Taxes Payable Value-Added Taxes Payable

Illustration: Halo Supermarket sells loaves of bread to Illustration: The VAT is collected every time a business
consumers on a given day for €2,400. Assuming a sales tax purchases products from another business in the product’s
rate of 10 percent, Halo Supermarket makes the following entry supply chain. To illustrate,
to record the sale.
1. Hill Farms Wheat Company grows wheat and sells it to
Cash 2,640 Sunshine Baking for €1,000. Hill Farms Wheat makes the
Sales Revenue 2,400 following entry to record the sale, assuming the VAT is 10
Sales Taxes Payable 240 percent.

Cash 1,100
Sales Revenue 1,000
Value-Added Taxes Payable 100

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Value-Added Taxes Payable Value-Added Taxes Payable

2. Sunshine Baking makes loaves of bread from this wheat and 3. Halo Supermarket sells the loaves of bread to consumers for
sells it to Halo Supermarket for €2,000. Sunshine Baking €2,400. Halo Supermarket makes the following entry to
makes the following entry to record the sale, assuming the record the sale, assuming the VAT is 10 percent.
VAT is 10 percent.
Cash 2,640
Cash 2,200 Sales Revenue 2,400
Sales Revenue 2,000 Value-Added Taxes Payable 240
Value-Added Taxes Payable 200
Halo Supermarket then sends only €40 to the tax authority as it
Sunshine Baking then remits €100 to the government, not deducts the €200 VAT already paid to Sunshine Baking.
€200. The reason: Sunshine Baking has already paid €100 to
Hill Farms Wheat.
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 Current Liabilities Current Liabilities

Income Tax Payable Employee-Related Liabilities

Businesses must prepare an income tax return and compute Amounts owed to employees for salaries or wages are
the income tax payable. reported as a current liability.

 Taxes payable are a current liability. Current liabilities may include:

 Corporations must make periodic tax payments.  Payroll deductions.

 Differences between taxable income and accounting  Compensated absences.

income sometimes occur (Chapter 19).
 Bonuses.

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Employee-Related Liabilities Employee-Related Liabilities

Payroll Deductions Illustration: Assume a weekly payroll of $10,000 entirely subject to

Social Security taxes (8%), with income tax withholding of $1,320 and
Taxes:
union dues of $88 deducted. The company records the wages and
► Social Security Taxes salaries paid and the employee payroll deductions as follows.

► Income Tax Withholding Wages and Salaries Expense 10,000

Withholding Taxes Payable 1,320
Social Security Taxes Payable 800
Union Dues Payable 88
Cash 7,792
ILLUSTRATION 13.4
Summary of Payroll Liabilities

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Employee-Related Liabilities Employee-Related Liabilities

Illustration: Assume a weekly payroll of $10,000 entirely subject to Compensated Absences

Social Security taxes (8%), with income tax withholding of $1,320 and
Paid absences for vacation, illness and maternity, paternity,
union dues of $88 deducted. The company records the employer
payroll taxes as follows. and jury leaves.

Vested rights - employer has an obligation to make payment to

Payroll Tax Expense 800
an employee even after terminating his or her employment.
Social Security Taxes Payable 800
Accumulated rights - employees can carry forward to future
periods if not used in the period in which earned.
The employer must remit to the government its share of Social Security tax
along with the amount of Social Security tax deducted from each employee’s
Non-accumulating rights - do not carry forward; they lapse if not
gross compensation. used.

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 Employee-Related Liabilities Employee-Related Liabilities

Illustration: Amutron NV began operations on January 1, 2019. The Profit-Sharing and Bonus Plans
company employs 10 individuals and pays each €480 per week.
Employees earned 20 unused vacation weeks in 2019. In 2020, the Payments to certain or all employees in addition to their regular
employees used the vacation weeks, but now they each earn €540 salaries or wages.
per week. Amutron accrues the accumulated vacation pay on  Bonuses paid are an operating expense.
December 31, 2019, as follows.
 Unpaid bonuses should be reported as a current liability.
Salaries and Wages Expense 9,600
Salaries and Wages Payable 9,600

In 2020, it records the payment of vacation pay as follows.

Salaries and Wages Payable 9,600

Salaries and Wages Expense 1,200
Cash 10,800
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LEARNING OBJECTIVE 2
Provisions Explain the accounting for
different types of provisions.
Recognition of a Provision

A provision is a liability of uncertain timing or amount. Companies accrue an expense and related liability for a
provision only if the following three conditions are met:
Reported either as current or non-current liability.
1. Company has a present obligation (legal or constructive) as
Common types are
a result of a past event;
► Obligations related to litigation.
2. Probable that an outflow of resources will be required to
► Warrantees or product guarantees.
settle the obligation; and
► Business restructurings.
3. A reliable estimate can be made.
► Environmental damage.

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It is assumed that a
Recognition of a Provision reliable estimate of the
Recognition Examples
amount of the obligation
can be determined.
Recognition Examples Constructive obligation is an obligation that derives from a
company’s actions where:

1. By an established pattern of past practice, published

policies, or a sufficiently specific current statement, the
company has indicated to other parties that it will accept
certain responsibilities; and

2. As a result, the company has created a valid expectation

on the part of those other parties that it will discharge those
responsibilities.
ILLUSTRATION 13.5
Recognition of a Provision—Warranty

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 Recognition Examples Recognition Examples

ILLUSTRATION 13.6
Recognition of a Provision—Refunds
It is assumed that a reliable
estimate of the amount of the
obligation can be determined.
ILLUSTRATION 13.7
Recognition of a Provision—Lawsuit
It is assumed that a reliable
estimate of the amount of the
obligation can be determined.

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Measurement of Provisions Measurement of Provisions

How does a company determine the amount to report Measurement Examples

for a provision?
IFRS:
Amount recognized should be the best estimate of the
expenditure required to settle the present obligation.
Best estimate represents the amount that a company would pay
to settle the obligation at the statement of financial position date.
Management must use judgment, based on past or similar
transactions, discussions with experts, and any other pertinent
information.
Toyota warranties. Toyota might determine that 80
percent of its cars will not have any warranty cost, 12
percent will have substantial costs, and 8 percent will have a much
smaller cost. In this case, by weighting all the possible outcomes by
their associated probabilities, Toyota arrives at an expected value
for its warranty liability.

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Measurement of Provisions Measurement of Provisions

Measurement Examples Measurement Examples

Management must use judgment, based on past or similar
transactions, discussions with experts, and any other pertinent
information.
Carrefour refunds. Carrefour sells many items at
varying selling prices. Refunds to customers for products
sold may be viewed as a continuous range of refunds, with each
point in the range having the same probability of occurrence. In this
case, the midpoint in the range can be used as the basis for
measuring the amount of the refunds.
Novartis lawsuit. Large companies like Novartis are
involved in numerous litigation issues related to their
products. Where a single obligation such as a lawsuit is being
measured, the most likely outcome of the lawsuit may be the best
estimate of the liability.
Measurement of the liability should consider the time value of money,
if material. Future events that may have an impact on the
measurement of the costs should be considered.

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 Common Types of Provisions Common Types of Provisions

Common Types: Litigation Provisions

1. Lawsuits 4. Environmental Companies must consider the following in determining whether
to record a liability with respect to pending or threatened
2. Warranties 5. Onerous contracts
litigation and actual or possible claims and assessments.
3. Consideration payable 6. Restructuring
1. The time period in which the underlying cause of action
occurred.
IFRS requires extensive disclosure related to provisions in the notes to
the financial statements. Companies do not record or report in the 2. The probability of an unfavorable outcome.
notes general risk contingencies inherent in business operations (e.g.,
the possibility of war, strike, uninsurable catastrophes, or a business
3. Ability to make a reasonable estimate of the amount of
recession). loss.

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Litigation Provisions Litigation Provisions

With respect to unfiled suits and unasserted claims and BE13-12: Scorcese A.S. is involved in a lawsuit at December 31,
assessments, a company must determine 2019. (a) Prepare the December 31 entry assuming it is probable
that Scorcese will be liable for ₺900,000 as a result of this suit. (b)
1. the degree of probability that a suit may be filed or a claim
Prepare the December 31 entry, if any, assuming it is not probable
or assessment may be asserted, and that Scorcese will be liable for any payment as a result of this suit.
2. the probability of an unfavorable outcome.
(a) Lawsuit Loss 900,000
If both are probable, if the loss is reasonably estimable, and if the Lawsuit Liability 900,000
cause for action is dated on or before the date of the financial
statements, then the company should accrue the liability. (b) No entry is necessary. The loss is not accrued because it
is not probable that a liability has been incurred at
12/31/19.
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Common Types of Provisions Warranty Provisions

Warranty Provisions Companies often provide one of two types of warranties to

customers:
Promise made by a seller to a buyer to make good on a
deficiency of quantity, quality, or performance in a product. Assurance-Type Warranty
If it is probable that customers will make warranty claims and a A quality guarantee that the good or service is free from
company can reasonably estimate the costs involved, the defects at the point of sale.
company must record an expense.  Obligations should be expensed in the period the
goods are provided or services performed (in other
words, at the point of sale).

 Company should record a warranty liability.

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 Assurance-Type Warranty Assurance-Type Warranty

Facts: Denson Machinery Company begins production of a new Solution: For the sale of the machines and related warranty costs
machine in July 2019 and sells 100 of these machines for $5,000 in 2019 the entry is as follows.
cash by year-end. Each machine is under warranty for one year.
1. To recognize sales of machines and accrual of warranty
Denson estimates, based on past experience with similar
liability:
machines, that the warranty cost will average $200 per unit.
Further, as a result of parts replacements and services performed July–December 2019
in compliance with machinery warranties, it incurs $4,000 in
warranty costs in 2019 and $16,000 in 2020. Cash 500,000
Sales Revenue 500,000
Question: What are the journal entries for the sale and the
related warranty costs for 2019 and 2020?

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Assurance-Type Warranty Assurance-Type Warranty

Solution: For the sale of the machines and related warranty costs Solution: For the sale of the machines and related warranty costs
in 2019 the entry is as follows. in 2019 the entry is as follows.

2. To record payment for warranties incurred: 3. Record the adjusting entry to record estimated warranty
expense and warranty liability for expected warranty
July–December 2019
claims in 2020:
Warranty Expense 4,000 December 31, 2019
Cash, Inventory, Accrued Payroll 4,000
Warranty Expense 16,000
Warranty Liability 16,000
At December 31, 2019, the statement of financial position reports a warranty
liability (current) of $16,000 ($20,000 − $4,000). The income statement for
2019 reports sales revenue of $500,000 and warranty expense of $20,000.
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Assurance-Type Warranty Warranty Provisions

Solution: For the sale of the machines and related warranty costs Companies often provide one of two types of warranties to
in 2019 the entry is as follows. customers:
4. To record payment for warranty costs incurred in 2020
Service-Type Warranty
related to 2019 machinery sales:
An extended warranty on the product at an additional cost.
January 1–December 31, 2020
 Usually recorded in an Unearned Warranty Revenue
Warranty Liability 16,000 account.
Cash, Inventory, Accrued Payroll 16,000  Recognize revenue on a straight-line basis over the period
the service-type warranty is in effect.
At the end of 2020, no warranty liability is reported for the machinery
sold in 2019.

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 Service-Type Warranty Service-Type Warranty

Facts: You purchase an automobile from Hamlin Auto for €30,000 Solution:
on January 2, 2019. Hamlin estimates the assurance-type
1. To record the sale of the automobile and related
warranty costs on the automobile to be €700 (Hamlin will pay for
warranties:
repairs for the first 36,000 miles or three years, whichever comes
first). You also purchase for €900 a service-type warranty for an January 2, 2019
Cash (€30,000 + €900) 30,900
additional three years or 36,000 miles. Hamlin incurs warranty
costs related to the assurance-type warranty of €500 in 2019 and Unearned Warranty Revenue 900
€200 in 2020. Hamlin records revenue on the service-type Sales Revenue 30,000
warranty on a straight-line basis.

Question: What entries should Hamlin make in 2019 and 2022?

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Service-Type Warranty Service-Type Warranty

Solution: Solution:

2. To record warranty costs incurred in 2019: 3. The adjusting entry to record estimated warranty expense
and warranty liability for expected assurance warranty
January 2–December 31, 2019
claims in 2020:
Warranty Expense 500
January 1–December 31, 2019
Cash, Inventory, Accrued Payroll 500
Warranty Expense 200
Warranty Liability 200

At December 31, 2019, the statement of financial position reports a warranty

liability of €200 (€700 – €500). The income statement for 2019 reports sales
revenue of €30,000 and warranty expense of €700.
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Service-Type Warranty Common Types of Provisions

Solution: Consideration Payable

4. To record revenue recognized in 2022 on the service-type Companies often make payments (provide consideration) to
warranty: their customers as part of a revenue arrangement.
December 31, 2022 Companies offer premiums, coupon offers, and rebates to
stimulate sales.
Unearned Warranty Revenue (€900 ÷ 3) 300
Warranty Revenue 300  Companies should charge the costs of premiums and
coupons to expense in the period of the sale that
benefits from the plan.
Warranty costs under the service-type warranty will be expensed as incurred in
2022–2024.

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 Consideration Payable Consideration Payable

Facts: Fluffy Cake Mix Ltd. sells boxes of cake mix for £3 per box. Solution:
In addition, Fluffy Cake Mix offers its customers a large durable
1. To record purchase of 20,000 mixing bowls at £2 per bowl
mixing bowl in exchange for £1 and 10 box tops. The mixing bowl
in 2019:
costs Fluffy Cake Mix £2, and the company estimates that
customers will redeem 60 percent of the box tops. The premium Premium Inventory (20,000 bowls x £2) 40,000
offer began in June 2019. During 2019, Fluffy Cake Mix purchased Cash 40,000
20,000 mixing bowls at £2, sold 300,000 boxes of cake mix for £3
per box, and redeemed 60,000 box tops.

Question: What entries should Fluffy Cake Mix record in 2019?

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Consideration Payable Consideration Payable

Solution: Solution:

2. The entry to record the sale of the cake mix boxes in 2019 3. To record the actual redemption of 60,000 box tops, the
is as follows. receipt of £1 per 10 box tops, and the delivery of the
mixing bowls:
Cash (300,000 boxes x £3) 900,000
Sales Revenue 900,000 Cash [(60,000 ÷ 10) x £1] 6,000
Premium Expense 6,000
Inventory of Premiums [(60,000 ÷ 10) x £2] 12,000

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Consideration Payable Consideration Payable

Solution: Solution:

The computation of the Premium Liability at 12/31/19 is as 4. The adjusting entry to record additional premium
follows. expense and the estimated premium liability at December
31, 2019, is as follows:

Premium Expense 12,000

Premium Liability 12,000

The December 31, 2019, statement of financial position reports Premium

inventory of £28,000 (£40,000 − £12,000) as a current asset and Premium
Liability of £12,000 (£18,000 − £6,000) as a current liability. The 2019 income
statement reports £18,000 (£6,000 + £12,000) premium expense as a selling
expense.

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