CHAPTER 2
CURRENT LIABILITIES, PROVISIONS, AND
CONTINGENCIES
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CURRENT LIABILITIES
“What is a Liability?”
Liability is defined as present obligation of the company
arising from past events, the settlement of which is expected
to result in an outflow from the company of resources,
embodying economic benefits.
Three essential characteristics:
1. Present obligation.
2. Arises from past events.
3. Results in an outflow of resources
(cash, goods, services).
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CURRENT LIABILITIES
Recall: Current assets are cash or other assets that companies
reasonably expect to convert into cash, sell, or consume in operations
within a single operating cycle or within a year.
Current liabilities are “obligations whose liquidation is reasonably
expected to require use of existing resources properly classified as
current assets, or the creation of other current liabilities.”
A current liability is reported if one of two conditions exists:
1. Liability is expected to be settled within its normal operating cycle; or
2. Liability is expected to be settled within 12 months after the reporting
date.
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
Typical Current Liabilities:
1. Accounts payable. 6. Customer advances and
deposits.
2. Notes payable.
7. Unearned revenues.
3. Current maturities of long-
term debt. 8. Sales and value-added
taxes payable.
4. Short-term obligations
expected to be refinanced. 9. Income taxes payable.
5. Dividends payable. 10. Employee-related liabilities.
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CURRENT LIABILITIES
Accounts Payable (trade accounts payable)
Balances owed to others for goods, supplies, or services
purchased on open account.
Arises because of time lag between the receipt of services
or acquisition of title to assets and the payment for them.
Terms of the sale (e.g., 2/10, n/30 or 1/10, E.O.M.) usually
state period of extended credit, commonly 30 to 60 days.
These liabilities typically are noninterest-bearing and are
reported at their face amounts.
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CURRENT LIABILITIES
Notes Payable
Written promises to pay a certain sum of money on a
specified future date.
Arise from purchases, financing, or other transactions.
Notes classified as short-term or long-term.
Notes may be interest-bearing or zero-interest-bearing.
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CURRENT LIABILITIES
E13-2: (Accounts and Notes Payable) The following are selected
2015 transactions of Darby Corporation.
Sept. 1 - Purchased inventory from Orion Company on account
for $50,000. Darby records purchases gross and uses a
periodic inventory system.
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.
3-7 LO 1
CURRENT LIABILITIES
Sept. 1 - Purchased inventory from Orion Company on
account for $50,000. Darby records purchases gross and
uses a periodic inventory system.
Sept. 1 Purchases 50,000
Accounts Payable 50,000
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CURRENT LIABILITIES
Oct. 1 - Issued a $50,000, 12-month, 8% note to Orion in
payment of account.
Oct. 1 Accounts Payable 50,000
Notes Payable 50,000
Interest calculation = ($50,000 x 8% x 3/12) = $1,000
Dec. 31 Interest Expense 1,000
Interest Payable 1,000
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CURRENT LIABILITIES
Oct. 1 - Borrowed $75,000 from the Shore Bank by signing a
12-month, zero-interest-bearing $81,000 note.
Oct. 1 Cash 75,000
Notes Payable 75,000
Interest calculation = ($6,000 x 3/12) = $1,500
Dec. 31 Interest Expense 1,500
Notes Payable 1,500
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CURRENT LIABILITIES
Customer Advances and Deposits
Returnable cash deposits received from customers and
employees.
To guarantee performance of a contract or service or
As guarantees to cover payment of expected future
obligations.
Note: May be classified as current or non-current liabilities.
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 required the deposit.
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CURRENT LIABILITIES: Unearned Revenues
Payment received before providing goods or performing
services.
How do these companies account for unearned revenues ?
1. When a company receives an advance payment, it debits Cash, and
credits a current liability account identifying the source of the
unearned revenue.
2. When a company recognizes revenue, it debits the unearned revenue
account, and credits a revenue account.
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CURRENT LIABILITIES
BE13-6: Sports Pro Magazine sold 12,000 annual subscriptions
on August 1, 2015, for €18 each. Prepare Sports Pro’s August 1,
2015, journal entry and the December 31, 2015, annual adjusting
entry.
Aug. 1 Cash 216,000
Unearned Revenue 216,000
(12,000 x €18)
Dec. 31 Unearned Revenue 90,000
Subscription Revenue 90,000
(€216,000 x 5/12 = €90,000)
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CURRENT LIABILITIES
Sales and Value-Added Taxes Payable
Consumption taxes are generally either
a sales tax or
a value-added tax (VAT).
Purpose is to generate revenue for the government.
The two systems use different methods to accomplish this
objective.
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Sales Taxes Payable
Illustration: Halo Supermarket sells loaves of bread to
consumers on a given day for €2,400. Assuming a sales tax
rate of 15 percent, Halo Supermarket makes the following entry
to record the sale.
Cash 2,760
Sales Revenue 2,400
Sales Taxes Payable 360
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Value-Added Taxes Payable
Illustration: The VAT is collected every time a business
purchases products from another business in the product’s
supply chain. To illustrate,
1. Hill Farms Wheat Company grows wheat and sells it to
Sunshine Baking for €1,000. Hill Farms Wheat makes the
following entry to record the sale, assuming the VAT is 15
percent.
Cash 1,500
Sales Revenue 1,000
Value-Added Taxes Payable 150
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Value-Added Taxes Payable
2. Sunshine Baking makes loaves of bread from this wheat and
sells it to Halo Supermarket for €2,000. Sunshine Baking
makes the following entry to record the sale, assuming the
VAT is 15 percent.
Cash 2,300
Sales Revenue 2,000
Value-Added Taxes Payable 300
Sunshine Baking then remits €150 to the government, not €300. The
reason: Sunshine Baking has already paid €150 to Hill Farms Wheat.
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Value-Added Taxes Payable
3. Halo Supermarket sells the loaves of bread to consumers for
€2,400. Halo Supermarket makes the following entry to
record the sale, assuming the VAT is 15 percent.
Cash 2,760
Sales Revenue 2,400
Value-Added Taxes Payable 360
Halo Supermarket then sends only €60 to the tax authority as it
deducts the €300 VAT already paid to Sunshine Baking.
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CURRENT LIABILITIES
Income Tax Payable
Businesses must prepare an income tax return and compute the
income tax payable.
Taxes payable are a current liability.
Corporations must make periodic tax payments.
Differences between taxable income and accounting income
sometimes occur. Because of these differences, the amount of
income taxes payable to the government in any given year may
differ substantially from income tax expense as reported on the
financial statements.
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FINANCIAL LIABILITIES
Under IFRS 9, financial liabilities are obligations to deliver cash or
another financial asset.
Examples:
Loans and Borrowings: Money borrowed that must be repaid, often
with interest.
Trade Payables: Amounts owed to suppliers for goods or services
received.
Bonds Payable: Long-term debt securities issued by a company to
raise capital.
Recognition and Measurement:
Initially recorded at fair value.
Subsequently measured at either amortized cost or fair value
depending on classification.
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Non-Financial Liabilities
Obligations that do not require delivering cash or another financial
asset.
Examples:
Deferred Revenue: Cash received in advance for services to be
provided later.
Employee Benefits: Liabilities for employee-related costs (e.g.,
salaries, pensions).
Provisions: Obligations with uncertain timing/amount, such as legal
or environmental provisions.
Recognition and Measurement:Recorded based on the best
estimate of the expenditure required to settle the obligation.Not
discounted unless the time value of money is material.
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Employee-Related Liabilities
Payroll Deductions
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.
Taxes:
► Social Security Taxes
► Income Tax Withholding
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Employee-Related Liabilities
Illustration: Assume a weekly payroll of $10,000 entirely subject to
Social Security taxes (8%), with income tax withholding of $1,320 and
union dues of $88 deducted. The company records the wages and
salaries paid and the employee payroll deductions as follows.
Wages and Salaries Expense 10,000
Withholding Taxes Payable 1,320
Social Security Taxes Payable 800
Union Dues Payable 88
Cash 7,792
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Employee-Related Liabilities
Illustration: Assume a weekly payroll of $10,000 entirely
subject to Social Security taxes (8%), with income tax
withholding of $1,320 and union dues of $88 deducted.
The company records the employer payroll taxes as
follows.
Payroll Tax Expense 800
Social Security Taxes Payable 800
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 gross
compensation.
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Decommissioning and Restoration Obligations
Decommissioning obligations arise when an entity is legally or
constructively required to dismantle, remove, or restore an asset after its
useful life. This typically applies to industries like mining, oil, gas, and
nuclear power where dismantling and site restoration are necessary.
Under IAS 37 an entity must recognize a provision for decommissioning
obligations if:
1. There is a present legal or constructive obligation as a result of past
events.
2. It is probable that an outflow of resources will be required to settle the
obligation.
3. The obligation can be reliably estimated.
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Reported either as
PROVISIONS
current or non-current liability.
Provision is a liability of uncertain timing or amount.
Present obligation from past event outflow of benefits
Legal obligation creates constructive obligation
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When to Recognize Provision?
present obligation probable outflow reliable estimates
Are all conditions met?
Provision Contingent liability
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When to recognize a provision?
Can you avoid the obligation by your future action?
Yes No
Do not recognize a Provision Recognize a Provision
Example: Training of Personnel Warranty repairs
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How to measure a Provision?
Judgment
Individual most likely outcome
Expected Value
51% or more
Risk and uncertainties Future events
Present Value No gains from disposal of asset
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Provision
Future operating losses Onerous Contract Restructuring
Liability Unavoidable cost › economic benefit Program planned and controlled by
Management that changes scope or
manner of business
No Provision Provision Detailed Plan
Impairment of asset
Penalty
Net cost of fulfilling
Lower of it
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Common Types of Provisions
Common Types:
1. Lawsuits 4. Environmental
2. Warranties 5. Onerous contracts
3. Consideration payable 6. Restructuring
IFRS requires extensive disclosure related to provisions in the notes to
the financial statements. Companies do not record or report in the notes
general risk contingencies inherent in business operations (e.g., the
possibility of war, strike, uninsurable catastrophes, or a business
recession).
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CONTINGENCIES
Possible obligation
Confirmed by future uncertain events
Present obligation unmeasurable or not probable
Not recorded disclosed
Nature of events
Estimates
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PRESENTATION AND ANALYSIS
Presentation of Current Liabilities
Usually reported at their full maturity value.
Difference between present value and the maturity
value is considered immaterial.
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