Financial accounting 10th by harmin app k

Prepared by
Coby Harmon
University of California, Santa Barbara
K-1

Westmont College


Appendix J

Other Significant Liabilities

Learning Objectives
1

2

3

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

1

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 1


Contingent Liabilities

Probability

Accounting

Probable

Accrue

Reasonably
Possible

Remote

K-4

Footnote

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.

K-5

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.

K-6

LO 1


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 1


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 1


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 1


Disclosure of Contingent Liabilities

Illustration K-2
Disclosure of contingent liability

K-10

LO 1


LEARNING

2

OBJECTIVE

Discuss the accounting for lease liabilities and off-balance-sheet
financing.

A lease is a contractual arrangement between a lessor (owner of the property) and a lessee (renter of
the property).



Gives the lessee the right to use specific property, 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 2


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 2


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 do.
Right-of-use Asset
Lease Liability

K-13

xxx
xxx

LO 2


Finance Leases

For a finance lease, the lessee must record a lease as an asset if any one of the following conditions
exist.

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.

4.

The present value of the lease payments equals or exceeds 90% of the fair value of the leased
property.

K-14

LO 2


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 2


Finance Leases

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

Capital Lease?

Capitalization Criteria:

1.

Transfer of ownership

NO

2.

Bargain purchase option

NO

3.

Lease term => 75% of economic life of leased property

4.

Present value of minimum lease payments => 90% of
FMV of property

Lease term

4 yrs.
Economic life

5 yrs.

YES

K-16

80%

YES - PV and FMV
are the same.

LO 2


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 2


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 2


LEARNING
OBJECTIVE

3

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 3


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 3

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.

K-21

LO 3


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 3


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 3


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 3


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 3