Chapter 12- Current Liabilities and Contingencies

Excom manufactures high-end whole home electronic systems. The company provides a one-year warranty for all products sold. The company estimates that the warranty cost is $300 per unit sold and reported a liability for estimated warranty costs $10.4 million at the beginning of this year. If during the current year, the company sold 60,000 units for a total of $324 million and paid warranty claims of $12,000,000 on current and prior year sales, what amount of liability would the company report on its balance sheet at the end of the current year? a. $3,733,333. b. $6,000,000. c. $16,400,000. d. $18,000,000.

c (Explanation: The ending balance of warranty liability = The beginning balance, $10,400,000 + incurred warranty during the year $18,000,000 (=60,000 units × $300) - Paid warranty liability during the year, $12,000,000 = $16,400,000)

Which of the following is a current liability? a. A long-term debt maturing currently, which is to be paid with cash in a sinking fund b. A long-term debt maturing currently, which is to be retired with proceeds from a new debt issue c. A long-term debt maturing currently, which is to be converted into common stock d. None of these answers are correct.

D

Which of the following is an example of a contingent liability? a. Obligations related to product warranties. b. Possible receipt from a litigation settlement. c. Pending court case with a probable favorable outcome. d. Tax loss carryforwards.

A

Which of the following is the proper way to report some gain contingencies? a. As an accrued amount. b. As deferred revenue. c. As an account receivable with additional disclosure explaining the nature of the contingency. d. As a disclosure only.

D

Which of these is not included in an employer's payroll tax expense? a. F.I.C.A. (social security) taxes b. Federal unemployment taxes c. State unemployment taxes d.Federal income taxes

D

Unearned revenue in which of the following situations a. Target makes a sale to a customer who uses their Target credit card. b. Target sells gift cards. c. Home Depot purchases grills on account from Weber. d. Home Depot sells a Weber grill that comes with a manufacturer's 10-year warranty.

B

Which of the following is not true about the discount on short-term notes payable? a. The Discount on Notes Payable account has a debit balance. b. The Discount on Notes Payable account should be reported as an asset on the balance sheet. c. When there is a discount on a note payable, the effective interest rate is higher than the stated discount rate. d. Discount on Notes Payable is a contra account to Notes Payable.

B

Greeson Corp. signed a three-month, zero-interest-bearing note on November 1, 2024 for the purchase of $500,000 of inventory. The face value of the note was $507,800. Greeson used a "Discount of Note Payable" account to initially record the note. Assuming that the discount will be amortized equally over the 3-month period and that there was no adjusting entry made for November, the adjusting entry made at December 31, 2024 will include a a. debit to Discount on Note Payable for $2,600. b. debit to Interest Expense for $5,200. c. credit to Discount on Note Payable for $2,600. d. credit to Interest Expense for $5,200.

B (Explanation: This is a zero-interest-bearing notes. Greeson needs to make the following entries November 1, 2024: Dr. Inventory $500,000 Dr. Discount on Note Payable $7,800 Cr. Notes Payable $507,800 December 31, 2024 -Adjusting entry: Dr. Interest Expense $5,200* Cr. Discount on notes payable $5,200 * $7,800 × 2/3 = $5,200.)

On January 1, 2025, Bacon Co. leased a building to Horner Corp. for a ten-year term at an annual rental of $175,000. At the inception of the lease, Bacon received $700,000 covering the first two years' rent of $350,000 and a security deposit of $350,000. This deposit will not be returned to Horner upon expiration of the lease but will be applied to the payment of rent for the last two years of the lease. What portion of the $700,000 should be shown as a current and long-term liability, respectively, in Bacon's December 31, 2025 balance sheet? a. Current Liability-$0 Long-term Liability-$700,000 b. Current Liability-$175,000 Long-term Liability-$350,000 c. Current Liability-$350,000 Long-term Liability-$350,000 d. Current Liability-$350,000 Long-term Liability-$175,000

B ( Explanation: Bacon Co need to make the following entry for the lease transaction. January 1, 2025 Dr. Cash $700,000 Cr. Unearned rental revenue (first two year rent) $350,000 Cr. Customer deposit $350,000 December 31, 2025 Dr. Unearned rent revenue $175,000 Cr. Rent revenue $175,000 Then, the remaining balance of unearned revenue = $350,000 - $175,000 = $175,000. This is a current liability because it requires a rent service next year. However, the customer deposit balance, $350,000, should be classified as a long-term liability because the required rent service will be provided 9th and 10th years.)

On August 1, Rock Tavern Consulting Group collected $9,000 on a 6-month contract to provide SEO services to Kruger Brothers, Inc. Assuming that the amount is earned equally over the 6 months and that Rock Tavern prepares financial statements monthly, the company's August 31 adjusting entry will include a. a debit to Cash and a credit to Unearned Revenue for $1,500. b. a debit to Unearned Revenue and a credit to Service Revenue for $1,500. c. a debit to Cash and a credit to Service Revenue for $7,500. d. a debit to Accounts Receivable and a credit to Unearned Revenue for $1,500.

B (Explanation: August 1 Dr. Cash $9,000 Cr. Unearned Service Revenue $9,000 August 31 Dr. Unearned Service Revenue $1,500 ($9,000 x 1/6 = $1,500) Cr. Service Revenue $1,500)

Palco Co., which has a taxable payroll of $1,200,000, is subject to FUTA tax of 0.8% and a state contribution rate of 4.0%. What is the total amount of federal and state unemployment tax for Palco Co.? a. $139,200 b. $57,600 c. $48,000 d.$33,600

B (Explanation: Unemployment taxes (FUTA and SUTA): Paid by the employer and not a cost to employees. Unemployment taxes = [Federal 0.8% + State 4.0%] × $1,200,000 = $57,600)

Sandy Shoes Foot Inc. is involved in litigation regarding a faulty product sold in a prior year. The company has consulted with its attorney and determined that it is possible that they may lose the case. The attorneys estimated that there is a 40% chance of losing. If this is the case, their attorney estimated that the amount of any payment would be $800,000. What is the required journal entry as a result of this litigation? a. Debit Litigation Expense for $800,000 and credit Litigation liability for $800,000. b. No journal entry is required. c. Debit Litigation Expense for $320,000 and credit Litigation Liability for $320,000. d. Debit Litigation Expense for $480,000 and credit Litigation Liability for $480,000.

B (Explanation: This is a loss contingency problem. Recognition of Loss Contingencies: depends on 1) the likelihood that the future event or events will confirm the incurrence of a liability and 2) the availability of reasonable estimate of the amount of loss. Likelihood of loss is only possible, not probable. Thus, Sandy will not recognize contingent loss and liability on the book {No journal entry}. Proper accounting treatment would be to disclose it in its footnotes)

Craig borrowed $700,000 on October 1, 2024, and is required to pay $720,000 on March 1, 2025. What amount is the note payable recorded at on October 1, 2024 (notes payable minus any discount on notes payable) and how much interest is recognized from October 1 to December 31, 2024? a. $700,000 and $0. b. $700,000 and $12,000. c. $720,000 and $0. d. $700,000 and $20,000.

B (Explanation: This is again a zero-interest-bearing notes problem. Craig makes the following entries October 1, 2024 Dr. Cash $700,000 Dr. Discount on notes payable $20,000 Cr. Notes Payable $720,000 December 31, 2024 Interest calculation = $20,000 × 3 / 5 = $12,000 Dr. Interest expense $12,000 Cr. Discount on notes payable $12,000)

Overton Corporation, a manufacturer of household paints, is preparing annual financial statements at December 31, 2024. Because of a recently proven health hazard in one of its paints, the government has clearly indicated its intention of having Overton recall all cans of this paint sold in the last six months. The management of Overton estimates that this recall would cost $800,000. What accounting recognition, if any, should be accorded this situation? a. No recognition b. Note disclosure only c. Operating expense of $800,000 and liability of $800,000 d. Appropriation of retained earnings of $800,000

C (Explanation: This is a loss contingency problem. Recognition of Loss Contingencies: depends on 1) the likelihood that the future event or events will confirm the incurrence of a liability and 2) the availability of reasonable estimate of the amount of loss. The statement, "the government has clearly indicated its intention of having Overton recall all cans...," indicates that the likelihood is "probable" and Overton has an estimate of the call. Thus, the proper accounting treatment would be to recognize contingent loss and liability on the book.)

Liabilities are a. any accounts having credit balances after closing entries are made. b. deferred credits that are recognized and measured in conformity with generally accepted accounting principles. c. obligations to transfer ownership shares to other entities in the future. d. obligations arising from past transactions and payable in assets or services in the future.

D

During 2023, Rao Co. introduced a new line of machines that carry a three-year warranty against manufacturer's defects. Based on industry experience, warranty costs are estimated at 2% of sales in the year of sale, 3% in the year after sale, and 4% in the second year after sale. Sales and actual warranty expenditures for the first three-year period were as follows: (assume the accrual method) 2023 Sales-$ 1,600,000 Actual Warranty Expenditures-$ 39,000 2024 Sales-2,500,000 Actual Warranty Expenditures-65,000 2025 Sales-2,100,000 Actual Warranty Expenditures-135,000 Total: Sales-$6,200,000 Actual Warranty Expenditures-$239,000 What amount should Rao report as a liability at December 31, 2025? a. $0 b. $71,000 c. $84,000 d. $319,000

D (Explanation: "Based on industry experience, warranty costs are estimated at 2% of sales in the year of the sale, 3% in the year after the sale, and 4% in the second year after the sale." The statement says that the company expects 2% sales of warranty claims in the first year, 3 % next year, and 4% in the year after the next year of original sales. In other words, they expect a total of 9% of sales as warranty costs. Then, why do we have to recognize a total of 9% of warranty when the company recognizes related sales rather than spreading out over three years? It is because we need to match expenses with related sales based on so-called the matching principle. When the company generated $1,600,000 in sales in 2023, they offered a warranty which will probably incur a total of 9% of sales amount as warranty costs in the future although actual warranty expenditure would incur 2%, 3%, and 4% over the three-year period. In other words, 9% of sales (warranty costs) is a necessary expense to generate $1,600,000 in 2023 sales. Thus, warranty expense, 9% * $1,600,000, should be recognized in 2023. You can apply the same reasoning to 2024 and 2025 sales. That is why if you want to know the liability as of the end of 2025, you have to multiply total sales by 9% and then subtract actual warranty expenditures in 2023, 2024, and 2025. Thus, the total warranty liability would be $6,200,000 × 9%, but it paid $239,000 as of December 31, 2025. Therefore, the balance of warranty liability as of December 31, 2025, is $319,000 (= $558,000 - $239,000).)