What is the difference between a contingent liability and an estimated liability?

Liabilities must be reported according to the accepted accounting principles. The most common accounting standards are the International Financial Reporting Standards (IFRS). However, many countries also follow their own reporting standards, such as the GAAP in the U.S. or the Russian Accounting Principles (RAP) in Russia. Although the recognition and reporting of the liabilities comply with different accounting standards, the main principles are close to the IFRS.

For instance, if a customer uses $6,000 worth of warranty services, the company debits the estimated warranty payable by $6,000 and credits cash or accounts payable by $6,000. This reflects the actual cost incurred and reduces the liability, ensuring that the expense was matched with the revenue in the period the product was sold. Current or short-term liabilities are a form of debt that is expected to be paid within the longer of one year of the balance sheet date or one operating cycle.

All of our content is based on objective analysis, and the opinions are our own. The matching convention requires the recording of the expense in the period of the sale, not when the repair is made. In all these situations, a past event has occurred that may give rise to liability depending on some future event. Contingent liabilities are potential liabilities that may or may not occur depending on future events. The outstanding money that the restaurant owes to its wine supplier is considered a liability.

Jan takes $100,000 of warranties and divides it by $1,000,000 in sales to derive at 10%. Investors consider the interest rates of bonds as well as the quality of the assets, if any, that are pledged as security. The other provisions in a bond contract are of limited or no value if the issuing corporation is in financial difficulties.

A corporation in such difficulties may not be able to sell its bonds, regardless of the attractive provisions attached to them. Notice that the dollar amounts in the entries for BDCC are identical to those for Bendix. The difference is that BDCC is recognizing a receivable from Bendix while Bendix is recognizing a payable to BDCC. Generally, the amount of these liabilities must be estimated; the actual amount cannot be determined until the event that confirms the liability occurs. A contingent liability is the result of an existing condition or situation whose final resolution depends on some future event.

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2. However, it should disclose this item in a footnote on the financial statements.
3. The $75,000 notes payable, due March 31, 2018 is a long-term liability since it is to be repaid beyond one year of the balance sheet date.
4. Companies of all sizes finance part of their ongoing long-term operations by issuing bonds that are essentially loans from each party that purchases the bonds.
5. Loans are often repaid in equal blended payments containing both interest and principal.
6. ElectroGadgets would record this amount on their balance sheet at the end of the year as an accrued expense, reflecting the anticipated future cash outflow related to warranty claims.

The $20,000 notes payable, due November 30, 2024 is a current liability because its maturity date is within one year of the balance sheet date, a characteristic of a current liability. The $75,000 notes payable, due March 31, 2023 is a long-term liability since it is to be repaid beyond one year of the balance sheet date. An estimated liability is an obligation for which there is no definitive amount. Instead, the accountant must make an estimate based on the available data. This results in an accrued expense that appears within the current liabilities section of the balance sheet. A contingent liability is an obligation that might have to be paid in the future but there are still unresolved matters that make it only a possibility, not a certainty.

Recording the Issuance of Bonds at a Discount

Warranties are promises to repair or replace broken or damaged parts or products. an estimated liability Since a company is unsure how many warranty claims they may receive, an appropriate estimate is required to calculate accurate warranty liabilities. Therefore, Jan estimates the new market value of ABC’s property and applies the new property tax percentages to come up with estimated property tax liabilities. Now her balance sheet is complete with the most current, accurate information available.

Finally, during 2024, the company incurred $35,000 of warranty expenditures related to these printers. Past experience indicates that Micro Printing will incur an average of $40 in repair expense for each printer sold. To illustrate, assume that Micro Printing Company manufactures and sells high-speed laser printers for personal computers.

Scenario 2: The Bond Contract Interest Rate is 12% and the Market Interest Rate Is 8%

A loan is a form of long-term debt that can be used by a corporation to finance its operations. Loans are often repaid in equal blended payments containing both interest and principal. The stated rate of 8% is less than the market rate of 9%, resulting in a present value less than the face amount of $500,000. Since the market rate is greater, the investor would not be willing to purchase bonds paying less interest at the face value. The bond issuer must, therefore, sell these at a discount in order to entice investors to purchase them. For the seller, the discount amount of $32,520 () is then amortized over the life of the bond issuance using the effective interest rate method.

Current vs. Non-Current Liabilities

Many of the accrual adjusting entries require estimated amounts. Let’s look at a historical example using AT&T’s (T) 2020 balance sheet. The current/short-term liabilities are separated from long-term/non-current liabilities.

Net pay calculations

The interest amount paid and received by the bond-holder will net to two months. This makes intuitive sense given that the bonds have only been held for two months making interest for two months the correct amount. When sinking fund bonds are issued, the corporation is required to deposit funds at regular intervals with a trustee. This feature ensures the availability of adequate cash for the redemption of the bonds at maturity.

1. The descriptive information disclosed to readers of financial statements includes the interest rate and maturity date of the bond issue.
2. Therefore, Jan estimates the new market value of ABC’s property and applies the new property tax percentages to come up with estimated property tax liabilities.
3. For example, if the employer withheld $100 of EI from Employee A’s gross pay, the employer would have to pay EI of $140 (calculated as $100 x 1.4).
4. An example of a contingent liability is a lawsuit where it is probable there will be a loss but the amount cannot be reliably determined.
5. This makes intuitive sense given that the bonds have only been held for two months making interest for two months the correct amount.
6. Warranties are promises to repair or replace broken or damaged parts or products.
7. As such, debentures are usually only issued by large, well-established companies.

We took the expense last year when we had the revenue, but now we’re in January. So what we’re gonna do is reduce the liability because we’ve estimated that this was gonna happen, right? This was a portion of that $80,000 that we expected to be exercised, so we’re gonna reduce our liability cause this is taking away from the total amount we expected. Could have been cash, accounts payable, maybe to a vendor who’s gonna fix them for us.

An employee is paid their net pay (gross pay less total deductions). Payroll deductions are amounts subtracted by the employer from an employee’s gross pay. Some deductions are optional and deducted by the employer based on directions made by the employee.