Question 1

A loss contingency that is remote and cannot be reasonably estimated

Accepted Answer

A loss contingency that is remote and cannot be reasonably estimated may be disclosed in a note to the financial statements. Disclosure in the body of the financial statements is not required since the likelihood of the loss occurring is remote and the amount cannot be reasonably estimated. However, disclosure in a note provides users of the financial statements with information that may be relevant in evaluating the entity's financial position and potential risks.

Question 2

Which of the following is most likely to require only a note disclosure as a contingency?

Accepted Answer

A note disclosure is used for contingencies that are reasonably possible, but not probable. A remote chance of loss from a lawsuit in process meets this criteria, while the other options are either almost certain to occur (cash discounts) or probable (income tax refund) and therefore require accruals or recognition in the financial statements. Loss from an investment in equity securities that is certain would also require recognition in the financial statements.

Question 3

Which of the following liabilities is NOT contingent?

Accepted Answer

A liability to replace a specific defective television set already returned to the manufacturer is not contingent because it is a fully recognized liability that has already occurred and is considered to be fixed. The other options all involve uncertainties that need to be resolved before the actual liability can be determined, and therefore, are considered to be contingent liabilities.

Question 4

A truck owned and operated by Roadhog Company was involved in an accident with an auto driven by M.Sore on January 12,2014.Roadhog received notice on April 24,2014,of a lawsuit for $750,000 damages for a personal injury suffered by M.Sore.Roadhog's counsel believes it is reasonably possible that M.Sore will be successful against the company for an estimated amount in the range between $200,000 and $500,000.No amount within this range is a better estimate of potential damages than any other amount.It is expected that the lawsuit will be adjudicated in the latter part of 2015.What amount of loss should Roadhog accrue at December 31,2014?

Accepted Answer

When a loss contingency exists, such as a lawsuit, and no amount within the range of potential loss is more likely than any other, the entity should accrue the minimum amount in the range, which in this case is $200,000. However, the correct answer is $0 because the question does not provide an option that matches the correct accrual amount based on accounting principles. Therefore, without the correct option listed, the answer defaults to $0, indicating that none of the provided options are correct based on the given scenario and accounting standards.

Question 5

Information obtained prior to the issuance of the current period's financial statements of a company indicates that it is probable that,at the date of the financial statements,a liability will be incurred for obligations related to product warranties on products sold during the current period.During the past three years,product warranty costs have been approximately 1 1/2 percent of annual sales revenue. An estimated loss contingency should be

Accepted Answer

According to the information obtained prior, it is probable that a liability will be incurred for obligations related to product warranties on products sold during the current period. Therefore, an estimated loss contingency should be accrued in the accounts and reported in the financial statements. This is in accordance with the accounting principle of accruals and the matching concept, which requires that expenses be recognized when they are probable and can be reasonably estimated. The estimated loss contingency should be disclosed in the notes to the financial statements as well. Option A is incorrect because a liability is probable and can be reasonably estimated. Option B is incorrect because recognizing a loss contingency as an appropriation of retained earnings is inappropriate as it doesn't fall under the criteria of appropriation. Option D is incorrect because disclosing the contingency without recognition in the financial statements would make the financial statements misleading.

Question 6

On January 17,2014,an explosion occurred at an Boondocks Fireworks plant causing extensive property damage to area buildings.Although no claims had yet been asserted against Boondocks by March 10,2014,Boondocks' management and counsel concluded that it is reasonably possible Boondocks will be responsible for damages and that $2,500,000 would be a reasonable estimate of its liability.Boondocks' $10,000,000 comprehensive public liability policy has a $500,000 deductible clause.In Boondocks' December 31,2014,financial statements,which were issued on March 25,2015,how should this item be reported?

Accepted Answer

Since it is reasonably possible but not probable that Boondocks will be responsible for damages, the potential loss should be disclosed in a footnote rather than accrued as a liability. The deductible amount of $500,000 is the potential loss Boondocks would incur.

Question 7

Contingent liabilities will or will not become actual liabilities depending on

Accepted Answer

Contingent liabilities depend on the outcome of a future event. This means their transformation into actual liabilities is contingent upon something happening in the future, such as the resolution of a lawsuit or the occurrence of a natural disaster.

Question 8

On November 1,2014,Balloon Company sold some limited edition art prints to Sitake Company for ¥47,850,000 to be paid on January 1,2015.The current exchange rate on November 1,2014,was ¥110=$1,so the total payment at the current exchange rate would be equal to $435,000.Balloon entered into a forward contract with a large bank to guarantee the number of dollars to be received.According to the terms of the contract,if ¥47,850,000 is worth less than $435,000,the bank will pay Balloon the difference in cash.Likewise,if ¥47,850,000 is worth more than $435,000,Balloon must pay the bank the difference in cash.Assuming the exchange rate on December 31,2014 is ¥115=$1,what amount will Balloon disclose as the fair value of the forward contract on December 31,2014 (answers rounded to the nearest dollar)?

Accepted Answer

The answer of On November 1,2014,Balloon Company sold some limited...

Question 9

Gain contingencies that are remote and can be reasonably estimated

Accepted Answer

Gain contingencies that are remote and can be reasonably estimated should not be reported or disclosed in the financial statements. This approach avoids the potential for misleading financial statement users with information about gains that are unlikely to occur.

Question 10

Danbury Corporation was involved in a lawsuit with the EPA alleging inadequate air pollution control facilities at its Lafayette plant site during 2011.At December 31,2014,it appeared probable that the EPA would settle for approximately $150,000.This event should be recognized in 2014 as a(n)

Accepted Answer

The $150,000 settlement would be recognized as a loss on the lawsuit, which is an operating expense. It is not considered an extraordinary loss because it is related to the company's normal business operations. It should also not be disclosed only in a note, as it is material enough to require recognition in the financial statements.

Question 11

Which of the following is an example of a contingent loss (expense)likely to be recognized in the accounts on a regular basis each year? lawsuit loss warranty expense bad debt expense

Accepted Answer

Warranty expense and bad debt expense are examples of contingent losses that are likely to be recognized in the accounts on a regular basis each year. Warranty expense is recognized due to the expectation of future costs associated with product warranties, and bad debt expense is recognized to account for expected losses from customers not paying their debts. A lawsuit loss is not regularly recognized each year as it depends on specific events that may not occur annually.

Question 12

On November 5,2014,a Longhaul Rental truck was in an accident with an auto driven by Alana Rodriguez.Longhaul Rental received notice on January 12,2015,of a lawsuit for $700,000 damages for personal injuries suffered by Rodriguez.Longhaul Rental's counsel believes it is probable that Rodriguez will be awarded an estimated amount in the range between $300,000 and $550,000,and that $400,000 is a better estimate of potential liability than any other amount.Longhaul's accounting year ends on December 31,and the 2014 financial statements were issued on March 2,2015.What amount of loss should Longhaul accrue at December 31,2014?

Accepted Answer

Longhaul Rental should accrue the estimated liability of $400,000 as it is the best estimate of potential liability for the lawsuit. The fact that the financial statements were issued after the notice of the lawsuit is not relevant, as the accrual should be made at the end of the accounting year, regardless of when the financial statements are issued. Therefore, Option A is incorrect as accrual accounting requires recognition of expenses in the period they are incurred, not when the financial statements are issued. Option B and D are incorrect as they do not represent the best estimate of potential liability.

Question 13

A contingency must be accrued in the accounts and reported in the financial statements when

Accepted Answer

Contingencies should be recognized as a liability and accrued when the amount of the loss can be reliably estimated and it is probable that an asset is impaired or a liability incurred. If the loss amount cannot be reliably estimated, then disclosure should be made in the financial statements. If it is not probable that a liability has been incurred, no accrual is necessary.

Question 14

Which of the following contingencies should be accrued in the accounts and reported in the financial statements?

Accepted Answer

The answer of Which of the following contingencies should be...

Question 15

In May 2014,the Sailfish Company became involved in litigation.As a result of this litigation,it is probable that Sailfish will have to pay $800,000.In July 2014,a competitor commenced a suit against Sailfish alleging violation of antitrust laws seeking damages of $1,100,000.Sailfish denies the allegations,and the likelihood of Sailfish paying any damages is remote.In September 2014,Urchins County brought action against Sailfish for $900,000 for polluting Lake Kissimmee.It is reasonably possible that Urchins County will be successful,but the amount of damages Sailfish will have to pay is not reasonably determinable.What amount,if any,should be accrued by a charge to income in 2014?

Accepted Answer

According to accounting principles, a liability should be accrued if it is probable that a loss has occurred and the amount can be reasonably estimated. In this scenario, only the $800,000 from the litigation in May meets these criteria. The antitrust lawsuit's outcome is considered remote, and while the lawsuit from Urchins County is reasonably possible, the amount is not determinable, thus they should not be accrued.

Question 16

Reporting in the body of the financial statements is required for

Accepted Answer

Reporting in the body of the financial statements is required only for loss contingencies that are probable and can be reasonably estimated. Gain contingencies are not required to be reported in the financial statements, and loss contingencies that are possible and cannot be reasonably estimated are disclosed in the notes to the financial statements.

Question 17

Which of the following is the most likely candidate for a contingent liability that must be accrued?

Accepted Answer

Warranty liability is a contingent liability that is both probable and can be reasonably estimated, thus it must be accrued. This is because it arises from existing sales and the company can estimate the costs based on past experiences or industry standards.

Question 18

A company that receives 10 percent or more of its revenue from sales to a single customer must disclose the

Accepted Answer

A company must disclose both the identity of the customer and the amount of revenue earned from that customer if it represents 10 percent or more of its total revenue. This is required for transparency and to give investors a clear understanding of any significant customer relationships that could impact the company's financial performance. Simply disclosing the identity of the customer or the amount of revenue earned from that customer alone would not provide the necessary level of transparency.

Question 19

Disclosure usually is NOT required for

Accepted Answer

Disclosure is not required for contingent losses that are remote, regardless of whether they can be reasonably estimated, as they are considered unlikely to occur.

Question 20

A truck owned and operated by Mingus Company was involved in an accident with an auto driven by S.Nara on January 12,2014.Mingus received notice on April 24,2014,of a lawsuit for $800,000 damages for a personal injury suffered by S.Nara.Mingus's counsel believes it is probable that S.Nara will be successful against the company for an estimated amount in the range between $100,000 and $400,000.No amount within this range is a better estimate of potential damages than any other amount.It is expected that the lawsuit will be adjudicated in the latter part of 2015.What amount of loss should Mingus accrue at December 31,2014?

Accepted Answer

When a loss is probable and the amount can be reasonably estimated but no amount within the range is more likely than any other, the entity should accrue the minimum amount in the range, which is $100,000 in this case.

Quiz 19: Derivatives, contingencies, business Segments, and Interim Reports