Week Five Homework Acct305

SOLUTIONS – WEEK FIVE – ACCT 305

Exercise 13-9 Requirement 1  Cash....................................................................... Liability – customer advance ............................

7,500 7,500

Requirement 2  Cash....................................................................... Liability – refundable deposits .........................

25,500 25,500

Requirement 3  Accounts receivable............................................... Sales revenue .................................................... Sales taxes payable ([5% + 2%] x $800,000)....

856,000 800,000 56,000

Brief Exercise 13-5 Cash (difference)....................................................... Discount on notes payable ($10,000,000 x 6% x 9/12) ......................................Notes payable (face amount) Effective interest rate: Discount ($10,000,000 x 6% x 9/12) Cash proceeds Interest rate for 9 months 

Annual effective rate

$     450,000  ÷ $9    ,550,000     4.712% x    12/9  ___________ 6.3%

9,550,000 450,000 10,000,000

Brief Exercise 13-8 This is a loss contingency and the estimated warranty liability is credited and warranty  expense is debited in the period in which the products under warranty are sold.   Right  will report a liability of $130,000: Warranty Liability _____________________________________________

150,000 Warranty expense (1% x $15,000,000) Actual expenditures20,000 130,000 Balance

Communication Case 13­8 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 2006, 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.   _______________________________ Note X: Contingency In accordance with a 2004 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.

Case 13­8 (concluded) 3. The contingency for warranties should be accrued: Warranty expense ([2% x $2,100 million] – $1 million) Estimated warranty liability 

41,000,000 41,000,000

The liability at December 31, 2006, is reported as $41 million. 4. The Crump Holdings lawsuit is a loss contingency.  Even though the lawsuit occurred in  2007, the cause for the action occurred in 2006.  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 2007 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 2006. 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.