Week 1
Week 1
information on the subjects discussed. Some information is compiled from different materials and
summarized from different books. Some information is based on contributors' perspective and
understanding. References are provided for informational purposes only and do not constitute
endorsement of websites or other sources. Readers should be aware that the websites/electronic
references listed in this course material may change. Hence, the contributors do not claim any
information presented in the materials and do not reflect their own work.
No. of Units: 6
Class Schedule: MTH / 9:00-1:00pm
SM Baliwag Complex, Dona Remedios Trinidad Highway, Brgy. Pagala, Baliwag, Bulacan
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MODULE 1
LIABILITIES
I. Pre-Test
Problem 1-1
On December 21,2020, Glare Company provided the following information:
Accounts payable. including deposit and advances
from customer of P250,000 1,250,000
Notes payable, including note payable to bank due on
December 31, 2022 of P500,000 1,500,000
Share dividend payable 400,000
Credit balances in customer’s account 200,000
Serial bonds payable in semiannual installment of P500,000 5,000,000
Accrued interest on bonds payable 150,000
Contested BIR tax assessment – possible obligation 300,000
Unearned rent income 100,000
Required:
Compute the total current liabilities on December 31,2020.
Problem 1-2
Easy Company provided the following information on December 31,2020:
Notes payable
Trade 3,000,000
Bank loans 2,000,000
Advances from officers 500,000
Accounts payable – trade 4,000,000
Bank overdraft 300,000
Dividends payable 1,000,000
Withholding tax payable 100,000
Mortgage payable 3,800,000
Income tax payable 800,000
Estimated warranty liability 600,000
Estimated damages payable y reason of breach of contract 700,000
Accrued liabilities 900,000
Estimated premium liability 200,000
Claim for increase of wages by employees covered in a pending lawsuit 3,500,000
Contract entered into for the construction of building 5,000,000
Required:
Compute the total current liabilities on December 31, 2020.
SM Baliwag Complex, Dona Remedios Trinidad Highway, Brgy. Pagala, Baliwag, Bulacan
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II. Learning Outcomes
ü To understand the concept of liabilities.
ü To describe the nature and type of current and noncurrent liabilities.
ü To explain the issue of long-term debt falling due within one year.
ü To explain the issue of breach of covenants attached to a long-term debt.
ü To describe formulas in computing bonus to officers and employees
III. Content:
LIABILITIES
Definition of Liabilities
Liabilities are present obligations of an entity to transfer an economic resource as a result of past events.
Accordingly, the essential characteristics of an accounting liability are:
a. The entity has a present obligation.
An obligation is a duty or responsibility that an entity has no practical ability to avoid.
The entity liable must be identified but it is not necessary that the payee to whom the obligation
is owed be identified.
b. The obligation is to transfer an economic resource.
This is the very heart of the definition of an accounting liability.
The economic resource is the asset that represents a right with a potential to produce economic
benefits.
Specifically, the obligation must be to pay cash, transfer noncash asset or provide service at some
future time
c. The liability arises from a past event.
This means that the liability is not recognized until it is incurred.
Present obligation
µ The present obligation may be a legal obligation or a constructive obligation.
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Transfer of an economic resource
Past event
& Liability must arise from a past transaction or event.
& The past event that leads to a legal or constructive obligation is known as an obligating event.
& The obligating event creates a present obligation because the entity has no realistic alternative
but to settle the obligation created by the event.
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Examples of liabilities
The more common type of liabilities includes the following:
a. Accounts payable to suppliers for the purchase of goods
b. Amounts withheld from employees for taxes and for contributions to the Social Security System,
Philhealth, Pag-ibig, BIR.
c. Accruals for salaries, interest, rent, taxes, product warranties and profit-sharing bonus
d. Cash dividends declared but not paid
e. Deposits and advances from customers
f. Debt obligations for borrowed funds – notes, mortgages, and bonds payable
g. Income tax payable
h. Unearned revenue
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Current liabilities vs. non-current liabilities
Current Liabilities Non-current liabilities
PAS 1, paragraph 69, provides that the entity shall The term noncurrent liability is a residual
classify a liability as current when: definition.
a. The entity expects to settle the liability
within the entity’s operating cycle.
b. The entity holds the liability primarily to
the purpose of trading.
c. The liability is due to be settled within
twelve months after the reporting period.
d. The entity does not have an unconditional
right to defer settlement of the liability for
at least twelve months after the reporting
period.
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Illustration 1: Current liabilities
ABC Co. has the following liabilities as of December 31, 20x1.
a. Trade accounts payable, net of debit balance in supplier's
account of P5,000, net of unreleased checks of P4,000, and net of
postdated checks of P2,000. P300,000
b. Credit balance in customers' accounts 2,000
c. Financial liability designated at FVPL 50,000
d. Bonds payable (maturing in 10 equal annual
installments of P100,000) 1,000,000
e. 12%, 5-year note payable issued on October 1, 20x1 100,000
f. Deferred tax liability 5,000
g. Unearned rent 4,000
h. Contingent liability 10,000
i. Reserve for contingencies 25,000
Solution:
a. Trade accounts payable gross of debit balance, unreleased
check, and postdated check (300K + 5K+ 4K + 2K). P311,000
b. Advances from customers (Cr. bal. in customers' accounts) 2,000
c. Financial liability designated at FVPL 50,000
d. Current portion of bonds payable 100,000
e. Interest payable on the note in 'e' (P100,000 x 12% x 3/12) 3,000
g. Unearned rent 4,000
Total current liabilities P470,000
Notes:
ü Deferred tax liabilities are always presented as noncurrent when an entity presents a classified
statement of financial position.
ü Contingent liability is not recognized but rather disclosed only in the notes.
ü Reserve for contingencies is an appropriation of retained earnings and, thus, presented in equity.
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h. Advances from affiliates payable in 15 months after year-end 23,000
i. Loan of XYZ, Inc. guaranteed by ABC - it is possible
that ABC will be held liable for the guarantee 45,000
Solution:
a. Trade accounts payable, net of cost of goods received
on consignment (300,000 - 10,000) P290,000
b. Held for trading financial liabilities 50,000
c. Bank overdraft 10,000
d. Income tax payable 50,000
e. Accrued expenses 5,000
Total current liabilities P405,000
Notes:
ü Deferred revenue is similar to unearned revenue except that deferred revenue is long-term.
ü Share dividends payable (stock dividends payable) is not a liability but rather an adjunct equity
account (i.e., presented as addition to share capital).
ü The guarantee on the loan is not recognized as liability because it is not probable (i.e, it is possible
only) that ABC will be held liable for the guarantee.
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Ø Refinancing refers to the replacement of an existing debt with a new one but with different terms,
e.g., an extended maturity date or a revised payment schedule.
Ø Refinancing normally entails a fee or penalty.
Ø A refinancing where the debtor is under financial distress called "troubled restructuring."
A liability which is due to be settled within twelve months after the reporting period is classified as non-
current, WHEN:
Refinancing on a long-term completed on or before the end Noncurrent.
basis of the reporting period
The entity has the discretion to for at least twelve months after Noncurrent.
refinance or roll over an the reporting period under an
obligation existing loan facility
If the entity has an to defer settlement of the Noncurrent.
unconditional right under the liability for at least twelve
existing loan facility months after the reporting
period
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Illustration: Refinancing
Fact pattern
ABC Co. has a 10%, P1,000,000 loan payable as of December 31, 20x1 that is maturing on July 1, 20x2.
Interest on the loan is due every July 1 and December 31.
Case 1: No discretion
On February 1, 20x2, ABC Co. entered into a refinancing agreement with a bank to refinance the
loan on a long-term basis. Both parties are financially capable of honoring the agreement's
provisions. ABC's financial statements were authorized for issue on March 15, 20x2.
Question: How much is presented as current liability in relation to the loan in ABC's 20x1 year-end
financial statements?
Answer: P1,000,000, the refinancing agreement is not at the discretion of ABC. The currently maturing
obligation is presented as current liability.
Case 2: With discretion
On February 1, 20x2, ABC Co. entered into a refinancing agreement with a bank to refinance
the loan on a long-term basis, both parties are financially capable of honoring the agreement's
provisions. ABC has the discretion to refinance or roll over the loan for at least twelve months
from December 31, 20x1 under an existing loan facility. ABC's financial statements were
authorized for issue on March 15, 20x2.
Question: How much is presented as current liability in relation to the loan in ABC's 20x1 year-end
financial statements?
Answer: None, the refinancing agreement is at the discretion of ABC. The loan payable is presented as
noncurrent.
Question: How much is presented as current liability in relation to the loan in ABC's 20x1 year-end
financial statements?
Answer: None, the refinancing is completed as of the end of reporting period. The loan payable is
presented as noncurrent.
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Covenants
µ Covenants are often attached to borrowing agreements which represents undertakings by the
borrower.
µ These covenants are restrictions on the borrower as to undertaking further borrowings, paying
dividends, maintaining specified level of working capital and so forth.
Breach of covenants
& Under these covenants, if certain conditions relating to the borrower’s financial situation are
breached, the liability becomes payable on demand.
The term trade and other payables is a line item for accounts payable, notes payable, accrued interest
on note payable, dividends payable and accrued expenses.
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Estimated liabilities
° Estimated liabilities are obligations which exist at the end of reporting period although their
amount is not definite.
° In many cases, the date when the obligation is due is not also definite and in some instances, the
exact payee cannot be identified or determined.
° But despite these circumstances, the existence of the estimated liabilities is valid and
unquestioned.
° Estimated liabilities are either current or noncurrent in nature,
° Examples include estimated liability for premium, award points, warranties, gift certificates and
bonus.
Deferred revenue
° Deferred revenue or unearned revenue is income already received but not yet earned.
° If the unearned revenue is realizable within one year, it is a current liability.
° Typical examples or current unearned/deferred revenue are unearned interest income, unearned
rental income, and unearned subscription revenue.
° If the deferred revenue is realizable in more than one year, it is classified as noncurrent liability.
° Typical examples of noncurrent deferred revenue are unearned revenue from long-term service
contracts and long-term leasehold advances.
Illustration
An entity sells equipment service contacts agreeing to service equipment for 2-year period.
Cash receipts from contracts are credited to unearned service revenue and service contract costs are
charged to service contract expense.
Revenue from service contracts is recognized as earned over the service period of the contract.
The following transactions occur in the first year:
Cash receipts from service contracts sold 1,000,000
Service contact costs paid 500,000
Service contact revenue recognized 800,000
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Gift certificate
Many megamalls, department stores and supermarkets sell gift certificates which are redeemable in
merchandise. The accounting procedure are:
1. When the gift certificates are sold:
Cash xx
Gift certificates payable xx
The latter amount is a current liability.
3. When the gift certificates expire or when gift certificates are not redeemed:
Gift certificates payable xx
Forfeited gift certificates xx
The Philippine Department of Trade Industry ruled that gift certificates no longer have an
expiration period.
Bonus computation
& Large entities often compensate key officers and employees by way of bonus for superior income
realized during the year.
& The main purpose of this scheme is to motivate officers and employees by directly relating their
well-being to the success of the entity.
& This compensation plan results in liability that must be measured and reported in the financial
statements. The bonus computation usually has four variations:
1. Bonus is expressed as a certain percent of income before bonus and before tax.
2. Bonus is expressed as a certain percent of income after bonus but before tax.
3. Bonus is expressed as a certain percent of income after bonus and after tax.
4. Bonus is expressed as a certain percent of income after tax but before bonus.
Illustration
Income before bonus and after tax 4,400,000
Bonus 10%
Income tax rate 30%
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Case 2 – After bonus but before tax
B = .10 (4,400,000 – B)
B = 440,000 - .10B
B + .10B = 440,000
1.1B = 440,000
B = 440,000/1.10
B = 400,000
Proof
Income before bonus and before tax 4,400,000
Less: Bonus 400,000
Income after bonus but before tax 4,000,000
Multiply by 10%
Bonus 400,000
Proof
Income before bonus and before tax 4,400,000
Bonus (287,850)
Tax (1,233,645)
Income after bonus and after tax 2,878, 645
Multiply by 10%
Bonus 287,850
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(+63) 927-533-0342 – (+63) 923-949-5265 [email protected]
Case 4 – After tax but before bonus
B = .10 (4,400,000 – T)
T = .30 (4,400,000 – B)
B = .10 (4,400,000 - .30 (4,400,000 – B)
B = .10 (4,400,000 – 1,320,000 + .30B)
B = 440,000 – 132,00 + .03B
B - .03B = 440,000 – 132,000
.97B = 308,000
B = 308,000 / .97
B = 317,526
Proof
Income before bonus and before tax 4,400,000
Tax (4,400,000 – 317,526 x 30%) 1,224,742
Income after tax but before bonus 3,175,258
Multiply by 10%
Bonus 317,526
Refundable deposits
& Refundable deposits consist of cash or property received from customers, but which are
refundable after compliance with certain condition.
& The best example of a refundable deposit is the customer deposit required for returnable
containers like bottles, drums, tanks, and barrels.
Illustration
A deposit of P10,000 is required from the customer for returnable containers. the containers cost P8,0000.
Cash 10,000
Container’s deposit 10,000
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IV. Activity – Supplementary
Required:
Compute the total current liabilities on December 31,2020.
Required:
Compute the total current liabilities on December 31, 2020.
SM Baliwag Complex, Dona Remedios Trinidad Highway, Brgy. Pagala, Baliwag, Bulacan
(+63) 927-533-0342 – (+63) 923-949-5265 [email protected]
Problem 1-3 (IAA)
Manchester Company provided the following information on December 31, 2020:
Income taxes withheld from employees 900,000
Cash balance at First State Bank 2,500,000
Cash overdraft at Harbor Bank 1,300,000
Accounts receivable with credit balance 750,000
Estimated expenses of meeting warranties on merchandise previously sold 500,000
Estimated damages as a result of unsatisfactory performance on a contract 1,500,000
Accounts payable 3,000,000
Deferred serial bonds, issued at par and bearing interest at 12%, payable in
semiannual installment of P500,000 due April 1 and October 1 of
each year, the last bond to be paid on October 1, 2026. Interest is also
paid semiannually. 5,000,000
Stock dividend payable 2,000,000
Required:
Compute the total current liabilities on December 31, 2020.
Required:
1. Compute total current liabilities.
2. Compute total noncurrent liabilities.
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However, the call option is not expected to be exercised given the prevailing market condition.
The 10% note payable is due on March 31, 2022. A debt covenant requires Cordillera Company to
maintain current assts at least equal to 150% of current liabilities.
On December 31,2020, Cordillera Company is in violation of this covenant.
However, Cordillera Company obtained a waiver from the creditor until June 2021 having convinced the
creditor that Cordillera’s normal 2 to 1 ratio of current assts to current liabilities will be reestablished
during the first half of 2021.
The 11% note payable matures on June 0, 2021. On January 31, 2021, before the issuance of the 2020
financial statements, the note payable was refinanced on a long-term basis.
Required:
Explain the appropriate classification of the notes payable as current or noncurrent in the statement of
financial position on December 31, 2020.
Required:
1. Present the liabilities on December 31, 2020.
2. Describe any financial statement disclosures.
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Problem 1-7 (IAA)
Cavalier Company provided the following information on December 31, 2020:
Accounts payable 6,500,000
Notes payable – bank 8,000,000
Interest payable 150,000
Mortgage note payable – 10% 2,000,000
Bonds payable 4,000,000
• Bank notes payable include two separate notes payable to First Bank.
A P3,000,000, 10% note issued March 1, 2019, payable om demand. Interest is payable every six
months.
A one-year, P5,000,000, 11% note issued January 2, 2020. On December 31, 2020, the entity
negotiated a written agreement with First Bank to replace the note with 2-year, P5,000,000, 10%
note to be issued January 2, 2021.
• The 10% mortgage note was issued October 1, 2019, with a term of 10 years.
Terms of the note give the holder the right to demand immediate payment if the entity fails to
make a monthly interest payment within 10 days of the date the payment is due
On December 31, 2020, the entity is three months behind in paying the required interest payment,
• The bonds payable is 10-year, 8% bonds, issued June 30, 2011. Interest is payable semiannually
on June 30 and December 31.
Required:
Compute the total current liabilities on December 31, 2020.
V. Activity/Assessment – Visit the MS Teams
Problem 1-8 (IAA)
Burma Company disclosed the following information about liabilities at year-end:
Accounts payable, after deducting debit balances in supplier’s
accounts amounting to P100,000 4,000,000
Accrued expenses 1,500,000
Credit balances of customer’s accounts 500,000
Share dividend payable 1,000,000
Claims for increase in wages and allowance by employees of
the entity, covered in pending lawsuit 400,000
Estimated expenses in redeeming prize coupons presented by customers 600,000
What total amount should be presented as current liabilities at year-end?
a. 6,700,000 c. 7,100,000
b. 6,600,000 d. 7,700,000
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Problem 1-9 (IAA)
Gar Company disclosed the following liability account balances on December 31,2020:
Accounts payable 1,900,000
Bonds payable 3.400.000
Premium on bond payable 200,000
Deferred tax liability 400,000
Dividends payable 500,000
Income tax payable 900,000
Note payable, due January 31, 2021 600,000
On December 31, 2020, what total amount should be reported as current liabilities?
a. 7,100,000 c. 3,900,000
b. 4,300,000 d. 4,100,000
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a. 8,000,000 c. 3,000,000
b. 5,000,000 d. 0
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Short-term borrowings 400,000
Mortgage payable, current portion P100,000 3,500,000
Bank loan payable, due June 30, 2021 1,000,000
The P 1,000,000 bank loan was refinanced with a 5-year loan on January 15,2021, with the first principal
payment due January 15, 2022.
The financial statements were issued February 28, 2021.
What total amount should be reported as current liabilities on December 31, 2020?
a. 1,150,000 c. 1,250,000
b. 2,250,000 d. 850,000
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c. 1,000,000 d. 500,000
2. What amount should be reported as deferred service revenue on December 31, 2020?
a. 540,000 c. 360,000
b. 480,000 d. 300,000
3. What is the contract revenue for 2021?
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a. 180,000 c. 300,000
b. 360,000 d. 120,000
4. What is the contract revenue for 2022?
a. 240,000 c. 180,000
b. 360,000 d. 0
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Weaver Company sells magazine subscriptions for a 1-year, 2-year or 3-year period
Cash receipts from subscribers are credited to magazine subscriptions collected in advance and this
account had a balance of P1,700,000 on January 1, 2020.
The entity provided the following information for the year ended December 31, 2020:
Cash receipts from subscribers 2,100,000
Magazine subscriptions revenue
Credited on December 31, 2020 1,500,000
On December 31, 2020, what amount should be reported as the balance for magazine subscriptions
collected in advance?
a. 1,900,000 c. 1,400,000
b. 2,300,000 d. 2,100,000
2020 2021
Sales 420,000 500,000
Less cancelations 20,000 30,000
Net sales 400,000 470,000
Subscription expirations:
2020 120,000
2021 155,000 130,000
2022 125,000 200,000
2023 140,000
400,000 470,000
1. On December 31, 2021, what amount should be reported as unearned subscription revenue?
a. 495,000 c. 465,000
b. 470,000 d. 340,000
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Farr Company sells products with reusable and expensive containers. The customer is charged a deposit
for each container delivered and receives a refund for each container returned within two years after the
year of delivery.
Containers held by customers on January 1, 2020, from deliveries in:
2018 75,000
2019 215,000 290,000
Containers delivered in 2020 390,000
What amount should be reported as current liability for advances from customers at year-end?
a. 1,480,000 c. 880,000
b. 1,380,000 d. 0
SM Baliwag Complex, Dona Remedios Trinidad Highway, Brgy. Pagala, Baliwag, Bulacan
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Problem 1-27 Adapted
Kent Company, a realty entity, maintains escrow accounts and pays real estate taxes for the mortgage
customers. Escrow funds are kept in interest-bearing accounts. Interest, less a 10% service fee, is credited
to the mortgagee's account and used to reduce future escrow payments.
The entity provided the following additional information for the current year:
Escrow accounts liability, January 1 700,000
Escrow payments received 1,580,000
Real estate taxes paid 1,720,000
Interest on escrow funds 50,000
What amount should be reported as escrow accounts liability on December 31?
a. 510,000 c. 605,000
b. 515,000 d. 610,000
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4. Bonus is certain percent of income after tax but before bonus.
but after deducting the bonus. The income before income tax and the bonus is P3,200,000.
What is the amount of the bonus?
a. 220,000 c. 320,000
b. 200,000 d. 440,000
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c. One that comes into existence due to a gain contingency:
d. One to be paid in cash and for which the amount and timing are known.
5. Which situation would not require that noncurrent liabilities be reported as current?
a. The long-term debt is callable by the creditor.
b. The creditor has the right to demand payment due to a contractual violation.
c. The long-term debt matures within the upcoming year•
d. All of these require the current classification,
8. Which of the following is a characteristic of a current liability but not a noncurrent liability?
a. Unavoidable obligation.
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b. Present obligation to transfer an economic resource.
c. Settlement is expected within the normal operating cycle or within 12 months,
whichever is longer.
d. The obligating event has already occurred.
2. At year-end, an entity has 120-day note payable outstanding. The entity has followed the policy of
replacing the note rather than repaying it over the last three years. The entity's treasurer says that this
policy is expected to continue indefinitely, and the arrangement is acceptable to the bank to which the
note was issued. What is the proper classification of the note in the year-end statement of financial
position?
a. Dependent on the intention of management
b. Dependent on the actual ability to refinance
c. Current liability, unless specific refinancing criteria are met
d. Noncurrent liability
3. An entity had a note payable due next year. After the end of reporting period and before the issuance
of the current year financial statements, the entity issued long-term bonds payable. Proceeds from the
bonds were used to repay the note when due. How should the entity classify the note payable at current
year-end?
a. Current liability with separate disclosure of the note refinancing
b. Current liability with no disclosure required
c. Noncurrent liability with separate disclosure of the note refinancing
d. Noncurrent liability with no separate disclosure required
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4. An entity has a loan due for repayment in six months' time, but the entity has the option to refinance
for repayment two years later. The entity plans to refinance this loan. In which section of the statement
of financial position should this loan be presented?
a. Current liabilities c. Noncurrent liabilities
b. Current assets d. Noncurrent assets
5. At year-end, an entity classified a note payable as current liability. Under what condition could the
entity reclassify note payable from current to noncurrent?
a. the entity has the intent and ability to reclassify the note before the end of reporting period.
b. If the entity has executed an agreement to refinance the note before issuance of the financial
statements.
c. If the entity has the intent and ability to rec1assify the note before the issuance of the financial
statements.
d. If the entity has executed an agreement to refinance the note before the end of reporting period.
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c. Current liability if the creditor intends to call the deb within one year
d. Current liability if it is probable that the creditor call the debt within one year
3. All else equal, a large increase in unearned revenue in the current period would be expected to
produce what effect on revenue in a future period?
a. Large increase because unearned revenue becomes revenue when earned.
b. Large decrease because unearned revenue implies that less revenue has been earned which
reduces revenue.
c. No effect because unearned revenue is a liability.
d large decrease because unearned revenue indicates collection problems that will reduce net
revenue in future period.
4. When a product is delivered for which a customer advance has been previously received, the
appropriate journal entry includes
a. A debit to revenue and credit to liability
b. A debit to revenue and credit to asset
c. A debit to asset and credit to revenue
d. A debit to liability and credit to revenue
5. When cash is received from customers in the form of a refundable deposit, the cash account is
increased with a corresponding increase in
a. Current liability c. Shareholders' equity
b. Revenue d. Contributed capital
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c. Revenue account should be decreased
d. Revenue account should be increased
2. A retail store received cash and issued gift certificates that are redeemable in merchandise. How
would the deferred revenue account be affected by the redemption and non-redemption of certificates,
respectively?
a. Decrease and No effect c. No effect and No effect
b. Decrease and decrease d. No effect and Decrease
3. An entity received an advance payment for special order goods that are to be manufactured and
delivered within six months. How should the advance; payment be reported?
a. Deferred charge c. Current liability
b. Contra asset account d. Noncurrent liability
4. At year-end, an entity sold refundable merchandise coupons. The entity received a. certain amount
for each coupon redeemable next year for merchandise with a certain retail price. At year-end, how
should the entity report these coupon transactions?
a. Unearned revenue at the merchandise's retail price
b. Unearned revenue at the cash received
c. Revenue at the merchandise's price
d. Revenue at the cash received
5. How would the proceeds received from the advance sale Of nonrefundable tickets for a theatrical
performance be reported in the statement of financial position before the performance?
a. Revenue for the entire proceeds
b. Revenue to the extent of related costs expanded
c. Unearned revenue to the extent of related costs expended
d. Unearned revenue for the entire proceeds
7. Under a royalty agreement with another entity, an entity will receive royalties from the assignment
of a patent for four years. The royalties received in advance should be reported as revenue
a. In the period received
b. In the period earned
c. Evenly over the life of the royalty agreement
d. At the date of the royalty agreement
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8. An entity is a retailer of home appliances and offers a service contract on each appliance sold.
Collections received for service contracts should be recorded as an increase in a
a. Deferred revenue account
b. Sales contracts receivable valuation account
c. Shareholders' equity valuation account
d. Service revenue account
9. An entity sells appliances that include a three-year warranty. Service calls under the warranty are
performed by an independent mechanic under a contract with the entity. Based on experience, warranty
costs are expected to be incurred for each machine sold. When should the entity recognize these
warranty costs?
a. Evenly over the life of the warranty
b. When the service calls are performed
c. When payments are made to the mechanic
d. When the machines are sold
10. At the end of the current year, an entity received an advance payment of 60% of the sales price for
special order goods to be manufactured and delivered within five months. At the same time, the entity
subcontracted for production of the special-order goods at a price equal to 40% of the main contract
price. What liabilities should be reported in the year-end statement of financial position?
a. None
b. Deferred revenue equal to 60% of the main contract price and payable to subcontractor
equal to 40% o the main contract price
c. Deferred revenue equal to 60% of the main contract price and no payable to
subcontractor
d. No deferred revenue but payable to subcontractor reported at 40% of the main contract
price
VI. References
Intermediate Accounting 2, 2020, Valix
Intermediate Accounting 2, 2020, Zeus Millan
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