Chapter 13 Current Liabilities and Contingencies

True/False Questions

1. Some liabilities are not contractual obligations and may not be payable in cash.

Answer: True Learning Objective: 1 Level of Learning:

2. Long-term debt that is callable by the creditor in the upcoming year should be classified as a current liability only if the debt is expected to be called.

Answer: False Learning Objective: 1 Level of Learning: 1

3. A customer advance produces a liability that is satisfied when the product or service is provided.

Answer: True Learning Objective: 3 Level of Learning: 1

4. Amounts withheld from employees in connection with payroll often represent liabilities to third parties.

Answer: True Learning Objective: 1 Level of Learning: 1

5. 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.

Answer: False Learning Objective: 6 Level of Learning:1

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

Answer: True Learning Objective: 6 Level of Learning: 1

7. The concept of substance over form influences the classification of obligations expected to be refinanced.

Answer: True Learning Objective: 4 Level of Learning: 1

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

Answer: False Learning Objective: 5 Level of Learning: 2

9. Warranty expense is recorded along with the related liability in the reporting period in which the product under warranty is sold.

Answer: True Learning Objective: 5 Level of Learning: 1

10. The cost of promotional offers should be recorded as expenses in the accounting period when the offers are redeemed by customers.

Answer: False Learning Objective: 6 Level of Learning: 2

Matching Pair Questions

Use the following to answer questions 11-15:

11-15. Listed below are ten terms followed by a list of phrases that describe or characterize five of the terms. Match each phrase with the correct term by placing the letter designating the best term in the space provided by the phrase.

Terms:

A. Accrued liabilities

B. Advances from customers

C. Callable

D. Discount on notes payable

E. Interest payable

F. Probable

G. Sales tax payable

H. Secured loan

I. Short-term note

J. Warranty liability

Phrases:

11. ____ A liability when received.

12. ____ Confirming event is likely to occur.

13. ____ A loss contingency accrued in the period of related sales.

14. ____ Most common temporary financing arrangement.

15. ____ Requires collateral.

Answer: 11-B; 12-F; 13-J; 14-I; 15-H

Use the following to answer questions 16-20:

16-20. Listed below are ten terms followed by a list of phrases that describe or characterize five of the terms. Match each phrase with the correct term by placing the letter designating the best term in the space provided by the phrase.

Terms:

A. Accrued liabilities

B. Advances from customers

C. Callable

D. Discount on notes payable

E. Interest payable

F. Probable

G. Sales tax payable

H. Secured loan

I. Short-term note

J. Warranty liability

Phrases:

16. ____ Due on demand.

17. ____ A contra liability account.

18. ____ A third party liability.

19. ____ Accrues with passage of time.

20. ____ Expenses incurred but not yet paid.

Answer: 16-C; 17-D; 18-G; 19-E; 20-A

Use the following to answer questions 21-25:

21-25. Listed below are ten terms followed by a list of phrases that describe or characterize five of the terms. Match each phrase with the correct term by placing the letter designating the best term in the space provided by the phrase.

Terms:

A. Accounting liabilities

B. Customer deposits

C. Effective interest

D. Factoring

E. Gain contingency

F. Interest paid on debt

G. Noncommitted line of credit

H. Reasonably possible

I. Subsequent event

J. Unasserted claims

Phrases:

21. ____ Liability until refunded.

22. ____ More than remote but less than likely.

23. ____ Face amount x rate x time.

24. ____ Not recorded until realized.

25. ____ Informal borrowing agreement.

Answer: 21-B; 22-H; 23-F; 24-E; 25-G

Use the following to answer questions 26-30:

26-30. Listed below are ten terms followed by a list of phrases that describe or characterize five of the terms. Match each phrase with the correct term by placing the letter designating the best term in the space provided by the phrase.

Terms:

A. Accounting liabilities

B. Customer deposits

C. Effective interest

D. Factoring

E. Gain contingency

F. Interest paid on debt

G. Noncommitted line of credit

H. Reasonably possible

I. Subsequent event

J. Unasserted claims

Phrases:

26. ____ Exceeds the stated rate on discounted notes.

27. ____ May include items that are not legal liabilities.

28. ____ Sale of receivables.

29. ____ Evaluated for recognition only if an unfavorable outcome is probable.

30. ____ Occurs in the current year before prior year financial statements are issued.

Answer: 26-C; 27-A; 28-D; 29-J; 30-I

Use the following to answer questions 31-35:

31-35. Listed below are ten terms followed by a list of phrases that describe or characterize five of the terms. Match each phrase with the correct term by placing the letter designating the best term in the space provided by the phrase.

Terms:

A. Accounts payable

B. Commercial paper

C. Committed line of credit

D. Current liabilities

E. Disclosure notes

F. Long-term liability

G. Loss contingency

H. Noninterest-bearing note

I. Pledging

J. Usual valuation of long-term liabilities

Phrases:

31. ____ Uses accounts receivable as collateral.

32. ____ Often requires compensating balance.

33. ____ Only formal credit instrument is the invoice.

34. ____ Effective interest higher than stated interest.

35. ____ Recorded if probable and amount is known or reasonably estimable.

Answer: 31-I; 32-C; 33-A; 34-H; 35-G

Use the following to answer questions 36-40:

36-40. Listed below are ten terms followed by a list of phrases that describe or characterize five of the terms. Match each phrase with the correct term by placing the letter designating the best term in the space provided by the phrase.

Terms:

A. Accounts payable

B. Commercial paper

C. Committed line of credit

D. Current liabilities

E. Disclosure notes

F. Long-term liability

G. Loss contingency

H. Noninterest-bearing notes

I. Pledging

J. Usual valuation of long-term liabilities

Phrases:

36. ____ Present value of interest plus present value of principal.

37. ____ Required for contingencies.

38. ____ Payable with current assets.

39. ____ Short-term debt to be refinanced with long-term bonds payable.

40. ____ Avoids registration with SEC.

Answer: 36-J; 37-E; 38-D; 39-F; 40-B

Use the following to answer questions 41-44:

41-44. Indicate (by letter) the way each of the items listed below should be reported on a balance sheet at December 31, 2006.

Reporting Method

A. Asset

L. Liability

D. Disclosure note only

N. Not reported

41. ____ An estimable gain that is contingent on a future event that appears exceedingly likely.

42. ____ An assessment of back taxes that probably will be asserted by the IRS, in which case a determinable additional payment is probable.

43. ____ Unassessed back taxes with a reasonable possibility of being asserted, in which case a determinable additional payment is probable.

44. ____ A extremely likely loss due an event that occurred previously and whose amount is unknown but estimable.

Answer: 41-D; 42-L; 43-N; 44-L

Multiple Choice Questions

45. The most common type of liability is:

A) One that comes into existence due to a loss contingency.

B) One that must be estimated.

C) One that comes into existence due to a gain contingency.

D) One to be paid in cash and for which the amount and timing are known.

Answer: D Learning Objective: 1 Level of Learning: 1

46. Which of the following is not a characteristic of a liability?

A) It represents a probable, future sacrifice of economic benefits.

B) It must be payable in cash.

C) It arises from present obligations to other entities.

D) It results from past transactions or events.

Answer: B Learning Objective: 1 Level of Learning: 1

47. Which of the following is not a liability?

A) An unused line of credit.

B) Estimated income taxes.

C) Sales tax collected from customers.

D) Advances from customers.

Answer: A Learning Objective: 1 Level of Learning: 2

48. Current liabilities are normally recorded at the amount expected to be paid rather than at their present value. This practice can be supported by GAAP according to the concept of:

A) Matching.

B) Consistency.

C) Materiality.

D) Conservatism.

Answer: C Learning Objective: 1 Level of Learning: 2

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

A) An obligation payable within one year.

B) An obligation payable within one year of the balance sheet date.

C) An obligation payable within one year or within the normal operating cycle, whichever is longer.

D) An obligation expected to be satisfied with current assets or by the creation of other current liabilities.

Answer: D Learning Objective: 1 Level of Learning: 1

50. Current liabilities are normally recorded at their:

A) Present value.

B) Cost.

C) Maturity amount.

D) Expected value.

Answer: C Learning Objective: 1 Level of Learning: 1

51. Which of the following is not a current liability?

A) Accounts payable.

B) A note payable due in 2 years.

C) Accrued interest payable.

D) Sales tax payable.

Answer: B Learning Objective: 4 Level of Learning: 2

52. The key accounting considerations relating to accounts payable are:

A) Determining their existence and ensuring that they are recorded in the appropriate accounting period.

B) Determining their present value and ensuring that they are recorded in the appropriate accounting period.

C) Determining their existence and determining the correct amount.

D) Determining the present value of the principal and the amount of the interest.

Answer: A Learning Objective: 1 Level of Learning: 2

53. Discount on a noninterest-bearing note payable is classified on the balance sheet as:

A) An asset.

B) A component of shareholders' equity.

C) A contingent liability.

D) A contra liability.

Answer: D Learning Objective: 2 Level of Learning: 1

54. The rate of interest that is actually incurred on a note payable is called the:

A) Face rate.

B) Contract rate.

C) Effective rate.

D) Stated rate.

Answer: C Learning Objective: 2 Level of Learning: 1

55. The rate of interest printed on the face of a note payable is called the:

A) Yield rate.

B) Effective rate.

C) Market rate.

D) Stated rate.

Answer: D Learning Objective: 2 Level of Learning: 1

56. Classifying liabilities as either current or long-term helps creditors assess:

A) The extent of a firm's liabilities.

B) The relative risk of a firm's liabilities.

C) The degree of a firm's liabilities.

D) The amount of a firm's liabilities.

Answer: B Learning Objective: 1 Level of Learning: 2

57. Large, highly rated firms sometimes sell commercial paper:

A) To borrow funds at a lower rate than through a bank.

B) To borrow funds that are not available at banks.

C) Because they can't borrow anywhere else.

D) Because the interest rate is locked in by the federal reserve board.

Answer: A Learning Objective: 4 Level of Learning: 2

58. When cash is received from customers in the form of a refundable deposit, the cash account is increased and there is a corresponding increase in:

A) A current liability.

B) A non-current asset.

C) Shareholders' equity.

D) Paid-in capital.

Answer: A Learning Objective: 1 Level of Learning: 2

59. When a deposit on returnable containers is forfeited, the firm holding the deposit will experience:

A) A decrease in cost of goods sold.

B) An increase in current liabilities.

C) An increase in accounts receivable.

D) An increase in revenue.

Answer: D Learning Objective: 1 Level of Learning: 2

60. 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:

A) Liabilities until the product or service is provided.

B) A component of shareholders' equity.

C) Long-term assets until the product or service is provided.

D) Revenue upon receipt of the advance payment.

Answer: A Learning Objective: 3 Level of Learning: 1

61. When a product or service is delivered for which a customer advance has been previously received, the appropriate journal entry includes:

A) A debit to a revenue and a credit to a liability account.

B) A debit to a revenue and a credit to an asset account.

C) A debit to an asset and a credit to a revenue account.

D) A debit to a liability and a credit to a revenue account.

Answer: D Learning Objective: 3 Level of Learning: 3

62. All of the following but one represent collections for third parties. Which one of the following is not a collection for a third party?

A) Sales tax payable.

B) Customer deposits.

C) Employee insurance deductions.

D) Social security taxes deductions.

Answer: B Learning Objective: 1 Level of Learning: 2

63. 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:

A) Higher working capital and a higher inventory turnover.

B) Lower working capital and a higher current ratio.

C) Higher working capital and a higher current ratio.

D) Higher working capital and a lower debt to equity ratio.

Answer: C Learning Objective: 4 Level of Learning: 2

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

A) Only if the amount is known.

B) Only if the amount is known or reasonably estimable.

C) Unless the amount is not reasonably estimable.

D) Even if the amount is not reasonably estimable.

Answer: D Learning Objective: 5 Level of Learning: 1

65. Which of the following situations would not require that long-term liabilities be reported as current liabilities on a classified balance sheet?

A) The long-term debt is callable by the creditor.

B) The creditor has the right to demand payment due to a contractual violation.

C) The long-term debt matures within the upcoming year.

D) All of the above require the current classification.

Answer: D Learning Objective: 4 Level of Learning: 2

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

A) The firm has a long-term line of credit.

B) The firm has tentative plans to issue long-term bonds.

C) The firm intends to and has the ability to refinance as long-term.

D) The firm has the ability to refinance on a long-term basis.

Answer: C Learning Objective: 4 Level of Learning: 1

67. Of the following, which typically would not be classified as a current liability?

A) Estimated liability from cash rebate program.

B) A long-term note payable maturing within the coming year.

C) Rent revenue received in advance.

D) A six-month bank loan to be paid with the proceeds from the sale of common stock.

Answer: D Learning Objective: 4 Level of Learning: 1

68. Gain contingencies usually are recognized in a company's income statement when:

A) Realized.

B) The amount can be reasonably estimated.

C) The gain is reasonably possible and the amount can be reasonable estimated.

D) The gain is probable and the amount can be reasonably estimated.

Answer: A Learning Objective: 5 Level of Learning: 1

69. A loss contingency should be accrued on a company's financial statements only if the likelihood that a liability has been incurred is:

A) At least remotely possible and the amount of the loss is known.

B) At least reasonably possible and the amount of the loss is known.

C) At least reasonably possible and the amount of the loss can be reasonably estimated.

D) Probable and the amount of the loss can be reasonably estimated.

Answer: D Learning Objective: 5 Level of Learning: 1

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

A) Reported in the income statement and disclosed.

B) Offset against shareholders' equity.

C) Disclosed, but not recognized in the income statement.

D) Neither recognized in the income statement nor disclosed.

Answer: C Learning Objective: 6 Level of Learning: 2

71. 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 probable.

D) The likelihood of a loss is eighty percent.

Answer: B Learning Objective: 5 Level of Learning: 2

72. Paul Company issues a product recall due to a defect discovered after the end of its fiscal year. Financial statements have not been issued yet. The action required on the books of Paul Company for this contingency for the year just ended is:

A) To disclose it in a footnote.

B) To accrue the liability.

C) To accrue the liability and explain it in a footnote.

D) To do nothing relative to the contingency.

Answer: A Learning Objective: 6 Level of Learning: 3

73. Which of the following is a contingency that would most likely require accrual?

A) Potential losses from extended warranties.

B) Customer premium offers.

C) Potential liability on a product where none have yet been sold.

D) Sales tax payable.

Answer: B Learning Objective: 6 Level of Learning: 2

74. Volt Electronics sells equipment that includes a three-year warranty. Volt repairs under the warranty are performed by an independent service company under a contract with Volt. Based on prior experience, warranty costs are estimated to be $25 per item sold. Volt should recognize these warranty costs:

A) When the equipment is sold.

B) When the repairs are performed.

C) When payments are made to the service firm.

D) Evenly over the life of the warranty.

Answer: A Learning Objective: 6 Level of Learning: 3

75. Which of the following is a contingency that should be accrued?

A) The company is being sued and a loss is reasonably possible and reasonably estimable.

B) The company deducts life insurance premiums from employees' paychecks.

C) The company offers a two-year warranty and the expenses can be reasonably estimated.

D) It is probable that the company will receive $100,000 in settlement of a lawsuit.

Answer: C Learning Objective: 5 Level of Learning: 2

76. The cost of customer premium offers should be charged to expense:

A) When the related product is sold.

B) When the premium offer expires.

C) Over the life cycle of the product to which the premium relates.

D) When the premiums are claimed.

Answer: A Learning Objective: 6 Level of Learning: 2

77. The accounting concept that requires recognition of a liability for customer premium offers is

A) Periodicity.

B) Conservatism.

C) Historical cost.

D) The matching principle.

Answer: D Learning Objective: 6 Level of Learning: 2

78. Which of the following may create employer liabilities in connection with their payrolls?

A) Employees' withholding taxes

B) Employee voluntary deductions

C) Employee fringe benefits

D) All of the above are correct.

Answer: D Learning Objective: 6 Level of Learning: 1

79. Accounting for costs of incentive programs for frequent customer purchases involves:

A) Recording an expense and a liability each period.

B) Recording a liability and a reduction of revenue each period.

C) Recording an expense and an asset reduction each period.

D) Recording an expense and revenue each period.

Answer: A Learning Objective: 6 Level of Learning: 2

80. Accounting for costs of incentive programs for frequent customer purchases:

A) Requires probability estimation.

B) Uses the matching principle.

C) Is a loss contingency situation.

D) All of the above are correct.

Answer: D Learning Objective: 6 Level of Learning: 1

81. Providing a monetary rebate program for purchasing a product:

A) Is accounted for similarly to product warranties.

B) Creates an expense for the seller in the period of sale.

C) Creates a contingent liability for the seller at the time of sale.

D) All of the above are correct.

Answer: D Learning Objective: 6 Level of Learning: 1

82. The main difference between accounting for rebate and cash discount coupons is:

A) The latter is not treated as an expense.

B) Only the former creates a contingent liability when issued.

C) The expense for the latter is deferred until redemption of the coupon.

D) There are no significant differences in accounting between the two.

Answer: C Learning Objective: 6 Level of Learning: 1

83. Which of the following have essentially the same accounting treatment?

A) Coupons for cash rebates and coupons for other premiums

B) Cents off coupons and coupons for other premiums

C) Cents off coupons and coupons for cash rebates

D) All of the above are correct.

Answer: A Learning Objective: 6. Level of Learning: 1

Use the following to answer questions 84-85:

In 2006, Holyoak Inc. offers a $20 cash rebate coupon to customers who purchased one of its new line of products. Holyoak sold 10,000 of these products during the year. By year end of 2006, 7,600 of the rebates had been claimed, and 7,100 had been paid. Holyoak's historical experience with such rebates indicates that 85% of customers claim the rebates.

84. What is the expense that Holyoak should report for its promotional rebates in its 2006 income statement?

A) $142,000

B) $152,000

C) $170,000

D) $200,000

Answer: C Learning Objective: 6 Level of Learning: 3

Rationale: This is the expected amount to be claimed from 2006 sales; i.e., $20 x 10,000 x .85.

85. What is the rebate promotion liability that Holyoak should report in its 12/31/06 balance sheet?

A) $20,000

B) $28,000

C) $18,000

D) None of the above is correct.

Answer: B Learning Objective: 6 Level of Learning: 3

Rationale: This is (8,500 expected 7,100 paid) x $20 = $28,000.

Use the following to answer questions 86-88:

Always Late Airline (ALA) operates a frequent flyer program in which mileage credits are earned by its customers for traveling on the airline. Awards are issued to members at the 25,000 miles level, and all awards expire five years from the date earned. The airline's historical experience indicates that 80% of all travel awards will actually be redeemed.

ALA accounts for its frequent flyer obligation on the accrual basis, using the incremental cost method. ALA's liability for free travel at the beginning of 2005 was $28 million. The incremental cost of free travel awards redeemed in 2005 was $19 million. The estimated cost of free travel earned for miles traveled in 2005 are $50 million.

86. What is the expense that ALA should report for its frequent flyer program in its 2005 income statement?

A) $40 million

B) $41 million

C) $50 million

D) $69 million

Answer: A Learning Objective: 6 Level of Learning: 3

Rationale: This is 80% of the $50 million cost of free travel awards earned.

87. Assume the same facts as in question 86, except that $2 million in earned travel awards on ALA expired during 2005. What is the expense that ALA should report for its frequent flyer program in its 2005 income statement?

A) $38 million

B) $40 million

C) $42 million

D) None of the above is correct.

Answer: B Learning Objective: 6 Level of Learning: 3

Rationale: The answer is the same as for question 86 because the cost for that year's customer benefits is the same.

88. Assume the same facts as in question 86. What is the frequent flyer program liability that ALA should report in its 12/31/05 balance sheet?

A) $31 million

B) $40 million

C) $45 million

D) None of the above is correct.

Answer: D Learning Objective: 6 Level of Learning: 3

Rationale: This is the beginning liability of $28 million awards redeemed of $19 million + new awards accrued of $40 million= $49 million.

89. On October 31, 2006, 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) More than the stated discount rate of 8%.

B) Less than the stated discount rate of 8%.

C) Equal to the stated discount rate of 8%.

D) Unrelated to the stated discount rate of 8%.

Answer: A Learning Objective: 2 Level of Learning: 3

90. In the current year, Hanna Company reported warranty expense of $190,000 and the warranty liability account increased by $20,000. What were warranty expenditures during the year?

A) $190,000.

B) $170,000.

C) $210,000

D) $0

Answer: B Learning Objective: 6 Level of Learning: 3

Rationale:

Expense	$190,000
Increase in liability	(20,000)
Expenditures	$170,000

91. Panther Co. had a warranty liability of $350,000 at the beginning of 2006, and $310,000 at end of 2006. Warranty expense is based on 4% of sales, which were $50 million for the year. What were the warranty expenditures for 2006?

A) $0.

B) $1,960,000.

C) $2,000,000.

D) $2,040,000.

Answer: D Learning Objective: 6 Level of Learning: 3

Rationale:

Warranty Liability
	$ 350,000
?	2,000,000	($50,000,000 x 4%)
	310,000

$350,000 + $2,000,000 $310,000 = $2,040,000

92. Carpenter Inc. had a balance of $80,000 in its warranty liability account as of December 31, 2005. In 2006, Carpenter's warranty expenditures were $445,000. Its warranty expense is calculated as 1% of sales. Sales in 2006 were $40 million. What was the balance in the warranty liability account as of December 31, 2006?

A) $ 35,000.

B) $425,000.

C) $125,000.

D) $480,000.

Answer: A Learning Objective: 6 Level of Learning: 3

Rationale:

Warranty Liability (in thousands)
	80
445	400	(40,000 x 1%)
	35

93. What is the effective interest rate on a 3-month, noninterest-bearing note with a stated rate of 12% and a maturity value of $200,000?

A) 12.36%.

B) 12.00 %.

C) 11.46%.

D) 3.00%.

Answer: A Learning Objective: 2 Level of Learning: 3

Rationale:

$200,000 x 12% x 3/12 = $6,000

$6,000/($200,000 $6,000) = 3.09%

3.09% x 12/3 = 12.36%

94. Oklahoma Oil Corp. paid interest of $785,000 during 2006, and the interest payable account decreased by $125,000. What was interest expense for the year?

A) $890,000.

B) $660,000.

C) $555,000.

D) $785,000.

Answer: B Learning Objective: 2 Level of Learning: 3

Rationale:

Interest paid	$ 785,000
Decrease in payable	(125,000)
Total interest expense	$660,000

95. On June 1, 2006, Dirty Harry Co. borrowed cash by issuing a 6-month noninterest-bearing note with a maturity value of $500,000 and a discount rate of 6%. What is the carrying value of the note as of September 30, 2006?

A) $525,000.

B) $300,000.

C) $495,000.

D) $475,000.

Answer: C Learning Objective: 2 Level of Learning: 3

Rationale:

Face amount	$500,000
Discount ($500,000 x 6% x 6/12)	(15.000	)
Carrying value, 6/1/06	485,000
Discount amortization (4/6)	10,000
Carrying value, 9/30/06	$495,000

Use the following to answer questions 96-98:

General Product Inc. shipped 100 million coupons in products it sold in 2006. The coupons are redeemable for thirty cents each. General anticipates that 70% of the coupons will be redeemed. The coupons expire on December 31, 2007. There were 45 million coupons redeemed in 2006, and 30 million redeemed in 2007.

96. What was General's coupon liability as of December 31, 2006?

A) $7.5 million.

B) $13.5 million.

C) $16.5 million.

D) $21.0 million.

Answer: A Learning Objective: 6 Level of Learning: 3

Rationale:

100 million x $.30 x 70% = $21 million

$21 million (45 x $.30) = $7.5 million

97. What was General's coupon promotion expense in 2006?

A) $30.0 million.

B) $21.0 million.

C) $13.5 million.

D) $7.5 million.

Answer: B Learning Objective: 6 Level of Learning: 3

Rationale:

100 million x $.30 x 70% = $21 million

98. What was General's coupon promotional expense in 2007?

A) Zero, since all the expense should be reflected in 2006.

B) $1.5 million.

C) $7.5 million.

D) $9.0 million.

Answer: B Learning Objective: 6 Level of Learning: 3

Rationale:

(in millions)

Sales in 2006:
Promotional expense	21.0
Estimated premium liability		21.0
Redemptions in 2006:
Estimated premium liability	13.5
Cash		13.5
Redemptions in 2007:
Estimated premium liability	7.5
Promotional expense	1.5
Cash		9.0

99. Slotnick Chemical received customer deposits on returnable containers in the amount of $300,000 during 2006. Fifteen percent of the containers were not returned. The deposits are based on the container cost marked up 20%. How much profit did Slotnick realize on the forfeited deposits?

A) $0.

B) $7,500.

C) $9,000.

D) $45,000.

Answer: B Learning Objective: 3 Level of Learning: 3

Rationale:

Total deposits forfeited ($300,000 x 15%)	$45,000
Less costs ($45,000/120%)	37,500
Profit	$ 7,500

100. On September 1, 2006, Hiker Shoes issued a $100,000, 8-month, noninterest-bearing note. The loan was made by Second Commercial Bank whose stated discount rate is 9%. Hiker's effective interest rate on this loan is:

A) 9.00%.

B) 9.49%.

C) 9.50%.

D) 9.57%.

Answer: D Learning Objective: 2 Level of Learning: 3

Rationale:

$100,000 x 9% x 8/12 = $6,000

[$6,000/$100,000 $6,000)] x 12/8 = 9.57%

101. Universal Travel Inc. borrowed $500,000 on November 1, 2006, and signed a 12-month note bearing interest at 6%. Interest is payable in full at maturity on October 31, 2007. In connection with this note, Universal Travel Inc. should report interest payable at December 31, 2006, in the amount of:

A) $ 8,000.

B) $30,000.

C) $ 5,000.

D) $25,000.

Answer: C Learning Objective: 2 Level of Learning: 3

Rationale:

$500,000 x 6% x 2/12 = $5,000

102. Jane's Donut Co. borrowed $200,000 on January 1, 2006, and signed a two-year note bearing interest at 12%. Interest is payable in full at maturity on January 1, 2008. In connection with this note, Jane's should report interest expense at December 31, 2006, in the amount of:

A) $0.

B) $24,000.

C) $48,000.

D) $50,880.

Answer: B Learning Objective: 2 Level of Learning: 3

Rationale:

$200,000 x 12% x 12/12 = $24,000

103. Clark's Chemical Company received customer deposits on returnable containers in the amount of $100,000 during 2006. Twelve percent of the containers were not returned. The deposits are based on the container cost marked up 20%. What is cost of goods sold relative to this forfeiture?

A) $0.

B) $2,000.

C) $10,000.

D) $14,400.

Answer: C Learning Objective: 3 Level of Learning: 3

Rationale:

($100,000 x 12%) 120% = $10,000

104. Branch Company, a building materials supplier, has $18,000,000 of notes payable due April 12, 2007. At December 31, 2006, Branch signed an agreement with First Bank to borrow up to $18,000,000 to refinance the notes on a long-term basis. The agreement specified that borrowings would not exceed 75% of the value of the collateral that Branch provided. At the date of issue of the December 31, 2006, financial statements, the value of Branch's collateral was $20,000,000. On its December 31, 2006, balance sheet, Branch should classify the notes as follows:

A) $15,000,000 long-term and $3,000,000 current liabilities.

B) $4,500,000 short-term and $13,500,000 current liabilities.

C) $18,000,000 of current liabilities.

D) $18,000,000 of long-term liabilities.

Answer: A Learning Objective: 1 Level of Learning: 3

Rationale:

Notes payable	$18,000,000
Refinancing ability ($20,000,000 x 75%)	15,000,000	L-T
Current liability from notes payable	$ 3,000,000	S-T

105. At the beginning of 2006, Angel Corporation began offering a 2-year warranty on its products. The warranty program was expected to cost Angel 4% of net sales. Net sales made under warranty in 2006 were $180 million. Fifteen percent of the units sold were returned in 2006 and repaired or replaced at a cost of $5.3 million. The amount of warranty expense on Angel's 2006 income statement is:

A) $ 5.3 million.

B) $ 7.2 million.

C) $10.6 million.

D) $27.0 million.

Answer: B Learning Objective: 6 Level of Learning: 3

Rationale:

$180 million x 4% = $7.2 million

Repairs during the year cost less than the estimated liability, so no additional expense is reported.

106. During 2006, Deluxe Leather Goods sold 800,000 reversible belts under a new sales promotional program. Each belt carried one coupon, which entitles the customer to a $5.00 cash rebate. Deluxe estimates that 70% of the coupons will be redeemed, even though only 350,000 coupons had been processed during 2006. At December 31, 2006, Deluxe should report a liability for unredeemed coupons of:

A) $ 560,000.

B) $1,050,000.

C) $1,225,000.

D) $1,750,000.

Answer: B Learning Objective: 6 Level of Learning: 3

Rationale:

[($800,000 x 70%) 350,000] x $5 = $1,050,000

107. Captain Cook Cereal includes one coupon in each package of Granola that it sells and offers a puzzle in exchange for $2.00 and 3 coupons. The puzzles cost Captain Cook $3.50 each. Experience indicates that 20% of the coupons eventually will be redeemed. During the last month of 2006, the first month of the offer, Captain Cook sold 6 million boxes of Granola and 900,000 of the coupons were redeemed. What amount should Captain Cook report as a liability for coupons on its December 31, 2006, balance sheet?

A) $ 0.

B) $150,000.

C) $300,000.

D) $450,000.

Answer: B Learning Objective: 6 Level of Learning: 3

Rationale:

[(6,000,000 x 20%) 900,000]/3 = 100,000 puzzles

100,000 x ($3.50 $2.00) = $150,000

108. Funzy Cereal includes one coupon in each package of Wheatos that it sells and offers a toy car in exchange for $1.00 and 3 coupons. The cars cost Funzy $1.50 each. Experience indicates that 40% of the coupons eventually will be redeemed. During the last month of 2006, the first month of the offer, Funzy sold 12 million boxes of Wheatos and 2.4 million of the coupons were redeemed. What amount should Funzy report as a promotional expense for coupons on its December 31, 2006, income statement?

A) $ 0.

B) $ 400,000.

C) $ 800,000.

D) $1,200,000.

Answer: C Learning Objective: 6 Level of Learning: 3

Rationale:

[(12,000,000 x 40%)/3] x ($1.50 $1.00) = $800,000

109. In May of 2006, Raymond Financial Services became involved in a tax dispute with the IRS. At December 31, 2006, the tax attorney for Raymond indicated that an unfavorable outcome to the dispute was probable. The additional taxes were estimated to be $770,000 but could be as high as $1,170,000. After the year-end, but before the 2006 financial statements were issued, Raymond accepted an IRS settlement offer of $900,000. Raymond should have reported an accrued liability on its December 31, 2006, balance sheet of:

A) $ 770,000.

B) $ 900,000.

C) $ 970,000.

D) $1,170,000.

Answer: B Learning Objective: 3 Level of Learning: 3

Problems

110. Ontario Resources, a natural energy supplier, borrowed $80 million cash on November 1, 2006, to fund a geological survey. The loan was made by Quebec Banque under a short-term credit line. Ontario Resources issued a 9-month, 12% promissory note with interest payable at maturity. Ontario Resources' fiscal period is the calendar year.

Required:

1. Prepare the journal entry for the issuance of the note by Ontario Resources.

2. Prepare the appropriate adjusting entry for the note by Ontario Resources on December 31, 2006. Show calculations.

3. Prepare the journal entry for the payment of the note at maturity. Show calculations.

Answer:

(1.)	11/1/2006 issuance of the note by Ontario Resources:
	Cash	80,000,000
	Notes payable		80,000,000
(2.)	12/31/2006 adjusting entry for the note by Ontario Resources:
	Interest expense	1,600,000
	Interest payable		1,600,000
	($80,000,000 x 12% x 2/12)
(3.)	8/1/2007 payment of the note at maturity:
	Interest expense*	5,600,000
	Interest payable (from adjusting entry)	1,600,000
	Notes payable (face amount)	80,000,000
	Cash (total)		87,200,000
	*($80,000,000 x 12% x 7/12)

Learning Objective: 2 Level of Learning: 3

111. A $90,000, 6-month, noninterest-bearing note is discounted at the bank at a 10% discount rate.