Dr. M. D. Chase
Intermediate Accounting-32C
Current Liabilities and Contingencies
Long Beach State University
Page 1
Current Liabilities and Contingencies
I. Liabilities: Liabilities are:
• Present obligations resulting from past transactions that will require a company to provide goods, pay
assets, or performance services in the current or future time period. The FASB in Statement of Financial
Accounting Concepts No. 3 states that obligations are recognized (i.e. recorded in the financial statements)
if they possess the following characteristics:
1. The obligation involves a probable future sacrifice of resources--a future transfer of cash, goods
or services or the forgoing of a future cash receipt--at a specified or determinable date.
2. The cash equivalent value of resources to be sacrificed must be measurable with reasonable
precision
3. The entity has little or no discretion to avoid the transfer and
4. The transaction or event giving rise to the entity's obligation has already occurred
A. Current Liabilities: Obligations that will require within the current year or operating cycle (whichever is
longer)
1. the use of current assets or
2. the creation of other current liabilities
B. Estimated Liabilities: Liabilities that are known to exist but whose amount cannot be precisely determined
until a future date are known as estimated liabilities. Examples would include warranty costs, tax liabilities,
health care costs, vacation pay and other fringe benefits and pension costs.
1, Estimated liabilities are recorded on the books at the most reasonable estimate of the amount known.
2. Estimated liabilities must be updated constantly and accrued for financial statement presentation to
insure proper matching of revenues and expenses
C. Contingent Liabilities (loss contingencies) : Liabilities that may come into existence depending upon the
outcome of some other event (contingent upon some other event) are known as contingent liabilities.
Examples of contingent liabilities include notes receivable discounted and possible losses as a result of a
lawsuit.
1. SFAS 5 states that contingent liabilities are recognized in the financial statements only if both of the
following criteria are met:
a. Information available prior to the issuance of the financial statements indicates that it is probable
that an asset had been impaired or that a liability had been incurred;
b. the amount of the loss can be reasonably estimated. If the estimate of loss falls within a range,
the lower end of the range is used to reflect the contingency on the financial statements.
2. Contingent liabilities that are not recorded in the financial statements are recognized by footnotes to
the financial statements (in the interest of conservatism) if there is a reasonable probability that a
loss or liability will result. For example, the existence of a lawsuit is typically disclosed but the dollar
amount of losses or liability that may result is not recorded in the financial statements. .
D. Accounting Issues in Accounting for Liabilities:
1. Recognize all liabilities in the period it comes into existence in order to match expenses with revenues
E. Valuation of Liabilities: In historical cost accounting, liabilities appear in the financial statements at the
present value of payments to be made in the future. The interest rate used to discount the liability is the
borrowing rate applicable to the specific firm.
1. Current liabilities are valued at the amount owed without discounting the amount
F. Classification of Current Liabilities: Current liabilities fall into the following classifications:
Dr. M. D. Chase
Intermediate Accounting-32C
1.
Current Liabilities and Contingencies
Long Beach State University
Page 2
Accounts Payable: Accounts payable are obligations that arise in the normal course of business.
a. Trade account payable: are short-term obligations to suppliers for purchases of inventory
b. Other accounts payable: liabilities incurred in the normal course of business for items other than
inventory (examples include purchases of office supplies and equipment).
c. Recording accounts payable:
1. Recall from your discussion of inventories that the theoretically correct cost of inventory (and
accounts payable) is its net cost (net of all cash discounts available). Measuring inventory cost
net of cash discounts is known as the net method. The net cost represents the cash equivalent
price of inventory and the amount of the discount lost represents a financing cost imposed for
failure to pay within the discount period.
2. In practice, many companies record inventories at gross amounts. Measuring inventories at the
gross amount is known as the gross method. If the gross method is used the balance in
purchase discounts account must be deducted from the purchases account to correctly measure
the cost of goods sold. The gross method is considered theoretically unsound for three
reasons:
a. it violates the matching principle by recording discounts when the payment is received
rather than when the sale was made;
b. it fails to differentiate discounts taken between goods on hand and goods sold which results
in an understatement of cost of goods sold and an overstatement of net income and ending
inventory;
c.
it identifies companies taking the discount as opposed to those not taking it. As pointed out
above, it is very expensive (36% per annum on a 2/10,n/30 discount scheme) not to take
advantage of cash discounts. Firms failing to take these discounts are either poorly
managed or experiencing cash flow or credit problems. Such firms should be identified.
Using the net method solves this problem by identifying those firms
3. Net and gross methods illustrated: Assume Dallas Inc. purchases $1,000 merchandise form
LYC Inc on 9/1/x1 terms 2/10,n/30. Dallas uses a periodic inventory system.
Books of Dallas Inc.
Transaction
Gross Method
Net Method
9/1/x1 Purchase $1,000 Inventory
on account, terms 2/10,n/30
Purchases......................1,000
Accounts Payable.......
1,000
Purchases................... ……980
Accounts Payable..........
980
Dallas pays within the discount
period
(pays on or before 9/11/x1)
Accounts Payable...........1,000
Purchase Discounts....
20
Cash...............................
980
Accounts Payable............ 980
Cash................................
980
Dallas pays after the discount
period
(pays after 9/11/x1)
Accounts payable.........1,000
Cash..............................
1,000
Accounts payable.................. 980
Purchase discounts lost*..... 20
cash..................... ………………. 1,000
*
could also be called interest
expense
2. Notes Payable: A note is an unconditional written promise by the maker (borrower) to pay a specified
Dr. M. D. Chase
Intermediate Accounting-32C
Current Liabilities and Contingencies
Long Beach State University
Page 3
amount on demand or at a certain future date. Companies borrow (and make notes) because they can
earn a greater return on their cash by investing it in the business than the bank charges to lend. For
example if a firm can earn a 20% return on cash invested in the company and borrow at 10%, it pays to
borrow rather than use the firms own money. Another reason for borrowing is if the firm has
insufficient excess cash to purchase the item outright.
a. Sources of notes payable: Notes usually result in the normal course of business from three types
of transactions:
1. Trade notes payable: result from the acquisition of "big ticket items" such as equipment or land;
trade notes payable are between the maker and the vendor.
2. Loan notes payable: result from cash borrowing activities; loan notes payable are between the
maker and the bank (lender);
3. Current maturities of long-term debt: represent the current portion of long-term debt i.e. that
portion of long-term indebtedness that will require the use of current assets or the creation of
a current liability
a. Excludable current maturities:
1. Short-term obligations expected to be refinanced: Current accounting practice is to
exclude short-term obligations from current liabilities if management has both:
a. the intend to refinance and
b. the ability to refinance as demonstrated by
1. Actual refinancing prior to BS date or
2. Entering into a financing agreement under terms that are readily determinable
2. Other excludable maturities: Companies often exclude current maturities if they meet
the following criteria:
a. maturities retired by assets accumulated for this purpose that have not been
previously reported as assets
b. are refinanced by proceeds from a new debt issue
c. converted into capital stock
b. Interest and noninterest bearing notes payable
1. Interest bearing notes require that interest be paid at a stated rate that is contained in the
note itself
2. Noninterest bearing notes (discounted notes): Notes that contain no stated interest rate on the
face of the note are called discounted or noninterest bearing notes. Such notes typically
include the interest in the payment. For example if you borrow $1,000 and sign a noninterest
bearing note promising to repay $1,090 in one year, you have signed a noninterest bearing
(discounted note. Although there is no stated interest rate on the note, you are paying 9%
interest over the one year term of the note
APB-21 requires that interest be recorded on receivables and payables unless:
1. the arise in the ordinary course of business and are due in one year or less
2. payment is to be made in property or service and not in cash
3. the receivable or payable represents security deposit (or other type of refundable deposit)
4. arise in the ordinary course of business of a bank or other lending institution
5. arise between members of a consolidated group (i.e. between subsidiaries of a common parent or between
parent and subsidiary)
6. payables or receivables whose interest rate is determined by a governmental agency
Note: This means that noninterest bearing notes must be due within one year or the operating cycle, whichever
is longer.
Dr. M. D. Chase
Intermediate Accounting-32C
Current Liabilities and Contingencies
Long Beach State University
Page 4
3. Accounting for notes payable: to illustrate the accounting for notes payable, consider the following
facts:
DMC, Inc. borrows $10,000 from the bank on October 1, 20x1. The loan is due on April 1, 20x2. DMC, Inc must
pay interest at 12% or be charged $600 ($10,000 x .12 x 6/12) if the note is discounted. The following table
reflects the accounting presentation and journal entries if the note is treated as interest bearing or if the note is
discounted:
Accounting for Interest Bearing and Noninterest Bearing (Discounted) Notes Payable
Note bears interest at 12%
Note bears no stated interest
(Note is discounted)
Record Making of Note:
October 1, 20x1
Cash................................10,000
Notes Payable.........
10,000
Cash...................................10,000
Disc. on Notes Payable.. 600
Notes Payable.................
10,600
Balance Sheet Disclosure at
end of October (10/31/20x1)
Current Liabilities:
Notes Payable..............$ 10,000
Current Liabilities:
Notes Payable.........................$10,600
Less: Disc on Notes Payable.. 600
$10,000
Adjusting Entry: 12/31/20x1
Interest Expense ............ 300*
Interest Payable......
300
*
($10,000 x .12 x 3/12) = $300
Interest Expense............ 300
Discount on Notes Payable
Balance Sheet Disclosure at
end of December (12/31/20x1)
Current Liabilities:
Notes Payable.................$10,000
Interest Payable............
300
10,300
Current Liabilities:
Notes Payable.........................$10,600
Less: Disc Notes Payable......
300
$10,300
Record Payment of the note:
April 1, 20x2
Note Payable............ 10,000
Interest Payable.....
300
Interest Expense....
300
Cash............... …….
10,600
Notes Payable.....................10,600
Interest Expense................ 300
Disc. on Notes Payable..
300
Cash................... ……………..
10,300
300
Note: 1. The balance sheet presentations are different but each method recognizes the same amount of
liability and interest expense.
c.
Dividends: Dividends are a distribution of capital to the stockholders (owners) of the corporation.
Dividends become liabilities only when they are declared by the board of directors. When declared,
the journal entry is to dr. dividends and cr. Dividends payable (which is a liability account)
Dividend declared:
Dividends………………………………10,000
Dividends Payable………..
10,000
note:
--the liability is created upon declaration
--stock dividends are not liabilities
--dividends in arrears are not liabilities
Dr. M. D. Chase
Intermediate Accounting-32C
Current Liabilities and Contingencies
Long Beach State University
Page 5
d. Short-term prepayments, agency revenue and unearned revenues: Short-term prepayments
(including unearned revenues) are liabilities. Examples include but are not limited to the following:
1. prepaid rent
2. returnable cash deposits
3. retainer fees
4. prepaid magazine subscriptions
5. Sales tax (this is an agency fee collected for the state and paid quarterly)
e.
Compensated Absences (vacation, sick leave, holidays etc)
1. Companies normally accrue liabilities (depending upon their labor contract) for compensated
absences if the following conditions are met:
a. services have been rendered
b. the obligation is part of an agreement that vests or accumulates
1. Vested rights are rights the employee is entitled to even if terminated
2. Accumulated rights are rights that are carried forward to future periods
c. it is probable that payment for the obligation will be required
d. the amount can be reasonably estimated
II. Accounting for Payrolls: Payroll refers to the total amount paid to employees in a given period. Payroll is
typically the largest current liability and accounting issues are complicated by state and federal laws
associated with the payroll liability that must be recorded by the employer.
A. Payroll Cycle: Special Issues: Accounting for the payroll cycle is more complex than either the
Sales/Collection or Purchases/Payment Cycles. This is due to the fact that federal and state laws mandate
that employers withhold and provide accounting records for certain taxes for both the firm (the
accounting entity) and for employees of the firm. This means that, for the payroll cycle, the accounting
system of the firm must maintain specific tax records for both the firm itself and the employees.
Note that in other cases, the accounting system is only required to maintain records for the firm itself
(the accounting entity).
1.
Accounting for the Payroll Cycle: Because the payroll cycle requires the accounting system to provide
records for both the firm (employer) and the employees, payroll can be divided into two categories:
a. Employer entry: This entry reflects amounts that are the responsibility of the employer only.
These items include:
-- Salaries Expense
-- Wages Expense
-- Federal Unemployment Tax (FUTA) ( .8% of the firs $50,000 charged to employer only; Note:
the actual charge is .6.2% reduced by the amount charged by SUTA (up to a deduction of 5.4%;
this results in the amount charged being .8% (6.2% - 5.4%))
-- State Unemployment Tax (SUTA)
-- Workers Compensation Insurance
-- Employers share of FICA
(5.4% charged to employer only)
(7.5% for employee and 7.5% for employer of the first
$50,000 of earnings i.e. $3,750 for both employee and
employer for a total of $7,500)
-- Employers share of pension contribution
-- Employers share of health insurance
A typical payroll entry covering employer costs might look like:
Payroll expense (by type i.e. Sales/Office etc.)........xxxx
FUTA payable............................................................
xxxx
SUTA payable............................................................
xxxx
This is the “Employer Entry”;
the entry made to record the
Dr. M. D. Chase
Intermediate Accounting-32C
Current Liabilities and Contingencies
Workers Compensation Insurance payable.........
Fica Payable (employer share)..............................
Health Insurance (employer share)......................
Pension payable (employer share)..........................
Long Beach State University
Page 6
xxxx
xxxx
xxxx
xxxx
NOTE: This "Employer" entry covers the employer taxes and other "employer" expenses that are the responsibility
of the employer only, and no portion of salaries or wages payable. This entry does not affect salaries or wages
payable in any way.
b. Employee entry: This entry reflects the amounts that must by deducted from salaries and wages
earned by employees to arrive at salaries and wages payable. This entry reflects only the amounts
withheld from employee wages and salaries. Some of these withholdings are required by law and
some are optional at the written request of employees. The employee entry reflects the following
items:
-- Federal withholding tax payable
-- State withholding tax payable
-- FICA (employee share) payable
-- Health insurance (employee share) payable
-- Union Dues payable
-- Other (charitable contributions etc)
A typical payroll entry reflecting employee costs might look like:
Salaries expense................................................xxxx
Wages expense...................................................xxxx
Federal withholding payable.....................
State withholding payable........................
FICA (employee share) payable..............
Pension payable (employee share)..........
Health insurance payable.........................
Salaries payable.........................................
Wages payable...........................................
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
This is the Employee Entry!
NOTE: The "employee" entry only reflects those amounts that are the responsibility of the employee only and are
deducted from the salaries and wages expense to arrive at the amount due to (payable to) employees.
B. Payroll Accounting Illustrated
1. Assume that employees earn $100,000, that the employees' withholding rates for federal income taxes
average 20 percent, that the employees' withholding rates for state income taxes average 4 percent,
and that employees owe 7.5 percent of their wages for Social Security taxes. In addition, employees, in
aggregate, owe $500 for union dues to be withheld by the employer and $3,000 for health insurance
plans . The employer must pay FICA taxes of 8 percent of gross wages and FUTA taxes of 6.2 percent
on the first $50,000 of gross wages. Part (5.4 percent) of the FUTA tax is payable to the state
government and part (0.8 percent) is payable to the federal government. The employer owes $4,500 for
payments to provide life and health insurance coverage. Employees have earned vacation pay estimated
Dr. M. D. Chase
Intermediate Accounting-32C
Current Liabilities and Contingencies
Long Beach State University
Page 7
to be $4,000; estimated employer payroll taxes and fringe benefits are 18 percent of the gross
amount.
Required: Present the necessary journal entries to record this payroll expense
Employee Entry:
Wages and Salaries Expense ...................... ………………… 100,000
U.S. Withholding Taxes Payable (100,000 x .2)…..
20,000
State Withholding Taxes Payable (100,000 x .04)
4,000
FICA Taxes Payable (100,000 x .075)......................
7,500
Withheld Dues Payable to Union ...............................
500
Insurance Premiums Payable ......................................
3,000
Wages and Salaries Payable .......................................
65,000
To record wage expense; plug for $64,500 actually payable to employees.
Employer Entry:
Wages and Salaries Expense ......................................................... 22,920
FICA Taxes Payable (100,000 x .075).....................................
7,500
FUTA Taxes Payable to U.S. Government (100k x .08) …….
800
FUTA Taxes Payable to State Government (100k x .054)..
5,400
Insurance Premiums Payable......................................................
4,500
Estimated Vacation Wages and Fringes Payable ..
4,720*
Employer's expense for amounts not payable directly to employees. Estimate of vacation pay and fringes thereon
earned during the current period; .18 x $4,000 = $720 + 4,000 = $4,720
C. Internal Control and Payroll Accounting
1. Importance of internal control: the relative size of payroll in proportion to other liabilities, the liquidity
of payroll and the fiduciary responsibility employers have to governmental agencies in the collection of
taxes make the internal control procedures relative to payroll accounting especially important
2. Payroll internal control procedures: Adequate internal control features for payroll include the following:
a. Separate personnel department: The process of hiring personnel should be separate and distinct
from other aspects of the business to help safeguard against placing bogus employees on the payroll
and insuring the correct salary is paid to employees. The personnel department should, at a
minimum provide the following services:
1. independently prepare employment records showing date of employment, salary, deductions and
personal data.
2. personnel department alone can authorize the payroll department to place new personnel on the
payroll.
3. changes in salary, and employee history are maintained by personnel department
4. personnel department conducts exit interviews on retirement or termination of employees and
notifies payroll department to commence retirement benefits or terminate salary.
b. Independent monitoring of employee work hours: timekeeping procedures for hourly employees
must be strictly controlled by time clock and verification procedures to insure that each employee
punches only his/her own timecard. Ideally, the timekeeping duties are lodged in a separate
department.
c.
Separate Payroll Department: The payroll department takes input from the personnel and
timekeeping departments to prepare he payroll. Payroll departments are responsible for
1. preparation of pay checks
Dr. M. D. Chase
Intermediate Accounting-32C
Current Liabilities and Contingencies
Long Beach State University
Page 8
2. computation of and maintenance of payroll deduction records
3. preparation of required governmental reports
d. Paymaster Function: the paymaster is responsible for the distribution of paychecks to the individual
employees. The paymaster function helps protect against the existence of fictitious employees and
the unauthorized distribution of checks to terminated employees.
III.
Contingencies: “…an existing condition, situation, or set of circumstances nvolving uncertainty as to possible
gain (a “gain contingency”) or loss (a loss contingency) that will be resolved when one or more future events
occur or fail to occur” SFAS 5
A. Contingency terminology:
1. Probable: The future event is likely to occur
2. Reasonably Possible: The chance of the future even occurring is more than remote but less than likely
3. Remote:
The chance of the future event is slight
B. Loss Contingencies:
1. Recognized in the financial statements if the future event is both probable and the amount can be
reasonably determined.
2. Certain loss contingencies (such as allowance for bad debts warranty claims etc), are normally accrued.
a. Companies that do not accrue loss contingencies must disclose the contingency in the notes to the
financial statements if that loss is reasonably possible.
3. Lawsuits present a dilemma and accounting is often dependent upon legal advise. The probable and
reasonably determinable criteria apply to lawsuits.
C. Gain Contingencies:
1. Represent a potential increase in assets or decrease in liabilities based on some future event that
may/may not occur.
a. Conservatism dictates that gain contingencies not be recognized in the accounts of the financial
statements but
b. Full disclosure dictates that they be disclosed in the notes to the financial statements “Adequate
disclosure shall be made of contingencies that might result in gains, but care shall be exercised to
avoid misleading implications as to the likelihood of realization.” SFAS 5
Dr. M. D. Chase
Intermediate Accounting-32C
Current Liabilities and Contingencies
Long Beach State University
Page 9
Problem 1 (Estimated Liabilities: Product Warranty Liability)
MannKine manufactures a new type of Kevlar surfboard and has become the largest surfboard manufacturer in the
world. Each board has a twenty-four-month warranty on the Kevlar skin and other components of the board. If a
repair under warranty is required, a charge for the labor is made. Management has found that 25 percent of the
boards sold require some warranty work before the twenty-four months pass. Furthermore, the average cost of
replacement materials has been $90 per repair. At the beginning of February, the account for the estimated
liability for product warranties had a credit balance of $12,400. During September, 105 boards were returned
under the warranty. The cost of the materials used in repairing the machines was $8,695, and $8,742 was
collected as service revenue for the labor involved. Also, during the month, 430 new boards were sold.
Required
1. Prepare general journal entries to record each of the following:
(a) the warranty work completed during the month, including related revenue; (b) the estimated liability for
product warranties for machines sold during the month.
2. Computed the balance of the estimated product warranty liabilities at the end of the month
Problem 2.
(Notes Payable)
Sailing Suppliers, Inc., whose fiscal year ends June 30, completed the following transactions:
May
11
21
June
July
Aug.
30
30
1
20
9
Signed a 90-day, 12 percent, $120,000 note payable to Wells Fargo Bank for a working capital loan
(The face value included interest)
Obtained a 60-day extension on a $24,000 trade account payable owed to a supplier by signing a
60-day, $24,000 interest bearing note. Interest is at the rate of 14 percent.
Made end-of-year adjusting entry to accrue interest expense.
Made end-of-year closing entry pertaining to interest expense.
Made appropriate reversing entry.
Paid off the note plus interest due the supplier.
Paid amount due bank on 90-day note.
Required:
1. Prepare general journal entries for the above transactions
2. Open general ledger accounts for Notes Payable, Discount, on Notes Payable , Interest Payable, and Interest
Expense. Post the relevant portions of the entries to these general ledger accounts.
Problem 3. (Estimated Liabilities: Taxes/Vacation Pay)
DMC Corporation prepares monthly financial statements and ends its fiscal year on June 30. In July, your first
month as accountant for the company, you find that the company has not previously accrued estimated liabilities.
In the past, the company, which has a large property tax bill, has charged property taxes to the month in which the
bill is paid.
--The tax bill for last year was $48,000, and it is estimated that the tax will increase by 10 percent in the coming
year. The tax bill is usually received on September 1, to be paid November 1.
--You also discover that the company allows employees who have worked for the company for one year to take two
weeks' paid vacation each year. The cost of these vacations had been charged to expense in the month of payment.
Approximately 85 percent of the employees qualify for this benefit.
You suggest to management that proper accounting treatment for these expenses is to spread their cost over the
entire year. Management agrees and asks you to make the proper adjustments.
Dr. M. D. Chase
Intermediate Accounting-32C
Current Liabilities and Contingencies
Long Beach State University
Page 10
Required
1.
Figure the proper monthly charge to property taxes expense, and prepare general journal entries for the
following:
July 31
Aug. 31
Sept.30
Oct. 31
Nov. 1
Nov. 30
Accrual of property tax expense
Accrual of property tax expense
Accrual of property tax expense (assume actual bill is $52,860)
Accrual of property tax expense
Payment of property tax
Accrual of property tax expense
2. Assume that for July the total payroll is $424,000, which includes $14,800 paid to employees who were on
vacation.
(a) Compute the vacation pay expense for July.
(b) Prepare a general journal entry to record the accrual of vacation pay expense for July.
(c) Prepare a general journal entry to record the wages of employees on vacation during the month of July
(ignore payroll deductions and taxes).
Problem 4. (Estimated Liabilities: Product Warranty)
Moose Tire Co. sells tires and guarantees them as long as the customer owns them. If a tire fails, the customer is
charged a percentage of the retail price based on the percentage of the tire that is worn, plus a service charge for
putting the tire on the ear. In the past, management found that only 2 percent of the tires sold required
replacement under warranty, and of those replaced an average 20 percent of the cost is collected under the
percentage pricing system. The average tire costs the company $55. At the beginning of July, the account for
estimated liability for product warranties had a credit balance of $22,746. During July, 125 tires were returned
under the warranty. The cost of the replacement tires was $4,625, of which $1,125 was recovered under the
percentage-worn formula. Service revenue amounted to $531. During the month, the company sold 3,525 tires.
Required
1.
Prepare general journal entries to record each of the following:
(a) the warranty work completed during the month including related revenues;
(b) the estimated liability for product warranties for tires sold during the month.
2. Compute the balance of the estimated product warranty liabilities at the end of the month.
Problem 5. (Notes Payable)
On July 1, 20x1, Shane Inc. purchases a truck from Dallas Corporation by signing a two-year, noninterest-bearing
$45,000 note. Shane currently pays 16 percent interest to borrow money at the bank.
Required
Prepare journal entries in both Shane's and Dallas's general journal to:
(1) record the purchase and the note;
(2) adjust the accounts after one year (assuming June 30 year end); and
(3) record payment of the note after two years (on June 30, 20x3). (Reversing entries are not made)
Dr. M. D. Chase
Intermediate Accounting-32C
Current Liabilities and Contingencies
Long Beach State University
Page 11
Problem 6. (Business decisions using the time value of money)
LYC Co. is in the lawn care business. The owner is considering the purchase of a special type of spraying machine
for $38,000. After carefully studying projected costs and revenues, management estimates that the machine will
produce a net cash flow of $10,500 for the next seven years. Management also believes that an interest rate (rate
of return) of 18 percent is appropriate for this analysis.
Required
Calculate the present value of the machine to LYC Corporation. Does the purchase appear to be a correct business
decision?
Problem 7 (Payroll Accounting)
The following information is the payroll data for MDC Inc. for the week ended April 19, 20x4.
--Shipper, Vincent Jackson earns $10.00 per hour and he worked 38 hours during the pay period.
--Sales manager, Norve Turner, earned his weekly salary of $800.
--Receptionist, Beyonce’ Knoles , earns $400 per week.
--Federal income tax is 25% of gross earnings, FUTA (Federal Unemployment Tax) is $2 per employee per week,
and FICA (Federal Insurance Compensation Act) is 1% of gross earnings.
Required:
1. Complete the payroll journal for the week ended April 19, 20x4. The next payroll check no. is 101.
2. Enter the summarized payroll data in the general journal and record the company's benefit costs for FUTA
and FICA at 100% of employee deductions.
Week
Ending
Employee
Name
Totals:
Hours
Regular Overtime
Sales
Debits
Gross Pay
Shipping Office
Credits
Employer Expense
Employee Expense
Fed FUTA FICA FICA Net Check
Tax
Pay
#
Dr. M. D. Chase
Intermediate Accounting-32C
Current Liabilities and Contingencies
Long Beach State University
Page 12
Solution Problem 1: Product Warranty Liability
Part 1
General Journal
Date 20x1
September
30
30
Description
Debit
Cash
Estimated Warranty Liability
Service Revenue
Inventory
To record estimated product warranty and warranty
service revenue for September
8,742
8,695
Product Warranty Expense (430 x .25 x $90)
Estimated Warranty Liability
To record estimated warranty expense for September
9,675
Credit
8,742
8,695
9,675
Part 2
Balance of estimated product warranty liabilities:
Beginning balance.................................$12,400
Less: cost of warranty materials used............. 8,695
Plus: estimated liability for surfboards sold..... 9,675
Ending balance
$13,380
Solution to Problem 2 (Notes Payable)
Part 1
General Journal
Date 20x1
May
11
21
June
30
Description
Debit
Cash
Discount on Notes Payable ($120,000 x 90/360 x .12)
Notes Payable
To record 90 day 12% note for working capital loan from
Wells Fargo Bank
116,400
3,600
Accounts Payable
Notes Payable
To record issuance of 60 day note in lieu of account
receivable
24,000
Interest Expense (50/90 x $3,600)
Discount on Notes Payable
2,373.33
Credit
120,000
24,000
2,000
Dr. M. D. Chase
Intermediate Accounting-32C
Current Liabilities and Contingencies
Long Beach State University
Page 13
373.33
Interest Payable
To record accrual of interest expense for fiscal year
30
July
1
20
Aug
9
Income Summary
Interest Expense
To close interest expense to the exp & rev summary
2,373.33
Discount on Notes Payable
Interest Payable
Interest Expense
To reverse interest expense adjustment
2,000
373.33
Notes Payable
Interest Expense (($24,000 x 60/360 x .14)
Cash
To record payment of Supplier Note plus interest
24,000
560
Notes Payable
Interest Expense ($120,000 x .12 x 90/360)
Cash
Discount on Notes Payable
Payment of Wells Fargo non interest bearing note
120,000
3,600
2,373.33
2,373.33
24,560
120,000
3,600
Dr. M. D. Chase
Intermediate Accounting-32C
Current Liabilities and Contingencies
Long Beach State University
Page 14
Solution to Problem 2, (Notes Payable)
Part 2
General Ledger
Notes Payable
Account No 21
Post
Date
May
Item
11
21
Balance
Ref
Debit
Credit
Debit
Credit
GJ105
120,000
120,000
GJ105
24,000
144,000
July 20
GJ105
24,000
120,000
Aug
GJ105
120,000
0
9
General Ledger
Discount on Notes Payable
Account No 22
Post
Date
May
Item
11
Ref
GJ1
05
June 30
GJ1
05
July
7
GJ1
05
Aug
9
GJ1
05
Balance
Debit
Credit
3,600
Debit
Credit
3,600
2,000
2,000
1,600
3,600
3,600
0
Dr. M. D. Chase
Intermediate Accounting-32C
Current Liabilities and Contingencies
Long Beach State University
Page 15
General Ledger
Interest Payable
Account No 24
Post
Date
Item
Ref
June 30
GJ1
05
July
GJ1
05
1
Balance
bit
De
dit
Cre
bit
De
373.33
it
Cred
373.33
373.33
0
General Ledger
Interest Expense
Account No 73
Post
Date
Item
June 30
30
July
1
20
Aug
9
Balance
De
Ref
bit
GJ1
05
2,373.3
3
dit
Cre
bit
De
it
Cred
2,373.3
3
GJ1
05
2,373.3
3
0
GJ1
05
2,373.3
3
2,373.3
3
GJ1
05
560
GJ1
05
3,600
1,813.33
1,787.6
7
Dr. M. D. Chase
Intermediate Accounting-32C
Current Liabilities and Contingencies
Long Beach State University
Page 16
Solution to Problem 3 (Estimated Liabilities: Taxes/Vacation Pay
General Journal
Date 20x1
July
31
31
31
Description
Debit
Vacation Pay Expense ($424,000 x .85 x 2/50 = $14,416)
Estimated Liability for Vacation Pay
To record estimated vacation pay expense
14,416
Estimated Liability for Vacation Pay
Wages Payable
To record wages of employees on vacation in July
4,800
Property Tax Expense [($48,000 x 1.10]/12 months
Estimated Property Tax Payable
To record estimated property tax for July
4,400
14,416
4,800
Aug
31
Property Tax Expense [($48,000 x 1.10]/12 months
Estimated Property Tax Payable
To record estimated property tax for Aug
4,400
Sept
30
Property Tax Expense
Estimated Property Tax Payable
To record estimated property tax for September and
adjust estimated tax liability for prior months based on
actual billing of $52,860
$52,860/12.............................. $4,405
add underestimate for prior months $5 x 2 10
$4,415
4,415
October
31
Property Tax Expense ($52,860/12 months)
Estimated Property Tax Payable
To record estimated property tax for Aug
4,405
Nov
Estimated Property Tax Payable
Prepaid Property Taxes
Cash
To record payment of property tax
17,620
35,240
Property Tax Expense ($52,860 x 1.1)/12 months)
Estimated Property Tax Payable
To record estimated property tax for Aug
4,845.50
Nov
1
30
Credit
4,400
4,400
4,415
4,405
52,860
4,845.50
Dr. M. D. Chase
Intermediate Accounting-32C
Current Liabilities and Contingencies
Long Beach State University
Page 17
Solution to Problem 4 (Estimated Liabilities: Product Warranty)
Part 1
General Journal
Date 20x1
(a) July 31
(b) July 31
Description
Debit
Cash
Estimated Product Warranty Liability
Service Revenue
Inventory
To record estimated warranty liability and related revenue
for July
1,656
3,500
Product Warranty Expense
Estimated Product Warranty Liability
To record estimated warranty expense for July
(3,525 x .02 x[$55 - (.2 x $55)] = $3,102
3,102
Part 2
Beginning Balance.......................................................$ 22,746
Add: Estimated Liability for tires sold.................
3,102
Less: Net cost of tires replaced........................ ….
3,500
Balance..............................................
$ 22,348
Credit
531
4,625
3,102
Dr. M. D. Chase
Intermediate Accounting-32C
Current Liabilities and Contingencies
Long Beach State University
Page 18
Solution to Problem 5 (Notes Payable)
Books of Shane, Inc.
General Journal
Date 20x1
July
1
20x2
June
30
20x3
June
30
Description
Debit
Trucks ($45,000 x .74316)
Discount on Notes Payable
Notes Payable
To record purchase on 16% discounted note with Dallas
Corp
33,442.2011,557
.80
Interest Expense (33,442.20 x .16 = $5,350.75)
Discount on Notes Payable
To record interest expense incurred for fiscal 20x2
5,350.75
Interest Expense ($11,557.80 - $5,350.75)
Notes Payable
Discount on Notes Payable
Cash
To record remaining interest expense incurred for fiscal
20x3 and payment of the note
6,207.05
45,000
Credit
45,000
5,350.75
6,207.05
45,000
Books of Dallas Corporation
General Journal
Date 20x1
July
1
20x2
June
30
20x3
June
30
Description
Debit
Notes Receivable
Discount on Notes Payable
Sales
To record Sale on 16% discounted note with Shane, Inc
45,000
11,557.80
Discount on Notes Receivable
Interest Earned (33,442.20 x .16 = $5,350.75)
To record interest earned for fiscal 20x2
5,350.75
Discount on Notes Receivable
Cash
Interest Earned
Note Receivable
To record receipt of payment on noninterest bearing not
and recognition of interest earned on same
6,207.05
45,000
Credit
33,442.20
5,350.75
6,207.05
45,000
Dr. M. D. Chase
Intermediate Accounting-32C
Current Liabilities and Contingencies
Long Beach State University
Page 19
Solution to Problem 6 (Business decision using the time value of money)
The present value of an ordinary annuity of $10,500 for seven years at 16 percent is:
4.03857 x $10,500 =
Cost of machine;
Net Benefit........
$
$
42,404.99
38,000.00
4,404.99
The purchase will benefit LYC by $4,404.99
Dr. M. D. Chase
Intermediate Accounting-32C
Current Liabilities and Contingencies
Long Beach State University
Page 20
Solution to Problem 7
Debits
Gross Pay
Hours
Week
Ending
April 19
April 19
April 19
Employee
Name
V Jackson
N Turner
B Knowles
Regular
Totals
38
Overtime
Sales
38
Shipping
Credits
Employer Expense
Office
400.00
2.00
2.00
2.00
3.80
8.00
4.00
Fed
Tax
95.00
200.00
100.00
400.00
6.00
15.80
395.00
380.00
800.00
800.00
380.00
FUTA
FICA
General Journal
Date
Mar 27
Mar 27
Description
Folio
Sales Salaries Expense
657
Shipping Wages Expense
658
Office Salaries Expense
659
Fed Inc Tax Payable
253
FICA Payable
256
Salaries Payable
226
To record employee payroll and expenses for
the week ending Apr. 19, l9X2
Debit
800.00
380.00
400.00
Payroll Taxes Expense
653
FUTA
255
FICA
256
To record employer payroll expenses for
the week ending Apr. 19,1982
21.80
Credit
395.00
15.80
1,169.20
6.00
15,80
Employee Expense
FICA
Net
Pay
3.80
281.20
8.00
592.00
4.00
296.00
15.80
1169.20
Check
#
101
102
103