CHAPTER ONE

CURRENT LIABILITIES, PROVISIONS, AND

CONTINGENCIES

13-1
 CURRENT LIABILITIES
“What is a Liability?”

Liability is defined as present obligation of the company

arising from past events, the settlement of which is expected
to result in an outflow from the company of resources,
embodying economic benefits.

Three essential characteristics:

1. Present obligation.

2. Arises from past events.

3. Results in an outflow of resources

(cash, goods, services).
13-2
 CURRENT LIABILITIES
Recall: Current assets are cash or other assets that companies
reasonably expect to convert into cash, sell, or consume in operations
within a single operating cycle or within a year.
Current liabilities are “obligations whose liquidation is reasonably
expected to require use of existing resources properly classified as
current assets, or the creation of other current liabilities.”

A 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.
13-3
 CURRENT LIABILITIES

Typical Current Liabilities:

1. Accounts payable. 6. Customer advances and
deposits.
2. Notes payable.
7. Unearned revenues.
3. Current maturities of long-
term debt. 8. Sales and value-added
taxes payable.
4. Short-term obligations
expected to be refinanced. 9. Income taxes payable.

5. Dividends payable. 10. Employee-related liabilities.

13-4
 CURRENT LIABILITIES

Accounts Payable (trade accounts payable)

Balances owed to others for goods, supplies, or services
purchased on open account.
 Arises because of 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.
 These liabilities typically are noninterest-bearing and are
reported at their face amounts.
13-5
 CURRENT LIABILITIES

Notes Payable
Written promises to pay a certain sum of money on a
specified future date.
 Arise from purchases, financing, or other transactions.
 Notes classified as short-term or long-term.
 Notes may be interest-bearing or zero-interest-bearing.

13-6
 CURRENT LIABILITIES

Interest-Bearing Note Issued

Illustration: Castle National Bank agrees to lend €100,000 on
March 1, 2015, 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 100,000

13-7
 Interest-Bearing Note Issued

If Landscape prepares financial statements semiannually, it

makes the following adjusting entry to recognize interest
expense and interest payable at June 30, 2015:

Interest calculation = (€100,000 x 6% x 4/12) = €2,000

Interest Expense 2,000

Interest Payable 2,000

13-8
 Interest-Bearing Note Issued

At maturity (July 1, 2016), Landscape records payment of the

note and accrued interest as follows.

Notes Payable 100,000

Interest Payable 2,000
Cash 102,000

13-9
 CURRENT LIABILITIES
Zero-Interest-Bearing Note Issued
This note does not explicitly state an interest rate on the
face of a note. Interest is still charged, however. At
maturity, the borrower must pay back an amount greater
than the cash received at issuance date.
Illustration: On March 1, Landscape issues a €102,000, four-month,
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 100,000
OR
Cash 100,000
Discount on Notes Payable 2,000
13-10
Notes Payable 102,000
 Zero-Interest-Bearing Note Issued

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/Discount on N/P 2,000

At maturity (July 1), Landscape must pay the note, as follows.

Notes Payable 102,000

Cash 102,000

13-11
 CURRENT LIABILITIES

E13-2: (Accounts and Notes Payable) The following are selected

2015 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
12-month, zero-interest-bearing $81,000 note.

Prepare journal entries for the selected transactions.

13-12 LO 1
 CURRENT LIABILITIES

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 50,000

Accounts Payable 50,000

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 CURRENT LIABILITIES

Oct. 1 - Issued a $50,000, 12-month, 8% note to Orion in

payment of account.

Oct. 1 Accounts Payable 50,000

Notes Payable 50,000

Interest calculation = ($50,000 x 8% x 3/12) = $1,000

Dec. 31 Interest Expense 1,000

Interest Payable 1,000

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 CURRENT LIABILITIES

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

Discount on Note payable 6,000
Notes Payable 81,000
Interest calculation = ($6,000 x 3/12) = $1,500

Dec. 31 Interest Expense 1,500

Discount on Notes Payable 1,500

13-15
 CURRENT LIABILITIES

Current Maturities of Long-Term Debt

Portion of bonds, mortgage notes, and other long-term
indebtedness that matures within the next fiscal year. It
categorizes this amount as current maturities of long-term
debt
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.

13-16
 CURRENT LIABILITIES

Short-Term Obligations Expected to Be Refinanced

Refinancing a short term obligation on a long term basis
means either replacing it with a long term obligation or equity
securities or renewing, extending or replacing it with short
term obligations for an uninterrupted period extending beyond
one year (or the normal operating cycle) from the date of the
company’s statement of financial position.
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

13-17 for at least 12 months after the reporting date.
 CURRENT LIABILITIES

E13-4 (Refinancing of Short-Term Debt): The CFO for Yong

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, 2014. 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, 2014, on Yongs’ statement of financial position.
13-18
 CURRENT LIABILITIES

Short-Term Obligation A: Yong has a $50,000 short-term

obligation due on March 1, 2015. The CFO discussed with its
lender whether the payment could be extended to March 1, 2017,
provided Yong agrees to provide additional collateral. An
agreement is reached on February 1, 2015, to change the loan
terms to extend the obligation’s maturity to March 1, 2017. The
financial statements are authorized for issuance on April 1, 2015.

Liability of Refinance Liability due Statement

$50,000 completed for payment Issuance

Dec. 31, 2014 Feb. 1, 2015 Mar. 1, 2015 Apr. 1, 2015

13-19
 CURRENT LIABILITIES

Short-Term Obligation A: Yong has a $50,000 short-term

obligation due on March 1, 2015. The CFO discussed with its
lender whether the payment could be extended to March 1, 2017,
provided Yong agrees to provide additional collateral. An
agreement is reached on February 1, 2015, to change the loan
terms to extend the obligation’s maturity to March 1, 2017. The
financial statements are authorized for issuance on April 1, 2015.

Current Liability
of $50,000 Since the agreement was not in place as of the reporting
date (December 31, 2014), the obligation should be
Dec. 31, 2014 reported as a current liability.

13-20
 CURRENT LIABILITIES

Short-Term Obligation B: Yong also has another short-term

obligation of $120,000 due on February 15, 2015. In its discussion
with the lender, the lender agrees to extend the maturity date to
February 1, 2016. The agreement is signed on December 18,
2014. The financial statements are authorized for issuance on
March 31, 2015.

Refinance Liability of Liability due Statement

completed $120,000 for payment Issuance

Dec. 18, 2014 Dec. 31, 2014 Feb. 15, 2015 Mar. 31, 2015

13-21
 CURRENT LIABILITIES

Short-Term Obligation B: Yong also has another short-term

obligation of $120,000 due on February 15, 2015. In its discussion
with the lender, the lender agrees to extend the maturity date to
February 1, 2016. The agreement is signed on December 18,
2014. The financial statements are authorized for issuance on
March 31, 2015.
Non-Current
Refinance Liability of Since the agreement was in place as of
completed $120,000
the reporting date (December 31, 2014),
the obligation is reported as a non-
Dec. 18, 2014 Dec. 31, 2014
current liability.

13-22
 Current Liabilities

Illustration: On December 31, 2014, Alexander Company had

$1,200,000 of short-term debt in the form of notes payable due
February 2, 2015. On January 21, 2015, the company issued 25,000
shares of its common stock for $36 per share, receiving $900,000
proceeds after brokerage fees and other costs of issuance. On
February 2, 2015, the proceeds from the stock sale, supplemented by
an additional $300,000 cash, are used to liquidate the $1,200,000
debt. The December 31, 2014, balance sheet is issued on February
23, 2015.
Instructions:
Show how the $1,200,000 of short-term debt should be presented on
the December 31, 2014, balance sheet, including note disclosure

13-23
 CURRENT LIABILITIES: Dividends
Payable
Amount owed by a corporation to its stockholders as a result of board
of directors’ authorization.
 Because companies always pay cash dividends within one year
of declaration (generally within three months), they classify
them as current liabilities.
 Undeclared dividends on cumulative preference shares not
recognized as a liability. Why? Because preferred dividends in
arrears are not an obligation until the board of directors
a u t h o r i z e s the payment.
 Dividends payable in the form of additional shares are not
recognized as a liability because such stock dividends do not
require future outlays of assets or services.
► Reported in equity because they represent retained
earnings in the process of transfer to paid-in capital.
13-24
 CURRENT LIABILITIES

Customer Advances and Deposits

Returnable cash deposits received from customers and
employees.
 To guarantee performance of a contract or service or
 As guarantees to cover payment of expected future
obligations.
Note: May be classified as current or non-current liabilities.
The classification of these items as current or noncurrent liabilities
depends on the time between the date of the deposit and the
termination of the relationship that required the deposit.
13-25
 CURRENT LIABILITIES: Unearned
Revenues
Payment received before providing goods or performing
services.
How do these companies account for unearned revenues ?
1. When a company receives an advance payment, it debits Cash, and
credits a current liability account identifying the source of the
unearned revenue.
2. When a company recognizes revenue, it debits the unearned
revenue account, and credits a revenue account.

13-26
 CURRENT LIABILITIES

BE13-6: Sports Pro Magazine sold 12,000 annual subscriptions

on August 1, 2015, for €18 each. Prepare Sports Pro’s August 1,
2015, journal entry and the December 31, 2015, annual adjusting
entry.

Aug. 1 Cash 216,000

Unearned Revenue 216,000
(12,000 x €18)

Dec. 31 Unearned Revenue 90,000

Subscription Revenue 90,000
(€216,000 x 5/12 = €90,000)

13-27 LO 2
 CURRENT LIABILITIES

Sales and Value-Added Taxes Payable

Consumption taxes are generally either
 a sales tax or
 a value-added tax (VAT).

Purpose is to generate revenue for the government.

The two systems use different methods to accomplish this

objective.

13-28
 Sales Taxes Payable

Illustration: Halo Supermarket sells loaves of bread to

consumers on a given day for €2,400. Assuming a sales tax
rate of 10 percent, Halo Supermarket makes the following entry
to record the sale.
Cash 2,640
Sales Revenue 2,400
Sales Taxes Payable 240

13-29
 Value-Added Taxes Payable

Illustration: The VAT is collected every time a business

purchases products from another business in the product’s
supply chain. To illustrate,

1. Hill Farms Wheat Company grows wheat and sells it to

Sunshine Baking for €1,000. Hill Farms Wheat makes the
following entry to record the sale, assuming the VAT is 10
percent.

Cash 1,100
Sales Revenue 1,000
Value-Added Taxes Payable 100

13-30
 Value-Added Taxes Payable

2. Sunshine Baking makes loaves of bread from this wheat and

sells it to Halo Supermarket for €2,000. Sunshine Baking
makes the following entry to record the sale, assuming the
VAT is 10 percent.

Cash 2,200
Sales Revenue 2,000
Value-Added Taxes Payable 200

Sunshine Baking then remits €100 to the government, not €200. The
reason: Sunshine Baking has already paid €100 to Hill Farms Wheat.

13-31
 Value-Added Taxes Payable

3. Halo Supermarket sells the loaves of bread to consumers for

€2,400. Halo Supermarket makes the following entry to
record the sale, assuming the VAT is 10 percent.

Cash 2,640
Sales Revenue 2,400
Value-Added Taxes Payable 240

Halo Supermarket then sends only €40 to the tax authority as it

deducts the €200 VAT already paid to Sunshine Baking.

13-32
 CURRENT LIABILITIES

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. Because of these differences, the amount of
income taxes payable to the government in any given year may
differ substantially from income tax expense as reported on the
financial statements.
13-33
 CURRENT LIABILITIES

Employee-Related Liabilities
Amounts owed to employees for salaries or wages are
reported as a current liability.

Current liabilities may include:

 Payroll deductions.
 Compensated absences.
 Bonuses.

13-34
 Employee-Related Liabilities
Payroll Deductions
To the extent that a company has not remitted the amounts
deducted to the proper authority at the end of the accounting
period, it should recognize them as current liabilities.
Taxes:
► Social Security Taxes
► Income Tax Withholding

13-35
 Employee-Related Liabilities

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 10,000

Withholding Taxes Payable 1,320
Social Security Taxes Payable 800
Union Dues Payable 88
Cash 7,792

13-36
 Employee-Related Liabilities

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.
13-37
 Employee-Related Liabilities

Profit-Sharing and Bonus Plans

Payments to certain or all employees in addition to their regular
salaries or wages.
Frequently the bonus amount depends on the company’s yearly
profit.
A company may consider bonus payments to employees as
additional wages and should include them as a deduction in
determining the net income for the year.
 Bonuses paid are an operating expense.
 Unpaid bonuses should be reported as a current liability.

13-38
 PROVISIONS

Provision (IAS 37) is a liability of uncertain timing or

amount.

Reported either as current or non-current liability.

Common types are

Uncertainty about the
► Obligations related to litigation (lawsuit). timing or amount of
the future expenditure
► Warrantees or product guarantees. required to settle the
obligation.
► Business restructurings.
► Environmental damage.

13-39
 Recognition of a Provision

Companies accrue an expense and related liability for a

provision only if the following three conditions are met:
1. Company has a present obligation (legal or constructive) as
a result of a past event;

2. Probable that an outflow of resources will be required to

settle the obligation; and

3. A reliable estimate can be made.

13-40
 Recognition of a Provision
Recognition Examples
A reliable estimate of the amount of the obligation can be determined.

ILLUSTRATION 13-5
Recognition of a Provision—Warranty
13-41
 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.

13-42
 Recognition Examples

A reliable estimate of the amount of the obligation can be determined.

ILLUSTRATION 13-6
Recognition of a Provision—Refunds
13-43
 Recognition Examples
A reliable estimate of the amount of the obligation can be determined.

ILLUSTRATION 13-7
13-44 Recognition of a Provision—Lawsuit
 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.

13-45
 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.

13-46
 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.

13-47
 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,

if material. Future events that may have an impact on the
measurement of the costs should be considered.

13-48
 Common Types of Provisions

Common Types:
1. Lawsuits 4. Environmental

2. Warranties 5. Onerous contracts

3. Consideration payable 6. Restructuring

IFRS requires extensive disclosure related to provisions in the notes to

the financial statements. 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).

13-49
 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. The time period in which the underlying cause of action

occurred.

2. The probability of an unfavorable outcome.

3. Ability to make a reasonable estimate of the amount of

13-50
loss.
 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.
13-51
 Litigation Provisions

BE13-12: Scorcese Inc. is involved in a lawsuit at December 31,

2015. (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 900,000

Lawsuit Liability 900,000

(b) No entry is necessary. The loss is not accrued because it

is not probable that a liability has been incurred at
12/31/15.
13-52
 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.

13-53
 Warranty Provisions

Companies often provide one of two types of warranties to

customers:

Assurance-Type Warranty
A quality guarantee that the good or service is free from
defects at the point of sale.
 Obligations should be expensed in the period the
goods are provided or services performed (in other
words, at the point of sale).
 Company should record a warranty liability.

13-54
 Assurance-Type Warranty

Facts: Denson Machinery Company begins production of a new

machine in July 2015 and sells 100 of these machines for $5,000
cash by year-end. Each machine is under warranty for one year.
Denson estimates, based on past experience with similar
machines, that the warranty cost will average $200 per unit.
Further, as a result of parts replacements and services performed
in compliance with machinery warranties, it incurs $4,000 in
warranty costs in 2015 and $16,000 in 2016.

Question: What are the journal entries for the sale and the
related warranty costs for 2015 and 2016?

13-55
 Assurance-Type Warranty

Solution: For the sale of the machines and related warranty

costs in 2015 the entry is as follows.

1. To recognize sales of machines and accrual of warranty

liability:

July–December 2015

Cash 500,000
Warranty Expense 20,000
Warranty Liability 20,000
Sales Revenue 500,000

13-56
 Assurance-Type Warranty

Solution: For the sale of the machines and related warranty

costs in 2015 the entry is as follows.

2. To record payment for warranties incurred:

July–December 2015

Warranty Liability 4,000

Cash, Inventory, Accrued Payroll 4,000

The December 31, 2015, statement of financial position reports

Warranty Liability as a current liability of $16,000. The income statement
for 2015 reports Warranty Expense of $20,000.

13-57
 Assurance-Type Warranty

Solution: For the sale of the machines and related warranty

costs in 2015 the entry is as follows.

3. To record payment for warranty costs incurred in 2016

related to 2015 machinery sales:

January 1–December 31, 2016

Warranty Liability 16,000

Cash, Inventory, Accrued Payroll 16,000

At the end of 2016, no warranty liability is reported for the machinery

sold in 2015.

13-58
 Warranty Provisions

Companies often provide one of two types of warranties to

customers:

Service-Type Warranty
An extended warranty on the product at an additional cost.
 Usually recorded in an Unearned Warranty Revenue
account.
 Recognize revenue on a straight-line basis over the period
the service-type warranty is in effect.

13-59
 Service-Type Warranty

Facts: You purchase an automobile from Hamlin Auto for €30,000

on January 2, 2014. Hamlin estimates the assurance-type
warranty costs on the automobile to be €700 (Hamlin will pay for
repairs for the first 36,000 miles or three years, whichever comes
first). You also purchase for €900 a service-type warranty for an
additional three years or 36,000 miles. Hamlin incurs warranty
costs related to the assurance-type warranty of €500 in 2014 and
€200 in 2015. Hamlin records revenue on the service-type
warranty on a straight-line basis.

Question: What entries should Hamlin make in 2014 and 2017?

13-60
 Service-Type Warranty

Solution:

1. To record the sale of the automobile and related

warranties:

January 2, 2014

Cash (€30,000 + €900) 30,900

Warranty Expense 700
Warranty Liability 700
Unearned Warranty Revenue 900
Sales Revenue 30,000

13-61
 Service-Type Warranty

Solution:

2. To record warranty costs incurred in 2014:

January 2–December 31, 2014

Warranty Liability 500

Cash, Inventory, Accrued Payroll 500

13-62
 Service-Type Warranty

Solution:

3. To record revenue recognized in 2017 on the service-

type warranty:

January 1–December 31, 2017

Unearned Warranty Revenue (€900 ÷ 3) 300

Warranty Revenue 300

13-63
 Common Types of Provisions

Consideration Payable
Companies often make payments (provide consideration) to
their customers as part of a revenue arrangement.

Companies offer premiums, coupon offers, and rebates to

stimulate sales.
 Companies should charge the costs of premiums and
coupons to expense in the period of the sale that
benefits from the plan.

13-64
 Common Types of Provisions

Environmental Provisions
Estimates to clean up existing toxic wastes sites are substantial.
In addition, cost estimates of cleaning up our air and preventing
future deterioration of the environment run even higher.
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.

13-65
 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,
► Closure and post-closure costs of landfills.

13-66
 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
► records a liability for the same amount.

13-67
 Environmental Provisions

Illustration: On January 1, 2015, 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, 2015 as follows.

Drilling Platform 620,920

Environmental Liability 620,920

13-68
 Environmental 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, 2015, 2016, 2017, 2018

Depreciation Expense ($620,920 ÷ 5) 124,184

Accumulated Depreciation—Plant Assets
124,184

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 Environmental 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, 2015, as follows.

December 31, 2015

Interest Expense ($620,920 x 10%) 62,092

Environmental Liability 62,092

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 Environmental Provisions

Illustration: On January 10, 2020, 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, 2020

Environmental Liability 1,000,000

Gain on Settlement of Environmental Liability 5,000
Cash 995,000

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 Common Types of Provisions
Onerous Contract Provisions
“The unavoidable costs of meeting the obligations exceed the
economic benefits expected to be received.”
An example of an onerous contract is a loss recognized on
unfavorable non cancelable commitments relate to inventory items.

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.

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 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 200,000

Lease Contract Liability 200,000

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 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 175,000

Lease Contract Liability 175,000

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 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.

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 Disclosure 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.

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 CONTINGENCIES
“An existing condition, situation, or set of circumstances
involving uncertainty as to possible gain (gain contingency)
or loss (loss contingency) to an enterprise that will
ultimately be resolved when one or more future events occur
or fail to occur.”
Contingent Liabilities/Loss Contingencies
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.
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 Loss Contingencies

Probability Accounting
and reasonably estimable
Probable Accrue
but not re
asonably e
stimable

Reasonably
Footnote
Possible

Remote Ignore

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 Contingent Liabilities

Illustration 13-16 presents the general guidelines for the

accounting and reporting of contingent liabilities.

ILLUSTRATION 13-16
Contingent Liability
Guidelines

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 CONTINGENCIES

Contingent Assets/Gain Contingencies

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.

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 Contingent Assets

The general rules related to contingent assets are presented

in Illustration 13-18.

ILLUSTRATION 13-18
Contingent Asset Guidelines

Contingent assets are disclosed when an inflow of economic benefits

is considered more likely than not to occur (greater than 50 percent).

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 PRESENTATION AND ANALYSIS

Presentation of Current Liabilities

 Usually reported at their full maturity value.
 Difference between present value and the maturity
value is considered immaterial.

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