P13-17 (continued)
Jan. 26 Accounts Payable 29,400
Purchases Discounts Lost 600
Cash 30,000
6 Vans 19,170
Cash 18,000
Use Taxes Payable 1,170
13-36
P13-18
2010
Nov. 1 Cash ($40,000 – $1,200) 38,800
Discount on Notes Payable
($40,000 x 12% x 3/12) 1,200
20 Estimated Liability under Warranties 2,900
Cash 2,900
30 Sales Salaries Expense: Compensated
Absences (2/3 x $14,400) 9,600
Office Salaries Expense: Compensated
13-37
P13-18 (continued)
Dec. 14 Premium Expense (20 x $5) 100
Inventory of Premium Disks 100
29 Loss from Accident 1,500
Estimated Liability Due to
Office Salaries Expense
($145,000 – $3,200) 141,800
Liability for Employee’s
Compensation for Future Absences 10,000
F.I.C.A. Taxes Payable
aB = 0.10 ($560,000 – T)
T = 0.30 ($560,000 – B)
P13-18 (continued)
aT = 0.30 ($560,000 – $40,412)
T = $155,876
31 Premium Expense 300
Estimated Premium Claims
Outstanding 300a
ANSWERS TO CASES
C13-1
1. Yes, because (a) it has borrowed money before the due date of the short-term note,
thereby establishing the intent to refinance on December 31, 2010; and (b) it has
C13-2
1. Warder must show intent and ability to refinance the convertible bonds on a long-term
13-39
C13-2 (continued)
2. The refinancing agreement must allow Warder to borrow for the entire amount of the note
to be able to exclude the full amount from current liabilities. Since the refinancing
C13-3 (AICPA adapted solution)
a. The two basic requirements for the accrual of a loss contingency (probability of loss and
reasonable estimation) are the results of the interaction of several concepts of accounting
The first requirement that must be satisfied for the accrual of a loss contingency is that at a
time prior to the issuance of the financial statements there is an indication that it is
earnings initially and understate earnings in future periods.
The second requirement for the accrual of a loss contingency states that the amount of
the loss must be reasonably estimable. The concept of measurement requires that the
13-40
C13-3 (continued)
b. Situation I
When a company sells a product subject to a warranty, it is probable that there will be
expenses incurred in future accounting periods relating to revenues recognized in the
Situation II
Even though (1) there is a probable loss on the contract, (2) the amount of the loss can be
reasonably estimated, and (3) the likelihood of the loss was discovered prior to the
issuance of the financial statements, the fact that the contract was entered into
subsequent to the date of the financial statements precludes accrual of the loss
contingency in financial statements for periods prior to the incurrence of the loss.
However, the fact that a material loss has been incurred subsequent to the date of the
financial statements but prior to their issuance should be disclosed by means of a note to
C13-4 (AICPA adapted solution)
1. An estimated loss from a loss contingency shall be accrued by a charge to income if both
of the following conditions are met:
13-41
C13-4 (continued)
2. Disclosure should be made for an estimated loss from a loss contingency that need not be
accrued by a charge to income when there is at least a reasonable possibility that a loss
C13-5 (AICPA adapted solution)
1. (a) Notes to Supey’s 2010 financial statements should disclose the nature of the loss on
cleanup and indicate that an estimate of the loss, or range of the loss, cannot be
made. No accrual should be made because the loss cannot be reasonably
2. An estimated loss on the purchase commitment, equal to the unrecoverable amount
of the contract price, should be reported as a reduction of 2010 income from
C13-6 (AICPA adapted solution)
1. Angela should report the estimated loss from the safety hazard as an expense in the
income statement and a liability in the balance sheet because both of the following
2. Angela should not report the estimated loss from the noninsurable flood risk as an expense
in the income statement or a liability in the balance sheet because no losses have
C13-6 (continued)
3. The purchase of the movie tickets should be accounted for by debiting an asset account-
-movie tickets inventory–and crediting cash. An accrual for the estimated promotion
C13-7
Since the wreck occurred on January 15, 2011 and not on or before December 31, 2010,
C13-8
The loss should be accrued and a liability recorded because:
1. A liability has been incurred at December 31, 2010 due to the faulty Stallions.
C13-9 (AICPA adapted solution)
1. Skinner should report the potential costs due to the discovery of a possible product defect
as an expense or loss in the income statement and as a liability in the balance sheet. In
2. Skinner should not report the potential claim for damages that may be received next year
in the current year’s income statement or balance sheet. Gain contingencies usually are
C13-9 (continued)
3. This year, Skinner should account for the potential costs due to the promotion campaign
as a premium expense and as a liability for 70 percent of the dollar amount of the
C13-10 (AICPA adapted solution)
1. For the safety hazard, Niki should accrue for a loss and a liability equal to the most likely
cost. The most likely loss is the best estimate of the expected loss. Accrual of a loss is
2. Niki should accrue for a loss and a liability for the note sold to a bank. The accrual should
3. Niki should disclose the possible loss on the assigned lease in notes to the 2010 financial
statements. Disclosures should include details of the assigned lease and the amounts due,
C13-11 (AICPA adapted solution)
1. For Type A merchandise, the estimated product warranty costs should be accrued by a
charge to income and a credit to a liability because both of the following conditions were
met:
2. The probable judgment ($400,000) should be accrued by a charge to income and a
credit to a liability because both of the following conditions were met:
C13-11 (continued)
2. b. (continued)
Thus, the principle of conservatism is being followed. Reese should disclose the
following in its financial statements or notes:
• The amount of the suit ($2 million)
C13-12
1. The total current liabilities were $13,225 million at the end of 2007. The largest current
liability was $6,915 million of accounts payable and accrued expenses (p. 67).
2. Accounts payable and accrued expenses at the end of 2007 consisted of: other accrued
3. The total loans and notes payable were $5,919 million at the end of 2007(p. 67). They
consisted primarily of commercial paper issued in the United States (p. 87). At the end of
4. At the end of 2007, the company was contingently liable for guarantees of indebtedness
owed by third parties of $267 million. This means if these third parties do not pay their
C13-13
Note to Instructor: This case does not have a definitive answer. From a financial reporting
perspective, GAAP is identified and summarized. From an ethical perspective, various
issues are raised for discussion purposes.
13-45
C13-13 (continued)
gathered about the meaning of Bob’s comment that there is a pretty good chance of
losing the lawsuit in the future and that the amount will be at least $400,000. Does “pretty
good chance” mean “probable” or “reasonably probable?” Furthermore, since the lawsuit
is for $1 million, is “at least $400,000″ the best estimate to use in the lawsuit? Or, is $640,000
(the joint probability of $400,000 x 0.60 + $1 million x 0.40) the most prudent number to use?
ANSWERS TO RESEARCH SIMULATIONS
R13-1
Note to Instructor: Students are expected to cite references GAAP in their research of this
issue. They might use the electronic database, pronouncements listed on the FASB web
site, the FASB Original Pronouncements, the FASB Current text, or other primary sources of
GAAP to obtain these references. They may also use the FASB Accounting Standards
Codification which is cited in parentheses.
To: President, Bogan Company
From: Student
I have researched the issue of how to account for the “sale” of $42,000 of inventory for
$50,000 on November 1, 2010 and agreement to “repurchase” the inventory at the end of
July, 2011. This agreement may fall under the category of a product financing
R13-1 (continued)
In my opinion, Bogan Company’s agreement with Hall Company is a product financing
arrangement that includes all characteristics (1) through (4). Hall appears to be created
solely to purchase the inventory and its debt (collateralized by the inventory) is
Furthermore, I recommend that the $400 storage expense and $800 interest expense be
reported in the 2010 income statement. I also recommend that the inventory be reported
as a current asset at a cost of $42,000, and the $40,000 note payable be reported as a
current liability on the 2010 ending balance sheet.
R13-2
Note to Instructor: Students are expected to cite references to GAAP in their research of
Costs of direct-response advertising that should be reported as an asset include only: (1)
the incremental direct costs incurred in transactions with independent third parties (such as
costs of idea development, writing copy, artwork, printing, magazine space and mailing)
and (2) payroll costs of employees directly associated with and devoting time to internal
advertising activities (these costs should include only that portion of total compensation
13-47
R13-2 (continued)
and fringe benefits directly related to time spent performing those advertising activities)
(par. 41) (FASB Cod. # 340-20-30). Allocated administrative costs, rent, depreciation, and
other occupancy costs are not costs of direct-response advertising activities. The costs of
direct-response advertising that are reported as assets should be amortized to income (as
Recommendations
Based on the GAAP cited above, I recommend reporting the various advertising costs in the
2010 financial statements as follows:
(1) $10,000 supervisor’s salary: Report as expense on 2010 income statement.
(5) $100,000 of magazine advertising space: Initially capitalize as a direct-response
advertising asset. Report $40,000 ($100,000 x 0.40 of expected total unit sales) as
advertising expense on 2010 income statement and report $160,000 as direct-
response advertising asset on 2010 ending balance sheet.
I recommend that the sales revenue involving the new product be reported at the amount