Contingencies and Commitments Flashcards
(9 cards)
During Year 4, a company became involved in a legal dispute with a supplier. At December 31, Year 4, the company’s legal advisor believed that an unfavorable outcome was probable. A reasonable estimate of resulting monetary damages is $100,000 but could be as much as $200,000. After the Year 4 financial statements were issued, the company agreed to settle the case for $125,000. What amount, if any, of accrued liability should the company have reported in its December 31, Year 4, balance sheet?
A. $0
B. $100,000
C. $125,000
D. $200,000
C. $125,000
100K was after FS were issued
Paxton Co. signed contracts for the purchase of raw materials to be executed the following year at a firm price of $5 million. The market price of the materials dropped to $3 million on December 31. What amount should Paxton record as an estimated liability on purchase commitments as of December 31?
A. $0
B. $2,000,000
C. $3,000,000
D. $5,000,000
B. $2,000,000
The loss is the estimated liability
LTTI Co. entered into a 3-year, non-cancelable contract to buy up to 1 million units of a product each year at $.10 per unit with a minimum annual guarantee purchase of 200,000 units. At the end of the first year, LTTI had only purchased 80,000 units and decided to cancel sales of the product. What amount should LTTI report as a loss related to the purchase commitment at the end of the first year?
A. $0
B. $8,000
C. $12,000
D. $52,000
D. $52,000
In this case, LTTI Co. guaranteed the purchase of 200,000 units per year for 3 years. If LTTI continued with the contract, the unit purchases would be recognized each year as they occurred. However, because LTTI decides in the first year that they will no longer be purchasing the units, the company must recognize the full loss from the noncancelable contract immediately (ie, in the first year).
The total loss recognized at the end of the first year is $52,000:
Loss from first year (200,000 unit guarantee − 80,000 units purchased) ×$0.10 per unit $12,000
Loss from future years 200,000 unit guarantee ×2 years × $0.10 per unit 40,000
$52,000
During Year 3, Manfred Corp. guaranteed a supplier’s $500,000 loan from a bank.
On October 1, Year 4, Manfred was notified that the supplier had defaulted on the loan and filed for bankruptcy protection. Counsel believes Manfred will probably have to pay between $250,000 and $450,000 under its guarantee.
As a result of the supplier’s bankruptcy, Manfred entered into a contract in December Year 4 to retool its machines so that Manfred could accept parts from other suppliers. Retooling costs are estimated to be $300,000.
What amount should Manfred report as a liability in its December 31, Year 4, balance sheet?
A. $250,000
B. $450,000
C. $550,000
D. $750,000
A. $250,000
Retooling costs would not be included
Blake Foods Corporation mails coupons to consumers which may be presented by a stated expiration date at retail food stores to obtain discounts on certain Blake products. Retailers are reimbursed for the face value of coupons redeemed, plus 10% of coupon value as compensation for handling costs. Blake honors requests for coupon redemption by retailers received up to 3 months after the consumer expiration date. In Blake’s experience, 60% of the coupons issued ultimately are redeemed. Information with respect to the two separate series of coupons issued by Blake during year 1 is as follows:
Series A Series B
Consumer expiration date June 30, year 1 December 31, year 1
Total face value of coupons issued $100,000 $200,000
Total payments to retailers as of December 31, year 1 $ 60,500 $ 40,500
What amount should Blake report as a liability for unredeemed coupons at December 31, year 1?
A. $0
B. $79,500
C. $91,500
D. $97,000
C. $91,500
This answer is correct. Two separate series of coupons were mailed to consumers during year 1. The first series expired on 6/30/Y1 and the problem indicated that Blake honors requests for coupon redemption by retailers only up to 3 months after the consumer expiration date. Therefore, no liability should be accrued for the Series A coupons. Payments of $40,500 have been made to retailers on the Series B coupons which expired on 12/31/Y1. To find the 12/31/Y1 liability, the $40,500 payments must be compared with the total expected payments to be made on the Series B coupons. Since Blake’s experience is that 60% of the coupons will be redeemed, $120,000 face value of Series B coupons are expected to be redeemed (60% × $200,000). Additionally, $12,000 is expected to be paid to retailers for handling ($120,000 × 10%). Thus, an accrued liability of $91,500 is required ($132,000 expected total payments − $40,500 payments to date).
Dunn Trading Stamp Co. records stamp service revenue and provides for the cost of redemptions in the year stamps are sold to licensees. Dunn’s past experience indicates that only 80% of the stamps sold to licensees will be redeemed. Dunn’s liability for stamp redemptions was $6,000,000 at December 31, Year 5. Additional information for Year 6 is as follows:
Stamp service revenue from stamps sold to licensees $4,000,000
Cost of redemptions (stamps sold prior to 1/1/Y6) 2,750,000
If all the stamps sold in Year 6 were presented for redemption in Year 7, the redemption cost would be $2,250,000. What amount should Dunn report as a liability for stamp redemptions at December 31, Year 6?
A. $7,250,000
B. $5,500,000
C. $5,050,000
D. $3,250,000
C. $5,050,000
Invern, Inc. has a self-insurance plan. Each year, retained earnings is appropriated for contingencies in an amount equal to insurance premiums saved less recognized losses from lawsuits and other claims. As a result of a year 2 accident, Invern is a defendant in a lawsuit in which it will probably have to pay damages of $190,000. What are the effects of this lawsuit’s probable outcome on Invern’s year 2 financial statements?
A. An increase in expenses and no effect on liabilities.
B. An increase in both expenses and liabilities.
C. No effect on expenses and an increase in liabilities.
D. No effect on either expenses or liabilities.
B. An increase in both expenses and liabilities.
Reserves for contingencies for general or unspecified business risks should
A. Be accrued in the financial statements and disclosed in the notes thereto.
B. Not be accrued in the financial statements but should be disclosed in the notes thereto.
C. Not be accrued in the financial statements and need not be disclosed in the notes thereto.
D. Be accrued in the financial statements but need not be disclosed in the notes thereto.
C. Not be accrued in the financial statements and need not be disclosed in the notes thereto.
This answer is correct because ASC Topic 450 states that no accrual, loss, or disclosure should be made for general or unspecified business risks and that they need not be disclosed. An estimated loss for a loss contingency shall be accrued only if the loss is probable and the amount of the loss is reasonably estimated. General or unspecified business risks do not meet these conditions.
Lute Corporation sells furnaces that include a three-year warranty. Lute can contract with a third party to provide these warranty services. Lute elects the fair value option for reporting financial liabilities. At what amount should Lute record the warranty liability on the balance sheet?
A. The cost of expected warranty services.
B. The present value of expected warranty costs.
C. The fair value of the contract to settle the warranty services.
D. The fair value of the contract to settle less the cost to provide services.
C. The fair value of the contract to settle the warranty services.
