ACCOUNTING FOR CURRENT
AND LONG-TERM LIABILITIES
LEARNING OBJECTIVES
1. Account for current liabilities
2. Identify and report contingent liabilities
3. Account for basic bonds-payable transactions
4. Measure interest expense by using the effective-interest method
5. Explain the advantages and disadvantages of borrowing
6. Report liabilities on the balance sheet
QUESTIONS ON OPENING VIGNETTE
1. Define current liabilities and provide several examples.
Solution:
Current liabilities are obligations that are due within one year or within the company’s operating cycle,
whichever is longer. Common examples of current liabilities include accounts payable, short-term
notes payable, salary payable, current portion of unearned revenue, current portion of bonds payable,
estimated warranty payable, payroll liabilities, sales tax payable, and interest payable.
(easy, L.O. 1)
2. As discussed at the beginning of chapter 8 in the textbook, The Home Depot owed $4,716,000,000 to
creditors at the beginning of 1999. Explain how The Home Depot can expect to pay back such a large
sum of money.
Solution:
The Home Depot can pay back its liabilities by operating profitably to generate cash and by keeping
liabilities at a manageable level.
(moderate, L.O. 1)
TRUE/FALSE QUESTIONS
3. Current liabilities are obligations due within one year or within the company’s normal operating cycle
if it is longer than one year.
(easy, L.O. 1, true)
4. The adjusting entry to accrue interest on a note payable requires a debit to interest payable.
(easy, L.O. 1, false)
5. The account sales tax payable represents a company’s liability to the state government for sales taxes
collected.
(moderate, L.O. 1, true)
6. An unearned revenue arises when a company receives cash from its customers in advance of earning
the revenue.
(easy, L.O. 1, true)
7. An accrued expense is an expense incurred by the company but not yet paid.
(moderate, L.O. 1, true)
8. Sales tax payable is a contra revenue account deducted from sales revenue on the income statement.
(easy, L.O. 1, false)
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9. The matching principle requires that warranty expense be recognized in the same period that the sales
revenue is recognized.
(easy, L.O. 1, true)
10. A contingent liability is a potential liability that depends on a future event arising out of a past
transaction.
(easy, L.O. 2, true)
11. The phrase term bonds applies when all the bonds in a particular issue mature in installments over a
period of time.
(moderate, L.O. 2, false)
12. A contingent liability that has a remote change of occurrence should be disclosed in the financial
statement footnotes.
(moderate, L.O. 2, false)
13. A contingent liability that has a probable chance of occurrence and can be reasonably estimated should
be disclosed in the financial statement footnotes.
(moderate, L.O. 2, false)
14. Unsecured bonds are also called debentures.
(moderate, L.O. 2, true)
15. A contingent gain requires an adjusting entry at year-end and should flow through the income
statement.
(easy, L.O. 2, false)
16. A bond issued at a price above its maturity or par value is sold at a discount.
(easy, L.O. 3, false)
17. The entry to record bonds issued at par between interest dates includes a credit to interest payable.
(moderate, L.O. 3, true)
18. An investor purchasing bonds between interest dates must pay accrued interest on the bonds.
(moderate, L.O. 3, true)
19. The market or effective rate of interest is used to calculate the actual amount of interest bondholders
will receive from a company issuing bonds.
(moderate, L.O. 3, false)
20. The carrying amount of bonds issued at a discount is calculated by subtracting Discount on Bonds
Payable from Bonds Payable.
(moderate, L.O. 3, true)
21. The effective-interest method of amortization keeps interest expense at the same percentage of the
bond’s carrying value for every interest payment over the bond’s life.
(easy, L.O. 4, true)
22. Interest expense will increase each period if a company uses the effective-interest method of
amortization and the bonds are issued at a discount.
(difficult, L.O. 4, true)
23. The carrying amount of bonds issued at a premium is calculated by adding Premium on Bonds Payable
to Bonds Payable.
(moderate, L.O. 4, true)
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24. The carrying value of bonds will decrease each interest period if the bonds were issued at a premium.
(moderate, L.O. 4, true)
25. Using the effective-interest method of amortization, interest expense is based on the carrying amount
of the bonds times the effective interest rate for the interest period.
(difficult, L.O. 4, true)
26. Earnings per share is the amount of a company’s total revenue for each share of its stock.
(moderate, L.O. 5, false)
27. The lessee in a capital lease capitalizes the asset in its financial statements even though it may never
take legal title to the property.
(easy, L.O. 5, true)
28. Generally Accepted Accounting Principles require companies to report the fair market value of their
available-for-sale, passive investments in the securities of other companies.
(moderate, L.O. 6, true)
29. When pension plan assets exceed the projected benefit obligation, the plan is said to be overfunded.
(moderate, L.O. 6, true)
30. Unearned revenues occur when a company receives cash from customers after earning the revenue.
(moderate, L.O. 1, false)
31. Stock prices are quoted in percentages, and bond prices are quoted in dollars.
(moderate, L.O. 2, false)
MULTIPLE CHOICE QUESTIONS
32. Current liabilities are obligations due within
a. one year or within the company’s normal operating cycle if it is longer than one year.
b. one year or within the company’s normal operating cycle if it is shorter than one year.
c. one month or within the company’s normal operating cycle if it is longer than one year.
d. one month or within the company’s normal operating cycle if it is shorter than one year.
(moderate, L.O. 1, a)
33. Failure to record an accrued liability causes a company to:
a. overstate assets
b. overstate expenses
c. overstate liabilities
d. overstate owner’s equity
(moderate, L.O. 1, d)
34. Warranty expense should be recorded in the period:
a. that the product sold is repaired or replaced
b. the product is sold
c. after the product is sold
d. that the product is paid for by the customer
(easy, L.O. 1, b)
35. On December 16, 2010, Bruder Corporation purchases $15,000 of equipment by issuing a one month,
10% note payable. The amount of accrued interest on December 31, 2010, is:
a. $63
b. $125
c. $625
d. $750
(moderate, L.O. 1, a)
180
36. Referring to question 35, the total amount of interest due when the note is mature:
a. $63
b. $125
c. $1,500
d. $4,500
(moderate, L.O. 1, b)
37. Referring to question 35, the entry on maturity date will include a:
a. debit to interest payable for $63
b. debit to interest expense for $125
c. credit to interest payable for $63
d. credit to interest expense for $125
(moderate, L.O. 1, a)
38. The adjusting entry to record accrued interest on a short-term note payable includes a:
a. debit to interest payable
b. debit to note payable
c. debit to interest expense
d. credit to interest expense
(moderate, L.O. 1, c)
39. Current liabilities fall into two categories:
a. contra liabilities and contingent liabilities
b. contingent liabilities and noncontingent liabilities
c. liabilities of a known amount and estimated liabilities
d. liabilities of a known amount and contingent liabilities
(moderate, L.O. 1, c)
40. Jake’s Hardware Company includes an 8.25% sales tax in the amount credited to the sales account. If
the sales account has a balance of $627,850, the amount of the sales tax payable to the state is:
a. $47,524
b. $47,850
c. $51,798
d. $51,932
(moderate, L.O. 1, c)
41. Short-term notes payable:
a. are generally due within six months
b. are shown as a reduction to notes receivable on the balance sheet
c. are shown on the balance sheet with current liabilities
d. are shown on the balance sheet after bonds payable
(easy, L.O. 1, c)
42. Jenkins Corporation sales for the day totaled $10,000. Jenkins collected an additional 6% in sales tax.
The entry to record the day’s sales includes a
a. debit to sales tax expense
b. debit to sales tax payable
c. credit to sales tax expense
d. credit to sales tax payable
(moderate, L.O. 1, d)
43. Book Company includes the sales tax in the amount recorded in the sales account. The adjusting entry
at the end of the period includes a:
181
a. credit to sales
b. debit to sales
c. debit to sales tax payable
d. debit to sales tax expense
(moderate, L.O. 1, b)
44. Potential liabilities that depend on future events arising out of past events are called:
a. contingent liabilities
b. estimated liabilities
c. deferred liabilities
d. accrued liabilities
(easy, L.O. 2, a)
45. The FASB requires probable contingent gains that can be reasonably estimated to be:
a. either recorded on the financial statements or reported in the notes to the financial statements
b. ignored until the actual gain materializes
c. reported in the notes to the financial statements
d. accrued and reported on the financial statements
(moderate, L.O. 2, b)
46. Secured bonds are also called:
a. debenture bonds
b. callable bonds
c. mortgage bonds
d. convertible bonds
(easy, L.O. 2, c)
47. The FASB requires that a contingent loss that can be estimated and has a reasonably possible chance of
occurrence to be:
a. accrued and reported on the financial statements
b. reported in the notes to the financial statements
c. ignored until the actual loss materializes
d. either accrued and reported on the financial statements or reported in the notes to the financial
statements
(moderate, L.O. 2, b)
48. Bonds in a particular issue which mature in installments over a period of time are called:
a. serial bonds
b. callable bonds
c. term bonds
d. convertible bonds
(easy, L.O. 2, a)
49. Bonds which are backed only by the good faith of the borrower are referred to as:
a. mortgage bonds
b. secured bonds
c. debenture bonds
d. registered bonds
(easy, L.O. 2, c)
50. The FASB requires probable contingent losses that can be reasonably estimated to be:
a. either recorded on the financial statements or reported in the notes to the financial statements
