CHAPTER 9: CURRENT LIABILITIES AND CONTINGENCIES
1. Liabilities are defined as probable future sacrifices of economic benefits arising from present obligations of a company
to provide services or assets in the future as defined by the FASB.
a.
True
b.
False
True
1
Easy
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2. Vacation pay and year-end bonuses would be considered legal liabilities.
a.
True
b.
False
False
1
Easy
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3. The ability to utilize financial resources and to adapt to changes in the business environment is referred to as a
company’s financial flexibility.
a.
True
b.
False
True
1
Easy
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4. The FASB is concerned with the accurate portrayal of liquidity because users evaluate future cash flows in their
decision making practices.
a.
True
b.
False
True
1
Easy
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5. The ability to refinance short-term obligations on a long-term basis can be demonstrated if the company has already
refinanced those obligations after the date of the balance sheet but before it is issued.
a.
True
b.
False
True
1
Easy
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6. Short-term debt that is expected to be refinanced on a long-term basis may be excluded from the current liability
classification if the company has the intent to refinance or the ability to refinance.
a.
True
b.
False
False
1
Easy
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Chapter 9: Current Liabilities and Contingencies
7. Compensated absences include vacation, holiday, sick, or other activities for which the company pays its employees.
a.
True
b.
False
True
1
Easy
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8. Bonus agreements can be structured in various ways. A typical bonus calculation could involve income before or after
taxes and income before or after the bonus.
a.
True
b.
False
True
1
Easy
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9. Assume that a company is facing a loss contingency. GAAP requires the company to categorize the likelihood of
occurrence of a future event that will confirm the loss as being plausible, remotely plausible, or remote.
a.
True
b.
False
False
1
Easy
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10. Assume that a company is facing a loss contingency. GAAP requires the company to recognize a liability even if the
company cannot determine whether or not the event has occurred.
a.
True
b.
False
False
1
Easy
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11. The FASB recommends that assets and liabilities with differing liquidities be arranged as separate items in the balance
sheet.
a.
True
b.
False
True
1
Easy
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12. Assets and liabilities with differing implications for financial flexibility should be reported together.
a.
True
b.
False
False
1
Easy
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13. All of the following are examples of legal liabilities except
a.
notes payable.
b.
sales tax payable.
c.
sick pay payable (may be taken as time off).
d.
property taxes payable.
c
1
Easy
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14. Under current standards of the FASB, liabilities include
a.
only legal obligations.
b.
both legal and illegal obligations.
c.
both legal and nonlegal obligations.
d.
legal, nonlegal, and illegal obligations.
c
1
Easy
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15. Which of the following statements is true?
a.
One of the essential characteristics of a liability is that the transaction or other event obligating the entity will
probably occur in the future.
b.
In order for there to be a liability, a duty or responsibility must be present that obligates a particular entity.
c.
In order for there to be a liability, a legally enforceable claim must be present.
d.
In order to have a liability, the identity of the recipient must be known.
b
1
Moderate
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16. Which is not a characteristic of a liability?
a.
There will be a probable future transfer or use of assets.
b.
There is little or no discretion to avoid the future sacrifice.
c.
The obligating transaction or event must have already happened.
d.
A legally enforceable claim must be present.
d
1
Easy
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17. Which of the following statements does not describe an essential characteristic of a liability?
a.
A liability is a present obligation that will be settled by a probable future transfer or use of assets.
b.
The obligated entity has little or no discretion to avoid the future sacrifice.
c.
The identity of the recipient must be known to the obligated party.
d.
The transaction or event obligating the enterprise has already occurred.
c
1
Easy
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18. Which of the following is a legal liability?
a.
sick pay that may be taken as time off
b.
sales taxes payable to the state
c.
gambling debt owed
d.
bribes due to foreign traders
b
1
Easy
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19. Which of the following is not a characteristic of a liability?
a.
It will be settled by a future transfer of assets.
b.
The company has no discretion to avoid the future sacrifice.
c.
The obligating event has already happened.
d.
All of these are characteristics of a liability.
d
1
Easy
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20. Which of the following is not an issue associated with liabilities?
a.
Identification
b.
Valuation and Measurement
c.
Assessment
d.
Reporting
c
1
Easy
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21. On the balance sheet, liabilities are generally classified as
a.
current or long-term.
b.
legal or nonlegal.
c.
material or immaterial.
d.
probable or estimated.
a
1
Easy
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22. Current liabilities are obligations of a company that it expects to liquidate within
a.
one year.
b.
the normal operating cycle.
c.
the normal operating cycle or one year, whichever is longer.
d.
the normal operating cycle or one year, whichever is shorter.
c
1
Easy
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23. Analysts use the quick ratio (also known as the acid test ratio) and the current ratio. The use of both ratios has become
common because
a.
the quick ratio is much easier to compute than the current ratio.
b.
interpretation of the current ratio is more difficult because of its complexity.
c.
the acid test is a more severe test of a company’s liquidity.
d.
the acid test a better measure of management’s effectiveness.
c
1
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24. Current liabilities are obligations whose liquidation is reasonably expected to require the use of existing current assets
or the creation of other current liabilities within
a.
one year or operating cycle, whichever is longer.
b.
one year.
c.
one year or operating cycle, whichever is shorter.
d.
an operating cycle.
a
1
Easy
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25. Which of the following statements is true?
a.
If ability to refinance a currently maturing obligation is present, the obligation should be classified as
noncurrent debt.
b.
If no reasonable estimate can be made of the minimum amount expected to be available for future refinancing,
the entire outstanding short-term obligation must be disclosed as a noncurrent obligation.
c.
The FASB has concluded that obligations that are due on demand should be classified as current liabilities,
even though liquidation of the liabilities is not expected within the next year or operating cycle, whichever is
longer.
d.
If a refinancing is soon to be accomplished by issuing common stock, a currently maturing short-term
obligation should be included in shareholders’ equity on the current balance sheet.
c
1
Moderate
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26. The operating cycle is typically defined as the time it requires to convert
a.
cash to inventory to receivables.
b.
raw materials to finished goods.
c.
finished goods to receivables to cash.
d.
cash to inventory to receivables to cash.
d
1
Easy
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27. With regard to liabilities, liquidity refers to
a.
a company’s ability to convert its assets to cash to pay for its liabilities.
b.
a company’s ability to use its financial resources to adapt to change.
c.
a company’s operating cycle.
d.
only liabilities and not assets.
a
1
Easy
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28. Management of current liabilities arises, in part, because of a concern over
a.
profitability.
b.
liquidity.
c.
timeliness.
d.
materiality.
b
1
Easy
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29. Short-term debt expected to be refinanced
a.
may be classified as long-term if both the intent to refinance and the ability to refinance exist.
b.
must always be reported as a current liability.
c.
may be classified as long-term if off-balance-sheet financing has been obtained.
d.
may be classified as long-term if there is an intent to refinance.
a
1
Easy
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30. Which of the following statements regarding the gross and net methods for recording trade accounts payable is true?
a.
The net method overstates accounts payable at the end of the accounting period.
b.
The net method is more widely used in practice than is the gross method.
c.
The gross method more accurately measures liquidity.
d.
The net method highlights management inefficiency because purchase discounts lost are recorded whenever an
invoice is paid after the cash discount period has expired.
d
1
Easy
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31. On December 1, 2016, Old Car Co. borrowed money at the bank by signing a 90-day non-interest-bearing note for
$24,000 that was discounted at 8%. Which of the following entries is correct?
a.
March 1, 2017
Note Payable 23,520
Cash 23,520
b.
December 31, 2016
Interest Expense 160
Interest Payable 160
c.
December 1, 2016
Cash 24,000
Note Payable 24,000
d.
December 31, 2016
Interest Expense 160
Discount on Notes Payable 160
d
1
Moderate
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32. On December 1, 2015, Sons, Inc. borrowed money at the bank by signing a 90-day non-interest-bearing note for
$40,000 that was discounted at 12%. Which of the following entries is not correct?
a.
December 31, 2015
Interest Expense 400
Discount on Note Payable 400
b.
Feb. 1, 2016
Interest Expense 800
Discount on Note Payable 800
c.
December 31, 2015
Discount on Note Payable 400
Interest Expense 400
d.
December 1, 2015
Cash 38,800
Discount on Note Payable 1,200
Note Payable 40,000
c
1
Moderate
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33. Which of the following statements is false?
a.
A dividend payable in shares of the issuing company’s stock is not reported as a current liability.
b.
Interest and dividends accrue as a liability as time passes.
c.
The declaration of a dividend may not result in a current liability.
d.
Undeclared dividends in arrears on cumulative preferred stock are not recognized as a liability.
b
1
Easy
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34. Discount on Notes Payable should be classified as a
a.
current asset.
b.
contra account to Notes Payable.
c.
part of shareholders’ equity.
d.
companion account to Notes Payable.
b
1
Moderate
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35. On January 1, 2016, the Pruett Company signed a six-month, non-interest-bearing note payable for $170,000 and
received $162,800 from Your Neighborhood Bank. On January 31, 2016, what amount should Pruett record for
interest expense, and what is the net carrying value of the note?
a.
$1,200; $161,600
b.
$0; $170,000
c.
$7,200; $170,000
d.
$1,200; $164,000
d
1
Challenging
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36. The Lawrence Company records its trade accounts payable net of any cash discounts. At the end of 2016, Lawrence
had a balance of $300,000 in its trade accounts payable account before any adjustments related to the following items:
1.
Goods shipped to Lawrence FOB shipping point were in transit on December 31. The
invoice price of the goods was $50,000, with a 2% discount allowed for prompt payment.
2.
Goods shipped to Lawrence FOB destination on December 29 arrived on January 2, 2017.
The invoice price of the goods was $9,000, with a 4% discount allowed for payment within
20 days.
3.
On December 10, Lawrence had recorded a shipment received. The recorded invoice price
was $24,750, net, with a 1% discount allowed for payment within 14 days. At the end of
the year, payment had not been made.
At what amount should Lawrence report trade accounts payable on its December 31, 2016 balance sheet?
a.
$349,000
b.
$349,250
c.
$357,680
d.
$357,930
b
1
Challenging
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37. Which of the following dividends is not considered a current liability when declared?
a.
property dividends
b.
stock dividends
c.
scrip dividends
d.
cash dividends
b
1
Easy
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38. Cooper’s inventory has been financed 100% with a long-term note. The note is coming due in 2016. Cooper has
received a commitment from a new lender that permits five-year refinancing of debt up to an amount equal to 50% of
inventory, which is expected to range between $14,000 and $20,000 in 2016. At December 31, 2015, how much of the
company’s currently maturing note payable can be classified as long-term debt?
a.
$7,000
b.
$6,000
c.
$10,000
d.
$9,000
a
1
Moderate
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39. Beta, Inc. had $10,000 of notes payable coming due on January 10, 2016. As of December 31, 2015, Beta was
negotiating with the lender to extend the due date of the note by two additional years. On January 5, 2016, the
company used $2,000 of excess cash to pay off part of the note. On January 8, 2016, the refinancing was completed,
the $2,000 payment was refunded and added back to the note balance, and the note was extended for another two
years. On Beta’s December 31, 2015 balance sheet, which was issued on April 1, 2016, how much of the $10,000 note
should be shown as current?
a.
$10,000
b.
$0
c.
$8,000
d.
$2,000
d
1
Moderate
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40. On December 31, 2016, the Wagner Company had the following liabilities:
Trade accounts payable
$150,000
11% note payable, maturing in equal installments of $40,000
on December 30 of each year through 2019
120,000
12% note payable, issued October 15, 2016, maturing
February 15, 2017
70,000
On December 31, Wagner signed a binding agreement with its bank to refinance the 12% note through February 14,
2019, at a variable interest rate.
What is the amount of Wagner’s current liabilities on December 31, 2016?
a.
$150,000
b.
$190,000
c.
$230,000
d.
$260,000
d
1
Moderate
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41. The Antarctica Company closes its books annually on December 31, while the city in which it is located has a fiscal
year beginning on April 1 and ending on March 31. Taxes on property are assessed on April 1 of each year. Property
taxes in the amount of $360,000 and $390,000 were assessed on April 1, 2015 and 2016, respectively. For the year
ended December 31, 2016, the Antarctica Company would report property tax expense of
a.
$360,000.
b.
$370,000.
c.
$382,500.
d.
$390,000.
c
1
Moderate
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42. Sick pay benefits that are related to an employee’s services already rendered, whose payment is probable and whose
amount can reasonably be estimated, must be accrued and recognized as a current liability if the obligation relates to
rights that
Accumulate
Vest
I.
No
No
II.
No
Yes
III.
Yes
No
IV.
Yes
Yes
a.
I
b.
II
c.
III
d.
IV
b
1
Moderate
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43. Unearned revenue (also called deferred revenue) can occur when
a.
services are provided prior to receipt of cash.
b.
goods are sold on account.
c.
services are provided after the receipt of cash.
d.
goods are sold for cash.
c
1
Easy
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44. Candy’s Video includes the amount of sales taxes collected directly in the price charged for merchandise, and the total
amount is credited to Sales. During January, Sales was credited for $310,117.50. The January 31 adjusting entry to
account for a 5% state sales tax should be
a.
Sales 14,767.50
Sales Taxes Payable 14,767.50
b.
Sales Tax Expense 14,767.50
Sales Taxes Payable 14,767.50
c.
Sales 15,505.88
Sales Taxes Payable 15,505.88
d.
Sales Tax Expense 15,505.88
Sales Taxes Payable 15,505.88
a
1
Moderate
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45. According to current GAAP, which of the following is not a condition suggesting that an accrual for vacation pay
should be made?
a.
The obligation must relate to rights that vest.
b.
The payment of compensation is probable.
c.
The obligation must relate to employee services already rendered.
d.
The amount can be reasonably estimated.
a
1
Easy
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46. GAAP relating to compensated absences
a.
applies to items such as vacation pay, severance pay, sick pay, and other long-term fringe benefits.
b.
establishes the same accruing standards for vacation pay, holiday pay, and sick pay.
c.
requires the use of current pay rates to accrue for compensated absences.
d.
does not require the accrual of accumulated nonvested sick pay.
d
1
Easy
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47. Which payroll tax is imposed on both the employee and the employer?
a.
federal income tax
b.
state unemployment tax
c.
FICA tax
d.
federal unemployment tax
c
1
Easy
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48. Cunningham, a branch manager, is allowed a bonus of 10% of income after bonus and tax. If the tax rate is 30% and
income before bonus and tax is $200,000, what is Mr. Cunningham’s bonus?
a.
$13,084
b.
$14,000
c.
$14,433
d.
$20,000
a
1
Moderate
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49. Lucas Company provides a bonus compensation plan under which key employees receive bonuses equal to 10% of
Lucas’s income after deducting income taxes but before deducting the bonus. If income before income tax and the
bonus is $400,000 and the income tax rate is 30%, the bonuses should total
a.
$27,160.
b.
$28,866.
c.
$36,400.
d.
$40,000.
b
1
Moderate
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50. Voluntary payroll deductions may include all of the following except
a.
charity donations.
b.
401K deductions.
c.
group health insurance.
d.
FICA taxes.
d
1
Easy
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51. All of the following payroll taxes are levied against the employer except
a.
FICA taxes.
b.
federal unemployment taxes.
c.
state unemployment taxes.
d.
federal income taxes withheld.
d
1
Easy
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