Professional Documents
Culture Documents
CHAPTER 9
TIME
NUMBER TOPIC CONTENT LO ADAPTED DIFFICULTY EST. AACSB AICPA BLOOM’S
TIME
NUMBER TOPIC CONTENT LO ADAPTED DIFFICULTY EST. AACSB AICPA BLOOM’S
9-13 Current Liabilities Criteria for classifying short- 3 Easy 5 Analytic Measurement Comprehension
term vs. long-term liability
9-14 Current Liabilities Criteria for classifying short- 3 Easy 5 Analytic Measurement Comprehension
term vs. long-term liability
9-15 Current Liabilities Balance sheet classification 3 Easy 5 Analytic Measurement Comprehension
of unpaid cash dividends vs.
stock dividends
9-16 Current Liabilities Measurement and reporting 3 Easy 5 Analytic Measurement Comprehension
for property taxes
9-17 Current Liabilities Unearned revenue; reporting 3 Easy 5 Analytic Measurement Comprehension
9-18 Payroll Current liabilities associated 4 Easy 5 Analytic Measurement Comprehension
with payroll
9-19 Compensated Accounting for 4 Easy 5 Analytic Measurement Comprehension
9-2
TIME
NUMBER TOPIC CONTENT LO ADAPTED DIFFICULTY EST. AACSB AICPA BLOOM’S
9-27 Warranty Costs Accounting for warranty 5 Easy 5 Analytic Measurement Comprehension
costs
9-28 Gain Contingency Criteria for recognition of 5 Easy 5 Analytic Measurement Comprehension
gain contingencies
M9-1 Accounts Payable Items included and excluded 3 AICPA Easy 5 Analytic Reporting Comprehension
in accounts payable
M9-2 Current Liabilities Accounting for notes 3 AICPA Easy 10 Analytic Reporting Comprehension
payable and accrued
interest
M9-3 Current Liabilities Accounting for customer 3 AICPA Easy 10 Analytic Measurement Comprehension
deposits
M9-4 Current Liabilities Items included and excluded 4 AICPA Easy 10 Analytic Reporting Application
in accrued expenses
M9-5 Compensated Accounting for future 4 AICPA Easy 10 Analytic Reporting Comprehension
9-3
TIME
NUMBER TOPIC CONTENT LO ADAPTED DIFFICULTY EST. AACSB AICPA BLOOM’S
RE9-3 Property Taxes Accounting for monthly 3 Easy 10 Analytic Measurement Comprehension
property tax expense; journal
entries
RE9-4 Compensated Accounting for 4 Easy 10 Analytic Measurement Application
Absences compensated absences;
journal entries
RE9-5 Payroll Accounting for payroll and 4 Easy 10 Analytic Measurement Application
compensated absences;
journal entries
RE9-6 Sales Tax Payable Sales tax adjusting journal 4 Easy 10 Analytic Measurement Application
entry
RE9-7 Payroll Journal entries for payroll and 4 Easy 10 Analytic Measurement Application
payroll taxes
RE9-8 Bonus Obligation Calculate bonuses and taxes 4 Easy 10 Analytic Measurement Application
9-4
RE9-10 Warranty Costs Journal entries for service- 5 Easy 10 Analytic Measurement Application
type warranty costs
RE9-11 Loss Contingency Journal entries to record 5 Easy 10 Analytic Measurement Application
estimated liability from
pending lawsuit
E9-1 Accounts Payable Accounts payable, 3 Easy 5 Analytic Measurement Application
and Cash Discounts perpetual inventory system;
net-of-cash discount
approach; journal entries;
conceptual extension; next
level
© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
TIME
NUMBER TOPIC CONTENT LO ADAPTED DIFFICULTY EST. AACSB AICPA BLOOM’S
E9-2 Notes Payable Periodic inventory system, 3 Easy 5 Analytic Measurement Application
interest-bearing; journal
entries to record transactions
E9-3 Non-Interest- Non-interest-bearing; journal 3 Moderate 10 Analytic Reporting Analysis
Bearing Notes entries, balance sheet
Payable disclosure; effective interest
rate calculation; conceptual
extension; next level
E9-4 Discounting of Notes Discounted, present value 3 Moderate 15 Analytic Reporting Analysis
Payable techniques; journal entries;
balance sheet disclosure
E9-5 Disclosure of Debt Balance sheet disclosure of 3 Easy 10 Analytic Reporting Application
currently maturing portion of
long-term debt
9-5
TIME
NUMBER TOPIC CONTENT LO ADAPTED DIFFICULTY EST. AACSB AICPA BLOOM’S
E9-12 Compensated No sick leave taken; journal 4 Easy 10 Analytic Reporting Application
Absences entries; balance sheet
disclosure; conceptual
extension; next level
E9-13 Sales Taxes Journal entries to record 4 Easy 10 Analytic Measurement Application
various transactions
E9-14 Payroll and Payroll Payroll taxes; journal entries 4 Moderate 10 Analytic Measurement Analysis
Taxes to record payroll transactions
E9-15 Bonus Obligation Computation of bonus and 4 Moderate 10 Analytic Measurement Analysis
income tax expense
E9-16 Loss Contingency Necessary journal entries 5 Moderate 10 Analytic Measurement Analysis
and/or disclosures; IFRS
terminology
E9-17 Assurance-Type Journal entries; balance 5 Moderate 10 Analytic Reporting Analysis
9-6
TIME
NUMBER TOPIC CONTENT LO ADAPTED DIFFICULTY EST. AACSB AICPA BLOOM’S
E9-21 Cash Rebates Journal entries to record 5 Moderate 10 Analytic Reporting Application
cash rebate and redemption
E9-22 Gain Contingency Discussion of accounting 5 Easy 10 Analytic Measurement Application
treatment as called for by
GAAP; next level
P9-1 Accounts Payable Accounts payable, net-of- 3 Moderate 25 Analytic Reporting Application
and Cash Discounts cash discount method;
journal entries, balance sheet
disclosure; current ratio
calculation; conceptual
extension; next level
P9-2 Notes Payable and Interest-bearing, non-interest- 3 Moderate 25 Analytic Measurement Application
Effective Interest bearing; computation of
cash received, effective
9-7
TIME
NUMBER TOPIC CONTENT LO ADAPTED DIFFICULTY EST. AACSB AICPA BLOOM’S
TIME
NUMBER TOPIC CONTENT LO ADAPTED DIFFICULTY EST. AACSB AICPA BLOOM’S
TIME
NUMBER TOPIC CONTENT LO ADAPTED DIFFICULTY EST. AACSB AICPA BLOOM’S
C9-6 Various Accrual or note disclosure 5 AICPA Moderate 20 Analytic Measurement Analysis
Contingency Issues associated with loss
contingency
C9-7 Product and Lawsuit Accounting for warranty 5 AICPA Moderate 20 Analytic Measurement Analysis
Contingencies costs
C9-8 Ethics and Ethics; contingent liabilities; Challenging 25 Analytic Measurement Analysis
Environmental environmental liabilities
Damage
C9-9 Analyzing Starbucks’ Using real company annual Moderate 25 Analytic Measurement Application
Current Liabilities reports; current liabilities;
and Contingencies accounts payable; loans or
Disclosures notes payable; contingent
liabilities
C9-10 Analyzing Moet Current liabilities; short-term Moderate 25 Analytic Measurement Analysis
9-10
9-1 Liabilities are the probable future sacrifices of economic benefits arising from present
obligations of a company to transfer assets or provide services to other entities in the
future as a result of past transactions or events. Probable refers to what can
reasonably be expected or believed based on available evidence or logic.
Obligations refer to duties imposed legally or socially which one is bound to do by
contract, promise, or moral responsibility.
9-2 A legal liability is incurred in a transaction that is contractual and requires payment of
cash or provision of services to other entities in the future. Examples are accounts
payable, notes payable, and sales taxes payable. Equitable and constructive
liabilities are those where there is no legal requirement for assets to be transferred,
but a transfer of assets typically occurs as a part of the normal operations of a
business. Examples of equitable and constructive liabilities are obligations for
vacation pay and year-end bonuses to employees.
9-4 False. A company does not need to know the identity of the recipient before the
time of settlement, as long as the three characteristics of a liability are met.
9-5 The primary issues include: (a) the identification of liabilities—the detection of a
company’s obligations; (2) valuation and measurement of the liabilities and the
related revenue or expense—the determination of an amount to record for each
obligation and to record as a revenue or expense; (3) the reporting on the financial
statements—the specific disclosures in both the company’s financial statements and
the related notes.
9-6 The operating cycle of a company is the period of time that elapses between the
use of cash to buy inventory, the sale of this inventory resulting in accounts
receivable, and the collection of these receivables in cash.
9-7 The liquidity of liabilities is important in accounting for them because users (investors,
creditors, and other decision makers) evaluate future cash flows in their decision-
making processes. In part, financial statement users predict future cash inflows from
liquid assets relative to future cash outflows needed to meet liabilities coming due.
9-11
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9-8 Financial flexibility refers to a company’s ability to use its financial resources to adapt
to change and to take advantage of opportunities. This involves the management of
cash and other resources as well as the potential to create new current and long-
term liabilities and to restructure existing debt. Therefore, a company with greater
financial flexibility generally has a greater ability to manage its debt relative to a
company with less financial flexibility.
9-9 Conceptually, a company should record and report on its balance sheet all liabilities
at the present value of the future payments they will require; however, in practice
current liabilities are valued at their face amount. Due to the short time period
involved, the difference between the maturity amount and the present value of
current liabilities is not material. The slight overstatement which results from recording
current liabilities at their maturity amount is justified on the basis of materiality and the
cost constraint.
9-10 Both interest-bearing and non-interest-bearing notes payable are promissory notes
that require the borrower to repay a sum of money on a specific date. Both notes
require the payment of interest and principal. For an interest-bearing note, the
principal amount equals the face value of the note, and the interest rate is stated
explicitly on the note. For a non-interest-bearing note, the face amount of the note
includes both principal and interest to maturity. The borrower receives less than the
face value of the note, and, therefore, the interest is implied as the difference
between the face value of the note and the cash received.
9-11 Generally, a company classifies the currently maturing portion of long-term debt as a
current liability. Therefore, the entire amount of the bonds payable ($300,000) would
be reported as a current liability to show the effect on the company’s liquidity.
9-12 If a liability becomes callable by the creditor within 1 year, a company should report
the entire amount of the long-term obligation as a current liability. The only
exceptions are if (1) the creditor has waived the right to request repayment for more
than 1 year from the balance sheet date or (2) it is probable that the company will
resolve the violation within a specified grace period, thus preventing it from
becoming callable.
9-13 The two criteria that must be met before a company can classify a short-term debt
that is expected to be refinanced as a noncurrent liability are (1) the company
intends to refinance on a long-term basis and (2) it has the ability to refinance on a
long-term basis.
9-14 A company demonstrates the ability to refinance currently maturing short-term debt
in one of two ways:
1. The company has issued long-term debt or equity for the short-term debt after
the date of its balance sheet but before that balance sheet is issued.
2. The company has entered into a long-term financing agreement before the
balance sheet is issued that clearly permits the company to refinance the short-
term debt on a long-term basis.
9-12
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9-15 Declared but unpaid cash dividends are reported as current liabilities on a
company’s balance sheet if the company expects to distribute the cash dividend
within the following year. In contrast, stock dividends (dividends payable in shares of
stock) are not reported as a current liability because they do not require a distribution
of assets. Instead , they require a distribution of a company’s own stock and are
reported as an element of shareholders’ equity.
9-16 Donald should estimate and accrue property taxes in equal monthly amounts during
Orange County’s fiscal year. Therefore, Donald will begin accruing a property tax
liability in October based on its estimate. This liability will be reported as a current
liability on Donald’s balance sheet. (If Donald has paid the property tax prior to the
end of the year, a prepaid asset may be reported.) Any difference between the
actual and estimated property taxes is treated as a change in accounting estimate.
9-17 Unearned revenue arises when a company collects amounts in advance of satisfying
its performance obligations. Because the amount has been collected but the
performance obligation has not yet been satisfied, it is reported as a liability. If the
company expects to satisfy the performance obligation (e.g., deliver the good or
perform the service) within the upcoming year (or operating cycle, if longer), the
liability is classified as a current liability on a company’s balance sheet.
9-18 An employer has various types of payroll-related liabilities. First, the employer has a
current liability related to employee withholdings for income taxes. The employer
must remit these withheld amounts to the appropriate governmental authorities at
specified times and through specified channels. Second, social security legislation
requires that employers withhold Federal Insurance Contribution Act (F.I.C.A.) taxes
from the wages of each employee. These amounts are remitted to the Internal
Revenue Service along with any income taxes withheld. Third, the employer incurs a
liability for unemployment insurance taxes. Finally, any voluntary payroll deductions
of the employee (e.g., group health insurance, life insurance, union dues, retirement
contributions) create a current liability of the employer until these amounts are
remitted to the appropriate entity.
9-19 Compensated absences are employee absences including vacation, holiday, illness,
or other personal activities for which a company pays its employees. Items such as
severance pay, share options, and long-term fringe benefits are not included. A
company accounts for compensated absences by recording an expense and
accruing a liability if: (1) the obligation is based on employee services already
rendered, (2) it relates to rights that vest or accumulate, (3) payment is probable,
and (4) the amount can be reasonably estimated. If all conditions are met except
the ability to make a reasonable estimate, the company discloses the facts relating
to the other conditions in the notes to its financial statements.
9-13
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9-21 The matching principle refers to the fact that a company should match expenses
arising from an existing condition with current revenues. To wait until the contingency
is confirmed to account for it would overstate current income and understate future
income.
Accounting for contingencies is conservative because generally only loss
contingencies are accrued. Gain contingencies are usually not recognized until they
are actually realized.
9-22 The two criteria that must be met before a loss contingency is reported in a
company’s financial statements are: (1) it is probable that a liability has been
incurred (or an asset has been impaired), and (2) the company can reasonably
estimate the amount of the loss.
9-23 The event that results in a possible loss must have occurred by the balance sheet
date. A company has until the date of issuance of the financial statements to assess
the probability of loss.
9-24 The conditions that must be met for a company to accrue the loss from an unfiled
lawsuit include:
1. The event resulting in the possible lawsuit must have occurred before the date of
the financial statements.
2. It is probable that the outcome of the lawsuit will result in a loss unfavorable.
3. The amount of the loss can be reasonably estimated.
9-25 Under IFRS, a provision that has a 51% chance of occurring is accrued because IFRS
use probable to mean the outcome is more likely than not to occur. Under U.S.
GAAP, the term probable is used to mean the outcome is likely to occur, which is a
more stringent threshold. Because of this difference in the use of the term probable, it
is likely that the amount would not be accrued under U.S. GAAP. It is “expected” that
there will be more accruals of loss contingencies under IFRS than under U.S. GAAP.
9-26 Under IFRS, if there is a range of possible outcomes with no amount being more likely
than another, the amount accrued as a provision (loss contingency) would be
measured as the mid-point of the range ($80,000).
9-28 A gain contingency is a potential increase in its assets or a potential decrease in its
liabilities, dependent upon the occurrence of some future event. A gain contingency
may be disclosed in the notes to the company’s financial statements, but care
should be taken to avoid misleading users as to the likelihood of realization of the
possible gain.
9-14
© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
ANSWERS TO MULTIPLE-CHOICE
RE9-1
October 1:
Inventory ...................................................................................................... 30,000
Notes Payable ...................................................................................... 30,000
December 1:
Notes Payable............................................................................................. 30,000
Interest Expense ($30,000 × 10% × 60/360) .............................................. 500
Cash ....................................................................................................... 30,500
RE9-2
October 1:
Inventory ...................................................................................................... 29,250
Discount on Notes Payable ($30,000 × 15% × 60/360) .......................... 750
Notes Payable ...................................................................................... 30,000
December 1:
Interest Expense .......................................................................................... 750
Discount on Notes Payable ................................................................ 750
RE9-3
9-15
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RE9-4
July 1:
Salaries Expense .......................................................................................... 66,000
Liability for Compensated Absences* .............................................. 66,000
*(50 employees × $176 per day × 15 allowable absences per year) × 1/2 year
RE9-5
August 20:
Salaries Expense .......................................................................................... 120,000
Liability for Compensated Absences ...................................................... 10,000
Cash ....................................................................................................... 130,000
RE9-6
May 31:
Sales .............................................................................................................. 40,000
Sales Taxes Payable* ........................................................................... 40,000
*$540,000 – ($540,000 ÷ 1.08)
RE9-7
RE9-8
B = 0.12($565,000 – B)
B = $67,800 – 0.12B
1.12B = $67,800
B = $60,536.00
T = 0.35($565,000 – $60,536)
T = $176,562.40
9-16
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RE9-9
Sale of toasters:
Cash or Accounts Receivable ($50 × 500) ............................................. 25,000
Sales ....................................................................................................... 25,000
RE9-10
Sale of machines:
Cash or Accounts Receivable ................................................................. 150,000
Sales (60 × $2,275) ................................................................................ 136,500
Unearned Warranty Revenue (60 × $225) ....................................... 13,500
RE9-11
SOLUTIONS TO EXERCISES
E9-1
1. 2016
Jan. 4 Inventory [(2,500 × $800) × 98%] .............................. 1,960,000
Accounts Payable .............................................. 1,960,000
13 Accounts Payable ($1,960,000 × 20%) ................... 392,000
Cash...................................................................... 392,000
9-17
© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
E9-1 (concluded)
2. The net price method is theoretically superior to the gross price method because it values
the inventory and the related liability at the amount that the company expects to pay to
acquire the goods. In addition, it does not include interest expense related to any
purchase discounts lost in inventory. Under the gross price method, both accounts
payable and inventory could be overstated.
E9-2
2016
Dec. 1 Inventory ............................................................................... 25,000
Notes Payable (Ringo Chemicals) ............................. 25,000
31 Interest Expense ................................................................... 250
Interest Payable ($25,000 × 0.12 × 1/12) .................... 250
2017
Apr. 1 Interest Expense ($25,000 × 0.12 × 3/12) .......................... 750
Interest Payable................................................................... 250
Notes Payable (Ringo Chemicals) ................................... 25,000
Cash................................................................................ 26,000
E9-3
1. 2016
Nov. 16 Cash ............................................................................ 19,400
Discount on Notes Payable
($20,000 × 0.12 × 90/360) ....................................... 600
Notes Payable..................................................... 20,000
2017
Feb. 15 Notes Payable ........................................................... 20,000
Cash...................................................................... 20,000
15 Interest Expense (1/2 × $600) ................................... 300
Discount on Notes Payable .............................. 300
$600
3. = 3.093% rate for 90 days
$19,400
× 4 (90-day periods per year)
12.37% effective annual rate
9-18
© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
E9-4
1. 2016
Oct. 30 Machine............................................................................. 21,779.37*
Discount on Notes Payable ............................................ 2,220.63
Notes Payable............................................................ 24,000.00
*P = $6,000(Pon=4, I=4%)
= $6,000(3.629895; Factor from Table 4 of TVM Module)
= $21,779.37
Dec. 31 Interest Expense (2/3 × $871.17, see schedule) ........... 580.78
Discount on Notes Payable ..................................... 580.78
2017
Jan. 31 Interest Expense (1/3 × $871.17, see schedule) ........... 290.39
Notes Payable .................................................................. 6,000.00
Discount on Notes Payable ..................................... 290.39
Cash............................................................................. 6,000.00
Apr. 30 Interest Expense (see schedule) .................................... 666.02
Notes Payable .................................................................. 6,000.00
Discount on Notes Payable ..................................... 666.02
Cash............................................................................. 6,000.00
2017
Jan. 31 $ 6,000.00 $ 871.17 $ 5,128.83 16,650.54
Apr. 30 6,000.00 666.02 5,333.98 11,316.56
July 31 6,000.00 452.66 5,547.34 5,769.22
Oct. 30 6,000.00 230.78* 5,769.22 0
$24,000.00 $ 2,220.63 $21,779.37
*Difference due to rounding
9-19
© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
E9-4 (concluded)
2. SANCHEZ COMPANY
Partial Balance Sheet
December 31, 2016
Property, Plant, and Equipment:
Machinery .................................................................................... $21,779.37
Current Liabilities:
Notes payable ............................................................................ $24,000.00
Less: Discount on notes payable ($2,220.63 – $580.78) ........ (1,639.85) 22,360.15
E9-5
RAMDEN COMPANY
Partial Balance Sheet
December 31, 2016 and 2017
2016 2017
Current Liabilities:
Bonds payable ........................................................................ $ 200,000 $ 200,000
Long-Term Liabilities:
Bonds payable ........................................................................ 1,800,000 1,600,000
E9-6
E9-7
9-20
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E9-7 (concluded)
E9-8
1.
2.
E9-9
1. 2016
Dec. 5 Cash ............................................................................ 12,000
Unearned Revenue: Gift Certificates .............. 12,000
31 Unearned Revenue: Gift Certificates..................... 9,875
Sales ...................................................................... 9,875
2017
Jan. 15 Unearned Revenue: Gift Certificates..................... 2,125
Sales ...................................................................... 2,125
9-21
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E9-10
Sept. 1, 2016
Property Taxes Payable ................................................... 2,400
Prepaid Property Taxes .................................................... 4,800
Cash............................................................................. 7,200
2. There will be no property tax liability at December 31, 2016. The taxes have been prepaid
and are a prepaid asset.
E9-11
9-22
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E9-12
1. 2016
Mar. 31 Salaries Expense ........................................................ 1,600
Liability for Compensated Absences
(5 employees × $160 daily rate × 8 days
× ¼ of year) ...................................................... 1,600
To record liability for sick pay.
31 Salaries Expense ....................................................... 2,400
Liability for Compensated Absences
(5 employees × $160 daily rate × 3 days
per quarter) ...................................................... 2,400
To record liability for vacation pay.
2. BETTINGHAUS CORPORATION
Partial Balance Sheet
March 31, 2016
Current Liabilities:
Liability for compensated absences ................................... $4,000
3. A compensated absence, like any accrued liability, represents an expense that has
been incurred but not yet paid. Because the company has an obligation to the
employee for services rendered, this obligation vests or accumulates, payment is
probable and can be reasonably estimated, and the company should accrue an
expense related to compensated absences. This ensures that any expense related to
compensated absences is recorded in the period in which the employees work and earn
the benefits.
E9-13
9-23
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E9-14
E9-15
E9-16
1. Since (1) the accident occurred prior to the date of the financial statements, (2) it is
probable that Farmers Products will suffer a loss from Johnson’s accident,(3) the amount
can be reasonably estimated, and the loss should be accrued. Because there is a range
of estimates with no amount in the range more likely than any other amount, Farmers will
accrue the minimum amount of the range as follows:
Loss from Litigation ........................................................... 6,000
Estimated Liability from Lawsuit ............................... 6,000
The nature of the litigation should also be described in the notes to the financial
statements.
9-24
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E9-17
1. 2016
Oct. 1 Cash or Accounts Receivable (900 × $125) .......... 112,500
Sales ...................................................................... 112,500
1 Warranty Expense (900 × $10) ................................. 9,000
Estimated Warranty Liability .............................. 9,000
3. 2016
Oct. 1 Cash or Accounts Receivable (900 × $125) .......... 112,500
Sales ...................................................................... 112,500
4. Companies offer warranties to increase sales. The expense warranty accrual method
provides the better measure of income because it properly matches warranty costs to
the revenues that the warranties helped generate. This method also creates a
contingent liability representing a company’s expected use of resources. Under the
modified cash basis method, a company’s liabilities will be understated. In addition, the
modified cash basis method understates warranty expense, and overstates income, if
the actual warranty repair occurs in a period other than the period in which the sale
occurs.
9-25
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E9-18
2. PEREIRA CORPORATION
Partial Balance Sheet
December 31, 2016
Current Liabilities:
Unearned warranty revenue .......................................... $11,200
E9-19
9-26
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E9-19 (concluded)
E9-20
3. Because the premium was offered to increase Tiger Cereal Company’s sales and the
redemption of the coupons is probable and can be reasonably estimated, Tiger should
record an estimate of this expense and the related liability in the period of the sale. If this
estimate were not made, Tiger’s expenses would not be properly matched against the
sales the premium helped to generate. Specifically, Tiger’s expenses would be
understated by $20,000—the value of the coupons that are expected to be redeemed
but were not redeemed during 2016. In addition, Tiger’s liabilities would not properly
reflect the company’s probable obligation. Specifically, Tiger’s liabilities would be
understated by $20,000.
9-27
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E9-21
1.
2017
Cash (or Accounts Receivable) 5,000,000
Sales Revenue 4,500,000*
Estimated Rebate Liability 500,000
To record liability for cash rebate at the time of sale.
2018
Estimated Rebate Liability 75,000
Cash (150,000 ÷ 10 × $5) 75,000
To record redemption of labels.
2.
2018
Estimated Rebate Liability 100,000
Sales Revenue* 50,000
Cash (300,000 ÷ 10 × $5) 150,000
To record redemption of labels.
* Note: The change in the transaction price is accounted for a reduction in sales in the
period of the change consistent with the guidance in FASB ASC 606 as discussed in
Chapter 17.
E9-22
The Braino Tech circumstances fit the requirements of a gain contingency. Gain contingencies
are disclosed in the notes to the financial statements. The reason gain contingencies are usually
not accrued is because to do so might cause revenue to be recognized prior to its realization.
Thus, GAAP takes a conservative approach with regard to the probable gain. Gains should not
be recognized until they are realized.
9-28
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SOLUTIONS TO PROBLEMS
P9-1
1. 2016
Dec. 24 Equipment (Computer) [$60,000 – ($60,000 × 0.02)] 58,800
Accounts Payable ..................................................... 58,800
29 Cash ................................................................................... 60,000
Notes Payable............................................................ 60,000
30 Retained Earnings ............................................................ 20,000
Dividends Payable (10,000 × $2.00) ........................ 20,000
31 Interest Expense ................................................................ 40
Interest Payable ($60,000 × 0.12 × 2/360) ............... 40
2017
Jan. 2 Accounts Payable ........................................................... 58,800
Cash............................................................................. 58,800
5 Dividends Payable ........................................................... 20,000
Cash............................................................................. 20,000
28 Interest Expense [($60,000 × 0.12 × 30/360) – $40] ....... 560
Notes Payable .................................................................. 60,000
Interest Payable................................................................ 40
Cash............................................................................. 60,600
2. BYRD COMPANY
Partial Balance Sheet
December 31, 2016
Current Liabilities:
Accounts payable ........................................................................ $58,800
Notes payable ............................................................................... 60,000
Interest payable............................................................................. 40
Dividends payable ........................................................................ 20,000
9-29
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P9-2
1. a. Cash received:
(1) Interest-bearing: $60,000
(2) Non-interest-bearing: $60,000 × 0.88 = $52,800
2. Interest-Bearing Non-Interest-Bearing
2016
Nov. 1 Cash 60,000 52,800
Discount on Notes Payable — 7,200
Notes Payable 60,000 60,000
Dec. 31 Interest Expense 1,200 1,200
Discount on Notes Payable — 1,200
Interest Payable 1,200 —
2017
Oct. 31 Interest Expense 6,000 6,000
Interest Payable 1,200 —
Discount on Notes Payable — 6,000
Cash 7,200 —
31 Notes Payable 60,000 60,000
Cash 60,000 60,000
3. While both notes pay the same dollar amount of interest ($7,200), the amount of cash
received is different. For the interest-bearing note, Edwin Inc. borrowed and has use of
$60,000 cash. For the non-interest-bearing note, Edwin borrowed and has use of $52,800
cash. Because less cash was borrowed with the non-interest-bearing note but the same
amount of interest was paid, the effective interest rate of the non-interest-bearing note is
higher than the effective interest rate of the interest-bearing note.
P9-3
2016
Nov. 1 Accounts Payable .............................................................. 20,000
Notes Payable (Johnson) ............................................... 20,000
9-30
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P9-3 (concluded)
2017
Mar. 1 Notes Payable (Johnson) ................................................... 20,000
Interest Payable................................................................... 400
Interest Expense ................................................................... 400
Cash ................................................................................... 20,800
1 Notes Payable (Winslow) ................................................... 32,000
Interest Payable................................................................... 320
Interest Expense ................................................................... 640
Cash ................................................................................... 32,960
P9-4
1. The $3,000,000 commercial paper liquidated prior to the refinancing will be classified as a
current liability on Palmer’s balance sheet at December 31, 2016. GAAP states that even
if funds used to retire short-term debt are replaced, the liability must nevertheless be
recorded as a current liability.
2. The remaining $4,000,000 will be classified as long-term debt, since Palmer issued the
long-term bonds after the balance sheet date but before the date of issuance, thereby
demonstrating the ability to refinance.
P9-5
9-31
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P9-6
1. 2016
Jan. 1 Machine...................................................................... 72,597.90*
Discount on Notes Payable ..................................... 7,402.10
Notes Payable..................................................... 80,000.00
*P = $20,000(Pon=4, i=4%)
= $20,000(3.629895; Factor from Table 4 of TVM Module)
= $72,597.90
9-32
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P9-7
Eight monthly entries: Nov. 30, 2016, through June 30, 2017
Property Tax Expense .................................................................... 1,320.00
Prepaid Property Taxes .......................................................... 1,320.00
2. ROSEN CORPORATION
Partial Balance Sheet
December 31, 2016
Current Assets:
Prepaid property taxes [$10,560.00 – (2 × $1,320.00)] ....... $7,920.00
P9-8
1. 2016
Mar. 31 Salaries Expense ........................................................ 9,000
Liability for Compensated Absences .............. 9,000*
*$1,800 + $1,200
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P9-8 (concluded)
2. REXALLO COMPANY
Partial Balance Sheet
June 30, 2016
Current Liabilities:
Liability for compensated absences ................................... $15,000
3. A compensated absence, like any accrued liability, represents an expense that has
been incurred but not yet paid. Because the company has an obligation to the
employee for services rendered, this obligation vests or accumulates, payment is
probable and can be reasonably estimated, and the company should accrue an
expense related to compensated absences. This ensures that any expense related to
compensated absences is recorded in the period in which the employees work and earn
the benefits (the matching principle).
P9-9
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P9-10
3. 2016
Dec. 31 Salaries Expense ....................................................... 350,000
Bonus Payable .................................................... 350,000
31 Income Tax Expense ................................................. 1,395,000
Income Taxes Payable ...................................... 1,395,000
4. NATIONAL MOTORS
Partial Balance Sheet
December 31, 2016
Current Liabilities:
Bonus payable ........................................................................ $ 350,000
Income taxes payable .......................................................... 1,395,000
P9-11
2. MAULDIN COMPANY
Partial Balance Sheet
December 31, 2016
Current Liabilities:
Sales taxes payable ............................................................... $56,075
9-35
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P9-12
1. (1) This loss contingency is accrued at the end of 2016 because (a) it is an existing
condition, (b) a loss is probable, and (c) the loss can be reasonably estimated.
The loss is accrued at the most likely amount ($80,000) within the range of
amounts as follows:
2016
Dec. 31 Loss from Litigation ..................................................... 80,000
Estimated Liability from Lawsuit .......................... 80,000
(2) This loss contingency is accrued at the end of 2016 because (a) it is an existing
condition, (b) a loss is probable (e.g., a recall notice has been issued), and (c)
the loss can be reasonably estimated. The loss is accrued at the estimated cost of
repairs ($200,000) as follows:
2016
Dec. 31 Repair and Maintenance Expense ......................... 200,000
Estimated Liability for Recall Repairs .................. 200,000
The potential lawsuits for injury claims are disclosed in a note to the financial
statements because there is a reasonable possibility that a loss may have been
incurred.
(3) This loss contingency is accrued at the end of 2016 because (a) it is an existing
condition, (b) a loss is probable, and (c) the loss can be reasonably estimated.
The loss is accrued at the minimum amount of the range ($40,000) because it is
not likely that the loss will be less, as follows:
2016
Dec. 31 Loss from Pollution Fine .............................................. 40,000
Estimated Liability for Pollution Fine.................... 40,000
(4) Because of conservatism, this gain contingency is not accrued but is disclosed in
the notes to the financial statements.
2. (1) With regard to the customer lawsuit, the accounting under IFRS would be the
same as U.S. GAAP. Specifically, the most likely amount ($80,000) is accrued as a
provision.
(2) With regard to the potential skateboard litigation, the loss related to the
estimated repairs of $200,000 is recorded similar to U.S. GAAP:
Repair and Maintenance Expense ........... 200,000
Estimated Liability for Recall Repairs .... 200,000
In addition, IFRS require that a provision (or contingency) be accrued when the
outcome is more likely than not to occur and a reliable estimate of the amount
can be made. The opinion of management is that it is reasonably possible that
$2,000,000 in damages will be awarded to the plaintiff. Therefore, an additional
accrual of this provision will be required as follows:
Loss from Litigation ........................................ 2,000,000
Estimated Liability from Lawsuit ............ 2,000,000
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P9-12 (concluded)
Note that the use of IFRS results in a larger accrual than under U.S. GAAP due to a
less stringent definition of the term probable.
(3) With regard to the environmental protection agency lawsuit, if an unfavorable
outcome is probable and there exists a range of estimates with no amount in the
range more likely than any other amount in the range, IFRS require that the mid-
point of the range be used to measure the liability. Therefore, the journal entry to
record the accrual of the provision would be:
Loss from Pollution Fine .............................. 50,000
Estimated Liability for Pollution Fine... 50,000
Note that the accrual under IFRS is larger than the accrual required under U.S.
GAAP.
(4) Finally, with regard to the breach of contract lawsuit, similar to U.S. GAAP, gain
contingencies are not accrued under IFRS.
9-37
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P9-13 (concluded)
P9-14
1. 2016
Cash (or Accounts Receivable) ................................................. 500,000
Sales .......................................................................................... 500,000
Warranty Expense [$500,000 × (0.03 + 0.05 + 0.07)] ................. 75,000
Estimated Warranty Liability .................................................. 75,000
Estimated Warranty Liability......................................................... 62,000
Cash (or other assets) ............................................................ 62,000
2017
Cash (or Accounts Receivable) ................................................. 650,000
Sales .......................................................................................... 650,000
Warranty Expense ($650,000 × 0.15) ........................................... 97,500
Estimated Warranty Liability ................................................. 97,500
Estimated Warranty Liability......................................................... 82,000
Cash (or other assets) ............................................................ 82,000
2018
Cash (or Accounts Receivable) ................................................. 700,000
Sales .......................................................................................... 700,000
Warranty Expense ($700,000 × 0.15) ........................................... 105,000
Estimated Warranty Liability .................................................. 105,000
Estimated Warranty Liability......................................................... 85,000
Cash (or other assets) ............................................................ 85,000
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P9-14 (concluded)
3. A basic objective in the recognition of loss contingencies is to record losses in the period
in which they are incurred. Therefore, a probable loss should be recognized in the same
period in which it resulted in the probable impairment of an asset or the probable
incurrence of a liability. The failure to accrue the loss contingency in the period of
occurrence will generally understate expenses, overstate earnings, overstate
shareholders’ equity, understate liabilities of the initial period, and understate earnings of
future periods.
P9-15
P9-16
1. October
Cash (or Accounts Receivable) (21,000 × $2.80) ........ 58,800
Sales ............................................................................. 58,800
9-39
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P9-16 (concluded)
November
Cash (or Accounts Receivable) (24,000 × $2.80) ........ 67,200
Sales ............................................................................. 67,200
December
Cash (or Accounts Receivable) (33,000 × $2.80) ........ 92,400
Sales ............................................................................. 92,400
9-40
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P9-17
2016
Jan. 5 Inventory [$30,000 – ($30,000 × 0.02)] ............................... 29,400
Accounts Payable ........................................................ 29,400
26 Accounts Payable .............................................................. 29,400
Purchase Discounts Lost ..................................................... 600
Cash................................................................................ 30,000
P9-18
2016
Nov. 1 Cash ($40,000 – $1,200) ...................................................... 38,800
Discount on Notes Payable ($40,000 × 0.12 × 3/12) ....... 1,200
Notes Payable............................................................... 40,000
9 Accounts Receivable ......................................................... 500,000
Sales (100 × $5,000)....................................................... 500,000
9 Warranty Expense (100 × $125) ......................................... 12,500
Estimated Warranty Liability ....................................... 12,500
12 Accounts Receivable ......................................................... 30,000
Sales (100 × $300) .......................................................... 30,000
9-41
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P9-18 (concluded)
9-42
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ANSWERS TO CASES
C9-1
1. Because Warder repaid the note with existing current assets on February 19, before the
long-term financing was obtained, the note payable should be reported as a current
liability on Warder’s year-end balance sheet. If Warder had obtained the financing prior
to the repayment of the debt, the amount could have been excluded from current
liabilities.
2. The refinancing agreement must allow Warder to borrow for the entire amount of the
note to be able to exclude the full amount from current liabilities. If Warder’s refinancing
agreement only allowed Warder to borrow for a portion of the amount of the note, it
could only reclassify as long term the amount borrowed or available to be borrowed
under the agreement. Since the refinancing agreement was entered into before the
statement issuance date, Warder shows both the intent and ability to refinance the notes
on a long-term basis. Therefore, excluding the note payable from current liabilities would
be proper.
3. If the shareholders will confirm that they will not make demand for payment within the
next year or operating cycle, then the notes payable may be omitted from current
liabilities.
4. If Warder plans to hold the deposits for longer than 1 year or one operating cycle,
whichever is longer, after the balance sheet date, then it can exclude this amount from
current liabilities.
a. The two basic requirements for the accrual of a loss contingency (probability of loss and
reasonable estimation) are the results of the interaction of several concepts of
accounting theory. Three of these concepts are the (1) period of time assumption, (2)
recognition principle, and (3) qualitative characteristic of verifiability. The first of these
concepts relates to the first characteristic of an event necessary before accruing a loss
contingency, and the second and third concepts relate to the second necessary
requirement for the accrual of a loss contingency.
The first requirement that must be satisfied for the accrual of a loss contingency is that at
a time prior to the issuance of the financial statements there is an indication that it is
probable that an asset has been impaired or a liability has been incurred at the date of
the financial statements. A basic objective in the recognition of losses is to record them in
the particular time period in which they are incurred. With respect to the accrual of a loss
contingency, a probable loss should be recognized in the same period in which it
resulted in the probable impairment of an asset or the probable incurrence of a liability.
The failure to accrue the loss contingency in the period of occurrence will generally
overstate earnings initially and understate earnings in future periods. Therefore, the
proper accounting for loss contingencies in the period in which they are incurred allows
for companies to provide financial statement users with timely information consistent with
the period of time assumption.
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C9-2 (continued)
The second requirement for the accrual of a loss contingency states that the amount of
the loss must be reasonably estimable. The recognition principle requires that an item
must meet the definition of an element, be measurable, be relevant, and be
representationally faithful in order to be recognized. Two of these criteria—measurability
and representational faithfulness—are particularly important for loss contingencies. In the
case of a loss contingency, the exact timing and magnitude of the loss may not be
known in advance. However, a reasonable estimate of the loss contingency can be
made based on past experience or other methods of analysis. In making the estimate,
the probability that a reasonable amount will be determined statistically is enhanced by
a large population of accounts from which the probable loss will occur (law of large
numbers). Thus, the loss contingency is both measurable and a faithful representation of
the underlying economic transaction, event, or arrangement.
Also related to the reasonable estimation of the probable future loss, the qualitative
characteristic of verifiability requires that the estimate must yield essentially the same
estimate when computed by different knowledgeable and independent individuals
using the available supporting data. The characteristic of verifiability is supportive of both
the qualitative characteristics of relevance and faithful representation.
b. Situation I
When a company sells a product subject to a warranty, it is probable that there will be
expenses incurred in future accounting periods relating to revenues recognized in the
current period. As such, a liability has been incurred to honor the warranty at the same
date as the recognition of the revenue. Based on prior experience or technical analysis,
the occurrence of warranty claims can be reasonably estimated and a probable dollar
estimate of the liability can be made. The contingent liability for warranties meets both of
the requirements for the accrual of a loss contingency, and the estimated amount of the
loss should be reflected in the financial statements. In addition to recording the accrual,
it may be advisable to disclose the factors used in arriving at the estimate by means of a
note, especially when there is a possibility of a greater loss than was accrued.
Situation II
Even though (1) there is a probable loss on the contract, (2) the amount of the loss can
be reasonably estimated, and (3) the likelihood of the loss was discovered prior to the
issuance of the financial statements, the fact that the contract was entered into
subsequent to the date of the financial statements precludes accrual of the loss
contingency in financial statements for periods prior to the incurrence of the loss.
However, the fact that a material loss has been incurred subsequent to the date of the
financial statements but prior to their issuance should be disclosed by means of a note to
the financial statements. The disclosure should contain the nature of the contingency
and an estimate of the amount of the probable loss or a range into which the loss will
probably fall.
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C9-2 (concluded)
Situation III
The fact that a company chooses to self-insure the contingency of injury to others
caused by its vehicles is not basis enough to accrue a loss contingency that has not
occurred at the date of the financial statements. An accrual or “reserve” cannot be
made for the amount of insurance premium that would have been paid had a policy
been obtained to insure the company against this particular risk. A loss contingency may
only be accrued if prior to the date of the financial statements a specific event has
occurred that will impair an asset or create a liability and an amount related to that
specific occurrence can be reasonably estimated. The fact that the company is self-
insuring this risk should be disclosed by means of a note to alert the financial statement
reader to the exposure created by the lack of insurance.
2. Disclosure should be made for an estimated loss from a loss contingency that need not
be accrued by a charge to income when there is at least a reasonable possibility that a
loss may have been incurred. The disclosure should indicate the nature of the
contingency and should estimate the possible loss or range of loss or state that such an
estimate cannot be made.
Disclosure of a loss contingency involving an unasserted claim is required when it is
probable that the claim will be asserted and there is a reasonable possibility that the
outcome will be unfavorable.
C9-4
Because the wreck occurred on December 15, 2016, prior to the end of Cork’s fiscal year-end,
the obligating event exists at the balance sheet date. The fact that no claims had yet been filed
is not relevant to whether a contingency exists or not. Instead, Cork must assess the probability
that these potential claims will result in a loss for the company. Because legal counsel believes
that a claim is probable, a liability should be accrued if the amount of the probable claims can
be estimated. However, Cork’s legal counsel cannot reasonably estimate these potential claims.
Therefore, no loss will be accrued, but disclosure of the contingency in the notes to the financial
statements is recommended.
9-45
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C9-5 [AICPA Adapted]
1. The accounting for the potential costs due to the discovery of a possible product defect
is subject to some ambiguity. On one hand, some argue that because it is probable that
a liability has been incurred and the amount can be reasonably estimated, Skinner
should report these costs as an expense or loss in the income statement and as a
contingent liability in the balance sheet, with appropriate disclosure of the nature of the
costs due to the discovery of a possible product defect.
On the other hand, a company has no legal obligation associated with a product
defect, and, therefore, no obligating event exists. In other words, because a liability is a
present obligation and the company has no such obligation until company
management announces a recall campaign (or government regulation requires the
recall of the defective product), no contingent liability exists. Therefore, the company
does not need to accrue a liability at the balance sheet date, although it may choose to
disclose the product defect in the notes to the financial statements.
2. Skinner should not report the potential claim for damages that may be received next
year in the current year’s income statement or balance sheet. Gain contingencies
usually are not recorded in the accounts in advance of their realization. However,
adequate disclosure should be made of gain contingencies, but care should be
exercised to avoid misleading implications as to the likelihood of realization.
3. This year, Skinner should account for the potential costs due to the promotion campaign
as a premium expense and as a liability for 70% of the dollar amount of the coupons
issued. The amount of the liability at the end of this year would be 30% of the dollar
amount of the coupons issued. This amount represents 70% of the dollar amount of the
coupons issued this year less 40% of the dollar amount of the coupons redeemed and for
which cash refunds were sent.
1. For the safety hazard, Niki should accrue a loss because the loss is both probable and
can be reasonably estimated. The amount of the accrued liability should be equal to the
most likely amount. The most likely loss is the best estimate of the expected loss. If no
amount in the range is a better estimate than any other amount in the range, the
minimum amount in the range should be accrued. In addition, Niki should separately
disclose in the notes to the 2016 financial statements the nature of the hazard and the
range of possible loss.
2. Niki should accrue for a loss and a liability for the note sold to a bank. The accrual should
equal the amount due on the note plus related costs and less any expected settlement
from the bankruptcy. Accrual is appropriate because it is probable that a loss has
occurred, as evidenced by the bankruptcy filing, even though this note is not yet due.
3. Niki should disclose the possible loss on the assigned lease in notes to the 2016 financial
statements. Disclosures should include details of the assigned lease and the amounts
due, estimates of any revenues that might be earned on the property, and any amounts
recoverable from Pro. Although disclosure is appropriate for the financial statements not
to be misleading, accrual of a loss is inappropriate because the loss is only reasonably
possible.
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C9-7 [AICPA Adapted]
1. For Type A merchandise, the estimated product warranty costs should be accrued by a
charge to income and a credit to a liability because both of the following conditions
were met:
a. It is probable that a liability has been incurred based on past experience. Thus,
the matching principle is being followed.
b. The amount of loss can be reasonably estimated as 1% of sales.
For Type B merchandise, the estimated product warranty costs should not be accrued by
a charge to income because the amount of loss cannot be reasonably estimated.
C9-8
Note to Instructor: This case does not have a definitive answer. From a financial reporting
perspective, GAAP is identified and summarized. From an ethical perspective, various issues are
raised for discussion purposes.
From a financial accounting perspective, this situation involves a loss contingency. An estimated
loss from a loss contingency is accrued and reported as a reduction of income and as a liability if it
is probable that a liability has been incurred and the amount of the loss can be reasonably
estimated. When there is a range of possible amounts, and some amount is the best estimate,
then this amount is accrued. If either of the two conditions is not met, but there is a reasonable
possibility that a loss may have been incurred, then the loss contingency (and amount) is disclosed
in the notes to the financial statements. Consideration must be given to Stan Hart’s knowledge of
company operations. It may be helpful, from an operations standpoint, to ascertain why Stan feels
the way he does. Consideration also must be given to Bob Brandt’s knowledge of the legal
process. To be “probable” that a loss has occurred, it is implicit that it must be probable that a
future event will occur confirming the occurrence of the loss. More information must be gathered
about the meaning of Bob’s comment that there is a pretty good chance of losing the lawsuit in
the future and that the amount will be at least $400,000. Does “pretty good chance” mean
“probable” or “reasonably probable”? Furthermore, since the lawsuit is for $1 million, is “at least
$400,000” the best estimate to use in the lawsuit? Or, is $640,000 (the joint probability of $400,000 ×
0.60 + $1 million × 0.40) the most prudent number to use? Also, how reliable are Bob Brandt’s
estimates? These issues must be resolved to determine whether to record and report the loss in the
financial statements or to disclose the lawsuit (and amount) in the related notes.
9-47
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C9-8 (concluded)
From an ethical perspective, the issue involves which alternative (recording and reporting the
loss in the financial statements versus disclosing the loss contingency in a note) is the most fair to
the stakeholders. In this case, the stakeholders include Stan Hart, the shareholders, the town, the
EPA, and the region through which the river runs. While Stan may claim the company has not
caused the fish kills, the EPA thinks it did. Stan may be biased in his thinking, because his bonus is
based on a percent of pretax income. Reporting of the loss in income will either significantly
reduce his bonus or eliminate it, depending on the amount of the loss. Reporting the loss will
significantly reduce income, which may decrease the market price of the company’s stock and
have an adverse effect on shareholders’ investments. Since Hart Corporation is the major
employer in the small town, a shutdown may cause harmful economic effects but we don’t
know the likelihood of a shutdown. Furthermore, the EPA must consider these economic factors
in its decisions. The region through which the river runs also must be considered because of the
impact on the fish and fishing (both leisure and commercial), as well as the possible costs of
downstream cleanup.
C9-9
1. (a) As with most companies, Starbucks reports its current liabilities at their maturity or face
amount. While this is not explicitly stated for common liabilities such as accounts
payable, Starbucks does disclose that its insurance reserves are not discounted. This
valuation is justified by the short time period involved.
(b) Starbucks’s total current liabilities were $5,377.3 million at the end of its 2013 fiscal
year.
(c) The largest current liability was an accrued litigation charge of $2,784.1 million (see
Requirement 3 below). Starbucks also reported $1,269.3 million of accrued liabilities
and deferred revenue of $653.7 million which represents amounts that the company
has collected in advance but has not yet earned.
2. Accrued liabilities consisted of accrued compensation costs (e.g., wages and salaries
payable) of $420.2 million, accrued occupancy costs of $120.7 million, accrued taxes of
$125 million, accrued dividends payable of $195.8 million, and other accrued costs of
$407.6 million, for a total of $1,269.3 million.
3. Starbucks was involved in a legal dispute with Kraft Foods regarding its distribution
arrangement which was terminated by Starbucks on March 1, 2011. Kraft denied it had
breached the arrangement and argued that if the agreement were to be discontinued,
Starbucks would owe Kraft for the fair value of the agreement plus a premium. On
December 6, 2010, a federal court action commenced in which Kraft sought $2.9 billion
in damages. On November 2, 2013, the arbitrator concluded that Starbucks owed Kraft
$2,227.5 million in damages plus interest and attorney fees of $556 million. Starbucks
accrued this amount as a current liability in its balance sheet.
9-48
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C9-9 (concluded)
This current ratio is significantly less than its current ratio of 1.90 in the previous year.
However, Starbucks’s largest current liability is the $2,784.1 million accrued litigation
charge (see answer to Requirement 3). Given operating cash flow of approximately $2.9
billion as well as the one-time nature of the litigation charge, Starbucks appears to be
sufficiently liquid to pay its obligations as they become due.
Dividing this ratio into 365 days, it appears that Starbucks is paying its suppliers, on
average, every 25 days.
C9-10
1. The total current liabilities were €9,482 million at the end of 2013. The largest current
liability was trade accounts payable of €3,134 million.
2. LVMH’s short-term borrowings consisted of short-term bonds and Euro Medium Term
Notes (EMTNs) of €696 million, commercial paper of €1,212 million, bank overdrafts of
€208 million, and other short-term borrowings of €860 million.
3. LVMH recognizes a provision whenever an obligation exists towards a third party resulting
in a probable disbursement and the amount can be reliably estimated. At the end of
2013, LVMH reported current provisions of €335 million which consists of provisions for
pensions, medical costs, and similar commitments (€13 million); contingencies and losses
(€282 million); and reorganizations (€40 million). While lawsuits and other litigation are
included in these amounts, LVMH provides no specific details on any pending litigation.
4. LVMH reports “other current liabilities” of €2,595 million. These consist of obligations
related to derivatives (€20 million); employees and social institutions (€924 million);
employee profit sharing (€95 million); taxes other than income taxes (€361 million);
advances and payments on account from customers (€139 million); deferred payments
for tangible and financial noncurrent assets (€367 million); deferred income (€116 million);
and other liabilities (€573 million).
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ANSWERS TO USING CODIFICATION
C9-11
Note to Instructor: Students are expected to cite references to GAAP in their research of this
issue. While they might use various sources to conduct their research, the FASB Accounting
Standards Codification, which is the primary source of GAAP, is cited.
From: Student
I have researched the issue of how to account for the “sale” of $42,000 of inventory for $50,000
on November 1, 2016, and agreement to “repurchase” the inventory at the end of July, 2017.
This agreement may fall under the category of a product financing arrangement. According to
FASB ASC 470-40-05, a product financing arrangement includes an agreement in which a
company (the sponsor) seeking to finance a product sells the product to another company (the
company through which the financing flows) and in a related transaction agrees to repurchase
the product. FASB ASC 470-40-05 identifies other characteristics commonly found in such
arrangements, including: (1) the company that purchases the product was established solely for
that purpose, (2) the debt of the company that purchases the product being financed is
guaranteed by the sponsor, (3) the sponsor is required to repurchase the product at specified
prices, and (4) the established payments received by the company from the sponsor are
sufficient to cover the costs incurred in purchasing and holding the product (including interest).
For an arrangement that has both characteristics (3) and (4), FASB ASC 470-40-25 states that the
sponsor shall record a liability at the time the proceeds are received from the other company,
shall not record the transaction as a sale, and shall not remove the covered product from its
balance sheet.
Furthermore, I recommend that the $400 storage expense and $800 interest expense be
reported in the 2016 income statement. I also recommend that the inventory be reported as a
current asset at a cost of $42,000, and the $40,000 note payable be reported as a current liability
on the 2016 ending balance sheet.
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C9-12
Note to Instructor: Students are expected to cite references to GAAP in their research of this
issue. While they might use various sources to conduct their research, the FASB Accounting
Standards Codification, which is the primary source of GAAP, is cited.
From: Student
In researching the issue of how to account for a product recall, it appears that generally
accepted accounting principles would allow the product recall to be treated as a loss
contingency. According to FASB ASC 450-10-20, a loss contingency is defined as:
In particular, FASB ASC 450-20-05 lists obligations related to product defects as an example of a
loss contingency. If the product recall is considered a loss contingency, FASB ASC 450-20-25-2
requires that a liability and an associated loss be accrued if both of the following conditions are
met:
a. Information available before the financial statements are issued or are available to be
issued indicates that it is probable that an asset had been impaired or a liability had
been incurred at the date of the financial statements.
Because the refrigerator has been sold to customers and it contains a manufacturing defect
(the defective damper control assembly), MacKenzie can conclude that it is probable that a
liability exists to correct the defect that will be validated at a future date. Based on MacKenzie’s
internal assessment, the amount of the loss can be reasonably estimated as being in the range
of $1,000,000 to $1,200,000. If no amount in the range is a better estimate than any other
amount, FASB ASC 450-20-30-1 requires that the minimum amount in the range be accrued.
Therefore, it appears that MacKenzie should accrue $1,000,000 in its current financial statements.
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C9-12 (concluded)
Because MacKenzie has no legal obligation to fix the defective assembly beyond its warranty
program, it can be argued that no obligating event has occurred. Therefore, no liability, outside
of the existing warranty, exists to repair the product defect until the obligating event occurs. In
this situation, the obligating event would be a recall announcement by MacKenzie’s board of
directors. If MacKenzie’s board of directors decides to not issue a recall on the defective part,
there would be no need to accrue a liability in the current year. Instead, MacKenzie would
increase its warranty estimate to reflect the increase in expected warranty repairs during the
warranty period due to the discovery of the product defect. In summary, MacKenzie would
only reflect a warranty liability for the estimate of defective assemblies to be repaired during the
warranty period.
Recommendations
Based on my research, it appears that both alternatives are accepted under generally
accepted accounting principles and the treatment of product recalls is a policy decision that
should be consistently applied.
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