Each business transaction is recorded using the double-entry accounting method with a credit entry to one account and a debit entry to another. Contingent liabilities are recorded as journal entries even though they’re not yet realized. Below are two examples where a bond is issued at a premium or discount. The interest expense and the amortization of the premium or discount is computed using the effective interest rate method. When sinking fund bonds are issued, the corporation is required to deposit funds at regular intervals with a trustee.

LO1 – Identify and explain current versus long-term liabilities.

In reality, bonds may be outstanding for a number of years, and related premiums and discounts can be substantial when millions of dollars of bonds are issued. These premiums and discounts are amortized using the effective interest method over the same number of periods as the related bonds are outstanding. The amortization of premiums and discounts is an intermediate financial accounting topic and is not covered here. Two common examples of estimated liabilities are warranties and income taxes. They’re recorded in the short-term liabilities section of the balance sheet.

1. There are several additional considerations related to the issue of bonds.
2. Most bond issues are sold in their entirety when market conditions are favourable.
3. A business maintains a Payroll Register that summarizes the hours worked for each employee per pay period.
4. The interest expense and the amortization of the premium or discount is computed using the effective interest rate method.

Recording the Issuance of Bonds at a Premium

A company might take out debt to expand and grow its business or an individual may take out a mortgage to purchase a home. Contingent what is an estimated liability liabilities are liabilities that may occur if a future event happens just like accrued liabilities and provisions. Shareholders and lenders should be warned about possible losses. An otherwise sound investment might look foolish after an undisclosed contingent liability is realized. On January 23, 2019, Zenox Company sold $105,000 of furniture on account that had a cost of $82,000. All of Zenox’s sales are covered by an unconditional 24-month replacement warranty.

Generally accepted accounting principles (GAAP) require contingent liabilities that can be estimated and are more likely to occur to be recorded in a company’s financial statements. In some cases, a company may want to repay a bond issue before its maturity. Examples of such bonds are callable bonds, which give the issuer the right to call and retire the bonds before maturity. For example, if market interest rates drop, the issuer will want to take advantage of the lower interest rate. The company can, then, sell a new bond issuance at the new, lower interest rate. Each bond issue is disclosed separately in the notes to the financial statements because each issue may have different characteristics.

Historical data indicates that warranty costs average 2% of the cost of sales. On January 29, 2019, Zenox replaced furniture with a cost of $2,000 that was covered by warranty. Libra Company borrowed $300,000 by signing a 3.5%, 45-day note payable on July 1, 2019. For example, on September 1, 2023, an investor purchases at face value, $100,000, 10-year, 8% bonds with interest payable each May 1 and November 1. Some bonds allow the bondholder to exchange bonds for a specified type and amount of the corporation’s share capital.

Bond Authorization

The bond indenture usually indicates the price at which bonds are callable. Corporate bond issuers are thereby protected in the event that market interest rates decline below the bond contract interest rate. The higher interest rate bonds can be called to be replaced by bonds bearing a lower interest rate. Shareholder approval is an important step because bondholders are creditors with a prior claim on the corporation’s assets if liquidation occurs. Further, dividend distributions may be restricted during the life of the bonds, and those shareholders affected usually need to approve this.

Accounting standards typically require these estimated liabilities to be updated regularly as new information becomes available. This way, the company’s financial statements accurately reflect its current financial position. “Estimated liability” refers to a potential financial obligation or debt that a company expects to owe in the future, but the exact amount is not yet known. These are often recorded as accrued expenses on a company’s balance sheet. Retirement plans are not the only liability that must be estimated.

Scenario 3: The Bond Contract Interest Rate is 12% and the Market Interest Rate Is 16%

A retailer has a sales tax liability on their books when they collect sales tax from a customer until they remit those funds to the county, city, or state. The most common liabilities are usually the largest such as accounts payable and bonds payable. Most companies will have these two-line items on their balance sheets because they’re part of ongoing current and long-term operations. 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.

The AT&T example has a relatively high debt level under current liabilities. Other line items like accounts payable (AP) and various future liabilities like payroll taxes will be higher current debt obligations for smaller companies. Contingent liabilities are those that are likely to be realized if specific events occur. These liabilities are categorized as being likely to occur and estimable, likely to occur but not estimable, or not likely to occur.