Chapter 13: Current Liabilities and Contingencies

Question: (Derivative Financial Instrument) Johnstone Co. purchased a put option on Ewing common shares on July 7,

2017, for \(240. The put option is for 200 shares, and the strike price is \)70. (The market price of a share of Ewing stock on that

date is \(70.) The option expires on January 31, 2018. The following data are available with respect to the put option.

Date Market Price of Ewing Shares Time Value of Put Option

September 30, 2017 \)77 per share $125

December 31, 2017 75 per share 50

January 31, 2018, 78 per share 0

Instructions

Prepare the journal entries for Johnstone Co. for the following dates.

(a) July 7, 2017—Investment in a put option on Ewing shares.

(b) September 30, 2017—Johnstone prepares financial statements.

(c) December 31, 2017—Johnstone prepares financial statements.

(d) January 31, 2018—Put option expires.

Under what conditions is an employer required to accrue a lability for sick pay? Under what conditions is an employer permitted but not required to accrue a liability for sick pay?

Question:Adriana Co., with annual net sales of $5 million, maintains a markup of 25% based on cost. Adriana’s expenses average 15% of net sales. What is Adriana’s gross profit and net profit in dollars?

Question: The following information is taken from the 2017 annual report of Bugant, Inc. Bugant’s fiscal year ends December 31 of each year. Bugant’s December 31, 2017, balance sheet is as follows.

Additional information concerning 2018 is as follows.

1. Sales were \)3,500, all for cash.
2. Purchases were \(2,000, all paid in cash.
3. Salaries were \)700, all paid in cash.
4. Property, plant, and equipment was originally purchased for \(2,000 and is depreciated straight-line over a 25-year life with no salvage value.
5. Ending inventory was \)1,900.
6. Cash dividends of \(100 were declared and paid by Bugant.
7. Ignore taxes.
8. The market rate of interest on bonds of similar risk was 12% during all of 2018.
9. Interest on the bonds is paid semiannually each June 30 and December 31.

Accounting

Prepare a balance sheet for Bugant, Inc. at December 31, 2018, and an income statement for the year ending December 31, 2018. Assume semiannual compounding of the bond interest.

Analysis

Use common ratios for analysis of long-term debt to assess Bugant’s long-run solvency. Has Bugant’s solvency changed much from 2017 to 2018? Bugant’s net income in 2017 was \)550 and interest expense was $169.

Principles

The FASB and the IASB allow companies the option of recognizing in their financial statements the fair values of their long-term debt. That is, companies have the option to change the balance sheet value of their long-term debt to the debt’s fair value and report the change in balance sheet value as a gain or loss in income. In terms of the qualitative characteristics of accounting information (Chapter 2), briefly describe the potential trade-off(s) involved in reporting long-term debt at its fair value.

(Equity Investment) Oregon Co. had purchased 200 shares of Washington Co. for \(40 each this year (Oregon

Co. does not have significant influence). Oregon Co. sold 100 shares of Washington Co. stock for \)45 each. At year-end, the price

per share of the Washington Co. the stock had dropped to $35.

Instructions

Prepare the journal entries for these transactions and any year-end adjustments.

Question: (Free-Standing Derivative) Warren Co. purchased a put option on Echo common shares on January 7, 2017,

for \(360. The put option is for 400 shares, and the strike price is \)85 (which equals the price of an Echo share on the purchase

date). The option expires on July 31, 2017. The following data are available with respect to the put option.

Date Market Price of Echo Shares Time Value of Put Option

March 31, 2017 \(80 per share \)200

June 30, 2017, 82 per share 90

July 6, 2017, 77 per share 25

Instructions

Prepare the journal entries for Warren Co. for the following dates.

(a) January 7, 2017—Investment in a put option on Echo shares.

(b) March 31, 2017—Warren prepares financial statements.

(c) June 30, 2017—Warren prepares financial statements.

(d) July 6, 2017—Warren settles the put option on the Echo shares.

Schmitt Company must make computations and adjusting entries for the following independent situations at December 31, 2018.

1. Its line of amplifiers carries a 3-year warranty against defects. On the basis of past experience the estimated warranty costs related to dollar sales are first year after sale—2% of sales revenue; second year after sale—3% of sales revenue; and third year after sale—5% of sales revenue. Sales and actual warranty expenditures for the first 3 years of business were:

Instructions

Compute the amount that Schmitt should report as a liability in its December 31, 2018, balance sheet. Assume that all sales are made evenly throughout each year with warranty expenses also evenly spaced relative to the rates above.

2. With some of its products, Schmitt includes coupons that are redeemable in merchandise. The coupons have no expiration date and, in the company’s experience, 40% of them are redeemed. The liability for unredeemed coupons at December 31, 2017, was \(9,000. During 2018, coupons worth \)30,000 were issued, and merchandise worth $8,000 was distributed in exchange for coupons redeemed.

Instructions

Compute the amount of the liability that should appear on the December 31, 2018, balance sheet

Distinguish between the accounting treatment for marketable versus nonmarketable equity securities.

Wynn Company offers a set of building blocks to customers who send in 3 UPC codes from Wynn cereal, along with 50¢. The block sets cost Wynn $1.10 each to purchase and 60¢ each to mail to customers. During 2017, Wynn sold1,200,000 boxes of cereal. The company expects 30% of the UPC codes to be sent in. During 2017, 120,000 UPC codes wereredeemed. Prepare Wynn’s December 31, 2017, adjusting entry.

(Equity Investments) Kenseth Company has the following securities in its portfolio on December 31, 2017.

None of these investments are accounted for under the equity method.

Investments Cost Fair Value

1,500 shares of Gordon, Inc., common \( 73,500 \) 69,000

5,000 shares of Wallace Corp., common 180,000 175,000

400 shares

of Martin, Inc., preferred 60,000 61,600

\(313,500 \)305,600

All of the securities were purchased in 2017.

In 2018, Kenseth completed the following securities transactions.

March 1 Sold the 1,500 shares of Gordon, Inc., common, @ \(45 less fees of \)1,200

April 1 Bought 700 shares of Earnhart Corp., common, @ \(75 plus fees of \)1,300

Kenseth’s portfolio of equity securities appeared as follows on December 31, 2018.

Investments Cost Fair Value

5,000 shares of Wallace Corp., common \(180,000 \)175,000

700 shares of Earnhart Corp., common 53,800 50,400

400 shares of Martin, Inc., preferred 60,000 58,000

\(293,800 \)283,400

Instructions

Prepare the general journal entries for Kenseth Company for:

(a) The 2017 adjusting entry.

(b) The sale of the Gordon stock.

(c) The purchase of the Earnhart stock.

(d) The 2018 adjusting entry for the portfolio.