Accounting Chapter 13, Chapter 13: Current Liabilities and Contingencies

Klein Corp. obtains a 6-month noninterest-bearing loan from its financial institution. The company signs a note for $10,000 and receives $9,500 from the bank. What is the annualized effective interest rate on this loan?

10.53% Reason: ($500/$9,500) x 12/6

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.

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

A loss contingency is recognized only if the event that gave rise to it occurred

before the financial statement date.

Which of the following obligations is not commonly classified as a current liability?

bonds payable

Generally, a current liability is expected to be satisfied from . (Enter one word per blank.)

current assets

Unsecured notes sold in minimum denominations of $25,000 with maturities ranging from 1 to 270 days are referred to as

commercial paper.

Warranties that assure the customer that the products are delivered free from major defects typically result in the accrual of

contingent liabilities

When it is uncertain whether an obligation really exists, we may recognize what is referred to as a

contingent loss.

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

Match the correct classification on the statement of cash flows with the reportable item. Instructions

financing-- cash received operating-- interest paid

All liabilities involve a probable ____ sacrifice of economic benefits and arise as a result of _____ transactions or events. Multiple choice question.

future; past

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

An otherwise successful company may fail to exist, if it experiences serious _____ problems.

liquidity

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.

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

Information relative to a loss contingency that becomes available after the fiscal year ends, but before the financial statement date

should be considered in determining the probability of a loss contingency. should be considered in estimating the amount of the loss.

On January 1, 2017, Merkel Company receives $1,814 from a customer related to products to be delivered on December 31, 2018. The company's effective interest rate is 5%. The company regularly sells the products for $2,000 in cash. On January 1, 2017, Merkel should recognize deferred revenue of: (round to whole dollars)

$1,814

Adeline Company, a retail store, sold gift cards totaling $242,000 during the 2017 holiday season. The gift cards do not have an expiration date. At the end of the year, gift cards totaling $83,000 have not yet been redeemed. What is the amount of sales revenue that Adeline should recognize for the year ended 12/31/2017?

$159,000

On January 1, 2017, Merkel Company received $1,814 from a customer related to products to be delivered on December 31, 2018. The company's effective interest rate is 5%. The company regularly sells the products for $2,000 in cash. The journal entry on December 31, 2018 (the date of delivery) will include a credit to revenue for:

$2,000

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.

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.

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: Interest is an annual rate and must be multiplied by the fraction of the annual period $20,000 x 8% x 6/12

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

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 noncurrent liability of $504,000 A current liability of $36,000

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. Instructions Drag and drop application. Accrue Accrue drop zone empty. Disclose only

Accrue-- can be reasonably estimated Disclose-- cannot be reasonably estimated

Which of the following liabilities should be classified as current?

An 18-month note that is due in December of the current year will be paid in full. A 6-month note that is due in December of the current year will be satisfied by signing a new 6-month note.

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.

Identify the steps necessary to determine whether unasserted claims or assessments should be recognized or disclosed. Instructions

Assess probability Treat the claim Recognize contingency

What financial reporting aspect helps investors and creditors assess the risks associated with liabilities that require expenditures of cash or other assets in the near term?

Classification as current or long-term

Which of the following statements regarding the recognition of liabilities is correct?

Conceptually, liabilities should be recognized at the present value of their future cash flows.

Which of the following concepts or principles is the primary reason why gain contingencies are not accrued, even if they are probable?

Conservatism

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.)

Current liability of $70,000 long-term liability of $140,000

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.

In December 2017, Becker Corp. learned of a favorable judgment of $1.5 million relating to litigation involving a competitor. The company's attorney informs Becker that the opposing litigant has filed an appeal and that the company may ultimately receive about $400,000. How should Becker recognize this gain contingency in its December 31, 2017, financial statements?

Disclose the gain contingency in the notes only.

Which of the following obligations are commonly classified as current liabilities? (Select all that apply.)

Dividends payable Accounts payable Commercial paper

Choose the correct formula for calculating interest.

Face amount x annual interest rate x fraction of the year

True or false: The ability to refinance on a long-term basis can only be demonstrated by actually refinancing prior to issuing financial statements.

False

Correctly match the accounting standards on the left with the correct requirement for classifying liabilities payable within the coming year that are to be refinanced as long-term liabilities.

GAAP-- refinancing must be completed before the date of issuance of the financial statements

In which section of the statement of cash flows should short-term borrowing typically be reported?

In the financing activities section

On December 1, 2017, Katie Corp. borrows $100,000 from its bank and signs a 6-month, 12% promissory note. What accounts should be debited when the interest is paid on the maturity date and what are the amounts? Assume that no interest accruals were made during 2018 relating to this note. (Select all that apply.)

Interest expense: $5,000 Interest payable: $1,000

Which of the following are common examples of accrued liabilities? (Select all that apply)

Interest payable Income tax payable Wages and salaries payable

The dollar amount of a potential loss from a contingent liability can be classified as (Select all that apply.)

Known Reasonably estimable

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 Warranty liabilities Uncollectible receivables

Which of the following are classified as current liabilities? (Select all that apply.)

Long-term loans with violated debt covenants Debt callable in the upcoming year, even when not expected to be called Current portion of long-term debt

Correctly match the accounting treatment with the specific scenario described. Instructions Drag and drop application. Loss is probable and reasonably estimable. Loss is probable and reasonably estimable. drop zone empty. Loss is reasonably possible and not reasonably estimable. Loss is reasonably possible and not reasonably estimable. drop zone empty. Loss is remote.

Loss is probable-- liabiilty is accrued and related info disclosed Loss is reasonable-- Disclosure note only Loss is remote-- no note needed

Match the terms with the correct description. Instructions Drag and drop application. Probable Probable drop zone empty. Reasonably possible Reasonably possible drop zone empty. Remote Remote drop zone empty.

Probable-- confirming event is likely to occur Reasonably possible-- chance that the confirming event will occur is more than remote but less than likely Remote-- the chance that the confirming event is slight

Which of the following represents the formal credit instrument for a trade notes payable?

Promissory note

Which of the following transactions will increase a company's working capital?

Receipt of cash on a long-term note

Which of the following transactions require the recognition of a liability?

Receipt of payment for a service performed next month. Collection of a refundable deposit from a customer.

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.

Which of the following are common types of employee compensation? (Select all that apply.)

Salaries Commissions Pensions

A contingent liability is accrued if which conditions are met? (Select all that apply.)

The amount of the loss can be reasonably estimated. It is probable that a future loss will occur.

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.

Which of the following are essential characteristics of a liability?

The future sacrifice arises from a present obligation. A future sacrifice of an economic benefit is probable. The obligation results from a past event.

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.

Robert Company is planning to refinance a loan that is due during 2018. On January 25, 2018, the loan is refinanced with a 5-year note. Which of the following is correct with respect to the classification of the liability on the company's December 31, 2017 balance sheet?

The liability should be classified as current under IFRS and as noncurrent under U.S. GAAP.

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 transactions require recognition of a liability on December 31?

The utility bill for December will be paid January 3. Receipt of inventory purchases on account.

Which of the following is correct regarding gain contingencies?

They are not accrued.

True or false: Companies can ignore the interest component of advanced payments if the period between payment and delivery is less than one year.

True

Identify the most common loss contingency that does not result in the recognition of a liability.

Uncollectible receivables

Which of the following represent an accrued liability? (Select all that apply.)

Unpaid interest relating to the past few months. Unpaid wages relating to the last few days in the current fiscal period just ended.

Which of the following represent common examples of employee-related third-party collections? (Select all that apply.)

Voluntary employee retirement contributions Union dues Social security contributions Income taxes

Cash received from customers in advance of providing the related services or delivering the related goods is recognized as:

a 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.

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.

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

The ability to refinance a loan can be demonstrated by (Select all that apply.)

an existing refinancing agreement actual financing prior to the issuance of financial statements

Which of the following is not a category used to assess the likelihood of a loss contingency?

certain

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.

When some doubt exists about whether or not a loss will occur in the future we refer to it as a(n)

contingent liability

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.)

credit cash $105,000 debit notes payable $100,000 debit interest expense $5,000

If a liability is classified as current, rather than noncurrent, the company's working capital will ______.

decrease

Adeline Company, a retail store, sold gift cards totaling $242,000 during the holiday season. The gift cards do not have an expiration date. At the end of the year, gift cards totaling $83,000 have not yet been redeemed. The $83,000 in unredeemed gift cards should be recognized as

deferred revenue.

The costs of satisfying product-related warranties should be recorded as an expense

during the year of sale.

Which of the following are common types of transactions that are recognized as "advances from customers?" (Select all that apply.)

gift certificates and cards airline tickets magazine subscriptions

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 effective interest rate on a noninterest bearing loan is _____ the stated rate.

higher than

When a customer pays far in advance for goods or services, the seller should recognize

interest expense

On January 1, 2017, Merkel Company received $1,814 from a customer related to products to be delivered on December 31, 2018. The company normally sells the products for $2,000 in cash. The company's effective interest rate is 5%. On December 31, 2017, Merkel should recognize

interest expense of $91

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.

In practice, accrual of loss contingencies related to litigation claims are uncommon because (select all that apply)

it may adversely affect the outcome of the litigation. the outcome related to litigation is highly uncertain.

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

Unearned or deferred revenues are reported as

liabilities

Growler Commercial Cleaning Company collects a $1,000 deposit associated with the rental of industrial cleaning equipment. The deposit is refundable upon return of the equipment. When the customer returns the cleaning equipment, Growler should debit the following account

liability—refundable deposits

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

Gain contingencies are ______ in the accounts; material ones are ___________ in the financial statements.

not recorded; disclosed

Current liabilities are those obligations that are payable within ______ or the operating cycle whichever is ____.

one year; longer

In the statement of cash flows, interest paid typically is reported in the

operating activities section

Current liabilities are those obligations that are payable within one year or the ____, whichever is ____.

operating cycle; longer

Classifying liabilities as current or noncurrent depends on when the contingent liability is expected to be .

paid

When accounts receivable serve as collateral for a loan, we refer to the arrangement as ______ accounts receivable.

pledging

Which of the following are used to categorize the likelihood of the occurrence of a future loss? (Select all that apply.)

probable remote reasonably possible

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.

Unearned revenue represents a liability until the

related product or service is provided

When goods are delivered for which the seller received cash in advance, the seller recognizes

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 revenue of $1,000. sales taxes payable of $100.

Which of the following are common types of collections for third parties that most entities experience? (Select all that apply.)

sales taxes payroll-related deductions

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

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

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 determining the probability of a loss contingency. should be considered in estimating the amount of the loss.

A liability is accrued for a contingent loss if (Select all that apply.)

the amount can be reasonably estimated it is probable the confirming event will occur

In practice, liabilities payable within 1 year typically are recorded at their maturity amount because

the time value of money component associated with these liabilities is immaterial.

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.

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 dollar amount of a potential loss when reporting a can be classified as either known, reasonably estimable, or not reasonably estimable.

loss contingency

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?

A current liability of $36,000 A noncurrent liability of $504,000

A contingent liability typically is accrued for product warranties because it meets which of the following criteria?

A future loss is probable. The amount of the future loss can be reasonably estimated.

Which of the following are essential characteristics of a liability?

A future sacrifice of an economic benefit is probable. The future sacrifice arises from a present obligation. The obligation results from a past event.

Which of the following is correct regarding accrued interest payable?

Accrued interest payable relates to interest already incurred but not yet paid.

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

Higher risk

Current liabilities already reported on balance sheet

Which of the following are classified as current liabilities?

Debt callable in the upcoming year, even when not expected to be called Current portion of long-term debt Long-term loans with violated debt covenants

Choose the statement that best reflects the nature of interest.

Interest is the "rent" paid by the borrower for using the lender's money.

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.

Lower risk

Noncurrent liabilities already reported on the balance sheet

Which of the following statements regarding noninterest-bearing notes is correct? (Select all that apply.)

Noninterest-bearing notes incur interest. The face amount of noninterest-bearing notes includes interest.

Which of the following represents the formal credit instrument for an accounts payable?

Supplier's invoice

Debt that is callable by the creditor in the upcoming year, but is not expected to be called, is reported as

a current liability

Which of the following statements regarding commercial paper are correct? (Select all that apply.)

They are unsecured notes. They are often purchased by other companies as investments. They have minimum denominations of $25,000.

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.

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.

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:

a current bonds payable of $1 million. a long-term bonds payable of $1 million.

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

Interest that has been incurred but not yet been paid is recognized as

accrued interest payable

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.

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.

An interest rate, unless otherwise specified, is typically a(n) ______ rate. (Enter one word per blank)

annual

Accounts payable typically

are offered on open account. are noninterest-bearing.

Accounts payable typically (Select all that apply.)

are offered on open account. are noninterest-bearing.

During December, Martin Department Stores sells $240,000 in gift cards. When it sells the gift cards, Martin should recognize

deferred revenue.

Jones Company signs a $15,000, 12-month note and receives $14,250 from the bank. On the day that Jones signs the note, the company should debit (Select all that apply.)

discount on notes payable for $750. cash for $14,250.

The sale of accounts receivables to obtain short-term financing is referred to as ______ receivables.

factoring

Jones Company signs a $15,000, 12-month note and receives $14,250 from the bank. Over the next 12 months, the carrying value of the note will

increase

Cash collected from customers as refundable deposits or as advance payments for products or services are recognized as

liabilities.

Taxes collected for taxing authorities are recognized as

liabilities.

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?

remote probable reasonably possible

Classifying liabilities as current or long-term helps creditors and investors assess the that the liability will require expenditure of cash or another asset.

risk

Obligations to suppliers of merchandise that bear interest and are for a longer term than open accounts are called

trade notes payable

The feature that distinguishes loss contingencies from other liabilities is the

uncertainty that a loss will occur.

Short-term bank loans (Select all that apply.)

usually have a lower interest rate than long-term debt. are frequently used by large corporations as a significant component of capital structure.

Revenue associated with the sale of gift cards normally is recognized

when the gift cards are redeemed