Chapter 13: Current Liabilities and Contingencies
Spencer Corp.'s attorney estimates that the company will ultimately have to pay between $250,000 and $500,000 relating to current litigation. Spencer should accrue a contingent liability and loss of:
$250,000.
Able Inc. sells a new product with a 2-year warranty. The company estimates that during the two years, the costs and related probabilities are: Year 1: $10,000 (20%) and $20,000 (80%); Year 2: $15,000 (50%); $25,000 (50%).The company's effective interest rate is 4%. Assuming the warranty costs are settled at the end of Years 1 and 2, calculate the estimated warranty liability using the expected cash flow method.
$35,797 Reason: [(10,000 x .20) + (20,000 x .80)] x 0.96154 + [(15,000 x .50) + (25,000 x .50)] x 0.92456 = $35,797
Abbott Corp.'s attorney estimates that the company will ultimately have to pay between $350,000 and $500,000 relating to current litigation, and that the most likely amount of the loss will be equal to $400,000. Abbott Corporation should accrue a contingent liability and loss of:
$400,000.
Greenbaum Inc. sells a new product with a 2-year warranty. The company estimates that during the two years, the costs and related probabilities are: Year 1: $20,000 (40%) and $30,000 (60%); Year 2: $30,000 (70%); $20,000 (30%).The company's effective interest rate is 5%. Calculate the estimated warranty liability using the expected cash flow method.
$49,251 Reason: $[(20k x .4)+(30k x .6) x 0.95238]+ $[(30k x .7)+(20k x .3) x 0.90703
Supreme Inc. sells its products with a 3-year warranty. The company estimates warranty costs relating to sales during 2017 as follows: 2017: $10,000; 2018: $25,000; 2019: $15,000. Assume that actual warranty costs during 2017 were as estimated. What is the amount of warranty expense that Supreme should recognize in its 2017 income statement?
$50,000 Reason: $10,000 + $25,000 + $15,000
Jingle Company signs a 6-month, $20,000 note. Stated annual interest rate is 8% payable at the maturity date. Interest incurred on the note is calculated as:
$800. Reason: $20,000 x 8% x 6/12
Which of the following liabilities should be classified as current? (Select all that apply.)
- A 6-month note that is due in December of the current year will be satisfied by signing a new 6-month note. - An 18-month note that is due in December of the current year will be paid in full.
Which of the following are essential characteristics of a liability? (Select all that apply.)
- A future sacrifice of an economic benefit is probable. - The obligation results from a past event. - The future sacrifice arises from a present obligation.
Which of the following statements regarding noninterest-bearing notes is correct? (Select all that apply.)
- The face amount of noninterest-bearing notes includes interest. - Noninterest-bearing notes incur interest.
Which of the following transactions require recognition of a liability on December 31? (Select all that apply.)
- The utility bill for December will be paid January 3. - Receipt of inventory purchases on account.
Which of the following statements regarding commercial paper are correct? (Select all that apply.)
- They have minimum denominations of $25,000. - They are often purchased by other companies as investments. - They are unsecured notes.
Short-term bank loans (Select all that apply.)
- are frequently used by large corporations as a significant component of capital structure. - usually have a lower interest rate than long-term debt.
Accounts payable typically (Select all that apply.)
- are offered on open account. - are noninterest-bearing.
On January 1, Western Corp. borrows $100,000 from FirstBank using a six-month, 10% promissory note. Interest and principal are payable at maturity. The journal entry on January 1 includes (Select all that apply.)
- credit notes payable $100,000 - debit cash $100,000
On January 1, Western Corp. borrows $100,000 from FirstBank using a six-month, 10% promissory note. Interest and principal are payable at maturity. The journal entry on June 30 includes (Select all that apply.)
- debit interest expense $5,000 - debit notes payable $100,000 - credit cash $105,000
On December 1, 2017, Kathryn Corp. borrows $100,000 from its bank and signs a 6-month, 12% promissory note. How many months of interest should be recognized in 2017?
1 month
What practical reason may motivate companies to rarely accrue losses for ongoing litigation?
Accrual of a contingent loss may adversely affect the outcome of the company's legal case.
Correctly match each scenario relating to probable future losses that exist at the balance sheet date with the correct accounting treatment.
Accrue = Amount of future loss can be reasonably estimated Disclose only = Amount of future loss cannot be reasonably estimated
Which of the following is correct regarding accrued interest payable?
Accrued interest payable relates to interest already incurred but not yet paid.
Which of the following transactions require the recognition of a liability? (Select all that apply.)
Collection of a refundable deposit from a customer. Receipt of payment for a service performed next month.
Which of the following concepts or principles is the primary reason why gain contingencies are not accrued, even if they are probable?
Conservatism
Newman Company has both a contingent gain and a contingent loss that it judges to be highly probable to result in future cash flows, which it is able to reasonably estimate. Which of the following should the company accrue for the current accounting period?
Contingent loss only
What conditions must be met to recognize employee compensation for future absences? (Select all that apply.)
Payment is probable. The paid absences vest or the benefits can be accumulated over time. The amount can be reasonably estimated. The obligation is attributable to employees' services already performed.
Which of the following are common types of employee compensation? (Select all that apply.)
Pensions Commissions Salaries
Match the terms with the correct description.
Probable = Confirming event is likely to occur Reasonably possible = The chance that the confirming event will occur is more than remote but less than likely Remote = Confirming event is likely to occur
Match the terms with the correct description.
Probable = Confirming event is likely to occur Reasonably possible = The chance that the confirming event will occur is more than remote but less than likely Remote = The chance that the confirming event will occur is slight
Which of the following represents the formal credit instrument for a trade notes payable?
Promissory note
The dollar amount of a potential loss from a contingent liability can be classified as (Select all that apply.)
Reasonably estimable Known
Which of the following transactions will increase a company's working capital?
Receipt of cash on a long-term note
On December 1, 2017, Kathryn Corp. borrows $100,000 from its bank and signs a 6-month, 12% promissory note. Interest is payable when the loan matures. What entry should Kathryn make on December 31 relating to its note?
Recognize interest expense and interest payable of $1,000.
Generally, a current liability is expected to be satisfied from
Short-term
Which of the following represents the formal credit instrument for an accounts payable?
Supplier's invoice
Which of the following is a requirement for recognizing employee compensation for future absences?
The amount of payment can be reasonably estimated.
A contingent liability typically is accrued for product warranties because it meets which of the following criteria? (Select all that apply.)
The amount of the future loss can be reasonably estimated. A future loss is probable.
Karin Company's loan is due on July 1, 2018. What conditions must Karin meet (at a minimum) so that the note can be classified as a long-term liability on the company's balance sheet at December 31, 2017? (Select all that apply.)
The company must intend to refinance the obligation on a long-term basis. The company must have demonstrated the ability to refinance the obligation on a long-term basis.
Identify the statement that best describes the discriminating definition for classifying a liability as current.
The liability is expected to be satisfied from current assets.
Which of the following is necessary for a loss contingency to exist?
The potential loss must arise from an event that occurred prior to the financial statement date.
Which of the following is correct regarding gain contingencies?
They are not accrued.
Which of the following statements is correct regarding short-term obligations?
They may be classified as long-term liabilities if they meet certain criteria.
Which of the following is an important characteristic of loss contingencies that is not commonly shared by other liabilities?
Uncertainty exists regarding whether a future event giving rise to the obligation will occur.
Identify the most common loss contingency that does not result in the recognition of a liability.
Uncollectible receivables
Grouper Company arranged for a line of credit with its local bank. The company can borrow up to $100,000 as needed. Grouper pays the bank a fee of $200 per year regardless of any specific borrowing under the arrangement. This is an example of:
a committed line of credit.
Debt that is callable by the creditor in the upcoming year, but is not expected to be called, is reported as:
a current liability
Norbert Company's recently signed a 20-year mortgage that requires monthly payments of principal and interest. Norbert should report the mortgage principal payments due during the following accounting period as:
a current liability
Walden Company collects the annual fee for 100 magazine renewals. The annual price is $104 per subscription and covers 52 weekly magazines. When Walden Company receives payment for each subscription renewal, the company should recognize:
a liability for $104.
Gunner Corp. has $2 million in bonds outstanding that mature during 2018. The company intends to refinance some of its obligation by issuing $1 million in 10-year bonds. On January 31, 2018, the new bond issue is sold. The funds will be utilized to pay part of the maturing bond obligation. The balance sheet at 12/31/2017 should show the following regarding the maturing bonds: (Select all that apply.)
a long-term bonds payable of $1 million. a current bonds payable of $1 million.
Christenson Corp. signs a short-term notes payable and pledges a portion of its accounts receivables as collateral. This type of loan is referred to as:
a secured loan.
A loss contingency is recognized only if the event that gave rise to it occurred:
before the financial statement date.
Which of the following is not a category used to assess the likelihood of a loss contingency?
certain
Unsecured notes sold in minimum denominations of $25,000 with maturities ranging from 1 to 270 days are referred to as:
commercial paper.
Mikel Company grants stock options and bonuses to its full-time employees. These benefits are considered employee ______.
compensation
Events occurring between the end of the fiscal year and the date the financial statements are issued or available to be issued should be:
considered to clarify financial statement elements at the reporting date.
Warranties that assure the customer that the products are delivered free from major defects typically result in the accrual of:
contingent liabilities
The dollar amount of a potential loss when reporting a _____ can be classified as either known, reasonably estimable, or not reasonably estimable.
contingent liability
When some doubt exists about whether or not a loss will occur in the future we refer to it as a(n):
contingent liability
When it is uncertain whether an obligation really exists, we may recognize what is referred to as a:
contingent loss.
If a liability is classified as current, rather than noncurrent, the company's working capital will ______.
decrease
Glocken Company is trying to increase its share of the consumer electronics market. To stimulate sales, the company offers cash rebates ranging from $25-$50 on all of its products. At December 31, 2017, the company estimates that, during 2018, customers will redeem $2,550 in rebates relating to 2017 sales. On December 31, 2017, Glocken should:
decrease revenue and recognize a liability for $2,550.
During December, Martin Department Stores sells $240,000 in gift cards. When it sells the gift cards, Martin should recognize:
deferred revenue.
Greene Company experienced a warehouse fire on January 28, 2018. The company estimates that the uninsured portion of its loss will be approximately $10,000. If the company's 2017 financial statements have not yet been issued, Greene should:
disclose the estimated loss in its 2017 financial statements.
The costs of satisfying product-related warranties should be recorded as an expense:
during the year of sale.
Which of the following are financially based performance measures commonly used to determine employee bonuses? (Select all that apply.)
earnings per share operating income net income
An extended warranty contract (Select all that apply.)
essentially constitutes a separate performance obligation. provides protection beyond the manufacturer's original warranty.
Werner Inc. sells its products with a 2-year warranty. On December 31, 2017, Werner recognized estimated warranty-related costs of $54,000 for its 2017 sales. During 2018, Werner incurs repair costs of $21,000 related to products sold during 2017. The journal entry to record the cost of repairs would include a debit to:
estimated warranty liability
All liabilities involve a probable ____ sacrifice of economic benefits and arise as a result of _____ transactions or events.
future; past
Which of the following are common types of transactions that are recognized as "advances from customers?" (Select all that apply.)
gift certificates and cards magazine subscriptions airline tickets
Premiums that obligate the company to provide noncash items to customers are (select all that apply)
identified as separate performance obligations. recorded as deferred revenue.
The costs incurred to satisfy customer claims under an extended warranty period are recorded:
in the same period as the warranty revenue
For a loss contingency to be accrued, (Select all that apply.)
it is not necessary that the lawsuit was filed before the end of the accounting period. the cause of the lawsuit must have occurred before the end of the accounting period.
A liability is accrued for a contingent loss if (Select all that apply.)
it is probable the confirming event will occur the amount can be reasonably estimated
With respect to on-going litigation, companies typically recognize related ____, but not related _____.
legal fees; losses
Amounts received that will be returned or remitted to others at a future date are recognized as:
liabilities
Taxes collected for taxing authorities are recognized as:
liabilities
Unearned or deferred revenues are reported as:
liabilities
Unredeemed cash rebates related to current year sales should be estimated and the amount treated as a(n): (Select all that apply.)
liability reduction in revenue
Growler Commercial Cleaning Company collects a $1,000 deposit associated with the rental of industrial cleaning equipment. The deposit is refundable when the customer returns the equipment. Upon receipt of the deposit, Growler should credit a:
liability—refundable deposits.
A company's cash position, its overall ability to obtain cash in the normal course of business, and to satisfy its current obligations reflects the company's:
liquidity
An otherwise successful company may fail to exist, if it experiences serious _____ problems.
liquidity
Roberts Corp. sells its products with a 2-year warranty. Estimated total warranty cost relating to sales for the year ended December 31, 2017, is $210,000. One-third of these estimated costs are expected to be incurred during 2018 with two-thirds expected to be incurred during 2019. Indicate the amount and classification of the estimated warranty cost on the balance sheet at 12/31/2017. (Select all that apply.)
long-term liability of $140,000 Current liability of $70,000
Recognition of costs related to manufacturers' quality assurance warranty during the same period that the related revenue is recognized is consistent with the:
matching principle
Material events giving rise to a contingency that occur after the end of the fiscal period but before the financial statements are issued:
must be disclosed in a subsequent events disclosure note.
Jones Company signs a $15,000, 12-month note and receives $14,250 from the bank. Jones probably signed a(n) ______.
noninterest-bearing note
Current liabilities are those obligations that are payable within ______ or the operating cycle whichever is ____.
one year; longer
Current liabilities are those obligations that are payable within one year or the ____, whichever is ____.
operating cycle; longer
Revenue related to extended warranty contracts typically is recognized:
over time.
Which of the following are used to categorize the likelihood of the occurrence of a future loss? (Select all that apply.)
probable reasonably possible remote
Seine Company, a trucking company, accidentally spilled a load of ice cream across an open field. The owner of the field has not yet demanded clean-up of the spill. Seine's expert source predicts that it is probable that the owner will file a claim and that Seine will probably have to pay for the clean-up cost of approximately $29,000. Upon determining these facts, Seine should:
recognize a contingent liability of $29,000.
Superior Printer Company sells a new model with a $30.00 mail-in rebate. At the end of the accounting period, the company estimates that 25% of the 2,000 rebates associated with sales during December will still be returned by customers. On December 31, Superior Printer should:
recognize an expense and estimated liability of $15,000.
Unearned revenue represents a liability until the:
related product or service is provided
Costs incurred to satisfy customer claims under an extended warranty period are recorded during the same period as the related:
revenue
Walden Company collects the annual fee for 100 magazine renewals. The annual price is $104 per subscription and covers 52 weekly magazines. The subscription period is from July 1 till June 30 of the following year. During the current calendar year for each subscription, Walden should recognize:
revenue of $52.
Growler Commercial Cleaning Company collects a $1,000 deposit associated with the rental of industrial cleaning equipment. The deposit is refundable when the customer returns the equipment within the 30 days of rental. If the customer does not return the equipment, Growler should recognize a:
sale on the equipment.
Lester Corp. sells merchandise to a customer for $1,000. The company also collects state and local sales taxes of 6% and 4%, respectively. At the time of sale, Lester should recognize the following credits in its ledger (Select all that apply.)
sales taxes payable of $100. sales revenue of $1,000.
If a borrower pledges specific assets as collateral for a loan, the loan is considered:
secured
Classifying liabilities as current or noncurrent depends on when the contingent liability is expected to be:
settled
Information relative to a loss contingency that becomes available after the fiscal year ends, but before the financial statement date (select all that apply)
should be considered in estimating the amount of the loss. should be considered in determining the probability of a loss contingency.
In practice, accrual of loss contingencies related to litigation claims are uncommon because (select all that apply)
the outcome related to litigation is highly uncertain. it may adversely affect the outcome of the litigation.
In practice, accrual of loss contingencies related to litigation claims are uncommon because (select all that apply):
the outcome related to litigation is highly uncertain. it may adversely affect the outcome of the litigation.
Revenue related to extended warranty contracts typically is recognized over time because:
the warranty provides coverage over time.
The most common way for corporations to obtain temporary financing is:
through short-term bank loans.
Obligations to suppliers of merchandise that bear interest and are for a longer term than open accounts are called:
trade notes payable
Premiums that obligate the company to provide noncash items are:
treated as separate performance obligations. recorded as deferred revenue until the premium is delivered.
The feature that distinguishes loss contingencies from other liabilities is the:
uncertainty that a loss will occur.
Extended warranty contracts provide:
warranty protection beyond the manufacturer's original warranty.
Revenue associated with the sale of gift cards normally is recognized:
when the gift cards are redeemed
Wagner Company's financial records show that it has a mortgage that requires monthly principal payments of $3,000. The mortgage loan matures in 15 years. What should Wagner show on its balance sheet at the end of the current year? (Select all that apply.)
A current liability of $36,000 A noncurrent liability of $504,000
Sally Company owes its employees $5,250 for the last 4 days of the year ended December 31. The company will pay this amount on January 7 as part of its regular payroll disbursements of $11,800. What, if anything, should Sally recognize on December 31?
An accrued liability of $5,250.
Which of the following represent the correct accounting treatment for loss contingencies that do not meet the criteria for accrual but are at least reasonably possible? (Select all that apply.)
An estimate of the potential loss should be made (if possible) and disclosed. A disclosure must describe the contingency.
Which of the following statements relating to subsequent events that occur between the end of the fiscal period and the issuance of the financial statements is correct?
Any material event should be disclosed in the financial statement notes.
Best Equipment Inc. sells its products with a 3-year limited warranty. During 2017, Best Equipment recognizes $550,000 in sales revenue. Based on past experience, some of its products will need repair during the warranty period. What is the appropriate accounting treatment for Best Equipment's product warranty?
Best should estimate the contingent liability and accrue it in 2017.
Supreme Inc. offers a 3-year extended warranty for all its products. On January 1, 2018, the company collects $45,000 relating to extended warranty contracts. What entry should Supreme make on January 1, 2018?
Debit cash and credit deferred revenue for $45,000.
Supreme Inc. offers a 3-year extended warranty for all its products. On January 1, 2018, the company collects $45,000 relating to extended warranty contracts. What entry should Supreme make on December 31, 2018?
Debit deferred revenue for $15,000 and credit revenue—extended warranty for $15,000.
Which of the following are classified as current liabilities? (Select all that apply.)
Debt callable in the upcoming year, even when not expected to be called Long-term loans with violated debt covenants Current portion of long-term debt
Taylor Company's attorney informs its client that it is possible, but not probable, that the company will lose a currently litigated lawsuit. No reliable estimate of the potential loss is currently available. How should Taylor accrue and/or disclose this potential loss?
Disclose the contingency and state that an estimate cannot be made.
Which of the following situations would give rise to an employee-related accrued liability as of December 31 of the current year? (Select all that apply.)
Employee bonuses earned during the year have not yet been paid. Labor negotiations resulted in a 4% pay increase retroactively applied to December of the current year.
Choose the correct formula for calculating interest.
Face amount x annual interest rate x fraction of the year
Choose the statement that best reflects the nature of interest.
Interest is the "rent" paid by the borrower for using the lender's money.
Match the following risk levels with the type of liability it is most frequently associated with from the perspective of a potential investor or creditor. Instructions:
Higher risk = Current liabilities already reported on balance sheet Lower risk = Noncurrent liabilities already reported on the balance sheet
The expected cash flow approach is the appropriate method for estimating _____ contingent liabilities.
Long term
A contingent liability is accrued if which conditions are met? (Select all that apply.)
It is probable that a future loss will occur. The amount of the loss can be reasonably estimated.
Identify a primary reason why financial statement users assess a company's liquidity.
Lack of liquidity can lead to the demise of a company that otherwise may have been successful
What type of costs relating to ongoing litigation are commonly recognized by companies?
Lawyer fees and other legal costs
Which of the following items represent loss contingencies? (Select all that apply.)
Legal liabilities Uncollectible receivables Warranty liabilities
Cash collected from customers as refundable deposits or as advance payments for products or services are recognized as:
Liabilities
A ____ of ____ is an agreement between a bank and a company that allows the company to borrow up to a specified amount without completing additional paper work. (Enter one word per blank)
Line of credit
In practice, the assets most commonly used to secure loans are (Select all that apply.)
account receivable inventory
Obligations to suppliers of merchandise and obligations for services purchased on open account are referred to as:
accounts payable
If a company judges the likelihood that an unasserted claim will be asserted at a future date, it is probable the outcome will be unfavorable, and the related amount can be estimated, the company should:
accrue a contingent liability
January 15, 2018, Munter Company learned of a judgment against the company in a lawsuit brought by a client relating to services provided by Munter during the 2017 fiscal period. The 2017 financial statements have not yet been issued. Munter should:
accrue an estimated liability if a loss is probable and estimable.
Interest that has been incurred but not yet been paid is recognized as:
accrued interest payable.
Expenses already incurred, but not yet paid are referred to as:
accrued liabilities.
Gift certificates, magazine subscriptions, layaway deposits, special order deposits, and airline tickets all are examples of:
advances from customers
Accrued liabilities relate to expenses that were _____, but not yet ____.
already incurred; paid
When employees have provided services for which they have not been paid by the financial statement date, the employer must recognize (Select all that apply.)
an accrued liability compensation expense
Schmidt Company borrows $10,000 from its bank and signs a 6-month note. Interest, which is due quarterly, is specified in the note as 6%. The interest rate stated in the loan agreement most likely applies to:
an entire year.
Consistent with SFAC No. 7, long-term contingent liabilities should be measured using:
an expected cash flow approach.
An interest rate, unless otherwise specified, is typically a(n) ______ rate. (Enter one word per blank)
annual
Earnings-per-share, net income, and operating income are commonly used financial performance indicators used to determine:
annual bonuses
