Current & Long-term Liabilities

1. Why are we concerned about Liabilities (current or long term?)

2. What is a Liability? How do they differ from Assets?

Asset Liability

Past transaction

Future benefit

Control

Generally, Liabilities are recorded at the present value of the liability – discounted
at a rate constant with the risk of the liability. Very short term liabilities are the
exception.
Do question 1

3. What is a contingency?

Contingency Æ An existing condition that involves uncertainty with

respect to a possible gain/loss that will be resolved at a
future date.

E.g., Lawsuits

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4. How should contingencies be reported?

Know $'s (or range) Cannot Estimate $'s (or range)

Out- Likely Unlikely Not Likely Unlikely Not
come Determinable Determinable
Loss Rec. & Ignore Disc. Disc. Ignore Disc.
Disc.

Gain Disc. Ignore Ignore Disc. Ignore Ignore

Rec. = Record (journalize) Disc. = Discl.* in Notes to F/S

* Details of contingency and

the range of possible settlement
amounts.

IFRS - IFRS treatment is somewhat similar, except the verbage differs.

“Probable” Not “Likely”

Do question 2

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5. What is off-balance sheet financing? Why do companies engage in these
transactions?

Off balance sheet financing Æ An attempt to borrow money or acquire the

use of an asset without recording a
corresponding debt obligation on the balance
sheet.

Examples:
• Capital vs. Operating Leases
• Special Purpose Entities (SPEs)

6. Estimated Liabilities – Warrantees

i. Warrantees can be embedded in the sales price ( 293)

Dr. Warr Exp

Cr. War Payable
- Accrue warrantee at sale or at year end.

Dr. Warr Payable

Cr. Cost of service

- Subsequent expenses are “recovered” from the payable

ii. Warrantees can be sold separately

Dr Cash
Cr Unearned warranty revenue

The revenue is recognized over time as repair costs are incurred.

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7. Estimated Liabilities – Asset Retirement Obligations (ARO’s)

Often, once a long-lived asses is outlived its usefulness (Forest Practices Code in
BC), there will be costs to retire the assets. Often, these are costs to “clean up”

When the obligation is incurred (and if it can be reasonably estimated) a liability

must be recorded for the fair value (i.e. present value) of settling the obligation.
The debit is added to the asset account and amortized along with the asset:

Dr Tree Licence (Asset)

Cr Asset Retirement Obligation (Liab.)

Each year the asset is amortized:

Dr Amortization expense
Cr Accumulated amortization (Tree License)

Also, each year interest on the liability is recorded (accrued) as accretion expense
(an operating expense)

Dr Accretion Expense
Cr Asset Retirement Obligation

Any additional increase in the obligation, is added to the asset and liability as
required.

When the obligation is finally settled:

Dr Asset Retirement Obligation

Cr Gain on Settlement of ARO (or Loss if appropriate)
Cr Cash

Question #3 to be distributed on Vista

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Question #1 Non-interest bearing Note Payable
Luongo Dentures Ltd. signed a 2 year non-interest bearing note payable on 1/1/X1,
promising to repay $10,000 at the end of 2 years. In return, Luongo receives goods
with a fair market value (FMV) of $8,573.

The discount rate that sets the PV of $10,000 to be paid in two periods equal to
$8,573 is 8% (effective interest rate).

Luongo has a December 31 year end. Show the activity in the T-accounts Notes
Payable, Discounts on Notes Payable and Interest Expense.

Period Beginning interest payment Ending Bal.

Bal.
Year 1 $8,573

Notes Payable Discount on Notes Payable Interest Expense

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Question #2 Contingencies
Roma Ltd. is a large, publicly traded distributor of natural gas. You are the senior
on the 2005 audit and you have noted the following items during a routine review
of outstanding legal matters with Tony Montana, Chief Legal Counsel for Roma.

Required:
For each item below, outline the appropriate GAAP treatment (including any
necessary journal entries and/or note disclosures).

Item #1
Roma is being sued by a man who claims that he hit his head on a gas meter that
was inappropriately placed at head level. The claimant has said in a statement that
he was running to his backyard to investigate a strange noise in the middle of the
night and ran full speed into the gas meter. He claims that he has suffered
irreparable brain damage and is suing for $1.4 million. Tony believes that this suit
is totally without merit.

Item #2
One of Roma’s residential customers is seeking unspecified damages after an
apparent gas leak caused a massive explosion that destroyed his home. He claims
in the suit that a faulty valve allowed massive amounts of gas to leak near his
garage. Tony has said that a field employee who investigated the incident noticed
that the valve was likely damaged before the explosion (possibly from the owner
backing his truck up against the main pipe). The matter is now before the courts
and Tony does not know how the case will be resolved.

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Item #3
Roma is being sued by a former employee who claims that he was terminated
without just cause. The claimant is seeking damages of between $50,000 and
$100,000. Based on an internal review of this case, Tony feels that the company
may indeed be liable for some damages. However, he has no idea what amount the
judge may decide to award. In other words, no amount within the $50,000 to
$100,000 range is a better estimate than the other.

Item #4
Roma successfully won a $2 million suit that it launched against one of its
competitors for corporate espionage. However, the defendant has appealed to a
higher court and a final decision is not anticipated for another 6 months. Tony is
confident that the higher court will reaffirm the lower court’s decision.

Item #5
At the start of the year, a supplier sued Roma for breach of contract. The suit was
for $25,000 and the company felt that it had a good case. However, Tony advised
the company to settle out of court for $5,000 as the cost of defending the suit
would have been substantially higher. The supplier accepted the settlement offer
and all of the appropriate paper work was completed before year-end.

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