Financial accounting 9th kieso kimmel appendix j

J-1


Appendix

J

Other Significant
Liabilities
Accounting in Action

Learning Objectives
After studying this chapter, you should be able to:
[1] Describe the accounting and disclosure requirements for contingent
liabilities.
[2] Contrast the accounting for operating and capital leases.
[3] Identify additional fringe benefits associated with employee compensation.

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Contingent Liabilities
Potential liability that may become an actual liability in the
future.
Three levels of probability:

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

Probable.



Reasonably possible.



Remote.

LO 1


Contingent Liabilities

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Probability

Accounting

Probable

Accrue

Reasonably
Possible

Footnote

Remote

Ignore

LO 1


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.

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LO 1


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.

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LO 1


Contingent Liabilities
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 2015, the company
honors warranty contracts on 300 units, at a total cost of
$24,000. At December 31, compute the estimated warranty
liability.
Illustration J-1
Computation of estimated
product warranty liability

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LO 1


Contingent Liabilities
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 2015, 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
Warranty Liability

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40,000
40,000

LO 1


Contingent Liabilities
Illustration: Prepare the entry to record the repair costs
incurred in 2015 to honor warranty contracts on 2015 sales.
Warranty Liability

24,000

Repair Parts

24,000

Assume that the company replaces 20 defective units in
January 2016, at an average cost of $80 in parts and labor.
Warranty Liability
Repair Parts

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1,600
1,600

LO 1


Contingent Liabilities
Disclosure of Contingent Liabilities
Illustration J-2

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LO 1


Appendix

J

Other Significant
Liabilities
Accounting in Action

Learning Objectives
After studying this chapter, you should be able to:
[1] Describe the accounting and disclosure requirements for contingent
liabilities.

[2] Contrast the accounting for operating and capital leases.
[3] Identify additional fringe benefits associated with employee compensation.

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Lease Liabilities
A lease is a contractual arrangement between a lessor (owner
of the property) and a lessee (renter of the property).
Illustration J-3
Types of leases

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LO 2


Lease Liabilities
Operating Lease
Rent Expense
Cash

xxx

Although technically legal
title may not pass, the
benefits from the use of
the property do.

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xxx

Substance
versus
Form

Capital Lease
Leased Equipment
Lease Liability

xxx
xxx

LO 2


Lease Liabilities
For a capital lease, the FASB has identified four criteria.
1. Lease transfers ownership of the property to the lessee.
2. Lease contains a bargain-purchase option.
3. Lease term is equal to 75 percent or more of the estimated
economic life of the leased property.
One or more
4. The present value of the minimum lease
must be met
payments (excluding executory costs)
for capital
lease
equals or exceeds 90 percent of the fair

accounting.
value of the leased property.

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LO 2


Lease Liabilities
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
(a) What type of lease is this? Explain.
(b) Prepare the journal entry to record the lease.

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LO 2


Lease Liabilities
Illustration: (a) What type of lease is this? Explain.

Capitalization Criteria:

Capital Lease?

1. Transfer of ownership

NO
NO

2. Bargain purchase option
3. Lease term => 75% of

economic life of leased
property
4. Present value of minimum

lease payments => 90% of
FMV of property
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Lease term
4 yrs.
Economic life
5 YES
yrs. - PV and FMV
are the same.
YES
80%

LO 2

Lease Liabilities
Illustration: (b) Prepare the journal entry to record the lease.

Leased Asset - Equipment

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 long-term liability.

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LO 2


Lease Liabilities
Question
The lessee must record a lease as an asset if the lease:
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.

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LO 2

Appendix

J

Other Significant
Liabilities
Accounting in Action

Learning Objectives
After studying this chapter, you should be able to:
[1] Describe the accounting and disclosure requirements for contingent
liabilities.
[2] Contrast the accounting for operating and capital leases.
[3] Identify additional fringe benefits associated with employee
compensation.

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Additional Liabilities for Employee
Fringe Benefits
Paid Absences
Paid absences for vacation, illness, and holidays.
Accrue a liability if:

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

Payment of the compensation is probable.



The amount can be reasonably estimated.

LO 3


Employee Fringe Benefits
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

1,100

Cash
1,100
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LO 3

Employee Fringe Benefits
Postretirement Benefits
Post-retirement benefits are benefits that employers
provide to retired employees for
1. health care and life insurance
2. pensions.
Companies account for post-retirement benefits on the
accrual basis.

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LO 3


Employee Fringe Benefits
Postretirement Health-Care and Life Insurance
Benefits

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

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.

LO 3


Employee Fringe Benefits

Pension
Plans

An arrangement whereby an employer provides benefits to employees
after they retire for services they provided while they were working.
Pension
PensionPlan
Plan
Administrator
Administrator

Employer
Employer

Retired

Employees

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Contributions

Benefit Payments

Assets &
Liabilities

LO 3


Employee Fringe Benefits
Defined-Contribution Plan


Employer contribution
determined by plan (fixed)



Risk borne by employees



Benefits based on plan value

Pension

Plans

Defined-Benefit Plan


Benefit determined by plan



Employer contribution varies
(determined by 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.

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LO 3