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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
13-1. Define liabilities and distinguish between current and long-term liabilities.
13-2. Account for the issuance and payment of various forms of notes and record the interest on the
notes.
13-3. Characterize accrued liabilities and liabilities from advance collection, and describe when and
how they should be recorded.
13-4. Determine when a liability can be classified as a noncurrent obligation.
13-5. Identify situations that constitute contingencies and the circumstances under which they should
be accrued.
13-6. Demonstrate the appropriate accounting treatment for contingencies, including unasserted
claims and assessments.
13-7. Discuss the primary differences between U.S. GAAP and IFRS with respect to current
liabilities and contingencies.
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Part A: Current Liabilities
I. 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 business’s 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
16-2 Intermediate Accounting, 8/e
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
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)
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
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:
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.
V. Liabilities from Advance Collection
A. Deposits and advances from customers (T13-8)
1. Collecting cash from a customer as a refundable deposit creates a liability to return the
deposit
2. Collecting cash from a customer as an advance payment for products or services
creates a deferred revenue liability that converts to revenue when the seller satisfies its
performance obligation to deliver products or services.
B. Gift cards are a common example of advanced collection. Record deferred 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
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:
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 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.
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
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. (T13-
13)
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.
16-4 Intermediate Accounting, 8/e
1. Is a claim or assessment probable? {If not, no disclosure is needed.}
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
IV. IFRS (T13-17) Several important differences:
A. IFRS refers to accrued liabilities as “provisions,” and refers to possible obligations that are
not accrued as “contingent liabilities.” The term “contingent liabilities” is used for all of
these obligations in U.S. GAAP.
B. IFRS requires disclosure (but not accrual) of two types of contingent liabilities: (1)
possible obligations whose existence will be confirmed by some uncertain future events
that the company does not control, and (2) a present obligation for which either it is not
C. IFRS defines “probable” as “more likely than not” (greater than 50%), which is a lower
threshold than typically associated with “probable” in U.S. GAAP.
D. If a liability is accrued, IFRS measures the liability as the best estimate of the expenditure
required to settle the present obligation. If there is a range of equally likely outcomes,
IFRS would use the midpoint of the range, while U.S. GAAP requires use of the low end
of the range.
E. If the effect of the time value of money is material, IFRS requires the liability to be stated
at present value. U.S. GAAP allows using present values under some circumstances, but
liabilities for loss contingencies like litigation typically are not discounted for time value
of money.
F. IFRS recognizes provisions and contingencies for “onerous” contracts, defined as those in
which the unavoidable costs of meeting the obligations exceed the expected benefits.
V. Decision-Makers’ Perspective (T13-18)
A. Liabilities impact a company’s 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 company’s 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
E. Outside analysts as well as managers should actively monitor risk management activities.
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A PowerPoint presentation of the chapter is available in the Connect library.
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The following can be reproduced on transparency film as they appear here, or you can
16-6 Intermediate Accounting, 8/e
CHARACTERISTICS OF LIABILITIES
Most liabilities obligate the debtor to pay cash at specified
times and result from legally enforceable agreements.
Some liabilities are not contractual obligations and may not
be payable in cash.
A liability has three essential characteristics. Liabilities:
2. that arise from present obligations (to transfer goods or
provide services) to other entities
➢ Notice that the definition of a liability involves the present, the
WHAT IS A CURRENT LIABILITY?
Classifying liabilities as either current or long-term helps
investors and creditors assess the relative risk of a company’s
liabilities.
Generally, current liabilities are payable within one year.
Formally, current liabilities are expected to require current
assets (or create current liabilities).
T13-2
16-8 Intermediate Accounting, 8/e
CURRENT LIABILITIES
General Mills, Inc.
Balance Sheet ($ in millions)
May 26, 2013 and May 27, 2012
Assets
[by classification]
Liabilities
CURRENT LIABILITIES: 2013 2012
Accounts payable $1,423.2 $1,148.9
LONG–TERM LIABILITIES:
[listed individually]
Shareholders’ equity
[by source]
Illustration 13–1
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:
2013 2012
Weighted Weighted
Dollars in millions: Average Average
Note Interest Note Interest
Payable Rate Payable Rate
U.S. commercial paper $ 515.5 0.2% $ 412.0 0.2%
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 have commercial paper programs available to us in
Illustration 13–1 (continued)
T13-3 (continued)
16-10 Intermediate Accounting, 8/e
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 ……………………………………………… 700,000
Illustration 13-3
Noninterest-Bearing Note
The proceeds of the note are reduced by the interest in a
“noninterest–bearing” note.
Situation: $700,000 noninterest-bearing note, with a 12%
“discount rate.” The $42,000 interest is “discounted” at the
outset, rather than explicitly stated:
May 1
Cash (difference) …………………………………… 658,000
Discount on notes ($700,000 x 12% x 6/12)…….. 42,000
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 interest for 6 months
T13-5
16-12 Intermediate Accounting, 8/e
ACCRUED LIABILITIES
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 ……………………………………………….. 700,000
Note payable ………………………………….. 700,000
Illustration 13-6
T13-7
16-14 Intermediate Accounting, 8/e
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.
($ in millions)
When Advance is Collected
Cash …………………………………………………….. 20
Illustration 13-10
T13-8
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
T13-9
16-16 Intermediate Accounting, 8/e
INTERNATIONAL FINANCIAL REPORTING STANDARDS
T13-10
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.
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) …………………. x,xxx
Liability ………………………….. x,xxx
➢ Some loss contingencies don’t 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
16-18 Intermediate Accounting, 8/e
ACCOUNTING TREATMENT OF LOSS CONTINGENCIES
DOLLAR AMOUNT OF POTENTIAL LOSS
________________________________
Reasonably Not Reasonably
Known Estimable Estimable
LIKELIHOOD
Liability Liability Disclosure
Probable Accrued Accrued Note
& Disclosure Note & Disclosure Note Only
_____________________________________________
Illustration 13-16
T13-12