13–41
PROBLEM 13-7 (Continued)
Expense warranty accrual method:
As of 12/31/12 the balance sheet would disclose a current liability
in the amount of $117,000 for Warranty Liability.
PROBLEM 13-8
Inventory of Premiums …………………………………………….
60,000
Cash ………………………………………………………………
60,000
(To record purchase of 40,000 puppets at
$1.50 each)
Cash ………………………………………………………………………
Sales Revenue ………………………………………………..
(To record sales of 480,000 boxes at
$3.75 each)
Premium Expense …………………………………………………..
34,500
Inventory of Premiums …………………………………….
34,500
[To record redemption of 115,000 coupons.
Computation: (115,000 ÷ 5) X $1.50 = $34,500]
Premium Expense …………………………………………………..
23,100
Premium Liability ……………………………………………
23,100
[To record estimated liability for premium
claims outstanding at December 31, 2013.]
Total estimated redemptions (40%) ………………………….
Coupons redeemed in 2013 ……………………………………..
Cost of estimated claims outstanding (77,000 ÷ 5) X $1.50 = $23,100
13–43
PROBLEM 13-9
(a) 2012
Inventory of Premiums ……………………………………………
562,500
Cash ………………………………………………………………
562,500
(To record the purchase of 250,000 CDs at
$2.25 each)
Cash [$600,000 – (240,000 X $.50)] …………………………..
480,000
Premium Expense …………………………………………………..
60,000
Inventory of Premiums ……………………………………
540,000
[To record the redemption of 1,200,000
wrappers, the receipt of $600,000
(1,200,000 ÷ 5) X $2.50, and the mailing
of 240,000 CDs]
Computation of premium expense:
240,000 CDs @ $2.25 each = ………………………….
Postage—240,000 X $.50 = …………………………..
Less: Cash received—
240,000 X $2.50 …………………………………
Premium Expense …………………………………………………..
Premium Liability ……………………………………………
(To record the estimated liability for
premium claims outstanding at 12/31/10)
Cash ………………………………………………………………………
868,620
Sales Revenue ………………………………………………..
868,620
(To record the sale of 2,895,400 candy bars
at 30 cents each)
PROBLEM 13-9 (Continued)
2013
Inventory of Premiums …………………………………………….
742,500
Cash ………………………………………………………………
742,500
(To record the purchase of 330,000 CDs
at $2.25 each)
Cash ………………………………………………………………………
823,080
Sales Revenue ………………………………………………..
823,080
(To record the sale of 2,743,600 candy
bars at 30 cents each)
Cash ($750,000 – $150,000) ………………………………………
600,000
Premium Liability ……………………………………………………
14,500
Premium Expense …………………………………………………..
60,500
Inventory of Premiums …………………………………….
675,000
(To record the redemption of 1,500,000
wrappers, the receipt of $750,000
[(1,500,000 ÷ 5) X $2.50], and the mailing
of 300,000 CDs.)
Computation of premium expense:
300,000 CDs @ $2.25 = ………………………………….
$675,000
Postage—300,000 @ $.50 = ………………………….
150,000
825,000
Less: Cash received—
(1,500,000 ÷ 5) X $2.50…………………………..
750,000
Premium expense for CDs issued …………………….
Less: Outstanding claims at 12/31/12
charged to 2012 but redeemed in 2013 ……
Premium Expense …………………………………………………..
$ 17,500*
Premium Liability ……………………………………………
17,500
*(350,000 ÷ 5) X ($2.25 + $.50 – $2.50) = $17,500
13–45
PROBLEM 13-9 (Continued)
(b)
Amount
*
$2.25 (250,000 – 240,000)
$60,000 + $14,500
$60,500 + $17,500
Premiums Liability
Current liability
PROBLEM 13-10
(a) Because the cause for litigation occurred before the date of the finan-
cial statements and because an unfavorable outcome is probable and
reasonably estimable, Windsor Airlines should report a loss and a
liability in the December 31, 2012, financial statements. The loss and
liability might be recorded as follows:
Note to the Financial Statements
Due to an accident which occurred during 2012, the Company is a
defendant in personal injury suits totaling $9,000,000. The Company is
charging the year of the casualty with $5,400,000 in estimated losses,
which represents the amount that the company legal counsel estimates
will finally be awarded.
PROBLEM 13-11
(a)
1.
Lawsuit Loss ……………………………………………………….
250,000
Lawsuit Liability ………………………………………………
250,000
2.
Loss from Expropriation …………………………..
Allowance for Expropriation
3.
No entry required.
(b)
1.
A loss and a liability have been recorded in the first case because
(i) information is available prior to the issuance of the financial
2.
An entry to record a loss and establish an allowance due to threat
of expropriation is necessary because the expropriation is imminent
as evidenced by the foreign government’s communicated intent
to expropriate and the prior settlements for properties already
PROBLEM 13-11 (Continued)
3.
Even though Polska’s chemical product division is uninsurable
due to high risk and has sustained repeated losses in the past, as
of the balance sheet date no assets have been impaired or liabili–
ties incurred nor is an amount reasonably estimable. Therefore,
this situation does not satisfy the criteria for recognition of a loss
PROBLEM 13-12
(1)
Sales of musical instruments and sound equipment ……….
$5,700,000
Estimated warranty cost ………………………………………………..
(2)
Estimated liability for warranties—1/1/12 ………………………..
$ 136,000
2012 warranty expense (Requirement 1) …………………………
114,000
Actual warranty costs during 2012 …………………………………
(3)
Coupons issued (1 coupon/$1 sale) ……………………………….
1,500,000
Estimated redemption rate …………………………………………….
.60
Estimated number of coupons to be redeemed ……………….
Exchange rate (200 coupons for a CD player) …………………
÷ 200
Estimated number of premium CD players
to be issued ……………………………………………………………….
Net cost of CD players ($32 – $20) ………………………………….
(4)
Inventory of premium CD players—1/1/12 ……………………….
$ 37,600
Premium CD players purchased during 2012
(6,500 X $32) ………………………………………………………………
208,000
Premium CD players available ……………………………………….
Premium CD players exchanged for coupons
during 2012 (1,200,000/200 X $32) ………………………………..
192,000
(5)
Estimated liability for premiums—1/1/12 …………………………
$ 44,800
2012 premium expense (Requirement 3) …………………………
54,000
Actual redemptions during 2012
[1,200,000/200 X ($32 – $20)] ……………………………………….
72,000
PROBLEM 13-13
1. Memo prepared by:
Date:
Millay Corporation
December 31, 2012
Recognition of Warranty Expense
During June of this year, the client began the manufacture and sale of a
new line of dishwasher. Sales of 120,000 dishwashers during this period
amounted to $60,000,000. These dishwashers were sold under a one-year
warranty, and the client estimates warranty costs to be $25 per appliance.
Because Millay accounts for warranties on the accrual basis, it must recog-
nize the entire $3,000,000 as warranty expense in the year of sale. The client
should have made the following journal entries:
(a) Cash …………………………………………………………. 60,000,000
Sales Revenue (120,000 X $500)………….. 60,000,000
(To record sale of 120,000 dishwashers)
PROBLEM 13-13 (Continued)
2. Memo prepared by:
Date:
Millay Corporation
December 31, 2012
River.
Although the litigation is pending, Sondgeroth believes that the suit will
probably be lost. A reasonable estimate of clean up costs and fines is
$2,750,000. The client neither disclosed nor accrued this loss in the finan-
cial statements.
PROBLEM 13-13 (Continued)
3. Memo prepared by:
Date:
Millay Corporation
December 31, 2012
Loss Contingency on
Patent Infringement Litigation
way disclose this information.
Because the loss is reasonably possible and can be estimated at $5,000,000,
it must be disclosed in the notes to the financial statements. I advised the
client to include as a footnote to the financial statements a discussion of
PROBLEM 13-14
1. Estimated warranty costs:
On 2011 sales $ 800,000 X .10 …………………………...
$ 80,000
On 2012 sales $1,100,000 X .10 …………………………...
110,000
On 2013 sales $1,200,000 X .10 …………………………...
120,000
Total estimated costs ………………………………….
Total warranty expenditures ………………………..
2.
Computation of liability for premium claims outstanding:
Unredeemed coupons for 2012
($9,000 – $8,000) ……………………………………………..
2013 coupons estimated to be redeemed
13–54
TIME AND PURPOSE OF CONCEPTS FOR ANALYSIS
CA 13-1 (Time 20–25 minutes)
Purpose—to provide the student with the opportunity to define a liability, to distinguish between current
and long-term liabilities, and to explain accrued liabilities. The student must also describe how liabilities
are valued, explain why notes payable are usually reported first in the current liabilities section, and to
indicate the items that may comprise “compensation to employees.”
CA 13-2 (Time 15–20 minutes)
Purpose—to provide three situations that require the application of judgment about the current or long–
term nature of the items. The student must think about when typical short-term items might not be
classified as current.
CA 13-3 (Time 30–40 minutes)
Purpose—to provide the student with a comprehensive case covering refinancing of short-term debt.
Four situations are presented in which the student must determine the proper classification and
disclosure of the debt in the financial statements. In order to thoroughly resolve the issues presented,
the student is expected to research the FASB codification.
CA 13-4 (Time 20–25 minutes)
Purpose—to provide the student with an opportunity for the student to analyze a situation in which
short-term debt is refinanced. The student must comment on the proper balance sheet classification for
the debt at three different balance sheet dates. The student is also required to determine the proper
balance sheet classifications if instead of actually refinancing the debt, a financing agreement had been
initiated. A structural case which calls for the student to apply the principles related to refinancing of
short-term debt.
CA 13-5 (Time 15–20 minutes)
Purpose—to provide the student with an opportunity to comment on the proper treatment in the
financial statements of a contingent loss incurred after the balance sheet date but before issuance of
the financial statements. In order to thoroughly answer the case the student will need to understand
proper accounting for contingencies.
CA 13-6 (Time 15–20 minutes)
Purpose—to provide the student with an opportunity to specify the conditions by which a loss
contingency can be recorded in the accounts. The student is also required to indicate the proper
disclosure in the financial statements of the situations where the amount of loss cannot be reasonably
estimated.
CA 13-7 (Time 15–20 minutes)
Purpose—to provide the student with an opportunity to discuss how product warranty costs and the fact
that a company is being sued should be reported.
CA 13-8 (Time 20–25 minutes)
Purpose—to provide the student with an opportunity to examine the ethical issues related to estimates
for bad debts and warranty obligations.
13–55
SOLUTIONS TO CONCEPTS FOR ANALYSIS
CA 13-1
(a) A liability is defined as “probable future sacrifices of economic benefits arising from present
obligations of a particular entity to transfer assets or provide services to other entities in the future
as a result of past transactions or events.” In other words, it is an obligation to transfer some type
of resource in the future as a result of a past transaction.
CA 13-2
1. Since the notes payable are due in less than one year from the balance sheet date, they would
generally be reported as a current liability. The only situation in which this short-term obligation
could possibly be excluded from current liabilities is if Rodriguez Corp. intends to refinance it. For
those notes to qualify for exclusion from current liabilities, the company must meet the following
CA 13-2 (Continued)
CA 13-3
(This case requires some research of FASB Codification.)
(a) No. GAAPs indicate that refinancing a short-term obligation on a long-term basis means either replacing
it with a long-term obligation or with equity securities, or renewing, extending, or replacing it with
short-term obligations for an uninterrupted period extending beyond one year (or the operating cycle,
if applicable) from the date of an enterprise’s balance sheet.
A short-term obligation, other than one classified as a current liability, shall be excluded from
current liabilities if the enterprise’s intent to refinance the short-term obligation on a long-term basis
is supported by an ability to consummate the refinancing demonstrated in one of the ways stipulated
in GAAP. One of the ways stipulated is the issuance of long-term debt or equity securities after the
date of the balance sheet but before that balance sheet is issued. The issuance of the long-term
debt or equity securities must be for the purpose of refinancing the short-term obligation on a long-
term basis.
13–57
CA 13-4
(a) The $3,000,000 of commercial paper liquidated in January would be classified as a current liability
in the corporation’s balance sheet at December 31, 2012. Since the $3,000,000 of commercial
CA 13-5
Because the casualty occurred subsequent to the balance sheet date, it does not meet the criteria of a
loss contingency; that is, an asset had not been impaired or a liability incurred at the date of the
balance sheet. Therefore, a loss contingency should not be accrued by a charge to expense due to the
CA 13-6
(a) Two conditions must exist before a loss contingency is recorded:
1. Information available prior to the issuance of the financial statements indicates that it is
probable that a liability has been incurred at the date of the financial statements.
2. The amount of the loss can be reasonably estimated.
13–58
CA 13-7
Part 1. For Product Grey, the estimated product warranty costs should be accrued by a charge to
expense and a credit to a liability because both of the following conditions were met:
Part 2. The probable judgment ($1,000,000) should be accrued by a charge to expense and a credit to
a liability because both of the following conditions were met:
1. It is probable that a liability has been incurred because Constantine’s lawyer states that it is
CA 13-8
(a) No, Hamilton should not follow his owner’s directive if his (Hamilton’s) original estimates are
reasonable.
13–59
FINANCIAL REPORTING PROBLEM
(a) P&G’s short-term borrowings were $16,320 million at June 30, 2009.
SHORT-TERM DEBT
The weighted average interest rate is 2.0%.
(b) 1. Working capital = Current assets less current liabilities.
($8,996,000,000) = ($21,905,000,000 – $30,901,000,000)
While P&G’s current and acid-test ratios are below one, this may not
indicate a weak liquidity position. Many large companies carry relatively
high levels of accounts payable, which charge no interest. For example,
(In millions)
Commercial paper
Floating rate notes
Total short-term debt
13–60
FINANCIAL REPORTING PROBLEM (Continued)
(c) P&G provided the following discussion related to commitments and
contingencies:
Note 10: Commitments and Contingencies
Guarantees
In conjunction with certain transactions, primarily divestitures, we may
provide routine indemnifications (e.g., indemnification for representa-