Chapter 13 Current Liabilities



Chapter 13 Current Liabilities and Contingencies

EXERCISES

Exercise 13-8

Requirement 1

Cash 7,500

Liability – customer advance 7,500

Requirement 2

Cash 25,500

Liability – refundable deposits 25,500

Requirement 3

Accounts receivable 856,000

Sales revenue 800,000

Sales taxes payable ([5% + 2%] x $800,000) 56,000

Exercise 13-10

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 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.

Exercise 13-13

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 (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 2011, the period in which the products under warranty are sold.

Requirement 2

2011 Sales

Accounts receivable 5,000,000

Sales 5,000,000

Accrued liability and expense

Warranty expense (3% x $5,000,000) 150,000

Estimated warranty liability 150,000

Actual expenditures

Estimated 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

Exercise 13-16

Requirement 1

This is a loss contingency. Some loss contingencies don’t involve liabilities at all. Some contingencies when resolved cause a noncash asset to be impaired, so accruing it means reducing the related asset rather than recording a liability. The most common loss contingency of this type is an uncollectible receivable, as described in this situation.

Requirement 2

Bad debt expense: 3% x $2,400,000 = $72,000

Requirement 3

Bad debt expense (3% x $2,400,000) 72,000

Allowance for uncollectible accounts 72,000

Requirement 4

Allowance for uncollectible accounts:

Beginning of 2011 $75,000

Write off of bad debts* 73,000

Credit balance before accrual 2,000

Year-end accrual (Req. 3) 72,000

End of 2011 $74,000

* Allowance for uncollectible accounts 73,000

Accounts receivable 73,000

Net realizable value:

Accounts receivable $490,000

Less: Allowance for uncollectible accounts (74,000)

Net realizable value $416,000

Exercise 13-21

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 reasonable possibility the violation will be corrected within the grace period).

__C_ 7. Note due March 3, 2012.

__C_ 8. Interest accrued on note, Dec. 31, 2011.

__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 loss in 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 13 months.

__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.

Exercise 13-24

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 312

Liability for settlement of environmental claims 312

In practice this liability would be accrued in multiple entries, increasing when Dow recognized additional liability and decreasing either when Dow paid off parts of the liability or revised downward their estimate of remediation and restoration costs.

PROBLEMS

Problem 13-1

Requirement 1

Blanton Plastics

Cash 14,000,000

Notes payable 14,000,000

L & T Bank

Notes receivable 14,000,000

Cash 14,000,000

Requirement 2

Adjusting entries (December 31, 2011)

Blanton Plastics

Interest expense ($14,000,000 x 12% x 3/12) 420,000

Interest payable 420,000

L & T Bank

Interest receivable 420,000

Interest revenue ($14,000,000 x 12% x 3/12) 420,000

Maturity (January 31, 2012)

Blanton Plastics

Interest expense ($14,000,000 x 12% x 1/12) 140,000

Interest payable (from adjusting entry) 420,000

Notes payable (face amount) 14,000,000

Cash (total) 14,560,000

L & T Bank

Cash (total) 14,560,000

Interest revenue ($14,000,000 x 12% x 1/12) 140,000

Interest receivable (from adjusting entry) 420,000

Notes receivable (face amount) 14,000,000

Problem 13-1 (concluded)

Requirement 3

a.

Issuance of note (October 1, 2011)

Cash (difference) 13,440,000

Discount on notes payable ($14,000,000 x 12% x 4/12) 560,000

Notes payable (face amount) 14,000,000

Adjusting entry (December 31, 2011)

Interest expense ($14,000,000 x 12% x 3/12) 420,000

Discount on notes payable 420,000

Maturity (January 31, 2012)

Interest expense ($14,000,000 x 12% x 1/12) 140,000

Discount on notes payable 140,000

Notes payable (face amount) 14,000,000

Cash 14,000,000

b.

Effective interest rate:

Discount ($14,000,000 x 12% x 4/12) $ 560,000

Cash proceeds ÷ $13,440,000

Interest rate for 4 months 4.1666%

x 12/4

___________

Annual effective rate 12.5%

CASES

Analysis Case 13-16

Requirement 1

Current ratio = Current assets

Current liabilities

= $1,879

$1,473

= 1.28

Industry average = 1.5

The current ratio is one of the most widely used ratios. It is intended as a measure of short-term solvency and is determined by dividing current assets by current liabilities. Comparing assets that either are cash or will be converted to cash in the near term, with those liabilities that must be satisfied in the near term, provides a useful measure of a company’s liquidity. A ratio of 1 to 1 or higher often is considered a rule-of-thumb standard, but like other ratios, acceptability should be evaluated in the context of the industry in which the company operates and other specific circumstances. IGF’s current ratio is slightly less than the industry average which, on the surface, might indicate a liquidity problem. Keep in mind, though, that industry averages are only one indication of adequacy and that the current ratio is but one indication of liquidity.

Case 13-16 (concluded)

Requirement 2

Acid-test ratio = Quick assets

(or quick ratio) Current liabilities

= $48 + 347 + 358

$1,473

= 0.51

Industry average = 0.80

The acid-test or quick ratio attempts to adjust for the implicit assumption of the current ratio that all current assets are equally liquid. This ratio is similar to the current ratio, but is based on a more conservative measure of assets available to pay current liabilities. Specifically, the numerator, quick assets, includes only cash and cash equivalents, short-term investments, and accounts receivable. By eliminating current assets such as inventories and prepaid expenses that are less readily convertible into cash, the acid-test ratio provides a more rigorous indication of a company's short-term solvency than does the current ratio.

Once again, IGF’s ratio is less than that of the industry as a whole. Is this confirmation that liquidity is an issue for IGF? Perhaps; perhaps not. It does, though, raise a red flag that suggests caution when assessing other areas. It’s important to remember that each ratio is but one piece of the puzzle. For example, profitability is probably the best long run indication of liquidity. Also, management may be very efficient in managing current assets so that some current assets – receivables or inventory – are more liquid than they otherwise would be and more readily available to satisfy liabilities.

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