Chapter 13 Current Liabilities

Chapter 13 Current Liabilities and ContingenciesExercises Exercise 13-1

Requirement 1

Cash

6,000,000

Notes payable

6,000,000

Requirement 2

Interest expense ($6,000,000 x 14% x 4/12)

280,000

Interest payable

280,000

Requirement 3

Interest expense ($6,000,000 x 14% x 2/12)

140,000Interest payable (from adjusting entry)

280,000Notes payable (face amount)

6,000,000

Cash (total)

6,420,000

Exercise 13-21.

Interest rateFiscal year-end

13%December 31

$300 million x 13% x 8/12 = $26 million2.

Interest rateFiscal year-end

10%October 31

$300 million x 10% x 6/12 = $15 million3.

Interest rateFiscal year-end

9%June 30

$300 million x 9% x 2/12 = $4.5 million4.

Interest rateFiscal year-end

7%January 31

$300 million x 7% x 9/12 = $15.75 millionExercise 13-32013Jan. 22No entry is made for a line of credit until a loan actually is made. It would be described in a disclosure note.

Mar. 1

Cash

7,000,000

Notes payable

7,000,000

June 1

Interest expense ($6,000,000 x 10% x 3/12)

175,000Notes payable (face amount)

7,000,000

Cash ($6,000,000 + 150,000)

7,175,000

Nov. 1

Cash (difference)

5,640,000Discount on notes payable ($6,000,000 x 8% x 9/12)

360,000

Notes payable (face amount)

6,000,000

Dec. 31

The effective interest rate is 8.5106% ($360,000 $5,640,000) x 12/9. So, properly, interest should be recorded at that rate times the outstanding balance times two-twelfths of a year:

Interest expense ($5,640,000 x 8.5106% x 2/12)

80,000

Discount on notes payable

80,000

However the same results are achieved if interest is recorded at the discount rate times the maturity amount times two-twelfths of a year:

Interest expense ($6,000,000 x 8% x 2/12)

80,000

Discount on notes payable

80,000

Exercise 13-3 (concluded)

2014Aug. 1

Interest expense ($6,000,000 x 8% x 7/12)*

280,000

Discount on notes payable

280,000

Notes payable (balance)

6,000,000

Cash (maturity amount)

6,000,000

* or, ($5,640,000 x 8.5106% x 7/12) = $280,000

Exercise 13-41.Noncurrent liability: $22 million

The 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 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 not corrected within a specified grace period unless it's probable the violation will be corrected within the grace period. In this case, the existing violation is expected to be corrected within 6 months.

2.Current liability: $9 million

The debt should be reported as a current liability because it is payable in the upcoming year, will not be refinanced with long-term obligations, and will not be paid with a bond sinking fund.

3.Current liability: $15 million

The requirement to classify currently maturing debt as a current liability includes debt that is callable by the creditor in the upcoming year even if the debt is not expected to be called

Exercise 13-5Requirement 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 (the warranted 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

7,500,000

Sales

7,500,000

Accrued liability and expenseWarranty expense (4% x $7,500,000)

300,000

Estimated warranty liability

300,000

Actual expendituresEstimated warranty liability

124,800

Cash, wages payable, parts and supplies, etc.

124,800

Requirement 3

Warranty Liability

300,000Estimated liability

Actual expenditures 124,800

175,200Balance

Problems Problem 13-1

Requirement 1

Schilling Motors

Cash

42,000,000

Notes payable

42,000,000

First Bank

Notes receivable

42,000,000

Cash

42,000,000

Requirement 2

Adjusting entries (December 31, 2013)

Schilling Motors

Interest expense ($42,000,000 x 12% x 2/12)

840,000

Interest payable

840,000

First Bank

Interest receivable

840,000

Interest revenue ($42,000,000 x 12% x 2/12)

840,000

Maturity (March 31, 2014)

Schilling Motors

Interest expense ($42,000,000 x 12% x 3/12)

1,260,000Interest payable (from adjusting entry)

840,000Notes payable (face amount)

42,000,000

Cash (total)

44,100,000

First Bank

Cash (total)

44,100,000

Interest revenue ($42,000,000 x 12% x 3/12)

1,260,000

Interest receivable (from adjusting entry)

840,000

Notes receivable (face amount)

42,000,000

Problem 13-1 (concluded)

Requirement 3

Issuance of note (November 1, 2013)

Cash (difference)

39,900,000Discount on notes payable ($42,000,000 x 12% x 5/12)

2,100,000

Notes payable (face amount)

42,000,000

Adjusting entry (December 31, 2013)

Interest expense ($42,000,000 x 12% x 2/12)

840,000

Discount on notes payable

840,000

Maturity (March 31, 2014)

Interest expense ($42,000,000 x 12% x 3/12)

1,260,000

Discount on notes payable

1,260,000

Notes payable (face amount)

42,000,000

Cash

42,000,000

Effective interest rate:

Discount ($42,000,000 x 12% x 5/12)$ 2,100,000

Cash proceeds $39,900,000

Interest rate for 4 months 5.26315%

x 12/5

___________

Annual effective rate12.63%

Problem 13-2

1.This is a loss contingency. Finley can use the information occurring after the end of the year in determining appropriate disclosure. It is unlikely that Finley would choose to accrue the $36 million loss because the judgment will be appealed and that outcome is uncertain. A disclosure note is appropriate:_______________________________

Note X: Contingency

In a lawsuit resulting from a dispute with a supplier, a judgment was rendered against Finley Corporation in the amount of $34 million plus interest, a total of $36 million at January 25, 2014. Finley plans to appeal the judgment. While management and legal counsel are presently unable to predict the outcome 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 material adverse effect on the company.

2.No disclosure is required because an EPA claim is as yet unasserted, and an assessment 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 is not required unless an unasserted claim is probable.Problem 13-2 (concluded)

3.This is a gain contingency. Gain contingencies are not accrued even if the gain is probable and reasonably estimable. The gain should be recognized only when realized.

Though gain contingencies are not recorded in the accounts, they should be disclosed in notes to the financial statements. _______________________________

Note X: Contingency

Finley is the plaintiff in a pending lawsuit filed against AA Asphalt for damages due to lost profits from rejected contracts and for unpaid receivables. The case is in final appeal. No amount has been accrued in the financial statements for possible collection of any claims in this litigation.

4.This is a loss contingency. Finley can use the information occurring after the end of the year in determining appropriate disclosure. Finley should accrue the $55 million loss because the ultimate outcome appears settled and the loss is probable. Loss litigation

55,000,000

Liability - litigation

55,000,000

A disclosure note also is appropriate:_________________________________Notes: LitigationIn October 2012, the State of Montana filed suit against the Company, seeking civil penalties and injunctive relief for violations of environmental laws regulating hazardous waste. On February 3, 2014, the Company announced that it had reached a settlement with state authorities on this matter. Based upon discussions with legal counsel, the Company, has accrued and charged to operations in 2013, $55 million to cover the anticipated cost of all violations. The Company believes that the ultimate settlement of this claim will not have a material adverse effect on the Company's financial position.

The McGraw-Hill Companies, Inc., 201313-

Intermediate Accounting, 7e The McGraw-Hill Companies, Inc., 2013Alternate Exercise and Problem Solutions13-