ch 13

A company buys an oil rig for $2,000,000 on January 1, 2014. The life of the rig is 10 years and the expected cost to dismantle the rig at the end of 10 years is $400,000 (present value at 10% is $154,220). 10% is an appropriate interest rate for this company. What expense should be recorded for 2014 as a result of these events?

($2,000,000 + $154,220) ÷ 10 = $215,422; $154,220 × .10 = $15,422

Companies should disclose other contingent liabilities:

-Guarantee of indebtedness of others -Obligations of commercial banks under "stand-by letters of credit" -Guarantees to repurchase receivables (or any related property)that have been sold or assigned

Presentation of contingencies Disclosure should include:

-Nature of contingency -An estimate of the possible loss or range of loss or a statement that an estimate cannot be made

Gain contingency: Typically are

-Possible receipts of monies from gifts, donations, asset sales, etc -Possible refunds from the government in tax disputes -Pending court cases with a probably favorable outcome

Exclude LT debts maturing currently if they are to be:

-Retired by assets accumulated that have not been shown as current assets -Refinanced or retired from the proceeds of a new debt issue -Converted into capital stock

matching justification

-The related income statement effect may be recognized before the actual payment occurs -The event was in PREVIOUS periods, and therefore any loss should be recognized immediately

Companies must consider the following factors in determining whether to record a liability with respect to pending or threatened litigation and actual or possible claims or assessments

-Time period in which the ACTION occurred, not the PAYMENT -Probability of an unfavorable outcome -Ability to make a reasonable estimate of the loss

Accrual-basis method

-charge warranty costs to operating expense in the year of sale -Method follows Matching Principle -Expense Warranty Approach

what losses are accrued?

-collectivibility of receivables -warranties and defects

theoretical justification for loss contingency

-conservatism -matching principal -full disclosure -relevance

what losses are NOT accrued?

-damage from fire etc -general unspecified business risks -risk of loss from catastrophes assumed by insurance

On January 3, 2014, Benton Corp. owned a machine that had cost $300,000. The accumulated depreciation was $180,000, estimated salvage value was $18,000, and fair value was $480,000. On January 4, 2014, this machine was irreparably damaged by Pogo Corp. and became worthless. In October 2014, a court awarded damages of $480,000 against Pogo in favor of Benton. At December 31, 2014, the final outcome of this case was awaiting appeal and was, therefore, uncertain. However, in the opinion of Benton's attorney, Pogo's appeal will be denied. At December 31, 2014, what amount should Benton accrue for this gain contingency?

0

Short term obligations expected to be refinanced, exclude from CL is both of the following are met:

1. Must intend to refinance the obligation on a LT basis 2. Must demonstrate an ability to refinance a. Actual refinancing b. Enter into financing agreement

relevance justification

A possible events that will have an economic impact on business is relevant information. Recall that for information to be relevant, it must have the possibility of altering a user's capital allocatin decision

contingencies

An existing set of circumstances involving uncertainty as to possible gain or loss to a business that will ultimately be resolved when one or more future events fail to occur

conservatism justification

CONSERVATISM: Accounting conservatism will recognize all probable future losses as they are discovered and most expenditures as they are incurred, but gains and revenue will be deferred until verified NEVER underestimate liabilities or expenses or overestimate assets or revenues- thus, gain contingencies are NEVER RECOGNIZED and rarely disclosed

what do you do with gain contingencies?

Gain contingencies ARE NOT RECORDED. Disclosed only if probability of receipt is high.

Current liabilities

Obligations whose liquidation is reasonably expected to require use of existing resources properly classified, or the creation of other current liabilities

Operating cycle

Period of time elapsing between the acquisition of goods and services and the final cash realization resulting from sales

Current maturities of LT debt

Portion of bonds, mortgage notes, and other LT debt that matures within next fiscal year ONLY PRINCIPAL IS RECLASSIFIED.

liability

Probable future economic detriment arising from past transactions

Guarantee & warranty costs

Promise made by a seller to a buyer to make good on a deficiency of quantity, quality, or performance in a product

Recognition of warranty costs incurred in 2015 (on 2014 sales):

Warranty Liability 16,000 (2015) Cash, Inventory, Accrued Payroll 16,000

Black Water Inc. is being sued by former employees as a result of negligence on the company's part. Black Water's lawyers state that it is probable that the company will lose the suit and be found liable for a judgment costing the company anywhere from $100,000,000 to $200,000,000. However, the lawyer states that the most probable cost is $125,000,000. As a result of the above facts, Black Water should accrue

a loss contingency of $125,000,000 and disclose an additional contingency of up to $75,000,000

Wooten Co. is being sued for illness caused to local residents as a result of negligence on the company's part in permitting the local residents to be exposed to highly toxic chemicals from its plant. Wooten's lawyer states that it is probable that Wooten will lose the suit and be found liable for a judgment costing Wooten anywhere from $1,600,000 to $8,000,000. However, the lawyer states that the most probable cost is $4,800,000. As a result of the above facts, Wooten should accrue

a loss contingency of $4,800,000 and disclose an additional contingency of up to $3,200,00

PROBABLY loss contingency

accrue, footnote

JE for lawsuit liability where it is PROBABLE that they lose

dr Lawsuit Loss 900,000 cr Lawsuit Liability 900,000

Recognition of warranty expense

dr Warranty Expense 4,000 (actual warranty cost year 1) cr Cash, Inventory, Accrued Payroll 4,000 Warranty Expense 16,000 (warranty costs year 2) Warranty Liability 16,000

settlement of aro JE

dr asset retirement obligation (our co) cr gain cr cash (dismantling price of other co?)

RECORDING ARO JE

dr drilling platform cr asset retirement obligation

full disclosure justification

even if the outcome is uncertain, failure to inform users of financial statements violates full disclosure

ARO's should be recorded as

fair value (typically discounted future cash flows) and written up to cost over the life of the liability

reasonably likely loss contingency

footnote

remote loss contingency

ignore

A company must recognize an asset retirement obligation (ARO) when

it has an existing legal obligation associated with the retirement of a long-lived asset and when it can reasonably estimate the amount of the liability

JE for lawsuit liability where it is NOT PROBABLE that they lose

nothing baby