Blueprint Problem: Current Liabilities

Current Liabilities

Current liabilities are those liabilities that are due within Selectone yeartwo years60 dayssix monthsCorrect 1 of Item 1 or one operating cycle, whichever is SelectlongershorterCorrect 2 of Item 1. Current liabilities are reported on the Selectbalance sheetincome statementCorrect 3 of Item 1.

Indicate whether each item listed in the following table would be listed as a current liability or not a current liability. Assume that the company's operating cycle is eight months.

Notes Payable

A note payable is like an IOU. Thepayor of the note.')" >makerof the note signs a contract (the note) stating that it will repay thepayeetheprincipalof the note plus interest on thedue date or the pay-off date.')" >maturity date. In order to be classified as a current liability, a note payable must have a maturity date of less than one year in the future. On the maturity date, the maker of the note must pay the payee thematurity valueof the note.

When an interest-bearing note payable is signed, the maker of the note must record the note as Selecta decreasean increaseCorrect 1 of Item 2 in liabilities in an amount equal to the Selectmaturity valueprincipalCorrect 2 of Item 2 of the note. At the end of the fiscal period, the maker of the note must record accrued interest incurred on the note. The entry to record accrued interest includes a debit to SelectInterest ExpenseInterest PayableCorrect 3 of Item 2 and a credit to SelectInterest ExpenseInterest PayableCorrect 4 of Item 2. On the maturity date, the maturity value of the note is paid to the payee.

APPLY THE CONCEPTS: Calculating accrued interest

Staven Company sells a seasonal product. Each year, it needs additional cash in order to stock up on inventory before its season begins. On April 1, 2010, Staven Company borrows money from its bank by signing a 12-month, 5% note for $86,000. The interest and principal are due at maturity. Calculate interest based on number of months rather than days. If required, round your answers to the nearest cent.

What is the amount of accrued interest that Staven will record on December 31, 2010? $

What is the amount of total interest that Staven will pay at maturity for the note? $

APPLY THE CONCEPTS: Recording notes payable, accrued interest, and payment of the note

Assume that the note above is due on the last day of the month that the note is outstanding. Record all entries connected with signing the note, accruing interest on December 31, and paying the note on its maturity date. If required, round your answers to the nearest cent.

Note: To avoid rounding errors, calculate interest based on number of months rather than days. Then calculate interest expense for 2011 as [Total interest - Interest expense accrued in 2010]

Contingent liabilities

A contingent liability requires three things:
1. An existing condition
2. An unknown outcome
3. Dependence on a future event

The classic example of a contingent liability is a lawsuit. The existing condition is the lawsuit that has already been filed. The outcome of the lawsuit has not yet been determined. The future event is the settlement of the suit. The settlement may cause the company to have a liability. If the company loses the suit, the liability is equal to the amount of the loss.

How the contingent liability is treated on financial statements is dependent on how likely it is that the future event will result in a liability for the company.

Click here to learn more about determining the treatment for a contingent liability:
1. Determine whether the possibility of loss is probable, reasonably possible, or remote.
2. If the possibility of loss is probable, can it be estimated?
3. If it is probable and estimable, record and disclose.
4. If it is probable and not estimable, disclose.
5. If it is reasonably possible, disclose.
6. If it is remote, do nothing.

It is important that all three criteria are present at the time financial statements are prepared in order for a contingent liability to exist. The possibility of a lawsuit being filed is not sufficient for the existence of a contingent liability. Generally accepted accounting principles do not allow a contingent asset to be recorded, even if the chance of a gain is probable. This is in accordance with the Selectconservatismmatchingmaterialityunit of measurementCorrect 1 of Item 6 principle.

Which of the following situations require the company to both record a liability and disclose it in the notes?

1. A lawsuit has been filed against Clay Corporation. The lawyer for Clay Corporation feels there is only a remote chance that the company will lose the lawsuit. SelectRequiredNot requiredCorrect 2 of Item 6

2. Hoffman Company's major product is sold with a warranty. Approximately 5% of sales are returned for repairs, and each repair costs, on average, $20. SelectRequiredNot requiredCorrect 3 of Item 6

3. Hubbard, Inc., has filed a lawsuit. Hubbard's lawyers feel that it is probable that the company will win the suit. SelectRequiredNot requiredCorrect 4 of Item 6

4. Smith Company inserts a $1.00 off coupon in 300,000 copies of the Sunday paper. In the past, 5% of the coupons were redeemed. SelectRequiredNot requiredCorrect 5 of Item 6

5. Lucky Lady Casino estimates that casino visitors have kept $100,000 worth of chips as souvenirs. Approximately 10% of those chips will eventually be turned in to the casino for the cash. SelectRequiredNot requiredCorrect 6 of Item 6

6. A lawsuit has been filed against Newman, Inc. The lawyer for Newman feels that it is probable that the company will lose the lawsuit. However, there is no reasonable way to estimate the amount of the loss. SelectRequiredNot requiredCorrect 7 of Item 6

7. A lawsuit has been filed against Shaw Company. The lawyer for Shaw feels that it is possible that the company will lose the suit. SelectRequiredNot requiredCorrect 8 of Item 6