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CHAPTER 13
Current Liabilities, Provisions, and
Contingencies
LEARNING OBJECTIVES
1. Describe the nature, valuation, and reporting of current liabilities.
CHAPTER REVIEW
1. Chapter 13 presents a discussion of the nature and measurement of items classified on
Current Liabilities
2. (L.O. 1) In general, liabilities involve future disbursements of assets or services. According
to the IASB, a liability has three essential characteristics: (a) it is a present obligation; (b)
3. The relationship between current assets and current liabilities is an important factor in the
4. Accounts payable represents obligations owed to others for goods, supplies, and services
purchased on open account. These obligations, commonly known as trade accounts
5. Notes payable are written promises to pay a certain sum of money on a specified future
6. Short-term notes payable resulting from borrowing funds from a lending institution may be
interest-bearing or zero-interest-bearing. Interest-bearing notes payable are reported as
a liability at the face amount of the note along with any accrued interest payable. A zero-
The interest accrued over the term of the note (€12,000) will increase the balance of the
7. The currently maturing portion of non-current debts may be classified as a current liability.
8. Certain short-term obligations expected to be refinanced on a non-current basis should
be excluded from current liabilities. The IASB allows a short-term obligation to be
9. Cash dividends payable are classified as current liabilities during the period subsequent
10. When returnable cash deposits are received from customers or employees, a liability
11. A company sometimes receives cash in advance of the performance of services or
issuance of merchandise. Such transactions result in a credit to a deferred or unearned
12. Current tax laws require most business enterprises to collect sales tax from customers
during the year and periodically remit these collections to the appropriate governmental
13. To illustrate the collection and remittance of sales tax by a company, assume that Bertram
Company recorded sales for the period of £230,000. Further, assume that Bertram is
14. A value-added tax (VAT) is a consumption tax, i.e., it is a cost to the end user, normally
a private individual. The VAT is collected every time a business purchases products from
15. A corporation should estimate and record the amount of income tax liability as computed
16. Employee-related liabilities include amounts owed to employees for salaries or wages
of an accounting period and are reported as a current liability. Other items related to
employee compensation that are often reported as current liabilities include:
a. Payroll deductions.
17. The following illustrates the concept of accrued liabilities related to payroll deductions.
Assume Nyles Company has a weekly payroll of $25,000 that is entirely subject to social
security taxes (7.65%), income tax withholding amounts to $3,300, and employee credit
union deductions for the week total $975. Two entries are necessary to record the payroll,
the first for the wages paid to employees and the second for the employer’s payroll taxes.
The two entries are as follows:
Salaries and Wages Expense ......................... 25,000
18. Compensated absences are absences from employment—such as vacation, illness,
maternity, paternity, and jury leaves. In connection with compensated absences, vested
rights exist when an employer has an obligation to make payment to an employee even if
that employee terminates. Accumulated rights are those that employees carry forward
to future periods if not used in the period in which earned. Any amounts for vested rights
19. If sick pay benefits vest, a company must accrue them. Accounting for sick pay benefits
that accumulate, but do not vest, depends on how the program is administered. If
20. Companies should recognize the expense and related liability for compensated absences
21. An obligation under a profit-sharing or bonus plan must be accounted for as an expense
22. Contractual agreements for conditional expenses, such as rent or royalty payments
Provisions
23. (L.O. 2) A provision is a liability of uncertain timing or amount, sometimes referred to as an
estimated liability. Common types of provisions are obligations related to litigation, warrantees
24. Companies accrue an expense and related liability for a provision only if three conditions
are met: (a) a company has a present obligation as a result of a past event; (b) it is
25. Warranties are an example of a legal obligation. Refunds are an example of a
constructive obligation that derives from a company’s actions where: (a) 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 (b) as a result, the company has created a valid expectation on the
26. Companies generally report only one current and one non-current amount for provisions
in the statement of financial position. IFRS requires extensive disclosure related to
provisions in the notes to the financial statements. When a company is threatened with
27. A warranty (product guarantee) represents a promise by a seller to a buyer to make good
on any deficiency of quantity, quality or performance specifications in a product. Warranty
28. An assurance-type warranty guarantees the product (service) meets agreed upon
specifications in the contract at the time of the sale and is included in the sales price.
29. A service-type warranty is sold separately from the product, usually as an extended
30. If a company offers premiums to customers in return for coupons, a liability should
31. As with other 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
32. The costs associated with the environmental liability are included in the cost of the related
long-lived asset and also recorded in a liability account. The environment costs are
33. Sometimes, companies have what are referred to as onerous contracts. These
contracts are ones in which the unavoidable costs of meeting the obligations exceed the
34. The accounting for restructuring provisions is controversial. As a result, IFRS is very
restrictive regarding when a restructuring is permitted and what types of costs may be
35. For a company to record restructuring costs and related liability, it must meet the general
requirements for recording provisions. In addition, companies are required to have a
36. Self-insurance is not insurance, but risk assumption. The conditions for accrual stated in
IFRS are not satisfied prior to the occurrence of the event.
37. The disclosures related to provisions are extensive. A company must provide a
reconciliation of its beginning to ending balance for each major class of provisions,
Contingencies
38. (L.O. 3) IFRS uses the term contingent for liabilities and assets that are not recognized
in the financial statements. Contingent liabilities are not recognized in the financial
statements because they are (a) a possible obligation (not yet confirmed as a present
39. 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
Presentation and Analysis
40. (L.O. 4) Current liabilities are usually recorded and reported in financial statements at
their full maturity value. Present value techniques are not normally used in measuring
41. Disclosure information should be sufficient to meet the requirement of full disclosure.
Companies should clearly identify secured liabilities, as well as indicate the related assets
42. Two ratios often used to analyze current liabilities are the current ratio and the acid-test
ratio.
LECTURE OUTLINE
This chapter can be covered in two or three class sessions. Students should be familiar with
trade and payroll liabilities. Short-term obligations expected to be refinanced and the accounting
for provisions are the conceptually challenging areas for many students.
A. (L.O. 1) The Concept of Liabilities.
2. In its conceptual framework study, The IASB stated that a liability possesses three
essential characteristics:
a. It is a present obligation.
B. A current liability is reported if one of two conditions exist:
1. The liability is expected to be settled within its normal operating cycle, or
C. Types of current liabilities
1. Accounts payable.
2. Notes payable
a. Trade notes.
d. Current maturities of long-term debt: that portion of long-term debt that matures
within the next fiscal year is reported as a current liability, unless they are to be:
(1) Retired by assets accumulated for this purpose that properly have not been
3. Short-term obligations expected to be refinanced.
a. IASB allows exclusion of short-term obligations from current liabilities if both of the
following conditions are met:
4. Dividends payable
a. Cash dividends payable become a liability on the date of declaration.
5. Customer advances and deposits.
6. Unearned revenues.
7. Sales taxes payable.
10. Employee-related liabilities
a. Social security taxes
(1) Provide social benefits to individuals and families.
c. Compensated absence: vacations, illness, maternity, paternity, and jury leaves
for which employees are paid.
(1) Vested rights: exist when an employer has an obligation to make payment to
an employee even after terminating his or her employment.
(5) If sick pay benefits vest, a company must accrue them.
(6) If sick pay benefits accumulate, but do not vest, a company may choose
whether to accrue them.
d. Profit-sharing and bonus plans: both should be accounted for as an operating
expense and a related current liability.
D. (L.O. 2) Provisions are liabilities of uncertain timing or amount, sometimes referred to as
estimated liabilities.
1. Companies accrue an expense and related liability for a provision only if three
conditions are met:
a. A company has a present obligation as a result of a past event;
2. If these three conditions are not met, no provision is recognized.
3. Warranties are an example of a legal obligation. The amount of the estimated
4. Refunds are an example of a constructive obligation that derives from a company’s
actions where:
a. By an established pattern of past practice, published policies, or a sufficiently
5. The amount of the estimated refund liability, where each point in the range of refunds
has the same probability of occurrence, is usually the midpoint in the range.
E. Common types of provisions
1. Companies generally report only one current and one non-current amount for provisions
in the statement of financial position.
3. Lawsuits:
a. The recording of a liability will depend on certain factors:
(1) The time period in which the underlying cause of action occurred;
c. A liability is accrued on unfiled suits and unasserted claims/assessments if:
(1) It is probable that a suit will filed or a claim/assessment asserted,
4. Warranties: The amount of the liability is an estimate of all costs that will be incurred
after sale and delivery.
a. Assurance-type warranty
(1) Cost is included in sales price.
b. Service-type warranty
(1) Sold separately from product as an extended warranty.
5. Premiums and coupons: a liability should be recognized at year-end for outstanding
premiums expected to be redeemed with an offsetting entry to Premium Expense.
6. Environmental Provisions
a. Included in the cost of the related asset at the present value of the environmental
costs.
7. Onerous contract provisions
a. Exist when the unavoidable costs of meeting the obligations exceed the economic
benefits expected to be received.
8. Restructuring provisions: accounting is controversial
a. IFRS is very restrictive in permitting restructurings and what types of costs may be
included.
b. Defined as a program that is planned and controlled by management and
c. Companies are also required to have a detailed formal restructuring plan and to
have raised valid expectations to those affected by implementing or announcing
the plan.
9. Self-insurance
a. The absence of insurance does not mean that a liability has been incurred at the
date of the financial statements.
10. Disclosures related to provisions are extensive.
a. Reconciliation of beginning to ending balances for each major class of provisions.
F. (L.O. 3) Contingencies
1. Contingent liabilities
a. Are not recognized in the financial statements because they are:
(1) A possible obligation (not yet conformed as a present obligation),
b. General guidelines for accounting and reporting contingent liabilities are:
(1) If it is virtually certain that a liability will occur (probability at least 90%),
record the liability.
c. Disclosure should include:
(1) A brief description of the nature of the contingent liability,
2. Contingent assets
a. A possible asset that arises from past events and whose existence will be
b. General guidelines for accounting and reporting contingent assets are:
(1) If it is virtually certain that an asset will occur (probability at least 90%), report
as an asset (no longer contingent).
G. (L.O. 4) Presentation and analysis
1. Presentation of current liabilities
a. Recorded and reported in financial statements at their full maturity value.
2. Analysis of current liabilities
a. Current ratio =
Current assets
Current liabilities
