Bonus accruals: when to accrue and how to measure

Answer C. Option C meets accrual criteria: the obligation arose from services rendered during Year 2, payment is probable, and the amount is reasonably estimable. Therefore Company X should record an accrued liability (accrued expense) as of December 31, Year 2. The scheduled payment in February Year 3 is a typical subsequent payment of an accrued expense and does not change recognition at the reporting date.

Why not A: This is tempting because goods were en route and an invoice exists, but under FOB destination title and risk transfer occur on delivery to the buyer. Because the goods were still in transit at year-end, Company X had not yet obtained title or assumed liability and should not accrue the purchase on December 31.

Why not B: Although the loss is considered probable, GAAP requires accrual only when the amount can be reasonably estimated. If no reasonable estimate can be made, the loss is disclosed (footnote) rather than recorded as an accrued liability.

Why not D: This looks like an obligation, but because the decision and announcement occurred after the reporting date and there was no approved or communicated plan before December 31, no constructive or legal obligation existed at year-end. The event is a subsequent event, not an accrued liability at the reporting date.

Answer B. The bonus is probable, reasonably estimable, and payable within a few months, so it must be accrued as a current liability. Accruing $90,000 raises current liabilities from $225,000 to $315,000 while current assets remain $450,000; the revised current ratio is 450,000 ÷ 315,000 ≈ 1.43, a decrease from 2.00.

Why not A: Tempting because one might conflate the timing of payment with classification, but this is incorrect: the bonus is payable within a few months and meets the accrual criteria, so it should be recorded as a current liability at year-end.

Why not C: Tempting because some candidates think recognizing a liability also reduces cash immediately; however, under accrual accounting the liability and expense are recorded now while cash is reduced only when the payment is actually made, so current assets remain $450,000 at year-end.

Why not D: Tempting if a student confuses accrued expenses with accrued revenues (which create receivables), but accruing an expense increases expense and a liability, not a current asset, so current assets do not increase and the 1.71 figure is incorrect.

Answer B. An accrued liability is recognized when the company has incurred an obligation by year-end and the amount can be reasonably estimated. Here, employees earned the bonus during Year 1 under a preexisting written plan and Stone can estimate the total as of December 31, so an accrual is required even though payment occurs in February Year 2.

Why not A: This is tempting because candidates conflate recognition with timing. Whether payment occurs within a year affects current vs. noncurrent classification, not whether the liability should be recognized at year-end when the obligation has been incurred and is estimable.

Why not C: Approval after year-end may be a formality, but it does not change recognition if the company had a binding plan and the obligation was incurred during the reporting period. Only if approval is required to create the obligation (i.e., the bonus is truly discretionary) would accrual be inappropriate.

Why not D: Liabilities do not require mathematical precision to be recognized; they must be reasonably estimable. If the total bonus can be reasonably estimated from available data, an accrual is appropriate even if final per-employee amounts are calculated later.

Answer B. The central question is whether a present obligation existed at the balance sheet date. Under U.S. GAAP, if employees earned the bonuses before year-end, the amount is reasonably estimable, and payment is probable (supported by the company's historical practice of board approval and payment), an accrued liability for compensation should be recognized even though formal board approval occurred after year-end. This is an adjusting event, recognition is appropriate because the obligating event occurred before the reporting date.

Why not A: This is tempting because both accounts payable and accrued liabilities are current liabilities; however, accounts payable typically arise from amounts invoiced by suppliers. Employee bonuses are recorded as accrued compensation (an accrued liability), not accounts payable, so this choice misidentifies the proper account.

Why not C: This distractor focuses on the timing of formal approval, but it ignores that the obligating event (employees earning the bonuses) occurred before December 31 and the amount is estimable and historically paid. That makes the matter an adjusting condition requiring accrual, not merely a subsequent event for disclosure only.

Why not D: This is tempting if one focuses only on the payment date, but it is incorrect because the obligation will be settled within the company's operating cycle/within 12 months of the balance sheet date and thus should be classified as a current liability.

Answer A. Orion should accrue the $200,000 gross unpaid payroll (withheld amounts remain liabilities) and the related employer payroll taxes of $15,000. The $150,000 annual bonus must be accrued because the company cannot reduce the total payout, and the related employer payroll taxes of $11,250 are accrued as well. The discretionary $60,000 retention bonus approved after year-end is not accrued. Total = $200,000 + $15,000 + $150,000 + $11,250 = $376,250.

Why not B: This reflects accruing only net wages (subtracting the $40,000 employee withholdings) plus the other items. That approach understates liabilities because employee withholdings are still liabilities payable to taxing authorities and gross payroll should be accrued.

Why not C: This looks like the candidate accrued gross payroll and the fixed bonus but omitted the employer payroll taxes on the bonus ($11,250). Employer payroll taxes related to accrued compensation must be accrued when the compensation is accrued.

Why not D: This includes the $60,000 retention bonus approved on January 20, Year 2. Because no legal or constructive obligation existed at December 31, Year 1, that post‑year approval does not create a Year 1 liability.