ACCT3305 Ch9 - Current Liabilities and Contingent Obligations

__________ include amounts that a company has collected from customers but for which it has not yet satisfied its performance obligations.

Unearned revenues

A company discloses any major issues affecting its current liabilities in a note to its financial statements. This satisfies the

full disclosure concept.

__________ refers to a company's ability to use its financial resources to adapt to change and to take advantage of opportunities.

Financial flexibility

Which order would most likely be seen on a balance sheet when presenting current liabilities?

Accounts payable, notes payable, accrued liability items, unearned revenue

ABC Corporation borrows $100,000 from the bank by issuing a $100,000, 11%, 3-month note. ABC's journal entry to pay the bank on the note's maturity date includes which of the following? a. A credit to Notes Payable for $100,000 b. A credit to Cash for $102,750 c. A debit to Interest Expense for $11,000 d. A credit to Interest Revenue for $2,750

b. A credit to Cash for $102,750 The journal entry to pay this note at maturity would include a debit to Notes Payable for $100,000, a debit to Interest Expense for $2,750, and a credit to Cash for $102,750.

ABC Company borrows money at a bank by issuing a $70,000, 3-month, non-interest-bearing note. The note is discounted on a 10% basis. What amount of cash will ABC Company receive from the bank?

$68,250 The correct formula to calculate cash received from a non-interest bearing note is Face Amount - (Face Amount × Interest Rate × Time) = $70,000 - ($70,000 × 10% × 3/12) = $68,250.

Current liabilities are obligations whose liquidations are reasonably expected to require the use of existing current assets or the creation of other current liabilities within

1 year or the normal operating cycle, whichever is longer.

Which of the following would not be considered an equitable and constructive liability? a. Notes payable b. Vacation pay c. Year-end bonuses d. Sick pay

a. Notes payable Notes payable is a legal liability because it is a contractual transaction. Equitable and constructive liabilities are those obligations where there is no legal requirement for assets to be transferred, but a transfer of assets typically occurs as a part of the normal operations of a business.

Discount on Notes Payable should be classified as a

contra account to Notes Payable. The account, Discount on Notes Payable, is classified as a contra account to Notes Payable. The journal entry to record the sale of a discounted note would debit Cash and Discount on Notes Payable and credit Notes Payable. Recognizing interest expense would be recorded as a debit to Interest Expense and a credit to Discount on Notes Payable.

Chocolate's Sweet Shop includes the amount of sales taxes collected directly in the price charged for merchandise, and the total amount is credited to Sales. During January, the Sales account was credited for $239,680. The January 31 adjusting entry to account for a 7% state sales tax would include a

credit to Sales Tax Payable. The adjusting journal entry would be a debit to Sales and a credit to Sales Taxes Payable for $16,778.

ABC Company has 50 employees who are each paid an average of $150 per day. The company has a policy allowing each employee 10 days of paid vacation each year. Assuming employees on average have used half of their paid days off, the accrual at year-end would include a

debit to Salaries Expense for $37,500. ABC Company needs to accrue $37,500 [(50 × $150 × 10) ÷ 2] since half of the time has been taken before year-end. The entry should include a debit to Salaries Expense and a credit to Salaries Payable.

Crispy Breakfast places a coupon in each box of its cereal product. Customers may send in five coupons and $3, and the company will send them a recipe book. Sufficient books were purchased at a cost of $5 each. A total of 500,000 boxes of product were sold in the current year. It was estimated that 4% of the coupons would be redeemed. During the current year, 9,000 coupons were redeemed. What is Crispy's premium expense for the current year?

$8,000 500,000 boxes of cereal were sold; five coupons are needed for a recipe book. 500,000 ÷ 5 = 100,000 potential recipe books, but only 4% are estimated to be redeemed, or 100,000 × 4% = 4,000 books. Each book ordered will be purchased by the customer for $3, and the cost to Crispy is $5 per book. Net cost is $5 - $3, or $2. $2 times 4,000 books equals a premium expense of $8,000.

ABC Company receives $68,250 on a note with a face amount of $70,000. What is the annual effective interest rate on this note? (Round percent to two decimal places at each stage in the calculation.)

10.24% The correct formula for annual effective interest rate is Total Interest Paid ÷ Amount of Cash Received (annualized) = $1,750 ÷ $68,250 = 2.56% × 12/3 = 10.24%.

__________ is an unsecured note payable that is commonly used to finance accounts receivable and inventories, as well as to meet other short-term obligations.

Commercial paper Commercial paper is an unsecured note payable that is commonly used to finance accounts receivable and inventories, as well as to meet other short-term obligations. Commercial paper generally has a maturity ranging from 30 to 270 days.

__________ are probable future sacrifices of economic benefits arising from present obligations of a company to transfer assets or provide services in the future as a result of past transactions or events.

Liabilities

With regard to liabilities, liquidity refers to

a company's ability to convert its assets to cash to pay its liabilities. Liquidity refers to how quickly a company can convert its assets to cash in order to cover operating costs and pay its liabilities when they become due.

Which of the following statements regarding contingent loss is not true? a. A company must accrue a contingent loss if the loss is possible and can be reasonably estimated. b. A company must disclose a contingent loss if the loss is possible and can be reasonably estimated. c. A company must accrue a contingent loss if the loss is probable and can be reasonably estimated. d. A company is not required to disclose or accrue a contingent loss if there is a remote possibility it will occur.

a. A company must accrue a contingent loss if the loss is possible and can reasonably estimated. A company must disclose a contingent loss if the loss is possible and can be reasonably estimated, but it is not required to disclose or accrue a contingent loss if there is a remote possibility it will occur. A company must accrue a contingent loss if the loss is probable and can be reasonably estimated, and it must disclose (not accrue) a contingent loss if the loss is possible and can be reasonably estimated.

Which of the following payroll taxes does not have a ceiling? a. FICA—Medicare b. FUTA c. FICA—OASDI d. SUTA

a. FICA--Medicare FICA—Medicare does not have a ceiling. FICA—OASDI, FUTA, and SUTA all have ceilings, meaning taxes are only paid up to a certain dollar amount of income.

Which of the following is a legal liability? a. Sales taxes payable to the state b. Year-end bonuses c. Sick pay that may be taken as time off d. Bribes due to foreign traders

a. Sales taxes payable to the state Legal liabilities, such as sales taxes, are incurred in transactions that are contractual—determined by written or oral agreements to pay cash or to provide goods or services to other entities in the future.

Which of the following dividends are not considered current liabilities when declared? a. Stock dividends b. Scrip dividends c. Property dividends d. Cash dividends

a. Stock dividends Property, scrip, and cash dividends are current liabilities when declared. A company does not report the amount owed for a stock dividend—a dividend payable in shares of stock—as a current liability. Because a stock dividend does not require the distribution of assets but is, instead, a distribution of a company's own stock, a company reports the declaration of a stock dividend as an element of shareholders' equity.

Which of the following statements does not describe an essential characteristic of a liability? a. The obligated entity has little or no discretion to avoid the future sacrifice. b. The identity of the recipient must be known to the obligated party. c. A liability is a present obligation that will be settled by a probable future transfer of assets or services. d. The transaction or event obligating the enterprise has already occurred.

b. The identity of the recipient must be known to the obligated party. Liabilities have three essential characteristics: a liability is a present obligation that will be settled by a probable future transfer of assets or services, the obligated entity has little or no discretion to avoid the future sacrifice, and the transaction or event obligating the enterprise has already occurred.

Current liabilities may be listed on the balance sheet in all of the following ways except a. according to amount (largest to smallest). b. in alphabetical order. c. in order of their average length of maturity. d. in order of liquidation preference.

b. in alphabetical order. Items within the current liability section of the balance sheet may be listed in order of their average length of maturity, according to the amount, or in order of liquidation preference. Alphabetical order is not an acceptable listing order for current liabilities.

Which of the following statements is not true? a. Currently maturing long-term debt is classified as a current liability unless refinanced. b. A company discloses any major issues affecting its current liabilities in a note to its financial statements. c. A company is not required to provide product warranty disclosures as long as it accrues for product warranty expense. d. Current liabilities are not offset against the assets that the company plans to use for its liquidation.

c. A company is not required to provide product warranty disclosures as long as it accrues for product warranty expense. A company discloses any major issues affecting its current liabilities in a note to its financial statements. Current liabilities are not offset against the assets that the company plans to use for its liquidation. Currently maturing long-term debt is classified as a current liability unless refinanced. A company is required to provide product warranty disclosures, including the accounting policy and method used to estimate its warranty liability and a tabular reconciliation of the changes in the warranty liability.

Which of the following statements is not true? a. When a company's board of directors declares a dividend, the company recognizes a current liability if it expects to distribute the dividends within the following year. b. If a company violates a long-term debt agreement and the liability becomes callable by the creditor within 1 year, the company reports the entire amount of the long-term obligation as a current liability. c. Management may never exclude short-term debt from current liabilities. d. Short-term debt is generally classified as a current liability.

c. Management may never exclude short-term debt from current liabilities. Short-term debt is generally classified as a current liability. If a company violates a long-term debt agreement and the liability becomes callable by the creditor within 1 year, the company reports the entire amount of the long-term obligation as a current liability. When a company's board of directors declares a dividend, the company recognizes a current liability if it expects to distribute the dividends within the following year. Management may exclude short-term debt from current liabilities if it has the intent and ability to refinance the debt.

All of the following are examples of legal liabilities except a. wages payable. b. sales tax payable. c. vacation payable. d. notes payable.

c. vacation payable. Notes payable, sales tax payable, and wages payable are examples of legal liabilities. Liabilities to employees for vacation pay or year-end bonuses, when such benefits are part of the company's normal employment practices and are not specified by an employment contract, are obligations that a company accepts by paying in the normal course of business.

Current liabilities are usually recorded and reported at their

maturity values.

Which of the following would not be considered a voluntary payroll deduction? a. Retirement savings b. Union dues c. Health insurance d. Federal income taxes

d. Federal income taxes Voluntary payroll deductions are contractual agreements between individual employees and employers. They include deductions such as health insurance, accident insurance, life insurance, union dues, and tax-sheltered retirement savings. Federal income taxes are not voluntary; employers are required to withhold them.

According to current U.S. GAAP, which of the following is not a condition suggesting that an accrual for vacation pay be made? a. The obligation must relate to employee services already rendered. b. The payment of compensation is probable. c. The amount can be reasonably estimated. d. The obligation must relate to rights that vest.

d. The obligation must relate to rights that vest. Three conditions must be present for a company to accrue vacation pay: the payment of compensation is probable, the obligation must relate to employee services already rendered, and the amount can be reasonably estimated.

All of the following are usually current liabilities except a. accounts payable. b. current portion of long-term debt. c. commercial paper. d. bonds payable.

d. bonds payable. Commercial paper maturities, accounts payable, and current portion of long-term debt are usually current liabilities. Bonds payable are generally long term. Even in the year they are due, they are usually paid from a bond sinking fund and not current assets.

Existing claims related to product warranties and litigation as of year-end indicate that it is probable that a liability has been incurred. However, as of year-end, the exact amount of the obligation cannot be reasonably estimated. Based on these facts, an estimated loss contingency should be

disclosed but not accrued. GAAP requires a company to accrue an estimated loss from a loss contingency if it is probable that a liability has been incurred and the company can reasonably estimate the amount of loss. In this situation, the company cannot estimate the amount of loss; therefore, the contingency will be disclosed in the notes to the financial statements.

Sick pay benefits that are related to an employee's services already rendered, whose payment is probable, and the amount reasonably estimated must be accrued and recognized as a current liability if the obligation relates to rights that

do not accumulate and do vest. If sick pay benefits vest and are not used by the end of the period, then the employer must recognize an expense and accrue a current liability. If sick pay benefits accumulate but do not vest, recognition and accrual is optional.