109) Away Travel filed suit against West Coast Travel seeking damages for copyright violations.
Away Travel’s legal counsel believes it is probable (but not certain) that Away Travel will win
the lawsuit for an estimated amount in the range of $100,000 to $200,000, with all amounts in
the range considered equally likely. How should Away Travel report this litigation?
A) As a receivable for $100,000 with disclosure of the range.
B) As a receivable for $150,000 with disclosure of the range.
C) As a receivable for $200,000 with disclosure of the range.
D) As a disclosure only. No receivable is reported.
110) Young Company is involved in a lawsuit. The liability that could arise as a result of this
lawsuit should be recorded on the books if the probability of Young owing money as a result of
the lawsuit is:
A) Remote and the amount is reasonably estimable.
B) Probable and the amount is reasonably estimable.
C) Reasonably possible and the amount is reasonably estimable.
D) Probable and the amount is not reasonably estimable.
111) Ogden Motors, Inc. is involved in a lawsuit. It is reasonably possible that the jury will find
in favor of the plaintiff and Ogden will owe ten million dollars. What is the appropriate reporting
of this lawsuit and what is the effect in the balance sheet?
A) Record; decrease stockholders’ equity and increase liabilities.
B) Record; increase stockholders’ equity and decrease liabilities.
C) Disclose; no effect in the balance sheet.
D) Disclose; decrease stockholders’ equity and decrease liabilities.
112) Amplify, Inc. was sued by Sound City for $50,000. Sound City feels very confident that it
will win the case and will be awarded the full amount. Amplify, Inc. feels it is probable that it
will lose the case and pay Sound City the full amount. Which of the following is correct?
A) Amplify, Inc. would record a loss and contingent liability for $50,000.
B) Sound City would record a gain and lawsuit receivable for $50,000.
C) Sound City would record nothing.
D) Amplify, Inc. would record a loss and contingent liability for $50,000; Sound City would
record nothing.
113) A company has two active lawsuits at the end of the year. In Lawsuit 1, the company feels
it is probable that it will win $10,000. In Lawsuit 2, the company feels that it is probable that it
will lose $6,000. At the end of the year, the company should report a:
A) Net gain for $4,000.
B) Loss for $6,000.
C) Net Loss for $4,000.
D) Gain for $10,000.
114) While providing services to Palmer Co., Raider Group caused damages of $125,000. As of
the end of the year, both parties agree that it is probable that Raider will pay Palmer the full
amount of the damages within the next two months. How would Raider and Palmer report the
lawsuit at the end of the year?
A) Raider reports a loss; Palmer reports nothing.
B) Raider reports nothing; Palmer reports nothing.
C) Raider reports nothing; Palmer reports a gain.
D) Raider reports a loss; Palmer reports a gain.
115) At the beginning of 2021, Angel Corporation began offering a 1-year warranty on its
products. The warranty program was expected to cost Angel 4% of net sales. Net sales made
under warranty in 2021 were $180 million. Five percent of the units sold were returned in 2021
and repaired or replaced at a cost of $5.3 million. The amount of warranty expense in Angel’s
2021 income statement is:
A) $5.3 million.
B) $7.2 million.
C) $9.0 million.
D) $27.0 million.
116) The account “Warranty Liability”:
A) is adjusted at the end of the year.
B) is closed at the end of the year.
C) has a year-end credit balance equal to the cost of warranty repairs made during the year.
D) is credited each time a warranty repair is made.
117) Strikers, Inc. sells soccer goals to customers over the Internet. History has shown that 2% of
Strikers’ goals will need repair under the warranty program. For the year, Strikers has sold 4,000
goals and 45 have been repaired. If the estimated cost to repair a goal is $200, what would be the
warranty expense for the year?
A) $0.
B) $16,000.
C) $7,000.
D) $9,000.
118) Strikers, Inc. sells soccer goals to customers over the Internet. History has shown that 2% of
Strikers’ goals will need repair under the warranty program. For the year, Strikers has sold 4,000
goals and 45 have been repaired. If the estimated cost to repair a goal is $200, what would be the
warranty liability at the end of the year?
A) $0.
B) $16,000.
C) $7,000.
D) $9,000.
119) Bears Inc. sells football helmets to local schools and warrants all of its products for one
year. While no helmets sold in 2021 have been returned yet, based upon previous years, Bears
Inc. estimates that 3% of its products will need repairs or be replaced within the next year. What
effect would this warranty have on assets, liabilities, and stockholders’ equity in 2021?
A) A decrease in assets and decrease in stockholders’ equity.
B) No journal entry is necessary until products under warranty are returned.
C) An increase in stockholders’ equity and a decrease in liabilities.
D) A decrease in stockholders’ equity and an increase in liabilities.
120) In 2021, a company estimates that warranty costs in the following year will be $25,000.
Actual warranty costs in 2022 are only $20,000. What is the effect on the accounting equation
when recording actual warranty costs in 2022?
A) Stockholders’ equity decreases.
B) Stockholders’ equity increases.
C) Liabilities increase.
D) Liabilities decrease.
121) Patriot Paddleboards sells a paddleboard model that carries a one-year warranty on all
included accessories. Past experience indicates that 15% of those sold will have defective
accessories within a year and that average repair cost is $20 per paddleboard. If 1,000 were sold
this year and 50 have already been repaired under warranty, the entry to record warranty expense
for the year would include a debit to:
A) Warranty Expense of $2,000.
B) Warranty Liability of $2,000.
C) Warranty Liability of $3,000.
D) Warranty Expense of $3,000.
122) Talks-A-Lot, Inc. sells cell phones to customers and expects that 10% of phones sold will
be returned for repair under its warranty program. The average repair cost is $75 per phone. For
2021, Talks-A-Lot has sold 750 cell phones and has repaired 30 of them as of December 31,
2021. What amount of warranty liability should be reported at December 31, 2021?
A) $2,250.
B) $3,375.
C) $5,625.
D) None, all expected returns from warranties have been received.
123) Carpenter Inc. estimates warranty expense at 2% of sales. Sales during the year were $4
million and warranty expenditures were $44,000. What was the balance in the Warranty Liability
account at the end of the year?
A) $44,000.
B) $80,000.
C) $36,000.
D) $480,000.
124) 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.
125) Gain contingencies usually are recognized in a company’s income statement when:
A) The gain is certain.
B) The amount is reasonably estimable.
C) The gain is reasonably possible and the amount is reasonably estimable.
D) The gain is probable and the amount is reasonably estimable.
126) A contingent liability should be recorded in a company’s financial statements only if the
likelihood of a loss occurring is:
A) At least remotely possible 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 is reasonably estimable.
D) Probable and the amount of the loss can be reasonably estimated.
127) When a gain contingency is probable and the amount of gain is reasonably estimable, the
gain should be:
A) Reported in the income statement and disclosed.
B) Offset against stockholders’ equity.
C) Disclosed, but not recognized in the income statement.
D) Reported in the income statement, but not disclosed.
128) A contingent liability should be disclosed in a note to the financial statements rather than
being recorded if:
A) The likelihood of a loss is remote.
B) The likelihood of a loss is reasonably possible.
C) The likelihood of a loss is probable.
D) The likelihood of a loss is eighty percent.
129) Volt Electronics sells equipment that includes a three-year warranty. Repairs under the
warranty are performed by an independent service company under a 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.
130) Which of the following is a contingency that should be recorded?
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.
131) Unified Airlines is being sued by Northeast Airlines for $5,000,000. At the end of the year,
Unified feels it is probable that it will pay $5,000,000 at some point in the following year. What
should Unified and Northeast record at the end of the year concerning the lawsuit?
A) Unified does not record any loss; Northeast records a $5,000,000 gain.
B) Unified records a $5,000,000 loss; Northeast does not record any gain.
C) Unified records a $5,000,000 loss; Northeast records a $5,000,000 gain.
D) Neither company records a loss or gain.
132) Unified Airlines is being sued by Northeast Airlines for $5,000,000. At the end of the year,
Unified feels it is reasonably possible that it will pay $5,000,000 at some point in the following
year. What should Unified and Northeast record at the end of the year concerning the lawsuit?
A) Unified does not record any loss; Northeast records a $5,000,000 gain.
B) Neither company records a loss or gain.
C) Unified records a $5,000,000 loss; Northeast records a $5,000,000 gain.
D) Unified records a $5,000,000 loss; Northeast does not record any gain.
133) Discount Travel has the following current assets: cash, $102 million; receivables, $94
million; inventory, $182 million; and other current assets, $18 million. Discount Travel also has
the following liabilities: accounts payable, $98 million; current portion of long-term debt, $35
million; and long-term debt, $23 million. Based on these amounts, what is the current ratio?
A) 2.54.
B) 2.98.
C) 4.04.
D) 2.84.
134) Discount Travel has the following current assets: cash, $102 million; receivables, $94
million; inventory, $182 million; and other current assets, $18 million. Discount Travel also has
the following liabilities: accounts payable, $98 million; current portion of long-term debt, $35
million; and long-term debt, $23 million. Based on these amounts, what is the acid-test ratio?
A) 1.47.
B) 2.00.
C) 2.84.
D) 3.86.
135) Which of the following statements regarding liquidity ratios is false?
A) A high current ratio generally indicates the ability to pay current liabilities on a timely basis.
B) A high acid-test ratio generally indicates the ability to pay current liabilities on a timely basis.
C) All current assets are due within one year and therefore have essentially equal liquidity.
D) As a rule of thumb, a current ratio of 1 or higher often reflects an acceptable level of liquidity.
136) Which of the following statements regarding liquidity ratios is true?
A) A low current ratio generally indicates the ability to pay current liabilities on a timely basis.
B) A low acid-test ratio generally indicates the ability to pay current liabilities on a timely basis.
C) All current assets are due within one year and therefore have essentially equal liquidity.
D) A high working capital generally indicates the ability to pay current liabilities on a timely
basis.
137) Which of the following is true regarding the relationship between the current ratio and the
acid-test ratio?
A) The current ratio will always be equal to or larger than the acid-test ratio for a specific
company.
B) The acid-test ratio will always be equal to or larger than the current ratio for a specific
company.
C) Either the current ratio or the acid-test ratio could be larger for a specific company.
D) One ratio will always exceed 1.0, while the other will always be less than 1.0.
138) A company’s liquidity refers to its:
A) Ability to collect accounts receivable.
B) Ability to sell inventory efficiently.
C) Ability to generate profits from operations.
D) Ability to pay currently maturing debts.
139) Which financial ratio relates most closely to a company’s ability to pay its short-term debts?
A) Receivables turnover
B) Debt to equity ratio
C) Return on assets
D) Current ratio
140) Working capital is
A) Current assets divided by current liabilities.
B) Current assets minus current liabilities.
C) Cash, short-term investments, and accounts receivable divided by current liabilities.
D) Cash, short-term investments, and accounts receivable minus current liabilities.
141) The current ratio is
A) Current assets divided by current liabilities.
B) Cash and short-term investments divided by current liabilities.
C) Cash, short-term investments, and accounts receivable divided by current liabilities.
D) Cash, short-term investments, accounts receivable, and inventory divided by current
liabilities.
142) The acid-test ratio is
A) Current assets divided by current liabilities.
B) Cash and short-term investments divided by current liabilities.
C) Cash, short-term investments, and accounts receivable divided by current liabilities.
D) Cash, short-term investments, accounts receivable, and inventory divided by current
liabilities.
143) Which of the following measures of liquidity does not control for the relative size of the
company?
A) Working capital.
B) Current ratio.
C) Acid-test ratio.
D) They all control for the relative size of the company.
144) Assuming a current ratio of 1.2 and an acid-test ratio of 0.80, how will the purchase of
inventory with cash affect each ratio?
A) Increase the current ratio and increase the acid-test ratio.
B) No change to the current ratio and decrease the acid-test ratio.
C) Decrease the current ratio and decrease the acid-test ratio.
D) Decrease the current ratio and increase the acid-test ratio.
145) Assuming a current ratio of 1.0 and an acid-test ratio of 0.80, how will the borrowing of
cash by issuing a six-month note payable affect each ratio?
A) Increase the current ratio and increase the acid-test ratio.
B) No change to the current ratio and increase the acid-test ratio.
C) Decrease the current ratio and decrease the acid-test ratio.
D) Decrease the current ratio and increase the acid-test ratio.
146) Assuming a current ratio of 1.2 and an acid-test ratio of 0.80, how will an increase in
accounts receivable affect each ratio?
A) No change to the current ratio and decrease the acid-test ratio.
B) Increase the current ratio and increase the acid-test ratio.
C) Decrease the current ratio and decrease the acid-test ratio.
D) Decrease the current ratio and increase the acid-test ratio.
147) Which of the following would not result in an increase in both the current ratio and the
acid-test ratio?
A) Increase in cash
B) Increase in inventory
C) Increase in accounts receivable
D) Increase in current investments
148) Which of the following would result in an increase in the current ratio, but not necessarily
the acid-test ratio?
A) Increase in current assets.
B) Increase in quick assets.
C) Decrease in current liabilities.
D) Decrease in current assets.
57
149) How many of the following transactions increase a company’s liquidity?
• Provide services on account.
• Pay workers’ salaries in the current period.
• Purchase office supplies with cash.
• Pay dividends to stockholders.
A) 0.
B) 1.
C) 2.
D) 3.
58
Match the following:
A) Interest on debt
B) Line of credit
C) The riskiness of a business’s obligations
D) Payroll taxes
E) Current portion of long-term debt
150) Long-term debt maturing within one year of the balance sheet date.
Difficulty: 2 Medium
Topic: Current vs. Long-Term Classification; Notes Payable; Payroll Liabilities; Current Portion
of Long-Term Debt
Learning Objective: 08-01 Distinguish between current and long-term liabilities.; 08-02 Account
for notes payable and interest expense.; 08-03 Account for employee and employer payroll
liabilities.; 08-04 Explain the accounting for other current liabilities.
Bloom’s: Understand
AACSB: Reflective Thinking
AICPA/Accessibility: BB Critical Thinking
151) FICA and FUTA.
Difficulty: 2 Medium
Topic: Current vs. Long-Term Classification; Notes Payable; Payroll Liabilities; Current Portion
of Long-Term Debt
Learning Objective: 08-01 Distinguish between current and long-term liabilities.; 08-02 Account
for notes payable and interest expense.; 08-03 Account for employee and employer payroll
liabilities.; 08-04 Explain the accounting for other current liabilities.
Bloom’s: Understand
AACSB: Reflective Thinking
AICPA/Accessibility: BB Critical Thinking
152) Informal agreement that permits a company to borrow up to a prearranged limit.
Difficulty: 2 Medium
Topic: Current vs. Long-Term Classification; Notes Payable; Payroll Liabilities; Current Portion
of Long-Term Debt
Learning Objective: 08-01 Distinguish between current and long-term liabilities.; 08-02 Account
for notes payable and interest expense.; 08-03 Account for employee and employer payroll
liabilities.; 08-04 Explain the accounting for other current liabilities.
Bloom’s: Understand
AACSB: Reflective Thinking
AICPA/Accessibility: BB Critical Thinking
59
153) Classifying liabilities as either current or long-term helps investors and creditors assess this.
Difficulty: 2 Medium
Topic: Current vs. Long-Term Classification; Notes Payable; Payroll Liabilities; Current Portion
of Long-Term Debt
Learning Objective: 08-01 Distinguish between current and long-term liabilities.; 08-02 Account
for notes payable and interest expense.; 08-03 Account for employee and employer payroll
liabilities.; 08-04 Explain the accounting for other current liabilities.
Bloom’s: Understand
AACSB: Reflective Thinking
AICPA/Accessibility: BB Critical Thinking
154) Amount of note payable × annual interest rate × fraction of the year.
Difficulty: 2 Medium
Topic: Current vs. Long-Term Classification; Notes Payable; Payroll Liabilities; Current Portion
of Long-Term Debt
Learning Objective: 08-01 Distinguish between current and long-term liabilities.; 08-02 Account
for notes payable and interest expense.; 08-03 Account for employee and employer payroll
liabilities.; 08-04 Explain the accounting for other current liabilities.
Bloom’s: Understand
AACSB: Reflective Thinking
AICPA/Accessibility: BB Critical Thinking
60
Match the following:
A) Accrual accounting
B) Current portion of long-term debt
C) Deferred revenues
D) Commercial paper
E) The riskiness of a business’s obligations
F) Recording a contingent liability
G) Interest expense
H) FICA
I) Acid-test ratio
J) Disclosure of a contingent liability
155) Cash, short-term investments, and accounts receivable all divided by current liabilities.
Difficulty: 2 Medium
Topic: Current vs. Long-Term Classification; Notes Payable; Payroll Liabilities; Deferred
Revenues; Current Portion of Long-Term Debt; Contingencies – General; Analysis – Acid-Test
Ratio
Learning Objective: 08-01 Distinguish between current and long-term liabilities.; 08-02 Account
for notes payable and interest expense.; 08-03 Account for employee and employer payroll
liabilities.; 08-04 Explain the accounting for other current liabilities.; 08-05 Apply the
appropriate accounting treatment for contingencies.; 08-06 Assess liquidity using current liability
ratios.
Bloom’s: Understand
AACSB: Reflective Thinking
AICPA/Accessibility: BB Critical Thinking
156) Loss is probable and amount is reasonably estimable.
Difficulty: 2 Medium
Topic: Current vs. Long-Term Classification; Notes Payable; Payroll Liabilities; Deferred
Revenues; Current Portion of Long-Term Debt; Contingencies – General; Analysis – Acid-Test
Ratio
Learning Objective: 08-01 Distinguish between current and long-term liabilities.; 08-02 Account
for notes payable and interest expense.; 08-03 Account for employee and employer payroll
liabilities.; 08-04 Explain the accounting for other current liabilities.; 08-05 Apply the
appropriate accounting treatment for contingencies.; 08-06 Assess liquidity using current liability
ratios.
Bloom’s: Understand
AACSB: Reflective Thinking
AICPA/Accessibility: BB Critical Thinking