Chapter 13 Current Liabilities and

EXERCISE
Contingencies
S
Requirement 1

Exercise 13-1

Cash ......................
........Notes payable

6,000,000

Interest expense ($6,000,000 x 14% x 4/12).........

280,000

6,000,000

Requirement 2

Interest payable...........................................

280,000

Requirement 3
Interest expense ($6,000,000 x 14% x 2/12).........

140,000

Interest payable (from adjusting entry)...............

Notes payable (face amount)..............................
Cash (total)....................................................

280,000
6,000,000

Exercise 13-2 1.

Interest rate
13%

6,420,000

Fiscal year-end
December 31

$300 million x 13% x 8/12 = $26 million

2.

Interest rate

Fiscal year-end

10%

October 31

$300 million x 10% x 6/12 = $15 million

3.

Interest rate

Fiscal year-end
The McGraw-Hill Companies, Inc., 2011

Alternate Exercise and Problem Solutions

13-1

9%

June 30

$300 million x 9% x 2/12 = $4.5 million

4.

Interest rate

Fiscal year-end

7%

January 31

$300 million x 7% x 9/12 = $15.75 million

Exercise 13-3

2011

Jan. 22 No entry is made for a line of credit until a loan actually is made. It
would be described in a disclosure note.
Mar. 1
Cash ..........................................................................
Notes payable.........................................................

6,000,000
6,000,000

June 1
Interest expense ($6,000,000 x 10% x 3/12)....................

150,000

Notes payable (face amount).........................................

Cash ($6,000,000 + 150,000)......................................

6,000,000
6,150,000

Nov. 1
Cash (difference)..........................................................

5,640,000

Discount on notes payable ($6,000,000 x 8% x 9/12)......

360,000

Notes payable (face amount).....................................

6,000,000

Dec. 31
The effective interest rate is 8.5106% ($360,000 $5,640,000) x 12/9. So,
properly, interest should be recorded at that rate times the outstanding balance
times one-twelfth of a year:

The McGraw-Hill Companies, Inc., 2011

13-2

Intermediate Accounting, 6e

Interest expense ($5,640,000 x 8.5106% x 2/12)..............

80,000

Discount on notes payable ....................................

80,000

However the same results are achieved if interest is recorded at the discount
rate times the maturity amount times two-twelfths of a year:

Interest expense ($6,000,000 x 8% x 2/12).....................

80,000

Discount on notes payable ....................................

80,000

Exercise 13-3 (concluded) 2012

Aug. 1
Interest expense ($6,000,000 x 8% x 7/12)*....................

280,000

Discount on notes payable ....................................

Notes payable (balance)...............................................

Cash (maturity amount).............................................

280,000

6,000,000
6,000,000

* or, ($5,640,000 x 8.5106% x 7/12) = $280,000

The McGraw-Hill Companies, Inc., 2011

Alternate Exercise and Problem Solutions

13-3

1. Noncurrent liability: $22 million

Exercise 13-4
The current liability classification includes (a) situations in
which the creditor has the right to demand payment because an existing
violation of a provision of the debt agreement makes it callable and (b)
situations in which debt is not yet callable, but will be callable within the year
if an existing violation is not corrected within a specified grace period unless
it's probable the violation will be corrected within the grace period. In this
case, the existing violation is expected to be corrected within 6 months.
2.Current liability: $9 million
The debt should be reported as a current liability because it is payable in the
upcoming year, will not be refinanced with long-term obligations, and will not
be paid with a bond sinking fund.
3.Current liability: $15 million
The requirement to classify currently maturing debt as a current liability includes
debt that is callable by the creditor in the upcoming year even if the debt is
not expected to be called

Exercise 13-5Requirement 1
This is a loss contingency. There may be a future sacrifice of
economic benefits (cost of satisfying the warranty) due to an existing
circumstance (the warranted awnings have been sold) that depends on an
uncertain future event (customer claims).
The liability is probable because product warranties inevitably entail costs. A
reasonably accurate estimate of the total liability for a period is possible based
on prior experience. So, the contingent liability for the warranty is accrued.
The estimated warranty liability is credited and warranty expense is debited in
2011, the period in which the products under warranty are sold.
Requirement 2
2011 Sales

The McGraw-Hill Companies, Inc., 2011

13-4

Intermediate Accounting, 6e

Accounts receivable............................................
Sales ................................................................

7,500,000
7,500,000

Accrued liability and expense

Warranty expense (4% x $7,500,000).........................
Estimated warranty liability ............................

300,000

Actual expenditures
Estimated warranty liability ...............................
Cash, wages payable, parts and supplies, etc. .

124,800

300,000

124,800

Requirement 3
Warranty Liability
__________________________________________

300,000 Estimated liability

Actual expenditures 124,800
175,200 Balance

PROBLEM
S

Requirement 1

Problem 13-1

Schilling Motors
Cash ................................. 42,000,000
...................Notes payable
........................42,000,000

First Bank
Notes receivable....................................................... 42,000,000
The McGraw-Hill Companies, Inc., 2011
Alternate Exercise and Problem Solutions

13-5

Cash .....................................................................

42,000,000

Requirement 2
Adjusting entries (December 31, 2011)
Schilling Motors
Interest expense ($42,000,000 x 12% x 2/12).................

840,000

Interest payable.....................................................

840,000

First Bank
Interest receivable....................................................

840,000

Interest revenue ($42,000,000 x 12% x 2/12).............

840,000

Maturity (March 31, 2012)

Schilling Motors
Interest expense ($42,000,000 x 12% x 3/12).................

1,260,000

Interest payable (from adjusting entry)........................

840,000
Notes payable (face amount)....................................... 42,000,000
Cash (total).............................................................
44,100,000

First Bank
Cash (total)................................................................. 44,100,000
Interest revenue ($42,000,000 x 12% x 3/12)...............

1,260,000

Interest receivable (from adjusting entry).................

Notes receivable (face amount)...............................

840,000
42,000,000

The McGraw-Hill Companies, Inc., 2011

13-6

Intermediate Accounting, 6e

Problem 13-1 (concluded)

Requirement 3

Issuance of note (November 1, 2011)

Cash (difference).........................................................

39,900,000

Discount on notes payable ($42,000,000 x 12% x 5/12)

2,100,000

Notes payable (face amount).........................................

42,000,000

Adjusting entry (December 31, 2011)

Interest expense ($42,000,000 x 12% x 2/12).................

840,000

Discount on notes payable....................................

840,000

Maturity (March 31, 2012)

Interest expense ($42,000,000 x 12% x 3/12).................
Discount on notes payable....................................

1,260,000
1,260,000

Notes payable (face amount)....................................... 42,000,000

Cash .....................................................................
42,000,000

Effective interest rate:

Discount ($42,000,000 x 12% x 5/12)
Cash proceeds
Interest rate for 4 months

Annual effective rate

2,100,000

$39,900,000
5.26315%
x 12/5
___________
12.63%
The McGraw-Hill Companies, Inc., 2011

Alternate Exercise and Problem Solutions

13-7

 The McGraw-Hill Companies, Inc., 2011

13-8

Intermediate Accounting, 6e

1. This is a loss contingency. Finley can use the information

Problem 13-2 occurring after the end of the year in determining appropriate
disclosure. It is unlikely that Finley would choose to accrue the
$36 million loss because the judgment will be appealed and that outcome is
uncertain. A disclosure note is appropriate:
_______________________________
Note X: Contingency
In a lawsuit resulting from a dispute with a supplier, a judgment was rendered
against Finley Corporation in the amount of $34 million plus interest, a total of $36
million at January 25, 2012. Finley plans to appeal the judgment. While
management and legal counsel are presently unable to predict the outcome or to
estimate the amount of any liability the company may have with respect to this
lawsuit, it is not expected that this matter will have a material adverse effect on the
company.

2. No disclosure is required because an EPA claim is as yet unasserted, and an

assessment is not probable. Even if an unfavorable outcome is thought to be
probable in the event of an assessment and the amount is estimable, disclosure is
not required unless an unasserted claim is probable.
Problem 13-2 (concluded) 3. This is a gain contingency. Gain contingencies are not
accrued even if the gain is probable and reasonably
estimable. The gain should be recognized only when realized.
Though gain contingencies are not recorded in the accounts, they should be
disclosed in notes to the financial statements.
_______________________________
Note X: Contingency

The McGraw-Hill Companies, Inc., 2011

Alternate Exercise and Problem Solutions

13-9

Finley is the plaintiff in a pending lawsuit filed against AA Asphalt for damages
due to lost profits from rejected contracts and for unpaid receivables. The case is
in final appeal. No amount has been accrued in the financial statements for
possible collection of any claims in this litigation.

4. This is a loss contingency. Finley can use the information occurring after the end
of the year in determining appropriate disclosure. Finley should accrue the $55
million loss because the ultimate outcome appears settled and the loss is probable.

Loss litigation...........................................
Liability - litigation..................................

55,000,000
55,000,000

A disclosure note also is appropriate:

_________________________________
Notes: Litigation
In October 2010, the State of Montana filed suit against the Company, seeking civil
penalties and injunctive relief for violations of environmental laws regulating
hazardous waste. On February 3, 2012, the Company announced that it had
reached a settlement with state authorities on this matter. Based upon discussions
with legal counsel, the Company, has accrued and charged to operations in 2011,
$55 million to cover the anticipated cost of all violations. The Company believes
that the ultimate settlement of this claim will not have a material adverse effect on
the Company's financial position.

The McGraw-Hill Companies, Inc., 2011

13-10

Intermediate Accounting, 6e