Accounting

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Quiz 7 :

Accounting for and Presentation of Liabilities

Quiz 7 :

Accounting for and Presentation of Liabilities

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Other accrued liabilities-warranties Prist Co. had not provided a warranty on its products, but competitive pressures forced management to add this feature at the beginning of 2016. Based on an analysis of customer complaints made over the past two years, the cost of a warranty program was estimated at 0.3% of sales. During 2016, sales totaled $6,900,000. Actual costs of servicing products under warranty totaled $19,400. Required: a. Use the horizontal model (or a T-account of the Estimated Warranty Liability) to show the effect of having the warranty program during 2016. b. What type of accrual adjustment should be made at the end of 2016? c. Describe how the amount of the accrual adjustment could be determined.
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The warranty programs are meant to assure customers that the company will be with them even in the case of failure of products purchased by them due to manufacturing defects. It is an effective tool to convert customers and increase sales. Companies that have warranty programs need to estimate the probable warranty related servicing costs and expense them in the same year the sales were made.
The actual costs of servicing the products will be different from the estimates. If they are widely deviant from the estimate, the company may decide to change the provision estimate for the next year accordingly. However, no adjustment to expenses will be done with reference to provisions made at the start of the year (i.e. at the end of previous year).
a.
Effect of having the warranty program during 2016.
Since the company was not having program before 2016, it would not have made liability provisions for these expenses. Hence, the servicing costs of products sold during 2016 would be directly debited to the servicing costs expense account. The impact on the financial statements is shown below:
img Since the company had warranty program only from 2016, and since it has not made any provisions in this regard at the close of the previous year, the servicing expenses during 2016 were directly debited to the income statement as shown above. The credit leg of the accounting entry will be cash as shown below:
img b.
Accrual adjustment at the end of 2016:
• The company has started selling its products with warranty features in 2016. It has also arrived at an estimate of warranty costs based on past experience as 0.3%. Hence, it would make a liability provision of 0.3% of sales for warranty costs.
• However, the company has already started servicing products under warranty program in the year 2016 itself. Hence, the provision should take cognizance of this fact while making the accrual adjustment. It means the liability provision will be less to the extent of servicing costs already encountered during the same year in which sales are made.
• Note that in the given problem, owing to the nature of the products sold by the company, most of the warranty related costs are experienced in the same year during which the sales are made.
• Hence, the liability provision will be less to that extent. While solving the previous problems, we assumed as if all the warranty costs will be encountered in future years for sales done in the current year. In these kind of situations, it is more proper to estimate the warranty costs that would spill over to future years alone instead of overall warranty costs as a percentage of sales.
c.
Amount of accrual adjustment to be made:
As explained before, the accrual adjustment should take into account any warranty expenses already debited to the income statement for the sales made during the current year, since the provision is estimated on the sales figure.
The additional expense to be debited for the year 2016 can be expressed as follows:
Additional warranty expense to be debited in year 2016
= Warranty provision required for 2017 for sales made in 2016
= 0.3% of sales of 2016 - Servicing costs already expensed during 2016
The servicing costs already expensed during 2016 can be found from the year end balance of warranty expense account maintained for this purpose. This amount is given as $19,400.
Hence, warranty liability provision required
img = $1,300
The accrual adjustment entry will be made as follows at the end of 2016:
Dr. Warranty Expenses Account…………………. 1,300
Cr. Accrued Liability - Warranty………………………1,300
Being warranty liability accrued
Note that the above entry and liability provision implies that the company expects $1,300 worth of servicing costs in year 2017 for sales made in 2016. Thus, the company has debited its income statement by 0.3% of sales of year 2016 in the same year in tune with the matching principle.
As pointed out before, in cases where most of the warranty costs occur in the same year, it is more proper to estimate only the warranty costs that would spill over to future years instead of overall warranty costs calculated as a percentage of sales.

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Other accrued liabilities-payroll For the payroll period ended on June 25, 2016, gross pay was $28,600, net pay was $20,400, FICA tax withholdings were $2,000, income tax withholdings were $5,000, and medical insurance contributions were$1,200. Required: Use the horizontal model (or write the journal entry) to show the effects of the payroll accrual on June 25, 2016.
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For the period ended on June 25, 2016, the company should recognize an expense due to pay roll in terms of gross pay amount of $28,600. Since the amount is not paid immediately from the cash account, the amount should be recognized as part of the liability accounts.
This means the expense account goes up by this amount while the liability account also increases by the same amount. Whenever the actual payment is done to the employees, the cash will decrease by that amount thereby also reducing the liability.
• The entire gross amount is not the actual wages payable to the employees. The employees will be paid only the net pay amount. Hence, only the net pay should be recorded as part of the wages payable liability account.
• The rest of the amount should be recorded as part of the withholding liability accounts. The amount from the gross pay is withheld and added to respective withholding liability accounts.
• For example, the medical insurance contributions should go to the medical insurance payable account. Whenever the company pays medical insurance on behalf of the employees, the cash will decrease while reducing the medical insurance payable account. The other components of the gross pay will also be treated in the same manner.
The impact on the financial statements will be as shown below:
img The accounting entry to record the payroll accrual will be as follows:
img The above accounting entry recognizes the payroll expense applicable for the period thereby impacting the income statement. The respective liability accounts impact the balance sheet which will show that quantum of liability in terms of pay roll expenses. As and when actual cash payment is made, the respective liability accounts will be reduced to the extent of cash disbursal.

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Notes payable-discount basis On August 1, 2016, Colombo Co.'s treasurer signed a note promising to pay $480,000 on December 31, 2016. The proceeds of the note were $456,000. Required: a. Calculate the discount rate used by the lender. b. Calculate the effective interest rate (APR) on the loan. c. Use the horizontal model (or write the journal entry) to show the effects of 1. Signing the note and the receipt of the cash proceeds on August 1, 2016. 2. Recording interest expense for the month of September. 3. Repaying the note on December 31, 2016.
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Note Payable:
Note payable is a promissory note, by which a borrower, borrows money and promise to pay it back with interest before predetermined period.
a.
Calculate the discount rate used by the lender as follows:
Firstly, calculate the discount amount.
It is notes payable on discount basis. The maturity amount is face value of the note and is given as $480,000 payable on December 31, 2016 and net proceeds are $114,000. The discount amount is equivalent to an interest paid in advance, that is the difference between face value and net proceeds from note.
img The discount rate used by the lender can be calculated by dividing discount amount with the note value multiplied with period of note payable.
img Therefore, discount rate used by lender is 12%.
b.
Calculate effective interest Rate (APR) on the loan.
Firstly, compute the discount amount.
img The APR of the loan gives the actual and effective interest being paid on the loan by the borrower. The annualized effective interest rate can be calculated as below:
img Therefore, effective interest rate paid by the borrower is 12.6%.
c.
Prepare a horizontal model and record the journal entry to show the effect for the transaction as follows:
1.
Show the effect on financial statement for receipts of cash proceeds on August 1, 2016 is shown below:
img The cash asset goes up along with liability in terms of Notes Payable. Note that the Discount Interest on Notes Payable is a Contra liability account. Hence, it is shown with negative sign on the liabilities side above.
Record the accounting entry pertaining to receipt of loan proceeds will be as follows:
img Cash is an asset. Increase in cash is debited. Hence, cash is debited for receipt. Notes payable is a liability. Increase in note payable is credited and discount on note payable is a contra liability, decrease in discount on note payable is debited.
2.
Prepare a horizontal model and record the journal entry to show the effect for the transaction as follows:
Firstly, compute the interest expense for the month of September.
The discount interest will be amortized over the loan period. The interest to be accrued for the month of September. The interest to be expensed can be calculated as follows:
img Now, show the transaction in horizontal model.
img Record the accounting entry of interest expense for September.
img Interest expense is an expense. Increase in expense is debited. Hence, interest expense is debited. Discount on note payable is a liability. Increase in liability is credited. Hence, discount on note payable is credited.
3.
Prepare a horizontal model and record the journal entry to show the effect for the transaction as follows:
The effect of repayment of note on the financial statements will be as follows:
img The loan will be repaid for the maturity amount of $480,000 on December 31, 2016. This will extinguish the Notes Payable amount pertaining to this loan. The cash account will be credited accordingly. The Discount interest on Notes Payable account will be zero consequent to interest amortized for the month of December, 2016.
Record the accounting entries for the payment of maturity amount of note will be recorded as below:
img Cash is an asset. Decrease in asset is credited, as cash is paid. Hence, it is credited. Notes payable is a liability. Decrease in liability is debited. Hence, notes payable is debited.

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Other accrued liabilities-warranties Kohl Co. provides warranties for many of its products. The January 1, 2016, balance of the Estimated Warranty Liability account was $35,200. Based on an analysis of warranty claims during the past several years, this year's warranty provision was established at 0.4% of sales. During 2016, the actual cost of servicing products under warranty was $15,600, and sales were $3,600,000. Required: a. What amount of Warranty Expense will appear on Kohl Co.'s income statement for the year ended December 31, 2016? b. What amount will be reported in the Estimated Warranty Liability account on the December 31, 2016, balance sheet?
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Bonds payable-calculate market value On August 1, 2008, Bonnie purchased $30,000 of Huber Co.'s 10%, 20-year bonds at face value. Huber Co. has paid the semiannual interest due on the bonds regularly. On August 1, 2016, market rates of interest had fallen to 8%, and Bonnie is considering selling the bonds. Required: Using the present value tables in Chapter 6, calculate the market value of Bonnie's bonds on August 1, 2016.
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Other accrued liabilities-real estate taxes Glennelle's Boutique, Inc., operates in a city in which real estate tax bills for one year are issued in May of the subsequent year. Thus, tax bills for 2016 are issued in May 2017 and are payable in July 2017. Required: a. Explain how the amount of tax expense for calendar 2016 and the amount of taxes payable (if any) at December 31, 2016, can be determined. b. Use the horizontal model (or write the journal entry) to show the effect of accruing 2016 taxes of $12,800 at December 31, 2016. c. Assume that the actual tax bill, received in May 2017, was for $13,600. Use the horizontal model (or write the journal entry) to show the effects of the appropriate adjustment to the amount previously accrued. d. Determine the income statement and balance sheet effects of not accruing 2016 taxes at December 31, 2016 (assuming that taxes in b are not accrued).
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Bonds payable-record issuance and discount amortization Alexi Co. issued $25 million face amount of 6%, 10-year bonds on June 1, 2016. The bonds pay interest on an annual basis on May 31 each year. Required: a. Assume that the market interest rates were slightly higher than 6% when the bonds were sold. Would the proceeds from the bond issue have been more than, less than, or equal to the face amount? Explain. b. Independent of your answer to part a , assume that the proceeds were $24,880,000. Use the horizontal model (or write the journal entry) to show the effect of issuing the bonds. c. Calculate the interest expense that Alexi Co. will show with respect to these bonds in its income statement for the fiscal year ended September 30, 2016, assuming that the discount of $120,000 is amortized on a straight-line basis.
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Unearned revenues-customer deposits NightWoundsTime Brewing Co. distributes its products in an aluminum keg. Customers are charged a deposit of $60 per keg; deposits are recorded in the Keg Deposits account. Required: a. Where on the balance sheet will the Keg Deposits account be found? Explain your answer. b. Use the horizontal model (or write the journal entry) to show the effect of giving a keg deposit refund to a customer for one keg. c. A keg use analyst who works for NightWoundsTime estimates that 200 kegs for which deposits were received during the year will never be returned. What accounting, if any, would be appropriate for the deposits associated with these kegs? d. Describe the accounting that would be appropriate for the cost of the kegs that are purchased and used by NightWoundsTime Brewing Co., including how to account for unreturned kegs.
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Unearned revenues-ticket sales Kirkland Theater sells season tickets for six events at a price of $189. For the 2016 season, 1,200 season tickets were sold. Required: a. Use the horizontal model (or write the journal entry) to show the effect of the sale of the season tickets. b. Use the horizontal model (or write the journal entry) to show the effect of presenting an event. c. Where on the balance sheet would the account balance representing funds received for performances not yet presented be classified?
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Bonds payable-record issuance and premium amortization Jessie Co. issued $2 million face amount of 7%, 20-year bonds on April 1, 2016. The bonds pay interest on an annual basis on March 31 each year. Required: a. Assume that market interest rates were slightly lower than 7% when the bonds were sold. Would the proceeds from the bond issue have been more than, less than, or equal to the face amount? Explain. b. Independent of your answer to part a , assume that the proceeds were $2,060,000. Use the horizontal model (or write the journal entry) to show the effect of issuing the bonds. c. Calculate the interest expense that Jessie Co. will show with respect to these bonds in its income statement for the fiscal year ended September 30, 2016, assuming that the premium of $60,000 is amortized on a straight-line basis.
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Financial leverage A firm issues long-term debt with an effective interest rate of 10%, and the proceeds of this debt issue can be invested to earn an ROI of 12%. What effect will this financial leverage have on the firm's ROE relative to having the same amount of funds invested by the owners/stockholders?
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Deferred income tax liability The difference between the amounts of book and tax depreciation expense, as well as the desire to report income tax expense that is related to book income before taxes, causes a long-term deferred income tax liability to be reported on the balance sheet. The amount of this liability reported on the balance sheets of many firms has been increasing over the years, creating the impression that the liability will never be paid. Why has the amount of the deferred income tax liability risen steadily for many firms?
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Notes payable-discount basis On April 15, 2016, Powell, Inc., obtained a six month working capital loan from its bank. The face amount of the note signed by the treasurer was $1,200,000. The interest rate charged by the bank was 9%. The bank made the loan on a discount basis. Required: a. Calculate the loan proceeds made available to Powell, and use the horizontal model (or write the journal entry) to show the effect of signing the note and the receipt of the cash proceeds on April 15, 2016. b. Calculate the amount of interest expense applicable to this loan during the fiscal year ended June 30, 2016. c. What is the amount of the current liability related to this loan to be shown in the June 30, 2016, balance sheet?
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Other accrued liabilities-warranties The balance of the Estimated Warranty Liability account was $25,000 on January 1, 2016, and $34,400 on December 31, 2016. Based on an analysis of warranty claims during the past several years, this year's warranty provision was established at 1.5% of sales, and sales during the year were $2,600,000. Required: a. What amount of warranty expense will appear on the income statement for the year ended December 31, 2016? b. What were the actual costs of servicing products under warranty during the year?
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Unearned revenues-rent On December 1, 2016, an advance rent payment of $25,800, representing a three-month prepayment for the months of December, January, and February, was received in cash from the company's tenant. Required: Use the horizontal model (or write the journal entries) to record the effects of the following items: a. The three months of rent collected in advance on December 1, 2016. b. The adjustment that will be made at the end of each month to show the amount of rent "earned" during the month.
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Bonds payable-various issues Reynolds Co. issued $85 million face amount of 5% bonds when market interest rates were 4.72% for bonds of similar risk and other characteristics. Required: a. How much interest will be paid annually on these bonds? b. Were the bonds issued at a premium or discount? Explain your answer. c. Will the annual interest expense on these bonds be more than, equal to, or less than the amount of interest paid each year? Explain your answer.
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Other accrued liabilities-payroll taxes At March 31, 2016, the end of the first year of operations at Lukancic, Inc., the firm's accountant neglected to accrue payroll taxes of $9,600 that were applicable to payrolls for the year then ended. Required: a. Use the horizontal model (or write the journal entry) to show the effect of the accrual that should have been made as of March 31, 2016. b. Determine the income statement and balance sheet effects of not accruing payroll taxes at March 31, 2016. c. Assume that when the payroll taxes were paid in April 2016, the payroll tax expense account was charged. Assume that at March 31, 2017, the accountant again neglected to accrue the payroll tax liability, which was $10,000 at that date. Determine the income statement and balance sheet effects of not accruing payroll taxes at March 31, 2017.
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Bonds payable-various issues Atom Endeavour Co. issued $310 million face amount of 8.5% bonds when market interest rates were 8.64% for bonds of similar risk and other characteristics. Required: a. How much interest will be paid annually on these bonds? b. Were the bonds issued at a premium or discount? Explain your answer. c. Will the annual interest expense on these bonds be more than, equal to, or less than the amount of interest paid each year? Explain your answer.
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Bonds payable-calculate market value On March 1, 2011, Catherine purchased $90,000 of Tyson Co.'s 10%, 20-year bonds at face value. Tyson Co. has regularly paid the annual interest due on the bonds. On March 1, 2016, market interest rates had risen to 12%, and Catherine is considering selling the bonds. Required: Using the present value tables in Chapter 6, calculate the market value of Catherine's bonds on March 1, 2016.
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Bonds payable-various issues On July 1, 2016, $12 million face amount of 7%, 10-year bonds were issued. The bonds pay interest on an annual basis on June 30 each year. The market interest rates were slightly higher than 7% when the bonds were sold. Required: a. How much interest will be paid annually on these bonds? b. Were the bonds issued at a premium or discount? Explain. c. Will the annual interest expense on these bonds be more than, equal to, or less than the amount of interest paid each year? Explain your answer.
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