Chapter one

Current Liabilities, Provisions,

and Contingencies
 CURRENT LIABILITIES

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

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.
 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.
 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.

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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

Interest-Bearing Note Issued

Illustration: Castle National Bank agrees to lend €100,000 on March
1, 2015, to Landscape Co. if Landscape signs a €100,000, 6 percent,
four-month note. Landscape records the cash received on March 1 as
follows:

Cash 100,000
Notes Payable 100,000

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 Interest-Bearing Note Issued

If Landscape prepares financial statements semiannually, it makes

the following adjusting entry to recognize interest expense and
interest payable at June 30, 2015:

Interest calculation = (€100,000 x 6% x 4/12) = €2,000

Interest Expense 2,000

Interest Payable 2,000

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 Interest-Bearing Note Issued

At maturity (July 1, 2016), Landscape records payment of the note

and accrued interest as follows.

Notes Payable 100,000

Interest Payable 2,000
Cash 102,000

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 CURRENT LIABILITIES

Zero-Interest-Bearing Note Issued

Illustration: On March 1, Landscape issues a €102,000, four-month,
zero-interest-bearing note to Castle National Bank. The present value
of the note is €100,000. Landscape records this transaction as
follows.

Cash 100,000
Notes Payable 100,000

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 Zero-Interest-Bearing Note Issued

If Landscape prepares financial statements semiannually, it makes

the following adjusting entry to recognize interest expense and the
increase in the note payable of €2,000 at June 30.

Interest Expense 2,000

Notes Payable 2,000

At maturity (July 1), Landscape must pay the note, as follows.

Notes Payable 102,000

Cash 102,000

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 CURRENT LIABILITIES

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.

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 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

Current Maturities of Long-Term Debt

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 that have not been shown as

current assets,

2. Refinanced, or retired from the proceeds of a new debt issue, or

3. Converted into ordinary shares.

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 CURRENT LIABILITIES

Short-Term Obligations Expected to Be

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.

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 CURRENT LIABILITIES

Customer Advances and Deposits

Returnable cash deposits received from customers and employees.
 May be classified as current or non-current liabilities.

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 CURRENT LIABILITIES

Unearned Revenues
Payment received before providing goods or performing
services.

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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 10 percent, Halo
Supermarket makes the following entry to record the sale.

Cash 2,640
Sales Revenue 2,400
Sales Taxes Payable 240

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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 10 percent.

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

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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

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 CURRENT LIABILITIES

Employee-Related Liabilities
Amounts owed to employees for salaries or wages are reported as a
current liability.

Current liabilities may include:

 Payroll deductions.
 Compensated absences.
 Bonuses.

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 Employee-Related Liabilities

Payroll Deductions
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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 Employee-Related Liabilities

Compensated Absences
Paid absences for vacation, illness and maternity, paternity,
and jury leaves.
Vested rights - employer has an obligation to make payment to
an employee even after terminating his or her employment.

Accumulated rights - employees can carry forward to future

periods if not used in the period in which earned.

Non-accumulating rights - do not carry forward; they lapse if not

used.

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 Employee-Related Liabilities

Illustration: Amutron Inc. began operations on January 1, 2015. The

company employs 10 individuals and pays each €480 per week.
Employees earned 20 unused vacation weeks in 2015. In 2016, the
employees used the vacation weeks, but now they each earn €540
per week. Amutron accrues the accumulated vacation pay on
December 31, 2015, as follows.

Salaries and Wages Expense 9,600

Salaries and Wages Payable 9,600

In 2016, 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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 Employee-Related Liabilities

Profit-Sharing and Bonus Plans

Payments to certain or all employees in addition to their regular
salaries or wages.
 Bonuses paid are an operating expense.
 Unpaid bonuses should be reported as a current liability.

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 PROVISIONS

Provision is a liability of uncertain timing or amount.

Reported either as current or non-current liability.

Common types are

► Obligations related to litigation. Uncertainty about the
► Warrantees or product guarantees. timing or amount of
the future expenditure
► Business restructurings. required to settle the
obligation.
► Environmental damage.

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 Recognition of a Provision

Companies accrue an expense and related liability for a

provision only if the following three conditions are met:
1. Company has a present obligation (legal or constructive) as
a result of a past event;

2. Probable that an outflow of resources will be required to

settle the obligation; and

3. A reliable estimate can be made.

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 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.

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 Measurement of Provisions

How does a company determine the amount to report

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.

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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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 Common Types of Provisions

Litigation Provisions
Companies must consider the following in determining whether
to record a liability with respect to pending or threatened
litigation and actual or possible claims and assessments.
1. The time period in which the underlying cause of action
occurred.

2. The probability of an unfavorable outcome.

3. Ability to make a reasonable estimate of the amount of

loss.

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 Litigation Provisions

With respect to unfiled suits and unasserted claims and

assessments, a company must determine

1. the degree of probability that a suit may be filed or a claim

or assessment may be asserted, and

2. the probability of an unfavorable outcome.

If both are probable, if the loss is reasonably estimable, and if the

cause for action is dated on or before the date of the financial
statements, then the company should accrue the liability.

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 Litigation Provisions

BE13-12: Scorcese Inc. is involved in a lawsuit at December 31,

2015. (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)
Prepare the December 31 entry, if any, assuming it is not probable
that Scorcese will be liable for any payment as a result of this suit.

(a) Lawsuit Loss 900,000

Lawsuit Liability 900,000

(b) No entry is necessary. The loss is not accrued because it

is not probable that a liability has been incurred at
12/31/15.
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 Common Types of Provisions

Warranty Provisions
Promise made by a seller to a buyer to make good on a
deficiency of quantity, quality, or performance in a product.

If it is probable that customers will make warranty claims and a

company can reasonably estimate the costs involved, the
company must record an expense.

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 Warranty Provisions

Companies often provide one of two types of warranties to

customers:

Assurance-Type Warranty
A quality guarantee that the good or service is free from
defects at the point of sale.
 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

Facts: Denson Machinery Company begins production of a new

machine in July 2015 and sells 100 of these machines for $5,000
cash by year-end. Each machine is under warranty for one year.
Denson estimates, based on past experience with similar
machines, that the warranty cost will average $200 per unit.
Further, as a result of parts replacements and services performed
in compliance with machinery warranties, it incurs $4,000 in
warranty costs in 2015 and $16,000 in 2016.

Question: What are the journal entries for the sale and the
related warranty costs for 2015 and 2016?

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 Assurance-Type Warranty

Solution: For the sale of the machines and related warranty

costs in 2015 the entry is as follows.

1. To recognize sales of machines and accrual of warranty

liability:

July–December 2015

Cash 500,000
Warranty Expense 20,000
Warranty Liability 20,000
Sales Revenue 500,000

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 Assurance-Type Warranty

Solution: For the sale of the machines and related warranty

costs in 2015 the entry is as follows.

2. To record payment for warranties incurred:

July–December 2015

Warranty Liability 4,000

Cash, Inventory, Accrued Payroll 4,000

The December 31, 2015, statement of financial position reports

Warranty Liability as a current liability of $16,000. The income statement
for 2015 reports Warranty Expense of $20,000.

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 Assurance-Type Warranty

Solution: For the sale of the machines and related warranty

costs in 2015 the entry is as follows.

3. To record payment for warranty costs incurred in 2016

related to 2015 machinery sales:

January 1–December 31, 2016

Warranty Liability 16,000

Cash, Inventory, Accrued Payroll 16,000

At the end of 2016, no warranty liability is reported for the machinery

sold in 2015.

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 Warranty Provisions

Companies often provide one of two types of warranties to

customers:

Service-Type Warranty
An extended warranty on the product at an additional cost.
 Usually recorded in an Unearned Warranty Revenue
account.
 Recognize revenue on a straight-line basis over the period
the service-type warranty is in effect.

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 Service-Type Warranty

Facts: You purchase an automobile from Hamlin Auto for €30,000

on January 2, 2014. Hamlin estimates the assurance-type
warranty costs on the automobile to be €700 (Hamlin will pay for
repairs for the first 36,000 miles or three years, whichever comes
first). You also purchase for €900 a service-type warranty for an
additional three years or 36,000 miles. Hamlin incurs warranty
costs related to the assurance-type warranty of €500 in 2014 and
€200 in 2015. Hamlin records revenue on the service-type
warranty on a straight-line basis.

Question: What entries should Hamlin make in 2014 and 2017?

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 Service-Type Warranty

Solution:

1. To record the sale of the automobile and related

warranties:

January 2, 2014

Cash (€30,000 + €900) 30,900

Warranty Expense 700
Warranty Liability 700
Unearned Warranty Revenue 900
Sales Revenue 30,000

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 Service-Type Warranty

Solution:

2. To record warranty costs incurred in 2014:

January 2–December 31, 2014

Warranty Liability 500

Cash, Inventory, Accrued Payroll 500

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 Service-Type Warranty

Solution:

3. To record revenue recognized in 2017 on the service-

type warranty:

January 1–December 31, 2017

Unearned Warranty Revenue (€900 ÷ 3) 300

Warranty Revenue 300

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 Common Types of Provisions

Environmental Provisions
A company must recognize an environmental liability when it
has an existing legal obligation associated with the retirement of a
long-lived asset and when it can reasonably estimate the amount
of the liability.

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 Environmental Provisions

Obligating Events. Examples of existing legal obligations,

which require recognition of a liability include, but are not
limited to:
► Decommissioning nuclear facilities,
► Dismantling, restoring, and reclamation of oil and gas
properties,
► Certain closure, reclamation, and removal costs of mining
facilities,
► Closure and post-closure costs of landfills.

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 Environmental Provisions

Measurement. A company initially measures an

environmental liability at the best estimate of its future costs.

Recognition and Allocation. To record an environmental

liability a company includes
► the cost associated with the environmental liability in the
carrying amount of the related long-lived asset, and
► records a liability for the same amount.

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 Environmental Provisions

Illustration: On January 1, 2015, Wildcat Oil Company erected an

oil platform in the Gulf of Mexico. Wildcat is legally required to
dismantle and remove the platform at the end of its useful life,
estimated to be five years. Wildcat estimates that dismantling and
removal will cost $1,000,000. Based on a 10 percent discount rate,
the fair value of the environmental liability is estimated to be
$620,920 ($1,000,000 x .62092). Wildcat records this liability on Jan.
1, 2015 as follows.

Drilling Platform 620,920

Environmental Liability 620,920

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 Environmental Provisions

Illustration: During the life of the asset, Wildcat allocates the asset
retirement cost to expense. Using the straight-line method, Wildcat
makes the following entries to record this expense.

December 31, 2015, 2016, 2017, 2018

Depreciation Expense ($620,920 ÷ 5) 124,184

Accumulated Depreciation—Plant Assets
124,184

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 Environmental Provisions

Illustration: In addition, Wildcat must accrue interest expense each

period. Wildcat records interest expense and the related increase in
the environmental liability on December 31, 2015, as follows.

December 31, 2015

Interest Expense ($620,920 x 10%) 62,092

Environmental Liability 62,092

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 Environmental Provisions

Illustration: On January 10, 2020, Wildcat contracts with Rig

Reclaimers, Inc. to dismantle the platform at a contract price of
$995,000. Wildcat makes the following journal entry to
record settlement of the liability.

January 10, 2020

Environmental Liability 1,000,000

Gain on Settlement of Environmental Liability 5,000
Cash 995,000

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 Common Types of Provisions

Onerous Contract Provisions

“The unavoidable costs of meeting the obligations exceed
the economic benefits expected to be received.”

The expected costs should reflect the least net cost of

exiting from the contract, which is the lower of

1. the cost of fulfilling the contract, or

2. the compensation or penalties arising from failure to fulfill

the contract.

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 Onerous Contract Provisions

Illustration: Sumart Sports operates profitably in a factory that

it has leased and on which it pays monthly rentals. Sumart
decides to relocate its operations to another facility. However,
the lease on the old facility continues for the next three years.
Unfortunately, Sumart cannot cancel the lease nor will it be able
to sublet the factory to another party. The expected costs to
satisfy this onerous contract are €200,000. In this case, Sumart
makes the following entry.

Loss on Lease Contract 200,000

Lease Contract Liability 200,000

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 Onerous Contract Provisions

Assume the same facts as above for the Sumart example and
the expected costs to fulfill the contract are €200,000. However,
Sumart can cancel the lease by paying a penalty of €175,000. In
this case, Sumart should record the liability as follows.

Loss on Lease Contract 175,000

Lease Contract Liability 175,000

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 Common Types of Provisions

Restructuring Provisions
Restructurings are defined as a “program that is planned and
controlled by management and materially changes either
1. the scope of a business undertaken by the company; or

2. the manner in which that business is conducted.”

Companies are required to have a detailed formal plan for the restructuring
and to have raised a valid expectation to those affected by implementation
or announcement of the plan.

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 Restructuring Provisions

IFRS provides specific guidance related to certain costs and

losses that should be excluded from the restructuring
provision.

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 Common Types of Provisions

Self-Insurance
Self-insurance is not insurance, but risk assumption.
There is little theoretical justification for the establishment of
a liability based on a hypothetical charge to insurance
expense.

Conditions for accrual stated in IFRS are not satisfied prior to

the occurrence of the event.

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 Disclosure Related to Provisions

A company must provide a reconciliation of its beginning to

ending balance for each major class of provisions, identifying
what caused the change during the period.

In addition,
► Provision must be described and the expected timing of
any outflows disclosed.
► Disclosure about uncertainties related to expected
outflows as well as expected reimbursements should be
provided.

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PROVISIONS

Provision is a liability of uncertain timing or amount.

Reported either as current or non-current liability.

Common types are

► Obligations related to litigation. Uncertainty about the
► Warrantees or product guarantees. timing or amount of
the future expenditure
► Business restructurings. required to settle the
obligation.
► Environmental damage.
 Recognition of a Provision

Companies accrue an expense and related liability for a

provision only if the following three conditions are met:
1. Company has a present obligation (legal or constructive) as
a result of a past event;

2. Probable that an outflow of resources will be required to

settle the obligation; and

3. A reliable estimate can be made.

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.
Measurement of Provisions

How does a company determine the amount to report

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.
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).
Common Types of Provisions

Litigation Provisions
Companies must consider the following in determining whether
to record a liability with respect to pending or threatened
litigation and actual or possible claims and assessments.
1. The time period in which the underlying cause of action
occurred.

2. The probability of an unfavorable outcome.

3. Ability to make a reasonable estimate of the amount of

loss.
Litigation Provisions

With respect to unfiled suits and unasserted claims and

assessments, a company must determine

1. the degree of probability that a suit may be filed or a claim

or assessment may be asserted, and

2. the probability of an unfavorable outcome.

If both are probable, if the loss is reasonably estimable, and if the

cause for action is dated on or before the date of the financial
statements, then the company should accrue the liability.
Litigation Provisions

BE13-12: Scorcese Inc. is involved in a lawsuit at December 31,

2015. (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)
Prepare the December 31 entry, if any, assuming it is not probable
that Scorcese will be liable for any payment as a result of this suit.

(a) Lawsuit Loss 900,000

Lawsuit Liability 900,000

(b) No entry is necessary. The loss is not accrued because it

is not probable that a liability has been incurred at
12/31/15.
Common Types of Provisions

Warranty Provisions
Promise made by a seller to a buyer to make good on a
deficiency of quantity, quality, or performance in a product.

If it is probable that customers will make warranty claims and a

company can reasonably estimate the costs involved, the
company must record an expense.
Warranty Provisions

Companies often provide one of two types of warranties to

customers:

Assurance-Type Warranty
A quality guarantee that the good or service is free from
defects at the point of sale.
 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.
Assurance-Type Warranty

Facts: Denson Machinery Company begins production of a new

machine in July 2015 and sells 100 of these machines for $5,000
cash by year-end. Each machine is under warranty for one year.
Denson estimates, based on past experience with similar
machines, that the warranty cost will average $200 per unit.
Further, as a result of parts replacements and services performed
in compliance with machinery warranties, it incurs $4,000 in
warranty costs in 2015 and $16,000 in 2016.

Question: What are the journal entries for the sale and the
related warranty costs for 2015 and 2016?
Assurance-Type Warranty

Solution: For the sale of the machines and related warranty

costs in 2015 the entry is as follows.

1. To recognize sales of machines and accrual of warranty

liability:

July–December 2015

Cash 500,000
Warranty Expense 20,000
Warranty Liability 20,000
Sales Revenue 500,000
Assurance-Type Warranty

Solution: For the sale of the machines and related warranty

costs in 2015 the entry is as follows.

2. To record payment for warranties incurred:

July–December 2015

Warranty Liability 4,000

Cash, Inventory, Accrued Payroll 4,000

The December 31, 2015, statement of financial position reports

Warranty Liability as a current liability of $16,000. The income statement
for 2015 reports Warranty Expense of $20,000.
Assurance-Type Warranty

Solution: For the sale of the machines and related warranty

costs in 2015 the entry is as follows.

3. To record payment for warranty costs incurred in 2016

related to 2015 machinery sales:

January 1–December 31, 2016

Warranty Liability 16,000

Cash, Inventory, Accrued Payroll 16,000

At the end of 2016, no warranty liability is reported for the machinery

sold in 2015.
Warranty Provisions

Companies often provide one of two types of warranties to

customers:

Service-Type Warranty
An extended warranty on the product at an additional cost.
 Usually recorded in an Unearned Warranty Revenue
account.
 Recognize revenue on a straight-line basis over the period
the service-type warranty is in effect.
Service-Type Warranty

Facts: You purchase an automobile from Hamlin Auto for €30,000

on January 2, 2014. Hamlin estimates the assurance-type
warranty costs on the automobile to be €700 (Hamlin will pay for
repairs for the first 36,000 miles or three years, whichever comes
first). You also purchase for €900 a service-type warranty for an
additional three years or 36,000 miles. Hamlin incurs warranty
costs related to the assurance-type warranty of €500 in 2014 and
€200 in 2015. Hamlin records revenue on the service-type
warranty on a straight-line basis.

Question: What entries should Hamlin make in 2014 and 2017?

Service-Type Warranty

Solution:

1. To record the sale of the automobile and related

warranties:

January 2, 2014

Cash (€30,000 + €900) 30,900

Warranty Expense 700
Warranty Liability 700
Unearned Warranty Revenue 900
Sales Revenue 30,000
Service-Type Warranty

Solution:

2. To record warranty costs incurred in 2014:

January 2–December 31, 2014

Warranty Liability 500

Cash, Inventory, Accrued Payroll 500
Service-Type Warranty

Solution:

3. To record revenue recognized in 2017 on the service-

type warranty:

January 1–December 31, 2017

Unearned Warranty Revenue (€900 ÷ 3) 300

Warranty Revenue 300
Common Types of Provisions

Environmental Provisions
A company must recognize an environmental liability when it
has an existing legal obligation associated with the retirement of a
long-lived asset and when it can reasonably estimate the amount
of the liability.
Environmental Provisions

Obligating Events. Examples of existing legal obligations,

which require recognition of a liability include, but are not
limited to:
► Decommissioning nuclear facilities,
► Dismantling, restoring, and reclamation of oil and gas
properties,
► Certain closure, reclamation, and removal costs of mining
facilities,
► Closure and post-closure costs of landfills.
Environmental Provisions

Measurement. A company initially measures an

environmental liability at the best estimate of its future costs.

Recognition and Allocation. To record an environmental

liability a company includes
► the cost associated with the environmental liability in the
carrying amount of the related long-lived asset, and
► records a liability for the same amount.
Environmental Provisions

Illustration: On January 1, 2015, Wildcat Oil Company erected an

oil platform in the Gulf of Mexico. Wildcat is legally required to
dismantle and remove the platform at the end of its useful life,
estimated to be five years. Wildcat estimates that dismantling and
removal will cost $1,000,000. Based on a 10 percent discount rate,
the fair value of the environmental liability is estimated to be
$620,920 ($1,000,000 x .62092). Wildcat records this liability on Jan.
1, 2015 as follows.

Drilling Platform 620,920

Environmental Liability 620,920
Environmental Provisions

Illustration: During the life of the asset, Wildcat allocates the asset
retirement cost to expense. Using the straight-line method, Wildcat
makes the following entries to record this expense.

December 31, 2015, 2016, 2017, 2018

Depreciation Expense ($620,920 ÷ 5) 124,184

Accumulated Depreciation—Plant Assets
124,184
Environmental Provisions

Illustration: In addition, Wildcat must accrue interest expense each

period. Wildcat records interest expense and the related increase in
the environmental liability on December 31, 2015, as follows.

December 31, 2015

Interest Expense ($620,920 x 10%) 62,092

Environmental Liability 62,092
Environmental Provisions

Illustration: On January 10, 2020, Wildcat contracts with Rig Reclaimers,

Inc. to dismantle the platform at a contract price of $995,000. Wildcat
makes the following journal entry to
record settlement of the liability.

January 10, 2020

Environmental Liability 1,000,000

Gain on Settlement of Environmental Liability 5,000
Cash 995,000
Common Types of Provisions

Onerous Contract Provisions

“The unavoidable costs of meeting the obligations exceed the
economic benefits expected to be received.”

The expected costs should reflect the least net cost of exiting from
the contract, which is the lower of

1. the cost of fulfilling the contract, or

2. the compensation or penalties arising from failure to fulfill the

contract.
Onerous Contract Provisions

Illustration: Sumart Sports operates profitably in a factory that it has

leased and on which it pays monthly rentals. Sumart decides to
relocate its operations to another facility. However, the lease on the
old facility continues for the next three years. Unfortunately, Sumart
cannot cancel the lease nor will it be able to sublet the factory to
another party. The expected costs to satisfy this onerous contract are
€200,000. In this case, Sumart makes the following entry.

Loss on Lease Contract 200,000

Lease Contract Liability 200,000
Onerous Contract Provisions

Assume the same facts as above for the Sumart example and the
expected costs to fulfill the contract are €200,000. However, Sumart
can cancel the lease by paying a penalty of €175,000. In this case,
Sumart should record the liability as follows.

Loss on Lease Contract 175,000

Lease Contract Liability 175,000
Common Types of Provisions

Restructuring Provisions
Restructurings are defined as a “program that is planned and
controlled by management and materially changes either
1. the scope of a business undertaken by the company; or

2. the manner in which that business is conducted.”

Companies are required to have a detailed formal plan for the restructuring and to
have raised a valid expectation to those affected by implementation or
announcement of the plan.
Restructuring Provisions

IFRS provides specific guidance related to certain costs and losses

that should be excluded from the restructuring provision.
Common Types of Provisions

Self-Insurance
Self-insurance is not insurance, but risk assumption.
There is little theoretical justification for the establishment of a
liability based on a hypothetical charge to insurance expense.

Conditions for accrual stated in IFRS are not satisfied prior to the
occurrence of the event.
Disclosure Related to Provisions

A company must provide a reconciliation of its beginning to ending

balance for each major class of provisions, identifying what caused
the change during the period.

In addition,
► Provision must be described and the expected timing of any
outflows disclosed.
► Disclosure about uncertainties related to expected outflows as
well as expected reimbursements should be provided.
CONTINGENCIES

Contingent Liabilities
Contingent liabilities are not recognized in the financial statements
because they are
1. A possible obligation (not yet confirmed),

2. A present obligation for which it is not probable that payment

will be made, or

3. A present obligation for which a reliable estimate of the

obligation cannot be made.
Contingent Liabilities

Illustration 13-16 presents the general guidelines for the

accounting and reporting of contingent liabilities.
 CONTINGENCIES

Contingent Assets
A contingent asset is a possible asset that arises from past events and
whose existence will be confirmed by the occurrence or non-
occurrence of uncertain future events not wholly within the control of
the company. Typical contingent assets are:
1. Possible receipts of monies from gifts, donations, bonuses.
2. Possible refunds from the government in tax disputes.
3. Pending court cases with a probable favorable outcome.

Contingent assets are not recognized on the statement of financial position.

Contingent Assets

The general rules related to contingent assets are presented below.

Contingent assets are disclosed when an inflow of economic benefits is

considered more likely than not to occur (greater than 50 percent).
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.
Presentation of Current Liabilities

Illustration 13-15