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Solution Manual For Cornerstones of Financial and Managerial Accounting 2nd Edition by Rich
Solution Manual For Cornerstones of Financial and Managerial Accounting 2nd Edition by Rich
Solution Manual For Cornerstones of Financial and Managerial Accounting 2nd Edition by Rich
2. In theory, a liability should not include the amount of future interest to be paid. For example,
a $200 payable due in 45 days is not really a $200 liability today because theoretically a
portion of that $200 payment made 45 days in the future will represent interest for the 45 days.
However, in liabilities that will be retired within three months (e.g., standard Accounts Payable),
the time value of money is ignored because it is deemed immaterial. In these cases, the
liability is recorded at the amount to be paid in the future.
3. Most liabilities are recognized when goods or services are received or money is borrowed.
4. Current liabilities are obligations that require the firm to pay cash or another current asset,
create a new current liability, or provide goods or services within the longer of one year or one
operating cycle. Some common examples of current liabilities include unearned sales revenue,
accounts payable, short-term notes payable, current portion of long-term debt, accrued
liabilities, and other payables.
5. Common ways in which to order current liabilities on the balance sheet include
(1) from largest to smallest,
(2) in the order in which they will be paid (order of liquidity), and
(3) in alphabetical order.
6. An account payable arises when a business purchases goods or services on credit. Unlike an
account payable, a note payable typically arises when a business borrows money or purchases
goods or services from a company that requires a formal agreement or contract. This formal
agreement or contract is what distinguishes the note payable from an account payable.
Additionally, notes payable typically bear interest, while accounts payable generally have
no interest.
8. Accrued liabilities represent the completed portion of activities in process at the end of the
period. They are recognized through adjusting entries. Some common examples include wages
payable, taxes payable, property taxes payable, and interest payable.
9. A note payable is typically created by borrowing money from a bank or purchasing goods or
services from a company that requires a formal agreement or contract.
10. Interest is typically ignored when creating an account payable because the payable is usually
due within 30 to 60 days. The amount of interest that would be associated with the payable is
minimal and is ignored as immaterial.
8-1
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11. Interest expense is computed by multiplying the principal amount of the loan times the annual
interest rate times the period of time (usually expressed as a fraction of a year).
12. The current portion of long-term debt is the amount of long-term debt principal that is due within
the next year. At the end of each accounting period, the long-term debt that is due during the
next year is reclassified as a current liability. In some cases, long-term debt that is due within
the next year will be paid with the proceeds of a new long-term debt issue, creating a new long-
term, not current, liability. When such refinancing is expected, the maturing obligation is not
transferred to current liabilities but remains classified as long-term debt.
13. Payroll taxes paid by employees through a deduction from their gross pay include federal, state,
and possibly city or county income taxes, as well as Social Security and Medicare. Payroll taxes
paid by employers include Social Security, Medicare, and federal and state unemployment taxes.
Social Security and Medicare together are called FICA. Employers match the FICA amount for
each employee.
14. Both unearned revenues and customer deposits arise when the entity receives resources from
customers in advance of the performance of services or the delivery of goods. Since the
customer has “performed” by paying ahead of time, the seller has incurred a liability either to
produce the goods or services or refund the customer’s advance payment.
15. A contingent liability is an obligation whose amount, timing, or recipient depends on future
events. For example, a firm may be contingently liable for damages under a lawsuit that has yet
to be decided by the courts. When the courts reach a decision, the liability will be known, but
until then it is contingent on that decision.
16. A contingency is recognized as a liability when it is both (1) probable and (2) reasonably
estimable.
17. The matching concept requires that all of the expenses associated with a revenue be recorded in
the period in which the related revenue is recorded. One of the expenses associated with the sale
of merchandise is the warranty cost that is expected to be incurred during the warranty period.
To the extent that warranty costs have not been incurred when the period ends, a liability must
be recorded to permit proper matching.
18. The current ratio is an appropriate measure of short-term liquidity if all of the current assets are
easily converted into cash. This means that accounts receivable are likely to be collected and
any inventory is likely to be sold. The quick ratio and the cash ratio exclude inventory because
it may be harder to liquidate. The quick ratio is appropriate when accounts receivable are highly
likely to be collected. In some cases, accounts receivable are not liquid, and in these cases, the
cash ratio provides a more appropriate measure of short-term liquidity.
19. The current, quick, and cash ratios all involve all or parts of current assets divided by current
liabilities. The current ratio includes all current assets, including inventory, divided by current
liabilities. The quick ratio includes cash, marketable securities, and accounts receivable in the
numerator and current liabilities in the denominator. The cash ratio includes only cash and
marketable securities divided by current liabilities. The cash ratio provides the most conservative
measure of short-term liquidity because it includes only highly liquid assets in the numerator.
20. Operating cash flow looks at the ability of cash generated from operating activities to meet
current obligations, whereas the current, quick, and cash ratios look at the status of the current
liabilities as they stand at a particular point in time.
8-2
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CHAPTER 8 Current and Contingent Liabilities
MULTIPLE-CHOICE EXERCISES
8-1. d
8-2. c
Journal
Date Account and Explanation Debit Credit
Dec. 31 Interest Expense 5,000
Interest Payable 5,000
(Record accrual of interest expense)
Journal
Date Account and Explanation Debit Credit
Oct. 1 Interest Expense 15,000
Interest Payable 5,000
Cash 20,000
(Record payment of note and interest)
8-5. b
8-6. c
8-7. c
Journal
Date Account and Explanation Debit Credit
Accounts Receivable 28,438
Sales Revenue* 26,250
Excise Taxes Payable (Federal)** 350
Sales Taxes Payable (State)*** 1,838
(Record sale)
8-3
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CHAPTER 8 Current and Contingent Liabilities
8-8. a
8-9. d
8-10. d
8-11. d
8-12. d
8-13. c
8-14. c
8-15. b
8-16. b
8-17. a
8-18. b
8-4
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CHAPTER 8 Current and Contingent Liabilities
CORNERSTONE EXERCISES
CE 8-19
Journal
Date Account and Explanation Debit Credit
Jun. 30 Cash 250,000
Notes Payable 250,000
(Record issuance of note payable)
CE 8-20
Journal
Date Account and Explanation Debit Credit
1. Jun. 1 Cash 400,000
Notes Payable 400,000
(Record issuance of note payable)
CE 8-21
Journal
Date Account and Explanation Debit Credit
Dec. 31 Interest Expense* 5,000
Interest Payable 5,000
(Record accrual of interest expense)
* $150,000 × 8% × 5/12 = $5,000
CE 8-22
Journal
Date Account and Explanation Debit Credit
Dec. 31 Interest Expense* 3,125
Interest Payable 3,125
(Record accrual of interest expense)
* $75,000 × 5% × 10/12 = $3,125
8-5
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CHAPTER 8 Current and Contingent Liabilities
CE 8-23
Journal
Date Account and Explanation Debit Credit
Apr. 2 Wages Payable 6,000
Wages Expense 4,000
Cash 10,000
(Record payment of wages)
CE 8-24
Journal
Date Account and Explanation Debit Credit
Accounts Receivable 80,000
Excise Taxes Payable (Federal) 500
Sales Taxes Payable (State)* 4,500
Sales Revenue 75,000
(Record sale)
* $75,000 × 6% = $4,500
CE 8-25
Journal
Date Account and Explanation Debit Credit
Cash 4,536
Sales Taxes Payable (State)* 336
Sales Revenue** 4,200
(Record sale)
* ($70 × 60) × 8% = $336
** $70 × 60 = $4,200
8-6
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CHAPTER 8 Current and Contingent Liabilities
CE 8-26
1. Net pay recorded by Hernandez: $383,750
2. Journal
Date Account and Explanation Debit Credit
Wages Expense 500,000
Income Taxes Payable 63,000
Social Security Taxes Payable (Employee) 31,000
Medicare Taxes Payable (Employee) 7,250
Charitable Contributions Payable 5,000
Union Dues Payable 10,000
Cash 383,750
(Record wages and liabilities)
Journal
Date Account and Explanation Debit Credit
Unemployment Taxes Expense (Federal)* 27,900
Social Security Taxes Expense 31,000
Medicare Taxes Expense 7,250
Unemployment Taxes Payable (Federal) 27,900
Social Security Taxes Payable (Employer) 31,000
Medicare Taxes Payable (Employer) 7,250
(Record employer payroll taxes)
* ($500,000 – $50,000) × 6.2% = $27,900
8-7
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CHAPTER 8 Current and Contingent Liabilities
CE 8-27
Journal
Date Account and Explanation Debit Credit
Wages Expense 10,000
Income Taxes Payable 1,200
Social Security Taxes Payable (Employee)* 620
Medicare Taxes Payable (Employee)** 145
Cash*** 8,035
(Record wages and liabilities)
CE 8-28
Journal
Date Account and Explanation Debit Credit
Social Security Taxes Expense 5,332
Medicare Taxes Expense 1,450
Unemployment Taxes Expense (State) 1,300
Unemployment Taxes Expense (Federal) 650
Social Security Taxes Payable (Employer)* 5,332
Medicare Taxes Payable (Employer)** 1,450
Unemployment Taxes Payable (State) 1,300
Unemployment Taxes Payable (Federal) 650
(Record employer payroll taxes)
* $86,000 × 6.2% = $5,332
** $100,000 × 1.45% = $1,450
8-8
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
CHAPTER 8 Current and Contingent Liabilities
CE 8-29
Journal
Date Account and Explanation Debit Credit
1. Cash 700
Unearned Sales Revenue 700
(Record payment received for services not
yet performed)
CE 8-30
Journal
Date Account and Explanation Debit Credit
1. Cash 300,000
Unearned Rent Revenue 300,000
(Record cash received for rent paid in advance)
8-9
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CHAPTER 8 Current and Contingent Liabilities
CE 8-31
1. 300 water heaters × $850 × 1% = $2,550 warranty liability
Journal
Date Account and Explanation Debit Credit
2. Dec. 31 Warranty Expense 2,550
Warranty Liability 2,550
(Record warranty expense)
CE 8-32
The warranty expense for the balloons sold in 2011 should be $37,500 (50
balloons × $25,000 × 3%). This amount is added to the $40,000 beginning
balance in the warranty liability account. Throughout the year, the warranty
liability account was debited for $15,000 of actual claims, leaving the ending
balance in the warranty liability account to be $62,500.
Warranty Liability
Beginning balance 40,000
Claims incurred 15,000
Warranty expense* 37,500
Ending balance 62,500
* $25,000 × 50 units × 3% = $37,500
8-10
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CHAPTER 8 Current and Contingent Liabilities
CE 8-33
Current Assets
1. Current Ratio =
Current Liabilities
$300,000 + $650,000 + $800,000 + $100,000
=
$500,000 + $150,000
$1,850,000
=
$650,000
= 2.85
4. NWA's current ratio appears adequate. However, it really depends on how liquid
NWA's inventory and accounts receivable are. If the inventory is slow moving or
difficult to sell (e.g., large ticket items in a recession), then the quick ratio may be
a better indicator of liquidity. The quick ratio is well below 2, but still appears
adequate for NWA to meet its short-term obligations if the accounts receivable
are collectible. If, on the other hand, accounts receivable may be difficult to
collect, the cash ratio is best. If this were the case, then NWA has serious liquidity
issues and there should be great concern regarding its ability to meet short-term
obligations.
8-11
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CHAPTER 8 Current and Contingent Liabilities
CE 8-34
Current Assets
1. Current Ratio =
Current Liabilities
$3,125,000 + $3,150,000 + $4,200,000 + $1,850,000
=
$3,500,000 + $1,800,000
$12,325,000
=
$5,300,000
= 2.33
4. GER's current ratio appears adequate. However, it really depends on how liquid
GER's inventory and accounts receivable are. If the inventory is slow moving or
difficult to sell (e.g., large ticket items in a recession), then the quick ratio may
be a better indicator of liquidity. The quick ratio is well below 2, but still appears
adequate for GER to meet its short-term obligations if the accounts receivable
are collectible. If, on the other hand, accounts receivable may be difficult to
collect, the cash ratio is best. If this were the case, then GER has serious liquidity
issues and there should be great concern regarding its ability to meet short-term
obligations.
8-12
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CHAPTER 8 Current and Contingent Liabilities
EXERCISES
E 8-35
Journal
Date Account and Explanation Debit Credit
1. May 18 Inventory 400,000
Accounts Payable 400,000
(Record purchase of inventory on credit)
E 8-36
Journal
Date Account and Explanation Debit Credit
Feb. 15 Inventory 800,000
Accounts Payable 800,000
(Record purchase of inventory on credit)
E 8-37
Journal
Date Account and Explanation Debit Credit
Dec. 31 Property Taxes Expense* 3,000
Property Taxes Payable 3,000
(Record accrued property taxes)
* $9,000 × 4/12 = $3,000
8-13
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CHAPTER 8 Current and Contingent Liabilities
E 8-38
Journal
Date Account and Explanation Debit Credit
Dec. 31 Income Taxes Expense* 140,000
Income Taxes Payable 140,000
(Record accrued income taxes)
E 8-39
Journal
Date Account and Explanation Debit Credit
Dec. 31 Wages Expense* 2,500
Wages Payable 2,500
(Record accrued wages)
* $5,000 × 3/6 = $2,500
E 8-40
Journal
Date Account and Explanation Debit Credit
Dec. 31 Wages Expense 20,000
Wages Payable* 20,000
(Record accrued wages)
E 8-41
The wages payable account would have 4 days of payroll accrued at $12,000
per day totaling $48,000.
8-14
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CHAPTER 8 Current and Contingent Liabilities
E 8-42
Journal
Date Account and Explanation Debit Credit
a. Purchases 30,000
Accounts Payable 30,000
(Record purchase of inventory on account)
f. Cash 25,000
Notes Payable 25,000
(Record issuance of note)
8-15
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CHAPTER 8 Current and Contingent Liabilities
E 8-43
Journal
Date Account and Explanation Debit Credit
a. Purchases 80,000
Accounts Payable 80,000
(Record purchase of inventory on account)
f. Cash 155,000
Notes Payable 155,000
(Record issuance of note)
8-16
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CHAPTER 8 Current and Contingent Liabilities
E 8-44
a. A legally enforceable claim against the business to be paid in three months
should be reported as a current liability.
E 8-45
Journal
Date Account and Explanation Debit Credit
a. Advertising Expense 2,680
Accounts Payable 2,680
(Record purchase of advertising)
8-17
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CHAPTER 8 Current and Contingent Liabilities
E 8-46
Journal
Date Account and Explanation Debit Credit
a
a. Dec. 31 Wages Expense 3,000
Wages Payable 3,000
(Record accrued wages)
b
b. 31 Income Taxes Expense 280,000
Income Taxes Payable 280,000
(Record accrued income taxes)
c
c. 31 Interest Expense 7,000
Interest Payable 7,000
(Record accrued interest)
d
d. 31 Wages Expense 15,000
Wages Payable 15,000
(Record accrued wages)
a
$5,000 × 3/5 = $3,000
b
$800,000 × 35% = $280,000
c
$280,000 × 6% × 5/12 = $7,000
d
($800,000 – $650,000) × 10% = $15,000
8-18
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CHAPTER 8 Current and Contingent Liabilities
E 8-47
Journal
Date Account and Explanation Debit Credit
a. Dec. 31 Wages Expense* 54,000
Wages Payable 54,000
(Record accrued wages)
E 8-48
Journal
Date Account and Explanation Debit Credit
Cash 145,125
Sales Taxes Payable (State)* 9,450
Excise Taxes Payable (Federal)** 270
Excise Taxes Payable (State)*** 405
Sales Revenue 135,000
(Record sale)
* $135,000 × 0.07 = $9,450
** $135,000 × 0.0020 = $270
*** $135,000 × 0.0030 = $405
8-19
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CHAPTER 8 Current and Contingent Liabilities
E 8-49
1. Journal
Date Account and Explanation Debit Credit
Jan. 31 Salaries Expense 237,480.00
Wages Expense 585,000.00
Cash* 651,060.28
Social Security Taxes Payable (Employee)** 50,993.76
Medicare Taxes Payable (Employee)*** 11,925.96
Income Taxes Payable 108,500.00
(Record salaries, wages, and liabilities)
8-20
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CHAPTER 8 Current and Contingent Liabilities
E 8-50
1. Journal
Date Account and Explanation Debit Credit
Dec. 1 Cash* 9,000
Unearned Sales Revenue 9,000
(Record receipt of payment for services not
yet performed)
* $1,500 × 6 months = $9,000
2. Journal
Date Account and Explanation Debit Credit
Dec. 31 Unearned Sales Revenue 1,500
Sales Revenue* 1,500
(Record recognition of revenue)
* $1,500 × 1 month = $1,500
3. Unearned sales revenue in the amount of $7,500 (see T-account below) would
appear among Irvine Pest Control’s current liabilities. A prepaid asset in the
amount of $7,500 would appear among Garden Grove’s current assets.
E 8-51
Warranty coverage qualifies as a contingent loss for the company providing
the warranty. That is, the company will incur a loss in the future if the products
covered by the warranty are defective. Companies must record a liability and a
corresponding expense if such contingent liabilities are probable and reasonably
estimable . For most companies, the amount of warranty losses is probable and
reasonably estimable based on past experience.
8-21
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CHAPTER 8 Current and Contingent Liabilities
E 8-52
Journal
Date Account and Explanation Debit Credit
Other Expense 3,000,000
Lawsuit Payable 3,000,000
(Record contingent liability)
E 8-53
1. a
2. a
3. a
4. c
5. a
6. b
7. b
8. c
9. c
10. a
8-22
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CHAPTER 8 Current and Contingent Liabilities
E 8-54
1. Televisions
Expected claims = [2,500 units × (2 ÷ 100)] = 50 units
Expected cost = (50 units × $45)………………………...………… $2,250
DVDs
Expected claims = [360 units × (5 ÷ 100)] = 18 units
Expected cost = (18 units × $15)…………………...……………… 270
Speakers
Expected claims = [700 units × (1 ÷ 100)] = 7 units
Expected cost = (7 units × $25)……………………..……………… 175
Total expected cost……………………………………………………… $2,695
Journal
Date Account and Explanation Debit Credit
Dec. 31 Warranty Expense 2,695
Warranty Liability 2,695
(Record warranty expense)
8-23
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CHAPTER 8 Current and Contingent Liabilities
E 8-55
3. The simplest way to raise their current ratio to 2.30 would be to use some of
the almost $6.6 billion in cash and equivalents to pay off some of their current
liabilities. This will lower their current assets, but it will also lower their
current liabilities by the same amount. And, because the current liabilities are
less than the current assets, this reduction in current liabilities will represent a
greater percentage reduction.
To decide the amount of the payment, the following equation must be solved
for x:
That is, Intel must use $316,310,000 of cash to pay down the current liabilities
by the same amount to achieve a current ratio of 2.30 by December 31st.
8-24
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CHAPTER 8 Current and Contingent Liabilities
PROBLEM SET A
P 8-56A
1. Journal
Date Account and Explanation Debit Credit
a. Feb. 16 Supplies 160,000
Accounts Payable 160,000
(Record purchase of supplies on account)
8-25
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
CHAPTER 8 Current and Contingent Liabilities
P 8-56A (Contd)
Journal
Date Account and Explanation Debit Credit
h. Oct. 15 Social Security Taxes Payable (Employee)** 92,500
Social Security Taxes Payable (Employer) 92,500
Medicare Taxes Payable (Employee)*** 21,633
Medicare Taxes Payable (Employer) 21,633
Income Taxes Payable 319,000
Cash 547,266
(Record employer payroll taxes)
2. Journal
Date Account and Explanation Debit Credit
Dec. 31 Interest Expense 25,000
Interest Payable* 25,000
(Record accrued interest)
* ($120,000 × 10% × 9/12) + ($300,000 × 8% × 8/12) = $25,000
8-26
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CHAPTER 8 Current and Contingent Liabilities
P 8-57A
1. Social Security: $315,000 × 0.062 = $19,530.00
Medicare: $315,000 × 0.0145 = $4,567.50
Federal unemployment: $295,312.50 × 0.008 = $2,362.50
State unemployment: $295,312.50 × 0.012 = $3,543.75
Net pay = $315,000 – $79,900 – $19,530.00 – $4,567.50 = $211,002.50
Journal
Date Account and Explanation Debit Credit
Sept. 30 Wages Expense 315,000.00
Income Taxes Payable 79,900.00
Social Security Taxes Payable (Employee) 19,530.00
Medicare Taxes Payable (Employee) 4,567.50
Cash 211,002.50
(Record wages and liabilities)
2. Pay……………………………………… 100%
Social Security………………………… 6.20%
Medicare………………………………… 1.45%
Fringe Benefits………………………… 30%
137.65% × $50,000 = $68,825
Federal Unemployment × $7,000 × 0.008 = 56
State Unemployment × $7,000 × 0.012 = 84
$68,965
8-27
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CHAPTER 8 Current and Contingent Liabilities
P 8-58A
1. Journal
Date Account and Explanation Debit Credit
2011
Oct. 1 Cash 600,000
Notes Payable 600,000
(Record issuance of note)
2. Journal
Date Account and Explanation Debit Credit
Dec. 31 Interest Expense* 12,000
Interest Payable 12,000
(Record accrued interest)
* $600,000 × 8% × 3/12 = $12,000
4. Journal
Date Account and Explanation Debit Credit
2012
May 1 Notes Payable 600,000
Interest Payable 12,000
Interest Expense* 16,000
Cash 628,000
(Record payment of note and interest)
* $600,000 × 8% × 4/12 = $16,000
8-28
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CHAPTER 8 Current and Contingent Liabilities
P 8-59A
1. Journal
Date Account and Explanation Debit Credit
2012
Dec. 1 Inventory 80,000
Accounts Payable 80,000
(Record purchase of inventory on account)
3. Journal
Date Account and Explanation Debit Credit
2013
Mar. 1 Accounts Payable 80,000
Notes Payable 80,000
(Record issuance of note to cover unpaid
account payable)
4. Journal
Date Account and Explanation Debit Credit
Jul. 1 Notes Payable 80,000
Interest Expense* 1,600
Cash 81,600
(Record payment of note and interest)
* $80,000 × 6% × 4/12 = $1,600
8-29
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CHAPTER 8 Current and Contingent Liabilities
P 8-60A
1. Electricity charges……………………………………………… $2,435,000
State excise tax:
a
Flat fee of $3.00 per customer …….……………………… $60,000
b
2% of total billing …….………………………………….…… 48,700 118,700
Federal excise tax:
c
Flat fee of $0.50 per customer ……………………………… $10,000
d
0.1% of total billing …………………………………………… 2,435 12,435
Total bill…………………………………………………………… $2,566,135
a
$3.00 × 20,000 customers = $60,000
b
$2,435,000 × 0.02 = $48,700
c
$0.50 × 20,000 customers = $10,000
d
$2,435,000 × 0.001 = $2,435
2. Journal
Date Account and Explanation Debit Credit
Accounts Receivable 2,566,135
Sales Revenue 2,435,000
Excise Taxes Payable (State) 118,700
Excise Taxes Payable (Federal) 12,435
(Record sale)
3. Journal
Date Account and Explanation Debit Credit
Cash 2,566,135
Accounts Receivable 2,566,135
(Record collection of receivables)
4. Journal
Date Account and Explanation Debit Credit
Excise Taxes Payable (State) 118,700
Cash 118,700
(Record payment)
8-30
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CHAPTER 8 Current and Contingent Liabilities
P 8-61A
1. Journal
Date Account and Explanation Debit Credit
Nov. 20 Cash* 187,500
Unearned Sales Revenue 187,500
(Record receipt of deposit for merchandise
not yet delivered)
* 750 units × $250 = $187,500
Current Liability:
Unearned Sales Revenue……………………………………… $ 50,000
Noncurrent Liability:
Unearned Sales Revenue……………………………………… $137,500
The portion of customer deposits pertaining to next year’s deliveries ($50,000 =
200 units × $250) should be classified as a current liability on the balance sheet
at the end of 2011; the remainder ($137,500) should be classified as a noncurrent
liability.
2. Journal
Date Account and Explanation Debit Credit
2012
Unearned Sales Revenue 50,000
Cash* 150,000
Sales Revenue** 200,000
(Record recognition of revenue)
Current Liability:
Unearned Sales Revenue……………………………………… $ 75,000
Noncurrent Liability:
Unearned Sales Revenue……………………………………… $ 62,500
The remaining balance in Unearned Sales Revenue is $137,500 (the original
$187,500 less the $50,000 recognized during 2012). Of this remaining amount,
$75,000 (300 units × $250) pertains to next year’s deliveries and would be
reported as a current liability on the balance sheet at the end of 2012, while
the remainder, $62,500, would be classified as a long-term liability.
8-31
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CHAPTER 8 Current and Contingent Liabilities
P 8-61A (Contd)
3. Journal
Date Account and Explanation Debit Credit
2013
Unearned Sales Revenuea 75,000
b
Cash 225,000
c
Sales Revenue 300,000
(Record recognition of revenue)
8-32
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CHAPTER 8 Current and Contingent Liabilities
P 8-62A
1. Warranty expense for 2011 is the expected number of warranty claims
times the expected cost of each claim.
Expected number of warranty claims:
6,350 repairs × 0.03 claims per repair = 191
Warranty expense:
191 expected claims × $300 per claim = $57,300
2. Journal
Date Account and Explanation Debit Credit
Warranty Liability 63,000
Cash 63,000
(Record warranty expense) 63,000
Warranty Liability
Balance, 1/1/11 50,000
Claims paid 63,000 Warranty expense 57,300
Balance, 12/31/11 44,300
The balance decreased because more claims were paid than were added
to the liability through warranty expense.
8-33
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CHAPTER 8 Current and Contingent Liabilities
P 8-63A
1. Current Ratio = Current Assets ÷ Current Liabilities
5. GER’s liquidity appears to hold constant when one looks only at the current
ratio. However, under further scrutiny, it is apparent (using the quick ratio, cash
ratio, and operating cash flow ratio) that this result is due to the significantly
higher amounts of receivables and inventories in 2012 as compared to 2011.
Because the receivables and inventories may not be easily converted to cash,
the liquidity of GER may be worsening.
8-34
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CHAPTER 8 Current and Contingent Liabilities
PROBLEM SET B
P 8-56B
1. Journal
Date Account and Explanation Debit Credit
a. Jan. 26 Supplies 25,000
Accounts Payable 25,000
(Record purchase of supplies on account)
8-35
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CHAPTER 8 Current and Contingent Liabilities
P 8-56B (Contd)
Journal
Date Account and Explanation Debit Credit
h. Oct. 10 Social Security Taxes Payable (Employee)** 140,000
Social Security Taxes Payable (Employer) 140,000
Medicare Taxes Payable (Employee)*** 32,742
Medicare Taxes Payable (Employer) 32,742
Income Taxes Payable 730,000
Cash 1,075,484
(Record employer payroll taxes)
2. Journal
Date Account and Explanation Debit Credit
Dec. 31 Interest Expense 21,250
Interest Payable* 21,250
(Record accrued interest)
* ($150,000 × 8% × 10/12) + ($300,000 × 9% × 5/12) = $21,250
8-36
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CHAPTER 8 Current and Contingent Liabilities
P 8-57B
1. Social Security: $1,250,000 × 0.062 = $77,500
Medicare: $1,250,000 × 0.0145 = $18,125
State unemployment: $1,000,000 × 0.0080 = $ 8,000
Federal unemployment: $1,000,000 × 0.0050 = $ 5,000
Net pay = $1,250,000 – $180,600 – $77,500 – $18,125 = $973,775
Journal
Date Account and Explanation Debit Credit
Mar. 31 Wages Expense 1,250,000
Income Taxes Payable 180,600
Social Security Taxes Payable (Employee) 77,500
Medicare Taxes Payable (Employee) 18,125
Cash 973,775
(Record wages and liabilities)
2. Pay………………………………………… 100%
Social Security…………………………… 6.2%
Medicare…………………………………… 1.45%
Fringe Benefits…………………………… 28%
135.65% × $80,000 = $108,520
State Unemployment × $7,000 × 0.008 = 56
Federal Unemployment × $7,000 × 0.005 = 35
$108,611
8-37
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CHAPTER 8 Current and Contingent Liabilities
P 8-58B
1. Journal
Date Account and Explanation Debit Credit
2012
Nov. 1 Cash 275,000
Notes Payable 275,000
(Record issuance of note)
2. Journal
Date Account and Explanation Debit Credit
Dec. 31 Interest Expense* 2,750
Interest Payable 2,750
(Record accrued interest)
* $275,000 × 6% × 2/12 = $2,750
4. Journal
Date Account and Explanation Debit Credit
2013
May 31 Notes Payable 275,000
Interest Payable 2,750
Interest Expense* 6,875
Cash 284,625
(Record payment of note and interest)
* $275,000 × 6% × 5/12 = $6,875
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CHAPTER 8 Current and Contingent Liabilities
P 8-59B
1. Journal
Date Account and Explanation Debit Credit
2012
Nov. 1 Inventory 770,000
Accounts Payable 770,000
(Record purchase of inventory on account)
3. Journal
Date Account and Explanation Debit Credit
2013
Feb. 1 Accounts Payable 770,000
Notes Payable 770,000
(Record issuance of note to cover unpaid
account payable)
4. Journal
Date Account and Explanation Debit Credit
2013
Sept. 1 Notes Payable 770,000
Interest Expense* 53,900
Cash 823,900
(Record payment of note and interest)
* $770,000 × 12% × 7/12 = $53,900
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CHAPTER 8 Current and Contingent Liabilities
P 8-60B
1. Electricity charges……………………………………………… $393,000.00
State excise tax:
Flat fee of $3.50 per customera…….……………………… $10,500.00
b
2% of total billing …….………………………………….…… 7,860.00 18,360.00
Federal excise tax:
Flat fee of $1.05 per customerc……………………………… $ 3,150.00
d
0.1% of total billing …………………………………………… 589.50 3,739.50
Total bill…………………………………………………………… $415,099.50
a
$3.50 × 3,000 customers = $10,500.00
b
$393,000 × 0.02 = $7,860.00
c
$0.50 × 3,000 customers = $1,500.00
d
$393,000 × 0.0015 = $589.50
2. Journal
Date Account and Explanation Debit Credit
Accounts Receivable 415,099.50
Sales Revenue 393,000.00
Excise Taxes Payable (State) 18,360.00
Excise Taxes Payable (Federal) 3,739.50
(Record sale)
3. Journal
Date Account and Explanation Debit Credit
Cash 415,099.50
Accounts Receivable 415,099.50
(Record collection of receivables)
4. Journal
Date Account and Explanation Debit Credit
Excise Taxes Payable (State) 18,360.00
Cash 18,360.00
(Record payment)
8-40
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CHAPTER 8 Current and Contingent Liabilities
P 8-61B
1. Journal
Date Account and Explanation Debit Credit
Nov. 20 Cash* 260,000
Unearned Sales Revenue 260,000
(Record receipt of deposit for merchandise
not yet delivered)
* 1,000 units × $260 = $260,000
Current Liability:
Unearned Sales Revenue………………………………………… $ 91,000
Noncurrent Liability:
Unearned Sales Revenue………………………………………… $169,000
The portion of customer deposits pertaining to next year’s deliveries ($90,000 =
350 units × $260) should be classified as a current liability on the balance sheet
at the end of 2011; the remainder ($169,000) should be classified as a noncurrent
liability.
2. Journal
Date Account and Explanation Debit Credit
2012
Unearned Sales Revenue 91,000
Cash* 364,000
Sales Revenue** 455,000
(Record recognition of revenue)
8-41
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CHAPTER 8 Current and Contingent Liabilities
P 8-61B (Contd)
3. Journal
Date Account and Explanation Debit Credit
2013
a
Unearned Sales Revenue 104,000
b
Cash 416,000
c
Sales Revenue 520,000
(Record recognition of revenue)
8-42
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CHAPTER 8 Current and Contingent Liabilities
P 8-62B
1. Warranty expense for 2011 is the expected number of warranty claims
times the expected cost of each claim.
Expected number of warranty claims:
4,500 repairs × 0.09 claims per repair = 405
Warranty expense:
405 expected claims × $250 per claim = $101,250
2. Journal
Date Account and Explanation Debit Credit
Warranty Liability 110,000
Cash 110,000
(Record warranty expense)
Warranty Liability
Balance, 1/1/11 25,000
Claims paid 110,000 Warranty expense 101,250
Balance, 12/31/11 16,250
The balance decreased because more claims were paid than were added
to the liability through warranty expense.
8-43
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CHAPTER 8 Current and Contingent Liabilities
P 8-63B
1. Current Ratio = Current Assets ÷ Current Liabilities
2011 = $135,918 ÷ $77,618
= 1.75
5. Chicago Water Slide’s liquidity appears to hold constant when one looks only
at the current ratio. However, under further scrutiny, it is apparent (using the
quick ratio, cash ratio, and operating cash flow ratio) that the improvement in
liquidity is only due to the significantly higher amounts of receivables and
inventories in 2011 as compared to 2010. Because the receivables and
inventories may not be easily converted to cash, the liquidity of Chicago
Water Slide may be worsening.
8-44
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CHAPTER 8 Current and Contingent Liabilities
CASES
Case 8-64
1. To the extent that the warranty liability is current (and it will be current for
any warranty work estimated to be performed in the next year), current
liabilities will be lowered. The current ratio is calculated as:
Current Assets ÷ Current Liabilities
This means that lowering the warranty liability will increase the
current ratio.
2. Jim should tell his boss that ethically they are to provide the best estimate
of the warranty liability they can. This means that the estimate should
reflect their “true” obligation as accurately as possible and the estimate
should be made without bias.
Doing as the boss suggests would make the financial statements
potentially misleading to investors and creditors such as the bank.
3. Jim’s first course of action is to try to reason with his boss. If this fails, he
should raise the issue to his boss’s boss. Ultimately, if Jim is unable to
resolve this issue in an ethical way within the department, he will have to
consider other options. As a publicly traded company, Jim should have a
hotline available to him that he can call to ask about any concerns
surrounding the accounting change that his boss asked him to make.
This hotline will be monitored by upper management and the board of
directors. If he decides to “blow the whistle” on his boss’s request,
he will have whistleblower protection to ensure that retaliation is not
taken against him.
8-45
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CHAPTER 8 Current and Contingent Liabilities
Case 8-65
1. Journal
Date Account and Explanation Debit Credit
Jan. 1 Cash 35,000
Notes Payable 35,000
(Record issuance of note)
The loan increased current assets and current liabilities by the same amount;
therefore, it did not change the excess of current assets over current liabilities.
2. Journal
Date Account and Explanation Debit Credit
Inventory 35,000
Cash 35,000
(Record purchase of inventory)
The inventory purchase increased and decreased current assets by the same
amount; therefore, it did not change either the amount of current assets or the
excess of current assets over current liabilities.
3. Rocky Mountain could borrow another $23,000 ($58,000 – $35,000 loan = $23,000
excess) under the restriction, provided that use of the proceeds in conjunction
with other transactions during January do not violate the restriction. Although
investment in inventory does not affect the excess of current assets over current
liabilities, investing in equipment reduces the excess of current assets over
current liabilities and, therefore, might violate the restriction.
8-46
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CHAPTER 8 Current and Contingent Liabilities
Case 8-66
1. At September 30, 2009, Whole Foods had current liabilities of $684,024 (in
thousands).
2. $389 (in thousands) (this includes both current installments of long-term debts
and capital lease obligations).
3. Kottaras v. Whole Foods is a class action suit seeking treble damages, equitable,
injunctive, and declaratory relief alleging that Whole Foods’ acquisition of Wild
Oats violates various provisions of federal antitrust laws.
“Whole Foods Market cannot at this time predict the likely outcome of this judicial
proceeding or estimate the amount or range of loss or possible loss that may
arise from it. The Company has not accrued any loss related to the outcome of
this case as of September 27, 2009.”
As such, it appears that Whole Foods has not recognized a contingent liability
related to this litigation.
Current Assets
4. Current Ratio =
Current Liabilities
$622,606
2008 =
$666,177
= 0.93
$1,055,380
2009 =
$684,024
= 1.54
5. Whole Foods’ current ratio is weak, but suggests a positive trend in short-term
liquidity. The 2008 ratio, in particular, suggested that Whole Foods’ current assets
would not generate sufficient cash to meet its current obligations. The 2009 ratio
is still weak as it's well below conventional standards of at least 2.
6. Note 2 to the financial statements states, “Restricted cash primarily relates to cash
held as collateral to support a portion of our projected workers’ compensation
obligations.” We have included these amounts in the following ratios (and in the
current ratio above) because we presume that the workers’ compensation
obligations are included in current liabilities.
8-47
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CHAPTER 8 Current and Contingent Liabilities
$430,130 + $71,023
2009 =
$684,024
= 0.73
7. The quick and cash ratios further reinforce that Whole Foods has severe
short-term liquidity problems. To be fair to Whole Foods, its inventories
are relatively easy to turn into cash. As such, the current ratio is the most
appropriate short-term liquidity ratio. However, as shown in parts (5) and
(6), the current ratio is also very weak.
$334,992
2008 =
$666,177
= 0.50
$587,721
2009 =
$684,024
= 0.86
9. The operating cash flow ratio indicates that Whole Foods is unable to
meet its current obligations with cash generated from operating activities.
However, as with the current, quick, and cash ratio, the trend is positive.
8-48
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CHAPTER 8 Current and Contingent Liabilities
Case 8-67
1. Aeropostale discloses “commitments and contingencies” together in Note 14.
The only contingencies mentioned are due to legal proceedings. The note
describes an SEC formal order of investigation regarding activities of Mr.
Finazzo, the former Executive VP and Chief Merchandising Officer. Although
Mr. Finazzo and South Bay Apparel have made payments and concessions
as partial restitution, Aeropostale may face penalties from the SEC. However,
as of January 30, 2010, nothing appears to have been accrued on the balance
sheet or income statement.
Further, Aeropostale states, “We are also party to various litigation matters
and proceedings in the ordinary course of business. In the opinion of our
management, dispositions of these matters are not expected to have a material
adverse effect on our financial position, results from operations, or cash flows.”
As such, Aeropostale does not include loss contingencies for these legal
proceedings on its income statement or balance sheet.
Abercrombie & Fitch discloses contingencies in Note 16. A&F goes into much
more detail regarding the suits to which it is party. However, at the end of the
note, A&F states, “Management is unable to quantify the potential exposure of
the aforesaid matters.” This indicates that management is unable to make a
reasonable estimate of any contingent losses and, therefore, A&F does not
accrue for such losses on its income statement or balance sheet.
Current Assets
3. Current Ratio =
Current Liabilities
A&F:
$1,072,010
2009 =
$449,797
= 2.38
$1,235,846
2010 =
$449,372
= 2.75
8-49
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CHAPTER 8 Current and Contingent Liabilities
$530,017
2010 =
$241,840
= 2.19
$346,976 + $0
2010 =
$241,840
= 1.43
= ####
8-50
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CHAPTER 8 Current and Contingent Liabilities
$680,113 + $32,356
2010 =
$449,372
= 1.59
Aeropostale:
$228,530 + $0
2009 =
$175,437
= 1.30
$346,976 + $0
2010 =
$241,840
= 1.43
6. The quick ratios are equivalent in 2009, but A&F’s is better in 2010. Further the
quick ratio trend is positive for both companies. Because Aeropostale has no
receivables, its quick and cash ratios are the same. In 2009, Aeropostale’s cash
ratio was somewhat better the A&F’s, but by the end of 2010 A&F’s was somewhat
better. And once again, the trend is positive for both companies. Further, as
even the cash ratios are well above one, neither company appears to have
liquidity problems.
8-51
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CHAPTER 8 Current and Contingent Liabilities
Aeropostale:
$202,135
2009 =
$175,437
= 1.15
$334,440
2010 =
$241,840
= 1.38
8. In 2009, Aeropostale’s operating cash flow ratio was slightly better than A&F’s.
However, while Aeropostale’s ratio improved by 20%, A&F’s ratio decreased
by approximately 17.4%. Further, while Aeropostale has sufficient operating
cash flows in 2010 to meet its current obligations, A&F does not.
8-52
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CHAPTER 8 Current and Contingent Liabilities
Case 8-68
1. Journal
Date Account and Explanation Debit Credit
a. Feb. 29 Inventory 5,325
Accounts Payable 5,325
(Record purchase of inventory)
29 Interest Expense* 67
Interest Payable 67
(Record accrued interest)
c. Cash 3,745
Unearned Sales Revenue 3,500
Sales Taxes Payable (State) 245
(Record unearned revenue and sales taxes)
8-53
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Solution Manual for Cornerstones of Financial and Managerial Accounting 2nd Edition by Rich
8-54
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