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Connect Intermediate Accounting Chapter 13

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Connect Intermediate Accounting Chapter 13

Q1. On July 1, Orcas Lab issued a $100,000, 12%, 8-month note. Interest is payable at maturity. What is the amount of interest expense that should be recorded in a year-end adjusting entry if the fiscal year-end is (a) December 31? (b) September 30?

Q2. Consider the following liabilities of Future Brands, Inc., at December 31, 2018, the company’s fiscal year-end. Should they be reported as current liabilities or long-term liabilities?

1. $77 million of 8% notes are due on May 31, 2022. The notes are callable by the company’s bank, beginning March 1, 2019.
2. $102 million of 8% notes are due on May 31, 2023. A debt covenant requires Future to maintain a current ratio (ratio of current assets to current liabilities) of at least 2 to 1. Future is in violation of this requirement but has obtained a waiver from the bank until May 2019, since both companies feel Future will correct the situation during the first half of 2019.

Q3. Right Medical introduced a new implant that carries a five-year warranty against manufacturer’s defects. Based on industry experience with similar product introductions, warranty costs are expected to approximate 1% of sales. Sales were $15 million and actual warranty expenditures were $20,000 for the first year of selling the product. What amount (if any) should Right report as a liability at the end of the year? (Enter your answers in whole dollars.)

Q4. Skill Hardware is the plaintiff in a $16 million lawsuit filed against a supplier. The litigation is in final appeal and legal counsel advises that it is virtually certain that Skill will win the lawsuit and be awarded $12 million.

How should Skill account for this event? (You may select more than one answer. Single click the box with the question mark to produce a check mark for a correct answer and double click the box with the question mark to empty the box for a wrong answer.)

Q5. Bell International can estimate the amount of loss that will occur if a foreign government expropriates some company property. Expropriation is considered reasonably possible.

How should Bell report the loss contingency? (You may select more than one answer. Single click the box with the question mark to produce a check mark for a correct answer and double click the box with the question mark to empty the box for a wrong answer.)

Q6. Household Solutions manufactures kitchen storage products. During the year, the company became aware of potential costs due to (1) a recently filed lawsuit for patent infringement for which the probability of loss is remote and damages can be reasonably estimated, (2) another recently filed lawsuit for food contamination by the plastics used in Household Solutions’ products for which a loss is probable but the amount of loss cannot be reasonably estimated, and (3) a new product warranty that is probable and can be reasonably estimated. Which, if any, of these costs should be accrued? (You may select more than one answer. Single click the box with the question mark to produce a check mark for a correct answer and double click the box with the question mark to empty the box for a wrong answer.)

Q7. At March 13, 2019, the Securities Exchange Commission is in the process of investigating a possible securities law violation by Now Chemical. The SEC has not yet proposed a penalty assessment. Now’s fiscal year ends on December 31, 2018, and its financial statements are published in March 2019. Management feels an assessment is reasonably possible, and if an assessment is made an unfavorable settlement of $13 million is probable. What, if any, action should Now take for its financial statements?

  • Liablility accrued and disclosure note.
  • Disclosure note only.
  • No disclosure required.

Q8. The following selected transactions relate to liabilities of United Insulation Corporation. United’s fiscal year ends on December 31.

2018

Jan.13 Negotiated a revolving credit agreement with Parish Bank that can be renewed annually upon bank approval. The amount available under the line of credit is $20 million at the bank’s prime rate.
Feb.1 Arranged a three-month bank loan of $5 million with Parish Bank under the line of credit agreement. Interest at the prime rate of 10% was payable at maturity.
May1 Paid the 10% note at maturity.
Dec.1 Supported by the credit line, issued $10 million of commercial paper on a nine-month note. Interest was discounted at issuance at a 9% discount rate.
31 Recorded any necessary adjusting entry(s).

2019

Sept.1 Paid the commercial paper at maturity.

Required:
Prepare the appropriate journal entries through the maturity of each liability for 2018 and 2019. (Do not round intermediate calculations. If no entry is required for a transaction/event, select “No journal entry required” in the first account field. Enter your answers in whole dollars.)

Q9. The following selected transactions relate to liabilities of Interstate Farm Implements for December of 2018. Interstate’s fiscal year ends on December 31.

Required:
Prepare the appropriate journal entries for these transactions.
1. On December 15, received $7,500 from Bradley Farms toward the purchase of a $98,000 tractor to be delivered on January 6, 2019.
2. During December, received $25,500 of refundable deposits relating to containers used to transport equipment parts.
3. During December, credit sales totaled $800,000. The state sales tax rate is 5% and the local sales tax rate is 2%. (This is a summary journal entry for the many individual sales transactions for the period.)

(For all requirements, if no entry is required for a transaction/event, select “No journal entry required” in the first account field.)

Q10. Cupola Awning Corporation introduced a new line of commercial awnings in 2018 that carry a two-year warranty against manufacturer’s defects. Based on their experience with previous product introductions, warranty costs are expected to approximate 3% of sales. Sales and actual warranty expenditures for the first year of selling the product were:

Sales Actual Warranty
Expenditures
$5,000,000 $37,500

Required:
1. Does this situation represent a loss contingency?
2. Prepare journal entries that summarize sales of the awnings (assume all credit sales) and any aspects of the warranty that should be recorded during 2018.
3. What amount should Cupola report as a liability at December 31, 2018?

Q11. The following selected transactions relate to contingencies of Classical Tool Makers, Inc., which began operations in July 2018. Classical’s fiscal year ends on December 31. Financial statements are issued in April 2019.

  1. Classical’s products carry a one-year warranty against manufacturer’s defects. Based on previous experience, warranty costs are expected to approximate 4% of sales. Sales were $2 million (all credit) for 2018. Actual warranty expenditures were $30,800 and were recorded as warranty expense when incurred.
  2. Although no customer accounts have been shown to be uncollectible, Classical estimates that 2% of credit sales will eventually prove uncollectible.
  3. In December 2018, the state of Tennessee filed suit against Classical, seeking penalties for violations of clean air laws. On January 23, 2019, Classical reached a settlement with state authorities to pay $1.5 million in penalties.
  4. Classical is the plaintiff in a $4 million lawsuit filed against a supplier. The suit is in final appeal and attorneys advise that it is virtually certain that Classical will win the case and be awarded $2.5 million.
  5. In November 2018, Classical became aware of a design flaw in an industrial saw that poses a potential electrical hazard. A product recall appears unavoidable. Such an action would likely cost the company $500,000.
  6. Classical offered $25 cash rebates on a new model of jigsaw. Customers must mail in a proof-of-purchase seal from the package plus the cash register receipt to receive the rebate. Experience suggests that 60% of the rebates will be claimed. Ten thousand of the jigsaws were sold in 2018. Total rebates to customers in 2018 were $105,000 and were recorded as promotional expense when paid.

Required:
1-a Prepare the year-end entries for any amounts that should be recorded as a result of each of the above contingencies.
1-b Indicate whether a disclosure note is needed for the above transactions.

Q12. Camden Biotechnology began operations in September 2018. The following selected transactions relate to liabilities of the company for September 2018 through March 2019. Camden’s fiscal year ends on December 31. Its financial statements are issued in April.

2018

  1. On September 5, opened checking accounts at Second Commercial Bank and negotiated a short-term line of credit of up to $15,000,000 at the bank’s prime rate (10.5% at the time). The company will pay no commitment fees.
  2. On October 1, borrowed $12 million cash from Second Commercial Bank under the line of credit and issued a five-month promissory note. Interest at the prime rate of 10% was payable at maturity. Management planned to issue 10-year bonds in February to repay the note.
  3. Received $2,600 of refundable deposits in December for reusable containers used to transport and store chemical-based products.
  4. For the September–December period, sales on account totaled $4,100,000. The state sales tax rate is 3% and the local sales tax rate is 3%. (This is a summary journal entry for the many individual sales transactions for the period.)
  5. Recorded the adjusting entry for accrued interest.

2019

  1. In February, issued $10 million of 10-year bonds at face value and paid the bank loan on the March 1 due date.
  2. Half of the storage containers covered by refundable deposits were returned in March. The remaining containers are expected to be returned during the next six months.

Required:
1. Prepare the appropriate journal entries for 2018 and 2019 transactions.
2. Prepare the current and long-term liability sections of the December 31, 2018, balance sheet. Trade accounts payable on that date were $252,000.

Q13. The unadjusted trial balance of the Manufacturing Equitable at December 31, 2018, the end of its fiscal year, included the following account balances. Manufacturing’s 2018 financial statements were issued on April 1, 2019.

Accounts receivable $92,500
Accounts payable 35,000
Bank notes payable 600,000
Mortgage note payable 1,200,000

Other information:

  1. The bank notes, issued August 1, 2018, are due on July 31, 2019, and pay interest at a rate of 10%, payable at maturity.
  2. The mortgage note is due on March 1, 2019. Interest at 9% has been paid up to December 31 (assume 9% is a realistic rate). Manufacturing intended at December 31, 2018, to refinance the note on its due date with a new 10-year mortgage note. In fact, on March 1, Manufacturing paid $250,000 in cash on the principal balance and refinanced the remaining $950,000.
  3. Included in the accounts receivable balance at December 31, 2018, were two subsidiary accounts that had been overpaid and had credit balances totaling $18,000. The accounts were of two major customers who were expected to order more merchandise from Manufacturing and apply the overpayments to those future purchases.
  4. On November 1, 2018, Manufacturing rented a portion of its factory to a tenant for $30,000 per year, payable in advance. The payment for the 12 months ended October 31, 2019, was received as required and was credited to rent revenue.

Required:
1. Prepare any necessary adjusting journal entries at December 31, 2018, pertaining to each item of other information (a–d).
2. Prepare the current and long-term liability sections of the December 31, 2018, balance sheet.

Q14. Eastern Manufacturing is involved with several situations that possibly involve contingencies. Each is described below. Eastern’s fiscal year ends December 31, and the 2018 financial statements are issued on March 15, 2019.

  1. Eastern is involved in a lawsuit resulting from a dispute with a supplier. On February 3, 2019, judgment was rendered against Eastern in the amount of $107 million plus interest, a total of $122 million. Eastern plans to appeal the judgment and is unable to predict its outcome though it is not expected to have a material adverse effect on the company.
  2. In November 2017, the State of Nevada filed suit against Eastern, seeking civil penalties and injunctive relief for violations of environmental laws regulating hazardous waste. On January 12, 2019, Eastern reached a settlement with state authorities. Based upon discussions with legal counsel, the Company feels it is probable that $140 million will be required to cover the cost of violations. Eastern believes that the ultimate settlement of this claim will not have a material adverse effect on the company.
  3. Eastern is the plaintiff in a $200 million lawsuit filed against United Steel for damages due to lost profits from rejected contracts and for unpaid receivables. The case is in final appeal and legal counsel advises that it is probable that Eastern will prevail and be awarded $100 million.
  4. At March 15, 2019, Eastern knows a competitor has threatened litigation due to patent infringement. The competitor has not yet filed a lawsuit. Management believes a lawsuit is reasonably possible, and if a lawsuit is filed, management believes damages of up to $33 million are reasonably possible.

Required:
1. Determine the appropriate means of reporting each situation.
2. Prepare the appropriate journal entries for these situations.

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