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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
http://www.downloadslide.com/


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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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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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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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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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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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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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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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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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Brief Exercise 134

Cash(difference).......................................................... 11,190,000Discount on notes payable ($12,000,000 x 9% x9/12) ..... 810,000


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


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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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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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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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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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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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


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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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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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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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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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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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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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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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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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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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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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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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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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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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



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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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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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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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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


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


Requirement 6

Promotional expense ([60% x $25 x 10,000] $105,000) ... 45,000Estimated premium liability.................................... 45,000


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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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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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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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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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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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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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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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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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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


Maturity (January 31, 2014)Interest expense($14,000,000 x 12% x1/12)................. 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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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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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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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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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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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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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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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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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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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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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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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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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).


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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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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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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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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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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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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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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