CHAPTER 22. Liabilities CONTENTS

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1 CHAPTER 22 Liabilities CONTENTS 22.1 Journal entries for various liabilities 22.2 Journal entries for employee entitlements 22.3 Provision for warranty claim expenses 22.4 Finance of an asset purchase by mortgage payable 22.5 Comparative ratios for analysing liabilities and comparing different entities

2 22.1 ADDITIONAL PROBLEMS Problem 22.1 Journal entries for various liabilities Mad Prices Ltd completed the following selected transactions during and The financial year for the company ends on 30 June. Aug. Sept. Oct. Oct. Nov. Dec May May June July Purchased office furniture and equipment from Office Supplies Ltd for $9600, and issued a 9%, 90-day promissory note for the purchase price plus interest. Paid Office Supplies Ltd 50% of the amount due on the 4 August promissory note. Accepted a new 10%, 30-day bill of exchange to cover the balance owing on the original note. Received an invoice dated 1 October from Office Renovations for $ for work performed in the company s administration building. A 2% discount is offered for payment within 15 days. Paid Office Supplies Ltd for the 15 September bill. Paid Office Renovations the amount owing on 1 October invoice. Discounted at a discount rate of 9% its own $ , 30-day commercial bill of exchange, accepted by the Australia Bank. Paid the Australia Bank the amount due. Issued to Queen s Electrics Ltd a 9%, 90-day promissory note for $ in settlement of account owing. Discounted at a discount rate of 10% its own $ , 60-day bill made out to the Australia Bank. The company decided to provide $5000 to cover the costs of damages associated with an accident which occurred to one of its customers while shopping in a store. Legal proceedings are in process. The company became aware that one of its manufacturing plants had caused environmental damages to a suburban creek. Investigations revealed that the company would be legally obliged to clean up the creek at a cost of some $ Paid the Australia Bank the amount due. Paid the amount due for the note issued on 1 May Required: Show how the above transactions, including any necessary adjusting entries on 30 June 2003, would be recorded in the general and cash journals of the company.

3 22.2 Solution MAD PRICES LTD General Journal Aug. 4 Office Furniture & Equipment Accounts Payable - Office Supplies Ltd To record purchase of furniture & equipment. Accounts Payable - Office Supplies Ltd Unexpired Interest Bills Payable To record 90 day bill at 9% and interest. (Interest = /365) Sept. 15 Bills Payable Unexpired Interest Accounts Payable - Office Supplies Ltd To write back 45 day bill unpaid and extended. Sept. 15 Interest Expense Office Supplies Ltd To record interest expense to renewal of bill. ( /365 = $99.42) Accounts Payable - Office Supplies Ltd Unexpired Interest Bills Payable To record new 30 day bill at 10 % for balance owing. (Owing $ ( ) = $ Interest /365 = 39.39) Oct. 1 Building Improvements Office Renovations To record cost of renovations Nov. 1 Unexpired Interest Bills Payable To record interest charge on 30 day bill at 9% (Interest = /365.) Dec 1 Interest Expense Unexpired Interest To record interest expense on 30 day bill May 1 Accounts Payable - Queen s Electrics Ltd Unexpired Interest Bills Payable To record 90 day bill at 9% plus interest. (Interest = /365) May 31 Unexpired Interest Bills Payable To record interest charge on 60 day bill at 10%. (Interest = /365) Damages in Lawsuit Provision for Damages in Lawsuit To provide for legal costs in lawsuit.

4 22.3 June 30 Environmental Damages Expense Provision for Environmental Damages To provide for cost of environmental cleanup. Interest Expense Unexpired Interest To record interest expense on 90 day bill to 30 June. Interest Expense Unexpired Interest To record interest expense on 60 day commercial bill to 30 June. July 31 Interest Expense Unexpired Interest To record expired interest expense on 30 day bill. July 31 Interest Expense Unexpired Interest To record expired interest expense on 30 day bill. Date Nov May 31 Accounts Credited Bills Payable Bills Payable Cash Receipts Journal (extract) Cash at Bank Debits Discount Allowed Accounts Receivable Credits Other Accounts Date Sept. 15 Oct. 15 Dec July 30 Accounts Debited Office Supplies Ltd Bills Payable Office Renovations Bills Payable Bills Payable Bills Payable Cash Payments Journal (extract) Ch No Other Accounts Debits Accounts Payable Cash at Bank Credits Discount Received

5 22.4 Problem 22.2 Journal entries for employee entitlements Lagoon Ltd provided the following account balances as they appeared in the ledger on 31 May 2000: Provision for Annual Leave Provision for Sick Leave Provision for Long-Service Leave Commissioner of Taxation Superannuation Fund Medical Insurance Payable Charity Contributions Payable $ Cr Cr Cr Cr Cr Cr 160 Cr The following transactions occurred during June and July: June July Paid workers compensation premium for year to 30 June 2001, $ Issued cheque payable to the Commissioner of Taxation in payment of employees tax instalment deductions for May. Also forwarded cheques to other organisations to cover liabilities for deductions made on behalf of employees. Prepared a general journal entry to record monthly payroll: Gross wages$ Income tax instalments Superannuation contributions3 942 Medical insurance1 840 Charity contributions240 Paid monthly wages by cheque drawn on the Cash at Bank account. Accrued long-service leave expense for June, $1300. Accrued annual leave expense for June, $9200. Accrued sick leave expense for June, $4300. Charged workers compensation expense for June, $1955. Issued cheque payable to Commissioner of Taxation for amount due. Paid other deduction liabilities from June payroll. Issued a cheque as an advance payment to an employee taking part of his long-service entitlement, $6000. Deductions were: tax $1548; life assurance premiums, $144; and medical insurance, $360. Prepared journal entry to record payroll for July: Gross wages$ Income tax instalments Superannuation4 010 Medical insurance1 848 Charity contributions261 Drew cheque to pay July wages to employees. Drew cheque to pay fringe benefits tax, $350. Accrued long-service leave expense for July, $1350. Accrued annual leave expense for July, $9300. Accrued sick leave expense for July, $4400. Required: Prepare journal entries to record the above transactions. (continued)

6 22.5 Solution LAGOON LTD General Journal 2000 June 1 Prepaid Workers' Compensation Insur Cash at Bank Commissioner of Taxation Superannuation Fund Medical Insurance Payable Charity Contributions Payable 160 Cash at Bank Wages Expense Commissioner of Taxation Superannuation Fund Medical Insurance Payable Charity Contributions Payable 240 Wages Payable Wages Payable Cash at Bank Long-Service Leave Expense Annual Leave Expense Sick Leave Expense Provision for Long-Service Leave Provision for Annual Leave Provision for Sick Leave Workers' Compensation Expense Prepaid Workers' Comp. Insurance July 5 Commissioner of Taxation Superannuation Fund Medical Insurance Payable Charity Contributions Payable 240 Cash at Bank Provision for Long-Service Leave Commissioner of Taxation Life Assurance Payable 144 Medical Insurance Payable 360 Cash at Bank 6000 July 28 Wages Expense Commissioner of Taxation Superannuation Fund Medical Insurance Payable Charity Contributions Payable 261 Wages Payable Wages Payable Cash at Bank Fringe Benefits Tax Expense 350 Cash at Bank Long-Service Leave Expense Annual Leave Expense Sick Leave Expense Provision for Long-Service Leave Provision for Annual Leave Provision for Sick Leave 4 400

7 22.6 Problem 22.3 Provision for warranty claim expenses Kozy Kitchenware Ltd specialises in the supply of microwave ovens. Three models are sold: a 650W which sells for $450, a 750W which sells for $650, and a 1000W which sells for $850. Each oven comes with a 12 months manufacturer s warranty, and the company supplements this warranty with its own 1-year full parts and labour warranty except for the first $25 which must be met, and prepaid, by the customer. To the end of the financial year ended 30 June 2001, warranty expenses incurred by the company from repairing 23 units after customer contributions was $2600. At 1 July 2000, the balance in the Provision for Warranty account stood at $2700. For the year ended 30 June 2001, records showed that the following sales in units were achieved: 650W, 120 units; 750W, 108 units; and 1000W, 84 units. Past records show that, on average, one in ten units is subject to a claim under the warranty offered, and this rate was equalled over the past year. The total warranty costs incurred during the year, including the customer contributions, to repair defective ovens were: 650W, $110; 750W, $130; and 1000W, $120. At 30 June 2001, it was decided to provide for future warranty costs on the assumption that there would be no increase in the costs of warranty repairs, and the customer contribution would be held at $25. During the year ended 30 June, the company sales of ovens were: 650W, 130 units; 750W, 112 units; and 1000W, 96 units. The number of ovens returned for repair with the $25 cash contribution was: 650W ovens, 12 units, 750W ovens, 8 units; and 1000W ovens, 9 units. In providing for future warranty costs at 30 June, it is anticipated that warranty costs will increase by 5%, but the customer contribution will remain the same. Due to improved quality control by the manufacturer, it was expected that the percentage of ovens requiring repairs under warranty in the future would be reduced to one in twelve ovens sold. No increase in sales prices is planned. Required: A. Show the following accounts as they would appear at 30 June 2001 after all adjusting and closing entries Revenue from Warranty Contributions, Warranty Expense, Provision for Warranty. B. Show general journal entries to record the receipt of customer contributions, the payment of warranty costs, and the adjustment of the Provision for Warranty. C. Show the following accounts for the past year as they would appear at 30 June after all adjusting and closing entries Revenue from Warranty Contributions, Warranty Expense, Provision for Warranty. Solution KOZY KITCHENWARE LTD A. Revenue from Warranty Contributions Date Explanation Debit Credit Balance 2001 June 30 Cash Clos. Ent Warranty Expense Date Explanation Debit Credit Balance 2001 June 30 Prov for Warranty Clos. ent Provision for Warranty Date Explanation Debit Credit Balance 2000 July June 30 Balance Cash at Bank Warranty Expense

8 22.7 B. June 30 Cash at Bank 575 Revenue from Warranty Contrib 575 To record contribution towards warranty Provision for Warranty Cash at Bank Warranty Expense Provision for Warranty To adjust Provision for Warrant C. Revenue from Warranty Contributions Date Explanation Debit Credit Balance June 30 Cash Clos. Ent Warranty Expense Date Explanation Debit Credit Balance June 30 Prov for Warranty Clos. ent Provision for Warranty Date Explanation Debit Credit Balance 2001 July 1 June 30 Balance Cash at Bank Warranty Expense

9 22.8 Problem 22.4 Finance of an asset purchase by mortgage payable Sydneysider Ltd, which was anxious to expand its operations, negotiated the purchase of land and a building for $ Under the terms of the purchase, the company paid the seller a deposit of $ and signed a 14% mortgage deed which required 100 quarterly payments of $ due each quarter commencing on 15 September. The company purchased the land and building and paid the deposit on 16 June The company s financial year ends on 31 December. Required: A. Prepare a quarterly payment schedule for 2000 and Use the following headings: Payment Date, Unpaid Balance at Beginning of Quarter, Cash Payment, Interest for One Quarter, Reduction in Principal, Principal Balance at End of Quarter, as illustrated in the text of the chapter. B. Prepare journal entries to record (1) purchase of the land and building and (2) the first four quarterly payments (assume 85% of the purchase price is assigned to the building). C. How would the mortgage payable be classified in the statement of financial position at 31 December 2000? Explain the basis of the classification. D. Show how the unpaid mortgage principal would be classified on the statement of financial position at 31 December Solution A. SYDNEYSIDER LTD LOAN REPAYMENT SCHEDULE A Payment Date 2000 June 16 Sep. 15 Dec Mar. 15 June 15 Sep. 15 Dec. 15 B Unpaid balance at begin. of quarter C Cash Payment D Interest for one quarter (B 3.5%) E Reduction in Principal (C D) F Principal at end of quarter (B E) (continued)

10 22.9 B June 16 Land Building Mortgage Payable To record purchase of land and buildings. 2. Sept. 15 Interest Expense Mortgage Payable 123 Cash at Bank To record quarterly mortgage payment. Dec. 15 Interest Expense Mortgage Payable 128 Cash at Bank To record quarterly mortgage payment. Mar. 15 Interest Expense Mortgage Payable 132 Cash at Bank To record quarterly mortgage payment. June 15 Interest Expense Mortgage Payable 137 Cash at Bank To record quarterly mortgage payment. C. The Mortgage Payable would be classified into two categories - current liabilities and non-current liabilities. That portion of the principal that will be repaid in the next financial year will be classified as a current liability, with the remainder being shown as a non-current liability. D. Statement of financial position (extract) as at 31 December 2003 Current Liabilities Mortgage Payable 556 Non-current Liabilities Mortgage Payable

11 22.10 Problem 22.5 Comparative ratios for analysing liabilities and comparing different entities Comparative data extracted from the annual reports of Peterson Ltd and Mattson Ltd appear below. All statement of financial position data are as at 30 June. Current assets Plant assets (net) Current liabilities Long-term liabilities Shareholders equity Retained profits Peterson Ltd Mattson Ltd $ $ $ Required: A. Calculate the liquidity and financial stability ratios for both companies for the years and B. Comment on the financial strength of each company based on the calculations in requirement A. C. On the basis of your calculations, which company has the greater financial strength? Explain why. Solution A. Current ratios Quick ratios Debt ratios Equity ratios Insufficient data given PETERSON LTD and MATTSON LTD Peterson Ltd Mattson Ltd = 2.17 = 2.16 = 2.8 = 2.36 Peterson Ltd Mattson Ltd = 25.3% = 31.6% = 30.0% = 30.4% Peterson Ltd Mattson Ltd = 74.7% = 68.4% = 70.0% = 69.6% Capitalisation ratios Peterson Ltd Mattson Ltd = 1.34:1 = 1.46:1 = 1.43:1 = 1.44:1 (continued)

12 22.11 B. Assuming a current ratio benchmark of 2.0:1, the short term liquidity position of both companies is good. Peterson Ltd s position has been maintained over the two year period, while Mattson Ltd s position has considerably improved its initially better position. A longer term trend analysis would be desirable before definite conclusions could be drawn. Both companies could generally be regarded as only lightly geared with both maintaining debt ratios of around 30%, although there has been a considerable drop in debt financing by Peterson Ltd from 31.6% to 25.3% from to The equity and capitalisation ratios confirm the gearing position disclosed by the debt ratios. C. Given the limited data available and the absence of industry averages, Peterson Ltd offers an improved position in relation to gearing, while not offering as good a position as Mattson Ltd in relation to shorter term liquidity. Both companies could benefit by increasing the levels of gearing, and Mattson Ltd would be in a better position to attract debt financing because of its stronger liquidity and larger asset backing. Mattson Ltd would therefore probably be favoured.

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