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Chapter 13: Current Liabilities

  • Page ID
    97940
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    Toyota Applies the Brakes

    On March 19, 2014, Toyota Motor Corporation agreed to settle an outstanding legal issue with the U.S. Department of Justice by paying a $1.2 billion (USD) penalty. This amount represented approximately 1/3 of the company's total profit in 2013. The issue related to a problem of unintended acceleration in various Toyota vehicles and the subsequent investigation of those problems. These problems received widespread media attention between November 2009 and January 2010, when Toyota recalled over 9 million vehicles worldwide to replace faulty floor mats and repair sticking accelerator pedals. The effect of this problem, and the resulting media frenzy, was significant: in one week of trading in January 2010, Toyota's share price dropped by 15%. The total cost to the company is difficult to determine, but is likely several billion dollars when the effects of lost sales, repairs, and the settled and outstanding lawsuits are combined with the above penalty.

    Companies like Toyota that manufacture complex consumer products can face significant product liabilities. Automobiles are likely to carry warranties that may require service over a period of several years. The costs of providing this service may be significant if there are product quality issues. As well, automobile manufacturers engage in a process of voluntary recalls when product faults potentially impact public safety. When product faults cause injury or death, the company faces further liabilities in the form of legal actions taken by the survivors.

    From an accounting perspective, the question is whether these warranty and product safety costs represent liabilities and, if so, how can they be measured? On Toyota's March 31, 2015, financial statement, an amount of 1,328,916 million yen was accrued as a "liability for quality assurance." Note 13 describes this amount as a combination of estimated warranty costs and costs for recalls and other safety measures. Since 2013, this amount had risen by 15% from the previous year by 32%.

    Toyota has recognized both the warranty costs and the recall costs as liabilities at the time of sale, based on the terms of the warranty contract and past experience. Although past experience can certainly provide a base for these estimations, there is no precise way to predict future expenditures, as there are numerous variables that affect product quality.

    With respect to legal actions taken by customers, these are even more difficult to predict, as the results are determined through the due process of the legal system. As a consequence of the unintended acceleration issue, Toyota faced hundreds of lawsuits, both individual and class action, claiming a wide range of damages. Note 23 of Toyota's March 31, 2015, financial statements indicated that the company was "unable to estimate a reasonably possible loss" beyond the amounts accrued.

    It is clear that companies like Toyota face significant challenges in accounting for product warranty and product safety issues. These amounts do, however, need to be accrued and disclosed when possible, as the amounts can be material to the operation of the business.

    (Sources: Douglas & Fletcher, 2014; Toyota Motor Corporation, 2016)

    Learning Objectives

    After completing this chapter, you should be able to:

    • Define current liabilities and account for various types of current liabilities.
    • Differentiate between financial and non-financial current liabilities.
    • Explain the accounting treatment of different types of current, financial liabilities.
    • Explain the accounting treatment of different types of current, non-financial liabilities.
    • Discuss the nature of provisions and contingencies and identify the appropriate accounting treatment for these.
    • Discuss the nature of commitments and guarantees and identify the appropriate accounting disclosure for these items.
    • Describe the presentation and disclosure requirements for various types of current liabilities.
    • Use ratio analysis of current liabilities to supplement the overall evaluation of a company's liquidity.
    • Identify differences in the accounting treatment of current liabilities between IFRS and ASPE.

    Introduction

    If you recall our discussion about financial statement elements from the review chapter, one of the key components of financial statements identified by the conceptual framework is the liability. The proper management of liabilities is an essential feature of business success. Liabilities can impose legal and operational constraints on a business, and managers need to be prudent and strategic in the management of these obligations. Shareholders and potential investors are also interested in the composition of a company's liabilities, as the restrictions created by these obligations will have a significant effect on the timing and amount of future cash flows. Creditors, of course, have a direct interest in the company's liabilities, as they are the ultimate beneficiaries of these obligations. Because of the broad interest in these types of accounts, it is important that the accountant have a thorough understanding of the issues in recognition, measurement, and disclosure of liabilities.

    Liabilities can take many forms. The most obvious example would be when a company borrows money from a bank and agrees to repay it later. Another common situation occurs when companies purchase goods on credit, agreeing to pay the supplier within a specified time period. These types of examples are easy to understand, but there are situations where the existence of the liability may not be so clear. When a retail store offers loyalty points to its customers, does this create a liability for the store? Or, when you purchase a new car and the manufacturer offers a five-year warranty against repairs, does this create a liability and, if so, how much should be recorded?

    In this chapter we will examine current liabilities, provisions, and contingent liabilities. We will look at the recognition, measurement, and disclosure requirements for these types of accounts. Long-term financial liabilities will be discussed in Chapter 14.

    Chapter Organization

     


    Chapter 13: Current Liabilities is shared under a not declared license and was authored, remixed, and/or curated by LibreTexts.

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