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Flashcards in Monetary Current Assets and Current Liabilities Deck (127):
1

At 12/31, a Company had the following balances at First State Bank:

  • Checking Account 101
  • Checking Account 102
  • Money Market Account
  • 90 Day CD
  • 180 Day CD (30 days left until maturity)

Which accounts are considered to be cash and cash equivalents?

  • Checking Account 101
  • Checking Account 102
  • Money Market Account
  • 90 Day CD

Note the 180 day CD is still not considered cash even though only 30 days remain until maturity. The original maturity date is the deciding factor.  

2

On October 31, 2005, Dingo, Inc. had cash accounts at three different banks. One account balance is segregated solely for a November 15, 2005, payment into a bond sinking fund. A second account, used for branch operations, is overdrawn. The third account, used for regular corporate operations, has a positive balance.

How should these accounts be reported in Dingo's October 31, 2005, classified balance sheet?

  1. The segregated account should be reported as a noncurrent asset, the regular account should be reported as a current asset, and the overdraft should be reported as a current liability.
  2. The segregated and regular accounts should be reported as current assets, and the overdraft should be reported as a current liability.
  3. The segregated account should be reported as a noncurrent asset, and the regular account should be reported as a current asset net of the overdraft.
  4. The segregated and regular accounts should be reported as current assets net of the overdraft.

The segregated account should be reported as a noncurrent asset, the regular account should be reported as a current asset, and the overdraft should be reported as a current liability.

The accounts are with different banks. Thus, the accounts cannot be offset against one another.

The overdraft is a liability because the bank honored a check or withdrawal causing the account to be negative. The firm owes the bank this amount.

The regular corporate account is part of the cash account, a current asset. The segregated account is a long-term investment. The cash in this asset is set aside for a specific purpose. There is no intent to use the cash for ordinary operating purposes.

3

The following are held by Smite Co.:

  • Cash in checking account $20,000
  • Cash in bond sinking fund account $30,000
  • Post-dated check from customer dated one month from balance sheet date $250
  • Petty cash $200
  • Commercial paper (matures in two months) $7,000
  • Certificate of deposit (matures in six months) $5,000

What amount should be reported as cash and cash equivalents on Smite's balance sheet?

  1. $57,200
  2. $32,200
  3. $27,450
  4. $27,200

$27,200

The cash balance is $20,200: the sum of the checking account balance and the petty cash. Because it has a maturity of less than three months, the only cash equivalent is the $7,000 of commercial paper. The final sum of these two accounts is $27,200.

4

The following information pertains to Grey Co. on December 31, 2003:

  • Checkbook balance $12,000
  • Bank statement balance $16,000
  • Check drawn on Grey's account, payable to a vendor, dated and recorded 12/31/03 but not mailed until 1/10/04 $1,800

On Grey's December 31, 2003 balance sheet, what amount should be reported as cash?

  • $12,000
  • $13,800
  • $14,200
  • $16,000

$13,800

The correct cash balance is the balance per the checkbook ($12,000) plus the $1,800 check written to the vendor, for a total of $13,800.

This check reduced the balance in the checkbook but was not mailed. Thus, the amount remains in Grey's cash balance at the end of the year. The bank statement balance is not the correct balance because information about transactions affecting cash near the end of the month, recorded by Grey, did not reach the bank by the cutoff date.

5

In preparing its August 31, 1990 bank reconciliation, Apex Corp. has the following information available:

  • Balance per bank statement, 8/31/90 $18,050
  • Deposit in transit, 8/31/90 $3,250
  • Return of customer's check for insufficient funds, 8/31/90 $600
  • Outstanding checks, 8/31/90 $2,750
  • Bank service charges for August $100

On August 31, 1990, Apex's correct cash balance is

  1. $18,550
  2. $17,950
  3. $17,850
  4. $17,550

$18,550

  • Balance per bank statement $18,050
  • Plus deposit in transit $3,250
  • Less outstanding checks ($2,750)
  • Equals ending cash balance $18,550

6

Hilltop Co.'s monthly bank statement shows a balance of $54,200. Reconciliation of the statement with company books reveals the following information:

  • Bank service charge $10
  • Insufficient funds check $650
  • Checks outstanding $1,500
  • Deposits in transit $350
  • Check deposited by Hilltop and cleared by the bank for $125, but improperly recorded by Hilltop as $152

What is the net cash balance after the reconciliation?

  1. $52,363.
  2. $53,023.
  3. $53,050.
  4. $53,077.

$53,050.

The reconciling items that need to be adjusted to the bank balance are: checks outstanding (-1,500) and deposit in transit (+350). The net cash after the reconciliation is: Bank balance $54,200 - 1,500 + 350 = $53,050. The bank service charge and insufficient funds are already reflected in the bank balance. The error is on Hilltop's books, not on the bank statement and therefore does not need to be included in the reconciliation.

7

The following information pertains to Park Co. on December 31, 2005:

  • Bank statement balance $10,000
  • Checkbook balance $14,000
  • Deposit in transit $5,000
  • Outstanding checks $1,000

In Park's December 31, 2005, balance sheet, cash should be reported as

  1. $9,000
  2. $10,000
  3. $14,000
  4. $15,000

$14,000

There is no information about errors in the book's records, represented by the checkbook balance. The deposit in transit and outstanding checks have been recorded by the firm. The checkbook balance reflects these amounts. It is the bank balance that does not. The checkbook balance is the correct ending cash balance.
As a check, take the ending balance per the bank + deposits in transit - outstanding checks; $10,000 + $5,000 - $1,000 = $14,000.

8

The following information relates to Jay Co.'s accounts receivable for 2004:

Accounts receivable, 1/1/04 $650,000

Credit sales for 2004 $2,700,000

Sales returns for 2004 $75,000

Accounts written off during 2004 $40,000

Collections from customers during 2004 $2,150,000

Estimated future sales returns at 12/31/04 $50,000

Estimated uncollectible accounts at 12/31/04 $110,000

What amount should Jay report for accounts receivable, before allowances for sales returns and uncollectible accounts, on December 31, 2004?

  1. $1,200,000
  2. $1,125,000
  3. $1,085,000
  4. $925,000

$1,085,000

The question is asking for the gross accounts receivable balance, before allowances for future sales returns, allowances, and uncollectible accounts:

AR 1/1 + Credit sales - Sales returns - Write-offs - Collections = AR 12/31 

$650,000 + $2,700,000 - $75,000 - $40,000 - $2,150,000 = $1,085,000

9

When the allowance method of recognizing uncollectible accounts is used, the entries at the time of collection of a small account previously written off would?

  1. Increase the allowance for uncollectible accounts.
  2. Increase net income.
  3. Decrease the allowance for uncollectible accounts.
  4. Have no effect on the allowance for uncollectible accounts.

Increase the allowance for uncollectible accounts.

The entries are:

  • Dr. Accounts receivable (Increase)
  • Cr. Allowance for uncollectibles (Increase)
  • Dr. Cash (Increase
    • Cr. Accounts receivable (Decrease)

10

Gibbs Co. uses the allowance method for recognizing uncollectible accounts. Ignoring deferred taxes, the entry to record the write-off of a specific uncollectible account

  1. Affects neither net income nor working capital.
  2. Affects neither net income nor accounts receivable.
  3. Decreases both net income and accounts receivable.
  4. Decreases both net income and working capital.

Affects neither net income nor working capital.

The entry is:

  • Dr. Allowance for uncollectible accounts (Decrease)
    • Cr. Accounts receivable (Decrease)

The allowance is contra to accounts receivable and thus the entry does not affect net accounts receivable. The entry does not affect current assets, working capital, or income. However, the entry does reduce gross accounts receivable. Thus, the answer "affects neither net income nor working capital" is the only possible correct answer. The answer "affects neither net income nor accounts receivable" is incorrect if "accounts receivable" is interpreted as gross accounts receivable.

11

Rue Co.'s allowance for uncollectible accounts had a credit balance of $12,000 on December 31, 2002. During 2003, Rue wrote-off uncollectible accounts of $48,000. The aging of accounts receivable indicated that a $50,000 allowance for uncollectible accounts was required on December 31, 2003. What amount of uncollectible accounts expense should Rue report for 2003?

  1. $48,000
  2. $50,000
  3. $60,000
  4. $86,000

$86,000

The preadjusted ending 2003 allowance balance is a $36,000 debit ($12,000 cr. beginning balance - $48,000 dr. from write-offs). When accounts are written off, the allowance is debited and accounts receivable is credited. The aging schedule indicates that a $50,000 ending credit allowance balance is required. Therefore, $86,000 of uncollectible accounts expense must be recognized to change the allowance balance from $36,000 dr. to $50,000 cr. An equation or T account approach also can be used to analyze the allowance account: Beginning balance $12,000 - write-offs $48,000 + uncollectible accounts expense (?) = Ending balance $50,000. Solving for uncollectible accounts expense yields $86,000.

12

During the year, Hauser Co. wrote off a customer's account receivable. Hauser used the allowance method for uncollectable accounts. What impact would the write-off have on net income and total assets?

  • Net income   
  • Total assets

  • Net income - NO EFFECT
  • Total assets - NO EFFECT

Under the allowance method for uncollectible accounts there is no impact on the balance sheet or net income when the receivable is written off. The estimated uncollectible is recognized at the time of the sale; therefore, when the account is written, off the allowance and the accounts receivable are both reduced resulting in no effect on the income statement or balance sheet.

13

Tinsel Co.'s balances in allowance for uncollectible accounts were $70,000 at the beginning of the current year and $55,000 at year end. During the year, receivables of $35,000 were written off as uncollectible. What amount should Tinsel report as uncollectible accounts expense at year end?

  1. $15,000
  2. $20,000
  3. $35,000
  4. $50,000

$20,000

To determine the amount of uncollectible expense (bad debt expense) use T accounts. Solve for ???? = 20,000

Allowance for uncollectible

70,000 Beg balance

Write-offs 35,000

???? Bad debt expense

$55,000 Ending Balance

  

 55,000 End balance

14

Adam Co. reported sales revenue of $2,300,000 in its income statement for the year ended December 31, 2005. Additional information was as follows:

  • Accounts receivable - Increase $150,000
  • Allowance for uncollectible accounts - Increase ($25,000)

Uncollectible accounts totaling $10,000 were written off during 2005. Under the cash basis of accounting, Adam would have reported 2005 sales of:

  1. $2,140,000
  2. $2,150,000
  3. $2,175,000
  4. $2,450,000

$2,140,000

Under the cash basis of accounting, sales equals cash collected from customers. An equation or T account may be used to determine this amount:

AR beginning + Sales - Write-offs - customer collections = AR ending

$500,000 + $2,300,000 - $10,000 - ???? = $650,000

Solving for the unknown (?) amount, customer collections equals $2,140,000. 

This is the amount collected from customers, and is the amount that would be reported as sales under the cash basis method of accounting.

15

Which method of recording uncollectible accounts expense is consistent with accrual accounting?

  • Allowance   
  • Direct write-off

  • Allowance - YES
  • Direct write-off - NO

The allowance method recognizes the estimate of bad debt expense (uncollectible accounts expense) in the year of sale. This is an example of accrual accounting, which measures expenses when incurred and revenues when earned.

The direct write-off method recognizes bad debt expense in the year of write-off, which may be after the year of sale. The direct write-off method is not consistent with accrual accounting.

16

When the allowance method of recognizing uncollectible accounts is used, how would the collection of an account previously written off affect accounts receivable and the allowance for uncollectible accounts?

  • Accounts receivable   
  • Allowance for uncollectible accounts  

  • Accounts receivable - NO EFFECT
  • Allowance for uncollectible accounts - INCREASE

The collection reverses the reduction in the allowance account when the specific account was written off. There is no net change in gross accounts receivable because the account was collected. The two journal entries often given for this transaction are: (1) dr. Accounts receivable, cr. Allowance; (2) dr. Cash; cr. Accounts receivable. The first entry reinstates the allowance. The offsetting debits and credits for accounts receivable in both two entries provide an internal record of the transaction.

17

Pie Co. uses the installment sales method to recognize revenue. Customers pay the installment notes in 24 equal monthly amounts, which include 12% interest.

What is an installment note's receivable balance six months after the sale?

  1. 75% of the original sales price.
  2. Less than 75% of the original sales price.
  3. The present value of the remaining monthly payments discounted at 12%.
  4. Less than the present value of the remaining monthly payments discounted at 12%.

The present value of the remaining monthly payments discounted at 12%.

The question does not specify the exact meaning of the term "note receivable balance." When the term "gross" is not applied, it is safe to assume that the balance referred to is the net balance, that is, net of interest yet to be recognized.

Notes are reported at present value, which is the amount net of interest yet to be recognized. However, note balances under the installment method include deferred gross margin yet to be realized, because deferred gross margin is subtracted as a separate line item.

Thus, the question is referring to the notes receivable balance exclusive of interest yet to be recognized, but inclusive of deferred gross margin yet to be realized. The note's balance is the present value of the remaining payments. This is a two-year note. Therefore, valuation at present value is required. The note's valuation is the present value of the remaining payments at the original discount rate.

18

Ace Co. sold King Co. a $20,000, 8%, 5-year note that required five equal annual year-end payments. This note was discounted to yield a 9% rate to King. The present value factors of an ordinary annuity of $1 for five periods are as follows:

8%3.992

9%3.890

What should be the total interest revenue earned by King on this note?

  1. $9,000
  2. $8,000
  3. $5,560
  4. $5,050

$5,560

Total interest over the life of the note equals the total amount paid by Ace over the life of the note less the proceeds to Ace. The proceeds equal the present value of the payments at the 9% yield rate. The annual payment is found using the 8% rate because that rate is contractually set and determines the annual payment.

The annual payment P is found as: $20,000 = P(3.992). P = $5,010

Total interest revenue = total payments by Ace - proceeds to Ace 
= 5($5,010) - $5,010(3.89) = $5,560.

19

Garr Co. received a $60,000, 6-month, 10% interest-bearing note from a customer. After holding the note for two months, Garr was in need of cash and discounted the note at the United Local Bank at 12%. 
The amount of cash Garr received from the bank was

  1. $60,480
  2. $60,630
  3. $61,740
  4. $62,520

$60,480

The calculation leading to the correct answer is:Maturity value of the note: $60,000 + $60,000(.10)(6/12) = $63,000

Less discount to bank: $63,000(.12)(4/12) = 2,520

Equals proceeds to Garr $60,480

20

After being held for 40 days, a 120-day, 12% interest-bearing note receivable was discounted at a bank at 15%. The proceeds received from the bank equal

  1. Maturity value less the discount at 12%.
  2. Maturity value less the discount at 15%.
  3. Face value less the discount at 12%.
  4. Face value less the discount at 15%.

Maturity value less the discount at 15%.

The bank charges its discount (its fee) on the maturity value, which is the face value of the note plus 12% interest for 120 days. The bank charges 15% on this amount for the 80 remaining days in the note term. Thus, the proceeds equal the maturity value less its fee.

21

Milton Co. pledged some of its accounts receivable to Good Neighbor Financing Corporation in return for a loan. Which of the following statements is correct?

  1. Good Neighbor Financing cannot take title to the receivables if Milton does not repay the loan. Title can only be taken if the receivables are factored.
  2. Good Neighbor Financing will assume the responsibility of collecting the receivables.
  3. Milton will retain control of the receivables.
  4. Good Neighbor Financing will take title to the receivables, and will return title to Milton after the loan is paid.

Milton will retain control of the receivables.

In a pledge arrangement, the title remains with the originator, in this case with Milton Co.

22

On November 1, 2004, Davis Co. discounted with recourse at 10%, a one-year, noninterest-bearing, $20,500 note receivable maturing on January 31, 2005.

What amount of contingent liability for this note must Davis disclose in its financial statements for the year ended December 31, 2004?

  1. $0
  2. $20,000
  3. $20,333
  4. $20,500

$20,500

The firm is contingent for the maturity amount, which for a noninterest-bearing note is the face value. If the maker of the note fails to pay the bank or financial institution with whom Davis discounted the note, Davis would be called on to pay the entire maturity amount.

23

On April 1, Aloe, Inc. factored $80,000 of its accounts receivable without recourse. The factor retained 10% of the accounts receivable as an allowance for sales returns and charged a 5% commission on the gross amount of the factored receivables. What amount of cash did Aloe receive from the factored receivables?

  1. $68,000
  2. $68,400
  3. $72,000
  4. $76,000

$68,000

The net cash received when the receivables were factored was $80,000 x .85 (100% - 10% - 5%) = $68,000.

24

Choose the correct accounting by the creditor for a loan impairment. 

  1. recognize a loss or expense upon recognizing the impairment. Column
  2. rate of interest to use in computing the revised book value of the receivable after the impairment.

YES/NO?

Original effective rate / New imputed Effective Rate?

  1. Yes  
  2. Original effective rate 

A loan impairment is recorded by reducing the net book value of the receivable to the present value of probable future cash inflows, discounted at the original rate in the receivable. The original rate is used because the loan continues to exist. The loss to the firm is measured at the rate existing when the original loan was created. The difference between the book value and present value, at the date of recognizing the impairment, is recorded as an expense or loss. There is no reason to report overstated assets.

25

When a note receivable is determined to be impaired,

  1. The note is written-off.
  2. No recognition of the impairment is required until a formal troubled-debt restructuring takes place.
  3. The note is written down to the nominal sum of future cash flows expected to be collected, including interest.
  4. A loss or expense is recognized as equal to the difference between the note carrying value and the present value of the cash flows expected to be received.

A loss or expense is recognized as equal to the difference between the note carrying value and the present value of the cash flows expected to be received.

A note is considered to be impaired if the present value of remaining cash flows is less than book value, using the rate in the note. This is caused by an expected delay in timing of cash flows or reduction in amount of cash flows compared with the original agreement. The creditor makes the determination that the note is impaired and writes the note down to present value. A loss is recorded for the decline in carrying value to present value.

26

On January 2, 2003, Emme Co. sold equipment with a carrying amount of $480,000 in exchange for a $600,000 noninterest-bearing note due January 2, 2006.

There was no established exchange price for the equipment. The prevailing rate of interest for a note of this type on January 2, 2003, was 10%. The present value of $1 at 10% for three periods is 0.75.

In Emme's 2003 income statement, what amount should be reported as gain (loss) on sale of machinery?

  1. ($30,000) loss.
  2. $30,000 gain.
  3. $120,000 gain.
  4. $270,000 gain.

($30,000) loss.

The proceeds on sale are measured as the present value of the note because there is no established market value for the equipment. The loss on sale is computed as:

Carrying amount $480,000

Less proceeds on sale: $600,000(.75) = 450,000

Equals loss on sale $30,000

27

Lyle, Inc. is preparing its financial statements for the year ended December 31, 2004. Accounts payable amounted to $360,000 before any necessary year-end adjustment related to the following:

At December 31, 2004, Lyle has a $50,000 debit balance in its accounts payable to Ross, a supplier, resulting from a $50,000 advance payment for goods to be manufactured to Lyle's specifications.

Checks in the amount of $100,000 were written to vendors and recorded on December 29, 2004. The checks were mailed on January 5, 2005.

What amount should Lyle report as accounts payable in its December 31, 2004 balance sheet?

  1. $510,000
  2. $410,000
  3. $310,000
  4. $210,000

$510,000

  • Balance before adjustments $360,000
  • Plus the advance, which should be placed in an asset account: advances to supplier. The $50,000 is added to accounts payable because accounts payable was debited on payment of the advance.$50,000
  • Include the amounts for checks written but not mailed. This amount should be reinstated to cash. $100,000
  • Equals correct ending balance $510,000

28

Bake Co.'s trial balance included the following at December 31, 2003:

  • Accounts payable $80,000
  • Bonds payable, due 2004 $300,000
  • Discount on bonds payable $15,000
  • Deferred income tax liability $25,000

The deferred income tax liability is not related to an asset for financial accounting purposes and is expected to reverse in 2004. What amount should be included in the current liability section of Bake's December 31, 2003 balance sheet?

  1. $365,000
  2. $390,000
  3. $395,000
  4. $420,000

$390,000

All of the items are current liabilities. The computation is:
80,000+(300,000-15,000)+25,000=$390,000.

29

Kew Co.'s accounts payable balance at December 31, 2002 was $2,200,000 before considering the following data:

  • Goods shipped to Kew F.O.B. shipping point on December 22, 2002 were lost in transit. The invoice cost of $40,000 was not recorded by Kew. On January 7, 2003, Kew filed a $40,000 claim against the common carrier.
  • On December 27, 2002, a vendor authorized Kew to return, for full credit, goods shipped and billed at $70,000 on December 3, 2002. The returned goods were shipped by Kew on December 28, 2002. A $70,000 credit memo was received and recorded by Kew on January 5, 2003.
  • Goods shipped to Kew F.O.B. destination on December 20, 2002 were received on January 6, 2003. The invoice cost was $50,000.

What amount should Kew report as accounts payable in its December 31, 2002 balance sheet?

  1. $2,170,000
  2. $2,180,000
  3. $2,230,000
  4. $2,280,000

$2,170,000

  • Preadjusted balance $2,200,000
  • Plus cost of goods in transit. The goods became the property of Kew at the shipping point (FOB shipping point). Kew owes the vendor for the goods. $40,000
  • Less credit for returned goods shipped back to vendor before year-end ($70,000)
  • Total accounts payable $2,170,000

30

Which of the following is generally associated with payables classified as accounts payable?

  • Periodic payment of interest    
  • Secured by collateral  

  • Periodic payment of interest - NO   
  • Secured by collateral - NO

Accounts payable is also labeled: accounts payable, trade. The accounts payable account is used only for routine trade payables, typically for purchases of inventory and supplies.

Interest accrued is recorded in accrued interest payable, and secured debt is recorded in other specifically-labeled liability accounts.

31

On December 31, 2005, special insurance costs, incurred but unpaid, were not recorded.

If these insurance costs were related to work-in-process, what is the effect of the omission on accrued liabilities and retained earnings in the December 31, 2005 balance sheet?

  • Accrued liabilities
  • Retained earnings

  • Accrued liabilities - UNDERSTATED
  • Retained earnings - NO EFFECT

Accrued liabilities are understated because the insurance costs were incurred but not paid. The firm has an obligation for coverage received. The omitted journal entry is: 

  • Dr. Work in process 
    • Cr. Accrued payables 

Retained earnings is unaffected because no expense has been incurred. The omission of the above entry has no effect on expenses or retained earnings.

Work in process is an asset. When work in process is completed and sold, this part of the total cost of work in process will be expensed.

32

As of December 1, year 2 a company obtained a $1,000,000 line of credit maturing in one year on which it has drawn $250,000, a $750,000 secured note due in five annual installments, and a $300,000 three-year balloon note. The company has no other liabilities. How should the company's debt be presented in its classified balance sheet on December 31, year 2 if no debt repayments were made in December?

  1. Current liabilities of $1,000,000; long-term liabilities of $1,050,000.
  2. Current liabilities of $500,000; long-term liabilities of $1,550,000.
  3. Current liabilities of $400,000; long-term liabilities of $900,000.
  4. Current liabilities of $500,000; long-term liabilities of $800,000

Current liabilities of $400,000; long-term liabilities of $900,000.

This question has three debt instruments that need to be categorized into current or long-term. The line of credit is due in one year so it is all current. The secured note is due in 5 annual installments so 1/5 is current and 4/5 is long-term. The balloon note is due in 3 years so it is all long term.

33

Wilk Co. reported the following liabilities at December 31, 2001:

  • Accounts payable trade $750,000
  • Short-term borrowings $400,000
  • Bank loan (current portion $100,000) $3,500,000
  • Other bank loan, matures June 30, 2002 $1,000,000

The bank loan of $3,500,000 was in violation of the loan agreement. The creditor had not waived the rights for the loan. What amount should Wilk report as current liabilities at December 31, 2001?

A.  $1,250,000

B.  $2,150,000

C.  $2,250,000

D.  $5,650,000

$5,650,000

Current liabilities are obligations of an entity that are expected to require the use of current assets or the providing of services (or the creation of another liability that will require the use of current assets or provision of services) during the next year or operating cycle, whichever is longer. 

For Wilk Co., accounts payable-trade, short-term borrowings, and the other bank loan, which matures during next year, are all (conventional) current liabilities. 
The bank loan for $3,500,000 also must be classified in total as a current liability because Wilk is in violation of the terms of the loan agreement, and the creditor has not waived its right to demand immediate loan payment.

The sum of the four accounts is $5,650,000.

34

Mill Co.'s trial balance included the following account balances at December 31, 2003:

Accounts payable $15,000

Bonds payable, due 2004 $25,000

Discount on bonds payable, due 2004 $3,000

Dividends payable 1/31/04 $8,000

Notes payable, due 2005 $20,000

What amount should be included in the current liability section of Mill's December 31, 2003 balance sheet?

  1. $45,000
  2. $51,000
  3. $65,000
  4. $78,000

$45,000

Each item in the list, except the notes payable, due more than one year from the 2003 balance sheet should be included in current liabilities. Except the notes payable, each item is due within one year of the 2003 balance sheet. The discount reduces the net bond liability.

Thus, current liabilities total $45,000 = $15,000 + ($25,000 - $3,000) + $8,000.

35

Kemp Co. must determine the December 31, 2002, year-end accruals for advertising and rent expenses. A bill for $500 in advertising expenses was received January 7, 2003, comprising costs of $375 for advertisements in December 2002 issues, and $125 for advertisements in January 2003 issues of the newspaper.

A store lease, effective December 16, 2001, calls for fixed rent of $1,200 per month, payable one month from the effective date and monthly thereafter. In addition, rent equal to 5% of net sales over $300,000 per calendar year is payable on January 31 of the following year. Net sales for 2002 were $550,000.

In its December 31, 2002 balance sheet, Kemp should report accrued liabilities of

  1. $12,875
  2. $13,000
  3. $13,100
  4. $13,475

$13,475

  • Portion of the $500 advertising bill relating to December 2002 $375
  • Lease rental ($1,200 x 1/2 of December) $600
  • Additional rental based on sales (.05)($550,000 - $300,000) $12,500
  • Total current liabilities = $13,475

36

Black Corp.'s accounts payable at December 31, 2004, totaled $900,000 before any necessary year-end adjustments relating to the following transactions:

On December 27, 2004, Black wrote and recorded checks to creditors totaling $400,000, causing an overdraft of $100,000 in Black's bank account at December 31, 2004. The checks were mailed out on January 10, 2005.

On December 28, 2004, Black purchased and received goods for $153,061, terms 2/10, n/30. Black records purchases and accounts payable at net amounts. The invoice was recorded and paid on January 3, 2005.

Goods shipped F.O.B. destination on December 20, 2004 from a vendor to Black were received January 2, 2005. The invoice cost was $65,000.

At December 31, 2004, what amount should Black report as total accounts payable?

  1. $1,515,000
  2. $1,450,000
  3. $1,153,061
  4. $1,053,061

$1,450,000

There is no liability at December 31, 2004 for the goods shipped FOB destination because title does not pass until the goods reach the destination, which did not occur until January. 

The firm must include the Dec. 28 receipt of goods in accounts payable because the firm has received the goods.

37

Dana Co.'s officers' compensation expense account had a balance of $224,000 at December 31, 2004 before any appropriate year-end adjustment relating to the following:

  • No salary accrual was made for December 30-31, 2004. Salaries for the two-day period totaled $3,500.
  • 2004 officers' bonuses of $62,500 were paid on January 31, 2005.

In its 2004 income statement, what amount should Dana report as officers' compensation expense?

  1. $290,000
  2. $286,500
  3. $227,500
  4. $224,000

$290,000

Both adjustments are included in compensation expense because they are costs of services rendered by employees in 2004. The firm has incurred a liability and therefore an expense as of 12/31/92 for each of these items. $290,000 = $224,000 + $3,500 + $62,500.

38

Lime Co.'s payroll for the month ended January 31, 2005, is summarized as follows:

  • Total wages $10,000
  • Federal income tax withheld $1,200

All wages paid were subject to FICA. FICA tax rates were 7% each for employee and employer. Lime remits payroll taxes on the 15th of the following month. In its financial statements for the month ended January 31, 2005, what amounts should Lime report as total payroll tax liability and as payroll tax expense?

  • Liability?
  • Expense?

  • Liability $2,600
  • Expense $700

The liability is the sum of the income tax withheld ($1,200) and twice the FICA rate applied to wages ($10,000 x .14 = $1,400) for a total of $2,600. The firm must pay 7% as well as the employees. The firm withholds the employee's 7% FICA tax thus increasing the firm's liability for FICA until these amounts are remitted, which occurs the next month.

The only firm expense is the firm's share of FICA tax: .07 x $10,000 or $700. The employee income tax and FICA withholdings are not expenses of the firm but rather of the employees.

39

Buc Co. receives deposits from its customers to protect itself against nonpayments for future services. These deposits should be classified by Buc as

  1. A.  A liability.
  2. B.  Revenue.
  3. C.  A deferred credit deducted from accounts receivable
  4. D.  A contra account

A liability.

The firm has an obligation to return the deposit, and therefore records a liability upon receipt. It is probable that the deposit will be returned, and it is a result of a past transaction. A deposit meets the general definition of a liability.

40

Barnel Corp. owns and manages 19 apartment complexes. On signing a lease, each tenant must pay the first and last month's rent and a $500 refundable security deposit.

The security deposits are rarely refunded in total, because cleaning costs of $150 per apartment are almost always deducted. About 30% of the time, the tenants are also charged for damages to the apartment, which typically cost $100 to repair.

If a one-year lease is signed on a $900 per month apartment, what amount would Barnel report as refundable security deposit?

  1. $1,400
  2. $500
  3. $350
  4. $320

$500

The damage deposit on all apartments is $500. Although it is likely that most tenants will be charged for some damages and cleaning, these reductions in the amount to be reimbursed cannot be anticipated. The damage to the apartments typically is not known until the end of the lease term.

The firm must maintain its $500 liability until the condition of each apartment becomes known at the end of the lease term. The conditions causing the need for repair or cleaning may not have occurred as of the balance sheet date.

41

On March 1, 2004, Fine Co. borrowed $10,000 and signed a two-year note bearing interest at 12% per annum compounded annually. Interest is payable in full at maturity on February 28, 2006.

What amount should Fine report as a liability for accrued interest at December 31, 2005?

  1. $0
  2. $1,000
  3. $1,200
  4. $2,320

$2,320

The accrued interest covers the period from the borrowing to 12/31/94 because no interest has yet been paid. The interest is also compounded (this is a stumbling point easily missed).

The 2005 ending balance in accrued interest payable therefore includes interest on 2004's accrued interest:

  • 2004: $10,000(.12)(10/12) $1,000
  • 2005: ($10,000 + $1,000)(.12)(12/12) #1,320
  • Total accrued interest payable, December 31, 2005 $2,320

42

A company issued a short-term note payable to a bank with a stated 12 percent rate of interest . The bank charged a .5% loan origination fee and remitted the balance to the company.

The effective interest rate paid by the company in this transaction would be

  1. Equal to 12.5%.
  2. More than 12.5%
  3. Less than 12.5%.
  4. Independent of 12.5%

More than 12.5%

The .5% loan origination fee reduces the proceeds to the borrower AND increases the total interest to be paid by the same amount. The effect is to raise the interest rate above 12.5%.

Assume the loan amount is $1,000 before the loan origination fee. Therefore, the net amount loaned is $995 [1 - .005($1,000)]. However, the full $1,000 must be paid at maturity. The total interest to be paid is thus increased by the $5 origination fee ($1,000 - $995).

For simplicity, assume the loan is for a full year. Then total interest paid is: .12($1,000) + $5 = $125.

The effective rate of interest for the year then is: $125/$995 = .1256. This exceeds 12.5%.

43

Mann Corp.'s liability account balances at June 30, 2003 included a 10% note payable in the amount of $3,600,000. 
The note is dated October 1, 2002, and is payable in three equal annual payments of $1,200,000 plus interest. The first interest and principal payment was made on October 1, 2003.

In Mann's June 30, 2004 balance sheet, what amount should be reported as accrued interest payable for this note?

  1. $270,000
  2. $180,000
  3. $90,000
  4. $60,000

$180,000

On October 1, 2003, the first payment was made. This payment included all interest due to that point, as well as the first $1,200,000 principal payment.

Thus, on that date, the liability balance is $2,400,000 (the remaining two principal payments). June 30, 2004 is 9 months after this first payment date. The accrued interest for 9 months is $180,000 = $2,400,000(.10)(9/12).

44

At December 31, 2005, a $1,200,000 note payable was included in Cobb Corp.'s liability account balances. The note is dated October 1, 2005, bears interest at 15%, and is payable in three equal annual payments of $400,000. The first interest and principal payment was made on October 1, 2006. In its December 31, 2006 balance sheet, what amount should Cobb report as accrued interest payable for this note?

  1. $135,000
  2. $90,000
  3. $45,000
  4. $30,000

$30,000

The $30,000 answer is correct and equals ($1,200,000 - $400,000)(.15)(3/12).

On 10/1/06, the first $400,000 principal payment was made. That left $800,000 of principal balance remaining on 10/1/06. The interest on that amount is computed as shown above.

45

Which of the following is reported as interest expense?

  1. Pension cost interest.
  2. Postretirement healthcare benefits interest
  3. Imputed interest on noninterest-bearing note
  4. Interest incurred to finance construction of machinery for own use

Imputed interest on noninterest-bearing note

A noninterest-bearing note actually causes interest to be paid by the maker. The term noninterest-bearing means that the note carries no stated rate of interest. The face value of the note includes interest however, and exceeds the principal amount of the note (the amount borrowed).

For example, a firm might borrow $4,000 and sign a $5,000 noninterest-bearing note. When the firm pays the $5,000 at maturity, it will be paying $1,000 in interest. The term "imputed" interest means that in computing interest expense, the amount of interest implied in the note (difference between face value and principal) is used to compute the interest rate for recognizing interest expense over the term of the note.

46

On September 30, World Co. borrowed $1,000,000 on a 9% note payable. World paid the first of four quarterly payments of $264,200 when due on December 30. In its December 31, balance sheet, what amount should World report as note payable?

  1. $735,800
  2. $750,000
  3. $758,300
  4. $825,800

$758,300

The first payment included interest of $22,500 (.09 x .25 x $1,000,000). Note that interest rates are always expressed for an annual period. Only 25% of year elapsed from Sept. 30 to the end of the year. The rest of the payment ($241,700 = $264,200 - $22,500) is principal. The note payable balance at Dec. 31 therefore is $758,300 ($1,000,000 - $241,700).

47

Taylored Corp. factors $200,000 of accounts receivable in a transaction in which control is surrendered and without recourse to Rich Corp. on July 1, year 1.  Rich assessed a fee of 3% and retains a holdback equal to 5% of the accounts receivable. In addition, Rich charged 15% interest computed on a weighted-average time to maturity of the receivables of 41 days.
 
Which of the following statements is correct?

  1. Taylored should record a liability on factoring of AR of $200,000.
  2. Taylored should remove all of the receivables from the books by crediting AR by $200,000.
  3. Taylored should remove the receivables without any holdback from the books by crediting AR by $190,000.
  4. Taylored should record a liability of $10,000 related to the holdback.

Taylored should remove all of the receivables from the books by crediting AR by $200,000.

A transfer in which control is surrendered does transfer title and therefore the receivables should be removed (credited) from the borrower’s balance sheet. If the factor retains a holdback for anticipated returns, a factor’s holdback (due from factor) is recorded as an asset.

48

Selected information for Cain Corp. for the year ended December 31, year 1, follows:

  • Average days’ sales in inventories 124
  • Average days’ sales in accounts receivable 48

The average number of days in the operating cycle for year 1 was

  1. 172
  2. 124
  3. 86
  4. 76

172

The average number of days in the operating cycle measures the length of time from purchase of inventory to collection of cash.  The formula is

  • Average days’ sales in inventories+Average days’ sales in accts. receivable=Average days’ operating cycle

124 days+48 days=172 days

Note that the average days’ sales in inventories measures the number of days from the purchase of inventory to the sale of inventory, while the average days’ sales in accounts receivable measures the number of days from the sale of inventory to the collection of cash.

49

A company has a current ratio of 2 to 1. This ratio will decrease if the company

  1. Receives a 5% stock dividend on one of its marketable securities.
  2. Pays a large account payable which had been a current liability.
  3. Borrows cash on a 6-month note.
  4. Sells merchandise for more than cost and records the sale using the perpetual inventory method.

Borrows cash on a 6-month note.

The issuance of a note for cash would increase both the numerator (current assets) and the denominator (current liabilities) an equal amount, thereby decreasing the current ratio. For example, assume the current ratio is 2/1. If the company issues a note that increases the current assets to 2.5 and the current liabilities to 1.5, the effect would be a decrease of the current ratio.

50

Tone Company is the defendant in a lawsuit filed by Witt in year 1 disputing the validity of a copyright held by Tone. At December 31, year 1, Tone determined that Witt would probably be successful against Tone for an estimated amount of $400,000. Appropriately, a $400,000 loss was accrued by a charge to income for the year ended December 31, year 1.  On December 15, year 2, Tone and Witt agreed to a settlement providing for cash payment of $250,000 by Tone to Witt, and transfer of Tone’s copyright to Witt.  The carrying amount of the copyright on Tone’s accounting records was $60,000 at December 15, year 2.  What would be the effect of the settlement on Tone’s income before income tax in year 2?

  1. No effect.
  2. $60,000 decrease.
  3. $90,000 increase.
  4. $150,000 increase.

$90,000 increase.

At 12/31/Y1, the contingent liability from the lawsuit met ASC Topic 450’s criteria for accrual (probable and reasonably estimable), so a loss and liability of $400,000 was recognized.  In year 2, the lawsuit was settled and the actual loss was $310,000 ($60,000 copyright transfer and $250,000 cash payment). This is a change in estimate which should be accounted for in the period of change per ASC Topic 250.  Therefore the $90,000 difference will be reflected in year 2 income.  The journal entry on 12/15/Y2 to record the settlement would be
 

  • Lawsuit liability 400,000 
  •      Gain from settlement of lawsuit 90,000
  •      Cash 250,000
  •      Copyright 60,000

51

Tinsel Co.'s balances in allowance for uncollectible accounts were $70,000 at the beginning of the current year and $55,000 at year-end. During the year, receivables of $35,000 were written off as uncollectible. What amount should Tinsel report at uncollectible accounts expense at year-end?

  1. $15,000
  2. $20,000
  3. $35,000
  4. $50,000

$20,000

Uncollectible accounts expense is equal to the ending allowance balance plus accounts written off less reinstatements less the beginning allowance balance ($55,000 − $70,000 + $35,000 = $20,000).

52

Marshall Company prepared an aging of its accounts receivable at December 31, year 2, and determined that the net realizable value of the receivables at that date is $50,000.  Additional information is available as follows:

  • Accounts receivable at December 31, year 1 $48,000
  • Accounts receivable at December 31, year 254,000
  • Allowance for doubtful accounts at December 31, year 1—credit balance 6,000
  • Accounts written off as uncollectible during year 25,000

Marshall’s bad debt expense for the year ended December 31, year 2, was

  1. $3,000
  2. $4,000
  3. $5,000
  4. $7,000

$3,000

The solutions approach is to prepare a T- account for the allowance for doubtful accounts.  The difference between the December 31, year 2, accounts receivable and the net realizable value is $4,000 ($54,000 − $50,000).  This the amount needed to reduce the gross accounts receivable to its net realizable value. Thus, the ending balance of the allowance for doubtful accounts should be $4,000.

53

A material overstatement in ending inventory was discovered after the year-end financial statements of a company were issued to the public.  What effect did this error have on the year­end financial statements?

  • Current assets
  • Gross profit

  • Current assets - Overstated
  • Gross profit - Overstated

An understatement of cost of goods sold will result in gross profit being overstated for the year.

54

Abbot Co. is being sued for illness caused to local residents as a result of negligence on the company’s part in permitting the local residents to be exposed to highly toxic chemicals from its plant.  Abbot’s lawyer states that it is probable that Abbot will lose the suit and be found liable for a judgment costing Abbot anywhere from $500,000 to $2,500,000. However, the lawyer states that the most probable cost is $1,000,000. As a result of the above facts, Abbot should accrue

  1. A loss contingency of $500,000 and disclose an additional contingency of up to $2,000,000.
  2. A loss contingency of $1,000,000 and disclose an additional contingency of up to $1,500,000.
  3. A loss contingency of $1,000,000 but not disclose any additional contingency.
  4. No loss contingency but disclose a contingency of $500,000 to $2,500,000.

A loss contingency of $1,000,000 and disclose an additional contingency of up to $1,500,000.

ASC Topic 450 requires that estimated losses from loss contingencies be accrued if the contingency is probable (as opposed to reasonably possible or remote) and the amount of loss can be reasonably estimated. ASC Topic 450 states that a range of loss rather than an estimate of a single loss amount is a basis for recording a probable loss. Furthermore, the loss should be recorded at the best estimate within the range. If there is no best estimate, one should use the minimum. The excess of the recorded amount within the range should be disclosed. Accordingly, a $1,000,000 loss contingency should be recorded in the accounts, because the lawyer stated that the most probable loss was $1,000,000. Additionally, $1,500,000 should be disclosed as a possible contingency because the range of the possible loss was up to $2,500,000.

55

On July 1, year 1, Cody Company obtained a $2,000,000, 180-day bank loan at an annual rate of 12%. The loan agreement requires Cody to maintain a $400,000 compensating balance in its checking account at the lending bank. Cody would otherwise maintain a balance of only $200,000 in this account. The checking account earns interest at an annual rate of 6%. Based on a 360-day year, the effective interest rate on the borrowing is

  1. 12%
  2. 12.67%
  3. 13.33%
  4. 13.5%

12.67%

The effective interest rate on a borrowing is the net annual interest cost divided by the net available proceeds from the borrowing. Cody’s gross annual interest cost is $240,000 ($2,000,000 × 12%). Cody is required to maintain a compensating balance of $400,000, which is $200,000 more than their normal balance of $200,000. Therefore, Cody earns incremental annual interest revenue of $12,000 ($200,000 × 6%) on the excess compensating balance. The net annual interest cost is $228,000 ($240,000 − $12,000). The net available proceeds from the borrowing is $1,800,000 ($2,000,000 loan less $200,000 excess compensating balance). Therefore, the effective annual interest rate is 12.67% ($228,000 − $1,800,000).

56

Lee Corporation’s checkbook balance on December 31, year 1, was $4,000. In addition, Lee held the following items in its safe on December 31:

  • Check payable to Lee Corporation, dated 1/2/Y2, not included in 12/31 checkbook balance$1,000
  • Check payable to Lee Corporation, deposited 12/20, and included in 12/31 checkbook balance, but returned by bank on 12/30, stamped "NSF." The check was redeposited 1/2/Y2, and cleared 1/7.200
  • Postage stamps received from mail-order customers75
  • Check drawn on Lee Corporation’s account, payable to vendor, dated and recorded 12/31, but not mailed until 1/15/Y2500

The proper amount to be shown as Cash on Lee’s balance sheet at December 31, year 1, is

  1. $3,800
  2. $4,000
  3. $4,300
  4. $4,875

$4,300

To be classified as cash, resources must be readily available for the payment of current obligations and must be free from any restrictions that limit its use in satisfying debts.  In this situation the $1,000 postdated check should be classified as a receivable.  The $75 of postage stamps should be included in office supplies inventory.  Since the company still maintains physical control of the $500 drawn against the checking account it should be added back to the cash balance.

  • Checkbook balance $4,000
  • Add:  Check drawn but not mailed + 500
  • Less: NSF check − 200
  • Corrected cash balance = $4,300

57

Redwood Co.’s financial statements had the following information at year-end:

  • Cash $60,000
  • Accounts receivable $180,000
  • Allowance for uncollectible accounts $8,000
  • Inventory $240,000
  • Short-term marketable securities $90,000
  • Prepaid rent $18,000
  • Current liabilities $400,000
  • Long-term debt $220,000
  • What was Redwood’s quick ratio?
  1. 0.81 to 1
  2. 0.83 to 1
  3. 0.94 to 1
  4. 1.46 to 1

0.81 to 1

The quick ratio is calculated by dividing quick assets by current liabilities. Quick assets are those current assets that can be quickly converted to cash. Because inventory and prepaid rent are not quickly converted to cash, they are not classified as quick assets. Cash, net accounts receivable, and short-term marketable securities are the quick assets in this case. Therefore, this answer is correct because the quick ratio is equal to 0.81 to 1 [($60 + $180 − $8 + $90)/$400].

58

Stark, Inc. has $1,000,000 of notes payable due June 15, year 2. At the financial statement date of December 31, year 1, Stark signed an agreement to borrow up to $1,000,000 to refinance the notes payable on a long-term basis. The financing agreement called for borrowings not to exceed 80% of the value of the collateral Stark was providing. At the date of issue of the December 31, year 1 financial statements, the value of the collateral was $1,200,000 and was not expected to fall below this amount during year 2. On the December 31, year 1 balance sheet, Stark should classify

  1. $40,000 of notes payable as short-term and $960,000 as long-term obligations.
  2. $200,000 of notes payable as short-term and $800,000 as long-term obligations.
  3. $1,000,000 of notes payable as short-term obligations.
  4. $1,000,000 of notes payable as long-term obligations.

$40,000 of notes payable as short-term and $960,000 as long-term obligations.

For a currently maturing liability to be classified as long-term, a company must show intent and ability to refinance the obligation (per ASC 470-10-45-14). Stark, Inc. intends to refinance the entire $1,000,000; however, Stark only has the ability to refinance $960,000 (.8 × $1,200,000) due to the financing agreement that limits borrowing to 80% of the value of collateral. Thus, $40,000 ($1,000,000 − $960,000) is considered short-term and $960,000 is considered long-term.

59

In determining whether to accrue employees’ compensation for future absences, among the conditions that must be met are that the obligation relates to rights that

  • Accumulate
  • Vest

  • Accumulate - YES
  • Vest - YES

Per ASC 710, accrual of compensation for future absences is required if all of the following conditions exist: (1) obligation of employer to compensate employees arises from services already performed; (2) obligation arises from vesting or accumulation of rights; (3) probable payment of compensation; and (4) amount can be reasonably estimated.

60

On December 31, year 1, Northpark Co. collected a receivable due from a major customer. Which of the following ratios would be increased by this transaction?

  1. Inventory turnover ratio.
  2. Receivable turnover ratio.
  3. Current ratio.
  4. Quick ratio.

Receivable turnover ratio.

Collection of a receivable results in an increase in cash and a decrease in the accounts receivable balance. The accounts receivable turnover ratio is computed by dividing net credit sales by the average net accounts receivable balance. Collection of a receivable reduces the average net accounts receivable balance. Thus the receivable turnover ratio increases.

61

Utica Company’s net accounts receivable were $250,000 at December 31, year 1, and $300,000 at December 31, year 2. Net cash sales for year 2 were $100,000. The accounts receivable turnover for year 2 was 5.0. What were Utica’s total net sales for year 2?

  1. $1,475,000
  2. $1,500,000
  3. $1,600,000
  4. $2,750,000

$1,475,000

The amount of cash sales ($100,000) was given, so credit sales must be computed to calculate total net sales. The formula for accounts receivable turnover is

  • AR turnover = Net Credit sales / Average AR

The information given can be inserted into the above equation.

  • Credit sales / (250,000 + 300,000/2) = 5.0 

Credit sales are $1,375,000.  Thus, total sales are $1,475,000 ($1,375,000 credit sales + $100,000 cash sales).

62

Verona Co. had $500,000 in short-term liabilities at the end of the current year. Verona issued $400,000 of common stock subsequent to the end of the year, but before the financial statements were issued. The proceeds from the stock issue were intended to be used to pay the short-term debt. What amount should Verona report as a short-term liability on its balance sheet at the end of the current year?

  1. $0
  2. $100,000
  3. $400,000
  4. $500,000

$100,000

ASC 470-10-45-14 allows classification of short-term liabilities expected to be refinanced to be classified as noncurrent assuming that the short-term liabilities do not arise from the normal course of business (e.g., accounts payable and accrued liabilities). Therefore this answer is correct because the $400,000 may be reclassified as noncurrent.

63

The following information pertains to a fire insurance policy in effect during calendar year 1, covering Vail Co.’s inventory:

  • Face amount of policy $800,000
  • Deductible clause $50,000
  • Amount of premium $4,000
  • Coinsurance clause 80%

Vail’s inventory averages $1,000,000 uniformly throughout the year.  Vail’s income tax rate is 40%. How much of a contingent liability should Vail accrue at December 31, year 1, to cover possible future fire losses?

  1. $0
  2. $30,000
  3. $46,000
  4. $120,000

$0

Per ASC Topic 450, a contingent liability shall only be accrued if the likelihood of occurrence is probable and the amount of the loss can be reasonably estimated. An event such as a possible future fire loss is not considered probable at 12/31/Y1 based on the information given nor can an amount of the loss from such an event be reasonably estimated. Thus, an accrual at 12/31/Y1 is not required.

64

When the accounts receivable of a company are sold outright to a company which normally buys accounts receivable of other companies without recourse, the accounts receivable have been

  1. Pledged.
  2. Assigned.
  3. Factored.
  4. Collateralized.

Factored.

Factoring traditionally has involved the outright sale of receivables to a financing institution known as a factor.  The classical variety of factoring (i.e., without recourse) provides two financial services to the business:  it permits the entity to obtain cash earlier and it transfers the risk of bad debts to the factor. The factor is compensated for each of the services.  Interest is charged based on the anticipated length of time between the date the factoring is consummated and the expected collection date of the receivables sold. A fee is charged based upon the factor’s anticipated bad debt losses.

Factoring is a transfer of accounts receivable to a transferee.  The arrangements involve (1) notification to the customer to forward future payments to the factor and (2) the transfer of receivables without recourse which means that the factor assumes the risk of loss from noncollection.  Thus, once a factoring arrangement without recourse is completed, the entity has no further involvement with the accounts, except for a return of merchandise.  The factoring without recourse qualifies as a sale of the receivables, and the difference between the cash received and the carrying value of the receivables is recognized as a gain or loss.

65

Which of the following ratios measures short-term solvency?

  1. Current ratio.
  2. Age of receivables.
  3. Creditors’ equity to total assets.
  4. Return on investment.

Current Ratio

Solvency—Measure short-term viability
 

  • Acid-test (quick) ratio—Measures ability to pay current liabilities from cash and near-cash items
    • Cash, Net receivables, Marketable securities / Current liabilities
  • Current ratio—Measures ability to pay current liabilities from cash, near-cash, and cash flow items
    • Current assets / Current liabilities

66

A company is in its first year of operations and has never written off any accounts receivable as uncollectible. When the allowance method of recognizing bad debt expense is used, the entry to recognize that expense

  1. Increases net income.
  2. Decreases current assets.
  3. Has no effect on current assets.
  4. Has no effect on net income.

Decreases current assets.

When the allowance method of recognizing bad debt expense is used, the journal entry is

  • Bad debt expense xxx 
    • Allowance for bad debts xxx

The allowance account is a contra account to accounts receivable. Since accounts receivable is a current asset, current assets will be decreased by the allowance for bad debts.

67

Zenk Co. wrote off obsolete inventory of $100,000 during year 1. What was the effect of this write-off on Zenk’s ratio analysis?

  1. Decrease in current ratio but not in quick ratio.
  2. Decrease in quick ratio but not in current ratio.
  3. Increase in current ratio but not in quick ratio.
  4. Increase in quick ratio but not in current ratio.

Decrease in current ratio but not in quick ratio.

When Zenk wrote off $100,000 of inventory, the current ratio decreased.  This true because the numerator of the ratio, current assets, decreased while the denominator stayed the same, resulting in a smaller ratio.  However, the calculation of the quick ratio excludes inventory from current assets.  Thus, the quick ratio is unaffected by any change in inventory levels. This answer is correct because the current ratio decreased while the quick ratio remained unchanged.

68

A method of estimating bad debts that focuses on the income statement rather than the balance sheet is the allowance method based on

  1. Direct write-off.
  2. Aging the trade receivable accounts.
  3. Credit sales.
  4. The balance in the trade receivable accounts.

Credit sales.

Estimating bad debts based on credit sales of the period is the income statement approach in that bad debts are treated as a function of sales.

69

On December 1, year 1, Paxton Co. had a note payable due on August 1, year 2. On January 20, year 2, Paxton signed a financing agreement to borrow the balance of the note payable from a lending institution to refinance the note. The agreement does not expire within one year, and no violation of any provision in the financing agreement exists. On February 1, year 2, Paxton was informed by its financial advisor that the lender is not expected to be financially capable of honoring the agreement. Paxton’s financial statements were issued on March 31, year 2. How should Paxton classify the note on its balance sheet at December 31, year 1?

  1. As a current liability because the financing agreement was signed after the balance sheet date.
  2. As a current liability because the lender is not expected to be financially capable of honoring the agreement.
  3. As a long-term liability because the agreement does not expire within one year.
  4. As a long-term liability because no violation of any provision in the financing agreement exists.

As a current liability because the lender is not expected to be financially capable of honoring the agreement.

According to ASC 470-10-45-14, three conditions must be met to disclose the short-term obligation as a long-term liability: the agreement does not expire within one year, no violation of any provision in the financing agreement exists at the balance sheet date, and the lender is expected to be financially capable of honoring the agreement. This answer is correct because this item indicates that the lender is not expected to be financially capable of honoring the agreement.

70

Smith Co. has a checking account at Small Bank and an interest-bearing savings account at Big Bank.  On December 31, year 1, the bank reconciliations for Smith are as follows:

Big Bank 

  • Bank balance $150,000
  • Deposit in transit $5,000
  • Book balance $155,000

Small Bank 

  • Bank balance $1,500
  • Outstanding checks ($8,500)
  • Book balance ($7,000)

What amount should be classified as cash on Smith’s balance sheet at December 31, year 1?

  1. $148,000
  2. $151,000
  3. $155,000
  4. $156,000

$155,000

The cash on Smith’s balance sheet is equal to the cash in the savings account in Big Bank of $155,000. The negative balance in the checking account at Small Bank would be reclassified as a payable and is reported as a liability on the balance sheet.

71

On March 31, year 1, Dallas Co. received an advance payment of 60% of the sales price for special-order goods to be manufactured and delivered within five months. At the same time, Dallas subcontracted for production of the special-order goods at a price equal to 40% of the main contract price. What liabilities should be reported in Dallas’ March 31, year 1 balance sheet?

  • Deferred revenues
  • Payables to subcontractor

  • Deferred revenues - 60% of main contract price
  • Payables to subcontractor - none

One of the three essential characteristics of a liability is that the transaction or event obligating the entity has occurred. The deferred revenue has been received, and thus a liability exists. The subcontractor has not produced the special-order goods as of March 31 so no liability should be recorded for the subcontractor payable.

72

In preparing its bank reconciliation for the month of March year 2, Derby Company has available the following information:

  • Balance per bank statement, 3/31/Y2 $36,050
  • Deposit in transit, 3/31/Y2 $6,250
  • Outstanding checks, 3/31/Y2 $5,750
  • Credit erroneously recorded by bank in Derby’s account, 3/12/Y2 $250
  • Bank service charges for March $50

What should be the correct balance of cash at March 31, year 2?

  1. $35,250
  2. $36,250
  3. $36,300
  4. $36,550

$36,300

The balance per bank statement ($36,050) must be adjusted to reflect deposits in transit and corrections as of 3/31/Y2 not yet recorded by the bank.

  • Balance per bank $36,050
  • Add: Deposit in transit $6,250
  • $42,300
  • Deduct: Outstanding checks $5,750 
  • Bank error  250 (6,000)

Correct balance $36,300

The bank service charges ($50) would be an adjustment to balance per books; it has already been recorded in the bank’s records.

73

In its December 31, year 1 balance sheet, Fleet Co. reported accounts receivable of $100,000 before allowance for uncollectible accounts of $10,000. Credit sales during year 2 were $611,000, and collections from customers, excluding recoveries, totaled $591,000. During year 2, accounts receivable of $45,000 were written off and $17,000 were recovered. Fleet estimated that $15,000 of the accounts receivable at December 31, year 2, were uncollectible. In its December 31, year 2 balance sheet, what amount should Fleet report as accounts receivable before allowance for uncollectible accounts?

  1. $58,000
  2. $67,000
  3. $75,000
  4. $82,000

$75,000

The ending accounts receivable balance for 12/31/Y1 was given.  This becomes the beginning balance for year 2.  The year 2 credit sales would be recorded by debiting accounts receivable and crediting sales.  The collections from customers would be recorded by debiting cash and crediting accounts receivable. The write-off of accounts receivable would be recorded by debiting the allowance account and crediting accounts receivable. The $17,000 of recoveries do not impact the ending balance of accounts receivable, as they are put back into accounts receivable and then taken out as they were paid in year 2.  The ending balance can then be solved for by adding up the debit column of accounts receivable and then subtracting the credit column.

$100,000 + $611,000 − $591,000 − $45,000 = $75,000

74

If the payment of compensation is probable, the amount can be reasonably estimated, and the obligation relates to rights that vest, employees’ compensation for future absences should be

  1. Accrued if attributable to employees’ services already rendered.
  2. Accrued if attributable to employees’ services not already rendered.
  3. Accrued if attributable to employees’ services whether already rendered or not.
  4. Recognized when paid.

Accrued if attributable to employees’ services already rendered.

Per ASC Topic 710, a liability for compensated absences should be accrued if the obligation is attributable to employees’ services already rendered, the obligation relates to rights which vest or accumulate, payment is probable, and the amount is reasonably estimable. This completes the conditions in ASC 710-10-25-1 which are necessary to accrue the liability.

75

Marshall Company prepared an aging of its accounts receivable at December 31, year 2, and determined that the net realizable value of the receivables at that date is $50,000.  Additional information is available as follows:

  • Accounts receivable at December 31, year 1 $48,000
  • Accounts receivable at December 31, year $254,000
  • Allowance for doubtful accounts at December 31, year 1—credit balance $6,000
  • Accounts written off as uncollectible during year $25,000

Marshall’s bad debt expense for the year ended December 31, year 2, was

  1. $3,000
  2. $4,000
  3. $5,000
  4. $7,000

$3,000

The solutions approach is to prepare a T- account for the allowance for doubtful accounts.  The difference between the December 31, year 2, accounts receivable and the net realizable value is $4,000 ($54,000 − $50,000).  This the amount needed to reduce the gross accounts receivable to its net realizable value. Thus, the ending balance of the allowance for doubtful accounts should be $4,000.

76

Gar, Inc.’s trial balance reflected the following liability account balances at December 31, year 1:

  • Accounts payable $19,000
  • Bonds payable, due year 2 $34,000
  • Deferred income tax liability $4,000
  • Discount on bonds payable $2,000
  • Dividends payable on 2/15/Y2 $5,000
  • Income tax payable $9,000
  • Notes payable, due 1/19/Y3 $6,000

The deferred income tax liability is based on temporary differences stemming from different depreciation methods for financial reporting and income taxes.

In Gar’s December 31, year 1 balance sheet, the current liabilities total was

  1. $71,000
  2. $69,000
  3. $67,000
  4. $65,000

$65,000

ASC 210-10-20 Glossary states that current liabilities are obligations whose liquidation is reasonably expected to require the use of current assets or the creation of other current liabilities. This means that generally, current liabilities are liabilities due within 1 year of the balance sheet date. Clearly, accounts payable ($19,000), dividends payable ($5,000) and income tax payable ($9,000) are current liabilities. Generally bonds payable are a long-term liability; however, since these bonds are due in year 2, they must be reported as a current liability at 12/31/Y1 ($34,000 face less $2,000 discount, or $32,000). Therefore, total current liabilities are $65,000 ($19,000 + $5,000 + $9,000 + $32,000). The deferred income tax payable ($4,000) is classified as a long-term liability because it is related to the noncurrent asset, property, plant, and equipment. Similarly, the notes payable ($6,000) are classified as long-term because they are due in year 3.

77

Blythe Corp. is a defendant in a lawsuit. Blythe's attorneys believe it is reasonably possible that the suit will require Blythe to pay a substantial amount. What is the proper financial statement treatment for this contingency?

  1. Accrued and disclosed.
  2. Accrued but not disclosed.
  3. Disclosed but not accrued.
  4. No disclosure or accrual.

Disclosed but not accrued.

Contingent liabilities that are deemed reasonably possible (estimable or not) are disclosed but not accrued.

78

If current assets exceed current liabilities, payments to creditors made on the last day of the month will

  1. Decrease current ratio.
  2. Increase current ratio.
  3. Decrease net working capital.
  4. Increase net working capital.

Increase current ratio.

If current assets exceed current liabilities prior to this payment, the current ratio is greater than 1. Subtracting an equal amount from both the numerator and the denominator of a fraction which is greater than 1 will increase the fraction. Working capital would not be affected because both cash (a current asset) and payables (a current liability) are decreased.

79

Wyatt Co. has a probable loss that can only be reasonably estimated within a range of outcomes. No single amount within the range is a better estimate than any other amount.  The loss accrual should be

  1. Zero.
  2. The maximum of the range.
  3. The mean of the range.
  4. The minimum of the range.

The minimum of the range.

Per ASC Topic 450, a loss contingency should be accrued if it is probable that a liability has been incurred at the balance sheet date and the amount of the loss is reasonably estimable. This loss must be accrued because it meets both criteria. ASC Topic 450 requires that when some amount within an estimated range is a better estimate than any other amount in the range, that amount is accrued. If no amount within the range is a better estimate than any other amount, the amount at the low end of the range is accrued and the amount at the high end is disclosed.

80

When a specific customer’s account receivable is written off as uncollectible, what will be the effect on net income under each of the following methods of recognizing bad debt expense?

  • Allowance
  • Direct Write-Off

  • Allowance - None
  • Direct Write-Off - Decreased

This answer is correct because under the allowance method a bad debt is written off by making the following entry:

  • Allowance for doubtful accounts xxx 
    • Accounts receivable xxx

Since neither of the accounts involved in this entry is closed to income summary, there can be no income statement effect. Under the direct write-off method, the entry to write off a bad debt would be

  • Bad debt expense xxx 
    • Accounts receivable xxx

Since the bad debt expense account is closed to income summary, the write-off will cause net income to decrease.

81

Gar Co. factored its receivables with recourse with Ross Bank. Assume Gar surrenders control of the receivables. Gar received cash as a result of this transaction, which is best described as a

  1. Loan from Ross collateralized by Gar’s accounts receivable.
  2. Loan from Ross to be repaid by the proceeds from Gar’s accounts receivable.
  3. Sale of Gar’s accounts receivable to Ross, with the risk of uncollectible accounts retained by Gar.
  4. Sale of Gar’s accounts receivable to Ross, with the risk of uncollectible accounts transferred to Ross.

Sale of Gar’s accounts receivable to Ross, with the risk of uncollectible accounts retained by Gar.

Under ASC Topic 860, the situation qualifies as a sale because the transferor surrenders control of the receivables. Since Ross has accepted the receivables subject to recourse, Gar has continuing involvement with the receivables and has, in effect, guaranteed the receivables.

82

On October 1, year 1, a company borrowed cash and signed a 3-year interest-bearing note on which both the principal and interest are payable on October 1, year 4. The company did not elect to use the fair value option for reporting financial liabilities. At December 31, year 3, accrued interest should

  1. Be reported on the balance sheet as a current liability.
  2. Be reported on the balance sheet as a noncurrent liability.
  3. Be reported on the balance sheet as part of long-term notes payable.
  4. Not be reported on the balance sheet as a liability.

Be reported on the balance sheet as a current liability.

ASC 210-10-20 Glossary states that current liabilities are obligations whose liquidation is reasonably expected to require the use of existing resources properly classified as current assets. Current liabilities include liabilities coming due in 1 year. Since the principal and interest are both payable within the next year, the accrued interest should be reported on the balance sheet as a current liability.

83

On April 1, Aloe, Inc. factored $80,000 of its accounts receivable without recourse.  The factor retained 10% of the accounts receivable as an allowance for sales returns and charged a 5% commission on the gross amount of the factored receivables.  What amount of cash did Aloe receive from the factored receivables?

  1. $68,000
  2. $68,400
  3. $72,000
  4. $76,000

$68,000

The proceeds from the factored accounts receivable is $80,000 less the 10% factor holdback of $8,000 ($80,000 × 10%), and less the 5% commission on the gross amount of receivables ($80,000 × 5%). Therefore, this answer is correct because the amount received from factoring the accounts receivable is $68,000 ($80,000 − $8,000 − $4,000).

84

Jackson Corporation provides an incentive compensation plan under which its president is to receive a bonus equal to 10% of Jackson’s income in excess of $100,000 before deducting income tax but after deducting the bonus. If income before income tax and the bonus is $320,000, the amount of the bonus should be

  1. $44,000
  2. $32,000
  3. $22,000
  4. $20,000

$20,000

Before multiplying by 10%, $100,000 and the amount of the bonus must be deducted from $320,000. The bonus can be calculated by setting up the following equation.

  • B = 10% ($320,000 − $100,000) − .1B)
  • B = $22,000 − .1B
  • 1.1B = $22,000
  • B = $20,000

 
Thus the bonus is $20,000.

85

Selected information for Cain Corp. for the year ended December 31, year 1, follows:

  • Average days’ sales in inventories 124
  • Average days’ sales in accounts receivable 48

The average number of days in the operating cycle for year 1 was

  1. 172
  2. 124
  3. 86
  4. 76

172

The average number of days in the operating cycle measures the length of time from purchase of inventory to collection of cash.  The formula is

  • Average days’ sales in inventories + Average days’ sales in accts. receivable
  • = Average days’ operating cycle

124 days + 48 days = 172 days

Note that the average days’ sales in inventories measures the number of days from the purchase of inventory to the sale of inventory, while the average days’ sales in accounts receivable measures the number of days from the sale of inventory to the collection of cash.

86

The Avec Company’s account balances at December 31, year 1, for accounts receivable and the related allowance for uncollectible accounts were $800,000 and $40,000 respectively. An aging of accounts receivable indicated that $71,100 of the December 31 receivables may be uncollectible. The net realizable value of accounts receivable was

  1. $688,900
  2. $728,900
  3. $760,000
  4. $768,900

$728,900

Since the total receivables per the books were $800,000 and accounts receivable of $71,100 were estimated to be uncollectible, those expected to be collectible were $728,900 ($800,000 − $71,100). The $40,000 is irrelevant as it represents the unadjusted balance of the allowance for uncollectible accounts.

87

The following financial ratios and calculations were based on information from Kohl Co.’s financial statements for the current year:

  • Accounts receivable turnover - Ten times during the year
  • Total assets turnover - Two times during the year
  • Average receivables during the year - $200,000

What was Kohl’s average total assets for the year?

  1. $2,000,000
  2. $1,000,000
  3. $ 400,000
  4. $ 200,000

$1,000,000

Accounts receivable turnover is equal to sales divided by average receivables, and total assets turnover is equal to sales divided by average total assets. Therefore, this answer is correct because sales is calculated to be $2,000,000 (10 × $200,000), and average total assets is calculated to be $1,000,000 ($2,000,000 ÷ 2).

88

Tinsel Co.'s balances in allowance for uncollectible accounts were $70,000 at the beginning of the current year and $55,000 at year-end. During the year, receivables of $35,000 were written off as uncollectible. What amount should Tinsel report at uncollectible accounts expense at year-end?

  • $15,000
  • $20,000
  • $35,000
  • $50,000

$20,000

Uncollectible accounts expense is equal to the ending allowance balance plus accounts written off less reinstatements less the beginning allowance balance ($55,000 − $70,000 + $35,000 = $20,000).

89

Morgan Company determined that: (1) it has a material obligation relating to employees’ rights to receive compensation for future absences attributable to employees’ services already rendered, (2) the obligation relates to rights that vest, and (3) payment of the compensation is probable.  The amount of Morgan’s obligation as of December 31, year 1, is reasonably estimated for the following employee benefits:

  • Vacation pay $100,000
  • Holiday pay $25,000

What total amount should Morgan report as its liability for compensated absences in its December 31, year 1 balance sheet?

  1. $0
  2. $25,000
  3. $100,000
  4. $125,000

$125,000

A liability for compensated absences should be accrued if the

  1. obligation is attributable to employees’ services already rendered,
  2. the obligation relates to rights which vest or accumulate,
  3. payment is probable, and
  4. the amount is reasonably estimable.

All four conditions are met. Per ASC Topic 710, both the vacation pay and holiday pay are considered compensated absences. Therefore, $125,000 ($100,000 + $25,000) should be accrued for compensated absences.

90

A company has outstanding accounts payable of $30,000 and a short-term construction loan in the amount of $100,000 at year-end. The loan was refinanced through issuance of long-term bonds after year-end but before issuance of financial statements. How should these liabilities be recorded in the balance sheet?

  1. Long-term liabilities of $130,000.
  2. Current liabilities of $130,000.
  3. Current liabilities of $30,000, long-term liabilities of $100,000.
  4. Current liabilities of $130,000, with required footnote disclosure of the refinancing of the loan.

Current liabilities of $30,000, long-term liabilities of $100,000.

Accounts payable is classified as a current liability. Although the construction loan was originally due at year-end, if the company has both the intent and ability to refinance with long-term debt, the $100,000 construction loan may be reclassified at year-end as a long-term liability. Therefore, this answer is correct because current liabilities of $30,000 and long-term liabilities of $100,000 should be reported on the balance sheet.

91

Based upon its past collection experience, Alden Company provides for bad debt expense at the rate of 2% of credit sales. On January 1, year 1, the allowance for doubtful accounts balance was $10,000. During year 1 Alden wrote off $18,000 of uncollectible receivables and recovered $5,000 of bad debts written off in prior years. If credit sales for year 1 totaled $1,000,000, the allowance for doubtful accounts balance at December 31, year 1, should be

  1. $12,000
  2. $17,000
  3. $20,000
  4. $30,000

$17,000

The ending balance of the allowance for doubtful accounts includes the Beginning balance + Recoveries of bad debts written off in prior years + Current year’s bad debt expense − Write-offs of uncollectibles. The beginning balance was $10,000 and write-offs (debits) were $18,000. Recoveries of bad debts written off in prior years ($5,000) would be a credit to the allowance account and a debit to accounts receivable. Finally, the credit to the allowance account for bad debts expense would be $20,000 (2% of $1,000,000), leaving a 12/31/year 1 balance of $17,000.

92

A loss contingency for which the amount of loss can be reasonably estimated should be accrued when the occurrence of the loss is

  • Reasonably possible
  • Remote

  • Reasonably possible - NO
  • Remote - NO

ASC Topic 450 requires accrual of a loss contingency only if both of the following conditions are met: (1) the future losses are probable and (2) the loss amount can be reasonably estimated. Loss contingencies that do not meet one or both of these criteria, but that are at least reasonably possible should be disclosed, but not accrued. Loss contingencies that have only a remote possibility of occurrence are generally not even disclosed.

93

Effective with the year ended December 31, year 1, Grimm Company adopted a new accounting method for estimating the allowance for doubtful accounts at the amount indicated by the year-end aging of accounts receivable.  The following data are available:

  • Allowance for doubtful accounts, 1/1/Y1 $24,000
  • Provision for doubtful accounts during year 1 (2% on credit sales of $1,000,000) $20,000
  • Bad debts written off, 11/30/Y1 $19,500
  • Estimated uncollectible accounts per aging $21,000

After year-end adjustment, the bad debt expense for year 1 would be

  1. $16,500
  2. $19,500
  3. $20,000
  4. $21,000

$16,500

Before the year-end adjustments, the allowance account had a balance of $24,500. To adjust the account to the appropriate balance indicated by the year-end aging ($21,000), it must be reduced by $3,500 ($24,500 − $21,000). Unadjusted bad debt expense is $20,000.  After the adjustment, bad debt expense is $16,500 ($20,000 − $3,500).

94

Fell, Inc. operates a retail grocery store that is required by law to collect refundable deposits of $.05 on soda cans. Information for year 2 follows:

  • Liability for returnable deposits—12/31/Y1 $150,000
  • Cans of soda sold in year 2 $10,000,000
  • Soda cans returned in year 2 $11,000,000

On February 1, year 2, Fell subleased space and received a $25,000 deposit to be applied toward rent at the expiration of the lease in year 6. In Fell’s December 31, year 2 balance sheet, the current and noncurrent liabilities for deposits were

  • Current
  • Noncurrent

  • Current - $100,000
  • Noncurrent - $25,000

Deposits (10,000,000 × $.05 = $500,000) are debited to cash and credited to the liability account, while deposits returned (11,000,000 × $.05 = $550,000) are debited to the liability account and credited to cash. The 12/31/Y2 balance of $100,000 is a current liability since the outstanding deposits are expected to be returned within the next year.  The year 6 rent collected in advance ($25,000) is a noncurrent liability since the obligation will not be satisfied within 1 year of the balance sheet date.

95

At June 30, Almond Co.’s cash balance was $10,012 before adjustments, while its ending bank statement balance was $10,772. Check number 101 was issued June 2 in the amount of $95, but was erroneously recorded in Almond’s general ledger balance as $59. The check was correctly listed in the bank statement at $95. The bank statement also included a credit memo for interest earned in the amount of $35, and a debit memo for monthly service charges in the amount of $50. What was Almond’s adjusted cash balance at June 30?

  1. $9,598
  2. $9,961
  3. $10,048
  4. $10,462

$9,961

Adjustments that should be made to the cash account are

  • Cash balance before adjustments $10,012
  • Less: Error in ledger ($95 − 59) ($36)
  • Plus: Interest earned $35
  • Less: Service charge ($50)
  • = Corrected balance $9,961

Therefore, this answer is correct.

96

Tallent Corporation had the following account balances at December 31, year 1:

  • Cash on hand and in banks $975,000
  • Cash legally restricted for additions to plant (expected to be disbursed in year 3) $600,000
  • Bank certificates of deposit (due February 1, year 2, purchased September 1, year 1) $250,000

In the current assets section of Tallent’s December 31, year 1 balance sheet, what total amount should be reported under the caption "cash and cash equivalents?"

  1. $1,225,000
  2. $975,000
  3. $1,575,000
  4. $1,825,000

$975,000

Cash on hand and in banks in included in "cash and cash equivalents" because it is both unrestricted and readily available. Cash legally restricted for plant additions should be shown in the long-term assets section as an investment. Bank certificates of deposit ($250,000 due on February 1, year 2) are excluded since the original maturity date was greater than three months. To qualify as cash, ASC Topic 305 requires that funds be available upon demand without restriction or penalty. However, to qualify as a cash equivalent, ASC Topic 305 requires the original maturity date to be three months or less from the date of purchase. Therefore, certificates of deposit or any other instruments having a original maturity date greater than three months from the date of purchase are not considered cash equivalents. Hence, Tallent’s cash and cash equivalents total $975,000, the amount of its cash on hand and in banks.

97

Lind Corp. declared a cash dividend of $50,000 on March 10, year 2, to stockholders of record March 25, year 2, payable on April 5, year 2. As a result of this cash dividend, working capital

  1. Decreased on March 10 by $50,000.
  2. Decreased on March 25 by $50,000.
  3. Decreased on April 5 by $50,000.
  4. Did not change.

Decreased on March 10 by $50,000.

Lind Corporation makes the following entry to record the dividend on the declaration date (March 10, year 2):

  • Dividends declared 50,000 
  •           Dividends payable 50,000

No entry is made on the date of record (March 25, year 2).  When the dividends are paid on April 5, year 2, Lind makes the following entry:

  • Dividends payable 50,000 
  •           Cash 50,000

Working capital equals current assets minus current liabilities.  On March 10, current liabilities (dividends payable) increased by $50,000, thereby reducing working capital by $50,000.  On April 5, both a current asset (cash) and a current liability are decreased by the same amount ($50,000), and this therefore has no effect on total working capital.

98

Cook Co. had the following balances at December 31, year 1:

  • Cash in checking account $350,000
  • Cash in money-market account $250,000
  • US Treasury bill, purchased 12/1/Y1, maturing 2/28/Y2 $800,000
  • US Treasury bond, purchased 3/1/Y1, maturing 2/28/Y2 $500,000

Cook’s policy is to treat as cash equivalents all highly-liquid investments with a maturity of 3 months or less when purchased. What amount should Cook report as cash and cash equivalents in its December 31, year 1 balance sheet?

  1. $600,000
  2. $1,150,000
  3. $1,400,000
  4. $1,900,000

$1,400,000

If no restrictions apply, cash in checking accounts ($350,000) is always included in cash. Per ASC Topic 305, cash equivalents are short-term, highly liquid investments which are readily convertible into cash and have maturities of 3 months or less from the date of purchase by the entity. Common examples are treasury bills, commercial paper, and money-market funds. In this case, the cash equivalents are the money-market account ($250,000) and the treasury bill ($800,000). Therefore, total cash and cash equivalents is $1,400,000 ($350,000 + $250,000 + $800,000). The maturity of the treasury bond was at least 12 months (3/1/Y1 to 2/28/Y2) from the date of purchase, therefore, it should not be reported in cash and cash equivalents.

99

Taylored Corp. factors $200,000 of accounts receivable in a transaction in which control is surrendered and without recourse to Rich Corp. on July 1, year 1. Rich assessed a fee of 3% and retains a holdback equal to 5% of the accounts receivable. In addition, Rich charged 15% interest computed on a weighted-average time to maturity of the receivables of 41 days. Taylored will receive and record cash of

  1. $190,630
  2. $174,630
  3. $180,630
  4. $184,630

$180,630

Taylored will receive the value of the receivables ($200,000), reduced by $10,000 for the amount of the holdback ($200,000 × .05), $6,000 withheld as fee income ($200,000 × .03), and $3,370 withheld as interest expense ($200,000 × .15 × 41/365). Therefore the correct answer is $180,630 ($200,000 − $6,000 − $3,370 − $10,000).

100

Office supplies were ordered by Dwyer Company from Orcutt Company on December 15, year 1. The terms of sale were FOB destination. Orcutt shipped the office supplies on December 28, year 1, and Dwyer received them on January 3, year 2. When should Dwyer record the account payable?

  1. December 15, year 1.
  2. December 28, year 1.
  3. December 31, year 1.
  4. January 3, year 2.

January 3, year 2.

When goods are shipped FOB destination, title does not pass to the buyer until the goods have been delivered. The purchase and related liability will not be recorded by Dwyer until title passes, which is on the date the supplies are received—January 3, year 2.

101

Taylored Corp. factors $200,000 of accounts receivable in a transaction in which control is surrendered and without recourse to Rich Corp. on July 1, year 1.  Rich assessed a fee of 3% and retains a holdback equal to 5% of the accounts receivable. In addition, Rich charged 15% interest computed on a weighted-average time to maturity of the receivables of 41 days.
 
Taylored’s cost of factoring the receivables would be

  1. $19,370
  2. $10,000
  3. $ 3,370
  4. $ 9,370

$19,370

If all receivables are collected, the costs incurred by Taylored would include a fee of $6,000 ($200,000 × .03) and interest expense of $3,370 ($200,000 × .15 × 41/365) for a total of $9,370.

102

When the allowance method of recognizing bad debt expense is used, the allowance for doubtful accounts would decrease when a(n)

  1. Specific account receivable is collected.
  2. Account previously written off is collected.
  3. Account previously written off becomes collectible.
  4. Specific uncollectible account is written off.

Specific uncollectible account is written off.

When the allowance method of recognizing bad debts is used, the entry to establish the allowance account is

  • Bad debts expensexx 
  •      Allowance for bad debts xx

The entry to write off a specific uncollectible account is

  • Allowance for bad debtsxx 
  •      AR xx

Thus, the allowance is decreased when the account is written off.

103

On December 31, year 1, Key Co. received two $10,000 noninterest-bearing notes from customers in exchange for services rendered. The note from Alpha Co., which is due in nine months, was made under customary trade terms, but the note from Omega Co., which is due in two years, was not. The market interest rate for both notes at the date of issuance is 8%. The present value of $1 due in nine months at 8% is .944. The present value of $1 due in two years at 8% is .857. At what amounts should these two notes receivable be reported in Key’s December 31, year 1 balance sheet?

  • Alpha
  • Omega

  • Alpha - $10,000
  • Omega - $8,570

Notes that arise from customers in the normal course of business and are due in one year are classified as current liabilities and recorded at their maturity value. Notes that are due in more than one year are classified as long-term liabilities and are recorded at their present value (ASC 310-10-30-2 and 835-30-25-4). This answer is correct because the Alpha note should be recorded at $10,000, and the Omega note should be recorded at its present value of $8,570 (.857 x $10,000).

104

Flax Company’s working capital at December 31, year 1, was $1,700,000. Data pertaining to year 2 are as follows:

  • Working capital provided by operations $900,000
  • Purchases of plant assets for cash $600,000
  • Short-term borrowings $950,000
  • Payments on short-term borrowings $500,000
  • Cash dividends paid on common stock $250,000

Flax’s working capital at December 31, year 2, was

  1. $2,450,000
  2. $2,200,000
  3. $2,000,000
  4. $1,750,000

$1,750,000

Working capital equals current assets less current liabilities. Any transactions which affect either current assets or current liabilities, but not both, will affect working capital.  If a transaction affects both current assets and current liabilities, the effects will offset and there will be no change in working capital.  Working capital at 12/31/Y1 is computed as follows:

  • 12/31/Y1 working capital $1,700,000
  • WC provided by operations $900,000
  • Cash purchases of plant assets ($600,000)
  • Cash dividends paid ($250,000)
  • 12/31/Y2 working capital $1,750,000

Cash purchases of plant assets and cash dividends paid both decrease working capital because cash, a current asset, is decreasing. Short-term borrowings (and payments on those borrowings) have no effect on working capital because both a current asset and a current liability are affected.  In a short-term borrowing cash (a current asset) increases and notes payable (a current liability) also increases.  These increases offset, and there is no effect on working capital.  When short-term borrowings are repaid, cash and notes payable both decrease. These decreases offset, and there is no effect on working capital.

105

Arno Corp.’s liability account balances at June 30, year 2, included a 10% note payable in the amount of $1,800,000. The note is dated October 1, year 1, and is payable in three equal annual payments of $600,000 plus interest. Arno does not elect the fair value option for reporting this financial liability. The first interest and principal payment was made on October 1, year 2. In Arno’s June 30, year 3 balance sheet, what amount should be reported as accrued interest payable for this note?

  1. $135,000
  2. $ 90,000
  3. $ 45,000
  4. $ 30,000

$90,000

Accrued interest payable at 6/30/Y3 is interest which has been expensed but not yet paid. Interest was last paid on 10/1/Y1, so the accrued interest payable includes interest expense incurred from 10/1/Y2 through 6/30/Y3 (9 months). The original balance of the note payable was $1,800,000, but the 10/1/Y2 principal payment of $600,000 reduced this balance to $1,200,000. Therefore, the interest payable at 6/30/Y3 is $90,000 ($1,200,000 × 10% × 9/12).

106

Taylored Corp. factors $200,000 of accounts receivable in a transaction in which control is surrendered and without recourse to Rich Corp. on July 1, year 1.  Rich assessed a fee of 3% and retains a holdback equal to 5% of the accounts receivable. In addition, Rich charged 15% interest computed on a weighted-average time to maturity of the receivables of 41 days.
 
Which of the following statements is correct?

  1. Taylored should record a liability on factoring of AR of $200,000.
  2. Taylored should remove all of the receivables from the books by crediting AR by $200,000.
  3. Taylored should remove the receivables without any holdback from the books by crediting AR by $190,000.
  4. Taylored should record a liability of $10,000 related to the holdback.

Taylored should remove all of the receivables from the books by crediting AR by $200,000.

A transfer in which control is surrendered does transfer title and therefore the receivables should be removed (credited) from the borrower’s balance sheet. If the factor retains a holdback for anticipated returns, a factor’s holdback (due from factor) is recorded as an asset.

107

Under IFRS, a provision is

  1. An event which is not recognized because it is not probable or cannot be measured reliably.
  2. An event which is probable and measurable.
  3. An event which is probable, but not measurable.
  4. An event which is probable, possible, or remote and measurable.

An event which is probable and measurable.

The second area in which the terminology and rules are different is “provisions” and “contingencies.”  Under IFRS, a “provision” is a liability that is uncertain in timing or amount.  Provisions are made for items such as taxes payable, compensated absences, bad debts, warranties, and other estimated liabilities.  A “contingency,” however, depends upon some future uncertainty or event.

108

When the allowance method of recognizing bad debt expense is used, the entries at the time of collection of a small account previously written off would

  1. Increase net income.
  2. Decrease the allowance for doubtful accounts.
  3. Have no effect on the allowance for doubtful accounts.
  4. Increase the allowance for doubtful accounts.

Increase the allowance for doubtful accounts.

This answer is correct.  The solutions approach is to determine the journal entries necessary to (1) reestablish and (2) collect the account receivable. The entry to reestablish the account would be

  • Accounts receivablexx 
  •       Allowance for doubtful accounts xx

The entry to record collection would be

  • Cashxx 
  •       Accounts receivable xx

The net effect is an increase in a current asset account, cash, and an increase in a contra asset account, allowance for doubtful accounts.

109

Tone Company is the defendant in a lawsuit filed by Witt in year 1 disputing the validity of a copyright held by Tone. At December 31, year 1, Tone determined that Witt would probably be successful against Tone for an estimated amount of $400,000. Appropriately, a $400,000 loss was accrued by a charge to income for the year ended December 31, year 1.  On December 15, year 2, Tone and Witt agreed to a settlement providing for cash payment of $250,000 by Tone to Witt, and transfer of Tone’s copyright to Witt.  The carrying amount of the copyright on Tone’s accounting records was $60,000 at December 15, year 2.  What would be the effect of the settlement on Tone’s income before income tax in year 2?

  1. No effect.
  2. $60,000 decrease.
  3. $90,000 increase.
  4. $150,000 increase.

$90,000 increase.

At 12/31/Y1, the contingent liability from the lawsuit met ASC Topic 450’s criteria for accrual (probable and reasonably estimable), so a loss and liability of $400,000 was recognized.  In year 2, the lawsuit was settled and the actual loss was $310,000 ($60,000 copyright transfer and $250,000 cash payment). This is a change in estimate which should be accounted for in the period of change per ASC Topic 250.  Therefore the $90,000 difference will be reflected in year 2 income.  The journal entry on 12/15/Y2 to record the settlement would be
 

  • Lawsuit liability $400,000 
  •      Gain from settlement of lawsuit $90,000
  •      Cash $250,000
  •      Copyright $60,000

110

Foster Co. adjusted its allowance for uncollectible accounts at year-end. The general ledger balances for the accounts receivable and the related allowance account were $1,000,000 and $40,000, respectively. Foster uses the percentage-of-receivables method to estimate its allowance for uncollectible accounts. Accounts receivable were estimated to be 5% uncollectible. What amount should Foster record as an adjustment to its allowance for uncollectible accounts at year-end?

  1. $10,000 decrease.
  2. $10,000 increase.
  3. $50,000 decrease.
  4. $50,000 increase.

$10,000 increase.

the required balance of the allowance is $50,000 ($1,000,000 × 5%), and the existing balance is $40,000. Therefore an increase of $10,000 is required.

111

The premium on a 3-year insurance policy expiring on December 31, year 3, was paid in total on January 2, year 1. If the company has a 6-month operating cycle, then on December 31, year 1, the prepaid insurance reported as a current asset would be for

  1. 6 months.
  2. 12 months.
  3. 18 months.
  4. 24 months.

12 months.

A current asset is cash and another asset that is expected to be converted into cash, sold, or consumed either in 1 year or in the operating cycle, whichever is longer. Since the company only has a 6-month operating cycle, the current portion of the prepaid insurance costs is 1 year or 12 months.

112

On September 30, World Co. borrowed $1,000,000 on a 9% note payable.  World paid the first of four quarterly payments of $264,200 when due on December 30.  In its December 31 balance sheet, what amount should World report as note payable?

  1. $735,800
  2. $750,000
  3. $758,300
  4. $825,800

$758,300

Interest expense is calculated as $1,000,000 × 9% × 3/12 months = $22,500. The payment of $264,200 less $22,500 in interest is equal to $241,700, which is the amount of the payment which is applied to the principal balance of the note. Therefore, this answer is correct because the carrying value of the note on December 31 is $758,300 ($1,000,000 − $241,700)

113

An estimated loss from a loss contingency that is probable and for which the amount of the loss can be reasonably estimated should

  1. Not be accrued but should be disclosed in the notes to the financial statements.
  2. Be accrued by debiting an appropriated retained earnings account and crediting a liability account or an asset account.
  3. Be accrued by debiting an expense account and crediting an appropriated retained earnings account.
  4. Be accrued by debiting an expense account and crediting a liability account or an asset account.

Be accrued by debiting an expense account and crediting a liability account or an asset account.

ASC Topic 450 requires that an estimated loss from a contingency be accrued by a charge to income and the recording of a liability if the loss is both probable and reasonably estimable. Loss contingencies that do not meet one or both of these criteria, but that are at least reasonably possible should be disclosed, but not accrued.

114

Mill Co.’s allowance for uncollectible accounts was $100,000 at the end of year 2 and $90,000 at the end of year 1. For the year ended December 31, year 2 Mill reported bad debt expense of $16,000 in its income statement. What amount did Mill debit to the appropriate account in year 2 to write off actual bad debts?

  1. $6,000
  2. $10,000
  3. $16,000
  4. $26,000

$6,000

During year 2, bad debt expense of $16,000 was recorded as a credit to the allowance account.  The write-off of actual bad debts may be calculated by plugging for the number that gives an ending allowance account balance of $100,000. Therefore, the debit entry is $6,000 ($90,000 + $16,000 − $100,000).

115

Ward Co. estimates its uncollectible accounts expense to be 2% of credit sales. Ward’s credit sales for year 1 were $1,000,000. During year 1, Ward wrote off $18,000 of uncollectible accounts. Ward’s allowance for uncollectible accounts had a $15,000 balance on January 1, year 1. In its December 31, year 1 income statement, what amount should Ward report as uncollectible accounts expense?

  1. $23,000
  2. $20,000
  3. $18,000
  4. $17,000

$20,000 - pay attention to what is being asked, the ending balance is 17,000 but the expense is 20,000.

When uncollectible accounts expense is estimated based on sales, the formula is

  • Annual sales × % uncollectible = Expense
  • $1,000,000 × 2% = $20,000

The other information given is not needed to compute uncollectible accounts expense as the % of sales method focuses on the income statement and proper matching of expense with revenue, unlike the aging method which focuses on the net realizable value of accounts receivable.  Ward’s allowance account activity for year 1 is shown below.

116

Bake Co.’s trial balance included the following at December 31, year 1:

  • Accounts payable $80,000
  • Bonds payable, due year 2 $300,000
  • Discount on bonds payable $15,000
  • Deferred income tax liability $25,000

The deferred income tax liability is not related to an asset for financial accounting purposes and is expected to reverse in year 2. What amount should be included in the current liability section of Bake’s December 31, year 2 balance sheet?

  1. $365,000
  2. $390,000
  3. $395,000
  4. $420,000

$390,000

The accounts payable and the bond payable are classified as current liabilities because they are due within the next 12 months. The bond payable is valued at its carrying value of $285,000 ($300,000 − $15,000 discount). The deferred income tax liability is classified as a current liability because it not related to an asset and it is expected to reverse in the next 12 months. This answer is correct because the amount of current liabilities is equal to $390,000 ($80,000 + $285,000 + $25,000).

117

Grim Corporation operates a plant in a foreign country.  It is probable that the plant will be expropriated. However, the foreign government has indicated that Grim will receive a definite amount of compensation for the plant. The amount of compensation is less than the fair market value but exceeds the carrying amount of the plant. The contingency should be reported

  1. As a valuation allowance as a part of stockholders’ equity.
  2. As a fixed asset valuation allowance account.
  3. In the notes to the financial statements.
  4. In the income statement.

In the notes to the financial statements.

A gain contingency results from the plant expropriation because the amount of compensation to be received from the foreign government exceeds the carrying amount of the plant. Per ASC Topic 450, “contingencies that might result in gains usually are not reflected in the accounts since to do so might be to recognize revenue prior to its realization.” Furthermore, “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.”

118

Gil Corp. has current assets of $90,000 and current liabilities of $180,000. Which of the following transactions would improve Gil’s current ratio?

  1. Refinancing a $30,000 long-term mortgage with a short-term note.
  2. Purchasing $50,000 of merchandise inventory with a short-term account payable.
  3. Paying $20,000 of short-term accounts payable.
  4. Collecting $10,000 of short-term accounts receivable.

Purchasing $50,000 of merchandise inventory with a short-term account payable.

  • Current Assets / Current Liabilities

When the existing current ratio is less than 1, increases of equal amounts to the numerator (current assets) and denominator (current liabilities) will improve the ratio.

119

All but one of the following are required before a transfer of receivables can be recorded as a sale.

  1. The transferred receivables are beyond the reach of the transferor and its creditors.
  2. The transferor has not kept effective control over the transferred receivables through a repurchase agreement.
  3. The transferor maintains continuing involvement.
  4. The transferee can pledge or sell the transferred receivables.

The transferor maintains continuing involvement.

Under ASC Topic 860, a sale occurs if the seller surrenders control of the receivables transferred. 

120

On September 1, year 1, a company borrowed cash and signed a 2-year interest-bearing note on which both the principal and interest are payable on September 1, year 3. The company did not elect the fair value option for reporting this note. At December 31, year 2, the liability for accrued interest should be

  1. Zero.
  2. For 4 months of interest.
  3. For 12 months of interest.
  4. For 16 months of interest.

For 16 months of interest.

Although the interest does not have to be paid until September 1, year 3, proper accrual accounting requires that at the end of each year an adjusting entry be made to accrue that year’s interest expense. Therefore, at the end of year 1, 4 months’ interest would be accrued. At the end of year 2, an additional 12 months of interest would be accrued, which makes the total interest accrued as of December 31, year 2, equal 16 months.

121

Finch Co. reported a total asset retirement obligation of $257,000 in last year’s financial statements.  This year, Finch acquired assets subject to unconditional retirement obligations measured at undiscounted cash flow estimates of $110,000 and discounted cash flow estimates of $68,000.  Finch paid $87,000 toward the settlement of previously recorded asset retirement obligations and recorded an accretion expense of $26,000.  What amount should Finch report for the asset retirement obligation in this year’s balance sheet?

  1. $238,000
  2. $264,000
  3. $280,000
  4. $306,000

$264,000

The asset retirement obligation (ARO) is recorded at its fair value in the period in which it is incurred. Subsequently, it is adjusted for revisions in estimates and the passage of time. The beginning balance in the asset retirement obligation account is $257,000. The fair value of the additional unconditional retirement obligations incurred during the year was $68,000 and increases the ARO. The $87,000 paid toward the settlement of obligations decreases the ARO. The $26,000 accretion expense is the expense recognized on the ARO due to the passage of time and will increase the ARO. ($257,000 + $68,000 — $87,000 + $26,000 = $264,000).

122

At the end of its first year of operations, December 31, year 1, Wonder Company had a net realizable value of accounts receivable of $500,000. During year 1 Wonder recorded charges to bad debt expense of $80,000 and wrote off as uncollectible accounts receivable of $20,000. What should Wonder report on its balance sheet at December 31, year 1, as accounts receivable before the allowance for doubtful accounts?

  1. $500,000
  2. $520,000
  3. $560,000
  4. $600,000

$560,000

To obtain the gross accounts receivable, the allowance for doubtful accounts must be added to the net receivables. The allowance for doubtful accounts is represented by the charges to bad debts expense less any write-offs. Wonder Company’s allowance is $60,000 ($80,000 − $20,000). Therefore, the gross accounts receivable are $560,000 ($500,000 + $60,000).

123

Marmol Corporation uses the allowance method for bad debts. During year 1, Marmol charged $30,000 to bad debt expense, and wrote off $25,200 of uncollectible accounts receivable. These transactions resulted in a decrease in working capital of

  1. $0
  2. $4,800
  3. $25,200
  4. $30,000

$30,000

The entry for the write-off is as follows:

  • Allowance for doubtful accounts         25,200 
  •       Accounts receivable              25,200

Both Accounts receivable and Allowance for doubtful accounts are reduced as a result of this transaction. Therefore, there is no effect on the net realizable value or working capital. The $30,000 of bad debt expense would be recorded as a credit to the allowance account, which therefore, would decrease working capital by $30,000.

124

When the allowance method of recognizing uncollectible accounts is used, how would the collection of an account previously written off affect accounts receivable and the allowance for uncollectible accounts?

  • Accounts receivable
  • Allowance for uncollectible accounts

  • Accounts receivable - No Effect
  • Allowance for uncollectible accounts - Increase

When an account is written off, the journal entry is debit the allowance for uncollectible accounts and credit accounts receivable. If the account is subsequently collected, an entry is made to reinstate the account receivable by debiting accounts receivable and crediting the allowance for uncollectible accounts. A second entry is made for the cash collection which involves debiting cash and crediting accounts receivable. Therefore, there is no change in accounts receivable when a previously written-off account is collected; accounts receivable is debited for the reinstatement, and credited for the payment. However, when the previously written-off account is collected, there is an increase in the allowance for uncollectible accounts.

125

Martin Pharmaceutical Co. is currently involved in two lawsuits. One is a class-action suit in which consumers claim that one of Martin's best selling drugs caused severe health problems. It is reasonably possible that Martin will lose the suit and have to pay $20 million in damages. Martin is suing another company for false advertising and false claims against Martin. It is probable that Martin will win the suit and be awarded $5 million in damages. What amount should Martin report on its financial statements as a result of these two lawsuits?

  1. $0
  2. $5 million income.
  3. $15 million expense.
  4. $20 million expense.

$0

Contingent losses are accrued when probable and estimable. Contingent gains are recognized when realized. Since Martin's contingent loss is only reasonably possible, it would not be accrued. Since Martin's contingent gain is not realized, it would not be accrued.

126

Rogo Corp.’s trial balance reflected the following account balances at December 31, year 1:

  • Accounts receivable (net) $16,000
  • Short-term investments $5,000
  • Accumulated depreciation on equipment and furniture $15,000
  • Cash $11,000
  • Inventory of merchandise $30,000
  • Equipment and furniture $25,000
  • Patent $4,000
  • Prepaid expenses $1,000
  • Land held for future business site $18,000

In Rogo Corp.’s December 31, year 1 balance sheet, the current assets total is

  1. $81,000
  2. $73,000
  3. $67,000
  4. $63,000

$63,000

Current assets are cash and other assets that are expected to be converted into cash, sold, or consumed either in 1 year or in the operating cycle, whichever is longer.  Included in this category are cash, temporary investments in marketable securities, short-term receivables, inventories, and prepaid expenses.  In this case, total current assets are $63,000.

  • Accounts receivable (net) $16,000
  • Short-term investments $5,000
  • Cash $11,000
  • Inventory of merchandise $30,000
  • Prepaid expenses $1,000
  • Total $63,000

Equipment and furniture ($25,000) and accumulated depreciation ($15,000) are reported in the property, plant, and equipment section.  Patent ($4,000) is reported as an intangible asset, (always long-term), and land held for future business site ($18,000) is reported as a long-term investment.

127

Willem Co. reported the following liabilities at December 31, year 1:

  • Accounts payable—trade $750,000
  • Short-term borrowings $400,000
  • Mortgage payable, current portion $100,000 $3,500,000
  • Other bank loan, matures June 30, year 2 $1,000,000

The $1,000,000 bank loan was refinanced with a 20-year loan on January 15, year 2, with the first principal payment due January 15, year 3.  Willem’s audited financial statements were issued February 28, year 2.  What amount should Willem report as current liabilities at December 31, year 1?

  1. $850,000
  2. $1,150,000
  3. $2,250,000
  4. $1,250,000

$1,250,000

Current liabilities are those liabilities expected to require the use of current assets or the creation of other current liabilities. Accounts payable--trade and short-term borrowings are classified as current liabilities because they are expected to be repaid within one year or the current operating cycle. The current portion of long-term debt for the mortgage payable of $100,000 should also be classified as a current liability because it is due and payable within one year. Therefore, this answer is correct because current liabilities are equal to $1,250,000 ($750,000 + $400,000 + $100,000). The $1,000,000 refinanced loan may be reclassified as a long-term liability.