Chapter 13 - Current Liabilities and Contingencies

CHAPTER 13
CURRENT LIABILITIES AND CONTINGENCIES

Overview
With the discussion of investments in the previous chapter we concluded our six-chapter coverage of assets that began in Chapter 7 with cash and receivables. This is the first of six chapters devoted to liabilities. Here, we focus on short-term liabilities. Bonds and long-term notes are discussed in the next chapter. Obligations relating to leases, income taxes, pensions, and other postretirement benefits are the subjects of the following four chapters. In Part A of this chapter, we discuss open accounts and notes, accrued liabilities, and other liabilities that are classified appropriately as current. In Part B we turn our attention to situations in which there is uncertainty as to whether an obligation really exists. These are designated as loss contingencies.

Learning Objectives
1. Define liabilities and distinguish between current and long-term liabilities. 2. Account for the issuance and payment of various forms of notes and record the interest on the notes. 3. Characterize accrued liabilities and liabilities from advance collection, and describe when and how they should be recorded. 4. Determine when a liability can be classified as a noncurrent obligation. 5. Identify situations that constitute contingencies and the circumstances under which they should be accrued. 6. Demonstrate the appropriate accounting treatment for contingencies, including unasserted claims and assessments. 7. Discuss the primary differences between U.S. GAAP and IFRS with respect to current liabilities and contingencies.

Part A: Current Liabilities

I.

Lecture Outline

Characteristics of Liabilities (T13-1) A. Most liabilities obligate the debtor to pay cash at specified times and result from legally enforceable agreements. B. Some liabilities are not contractual obligations and may not be payable in cash. C. A liability is a present obligation to sacrifice assets in the future because of something that already has occurred. II. What is a Current Liability? (T13-2) A. Classifying liabilities as either current or long-term helps investors and creditors assess the relative risk of a businesss liabilities. B. Current liabilities are expected to require current assets and usually are payable within one year. C. Current liabilities ordinarily are reported at their maturity amounts. (T13-3) 1. Practical expediency 2. Conceptually, liabilities should be recorded at their present values. 3. Relatively short time to maturity

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III. Accounts Payable and Notes A. Open accounts and notes 1. Accounts payable Buying merchandise on account in the ordinary course of business creates accounts payable 2. Trade notes payable Formally recognized by a written promissory note; sometimes bear interest B. Short-term notes payable 1. Line of credit allows a company to borrow cash without having to follow formal loan procedures and paperwork 2. Interest on notes face amount x annual rate x time to maturity (T13-4) 3. Noninterest-bearing notes interest is discounted from the face amount of a note; the effective interest rate is higher than the stated discount rate (T13-5) 4. Secured loans a specified asset (often inventory or accounts receivable) is pledged as collateral or security for the loan C. Commercial paper (Exercise 13-3) 1. Large, highly rated firms 2. Lower rate than through a bank loan 3. Unsecured notes sold in minimum denominations of $25,000 4. Maturities ranging from 30 to 270 days 5. Interest often discounted at the issuance of the note 6. Usually backed by a line of credit 7. Recording its issuance and payment exactly the same as forms of notes payable IV. Accrued Liabilities (T13-6) A. Represent expenses already incurred, but for which cash has yet to be paid (accrued expenses) B. Recorded by adjusting entries at the end of the reporting period C. Common examples: salaries and wages payable, income taxes payable, and interest payable (T13-7) D. An employer accrues an expense and related liability for employees' compensation for future absences such as vacation pay if the obligation meets 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. V. Liabilities from Advance Collection A. Deposits and advances from customers (T13-8) 1. Collecting cash from a customer as a refundable deposit or as an advance payment for products or services 2. Creates a liability to return the deposit or to supply the products or services. B. Gift cards are a common example of advanced collection. Record unearned revenue liability when sell the card, and then reduce it and recognize revenue if the gift card is redeemed or the probability of redemption is viewed as remote. C. Collections for third parties

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1. Sales taxes collected from customers represent liabilities until remitted. 2. Payroll-related deductions such as withholding taxes, social security taxes, employee insurance, employee contributions to retirement plans, and union dues [discussed in the Appendix] VI. A Closer Look at the Current and Noncurrent Classification A. Current maturities of long-term debt (Exercise 13-10) 1. The currently maturing portion of a long-term debt must be reported as a current liability. 2. Long-term liabilities that are due on demand by terms of the contract or violation of contract covenants must be reported as current liabilities. B. Short-term obligations can be reported as noncurrent liabilities if the company: 1. Intends to refinance on a long-term basis and 2. Demonstrates the ability to do so by a refinancing agreement or by actual financing. (T13-9) 3. Under U.S. GAAP, liabilities payable within the coming year are classified as longterm liabilities if refinancing is completed before date of issuance of the financial statements. Under IFRS, refinancing must be completed before the balance sheet date. The FASB is considering an exposure draft proposing the IFRS method. (T13-10)

Part B: Contingencies
I. Loss Contingencies (T13-11) A. Involves an existing uncertainty as to whether a loss really exists, where the uncertainty will be resolved only when some future event occurs B. Accrued only if a loss is 1. Probable and 2. The amount can reasonably be estimated. (T13-12) C. The contingent liability for product warranties almost always is accrued. (Exercise 13-13) D. The contingent liability for premiums (like cash rebates) almost always is accrued. (T1313) E. When the cause of a loss contingency occurs before the year-end, a clarifying event before financial statements are issued can be used to determine how the contingency is reported. (T13-14)

II. Unasserted Claims and Assessments (T13-15) A. It must be probable that an unasserted claim or assessment or an unfiled lawsuit will occur before considering whether and how to report the possible loss. 1. Is a claim or assessment probable? {If not, no disclosure is needed.} 2. Only if a claim or assessment is probable should we evaluate (a) the likelihood of an unfavorable outcome and (b) whether the dollar amount can be estimated. B. If the conclusion of step 1 is that the claim or assessment is not probable, no further action is required. III. Gain Contingencies (T13-16) A. Gain contingencies are not accrued. B. Conservatism

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IV. IFRS (T13-17) A. We accrue a loss contingency under U.S. GAAP if its both probable and can be reasonably estimated. IFRS is similar, but the threshold is more likely than not. This is a lower threshold than probable. B. Another difference in accounting relates to whether to report a long-term contingency at its face amount or its present value. Under IFRS, present value of the estimated cash flows is reported when the effect of time value of money is material. According to US GAAP, though, discounting of cash flows is allowed when the timing of cash flows is certain. Decision-Makers Perspective (T13-18) A. Liabilities impact a companys liquidity. B. Liquidity refers to a company's cash position and overall ability to obtain cash in the normal course of business. C. Critical that managers as well as outside investors and creditors maintain close scrutiny of a companys liquidity D. The current ratio is a measure of short-term solvency. 1. Determined by dividing current assets by current liabilities 2. Should be evaluated in the context of the industry in which the company operates and other specific circumstances 3. But one indication of liquidity 4. Acid-test or quick ratio, by eliminating current assets such as inventories and prepaid expenses that are less readily convertible into cash, provides a more rigorous indication of a company's short-term solvency. E. Outside analysts as well as managers should actively monitor risk management activities.

PowerPoint Slides
A PowerPoint presentation of the chapter is available at the textbook website.

Teaching Transparency Masters

The following can be reproduced on transparency film as they appear here, or you can use the disk version of this manual and first modify them to suit your particular needs or preferences.

CHARACTERISTICS OF LIABILITIES
Most liabilities obligate the debtor to pay cash at specified times and result from legally enforceable agreements.

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Chapter 13 - Current Liabilities and Contingencies

Some liabilities are not contractual obligations and may not be

payable in cash. A liability has three essential characteristics. Liabilities: 1. 2. 3. are probable, future sacrifices of economic benefits that arise from present obligations (to transfer goods or provide services) to other entities that result from past transactions or events

Notice that the definition of a liability involves the present, the future, and the past. It is a present responsibility, to sacrifice assets in the future, caused by a transaction or other event that already has happened.

T13-1

WHAT IS A CURRENT LIABILITY? Classifying liabilities as either current or long-term helps investors and creditors assess the relative risk of a companys liabilities.

Generally, current liabilities are payable within one year. Formally, current liabilities are expected to require current
assets (or create current liabilities).
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Conceptually,

liabilities should be recorded at their present values, but ordinarily are reported at their maturity amounts.

T13-2

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Chapter 13 - Current Liabilities and Contingencies

CURRENT LIABILITIES
General Mills, Inc. Balance Sheet ($ in millions) May 31, 2009 and May 25, 2008 Assets [by classification] Liabilities CURRENT LIABILITIES: Accounts payable Current portion of long-term debt Notes payable Deferred income taxes Other current liabilities Total current liabilities LONG-TERM LIABILITIES: [listed individually] Shareholders equity [by source] 2009 $ 803 509 812 -1,482 $3,606 2008 $937 442 2,209 28 1,240 $4,856

Graphic 131

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Chapter 13 - Current Liabilities and Contingencies

T13-3

8: Debt Notes Payable. The components of notes payable and their respective weighted average interest rates at the end of the period are as follows:
2009
Dollars in millions:

2008
Note Rate Weighted Average Interest Payable

Note 1 Rate

Weighted Average Interest Payable

U.S. commercial paper Euro commercial paper Financial institutions Total notes payable

$ 402 0.5% $ 688 275 0.5 1,386 135 12.9 135 $812 2.6% $2,209

2.9% 3.4 9.6 3.6%

To ensure availability of funds, we maintain bank credit lines sufficient to cover our outstanding short-term borrowings. Commercial paper is a continuing source of short-term financing. We issue commercial paper in the United States, Canada, and Europe. Our commercial paper borrowings are supported by $2.9 billion of fee-paid committed credit lines, consisting of a $1.8 billion facility expiring in October 2012 and a $1.1 billion facility expiring in October 2010. We also have $401.9 million in uncommitted credit lines, which support our foreign operations. As of May 31, 2009, there were no amounts outstanding on the fee-paid committed credit lines and $134.7 million was drawn on the uncommitted lines.

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Chapter 13 - Current Liabilities and Contingencies

Graphic 131 (continued)

T13-3 (continued)

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Chapter 13 - Current Liabilities and Contingencies

NOTE ISSUED FOR CASH

Interest on notes is calculated as: FACE AMOUNT x ANNUAL RATE x TIME TO MATURITY

On May 1, Affiliated Technologies, Inc., a consumer electronics firm, borrowed $700,000 cash from First BancCorp under a noncommitted short-term line of credit arrangement and issued a 6-month, 12% promissory note. Interest was payable at maturity. May 1 Cash ....................................................... Notes payable..................................... November 1 Interest expense ($700,000 x 12% x 6/12)........ Notes payable......................................... Cash ($700,000 + 42,000)......................... 700,000 42,000 700,000

700,000

742,000
Illustration 13-1

T13-4

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Chapter 13 - Current Liabilities and Contingencies

Noninterest-Bearing Note The

proceeds of the note are reduced by the interest in a noninterest-bearing note. $700,000 noninterest-bearing note, with a 12% discount rate. The $42,000 interest is discounted at the outset, rather than explicitly stated: 658,000 42,000 700,000 42,000 700,000

Situation:

May 1 Cash (difference)........................................... Discount on notes ($700,000 x 12% x 6/12)........ Notes payable (face amount)...................... November 1 Interest expense ........................................ Discount on notes ................................. Notes payable (face amount).......................... Cash ......................................................

42,000 700,000

The amount borrowed is only $658,000, but the interest is calculated as the discount rate times the $700,000 face amount. This causes the effective interest rate to be higher than the 12% stated rate: $ 42,000 $658,000 = 6.38% 12/6 x
__________

interest for 6 months amount borrowed rate for 6 months to annualize the rate T13-5

= 12.76% effective interest rate

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Chapter 13 - Current Liabilities and Contingencies

ACCRUED LIABILITIES Liabilities

paid. accrue for expenses that are incurred, but not yet

Recorded Common

by adjusting entries at the end of the reporting period, prior to preparing financial statements. examples are: salaries and wages payable, income taxes payable, and interest payable.

T13-6

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Chapter 13 - Current Liabilities and Contingencies

ACCRUED INTEREST PAYABLE Assume the fiscal period for Affiliated Technologies ends on
June 30, two months after the 6-month note is issued. The issuance of the note, intervening adjusting entry, and note payment would be recorded as shown below: Issuance of note May 1 Cash .......................................................... Note payable.......................................... Accrual of interest on June 30 Interest expense ($700,000 x 12% x 2/12)......... Interest payable..................................... Note payment November 1 Interest expense ($700,000 x 12% x 4/12)......... Interest payable (from adjusting entry)........... Note payable............................................. Cash ($700,000 + 42,000).............................

700,000

700,000

14,000 14,000 28,000 14,000 700,000

742,000
Illustration 13-1a

T13-7

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Chapter 13 - Current Liabilities and Contingencies

Customer Advance A
customer advance produces an obligation that is satisfied when the product or service is provided.

Tomorrow Publications collects magazine subscriptions from customers at the time subscriptions are sold. Subscription revenue is recognized over the term of the subscription. Tomorrow collected $20 million in subscription sales during its first year of operations. At December 31, the average subscription was one-fourth expired.
($ in millions)

When Advance is Collected Cash................................................................ Unearned subscriptions revenue ............... When Product is Delivered Unearned subscriptions revenue.................... Subscriptions revenue................................

20

20

Common example: Gift cards.

Earn the revenue when either the gift card is used or the probability of redemption is viewed as remote.
Illustration 13-4

T13-8

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Chapter 13 - Current Liabilities and Contingencies

Short-Term Obligations Expected to Be Refinanced Short-term obligations can be reported as noncurrent liabilities
only if the company: (a) intends to refinance on a long-term basis and (b) demonstrates the ability to do so

by either an existing refinancing agreement or by actual financing (prior to the issuance of the financial statements).

The specific form of the long-term refinancing (bonds, bank loans, equity securities) is irrelevant when determining the appropriate classification. The concept of substance over form.

T13-9

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Chapter 13 - Current Liabilities and Contingencies

INTERNATIONAL FINANCIAL REPORTING STANDARDS Classification of Liabilities to be Refinanced.

Under U.S. GAAP, liabilities payable within the coming year are classified as long-term liabilities if refinancing is completed before date of issuance of the financial statements. Under IFRS, refinancing must be completed before the balance sheet date.

T13-10

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Chapter 13 - Current Liabilities and Contingencies

LOSS CONTINGENCIES A
loss contingency involves an existing uncertainty as to whether a loss really exists, where the uncertainty will be resolved only when some future event occurs. date; otherwise, regardless of the likelihood of the eventual outcome, no liability could have existed at the statement date.

The cause of the uncertainty must occur before the statement

A liability is accrued if it is both(a) probable that the confirming event will occur and (b) the amount can be at least reasonably estimated: Loss (or expense)....................... Liability.................................. x,xxx

x,xxx

Some loss contingencies dont involve liabilities at all. Some contingencies when resolved cause a noncash asset to be impaired, so accruing it means reducing the related asset rather than recording a liability (e.g. accounts receivable).

T13-11

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Chapter 13 - Current Liabilities and Contingencies

ACCOUNTING TREATMENT OF LOSS CONTINGENCIES

DOLLAR AMOUNT OF POTENTIAL LOSS ________________________________ Reasonably Not Reasonably Known Estimable Estimable LIKELIHOOD Probable Disclosure Note & Disclosure Note & Disclosure Note Only _____________________________________________ Disclosure Disclosure Disclosure Note Note Note Only Only Only _____________________________________________ No Disclosure Required No Disclosure Required No Disclosure Required Liability Accrued Liability Accrued

Reasonably Possible

Remote

Graphic 13-10

T13-12

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Chapter 13 - Current Liabilities and Contingencies

PRODUCT WARRANTIES AND GUARANTEES

The contingent liability for product warranties almost always

is accrued. Caldor Health, a supplier of in-home health care products, introduced a new therapeutic chair carrying a 2-year warranty against defects. Estimates based on industry experience indicate warranty costs of 3% of sales during the first 12 months following the sale and 4% the next 12 months, totaling 7% that should be accrued in the year of sale. During December of 2011, its first month of availability, Caldor sold $2 million of the chairs. During December Cash (and accounts receivable)................. Sales revenue ........................................ December 31, 2011 (adjusting entry) Warranty expense ([3% + 4%] x $2,000,000)..... Estimated warranty liability .................. 2,000,000 140,000

2,000,000 140,000

When customer claims are made and costs are incurred to satisfy those claims the liability is reduced (lets say $61,000 in 2012): Estimated warranty liability ..................... 61,000 Cash, wages payable, parts and supplies, etc. 61,000
Illustration 13-6

T13-13

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Chapter 13 - Current Liabilities and Contingencies

SUBSEQUENT EVENTS If
information becomes available that sheds light on a contingency that existed when the fiscal year ended, that information should be used in determining the probability of a loss contingency materializing and in estimating the amount of the loss.

Cause of Loss Contingency Clarification ________________________________________________________________ Fiscal Year Ends Financial Statements

If an event giving rise to a contingency occurs after the yearend, a liability should not be accrued.
Cause of Loss Contingency Clarification or Clarification ________________________________________________________________ Fiscal Year Ends Financial Statements

T13-14

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Chapter 13 - Current Liabilities and Contingencies

UNASSERTED CLAIMS AND ASSESSMENTS

It must be probable that an unasserted claim or assessment or

an unfiled lawsuit will occur before considering whether and how to report the possible loss. Example: The EPA is in the process of investigation possible violations of clean air laws at a companys factory, but has not proposed a penalty assessment. Since the claim or assessment is unasserted as yet, a two-step process is involved in deciding how it should be reported: 1. Is a claim or assessment probable? {If not, no disclosure is needed.} 2. Only if a claim or assessment is probable should we evaluate (a) the likelihood of an unfavorable outcome and (b) whether the dollar amount can be estimated. If the conclusion of step 1 is that the claim or assessment is not probable, no further action is required.

T13-15

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Chapter 13 - Current Liabilities and Contingencies

GAIN CONTINGENCIES

Uncertain situations that might result in a gain. Gain contingencies are not accrued. Desirable to anticipate losses, but recognizing
await their realization.

gains should

Should be disclosed in notes to the financial statements.

Care should be taken that the disclosure note not give "misleading implications as to the likelihood of realization."

T13-16

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Chapter 13 - Current Liabilities and Contingencies

INTERNATIONAL FINANCIAL REPORTING STANDARDS Contingencies.

Overall, accounting for contingent losses is quite similar between IFRS and U.S. GAAP. Key differences: IFRS defines probable as more likely than not, which is a lower threshold than typically associated with probable in U.S. GAAP. IFRS refers to these accrued liabilities as provisions, and refers to possible obligations that are not accrued as contingent liabilities, while the term contingent liabilities is used for all of these obligations in U.S. GAAP. If there is a range of equally likely outcomes associated with a contingency, IFRS requires using the midpoint of the range, while U.S. GAAP requires use of the low end of the range. IFRS requires reporting present values of estimated cash flows when the effect of time value of money is material. U.S. GAAP allows using present values under some circumstances when the timing of cash flows is fixed or reliably determinable. Heres a portion of a footnote from the 2009 financial statements of Vodafone, which reports under IFRS: Note 2: Significant Accounting Policies (in part) Provisions are recognized when the Group has a present obligation (legal or constructive) as a result of a past event, it is probable that the Group will be required to settle that obligation and a reliable estimate can be made of the amount of the obligation. Provisions are measured at the directors best estimate of the expenditure required to settle the obligation at the balance sheet date and are discounted to present value where the effect is material.

T13-17

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Chapter 13 - Current Liabilities and Contingencies

DECISION-MAKERS PERSPECTIVE

Current Critical

liabilities impact a companys liquidity. Liquidity refers to a company's cash position and overall ability to obtain cash in the normal course of business. that managers as well as outside investors and creditors maintain close scrutiny of this aspect of a companys well-being. current liabilities. Compares liabilities that must be satisfied in the near term with assets that either are cash or will be converted to cash in the near term. Like other ratios, acceptability should be evaluated in the context of the industry in which the company operates and other specific circumstances. Some companies manage working capital carefully enough to maintain a relatively low current ratio by maintaining low receivables and high payables. By eliminating current assets such as inventories and prepaid expenses that are less readily convertible into cash, the acid-test ratio provides a more rigorous indication of a company's short-term solvency.
T13-18

The current ratio is determined by dividing current assets by

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DECISION-MAKERS PERSPECTIVE (continued)

Its important to remember that each ratio is but one piece of

the puzzle. In fact, profitability is probably the best long-run indication of liquidity. Turnover ratios help measure the efficiency of asset management.

Most companies attempt to actively manage the risk associated

with these and other obligations. It is important for top management and outside analysts to understand and closely monitor risk management strategies. It is similarly important for investors and creditors to become informed about risks companies face and how well equipped those companies are in managing that risk. The risk disclosures and derivative disclosures we discussed in this and the previous chapter contribute to that understanding.

T13-18 (continued)

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Chapter 13 - Current Liabilities and Contingencies

SUGGESTIONS FOR CLASS ACTIVITIES

1. Business Scenario
Outpost Healthcare, Inc. provides long-term healthcare services primarily through the operation of nursing centers and hospitals. It operates 380 nursing centers, with 45,627 licensed beds in 35 states, and a rehabilitation therapy business. The following news release appeared in March 2008. OUTPOST HEALTHCARE ANNOUNCES FISCAL 2007 RESULTS Company Provides Operating Guidance for Fiscal 2008 Hall, Indiana. (March 5, 2008) Outpost Healthcare, Inc. (the "Company") (NASDAQ: OUTP) today announced its operating results for the fourth quarter and fiscal year ended December 31, 2007. Revenues for the fourth quarter of 2007 grew 7% to $689 million compared to $644 million in the fourth quarter last year, and net income from operations for the current quarter totaled $15.1 million or $0.74 per diluted share. Operating results for the fourth quarter of 2007 included an unusual pretax gain of $3.1 million ($2.3 million net of tax or $0.06 per diluted share) recorded in connection with the resolution of a loss contingency related to a partnership interest.

Suggestions: Have the class consider how Outpost might have recorded a gain in connection with the resolution of a loss contingency the loss contingency. What might have led to the loss contingency being recorded? How did they record it? How would the gain be recorded? Points to note: Apparently a previously recorded loss was higher than the ultimate outcome. Such situations are treated as changes in estimates. That is, no adjustment is made to the original reporting. Instead, when the estimate turns out to be wrong, a gain is recorded for the overstatement of the loss. Outpost apparently had felt the loss contingency was both probable and reasonably estimable. The loss contingency would have been accrued with a debit to a loss and a credit to a liability. The subsequent gain would be offset with a debit to the liability.

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2.

Real World Scenario

The following represents a portion of a recent press release:

FUELTECHREPORTSSECONDQUARTER2009 RESULTS

Mon Aug 10, 2009 6:12pm EDT

WARRENVILLE, Ill.--(Business Wire)-Fuel Tech, Inc. (NASDAQ: FTEK), a world leader in advanced engineering solutions for the optimization of combustion systems and emissions control in utility and industrial applications, today reported results for the three- and six-month periods ended June 30, 2009. Second-Quarter 2009 The Air Pollution Control technology segment (APC segment) generated revenues of $9.2 million, a decrease of 12% versus the second quarter of 2008. This segment continues to feel the effects of deferred capital investment by electric utilities and other industrial customers as the combination of an economic slowdown, reduced electricity demand, shortfalls in cash generation by power providers and ongoing uncertainty over the ultimate outcome of the Clean Air Interstate Rule (CAIR) served to depress outlays for NOx control systems. Segment gross margins were 49% versus the 46% reported in the second quarter of 2008. Contributing to the increase was a partial reversal of the first-quarter 2009 contingent loss provision on an APC contract, which has now been resolved.

Suggestions: Have the class consider the effect of the loss contingency. What motivated Fuel Tech to reverse the loss contingency? (Resolution of the contingency at a reduced amount.) How did they record it? (Reversed part of the prior accrual entry.) Is there any potential for earnings management with loss contingencies? (Yes, if over accrue in a very good or very bad period, can reverse that later to benefit income in a future period.)

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3.

Dell Analysis

Have students, individually or in groups, go to the most recent Dell annual report at Dells web site at: www.Dell.com/. Ask them to: 1. Compare accounts payable, accrued expenses, and other current liabilities with those in the annual report that came with the textbook. Are there any discernible trends? How might they be interpreted? 2. Determine what contingencies are reported in the disclosure notes. Are any accrued? 3. Read Management's Discussion and Analysis of Results of Financial Condition and Results of Operations and determine managements view of Dells current liquidity.

4.

Professional Skills Development Activities

The following are suggested assignments from the end-of-chapter material that will help your students develop their communication, research, analysis, and judgment skills. Communication Skills. In addition to Communication Cases 13-7, 13-8, 13-10, and 13-12, Judgment Case 13-9 can be adapted to ask students to write a memo to the veteran Board member. Real World Case 13-13 and IFRS case 13-14 are suitable for student presentation(s). Communication Case 13-7, Real World Case 13-2 and Analysis Case 13-17 do well as group assignments. Ethics Case 13-5 creates good class discussions. Research Skills. In their professional lives, our graduates will be required to locate and extract relevant information from available resource material to determine the correct accounting practice, perhaps identifying the appropriate authoritative literature to support a decision using the FASBs Accounting Standards Codification. Exercises 13-26 and 13-27 and Research Cases 13-1, 13-3, 13-6, and 13-11 provide an excellent opportunity to help students develop this skill. Analysis Skills. The Broaden Your Perspective section includes Analysis Cases that direct students to gather, assemble, organize, process, or interpret date to provide options for making business and investment decisions. In addition to Analysis Cases 13-16 and 13-17, Exercise 13-7, Problems 13-8 and 13-9, and Real World Cases 13-2 and 13-13 also provide opportunities to develop analysis skills. Judgment Skills. The Broaden Your Perspective section includes Judgment Cases that require students to critically analyze issues to apply concepts learned to business situations in order to evaluate options for decision-making and provide an appropriate conclusion. In addition to Judgment Cases 13-4 and 13-9, Trueblood Case 13-6 also requires students to exercise judgment.

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5.

Ethical Dilemma
The chapter contains the following ethical dilemma:

ETHICAL DILEMMA
You are Chief Financial Officer of Camp Industries. Camp is the defendant in a $44 million class action suit. The companys legal counsel informally advises you that chances are remote that the company will emerge victorious in the lawsuit. Counsel feels the company will probably lose $30 million. You recall that a loss contingency should be accrued if a loss is probable and the amount can reasonably be estimated. A colleague points out that, in practice, accrual of a loss contingency for unsettled litigation is rare. After all, disclosure that management feels it is probable that the company will lose a specified dollar amount would be welcome ammunition for the opposing legal counsel. He suggests that a loss not be recorded until after the ultimate settlement has been reached. What do you think? You may wish to discuss this in class. If so, discussion should include these elements. Step 1 The Facts: Camp Industries is the defendant in a $44 million class action suit. Legal Counsel believes that the company will not win the lawsuit and will probably lose $30 million. GAAP mandates that a loss contingency should be accrued if the loss is probable and the amount reasonably can be estimated. In an effort not to influence the decision of the court, you, as CFO, are considering deferring recognition of the loss until after settlement has been reached. Step 2 The Ethical Issue and the Stakeholders: The ethical issue or dilemma is whether your obligation to protect company interests in the lawsuit is greater than your obligation to provide full disclosure of relevant information to users of the financial statements. Stakeholders include you as CFO, other company management, employees, current and future creditors, current and future investors, and members of the class action suit. Step 3 Values: Values include competence, honesty, integrity, objectivity, loyalty to the company, and responsibility to users of financial statements. Step 4 Alternatives: 1. Omit the recognition of the probable loss as a contingent liability on the balance sheet. 2. Record the probable loss on the income statement and as a liability on the balance sheet.

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Step 5 Evaluation of Alternatives in Terms of Values: 1. Alternative 1 illustrates loyalty to protecting company interests during the trial. 2. Alternative 2 reflects values of competence, honesty, integrity, objectivity, and responsibility to users of the financial statements. Step 6 Consequences: Alternative 1 Positive Consequences: Opposing legal counsel will not learn about the companys estimation of the loss. Positive litigation outcome, though unlikely, will not be hurt. Negative Consequences: Users of the financial statements would not receive full disclosure. Alternative 2 Positive Consequences: Users of financial statements would become fully informed of the pending loss. You would maintain your integrity. Negative Consequences: You may incur the disfavor higher management and legal counsel and lose your job. The company may lose the lawsuit or be forced into paying a higher settlement due to the disclosure. The stock price may suffer with negative consequences to investors, creditors, employees, and their families. Note: In practice, loss contingencies from unsettled lawsuits rarely if ever are accrued. Disclosure notes typically note the difficulty of predicting court decisions. Step 7 Decision: Student(s) must decide their course of action.

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Assignment Charts
Questions
13-1 13-2 13-3 13-4 13-5 13-6 13-7 13-8 13-9 13-10 13-11 13-12 13-13 13-14 13-15 13-16 13-17 13-18 13-19 13-20 13-21 13-22 13-23 13-24 13-25 13-26 Learning Objective(s) 1 1 1 2 2 2 3 3 3 3 3 4 4 4,7 5 5 5 5,7 6 6 6 6 6 6,7 6 6 Est. time Topic (min.) Essential characteristics of liabilities 5 Distinguish current from long-term liabilities 5 Measurement of current liabilities 5 Line of credit 5 Noninterest-bearing notes 5 Commercial paper 5 Accrued salaries 5 Compensated absenses 5 Refundable deposits and customer advances 5 Gift cards 5 Collections for third parties 5 Classification as a noncurrent obligation 5 Classification as a noncurrent obligation 5 IFRS; Classification as a noncurrent obligation 5 Define a loss contingency 5 Three categories of likelihood 5 Conditions for a loss contingency to be accrued 5 IFRS; Contingent liability definition 5 Accounting for a loss contingency not accrued 5 Two loss contingencies almost always accrued 5 Manufacturers warranty versus extended 5 warranty Subsequent events 5 Subsequent events 5 IFRS; Range of equally likely losses 5 Unasserted assessment 5 Gain contingency 5

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Chapter 13 - Current Liabilities and Contingencies

Brief Exercises
13-1 13-2 13-3

13-4 13-5 13-6 13-7 13-8 13-9 13-10 13-11 13-12 13-13 13-14 13-15 13-16 13-17

Learning Est. time Objective(s) Topic (min.) 2, 3 Bank loan; accrued interest 5 2, 3 Non-interest-bearing note; accrued interest 5 2, 3 Determining accrued interest in various 5 situations 2 Commercial paper 5 2 Non-interest-bearing note; accrued interest 5 3 Advance collection 5 3, 7 IFRS; Advance collection 5 3 Sales tax 5 4 Refinancing debt 5 4, 7 IFRS; Refinancing debt 5 5, 6 Warranties 5 5, 6 Product recall 5 5, 6 Unasserted assessment 5 5, 6 Contingency 5 5, 6 Contingency 5 5, 6, 7 IFRS; Contingency 5 5, 6 Contingencies 5 Learning Est. time Objective(s) Topic (min.) 2, 3 Bank loan; accrued interest 10 2, 3 Determining accrued interest in various situations 15 2 Short-term notes 20 3 Paid future absences 10 3 Paid future absences 10 1 Customer advances; sales taxes 20 3 Customer deposits 15 3 Various transactions involving accrued liabilities 10 3 Gift cards 15 1, 4 Current noncurrent classification of debt 10 1, 4, 7 IFRS; Currentnoncurrent classification 10 1, 4 Current noncurrent classification of debt 15 5, 6 Warranties 15 5, 6 Extended warranties 15 5, 6 Contingency; product recall 15 5, 6 Impairment of accounts receivable 15 5, 6 Premiums 15 6 Unasserted assessment 15 5, 6 Various transactions involving contingencies 30 5, 6, 7 IFRS; Various transactions 30

Exercises
13-1 13-2 13-3 13-4 13-5 13-6 13-7 13-8 13-9 13-10 13-11 13-12 13-13 13-14 13-15 13-16 13-17 13-18 13-19 13-20

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Chapter 13 - Current Liabilities and Contingencies

13-21 13-22 13-23 13-24 13-25 13-26 13-27

1, 2, 3, 4, 5, 6 5 6 5, 6 3 5 3, 4, 5

Disclosures of liabilities; matching Change in accounting estimate Change in accounting estimate Contingency; Dow Chemical Company disclosure Payroll-related liabilities [based on appendix] Contingency, codification Various liabilities, codification

25 15 10 15 10 15 20

CPA/CMA Exam Questions

CPA-1 CPA-2 CPA-3 CPA-4 CPA-5 CPA-6 CMA-1 CMA-2 CMA-3 CMA-4

Learning Objective(s) 6 6 3 3 5 4 5 5 6 4

Topic Coupons Warranty Note payable Employee absences Lawsuit Refinance debt Employee absences Loss contingency Loss contingency Refinance debt

Est. time (min.) 3 3 3 3 3 3 3 3 3 3

Problems
13-1 13-2 13-3 13-4 13-5 13-6 13-7 13-8 13-9 13-10 13-11

Learning Objective(s) 2, 3 1, 2, 3, 4 1, 4 1, 2, 3, 4 3 5, 6 4, 5, 6, 7 6 6 4, 5 1, 2, 3, 4, 5, 6

Est. time Topic (min.) Bank loan; accrued interest 20 Various transactions involving liabilities 20 Current noncurrent classification of debt 30 Various liabilities 20 Bonus compensation 25 Various contingencies 35 IFRS; Various liabilities 30 Expected cash flow approach; product recall 25 Subsequent events 25 Subsequent events; classification of debt; loss contingency; financial statement effects 35 Concepts; terminology; matching 15

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Chapter 13 - Current Liabilities and Contingencies

13-12 13-13

4, 5 3

Various liabilities; frequent flyer program; balance sheet classification; prepare liability section of balance sheet; write footnotes 45 Payroll-related liabilities [based on appendix] 15

Star Problems Cases

Research Case 13-1 Real World Case 13-2 Research Case 13-3 Ethics Case 13-4 Judgment Case 13-5 Trueblood Accounting Case 13-6 Communication Case 13-7 Communication Case 13-8 Judgment Case 13-9 Communication Case 13-10 Research Case 13-11 Communication Case 13-12 Real World Case 13-13 Ethics Case 13-14 IFRS Case 13-15 Analysis Case 13-16 Analysis Case 13-17 Real World Case 13-18

Learning Est. time Objective(s) Topic (min.) 1, 2 Bank loan: accrued interest; codification 30 1, 3 Returnable containers; Memphis Zoo 15 Relationship of liabilities to assets and owners 20 1 equity; SFAC 1 Outdoors R Us 20 3 Paid future absences 20 5 Contingencies; research 60 Exceptions to the general classification 4 guideline; group interaction 40 5, 6 Various contingencies 20 5, 6 Loss contingency and full disclosure 15 5, 6 Change in loss contingency; write a memo 45 Researching the way contingencies are 5, 6 reported; retrieving information from the 60 Internet 5, 6 Accounting changes 45 5, 6 Lawsuit settlement; SkillSoft 20 5 Profits guaranteed 20 IFRS; Accounting for current liabilities and 1-7 contingencies in other countries 45 1 Analyzing financial statements; liquidity ratios 25 1 Reporting current liabilities; liquidity; Dell 20 1 Contingencies; Microsoft 20 7 IFRS; Unearned revenue, contingencies; British Airways 20

British Airways

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