Problem 9-21B: Contingent Liabilities

Required

How should each of the following situations be reported in the financial statements?

a. It has been determined that one of the company’s products has caused a safety hazard. It is considered probable that liabilities have been incurred and a reasonable estimate of the amount can be made.

b. A company warehouse is located in a section of the city that has routinely flooded in the past. Consequently, the company can no longer find a source of insurance for the warehouse. No flood has yet occurred this year.

c. Because of newly passed legislation, a company will have to upgrade its facilities over the next two years. Significant expenditures will occur, but at this time the amount has not been determined.

Problem 9-22B: Current Liabilities

The following selected transactions were taken from the books of Dodson Company for Year 1:

1. On March 1, Year 1, borrowed $60,000 cash from the local bank. The note had a 6 percent interest rate and was due on September 1, Year 1.
2. Cash sales for the year amounted to $240,000 plus sales tax at the rate of 7 percent.
3. Dodson provides a 90-day warranty on the merchandise sold. The warranty expense is estimated to be 2 percent of sales.
4. Paid the sales tax to the state sales tax agency on $200,000 of the sales.
5. Paid the note due on September 1 and the related interest.
6. On October 1, Year 1, borrowed $50,000 cash from the local bank. The note had a 7 percent interest rate and a one-year term to maturity.
7. Paid $3,800 in warranty repairs.
8. A customer has filed a lawsuit against Dodson for $150,000 for breach of contract. The company attorney does not believe the suit has merit.

Required
a. Answer the following questions:

(1) What amount of cash did Dodson pay for interest during the year?

(2) What amount of interest expense is reported on Dodson’s income statement for the year?

(3) What is the amount of warranty expense for the year?

b. Prepare the current liabilities section of the balance sheet at December 31, Year 1. (Hint: First post the liabilities transactions to T-accounts.)

c. Show the effect of these transactions on the financial statements using a horizontal statements model like the one shown next. Use + for increase, − for decrease, and NA for not affected. In the Cash Flow column, indicate whether the item is an operating activity (OA), investing activity (IA), or financing activity (FA). The first transaction is recorded as an example