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The McGraw-Hill Companies, Inc., 2013
Solutions Manual, Vol.2, Chapter 13 131
Chapter 13 Current Liabilities and Contingencies
AACSB assurance of learning standards in accounting and business education require
documentation of outcomes assessment. Although schools, departments, and faculty may approachassessment and its documentation differently, one approach is to provide specific questions onexams that become the basis for assessment. To aid faculty in this endeavor, we have labeled eachquestion, exercise, and problem inIntermediate Accounting, 7e, with the following AACSB learningskills:
Questions AACSB Tag Brief Exercises AACSB Tag131 Reflective thinking 1312 Analytic132 Reflective thinking 1313 Analytic133 Reflective thinking 1314 Analytic134 Reflective thinking 1315 Analytic135 Reflective thinking 1316 Analytic
136 Reflective thinking 1317 Analytic137 Reflective thinking 1318 Analytic138 Reflective thinking 1319 Analytic139 Reflective thinking 1320 Analytic
1310 Reflective thinking Exercises1311 Reflective thinking 131 Analytic1312 Reflective thinking 132 Analytic1313 Reflective thinking 133 Analytic1314 Diversity, Reflective thinking 134 Analytic1315 Reflective thinking 135 Analytic1316 Reflective thinking 136 Analytic1317 Reflective thinking 137 Analytic1318 Diversity, Reflective thinking 138 Analytic1319 Reflective thinking 139 Analytic1320 Reflective thinking 1310 Communications1321 Reflective thinking 1311 Analytic1322 Reflective thinking 1312 Analytic1323 Reflective thinking 1313 Analytic1324 Diversity, Reflective thinking 1314 Communications1325 Diversity, Reflective thinking 1315 Analytic, Reflective thinking1326 Reflective thinking 1316 Analytic1327 Reflective thinking 1317 Analytic, Reflective thinking1328 Diversity, Reflective thinking 1318 Analytic, Communications
Brief Exercises 1319 Analytic
131 Analytic 1320 Reflective thinking132 Analytic 1321 Analytic133 Analytic 1322 Analytic, Reflective thinking
134 Analytic 1323 Reflective thinking135 Analytic 1324 Analytic136 Analytic 1325 Analytic137 Analytic 1326 Analytic138 Analytic 1327 Analytic139 Analytic CPA/CMA
1310 Analytic 1 Analytic1311 Analytic 2 Analytic
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The McGraw-Hill Companies, Inc., 2013
132 Intermediate Accounting, 7e
CPA/CMA cont. AACSB Tags3 Analytic4 Analytic5 Analytic6 Analytic7 Diversity, Reflective thinking8 Diversity, Reflective thinking
9 Diversity, Reflective thinking 1 Reflective thinking2 Reflective thinking3 Reflective thinking4 Reflective thinking
Problems131 Analytic132 Analytic133 Analytic134 Analytic135 Analytic136 Analytic137 Analytic, Reflective thinking
138 Analytic139 Analytic1310 Analytic1311 Reflective thinking1312 Analytic, Communications1313 Analytic
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The McGraw-Hill Companies, Inc., 2013
Solutions Manual, Vol.2, Chapter 13 133
QUESTIONS FOR REVIEW OF KEY TOPICS
Question 131A liability involves the past, the present, and the future. It is a present responsibility, to
sacrifice assets in the future, caused by a transaction or other event that already has happenedSpecifically, Elements of Financial Statements, Statement of Financial Accounting Concepts No.6,par. 36, describes three essential characteristics: Liabilities
1. areprobable, futuresacrifices of economic benefits2. that arise frompresentobligations (to transfer goods or provide services) to other entities3. that result frompasttransactions or events.
Question 132Liabilities traditionally are classified as either current liabilities or long-term liabilities in a
classified balance sheet. Current liabilities are those expected to be satisfied with current assetsorby the creation of other current liabilities. Usually, but with exceptions, current liabilities areobligations payable within one year or within the firm's operating cycle, whichever is longer.
Question 133In concept, liabilities should be reported at theirpresent values; that is, the valuation amount is
the present value of all future cash payments resulting from the debt, usually principal and/or interestpayments. In this case, the amount would be determined as the present value of $100,000,discounted for three months at an appropriate rate of interest for a debt of this type. This is properbecause of the time value of money.
In practice, liabilities ordinarily are reported at their maturity amounts ifpayable within oneyear because the relatively short time period makes the interest or time value component immaterial[FASB ASC 83530153: InterestImputation of InterestScope and Scope Exceptions(previously Interest on Receivables and Payables, Accounting Principles Board Opinion No 21
(New York, AICPA, August 1971, Par. 3))] specifically exempts from present value valuation allliabilities arising in connection with suppliers in the normal course of business and due within ayear.
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The McGraw-Hill Companies, Inc., 2013
134 Intermediate Accounting, 7e
Answers to Questions (continued)
Question 134Lines of credit permit a company to borrow cash from a bank up to a prearranged limit at a
predetermined, usually floating, rate of interest. The interest rate often is based on current rates of
the prime London interbank borrowing, certificates of deposit, bankers acceptance, or otherstandard rates. Lines of credit usually must be available to support the issuance of commercialpaper.
Lines of credit can be noncommitted or committed. A noncommittedline of credit allows thecompany to borrow without having to follow formal loan procedures and paperwork at the time ofthe loan and is less formal, usually without a commitment fee. Sometimes a compensating balanceis required to be on deposit with the bank as compensation for the service. A committed line of
credit is more formal. It usually requires a commitment fee in the neighborhood of 1/4of one percent
of the unused balance during the availability period. Sometimes compensating balances also arerequired.
Question 135When interest is discounted from the face amount of a note at the time it is written, it usually
is referred to as a noninterest-bearing note. Noninterest-bearing notes do, of course entail interest,but the interest is deducted (or discounted) from the face amount to determine the cash proceedsmade available to the borrower at the outset and included in the amount paid at maturity. In fact, theeffective interest rate is higher than the stated discount rate because the discount rate is applied tothe face value, but the cash borrowed is less than the face value.
Question 136Commercial paper represents loans from other corporations. It refers to unsecured notes sold
in minimum denominations of $25,000 with maturities ranging from 30 to 270 days. The firm
would be required to file a registration statement with the SEC if the maturity is beyond 270 days.The name commercial paper implies that a paper certificate is issued to the lender to represent theobligation. But, increasingly, no paper is created because the entire transaction is computerized.Recording the issuance and payment of commercial paper is the same as for notes payable.
The interest rate usually is lower than in a bank loan because commercial paper (a) typically isissued by large, sound companies (b) directly to the lender, and (c) normally is backed by a line ofcredit with a bank.
Question 137This is an example of an accrued expensean expense incurred during the current period, but
not yet paid. he expense and related liability should be recorded as follows:
Salaries expense 5,000Salaries payable 5,000
This achieves a proper matching of this expense with the revenues it helps generate, andrecognizes that a liability has been created by the employee earning wages for which she has not yetbeen paid.
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The McGraw-Hill Companies, Inc., 2013
Solutions Manual, Vol.2, Chapter 13 135
Answers to Questions (continued)
Question 138An employer should accrue an expense and the related liability for employees' compensation for
future absences, like vacation pay, if the obligation meets each of four conditions: (1) the obligation
is attributable to employees' services already performed, (2) the paid absence can be taken in a lateryearthe benefit vests (will be compensated even if employment is terminated) or the benefit can beaccumulated over time, (3) the payment is probable, and (4) the amount can be reasonablyestimated.
Customary practice should be considered when deciding whether an obligation exists. Forinstance, whether the rights to paid absences have been earned by services already renderedsometimes depends on customary policy for the absence in question. An example is whethercompensation for upcoming sabbatical leave should be accrued. Is it granted only to performresearch beneficial to the employer? Or, is it customary that sabbatical leave is intended to provideunrestrained compensation for past service?
Similar concerns also influence whether unused rights to the paid absences can be carried
forward or expire. Although holiday time, military leave, maternity leave, and jury time typically donot accumulate if unused, if it is customary practice that one can be carried forward, a liability isaccrued if its probable employees will be compensated in a future year. Similarly, sick pay isspecifically excluded from mandatory accrual, according to GAAP regarding compensated absencesbecause future absence depends on future illness, which usually is not a certainty. But, if companypolicy or custom is that employees are paid sick pay even when their absence is not due to illnessa liability for unused sick pay should be recorded.
Question 139When a company collects cash from a customer as a refundable deposit or as an advance
payment for products or services, a liability is created obligating the firm to return the deposit or to
supply the products or services. When the amount is to be returned to the customer in cash, it is arefundable deposit. When the amount will be applied to the purchase price when goods aredelivered or services provided (gift certificates, magazine subscriptions, layaway deposits, speciaorder deposits, and airline tickets), it is a customer advance.
Question 1310Gift cards are a particular form of advance collection of revenues. When the payment is
received, the seller debits cash and credits an unearned revenue liability. Later, unearned revenue isreduced and revenue recognized either when the customer redeems the gift card or when theprobability of redemption is viewed as remote, based on an expiration date or the companysexperience.
Question 1311Examples of amounts collected for third parties that represent liabilities until remitted are sales
taxes, and payroll-related deductions such as federal and state income taxes, social security taxesemployee insurance, employee contributions to retirement plans, and union dues.
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The McGraw-Hill Companies, Inc., 2013
136 Intermediate Accounting, 7e
Answers to Questions (continued)
Question 1312The requirement to classify currently maturing debt as a current liability includes debt that is
callable, or due on demand, by the creditor in the upcoming year, even if the debt is not expected to
be called.
Question 1313Short-term obligations can be reported as noncurrent liabilities if the company (a) intends to
refinance on a long-term basis and (b) demonstrates the abilityto do so by a refinancing agreementor byactual financing.
Question 1314Under U.S. GAAP, ability to finance must be demonstrated by securing financing prior to the
date the balance sheet is issued; under IFRS, ability to finance must be demonstrated by securingfinancing prior to the balance sheet date (which typically is a couple of months earlier than the date
of issuance).
Question 1315Aloss contingency is an existing situation or set of circumstances involving potential loss that
will be resolved when some future event occurs or doesnt occur. Examples: (1) a possible repair toa product under warranty, (2) a possible uncollectible receivable, (3) being the defendant in alawsuit.
Question 1316The likelihood that the future event(s) will confirm the incurrence of the liability must be
categorized as:
PROBABLEthe confirming event is likely to occur.
REASONABLY POSSIBLEthe chance the confirming event will occur is more than remote butless than likely.
REMOTEthe chance the confirming event will occur is slight.
Question 1317A liability should be accruedif it is bothprobablethat the confirming event will occur and the
amount can be at least reasonably estimated.
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The McGraw-Hill Companies, Inc., 2013
Solutions Manual, Vol.2, Chapter 13 137
Answers to Questions (continued)
Question 1318Under U.S. GAAP, the term contingent liability is used to refer generally to contingent
losses, regardless of probability. Under IFRS, a contingent liability refers only to those
contingencies that are not recognized in the financial statements; the term provision is used torefer to those that are accrued as liabilities because they are probable and reasonably estimable.
Question 1319If one or both of the accrual criteria is not met, but there is at least a reasonable possibilitythat
an obligation exists (the loss will occur), a disclosure note should describe the contingency. Thenote also should provide an estimate of the possible loss or range of loss, if possible. If an estimatecannot be made, a statement to that effect should be included.
Question 1320
1. Manufacturers product warrantiesthese inevitably involve expenditures, and reasonablyaccurate estimates of the total liability for a period usually are possible, based on priorexperience.
2. Cash rebates and other premium offersthese inevitably involve expenditures, and reasonablyaccurate estimates of the total liability for a period usually are possible, based on priorexperience.
Question 1321The contingent liability for warranties and guarantees usually is accrued. The estimated
warranty (guarantee) liability is credited and warranty (guarantee) expense is debited in the reporting
period in which the product under warranty is sold. An extended warranty provides warrantyprotection beyond the manufacturers original warranty. A manufacturers warranty is offered as anintegral part of the product package. By contrast, an extended warranty is priced and sold separatelyfrom the warranted product. It essentially constitutes a separate sales transaction and is recorded assuch.
Question 1322Several weeks usually pass between the end of a companys fiscal year and the date the
financial statements for that year actually are issued. Any enlightening events occurring during thisperiod should be used to assess the nature of a loss contingency existing at the report date. Since aliability should be accrued if it is both probable that the confirming event will occur and the amountcan be at least reasonably estimated, the contingency should be accrued.
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The McGraw-Hill Companies, Inc., 2013
138 Intermediate Accounting, 7e
Answers to Questions (concluded)
Question 1323When a contingency comes into existence only after the year-end, a liability cannot be accrued
because none existed at the end of the year. Yet, if the loss is probable and can be reasonablyestimated, the contingency should be described in a disclosure note. The note should include theeffect of the loss on key accounting numbers affected. Furthermore, even events other thancontingencies that occur after the year-end but before the financial statements are issued must bedisclosed in a subsequent events disclosure note if they have a material effect on the companysfinancial position (i.e., an issuance of debt or equity securities, a business combination, ordiscontinued operations).
Question 1324In U.S. GAAP, the low end of the range is accrued as a liability, and the rest of the range is
disclosed. In IFRS, the mid-point of the range is accrued.
Question 1325In IFRS, present values must be used to measure a liability whenever the time value of money
is material. That requirement does not exist for U.S. GAAP.
Question 1326When an assessment is probable, reporting the possible obligation would be warranted if an
unfavorable settlement is at least reasonably possible. This means an estimated loss and contingentliability would be accrued if (a) an unfavorable outcome is probable and (b) the amount can bereasonably estimated. Otherwise, note disclosure would be appropriate. So, when the assessment isunasserted as yet, a two-step process is involved in deciding how it should be reported:
1. Is the assessmentprobable? If it is not, no disclosure is warranted.
2. If the assessment isprobable, evaluate (a) thelikelihood of an unfavorable outcome and (b)whether the dollar amount can be estimated to determine whether it should be accrued,disclosed only, or neither.
Question 1327You should not accrue your gain. A gain contingency should not be accrued. This
conservative treatment is consistent with the general inclination of accounting practice to anticipatelosses, but to recognize gains only at their realization. Though gain contingencies are not recordedin the accounts, they should be disclosed in notes to the financial statements. Attention should bepaid that the disclosure note not give "misleading implications as to the likelihood of realization."
Question 1328You should accrue your gain. Under IFRS, a gain contingency is accrued if it is virtuallycertain to occur, as is the case with respect to this gain.
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The McGraw-Hill Companies, Inc., 2013
Solutions Manual, Vol.2, Chapter 13 139
BRIEF EXERCISES
Brief Exercise 131
Cash ............................................................... 60,000,000Notes payable .............................................. 60,000,000
Interest expense($60,000,000 x 12% x3/12)........ 1,800,000
Interest payable .......................................... 1,800,000
Brief Exercise 132
Cash(difference).......................................................... 54,600,000Discount on notes payable ($60,000,000 x 12% x9/12) ... 5,400,000
Notes payable(face amount).................................... 60,000,000
Interest expense($60,000,000 x 12% x3/12)................... 1,800,000
Discount on notes payable .................................... 1,800,000
Brief Exercise 133
a.
December 31
$100,000 x 12% x6/12= $6,000
b.September 30
$100,000 x 12% x3/12= $3,000
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The McGraw-Hill Companies, Inc., 2013
1310 Intermediate Accounting, 7e
Brief Exercise 134
Cash(difference).......................................................... 11,190,000Discount on notes payable ($12,000,000 x 9% x9/12) ..... 810,000
Notes payable(face amount).................................... 12,000,000
Interest expense ........................................................ 810,000Discount on notes payable........................................... 810,000
Notes payable(face amount)........................................ 12,000,000Cash ....................................................................... 12,000,000
Brief Exercise 135
Cash(difference).......................................................... 9,550,000Discount on notes payable ($10,000,000 x 6% x9/12) ..... 450,000
Notes payable(face amount).................................... 10,000,000
Effective interest rate:
Discount ($10,000,000 x 6% x9
/12) $ 450,000Cash proceeds $9,550,000Interest rate for 9 months 4.712%
x 12/9
___________Annual effective rate 6.3%
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The McGraw-Hill Companies, Inc., 2013
Solutions Manual, Vol.2, Chapter 13 1311
Brief Exercise 136
December 12Cash ....................................................................... 24,000
Liabilitycustomer advance............................ 24,000
January 16Cash ....................................................................... 216,000Liabilitycustomer advance................................ 24,000
Sales revenue ..................................................... 240,000
Brief Exercise 137
In 2013 Lizzie would recognize $11,500 of revenue ($4,000 + 3,000 + 2,500 +2,000). In 2014 Lizzie would recognize the remainder of $6,500 ($18,000 11,500), either because gift cards were redeemed (the $1,000 in January and the$500 in February) or because they are viewed as expired.
Brief Exercise 138
Accounts receivable .............................................. 645,000Sales revenue .................................................... 600,000Sales taxes payable([6% + 1.5%] x $600,000)....... 45,000
Brief Exercise 139
1. Current liabilityThe requirement to classify currently maturing debt as a current liabilityincludes debt that is callable, or due on demand, by the creditorin the upcoming year even ifthe debt is not expected to be called.
2 Long-term liabilityThe current liability classification includes (a) situations in which the
creditor has the right to demand payment because an existing violation of a provision of the debtagreement makes it callable and (b) situations in which debt is not yet callable, but will becallable within the year if an existing violation is not corrected within a specified graceperiodunless it'sprobablethe violation will be corrected within the grace period. In this casethe existing violation is expected to be corrected within six months.
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The McGraw-Hill Companies, Inc., 2013
1312 Intermediate Accounting, 7e
Brief Exercise 1310
Under U.S. GAAP, the debt would be classified as long-term for both completiondates, as what is key is that the refinancing be completed before the financialstatements are issued.
Brief Exercise 1311
Under IFRS, the debt would be classified as long-term if the refinancing wascompleted by December 15, 2013, but not if completed by January 15, 2014,
because for IFRS what is key is that the refinancing be completed by the balancesheet date.
Brief Exercise 1312
This is a loss contingency and the estimated warranty liability is credited andwarranty expense is debited in the period in which the products under warranty
are sold. Right will report a liability of $130,000:
Warranty Liability_________________________________________
150,000 Warranty expense(1% x $15,000,000)Actual expenditures 20,000
130,000 Balance
Brief Exercise 1313
This is a loss contingency and should be accrued because it is both probable thatthe confirming event will occur and the amount can be at least reasonablyestimated. Goo Goo should report a $5.5 million loss in its income statement anda $5.5 million liability in its balance sheet
Lossproduct recall ....................................................... 5,500,000Liabilityproduct recall .......................................... 5,500,000
A disclosure note also is appropriate.
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The McGraw-Hill Companies, Inc., 2013
Solutions Manual, Vol.2, Chapter 13 1313
Brief Exercise 1314
This is a gain contingency. Gain contingencies are not accrued even if the gain isprobable and reasonably estimable. The gain should be recognized only whenrealized. A carefully worded disclosure note is appropriate.
Brief Exercise 1315
This is a loss contingency. A liability should be accruedif it is bothprobablethatthe confirming event will occur and the amount can be at least reasonablyestimated. If one or both of these criteria is not met (as in this case), but there is atleast a reasonable possibility that the loss will occur, a disclosure note shoulddescribe the contingency. Thats what Bell should do here.
Brief Exercise 1316
Only the third situations costs should be accrued. A liability should be accruedfor a loss contingency if it is both probablethat the confirming event will occurand the amount can be at least reasonably estimated. If one or both of thesecriteria is not met, but there is at least a reasonable possibility that the loss willoccur, a disclosure note should describe the contingency. Both criteria are metonly for the warranty costs.
Brief Exercise 1317
Under U.S. GAAP, no liability would be recognized, because a 51% chance is lessthan the level of probability typically associated with probable in the UnitedStates. A liability would be accrued under IFRS, as 51% is clearly more likelythan not. If a liability were accrued under U.S. GAAP, it would be for $10million, the low end of the range, but under IFRS it would be for $15 million, themidpoint of the range.
Brief Exercise 1318
No disclosure is required because an EPA claim is not yet asserted, and an
assessment is notprobable. Even if an unfavorable outcome is thought to beprobable in the event of an assessment and the amount is estimable, disclosure isnot required unless an unasserted claim is probable.
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The McGraw-Hill Companies, Inc., 2013
1314 Intermediate Accounting, 7e
EXERCISES
Exercise 131
Requirement 1
Cash ................................................................ 16,000,000Notes payable .............................................. 16,000,000
Requirement 2
Interest expense($16,000,000 x 12% x2/12)........ 320,000
Interest payable............................................ 320,000
Requirement 3
Interest expense($16,000,000 x 12% x7/12)........ 1,120,000
Interest payable (from adjusting entry)................ 320,000Notes payable(face amount).............................. 16,000,000
Cash(total).................................................... 17,440,000
Exercise 1321. Interest rate Fiscal year-end
12% December 31
$400 million x 12% x6/12= $24 million2. Interest rate Fiscal year-end
10% September 30
$400 million x 10% x3/12= $10 million3. Interest rate Fiscal year-end
9% October 31$400 million x 9% x4/12= $12 million
4. Interest rate Fiscal year-end6% January 31
$400 million x 6% x7/12= $14 million
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The McGraw-Hill Companies, Inc., 2013
Solutions Manual, Vol.2, Chapter 13 1315
Exercise 133
2013
Jan. 13 No entry is made for a line of credit until a loan actually is made. Itwould be described in a disclosure note.
Feb. 1Cash .......................................................................... 5,000,000
Notes payable ........................................................ 5,000,000
May 1Interest expense($5,000,000 x 10% x3/12).................... 125,000
Notes payable(face amount)........................................ 5,000,000
Cash($5,000,000 + 125,000)...................................... 5,125,000
Dec. 1Cash(difference).......................................................... 9,325,000Discount on notes payable ($10,000,000 x 9% x9/12) ..... 675,000
Notes payable(face amount).................................... 10,000,000
Dec. 31
The effective interest rate is 9.6515% ($675,000 $9,325,000) x 12/9. So,
properly, interest should be recorded at that rate times the outstanding balance
times one-twelfth of a year:
Interest expense($9,325,000 x 9.6515% x1/12).............. 75,000
Discount on notes payable .................................... 75,000
However the same results are achieved if interest is recorded at the discountrate times the maturity amount times one-twelfth of a year:
Interest expense($10,000,000 x 9% x1/12).................... 75,000
Discount on notes payable .................................... 75,000
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The McGraw-Hill Companies, Inc., 2013
1316 Intermediate Accounting, 7e
Exercise 133 (concluded)
2014
Sept. 1Interest expense($10,000,000 x 9% x8/12)*.................. 600,000
Discount on notes payable ................................... 600,000
Notes payable(balance).............................................. 10,000,000Cash(maturity amount)............................................. 10,000,000
* or, ($9,325,000 x 9.6515% x8/12) = $600,000
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The McGraw-Hill Companies, Inc., 2013
Solutions Manual, Vol.2, Chapter 13 1317
Exercise 134
Wages expense (increases wages expense to $410,000)........... 6,000Liabilitycompensated future absences .................... 6,000*
* ($404,000 4,000] = $400,000 non-vacation wages
x 1/40 = $10,000 vacation pay earned
(4,000) vacation pay taken= $ 6,000 vacation pay carried over
Exercise 135
Requirement 1
Wages expense (700 x $900) .............................................. 630,000Liabilitycompensated future absences ............ 630,000
Requirement 2
Liabilitycompensated future absences ................. 630,000Wages expense ($31 million + [5% x $630,000]) .............. 31,031,500
Cash (or wages payable) (total)............................. 31,661,500
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The McGraw-Hill Companies, Inc., 2013
1318 Intermediate Accounting, 7e
Exercise 136
Requirement 1
Cash ............................................................................ 5,200Liabilitygift certificates...................................... 5,200
Cash ($2,100 + 84 1,300)............................................. 884Liabilitygift certificates ......................................... 1,300
Sales revenue .......................................................... 2,100Sales taxes payable(4% x $2,100)............................. 84
Requirement 2
Gift certificatessold $5,200
Gift certificatesredeemed (1,300)Liability to be reported at December 31 $3,900
Requirement 3
The sales tax liability is a current liability because it is payable in January.
The liability for gift certificates is part current and part noncurrent:
Gift certificatessold $5,200
x 80%
Estimated current liability $4,160
Gift certificatesredeemed (1,300)
Current liability at December 31 $2,860
Noncurrent liability at December 31($5,200 x 20%) 1,040
Total $3,900
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The McGraw-Hill Companies, Inc., 2013
Solutions Manual, Vol.2, Chapter 13 1319
Exercise 137
Requirement 1
Deposits CollectedCash .................................................................. 850,000Liabilityrefundable deposits .................... 850,000
Containers ReturnedLiabilityrefundable deposits........................ 790,000
Cash .............................................................. 790,000
Deposits ForfeitedLiabilityrefundable deposits........................ 35,000
Revenuesale of containers ........................ 35,000
Cost of goods sold ............................................ 35,000Inventory of containers................................ 35,000
Requirement 2
Balance on January 1 $530,000
Deposits received 850,000
Deposits returned (790,000)
Deposits forfeited (35,000)
Balance on December 31 $555,000
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The McGraw-Hill Companies, Inc., 2013
1320 Intermediate Accounting, 7e
Exercise 138
Requirement 1
Cash ........................................................................ 7,500Liabilitycustomer advance ............................ 7,500
Requirement 2
Cash ........................................................................ 25,500Liabilityrefundable deposits ......................... 25,500
Requirement 3
Accounts receivable ............................................... 856,000
Sales revenue..................................................... 800,000Sales taxes payable([5% + 2%] x $800,000).......... 56,000
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The McGraw-Hill Companies, Inc., 2013
Solutions Manual, Vol.2, Chapter 13 1321
Exercise 139
Requirement 1
The entire $10,000 sold in January will be recognized as revenue during2011. $6,000 because of gift card redemption; $4,000 because of gift cardbreakage.
Requirement 2
January Gift Card SalesCash .................................................................. 10,000
Liabilityunearned gift card revenue ......... 10,000
Redemption of January Gift CardsLiabilityunearned gift card revenue ............ 6,000
Revenuegift cards ..................................... 6,000
Expiration of January Gift CardsLiabilityunearned gift card revenue ............ 4,000
Revenuegift cards ..................................... 4,000
Requirement 3
Of the $16,000 sold in March, $10,000 will be recognized as revenue:
$4,000 because of gift card redemption; $6,000 of the remaining $12,000because of gift card expiration. To calculate the amount of gift cardbreakage, consider that, if March sales all occurred on the first day of themonth, all would have been outstanding for 10 months during 2013 andtherefore all $12,000 of nonredeemed gift cards would be viewed asexpired. On the other hand, if March sales all occurred on the last day ofthe month, none would have been outstanding for 10 months during 2013and therefore none of the $12,000 of nonredeemed gift cards would beviewed as expired. Assuming that sales of gift cards occur on average onMarch 15 gets us to the average of ($12,000 + 0) 2 = $6,000 from giftcard expiration.
Requirement 4
The only liability at 12/31/2013 would be the $6,000 of unexpired March
gift cards (see answer to requirement 3).
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The McGraw-Hill Companies, Inc., 2013
1322 Intermediate Accounting, 7e
Exercise 1310
The FASB Accounting Standards Codification represents the single source of
authoritative U.S. generally accepted accounting principles. The specific citation for
each of the following items is:
1. If it is only reasonably possible that a contingent loss will occur, the
contingent loss should be disclosed:
FASB ACS 45020503: ContingenciesLoss ContingenciesDisclosure
Unrecognized Contingencies.
2. Criteria allowing short-term liabilities expected to be refinanced to be
classified as long-term liabilities:FASB ACS 470104514: DebtOverallOther Presentation MattersIntent
and Ability to Refinance on a Long-Term Basis.
3. Accounting for separately priced extended warranty contracts:
FASB ACS 60520253: Revenue RecognitionServicesRecognition
Separately Priced Extended Warranty and Product Maintenance Contracts.
4. The criteria to determine if an employer must accrue a liability for vacation
pay.FASB ASC 71010251:CompensationGeneralOverallRecognition.
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Solutions Manual, Vol.2, Chapter 13 1323
Exercise 1311Normally, short-term debt (payable within a year) is classified as current liabilities
However, when such debt is to be refinanced on a long-term basis, it may be included
with long-term liabilities. The narrative indicates that Sprint has both (1) the intentand (2) the ability ("existing long-term credit facilities") to refinance on a long-term
basis. Thus, Sprint reported the debt as long-term liabilities.
Exercise 1312
Requirement 1
Normally, IFRS requires that short-term debt (payable within a year) be classified
as current liabilities. However, when such debt is to be refinanced on a long-term
basis, it may be included with long-term liabilities. The narrative indicates that Sprint
has both (1) the intent and (2) the ability ("existing long-term credit facilities") to
refinance on a long-term basis. Thus, Sprint reported the debt as long-term liabilities.
Requirement 2
IFRS requires that the refinancing capability be in place as of the balance sheet
date. Therefore, given that the refinancing was not arranged until after year-end, IFRS
would require that the debt be classified as a current liability.
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The McGraw-Hill Companies, Inc., 2013
1324 Intermediate Accounting, 7e
Exercise 1313
1. Current liability: $10 millionThe requirement to classify currently maturing debt as a current liability
includes debt that is callable by the creditor in the upcoming yeareven if thedebt is not expected to be called.
2. Noncurrent liability: $14 millionThe current liability classification includes (a) situations in which the creditorhas the right to demand payment because an existing violation of a provision ofthe debt agreement makes it callable and (b) situations in which debt is not yetcallable, but will be callable within the year if an existing violation is notcorrected within a specified grace periodunless it's probable the violationwill be corrected within the grace period. In this case, the existing violation is
expected to be corrected within six months.
3. Current liability: $7 millionThe debt should be reported as a current liability because it is payable in theupcoming year, will not be refinanced with long-term obligations, and will not
be paid with a bond sinking fund.
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Solutions Manual, Vol.2, Chapter 13 1325
Exercise 1314
Requirement 1
The specific citation that specifies the guidelines for accruing loss contingencies isFASB ACS 45020252: ContingenciesLoss ContingenciesRecognitionGeneralRule.
Requirement 2
Specifically, the guidelines are that an estimated loss from a loss contingency beaccrued by a charge to income if both of the following conditions are met:
a.
Information available prior to issuance of the financial statements indicates thatit is probable that an asset had been impaired or a liability had been incurred atthe date of the financial statements.
b. The amount of loss can be reasonably estimated.
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The McGraw-Hill Companies, Inc., 2013
1326 Intermediate Accounting, 7e
Exercise 1315
Requirement 1
This is a loss contingency. There may be a future sacrifice of economic
benefits (cost of satisfying the warranty) due to an existing circumstance (thewarranted awnings have been sold) that depends on an uncertain future event
(customer claims).
The liability is probable because product warranties inevitably entail costs. A
reasonably accurate estimate of the total liability for a period is possible based
on prior experience. So, the contingent liability for the warranty is accrued.
The estimated warranty liability is credited and warranty expense is debited in
2013, the period in which the products under warranty are sold.
Requirement 2
2013 SalesAccounts receivable ............................................ 5,000,000
Sales................................................................ 5,000,000
Accrued liability and expenseWarranty expense (3% x $5,000,000) ......................... 150,000
Estimated warranty liability ........................... 150,000
Actual expendituresEstimated warranty liability ............................... 37,500
Cash, wages payable, parts and supplies, etc. 37,500
Requirement 3
Warranty Liability_________________________________________
150,000 Estimated liability
Actual expenditures 37,500
112,500 Balance
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The McGraw-Hill Companies, Inc., 2013
Solutions Manual, Vol.2, Chapter 13 1327
Exercise 1316
Requirement 1
This is not a loss contingency. An extended warranty is priced and sold
separately from the warranted product and therefore essentially constitutes aseparate sales transaction. Since the earning process for an extended
warranty continues during the contract period, revenue should be recognized
over the same period. Revenue from separately priced extended warranty
contracts are deferred as a liability at the time of sale, and recognized over
the contract period on a straight-line basis.
Requirement 2
During the yearAccounts receivable ............................................. 412,000Unearned revenueextended warranties........ 412,000
December 31 (adjusting entry)Unearned revenueextended warranties............ 57,937.50
Revenueextended warranties*...................... 57,937.50
* If warranties don't earn any revenue for 90 days (after the free
warranty expires), then only sales up until 9/30 can earn any revenue,with sales on 1/1 earning nine months worth of revenue, and sales on9/30 earning one day of revenue. If sales proceed smoothly during theyear, we can assume that, as of 9/30, they have made $412,000(.75) =$309,000 of sales. So, during that nine-month period, the $309,000 isoutstanding an average of 4.5 months, and so should earn 4.5 24 x$309,000 of revenue, or $57,937.50.
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The McGraw-Hill Companies, Inc., 2013
1328 Intermediate Accounting, 7e
Exercise 1317
Requirement 1
This is a loss contingency. A liability is accrued if it is both probable that theconfirming event will occur and the amount can be at least reasonably estimated. Ifone or both of these criteria is not met, but there is at least a reasonable possibility thatthe loss will occur, a disclosure noteshould describe the contingency. In this case, aliability is accruedsince both of these criteria are met.
Requirement 2
Loss:
$2 million
Requirement 3
Liability:
$2 million
Requirement 4
Lossproduct recall ............................................................... 2,000,000
Liabilityproduct recall .......................................... 2,000,000
A disclosure note also is appropriate.
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Solutions Manual, Vol.2, Chapter 13 1329
Exercise 1318
Requirement 1This is a loss contingency. Some loss contingencies dont involve liabilities at
all. Some contingencies when resolved cause a noncash asset to be impaired, soaccruing it means reducing the related asset rather than recording a liability. The mostcommon loss contingency of this type is an uncollectible receivable, as described inthis situation.
Requirement 2
Bad debt expense: 3% x $2,400,000 = $72,000
Requirement 3
Bad debt expense (3% x $2,400,000) ................................. 72,000Allowance for uncollectible accounts .................. 72,000
Requirement 4
Allowance for uncollectible accounts:Beginning of 2013 $75,000Write off of bad debts* 73,000Credit balance before accrual 2,000Year-end accrual (Req. 3) 72,000
End of 2013 $74,000
* Allowance for uncollectible accounts........................ 73,000Accounts receivable.......................................... 73,000
Net realizable value:Accounts receivable $490,000Less: Allowance for uncollectible accounts (74,000)
Net realizable value $416,000
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The McGraw-Hill Companies, Inc., 2013
1330 Intermediate Accounting, 7e
Exercise 1319
Requirement 1
Promotional expense:
70% x $5 x 20,000 = $70,000
Requirement 2
Premium liability:
$70,000 22,000 = $48,000
Requirement 3
Promotional expense ([70% x $5 x 20,000] $22,000) ....... 48,000Estimated premium liability.................................... 48,000
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Solutions Manual, Vol.2, Chapter 13 1331
Exercise 1320
Scenario 1
No disclosure is required because an EPA claim is as yet unasserted, and anassessment is notprobable.
Scenario 2
No disclosure is required because an EPA claim is as yet unasserted, and anassessment is notprobable. Even if an unfavorable outcome is thought to be
probable in the event of an assessment and the amount is estimable, disclosure isnot required unless an unasserted claim is probable.
Scenario 3
A disclosure note is required because an EPA claim is as yet unasserted, but anassessment is probable. Since an unfavorable outcome is not thought to be
probable in the event of an assessment, no accrual is needed, but since anunfavorable outcome is thought to be reasonably possible in the event of anassessment, disclosure in a footnote is required. Keep in mind, though, that in
practice, disclosure of an unasserted claim is rare. Such disclosure would alert theother party, the EPA in this case, of a potential point of contention that mayotherwise not surface. The outcome of litigation and any resulting loss are highly
uncertain, making difficult the determination of their possibility of occurrence.Scenario 4
Accrual of the loss is required because an EPA claim is as yet unasserted, but anassessment is probable. Since an unfavorable outcome also is thought to be
probablein the event of an assessment, accrual is needed. Keep in mind, though,that in practice, accrual of an unasserted claim is rare. Such disclosure would alertthe other party, the EPA in this case, of a potential point of contention that mayotherwise not surface. Accrual could be offered in court as an admission ofresponsibility. A loss usually is not recorded until after the ultimate settlement
has been reached or negotiations for settlement are substantially completed.
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The McGraw-Hill Companies, Inc., 2013
1332 Intermediate Accounting, 7e
Exercise 1321
Requirement 1
Warranty expense ([4% x $2,000,000] $30,800) ............. 49,200Estimated warranty liability .................................. 49,200
Requirement 2
Bad debt expense (2% x $2,000,000) ................................. 40,000Allowance for uncollectible accounts ................... 40,000
Requirement 3
This is a loss contingency. Classical can use the information occurring after
the end of the year and before the financial statements are issued to determineappropriate disclosure.
Losslitigation ......................................................... 1,500,000Liabilitylitigation ............................................... 1,500,000
A disclosure note also is appropriate.
Requirement 4
This is a gain contingency. Gain contingencies are not accrued even if thegain is probable and reasonably estimable. The gain should be recognized onlywhen realized. A disclosure note is appropriate.
Requirement 5
Lossproduct recall .................................................... 500,000Liabilityproduct recall .......................................... 500,000
A disclosure note also is appropriate.
Requirement 6
Promotional expense ([60% x $25 x 10,000] $105,000) ... 45,000Estimated premium liability.................................... 45,000
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Solutions Manual, Vol.2, Chapter 13 1333
Exercise 1322
Requirement 1
Erismus would recognize a liability of $1,000,000, as IFRS definesprobable as more likely than not (> 50%), and they are more likely thannot to lose in court.
Requirement 2
Erismus would recognize a liability of $3,000,000, as they are more likelythan not to lose in court, and IFRS requires that they take the midpoint of therange of equally likely outcomes.
Requirement 3
Erismus would recognize a liability of $3,500,000, as they are more likelythan not to lose in court, and IFRS requires that they take the present value offuture outcomes if time-value-of-money effects are material.
Requirement 4
This is a gain contingency. Gain contingencies are not accrued under IFRSwhen the gain is probable and reasonably estimable. The gain should berecognized only when realized. A disclosure note is appropriate.
Requirement 5
This is a gain contingency. Gain contingencies are accrued under IFRSwhen the gain is virtually certain and reasonably estimable. Erismus wouldrecognize a gain of $500,000, recorded at present value if the time value ofmoney is material.
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The McGraw-Hill Companies, Inc., 2013
1334 Intermediate Accounting, 7e
Exercise 1323
Item Reporting Method
__C_ 1. Commercial paper. N. Not reported__D_ 2. Noncommitted line of credit. C. Current liability__C_ 3. Customer advances. L. Long-term liability__C_ 4. Estimated warranty cost. D. Disclosure note only__C_ 5. Accounts payable. A. Asset__C_ 6. Long-term bonds that will be callable by the creditor in the upcoming
year unless an existing violation is not corrected (there is a reasonablepossibility the violation will be corrected within the grace period).
__C_ 7. Note due March 3, 2014.__C_ 8. Interest accrued on note, Dec. 31, 2013.__L_ 9. Short-term bank loan to be paid with proceeds of sale of common stock.__D_ 10. A determinable gain that is contingent on a future event that appears
extremely likely to occur in three months.__C_ 11. Unasserted assessment of back taxes that probably will be asserted, in
which case there would probably be a lossin six months.__N_ 12. Unasserted assessment of back taxes with a reasonable possibility of
being asserted, in which case there would probably be a loss in 13months.
__C_ 13. A determinable loss from a past event that is contingent on a future event
that appears extremely likely to occur in three months.__A_ 14. Bond sinking fund.__C_ 15. Long-term bonds callable by the creditor in the upcoming year that are
not expected to be called.
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The McGraw-Hill Companies, Inc., 2013
Solutions Manual, Vol.2, Chapter 13 1335
Exercise 1324
Requirement 1
Accrued liability and expenseWarranty expense (3% x $3,600,000) ............................................... 108,000
Estimated warranty liability............................................... 108,000
Actual expenditures (summary entry)Estimated warranty liability................................................... 88,000
Cash, wages payable, parts and supplies, etc. ................... 88,000
Requirement 2
Actual expenditures (summary entry)Estimated warranty liability ($50,000 23,000)....................... 27,000Loss on product warranty (3% 2%] x $2,500,000)................... 25,000
Cash, wages payable, parts and supplies, etc. ................... 52,000*
*(3% x $2,500,000) $23,000 = $52,000
Exercise 1325
1. This is a change in estimate.
To revise the liability on the basis of the new estimate:Liabilitylitigation ($1,000,000 600,000).................. 400,000
Gainlitigation ...................................................... 400,000
2. A disclosure note should describe the effect of a change in estimate on incomebefore extraordinary items, net income, and related per-share amounts for thecurrent period.
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The McGraw-Hill Companies, Inc., 2013
1336 Intermediate Accounting, 7e
Exercise 1326
The note describes a loss contingency. Dow anticipates a future sacrifice of
economic benefits (cost of remediation and restoration) due to an existing
circumstance (environmental violations) that depends on an uncertain future event
(requirement to pay claim).
Dow considers the liability probable and the amount is reasonably estimable.
As a result, the company accrued the liability:
($ in millions)
Loss provision from environmental claims..................... 607Liability for settlement of environmental claims.... 607
In practice this liability would be accrued in multiple entries, increasing when Dowrecognized additional liability and decreasing either when Dow paid off parts of theliability or revised downward their estimate of remediation and restoration costs.
Exercise 1327
Salaries and wages expense (total amount earned) ..... 500,000Withholding taxes payable(federal income tax)... 100,000
Social security taxes payable($500,000 x 6.2%)
.. 31,000Medicare taxes payable($500,000 x 1.45%)......... 7,250Salaries and wages payable(net pay) ................. 361,750
Payroll tax expense (total)...................................... 68,250Social security taxes payable(employers matching amount) 31,000Medicare taxes payable(employers matching amount) 7,250Federal unemployment tax payable($500,000 x 0.6%) 3,000State unemployment taxpayable($500,000 x 5.4%) 27,000
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Solutions Manual, Vol.2, Chapter 13 1337
CPA / CMA REVIEW QUESTIONS
CPA Exam Questions
1. d. The accrued interest at end of the first year, February 28, 2013, is $1,200($10,000 x 12% = $1,200). The interest for the remaining ten months iscompounded based on the carrying amount of the total liability at February28, 2011, $11,200 ($10,000 principal plus the $1,200 accrued interest).Therefore, the interest is $11,200 x 12% x 10/12= $1,120 for the last tenmonths. The accrued interest liability at December 31, 2013, would be thetotal interest for the two time periods, $1,200 + 1,120 = $2,320.
2. a. The liability for compensated absences at December 31, 2013, is $15,000
for the 150 vacation days times $100 per day. The key word in dealing withsick pay is the word required. The problem asks what is the liabilityrequiredat December 31, 2013. Since the accrual of sick pay is optional,
North Corp. would not be requiredto accrue a liability for sick pay.
3. a. The amount excluded from current liabilities through refinancing cannotexceed the amount actually refinanced. Therefore, Largo should considerthe $500,000 paid by the refinancing to be a long-term liability and the$250,000 a current liability on the December 31, 2013, balance sheet. The
refinancing was completed before the issuance of the financial statementsand meets both criteria (intent and financial ability) for the classification ofthe $500,000 as a long-term liability.
4. a. Gain contingencies should not be recognized in the financial statementsuntil realized. Adequate disclosure should be made in the notes but careshould be taken to avoid misleading implications as to the likelihood ofrealization of the contingent gain.
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The McGraw-Hill Companies, Inc., 2013
1338 Intermediate Accounting, 7e
CPA Exam Questions (concluded)
5. a.
Packages of candy sold 110,000
Times expected redemption rate ! 60 %Equals protected coupons returned 66,000Divided by coupons required for each toy 5 couponsEquals expected toys to be mailed = 13,200
Times net cost per toy ($.80 .50) ! .30
Liability on balance sheet at December 31, 2013 $3,960
6. d.
2013 and 2014 sales = $ 400,000Warranty % 6 %2013 and 2014 allowance $ 24,000Actual expenditure (9,750)12/31/14 remaining liability $ 14,250
7. a. Under IFRS, contingent liabilities (called provisions) are accrued if theprobability of payment is more likely than not, defined as a probability ofgreater than 50%.
8. a. Under IFRS, contingent assets are accrued if they are virtually certain tooccur.
9. c. Under IFRS, contingent liabilities (called provisions) are accrued equal tothe expected value of a range of equally likely amounts. In this case, $15million is the expected value of the range of $10 million to $20 million.
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Solutions Manual, Vol.2, Chapter 13 1339
CMA Exam Questions
1.
b. If an enterprise intends to refinance short-term obligations on a long-term
basis and demonstrates an ability to consummate the refinancing, theobligations should be excluded from current liabilities and classified asnoncurrent. Under U.S. GAAP the ability to consummate the refinancingmay be demonstrated by a post-balance-sheet-date issuance of a long-termobligation or equity securities, or by entering into a financing agreement.
2. d. There are four requirements that must be met before a liability is accrued forfuture compensated absences. These requirements are that the obligationmust arise for past services, the employee rights must vest or accumulate,
payment is probable, and the amount can be reasonably estimated. If theamount cannot be reasonably estimated, no liability should be recorded.However, the obligation should be disclosed.
3. c. GAAP requires a contingent liability to be recorded, along with the relatedloss, when it is probable that an asset has been impaired or a liability has
been incurred, and the amount of the loss can be reasonably estimated. Thekey words are probable and reasonably estimated.
4. c. The likelihood of contingencies is divided into three categories: probable
(likely to occur), reasonably possible, and remote. When contingent lossesare probable and the amount can be reasonably estimated, the amount of theloss should be charged against income. If the amount cannot be reasonablyestimated but the loss is at least reasonably possible, full disclosure should
be made, including a statement that an estimate cannot be made.
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The McGraw-Hill Companies, Inc., 2013
1340 Intermediate Accounting, 7e
PROBLEMS
Problem 131
Requirement 1
Blanton PlasticsCash ......................................................................... 14,000,000
Notes payable ....................................................... 14,000,000
L & T BankNotes receivable ....................................................... 14,000,000
Cash ..................................................................... 14,000,000
Requirement 2
Adjusting entries (December 31, 2013)
Blanton PlasticsInterest expense($14,000,000 x 12% x3/12)................. 420,000
Interest payable..................................................... 420,000
L & T BankInterest receivable .................................................... 420,000
Interest revenue($14,000,000 x 12% x3/12).............. 420,000
Maturity (January 31, 2014)
Blanton PlasticsInterest expense($14,000,000 x 12% x1/12)................. 140,000
Interest payable (from adjusting entry)......................... 420,000Notes payable(face amount)....................................... 14,000,000
Cash(total)............................................................. 14,560,000
L & T Bank
Cash(total)
................................................................ 14,560,000Interest revenue($14,000,000 x 12% x1/12) ................ 140,000
Interest receivable (from adjusting entry)................. 420,000Notes receivable (face amount)............................... 14,000,000
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Solutions Manual, Vol.2, Chapter 13 1341
Problem 131 (concluded)
Requirement 3
a.
Issuance of note (October 1, 2013)Cash(difference)........................................................ 13,440,000Discount on notes payable ($14,000,000 x 12% x4/12) 560,000
Notes payable (face amount) ......................................... 14,000,000
Adjusting entry (December 31, 2013)Interest expense($14,000,000 x 12% x3/12)................. 420,000
Discount on notes payable ................................... 420,000
Maturity (January 31, 2014)Interest expense($14,000,000 x 12% x1/12)................. 140,000
Discount on notes payable ................................... 140,000
Notes payable(face amount)...................................... 14,000,000Cash..................................................................... 14,000,000
b.
Effective interest rate:Discount ($14,000,000 x 12% x4/12) $ 560,000
Cash proceeds $13,440,000Interest rate for four months 4.1666%
x 12/4
___________Annual effective rate 12.5%
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The McGraw-Hill Companies, Inc., 2013
1342 Intermediate Accounting, 7e
Problem 132
Requirement 1
2013
a. No entry is made for a line of credit until a loan actually is made. Itwould be described in a disclosure note.
b. Cash.................................................................... 12,000,000Notes payable ................................................. 12,000,000
c. Cash ..................................................................... 2,600Liabilityrefundable deposits ..................... 2,600
d. Accounts receivable(total)................................... 4,346,000Sales revenue(given)...................................... 4,100,000Sales taxes payable([3% + 3%] x $4,100,000)... 246,000
e. Interest expense($12,000,000 x 10% x3/12)............ 300,000
Interest payable ............................................. 300,000
2014
f. Cash.................................................................... 10,000,000
Bonds payable ................................................ 10,000,000
Interest expense($12,000,000 x 10% x2/12)............ 200,000
Interest payable (from adjusting entry).................... 300,000Notes payable(face amount).................................. 12,000,000
Cash($12,000,000 + 500,000)............................ 12,500,000
g. Liabilityrefundable deposits .......................... 1,300Cash ............................................................... 1,300
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Solutions Manual, Vol.2, Chapter 13 1343
Problem 132 (concluded)
Requirement 2
CURRENT LIABILITIES:Accounts payable $ 252,000Current portion of bank loan 2,000,000*Liabilityrefundable deposits 2,600Sales taxes payable 246,000Accrued interest payable 300,000
Total current liabilities $2,800,600
LONG-TERM LIABILITIES:Bank loan to be refinanced
on a long-term basis $10,000,000** The intent of management is to refinance all
$12,000,000 of the bank loan, but the actual refinancingdemonstrates the ability only for $10,000,000.
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The McGraw-Hill Companies, Inc., 2013
1344 Intermediate Accounting, 7e
Problem 133
Requirement 1
a. The requirement to classify currently maturing debt as a current liabilityincludes debt that is callable by the creditor in the upcoming yeareven if thedebt is not expected to be called. So, the entire $40 million debt is a currentliability.
b. $5 million can be reported as long term, but $1 million must be reported as acurrent liability. Short-term obligations that are expected to be refinanced withlong-term obligations can be reported as noncurrent liabilities only if the firm(a) intendsto refinance on a long-term basis and (b) actually has demonstratedthe ability to do so. Ability to refinance on a long-term basis can be
demonstrated by either an existing refinancing agreement or by actualfinancing prior to the issuance of the financial statements. The refinancingagreement in this case limits the ability to refinance to $5 million of the notes.In the absence of other evidence of ability to refinance, the remaining $1million cannot be reported as long term.
c. The entire $20 million maturity amount should be reported as a current liabilitybecause that amount is payable in the upcoming year and it will not berefinanced with long-term obligations nor paid with a bond sinking fund.
d. The entire $12 million loan should be reported as a long-term liability becausethat amount is payable in 2019 and it will not be refinanced with long-termobligations or paid with a bond sinking fund. The current liabilityclassification includes (a) situations in which the creditor has the right todemand payment because an existing violation of a provision of the debtagreement makes it callable and (b) situations in which debt is not yet callable,
but will be callable within the year if an existing violation is not correctedwithin a specified grace periodunless it's probable the violation will becorrected within the grace period. Here, the existing violation is expected to becorrected within six months (actually three months in this case).
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Problem 133 (concluded)Requirement 2
December 31, 2013
($ in millions)Current Liabilities
Accounts payable and accruals $ 2210% notes payable due May 2014 1Currently maturing portion of long-term debt:
11% bonds due October 31, 2024,redeemable on October 31, 2014 $40
12% bonds due September 30, 2014 20 60Total Current Liabilities 83
Long-Term DebtCurrently maturing debt classified as long-term:
10% notes payable due May 2014 (Note X) 59% bank loan due October 2019 12Total Long-Term Liabilities 17
Total Liabilities $100
NOTEX:CURRENTLY MATURING DEBT CLASSIFIED AS LONG-TERM
The Company intends to refinance $6 million of 10% notes that mature in May of
2014. In March, 2014, the Company negotiated a line of credit with a commercialbank for up to $5 million any time during 2014. Any borrowings will mature twoyears from the date of borrowing. Accordingly, $5 million was reclassified tolong-term liabilities.
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The McGraw-Hill Companies, Inc., 2013
1346 Intermediate Accounting, 7e
Problem 134
Requirement 1
a. Interest expense($600,000 x 10% x5/12) ...................... 25,000
Interest payable ................................................ 25,000
b. No adjusting entry since interest has been paid up to December 31. $950,000can be reported as a noncurrent liability, because (a) intent and (b) ability torefinance has been demonstrated for that amount.
c. Accounts receivable(to eliminate the credit balance) ... 18,000Advances from customers ................................ 18,000
d. Rent revenue (10/12x $30,000)................................. 25,000
Unearned rent revenue .................................... 25,000
Requirement 2
CURRENT LIABILITIES:Accounts payable $ 35,000Current portion of long-term debt250,000Accrued interest payable 25,000Advances from customers 18,000Unearned rent revenue 25,000
Bank notes payable 600,000Total current liabilities $953,000
LONG-TERM LIABILITIES:Mortgage note payable $950,000
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The McGraw-Hill Companies, Inc., 2013
Solutions Manual, Vol.2, Chapter 13 1347
Problem 135
Requirement 1
B = .10 ($150,000 B T), where B = the bonusT = income tax
T = .30 ($150,000 B)
Requirement 2
Since income tax (T) is a component of both equations, we can combine the twoand then solve for the remaining unknown amount (B):
Substitute value of T for T:
B = .10 [ $150,000 B .30 ($150,000 B)]
Reduce the right-hand side of the equation to one known and one unknown value:
B = .10 ( $150,000 B $45,000 + .30B)
B = .10 ( $105,000 .70B)
B = $10,500 .07B
Add .07B to both sides
1.07B = $10,500
Divide both sides by 1.07
B = $9,813
Requirement 3
Bonus compensation expense ............................. 9,813Accrued bonus compensation payable ........... 9,813
Requirement 4
The approach is the same in any case: (1) express the bonus formula as one ormore algebraic equation(s), (2) use algebra to solve for the amount of the bonus. Forexample, the bonus might specify that the bonus is 10% of the divisions income
before tax,but after the bonus itself:B = .10 ($150,000 B)
B = $15,000 .10B
1.10B = $15,000
B = $13,636
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The McGraw-Hill Companies, Inc., 2013
1348 Intermediate Accounting, 7e
Problem 136
a. This is a loss contingency. Eastern can use the information occurring after the endof the year in determining appropriate disclosure. It is unlikely that Eastern would
choose to accrue the $122 million loss because the judgment will be appealed andthat outcome is uncertain. A disclosure note is appropriate:
_______________________________Note X: ContingencyIn a lawsuit resulting from a dispute with a supplier, a judgment was renderedagainst Eastern Manufacturing Corporation in the amount of $107 million plusinterest, a total of $122 million at February 3, 2014. Eastern plans to appeal the
judgment. While management and legal counsel are presently unable to predict theoutcome or to estimate the amount of any liability the company may have with
respect to this lawsuit, it is not expected that this matter will have a materialadverse effect on the company.
b. This is a loss contingency. Eastern can use the information occurring after the endof the year in determining appropriate disclosure. Eastern should accrue the $140million loss because the ultimate outcome appears settled and the loss is probable.
Losslitigation ........................................... 140,000,000Liabilitylitigation ................................. 140,000,000
A disclosure note also is appropriate:
_________________________________Notes: LitigationIn November 2012, the State of Nevada filed suit against the Company, seekingcivil penalties and injunctive relief for violations of environmental laws regulatinghazardous waste. On January 12, 2014, the Company announced that it hadreached a settlement with state authorities on this matter. Based upon discussions
with legal counsel, the Company has accrued and charged to operations in 2013,$140 million to cover the anticipated cost of all violations. The Company believesthat the ultimate settlement of this claim will not have a material adverse effect onthe Company's financial position.
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The McGraw-Hill Companies, Inc., 2013
Solutions Manual, Vol.2, Chapter 13 1349
Problem 136 (concluded)
c. This is a gain contingency. Gain contingencies are not accrued even if the gain isprobable and reasonably estimable. The gain should be recognized only when
realized.Though gain contingencies are not recorded in the accounts, they should bedisclosed in notes to the financial statements.
_______________________________Note X: ContingencyEastern is the plaintiff in a pending lawsuit filed against United Steel for damagesdue to lost profits from rejected contracts and for unpaid receivables. The case isin final appeal. No amount has been accrued in the financial statements for
possible collection of any claims in this litigation.
d.No disclosure is required because an EPA claim is as yet unasserted, and anassessment is not probable. Even if an unfavorable outcome is thought to be
probable in the event of an assessment and the amount is estimable, disclosure isnot required unless an unasserted claim is probable.
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The McGraw-Hill Companies, Inc., 2013
1350 Intermediate Accounting, 7e
Problem 137
Requirement 1
Item (a): Because the loss is probable and can be reasonably estimated,HW would be required to accrue a liability under both U.S. GAAP andIFRS, but the amount of the liability would differ between the two. UnderU.S. GAAP, the liability would be for $5,000,000, the low end of therange, while under IFRS the liability would be for $7,500,000, themidpoint of the range.
Item (b): Under IFRS, present values would be used, so the relevantmidpoint of the range that would be accrued as a liability would be$5,500,000. Under U.S. GAAP, present values would not be used given
the uncertain timing of cash flows, so HW would still use the lower end ofthe undiscounted range, or $5,000,000.
Item (c): This item is only probable according to IFRSs use of the term, soit would only be accrued as a liability under IFRS, for the midpoint of therange ($6,000,000).
Item (d): This item would be classified as long-term under U.S. GAAP, butshort-term under IFRS, given that the financing was obtained prior tofinancial statement issuance but not before the balance sheet date.
Requirement 2
Total liabilities under U.S. GAAP equal $5,000,000 + 5,000,000 + 0 +10,000,000 = $20,000,000.
Total liabilities under IFRS equal $7,500,000 + 5,500,000 + 6,000,000 +10,000,000 = $29,000,000.
In this case, U.S. GAAP provides the lower total liabilities.
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The McGraw-Hill Companies, Inc., 2013
Solutions Manual, Vol.2, Chapter 13 1351
Problem 138
Requirement 1
Heinrich would record a contingent liability (and loss) of $27,619,020, calculated asfollows:
$40,000,000 x 20% = $ 8,000,00030,000,000 x 50% = 15,000,00020,000,000 x 30% = 6,000,000
$29,000,000
x .95238*
$27,619,020
*Present value of $1, n= 1, i= 5% (from Table 6A-2)
Requirement 2
Lossproduct recall 27,619,020Liabilityproduct recall 27,619,020
Requirement 3
The difference between $29,000,000 and the initial value of the liability of
$27,619,020 represents interest expense, which Heinrich will accrue during 2012 asfollows:
Interest expense 1,380,980Liabilityproduct recall 1,380,980
Requirement 4
Interest increases the liability to $29 million at the end of 2014. Since there is adifference between the actual costs, $30 million, and the $29 million liabilityHeinrich will record an additional loss.
Liabilityproduct recall 29,000,000Lossproduct recall 1,000,000
Cash 30,000,000
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The McGraw-Hill Companies, Inc., 2013
1352 Intermediate Accounting, 7e
Problem 138 (concluded)
Requirement 5
By the traditional approach, Heinrich would accrue the most likely amount, $30
million:
Lossproduct recall 30,000,000Liabilityproduct recall 30,000,000
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The McGraw-Hill Companies, Inc., 2013
Solutions Manual, Vol.2, Chapter 13 1353
Problem 139Case 1
Note Only. When a contingency comes into existence after the year-end, a liability
cannot be accrued because it didnt exist at the end of the year. However, if theloss is probable and can be estimated, the situation should be described in a
disclosure note.
Case 2
Note Only. Since an unasserted claim or assessment is probable, the likelihood of
an unfavorable outcome and the feasibility of estimating a dollar amount should
be considered in deciding whether and how to report the possible loss. An
estimated loss and contingent liability cannot be accrued since an unfavorable
outcome is only reasonably possible even though the amount can be reasonably
estimated.
Case 3
Accrual and Disclosure Note. When the cause of a loss contingency occurs before
the year-end, a clarifying event before financial statements are issued can be used
to determine how the contingency is reported. Even though the loss was not
probable at year-end, it becomes so before financial statements are issued. The
situation also should be described in a disclosure note.
Case 4
No Disclosure. Even though the cause of the contingency occurred before year-end
Lincoln is unaware of the loss contingency when the financial statements are
issued.
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The McGraw-Hill Companies, Inc., 2013
1354 Intermediate Accounting, 7e
Problem 1310
Requirement 1
Portion of the notes payable notrefinancedon a long-term basis through the stock sale .................. $3,000,000
Liability for the payment of employees medical bills ... 75,000Total .............................................................................. $3,075,000
Normally, short-term debt (payable within a year) is classified as current
liabilities. However, when such debt is to be refinanced on a long-term basis, it
may be included with long-term liabilities. The narrative indicates that Rushingrefinanced $9 million of the notes payable on a long-term basis. Thus, Rushing
should report that amount among long-term liabilities. The remaining $3 million
was a current liability at Dec. 31.
The $75,000 payment of the employees medical bills is a loss contingency as
of Dec. 31. Rushing can use the information occurring after the end of the year
and before the financial statements are issued (the settlement) to determine
appropriate disclosure. That information confirms that payment was probable
(certain) and the amount can be at least reasonably estimated (known).
A disclosure note also is appropriate.
Requirement 2
Portion of the notes payable refinancedon a long-term basis through the stock sale .................. $9,000,000
Normally, short-term debt (payable within a year) is classified as current
liabilities. However, when such debt is to be refinanced on a long-term basis, itmay be included with long-term liabilities. The narrative indicates that Rushing
refinanced $9 million of the notes payable on a long-term basis. Thus, Rushing
should report that amount among long-term liabilities.
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The McGraw-Hill Companies, Inc., 2013
Solutions Manual, Vol.2, Chapter 13 1355
Problem 1310 (concluded)
Requirement 3
If the settlement agreement had occurred on March 15, 2014, instead, the$75,000 payment of the employees medical bills would not have been accrued as
either a current or long-term liability because that payment had not been
determined to be probable as of the publication of the financial statements.
Requirement 4
If the work-site injury had occurred on January 3, 2014, instead, the $75,000
payment of the employees medical bills would not have been accrued as either acurrent or long-term liability because the cause of the liability had not occurred as
of Dec. 31, 2013. Thus, the liability did not exist as of that date.
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The McGraw-Hill Companies, Inc., 2013
1356 Intermediate Accounting, 7e
Problem 1311
List A List Bj_ 1. Face amount x Interest rate x Time a. Informal agreement
g 2. Payable with current assets b. Secured loanh 3. Short-term debt to be refinanced c. Refinancing prior to the issuance
with common stock of thefinancial statementsi_ 4. Present value of interest plus d. Accounts payable
present value of principal e. Accrued liabilitiesd 5. Noninterest-bearing f. Commercial papera 6. Noncommitted line of credit g. Current liabilities
b_ 7. Pledged accounts receivable h. Long-term liabilityc_ 8. Reclassification of debt i. Usual valuation of liabilitiesf_ 9. Purchased by other corporations j. Interest on debte_ 10. Expenses not yet paid k. Customer advancesl_ 11. Liability until refunded l. Customer depositsk_ 12. Applied against purchase price
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The McGraw-Hill Companies, Inc., 2013
Solutions Manual, Vol.2, Chapter 13 1357
Problem 1312
Requirement 1
The requirement to classify currently maturing debt as a current liability includesdebt that is callable by the creditor in the upcoming yeareven if the debt is notexpected to be called. So, the entire $90 million debt is a current liability.
Requirement 2
The entire $30 million loan should be reported as a long-term liability because thatamount is payable in 2019. The current liability classification includes (a) situationsin which the creditor has the right to demand payment because an existing violation ofa provision of the debt agreement makes it callable and (b) situations in which debt is
not yet callable, but will be callable within the year if an existing violation is notcorrected within a specified grace periodunless it's probable the violation will becorrected within the grace period. Here, the existing violation is expected to becorrected within six months (actually six weeks in this case).
Requirement 3
The intent of management is to refinance all $45,000,000 of the 7% notes, but therefinancing agreement demonstrates the ability only for $40,000,000. $40 million can
be reported as long term, but $5 million must be reported as a current liability. Short-
term obligations that are expected to be refinanced with long-term obligations can bereported as noncurrent liabilities only if the firm (a) intends to refinance on a long-term basis and (b) actually has demonstrated the abilityto do so. Ability to refinanceon a long-term basis can be demonstrated by either an existing refinancing agreementor by actual financing prior to the issuance of the financial statements. Therefinancing agreement in this case limits the ability to refinance to $40 million of thenotes. In the absence of other evidence of ability to refinance, the remaining $5million cannot be reported as long term.
Requirement 4
The lawsuit resulting from a dispute with a food caterer should not be accrued.The suit is in appeal and it is not deemed probable that that transit will lose the appeal.
Note disclosure is required.
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The McGraw-Hill Companies, Inc., 2013
1358 Intermediate Accounting, 7e
Problem 1312 (continued)
Requirement 5
December 31, 2013($ in millions)
Current LiabilitiesAccounts payable and accruals $ 436.5% bonds maturing on July 31, 2022, callable July 31, 2014 90Current portion of 7% notes payable due May 2014 5
Total Current Liabilities 138
Long-Term Debt8% bank loan payable on October 31, 2019 30
Currently maturing debt classified as long-term:7% notes payable due May 2014 (Note X) 40
Total Long-Term Liabilities 70 Total Liabilities $208
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The McGraw-Hill Companies, Inc., 2013
Solutions Manual, Vol.2, Chapter 13 1359
Problem 1312 (continued)
Requirement 6
NOTEX:CALLABLEDEBT CLASSIFIED AS CURRENT
Transit has outstanding 6.5% bonds with a face amount of $90 million. The bondsmature on July 31, 2022. Bondholders have the option of calling (demanding
payment on) the bonds on July 31, 2014, at a redemption price of $90 million.Market conditions are such that the call option is not expected to be exercised. TheCompany is required to report debt that is callable by the creditor in the upcomingyear even if the debt is not expected to be called. Accordingly, the $90 million of6.5% bonds is reported as a current liability.
NOTEX:LOAN IN VIOLATION OFDEBT COVENANT
A $30 million 8% bank loan is payable on October 31, 2019. The bank has theright to demand payment after any fiscal year-end in which the Companys ratio ofcurrent assets to current liabilities falls below a contractual minimum of 1.9 to 1and remains so for six months. That ratio was 1.75 on December 31, 2013, due
primarily to an intentional temporary decline in parts inventories. Normalinventory levels will be reestablished during the sixth week of 2014. Accordingly,
the loan is reported as a long-term liability in the balance sheet.
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The McGraw-Hill Companies, Inc., 2013
1360 Intermediate Accounting, 7e
Problem 1312 (concluded)
NOTEX:CURRENTLY MATURING DEBT CLASSIFIED AS LONG-TERM
The Company intends to refinance $45 million of 7% notes that mature in May of2014. In February 2014, the Company negotiated a line of credit with acommercial bank for up to $40 million any time during 2014. Any borrowings willmature two years from the date of borrowing. Accordingly, $40 million wasreclassified to long-term liabilities.
NOTEX:LAWSUIT
The Company is involved in a lawsuit resulting from a dispute with a food caterer.On February 13, 2014, judgment was rendered against the Company in the amountof $53 million plus interest, a total of $54 million. The Company plans to appealthe judgment and is unable to predict its outcome, though it is not expected to havea material adverse effect on the company.
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The McGraw-Hill Companies, Inc., 2013