Question & Answer

Southeast Airlines Inc. awards members of its Flightline program a second ticket at half price, valid for 2 years anywhere on its flight system, when a full-price ticket is purchased. How would you account for the full-fare and half-fare tickets?

How does the expense warranty approach differ from the sales warranty approach?

Grant Company has had a record-breaking year in terms of growth in sales and profitability. However, market research indicates that it will experience operating losses in two of its major businesses next year. The controller has proposed that the company record a provision for these future losses this year, since it can afford to take the charge and still show good results. Advise the controller on the appropriateness of this charge.

Contrast the cash-basis method and the accrual method of accounting for warranty costs.

How are the terms “probable,” “reasonably possible,” and “remote” related to contingent liabilities?

Distinguish between a determinable current liability and a contingent liability. Give two examples of each type.

Under what conditions should a contingent liability be recorded?

Define (a) a contingency and (b) a contingent liability.

Faith Battle operates a health food store, and she has been the only employee. Her business is growing, and she is considering hiring some additional staff to help her in the store. Explain to her the various payroll deductions that she will have to account for, including their potential impact on her financial statements, if she hires additional staff.

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

Under what conditions must an employer accrue a liability for the cost of compensated absences?

What are compensated absences?

How does unearned revenue arise? Why can it be classified properly as a current liability? Give several examples of business activities that result in unearned revenues.

Discuss the accounting treatment or disclosure that should be accorded a declared but unpaid cash dividend, an accumulated but undeclared dividend on cumulative preferred stock, and a stock dividend distributable.

What evidence is necessary to demonstrate the ability to consummate the refinancing of short-term debt?

Under what conditions should a short-term obligation be excluded from current liabilities?

How should a debt callable by the creditor be reported in the debtor’s financial statements?

What is the nature of a “discount” on notes payable?

How is present value related to the concept of a liability?

Leon Wight, a newly hired loan analyst, is examining the current liabilities of a corporate loan applicant. He observes that unearned revenues have declined in the current year compared to the prior year. Is this a positive indicator about the client’s liquidity? Explain.

How are current liabilities related by definition to current assets? How are current liabilities related to a company’s operating cycle?

Why is the liabilities section of the balance sheet of primary significance to bankers?

Assume that your friend Will Morris, who is a music major, asks you to define and discuss the nature of a liability. Assist him by preparing a definition of a liability and by explaining to him what you believe are the elements or factors inherent in the concept of a liability.

Distinguish between a current liability and a long-term debt.

As a new intern for the local branch office of a national brokerage firm, you are excited to get an assignment that allows you to use your accounting expertise. Your supervisor provides you the spreadsheet below, which contains data for the most recent quarter for three companies that the firm has been recommending to its clients as “buys.” Each of the companies’ returns on assets has outperformed their industry cohorts in the past. But, given recent challenges in their markets, there is concern that the companies may experience operating challenges and lower earnings. (All numbers in millions, except return on assets.)

Instructions

(a) The fair value for each of these companies is lower than the corresponding book value. What implications does this have for each company’s future prospects?

(b) To date, none of these companies has recorded goodwill impairments. Your supervisor suspects that they will need to record impairments in the near future, but he is unsure about the goodwill impairment rules. Is it likely that these companies will recognize impairments? Explain.

(c) Estimate the amount of goodwill impairment for each company and prepare the journal entry to record the impairment. For each company, you may assume that the book value less the carrying value of the goodwill approximates the fair value of the companies’ net assets.

(d) Discuss the effects of your entries in part (c) on your evaluation of these companies based on the return on assets ratio.