Question

(Current versus Long-Term Liabilities) Samson Corporation is preparing its December 31, 2020 statement of financial position. The following items may be reported as either current or long-term liabilities:

1. On December 15, 2020, Samson declared a cash dividend of $1.50 per common share to shareholders of record on December 31. The dividend is payable on January 15, 2021. Samson has issued 1 million common shares.
2. Also, on December 31, Samson declared a 10% stock dividend to shareholders of record on January 15, 2021. The dividend will be distributed on January 31, 2021. Samson's common shares have a market value of $54 per share.
3. At December 31, bonds payable of $100 million is outstanding. The bonds pay 7% interest every September 30 and mature in instalments of $25 million every September 30, beginning on September 30, 2021.
4. At December 31, 2019, customer advances were $12 million. During 2020, Samson collected $40 million in customer advances, and advances of $25 million were earned.
5. At December 31, 2020, Samson has an operating line of credit with a balance of $3.5 million outstanding. For several years now, Samson has successfully met all the conditions of this bank loan. If Samson defaults on any of the loan conditions in any way, the bank has the right to demand payment of the loan.
6. Samson is contingently liable for a bank loan in the amount of $10 million of its associated company, DD Ross Ltd. Samson has guaranteed the bank that, should DD Ross default on the loan or any outstanding interest payable, Samson will have to pay any and all outstanding balances. DD Ross is in an excellent financial position and shows no signs of defaulting on the terms of the bank loan.
Instructions
a. For each item above, indicate the dollar amounts to be reported as a current liability and as a long-term liability, if any.

b. Referring to the definition of a liability (discussed in Chapter 2), explain the accounting treatment of item 4 above.

c. Can you think of a reason why Samson would be willing to guarantee the bank loan of its associate, DD Ross Ltd.? What possible benefit could this burden bring Samson?

Answer 1

(a)
1.Dividends payable of $1,500,000 will be reported as a current liability (1,000,000 X $1.50).
2 No amounts are reported as a current or long-term liability. Stock dividends distributable are reported in the shareholders' equity section.
3.Bonds payable of $25,000,000 and interest payable of $1,750,000 ($100,000,000 X 7% X 3/12) will be reported as a current liability. Bonds payable of $75,000,000 will be reported as a long-term liability.
4.Customer advances of $27,000,000 will be reported as a current liability ($12,000,000 + $40,000,000 – $25,000,000).
5.Demand bank loans must be classified as current liabilities.
6.Although the terms and condition of the guarantee for the DD Ross Ltd. bank loan must be disclosed in the notes to the financial statements, no amount of liability is reportable on Samson’s statement of financial position.

(b)Liabilities have two essential characteristics:
i.it is obligation as a result of past events
ii. it involves cash outflow
. When Samson accepts an advance from a customer, an economic burden or obligation arises that is satisfied when Samson provides the related goods or services. The obligation is a present and enforceable until the related goods or services are delivered. Earned customer advances of $25 million no longer represent a liability because the economic burden or obligation has been satisfied.

(c)Samson may have a much stronger financial position than its Associate and by providing the guarantee the bank would be more confident that the loan and related interest will be fully repaid on a timely basis. The guarantee would typically lead to lower interest rates being charged on the loan. Since Samson is associated with DD Ross, increased income of the associate will benefit Samson indirectly