CURRENT LABILITIES AND CONTINGENCIES
21. Liabilities are
a. any accounts having credit balances after
closing entries are made.
b. deferred credits that are recognized and
measured in conformity with generally
accepted accounting principles.
c. obligations to transfer ownership shares to
other entities in the future.
d. obligations arising from past transactions
and payable in assets or services in the
future.
22. Which of the following is a current liability?
a. A long-term debt maturing currently, which
is to be paid with cash in a sinking fund
b. A long-term debt maturing currently, which
is to be retired with proceeds from a new
debt issue
c. A long-term debt maturing currently, which
is to be converted into common stock
d. None of these
23. Which of the following is true about accounts
payable?
1.Accounts payable should not be reported at their
present value.
2.When accounts payable are recorded at the net
amount, a Purchase Discounts account will be used.
3.When accounts payable are recorded at the gross
amount, a Purchase Discounts Lost account will be
used.
a. 1
b. 2
c. 3
d. Both 2 and 3 are true.
24. Among the short-term obligations of Lance
Company as of December 31, the balance sheet
date, are notes payable totaling $250,000 with
the Madison National Bank. These are 90-day
notes, renewable for another 90-day period.
These notes should be classified on the balance
sheet of Lance Company as
a. current liabilities.
b. deferred charges.
c. long-term liabilities.
d. intermediate debt.
25. Which of the following is not true about the
discount on short-term notes payable?
a. The Discount on Notes Payable account has a
debit balance.
b. The Discount on Notes Payable account should
be reported as an asset on the balance sheet.
c. When there is a discount on a note payable,
the effective interest rate is higher than
the stated discount rate.
d. All of these are true.
26. Which of the following may be a current
liability?
a. Withheld Income Taxes
b. Deposits Received from Customers
c. Deferred Revenue
d. All of these
27. Which of the following items is a current
liability?
a. Bonds (for which there is an adequate
sinking fund properly classified as a long-
term investment) due in three months.
b. Bonds due in three years.
c. Bonds (for which there is an adequate
appropriation of retained earnings) due in
eleven months.
d. Bonds to be refunded when due in eight
months, there being no doubt about the
marketability of the refunding issue.
28. Which of the following should not be included
in the current liabilities section of the
balance sheet?
a. Trade notes payable
 b. Short-term zero-interest-bearing notes firm intends to refinance the obligation on
payable a long-term basis.
c. The discount on short-term notes payable b. A company may exclude a short-term
d. All of these are included obligation from current liabilities if the
firm can demonstrate an ability to
29. Which of the following is a current liability? consummate a refinancing.
a. Preferred dividends in arrears c. A company may exclude a short-term
b. A dividend payable in the form of additional obligation from current liabilities if it is
shares of stock paid off after the balance sheet date and
c. A cash dividend payable to preferred subsequently replaced by long-term debt
stockholders before the balance sheet is issued.
d. All of these d. None of these.

34. The ability to consummate the refinancing of a

30. Stock dividends distributable should be short-term obligation may be demon- strated
classified on the by
a. income statement as an expense. a. actually refinancing the obligation by
b. balance sheet as an asset. issuing a long-term obligation after the
c. balance sheet as a liability. date of the balance sheet but before it is
d. balance sheet as an item of stockholders' issued.
equity. b. entering into a financing agreement that
permits the enterprise to refinance the debt
31. Of the following items, the only one which on a long-term basis.
should not be classified as a current liability is c. actually refinancing the obligation by
a. current maturities of long-term debt. issuing equity securities after the date of
b. sales taxes payable. the balance sheet but before it is issued.
c. short-term obligations expected to be d. all of these.
refinanced.
d. unearned revenues. 35. Which of the following statements is false?
a. A company may exclude a short-term
32. An account which would be classified as a obligation from current liabilities if the
current liability is firm intends to refinance the obligation on
a. dividends payable in the company's stock. a long-term basis and demonstrates an
b. accounts payable—debit balances. ability to complete the refinancing.
c. losses expected to be incurred within the b. Cash dividends should be recorded as a
next twelve months in excess of the liability when they are declared by the
company's insurance coverage. board of directors.
d. none of these. c. Under the cash basis method, warranty costs
are charged to expense as they are paid.
33. Which of the following statements is correct? d. FICA taxes withheld from employees' payroll
a. A company may exclude a short-term checks should never be recorded as a
obligation from current liabilities if the liability since the employer will eventually
 remit the amounts withheld to the
appropriate taxing authority.
36. Which of the following is not a correct
statement about sales taxes?
a. Sales taxes are an expense of the seller.
b. Many companies record sales taxes in the
sales account.
c. If sales taxes are included in the sales
account, the first step to find the amount
of sales taxes is to divide sales by 1 plus
the sales tax rate.
d. All of these are true.
S37. If a short-term obligation is excluded from
current liabilities because of refinancing, the
footnote to the financial statements describing
this event should include all of the following
information except
a. a general description of the financing
arrangement.
b. the terms of the new obligation incurred or
to be incurred.
c. the terms of any equity security issued or
to be issued.
d. the number of financing institutions that
refused to refinance the debt, if any.
38. In accounting for compensated absences,
the difference between vested rights and
accumulated rights is
a. vested rights are normally for a longer
period of employment than are accumulated
rights.
b. vested rights are not contingent upon an
employee's future service.
c. vested rights are a legal and binding
obligation on the company, whereas
accumulated rights expire at the end of the
accounting period in which they arose.
d. vested rights carry a stipulated dollar
amount that is owed to the employee;
accumulated rights do not represent monetary
compensation.
P39. An employee's net (or take-home) pay is
determined by gross earnings minus amounts for
income tax withholdings and the employee's
a. portion of FICA taxes, and unemployment
taxes.
b. and employer's portion of FICA taxes, and
unemployment taxes.
c. portion of FICA taxes, unemployment taxes,
and any voluntary deductions.
d. portion of FICA taxes, and any voluntary
deductions.
40. Which of these is not included in an employer's
payroll tax expense?
a. F.I.C.A. (social security) taxes
b. Federal unemployment taxes
c. State unemployment taxes
d. Federal income taxes
41. Which of the following is a condition for
accruing a liability for the cost of
compensation for future absences?
a. The obligation relates to the rights that
vest or accumulate.
b. Payment of the compensation is probable.
c. The obligation is attributable to employee
services already performed.
d. All of these are conditions for the accrual.
42. A liability for compensated absences such as
vacations, for which it is expected that
employees will be paid, should
a. be accrued during the period when the
compensated time is expected to be used by
employees.
b. be accrued during the period following
vesting.
c. be accrued during the period when earned.
d. not be accrued unless a written contractual
obligation exists.
 d. Event is unusual in nature and event occurs
43. The amount of the liability for compensated infrequently.
absences should be based on
47. Mark Ward is a farmer who owns land which
1.the current rates of pay in effect when employees
borders on the right-of-way of the Northern
earn the right to compensated absences.
Railroad. On August 10, 2007, due to the
2.the future rates of pay expected to be paid when
admitted negligence of the Railroad, hay on the
employees use compensated time.
farm was set on fire and burned. Ward had had
3.the present value of the amount expected to be paid
a dispute with the Railroad for several years
in future periods.
concerning the ownership of a small parcel of
a. 1.
land. The representative of the Railroad has
b. 2.
offered to assign any rights which the Railroad
c. 3.
may have in the land to Ward in exchange for a
d. Either 1 or 2 is acceptable.
release of his right to reimbursement for the
loss he has sustained from the fire. Ward
44. Which of the following is the proper way to
appears inclined to accept the Railroad's
report a gain contingency?
offer. The Railroad's 2007 financial statements
a. As an accrued amount.
should include the following related to the
b. As deferred revenue.
incident:
c. As an account receivable with additional
a. recognition of a loss and creation of a
disclosure explaining the nature of the
liability for the value of the land.
contingency.
b. recognition of a loss only.
d. As a disclosure only.
c. creation of a liability only.
d. disclosure in note form only.
45. Which of the following contingencies need not
be disclosed in the financial statements or the
48. A contingency can be accrued when
notes thereto?
a. it is certain that funds are available to
a. Probable losses not reasonably estimable
settle the disputed amount.
b. Environmental liabilities that cannot be
b. an asset may have been impaired.
reasonably estimated
c. the amount of the loss can be reasonably
c. Guarantees of indebtedness of others
estimated and it is probable that an asset
d. All of these must be disclosed.
has been impaired or a liability incurred.
d. it is probable that an asset has been
46. Which of the following sets of conditions would
impaired or a liability incurred even though
give rise to the accrual of a contingency under
the amount of the loss cannot be reasonably
current generally accepted accounting
estimated.
principles?
49. A contingent liability
a. Amount of loss is reasonably estimable and
a. definitely exists as a liability but its
event occurs infrequently.
amount and due date are indeterminable.
b. Amount of loss is reasonably estimable and
b. is accrued even though not reasonably
occurrence of event is probable.
estimated.
c. Event is unusual in nature and occurrence of
c. is not disclosed in the financial
event is probable.
statements.
 d. is the result of a loss contingency.
50. To record an asset retirement obligation (ARO),
the cost associated with the ARO is
a. expensed.
b. included in the carrying amount of the
related long-lived asset.
c. included in a separate account.
d. none of these.
51. A company is legally obligated for the costs
associated with the retirement of a long-lived
asset
a. only when it hires another party to perform
the retirement activities.
b. only if it performs the activities with its
own workforce and equipment.
c. whether it hires another party to perform
the retirement activities or performs the
activities itself.
d. when it is probable the asset will be
retired.
52. Assume that a manufacturing corporation has (1)
good quality control, (2) a one-year operating
cycle, (3) a relatively stable pattern of
annual sales, and (4) a continuing policy of
guaranteeing new products against defects for
three years that has resulted in material but
rather stable warranty repair and replacement
costs. Any liability for the warranty
a. should be reported as long-term.
b. should be reported as current.
c. should be reported as part current and part
long-term.
d. need not be disclosed.
53. Lopez Corporation, a manufacturer of household
paints, is preparing annual financial
statements at December 31, 2007. Because of a
recently proven health hazard in one of its
paints, the government has clearly indicated
its intention of having Lopez recall all cans
of this paint sold in the last six months. The
management of Lopez estimates that this recall
would cost $800,000. What accounting
recognition, if any, should be accorded this
situation?
a. No recognition
b. Note disclosure only
c. Operating expense of $800,000 and liability
of $800,000
d. Appropriation of retained earnings of
$800,000
54. Information available prior to the issuance of
the financial statements indicates that it is
probable that, at the date of the financial
statements, a liability has been incurred for
obligations related to product warranties. The
amount of the loss involved can be reasonably
estimated. Based on the above facts, an
estimated loss contingency should be
a. accrued.
b. disclosed but not accrued.
c. neither accrued nor disclosed.
d. classified as an appropriation of retained
earnings.
P55. Mayberry Co. has a loss contingency to accrue.
The loss amount 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 amount of loss
accrual should be
a. zero.
b. the minimum of the range.
c. the mean of the range.
d. the maximum of the range.
S56. Marx Company becomes aware of a lawsuit after
the date of the financial statements, but
before they are issued. A loss and related
liability should be reported in the financial
statements if the amount can be reasonably
 estimated, an unfavorable outcome is highly b. showing the amount among the liabilities but
probable, and not extending it to the liability total.
a. the Marx Company admits guilt. c. an appropriation of retained earnings.
b. the court will decide the case within one d. appropriately classifying them as regular
year. liabilities in the balance sheet.
c. the damages appear to be material. 61. The numerator of the acid-test ratio consists
d. the cause for action occurred during the of
accounting period covered by the financial a. total current assets.
statements. b. cash and marketable securities.
S57. Use of the accrual method in accounting for c. cash and net receivables.
product warranty costs d. cash, marketable securities, and net
a. is required for federal income tax purposes. receivables.
b. is frequently justified on the basis of *62. Which of the following is not a permissible
expediency when warranty costs are method of calculating a bonus to an employee?
immaterial. a. The bonus is based on income before
c. finds the expense account being charged when deductions for the bonus and income taxes.
the seller performs in compliance with the b. The bonus is based on income after deduction
warranty. of the bonus but before deduction of income
d. represents accepted practice and should be taxes.
used whenever the warranty is an integral c. The bonus is based on income after
and inseparable part of the sale. deductions for the bonus and income taxes.
S58. Which of the following is not acceptable d. All of these are permissible.
treatment for the presentation of current
liabilities? It An It An It An It An It An It An It An
a. Listing current liabilities in order of em
21 s.
d em
27 s.
c em
33 s.
d em
39 s.
d em
45 s.
d em
51 s.
c em
57 s.
d
maturity
.
22 d .
28 d .
34 d .
40 d .
46 b . .
52 c 58 c
b. Listing current liabilities according to
amount . a
23 . c
29 . d
35 . d
41 . a
47 . c 59
53 . a
c. Offsetting current liabilities against . a
24 . d
30 . a
36 . c
42 . c
48 . a 60
54 . d
assets that are to be applied to their . b . c . d . d . d . b 61. d
liquidation 25 31 37 43 49 55
d. Showing current liabilities immediately . d
26 . d
32 . b
38 . d
44 . b
50 . d 62
56 . d
below current assets to obtain a . . . . . . .
presentation of working capital Solutions to those Multiple Choice questions for which the
P59. The ratio of current assets to current answer is “none of these.”
liabilities is called the 22. A long-term debt maturing currently to be paid with
a. current ratio. current assets is a current liability.
b. acid-test ratio. 32. Accounts Payable, Wages Payable, etc., would be
c. current asset turnover ratio. examples of current liabilities.
d. current liability turnover ratio. 33. The company must both intend to refinance the
60. Accrued liabilities are disclosed in financial obligation on a long-term basis and demonstrate the
statements by ability to consummate the refinancing to exclude a
a. a footnote to the statements. short-term obligation from current liabilities.
 MULTIPLE CHOICE—Computational

63. Edson Corp. signed a three-month, zero-interest-bearing note on November 1,

2007 for the purchase of $150,000 of inventory. The face value of the note
was $152,205. Assuming Edson used a “Discount on Note Payable” account to
initially record the note and that the discount will be amortized equally
over the 3-month period, the adjusting entry made at December 31, 2007 will
include a
a. debit to Discount on Note Payable for $735.
b. debit to Interest Expense for $1,470.
c. credit to Discount on Note Payable for $735.
d. credit to Interest Expense for $1,470.

64. The effective interest on a 12-month, zero-interest-bearing note payable of

$300,000, discounted at the bank at 10% is
a. 10.87%.
b. 10%.
c. 9.09%.
d. 11.11%.

65. On February 10, 2007, after issuance of its financial statements for 2006,
Flynn Company entered into a financing agreement with Lebo Bank, allowing Flynn
Company to borrow up to $4,000,000 at any time through 2009. Amounts borrowed under
the agreement bear interest at 2% above the bank's prime interest rate and mature
two years from the date of loan. Flynn Company presently has $1,500,000 of notes
payable with First National Bank maturing March 15, 2007. The company intends to
borrow $2,500,000 under the agreement with Lebo and liquidate the notes payable to
First National. The agreement with Lebo also requires Flynn to maintain a working
capital level of $6,000,000 and prohibits the payment of dividends on common stock
without prior approval by Lebo Bank. From the above information only, the total
short-term debt of Flynn Company as of the December 31, 2007 balance sheet date is
a. $0.
b. $1,500,000.
c. $2,000,000.
d. $4,000,000.

66. On December 31, 2006, Frye Co. has $2,000,000 of short-term notes payable
due on February 14, 2007. On January 10, 2007, Frye arranged a line of credit
with County Bank which allows Frye to borrow up to $1,500,000 at one percent
above the prime rate for three years. On February 2, 2007, Frye borrowed
$1,200,000 from County Bank and used $500,000 additional cash to liquidate
$1,700,000 of the short-term notes payable. The amount of the short-term
notes payable that should be reported as current liabilities on the December
31, 2006 balance sheet which is issued on March 5, 2007 is
a. $0.
b. $300,000.
c. $500,000.
d. $800,000.

Use the following information for questions 67 and 68.

Raney Co. is a retail store operating in a state with a 6% retail sales tax. The
retailer may keep 2% of the sales tax collected. Raney Co. records the sales tax
in the Sales account. The amount recorded in the Sales account during May was
$148,400.

67. The amount of sales taxes (to the nearest dollar) for May is
 a. $8,726.
b. $8,400.
c. $8,904.
d. $9,438.

68. The amount of sales taxes payable (to the nearest dollar) to the state for
the month of May is
a. $8,551.
b. $8,232.
c. $8,726.
d. $9,249.

69. Trent, Inc., is a retail store operating in a state with a 5% retail sales
tax. The state law provides that the retail sales tax collected during the month
must be remitted to the state during the following month. If the amount collected
is remitted to the state on or before the twentieth of the following month, the
retailer may keep 3% of the sales tax collected. On April 10, 2007, Trent remitted
$81,480 tax to the state tax division for March 2007 retail sales. What was Trent
's March 2007 retail sales subject to sales tax?
a. $1,629,600.
b. $1,596,000.
c. $1,680,000.
d. $1,645,000.

70. Holbert Corporation has $2,500,000 of short-term debt it expects to retire

with proceeds from the sale of 75,000 shares of common stock. If the stock
is sold for $20 per share subsequent to the balance sheet date, but before
the balance sheet is issued, what amount of short-term debt could be excluded
from current liabilities?
a. $1,500,000
b. $2,500,000
c. $1,000,000
d. $0

71. Grogan Corporation has $1,800,000 of short-term debt it expects to retire

with proceeds from the sale of 60,000 shares of common stock. If the stock
is sold for $20 per share subsequent to the balance sheet date, but before
the balance sheet is issued, what amount of short-term debt could be excluded
from current liabilities?
a. $1,200,000
b. $1,800,000
c. $600,000
d. $0

72. Timmons Co., which has a taxable payroll of $500,000, is subject to FUTA tax
of 6.2% and a state contribution rate of 5.4%. However, because of stable
employment experience, the company’s state rate has been reduced to 2%. What
is the total amount of federal and state unemployment tax for Timmons Co.?
a. $58,500
b. $41,000
c. $20,000
d. $14,000
73. Unruh Co., which has a taxable payroll of $400,000, is subject to FUTA tax
of 6.2% and a state contribution rate of 5.4%. However, because of stable
employment experience, the company’s state rate has been reduced to 2%. What
is the total amount of federal and state unemployment tax for Unruh Co.?
a. $46,800
b. $32,800
c. $16,000
 d. $11,200

74. A company gives each of its 50 employees (assume they were all employed
continuously through 2007 and 2008) 12 days of vacation a year if they are employed
at the end of the year. The vacation accumulates and may be taken starting January
1 of the next year. The employees work 8 hours per day. In 2007, they made $14
per hour and in 2008 they made $16 per hour. During 2008, they took an average of
9 days of vacation each. The company’s policy is to record the liability existing
at the end of each year at the wage rate for that year. What amount of vacation
liability would be reflected on the 2007 and 2008 balance sheets, respectively?
a. $67,200; $93,600
b. $76,800; $96,000
c. $67,200; $96,000
d. $76,800; $93,600

75. A company gives each of its 50 employees (assume they were all employed
continuously through 2007 and 2008) 12 days of vacation a year if they are
employed at the end of the year. The vacation accumulates and may be taken
starting January 1 of the next year. The employees work 8 hours per day.
In 2007, they made $17.50 per hour and in 2008 they made $20 per hour. During
2008, they took an average of 9 days of vacation each. The company’s policy
is to record the liability existing at the end of each year at the wage rate
for that year. What amount of vacation liability would be reflected on the
2007 and 2008 balance sheets, respectively?
a. $84,000; $117,000
b. $96,000; $120,000
c. $84,000; $120,000
d. $96,000; $117,000

76. The total payroll of Waters Company for the month of October, 2007 was
$360,000, of which $90,000 represented amounts paid in excess of $90,000 to
certain employees. $300,000 represented amounts paid to employees in excess
of the $7,000 maximum subject to unemployment taxes. $90,000 of federal
income taxes and $9,000 of union dues were withheld. The state unemployment
tax is 1%, the federal unemployment tax is .8%, and the current F.I.C.A. tax
is 7.65% on an employee’s wages to $90,000 and 1.45% in excess of $90,000.
What amount should Waters record as payroll tax expense?
a. $118,620.
b. $113,040.
c. $23,040.
d. $28,440.

Use the following information for questions 77 and 78.

Simson Company has 35 employees who work 8-hour days and are paid hourly. On
January 1, 2006, the company began a program of granting its employees 10 days of
paid vacation each year. Vacation days earned in 2006 may first be taken on January
1, 2007. Information relative to these employees is as follows:
Hourly Vacation Days EarnedVacation Days Used
Year Wages by Each Employee by Each Employee
2006 $25.80 10 0
2007 27.00 10 8
2008 28.50 10 10

Simson has chosen to accrue the liability for compensated absences at the current
rates of pay in effect when the compensated time is earned.
77. What is the amount of expense relative to compensated absences that should
be reported on Simson’s income statement for 2006?
a. $0.
 b. $68,880.
c. $75,600.
d. $72,240.

78. What is the amount of the accrued liability for compensated absences that
should be reported at December 31, 2008?
a. $94,920.
b. $90,720.
c. $79,800.
d. $95,760.

79. A company offers a cash rebate of $1 on each $4 package of light bulbs sold
during 2007. Historically, 10% of customers mail in the rebate form. During
2007, 4,000,000 packages of light bulbs are sold, and 140,000 $1 rebates are
mailed to customers. What is the rebate expense and liability, respectively,
shown on the 2007 financial statements dated December 31?
a. $400,000; $400,000
b. $400,000; $260,000
c. $260,000; $260,000
d. $140,000; $260,000

80. A company buys an oil rig for $1,000,000 on January 1, 2007. The life of
the rig is 10 years and the expected cost to dismantle the rig at the end of
10 years is $200,000 (present value at 10% is $77,110). 10% is an appropriate
interest rate for this company. What expense should be recorded for 2007 as
a result of these events?
a. Depreciation expense of $120,000
b. Depreciation expense of $100,000 and interest expense of $7,711
c. Depreciation expense of $100,000 and interest expense of $20,000
d. Depreciation expense of $107,710 and interest expense of $7,711

81. Wellman Company self insures its property for fire and storm damage. If the
company were to obtain insurance on the property, it would cost them
$1,000,000 per year. The company estimates that on average it will incur
losses of $800,000 per year. During 2007, $350,000 worth of losses were
sustained. How much total expense and/or loss should be recognized by Wellman
Company for 2007?
a. $350,000 in losses and no insurance expense
b. $350,000 in losses and $450,000 in insurance expense
c. $0 in losses and $800,000 in insurance expense
d. $0 in losses and $1,000,000 in insurance expense

82. A company offers a cash rebate of $1 on each $4 package of batteries sold

during 2007. Historically, 10% of customers mail in the rebate form. During
2007, 6,000,000 packages of batteries are sold, and 210,000 $1 rebates are
mailed to customers. What is the rebate expense and liability, respectively,
shown on the 2007 financial statements dated December 31?
a. $600,000; $600,000
b. $600,000; $390,000
c. $390,000; $390,000
d. $210,000; $390,000
83. A company buys an oil rig for $2,000,000 on January 1, 2007. The life of
the rig is 10 years and the expected cost to dismantle the rig at the end of
10 years is $400,000 (present value at 10% is $154,220). 10% is an
appropriate interest rate for this company. What expense should be recorded
for 2007 as a result of these events?
a. Depreciation expense of $240,000
b. Depreciation expense of $200,000 and interest expense of $15,422
c. Depreciation expense of $200,000 and interest expense of $40,000
 d. Depreciation expense of $215,420 and interest expense of $15,422

84. During 2006, Younger Co. introduced a new line of machines that carry a
three-year warranty against manufacturer’s defects. Based on industry
experience, warranty costs are estimated at 2% of sales in the year of sale,
4% in the year after sale, and 6% in the second year after sale. Sales and
actual warranty expenditures for the first three-year period were as follows:
Sales Actual Warranty Expenditures
2006 $ 600,000 $ 9,000
2007 1,500,000 45,000
2008 2,100,000 135,000
$4,200,000 $189,000
What amount should Younger report as a liability at December 31, 2008?
a. $0
b. $15,000
c. $204,000
d. $315,000

85. Milner Frosted Flakes Company offers its customers a pottery cereal bowl if
they send in 3 boxtops from Milner Frosted Flakes boxes and $1.00. The company
estimates that 60% of the boxtops will be redeemed. In 2007, the company sold
675,000 boxes of Frosted Flakes and customers redeemed 330,000 boxtops
receiving 110,000 bowls. If the bowls cost Milner Company $2.50 each, how
much liability for outstanding premiums should be recorded at the end of
2007?
a. $25,000
b. $37,500
c. $62,500
d. $87,500

86. During 2006, Venable Co. introduced a new line of machines that carry a
three-year warranty against manufacturer’s defects. Based on industry
experience, warranty costs are estimated at 2% of sales in the year of sale,
4% in the year after sale, and 6% in the second year after sale. Sales and
actual warranty expenditures for the first three-year period were as follows:
Sales Actual Warranty Expenditures
2006 $ 400,000 $ 6,000
2007 1,000,000 30,000
2008 1,400,000 90,000
$2,800,000 $126,000
What amount should Venable report as a liability at December 31, 2008?
a. $0
b. $10,000
c. $136,000
d. $210,000
87. Pryor Frosted Flakes Company offers its customers a pottery cereal bowl if
they send in 4 boxtops from Pryor Frosted Flakes boxes and $1.00. The company
estimates that 60% of the boxtops will be redeemed. In 2007, the company sold
500,000 boxes of Frosted Flakes and customers redeemed 220,000 boxtops
receiving 55,000 bowls. If the bowls cost Pryor Company $2.50 each, how much
liability for outstanding premiums should be recorded at the end of 2007?
a. $20,000
b. $30,000
c. $50,000
d. $70,000

Use the following information for questions 88, 89, and 90.
Kent Co. includes one coupon in each bag of dog food it sells. In return for eight
coupons, customers receive a leash. The leashes cost Kent $2.00 each. Kent estimates
that 40 percent of the coupons will be redeemed. Data for 2006 and 2007 are as
follows:
2006 2007
Bags of dog food sold 500,000 600,000
Leashes purchased 18,000 22,000
Coupons redeemed 120,000 150,000

88. The premium expense for 2006 is

a. $25,000.
b. $30,000.
c. $35,000.
d. $50,000.

89. The estimated liability for premiums at December 31, 2006 is

a. $7,500.
b. $10,000.
c. $17,500.
d. $20,000.

90. The estimated liability for premiums at December 31, 2007 is

a. $11,250.
b. $21,250.
c. $22,500.
d. $42,500.

91. Vernon 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. Vernon's lawyer states that
it is probable that Vernon will lose the suit and be found liable for a
judgment costing Vernon anywhere from $1,200,000 to $6,000,000. However, the
lawyer states that the most probable cost is $3,600,000. As a result of the
above facts, Vernon should accrue
a. a loss contingency of $1,200,000 and disclose an additional contingency
of up to $4,800,000.
b. a loss contingency of $3,600,000 and disclose an additional contingency
of up to $2,400,000.
c. a loss contingency of $3,600,000 but not disclose any additional
contingency.
d. no loss contingency but disclose a contingency of $1,200,000 to $6,000,000.

92. Moore Company estimates its annual warranty expense as 4% of annual net
sales. The following data relate to the calendar year 2007:
Net sales $1,500,000
Warranty liability account
Balance, Dec. 31, 2007 $10,000 debit before adjustment
Balance, Dec. 31, 2007 50,000 credit after adjustment
Which one of the following entries was made to record the 2007 estimated
warranty expense?
a. Warranty Expense ........................... 60,000
Retained Earnings (prior-period adjustment) 10,000
Warranty Liability .................... 50,000
b. Warranty Expense ........................... 50,000
Retained Earnings (prior-period adjustment) 10,000
Warranty Liability .................... 60,000
 c. Warranty Expense ........................... 40,000
Warranty Liability .................... 40,000
d. Warranty Expense ........................... 60,000
Warranty Liability .................... 60,000

93. In 2006, Slimon Corporation began selling a new line of products that carry
a two-year warranty against defects. Based upon past experience with other
products, the estimated warranty costs related to dollar sales are as follows:
First year of warranty 2%
Second year of warranty 5%
Sales and actual warranty expenditures for 2006 and 2007 are presented
below:
2006 2007
Sales $300,000 $400,000
Actual warranty expenditures 10,000 20,000
What is the estimated warranty liability at the end of 2007?
a. $19,000.
b. $29,000.
c. $49,000.
d. $8,000.

94. On January 3, 2007, Alton Corp. owned a machine that had cost $200,000. The
accumulated depreciation was $120,000, estimated salvage value was $12,000,
and fair market value was $320,000. On January 4, 2007, this machine was
irreparably damaged by Reed Corp. and became worthless. In October 2007, a
court awarded damages of $320,000 against Reed in favor of Alton. At December
31, 2007, the final outcome of this case was awaiting appeal and was,
therefore, uncertain. However, in the opinion of Alton’s attorney, Reed’s
appeal will be denied. At December 31, 2007, what amount should Alton accrue
for this gain contingency?
a. $320,000.
b. $260,000.
c. $200,000.
d. $0.

95. Horton Food Company distributes to consumers coupons which may be presented
(on or before a stated expiration date) to grocers for discounts on certain
products of Horton. The grocers are reimbursed when they send the coupons
to Horton. In Horton's experience, 50% of such coupons are redeemed, and
generally one month elapses between the date a grocer receives a coupon from
a consumer and the date Horton receives it. During 2007 Horton issued two
separate series of coupons as follows:
Consumer Amount Disbursed
Issued On Total Value Expiration Date as of 12/31/07
1/1/07 $375,000 6/30/07 $177,000
7/1/07 540,000 12/31/07 225,000
The only journal entries to date recorded debits to coupon expense and credits
to cash of $536,000. The December 31, 2007 balance sheet should include a
liability for unredeemed coupons of
a. $0.
b. $45,000.
c. $93,000.
d. $270,000.

96. Presented below is information available for Norton Company.

Current Assets
 Cash $ 4,000
Short-term investments 75,000
Accounts receivable 61,000
Inventories 110,000
Prepaid expenses 30,000
Total current assets $280,000
Total current liabilities are $120,000. The acid-test ratio for Norton is
a. 2.33 to 1.
b. 2.08 to 1.
c. 1.17 to 1.
d. .54 to 1.

Use the following information for questions *97 and *98.

Norris Co. has a contract with its president to pay her a 5% bonus for 2006 and
2007. The federal income tax rate is 30% during these two years.

*97. In 2006, income before deductions for the bonus and federal income taxes was
$600,000. If the bonus is based on income before deduction of the bonus but
after deduction of income tax, the bonus (to the nearest dollar) is
a. $20,690.
b. $21,000.
c. $21,320.
d. $30,000.

*98. In 2007, income before deductions for the bonus and federal income taxes was
$800,000. If the bonus is based on income after deductions for the bonus
and income tax, the bonus (to the nearest dollar) is
a. $26,292.
b. $26,666.
c. $27,053.
d. $40,000.
*99. Farr Products Corp. provides an incentive compensation plan under which its
president receives a bonus equal to 20% of the corporation's income in excess
of $300,000 before income tax but after the bonus. If income before tax and
bonus is $1,200,000 and the effective tax rate is 30%, the amount of the
bonus would be
a. $126,000.
b. $150,000.
c. $180,000.
d. $240,000.

Multiple Choice Answers—Computational

Ite Ans Ite Ans Ite Ans Ite Ans Ite Ans Ite Ans Ite Ans
m
63. .
b m
69. .
c m
75. .
c m
81. .
a m
87. .
b m
93. .
a m
*99 .
b
64. d 70. a 76. c 82. b 88. d 94. d .
65. b 71. a 77. d 83. d 89. d 95. b
66. d 72. d 78. a 84. d 90. d 96. c
67. b 73. d 79. b 85. b 91. b *97 c
68. b 74. c 80. d 86. d 92. d *98. c
.
MULTIPLE CHOICE—CPA Adapted

100. Which of the following is generally associated with payables classified as

accounts payable?
Periodic Payment Secured
of Interest by Collateral
 a. No No
b. No Yes
c. Yes No
d. Yes Yes

101. On January 1, 2007, Didde Co. leased a building to Ellis Corp. for a ten-
year term at an annual rental of $80,000. At inception of the lease, Didde
received $320,000 covering the first two years' rent of $160,000 and a
security deposit of $160,000. This deposit will not be returned to Ellis upon
expiration of the lease but will be applied to payment of rent for the last
two years of the lease. What portion of the $320,000 should be shown as a
current and long-term liability, respectively, in Didde's December 31, 2007
balance sheet?
Current LiabilityLong-term Liability
a. $0 $320,000
b. $80,000 $160,000
c. $160,000 $160,000
d. $160,000 $80,000

102. On September 1, 2006, Looper Co. issued a note payable to National Bank in
the amount of $1,200,000, bearing interest at 12%, and payable in three equal
annual principal payments of $400,000. On this date, the bank's prime rate
was 11%. The first payment for interest and principal was made on September
1, 2007. At December 31, 2007, Looper should record accrued interest payable
of
a. $48,000.
b. $44,000.
c. $32,000.
d. $29,334.
103. Included in Sauder Corp.'s liability account balances at December 31, 2006,
were the following:
7% note payable issued October 1, 2006, maturing September 30, 2007$250,000
8% note payable issued April 1, 2006, payable in six equal annual
installments of $150,000 beginning April 1, 2007 600,000
Sauder 's December 31, 2006 financial statements were issued on March 31,
2007. On January 15, 2007, the entire $600,000 balance of the 8% note was
refinanced by issuance of a long-term obligation payable in a lump sum. In
addition, on March 10, 2007, Sauder consummated a noncancelable agreement
with the lender to refinance the 7%, $250,000 note on a long-term basis, on
readily determinable terms that have not yet been implemented. On the December
31, 2006 balance sheet, the amount of the notes payable that Sauder should
classify as short-term obligations is
a. $175,000.
b. $125,000.
c. $50,000.
d. $0.

104. Barr Company’s salaried employees are paid biweekly. Occasionally, advances
made to employees are paid back by payroll deductions. Information relating
to salaries for the calendar year 2007 is as follows:
12/31/06 12/31/07
Employee advances $12,000 $ 18,000
Accrued salaries payable 65,000 ?
Salaries expense during the year 650,000
Salaries paid during the year (gross) 625,000
At December 31, 2007, what amount should Barr report for accrued salaries
payable?
 a. $90,000.
b. $84,000.
c. $72,000.
d. $25,000.

105. Quirk Corp.'s payroll for the pay period ended October 31, 2007 is summarized
as follows:
Federal Amount of Wages Subject
Department Total Income Tax to Payroll Taxes
Payroll Wages Withheld F.I.C.A.
Unemployment
Factory $ 75,000 $ 9,000 $70,000 $22,000
Sales 22,000 3,000 16,000 2,000
Office 18,000 2,000 8,000 —
$115,000 $14,000 $94,000 $24,000
Assume the following payroll tax rates:
F.I.C.A. for employer and employee 7% each
Unemployment 3%
What amount should Quirk accrue as its share of payroll taxes in its October
31, 2007 balance sheet?
a. $21,300.
b. $14,720.
c. $13,880.
d. $7,300.

106. Dexter Co. sells major household appliance service contracts for cash. The
service contracts are for a one-year, two-year, or three-year period. Cash
receipts from contracts are credited to unearned service contract revenues.
This account had a balance of $480,000 at December 31, 2006 before year-end
adjustment. Service contract costs are charged as incurred to the service
contract expense account, which had a balance of $120,000 at December 31,
2006. Outstanding service contracts at December 31, 2006 expire as follows:
During 2007 During 2008 During 2009
$100,000 $160,000 $70,000
What amount should be reported as unearned service contract revenues in
Dexter's December 31, 2006 balance sheet?
a. $360,000.
b. $330,000.
c. $240,000.
d. $220,000.

107. Utley Trading Stamp Co. records stamp service revenue and provides for the
cost of redemptions in the year stamps are sold to licensees. Utley's past
experience indicates that only 80% of the stamps sold to licensees will be
redeemed. Utley's liability for stamp redemptions was $7,500,000 at December
31, 2005. Additional information for 2006 is as follows:
Stamp service revenue from stamps sold to licensees$5,000,000
Cost of redemptions 3,400,000
If all the stamps sold in 2006 were presented for redemption in 2007, the
redemption cost would be $2,500,000. What amount should Utley report as a
liability for stamp redemptions at December 31, 2006?
a. $9,100,000.
b. $6,600,000.
c. $6,100,000.
d. $4,100,000.
108. Lett 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
a. zero.
b. the maximum of the range.
c. the mean of the range.
d. the minimum of the range.

109. During 2006, Blass Co. introduced a new product carrying a two-year warranty
against defects. The estimated warranty costs related to dollar sales are 2%
within 12 months following sale and 4% in the second 12 months following
sale. Sales and actual warranty expenditures for the years ended December
31, 2006 and 2007 are as follows:
Actual Warranty
Sales Expenditures
2006 $ 800,000 $12,000
2007 1,000,000 30,000
$1,800,000 $42,000
At December 31, 2007, Blass should report an estimated warranty liability of
a. $0.
b. $10,000.
c. $30,000.
d. $66,000.

110. In March 2007, an explosion occurred at Howe Co.'s plant, causing damage to
area properties. By May 2007, no claims had yet been asserted against Howe.
However, Howe's management and legal counsel concluded that it was reasonably
possible that Howe would be held responsible for negligence, and that
$4,000,000 would be a reasonable estimate of the damages. Howe's $5,000,000
comprehensive public liability policy contains a $400,000 deductible clause.
In Howe's December 31, 2006 financial statements, for which the auditor's
fieldwork was completed in April 2007, how should this casualty be reported?
a. As a note disclosing a possible liability of $4,000,000.
b. As an accrued liability of $400,000.
c. As a note disclosing a possible liability of $400,000.
d. No note disclosure of accrual is required for 2006 because the event
occurred in 2007.
Multiple Choice Answers—CPA Adapted
Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans.
100. a 102. c 104. a 106. b 108. d 110. c
101. b 103. d 105. d 107. c 109. d
DERIVATIONS — Computational
No. Answer Derivation
63. b $152,205 – $150,000 = $2,205.
$2,205 × 2/3 = $1,470.
64. d $30,000 ÷ ($300,000 – $30,000) = 0.1111 = 11.11%.
65. b $1,500,000.
66. d $2,000,000 – $1,200,000 = $800,000.
67. b S + .06S = $148,400, S = $140,000.
$148,400 – $140,000 = $8,400.
68. b $8,400 × .98 = $8,232.
69. c .05S × .97 = $81,480, S = $1,680,000.
70. a 75,000 × $20 = $1,500,000.
71. a 60,000 × $20 = $1,200,000.
72. d [(.062 – .054) + .02] × $500,000 = $14,000.
DERIVATIONS — Computational (cont.)
No. Answer Derivation
73. d [(.062 – .054) + .02] × $400,000 = $11,200.
74. c 50 × 12 × 8 × $14 = $67,200; 50 × 15 × 8 × $16 = $96,000.
75. c 50 × 12 × 8 × $17.50 = $84,000; 50 × 15 × 8 × $20 = $120,000.
76. c ($270,000 × 7.65%) + ($90,000 × 1.45%) + ($60,000 × 1.8%) =
$23,040.
77. d $25.80 × 8 × 10 × 35 = $72,240.
78. a ($28.50 × 8 × 10 × 35) + ($27.00 × 8 × 2 × 35) = $94,920.
79. b 4,000,000 × .10 × $1 = $400,000; $400,000 – $140,000 = $260,000.
80. d ($1.000,000 + $77,110) ÷ 10 = $107,710; $77,110 × .10 = $7,711.
81. a
82. b 6,000,000 × .10 × $1 = $600,000; $600,000 – $210,000 = $390,000.
83. d ($2,000,000 + $154,220) ÷ 10 = $215,420; $154,220 × .10 = $15,422.
84. d ($4,200,000 × .12) – $189,000 = $315,000.
85. b {[(675,000 × .60) – 330,000] ÷ 3} × $1.50 = $37,500.
86. d ($2,800,000 .12) – $126,000 = $210,000.
87. b {[(500,000 × .60) – 220,000] ÷ 4} × $1.50 = $30,000.
88. d [(500,000 × .4) ÷ 8] × $2 = $50,000.
89. d [(200,000 – 120,000) ÷ 8] × $2 = $20,000.
90. d {[(600,000 × .4) – 150,000] ÷ 8} × $2 = $22,500.
$22,500 + $20,000 = $42,500.
91. b $3,600,000 and $2,400,000.
92. d $1,500,000 × .04 = $60,000.
93. a [($300,000 + $400,000) × .07] – $30,000 = $19,000.
94. d $0, gain contingencies are not accrued.
95. b ($540,000 × .5) – $225,000 = $45,000.
DERIVATIONS — Computational (cont.)
No. Answer Derivation
$4,000 + $75,000 + $61,000
96. c ————————————— = 1.17 to 1.
$120,000
*97. c B = {$600,000 – [($600,000 – B) × .3]} × .05
B = $21,320.
*98. c B = .05 {$800,000 – B – [($800,000 – B) × .3]}
B = $27,053.
*99. b B = .20 [($1,200,000 – $300,000) – B]
B = $150,000.
DERIVATIONS — CPA Adapted
No. Answer Derivation
100. a Conceptual—accounts payable generally are zero-interest-bearing and
unsecured.
101. b $80,000 and $160,000.
4
102. c $800,000 × .12 × — = $32,000.
12
103. d Conceptual—both notes have been refinanced by long-term obligations
104. a $650,000 + $65,000 – $625,000 = $90,000
105. d ($94,000 × .07) + ($24,000 × .03) = $7,300.
106. b $100,000 + $160,000 + $70,000 = $330,000
107. c ($2,500,000 × .8) + $7,500,000 – $3,400,000 = $6,100,000.
108. d Conceptual.
109. d ($1,800,000 × .06) – $42,000 = $66,000.
110. c Conceptual.