Chapter 13 Current Liabilities and Contingencies
129. MullerB Company’s employees earn vacation time at the rate of 1 hour per 40-hour work
period. The vacation pay vests immediately, meaning an employee is entitled to the pay even
if employment terminates. During 2016, total wages paid to employees equaled $808,000,
including $8,000 for vacations actually taken in 2016, but not including vacations related to
2016 that will be taken in 2017. All vacations earned before 2016 were taken before January
1, 2016. No accrual entries have been made for the vacations.
Required:
Prepare the appropriate adjusting entry for vacations earned but not taken in 2016.
Answer:
130. The following facts relate to gift cards sold by Sunbru Coffee Company during 2016.
Sunbru’s fiscal year ends on December 31.
(a.) In October 2016, sold $3,000 of gift cards, and redeemed $500 of those gift cards.
(b.) In November 2016, sold $4,000 of gift cards, and redeemed $1,400 of October gift cards
and $700 of November gift cards.
(c.) In December 2016, sold $3,000 of gift cards, and redeemed $200 of October gift cards,
$2,000 of November gift cards, and $400 of December gift cards.
(d.) Sunbru views a gift card to be “broken” (with a remote probability of redemption) two
months after the end of the month in which it is sold. Thus, an unredeemed gift card sold
at any time during July would be viewed as broken as of September 30.
Required:
1. Prepare all journal entries appropriate to be recorded only during the month of December
2016 relevant to gift card sales, gift card redemptions, and gift card breakage.
2. Determine the balance of the deferred revenue liability to be reported in the December 31,
2016, balance sheet. Show the relevant T-account information to support your answer.
Chapter 13 Current Liabilities and Contingencies
Answer:
131. Diversified Industries sells perishable electronic products. Some must be shipped in reusable
containers. Customers pay a deposit for each container. The deposit is equal to the container’s
cost. Customers receive a refund when the container is returned. During 2016, deposits
collected on containers shipped were $700,000. Deposits are forfeited if containers are not
returned in 18 months. Containers held by customers on January 1, 2016, were $330,000.
During 2016, $410,000 was refunded and deposits of $25,000 were forfeited.
Required:
1. Prepare the appropriate journal entries for the deposits received and returned during 2016.
2. Determine the liability for refundable deposits to be reported in the December 31, 2016,
balance sheet.
Chapter 13 Current Liabilities and Contingencies
132. At December 31, 2016, Cordova Leather’s liabilities include the following:
1. $15 million of noncallable 9% notes were issued for $15 million on August 31, 1994. The
notes mature on July 31, 2017. Sufficient cash is expected to be available to retire the
notes at maturity.
2. $30 million of 8% notes were issued for $30 million on May 31, 2012. The notes mature
on May 31, 2022, but investors have the option of calling (demanding payment on) the
notes on June 30, 2017. However, the call option is not expected to be exercised, given
prevailing market conditions.
3. $18 million of 10% notes are due on March 31, 2018. A debt covenant requires Cordova
to maintain current assets at least equal to 150% of its current liabilities. On December 31,
2016, Cordova is in violation of this covenant. Cordova obtained a waiver from Village
Bank until June 2017, having convinced the bank that the company’s normal 2 to 1 ratio
of current assets to current liabilities will be reestablished during the first half of 2017.
Required:
For each of the three liabilities, indicate the portion of the debt that can be excluded from
classification as a current liability (that is, reported as a noncurrent liability). Explain.
Chapter 13 Current Liabilities and Contingencies
Answer:
133. In its 2016 annual report to shareholders, Border Airlines Inc. presented the following balance
sheet information about its liabilities:
2016
2015
CURRENT LIABILITIES
Accounts payable
$1,717,000,000
$1,178,000,000
Accrued salaries and wages
$681,000,000
$924,000,000
Accrued liabilities
$1,336,000,000
$1,143,000,000
Air traffic liability
$2,763,000,000
$2,696,000,000
Payable to affiliates, net
$66,000,000
$511,000,000
Current maturities of long-term debt
$421,000,000
$108,000,000
Current obligations under capital leases
$189,000,000
$201,000,000
Total current liabilities
$7,173,000,000
$6,761,000,000
LONG-TERM DEBT, LESS CURRENT MATURITIES
$6,530,000,000
$2,601,000,000
In addition, Border presented the following among its note disclosures:
Maturities of long-term debt (including sinking fund requirements) for the next five years are:
2017 – $421 million; 2018 – $212 million; 2019 – $273 million; 2020 – $1.0 billion; 2021 –
$777 million.
Required:
Consider the appropriate classification of these long-term debt obligations. Assuming no more
long-term debt will be issued, what are the implications of the information above for Border’s
liquidity and solvency risk in 2016 and the following years?
134. Mozart Music Co. began operations in December of 2016. The company sold gift certificates
during December in various amounts totaling $1,600. The gift certificates are redeemable for
merchandise within three years of the purchase date. However, experience within the industry
predicts that 90% of gift certificates will be redeemed within one year. Certificates totaling
$500 were presented for redemption during 2016 as part of merchandise purchases having a
total retail price of $750.
Required:
1. Determine the liability for gift certificates to be reported in the December 31, 2016,
balance sheet.
2. What is the appropriate classification (current or noncurrent) of the liabilities at December
31, 2016? Show calculations.
Answer:
Chapter 13 Current Liabilities and Contingencies
Use the following to answer questions 135–137:
In its 2016 annual report to shareholders, the Goodday Chemical Company included the following
disclosure note excerpts on CONTINGENCIES in its annual report to shareholders:
At December 31, 2016, Goodday had recorded liabilities aggregating $66.5 million for
anticipated costs related to various environmental matters, primarily the remediation of
numerous waste disposal sites and certain properties sold by Goodday. These costs include
legal and consulting fees, site studies, the design and implementation of remediation plans,
post-remediation monitoring and related activities and will be paid over several years. The
amount of Goodday’s ultimate liability in respect of these matters may be affected by several
uncertainties, primarily the ultimate cost of required remediation and the extent to which other
responsible parties contribute.
At December 31, 2016, Goodday had recorded liabilities aggregating $218.7 million for
potential product liability and other tort claims, including related legal fees expected to be
incurred, presently asserted against Goodday. The amount recorded was determined on the
basis of an assessment of potential liability using an analysis of available information with
respect to pending claims, historical experience, and, where available, current trends.
Goodday is a defendant in numerous lawsuits involving at December 31, 2016, approximately
63,000 claimants alleging various asbestos-related personal injuries purported to result from
exposure to asbestos in certain rubber-coated products manufactured by Goodday in the past
or in certain Goodday facilities. Typically, these lawsuits have been brought against multiple
defendants in state and federal courts. In the past, Goodday has disposed of approximately
22,000 cases by defending and obtaining the dismissal thereof or by entering into a settlement.
Goodday has policies and coverage–in-place agreements with certain of its insurance carriers
that cover a substantial portion of estimated indemnity payments and legal fees in respect of
the pending claims. At December 31, 2016, Goodday has recorded an asset in the amount it
expects to collect under the policies and coverage–in-place agreements with certain carriers
related to its estimated asbestos liability. Goodday has also commenced discussions with
certain of its excess coverage insurance carriers to establish arrangements in respect of their
policies.
Subject to the uncertainties referred to above, Goodday has concluded that in respect of any of
the above described liabilities, it is not reasonably possible that it would incur a loss exceeding
the amount recognized at December 31, 2016, with respect thereto which would be material
relative to the consolidated financial position, results of operations, or liquidity of Goodday.
135.
Briefly explain the GAAP requirement from which the costs/obligations for environmental
cleanup and product liability/tort claim matters were accrued in the financial statements.
131. What is the point of the last paragraph of the Goodday disclosure? Explain in terms of
authoritative GAAP.
136. Show the summary journal entry that Goodday recorded for the environmental cleanup and
product liability/tort claim matters, described in the note disclosure.
137. The following selected transactions relate to contingencies of Eastern Products Inc., which
began operations in July 2016. Eastern’s fiscal year ends on December 31. Financial
statements are published in April 2017.
1. No customer accounts have been shown to be uncollectible as yet, but Eastern estimates
that 3% of credit sales will eventually prove uncollectible. Sales were $300 million (all
credit) for 2016.
2. Eastern offers a one-year warranty against manufacturer’s defects for all its products.
Industry experience indicates that warranty costs will approximate 2% of sales. Actual
warranty expenditures were $3.5 million in 2016 and were recorded as warranty expense
when incurred.
3. In December 2016, Eastern became aware of an engineering flaw in a product that poses a
potential risk of injury. As a result, a product recall appears inevitable. This move would
Chapter 13 Current Liabilities and Contingencies
likely cost the company $1.5 million.
4. In November 2016, the State of Vermont filed suit against Eastern, asking civil penalties
and injunctive relief for violations of clean water laws. Eastern reached a settlement with
state authorities to pay $4.2 million in penalties on February 3, 2017.
5. Eastern is the plaintiff in a $40 million lawsuit filed against a customer for costs and lost
profits from contracts rejected in 2016. The lawsuit is in final appeal and attorneys advise
that it is virtually certain that Eastern will be awarded $30 million.
Required:
Prepare the appropriate journal entries that should be recorded as a result of each of these
contingencies. If no journal entry is indicated, state why.
138. The following selected transactions relate to contingencies of Bowe-Whitney Inc. Bowe-
Whitney’s fiscal year ends on December 31, 2016, and financial statements are published in
March 2017.
1. Bowe-Whitney is involved in a lawsuit resulting from a dispute with a customer over a
2016 transaction. At December 31, attorneys advised that it was probable that Bowe–
Whitney would lose $3 million in an unfavorable outcome. On February 12, 2017,
Chapter 13 Current Liabilities and Contingencies
judgment was rendered against Bowe-Whitney in the amount of $14 million plus interest,
a total of $15.2 million. Bowe-Whitney does not plan to appeal the judgment.
2. Since August of 2016, Bowe-Whitney has been involved in labor disputes at two of its
facilities. Negotiations between the company and the unions have not produced a
settlement and, since January 2016, strikes have been ongoing at these facilities. It is
virtually certain that material costs will be incurred but the amount of resultant costs
cannot be adequately predicted.
3. Bowe-Whitney is the defendant in a lawsuit filed in January 2017 in which Access
Company seeks $10 million as an adjustment to the purchase price related to the sale of
Bowe-Whitney’s hardwood division in 2016. The lawsuit alleges that Bowe-Whitney
misrepresented the division’s assets and liabilities. Legal counsel advises that it is
reasonably possible that Bowe-Whitney could lose $5 million, but that it’s extremely
unlikely it could lose the $10 million asked for.
4. At March 1, 2017, the EPA is in the process of investigating the possibility of
environmental violations at one of Bowe-Whitney’s sites, but has not proposed a penalty
assessment. Management feels an assessment is reasonably possible, and if an assessment
is made, a settlement of up to $33 million is probable.
Required:
Prepare journal entries that should be recorded as a result of each of the above contingencies.
Chapter 13 Current Liabilities and Contingencies
139. Concept 1 Office Products sells office electronics that carry a 60-day manufacturer’s warranty.
At the time of purchase, customers are offered the opportunity to also buy a 1-year or 2-year
extended warranty for an additional charge.
Required:
1. Does the sale of the extended warranty represent a loss contingency?
2. Provide journal entries for the extended warranty sales and revenue recognition.
140. In its 2016 annual report to shareholders, Hyer Aviation Group Inc. included the following
disclosure:
On October 6, 2015, the company’s subsidiary, Pyro Aeroplex, filed suit against
Syntex, an unincorporated division of Bright American Corporation, for breach of
contract and fraud with regard to the supply of deficient wire rope that is installed as
aircraft flight control cables on WD-50 aircraft. The case, filed in the circuit court of
Bell County, Arkansas, was brought to trial and on September 20, 2016, a jury returned
with a verdict in favor of the company in the amount of $17.5 million. The Court, upon
a post-judgment motion filed by Pyro, reduced the judgment to $4.5 million. Pyro has
appealed that Order to the Supreme Court of Arkansas. The company believes the
appeal is without merit and will continue to pursue final judgment on the Order. The
company, pending appeal, has not recorded the $4.5 million favorable judgment.
Required:
What journal entries, if any, has Hyer recorded regarding this contingency? Explain its
rationale.
Chapter 13 Current Liabilities and Contingencies
Use the following to answer questions 141–144:
The following facts apply to TinyPart Toy Company’s pending litigation as of December 31, 2016:
a. TinyPart is defending against a lawsuit and believes there is a 51% chance it will lose in court.
If it loses, TinyPart estimates that damages will be $100,000.
b. TinyPart is defending against another lawsuit for which management believes it is virtually
certain to lose in court. If it loses the lawsuit, management estimates damages will fall
somewhere in the range of $30,000 to $50,000, with each amount in that range equally likely
to occur.
c. TinyPart is defending against another lawsuit that is identical to item (b), but the relevant
losses will only occur far into the future. The present values of the endpoints of the range are
$15,000 and $25,000. TinyPart’s management believes the effects of time value of money on
these amounts are material, but also believes the timing of these amounts is uncertain.
d. TinyPart is defending against a fourth lawsuit and believes there is only a 25% chance it will
lose in court. If TinyPart loses, it believes damages will fall somewhere in the range of
$35,000 to $40,000, with each amount in that range equally likely to occur.
141. Indicate how TinyPart would disclose or account for the lawsuit described in part (a) under
U.S. GAAP and under IFRS in the financial statements for the year ended December 31, 2016.
142. Indicate how TinyPart would disclose or account for the lawsuit described in part (b) under
U.S. GAAP and under IFRS in the financial statements for the year ended December 31, 2016.
Chapter 13 Current Liabilities and Contingencies
143. Indicate how TinyPart would disclose or account for the lawsuit described in part (c) under
U.S. GAAP and under IFRS in the financial statements for the year ended December 31, 2016.
144. Indicate how TinyPart would disclose or account for the lawsuit described in part (d) under
U.S. GAAP and under IFRS in the financial statements for the year ended December 31, 2016.
145. In 2016, Cap City Inc. introduced a new line of televisions that carry a two-year warranty
against manufacturer’s defects. Based on past experience with similar products, warranty costs
are expected to be approximately 1% of sales during the first year of the warranty and
approximately an additional 3% of sales during the second year of the warranty. Sales were
$6,000,000 for the first year of the product’s life and actual warranty expenditures were
$29,000. Assume that all sales are on credit.
Required:
1. Prepare journal entries to summarize the sales and any aspects of the warranty for 2016.
2. What amount should Cap City report as a liability at December 31, 2016?
Answer:
146. Albertson Corporation began a special promotion in July 2016 in an attempt to increase sales.
A coupon was provided at various grocery stores upon checkout. Customers could send in five
coupons for a free prize. Each prize cost Albertson Corporation $3.00. Albertson’s
management estimated that 80% of the coupons would be redeemed. For the six months ended
December 31, 2016, the following information is available:
Coupons distributed
2,000,000
Prizes purchased
240,000
Coupons redeemed
560,000
Required:
What is the estimated liability associated with the coupons at December 31, 2016?