13-1
CHAPTER 13
Current Liabilities and Contingencies
ASSIGNMENT CLASSIFICATION TABLE (BY TOPIC)
Topics
Questions
Brief
Exercises
Exercises
Problems
Concepts
for Analysis
1.
Concept of liabilities;
definition and classification
of current liabilities.
1, 2, 3,
4, 6, 8
1, 16
1, 2
1, 2
4.
Deposits and advance
payments.
5, 12
5
2
5.
Compensated absences.
13, 14, 15
8
5, 6, 16
6.
Collections for third parties.
6, 7
7, 8, 9, 16
3, 4
8.
Guaranties and warranties.
21, 23
13, 14
10, 11, 16
5, 6, 7,
7, 8
12, 14
9.
Premiums and awards
offered to customers.
24, 25
15
12, 15, 16
8, 9, 12, 14
Self-insurance, litigation,
claims, and assessments,
asset retirement obligations.
26, 27, 28
10, 11, 12
2, 10,
11, 13
6, 7
Presentation and analysis.
29, 30, 31
17, 18, 19
9
3
2.
Accounts and notes
payable; dividends payable.
7, 11
1, 2, 3
2, 16
1, 2
1, 2
3.
Short-term obligations
expected to be refinanced.
9, 10
4
3, 4
3, 4
13-2
ASSIGNMENT CLASSIFICATION TABLE (BY LEARNING OBJECTIVE)
Learning Objectives
Exercises
Problems
1. Describe the nature, type, and valuation
of current liabilities.
1, 2, 7
1, 2
4. Identify the criteria used to account for and
disclose gain and loss contingencies.
13
7, 10, 11, 13
6. Indicate how to present and analyze liabilities
and contingencies.
16, 17,
18, 19
9
2. Explain the classification issues of short-term
debt expected to be refinanced.
4
3, 4
7, 8, 9
5, 6, 8, 9
3, 4
13-3
ASSIGNMENT CHARACTERISTICS TABLE
Item
Description
Level of
Difficulty
Time
(minutes)
E13-1
Balance sheet classification of various liabilities.
Simple
10–15
E13-8
Payroll tax entries.
Simple
10–15
E13-9
Payroll tax entries.
Simple
15–20
E13-10
Warranties.
Simple
10–15
E13-11
Warranties.
Moderate
15–20
E13-12
Premium entries.
Simple
15–20
E13-13
Contingencies.
Moderate
20–30
Asset retirement obligation.
Moderate
25–30
E13-15
Premiums.
Moderate
20–30
E13-16
Financial statement impact of liability transactions.
Moderate
20–25
E13-17
Ratio computations and discussion.
Simple
10–15
E13-18
Ratio computations and analysis.
Simple
20–25
E13-19
Ratio computations and effect of transactions.
Moderate
15–25
P13-1
Current liability entries and adjustments.
Simple
25–30
P13-2
Liability entries and adjustments.
Simple
25–35
P13-3
Payroll tax entries.
Moderate
20–30
P13-4
Payroll tax entries.
Simple
20–25
P13-5
Warranties, accrual, and cash basis.
Simple
15–20
P13-6
Extended warranties.
Simple
10–20
P13-7
Warranties, accrual, and cash basis.
Moderate
25–35
P13-8
Premium entries.
Moderate
15–25
P13-9
Premium entries and financial statement presentation.
Moderate
30–45
P13-10
Loss contingencies: entries and essay.
Simple
25–30
P13-11
Loss contingencies: entries and essays.
Moderate
35–45
P13-12
Warranties and premiums.
Moderate
20–30
P13–13
Liability errors.
Moderate
25–35
P13-14
Warranty and coupon computation.
Moderate
20–25
CA13-1
Nature of liabilities.
Moderate
20–25
CA13-2
Current versus noncurrent classification.
Moderate
15–20
CA13-3
Refinancing of short-term debt.
Moderate
30–40
CA13-4
Refinancing of short-term debt.
Moderate
20–25
CA13-5
Loss contingencies.
Simple
15–20
CA13-6
Loss contingency.
Simple
15–20
CA13-7
Warranties and loss contingencies.
Simple
15–20
CA13-8
Warranties.
Moderate
20–25
E13-2
Accounts and notes payable.
Moderate
15–20
E13-3
Refinancing of short-term debt.
Simple
10–12
E13-4
Refinancing of short-term debt.
Simple
20–25
E13-5
Compensated absences.
Moderate
25–30
E13-6
Compensated absences.
Moderate
25–30
E13-7
Adjusting entry for sales tax.
Simple
SOLUTIONS TO CODIFICATION EXERCISES
CE13-1
Master Glossary
(a) An obligation associated with the retirement of a tangible long-lived asset.
CE13-2
According to FASB ASC 410-20-50 (Asset Retirement and Environmental Obligations):
50-1 An entity shall disclose all of the following information about its asset retirement obligations:
(a) A general description of the asset retirement obligations and the associated long-lived
assets
50-2 If the fair value of an asset retirement obligation cannot be reasonably estimated, that
fact and the reasons therefor shall be disclosed.
13-5
CE13-3
According to FASB ASC 450-10-55 (Contingencies —Implementation Guidance and Illustrations):
Depreciation
Estimates Used in Accruals
55-3 Amounts owed for services received, such as advertising and utilities, are not contingencies
even though the accrued amounts may have been estimated; there is nothing uncertain about
the fact that those obligations have been incurred.
Changes in Tax Law
CE13-4
According to FASB ASC 710-10–25-1 (Compensation Recognition—Compensated Absences), an
employer must accrue a liability for employees’ compensation for future absences if all of the following
conditions are met:
(a) The employer’s obligation relating to employees’ rights to receive compensation for future
absences is attributable to employees’ services already rendered.
ANSWERS TO QUESTIONS
1. Current liabilities are obligations whose liquidation is reasonably expected to require use of
2. You might explain to your friend that the accounting profession at one time prepared financial
statements somewhat in accordance with the broad or loose definition of a liability submitted by the
AICPA in 1953: “Something represented by a credit balance that is or would be properly carried
forward upon a closing of books of account according to the rules or principles of accounting,
provided such credit balance is not in effect a negative balance applicable to an asset. Thus the
3. As a lender of money, the banker is interested in the priority his/her claim has on the company’s
assets relative to other claims. Close examination of the liability section and the related footnotes
discloses amounts, maturity dates, collateral, subordinations, and restrictions of existing contractual
obligations, all of which are important to potential creditors. The assets and earning power are
likewise important to a banker considering a loan.
4. Current liabilities are obligations whose liquidation is reasonably expected to require the use of
5. Unearned revenue is a liability that arises from current sales but for which some future services or
products are owed to customers in the future. At the time of a sale, customers pay not only for the
delivered product, but they also pay for future products or services (e.g., another plane trip, hotel
6. Payables and receivables generally involve an interest element. Recognition of the interest element
(the cost of money as a factor of time and risk) results in valuing future payments at their current
value. The present value of a liability represents the debt exclusive of the interest factor.
Questions Chapter 13 (Continued)
7. A discount on notes payable represents the difference between the present value and the face
8. Liabilities that are due on demand (callable by the creditor) should be classified as a current
liability. Classification of the debt as current is required because it is a reasonable expectation that
9. An enterprise should exclude a short-term obligation from current liabilities only if (1) it intends to
refinance the obligation on a long-term basis, and (2) it demonstrates an ability to consummate the
refinancing.
10. The ability to consummate the refinancing may be demonstrated (i) by actually refinancing the short-
term obligation through issuance of long-term obligation or equity securities after the date of the
11. A cash dividend formally authorized by the board of directors would be recorded by a debit to
Retained Earnings and a credit to Dividends Payable. The Dividends Payable account should be
classified as a current liability.
12. Unearned revenue arises when a company receives cash or other assets as payment from a
customer before conveying (or even producing) the goods or performing the services which it has
committed to the customer.
Unearned revenue is assumed to represent the obligation to the customer to refund the assets
Questions Chapter 13 (Continued)
13. Compensated absences are employee absences such as vacation, illness, and holidays for which
it is expected that employees will be paid.
14. A liability should be accrued for the cost of compensated absences if all of the following conditions
are met:
(a) The employer’s obligation relating to employees’ rights to receive compensation for future
15. An employer is required to accrue a liability for “sick pay” that employees are allowed to accumu–
late and use as compensated time off even if their absence is not due to illness. An employer is
permitted but not required to accrue to liability for sick pay that employees are allowed to claim
only as a result of actual illness.
16. Employers generally hold back from each employee’s wages amounts to cover income taxes
(withholding), the employee’s share of FICA taxes, and other items such as union dues or health
17. (a) A contingency is defined as an existing condition, situation, or set of circumstances involving
uncertainty as to possible gain (gain contingency) or loss (loss contingency) to an enterprise
that will ultimately be resolved when one or more future events occur or fail to occur.
(b) A contingent liability is a liability incurred as a result of a loss contingency.
18. A contingent liability should be recorded and a charge accrued to expense only if:
19. A current determinable liability is susceptible to precise measurement because the date of payment,
the payee, and the amount of cash needed to discharge the obligation are reasonably certain. There
is nothing uncertain about (1) the fact that the obligation has been incurred and (2) the amount of the
obligation.
13-9
Questions Chapter 13 (Continued)
20. The terms probable, reasonably possible, and remote are used in GAAP to denote the chances
of a future event occurring, the result of which is a gain or loss to the enterprise. If it is probable
that a loss has been incurred at the date of the financial statements, then the liability (if reasonably
21. Under the cash-basis method, warranty costs are charged to expense in the period in which the
seller or manufacturer performs in compliance with the warranty, no liability is recorded for future
22. Under U.S. GAAP, companies may not record provisions for future operating losses. Such provi–
sions do not meet the definition of a liability, since the amount is not the result of a past transaction
23. The expense warranty approach and the sales-warranty approach are both variations of the accrual
method of accounting for warranty costs. The expense warranty approach charges the estimated
future warranty costs to operating expense in the year of sale or manufacture. The sales-warranty
approach defers a certain percentage of the original sales price until some future time when actual
costs are incurred or the warranty expires.
24. Southeast Airlines Inc.’s award plan is in the nature of a discounted ticket sale. Therefore, the full-
fare ticket should be recorded as unearned transportation revenue (liability) when sold and
25. Although the accounting for this transaction has been studied, no authoritative guideline has been
developed to record this transaction. In the case of a free ticket award, AcSEC proposed that
26. An asset retirement obligation must be recognized when a company has an existing legal obligation
associated with the retirement of a long-lived asset and when the amount can be reasonably
estimated.
27. The absence of insurance does not mean that a liability has been incurred at the date of the financial
statements. Until the time that an event (loss contingency) occurs there can be no diminution in the
13–10
Questions Chapter 13 (Continued)
28. In determining whether or not to record a liability for pending litigation, the following factors must
be considered:
(a) The time period in which the underlying cause for action occurred.
29. There are several defensible recommendations for listing current liabilities: (1) in order of maturity,
(2) according to amount, (3) in order of liquidation preference. The authors’ recent review of pub–
lished financial statements disclosed that a significant majority of the published financial statements
examined listed “notes payable” first, regardless of relative amount, followed most often by “accounts
payable,” and ending the current liability section with “current portion of long–term debt.”
30. The acid-test ratio and the current ratio are both measures of the short-term debt-paying ability of
the company. The acid-test ratio excludes inventories and prepaid expenses on the basis that these
31. (a) A liability for goods purchased on credit should be recorded when title passes to the purchaser.
If the terms of purchase are f.o.b. destination, title passes when the goods purchased arrive; if
f.o.b. shipping point, title passes when shipment is made by the vendor.
(b) Officers’ salaries should be recorded when they become due at the end of a pay period.
Accrual of unpaid amounts should be recorded in preparing financial statements dated other
than at the end of a pay period.
13–11
SOLUTIONS TO BRIEF EXERCISES
BRIEF EXERCISE 13-1
July 1
Purchases ……………………………………………………….
60,000
Accounts Payable …………………………………………..
60,000
Cash ……………………………………………………….
1,200
July 3
Accounts Payable …………………………………………………..
Purchase Returns and Allowances …………………..
6,000
July 10
Accounts Payable …………………………………………………..
54,000
Cash ($54,000 X 98%) …………………………..
52,920
Purchase Discounts ………………………………………..
1,080
BRIEF EXERCISE 13-2
11/1/12
Cash ……………………………………………………….
40,000
Notes Payable …………………………..…………………….
40,000
12/31/12
Interest Expense ……………………………………………………..
Interest Payable
($40,000 X 9% X 2/12) …………………………..
2/1/13
Notes Payable ……………………………………………………….
Interest Payable ………………………………………………………
Interest Expense ……………………………………………………..
Cash
[($40,000 X 9% X 3/12) + $40,000] …………………..
40,900
BRIEF EXERCISE 13-3
11/1/12
Cash ………………………………………………………………………
60,000
Discount on Notes Payable …………………………..
1,350
Notes Payable ………………………………………………..
61,350
12/31/12
Interest Expense …………………………………………………….
13–12
BRIEF EXERCISE 13-3 (Continued)
2/1/13
Interest Expense ……………………………………………………..
450
Discount on Notes Payable …………………………..
450
Notes Payable ……………………………………………………….
Cash ……………………………………………………….
BRIEF EXERCISE 13-4
(a) Since both criteria are met (intent and ability), none of the $500,000
would be reported as a current liability. The entire amount would be
reported as a long-term liability.
BRIEF EXERCISE 13-5
8/1/12
Cash ……………………………………………………….
216,000
Unearned Sales Revenue
(12,000 X $18) ………………………………………………
216,000
12/31/12
Unearned Sales Revenue …………………………..
Sales Revenue
($216,000 X 5/12 = $90,000) …………………………..
90,000
BRIEF EXERCISE 13-6
(a)
Accounts Receivable ………………………………………………
31,800
Sales Revenue ………………………………………………..
30,000
Sales Taxes Payable
($30,000 X 6% = $1,800) …………………………..
1,800
(b)
Cash ………………………………………………………………………
Sales Revenue ………………………………………………..
13–13
BRIEF EXERCISE 13-7
Salaries and Wages Expense …………………………………..
24,000
FICA Taxes Payable ………………………………………..
1,836
Withholding Taxes Payable ……………………………..
3,910
Insurance Premiums Payable …………………………..
250
Cash ………………………………………………………………
18,004
BRIEF EXERCISE 13-9
12/31/12
Salaries and Wages Expense …………………………..
350,000
Salaries and Wages Payable …………………………..
350,000
2/15/13
Salaries and Wages Payable …………………………..
350,000
Cash ……………………………………………………….
350,000
BRIEF EXERCISE 13-10
(a)
Lawsuit Loss ……………………………………………………….
900,000
Lawsuit Liability ……………………………………………..
900,000
BRIEF EXERCISE 13-11
Salaries and Wages Expense …………………………………..
Salaries and Wages Payable
(30 X 2 X $500) ……………………………………………..
13–14
BRIEF EXERCISE 13-12
Oil Platform …………………………………………………………….
450,000
Asset Retirement Obligation …………………………..
450,000
BRIEF EXERCISE 13-13
BRIEF EXERCISE 13-14
(a)
Cash ………………………………………………………………………
1,980,000
Unearned Warranty Revenue
(20,000 X $99) ………………………………………………
1,980,000
(b)
Warranty Expense …………………………………………………..
Inventory ……………………………………………………….
(c)
Unearned Warranty Revenue …………………………..
Warranty Revenue
($1,980,000 X 180/1,080*) …………………………..
BRIEF EXERCISE 13-15
Premium Expense …………………………………………………….
96,000
Premium Liability ……………………………………………..
96,000*
*UPC codes expected to be sent in (30% X 1,200,000) …
UPC codes already redeemed …………………………………..
(240,000 ÷ 3) X ($1.10 + $0.60 – $0.50) ……………………..
Warranty Expense …………………………………………………..
Inventory ……………………………………………………….
Warranty Expense …………………………………………………..
Warranty Liability ……………………………………………………
SOLUTIONS TO EXERCISES
EXERCISE 13-1 (10–15 minutes)
(a) Current liability.
(b) Current liability.
(c) Current liability or long-term liability depending on term of warranty.
EXERCISE 13-2 (15–20 minutes)
(a)
Sept. 1
Purchases ……………………………………………………….
50,000
Accounts Payable …………………………..
50,000
Oct. 1
Accounts Payable …………………………………………………..
50,000
Notes Payable …………………………..
50,000
Oct. 1
Cash ……………………………………………………….
75,000
Discount on Notes Payable …………………………..
6,000
Notes Payable …………………………..
(b)
Dec. 31
Interest Expense …………………………………………………….
1,000
Interest Payable
($50,000 X 8% X 3/12) …………………………..
1,000
Dec. 31
Interest Expense …………………………………………………….
($6,000 X 3/12) …………………………..
1,500
EXERCISE 13-2 (Continued)
(c)
1.
Note payable ………………………………………………………
$ 50,000
Interest payable …………………………..……………………..
1,000
$ 51,000
Less discount ($6,000 – $1,500) …………………………..
4,500
$ 76,500
EXERCISE 13-3 (10–12 minutes)
ALEXANDER COMPANY
Current liabilities:
Notes payable (Note 1) …………………………………………….
Long-term debt:
Notes payable refinanced in February 2013 (Note 1) ….
Note 1.
Short-term debt refinanced. As of December 31, 2012, the company had notes
payable totaling $1,200,000 due on February 2, 2013. These notes were
refinanced on their due date to the extent of $900,000 received from the
issuance of common stock on January 21, 2013. The balance of $300,000
was liquidated using current assets.
Current liabilities:
Notes payable (Note 1) …………………………………………….
Long-term debt:
Short-term debt expected to be refinanced (Note 1) …..
(Same footnote as above.)
13–17
EXERCISE 13-4 (20–25 minutes)
SANTANA COMPANY
Partial Balance Sheet
December 31, 2012
Current liabilities:
Notes payable (Note 1) ……………………………………………
$4,000,000*
Note 1.
Under a financing agreement with Golden State Bank the Company may
borrow up to 60% of the gross amount of its accounts receivable at an
interest cost of 1% above the prime rate. The Company intends to issue
EXERCISE 13-5 (25–30 minutes)
(a)
2012
To accrue the expense and liability for vacations
Salaries and Wages Expense ………………………
8,640
Salaries and Wages Payable ……………….
8,640
(1)
To accrue the expense and liability for sick pay
Salaries and Wages Expense ………………………
5,184
Salaries and Wages Payable ……………….
(2)
To record sick leave paid
Salaries and Wages Payable ……………………….
(3)
Cash ………………………………………………….
Long-term debt:
EXERCISE 13-5 (Continued)
2013
To accrue the expense and liability for vacations
Salaries and Wages Expense ……………………..
9,360
Salaries and Wages Payable ………………
9,360
(4)
To accrue the expense and liability for sick pay
Salaries and Wages Expense ……………………..
5,616
Salaries and Wages Payable ………………
5,616
(5)
To record vacation time paid
Salaries and Wages Payable ………………………
(6)
Cash …………………………………………………
8,424
(7)
To record sick leave paid
Salaries and Wages Expense ……………………..
144
Salaries and Wages Payable ………………………
4,536
(8)
Cash …………………………………………………
4,680
(9)
(1)
9 employees X $12.00/hr. X 8 hrs./day X 10 days =
$8,640
(2)
9 employees X $12.00/hr. X 8 hrs./day X 6 days =
$5,184
(3)
9 employees X $12.00/hr. X 8 hrs./day X 4 days =
$3,456
(4)
9 employees X $13.00/hr. X 8 hrs./day X 10 days =
$9,360
(5)
9 employees X $13.00/hr. X 8 hrs./day X 6 days =
$5,616
(6)
9 employees X $12.00/hr. X 8 hrs./day X 9 days =
$7,776
(7)
9 employees X $13.00/hr. X 8 hrs./day X 9 days =
$8,424
(8)
9 employees X $12.00/hr. X 8 hrs./day X (6–4) days =
$1,728
9 employees X $13.00/hr. X 8 hrs./day X (5–2) days =
+2,808
= $4,536
Note: Vacation days and sick days are paid at the employee’s current wage.
Also, if employees earn vacation pay at different pay rates, a consistent pattern
of recognition (e.g., first-in, first-out) could be employed which liabilities have
been paid.
13–19
EXERCISE 13-5 (Continued)
(b) Accrued liability at year-end:
2012
2013
Vacation
Wages
Payable
Sick Pay
Wages
Payable
Vacation
Wages
Payable
Sick Pay
Wages
Payable
(1)
9 employees X $12.00/hr. X 8 hrs./day X 10 days =
$ 8,640
(2)
9 employees X $12.00/hr. X 8 hrs./day X (6–4) days =
$ 1,728
(3)
9 employees X $12.00/hr. X 8 hrs./day X (10–9) days =
9 employees X $13.00/hr. X 8 hrs./day X 10 days =
$10,224
EXERCISE 13-6 (25–30 minutes)
(a)
2012
To accrue the expense and liability for vacations
Salaries and Wages Expense …………….
9,288
(1)
Salaries and Wages Payable ………
9,288
To record sick leave paid
Salaries and Wages Expense …………….
3,456
(2)
Cash …………………………………………
To record vacation time paid
No entry, since no vacation days were used.
Jan. 1 balance
(3,456)
Dec. 31 balance
(1)
(2)
(3)
(4)
EXERCISE 13-6 (Continued)
2013
To accrue the expense and liability for vacations
Salaries and Wages Expense…………….
9,864
(3)
Salaries and Wages Payable ……..
9,864
To record sick leave paid
Salaries and Wages Expense…………….
4,680
(4)
Cash ………………………………………..
To record vacation time paid
Salaries and Wages Expense…………….
65
Salaries and Wages Payable ……………..
8,359
(5)
Cash ………………………………………..
8,424
(6)
(1) 9 employees X $12.90/hr. X 8 hrs./day X 10 days = $9,288
(4) 9 employees X $13.00/hr. X 8 hrs./day X 5 days = $4,680
(5) 9 employees X $12.90/hr. X 8 hrs./day X 9 days = $8,359
(b)
Accrued liability at year-end:
Jan. 1 balance
+ accrued
(1)
9 employees X $12.90/hr. X 8 hrs./day X 10 days =
$ 9,288
(2)
9 employees X $12.90/hr. X 8 hrs./day X 1 day =
$ 929
9 employees X $13.70/hr. X 8 hrs./day X 10 days =
9,864
$10,793