16) If the likelihood of a future event is reasonably possible, how should the company report the
contingency?
17) If a contingency that is probable can be reasonably estimated, a liability is recorded and an expense is
accrued.
18) Only contingencies that are probable and can be estimated are recorded as a liability and an accrued
expense.
19) A contingency was evaluated at year-end. Management felt it was probable that this would become
an actual liability and the amount could be reasonably estimated. If this is reported on the balance sheet,
it could be considered a violation of generally accepted accounting principles.
20) Contingencies that are probable but cannot be estimated are recorded as liabilities and disclosed in
the notes to the financial statements.
21) Under IFRS, “probable” is defined as more than a 50% chance.
22) Which of the following is the proper treatment for a contingency that is probable but the exact amount
of which is not known? The amount can be estimated.
A) The liability should be doubled following conservatism.
B) The liability should be estimated and recorded.
C) The liability should be ignored.
D) The liability should be reported in the notes to the financial statements.
23) Which of the following is an example of an estimable probable contingency?
A) FICA Taxes Payable
B) Income Taxes Payable
C) Warranty Payable
D) Accounts Payable
24) A contingency was evaluated at year-end. Management felt it was probable that this would become
an actual liability and the amount could be reasonably estimated. If this was not reported on the balance
sheet or in the notes to the financial statements, what is the effect on the financial reporting of the
company?
A) There would be no effect.
B) The liabilities on the balance sheet would be understated.
C) The information about the transaction would be inadequately disclosed in the notes.
D) The net income of the company would be understated.
25) If the likelihood of a future event is probable and the amount of the expense cannot be estimated, how
should the company report the contingency?
26) If the likelihood of a future event is probable and the amount of the expense can be estimated, how
should the company report the contingency?
27) Analyze the following independent situations.
Required: For each situation, state the likelihood of a future event and state how the contingency will be
reported.
a. Company A estimates it will have to pay $85,000 in warranty repairs next year.
b. Company B is being sued by a customer. Company B’s attorneys feel that this is a frivolous lawsuit
and there is very little chance that the customer will win.
c. Company C co–signed a note payable for Company D. Company D is having serious financial
problems and it is reasonably possible that Company C will have to pay the note.
d. Company E is being sued for a patent infringement. Company E’s attorney feels that Company E will
be found liable for damages caused by the patent infringement. However, the attorney states it is not
possible to estimate the amount of the award.
1) Investors use the times-interest-earned ratio to evaluate a company‘s ability to pay interest expense.
2) The times-interest-earned ratio is also called the short interest ratio.
3) A high interest-coverage ratio indicates a company has difficulty in paying interest expense.
4) The times-interest-earned ratio is calculated as EBIT divided by interest expense.
5) The times-interest-earned ratio is 6.25 for Retailer A and 5.1 for Retailer B. This indicates that Retailer B
will find it easier to pay interest expense.
6) The times-interest-earned ratio is calculated as ________.
A) earnings before interest and tax divided by interest expense
B) profit before tax divided by interest expense
C) net income divided by interest expense
D) income tax expense plus interest expense divided by interest expense
7) The information related to interest expense of Classic Music, Inc. is given below:
Net income
$264,000
Income tax expense
107,000
Interest expense
66,000
Based on the above data, which of the following is the times-interest-earned ratio? (Round the final
answer to two decimal places.)
A) 4.08 times
B) 4 times
C) 6.62 times
D) 5 times
8) The times-interest-earned ratios of Orlando, Inc. are 20.56 and 7.35 for 2018 and 2019, respectively.
Which of the following can be the possible reason for such a change from 2018 to 2019?
A) Orlando, Inc. incurred less debt specifically in its revolving line of credit.
B) Orlando, Inc. incurred more debt specifically in its revolving line of credit.
C) Orlando, Inc. paid less interest in its revolving line of credit.
D) Orlando, Inc.’s debt-paying ability increased.
9) The times-interest-earned ratios of four companies are given below:
Forge Corp.
8.9
Fellow, Inc.
9.2
Stacy Corp.
6.7
Bennett, Inc.
13.5
Which of the above companies has the highest debt-paying ability?
A) Forge Corp.
B) Fellow, Inc.
C) Stacy Corp.
D) Bennett, Inc.
10) Which of the following statements about the times-interest-earned ratio is true?
A) A lower ratio indicates a higher debt paying ability.
B) Debt reduction leads to an increase in interest expense.
C) The times-interest-earned ratio is also called the interest-coverage ratio.
D) The times-interest-earned ratio is calculated by dividing gross income by interest expense.
11) The information related to Jazz Music, Inc. is given below:
Year ended December Year ended December
31, 2018 31, 2019
Net Income $81,510 $210,570
Income Tax Expense 55,910 103,505
Interest Expense 6,595 59,505
Calculate the times-interest-earned ratio for each year . Round all calculations to two decimal places.
12) Rock Music, Inc. signed a 200-day, 5%, $5,000 note on April 1, 2018, and this was the only note
payable for the company. Calculate the times-interest-earned ratio of Rock Music, Inc. if its earnings
before interest and taxes for the year ending December 31, 2018, is $4,300. Round all calculations to two
decimal places. (Use a 360-day year.)