Graduate Manufacturing Company -

Your accounting firm has been hired to consult with the Graduate Manufacturing Company (GMC). GMC is preparing its annual financial statements as of December 31, 2009.

GMC has requested guidance concerning 7 specific reporting issues. You have been assigned to prepare a written report to be presented to GMC's senior management that explains the proper accounting treatment for each item.

For each issue, your analysis should include:

1. Any accounting entries needed, in journal entry form.
2. Any financial statement disclosures needed.
3. A discussion of why these accounting entries are appropriate and necessary, from accounting theory and regulatory standpoints.
4. References to the appropriate accounting authority supporting your conclusions using the FASB's ASC suggested reference notation that can be found in the ASC Notice to Constituents, to the section level.

Item 1

GMC has outstanding $500,000 of bonds that GMC issued 19 years ago and that mature on December 31, 2010.

GMC's has two questions regarding this issue.

First, how should the outstanding bonds be reported on the December 31, 2009 balance sheet?

Second, GMC is currently working with their banks to arrange a secured long-term loan in the amount of the bond issue which will used to redeem the bonds. The loan, if completed, will be effective on December 31, 2010. Given GMC's excellent credit rating and the value of the collateral securing the loan, GMC's management is completely confident that the loan will be approved. Your firm's management has indicated to you that there is no doubt that GMC will receive the long-term loan to redeem the bonds. Since GMC will replace the bond liability with another long-term liability, GMC's management want to report the current bonds issue as a long-term liability. How may the outstanding bonds be reported as a long-term liability on the December 31, 2009 balance sheet with the appropriate disclosures?

Item 2

In July of 2009, a client of GMC's was touring GMC's factory when a part on a machine broke, injuring the client. At the time of the accident, the client was on a guided tour and was following all of GMC's instructions and did not, in any way, contribute to the cause of the accident. GMC's attorneys have concluded that it is very likely that GMC is financially responsible for the client's injuries and estimated that the total cost to GMC will be approximately $250,000 including medical expenses, lost wages, etc. Fortunately the client is expected to fully recover. GMC and the client's attorney are in negotiations and expect to reach a settlement soon. The client has not filed a lawsuit.

GMC would like your firm to prepare the necessary accounting entries and disclosures, if any are necessary, to record this potential liability as of December 31, 2009.

Item 3

GMC sells its products with a 3 year manufacturer's warranty. History has shown that the costs of satisfying warranty claims totals approximately 6% of the selling price of the product and that 50% of the claims occur in the first year after the sale, 30% in the second year after the sale, and 20% in the third year after the sale. GMC's revenues from the sale of its products have been $20 million in 2007; $24 million in 2008; and $27 million in 2009.

GMC would like your firm to prepare the necessary accounting entries and disclosures, if any are necessary, to record the potential liability for warranty expenses as of December 31, 2009.

Item 4

GMC has developed a new product, the X-42 hyper accelerator. It is a bolt-on aftermarket product for automobiles that add 50% to the existing acceleration rate and will be marketed to hot rod owners beginning in January 2010.

Extensive testing and analysis, along with extensive consultation with GMC's attorneys indicate that this product will lead to some product liability claims from injuries sustained due to inexperience of drivers using this product. GMC's attorneys not are confident that GMC can successfully defend all law suits arising from the use of this product. However, because of the warning notices on the product, it is probable that GMC will incur only $500,000 per year in costs arising from product liability claims related to this product. Because of the high profit margin on this product, GMC plans to go ahead with its marketing plans for the X-42.

GMC would like your firm to prepare the necessary accounting entries and disclosures, if any are necessary, to record the potential liability for product liability as of December 31, 2009.

Item 5

One of GMC's factories is in a Federal flood zone, although it has not actually flooded in more than 10 years. The flood plain indicates that there is a probability of a major flood every 25 years. GMC has taken precautions to minimize any impact of a flood, such as building up the ground level before construction of the factory, locating sensitive equipment on higher floors, investing in barriers and pumps to keep flood water out, etc. However, management estimates that it is probable that GMC will incur $200,000 in expenses in the event of a major flood.

GMC would like your firm to prepare the necessary accounting entries and disclosures, if any are necessary, to record the potential costs of a major flood on the December 31, 2009 balance sheet.

Item 6

On one of its properties, GMC has discovered toxic materials that were apparently deposited there by a former owner. GMC has determined that the former owner responsible has died leaving no assets.

The requirements of federal law require that GMC remove the toxic materials and restore the land to a non-toxic state.

GMC is currently conducting analysis of the scope of the work necessary and has obtained 3 estimates from chemical engineering firms that are qualified to clean up toxic waste. The estimates, which are not binding estimates, are $200,000; $2,000,000; and $20,000,000. The engineering firms indicate that, until they actually begin excavation, it is not possible to determine the full extent of the work necessary.

GMC would like your firm to prepare the necessary accounting entries and disclosures, if any are necessary, to record the potential costs of the toxic materials cleanup.

Item 7

GMC has filed a patent infringement lawsuit against a competitor, requesting $10,000,000 in damages. GMC's attorneys have concluded that it is probable that GMC will win the suit and collect the full $10,000,000 in 2010. GMC's management want to record the $10,000,000 in 2009 because GMC has suffered from the infringement which reduced its revenues in 2009. Since they are confident that they will win the suit, they maintain that proper matching of revenues with expenses require that they record the $10,000,000 gain in 2009 to offset the $10,000,000 in damages already incurred.

GMC would like your firm to prepare the necessary accounting entries and disclosures, if any are necessary, to record the potential gain from this lawsuit.