Chapter 12: Liabilities
Dry Clean Depot Limited
Liability recognition (W*)
Measurement of estimated liabilities
Long-term note—borrower and lender
Note with below-market interest rate
Debt issuance, fair value
Bonds—compare effective interest, straight-line
Bonds—effective interest, straight-line (*W)
Bonds issued between interest dates (*W)
Bonds—between interest dates; effective interest
Bonds issued between interest dates
Upfront fees and notes payable
Retirement—open market purchase
Bond retirement (W*)
Bond issuance and retirement, accrued interest
Bond issuance, defeasance
Foreign exchange (*W)
Partial statement of cash flow
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The definition of a liability embodies a future sacrifice of assets or services, a present obligation, as a result of a past transaction or event.
A financial liability exists when one company has a liability and another entity has a financial asset. Non-financial liabilities are all other liabilities; no corresponding financial asset arises on the books of the counter-party. Examples include liabilities for environmental remediation, lawsuits and warranties. [Other examples are acceptable.] Liabilities must be probable of payment (>50% probability) to be recognized. Amounts are measured at best estimate, which is expected value for large populations and most likely outcome for small populations. Most likely outcome is informed by expected value and cumulative probabilities. If suggested proposals for change are adopted, the liability will be measured at expected value as long as an obligating event takes place.
Accounting for the lawsuit is complicated at this stage because the company and/or the lawyer would be unwilling to admit in print (i.e., in the financial statements) that they would settle the lawsuit, and at what amount. This might provide too much information to the plaintiff. Note disclosure of the lawsuit, in general terms, is the likely outcome, although an accrual for $150,000 would be made if the company were to share this information with its accountants. This is the ethically appropriate outcome. If the accrual is made, separate disclosure would be minimal so its treatment would not be obvious to the plaintiff.
A purchase order is an executory contract, and is not a liability until the other party performs its obligations under the contract. That is, the amount becomes a liability when the goods are delivered, but not until then. Some liability would be recognized if the contract became an onerous contact. This would happen if the fair value of the goods were to fall below $10 per case. A liability would be recognized for the amount of the loss because that amount has no economic value.
5. No liability will be recorded for coupons that involve a modest decrease in purchase price. The only result of the coupon program is that gross profit will be lower in the period in which the coupons are used. A liability would only be recorded if the coupon program resulted in cash being paid out, or products sold at less than cost. Here, it is assumed that the $14 regular price...
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