- What is the difference between a current liability and a noncurrent liability?
- Give an example of a current liability and a noncurrent liability.
- Why is it important that a company be able to pay its liabilities as they come due?
- Why are financial statement users particularly concerned about the amount of current liabilities a company has?
- How is a company’s current ratio calculated?
- What are the three characteristics of liabilities according to FASB?
- What are “accrued liabilities”?
- How do companies account for gift cards it has sold?
- Define “commitments.”
- What two criteria must be met for a company to record a contingency?
- Give three examples of possible contingencies that a company would report.
- How would a company report a contingency that is “reasonably possible”?
- How would a company report a contingency where the chance of loss is “remote”?
- How are contingent gains reported?
- How should a company go about estimating liabilities like product warranties?
- How is the age of accounts payable calculated?
True or False
- ____ Contingent gains should only be recorded if they are probable and can be reasonably estimated.
- ____ A current ratio of less than one means that a company has more current assets than current liabilities.
- ____ A long-term note payable is an example of a current liability.
- ____ Restatement of financial statements should occur if a company attempts to mislead investors by understating its liabilities.
- ____ Embedded and extended warranties should be accounted for in the same way.
- ____ When estimating its warranty liability, a company should consider things like the state of the economy.
- ____ Contingent liabilities should be reported on the balance sheet if they are both probable and can be reasonably estimated.
- ____ Age of accounts payable can help users determine if a company is having trouble paying its bills.
- ____ Unearned revenue and accounts receivable are examples of current liabilities.
- ____ Liabilities for gift cards and similar items must be kept on the balance sheet until they are redeemed, regardless of how long that takes.
Which of the following is not normally a current liability?
- Accounts payable
- Bonds payable
- Interest payable
- Income taxes payable
Sierra Inc. manufacturers environmentally friendly appliances. It offers a two-year warranty standard. In Year 1, Sierra sold 450,000 toasters. Past experience has told Sierra that approximately 4 percent of the toasters require repair at an average cost of $10 each. During Year 1, Sierra actually spends $38,000 and during Year 2, Sierra actually spends $105,000. What is the balance in the warranty liability account at the end of year 2?
Reporting contingent losses but not contingent gains is an example of which accounting principle?
- Going concern
Watkins Inc. has the following assets:
Cash $400 Inventory $730 Prepaid Rent $460 Equipment $4,000
- >It has the following liabilities
Accounts Payable $560 Unearned revenue $200 Long-term Note Payable $3,500
- >What is Watkins’ current ratio?
The following figures appeared on Whazzit’s financial statements for the year:
Cost of goods sold $1,968,000 Beginning inventory 238,000 Ending inventory 249,000 Accounts payable 167,000
- >What was Whazzit’s age of accounts payable?
- 31.1 day
- 47.9 days
- 42.3 days
- 30.8 days
Maxout Company sells computers. The computers have an embedded one-year warranty, but customers may choose to buy an extended warranty that covers the computer for two years beyond that. The cost of the extended warranty is $200. What journal entry would Maxout make at the end of the second year after the computer is purchased, assuming the customer also purchases the extended warranty?
Which of the following is not a criterion that must be met for an item to be classified as a liability?
- It is a certain future sacrifice
- The sacrifice is from the entity’s assets or services
- It is a probable future sacrifice
- It arises from a present obligation that results from a past transaction
Knockoff Corporation makes a videogame unit known as the Gii. During the month of June, the following transactions occurred. Record any necessary journal entries for a–e.
- Knockoff purchased $300,000 of raw materials inventory on account.
- The company incurs salary expense of $45,000, which will not be paid until the beginning of July.
- Knockoff owes the IRS and other government entities $120,000 in taxes.
- OK Buy places an advance order for Giis and pays Knockoff $23,000. The Giis will be shipped in July.
- Knockoff owes a local bank $4,000 in interest.
- If Knockoff has $800,000 in current assets, and all current liabilities are given in a–e above, what is Knockoff’s current ratio?
- Knockoff’s main competitor, PlayItAgain, has a current ratio of 2.1. You are trying to decide which company to invest in. Which current ratio do you prefer? Why?
OK Buy sells gift cards in various denominations. The company likes to sell these because it receives the cash immediately, but knows that a certain percentage will never be redeemed for merchandise. On December 1, OK Buy had a balance in unearned revenue from sales of gift cards of $728,000.
- During December, OK Buy sold an additional $578,000 in gift cards. Prepare this journal entry.
- During December, $327,000 worth of gift cards were redeemed to purchase inventory that had originally cost OK Buy $190,000. Prepare these journal entries.
- On December 31, OK Buy’s accountant determines that 3 percent of the outstanding gift cards will never be redeemed for various reasons. She used past history to help determine this figure. Prepare a journal entry if necessary.
- What is the balance in OK Buy’s unearned revenue account on December 31 after all of the above transactions have been recorded?
Ingalls Company is a fine jeweler located in a mall in a midsize city. During December 20X4, an unfortunate accident happens. Mrs. Rita Yeargin trips over a giant, singing Rudolph set up by the mall management company and went sprawling into Ingalls’ store where she cracked her head on a display case. She spent several days in the hospital with a sprained ankle, bruised elbow and a concussion. Prior to the end of the year, Mrs. Yeargin’s lawyer files papers to sue both the mall management company and Ingalls for $1,000,000. Ingalls’ insurance company tells it that its policy does not cover accidents involving giant, singing Rudolphs. Ingalls’s attorney tells it that it is difficult to guess what a jury might do in this case. He estimates that Ingalls will probably be liable for only 20 percent of the $1,000,000 since the Rudolph actually belongs to the mall.
- Determine if Ingalls needs to record a journal entry on December 31, 20X4, and if so, record it.
Sadler Corporation produces lawnmowers. The lawnmowers come with a three-year warranty. During 20X6, Sadler sold 20,000 lawnmowers that cost $5,800,000 to manufacture for $10,000,000 cash. Sadler’s accountant estimates that 10 percent will need to be repaired at some point over the next three years at an average cost of $37 per lawnmower.
- Make the journal entry to record the sale of the lawnmowers in 20X6.
- Record warranty expense for 20X6.
- During 20X7, Sadler spends $24,000 to repair the lawnmowers. Record this.
- At the end of 20X7, Sadler’s accountant reevaluates the warranty estimates. The accountant believes that the actual warranty liability may be higher than her original estimates. She now believes that an additional $17,000 should be added. Make the necessary journal entry.
- During 20X8, Sadler spends $60,000 to repair the lawnmowers. Record this.
The Eyes Have It sells custom eyewear with a one-year embedded warranty. Customers may purchase an extended one-year warranty beyond that. During 20X7, the company sold 52,000 pairs of eyeglasses for $1,000,000. Customers who purchased 75 percent of those pairs also purchased the one-year extended warranty. This brought in $200,000 cash.
- Record the sale of the extended warranties in 20X7.
- Assume that during 20X9, the company spent $34,000 to repair glasses under the extended warranty. Record this entry.
- Record the entry Eyes will make when the extended warranties expire.
In several past chapters, we have met Heather Miller, who started her own business, Sew Cool. The financial statements for December are shown below. To calculate age of accounts payable, assume that beginning inventory on 6/1/20X8, when Sew Cool started business, was zero. Also, assume that Sew Cool was only in business for 210 days.
Figure 13.23 Sew Cool Financial Statements
- >Based on the financial statements determine the following:
- Current ratio
- Age of accounts payable
This problem will carry through several chapters, building in difficulty. It allows students to continuously practice skills and knowledge learned in previous chapters.
Figure 13.26 Webworks Financial Statements