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Chapter 13 Current Liabilities and Contingencies
64. Kline Company refinanced current debt as long-term debt on January 5, 2017. Kline’s fiscal
year ended on December 31, 2016, and its financial statements will be issued sometime in
early March 2017. Under IFRS, how would Kline classify the debt on its December 31, 2016,
balance sheet?
a. In the “mezzanine” between current and noncurrent liabilities.
b. Kline would not classify the debt as current or noncurrent, but rather would write a
disclosure note explaining the circumstances.
c. As a noncurrent liability.
d. As a current liability.
65. Branch Company, a building materials supplier, has $18,000,000 of notes payable due April
12, 2017. At December 31, 2016, Branch signed an agreement with First Bank to borrow up to
$18,000,000 to refinance the notes on a long-term basis. The agreement specified that
borrowings would not exceed 75% of the value of the collateral that Branch provided. At the
date of issue of the December 31, 2016, financial statements, the value of Branch's collateral
was $20,000,000. On its December 31, 2016, balance sheet, Branch should classify the notes
as follows:
a. $15,000,000 long-term and $3,000,000 current liabilities.
b. $4,500,000 short-term and $13,500,000 current liabilities.
c. $18,000,000 of current liabilities.
d. $18,000,000 of long-term liabilities.
66. Other things being equal, most managers would prefer to report liabilities as noncurrent rather
Chapter 13 Current Liabilities and Contingencies
than current. The logic behind this preference is that the long-term classification permits the
company to report:
a. Higher working capital and a higher inventory turnover.
b. Lower working capital and a higher current ratio.
c. Higher working capital and a higher current ratio.
d. Higher working capital and a lower debt to equity ratio.
67. Financial statement note disclosure is required for material potential losses when the loss is at
least reasonably possible:
a. Only if the amount is known.
b. Only if the amount is known or reasonably estimable.
c. Unless the amount is not reasonably estimable.
d. Even if the amount is not reasonably estimable.
68. Gain contingencies usually are recognized in a company's income statement when:
a. Realized.
b. The amount can be reasonably estimated.
c. The gain is reasonably possible and the amount can be reasonable estimated.
d. The gain is probable and the amount can be reasonably estimated.
69. Gray Co. estimates it is probable that it will receive a $10,000 gain contingency and pay a
$4,000 loss contingency. After recording the appropriate journal entries to recognize
contingent amounts, Gray Co.’s net assets will:
a. Increase by $10,000.
b. Increase by $6,000.
c. Decrease by $4,000.
d. Not change.
Chapter 13 Current Liabilities and Contingencies
70. A company should accrue a loss contingency only if the likelihood that a liability has been
incurred is:
a. More likely than not and the amount of the loss is known.
b. At least reasonably possible and the amount of the loss is known.
c. At least reasonably possible and the amount of the loss can be reasonably estimated.
d. Probable and the amount of the loss can be reasonably estimated.
71. A loss contingency should be accrued in a company's financial statements only if the
likelihood that a liability has been incurred is:
a. At least remotely possible and the amount of the loss is known.
b. Reasonably possible and the amount of the loss is known.
c. Reasonably possible and the amount of the loss can be reasonably estimated.
d. Probable and the amount of the loss can be reasonably estimated.
72. A contingent loss should be reported in a disclosure note to the financial statements rather than
being accrued if:
a. The likelihood of a loss is remote.
b. The incurrence of a loss is reasonably possible.
c. The incurrence of a loss is more likely than not.
d. The likelihood of a loss is probable.
Chapter 13 Current Liabilities and Contingencies
73. Which of the following is a contingency that should be accrued?
a. The company is being sued and a loss is reasonably possible and reasonably estimable.
b. The company deducts life insurance premiums from employees' paychecks.
c. The company offers a two-year warranty and the expenses can be reasonably estimated.
d. It is probable that the company will receive $100,000 in settlement of a lawsuit.
74. Paul Company issues a product recall due to an apparently preexisting and material defect
discovered after the end of its fiscal year. Financial statements have not yet been issued. The
action required of Paul Company for this reasonably estimable contingency for the year just
ended is:
a. To disclose it in a note to the financial statements.
b. To accrue a long-term liability.
c. To accrue the liability and explain it in a note to the financial statements.
d. To do nothing relative to the contingency.
75. Accounting for costs of incentive programs for customer purchases:
a. Requires probability estimation.
b. Follows the matching principle.
c. Is a loss contingency situation.
d. All of these answer choices are correct.
76. Providing a monetary rebate program for purchasing a product:
Chapter 13 Current Liabilities and Contingencies
a. Is accounted for similarly to product warranties.
b. Creates an expense for the seller in the period of sale.
c. Creates a contingent liability for the seller at the time of sale.
d. All these answer choices are correct.
77. An extended warranty typically results in the seller:
a. Accruing an expense for anticipated warranty costs at the time the warranty is sold.
b. Estimating the contingent liability associated with the warranty at the time the warranty is
sold.
c. Recognizing revenue over the life of the extended warranty.
d. Refunding warranty payments upon expiration of the warranty.
78. A quality-assurance warranty typically results in the seller:
a. Accruing an expense for anticipated warranty costs at the time the warrantied product is
sold.
b. Recognizing an asset for accrued warranty costs which is amortized over the life of the
warranty.
c. Recognizing revenue over the life of the extended warranty.
d. Refunding warranty payments upon expiration of the warranty.
Chapter 13 Current Liabilities and Contingencies
79. Which of the following is true about the initial journal entry used to record quality-assurance
warranties?
Recognize a Recognize
contingent liability deferred revenue
a. No No
b. No Yes
c. Yes No
d. Yes Yes
80. Which of the following is true about the initial journal entry used to record extended
warranties?
Recognize a Recognize
contingent liability deferred revenue
a. No No
b. No Yes
c. Yes No
d. Yes Yes
81. Blue Co. can estimate the amount of loss that will occur if a foreign government expropriates
some of the company’s assets in that country. If the likelihood of expropriation is remote, a
loss contingency should be:
a. Disclosed but not accrued as a liability.
b. Disclosed and accrued as a liability.
c. Accrued as liability but not disclosed.
d. Neither accrued as a liability nor disclosed.
Chapter 13 Current Liabilities and Contingencies
82. Orange Co. can estimate the amount of loss that will occur if a foreign government
expropriates some of the company’s assets in that country. If expropriation is reasonably
possible, a loss contingency should be:
a. Disclosed but not accrued as a liability.
b. Disclosed and accrued as a liability.
c. Accrued as liability but not disclosed.
d. Neither accrued as a liability nor disclosed.
83. Red Co. can estimate the amount of loss that will occur if a foreign government expropriates
some of the company’s assets in that country. If expropriation is probable, a loss contingency
should be:
a. Disclosed but not accrued as a liability.
b. Disclosed and accrued as a liability.
c. Accrued as liability but not disclosed.
d. Neither accrued as a liability nor disclosed.
84. Z Co. filed suit against W Inc. in 2016 seeking damages for patent infringement. At December
31, 2016, legal counsel for Z believed that it was probable that Z would be successful against
W for an estimated amount in the range of $30 million to $60 million, with each amount in
that range considered equally likely. Z was awarded $40 million in April 2017. Z should
report this award in its 2016 financial statements, issued in March 2017 as:
a. A receivable and deferred revenue of $40 million.
b. A receivable and revenue of $40 million.
c. A disclosure of a gain contingency of $40 million.
d. A disclosure of a gain contingency of an undetermined amount in the range of $30 million
to $60 million.
85. When a material gain contingency is probable and the amount of gain can be reasonably
estimated, the gain should be:
a. Reported in the income statement and disclosed.
b. Offset against shareholders' equity.
c. Disclosed but not recognized in the income statement.
d. Neither recognized in the income statement nor disclosed.
86. Which of the following is a contingency that would most likely require accrual?
a. Potential claims on extended warranties.
b. Customer premium offers.
c. Potential liability on a product where none have yet been sold.
d. Sales tax payable.
87. A customer of RoughEdge Sharpeners alleges that RoughEdge’s new razor sharpener had a
defect that resulted in serious injury to the customer. RoughEdge believes the customer has a
51% chance of winning the case, and that if the customer wins the case, there is a range of
losses of between $1,000,000 and $3,000,000 in which any number is equally likely to occur.
Under U.S. GAAP, RoughEdge should accrue a liability in the amount of:
a. $0.
b. $1,000,000.
c. $2,000,000.
d. $3,000,000.
88. A customer of Razor Sharpeners alleges that Razor’s new razor sharpener had a defect that
resulted in serious injury to the customer. Razor believes the customer has a 51% chance of
winning the case, and that if the customer wins the case, there is a range of losses of between
$1,000,000 and $3,000,000 in which any number is equally likely to occur. Under IFRS,
Razor should accrue a liability in the amount of:
a. $0.
b. $1,000,000.
c. $2,000,000.
d. $3,000,000.
89. Volt Electronics sells equipment that includes a three-year warranty. Repairs under the
warranty are performed by an independent service company under contract with Volt. Based
on prior experience, warranty costs are estimated to be $25 per item sold. Volt should
recognize these warranty costs:
a. When the equipment is sold.
b. When the repairs are performed.
c. When payments are made to the service firm.
d. Evenly over the life of the warranty.
90. As part of a promotion campaign, Funzy Cereal includes one coupon in each issue of various
national magazines and offers a toy car in exchange for $1.00 and three coupons. The cars cost
Funzy $1.50 each. Experience indicates that 4% of the coupons eventually will be redeemed.
During the last month of 2013, the first month of the offer, 12 million coupons were
distributed and 240,000 million of the coupons were redeemed. What amount should Funzy
report as a promotional expense for coupons on its December 31, 2013, income statement?
a. $ 0.
b. $ 40,000.
c. $ 80,000.
Chapter 13 Current Liabilities and Contingencies
d. $120,000.
91. At the beginning of 2016, Angel Corporation began offering a two-year warranty on its
products. The warranty program was expected to cost Angel 4% of net sales. Net sales made
under warranty in 2016 were $180 million. Fifteen percent of the units sold were returned in
2016 and repaired or replaced at a cost of $5.3 million. The amount of warranty expense on
Angel's 2016 income statement is:
a. $ 5.3 million.
b. $ 7.2 million.
c. $10.6 million.
d. $27.0 million.
92. During 2016, Deluxe Leather Goods sold 800,000 reversible belts under a new sales
promotional program. Each belt carried one coupon, which entitles the customer to a $5.00
cash rebate. Deluxe estimates that 70% of the coupons will be redeemed, even though only
350,000 coupons had been processed during 2016. At December 31, 2016, Deluxe should
report a liability for unredeemed rebates of:
a. $ 560,000.
b. $1,050,000.
c. $1,225,000.
d. $1,750,000.
Use the following to answer questions 93 and 94:
Chapter 13 Current Liabilities and Contingencies
In 2016, Holyoak Inc. offers a $20 cash rebate coupon to customers who purchased one of its new line
of products. Holyoak sold 10,000 of these products during the year. By year-end of 2016, 7,600 of the
rebates had been claimed, and 7,100 had been paid. Holyoak's historical experience with such rebates
indicates that 85% of customers claim the rebates.
93. What is the expense that Holyoak should report for its promotional rebates in its 2016 income
statement?
a. $142,000.
b. $152,000.
c. $170,000.
d. $200,000.
94. What is the rebate promotion liability that Holyoak should report in its December 31, 2016,
balance sheet?
a. $20,000.
b. $28,000.
c. $18,000.
d. $19,000.
95. In the current year, Hanna Company reported quality-assurance warranty expense of $190,000
and the warranty liability account increased by $20,000. What were warranty expenditures
during the year?
a. $190,000.
b. $170,000.
c. $210,000
d. $ 0.
96. Panther Co. had a quality-assurance warranty liability of $350,000 at the beginning of 2016
and $310,000 at the end of 2016. Warranty expense is based on 4% of sales, which were $50
million for the year. What were the warranty expenditures for 2016?
a. $0.
b. $1,960,000.
c. $2,000,000.
d. $2,040,000.
97. Carpenter Inc. had a balance of $80,000 in its quality-assurance warranty liability account as
of December 31, 2015. In 2016, Carpenter's warranty expenditures were $445,000. Its
warranty expense is calculated as 1% of sales. Sales in 2016 were $40 million. What was the
balance in the warranty liability account as of December 31, 2016?
a. $ 35,000.
b. $425,000.
c. $125,000.
d. $480,000.
Chapter 13 Current Liabilities and Contingencies
Use the following to answer questions 98–100:
General Product Inc. distributed 100 million coupons in 2016. The coupons are redeemable for 30
cents each. General anticipates that 70% of the coupons will be redeemed. The coupons expire on
December 31, 2017. There were 45 million coupons redeemed in 2016 and 30 million redeemed in
2017.
98. What was General's coupon promotion expense in 2016?
a. $30.0 million.
b. $21.0 million.
c. $13.5 million.
d. $7.5 million.
99. What was General's coupon liability as of December 31, 2016?
a. $7.5 million.
b. $13.5 million.
c. $16.5 million.
d. $21.0 million.
100. What was General's coupon promotional expense in 2017?
a. Zero, since all the expense should be reflected in 2016.
b. $1.5 million.
c. $7.5 million.
d. $9.0 million.
Chapter 13 Current Liabilities and Contingencies
101. During the year, L&M Leather Goods sold 1,000,000 reversible belts under a new sales
promotional program. Each belt carried one coupon, which entitles the customer to a $4.00
cash rebate. L&M estimates that 70% of the coupons will be redeemed, even though only
500,000 coupons had been processed during the year. At December 31, L&M should report a
liability for unredeemed coupons of:
a. $ 700,000.
b. $ 800,000.
c. $1,000,000.
d. $2,800,000.
102. Which of the following may create employer liabilities in connection with their payrolls?
a. Employee withholding taxes.
b. Employee voluntary deductions.
c. Employee fringe benefits.
d. All of these answer choices are correct.
103. Barbara Muller Services (BMS) pays its employees monthly. The payroll information listed
below is for January 2016, the first month of BMS’s fiscal year.
Salaries $80,000
Federal income taxes to be withheld 16,000
Federal unemployment tax rate 0.80%
State unemployment tax rate (after FUTA deduction) 5.40%
Social security tax rate 6.2%
Medicare tax rate 1.45%
The journal entry to record payroll for the January 2016 pay period will include a debit to
payroll tax expense of:
a. $ 6,120.
b. $ 4,960.
c. $11,080.
d. $57,880.
Chapter 13 Current Liabilities and Contingencies
Matching Pair Questions
104. Listed below are five terms followed by a list of phrases that describe or characterize each of
the terms. Match each phrase with the number for the most correct term.
TERM
PHRASE
NUMBER
1. Short-term note
Liabilities when received.
____
2. Warranty liability
Confirming event is likely to occur.
____
3. Advances from customers
A loss contingency accrued in the period of
related sales.
____
4. Probable
Most common temporary financing arrangement.
____
5. Secured loan
Requires collateral.
____
105. Listed below are five terms followed by a list of phrases that describe or characterize each of
the terms. Match each phrase with the number for the most correct term.
TERM
PHRASE
NUMBER
1. Sales tax payable
Due on demand.
____
2. Callable
Contra liability.
____
3. Accrued liabilities
A third party liability.
____
4. Discount on notes payable
Accrues with passage of time.
____
5. Interest payable
Expenses incurred but not yet paid.
____
106. Listed below are five terms followed by a list of phrases that describe or characterize each of
the terms. Match each phrase with the number for the most correct term.
TERM
PHRASE
NUMBER
1. Noncommitted lines of credit
Liabilities until refunded.
____
2. Gain contingencies
More than remote but less than likely.
____
3. Customer deposits
Face amount x rate x time.
____
4. Reasonably possible
Not recorded until realized.
____
5. Interest paid on debt
Informal borrowing agreements.
____
Answer:
Chapter 13 Current Liabilities and Contingencies
107. Listed below are five terms followed by a list of phrases that describe or characterize each of
the terms. Match each phrase with the number for the most correct term.
TERM
PHRASE
NUMBER
1. Subsequent events
Larger than that stated on discounted notes.
____
2. Unasserted claims
May include items that are not legally enforceable.
____
3. Liabilities
Sale of receivables.
____
4. Factoring
Evaluated for recognition only if an unfavorable
outcome is probable.
____
5. Effective interest
Occur in the current year before prior year financial
statements are issued.
____
Answer:
108. Listed below are five terms followed by a list of phrases that describe or characterize each of
the terms. Match each phrase with the number for the most correct term.
TERM
PHRASE
NUMBER
1. Noninterest-bearing notes
Use accounts receivable as collateral.
____
2. Committed lines of credit
Often require compensating balance.
____
3. Loss contingencies
The formal credit instrument is the invoice.
____
4. Secured loans
Effective interest higher than stated interest.
____
5. Accounts payable
Recorded if probable and amount is known or
reasonably estimable.
____
Answer:
Chapter 13 Current Liabilities and Contingencies
