CHAPTER 13

CURRENT LIABILITIES AND CONTINGENCIES

MULTIPLE CHOICE—Conceptual
21. Liabilities are
a. any accounts having credit balances after closing entries are made.
b. deferred credits that are recognized and measured in conformity with generally accepted
accounting principles.
c. obligations to transfer ownership shares to other entities in the future.
d. obligations arising from past transactions and payable in assets or services in the future.

22. Which of the following is a current liability?

a. A long-term debt maturing currently, which is to be paid with cash in a sinking fund
b. A long-term debt maturing currently, which is to be retired with proceeds from a new debt
issue
c. A long-term debt maturing currently, which is to be converted into common stock d.
None of these

23. Which of the following is true about accounts payable?

1. Accounts payable should not be reported at their present value.
2. When accounts payable are recorded at the net amount, a Purchase Discounts
account will be used.
3. When accounts payable are recorded at the gross amount, a Purchase Discounts Lost
account will be used.
a. 1
b. 2
c. 3
d. Both 2 and 3 are true.

24. Among the short-term obligations of Lance Company as of December 31, the balance sheet date,
are notes payable totaling $250,000 with the Madison National Bank. These are 90-day notes,
renewable for another 90-day period. These notes should be classified on the balance sheet of
Lance Company as
a. current liabilities.
b. deferred charges.
c. long-term liabilities.
d. intermediate debt.

25. Which of the following is not true about the discount on short-term notes payable?
a. The Discount on Notes Payable account has a debit balance.
b. The Discount on Notes Payable account should be reported as an asset on the balance sheet.
c. When there is a discount on a note payable, the effective interest rate is higher than the
stated discount rate.
d. All of these are true.
26. Which of the following may be a current liability?
a. Withheld Income Taxes
b. Deposits Received from Customers
c. Deferred Revenue
d. All of these

27. Which of the following items is a current liability?

a. Bonds (for which there is an adequate sinking fund properly classified as a long-term
investment) due in three months.
b. Bonds due in three years.
c. Bonds (for which there is an adequate appropriation of retained earnings) due in eleven
months.
d. Bonds to be refunded when due in eight months, there being no doubt about the
marketability of the refunding issue.

28. Which of the following should not be included in the current liabilities section of the balance
sheet?
a. Trade notes payable
b. Short-term zero-interest-bearing notes payable
c. The discount on short-term notes payable d.
All of these are included

29. Which of the following is a current liability?

a. Preferred dividends in arrears
b. A dividend payable in the form of additional shares of stock c. A
cash dividend payable to preferred stockholders
d. All of these

30. Stock dividends distributable should be classified on the

a. income statement as an expense.
b. balance sheet as an asset.
c. balance sheet as a liability.
d. balance sheet as an item of stockholders' equity.
31. Of the following items, the only one which should not be classified as a current liability is
a. current maturities of long-term debt.
b. sales taxes payable.
c. short-term obligations expected to be refinanced.
d. unearned revenues.

32. An account which would be classified as a current liability is

a. dividends payable in the company's stock.
b. accounts payable—debit balances.
c. losses expected to be incurred within the next twelve months in excess of the company's
insurance coverage.
d. none of these.

33. Which of the following is a characteristic of a current liability but not a long-term liability?
a. Unavoidable obligation.
b. Present obligation that entails settlement by probable future transfer or use of cash, goods, or
services.
c. Liquidation is reasonably expected to require use of existing resources classified as current
assets or create other current liabilities.
d. Transaction or other event creating the liability has already occurred.

34. Which of the following is not considered a part of the definition of a liability?
a. Unavoidable obligation.
b. Transaction or other event creating the liability has already occurred.
c. Present obligation that entails settlement by probable future transfer or use of cash, goods, or
services.
d. Liquidation is reasonably expected to require use of existing resources classified as current
assets or create other current liabilities.

35. Why is the liability section of the balance sheet of primary importance to bankers?
a. To evaluate the entity's credit quality.
b. To assist in understanding the entity's liquidity.
c. To better understand sources of repayment.
d. To evaluate operating efficiency.

36. What is the relationship between current liabilities and a company's operating cycle?
a. Liquidation of current liabilities is reasonably expected within the company's operating cycle
(or one year if less).
b. Current liabilities are the result of operating transactions.
c. Current liabilities can't exceed the amount incurred in one operating cycle.
d. There is no relationship between the two.

37. What is the relationship between present value and the concept of a liability?
a. Present values are used to measure certain liabilities.
b. Present values are not used to measure liabilities.
c. Present values are used to measure all liabilities.
d. Present values are only used to measure long-term liabilities.
38. What is a discount as it relates to zero-interest-bearing notes payable?
a. The discount represents the lender's costs to underwrite the note.
b. The discount represents the credit quality of the borrower.
c. c. The discount represents the cost of borrowing.
d. The discount represents the allowance for uncollectible amounts.

39. Where is debt callable by the creditor reported on the debtor's financial statements?
a. Long-term liability.
b. Current liability if the creditor intends to call the debt within the year, otherwise a long- term
liability.
c. Current liability if it is probable that creditor will call the debt within the year, otherwise a
long-term liability.
d. Current liability.

40. Which of the following is not a condition necessary to exclude a short-term obligation from
current liabilities?
a. Intend to refinance the obligation on a long-term basis.
b. Obligation must be due with one year.
c. Demonstrate the ability to complete the refinancing.
d. Subsequently refinance the obligation on a long-term basis.

41. Which of the following does not demonstrate evidence regarding the ability to consummate a
refinancing of short-term debt?
a. Management indicated that they are going to refinance the obligation.
b. Actually refinance the obligation.
c. Have capacity under existing financing agreements that can be used to refinance the
obligation.
d. Enter into a financing agreement that clearly permits the entity to refinance the obligation.

42. A company has not declared a dividend on its cumulative preferred stock for the past three years.
What is the required accounting treatment or disclosure in this situation?
a. Record a liability for cumulative amount of preferred stock dividends not declared.
b. b. Disclose the amount of the dividends in arrears.
c. Record a liability for the current year's dividends only.
d. No disclosure or recognition is required.

43. Which of the following situations may give rise to unearned revenue?
a. Providing trade credit to customers.
b. Selling inventory.
c. Selling magazine subscriptions.
d. Providing manufacturer warranties.

44. Which of the following statements is correct?

a. A company may exclude a short-term obligation from current liabilities if the firm intends to
refinance the obligation on a long-term basis.
b. A company may exclude a short-term obligation from current liabilities if the firm can
demonstrate an ability to consummate a refinancing.
c. A company may exclude a short-term obligation from current liabilities if it is paid off after the
balance sheet date and subsequently replaced by long-term debt before the balance sheet is
issued.
d. None of these.
 45. The ability to consummate the refinancing of a short-term obligation may be demon- strated by
a. actually refinancing the obligation by issuing a long-term obligation after the date of the
balance sheet but before it is issued.
b. entering into a financing agreement that permits the enterprise to refinance the debt on a
long-term basis.
c. actually refinancing the obligation by issuing equity securities after the date of the balance
sheet but before it is issued.
d. all of these.

46. Which of the following statements is false?

a. A company may exclude a short-term obligation from current liabilities if the firm intends to
refinance the obligation on a long-term basis and demonstrates an ability to complete the
refinancing.
b. Cash dividends should be recorded as a liability when they are declared by the board of
directors.
c. Under the cash basis method, warranty costs are charged to expense as they are paid. d. FICA
taxes withheld from employees' payroll checks should never be recorded as a
liability since the employer will eventually remit the amounts withheld to the
appropriate taxing authority.

47. Which of the following is not a correct statement about sales taxes?
a. Sales taxes are an expense of the seller.
b. Many companies record sales taxes in the sales account.
c. If sales taxes are included in the sales account, the first step to find the amount of sales taxes
is to divide sales by 1 plus the sales tax rate.
d. All of these are true.
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48. If a short-term obligation is excluded from current liabilities because of refinancing, the
footnote to the financial statements describing this event should include all of the following
information except
a. a general description of the financing arrangement.
b. the terms of the new obligation incurred or to be incurred.
c. the terms of any equity security issued or to be issued.
d. the number of financing institutions that refused to refinance the debt, if any.
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49. In accounting for compensated absences, the difference between vested rights and
accumulated rights is
a. vested rights are normally for a longer period of employment than are accumulated rights.
b. vested rights are not contingent upon an employee's future service.
c. vested rights are a legal and binding obligation on the company, whereas accumulated rights
expire at the end of the accounting period in which they arose.
d. vested rights carry a stipulated dollar amount that is owed to the employee; accumulated
rights do not represent monetary compensation.
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50. An employee's net (or take-home) pay is determined by gross earnings minus amounts for
income tax withholdings and the employee's
a. portion of FICA taxes and unemployment taxes.
b. and employer's portion of FICA taxes, and unemployment taxes.
c. portion of FICA taxes, unemployment taxes, and any voluntary deductions.
d. portion of FICA taxes and any voluntary deductions.
51. Which of these is not included in an employer's payroll tax expense?
a. F.I.C.A. (social security) taxes
b. Federal unemployment taxes
c. State unemployment taxes
d. Federal income taxes

52. Which of the following is a condition for accruing a liability for the cost of compensation for future
absences?
a. The obligation relates to the rights that vest or accumulate.
b. Payment of the compensation is probable.
c. The obligation is attributable to employee services already performed.
d. d. All of these are conditions for the accrual.

53. A liability for compensated absences such as vacations, for which it is expected that employees
will be paid, should
a. be accrued during the period when the compensated time is expected to be used by
employees.
b. be accrued during the period following vesting.
c. c. be accrued during the period when earned.
d. not be accrued unless a written contractual obligation exists.

54. The amount of the liability for compensated absences should be based on
1. the current rates of pay in effect when employees earn the right to compensated
absences.
2. the future rates of pay expected to be paid when employees use compensated
time.
3. the present value of the amount expected to be paid in future periods.
a. 1.
b. 2.
c. 3.
d. Either 1 or 2 is acceptable.

55. What are compensated absences?

a. Unpaid time off.
b. A form of healthcare.
c. Payroll deductions.
d. Paid time off.

56. Which gives rise to the requirement to accrue a liability for the cost of compensated absences?
a. Payment is probable.
b. Employee rights vest or accumulate.
c. Amount can be reasonably estimated.
d. d. All of the above.

57. Under what conditions is an employer required to accrue a liability for sick pay?
a. Sick pay benefits can be reasonably estimated.
b. b. Sick pay benefits vest.
c. Sick pay benefits equal 100% of the pay.
d. Sick pay benefits accumulate.
58. Which of the following taxes does not represent a common payroll deduction?
a. Federal income taxes.
b. FICA taxes.
c. State unemployment taxes.
d. State income taxes.

59. What is a contingency?

a. An existing situation where certainty exists as to a gain or loss that will be resolved when one
or more future events occur or fail to occur.
b. An existing situation where uncertainty exists as to possible loss that will be resolved when
one or more future events occur.
c. An existing situation where uncertainty exists as to possible gain or loss that will not be
resolved in the foreseeable future.
d. An existing situation where uncertainty exists as to possible gain or loss that will be resolved
when one or more future events occur or fail to occur.

60. When is a contingent liability recorded?

a. When the amount can be reasonably estimated.
b. When the future events are probable to occur and the amount can be reasonably estimated.
c. When the future events are probable to occur.
d. When the future events will possibly occur and the amount can be reasonably estimated.

61. Which of the following is an example of a contingent liability? a.

Obligations related to product warranties.
b. Possible receipt from a litigation settlement.
c. Pending court case with a probable favorable outcome.
d. Tax loss carryforwards.

62. Which of the following terms is associated with recording a contingent liability?
a. Possible.
b. Likely.
c. Remote.
d. Probable.

63. Which of the following is the proper way to report a gain contingency?
a. As an accrued amount.
b. As deferred revenue.
c. As an account receivable with additional disclosure explaining the nature of the contingency.
d. As a disclosure only.

64. Which of the following contingencies need not be disclosed in the financial statements or the
notes thereto?
a. Probable losses not reasonably estimable
b. Environmental liabilities that cannot be reasonably estimated
c. Guarantees of indebtedness of others d.
All of these must be disclosed.
65. Which of the following sets of conditions would give rise to the accrual of a contingency under
current generally accepted accounting principles?
a. Amount of loss is reasonably estimable and event occurs infrequently.
b. Amount of loss is reasonably estimable and occurrence of event is probable.
c. Event is unusual in nature and occurrence of event is probable.
d. Event is unusual in nature and event occurs infrequently.

66. Jeff Beck is a farmer who owns land which borders on the right-of-way of the Northern Railroad.
On August 10, 2012, due to the admitted negligence of the Railroad, hay on the farm was set on
fire and burned. Beck had had a dispute with the Railroad for several years concerning the
ownership of a small parcel of land. The representative of the Railroad has offered to assign any
rights which the Railroad may have in the land to Beck in exchange for a release of his right to
reimbursement for the loss he has sustained from the fire. Beck appears inclined to accept the
Railroad's offer. The Railroad's 2012 financial statements should include the following related to
the incident:
a. recognition of a loss and creation of a liability for the value of the land.
b. recognition of a loss only.
c. creation of a liability only.
d. disclosure in note form only.

67. A contingency can be accrued when

a. it is certain that funds are available to settle the disputed amount.
b. an asset may have been impaired.
c. the amount of the loss can be reasonably estimated and it is probable that an asset has been
impaired or a liability incurred.
d. it is probable that an asset has been impaired or a liability incurred even though the amount
of the loss cannot be reasonably estimated.

68. A contingent liability

a. definitely exists as a liability but its amount and due date are indeterminable.
b. is accrued even though not reasonably estimated.
c. is not disclosed in the financial statements. d.
is the result of a loss contingency.

69. To record an asset retirement obligation (ARO), the cost associated with the ARO is
a. expensed.
b. included in the carrying amount of the related long-lived asset.
c. included in a separate account.
d. none of these.

70. A company is legally obligated for the costs associated with the retirement of a long-lived asset
a. only when it hires another party to perform the retirement activities.
b. only if it performs the activities with its own workforce and equipment.
c. whether it hires another party to perform the retirement activities or performs the activities
itself.
d. when it is probable the asset will be retired.
 71. Assume that a manufacturing corporation has (1) good quality control, (2) a one-year operating
cycle, (3) a relatively stable pattern of annual sales, and (4) a continuing policy of guaranteeing
new products against defects for three years that has resulted in material but rather stable
warranty repair and replacement costs. Any liability for the warranty
a. should be reported as long-term.
b. should be reported as current.
c. should be reported as part current and part long-term.
d. need not be disclosed.
72. Ortiz Corporation, a manufacturer of household paints, is preparing annual financial statements at
December 31, 2012. Because of a recently proven health hazard in one of its paints, the
government has clearly indicated its intention of having Ortiz recall all cans of this paint sold in
the last six months. The management of Ortiz estimates that this recall would cost $800,000.
What accounting recognition, if any, should be accorded this situation?
a. No recognition
b. Note disclosure only
c. Operating expense of $800,000 and liability of $800,000
d. Appropriation of retained earnings of $800,000
73. Information available prior to the issuance of the financial statements indicates that it is probable
that, at the date of the financial statements, a liability has been incurred for obligations related to
product warranties. The amount of the loss involved can be reasonably estimated. Based on the
above facts, an estimated loss contingency should be a. accrued.
b. disclosed but not accrued.
c. neither accrued nor disclosed.
d. classified as an appropriation of retained earnings.
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74. Espinosa Co. has a loss contingency to accrue. The loss amount can only be reasonably
estimated within a range of outcomes. No single amount within the range is a better
estimate than any other amount. The amount of loss accrual should be
a. zero.
b. the minimum of the range.
c. the mean of the range.
d. the maximum of the range.
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75. Dean Company becomes aware of a lawsuit after the date of the financial statements, but
before they are issued. A loss and related liability should be reported in the financial
statements if the amount can be reasonably estimated, an unfavorable outcome is highly
probable, and
a. the Dean Company admits guilt.
b. the court will decide the case within one year.
c. the damages appear to be material.
d. the cause for action occurred during the accounting period covered by the financial
statements.
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76. Use of the accrual method in accounting for product warranty costs
a. is required for federal income tax purposes.
b. is frequently justified on the basis of expediency when warranty costs are immaterial.
c. finds the expense account being charged when the seller performs in compliance with the
warranty.
d. represents accepted practice and should be used whenever the warranty is an integral and
inseparable part of the sale.
77. Which of the following best describes the accrual method of accounting for warranty costs?
a. Expensed when paid.
b. Expensed when warranty claims are certain. c.
Expensed based on estimate in year of sale.
d. Expensed when incurred.

78. Which of the following best describes the cash-basis method of accounting for warranty costs?
a. Expensed based on estimate in year of sale.
b. Expensed when liability is accrued.
c. Expensed when warranty claims are certain. d.
Expensed when incurred.

79. Which of the following is a characteristic of the expense warranty approach, but not the sales
warranty approach?
a. Estimated liability under warranties.
b. Warranty expense.
c. Unearned warranty revenue.
d. Warranty revenue.

80. An electronics store is running a promotion where for every video game purchased, the customer
receives a coupon upon checkout to purchase a second game at a 50% discount. The coupons
expire in one year. The store normally recognized a gross profit margin of 40% of the selling price
on video games. How would the store account for a purchase using the discount coupon?
a. The reduction in sales price attributed to the coupon is recognized as premium expense.
b. The difference between the cost of the video game and the cash received is recognized as
premium expense.
c. Premium expense is not recognized.
d. The difference between the cost of the video game and the selling price prior to the coupon is
recognized as premium expense.

81. What condition is necessary to recognize an asset retirement obligation?

a. Company has an existing legal obligation and can reasonably estimate the amount of the
liability.
b. Company can reasonably estimate the amount of the liability.
c. Company has an existing legal obligation.
d. Obligation event has occurred.

82. Which of the following are not factors that are considered when evaluating whether or not to
record a liability for pending litigation?
a. Time period in which the underlying cause of action occurred. b.
The type of litigation involved.
c. The probability of an unfavorable outcome.
d. The ability to make a reasonable estimate of the amount of the loss.
 83. How do you determine the acid-test ratio?
a. The sum of cash and short-term investments divided by short-term debt.
b. Current assets divided by current liabilities.
c. Current assets divided by short-term debt.
d. The sum of cash, short-term investments and net receivables divided by current liabilities.

84. What does the current ratio inform you about a company?
a. The extent of slow-moving inventories.
b. The efficient use of assets. c.
The company's liquidity.
d. The company's profitability.
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85. Which of the following is not acceptable treatment for the presentation of current
liabilities?
a. Listing current liabilities in order of maturity
b. Listing current liabilities according to amount
c. Offsetting current liabilities against assets that are to be applied to their liquidation
d. Showing current liabilities immediately below current assets to obtain a presentation of
working capital

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86. The ratio of current assets to current liabilities is called the
a. current ratio.
b. acid-test ratio.
c. current asset turnover ratio.
d. current liability turnover ratio.

87. Accrued liabilities are disclosed in financial statements by

a. a footnote to the statements.
b. showing the amount among the liabilities but not extending it to the liability total.
c. an appropriation of retained earnings.
d. appropriately classifying them as regular liabilities in the balance sheet.

88. The numerator of the acid-test ratio consists of

a. total current assets.
b. cash and marketable securities.
c. cash and net receivables.
d. cash, marketable securities, and net receivables.

89. Each of the following are included in both the current ratio and the acid-test ratio except
a. cash.
b. short-term investments.
c. net receivables.
d. inventory.
Multiple Choice Answers—Conceptual
Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans.
21. d 31. c 41. a 51. d 61. a 71. c 81. a
22. d 32. d 42. b 52. d 62. d 72. c 82. b
23. a 33. c 43. c 53. c 63. d 73. a 83. d
24. a 34. d 44. d 54. d 64. d 74. b 84. c
25. b 35. b 45. d 55. d 65. b 75. d 85. c
26. d 36. a 46. d 56. d 66. a 76. d 86. a
27. c 37. a 47. a 57. b 67. c 77. c 87. d
28. d 38. c 48. d 58. c 68. d 78. d 88. d
29. c 39. d 49. b 59. d 69. b 79. a *89. d
30. d 40. d 50. d 60. b 70. c 80. b
Solutions to those Multiple Choice questions for which the answer is “none of these.”
22. A long-term debt maturing currently to be paid with current assets is a current liability.
32. Accounts Payable, Wages Payable, etc., would be examples of current liabilities.
44. The company must both intend to refinance the obligation on a long-term basis and
demonstrate the ability to consummate the refinancing to exclude a short-term obligation
from current liabilities.

MULTIPLE CHOICE—Computational
90. Glaus Corp. signed a three-month, zero-interest-bearing note on November 1, 2012 for the
purchase of $250,000 of inventory. The face value of the note was $253,675. Assuming Glaus used
a “Discount on Note Payable” account to initially record the note and that the discount will be
amortized equally over the 3-month period, the adjusting entry made at December 31, 2012 will
include a
a. debit to Discount on Note Payable for $1,225. b.
debit to Interest Expense for $2,450.
c. credit to Discount on Note Payable for $1,255.
d. credit to Interest Expense for $2,450.

91. The effective interest on a 12-month, zero-interest-bearing note payable of $300,000, discounted
at the bank at 8% is
a. 8.51%.
b. 8%.
c. 11.49%.
d. 8.70%.
92. On September 1, Hydra purchased $13,300 of inventory items on credit with the terms 1/15, net
30, FOB destination. Freight charges were $280. Payment for the purchase was made on
September 18. Assuming Hydra uses the perpetual inventory system and the net method of
accounting for purchase discounts, what amount is recorded as inventory from this purchase?
a. $13,167.
b. $13,447.
c. $13,580.
d. $13,300.

93. Sodium Inc. borrowed $280,000 on April 1. The note requires interest at 12% and principal to be
paid in one year. How much interest is recognized for the period from April 1 to December 31?
a. $0.
b. $33,600.
c. $8,400.
d. $25,200.

94. Collier borrowed $350,000 on October 1 and is required to pay $360,000 on March 1. What
amount is the note payable recorded at on October 1 and how much interest is recognized from
October 1 to December 31?
a. $350,000 and $0.
b. $350,000 and $6,000.
c. $360,000 and $0.
d. $350,000 and $10,000.

95. Purest owes $2 million that is due on February 28. The company borrows $1,600,000 on February
25 (5-year note) and uses the proceeds to pay down the $2 million note and uses other cash to
pay the balance. How much of the $2 million note is classified as long- term in the December 31
financial statements.
a. $2,000,000.
b. $0.
c. $1,600,000.
d. $400,000.

96. Vista newspapers sold 6,000 of annual subscriptions at $125 each on September 1. How much
unearned revenue will exist as of December 31?
a. $0.
b. $500,000.
c. $250,000.
d. $750,000.

97. Purchase Retailer made cash sales during the month of October of $221,000. The sales are subject
to a 6% sales tax that was also collected. Which of the following would be included in the
summary journal entry to reflect the sale transactions?
a. Debit Cash for $221,000.
b. Credit Sales Taxes Payable for $12,510.
c. Credit Sales Revenue for $208,490.
d. Credit Sales Taxes Payable for $13,260.
 98. On February 10, 2012, after issuance of its financial statements for 2011, House Company entered
into a financing agreement with Lebo Bank, allowing House Company to borrow up to $6,000,000
at any time through 2014. Amounts borrowed under the agreement bear interest at 2% above the
bank's prime interest rate and mature two years from the date of loan. House Company presently
has $2,250,000 of notes payable with First National Bank maturing March 15, 2012. The company
intends to borrow $3,750,000 under the agreement with Lebo and liquidate the notes payable to
First National. The agreement with Lebo also requires House to maintain a working capital
level of
$9,000,000 and prohibits the payment of dividends on common stock without prior
approval by Lebo Bank. From the above information only, the total short-term debt of
House Company as of the December 31, 2012 balance sheet date is
a. $0.
b. $2,250,000.
c. $3,000,000.
d. $6,000,000.

99. On December 31, 2012, Irey Co. has $4,000,000 of short-term notes payable due on February 14,
2013. On January 10, 2013, Irey arranged a line of credit with County Bank which allows Irey to
borrow up to $3,000,000 at one percent above the prime rate for three years. On February 2,
2013, Irey borrowed $2,400,000 from County Bank and used
$1,000,000 additional cash to liquidate $3,400,000 of the short-term notes payable. The
amount of the short-term notes payable that should be reported as current liabilities on the
December 31, 2012 balance sheet which is issued on March 5, 2013 is
a. $0.
b. $600,000.
c. $1,000,000.
d. $1,600,000.

Use the following information for questions

100 and 101.
Stine Co. is a retail store operating in a state with a 6% retail sales tax. The retailer may keep 2%
of the sales tax collected. Stine Co. records the sales tax in the Sales Revenue account. The
amount recorded in the Sales Revenue account during May was $222,600.

100. The amount of sales taxes (to the nearest dollar) for May is a.
$13,089.
b. $12,600.
c. $13,356.
d. $14,157.

101. The amount of sales taxes payable (to the nearest dollar) to the state for the month of May is
a. $12,826.
b. $12,348.
c. $13,089.
d. $13,873.
102. Vopat, Inc., is a retail store operating in a state with a 5% retail sales tax. The state law provides
that the retail sales tax collected during the month must be remitted to the state during the
following month. If the amount collected is remitted to the state on or before the twentieth of
the following month, the retailer may keep 3% of the sales tax collected. On April 10, 2012, Vopat
remitted $135,800 tax to the state tax division for March 2012 retail sales. What was Vopat 's
March 2012 retail sales subject to sales tax?
a. $2,716,000.
b. $2,660,000.
c. $2,800,000.
d. $2,741,667.

103. Jenkins Corporation has $2,500,000 of short-term debt it expects to retire with proceeds from the
sale of 90,000 shares of common stock. If the stock is sold for $20 per share subsequent to the
balance sheet date, but before the balance sheet is issued, what amount of short-term debt could
be excluded from current liabilities?
a. $1,800,000
b. $2,500,000
c. $700,000
d. $0

104. Ermler Corporation has $1,800,000 of short-term debt it expects to retire with proceeds from the
sale of 50,000 shares of common stock. If the stock is sold for $20 per share subsequent to the
balance sheet date, but before the balance sheet is issued, what amount of short-term debt could
be excluded from current liabilities?
a. $1,000,000
b. $1,800,000
c. $800,000
d. $0

105. Preston Co., which has a taxable payroll of $700,000, is subject to FUTA tax of 6.2% and a state
contribution rate of 5.4%. However, because of stable employment experience, the company’s
state rate has been reduced to 2%. What is the total amount of federal and state unemployment
tax for Preston Co.?
a. $81,900
b. $57,400
c. $28,000
d. $19,600

106. Roark Co., which has a taxable payroll of $600,000, is subject to FUTA tax of 6.2% and a state
contribution rate of 5.4%. However, because of stable employment experience, the company’s
state rate has been reduced to 2%. What is the total amount of federal and state unemployment
tax for Roark Co.?
a. $70,200
b. $49,200
c. $24,000
d. $16,800
107. A company gives each of its 50 employees (assume they were all employed continuously through
2012 and 2013) 12 days of vacation a year if they are employed at the end of the year. The
vacation accumulates and may be taken starting January 1 of the next year. The employees work
8 hours per day. In 2012, they made $21 per hour and in 2013 they made $24 per hour. During
2013, they took an average of 9 days of vacation each. The company’s policy is to record the
liability existing at the end of each year at the wage rate for that year. What amount of vacation
liability would be reflected on the 2012 and 2013 balance sheets, respectively?
a. $100,800; $140,400
b. $115,200; $144,000
c. $100,800; $144,000
d. $115,200;
$140,400

108. A company gives each of its 50 employees (assume they were all employed continuously through
2012 and 2013) 12 days of vacation a year if they are employed at the end of the year. The
vacation accumulates and may be taken starting January 1 of the next year. The employees work
8 hours per day. In 2012, they made $24.50 per hour and in 2013 they made $28 per hour. During
2013, they took an average of 9 days of vacation each. The company’s policy is to record the
liability existing at the end of each year at the wage rate for that year. What amount of vacation
liability would be reflected on the 2012 and 2013 balance sheets, respectively?
a. $117,600; $163,800
b. $134,400; $168,000
c. $117,600; $168,000
d. $134,400;
$163,800

109. The total payroll of Teeter Company for the month of October, 2012 was $600,000, of which
$150,000 represented amounts paid in excess of $106,800 to certain employees.
$500,000 represented amounts paid to employees in excess of the $7,000 maximum
subject to unemployment taxes. $150,000 of federal income taxes and $15,000 of union
dues were withheld. The state unemployment tax is 1%, the federal unemployment tax is
.8%, and the current F.I.C.A. tax is 7.65% on an employee’s wages to $106,800 and
1.45% in excess of $106,800. What amount should Teeter record as payroll tax expense?
a. $197,700.
b. $188,400.
c. $38,400.
d. $47,400.

Use the following information for questions 110 and 111.

Vargas Company has 35 employees who work 8-hour days and are paid hourly. On January 1,
2011, the company began a program of granting its employees 10 days of paid vacation each
year. Vacation days earned in 2011 may first be taken on January 1, 2012. Information relative to
these employees is as follows:
Hourly Vacation Days Earned Vacation Days Used
Year Wages by Each Employee by Each Employee
2011 $21.50 10 0
2012 22.50 10 8
2013 23.75 10 10

Vargas has chosen to accrue the liability for compensated absences at the current rates of pay in
effect when the compensated time is earned.
110. What is the amount of expense relative to compensated absences that should be reported on
Vargas’s income statement for 2011?
a. $0.
b. $57,400.
c. $63,000.
d. $60,200.
111. What is the amount of the accrued liability for compensated absences that should be reported at
December 31, 2013?
a. $79,100.
b. $75,600.
c. $66,500.
d. $79,800.
112. CalCount pays a weekly payroll of $170,000 that includes federal taxes withheld of
$25,400, FICA taxes withheld of $15,780, and 401(k) withholdings of $18,000. What is the
effect of assets and liabilities from this transaction?
a. Assets decrease $170,000 and liabilities do not change.
b. Assets decrease $128,820 and liabilities increase $41,180.
c. Assets decrease $128,820 and liabilities decrease $41,180. d.
Assets decrease $110,820 and liabilities increase $59,180.
113. CalCount provides its employees two weeks of paid vacation per year. As of December 31, 65
employees have earned two weeks of vacation time to be taken the following year. If the average
weekly salary for these employees is $1,140, what is the required journal entry?
a. Debit Salaries and Wages Expense for $148,200 and credit Salaries and Wages Payable for
$148,200.
b. No journal entry required.
c. Debit Salaries and Wages Payable for $147,600 and credit Salaries and Wages Expense for
$147,600.
d. Debit Salaries and Wages Expense for $74,100 and credit Salaries and Wages Payable for
$74,100.

114. Tender Foot Inc. is involved in litigation regarding a faulty product sold in a prior year. The
company has consulted with its attorney and determined that it is possible that they may lose the
case. The attorneys estimated that there is a 40% chance of losing. If this is the case, their
attorney estimated that the amount of any payment would be $500,000. What is the required
journal entry as a result of this litigation?
a. Debit Litigation Expense for $500,000 and credit Litigation liability for $500,000. b. No
journal entry is required.
c. Debit Litigation Expense for $200,000 and credit Litigation Liability for $200,000.
d. Debit Litigation Expense for $300,000 and credit Litigation Liability for $300,000.

115. Recycle Exploration is involved with innovative approaches to finding energy reserves. Recycle
recently built a facility to extract natural gas at a cost of $15 million. However, Recycle is also
legally responsible to remove the facility at the end of its useful life of twenty years. This cost is
estimated to be $21 million (the present value of which is $8 million). What is the journal entry
required to record the asset retirement obligation?
a. No journal entry required.
b. Debit Natural Gas Facility for $21,000,000 and credit Asset Retirement Obligation for
$21,000,000
 c. Debit Natural Gas Facility for $6,000,000 and credit Asset Retirement Obligation for
$6,000,000.
d. Debit Natural Gas Facility for $8,000,000 and credit Asset Retirement Obligation for
$8,000,000.
116. Warranty4U provides extended service contracts on electronic equipment sold through major
retailers. The standard contract is for three years. During the current year, Warranty4U provided
42,000 such warranty contracts at an average price of $81 each. Related to these contracts, the
company spent $400,000 servicing the contracts during the current year and expects to spend
$2,100,000 more in the future. What is the net profit that the company will recognize in the
current year related to these contracts?
a. $902,000.
b. $3,002,000.
c. $300,667.
d. $734,000.

117. Electronics4U manufactures high-end whole home electronic systems. The company provides a
one-year warranty for all products sold. The company estimates that the warranty cost is $200
per unit sold and reported a liability for estimated warranty costs
$7.8 million at the beginning of this year. If during the current year, the company sold
60,000 units for a total of $243 million and paid warranty claims of $9,000,000 on current
and prior year sales, what amount of liability would the company report on its balance
sheet at the end of the current year?
a. $3,000,000.
b. $4,200,000.
c. $10,800,000.
d. $12,000,000.

118. A company offers a cash rebate of $1 on each $4 package of light bulbs sold during 2012.
Historically, 10% of customers mail in the rebate form. During 2012, 3,000,000 packages of light
bulbs are sold, and 160,000 $1 rebates are mailed to customers. What is the rebate expense and
liability, respectively, shown on the 2012 financial statements dated December 31?
a. $300,000; $300,000
b. $300,000; $140,000
c. $140,000; $140,000
d. $160,000; $140,000

119. A company buys an oil rig for $2,000,000 on January 1, 2012. The life of the rig is 10 years and the
expected cost to dismantle the rig at the end of 10 years is $400,000 (present value at 10% is
$154,220). 10% is an appropriate interest rate for this company. What expense should be
recorded for 2012 as a result of these events?
a. Depreciation expense of $240,000
b. Depreciation expense of $200,000 and interest expense of $15,422
c. Depreciation expense of $200,000 and interest expense of $40,000 d.
Depreciation expense of $215,420 and interest expense of $15,422

120. Ziegler Company self insures its property for fire and storm damage. If the company were to
obtain insurance on the property, it would cost them $1,500,000 per year. The company
estimates that on average it will incur losses of $1,200,000 per year. During 2012, $525,000 worth
of losses were sustained. How much total expense and/or loss should be recognized by Ziegler
Company for 2012?
a. $525,000 in losses and no insurance expense
 b. $525,000 in losses and $675,000 in insurance expense
c. $0 in losses and $1,200,000 in insurance expense
d. $0 in losses and $1,500,000 in insurance expense

121. A company offers a cash rebate of $2 on each $6 package of batteries sold during 2012.
Historically, 10% of customers mail in the rebate form. During 2012, 6,000,000 packages of
batteries are sold, and 210,000 $2 rebates are mailed to customers. What is the rebate expense
and liability, respectively, shown on the 2012 financial statements dated December 31?
a. $1,200,000; $1,200,000
b. $1,200,000; $780,000
c. $780,000; $780,000
d. $420,000; $780,000

122. A company buys an oil rig for $3,000,000 on January 1, 2012. The life of the rig is 10 years and the
expected cost to dismantle the rig at the end of 10 years is $600,000 (present value at 10% is
$231,330). 10% is an appropriate interest rate for this company. What expense should be
recorded for 2012 as a result of these events?
a. Depreciation expense of $360,000
b. Depreciation expense of $300,000 and interest expense of $23,133
c. Depreciation expense of $300,000 and interest expense of $60,000 d.
Depreciation expense of $323,133 and interest expense of $23,133

123. During 2011, Vanpelt Co. introduced a new line of machines that carry a three-year warranty
against manufacturer’s defects. Based on industry experience, warranty costs are estimated at 2%
of sales in the year of sale, 3% in the year after sale, and 4% in the second year after sale. Sales
and actual warranty expenditures for the first three-year period were as follows:
Sales Actual Warranty Expenditures
2011 $ 600,000 $ 9,000
2012 1,500,000 65,000
2013 2,100,000 135,000
$4,200,000 $209,000
What amount should Vanpelt report as a liability at December 31, 2013?
a. $0
b. $12,000
c. $54,000
d. $169,000

124. Palmer Frosted Flakes Company offers its customers a pottery cereal bowl if they send in 3
boxtops from Palmer Frosted Flakes boxes and $1. The company estimates that 60% of the
boxtops will be redeemed. In 2012, the company sold 675,000 boxes of Frosted Flakes and
customers redeemed 330,000 boxtops receiving 110,000 bowls. If the bowls cost Palmer
Company $3 each, how much liability for outstanding premiums should be recorded at the end of
2012?
a. $270,000
b. $50,000
c. $75,000
d. $138,000
125. During 2011, Stabler Co. introduced a new line of machines that carry a three-year warranty
against manufacturer’s defects. Based on industry experience, warranty costs are estimated at 2%
of sales in the year of sale, 3% in the year after sale, and 4% in the second year after sale. Sales
and actual warranty expenditures for the first three-year period were as follows:
Sales Actual Warranty Expenditures
2011 $ 400,000 $ 6,000
2012 1,000,000 40,000
2013 1,400,000 90,000
$2,800,000 $136,000
What amount should Stabler report as a liability at December 31, 2013?
a. $0
b. $28,000
c. $36,000
d. $116,000

126. LeMay Frosted Flakes Company offers its customers a pottery cereal bowl if they send in 4
boxtops from LeMay Frosted Flakes boxes and $1. The company estimates that 60% of the
boxtops will be redeemed. In 2012, the company sold 500,000 boxes of Frosted Flakes and
customers redeemed 220,000 boxtops receiving 55,000 bowls. If the bowls cost LeMay Company
$3 each, how much liability for outstanding premiums should be recorded at the end of 2012?
a. $150,000
b. $40,000
c. $60,000
d. $84,000

Use the following information for questions 127, 128, and 129.
Mott Co. includes one coupon in each bag of dog food it sells. In return for eight coupons,
customers receive a leash. The leashes cost Mott $3 each. Mott estimates that 40 percent of the
coupons will be redeemed. Data for 2012 and 2013 are as follows:
2012 2013
Bags of dog food sold 500,000 600,000
Leashes purchased 18,000 22,000
Coupons redeemed 120,000 150,000

127. The premium expense for 2012 is a.

$37,500.
b. $45,000.
c. $52,500.
d. $75,000.

128. The premium liability at December 31, 2012 is a.

$11,250.
b. $15,000.
c. $26,250.
d. $30,000.
129. The premium liability at December 31, 2013 is a.
$16,875
b. $31,875.
c. $33,750.
d. $63,750.

130. Winter Co. is being sued for illness caused to local residents as a result of negligence on the
company's part in permitting the local residents to be exposed to highly toxic chemicals from its
plant. Winter's lawyer states that it is probable that Winter will lose the suit and be found liable
for a judgment costing Winter anywhere from $1,600,000 to
$8,000,000. However, the lawyer states that the most probable cost is $4,800,000. As a
result of the above facts, Winter should accrue
a. a loss contingency of $1,600,000 and disclose an additional contingency of up to
$6,400,000.
b. a loss contingency of $4,800,000 and disclose an additional contingency of up to
$3,200,000.
c. a loss contingency of $4,800,000 but not disclose any additional contingency.
d. no loss contingency but disclose a contingency of $1,600,000 to $8,000,000.

131. Nance Company estimates its annual warranty expense as 2% of annual net sales. The following
data relate to the calendar year 2012:
Net sales $1,500,000
Warranty liability account
Balance, Dec. 31, 2012 $10,000 debit before adjustment
Balance, Dec. 31, 2012 50,000 credit after adjustment
Which one of the following entries was made to record the 2012 estimated warranty
expense?
a. Warranty Expense ............................................................... 30,000
Retained Earnings (prior-period adjustment) ............ 5,000
Warranty Liability ...................................................... 25,000
b. Warranty Expense ............................................................... 25,000
Retained Earnings (prior-period adjustment) ...................... 5,000
Warranty Liability ...................................................... 30,000
c. Warranty Expense ............................................................... 20,000
Warranty Liability ...................................................... 20,000
d. Warranty Expense......................................................................30,000
Warranty Liability ...................................................... 30,000

132. In 2012, Payton Corporation began selling a new line of products that carry a two-year warranty
against defects. Based upon past experience with other products, the estimated warranty costs
related to dollar sales are as follows:
First year of warranty 2%
Second year of warranty 5%
Sales and actual warranty expenditures for 2012 and 2013 are presented below:
2012 2013
Sales $600,000 $800,000
Actual warranty expenditures 20,000 40,000
 What is the estimated warranty liability at the end of 2013?
a. $38,000.
b. $58,000.
c. $98,000.
d. $16,000.

133. On January 3, 2012, Boyer Corp. owned a machine that had cost $300,000. The accumulated
depreciation was $180,000, estimated salvage value was $18,000, and fair value was $480,000.
On January 4, 2012, this machine was irreparably damaged by Pine Corp. and became worthless.
In October 2012, a court awarded damages of $480,000 against Pine in favor of Boyer. At
December 31, 2012, the final outcome of this case was awaiting appeal and was, therefore,
uncertain. However, in the opinion of Boyer’s attorney, Pine’s appeal will be denied. At December
31, 2012, what amount should Boyer accrue for this gain contingency?
a. $480,000.
b. $390,000.
c. $300,000.
d. $0.

134. Fuller Food Company distributes to consumers coupons which may be presented (on or before a
stated expiration date) to grocers for discounts on certain products of Fuller. The grocers are
reimbursed when they send the coupons to Fuller. In Fuller's experience, 50% of such coupons are
redeemed, and generally one month elapses between the date a grocer receives a coupon from a
consumer and the date Fuller receives it. During 2012 Fuller issued two separate series of
coupons as follows:
Consumer Amount Disbursed
Issued On Total Value Expiration Date as of 12/31/12
1/1/12 $500,000 6/30/12 $236,000
7/1/12 720,000 12/31/12 300,000
The only journal entries to date recorded debits to coupon expense and credits to cash of
$715,000. The December 31, 2012 balance sheet should include a liability for
unredeemed coupons of
a. $0.
b. $60,000.
c. $124,000.
d. $360,000.

135. Presented below is information available for Morton Company.

Current Assets
Cash $ 4,000
Short-term investments 75,000
Accounts receivable 61,000
Inventory 110,000
Prepaid expenses 30,000
Total current assets $280,000
Total current liabilities are $110,000. The acid-test ratio for Morton is
a. 2.55 to 1.
b. 2.27 to 1.
c. 1.27 to 1.
d. 0.72 to 1.
 Multiple Choice Answers—Computational
Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans.
90. b 97. d 104. a 111. a 118. b 125. d 132. a
91. d 98. b 105. d 112. d 119. d 126. b 133. d
92. a 99. d 106. d 113. a 120. a 127. d 134. b
93. d 100. b 107. c 114. b 121. b 128. d 135. c
94. b 101. b 108. c 115. d 122. d 129. d
95. c 102. c 109. c 116. d 123. d 130. b
96. b 103. a 110. d 117. c 124. b 131. d

1. Some liabilities are not contractual obligations and may not be payable in cash.

Answer: True

2. Long-term debt that is callable by the creditor in the upcoming year should be classified as a
current liability only if the debt is expected to be called.

Answer: False

3. A customer advance produces a liability that is satisfied when the product or service is
provided.

Answer: True

4. Amounts withheld from employees in connection with payroll often represent liabilities to third
parties.

Answer: True

5. A company should accrue a liability for a loss contingency if it is at least reasonably possible
that assets have been impaired, and the amount of potential loss can be reasonably estimated.

Answer: False

6. A disclosure note is required for all material loss contingencies for which the probability of loss
is reasonably possible.

Answer: True

7. The concept of substance over form influences the classification of obligations expected to be
refinanced.

Answer: True

8. For a loss contingency to be accrued, the claim must have been made before the accounting
period ended.
Answer: False

9. Warranty expense is recorded along with the related liability in the reporting period in which the
product under warranty is sold.

Answer: True

10. The cost of promotional offers should be recorded as expenses in the accounting period when
the offers are redeemed by customers.

Answer: False

Matching Pair Questions

Use the following to answer questions 11-15:

11-15. Listed below are ten terms followed by a list of phrases that describe or characterize five of the
terms. Match each phrase with the correct term by placing the letter designating the best term in the
space provided by the phrase.

Terms:

A. Accrued liabilities

B. Advances from customers

C. Callable

D. Discount on notes payable

E. Interest payable

F. Probable

G. Sales tax payable

H. Secured loan

I. Short-term note

J. Warranty liability

Phrases:

11. __B__ A liability when received.

12. __F__ Confirming event is likely to occur.

13. __J__ A loss contingency accrued in the period of related sales.

14. __I__ Most common temporary financing arrangement.

15. __H__ Requires collateral.

Answer: 11-B; 12-F; 13-J; 14-I; 15-H

Use the following to answer questions 16-20:

16-20. Listed below are ten terms followed by a list of phrases that describe or characterize five of the
terms. Match each phrase with the correct term by placing the letter designating the best term in the
space provided by the phrase.

Terms:

A. Accrued liabilities

B. Advances from customers

C. Callable

D. Discount on notes payable

E. Interest payable

F. Probable

G. Sales tax payable

H. Secured loan

I. Short-term note

J. Warranty liability

Phrases:

16. __C__ Due on demand.

17. __D__ A contra liability account.

18. __G__ A third party liability.

19. __E__ Accrues with passage of time.

20. __A__ Expenses incurred but not yet paid.

Answer: 16-C; 17-D; 18-G; 19-E; 20-A

Use the following to answer questions 21-25:

21-25. Listed below are ten terms followed by a list of phrases that describe or characterize five of the
terms. Match each phrase with the correct term by placing the letter designating the best term in the
space provided by the phrase.

Terms:

A. Accounting liabilities

B. Customer deposits

C. Effective interest

D. Factoring

E. Gain contingency

F. Interest paid on debt

G. Noncommitted line of credit

H. Reasonably possible

I. Subsequent event

J. Unasserted claims

Phrases:

21. __B__ Liability until refunded.

22. __H__ More than remote but less than likely.

23. __F__ Face amount x rate x time.

24. __E__ Not recorded until realized.

25. __G__ Informal borrowing agreement.

Answer: 21-B; 22-H; 23-F; 24-E; 25-G

Use the following to answer questions 26-30:

26-30. Listed below are ten terms followed by a list of phrases that describe or characterize five of the
terms. Match each phrase with the correct term by placing the letter designating the best term in the
space provided by the phrase.

Terms:

A. Accounting liabilities

B. Customer deposits

C. Effective interest

D. Factoring

E. Gain contingency

F. Interest paid on debt

G. Noncommitted line of credit

H. Reasonably possible

I. Subsequent event

J. Unasserted claims

Phrases:

26. __C__ Exceeds the stated rate on discounted notes.

27. __A__ May include items that are not legal liabilities.

28. __D__ Sale of receivables.

29. __J__ Evaluated for recognition only if an unfavorable outcome is probable.

30. __I__ Occurs in the current year before prior year financial statements are issued.

Answer: 26-C; 27-A; 28-D; 29-J; 30-I

Use the following to answer questions 31-35:

31-35. Listed below are ten terms followed by a list of phrases that describe or characterize five of the
terms. Match each phrase with the correct term by placing the letter designating the best term in the
space provided by the phrase.
Terms:

A. Accounts payable

B. Commercial paper

C. Committed line of credit

D. Current liabilities

E. Disclosure notes

F. Long-term liability

G. Loss contingency

H. Noninterest-bearing note

I. Pledging

J. Usual valuation of long-term liabilities

Phrases:

31. __I__ Uses accounts receivable as collateral.

32. __C__ Often requires compensating balance.

33. __A__ Only formal credit instrument is the invoice.

34. __H__ Effective interest higher than stated interest.

35. __G__ Recorded if probable and amount is known or reasonably estimable.

Answer: 31-I; 32-C; 33-A; 34-H; 35-G

Use the following to answer questions 36-40:

36-40. Listed below are ten terms followed by a list of phrases that describe or characterize five of the
terms. Match each phrase with the correct term by placing the letter designating the best term in the
space provided by the phrase.

Terms:

A. Accounts payable

B. Commercial paper

C. Committed line of credit

D. Current liabilities
E. Disclosure notes

F. Long-term liability

G. Loss contingency

H. Noninterest-bearing notes

I. Pledging

J. Usual valuation of long-term liabilities

Phrases:

36. __J__ Present value of interest plus present value of principal.

37. __E__ Required for contingencies.

38. __D__ Payable with current assets.

39. __F__ Short-term debt to be refinanced with long-term bonds payable.

40. __B__ Avoids registration with SEC.

Answer: 36-J; 37-E; 38-D; 39-F; 40-B

Use the following to answer questions 41-44:

41-44. Indicate (by letter) the way each of the items listed below should be reported on a balance
sheet at December 31, 2006.

Reporting Method

A. Asset

L. Liability

D. Disclosure note only

N. Not reported

41. __D__ An estimable gain that is contingent on a future event that appears exceedingly likely.

42. __L__ An assessment of back taxes that probably will be asserted by the IRS, in which case a
determinable additional payment is probable.

43. __N__ Unassessed back taxes with a reasonable possibility of being asserted, in which case a
determinable additional payment is probable.

44. __L__ A extremely likely loss due an event that occurred previously and whose amount is
unknown but estimable.
Answer: 41-D; 42-L; 43-N; 44-L

Multiple Choice Questions

45. The most common type of liability is:

a. One that comes into existence due to a loss contingency.

b. One that must be estimated.
c. One that comes into existence due to a gain contingency.
d. One to be paid in cash and for which the amount and timing are known.

Answer: D

46. Which of the following is not a characteristic of a liability?

a. It represents a probable, future sacrifice of economic benefits.

b. It must be payable in cash.
c. It arises from present obligations to other entities.
d. It results from past transactions or events.

Answer: B

47. Which of the following is not a liability?

a. An unused line of credit.

b. Estimated income taxes.
c. Sales tax collected from customers.
d. Advances from customers.

Answer: A

48. Current liabilities are normally recorded at the amount expected to be paid rather than at their
present value. This practice can be supported by GAAP according to the concept of:

a. Matching.
b. Consistency.
c. Materiality.
d. Conservatism.

Answer: C

49. Which of the following is the best definition of a current liability?

a. An obligation payable within one year.

b. An obligation payable within one year of the balance sheet date.
c. An obligation payable within one year or within the normal operating cycle, whichever is longer.
d. An obligation expected to be satisfied with current assets or by the creation of other current
liabilities.

Answer: D
50. Current liabilities are normally recorded at their:

a. Present value.
b. Cost.
c. Maturity amount.
d. Expected value.

Answer: C

51. Which of the following is not a current liability?

a. Accounts payable.
b. A note payable due in 2 years.
c. Accrued interest payable.
d. Sales tax payable.

Answer: B

52. The key accounting considerations relating to accounts payable are:

a. Determining their existence and ensuring that they are recorded in the appropriate accounting
period.
b. Determining their present value and ensuring that they are recorded in the appropriate
accounting period.
c. Determining their existence and determining the correct amount.
d. Determining the present value of the principal and the amount of the interest.

Answer: A

53. Discount on a noninterest-bearing note payable is classified on the balance sheet as:

a. An asset.
b. A component of shareholders' equity.
c. A contingent liability.
d. A contra liability.

Answer: D

54. The rate of interest that is actually incurred on a note payable is called the:

a. Face rate.
b. Contract rate.
c. Effective rate.
d. Stated rate.

Answer: C

55. The rate of interest printed on the face of a note payable is called the:

a. Yield rate.
b. Effective rate.
 c. Market rate.
d. Stated rate.

Answer: D

56. Classifying liabilities as either current or long-term helps creditors assess:

a. The extent of a firm's liabilities.

b. The relative risk of a firm's liabilities.
c. The degree of a firm's liabilities.
d. The amount of a firm's liabilities.

Answer: B

57. Large, highly rated firms sometimes sell commercial paper:

a. To borrow funds at a lower rate than through a bank.

b. To borrow funds that are not available at banks.
c. Because they can't borrow anywhere else.
d. Because the interest rate is locked in by the federal reserve board.

Answer: A

58. When cash is received from customers in the form of a refundable deposit, the cash account is
increased and there is a corresponding increase in:

a. A current liability.
b. A non-current asset.
c. Shareholders' equity.
d. Paid-in capital.

Answer: A

59. When a deposit on returnable containers is forfeited, the firm holding the deposit will experience:

a. A decrease in cost of goods sold.

b. An increase in current liabilities.
c. An increase in accounts receivable.
d. An increase in revenue.

Answer: D

60. At times, businesses require advance payments from customers that will be applied to the
purchase price when goods are delivered or services provided. These customer advances represent:

a. Liabilities until the product or service is provided.

b. A component of shareholders' equity.
c. Long-term assets until the product or service is provided.
d. Revenue upon receipt of the advance payment.

Answer: A
61. When a product or service is delivered for which a customer advance has been previously
received, the appropriate journal entry includes:

a. A debit to a revenue and a credit to a liability account.

b. A debit to a revenue and a credit to an asset account.
c. A debit to an asset and a credit to a revenue account.
d. A debit to a liability and a credit to a revenue account.

Answer: D

62. All of the following but one represent collections for third parties. Which one of the following is not
a collection for a third party?

a. Sales tax payable.

b. Customer deposits.
c. Employee insurance deductions.
d. Social security taxes deductions.

Answer: B

63. Other things being equal, most managers would prefer to report liabilities as noncurrent rather
than current. The logic behind this preference is that the long-term classification permits the company
to report:

a. Higher working capital and a higher inventory turnover.

b. Lower working capital and a higher current ratio.
c. Higher working capital and a higher current ratio.
d. Higher working capital and a lower debt to equity ratio.

Answer: C

64. Footnote disclosure is required for material potential losses when the loss is at least reasonably
possible:

a. Only if the amount is known.

b. Only if the amount is known or reasonably estimable.
c. Unless the amount is not reasonably estimable.
d. Even if the amount is not reasonably estimable.

Answer: D

65. Which of the following situations would not require that long-term liabilities be reported as current
liabilities on a classified balance sheet?

a. The long-term debt is callable by the creditor.

b. The creditor has the right to demand payment due to a contractual violation.
c. The long-term debt matures within the upcoming year.
d. All of the above require the current classification.
Answer: D

66. Short-term obligations can be reported as long-term liabilities if:

a. The firm has a long-term line of credit.

b. The firm has tentative plans to issue long-term bonds.
c. The firm intends to and has the ability to refinance as long-term.
d. The firm has the ability to refinance on a long-term basis.

Answer: C

67. Of the following, which typically would not be classified as a current liability?

a. Estimated liability from cash rebate program.

b. A long-term note payable maturing within the coming year.
c. Rent revenue received in advance.
d. A six-month bank loan to be paid with the proceeds from the sale of common stock.

Answer: D

68. Gain contingencies usually are recognized in a company's income statement when:

a. Realized.
b. The amount can be reasonably estimated.
c. The gain is reasonably possible and the amount can be reasonable estimated.
d. The gain is probable and the amount can be reasonably estimated.

Answer: A

69. A loss contingency should be accrued on a company's financial statements only if the likelihood
that a liability has been incurred is:

a. At least remotely possible and the amount of the loss is known.

b. At least reasonably possible and the amount of the loss is known.
c. At least reasonably possible and the amount of the loss can be reasonably estimated.
d. Probable and the amount of the loss can be reasonably estimated.

Answer: D

70. When a gain contingency is probable and the amount of gain can be reasonably estimated, the
gain should be:

a. Reported in the income statement and disclosed.

b. Offset against shareholders' equity.
c. Disclosed, but not recognized in the income statement.
d. Neither recognized in the income statement nor disclosed.

Answer: C
71. A contingent loss should be reported in a footnote to the financial statements rather than being
accrued if:

a. The likelihood of a loss is remote.

b. The incurrence of a loss is reasonably possible.
c. The incurrence of a loss is probable.
d. The likelihood of a loss is eighty percent.

Answer: B

72. Paul Company issues a product recall due to a defect discovered after the end of its fiscal year.
Financial statements have not been issued yet. The action required on the books of Paul Company
for this contingency for the year just ended is:

a. To disclose it in a footnote.
b. To accrue the liability.
c. To accrue the liability and explain it in a footnote.
d. To do nothing relative to the contingency.

Answer: A

73. Which of the following is a contingency that would most likely require accrual?

a. Potential losses from extended warranties.

b. Customer premium offers.
c. Potential liability on a product where none have yet been sold.
d. Sales tax payable.

Answer: B

74. Volt Electronics sells equipment that includes a three-year warranty. Volt repairs under the
warranty are performed by an independent service company under a contract with Volt. Based on
prior experience, warranty costs are estimated to be $25 per item sold. Volt should recognize these
warranty costs:

a. When the equipment is sold.

b. When the repairs are performed.
c. When payments are made to the service firm.
d. Evenly over the life of the warranty.

Answer: A

75. Which of the following is a contingency that should be accrued?

a. The company is being sued and a loss is reasonably possible and reasonably estimable.
b. The company deducts life insurance premiums from employees' paychecks.
c. The company offers a two-year warranty and the expenses can be reasonably estimated.
d. It is probable that the company will receive $100,000 in settlement of a lawsuit.
Answer: C

76. The cost of customer premium offers should be charged to expense:

a. When the related product is sold.

b. When the premium offer expires.
c. Over the life cycle of the product to which the premium relates.
d. When the premiums are claimed.

Answer: A

77. The accounting concept that requires recognition of a liability for customer premium offers is

a. Periodicity.
b. Conservatism.
c. Historical cost.
d. The matching principle.

Answer: D

78. Which of the following may create employer liabilities in connection with their payrolls?

a. Employees' withholding taxes

b. Employee voluntary deductions
c. Employee fringe benefits
d. All of the above are correct.

Answer: D

79. Accounting for costs of incentive programs for frequent customer purchases involves:

a. Recording an expense and a liability each period.

b. Recording a liability and a reduction of revenue each period.
c. Recording an expense and an asset reduction each period.
d. Recording an expense and revenue each period.

Answer: A

80. Accounting for costs of incentive programs for frequent customer purchases:

a. Requires probability estimation.

b. Uses the matching principle.
c. Is a loss contingency situation.
d. All of the above are correct.

Answer: D

81. Providing a monetary rebate program for purchasing a product:

 a. Is accounted for similarly to product warranties.
b. Creates an expense for the seller in the period of sale.
c. Creates a contingent liability for the seller at the time of sale.
d. All of the above are correct.

Answer: D

82. The main difference between accounting for rebate and cash discount coupons is:

a. The latter is not treated as an expense.

b. Only the former creates a contingent liability when issued.
c. The expense for the latter is deferred until redemption of the coupon.
d. There are no significant differences in accounting between the two.

Answer: C

83. Which of the following have essentially the same accounting treatment?

a. Coupons for cash rebates and coupons for other premiums

b. Cents off coupons and coupons for other premiums
c. Cents off coupons and coupons for cash rebates
d. All of the above are correct.

Answer: A

Use the following to answer questions 84-85:

In 2006, Holyoak Inc. offers a $20 cash rebate coupon to customers who purchased one of its new
line of products. Holyoak sold 10,000 of these products during the year. By year end of 2006, 7,600 of
the rebates had been claimed, and 7,100 had been paid. Holyoak's historical experience with such
rebates indicates that 85% of customers claim the rebates.

84. What is the expense that Holyoak should report for its promotional rebates in its 2006 income
statement?

a. $142,000
b. $152,000
c. $170,000
d. $200,000

Answer: C

Rationale: This is the expected amount to be claimed from 2006 sales; i.e., $20 x 10,000 x .85.

85. What is the rebate promotion liability that Holyoak should report in its 12/31/06 balance sheet?

a. $20,000
b. $28,000
c. $18,000
d. None of the above is correct.
Answer: B

Rationale: This is (8,500 expected 7,100 paid) x $20 = $28,000.

Use the following to answer questions 86-88:

Always Late Airline (ALA) operates a frequent flyer program in which mileage credits are earned by
its customers for traveling on the airline. Awards are issued to members at the 25,000 miles level,
and all awards expire five years from the date earned. The airline's historical experience indicates
that 80% of all travel awards will actually be redeemed.

ALA accounts for its frequent flyer obligation on the accrual basis, using the incremental cost method.
ALA's liability for free travel at the beginning of 2005 was $28 million. The incremental cost of free
travel awards redeemed in 2005 was $19 million. The estimated cost of free travel earned for miles
traveled in 2005 are $50 million.

86. What is the expense that ALA should report for its frequent flyer program in its 2005 income
statement?

a. $40 million
b. $41 million
c. $50 million
d. $69 million

Answer: A

Rationale: This is 80% of the $50 million cost of free travel awards earned.

87. Assume the same facts as in question 86, except that $2 million in earned travel awards on ALA
expired during 2005. What is the expense that ALA should report for its frequent flyer program in its
2005 income statement?

a. $38 million
b. $40 million
c. $42 million
d. None of the above is correct.

Answer: B

Rationale: The answer is the same as for question 86 because the cost for that year's customer
benefits is the same.

88. Assume the same facts as in question 86. What is the frequent flyer program liability that ALA
should report in its 12/31/05 balance sheet?

a. $31 million
b. $40 million
c. $45 million
d. None of the above is correct.

Answer: D
Rationale: This is the beginning liability of $28 million awards redeemed of $19 million + new awards
accrued of $40 million= $49 million.

89. On October 31, 2006, Simeon Builders borrowed $16 million cash and issued a 7-month,
noninterest-bearing note. The loan was made by Star Finance Co. whose stated discount rate is 8%.
Sky's effective interest rate on this loan is:

a. More than the stated discount rate of 8%.

b. Less than the stated discount rate of 8%.
c. Equal to the stated discount rate of 8%.
d. Unrelated to the stated discount rate of 8%.

Answer: A

90. In the current year, Hanna Company reported warranty expense of $190,000 and the warranty
liability account increased by $20,000. What were warranty expenditures during the year?

a. $190,000.
b. $170,000.
c. $210,000
d. $0

Answer: B

Rationale:

Expense $190,000

Increase in (20,000)
liability

Expenditures $170,000

91. Panther Co. had a warranty liability of $350,000 at the beginning of 2006, and $310,000 at end of
2006. Warranty expense is based on 4% of sales, which were $50 million for the year. What were the
warranty expenditures for 2006?

a. $0.
b. $1,960,000.
c. $2,000,000.
d. $2,040,000.

Answer: D

Rationale:

Warranty Liability

$ 350,000
 ? 2,000,000 ($50,000,000 x
4%)

310,000

$350,000 + $2,000,000 $310,000 = $2,040,000

92. Carpenter Inc. had a balance of $80,000 in its warranty liability account as of December 31, 2005.
In 2006, Carpenter's warranty expenditures were $445,000. Its warranty expense is calculated as 1%
of sales. Sales in 2006 were $40 million. What was the balance in the warranty liability account as of
December 31, 2006?

a. $ 35,000.
b. $425,000.
c. $125,000.
d. $480,000.

Answer: A

Rationale:

Warranty Liability
(in thousands)

80

445 400 (40,000 x 1%)

35

93. What is the effective interest rate on a 3-month, noninterest-bearing note with a stated rate of
12% and a maturity value of $200,000?

a. 12.36%.
b. 12.00 %.
c. 11.46%.
d. 3.00%.

Answer: A

Rationale:

$200,000 x 12% x 3/12 = $6,000

$6,000/($200,000 $6,000) = 3.09%

3.09% x 12/3 = 12.36%

94. Oklahoma Oil Corp. paid interest of $785,000 during 2006, and the interest payable account
decreased by $125,000. What was interest expense for the year?

a. $890,000.
b. $660,000.
c. $555,000.
d. $785,000.

Answer: B

Rationale:

Interest paid $ 785,000

Decrease in payable (125,000)

Total interest $660,000

expense

95. On June 1, 2006, Dirty Harry Co. borrowed cash by issuing a 6-month noninterest-bearing note
with a maturity value of $500,000 and a discount rate of 6%. What is the carrying value of the note as
of September 30, 2006?

a. $525,000.
b. $300,000.
c. $495,000.
d. $475,000.

Answer: C

Rationale:

Face amount $500,000

Discount ($500,000 x 6% x 6/12) (15.000 )
Carrying value, 6/1/06 485,000
Discount amortization (4/6) 10,000
Carrying value, 9/30/06 $495,000

Use the following to answer questions 96-98:

General Product Inc. shipped 100 million coupons in products it sold in 2006. The coupons are
redeemable for thirty cents each. General anticipates that 70% of the coupons will be redeemed. The
coupons expire on December 31, 2007. There were 45 million coupons redeemed in 2006, and 30
million redeemed in 2007.

96. What was General's coupon liability as of December 31, 2006?

a. $7.5 million.
 b. $13.5 million.
c. $16.5 million.
d. $21.0 million.

Answer: A

Rationale:

100 million x $.30 x 70% = $21 million

$21 million (45 x $.30) = $7.5 million

97. What was General's coupon promotion expense in 2006?

a. $30.0 million.
b. $21.0 million.
c. $13.5 million.
d. $7.5 million.

Answer: B

Rationale:

100 million x $.30 x 70% = $21 million

98. What was General's coupon promotional expense in 2007?

a. Zero, since all the expense should be reflected in 2006.

b. $1.5 million.
c. $7.5 million.
d. $9.0 million.

Answer: B

Rationale:

(in millions)

Sales in 2006:

Promotional expense 21.0

Estimated premium liability 21.0

Redemptions in 2006:

Estimated premium liability 13.5

Cash 13.5

Redemptions in 2007:
 Estimated premium liability 7.5

Promotional expense 1.5

Cash 9.0

99. Slotnick Chemical received customer deposits on returnable containers in the amount of
$300,000 during 2006. Fifteen percent of the containers were not returned. The deposits are based
on the container cost marked up 20%. How much profit did Slotnick realize on the forfeited deposits?

a. $0.
b. $7,500.
c. $9,000.
d. $45,000.

Answer: B

Rationale:

Total deposits forfeited ($300,000 x $45,000

15%)

Less costs ($45,000/120%) 37,500

Profit $ 7,500

100. On September 1, 2006, Hiker Shoes issued a $100,000, 8-month, noninterest-bearing note. The
loan was made by Second Commercial Bank whose stated discount rate is 9%. Hiker's effective
interest rate on this loan is:

a. 9.00%.
b. 9.49%.
c. 9.50%.
d. 9.57%.

Answer: D

Rationale:

$100,000 x 9% x 8/12 = $6,000

[$6,000/$100,000 $6,000)] x 12/8 = 9.57%

101. Universal Travel Inc. borrowed $500,000 on November 1, 2006, and signed a 12-month note
bearing interest at 6%. Interest is payable in full at maturity on October 31, 2007. In connection with
this note, Universal Travel Inc. should report interest payable at December 31, 2006, in the amount
of:
 a. $ 8,000.
b. $30,000.
c. $ 5,000.
d. $25,000.

Answer: C

Rationale:

$500,000 x 6% x 2/12 = $5,000

102. Jane's Donut Co. borrowed $200,000 on January 1, 2006, and signed a two-year note bearing
interest at 12%. Interest is payable in full at maturity on January 1, 2008. In connection with this note,
Jane's should report interest expense at December 31, 2006, in the amount of:

a. $0.
b. $24,000.
c. $48,000.
d. $50,880.

Answer: B

Rationale:

$200,000 x 12% x 12/12 = $24,000

103. Clark's Chemical Company received customer deposits on returnable containers in the amount
of $100,000 during 2006. Twelve percent of the containers were not returned. The deposits are based
on the container cost marked up 20%. What is cost of goods sold relative to this forfeiture?

a. $0.
b. $2,000.
c. $10,000.
d. $14,400.

Answer: C

Rationale:

($100,000 x 12%) 120% = $10,000

104. Branch Company, a building materials supplier, has $18,000,000 of notes payable due April 12,
2007. At December 31, 2006, Branch signed an agreement with First Bank to borrow up to
$18,000,000 to refinance the notes on a long-term basis. The agreement specified that borrowings
would not exceed 75% of the value of the collateral that Branch provided. At the date of issue of the
December 31, 2006, financial statements, the value of Branch's collateral was $20,000,000. On its
December 31, 2006, balance sheet, Branch should classify the notes as follows:

a. $15,000,000 long-term and $3,000,000 current liabilities.

b. $4,500,000 short-term and $13,500,000 current liabilities.
c. $18,000,000 of current liabilities.
 d. $18,000,000 of long-term liabilities.

Answer: A

Rationale:

Notes payable $18,000,000

Refinancing ability ($20,000,000 x 15,000,000 L-

75%) T

Current liability from notes payable $ 3,000,000 S-

T

105. At the beginning of 2006, Angel Corporation began offering a 2-year warranty on its products.
The warranty program was expected to cost Angel 4% of net sales. Net sales made under warranty in
2006 were $180 million. Fifteen percent of the units sold were returned in 2006 and repaired or
replaced at a cost of $5.3 million. The amount of warranty expense on Angel's 2006 income
statement is:

a. $ 5.3 million.
b. $ 7.2 million.
c. $10.6 million.
d. $27.0 million.

Answer: B

Rationale:

$180 million x 4% = $7.2 million

Repairs during the year cost less than the estimated liability, so no additional expense is reported.

106. During 2006, Deluxe Leather Goods sold 800,000 reversible belts under a new sales
promotional program. Each belt carried one coupon, which entitles the customer to a $5.00 cash
rebate. Deluxe estimates that 70% of the coupons will be redeemed, even though only 350,000
coupons had been processed during 2006. At December 31, 2006, Deluxe should report a liability for
unredeemed coupons of:

a. $ 560,000.
b. $1,050,000.
c. $1,225,000.
d. $1,750,000.

Answer: B

Rationale:

[($800,000 x 70%) 350,000] x $5 = $1,050,000

107. Captain Cook Cereal includes one coupon in each package of Granola that it sells and offers a
puzzle in exchange for $2.00 and 3 coupons. The puzzles cost Captain Cook $3.50 each. Experience
indicates that 20% of the coupons eventually will be redeemed. During the last month of 2006, the
first month of the offer, Captain Cook sold 6 million boxes of Granola and 900,000 of the coupons
were redeemed. What amount should Captain Cook report as a liability for coupons on its December
31, 2006, balance sheet?

a. $ 0.
b. $150,000.
c. $300,000.
d. $450,000.

Answer: B

Rationale:

[(6,000,000 x 20%) 900,000]/3 = 100,000 puzzles

100,000 x ($3.50 $2.00) = $150,000

108. Funzy Cereal includes one coupon in each package of Wheatos that it sells and offers a toy car
in exchange for $1.00 and 3 coupons. The cars cost Funzy $1.50 each. Experience indicates that
40% of the coupons eventually will be redeemed. During the last month of 2006, the first month of the
offer, Funzy sold 12 million boxes of Wheatos and 2.4 million of the coupons were redeemed. What
amount should Funzy report as a promotional expense for coupons on its December 31, 2006,
income statement?

a. $ 0.
b. $ 400,000.
c. $ 800,000.
d. $1,200,000.

Answer: C

Rationale:

[(12,000,000 x 40%)/3] x ($1.50 $1.00) = $800,000

109. In May of 2006, Raymond Financial Services became involved in a tax dispute with the IRS. At
December 31, 2006, the tax attorney for Raymond indicated that an unfavorable outcome to the
dispute was probable. The additional taxes were estimated to be $770,000 but could be as high as
$1,170,000. After the year-end, but before the 2006 financial statements were issued, Raymond
accepted an IRS settlement offer of $900,000. Raymond should have reported an accrued liability on
its December 31, 2006, balance sheet of:

a. $ 770,000.
b. $ 900,000.
c. $ 970,000.
d. $1,170,000.Answer: B
1. Bonds can
A) be secured by collateral or they can be unsecured.
B) be registered or unregistered.
 C) all mature on the same date, or portions can mature over a period of several
years.
D) All of the above.
Feedback:
The correct answer is D
Bonds are classified by the following characteristics: Bonds can be secured by collateral, or
they can be unsecured. Bonds can be registered or unregistered. Bonds can all mature on the
same date, or portions can mature over a period of several years.

2. All of the following are disadvantages of raising capital through the issue of bonds
except
A) the bonds are classified as a long-term liability.
B) interest must be paid even if the firm suffers a loss.
C) the face amount must be repaid at maturity.
D) interest is deductible for income tax purposes.
Feedback:
The correct answer is D
The fact that interest on bonds is deductible for income tax purposes is an advantage (rather
than a disadvantage) of issuing bonds.

3. When bonds mature, a corporation will pay the bondholders

A) the current market value of the bonds.
B) the face amount plus the original premium or minus the original discount.
C) the face amount plus the interest accrued since the date the bonds were issued.
D) the face amount of the bonds.
Feedback:
The correct answer is D
The face amount of the bonds, the principal, is the amount that the corporation owes to the
bond holders. At maturity, when the bonds are retired, the bonds payable account is debited
for the face amount of the bonds.

4. On April 1, 2016, Tyler Corporation issued 100 registered, unsecured bonds that will mature
in 10 years. The face value of each bond is $1,000. The bond interest rate is 10 percent.
Interest will be paid on April 1 and October 1 of each year. The entry to record the first interest
payment on October 1, 2010 would include a
A) debit to the Bond Interest Expense account for $5,000.
B) debit to the Bond Interest Expense account for $10,000.
C) debit to the Bond Interest Expense account for $100,000.
D) None of the above.

5. The entry to record the adjustment for accrued bond interest includes a
A) debit to the Bond Interest Expense account and a credit to the Cash account.
B) debit to the Bond Interest Expense account and a credit to the Bond Interest
Payable account.
 C) debit to the Bond Interest Payable account and a credit to the Bond Interest
Expense account.
D) debit to the Bond Interest Expense account and a credit to the Bonds Payable
account.
Feedback:
The correct answer is B
The entry to record the adjustment for accrued bond interest includes a debit to the Bond
Interest Expense account and a credit to the Bond Interest Payable account.

6. When bonds are issued at a discount, the bond discount

A) reduces the amount of interest expense over the life of the bonds.
B) increases the amount of interest expense over the life of the bonds.
C) reduces the cash paid for interest by the bond issuer.
D) is charged to interest expense when the bond is issued.
Feedback:
The correct answer is B
When bonds are issued at a discount, the bond discount increases the amount of interest
expense over the life of the bonds.

7. On December 31, 2016, a corporation issued $200,000 face value, 12 percent bonds that
mature 10 years from the date of issue. The issue price was 97. If the firm uses the straight-
line method of amortization, interest expense for 2017 will be reported at
A) $24,600.
B) $24,000.
C) $23,400.
D) $19,400.
Feedback:
The correct answer is A
Interest expense is the sum of the cash interest payment plus the amount of the amortization
of the discount. The cash payment is $24,000, or $200,000 x 12 percent. The amount of the
discount is $6,000, or $200,000 – ($200,000 x .97). One year's amortization of the discount is
$600, or $6,000/10 years. The interest expense calculated is $24,600, $24,000 + $600.

8. Tyler Corporation decides to accumulate funds in a bond sinking fund for each of the years
that its bonds are outstanding. The net earnings of the fund will reduce the amount that the
corporation has to add each year. At the maturity date of the bonds, the sinking fund will have
the $1,000,000 needed to retire the bonds. The entry to record the retirement of the bonds will
include a
A) credit to the Cash account for $1,000,000.
B) debit to the Bonds Payable account for $1,000,000.
C) debit to the Bonds Sinking Fund Investment account for $1,000,000.
D) None of the above.
 9. Suppose that the board of directors of Charles Corporation decided to appropriate $100,000
of retained earnings during each of the last five years its bonds are outstanding. When the
bonds are retired, the entries to record the retirement will include a
A) debit to the Retained Earnings Appropriated for Bond Retirement account for
$100,000.
B) debit to the Retained Earnings account for $100,000.
C) debit to the Retained Earnings Appropriated for Bond Retirement account for
$500,000.
D) debit to the Retained Earnings account for $500,000.
Feedback:
The correct answer is C
When the bonds are retired, the entries to record the retirement will include a debit to the
Retained Earnings Appropriated for Bond Retirement account for $500,000 (or 5 x $100,000)
and a credit to the Retained Earning account for $500,000.

10. A corporation paid $104,000 to retire bonds with a face value of $100,000 and an
unamortized premium balance of $3,000. The entry to record the early retirement of the bonds
will include the recognition of a loss of
A) $7,000.
B) $4,000.
C) $3,000.
D) $1,000.
Feedback:
The correct answer is D
The entry to record the early retirement of the bonds will include a debit to the Bonds Payable
account for $100,000, a debit to the Premium on Bonds Payable account for $3,000, a debit to
the Loss on Early Retirement of Bonds account for $1,000, and a credit to the Cash account
for $104,000.

BONDS PAYABLE

TRUE FALSE—Conceptual

1. Companies usually make bond interest payments semiannually, although the interest rate is generally expressed
as an annual rate.

2. A mortgage bond is referred to as a debenture bond.

3. Bond issues that mature in installments are called serial bonds.

4. If the market rate is greater than the coupon rate, bonds will be sold at a premium.

5. The interest rate written in the terms of the bond indenture is called the effective yield or market rate.
 6. The stated rate is the same as the coupon rate.

7. Amortization of a premium increases bond interest expense, while amortization of a discount decreases bond
interest expense.

8. A bond may only be issued on an interest payment date.

9. The cash paid for interest will always be greater than interest expense when using effective-interest
amortization for a bond.

10. Bond issue costs are capitalized as a deferred charge and amortized to expense over the life of the bond issue.

11. The replacement of an existing bond issue with a new one is called refunding.

12. If a long-term note payable has a stated interest rate, that rate should be considered to be the effective rate.

13. The implicit interest rate is the rate that equates the cash received with the amounts received in the future.

14. The process of interest-rate approximation is called imputation, and the resulting interest rate is called an
imputed interest rate.

15. Off-balance-sheet financing is an attempt to borrow monies in such a way to minimize the reporting of debt on
the balance sheet.

16. The debt to total assets ratio will go up if an equal amount of assets and liabilities are added to the balance
sheet.

17. If a company plans to retire long-term debt from a bond retirement fund, it should report the debt as current.

18. The times interest earned ratio is computed by dividing income before interest expense by interest expense.

*19. The loss to be recognized by a creditor on an impaired loan is the difference between the investment in the loan
and the expected undiscounted future cash flows from the loan.
*20. In a troubled debt restructuring, the loss recognized by the creditor will equal the gain recognized by the debtor.

True False Answers—Conceptual

Item Ans. Item Ans. Item Ans. Item Ans.

1. T 6. T 11. T 16. T
2. F 7. F 12. F 17. F
3. T 8. F 13. T 18. F
4. F 9. F 14. T 19. F
MULTIPLE CHOICE—Conceptual
5. F 10. T 15. T 20. F

21. An example of an item which is not a liability is

a. dividends payable in stock.

b. advances from customers on contracts.
c. accrued estimated warranty costs.
d. the portion of long-term debt due within one year.

22. The covenants and other terms of the agreement between the issuer of bonds and the lender are set forth in
the

a. bond indenture.
b. bond debenture.
c. registered bond.
d. bond coupon.

23. The term used for bonds that are unsecured as to principal is

a. junk bonds.
b. debenture bonds.
c. indebenture bonds.
d. callable bonds.

P
24. Bonds for which the owners' names are not registered with the issuing corporation are called

a. bearer bonds.
b. term bonds.
c. debenture bonds.
d. secured bonds.

S
25. Bonds that pay no interest unless the issuing company is profitable are called

a. collateral trust bonds.

b. debenture bonds.
c. revenue bonds.
d. income bonds.
S
26. If bonds are issued initially at a premium and the effective-interest method of amortization is used, interest
expense in the earlier years will be

a. greater than if the straight-line method were used.

b. greater than the amount of the interest payments.
c the same as if the straight-line method were used.
d. less than if the straight-line method were used.

27. The interest rate written in the terms of the bond indenture is known as the

a. coupon rate.
b. nominal rate.
c. stated rate.
d. coupon rate, nominal rate, or stated rate.

28. The rate of interest actually earned by bondholders is called the

a. stated rate.
b. yield rate.
c. effective rate.
d. effective, yield, or market rate.

Use the following information for questions 29 and 30:

Fox Co. issued $100,000 of ten-year, 10% bonds that pay interest semiannually. The bonds are sold to yield 8%.

29. One step in calculating the issue price of the bonds is to multiply the principal by the table value for

a. 10 periods and 10% from the present value of 1 table.

b. 20 periods and 5% from the present value of 1 table.
c. 10 periods and 8% from the present value of 1 table.
d. 20 periods and 4% from the present value of 1 table.

30. Another step in calculating the issue price of the bonds is to

a. multiply $10,000 by the table value for 10 periods and 10% from the present value of an annuity
table.
b. multiply $10,000 by the table value for 20 periods and 5% from the present value of an annuity
table.
c. multiply $10,000 by the table value for 20 periods and 4% from the present value of an annuity
table.
d. none of these.

31. Reich, Inc. issued bonds with a maturity amount of $200,000 and a maturity ten years from date of issue. If the
bonds were issued at a premium, this indicates that

a. the effective yield or market rate of interest exceeded the stated (nominal) rate.
b. the nominal rate of interest exceeded the market rate.
c. the market and nominal rates coincided.
d. no necessary relationship exists between the two rates.
32. If bonds are initially sold at a discount and the straight-line method of amortization is used, interest expense in
the earlier years will

a. exceed what it would have been had the effective-interest method of amortization been used.
b. be less than what it would have been had the effective-interest method of amortization been used.
c. be the same as what it would have been had the effective-interest method of amortiza-tion been
used.
d. be less than the stated (nominal) rate of interest.

33. Under the effective-interest method of bond discount or premium amortization, the periodic interest expense is
equal to

a. the stated (nominal) rate of interest multiplied by the face value of the bonds.
b. the market rate of interest multiplied by the face value of the bonds.
c. the stated rate multiplied by the beginning-of-period carrying amount of the bonds.
d. the market rate multiplied by the beginning-of-period carrying amount of the bonds.

34. When the effective-interest method is used to amortize bond premium or discount, the periodic amortization
will

a. increase if the bonds were issued at a discount.

b. decrease if the bonds were issued at a premium.
c. increase if the bonds were issued at a premium.
d. increase if the bonds were issued at either a discount or a premium.

35. If bonds are issued between interest dates, the entry on the books of the issuing corporation could include a

a. debit to Interest Payable.

b. credit to Interest Receivable.
c. credit to Interest Expense.
d. credit to Unearned Interest.

36. When the interest payment dates of a bond are May 1 and November 1, and a bond issue is sold on June 1, the
amount of cash received by the issuer will be

a. decreased by accrued interest from June 1 to November 1.

b. decreased by accrued interest from May 1 to June 1.
c. increased by accrued interest from June 1 to November 1.
d. increased by accrued interest from May 1 to June 1.

37. Theoretically, the costs of issuing bonds could be

a. expensed when incurred.

b. reported as a reduction of the bond liability.
c. debited to a deferred charge account and amortized over the life of the bonds.
d. any of these.

38. The printing costs and legal fees associated with the issuance of bonds should

a. be expensed when incurred.

b. be reported as a deduction from the face amount of bonds payable.
c. be accumulated in a deferred charge account and amortized over the life of the bonds.
d. not be reported as an expense until the period the bonds mature or are retired.
39. Treasury bonds should be shown on the balance sheet as

a. an asset.
b. a deduction from bonds payable issued to arrive at net bonds payable and outstanding.
c. a reduction of stockholders' equity.
d. both an asset and a liability.

40. An early extinguishment of bonds payable, which were originally issued at a premium, is made by purchase of
the bonds between interest dates. At the time of reacquisition

a. any costs of issuing the bonds must be amortized up to the purchase date.
b. the premium must be amortized up to the purchase date.
c. interest must be accrued from the last interest date to the purchase date.
d. all of these.

41. The generally accepted method of accounting for gains or losses from the early extinguishment of debt treats
any gain or loss as

a. an adjustment to the cost basis of the asset obtained by the debt issue.
b. an amount that should be considered a cash adjustment to the cost of any other debt issued over
the remaining life of the old debt instrument.
c. an amount received or paid to obtain a new debt instrument and, as such, should be amortized over
the life of the new debt.
d. a difference between the reacquisition price and the net carrying amount of the debt which
should be recognized in the period of redemption.

P
42. "In-substance defeasance" is a term used to refer to an arrangement whereby

a. a company gets another company to cover its payments due on long-term debt.
b. a governmental unit issues debt instruments to corporations.
c. a company provides for the future repayment of a long-term debt by placing purchased
securities in an irrevocable trust.
d. a company legally extinguishes debt before its due date.

P
43. A corporation borrowed money from a bank to build a building. The long-term note signed by the corporation is
secured by a mortgage that pledges title to the building as security for the loan. The corporation is to pay the
bank $80,000 each year for 10 years to repay the loan. Which of the following relationships can you expect to
apply to the situation?

a. The balance of mortgage payable at a given balance sheet date will be reported as a long-term
liability.
b. The balance of mortgage payable will remain a constant amount over the 10-year period.
c. The amount of interest expense will decrease each period the loan is outstanding, while the
portion of the annual payment applied to the loan principal will increase each period.
d. The amount of interest expense will remain constant over the 10-year period.

S
44. A debt instrument with no ready market is exchanged for property whose fair market value is currently
indeterminable. When such a transaction takes place

a. the present value of the debt instrument must be approximated using an imputed interest
rate.
b. it should not be recorded on the books of either party until the fair market value of the property
becomes evident.
 c. the board of directors of the entity receiving the property should estimate a value for the property
that will serve as a basis for the transaction.
d. the directors of both entities involved in the transaction should negotiate a value to be assigned to
the property.
45. When a note payable is issued for property, goods, or services, the present value of the note is measured by

a. the fair value of the property, goods, or services.

b. the market value of the note.
c. using an imputed interest rate to discount all future payments on the note.
d. any of these.

46. When a note payable is exchanged for property, goods, or services, the stated interest rate is presumed to be
fair unless

a. no interest rate is stated.

b. the stated interest rate is unreasonable.
c. the stated face amount of the note is materially different from the current cash sales price for similar
items or from current market value of the note.
d. any of these.

47. Discount on Notes Payable is charged to interest expense

a. equally over the life of the note.

b. only in the year the note is issued.
c. using the effective-interest method.
d. only in the year the note matures.

48. Which of the following is an example of "off-balance-sheet financing"?

1. Non-consolidated subsidiary.

2. Special purpose entity.

3. Operating leases.

a. 1
b. 2
c. 3
d. All of these are examples of "off-balance-sheet financing."

S
49. When a business enterprise enters into what is referred to as off-balance-sheet financing, the company

a. is attempting to conceal the debt from shareholders by having no information about the debt
included in the balance sheet.
b. wishes to confine all information related to the debt to the income statement and the statement of
cash flow.
c. can enhance the quality of its financial position and perhaps permit credit to be obtained
more readily and at less cost.
d. is in violation of generally accepted accounting principles.

S
50. Long-term debt that matures within one year and is to be converted into stock should be reported

a. as a current liability.
b. in a special section between liabilities and stockholders’ equity.
 c. as noncurrent.
d. as noncurrent and accompanied with a note explaining the method to be used in its
liquidation.

51.Which of the following must be disclosed relative to long-term debt maturities and sinking fund requirements?

a. The present value of future payments for sinking fund requirements and long-term debt maturities
during each of the next five years.
b. The present value of scheduled interest payments on long-term debt during each of the next five
years.
c. The amount of scheduled interest payments on long-term debt during each of the next five years.
d. The amount of future payments for sinking fund requirements and long-term debt maturities
during each of the next five years.

52. Note disclosures for long-term debt generally include all of the following except

a. assets pledged as security.

b. call provisions and conversion privileges.
c. restrictions imposed by the creditor.
d. names of specific creditors.

53. The times interest earned ratio is computed by dividing

a. net income by interest expense.

b. income before taxes by interest expense.
c. income before income taxes and interest expense by interest expense.
d. net income and interest expense by interest expense.

54. The debt to total assets ratio is computed by dividing

a. current liabilities by total assets.

b. long-term liabilities by total assets.
c. total liabilities by total assets.
d. total assets by total liabilities.

*55. In a troubled debt restructuring in which the debt is continued with modified terms and the carrying amount of
the debt is less than the total future cash flows,

a. a loss should be recognized by the debtor.

b. a gain should be recognized by the debtor.
c. a new effective-interest rate must be computed.
d. no interest expense or revenue should be recognized in the future.

*56. A troubled debt restructuring will generally result in a

a. loss by the debtor and a gain by the creditor.

b. loss by both the debtor and the creditor.
c. gain by both the debtor and the creditor.
d. gain by the debtor and a loss by the creditor.

*57. In a troubled debt restructuring in which the debt is settled by a transfer of assets with a fair market value less
than the carrying amount of the debt, the debtor would recognize
 a. no gain or loss on the settlement.
b. a gain on the settlement.
c. a loss on the settlement.
d. none of these.

58.In a troubled debt restructuring in which the debt is continued with modified terms, a gain should be recognized at
the date of restructure, but no interest expense should be recognized over the remaining life of the debt, whenever the

a. carrying amount of the pre-restructure debt is less than the total future cash flows.
b. carrying amount of the pre-restructure debt is greater than the total future cash flows.
c. present value of the pre-restructure debt is less than the present value of the future cash flows.
d. present value of the pre-restructure debt is greater than the present value of the future cash flows.

*59. In a troubled debt restructuring in which the debt is continued with modified terms and the carrying amount of
the debt is less than the total future cash flows, the creditor should

a. compute a new effective-interest rate.

b. not recognize a loss.
c. calculate its loss using the historical effective rate of the loan.
d. calculate its loss using the current effective rate of the loan.

Multiple Choice Answers—Conceptual

Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans.
21. a 27. d 33. d 39. b 45. d 51. d *57. b
22. a 28. d 34. d 40. d 46. d 52. d *58. b
23. b 29. d 35. c 41. d 47. c 53. c *59. c
24. a 30. d 36. d 42. c 48. d 54. c
25. d 31. b 37. d 43. c 49. c *55. c
26. a 32. a 38. c 44. a 50. d *56. d

Solutions to those Multiple Choice questions for which the answer is “none of these.”

30. multiply $5,000 by the table value for 20 periods and 4% from the present value of an annuity table.