RSM219H1 Chapter Notes -Net Present Value, Contingent Liability, Current Liability

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Published on 12 Apr 2013
School
UTSG
Department
Rotman Commerce
Course
RSM219H1
Professor
Page:
of 9
Ch 9 Current Liabilities, Contingencies and
Commitments 11/04/2013 2:24:00 PM
• Liabilities represent the company’s obligations arising from past
transactions or events
- Represents a duty, responsibility, or obligation that imposes an
economic burden
- Enforcement; the entity has little or no discretion to avoid the
obligation . The creditor has the right to pursue legal action
- Obligation exists at the present time. The exact amount may not be
determined until a later event has occurred, but the underlying
transaction or event creating the obligation has already occurred.
• Contingent liability : the liability has not been recorded in the accounts,
because the obligation is conditional, dependent, or contingent on the
occurrence of a low-probability.
• Mutually unexecuted contract is not recorded in the accounting system
because both parties have not performed their part of the contract
• Partially executed contract : one in which one party has performed part of
all of its obligation
Valuation Methods for Liabilities
1) Present Value
2) Gross amount of the obligation: the total amount of payments to be
made;
- May not adequately measure the obligation
- If the rental agreement can be cancelled at any time, the company is only
obligated to pay the current amount
- It ignores the time value of money since interest only accrues as an
obligation as time passes, the only liability that exists is for the principal of
the loan.
3) Net Present Value of the obligation
-Recognizes the amount of the obligation in its net present value. As time
passes, interest expense is recorded which recognizes the cost of the loan
and increases the liability
-Future payments of principal and interest are discounted back to the
current period using a discount rate
Canadian Practice:
- Record liabilities at the present value of the future payments
- Short-term liabilities is recorded as the gross amount because the
difference in the amounts would not be material
Current Liabilities Related to Operating Activities
1. Accounts Payable
Generally does not have interest charges
Discount for early payments or penalty doe late payments
Called trade accounts payable
2. Wages & other payroll liabilities
Fringe Benefits : pension plan, medical insurance, union dues,
vacation pay must be recognized.
must accrue wages earned since the last pay period
Company acts as government agent in collecting taxes , keep track
of the amounts deducted from employees’ earnings and report a
liability to pay these amounts to the government
3. Corporate Income Tax
Companies are subject to Federal corporate income taxes&
Provincial corporate taxes
Payment of taxes does not always coincide with the incurrence of
the tax
Most companies are required to make installments based on the
previous years’ tax payable
4. Warranty Obligations
The sale of goods or services sold may result in implicit or explicit
guarantees to the buyer
Warranty service is included in the price of the product
To satisfy the matching principal, a warranty expense and a
warranty liability must be recognized, based on an estimated future
cost using past history of claims.
Warranty expense (SE)
3,000
Estimated warranty (L)
3,000
W.E. is recorded as an expense in the year of sale whereas the
portion of the obligation that is expected to be settled will be
grouped into current or noncurrent liabilities.
Estimated warranty (L)
1,700
Cash (A)
1,700
No expense is recorded when actual warranty costs are incurred;
the warranty liability is debited
If it’s not recorded in the same period, the profit would be
overestimated.
IFRS have moved towards measuring warranty obligations as the
sales value of the warranty service rather than the company’s cost
to provide it.
5. Unearned Revenues
Deposits or down payments aka unearned revenues, deferred
revenues
In the liability section because by accepting the money in advance,
they incur an obligation to provide the related goods or services
Revenue is recorded when they delivery the goods/services
6. Gift Certificates and Prepaid Cards
Revenue is recognized only when the cards are redeemed for goods
or services
When a card is sold, the company records the cash received and an
offsetting liability an obligation to provide goods and services
Cash (A)
10,000
Unearned Revenue (L)
10,000
Unearned Revenue (L)
2,000
Sales (SE)
2,000
Costs of goods sold (SE)
1,500
Inventory (A)
1,500
7. Customer Rewards & Loyalty Programs
Similar to those with warranty obligations
Estimate the cost of the free goods and services that it provides in
the future, and accrue this as an expense in the period when the
sales revenue was recorded . Credit to a liability account and debit
it while customers redeem them.
Recent standards under IFRS have moved towards measuring
loyalty program liabilities as the sales value of the goods or

Document Summary

11/04/2013 2:24:00 pm: liabilities represent the company"s obligations arising from past transactions or events. Represents a duty, responsibility, or obligation that imposes an economic burden. Enforcement; the entity has little or no discretion to avoid the obligation . The creditor has the right to pursue legal action. Valuation methods for liabilities: present value, gross amount of the obligation: the total amount of payments to be made; If the rental agreement can be cancelled at any time, the company is only obligated to pay the current amount. It ignores the time value of money since interest only accrues as an obligation as time passes, the only liability that exists is for the principal of the loan: net present value of the obligation. Recognizes the amount of the obligation in its net present value. As time passes, interest expense is recorded which recognizes the cost of the loan and increases the liability.