Chapter 9: Current Liabilities, Contingencies, and the True Value of Money
Valance & Company
Use the selected data from the balance sheet and cash flow statements for Valance & Company to answer the questions
that follow.
Valance & Company
Balance Sheet
(Selected Information)
(in millions)
December 31,
2017
2016
Cash and cash equivalents
$ 76.9
$ 81.6
Current Liabilities:
Loans payable
$ 656.7
$ 634.7
Accounts payable and accrued expenses
1,964.9
1,609.8
Income taxes payable
298.6
319.4
Current portion of long-term debt
14.5
26.5
Total current liabilities
$2,934.7
$2,590.4
Long-term debt
$1,490.4
$1,048.4
Deferred income taxes
298.9
303.3
Other long-term liabilities
1,190.5
1076.1
Valance & Company
Statements of Cash Flow
(Selected Information)
(in millions)
Year ended Dec. 31,
2017
Operating activities
Net income
$ 948.7
Adjustments to reconcile net income to net cash
provided from operating activities:
Depreciation and amortization
664.1
Other
-0-
Changes in operating assets and liabilities:
Accounts receivable
(459.1)
Inventories
(104.8)
Accounts payable and accrued expenses
355.1
Other working capital items
(141.6)
Other noncurrent assets and liabilities
34.2
Net cash provided by operating activities
$1,296.6
Financing activities
Purchase of treasury stock
$ (11.4)
Proceeds from exercise of stock options
149.5
Decrease in long-term debt
(149.5)
Increase in loans payable
577.7
Dividends paid
(450.8)
Net cash provided (used in) financing activities
$1,005.0
192. Refer to the data for Valance & Company.
Required:
(1) What current liabilities appearing on the balance sheet do not appear in the operating activities section of the statement
of cash flows? Why?
(2) What current liabilities appear in the operating activities category of Valance’s statement of cash flows? How does the
change for each year affect the cash flows from operating activities for that year?
ANSWER:
(1) The loans payable account does not appear in the operating activities category. Borrowing
money is not part of operations. Similarly, the current portion of long-term debt does not
appear in this category of the cash flow statement.
(2) The current liabilities that appear in the operating activities category of the statement of
cash flows are accounts payable and accrued expenses.
The positive amount in 2017 of $355.1 (million) in the cash flow statement indicates an
increase in the balances in the accounts payable and accrued expenses accounts. The positive
amount in 2016 of $91.2 (million) means the same thing.
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.09-03 – LO: 09-03
KEYWORDS:
Bloom’s: Analyzing
193. Refer to the data for Valance & Company.
Required:
(1) Give a possible explanation for each change in the liabilities listed in the cash flow statement. Do you think these
changes are beneficial for Valance? Why or why not?
(2) If there were a balance in the dividends payable account at the end of the year, would this appear in the operating
activities category of the cash flow statement? Why or why not?
ANSWER:
(1) Accounts Payable and accrued expenses increased in 2017 and 2016 due to growth in the
business. Other noncurrent liabilities increased for perhaps the same reason. Long-term debt
decreased in both years although much more in 2017. Loans payable increased in both years,
perhaps in conjunction with the repayment of long-term debt due to taking advantage of
lower short-term interest rates. The increase in debt will generally lower profits due to higher
interest expense. Overall, Valance does not seem to be significantly impacted by these
changes. Additional information from the rest of the financial statements would be needed to
provide a complete answer to this question.
(2) The dividends payable account would not appear in the operating activities category of
the cash flow statement. Dividends are a reduction of retained earnings rather than an
expense on the income statement. The change in dividends payable would appear in the
financing activities category of the cash flow statement as shown above.
DIFFICULTY:
Hard
LEARNING OBJECTIVES:
FACC.PONO.13.09-03 – LO: 09-03
KEYWORDS:
Bloom’s: Analyzing
194. Grain Company sells a product for $760. When the customer buys it, Grain provides a one-year warranty. Grain sold
1,500 products during 2016. Based on analysis of past warranty records, Grain estimates that repairs will average 6% of
total sales.
Required:
1. Prepare the journal entry to record the estimated liability.
2. Assume that during 2016, products under warranty must be repaired using repair parts from inventory costing $49,600.
Prepare the journal entry to record the repair of products.
3. Assume that the balance of the Estimated Liabilities for Warranties account as of the beginning of 2016 was $1,700.
Calculate the balance of the account as of the end of 2016.
ANSWER:
1.
Warranty Expense
68,400
Estimated Liability for Warranties
68,400
To record estimated warranty expense.
Balance Sheet
Income Statement
Assets
=
Liabilities
+
Stockholders’
Equity
Revenues
–
Expenses
=
Net
Income
Estimated
Liability for
Warranties
68,400*
(68,400)
Warranty
Expense
68,400
(68,400)
*$760 × 1,500 × 6% = $68,400
2.
Estimated Liability for Warranties
49,600
Inventory
49,600
To record actual warranty costs.
Balance Sheet
Income Statement
Assets
=
Liabilities
+
Stockholders’
Equity
Revenues
–
Expenses
=
Net
Income
Inventory
(49,600)
Estimated Liability
for
Warranties (49,600)
3.Beginning balance
$ 1,700
Add: Warranty estimate
68,400
Less: Actual expense
(49,600)
Ending balance
$ 20,500
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.09-04 – LO: 09-04
KEYWORDS:
Bloom’s: Analyzing
Chapter 9: Current Liabilities, Contingencies, and the True Value of Money
Note Disclosure of Legal Matters
Use the Note Disclosure Of Legal Matters below to answer the questions that follow.
Note 13 – Legal Matters
On December 14, 2016, the Company was served with a class action complaint filed in federal court in Burlington,
Vermont. The complaint, captioned John Doe vs. The Company was filed by a Company’s shareholder on behalf of
himself and purportedly on behalf of all other Company’s shareholders who purchased the common stock of the Company
during the period from March 25, 2015 through December 19, 2015. Plaintiff alleges that the Company violated the
federal securities laws by making, in 2015, untrue statements of material facts and omitting to state material facts
primarily concerning the Company’s construction and start-up of its new manufacturing facility. Also named as
defendants in the Complaint are certain present and former officers and directors of the Company. Plaintiff is seeking an
unspecified amount of monetary damages.
While this action is in its preliminary stages, management believes, based on an initial review, the allegations made in the
lawsuit are without merit and the Company intends to defend the lawsuit vigorously.
195. Review the Note Disclosure of Legal Matters.
Required:
(1) What type of liability does this lawsuit typify?
(2) In your opinion, should the Company prepare a journal entry in 2016 to record a liability for this lawsuit? Why or why
not?
ANSWER:
(1) This is an example of a contingent liability. The company has a possible loss, but it is not
clear that there will be an actual loss.
(2) No, the Company should not have made an entry. The litigation has just started and may
be in the court system for years to come. The monetary amount is not known. A contingent
liability should be recorded only when its occurrence is probable and the amount of damages
can be reasonably estimated.
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.09-04 – LO: 09-04
KEYWORDS:
Bloom’s: Analyzing
196. Review the Note Disclosure of Legal Matters.
Required:
(1) If you were to make an entry for the lawsuit against Company, what monetary amount should be recorded? On what
did you base your decision with regard to the amount?
(2) Does the disclosure imply that the Company is involved in only this litigation at this time?
(3) Why did this lawsuit arise? Do you believe it to be a reasonable one or do you think that the plaintiff, has little grounds
for this lawsuit?
ANSWER:
(1) None. If an entry were to be made, this would mean that Company had lost the lawsuit.
Had the company lost the lawsuit, the amount of damages awarded by the court would have
to be recorded as an expense.
(2) The note disclosure on legal matters only mentions this litigation. However, this does not
imply that it is the only litigation. Unfortunately, lawsuits are a fact of life for U.S.
businesses. The Company is probably involved in many lawsuits at any one time. The fact
that other litigation is not mentioned means that either the other suits, both individually and
collectively, would have an immaterial effect on the financial position of the Company or in
management’s opinion, the risk of loss is remote. It is not necessary to mention normal
business risks in this type of disclosure.
(3) The lawsuit arose because the plaintiff believes that, during the time in question, the
officers and directors either made false statements about the construction of the plant or
failed to inform the shareholders of the problems they were having. Presumably, had
potential investors been aware of the problems, they might have avoided purchasing the
Company’s stock At this point the students will offer their own opinions.
They may believe that the plaintiff was in fact damaged. Or this is just another case of suing
in a attempt to recover from a bad investment decision. Investing in stock involves risk and
the loss Doe incurred was the result of his own risk-taking activities. Suits like this are bad
for business as they divert attention away from the real issues and problems.
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.09-04 – LO: 09-04
KEYWORDS:
Bloom’s: Analyzing
197. Riley Corporation manufactures and sells weedeaters. Riley provides all customers with a three-year warranty
guaranteeing to repair, free of charge, any defects reported during this time period. During the year, it sold 85,000
weedeaters for $225 each. Analysis of past warranty records indicates that 8% of all sales will be returned for repair
within the warranty period. Riley expects to incur expenditures of $15 to repair each weedeater. The account Estimated
Liability for Warranties had a balance of $115,000 on January 1. Riley incurred $90,000 in actual expenditures during the
year.
Required:
Prepare all journal entries necessary to record the events related to the warranty transactions during the year. Determine
the adjusted ending balance in the Estimated Liability for Warranties account.
ANSWER:
Cash
19,125,000
Sales
19,125,000
To record sales of weedeaters.
To record current year’s estimated expense.
Estimated Liability for Warranties
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
198. Below are three notes payable:
Note Face Value (Principal)
Rate
Term
1
$30,000
4%
6 years
2
30,000
6%
4 years
3
30,000
8%
3 years
Required:
Part 1. For each of the notes, calculate the simple interest due at the end of the term.
Part 2. Now assume that the interest on the notes is compounded annually. Calculate the amount of interest due at the end
of the term for each note.
Part 3. Finally, assume that the interest on the notes is compounded semiannually. Calculate the amount of interest due at
the end of the term for each note.
Part 4. What conclusion can you draw from a comparison of your results of each of the three scenarios?
ANSWER:
Part 1.
*$30,000 × 4% × 6 years = $7,200
*$30,000 × 6% × 4 years = $7,200
*$30,000 × 8% × 3 years = $7,200
200. You just won the lottery. You can take your $2 million in a lump sum today, or you can receive $220,000 per year
over the next 12 years. Assuming a 6% interest rate, which would you prefer, ignoring tax considerations?
ANSWER:
$220,000 × 8.384 = $1,844,480
Because the present value of the payments over 12 years is less than the $2 million
immediate payment, you should take the immediate payment.
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.09-06 – LO: 09-06
KEYWORDS:
Bloom’s: Analyzing
201. Assume that you want to accumulate $20,000 as a down payment on a home. You believe that you can save $2,000
per semiannual period, and your bank will pay interest of 6% per year, or 3% per semiannual period. How long will it take
you to accumulate the desired amount?
ANSWER:
The accumulated amount of $20,000 represents the future value of an annuity of $2,000 per
semiannual period. Therefore, we must use the Future Value of Annuity of $1 table (Table 9-
3 in the text) and solve for the interest factor or table factor as follows:
Table factor = $20,000/$2,000 = 10.00
Using Table 9-3, you must scan down the 3% column until you find a table value that is near
10.00. The closest table value you find is 10.159. That table value corresponds to nine
periods. Therefore, if $2,000 is deposited per semiannual period and the money is invested at
3% per semiannual period, it will take nine semiannual periods (4 1/2 years) to accumulate
$20,000.
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.09-07 – LO: 09-07
KEYWORDS:
Bloom’s: Analyzing
202. You just purchased an automobile for $19,450 and must decide how to pay for it. Your local bank has granted you a
five-year loan. Annual payments on the loan will be made at the end of each year and the amount of the loan payments,
which include principal and interest, is $5,000 per year. What is the interest rate that is being charged on the loan?
ANSWER:
$19,450 / $5,000 = 3.890 table factor
Using the PV of an Annuity table (Table 9-4 in the text), for 5 periods, this factor indicates
that you are being charged 9% interest.
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.09-07 – LO: 09-07
KEYWORDS:
Bloom’s: Analyzing
203. Ashley Wilson’s grandparents want to give her some money when she graduates from high school. They have
offered Ashley the following three choices:
a. Receive $25,000 immediately. Assume that interest is compounded annually.
b. Receive $3,200 at the end of each six months for four years. Ashley will receive the first check in six months.
c. Receive $7,000 at the end of each year for four years. Assume that interest is compounded annually.
Required:
Ashley wants to have money for a new car when she graduates from college in four years. Assuming an interest rate of
8%, what option should she choose to have the most money in four years? (Round your answers to the nearest dollar.)
ANSWER:
a. $25,000 × 1.36049 (future value of $1 for n = 4, i = 8%) = $34,012
b. $3,200 × 9.21423 (future value of annuity of $1 for n = 8, i = 4%) = $29,486
c. $7,000 × 4.50611 (future value of annuity of $1 for n = 4, i = 8%) = $31,543
Option (a) is preferable.
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.09-06 – LO: 09-06
FACC.PONO.13.09-07 – LO: 09-07
KEYWORDS:
Bloom’s: Applying
204. Apply the time value of money in the following independent situations:
1. Jason Marx deposited $29,500 in the bank on January 1, 1999, at an interest rate of 12% compounded annually. How
much has accumulated in the account by January1, 2016?
2. June Cunningham deposited $54,200 in the bank on January 1, 2006. On January 2, 2016, this deposit has accumulated
to $106,611. Interest is compounded annually on the account. What rate of interest did June earn on the deposit?
ANSWER:
1. $29,500 × 6.86604 (future value of $1 for n = 17, i = 12%) = $202,548
2. $106,611/$54,200 = 1.967; future value of $1 for n = 10, i = 7%
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.09-06 – LO: 09-06
FACC.PONO.13.09-07 – LO: 09-07
KEYWORDS:
Bloom’s: Applying
205. Apply the time value of money in the following independent situations:
1. Margaret Carlson made a deposit in the bank on January 1, 2009. The bank pays interest at the rate of 8% compounded
annually. On January 1, 2016, the deposit has accumulated to $40,000. How much money did Margaret originally deposit
on January 1, 2009?
2. Claude Cooper deposited $15,600 in the bank on January 1 a few years ago. The bank pays an interest rate of 10%
compounded annually, and the deposit is now worth $40,420. For how many years has the deposit been invested?
ANSWER:
1. $40,000/1.71382 = (future value of $1 for n = 7, i = 8%) = $23,340
OR: $40,000 × 0.58349 (present value of $1 for n = 7, i = 8%) = $23,340
2. $40,420/$15,600 = 2.591; future value of $1 for i = 10%, n = 10 years
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.09-06 – LO: 09-06
FACC.PONO.13.09-07 – LO: 09-07
KEYWORDS:
Bloom’s: Applying
Essay
206. You have received an email from a new accounting client, Jamal Parker, who has just started a new business. Jamal
would like you to explain whether it is really that beneficial for him to take advantage of a 2/10, net 30 discount offered
by one of his suppliers, given his limited cash flow. In a memo, explain to him why this is or is not a sound financial
move for his new company. Most firms attempt to pay their accounts payable within the discount period to take advantage
of the discount. Why is that normally a sound financial move?
ANSWER:
MEMORANDUM
TO: Jamal Parker
FROM: (student)
DATE: XXX
It is generally beneficial for a company to take advantage of discounts available because of
the rate of the discount. In this case, since a 2% discount is available for payment within ten
days, a your firm could even borrow money and pay interest on the loan in order to take
advantage of the discount. After all, if your supplier is going to give you a 2% discount for
paying on Day 10 instead of Day 30, that means you are earning 2% on your money over
20/360 of a year. If you took the 2% discount throughout the year, you would be getting a
36% annual return on your money, since there are 18 periods of 20 days each in a year. Also,
prompt payment of accounts is essential in order to ensure good relationships with suppliers
and other creditors and will increase your credit rating.
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.09-021 – LO: 09-02
KEYWORDS:
Bloom’s: Analyzing
207. Your friend, Sal Dunn, has started a new business, but has recently encountered a slight cash flow problem. He
obtains a $1,000 loan at 10% per year from a local bank, but would like to ask you about the terms. The bank has
deducted the interest in advance and he wants to know if 10% is his effective interest rate. How would you respond in an
email?
ANSWER:
Hello Sal:
Good to hear from you!
Regarding your question, the “real” rate or effective rate of interest is not 10%. This rate can
be calculated as $100 interest divided by your proceeds of $900, or approximately 11.11%.
The rate is calculated on the basis of the amount that your company actually obtained, rather
than the face amount of the note. This is sometimes referred to as discounting a note. The
interest rate on a discounted note is always higher than it appears.
I hope your business is on the upswing. Let me know if you have any other questions.
Your friend,
(student)
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.09-021 – LO: 09-02
KEYWORDS:
Bloom’s: Analyzing
208. A firm’s year ends on December 31. Its tax is computed and submitted to the U.S. Treasury on March 15 of the
following year. When should the taxes be reported as a liability?
ANSWER:
Income tax is an item that should be accrued as a liability as of year-end. If the firm’s year-
end is December 31, then the amount should appear as a current liability on the balance sheet
dated December 31. The business must make an accounting entry, usually as one of the year-
end adjusting entries, to record the amount of tax that has been incurred but is unpaid.
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
FACC.PONO.13.09-02 – LO: 09-02
KEYWORDS:
Bloom’s: Applying
209. According to the text, almost all current liabilities appear in the Operating Activities category of the statement of
cash flows, but there are exceptions. Explain the exceptions and give an example.
ANSWER:
Almost all current liabilities appear in the Operating Activities category of the statement of
cash flows, but there are exceptions. If a current liability is not directly related to operating
activities, it should not appear in that category. For example, if a company like Home Depot
uses some notes payable as a means of financing, distinct from operating activities, those
borrowings and repayments are reflected in the Financing Activities rather than the Operating
Activities category.
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
FACC.PONO.13.09-03 – LO: 09-03
KEYWORDS:
Bloom’s: Applying
210. Dallas Company uses the indirect method of preparing the statement of cash flows and has the following current
liabilities at the beginning of the period: Accounts Payable, $35,000; Taxes Payable, $15,000. At the end of the period, the
balances of the account are as follows: Accounts Payable, $25,000; Taxes Payable, $20,000. What amounts will appear in
the cash flow statement? In what category of the statement will they appear?
ANSWER:
The amounts appearing in the cash flow statement should be in the Operating Activities
category of the statement. The amounts shown should be the changes in the balances of the
accounts.
Accounts Payable decreased by $10,000 and should appear as a decrease in the cash flow
statement.
Taxes Payable increased by $5,000 and should appear as an increase in the cash flow
statement.
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
FACC.PONO.13.09-03 – LO: 09-03
KEYWORDS:
Bloom’s: Applying
211. There are very important differences between U.S. and international standards regarding contingencies. Even the
terms used to refer to situations with unknown outcomes differ. Explain these differences.
ANSWER:
International standards use the term provision for those items that must be recorded on the
balance sheet. As in U.S. standards, an item should be recorded if the loss or outflow is
probable and can be reasonably estimated.
However, the meaning of the term probable is somewhat different. In international standards,
probable means the loss or outflow is “more likely than not” to occur. This is a lower
threshold than in U.S. standards and may cause more items to be recorded as liabilities.
In addition, international standards require the amount recorded as a liability to be
“discounted” or recorded as a present value amount, while U.S. standards do not have a
similar requirement.
In international standards, the term contingent liability is used only for those items that are
not recorded on the balance sheet but are disclosed in the notes that accompany the
statements.
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.09-04 – LO: 09-04
KEYWORDS:
Bloom’s: Applying
212. What is the difference between simple interest and compound interest? Is the amount of interest higher or lower
when the interest is simple rather than compound?
ANSWER:
Simple interest is calculated on the balance of the principal only. Compound interest is
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
FACC.PONO.13.09-05 – LO: 09-05
213. The present value and future value concepts are applied to measure the amount of several accounts common in
accounting. What are some accounts that are valued in this manner?
ANSWER:
Loan payable and bond payable accounts are recorded at present value amounts. Other
accounts based on present value concepts are pensions, leases, and some long-term
receivables. The future value concept is used to determine the amount that would be
accumulated in an investment account at a date in the future.
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
FACC.PONO.13.09-06 – LO: 09-06
FACC.PONO.13.09-07 – LO: 09-07
KEYWORDS:
Bloom’s: Applying
214. Define the term annuity. Can the present value of an annuity be calculated as a series of single amounts? If so, how?
ANSWER:
The word annuity means a series of payments of the same amount. The present value of an
annuity could be calculated as a series of single amounts, but not with a single calculation.
You would first calculate the present value of a single payment one year in the future; then
the present value of a single payment two years in the future, etc. The present value of the
single sums would be totaled to determine the present value of an annuity. To avoid the
calculations, tables have been developed to calculate the present value of an annuity based on
one calculation.
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
FACC.PONO.13.09-06 – LO: 09-06
KEYWORDS:
Bloom’s: Applying
215. Assume that you know the total dollar amount of a loan and the amount of the monthly payments. How can you
determine the interest rate as a percentage of the loan?
ANSWER:
The interest rate of the loan could be calculated by dividing the total dollar amount of the
loan by the dollar amount of the monthly payments. The result is a number that represents an
interest factor or table value in the table for the present value of an annuity. Find the table
value that corresponds to the number of years of the loan, and then read across that row to
find the interest rate.
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
FACC.PONO.13.09-07 – LO: 09-07
KEYWORDS:
Bloom’s: Applying