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ALL Week Included
E13-13 (Contingencies) Presented below are three independent situations. Answer the question at the end of each situation.

1. During 2010, Maverick Inc. became involved in a tax dispute with the IRS. Maverick’s attorneys
have indicated that they believe it is probable that Maverick will lose this dispute. They
also believe that Maverick will have to pay the IRS between $800,000 and $1,400,000. After
the 2010 financial statements were issued, the case was settled with the IRS for $1,200,000.
What amount, if any, should be reported as a liability for this contingency as of December 31,

2. On October 1, 2010, Holmgren Chemical was identified as a potentially responsible party by the
Environmental Protection Agency. Holmgren’s management along with its counsel have concluded
that it is probable that Holmgren will be responsible for damages, and a reasonable estimate of
these damages is $6,000,000. Holmgren’s insurance policy of $9,000,000 has a deductible clause
of $500,000. How should Holmgren Chemical report this information in its financial statements at
December 31, 2010?

3. Shinobi Inc. had a manufacturing plant in Darfur, which was destroyed in the civil war. It is not
certain who will compensate Shinobi for this destruction, but Shinobi has been assured by governmental officials that it will receive a definite amount for this plant. The amount of the compensation will be less than the fair value of the plant, but more than its book value. How should the
contingency be reported in the financial statements of Shinobi Inc.?

P13-9 (Premium Entries and Financial Statement Presentation) Sycamore Candy Companyoffers a CD single as a premium for every five candy bar wrappers presented by customers together with $2.50. The candy bars are sold by the company to distributors for 30 cents each. The purchase price of each CD to the company is $2.25; in addition it costs 50 cents to mail each CD. The results of the premium plan for the years 2010 and 2011 are as follows. (All purchases and sales are for cash.)
2010 2011
CDs purchased 250,000 330,000
Candy bars sold 2,895,400 2,743,600
Wrappers redeemed 1,200,000 1,500,000
2010 wrappers expected to be redeemed in 2011 290,000
2011 wrappers expected to be redeemed in 2012 350,000

(a) Prepare the journal entries that should be made in 2010 and 2011 to record the transactions related
to the premium plan of the Sycamore Candy Company.
(b) Indicate the account names, amounts, and classifications of the items related to the premium plan
that would appear on the balance sheet and the income statement at the end of 2010 and 2011.

*E14-21 (Term Modification without Gain—Debtor’s Entries) On December 31, 2010, theAmerican Bank enters into a debt restructuring agreement with Barkley Company, which is now experiencing financial trouble. The bank agrees to restructure a 12%, issued at par, $3,000,000 note receivable by the following modifications:

1. Reducing the principal obligation from $3,000,000 to $2,400,000.
2. Extending the maturity date from December 31, 2010, to January 1, 2014.
3. Reducing the interest rate from 12% to 10%.
Barkley pays interest at the end of each year. On January 1, 2014, Barkley Company pays $2,400,000 in cash to Firstar Bank.

(a) Will the gain recorded by Barkley be equal to the loss recorded by American Bank under the debt
(b) Can Barkley Company record a gain under the term modification mentioned above? Explain.
(c) Assuming that the interest rate Barkley should use to compute interest expense in future periods
is 1.4276%, prepare the interest payment schedule of the note for Barkley Company after the debt
(d) Prepare the interest payment entry for Barkley Company on December 31, 2012.
(e) What entry should Barkley make on January 1, 2014?


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