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

4. 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 amountof 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

7. Valuation Methods • Canadian practice • Record liabilities at the present value of the future payments • Exception: short-term liabilities

8. 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

11. 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

12. 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

14. 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

15. Short-Term Notes and Interest Payable

16. 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

17. 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

19. 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

23. 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

24. Contingencies • Contingent liabilities (losses) • When the incurrence of the liability is contingent upon some future event • Examples • Settlement of a lawsuit • Guarantee of another company’s loan

25. 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

26. 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

27. 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

28. 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

29. 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%

30. Liability Method

31. Liability Method

32. 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

33. Deferral Method

34. 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 Differences Liability Method Deferral Method