Libby 4ce Solutions Manual - Ch10

Chapter 10
Reporting and Interpreting Current Liabilities

Revised: May 14, 2011
ANSWERS TO QUESTIONS
1. Liabilities are obligations that result from transactions that require future payment of
assets or the future performance of services. The obligations are definite in amount or
are subject to reasonable estimation. A liability usually has a definite payment date
known as the maturity or due date. A current liability is a short-term liability; that is,
one that will be paid during the coming year or the current operating cycle of the
business, whichever is longer. It is assumed that the current liability will be paid out of
current assets. All other liabilities are defined as long-term liabilities.
2. One of the main sources of information available to external parties for determining
the number, type, and amounts of liabilities of a business are the published financial
statements. The statement of financial position includes liabilities and the notes to the
statements contain further detail on the liabilities that are on the statement of
financial position as well as on contingent liabilities and commitments. These
statements have more credibility when they have been audited by an independent
auditor (usually a chartered accountant).
3. A liability is initially measured at its current cash equivalent amount. Conceptually,

this amount is the present value of all of the future payments of principal and interest.
For a short-term liability the current cash equivalent amount is usually the same as the
maturity amount. The current cash equivalent amount for an interest-bearing liability
at the going rate of interest is the same as the maturity value. For a long-term liability,
the current cash equivalent amount will be less than the maturity amount: (1) if there
is no stated rate of interest, or (2) if the stated rate of interest is less than the going
rate of interest.
4. Most debts specify a definite amount that is due at a specified date in the future.
However, there are situations where it is known that an obligation or liability exists
although the exact amount is unknown. Liabilities that are known to exist but the exact
amount is not yet known must be recorded in the accounts and reported in the
financial statements at an estimated amount, assuming that a reasonable estimate can
be made. Examples of a known obligation of an estimated amount are estimated
income tax at the end of the year, property taxes at the end of the year, and obligations
under warranty contracts for merchandise sold.
5. Working capital is computed as total current assets minus total current liabilities. It is
the amount of current assets that would remain if all current liabilities were paid,
assuming no loss or gain on liquidation of those assets.
Financial Accounting, 4ce, Libby, Libby, Short, Kanaan, Gowing © 2011 McGraw-Hill Ryerson Limited. All rights reserved.
10-1
6. The current ratio is the percentage relationship of current assets to current liabilities.
It is computed by dividing current assets by current liabilities. The current ratio is
influenced by the amount of current liabilities. Therefore, it is particularly important
that liabilities be considered carefully before classifying them as current versus long
term. The shifting of a liability from one of these categories to the other may
significantly affect the current ratio. This ratio is used by creditors because it is an
important measure of a firm’s ability to meet short-term obligations as they generally
come due. Thus, the proper classification of liabilities is particularly significant.
7. An accrued liability is an expense that was incurred before the end of the current
period but has not yet been paid or recorded. Therefore, an accrued liability is
recognized when such a transaction is recorded. A typical example is wages earned
during the last few days of the accounting period but not recorded because the payroll
was not prepared (or paid) that included these wages. Assuming wages of $2,000 were
incurred but not yet paid as at December 31, the adjusting entry to record the accrued
liability and the wage expense would be as follows:
December 31:
Wage expense (+E SE) .................................................................. 2,000
Wages payable (+L) ......................................................................... 2,000
8. Deferred revenue (also called unearned revenue or revenue collected in advance) is
revenue that has been collected in advance of being earned and recorded in the
accounts by the entity. Because the amount has already been collected and the goods
or services have not yet been provided, there is a liability to provide goods or services
to the party who made the payment in advance. A typical example is the collection of
rent on December 15 for one full month to January 15 when the accounting period
ends on December 31. At the date of the collection of the rent the following entry is
usually made:
December 15:
Cash (+A)............................................................................................... 4,000
Rent revenue (+R +SE) ......................................................... 4,000
On the last day of the period, the following adjusting entry should be made to
recognize the deferred revenue as a liability:
December 31:
Rent revenue (R SE)............................................................... 2,000
Deferred rent revenue (+L)..................................................... 2,000
The deferred rent revenue (credit) is reported as a liability on the statement of
financial position because two weeks’ occupancy is owed in the next period for which
the lessee has already made payment.
9. A note payable is a formal written contract prepared when a company borrows

money. The note specifies the amount borrowed, the date by which it must be repaid,
and the interest rate associated with the borrowing. Interest payable is the other
10-2
liability associated with a note payable, as interest regularly accrues on the note until
it is repaid.
10. A provision is a liability that must be recognized when the following conditions are
met: (1) an entity has a present obligation as a result of a past event, (2) it is probable
that cash or other assets will be required to settle the obligation, and (3) a reliable
estimate can be made of the amount of the obligation. It differs from other liabilities in
that there is uncertainty as to the amount that will be required to settle the provision
or the timing of the liability.
11. A contingent liability is not an effective liability; rather it is a potential future liability.
A contingent liability arises because of some transaction or event that has already
occurred which may, depending upon one or more future events (occurring or not
occurring), cause the creation of a true liability. A typical example is a lawsuit for
damages where an accident has occurred. Whether the defendant has a liability
depends upon the ultimate decision of the court. Pending that decision there is a
contingent liability (and a contingent loss). This contingency must be recorded and
reported (debit, loss; credit, liability) if it is “likely” that the decision will require the
payment of damages, and the amount can be reasonably estimated. If the occurrence
of the confirming future event is not determinable, or if the event is likely to occur but
the amount of the loss cannot be reasonably estimated, information about the
contingent loss must be disclosed in the footnotes to the financial statements.
Disclosure of unlikely contingencies is desirable but not required.
12. Interest expense = $4,000 x 12% x 9/12 = $360.
13. The concept of the time value of money is another way to describe interest. Time value
of money refers to the fact that a dollar received today is worth more than a dollar to
be received at any later date because of interest that is earned over time.
10-3
Authors’ Recommended Solution Time
(Time in minutes)
Alternate Cases and

Exercises Problems Problems Projects
No. Time No. Time No. Time No. Time
1 20 E 1 35 M 1 35 E 1 25 E
2 20 E 2 35 E 2 25 E 2 20 E
3 10 E 3 25 E 3 40 M 3 25 M
4 30 M 4 30 M 4 30 M 4 20 D
5 20 M 5 40 M 5 15 M 5 20 M
6 20 E 6 20 M 6 25 M 6 25 M
7 15 E 7 30 M 7 25 M 7 20 M
8 20 D 8 30 M 8 10 E 8 20 M
9 10 E 9 25 M 9 50 D 9 20 M
10 10 M 10 20 M 10 *
11 25 M 11 20 M
12 10 M 12 10 E
13 20 M 13 30 D
14 15 M
15 20 D
E = Easy M = Moderate D = Difficult
* Due to the nature of such cases and projects, it is very difficult to estimate the amount of
time students will need to complete the assignment. As with any open-ended project, it is
possible for students to devote a large amount of time to such assignments. While students
often benefit from the extra effort, we find that some become frustrated by the perceived
difficulty of the task. You can reduce student frustration and anxiety by making your
expectations clear. For example, when our goal is to sharpen research skills, we devote
class time discussing research strategies. When we want the students to focus on a real
accounting issue, we offer suggestions about possible companies or industries.
10-4
EXERCISES
E10–1
Title of Liability Account

Event Affected by Event Amount of Current Liability
a. Deferred passenger revenue $470
b. Deposits from customers $50,000
c. Note payable $10,000

Interest payable $150 [=$10,000 x .09 x (2/12)]
d. Deferred subscription revenue $1,800
e. None, assuming that the amount due

was paid within 30 days.
f. None, because the bill relates to calls

made in January 2012.
E10–2
Req. 1
(a) Current assets ($530,000 – $362,000)......................................... $168,000

Current liabilities:
Trade payables................................................................................... $56,000
Income taxes payable...................................................................... 14,000
Liability for withholding taxes.................................................... 3,000
Rent revenue collected in advance........................................... 7,000
Wages payable................................................................................... 7,000
Property taxes payable.................................................................. 3,000
Note payable, 10% (due in 6 months)..................................... 12,000
Interest payable................................................................................. 400 (102,400)
Working capital...................................................................................... $ 65,600
10-5
E10–2 (continued)
(b) Current ratio = $168,000  $102,400 = 1.64
Working capital is critical for the efficient operation of a business. Current assets
include cash and assets that will be collected in cash within one year or the normal
operating cycle of the company. A business with insufficient working capital may not
be able to pay its short-term creditors on a timely basis and could, eventually, result in
bankruptcy.
The current ratio is a measure of liquidity. It helps analysts assess a company’s ability
to meet its short-term obligations as they generally come due.
Req. 2
Contingent liabilities that are disclosed in the notes to the financial statements do not affect
the total amount of current liabilities reported on the statement of financial position.
Hence, the previous computations are not affected by such disclosures.
E10–3
Current Ratio Working Capital

a. Increase No change
b. Decrease Decrease
c. Decrease No change
d. Decrease No change
The above can be checked by calculating the values. Knowing that the current ratio is 2 and
the amount of working capital is $1,240,000 the current assets are $2,480,000 and the
current liabilities are $1,240,000.
10-6
E10–4
Req. 1
March 31, 2011:
Compensation expense (+E SE)........................................................... 224,000
Liability for income taxes withheld (+L)............................................ 46,000
Liability for union dues withheld (+L)................................................ 3,000
Liability for insurance premiums withheld(+L)............................. 1,000
CPP payable (+L)........................................................................................... 16,445
EI payable (+L) ............................................................................................. 9,611
Cash (A).......................................................................................................... 147,944
Payroll for March including employee deductions.
Req. 2
March 31, 2011:
Compensation expense (+E SE)........................................................... 29,900
CPP payable (+L)........................................................................................... 16,445
EI payable (+L)............................................................................................... 13,455
Employer’s additional payroll expenses for March
($9,611 x 1.4 = $13,455).
Req. 3
Liability for income taxes withheld (L)................................................. 46,000

Liability for union dues withheld (L)..................................................... 3,000
Liability for insurance premiums withheld (L)................................. 1,000
CPP payable (L) ($16,445 x 2)................................................................... 32,890
EI payable (L) ($9,611 + $13,455)........................................................... 23,066
Cash (A).......................................................................................................... 105,956
Remittance of employee deductions and employer-related
amounts for March.
Req. 4
The total compensation expense was $253,900, comprised of $224,000 of salaries and
wages plus $29,900 of additional payroll charges levied on the employer.
The total payroll (salaries and wages) was $224,000. The take-home pay was $147,944 and
the percent of payroll that was take-home pay was 66% = $147,944  $224,000.
Employee compensation is a large cost for most organizations. Employers are not
concerned about the distinction between salaries and fringe benefits because both are
expenses that are deductible for tax purposes. Employees sometimes prefer an extra dollar
in fringe benefits over an extra dollar of salary because some fringe benefits are either not
taxable or are not taxable in the current period. In the absence of tax effects, most
employees prefer increases in salaries because they have full control over those dollars.
10-7
E10–5
Req. 1
The additional labour expense was $10,933 [$6,013 + ($3,514 x 1.4)], which represents the
total of the additional payroll charges levied on the employer. The employees’ take-home
pay was $41,373; that is, the total of salaries and wages less the deductions paid by the
employees (i.e., $69,000 – $16,900 – $1,200 – $6,013 – $3,514 = $41,373).
Req. 2
Statement of financial position liabilities:
Liability for income taxes withheld................................................................................ $ 16,900
Liability for union dues withheld..................................................................................... 1,200
Canada Pension Plan contributions payable ($6,013 + $6,013)........................ 12,026
Employment Insurance contributions payable ($3,514 + ($3,514 x 1.4)).... 8,434
Total......................................................................................................................................... $38,560
Req. 3
Both managers and analysts would understand that a 10% increase in salaries is more
expensive than a 10% increase in the employer’s share of CPP (or any other benefit). The
reason is that many benefits are stated as a percentage of salary. As a result, the cost of a
10% increase in salaries results in an increase in both salaries and fringe benefits.
E10–6
Req. 1
November 1, 2011:
Cash (+A)................................................................................................... 4,500,000
Note payable (+L)............................................................................. 4,500,000
Borrowed on 6-month, 8%, note payable.
Req. 2
December 31, 2011 (end of the fiscal year):

Interest expense (+E SE)............................................................. 60,000
Interest payable (+L)....................................................................... 60,000
Adjusting entry for 2 months’ accrued interest
($4,500,000 x 8% x 2/12 = $60,000).
10-8
E10–6 (continued)
Req. 3
April 30, 2012 (maturity date):

Note payable (L).................................................................................. 4,500,000
Interest payable (per above) (L).................................................. 60,000
Interest expense ($4,500,000 x 8% x 4/12) (+E SE) 120,000
Cash (A)............................................................................................... 4,680,000
Paid note plus interest at maturity.
Req. 4
It is doubtful that long-term borrowing would be appropriate in this situation. After the
Christmas season, Sears will collect cash from its credit sales. At this point, it does not need
borrowed funds. It would be costly to pay interest on a loan that was not needed. It might
be possible to borrow for a longer term at a lower interest rate and invest idle cash to offset
the interest charges. Sears should explore this possibility with its bank but in most cases it
would be better to borrow on a short-term basis to meet short-term needs.
E10–7 (Amounts in thousands)
Date Assets Liabilities Shareholders’ Equity
Nov. 1, 2011 Cash + $4,500 Note Payable + $4,500 Not Affected
Dec. 31, 2011 Not Affected Interest Payable + $60 Interest Expense – $60
April 30, 2012 Cash – $4,680 Note Payable – $4,500 Interest Expense – $120
Interest Payable – $60
E10–8
This type of classification is consistent with generally accepted accounting principles. An

analyst wants liabilities classified in terms of the timing of the expected cash flows. If a
short-term obligation is expected to be refinanced on a long-term basis, there will be no
cash flow in the short term. It is reasonable to classify that type of obligation as long term.
If a company classifies a short-term obligation as long term, it must have both the intent
and ability to refinance the obligation. Analysts would be most concerned about the
company's ability to refinance.
10-9
E10–9
Req. 1
Warranty expense for 2011 = $7,200,000 x 0.004 = $28,800
Req. 2
Estimated warranty liability, January 1, 2011 $70,400

+ Warranty expense for the year 28,800
– Cost of servicing products under warranty (32,200)
= Estimated warranty liability, December 31, 2011 $67,000
E10–10
Warranty costs are incurred because Amster Corp. provides a warranty on its products for
2 years after sale. These costs relate to the sales that are made in a particular accounting
period and represent obligations to be settled in the future in the form of repair costs that
include the cost of replacement parts and/or labour costs to fix the defective or
malfunctioning product. Therefore, these costs should be accounted for as expenses during
the period of sale in conformity with the matching principle. Since these expenses are not
known in advance, they must be estimated based on the company’s past experience with
warranty costs. To estimate the warranty liability, Amber’s management would first
estimate the percentage of repairs that may be required by customers under the warranty
and then multiply that percentage by $100, which is the estimated repair cost per unit.
The warranty expense would be reported on the income statement, and the estimated
warranty liability would ideally be split in two portions: a current liability reflecting the
cost of warranty work that is expected to be done within one year of the statement of
financial position date, and a non-current liability for the remaining portion of the
estimated liability. For practical purposes, if the non-current portion is not significant, then
the full amount may be reported as a current liability in conformity with the materiality
concept.
10-10
E10–11
Req. 1
Jan. 10, 2012 Inventory +$36,000 Trade payables +$36,000 Not Affected
March 1, 2012 Cash +$200,000 Note Payable +$200,000 Not Affected
April 5, 2012 Trade receivables GST Payable +$3,000 Revenues

+$67,800 PST Payable +$4,800 +$64,000
Inventory Cost of sales
–$42,000 ($60,000 x –$42,000 ($60,000 x
70%) 70%)
Req. 2
February 28, 2013 Cash paid: $212,000 [$200,000 + ($200,000 x 6%)]
Req. 3
Transactions (a) and (c) have no impact on cash flows because there is neither an inflow
nor an outflow of cash. Transaction (b) results in an inflow of cash from borrowing, which
is a financing activity. The February 28th payment is an outflow of cash. (Note to instructor:
If you have emphasized the Statement of cash flows, you should discuss the specific nature
of these cash flows. The repayment of principal is a cash flow from financing activities and
the payment of interest expense is a component of cash flows from operating activities.)
Req. 4
Assuming that the current ratio is greater than one prior to each transaction, transactions
(a) and (b) will decrease the ratio, and transaction (c) will increase the ratio (the
repayment of the note will also increase the current ratio). The answer to this type of
question is not always obvious so it may be useful to “prove” it with hypothetical numbers.
For example, assume that current assets are $36,000 and current liabilities equal $18,000
before transaction (a). The current ratio is 2.0. After the transaction, current assets
increase to $72,000 and current liabilities increase to $54,000, and the current ratio
decreases to 1.33. The reason for this decrease is that current assets increase by 100
percent whereas current liabilities increase by 300 percent, a larger percentage.
10-11
E10-12
2008 Buzz does not have to record or disclose the liability because the chance of the
liability occurring is remote.
2009 Buzz does not have to record or disclose the liability because the chance of the
liability occurring is remote.
2010 Buzz should disclose the contingent liability in a note because the matter is
potentially significant but the occurrence (or non-occurrence) of the confirming
event is not determinable.
2011 Buzz should probably record the liability since the existence of a liability appears
to be confirmed and the amount appears to be known. However, one could argue
that although the jury has returned a verdict a liability need not be recorded if the
company’s attorneys are very confident that the verdict will be overturned on
appeal. In this case, a note would disclose the jury’s verdict and the company’s
confidence of having the verdict reversed.
2012 Buzz must now record the loss and the liability because the existence of the
liability and the amount ($150,000) are both known.
E10–13
Req. 1
(a) Income tax payable:

2011: $20,000 x 32% = $6,400
2012: $16,000 x 32% = $5,120
(b) Deferred income tax:
2011: $4,000 x 32% = $1,280 (originating, a debit – an asset)*
2012: $4,000 x 32% = $1,280 (reversing, a credit – eliminates the asset)
*This is a deferred income tax asset (a debit) because the expense is deductible in the
income statement before it is deducted in the tax return. In other words, there will be less
income tax in the future because of relatively lower taxable amounts (and the asset will
thus be eliminated).
10-12
E10–13 (continued)
The tax-related amounts for 2011 and 2012 are as follows:
2011 2012
Pretax profit $16,000 20,000
Add: non-deductible expense 4,000 (4,000)
Taxable income 20,000 16,000
Income tax expense (pretax profit x 32%) 5,120 Dr. 6,400 Dr.
Income tax payable 6,400 Cr. 5,120 Cr.
Deferred income tax 1,280 Dr. 1,280 Cr.
Req. 2
Reporting:
2011 2012
Income statement:
Income tax expense (see below)............................................................ $5,120 $6.400
Statement of financial position:
Current assets
Deferred income tax asset...................................................................... $1,280 -0-
Current Liabilities:
Income tax payable.................................................................................... $6,400 $5,120
(Note: in practice, the current and deferred portions of income tax expense would each be
disclosed.)
Req. 3
Tax expense is based on profit reported on the income statement. It is a necessary cost
associated with profitable operations and should be recorded in the same period. Income
tax is the cost of doing business. Accountants apply the matching process, which means the
amount of tax expense and taxes currently payable are usually different.
10-13
E10–14
Req. 1
2010: $18,000 x 30% = $5,400
2011: $27,000 x 30% = $8,100
2010: $3,000 x 30% = $900 (originating, a credit – a liability)*
2011: $3,000 x 30% = $900 (reversing, a debit– eliminates the liability)
*This is a deferred income tax liability (a credit) because the expense is deducted in the
income tax return (2010) before it is deducted in the income statement (2011). This means
that the income tax paid in 2010 was less than the amount that would have been paid
based on accounting income.
The tax-related amounts for 2010 and 2011 are as follows:
2010 2011
Pretax profit $21,000 24,000
Deduct: taxable expense (3,000) 3,000
Taxable income 18,000 27,000
Income tax expense (pretax profit x 30%) 6,300 Dr. 7,200 Dr.
Income tax payable 5,400 Cr. 8,100 Cr.
Deferred income tax 900 Cr. 900 Dr.
Req. 2
Entries to record income taxes:

2010 2011
Income tax expense (+E SE)............................... 6.300 7,200
Deferred income tax liability (+L / –L) (Req. 1) 900o 900r
Income tax payable (+L) (Req. 1)....................... 5,400 8,100
o
= originating; r = reversing
Req. 3
Reporting:
2010 2011
Income statement:
Income tax expense.......................................................................... $6,300 $7,200
(In practice, the current and deferred portions of income tax expense would each be
disclosed.)
10-14
E10-14(continued)

2010 2011
Income tax payable...................................................................... $5,400 $8,100
Deferred income tax liability................................................... 900
Req. 4
There are separate rules governing the determination of tax expense (financial reporting
standards) and the amount of taxes currently payable (Income Tax Act) for publicly
accountable enterprises. As a result, these two amounts are different for most companies.
Management must incur the additional cost of preparing separate tax and financial
accounting reports in order to comply with IFRS. Small, privately-owned businesses that
are not subject to either IFRS or Accounting Standards for Private Enterprises may choose
to use the tax rules for financial reporting as well in order to save on the cost of preparing
financial statements.
10-15
E10–15
Req. 1

2010—$32,000 x 28% = $ 8,960
2011—$56,000 x 28% = $15,680
2012—$85,000 x 28% = $23,800
(b) Deferred income tax (related to depreciation):

2010 2011 2012
Straight-line depreciation ($75,000  3).................. $ 25,000 $25,000 $25,000
Accelerated depreciation (CCA per tax return)...... 37,500 25,000 12,500
Temporary difference................................................... $(12,500) $–0– $12,500
Multiply by tax rate............................................................. x 28% — x 28%
Deferred income tax........................................................... $ (3,500) — $ 3,500
(originating (reversing;
liability; debit)
credit)
The originating difference is a liability (a credit) because additional income taxes must be
paid in the future. This results from lower depreciation deductions (CCA) in the tax return
in the future; that is, lower tax deductions mean more income tax in the future on other
taxable amounts.
Req. 2
Reporting:
2010 2011 2012
Income statement:
Income tax expense......................................................................... $12,460 $15,680 $20,300
2010: $8,960 + $3,500 = $12,460.

2011: $15,680 + $0 = $15,680.
2012: $23,800 - $3,500 = $20,300.
(Note: in practice, the current and future portions of

income tax expense would each be disclosed.)

Income tax payable...................................................................... $8,960 $15,680 $23,800
Long-term Liabilities:
Deferred income tax liability $3,500 $3,500 $0
10-16
PROBLEMS
P10–1
Req. 1
January 15:
Purchases (+T)........................................................................................ 13,580
Cash (–A)............................................................................................... 13,580
Purchased merchandise.
April 1:
Cash (+A)................................................................................................... 500,000
Note payable, short term (+L)..................................................... 500,000
Borrowed on short-term note.
June 14:
Cash (+A)................................................................................................... 10,000
Deferred revenue (+L).................................................................... 10,000
Received customer deposit.
July 15:
Deferred revenue (–L)......................................................................... 2,500
Revenue (+R +SE)........................................................................ 2,500
Performed service.
December 12:
Electricity expense (+E SE)........................................................ 540
Trade payables (+L)......................................................................... 540
Received electricity bill.
December 31:
Wage expense (+E SE).................................................................. 12,000
Wages payable (+L).......................................................................... 12,000
Adjusting entry for unpaid wages.
Req. 2
December 31:
Adjusting entry for 9 months' interest on note payable
($500,000 x 8% x 9/12 = $30,000).
10-17
P10–1 (continued)
Req. 3
Transaction Effect on Current Effect on

Ratio Working Capital
January 15 No change No change
April 1 Decrease No change
June 14 Decrease No change
July 15 Increase Increase
December 12 Decrease Decrease
December 31 Decrease Decrease
P10–2
Req. 1
January 8:
Purchases (+T)........................................................................................ 12,420
Trade payables (+L)......................................................................... 12,420
January 17:
Trade payables (–L).............................................................................. 12,420
Cash (–A)............................................................................................... 12,420
Paid the invoice received January 8.
March 10:
Trade receivables (+A)........................................................................ 22,600
Sales revenue (+R +SE)............................................................. 20,000
PST payable (+L)............................................................................... 1,600
GST payable (+L)............................................................................... 1,000
Sold merchandise on account.
April 1:
Cash (+A)................................................................................................... 40,000
Note payable, short term (+L)..................................................... 40,000
Borrowed on 12-month, 8%, interest-bearing note.
10-18
P10–2 (continued)
June 3:
Purchases (+T) ....................................................................................... 17,820
Trade payables (+L)......................................................................... 17,820
July 5:
Trade payables (–L).............................................................................. 17,820
Cash (–A)............................................................................................... 17,820
Paid the invoice received June 3.
August 1:
Cash (+A)................................................................................................... 6,000
Rent revenue (+R +SE) ($6,000 x 5/6)............................... 5,000
Deferred rent revenue (+L) ($6,000 x 1/6)............................ 1,000
Collected rent revenue for 6 months of which one month was for the subsequent year.
No adjustment is required at year end.
December 20:
Cash (+A)................................................................................................... 100
Liability-deposit on trailer (+L).................................................. 100
Received deposit from customer.
December 31:
Wage expense (+E SE).................................................................. 7,200
Wages payable (+L).......................................................................... 7,200
Adjusting entry for unpaid wages.
Req. 2
December 31:
Adjusting entry for 9 months' interest on note payable
($40,000 x 8% x 9/12 = $2,400).
Req. 3
Statement of financial position, December 31, 2012:
Current Liabilities
Note payable, short term............................................................... $40,000
Deposit on trailer.............................................................................. 100
Wages payable.................................................................................... 7,200
Interest payable................................................................................. 2,400
GST and PST payable........................................................................ 2,600
Deferred rent revenue ................................................................... 1,000
Total................................................................................................... $53,300
10-19
P10–2 (continued)
Req. 4 (Assuming current ratio is greater than one prior to each transaction/entry)
Transaction Effect
January 8 Decrease
January 17 Increase
March 10 Increase
April 1 Decrease
June 3 Decrease
July 5 Increase
August 1 Increase
December 20 Decrease
December 31 (Wages) Decrease
December 31 (Interest) Decrease
P10–3
Req. 1
January 8 Purchases * Trade payables +$12,420 No effect
+$12,420
January 17 Cash –$12,420 Trade payables –$12,420 No effect
March 10 Trade PST Payable +$1,600 Sales Revenue +$20,000
receivables GST Payable +$1,000
+22,600
April 1 Cash +$40,000 Note Payable +$40,000 No effect
June 3 Purchases * Trade payables +$17,820 No effect
+$17,820
July 5 Cash –$17,820 Trade payables –$17,820 No effect
August 1 Cash +$6,000 Revenue Collected in Advance Rent Revenue +$5,000
+$1,000
Dec. 20 Cash +$100 Deposit on Trailer + $100 No effect
Dec. 31 No effect Wages Payable +$7,200 Wage Expense –$7,200
Dec. 31 No effect Interest Payable +$2,400 Interest Expense –$2,400
* The purchases represent additional inventory on hand.
10-20
P10–3 (continued)
Req. 2
Transaction Effect
January 8 No effect
January 17 Decrease
March 10 No effect
April 1 Financing activity (no effect on operating activities)
June 3 No effect
July 5 Decrease
August 1 Increase
December 20 Increase
December 31 (wages) No effect
December 31 (interest) No effect
P10–4
Req. 1
(a) Adjusting entry, December 31, 2012:

Wage expense (+E SE).................................................................. 10,200
Wages payable (+L).......................................................................... 10,200
(b) January 6, 2013:

Wages payable (L).............................................................................. 10,200
Cash (A)............................................................................................... 10,200
Req. 2
(a) December 10, 2012:

Cash (+A)................................................................................................... 6,000
Rent revenue (+R +SE)............................................................... 6,000
Collection of rent revenue for one month.
(b) December 31, 2012:

Rent revenue (R SE).................................................................... 2,000
Deferred rent revenue (+L).......................................................... 2,000
Rent collected in advance (10/30 x $6,000 = $2,000).
10-21
P10–4 (continued)
Req. 3

Dec. 31, 2012 No impact Wages Payable + $10,200 Wage Expense – $10,200
Jan. 6, 2013 Cash – $10,200 Wages Payable – $10,200 No impact
Dec. 10, 2012 Cash + $6,000 No impact Rent Revenue + $6,000
Dec. 31, 2012 No impact Deferred Rent Revenue Rent Revenue – $2,000
+ $2,000
Req. 4
Statement of financial position at December 31, 2012:

Wages payable.................................................................................... 10,200
Deferred rent revenue .................................................................. 2,000
Req. 5
Accrual based accounting is more beneficial to financial analysts because it records

revenues when they are earned and expenses when they are incurred, regardless of when
the related cash is received or paid. Cash-based accounting only records revenues when
they are received and expenses when they are paid. A financial analyst is looking towards
the future of the company, so it is helpful to know how much cash will be coming into and
out of the company at later dates. Cash based accounting limits financial analysts to only
what has happened in prior periods and tells them very little about future events and cash
flows that will affect the financial health of the company.
Cash basis accounting may also be susceptible to manipulation.
10-22
P10–5
Req. 1
2010:
Warranty Expense increases by $1 billion; Warranty Payable increases by $1 billion.
2011:
Warranty Payable decreases by $1 billion; Cash decreases by $1 billion. There is therefore
no warranty liability at the end of 2011.
Req. 2
2010:
Cash increases by $100,000,000; Deferred Revenue increases by $100,000,000.
2011:
Deferred Revenue decreases by $60,000,000; Revenue increases by $60,000,000.
Therefore, the balance in Deferred Revenue at the end of 2011 is $40,000,000.
Req. 3
The company should probably report litigation expense and the related liability after the
jury awarded damages. However, if lawyers for Brunswick are very confident of their
grounds for appeal, the company might only report a contingent liability in the notes to the
financial statements. In such situations, good professional judgment must be exercised by
management as well as the company’s attorneys and auditors.
Req. 4
The current ratio for Coke is 0.94, which is relatively a low ratio. In isolation, it might seem
like an indication of trouble but analysts would look at much more information. For
example, they would consider the revenue the company generates annually, and the
available credit the company has. Analysts would also compare the ratio to similar
companies. For example, the current ratio for PepsiCo was 1.44 which is approximately
50% higher than Coke’s. This brief exercise is intended to open a discussion concerning the
need to avoid placing too much emphasis on a specific accounting number or ratio.
Req. 5
Many manufacturing companies have some adverse impact on our environment. In many
cases, the law requires these companies to rectify these negative effects. Alcoa refers to
these environmental cleanup efforts as “remedial efforts.” Alcoa records the cost of future
environmental cleanup efforts in the year that the need for rectifying the damage first
becomes likely, instead of waiting until the year that the work is actually performed. This
policy is consistent with the matching principle. Environmental damage can be thought of
(by some people) as a necessary cost of producing aluminum. According to that reasoning,
the cost of future environmental cleanup efforts should be matched with the cost of the
aluminum produced, rather than deferring recognition of the expense to the period in
which the cleanup work actually takes place.
10-23
P10–6
Req. 1
Estimated Warranty Liability
931 Beginning balance
Warranty payments 400 X Warranty expense
1,040 Ending balance
$931 + X – 400 = 1,040; X = $509
Req. 2
Estimated warranty liability (L)................................................... 400
Cash (A)............................................................................................. 400
Payments to customers in exchange for returned products.
Note: Bombardier simply returned cash to customers instead of repairing the defective
products, thus the credit is to the cash account. In some cases, repairs under warranty
affect the inventory accounts when parts must be replaced, as well as the wages
payable account for the labour expenses incurred to complete the repairs. The entry
above assumes that the defective products have no value. If they have any value, then
the inventory account would be debited for their value and the estimated warranty
liability would be reduced accordingly.
Warranty expense (+E SE)......................................................... 509

Estimated warranty liability (+L)............................................. 509
To recognize warranty expense for the period.
Req. 3
2010 2009 2008
Estimated warranty liability / Revenues 5.37% 4.72% 5.95%
The ratio decreased in 2009 but increased in 2010. The decrease may have been due to a
reduction in the rate of defective products that required a lower provision for warranties in
that year. It could also indicate that the company overstated the amount of the provisions
for the years 2008 and 2010 which resulted in higher ending balances for the estimated
warranty liability account relative to the amount of revenues generated in those years.
Req. 4
The limited evidence that is available to us does not suggest that Bombardier should be
increasing its warranty liability in future years. Another ratio that would be helpful in
addressing this issue is that of warranty payments divided by revenues. This will show if
the warranty costs are increasing or decreasing over time. Another factor to be considered
is whether Bombardier has changed (shortened or lengthened) the warranty period for its
products. If the warranty period has become longer over time because of competitive
pressures, then the estimated liability may need to be increased.
10-24
P10–7
CASE A
Req. 1
The cash deposit for each keg is potentially refundable to the depositor. EBC must return
the cash received if the customer returns the keg in the future. Hence, the Keg Deposits
account is essentially a liability account. There is no information about time limits or the
percentage of kegs that are not returned. It is possible, however, for EBC to estimate the
portion of the deposits that is usually kept by the company and consider this amount as
revenue. This is very similar to the issues faced by companies that offer "points" that can
be redeemed for services or products in the future, such as Canadian Tire and Petro-
Canada. Assuming this is a current liability then the Keg Deposits account would appear in
the current liabilities section of the statement of financial position. If the value is material
then it may be disclosed as a separate item; otherwise it is combined with other liabilities
as part of "Other current liabilities," perhaps with an explanatory note.
Req. 2
The company has received a reliable estimate that an amount of $1,250 (50 x $25) will
never be returned to customers. This amount becomes revenue for the period. The
company recognizes this revenue by making the following adjusting entry at year end:
Keg Deposits (–L)………………………….. 1,250

Revenue from deposits (+R → +SE)………………….1,250
CASE B
Req. 1
September 1, 2011:
Cash (+A)................................................................................................... 72,000
Deferred rent revenue (+L)......................................................... 72,000
Received rent for six months in advance.
December 31, 2011:

Deferred rent revenue (L)............................................................... 48,000
Rent revenue (+R +SE).............................................................. 48,000
To recognize rent revenue for four months of the year.
Alternatively, the cash received could have been credited to Rent Revenue. In that case the
journal entries would be as follows:
10-25
P10–7 (continued)
September 1, 2011:
Cash (+A)................................................................................................... 72,000
Rent revenue (+R +SE).............................................................. 72,000
Received rent for six months in advance.
December 31, 2011:
Rent revenue (R SE).................................................................... 24,000
Deferred rent revenue (+L)......................................................... 24,000
To recognize deferred rent revenue for two months of the year.
Req. 2
The total amount received, $72,000, will be partially earned in 2011. Specifically, $16,000
[($72,000 / 18) x 4 months] is earned in 2011, and the remainder, $56,000 will be earned
over the next 14 months. By December 31, 2012, a total of $64,000 will have been earned,
and the other $8,000 will be earned in 2013. As a result, $48,000 represents a current
liability, and $8,000 should be classified as a non-current liability on the December 31,
2011 statement of financial position. However, classification of the $8,000 as non-current
may not be considered material.
CASE C
April 2012:
Cash (+A) [150 x $60].......................................................................... 9,000
Deferred subscription revenue (+L)........................................ 9,000
Received one-year subscriptions from 150 customers.
April 30, 2012:

Deferred subscription revenue (L).............................................. 450
Subscription revenue (+R +SE)............................................. 450
To recognize subscription revenue for one month from 90
subscribers (90 x $5 per month).
10-26
P10–8
Current ratio
Before reclassification: $10.8 ÷ $10.1 = 1.07
After reclassification: $10.8 ÷ $8.8 = 1.23
The current liability classification is based on the expectation that the company will pay the
liabilities during the subsequent year. Analysts are interested in this classification because
it provides important information to use when predicting future cash flows. If management
has the intent and the ability to refinance a short-term liability, then it will not result in a
cash outflow. In this circumstance, it is appropriate to reclassify the debt as long term.
The current ratio for PepsiCo is very low when compared to most companies. The
Company, however, is not experiencing a liquidity problem. It generates large cash flows
from operations and has a significant line of credit available if it needs additional funds.
Furthermore, the industry traditionally operates with a relatively low current ratio. Coke,
for example, has a .94 current ratio. It is therefore unlikely that management made the
reclassification simply to increase its current ratio. Instead the Company was probably
trying to get a better balance between short-term and long-term borrowings.
Because management has the ability and intent to refinance the borrowings on a long-term
basis, the current ratio should be based on the reclassification. The analyst might want to
use the ratio before reclassification if he or she thought that the reclassification was only
intended to manipulate the ratio (which does not appear to be the case). The analyst should
use caution when comparing the current ratio for the current year (after reclassification)
with the ratio for the previous year (before reclassification).
P10–9
Req. 1
Payables and accruals refer to amounts that should be paid to suppliers of goods and
services in the near future. The account balance increases when raw materials and
merchandise are purchased on account, and decreases when payments are made.
Deferred revenue represents an amount of cash (or other assets) received by the company
in exchange for goods and/or services to be provided in the future. The account balance
increases with the receipt of cash from customers in advance, and decreases when goods
are delivered and services are provided to these customers.
Dividends payable reflects an amount of dividends that has been declared by the
company’s board of directors but has not been paid yet. The account balance increases
when the board of directors declares dividends and is reduced when cash is paid to
shareholders.
10-27
P10–9 (continued)
Income taxes payable refers to an outstanding obligation to pay income taxes to the
taxation authorities based on the current period’s taxable income. The account balance
increases when taxes are accrued and decreased when the taxes are paid.
Deferred income liabilities result from temporary differences caused by reporting revenues
and expenses on the company’s income statement in conformity with financial reporting
standards and on the tax return in accordance with the Income Tax Act. The account
balance increases when temporary differences in accounting for specific revenue and
expense items lead to reporting income before income taxes that exceeds taxable income
for the period. The account balance is reduced when the reverse occurs.
The current portion of debt obligations represents the portion of long-term debt that is
payable within one year of the statement of financial position date. The account balance
increases when long-term debt is reclassified as a current liability and is reduced when the
debt is paid.
Req. 2
Deferred revenue, May 1, 2007 ...................................................... $ 2,057

Collections in advance during the year........................................ X
Revenue earned during the year..................................................... (15,473)
Deferred revenue, April 30, 2008 .................................................. $10,541
$2,057 + X - $15,473 = $10,541; Collections in advance = $23,957
Deferred Revenue
2,057 Beginning balance
Revenue earned 15,473 X Collections in advance
10,541 Ending balance
Journal entry:
Cash (+A) .................................................................................................. 23,957
Deferred revenue (+L)................................................................... 23,957
Collections from customers in advance.
Req. 3
Retained earnings (−SE)..................................................................... 22,891

Dividends payable (+L)................................................................. 22,891
Declaration of dividends payable to shareholders.
10-28
10-29
P10–9 (continued)
Dividends payable (−L)....................................................................... 22,720

Cash (−A).............................................................................................. 22,720
Payment of cash dividends to shareholders.
$11,241 + $22,891 – X = $11,412
P10–10
Req. 1
Do not record a liability nor disclose a contingency. Rationale: For major auto
manufacturers these types of lawsuits occur from time to time and may be considered to be
a normal business risk (at least to some extent) in the industry. Also, in this case, because
no specific lawsuit has been filed in respect of the new car any disclosure of a contingency
would be so general that it would probably not provide useful information.
Req. 2
Do not record a liability nor disclose a contingency. Rationale: In this case, there is no direct
evidence of a possible contingency. In fact, there is a great deal of uncertainty that a
contingency may exist at all. For example, we are told that the company’s product “may”
infringe on another company’s patent. Furthermore, we do not know the likelihood that the
other company will ever discover the possible infringement.
Req. 3
Record a liability. Rationale: The liability exists (the “clean-up” is required by provincial
law) and the amount can be reasonably estimated. The amount of the liability would be for
$3 million if the company’s management wishes to be conservative and include the higher
end of the estimated amount. Alternatively, management could report a liability for $2.5
million, representing the average of $2 and $3 million.
Req. 4
Record a liability. Rationale: Prudence (i.e., conservatism) suggests that the opinion of the
company’s attorneys should be seriously considered. As such, it would be appropriate to
record a liability. The amount recorded for the liability might be less than $1,000,000 if the
company’s attorneys are confident that the amount of damages will be reduced on appeal.
Req. 5
Record a liability for $250,000. Rationale: Management has accepted its obligation to the
customer, intends to discharge it and the amount is known.
10-30
P10–11
Req. 1 and 2
2009 2008 2007 2006 2005 2004
Current ratio 1.36 1.35 1.28 1.36 2.15 0.79
Trade payables turnover 9.16 2.92 1.88 1.93 1.94
Average age of payables (days) 40 125 195 189 188
The current ratio fluctuated between 0.79 and 2.15 during the six-year period and was
relatively stable over the last four years, 2006-2009. While a current ratio that exceeds 1.0
provides a margin of safety for short-term creditors, Burberry’s current ratio should be
compared to the norm for the industry for a better assessment of its current level.
The trade payables turnover ratio was relatively stable between 2005 and 2007. It
increased in 2008 and then tripled in 2009, indicating that Burberry is paying its trade
supplies over shorter periods of time, as evidenced by the decreasing trend in the average
age of payables. While the decrease in the average age of payables does not benefit the
company from a cash management perspective, it improves its relationship with its trade
suppliers, especially if the credit period granted by the suppliers is shorter than the
average age of payables. The large increase in 2009 should be investigated to see if there is
a specific reason for it.
P10–12
a. Remain the same
b. Decrease
c. Remain the same
d. Remain the same (financing activity)
e. Remain the same
f. Decrease
g. Remain the same
h. Decrease only for the interest that is paid (repayment of the principal is a
financing activity)
i. Increase
j. Decrease
10-31
P10–13
Req. 1
(a) Income Taxes Payable: $32,400  30% = $9,720
(b) Deferred Income Tax

Straight Line Depreciation: $11,000 ($44,000 - $0) / 4
Accelerated Depreciation (CCA): (17,600)
Temporary Difference: $( 6,600)
Multiply by Tax Rate: 30%
Deferred Income Tax: $ (1,980) – Originating liability
The originating difference is a liability (a credit) because additional income taxes must
be paid in the future. This results from lower depreciation deductions (CCA) in the tax
return in the future; that is, lower tax deductions mean more income tax payable in the
future on other taxable amounts.
Req. 2
Income Tax Expense (+E SE) [($59,000 – 20,000) x 30%] 11,700

Deferred Income Tax Liability (+L)........................................... 1,980
Income Tax Payable (+L) ($9,720 x 15%) …………………... 1,458
Cash (A) ($9,720 x 85%)............................................................. 8,262
Req. 3
Reporting:
Income Statement for 2011:
Income Tax Expense...................................$11,700*
* In practice, the current and future portions of income tax expense would each be
disclosed.
Statement of financial position, December 31, 2011:

Income Tax Payable $1,458
Non-current Liabilities**:
Deferred Income Tax Liability $1,980
** The deferred income tax liability is classified as long-term because it is related to a long-
term item (equipment).
10-32
ALTERNATE PROBLEMS
AP10–1
Req. 1
January 2, 2012:
Accrued Interest Payable (L)......................................................... 52,000
Cash (A)............................................................................................... 52,000
(Assuming no reversing entries on Jan. 1, 2011.)
April 30, 2012:

Cash (+A)................................................................................................... 550,000
Note Payable (+L)............................................................................. 550,000
May 20, 2012:

Cash (+A)................................................................................................... 6,840
Sales revenue (+R +SE).............................................................. 6,000
HST payable (+L)............................................................................... 840
June 3, 2012:
Inventory (+A)......................................................................................... 75,800
Trade payables (+L)......................................................................... 75,800
July 5, 2012:
Trade payables (L).............................................................................. 75,800
Cash (A)............................................................................................... 75,800
August 31, 2012:

Cash (+A)................................................................................................... 6,000
Revenue (+R +SE) ($6,000 x 4/6)......................................... 4,000
Deferred Revenue (L)...................................................................... 2,000
Req. 2 (Adjusting and reclassification entries, Dec. 31, 2012)
Long-term Liability (L)..................................................................... 100,000

Current Liability (+L)..................................................................... 100,000
Note: in practice, specific accounts would be used.
Interest Expense (+E SE)............................................................. 22,000

Accrued Interest Payable (+L)..................................................... 22,000
($550,000 x 6% x 8/12 = $22,000)
Wage Expense (+E SE)................................................................. 85,000

Wages Payable (+L).......................................................................... 85,000
10-33
AP10–1 (continued)
Income Tax Expense (+E SE)..................................................... 125,000

Income Tax Payable (+L)............................................................... 93,000
Deferred Income Tax Liability (+L)........................................... 32,000
Req. 3
Current Liabilities
Wages Payable $ 85,000
Income Tax Payable 93,000
Deferred Income Tax Liability* 32,000
HST Payable 840
Accrued Interest Payable 22,000
Deferred Revenue 2,000
Note Payable 550,000
Current Portion of Long-term Debt 100,000
Total Current Liabilities $884,840
* It is assumed that the deferred income tax liability is a current item. A different
assumption could have been made.
Req. 4
Effect on current ratio assuming the ratio is less than one prior to each transaction/ entry:
January 2, 2012 Decreases

April 30, 2012 Increases
May 20, 2012 Increases
June 3, 2012 Increases
July 5, 2012 Decreases
August 31, 2012 Increases
December 31, 2012 (Reclassification) Decreases
December 31, 2012 (Interest) Decreases
December 31, 2012 (Wages) Decreases
December 31, 2012 (Income taxes) Decreases
10-34
AP10–2
Req. 1
Date Assets Liabilities Shareholders’

Equity
January 2, 2012 Cash – $52,000 Accrued Interest Payable No effect
– $52,000
April 30, 2012 Cash + $550,000 Note Payable + $550,000 No effect
May 20, 2012 Cash + $6,840 HST Payable + $840 Sales Revenue
Inventory amount + $6,000
not known Cost of good sold
amount not known
June 3, 2012 Inventory Trade payables+ $75,800 No effect
+ $75,800
July 5, 2012 Cash – $75,800 Trade payables – $75,800 No effect
August 31, 2012 Cash + $6,000 Deferred Revenue + $2,000 Revenue + $4,000
Dec. 31, 2012 No effect Accrued Interest Payable Interest Expense
(Interest) + $22,000 – $22,000
Dec. 31, 2012 No effect Long-term Liability – $100,000 No effect
(Reclassification) Current Liability + $100,000
Dec. 31, 2012 No effect Wages Payable + $85,000 Wage Expense
(Wages) – $85,000
Dec. 31, 2012 No effect Income Tax Payable+ $93,000 Income Tax Expense
(Income Taxes) Deferred Income Tax Liability – $125,000
+ $32,000
Req. 2
Effect on Cash from Operating Activities:
January 2, 2012 Decreased

April 30, 2012 No effect (financing activity)
May 20, 2012 Increased
June 3, 2012 No effect
July 5, 2012 Decreased
August 31, 2012 Increased
December 31, 2012 (Interest) No effect
December 31, 2012 (Reclassification) No effect
December 31, 2012 (Wages) No effect
December 31, 2012 (Income tax) No effect
10-35
AP10–3
Req.1
Warranty Expense increases by $3.9 billion; Warranty Payable decreases by $0.1 billion
(Accrual of $3.9 less payments of $4).
Req. 2
Customer deposits are reported as a liability until the associated revenue has been earned.
For cruises of 10 days or less, revenue is reported as earned when the trip is completed.
For longer cruises revenue is reported as earned on a pro rata basis based on the number
of days. Therefore the liability on the statement of financial position would consist of
deposits for all cruises that were not started at year end, incomplete 10-day cruises in
progress, and a pro rata amount for uncompleted cruises longer than 10 days. The
calculation for 2011 is as follows:
Incomplete 10-day cruises $ 4.0 million

Partial Cruises (>10 days) $8 million  (1 – 60%) 3.2 million
Cruises not started 7.0 million
Total Deferred revenue $14.2 million
Req. 3
Many of the lawsuits against the company are not material in amount. The company did
record $31.2 million in losses related to litigation. In one lawsuit, the company recorded a
loss of $12 million, but had to reverse $8.1 million of that amount when the actual loss was
determined. The recording of the accrued loss reduced income. The reversal increased
income.
Req. 4
While the current ratio is low and tending downward, it is doubtful that Exxon is
experiencing financial difficulty. The company has a reputation for aggressive cash
management. It would be useful to study the Statement of Cash Flows to determine if Exxon
is generating significant cash resources from operating activities. It would also be useful to
read analysts’ assessment of Exxon’s liquidity, especially compared to the liquidity of its
competitors.
10-36
Req. 5
To the extent that reasonable estimates can be made Brunswick records the cost of future
environmental cleanup efforts in the year that the underlying commitments (or plans) are
made, rather than waiting until the year when the work is actually performed. One
justification for this policy is the matching concept. Under the matching concept all costs
related to earning revenue should be reported in the same accounting period as the
revenue. Prudence is another important justification for the approach used by Brunswick,
i.e., liabilities and expenses should not be understated (nor should assets and income be
overstated).
AP10–4
Req. 1
Warranty Liability, 2008
Warranty payments 460 X Warranty expense
358 Ending balance
$412 + X – 460 = 358; X = $406
Warranty Liability, 2009

Warranty payments 406 Y Warranty expense
316 Ending balance
$358 + Y – 406 = 316; Y = $364
Req. 2
Warranty expense (+E SE)......................................................... 364

Estimated warranty liability (+L)............................................. 364
To recognize warranty expense for the year.
Estimated warranty liability (L)................................................... 406

Cash, Inventory (A) and/or Wages payable (+L)............ 406
Settlements made under the product warranty.
10-37
Req. 3
2009 2008 2007
Warranty expense / net sales 0.38% 0.39% 0.47%
Warranty expense decreased from $466 in 2007 to $364 in 2009, a decrease of 22 percent
(0.09 percent of net sales). The decrease may be due to a decrease in the rate of defective
goods produced by the company or purchased from parts suppliers. It could also signal a
less conservative estimate of the warranty liability based on the company’s experience with
existing products.
Req. 4
The information available for the three years indicates that the settlements made during
2009 and 2008 were higher than the warranty expense that has been recognized for each
of these years. This, combined with the decrease in warranty expense as a percentage of
net revenue, has resulted in decreasing the balance of the Warranty liability account from
$412 at the end of 2007 to $316 at the end of 2009. The ratio of warranty expense to net
sales should be reviewed in 2010 in light of the settlements that are made during that year.
Req. 5
Extended Warranty Deferred Revenue, 2008
Warranty revenue X 335 Deferred revenue
589 Ending balance
$409 + 335 – X = $589; X = $155
Extended Warranty Deferred Revenue, 2009

Warranty revenue Y 283 Deferred revenue
665 Ending balance
$589 + 283 – Y = $665; Y = $207
Extended warranty deferred revenue (L)................................ 207

Extended warranty revenue (+R +SE)............................... 207
To recognize revenue related to extended warranties.
10-38
AP10–5
The contractual agreement that General Mills entered into allows them to reclassify the
current borrowings as non-current debt. Management would want to do this in order to
improve the current ratio and other measures of liquidity. A financial analyst’s answer
would not be different. A financial analyst would not be concerned because the company
has the ability to extend the maturity dates of the debt beyond the current year.
AP10–6
Req. 1
Trade payables and accrued liabilities refer to amounts that should be paid to suppliers of
goods and services in the near future. The account balance increases when raw materials
and merchandise and other expenses are purchased on account and decreases when
payments are made.
Customers’ deposits represent an amount of cash (or other assets) received by the
company as a deposit on future delivery of goods and/or services. The account balance
increases with the receipt of cash from customers in advance, and decreases when goods
are delivered and services are provided to these customers.
Dividends payable reflects an amount of dividends that has been declared by the
company’s board of directors but has not been paid yet. The account balance increases
when the board of directors declares dividends and is reduced when cash is paid to
shareholders.
Deferred warranty plan revenue represents collections from customers who purchased
specific plans that extend the warranty on the purchased goods beyond the original
warranty period offered by the product’s manufacturer. The account balance increases
when additional plans are sold to customers and is reduced when the deferred warranty
plan expires over time.
Income taxes payable refers to an outstanding obligation to pay income taxes to the
taxation authorities based on the current period’s taxable income. The account balance
increases when taxes are accrued and decreased when the taxes are paid.
Req. 2
Deferred warranty plan revenue, January 1, 2009................. $15,267

Collections from customers in advance during 2009............ X
Warranty revenue earned during 2009....................................... (15,900)
Deferred warranty plan revenue, December 31, 2009......... $16,150
$15,267 + X – $15,900 = $16,150; Collections from customers = $16,783
10-39
Journal entries
During 2009:
Cash (+A)................................................................................................... 16,783
Deferred warranty plan revenue (+L).................................... 16,783
Sale of extended warranty plans to customers.
Deferred warranty plan revenue (L).......................................... 15,900

Warranty revenue (+R +SE)................................................... 15,900
To recognize warranty revenue based on periodic expiration
of warranty plans during the year.
Req. 3
Retained earnings (SE)..................................................................... 33,951

Dividends payable (+L)................................................................. 33,951
Declaration of dividends payable to shareholders.
Dividends payable (L)....................................................................... 33,965

Cash (A)............................................................................................. 33,965
Payment of cash dividends to shareholders.
$4,952 + $33,951 – X = $4,938
AP10–7
Req. 1 and 2
2009 2008 2007 2006 2005 2004
Current ratio 2.66 2.13 2.02 1.97 1.89 2.04
Trade payables turnover 5.82 4.08 2.72 3.08 4.38
Average age of payables (days) 63 89 134 119 83
The current ratio fluctuated between 1.89 and 2.66 during the six-year period and showed
signs of improvement over the last five years, 2005-2009. While a current ratio that
exceeds 1.0 provides a margin of safety for short-term creditors, the current ratio of Guess
should be compared to the norm for the industry for a better assessment of its current
level.
The trade payables turnover ratio decreased in 2006 and 2007 but shows an increasing
trend in 2008 and 2009, indicating that in those years Guess paid its trade supplies over
shorter periods of time, as evidenced by the decreasing trend in the average age of
payables. The company’s trade suppliers should be pleased with this change, but the credit
period granted by the suppliers may still be longer than the average age of the payables.
10-40
AP10–8
a. Decrease
b. Decrease
c. Decrease
d. Remain the same (financing activity)
e. Decrease
f. Remain the same
g. Decrease
h. Decrease
i. Remain the same
AP10–9
Req. 1
2011 — $72,000 x 35% = $25,200
2012 — $87,000 x 35% = $30,450

Expense:
2011 — $8,000 x 35% = $2,800 (originating; a credit – a liability)*
2012 — $8,000 x 35% = $2,800 (reversing; a debit – eliminates the liability)
*This is a deferred income tax liability (a credit) because the related expense is
deducted in the tax return before it is deducted in the income statement. Therefore,
there will be a lower future tax deduction and this will result in more income tax in the
future on other taxable amounts.
Revenue
2012 — $6,000 x 35% = $2,100 (originating; a credit – a liability)*
2013 — $6,000 x 35% = $2,100 (reversing; a debit – eliminates the liability)
*This is a deferred income tax liability (a credit) because it is related to revenue that is
included in the tax return after it is included in the 2012 income statement. Therefore,
at the end of 2012 there is an income tax liability related to this temporary difference.
Net deferred income tax amounts:
2011 — $2,800 (originating liability; a credit)

2012 — $2,800 (reversing; a debit) – $2,100 (originating; a credit) = $700, net debit
2013 — $2,100 (reversing; a debit)
10-41
Req. 2
Entries to record income taxes:
2011 2012
Income tax expense (+E SE)............................... 28,000 * 29,750 **
Deferred income tax liability (Req. 1) (+L).... 2,800 o 700 r
Income tax payable *** (+L)................................. 5,040 6,090
Cash **** (–A) ............................................................. 20,160 24,360
* $25,200 + $2,800 = $28,000

** $30,450 – $700 = $29,750
*** Income taxes payable per Req. 1 times 20%
**** Income taxes payable per Req. 1 times 80%
o
= originating; r = reversing
Req. 3
Reporting:
2011 2012
Income statement:
Income tax expense (note)............................................................ $28,000 $29,750
Note: In practice, the current and deferred portions of income tax expense would be
disclosed for each year.

Income tax payable (Req. 2).................................................... 5,040 6,090
Deferred income tax liability (Req. 1)................................. 2,800 2,100 *
*$2,800 – $700 = $2,100. This amount will reverse in 2013.
Req. 4
A deferred income tax amount will be paid at some point (perhaps, indefinite) in the future
whereas current income taxes payable will be paid on a specific date. As a result, most
analysts see the nature of these two liabilities as being somewhat different. To illustrate,
some companies with an expanding amount of plant and equipment may be able to defer
deferred income taxes indefinitely if the amount of new deferred income taxes on recently
purchased assets exceeds the amount of the reversal on older assets. In other words, the
deferred income tax liability would constantly increase. In this case, analysts would not
include the amount of deferred income taxes in their projections of cash flows.
10-42
CASES AND PROJECTS
FINDING AND INTERPRETING FINANCIAL INFORMATION
CP10–1
Req. 1
Yes, it does.
Current income tax payable, December 31, 2008: CHF 824 million
Source: Statement of financial position.
Req. 2
The company uses the indirect method to determine cash flow from operating activities.
The increase in trade payables affected cash flow from operating activities favourably by
CHF 78 million for the fiscal year ended December 31, 2008.
Source: Note 22: Statement of cash flows
Req. 3
Non-current financial liabilities, is CHF 6,344 million at December 31, 2008.
Req. 4
December 31, 2008, Deferred tax liabilities were CHF 1,341 million.
Source: Statement of financial position
Req. 5
Yes. Note 18.2 states that the company is exposed to contingent liabilities amounting to a
maximum of CHF644 million.
10-43
CP10–2
Req. 1
Trade and other payables, December 31, 2008:
Current €1,551 million

Non-current € 61 million
Req. 2
The company uses the indirect method to determine cash flow from operating activities.
Increase in payables increased cash flow from operating activities by €2 million for the
fiscal year ended December 31, 2008.
Source: Note 34 (i) of the annual report: Notes to the statement of cash flows.
Req. 3
Non-current borrowings were €1,194 million December 31, 2008.
Req. 4
The company discloses information about various contingent liabilities and financial
commitments in Note 33 to its financial statements.
10-44
CP10–3
(The solution is based on the annual reports for Cadbury and Nestle for the fiscal year
ended December 31, 2008. All dollar amounts are in millions.)
Req. 1
Current Ratio (at the fiscal year-end date for each company):
Current Ratio = CA / CL
Nestlé: CHF 33,048 / CHF 33,223 = 0.99
Cadbury: €2,635 / €3,388 = 0.78
Source: Statement of financial position of each company.
Req. 2
(i) Trade payables Turnover Ratio (for the most recent fiscal year for each company):
Nestlé Cadbury
Cost of sales CHF 47,339 €2,870
÷ Average Trade payables CHF 13,393.5a €1,626b
= A/P Turnover Ratio 3.53 1.77
a
(CHF 12,608 + CHF 14,179) / 2 = CHF 13,393.5
b
(€ 1,551 + €1,701) / 2 = €1,626
Note: Trade payables include “other payables” in each case.
Source: Income statement and statement of financial position of each company.
Req. 3
Both of Nestlé’s ratios are better, although Nestlé’s current ratio is under 1.0 and Nestlé
takes over 100 days to pay its trade payables (365 ÷ 3.53). One might conclude that the
liquidity of both companies is poor, but one must be careful before reaching such a
conclusion. For example, both companies continue to generate positive cash flow from
operating activities and have cash on hand at year end.
10-45
FINANCIAL REPORTING AND ANALYSIS CASES
CP10–4
Req. 1
The cost of a free ticket could be measured in terms of what economists call “opportunity
cost.” If providing free tickets meant that there were not sufficient seats available to sell to
paying passengers, the opportunity cost would be the lost revenue from not having extra
seats. The incremental cost approach uses an estimate of cash expenditures to measure the
liability associated with a frequent flyer program, but many analysts probably prefer a
broader definition that would reflect the total impact of the program on the profitability of
the company (i.e., the “cost” of lost revenues). Unfortunately, opportunity costs are very
difficult to measure.
Another option would be to use the cost of providing the service using an estimated cost
per mile/point. This could be difficult to estimate.
Req. 2
Southwest would debit an expense account because of the matching concept. The cost of a
frequent flyer program is an expense that should be matched with current revenue, i.e.,
when a customer earns points towards future flights.
CP10–5
Req. 1 and 2
2009 2008 2007 2006 2005

Trade payables turnover* 3.84 3.53 3.37 3.44 3.75
Inventory turnover 5.09 5.09 5.21 5.03 5.00
Trade receivables turnover 10.77 9.74 9.07 8.50 8.66
Average age of payables 95.1 103.4 108.3 106.1 97.3

Days supply of inventory 71.7 71.7 70.1 72.6 73.0
Average collection period 33.9 37.5 40.2 42.9 42.1
Average period to convert inventory to cash 105.6 109.2 110.3 115.5 115.1
Cash conversion cycle 10.5 5.8 2.0 9.4 17.8
The trade payables turnover and the inventory turnover ratios show some variations in
their levels during the five-year period, 2005–2009, but the variations are relatively small.
In contrast, Nestlé has improved on its trade receivable turnover over time. The increase in
this ratio was the result of shortening the average collection period. This has allowed the
company to convert its inventory to cash in 2009 just in time to pay its trade suppliers.
10-46
CP10–6
RIM summarizes the history of the litigation award to NTP for patent infringement in Note
15. A more comprehensive information set can be obtained, however, by reading the notes
from 2003 until 2006 accompanying this disclosure. In 2003, RIM disclosed, in Note 14, a
litigation expense of $4.9 million related to the NTP lawsuit as well as compensatory
damages for $23.1 million assessed by a U.S. jury. In total, the charges related to the NTP
lawsuit contributed $28.0 million to the overall Accrued litigation and related expenses
which totalled $50.7 million. RIM also disclosed that it had filed an appeal and that the
judge had determined that the rate of interest accruing on the compensatory damages was
the prime rate.
To make sure RIM would pay if the long appeal process resulted in affirming the verdict,
the company was ordered to create an interest-bearing account and make quarterly
deposits equal to the royalties RIM would have paid to NTP. The judge ruled that RIM was
also liable for pre-judgment interest on the royalties not paid to NTP from the point at
which RIM started earning revenue from NTP's technology, compounded quarterly at the
prime rate. By May 2003, the U.S. court ruled that the royalty rate for any post-judgment
compensation to NTP would increase by 50%, from 5.7% to 8.55% and that RIM had to pay
80% of NTP's attorney's fees incurred up to that date. RIM then recorded an additional
provision of $13.5 million in the fourth quarter of fiscal year 2003 for enhanced post-
judgment compensation, as well as $5 million for the attorney's fees. RIM also made a
provision to pay interest on the post-judgment compensation. In total, the company
recorded an additional expense of $22.5 million that included not only the amounts already
mentioned but also pre-judgment interest and additional estimated future costs of
litigation in this matter. RIM also disclosed that the total expense to date was $58.2 million
of which $7.5 million was disbursed by the end of fiscal year 2003. RIM noted that the
ultimate cost could be materially different from the provision.
Sure enough by the first quarter of fiscal 2004 (as reported in Note 16 for fiscal year 2004)
the company had added $7.5 million to the provision. It classified $6.3 million as restricted
cash and reported on a final order to pay monetary damages to NTP of $53.7 million. RIM
appealed the judge’s decision but continued to add to expenses each quarter to provide for
post-judgment compensatory damages payable to NTP should the initial verdict be
affirmed. By year end the provision recorded was $35.2 million.
In 2005, RIM disclosed in Note 15 the progress of this litigation. The Company disclosed
quarterly additions to the bank account in which the post-judgment royalties were
deposited. The appeal results were not conclusive as they revealed procedural errors, but
not substantive errors, and the appeal court left it to the district court to decide what effect
this should have on the amount payable to NTP. RIM went on to report that it had signed a
binding agreement with NTP on March 16, 2005 to pay NTP $450 million in return for
unrestricted use of their patented technology and resolving all previous claims. RIM also
reported the various components of a total incremental expense of $352.6 million.
10-47
CP 10–6 (continued)
On March 3, 2006, RIM and NTP jointly announced that they settled the lawsuit. RIM paid
NTP $612.5 million in to settle all claims against RIM. As at February 26, 2005, RIM had
accrued $450.0 million in respect of the NTP litigation. As the final settlement amount paid
on March 3, 2006 was $612.5 million, RIM recorded an additional charge to its 2006
income in the amount of $162.5 million.
Req. 2
Journal entry to record the payment of $612.5 million to NTP on March 3, 2006:
Litigation expense (+E SE) ........................................................ 162,500,000

Accrued litigation – NTP (−L)........................................................... 450,000,000
Cash (−A).............................................................................................. 612,500,000
The three amounts are disclosed in Note 15 to the financial statements.
Req. 3
Yes, RIM does report other litigation in note 12 to its financial statements for the year
ended March 4, 2006. It has not provided estimates of future liabilities because RIM's
managers claim they cannot determine what these amounts may be.
10-48
CRITICAL THINKING CASES
CP10–7
Current Ratio Working Capital Liquidity

a. Decrease No Change Short-term improvement
b. Increase Increase Improvement
c. Increase Increase Improvement
d. Increase No Change No Change
e. No Change No Change Improvement
f. Increase Increase No Change*
*Employees would be paid in any case. However, the net result is that current
liabilities are reduced.
CP10–8
While the question focuses on ethics, we believe that students should analyze the proposed
strategy. Refusing to accept merchandise would result in a higher current ratio (assuming
that it is currently greater than one). If the merchandise is purchased on credit, a constant
amount added to current liabilities and current assets results in a lower current ratio.
Management could actually improve the current ratio by shipping merchandise to
customers because it would record trade receivables based on selling price and reduce
inventory based on cost.
There are legitimate ethical issues raised when management alters the operations of a
business to achieve an accounting result. Students should understand, however, that
management in many organizations engages in behaviour designed to affect accounting
reports, e.g., asking or requiring employees to work overtime in order to ship merchandise
that has been ordered at year-end.
We have included strategies for affecting ratios as well as reported profits. We have found
some students believe some strategies are ethical but others are not. In such situations, we
have been able to have very meaningful discussions concerning situational ethics.
10-49
CP10–9
Strong cash flows are associated with financial strength. A company with good cash flows
often does not need a large amount of working capital because its ability to generate cash
provides it with an appropriate level of liquidity.
Cash flow represents a stream of new resources. Working capital is an inventory of

resources. Most analysts would prefer to see strong cash flows rather than a large amount
of working capital.
FINANCIAL REPORTING AND ANALYSIS TEAM PROJECT
CP10–10
The response to this case will depend on the companies selected by the students.
10-50

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Libby 4ce Solutions Manual - Ch10

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Chapter 10

Reporting and Interpreting Current Liabilities

3. A liability is initially measured at its current cash equivalent amount. Conceptually,

9. A note payable is a formal written contract prepared when a company borrows

12. Interest expense = $4,000 x 12% x 9/12 = $360.

Alternate Cases and

E = Easy M = Moderate D = Difficult

Title of Liability Account

b. Deposits from customers $50,000

c. Note payable $10,000

d. Deferred subscription revenue $1,800

e. None, assuming that the amount due

f. None, because the bill relates to calls

(a) Current assets ($530,000 – $362,000)......................................... $168,000

(b) Current ratio = $168,000  $102,400 = 1.64

Current Ratio Working Capital

Liability for income taxes withheld (L)................................................. 46,000

December 31, 2011 (end of the fiscal year):

April 30, 2012 (maturity date):

E10–7 (Amounts in thousands)

Date Assets Liabilities Shareholders’ Equity

Nov. 1, 2011 Cash + $4,500 Note Payable + $4,500 Not Affected

This type of classification is consistent with generally accepted accounting principles. An

Warranty expense for 2011 = $7,200,000 x 0.004 = $28,800

Estimated warranty liability, January 1, 2011 $70,400

Date Assets Liabilities Shareholders’ Equity

March 1, 2012 Cash +$200,000 Note Payable +$200,000 Not Affected

April 5, 2012 Trade receivables GST Payable +$3,000 Revenues

February 28, 2013 Cash paid: $212,000 [$200,000 + ($200,000 x 6%)]

(a) Income tax payable:

The tax-related amounts for 2010 and 2011 are as follows:

Entries to record income taxes:

Statement of financial position:

(a) Income tax payable:

(b) Deferred income tax (related to depreciation):

2010: $8,960 + $3,500 = $12,460.

(Note: in practice, the current and future portions of

Statement of financial position:

Transaction Effect on Current Effect on

* The purchases represent additional inventory on hand.

(a) Adjusting entry, December 31, 2012:

(b) January 6, 2013:

(a) December 10, 2012:

(b) December 31, 2012:

Date Assets Liabilities Shareholders’ Equity

Jan. 6, 2013 Cash – $10,200 Wages Payable – $10,200 No impact

Dec. 10, 2012 Cash + $6,000 No impact Rent Revenue + $6,000

Statement of financial position at December 31, 2012:

Accrual based accounting is more beneficial to financial analysts because it records

Cash basis accounting may also be susceptible to manipulation.

Warranty expense (+E SE)......................................................... 509

Keg Deposits (–L)………………………….. 1,250

December 31, 2011:

April 30, 2012:

Deferred revenue, May 1, 2007 ...................................................... $ 2,057

$2,057 + X - $15,473 = $10,541; Collections in advance = $23,957

Retained earnings (−SE)..................................................................... 22,891

Dividends payable (−L)....................................................................... 22,720

(a) Income Taxes Payable: $32,400  30% = $9,720

(b) Deferred Income Tax

Income Tax Expense (+E SE) [($59,000 – 20,000) x 30%] 11,700

Statement of financial position, December 31, 2011:

April 30, 2012: