Question

 

"1 see an all-nighter coming on," Gayle grumbled. "V-,Thy did Mitch just now give us this assignment?" Your client, Western 

Manufacturing, is involved with several situations that possibly involve contingencies. The assignment Gayle refers to is to 

draft appropriate accounting treatment for each situation described below in time for tomorrow's meeting of the audit 

group. Western's fiscal year is the calendar year 2018, and the 2018 financial statements are issued on March 15, 2019. 

l. During 201 S, Western experienced labor disputes at three of its plants. Management 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 since March l, 2019. It is virtually certain that material costs will be incurred but the 

amount of possible costs cannot be reasonably ascertained. 

2. In accordance with a 2016 contractual agreement with A. J. Conner Company, Western is entitled to $37 million for certain 

fees and expense reimbursements. These were written off as bad debts in 2017. A. J. Conner has filed for bankruptcy. The 

bankruptcy court on February 4, 2019, ordered A. J. Conner to pay $23 million immediately upon consummation of a 

proposed merger with Garner Holding Group. 

3. Western warrants most products it sells against defects in materials and workmanship for a period of a year. Based on their 

experience with previous product introductions, warranty costs are expected to approximate 2% of sales. A warranty liability 

of $39 million was reported at December 3 1, 2017. Sales of warranted products during 201 S were $2,100 million and actual 

warranty expenditures were $40 million. 

4. Western IS involved in a suit filed in January 2019 by Crump Holdings seeking SSS million, as an adjustment to the purchase 

price in connection with the Company's sale of its textile business in 2018. The suit alleges that Western misstated the assets 

and liabilities used to calculate the purchase price for the textile division. Legal counsel advises that it is reasonably possible 

that Western could end up losing an indeterminable amount not expected to have a material adverse effect on the Company's 

financial position. 

REQUIRED

1. Determine the appropriate means of reporting each situation.

2. In a memo to the audit manager , Mitch Riley, explain your reasoning. Include any necessary journal entries and drafts of appropriate disclosure notes.

Answer 1

Appropriate Methods to report the situations:

1. In the Notes to Accounts give the disclosure under Contingent Liability Note in following manner -

" Currently there are disputes going on between management and labour unions regarding wage rates, after lot of deliberations a mutual conclusion could not be reached. Hence, Management apprehends that company will have to pay a material amount in the form of compensation but amount of the compensation cannot be determined with precision hence provision for the same is not made in the books of accounts.

2. To give effect to the given transactions following entries shall be passed in the books:

Trade Receivable A/c___________Dr. $ 23.00 Mn

To Bad debts recovered - $23.00 Mn

(Being earlier bad debts written off, now recoverable as a result of proposed merger as per court order, hence recognised in the books of accounts)

3. First entry to recognise warranty expenditure-

Provision for Warranty expenditure A/c____Dr. $ 39.00 Mn

Warranty Expenditure A/c_________Dr. $ 1.00 Mn.

To Bank A/c $ 40.00 Mn.

(Being warranty expenditure incurred. Amount of existing provision utilised for providing warranty and remaining amount debited to income and expediture account)

Second entry: For creating new provision

Income and Expenditure A/c__________Dr. $ 42.00 Mn. -

To Provision for warranty       - $ 42.00 Mn.

4. Disclosure in Notes to Accounts under contingent liability:

"There is a suit filed against company by Crump Holding for sale of it's textile division to the later. As per company's legal counsel's opinion it is reasonably possible that company may end up losing the suit and charges against the company will materialise. The amount of charges can not be determined with precision hence appropriate provision is not made in the books of accounts, otherwise provision is required."

Q2. - Memo to Audit Manager -

Dear Sir,

To appropriately present the financial position of the company we have made required journal entries to give effect to material transactions so as to make financial statements true and fair.

In two situations where provisions are required due to inability to calculate appropriate amounts provisions are not made but same are shown in contingent liability notes to accounts. While making any decision effect required to be given for these provisions shall be taken into consideration so as to take informed decision.