Professional Documents
Culture Documents
ACC101 Ch. 09
ACC101 Ch. 09
Exercises
Estimated
Time in
Minutes
Level
1
2
3
10
10
10
Easy
Easy
Easy
4
5
6
7
8
20
15
10
15
15
Mod
Mod
Mod
Mod
Mod
9
10
5
5
Easy
Mod
15
Mod
12
20
Mod
6. Calculate amounts using the future value and present value concepts.
13
14
15
16
20*
21*
5
5
10
10
10
10
Easy
Mod
Mod
Mod
Diff
Diff
17
18
19
20*
21*
5
10
10
10
10
Mod
Mod
Diff
Diff
Diff
9-1
9-2
Learning Outcomes
Problems
and
Alternates
Estimated
Time in
Minutes
Level
10*
10
Mod
1
9*
40
30
Mod
Mod
2
3
30
20
Mod
Diff
4
5
10*
20
10
10
Mod
Mod
Mod
6
9*
40
30
Diff
Mod
7
8
11*
12*
25
30
10
10
Easy
Mod
Diff
Diff
11*
12*
10
10
Diff
Diff
Learning Outcomes
Cases
Estimated
Time in
Minutes
9-3
Level
1*
5*
30
25
Mod
Mod
1*
5*
30
25
Mod
Mod
2*
3*
20
25
Mod
Mod
2*
3*
4
7
8
15
20
30
20
Mod
Mod
Mod
Mod
15
Mod
9-4
QUESTIONS
1. A current liability is an obligation that will be satisfied within the next operating cycle,
or within one year if the cycle is shorter than one year. Current liabilities are
important to determine a firms liquidity, i.e., its ability to pay for those items due
within a short time period.
2. Generally, it is to the companys benefit to take advantage of discounts available
because of the rate of the discount. For example if a 2% discount is available for
payment within ten days, a firm can borrow money and pay interest on the loan in
order to take advantage of the discount. Also, prompt payment of accounts is
essential in order to ensure good relationships with suppliers and other creditors.
3. No, the real rate of interest is not 10%. The real interest rate could be calculated as
$100/$900, or approximately 11.11%. The rate should be calculated on the basis of
the amount that the firm actually obtained, rather than the face amount of the note.
4. The account Discount on Notes Payable is a balance sheet account. The account
has a debit balance and should be classified as a contra liability.
5. Income tax is an item that should be accrued as a liability as of year-end. If the firms
year-end is December 31, then the amount should appear as a current liability on
the balance sheet dated December 31.
6. A contingent liability involves an existing condition where the outcome of that
condition is not known with certainty and is dependent on some event that will occur
in the future. Contingent liabilities are accounted for differently than contingent
assets because of the principle of conservatism. It should be noted that this principle
leads to an inconsistency when accounting for contingent assets and contingent
liabilities.
7. A contingent liability should be recorded only if its likelihood of occurrence is
probable and the amount can be reasonably estimated. The firm must make a goodfaith effort to estimate the amount when it is not known. If the dollar amount cannot
be estimated, the contingent liability should be disclosed in the notes to the financial
statements.
8. The lawsuit should be described in as much detail as possible in the notes to the
financial statements. The nature of the lawsuit and the expected resolution should
be described. If the dollar amount can be estimated, it should be disclosed. If it
cannot be estimated, it may be possible to determine and disclose a range of values
that represents the potential loss to the firm.
9. Simple interest is calculated on the balance of the principal only. Compound interest
is calculated on the principal plus previous amounts of interest accumulated. The
amount of interest accumulated by simple interest is always less than the amount if
interest is compounded at the same interest rate.
9-5
9-6
BRIEF EXERCISES
LO 1
If the company paid $40,000, it would have current assets of $40,000 and current
liabilities of $20,000 and achieve its goal of a 2:1 current ratio.
LO 2
If you pay within 15 days, you receive a 3% discount and must pay $4,850.
If you pay after 15 days, you must pay $5,000.
LO 3
LO 4
A contingent liability must be recorded as a liability on the balance sheet if the likelihood
of loss is probable, and the amount can be reasonably estimated. It must be disclosed
in the footnotes if the likelihood of loss is at least reasonably possible.
A contingent asset is treated more conservatively. It normally is not recorded as an
asset on the balance sheet until the asset is received.
LO 5
9-7
If simple interest at Bank 1, then the amount would be $1,250 or $1,000 + ($1,000
0.05 5 years).
If compound interest at Bank 2, then the amount would be $1,276 or ($1,000 1.276)
from Table 9-1 where n = 5, i = 5%.
LO 6
LO 7
9-8
EXERCISES
LO 1
LO 1
1. and 2.
Classification
a.
b.
c.
d.
e.
f.
Current liability
Current liability
Long-term liability
Current liability
Current liability
Current liability
and
Long-term liability
g. Current liability
Account Title
Accounts Payable
Notes Payable
Notes Payable
Wages Payable
Interest Payable
Current Portion of Long-Term Debt
Long-Term Debt
Taxes Payable
3. Investors are interested in this information because it enables them to better predict
the timing of future cash flows. Items that are classified as current liabilities require
the use of current assets to satisfy them, whereas long-term liabilities do not.
LO 1
JACKIE COMPANY
BALANCE SHEET
DECEMBER 31, 2008
Current liabilities:
Accounts payable
Notes payable, 10%, due June 2, 2009
Less: discount on notes payable
Current maturities of long-term debt
Other Accrued liabilities:
Interest payable
Wages payable
Unearned revenue
Income taxes payable
Total current liabilities
LO 2
$3,010
6,000
4,320
850
6,900
13,330
61,250
$106,730
1. a. Purchases
Accounts Payable
To record purchase of inventory on account.
BALANCE SHEET
Assets
Liabilities
Accounts Payable
Liabilities
8,000
INCOME STATEMENT
8,000
Purchases
(8,000)
44,500
8,900
35,600
BALANCE SHEET
Assets
8,000
b. Land
Cash (20% $44,500)
Notes Payable
To record purchase of land.
Land
Cash
$ 24,400
$1,000
150
INCOME STATEMENT
+ Stockholders Equity + Revenues Expenses
35,600
9-9
9-10
c. Accounts Payable
Purchase Returns and Allowances
To record purchase return.
BALANCE SHEET
Assets
Liabilities
Accounts Payable
INCOME STATEMENT
(450)
BALANCE SHEET
Cash
Liabilities
Cash
13,800
Liabilities
Notes Payable
Discount on
Notes Payable
Cash
5,000*
Liabilities
Unearned
Revenue
7,550
13,800
1,200
15,000
INCOME STATEMENT
5,000
5,000
BALANCE SHEET
=
7,550
(7,550)
450
INCOME STATEMENT
BALANCE SHEET
=
Purchase Returns
and Allowances
e. Cash
Discount on Notes Payable
Notes Payable
To record loan less interest in advance.
Assets
450
d. Accounts Payable
Cash
To record payment of account payable.
Assets
450
INCOME STATEMENT
+ Stockholders Equity + Revenues Expenses
5,000
Cash
114,480*
Accounts
Receivable 12,720
Liabilities
Sales Tax
Payable
9-11
114,480
12,720
120,000
7,200
INCOME STATEMENT
120,000
7,200
Liabilities
Interest Payable
Interest Expense
1,898.67
1,898.67
INCOME STATEMENT
e. Interest Expense
Discount on Notes Payable ($1,200 7/12)
To record interest in advance as interest expense.
BALANCE SHEET
Assets
Liabilities
Discount on
Notes Payable
700
700
INCOME STATEMENT
(700)
700*
Liabilities
Unearned
Revenue
1,750
1,750
INCOME STATEMENT
1,750
9-12
$ 7,200.00
35,600.00
$15,000.00
500.00
14,500.00
3,250.00
1,898.67
$62,448.67
LO 2
1.
KRUSE COMPANY
BALANCE SHEET
DECEMBER 31, 2008
Current liabilities:
Accounts payable
Notes payable, 12%, due in 60 days
Taxes payable
Salaries payable
Total current liabilities
$ 55,000
20,000
15,000
10,000
$100,000
$ 15,000
180,000
(20,000)
40,000
85,000
$300,000
9-13
LO 2
LO 2
1. 2008
July 1
Cash
Note Payable
To record borrowing by note.
BALANCE SHEET
Assets
Cash
=
25,000
2. Dec. 31
Liabilities
Note Payable
INCOME STATEMENT
25,000
Interest Expense
Interest Payable
To record interest accrued on loan.
=
Liabilities
Interest Payable
25,000
BALANCE SHEET
Assets
25,000
1,000
1,000
INCOME STATEMENT
Interest Expense
(1,000)
9-14
3. 2009
May 1
Note Payable
Interest Expense
Interest Payable
Cash
To record payment of principal and interest.
BALANCE SHEET
Assets
Cash
(26,667)
Liabilities
Note Payable
Interest Payable
25,000
667
1,000
26,667
INCOME STATEMENT
Interest Expense
(667)*
LO 2
1. 2008
Oct. 1
Cash
Discount on Notes Payable
Notes Payable
To record borrowing by note.
BALANCE SHEET
Assets
Cash 16,380
Liabilities
Notes Payable
Discount on
Notes Payable
16,380
1,620
18,000
INCOME STATEMENT
*$18,000 9% = $1,620
2. Dec. 31
Interest Expense
Discount on Notes Payable
To record accrued interest on note.
BALANCE SHEET
Assets
Liabilities
Discount on
Notes Payable
405
405
INCOME STATEMENT
(405)
3. 2009
Oct. 1
Interest Expense
Notes Payable
Discount on Notes Payable
Cash
To record payment of note and
amortization of discount.
BALANCE SHEET
Assets
Cash
(18,000)
Liabilities
9-15
1,215
18,000
1,215
18,000
INCOME STATEMENT
+ Stockholders Equity + Revenues Expenses
Notes Payable
(18,000)
Discount on
Notes Payable 1,215*
Interest Expense
(1,215)
LO 3
Accounts payable: O
Current maturities of long-term debt: F
Notes payable: F
Other accrued liabilities: O
Salaries and wages payable: O
Taxes payable: O
LO 3
9-16
LO 4
Cash/Accounts Receivable
Sales
To record sales of dishwashers.
32,500,000
32,500,000
BALANCE SHEET
Assets
Liabilities
INCOME STATEMENT
+ Stockholders Equity + Revenues Expenses
Cash/Accounts
Receivable
32,500,000*
Sales
32,500,000
Warranty Expense
Estimated Liability for Warranties
To record current years estimated expense.
BALANCE SHEET
Assets
Liabilities
Estimated
Liability for
Warranties
168,000
168,000
INCOME STATEMENT
(168,000)
168,000*
(150,000)
Beginning Balance
Warranty Estimate
Actual Expense
Ending Balance
Liabilities
Estimated
Liability for
Warranties
150,000
150,000
INCOME STATEMENT
(150,000)
$ 120,000
168,000
(150,000)
$ 138,000
LO 5
9-17
Part 1.
1. $20,000 4% 6 years = $4,800
2. $20,000 6% 4 years = $4,800
3. $20,000 8% 3 years = $4,800
Part 2.
1. Table 9-1 n = 6, i = 4%
Future value = $20,000 1.265 = $25,300
Interest = future value beginning amount
= $25,300 $20,000
= $5,300
2. Table 9-1 n = 4, i = 6%
Future value = $20,000 1.262 = $25,240
Interest = future value beginning amount
= $25,240 $20,000
= $5,240
3. Table 9-1 n = 3, i = 8%
Future value = $20,000 1.260 = $25,200
Interest = future value beginning amount
= $25,200 $20,000
= $5,200
Part 3.
1. Table 9-1 n = 12, i = 2%
Future value = $20,000 1.268 = $25,360
Interest = future value beginning amount
= $25,360 $20,000
= $5,360
2. Table 9-1 n = 8, i = 3%
Future value = $20,000 1.267 = $25,340
Interest = $25,340 $20,000 = $5,340
3. Table 9-1 n = 6, i = 4%
Future value = $20,000 1.265 = $25,300
Interest = $25,300 $20,000 = $5,300
You would want to choose an investment that yields the highest future value. All
other factors being equal, higher interest rates, more frequent compounding, and a
longer term will increase the future value of your investment.
9-18
LO 6
n = 10, i = 5%
Present value = amount table factor
= $150,000 0.614
= $92,100
or
Future value = amount table factor
$150,000
= ? 1.629
Amount
= $150,000/1.629
= $92,081
Slight difference due to rounding.
LO 6
n = 2, i = 8%
n = 4, i = 4%
n = 8, i = 2%
LO 6
n = 5, i = 8%
n = 10, i = 4%
n = 20, i = 2%
LO 6
LO 7
LO 7
9-19
n = 15, i = 4%
LO 7
$2,960.00
2,501.20
$ 458.80
$2,850.40
2,501.20
$ 349.20
$458.80
349.20
$109.60
Payments would be smaller and total interest would be less if she made monthly
payments.
9-20
MULTICONCEPT EXERCISES
LO 6,7
Present value of 1:
Present value of 2:
$100,000
$108,000
Present value of 3:
$ 20,000
Present value of 4:
$ 10,000
1.000 =
0.926 =
n =
5.747 =
n =
11.258 =
n =
$100,000
$100,008
1, i = 8%
$114,940
8, i = 8%
$112,580
30, i = 8%
LO 6,7
1. $53,300/$13,000 = 4.100 table factor for present value of an annuity for 5 years,
i = 7%.
2. $13,300 15.026 (future value of an annuity for n = 12, i = 4%) = $199,846.
No, Sampson will not have accumulated quite enough money.
9-21
PROBLEMS
PROBLEM 9-1 NOTES AND INTEREST
LO 2
1. a. Jan. 1
Cash
Note Payable
To record loan at 10% interest.
BALANCE SHEET
Assets
Cash
=
25,000
Liabilities
Note Payable
25,000
25,000
INCOME STATEMENT
Feb. 1 Equipment
Discount on Notes Payable
Notes Payable
To record non-interest-bearing note.
BALANCE SHEET
Assets
Equipment
=
18,800
Liabilities
Notes Payable
Discount on
Notes Payable
18,800
1,200
20,000
INCOME STATEMENT
d.
Mar. 1 Cash
Loan Payable
To record loan with line of credit.
BALANCE SHEET
Assets
Cash
150,000
Liabilities
Loan Payable
INCOME STATEMENT
150,000
BALANCE SHEET
Cash
(102,250)
Liabilities
Loan Payable
150,000
150,000
100,000
2,250
102,250
INCOME STATEMENT
Interest
Expense
(2,250)*
9-22
Liabilities
Interest Payable
*Interest-bearing
$25,000 10%
6/12
$50,000 9%
4/12
Sub-total
1,250
1,500
2,750
2,750
2,750
INCOME STATEMENT
Interest Expense
Liabilities
1,000
INCOME STATEMENT
Interest Expense(1,000)
Note Payable
1,000
Notes Payable
Interest Expense
Cash
Discount on Note Payable
To record payment of non-interest-bearing note.
BALANCE SHEET
Assets
Cash
1,000
Discount on
g. Aug. 1
(2,750*)
(20,000)
Discount on
Liabilities
Note Payable
20,000
200
INCOME STATEMENT
+ Stockholders Equity + Revenues Expenses
(20,000)
Expense
Note Payable
20,000
200
Interest
(200)
200*
h. Sept. 1 Cash
Loan Payable
To record loan from line of credit
BALANCE SHEET
Assets
Cash
200,000
Liabilities
Loan Payable
200,000
200,000
INCOME STATEMENT
9-23
Liabilities
Accounts
Payable
Notes Payable
INCOME STATEMENT
(12,000)
12,000
BALANCE SHEET
Cash
(27,500)
Liabilities
Note Payable
Interest Payable
12,000
12,000
25,000
1,250
1,250
27,500
INCOME STATEMENT
Interest
Expense
(1,250)*
2. Line of credit:
$50,000 9% 10/12 =
$200,000 9% 4/12 =
8% Note:
$12,000 8% 2/12 =
LO 3
$3,750
6,000
160
$9,910
xxx
1,378
21,159
208
2. Panera Bread must have access to cash or other assets that can be converted to
cash, in amounts sufficient to pay its current liabilities. Paneras current ratio would
be useful in assessing its liquidity. However, Panera would be expected to have
some amount of inventory on hand. Therefore, its quick ratio would be a more
conservative measure of its ability to pay its bills on time.
9-24
LO 3
$ xxx,xxx
1,125
12,458
(14,846)
(794)
(1,880)
(7,083)
(262,565)
2. The change in current maturities of long-term debt during the year is not included as
an adjustment above because it is not directly related to Wendys operating
activities.
LO 4
9-25
LO 4
1. Warranty Expense
Estimated Liability for Warranties
To record current years estimated warranty cost.
BALANCE SHEET
Assets
5,400
INCOME STATEMENT
Liabilities
Estimated
Liability for
Warranties
5,400
(5,400)
5,400
4,950
4,950
BALANCE SHEET
Assets
Inventory
LO 5
=
(4,950)
Liabilities
Estimated
Liability for
Warranties
INCOME STATEMENT
+ Stockholders Equity + Revenues Expenses
(4,950)
1. 2008
Dec. 31
Interest Expense
Interest Payable
To record accrued interest on 8% note for 2007.
BALANCE SHEET
Assets
12/31
Liabilities
Interest Payable
1,000
1,000
INCOME STATEMENT
+ Stockholders Equity + Revenues Expenses
1,000*
Interest Expense
(1,000)
2009
Dec. 31
Interest Expense
Interest Payable
To record accrued interest on 8% note for 2008.
BALANCE SHEET
Assets
12/31
Liabilities
Interest Payable
*$25,000 8% 1 = $2,000
2,000
2,000
INCOME STATEMENT
+ Stockholders Equity + Revenues Expenses
2,000*
Interest Expense
(2,000)
9-26
2010
June 30 Interest Expense
Interest Payable
Note Payable
Cash
To record repayment of note plus interest.
BALANCE SHEET
Assets
6/30 Cash
(29,000)
Liabilities
Note Payable
Interest Payable
1,000
3,000
25,000
29,000
INCOME STATEMENT
Interest Expense
(1,000)**
2. 2008
Dec. 31
Interest Expense
Interest Payable
To record accrued interest for 2008.
BALANCE SHEET
Assets
12/31
Liabilities
Interest Payable
1,000
1,000
INCOME STATEMENT
Interest Expense
(1,000)
2009
Dec. 31
Interest Expense
Interest Payable
To record accrued interest for 2009.
BALANCE SHEET
Assets
12/31
Liabilities
Interest Payable
2,122
2,122
INCOME STATEMENT
Interest Expense
$
$
(2,122)
1,040
1,082
2,122
9-27
2010
June 30 Interest Expense
Interest Payable
Note Payable
Cash
To record repayment of note plus interest.
Assets
29,247
Liabilities
3,122
25,000
BALANCE SHEET
Assets
6/30 Cash
(29,247)
29,247
+
Owners Equity
1,125
INCOME STATEMENT
Liabilities
Note Payable
Interest Payable
1,125
3,122
25,000
Interest Expense
(1,125)**
LO 6
Year
2008
2009
2010
2011
2012
LO 6
$4,000
4,247
$ 247
Principal at
Beginning of Year
$1,000
1,040
1,092
1,158
1,239
Interest
Factor
1.04
1.05
1.06
1.07
1.08
Accumulated
at End of Period
$1,040
1,092
1,158
1,239
1,338
9-28
MULTICONCEPT PROBLEMS
LO 2,5
1. a. $103,200
b. $103,200/(100% 14%) = $120,000
2. a. $103,200 14% = $14,448; $14,448/$103,200 = 14%
b. ($120,000 $103,200)/$103,200 = 16.28%
3. a. 2008
July 1
Cash
Note Payable
To record issuance of note.
BALANCE SHEET
Assets
Cash
103,200
Liabilities
Note Payable
BALANCE SHEET
=
Liabilities
Interest Payable
103,200
INCOME STATEMENT
103,200
7,224
7,224
INCOME STATEMENT
Interest Expense
(7,224)
2009
July 1
Note Payable
Interest Expense
Interest Payable
Cash
To record payment of interest and principal
BALANCE SHEET
Assets
Cash
(117,648)
Liabilities
Note Payable
Interest
Payable
103,200
7,224
7,224
117,648
INCOME STATEMENT
Interest Expense
(7,224)
9-29
b. 2008
July 1
Cash
Discount on Note Payable
Note Payable
To record issuance of note.
BALANCE SHEET
Assets
Cash
103,200
8,400
8,400
INCOME STATEMENT
Liabilities
Discount on
Note Payable
120,000
INCOME STATEMENT
Liabilities
Note Payable
Discount on
Note Payable
103,200
16,800
(8,400)
(8,400)*
2009
July 1
Interest Expense
Note Payable
Discount on Note Payable
Cash
To record payment of the note.
BALANCE SHEET
Assets
Cash
(120,000)
8,400
120,000
INCOME STATEMENT
Liabilities
Note Payable
Discount on
Note Payable
8,400
120,000
Interest Expense
(8,400)
(8,400)
4. a. Note payable
b. Note payable
Less: Discount on note payable
$103,200
$120,000
16,800
$103,200
9-30
LO 1,4
LO 6,7
9-31
ALTERNATE PROBLEMS
PROBLEM 9-1A NOTES AND INTEREST
LO 2
1. a. Jan. 1
Cash
Note Payable
To record issuance of note.
BALANCE SHEET
Assets
Cash
=
35,000
Liabilities
Note Payable
35,000
35,000
INCOME STATEMENT
Liabilities
Note Payable
Discount on
Note Payable
26,320
26,320
1,680
28,000
INCOME STATEMENT
d. Mar. 1 Cash
Loan Payable
To record line of credit borrowing.
BALANCE SHEET
Assets
Mar. 1 Cash
210,000
Liabilities
Loan Payable
BALANCE SHEET
June 1 Cash (143,150)
Liabilities
Loan Payable
210,000
INCOME STATEMENT
210,000
140,000
3,150
143,150
INCOME STATEMENT
Interest
Expense
(3,150)*
9-32
3,850
3,850
BALANCE SHEET
Assets
June 30
INCOME STATEMENT
Liabilities
Interest Payable
$
$
3,850
BALANCE SHEET
=
June 30
(3,850)
1,750
2,100
3,850
Interest Expense
Liabilities
Discount on
Notes Payable
1,400
1,400
INCOME STATEMENT
+ Stockholders Equity + Revenues Expenses
Interest Expense
(1,400)
(1,400)*
(28,000)
Liabilities
Notes Payable
Discount on
Notes Payable
INCOME STATEMENT
(28,000)
Cash
280,000
Liabilities
Loan Payable
Interest Expense
(280)
280
BALANCE SHEET
=
28,000
280
h. Sept. 1 Cash
Loan Payable
Borrowed on line of credit.
Assets
28,000
280
280,000
280,000
INCOME STATEMENT
9-33
Liabilities
Notes Payable
Accounts
Payable
BALANCE SHEET
Cash
(38,500)
Liabilities
Notes Payable
Interest Payable
16,800
INCOME STATEMENT
16,800
35,000
1,750
1,750
38,500
INCOME STATEMENT
Interest
Expense
(1,750)*
2. Line of credit:
($210,000 $140,000) 9% 10/12 =
$280,000 9% 4/12 =
8% Note:
$16,800 8% 2/12 =
$ 5,250
8,400
224
$13,874
9-34
LO 3
9-35
LO 4
LO 4
1. Warranty Expense
Estimated Liability for Warranties
To record estimated warranty expense.
BALANCE SHEET
Assets
15,360
INCOME STATEMENT
Liabilities
Estimated
Liability for
Warranties
15,360
(15,360)
15,360*
10,200
10,200
BALANCE SHEET
Assets
Inventory
(10,200)
Liabilities
Estimated
Liability for
Warranties
INCOME STATEMENT
+ Stockholders Equity + Revenues Expenses
(10,200)
3. Beginning Balance
Add: Warranty estimate
Less: Actual expense
Ending Balance
LO 5
$ 1,100
15,360
(10,200)
$ 6,260
$25,000 6% 6/12 =
$25,000 6% 12/12 =
$25,000 6% 6/12 =
$ 750
1,500
750
$3,000
9-36
$ 750
$773
796
1,569
820
$3,139
LO 6
Year
2008
2009
2010
2011
2012
LO 6
$3,139
3,000
$ 139
Principal at
Beginning of Year
$2,000
2,080
2,184
2,315
2,477
Interest
Factor
1.04
1.05
1.06
1.07
1.08
Accumulated
at End of Period
$2,080
2,184
2,315
2,477
2,675
9-37
LO 2,5
1. a. $206,400
b. $206,400/(100% 14%) = $240,000
2. a. $206,400 14% = $28,896; $28,896/$206,400 = 14%
b. ($240,000 $206,400)/$206,400 = 16.28%
3.
a. 2008
July 1
Cash
Note Payable
To record issuance of note.
BALANCE SHEET
Assets
Cash
206,400
Dec. 31
Liabilities
Note Payable
BALANCE SHEET
=
Liabilities
Interest Payable
206,400
INCOME STATEMENT
Interest Expense
Interest Payable
To record accrual of interest.
Assets
206,400
14,448
14,448
INCOME STATEMENT
Interest
Expense
(14,448)
2009
July 1
Note Payable
Interest Expense
Interest Payable
Cash
To record payment of note plus interest.
BALANCE SHEET
Assets
Cash
(235,296)
Liabilities
Note Payable
Interest
Payable
206,400
14,448
14,448
235,296
INCOME STATEMENT
+ Stockholders Equity + Revenues Expenses
(206,400)
(14,448)
Interest
Expense
(14,448)
9-38
b. 2008
July 1
Cash
Discount on Note Payable
Note payable
To record non-interest-bearing loan.
BALANCE SHEET
Assets
Cash
206,400
Dec. 31
Interest Expense
Discount on Note Payable
To record interest on loan.
BALANCE SHEET
Assets
16,800
16,800
INCOME STATEMENT
Liabilities
Discount on
Note Payable
240,000
INCOME STATEMENT
Liabilities
Note Payable
Discount on
Note Payable
206,400
33,600
Interest
Expense
(16,800)
2009
July 1
Interest Expense
Note Payable
Discount on Note Payable
Cash
To record payment of the loan.
BALANCE SHEET
Assets
Cash
(240,000)
16,800
240,000
INCOME STATEMENT
Liabilities
Note Payable
Discount on
Note Payable
16,800
240,000
Interest
Expense
(16,800)
(16,800)
4. a. Note payable
b. Note payable
Less: Discount on note payable
$206,400
$240,000
33,600
$206,400
LO 1,4
9-39
LO 6,7
LO 6,7
9-40
CASES
READING AND INTERPRETING FINANCIAL STATEMENTS
LO 1,2
1. General Mills for 2006 (in millions): current assets $3,176/current liabilities $6,138 =
0.52
For 2005 (in millions): current assets $3,055/current liabilities $4,184 = 0.73
2. Kelloggs for 2006 (in millions): current assets $2,427/current liabilities $4,020 = 0.60
For 2005 (in millions): current assets $2,196/current liabilities $3,162 = 0.69
Both companies have a current ratio of less than 1.0. This means they have more
current liabilities than current assets. However, both companies are well-managed
and have the ability to generate cash to pay their obligations.
3. Both companies indicate they are party to lawsuits and litigation. Neither company
has recorded an amount on the balance sheet as a liability because of these
matters. Both companies have disclosed the lawsuits in the footnotes.
LO 1,2
LO 3,4
9-41
1. The company has recorded a liability because they have agreed to settle the
lawsuits and pay an amount to the plaintiffs. A contingent liability should be recorded
if the amount is a material amount and if the likelihood of an unfavorable outcome is
probable and if the amount of the loss can be reasonably estimated. When an
amount is recorded it will decrease the companys net income and increase its
liabilities.
2. In the second lawsuit the company has determined that a loss from the lawsuit is not
probable. In that case, the company should disclose the existence of the lawsuit in
the footnotes, along with an estimated dollar amount of loss. There is a difference
between the treatment of the lawsuits in the first and second paragraphs because
the company has a different assessment of the likelihood of a loss.
LO 4
1. The company recorded a contingent liability for their estimate of the amount of the
loss that would be assessed for environmental matters. A company should record
the amounts if they are material and if the likelihood of the loss is probable and can
be reasonably estimated.
2. The effect of the recording of the liability was a decrease in the companys net
income and an increase in their liabilities. In this case, however, the company
indicated that the amount involved was not material to our operations or financial
position.
MAKING FINANCIAL DECISIONS
LO 1,2
1. The company is experiencing difficulties that are similar to many small, start-up
companies. The company must either take action to get a 2 to 1 ratio of current
assets to current liabilities or must approach its bank and ask for a modification of
that provision. If the firm wishes to achieve a 2 to 1 ratio, it must increase current
assets,
decrease current liabilities, or both. Actions that should be considered include the
following:
a. Request from the bank a long-term line of credit to be used to pay the current
liabilities.
9-42
b. Work with creditors to stretch out the payment of liabilities in order to conserve
current assets.
c. Speed the sale of inventory and the collection of cash from customers.
d. Delay the purchase of additional inventory.
Normally, a combination of all the above actions is necessary and should be
recommended. However, the above actions are rather short-term in nature. The firm
must achieve a solid financial base to alleviate similar liquidity problems.
2. Some actions to improve liquidity are referred to as window-dressing. The term
refers to actions that artificially make the financial statements appear more favorable
for a short time. An example of window-dressing in this case would be to use current
assets to pay current liabilities which in many cases will increase the current ratio.
Window-dressing actions are seldom beneficial in the long run. In fact, such actions
do not recognize the other financial needs of the firm and may be detrimental in the
long run.
LO 7
The only way to compare the dollars is to determine the present value of each of these
options discounted at 8%.
a. $2,000 + ($18,000 1.08) 0.926 = $20,001 (rounded)
b. $2,000 + [$18,000 (1 + 0.02)4] 0.926 = $20,042 (rounded)
c. $21,600 0.926 = $20,002 (rounded)
The present value of $20,000 cash sale is $20,000. When these options are compared,
the option with the highest present value of cash flows, discounted at 8%, is Option b.
Kathy should also consider the financial position of the buyer, because these amounts
are not materially different. Since the buyer is starting a new business, she may be
better off taking the cash up front if it is possible for the buyer to get cash from another
source.
ETHICAL DECISION MAKING
LO 4
The purpose of the case is to allow students to understand that judgment is necessary
in the accrual of an estimated liability such as warranty costs. Because the decision
requires the exercise of judgment, it should be emphasized that there is no right answer,
and in this case few good alternatives seem to exist. Discussion of the case should
begin with the evidence available, which convinced John that 5% is inadequate as an
accrual for warranties. Can he rely on the evidence? Would others reach the same
9-43
conclusion with the same evidence? If students conclude that John should stick with his
decision, then the available courses of action should be examined.
Students should be encouraged to develop the pros and cons of (a) remaining silent
and accepting the 5% figure, (b) approaching the owner and informing him that the
expense is understated, (c) approaching the bank officer and relating his concern. While
Options b and c may appear to be morally correct, students should see the negative
consequences that could result if John did not follow the chain of command. Can an
employee always make decisions that are consistent with personal and team
objectives?
Finally, students should be encouraged to develop innovative compromise solutions.
How could the company prevent similar situations? Could a third party serve as an
arbitrator? What should be the role of the internal and external auditors in this matter?
LO 4
The retainer fee should be recorded as sales when the sales are made and charged off
against the retainer. Even if the retainer were nonrefundable, the amount would be
recognized as sales at the time the goods are delivered, on the basis of the going
concern concept. The controller may be eager to show the amount as sales because
the amount may improve net income, since sales would be recorded with no
corresponding expenses. Ratios that involve net income would be improved. Working
capital would be increased because a lower liability amount would be reported.
Correspondingly, the working capital ratios would improve.
9-1