Question 1

Recognizing the obligation for product warranties is a claims exchange transaction.

Accepted Answer

Recognizing the obligation for product warranties is a situation where a buyer expects a product to function as intended, and when it doesn't, they can make a claim for repair, replacement, or refund under the product's warranty. This involves a claims exchange transaction between the buyer and the retailer or manufacturer.

Question 2

Vacation pay is considered a contingent liability to the extent that the obligation exists due to work already performed.

Accepted Answer

False

Question 3

Payment of interest on a note payable is considered a financing activity on the statement of cash flows.

Accepted Answer

Payment of interest on a note payable is considered an operating activity on the statement of cash flows, as it relates to the cost of borrowing money for business operations.

Question 4

When calculating interest expense on a 6-month note, multiply the principal by the interest rate, and then multiply by 6/12.

Accepted Answer

This is correct because interest expense is calculated based on the principal amount and interest rate, and it is usually expressed as an annual rate. Since a 6-month note is half a year, you would need to multiply the annual interest rate by 6/12 to get the interest expense for that period.

Question 5

In September of Year 1, Hansen Company issued a note payable to borrow money from its bank. Principal and interest on the note would come due in June Year 2. Interest expense on this note must be accrued at the end of Year 1 for the period from issuance of the note to the last day of the accounting period.

Accepted Answer

Interest must be accrued on the note payable from the date of issuance to the end of the accounting period, which is Year 1. This is necessary to properly record the interest expense that has been incurred but not yet paid.

Question 6

Flora's Flower Market sells eight potted petunias to a customer for $50.00, plus 5% sales tax. Flora's will recognize $52.50 in sales revenue.

Accepted Answer

Only the $50 selling price is considered revenue.The $2.50 of sales tax collected is recorded as a liability (sales tax payable).

Question 7

All lawsuits in which a company has been named a defendant should be either disclosed in the company's notes to the financial statements, or recognized as a liability on its balance sheet.

Accepted Answer

If the likelihood of a future obligation arising is remote,which might be the case with a frivolous lawsuit,no liability need be recognized in the financial statements or disclosed in the notes to the statements.

Question 8

At the end of Year 1, Durango Company recognized its obligation under product warranties. During Year 2, it replaced products to its customers under the terms of the warranties. The Year 2 warranty settlements should be recorded as asset use transactions.

Accepted Answer

The Year 2 warranty settlements represent the fulfillment of the company's previously recognized warranty obligation, leading to a reduction in the liability and the use of assets (such as inventory or cash) to settle the warranty claims, thus being recorded as asset use transactions.

Question 9

Davis Corporation borrowed $50,000 on January 1, Year 1. The loan is for a ten-year period and has an annual interest rate of 9%. At the end of each year, Davis will make a payment of $7,791, which includes both principal and interest. The amount of the payment for Year 1 that is reduction of principal is $3,587.

Accepted Answer

The amount of the payment for Year 1 that is reduction of principal can be calculated as follows:

Payment amount - (Beginning balance x Interest rate) = Principal reduction
$7,791 - ($50,000 x 0.09) = $2,791

Therefore, the correct answer is B, and the statement in the question is false.

Question 10

Loans that require payment of interest at regular intervals and payment of principal at maturity are installment notes.

Accepted Answer

Installment notes require the borrower to make regular payments that include both principal and interest over the term of the loan, not just interest payments with principal paid at maturity.

Question 11

A classified balance sheet is one that distinguishes between operating and non-operating assets.

Accepted Answer

A classified balance sheet distinguishes between current and non-current assets and liabilities, but does not necessarily distinguish between operating and non-operating assets.

Question 12

If a company offers a warranty on the products it sells, the company records the warranty expense at the time that the warranty service is provided to customers under the terms of the warranty.

Accepted Answer

The company records the estimated warranty expense at the time of sale, as part of the cost of goods sold. The actual warranty expenses are incurred later when the warranty service is provided to customers.

Question 13

Joseph Company is preparing to repay a one-year note on May 1, Year 1. The first step in this process is to accrue eight months of interest expense.

Accepted Answer

When preparing to repay a one-year note, the interest expense should be accrued for the entire period the note has been outstanding, not just for a portion of it, unless the note has only been outstanding for eight months by the repayment date.

Question 14

For a long-term note payable, repaying a portion of principal along with interest payments is called loan amortization.

Accepted Answer

Loan amortization involves paying back both principal and interest over the course of the loan, typically through a series of regular payments.

Question 15

Davis Corporation borrowed $50,000 on January 1, Year 1. The loan is for a ten-year period and has an annual interest rate of 9%. At the end of each year, Davis will make a payment of $7,791, which includes both principal and interest. The amount of the payment for Year 1 that is interest expense is $4,500.

Accepted Answer

The total payment of $7,791 includes both principal and interest. The interest expense for Year 1 is given as $4,500, which is calculated as follows:

Total payment for Year 1 = $7,791 
Principal payment for Year 1 = Total payment - Interest expense 
Principal payment for Year 1 = $7,791 - $4,500 = $3,291

Therefore, the amount of the payment for Year 1 that is interest expense is $4,500.

Question 16

If a company is located in an area where floods or earthquakes are deemed to be possible, the company should record a contingent liability.

Accepted Answer

A contingent liability is recorded only if the event is probable and the amount can be reasonably estimated. Simply being located in an area where floods or earthquakes are possible does not meet these criteria unless a specific event has occurred or is imminent that would make a liability probable and estimable.

Question 17

Vogle Company purchased $8,000 of equipment by making a $500 down payment and issuing a note for the remainder. As a result of this event, assets increased by $8,000.

Accepted Answer

Assets increased by $7,500 because the equipment purchase increased assets by $8,000, but the $500 down payment decreased cash (also an asset) by $500, resulting in a net increase in assets of $7,500.

Question 18

Contingent liabilities are only recognized if they arise from past events.

Accepted Answer

Contingent liabilities are potential obligations that may arise from past events, but their existence and amount are uncertain and will be confirmed only by future events that are not completely within the control of the entity. Therefore, recognizing contingent liabilities is based on past events, but the actual obligation will only arise in the future if certain conditions are met.

Question 19

Sales tax is reported as revenue when it is collected, and reported as an expense when it is paid.

Accepted Answer

Sales tax collected from customers is not reported as revenue; it is a liability until it is remitted to the government.

Question 20

Monthly remittance of sales tax due has no impact on the income statement, but reduces cash flow from operating activities.

Accepted Answer

Monthly remittance of sales tax is a liability and does not affect the income statement. However, it affects cash flow from operating activities because it is a cash outflow.

Quiz 7: Accounting for Liabilities