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    Accounting for Liabilities

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    1. Highland Company had the following question regarding reporting of contingencies on their financial statements for the year 2007:

    a. They were being sued by local residents for negligence causing local residents to become ill from toxic chemicals used at its plant. Highland attorneys state that it is probable that they will lose the suit and will be liable for a judgment costing Highland anywhere from $1,100,000 to $6,100,000. The attorneys feel that the most probable cost is $3,500,000. How much should Highland accrue as a result of these facts? Provide the justification for the amount you specify.

    b. On January 3rd, Highland owned a machine costing $250,000. The accumulated depreciation was $150,000, estimated salvage value $15,000 and fair market value was $350,000. On January 4, 2007, the machine was damaged beyond repair by Squire Company and was deemed worthless. In October 2007, a court awarded damages of $400,000 against Squire in favor of Highland. At December 31, 2007, the case was awaiting appeal and, therefore uncertain. In the opinion of Highland's attorney, Squire's appeal will be denied. What amount should Highland accrued at December 31, 2007 for this contingency and why?

    2. Larson Company incurred payroll of $1,020,000. Of that amount, $210,000 represents wages in excess of $90,000 per employee. Of that amount, $750,000 represents amounts paid in excess of $7,000 per employee. Income taxes were withheld in the amount of $315,000. State unemployment tax is 1.2% and federal unemployment tax is .8%. FICA tax is 7.65 on wages up to $90,000 and 1.45% in excess of $90,000 per employee.

    a. Prepare the journal entry to record the wages and withholding taxes
    b. Prepare the journal entry to record the employer payroll taxes.
    c. Prepare the journal entry to record payment of payroll and payroll taxes.

    3. Wiley Inc operates in a state with a 6% sales tax. State law requires that the sales tax collected during the month be remitted during the following month prior to the 20th day of the month. If remitted on a timely basis, the retailer may keep 2% of the sales tax collected. On May 10, 2007, Wiley, Inc remitted $91,450 to the state tax division for April 2007 sales. Calculate the amount of Wiley's April 2007 sales subject to sales tax, and, record the journal entry that would be made when the tax is paid assuming that any revenue related to collection has not been booked. Sales have been booked for April with a credit to sales tax payable.

    4. Can the present value of minimum lease payments differ between the leaser and lessee? If so, how?

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    Solution Preview

    1.
    a. Because there is a present liability on Highland's part as the result of past events, it is probable that there will be an outflow of net assets to settle the liability, and the liability can be reliably estimated, the liability must be accrued. Because experts (the lawyer) have determined a most probable cost of $3,500,000, the liability should be accrued for $3,500,000. (Had the settlement been possible instead of probable, the liability would merely be disclosed.)

    b. This is a contingent asset. That is, there is a probability that the company will realize income as the result of a past event. Under U.S. GAAP, contingent income is not recognized, though it can be disclosed in the notes to the financial statements if it is material and occurs between the close of the reporting period and the date the statements ...

    Solution Summary

    1. Highland Company had the following question regarding reporting of contingencies on their financial statements for the year 2007:

    a. They were being sued by local residents for negligence causing local residents to become ill from toxic chemicals used at its plant. Highland attorneys state that it is probable that they will lose the suit and will be liable for a judgment costing Highland anywhere from $1,100,000 to $6,100,000. The attorneys feel that the most probable cost is $3,500,000. How much should Highland accrue as a result of these facts? Provide the justification for the amount you specify.

    b. On January 3rd, Highland owned a machine costing $250,000. The accumulated depreciation was $150,000, estimated salvage value $15,000 and fair market value was $350,000. On January 4, 2007, the machine was damaged beyond repair by Squire Company and was deemed worthless. In October 2007, a court awarded damages of $400,000 against Squire in favor of Highland. At December 31, 2007, the case was awaiting appeal and, therefore uncertain. In the opinion of Highland's attorney, Squire's appeal will be denied. What amount should Highland accrued at December 31, 2007 for this contingency and why?

    2. Larson Company incurred payroll of $1,020,000. Of that amount, $210,000 represents wages in excess of $90,000 per employee. Of that amount, $750,000 represents amounts paid in excess of $7,000 per employee. Income taxes were withheld in the amount of $315,000. State unemployment tax is 1.2% and federal unemployment tax is .8%. FICA tax is 7.65 on wages up to $90,000 and 1.45% in excess of $90,000 per employee.

    a. Prepare the journal entry to record the wages and withholding taxes
    b. Prepare the journal entry to record the employer payroll taxes.
    c. Prepare the journal entry to record payment of payroll and payroll taxes.

    3. Wiley Inc operates in a state with a 6% sales tax. State law requires that the sales tax collected during the month be remitted during the following month prior to the 20th day of the month. If remitted on a timely basis, the retailer may keep 2% of the sales tax collected. On May 10, 2007, Wiley, Inc remitted $91,450 to the state tax division for April 2007 sales. Calculate the amount of Wiley's April 2007 sales subject to sales tax, and, record the journal entry that would be made when the tax is paid assuming that any revenue related to collection has not been booked. Sales have been booked for April with a credit to sales tax payable.

    4. Can the present value of minimum lease payments differ between the leaser and lessee? If so, how?

    $2.19

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