ACC 302 - Chapter 13 Class Prep PDF

Preview

Summary

Professor Woelfert...

Description

ACC 302 Class Prep Questions CH #13 – Current Liabilities Assignment: Please begin your preparation by reading the Learning Objectives (LOs), discussion of the chapter topic, and Preview at the front of the chapter. These will give you a bird’s eye view of the content we will cover. Next, casually read the large and bold type on the pages covering those LOs. With that you will have a better idea of what you’re going to learn. Then review the chapter again, going where these questions lead you and taking notes on the concepts while looking up definitions for any words you are not familiar with. Review the summary of the LOs assigned at the back of the chapter. Then you’ll be in a good position to double back to the start and answer the questions below including the Brief Exercises (BEs) that help you learn the basics of the LOs assigned. Show your work. When we meet in class I’ll choose students at random to present their answers to these questions and show and discuss their work on the BEs with the class. The goal will be to be able to discuss and explain your answers rather than read them. Then we will work together in groups to complete more challenging exercises and problems. After class you will be expected to complete exercises we don’t get to in class, regularly review this work in order to master it, add it to your long-term memory, in order to be prepared for comprehensive assessments, your career, and, perhaps, the CPA Exam.

1. (LO 1) Explain what a liability is as if you are explaining this to an art major who knows nothing about accounting using an analogy. a. A liability creates an obligation for the future settlement between two parties through the transfer of cash, goods or services. As an art major, maybe you require certain resources like art supplies to succeed in your classes. A liability would arise if the bookstore were to give you these supplies and tell you that you must pay them for them in 30 days. So before the 30 days are up you pay the bookstore for these supplies closing out the liability “on your books.” 2. What is the difference between current and long-term liabilities? a. Current Liability: Cash or other assets that companies reasonably expect to convert into cash, sell, or consume in operations within a single operating cycle or within a year. b. Long Term Liability: These liabilities are similar in their nature, however, allow for a longer term of repayment extending beyond the operating cycle. They allow for cash or other assets to be converted into cash or consumed over more than one year or even longer. 3. What is an enterprise’s operating cycle? Name and industry with an unusually long operating cycle. Name a business you may have been in having a very short operating cycle. a. An enterprise’s operating cycle is the period of time elapsing between the acquisition of goods and services involved in the manufacturing process and the final cash realization resulting from sales and subsequent collections. Industries that manufacture products requiring an aging process, and certain capital-intensive industries, have an operating cycle of considerably more than a year. Most retail and service establishments have several operating cycles within a year. (Food). 4. Prepare a brief explanation, in your own words, to answer these questions: A. How are business income taxes computed? a. Businesses must prepare an income tax return and compute the income taxes payable resulting from the operations of the current period. Taxes payable is a liability account that captures the computation of income tax based on a progressive tax rate schedule. (Taxable Income x Tax Rate = Taxes Payable). B. How is the amount due to the treasury classified and therefore recorded in the balance sheet?

a.

C. D.

E.

F.

It is classified as a liability because it is a way for a business to pay itself back through regaining more ownership of itself. (Taxes Payable – Current Liability). What types of entities pay income taxes? a. Corporations Exactly when are the payments made to the IRS? a. Most corporations make periodic tax payments throughout the year in a authorized bank depository. These payments are based on estimates of the total annual tax liability. As the total tax liability changes, so too do the payments. (Quarterly). How might a difference between Income Tax Expense (computed per GAAP) and Income Tax Payable (computed per the Cash Basis/IRS Code) arise? a. If the IRS is to raise or lower the tax rates in a later time, the corporation can show a difference and must adjust to it immediately to stay on track with paying proper taxes. Look at the other adjusting entries and related current liabilities discussed in this LO. What are the common threads you see among them? Can you see how each will cause a difference between Income Tax Expense (computed per GAAP) and Income Tax Payable (computed per the Cash Basis/IRS Code) arise? a. Yes, it’s as if all of these accounts would have to be restated with accurate values to adjust for the difference. Or the book talks about writing this difference down as a debit to current operations and a credit to income tax payable and moving forward.

5. Illustrate computation and recording of the year-end adjustments for interest and payment of principal and interest at maturity of a note using (BE 2). (monthly payment daily interest amount ex) a. Nov 1, 2017: Cash 40000 Notes Payable 40000 Dec 31, 2017: Interest Expenses 600 Interest Payable 600 Feb 1, 2018: Interest Payable 600 Interest Expense 300 Notes payable 40000 Cash 40900 6. What are CMLTD? Who cares? Why? What are the exceptions? a. Current Maturities of Long-Term Debt are the current liabilities regarding bonds, mortgage notes, and other long-term indebtedness that matures within the next fiscal year. Shareholders care most as they want to see a business’s ability to pay off their liabilities as they come due. The expectation is to pay all of these liabilities off and continue to create growth from within. 7. (LO 2) What are the current criteria for excepting short term obligations expected to be refinanced from the current liability classification and how does a company demonstrate the ability to consummate a refinancing? a. The business must intend to refinance the obligation on a long-term basis. This means that they intend to refinance the short-term obligation so that it will not require the use of working capital during the ensuing fiscal year. b. The business must demonstrate an ability to consummate the refinancing by:

i. Actually refinancing the short-term obligation by issuing a long-term obligation or equity securities after the date of the balance sheet but before it is issued. ii. Entering into a financing agreement that clearly permits the company to refinance the debt on a long-term basis on terms that are readily determinable. 8. Explain what happened at Penn Central and how it relates to what Epictetus said. (BE 9) a. Since both criteria for reclassification is met (intent and ability) the entire $500,000 stats as long-term. b. Because repayment required existing 12/31/17 current assets, the entire $500,000 should be recorded as current. 9. (LO 3) What are contingencies? a. An existing condition, situation, or set of circumstances involving uncertainty as to possible gain or loss to an enterprise that will ultimately be resolved when one or more future events occur or fail to occur. 10. Define contingent gains. a. Claims or rights to receive assets (or have a liability reduced) whose existence is uncertain but which may become valid eventually. 11. Give examples of and discuss proper recording of contingent gains. a. Possible receipts of monies from gifts, donations, asset sales, and so on. b. Possible refunds from the government in tax disputes. c. Pending court cases with a probable favorable outcome. d. Tax loss carryforwards. A company discloses gain contingencies in the notes only when a high probability exists for realizing them 12. Explain what a gain contingency is and give an example. a. Merck may be a defendant in a lawsuit, and any payment is contingent upon the outcome of a settlement or an administrative or court proceeding. b. Ford provides a warranty for a car it sells, and any payments are contingent on the number of cars that qualify for benefits under the warranty.

13. What is a contingent liability dependent upon? Under what conditions do we record a contingent liability? What are the different types of contingent liabilities? a. They depend on the occurrence of one or more future events to confirm either the amount payable, the payee, the date payable, or its existence. These factors depend on a contingency. b. Probable: The future event is likely to occur; Reasonably Possible: The chance of occurrence is more than remote, but less than likely; Remote: The chance of occurrence is slight. i. Information available prior to the issuance of the financial statements indicates that it is probable that a liability has been incurred at the date of the financial statements. ii. The amount of the loss can be reasonably estimated.

14. What are the three main factors in determining whether to record a liability for litigation claims and assessments? How does timing affect recognition of these? Would an entity put an amount on it? Why or why not? (BE 10 and BE 11) (Ex 13) a. The time period in which the underlying cause of action occurred; The probability of an unfavorable outcome; The ability to make a reasonable estimate of the amount of loss. b. BE 10: a) DR-Lawsuit Loss $900,000 CR-Lawsuit Liability $900,000 b) No Entry c. BE 11: DR-Litigation Expense $300,000 CR-Litigation Liability $300,000 d. EX 13:

15. What is a warranty? Explain the two types. a. A promise made by a seller to a buyer to make good on a deficiency of quantity, quality, or performance in a product. i. Assurance-Type Warranty: Warranty that the product meets agreed-upon specifications in the contract at the time the product is sold; included in the sales price of a product. ii. Service-Type Warranty: Warranty that provides an additional service beyond the assurance-type warranty; Not included in the sales price of a product. 16. Explain and illustrate the assurance-type warranty using (BE 13). (Ex 10) a. BE 13: DR-Cash $1,000,000 CR-Sales Rev. $1,000,000 i. DR-Warranty Expense $70,000 CR-Inventory $70,000 ii. Adjusting Entry: DR-Warranty Expense $55,000 CR-Warranty Liab. $55,000 a. ($125,000-$70,000) b. EX 10:

17. Explain and illustrate the service-type warranty approach using (BE 14). (Ex 11) a. BE 14: Sales Contracts Cash (20,000 x 99) $1,980,000 Unearned Warranty Rev. $1,980,000

Cost of Servicing Warranty Exp. $180,000 Inventory $180,000

Recognized warranty rev. Unearned warranty rev. $990,000 (1/2)

b. BE 10:

18. What is a premium? What is a coupon? Why do entities offer these? Illustrate the accounting for a premium using (BE 15). (Ex 12) a. Premium: May be silverware, dishes, small appliance, toy, transportation, etc. b. Coupon: Can be redeemed for a cash discount on items purchased. c. Companies offer these to stimulate sales!

d. BE 15: DR-Premium Exp. $96,000 CR-Liability for Premiums $96,000 (.30 x 1,200,000) = 360,000 *Estimated future redemptions would then be 240,000* (240,000/3) x ($1.10 + $0.60 - $0.50) = $96,000 e. EX 12:

19. Give an example of circumstances under which a company will record and asset retirement obligation (ARO) and illustrate the recording or an ARO using (BE 12). (Ex 14) a. Decommissioning of nuclear facilities; Dismantling, restoring, and reclaiming of oil and gas properties; Certain closure, reclamation, and removal costs of mining facilities; Closure and post-closure costs of landfills. b. BE 12: DR-Oil Platform $450,000 CR-(ARO) $450,000 c. EX 14:

20. (LO 4) Where and how are current liabilities presented? a. In practice, current liabilities are usually recorded and reported in financial statements at their full maturity value. 21. How do we present short term obligations expected to be refinanced? a. In a note saying: i. A general description of the financing agreement. ii. The terms of any new obligation incurred or to be incurred. iii. The terms of any equity security issued or to be issued. 22. How do we present contingencies? a. A company records a loss contingency and a liability if the loss is both probable and estimable. But, if the loss is either probable or estimable but not both, and if there is at least a reasonable possibility that a company may have incurred a liability, it must disclose the following in the notes: i. The nature of the contingency ii. An estimate of the possible loss or range of loss or a statement that an estimate cannot be made. b. Companies should disclose certain other contingent liabilities, even if the possibility of loss is remote: i. Guarantees of indebtedness of others ii. Obligations of commercial banks under “stand-by letters of credit” iii. Guarantees to repurchase receivables that have been sold or assigned 23. How do you calculate current ratio and what does it indicate? How do you calculate the acid test ratio and what does it indicate? a. Current Assets/Current Liabilities i. The value of assets that can cover current liabilities at any given time.

b. (Cash + ST Investments + A/R) / Current Liabilities i. Determines a business’s liquidity based on monetary values alone. 24. How do you calculate Return on assets and what does it indicate? How do you calculate the debt to assets ratio and what does it indicate? a. An indicator of how profitable a company is relative to its total assets i. Net Income/Total Assets b. A leverage ratio that defines the total amount of debt relative to assets. i. (ST Debt + LT Debt) / Total Assets 25. The owner of a small company with $12,500 in current assets, $10,000 in current liabilities and a debt covenant ( http://www.investopedia.com/terms/c/covenant.asp ) which requires a minimum 1.25:1.0 current ratio is thinking about stocking up on inventory purchasing $1,000 on account before the reporting period ends asks you if this is a good idea. What do you tell her? She also wonders if she should complete a $2,000 service job presently in process before the period ends, or take time off. The customer paid in full for the job in advance before she started. Calculate what the current ratio would be if none, either, or both of the transactions were consummated. Consider which and what types of accounts would be affected and what the effect of the changes in those account balances would have on the current ratio....