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APPENDIX J
OTHER SIGNIFICANT LIABILITIES
SUMMARY OF QUESTIONS BY OBJECTIVES AND BLOOM’S TAXONOMY
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True-False Statements
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Multiple Choice Questions
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Exercises
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Completion Statements
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SUMMARY OF LEARNING OBJECTIVES BY QUESTION TYPE
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Learning Objective 1
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Learning Objective 2
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Learning Objective 3
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Note: TF = True-False C = Completion
MC = Multiple Choice Ex = Exercise
Matching: 39, Short Answer:40
Test Bank for Financial Accounting, Ninth Edition
J - 2
CHAPTER STUDY OBJECTIVES
1. Describe the accounting and disclosure requirements for contingent liabilities. If it is
probable that (likely to occur) the contingency will happen and the amount is reasonably
estimable, the liability should be recorded in the accounts. However, if it is only reasonably
possible (it could occur), then it need be disclosed only in the notes to the financial
statements. If the possibility that the contingency will happen is remote (unlikely to occur), it
need not be recorded or disclosed.
2. Contrast the accounting for operating and capital leases. For an operating lease, lease
(or rental) payments are recorded as an expense by the lessee (renter). For a capital lease,
the lessee records the asset and related obligation at the present value of the future lease
payments.
3. Identify additional fringe benefits associated with employee compensation. Additional
fringe benefits associated with wages are paid absences (paid vacations, sick pay benefits,
and paid holidays), post-retirement health care and life insurance, and pensions. The two
most common types of pension arrangements are a defined contribution plan and a defined
benefit plan.
TRUE-FALSE STATEMENTS
1. Contingent liabilities should be recorded in the accounts if there is a remote possibility that
the contingency will actually occur.
2. A contingent liability is a liability that may occur if some future event takes place.
3. In concept, the estimating of Warranty Expense when products are sold under warranty is
similar to the estimating of Bad Debts Expense based on credit sales.
4. Repair costs incurred in honoring warranty contracts should be debited to Warranty
Liability.
5. The renting of an apartment is an example of a capital lease.
6. An operating lease transfers substantially all the benefits and risks of ownership to the
lessee.
Other Significant Liabilities
J - 3
7. A capital lease requires the lessee to record the lease as a purchase of an asset.
8. When vacation benefits are paid, Vacation Benefits Expense is debited.
9. Postretirement benefits are accounted for on a cash basis.
10. In a defined contribution plan, an employer only recognizes pension expense for the
amount that the employer is required to contribute under the plan.
Business Economics
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MULTIPLE CHOICE QUESTIONS
11. If a contingent liability is reasonably estimable and it is reasonably possible that the
contingency will occur, the contingent liability
a. should be recorded in the accounts.
b. should be disclosed in the notes accompanying the financial statements.
c. should not be recorded or disclosed in the notes until the contingency actually
happens.
d. must be paid for the amount estimated.
12. The accounting for warranty cost is based on the expense recognition principle, which
requires that the estimated cost of honoring warranty contracts should be recognized as
an expense
a. when the product is brought in for repairs.
b. in the period in which the product was sold.
c. at the end of the warranty period.
d. only if the repairs are expected to be made within one year.
13. If a liability is dependent on a future event, it is called a
a. potential liability.
b. hypothetical liability.
c. probabilistic liability.
d. contingent liability.
Test Bank for Financial Accounting, Ninth Edition
J - 4
14. A contingency that is remote
a. should be disclosed in the financial statements.
b. must be accrued as a loss.
c. does not need to be disclosed.
d. is recorded as a contingent liability.
15. The accounting for warranty costs is based on the
a. going concern principle.
b. expense recognition principle.
c. conservatism principle.
d. full disclosure principle.
16. Warranty expenses are reported on the income statement as
a. administrative expenses.
b. part of cost of goods sold.
c. contra-revenues.
d. selling expenses.
17. Marin Company sells 9,000 units of its product in 2015 for $500 each. The selling price
includes a one-year warranty on parts. It is expected that 3% of the units will be defective
and that repair costs will average $50 per unit. In the year of sale, warranty contracts are
honored on 180 units for a total cost of $9,000.
What amount should Marin Company report as Warranty Expense in its 2015 income
statement?
a. $13,500.
b. $9,000.
c. $4,500.
d. $67,500.
18. Marin Company sells 9,000 units of its product in 2015 for $500 each. The selling price
includes a one-year warranty on parts. It is expected that 3% of the units will be defective
and that repair costs will average $50 per unit. In the year of sale, warranty contracts are
honored on 180 units for a total cost of $9,000.
What amount will be reported on Marin Company's balance sheet as Warranty Liability on
December 31, 2015?
a. $9,000.
b. $13,500.
c. $4,500.
d. Cannot be determined.
Other Significant Liabilities
J - 5
19. Which of the following items would not be identified if a contingent liability were disclosed
in a financial statement note?
a. The nature of the item
b. The expected outcome of the future event
c. A numerical probability of the expected loss
d. The amount of the contingency, if known
20. Disclosure of a contingent liability is usually made
a. parenthetically, in the body of the balance sheet.
b. parenthetically, in the body of the income statement.
c. in a note to the financial statements.
d. in the management discussion section of the financial statements.
21. A lease where the intent is temporary use of the property by the lessee with continued
ownership of the property by the lessor is called
a. off-balance sheet financing.
b. an operating lease.
c. a capital lease.
d. a purchase of property.
22. Which of the following is not a condition which would require the recording of a lease
contract as a capital lease?
a. The lease transfers ownership of the property to the lessee.
b. The lease contains a bargain purchase option.
c. The lease term is less than 75% of the economic life of the leased property.
d. The present value of the lease payments equals or exceeds 90% of the fair value of
the leased property.
23. In a lease contract,
a. the owner of the property is called the lessee.
b. the presence of a bargain purchase option indicates that it is a capital lease.
c. the renter of the property is called the lessor.
d. there is always a transfer of ownership at the end of the lease term.
Test Bank for Financial Accounting, Ninth Edition
J - 6
24. Which of the following statements concerning leases is true?
a. Capital leases are favored by lessees.
b. The appearance of the account, Leased Asset, on the balance sheet, signifies an
operating lease.
c. The portion of a lease liability expected to be paid in the next year is reported as a
current liability.
d. Present value is irrelevant in accounting for leases.
25. If the present value of lease payments equals or exceeds 90% of the fair value of the
leased property, the
a. conditions are met for the lease to be considered a capital lease.
b. lease is uneconomical and should not be entered into.
c. lease may be classified as an operating lease.
d. recording of a lease liability is optional—that is, the off-balance sheet approach can be
elected.
26. In a capital lease, the amount capitalized is the
a. sum of the lease payments over the life of the lease.
b. fair value of the leased asset on the date the lease is signed.
c. present value of the lease payments.
d. future value of the asset as of the lease termination date.
27. Postretirement benefits consist of payments by employers to retired employees for
a. health care and life insurance only.
b. health care and pensions only.
c. life insurance and pensions only.
d. health care, life insurance, and pensions.
28. The paid absence that is most commonly accrued is
a. voting leave.
b. vacation time.
c. maternity leave.
d. disability leave.
29. Larson Company has twenty employees who each earn $120 per day. If they accumulate
vacation time at the rate of 1.5 vacation days for each month worked, the amount of
vacation benefits that should be accrued at the end of the month is
a. $240.
b. $2,400.
c. $3,600.
d. $360.
Other Significant Liabilities
J - 7
30. An employer's estimated cost for postretirement benefits for its employees should be
a. recognized as an expense when paid.
b. recognized as an expense during the employees' work years.
c. recognized as an expense during the employees' retirement years.
d. charged to the goodwill account because providing employees with benefits generates
employee goodwill.
Answers to Multiple Choice Questions
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EXERCISES
Ex. 31
Sam Myers sells televisions with a 2-year warranty. Past experience indicates that 2% of the units
sold will be returned during the warranty period for repairs. The average cost of repairs under
warranty is estimated to be $75 per unit. During 2015, 9,000 units were sold at an average price
of $400. During the year, repairs were made on 50 units at a cost of $3,900.
Instructions
Prepare journal entries to record the repairs made under warranty and estimated warranty
expense for the year.
Test Bank for Financial Accounting, Ninth Edition
J - 8
Ex. 32
Hutton Cape Company, which prepares annual financial statements, is preparing adjusting
entries on December 31. Analysis indicates the following:
1. The company is the defendant in an employee discrimination lawsuit involving $50,000 of
damages. Legal counsel believes it is unlikely that the company will have to pay any
damages.
2. Employees are entitled to one day's vacation for each month worked. The company employs
50 people who earn $120 per day and 30 who earn $160 per day. All employees worked the
entire year.
3. The company is a defendant in a $500,000 product liability lawsuit. Legal counsel believes
that the company probably will have to pay the amount requested.
4. The company has a defined benefit pension plan in which total pension expense for
December is $50,000. The company funds one half of the expense and records a liability or
the balance due.
Instructions
Prepare any adjusting entries necessary at the end of the year.
Ex. 33
Sandra Sikes sells exercise machines for home use. The machines carry a 2-year warranty. Past
experience indicates that 5% of the units sold will be returned during the warranty period for
repairs. The average cost of repairs under warranty is $40 for labor and $50 for parts per unit.
During 2015, 3,000 exercise machines were sold at an average price of $800. During the year, 95
of the machines that were sold were repaired at the average price per unit.
Instructions
(a) Prepare the journal entry to record the repairs made under warranty.
(b) Prepare the journal entry to record the estimated warranty expense for the year.
Other Significant Liabilities
J - 9
Ex. 34
Roberts Company is preparing monthly adjusting entries at December 31. An analysis reveals the
following:
1. During December, Roberts Company sold 3,000 units of a product that carries a 60-day
warranty. The sales for this product totaled $100,000. The company expects 4% of the units
to need repair under the warranty and it estimates that the average repair cost per unit will be
$20.
2. The company has been sued by a disgruntled employee. Legal counsel believes that it is
reasonably possible that the company will have to pay $200,000 in damages.
3. The company has been named as one of several defendants in a $400,000 damage suit.
Legal counsel believes it is unlikely that the company will have to pay any damages.
4. Employees earn vacation pay at a rate of 1 day per month. During December, ten employees
qualify for vacation pay. Their average daily wage is $80 per employee.
Instructions
Prepare adjusting entries, if required, for each of the four items.
Test Bank for Financial Accounting, Ninth Edition
J - 10
Solution 34 (10 min.)
Ex. 35
Presented below are three different aircraft lease transactions that occurred for Western Airways
in 2015. All the leases start on January 1, 2015. In no case does Western receive title to the
aircraft during or at the end of the lease period; nor is there a bargain purchase option.
Lessor
Utah Insurance Laine Leasing Howard Leasing
Type of property 747 Aircraft 727 Aircraft MD-11 Aircraft
Yearly rental $8,272,293 $4,954,021 $2,851,861
Lease term 15 years 15 years 20 years
Estimated economic life 25 years 25 years 25 years
Fair value of
leased asset $77,000,000 $49,000,000 $32,000,000
Present value of lease
rental payments $70,000,000 $42,000,000 $28,000,000
Instructions
(a) Which of the above leases are operating leases and which are capital leases? Explain your
answer.
(b) How should the lease transaction with Utah Insurance be recorded in 2015?
(c) How should the lease transaction with Laine Leasing be recorded in 2015?
Other Significant Liabilities
J - 11
Solution 35 (10 – 14 min.)
Ex. 36
Ryan Corporation entered into the following transactions:
1. Hewitt Car Rental leased a car to Ryan Corporation for one year. Terms of the operating
lease call for monthly payments of $750.
2. On January 1, 2015, Ryan Corporation entered into an agreement to lease 20 machines from
Meeks Corporation. The terms of the lease agreement require an initial payment of $210,000
and then three annual rental payments of $210,000 beginning on December 31, 2015. The
present value of the three rental payments is $522,238. The lease is a capital lease.
Instructions
Prepare the appropriate journal entries to be made by Ryan Corporation in January related to the
lease transactions.
Test Bank for Financial Accounting, Ninth Edition
J - 12
COMPLETION STATEMENTS
37. A contingent liability should be recorded in the accounts if it is ________________ that
the contingency will occur and the amount is ________________.
38. A lease may be classified as an ______________ lease or as a ____________ lease.
Answers to Completion Statements
MATCHING
39. Match the items below by entering the appropriate code letter in the space provided.
A. Capital lease D. Defined benefit plan
B. Contingent liability E. Defined contribution plan
C. Operating lease
____ 1. A contractual arrangement that gives the lessee temporary use of property.
____ 2. The cash paid by the employer to the pension plan is defined.
____ 3. A contractual arrangement which is in effect a purchase of property.
____ 4. A pension plan where employee receipts after retirement are defined.
____ 5. A potential liability that may become an actual liability in the future.
Other Significant Liabilities
J - 13
SHORT-ANSWER ESSAY
S-A E 40
A company will incur product repair costs in the future if products that it sells currently under
warranty are brought in for repair during the warranty period. The company will also incur bad
debt expense in the future if customers who buy on credit currently are unable to pay their
accounts. Are the accounting procedures for these two contingent costs (warranty expense and
bad debt expense) related to or guided by the same accounting principle? Briefly explain.
