Chapter 13. Current Liabilities. Assessment Questions. What are liabilities? Liabilities are amounts payable to others.

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1 Assessment Questions AS-1 ( 1 ) What are liabilities? Liabilities are amounts payable to others. AS-2 ( 1 ) Name the two classes of liabilities. Liabilities may be either current (payable within the next year), or non-current (payable after one year). AS-3 ( 1 ) How are current liabilities presented on the balance sheet? Current liabilities are shown as the first sub-heading below the main heading liabilities. The balance sheet must show the total dollar figure for current liabilities. Current liabilities are followed by non-current liabilities. A total must be shown for all liabilities (i.e. total liabilities). 1

2 AS-4 ( 1 ) Define known (determinable) liabilities. Known (determinable) liabilities, have an exact amount and defined due date that can be determined from examination of invoices, contracts, etc. AS-5 ( 1 ) Provide four examples of determinable (known) liabilities. Trade payables (owing to suppliers) Short-term notes payable Unearned revenues (e.g. payments received in advance from customers) Provincial Sales Tax (PST), Goods and Services Tax (GST) and Harmonized Sales Tax (HST) payable AS-6 ( 8 ) Provide three examples of estimated or contingent (unknown) liabilities. amounts that may be owing against product warranties potential lawsuits that are not known but must be accounted for insurance claims AS-7 ( 1 ) Define accrued expenses. Accrued charges are known liabilities or expenses that have been incurred and that are expected to be paid in the future. They are amounts that can be calculated, usually on the basis of time. 2

3 Chapter 13 AS-8 ( 9 ) What is the normal source of funds used to pay current liabilities? Current liabilities are paid using current assets. AS-9 ( 9 ) How should the purchase of capital assets be financed? Capital assets should be financed using non-current liabilities, the term of which matches the life of the capital asset. AS-10 ( 5 ) List the items you expect to find on a note payable. The name of the person to whom the amount is owing The amount in words and in numbers The annual interest rate The date the note must be paid The issue date The name of the person who must pay the amount 3

4 Application Questions AP-1 ( 2 ) A company has repairs completed on the heating system. The service man hands the accountant an invoice for $1,000 dated May 25, due in one month. Write the journal entry the company must prepare to record this transaction. AP-2 ( 2 ) May 25 Maintenance Expense 1,000 Accounts Payable 1,000 To record repairs on heating system A company uses substantial amounts of utilities (hydro and water) with an average cost of $6,000 per month. They receive and pay the actual bill on the 15th of each month. In January 2014, the company received their bill in the amount of $6,207 for the period December 15 to January 15. The bill was paid right away. Assume the company prepares monthly financial statements. Required: a) Give the journal entry to record the estimate of utilities expense for the period Dec , b) Record the journal entry required for payment of the bill on January 15, Dec 31 Utilities Expense 3,000 Utilities Payable 3,000 To accrue utilities expense for the period Dec , 2013 Jan 15 Utilities Payable 3,000 Utilities Expense 3,207 Cash 6,207 To record payment of utilities expense for the month 4

5 Chapter 13 AP-3 ( 6 ) Cervera Company borrowed $100,000 from the local branch. The loan is payable in equal installments over five years. Required: Write the journal entry to record the loan. How much of the loan would be considered current? Jan 1 Cash 100,000 Loan Payable 100,000 Borrowed $100,000 term debt payable over 5 years The current portion is $20,000 AP-4 ( 5 ) NOTE PAYABLE For the Value Received, the undersigned promises to pay to the order of U. Paymee the sum of ***** $5,000 and 00/100 Dollars *********************** ($5,000.00) with annual interest of 5% on any unpaid balance. This note shall mature and be payable, along with accrued interest on: July 31, 2014 February 1, 2014 Issue Date A. Notemaker Maker Signature Answer the following questions regarding the note shown above. a) Who is the lender? b) Who is the borrower? c) When is payment due? 5

6 d) When was the note issued? e) When is interest payable? f) What amount must the borrower pay to the lender? Lender U. Paymee Borrower A. Notemaker Payment Due July 31, 2014 Issue Date February 1, 2014 Date Interest Payable July 31, 2014 Payable by Borrower to Lender $5,000 + (5% $5,000) 6 12 = $5,125 AP-5 ( 5 ) On May 1, 2014, ACME Bank agreed to lend Mirza Enterprises $100,000. To that effect, Mirza signed a $100,000, 10-month, 12% note. Mirza Enterprises has a year-end of December 31. Required: Prepare the journal entry for Mirza Enterprises: a) On the date the note was signed b) At year-end c) On March 1, 2015 when the note is repaid May 1 Cash 100,000 Notes Payable 100,000 To record a 10-month, 12% note payable Dec 31 Interest Expense 8,000 Interest Payable 8,000 To record interest payable from note ($100,000 12% 8 12 = $8,000) Mar 1 Notes Payable 100,000 Interest Payable 8,000 Interest Expense 2,000 Cash 110,000 To record repayment of note and additional interest 6

7 Chapter 13 AP-6 ( 5 ) On June 15, 2014, Actor Surplus agreed to lend Wei Hong Enterprises $250,000. To that effect, Wei signed a $250,000, 8-month, 10% note. Wei Hong Enterprises has a year-end of November 30. Required: Prepare the journal entry for Wei Hong Enterprises: a) On the date the note was signed b) At year-end c) On February 16, 2015 when the note is repaid Jun 15 Cash 250,000 Notes Payable 250,000 To record an 8-month,10% note payable Nov 30 Interest Expense 11,458 Interest Payable 11,458 To record interest payable from note ($250,000 10% = $11,458) Feb 16 Notes Payable 250,000 Interest Payable 11,458 Interest Expense 5,209 Cash 266,667 To record repayment of note and additional interest. Interest expense at Feb 16 is: ($250,000 10% = $5,209) AP-7 ( 5 ) Darren Spoon from Company ABC signed a 7% half-year note payable for $100,000 on November 1, The note is due with interest on May 1, Company ABC has a year-end of Dec 31. Required: a) journal entry recording receipt of cash b) journal entry accruing interest at the year-end c) ultimate payment of the note in the new year 7

8 Nov 1 Cash 100,000 Note Payable 100,000 To record 3-year note payable at 7% interest Dec 31 Interest Expense 1,167 Interest Payable 1,167 To record interest expense for 2 months May 1 Note Payable 100,000 Interest Payable 1,167 Interest Expense 2,333 Cash 103,500 To record final interest expense and paying back note payable AP-8 ( 4 ) The local transit company, in co-operation with local colleges and universities sells transit passes for the semester for $200 each. The passes are only sold prior to the start of the semester, and for the fall semester are good from September 1 to December 31. The transit company sold 1,000 passes on August 1. Required: Write the entry for: a) The sale of the passes b) The entry to be recorded on September 30. Aug 1 Cash 200,000 Unearned Transit Pass Revenue 200,000 To record the sale of 1,000 passes Sept 30 Unearned Transit Pass Revenue 50,000 Transit Revenue 50,000 To recognize ticket revenue earned for the month (1/4 x $200,000) 8

9 Chapter 13 AP-9 ( 7 ) Erik Tilly is starting a new business with some other investors. In addition, he is loaning the company $200,000 at a nominal rate of interest of 2% per annum and due in one year. Record the journal entry the new business has to make regarding the shareholder loan on August 1. Aug 1 Cash 200,000 Shareholders loan 200,000 To record shareholder loan for $200,000 at 2% interest per annum AP-10 ( 8 ) Lee-Yau Enterprises sells heavy-duty lawnmower equipment. On May 4, they sold a lawnmower (on account) for $45,000 which included a 4-year unlimited warranty. The corporation s accountant estimates that an amount of $3,000 will be paid out in warranty obligations. The cost of goods sold is $17,000. Assume Lee-Yau uses a perpetual inventory system. Prepare the journal entries relating to these transactions. May 4 Accounts Receivable Sales 45,000 45,000 To record the sale of the lawnmower May 4 COGS Inventory 17,000 17,000 To record the sale of inventory May 4 Warranty Expense 3,000 Estimated Warranty Liability 3,000 To accrue for estimated warranty costs AP-11 ( 8 ) Refer to AP-10 above. Suppose Lee-Yau is required to repair the lawnmower sold (there is a faulty wire) and Lee-Yau spends $500 in cash on October 15 remedying the problem. Record the journal entry for this transaction. Oct 15 Estimated Warranty Liability 500 Cash 500 To record the amount spent honoring the warranty on the lawnmower 9

10 AP-12 ( 8 ) Los Amigos Manufacturing Ltd. builds and sells cars. They recently sold 150 cars for $30,000 each. The cost to build each car is $7,000. Los Amigos does not sell warranties with the purchase of the car; however, the customer has the option to purchase the warranty separately. Los Amigos sold a 4-year warranty for each car sold. Each warranty costs $2,000. Prepare the journal entries for the sale of the cars and warranties. Assume the cars were purchased on account and that the warranties were paid for in cash. Los Amigos uses a perpetual inventory system. Accounts Receivable 4,500,000 Sales 4,500,000 To record the sale of 150 cars on account COGS 1,050,000 Inventory 1,050,000 To record the sale of inventory Cash 300,000 Unearned Warranty Revenue 300,000 To record the sale of the 4-year warranties AP-13 ( 8 ) Refer to AP-12 above. Record the journal entry related to unearned warranty revenue at the end of 1 year from date of sale of the cars. Unearned Warranty Revenue 75,000 Warranty Revenue 75,000 To recognize one year of warranty revenue related to 4-year warranties 1/4 $300,000 = $75,000 10

11 Chapter 13 AP-14 ( 9 ) Shown below is a partial balance sheet for a manufacturer. Required: a) Calculate the current ratio for 2014 b) Calculate the quick ratio for 2014 c) Comment on the current ratio and quick ratio a) Current ratio = current assets current liabilities = 3,477,354 1,474,431 = 2.36:1 b) Cash + Short-Term Investments + Net Accounts Receivable Quick Ratio = = (1,184, , ,249,381) 1,474,431 = 1.94:1 c) Generally speaking, both the current ratio and quick ratio are good. The current ratio is above 2:1. The quick ratio is almost double the minimum requirement of 1:1. 11

12 AP-15 ( 5 ) On September 1, 2014, Express Inc. purchased a delivery truck from MJ Trucks, costing $80,000. However, due to cash flow problems, Express Inc. is currently unable to make the payment. Therefore, in order to ensure MJ Trucks for the payment, Express Inc. signed a oneyear note with 3% interest per annum, to be payable at maturity. Express Inc s year-end is on December 31. Prepare all the necessary journal entries related to the notes payable from the time it is signed to the maturity date. Sep 1, 2014 Delivery Truck 80,000 Notes Payable 80,000 To record the purchase of delivery truck Dec 31, 2014 Interest Expense 800 Interest Payable 800 To record interest accrued ( , ) Sep 1, 2015 Note Payable 80,000 Interest Expense 1,600 Interest Payable 800 Cash 82,400 To record the payment of note payable, plus interest accrued AP-16 ( 5 ) On February 1, 2014, Red Ball Inc. received a bank loan for $30,000. The loan bears an interest rate of 2.5% per annum, and will mature in two years. Red Ball Inc. has a December 31 yearend. The partial principle of $15,000 plus interest is payable every January 31. Prepare the necessary journal entries from February 1, 2014 to January 31, Feb 1, 2014 Cash 30,000 Loan Payable 30,000 Borrowed $30,000 loan payable over 2 years Dec 31, 2014 Interest Expense 688 Interest Payable 688 To record interest accrued (0.025 x 30,000 x 11/12) 12

13 Chapter 13 Jan 31, 2015 Loan Payable 15,000 Interest Expense 62 Interest Payable 688 Cash 15,750 To record the yearly payment of note payable, plus interest accrued Dec 31, 2015 Interest Expense 344 Interest Payable 344 To record interest accrued (0.025 x 15,000 x 11/12) Jan 31, 2016 Loan Payable 15,000 Interest Expense 31 Interest Payable 344 Cash 15,375 To record the last payment of note payable, plus interest accrued AP-17 ( 8 ) Shining Star Corporation produces and sells washing machines, and provides the customers with a one-year warranty on all its products. It is estimated that the company incurs approximately $50 of warranty expense on all the machines sold. During the year 2013, the company sold 400 washing machines. Required: a) Prepare a journal entry to record the estimated warranty liability. Warranty Expense 20,000 Estimated Warranty Liability 20,000 To record estimated warranty liability ($50 x 400 machines) 13

14 b) During the year 2014, the company used $5,000 worth of inventory parts and paid $10,000 for maintenance staff salaries. Prepare a journal entry to record this transaction. Estimated Warranty Liability 15,000 Inventory (parts) 5,000 Cash 10,000 To record inventory and wages for warranty work c) At the end of year 2014, the company decided to decrease its estimated liability by the remaining balance. Prepare a journal entry to record this transaction. Estimated Warranty Liability 5,000 Warranty Expense 5,000 To decrease the balance of estimated liability owing AP-18 ( 8 ) Refer to AP-17. Shining Star Corporation also provides its customers with an option to purchase a three-year warranty on machines. On March 1, 2014, Shining Star received $30,000 cash from customers who purchased extended warranty life for their washing machines. Required: a) Prepare a journal entry to record the transaction. Mar 1, 2014 Cash 30,000 Unearned Warranty Revenue 30,000 Received payment for a 3-year warranty option 14

15 Chapter 13 b) Prepare the journal entry required on March 1, Mar 1, 2015 Unearned Warranty Revenue 10,000 Warranty Revenue 10,000 To recognize one year of unearned warranty revenue as earned AP-19 ( 7 ) Buckle Corp. borrowed $75,000 from shareholders, to be paid over a period of 5 years. Required: a) Prepare a journal entry to record the loan. Cash 75,000 Shareholders' Loan 75,000 To record a shareholder's loan b) Buckle Corp. paid back $10,000 of the loan. Prepare a journal entry to record the transaction. Shareholders' Loan 10,000 Cash 10,000 To record the withdrawal from the Shareholders Loan account 15

16 AP-20 ( 9 ) The Balance Sheet of Pinewood Electronics Inc. for 2013 and 2014 is shown below: Current Assets Pinewood Electronics Inc. Balance Sheet As at December 31, Cash $90,000 $63,000 Accounts Receivable 120, ,000 Inventory 212, ,000 Short-term Investments 100,000 15,000 Total Current Assets 522, ,000 Other Assets 210, ,000 Total Assets $732,000 $535,000 90,000 70,000 Long term debt 110,000 40,000 Total Liabilities 200, ,000 Shareholders Equity 532, ,000 Total Liabilities and Equity $732,000 $535,000 Note: Shareholders equity for 2012 is $415,000. Required: a) Calculate the current ratio for both years Current Assets $522,000 $325,000 $90,000 $70,000 = Current Ratio

17 Chapter 13 b) Calculate the quick ratio for both years Cash $90,000 $63,000 + Short term Investments 100,000 15,000 + Net Accounts Receivable 120, ,000 90,000 70,000 = Quick Ratio c) In which year does Pinewood Electronics Inc. have a better performance? The company has a better performance in 2014 because the company s ability to meet it s short-term obligations has increased significantly. AP-21 ( 9 ) EPZA Enterprises had the following account information for the year 2014: Accounts Receivable $200,000 Accounts Payable 80,000 Bonds Payable, due in 10 years 300,000 Cash 100,000 Interest Payable, due in 3 months 10,000 Inventory 400,000 Land 250,000 Notes Payable, due in 6 months 50,000 Prepaid Expenses 40,000 Required: a) Calculate current ratio. Current Ratio = = = 5.29 Current Assets $740,000 $140,000 17

18 b) Calculate quick ratio. Quick Ratio = = (Cash + Short term Investments + Net Accounts Receivable) $300,000 $140,000 = 2.14 AP-22 ( 2, 4, 8 ) GoodJob Ltd. buys and sells home appliances and uses the perpetual inventory system. During the year 2014, the company had the following transactions: Jan 15 Feb 4 Feb 4 Feb 15 May 8 Jul 11 Purchased vacuum cleaners worth $60,000 from V Wholesalers, on account. Sold vacuum cleaners for $45,000 cash, which includes a 3-year warranty. GoodJob bought these vacuum cleaners for $30,000. Recorded $15,000 of estimated warranty liability for the year. Paid the full amount owing to V Wholesalers. Received utilities bill for $3,000, to be paid exactly after 15 days. Received $42,000 cash for the sale of vacuum cleaners which cost the company $30,000. The delivery is to be made on August 31. Required: Prepare journal entries to record the above transactions. Jan 15 Inventory 60,000 Accounts Payable 60,000 To record purchase of vacuum cleaners Feb 4 Cash 45,000 Sales Revenue 45,000 To record cash sales Cost of Goods Sold 30,000 Inventory 30,000 To record costs of goods sold Feb 4 Warranty Expense 15,000 Estimated Warranty Liability 15,000 To record estimated warranty liability 18

19 Chapter 13 Feb 15 Accounts Payable 60,000 Cash 60,000 To record payment to V Wholesalers May 8 Utilities Expense 3,000 Accounts Payable 3,000 To record utilities expense May 23 Accounts Payable 3,000 Cash 3,000 To record payment of accounts payable Jul 11 Cash 42,000 Unearned Revenue 42,000 To record the deposit of vacuum cleaners sale Aug 31 Unearned Revenue 42,000 Sales Revenue 42,000 To record delivery of vacuum cleaners Cost of Goods Sold 30,000 Inventory 30,000 To record costs of goods sold AP-23 ( 2, 4, 5 ) Shawn Clarity owns a consulting firm called Clarity Solutions. The firm had the following transactions during the year 2014: Jan 1 Mar 11 Apr 1 Received $10,000 consulting fees from a client. $5,000 worth of services have been provided, and the rest will be provided on February 16. Purchased office equipment worth $500, on account. Purchased new office furniture for $7,000 from JJ Store by issuing a 6-month note with 4% interest. Interest and principle payment is due at maturity. May 11 Paid $500 cash for the purchase of equipment on Mar 11. Jun 12 Oct 19 Received a $600 invoice for repair services, to be paid after 45 days. Received $2,000 cash from a client for consulting services provided. 19

20 Required: Prepare journal entries to record the above transactions. Jan 1 Cash 10,000 Unearned Revenue 5,000 Service Revenue 5,000 To record the $5,000 cash sales and the deposit for consulting services to be provided later Feb 16 Unearned Revenue 5,000 Service Revenue 5,000 To record the revenue earned Mar 11 Property, Plant and Equipment - Office Equipment 500 Accounts Payable 500 To record the purchase of office equipment Apr 1 Property, Plant and Equipment - Furniture 7,000 Note Payable 7,000 To record a 6-month, 4% note payable May 11 Accounts Payable 500 Cash 500 To record the payment of accounts payable Jun 12 Repair Expense 600 Accounts Payable 600 To record the invoice for Repairs Jul 27 Accounts Payable 600 Cash 600 To record the payment of accounts payable Sep 30 Note Payable 7,000 Interest Expense 140 Cash 7,140 To record the payment of note payable plus interest Oct 19 Cash 2,000 Service Revenue 2,000 To record cash sales 20

21 Chapter 13 AP-24 ( 2, 4, 6 ) During the year 2014, FitnessFirst Ltd. had the following transactions: Feb 1 Borrowed a five-year loan for $150,000 with an interest rate of 5% per annum. Annual principle payment of $30,000 and interest is payable at the end of January. Mar 1 Apr 14 May 25 Jun 14 Sep 1 Sold 100 three-month club membership to customers for a total $6,000 cash. Regardless of the number of times a customer visits the club, the monthly memberships are not refundable. Purchased treadmills worth $20,000 from RunRun Company, on account. Received utilities bill for $1,000, to be paid after 30 days. Paid $10,000 cash to RunRun Company to reduce the balance owing. Received $10,000 cash from customers for the sale of one-month membership. Once the customer has paid the membership fees, it cannot be refunded. Required: Prepare journal entries to record the above transactions. Feb 1 Cash 150,000 Loan Payable 150,000 Borrowed $150,000 loan payable over 5 years Mar 1 Cash 6,000 Unearned Revenue 6,000 Record the deposit of membership fees Mar 31 Unearned Revenue 2,000 Service Revenue 2,000 Record the revenue earned for the month Apr 14 Property, Plant and Equipment - Equipment 20,000 Accounts Payable 20,000 Purchased treadmills on account Apr 30 Unearned Revenue 2,000 Service Revenue 2,000 Record the revenue earned for the month 21

22 May 25 Utilities Expense 1,000 Accounts Payable 1,000 Record utilities expense May 31 Unearned Revenue 2,000 Service Revenue 2,000 Record the revenue earned for the month Jun 14 Accounts Payable 10,000 Cash 10,000 Partial payment of amount owing to RunRun Company Jun 24 Accounts Payable 1,000 Cash 1,000 Payment of utilities expense Sep 1 Cash 10,000 Service Revenue 10,000 Record cash sales AP-25 ( 2, 3 ) Porch Living sells outdoor furniture and accessories. They operate in a province which has a 7% PST and 5% GST. Porch Living charges PST and GST to their customers, but only has to pay GST on the purchase of inventory. The following transactions occurred during May, 2014 May 2 Purchased inventory for $5,000 plus GST on account. May 5 Sold inventory to a customer for $2,000 plus GST and PST on account. The inventory had a cost of $1,200. May 12 Purchased $300 worth of office supplies, plus GST and PST. Paid cash. May 25 Sold inventory to a customer for $6,000 plus GST and PST for cash. The inventory had a cost of $3,200. May 27 Received the total amount owing from the customer from May 5. May 28 Paid the supplier from May 2 the amount owing. May 31 Prepared the PST remittance to the provincial government. May 31 Prepared the GST remittance to the federal government. 22

23 Chapter 13 Required: Record the transactions for May May 2 Inventory 5,000 GST Recoverable 250 Accounts Payable 5,250 Purchased inventory on account May 5 Accounts Receivable 2,240 GST Payable 100 PST Payable 140 Sales Revenue 2,000 Sales on account Cost of Goods Sold 1,200 Inventory 1,200 COGS for the above sale May 12 Office Supplies 321 GST Recoverable 15 Cash 336 Purchased office supplies May 25 Cash 6,720 GST Payable 300 PST Payable 420 Sales Revenue 6,000 Sales for cash Cost of Goods Sold 3,200 Inventory 3,200 COGS for the above sale May 27 Cash 2,240 Accounts Receivable 2,240 Received cash from customer May 28 Accounts Payable 5,250 Cash 5,250 Paid supplier May 31 PST Payable 560 Cash 560 PST remittance May 31 GST Payable 400 GST Recoverable 265 Cash 135 GST remittance 23

24 AP-26 ( 2, 3 ) Signet Sales operates in a province where HST is applied to all sales at 13%. During July, 2014, they had the following sales. Jul 10 Jul 12 Sold inventory to a customer for $1,000 plus HST on account. The inventory had a cost of $700. Sold inventory to a customer for $4,000 plus HST for cash. The inventory had a cost of $2,900. Required: Record the transactions for July Jul 10 Accounts Receivable 1,130 HST Payable 130 Sales Revenue 1,000 Sales on account Cost of Goods Sold 700 Inventory 700 COGS for the above sale Jul 12 Cash 4,520 HST Payable 520 Sales Revenue 4,000 Sales on account Cost of Goods Sold 2,900 Inventory 2,900 COGS for the above sale AP-27 ( 3 ) Tasty Cafe has recorded all their transactions for the month of September As of September 30, the balance of the HST Payable account was $3,500 and the balance of the HST Recoverable account was $3,900. a) Will Tasty Cafe be remitting sales tax to the government, or will they be receiving a refund? Tasty Cafe will be receiving a refund because they spent more HST than they collected. 24

25 Chapter 13 b) Prepare the journal entry that Tasty Cafe will prepare on September 30 Sep 30 HST Receivable 400 HST Payable 3,500 HST Recoverable 3,900 HST refund Note: HST Receivable is debited instead of Cash, since there will likely be a delay of a few days while the government processes the refund to send cash to the business. AP-28 ( 2, 3 ) Toy Retailer operates in a province where HST is applied at 13%. During August, 2014, they had the following transactions. Aug 12 Aug 15 Sold inventory to a customer for $2,000 plus HST for cash. The inventory had a cost of $1,100. Purchased inventory for $5,000 plus HST on account. Required: Record the transactions for July Aug 12 Cash 2,260 HST Payable 260 Sales Revenue 2,000 Sales on account Cost of Goods Sold 1,100 Inventory 1,100 COGS for the above sale Aug 15 Inventory 5,000 HST Recoverable 650 Accounts Payable 5,650 Purchased inventory on account 25

26 Exercise Questions EX-1 ( 6 ) On May 1, 2014, Verico Company borrowed $98,000 from the local branch. The loan is payable in equal installments over 5 years. a) Write the journal entry to record the loan. Date Account Title and Explanation DR CR May 1 Cash 98,000 Loan Payable 98,000 Receive loan from bank b) How much of the loan would be considered long-term? Long-Term Portion $78,400 EX-2 ( 5 ) On August 1, 2014, DEBTS Bank agreed to lend Mirza Enterprises $110,000. To that effect, Mirza signed a $110,000, 10 month, 12% note. Mirza Enterprises has a year end of December 31. Interest is payable at maturity. Required: Prepare the journal entry for Mirza Enterprises: a) On the date the note was signed b) At year end c) On May 31, 2015 when the note is repaid 26

27 Chapter 13 Aug 1 Cash 110,000 Notes Payable 110,000 To record the note payable Dec 31 Interest Expense 5,500 Interest Payable 5,500 To record interest payable from note May 31 Interest Expense 5,500 Interest Payable 5,500 Notes Payable 110,000 Cash 121,000 To record repayment of note and additional interest EX-3 ( 4 ) A local transit company sells transit passes for $150 each. The company sold 1,200 units on February 1, 2014, and each one is valid for 6 months. Required: Write the entry for: a) The sale of the transit passes b) The entry to be recorded on June 30, the company s year end. Feb 1 Cash 180,000 Unearned Revenue 180,000 To record the sale of transit passes Jun 30 Unearned Revenue 150,000 Sales Revenue 150,000 To recognize revenue earned for the month EX-4 ( 5 ) On July 1, 2014, Express Inc. purchased a delivery truck from DW Trucks, costing $85,000. However, due to cash flow problems, Express Inc. is currently unable to make the payment. Therefore, in order to ensure DW Trucks for the payment, Express Inc. signed a one year note with 6% interest per annum, to be payable at maturity. Express Inc. s year end is on December 31. Prepare all the necessary journal entries related to the notes payable from the time it is signed to the maturity date. 27

28 Jul 1 Delivery Truck 85,000 Notes Payable 85,000 To record the purchase of delivery truck Dec 31 Interest Expense 2,550 Interest Payable 2,550 To record interest accrued Jun 30 Interest Expense 2,550 Interest Payable 2,550 Notes Payable 85,000 Cash 90,100 To record the payment of note payable EX-5 ( 5 ) On May 1, 2014, Cool Water Inc. issued a $50,000, 6 month note payable with a 7% interest rate. Cool Water Inc. has a September 30 year end. Prepare the necessary journal entries to record: a) The issuance of the note payable on May 1, b) The required adjusting entry on September 30, c) The payment of interest and repayment of the note on November 1, Date Account Title and Explanation DR CR May 1 Cash 50,000 Notes Payable 50,000 Issued notes payable Sep 30 Interest Expense 1,458 Interest Payable 1,458 Accrued interest on notes payable at year-end Nov 1 Interest Expense 292 Interest Payable 1,458 Notes Payable 50,000 Cash 51,750 Repaid note and interest 28

29 Chapter 13 EX-6 ( 5 ) On November 1, 2014, Compression Inc. issued a $100,000, 8 month note payable with a 5% interest rate. Compression Inc. has a December 31st year end. Prepare the necessary journal entries to record: a) The issuance of the notes payable on November 1, b) The required adjusting entry on December 31, c) The payment of interest and repayment of the note on July 1, Date Account Title and Explanation DR CR Nov 1 Cash 100,000 Notes Payable 100,000 Issued notes payable Dec 31 Interest Expense 833 Interest Payable 833 Accrued interest on notes payable at year-end Jul 1 Interest Expense 2, Interest Payable 833 Notes Payable 100,000 Cash 103,333 Repaid note and interest EX-7 ( 5 ) On April 1, 2014, Sinister Inc. issued a $600,000, 6-month note payable with a 12% interest rate. Sinister Inc. has a June 30th year end. a) Record the issuance of the note payable on April 1, b) Prepare the required adjusting entry on June 30, c) Record the payment of interest and repayment of the note on Oct 1, Date Account Title and Explanation DR CR Apr 1 Cash 600,000 Notes Payable 600,000 Issued notes payable Jun 30 Interest Expense 18,000 Interest Payable 18,000 Accrued interest on notes payable at year-end Oct 1 Interest Expense 18,000 Interest Payable 18,000 Notes Payable 600,000 Cash 636,000 Repaid note and interest 29

30 EX-8 ( 8 ) SASA Inc., a manufacturer of photocopying machines, offers customers a warranty of three years on the purchase of each machine. If a machine breaks down during this warranty period, SASA is required to repair or replace the machine. On the basis of historical experience, SASA determines that an average of $80 of parts per machine will be use for warranty obligations. SASA sold 300 machines during a) Prepare the journal entry to record the estimated warranty liability for b) Prepare the journal entry recorded in 2015 assuming SASA uses $5,000 in parts for warranty claims. Date Account Title and Explanation DR CR a) Warranty Expense 24,000 Estimated Warranty Liability 24,000 To record estimated warranty liability b) Estimated Warranty Liability 5,000 Inventory (parts) 5,000 To record inventory and wages for warranty work c) How would the income statement be impacted if SASA used $5,000 in parts in 2015 for warranty claims? There is no effect on the income statement since the estimated warranty has already been expensed in the year the machine was sold. EX-9 ( 8 ) Solace produces and sells sunglasses and provides customers with a one-year warranty on all products. It is estimated that the company incurs approximately $10 of warranty expense on each pair sold. During 2014, the company sold 400 pairs of sunglasses. a) Prepare a journal entry to record the estimated warranty liability. b) During the year 2014, the company used $200 worth of inventory parts and paid $100 cash for staff salaries towards warranty claims. Prepare a journal entry to record this transaction. Date Account Title and Explanation DR CR a) Warranty Expense 4,000 Estimated Warranty Liability 4,000 To record estimated warranty liability 30 b) Estimated Warranty Liability 300 Inventory (parts) 200 Cash 100 To record inventory and wages for warranty work

31 Chapter 13 EX-10 ( 8 ) Inline Co. sells Spartan laptops for $3,500 each. Each laptop comes with a three-year warranty that requires the corporation to replace defective parts and provide the labor. Assume the warranty is honored equally over the three years. During 2013 the corporation sold 300 laptops. Based on past experience, the estimated average cost for repairs under warranties will be $150 for parts and $200 for labor per laptop sold. During 2014, actual repair costs were $12,000 for parts and $24,000 for labor. a) Prepare a journal entry to record the estimated warranty liability in Date Account Title and Explanation DR CR a) Warranty Expense 105,000 Estimated Warranty Liability 105,000 To record estimated warranty liability b) Explain how the warranty liability and expense will appear on the balance sheet and income statement on December 31, The estimated warranty liability will be split into a current portion of $35,000 ($105,000 3 years) and a long-term portion of $70,000 ($105,000 - $35,000). The warranty expense will appear as an operating expense on the income statement. c) Prepare the journal entry to record the warranty costs for Date Account Title and Explanation DR CR c) Estimated Warranty Liability 36,000 Inventory (parts) 12,000 Cash 24,000 To record inventory and wages for warranty work d) Explain how the warranty liability and expense will appear on the balance sheet and income statement in December 31, The estimated warranty liability will have a balance of $69,000 ($105,000 - $36,000). This will be split into a current portion of $34,500 ($69,000 2 years) and a long-term portion of $34,500 ($69,000 - $34,500). Warranty expense will not appear on the income statement in 2014 (relating to sales made in 2013). 31

32 EX-11 ( 4 ) Spinicker Corporation sells in-home stereo systems. The corporation also sells a 4 year warranty contract as a separate service. Spinicker sold 40,000 warranty contracts at $100 each in Spinicker recognizes warranty revenue evenly over the warranty period. a) Prepare a journal entry to record the sale of the warranty contracts. Date Account Title and Explanation DR CR a) Cash 4,000,000 Unearned Warranty Revenue 4,000,000 Record the sale of the 3-year warranties b) Explain how the unearned warranty revenue will appear on the balance sheet at the end of The unearned warranty revenue account will be split into a current portion of $1,000,000 ($4,000,000 4 years) and a long-term portion of $3,000,000 ($4,000,000 - $1,000,000). c) Prepare the journal entry to record warranty revenue in Date Account Title and Explanation DR CR c) Unearned Warranty Revenue 1,000,000 Warranty Revenue 1,000,000 Recognize one year warranty revenue as earned 32

33 Chapter 13 Case Study CS-1 ( 9 ) Locate the financial statements of a company with total assets greater than $1 billion. State the name of the company Note the date of the financial statements Locate the liabilities section What is the amount of current liabilities? What is the amount of non-current liabilities? What is the amount of current assets? What is the amount of owner s equity? Calculate the ratio of total liabilities to owners equity Does the company have any shareholder loans? Calculate the current ratio Calculate the quick ratio Comment on the current and quick ratios Does the company have any contingencies? Review the notes to the financial statements. Summarize any notes related to liabilities State the name of the company Note the date of the financial statements Locate the Liabilities section Shoppers Drug Mart Dec-07 What is the amount of current liabilities? $2,159,045 What is the amount of non-current liabilities? 2,433,873 What is the amount of current assets? 2,172,199 What is the amount of owner s equity? 1,581,135 Calculate the ratio of total liabilities to owner s equity (2,159, ,433,873) 1,581,135 = 2.9:1 Does the company have any shareholder loans? Calculate the current ratio 2,172,199 2,159,045 = 1:1 Calculate the quick ratio (27, ,306) 2,159,045 = 0.18:1 Comment on the current and quick ratios Does the company have any contingencies? Review the notes to the financial statements. Summarize any notes related to liabilities No Both ratios are unfavorable, and well below acceptable standards. The company may have difficulty paying current liabilities. Yes The company has many liabilities, including commercial paper, and future income taxes among others. 33

34 Critical Thinking CT-1 ( 8 ) Contingent liabilities arise when the payment of a liability depends on uncertain future events, such as the result of a lawsuit. Current accounting practice requires that when a contingent liability is likely, and the amount can be reasonably estimated, the amount must be accrued on the balance sheet. Is this practice reasonable, (in light of the fact that the liability is not definite), and only estimates are used? Does this practice mislead owners regarding the actual state of affairs surrounding liabilities? Discuss. The purpose of financial statements is to provide useful information to those who make important decisions regarding the company. These users can be internal (e.g. management reviewing operations for an accounting period) or external (e.g. potential investors considering whether or not to invest in the company). With that in mind, we must consider whether the recognition of contingent liabilities does or does not provide useful information. Some investors may argue that to properly assess the risks involved with their investment that accruing for contingent liabilities (which are likely and measurable) will help them determine what they are getting into. For example, potential investors would like to know (before investing) whether a company is likely to lose a lawsuit and, thus, pay out a large sum which will affect their profitability. Investors want all the facts before putting their money down. Others, however, may argue that accruing for liabilities that may or may not occur will put the company under an unnecessary negative light. For example, management at a company may be trying to obtain a loan and, so, have to provide GAAP compliant financial statements. Accruing for liabilities will decrease their profitability (recall that accruing for a liability involves debiting an expense) and make it more difficult for them to obtain the loan. Not obtaining the loan will affect their operations and their competitiveness - all for the sake of a liability that may or may not occur. 34

35 Chapter 13 Even though the above examples indicate that external users (e.g. investors) are pro accruing for contingent liabilities while internal users (e.g. management) feel otherwise, that may not always be the case. For example, if a private corporation is experiencing record profits, then they are also paying record taxes. Therefore, management may have a bias to accrue liabilities to lower net income so that they pay less taxes. As you can see, the question over whether or not to accrue for contingent liabilities that are likely and measurable is debatable. For now, however, preparers of the financial statements have to abide by GAAP with the intention of presenting useful information to the users. 35

36 Notes 36