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Loss Contingencies

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During an audit engagement, Harper CPA has satisfactorily completed an examination of accounts payable and other liabilities and now plans to determine whether there are any loss contingencies arising from litigation, claims, or assessments

What audit procedures should Harper follow with respect to the existence of loss contingencies arising from litigation, claims, and assessments: do not discuss reporting requirements.

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Hello Student,

For this problem, the first thing you need to take note of is what is a contingency or a contingent liability or loss. It is one of the requirements of auditors during an engagement to ascertain whether there are any loss contingencies arising from litigation, claims and assessments. This is important since the auditor needs to see to it that management makes the relevant adjustments to the financial statements or make the relevant disclosures, depending on the level uncertainty that exists with claims. It is also done so as to help them (auditors) in forming an opinion as to the fairness of the financial statements.

According to FASB Statement No.5 Accounting for Contingencies, a contingency is defined as "an existing condition, situation, or set of circumstances involving uncertainty as to possible gain (gain contingency) or loss (loss contingency) to an enterprise that will ...

Solution Summary

This solution provides information related to the requisite audit procedures a company should follow with respect to the existence of loss contingencies arising from litigation, claims, and assessments.

See Also This Related BrainMass Solution

Partial Balance Sheet, Ratios and Loss Contingency

See attached file for Problem 10.7.

The following items were taken from accounting records of Minnesota Satellite telephone corporation (MinnSat) for the year ended December 31, 2009 (dollar amounts are in thousands):


Accounts payable $65,600
Accrued expenses payable (other than interest) 11,347
6 3/4% Bonds payable, due February 1, 2010 100,000
8 1/2% Bonds payable, due June 1, 2010 250,000
Discount on bonds payable (8 1/2% bonds of 2010) 260
11% Bonds payable, due June 1, 2019 300,000
Premium on bonds payable (11% bonds of 2017) 1,700
Accrued interest payable 7,333
Bond interest payable 61,000
Other interest payable 17,000
Notes payable (short-term) 110,000
Lease payment obligations-capital leases 23,600
Pension obligation 410,000
Unfunded obligation-postretirement benefits 72,000
other than pensions
Deferred income taxes 130,000
Income taxes expense 66,900
Income taxes payable 17,300
Operating income 280,800
Net income 134,700
Total assets 2,093,500

Additional information:
1. Refinance of 6 3/4% bonds accomplished through issuance of
9% 20 year general debentures $150,000
2. Bonds due 6/1/08 will be repaid from bond sinking fund
3. Total lease payments due in 2010 14,400
Portion applicable to operating leases 7,479
Portion applicable to capital leases 6,921
Interest expense portion of capital lease payments 2,300
Capital lease payment reduction portion of 4,621
capital lease payments
4. Pension plan is fully funded with independent trustee
5. Portion of retired worker health insurance obligation 18,000
to be funded during 2010
6. 2009 income taxes payable must be paid 3/15/10 17,300

Other information

1. The 6¾% percent bonds due in February 2010 will be refinanced in January 2010 through the issuance of $150,000 in 9 percent, 20-year bonds payable.

2. The 8½% percent bonds due June 1, 2010, will be repaid entirely from a bond sinking fund.

3. MinnSat is committed to total lease payments of $14,000 in 2010. Of this amount, $7,479 is applicable to operating leases, and $6,921 to capital lease. Payments on capital leases will be applied as follows: $2,300 to interest expense and $4,621 to reduction in the capitalized lease payment obligation.

4. MinnSat's pension plan is fully funded with an independent trustee.

5. The obligation for the postretirement benefits other than pensions consists of a commitment to maintain health insurance for retired workers. During 2010, MinnSat will fund $18,000 of this obligation.

6. The $17,300 in income tax payable relates to income taxes levied in 2009 and must be paid on or before March 15, 2010. No portion of the deferred tax liability is regarded as a current liability.


a. Using this information, prepare the current liabilities and long term liabilities sections of a classified balance sheet as of December 31, 2009. (Within each classification, items may be listed in any order.)

b. Explain briefly how the information in each of the six numbered paragraphs affected your presentation of the company's liabilities.

c. Compute as of December 31, 2009, the company's (1) debt ratio and (2) interest coverage ratio.

d. Solely on the basis of information state in this problem, indicate whether this company appears to be an outstanding, medium, or poor long term credit risk. State specific reasons for your conclusion.

Total liabilities (part a) = $1,088,620

10.7 Excel File attachment below


Case 10.3

Discuss each of the following situations, indicating whether the situation is a loss contingency that should be recorded or disclosed in the financial statements of Aztec Airlines. If the situation is not a loss contingency, explain how (if at all) it should be reported in the company's financial statements (Assume that all dollar amounts are material.)

a. 1. Aztec estimates that $700,000 of its accounts receivables will prove to be uncollectable.

2. The company's president is in poor health and has previously suffered two heart attacks.

3. As with any airline, Aztec faces the risk that a future airplane crash could cause considerable loss.

4. Aztec is being sued for $10 million for failing to adequately provide for passengers whose reservations were canceled as a result of the airline overbooking certain flights. This suit will not be resolved for a year or more.

B. Make a general statement that summarizes management's ethical responsibility regarding reporting loss contingencies in financial statements.

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