Reporting and Interpreting Liabilities Chapter

Chapter 09 - Reporting and Interpreting Liabilities
Chapter 09
Reporting and Interpreting Liabilities
True / False Questions
1. When a liability is initially recorded, it is recorded at the future amount of all payments.
True False
2. A current liability is always a short-term obligation expected to be paid within one year of
the balance sheet date.
True False
3. A quick ratio that is high according to an industry average might mean the company may
have excessive inventory levels or slow moving inventory items.
True False
4. The quick ratio can be manipulated by management through paying off current liabilities
before the end of the accounting period.
True False
5. Many strong companies intentionally create low quick ratios.

True False
6. Quick assets include cash, accounts receivable, and inventory.

True False
7. Selling inventory on account increases the quick ratio.

True False
9-1
8. Purchasing inventory on account decreases the quick ratio.

True False
9. A current liability is created when a customer pays cash for services to be provided in the
future.
True False
10. Purchasing inventory on account increases the accounts payable turnover ratio.
True False
11. The choice of inventory method has an impact on the accounts payable turnover ratio.
True False
12. The accounts payable turnover ratio is calculated by dividing accounts payable by cash
payments to suppliers.
True False
13. Income taxes payable is an example of an accrued liability.

True False
14. The accounts payable turnover ratio is difficult to manipulate.

True False
15. The accrual of interest on a short-term note payable decreases both the quick ratio and
current assets.
True False
9-2
16. The FICA (social security) tax is a matching tax with a portion paid by both the employer
and the employee.
True False
17. A company borrowed $100,000 at 6% interest on September 1, 2009. Assuming no

adjusting entries have been made during the year, the entry to record interest accrued on
December 31, 2009 would include a debit to interest expense and a credit to interest payable
for $2,000.
True False
18. An estimated liability can't be reported on the balance sheet.

True False
19. A contingent liability is reported on the balance sheet if it is probable and can be
estimated.
True False
20. A contingent liability is disclosed in a note to the financial statements when the liability is
reasonably possible and can be estimated.
True False
21. The journal entry to record a contingent liability creates an accrued liability on the balance
sheet and a loss on the income statement.
True False
22. A contingent liability can't be disclosed in a note to the financial statements unless it can
be estimated.
True False
9-3
23. Working capital is a measure of short-run liquidity and is measured by dividing current
assets by current liabilities.
True False
24. Working capital decreases when accrued wages expense is recorded at year-end.
True False
25. Working capital decreases when a company pays taxes payable.

True False
26. Working capital increases when a company accrues revenues at year-end.

True False
27. Long-term liabilities are reported on the balance sheet at an amount equal to the future
cash flows.
True False
28. Operating leases are reported on the balance sheet at an amount equal to the present value
of the future cash flows.
True False
29. For the present value of a single amount, the compounding period may only be once a
year.
True False
30. An annuity is a series of consecutive payments, each one increasing by a fixed dollar
amount over the payment amount of the prior year.
True False
9-4
Multiple Choice Questions
31. Which of the following statements is correct?

A. Current liabilities are initially recorded at the amount of their principal plus interest.
B. Current liabilities are those liabilities due within one year.
C. Liquidity refers to the ability to pay all debts within one year.
D. Current liabilities affect both the quick ratio and working capital.
32. Which of the following is not a current liability?

A. A liability due within one-year for a business with a fifteen-month operating cycle.
B. A liability due within three months for a business with a two-month operating cycle.
C. A liability due within one-year for a business with a nine-month operating cycle.
D. A liability due within fifteen months for a business with a one-year operating cycle.
33. Which of the following is incorrect?

A. Current liabilities are those that will be satisfied within one year or the operating cycle,
whichever is longer.
B. Liquidity is the ability of the company to meet its total obligations.
C. Current liabilities impact a company's liquidity.
D. Working capital is equal to current assets minus current liabilities.
34. How is the quick ratio calculated?

A. It is current assets minus current liabilities.
B. It is current assets divided by current liabilities.
C. It is quick assets divided by current liabilities.
D. It is current liabilities divided by current assets.
35. Which of the following accounts would not be considered when calculating the quick
ratio?
A. Marketable securities.
B. Inventory.
C. Accounts receivable.
D. Accounts payable.
9-5
ratio?
A. Taxes payable
B. Accounts receivable
C. Cash
D. Prepaid rent
37. A company has a quick ratio of 1.9 before paying off a large current liability with cash. As
a result, what happens to the quick ratio?
A. It is greater than 1.9.
B. It is less than 1.9.
C. It remains equal to 1.9.
D. It is either greater than 1.9 or less than 1.9 depending upon the dollar amount involved.
9-6
39. The following is a partial list of account balances from the books of Probst Enterprise at
the end of 2010:
Based solely upon these balances, what is the quick ratio?

A. 0.76
B. 1.15
C. 0.26
D. 0.79
40. At year-end 2010, General Tech reported a quick ratio of 2.75 and at year-end 2009 it was
3.10. Which of the following is a potential cause of the decrease in this ratio?
A. An increase in accounts payable and a decrease in inventories.
B. A decrease in inventories and an increase in long-term notes payable.
C. A decrease in short-term borrowings and an increase in cash.
D. An increase in accounts payable and a decrease in cash.
41. If the quick ratio has been increasing over the past several years, which of the following
would cause the ratio to continue to increase?
A. An increase in accounts payable.
B. An increase in inventories.
C. An increase in short-term borrowings.
D. A decrease in taxes payable.
9-7
42. Chavez Chocolates had a quick ratio of 1.74 at year-end 2009. Which of the following
would cause the ratio to decrease during 2010?
A. A decrease in both cash and marketable securities.
B. An increase in both cash and marketable securities.
C. An increase in current assets that exceeded the increase in current liabilities.
D. Current assets as a percentage of total assets increased while current liabilities as a
percentage of total liabilities and stockholders' equity decreased.

A. Social Security tax is employer paid only.
B. The pay period always ends in conjunction with the company's fiscal year end.
C. Many fringe benefits such as sick and vacation leave benefits should be recognized when
the employee earns the benefit not when they take the leave.
D. Unemployment taxes are paid by the employee only.
44. Which of the following describes an accrued liability?

A. It is an expense that has been both incurred and paid.
B. It is an expense that has been incurred but not yet paid.
C. It is an expense that has been prepaid but not yet consumed.
D. It is a liability where the cash flow has taken place but the revenue has yet to be earned.
45. Miranda Company borrowed $100,000 cash on September 1, 2010, and signed a one-year
6%, interest-bearing note payable. Assuming no adjusting entries have been made during the
year, the required adjusting entry at the end of the accounting period, December 31, 2010,
would be which of the following?
A.
B.
C.
D.
9-8
6%, interest-bearing note payable. The interest and principal are both due on August 31, 2011.
Assume that the appropriate adjusting entry was made on December 31, 2010 and that no
adjusting entries have been made during 2011. The required journal entry to pay the note on
August 31, 2011 would be which of the following?
A.
B.
C.
D.
47. Landseeker's Restaurants reported cost of goods sold of $322 million and accounts
payable of $83 million for 2011. In 2010, cost of goods sold was $258 million and accounts
payable was $72 million. What was Landseeker's accounts payable turnover ratio in 2011?
A. 4.23
B. 4.15
C. 4.04
D. 3.91
48. Which of the following transactions will decrease the accounts payable turnover ratio?
A. Using cash to pay an accounts payable balance.
B. Selling inventory on account.
C. Selling inventory for cash.
D. A customer returning inventory purchased on account.
9-9
49. Which of the following statements incorrectly describes the accounts payable turnover
ratio?
A. A high ratio indicates that suppliers are being paid in a timely manner.
B. It increases when inventory is sold on account regardless of the sales price.
C. It can be manipulated by aggressively paying off accounts payable at year-end.
D. It is not affected by the choice of inventory accounting methods.
50. On September 1, 2010, Donna Equipment signed a one-year, 8% interest-bearing note

payable for $50,000. Assuming that Donna Equipment maintains its books on a calendar year
basis, how much interest expense that should be reported in the 2011 income statement?
A. $2,667
B. $4,000
C. $1,333
D. $3,000
51. Phipps Company borrowed $25,000 cash on October 1, 2010, and signed a six-month, 8%
interest-bearing note payable with interest payable at maturity. Assuming that no adjusting
entries have been made during the year, the amount of accrued interest payable to be reported
on the December 31, 2010 balance sheet is which of the following?
A. $250
B. $300
C. $500
D. $750
interest-bearing note payable with interest payable at maturity. The amount of interest expense
to be reported during 2011 is which of the following?
A. $1,000
B. $300
C. $500
D. $750
9-10
53. Failure to make a necessary adjusting entry for accrued interest on a note payable would
result in which of the following?
A. An understatement of both liabilities and stockholders' equity.
B. Net income to be overstated and assets to be understated.
C. Net income to be understated and liabilities to be understated.
D. An overstatement of net income, an understatement of liabilities, and an overstatement of
stockholders' equity.
54. The adjusting entry to record accrued interest on a note payable would not result in which
of the following?
A. A decrease in net income.
B. A decrease in stockholders' equity.
C. An increase in liabilities.
D. A decrease in current assets.
55. Which of the following statements is incorrect?

A. The currently maturing portion of long-term debt must be classified as a current liability.
B. The non-current portion of long-term debt will remain reported as a long-term liability.
C. When a company plans to refinance the currently maturing debt on a long-term basis, it
must still report the currently maturing debt as a current liability.
D. The currently maturing portion of long-term debt is a current liability if it is due within the
longer of one-year or the operating cycle.
56. Purdum Farms borrowed $10 million by signing a five year note on January 1, 2010 and
repayments of the principal are payable annually in $2 million installments. Purdum Farms
makes the first payment December 31, 2010 and then prepares its balance sheet. What amount
will be reported as current and long-term liabilities respectively in connection with the note at
December 31, 2010?
A. $2 million in current liabilities and $8 million in long-term liabilities.
B. $2 million in current liabilities and $6 million in long-term liabilities.
C. Zero in current liabilities and $8 million in long-term liabilities.
D. Zero in current liabilities and $10 million in long-term liabilities.
9-11
57. How should a contingent liability that is "reasonably possible" but "cannot reasonably be
estimated" be reported within the financial statements?
A. It must be recorded and reported as a liability.
B. It does not need to be recorded or reported as a liability.
C. It must only be disclosed as a note to the financial statements.
D. It must be reported as a liability, but not disclosed in a note.
58. Young Company is involved in a lawsuit. When would the lawsuit be recorded as a
liability on the balance sheet?
A. When the loss probability is remote and the amount can be reasonably estimated.
B. When the loss is probable and the amount can be reasonably estimated.
C. When the loss probability is reasonably possible and the amount can be reasonably
estimated.
D. When the loss is probable regardless of whether the loss can be reasonably estimated.
59. Houston Company is involved in a lawsuit. In which of the following situations is only
footnote disclosure of the contingent liability reported within the financial statements?
A. When the loss is remote and the amount cannot be reasonably estimated.
C. When the loss is reasonably possible and the amount can be reasonably estimated.
D. When the loss is remote and the amount can be reasonably estimated.
60. Which of the following statements about contingent liabilities is incorrect?

A. A disclosure note is required when the loss is reasonably possible and the amount cannot
be reasonably estimated.
B. A disclosure note is required when the loss is probable and the amount can be reasonably
estimated.
C. A disclosure note is required when the loss is reasonably possible and the amount can be
reasonably estimated.
D. A disclosure note is required when the loss is remote and the amount can be reasonably
estimated.
9-12
61. Rice Corporation's attorney has provided the following summaries of three lawsuits
against Rice:
 Lawsuit A: The loss is probable, but the loss can't be reasonably estimated.
 Lawsuit B: The loss is reasonably possible, but the loss can't be reasonably estimated
 Lawsuit C: The loss is reasonably possible and can be reasonably estimated.
Which of the following statements is correct?

A. A disclosure note is required for each of the three lawsuits.
B. A disclosure note is required only for lawsuits A & C.
C. A disclosure note is required only for lawsuit A.
D. A disclosure note is required only for lawsuits B & C.
against Rice:
 lawsuit A: The loss is probable, but the loss can't be reasonably estimated.
 lawsuit B: The loss is reasonably possible, but the loss can't be reasonably estimated.
 lawsuit C: The loss is reasonably possible and can be reasonably estimated.
Which of the following statements is incorrect?

A. A disclosure note is required for Lawsuit A.
B. A disclosure note is required for lawsuit B.
C. A disclosure note is required for lawsuit C.
D. Lawsuit A is reported on the balance sheet as a liability.
63. Darwin Corporation's attorney has provided the following summaries of three lawsuits
against Darwin:
 lawsuit A: The loss is probable and the loss can be reasonably estimated.
 lawsuit B: The loss is reasonably possible and the loss can't be reasonably estimated.
 lawsuit C: The loss is reasonably possible and the loss can be reasonably estimated.

A. A disclosure note is required for lawsuit A.
B. A disclosure note is required for lawsuit C.
C. A disclosure note is not required for lawsuit B.
9-13
64. Smith Corporation entered into the following transactions:
 Purchased inventory on account.

 Collected an account receivable.
 Purchased equipment using cash.

A. The inventory purchase on account increased working capital.
B. Collecting an account receivable increases working capital.
C. The equipment purchase decreases working capital.
D. The inventory purchase on account increased the quick ratio.

Which of the above transactions resulted in an increase in working capital?

A. The inventory purchase on account.
B. Collecting an account receivable.
C. The purchase of equipment using cash.
D. None of the transactions resulted in an increase in working capital.
66. SRJ Corporation entered into the following transactions:
 The accrual of interest expense on a six-month note payable.

 Collected cash for services to be provided within the next six months.
 The accrual of revenue.
Which of the above transactions resulted in a decrease in working capital?

A. The accrual of interest expense.
B. Collecting cash for services to be provided in the future.
C. The accrual of revenue.
D. Both the accrual of interest expense and the accrual of revenue.
9-14


D. Both the accrual of revenue and the collection of cash for future services.

Which of the following statements is correct with respect to determining the net cash flow
from operating activities on a statement of cash flows?
A. The accrual of interest expense is added to net income.
B. Collecting cash for services to be provided in the future is deducted from net income.
C. The accrual of revenue is added to net income.
D. Collecting cash for services to be provided in the future doesn't require an adjustment to
net income.
69. Rocket Corporation entered into the following transactions:
 The accrual of wages and salaries expense.

 The cash payment of a six-month note payable.
 The cash payment in advance for a one-year insurance policy.
Which of the following statements is correct with respect to determining Rocket's working
capital? Assume that Rocket's operating cycle is four months.
A. The accrual of wages and salaries expense decreases working capital.
B. The cash payment of the note payable decreases working capital.
C. The purchase of the insurance policy increases working capital.
D. The cash payments for the note and insurance both decrease working capital.
9-15

 The cash sale of equipment for a loss.
Which of the following statements is correct with respect to determining Rocket's cash flows
from operating activities on the statement of cash flows?
A. The accrual of wages and salaries expense is deducted from net income.
B. The loss on the equipment sale is deducted from net income.
C. The cash payment to purchase the insurance policy is deducted from net income.
D. The accrual of wages and the equipment loss are both deducted from net income.
71. Short Company purchased land by paying $10,000 cash on the purchase date and agreeing
to pay $10,000 for each of the next ten years beginning one-year from the purchase date.
Short's incremental borrowing rate is 10%. What amount of liability would be reported on the
balance sheet as of the purchase date, after the initial $10,000 payment was made?
A. $100,000
B. $38,550
C. $61,446
D. $71,446
Short's incremental borrowing rate is 10%. At what amount would the land be reported at on
the balance sheet?
A. $100,000
B. $38,550
C. $110,000
D. $71,446
9-16
73. Libby Company purchased equipment by paying $5,000 cash on the purchase date and
agreeing to pay $5,000 every six months during the next four years; the first payment is due
six months after the purchase date. Libby's incremental borrowing rate is 8%. At what amount
would the equipment be reported at on the balance sheet as of the purchase date?
A. $45,000
B. $38,664
C. $33,664
D. $40,000
would the liability be reported on the balance sheet as of the purchase date, after the initial
$5,000 payment was made?
A. $45,000
B. $33,664
C. $38,664
D. $40,000
75. Rae Company purchased a new vehicle by paying $10,000 cash on the purchase date and
agreeing to pay $3,000 every three months during the next five years; the first payment is due
three months after the purchase date. Rae's incremental borrowing rate is 12%. At what
amount would the liability be reported at on the balance sheet as of the purchase date, after
the initial $10,000 payment was made?
A. $44,633
B. $50,000
C. $54,633
D. $60,000
9-17
amount would the vehicle be reported at on the balance sheet as of the purchase date?
A. $44,633
B. $50,000
C. $54,633
D. $60,000
77. Rusty Corporation purchased a rust-inhibiting machine by paying $50,000 cash on the
purchase date and agreeing to pay $10,000 every three months during the next two years; the
first payment is due three months after the purchase date. Rusty's incremental borrowing rate
is 8%. At what amount would the machine be reported at on the balance sheet as of the
purchase date?
A. $123,255
B. $130,000
C. $80,000
D. $73,255
is 8%. At what amount would the liability be reported at on the balance sheet as of the
purchase date, after the initial $50,000 payment was made?
A. $123,255
B. $130,000
C. $80,000
D. $73,255
9-18
79. Rachel Corporation purchased a building by paying $90,000 cash on the purchase date,
agreeing to pay $50,000 every year for the next nine years and $100,000 ten years from the
purchase date; the first payment is due one year after the purchase date. Rachel's incremental
borrowing rate is 10%. At what amount would the building be reported at on the balance sheet
as of the purchase date?
A. $326,500
B. $460,000
C. $287,950
D. $416,500
borrowing rate is 10%. At what amount would the liability be reported at on the balance sheet
as of the purchase date, after the initial $90,000 payment was made?
A. $326,500
B. $460,000
C. $287,950
D. $416,500
81. Rudy Corporation is looking to purchase a building costing $500,000 by paying $100,000
cash on the purchase date, and agreeing to make annual payments for the next ten years; the
first payment is due one year after the purchase date. Rudy's incremental borrowing rate is
10%. How much will each of the annual payments be?
A. $65,098
B. $86,821
C. $55,098
D. $44,000
9-19
82. Grant Corporation is looking to purchase a building costing $900,000 by paying $300,000
cash on the purchase date, and agreeing to make payments every three months for the next
five years; the first payment is due three months after the purchase date. Grant's incremental
borrowing rate is 8%. How much will each of the payments be?
A. $55,041
B. $61,112
C. $36,694
D. $32,400
83. Husky Corporation is looking to purchase a building costing $500,000 by agreeing to

make payments every three months for the next five years; the first payment is due three
months after the purchase date. Husky's incremental borrowing rate is 12%. How much will
each of the payments be?
A. $28,000
B. $66,940
C. $37,981
D. $33,608
84. Huck Corporation is looking to purchase a truck costing $49,000 by agreeing to make
payments every three months for the next two years; the first payment is due three months
after the purchase date. Huck's incremental borrowing rate is 8%. How much will each of the
payments be?
A. $6,248
B. $6,689
C. $8,527
D. $5,709
85. You have been asked to compute the cash equivalent price of a machine assuming the cost
(including principal and interest) is to be paid in two unequal payments after the acquisition
date. Which of the following table values would be used to find the cost of the machine?
A. Present value of a single amount.
B. Present value of an annuity.
C. Future value of a single amount.
D. Future value of an annuity.
9-20
86. Straight Industries purchased a large piece of equipment from Curvy Company on January
1, 2010. Straight Industries signed a note, agreeing to pay Curvy Company $400,000 for the
equipment on December 31, 2012. The market rate of interest for similar notes was 8%. The
present value of $400,000 discounted at 8% for three years was $317,520. On January 1,
2010, Straight Industries recorded the purchase with a debit to equipment for $317,520 and a
credit to notes payable for $317,520. On December 31, 2010, Straight recorded an adjusting
entry to account for interest that had accrued on the note. Assuming no adjusting entries have
been made during the year, how much interest expense would have accrued at December 31,
2010?
A. $25,402
B. $32,000
C. $29,693
D. $27,493
present value of $400,000 discounted at 8% for three years is $317,520. On January 1, 2010,
Straight recorded the purchase with a debit to equipment for $317,520 and a credit to notes
payable for $317,520. On Straight Industries' balance sheet for the year ended December 31,
2010, the book value of the liability for notes payable, including accrued interest would be
which of the following?
A. $342,922
B. $349,520
C. $345,013
D. $347,213
payable for $317,520. How much is the 2011 interest expense, assuming that the December
31, 2010 adjusting entry was made?
A. $27,434
B. $27,962
C. $32,000
D. $29,693
9-21
89. Alden Trucking Company is replacing part of their fleet of trucks by purchasing them
under a note agreement with Kenworthy on January 1, 2010. Alden financed $37,908,000, the
note agreement will require $10 million in annual payments starting on December 31, 2010
and continuing for a total of five years (final payment December 31, 2014). Kenworthy will
charge Alden Trucking Company the market interest rate of 10% compounded annually. What
is the note and interest payable liability on December 31, 2010 after the first payment was
made?
A. $32,908,000
B. $31,698,800
C. $40,000,000
D. $27,908,000
charge Alden Trucking Company the market interest rate of 10% compounded annually. How
much is the 2011 interest expense?
A. $3,169,880
B. $3,290,800
C. $4,000,000
D. $2,790,800
91. A company's income statement reported net income of $40,000 during 2010. The income
tax return excluded a revenue item of $3,000 (reported on the income statement) because
under the tax laws the $3,000 would not be reported for tax purposes until 2011. Which of the
following statements is correct assuming a 35% tax rate?
A. A $3,000 deferred tax liability is reported as of December 31, 2010.
B. A $3,000 deferred tax asset is reported as of December 31, 2010.
C. A $1,050 deferred tax liability is reported as of December 31, 2010.
D. A $1,050 deferred tax asset is reported as of December 31, 2010.
9-22
following statements is incorrect assuming a 35% tax rate?
A. Income tax expense on the income statement exceeds the tax liability to the IRS.
B. The $6,000 of revenue creates a deferred tax liability.
D. Income tax expense on the income statement is $25,900.
93. A company's 2010 income tax return reported a $75,000 tax liability. During 2010, the
deferred income tax liability account increased $9,000. Which of the following statements is
correct?
A. Income tax expense on the 2010 income statement was $75,000.
B. Income tax expense on the 2010 income statement was $64,000.
C. Income tax expense on the 2010 income statement was $9,000.
D. Income tax expense on the 2010 income statement was $84,000.
94. If income tax expense reported on the income statement is $45,000 for 2010, and the tax
return for 2010 (the first year) shows an income tax liability of $42,000, the deferred income
tax on the balance sheet at the end of 2010 will be which of the following? Assume a 40% tax
rate.
A. A $3,000 liability.
B. A $3,000 asset.
C. A $7,500 liability.
D. A $7,500 asset.
95. How much needs to be invested today if your goal is to have $100,000 five years from
today? The return on the investment is expected to be 10% and will be compounded semi-
annually.
A. $61,390
B. $62,090
C. $66,667
D. $50,000
9-23
96. Which of the following correctly describes the accounting for leases?
A. A capital lease is not reported on the balance sheet as a liability.
B. A capital lease reports an asset on the balance sheet.
C. An operating lease reports an operating asset on the balance sheet.
D. An operating lease reports a liability on the balance sheet.
97. Which of the following questions is asked with respect to determining the accounting for
leases?
A. Is the lease term greater than 90% of the asset's estimated life?
B. Is the present value of the payments greater than 75% of the asset's fair market value?
C. Does the lease provide for an opportunity for the lessee to purchase the leased asset during
the lease term at fair market value?
D. Does the lease provide for a transfer of title of the leased asset at the end of the lease term
to the lessee?
98. Which of the following questions is incorrect with respect to determining the accounting
for leases?
A. Is the lease term greater than 75% of the asset's expected economic life?
C. Does the lease provide for an opportunity for the lessee to purchase the leased asset for a
price less than fair market value?
to the lessee?
99. How much needs to be invested today if your goal is to be able to withdraw $5,000 for
each of the next ten years beginning one year from today? The return on the investment is
expected to be 12%.
A. $44,645
B. $36,291
C. $28,251
D. $50,000
9-24
each of the next nine years beginning one year from today and $50,000 ten years from today?
The return on the investment is expected to be 6%.
A. $68,017
B. $95,937
C. $78,176
D. $132,075
Essay Questions
101. Halbur Company reported total assets of $150,000, current assets of $60,000, and total
stockholders' equity of $60,000 and noncurrent liabilities of $65,000.
Requirements (show computations):
1. Compute working capital.

2. Compute the current ratio.
9-25
102. Moore Company has the following partial list of account balances at year-end:
Requirements:
A. Compute the quick ratio.

B. Determine the amount of working capital.
C. Assume that cash is used to pay the balance due on accounts payable.
1. Compute the new quick ratio.

2. Compute the new amount of working capital.
D. Compute the accounts payable turnover ratio (use year-end amounts,)
9-26
103. Sharp Company borrowed $500,000 on a 6% one-year, interest bearing note dated
November 1, 2010 with interest payable at maturity. The annual accounting period ends on
December 31. Assuming that adjusting entries are only made at December 31, the company's
fiscal year-end, prepare journal entries for each of the following dates:
A. November 1, 2010.
B. December 31, 2010.
C. October 31, 2011.
104. Wolf Company borrowed $5,000 on an 8% note payable on March 1, 2010. The maturity
date of the note (and payment of all interest) is September 1, 2011. The accounting period
ends December 31. Assuming no adjusting entries are made during the year, prepare the
journal entry for each of the following dates:
A. March 1, 2010.
C. September 1, 2011.
9-27
105. The following data were provided by the detailed payroll records of Mountain
Corporation for the month of March 2011:
FICA taxes at a 7.65% rate (no employee had reached the maximum).
Requirements:
A. Prepare the March 31, 2011 journal entry to record the payroll and the related employee
deductions.
B. Give the March 31, 2011 journal entry to record the employer's FICA payroll tax expense.
9-28
106. The following is a partial list of account balances for Coen, Inc. as of December 31,
2010:
Required:
Prepare the liability section of Coen Inc.'s classified balance sheet for December 31, 2010.
9-29
107. The following data is available for Tommy's Toys for the years 2008 through 2011:
108. Answer the following four questions.
A. What is a contingent liability?

B. When must a contingent liability be recorded through a journal entry?
C. When should a contingent liability be disclosed in the footnotes to the financial statements?
D. When is disclosure of a contingent liability not required?
9-30
109. In a recent year, The Walt Disney Company reported the following increases or decreases
in current assets and current liabilities. Identify whether each of these increases or decreases
caused cash to increase or decrease. Show increases with a (+) in front of the amount and
decreases with a (-) in front of the amount in the column labeled cash effect.
110. Border Company purchased a truck that cost $17,000. The company signed a $17,000
note payable that specified four equal annual payments (at each year-end), each of which
includes a payment on the principal and interest on the unpaid balance at 10% per annum.
Requirements:
A. Calculate the amount of each equal payment (round to the nearest dollar).
B. Prepare the journal entry to record the purchase of the truck.
C. Prepare the journal entry to record the first annual payment on the note (assume no interest
has been accrued during the year).
D. Will the interest paid with the first annual payment be more or less than the interest paid
with the second annual payment? Explain your answer.
9-31
111. Fold and Hold Corporation purchased a machine which had a current cash equivalent
cost of $38,971 on January 1, 2010. Fold and Hold paid cash of $10,000 and signed an
interest-bearing note for the balance, payable in six equal annual installments on each
December 31 beginning with December 31, 2010. The note specified a 10% interest rate on
the unpaid balance.
Requirements:
A. Prepare the journal entry to record the purchase on January 1, 2010 (round to the nearest
dollar).
B. Prepare the entry to record the first installment payment on December 31, 2010 (round to
the nearest dollar). Assume that no adjusting entries have been made during the year.
9-32
112. Information Company purchased an asset that cost $70,000 on January 1, 2010.
Arrangements were made with the supplier to pay $10,000 cash on January 1, 2010, and the
balance was to be paid over a three-year period, with equal annual payments of $24,553 to be
made at the end of 2010, 2011, and 2012. Each payment will include principal plus interest on
the unpaid balance at 11% per year.
Requirements:
A. Complete the following table:
*Round to reduce principal to zero.

B. Prepare the journal entry for the payment on December 31, 2011.
C. Explain the change, over time, on the amount of interest and the balance of the debt
principal.
9-33
113. On January 1, 2010, Mission Company agreed to buy some equipment from Anna
Company. Mission Company signed a note, agreeing to pay Anna Company $500,000 for the
equipment on December 31, 2012. The market rate of interest for this note was 10%.
Requirements:
A. Prepare the journal entry Mission Company would record on January 1, 2010 related to
this purchase.
B. Prepare the December 31, 2010, adjusting entry to record interest expense related to the
note for the first year. Assume that no adjusting entries have been made during the year.
C. Prepare the December 31, 2011, adjusting entry to record interest expense related to the
note for the second year. Assume that no adjusting entries have been made during the year.
D. Prepare the entry Mission Company would record on December 31, 2012, the due date of
the note to record interest expense for the third year and payment of the note. Assume that no
adjusting entries have been made during the year.
114. Why are present value concepts and applications so important when companies purchase
equipment financed by the seller?
9-34
115. Answer each of the independent problems (show computations):
A. Company A deposited $20,000 in a savings account on January 1, 2009, that will

accumulate 6% interest each December 31.
1. What will be the fund balance as of December 31, 2013?

2. How much interest will be earned as of December 31, 2013?
B. Company B needs to accumulate a $50,000 fund by making five equal annual deposits.
Assuming a 7% interest accumulation, how much must be deposited at the end of each year?
C. Company C has a new machine that has an estimated life of five years and a $5,000
residual value. Assuming an 8% interest rate, what is the present value of the estimated
residual value?
D. Company D owes a $50,000 debt that is now due (January 1, 2011). Arrangements have
been made to pay it off in five equal annual installments starting December 31, 2011 (an
ordinary annuity situation).
1. Assuming 8% interest, how much will be the annual payment?

2. Give the entry for Company D above for the first payment on December 31, 2009 on the
note payable. Assume that no adjusting entries have been made during the year.
under the tax laws the $10,000 would not be reported for tax purposes until 2011.
Prepare the journal entry to record the 2010 income tax expense assuming a 40% tax rate.
9-35
117. A company's income statement reported income tax expense of $200,000 during 2010.
The deferred tax liability on the balance sheet increased $20,000 during 2010. How much was
the company's tax liability during 2010?
9-36
Chapter 09 Reporting and Interpreting Liabilities Answer Key
True / False Questions
1. When a liability is initially recorded, it is recorded at the future amount of all payments.
FALSE
Liabilities are initially recorded in terms of their current cash equivalent.
AACSB: Reflective Thinking

AICPA BB: Critical Thinking
AICPA FN: Reporting
Bloom's: Remember
Difficulty: Easy
Learning Objective: 09-01 Define; measure; and report current liabilities
Topic Area: Liabilities Defined And Classified
9-37
2. A current liability is always a short-term obligation expected to be paid within one year of
the balance sheet date.
FALSE
A current liability is due within one year or the operating cycle, whichever is longer.

AICPA FN: Reporting
Bloom's: Remember
Difficulty: Easy
3. A quick ratio that is high according to an industry average might mean the company may
have excessive inventory levels or slow moving inventory items.
FALSE
Inventory is not a quick asset.

AICPA FN: Measurement
Bloom's: Remember
Difficulty: Easy
Learning Objective: 09-02 Use the quick ratio.
4. The quick ratio can be manipulated by management through paying off current liabilities
before the end of the accounting period.
TRUE
The quick ratio can be manipulated through transactions involving quick assets and current
liabilities.

Bloom's: Remember
Difficulty: Easy
9-38
5. Many strong companies intentionally create low quick ratios.

TRUE
Many strong companies use sophisticated management techniques to minimize their current
asset investment, and as a result, have low quick ratios.

Bloom's: Remember
Difficulty: Easy
6. Quick assets include cash, accounts receivable, and inventory.

FALSE
Quick assets include cash, marketable securities, and accounts receivable.

Bloom's: Remember
Difficulty: Easy
7. Selling inventory on account increases the quick ratio.

TRUE
Quick assets include cash, marketable securities, and accounts receivable. Selling inventory
on account increases accounts receivable and therefore increases the numerator of the quick
ratio.

Bloom's: Understand
Difficulty: Easy
9-39
8. Purchasing inventory on account decreases the quick ratio.

FALSE
Purchasing inventory on account increases current liabilities (the denominator) and therefore
decreases the quick ratio.

Bloom's: Understand
Difficulty: Easy
9. A current liability is created when a customer pays cash for services to be provided in the
future.
TRUE
Current liabilities include unearned (deferred) revenues.

AICPA FN: Reporting
Bloom's: Remember
Difficulty: Easy
10. Purchasing inventory on account increases the accounts payable turnover ratio.
FALSE
Purchasing inventory on account increases accounts payable, the accounts payable turnover
ratio denominator, which therefore decreases the ratio.

Bloom's: Understand
Difficulty: Easy
Learning Objective: 09-03 Analyze the accounts payable turnover ratio.
9-40
11. The choice of inventory method has an impact on the accounts payable turnover ratio.
FALSE
The accounts payable turnover numerator ratio is cost of goods sold, which is impacted by the
choice of inventory method.

Bloom's: Understand
Difficulty: Easy
12. The accounts payable turnover ratio is calculated by dividing accounts payable by cash
payments to suppliers.
FALSE
The accounts payable turnover ratio is cost of goods sold divided by average accounts
payable.

Bloom's: Understand
Difficulty: Easy
13. Income taxes payable is an example of an accrued liability.

TRUE
An accrued liability is created by an expense that has been incurred, but has yet to be paid.

AICPA FN: Reporting
Bloom's: Remember
Difficulty: Easy
9-41
14. The accounts payable turnover ratio is difficult to manipulate.

FALSE
The accounts payable turnover ratio can be manipulated by paying accounts payable at year-
end and can also be manipulated by the choice of inventory method.

Bloom's: Understand
Difficulty: Easy
15. The accrual of interest on a short-term note payable decreases both the quick ratio and
current assets.
FALSE
The interest accrual increases current liabilities and therefore decreases the quick ratio. The
interest accrual does not affect current assets.

AICPA FN: Reporting, Measurement
Bloom's: Understand
Difficulty: Easy
Learning Objective: 09-04 Report notes payable and explain the time value of money.
16. The FICA (social security) tax is a matching tax with a portion paid by both the employer
and the employee.
TRUE
The social security tax is equally shared by the employer and employee.

Bloom's: Understand
Difficulty: Easy
9-42
17. A company borrowed $100,000 at 6% interest on September 1, 2009. Assuming no

adjusting entries have been made during the year, the entry to record interest accrued on
December 31, 2009 would include a debit to interest expense and a credit to interest payable
for $2,000.
TRUE
Interest expense ($2,000) = Amount borrowed ($100,000)  Interest rate (6%)  Number of
months borrowed relative to a year (4  12)

Bloom's: Apply
Difficulty: Easy
18. An estimated liability can't be reported on the balance sheet.

FALSE
Estimated liabilities, such as warranty liabilities, are reported on the balance sheet.

AICPA FN: Reporting
Bloom's: Understand
Difficulty: Easy
19. A contingent liability is reported on the balance sheet if it is probable and can be
estimated.
TRUE
Contingent liabilities are reported on the balance sheet when they are both probable and can
be estimated.

AICPA FN: Reporting
Bloom's: Understand
Difficulty: Easy
Learning Objective: 09-05 Report contingent liabilities
9-43
20. A contingent liability is disclosed in a note to the financial statements when the liability is
reasonably possible and can be estimated.
TRUE
Contingent liabilities are disclosed via a note when they are reasonably possible.

AICPA FN: Reporting
Bloom's: Understand
Difficulty: Easy
21. The journal entry to record a contingent liability creates an accrued liability on the balance
sheet and a loss on the income statement.
TRUE
The recording of a contingent liability debits a loss account and credits accrued contingency
liability.

AICPA FN: Reporting
Bloom's: Understand
Difficulty: Easy
22. A contingent liability can't be disclosed in a note to the financial statements unless it can
be estimated.
FALSE
Contingent liabilities are disclosed via a note when they are reasonably possible, regardless of
whether they can be estimated.

AICPA FN: Reporting
Bloom's: Understand
Difficulty: Easy
9-44
23. Working capital is a measure of short-run liquidity and is measured by dividing current
assets by current liabilities.
FALSE
Working capital is current assets minus current liabilities.

Bloom's: Understand
Difficulty: Easy
Learning Objective: 09-06 Explain the importance of working capital and its impact on cash flows.
Topic Area: Focus On Cash Flows
24. Working capital decreases when accrued wages expense is recorded at year-end.
TRUE
Working capital is current assets minus current liabilities. Accruing wages expense at year-end
increases current liabilities and therefore decreases working capital.

Bloom's: Understand
Difficulty: Easy
25. Working capital decreases when a company pays taxes payable.

FALSE
Working capital is current assets minus current liabilities. Paying taxes payable decreases both
current assets and current liabilities, therefore working capital remains the same.

Bloom's: Understand
Difficulty: Easy
9-45
26. Working capital increases when a company accrues revenues at year-end.

TRUE
Working capital is current assets minus current liabilities. Accruing revenues increases current
assets, therefore working capital increases.

Bloom's: Understand
Difficulty: Easy
27. Long-term liabilities are reported on the balance sheet at an amount equal to the future
cash flows.
FALSE
Long-term liabilities are reported on the balance sheet at the present value of the future cash
flows.

Bloom's: Understand
Difficulty: Easy
Learning Objective: 09-07 Report long-term liabilities.
Topic Area: Long-Term Liabilities
28. Operating leases are reported on the balance sheet at an amount equal to the present value
of the future cash flows.
FALSE
Operating leases do not meet the criteria to be included on the balance sheet.

Bloom's: Understand
Difficulty: Easy
9-46
29. For the present value of a single amount, the compounding period may only be once a
year.
FALSE
Compounding can be many times during a year when finding the present value of a single
sum.

Bloom's: Understand
Difficulty: Easy
Learning Objective: 09-08 Compute present values.
Topic Area: Present Value
30. An annuity is a series of consecutive payments, each one increasing by a fixed dollar
amount over the payment amount of the prior year.
FALSE
An annuity has equal payments over equal time intervals.

Bloom's: Understand
Difficulty: Easy
Topic Area: Present Value
Multiple Choice Questions
9-47

A. Current liabilities are initially recorded at the amount of their principal plus interest.
B. Current liabilities are those liabilities due within one year.
C. Liquidity refers to the ability to pay all debts within one year.
D. Current liabilities affect both the quick ratio and working capital.
Current liabilities are the denominator in the quick ratio and are deducted from current assets
when calculating working capital.

AICPA FN: Reporting
Bloom's: Understand
Difficulty: Medium
32. Which of the following is not a current liability?

A. A liability due within one-year for a business with a fifteen-month operating cycle.
B. A liability due within three months for a business with a two-month operating cycle.
C. A liability due within one-year for a business with a nine-month operating cycle.
D. A liability due within fifteen months for a business with a one-year operating cycle.
A current liability is due within one-year or the operating cycle whichever is longer.

AICPA FN: Reporting
Bloom's: Understand
Difficulty: Medium
9-48
33. Which of the following is incorrect?

A. Current liabilities are those that will be satisfied within one year or the operating cycle,
whichever is longer.
B. Liquidity is the ability of the company to meet its total obligations.
C. Current liabilities impact a company's liquidity.
D. Working capital is equal to current assets minus current liabilities.
Liquidity is the ability to pay current liabilities.

AICPA FN: Reporting
Bloom's: Understand
Difficulty: Medium
34. How is the quick ratio calculated?

A. It is current assets minus current liabilities.
B. It is current assets divided by current liabilities.
C. It is quick assets divided by current liabilities.
D. It is current liabilities divided by current assets.
The quick ratio is quick assets divided by current liabilities.

Bloom's: Understand
Difficulty: Medium
9-49
ratio?
A. Marketable securities.
B. Inventory.
C. Accounts receivable.
D. Accounts payable.

Bloom's: Understand
Difficulty: Medium
ratio?
A. Taxes payable
B. Accounts receivable
C. Cash
D. Prepaid rent

Bloom's: Understand
Difficulty: Medium
9-50
The decrease in the numerator (quick assets) is less percentage wise relative to the decrease in
the denominator, therefore the ratio increases.
AACSB: Analytic
Bloom's: Apply
Difficulty: Medium
The decrease in the numerator (quick assets) is greater percentage wise relative to the
decrease in the denominator, therefore the ratio decreases.
AACSB: Analytic
Bloom's: Apply
Difficulty: Medium
9-51
39. The following is a partial list of account balances from the books of Probst Enterprise at
the end of 2010:
Based solely upon these balances, what is the quick ratio?

A. 0.76
B. 1.15
C. 0.26
D. 0.79
The quick ratio (0.76) equals quick assets ($6,500 + $12,300) divided by current liabilities
($20,500 + $1,200 + $1,300 + $1,900).
AACSB: Analytic
Bloom's: Apply
Difficulty: Medium
9-52
40. At year-end 2010, General Tech reported a quick ratio of 2.75 and at year-end 2009 it was
3.10. Which of the following is a potential cause of the decrease in this ratio?
A. An increase in accounts payable and a decrease in inventories.
B. A decrease in inventories and an increase in long-term notes payable.
C. A decrease in short-term borrowings and an increase in cash.
D. An increase in accounts payable and a decrease in cash.
The decrease in the numerator (cash) and the increase in the denominator (accounts payable),
each would cause the quick ratio to decrease.
AACSB: Analytic
Bloom's: Apply
Difficulty: Medium
41. If the quick ratio has been increasing over the past several years, which of the following
would cause the ratio to continue to increase?
A. An increase in accounts payable.
B. An increase in inventories.
C. An increase in short-term borrowings.
D. A decrease in taxes payable.
The decrease in the denominator (taxes payable), would cause the quick ratio to increase.
AACSB: Analytic
Bloom's: Apply
Difficulty: Medium
9-53
42. Chavez Chocolates had a quick ratio of 1.74 at year-end 2009. Which of the following
would cause the ratio to decrease during 2010?
A. A decrease in both cash and marketable securities.
B. An increase in both cash and marketable securities.
C. An increase in current assets that exceeded the increase in current liabilities.
D. Current assets as a percentage of total assets increased while current liabilities as a
percentage of total liabilities and stockholders' equity decreased.
The increase in the numerator (cash and marketable securities) would cause the quick ratio to
increase.
AACSB: Analytic
Bloom's: Apply
Difficulty: Hard

A. Social Security tax is employer paid only.
B. The pay period always ends in conjunction with the company's fiscal year end.
C. Many fringe benefits such as sick and vacation leave benefits should be recognized when
the employee earns the benefit not when they take the leave.
D. Unemployment taxes are paid by the employee only.
Expenses should be recognized when they are incurred.

AICPA FN: Reporting
Bloom's: Understand
Difficulty: Medium
9-54
44. Which of the following describes an accrued liability?

A. It is an expense that has been both incurred and paid.
B. It is an expense that has been incurred but not yet paid.
C. It is an expense that has been prepaid but not yet consumed.
D. It is a liability where the cash flow has taken place but the revenue has yet to be earned.
An accrued liability is recorded when an expense is incurred but not yet paid.

AICPA FN: Reporting
Bloom's: Understand
Difficulty: Medium
6%, interest-bearing note payable. Assuming no adjusting entries have been made during the
year, the required adjusting entry at the end of the accounting period, December 31, 2010,
would be which of the following?
A.
B.
C.
D.
Interest expense ($2,000) = Amount borrowed ($100,000)  Interest rate (6%)  Number of
months borrowed relative to a year (4  12)
AACSB: Analytic
Bloom's: Apply
Difficulty: Medium
9-55
6%, interest-bearing note payable. The interest and principal are both due on August 31, 2011.
Assume that the appropriate adjusting entry was made on December 31, 2010 and that no
adjusting entries have been made during 2011. The required journal entry to pay the note on
August 31, 2011 would be which of the following?
A.
B.
C.
D.
December 31, 2010: Interest expense ($2,000) = Amount borrowed ($100,000)  Interest rate
(6%)  Number of months borrowed relative to a year (4  12).
August 31, 2011: Interest expense ($4,000) = Amount borrowed ($100,000)  Interest rate
(6%)  Number of months borrowed relative to a year (8  12).
The credit to cash ($106,000) equals the amount borrowed ($100,000) plus the interest for
one-year ($6,000).
AACSB: Analytic
Bloom's: Apply
Difficulty: Medium
9-56
47. Landseeker's Restaurants reported cost of goods sold of $322 million and accounts
payable of $83 million for 2011. In 2010, cost of goods sold was $258 million and accounts
payable was $72 million. What was Landseeker's accounts payable turnover ratio in 2011?
A. 4.23
B. 4.15
C. 4.04
D. 3.91
Accounts payable turnover (4.15) = Cost of goods sold ($322 million)  Average accounts
payable ($83 million + $72 million)  2
AACSB: Analytic
Bloom's: Apply
Difficulty: Medium
48. Which of the following transactions will decrease the accounts payable turnover ratio?
A. Using cash to pay an accounts payable balance.
B. Selling inventory on account.
C. Selling inventory for cash.
D. A customer returning inventory purchased on account.
Accounts payable turnover = Cost of goods sold  Average accounts payable; a return of
inventory purchased by a customer decreases cost of goods sold.
AACSB: Analytic
Bloom's: Apply
Difficulty: Medium
9-57
49. Which of the following statements incorrectly describes the accounts payable turnover
ratio?
A. A high ratio indicates that suppliers are being paid in a timely manner.
B. It increases when inventory is sold on account regardless of the sales price.
C. It can be manipulated by aggressively paying off accounts payable at year-end.
D. It is not affected by the choice of inventory accounting methods.
Accounts payable turnover = Cost of goods sold  Average accounts payable; the choice of
inventory method affects cost of goods sold and therefore affects the ratio as well.
AACSB: Analytic
Bloom's: Apply
Difficulty: Medium
50. On September 1, 2010, Donna Equipment signed a one-year, 8% interest-bearing note

payable for $50,000. Assuming that Donna Equipment maintains its books on a calendar year
basis, how much interest expense that should be reported in the 2011 income statement?
A. $2,667
B. $4,000
C. $1,333
D. $3,000
2011 interest expense ($2,667) = Amount borrowed ($50,000)  Interest rate (8%)  Number
of months borrowed relative to a year (8  12)
AACSB: Analytic
Bloom's: Apply
Difficulty: Medium
9-58
interest-bearing note payable with interest payable at maturity. Assuming that no adjusting
entries have been made during the year, the amount of accrued interest payable to be reported
on the December 31, 2010 balance sheet is which of the following?
A. $250
B. $300
C. $500
D. $750
December 31, 2010 interest payable ($500) = Amount borrowed ($25,000)  Interest rate
(8%)  Number of months borrowed during 2010 relative to a year (3  12)
AACSB: Analytic
Bloom's: Apply
Difficulty: Medium
interest-bearing note payable with interest payable at maturity. The amount of interest expense
to be reported during 2011 is which of the following?
A. $1,000
B. $300
C. $500
D. $750
2011 interest expense ($500) = Amount borrowed ($25,000)  Interest rate (8%)  Number of
months borrowed during 2011 relative to a year (3  12)
AACSB: Analytic
Bloom's: Apply
Difficulty: Medium
9-59
53. Failure to make a necessary adjusting entry for accrued interest on a note payable would
result in which of the following?
A. An understatement of both liabilities and stockholders' equity.
B. Net income to be overstated and assets to be understated.
C. Net income to be understated and liabilities to be understated.
D. An overstatement of net income, an understatement of liabilities, and an overstatement of
stockholders' equity.
The adjusting entry increases interest payable and interest expense, which decreases both net
income and stockholders' equity. Failure to make the entry causes both net income and
stockholders' equity to be overstated, and liabilities to be understated.
AACSB: Analytic
Bloom's: Apply
Difficulty: Medium
54. The adjusting entry to record accrued interest on a note payable would not result in which
of the following?
A. A decrease in net income.
B. A decrease in stockholders' equity.
C. An increase in liabilities.
D. A decrease in current assets.
The adjusting entry increases interest payable and interest expense, which decreases both net
income and stockholders' equity. An accrual doesn't involve a cash flow and doesn't affect
current assets.
AACSB: Analytic
Bloom's: Apply
Difficulty: Medium
9-60
55. Which of the following statements is incorrect?

A. The currently maturing portion of long-term debt must be classified as a current liability.
B. The non-current portion of long-term debt will remain reported as a long-term liability.
C. When a company plans to refinance the currently maturing debt on a long-term basis, it
must still report the currently maturing debt as a current liability.
D. The currently maturing portion of long-term debt is a current liability if it is due within the
longer of one-year or the operating cycle.
If the currently maturing debt is to be refinanced on a long-term basis, it is excluded from

current liabilities.

AICPA FN: Reporting
Bloom's: Understand
Difficulty: Medium
56. Purdum Farms borrowed $10 million by signing a five year note on January 1, 2010 and
repayments of the principal are payable annually in $2 million installments. Purdum Farms
makes the first payment December 31, 2010 and then prepares its balance sheet. What amount
will be reported as current and long-term liabilities respectively in connection with the note at
December 31, 2010?
A. $2 million in current liabilities and $8 million in long-term liabilities.
B. $2 million in current liabilities and $6 million in long-term liabilities.
C. Zero in current liabilities and $8 million in long-term liabilities.
D. Zero in current liabilities and $10 million in long-term liabilities.
The $2,000,000 payment due on December 31, 2011 is a current liability and the three later
(2012, 2013, and 2014) payments ($2,000,000  3) are reported as long-term liabilities.
AACSB: Analytic
Bloom's: Apply
Difficulty: Medium
9-61
57. How should a contingent liability that is "reasonably possible" but "cannot reasonably be
estimated" be reported within the financial statements?
A. It must be recorded and reported as a liability.
B. It does not need to be recorded or reported as a liability.
C. It must only be disclosed as a note to the financial statements.
D. It must be reported as a liability, but not disclosed in a note.
A contingent liability that is reasonably possible but cannot reasonably be estimated is

disclosed in the notes to the financial statements.

AICPA FN: Reporting
Bloom's: Understand
Difficulty: Medium
58. Young Company is involved in a lawsuit. When would the lawsuit be recorded as a
liability on the balance sheet?
A. When the loss probability is remote and the amount can be reasonably estimated.
C. When the loss probability is reasonably possible and the amount can be reasonably
estimated.
D. When the loss is probable regardless of whether the loss can be reasonably estimated.
A contingent liability that is probable and can be reasonably estimated is reported as a liability
on the balance sheet.

AICPA FN: Reporting
Bloom's: Understand
Difficulty: Medium
9-62
59. Houston Company is involved in a lawsuit. In which of the following situations is only
footnote disclosure of the contingent liability reported within the financial statements?
A. When the loss is remote and the amount cannot be reasonably estimated.
C. When the loss is reasonably possible and the amount can be reasonably estimated.
D. When the loss is remote and the amount can be reasonably estimated.
A contingent liability that is reasonably possible and can reasonably be estimated is disclosed
in the notes to the financial statements.

AICPA FN: Reporting
Bloom's: Understand
Difficulty: Medium
60. Which of the following statements about contingent liabilities is incorrect?

A. A disclosure note is required when the loss is reasonably possible and the amount cannot
be reasonably estimated.
B. A disclosure note is required when the loss is probable and the amount can be reasonably
estimated.
C. A disclosure note is required when the loss is reasonably possible and the amount can be
D. A disclosure note is required when the loss is remote and the amount can be reasonably
estimated.
A disclosure note is not required when the loss probability is remote.

AICPA FN: Reporting
Bloom's: Understand
Difficulty: Medium
9-63
against Rice:
 Lawsuit A: The loss is probable, but the loss can't be reasonably estimated.
 Lawsuit B: The loss is reasonably possible, but the loss can't be reasonably estimated
 Lawsuit C: The loss is reasonably possible and can be reasonably estimated.

A. A disclosure note is required for each of the three lawsuits.
B. A disclosure note is required only for lawsuits A & C.
C. A disclosure note is required only for lawsuit A.
D. A disclosure note is required only for lawsuits B & C.
Contingent losses which are either probable or reasonably possible must be disclosed.

AICPA FN: Reporting
Bloom's: Apply
Difficulty: Medium
9-64
against Rice:
 lawsuit A: The loss is probable, but the loss can't be reasonably estimated.
 lawsuit B: The loss is reasonably possible, but the loss can't be reasonably estimated.
 lawsuit C: The loss is reasonably possible and can be reasonably estimated.

A. A disclosure note is required for Lawsuit A.
B. A disclosure note is required for lawsuit B.
C. A disclosure note is required for lawsuit C.
To be reported as a liability on the balance sheet, contingent losses must be both probable and

AICPA FN: Reporting
Bloom's: Apply
Difficulty: Medium
9-65
63. Darwin Corporation's attorney has provided the following summaries of three lawsuits
against Darwin:
 lawsuit A: The loss is probable and the loss can be reasonably estimated.
 lawsuit B: The loss is reasonably possible and the loss can't be reasonably estimated.
 lawsuit C: The loss is reasonably possible and the loss can be reasonably estimated.

A. A disclosure note is required for lawsuit A.
B. A disclosure note is required for lawsuit C.
C. A disclosure note is not required for lawsuit B.
A contingent liability that is reasonably possible is disclosed in the notes to the financial
statements regardless of whether it can be reasonably estimated.

AICPA FN: Reporting
Bloom's: Apply
Difficulty: Medium
9-66


A. The inventory purchase on account increased working capital.
B. Collecting an account receivable increases working capital.
C. The equipment purchase decreases working capital.
D. The inventory purchase on account increased the quick ratio.
The cash payment decreases current assets and therefore working capital. The equipment is a
long-term asset.

AICPA FN: Reporting
Bloom's: Apply
Difficulty: Medium
9-67


A. The inventory purchase on account.
B. Collecting an account receivable.
C. The purchase of equipment using cash.
D. None of the transactions resulted in an increase in working capital.
The inventory purchase and the collection of the receivable didn't affect working capital. The
cash payment decreases current assets and therefore working capital.

AICPA FN: Reporting
Bloom's: Apply
Difficulty: Medium
9-68

Which of the above transactions resulted in a decrease in working capital?

D. Both the accrual of interest expense and the accrual of revenue.
The interest accrual increases interest payable, which increases current liabilities and
decreases working capital.

AICPA FN: Reporting
Bloom's: Apply
Difficulty: Medium
9-69


D. Both the accrual of revenue and the collection of cash for future services.
The accrual of revenue increases accounts receivable which increases current assets and
increases working capital.

AICPA FN: Reporting
Bloom's: Apply
Difficulty: Medium
9-70

Which of the following statements is correct with respect to determining the net cash flow
from operating activities on a statement of cash flows?
A. The accrual of interest expense is added to net income.
B. Collecting cash for services to be provided in the future is deducted from net income.
C. The accrual of revenue is added to net income.
D. Collecting cash for services to be provided in the future doesn't require an adjustment to
net income.
Accruing interest expense reduces income but doesn't involve a cash flow; therefore it is
added to net income.

AICPA FN: Reporting
Bloom's: Apply
Difficulty: Medium
9-71

 The cash payment of a six-month note payable.
Which of the following statements is correct with respect to determining Rocket's working
capital? Assume that Rocket's operating cycle is four months.
A. The accrual of wages and salaries expense decreases working capital.
B. The cash payment of the note payable decreases working capital.
C. The purchase of the insurance policy increases working capital.
D. The cash payments for the note and insurance both decrease working capital.
Accruing wages and salaries expense increases current liabilities which decreases working
capital.

AICPA FN: Reporting
Bloom's: Apply
Difficulty: Medium
9-72

 The cash sale of equipment for a loss.
Which of the following statements is correct with respect to determining Rocket's cash flows
from operating activities on the statement of cash flows?
A. The accrual of wages and salaries expense is deducted from net income.
B. The loss on the equipment sale is deducted from net income.
C. The cash payment to purchase the insurance policy is deducted from net income.
D. The accrual of wages and the equipment loss are both deducted from net income.
The purchase of the insurance policy creates a deferral which is not reported in net income.
Therefore the cash payment is deducted from net income.

AICPA FN: Reporting
Bloom's: Apply
Difficulty: Medium
Short's incremental borrowing rate is 10%. What amount of liability would be reported on the
balance sheet as of the purchase date, after the initial $10,000 payment was made?
A. $100,000
B. $38,550
C. $61,446
D. $71,446
The liability ($61,446) is equal to the present value of the ten remaining payments [$10,000 
6.1446 (present value of a 10% ordinary annuity)]
AACSB: Analytic
Bloom's: Apply
Difficulty: Medium
Topic Area: Present Value Concepts
9-73
Short's incremental borrowing rate is 10%. At what amount would the land be reported at on
the balance sheet?
A. $100,000
B. $38,550
C. $110,000
D. $71,446
The land cost ($71,446) is equal to the present value of the ten remaining payments [$10,000
 6.1446 (present value of a 10%, 10-period ordinary annuity)] plus the initial payment
($10,000).
AACSB: Analytic
Bloom's: Apply
Difficulty: Medium
would the equipment be reported at on the balance sheet as of the purchase date?
A. $45,000
B. $38,664
C. $33,664
D. $40,000
The equipment cost ($38,664) is equal to the present value of the eight remaining payments
[$5,000  6.7327 (present value of a 4%, 8-period ordinary annuity)] plus the initial payment
($5,000).
AACSB: Analytic
Bloom's: Apply
Difficulty: Medium
Learning Objective: 09-09 Apply present value concepts to liabilities. Apply present value concepts to liabilities.
9-74
would the liability be reported on the balance sheet as of the purchase date, after the initial
$5,000 payment was made?
A. $45,000
B. $33,664
C. $38,664
D. $40,000
The liability ($33,664) is equal to the present value of the eight remaining payments [$5,000 
6.7327 (present value of a 4%, 8-period ordinary annuity)].
AACSB: Analytic
Bloom's: Apply
Difficulty: Medium
amount would the liability be reported at on the balance sheet as of the purchase date, after
the initial $10,000 payment was made?
A. $44,633
B. $50,000
C. $54,633
D. $60,000
The liability ($44,633) is equal to the present value of the twenty remaining payments [$3,000
 14.8775 (present value of a 3%, 20-period ordinary annuity)].
AACSB: Analytic
Bloom's: Apply
Difficulty: Medium
9-75
amount would the vehicle be reported at on the balance sheet as of the purchase date?
A. $44,633
B. $50,000
C. $54,633
D. $60,000
The vehicle ($54,633) is equal to the present value of the twenty remaining payments [$3,000
 14.8775 (present value of a 3%, 20-period ordinary annuity)] plus the initial $10,000
payment.
AACSB: Analytic
Bloom's: Apply
Difficulty: Medium
is 8%. At what amount would the machine be reported at on the balance sheet as of the
purchase date?
A. $123,255
B. $130,000
C. $80,000
D. $73,255
The machine ($123,255) is equal to the present value of the eight remaining payments
[$10,000  7.3255 (present value of a 2%, 8-period ordinary annuity)] plus the initial $50,000
payment.
AACSB: Analytic
Bloom's: Apply
Difficulty: Medium
9-76
is 8%. At what amount would the liability be reported at on the balance sheet as of the
purchase date, after the initial $50,000 payment was made?
A. $123,255
B. $130,000
C. $80,000
D. $73,255
The liability ($73,255) is equal to the present value of the eight remaining payments [$10,000
 7.3255 (present value of a 2%, 8-period ordinary annuity)].
AACSB: Analytic
Bloom's: Apply
Difficulty: Medium
borrowing rate is 10%. At what amount would the building be reported at on the balance sheet
as of the purchase date?
A. $326,500
B. $460,000
C. $287,950
D. $416,500
The building ($416,500) is equal to the present value of the nine annual payments [$50,000 
5.7590 (present value of a 10%, 9-period ordinary annuity)], plus the present value of the
payment due ten years from today [$100,000  .3855 (present value of a 10-period, 10%
single sum)], plus the initial $90,000 cash payment.
AACSB: Analytic
Bloom's: Apply
Difficulty: Medium
9-77
borrowing rate is 10%. At what amount would the liability be reported at on the balance sheet
as of the purchase date, after the initial $90,000 payment was made?
A. $326,500
B. $460,000
C. $287,950
D. $416,500
The liability ($326,500) is equal to the present value of the nine annual payments [$50,000 
5.7590 (present value of a 10%, 9-period ordinary annuity)] plus the present value of the
payment due ten years from today [$100,000  .3855 (present value of a 10-period, 10%
single sum)].
AACSB: Analytic
Bloom's: Apply
Difficulty: Medium
81. Rudy Corporation is looking to purchase a building costing $500,000 by paying $100,000
cash on the purchase date, and agreeing to make annual payments for the next ten years; the
first payment is due one year after the purchase date. Rudy's incremental borrowing rate is
10%. How much will each of the annual payments be?
A. $65,098
B. $86,821
C. $55,098
D. $44,000
The annual payment ($69,457) is equal to the amount financed ($400,000) divided by the
present value of a 10%, 10-period ordinary annuity factor (6.1446).
AACSB: Analytic
Bloom's: Apply
Difficulty: Medium
9-78
82. Grant Corporation is looking to purchase a building costing $900,000 by paying $300,000
cash on the purchase date, and agreeing to make payments every three months for the next
five years; the first payment is due three months after the purchase date. Grant's incremental
borrowing rate is 8%. How much will each of the payments be?
A. $55,041
B. $61,112
C. $36,694
D. $32,400
AACSB: Analytic
Bloom's: Apply
Difficulty: Medium
83. Husky Corporation is looking to purchase a building costing $500,000 by agreeing to

make payments every three months for the next five years; the first payment is due three
months after the purchase date. Husky's incremental borrowing rate is 12%. How much will
each of the payments be?
A. $28,000
B. $66,940
C. $37,981
D. $33,608
AACSB: Analytic
Bloom's: Apply
Difficulty: Medium
9-79
84. Huck Corporation is looking to purchase a truck costing $49,000 by agreeing to make
payments every three months for the next two years; the first payment is due three months
after the purchase date. Huck's incremental borrowing rate is 8%. How much will each of the
payments be?
A. $6,248
B. $6,689
C. $8,527
D. $5,709
AACSB: Analytic
Bloom's: Apply
Difficulty: Medium
85. You have been asked to compute the cash equivalent price of a machine assuming the cost
(including principal and interest) is to be paid in two unequal payments after the acquisition
date. Which of the following table values would be used to find the cost of the machine?
A. Present value of a single amount.
B. Present value of an annuity.
C. Future value of a single amount.
D. Future value of an annuity.
The two unequal payments must be discounted using the present value of a single amount
table values. The payments are unequal, so therefore the annuity table values can't be used.

Bloom's: Understand
Difficulty: Medium
9-80
present value of $400,000 discounted at 8% for three years was $317,520. On January 1,
2010, Straight Industries recorded the purchase with a debit to equipment for $317,520 and a
credit to notes payable for $317,520. On December 31, 2010, Straight recorded an adjusting
entry to account for interest that had accrued on the note. Assuming no adjusting entries have
been made during the year, how much interest expense would have accrued at December 31,
2010?
A. $25,402
B. $32,000
C. $29,693
D. $27,493
2010 interest expense ($25,402) = Note payable liability at the beginning of 2010 ($317,520)
 Interest rate (8%)
AACSB: Analytic
Bloom's: Apply
Difficulty: Medium
9-81
payable for $317,520. On Straight Industries' balance sheet for the year ended December 31,
2010, the book value of the liability for notes payable, including accrued interest would be
which of the following?
A. $342,922
B. $349,520
C. $345,013
D. $347,213
 Interest rate (8%)
December 31, 2010 liability book value ($342,922) = January 1, 2010 balance ($317,520) +
2010 accrued interest expense ($25,402)
AACSB: Analytic
Bloom's: Apply
Difficulty: Medium
9-82
payable for $317,520. How much is the 2011 interest expense, assuming that the December
31, 2010 adjusting entry was made?
A. $27,434
B. $27,962
C. $32,000
D. $29,693
 Interest rate (8%).
December 31, 2010 liability book value ($342,922) = January 1, 2010 balance ($317,520) +
2010 accrued interest expense ($25,402).
 Interest rate (8%).
AACSB: Analytic
Bloom's: Apply
Difficulty: Medium
9-83
charge Alden Trucking Company the market interest rate of 10% compounded annually. What
is the note and interest payable liability on December 31, 2010 after the first payment was
made?
A. $32,908,000
B. $31,698,800
C. $40,000,000
D. $27,908,000
December 31, 2010 note payable liability ($31,698,800) = Initial debt ($37,908,000) +
Interest expense ($37,908,000  10%) - First annual payment ($10,000,000).
AACSB: Analytic
Bloom's: Apply
Difficulty: Medium
9-84
charge Alden Trucking Company the market interest rate of 10% compounded annually. How
much is the 2011 interest expense?
A. $3,169,880
B. $3,290,800
C. $4,000,000
D. $2,790,800
December 31, 2010 note payable liability ($31,698,800) = Initial debt ($37,908,000) + 2010
interest expense ($37,908,000  10%) - First annual payment ($10,000,000).
2011 interest expense ($3,169,880) = January 1, 2011 book value ($31,698,800)  10%
AACSB: Analytic
Bloom's: Apply
Difficulty: Medium
following statements is correct assuming a 35% tax rate?
A. A $3,000 deferred tax liability is reported as of December 31, 2010.
B. A $3,000 deferred tax asset is reported as of December 31, 2010.
D. A $1,050 deferred tax asset is reported as of December 31, 2010.
The $3,000 future taxable amount creates a $1,050 deferred tax liability ($3,000  .35).
AACSB: Analytic
Bloom's: Apply
Difficulty: Medium
9-85
following statements is incorrect assuming a 35% tax rate?
A. Income tax expense on the income statement exceeds the tax liability to the IRS.
B. The $6,000 of revenue creates a deferred tax liability.
D. Income tax expense on the income statement is $25,900.
The income tax expense ($80,000  .35) on the income statement is $28,000.
AACSB: Analytic
Bloom's: Apply
Difficulty: Medium
93. A company's 2010 income tax return reported a $75,000 tax liability. During 2010, the
deferred income tax liability account increased $9,000. Which of the following statements is
correct?
A. Income tax expense on the 2010 income statement was $75,000.
B. Income tax expense on the 2010 income statement was $64,000.
C. Income tax expense on the 2010 income statement was $9,000.
D. Income tax expense on the 2010 income statement was $84,000.
The income tax expense ($84,000) on the 2010 income statement equals the IRS tax liability
($75,000) plus the increase in the deferred income tax liability ($9,000).
AACSB: Analytic
Bloom's: Apply
Difficulty: Medium
9-86
94. If income tax expense reported on the income statement is $45,000 for 2010, and the tax
return for 2010 (the first year) shows an income tax liability of $42,000, the deferred income
tax on the balance sheet at the end of 2010 will be which of the following? Assume a 40% tax
rate.
A. A $3,000 liability.
B. A $3,000 asset.
C. A $7,500 liability.
D. A $7,500 asset.
The income tax expense ($45,000) on the 2010 income statement equals the IRS tax liability
($42,000) plus the deferred income tax liability ($3,000) that was created during 2010.
AACSB: Analytic
Bloom's: Apply
Difficulty: Medium
95. How much needs to be invested today if your goal is to have $100,000 five years from
today? The return on the investment is expected to be 10% and will be compounded semi-
annually.
A. $61,390
B. $62,090
C. $66,667
D. $50,000
The investment ($61,391) is equal to the future amount ($100,000) multiplied by the present
value of $1, 10-period, 5% table value (.6139).
AACSB: Analytic
Bloom's: Apply
Difficulty: Medium
Topic Area: Computing Present Value
9-87
96. Which of the following correctly describes the accounting for leases?
A. A capital lease is not reported on the balance sheet as a liability.
B. A capital lease reports an asset on the balance sheet.
C. An operating lease reports an operating asset on the balance sheet.
D. An operating lease reports a liability on the balance sheet.
A capital lease reports both an asset and a liability on the balance sheet.

AICPA FN: Reporting
Bloom's: Understand
Difficulty: Medium
97. Which of the following questions is asked with respect to determining the accounting for
leases?
A. Is the lease term greater than 90% of the asset's estimated life?
C. Does the lease provide for an opportunity for the lessee to purchase the leased asset during
the lease term at fair market value?
to the lessee?
One of the four questions is with respect to the transfer of title.

AICPA FN: Reporting
Bloom's: Understand
Difficulty: Medium
9-88
98. Which of the following questions is incorrect with respect to determining the accounting
for leases?
A. Is the lease term greater than 75% of the asset's expected economic life?
C. Does the lease provide for an opportunity for the lessee to purchase the leased asset for a
price less than fair market value?
to the lessee?
The present value test uses 90% rather than 75%.

AICPA FN: Reporting
Bloom's: Understand
Difficulty: Medium
each of the next ten years beginning one year from today? The return on the investment is
expected to be 12%.
A. $44,645
B. $36,291
C. $28,251
D. $50,000
The investment ($28,251) is equal to the payments ($5,000) multiplied by the present value of
a $1 annuity, 10-period, 12% table value (5.6502).
AACSB: Analytic
Bloom's: Apply
Difficulty: Medium
9-89
each of the next nine years beginning one year from today and $50,000 ten years from today?
The return on the investment is expected to be 6%.
A. $68,017
B. $95,937
C. $78,176
D. $132,075
The investment ($95,937) = [$10,000 multiplied by the present value of a $1 annuity, 9-

period, 6% table value (6.8017)] plus [$50,000 multiplied by the present value of a $1, 10-
period, 6% table value (.5584)]
AACSB: Analytic
Bloom's: Apply
Difficulty: Medium
Essay Questions
9-90
101. Halbur Company reported total assets of $150,000, current assets of $60,000, and total
stockholders' equity of $60,000 and noncurrent liabilities of $65,000.
Requirements (show computations):
1. Compute working capital.

2. Compute the current ratio.
Answers will vary
Feedback:
1. Total assets ($150,000) = Current liabilities ($X) + Noncurrent liabilities ($65,000) +

Stockholders' equity ($60,000)
Current liabilities = $25,000
Working Capital ($35,000) = Current assets ($60,000) - Current liabilities ($25,000)
2. Current Ratio (2.4) = Current assets ($60,000)  Current liabilities ($25,000)
AACSB: Analytic
Bloom's: Apply
Difficulty: Medium
9-91
102. Moore Company has the following partial list of account balances at year-end:
Requirements:
A. Compute the quick ratio.

B. Determine the amount of working capital.
C. Assume that cash is used to pay the balance due on accounts payable.
1. Compute the new quick ratio.

2. Compute the new amount of working capital.
D. Compute the accounts payable turnover ratio (use year-end amounts,)
9-92
Answers will vary
Feedback
A. Quick assets ($27,600) = Cash ($23,000) + Accounts receivable ($4,600)

Current liabilities ($13,400) = Accounts payable ($1,500) + Notes payable ($1,000) + Salaries
payable ($900) + Taxes payable ($10,000)
Quick ratio (2.06) = Quick assets ($27,600)  Current liabilities ($13,400)
B. Current assets ($31,900) = Cash ($23,000) + Accounts receivable ($4,600) + Inventory

($4,300)
Working capital ($18,500) = Current assets ($31,900) - Current liabilities ($13,400)
C.
1. Quick assets ($26,100) = Cash ($21,500) + Accounts receivable ($4,600)

Current liabilities ($11,900) = Notes payable ($1,000) + Salaries payable ($900) + Taxes
payable ($10,000)
Quick ratio (2.19) = Quick assets ($26,100)  Current liabilities ($11,900)
2. Current assets ($30,400) = Cash ($21,500) + Accounts receivable ($4,600) + Inventory
($4,300)
Working capital ($18,500) = Current assets ($30,400) - Current liabilities ($11,900)
D. Accounts payable turnover (2.1) = Cost of Goods Sold ($3,200)  Accounts payable
($1,500)
AACSB: Analytic
Bloom's: Apply
Difficulty: Medium
9-93
103. Sharp Company borrowed $500,000 on a 6% one-year, interest bearing note dated
November 1, 2010 with interest payable at maturity. The annual accounting period ends on
December 31. Assuming that adjusting entries are only made at December 31, the company's
fiscal year-end, prepare journal entries for each of the following dates:
A. November 1, 2010.
C. October 31, 2011.
Answers will vary
Feedback:
AACSB: Analytic
Bloom's: Apply
Difficulty: Medium
9-94
104. Wolf Company borrowed $5,000 on an 8% note payable on March 1, 2010. The maturity
date of the note (and payment of all interest) is September 1, 2011. The accounting period
ends December 31. Assuming no adjusting entries are made during the year, prepare the
journal entry for each of the following dates:
A. March 1, 2010.
C. September 1, 2011.
Answers will vary
Feedback:
AACSB: Analytic
Bloom's: Apply
Difficulty: Medium
9-95
105. The following data were provided by the detailed payroll records of Mountain
Corporation for the month of March 2011:
FICA taxes at a 7.65% rate (no employee had reached the maximum).
Requirements:
A. Prepare the March 31, 2011 journal entry to record the payroll and the related employee
deductions.
B. Give the March 31, 2011 journal entry to record the employer's FICA payroll tax expense.
Answers will vary
Feedback:
AACSB: Analytic
Bloom's: Apply
Difficulty: Medium
9-96
106. The following is a partial list of account balances for Coen, Inc. as of December 31,
2010:
Required:
Prepare the liability section of Coen Inc.'s classified balance sheet for December 31, 2010.
Answers will vary
Feedback:
9-97
AACSB: Analytic
Bloom's: Apply
Difficulty: Medium
9-98
107. The following data is available for Tommy's Toys for the years 2008 through 2011:
Answers will vary
Feedback:
A1. 2011 accounts payable turnover (7.34) = Cost of goods sold ($7,506)  Average inventory
[$1,023 + $1,022] 2)
A2. 2010 accounts payable turnover (8.05) = Cost of goods sold ($7,646)  Average inventory
[$1,022 + $878]  2)
A3. 2009 accounts payable turnover (8.79) = Cost of goods sold ($7,799/ [$878 + $896]  2).
B1. 49.7 days = 365 days  accounts payable turnover (7.34)
C. Over the three year period, Tommy's Toys accounts payable turnover ratio has decreased
and the number of days it takes them to pay vendors has increased from 42 in 2009 to 50 days
in 2011. If their suppliers offer them credit terms of 30 days, then Tommy's Toys is taking
almost twice that time to pay them. It would be a good idea to compare the accounts payable
turnover ratio of competitors with that of Tommy's Toys to see if they are in line with other
similar companies.
AACSB: Analytic
Bloom's: Apply
Difficulty: Medium
9-99
108. Answer the following four questions.
A. What is a contingent liability?

B. When must a contingent liability be recorded through a journal entry?
C. When should a contingent liability be disclosed in the footnotes to the financial statements?
D. When is disclosure of a contingent liability not required?
Answers will vary
Feedback: A. Contingent liabilities are potential liabilities that arise due to past events.
B. Whether or not the potential liability becomes a recorded liability depends upon the
outcome of future events. For example, a company is currently involved in a product liability
lawsuit. The company may have to pay the plaintiff if the settlement is unfavorable. A
contingent liability must be recorded if it is probable that the future events will occur and the
amount can be reasonably estimated.
C. Contingent liabilities should be disclosed in the footnotes to the financial statements if it is
probable that future events will occur but the amount cannot be reasonably estimated.
Footnote disclosure should also occur if it is reasonably possible that the future events will
occur whether or not it can be reasonably estimated.
D. Disclosure is not required if the probability of future events occurring is remote.

AICPA FN: Reporting
Bloom's: Understand
Difficulty: Medium
9-100
109. In a recent year, The Walt Disney Company reported the following increases or decreases
in current assets and current liabilities. Identify whether each of these increases or decreases
caused cash to increase or decrease. Show increases with a (+) in front of the amount and
decreases with a (-) in front of the amount in the column labeled cash effect.
Answers will vary
Feedback: (1) +$366, (2) +$103, (3) -$848, (4) -$179, (5) +$292, (6) +$69.
AACSB: Analytic
Bloom's: Apply
Difficulty: Medium
9-101
110. Border Company purchased a truck that cost $17,000. The company signed a $17,000
note payable that specified four equal annual payments (at each year-end), each of which
includes a payment on the principal and interest on the unpaid balance at 10% per annum.
Requirements:
A. Calculate the amount of each equal payment (round to the nearest dollar).
B. Prepare the journal entry to record the purchase of the truck.
C. Prepare the journal entry to record the first annual payment on the note (assume no interest
has been accrued during the year).
D. Will the interest paid with the first annual payment be more or less than the interest paid
with the second annual payment? Explain your answer.
Answers will vary
Feedback:
A. $17,000  3.1699 (present value of annuity, 10%, 4 periods) = $5,363
B.
C.
D. The interest paid on the first installment will be more than the interest on the second
payment because the principal is lower.
AACSB: Analytic
Bloom's: Apply
Difficulty: Hard
9-102
111. Fold and Hold Corporation purchased a machine which had a current cash equivalent
cost of $38,971 on January 1, 2010. Fold and Hold paid cash of $10,000 and signed an
interest-bearing note for the balance, payable in six equal annual installments on each
December 31 beginning with December 31, 2010. The note specified a 10% interest rate on
the unpaid balance.
Requirements:
A. Prepare the journal entry to record the purchase on January 1, 2010 (round to the nearest
dollar).
B. Prepare the entry to record the first installment payment on December 31, 2010 (round to
the nearest dollar). Assume that no adjusting entries have been made during the year.
Answers will vary
Feedback:
AACSB: Analytic
Bloom's: Apply
Difficulty: Medium
9-103
112. Information Company purchased an asset that cost $70,000 on January 1, 2010.
Arrangements were made with the supplier to pay $10,000 cash on January 1, 2010, and the
balance was to be paid over a three-year period, with equal annual payments of $24,553 to be
made at the end of 2010, 2011, and 2012. Each payment will include principal plus interest on
the unpaid balance at 11% per year.
Requirements:
A. Complete the following table:
*Round to reduce principal to zero.

B. Prepare the journal entry for the payment on December 31, 2011.
C. Explain the change, over time, on the amount of interest and the balance of the debt
principal.
Answers will vary
Feedback:
C. Interest decreases over time because part of each debt payment reduces principal. As a
result, over time the debt principal decreases each year.
9-104
AACSB: Analytic
Bloom's: Apply
Difficulty: Medium
9-105
113. On January 1, 2010, Mission Company agreed to buy some equipment from Anna
Company. Mission Company signed a note, agreeing to pay Anna Company $500,000 for the
equipment on December 31, 2012. The market rate of interest for this note was 10%.
Requirements:
A. Prepare the journal entry Mission Company would record on January 1, 2010 related to
this purchase.
B. Prepare the December 31, 2010, adjusting entry to record interest expense related to the
note for the first year. Assume that no adjusting entries have been made during the year.
C. Prepare the December 31, 2011, adjusting entry to record interest expense related to the
note for the second year. Assume that no adjusting entries have been made during the year.
D. Prepare the entry Mission Company would record on December 31, 2012, the due date of
the note to record interest expense for the third year and payment of the note. Assume that no
adjusting entries have been made during the year.
9-106
Answers will vary
Feedback:
A.
$500,000  0.7513 (present value of $1, 10%, 3 periods) = $375,650.
B.
$375,650  .10 = $37,565.
C.
$375,650 + $37,565 = $413,215  10% = $41,322.
D.
($375,650 + $37,565 + $41,322)  .10 = $45,454 (Rounding error of $1; you must use
$45,463 in order to leave notes payable with a zero balance.)
9-107
AACSB: Analytic
Bloom's: Apply
Difficulty: Medium
114. Why are present value concepts and applications so important when companies purchase
equipment financed by the seller?
Answers will vary
Feedback: Present value concepts are very important in seller-financed purchases because the
debt payments will include principal and interest payments. The equipment should be
capitalized at an amount equal to the present value of the purchase. That is, the asset account
should reflect what the equipment could have been acquired for in terms of "today's dollars".
The additional amounts for interest are charges for borrowing. These interest amounts should
be reported as interest expense as incurred.

Bloom's: Understand
Difficulty: Medium
9-108
115. Answer each of the independent problems (show computations):
A. Company A deposited $20,000 in a savings account on January 1, 2009, that will

accumulate 6% interest each December 31.
1. What will be the fund balance as of December 31, 2013?

2. How much interest will be earned as of December 31, 2013?
B. Company B needs to accumulate a $50,000 fund by making five equal annual deposits.
Assuming a 7% interest accumulation, how much must be deposited at the end of each year?
C. Company C has a new machine that has an estimated life of five years and a $5,000
residual value. Assuming an 8% interest rate, what is the present value of the estimated
residual value?
D. Company D owes a $50,000 debt that is now due (January 1, 2011). Arrangements have
been made to pay it off in five equal annual installments starting December 31, 2011 (an
ordinary annuity situation).
1. Assuming 8% interest, how much will be the annual payment?

2. Give the entry for Company D above for the first payment on December 31, 2009 on the
note payable. Assume that no adjusting entries have been made during the year.
Answers will vary
Feedback:
A.
1. $20,000 x 1.3382 (Future value of $1, 6%, 5 periods = $26,764.

2. $26,764 - 20,000 = $6,764.
B. $50,000  5.7507 (future amount of a $1 ordinary annuity, 7%, 5 periods) = $8,695.
C. $5,000 x 0.6806 (present value of $1, 8%, 5 periods) = $3,403.
D.
9-109

Bloom's: Understand
Difficulty: Hard
under the tax laws the $10,000 would not be reported for tax purposes until 2011.
Prepare the journal entry to record the 2010 income tax expense assuming a 40% tax rate.
Answers will vary
Feedback:
AACSB: Analytic
Bloom's: Apply
Difficulty: Medium
117. A company's income statement reported income tax expense of $200,000 during 2010.
The deferred tax liability on the balance sheet increased $20,000 during 2010. How much was
the company's tax liability during 2010?
Answers will vary
Feedback:
AACSB: Analytic
Bloom's: Apply
Difficulty: Medium
9-110

Reporting and Interpreting Liabilities Chapter

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Reporting and Interpreting Liabilities Chapter

Uploaded by

Copyright:

Available Formats

Chapter 09 - Reporting and Interpreting Liabilities

True / False Questions

5. Many strong companies intentionally create low quick ratios.

6. Quick assets include cash, accounts receivable, and inventory.

7. Selling inventory on account increases the quick ratio.

8. Purchasing inventory on account decreases the quick ratio.

13. Income taxes payable is an example of an accrued liability.

14. The accounts payable turnover ratio is difficult to manipulate.

17. A company borrowed $100,000 at 6% interest on September 1, 2009. Assuming no

18. An estimated liability can't be reported on the balance sheet.

25. Working capital decreases when a company pays taxes payable.

26. Working capital increases when a company accrues revenues at year-end.

Multiple Choice Questions

31. Which of the following statements is correct?

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

33. Which of the following is incorrect?

34. How is the quick ratio calculated?

Based solely upon these balances, what is the quick ratio?

43. Which of the following statements is correct?

44. Which of the following describes an accrued liability?

50. On September 1, 2010, Donna Equipment signed a one-year, 8% interest-bearing note

55. Which of the following statements is incorrect?

60. Which of the following statements about contingent liabilities is incorrect?

Which of the following statements is correct?

Which of the following statements is incorrect?

Which of the following statements is incorrect?

64. Smith Corporation entered into the following transactions:

 Purchased inventory on account.

Which of the following statements is correct?

65. Smith Corporation entered into the following transactions:

 Purchased inventory on account.

Which of the above transactions resulted in an increase in working capital?

66. SRJ Corporation entered into the following transactions:

 The accrual of interest expense on a six-month note payable.

Which of the above transactions resulted in a decrease in working capital?

67. SRJ Corporation entered into the following transactions:

 The accrual of interest expense on a six-month note payable.

Which of the above transactions resulted in an increase in working capital?

68. SRJ Corporation entered into the following transactions:

 The accrual of interest expense on a six-month note payable.

69. Rocket Corporation entered into the following transactions:

 The accrual of wages and salaries expense.

70. Rocket Corporation entered into the following transactions:

 The accrual of wages and salaries expense.

83. Husky Corporation is looking to purchase a building costing $500,000 by agreeing to

Requirements (show computations):

1. Compute working capital.

A. Compute the quick ratio.

1. Compute the new quick ratio.

D. Compute the accounts payable turnover ratio (use year-end amounts,)

108. Answer the following four questions.

A. What is a contingent liability?

A. Complete the following table:

*Round to reduce principal to zero.

115. Answer each of the independent problems (show computations):

A. Company A deposited $20,000 in a savings account on January 1, 2009, that will

1. What will be the fund balance as of December 31, 2013?

1. Assuming 8% interest, how much will be the annual payment?

Chapter 09 Reporting and Interpreting Liabilities Answer Key

True / False Questions

Liabilities are initially recorded in terms of their current cash equivalent.

AACSB: Reflective Thinking

AACSB: Reflective Thinking