13 Current Liabilities and Contingencies CONCEPTS FOR ANALYSIS 13
CONCEPTS FOR ANALYSIS
CA13-1 (Nature of Liabilities) Presented below is the current liabilities section of Micro Corporation…
Instructions
Answer the following questions.
(a) What are the essential characteristics that make an item a liability?
(b) How does one distinguish between a current liability and a long-term liability?
(c) What are accrued liabilities? Give three examples of accrued liabilities that Micro might have.
(d) What is the theoretically correct way to value liabilities? How are current liabilities usually valued?
(e) Why are notes payable reported first in the current liabilities section?
(f) What might be the items that comprise Micro’s liability for “Compensation to employees”?
CA13-2 (Current versus Noncurrent Classification) Rodriguez Corporation includes the following items in its liabilities at December 31, 2017.
1. Notes payable, $25,000,000, due June 30, 2018.
2. Deposits from customers on equipment ordered by them from Rodriguez, $6,250,000.
3. Salaries and wages payable, $3,750,000, due January 14, 2018.
Instructions
Indicate in what circumstances, if any, each of the three liabilities above would be excluded from current liabilities.
CA13-3 WRITING (Refinancing of Short-Term Debt) Dumars Corporation reports in the current liability section of its balance sheet at December 31, 2017 (its year-end), short-term obligations of $15,000,000, which includes the current portion of 12% long-term debt in the amount of $10,000,000 (matures in March 2018). Management has stated its intention to refinance the 12% debt whereby no portion of it will mature during 2018. The date of issuance of the financial statements is March 25, 2018.
Instructions
(a) Is management’s intent enough to support long-term classification of the obligation in this situation?
(b) Assume that Dumars Corporation issues $13,000,000 of 10-year debentures to the public in January 2018 and that management intends to use the proceeds to liquidate the $10,000,000 debt maturing in March 2018.
Furthermore, assume that the debt maturing in March 2018 is paid from these proceeds prior to the issuance of the financial statements. Will this have any impact on the balance sheet classification at December 31, 2017?
Explain your answer.
(c) Assume that Dumars Corporation issues common stock to the public in January and that management intends to entirely liquidate the $10,000,000 debt maturing in March 2018 with the proceeds of this equity securities issue. In light of these events, should the $10,000,000 debt maturing in March 2018 be included in current liabilities at December 31, 2017?
(d) Assume that Dumars Corporation, on February 15, 2018, entered into a financing agreement with a commercial bank that permits Dumars Corporation to borrow at any time through 2019 up to $15,000,000 at the bank’s prime rate of interest.
Borrowings under the financing agreement mature three years after the date of the loan. The agreement is not cancelable except for violation of a provision with which compliance is objectively determinable. No violation of any provision exists at the date of issuance of the financial statements. Assume further that the current portion of long-term debt does not mature until August 2018. In addition, management intends to refinance the $10,000,000 obligation under the terms of the financial agreement with the bank, which is expected to be financially capable of honoring the agreement.
(1) Given these facts, should the $10,000,000 be classified as current on the balance sheet at December 31, 2017?
(2) Is disclosure of the refinancing method required?
CA13-4 WRITING (Loss Contingencies) On February 1, 2018, one of the huge storage tanks of Viking Manufacturing Company exploded. Windows in houses and other buildings within a one-mile radius of the explosion were severely damaged, and a number of people were injured. As of February 15, 2018 (when the December 31, 2017, financial statements were completed and sent to the publisher for printing and public distribution), no suits had been filed or claims asserted against the company as a consequence of the explosion. The company fully anticipates that suits will be filed and claims asserted for injuries and damages.
Because the casualty was uninsured and the company is considered at fault, Viking Manufacturing will have to cover the damages from its own resources.
Instructions
Discuss fully the accounting treatment and disclosures that should be accorded the casualty and related contingent losses in the financial statements dated December 31, 2017.
CA13-5 (Loss Contingency) Presented below is a note disclosure for Matsui Corporation.
Litigation and Environmental: The Company has been notified, or is a named or a potentially responsible party in a number of governmental (federal, state and local) and private actions associated with environmental matters, such as those relating to hazardous wastes, including certain sites which are on the United States EPA National Priorities List (“Superfund”). These actions seek clean-up costs, penalties and/or damages for personal injury or to property or natural resources.
In 2017, the Company recorded a pre-tax charge of $56,229,000, included in the “Other expense (income)—net” caption of the Company’s consolidated income statements, as an additional provision for environmental matters. These expenditures are expected to take place over the next several years and are indicative of the Company’s commitment to improve and maintain the environment in which it operates. At December 31, 2017, environmental accruals amounted to $69,931,000, of which $61,535,000 are considered noncurrent and are included in the “Deferred credits and other liabilities” caption of the Company’s consolidated balance sheets.
While it is impossible at this time to determine with certainty the ultimate outcome of environmental matters, it is management’s opinion, based in part on the advice of independent counsel (after taking into account accruals and insurance coverage applicable to such actions) that when the costs are finally determined they will not have a material adverse effect on the financial position of the Company.
Instructions
Answer the following questions.
(a) What conditions must exist before a loss contingency can be recorded in the accounts?
(b) Suppose that Matsui Corporation could not reasonably estimate the amount of the loss, although it could establish with a high degree of probability the minimum and maximum loss possible. How should this information be reported in the financial statements?
(c) If the amount of the loss is uncertain, how would the loss contingency be reported in the financial statements?
CA13-6 (Warranties and Loss Contingencies) The following two independent situations involve loss contingencies.
Part 1: Benson Company sells two products, Grey and Yellow. Each carries a 1-year warranty.
1. Product Grey—Product warranty costs, based on past experience, will normally be 1% of sales.
2. Product Yellow—Product warranty costs cannot be reasonably estimated because this is a new product line. However, the chief engineer believes that product warranty costs are likely to be incurred.
Instructions
How should Benson report the estimated product warranty costs for each of the two types of merchandise above? Discuss the rationale for your answer. Do not discuss disclosures that should be made in Benson’s financial statements or notes.
Part 2: Constantine Company is being sued for $4,000,000 for an injury caused to a child as a result of alleged negligence while the child was visiting the Constantine Company plant in March 2017. The suit was filed in July 2017. Constantine’s lawyer states that it is probable that Constantine will lose the suit and be found liable for a judgment costing anywhere from $400,000 to $2,000,000. However, the lawyer states that the most probable judgment is $1,000,000.
Instructions
How should Constantine report the suit in its 2017 financial statements? Discuss the rationale for your answer. Include in your answer disclosures, if any, that should be made in Constantine’s financial statements or notes.
(AICPA adapted)
CA13-7 ETHICS (Warranties) The Dotson Company, owner of Bleacher Mall, charges Rich Clothing Store a rental fee of $600 per month plus 5% of yearly profits over $500,000. Matt Rich, the owner of the store, directs his accountant, Ron Hamilton, to increase the estimate of bad debt expense and warranty costs in order to keep profits at $475,000.
Instructions
Answer the following questions.
(a) Should Hamilton follow his boss’s directive?
(b) Who is harmed if the estimates are increased?
(c) Is Matt Rich’s directive ethical?
