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This 0 page Class Notes was uploaded by Petey Martin on Saturday November 14, 2015. The Class Notes belongs to ACC 201 at University of Rochester taught by WOJDAT K in Summer 2015. Since its upload, it has received 33 views. For similar materials see FINANCIAL ACCOUNTING in Accounting at University of Rochester.
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Date Created: 11/14/15
Petey Martin Notes 111215 0 Firms also often pay amounts for fringe bene ts earned by employees such as health insurance and retirement bene ts employees have earned These are also expenses over and above salary and wages not simply withheld from employee pay although some rms may require a partial employee contribution Fringe bene ts earned by employees due to work performed during the scal year will be accrued liabilities if not paid for by the rm as of the end of the scal year 0 Examples are amounts owed to insurance companies and pension funds as of the end of the scal year 0 Firm also must accrue vacation expense in the year that the employee earns the vacation not the year vacation is taken Journal entry as of end of scal year 0 Salary and Wage Expense Accrued Vacation Liability 0 To record an expense for unused vacation time in the year employees performed the service that earned them the vacation time Journal entry as of time vacation earned in prior years is taken Accrued Vacation Liability Cash 0 To record payment for vacation earned by prior year s service 0 Deferred Revenue and Service Obligations Deferred revenue represents fees received by a rm in advance of the rm providing goods or services to a customer eg prepaid cards at Starbucks Deferred revenue is recorded as a liability at amount received 0 Liability is service owed in future 0 Liability is classi ed as current or long term depending on when they are to be satis ed 0 Resolution of liability in through performance not through payment of cash 0 Notes Pavable Short term borrowings with formal document specifying amount borrowed interest rate and when repayment is due are recorded as notes payable 0 Recorded liability initially at amount borrowed o Accrue interest principle x int rate gtlt time Q earned by the lender regardless of when interest is paid to the lender 0 Interest is payment for use of money for period of time o The longer the borrowed money is held the more interest is owed 0 Under the matching principal interest is recorded in the period during which the borrowed money is used not when it is paid Firm borrower records each payment made as a payment of interest andor a repayment of the loan 0 Current Portion of Long Term Debt When a rm borrows with repayment due more than one year after the date of the nancial statements the liability is classi ed as long term The liability is reclassi ed as short term for the scal year that ends within one year or operating cycle if longer of the repayment date 0 The liability is a current liability as of the end of this particular scal year However if a rm has the intention and the ability to re nance current liabilities when they come due no net cash out ow will occur within one year Repayment of the debt coming due will come from the proceeds of new debt or through the renegotiation of the outstanding debt issue to a new maturity date GAAP requires that liabilities that will not generate a net cash out ow in one year not be shown as current 0 So long term debt is not reclassi ed as a current liability if the issuing rm has the intention and the ability to re nance it even if repayment of the debt is due less than a year or operating cycle if longer after the date of the nancial statements 0 In addition short term borrowing such as notes payable may be reclassi ed as long term if the rm has the intention and the ability to re nance it 0 Long term liabilities 0 Long term liabilities are liabilities not classi ed as current Liabilities for which the sacri ce of economic bene ts will take place more than one year or operating cycle if longer after the date of the nancial statements These obligations may be created through borrowing or through other business activities 0 Longterm Debt is an example of a long term liability Longterm debt is an amount owed to lenders but due gt 1 year or operating cycle if longer after the date of the nancial statements 0 Or that will be re nanced as above The term note payable is usually applied to debt arising through the rm borrowing from one party such as an insurance company or pension plan Classi ed as long term if due date is more than one year after the date of the nancial statements The term bonds payable is usually applied to debt arising through the rm borrowing from multiple parties via the issuance of bonds which are securities that can trade like stock rm could also issue bonds for borrowing from one party Classi ed as long term if due date is more than one year after the date of the nancial statements Longterm debt is originally recorded as a liability for the amount borrowed o This liability grows g shrinks over time depending on the relationship between interest expense incurred and interest paid 0 Debt denoted in foreign currency must be converted to dollars at the exchange rate existing as of each balance sheet date which can lead to dollar value of the liability varvind from period to period bevond effect of borrowing repaying and interest Eg if the conversion rate is 100 to 180 as of the balance sheet date a 1M debt would be reported at 18M but would be reported at 20M if the conversion rate is 100 to 200 as of the balance sheet date 0 Many liabilities require signi cant estimates 0 Retirement Bene ts 0 Pensions involve payments to employees during their retirement De ned contribution plan employee is only entitled to what the employer has contributed to the plan plus whatever plan has earned on this contribution o Expense to employer is the contribution o No liability arises from de ned contribution plans except if a required contribution is unpaid o Employer s only obligation is to make the contribution De ned bene ts plan employee is entitled to receive promised bene ts upon retirement The costs of these future bene ts must be estimated and recorded as an expense of the period during which the employee performed the service that earned the employee the future bene t 0 Matching principle Accounting is complex but each year39s expense includes the change during the year in the present value of the bene ts promised each employee 0 PV of bene ts increases through time as employees years of service and pay increases and as employee retirement nears PV value of bene ts also changes with other factors such as changes in life expectancy The rm has an economic liability equal to the entire unfunded present value of cumulative bene ts and there is an economic asset if the plan is over funded 0 Accounting rules now call for BS to show the liability or asset rather than showing it in the notes Pension obligation can be very large 0 Information on the amount of the obligation is very important to the forecast of a rm s future cash ows Above accounting treatment is designed to re ect the full cost of operations Without the accrual of a liability the cost of using employees services etc would be understated each period lf cost of future expenditures is not re ected in the expenses of the period during which the obligations arise this could result in rms employees being given excessive future bene ts because current managers don t see the full cost perhaps to the point where rm s future survival is in jeopardy Contingent liabilities refer to potential but not certain onga ons O O O Contingent obligations are de ned as Potential obligations arising due to past events Actual cost depends on future event As of the date of the event giving rise to the contingent obligation accrue as an expense and liability the best estimate of the amount of related future expenditures Future economic sacri ce is probable AND Amount of sacri ce is estimable Disclose the obligation in the notes to the nancial statements if Future economic sacri ce is probable but not estimable OR Future economic sacri ce is reasonably possible whether amount is estimable or not 0 Disclosure must include best estimate of amount of future obligation if estimable Summed up as follows Reasonable Probable Possible Remote subject to estimate liability disclose neither not subject to estimate disclose disclose neither Probable high chance of future event giving rise to actual obligation occurring Reasonably possible chance of future event giving rise to actual obligation occurring is more than remote and less than probable Remote slight chance of future event giving rise to actual obligation occurring De nition of probability requires signi cant management judgment Under GAAP probable means about 7080 likely or more but under IFRS it means 50 likely or more speci cally more likely than not Litigation is a common contingent obligation Past event is lawsuit contingency is outcome of the trial Usually not accrued as accrual would imply rm believes it is likely to lose the case 0 Although rm may accrue defense costs and then offset this accrual against any settlement HarleyDavidson disclosed in its notes that a state jury found the company liable for 72M in damages 0 No liability was accrued on grounds that obligation was only reasonably possible because verdict was appealed HarleyDavidson reported a 5M loss when an out of court settlement of 5M was reached 0 A related liability was then reported on the balance sheet as the obligation was now de ned as probable o Litigation Loss 5000000 Accrued Settlement 5000000 Warranty obligations and frequent ier obligations are contingent obligations Potential obligations arise from past sales Breakage or redemption is the future uncertain event that actual cost depends on Both warranty and frequent ier obligations are accrued as a liability with an associated expense recognized in the same time period during which the underlying sale that gave rise to the obligation is recognized as revenue Future obligations are estimable and probable at that time The estimated cost of future warranty repair work must be accrued as an expense of the period in which the related product is sold and an associated liability recognizing the obligation to provide free repairs must be recorded during that period Warranty Expense Accrued Warranty Payable When the work is paid for during a later period the liability is resolved Accrued Warranty Payable Cash 0 Warranty liability is for future service owed by the rm as of the date of the nancial statements and will be reported as part of the balance sheet 0 Cost of future warranty work associated with generating current sales will be recognized as an expense of the income statement of the period during which the associated sale is recognized as revenue 0 The incremental cost associated with providing free ights must be accrued as an expense of the period during which the associated ticket sale is recognized as revenue and an associated liability recognizing the obligation to provide free ights must be recorded at that time Promotion Expense Accrued Promotion Liability 0 When the costs of providing free ights are paid for during a later period the liability is resolved Accrued Promotion Liability Cash 0 Freduent ier obligations are liabilities for future service owed by the rm as of the date of the nancial statements and will be reported as part of the balance sheet Liability is not the revenue lost due to free ights 0 Expenditures associated with cost of future free ights are part of the cost of generating current sales and will be recognized as an expense in the income statement of the period during which the associated sale is recognized as revenue 0 Accruals cause associated expense to be recognized in income statement for period during which the revenue from the underlying sale was recognized Obligations to leasing companies are sometimes recorded as liabilities discussion is to make this much more generally appHed o If the lease covers so much of a leased asset39s life Q value that it is tantamount to buying the asset then the lease is called a capital lease In this case the transaction is recorded as though the rm bought the asset and borrowed the present value of the lease payments An asset and liability would then be recorded in an amount equal to the present value of the lease payments Each lease payment is then treated as partly interest expense and partly repayment of the liability o Eventually reducing the liability to zero at the end of the lease The asset is depreciated iust as is anv other asset 0 A lease meeting My of the below criteria is a capital lease Lease is for a term equal to 75 or more of the asset s estimated useful life Present value of the lease payments at signing is equal to 90 or more of the leased asset s fair market value Ownership of the lease is transferred to the lessee at the end of the lease The lease allows the lessee to purchase the asset at a price that is less than the asset s fair market value at the end of the lease term 0 When the lease is not accounted for as a capital lease it is treated as an operating lease and no asset or liability is recorded at the signing of the lease For an operating lease each cash payment is recorded as rent expense and a cash reduction 0 Managers may try to structure leases as operating leases to reduce the amount of liabilities or maybe even assets reported on their rms balance sheets