FINANCIAL ACCOUNTING A USER PERSPECTIVE

1
FINANCIAL ACCOUNTINGA USER PERSPECTIVE

• Hoskin Fizzell Davidson
• Second Canadian Edition

2
Liabilities

• Chapter Nine

3
Recognition for Liabilities

• Classify as liabilities if
• Transfer of assets or the delivery of services or
  other benefits
• Company has little or no discretion
• Results from an event that has already occurred

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Contingent Liability

• If there is a possibility of the future transfer
  of assets, and
• If the future obligation is contingent on certain
  events occurring, then
• Company should disclose in a note to the
  financial statements

5
Valuation Methods

• Gross amount of the obligation
• May not measure obligation accurately
• Ignores the time value of money

6
Valuation Methods

• Net present value of the obligation
• Recognizes the time value of money
• Future payments of principal and interest are
  discounted back to the current period using a
  discount rate

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Valuation Methods

• Canadian practice
• Record liabilities at the present value of the
  future payments
• Exception short-term liabilities

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Working Capital Loans and Lines of Credit

• Short-term loan from a bank
• Secured by accounts receivable or inventory
  balances
• Results in negative cash balance

9
Accounts Payable

• Occur when goods or services are purchased on
  credit
• Called trade accounts payable
• Payment deferred for 30-60 days
• Generally do not carry interest charges, unless
  payment is delayed

10
Wages and Other Payroll Payables

• Accrual of wages since the last pay period
• Fringe benefits
• Health care, pensions, vacation pay
• Company acts as government agent in collecting
  taxes
• Income taxes, CPP (QPP), EI, WCB

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Wages and Other Payroll Payables

• Deductions from employees earned income
• SE-Wages expense 7,500.00
• L-Employee income tax payable 990.00
• L-CPP contribution payable 240.00
• L-EI taxes payable 202.50
• A-Cash 6,067.50

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Wages and Other Payroll Payables

• Additional amounts paid by employer
• SE-Wages expense 7,500.00
• L-CPP contribution payable 240.00
• L-EI taxes payable 283.50

13
Short-Term Notes and Interest Payable

• Short-term notes
• Borrowings that require repayment in the next
  year or operating cycle
• Carry explicit interest rates, or represent
  implicit interest amounts
• Interest expense and payable
• Recognized over the life of the loans

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Short-Term Notes and Interest Payable

• Example
• Borrowing of 10,000 at 9.
• Six monthly payments of 1,710.70
• Monthly instalments included reductions of the
  principal, plus interest
• Interest is calculated on the decreasing amount
  of principal

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Short-Term Notes and Interest Payable
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Short-Term Notes and Interest Payable

• Entry at the end of the first month
• SE-Interest expense 75.00
• L-Short-term note payable 1,635.70
• A-Cash 1,710.70

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Income Taxes Payable

• Companies are subject to taxes
• Federal corporate income taxes
• Provincial corporate taxes
• Payment of taxes does not always coincide with
  the incurrence of the tax
• Results in taxes payable

18
Warranty Payable

• Goods or services sold may result in guarantees
  to the buyer
• May result in warranty service
• Estimate the amount of warranty expense to match
  to the revenue from the sale
• Estimate based on past history

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Warranty Payable

• Record the estimated warranty obligation (in the
  period of the sale)
• SE-Warranty expense 460
• L-Estimated warranty obligation 460

20
Warranty Payable

• Record the repair work (in the period when the
  work is done)
• L-Estimated warranty obligation 126
• A-Cash 126

21
Unearned Revenues

• If customers are required to make downpayments
  prior to the receipt of goods or services
• Defer the recognition of revenue
• Liabilities
• Unearned revenues, or
• Deferred revenues

22
Current Portion of Long-Term Debt

• When long-term debt comes within a year of being
  due
• Must be reclassified as a current liability

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Commitments

• Purchase commitment
• An agreement to purchase items in the future for
  a negotiated price
• Discuss in a note to the financial statements if
  material to future operations

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Contingencies

• Contingent liabilities (losses)
• When the incurrence of the liability is
  contingent upon some future event
• Examples
• Settlement of a lawsuit
• Guarantee of another companys loan

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Contingencies

• In Canada, recognize a contingent loss if
• The use of assets or performance of services are
  required
• The amount of the loss can be reasonably estimated

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Deferred Taxes

• Differing calculations
• Income tax expense from the income statement
• Income tax payable according to Revenue Canada
• Two methods Liability method and Deferral method

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Liability Method

• Focuses on the balance sheet
• Attempts to measure the liability to pay taxes in
  the future based on a set of assumptions about
  future revenues and expenses

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Liability Method

• Calculate (pro forma) future income taxes payable
  based on temporary differences existing in the
  current period
• A liability in the current period will become a
  tax deduction as actual costs are incurred

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Liability Method

• Assumptions
• Income before tax and warranties 10,000
• Warranty expense (accounting purposes)
• Year 1 200
• Actual warranty costs incurred
• Year 1 50
• Year 2 70
• Year 3 80
• Tax rate 40

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Liability Method
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Liability Method
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Deferral Method

• Focuses on the income statement
• Tax expense is based on the recognized revenues
  and expenses on the income statement
• Uses the tax rates in effect in the current year

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Deferral Method
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Differences
Liability Method
Deferral Method

• Balance sheet focus
• Future tax rate
• Future reviews of tax assets and liabilities

• Income statement focus
• Current tax rate
• Deferred taxes drawn down no periodic reviews