Chapter 13 Current Liabilities and Contingencies
True/False Questions
1. Some liabilities are not contractual obligations and may not be payable in cash.
2. A line of credit is an agreement to provide long-term financing, typically made with a bank or
a group of banks.
3. Amounts withheld from employees in connection with payroll often represent liabilities to be
remitted to third parties.
4. A customer advance produces a liability that is satisfied when the product or service is
provided.
5. Revenue is recognized upon sale of gift cards, rather than being deferred.
6. Long-term debt that is callable by the creditor in the upcoming year should be classified as a
current liability only if the debt is expected to be called.
7. The concept of substance over form influences the classification of obligations expected to be
refinanced.
8. Under IFRS, a liability that is refinanced after the balance sheet date but before the financial
statements are issued would typically be classified as a current liability.
8. Expense for a quality-assurance warranty is recorded along with the related liability in the
reporting period in which the product under warranty is sold.
10. For a loss contingency to be accrued, the claim must have been made before the accounting
period ended.
11. A company should accrue a liability for a loss contingency if it is at least reasonably possible
that assets have been impaired and the amount of potential loss can be reasonably estimated.
12. A disclosure note is required for all material loss contingencies for which the probability of
loss is reasonably possible.
13. A liability for an unasserted claim must be accrued if it is reasonably possible that the claim
will be asserted.
14. An asset for a gain contingency should not be accrued unless it is probable that the gain
contingency will be realized.
15. Under IFRS, the term “probable” indicates a threshold of probability that is substantially more
than a 50 percent chance of occurrence.
16. Under IFRS, if it is probable that a contingent liability will result in a future payment but there
is a range of equally likely amounts that will be paid, the midpoint of the range should be
accrued as a loss.
17. The cost of promotional offers should be recorded as expenses in the accounting period when
the offers are redeemed by customers.
18. Unlike the Social Security tax there is no maximum wage base for the Medicare portion of the
Chapter 13 Current Liabilities and Contingencies
FICA tax.
19. State and Federal Unemployment Taxes (SUTA and FUTA) must be withheld from
employees’ wages.
Chapter 13 Current Liabilities and Contingencies
Multiple Choice Questions
20. The most common type of liability is:
a. One that comes into existence due to a loss contingency.
b. One that must be estimated.
c. One that comes into existence due to a gain contingency.
d. One to be paid in cash and for which the amount and timing are known.
21. Which of the following is not a characteristic of a liability?
a. It represents a probable, future sacrifice of economic benefits.
b. It must be payable in cash.
c. It arises from present obligations to other entities.
d. It results from past transactions or events.
22. Which of the following is the best definition of a current liability?
a. An obligation payable within one year.
b. An obligation payable within one year of the balance sheet date.
c. An obligation payable within one year or within the normal operating cycle, whichever is
longer.
d. An obligation expected to be satisfied with current assets or by the creation of other
current liabilities.
23. Which of the following is not a liability?
a. An unused line of credit.
b. Estimated income taxes.
c. Sales tax collected from customers.
Chapter 13 Current Liabilities and Contingencies
d. Advances from customers.
24. Current liabilities normally are recorded at their:
a. Present value.
b. Cost.
c. Maturity amount.
d. Expected value.
25. Current liabilities are normally recorded at the amount expected to be paid rather than at their
present value. This practice can be supported by GAAP according to the concept of:
a. Matching.
b. Consistency.
c. Materiality.
d. Conservatism.
26. The key accounting considerations relating to accounts payable are:
a. Determining their existence and ensuring that they are recorded in the appropriate
accounting period.
b. Determining their present value and ensuring that they are recorded in the appropriate
accounting period.
c. Determining their existence and determining the correct amount.
d. Determining the present value of the principal and the amount of the interest.
27. Classifying liabilities as either current or long-term helps creditors assess:
a. Profitability.
b. The relative risk of a firm’s liabilities.
c. The degree of a firm’s liabilities.
d. The amount of a firm’s liabilities.
28. When cash is received from customers in the form of a refundable deposit, the cash account is
increased with a corresponding increase in:
a. A current liability.
b. Revenue.
c. Shareholders’ equity.
d. Paid-in capital.
29. A discount on a noninterest-bearing note payable is classified in the balance sheet as:
a. An asset.
b. A component of shareholders’ equity.
c. A contingent liability.
d. A contra liability.
30. The rate of interest printed on the face of a note payable is called the:
Chapter 13 Current Liabilities and Contingencies
a. Yield rate.
b. Effective rate.
c. Market rate.
d. Stated rate.
31. The rate of interest that actually is incurred on a note payable is called the:
a. Face rate.
b. Contract rate.
c. Effective rate.
d. Stated rate.
32. On October 31, 2016, Simeon Builders borrowed $16 million cash and issued a 7-month,
noninterest-bearing note. The loan was made by Star Finance Co. The stated discount rate is
8%. Sky’s effective interest rate on this loan is:
a. More than the stated discount rate of 8%.
b. Less than the stated discount rate of 8%.
c. Equal to the stated discount rate of 8%.
d. Unrelated to the stated discount rate of 8%.
33. On April 31, 2016, Elkhorn Associates borrowed $10 million cash from Colonial Bank and
issued a 5-month, noninterest-bearing note, priced to yield an effective interest rate of 10%.
The stated discount rate on this loan is:
a. More than the effective interest rate.
b. Less than the effective interest rate.
c. Equal to the effective interest rate.
d. Unrelated to the effective interest rate.
Chapter 13 Current Liabilities and Contingencies
34. Large, highly rated firms sometimes sell commercial paper:
a. To borrow funds at a lower rate than through a bank.
b. To earn a profit on the paper.
c. To avoid paperwork.
d. Because the interest rate is locked in by the Federal Reserve Board.
35. Jane’s Donut Co. borrowed $200,000 on January 1, 2016, and signed a two-year note bearing
interest at 12%. Interest is payable in full at maturity on January 1, 2018. In connection with
this note, Jane’s should report interest expense at December 31, 2016, in the amount of:
a. $0.
b. $24,000.
c. $48,000.
d. $50,880.
36. What is the effective interest rate (rounded) on a 3-month, noninterest-bearing note with a
stated rate of 12% and a maturity value of $200,000?
a. 12.4%.
b. 13.6 %.
c. 11.5%.
d. 3.1%.
Chapter 13 Current Liabilities and Contingencies
37. On September 1, 2016, Hiker Shoes issued a $100,000, 8-month, noninterest-bearing note.
The loan was made by Second Commercial Bank where the stated discount rate is 9%. Hiker’s
effective interest rate on this loan (rounded) is:
a. 9.0%.
b. 9.5%.
c. 9.6%.
d. 9.7%.
38. Universal Travel Inc. borrowed $500,000 on November 1, 2016, and signed a 12-month note
bearing interest at 6%. Interest is payable in full at maturity on October 31, 2017. In
connection with this note, Universal Travel Inc. should report interest payable at December
31, 2016, in the amount of:
a. $ 8,000.
b. $30,000.
c. $ 5,000.
d. $25,000.
39. Oklahoma Oil Corp. paid interest of $785,000 during 2016, and the interest payable account
Chapter 13 Current Liabilities and Contingencies
decreased by $125,000. What was interest expense for the year?
a. $910,000.
b. $660,000.
c. $555,000.
d. $785,000.
40. On June 1, 2016, Dirty Harry Co. borrowed cash by issuing a 6-month noninterest-bearing
note with a maturity value of $500,000 and a discount rate of 6%. Assuming straight-line
amortization of the discount, what is the carrying value of the note as of September 30, 2016?
a. $525,000.
b. $300,000.
c. $495,000.
d. $475,000.
41. At times, businesses require advance payments from customers that will be applied to the
purchase price when goods are delivered or services provided. These customer advances
represent:
a. Liabilities until the product or service is provided.
b. A component of shareholders’ equity.
c. Long-term assets until the product or service is provided.
d. Revenue upon receipt of the advance payment.
42. Which of the following is not true about deferred revenue?
a. Deferred revenue with respect to gift cards is recognized as revenue when the gift cards
expire.
b. Deferred revenue is a liability.
c. Deferred revenue is recognized on credit sales when collectibility can be estimated.
d. Customer prepayments typically require recognition of deferred revenue.
43. M Corp. has an employee benefit plan for compensated absences that gives each employee 15
paid vacation days. Vacation days can be carried over indefinitely. Employees can elect to
receive payment in lieu of vacation days. At December 31, 2016, M’s unadjusted balance of
liability for compensated absences was $30,000. M estimated that there were 200 total
vacation days available at December 31, 2016. M’s employees earn an average of $150 per
day. In its December 31, 2016, balance sheet, what amount of liability for compensated
absences is M required to report?
a. $ 0.
b. $ 30,000.
c. $225,000.
d. $450,000.
44. Which of the following generally is associated with accounts payable?
Reported at
Interest expense present value
a. No No
b. No Yes
c. Yes No
d. Yes Yes
45. Lake Co. receives nonrefundable advance payments with special orders for containers
constructed to customer specifications. Related information for 2016 is as follows ($ in
millions):
Customer advances balance, Dec. 31, 2015 $110
Advances received with 2016 orders 195
Advances applicable to orders shipped in 2016 180
Advances from orders canceled in 2016 45
What amount should Lake report as a current liability for advances from customers in its Dec.
31, 2016, balance sheet?
a. $0.
b. $80.
c. $125.
d. $170.
46. All of the following but one represent collections for third parties. Which one of the following
is not a collection for a third party?
a. Sales tax payable.
b. Customer deposits.
c. Employee insurance deductions.
d. Social security taxes deductions.
47. When a deposit on returnable containers is forfeited, the firm holding the deposit will
experience:
a. A decrease in cost of goods sold.
b. An increase in current liabilities.
c. An increase in accounts receivable.
Chapter 13 Current Liabilities and Contingencies
d. An increase in revenue.
48. B Corp. has an employee benefit plan for compensated absences that gives each employee 10
paid vacation days and 10 paid sick days. Both vacation and sick days can be carried over
indefinitely. Employees can elect to receive payment in lieu of vacation days; however, no
payment is given for sick days not taken. At December 31, 2016, B’s unadjusted balance of
liability for compensated absences was $42,000. B estimated that there were 300 total vacation
days and 150 sick days available at December 31, 2016. B’s employees earn an average of
$200 per day. In its December 31, 2016, balance sheet, what amount of liability for
compensated absences is B required to report?
a. $ 60,000.
b. $ 84,000.
c. $ 90,000.
d. $144,000.
49. On January 1, 2016, G Corporation agreed to grant all its employees two weeks paid vacation
each year, with the stipulation that vacations earned each year can be taken the following year.
For the year ended December 31, 2016, G’s employees each earned an average of $800 per
week. A total of 500 vacation weeks earned in 2016 were not taken during 2016. Wage rates
for employees rose by an average of 5 percent by the time vacations actually were taken in
2017. What is the amount of G’s 2017 wages expense related to 2016 vacation time?
a. $ 0.
b. $ 20,000.
c. $400,000.
d. $420,000.
50. Revenue for gift card breakage should be recognized:
a. When the gift card is sold.
b. No later than the last day of the operating period in which the gift card is delivered to the
customer.
c. When the probability of gift card redemption is viewed as remote.
d. Under no circumstances, as gift cards are not themselves a delivered product, but rather a
selling technique.
51. All else equal, a large increase in deferred revenue in the current period would be expected to
produce what effect on revenue in a future period?
a. Large increase, because deferred revenue becomes revenue when the seller has satisfied
its performance obligations.
b. Large decrease, because deferred revenue implies that less revenue has been earned,
which reduces future revenue.
c. No effect, because deferred revenue is a liability, so payment will use assets rather than
providing revenue.
d. Large decrease, because deferred revenue indicates collection problems that will reduce
net revenues in future periods.
52. Peterson Photoshop sold $1,000 in gift cards on a special promotion on October 15, 2016, and
sold $1,500 in gift cards on another special promotion on November 15, 2016. Of the cards
sold in October, $100 were redeemed in October, $250 in November, and $300 in December.
Of the cards sold in November, $150 were redeemed in November and $350 were redeemed in
December. Peterson views the probability of redemption of a gift card as remote if the card
has not been redeemed within two months. At 12/31/2016, Peterson would show an deferred
revenue account for the gift cards with a balance of:
a. $0.
b. $1,000.
c. $1,350.
Chapter 13 Current Liabilities and Contingencies
d. $1,500.
53. When a product or service is delivered for which a customer advance has been previously
received, the appropriate journal entry includes:
a. A debit to a revenue and a credit to a liability account.
b. A debit to a revenue and a credit to an asset account.
c. A debit to an asset and a credit to a revenue account.
d. A debit to a liability and a credit to a revenue account.
54. Clark’s Chemical Company received customer deposits on returnable containers in the amount
of $100,000 during 2016. Twelve percent of the containers were not returned. The deposits are
based on the container cost marked up 20%. What is cost of goods sold relative to this
forfeiture?
a. $0.
b. $2,000.
c. $10,000.
d. $14,400.
55. In May of 2016, Raymond Financial Services became involved in a penalty dispute with the
EPA. At December 31, 2016, the environmental attorney for Raymond indicated that an
unfavorable outcome to the dispute was probable. The additional penalties were estimated to
Chapter 13 Current Liabilities and Contingencies
be $770,000 but could be as high as $1,170,000. After the year-end, but before the 2016
financial statements were issued, Raymond accepted an EPA settlement offer of $900,000.
Raymond should have reported an accrued liability on its December 31, 2016, balance sheet
of:
a. $ 770,000.
b. $ 900,000.
c. $ 970,000.
d. $1,170,000.
56. Slotnick Chemical received customer deposits on returnable containers in the amount of
$300,000 during 2016. Fifteen percent of the containers were not returned. The deposits are
based on the container cost marked up 20%. How much profit did Slotnick realize on the
forfeited deposits?
a. $0.
b. $7,500.
c. $9,000.
d. $45,000.
57. Which of the following is not a current liability?
a. Accounts payable.
b. A note payable due in two years.
c. Accrued interest payable.
d. Sales tax payable.
Chapter 13 Current Liabilities and Contingencies
58. Short-term obligations can be reported as long-term liabilities if:
a. The firm has a long-term line of credit.
b. The firm has tentative plans to issue long-term bonds.
c. The firm intends to and has the ability to refinance as long-term.
d. The firm has the ability to refinance on a long-term basis.
59. Of the following, which typically would not be classified as a current liability?
a. Estimated liability from cash rebate program.
b. A long-term note payable maturing within the coming year.
c. Rent revenue received in advance.
d. A six-month bank loan to be paid with the proceeds from the sale of common stock.
60. Which of the following situations would not require that long-term liabilities be reported as
current liabilities on a classified balance sheet?
a. The long-term debt is callable by the creditor.
b. The creditor has the right to demand payment due to a contractual violation.
c. The long-term debt matures within the upcoming year.
d. The company intended to refinance the debt and did so prior to issuance of the financial
statements.
61. A long-term liability should be reported as a current liability in a classified balance sheet if the
long-term debt:
a. Is callable by the creditor.
b. Is secured by adequate collateral.
Chapter 13 Current Liabilities and Contingencies
c. Will be refinanced with stock.
d. Will be refinanced with debt.
62. On December 31, 2016, L Inc. had a $1,500,000 note payable outstanding, due July 31, 2017.
L borrowed the money to finance construction of a new plant. L planned to refinance the note
by issuing long-term bonds. Because L temporarily had excess cash, it prepaid $500,000 of the
note on January 23, 2017. In February 2017, L completed a $3,000,000 bond offering. L will
use the bond offering proceeds to repay the note payable at its maturity and to pay
construction costs during 2017. On March 13, 2017, L issued its 2016 financial statements.
What amount of the note payable should L include in the current liabilities section of its
December 31, 2016, balance sheet?
a. $ 0.
b. $ 500,000.
c. $1,000,000.
d. $1,500,000.
63. Liabilities payable within the coming year are classified as long-term liabilities if refinancing
is completed before date of issuance of the financial statements under:
a. U.S. GAAP.
b. IFRS.
c. Either U.S. GAAP and IFRS.
d. Neither U.S. GAAP and IFRS.