J-1 Appendix J Other Significant Liabilities Accounting in Action Learning Objectives After studying this chapter, you should be able to: [1] Describe the accounting and disclosure requirements for contingent liabilities [2] Contrast the accounting for operating and capital leases [3] Identify additional fringe benefits associated with employee compensation J-2 Contingent Liabilities Potential liability that may become an actual liability in the future Three levels of probability: J-3  Probable  Reasonably possible  Remote LO Contingent Liabilities J-4 Probability Accounting Probable Accrue Reasonably Possible Footnote Remote Ignore LO Contingent Liabilities Question A contingent liability should be recorded in the accounts when: a it is probable the contingency will happen, but the amount cannot be reasonably estimated b it is reasonably possible the contingency will happen, and the amount can be reasonably estimated c it is probable the contingency will happen, and the amount can be reasonably estimated d it is reasonably possible the contingency will happen, but the amount cannot be reasonably estimated J-5 LO Contingent Liabilities Recording a Contingent Liability Product warranty contracts result in future costs that companies may incur in replacing defective units or repairing malfunctioning units Estimated cost of honoring product warranty contracts should be recognized as an expense in the period in which the sale occurs J-6 LO Contingent Liabilities Illustration: Denson Manufacturing Company sells 10,000 washers and dryers at an average price of $600 each The selling price includes a one-year warranty on parts Denson expects that 500 units (5%) will be defective and that warranty repair costs will average $80 per unit In 2015, the company honors warranty contracts on 300 units, at a total cost of $24,000 At December 31, compute the estimated warranty liability Illustration J-1 Computation of estimated product warranty liability J-7 LO Contingent Liabilities Illustration: Denson Manufacturing Company sells 10,000 washers and dryers at an average price of $600 each The selling price includes a one-year warranty on parts Denson expects that 500 units (5%) will be defective and that warranty repair costs will average $80 per unit In 2015, the company honors warranty contracts on 300 units, at a total cost of $24,000 At December 31, compute the estimated warranty liability Make the required adjusting entry Warranty Expense Warranty Liability J-8 40,000 40,000 LO Contingent Liabilities Illustration: Prepare the entry to record the repair costs incurred in 2015 to honor warranty contracts on 2015 sales Warranty Liability 24,000 Repair Parts 24,000 Assume that the company replaces 20 defective units in January 2016, at an average cost of $80 in parts and labor Warranty Liability Repair Parts J-9 1,600 1,600 LO Contingent Liabilities Disclosure of Contingent Liabilities Illustration J-2 J-10 LO Lease Liabilities A lease is a contractual arrangement between a lessor (owner of the property) and a lessee (renter of the property) Illustration J-3 Types of leases J-12 LO Lease Liabilities Operating Lease Rent Expense Cash xxx Although technically legal title may not pass, the benefits from the use of the property J-13 xxx Substance versus Form Capital Lease Leased Equipment Lease Liability xxx xxx LO Lease Liabilities For a capital lease, the FASB has identified four criteria Lease transfers ownership of the property to the lessee Lease contains a bargain-purchase option Lease term is equal to 75 percent or more of the estimated economic life of the leased property One or more The present value of the minimum lease must be met payments (excluding executory costs) for capital lease equals or exceeds 90 percent of the fair accounting value of the leased property J-14 LO Lease Liabilities Illustration: Gonzalez Company decides to lease new equipment The lease period is four years; the economic life of the leased equipment is estimated to be five years The present value of the lease payments is $190,000, which is equal to the fair market value of the equipment There is no transfer of ownership during the lease term, nor is there any bargain purchase option Instructions (a) What type of lease is this? Explain (b) Prepare the journal entry to record the lease J-15 LO Lease Liabilities Illustration: (a) What type of lease is this? Explain Capitalization Criteria: Capital Lease? Transfer of ownership NO NO Bargain purchase option Lease term => 75% of economic life of leased property Present value of minimum lease payments => 90% of FMV of property J-16 Lease term yrs Economic life YES yrs - PV and FMV are the same YES 80% LO Lease Liabilities Illustration: (b) Prepare the journal entry to record the lease Leased Asset - Equipment 190,000 Lease Liability 190,000 The portion of the lease liability expected to be paid in the next year is a current liability The remainder is classified as a long-term liability J-17 LO Lease Liabilities Question The lessee must record a lease as an asset if the lease: a transfers ownership of the property to the lessor b contains any purchase option c term is 75% or more of the useful life of the leased property d payments equal or exceed 90% of the fair market value of the leased property J-18 LO Appendix J Other Significant Liabilities Accounting in Action Learning Objectives After studying this chapter, you should be able to: [1] Describe the accounting and disclosure requirements for contingent liabilities [2] Contrast the accounting for operating and capital leases [3] Identify additional fringe benefits associated with employee compensation J-19 Additional Liabilities for Employee Fringe Benefits Paid Absences Paid absences for vacation, illness, and holidays Accrue a liability if: J-20  Payment of the compensation is probable  The amount can be reasonably estimated LO Employee Fringe Benefits Illustration: Academy Company employees are entitled to one day’s vacation for each month worked If 30 employees earn an average of $110 per day in a given month Vacation Benefits Expense 3,300 Vacation Benefits Liability 3,300 Academy pays vacation benefits for 10 employees Vacation Benefits Liability 1,100 Cash 1,100 J-21 LO Employee Fringe Benefits Postretirement Benefits Post-retirement benefits are benefits that employers provide to retired employees for health care and life insurance pensions Companies account for post-retirement benefits on the accrual basis J-22 LO Employee Fringe Benefits Postretirement Health-Care and Life Insurance Benefits J-23  Companies estimate and expense postretirement costs during the working years of the employee  Companies rarely sets up funds to meet the cost of the future benefits ► Pay-as-you-go basis for these costs ► Major reason is that the company does not receive a tax deduction until it actually pays the medical bill LO Employee Fringe Benefits Pension Plans An arrangement whereby an employer provides benefits to employees after they retire for services they provided while they were working Pension PensionPlan Plan Administrator Administrator Employer Employer Retired Employees J-24 Contributions Benefit Payments Assets & Liabilities LO Employee Fringe Benefits Defined-Contribution Plan  Employer contribution determined by plan (fixed)  Risk borne by employees  Benefits based on plan value Pension Plans Defined-Benefit Plan  Benefit determined by plan  Employer contribution varies (determined by Actuaries)  Risk borne by employer  Companies record pension costs as an expense  Actuaries estimate the employer contribution by considering mortality rates, employee turnover, interest and earning rates, early retirement frequency, future salaries, etc J-25 LO Copyright “Copyright © 2014 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.” J-26 ... leased property J- 18 LO Appendix J Other Significant Liabilities Accounting in Action Learning Objectives After studying this chapter, you should be able to: [1] Describe the accounting and disclosure... Illustration J- 2 J- 10 LO Appendix J Other Significant Liabilities Accounting in Action Learning Objectives After studying this chapter, you should be able to: [1] Describe the accounting and disclosure.. .Appendix J Other Significant Liabilities Accounting in Action Learning Objectives After studying this chapter, you should be able to: [1] Describe the accounting and disclosure