Prepared by Coby Harmon University of California, Santa Barbara K-1 Westmont College Appendix J Other Significant Liabilities Learning Objectives K-2 Describe the accounting and disclosure requirements for contingent liabilities Discuss the accounting for lease liabilities and off-balance-sheet financing Discuss additional fringe benefits associated with employee compensation LEARNING OBJECTIVE Describe the accounting and disclosure requirements for contingent liabilities Potential liability that may become an actual liability in the future Three levels of probability: K-3  Probable  Reasonably possible  Remote LO Contingent Liabilities Probability Accounting Probable Accrue Reasonably Possible Remote K-4 Footnote Ignore LO Contingent Liabilities Question A contingent liability should be recorded in the accounts when: a it is probable the contingency will happen, but the amount cannot be reasonably estimated b it is reasonably possible the contingency will happen, and the amount can be reasonably estimated c it is probable the contingency will happen, and the amount can be reasonably estimated d it is reasonably possible the contingency will happen, but the amount cannot be reasonably estimated K-5 LO Contingent Liabilities Recording a Contingent Liability Product warranty contracts result in future costs that companies may incur in replacing defective units or repairing malfunctioning units Estimated cost of honoring product warranty contracts should be recognized as an expense in the period in which the sale occurs K-6 LO Recording a Contingent Liability Illustration: Denson Manufacturing Company sells 10,000 washers and dryers at an average price of $600 each The selling price includes a one-year warranty on parts Denson expects that 500 units (5%) will be defective and that warranty repair costs will average $80 per unit In 2019, the company honors warranty contracts on 300 units, at a total cost of $24,000 At December 31, compute the estimated warranty liability Illustration K-1 Computation of estimated product warranty liability K-7 LO Recording a Contingent Liability Illustration: Denson Manufacturing Company sells 10,000 washers and dryers at an average price of $600 each The selling price includes a one-year warranty on parts Denson expects that 500 units (5%) will be defective and that warranty repair costs will average $80 per unit In 2019, the company honors warranty contracts on 300 units, at a total cost of $24,000 At December 31, compute the estimated warranty liability Make the required adjusting entry Warranty Expense 40,000 Warranty Liability 40,000 K-8 LO Recording a Contingent Liability Illustration: Prepare the entry to record the repair costs incurred in 2019 to honor warranty contracts on 2019 sales Warranty Liability Repair Parts 24,000 24,000 Assume that the company replaces 20 defective units in January 2020, at an average cost of $80 in parts and labor Warranty Liability Repair Parts K-9 1,600 1,600 LO Disclosure of Contingent Liabilities Illustration K-2 Disclosure of contingent liability K-10 LO Accounting for Lease Arrangements The accounting depends on the whether a lease is classified as a finance lease or an operating lease Illustration K-3 Types of leases K-12 LO Accounting for Lease Arrangements Substance versus Operating Lease Lease Expense Cash Form xxx xxx Although technically legal title may not pass, Finance Lease the benefits from the use of the property Right-of-use Asset Lease Liability K-13 xxx xxx LO Finance Leases For a finance lease, the lessee must record a lease as an asset if any one of the following conditions exist Lease transfers ownership of the property to the lessee Lease contains a bargain-purchase option Lease term is equal to 75 percent or more of the estimated economic life of the leased property The present value of the lease payments equals or exceeds 90% of the fair value of the leased property K-14 LO Finance Leases Illustration: Gonzalez Company decides to lease new equipment The lease period is four years; the economic life of the leased equipment is estimated to be five years The present value of the lease payments is $190,000, which is equal to the fair market value of the equipment There is no transfer of ownership during the lease term, nor is there any bargain purchase option Instructions K-15 (a) What type of lease is this? Explain (b) Prepare the journal entry to record the lease LO Finance Leases Illustration: (a) What type of lease is this? Explain Capital Lease? Capitalization Criteria: Transfer of ownership NO Bargain purchase option NO Lease term => 75% of economic life of leased property Present value of minimum lease payments => 90% of FMV of property Lease term yrs Economic life yrs YES K-16 80% YES - PV and FMV are the same LO Finance Leases Illustration: (b) Prepare the journal entry to record the lease Right-of-use Asset 190,000 Lease Liability 190,000 The portion of the lease liability expected to be paid in the next year is a current liability The remainder is classified as a longterm liability K-17 LO Finance Leases Question The lessee must record a lease as an asset if the lease: K-18 a transfers ownership of the property to the lessor b contains any purchase option c term is 75% or more of the useful life of the leased property d payments equal or exceed 90% of the fair market value of the leased property LO LEARNING OBJECTIVE Discuss additional fringe benefits associated with employee compensation Paid Absences Paid absences for vacation, illness, and holidays Accrue a liability if: K-19  Payment of the compensation is probable  The amount can be reasonably estimated LO Paid Absences Illustration: Academy Company employees are entitled to one day’s vacation for each month worked If 30 employees earn an average of $110 per day in a given month Vacation Benefits Expense 3,300 Vacation Benefits Liability 3,300 Academy pays vacation benefits for 10 employees Vacation Benefits Liability Cash K-20 1,100 1,100 LO Postretirement Benefits Post-retirement benefits are benefits that employers provide to retired employees for health care and life insurance pensions Companies account for post-retirement benefits on the accrual basis K-21 LO Postretirement Benefits POSTRETIREMENT HEALTHCARE AND LIFE INSURANCE BENEFITS  Companies estimate and expense postretirement costs during the working years of the employee  Companies rarely sets up funds to meet the cost of the future benefits ► Pay-as-you-go basis for these costs ► Major reason is that the company does not receive a tax deduction until it actually pays the medical bill K-22 LO PENSION Postretirement Benefits PLANS An arrangement whereby an employer provides benefits to employees after they retire for services they provided while they were working Pension Plan Pension Plan Administrator Administrator Employer Employer Contributions Retired Employees Benefit Payments Assets & Liabilities K-23 LO PENSION Postretirement Benefits PLANS Defined-Contribution Plan Defined-Benefit Plan  Employer contribution determined by plan (fixed)  Benefit determined by plan  Risk borne by employees  Employer contribution varies (determined by  Benefits based on plan value Actuaries)  Risk borne by employer  Companies record pension costs as an expense  Actuaries estimate the employer contribution by considering mortality rates, employee turnover, interest and earning rates, early retirement frequency, future salaries, etc K-24 LO Postretirement Benefits POSTRETIREMENT BENEFITS AS LONG-TERM LIABILITIES While part of the liability associated with (1) postretirement healthcare and life insurance benefits and (2) pension plans is generally a current liability,  the greater portion of these liabilities extends many years into the future  Many companies are required to report significant amounts as long-term liabilities for postretirement benefits K-25 LO Copyright “Copyright © 2017 John Wiley & Sons, Inc All rights reserved Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc The purchaser may make back-up copies for his/her own use only and not for distribution or resale The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.” K-26 ... which is owned by the lessor, for a specified period of time  K- 11 The lessee makes rental payments over the lease term to the lessor LO Accounting for Lease Arrangements The accounting depends... Liabilities K- 23 LO PENSION Postretirement Benefits PLANS Defined-Contribution Plan Defined-Benefit Plan  Employer contribution determined by plan (fixed)  Benefit determined by plan  Risk borne by. ..Appendix J Other Significant Liabilities Learning Objectives K- 2 Describe the accounting and disclosure requirements for contingent liabilities Discuss the accounting for lease