13 Current Liabilities and Contingencies PROBLEMS 13
PROBLEMS
P13-1 (L01) GROUPWORK (Current Liability Entries and Adjustments) Described below are certain transactions of Edwardson Corporation. The company uses the periodic inventory system.
1. On February 2, the corporation purchased goods from Martin Company for $70,000 subject to cash discount terms of 2/10, n/30. Purchases and accounts payable are recorded by the corporation at net amounts after cash discounts. The invoice was paid on February 26.
2. On April 1, the corporation bought a truck for $50,000 from General Motors Company, paying $4,000 in cash and signing a 1-year, 12% note for the balance of the purchase price.
3. On May 1, the corporation borrowed $83,000 from Chicago National Bank by signing a $92,000 zero-interest-bearing note due 1 year from May 1.
4. On August 1, the board of directors declared a $300,000 cash dividend that was payable on September 10 to stockholders of record on August 31.
Instructions
(a) Make all the journal entries necessary to record the transactions above using appropriate dates.
(b) Edwardson Corporation’s year-end is December 31. Assuming that no adjusting entries relative to the transactions above have been recorded, prepare any adjusting journal entries concerning interest that are necessary to present fair financial statements at December 31. Assume straight-line amortization of discounts.
P13-2 (L01,3) EXCEL (Liability Entries and Adjustments) Listed below are selected transactions of Schultz Department
Store for the current year ending December 31.
1. On December 5, the store received $500 from the Selig Players as a deposit to be returned after certain furniture to be used in stage production was returned on January 15.
2. During December, cash sales totaled $798,000, which includes the 5% sales tax that must be remitted to the state by the fifteenth day of the following month.
3. On December 10, the store purchased for cash three delivery trucks for $120,000. The trucks were purchased in a state that applies a 5% sales tax.
4. The store determined it will cost $100,000 to restore the area (considered a land improvement) surrounding one of its store parking lots, when the store is closed in 2 years. Schultz estimates the fair value of the obligation at December 31 is $84,000.
Instructions
Prepare all the journal entries necessary to record the transactions noted above as they occurred and any adjusting journal entries relative to the transactions that would be required to present fair financial statements at December 31. Date each entry. For simplicity, assume that adjusting entries are recorded only once a year on December 31.
P13-3 (L01) (Payroll Tax Entries) Cedarville Company pays its office employee payroll weekly. Below is a partial list of employees and their payroll data for August. Because August is their vacation period, vacation pay is also listed.
…
Assume that the federal income tax withheld is 10% of wages. Union dues withheld are 2% of wages. Vacations are taken the second and third weeks of August by Robbins, Kirk, and Sprouse. The state unemployment tax rate is 2.5% and the federal is 0.8%, both on a $7,000 maximum. The FICA rate is 7.65% on employee and employer on a maximum of $118,500 per employee. In addition, a 1.45% rate is charged both employer and employee for an employee’s wages in excess of $118,500.
Instructions
Make the journal entries necessary for each of the four August payrolls. The entries for the payroll and for the company’s liability are made separately. Also make the entry to record the monthly payment of accrued payroll liabilities.
P13-4 (L01) EXCEL (Payroll Tax Entries) The following is a payroll sheet for Otis Import Company for the month of September 2017. The company is allowed a 1% unemployment compensation rate by the state; the federal unemployment tax rate is 0.8% and the maximum for both is $7,000. Assume a 10% federal income tax rate for all employees and a 7.65% FICA tax on employee and employer on a maximum of $118,500. In addition, 1.45% is charged both employer and employee for an employee’s wages in excess of $118,500 per employee.
Instructions
(a) Complete the payroll sheet and make the necessary entry to record the payment of the payroll.
(b) Make the entry to record the payroll tax expenses of Otis Import Company.
(c) Make the entry to record the payment of the payroll liabilities created. Assume that the company pays all payroll liabilities at the end of each month.
P13-5 (L03) GROUPWORK (Warranties) Brooks Corporation sells computers under a 2-year warranty contract that requires the corporation to replace defective parts and to provide the necessary repair labor. During 2017, the corporation sells for cash 400 computers at a unit price of $2,500. On the basis of past experience, the 2-year warranty costs are estimated to be $155 for parts and $185 for labor per unit. (For simplicity, assume that all sales occurred on December 31, 2017.) The warranty is not sold separately from the computer.
Instructions
(a) Record any necessary journal entries in 2017.
(b) What liability relative to these transactions would appear on the December 31, 2017, balance sheet and how would it be classified?
(c) In 2018, the actual warranty costs to Brooks Corporation were $21,400 for parts and $39,900 for labor. Record any necessary journal entries in 2018.
P13-6 (L03) (Extended Warranties) Dos Passos Company sells televisions at an average price of $900 and also offers to each customer a separate 3-year warranty contract for $90 that requires the company to perform periodic services and to replace defective parts. During 2017, the company sold 300 televisions and 270 warranty contracts for cash. It estimates the 3-year warranty costs as $20 for parts and $40 for labor, and accounts for warranties separately. Assume sales occurred on December 31, 2017, and straight-line recognition of warranty revenues occurs.
Instructions
(a) Record any necessary journal entries in 2017.
(b) What liability relative to these transactions would appear on the December 31, 2017, balance sheet and how would it be classified?
In 2018, Dos Passos Company incurred actual costs relative to 2017 television warranty sales of $2,000 for parts and $4,000 for labor.
(c) Record any necessary journal entries in 2018 relative to 2017 television warranties.
(d) What amounts relative to the 2017 television warranties would appear on the December 31, 2018, balance sheet and how would they be classified?
P13-7 (L03) (Warranties) Alvarado Company sells a machine for $7,400 with a 12-month warranty agreement that requires the company to replace all defective parts and to provide the repair labor at no cost to the customers. With sales being made evenly throughout the year, the company sells 600 machines in 2017 (warranty expense is incurred half in 2017 and half in 2018). As a result of product testing, the company estimates that the total warranty cost is $390 per machine ($170 parts and $220 labor).
Instructions
Assuming that actual warranty costs are incurred exactly as estimated, what journal entries would be made relative to the following facts?
(a) Sale of machinery and warranty expense incurred in 2017.
(b) Warranty accrual on December 31, 2017.
(c) Warranty costs incurred in 2018.
(d) What amount, if any, is disclosed in the balance sheet as a liability for future warranty costs as of December 31, 2017?
P13-8 (L03) (Premium Entries) To stimulate the sales of its Alladin breakfast cereal, Loptien Company places 1 coupon in each box. Five coupons are redeemable for a premium consisting of a children’s hand puppet. In 2018, the company purchases 40,000 puppets at $1.50 each and sells 480,000 boxes of Alladin at $3.75 a box. From its experience with other similar premium offers, the company estimates that 40% of the coupons issued will be mailed back for redemption. During 2018, 115,000 coupons are presented for redemption.
Instructions
Prepare the journal entries that should be recorded in 2018 relative to the premium plan.
P13-9 (L03,4) (Premium Entries and Financial Statement Presentation) Sycamore Candy Company offers an MP3 download (seven-single medley) as a premium for every five candy bar wrappers presented by customers together with $2.50. The candy bars are sold by the company to distributors for 30 cents each. The purchase price of each download code to the company is $2.25. In addition, it costs 50 cents to distribute each code. The results of the premium plan for the years 2017 and 2018 are as follows. (All purchases and sales are for cash.)
Instructions
(a) Prepare the journal entries that should be made in 2017 and 2018 to record the transactions related to the premium plan of the Sycamore Candy Company.
(b) Indicate the account names, amounts, and classifications of the items related to the premium plan that would appear on the balance sheet and the income statement at the end of 2017 and 2018.
P13-10 (L03) WRITING (Loss Contingencies: Entries and Essay) On November 24, 2017, 26 passengers on Windsor Airlines
Flight No. 901 were injured upon landing when the plane skidded off the runway. Personal injury suits for damages totaling $9,000,000 were filed on January 11, 2018, against the airline by 18 injured passengers. The airline carries no insurance. Legal counsel has studied each suit and advised Windsor that it can reasonably expect to pay 60% of the damages claimed. The financial statements for the year ended December 31, 2017, were issued February 27, 2018.
Instructions
(a) Prepare any disclosures and journal entries required by the airline in preparation of the December 31, 2017, financial statements.
(b) Ignoring the November 24, 2017, accident, what liability due to the risk of loss from lack of insurance coverage should Windsor Airlines record or disclose? During the past decade, the company has experienced at least one accident per year and incurred average damages of $3,200,000. Discuss fully.
P13-11 (L03) WRITING (Loss Contingencies: Entries and Essays) Polska Corporation, in preparation of its December 31, 2017, financial statements, is attempting to determine the proper accounting treatment for each of the following situations.
1. As a result of uninsured accidents during the year, personal injury suits for $350,000 and $60,000 have been filed against the company. It is the judgment of Polska’s legal counsel that an unfavorable outcome is unlikely in the $60,000 case but that an unfavorable verdict approximating $250,000 will probably result in the $350,000 case.
2. Polska owns a subsidiary in a foreign country that has a book value of $5,725,000 and an estimated fair value of $9,500,000.
The foreign government has communicated to Polska its intention to expropriate the assets and business of all foreign investors. On the basis of settlements other firms have received from this same country, Polska expects to receive 40% of the fair value of its properties as final settlement.
3. Polska’s chemical product division consisting of five plants is uninsurable because of the special risk of injury to employees and losses due to fire and explosion. The year 2017 is considered one of the safest (luckiest) in the division’s history because no loss due to injury or casualty was suffered. Having suffered an average of three casualties a year during the rest of the past decade (ranging from $60,000 to $700,000), management is certain that next year the company will probably not be so fortunate.
Instructions
(a) Prepare the journal entries that should be recorded as of December 31, 2017, to recognize each of the situations above.
(b) Indicate what should be reported relative to each situation in the financial statements and accompanying notes. Explain why.
P13-12 (L03) (Warranties and Premiums) Garison Music Emporium carries a wide variety of musical instruments, sound reproduction equipment, recorded music, and sheet music. Garison uses two sales promotion techniques—warranties and premiums—to attract customers.
Musical instruments and sound equipment are sold with a 1-year warranty for replacement of parts and labor. The estimated warranty cost, based on past experience, is 2% of sales.
The premium is offered on the recorded and sheet music. Customers receive a coupon for each dollar spent on recorded music or sheet music. Customers may exchange 200 coupons and $20 for an MP3 player. Garison pays $32 for each player and estimates that 60% of the coupons given to customers will be redeemed.
Garison’s total sales for 2017 were $7,200,000—$5,700,000 from musical instruments and sound reproduction equipment and $1,500,000 from recorded music and sheet music. Replacement parts and labor for warranty work totaled $94,000 during
2017. A total of 6,500 players used in the premium program were purchased during the year and there were 1,200,000 coupons redeemed in 2017.
The balances in the accounts related to warranties and premiums on January 1, 2017, were as shown below.
Inventory of Premiums $ 37,600
Premium Liability 44,800
Warranty Liability 136,000
Instructions
Garison Music Emporium is preparing its financial statements for the year ended December 31, 2017. Determine the amounts that will be shown on the 2017 financial statements for the following.
(a) Warranty Expense. (d) Inventory of Premiums.
(b) Warranty Liability. (e) Premium Liability.
(c) Premium Expense.
(CMA adapted)
P13-13 (L03) WRITING GROUPWORK (Liability Errors) You are the independent auditor engaged to audit Millay Corporation’s
December 31, 2017, financial statements. Millay manufactures household appliances. During the course of your audit, you discovered the following contingent liabilities.
1. Millay began production of a new dishwasher in June 2017 and, by December 31, 2017, sold 120,000 to various retailers for $500 each. Each dishwasher is under a 1-year warranty. The company estimates that its warranty expense per dishwasher will amount to $25. At year-end, the company had already paid out $1,000,000 in warranty expenses.
Millay’s income statement shows warranty expenses of $1,000,000 for 2017. Millay accounts for warranty costs on the accrual basis.
2. In response to your attorney’s letter, Morgan Sondgeroth, Esq., has informed you that Millay has been cited for dumping toxic waste into the Kishwaukee River. Clean-up costs and fines amount to $2,750,000. Although the case is still being contested, Sondgeroth is certain that Millay will most probably have to pay the fine and clean-up costs. No disclosure of this situation was found in the financial statements.
3. Millay is the defendant in a patent infringement lawsuit by Megan Drabek over Millay’s use of a hydraulic compressor in several of its products. Sondgeroth claims that, if the suit goes against Millay, the loss may be as much as $5,000,000. However, Sondgeroth believes the loss of this suit to be only reasonably possible. Again, no mention of this suit is made in the financial statements.
As presented, these contingencies are not reported in accordance with GAAP, which may create problems in issuing a favorable audit report. You feel the need to note these problems in the work papers.
Instructions
Heading each page with the name of the company, balance sheet date, and a brief description of the problem, write a brief narrative for each of the above issues in the form of a memorandum to be incorporated in the audit work papers. Explain what led to the discovery of each problem, what the problem really is, and what you advised your client to do (along with any appropriate journal entries) in order to bring these contingencies in accordance with GAAP.
P13-14 (L03) (Warranty and Coupon Computation) Schmitt Company must make computations and adjusting entries for the following independent situations at December 31, 2018.
1. Its line of amplifiers carries a 3-year warranty against defects. On the basis of past experience the estimated warranty costs related to dollar sales are first year after sale—2% of sales revenue; second year after sale—3% of sales revenue; and third year after sale—5% of sales revenue. Sales and actual warranty expenditures for the first 3 years of business were:
Sales Warranty
Revenue Expenditures
2016 $ 800,000 $ 6,500
2017 1,100,000 17,200
2018 1,200,000 62,000
Instructions
Compute the amount that Schmitt should report as a liability in its December 31, 2018, balance sheet. Assume that all sales are made evenly throughout each year with warranty expenses also evenly spaced relative to the rates above.
2. With some of its products, Schmitt includes coupons that are redeemable in merchandise. The coupons have no expiration date and, in the company’s experience, 40% of them are redeemed. The liability for unredeemed coupons at December 31, 2017, was $9,000. During 2018, coupons worth $30,000 were issued, and merchandise worth $8,000 was distributed in exchange for coupons redeemed.
Instructions
Compute the amount of the liability that should appear on the December 31, 2018, balance sheet.
(AICPA adapted)
