Accounting Question

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College of Administration and Financial Sciences
Assignment (2)
Deadline: Saturday 11/11/2023 @ 23:59
Course Name: Financial Accounting
Student’s Name:
Course Code: ACCT201
Student’s ID Number:
Semester: First Term 23/24
CRN: 10666
Academic Year: 1445 H
For Instructor’s Use only
Instructor’s Name: Dr Fathimunisa hanfy
Students’ Grade:
/15
Level of Marks: High/Middle/Low
Instructions – PLEASE READ THEM CAREFULLY
• The Assignment must be submitted on Blackboard (WORD format only) via
allocated folder.
• Assignments submitted through email will not be accepted.
• Students are advised to make their work clear and well presented, marks may be
reduced for poor presentation. This includes filling your information on the
cover page.
• Students must mention question number clearly in their answer.
• Late submission will NOT be accepted.
• Avoid plagiarism, the work should be in your own words, copying from students
or other resources without proper referencing will result in ZERO marks. No
exceptions.
• All answers must be typed using Times New Roman (size 12, double-spaced)
font. No pictures containing text will be accepted and will be considered plagiarism.
• Submissions without this cover page will NOT be accepted.
College of Administration and Financial Sciences
Assignment Question(s):
Question 1:
(Marks: 15)
(5 Marks)
During June, the following changes in inventory took place:
June 1 Balance
1,400 units @
14 Purchased
900 units @
24 Purchased
700 units @
8 Sold
400 units @
10 Sold
1,000 units @
29 Sold
500 units @
Perpetual inventories are maintained in units only.
SR 24
36
30
50
40
44
Instructions
What is the cost of the ending inventory under the following methods? (Show calculations.)
(a) FIFO.
(b) Average Cost.
College of Administration and Financial Sciences
Question 2:
(5 Marks)
A Company began operations in 2020 and determined its ending inventory at cost and at
a LCNRV at December 31, 2020, and December 31, 2021. This information is presented below.
Cost
Net Realizable Value
31/12/20
SR 520,000
SR 485,000
31/12/21
615,000
585,000
Instructions
(a) Prepare the journal entries required at December 31, 2020, and December 31, 2021,
assuming that the inventory is recorded at LCNRV, using a perpetual inventory system
and the cost-of-goods-sold method.
(b) Prepare the journal entries required at December 31, 2020, and December 31, 2021,
assuming that the inventory is recorded at cost, using a perpetual system and the loss
method.
(c) Which of the two methods above provides the higher net income in each year?
College of Administration and Financial Sciences
Question 3:
(5 Marks)
On March 1, a Company began construction of a small building. The following
expenditures were incurred for construction:
March 1
May 1
July 1
SR 75,000
180,000
100,000
April 1
June 1
SR 74,000
270,000
The building was completed and occupied on July 1. To help pay for construction SR50,000 was
borrowed on March 1 on a 12%, three-year note payable. The only other debt outstanding during
the year was a SR500,000, 10% note issued two years ago.
Instructions
(a) Calculate the weighted-average accumulated expenditures.
(b) Calculate avoidable interest.
Depreciation – Method of Cost Allocation
Straight-Line Method
Illustration 11-2
Stanley Coal
Mines Facts
Illustration: Stanley computes depreciation as follows:
Illustration 11-4
11-11
LO 3
Depreciation – Method of Cost Allocation
Diminishing-Charge Methods
Illustration 11-2
Stanley Coal
Mines Facts
Sum-of-the-Years’-Digits. Each fraction uses the sum of the
years as a denominator (5 + 4 + 3 + 2 + 1 = 15). The
numerator is the number of years of estimated life remaining
as of the beginning of the year.
11-12
Alternate sum-of-theyears’ calculation
n(n+1)
2
=
5(5+1)
2
= 15
LO 3
Depreciation – Method of Cost Allocation
Sum-of-the-Years’-Digits
Illustration 11-6
11-13
LO 3 Compare activity, straight-line, and diminishingcharge methods of depreciation.
Depreciation – Method of Cost Allocation
Diminishing-Charge Methods
Illustration 11-2
Stanley Coal
Mines Facts
Declining-Balance Method.
►
Utilizes a depreciation rate (%) that is some multiple of
the straight-line method.
►
Does not deduct the residual value in computing the
depreciation base.
11-14
LO 3
Depreciation – Method of Cost Allocation
Declining-Balance Method
Illustration 11-7
11-15
LO 3 Compare activity, straight-line, and diminishingcharge methods of depreciation.
Depreciation – Method of Cost Allocation
Component Depreciation
IFRS requires that each part of an item of property, plant,
and equipment that is significant to the total cost of the
asset must be depreciated separately.
11-16
LO 4 Explain component depreciation.
Depreciation – Method of Cost Allocation
Component Depreciation
Illustration: EuroAsia Airlines purchases an airplane for
€100,000,000 on January 1, 2011. The airplane has a useful
life of 20 years and a residual value of €0. EuroAsia uses the
straight-line method of depreciation for all its airplanes.
EuroAsia identifies the following components, amounts, and
useful lives.
Illustration 11-8
11-17
LO 4 Explain component depreciation.
Depreciation – Method of Cost Allocation
Computation of depreciation expense for EuroAsia for 2011.
Illustration 11-9
Depreciation journal entry for 2011.
Depreciation Expense
8,600,000
Accumulated Depreciation—Airplane
11-18
8,600,000
LO 4 Explain component depreciation.
Depreciation – Method of Cost Allocation
Special Depreciation Issues
(1) How should companies compute depreciation for
partial periods?
(2) Does depreciation provide for the replacement of
assets?
(3) How should companies handle revisions in
depreciation rates?
11-19
LO 4 Explain component depreciation.
Depreciation – Method of Cost Allocation
E11-5 (Depreciation Computations—Four Methods): Maserati
Corporation purchased a new machine for its assembly process on
August 1, 2010. The cost of this machine was €150,000. The
company estimated that the machine would have a salvage value of
€24,000 at the end of its service life. Its life is estimated
at 5 years and its working hours are estimated at 21,000 hours. Yearend is December 31.
Instructions: Compute the depreciation expense for 2010 under the
following methods.
(a) Straight-line depreciation.
(c) Sum-of-the-years’-digits.
(b) Activity method
(d) Double-declining balance.
11-20
LO 3 Compare activity, straight-line, and diminishingcharge methods of depreciation.
Depreciation – Method of Cost Allocation
Straight-line Method
Annual
Expense
Accum.
Deprec.
$ 10,500
$ 10,500
Year
Depreciable
Base
2010
$ 126,000
/
5
=
$ 25,200
2011
126,000
/
5
=
25,200
25,200
35,700
2012
126,000
/
5
=
25,200
25,200
60,900
2013
126,000
/
5
=
25,200
25,200
86,100
2014
126,000
/
5
=
25,200
25,200
111,300
2015
126,000
/
5
=
25,200
14,700
126,000
Years
Partial
Year
Current
Year
Expense
x
x
5/12
7/12
=
=
$ 126,000
Journal entry:
2010
Depreciation expense
10,500
Accumultated depreciation
11-21
10,500
LO 3 Compare activity, straight-line, and diminishingcharge methods of depreciation.
Depreciation – Method of Cost Allocation
Activity Method
(Assume 800 hours used in 2010)
($126,000 / 21,000 hours = $6 per hour)
Year
(Given)
Hours
Used
2010
800
Rate per
Hours
x
$6
Annual
Expense
=
2011
x
=
2012
x
=
2013
x
=
2014
x
=
$
Partial
Year
4,800
800
Current
Year
Expense
Accum.
Deprec.
$
4,800
$ 4,800
$
4,800
Journal entry:
2010
Depreciation expense
Accumultated depreciation
11-22
4,800
4,800
LO 3
Depreciation – Method of Cost Allocation
5/12 = .416667
7/12 = .583333
Sum-of-the-Years’-Digits Method
Current
Year
Depreciable
Base
2010
$ 126,000
x
2011
126,000
2012
Annual
Expense
Years
5/15
Year
Expense
Accum.
Deprec.
5/12
$ 17,500
$ 17,500
=
42,000
x
4.58/15 =
38,500
38,500
56,000
126,000
x
3.58/15 =
30,100
30,100
86,100
2013
126,000
x
2.58/15 =
21,700
21,700
107,800
2014
126,000
x
1.58/15 =
13,300
13,300
121,100
2015
126,000
x
.58/15
4,900
4,900
126,000
=
x
Partial
Year
$ 126,000
Journal entry:
2010
11-23
Depreciation expense
Accumultated depreciation
17,500
17,500
LO 3
Depreciation – Method of Cost Allocation
Double-Declining Balance Method
Rate
per Year
Annual
Expense
Partial
Year
Current
Year
Expense
5/12
= $ 25,000
Year
Depreciable
Base
2010
$ 150,000 x
40%
=
$ 60,000 x
2011
125,000 x
40%
=
50,000
50,000
2012
75,000 x
40%
=
30,000
30,000
2013
45,000 x
40%
=
18,000
18,000
2014
27,000 x
40%
=
10,800
Plug
3,000
$ 126,000
Journal entry:
2010
Depreciation expense
Accumultated depreciation
11-24
25,000
25,000
LO 3
Depreciation – Method of Cost Allocation
Depreciation and Replacement of PP&E
Depreciation
►
Does not involve a current cash outflow.
►
Funds for the replacement of the assets come from
the revenues.
11-25
LO 4 Explain component depreciation.
Depreciation – Method of Cost Allocation
Revision of Depreciation Rates
11-26

Accounted for in the current and prospective periods.

Not handled retrospectively

Not considered errors or extraordinary items
LO 4 Explain component depreciation.
Change in Estimate Example
Arcadia HS, purchased equipment for $510,000 which was
estimated to have a useful life of 10 years with a residual value
of $10,000 at the end of that time. Depreciation has been
recorded for 7 years on a straight-line basis. In 2010 (year 8), it
is determined that the total estimated life should be 15 years
with a residual value of $5,000 at the end of that time.
Questions:
11-27

What is the journal entry to correct
the prior years’ depreciation?

Calculate the depreciation expense
for 2010.
No Entry
Required
LO 4 Explain component depreciation.
Change in Estimate Example
Equipment cost
Salvage value
Depreciable base
Useful life (original)
Annual depreciation
After 7 years
$510,000
First, establish NBV
– 10,000
at date of change in
estimate.
500,000
10 years
$ 50,000 x 7 years = $350,000
Balance Sheet (Dec. 31, 2009)
11-28
Equipment
Accumulated depreciation
$510,000
350,000
Net book value (NBV)
$160,000
LO 4 Explain component depreciation.
Change in Estimate Example
Net book value
Salvage value (new)
Depreciable base
Useful life remaining
Annual depreciation
$160,000
5,000
155,000
8 years
$ 19,375
After 7 years
Depreciation
Expense calculation
for 2010.
Journal entry for 2010
Depreciation expense
19,375
Accumulated depreciation
11-29
19,375
LO 4 Explain component depreciation.
Impairments
Recognizing Impairments
A long-lived tangible asset is impaired when a company is not
able to recover the asset’s carrying amount either through
using it or by selling it.
On an annual basis, companies review the asset for indicators
of impairments—that is, a decline in the asset’s cash-
generating ability through use or sale.
11-30
LO 5 Explain the accounting issues related to asset impairment.
Impairments
Recognizing Impairments
If impairment indicators are present, then an impairment test
must be conducted.
Illustration 11-15
11-31
LO 5
Impairments
Example: Assume that Cruz Company performs an impairment
test for its equipment. The carrying amount of Cruz’s equipment is
$200,000, its fair value less costs to sell is $180,000, and its
value-in-use is $205,000.
Illustration 11-15
$200,000
$205,000
No
Impairment
11-32
$180,000
$205,000
LO 5
Impairments
Example: Assume the same information for Cruz Company
except that the value-in-use of Cruz’s equipment is $175,000
rather than $205,000.
$20,000 Impairment Loss
Illustration 11-15
$200,000
11-33
$180,000
$180,000
$175,000
LO 5
Impairments
Example: Assume the same information for Cruz Company
except that the value-in-use of Cruz’s equipment is $175,000
rather than $205,000.
$20,000 Impairment Loss
Illustration 11-15
$200,000
$180,000
Cruz makes the following entry to record the impairment loss.
Loss on Impairment
20,000
Accumulated Depreciation—Equipment
11-34
20,000
LO 5
Impairments
Impairments Illustrations
Case 1
At December 31, 2011, Hanoi Company has equipment with a cost of
VND26,000,000, and accumulated depreciation of VND12,000,000. The
equipment has a total useful life of four years with a residual value of
VND2,000,000. The following information relates to this equipment.
1.
The equipment’s carrying amount at December 31, 2011, is
VND14,000,000 (VND26,000,000 VND12,000,000).
2.
Hanoi uses straight-line depreciation. Depreciation was VND6,000,000
for 2011 and is recorded.
3.
Hanoi has determined that the recoverable amount for this asset at
December 31, 2011, is VND11,000,000.
4.
11-35
The remaining useful life after December 31, 2011, is two years.
LO 5
Impairments
Case 1: Hanoi records the impairment on its equipment at
December 31, 2011, as follows.
VND3,000,000 Impairment Loss
Illustration 11-15
VND14,000,000
Loss on Impairment
VND11,000,000
3,000,000
Accumulated Depreciation—Equipment
11-36
3,000,000
LO 5
Impairments
Equipment
Less: Accumulated Depreciation-Equipment
Carrying value (Dec. 31, 2011)
VND 26,000,000
15,000,000
VND 11,000,000
Hanoi Company determines that the equipment’s total useful life has
not changed (remaining useful life is still two years). However, the
estimated residual value of the equipment is now zero. Hanoi
continues to use straight-line depreciation and makes the following
journal entry to record depreciation for 2012.
Depreciation Expense
5,500,000
Accumulated Depreciation—Equipment
11-37
5,500,000
LO 5
Impairments
Impairments Illustrations
Case 2
At the end of 2010, Verma Company tests a machine for impairment. The
machine has a carrying amount of $200,000. It has an estimated remaining
useful life of five years. Because there is little market-related information on
which to base a recoverable amount based on fair value, Verma determines
the machine’s recoverable amount should be based on value-in-use. Verma
uses a discount rate of 8 percent. Verma’s analysis indicates that its future
cash flows will be $40,000 each year for five years, and it will receive a
residual value of $10,000 at the end of the five years. It is assumed that all
cash flows occur at the end of the year.
Illustration 11-16
11-38
LO 5
Impairments
Case 2: Computation of the impairment loss on the machine at
the end of 2010.
$33,486 Impairment Loss
Illustration 11-15
$200,000
$166,514
Unknown
11-39
$166,514
LO 5
Impairments
Case 2: Computation of the impairment loss on the machine at
the end of 2010.
$33,486 Impairment Loss
Illustration 11-15
$200,000
$166,514
Loss on Impairment
33,486
Accumulated Depreciation—Machine
Unknown
11-40
33,486
$166,514
LO 5
Impairments
Reversal of Impairment Loss
Illustration: Tan Company purchases equipment on January 1, 2010,
for $300,000, useful life of three years, and no residual value.
At December 31, 2010, Tan records an impairment loss of $20,000.
Loss on Impairment
Accumulated Depreciation—Equipment
11-41
20,000
20,000
LO 5
Impairments
Reversal of Impairment Loss
Depreciation expense and related carrying amount after the
impairment.
At the end of 2011, Tan determines that the recoverable amount of the
equipment is $96,000. Tan reverses the impairment loss.
Accumulated Depreciation—Equipment
Recovery of Impairment Loss
11-42
6,000
6,000
LO 5
Impairments
Cash-Generating Units
When it is not possible to assess a single asset for impairment
because the single asset generates cash flows only in combination
with other assets, companies identify the smallest group of assets that
can be identified that generate cash flows independently of the cash
flows from other assets.
11-43
LO 5 Explain the accounting issues related to asset impairment.
Impairments
Impairment of Assets to Be Disposed Of

Report the impaired asset at the lower-of-cost-or-net
realizable value (fair value less costs to sell).

No depreciation or amortization is taken on assets held for
disposal during the period they are held.

Can write up or down an asset held for disposal in future
periods, as long as the carrying amount after the write up
never exceeds the carrying amount of the asset before the
impairment.
11-44
LO 5 Explain the accounting issues related to asset impairment.
Impairments
Illustration 11-18
Graphic of Accounting
for Impairments
11-45
LO 5
Depletion
Natural resources can be divided into two categories:
1. Biological assets (timberlands)
►
Fair value approach (chapter 9)
2. Mineral resources (oil, gas, and mineral mining).
►
Complete removal (consumption) of the asset.
►
Replacement of the asset only by an act of nature.
Depletion – process of allocating the cost of mineral resources.
11-46
LO 6 Explain the accounting procedures for depletion of mineral resources.
Depletion
Establishing a Depletion Base
Computation of the depletion base involves:
(1) Pre-exploratory costs.
(2) Exploratory and evaluation costs.
(3) Development costs.
11-47
LO 6 Explain the accounting procedures for depletion of mineral resources.
Depletion
Write-off of Resource Cost
Normally, companies compute depletion on a units-ofproduction method (activity approach). Depletion is a function
of the number of units extracted during the period.
Calculation:
Total cost – Residual value
Total estimated units available
Units extracted x Cost per unit
11-48
= Depletion cost per unit
= Depletion
LO 6 Explain the accounting procedures for depletion of mineral resources.
Depletion
Illustration: MaClede Co. acquired the right to use 1,000
acres of land in South Africa to mine for silver. The lease cost
is $50,000, and the related exploration costs on the property
are $100,000. Intangible development costs incurred in
opening the mine are $850,000. MaClede estimates that the
mine will provide approximately 100,000 ounces of silver.
Illustration 11-18
11-49
LO 6 Explain the accounting procedures for depletion of mineral resources.
Depletion
If MaClede extracts 25,000 ounces in the first year, then the
depletion for the year is $250,000 (25,000 ounces x $10).
Inventory
Accumulated Depletion
250,000
250,000
MaClede’s statement of financial position:
Depletion cost related to inventory sold is part of cost of goods sold.
11-50
LO 6
Depletion
Estimating Recoverable Reserves

Same as accounting for changes in estimates.

Revise the depletion rate on a prospective basis.

Divides the remaining cost by the new estimate of the
recoverable reserves.
11-51
LO 6 Explain the accounting procedures for depletion of mineral resources.
Depletion
Liquidating Dividends – Dividends greater than the
amount of accumulated net income.
Illustration: Callahan Mining had a retained earnings balance
of £1,650,000, accumulated depletion on mineral properties of
£2,100,000, and share premium of £5,435,493. Callahan’s board
declared a dividend of £3 a share on the 1,000,000 shares
outstanding. It records the £3,000,000 cash dividend as follows.
Retained Earnings
1,650,000
Share Premium—Ordinary
1,350,000
Cash
11-52
3,000,000
LO 6 Explain the accounting procedures for depletion of mineral resources.
Depletion
Presentation on the Financial Statements
Disclosures related to E&E expenditures should include:
1. Accounting policies for exploration and evaluation
expenditures, including the recognition of E&E assets.
2. Amounts of assets, liabilities, income and expense,
and operating cash flow arising from the exploration
for and evaluation of mineral resources.
11-53
LO 6 Explain the accounting procedures for depletion of mineral resources.
Revaluations
Recognizing Revaluations
Companies may value long-lived tangible asset after
acquisition at cost or fair value.
Network Rail (GBR) elected to use fair values to account for its
railroad network.
►
Increased long-lived tangible assets by £4,289 million.
►
Change in the fair value accounted for by adjusting the
asset account and establishing an unrealized gain.
►
11-54
Unrealized gain is often referred to as revaluation surplus.
LO 7 Explain the accounting for revaluations.
Revaluations
Revaluation—Land
Illustration: Siemens Group (DEU) purchased land for
€1,000,000 on January 5, 2010. The company elects to use
revaluation accounting for the land in subsequent periods. At
December 31, 2010, the land’s fair value is €1,200,000. The
entry to record the land at fair value is as follows.
Land
200,000
Unrealized Gain on Revaluation – Land
200,000
Unrealized Gain on Revaluation—Land increases other comprehensive
income in the statement of comprehensive income.
11-55
LO 7 Explain the accounting for revaluations.
Revaluations
Revaluation—Depreciable Assets
Illustration: Lenovo Group (CHN) purchases equipment for
¥500,000 on January 2, 2010. The equipment has a useful life
of five years, is depreciated using the straight-line method of
depreciation, and its residual value is zero. Lenovo chooses to
revalue its equipment to fair value over the life of the
equipment. Lenovo records depreciation expense of ¥100,000
(¥500,000 5) at December 31, 2010, as follows.
Depreciation Expense
100,000
Accumulated Depreciation—Equipment
11-56
100,000
LO 7 Explain the accounting for revaluations.
Revaluations
Revaluation—Depreciable Assets
After this entry, Lenovo’s equipment has a carrying amount of
¥400,000 (¥500,000 – ¥100,000). Lenovo receives an
independent appraisal for the fair value of equipment at
December 31, 2010, which is ¥460,000.
Accumulated Depreciation—Equipment
11-57
100,000
Equipment
40,000
Unrealized Gain on Revaluation—Equipment
60,000
LO 7 Explain the accounting for revaluations.
Revaluations
Revaluation—Depreciable Assets
Illustration 11-22
Financial Statement
Presentation—Revaluations
Lenovo reports depreciation expense of ¥100,000. The Accumulated Other
Comprehensive Income account related to revaluations cannot have a negative
balance.
11-58
LO 7 Explain the accounting for revaluations.
Revaluations
Revaluations Issues
Company can select to value only one class of assets, say buildings,
and not revalue other assets such as land or equipment.
Most companies do not use revaluation accounting.
11-59
►
Substantial and continuing costs associated with appraisals.
►
Gains associated with revaluations above historical cost are
not reported in net income but rather go directly to equity.
►
Losses associated with revaluation below historical cost
decrease net income. In addition, the higher depreciation
charges related to the revalued assets also reduce net
income.
LO 7 Explain the accounting for revaluations.
Presentation and Analysis
Presentation of Property, Plant, Equipment,
and Mineral Resources
Depreciating assets, use Accumulated Depreciation.
Depleting assets may include use of Accumulated Depletion
account, or the direct reduction of asset.
Disclosures
11-60
Basis of valuation (usually cost)
Pledges, liens, and other commitments
LO 8 Explain how to report and analyze property,
plant, equipment, and mineral resources.
Presentation and Analysis
Analysis of Property, Plant, and Equipment
Asset Turnover Ratio
Measure of a firm’s
ability to generate
sales from a particular
investment in assets.
Illustration 11-24
11-61
LO 8
Presentation and Analysis
Analysis of Property, Plant, and Equipment
Profit Margin on Sales
Measure of the ability to
generate operating
income from a particular
level of sales.
Illustration 11-25
11-62
LO 8
Presentation and Analysis
Analysis of Property, Plant, and Equipment
Rate of Return on Assets
Measures a firm’s
success in using assets
to generate earnings.
Illustration 11-26
11-63
LO 8
Presentation and Analysis
Analyst obtains further insight into the behavior of ROA by
disaggregating it into components of profit margin on sales and
asset turnover as follows:
Rate of Return
on Assets
=
Net Income
Profit Margin on
Sales
Net Income
11-64
Asset Turnover
Net Sales
x
=
Average Total Assets
x
Net Sales
Average Total Assets
LO 8 Explain how to report and analyze property,
plant, equipment, and mineral resources.
Presentation and Analysis
Analyst obtains further insight into the behavior of ROA by
disaggregating it into components of profit margin on sales and
asset turnover as follows:
Rate of Return
on Assets
=
€644
Profit Margin on
Sales
€644
(€9,533 €8,325) / 2
11-65
€10,799
(€9,533 €8,325) / 2
€10,799
=
Asset Turnover
x
=
7.2%
x
5.96%
x
1.21
LO 8 Explain how to report and analyze property,
plant, equipment, and mineral resources.
11-66

Under both iGAAP and U.S. GAAP, interest costs incurred during
construction must be capitalized.

The accounting for exchanges of non-monetary assets has recently
converged between IFRS and U.S. GAAP. U.S. GAAP now requires that
gains on exchanges of non-monetary assets be recognized if the
exchange has commercial substance. This is the same framework used
in IFRS.

U.S. GAAP also views depreciation as allocation of cost over an asset’s
life. U.S. GAAP permits the same depreciation methods (straight-line,
diminishing-balance, units-of-production) as IFRS.
11-67

IFRS requires component depreciation. Under U.S. GAAP, component
depreciation is permitted but is rarely used.

Under IFRS, companies can use either the historical cost model or the
revaluation model. U.S. GAAP does not permit revaluations of property,
plant, and equipment or mineral resources.

In testing for impairments of long-lived assets, U.S. GAAP uses a twostep model to test for impairments. The IFRS impairment test is stricter.
However, unlike U.S. GAAP, reversals of impairment losses are
permitted.
The general rules for revaluation accounting are as follows.
1. When a company revalues its long-lived tangible assets above
historical cost, it reports an unrealized gain that increases other
comprehensive income. Thus, the unrealized gain bypasses net
income, increases other comprehensive income, and increases
accumulated other comprehensive income.
2. If a company experiences a loss on impairment (decrease of
value below historical cost), the loss reduces income and
retained earnings. Thus, gains on revaluation increase equity
but not net income, whereas losses decrease income and
retained earnings (and therefore equity).
11-68
LO 9 Explain revaluation accounting procedures.
3. If a revaluation increase reverses a decrease that was
previously reported as an impairment loss, a company credits
the revaluation increase to income using the account Recovery
of Impairment Loss up to the amount of the prior loss. Any
additional valuation increase above historical cost increases
other comprehensive income and is credited to Unrealized Gain
on Revaluation.
4. If a revaluation decrease reverses an increase that was
reported as an unrealized gain, a company first reduces other
comprehensive income by eliminating the unrealized gain. Any
additional valuation decrease reduces net income and is
reported as a loss on impairment.
11-69
LO 9 Explain revaluation accounting procedures.
Revaluation of Land
Revaluation—2010: Valuation Increase
Illustration: Unilever Group (GBR and NLD) purchased land on
January 1, 2010, that cost €400,000. Unilever decides to report the
land at fair value in subsequent periods. At December 31, 2010, an
appraisal of the land indicates that its fair value is €520,000. Unilever
makes the following entry to record the increase in fair value.
Land
120,000
Unrealized Gain on Revaluation—Land
120,000
Illustration 11A-1
11-70
LO 9
Revaluation of Land
Revaluation—2011: Decrease below Cost
Illustration: What happens if the land’s fair value at December 31,
2011, is €380,000, a decrease of €140,000 (€520,000 – €380,000)?
Unrealized Gain on Revaluation—Land
120,000
Loss on Impairment
20,000
Land
140,000
Illustration 11A-2
11-71
LO 9
Revaluation of Land
Revaluation—2012: Recovery of Loss
Illustration: At December 31, 2012, Unilever’s land value increases
to €415,000, an increase of €35,000 (€415,000 – €380,000).
Land
35,000
Unrealized Gain on Revaluation—Land
15,000
Recovery of Impairment Loss
20,000
Illustration 11A-3
11-72
LO 9
Copyright
Copyright © 2011 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.
11-73
12-1
CHAPTER
12
INTANGIBLE ASSETS
Intermediate Accounting
IFRS Edition
Kieso, Weygandt, and Warfield
12-2
Learning Objectives
1.
Describe the characteristics of intangible assets.
2.
Identify the costs to include in the initial valuation of intangible assets.
3.
Explain the procedure for amortizing intangible assets.
4.
Describe the types of intangible assets.
5.
Explain the conceptual issues related to goodwill.
6.
Describe the accounting procedures for recording goodwill.
7.
Explain the accounting issues related to intangible asset impairments.
8.
Identify the conceptual issues related to research and development
costs.
9.
Describe the accounting for research and development and similar costs.
10. Indicate the presentation of intangible assets and related items.
12-3
Intangible Assets
Intangible
Asset Issues
Types of
Intangibles
Impairment of
Intangibles
Research and
Development
Costs
Characteristic
s
Marketingrelated
Limited-life
intangibles
Identifying
R&D
Intangible
assets
Valuation
Customerrelated
Reversal of
impairment
loss
Accounting for
R&D
R&D costs
Indefinite-life
intangibles
other than
goodwill
Conceptual
questions
Amortization
Artisticrelated
Contractrelated
Technologyrelated
Goodwill
12-4
Goodwill
Similar costs
Presentation of
Intangibles and
Related Items
Intangible Asset Issues
Characteristics
Three Main Characteristics:
(1) Identifiable,
(2) Lack physical existence.
(3) Not monetary assets.
Normally classified as non-current asset.
12-5
LO 1 Describe the characteristics of intangible assets.
Intangible Asset Issues
Valuation
Purchased Intangibles:

Recorded at cost.

Includes all costs necessary to make the intangible asset
ready for its intended use.

12-6
Typical costs include:
►
Purchase price.
►
Legal fees.
►
Other incidental expenses.
LO 2 Identify the costs to include in the initial valuation of intangible assets.
Intangible Asset Issues
Valuation
Internally Created Intangibles:

Companies expense all research phase costs and some
development phase costs.

Certain development costs are capitalized once economic
viability criteria are met.

IFRS identifies several specific criteria that must be met
before development costs are capitalized.
12-7
LO 2 Identify the costs to include in the initial valuation of intangible assets.
Intangible Asset Issues
Internally Created Intangibles
12-8
Illustration 12-1
Research and
Development Stages
LO 2 Identify the costs to include in the initial valuation of intangible assets.
Intangible Asset Issues
Amortization of Intangibles
Limited-Life Intangibles:
12-9

Amortize by systematic charge to expense over useful life.

Credit asset account or accumulated amortization.

Useful life should reflect the periods over which the asset
will contribute to cash flows.

Amortization should be cost less residual value.

IFRS requires companies to assess the residual values
and useful lives of intangible assets at least annually.
LO 3 Explain the procedure for amortizing intangible assets.
Intangible Asset Issues
Amortization of Intangibles
Indefinite-Life Intangibles:
12-10

No foreseeable limit on time the asset is expected to
provide cash flows.

No amortization.

Must test indefinite-life intangibles for impairment at least
annually.
LO 3 Explain the procedure for amortizing intangible assets.
Intangible Asset Issues
Amortization of Intangibles
12-11
Illustration 12-2
Accounting Treatment
for Intangibles
LO 3 Explain the procedure for amortizing intangible assets.
Types of Intangibles
Six Major Categories:
12-12
(1) Marketing-related.
(4) Contract-related.
(2) Customer-related.
(5) Technology-related.
(3) Artistic-related.
(6) Goodwill.
LO 4 Describe the types of intangible assets.
Types of Intangibles
Marketing-Related Intangible Assets

Examples:
►
12-13
Trademarks or trade names, newspaper
mastheads, Internet domain names, and noncompetition agreements.

In the United States trademark or trade name has
legal protection for indefinite number of 10 year renewal
periods.

Capitalize acquisition costs.

No amortization.
LO 4 Describe the types of intangible assets.
Types of Intangibles
Customer-Related Intangible Assets

Examples:
►
12-14
Customer lists, order or production backlogs, and both
contractual and non-contractual customer
relationships.

Capitalize acquisition costs.

Amortized to expense over useful life.
LO 4 Describe the types of intangible assets.
Types of Intangibles
Illustration: Green Market Inc. acquires the customer list of a
large newspaper for €6,000,000 on January 1, 2011. Green
Market expects to benefit from the information evenly over a
three-year period. Record the purchase of the customer list and
the amortization of the customer list at the end of each year.
Jan. 1
Customer List
6,000,000
Cash
Dec. 31
2010
2011
2012
12-15
Amortization expense
Customer list
6,000,000
2,000,000
2,000,000
LO 4 Describe the types of intangible assets.
Types of Intangibles
Artistic-Related Intangible Assets

Examples:
►
Plays, literary works, musical works, pictures,
photographs, and video and audiovisual material.

Copyright granted for the life of the creator plus 70 years.

Capitalize costs of acquiring and defending.

Amortized to expense over useful life.
and
12-16
Mickey
Mouse
LO 4
Types of Intangibles
Contract-Related Intangible Assets

Examples:
►
12-17
Franchise and licensing agreements, construction
permits, broadcast rights, and service or supply
contracts.

Franchise (or license) with a limited life should be amortized
to expense over the life of the franchise.

Franchise with an indefinite life should be carried at cost
and not amortized.
LO 4
Types of Intangibles
Technology-Related Intangible Assets

Examples:
►
12-18
Patented technology and trade secrets granted by a
governmental body.

Patent gives holder exclusive use for a period of 20 years.

Capitalize costs of purchasing a patent.

Expense any R&D costs in developing a patent.

Amortize over legal life or useful life, whichever is shorter.
LO 4 Describe the types of intangible assets.
Types of Intangibles
Illustration: Harcott Co. incurs $180,000 in legal costs on
January 1, 2011, to successfully defend a patent. The patent’s
useful life is 20 years, amortized on a straight-line basis. Harcott
records the legal fees and the amortization at the end of 2011 as
follows.
Jan. 1
Patent
180,000
Cash
Dec. 31
Patent amortization expense
Patent
12-19
180,000
9,000
9,000
LO 4 Describe the types of intangible assets.
Types of Intangibles
Goodwill
Conceptually, represents the future economic benefits arising
from the other assets acquired in a business combination that
are not individually identified and separately recognized.
Only recorded when an entire business is purchased.
Goodwill is measured as the excess of …
cost of the purchase over the FMV of the identifiable net
assets purchased.
Internally created goodwill should not be capitalized.
12-20
LO 5 Explain the conceptual issues related to goodwill.
Recording Goodwill
Illustration: Multi-Diversified, Inc. decides that it needs a parts
division to supplement its existing tractor distributorship. The
president of Multi-Diversified is interested in buying São Paulo,
Brazil. The illustration presents the statement of financial position
of Tractorling Company.
Illustration 12-4
12-21
LO 6 Describe the accounting procedures for recording goodwill.
Recording Goodwill
Illustration: Multi-Diversified investigates Tractorling’s underlying
assets to determine their fair values.
Illustration 12-5
Tractorling Company decides to accept Multi-Diversified’s offer of
$400,000. What is the value of the goodwill, if any?
12-22
LO 6 Describe the accounting procedures for recording goodwill.
Recording Goodwill
Illustration: Determination of Goodwill.
Illustration 12-6
12-23
LO 6 Describe the accounting procedures for recording goodwill.
Recording Goodwill
Illustration: Multi-Diversified records this transaction as
follows.
Property, Plant, and Equipment
Patents
Inventories
Receivables
Cash
Goodwill
Liabilities
Cash
12-24
205,000
18,000
122,000
35,000
25,000
50,000
55,000
400,000
LO 6 Describe the accounting procedures for recording goodwill.
Goodwill
Goodwill Write-off

Goodwill considered to have an indefinite life.

Should not be amortized.

Only adjust carrying value when goodwill is impaired.
Bargain Purchase
12-25

Purchase price less than the fair value of net assets
acquired.

Amount is recorded as a gain by the purchaser.
LO 6 Describe the accounting procedures for recording goodwill.
Impairment of Intangible Assets
Impairment of Limited-Life Intangibles
Same as impairment for long-lived assets in Chapter 11.
Illustration 11-15
12-26
LO 7 Explain the accounting issues related to intangible-asset impairments.
Impairment of Intangible Assets
Illustration: Lerch, Inc. has a patent on how to extract oil from
shale rock, with a carrying value of $5,000,000 at the end of 2010.
Unfortunately, several recent non-shale-oil discoveries adversely
affected the demand for shale-oil technology, indicating that the
patent is impaired. Lerch determines the recoverable amount for
the patent, based on value-in-use (because there is no active
market for the patent). Lerch estimates the patent’s value-in-use at
$2,000,000, based on the discounted expected net future cash
flows at its market rate of interest.
12-27
LO 7 Explain the accounting issues related to intangible asset impairments.
Impairment of Intangible Assets
Calculate the impairment loss (based on value-in-use).
$3,000,000 Impairment Loss
Illustration 11-15
$5,000,000
$2,000,000
Unknown
12-28
$2,000,000
LO 7 Explain the accounting issues related to intangible asset impairments.
Impairment of Intangible Assets
Calculate the impairment loss (based on value-in-use).
$3,000,000 Impairment Loss
Illustration 11-15
$5,000,000
$2,000,000
Entry to record the impairment loss.
Loss on Impairment
Patents
12-29
3,000,000
Unknown
3,000,000
$2,000,000
LO 7 Explain the accounting issues related to intangible asset impairments.
Impairment of Intangible Assets
Reversal of Impairment Loss
Illustration: The carrying value of the patent after impairment is
$2,000,000. Lerch’s amortization is $400,000 ($2000,000 / 5) over the
remaining five years of the patent’s life. The amortization expense and
related carrying amount after the impairment is shown below:
Illustration 12-8
12-30
LO 7 Explain the accounting issues related to intangible asset impairments.
Impairment of Intangible Assets
Reversal of Impairment Loss
Early in 2012, based on improving conditions in the market for
shale-oil technology, Lerch remeasures the recoverable amount of
the patent to be $1,750,000. In this case, Lerch reverses a portion
of the recognized impairment loss.
Patents ($1,750,000-$1,600,000)
Loss on Impairment
12-31
150,000
150,000
LO 7 Explain the accounting issues related to intangible asset impairments.
Impairment of Intangible Assets
Impairment of Indefinite-Life Intangibles Other
than Goodwill

Should be tested for impairment at least annually.

Impairment test is the same as that for limited-life
intangibles. That is,
►
compare the recoverable amount of the intangible
asset with the asset’s carrying value.
►
If the recoverable amount is less than the carrying
amount, the company recognizes an impairment.
12-32
LO 7 Explain the accounting issues related to intangible asset impairments.
Impairment of Intangible Assets
Illustration: Arcon Radio purchased a broadcast license for
$2,000,000. The license is renewable every 10 years. Arcon Radio
has renewed the license with the GCC twice, at a minimal cost.
Because it expects cash flows to last indefinitely, Arcon reports the
license as an indefinite-life intangible asset. Recently, the GCC
decided to auction these licenses to the highest bidder instead of
renewing them. Based on recent auctions of similar licenses, Arcon
Radio estimates the fair value less costs to sell (the recoverable
amount) of its license to be $1,500,000.
Illustration 12-9
12-33
LO 7 Explain the accounting issues related to intangible asset impairments.
Impairment of Intangible Assets
Impairment of Goodwill
12-34

Companies must test goodwill at least annually.

Impairment test is conducted based on the cash-generating
unit to which the goodwill is assigned.

Because there is rarely a market for cash-generating units,
estimation of the recoverable amount for goodwill
impairments is usually based on value-in-use estimates.
LO 7 Explain the accounting issues related to intangible asset impairments.
Impairment of Intangible Assets
Illustration: Kohlbuy Corporation has three divisions. It purchased
one division, Pritt Products, four years ago for $2 million.
Unfortunately, Pritt experienced operating losses over the last three
quarters. Kohlbuy management is now reviewing the division (the
cash-generating unit), for purposes of its annual impairment
testing. Pritt Division’s net assets, including the associated goodwill
of $900,000 from the purchase:
Illustration 12-10
12-35
LO 7
Impairment of Intangible Assets
Kohlbuy determines the recoverable amount for the Pritt Division to
be $2,800,000, based on a value-in-use estimate.
Illustration 11-15
$2,400,000
$2,800,000
No
Impairment
Unknown
12-36
$2,800,000
LO 7
Impairment of Intangible Assets
Assume that the recoverable amount for the Pritt Division is
$1,900,000, instead of $2,800,000.
$500,000 Impairment Loss
Illustration 11-15
$2,400,000
$1,900,000
Unknown
12-37
$1,900,000
LO 7
Impairment of Intangible Assets
Assume that the recoverable amount for the Pritt Division is
$1,900,000, instead of $2,800,000.
$500,000 Impairment Loss
Illustration 11-15
$2,400,000
$1,900,000
Loss on Impairment
500,000
Goodwill
500,000
Unknown
12-38
$1,900,000
LO 7
Research and Development Costs
Research and development (R&D) costs are not in
themselves intangible assets.
Frequently results in something that a company patents or
copyrights such as:
12-39
►
new product,
►
formula,
►
process,
►
composition, or
►
idea,
►
literary work.
LO 8 Identify the conceptual issues related to research and development costs.
Research and Development Costs
Companies spend considerable sums on research and
development.
Illustration 12-12
12-40
LO 8 Identify the conceptual issues related to research and development costs.
Research and Development Costs
12-41

Research costs must be expensed as incurred.

Development costs may or may not be expensed as
incurred.

Capitalization begins when the project is far enough along
in the process such that the
economic benefits of the R&D
project will flow to the company
(the project is economically
viable).
LO 8 Identify the conceptual issues related to research and development costs.
Research and Development Costs
Identifying R & D Activities
Illustration 12-13
Research Activities
Examples
Original and planned investigation
undertaken with the prospect of gaining
new scientific or technical knowledge
and understanding.
Laboratory research aimed at discovery of
new knowledge; searching for applications of
new research findings.
Development Activities
Examples
Application of research findings or other
knowledge to a plan or design for the
production of new or substantially
improved materials, devices, products,
processes, systems, or services
before the start of commercial
production or use.
12-42
Conceptual formulation and design of
possible product or process alternatives;
construction of prototypes and
operation of pilot plants.
LO 8 Identify the conceptual issues related to research and development costs.
Research and Development Costs
Accounting for R & D Activities
Costs Associated with R&D Activities:
12-43

Materials, Equipment, and Facilities

Personnel

Purchased Intangibles

Contract Services

Indirect Costs
LO 9 Describe the accounting for research and development and similar costs.
Research and Development Costs
E12-1: Indicate how items on the list below would generally be
reported in the financial statements.
Item
Classification
1.
Investment in a subsidiary company.
1.
Long-term investments
2.
Timberland.
2.
PP&E
3.
Cost of engineering activity required
to advance the design of a product to
the manufacturing stage.
3.
R&D expense
4.
Prepaid rent
5.
PP&E
6.
R&D expense
4.
Lease prepayment.
5.
Cost of equipment obtained.
6.
Cost of searching for applications of
new research findings.
12-44
LO 9
Research and Development Costs
Item
7.
8.
9.
Classification
Cost incurred in the formation of a
corporation.
7.
Expense
8.
Operating loss
Operating losses incurred in the
start-up of a business.
9.
Expense
Training costs incurred in start-up
of new operation.
11. Not recorded
10. Purchase cost of a franchise.
10. Intangible
12. R&D expense
11. Goodwill generated internally.
12. Cost of testing in search of product
alternatives.
12-45
LO 9 Describe the accounting for research and development and similar costs.
Research and Development Costs
Item
Classification
13. Goodwill acquired in the purchase
of a business.
13. Intangible
14. Cost of developing a patent.
15. Intangible
15. Cost of purchasing a patent from
an inventor.
16. Intangible
16. Legal costs incurred in securing a
patent.
14. R&D expense
17. Intangible
17. Unrecovered costs of a successful
legal suit to protect the patent.
12-46
LO 9 Describe the accounting for research and development and similar costs.
Research and Development Costs
Item
Classification
18. Cost of conceptual formulation of
possible product alternatives.
18. R&D expense
19. Cost of purchasing a copyright.
20. Intangible
20. Development costs incurred after
achieving economic viability.
21. Long-term investment
21. Long-term receivables.
22. Cost of developing a trademark.
19. Intangible
22. Expense
23. Intangible
23. Cost of purchasing a trademark.
12-47
LO 9 Describe the accounting for research and development and similar costs.
Research and Development Costs
Other Costs Similar to R & D Costs

Start-up costs for a new operation.
►

Initial operating losses.
►

should expensed as incurred.
Should not be capitalized.
Advertising costs.
►
Should expensed as incurred.
If R&D–related intangibles (often referred to as in-process R&D) are also acquired in
a business combination, they are also recognized and measured at fair value.
12-48
LO 9 Describe the accounting for research and development and similar costs.
Research and Development Costs
E12-17: Compute the amount to be reported as research and
development expense.
$330,000 / 5 = $66,000
Cost of equipment acquired that will have alternative
uses in future R&D projects over the next 5 years.
R&D
Expense
$330,000
$66,000
Materials consumed in R&D projects
59,000
59,000
Consulting fees paid to outsiders for R&D projects
100,000
100,000
Personnel costs of persons involved in R&D projects
128,000
128,000
Indirect costs reasonably allocable to R&D projects
50,000
50,000
Materials purchased for future R&D projects
34,000
0
$403,000
12-49
LO 9 Describe the accounting for research and development and similar costs.
Presentations of Intangibles and Related Items
Presentation of Intangible Assets
Statement of Financial Position
12-50
►
Intangible assets shown as a separate item.
►
Reporting is similar to the reporting of property, plant, and
equipment.
►
Contra accounts may not be shown for intangibles.
►
Companies should report as a separate item all intangible
assets other than goodwill.
LO 10 Indicate the presentation of intangible assets and related items.
Presentations of Intangibles and Related Items
Presentation of Intangible Assets
Income Statement
12-51
►
Amortization expense.
►
Impairment losses and reversals other than goodwill
separately (usually in the operating section).
LO 10 Indicate the presentation of intangible assets and related items.
Presentations of Intangibles and Related Items
Presentation of Intangible Assets
Illustration 12-15
12-52
LO 10 Indicate the presentation of intangible assets and related items.
Presentations of Intangibles and Related Items
Presentation of Intangible Assets
Illustration 12-16
12-53
LO 10 Indicate the presentation of intangible assets and related items.
►
Both U.S. GAAP and IFRS segregate the costs associated with
research and development into the two components. Costs in the
research phase are always expensed under both IFRS and U.S. GAAP.
Under IFRS, however, costs in the development phase are capitalized
once economic viability is achieved.
►
While IFRS permits some capitalization of internally generated
intangible assets (e.g., brands and development costs that meet
economic viability criteria), U.S. GAAP requires expensing of all
research and development costs.
12-54
12-55
►
Under U.S. GAAP, impairment loss is measured as the excess of the
carrying amount over the asset’s fair value. Under IFRS, the impairment
test is based on the asset’s carrying amount compared to its
recoverable amount (the higher of the asset’s fair value less costs to
sell and its value-in-use).
►
While IFRS allows reversal of impairment losses when there has been a
change in economic conditions or in the expected use of the asset,
under U.S. GAAP, impairment losses cannot be reversed for assets to
be held and used; the impairment loss results in a new cost basis for
the asset. IFRS and U.S. GAAP are similar in the accounting for the
impairments of assets held for disposal.
►
12-56
With issuance of a recent converged statement on business
combinations (IFRS 3 and SFAS No. 141—Revised ), IFRS and U.S.
GAAP are very similar for intangibles acquired in a business
combination. That is, companies recognize an intangible asset
separately from goodwill if the intangible represents contractual or legal
rights or is capable of being separated or divided and sold, transferred,
licensed, rented, or exchanged. In addition, under both U.S. GAAP and
IFRS, companies recognize acquired in-process research and
development (IPR&D) as a separate intangible asset if it meets the
definition of an intangible asset and its fair value can be measured
reliably.
Copyright
Copyright © 2011 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.
12-57
13-1
CHAPTER
13
CURRENT LIABILITIES, PROVISIONS,
AND CONTINGENCIES
Intermediate Accounting
IFRS Edition
Kieso, Weygandt, and Warfield
13-2
Learning Objectives
1.
Describe the nature, type, and valuation of current liabilities.
2.
Explain the classification issues of short-term debt expected to
be refinanced.
3.
Identify types of employee-related liabilities.
4.
Explain the accounting for different types of provisions.
5.
Identify the criteria used to account for and disclose contingent
liabilities and assets.
6.
Indicate how to present and analyze liability-related information.
13-3
Current Liabilities and Contingencies
Current Liabilities
Provisions
What is a liability?
Recognition
What is a current
liability?
Presentation and
Analysis
Measurement
Contingent
liabilities
Presentation of
current liabilities
Common types
Contingent assets
Analysis of current
liabilities
Disclosures
13-4
Contingencies
What is a Liability?
Three essential characteristics:
1. Present obligation.
2. Arises from past events.
3. Results in an outflow of
resources (cash, goods,
services).
13-5
What is a Current Liability?
Current liability is reported if one of two conditions exists:
1. Liability is expected to be settled within its normal operating
cycle; or
2. Liability is expected to be settled within 12 months after the
reporting date.
The operating cycle is the period of time elapsing between the
acquisition of goods and services and the final cash realization resulting
from sales and subsequent collections.
13-6
LO 1 Describe the nature, type, and valuation of current liabilities.
What is a Current Liability?
Typical Current Liabilities:

Accounts payable.

Notes payable.

Current maturities of longterm debt.


13-7
Short-term obligations
expected to be refinanced.

Customer advances and
deposits.

Unearned revenues.

Sales taxes payable.

Income taxes payable.

Employee-related liabilities.
Dividends payable.
LO 1 Describe the nature, type, and valuation of current liabilities.
What is a Current Liability?
Accounts Payable (trade accounts payable)
Balances owed to others for goods, supplies, or services
purchased on open account.

Time lag between the receipt of services or acquisition
of title to assets and the payment for them.

Terms of the sale (e.g., 2/10, n/30 or 1/10, E.O.M.)
usually state period of extended credit, commonly 30 to
60 days.
13-8
LO 1 Describe the nature, type, and valuation of current liabilities.
What is a Current Liability?
Notes Payable
Written promises to pay a certain sum of money on a
specified future date.
13-9

Arise from purchases, financing, or other transactions.

Notes classified as short-term or long-term.

Notes may be interest-bearing or zero-interest-bearing.
LO 1 Describe the nature, type, and valuation of current liabilities.
What is a Current Liability?
Interest-Bearing Note Issued
Illustration: Castle National Bank agrees to lend $100,000 on
March 1, 2011, to Landscape Co. if Landscape signs a $100,000,
6 percent, four-month note. Landscape records the cash received
on March 1 as follows:
Cash
100,000
Notes Payable
13-10
100,000
LO 1 Describe the nature, type, and valuation of current liabilities.
What is a Current Liability?
If Landscape prepares financial statements semiannually, it
makes the following adjusting entry to recognize interest
expense and interest payable at June 30:
Interest calculation =
Interest expense
Interest payable
13-11
($100,000 x 6% x 4/12) = $2,000
2,000
2,000
LO 1 Describe the nature, type, and valuation of current liabilities.
What is a Current Liability?
At maturity (July 1), Landscape records payment of the note and
accrued interest as follows.
Notes payable
100,000
Interest payable
2,000
Cash
13-12
102,000
LO 1 Describe the nature, type, and valuation of current liabilities.
What is a Current Liability?
Zero-Bearing Note Issued
Illustration: On March 1, Landscape issues a $102,000, fourmonth, zero-interest-bearing note to Castle National Bank. The
present value of the note is $100,000. Landscape records this
transaction as follows.
Cash
100,000
Notes payable
13-13
100,000
LO 1 Describe the nature, type, and valuation of current liabilities.
What is a Current Liability?
If Landscape prepares financial statements semiannually, it
makes the following adjusting entry to recognize interest expense
and the increase in the note payable of $2,000 at June 30.
Interest expense
2,000
Notes payable
2,000
At maturity (July 1), Landscape must pay the note, as follows.
Notes payable
Cash
13-14
102,000
102,000
LO 1 Describe the nature, type, and valuation of current liabilities.
What is a Current Liability?
E13-2: (Accounts and Notes Payable) The following are selected
2010 transactions of Darby Corporation.
Sept. 1 – Purchased inventory from Orion Company on account
for $50,000. Darby records purchases gross and uses a periodic
inventory system.
Oct. 1 – Issued a $50,000, 12-month, 8% note to Orion in
payment of account.
Oct. 1 – Borrowed $75,000 from the Shore Bank by signing a 12month, zero-interest-bearing $81,000 note.
Prepare journal entries for the selected transactions.
13-15
LO 1 Describe the nature, type, and valuation of current liabilities.
What is a Current Liability?
Sept. 1 – Purchased inventory from Orion Company on account
for $50,000. Darby records purchases gross and uses a
periodic inventory system.
Sept. 1
Purchases
Accounts payable
13-16
50,000
50,000
LO 1 Describe the nature, type, and valuation of current liabilities.
What is a Current Liability?
Oct. 1 – Issued a $50,000, 12-month, 8% note to Orion in payment
of account.
Oct. 1
Accounts payable
50,000
Notes payable
Interest calculation =
Dec. 31
($50,000 x 8% x 3/12) = $1,000
Interest expense
Interest payable
13-17
50,000
1,000
1,000
LO 1 Describe the nature, type, and valuation of current liabilities.
What is a Current Liability?
Oct. 1 – Borrowed $75,000 from the Shore Bank by signing a 12-
month, zero-interest-bearing $81,000 note.
Oct. 1
Cash
75,000
Notes payable
Interest calculation =
Dec. 31
($6,000 x 3/12) = $1,500
Interest expense
Notes payable
13-18
75,000
1,500
1,500
LO 1 Describe the nature, type, and valuation of current liabilities.
What is a Current Liability?
Current Maturities of Long-Term Debt
Portion of bonds, mortgage notes, and other long-term
indebtedness that matures within the next fiscal year.
Exclude long-term debts maturing currently if they are to be:
1. Retired by assets accumulated that have not been shown
as current assets,
2. Refinanced, or retired from the proceeds of a new debt
issue, or
3. Converted into ordinary shares.
13-19
LO 1 Describe the nature, type, and valuation of current liabilities.
What is a Current Liability?
Short-Term Obligations Expected to Be
Refinanced
Exclude from current liabilities if both of the following
conditions are met:
1. Must intend to refinance the obligation on a long-term
basis.
2. Must have an unconditional right to defer settlement of
the liability for at least 12 months after the reporting date.
13-20
LO 2 Explain the classification issues of short-term
debt expected to be refinanced.
What is a Current Liability?
E13-4 (Refinancing of Short-Term Debt): The CFO for
Hendricks Corporation is discussing with the company’s chief
executive officer issues related to the company’s short-term
obligations. Presently, both the current ratio and the acid-test ratio
for the company are quite low, and the chief executive officer is
wondering if any of these short-term obligations could be
reclassified as long-term. The financial reporting date is
December 31, 2010. Two short-term obligations were discussed,
and the following action was taken by the CFO.
Instructions: Indicate how these transactions should be reported
at Dec. 31, 2010, on Hendricks’ statement of financial position.
13-21
LO 2
What is a Current Liability?
Short-term obligation A: Hendricks has a $50,000 short-term
obligation due on March 1, 2011. The CFO discussed with its
lender whether the payment could be extended to March 1, 2013,
provided Hendricks agrees to provide additional collateral. An
agreement is reached on February 1, 2011, to change the loan
terms to extend the obligation’s maturity to March 1, 2013. The
financial statements are authorized for issuance on April 1, 2011.
Liability of
$50,000
Refinance
completed
Liability due
for payment
Statement
Issuance
Dec. 31, 2010
Feb. 1, 2011
Mar. 1, 2011
Apr. 1, 2011
13-22
LO 2 Explain the classification issues of short-term
debt expected to be refinanced.
What is a Current Liability?
Short-term obligation A: Hendricks has a $50,000 short-term
obligation due on March 1, 2011. The CFO discussed with its
lender whether the payment could be extended to March 1, 2013,
provided Hendricks agrees to provide additional collateral. An
agreement is reached on February 1, 2011, to change the loan
terms to extend the obligation’s maturity to March 1, 2013. The
financial statements are authorized for issuance on April 1, 2011.
Current Liability
of $50,000
Dec. 31, 2010
13-23
Since the agreement was not in place as of the reporting
date (December 31, 2010), the obligation should be
reported as a current liability.
LO 2 Explain the classification issues of short-term
debt expected to be refinanced.
What is a Current Liability?
Short-term obligation B: Hendricks also has another short-term
obligation of $120,000 due on February 15, 2011. In its discussion
with the lender, the lender agrees to extend the maturity date to
February 1, 2012. The agreement is signed on December 18,
2010. The financial statements are authorized for issuance on
March 31, 2011.
Refinance
completed
Liability of
$120,000
Liability due
for payment
Statement
Issuance
Dec. 18, 2010
Dec. 31, 2010
Feb. 15, 2011
Mar. 31, 2011
13-24
LO 2 Explain the classification issues of short-term
debt expected to be refinanced.
What is a Current Liability?
Short-term obligation B: Hendricks also has another short-term
obligation of $120,000 due on February 15, 2011. In its discussion
with the lender, the lender agrees to extend the maturity date to
February 1, 2012. The agreement is signed on December 18,
2010. The financial statements are authorized for issuance on
March 31, 2011.
Refinance
completed
Non-Current
Liability of
$120,000
Dec. 18, 2010
Dec. 31, 2010
13-25
Since the agreement was in place as of
the reporting date (December 31, 2010),
the obligation is reported as a noncurrent liability.
LO 2 Explain the classification issues of short-term
debt expected to be refinanced.
What is a Current Liability?
Dividends Payable
Amount owed by a corporation to its stockholders as a result
of board of directors’ authorization.

Generally paid within three months.

Undeclared dividends on cumulative preference shares
not recognized as a liability.

Dividends payable in the form of additional shares are
not recognized as a liability. Reported in equity.
13-26
LO 2 Explain the classification issues of short-term
debt expected to be refinanced.
What is a Current Liability?
Customer Advances and Deposits
Returnable cash deposits received from customers and
employees.

13-27
May be classified as current or non-current liabilities.
LO 2 Explain the classification issues of short-term
debt expected to be refinanced.
What is a Current Liability?
Unearned Revenues
Payment received before delivering goods or rendering
services?
13-28
Illustration 13-2
Unearned and Earned
Revenue Accounts
LO 2 Explain the classification issues of short-term
debt expected to be refinanced.
What is a Current Liability?
BE13-6: Sports Pro Magazine sold 12,000 annual subscriptions
on August 1, 2010, for $18 each. Prepare Sports Pro’s August 1,
2010, journal entry and the December 31, 2010, annual adjusting
entry.
Aug. 1
Cash
216,000
Unearned revenue
216,000
(12,000 x $18)
Dec. 31
Unearned revenue
Subscription revenue
90,000
90,000
($216,000 x 5/12 = $90,000)
13-29
LO 2 Explain the classification issues of short-term
debt expected to be refinanced.
What is a Current Liability?
Sales Taxes Payable
Retailers must collect sales taxes or value-added taxes (VAT)
from customers on transfers of tangible personal property and
on certain services and then remit to the proper governmental
authority.
13-30
LO 2 Explain the classification issues of short-term
debt expected to be refinanced.
What is a Current Liability?
BE13-7: Dillons Corporation made credit sales of $30,000 which are
subject to 6% sales tax. The corporation also made cash sales which
totaled $20,670 including the 6% sales tax. (a) prepare the entry to
record Dillons’ credit sales. (b) Prepare the entry to record Dillons’
cash sales.
Accounts receivable
Sales
Sales tax payable
31,800
($30,000 x 6% = $1,800)
Cash
Sales ($20,670  1.06 = $19,500)
Sales tax payable
13-31
30,000
1,800
20,670
19,500
1,170
LO 2
What is a Current Liability?
Income Tax Payable
Businesses must prepare an income tax return and compute
the income tax payable.

Taxes payable are a current liability.

Corporations must make periodic tax payments.

Differences between taxable income and accounting
income sometimes occur (Chapter 19).
13-32
LO 2 Explain the classification issues of short-term
debt expected to be refinanced.
What is a Current Liability?
Employee-Related Liabilities
Amounts owed to employees for salaries or wages are
reported as a current liability.
Current liabilities may include:
13-33

Payroll deductions.

Compensated absences.

Bonuses.
LO 3 Identify types of employee-related liabilities.
What is a Current Liability?
Payroll Deductions
Taxes:
►
Social Security Taxes
►
Income Tax Withholding
Illustration 13-3
Summary of Payroll Liabilities
13-34
LO 3 Identify types of employee-related liabilities.
What is a Current Liability?
Illustration: Assume a weekly payroll of $10,000 entirely subject to
Social Security taxes (8%), with income tax withholding of $1,320 and
union dues of $88 deducted. The company records the wages and
salaries paid and the employee payroll deductions as follows.
Wages and salaries expense
Withholding taxes payable
1,320
Social security taxes payable
800
Union dues payable
88
Cash
13-35
10,000
7,792
LO 3 Identify types of employee-related liabilities.
What is a Current Liability?
Illustration: Assume a weekly payroll of $10,000 entirely subject to
Social Security taxes (8%), with income tax withholding of $1,320 and
union dues of $88 deducted. The company records the employer
payroll taxes as follows.
Payroll tax expense
800
Social security taxes payable
800
The employer must remit to the government its share of Social Security tax
along with the amount of Social Security tax deducted from each employee’s
gross compensation.
13-36
LO 3 Identify types of employee-related liabilities.
What is a Current Liability?
Compensated Absences
Paid absences for vacation, illness and maternity, paternity,
and jury leaves.
Vested rights – employer has an obligation to make payment to
an employee even after terminating his or her employment.
Accumulated rights – employees can carry forward to future
periods if not used in the period in which earned.
Non-accumulating rights – do not carry forward; they lapse if
not used.
13-37
LO 3 Identify types of employee-related liabilities.
What is a Current Liability?
Illustration: Amutron Inc. began operations on January 1, 2011. The
company employs 10 individuals and pays each €480 per week.
Employees earned 20 unused vacation weeks in 2011. In 2012, the
employees used the vacation weeks, but now they each earn €540
per week. Amutron accrues the accumulated vacation pay on
December 31, 2011, as follows.
Wages expense
9,600
Vacation wages payable
9,600
In 2012, it records the payment of vacation pay as follows.
13-38
Vacation wages payable
9,600
Wages expense
1,200
Cash
10,800
LO 3
What is a Current Liability?
Profit-Sharing and Bonus Plans
Payments to certain or all employees in addition to their
regular salaries or wages.
13-39

Bonuses paid are an operating expense.

Unpaid bonuses should be reported as a current liability.
LO 3 Identify types of employee-related liabilities.
Provisions
Provision is a liability of uncertain timing or amount.
Reported either as current or non-current liability.
Common types are
13-40
►
Obligations related to litigation.
►
Warrantees or product guarantees.
►
Business restructurings.
►
Environmental damage.
Uncertainty about
the timing or
amount of the
future expenditure
required to settle
the obligation.
LO 4 Explain the accounting for different
types of provisions.
Recognition of a Provision
Companies accrue an expense and related liability for a provision
only if the following three conditions are met:
1. Warrantees or product guarantees.
2. Probable that an outflow of resources will be required to
settle the obligation; and
3. A reliable estimate can be made.
13-41
LO 4 Explain the accounting for different
types of provisions.
Recognition of a Provision
Recognition Examples
A reliable estimate of the amount of the obligation can be determined.
Illustration 13-4
13-42
LO 4
Recognition of a Provision
Recognition Examples
Constructive obligation is an obligation that derives from a
company’s actions where:
1. By an established pattern of past practice, published policies,
or a sufficiently specific current statement, the company has
indicated to other parties that it will accept certain
responsibilities; and
2. As a result, the company has created a valid expectation on
the part of those other parties that it will discharge those
responsibilities.
13-43
LO 4 Explain the accounting for different
types of provisions.
Recognition of a Provision
Recognition Examples
A reliable estimate of the amount of the obligation can be determined.
Illustration 13-5
13-44
LO 4
Recognition of a Provision
Recognition Examples
A reliable estimate of the amount of the obligation can be determined.
Illustration 13-6
13-45
LO 4
Measurement of Provisions
How does a company determine the amount to report
for a provision?
IFRS:
Amount recognized should be the best estimate of the
expenditure required to settle the present obligation.
Best estimate represents the amount that a company would
pay to settle the obligation at the statement of financial
position date.
13-46
LO 4 Explain the accounting for different
types of provisions.
Measurement of Provisions
Measurement Examples
Management must use judgment, based on past or similar
transactions, discussions with experts, and any other pertinent
information.
Toyota warranties. Toyota might determine that 80
percent of its cars will not have any warranty cost, 12
percent will have substantial costs, and 8 percent will have a much
smaller cost. In this case, by weighting all the possible outcomes by
their associated probabilities, Toyota arrives at an expected value for
its warranty liability.
13-47
LO 4 Explain the accounting for different
types of provisions.
Measurement of Provisions
Measurement Examples
Management must use judgment, based on past or similar
transactions, discussions with experts, and any other pertinent
information.
Carrefour refunds. Carrefour sells many items at
varying selling prices. Refunds to customers for products
sold may be viewed as a continuous range of refunds, with each
point in the range having the same probability of occurrence. In this
case, the midpoint in the range can be used as the basis for
measuring the amount of the refunds.
13-48
LO 4 Explain the accounting for different
types of provisions.
Measurement of Provisions
Measurement Examples
Novartis lawsuit. Large companies like Novartis are
involved in numerous litigation issues related to their
products. Where a single obligation such as a lawsuit is being
measured, the most likely outcome of the lawsuit may be the best
estimate of the liability.
Measurement of the liability should consider the time value of money.
Future events that may have an impact on the measurement of the
costs should be considered.
13-49
LO 4 Explain the accounting for different
types of provisions.
Common Types of Provisions
Common Types:
1. Lawsuits
4. Environmental
2. Warranties
5. Onerous contracts
3. Premiums
6. Restructuring
IFRS requires extensive disclosure related to provisions in the notes to
the financial statements, however companies do not record or report in
the notes general risk contingencies inherent in business operations
(e.g., the possibility of war, strike, uninsurable catastrophes, or a
business recession).
13-50
LO 4 Explain the accounting for different
types of provisions.
Common Types of Provisions
Litigation Provisions
Companies must consider the following in determining whether
to record a liability with respect to pending or threatened
litigation and actual or possible claims and assessments.
1. Time period in which the underlying cause of action
occurred.
2. Probability of an unfavorable outcome.
3. Ability to make a reasonable estimate of the amount of
loss.
13-51
LO 4 Explain the accounting for different
types of provisions.
Common Types of Provisions
Litigation Provisions
With respect to unfiled suits and unasserted claims and
assessments, a company must determine
1. the degree of probability that a suit may be filed or a claim
or assessment may be asserted, and
2. the probability of an unfavorable outcome.
If both are probable, if the loss is reasonably estimable, and if the
cause for action is dated on or before the date of the financial
statements, then the company should accrue the liability.
13-52
LO 4 Explain the accounting for different
types of provisions.
Common Types of Provisions
BE13-10: Scorcese Inc. is involved in a lawsuit at December 31,
2010. (a) Prepare the December 31 entry assuming it is probable
that Scorcese will be liable for $900,000 as a result of this suit. (b)
Prepare the December 31 entry, if any, assuming it is not probable
that Scorcese will be liable for any payment as a result of this suit.
(a)
Lawsuit loss
Lawsuit liability
900,000
900,000
(b) No entry is necessary. The loss is not accrued because it
is not probable that a liability has been incurred at
12/31/10.
13-53
LO 4 Explain the accounting for different
types of provisions.
Common Types of Provisions
Warranty Provisions
Promise made by a seller to a buyer to make good on a deficiency
of quantity, quality, or performance in a product.
If it is probable that customers will make warranty claims and a
company can reasonably estimate the costs involved, the
company must record an expense.
13-54
LO 4 Explain the accounting for different
types of provisions.
Common Types of Provisions
Warranty Provisions
Two basic methods of accounting for warranty costs:
Cash-Basis method
►
Expense warranty costs as incurred, because
1. it is not probable that a liability has been
incurred, or
2. it cannot reasonably estimate the amount of
the liability.
13-55
LO 4 Explain the accounting for different
types of provisions.
Common Types of Provisions
Warranty Provisions
Two basic methods of accounting for warranty costs:
Accrual-Basis method
13-56
►
Charge warranty costs to operating expense in the
year of sale.
►
Method is the generally accepted method.
►
Referred to as the expense warranty approach.
LO 4 Explain the accounting for different
types of provisions.
Common Types of Provisions
BE13-13: Streep Factory provides a 2-year warranty with one of its
products which was first sold in 2010. In that year, Streep spent
$70,000 servicing warranty claims. At year-end, Streep estimates that
an additional $400,000 will be spent in the future to service warranty
claims related to 2010 sales. Prepare Streep’s journal entry to record
the $70,000 expenditure, and the December 31 adjusting entry.
2010
Warranty expense
70,000
Cash
12/31/10
70,000
Warranty expense
400,000
Warranty liability
13-57
400,000
LO 4 Explain the accounting for different
types of provisions.
Common Types of Provisions
Premiums and Coupons
Companies should charge the costs of premiums and coupons
to expense in the period of the sale that benefits from the plan.
Accounting:

Estimate the number of outstanding premium offers that
customers will present for redemption.

Charge cost of premium offers to Premium Expense and
credits Premium Liability.
13-58
LO 4 Explain the accounting for different
types of provisions.
Common Types of Provisions
Illustration: Fluffy Cakemix Company offered its customers a large
non-breakable mixing bowl in exchange for 25 cents and 10 boxtops.
The mixing bowl costs Fluffy Cakemix Company 75 cents, and the
company estimates that customers will redeem 60 percent of the
boxtops. The premium offer began in June 2011 and resulted in the
transactions journalized below. Fluffy Cakemix Company records
purchase of 20,000 mixing bowls as follows.
Inventory of Premium Mixing Bowls
Cash
15,000
15,000
$20,000 x .75 = $15,000
13-59
LO 4 Explain the accounting for different
types of provisions.
Common Types of Provisions
Illustration: The entry to record sales of 300,000 boxes of cake mix
would be:
300,000 x .80 = $240,000
Cash
240,000
Sales
240,000
Fluffy records the actual redemption of 60,000 boxtops, the receipt
of 25 cents per 10 boxtops, and the delivery of the mixing bowls as
follows.
Cash [(60,000 / 10) x $0.25]
1,500
Premium Expense
3,000
Inventory of Premium Mixing Bowls
13-60
Computation: (60,000 / 10) x $0.75 = $4,500
4,500
LO 4
Common Types of Provisions
Illustration: Finally, Fluffy makes an end-of-period adjusting entry
for estimated liability for outstanding premium offers (boxtops) as
follows.
Premium Expense
Premium Liability
13-61
6,000
6,000
LO 4
Common Types of Provisions
Environmental Provisions
A company must recognize an environmental liability
when it has an existing legal obligation associated with the
retirement of a long-lived asset and when it can reasonably
estimate the amount of the liability.
13-62
LO 4 Explain the accounting for different
types of provisions.
Common Types of Provisions
Environmental Provisions
Obligating Events. Examples of existing legal obligations, which
require recognition of a liability include, but are not limited to:
►
Decommissioning nuclear facilities,
►
Dismantling, restoring, and reclamation of oil and gas
properties,
►
Certain closure, reclamation, and removal costs of mining
facilities,
►
13-63
Closure and post-closure costs of landfills.
LO 4 Explain the accounting for different
types of provisions.
Common Types of Provisions
Environmental Provisions
Measurement. A company initially measures an environmental
liability at the best estimate of its future costs.
Recognition and Allocation. To record an environmental liability
a company includes
►
the cost associated with the environmental liability in the
carrying amount of the related long-lived asset, and
►
13-64
records a liability for the same amount.
LO 4 Explain the accounting for different
types of provisions.
Common Types of Provisions
Illustration: On January 1, 2010, Wildcat Oil Company erected an
oil platform in the Gulf of Mexico. Wildcat is legally required to
dismantle and remove the platform at the end of its useful life,
estimated to be five years. Wildcat estimates that dismantling and
removal will cost $1,000,000. Based on a 10 percent discount rate,
the fair value of the environmental liability is estimated to be
$620,920 ($1,000,000 x .62092). Wildcat records this liability on Jan.
1, 2011 as follows.
Drilling platform
Environmental liability
13-65
620,920
620,920
LO 4 Explain the accounting for different
types of provisions.
Common Types of Provisions
Illustration: During the life of the asset, Wildcat allocates the asset
retirement cost to expense. Using the straight-line method, Wildcat
makes the following entries to record this expense.
December 31, 2011, 2012, 2013, 2014, 2015
Depreciation expense ($620,920 / 5)
Accumulated depreciation
13-66
124,184
124,184
LO 4 Explain the accounting for different
types of provisions.
Common Types of Provisions
Illustration: In addition, Wildcat must accrue interest expense each
period. Wildcat records interest expense and the related increase in
the environmental liability on December 31, 2011, as follows.
December 31, 2011
Interest expense ($620,092 x 10%)
Environmental liability
13-67
62,092
62,092
LO 4 Explain the accounting for different
types of provisions.
Common Types of Provisions
Illustration: On January 10, 2016, Wildcat contracts with Rig
Reclaimers, Inc. to dismantle the platform at a contract price of
$995,000. Wildcat makes the following journal entry to
record settlement of the liability.
January 10, 2016
Environmental liability
1,000,000
Gain on settlement of liability
Cash
13-68
5,000
995,000
LO 4 Explain the accounting for different
types of provisions.
Common Types of Provisions
Onerous Contract Provisions
“The unavoidable costs of meeting the obligations exceed the
economic benefits expected to be received.”
The expected costs should reflect the least net cost of exiting from
the contract, which is the lower of
1. the cost of fulfilling the contract, or
2. the compensation or penalties arising from failure to fulfill the
contract.
13-69
LO 4 Explain the accounting for different
types of provisions.
Common Types of Provisions
Onerous Contract Provisions
Illustration: Sumart Sports operates profitably in a factory that it
has leased and on which it pays monthly rentals. Sumart decides to
relocate its operations to another facility. However, the lease on the
old facility continues for the next three years. Unfortunately, Sumart
cannot cancel the lease nor will it be able to sublet the factory to
another party. The expected costs to satisfy this onerous contract
are €200,000. In this case, Sumart makes the following entry.
Loss on lease contract
Lease contract liability
13-70
200,000
200,000
LO 4 Explain the accounting for different
types of provisions.
Common Types of Provisions
Onerous Contract Provisions
Assume the same facts as above for the Sumart example and the
expected costs to fulfill the contract are €200,000. However,
Sumart can cancel the lease by paying a penalty of €175,000. In
this case, Sumart should record the liability as follows.
Loss on lease contract
Lease contract liability
13-71
175,000
175,000
LO 4 Explain the accounting for different
types of provisions.
Common Types of Provisions
Restructuring Provisions
Restructurings are defined as a “program that is planned and
controlled by management and materially changes either
1. the scope of a business undertaken by the company; or
2. the manner in which that business is conducted.”
Companies are required to have a detailed formal plan for the restructuring
and to have raised a valid expectation to those affected by implementation
or announcement of the plan.
13-72
LO 4 Explain the accounting for different
types of provisions.
Common Types of Provisions
Restructuring Provisions
IFRS provides specific guidance related to certain costs and losses
that should be excluded from the restructuring provision.
Illustration 13-9
13-73
LO 4 Explain the accounting for different
types of provisions.
Common Types of Provisions
Restructuring Provisions
Illustration 13-10
13-74
LO 4
Common Types of Provisions
Self-Insurance
Self-insurance is not insurance, but risk assumption.
There is little theoretical justification for the establishment
of a liability based on a hypothetical charge to insurance
expense.
Conditions for accrual stated in IFRS are not satisfied prior
to the occurrence of the event.
13-75
LO 4 Explain the accounting for different
types of provisions.
Disclosures Related To Provisions
A company must provide a reconciliation of its beginning to
ending balance for each major class of provisions, identifying
what caused the change during the period.
In addition,
►
Provision must be described and the expected timing of
any outflows disclosed.
►
Disclosure about uncertainties related to expected
outflows as well as expected reimbursements should be
provided.
13-76
LO 4 Explain the accounting for different
types of provisions.
Contingent Liabilities
Contingent liabilities are not recognized in the financial
statements because they are
1. A possible obligation (not yet confirmed),
2. A present obligation for which it is not probable that
payment will be made, or
3. A present obligation for which a reliable estimate of the
obligation cannot be made.
13-77
LO 5 Identify the criteria used to account for and
disclose contingent liabilities and assets.
Contingent Liabilities
Contingent Liabilities Guidelines
Illustration 13-12
13-78
LO 5 Identify the criteria used to account for and
disclose contingent liabilities and assets.
Contingent Assets
A contingent asset is a possible asset that arises from past
events and whose existence will be confirmed by the occurrence
or non-occurrence of uncertain future events not wholly within the
control of the company. Typical contingent assets are:
1. Possible receipts of monies from gifts, donations, bonuses.
2. Possible refunds from the government in tax disputes.
3. Pending court cases with a probable favorable outcome.
Contingent assets are not recognized on the statement of financial position.
13-79
LO 5 Identify the criteria used to account for and
disclose contingent liabilities and assets.
Contingent Assets
Contingent Asset Guidelines
Illustration 13-14
Contingent assets are disclosed when an inflow of economic
benefits is considered more likely than not to occur (greater than 50
percent).
13-80
LO 5 Identify the criteria used to account for and
disclose contingent liabilities and assets.
Presentation of Current Liabilities
Presentation of Current Liabilities

Usually reported at their full maturity value.

Difference between present value and the maturity
value is considered immaterial.
13-81
LO 6 Indicate how to present and analyze liability-related information.
Presentation of Current Liabilities
Illustration 13-15
13-82
LO 6 Indicate how to present and analyze liability-related information.
Analysis of Current Liabilities
Liquidity regarding a liability is the expected time to elapse
before its payment. Two ratios to help assess liquidity are:
13-83
LO 6 Indicate how to present and analyze liability-related information.
Copyright
Copyright © 2011 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.
13-84
14-1
CHAPTER
14
NON-CURRENT LIABILITIES
Intermediate Accounting
IFRS Edition
Kieso, Weygandt, and Warfield
14-2
Learning Objectives
1.
Describe the formal procedures associated with issuing long-term
debt.
2.
Identify various types of bond issues.
3.
Describe the accounting valuation for bonds at date of issuance.
4.
Apply the methods of bond discount and premium amortization.
5.
Explain the accounting for long-term notes payable.
6.
Describe the accounting for the extinguishment of non-current
liabilities.
7.
Describe the accounting for the fair value option.
8.
Explain the reporting of off-balance-sheet financing arrangements.
9.
Indicate how to present and analyze non-current liabilities.
14-3
Long-Term Liabilities
Bonds Payable
Issuing bonds
Types and ratings
Long-Term
Notes Payable
Notes issued at face
value
Valuation
Notes not issued at
face value
Effective-interest
method
Special situations
Mortgage notes payable
14-4
Special Issues
Extinguishments
Fair value option
Off-balance-sheet
financing
Presentation and analysis
Bonds Payable
Non-current liabilities (long-term debt) consist of an
expected outflow of resources arising from present obligations
that are not payable within a year or the operating cycle of
the company, whichever is longer.
Examples:
►
Bonds payable
►
Pension liabilities
►
Long-term notes payable
►
Lease liabilities
►
Mortgages payable
Long-term debt has various
covenants or restrictions.
14-5
LO 1 Describe the formal procedures associated with issuing long-term debt.
Issuing Bonds

Bond contract known as a bond indenture.

Represents a promise to pay:
(1) sum of money at designated maturity date, plus
(2) periodic interest at a specified rate on the maturity
amount (face value).

Paper certificate, typically a $1,000 face value.

Interest payments usually made semiannually.

Used when the amount of capital needed is too large for one
lender to supply.
14-6
LO 1 Describe the formal procedures associated with issuing long-term debt.
Types and Ratings of Bonds
Common types found in practice:
14-7

Secured and Unsecured (debenture) bonds.

Term, Serial, and Callable bonds.

Convertible, Commodity-Backed, Deep-Discount bonds.

Registered and Bearer (Coupon) bonds.

Income and Revenue bonds.
LO 2 Identify various types of bond issues.
Types and Ratings of Bonds
Corporate bond listing.
Company
Name
Price as a % of par
Interest rate paid as
a % of par value
14-8
Interest rate based on price
Creditworthiness
LO 2 Identify various types of bond issues.
Valuation of Bonds Payable
Issuance and marketing of bonds to the public:
14-9

Usually takes weeks or months.

Issuing company must
►
Arrange for underwriters.
►
Obtain regulatory approval of the bond issue,
undergo audits, and issue a prospectus.
►
Have bond certificates printed.
LO 3 Describe the accounting valuation for bonds at date of issuance.
Valuation of Bonds Payable
Selling price of a bond issue is set by the

supply and demand of buyers and sellers,

relative risk,

market conditions, and

state of the economy.
Investment community values a bond at the present value of
its expected future cash flows, which consist of (1) interest and
(2) principal.
14-10
LO 3 Describe the accounting valuation for bonds at date of issuance.
Valuation of Bonds Payable
Interest Rate


Stated, coupon, or nominal rate = Rate written in the
terms of the bond indenture.

Bond issuer sets this rate.

Stated as a percentage of bond face value (par).
Market rate or effective yield = Rate that provides an
acceptable return commensurate with the issuer’s risk.

14-11
Rate of interest actually earned by the bondholders.
LO 3 Describe the accounting valuation for bonds at date of issuance.
Valuation of Bonds Payable
How do you calculate the amount of interest that is actually
paid to the bondholder each period?
(Stated rate x Face Value of the bond)
How do you calculate the amount of interest that is actually
recorded as interest expense by the issuer of the bonds?
(Market rate x Carrying Value of the bond)
14-12
LO 3 Describe the accounting valuation for bonds at date of issuance.
Valuation of Bonds Payable
Assume Stated Rate of 8%
14-13
Market Interest
Bonds Sold At
6%
Premium
8%
Par Value
10%
Discount
LO 3
Bonds Issued at Par
Illustration: Santos Company issues $100,000 in bonds dated
January 1, 2011, due in five years with 9 percent interest
payable annually on January 1. At the time of issue, the market
rate for such bonds is 9 percent.
Illustration 14-1
14-14
LO 3 Describe the accounting valuation for bonds at date of issuance.
Bonds Issued at Par
Illustration 14-1
Illustration 14-2
14-15
LO 3 Describe the accounting valuation for bonds at date of issuance.
Bonds Issued at Par
Journal entry on date of issue, Jan. 1, 2011.
Cash
100,000
Bonds payable
100,000
Journal entry to record accrued interest at Dec. 31, 2011.
Bond interest expense
9,000
Bond interest payable
9,000
Journal entry to record first payment on Jan. 1, 2012.
Bond interest payable
Cash
14-16
9,000
9,000
LO 3
Bonds Issued at a Discount
Illustration: Assuming now that Santos issues $100,000 in
bonds, due in five years with 9 percent interest payable
annually at year-end. At the time of issue, the market rate for
such bonds is 11 percent.
Illustration 14-3
14-17
LO 3 Describe the accounting valuation for bonds at date of issuance.
Bonds Issued at a Discount
Illustration 14-3
Illustration 14-4
14-18
LO 3 Describe the accounting valuation for bonds at date of issuance.
Bonds Issued at a Discount
Journal entry on date of issue, Jan. 1, 2011.
Cash
92,608
Bonds payable
92,608
Journal entry to record accrued interest at Dec. 31, 2011.
Bond interest expense
10,187
Bond interest payable
9,000
Bonds payable
1,187
Journal entry to record first payment on Jan. 1, 2012.
Bond interest payable
Cash
14-19
9,000
9,000
LO 3
Bonds Issued at a Discount
When bonds sell at less than face value:
14-20
►
Investors demand a rate of interest higher than stated rate.
►
Usually occurs because investors can earn a higher rate
on alternative investments of equal risk.
►
Cannot change stated rate so investors refuse to pay face
value for the bonds.
►
Investors receive interest at the stated rate computed on
the face value, but they actually earn at an effective rate
because they paid less than face value for the bonds.
LO 3 Describe the accounting valuation for bonds at date of issuance.
Effective-Interest Method
Bond issued at a discount – amount paid at maturity is more
than the issue amount.
Bonds issued at a premium – company pays less at maturity
relative to the issue price.
Adjustment to the cost is recorded as bond interest expense over
the life of the bonds through a process called amortization.
Required procedure for amortization is the effective-interest
method (also called present value amortization).
14-21
LO 4 Apply the methods of bond discount and premium amortization.
Effective-Interest Method
Effective-interest method produces a periodic interest expense
equal to a constant percentage of the carrying value of the bonds.
Illustration 14-5
14-22
LO 4 Apply the methods of bond discount and premium amortization.
Effective-Interest Method
Bonds Issued at a Discount
Illustration: Evermaster Corporation issued $100,000 of 8%
term bonds on January 1, 2011, due on January 1, 2016, with
interest payable each July 1 and January 1. Investors require an
effective-interest rate of 10%. Calculate the bond proceeds.
Illustration 14-6
14-23
LO 4 Apply the methods of bond discount and premium amortization.
Effective-Interest Method
Illustration 14-7
14-24
LO 4
Effective-Interest Method
Illustration 14-7
Journal entry on date of issue, Jan. 1, 2011.
Cash
Bonds payable
14-25
92,278
92,278
LO 4
Effective-Interest Method
Illustration 14-7
Journal entry to record first payment and amortization of the
discount on July 1, 2011.
Bond interest expense
Bonds payable
Cash
14-26
4,614
614
4,000
LO 4
Effective-Interest Method
Illustration 14-7
Journal entry to record accrued interest and amortization of the
discount on Dec. 31, 2011.
Bond interest expense
Bond interest payable
Bonds payable
14-27
4,645
4,000
645
LO 4
Effective-Interest Method
Bonds Issued at a Premium
Illustration: Evermaster Corporation issued $100,000 of 8%
term bonds on January 1, 2011, due on January 1, 2016, with
interest payable each July 1 and January 1. Investors require an
effective-interest rate of 6%. Calculate the bond proceeds.
Illustration 14-8
14-28
LO 4 Apply the methods of bond discount and premium amortization.
Effective-Interest Method
Illustration 14-9
14-29
LO 4
Effective-Interest Method
Illustration 14-9
Journal entry on date of issue, Jan. 1, 2011.
Cash
Bonds payable
14-30
108,530
108,530
LO 4
Effective-Interest Method
Illustration 14-9
Journal entry to record first payment and amortization of the
premium on July 1, 2011.
Bond interest expense
Bonds payable
Cash
14-31
3,256
744
4,000
LO 4
Effective-Interest Method
Accrued Interest
What happens if Evermaster prepares financial statements at the
end of February 2011? In this case, the company prorates the
premium by the appropriate number of months to arrive at the
proper interest expense, as follows.
Illustration 14-10
14-32
LO 4 Apply the methods of bond discount and premium amortization.
Effective-Interest Method
Accrued Interest
Illustration 14-10
Evermaster records this accrual as follows.
Bond interest expense
Bonds payable
Bond interest payable
14-33
1,085.33
248.00
1,333.33
LO 4 Apply the methods of bond discount and premium amortization.
Effective-Interest Method
Bonds Issued between Interest Dates
Bond investors will pay the seller the interest accrued
from the last interest payment date to the date of issue.
On the next semiannual interest payment date, bond
investors will receive the full six months’ interest payment.
14-34
LO 4 Apply the methods of bond discount and premium amortization.
Effective-Interest Method
Bonds Issued at Par
Illustration: Assume Evermaster issued its five-year bonds,
dated January 1, 2011, on May 1, 2011, at par ($100,000).
Evermaster records the issuance of the bonds between interest
dates as follows.
($100,000 x .08 x 4/12) = $2,667
Cash
100,000
Bonds payable
Cash
2,667
Bond interest expense
14-35
100,000
2,667
LO 4 Apply the methods of bond discount and premium amortization.
Effective-Interest Method
Bonds Issued at Par
On July 1, 2011, two months after the date of purchase,
Evermaster pays the investors six months’ interest, by making
the following entry.
Bond interest expense
Cash
14-36
($100,000 x .08 x 1/2) = $4,000
4,000
4,000
LO 4
Effective-Interest Method
Bonds Issued at Discount or Premium
Illustration: Assume that the Evermaster 8% bonds were issued
on May 1, 2011, to yield 6%. Thus, the bonds are issued at a
premium price of $108,039. Evermaster records the issuance of
the bonds between interest dates as follows.
Cash
108,039
Bonds payable
Cash
2,667
Bond interest expense
14-37
108,039
2,667
LO 4 Apply the methods of bond discount and premium amortization.
Effective-Interest Method
Bonds Issued at Discount or Premium
Evermaster then determines interest expense from the date of
sale (May 1, 2011), not from the date of the bonds (January 1,
2011).
Illustration 14-12
14-38
LO 4 Apply the methods of bond discount and premium amortization.
Effective-Interest Method
Bonds Issued at Discount or Premium
The premium amortization of the bo…