Question

Transit Airlines provides regional jet service in the Mid-South. The following is information on liabilities of Transit at December 31, 2021. Transit's fiscal year ends on December 31. Its annual financial statements are issued in April. 1. Transit has outstanding 8.6% bonds with a face amount of $80 million. The bonds mature on July 31, 2027. Bondholders have the option of calling (demanding payment on) the bonds on July 31, 2022, at a redemption price of $80 million. Market conditions are such that the call option is not expected to be exercised. 2. A $32 million 6% bank loan is payable on October 31, 2024. The bank has the right to demand payment after any fiscal year-end in which Transit's ratio of current assets to current liabilities falls below a contractual minimum of 1.9 to 1 and remains so for six months. That ratio was 1.75 on December 31, 2021, due primarily to an intentional temporary decline in parts inventories. Normal inventory levels will be reestablished during the sixth week of 2022. 3. Transit management intended to refinance $46 million of 6% notes that mature in May 2022. In late February 2022, prior to the issuance of the 2021 financial statements, Transit negotiated a line of credit with a commercial bank for up to $42 million any time during 2022. Any borrowings will mature two years from the date of borrowing. 4. Transit is involved in a lawsuit resulting from a dispute with a food caterer. On February 13, 2022, judgment was rendered against Transit in the amount of $50 million plus interest, a total of $51 million. Transit plans to appeal the judgment and is unable to predict its outcome though it is not expected to have a material adverse effect on the company. Required: 1. How should the 8.6% bonds be classified by Transit among liabilities in its balance sheet? 2. How should the 6% bank loan be classified by Transit among liabilities in its balance sheet? 3. How should the 6% notes be classified by Transit among liabilities in its balance sheet? 4. How should the lawsuit be reported by Transit? 5. Calculate the total current liabilities, total long-term liabilities, and total liabilities of a classified balance sheet for Transit Airlines at December 31, 2021. Transit's accounts payable and accruals were $40 million,

Answer 1

Transit Airlines Requirement 1 Current liability $80 million The requirement to classify currently maturing debt as a current liability includes debt that is callable by the creditor in the upcoming year-even if the debt is not expected to be called. So, the entire $80 million debt is a current liability. Requirement 2 Long-term liability $32 million The entire $32 million loan should be reported as a long-term liability because that amount is payable in 2024. The current liability classification includes (a) situations in which the creditor has the right to demand payment because an existing violation of a provision of the debt agreement makes it callable and (b) situations in which debt is not yet callable, but will be callable within the year if an existing violation is not corrected within a specified grace period-unless it's probable the violation will be corrected within the grace period. Here, the existing violation is expected to be corrected within six months (actually six weeks in this case). Requirement 3 Current liability Long-term liability $4 million $42 million The intent of management is to refinance all $46,000,000 of the 6% notes, but the refinancing agreement demonstrates the ability only for $42,000,000. $42 million can be reported as long term, but $4 million must be reported as a current liability. Short-term obligations that are expected to be refinanced with long-term obligations can be reported as noncurrent liabilities only if the firm (a) intends to refinance on a long-term basis and (b) actually has demonstrated the ability to do so. Ability to refinance on a long-term basis can be demonstrated by either an existing refinancing agreement or by actual financing prior to the issuance of the financial statements. The refinancing agreement in this case limits the ability to refinance to $42 million of the notes. In the absence of other evidence of ability to refinance, the remaining $4 million cannot be reported as long term. Requirement 4 The lawsuit should be reported as: A disclosure note only should be provided. The lawsuit resulting from a dispute with a food caterer should not be accrued. The suit is in appeal and it is not deemed probable that that Transit will lose the appeal. Note disclosure is required. Requirement 5 December 31, 2021 Current Liabilities Accounts payable and accruals 8.6% bonds maturing on July 31, 2027, callable July 31, 2022 Current portion of 6% notes payable due May 2022 Total Current Liabilities $40 million $80 million $4 million $124 million $32 million Long-Term Debt 6% bank loan payable on October 31, 2024 Currently maturing debt classified as long-term: 6% notes payable due May 2022 (Note X) Total Long-Term Liabilities Total Liabilities $42 million $74 million $198 million