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# JUNIOR PHILIPPINE INSTITUTE OF ACCOUNTANTS, INC.

## REVIEWER IN ACCOUNTING THEORY & PRACTICE I

CURRENT LIABILITIES

Shooting Star Hotel collects 15% in city sales taxes on room rentals, in addition to a \$2 per room, per night,
occupancy tax. Sales taxes for each month are due at the end of the following month, and occupancy taxes
are due 15 days after the end of each calendar quarter. On January 3, 1994, Shooting Star paid its November
1993 sales taxes and its fourth quarter 1993 occupancy taxes. Additional information pertaining to Shooting
Star operations is:
1993
Room rentals
Room nights
October
\$100,000
1,100
November
110,000
1,200
December
150,000
1,800
What amounts should Hudson report as sales taxes payable and occupancy taxes payable in its December
31, 1993, balance sheet?
Solution:
Oct
Nov
Dec

15% City
Sales Tax
\$
16,500
22,500
\$39,000

Date
Paid
11/30
1/3
-

Occupancy
Tax
\$2,200
2,400
3,600
\$8,200

Date
Paid
1/3
1/3
1/3

Under state law, Groudon Company may pay 3% of eligible gross wages or it may reimburse the state
directly for actual unemployment claims. Groudon believes that actual unemployment claims will be 2% of
eligible gross wages and has chosen to reimburse the state. Eligible gross wages are defined as the first
\$10,000 of gross wages paid to each employee. Groudon had five employees each of whom earned \$20,000
during 1993. In its December 31, 1993, balance sheet, what amount should Groudon report as accrued
liability for unemployment claims?
Solution: \$ 1,000. The estimate is 2% of the eligible wages of 5 persons x \$ 10,000 eligible wages per person.
Thus, the accrued liability for unemployment claims = 2% \$ 50,000 = \$ 1,000.

Underwater Cavern Co., a division of Mossdeep, Inc., maintains escrow accounts and pays real estate taxes
for Nationals mortgage customers. Escrow funds are kept in interest-bearing accounts. Interest, less a 10%
service fee, is credited to the mortgagee's account and used to reduce future escrow payments. Additional
information follows:
Escrow accounts liability, 1/1/92
\$ 700,000
1,580,000
Real estate taxes paid during
1,720,000
Interest on escrow funds during 1992
50,000
What amount should Kent report as escrow accounts liability in its December 31, 1992, balance sheet?
Solution: \$ 605,000. Escrow account liability is increased by amounts received from mortgages and is
decreased by payments for taxes. Interest earned, less 10%, is credited (increase) to the escrow account.
Escrow Liability: \$ 700,000 + 1,580,000 + 45,000 (\$50,000 less 10%) 1,720,000 = \$ 605,000

Able Co. provides an incentive compensation plan under which its president receives a bonus equal to 10%
of the corporation's income before income tax but after deduction of the bonus. If the tax rate is 40% and
net income after bonus and income tax was \$360,000, what was the amount of the bonus?
Solution: \$ 60,000. If net income after bonus and tax is \$360,000 and the tax rate is 40%, net income after
bonus can be calculated as follows: \$360,000/.6 = \$600,000 (.6 = 100% - 40% tax rate)
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Oak Co. offers a three-year warranty on its products. Oak previously estimated warranty costs to be 2% of
sales. Due to a technological advance in production at the beginning of 1994, Oak now believes 1% of sales
to be a better estimate of warranty costs. Warranty costs of \$80,000 and \$96,000 were reported in 1992
and 1993, respectively. Sales for 1994 were \$5,000,000. What amount should be disclosed in Oak's 1994
financial statements as warranty expense?
Solution: \$ 50,000. Warranty expense is calculated as a percentage of sales. Any change in the estimate of
the percentage is recorded prospectively, from the current year forward. Thus, 1994 warranty expense
equals \$ 50,000 [1% x \$5,000,000].

House Publishers offered a contest in which the winner would receive \$1,000,000, payable over 20 years.
On December 31, 1993, House announced the winner of the contest and signed a note payable to the
winner for \$1,000,000, payable in \$50,000 installments every January 2. Also on December 31, 1993, House
purchased an annuity for \$418,250 to provide the \$950,000 prize monies remaining after the first \$50,000
installment, which was paid on January 2, 1994. In its 1993 income statement, what should House report as
contest prize expense?
Solution: \$ 468,250. The contest prize expense is reported as the present value of the future cash flows. The
present value of the \$50,000 due January 2, 1994 equals \$50,000. The present value of the \$950,000 due in
19 future payments of \$50,000 annually equals \$418,250. The expense equals \$468,250, the total of the
present values. The correct journal entry follows:
Contest Prize Expense
468,250
Discount on Notes Payable
531,750
Notes Payable, current portion
50,000
Notes Payable, net of current portion
950,000

Dunne Co. sells equipment service contracts that cover a two-year period. The sales price of each contract is
\$600. Dunne's past experience is that, of the total dollars spent for repairs on service contracts, 40% is
incurred evenly during the first contract year and 60% evenly during the second contract year. Dunne sold
1,000 contracts evenly throughout 1992. In its December 31, 1992, balance sheet, what amount should
Dunne report as deferred service contract revenue?
Solution: \$ 480,000. When service contracts are sold, the entire proceeds are reported as deferred revenue.
Revenue is recognized, and deferral reduced as the service is performed. Since repairs are made evenly (July 1
is average date), only of the 40% of repairs will be in 1992.
1992 deferral (\$600 x 1,000)
Earned in 1992 (600,000 x 40% x 1/2)
Deferral 12-31-92

\$ 600,000
(120,000)
\$ 480,000

Zach Corp. pays commissions to its sales staff at the rate of 3% of net sales. Sales staff are not paid salaries
but are given monthly advances of \$15,000. Advances are charged to commission expense, and
reconciliations against commissions are prepared quarterly. Net sales for the year ended March 31, 1992,
were \$15,000,000. The unadjusted balance in the commissions expense account on March 31, 1992, was
\$400,000. March advances were paid on April 3, 1992. In its income statement for the year ended March 31,
1992, what amount should Zach report as commission expense?
Solution: \$450,000. The commission expense is 3% of net sales of \$15,000,000, or \$450,000. An adjustment
would be required on March 31, 1992 to bring the expense to this amount.

On February 12, 1992, VIP Publishing, Inc. purchased the copyright to a book for \$15,000 and agreed to
pay royalties equal to 10% of book sales, with a guaranteed minimum royalty of \$60,000. VIP had book
sales of \$800,000 in 1992. In its 1992 income statement, what amount should VIP report as royalty
expense?
Solution: \$80,000. Royalty expense is the larger of minimum royalties of \$60,000, or 10% of sales, \$80,000.
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Dana Co.'s officers' compensation expense account had a balance of \$224,000 at December 31, 1992, before
any appropriate year-end adjustment relating to the following:
No salary accrual was made for December 30-31, 1992. Salaries for the two-day period totaled \$3,500.
1992 officers' bonuses of \$62,500 were paid on January 31, 1993.
In its 1992 income statement, what amount should Dana report as officers' compensation expense?
Solution: \$290,000.

## Salaries and Officers' bonuses should be accrued at year-end.

\$224,000 + \$62,500 + \$3,500 = \$290,000

On November 10, 1988, a Garry Corp. truck was in an accident with an auto driven by Dacey. On January 10,
1989, Garry received notice of a lawsuit seeking \$800,000 in damages for personal injuries suffered by
Dacey. Garry Corp.'s counsel believes it is reasonably possible that Dacey will be awarded an estimated
amount in the range between \$250,000 and \$500,000, and that \$400,000 is a better estimate of potential
liability than any other amount. Garry's accounting year ends on December 31, and the 1988 financial
statements were issued on March 6, 1989. What amount of loss should Garry accrue at December 31, 1988?
Solution: \$0. Only footnote disclosure is required for a "reasonably possible" (not "probable") loss.

On January 17, 1991, an explosion occurred at a Sims Co. plant causing extensive property damage to area
buildings. Although no claims had yet been asserted against Sims by March 10, 1991, Sims' management
and counsel concluded that it is likely that claims will be asserted and that it is reasonably possible Sims will
be responsible for damages. Sims' management believed that \$1,250,000 would be a reasonable estimate
of its liability. Sims' \$5,000,000 comprehensive public liability policy has a \$250,000 deductible clause. In
Sims' December 31, 1990, financial statements, which were issued on March 25, 1991, how should this item
be reported?
Solution: As a footnote disclosure indicating the possible loss of \$250,000

## Brite Corp. had the following liabilities at December 31, 1993:

Accounts payable
\$ 55,000
Unsecured notes, 8%, due 7-1-94
400,000
Accrued expenses
35,000
Contingent liability
450,000
Deferred income tax liability
25,000
Senior bonds, 7%, due 3-31-94
1,000,000
The contingent liability is an accrual for possible losses on a \$1,000,000 lawsuit filed against Brite. Brite's legal
counsel expects the suit to be settled in 1995, and has estimated that Brite will be liable for damages in the
range of \$450,000 to \$750,000. The deferred income tax liability is not related to an asset or liability for
financial reporting and is expected to reverse in 1995. What amount should Brite report in its December 31,
1993, balance sheet for current liabilities?
Solution: \$1,490,000.

## \$55,000 + 400,000 + 35,000 + 1,000,000 = \$1,490,000

During 1990, Gum Co. introduced a new product carrying a two-year warranty against defects. The
estimated warranty costs related to dollar sales are 2% within 12 months following the sale and 4% in the
second 12 months following the sale. Sales and actual warranty expenditures for the years ended December
31, 1990 and 1991 are as follows:
Sales
Actual warranty expenditures
1990
\$150,000
\$2,250
1991
250,000
7,500
\$400,000
\$9,750
What amount should Gum report as estimated warranty liability in its December 31, 1991, balance sheet?
Solution: \$ 14,250.

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## The following information pertains to Rik Co.'s two employees:

Name Weekly salary in 1991
Number of weeks worked
Vacation rights vest or accumulate
Ryan
\$800
52
Yes
Todd
\$600
52
No
Neither Ryan nor Todd took the usual two-week vacation in 1991. In Rik's December 31, 1991, financial
statements, what amount of vacation expense and liability should be reported?
Solution: \$1,600.

\$1,600 of vested vacation expense & liability should be reported as of Dec. 31, 1991
(for Ryan who is vested; but not for Todd who is not vested).

On January 1, 1991, Baker Co. decided to grant its employee's 10 vacation days and five sick days each year.
Sick days may not be carried over to the next year. Each employee took an average of three sick days in
1991. During 1991, each of Baker's six employees earned \$100 per day and earned 10 vacation days. Any
earned but unused vacation days may be carried over to the following year. These vacation days were
taken during 1992. What amount should Baker accrue as compensated absence liability as of Dec 31, 1991?
Solution: \$6,000.

## Vacation days earned: 6 employees x 10 days x \$100 = \$6,000

Case Cereal Co. frequently distributes coupons to promote new products. On October 1, 1991, Case mailed
1,000,000 coupons for \$.45 off each box of cereal purchased. Case expects 120,000 of these coupons to be
redeemed before the December 31, 1991, expiration date. It takes 30 days from the redemption date for
Case to receive the coupons from the retailers. Case reimburses the retailers an additional \$.05 for each
coupon redeemed. As of December 31, 1991, Case had paid retailers \$25,000 related to these coupons and
had 50,000 coupons on hand that had not been processed for payment. What amount should Case report as
a liability for coupons in its December 31, 1991, balance sheet?
Solution: \$35,000.

## (120,000 x \$.50) - \$ 25,000 = \$ 35,000

Beck, the active partner in Beck & Cris, receives an annual bonus of 25% of partnership net income after
deducting the bonus. For the year ended December 31, 1988, partnership net income before the bonus
amounted to \$300,000. Becks 1988 bonus should be:
Solution: \$60,000.

## B = 25% (\$300,000 B); B = \$75,000 / 1.25 = \$60,000

North Corp. has an employee benefit plan for compensated absences that gives employees 10 paid vacation
days and 10 paid sick days. Both vacation and sick days can be carried over indefinitely. Employees can elect
to receive payment in lieu of vacation days; however, no payment is given for sick days not taken. At
December 31, 1992, North's unadjusted balance of liability for compensated absences was \$21,000. North
estimated that there were 150 vacation days and 75 sick days available at December 31, 1992. North's
employees earn an average of \$100 per day. In its December 31, 1992, balance sheet, what amount of
liability for compensated absences is North required to report?
Solution: \$15,000.
150 vacation days \$100 per day = \$15,000.
Note that in the above problem, the \$21,000 unadjusted balance on the books is a "distractor."

In December 1994, Mill Co. began including one coupon in each package of candy that it sells and offering a
toy in exchange for 50 cents and five coupons. The toys cost Mill 80 cents each. Eventually 60% of the
coupons will be redeemed. During December, Mill sold 110,000 packages of candy and no coupons were
redeemed. In its December 31, 1994, balance sheet, what amount should Mill report as estimated liability
for coupons?
Solution: \$3,960.

## 110,000 x 60% = 66,000 / 5 coupons per toy = 13,200 toys

(80 - 50) x 13,200 = \$ 3,960
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East Corp. manufactures stereo systems that carry a two-year warranty against defects. Based on past
experience, warranty costs are estimated at 4% of sales for the warranty period. During 1990, stereo
system sales totaled \$3,000,000, and warranty costs of \$67,500 were incurred. In its income statement for
the year ended December 31, 1990, East should report warranty expense of:
Solution: \$120,000.

\$3,000,000 x 4% = \$120,000
Liability = \$120,000 - 67,500 = \$52,500

Ross Co. pays all salaried employees on a Monday for the five-day workweek ended the previous Friday. The
last payroll recorded for the year ended December 31, 1992, was for the week ended December 25, 1992.
The payroll for the week ended January 1, 1993, included regular weekly salaries of \$80,000 and vacation
pay of \$25,000 for vacation time earned in 1992 not taken by December 31, 1992. Ross had accrued a
liability of \$20,000 for vacation pay at December 31, 1991. In its December 31, 1992, balance sheet, what
amount should Ross report as accrued salary and vacation pay?
Solution: \$89,000.

## \$80,000 - (\$80,000 1/5) = \$64,000

\$64,000 + 25,000 = \$89,000

Marr Co. sells its products in reusable containers. The customer is charged a deposit for each container
delivered and receives a refund for each container returned within two years after the year of delivery. Marr
accounts for the containers not returned within the time limit as being retired by sale at the deposit
amount. Information for 1989 is as follows:
Container deposits at December 31, 1988 from deliveries in:
1987
\$150,000
1988
430,000
Deposits for containers delivered in 1989
\$ 780,000
Deposits for containers returned in 1989 from deliveries in:
1987
\$ 90,000
1988
250,000
1989
286,000
In Marr's December 31, 1989 balance sheet, the liability for deposits on returnable containers should be:
Solution: \$674,000.

## \$ 430,000 + 780,000 250,000 286,000 = \$674,000

Dunn Trading Stamp Co. records stamp service revenue and provides for the cost of redemptions in the year
stamps are sold to licensees. Dunn's past experience indicates that only 80% of the stamps sold to licensees
will be redeemed. Dunn's liability for stamp redemptions was \$6,000,000 at December 31, 1988. Additional
information for 1989 is as follows:
Stamp service revenue from stamps sold to licensees
\$ 4,000,000
Cost of redemptions (stamps sold prior to 1/1/89)
2,750,000
If all the stamps sold in 1989 were presented for redemption in 1990, the redemption cost would be
\$2,250,000. What amount should Dunn report as a liability for stamp redemptions at December 31, 1989?
Solution: \$5,050,000.

## \$6,000,000 + (\$2,250,000 80%) - 2,750,000 = \$5,050,000

Baker Co. sells consumer products that are packaged in boxes. Baker offered an unbreakable glass in
exchange for two box tops and \$1 as a promotion during the current year. The cost of the glass was \$2.00.
Baker estimated at the end of the year that it would be probable that 50% of the box tops will be redeemed.
Baker sold 100,000 boxes of the product during the current year and 40,000 box tops were redeemed
during the year for the glasses. What amount should Baker accrue as an estimated liability at the end of the
current year, related to the redemption of box tops?
Solution: \$5,000.

## (100,000 x 50%) 40,000 = 10,000 / 2 = 5,000 premiums

5,000 x (\$2 1) = \$5,000
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Toddler Care Co. offers three payment plans on its 12-month contracts. Information on the three plans and
the number of children enrolled in each plan for the September 1, 1991, through August 31, 1992, contract
year follows:
Plan
Initial payment per child
Monthly fees per child
Number of children
#1
\$500
\$15
#2
200
30
12
#3
50
9
Toddler received \$9,900 of initial payments on September 1, 1991, and \$3,240 of monthly fees during the
period September 1 through December 31, 1991. In its December 31, 1991, balance sheet, what amount
should Toddler report as deferred revenues?
Solution: \$6,600.

## \$9,900 x 8/12 (1/1/92 - 8/31/92) = \$6,600

In its 1993 financial statements, Cris Co. reported interest expense of \$85,000 in its income statement and
cash paid for interest of \$68,000 in its cash flow statement. There was no prepaid interest or interest
capitalization either at the beginning or end of 1993. Accrued interest at December 31, 1992, was \$15,000.
What amount should Cris report as accrued interest payable in its December 31, 1993, balance sheet?
Solution: \$32,000

## \$ 15,000 + 85,000 68,000 = \$ 32,000

On December 31, 1992, Roth Co. issued a \$10,000 face value note payable to Wake Co. in exchange for
services rendered to Roth. The note, made at usual trade terms, is due in nine months and bears interest,
payable at maturity, at the annual rate of 3%. The market interest rate is 8%. The compound interest factor
of \$1 due in nine months at 8% is .944. At what amount should the note payable be reported in Roth's
December 31, 1992, balance sheet?
Solution: \$10,000. Normally interest is imputed when no (or an unreasonably low) rate is stated. An
exception exists for receivables and payables arising from transactions with customers or suppliers in the
normal course of business when the trade terms do not exceed one year. The note is recorded at \$10,000.

Able, Inc. had the following amounts of long-term debt outstanding at December 31, 1991:
14 1/2% term note, due 1992
\$ 3,000
11 1/8% term note, due 1995
107,000
8% note, due in 11 equal annual principal payments,
plus interest beginning December 31, 1992
110,000
7% guaranteed debentures, due 1996
100,000
Total
\$ 320,000
Able's annual sinking-fund requirement on the guaranteed debentures is \$4,000 per year. What amount
should Able report as current maturities of long-term debt in its December 31, 1991, balance sheet?
Solution: \$13,000. The \$4,000 sinking-fund requirement would be disclosed in a footnote but is not included as
a current maturity of long-term debt. Deposits into a bond sinking fund are an asset held by a trustee to repay
the entire liability at maturity.

On December 31, 1999, Key Co. received two \$10,000 non-interest-bearing notes from customers in
exchange for services rendered. The note from Alpha Co., which is due in nine months, was made under
customary trade terms, but the note from Omega Co., which is due in two years, was not. The market
interest rate for both notes at the date of issuance is 8%. The present value of \$1 due in nine months at 8%
is .944. The present value of \$1 due in two years at 8% is .857. At what amounts should these two notes
receivable be reported in Key's December 31, 1999, balance sheet?
Solution: Alpha, \$10,000 and Omega, \$8,570
Because the term of the Alpha note does not exceed one year, it is recorded at its face amount of \$10,000,
while the two-year Omega note must be reported at the present value of the obligation calculated using the
market interest rate of 8%: \$10,000 x 0.857 = \$8,570
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As of December 15, 2002, Aviator had dividends in arrears of \$200,000 on its cumulative preferred stock.
Dividends for 2002 of \$100,000 have not yet been declared. The board of directors plans to declare cash
dividends on its preferred and common stock on January 16, 2003. Aviator paid an annual bonus to its CEO
based on the company's annual profits. The bonus for 2002 was \$50,000, and it will be paid on February 10,
2003. What amount should Aviator report as current liabilities on its balance sheet at December 31, 2002?
Solution: \$50,000. The dividends were not declared in 2002 and as such should not be accrued for. Upon
declaration, they become a debt of the corporation.

In May, 2005, Sonic Company became involved in litigation. The suit is being contested, but Sonics lawyer
believes it is possible that Sonic may be held liable for damages estimated in the range between \$ 2,000,000
and \$ 3,000,000, and no amount is a better estimate of potential liability than any other amount. Determine
the amount if any, that should be reported as current liability in Sonics December 31, 2005 balance sheet.
Solution: \$ -0-. Only Disclosure is required.

Ice Companys president gets an annual bonus of 10% of net income after bonus & income tax. Assume the
tax rate of 30% & the income before bonus and tax is \$9,600,000. Compute for the amount of the bonus.
Solution: \$ 628,037.

## B = 10% (\$9,600,000 B T); T = 30% (\$9,600,000 B) = \$2,880,000 0.3B

B = 10% (\$9,600,000 B (\$2,880,000 0.3B))
B = \$672,000 0.07B
B = \$628,037

During 2005, Super Sonic entered in a noncancellable commitment to purchase 320,000 units of inventory
at fixed price of \$5 per unit, delivery to be made in 2006. On December 31, 2005, the purchase price of this
inventory item had fallen to \$4.40 per unit. The goods covered by the purchase contract were delivered on
January 28, 2006. Determine the amount if any, that should be reported as current liability in Super Sonics
December 31, 2005 balance sheet.
Solution: \$ 192,000.

## 320,000 units x (\$5-4.40) = \$ 192,000 (Liability on Purchase Commitments)

Speed Company has a one year product warranty on selected items in its product line. The estimated
warranty liability on sales made during 2004, which was outstanding as of December 31, 2004, amounted to
\$416,000. The warranty costs on sales made in 2005 are estimated at \$1,504,000. Actual warranty costs
incurred during the current 2005 fiscal year are as follows:
Warranty claims honored on 2004 sales
\$ 416,000
Warranty claims honored on 2005 sales
992,000
Total warranty claims honored
\$ 1,408,000
Compute for the amount of estimated warranty liability to be reported in the Dec 31, 2005 balance sheet.
Solution: \$ 512,000.

## \$ 416,000 + 1,504,000 1,408,000 = \$ 512,000

To increase sales, the Ultimate Company inaugurated a promotional campaign on June 30, 2005. Ultimate
placed a coupon redeemable for a premium in each package of product sold. Each premium costs P100. A
premium is offered to customers who send in 5 coupons and a remittance of P30. The distribution cost per
premium is P20. Ultimate estimated that only 60% of the coupons issued will be redeemed. For the six
months ended December 31, 2005, the following is available:
Packages of product sold 160,000