CHAPTER 8

LIABILITIES

Exercise 8-1: Fill in the blanks.

1. A present obligation to transfer assets in the future is called a liability .

2. Current liabilities must be paid within 1 year or the operating cycle .
3. A written promise to pay another party is referred to as a note payable .
4. The process of deducting the interest in advance on a note is called discounting
5. Possible future liabilities are referred to as contingent liabilities.
6. Special deals offered to customers upon the return of box tops or labels are called
premiums .
7. Liabilities of uncertain timing or amount are called provisions .
8. A bond is promise to pay principal and interest .
9. Bonds that pay back the principal at one time are called term bonds.
10. If the contract rate is greater than the market rate, the bond will be sold at a _ premium ,
while if it is less, the bond will be sold at a discount .

Exercise 8-2: True or False

False 1. A zero-interest-bearing note payable that is issued at a discount will not result in
any interest expense being recognized.
True 2. Magazine subscriptions and airline ticket sales both result in unearned revenues.
True 3. A provision differs from other liabilities in that there is greater uncertainty about
the timing and amount of settlement.
True 4. Current liabilities are usually recorded and reported in financial statements at their
full maturity value.
True 5. Contingent liabilities are not reported in the financial statements but may be
disclosed in the notes to the financial statements if the likelihood of an
unfavorable outcome is possible.
False 6. Paying a current liability with cash will always reduce the current ratio.
False 7. The excess of current assets over current liabilities is called the current ratio.
False 8. Current liabilities include accrued wages, taxes owed and prepaid expenses.
True 9. Notes payable can sometimes be issued for the purchase of goods rather than having
an account payable.
False 10. Unearned revenue should be recorded as income on the Income Statement.

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 Exercise 8-3: Liability Classification

Identify the liability classification of the items described below by writing CL for current
liability and NCL for noncurrent liability.

CL 1. Current maturities of long-term debts to be paid from current assets

CL 2. Cash received for services to be rendered during the period.
NCL 3. Bonds Payable
CL 4. Cash dividends payable
CL or NCL 5. Service warranties on appliance sales
CL 6. Gift certificates sold to customers but not yet redeemed
CL 7. Sales Tax Payable
NCL 8. 5-year Notes Payable
CL 9. Bonds redeemable next accounting period
CL 10. Employees payroll deductions unremitted

Exercise 8-4: Multiple Choice - Theory

1. Examples of current liabilities include all of the following except

a. Long-term mortgage
b. Unpaid dividends
c. Sales tax payable
d. Unearned income

2. For a liability to exist,

a. a past transaction or event must have occurred.
b. the exact amount must be known.
c. the identity of the party owed must be known.
d. an obligation to pay cash in the future must exist.

3. Which of the following is not considered a characteristic of a liability?

a. Present obligation
b. Arises from past events.
c. Results in an outflow of resources.
d. Liquidation is reasonably expected to require use of current assets.

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4. Which of the following terms is associated with recognizing a provision?

a. Possible but not probable

b. Unlikely
c. Somewhat remote
d. Probable

5. Bond discount should be presented in the financial statements of the issuer as a(n)

a. contra liability
b. adjunct liability
c. deferred charge
d. contra asset

6. Which of the following may be a current liability?

a. Income tax withheld from employees

b. Deposits received from customers
c. Unearned revenue
d. All of these answers are correct

7. Share dividends distributable should be classified on the

a. income statement as an expense.

b. statement of financial position as an asset.
c. statement of financial position as a liability.
d. statement of financial position as an item of equity.

8. What does the current ratio inform you about a company?

a. The current asset available in the current operation

b. The company’s solvency
c. The company's liquidity
d. The company's profitability

9. A note payable is recorded at present value if it is a/an

a. Payable within one year

b. Zero interest bearing note payable within one year
c. Zero interest-bearing note payable beyond one-year
d. Interest-bearing note, whether short-term or long-term.

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10. From a liquidity standpoint it is more desirable for a firm to have current

a. assets equal to current liabilities.

b. liabilities exceeding current assets.
c. assets exceeding current liabilities.
d. liabilities exceeding non-current liabilities.

Exercise 8-5: Problem Solving

1. Current Liabilities. The following information pertains to Prince Company as of December
31, 2020:

Accounts payable ₱ 480,000

Notes payable, including note payable to bank on 12/31/20 858,000
Share dividend distributable 75,000
Bonds payable due on 12/31/2025 3,000,000
Accrued interest on bonds payable 20,000
Accrued salaries expense 40,000
Unearned rent income 18,000

Compute the total current liabilities on December 31, 2020.

Accounts payable P 480,000

Notes payable 858,000
Accrued interest on bonds payable 20,000
Accrued salaries payable 40,000
Unearned rent income 18,000
____________
Total current liabilities P 1,416,000
===========

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2. Accounts Payable. King Co.’s accounts payable at December 31, 2020 was ₱1,400,000
before considering the following data:
• Goods shipped to King on December 22, 2020, FOB shipping point, were lost in transit.
The invoice cost of ₱80,000 was not recorded by King. On Jan. 5, 2021, King filed a
₱80,000 claim against the common carrier.
• Goods shipped to King on Dec. 20, 2020, FOB destination, were received on Jan. 6,
2021. The invoice cost was ₱50,000.
What amount should King report as accounts payable in its December 31, 2020 statement of
financial position?

Accounts payable before adjustment P 1,400,000

Unrecorded invoice 80,000
__________
Accounts payable, December 31, 2019 P 1,480,000
==========

3. Unearned Income. Star Pro Magazine sold 10,000 annual subscriptions on August 1, 2020,
for ₱200 each. How much is the unearned subscription income on August 1, 2020? How much
is the unearned subscription income balance on December 31, 2020?

Unearned subscription, August 1

10,000 annual subscriptions x P200 = P2,000,000
========

Unearned subscription, December 31

P2,000,000 x 7/12 = P1,166,667
========

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4. Premiums. Regal Studios, in an effort to promote the release of their new movie "Ninjas from
Space," began a national sales promotion campaign. Two coupons from specially marked
boxes (one coupon in each box) of "Sugar Charms" cereal are redeemable for one ticket to the
show. Tickets cost Regal ₱15 each. Regal estimates that 40 percent of the coupons will be
redeemed. At the end of 2020, the following information is available:

Boxes of cereal sold 640,000

Movie tickets purchased by Regal 140,000
Coupons redeemed 250,000

What is the estimated liability for premium claims outstanding at December 31, 2020?

Number of coupons available 640,000

Expected redemption rate 40%
_______
256,000
(Two coupons per ticket) 50%
_______

Estimated premium 128,000

Premiums redeemed to date
(250,000/2 coupons per ticket) 125,000
________
Expected remaining premiums 3,000
=======

Estimated liability (3,000 tickets x P15) P45,000

======

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5. Warranties. In the calendar year 2020, Golden Enterprises sold 4,000 units of its product for
₱10,000 each. The selling price included a one-year warranty on parts. It is expected that 3%
of the units would be defective and that repair costs would average ₱1,500 per unit. In 2020,
warranty contracts were honoured on 80 units of product for a total cost of ₱120,000. The
Provision for Warranty account had a balance of ₱120,000 at January 1, 2020.
What amount should Golden accrue on December 31, 2020 for estimated warranty costs?

Provision for warranty, Jan 1, 2020 P120,000

Estimated warranty costs for 2020
(4,000 x 3% x P1,500) 180,000
Warranty contracts honoured during the year (120,000)
_________
Estimated warranty costs, December 31, 2020 P 180,000
========

6. Notes Payable – Interest bearing note. On January 1, 2020, Barney Corporation acquired a
tract of land for ₱10,000,000. Barney Corporation paid ₱1,000,000 and signed a 3-year
promissory note for the balance plus 10% interest compounded annually. The note matures on
January 1, 2023. Determine the total amount to be paid on the maturity date of the note?

Total amount to be paid on the maturity date of the note

P9,000,000 x 1.1 x 1.1 x 1.1 = P11,979,000
==========

7. Notes Payable – Noninterest bearing note. On January 1, 2020, JFK Inc. acquired a building
for ₱12,000,000. JFK paid ₱2,000,000 and signed a noninterest bearing note for the balance
which is payable in 4 annual installments every December 31 of each year. The prevailing
interest rate for a note of this type is 12%. The present value of an ordinary annuity of 1 for
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 four periods is 3.03735.
a. Determine the present value of the note on January 1, 2020.
b. Determine the discount on notes payable on January 1, 2020.

Annual installment (P10M / 4) = P2,500,000

Present value of ordinary annuity 3.03735
_________
Present value of the note P 7,593,375
=========

Face value of the note P 10,000,000

Present value of the note 7,593,375
___________
Discount on notes payable P 2,406,625
==========

8. Contingent Liabilities. In August, 2020, a worker was injured in the factory in an accident
partially the result of his own negligence. The worker has sued Lester Co. for ₱800,000.
Counsel believes it is possible but not probable that the outcome of the suit will be unfavorable
and that the settlement would cost the company from ₱250,000 to ₱500,000.
Discuss the proper accounting treatment, including any required disclosures for the situation.

Lester Co. should disclose in the notes to the financial statements the existence of a
possible contingent liability related to the lawsuit. The note should indicate the range
of the possible loss. The contingent liability should not be accrued because the loss is
possible, not probable.

9. Bonds Payable. On January 1, 2020, Gillian Co. issued its 10% bonds at face amount of
₱3,000,000, which will mature on January 1, 2025. The bonds were issued for ₱3,405,000 to
yield 8%, resulting in bond premium of ₱405,000. Gillian uses the effective-interest method
of amortizing bond premium. Interest is payable annually on December 31.

a. What is the issue price of the bonds?

b. What should be the carrying value of the bonds at December 31, 2020?

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Issue price of the bonds P 3,405,000
=========

PV of bond, 1/1/2020 P3,405,000

Amortized premium
Effective interest (P3,405,000 x 8%) P(272,400)
Interest paid (P3,000,000 x 10%) 300,000
_________ (27,600)
_________
Carrying value of bonds, 12/31/2020 P3,377,400
=========

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10. Bonds Payable. On January 1, Dion Inc. issued ₱5,000,000, 9% bonds for ₱4,695,000. The
market rate of interest for these bonds is 10%. Interest is payable annually on December 31.
Dion uses the effective-interest method of amortizing bond discount.
a. How much is the interest expense for year?
b. What amount should be reported as bonds payable at the end of the first year

PV of bonds or issue price P4,695,000

Effective interest rate 0.10
__________
Interest expense for the year P 469,500
=========

PV of bonds or issue price P4,695,000

Amortized discount
Effective interest (P4,695,000 x .10) P469,500
Interest paid (P5,000,000 x .09) 450,000
_______ 19,500
________
Bonds payable, end of the year P4,714,000
========

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11. Total Liabilities. The following data pertain to PO Company as of June 30, 2020:
a. Accounts payable arising from purchased of goods, ₱115,000.
b. Cash dividends payable, ₱30,000.
c. Income tax payable, ₱18,000.
d. Accrued salaries payable, ₱20,000.
e. Customer’s deposits, ₱9,900.
f. Provision for warranty, ₱5,200,
g. Reserve for contingencies, ₱50,000
h. Mortgage payable, ₱2,000,000

Based on the above data, what is the total amount of actual liabilities to be reported on the
statement of financial position of June 30, 2020?

Accounts payable P115,000

Cash dividends payable 30,000
Income tax payable 18,000
Accrued salaries payable 20,000
Customers’ deposits 9,900
Provisions for warranty 5,200
Mortgage payable 2,000,000
__________
Total actual liabilities P 2,198,000
=========

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 12. Liquidity and Solvency Ratio. Presented below is information available for Martin
Company.

Total current assets ₱2,800,000

Total assets 8,500,000
Total current liabilities 1,200,000
Total liabilities 3,000,000
Income before income taxes 690,000
Interest expense 150,000

a. What is the working capital of Martin Company?

b. What is the current ratio of Martin Company?
c. Is the company liquid, able to pay current maturing obligations?
d. What is the debt to total assets ratio of the company?
e. What is the times interest earned ratio of the company?
f. Is the company solvent?

Working capital (P2,800,000 – P1,200,000) = P1,600,000

========

Current ratio (P2,800,000/P1,200,000) = 2.3 : 1

Yes, the company has enough current assets to pay current liabilities.

Debt to total assets ratio (P3,000,000/P8,500,000) = 35%

Times interest earned

[ (P690,000 + P150,000) / P150,000 ] = 5.6

Yes, the company has enough resources to settle obligations.

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