Chapter 13 Current Liabilities and Contingencies

QUESTIONS FOR REVIEW OF KEY TOPICS

Question 13-1
A liability entails the present, the future, and the past. It is a present responsibility, to sacrifice
assets in the future, caused by a transaction or other event that already has happened. Specifically,
“Elements of Financial Statements,” Statement of Financial Accounting Concepts No. 6, par. 36,
describes three essential characteristics: Liabilities–
1. are probable, future sacrifices of economic benefits
2. that arise from present obligations (to transfer goods or provide services) to other entities
3. that result from past transactions or events.

Question 13-2
Liabilities traditionally are classified as either current liabilities or long-term liabilities in a
classified balance sheet. Current liabilities are those expected to be satisfied with current assets or by
the creation of other current liabilities (Committee on Accounting Procedure, American Institute of
CPAs, Accounting Research and Terminology Bulletin, Final Edition, p. 21). Usually, but with
exceptions, current liabilities are obligations payable within one year or within the firm's operating
cycle, whichever is longer.

Question 13-3
In concept, liabilities should be reported at their present values; that is, the valuation amount is the
present value of all future cash payments resulting from the debt, usually principal and/or interest
payments. In this case, the amount would be determined as the present value of $100,000, discounted
for three months at an appropriate rate of interest for a debt of this type.
This is proper because of the time value of money. In practice, liabilities ordinarily are reported at
their maturity amounts if payable within one year because the relatively short time period makes the
interest or time value component immaterial. Accounting Principles Board Opinion No 21, “Interest on
Receivables and Payables,” specifically exempts from present value valuation all liabilities arising in
connection with suppliers in the normal course of business and due within a year.
Answers to Questions (continued)

Question 13-4
Lines of credit permit a company to borrow cash from a bank up to a prearranged limit at a
predetermined, usually floating, rate of interest. The interest rate often is based on current rates of the
prime London interbank borrowing, certificates of deposit, bankers’ acceptance, or other standard rates.
Lines of credit usually must be available to support the issuance of commercial paper.
Lines of credit can be noncommitted or committed. A noncommitted line of credit allows the
company to borrow without having to follow formal loan procedures and paperwork at the time of the
loan and is less formal, usually without a commitment fee. Sometimes a compensating balance is
required to be on deposit with the bank as compensation for the service. A committed line of credit is
more formal. It usually requires a commitment fee in the neighborhood of 1/4 of one percent of the
unused balance during the availability period. Sometimes compensating balances also are required.

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Question 13-5
When interest is “discounted” from the face amount of a note at the time it is written, it usually is
referred to as a “noninterest-bearing” note. They do, of course entail interest, but the interest is
deducted (or discounted) from the face amount to determine the cash proceeds made available to the
borrower at the outset and included in the amount paid at maturity. In fact, the effective interest rate is
higher than the stated discount rate because the discount rate is applied to the face value, but the cash
borrowed is less than the face value.

Question 13-6
Commercial paper represents loans from other corporations. It refers to unsecured notes sold in
minimum denominations of $25,000 with maturities ranging from 30 to 270 days. The firm would be
required to file a registration statement with the SEC if the maturity is beyond 270 days. The name
“commercial paper” implies that a paper certificate is issued to the lender to represent the obligation.
But, increasingly, no paper is created because the entire transaction is computerized. Recording the
issuance and payment of commercial paper is the same as for notes payable.
The interest rate usually is lower than in a bank loan because commercial paper (a) typically is
issued by large, sound companies (b) directly to the lender, and (c) normally is backed by a line of credit
with a bank.

Question 13-7
This is an example of an accrued expense – an expense incurred during the current period, but not
yet paid. The expense and related liability should be recorded as follows:

Salaries expense 5,000

Salaries payable 5,000
This achieves a proper matching of this expense with the revenues it helps generate.

Question 13-8
When a company collects cash from a customer as a refundable deposit or as an advance payment
for products or services, a liability is created obligating the firm to return the deposit or to supply the
products or services. When the amount is to be returned to the customer in cash, it is a refundable
deposit. When the amount will be applied to the purchase price when goods are delivered or services
provided (gift certificates, magazine subscriptions, layaway deposits, special order deposits, and airline
tickets) it is a customer advance.

Question 13-9
Examples of amounts collected for third parties that represent liabilities until remitted are sales
taxes, and payroll-related deductions such as federal and state income taxes, social security taxes,
employee insurance, employee contributions to retirement plans, and union dues.

Question 13-10

1. Current liability — The requirement to classify currently maturing debt as a current liability
includes debt that is callable, or due on demand, by the creditor in the upcoming year even if the
debt is not expected to be called.

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 2 Long-term liability — The current liability classification includes (a) situations in which the
creditor has the right to demand payment because an existing violation of a provision of the debt
agreement makes it callable and (b) situations in which debt is not yet callable, but will be callable
within the year if an existing violation is not corrected within a specified grace period – unless it's
probable the violation will be corrected within the grace period. In this case, the existing violation
is expected to be corrected within 6 months.

Question 13-11
Short-term obligations can be reported as noncurrent liabilities if the company (a) intends to
refinance on a long-term basis and (b) demonstrates the ability to do so by a refinancing agreement or by
actual financing.

Question 13-12
A loss contingency is an existing situation, or set of circumstances involving potential loss that
will be resolved when some future event occurs or doesn’t occur. Examples: (1) an unsettled tax
deficiency assessed by the IRS, (2) a possible uncollectible receivable, (3) being the defendant in a
lawsuit.

Question 13-13
The likelihood that the future event(s) will confirm the incurrence of the liability must be
categorized as:

PROBABLE – the confirming event is likely to occur.

REASONABLY POSSIBLE– the chance the confirming event will occur is more than remote but less
than likely.

REMOTE– the chance the confirming event will occur is slight.

Question 13-14
A liability should be accrued if it is both probable that the confirming event will occur and the
amount can be at least reasonably estimated.

Question 13-15
If one or both of the accrual criteria is not met, but there is at least a reasonable possibility that an
obligation exists (the loss will occur), a disclosure note should describe the contingency. The note also
should provide an estimate of the possible loss or range of loss, if possible. If an estimate cannot be
made, a statement to that effect should be included.

Question 13-16

1. Manufacturers’ product warranties — these inevitably involve expenditures, and reasonably

accurate estimates of the total liability for a period usually are possible, based on prior experience.

2. Cash rebates and other premium offers — these inevitably involve expenditures, and reasonably
accurate estimates of the total liability for a period usually are possible, based on prior experience.

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Question 13-17
The contingent liability for warranties and guarantees usually is accrued. The estimated warranty
(guarantee) liability is credited and warranty (guarantee) expense is debited in the reporting period in
which the product under warranty is sold. An extended warranty provides warranty protection beyond
the manufacturer’s original warranty. A manufacturer’s warranty is offered as an integral part of the
product package. By contrast, an extended warranty is priced and sold separately from the warranted
product. It essentially constitutes a separate sales transaction and is recorded as such.

Question 13-18
Several weeks usually pass between the end of a company’s fiscal year and the date the financial
statements for that year actually are issued. Any enlightening events occurring during this period should
be used to assess the nature of a loss contingency existing at the report date. Since a liability should be
accrued if it is both probable that the confirming event will occur and the amount can be at least
reasonably estimated, the contingency should be accrued.

Question 13-19
When a contingency comes into existence only after the year-end, a liability cannot be accrued
because none existed at the end of the year. Yet, if the loss is probable and can be reasonably estimated,
the contingency should be described in a disclosure note. The note should include the effect of the loss
on key accounting numbers affected. Furthermore, even events other than contingencies that occur after
the year-end but before the financial statements are issued must be disclosed in a “subsequent events”
disclosure note if they have a material effect on the company’s financial position. (i.e., an issuance of
debt or equity securities, a business combination, or discontinued operations).

Question 13-20
When an assessment is probable, reporting the possible obligation would be warranted if an
unfavorable settlement is at least reasonably possible. This means an estimated loss and contingent
liability would be accrued if (a) an unfavorable outcome is probable and (b) the amount can be
reasonably estimated. Otherwise footnote disclosure would be appropriate. So, when the assessment is
unasserted as yet, a two-step process is involved in deciding how it should be reported:

1. Is the assessment probable? If it is not, no disclosure is warranted.

2. If the assessment is probable, evaluate (a) the likelihood of an unfavorable outcome and (b)
whether the dollar amount can be estimated to determine whether it should be accrued,
disclosed only, or neither.

Question 13-21
You should not accrue your gain. A gain contingency should not be accrued. This conservative
treatment is consistent with the general inclination of accounting practice to anticipate losses, but to
recognize gains only at their realization. Though gain contingencies are not recorded in the accounts,
they should be disclosed in notes to the financial statements. Attention should be paid that the
disclosure note not give "misleading implications as to the likelihood of realization."

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EXERCISES

Exercise 13-1

Requirement 1

Cash ............................................................................ 8,000,000

Notes payable ......................................................... 8,000,000

Requirement 2

Interest expense ($8,000,000 x 12% x 2/12) .............. 160,000

Interest payable...................................................... 160,000

Requirement 3

Interest expense ($8,000,000 x 12% x 7/12) .............. 560,000

Interest payable (from adjusting entry)...................... 160,000
Notes payable (face amount) ...................................... 8,000,000
Cash (total) ............................................................. 8,720,000

2004

Sept. 1
Interest expense ($10,000,000 x 9% x 8/12)* ......................... 600,000
Discount on notes payable ................................................. 600,000

Notes payable (balance) .......................................................... 10,000,000

Cash (maturity amount) ...................................................... 10,000,000

* or, ($9,325,000 x 9.6515% x 8/12) = $600,000

Exercise 13-5

Requirement 1

Cash........................................................................................... 5,200
Liability – gift certificates ................................................... 5,200

Cash ($2,100 + 84 - 1,300) ....................................................... 884

Liability – gift certificates ........................................................ 1,300
Sales revenue ........................................................................ 2,100
Sales taxes payable (4% x $2,100) ....................................... 84

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Requirement 2
Gift certificates sold $5,200
Gift certificates redeemed 1,300
Liability to be reported at December 31 $3,900

Requirement 3

The sales tax liability is a current liability because it is payable in January.

The liability for gift certificates is part current and part noncurrent:
Gift certificates sold $5,200
x 80%
Estimated current liability $4,160
Gift certificates redeemed (1,300)
Current liability at December 31 $2,860
Noncurrent liability at December 31 ($5,200 x 20%) 1,040
Total $3,900

Exercise 13-7

Requirement 1

Cash .................................................................................... 7,500

Liability – customer advance ........................................ 7,500

Requirement 2

Cash .................................................................................... 25,500

Liability – refundable deposits ..................................... 25,500

Requirement 3

Accounts receivable............................................................ 856,000

Sales revenue ................................................................ 800,000
Sales taxes payable ([5% + 2%] x $800,000) ................ 56,000

Exercise 13-8
Normally, short-term debt (payable within a year) is classified as current liabilities. However, when
such debt is to be refinanced on a long-term basis, it may be included with long-term liabilities. The
narrative indicates that Sprint has both (1) the intent and (2) the ability ("existing long-term credit
facilities") to refinance on a long-term basis. Thus, Sprint reported the debt as long-term liabilities.

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Exercise 13-10

Requirement 1
This is a loss contingency. There may be a future sacrifice of economic benefits (cost of
satisfying the warranty) due to an existing circumstance (the warranted awnings have been sold)
that depends on an uncertain future event (customer claims).
The liability is probable because product warranties inevitably entail costs. A reasonably
accurate estimate of the total liability for a period is possible based on prior experience. So, the
contingent liability for the warranty is accrued. The estimated warranty liability is credited and
warranty expense is debited in 2003, the period in which the products under warranty are sold.

Requirement 2

2003 Sales
Accounts receivable ......................................................... 5,000,000
Sales ............................................................................ 5,000,000

Accrued liability and expense

Warranty expense (3% x $5,000,000) ............................. 150,000
Estimated warranty liability ....................................... 150,000

Actual expenditures
Estimated warranty liability ............................................ 37,500
Cash, wages payable, parts and supplies, etc. ............ 37,500

Requirement 3

Warranty Liability
_________________________________________

150,000 Estimated liability

Actual expenditures 37,500

112,500 Balance

Exercise 13-16

Requirement 1

Warranty expense ([4% x $2,000,000] - $30,800) .................. 49,200

Estimated warranty liability ............................................... 49,200

Requirement 2

Bad debt expense (2% x $2,000,000) ...................................... 40,000

Allowance for uncollectible accounts ................................ 40,000

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Requirement 3

This is a loss contingency. Classical can use the information occurring after the end of the
year and before the financial statements are issued to determine appropriate disclosure.

Loss – litigation ....................................................................... 1,500,000

Liability - litigation............................................................. 1,500,000

A disclosure note also is appropriate.

Requirement 4

This is a gain contingency. Gain contingencies are not accrued even if the gain is probable
and reasonably estimable. The gain should be recognized only when realized. A disclosure
note is appropriate.

Requirement 5

Loss – product recall .................................................................. 500,000

Liability - product recall ........................................................ 500,000

A disclosure note also is appropriate.

Requirement 6

Promotional expense ([60% x $25 x 10,000] – $105,000)......... 45,000

Estimated premium liability .................................................. 45,000

Exercise 13-18

Item Reporting Method

__C_ 1. Commercial paper. N. Not reported

__D_ 2. Noncommitted line of credit. C. Current liability
__C_ 3. Customer advances. L. Long-term liability
__C_ 4. Estimated warranty cost. D. Disclosure note only
__C_ 5. Accounts payable. A. Asset
__C_ 6. Long-term bonds that will be callable by the creditor in the upcoming year unless an
existing violation is not corrected (there is a reasonable possibility the violation will be
corrected within the grace period).
__C_ 7. Note due March 3, 2004.
__C_ 8. Interest accrued on note, Dec. 31, 2003.
__L_ 9. Short-term bank loan to be paid with proceeds of sale of common stock.
__D_ 10. A determinable gain that is contingent on a future event that appears
extremely likely to occur in three months.
__C_ 11. Unasserted assessment of back taxes that probably will be asserted, in which case there
would probably be a loss in six months.
__N_ 12. Unasserted assessment of back taxes with a reasonable possibility of being asserted, in
which case there would probably be a loss in 13 months.
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 __C_ 13. A determinable loss that is contingent on a future event that appears extremely likely to
occur in three months.
__A_ 14. Bond sinking fund.
__C_ 15. Long-term bonds callable by the creditor in the upcoming year that are not expected to be
called.

Exercise 13-21
The note describes a loss contingency. Dow anticipates a future sacrifice of economic benefits
(cost of remediation and restoration) due to an existing circumstance (environmental violations) that
depends on an uncertain future event (requirement to pay claim).
Dow considers the liability probable and the amount is reasonably estimable. As a result, the
company accrued the liability:
($ in millions)

Loss provision from environmental claims ................................ 325

Liability for settlement of environmental claims .................. 325

Exercise 13-22

Salaries and wages expense (total amount earned) 500,000

Withholding taxes payable (federal income tax) 100,000
........Social security taxes payable ($500,000 x 6.2%) 31,000
................ Medicare taxes payable ($500,000 x 1.45%) 7,250
........... Salaries and wages payable (net pay) 361,750

Payroll tax expense (total) ............................. 69,250

Social security payable (employer’s matching amount) 31,000
FICA taxes payable (employer’s matching amount) 7,250
Federal unemployment tax payable ($500,000 x 0.8%) 4,000
..State unemployment tax payable ($500,000 x 5.4%) 27,000

Problem 13-2

Requirement 1

2003

a. No entry is made for a line of credit until a loan actually is made. It would be described
in a disclosure note.

b. Cash ................................................................................. 12,000,000

Notes payable............................................................. 12,000,000

c. Cash.................................................................................. 2,600
Liability – refundable deposits ................................. 2,600

d. Accounts receivable (total) .............................................. 4,346,000

Sales revenue (given)................................................. 4,100,000
Sales taxes payable ([3% + 3%] x $4,100,000) ......... 246,000
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 e. Interest expense ($12,000,000 x 10% x 3/12) ................. 300,000
Interest payable ......................................................... 300,000

2004

f. Cash ................................................................................. 10,000,000

Bonds payable............................................................ 10,000,000

Interest expense ($12,000,000 x 10% x 2/12) ................. 200,000

Interest payable (from adjusting entry)........................... 300,000
Notes payable (face amount) ........................................... 12,000,000
Cash ($12,000,000 + 500,000)................................... 12,500,000

g. Liability – refundable deposits ....................................... 1,300

Cash............................................................................ 1,300

Requirement 2

CURRENT LIABILITIES:
Accounts payable $ 252,000
Current portion of bank loan 2,000,000*
Liability – refundable deposits 2,600
Sales taxes payable 246,000
Accrued interest payable 300,000
Total current liabilities $2,800,600

LONG-TERM LIABILITIES:
Bank loan to be refinanced
on a long-term basis $10,000,000*

* The intent of management is to refinance all $12,000,000 of

the bank loan, but the actual refinancing demonstrates the
ability only for $10,000,000.

Problem 13-3

Requirement 1

a. The requirement to classify currently maturing debt as a current liability includes debt that is
callable by the creditor in the upcoming year – even if the debt is not expected to be called. So,
the entire $40 million debt is a current liability.

b. $5 million can be reported as long term, but $1 million must be reported as a current liability.
Short-term obligations that are expected to be refinanced with long-term obligations can be
reported as noncurrent liabilities only if the firm (a) intends to refinance on a long-term basis
and (b) actually has demonstrated the ability to do so. Ability to refinance on a long-term basis

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 can be demonstrated by either an existing refinancing agreement or by actual financing prior to
the issuance of the financial statements. The refinancing agreement in this case limits the
ability to refinance to $5 million of the notes. In the absence of other evidence of ability to
refinance, the remaining $1 million cannot be reported as long term.

c. The entire $20 million maturity amount should be reported as a current liability because that
amount is payable in the upcoming year and it will not be refinanced with long-term obligations
nor paid with a bond sinking fund.

d. The entire $12 million loan should be reported as a long-term liability because that amount is
payable in 2006 and it will not be refinanced with long-term obligations nor paid with a bond
sinking fund. The current liability classification includes (a) situations in which the creditor has
the right to demand payment because an existing violation of a provision of the debt agreement
makes it callable and (b) situations in which debt is not yet callable, but will be callable within
the year if an existing violation is not corrected within a specified grace period – unless it's
probable the violation will be corrected within the grace period. Here, the existing violation is
expected to be corrected within 6 months (actually 3 months in this case).

Requirement 2
December 31, 2003
($ in millions)
Current Liabilities
Accounts payable and accruals $ 22
10% notes payable due May 2004 1
Currently maturing portion of long-term debt:
11% bonds due October 31, 2014,
redeemable on October 31, 2004 $40
12% bonds due September 30, 2004 20 60
Total Current Liabilities 83
Long-Term Debt
Currently maturing debt classified as long-term:
10% notes payable due May 2004 (Note X) 5
9% bank loan due October 2009 12
Total Long-Term Liabilities 17
Total Liabilities $100

NOTE X: CURRENTLY MATURING DEBT CLASSIFIED AS LONG-TERM

The Company intends to refinance $6 million of 10% notes that mature in May of 2004. In March,
2004, the Company negotiated a line of credit with a commercial bank for up to $5 million any time
during 2004. Any borrowings will mature two years from the date of borrowing. Accordingly, $5
million was reclassified to long-term liabilities.

Problem 13-5

a. This is a loss contingency. Eastern can use the information occurring after the end of the year in
determining appropriate disclosure. It is unlikely that Eastern would choose to accrue the $122

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 million loss because the judgment will be appealed and that outcome is uncertain. A disclosure
note is appropriate:

_______________________________
Note X: Contingency
In a lawsuit resulting from a dispute with a supplier, a judgment was rendered against Eastern
Corporation in the amount of $107 million plus interest, a total of $122 million at February 3, 2004.
Eastern plans to appeal the judgment. While management and legal counsel are presently unable to
predict the outcome or to estimate the amount of any liability the company may have with respect to
this lawsuit, it is not expected that this matter will have a material adverse effect on the company.

b. This is a loss contingency. Eastern can use the information occurring after the end of the year in
determining appropriate disclosure. Eastern should accrue the $140 million loss because the
ultimate outcome appears settled and the loss is probable.

Loss – litigation ...................................................... 140,000,000

Liability - litigation............................................. 140,000,000

A disclosure note also is appropriate:

_________________________________
Notes: Litigation
In November 2002, the State of Nevada filed suit against the Company, seeking civil penalties and
injunctive relief for violations of environmental laws regulating hazardous waste. On January 12,
2004, the Company announced that it had reached a settlement with state authorities on this matter.
Based upon discussions with legal counsel, the Company, has accrued and charged to operations in
2003, $140 million to cover the anticipated cost of all violations. The Company believes that the
ultimate settlement of this claim will not have a material adverse effect on the Company's financial
position.

c. This is a gain contingency. Gain contingencies are not accrued even if the gain is probable and
reasonably estimable. The gain should be recognized only when realized.

Though gain contingencies are not recorded in the accounts, they should be disclosed in notes to the
financial statements.

_______________________________
Note X: Contingency
Eastern is the plaintiff in a pending lawsuit filed against United Steel for damages due to lost profits
from rejected contracts and for unpaid receivables. The case is in final appeal. No amount has been
accrued in the financial statements for possible collection of any claims in this litigation.

d. No disclosure is required because an IRS claim is as yet unasserted, and an assessment is not
probable. Even if an unfavorable outcome is thought to be probable in the event of an assessment
and the amount is estimable, disclosure is not required unless an unasserted claim is probable.

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Problem 13-9
List A List B
j_ 1. Face amount x Interest rate x Time a. Informal agreement
g 2. Payable with current assets b. Secured loan
h 3. Short-term debt to be refinanced c. Refinancing prior to the issuance
with common stock of the financial statements
i_ 4. Present value of interest plus d. Accounts payable
present value of principal e. Accrued liabilities
d 5. Noninterest-bearing f. Commercial paper
a 6. Noncommitted line of credit g. Current liabilities
b_ 7. Pledged accounts receivable h. Long-term liability
c_ 8. Reclassification of debt i. Usual valuation of liabilities
f_ 9. Purchased by other corporations j. Interest on debt
e_ 10. Expenses not yet paid k. Customer advances
l_ 11. Liability until refunded l. Customer deposits
k_ 12. Applied against purchase price

Communication Case 13-7

Memorandum:

To: Mitch Riley

From: Your Name
Re: Accounting for contingencies

Below is a brief overview of my initial thoughts on how Western should account for the four
contingencies in question.

1. The labor disputes constitute a loss contingency. Though a loss is probable, the amount of loss
is not reasonably estimable. A disclosure note is appropriate:

_______________________________
Note X: Contingency
During 2003, the Company experienced labor disputes at three of its plants. The Company
hopes an agreement will soon be reached. However negotiations between the Company and
the unions have not produced an acceptable settlement and, as a result, strikes are ongoing at
these facilities.

2. The A. J. Conner matter is a gain contingency. Gain contingencies are not accrued even if the
gain is probable and reasonably estimable. The gain should be recognized only when realized.

Though gain contingencies are not recorded in the accounts, they should be disclosed in notes to
the financial statements.

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 _______________________________
Note X: Contingency
In accordance with a 2001 contractual agreement with A.J. Conner Company, the Company is
entitled to $37 million for certain fees and expense reimbursements. The bankruptcy court has
ordered A.J. Conner to pay the Company $23 million immediately upon consummation of a
proposed merger with Garner Holding Group.

3. The contingency for warranties should be accrued:

Warranty expense ([2% x $2,100 million] – $1 million) 41,000,000

Estimated warranty liability 41,000,000

The liability at December 31, 2003, is reported as $41 million.

4. The Crump Holdings lawsuit is a loss contingency. Even though the lawsuit occurred in 2004,
the cause for the action occurred in 2003. Only a disclosure note is needed because an
unfavorable outcome is reasonably possible, but not probable. Also, the amount is not
reasonably estimable.

_______________________________
Note X: Contingency
Crump Holdings filed suit in January 2004 against the Company seeking $88 million, as an
adjustment to the purchase price in connection with the Company's sale of its textile business
in 2003. Crump alleges that the Company misstated the assets and liabilities used to calculate
the purchase price for the division. The Company has answered the complaint and intends to
vigorously defend the lawsuit. Management believes that the final resolution of the case will
not have a material adverse effect on the Company's financial position.

We can discuss these further in our meeting later today.

Analysis Case 13-17

1. The five components of current liabilities are:

2001 2000
Current Liabilities:
Current portion of long-term debt $ 221,392 $ 6,537
Accrued salaries and employee benefits 699,906 755,747
Accounts payable 1,255,298 1,120,855
Accrued expenses 1,072,920 1,007,887
Total current liabilities 3,249,516 2,891,026

2. Current assets are sufficient to cover current liabilities in both 2001 and 2000:

Total current assets: $ 3,449,061 $3,284,744

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 The current ratio for 2001 is: $3,449,061 ÷ 3,249,516 = 1.06
The current ratio for 2000 is: $3,284,744 ÷ 2,891,026 = 1.14,
which is close to the same.

Comparing liabilities that must be satisfied soon with assets that either are cash or will be converted
to cash soon provides a useful measure of a company’s liquidity. A current ratio of 1 to 1 or higher
sometimes is considered a rule-of-thumb standard. However, the current ratio is but one indication
of liquidity. Each ratio is but one piece of the puzzle.

3. From Note 3 we see that the two largest accrued expenses for FedEx in 2001 were insurance expense
and compensated absences. An accrued expense is an expense incurred during the current period,
but not yet paid. FedEx recorded these as adjusting entries at the end of the reporting period with
debits to the appropriate expenses and credits to related liabilities. This helps achieve a proper
matching of expenses with the revenues they help generate.

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