Far 3- Liabilities

Current liabilities are liabilities that will be settled within one year or the operating cycle whichever is longer. Current liabilities are valued at their NRV or Settlement value. They include accounts payable, accrued expenses, dividends payabe, income taxes payable, current portio of L/T debt.

Accounts payable is a liabilities account that arising when obtaining goods or services from vendors in the ordinary course of business when money is not paid right away. They usually incorporate discounts in order to get the person to pay in a timely fashion and if so they are awarded with a discount. There are 2 methods to account for these:

1. Gross Method- Purchases are shown at Gross, if the discount is taken, it is considered a reduction of Cost of Sales. Journal Entries are the following:

• Purchases 100(gross)
•     A/P 100(gross)

• A/P 100
•     Cash 90(discount price)
•     Discount 10(reduce cogs)

2. Net Method- purchases are shown at net, if the discount is not taken considered interest expense.

• Purchase 90(discount price)
•     A/P 90

• A/P 90
• Expense 10(because not taken)
•     Cash 100

• Accrued Liabilities/Expenses(Current Liabilities)- this is an expense that is incurred but not yet paid in cash.
• EX. unpaid salaries or taxes at the end of the year. Employees share of taxes that the employer withholds are not an expense of the employer, even though they are a liability. Example of entry:

• Expense x
•     Accrued Liability x

• Accrued Liability x
•     Cash x

Prepaid Expenses(Current Asset)-expenses paid in cash, but not yet incurred. Example, is prepaid rent. Entries are:

• Prepaid Expense x
•     Cash x

• Expense x
•     Prepaid Expense x

Deferred Revenues(Current Liability)- revenue collected but not yet earned. Ex. rent collected or subscriptions collected in advance or gift certificates issued, but not yet redeemed. Entries are:

• Cash x
•     Unearned Revenue x

• Unearned Revenue x
•     Revenue x

Revenue Receivable(Current Asset)-revenue earned but not yet collected. Ex. revenue earned but still due from customer. Entries are:

• Receivable x
•     Revenue x

• Cash x 
•     Receivable x

Warranty costs- products sold by the client often includes warranties promising repairs or replacement for a limited time period. In most cases, it is impossible to determine how much of the sales price is for the product, and how much for the warranty commitment. As a result, revenue is recognized in its entirety on the date of sale, and the estimated warranty cost accured at the same time.

The method of estimation to be used is the percentage of sales approach. It is similar to the equivalent approach for bad debts.

For Example assume a client has cash sales of 1,000 in 200x, its first year of operations. The products are covered by a 2-year warranty, and the client estimates that costs equal to 1% of sales will have to be spent in the first year of the warranty, and 3% of sales in the second and final year of the warranty. Let's also assume the client has spent $6 on warranty repairs in 200x. Entries are as follows:

• The entry to record the sale is:
• Cash 1000
•     Sales 1000

• At the same time, warrant costs are estimated to total 4% of sales over the warranty periods are reported:
• Warranty Expense 40
•     Estimated Warranty Liability 40

• The amount spent on actual repairs is applied to the liability:
• Estimated warranty liability 6
•     Cash 6

many retail stores offer service contracts in connection with goods sold. Unlike warranties, service contracts are priced and sold separately, so its is possible to identify the revenue associated with them. As a result, proceeds from the sale of a service contract are systematically allocated over the period of the contract. In this case, actual repair costs are simply recorded as they occur in expenses.

One problem with the allocation of revenue, however, is that a straight-line approach isn't justified, since the amount of repairs and replacements will normally increase as products get older, so more of the revenue is earned later in the contract period.

For example, assume a 4year service contract is being sold to a customer. Rather than expect that 25% of servicing will take place in each year, it might be more reasonable to expect a steady increase over time so that 10% of total service is rendered in the 1st year of the contract, 20% in the 2nd year, 30% in the 3rd year, and 40% in the 4th year. Although there will even be a difference between the first 6months and the lst 6months of the year. Lets assume that the pace of repairs within each year is even. if 100 dollars of contracts are sold in 20x1 throughout the year, the entry for the collection of contract money is:

• Cash 100
•     Deferred Revenue 100

At the end of the year, revenue for the time that has elapsed on the average contract is:

• Deferred Revenue 5
•     Service Revenue 5

Notice that only 5% not 10% has been earned by the end of 20x1. This is because the service contracts were sold throughout the year, not all on 1/1/x1, so the average contract is only 1/2 a year.

many companies issue coupons for discount on their products, distributing them through newspapers, mailings, and other means. The costs associated with these coupons are uncertain, since many of the coupons will never actually be used. For those that are used, the actual cost to the client will usually be greater than the face value of the coupon, since the merchants redeeming coupons are usually reimbursed for handling costs associated with processing them.

• To determine the estimated liability for unredeemed coupons at the B/S date, take the following steps:
• 1. Determine the total face value of the coupons issued.
• 2. Add the handling fee % promised to merchants.
• 3. Multiply by the % of coupons expected to be redeemed.
• 4. Subtract payments already made to merchants for redeemed coupons.

In determining the estimated liability for unredeemed coupons, ignore any coupons that expired long enough before the B/S date so that redemption is no longer considered to have any reasonable chance of occurring. For example lets look below:

• Face value $500
• Expiration Date 12/31/x1
• Handling fee paid to merchants 20%
• Normal time merchants take coupons 1mo
• Payments to merchants in 20x1 $300
• Total coupons expected to be redeemed 60%

• In applying the steps:
• 1. There are $500 in coupons
• 2. The handling fee of 20% adds $100 to the possible cost making it now $600
• 3. 60% of coupons are expected to be redeemed costing $360
• 4. $300 has already been paid out, so that a remaining liability for unredeemed coupons of $60 exists.

Compensated absenses is when an employer is paying his/her employees for vacation or sick pay. Recognition of these costs must take into consideration 2 accounting issues:

Matching-costs should be recognized at the time employees render the services that entitle them to compensated absenses.

Faithful Representation-Costs should only be recognized if they have been paid or are likely to be paid in the future.

• A company will report a liability if all four of the following criteria are met:
• 1. The obligation for the compensation for future absenses results from services already provided by the employees.
• 2. The right to compensatation either vests or accumulates
• 3. The payment is probable.
• 4. The amount of the payment can be reasonable estimated.

Sick pay will be recorded as liability if they are more likely than not going to be taken as in personnel taking the sick days and they vest and accumulate.

Vacation days are recognized if they accumulate or vest as well meaning that days not taken in current period may be used in the future period.

Entries are simply:

• Vacation Expense x
•     Vacation payable x

• Sick Expense x
•     Sick Payable x

payroll taxes need to be accured at the time related payroll expenses are recognized. It is important, however, to distinguish employer taxes from employee taxes on payroll. The employee is not costs to the company but instead withholdings from employee gross pay. However, the employer does meet the definition of accrued taxes and he is an expense to the company. An example entry is the following:

• Payroll expense 100
• Payroll tax expense 11
•     Cash 77
•     Accrued payroll tax 11
•     Withholding due to IRS 23