Chapter 8: Current and Contingent Liabilities

Question 1

the sources of cash and other financial resources used to acquire assets.

Answer 1

liabilities and equity

Question 2

What are the 3 kinds of business obligations?

Answer 2

1. Current liabilities
2. Contingent liabilities
3. Long-term debt

Question 3

Contingent liabilities can be either current or long-term, but they are iffy in what two ways?

Answer 3

1. they may or may not turn into actual obligations
2. for those contingencies that do become obligations, the timing and amount of the required payment is uncertain

Question 4

probable future sacrifices of economic benefits; usually require the payment of cash, the transfer of assets other than cash, or the performance of services.

Answer 4

liabilities

Question 5

What are the 4 characteristics of liabilities?

Answer 5

1. Payment of Cash
2. Certainty
3. Legal enforceability
4. Payment recipient

Question 6

What characteristic of liabilities does this describe?

Although liabilities frequently require the payment of cash, some may require the transfer of assets other than cash or the performance of services.

Answer 6

Payment of cash

Question 7

What characteristic of liabilities does this describe?

Although the exact amount and timing of future payments are usually known, for some liabilities they may not be.

Answer 7

Certainty

Question 8

What characteristic of liabilities does this describe?

Although many liabilities are legally enforceable claims, some may merely represent probable claims.

Answer 8

Legal enforceability

Question 9

What characteristic of liabilities does this describe?

Although liabilities usually identify the entity to be paid, the definition does not exclude payment to as yet unidentified recipients.

Answer 9

Payment recipient

Question 10

Most liabilities are recognized when:

Answer 10

goods or services are received or money is borrowed.

Question 11

When a liability depends on a future event (ex: a contingent liability), such as the outcome of a lawsuit, recognition depends on how _______ the occurrence of the event is and whether a _______ _______ of the payment amount can be made.

Answer 11

likely; good estimate

Question 12

If the future payment is judged to be less than likely to occur or the payment is not estimable, the obligation (should/shouldn’t) be recognized. Such obligations may require disclosure in footnotes to financial statements.

Answer 12

shouldn’t

Question 13

an obligation whose amount or timing is uncertain and depends on future events.

Answer 13

contingent liability

Question 14

When you owe money you typically pay _________.

Answer 14

interest

Question 15

How do you calculate Total Payment when interest is involved?

Answer 15

Total Payment = Principal + (Principal x Interest Rate x Period)

Question 16

How do you calculate interest?

Answer 16

Principal x Interest Rate x Period = Interest

Question 17

T or F: We ignore the interest for most current liabilities because the amount of interest is relatively small (or “immaterial”). So most current liabilities are simply recorded and reported at the total amount owed.

Answer 17

True

Question 18

obligations that require the firm to pay cash or another current asset, create a new current liability, or provide goods or services within the longer of 1 year or one operating cycle (since most firms have operating cycles shorter than 1 year, the 1-year rule usually applies).

Answer 18

current liabilities

Question 19

Current liabilities are reported on the ________ _______.

Answer 19

balance sheet

Question 20

an obligation that arises when a business purchases goods or services on credit.

Answer 20

accounts payable

Question 21

Accounts payable are usually due within ______ to _____ days.

Answer 21

30 - 60

Question 22

T or F: Accounts payable require the payment of interest.

Answer 22

False; they seldom require the payment of interest

Question 23

T or F: Accounts payable require a formal agreement or contract

Answer 23

False; they do not

Question 24

liabilities that usually represent the completed portion of activities that are in process at the end of the period; recognized by adjusting entries at the end of the period.

Answer 24

accrued liabilities

Question 25

What are two examples of accrued liabilities?

Answer 25

Wages payable and income taxes payable

Question 26

a payable that arises when a business borrows money or purchases goods or services from a company that requires a formal agreement or contract.

Answer 26

notes payable

Question 27

The agreement for a note payable typically shows the ________ of repayment and ________ (principal and/or interest) to be repaid.

Answer 27

timing; amount

Question 28

A note payable typically matures between ____-___ months, but can be longer (if its maturity is greater than 12 months, it will be classified as a long-term liability)

Answer 28

3-12

Question 29

A note payable can be created as an extension of time to pay an ________ ________ amount

Answer 29

accounts payable

Question 30

A note payable from a bank is called an __________ _________ ______ because it explicitly states an ________ _____.

Answer 30

• interest-bearing note
• interest rate

Question 31

A note payable from a banks specifies the amount to be repaid _______, stating the ______ and _______ rate.

Answer 31

• indirectly
• principal
• interest

Question 32

A note payable from a bank is recorded in a transaction at what amount?

Answer 32

at the amount borrowed

Question 33

Notes payable are often created when a borrower is unable to pay an account payable in a timely manner.
In this case, the borrower is typically granted a ________ ________, but the creditor requires that a formal note be signed to impose interest.

Answer 33

payment extension

Question 34

T or F: a current liability can be retired through creation of a new current liability. If true, what’s an example of this?

Answer 34

true; rolling an account payable into a short-term note payable

Question 35

At the end of each accounting period, the long-term debt that is due during the next year is reclassified as a ________ ________.

Answer 35

current liability

Question 36

T or F: Since the reclassification of most long-term debt as current doesn’t usually change the accounts or amounts involved, journal entries are not required.

Answer 36

true

Question 37

In some cases, long-term debt that’s due within the next year will be paid with the proceeds of a new long-term debt issue. A new long-term debt issue is creation of a new ______-______, not current, liability. When such refinancing is expected, the maturing obligation is not transferred to current liabilities but is left as a long-term debt.

Answer 37

long-term

Question 38

What three taxes (which are other payables) are collected by a company on behalf of a local, state, or federal taxing authority?

These are not additions to _______, although collected as part of the selling price.

Answer 38

• Sales, usage, and excise taxes
• revenue

Question 39

money collected from the customer for the governmental unit levying the tax.

Answer 39

sales taxes

Question 40

Tax collections are _______ until paid to the taxing authority, usually ______.

Answer 40

liabilities; quarterly

Question 41

taxes from employee’s earnings which are liabilities until they are paid to the taxing authority.

Answer 41

withholding and payroll taxes

Question 42

T or F: Employees and employers both incur payroll taxes.

Answer 42

true

Question 43

Employees must pay certain taxes that are “withheld” from their paycheck. This is the difference between ______ pay and _____ pay.

Answer 43

gross; net

Question 44

Employee withholdings can include what three things?

Answer 44

1. Federal, state, and possibly local income taxes
2. Social Security and Medicare taxes (FICA)
3. 401(k) retirement, parking, union dues, health insurance, etc.

Question 45

The business itself must pay certain taxes based on _______ ________. These amounts are not withheld from employee pay; they are additional amounts that must be paid over and above _______ pay.

Answer 45

employee payrolls; gross

Question 46

Employers withholdings (what they pay) includes what three things?

Answer 46

1. Match to employee’s Social Security and Medicare taxes (FICA)
2. Federal and state unemployment taxes
3. Fringe benefits including 401(k) contributions, health insurance or other.

Question 47

if you have $400 withheld from your paycheck for Social Security, your employer pays the federal government $______ related to your employment.

Answer 47

$800 (they pay double)

Question 48

a liability that occurs when a company receives payment for goods (in advance) that will be delivered or services that will be performed in the future.

Answer 48

unearned revenue

Question 49

A long-term liability that is similar to unearned revenue, called _______ ________, is recorded when customers make advance payments or security deposits that are not expected to be earned or returned soon enough to qualify as current liabilities.

Answer 49

customer deposits

Question 50

liability that involves the possibility of an existing condition, situation, or set of circumstances that have uncertainties of a gain or loss.

Answer 50

contingent liabilities

Question 51

A contingent liability is not recognized in the accounts unless both of the following are true (2 things):

Answer 51

1. The event on which it is contingent is probable
2. A reasonable estimate of the loss can be made

Question 52

T or F: If the contingent event is considered only reasonably possible, or reliable measurement of the liability is impossible, no liability is recorded, but the event must be disclosed in the financial statements.

Answer 52

true

Question 53

If the contingent event is considered _________, neither a journal entry nor a disclosure in the financial statements are necessary.

Answer 53

remote

Question 54

What are 3 examples of contingent liabilities?

Answer 54

1. Warranties
2. Lawsuits
3. Pensions

Question 55

Most large companies are party to multiple lawsuits at any point in time. Estimating when a loss is probable and determining a reasonable estimate requires information from the attorneys, but businesses _______ record a contingent liability prior to the jury deciding against them.

Answer 55

rarely

Question 56

The likelihood that a contingent event will occur may change over time. A contingent liability that should not be recorded or disclosed at one time may need to be recorded or disclosed later because the facts and circumstances change. This frequently happens to contingent liabilities arising from _________.

Answer 56

litigation

Question 57

a guarantee to repair or replace defective goods during a period (ranging from a few days to several years) following the sale.

Answer 57

warranty

Question 58

Warranty expenses can occur in the accounting period of the sale or in __________ accounting periods.

Answer 58

subsequent

Question 59

Future warranty costs on the sales that occurred in the current accounting period must be ________.

Answer 59

estimated

Question 60

Businesses are likely able to make reasonable estimates of their warranty costs based on _____ _______.

Answer 60

past experience

Question 61

The recognition of warranty expense and (estimated) warranty liability is recorded by an _________ journal entry at the end of the accounting period.

Answer 61

adjustment

Question 62

As warranty claims are paid to customers or related expenditures are made, the liability is (increased/reduced).

Answer 62

reduced

Question 63

T or F: the income statement effect of warranties (activity in the equity column) occurs when goods are sold. Payment or other asset outflows associated with the satisfaction of warranty claims do not affect the income statement.

Answer 63

true

Question 64

Analyzing current liabilities can help determine if a company is able to meet its _____-______ _________.

Answer 64

short-term obligations

Question 65

What are the four ratios that are often used to analyze a company’s ability to meet its current obligations?

Answer 65

1. Current Ratio
2. Quick Ratio
3. Cash Ratio
4. Operating Cash Flow Ratio

Question 66

How do you calculate Current Ratio?

Answer 66

Current Ratio = Current Assets / Current Liabilities

Question 67

How do you calculate Quick Ratio?

Answer 67

Quick Ratio = (Cash + Marketable Securities + Accounts Receivable) / Current Liabilities

Question 68

How do you calculate Cash Ratio?

Answer 68

Cash Ratio = (Cash + Marketable Securities) / Current Liabilities

Question 69

How do you calculate Operating Cash Flow Ratio?

Answer 69

Operating Cash Flow Ratio = Cash Flows from Operating Activities / Current Liabilities

Question 70

What ratio does this describe?
- Compares all or parts of current assets to current liabilities
- Calculation greater than 1.0 implies a company can meet its obligations.

Answer 70

Current Ratio

Question 71

What ratio compares current assets (less inventory) to current liabilities?

Answer 71

Quick Ratio

Question 72

What ratio looks at the ability of cash generated from operating activities to meet current obligations?

Answer 72

Operating Cash Flow Ratio

Question 73

Both the quick and cash ratio exclude ________ because including it assumes that sales will be made.

Answer 73

inventories

Question 74

The quick ratio assumes that accounts receivable are _______. This is true when customers have low credit risk and pay in relatively short amounts of time.

Answer 74

liquid

Question 75

T or F: As with the current ratio, the operating cash flow ratio assumes that sales will continue into the future.

Answer 75

true

Question 76

most of the information to calculate the ratios can be found on the ______ _______ (except for cash flows from operating activities, which is on the ______ ____ _____ _____).

Answer 76

• balance sheet
• statement of cash flows

Question 77

Current ratio depends on how liquid ________ and ________ _______ are. If the inventory is slow moving, then the _____ ______ may be a better indicator of liquidity. If accounts receivable may be difficult to collect, the _____ _____ is the best indicator of liquidity.

Answer 77

• inventory; accounts receivable
• quick ratio
• cash ratio