13 Current Liabilities and Contingencies EXERCISES
EXERCISES
E13-1 (L01) (Balance Sheet Classification of Various Liabilities) How would each of the following items be reported on the balance sheet?
(a) Accrued vacation pay. (j) Premium offers outstanding.
(b) Estimated taxes payable. (k) Discount on notes payable.
(c) Service warranties on appliance sales. (l) Personal injury claim pending.
(d) Bank overdraft. (m) Current maturities of long-term debts to be paid from current assets.
(e) Employee payroll deductions unremitted.
(f) Unpaid bonus to officers. (n) Cash dividends declared but unpaid.
(g) Deposit received from customer to guarantee performance of a contract. (o) Dividends in arrears on preferred stock. (p) Loans from officers.
(h) Sales taxes payable.
(i) Gift certificates sold to customers but not yet redeemed.
E13-2 (L01) EXCEL (Accounts and Notes Payable) The following are selected 2017 transactions of Sean Astin Corporation.
Sept. 1 Purchased inventory from Encino Company on account for $50,000. Astin records purchases gross and uses a periodic inventory system.
Oct. 1 Issued a $50,000, 12-month, 8% note to Encino in payment of account.
Oct. 1 Borrowed $50,000 from the Shore Bank by signing a 12-month, zero-interest-bearing $54,000 note.
Instructions
(a) Prepare journal entries for the selected transactions above.
(b) Prepare adjusting entries at December 31.
(c) Compute the total net liability to be reported on the December 31 balance sheet for:
(1) The interest-bearing note.
(2) The zero-interest-bearing note.
E13-3 (L01) (Compensated Absences) Matt Broderick Company began operations on January 2, 2016. It employs 9 individuals who work 8-hour days and are paid hourly. Each employee earns 10 paid vacation days and 6 paid sick days annually. Vacation days may be taken after January 15 of the year following the year in which they are earned. Sick days may be taken as soon as they are earned; unused sick days accumulate. Additional information is as follows…
Instructions
(a) Prepare journal entries to record transactions related to compensated absences during 2016 and 2017.
(b) Compute the amounts of any liability for compensated absences that should be reported on the balance sheet at December 31, 2016 and 2017.
E13-4 (L01) EXCEL (Compensated Absences) Assume the facts in E13-3 except that Matt Broderick Company has chosen not to accrue paid sick leave until used, and has chosen to accrue vacation time at expected future rates of pay without discounting.
The company used the following projected rates to accrue vacation time.
…
Instructions
(a) Prepare journal entries to record transactions related to compensated absences during 2016 and 2017.
(b) Compute the amounts of any liability for compensated absences that should be reported on the balance sheet at December 31, 2016, and 2017.
E13-5 (L01) (Adjusting Entry for Sales Tax) During the month of June, Rowling Boutique recorded cash sales of $233,200 and credit sales of $153,700, both of which include the 6% sales tax that must be remitted to the state by July 15.
Instructions
Prepare the adjusting entry that should be recorded to fairly present the June 30 financial statements.
E13-6 (L01) (Payroll Tax Entries) The payroll of YellowCard Company for September 2016 is as follows.
Total payroll was $480,000, of which $110,000 is exempt from Social Security tax because it represented amounts paid in excess of $118,500 to certain employees. The amount paid to employees in excess of $7,000 was $400,000. Income taxes in the amount of $80,000 were withheld, as was $9,000 in union dues. The state unemployment tax is 3.5%, but YellowCard Company is allowed a credit of 2.3% by the state for its unemployment experience. Also, assume that the current FICA tax is 7.65% on an employee’s wages to $118,500 and 1.45% in excess of $118,500. No employee for YellowCard makes more than $125,000. The federal unemployment tax rate is 0.8% after state credit.
Instructions
Prepare the necessary journal entries if the wages and salaries paid and the employer payroll taxes are recorded separately.
E13-7 (L01) (Payroll Tax Entries) Green Day Hardware Company’s payroll for November 2017 is summarized below.
At this point in the year, some employees have already received wages in excess of those to which payroll taxes apply. Assume that the state unemployment tax is 2.5%. The FICA rate is 7.65% on an employee’s wages to $118,500 and 1.45% in excess of $118,500. Of the $188,000 wages subject to FICA tax, $20,000 of the sales wages is in excess of $118,500. Federal unemployment tax rate is 0.8% after credits. Income tax withheld amounts to $16,000 for factory, $7,000 for sales, and $6,000 for administrative.
Instructions
(a) Prepare a schedule showing the employer’s total cost of wages for November by function. (Round all computations to nearest dollar.)
(b) Prepare the journal entries to record the factory, sales, and administrative payrolls including the employer’s payroll taxes.
E13-8 (L02) (Refinancing of Short-Term Debt) On December 31, 2017, Hattie McDaniel Company had $1,200,000 of shortterm debt in the form of notes payable due February 2, 2018. On January 21, 2018, the company issued 25,000 shares of its common stock for $38 per share, receiving $950,000 proceeds after brokerage fees and other costs of issuance. On February 2, 2018, the proceeds from the stock sale, supplemented by an additional $250,000 cash, are used to liquidate the $1,200,000 debt. The December 31, 2017, balance sheet is issued on February 23, 2018.
Instructions
Show how the $1,200,000 of short-term debt should be presented on the December 31, 2017, balance sheet, including note disclosure.
E13-9 (L02) (Refinancing of Short-Term Debt) On December 31, 2017, Kate Holmes Company has $7,000,000 of short-term debt in the form of notes payable to Gotham State Bank due in 2018. On January 28, 2018, Holmes enters into a refinancing agreement with Gotham that will permit it to borrow up to 60% of the gross amount of its accounts receivable. Receivables are expected to range between a low of $6,000,000 in May to a high of $8,000,000 in October during the year 2018. The interest cost of the maturing short-term debt is 15%, and the new agreement calls for a fluctuating interest at 1% above the prime rate on notes due in 2022. Holmes’s December 31, 2017, balance sheet is issued on February 15, 2018.
Instructions
Prepare a partial balance sheet for Holmes at December 31, 2017, showing how its $7,000,000 of short-term debt should be presented, including footnote disclosure.
E13-10 (L03) (Warranties) Soundgarden Company sold 200 color laser copiers on July 10, 2017, for $4,000 apiece, together with a 1-year warranty. Maintenance on each copier during the warranty period is estimated to be $330.
Instructions
Prepare entries to record the sale of the copiers, the related warranty costs, and any accrual on December 31, 2017. Actual warranty costs (inventory) incurred in 2017 were $17,000.
E13-11 (L03) (Warranties) Early in 2017, Sheryl Crow Equipment Company sold 500 Rollomatics during 2017 at $6,000 each. During 2017, Crow spent $20,000 servicing the 2-year assurance warranties that accompany the Rollomatic. All applicable transactions are on a cash basis.
Instructions
(a) Prepare 2017 entries for Crow. Assume that Crow estimates the total cost of servicing the warranties will be $55,000 for 2 years.
(b) Prepare 2017 entries for Crow assuming that the warranties are not an integral part of the sale (a service-type warranty).
Assume that of the sales total, $56,000 relates to sales of warranty contracts. Crow estimates the total cost of servicing the warranties will be $55,000 for 2 years. Estimate revenues to be recognized on a straight-line basis.
E13-12 (L03) (Premium Entries) No Doubt Company includes 1 coupon in each box of soap powder that it packs, and 10 coupons are redeemable for a premium (a kitchen utensil). In 2017, No Doubt Company purchased 8,800 premiums at 80 cents each and sold 110,000 boxes of soap powder at $3.30 per box; 44,000 coupons were presented for redemption in 2017. It is estimated that 60% of the coupons will eventually be presented for redemption.
Instructions
Prepare all the entries that would be made relative to sales of soap powder and to the premium plan in 2017.
E13-13 (L03) (Contingencies) Presented below are three independent situations. Answer the question at the end of each situation.
1. During 2017, Salt-n-Pepa Inc. became involved in a tax dispute with the IRS. Salt-n-Pepa’s attorneys have indicated that they believe it is probable that Salt-n-Pepa will lose this dispute. They also believe that Salt-n-Pepa will have to pay the
IRS between $900,000 and $1,400,000. After the 2017 financial statements were issued, the case was settled with the IRS for $1,200,000. What amount, if any, should be reported as a liability for this contingency as of December 31, 2017?
2. On October 1, 2017, Alan Jackson Chemical was identified as a potentially responsible party by the Environmental Protection Agency. Jackson’s management along with its counsel have concluded that it is probable that Jackson will be responsible for damages, and a reasonable estimate of these damages is $5,000,000. Jackson’s insurance policy of $9,000,000 has a deductible clause of $500,000. How should Alan Jackson Chemical report this information in its financial statements at December 31, 2017?
3. Melissa Etheridge Inc. had a manufacturing plant in Sudan, which was destroyed in the civil war. It is not certain who will compensate Etheridge for this destruction, but Etheridge has been assured by governmental officials that it will receive a definite amount for this plant. The amount of the compensation will be less than the fair value of the plant, but more than its book value. How should the contingency be reported in the financial statements of Etheridge Inc.?
E13-14 (L03) (Asset Retirement Obligation) Oil Products Company purchases an oil tanker depot on January 1, 2017, at a cost of $600,000. Oil Products expects to operate the depot for 10 years, at which time it is legally required to dismantle the depot and remove the underground storage tanks. It is estimated that it will cost $75,000 to dismantle the depot and remove the tanks at the end of the depot’s useful life.
Instructions
(a) Prepare the journal entries to record the depot and the asset retirement obligation for the depot on January 1, 2017. Based on an effective-interest rate of 6%, the present value of the asset retirement obligation on January 1, 2017, is $41,879.
(b) Prepare any journal entries required for the depot and the asset retirement obligation at December 31, 2017. Oil Products uses straight-line depreciation; the estimated salvage value for the depot is zero.
(c) On December 31, 2026, Oil Products pays a demolition firm to dismantle the depot and remove the tanks at a price of $80,000. Prepare the journal entry for the settlement of the asset retirement obligation.
E13-15 (L03) GROUPWORK (Premiums) The following are three independent situations.
1. Hairston Stamp Company records stamp service revenue and provides for the cost of redemptions in the year stamps are sold to licensees. Hairston’s past experience indicates that only 80% of the stamps sold to licensees will be redeemed. Hairston’s liability for stamp redemptions was $13,000,000 at December 31, 2016. Additional information for 2017 is as follows.
Stamp service revenue from stamps sold to licensees $9,500,000
Cost of redemptions (stamps sold prior to 1/1/17) 6,000,000
If all the stamps sold in 2017 were presented for redemption in 2018, the redemption cost would be $5,200,000. What amount should Hairston report as a liability for stamp redemptions at December 31, 2017?
2. In packages of its products, Burnitz Inc. includes coupons that may be presented at retail stores to obtain discounts on other Burnitz products. Retailers are reimbursed for the face amount of coupons redeemed plus 10% of that amount for handling costs. Burnitz honors requests for coupon redemption by retailers up to 3 months after the consumer expiration date. Burnitz estimates that 60% of all coupons issued will ultimately be redeemed. Information relating to coupons issued by Burnitz during 2017 is as follows.
Consumer expiration date 12/31/17
Total face amount of coupons issued $800,000
Total payments to retailers as of 12/31/17 330,000
What amount should Burnitz report as a liability for unredeemed coupons at December 31, 2017?
3. Roland Company sold 700,000 boxes of pie mix under a new sales promotional program. Each box contains one coupon, which submitted with $4.00, entitles the customer to a baking pan. Roland pays $6.00 per pan and $0.50 for handling and shipping. Roland estimates that 70% of the coupons will be redeemed, even though only 250,000 coupons had been processed during 2017. What amount should Roland report as a liability for unredeemed coupons at December 31, 2017? (AICPA adapted)
E13-16 (L04) (Financial Statement Impact of Liability Transactions) Presented below is a list of possible transactions.
1. Purchased inventory for $80,000 on account (assume perpetual system is used).
2. Issued an $80,000 note payable in payment on account (see item 1 above).
3. Recorded accrued interest on the note from item 2 above.
4. Borrowed $100,000 from the bank by signing a 6-month, $112,000, zero-interest-bearing note.
5. Recognized 4 months’ interest expense on the note from item 4 above.
6. Recorded cash sales of $75,260, which includes 6% sales tax.
7. Recorded wage expense of $35,000. The cash paid was $25,000; the difference was due to various amounts withheld.
8. Recorded employer’s payroll taxes.
9. Accrued accumulated vacation pay.
10. Recorded an asset retirement obligation.
11. Recorded bonuses due to employees.
12. Recorded a contingent loss on a lawsuit that the company will probably lose.
13. Accrued warranty expense.
14. Paid warranty costs that were accrued in item 13 above.
15. Recorded sales of product and related service-type warranties.
16. Paid warranty costs under contracts from item 15 above.
17. Recognized warranty revenue (see item 15 above).
18. Recorded estimated liability for premium claims outstanding.
Instructions
Set up a table using the format shown below and analyze the effect of the 18 transactions on the financial statement categories indicated.
Use the following code:
I: Increase D: Decrease NE: No net effect
E13-17 (L04) (Ratio Computations and Discussion) Sprague Company has been operating for several years, and on December 31, 2017, presented the following balance sheet…
Instructions
Compute each of the following ratios. For each of the four, indicate the manner in which it is computed and its significance as a tool in the analysis of the financial soundness of the company.
(a) Current ratio. (c) Debt to assets ratio.
(b) Acid-test ratio. (d) Return on assets.
E13-18 (L04) (Ratio Computations and Analysis) Prior Company’s condensed financial statements provide the following information…
Instructions
(a) Determine the following for 2017.
(1) Current ratio at December 31.
(2) Acid-test ratio at December 31.
(3) Accounts receivable turnover.
(4) Inventory turnover.
(5) Return on assets.
(6) Profit margin on sales.
(b) Prepare a brief evaluation of the financial condition of Prior Company and of the adequacy of its profits.
E13-19 (L04) (Ratio Computations and Effect of Transactions) Presented below is information related to Carver Inc.
Instructions
(a) Compute the following ratios or relationships of Carver Inc. Assume that the ending account balances are representative unless the information provided indicates differently.
(1) Current ratio.
(2) Inventory turnover.
(3) Accounts receivable turnover.
(4) Earnings per share.
(5) Profit margin on sales.
(6) Return on assets on December 31, 2017.
(b) Indicate for each of the following transactions whether the transaction would improve, weaken, or have no effect on the current ratio of Carver Inc. at December 31, 2017.
(1) Write off an uncollectible account receivable, $2,200.
(2) Purchase additional capital stock for cash.
(3) Pay $40,000 on notes payable (short-term).
(4) Collect $23,000 on accounts receivable.
(5) Buy equipment on account.
(6) Give an existing creditor a short-term note in settlement of account.
