CHAPTER 9

Current Liabilities, Contingencies,

and the Time Value of Money
OVERVIEW OF EXERCISES, PROBLEMS, AND CASES
Estimated
Time in
Learning Outcomes Exercises Minutes Level
1. Identify the components of the current liability category of 1 10 Easy
the balance sheet. 2 10 Easy
3 10 Easy

2. Examine how accruals affect the current liability category. 4 20 Mod

5 15 Mod
6 10 Mod
7 15 Mod
8 15 Mod

3. Show that you understand how changes in current liabilities 9 5 Easy

affect the statement of cash flows. 10 5 Mod
11 5 Mod

4. Determine when contingent liabilities should be presented on the 12 15 Mod

balance sheet or disclosed in notes and how to calculate their amounts.

5. Explain the difference between simple and compound interest. 13 20 Mod

6. Calculate amounts using the future value and present value concepts. 14 5 Easy
15 5 Mod
16 10 Mod
17 10 Mod
24* 10 Diff
25* 10 Diff

7. Apply the compound interest concepts to some common 18 5 Mod

accounting situations. 19 10 Mod
20 10 Diff
24* 10 Diff
25* 10 Diff

8. Show that you understand the deductions 21 15 Mod

and expenses for payroll accounting (Appendix A). 22 20 Mod

9. Determine when compensated absences must be 23 10 Diff

accrued as a liability (Appendix A).
*Exercise, problem, or case covers two or more learning outcomes
Level = Difficulty levels: Easy; Moderate (Mod); Difficult (Diff)

9-1
9-2 FINANCIAL ACCOUNTING SOLUTIONS MANUAL

Problems Estimated
and Time in
Learning Outcomes Alternates Minutes Level
1. Identify the components of the current liability category of 12* 10 Mod
the balance sheet.

2. Examine how accruals affect the current liability category. 1 40 Mod

11* 30 Mod

3. Show that you understand how changes in current 2 30 Mod

liabilities affect the statement of cash flows. 3 20 Diff

4. Determine when contingent liabilities should be presented on the 4 20 Mod

balance sheet or disclosed in notes and how to calculate 5 10 Mod
their amounts. 12* 10 Mod

5. Explain the difference between simple and compound interest. 6 40 Diff

11* 30 Mod

6. Calculate amounts using the future value and present value concepts. 7 25 Easy
8 30 Mod
13* 10 Diff
14* 10 Diff

7. Apply the compound interest concepts to some common 13* 10 Diff

accounting situations. 14* 10 Diff

8. Show that you understand the deductions 9 30 Mod

and expenses for payroll accounting (Appendix A).

9. Determine when compensated absences must be 10 10 Mod

accrued as a liability (Appendix A).

*Exercise, problem, or case covers two or more learning outcomes

Level = Difficulty levels: Easy; Moderate (Mod); Difficult (Diff)
 CHAPTER 9 • CURRENT LIABILITIES, CONTINGENCIES, AND THE TIME VALUE OF MONEY 9-3

Estimated
Time in
Learning Outcomes Cases Minutes Level
1. Identify the components of the current liability category of 1* 30 Mod
the balance sheet. 5* 25 Mod

2. Examine how accruals affect the current liability category. 1* 30 Mod

5* 25 Mod

3. Show that you understand how changes in current liabilities 2* 20 Mod

affect the statement of cash flows. 3* 25 Mod

4. Determine when contingent liabilities should be presented on the 2*

balance sheet or disclosed in notes and how to calculate 3* 25 Mod
their amounts. 4 20 Mod
7 30 Mod
8 20 Mod

5. Explain the difference between simple and compound interest.

6. Calculate amounts using the future value and present value concepts.

7. Apply the compound interest concepts to some common 6 25 Mod

accounting situations.

8. Show that you understand the deductions and

expenses for payroll accounting (Appendix A).

9. Determine when compensated absences must be

accrued as a liability (Appendix A).

*Exercise, problem, or case covers two or more learning outcomes

Level = Difficulty levels: Easy; Moderate (Mod); Difficult (Diff)
9-4 FINANCIAL ACCOUNTING SOLUTIONS MANUAL

QUESTIONS

1. A current liability is an obligation that will be satisfied within the next operating cycle,
or within one year if the cycle is shorter than one year. Current liabilities are
important to determine a firm’s liquidity, i.e., its ability to pay for those items due
within a short time period.
2. Generally, it is to the company’s benefit to take advantage of discounts available
because of the rate of the discount. For example, if a 2% discount is available for
payment within 10 days, a firm can borrow money and pay interest on the loan in
order to take advantage of the discount. Also, prompt payment of accounts is
essential in order to ensure good relationships with suppliers and other creditors.
3. No, the real rate of interest is not 10%. The real interest rate could be calculated as
$100/$900, or approximately 11.11%. The rate should be calculated on the basis of
the amount that the firm actually obtained, rather than the face amount of the note.
4. The account Discount on Notes Payable is a balance sheet account.
5. Income tax is an item that should be accrued as a liability as of year-end. If the firm’s
year-end is December 31, then the amount should appear as a current liability on
the balance sheet dated December 31.
6. A contingent liability involves an existing condition where the outcome of that
condition is not known with certainty and is dependent on some event that will occur
in the future. Contingent liabilities are accounted for differently than contingent
assets because of the conservatism principle. It should be noted that the accounting,
while conservative, leads to an inconsistency in the accounting for assets and
liabilities.
7. A contingent liability should be recorded only if its likelihood of occurrence is
probable and the amount can be reasonably estimated. The firm must make a good-
faith effort to estimate the amount when it is not known. If the dollar amount cannot
be estimated, the contingent liability should be disclosed in the notes to the financial
statements.
8. The lawsuit should be described in as much detail as possible in the notes to the
financial statements. The nature of the lawsuit and the expected resolution should
be described. If the dollar amount can be estimated, it should be disclosed. If it
cannot be estimated, it may be possible to determine and disclose a range of values
that represents the potential loss to the firm.
9. Simple interest is calculated on the balance of the principal only. Compound interest
is calculated on the principal plus previous amounts of interest accumulated. The
amount of interest accumulated by simple interest is always less than the amount if
interest is compounded at the same interest rate.
 CHAPTER 9 • CURRENT LIABILITIES, CONTINGENCIES, AND THE TIME VALUE OF MONEY 9-5

10. If interest is compounded quarterly, it should be calculated at one-fourth of the

annual rate but for four times as many compounding periods. The amount
accumulated for quarterly compounding will always exceed the amount accumulated
for annual compounding because of the “interest on interest” feature of compound
interest.
11. A future value represents the amount that will be accumulated at a future time if a
known amount is invested for a given time at a given interest rate. The present value
represents the value today of an amount to be received or paid at a future time. You
can determine whether or not to calculate a present value or future value based on
the timing of the known and unknown quantities. If the known amount is in the pres-
ent time, you are attempting to calculate the future amount. If the known amount is in
the future, you are attempting to calculate the present value of an equivalent
amount.
12. The word annuity means a series of payments of the same amount. The present
value of an annuity could be calculated as a series of single amounts, but not with a
single calculation. You would first calculate the present value of a single payment
one year in the future; then the present value of a single payment two years in the
future, etc. The present value of the single sums would be totaled to determine the
present value of an annuity. To avoid the calculations, tables have been developed
to calculate the present value of an annuity based on one calculation.
13. The interest rate of the loan could be calculated by dividing the total dollar amount of
the loan by the dollar amount of the monthly payments. The result is a number that
represents an interest factor or table value in the table for the present value of an
annuity. Find the table value that corresponds to the number of years of the loan,
and then read across that row to find the interest rate.
14. Loan payable and bond payable accounts are recorded at present value amounts.
Other accounts based on present value concepts are pensions, leases, and some
long-term receivables.
15. The amount of income tax withheld should be treated as a current liability of the
employer’s financial statements until the time the amount is remitted to the U.S.
Treasury.
16. Unemployment tax should be recorded as a debit to an expense account and a
credit to a liability account. The expense account appears on the employer’s income
statement as an expense in the year incurred. The liability should appear on the
balance sheet as a current liability until the tax is remitted.
17. Compensated absences are absences from employment such as vacation, illness,
and holidays, for which it is expected that employees will be paid.
18. The statement given is not a correct statement. Vacation pay should be recorded as
an expense when the employee earns the vacation days and not in the period when
the employee actually takes the vacation.
9-6 FINANCIAL ACCOUNTING SOLUTIONS MANUAL

EXERCISES

LO 1 EXERCISE 9-1 CURRENT LIABILITIES

The treatment of the items should be as follows:

Taxes Payable—Current liability
Accounts Receivable—Current asset
Notes Payable, 9%, due in 90 days—Current liability
Investment in Bonds—Long-term asset
Capital Stock—Stockholders’ equity
Accounts Payable—Current liability
Estimated Warranty Payable in 2008—Current liability
Retained Earnings—Stockholders’ equity
Trademark—Intangible asset
Mortgage Payable—$10,000 due in 2008 should be current liability.
The remaining portion should be long-term liability.

LO 1 EXERCISE 9-2 CURRENT LIABILITIES

1. and 2.
Classification Account Title
a. Current liability Accounts Payable
b. Current liability Notes Payable
c. Long-term liability Notes Payable
d. Current liability Wages Payable
e. Current liability Interest Payable
f. Current liability Current Portion of Long-Term Debt
and
Long-term liability Long-Term Debt
g. Current liability Taxes Payable
3. Investors are interested in this information because it enables them to better predict
the timing of future cash flows. Items that are classified as current liabilities require
the use of current assets to satisfy them, whereas long-term liabilities do not.
 CHAPTER 9 • CURRENT LIABILITIES, CONTINGENCIES, AND THE TIME VALUE OF MONEY 9-7

LO 1 EXERCISE 9-3 CURRENT LIABILITIES SECTION

JACKIE COMPANY
BALANCE SHEET
DECEMBER 31, 2007
Current liabilities:
Accounts payable $ 24,400
Notes payable, 10%, due June 2, 2008 $1,000
Less: Discount on notes payable 150 850
Current maturities of long-term debt 6,900
Other accrued liabilities:
Interest payable $3,010
Wages payable 6,000
Unearned revenue 4,320 13,330
Income taxes payable 61,250
Total current liabilities $106,730

LO 2 EXERCISE 9-4 TRANSACTION ANALYSIS

1. a. The effect on the accounting equation of purchasing inventory on account is as

follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

Accounts Payable 8,000 Purchases (8,000)

b. The effect on the accounting equation of purchasing land is as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

Land 44,500 Notes Payable 35,600

Cash (8,900)*

*$44,500 × 20% = $8,900

c. The effect on the accounting equation of the purchase return is as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

Accounts Payable (450) Purchase Returns

and Allowances 450
9-8 FINANCIAL ACCOUNTING SOLUTIONS MANUAL

EXERCISE 9-4 (Continued)

d. The effect on the accounting equation of the payment on account is as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

Cash (7,550) Accounts Payable (7,550)

e. The effect on the accounting equation of the loan less interest in advance is as
follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

Cash 13,800 Notes Payable 15,000

Discount on
Notes Payable (1,200)

f. The effect on the accounting equation of the sale of gift certificates is as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

Cash 5,000* Unearned

Revenue 5,000

*200 × $25 = $5,000

g. The effect on the accounting equation of the sales and related sales tax is as
follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

Cash 114,480* Sales Tax Sales 120,000

Accounts Payable 7,200
Receivable 12,720

*$127,200 × 90% = $114,480

 CHAPTER 9 • CURRENT LIABILITIES, CONTINGENCIES, AND THE TIME VALUE OF MONEY 9-9

EXERCISE 9-4 (Concluded)

2. b. The effect on the accounting equation of the accrual of interest on the note is as
follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

Interest Payable 1,898.67* Interest Expense (1,898.67)

*$35,600 × 8% × 8/12 = $1,898.67

e. The effect on the accounting equation of the recognition of interest on the note is
as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

Discount on Interest Expense (700)

Notes Payable 700*

*$1,200 × 7/12 = $700

f. The effect on the accounting equation of the redemption of the gift certificates is
as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

Unearned Sales 1,750

Revenue (1,750)*

*$5,000 × 35% = $1,750

3. Sales tax payable $ 7,200.00

Notes payable, due November 1 35,600.00
Notes payable, due June 1 $15,000.00
Less: Discount on notes payable* 500.00 14,500.00
Unearned sales revenue** 3,250.00
Interest payable 1,898.67
Total current liabilities $62,448.67
*$1,200 – $700 = $500
**$5,000 – $1,750 = $3,250
9-10 FINANCIAL ACCOUNTING SOLUTIONS MANUAL

LO 2 EXERCISE 9-5 CURRENT LIABILITIES AND RATIOS

1. KRUSE COMPANY
BALANCE SHEET
DECEMBER 31, 2007
Current liabilities:
Accounts payable $ 55,000
Notes payable, 12%, due in 60 days 20,000
Taxes payable 15,000
Salaries payable 10,000
Total current liabilities $100,000

2. Working capital = Current assets – Current liabilities

= $300,000* – $100,000
= $200,000
*Current assets = Cash $ 15,000
Accounts receivable 180,000
Less: Allowance for doubtful accounts (20,000)
Marketable securities 40,000
Inventory 85,000
$300,000

3. Current ratio = Current assets/Current liabilities

= $300,000/$100,000
= 3:1
Kruse has sufficient current assets to meet its short-term obligations (pay its current
liabilities).
 CHAPTER 9 • CURRENT LIABILITIES, CONTINGENCIES, AND THE TIME VALUE OF MONEY 9-11

LO 2 EXERCISE 9-6 DISCOUNTS

1. a. Purchase price × Discount rate = Discount

$450 × 2% = $9.00
Annualized interest rate = 2% × (360/30) = 0.24, or 24%

b. Discount = $1,500 × 1% = $15

Annualized interest rate = 1% × (360/20) = 0.18, or 18%

2. a. Discount/Purchase price = Discount rate

($200 – $196)/$200 = 0.02, or 2%

b. ($2,800 – $2,674)/$2,800 = 0.045, or 4.5%

LO 2 EXERCISE 9-7 NOTES PAYABLE AND INTEREST

1. The effect on the accounting equation of issuing the note is as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

Cash 25,000 Notes Payable 25,000

2. The effect on the accounting equation of the year-end adjustment for interest
expense is as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

Interest Payable 1,000* Interest Expense (1,000)

*$25,000 × 8% × 6/12 = $1,000

3. The effect on the accounting equation of the payment of the principal and interest is
as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

Cash (26,667) Notes Payable (25,000) Interest

Interest Payable (1,000) Expense (667)*

*$25,000 × 8% × 4/12 = $667

9-12 FINANCIAL ACCOUNTING SOLUTIONS MANUAL

LO 2 EXERCISE 9-8 NON-INTEREST-BEARING NOTES PAYABLE

1. The effect on the accounting equation of the issuance of the note is as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

Cash 16,380 Notes Payable 18,000

Discount on
Notes Payable (1,620)*

*$18,000 × 9% = $1,620

2. The effect on the accounting equation of the accrual of interest is as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

Discount on Interest Expense (405)

Notes Payable 405*

*$1,620 × 3/12 = $405

3. The effect on the accounting equation of the payment of the note is as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

Cash (18,000) Notes Payable (18,000) Interest Expense (1,215)

Discount on
Notes Payable 1,215*

*$1,620 – $405 = $1,215

4. Effective interest rate = $1,620/$16,380 = 9.89%

 CHAPTER 9 • CURRENT LIABILITIES, CONTINGENCIES, AND THE TIME VALUE OF MONEY 9-13

LO 3 EXERCISE 9-9 IMPACT OF TRANSACTIONS INVOLVING CURRENT LIABILITIES

ON STATEMENT OF CASH FLOWS

Accounts payable: O
Current maturities of long-term debt: F
Notes payable: F
Other accrued liabilities: O
Salaries and wages payable: O
Taxes payable: O

LO 3 EXERCISE 9-10 IMPACT OF TRANSACTIONS INVOLVING CONTINGENT

LIABILITIES ON STATEMENT OF CASH FLOWS

Estimated liability for warranties: O

Estimated liability for product premiums: O
Estimated liability for probable loss relating to litigation: O

LO 3 EXERCISE 9-11 IMPACT OF TRANSACTIONS INVOLVING PAYROLL LIABILITIES

ON STATEMENT OF CASH FLOWS

Accrued vacation days (compensated absences): O

Health insurance premiums payable: O
FICA payable: O
Union dues payable: O
Salary payable: O
Unemployment taxes payable: O
9-14 FINANCIAL ACCOUNTING SOLUTIONS MANUAL

LO 4 EXERCISE 9-12 WARRANTIES

The effect on the accounting equation of the sales made with warranties is as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

Cash/Accounts Sales 32,500,000

Receivable 32,500,000*

*$325 × 100,000 = $32,500,000

The effect on the accounting equation of the current year's estimated warranty expense
is as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

Estimated Warranty
Liability for Expense (168,000)
Warranties 168,000*

*(100,000 units × 12%) × $14 = $168,000

The effect on the accounting equation of the actual expenditures for warranty work is as
follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

Cash/ Estimated
Inventory (150,000) Liability for
Warranties (150,000)

Beginning balance $ 120,000

Warranty estimate 168,000
Actual expense (150,000)
Ending balance $ 138,000
 CHAPTER 9 • CURRENT LIABILITIES, CONTINGENCIES, AND THE TIME VALUE OF MONEY 9-15

LO 5 EXERCISE 9-13 SIMPLE VERSUS COMPOUND INTEREST

Part 1.
1. $20,000 × 4% × 6 years = $4,800
2. $20,000 × 6% × 4 years = $4,800
3. $20,000 × 8% × 3 years = $4,800
Part 2.
1. n = 6, i = 4%
Future value = $20,000 × 1.265 = $25,300
Interest = Future value – Beginning amount
= $25,300 – $20,000
= $5,300
2. n = 4, i = 6%
Future value = $20,000 × 1.262 = $25,240
Interest = Future value – Beginning amount
= $25,240 – $20,000
= $5,240
3. n = 3, i = 8%
Future value = $20,000 × 1.260 = $25,200
Interest = Future value – Beginning amount
= $25,200 – $20,000
= $5,200
Part 3.
1. n = 12, i = 2%
Future value = $20,000 × 1.268 = $25,360
Interest = Future value – Beginning amount
= $25,360 – $20,000
= $5,360

2. n = 8, i = 3%
Future value = $20,000 × 1.267 = $25,340
Interest = $25,340 – $20,000 = $5,340

3. n = 6, i = 4%
Future value = $20,000 × 1.265 = $25,300
Interest = $25,300 – $20,000 = $5,300
You would want to choose an investment that yields the highest future value. All
other factors being equal, higher interest rates, more frequent compounding, and a
longer term will increase the future value of your investment.
9-16 FINANCIAL ACCOUNTING SOLUTIONS MANUAL

LO 6 EXERCISE 9-14 PRESENT VALUE, FUTURE VALUE

n = 10, i = 5%
Present value = Amount × Table factor
= $150,000 × 0.614
= $92,100
or
Future value = Amount × Table factor
$150,000 = ? × 1.629
Amount = $150,000/1.629
= $92,081
Slight difference due to rounding.

LO 6 EXERCISE 9-15 EFFECT OF COMPOUNDING PERIOD

1. $1,000 × 1.166 = $1,166 n = 2, i = 8%

2. $1,000 × 1.170 = $1,170 n = 4, i = 4%
3. $1,000 × 1.172 = $1,172 n = 8, i = 2%

LO 6 EXERCISE 9-16 PRESENT VALUE, FUTURE VALUE

1. a. $7,000 × 1.469 = $10,283 n = 5, i = 8%

b. $7,000 × 1.480 = $10,360 n = 10, i = 4%
c. $7,000 × 1.486 = $10,402 n = 20, i = 2%

2. a. $15,000 × 0.681 = $10,215 n = 5, i = 8%

b. $15,000 × 0.676 = $10,140 n = 10, i = 4%
c. $15,000 × 0.673 = $10,095 n = 20, i = 2%

LO 6 EXERCISE 9-17 PRESENT VALUE, FUTURE VALUE

1. a. $16,000 × 1.469 = $23,504 n = 5, i = 8%

b. $16,000 × 1.480 = $23,680 n = 10, i = 4%
c. $16,000 × 1.486 = $23,776 n = 20, i = 2%

2. a. $20,000 × 0.681 = $13,620 n = 5, i = 8%

b. $20,000 × 0.676 = $13,520 n = 10, i = 4%
c. $20,000 × 0.673 = $13,460 n = 20, i = 2%
 CHAPTER 9 • CURRENT LIABILITIES, CONTINGENCIES, AND THE TIME VALUE OF MONEY 9-17

LO 7 EXERCISE 9-18 ANNUITY

$2,000 × 20.024 = $40,048 n = 15, i = 4%

LO 7 EXERCISE 9-19 CALCULATION OF YEARS

$41,000/$1,600 = 25.625 table figure at 4% interest = about 18 years.

LO 7 EXERCISE 9-20 VALUE OF PAYMENTS

1. Present value = Payment × Table factor

= $1,480 × 1.690 = $2,501.20
(present value of an annuity of $1 for n = 2, i = 12%)

2. n = 8, i = 3%
Present value = Payment × Table factor
$2,501.20 = payment × 7.020
Payment = $2,501.20/7.020 = $356.30
With annual payments:
2 payments at $1,480 = $2,960.00
Less: Present value 2,501.20
Interest expense $ 458.80
With quarterly payments:
8 payments at $356.30 = $2,850.40
Less: Present value 2,501.20
Interest expense $ 349.20
Interest with annual payments $458.80
Less: Interest with quarterly payments 349.20
Interest saved $109.60
Payments would be smaller and total interest would be less if she made monthly
payments.
9-18 FINANCIAL ACCOUNTING SOLUTIONS MANUAL

LO 8 EXERCISE 9-21 PAYROLL TRANSACTIONS (Appendix A)

1. Gross pay $ 385,000

Withholdings:
Federal income tax ($385,000 × 28%) (107,800)
State income tax ($385,000 × 5%) (19,250)
FICA tax ($385,000 × 7.65%) (29,453)
Deductions:
Health insurance (7,000)
Union dues (980)
Net pay $ 220,517

The effect on the accounting equation of the payroll is as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

Salary and Salary and

Wages Wages
Payable 220,517 Expense (385,000)
Federal Income
Tax Payable 107,800
State Income
Tax Payable 19,250
FICA Tax
Payable 29,453
Health
Insurance
Payable 7,000
Union Dues
Payable 980

2. The employer’s portion of payroll taxes would be calculated as follows:

FICA tax payable $29,453

Federal unemployment tax 3,080 ($385,000 × 0.8%)
State unemployment tax 12,320 ($385,000 × 3.2%)
Total $44,853

3. A company’s fringe benefits would be reported as additional payroll expenses.

Amounts to be contributed to health insurance coverage would be reported as a
liability until remitted to the insurance company.
 CHAPTER 9 • CURRENT LIABILITIES, CONTINGENCIES, AND THE TIME VALUE OF MONEY 9-19

LO 8 EXERCISE 9-22 PAYROLL, EMPLOYER’S PORTION (Appendix A)

1. Dell FICA: $11,710 × 7.65% = $ 896

Unemp: $ 0
Fin FICA: $ 2,660 × 7.65% = $ 203
Unemp: $ 2,660 × 0.8% = $ 21
$ 2,660 × 2.6% = $ 69
Hook FICA: $15,660 × 7.65% = $1,198
Unemp: $ 0
Patty FICA: $26,200 × 7.65% = $2,004
Unemp: $ 0
Tuss FICA: $19,350 × 7.65% = $1,480
Unemp: $ 0
Woo FICA: $ 3,900 × 7.65% = $ 298
Unemp: $ 700 × 0.8% = $ 6
$ 700 × 2.6% = $ 18

2. The effect on the accounting equation of the employer's portion of payroll taxes is
as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

FICA Tax Payable 6,079 Payroll Tax

Federal Unemployment Expense (6,193)
Tax Payable 27
State Unemployment
Tax Payable 87
9-20 FINANCIAL ACCOUNTING SOLUTIONS MANUAL

LO 9 EXERCISE 9-23 COMPENSATED ABSENCES (Appendix A)

1. a. Wonder Inc. should record only a transaction for vacation days at the time payroll
is recognized.
b. Sick days are not recognized as an expense until employees are actually absent.

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

Accrued Vacation Vacation Days

Days 3,600* Expense (3,600)
*$72,000 ÷ 24 = $3,000 per employee ÷ 20 = $150 per day × 24 = $3,600

2. From an internal control perspective, key employees should be required to take

annual vacations rather than accumulating vacation time. As noted above, sick pay
is not accrued; it is expensed as incurred. As a result, under certain circumstances,
sick pay that has been accumulating and then is taken in a single year may
adversely affect the company’s financial statements for that year.

MULTI-CONCEPT EXERCISES

LO 6,7 EXERCISE 9-24 COMPARE ALTERNATIVES

Present value of 1: $100,000 × 1.000 = $100,000

Present value of 2: $108,000 × 0.926 = $100,008
n = 1, i = 8%
Present value of 3: $ 20,000 × 5.747 = $114,940
n = 8, i = 8%
Present value of 4: $ 10,000 × 11.258 = $112,580
n = 30, i = 8%
Jane should choose Option 3.

LO 6,7 EXERCISE 9-25 TWO SITUATIONS

1. $53,300/$13,000 = 4.100 table factor for present value of an annuity for 5 years,
i = 7%.
2. $13,300 × 15.026 (future value of an annuity for n = 12, i = 4%) = $199,846.
No, Sampson will not have accumulated quite enough money.
 CHAPTER 9 • CURRENT LIABILITIES, CONTINGENCIES, AND THE TIME VALUE OF MONEY 9-21

PROBLEMS

LO 2 PROBLEM 9-1 NOTES AND INTEREST

a. The effect on the accounting equation of issuing a loan at 10% interest on

January 1 is as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

Cash 25,000 Notes Payable 25,000

b. On January 10, only a memorandum entry is made.

c. The effect on the accounting equation of issuing a non-interest-bearing note on

February 1 is as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

Equipment 18,800 Notes Payable 20,000

Discount on
Notes Payable (1,200)*
*$20,000 × 12% × 1/2 = $1,200

d. The effect on the accounting equation of borrowing on March 1 with a line of

credit is as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

Cash 150,000 Loan Payable 150,000

e. The effect on the accounting equation of the partial payment of the line of credit
on June 1 is as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

Cash (102,250) Loan Payable (100,000) Interest

Expense (2,250)*
*$100,000 × 9% × 3/12 = $2,250
9-22 FINANCIAL ACCOUNTING SOLUTIONS MANUAL

PROBLEM 9-1 (Continued)

f. The effect on the accounting equation of accruing interest on the interest-

bearing note on June 30 is as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

Interest Payable 2,750* Interest Expense (2,750)

*Interest-bearing
$25,000 × 10%
× 6/12 $1,250
$50,000 × 9%
× 4/12 1,500
Subtotal $ 2,750

The effect on the accounting equation of accruing interest on the non-interest-

bearing note on June 30 is as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

Discount on Interest Expense (1,000)

Notes Payable 1,000*

Non-interest-bearing
$1,200 × 5/6 = $1,000

g. The effect on the accounting equation of the August 1 payment of the six-month
non-interest-bearing note is as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

Cash (20,000) Notes Payable (20,000) Interest

Discount on Expense (200)
Notes Payable 200*

*$1,200 – $1,000 = $200

 CHAPTER 9 • CURRENT LIABILITIES, CONTINGENCIES, AND THE TIME VALUE OF MONEY 9-23

PROBLEM 9-1 (Concluded)

h. The effect on the accounting equation of the amount borrowed on September 1

on the line of credit is as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

Cash 200,000 Loan Payable 200,000

i. The effect on the accounting equation of the payment of the November 1

issuance of a three-month note in payment of account is as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

Accounts
Payable (12,000)
Notes Payable 12,000

j. The effect on the accounting equation of payment of the 10% note and interest
on December 31 is as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

Cash (27,500) Notes Payable (25,000) Interest

Interest Payable (1,250) Expense (1,250)*

*$25,000 × 10% × 6/12 = $1,250

2. Line of credit:
$50,000 × 9% × 10/12 = $3,750
$200,000 × 9% × 4/12 = 6,000
8% Note:
$12,000 × 8% × 2/12 = 160
$9,910
9-24 FINANCIAL ACCOUNTING SOLUTIONS MANUAL

LO 3 PROBLEM 9-2 EFFECTS OF SARA LEE’S CURRENT LIABILITIES ON ITS

STATEMENT OF CASH FLOWS

1. Adjustments to reconcile net income to net cash provided by operating activities:

Net income $xxx
Adjustments to reconcile net income to net
cash provided by operating activities:
Decrease in accounts payable (21)*
Changes in accrued liabilities:
Decrease in payroll and employee benefits $ (33)
Increase in advertising and promotions 100
Increase in taxes other than payroll and income 11
Increase in income taxes 246
Decrease in other (53) 271*
*The amount reported on Sara Lee’s statement of cash flows differs from that
calculated here; the reason for the difference is not readily apparent from its
annual
report.
The changes in notes payable and in current portion of long-term debt during the
year are not included as adjustments above because they are not directly related to
Sara Lee’s operating activities. Transactions related to notes payable and long-term
payable and long-term debt are financing activities.
2. Sara Lee must have access to cash or other assets that can be converted to cash, in
amounts sufficient to pay its current liabilities. Sara Lee’s current ratio would be
useful in assessing its liquidity. However, Sara Lee would be expected to have a
large amount of inventory on hand. Therefore, its quick ratio would be a more
conservative measure of its ability to pay its bills on time.

LO 3 PROBLEM 9-3 EFFECTS OF TOMMY HILFIGER’S CHANGES IN CURRENT ASSETS

AND LIABILITIES ON STATEMENT OF CASH FLOWS

1. Operating Activities Section of Cash Flow Statement:

Net income $xxx,xxx
Adjustments to reconcile net income to net
cash provided by operating activities:*
Increase in accounts receivable (3,205)
Decrease in inventories 23,352
Increase in other current assets (8,159)
Decrease in accounts payable (15,035)
Increase in accrued expenses and other liabilities 21,267
*The amount reported on Hilfiger’s statement of cash flows differs from that
calculated here; the reason for the difference is not readily apparent from its
 CHAPTER 9 • CURRENT LIABILITIES, CONTINGENCIES, AND THE TIME VALUE OF MONEY 9-25

annual
report.
9-26 FINANCIAL ACCOUNTING SOLUTIONS MANUAL

PROBLEM 9-3 (Concluded)

2. The change in short-term borrowings during the year is not included as an

adjustment above because it is not directly related to Hilfiger’s operating activities.
Transactions related to short-term borrowings are financing activities.

LO 4 PROBLEM 9-4 WARRANTIES

1. XX defective units × $150 per unit = $12,600

XX defective units = $12,600/$150 per unit
Defective units = 84

2. 600 units sold × XX% = 84 defective units

XX% = 84 defective units/600 units sold = 14% of sales

3. If the actual amount of warranty costs incurred during 2008 is significantly higher
than the estimated liability recorded for warranty costs at the end of 2007, Clearview
should review its method for determining the accrual for warranty costs. Clearview
should ensure that its estimates of the number of defective television sets sold and
the average costs for replacement parts and labor are reasonable. Most likely, one
or more of those estimates were too low.

LO 4 PROBLEM 9-5 WARRANTIES

1. The effect on the accounting equation of the current year’s estimated warranty
cost is as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

Estimated Warranty
Liability for Expense (5,400)
Warranties 5,400

$1,500 × 120 × 3% = $5,400

2. The effect on the accounting equation of the actual warranty repairs is as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

Inventory (4,950) Estimated

Liability for
Warranties (4,950)
 CHAPTER 9 • CURRENT LIABILITIES, CONTINGENCIES, AND THE TIME VALUE OF MONEY 9-27

LO 5 PROBLEM 9-6 COMPARISON OF SIMPLE AND COMPOUND INTEREST

1. The effect on the accounting equation of the interest accrual for 2007 is as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

2007
12/31 Interest Payable 1,000* Interest Expense (1,000)

*$25,000 × 8% × 1/2 = $1,000

The effect on the accounting equation of the interest accrual for 2008 is as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

2008
12/31 Interest Payable 2,000* Interest Expense (2,000)

*$25,000 × 8% × 1 = $2,000

The effect on the accounting equation of the payment of the note and interest is as
follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

2009
6/30 Cash (29,000) Notes Payable (25,000) Interest Expense (1,000)**
Interest Payable (3,000)*

*$1,000 + $2,000 = $3,000

**$25,000 × 8% × 1/2 = $1,000

2. The effect on the accounting equation of the interest accrual for 2007 is as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

2007
12/31 Interest Payable 1,000 Interest Expense (1,000)

*$25,000 × 8% × 1/2 = $1,000

9-28 FINANCIAL ACCOUNTING SOLUTIONS MANUAL

PROBLEM 9-6 (Concluded)

The effect on the accounting equation of the interest accrual for 2008 is as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

2008
12/31 Interest Payable 2,122 Interest Expense (2,122)

First 6 months: ($25,000 + $1,000) × 8% × 1/2 year = $1,040

Second 6 months: ($26,000 + $1,040) × 8% × 1/2 year = 1,082
Total $ 2,122

The effect on the accounting equation of the payment of the note and interest is as
follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

2009
6/30 Cash (29,247) Notes Payable (25,000) Interest Expense (1,125)**
Interest Payable (3,122)*

*$1,000 + $2,122 = $3,122

**($27,040 + $1,082) × 8% × 1/2 year = $1,125

3. Interest recognized in (b) ($1,000 + $2,000 + $1,000) $4,000

Interest recognized in (a) ($1,000 + $2,122 + $1,125) 4,247
Additional interest with compounding at 8% $ 247

LO 6 PROBLEM 9-7 INVESTMENT WITH VARYING INTEREST RATE

Principal at Interest Accumulated

Year Beginning of Year Factor at End of Period
2007 $1,000 1.04 $1,040
2008 1,040 1.05 1,092
2009 1,092 1.06 1,158
2010 1,158 1.07 1,239
2011 1,239 1.08 1,338
 CHAPTER 9 • CURRENT LIABILITIES, CONTINGENCIES, AND THE TIME VALUE OF MONEY 9-29

LO 6 PROBLEM 9-8 COMPARISON OF ALTERNATIVES

a. $180,000 × 1.0 = $180,000

b. $196,200 × 0.926 (present value of $1 for n = 1, i = 8%) = $181,681
c. $220,500 × 0.857 (present value of $1 for n = 2, i = 8%) = $188,969
d. $55,000 × 3.312 (present value of annuity of $1 for n = 4, i = 8%) = $182,160
Option (a) is the least cost alternative.

LO 8 PROBLEM 9-9 PAYROLL ENTRIES (Appendix A)

1. The effect on the accounting equation of accruing the amount payable to

employees is as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

Salary Payable 142,550 Salary Expense (210,000)

Income Tax
Payable 42,500
FICA Tax
Payable 16,000
Heart Fund
Payable 5,800
Union Dues
Payable 3,150

2. The effect on the accounting equation when the employees are paid is as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

Cash (142,550) Salary Payable (142,550)

3. The effect on the accounting equation of recording the employer's payroll costs is
as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

FICA Tax Payroll Tax

Payable 16,000 Expense (22,300)
Unemployment
Tax Payable 6,300*

*$210,000 × 3% = $6,300
9-30 FINANCIAL ACCOUNTING SOLUTIONS MANUAL

PROBLEM 9-9 (Concluded)

4. The effect on the accounting equation of remitting the withholdings is as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

Cash (89,750) Income Tax

Payable (42,500)
FICA Tax
Payable (32,000)
Heart Fund
Payable (5,800)
Union Dues
Payable (3,150)
Unemployment
Tax Payable (6,300)

LO 9 PROBLEM 9-10 COMPENSATED ABSENCES (Appendix A)

To: Bookkeeper
Each time payroll is recorded, you must recognize vacation and sick day expense and a
corresponding liability. This is necessary because employees have performed the
service and payment is certain, since they are vested (receive payment when they retire
or quit). The amount to be recognized for vacation pay expense will be equal to the
weekly payroll divided by 20, since we have five work days in each work week and
employees accrue one vacation day for every four weeks they work. To calculate the
amount to be recognized for sick pay expense, first calculate the weekly payroll less the
pay earned by employees who were absent one or more days during the week. This
amount is then divided by 30, since we have five work days in each week and
employees accrue one sick day for every six weeks they work.

MULTI-CONCEPT PROBLEMS

LO 2,5 PROBLEM 9-11 INTEREST IN ADVANCE VERSUS INTEREST PAID WHEN LOAN
IS DUE

1. a. $103,200
b. $103,200/(100% – 14%) = $120,000

2. a. $103,200 × 14% = $14,448; $14,448/$103,200 = 14%

b. ($120,000 – $103,200)/$103,200 = 16.28%
 CHAPTER 9 • CURRENT LIABILITIES, CONTINGENCIES, AND THE TIME VALUE OF MONEY 9-31

PROBLEM 9-11 (Continued)

3. a. The effect on the accounting equation of the issuance of the note on July 1,
2007, is as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

Cash 103,200 Notes Payable 103,200

The effect on the accounting equation of accruing the interest for 2007 on
December 31 is as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

Interest Payable 7,224* Interest Expense (7,224)

*$103,200 × 14% × 6/12 = $7,224

The effect on the accounting equation of payment of the principal and interest on
July 1, 2008, is as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

Cash (117,648) Notes Payable (103,200) Interest Expense (7,224)

Interest
Payable (7,224)

b. The effect on the accounting equation of issuing the note on July 1, 2007, is as
follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

Cash 103,200 Notes Payable 120,000

Discount on
Notes Payable (16,800)

The effect on the accounting equation of accruing the interest for 2007 on
December 31 is as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

Discount on Interest Expense (8,400)

Notes Payable 8,400*

*$16,800 × 1/2 = $8,400

9-32 FINANCIAL ACCOUNTING SOLUTIONS MANUAL

PROBLEM 9-11 (Concluded)

The effect on the accounting equation of the payment of the note on July 1, 2008, is
as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

Cash (120,000) Notes Payable (120,000) Interest Expense (8,400)

Discount on
Notes Payable 8,400

4. a. Note payable $103,200

b. Note payable $120,000
Less: Discount on note payable 16,800
$103,200

LO 1,4 PROBLEM 9-12 CONTINGENT LIABILITIES

1. Items a, d, e: The liability is probable and an estimate is available.

2. Item c: The liability is reasonably possible, but an estimate is not available.
Item b is not recorded or disclosed, because it is a contingent asset.

LO 6,7 PROBLEM 9-13 TIME VALUE OF MONEY CONCEPTS

1. $9,750 × 5.895 (future value of $1 for n = 17, i = 11%) = $57,476

2. $42,487/$21,600 = 1.967; future value of $1 for n = 10, i = 7%
3. $15,000/1.714 (future value of $1 for n = 7, i = 8%) = $8,751
OR: $15,000 × 0.583 (present value of $1 for n = 7, i = 8%) = $8,745. Slight
difference due to rounding.
4. $15,026/$5,800 = 2.591; future value of $1 for i = 10%, n = 10 years
 CHAPTER 9 • CURRENT LIABILITIES, CONTINGENCIES, AND THE TIME VALUE OF MONEY 9-33

LO 6,7 PROBLEM 9-14 COMPARISON OF ALTERNATIVES

a. $15,000 × 1.360 (future value of $1 for n = 4, i = 8%) = $20,400

b. $2,250 × 9.214 (future value of annuity of $1 for n = 8, i = 4%) = $20,731.50
c. $4,350 × 4.506 (future value of annuity of $1 for n = 4, i = 8%) = $19,601.10
Alternative (b) is preferable.

ALTERNATE PROBLEMS

LO 2 PROBLEM 9-1A NOTES AND INTEREST

1. a. The effect on the accounting equation of issuing the note on January 1 is as

follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

Cash 35,000 Notes Payable 35,000

b. January 10. Only a memorandum note would be made.

c. The effect on the accounting equation of the issuance of a non-interest-bearing

note is as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

2/1 Equip- 26,320 Notes Payable 28,000

ment Discount on
Notes Payable (1,680)*

*$28,000 × 12% × 1/2 = $1,680

d. The effect on the accounting equation of the line of credit borrowing is as

follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

3/1 Cash 210,000 Loan Payable 210,000

9-34 FINANCIAL ACCOUNTING SOLUTIONS MANUAL

PROBLEM 9-1A (Continued)

e. The effect on the accounting equation of the partial payment of the line of credit
is as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

6/1 Cash (143,150) Loan Payable (140,000) Interest

Expense (3,150)*

*$140,000 × 9% × 3/12 = $3,150

f. The effect on the accounting equation of accruing interest on the interest-

bearing note is as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

6/30 Interest Payable 3,850* Interest Expense (3,850)

*$35,000 × 0.10 × 6/12 $1,750

$70,000 × 0.09 × 4/12 2,100
$3,850
The effect on the accounting equation of accruing interest on the non-interest-
bearing note is as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

6/30 Discount on Interest Expense (1,400)

Notes Payable 1,400*

*$1,680 × 5/6 = $1,400

g. The effect on the accounting equation of repayment of the non-interest-bearing

note on August 1 is as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

Cash (28,000) Notes Payable (28,000) Interest Expense (280)

Discount on
Notes Payable 280
 CHAPTER 9 • CURRENT LIABILITIES, CONTINGENCIES, AND THE TIME VALUE OF MONEY 9-35

PROBLEM 9-1A (Concluded)

h. The effect on the accounting equation of borrowing on the line of credit on

September 1 is as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

Cash 280,000 Loan Payable 280,000

i. The effect on the accounting equation of issuance of the 8% note in payment of

account on November 1 is as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

Notes Payable 16,800

Accounts
Payable (16,800)

j. The effect on the accounting equation of the repayment of the note plus interest
on December 31 is as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

Cash (38,500) Notes Payable (35,000) Interest

Interest Payable (1,750) Expense (1,750)*

*$35,000 × 10% × 6/12 = $1,750

2. Line of credit:
($210,000 – $140,000) × 9% × 10/12 = $ 5,250
$280,000 × 9% × 4/12 = 8,400
8% Note:
$16,800 × 8% × 2/12 = 224
$13,874
9-36 FINANCIAL ACCOUNTING SOLUTIONS MANUAL

LO 3 PROBLEM 9-2A EFFECTS OF BOEING’S CURRENT LIABILITIES ON ITS

STATEMENT OF CASH FLOWS

1. Adjustments to reconcile net income to net cash provided by operating activities:

Net income $ xxx
Adjustments to reconcile net income to net cash
provided by operating activities:
Increase in accounts payable and other liabilities 1,355
Increase in advances in excess of related costs 659
Increase in income taxes payable 245*
*The amount reported on Boeing’s statement of cash flows differs from that
calculated here because of the impact of deferred taxes.
The changes in short-term debt and current portion of long-term debt during the year
are not included as adjustments above because they do not directly relate to
Boeing’s operating activities. Transactions relating to long-term debt are financing
activities.

2. Boeing must have access to cash, or other assets that can be converted to cash, in
amounts sufficient to pay its current liabilities. Boeing’s current ratio would be useful
in assessing its liquidity. However, Boeing would be expected to have a large
amount of inventory on hand. Therefore, its quick ratio would be a more
conservative measure of its ability to pay its bills on time.

LO 3 PROBLEM 9-3A EFFECTS OF NIKE’S CHANGES IN CURRENT ASSETS AND

LIABILITIES ON ITS STATEMENT OF CASH FLOWS

1. Adjustments to reconcile net income to net cash provided by operating activities:

Net income $xxx,xxx
Adjustments to reconcile net income to net
cash provided by operating activities:*
Increase in accounts receivable (36.3)
Increase in inventories (118.7)
Increase in prepaid expenses and other current assets (31.9)
Increase in accounts payable 191.1
Decrease in income taxes payable (12.4)
Decrease in accrued liabilities (61.8)
*The amount reported on Nike’s statement of cash flows differs from that calculated
here; the reason for the difference is not readily apparent from its annual report.

2. The changes in the current portion of long-term debt and notes payable during the
year are not included as adjustments above because they are not directly related to
Nike’s operating activities. Transactions involving long-term debt and notes payable
are financing activities.
 CHAPTER 9 • CURRENT LIABILITIES, CONTINGENCIES, AND THE TIME VALUE OF MONEY 9-37

LO 4 PROBLEM 9-4A WARRANTIES

1. XX defective units × $300 per unit = $25,200

XX defective units = $25,200/$300 per unit
Defective units = 84

2. XX% = 84 defective units/600 units sold = 14% of sales

LO 4 PROBLEM 9-5A WARRANTIES

1. The effect on the accounting equation of estimating the warranty expense is as

follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

Estimated Warranty
Liability for Expense (15,360)
Warranties 15,360*

*$3,200 × 120 × 4% = $15,360

2. The effect on the accounting equation of the actual warranty costs is as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

Inventory (10,200) Estimated

Liability for
Warranties (10,200)

3. Beginning balance $ 1,100

Add: Warranty estimate 15,360
Less: Actual expense (10,200)
Ending balance $ 6,260

LO 5 PROBLEM 9-6A COMPARISON OF SIMPLE AND COMPOUND INTEREST

1. Dec. 31, 2007 $25,000 × 6% × 6/12 = $ 750

Dec. 31, 2008 $25,000 × 6% × 12/12 = 1,500
June 30, 2009 $25,000 × 6% × 6/12 = 750
Total accrued $3,000
9-38 FINANCIAL ACCOUNTING SOLUTIONS MANUAL

PROBLEM 9-6A (Concluded)

2. Dec. 31, 2007: $25,000 × 6% × 1/2 = $ 750

Dec. 31, 2008:
First 6 months: ($25,000 + $750) × 6% × 1/2 year = $773
Second 6 months: ($25,750 + $773) × 6% × 1/2 year = 796
Total for 2008 1,569
June 30, 2009: ($26,523 + $796) × 6% × 6/12 = 820
Total accrued $3,139

3. Interest recognized in (2) ($750 + $1,569 + $820) $3,139

Interest recognized in (1) ($750 + $1,500 + $750) 3,000
Additional interest with compounding at 6% $ 139

LO 6 PROBLEM 9-7A INVESTMENT WITH VARYING INTEREST RATE

Principal at Interest Accumulated

Year Beginning of Year Factor at End of Period
2007 $2,000 1.04 $2,080
2008 2,080 1.05 2,184
2009 2,184 1.06 2,315
2010 2,315 1.07 2,477
2011 2,477 1.08 2,675

LO 6 PROBLEM 9-8A COMPARISON OF ALTERNATIVES

a. $270,000 × 1.0 = $270,000 n = 0, i = 8%

b. $294,300 × 0.926 (present value of $1 for n = 1, i = 8%) = $272,522
c. $334,750 × 0.857 (present value of $1 for n = 2, i = 8%) = $286,881
d. $82,500 × 3.312 (present value of annuity of $1 for n = 4, i = 8%) = $273,240
Option (a) is the least cost alternative.
 CHAPTER 9 • CURRENT LIABILITIES, CONTINGENCIES, AND THE TIME VALUE OF MONEY 9-39

LO 8 PROBLEM 9-9A PAYROLL TRANSACTIONS (Appendix A)

1. The effect on the accounting equation of accruing the amount payable to the
employees is as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

Salary Payable 228,080 Salary Expense (336,000)

Income Tax
Payable 68,000
FICA Tax
Payable 25,600
Heart Fund
Payable 9,280
Union Dues
Payable 5,040

2. The effect on the accounting equation when the employees are paid is as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

Cash (228,080) Salary Payable (228,080)

3. The effect on the accounting equation of recording the employer's payroll costs is
as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

FICA Tax Payroll Tax

Payable 25,600 Expense (35,680)
Unemployment
Tax Payable 10,080*

*$336,000 × 3% = $10,080

4. The effect on the accounting equation when the withholdings are remitted is as
follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

Cash (143,600) Income Tax

Payable (68,000)
FICA Tax
Payable (51,200)
Heart Fund
Payable (9,280)
Union Dues
Payable (5,040)
Unemployment
Tax Payable (10,080)
9-40 FINANCIAL ACCOUNTING SOLUTIONS MANUAL

LO 9 PROBLEM 9-10A COMPENSATED ABSENCES (Appendix A)

If sick days are allowed to accrue to employees and are paid to employees when they
retire, the sick days should be considered an expense when they are earned and not
when they are paid. The accountant should recommend a change in policy to corporate
headquarters. Divisional budgets should reflect the cost of sick days as they are earned.
This would prevent the problem that occurs when several employees all retire at the
same time. Of course, the policy should include measures to ensure that divisions do
not overestimate or underestimate the cost of accrued sick days.

ALTERNATE MULTI-CONCEPT PROBLEMS

LO 2,5 PROBLEM 9-11A INTEREST IN ADVANCE VERSUS INTEREST PAID WHEN LOAN
IS DUE

1. a. $206,400
b. $206,400/(100% – 14%) = $240,000

2. a. $206,400 × 14% = $28,896; $28,896/$206,400 = 14%

b. ($240,000 – $206,400)/$206,400 = 16.28%

3. a. The effect on the accounting equation of issuing the interest-bearing note on July
1, 2007, is as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

Cash 206,400 Notes Payable 206,400

The effect on the accounting equation of the accrual of interest on December 31,
2007, is as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

Interest Payable 14,448* Interest

Expense (14,448)

*$206,400 × 14% × 6/12 = $14,448

 CHAPTER 9 • CURRENT LIABILITIES, CONTINGENCIES, AND THE TIME VALUE OF MONEY 9-41

PROBLEM 9-11A (Concluded)

The effect on the accounting equation of payment of the note plus interest on July
1, 2008, is as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

Cash (235,296) Notes Payable (206,400) Interest

Interest Expense (14,448)
Payable (14,448)

b. The effect on the accounting equation of issuing the non-interest-bearing note

on July 1, 2007, is as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

Cash 206,400 Notes Payable 240,000

Discount on
Notes Payable (33,600)

The effect on the accounting equation of accruing interest on the note on December
31, 2007, is as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

Discount on Interest
Notes Payable 16,800* Expense (16,800)

*$33,600 × 1/2 = $16,800

The effect on the accounting equation of the payment of the note on July 1, 2008, is
as follows:

BALANCE SHEET INCOME STATEMENT

Assets = Liabilities + Stockholders’ Equity + Revenues – Expenses

Cash (240,000) Notes Payable (240,000) Interest

Discount on Expense (16,800)
Notes Payable 16,800

4. a. Note payable $206,400

b. Note payable $240,000
Less: Discount on note payable 33,600
$206,400
9-42 FINANCIAL ACCOUNTING SOLUTIONS MANUAL

LO 1,4 PROBLEM 9-12A CONTINGENT LIABILITIES

1. Items a, d, e: The liability is probable in occurrence, and an estimate is available.

2. Item b: The liability is possible, but an estimate is not available.
Item c is not recorded or disclosed, because it is a contingent asset.

LO 6,7 PROBLEM 9-13A TIME VALUE OF MONEY CONCEPTS

1. $19,500 × 5.895 (future value of $1 for n = 17, i = 11%) = $114,953

2. $84,974/$43,200 = 1.967; future value of $1 for n = 10, i = 7%
3. $30,000/1.714 = (future value of $1 for n = 7, i = 8%) = $17,503
OR: $30,000 × 0.583 (present value of $1 for n = 7, i = 8%) = $17,490. Slight
difference due to rounding.
4. $30,052/$11,600 = 2.591; future value of $1 for i = 10%, n = 10 years

LO 6,7 PROBLEM 9-14A COMPARISON OF ALTERNATIVES

a. $16,000 × 1.360 (future value of $1 for n = 4, i = 8%) = $21,760

b. $2,400 × 9.214 (future value of annuity of $1 for n = 8, i = 4%) = $22,114
c. $4,640 × 4.506 (future value of annuity of $1 for n = 4, i = 8%) = $20,908
Option (b) is preferable.

DECISION CASES

READING AND INTERPRETING FINANCIAL STATEMENTS

LO 1,2 DECISION CASE 9-1 FINISH LINE’S CURRENT LIABILITIES

1. For 2005: Current assets $381,527/Current liabilities $142,415 = 2.67

For 2004: Current assets $371,800/Current liabilities $137,016 = 2.71
The current ratio for both years indicates that the company has maintained a strong
liquidity position. The company has sufficient current assets on hand to meet its
obligations when they come due.
 CHAPTER 9 • CURRENT LIABILITIES, CONTINGENCIES, AND THE TIME VALUE OF MONEY 9-43

DECISION CASE 9-1 (Concluded)

2. Accrued property and sales tax would represent taxes that have been incurred by
the company but have not yet been paid. They are treated as an expense in the
period incurred under accrual accounting methods even though they will not be paid
until the following period.
3. A note to the statement indicates the company is party to several lawsuits. The
lawsuits have been disclosed in the notes but have not been recorded as a liability
on the balance sheet because the company does not feel that it is probable that a
material amount of loss will occur.

LO 3,4 DECISION CASE 9-2 COMPARING TWO COMPANIES IN THE SAME INDUSTRY:
FOOT LOCKER AND FINISH LINE

1. For 2005, Finish Line generated slightly more than $74 million from operating
activities, and Foot Locker generated $354 million. Both are positive indications
about the companies. It should be noted that Foot Locker is a larger company and
therefore must generate more from operating activities. For both companies, the
primary source of operating activities was the net income generated.
2. A negative amount for inventories in the operating category indicates the company
had to spend cash to increase its inventory levels. This could be a positive sign that
the company expects sales to increase. However, it should be monitored carefully to
make sure the company is not holding obsolete or unsalable inventory.
3. A positive amount for accounts payable indicates that accounts payable has
increased during the period. This is consistent with the increase in inventory levels
and indicates the company has purchased inventory on account and will have to pay
for it in the following period.
4. The most important reason was the $171 million recognized as depreciation and
amortization. Depreciation reduces a company’s net income but does not require
cash. Therefore, it appears as a positive amount on the statement of cash flows.

LO 3,4 DECISION CASE 9-3 MICROSOFT CORPORATION’S CONTINGENT LIABILITIES

1. How the settlement of the lawsuit should be treated is a matter of judgment. It

appears that the payment of $497 million is probable and the amount has been
determined. If that is the case, then the settlement should be recorded as an
expense on the income statement and as a current liability on the balance sheet. It
appears that Microsoft took such action and recorded the amount on its financial
statements.
9-44 FINANCIAL ACCOUNTING SOLUTIONS MANUAL

DECISION CASE 9-3 (Concluded)

2. Since the accrual is reported on the income statement, it affects the net income
reported. However, the amount does not represent a cash payment during 2004.
Therefore, the increase in the current liability representing the settlement should be
added back in the Operating Activities section of the cash flows statement. The
settlement will actually affect cash flows in the period that it is paid.
3. How the legal dispute should be reported is also a matter of judgment. In this case, it
does not appear that a loss was both probable and could be reasonably estimated at
the balance sheet date. Therefore, the company is not required to record a
contingent liability on the balance sheet but is required to disclose the existence of
the legal dispute in the notes. Accrual of the liability should occur when the company
believes that the loss is probable and the amount of the loss can be reasonably
estimated.

LO 4 DECISION CASE 9-4 FORD MOTOR COMPANY’S CONTINGENT LIABILITY

1. The company has stated quite strongly in the notes that in its belief the amount of
possible loss from the lawsuits in the future could not be estimated. (Note that the
company does not make statements about whether a loss is “probable.”) Because
the accounting rule requires a loss to be both probable and subject to reasonable
estimation, the company has not recorded a liability for the lawsuits as of the
balance sheet date.
2. The lawsuits regarding Firestone tires are still ongoing as of the date of publication
of the text. Therefore, it cannot be determined when Ford did in fact record the
liability related to the lawsuits and personal injury claims. However, events occurring
after 2000 may cause students to question whether or not the note in the 2000
annual report was sufficient reporting of the company’s exposure to loss.

MAKING FINANCIAL DECISIONS

LO 1,2 DECISION CASE 9-5 CURRENT RATIO LOAN PROVISION

1. The company is experiencing difficulties that are similar to many small, start-up
companies. The company must either take action to get a 2:1 ratio of current assets
to current liabilities or must approach its bank and ask for a modification of that
provision. If the firm wishes to achieve a 2:1 ratio, it must increase current assets,
decrease current liabilities, or both. Actions that should be considered include the
following:
a. Request from the bank a long-term line of credit to be used to pay the current
liabilities.
 CHAPTER 9 • CURRENT LIABILITIES, CONTINGENCIES, AND THE TIME VALUE OF MONEY 9-45

b. Work with creditors to stretch out the payment of liabilities in order to conserve
current assets.
DECISION CASE 9-5 (Concluded)

c. Speed the sale of inventory and the collection of cash from customers.
d. Delay the purchase of additional inventory.
Normally, a combination of all the above actions is necessary and should be
recommended. However, the above actions are rather short term in nature. The firm
must achieve a solid financial base to alleviate similar liquidity problems.
2. Some actions to improve liquidity are referred to as window-dressing. The term
refers to actions that artificially make the financial statements appear more favorable
for a short time. An example of window-dressing in this case would be to use current
assets to pay current liabilities which in many cases will increase the current ratio.
Window-dressing actions are seldom beneficial in the long run. In fact, such actions
do not recognize the other financial needs of the firm and may be detrimental in the
long run.

LO 7 DECISION CASE 9-6 ALTERNATIVE PAYMENT OPTIONS

The only way to compare the dollars is to determine the present value of each of these
options discounted at 8%.

a. $2,000 + [($18,000 × 1.08) × 0.926] = $20,001 (rounded)

b. $2,000 + [$18,000 × (1 + 0.02)4 × 0.926] = $20,042 (rounded)
c. $21,600 × 0.926 = $20,002 (rounded)

The present value of a $20,000 cash sale is $20,000. When these options are
compared, the option with the highest present value of cash flows, discounted at 8%, is
option (b). Kathy should also consider the financial position of the buyer, because these
amounts are not materially different. Since the buyer is starting a new business, she
may be better off taking the cash up front if it is possible for the buyer to get cash from
another source.
9-46 FINANCIAL ACCOUNTING SOLUTIONS MANUAL

ETHICAL DECISION MAKING

LO 4 DECISION CASE 9-7 WARRANTY COST ESTIMATE

The purpose of the case is to allow students to understand that judgment is necessary
in the accrual of an estimated liability such as warranty costs. Because the decision
requires the exercise of judgment, it should be emphasized that there is no right
answer, and in this case few good alternatives seem to exist. Discussion of the case
should
begin with the evidence available, which convinced John that 5% is inadequate as an
accrual for warranties. Can he rely on the evidence? Would others reach the same
conclusion with the same evidence? If students conclude that John should stick with his
decision, then the available courses of action should be examined.
Students should be encouraged to develop the pros and cons of (a) remaining silent
and accepting the 5% figure, (b) approaching the owner and informing him that the
expense is understated, (c) approaching the bank officer and relating his concern. While
options (b) and (c) may appear to be “morally correct,” students should see the negative
consequences that could result if John did not follow the chain of command. Can an
employee always make decisions that are consistent with personal and team
objectives?
Finally, students should be encouraged to develop innovative compromise solutions.
How could the company prevent similar situations? Could a third party serve as an
arbitrator? What should be the role of the internal and external auditors in this matter?

LO 4 DECISION CASE 9-8 RETAINER FEES AS SALES

The retainer fee should be recorded as sales when the sales are made and charged off
against the retainer. Even if the retainer were nonrefundable, the amount would be
recognized as sales at the time the goods are delivered, on the basis of the going
concern concept. The controller may be eager to show the amount as sales because
the amount may improve net income, since sales would be recorded with no
corresponding expenses. Ratios that involve net income would be improved. Working
capital would be increased because a lower liability amount would be reported.
Correspondingly, the working capital ratios would improve.
 CHAPTER 9 • CURRENT LIABILITIES, CONTINGENCIES, AND THE TIME VALUE OF MONEY 9-47

REAL WORLD PRACTICE 9.1

Accounts listed as current liabilities include the following:

Notes payable
Current maturities of long-term debt
Trade accounts payable
Income taxes payable
Liabilities associated with assets held for sale
Accrued expenses and other current liabilities

Trade Accounts Payable increased by $21.4 million ($123.7 – $102.3) from 2003 to
2004.

REAL WORLD PRACTICE 9.2

The accrued expenses include amounts owed, but unpaid, at the end of the period for
items such as salaries, utilities, and taxes. The items are not included in the Accounts
Payable account because the Accounts Payable account reflects the amount owed to
the companies from which Foot Locker buys parts and supplies used to produce its
products.