Chapter 12
Financial Liabilities and Provisions

True / False Questions
 
1. Conceptually, liabilities constitute a present obligation as a result of a past event and entail an expected future sacrifice of assets or services. 
TRUE

Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 12-01 Define the meaning of a liability and distinguish between financial; non-financial liabilities and constructive obligations.
Topic: 12-01 Liability Definition and Categories
 
2. Under ASPE, only legal obligations are recognized. 
TRUE

Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 12-01 Define the meaning of a liability and distinguish between financial; non-financial liabilities and constructive obligations.
Learning Objective: 12-08 Compare and contrast the reporting and measurement of liabilities under ASPE and IFRS.
Topic: 12-65 Looking Ahead
 
3. A reasonable expectation on the part of a company's stakeholders arising from a company's past practices or behaviour may constitute a constructive obligation in certain instances. 
TRUE

Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 12-01 Define the meaning of a liability and distinguish between financial; non-financial liabilities and constructive obligations.
Topic: 12-02 Constructive Obligations

4. A contingency may become a provision if the likelihood of the contingent event greatly increases. 
TRUE

Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 12-01 Define the meaning of a liability and distinguish between financial; non-financial liabilities and constructive obligations.
Learning Objective: 12-04 Explain how provisions are measured.
Topic: 12-29 Contingency
 
5. Under IFRS, most financial liabilities are valued at Fair Value. 
FALSE

Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 12-01 Define the meaning of a liability and distinguish between financial; non-financial liabilities and constructive obligations.
Topic: 12-03 Categories of Liabilities
Topic: 12-04 Categories of Financial Liabilities
 
6. An improvement to a company's credit rating under IFRS will lead to a reduction in the carrying amount of any financial liabilities and a gain being reported in OCI. 
FALSE

Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 12-01 Define the meaning of a liability and distinguish between financial; non-financial liabilities and constructive obligations.
Topic: 12-04 Categories of Financial Liabilities
 
7. Loan guarantees are only recorded if they are likely to be paid. 
TRUE

Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 12-03 Account for common financial liabilities.
Topic: 12-07 Common Financial Liabilities

8. Accrued liabilities made due to routine operating expenses are not normally discounted. 
TRUE

Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 12-01 Define the meaning of a liability and distinguish between financial; non-financial liabilities and constructive obligations.
Topic: 12-06 Discounting
 
9. For a small population, the best estimate for the amount of a provision that must be recognized is the expected value of the possible outcomes. 
FALSE

Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 12-02 Classify financial liablilites and explain the recognition and measurement requirements initially and in susequent reporting periods.
Topic: 12-06 Discounting
 
10. Under IFRS, provisions are always recorded at their expected value. 
FALSE

Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 12-02 Classify financial liablilites and explain the recognition and measurement requirements initially and in susequent reporting periods.
Topic: 12-06 Discounting
 
11. For a large population, the best estimate for the amount of a provision that must be recognized is the most likely outcome with respect to the expected value and cumulative probabilities. 
FALSE

Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 12-02 Classify financial liablilites and explain the recognition and measurement requirements initially and in susequent reporting periods.
Topic: 12-06 Discounting

12. Under ASPE, contingent liabilities which are more likely than not, are accrued at the lowest end of the range. 
TRUE

Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 12-08 Compare and contrast the reporting and measurement of liabilities under ASPE and IFRS.
Topic: 12-65 Looking Ahead
 
13. Contingent assets may be recorded under ASPE but not under IFRS. 
TRUE

Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 12-01 Define the meaning of a liability and distinguish between financial; non-financial liabilities and constructive obligations.
Learning Objective: 12-08 Compare and contrast the reporting and measurement of liabilities under ASPE and IFRS.
Topic: 12-65 Looking Ahead
 
14. Executory contracts seldom require a journal entry, while onerous contracts do. 
TRUE

Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 12-05 Illustrate various examples of provisions and explain issues related to timing of recognition.
Topic: 12-32 Examples of Provisions
 
15. Discounting is not required when the time value of money is immaterial or if the amount and timing of cash flows is highly uncertain. 
TRUE

Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 12-02 Classify financial liablilites and explain the recognition and measurement requirements initially and in susequent reporting periods.
Topic: 12-06 Discounting

16. Financial liabilities are initially recognized at fair value and at cost, amortized cost or fair value post-acquisition. 
TRUE

Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 12-01 Define the meaning of a liability and distinguish between financial; non-financial liabilities and constructive obligations.
Learning Objective: 12-02 Classify financial liablilites and explain the recognition and measurement requirements initially and in susequent reporting periods.
Topic: 12-04 Categories of Financial Liabilities
 
17. A company decides to relocate a group from a discontinued business segment to a division with ongoing operations. The expenses incurred in doing so would qualify as a restructuring charge. 
FALSE

Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 12-05 Illustrate various examples of provisions and explain issues related to timing of recognition.
Topic: 12-32 Examples of Provisions
 
18. Under the warranty expense approach, there should be no income statement effects for warranty repairs performed after the year of sale (assuming that accrued warranty expenses and expenditures equal one another). 
TRUE

Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 12-01 Define the meaning of a liability and distinguish between financial; non-financial liabilities and constructive obligations.
Learning Objective: 12-05 Illustrate various examples of provisions and explain issues related to timing of recognition.
Topic: 12-32 Examples of Provisions

19. Under the warranty revenue approach, there should be no income statement effects for warranty repairs performed after the year of sale (assuming that accrued warranty expenses and expenditures equal one another). 
FALSE

Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 12-01 Define the meaning of a liability and distinguish between financial; non-financial liabilities and constructive obligations.
Learning Objective: 12-05 Illustrate various examples of provisions and explain issues related to timing of recognition.
Topic: 12-32 Examples of Provisions
 
20. An onerous contract is one where the unavoidable costs of meeting the contract may or may not exceed the benefits derived from the contract. 
FALSE

Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 12-02 Classify financial liablilites and explain the recognition and measurement requirements initially and in susequent reporting periods.
Topic: 12-32 Examples of Provisions
 
21. A lawsuit in progress wherein the defendant will probably be found guilty would likely be accounted for as a provision. 
TRUE

Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 12-04 Explain how provisions are measured.
Learning Objective: 12-05 Illustrate various examples of provisions and explain issues related to timing of recognition.
Topic: 12-33 Lawsuits
 
22. Warranties provisions may arise from legal or constructive obligations. 
TRUE

Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 12-04 Explain how provisions are measured.
Learning Objective: 12-05 Illustrate various examples of provisions and explain issues related to timing of recognition.
Topic: 12-37 Warranty

23. Once a company has formally decided to restructure its operations, a provision must be made for the restructuring. 
FALSE

Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 12-05 Illustrate various examples of provisions and explain issues related to timing of recognition.
Topic: 12-36 Restructuring
 
24. Loyalty points are provided (accrued) for and reversed once the points are redeemed. 
TRUE

Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 12-03 Account for common financial liabilities.
Learning Objective: 12-05 Illustrate various examples of provisions and explain issues related to timing of recognition.
Topic: 12-43 Loyalty Programs
 
25. Self-insurance costs for expected losses must never be provided for. 
FALSE

Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 12-04 Explain how provisions are measured.
Topic: 12-46 Self-Insurance
 
26. Current liabilities are usually discounted. 
FALSE

Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 12-03 Account for common financial liabilities.
Topic: 12-06 Discounting

27. A decline in value of a company's reporting currency relative to the foreign currency in which it has payables will result in a foreign exchange gain on the reporting company's books. 
FALSE

Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 12-03 Account for common financial liabilities.
Topic: 12-21 Foreign Currency Payables
 
28. Adjustments to fair value relating to FVTPL liabilities will always flow through earnings. 
TRUE

Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 12-04 Explain how provisions are measured.
Topic: 12-04 Categories of Financial Liabilities
 
29. Loan guarantees must be provided for; the amount of the provision is the probability of payout multiplied by the fair value of the loan guarantee. 
TRUE

Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 12-04 Explain how provisions are measured.
Topic: 12-10 Loan Guarantees
 
30. A company may reclassify a current financial liability to a long-term one only if there is a contractual agreement in place by the reporting date to replace the financing. 
TRUE

Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 12-02 Classify financial liablilites and explain the recognition and measurement requirements initially and in susequent reporting periods.
Learning Objective: 12-03 Account for common financial liabilities.
Learning Objective: 12-07 Demonstrate how liabilities are presented and disclosed in the statements.
Topic: 12-59 Short-Term Obligations with an Arrangement for Refinancing

31. Debt issue costs may be expensed or included in the cost of the debt. 
TRUE

Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 12-02 Classify financial liablilites and explain the recognition and measurement requirements initially and in susequent reporting periods.
Learning Objective: 12-03 Account for common financial liabilities.
Topic: 12-04 Categories of Financial Liabilities
 
32. Normal business risks that are insured must be provided for. 
FALSE

Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 12-04 Explain how provisions are measured.
Topic: 12-46 Self-Insurance
 
33. An administrative fee pertaining to an unsuccessful loan application is to be immediately expensed. 
TRUE

Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 12-03 Account for common financial liabilities.
Topic: 12-04 Categories of Financial Liabilities
 
34. Capitalization of borrowing costs on qualifying assets will continue even if work on the asset has temporarily ceased. 
FALSE

Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 12-04 Explain how provisions are measured.
Learning Objective: 12-05 Illustrate various examples of provisions and explain issues related to timing of recognition.
Topic: 12-29 Contingency

35. Accounts payable should include only obligations directly related to the primary and continuing operations of an entity. 
TRUE

Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 12-01 Define the meaning of a liability and distinguish between financial; non-financial liabilities and constructive obligations.
Learning Objective: 12-02 Classify financial liablilites and explain the recognition and measurement requirements initially and in susequent reporting periods.
Topic: 12-08 Accounts Payable
 
36. Capitalization of borrowing costs on qualifying assets is mandatory under both IFRS and ASPE. 
FALSE

Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 12-06 Explain the impact of discounting liabilities.
Learning Objective: 12-08 Compare and contrast the reporting and measurement of liabilities under ASPE and IFRS.
Topic: 12-65 Looking Ahead
 
37. Under IFRS, a loss contingency must be credited to a liability account only if the occurrence of the contingent event is probable and if the amount of loss can be reasonably estimated. 
FALSE

Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 12-01 Define the meaning of a liability and distinguish between financial; non-financial liabilities and constructive obligations.
Learning Objective: 12-04 Explain how provisions are measured.
Learning Objective: 12-08 Compare and contrast the reporting and measurement of liabilities under ASPE and IFRS.
Topic: 12-29 Contingency

38. A gain contingency will usually not be recorded in the accounts and reported in the financial statements even though its occurrence is probable. 
TRUE

Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 12-01 Define the meaning of a liability and distinguish between financial; non-financial liabilities and constructive obligations.
Learning Objective: 12-04 Explain how provisions are measured.
Topic: 12-29 Contingency
 
39. Under ASPE, disclosure in the footnotes to the financial statements is the only way to properly report contingent losses. 
FALSE

Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 12-01 Define the meaning of a liability and distinguish between financial; non-financial liabilities and constructive obligations.
Learning Objective: 12-04 Explain how provisions are measured.
Learning Objective: 12-08 Compare and contrast the reporting and measurement of liabilities under ASPE and IFRS.
Topic: 12-65 Looking Ahead
 
40. Under IFRS, a continuity schedule must be provided for both provisions and contingencies. 
FALSE

Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 12-04 Explain how provisions are measured.
Learning Objective: 12-08 Compare and contrast the reporting and measurement of liabilities under ASPE and IFRS.
Topic: 12-29 Contingency
Topic: 12-32 Examples of Provisions

Multiple Choice Questions

41. A brewing company operating in an Ontario city experiencing water shortages received its water bill for December 2013, on December 31, 2013. The bill ($8,000) represents the cost of water used in December to make its product. The company will not publish the 2013 financial statements until February 2014. Therefore, the adjusting entry as of December 31, 2013 includes which of the following? 
A. cr. utilities payable $8,000
B. cr. cash $8,000
C. cr. utilities expense $8,000
D. no adjusting entry needed because the bill will not be paid until January 2014

Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 12-01 Define the meaning of a liability and distinguish between financial; non-financial liabilities and constructive obligations.
Topic: 12-38 Cost Deferral-Example
Topic: 12-40 Restoration and Environmental Obligations
 
42. A short-term note payable may include all of the following except: 
A. Trade notes payable.
B. Non trade notes payable.
C. A current portion of a long-term liability.
D. Unearned revenue.

Blooms: Remember
Difficulty: 2 Medium
Learning Objective: 12-03 Account for common financial liabilities.
Topic: 12-09 Notes Payable
 
43. Which of the following statements is correct? 
A. Under IFRS, contingencies may be accrued, but not under ASPE.
B. Litigation for which the company will probably be found guilty would normally be accrued as a provision.
C. Under IFRS, content gains should be recognized if they are reasonably certain to occur.
D. A contingency is more likely to require an accrual than a provision.

Blooms: Remember
Difficulty: 2 Medium
Learning Objective: 12-01 Define the meaning of a liability and distinguish between financial; non-financial liabilities and constructive obligations.
Learning Objective: 12-04 Explain how provisions are measured.
Topic: 12-29 Contingency

44. A firm sold $100,000 worth of goods during 2014. The firm extends warranty coverage on these goods. Historically, warranty costs have averaged 2% of total sales. During 2014, the firm incurred $1,000 to service goods sold in 2013 and $200 to service goods sold in 2014. What is warranty expense for 2014? 
A. $200
B. $1,200
C. $2,000
D. $3,200

Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 12-01 Define the meaning of a liability and distinguish between financial; non-financial liabilities and constructive obligations.
Learning Objective: 12-04 Explain how provisions are measured.
Topic: 12-39 Warranty as a Constructive Liability
 
45.  You are an investor and have just purchased a bond on July 1 which pays interest every March 1 and September 1. When you receive your first interest cheque, you will receive and have earned how many months interest?

 	Received	Earned	
1	6	6	
2	6	2	
3	2	2	
4	4	4	
5	6	4	
 
A.  Choice 1 
B.  Choice 2 
C.  Choice 3 
D.  Choice 4 
E.  Choice 5 

Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 12-03 Account for common financial liabilities.
Learning Objective: 12-06 Explain the impact of discounting liabilities.
Topic: 12-58 Classification of Notes Payable

46. On November 7, 2014 local residents sued Brimley Corporation for excess chemical emissions that caused some of them to seek medical attention. The total lawsuit is $8,000,000. Brimley Corporation's lawyers believe that the lawsuit will be successful and that the amount to be paid to the residents will be $4,000,000. On its December 31, 2014 financial statements Brimley should: 
A. Accrue a provision loss of $8,000,000 with no financial statement disclosure necessary.
B. Accrue a provision loss of $4,000,000 and note disclose.
C. Do nothing as the lawsuit has not yet ended.
D. Simply disclose the details regarding the lawsuit in a note.

Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 12-01 Define the meaning of a liability and distinguish between financial; non-financial liabilities and constructive obligations.
Learning Objective: 12-04 Explain how provisions are measured.
Learning Objective: 12-05 Illustrate various examples of provisions and explain issues related to timing of recognition.
Topic: 12-33 Lawsuits
 
47. ABC Inc. has 50 pending lawsuits for which it may be found liable. The expected value (sum of the probabilities of the outcomes multiplied by their respective payouts) amounts to $100,000. However, the company's controller believes that the most likely outcome will be a payout of $120,000. Which of the following statements pertaining to the accrual of the provision is correct? 
A. There is a large population of lawsuits, so a provision of $100,000 must be accrued.
B. There is a large population of lawsuits, so a provision of $120,000 must be accrued.
C. There is a small population of lawsuits, so a provision of $100,000 must be accrued.
D. There is a small population of lawsuits, so a provision of $120,000 must be accrued.

Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 12-04 Explain how provisions are measured.
Learning Objective: 12-05 Illustrate various examples of provisions and explain issues related to timing of recognition.
Topic: 12-33 Lawsuits

48. Which one of the following items is not a liability? 
A. Accrued estimated warranty costs
B. Dividends payable in shares
C. Advances from customers on contracts
D. The portion of long-term debt due within one year

Blooms: Remember
Difficulty: 2 Medium
Learning Objective: 12-01 Define the meaning of a liability and distinguish between financial; non-financial liabilities and constructive obligations.
Topic: 12-01 Liability Definition and Categories
 
49. A company has commenced work on a non-cancellable fixed price construction contract in the amount of $6 million. Costs of $4 million have been incurred to date, and it is expected that $3.2 million in additional costs will have to be incurred to complete the contract. The company adheres to IFRS. Which of the following statements with respect to the contract are correct? 
A. There is a constructive obligation to finish the contract.
B. The company will have recognized $3 million in profit on the contract to date.
C. The company has a constructive obligation to accrue a loss of $1.2 million plus any previously recognized profit.
D. This is an onerous contract, so the company must accrue a loss of $1.2 million plus any previously recognized profit.

Blooms: Remember
Difficulty: 2 Medium
Learning Objective: 12-01 Define the meaning of a liability and distinguish between financial; non-financial liabilities and constructive obligations.
Learning Objective: 12-04 Explain how provisions are measured.
Learning Objective: 12-05 Illustrate various examples of provisions and explain issues related to timing of recognition.
Topic: 12-32 Examples of Provisions
 
50. Constructive obligations may arise from: 
A. Accrued Liabilities resulting from operations.
B. Warranty obligations.
C. Notes Payable.
D. Unearned Revenues.

Blooms: Remember
Difficulty: 2 Medium
Learning Objective: 12-01 Define the meaning of a liability and distinguish between financial; non-financial liabilities and constructive obligations.
Topic: 12-02 Constructive Obligations

51.  Jake Co. includes three coupons in each bag of dog food it sells. In return for fifteen coupons, customers receive a dog leash. The leashes cost Jones $2.00 each. Jake estimates that 50% of the coupons will be redeemed. Data for 2014 and 2015 are as follows:

 	2014	2015	
Bags of dog food sold	200,000	300,000	
Leashes purchased	50,000	50,000	
Coupons redeemed	100,000	50,000	

 The estimated liability for premiums for Jake Co. as at December 31, 2015 is:  
A.  $80,000. 
B.  $20,000. 
C.  $160,000. 
D.  $50,000. 

Blooms: Remember
Difficulty: 2 Medium
Learning Objective: 12-01 Define the meaning of a liability and distinguish between financial; non-financial liabilities and constructive obligations.
Learning Objective: 12-05 Illustrate various examples of provisions and explain issues related to timing of recognition.
Topic: 12-42 Coupons and Gift Cards
 
52. Long-term obligations (i.e., debts) that is callable for early payment: 
A. Must continue to be classified as a long-term liability by the debtor, if a provision of the debt covenant has been violated.
B. Must continue to be classified as a long-term liability in all situations.
C. Must be reported as current liabilities by the debtor if callable on demand.
D. Can be reported as current liabilities by the debtor only if callable because a provision of the debt covenant has been violated.

Blooms: Remember
Difficulty: 2 Medium
Learning Objective: 12-07 Demonstrate how liabilities are presented and disclosed in the statements.
Topic: 12-59 Short-Term Obligations with an Arrangement for Refinancing

53. A company had sales of $1 million. Coupons in the amount of $1 per $10 in sales were given to paying customers. History has shown that 50% of all coupons are redeemed. Which of the following statements is correct? 
A. A provision for $50,000 must be recognized.
B. A provision for $100,000 must be recognized.
C. A provision for $1 million must be recognized.
D. No provision is necessary.

Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 12-01 Define the meaning of a liability and distinguish between financial; non-financial liabilities and constructive obligations.
Learning Objective: 12-04 Explain how provisions are measured.
Learning Objective: 12-05 Illustrate various examples of provisions and explain issues related to timing of recognition.
Topic: 12-42 Coupons and Gift Cards
 
54. By law, a fleet of aircraft must be subject to a major overhaul every 5 years as part of its scheduled maintenance program. Which of the following statements is correct? 
A. An accrual should be made in each of the 5 years preceding the overhaul.
B. The costs of the overhaul should be expensed as incurred.
C. The cost of the overhaul should be deferred and amortized.
D. The estimated cost of the overhaul should be disclosed as part of a continuity schedule in the notes to the financial statements.

Blooms: Remember
Difficulty: 2 Medium
Learning Objective: 12-01 Define the meaning of a liability and distinguish between financial; non-financial liabilities and constructive obligations.
Learning Objective: 12-04 Explain how provisions are measured.
Learning Objective: 12-05 Illustrate various examples of provisions and explain issues related to timing of recognition.
Topic: 12-45 Repairs and Maintenance

55. Which of the following statements is correct? 
A. For companies that are self-insured, a provision must be established for events taking place prior to the reporting period if known.
B. There is no guidance for self-insurance under IFRS.
C. Contingent assets are only recorded when it is virtually certain that the benefits relating to the contingent assets will be received.
D. Contingent assets are only recorded when it is reasonably certain that the benefits relating to the contingent assets will be received.

Blooms: Remember
Difficulty: 2 Medium
Learning Objective: 12-04 Explain how provisions are measured.
Learning Objective: 12-05 Illustrate various examples of provisions and explain issues related to timing of recognition.
Topic: 12-29 Contingency
 
56. Information obtained prior to the issuance of the current period's financial statements of KG Company indicates that it is probable that, at the date of the financial statements, a liability will be incurred for obligations related to product warranties on products sold during the current period. During the past three years, product warranty costs have been approximately 1 1/2 percent of annual sales revenue. An estimated loss contingency should be: 
A. Neither accrued nor disclosed in the financial statements.
B. Recognized as an appropriation of retained earnings.
C. Accrued in the accounts and reported in the financial statements.
D. Disclosed in the financial statements but not accrued.

Blooms: Remember
Difficulty: 2 Medium
Learning Objective: 12-04 Explain how provisions are measured.
Learning Objective: 12-05 Illustrate various examples of provisions and explain issues related to timing of recognition.
Topic: 12-29 Contingency

57. Contingent liabilities will or will not become actual liabilities depending on: 
A. Whether they are probable and estimable
B. The degree of uncertainty
C. The present condition suggesting a liability
D. The outcome of a future event

Blooms: Remember
Difficulty: 2 Medium
Learning Objective: 12-04 Explain how provisions are measured.
Learning Objective: 12-05 Illustrate various examples of provisions and explain issues related to timing of recognition.
Topic: 12-29 Contingency
 
58. Under IFRS, which of the following will only require only a note disclosure as a contingency? 
A. Cash discounts given for early payment by customers; almost always taken
B. Remote chance of loss from a lawsuit in process
C. Probable claim for an income tax refund
D. Loss from an investment in equity securities that is certain

Blooms: Remember
Difficulty: 2 Medium
Learning Objective: 12-04 Explain how provisions are measured.
Learning Objective: 12-05 Illustrate various examples of provisions and explain issues related to timing of recognition.
Topic: 12-29 Contingency
 
59. Which of the following contingencies should be accrued in the accounts and reported in the financial statements? 
A. The estimated expenses of a one-year product warranty.
B. The company is forcefully contesting a personal injury suit and a loss is possible and reasonably estimable.
C. An accommodation endorsement involving a remote loss.
D. It is probable that the company will receive $50,000 in settlement of a lawsuit.

Blooms: Remember
Difficulty: 2 Medium
Learning Objective: 12-04 Explain how provisions are measured.
Learning Objective: 12-05 Illustrate various examples of provisions and explain issues related to timing of recognition.
Topic: 12-29 Contingency

60. KR Corporation was involved in a lawsuit with the Government alleging inadequate air pollution control facilities at its Glowworm plant site during 2013. At December 31, 2016, it appeared probable the Government would settle for approximately $150,000. This event should be recorded (i.e., recognized) in 2016 as a(n): 
A. Loss on the lawsuit (operating expense).
B. Unusual gain.
C. Prior period adjustment.
D. Unusual loss.
E. Disclosure of contingency loss only in a note.

Blooms: Remember
Difficulty: 2 Medium
Learning Objective: 12-04 Explain how provisions are measured.
Learning Objective: 12-05 Illustrate various examples of provisions and explain issues related to timing of recognition.
Topic: 12-33 Lawsuits
 
61. On January 1, 2014, DWW borrowed $400,000 cash and signed a one-year, 12 percent interest-bearing note payable. Assuming a 40 percent average income tax rate for DWW Corporation, the net effective interest rate on this note was: 
A. 4.8 percent.
B. 6.0 percent.
C. 7.2 percent.
D. 12.0 percent.

Blooms: Apply
Difficulty: 1 Easy
Learning Objective: 12-04 Explain how provisions are measured.
Learning Objective: 12-05 Illustrate various examples of provisions and explain issues related to timing of recognition.
Topic: 12-51 Example 1: No-Interest Note Payable
 
62. XYZ borrowed $60,000 for one year and signed an 18 percent, interest-bearing note payable. Assuming XYZ has an income tax rate of 45 percent, the net effective rate was: 
A. 8.1 percent.
B. 9.9 percent.
C. 11.7 percent.
D. 18 percent.

Blooms: Apply
Difficulty: 1 Easy
Learning Objective: 12-04 Explain how provisions are measured.
Learning Objective: 12-05 Illustrate various examples of provisions and explain issues related to timing of recognition.
Topic: 12-51 Example 1: No-Interest Note Payable

63. On September 1, 2012, Company B signed a $7,392, two-year non-interest-bearing note payable in full on August 31, 2014. Company B received $6,000 cash. What was the yield or effective rate of interest? 
A. 11 percent
B. 14 percent
C. 18 percent
D. 23 percent

Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 12-06 Explain the impact of discounting liabilities.
Topic: 12-51 Example 1: No-Interest Note Payable
 
64. VCR Company owed a $73,311 debt due on January 1, 2012. An agreement was reached to pay it off in three equal annual payments of $30,000 each, starting on December 31, 2012. The interest rate was 11 percent. The balance in the liability account of VCR Company on January 1, 2014 is (round annual payment to nearest $1): 
A. $27,026
B. $51,875
C. $73,311
D. $90,000

Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 12-06 Explain the impact of discounting liabilities.
Topic: 12-52 Example 2: Note Payable with Different Market and Stated Rate
 
65. XY Company owed a $45,489 due on January 1, 2015. An agreement was reached to pay it off in five equal annual payments, starting on December 31, 2015. The interest rate was 10 percent. The total amount of interest paid under the terms of the agreement was (round annual payment to nearest $1): 
A. $25,000
B. $22,745
C. $14,511
D. $6,000

Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 12-06 Explain the impact of discounting liabilities.
Topic: 12-52 Example 2: Note Payable with Different Market and Stated Rate

66. A firm sells products covered by a three-year warranty. From the past experience of the other firms in the industry, the firm expects to incur warranty costs equal to 1% of sales. Firm sales were $40,000 and $50,000 in 2013 and 2014 respectively. In 2014, the firm spent $200 to repair goods sold in 2013, and $300 to repair goods sold in 2014. The firm received no warranty servicing demands from customers in 2013, the firm's first year of operations. What is the balance in the warranty liability account on January 1, 2014? 
A. $400
B. $500
C. $300
D. $0

Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 12-06 Explain the impact of discounting liabilities.
Topic: 12-39 Warranty as a Constructive Liability
 
67. On January 1, 2014, JG purchased a machine and gave a $30,000 three-year, 8% note. The market or "going" interest rate was 12%. The annual interest payments are to be paid on each December 31. On January 1, 2014, JG should record the net liability amount determined as follows: 
A. Compute the present value of its face amount and the three $2,400 interest amounts by using a discount rate of 8%.
B. Compute the present value of its face amount and the three $2,400 interest amounts by using a discount rate of 12%.
C. Use its face amount, $30,000 plus the $7,200 interest.
D. Use its face amount, $30,000 minus $7,200 interest.

Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 12-06 Explain the impact of discounting liabilities.
Topic: 12-39 Warranty as a Constructive Liability

68. Ryan Company borrow $45,000 US when the exchange rate for US $1.00 is Cdn. $1.46. When the debt was repaid the exchange rate changes to US $1.00 = Cdn. $1.38. Ryan Company records the amount on the date of exchange as: 
A. A foreign exchange loss of $3,600.
B. A foreign exchange gain of $3,600.
C. A foreign exchange gain of $62,100.
D. A foreign exchange loss of $62,100.

Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 12-01 Define the meaning of a liability and distinguish between financial; non-financial liabilities and constructive obligations.
Learning Objective: 12-03 Account for common financial liabilities.
Topic: 12-21 Foreign Currency Payables

Short Answer Questions
 
69.  A company has been sued for damages as a result of illness caused to local residents due to the emission of highly toxic chemicals from its plant. The company's legal firm advises that it is probable that the company will lose the suit and that it probably will result in a judgment of $2 million to $10 million in damages. However, the legal firm believes that the most probable amount of the loss will be $6 million, and that the suit will be terminated about three years hence. The company has no other lawsuits pending.

(a) Should the company disclose this event in the year the suit was filed? (check one) _____ No; _____ Note only; _____ A loss in the income statement.
(b) If a loss should be reported, give the journal entry required:  
 (a) a loss in the income statement.
 (b)

Loss-pollution (lawsuit pending)	6,000,000	 	
   Estimated liability pollution lawsuit	 	6,000,000	

Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 12-04 Explain how provisions are measured.
Learning Objective: 12-05 Illustrate various examples of provisions and explain issues related to timing of recognition.
Topic: 12-33 Lawsuits

70.  On January 1, 2012, a company purchased a machine that had a list price of $23,500. The purchase terms agreed upon were: cash down payment $12,000 plus a 15% note payable of $9,132 (its present value). The note is payable in three equal annual instalments (interest plus principal) on each December 31. Round to the nearest dollar.

Required:

(a) Give the entry to record the acquisition of the machine.
(b) Give the adjusting entry required on September 30, 2013, for interest assuming this is the end of the accounting period.  
 (a)

Machine	21,132	 	
    Cash	 	12,000	
    Note payable	 	9,132	

 (b)

Interest expense	731	 	
     Interest payable (975  9/12)	 	731	

Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 12-03 Account for common financial liabilities.
Learning Objective: 12-06 Explain the impact of discounting liabilities.
Topic: 12-51 Example 1: No-Interest Note Payable
Topic: 12-52 Example 2: Note Payable with Different Market and Stated Rate

71.  On January 1, 2000, a corporation purchased a machine (10 year estimated useful life; no residual value; straight-line method) by paying cash $1,500 and signing a note payable with a face amount of $4,500, 8% interest payable each December 31. The maturity date is December 31, 2002. The going market rate of interest was 10%. Give all required entry (entries) at each of the following dates:

January 1, 2000:
December 31, 2000:  
 January 1, 2000:

Machine ($1,500 + $4,276)	5,776	
Cash (given)	1,500	
Note payable (net)*	4,276	

*principal $4,500  (PV1, 10%, 3)(.75131)	3,381	 	
*interest $360  (PVA, 10%, 3)(2.48685)	895	 	
 	4,276	 	
December 31, 2000:	 	 	
 	 	 	
Depreciation expense ($,5776/10 years)	578	 	
        Accumulated depreciation	 	578	
Interest expense ($4,276  .10)	428	 	
        Cash ($4,500  .08)	 	360	
        Note payable ($428 - 360)	 	68	

Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 12-03 Account for common financial liabilities.
Learning Objective: 12-06 Explain the impact of discounting liabilities.
Topic: 12-52 Example 2: Note Payable with Different Market and Stated Rate

72.  On September 1, 2020, a company purchased a machine and paid for it by signing a two-year noninterest-bearing note, face $4,000. The note is payable August 31, 2022. The going rate of interest was 18% per year. The accounting period ends December 31.

(a) Compute the cost of the machine.
(b) Give all appropriate entries throughout the term of the note.

Use the net method.  
 (a) $4,000  (PV1, 18%, 2)(.71818) = $2,873
 (b) September 1, 2000

Machine	2,873	 	
Note payable	 	2,873	

 December 31, 2020

Interest expense ($2,873  .18  4/12)	172	 	
Note payable	 	172	

 December 31, 2021

Interest expense	548*	 	
Note payable	 	548	

 August 31, 2022

Note payable ($2,873 + $172 + $548)	3,593	 	
Interest expense ($4,000 - $3,593)	407	 	
   Cash	 	4,000	
*$2,873  .18 = $517  8/12 =	 	345	
Or ($2,873 + $172)  .18	 	548	
($2,873 + $517)  .18 = $610  4/12	 	203	

Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 12-03 Account for common financial liabilities.
Learning Objective: 12-06 Explain the impact of discounting liabilities.
Topic: 12-51 Example 1: No-Interest Note Payable

73.  On September 1, 2020, a company signed a $6,540, one-year, non-interest-bearing note payable and received $6,000 cash.

(a) What was the imputed rate of interest? ________________%.
(b) Give the entry required at September 1, 2020, to record the receipt of the cash (record on net basis).
(c) Give the adjusting entry required at the end of the accounting year, December 31, 2020.
(d) Give the entry required on the due date, August 31, 2021, assuming no reversing entries were made.  
 (a) $6,540 - $6,000 = $540  $6,000 = 9%
 (b) September 1, 2020
 
Cash	6,000	 	
Note payable	 	6,000	

 (c) December 31, 2020:

Interest expense ($540  4/12)	180	 	
Note payable	 	180	

 (d) August 31, 2021:

Note payable	6,000	 	
Interest expense ($540  8/12)	360	 	
Interest payable	180		
Cash	 	6,540	

Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 12-03 Account for common financial liabilities.
Learning Objective: 12-06 Explain the impact of discounting liabilities.
Topic: 12-51 Example 1: No-Interest Note Payable

74.  Quality 9000 International Inc., which began operations in 1996, sells 20,000 units of its product each year under the following warranty: defective units will be fixed free of charge during the calendar year of purchase and the next two calendar years. (This means it is best to buy from this company early in the year.) Only 1% of units sold have required warranty service in the past. The average cost has been $200 per unit for servicing. Units require service only once and the likelihood of a unit requiring service is the same during each year in the warranty period. What is the balance in the warranty liability account at December 31, 1999?  
 As of Dec. 31/99, the warranty for 1996, 1997 units is expired;
 Dec. 31/99 liability =

For 1998 sales: 1/3(20,000)($200)(.01)	= $13,333	
For 1999 sales: 2/3(20,000)($200)(.01)	= 26,667	
Total liability at Dec. 31/1999	$40,000	

Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 12-01 Define the meaning of a liability and distinguish between financial; non-financial liabilities and constructive obligations.
Learning Objective: 12-04 Explain how provisions are measured.
Learning Objective: 12-05 Illustrate various examples of provisions and explain issues related to timing of recognition.
Topic: 12-37 Warranty

75.  A firm sells a remarkable product, which serves many household purposes. The firm is confident about its product and is so anxious to sell a large number of units that it grants a 3-year warranty. The warranty agreement specifies that any malfunction or other problem will be fixed at no cost to the customer, unless the customer has abused the product. Based on experience with other household products it has sold in the past, 3% of total units sold will require service over the warranty period at an average cost of $200 per unit. The following information relates to the first two years of the product's life:

 	Year 1	Year 2	
Unit sales	$20,000	$5,000	
Actual warranty costs incurred	35,000	80,000	

 What is the balance of the warranty liability account at January 1, Year 3? Assume that the company did not revise its estimate of future warranty claims frequency.  
 January 1, 20  3 warranty liability balance =
 (20,000 + 25,000) .03($200) - $35,000 - $80,000 = $155,000 

Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 12-01 Define the meaning of a liability and distinguish between financial; non-financial liabilities and constructive obligations.
Learning Objective: 12-04 Explain how provisions are measured.
Learning Objective: 12-05 Illustrate various examples of provisions and explain issues related to timing of recognition.
Topic: 12-37 Warranty

76.  At December 31, 2015, ABC Company has the following three separate lawsuits pending against it: Suit A-Plaintiffs seek damages of $40,000; Suit B-Plaintiff seeks damages of $200,000; and Suit C-Plaintiff seeks damages of $20,000.
ABC management and legal counsel have made the assessments indicated below. For each suit, taking into account the assessment, you are to (a) give the accrual entry if it is required (if not, state why) and (b) indicate whether a disclosure note is required and explain the reason.

CASE A-Remote that ABC will lose the suit.

(a) Accrual entry:
(b) Disclosure note: _______ Yes ______ No. Explanation:

CASE B-Reasonably possible that ABC will lose; reasonable estimate of damages $4,000.

(a) Accrual entry:
(b) Disclosure note: ______ Yes _______ No. Explanation:

CASE C-Probable that ABC will lose; reasonable estimate of damages $10,000.

(a) Accrual entry:
(b) Disclosure note: ______ Yes ______ No. Explanation:  
CASE A
 
 (a) None permitted for remote loss contingencies
 (b) No (permissible but not required)
 
 CASE B
 
 (a) None
 (b) Yes (required for reasonably possible loss contingencies)
 
 CASE C

(a) Estimated loss-Damages from lawsuit	20,000	 	
    Estimated liability-Damages from lawsuit	 	20,000	

 (b) Yes or no (Disclosure often required in addition to the journal entry) for full disclosure. 

Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 12-04 Explain how provisions are measured.
Learning Objective: 12-05 Illustrate various examples of provisions and explain issues related to timing of recognition.
Topic: 12-33 Lawsuits
 
77.  BRIEFLY explain how the treatment of contingencies differs under IFRS and ASPE.  
 Contingencies may or may not be accrued under ASPE but are never accrued under IFRS. Both IFRS and ASPE require the disclosure of contingencies. 

Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 12-04 Explain how provisions are measured.
Learning Objective: 12-08 Compare and contrast the reporting and measurement of liabilities under ASPE and IFRS.
Topic: 12-29 Contingency
 
78.  On September 1, 2014, XYZ borrowed $100,000 on a 9%, two-year, note payable. Simple interest is payable on August 31, 2015 and 2016. XYZ's reporting year ends December 31 and the company does not use reversing entries for interest. The required entry on August 31, 2015, is:  
 Please see the following table:

Interest Expense	6,000	 	
Interest Payable	3,000	 	
    Cash	 	9,000	

Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 12-03 Account for common financial liabilities.
Learning Objective: 12-06 Explain the impact of discounting liabilities.
Topic: 12-51 Example 1: No-Interest Note Payable