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Chapter 009: Reporting and Interpreting Liabilities

True / False Questions


1. The mixture of debt and equity for a business is called its capital structure.
TRUE

AACSB Tag: Relative Thinking


Difficulty: Easy
L.O.: 1

2. A current liability is always a short-term obligation expected to be paid within one year of
the balance sheet date.
FALSE

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 1

3. A current ratio that is high according to an industry average might mean the company may
have excessive inventory levels or slow moving inventory items.
TRUE

AACSB Tag: Relative Thinking


Difficulty: Easy
L.O.: 2

4. A current ratio can be manipulated by management through paying off current liabilities
before the end of the accounting period.
TRUE

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 2

9-1
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Chapter 009: Reporting and Interpreting Liabilities

5. A liability, to be reported on the balance sheet, must have a fixed, known amount to be paid
in the future.
FALSE

AACSB Tag: Relative Thinking


Difficulty: Hard
L.O.: 3

6. The FICA (social security) tax is a matching tax with a portion paid by both the employer
and the employee.
TRUE

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 3

7. The accounts payable turnover ratio is computed by dividing sales by average accounts
payable.
FALSE

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 3

8. Interest is a function of the amount borrowed times the interest rate.


FALSE

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 4

9-2
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Chapter 009: Reporting and Interpreting Liabilities

9. A company borrowed $100,000 at 6% interest on September 1, 2009. Assuming no


adjusting entries have been made during the year, the entry to record interest accrued on
December 31, 2009 would include a debit to interest expense and a credit to interest payable
for $3,000.
FALSE

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 4

10. All contingent liabilities should be classified as either current or long-term liabilities on
the balance sheet for the current period.
FALSE

AACSB Tag: Communication


Difficulty: Medium
L.O.: 5

11. A contingent liability that is "probable" and can be "reasonably estimated" must be
accrued and reported as a liability.
TRUE

AACSB Tag: Communication


Difficulty: Medium
L.O.: 5

12. When current liabilities decrease during the year, then we create a positive effect on cash
flow from operating activities.
FALSE

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 6

9-3
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Chapter 009: Reporting and Interpreting Liabilities

13. Excessive or slow moving inventory could be the reason working capital is low.
FALSE

AACSB Tag: Relative Thinking


Difficulty: Easy
L.O.: 6

14. A secured debt is where the borrowing company pledges specific assets as collateral for
the loan.
TRUE

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 7

15. As corporations have expanded globally, it has become common to borrow money in
foreign currencies as a way to lessen exposure to exchange rate risk.
TRUE

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 7

16. For the present value of a single amount, the compounding period may only be once a
year.
FALSE

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 8

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Chapter 009: Reporting and Interpreting Liabilities

17. An annuity is a series of consecutive payments, each one increasing by a fixed dollar
amount over the payment amount of the prior year.
FALSE

AACSB Tag: Relative Thinking


Difficulty: Easy
L.O.: 8

18. In the recognition of revenues and expenses, temporary and permanent differences
between the financial statements and the tax return will result in deferred taxes.
FALSE

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: Sup A

19. Tax evasion involves illegal means to avoid paying taxes, but tax planning considers legal
means to postpone paying taxes.
TRUE

AACSB Tag: Ethics


Difficulty: Medium
L.O.: Sup B

20. A reciprocal relationship exists between the "future value of $1" and the "present value of
$1."
TRUE

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: Sup. D

9-5
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Chapter 009: Reporting and Interpreting Liabilities

Multiple Choice Questions


21. A liability is measured in terms of its
A. amount owed plus interest.
B. current cash equivalent.
C. historical cost.
D. none of the other answers is correct.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 1

22. Which of the following statements is true?


A. Use of more debt in the company's capital structure usually reduces the rate of return
generated for stockholders.
B. Use of more debt in the capital structure can lead to positive financial leverage if we can
generate a return on investment in assets greater than the cost of borrowing.
C. Use of more debt decreases the level of risk assumed by a company.
D. All statements are false.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 1

23. Which of the following statements is true?


A. Liabilities are initially recorded at the amount of their principle plus interest.
B. Liabilities can decrease the return on stockholders' equity if the interest rate paid is less
than the return on assets.
C. Capital structure is the relative proportion of debt and equity financing.
D. Liabilities are current if due within 60 days.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 1

9-6
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Chapter 009: Reporting and Interpreting Liabilities

24. Which of the following is false?


A. Current liabilities are those that will be satisfied within one year or the operating cycle,
whichever is longer.
B. Liquidity is the ability of the company to meet its total obligations.
C. Current liabilities impact a company's liquidity.
D. Working capital is equal to current assets minus current liabilities.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 1

25. The current ratio is computed as follows


A. current assets divided by total assets.
B. current assets divided by current liabilities.
C. current liabilities divided by total assets.
D. current liabilities divided by current assets.

AACSB Tag: Relative Thinking


Difficulty: Easy
L.O.: 2

26. A company has a current ratio of 1.9 before paying off a large current liability with cash.
Following this payment, the current ratio will be
A. greater than 1.9.
B. less than 1.9.
C. equal to 1.9.
D. greater than 1.9 or less than 1.9 depending upon the dollar amount involved.

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 2

9-7
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Chapter 009: Reporting and Interpreting Liabilities

27. The following is a partial list of account balances from the books of Probst Enterprise at
the end of 2009:

Based solely upon these balances, the amount of current liabilities appearing on Probst
Enterprise's 2009 year-end balance sheet should be
A. $24,900.
B. $24,100.
C. $23,700.
D. $20,500.

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 2

28. In 2009, General Tech reported a current ratio of 2.75 and in 2008 it was 3.10. Which of
the following is a potential cause of a fall in this ratio?
A. An increase in accounts payable.
B. A decrease in inventories.
C. A decrease in short-term borrowings.
D. Both an increase in accounts payable and a decrease in inventories could cause the ratio to
fall.

AACSB Tag: Relative Thinking


Difficulty: Hard
L.O.: 2

9-8
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Chapter 009: Reporting and Interpreting Liabilities

29. If a current ratio has been increasing over the past several years, which of the following
would cause the ratio to rise?
A. An increase in accounts payable.
B. An increase in inventories.
C. An increase in short-term borrowings.
D. A decrease in prepaid rent.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 2

30. In 2009, The Western Air Freight Company reported current assets of $12,094 million,
total assets of $31,327 million, current liabilities of $10,971 million, and total liabilities of
$15,392 million. What was their current ratio for 2009?
A. 1.63
B. 1.10
C. 2.12
D. 1.89

AACSB Tag: Analytic


Difficulty: Easy
L.O.: 2

31. Chavez Chocolates had a current ratio of 1.74 in 2008. Which of the following would
cause the ratio to decrease in 2009?
A. A decrease in cash and equivalents and short-term investments.
B. An increase in cash and equivalents and short-term investments.
C. An increase in current assets that exceeded the increase in current liabilities.
D. Current assets as a percentage of total assets increased while current liabilities as a
percentage of total liabilities and stockholders' equity decreased.

AACSB Tag: Relative Thinking


Difficulty: Hard
L.O.: 2

9-9
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Chapter 009: Reporting and Interpreting Liabilities

32. Which of the following would most likely cause an increase in the current ratio?
A. A short-term borrowing of $100.
B. A purchase of $100 of inventory for cash.
C. A $100 payment to suppliers thereby reducing accounts payable
D. A $100 receipt of cash from a customer's accounts receivable.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 2

33. Which of the following is always a current liability?


A. Pension obligations
B. Estimated warranty liability
C. Accounts payable
D. Bonds payable

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 2

34. Which of the following usually is not a current liability?


A. Wages payable.
B. Rent revenue collected in advance.
C. Dividends payable.
D. Pension obligations.

AACSB Tag: Relative Thinking


Difficulty: Easy
L.O.: 2

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Chapter 009: Reporting and Interpreting Liabilities

35. Which of the following is true?


A. Social Security tax is employer paid only.
B. The pay period always ends in conjunction with the company's fiscal year end.
C. Many fringe benefits such as sick and vacation leave benefits should be recognized when
the employee earns the benefit not when they take the leave.
D. Medical insurance benefits are always paid by the employee and not by the employer.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 3

36. An accrued liability results from an expense that is


A. incurred and paid.
B. incurred but not yet paid.
C. paid but not yet incurred.
D. neither incurred nor paid.

AACSB Tag: Relative Thinking


Difficulty: Easy
L.O.: 3

37. Which of the following statements is false relating to payroll taxes?


A. When recording the payroll entry, the credit to cash is usually more than the debit to
compensation expense.
B. FICA (social security) tax is a "matching" tax with the employer.
C. Income taxes withheld from employees' paychecks are liabilities of the employer.
D. None of the other answers is false.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 3

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Chapter 009: Reporting and Interpreting Liabilities

38. Gross wages of $20,000 accrued but not paid to employees at the end of 2010 should be
recorded by the employer in a journal entry that includes a
A. debit of $20,000 to Compensation payable.
B. credit of $20,000 to Cash.
C. debit of $20,000 to Compensation expense.
D. debit of $20,000 to Cash.

AACSB Tag: Analytic


Difficulty: Easy
L.O.: 3

39. Miranda Company borrowed $100,000 cash on September 1, 2010, and signed a one-year
6%, interest-bearing note payable. Assuming no adjusting entries have been made during the
year, the required adjusting entry at the end of the accounting period, December 31, 2010,
would be
A.

B.

C.

D.

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 3

9-12
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Chapter 009: Reporting and Interpreting Liabilities

40. The federal government requires


A. only the employer to pay FICA taxes.
B. only the employee to pay FICA taxes.
C. both the employer and the employee to pay FICA taxes.
D. neither the employer nor the employee to pay FICA taxes.

AACSB Tag: Relative Thinking


Difficulty: Easy
L.O.: 3

41. The amount of federal income tax that is withheld from employees' paychecks by the
employer should
A. be recorded on the employer's books as a current liability.
B. be recorded on the employer's books as an asset.
C. be recorded on the employer's books as revenue.
D. not be recorded on the employer's books.

AACSB Tag: Relative Thinking


Difficulty: Easy
L.O.: 3

42. Deferred revenue is another term for


A. Prepaid expenses.
B. Sales revenue.
C. Trade payables.
D. Unearned revenue.

AACSB Tag: Relative Thinking


Difficulty: Easy
L.O.: 3

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Chapter 009: Reporting and Interpreting Liabilities

43. Landseeker's Restaurants reported cost of goods sold of $322 million and accounts
payable of $83 million for 2008. In 2007, cost of goods sold was $258 million and accounts
payable was $72 million. What was Landseeker's accounts payable turnover ratio in 2008?
A. 4.23
B. 4.15
C. 4.04
D. 3.91

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 3

44. In 2008, StarHotels reported an accounts payable turnover ratio of 11.0 and a current ratio
of 1.52. Their statement of cash flows shows good cash flow from operations. Which of the
following interpretations of these ratios is most likely?
A. Since the two ratios are fairly high, it indicates StarHotels has little difficulty paying its
bills in a timely manner.
B. Since both these ratios are low, it might indicate poor liquidity and inability to pay vendors
in a timely manner.
C. StarHotels practices aggressive cash management strategies including investing excess
cash in operations and using vendors to finance operations by making slow payment to them.
D. StarHotels must be carrying a low amount of current liabilities in comparison to its total
liabilities.

AACSB Tag: Relative Thinking


Difficulty: Hard
L.O.: 3

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Chapter 009: Reporting and Interpreting Liabilities

45. General Tech and AmericanBio are both in the biotechnology industry. In 2009, General
Tech reported a payable turnover of 8.2 and in 2009; AmericanBio reported a ratio of 4.2.
Which of the following is an incorrect reason for the difference in ratios?
A. AmericanBio has a higher average accounts payable in comparison to their cost of goods
sold.
B. AmericanBio is taking longer to pay vendors.
C. AmericanBio has a lower average accounts payable in comparison to their cost of goods
sold.
D. General Tech has a better payment record in terms of timely payment to vendors.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 3

46. On September 1, 2009, Donna Equipment signed a one-year, 8% interest-bearing note


payable for $50,000. Assuming that Donna Equipment maintains its books on a calendar year
basis, the amount of interest expense that should be reported in the 2010 income statement for
this note (rounded to the nearest dollar) would be
A. $2,667.
B. $4,000.
C. $1,333.
D. $3,000.

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 4

47. Phipps Company borrowed $25,000 cash on October 1, 2009, and signed a six-month, 8%
interest-bearing note payable with interest payable at maturity. Assuming that no adjusting
entries have been made during the year, the amount of accrued interest payable that should be
shown on the 2009 balance sheet for the year ended December 31, 2009 is
A. $250.
B. $300.
C. $500.
D. $750.

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 4

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Chapter 009: Reporting and Interpreting Liabilities

48. Failure to make a necessary adjusting entry for accrued interest on a note payable would
cause
A. an understatement of liabilities and stockholders' equity.
B. net income to be overstated and assets to be understated.
C. net income to be understated and liabilities to be understated.
D. an overstatement of net income, an understatement of liabilities, and an overstatement of
stockholders' equity.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 4

49. On July 1, 2009, Prism, Inc. borrowed $30,000 from First Bank on a one year, 10% note
payable. Interest is payable on June 30, 2010, the due date of the note. Prism's accounting
year ends December 31, 2009. The journal entry required on the company's books to record
the note payable on July 1, 2009 would include a
A. credit to notes payable for $30,000.
B. credit to notes payable for $33,000.
C. debit to cash for $27,000.
D. debit to interest expense for $3,500.

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 4

50. On July 1, 2009, Prism, Inc. borrowed $30,000 from First Bank on a one year, 10% note
payable. Interest is payable on June 30, 2010, the due date of the note. Prism's accounting
year ends December 31, 2009. Assuming no adjusting entries have been made during the year,
the journal entry required on the company's books to record the interest accrued on December
31, 2009, would include a
A. debit to Interest Expense for $1,500.
B. credit to Interest Expense for $1,500.
C. credit to Cash for $1,500.
D. debit to Notes Payable for $1,500.

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 4

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Chapter 009: Reporting and Interpreting Liabilities

51. On July 1, 2009, Prism, Inc. borrowed $30,000 from First Bank on a one year, 10% note
payable. Interest is payable on June 30, 2010, the due date of the note. Prism's accounting
year ends December 31, 2009. On the company's December 31, 2009 year-end balance sheet,
the notes payable account should be reported as a
A. $31,500 long-term liability.
B. $31,500 current liability.
C. $30,000 long-term liability.
D. $30,000 current liability.

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 4

52. On January 2, 2009, Hill Company borrowed $10,000 from Bank Three. The loan was to
be repaid in equal principal installments of $2,000, payable on December 31 of each year,
beginning on December 31, 2009. Disregarding interest, the amount of the $10,000 loan that
should be considered a current liability on the company's balance sheet for the year ended
December 31, 2009 would be
A. $8,000.
B. $6,000.
C. $4,000.
D. $2,000.

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 4

53. Which of the following statements is false?


A. The currently maturing portion of long-term debt must be classified as a current liability.
B. The non-current portion of long-term debt will remain disclosed as a long-term liability.
C. When a company plans to refinance the currently maturing debt, it must still disclose the
currently maturing portion as a current liability.
D. Only current liabilities affect liquidity.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 4

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Chapter 009: Reporting and Interpreting Liabilities

54. Purdum Farms borrowed $10 million by signing a five year note on January 1, 2009 and
repayments of the principle are payable annually in $2 million dollar installments. Purdum
Farms makes the first payment December 31, 2009 and then prepares its balance sheet. What
amount will be reported as current and long-term liabilities respectively in connection with
the note at December 31, 2009?
A. $2 million in current liabilities and $8 million in long-term liabilities.
B. $2 million in current liabilities and $6 million in long-term liabilities.
C. Zero in current liabilities and $8 million in long-term liabilities.
D. Zero in current liabilities and $10 million in long-term liabilities.

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 4

55. Which of the following is usually not considered to be a long-term liability?


A. Bonds payable.
B. Mortgages payable.
C. Accrued post-retirement benefits.
D. FICA taxes payable.

AACSB Tag: Relative Thinking


Difficulty: Easy
L.O.: 4

56. A potential future liability arising from an event that has already happened, usually is
called
A. an accrued liability.
B. a contingent liability.
C. a deferred liability.
D. an estimated liability.

AACSB Tag: Relative Thinking


Difficulty: Easy
L.O.: 5

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Chapter 009: Reporting and Interpreting Liabilities

57. A contingent liability that is "reasonably possible" but "cannot reasonably be estimated"
A. must be recorded and reported as a liability.
B. does not need to be recorded or reported as a liability.
C. must only be disclosed as a note to the financial statements.
D. must be reported as a liability, but not recorded.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 5

58. Young Company is involved in a lawsuit. The liability which could arise as a result of this
lawsuit should be recorded on the books if the probability of Young Company owing money
as a result of the lawsuit is
A. remote and the amount can be reasonably estimated.
B. probable and the amount can be reasonably estimated.
C. reasonably possible and the amount can be reasonably estimated.
D. probable and the amount cannot be reasonably estimated.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 5

59. Houston Company is involved in a lawsuit. Footnote disclosure of the contingent liability
which could arise does not have to be presented if the probability of Houston Company owing
money as a result of the lawsuit is
A. reasonably possible and the amount cannot be reasonably estimated.
B. probable and the amount cannot be reasonably estimated.
C. reasonably possible and the amount can be reasonably estimated.
D. remote and the amount can be reasonably estimated.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 5

9-19
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Chapter 009: Reporting and Interpreting Liabilities

60. Ogden Motors, Inc. is involved in a lawsuit. It is probable that the jury will find in favor
of the plaintiff and Ogden Motors will owe ten million dollars. Even though the lawsuit is not
yet settled, Ogden Motors should record a liability in the balance sheet and
A. a prepaid expense.
B. a loss.
C. deferred revenue.
D. a contra-asset.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 5

61. When inventory increases from last year to the current year and accounts payable
decreases during the period, the following are the effects on cash flow from operating
activities:
A. Cash is decreased for both the increase in inventory and decrease in accounts payable.
B. Cash is decreased for the increase in inventory but increased for the decrease in accounts
payable.
C. Cash is increased for both the increase in inventory and the decrease in accounts payable.
D. Cash is increased for the increase in inventory but decreased for the decrease in accounts
payable.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 6

62. When a company increases accounts payable from one year to the next, the effect on cash
flows from operating activities
A. is a decrease in cash caused by paying down our debt to vendors.
B. is an increase in cash because we have not paid cash for all the inventory and services
purchased on credit during the period.
C. is a decrease to cash because we will have to pay these liabilities in the future.
D. is an increase to cash because we have received cash from vendors.

AACSB Tag: Relative Thinking


Difficulty: Easy
L.O.: 6

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Chapter 009: Reporting and Interpreting Liabilities

63. Which of the following statements is true?


A. Long-term liabilities are those not expected to be paid in the next year.
B. Long-term liabilities affect liquidity.
C. The income taxes payable account is typically a long-term liability.
D. The salaries payable is typically a long-term liability.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 7

64. On January 1, 2009, Simko Company acquired a truck that had a purchase price of
$20,000. The seller agreed to allow Simko to pay for the truck over a three-year period at 10%
interest with equal payments due at the end of 2009, 2010 and 2011. The amount of each
annual payment the company must make is (round to the nearest dollar)

A. $6,042
B. $8,042
C. $15,026
D. $15,206

AACSB Tag: Analytic


Difficulty: Hard
L.O.: 8

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Chapter 009: Reporting and Interpreting Liabilities

65. If the market rate of interest is 10%, a rational person would just as soon receive $1,100
three years from now as what amount today (round to the nearest dollar)?

A. $ 783.
B. $ 826.
C. $1,000.
D. $1,100.

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 8

66. Present value can be defined as the


A. future amount of a sum of money held now.
B. value today of future cash inflow(s).
C. maturity value of a debt.
D. sum of cash inflows over a future period of time.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 8

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Chapter 009: Reporting and Interpreting Liabilities

67. On January 1, 2009, Hopkins Company purchased a machine that had a sticker (list) price
of $22,000. The seller agreed to allow Hopkins Company to pay for the machine over a threeyear period at 10% interest on the unpaid balance and with equal payments of $8,444 due at
the end of 2009, 2010, and 2008. The amount that should be debited to the asset account,
Machinery, on the day the contract was initiated is (rounded to the nearest dollar)

A. $27,865.
B. $25,332.
C. $22,000.
D. $20,999.

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 9

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Chapter 009: Reporting and Interpreting Liabilities

68. On January 1, 2009, Clem Company purchased a machine. The seller agreed that a total of
$9,000 would be paid over a three-year period$3,000 per year at the end of 2009, 2010, and
2011. At the time the machine was purchased, the market rate of interest was 10%. The
amount that should be debited to the asset account, Machinery, on the date of purchase is
(round to the nearest dollar)

A. $9,000.
B. $9,948.
C. $7,461.
D. $9,016.

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 9

69. You have been asked to compute the cash equivalent price of a machine assuming the cost
(including principal and interest) is to be paid in two equal payments after the acquisition
date. The interest concept that best describes this application is
A. present value of a single amount.
B. present value of an annuity.
C. future value of a single amount.
D. future value of an annuity.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 9

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Chapter 009: Reporting and Interpreting Liabilities

70. Straight Industries purchased a large piece of equipment from Curvy Company on January
2, 2009. Straight Industries signed a note, agreeing to pay Curvy Company $400,000 for the
equipment on December 31, 2011. The market rate of interest for similar notes was 8%. The
present value of $400,000 discounted at 8% for three years is $317,520. On January 2, 2009,
Straight Industries recorded the purchase with a debit to equipment for $317,520 and a credit
to notes payable for $317,520. On December 31, 2009, Straight recorded an adjusting entry to
account for interest that had accrued on the note. Assuming no adjusting entries have been
made during the year, the approximate amount of interest expense that would have accrued at
December 31, 2009, would be
A. $25,400.
B. $32,000.
C. $76,200.
D. $96,000.

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 9

71. Straight Industries purchased a large piece of equipment from Curvy Company on January
2, 2009. Straight Industries signed a note, agreeing to pay Curvy Company $400,000 for the
equipment on December 31, 2011. The market rate of interest for similar notes was 8%. The
present value of $400,000 discounted at 8% for three years is $317,520. On January 2, 2009,
Straight recorded the purchase with a debit to equipment for $317,520 and a credit to notes
payable for $317,520. On Straight Industries' balance sheet for the year ended December 31,
2009, the book value of the liability for notes payable related to this purchase would equal
A. $317,520.
B. an amount less than $317,520.
C. an amount more than $317,520.
D. an amount more or less than $317,520 depending upon Straight's income for the year.

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 9

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Chapter 009: Reporting and Interpreting Liabilities

72. Straight Industries purchased a large piece of equipment from Curvy Company on January
2, 2009. Straight Industries signed a note, agreeing to pay Curvy Company $400,000 for the
equipment on December 31, 2011. The market rate of interest for similar notes was 8%. The
present value of $400,000 discounted at 8% for three years is $317,520. On January 2, 2009,
Straight recorded the purchase with a debit to equipment for $317,520 and a credit to notes
payable for $317,520. Accrued interest was recorded annually. On December 31, 2011, the
due date of the note, Straight paid the amount due and recorded the transaction with a
A. debit to notes payable $400,000.
B. debit to notes payable $317,520.
C. credit to notes payable for $400,000.
D. credit to notes payable for $317,520.

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 9

73. Alden Trucking Company is replacing part of their fleet of trucks by purchasing them
under a note agreement with Kenworthy on January 1, 2009. The note agreement will require
$10 million in annual payments starting on December 31, 2009 and continuing for a total of
five years (final payment December 31, 2013). Kenworthy will charge Alden Trucking
Company the market interest rate of 10% compounded annually. (Round answers to the
nearest tenth of a million.)
How much will Alden Trucking Company record as a debit to their equipment account and as
a credit to their notes payable account on January 1, 2009?

A. $50.0 million
B. $10.0 million
C. $37.9 million
D. $61.1 million

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 9

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Chapter 009: Reporting and Interpreting Liabilities

74. Alden Trucking Company is replacing part of their fleet of trucks by purchasing them
under a note agreement with Kenworthy on January 1, 2009. The note agreement will require
$10 million in annual payments starting on December 31, 2009 and continuing for a total of
five years (final payment December 31, 2013). Kenworthy will charge Alden Trucking
Company the market interest rate of 10% compounded annually. Round answers to the
nearest tenth of a million.
How much of the first $10 million payment on December 31, 2009 is interest?

A. $5.0 million
B. $3.8 million
C. $1.0 million
D. $2.8 million

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 9

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Chapter 009: Reporting and Interpreting Liabilities

75. Alden Trucking Company is replacing part of their fleet of trucks by purchasing them
under a note agreement with Kenworthy on January 1, 2009. The note agreement will require
$10 million in annual payments starting on December 31, 2009 and continuing for a total of
five years (final payment December 31, 2013). Kenworthy will charge Alden Trucking
Company the market interest rate of 10% compounded annually. Round answers to the
nearest tenth of a million.
What is the remaining obligation on January 1, 2010 after the first payment has been made?

A. $31.7 million
B. $37.9 million
C. $40.0 million
D. $27.9 million

AACSB Tag: Analytic


Difficulty: Hard
L.O.: 9

76. Deferred income taxes should be reported on a corporation's


A. income tax return.
B. balance sheet.
C. income statement.
D. both the balance sheet and income statement.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: Sup A

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Chapter 009: Reporting and Interpreting Liabilities

77. Gammell, Inc. reported net income of $40,000 for 2009. The income tax return excluded a
revenue item of $3,000 (reported on the income statement) because under the tax laws the
$3,000 would not be reported for tax purposes until 2010. Assuming a 35% income tax rate,
this situation would cause a 2009 deferred tax amount of
A. $3,000 (debit).
B. $3,000 (credit).
C. $1,050 (debit).
D. $1,050 (credit).

AACSB Tag: Analytic


Difficulty: Hard
L.O.: Sup A

78. Situations which require that deferred income tax be reported involve a difference that is
called a
A. permanent difference.
B. reversing tax inverse difference.
C. temporary difference.
D. contingent liability.

AACSB Tag: Relative Thinking


Difficulty: Easy
L.O.: Sup A

79. If income tax expense reported on the income statement is $45,000 for 2009, and the tax
return for 2009 (the first year) shows an income tax liability of $42,000 the deferred income
tax amount on the balance sheet at the end of 2009 will be
A. debit of $3,000.
B. credit of $3,000.
C. credit of $42,000.
D. credit of $45,000.

AACSB Tag: Analytic


Difficulty: Medium
L.O.: Sup B

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Chapter 009: Reporting and Interpreting Liabilities

80. An amount is to be deposited in a savings account at the end of each year in order to
provide funds for a trip to Europe at the end of the fourth year. You have been asked to
determine the amount of the annual deposit. The interest concept that best describes this
application is
A. present value of a single amount.
B. present value of an annuity.
C. future value of a single amount.
D. future value of an annuity.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: Sup. D

Essay Questions
81. Halbur Company reported total assets of $150,000; current assets of $60,000; total
stockholders' equity of $60,000; and noncurrent liabilities of $65,000.
Required: (show computations).
1. Compute Working Capital.
2. Compute the Current Ratio.
1. $150,000 = $65,000 + ? + $60,000
Current liabilities = $25,000
Working Capital = $60,000 $25,000 = $35,000
2. Current Ratio = $60,000/$25,000 = 2.4 to 1

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 2

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Chapter 009: Reporting and Interpreting Liabilities

82. Moore Company has the following partial list of account balances at year end:

Required:
A. Compute the current ratio.
B. Determine the amount of working capital.
C. Assume that cash is used to pay the balance due on accounts payable.
1. Compute the new current ratio.
2. Compute the new amount of working capital.
D. Compute the accounts payable turnover ratio (use year-end amounts,)
A. Current assets = Cash + Accounts receivable = $3,000 + $1,600 = $4,600.
Current liabilities = Accounts payable + Notes payable + Salaries payable = $1,500 + $1,000
+ $900 = $3,400.
Current ratio = Current assets/Current liabilities = $4,600/$3,400 = 1.35
B. Working capital = $4,600
$3,400 = $1,200.
C. Current assets = $1,500 + $1,600 = $3,100.
Current liabilities = $1,000 + $900 = $1,900.
1. Current ratio = 1.63
2. Working capital = $3,100 $1,900 = $1,200
D. Cost of Goods Sold/Accounts payable = $3,200/$1,500 = 2.1 times.

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 2

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Chapter 009: Reporting and Interpreting Liabilities

83.
A. Calculate the following:
1. Tommy's Toys 2009 current ratio
2. Tommy's Toys 2008 current ratio
3. Tommy's Toys 2009 working capital
4. Tommy's Toys 2008 working capital
5. Debbie's Dolls 2009 current ratio
6. Debbie's Dolls 2008 current ratio
7. Debbie's Dolls 2009 working capital
8. Debbie's Dolls 2008 working capital
B. Interpret what changes have taken place for Tommy's Toys and Debbie's Dolls in their
current ratio.
A1. 1.28
A2. 1.08
A3. $1,878 million
A4. $ 515 million
A5. 1.10
A6. 1.06
A7. $1,123 million
A8. $ 510 million
B. Debbie's Dolls current ratio has stayed the same between 2008 and 2009. Tommy's Toys
current ratio improved a little between 2008 and 2009 caused by an increase in current assets
which exceeds the increase in current liabilities. It appears as if both competitors practice
aggressive cash management strategies to assure current assets are minimized and they use
their vendors to help finance their current assets.

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 2

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Chapter 009: Reporting and Interpreting Liabilities

84. At the end of the annual accounting period the adjusting entries for the following three
items have not been made. You are to provide the 2010 adjusting entry for each item.
A. Unpaid wages for the last two days of December, 2010 amounting to $3,200 have not been
recorded (disregard payroll taxes).
B. On December 1, 2010 rent revenue of $600 was collected for December and January rent.
(Rent revenue was credited for a total of $600).
C. A $4,000, six-month, 10% interest-bearing note payable was signed on October 1, 2010.
No adjusting entries have been made during the year.

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 3

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Chapter 009: Reporting and Interpreting Liabilities

85. Sharp Company borrowed $500,000 on a 6% one-year, interest bearing note dated
November 1, 2009. The annual accounting period ends on December 31. Assume that
adjusting entries are only made at December 31, the company's fiscal year end, give journal
entries for:
A. November 1, 2009.
B. December 31, 2009.
C. October 31, 2010.

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 3

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Chapter 009: Reporting and Interpreting Liabilities

86. Wolf Company borrowed $5,000 on an 8% (annual rate). interest-bearing note payable on
March 1, 2008. The maturity date of the note (and payment of all interest) is September 1,
2009. The accounting period ends December 31. Give the entry for each of the following
dates. Assume simple interest and that adjusting entries are made annually. Round to the
nearest dollar.
A. March 1, 2008
B. December 31, 2008
C. September 1, 2009.

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 3

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Chapter 009: Reporting and Interpreting Liabilities

87. The following data were provided by the detailed payroll records of Mountain
Corporation for the month of March 2009:

FICA taxes at a 7.65% rate (no employee had reached the maximum).
Required:
A. Give the March 31, 2009 entry to record the payroll and the related employee deductions.
B. Give the March 31, 2009 entry to record the employer's FICA payroll tax expense.

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 3

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Chapter 009: Reporting and Interpreting Liabilities

88. The following is a partial list of account balances for Coen, Inc. as of December 31, 2010

Required:
Prepare the liability section of Coen Inc.'s classified balance sheet for December 31, 2010.

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 3

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Chapter 009: Reporting and Interpreting Liabilities

89. The following data is available for Tommy's Toys for the years 2006 through 2009:

A. Calculate the accounts payable turnover ratio for the following years:
1. 2009
2. 2008
3. 2007
B. Calculate the number of days it is taking Tommy's Toys to pay their vendors (assume a
365 day year):
1. 2009
2. 2008
3. 2007
C. Explain whether Tommy's Toys is doing a better job of paying their vendors in a timely
manner.
A1. 7.34($7,506/ [1,023 + 1,022]/2)
A2. 8.05 ($7,646/ [1,022 + 878]/2)
A3. 8.79 ($7,799/ [878 + 896]/2).
B1. 50 days (365/7.34)
B2. 45 days (365/8.05)
B3. 42 days (365/8.79).
C. Over the three year period, Tommy's Toys accounts payable turnover ratio has decreased
and the number of days it takes them to pay vendors has increased from 42 in 2007 to 50 days
in 2009. If their suppliers offer them credit terms of 30 days, then Tommy's Toys is taking
almost twice that time to pay them. It would be a good idea to compare the accounts payable
turnover ratio of competitors with that of Tommy's Toys to see if they are in line with other
similar companies.

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 3

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Chapter 009: Reporting and Interpreting Liabilities

90. Answer the following four questions.


A. What is a contingent liability?
B. When must a contingent liability be recorded through a journal entry?
C. When should a contingent liability be disclosed in the footnotes to the financial statements?
D. When is disclosure of a contingent liability not required?
A. Contingent liabilities are potential liabilities that arise due to past events.
B. Whether or not the potential liability becomes a recorded liability depends upon the
outcome of future events. For example, a company is currently involved in a product liability
lawsuit. The company may have to pay the plaintiff if the settlement is unfavorable. A
contingent liability must be recorded if it is probable that the future events will occur and the
amount can be reasonably estimated.
C. Contingent liabilities should be disclosed in the footnotes to the financial statements if it is
probable that future events will occur but the amount cannot be reasonably estimated.
Footnote disclosure should also occur if it is reasonably possible that the future events will
occur whether or not it can be reasonably estimated.
D. Disclosure is not required if the probability of future events occurring is remote.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 5

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Chapter 009: Reporting and Interpreting Liabilities

91. In a recent year, The Walt Disney Company reported the following increases or decreases
in current assets and current liabilities. Identify whether each of these increases or decreases
caused cash to increase or decrease. Show increases with a (+) in front of the amount and
decreases with a (
) in front of the amount in the column labeled cash effect.

(1) +$366, (2) +$103, (3)

$848, (4)

$179, (5) +$292, (6) +$69.

AACSB Tag: Analytic


Difficulty: Easy
L.O.: 6

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Chapter 009: Reporting and Interpreting Liabilities

92. Melissa is considering several possible investment alternatives when the market rate of
interest is 8%.
Option 1: Melissa could receive $10,000 today.
Option 2: Melissa could receive $3,000 at the end of each year for four years.
Option 3: Melissa could receive $15,000 five years from now.

Required:
A. Calculate the present value of each option assuming Melissa can earn 8% on any of the
investment funds.
B. Which option results in the greatest financial benefit to Melissa?

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 8

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Chapter 009: Reporting and Interpreting Liabilities

93. Meade Company has accumulated a cash fund to use for future expansion. The following
accumulation schedule for the fund was prepared. The column titles are omitted on purpose:

Required:
Refer to the schedule above and respond to the following questions.
A. What was the fund's goal in dollars?
B. What was the annual contribution to the fund?
C. What interest rate was earned?
D. What amount of interest was earned in 2006? 2008?
E. Give the entry on 12/31/2007.
A. $22,001
B. $4,811
C. $433
$4,811 = 9%
$905
$10,055 = 9%
$1,419
$15,771 = 9%
D. 2006: -0-; 2008: $905

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 8

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Chapter 009: Reporting and Interpreting Liabilities

94. Border Company purchased a truck that cost $17,000. The company signed a $17,000
note payable that specified four equal annual payments (at each year-end), each of which
includes a payment on the principal and interest on the unpaid balance at 10% per annum. The
present value of an annuity factor is 3.1699 (I = 10%, n = 4.)
A. Compute the amount of each equal payment (round to the nearest dollar).
B. Give the entry to record the purchase of the truck.
C. Give the entry to record the first annual payment on the note (assume no interest has been
accrued during the year).
D. Will the interest paid with the first annual payment be more or less than the interest paid
with the second annual payment? Explain your answer.
A. $17,000

3.1699 (present value of annuity) = $5,363

D. The interest paid on the first installment will be more than the interest on the second
payment because the principal is lower.

AACSB Tag: Analytic


Difficulty: Hard
L.O.: 9

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Chapter 009: Reporting and Interpreting Liabilities

95. Fold and Hold Corporation purchased a machine which had a current cash equivalent cost
of $38,971 on January 1, 2009. Fold and Hold paid cash of $10,000 and signed an interestbearing note for the balance, payable in six equal annual installments on each December 31
beginning with December 31, 2009. The note specified a 10% interest rate on the unpaid
balance. The present value of an annuity factor is 4.3553 (I = 10%, n = 6.)
A. Give the entry to record the purchase on January 1, 2009 (round to the nearest dollar).
B. Give the entry to record the first installment payment on December 31, 2009 (round to the
nearest dollar).

AACSB Tag: Analytic


Difficulty: Hard
L.O.: 9

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Chapter 009: Reporting and Interpreting Liabilities

96. Information Company purchased an asset that cost $70,000 on January 1, 2009.
Arrangements were made with the supplier to pay $10,000 cash on January 1, 2009, and the
balance was to be paid over a three-year period, with equal annual payments of $24,553 to be
made at the end of 2009, 2010, and 2011. Each payment will include principal plus interest on
the unpaid balance at 11% per year.
A. Complete the following table:

B. Give the entry for the payment on December 31, 2010.


C. Explain the change, over time, on the amount of interest and the balance of the debt
principal.

C. Interest decreases over time because part of each debt payment reduces principal. As a
result, over time the debt principal decreases each year.

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 9

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Chapter 009: Reporting and Interpreting Liabilities


97. On January 1, 2009, Mission Company agreed to buy some equipment from Anna
Company. Mission Company signed a note, agreeing to pay Anna Company $500,000 for the
equipment on December 31, 2011. The market rate of interest for this note was 10%.
Required:
A. Prepare the journal entry Mission Company would record on January 1, 2009 related to
this purchase.
B. Prepare the December 31, 2009, adjusting entry to record interest expense related to the
note for the first year. Assume that no adjusting entries have been made during the year.
C. Prepare the December 31, 2010, adjusting entry to record interest expense related to the
note for the second year. Assume that no adjusting entries have been made during the year.
D. Prepare the entry Mission Company would record on December 31, 2011, the due date of
the note to record interest expense for the third year and payment of the note. Assume that no
adjusting entries have been made during the year.

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Chapter 009: Reporting and Interpreting Liabilities

AACSB Tag: Analytic


Difficulty: Hard
L.O.: 9

98. Why are present value concepts and applications so important when companies purchase
equipment financed by the seller?
Present value concepts are very important in seller-financed purchases because the debt
payments will include principal and interest payments. The equipment should be capitalized at
an amount equal to the present value of the purchase. That is, the asset account should reflect
what the equipment could have been acquired for in terms of "today's dollars". The additional
amounts for interest are charges for borrowing. These interest amounts should be reported as
interest expense as incurred.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 9

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Chapter 009: Reporting and Interpreting Liabilities

99. The following table values are provided for use in solving the following independent
problems (show computations):

A. Company A deposited $20,000 in a savings account on January 1, 2009, that will


accumulate 6% interest each December 31.
What will be the fund balance at the end of Year 5?
How much interest will be earned by the end of Year 5?
B. Company B needs to accumulate a $50,000 fund by making five equal annual deposits.
Assuming a 7% interest accumulation, how much must be deposited at the end of each year?
C. Company C has a new machine that has an estimated life of five years and a $5,000
residual value. Assuming an 8% interest rate, what is the present value of the estimated
residual value?
D. Company D owes a $50,000 debt that is now due (January 1, 2009). Arrangements have
been made to pay it off in five equal annual installments starting December 31, 2009 (an
ordinary annuity situation).
1. Assuming 8% interest, how much will be the annual payment?
2. Give the entry for Company D above for the first payment on December 31, 2009 on the
note payable. Assume that no adjusting entries have been made during the year.
A. 1. $20,000
1.3382 (Fn = 5; I = 6%) = $26,764.
2. $26,764 20,000 = $6,764.
B. $50,000
5.7507 (Fn = 5; I = 7%) = $8,695.
C. $5,000
0.6806 (Pn = 5; I = 8%) = $3,403.
D.

AACSB Tag: Analytic


Difficulty: Hard
L.O.: Sup. D

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Chapter 009: Reporting and Interpreting Liabilities

100. At the beginning of Year 1, Parks Corporation placed $10,000 in a savings account at
9%.

A. Assuming no withdrawals, complete the following tabulation (round to the nearest dollar).

B. Give the required journal entry at the end of Year 10 to record only the year 10 earnings:

AACSB Tag: Analytic


Difficulty: Medium
L.O.: Sup. D

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Chapter 009: Reporting and Interpreting Liabilities

Matching Questions
101. Match the liabilities with their usual classification on the balance sheet.
1. Bond payable, current portion
2. Mortgage payable (due in two years)
3. FICA taxes payable
4. Accounts payable
5. Notes payable (due in three years)
6. Rent payable
7. Interest payable
8. Income tax payable
9. Accounts receivable
10. Accumulated depreciation
11. Cash deposits (advances) received from customers
for services to be performed in six months
12. Employee income taxes withheld
13. Bond payable (due in six years)
14. Allowance for doubtful accounts
15. Deferred income tax (a credit balance)

Current liability
Current liability
Current liability
Long-term liability
Current liability
Long-term liability
Current liability
Long-term liability
Current or longterm liability
Not a liability

6
3
7
2
1
5
11
13

Current liability
Not a liability
Current liability
Not a liability
Current liability

12
9
4
14
8

15
10

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 1

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Chapter 009: Reporting and Interpreting Liabilities

102. Indicate the interest concept which each of the following items exemplifies.
1. A single sum is deposited to create a fund at the end of
three years. The amount of the fund is to be determined
2. A current debt is to be paid in four equal installments at the
end of each of the next four years. The amount of each
installment is to be determined
3. An equal amount is deposited in a savings account at the
end of each year in order to accumulate a fund for a trip to
Japan at the end of the fourth year. The amount of the annual
deposit is to be determined
4. The cash equivalent price of a machine is to be determined
assuming a specified single sum is to be paid two years after
the acquisition date

Present value
of $1. 4
Future value
of $1. 2
Future value
of annuity of
$1. 3
Present value
of annuity of
$1. 1

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: Sup. D

9-51
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