Ch10 SM Libby3ce

Chapter 10
Reporting and Interpreting Current Liabilities

ANSWERS TO QUESTIONS
1.
Liabilities are obligations that result from transactions that require future payment of
assets or the future performance of services. The obligations are definite in
amount or are subject to reasonable estimation. A liability usually has a definite
payment date known as the maturity or due date. A current liability is a short-term
liability; that is, one that will be paid during the coming year or the current operating
cycle of the business, whichever is longer. It is assumed that the current liability will
be paid out of current assets. All other liabilities are defined as long-term liabilities.
2.
One of the main sources of information available to external parties for determining
the number, type, and amounts of liabilities of a business are the published
financial statements. The balance sheet includes liabilities and the notes to the
statements contain further detail on the liabilities that are on the balance sheet as
well as on contingent liabilities and commitments. These statements have more
credibility when they have been audited by an independent auditor (usually a
chartered accountant).
3.
A liability is initially measured at its current cash equivalent amount. Conceptually,

this amount is the present value of all of the future payments of principal and
interest. For a short-term liability the current cash equivalent amount is usually the
same as the maturity amount. The current cash equivalent amount for an interestbearing liability at the going rate of interest is the same as the maturity value. For a
long-term liability, the current cash equivalent amount will be less than the maturity
amount: (1) if there is no stated rate of interest, or (2) if the stated rate of interest is
less than the going rate of interest.
4.
Most debts specify a definite amount that is due at a specified date in the future.
However, there are situations where it is known that an obligation or liability exists
although the exact amount is unknown. Liabilities that are known to exist but the
exact amount is not yet known must be recorded in the accounts and reported in
the financial statements at an estimated amount, assuming that a reasonable
estimate can be made. Examples of a known obligation of an estimated amount are
estimated income tax at the end of the year, property taxes at the end of the year,
and obligations under warranty contracts for merchandise sold.
5.
Working capital is computed as total current assets minus total current liabilities. It
is the amount of current assets that would remain if all current liabilities were paid,
assuming no loss or gain on liquidation of those assets.
Financial Accounting, 3ce, Libby, Libby, Short, Kanaan, Gowing
2008 McGraw-Hill Ryerson Limited. All rights reserved.
10-1
6.
The current ratio is the percentage relationship of current assets to current

liabilities. It is computed by dividing current assets by current liabilities. The current
ratio is influenced by the amount of current liabilities. Therefore, it is particularly
important that liabilities be considered carefully before classifying them as current
versus long term. The shifting of a liability from one of these categories to the other
may significantly affect the current ratio. This ratio is used by creditors because it is
an important measure of a firms ability to meet short-term obligations as they
generally come due. Thus, the proper classification of liabilities is particularly
significant.
7.
An accrued liability is an expense that was incurred before the end of the current
period but has not yet been paid or recorded. Therefore, an accrued liability is
recognized when such a transaction is recorded. A typical example is wages
earned during the last few days of the accounting period but not recorded because
the payroll was not prepared (or paid) that included these wages. Assuming wages
of $2,000 were incurred but not yet paid as at December 31, the adjusting entry to
record the accrued liability and the wage expense would be as follows:
December 31:
Wage expense (E) 2,000
Wages payable (L) ..........
8.
2,000
Deferred revenue (usually called unearned revenue or revenue collected in

advance) is revenue that has been collected in advance of being earned and
recorded in the accounts by the entity. Because the amount has already been
collected and the goods or services have not yet been provided, there is a liability
to provide goods or services to the party who made the payment in advance. A
typical example is the collection of rent on December 15 for one full month to
January 15 when the accounting period ends on December 31. At the date of the
collection of the rent the following entry is usually made:
December 15:
Cash (+A).....................................................................
Rent revenue (+R +SE) .......................................
4,000
4,000
On the last day of the period, the following adjusting entry should be made to
recognize the deferred revenue as a liability:
December 31:
Rent revenue (R SE)............................................
Deferred rent revenue (or Rent revenue collected in
advance) (+L)........................................................
2,000
2,000
The deferred rent revenue (credit) is reported as a liability on the balance sheet
because two weeks occupancy is owed in the next period for which the lessee has
already made payment.
10-2
9.
A note payable is a written promise to pay a stated sum at one or more specified
dates in the future. A note payable also specifies the interest rate associated with
the borrowing. Since notes payable require the payment of interest at a future point
in time, the liability account Interest payable is usually associated with notes
payable.
10. A contingent liability is not an effective liability; rather it is a potential future liability.
A contingent liability arises because of some transaction or event that has already
occurred which may, depending upon one or more future events (occurring or not
occurring), cause the creation of a true liability. A typical example is a lawsuit for
damages where an accident has occurred. Whether the defendant has a liability
depends upon the ultimate decision of the court. Pending that decision there is a
contingent liability (and a contingent loss). This contingency must be recorded and
reported (debit, loss; credit, liability) if it is likely that the decision will require the
payment of damages, and the amount can be reasonably estimated. If the
occurrence of the confirming future event is not determinable, or if the event is
likely to occur but the amount of the loss cannot be reasonably estimated,
information about the contingent loss must be disclosed in the footnotes to the
financial statements. Disclosure of unlikely contingencies is desirable but not
required.
11. Interest expense = $4,000 x 12% x 9/12 = $360.
12. The concept of the time value of money is another way to describe interest. Time
value of money refers to the fact that a dollar received today is worth more than a
dollar to be received at any later date because of interest that is earned over time.
10-3
Authors Recommended Solution Time

(Time in minutes)
Exercises
No.
Time
1
20 E
2
20 E
3
10 E
4
30 M
5
20 M
6
20 E
7
15 E
8
20 D
9
10 E
10
10 M
11
25 M
12
10 M
13
20 M
14
15 M
15
20 D
E = Easy
Alternate
Problems
No.
Time
A1
35 E
A2
25 E
A3
40 M
A4
30 M
A5
15 M
A6
25 M
A7
25 M
A8
10 E
A9
50 D
Problems
No.
Time
1
35 M
2
35 E
3
25 E
4
30 M
5
40 M
6
20 M
7
30 M
8
30 M
9
25 M
10
20 M
11
20 M
12
10 E
13
30 D
M = Moderate
Cases and
Projects
No.
Time
1
25 E
2
20 E
3
25 M
4
20 D
5
20 M
6
45 D
7
25 M
8
20 M
9
20 M
10
20 M
11
20 M
12
*
D = Difficult
* Due to the nature of such cases and projects, it is very difficult to estimate the
amount of time students will need to complete the assignment. As with any open-ended
project, it is possible for students to devote a large amount of time to such assignments.
While students often benefit from the extra effort, we find that some become frustrated
by the perceived difficulty of the task. You can reduce student frustration and anxiety by
making your expectations clear. For example, when our goal is to sharpen research
skills, we devote class time discussing research strategies. When we want the students
to focus on a real accounting issue, we offer suggestions about possible companies or
industries.
10-4
EXERCISES
E101
Event
Title of Liability Account

Affected by Event
Amount of Current Liability
a.
Unearned passenger revenue
$470
b.
Deposits from customers
$50,000
c.
Note payable
$10,000
Interest payable
$150 [=$10,000 x .09 x (2/12)]
d.
Unearned subscription revenue
$1,800
e.
None, assuming that the amount

due was paid within 30 days.
f.
None, because the bill relates to

calls made in January 2009.
10-5
E102
Req. 1
(a) Current assets ($295,100 $125,000)...........................
Current liabilities:
Accounts payable........................................................
Income taxes payable..................................................
Liability for withholding taxes.......................................
Rent revenue collected in advance.............................
Wages payable............................................................
Property taxes payable................................................
Note payable, 10% (due in 6 months).........................
Interest payable...........................................................
Working capital................................................................
$170,100
$60,000
12,000
3,000
14,000
7,800
2,000
10,000
300
(109,100)
$ 61,000
(b) Current ratio = $170,100 $109,100 = 1.56

Working capital is critical for the efficient operation of a business. Current assets
include cash and assets that will be collected in cash within one year or the normal
operating cycle of the company. A business with insufficient working capital may not
be able to pay its short-term creditors on a timely basis and could, eventually, result
in bankruptcy.
The current ratio is a measure of liquidity. It helps analysts assess a companys
ability to meet its short-term obligations as they generally come due.
Req. 2
Contingent liabilities that are disclosed in the notes to the financial statements do not
affect the total amount of current liabilities reported on the balance sheet. Hence, the
previous computations are not affected by such disclosures.
E103
Current Ratio
a. Increase
b. Decrease
c. Decrease
d. Decrease
Working Capital
No change
Decrease
No change
No change
The above can be checked by calculating the values. Knowing that the current ratio is 2
and the amount of working capital is $1,240,000 the current assets are $2,480,000 and
the current liabilities are $2,480.
10-6
E104
Req. 1
March 31, 2007:
Compensation expense (+E SE)........................................
Liability for income taxes withheld (+L)................................
Liability for union dues withheld (+L)....................................
Liability for insurance premiums withheld(+L)......................
CPP payable (+L).................................................................
EI payable (+L) ....................................................................
Cash (A)..............................................................................
Payroll for March including employee deductions.
224,000
46,000
3,000
1,000
16,445
9,611
147,944
Req. 2
March 31, 2007:
Compensation expense (+E SE)........................................
CPP payable (+L).................................................................
EI payable (+L).....................................................................
Employers additional payroll expenses for March
($9,611 x 1.4 = $13,455).
29,900
16,445
13,455
Req. 3
Liability for income taxes withheld (L)....................................
Liability for union dues withheld (L)........................................
Liability for insurance premiums withheld (L).........................
CPP payable (L) ($16,445 x 2)...............................................
EI payable (L) ($9,611 + $13,455).........................................
Cash (A)..............................................................................
Remittance of employee deductions and employer-related
amounts for March.
46,000
3,000
1,000
32,890
23,066
105,956
Req. 4
The total compensation expense was $253,900, comprised of $224,000 of salaries and
wages plus $29,900 of additional payroll charges levied on the employer.
The total payroll (salaries and wages) was $224,000. The take-home pay was $147,944
and the percent of payroll that was take-home pay was 66% = $147,944 $224,000.
Employee compensation is a large cost for most organizations. Employers are not
concerned about the distinction between salaries and fringe benefits because both are
expenses that are deductible for tax purposes. Employees sometimes prefer an extra
dollar in fringe benefits over an extra dollar of salary because some fringe benefits are
either not taxable or are not taxable in the current period. In the absence of tax effects,
most employees prefer increases in salaries because they have full control over those
dollars.
10-7
E105
Req. 1
The additional labour expense was $10,933 [$6,013 + ($3,514 x 1.4)], which represents
the total of the additional payroll charges levied on the employer. The employees takehome pay was $59,373; that is, the total of salaries and wages less the deductions paid
by the employees (i.e., $79,000 $8,900 $1,200 $6,013 - $3,514 = $59,373).
Req. 2
Balance sheet liabilities:
Liability for income taxes withheld...........................................................
Liability for union dues withheld...............................................................
Canada Pension Plan contributions payable ($6,013 + $6,013).............
Employment Insurance contributions payable ($3,514 + ($3,514 x 1.4))
Total......................................................................................................
$ 8,900
1,200
12,026
8,434
$30,560
Req. 3
Both managers and analysts would understand that a 10% increase in salaries is more
expensive than a 10% increase in the employers share of CPP (or any other benefit).
The reason is that many benefits are stated as a percentage of salary. As a result, the
cost of a 10% increase in salaries results in an increase in both salaries and fringe
benefits.
E106
Req. 1
November 1, 2007:
Cash (+A)........................................................................ 4,500,000
Note payable (+L)........................................................
Borrowed on 6-month, 10%, note payable.
4,500,000
Req. 2
December 31, 2007 (end of the fiscal year):
Interest expense (+E SE)...........................................
Interest payable (+L)....................................................
Adjusting entry for 2 months accrued interest
($4,500,000 x 10% x 2/12 = $75,000).
75,000
75,000
10-8
E106 (continued)
Req. 3
April 30, 2008 (maturity date):
Note payable (L)............................................................
Interest payable (per above) (L)....................................
Interest expense ($4,500,000 x 10% x 4/12) (+E SE)
Cash (A).....................................................................
Paid note plus interest at maturity.
4,500,000
75,000
150,000
4,725,000
Req. 4
It is doubtful that long-term borrowing would be appropriate in this situation. After the
Christmas season, Hudsons Bay will collect cash from its credit sales. At this point, it
does not need borrowed funds. It would be costly to pay interest on a loan that was not
needed. It might be possible to borrow for a longer term at a lower interest rate and
invest idle cash to offset the interest charges. Hudsons Bay should explore this
possibility with its bank but in most cases it would be better to borrow on a short-term
basis to meet short-term needs.
E107 (Amounts in thousands)
Date
Assets
Liabilities
Shareholders Equity
Nov. 1, 2007
Cash + $4,500
Note Payable + $4,500
Not Affected
Dec. 31, 2007
Not Affected
Interest Payable + $75
Interest Expense $75
April 30, 2008
Cash $4,725
Note Payable $4,500

Interest Payable $75
Interest Expense $150
E108
This type of classification is consistent with generally accepted accounting principles. An
analyst wants liabilities classified in terms of the timing of the expected cash flows. If a
short-term obligation is expected to be refinanced on a long-term basis, there will be no
cash flow in the short term. It is reasonable to classify that type of obligation as long
term.
If a company classifies a short-term obligation as long term, it must have both the intent
and ability to refinance the obligation. Analysts would be most concerned about the
company's ability to refinance.
10-9
E109
Req. 1
Warranty expense for 2008 = $3,600,000 x 0.004 = $14,400
Req. 2
Estimated warranty liability, January 1, 2008
+ Warranty expense for the year
Cost of servicing products under warranty
= Estimated warranty liability, December 31, 2008
$35,200
14,400
(15,600)
$34,000
E1010
Warranty costs are incurred because Amster Corp. provides a warranty on its products
for 2 years after sale. These costs relate to the sales that are made in a particular
accounting period and represent obligations to be settled in the future in the form of
repair costs that include the cost of replacement parts and/or labour costs to fix the
defective or malfunctioning product. Therefore, these costs should be accounted for as
expenses during the period of sale in conformity with the matching principle. Since
these expenses are not known in advance, they must be estimated based on the
companys past experience with warranty costs. To estimate the warranty liability,
Ambers management would first estimate the percentage of repairs that may be
required by customers under the warranty and then multiply that percentage by $100,
which is the estimated repair cost per unit.
The warranty expense would be reported on the income statement, and the estimated
warranty liability would ideally be split in two portions: a current liability reflecting the
cost of warranty work that is expected to be done within one year of the balance sheet
date, and a non-current liability for the remaining portion of the estimated liability. For
practical purposes, if the non-current portion is not significant, then the full amount may
be reported a current liability in conformity with the materiality concept.
10-10
E1011
Req. 1
Date
Assets
Liabilities
Shareholders Equity
Jan. 10, 2008
Inventory + $18,000
Accounts Payable +$18,000
Not Affected
March 1, 2008 Cash + $100,000
Not Affected
April 5, 2008
GST Payable + $1,800

PST Payable + $2,400
Revenues
+ $30,000
Cost of goods sold
$21,000 ($30,000 x
70%)
Accounts Receivable
+ $34,200
Inventory
$21,000 ($30,000 x
70%)
Req. 2
February 28, 2009
Cash paid:
$108,000 [$100,000 + ($100,000 x 8%)]
Req. 3
Transactions (a) and (c) have no impact on cash flows because there is neither an
inflow nor an outflow of cash. Transaction (b) results in an inflow of cash from
borrowing, which is a financing activity. The February 28 th payment is an outflow of
cash. (Note to instructor: If you have emphasized the Cash Flow Statement, you should
discuss the specific nature of these cash flows. The repayment of principal is a cash
flow from financing activities and the payment of interest expense is a component of
cash flows from operating activities.)
Req. 4
Assuming that the current ratio is greater than one prior to each transaction,
transactions (a) and (b) will decrease the ratio, and transaction (c) will increase the ratio
(the repayment of the note will also increase the current ratio). The answer to this type
of question is not always obvious so it may be useful to prove it with hypothetical
numbers. For example, assume that current assets are $36,000 and current liabilities
equal $18,000 before transaction (a). The current ratio is 2.0. After the transaction,
current assets increase to $54,000 and current liabilities increase to $36,000, and the
current ratio decrease to 1.5. The reason for this decrease is that current assets
increase by 50 percent whereas current liabilities increase by 100 percent, a larger
percentage.
10-11
E10-12
2005
Buzz does not have to record or disclose the liability because the chance of the
liability occurring is remote.
2006
Buzz does not have to record or disclose the liability because the chance of the
liability occurring is remote.
2007
Buzz should disclose the contingent liability in a note because the matter is
potentially significant but the occurrence (or non-occurrence) of the confirming
event is not determinable.
2008
Buzz should probably record the liability since the existence of a liability
appears to be confirmed and the amount appears to be known. However, one
could argue that although the jury has returned a verdict a liability need not be
recorded if the companys attorneys are very confident that the verdict will be
overturned on appeal. In this case, a note would disclose the jurys verdict and
the companys confidence of having the verdict reversed.
2009
Buzz must now record the loss and the liability because the existence of the
liability and the amount ($150,000) are both known.
E1013
Req. 1
(a) Income tax payable:
2008: $12,200 x 40% = $4,880
2009: $20,800 x 40% = $8,320
(b) Future income tax:
2008: $2,800 x 40% = $1,120 (originating, a credit a liability)*
2009: $2,800 x 40% = $1,120 (reversing, a debit eliminates the liability)
*This is a future income tax liability (a credit) because the expense is deducted in the
tax return before it is deducted in the income statement. In other words, there will be
more income tax in the future because of relatively higher taxable amounts (and the
liability will thus be eliminated).
10-12
E1013 (continued)
The tax-related amounts for 2008 and 2009 are as follows:
2008
$15,000
(2,800)
12,200
Pretax income
Less early deduction of expense
Taxable income
Income tax expense (pretax income x 40%)
Income tax payable
Future income tax
2009
18,000
2,800
20,800
6,000 Dr.
4,880 Cr.
1,120 Cr.
7,200 Dr.
8,320 Cr.
1,120 Dr.
Req. 2
Reporting:
2008
Income statement:
Income tax expense (see below).......................................... $6,000
2009
$7,200
Balance sheet:
Current Liabilities:
Income tax payable........................................................... $4,880
Future income tax liability
1,120
$8,320
-0-
(Note: in practice, the current and future portions of income tax expense would each be
disclosed.)
Req. 3
Tax expense is based on income reported on the income statement. It is a necessary
cost associated with earning income and should be recorded in the same period.
Income tax is the cost of doing business. Accountants apply the matching concept,
which means the amount of tax expense and taxes currently payable are usually
different.
E1014
Req. 1
2007: $20,000 x 35% = $7,000
2008: $14,000 x 35% = $4,900
2007: $5,000 x 35% = $1,750 (originating, a debit an asset)*
2008: $5,000 x 35% = $1,750 (reversing, a credit eliminates the asset)
*This is a future income tax asset (a debit) because the related revenue is included in
the income tax return (2007) and therefore taxed, before it is included in the income
statement (2008). This means that the income tax was paid in advance (i.e., a
prepayment of income tax), and therefore represents an asset.
10-13
E1014 (continued)
The tax-related amounts for 2007 and 2008 are as follows:
2007
$15,000
5,000
20,000
Pretax income
Add: taxable revenue
Taxable income
Income tax expense (pretax income x 40%)
Income tax payable
Future income tax
2008
19,000
(5,000)
14,000
5,250 Dr.
7,000 Cr.
1,750 Dr.
6,650 Dr.
4,900 Cr.
1,750 Cr.
Req. 2
Entries to record income taxes:
Income tax expense (+E SE)....................
Future income tax asset (+A / A) (Req. 1). . .
Income tax payable (+L) (Req. 1)...............
o
= originating; r = reversing
2007
5,250
1,750o
7,000
2008
6,650
1,750 r
4,900
Req. 3
Reporting:
Income statement:
Income tax expense.....................................................
2007
2008
$5,250
$6,650
(In practice, the current and future portions of income tax expense would each be
disclosed.)
Balance sheet:
Current Assets:
Future income tax asset...........................................
Income tax payable..................................................
2007
$1,750
2008
$ 0
$7,000
$4,900
Req. 4
There are separate rules governing the determination of tax expense (GAAP) and the
amount of taxes currently payable (Income Tax Act) for public corporations. As a result,
these two amounts are different for most companies. Management must incur the
additional cost of preparing separate tax and financial accounting reports in order to
comply with GAAP. Small, privately-owned businesses that are not subject to GAAP
may choose to use the tax rules for financial reporting as well in order to save on the
cost of preparing financial statements.
10-14
E1015
Req. 1
2007$32,000 x 28% = $ 8,960
2008$56,000 x 28% = $15,680
2009$85,000 x 28% = $23,800
(b) Future income tax (related to amortization):
2007
2008
2009
$ 25,000 $25,000
$25,000
37,500
25,000
12,500
$(12,500) $0
$12,500
x 28%
x 28%
$ (3,500)
$ 3,500
(originating
(reversing;
liability;
debit)
credit)
Straight-line amortization ($75,000 3)............

Accelerated amortization (CCA per tax return)..
Temporary difference......................................
Multiply by tax rate.............................................
Future income tax..............................................
The originating difference is a liability (a credit) because additional income taxes must
be paid in the future. This results from lower amortization deductions (CCA) in the tax
return in the future; that is, lower tax deductions mean more income tax in the future on
other taxable amounts.
Req. 2
Reporting:
2007
Income statement:
Income tax expense....................................................
2008
2009
$12,460
$15,680
$20,300
$8,960
$15,680
$23,800
$3,500
$3,500
$0
2007: $8,960 + $3,500 = $12,460.

2008: $15,680 + $0 = $15,680.
2009: $23,800 - $3,500 = $20,300.
(Note: in practice, the current and future portions of
income tax expense would each be disclosed.)
Balance sheet:
Income tax payable.................................................
Long-term Liabilities:
Future income tax liability
10-15
PROBLEMS
P101
Req. 1
January 15:
Purchases (+T)................................................................
Cash (A).....................................................................
Purchased merchandise.
April 1:
Cash (+A)........................................................................
Note payable, short term (+L)......................................
Borrowed on short-term note.
June 14:
Cash (+A)........................................................................
Unearned revenue (+L)................................................
Received customer deposit.
July 15:
Unearned revenue (L)...................................................
Revenue (+R +SE)...................................................
Performed service.
December 12:
Electricity expense (+E SE).......................................
Accounts payable (+L).................................................
Received electricity bill.
December 31:
Wage expense (+E SE).............................................
Wages payable (+L).....................................................
Adjusting entry for unpaid wages.
13,580
13,580
500,000
500,000
10,000
10,000
2,500
2,500
540
540
12,000
12,000
Req. 2
December 31:
Adjusting entry for 9 months' interest on note payable
($500,000 x 8% x 9/12 = $30,000).
30,000
30,000
10-16
P101 (continued)
Req. 3
Transaction
Effect on
Current Ratio
Effect on
Working Capital
January 15
No change
No change
April 1
Decrease
No change
June 14
Decrease
No change
July 15
Increase
Increase
December 12
Decrease
Decrease
December 31
Decrease
Decrease
P102
Req. 1
January 8:
Purchases (+T)................................................................
January 17:
Accounts payable (L).....................................................
Cash (A).....................................................................
Paid the invoice received January 8.
March 10:
Accounts receivable (+A)................................................
Sales revenue (+R +SE)..........................................
GST payable (+L)........................................................
PST payable (+L)........................................................
Sold merchandise on account.
April 1:
Cash (+A)........................................................................
Note payable, short term (+L)......................................
Borrowed on 12-month, 12%, interest-bearing note.
June 3:
Purchases (+T) ...............................................................
12,420
12,420
12,420
12,420
11,400
10,000
600
800
40,000
40,000
17,820
17,820
10-17
P102 (continued)
July 5:
Accounts payable (L).....................................................
Cash (A).....................................................................
Paid the invoice received June 3.
17,820
17,820
August 1:
Cash (A)...........................................................................
5,400
4,500
Rent revenue (+R +SE) ($5,400 x 5/6)....................
Unearned rent revenue (+L) ($5,400 x 1/6).................
900
Collected rent revenue for 6 months of which one month was for the subsequent
year. No adjustment is required at year end.
December 20:
Cash (+A)........................................................................
Liability-deposit on trailer (+L).....................................
Received deposit from customer.
December 31:
Wage expense (+E SE).............................................
Wages payable (+L).....................................................
Adjusting entry for unpaid wages.
100
100
7,200
7,200
Req. 2
December 31:
Adjusting entry for 9 months' interest on note payable
($40,000 x 12% x 9/12 = $3,600).
3,600
3,600
Req. 3
Balance Sheet, December 31, 2008:
Current Liabilities
Note payable, short term.............................................
Deposit on trailer..........................................................
Wages payable............................................................
Interest payable...........................................................
GST and PST payable..................................................
Unearned rent revenue ...............................................
$40,000
100
7,200
3,600
1,500
900
Total..........................................................................
$53,300
10-18
P102 (continued)
Req. 4 (Assuming current ratio is greater than one prior to each transaction/entry)
Transaction
January 8
January 17
March 10
April 1
June 3
July 5
August 1
December 20
December 31 (Wages)
December 31 (Interest)
Effect
Decrease
Increase
Increase
Decrease
Decrease
Increase
Increase
Decrease
Decrease
Decrease
P103
Req. 1
Date
January 8
Liabilities
Accounts Payable + $12,420
Shareholders Equity
No effect
Accounts Payable $12,420

GST Payable +$600
PST Payable +$800
No effect
Sales Revenue +
$10,000

Accounts Payable + $17,820
No effect
No effect
July 5
August 1
Assets
Purchases *
+ $12,420
Cash $12,420
Accounts
Receivable
+11,400
Cash + $40,000
Purchases *
+ $17,820
Cash $17,820
Cash + $5,400

Revenue Collected in
Advance + $900
No effect
Rent Revenue + $4,500
Dec. 20
Dec. 31
Dec. 31
Cash + $100
No effect
No effect
Deposit on Trailer + $100

Wages Payable + $7,200
Interest Payable + $3,600
No effect
Wage Expense - $7,200
Interest Expense
$3,600
January 17
March 10
April 1
June 3
* The purchases represent additional inventory on hand.
10-19
P103 (continued)
Req. 2
Transaction
January 8
January 17
March 10
April 1
June 3
July 5
August 1
December 20
December 31 (wages)
December 31 (interest)
Effect
No effect
Decrease
No effect
Financing activity (no effect on operating activities)
No effect
Decrease
Increase
Increase
No effect
No effect
P104
Req. 1
(a) Adjusting entry, December 31, 2009:
Wage expense (+E SE).............................................
Wages payable (+L).....................................................
5,100
(b) January 6, 2010:

Wages payable (L).........................................................
Cash (A).....................................................................
5,100
5,100
5,100
Req. 2
(a) December 10, 2009:
Cash (+A)........................................................................
Rent revenue (+R +SE)............................................
Collection of rent revenue for one month.
(b) December 31, 2009:
Rent revenue (R SE)................................................
Unearned rent revenue (+L)........................................
Rent collected in advance (10/30 x $3,000 = $1,000).
3,000
3,000
1,000
1,000
10-20
P104 (continued)
Req. 3
Date
Dec. 31, 2009
Assets
No impact
Liabilities
Shareholders Equity
Wage Expense - $5,100
Jan. 6, 2010
Cash - $5,100
Wages Payable - $5,100
No impact
Dec. 10, 2009
Cash + $3,000 No impact
Rent Revenue + $3,000
Dec. 31, 2009
No impact
Rent Revenue - $1,000
Unearned Rent Revenue

+ $1,000
Req. 4
Balance sheet at December 31, 2009:
Wages payable............................................................
Unearned rent revenue ...............................................
5,100
1,000
Req. 5
Accrual based accounting is more beneficial to financial analysts because it records
revenues when they are earned and expenses when they are incurred, regardless of
when the related cash is received or paid. Cash-based accounting only records
revenues when they are received and expenses when they are paid. A financial analyst
is looking towards the future of the company, so it is helpful to know how much cash will
be coming into and out of the company at later dates. Cash based accounting limits
financial analysts to only what has happened in prior periods and tells them very little
about future events and cash flows that will affect the financial health of the company.
Cash basis accounting may also be susceptible to manipulation.
10-21
P105
Req. 1
2007:
Warranty Expense increases by $2 million; Warranty Payable increases by $2 million.
2008:
Warranty Payable decreases by $2,000,000; Cash decreases by $2,000,000. There is
therefore no warranty liability at the end of 2008.
Req. 2
2007:
Cash increases by $10,000,000; Unearned Revenue increases by $10,000,000.
2008:
Unearned Revenue decreases by $8,000,000; Revenue increases by $8,000,000.
Therefore, the balance in Unearned Revenue at the end of 2008 is $2,000,000.
Req. 3
The company should probably report litigation expense and the related liability after the
jury awarded damages. However, if lawyers for Brunswick are very confident of their
grounds for appeal, the company might only report a contingent liability in the notes to
the financial statements. In such situations, good professional judgment must be
exercised by management as well as the companys attorneys and auditors.
10-22
P105 (continued)
Req. 4
The current ratio for Coke is .80, which is relatively a low ratio. In isolation, it might
seem like an indication of trouble but analysts would look at much more information. For
example, Coke was able to generate over $2.2 billion in cash from its operations. The
Company had a line of credit that will permit it to borrow $1.6 billion in credit. Analysts
would also compare the ratio to similar companies. For example, the current ratio for
PepsiCo was .79, i.e., virtually identical to that of Coke. This brief exercise is intended to
open a discussion concerning the need to avoid placing too much emphasis on a
specific accounting number or ratio.
Req. 5
Many manufacturing companies have some adverse impact on our environment. In
many cases, the law requires these companies to rectify these negative effects. Alcoa
refers to these environmental cleanup efforts as remedial efforts. Alcoa records the
cost of future environmental cleanup efforts in the year that the need for rectifying the
damage is first becomes likely, instead of waiting until the year that the work is actually
performed. This policy is consistent with the matching principle. Environmental damage
can be thought of (by some people) as a necessary cost of producing aluminum.
According to that reasoning, the cost of future environmental cleanup efforts should be
matched with the cost of the aluminum produced, rather than deferring recognition of
the expense to the period in which the cleanup work actually takes place.
10-23
P106
Req. 1
Estimated Warrant Liability
1,055
Warranty payments
469
Beginning balance
Warranty expense
970
Ending balance
$1,055 + X 469 = 970; X = $384

Req. 2
Estimated warranty liability (L)......................................
Cash (A)....................................................................
Payments to customers in exchange for returned products.
469
469
Note: Bombardier simply returned cash to customers instead of repairing the defective
products, thus the credit is to the cash account. In some cases, repairs under
warranty affect the inventory accounts when parts must be replaced, as well as the
wages payable account for the labour expenses incurred to complete the repairs.
The entry above assumes that the defective products have no value. If they have
any value, then the inventory account would be debited for their value and the
estimated warranty liability would be reduced accordingly.
Warranty expense (+E SE)........................................
Estimated warranty liability (+L)..................................
To recognize warranty expense for the period.
384
384
Req. 3
2006
6.59%
Estimated warranty liability / revenues
2005
6.79%
2004
6.01%
The ratio increased in 2005 then decreased slightly in 2006. The increase may be due to
an increase in the rate of defective products that requires a higher provision for
warranties. It could also indicate that the company overstated the amount of the
provisions for the years 2005 and 2006 which resulted in higher ending balances for the
estimated warranty liability account relative to the amount of revenues generated in
those years.
Req. 4
The limited evidence that is available to us does not suggest that Bombardier should be
reducing is warranty liability in future years. Another ratio that would be helpful in
addressing this issue is that of warranty payments divided by revenues. This will show if
the warranty costs are increasing or decreasing over time. Another factor to be
considered is whether Bombardier has changed (shortened or lengthened) the warranty
period for its products. If the warranty period has become longer over time because of
competitive pressures, then the estimated liability should not be reduced.
10-24
P107
CASE A
Req. 1
The cash deposit for each keg is potentially refundable to the depositor. EBC must
return the cash received if the customer returns the keg in future. Hence, the Keg
Deposits account is essentially a liability account. There is no information about time
limits or the percentage of kegs that are not returned. It is possible, however, for EBC
to estimate the portion of the deposits that is usually kept by the company and consider
this amount as revenue. This is very similar to the issues faced by companies that offer
"points" that can be redeemed for services or products in the future, such as Canadian
Tire and Petro-Canada. Assuming this is a current liability then the Keg Deposits
account would appear in the current liabilities section of the balance sheet. If the value
is material then it may be disclosed as a separate item, otherwise it is combined with
other liabilities as part of "Other current liabilities," perhaps with an explanatory note.
Req. 2
The company has received a reliable estimate that an amount of $1,250 (50 x $25) will
never be returned to customers. This amount becomes revenue for the period. The
company recognizes this revenue by making the following adjusting entry at year end:
Keg Deposits (L)
Revenue from deposits
1,250
1,250
CASE B
Req. 1
September 1, 2008:
Cash (+A)........................................................................
Unearned rent revenue (+L).......................................
Received rent for six months in advance.
December 31, 2008:
Unearned rent revenue (L)............................................
Rent revenue (+R +SE)...........................................
To recognize rent revenue for four months of the year.
9,000
9,000
6,000
6,000
Alternatively, the cash received could have been credited to Rent Revenue. In that case
the journal entries would be as follows:
10-25
P107 (continued)
September 1, 2008:
Cash (+A)........................................................................
Rent revenue (+R +SE)...........................................
Received rent for six months in advance.
December 31, 2008:
Rent revenue (R SE)................................................
Unearned rent revenue (+L).......................................
To recognize unearned rent revenue for two months of the year.
9,000
9,000
3,000
3,000
Req. 2
The total amount received, $9,000, will be partially earned in 2008. Specifically, $2,000
[($9,000 / 18) x 4 months] is earned in 2006, and the remainder, $7,000 will be earned
over the next 14 months. By December 31, 2009, a total of $6,000 will have been
earned, and the other $1,000 will be earned in 2010. As a result, $6,000 represents a
current liability, and $1,000 should be classified as a non-current liability on the
December 31, 2008 balance sheet. However classification of the $1,000 as non-current
may not be considered material.
CASE C
April 2009:
Cash (+A) [150 x $60].....................................................
Unearned subscription revenue (+L)..........................
Received one-year subscriptions from 150 customers.
April 30, 2009:
Unearned subscription revenue (L)...............................
Subscription revenue (+R +SE)..............................
To recognize subscription revenue for one month from 70
subscribers (70 x $5 per month).
9,000
9,000
350
350
10-26
P108
The current liability classification is based on the expectation that the company will pay
the liabilities during the subsequent year. Analysts are interested in this classification
because it provides important information to use when predicting future cash flows. If
management has the intent and the ability to refinance a short-term liability, then it will
not result in a cash outflow. In this circumstance, it is appropriate to reclassify the debt
as long term.
The current ratio for PepsiCo is very low when compared to most companies. The
Company, however, is not experiencing a liquidity problem. It generates large cash
flows from operations and has a significant line of credit available if it needs additional
funds. Furthermore, the industry traditionally operates with a relatively low current ratio.
Coke, for example, has a .80 current ratio. It is therefore unlikely that management
made the reclassification simply to increase its current ratio. Instead the Company was
probably trying to get a better balance between short-term and long-term borrowings.
Because management has the ability and intent to refinance the borrowings on a longterm basis, the current ratio should be based on the reclassification. The analyst might
want to use the ratio before reclassification if he or she thought that the reclassification
was only intended to manipulate the ratio (which does not appear to be the case). The
analyst should use caution when comparing the current ratio for the current year (after
reclassification) with the ratio for the previous year (before reclassification).
P109
Req. 1
Payables and accruals refer to amounts that should be paid to suppliers of goods and
services in the near future. The account balance increases when raw materials and
merchandise are purchased on account, and decreases when payments are made.
Deferred revenue represents an amount of cash (or other assets) received by the
company in exchange for goods and/or services to be provided in the future. The
account balance increases with the receipt of cash from customers in advance, and
decreases when goods are delivered and services are provided to these customers.
Dividends payable reflects an amount of dividends that has been declared by the
companys board of directors but has not been paid yet. The account balance increases
when the board of directors declares dividends and is reduced when cash is paid to
shareholders.
Income taxes payable refers to an outstanding obligation to pay income taxes to the
taxation authorities based on the current periods taxable income.
10-27
P109 (continued)
Future income liabilities result from temporary differences caused by reporting revenues
and expenses on the companys income statement in conformity with GAAP and on the
tax return in accordance with the Income Tax Act. The account balance increases when
temporary differences in accounting for specific revenue and expense items lead to
reporting income before income taxes that exceeds taxable income for the period. The
account balance is reduced when the reverse occurs.
The current portion of debt obligations represents the portion of long-term debt that is
payable within one year of the balance sheet date. The account balance increases
when long-term debt is reclassified as a current liability and is reduced when the debt is
paid.
Req. 2
Deferred revenue, January 1, 2006 ................................
Collections in advance during the year...........................
Revenue earned during the year.....................................
Deferred revenue, December 31, 2006 ..........................
$3,180 + X - $23,957 = $2,608;
$ 3,180
X
(23,957)
$ 2,608
Collections in advance = $23,385
Deferred Revenue
3,180
Warranty payments
23,957
X
2,608
Beginning balance
Warranty expense
Ending balance
Journal entry:
Cash (+A) .......................................................................
Deferred revenue (+L)................................................
Collections from customers in advance.
23,385
23,385
Req. 3
Retained earnings...........................................................
Dividends payable.......................................................
Declaration of dividends payable to shareholders.
17,083
Dividends payable...........................................................
Cash............................................................................
Payment of cash dividends to shareholders.
$6,404 + $17,083 X = $8,548
14,939
17,083
14,939
10-28
P1010
Req. 1
Do not record a liability nor disclose a contingency. Rationale: For major auto
manufacturers these types of lawsuits occur from time to time and may be considered to
be a normal business risk (at least to some extent) in the industry. Also, in this case,
because no specific lawsuit has been filed in respect of the new car any disclosure of a
contingency would be so general that it would probably not provide useful information.
Req. 2
Do not record a liability nor disclose a contingency. Rationale: In this case, there is no
direct evidence of a possible contingency. In fact, there is a great deal of uncertainty
that a contingency may exist at all. For example, we are told that the companys product
may infringe on another companys patent. Furthermore, we do not know the likelihood
that the other company will ever discover the possible infringement.
Req. 3
Record a liability. Rationale: The liability exists (the clean-up is required by provincial
law) and the amount can be reasonably estimated. The amount of the liability would be
for $3 million if the companys management wishes to be conservative and include the
higher end of the estimated amount. Alternatively, management could report a liability
for $2.5 million, representing the average of $2 and $3 million.
Req. 4
Record a liability. Rationale: Prudence (i.e., conservatism) suggests that the opinion of
the companys attorneys should be seriously considered. As such, it would be
appropriate to record a liability. The amount recorded for the liability might be less than
$1,000,000 if the companys attorneys are confident that the amount of damages will be
reduced on appeal.
Req. 5
Record a liability for $250,000. Rationale: Management has accepted its obligation to
the customer, intends to discharge it and the amount is known.
10-29
P1011
Req. 1 and 2
Current ratio
Accounts payable turnover
Average age of payables (days)
2006
1.07
2.40
152
2005
0.99
2.67
137
2004
0.85
2.52
145
2003
1.21
1.86
196
2002
0.91
1.67
219
2001
0.80
The current ratio fluctuated between 0.80 and 1.21 during the six-year period and
showed signs of improvement over the last three years, 2004-2006. While a current
ratio that exceeds 1.0 provides a margin of safety for short-term creditors, Suncors
current ratio should be compared to the norm for the industry for a better assessment of
its current level.
The accounts payable turnover ratio shows an increasing trend indicating that Suncor is
paying its trade supplies over shorter periods of time, as evidenced by the decreasing
trend in the average age of payables. While the decrease in the average age of
payables does not benefit the company from a cash management perspective, it
improves its relationship with its trade suppliers, especially if the credit period granted
by the suppliers in shorter than the average age of payables.
Req. 3
The use of the LIFO inventory costing method affects the cost of ending inventory and
the cost of goods sold, but it does not affect the cost of purchases. Therefore, if Suncor
used the FIFO inventory costing method, then the inventory at the end of 2006 would be
$832 ($589 + $243). This will increase the current assets to $2,545 ($2,302 + $243) and
the current ratio to 1.18. However, both the accounts payable turnover ratio and the
average age of payables would not be affected by the inventory costing method.
Since the FIFO cost provides a better indicator of the current value of inventory
compared to LIFO cost, the current ratio under FIFO provides a better indication of the
margin of safety for short-term creditors. But, the choice of an inventory costing method
does not affect the efficiency of managing accounts payable.
P1012
a.
b.
c.
d.
e.
f.
g.
h.
i.
j.
Remain the same

Decrease
Remain the same
Remain the same (financing activity)
Remain the same
Decrease
Remain the same
Decrease only for the interest that is paid (repayment of the principal is a
financing activity)
Increase
Decrease
10-30
P1013
Req. 1
(a) Income Taxes Payable:
$32,400 30% = $9,720
(b) Future Income Tax

Straight Line Amortization:
Accelerated Amortization (CCA):
Temporary Difference:
Multiply by Tax Rate:
Future Income Tax:
$11,000
($44,000 - $0) / 4
(17,600)
$( 6,600)
30%
$(1,980) Originating liability
The originating difference is a liability (a credit) because additional income taxes

must be paid in the future. This results from lower amortization deductions (CCA) in
the tax return in the future; that is, lower tax deductions mean more income tax in
the future on other taxable amounts.
Req. 2
Income Tax Expense (+E SE) [($59,000 20,000) x 30%]
Future Income Tax Liability (+L)..................................
Income Tax Payable (+L) ($9,720 x 15%) .
Cash (A) ($9,720 x 85%)...........................................
11,700
1,980
1,458
8,262
Req. 3
Reporting:
Income Statement for 2007:
Income Tax Expense........................$11,700 *
* In practice, the current and future portions of income tax expense would each be
disclosed.
Balance Sheet, December 31, 2007:
Income Tax Payable
Long-term Liabilities **:
Future Income Tax Liability
$1,458
$1,980
** The future income tax liability is classified as long-term because it is related to a longterm item (equipment).
10-31
ALTERNATE PROBLEMS
AP101
Req. 1
January 2, 2008:
Accrued Interest Payable (L).........................................
Cash (A).....................................................................
(Assuming no reversing entries on Jan. 1, 2008.)
April 30, 2008:
Cash (+A)........................................................................
Note Payable (+L)........................................................
May 20, 2008:
Cash (+A)........................................................................
Sales revenue (+R +SE)..........................................
HST payable (+L)........................................................
52,000
52,000
550,000
550,000
5,700
5,000
700
June 3, 2008:
Inventory (+A)..................................................................
Accounts Payable (+L).................................................
75,800
July 5, 2008:
Accounts Payable (L)....................................................
Cash (A).....................................................................
75,800
August 31, 2008:

Cash (+A)........................................................................
Revenue (+R +SE) ($9,000 x 4/6)...........................
Deferred Revenue (L)..................................................
75,800
75,800
9,000
6,000
3,000
Req. 2 (Adjusting and reclassification entries, Dec. 21, 2008)

Long-term Liability (L)....................................................
Current Liability (+L)...................................................
Note: in practice, specific accounts would be used.
100,000
Interest Expense (+E SE)..........................................

Accrued Interest Payable (+L).....................................
($550,000 x 10% x 8/12 = $36,667)
36,667
Wage Expense (+E SE).............................................

Wages Payable (+L)....................................................
85,000
100,000
36,667
85,000
10-32
AP101 (continued)
Income Tax Expense (+E SE)....................................
Income Tax Payable (+L).............................................
Future Income Tax Liability (+L)..................................
125,000
93,000
32,000
Req. 3
Balance Sheet:
Current Liabilities
Wages Payable
Income Tax Payable
Future Income Tax Liability *
HST Payable
Accrued Interest Payable
Deferred Revenue
Note Payable
Current Portion of Long-term Debt
Total Current Liabilities
$ 85,000
93,000
32,000
700
36,667
3,000
550,000
100,000
$900,367
* It is assumed that the future income tax liability is a current item. A different
assumption could have been made.
Req. 4
Effect on current ratio assuming the ratio is less than one prior to each transaction/
entry:
January 2, 2008
April 30, 2008
May 20, 2008
June 3, 2008
July 5, 2008
August 31, 2008
December 31, 2008 (Reclassification)
December 31, 2008 (Interest)
December 31, 2008 (Wages)
December 31, 2008 (Income taxes)
Decreases
Increases
Increases
Increases
Decreases
Increases
Decreases
Decreases
Decreases
Decreases
10-33
AP102
Req. 1
Date
Assets
January 2, 2008
Cash $52,000
April 30, 2008

May 20, 2008
Cash + $550,000
Cash + $5,700
Inventory amount
not known
June 3, 2008
Inventory
+ $75,800
Cash $75,800
Cash + $9,000
No effect
July 5, 2008
August 31, 2008
Dec. 31, 2008
(Interest)
Dec. 31, 2008
(Reclassification)
Dec. 31, 2008
(Wages)
Dec. 31, 2008
(Income Taxes)
No effect
No effect
No effect
Liabilities
$52,000
HST Payable + $700
Accounts Payable+ $75,800

Deferred Revenue + $3,000
+ $36,667
Long-term Liability $100,000
Current Liability + $100,000
Income Tax Payable+ $93,000
Future Income Tax Liability
+ $32,000
Shareholders
Equity
No effect
No effect
Sales Revenue
+ $5,000
Cost of good sold
amount not known
No effect
No effect
Revenue + $6,000
Interest Expense
$36,667
No effect
Wage Expense
$85,000
Income Tax Expense
$125,000
Req. 2
Effect on Cash from Operating Activities:
January 2, 2008
April 30, 2008
May 20, 2008
June 3, 2008
July 5, 2008
August 31, 2008
December 31, 2008 (Interest)
December 31, 2008 (Reclassification)
December 31, 2008 (Wages)
December 31, 2008 (Income tax)
Decreased
No effect (financing activity)
Increased
No effect
Decreased
Increased
No effect
No effect
No effect
No effect
10-34
AP103
Req.1
2007
Warranty Expense increases by $8,500,000; Warranty Payable increases by
$8,500,000.
2008:
Warranty Payable decreases by $8,500,000; no impact on Warranty Expense; Cash
decreases by $8,500,000. There is therefore no warranty liability at the end of 2006.
2007
Expense
Liability
+$8.5 million
+$8.5 million
2008
Liability
$8.5 million
Cash, Wages Payable, Inventory $8.5 million
Req. 2
Customer deposits are reported as a liability until, in the judgment of management, the
associated revenue has been earned.
Incomplete 10-day cruises
Partial Cruises (>10 days)
Cruises not started
Total unearned revenue
$8 million (1 60%)
$ 4.0 million
3.2 million
7.0 million
$14.2 million
Req. 3
Many of the lawsuits against the company are not material in amount. The company did
record $31.2 million in losses related to litigation. In one lawsuit, the company recorded
a loss of $12 million, but had to reverse $8.1 million of that amount when the actual loss
was determined. The recording of the accrued loss reduced income. The reversal
increased income.
Req. 4
While the current ratio is low and tending downward, it is doubtful that Exxon is
experiencing financial difficulty. The company has a reputation for aggressive cash
management. It would be useful to study the Cash Flow Statement to determine if
Exxon is generating significant cash resources from operating activities. It would also be
useful to read analysts assessment of Exxons liquidity, especially compared to the
liquidity of its competitors.
10-35
AP103 (continued)
Req. 5
To the extent that reasonable estimates can be made Brunswick records the cost of
future environmental cleanup efforts in the year that the underlying commitments (or
plans) are made, rather than waiting until the year when the work is actually performed.
One justification for this policy is the matching concept. Under the matching concept all
costs related to earning revenue should be reported in the same accounting period as
the revenue. Conservatism is another important justification for the approach used by
Brunswick, i.e., liabilities and expenses should not be understated (nor should assets
and income be overstated).
AP104
Req. 1
Accrued Warranty, 2005
19,291
Warranty payments
40,997
X
37,040
$19,291 + X 40,997 = 37,040;
Beginning balance
Warranty expense
Ending balance
X = $58,746
Accrued Warranty, 2006

37,040
Warranty payments
64,898
Y
64,839
$37,040 + Y 64,898 = 64,839;
Beginning balance
Warranty expense
Ending balance
Y = $92,697
Req. 2
Warranty expense (+E SE)........................................
Estimated warranty liability (+L)..................................
To recognize warranty expense for the year.
92,697
Estimated warranty liability (L)......................................

Cash, Inventory (A) and/or Wages payable (+L)......
Settlements made under the product warranty.
64,898
92,697
64,898
10-36
AP104 (continued)
Req. 3
2006
2.33%
Warranty expense / net sales
2005
1.52%
2004
1.52%
The ratio increased in 2006 by 53% (0.81% of net sales). The increase may be due to an
increase in the rate of defective goods produced by the company or purchased from
parts suppliers. It could also signal a conservative estimate of the warranty liability
associated with the introduction of new products that have not been tested in the market
yet.
Req. 4
The information available for the three years indicates that the settlements made during
2005 and 2006 were lower than the warranty expense that has been recognized for
each of these years. This, combined with the increase in warranty expense as a
percentage of net revenue, has resulted in increasing the balance of the Accrued
warranty account from $40,997 at the end of 2005 to $64,898 at the end of 2006. The
ratio of warranty expense to net sales should be reviewed in 2007 in light of the
settlements that are made during that year.
Req. 5
Extended Warranty Deferred Revenue, 2005
Warranty revenue
178,381
23,193
87,806
$178,381 + 23,193 X = $87,806;
Beginning balance
Unearned revenue
Ending balance
X = $113,768
Extended Warranty Deferred Revenue, 2006

Warranty revenue
$87,806 + 10,885 Y = $40,039;
87,806
10,885
Beginning balance
Unearned revenue
40,039
Ending balance
Y = $58,652
Extended warranty deferred revenue (L)......................

Extended warranty revenue (+R +SE)....................
To recognize revenue related to extended warranties.
58,652
58,652
10-37
AP105
The contractual agreement that General Mills entered into allows them to reclassify the
current borrowings as non-current debt. Management would want to do this in order to
improve the current ratio and other measures of liquidity. A financial analysts answer
would not be different. A financial analyst would not be concerned because the
company has the ability to extend the maturity dates of the debt beyond the current
year.
AP106
Req. 1
Accounts payables and accrued liabilities refer to amounts that should be paid to
suppliers of goods and services in the near future. The account balance increases when
raw materials and merchandise are purchased on account, and decreases when
payments are made.
Customers deposits represent an amount of cash (or other assets) received by the
company as a deposit on future delivery of goods and/or services. The account balance
increases with the receipt of cash from customers in advance, and decreases when
goods are delivered and services are provided to these customers.
Dividends payable reflects an amount of dividends that has been declared by the
companys board of directors but has not been paid yet. The account balance increases
when the board of directors declares dividends and is reduced when cash is paid to
shareholders.
Deferred warranty plan revenue represents collections from customers who purchased
specific plans that extend the warranty on the purchased goods beyond d the original
warranty period offered by the products manufacturer. The account balance increases
when additional plans are sold to customers and is reduced when the deferred warranty
plan expires over time.
Income taxes payable refers to an outstanding obligation to pay income taxes to the
taxation authorities based on the current periods taxable income.
Future income liabilities result from temporary differences caused by reporting revenues
and expenses on the companys income statement in conformity with GAAP and on the
tax return in accordance with the Income Tax Act. The account balance increases when
temporary differences in accounting for specific revenue and expense items lead to
reporting income before income taxes that exceeds taxable income for the period. The
account balance is reduced when the reverse occurs.
10-38
AP106 (continued)
Req. 2
Deferred warranty plan revenue, January 1, 2006..........
Collections from customers in advance during 2006......
Warranty revenue earned during 2006............................
Deferred warranty plan revenue, December 31, 2006....
$10,299 + X - $9,818 = $9,971;
$10,299
X
(9,818)
$9,971
Collections from customers = $9,490
Deferred Warranty Plan Revenue

Warranty payments
9,818
10,299 Beginning balance

Warranty expense
X
9,971 Ending balance
Journal entries
During 2006:
Cash (+A)........................................................................
Deferred warranty plan revenue (+L)..........................
Sale of extended warranty plans to customers.
Deferred warranty plan revenue (L)..............................
Warranty revenue (+R +SE)....................................
To recognize warranty revenue based on periodic
expiration of warranty plans during the year.
9,490
9,490
9,818
9,818
Req. 3
Retained earnings (SE).................................................
Dividends payable (+L)...............................................
Declaration of dividends payable to shareholders.
14,725
Dividends payable (L)....................................................

Cash (A)....................................................................
Payment of cash dividends to shareholders.
$3,844 + $14,725 X = $4,424
14,145
14,725
14,145
10-39
AP107
Req. 1 and 2
Current ratio
Accounts payable turnover
Average age of payables (days)
2006
0.99
4.41
83
2005
0.97
6.03
61
2004
0.84
5.52
66
2003
0.78
5.34
68
2002
1.09
5.20
70
2001
0.89
The current ratio fluctuated between 0.78 and 1.09 during the six-year period and
showed signs of improvement over the last four years, 2003-2006. While a current ratio
that exceeds 1.0 provides a margin of safety for short-term creditors, Imperial Oils
current ratio should be compared to the norm for the industry for a better assessment of
its current level.
The accounts payable turnover ratio shows an increasing trend between 2002 and
2005, indicating that Imperial Oil paid its trade supplies over shorter periods of time, as
evidenced by the decreasing trend in the average age of payables. However, the ration
dropped significantly in 2006 with a corresponding increase in the average age of
payables. While the increase in the average age of payables benefits the company from
a cash management perspective, the companys trade suppliers may not be pleased
with this change, especially if the credit period granted by the suppliers in shorter than
the average age of payables.
Req. 3
The use of the LIFO inventory costing method affects the cost of ending inventory and
the cost of goods sold, but it does not affect the cost of purchases. Therefore, if Imperial
Oil used the FIFO inventory costing method, then the ending inventory would be much
larger than the amount reported under LIFO, as show in the table below.
Current assets
Adjustment of inventory from
LIFO to FIFO
Adjusted current assets
Adjusted current ratio
2006
$5,309
2005
$4,999
2004
$3,897
2003
$2,628
2002
$2,980
2001
$2,685
506
5,815
1.09
941
5,940
1.15
797
4,694
1.01
1,013
3,641
1.07
1,429
4,409
1.61
1,509
4,194
1.39
The switch from LIFO to FIFO increases the current assets and the current ratio for
each of the six years. However, both the accounts payable turnover ratio and the
average age of payables would not be affected by the inventory costing method.
Since the FIFO cost provides a better indicator of the current value of inventory
compared to LIFO cost, the current ratio under FIFO provides a better indication of the
margin of safety for short-term creditors. But, the choice of an inventory costing method
does not affect the efficiency of managing accounts payable.
AP108
10-40
a. Decrease
b. Decrease
c. Decrease
d. Remain the same (financing activity)
e. Decrease
f. Remain the same
g. Decrease
h. Decrease
i. Remain the same
AP109
Req. 1
2007 $72,000 x 35% = $25,200
2008 $87,000 x 35% = $30,450
Expense:
2007 $8,000 x 35% = $2,800 (originating; a credit a liability) *
2008 $8,000 x 35% = $2,800 (reversing; a debit eliminates the liability)
*This is a future income tax liability (a credit) because the related expense is
deducted in the tax return before it is deducted in the income statement. Therefore,
there will be a lower future tax deduction and this will result in more income tax in
the future on other taxable amounts.
Revenue
2008 $6,000 x 35% = $2,100 (originating; a credit a liability) *
2009 $6,000 x 35% = $2,100 (reversing; a debit eliminates the liability)
*This is a future income tax liability (a credit) because it is related to revenue that is
included in the tax return after it is included in the 2008 income statement.
Therefore, at the end of 2008 there is an income tax liability related to this temporary
difference.
Net future income tax amounts:
2007 $2,800 (originating liability; a credit)
2008 $2,800 (reversing; a debit) - $2,100 (originating; a credit) = $700, net debit
2009 $2,100 (reversing; a debit)
10-41
AP109 (continued)
Req. 2
Entries to record income taxes:
2007
Income tax expense (+E SE).................... 28,000 *
Future income tax liability (Req. 1) (+L).....
2,800 o
Income tax payable *** (+L)........................
5,040
Cash **** (A) ............................................
20,160
2008
29,750 **
700 r
6,090
24,360
* $25,200 + $2,800 = $28,000

** $30,450 $700 = $29,750
*** Income taxes payable per Req. 1 times 20%
**** Income taxes payable per Req. 1 times 80%
o
= originating; r = reversing
Req. 3
Reporting:
Income statement:
Income tax expense (note)..........................................
2007
2008
$28,000
$29,750
Note: In practice, the current and future portions of income tax expense would be
disclosed for each year.
Balance sheet:
Income tax payable (Req. 2)....................................
Future income tax liability (Req. 1)..........................
5,040
2,800
6,090
2,100 *
*$2,800 $700 = $2,100. This amount will reverse in 2009.

Req. 4
A future income tax amount will be paid at some point (perhaps, indefinite) in the future
whereas current income taxes payable will be paid on a specific date. As a result, most
analysts see the nature of these two liabilities as being somewhat different. To illustrate,
some companies with an expanding amount of plant and equipment may be able to
defer future income taxes indefinitely if the amount of new future income taxes on
recently purchased assets exceeds the amount of the reversal on older assets. In other
words, the future income tax liability is constantly increasing. In this case, analysts
would not include the amount of future income taxes in their projections of cash flows.
10-42
CASES AND PROJECTS

FINDING AND INTERPRETING FINANCIAL INFORMATION
CP101
(The solution is based on the annual report for Van Houtte Inc. for the fiscal year ended
March 31, 2007.)
Req. 1
Income taxes payable, March 31, 2007:
$14,097,000
Source: Balance sheet.

Req. 2
The company uses the indirect method to determine cash flow from operating activities.
The increase in accounts payable and accrued liabilities affected cash flow from
operating activities favourably by $3,139,000 for the fiscal year ended March 31, 2007.
(Note: Van Houtte discloses accounts payable as part of accounts payable and
accrued liabilities.)
Source: Note 17: Additional information on cash flows
Req. 3
Long-term debt, including the current portion is $52,480,000 ($52,073,000 + 1,407,000)
at March 31, 2007.
Req. 4
March 31, 2007
Future income tax assets
Current
Noncurrent
Future income tax liabilities noncurrent
$1,571,000
3,228,000
1,201,000
Source: Balance sheet

Req. 5
Post-retirement or defined benefit pension programs
The balance sheet includes an amount of $3,135 under Other liabilities. This liability is
related to post employment and retirement benefits as disclosed in Note 12 to the
financial statements.
10-43
CP102
(The solution is based on the annual report for The Forzani Group Ltd. (FGL) for the
fiscal year ended January 28, 2007.)
Req. 1
Accounts payable and accrued liabilities, January 28, 2007:
$230,977,000

Req. 2
The company uses the indirect method to determine cash flow from operating activities.
The decrease in accounts payable and accrued liabilities decreased cash flow from
operating activities by $19,951,000 for the fiscal year ended January 28, 2007.
Source: Note 7 of the annual report: Supplementary Cash Flow Information.
Req. 3
Long-term debt including the current portion is $60,385,000 ($58,303,000 + 2,082,000)
as at January 28, 2007.
Req. 4
Note 12 of the annual report discloses information about guarantees and contingencies.
Contingencies consist of certain claims and lawsuits that have been brought against the
Company in the ordinary course of business. The note states that they it is
managements opinion that contingent liabilities are adequately covered by insurance
and will not materially affect the companys financial position.
10-44
CP103
(The solution is based on the annual report for Van Houtte Inc. for the fiscal year ended
March 31, 2007 and the annual report for The Forzani Group Ltd. (FGL) for the fiscal
year ended January 28, 2007. All dollar amounts are in thousands.)
Req. 1
Current Ratio (at the fiscal year-end date for each company):
Current Ratio = CA / CL
$ 96,093 / $ 60,620 = 1.59
$393,196 / $233,059 = 1.69
Van Houtte:
FGL:
Source: Balance sheet of each company.

Req. 2
(i) Accounts Payable Turnover Ratio (for the most recent fiscal year for each company):
Van Houtte
$198,000
$36,718.5 a
5.39
Cost of Goods Sold

Average Accounts Payable
= A/P Turnover Ratio
FGL
$812,363
$237,635 b
3.42
($34,434 + $39,003) / 2 = $36,718.5

($244,293 + $230,977) / 2 = $237,635
Note: Accounts payable includes accrued liabilities in each case.
b
Source: Income statement and balance sheet of each company.

(ii) Long-term debt including the current portion reported under current liabilities:
Van Houtte:
$52,480 ($52,073 + $1,407)
FGL:
$60,385 ($58,303 + $2,082)
Source: Balance sheet of each company.
10-45
CP103 (continued)
Req. 3
The current ratios for Van Houtte and FGL are comparable. They are both lower than 2
(a common benchmark for assessing liquidity).
Van Houttes accounts payable turnover ratio is higher than FGLs. However, as noted in
the textbook, a high accounts payable turnover ratio (although usually suggestive of
good liquidity) might instead imply an inefficient use of resources.
A more stringent measure of liquidity is the quick ratio, which is often defined as:
(Cash and cash equivalents + Accounts receivable) / Current liabilities
The quick ratio as at each companys most recent fiscal year-end date is:
Van Houtte: ($4,884 + $48,459 +$8,320) / $60,620 = 1.02
FGL:
($22,758 + $65,543) / $233,059 = 0.38
Van Houttes quick ratio is more than double that of FGL, indicating that Van Houttes
liquidity is much better than that of FGL.
From the foregoing calculations and brief discussion one might conclude that FGLs
liquidity is poor, especially when compared to that of Van Houtte. One must be careful
before reaching such a conclusion. For example, the company continues to generate
positive cash flow from operating activities and has access to significant credit facilities,
as explained in Managements Discussion and Analysis section of the annual report.
10-46
FINANCIAL REPORTING AND ANALYSIS CASES

CP104
Req. 1
The cost of a free ticket could be measured in terms of what economists call
opportunity cost. If providing free tickets meant that there were not sufficient seats
available to sell to paying passengers, the opportunity cost would be the lost revenue
from not having extra seats. The incremental cost approach uses an estimate of cash
expenditures to measure the liability associated with a frequent flyer program, but many
analysts probably prefer a broader definition that would reflect the total impact of the
program on the profitability of the company (i.e., the cost of lost revenues).
Unfortunately, opportunity costs are very difficult to measure.
Another option would be to use the cost of providing the service using an estimated cost
per mile/point. This could be difficult to estimate.
Req. 2
Southwest would debit an expense account because of the matching concept. The cost
of a frequent flyer program is an expense that should be matched with current revenue,
i.e., when a customer earns points towards future flights.
CP105
Req. 1 and 2
Accounts payable turnover*
Inventory turnover
Accounts receivable turnover
2006
11.6
5.4
37.5
2005
13.2
5.4
39.6
2004
12.6
5.7
43.2
2003
11.6
5.6
38.6
Average age of payables
31.5
27.7
29.0
31.5
Days supply of inventory

Average collection period
Average period to convert inventory to cash
Cash conversion cycle
67.6
9.7
77.3
45.8
67.6
9.2
76.8
49.1
64.0
8.4
72.4
43.4
65.2
9.5
74.7
43.2
* Cost of purchases = Cost of goods sold + Ending inventory Beginning inventory
The three turnover ratios show some variations in their levels during the four-year
period, 2003-2006. But the variations are relatively small, which reflects stability in the
companys management of its cash.
10-47
CP106
Students will discuss a variety of issues. In class, we like to explore such topics as
corporate responsibility for the environment and strategies that focus on maintaining
clean operations versus costly clean-up. From a financial reporting perspective, we
emphasize the difficulty of measuring future environmental costs and the challenge of
providing appropriate disclosure of any contingent liabilities in the notes to the financial
statements.
CP107
RIM summarizes the history of the litigation award to NTP for patent infringement in
Note 15. A more comprehensive information set can be obtained, however, by reading
the notes from 2003 until 2006 accompanying this disclosure. In 2003, RIM disclosed,
in Note 14, a litigation expense of $4.9 million related to the NTP lawsuit as well as
compensatory damages for $23.1 million assessed by a U.S. jury. In total, the charges
related to the NTP lawsuit contributed $27.8 million to the overall Accrued litigation and
related expenses which totaled $50.7 million. RIM also disclosed that it had filed an
appeal and that the judge had determined that the rate of interest accruing on the
compensatory damages was the prime rate.
To make sure RIM would pay if the long appeal process results in affirming the verdict,
the company was ordered to create an interest-bearing account and make quarterly
deposits equal to the royalties RIM would have paid to NTP. The judge ruled that RIM
was also liable for pre-judgment interest on the royalties not paid to NTP from the point
at which RIM started earning revenue from NTP's technology, compounded quarterly at
the prime rate. By May 2003, the U.S. court ruled that the royalty rate for any postjudgment compensation to NTP would increase by 50%, from 5.7% to 8.55% and that
RIM had to pay 80% of NTP's attorney's fees incurred up to that date. RIM then
recorded an additional provision of $13.5 million in the fourth quarter of fiscal year 2003
for enhanced post-judgment compensation, as well as $5 million for the attorney's fees.
RIM also made a provision to pay interest on the post-judgment compensation. In total,
the company recorded an additional expense of $22.5 million that included not only the
amounts already mentioned but also pre-judgment interest and additional estimated
future costs of litigation in this matter. RIM also disclosed that the total expense to date
was $58.2 million of which $7.5 million was disbursed by the end of fiscal year 2003.
RIM noted that the ultimate cost could be materially different from the provision.
Sure enough by the first quarter of fiscal 2004 (as reported in Note 16 for fiscal year
2004) the company had added $7.5 million to the provision. It classified $6.3 million as
restricted cash and reported on a final order to pay monetary damages to NTP of $53.7
million. RIM appealed the judges decision but continued to add to expenses each
quarter to provide for post-judgment compensatory damages payable to NTP should the
initial verdict be affirmed. By year end the provision recorded was $35.2 million.
10-48
CP 107 (continued)
In 2005, RIM disclosed in Note 15 the progress of this litigation. The Company
disclosed quarterly additions to the bank account in which the post-judgment royalties
were deposited. The appeal results were not conclusive as they revealed procedural
errors, but not substantive errors, and the appeal court left it to the district court to
decide what effect this should have on the amount payable to NTP. RIM went on to
report that it had signed a binding agreement with NTP on March 16, 2005 to pay NTP
$450 million in return for unrestricted use of their patented technology and resolving all
previous claims. RIM also reported the various components of a total incremental
expense of $352.6 million.
On March 3, 2006, RIM and NTP jointly announced that they settled the lawsuit. RIM
paid NTP $612.5 million in to settle all claims against RIM. As at February 26, 2005,
RIM had accrued $450.0 million in respect of the NTP litigation. As the final settlement
amount paid on March 3, 2006 was $612.5 million, RIM recorded an additional charge
to its 2006 income in the amount of $162.5 million.
Req. 2
Journal entry to record the payment of $612.5 million to NTP on March 3, 2006:
Litigation expense (E SE) ......................................... 162,500,000
Accrued litigation NTP (L)............................................. 450,000,000
Cash (A)......................................................................
612,500,000
The three amounts are disclosed in Note 15 to the financial statements.

Req. 3
Yes, RIM does report other litigation in note 12 to its financial statements for the year
ended March 4, 2006. It has not provided estimates of future liabilities because RIM's
managers claim they cannot determine what these amounts may be.
10-49
CRITICAL THINKING CASES

CP108
a.
b.
c.
d.
e.
f.
Current Ratio
Decrease
Increase
Increase
Increase
No Change
Increase
Working Capital
No Change
Increase
Increase
No Change
No Change
Increase
Liquidity
Short-term improvement
Improvement
Improvement
No Change
Improvement
No Change*
*Employees would be paid in any case. However, the net result is that current
liabilities are reduced.
CP109
While the question focuses on ethics, we believe that students should analyze the
proposed strategy. Refusing to accept merchandise would result in a higher current ratio
(assuming that it is currently greater than one). If the merchandise is purchased on
credit, a constant amount added to current liabilities and current assets results in a
lower current ratio. Management could actually improve the current ratio by shipping
merchandise to customers because it would record accounts receivable based on
selling price and reduce inventory based on cost.
There are legitimate ethical issues raised when management alters the operations of a
business to achieve an accounting result. Students should understand, however, that
management in many organizations engage in behaviour designed to affect accounting
reports, e.g., asking or requiring employees to work overtime in order to ship
merchandise that has been ordered at year-end.
We have included strategies for affecting ratios as well as reported profits. We have
found some students believe some strategies are ethical but others are not. In such
situations, we have been able to have very meaningful discussions concerning
situational ethics.
10-50
CP1010
Strong cash flows are associated with financial strength. A company with good cash
flows often does not need a large amount of working capital because its ability to
generate cash provides it with an appropriate level of liquidity.
Cash flow represents a stream of new resources. Working capital is an inventory of
resources. Most analysts would prefer to see strong cash flows rather than a large
amount of working capital.
CP1011
The class discussion may take various forms. It is important to emphasize the purpose
of this assignment, namely that it is possible to have a consensus in accounting on an
issue in the abstract but often there is considerable disagreement when the question is
more specific.
FINANCIAL REPORTING AND ANALYSIS TEAM PROJECT
CP1012
The response to this case will depend on the companies selected by the students.
Final version: May 18, 2008
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Chapter 10

Reporting and Interpreting Current Liabilities

A liability is initially measured at its current cash equivalent amount. Conceptually,

Financial Accounting, 3ce, Libby, Libby, Short, Kanaan, Gowing

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The current ratio is the percentage relationship of current assets to current

Deferred revenue (usually called unearned revenue or revenue collected in

Financial Accounting, 3ce, Libby, Libby, Short, Kanaan, Gowing

2008 McGraw-Hill Ryerson Limited. All rights reserved.

Financial Accounting, 3ce, Libby, Libby, Short, Kanaan, Gowing

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Authors Recommended Solution Time

Financial Accounting, 3ce, Libby, Libby, Short, Kanaan, Gowing

2008 McGraw-Hill Ryerson Limited. All rights reserved.

Title of Liability Account

Amount of Current Liability

Unearned passenger revenue

Deposits from customers

$150 [=$10,000 x .09 x (2/12)]

Unearned subscription revenue

None, assuming that the amount

None, because the bill relates to

Financial Accounting, 3ce, Libby, Libby, Short, Kanaan, Gowing

2008 McGraw-Hill Ryerson Limited. All rights reserved.

(b) Current ratio = $170,100 $109,100 = 1.56

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Financial Accounting, 3ce, Libby, Libby, Short, Kanaan, Gowing

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Note Payable + $4,500

Dec. 31, 2007

Interest Payable + $75

Interest Expense $75

April 30, 2008

Note Payable $4,500

Interest Expense $150

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Financial Accounting, 3ce, Libby, Libby, Short, Kanaan, Gowing

2008 McGraw-Hill Ryerson Limited. All rights reserved.

Jan. 10, 2008

Accounts Payable +$18,000

March 1, 2008 Cash + $100,000

Note Payable + $100,000

GST Payable + $1,800

$108,000 [$100,000 + ($100,000 x 8%)]

Financial Accounting, 3ce, Libby, Libby, Short, Kanaan, Gowing

2008 McGraw-Hill Ryerson Limited. All rights reserved.

Financial Accounting, 3ce, Libby, Libby, Short, Kanaan, Gowing

2008 McGraw-Hill Ryerson Limited. All rights reserved.

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Straight-line amortization ($75,000 3)............

2007: $8,960 + $3,500 = $12,460.

Financial Accounting, 3ce, Libby, Libby, Short, Kanaan, Gowing

2008 McGraw-Hill Ryerson Limited. All rights reserved.

Financial Accounting, 3ce, Libby, Libby, Short, Kanaan, Gowing

2008 McGraw-Hill Ryerson Limited. All rights reserved.

2008 McGraw-Hill Ryerson Limited. All rights reserved.

Financial Accounting, 3ce, Libby, Libby, Short, Kanaan, Gowing

2008 McGraw-Hill Ryerson Limited. All rights reserved.

Accounts Payable $12,420

Note Payable + $40,000

Accounts Payable $17,820

Deposit on Trailer + $100