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Exam 13: Current Liabilities and Contingencies

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Question 41

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A company should accrue a liability for a loss contingency if it is at least reasonably possible that assets have been impaired and the amount of potential loss can be reasonably estimated.

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Question 42

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A contingent loss should be reported in a footnote to the financial statements rather than being accrued if:

A) The likelihood of a loss is remote.
B) The incurrence of a loss is reasonably possible.
C) The incurrence of a loss is more likely than not.
D) The likelihood of a loss is probable.

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Question 43

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When a gain contingency is probable and the amount of gain can be reasonably estimated, the gain should be:

On October 31, 2009, Simeon Builders borrowed $16 million cash and issued a 7-month, noninterest-bearing note. The loan was made by Star Finance Co. whose stated discount rate is 8%. Sky's effective interest rate on this loan is:

A disclosure note is required for all material loss contingencies for which the probability of loss is reasonably possible.

At times, businesses require advance payments from customers that will be applied to the purchase price when goods are delivered or services provided. These customer advances represent:

Diversified Industries sells perishable electronic products. Some must be shipped in reusable containers. Customers pay a deposit for each container. The deposit is equal to the container's cost. Customers receive a refund when the container is returned. During 2009, deposits collected on containers shipped were $700,000. Deposits are forfeited if containers are not returned in 18 months. Containers held by customers on January 1, 2009, were $330,000. During 2009, $410,000 was refunded and deposits of $25,000 were forfeited. Required: 1. Prepare the appropriate journal entries for the deposits received and returned during 2009. 2. Determine the liability for refundable deposits to be reported in the December 31, 2009, balance sheet.

Stern Corporation borrowed $10 million cash on September 1, 2009, to provide additional working capital for the year's production. Stern issued a 6-month, 10% promissory note to Second State Bank. Interest on the note is payable at maturity. Each firm uses the calendar year as the fiscal year. Required: 1. Prepare all journal entries from issuance to maturity for Stern Corporation. 2. Prepare all journal entries from issuance to maturity for Second State Bank.

Other things being equal, most managers would prefer to report liabilities as noncurrent rather than current. The logic behind this preference is that the long-term classification permits the company to report:

On May 1, Lectric Industries issued 9-month notes in the amount of $60 million. Interest is payable at maturity. Required: Determine the amount of interest expense that should be recorded in a year-end adjusting entry under each of the following independent assumptions: $\begin{array}{ccc}&\text { Interest rate }&\text { Fiscal Year End }\\1 . & 8 \% & \text { January } 31 \\2 . & 10 \% & \text { October } 31 \\3 . & 9 \% & \text { June } 30 \\4 . & 13 \% & \text { December } 31\end{array}$

Muller Corp. pays its employees monthly. The payroll information listed below is for January, 2009, the first month of Muller's fiscal year. Required: Prepare the appropriate journal entries to record salaries and wages expense and payroll tax expense for the January 2009 pay period. $\begin{array} { l r } \text { Salaries } & \$ 400,000 \\\text { Federal income taxes to be withheld } & 80,000 \\\text { Federal unemployment tax rate } & 0.80 \% \\\text { State unemployment tax rate (after FUTA deduction) }& 5.40 \% \\\text { Social security tax rate } & 6.2 \% \\\text { Medicare tax rate } & 1.45 \%\end{array}$

Unlike the Social security tax there is no maximum wage base for the Medicare portion of the FICA tax.

Which of the following is the best definition of a current liability?

Sunnyvale Computer Company sells a line of computers that carry a 6-month warranty. Customers are offered the opportunity to buy a 2-year extended warranty for an additional charge. During 2009, Sunnyvale received $320,000 from customers for these extended warranties. All sales are on credit, and funds are received evenly throughout the year and the warranties go into effect immediately after purchase. Required: Prepare a summary journal entry to record sales of the extended warranties. Also prepare any other entries associated with the warranties that should be recorded during 2009.

Footnote disclosure is required for material potential losses when the loss is at least reasonably possible:

A long-term liability should be reported as a current liability in a classified balance sheet if the long-term debt

Fusion, Inc. introduced a new line of circuits in 2009 that carry a four-year warranty against manufacturer's defects. Based on their experience with previous product introductions, warranty costs are expected to approximate 3% of sales. Sales and actual warranty expenditures for the first year of selling the product were: Required: 1. Does this situation represent a loss contingency? Why or why not? How should it be accounted for? 2. Prepare journal entries that summarize sales of the circuits (assume all credit sales) and any aspects of the warranty that should be recorded during 2009. 3. What amount should Fusion report as a liability at December 31, 2009? $\begin{array} { c c } { \text { Actual warranty } } \\\text { Sales } & \text { Expenditures } \\\$ 15 \text { million } & \$ 200,000\end{array}$

Short-term obligations can be reported as long-term liabilities if:

On November 1, 2009, a $216,000, 9-month, noninterest-bearing note is discounted at the bank at a 10% discount rate. Required: 1. Prepare the appropriate journal entry to record the issuance of the note. 2. Determine the effective interest rate. 3. Prepare the appropriate journal entry on December 31, 2009, to record interest on the note for the 2009 financial statements. 4. Prepare the appropriate journal entry(s) on July 31, 2010, to record interest and the payment of the note.

For a loss contingency to be accrued, the claim must have been made before the accounting period ended.