CHAPTER 10

CuRrent Liabilities

Summary of Questions by STUDY Objectives
and Bloom’s Taxonomy

Note: K = Knowledge C = Comprehension AP = Application

SUMMARY OF STUDY OBJECTIVES BY QUESTION TYPE

Note: TF = True-False MC = Multiple Choice Ma = Matching

summary of questions by LEVEL OF DIFFICULTY (LOD)

Note: E = Easy M = Medium H=Hard

CHAPTER STUDY OBJECTIVES

1. Account for determinable or certain current liabilities. Liabilities are present obligations arising from past events, to make future payments of assets or services. Determinable liabilities have certainty about their existence, amount, and timing—in other words, they have a known amount, payee, and due date. Examples of determinable current liabilities include operating lines of credit, notes payable, accounts payable, unearned revenue, current maturities of long-term debt, and accrued liabilities such as interest.

2. Account for estimated liabilities. Estimated liabilities exist, but their amount or timing is uncertain. As long as it is likely the company will have to settle the obligation, and the company can reasonably estimate the amount, the liability is recognized. Product warranties, customer loyalty programs, and gift cards result in liabilities that must be estimated. They are recorded either as an expense (or as a decrease in revenue) or a liability in the period when the sales occur. These liabilities are reduced when repairs under warranty or redemptions occur. Gift cards are a type of unearned revenue as they result in a liability until the gift card is redeemed. As some cards are never redeemed, it is necessary to estimate the liability and make adjustments.

3. Account for contingencies. A contingency is an existing condition or situation that is uncertain, where it cannot be known if a loss (and a related liability) will result until a future event happens, or does not happen. Under ASPE, a liability for a contingent loss is recorded if it is it likely a loss will occur and the amount of the contingency can be reasonably estimated. Under IFRS, the threshold for recording the loss is lower. It is recorded if a loss is probable. Under ASPE, these liabilities are called contingent liabilities, and under IFRS, these liabilities are called provisions. If it is not possible to estimate the amount, these liabilities are only disclosed. They are not disclosed if they are unlikely.

4. Prepare the current liabilities section of the balance sheet. The nature and amount of each current liability and contingency should be reported in the balance sheet or in the notes accompanying the financial statements. Traditionally, current liabilities are reported first and in order of liquidity. International companies sometimes report current liabilities on the lower section of the balance sheet and in reverse order of liquidity.

TRUE-FALSE STATEMENTS

1. A liability is defined as a past obligation, arising from present events to make future payments of assets or services.

2. A future commitment is NOT considered a liability unless a present obligation also exists.

3. Liabilities with a known amount, payee and due date are often referred to as determinable liabilities.

4. An operating line of credit is a credit which is set up by a major supplier to assist the company with their purchases online.

5. Collateral is usually required by a bank as protection in case the company is unable to repay the bank.

6. Money borrowed on a line of credit is normally borrowed on a long-term basis.

7. A bank overdraft is the same as an operating line of credit.

8. Bank overdrafts will require a journal entry at the end of the year to record the amount.

9. Prime rate refers to the rate that banks charge their worst customers.

10. A note payable will result in more security of the debt obligation for the creditor than an account payable.

11. A note payable must be payable within one year.

12. If a note payable is payable in a term longer than one year, it will be classified as a non-current liability.

13. A note payable must always have an interest rate attached to it.

14. A $15,000, 9-month, 8% note payable requires an interest payment of $900 at maturity if no interest was previously paid.

15. At its December 31, 2014 year end, Jamison Company recorded $200 interest payable on a $10,000, 3 month, 5% note payable. The company’s financial statements will present notes payable of $10,200.

16. It is NOT necessary to prepare an adjusting entry to recognize the current maturity of long term debt.

17. Current maturities of long-term debt refer to the amount of interest on a note payable that must be paid in the current year.

18. An estimated liability is a liability that is known to exist but whose amount and timing are uncertain.

19. As long as it is likely the company will have to settle the obligation, and the company can reasonably estimate the amount, the liability is recognized.

20. Warranty liabilities are estimated based on actual warranty costs incurred to date.

21. After the warranty liability has been established, the costs in the future will be recorded with a debit to Warranty Expense.

22. Canadian Tire Money represents a liability to Canadian Tire.

23. With a customer loyalty program, the cost of the program is usually shown as a sales discount and reported as a contra sales account.

24. When a company issues a gift card, the company will record the gift card in revenue in the period in which it is sold.

25. Contingencies are events with certain outcomes.

26. Under IFRS, a provision is a liability of certain timing and amounts.

27. Under ASPE, a contingent liability is defined as a liability that is contingent on the occurrence or non-occurrence of some future event.

28. ASPE considers a liability to be a contingent liability as long as its ultimate existence depends on the outcome of a future event, even if the event is likely to occur.

29. IFRS is generally regarded as having a higher threshold for recognizing liabilities.

30. Under ASPE, current liabilities are the first category reported in the liability section of the Balance Sheet.

31. Current Liabilities are usually listed in order of liquidity.

32. Companies who are reporting under IFRS will have the choice to report current liabilities in a lower section of the Balance Sheet.

ANSWERS TO TRUE-FALSE STATEMENTS

MULTIPLE CHOICE QUESTIONS

52. Most companies pay current liabilities

a. out of current assets.

b. by issuing interest-bearing notes payable.

c. by issuing common shares.

d. by creating non-current liabilities.

53. A determinable liability is one which

a. has uncertainty with the timing of the due date.

b. has uncertainty about the amount which is owed.

c. has a known payee.

d. has an amount which is due within one year.

54. A current liability is a debt that can reasonably be expected to be paid

a. within one year.

b. between 6 months and 18 months.

c. out of currently recognized revenues.

d. out of cash currently on hand.

55. An operating line of credit

a. is a non-current liability.

b. is required by all companies.

c. helps companies manage temporary cash shortages.

d. is usually required by the bank in case a company is unable to repay a loan.

56. All of the following are definitely determinable liabilities EXCEPT

a. current maturities of long-term debt.

b. operating lines of credit.

c. a future commitment to purchase an asset.

d. accounts payable.

57. Determinable liabilities involve no uncertainty about all of the following EXCEPT

a. the existence of the liability.

b. the amount of the liability.

c. the eventual payment of the liability.

d. all of the above involve no uncertainty with respect to the determinable liability.

58. Operating line of credit borrowings usually

a. are credited to a note payable account.

b. are reported as a non-current liability.

c. are debited to the cash account and result in a current liability.

d. are required by all companies.

59. With an interest-bearing note, the amount of assets received upon issue of the note is generally

a. equal to the note's face value.

b. greater than the note's face value.

c. less than the note's face value.

d. equal to the note's maturity value.

60. A note payable is in the form of

a. a contingency that is reasonably likely to occur.

b. a written promissory note.

c. an oral agreement.

d. a standing agreement.

61. The entry to record the proceeds upon issuing an interest-bearing note is:

a. Interest Expense

Cash

Notes Payable

b. Cash

Notes Payable

c. Notes Payable

Cash

d. Cash

Notes Payable

Interest Payable

Use the following information for questions 62–64.

Algonquin Provincial Bank agrees to lend Grimwood Brick Company $80,000 on January 1. Grimwood Brick Company signs an $80,000, 9-month, 5% note.

62. The entry made by Grimwood Brick Company on January 1 to record the proceeds and issue of the note is:

a. Interest Expense 3,000

Cash 77,000

Notes Payable 80,000

b. Cash 80,000

Notes Payable 80,000

c. Cash 80,000

Interest Expense 3,000

Notes Payable 83,000

d. Cash 80,000

Interest Expense 3,000

Notes Payable 80,000

Interest Payable 3,000

63. What is the adjusting entry required if Grimwood Brick Company prepares financial statements on June 30?

a. Interest Expense 2,000

Interest Payable 2,000

b. Interest Expense 2,000

Cash 2,000

c. Interest Payable 2,000

Cash 2,000

d. Interest Payable 2,000

Interest Expense 2,000

64. What entry will Grimwood Brick Company make to pay off the note and interest at maturity assuming that interest has been accrued to September 30?

a. Notes Payable 83,000

Cash 83,000

b. Notes Payable 80,000

Interest Payable 3,000

Cash 83,000

c. Interest Expense 3,000

Notes Payable 80,000

Cash 83,000

d. Interest Payable 2,000

Notes Payable 80,000

Interest Expense 1,000

Cash 83,000

65. As interest is recorded on an interest-bearing note, the Interest Expense account is

a. increased; the Notes Payable account is increased.

b. increased; the Notes Payable account is decreased.

c. increased; the Interest Payable account is increased.

d. decreased; the Interest Payable account is increased.

66. When an interest-bearing note matures, the balance in the Notes Payable account is

a. less than the total amount repaid by the borrower.

b. the difference between the maturity value of the note and the face value of the note.

c. equal to the total amount repaid by the borrower.

d. greater than the total amount repaid by the borrower.

Use the following information for questions 67–68.

On October 1, Jacob's Auto Service borrows $75,000 from Provincial Bank on a $75,000, 3-month, 6% note.

67. What entry must Jacob's Auto Service make on December 31 before financial statements are prepared?

a. Interest Payable 1,125

Interest Expense 1,125

b. Interest Expense 4,500

Interest Payable 4,500

c. Interest Expense 1,125

Interest Payable 1,125

d. Interest Expense 1,125

Notes Payable 1,125

68. The entry by Jacob's Auto Service to record payment of the note and accrued interest on January 1 is:

a. Notes Payable 76,125

Cash 76,125

b. Notes Payable 75,000

Interest Payable 1,125

Cash 76,125

c. Notes Payable 75,000

Interest Payable 4,500

Cash 79,500

d. Notes Payable 75,000

Interest Expense 1,125

Cash 76,125

69. Interest expense on an interest-bearing note is

a. always equal to zero.

b. accrued over the life of the note.

c. only recorded at the time the note is issued.

d. only recorded at maturity when the note is paid.

70. The entry to record the payment of an interest-bearing note at maturity after all interest expense has been recognized is:

a. Notes Payable

Interest Payable

Cash

b. Notes Payable

Interest Expense

Cash

c. Notes Payable

Cash

d. Notes Payable

Cash

Interest Payable

71. The current portion of long-term debt should

a. be paid immediately.

b. be reclassified as a current liability.

c. be classified as a non-current liability.

d. not be separated from the non-current portion of debt.

72. Examples of determinable current liabilities include all of the following EXCEPT

a. current maturities of long-term debt.

b. bank indebtedness from operating lines of credit.

c. unearned revenues.

d. contingencies.

73. A company has a negative (credit) balance in the Cash account at the end of the year. This amount can be called all of the following EXCEPT

a. bank indebtedness.

b. operating line of credit.

c. bank overdraft.

d. bank advances.

74. Which of the following is NOT considered an estimated liability?

a. accrued wages

b. gift card promotions

c. warranties

d. customer loyalty programs

Use the following information for questions 75–76.

Shediac Bay Marina had a customer loyalty program at its gas dock. For every litre of gasoline purchased, the customer would get a redemption award of $.015 which can be used to purchase products in the company’s retail marine store. In July, the company sold 100,500 litres of gasoline.

75. The entry to record the liability for the July sales would a $______ credit to ________.

a. $1,507.50; Redemption Reward Liability

b. $1,507.50; Sales Discounts

c. $1507.50; Cash

d. $3,015; Cash

76. By the end of the August, customers redeemed 25,000 of the rewards. Shediac should make which of the following entries to record the redemption?

a. Cash 375

Redemption Reward Liability 375

b. Redemption Reward Liability 375

Cash 375

c. Cash 375

Redemption Reward Liability 375

d. Redemption Expense 375

Cash 375

77. The sales discount for redemptions rewards is recorded as a(n)

a. current asset.

b. current liability.

c. expense account.

d. contra sales account.

78. The accounting for warranty costs is based on the concept of matching expenses with revenues, which requires that the estimated cost of honouring warranty contracts should be recognized as an expense

a. when the product is brought in for repairs.

b. in the period in which the product was sold.

c. at the end of the warranty period.

d. only if the repairs are expected to be made within one year.

Use the following information for questions 79–80.

Kim Company sells 2,000 units of its product for $500 each in 2014. The selling price includes a one-year warranty on parts. It is expected that 3% of the units will be defective and that repair costs will average $100 per unit. In 2014, warranty contracts are honoured on 40 units for a total cost of $4,000.

79. What amount should Kim Company accrue on December 31, 2014 for estimated warranty expense?

a. $6,000

b. $4,000

c. $2,000

d. $30,000

80. What amount will be reported on Kim Company's balance sheet as Estimated Warranty Liability on December 31, 2014?

a. $4,000

b. $6,000

c. $2,000

d. cannot be determined

81. Product warranties are promises made by the ________ to repair or replace the product if it is defective or does not perform as intended.

a. buyer

b. employees

c. manufacturer

d. government

82. Warranties are also known as

a. determinable liabilities.

b. customer loyalty programs.

c. contingencies.

d. guarantees.

83. Under the expense approach, the warranty liability is measured using

a. the estimated future cost of servicing the product warranty.

b. actual costs of past years repairs.

c. the estimated sales of past years.

d. the estimated future returns of products.

84. The warranty liability account will be carried from year to year and will be increased by

a. current years repairs to non-warranty products.

b. current years estimated warranty expense.

c. prior years estimated warranty expense.

d. current years actual warrant expense.

85. Loyalty programs are designed to

a. decrease sales.

b. increase inventory levels.

c. increase sales.

d. decrease cost of goods sold.

86. Accountants have decided that when a loyalty program results in a reduced future selling price, it should be accounted for as a decrease in

a. revenue.

b. expenses.

c. assets.

d. liabilities.

87. The Redemption Reward Liability account is reported as a

a. current asset.

b. contra sales account.

c. current liability.

d. non-current liability.

88. Under ASPE, a contingent liability must be accrued in the financial statements if

a. it can be reasonably estimated and unlikely to occur.

b. it can be reasonably estimated and likely to occur.

c. it is likely to occur but cannot be reasonably estimated.

d. the amount of the potential loss is greater than the balance in the cash account.

89. Under ASPE, the following should NOT be disclosed in notes to the financial statements.

a. If the contingency is unlikely and the chance of occurrence is small.

b. If the contingency is likely but the amount of the loss cannot be reasonably estimated.

c. If the existence of the contingent liability is not determinable.

d. If the contingency is unlikely but it could have a substantial negative effect on the company’s financial position.

90. If a liability is dependent on a future event, it is called a

a. potential loss.

b. hypothetical loss.

c. probabilistic loss.

d. contingent loss.

91. Under ASPE, a contingency that is NOT likely to occur

a. should be disclosed in the financial statements.

b. must be accrued as a loss.

c. does not need to be disclosed unless the loss would result in a substantial negative effect on the company's financial position.

d. is recorded as a contingent loss.

92. Disclosure of a contingent loss is usually made

a. parenthetically, in the body of the balance sheet.

b. parenthetically, in the body of the income statement.

c. in a note to the financial statements.

d. in the management discussion section of the financial statement.

93. If it is likely that a company will lose a lawsuit and the amount can be reliably estimated then the company must

a. record the asset.

b. disclose only in the notes to the financial statements.

c. not record or disclose any information.

d. record the loss and the liability.

94. Under ASPE, a liability for a contingent loss is recorded if both of the following conditions are met:

a. occurrence is high and amount cannot be estimated.

b. amount is reasonably estimated and occurrence is low.

c. occurrence is low and amount is determinable.

d. occurrence is high and amount can be reasonable estimated.

95. Under IFRS, a liability is recorded if the chance of occurrence is

a. likely.

b. probable.

c. unlikely.

d. undeterminable.

96. Under ASPE, only ________________contingent losses are recognized.

a. highly likely

b. probable

c. more likely than not

d. unlikely

97. Under IFRS, the term used for an uncertain liability is

a. contingent liability.

b. undeterminable liability.

c. provision.

d. estimated liability.

98. The following are general risk contingencies that can affect anyone who is operating a business and are not reported in the notes to the financial statements, EXCEPT

a. war.

b. strike.

c. lawsuit.

d. recession.

99. The relationship between current liabilities and current assets is

a. useful in determining income.

b. useful in evaluating a company's short-term debt paying ability.

c. called the matching principle.

d. useful in determining the amount of a company's long-term debt.

100. The relationship of current assets to current liabilities is used in evaluating a company's

a. profitability.

b. revenue-producing ability.

c. short-term debt paying ability.

d. long-range solvency.

101. Muffin Company issued a five-year, interest-bearing note payable for $50,000 on January 1, 2014. Each January the company is required to pay $10,000 on the note. How will this note be reported on the December 31, 2015 balance sheet?

a. Long-term debt, $50,000

b. Long-term debt, $40,000

c. Long-term debt, $30,000; Long-term debt due within one year, $10,000

d. Long-term debt of $40,000; Long-term debt due within one year, $10,000

102. Under ASPE, Current Liabilities are usually listed

a. after long-term debt on the balance sheet.

b. in order of liquidity on the balance sheet.

c. in order of maturity on the balance sheet.

d. in increasing order of magnitude on the balance sheet.

103. Current maturities of long-term debt

a. require an adjusting entry.

b. are optionally reported on the balance sheet.

c. can be properly classified during balance sheet preparation, with no adjusting entry required.

d. are not considered to be current liabilities.

ANSWERS TO MULTIPLE CHOICE QUESTIONS

MATCHING QUESTION

104. Match the items below by entering the appropriate code letter in the space provided.

A. Current liability

B. Notes Payable

C. Contingent liability

1. An obligation in the form of a written promissory note

2. A potential liability that may become an actual liability in the future

3. A debt than can reasonably be expected to be paid from current assets

ANSWERS TO MATCHING QUESTION

1. B

2. C

3. A

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